SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2006
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-26371
EASYLINK SERVICES CORPORATION
(Exact Name of Registrant as Specified in Charter)
Delaware 13-3787073
(State or other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
33 Knightsbridge Road, Piscataway, NJ 08854
(Address of Principal Executive Office) (Zip Code)
(732) 652-3500
(Registrant's Telephone Number Including Area Code)
Indicate by check whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X | No | |
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer.
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
Common stock outstanding at April 25, 2006: Class A common stock $0.01 par value
54,342,436 shares.
EASYLINK SERVICES CORPORATION
MARCH 31, 2006
FORM 10-Q
INDEX
Page
Number
PART I: FINANCIAL INFORMATION
Item 1: Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets as of March 31,
2006 (unaudited) and December 31, 2005..............................................3
Unaudited Condensed Consolidated Statements of Operations for the
three months ended March 31, 2006 and 2005..........................................4
Unaudited Condensed Consolidated Statements of Cash Flows for the
three months ended March 31, 2006 and 2005..........................................5
Notes to Unaudited Interim Condensed Consolidated Financial
Statements..........................................................................6
Item 2: Management's Discussion and Analysis of Financial Condition and
Results of Operations..............................................................14
Item 3: Quantitative and Qualitative Disclosure about Market Risk..........................17
Item 4: Controls and Procedures............................................................17
PART II: OTHER INFORMATION
Item 1: Legal Proceedings..................................................................19
Item 1A: Risk Factors.......................................................................19
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds........................31
Item 3: Defaults Upon Senior Securities....................................................31
Item 4: Submission of Matters to a Vote of Security Holders................................31
Item 5: Other Information..................................................................31
Item 6: Exhibits...........................................................................32
Signatures....................................................................................33
2
EasyLink Services Corporation
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
Mar 31, Dec 31,
2006 2005
------- --------
Unaudited)
ASSETS
Current assets:
Cash and cash equivalents.................................................. $4,090 $6,282
Accounts receivable, net of allowance for doubtful accounts of $2,161 and
$2,330 as of March 31, 2006 and December 31, 2005, respectively............ 11,428 11,416
Prepaid expenses and other current assets.................................. 2,551 2,653
-------- --------
Total current assets....................................................... 18,069 20,351
Property and equipment, net................................................ 9,971 10,252
Goodwill, net.............................................................. 6,213 6,213
Other intangible assets, net............................................... 5,862 6,264
Other assets............................................................... 890 895
-------- --------
Total assets............................................................... $41,005 $43,975
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable........................................................... $7,232 $6,464
Accrued expenses........................................................... 8,799 10,432
Loans and notes payable.................................................... 9,000 10,550
Other current liabilities.................................................. 1,369 1,467
Net liabilities of discontinued operations................................. 928 928
-------- -------
Total current liabilities.................................................. 27,328 29,841
Other long term liabilities................................................ 1,668 1,753
-------- ---------
Total liabilities.......................................................... 28,996 31,594
-------- --------
Stockholders' equity:
Common stock:
Class A--500,000,000 shares authorized at March 31, 2006 and December 31,
2005, 45,375,789 and 45,225,130 shares issued and outstanding at
March 31, 2006 and December 31, 2005, respectively......................... 454 452
Additional paid-in capital................................................. 554,483 554,337
Accumulated other comprehensive loss....................................... (814) (670)
Accumulated deficit........................................................ (542,114) (541,738)
-------- ---------
Total stockholders' equity................................................. 12,009 12,381
-------- ------
Commitments and contingencies
Total liabilities and stockholders' equity................................. $41,005 $43,975
======= =======
See accompanying notes to unaudited condensed consolidated
financial statements.
3
EasyLink Services Corporation
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
Three Months Ended March 31,
2006 2005
---- ----
Revenues................................................................... $18,461 $20,378
Cost of revenues........................................................... 7,463 7,769
-------- ------
Gross profit............................................................... 10,998 12,609
-------- ------
Operating expenses:
Sales and marketing........................................................ 4,555 5,129
General and administrative................................................. 4,767 5,600
Product development........................................................ 1,747 1,700
Separation agreement costs................................................. --- 2,312
Amortization of intangible assets.......................................... 359 517
-------- -------
11,428 15,258
-------- -------
Loss from operations....................................................... (430) (2,649)
--------- -------
Other income (expense), net:
Interest income............................................................ 47 25
Interest expense........................................................... (405) (323)
Other, net................................................................. 63 21
-------- -----
Total other income (expense), net.......................................... (295) (277)
-------- -----
Loss before income taxes................................................... (725) (2,926)
Credit for income taxes.................................................... (349) (185)
-------- ---------
Net loss................................................................... $ (376) $(2,741)
======== ========
Basic and diluted net loss per share....................................... $(0.01) $(0.06)
======== ========
Basic and diluted weighted-average shares outstanding...................... 45,303,218 44,240,317
========== ==========
See accompanying notes to unaudited condensed consolidated
financial statements.
4
EasyLink Services Corporation
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Three Months Ended March 31,
2006 2005
---- ----
Cash flows from operating activities:
Net loss $ (376) $ (2,741)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation 727 948
Amortization 402 592
Issuance of shares as matching contributions to employee
benefit plans 108 123
Separation agreement costs --- 2,312
Other 26 136
Changes in operating assets and liabilities:
Accounts receivable, net (10) (765)
Prepaid expenses and other current assets 92 586
Accounts payable, accrued expenses and other liabilities (1,035) (2,555)
--------- ---------
Net cash used in operating activities (66) (1,364)
--------- ---------
Cash flows from investing activities:
Purchases of property and equipment, including capitalized software (395) (1,675)
----- ---------
Net cash used in investing activities (395) (1,675)
----- ---------
Cash flows from financing activities:
Proceeds of bank loan advances --- 950
Payments of bank loan advances (950) ---
Principal payments of notes payable (600) (2,025)
Other (4) (56)
--------- ---------
Net cash used in financing activities (1,554) (1,131)
--------- ---------
Effect of foreign exchange rate changes
on cash and cash equivalents (177) 26
---------- ---------
Net decrease in cash and cash equivalents (2,192) (4,144)
Cash and cash equivalents at beginning of the period 6,282 12,216
--------- ---------
Cash and cash equivalents at the end of the period $4,090 $8,072
======== ========
Supplemental disclosure of cash flow information:
Cash paid for interest $ 396 $ 281
Cash paid for taxes $ 189 $ 134
Purchase of property, plant and equipment through
capital lease obligations $ --- $ 91
5
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
(a) Summary of Operations
The Company offers a broad range of information exchange services to businesses
and service providers, including Transaction Management Services consisting of
integrated desktop messaging services and document capture and management
services such as fax to database, fax to data and data conversion services; and
Transaction Delivery Services consisting of electronic data interchange or
"EDI," and production messaging services utilizing email, fax and telex.
The Company operates in a single industry segment, business communication
services. Although the Company provides various major service offerings, many
customers employ multiple services using the same access and network facilities.
Similarly, network operations and customer support services are provided across
various services. Accordingly, allocation of expenses and reporting of operating
results by individual services would be impractical and arbitrary. Services are
provided in the United States and certain other regions in the world
(predominantly in the United Kingdom).
(b) Unaudited Interim Condensed Consolidated Financial Information
The accompanying interim condensed consolidated financial statements as of March
31, 2006 and for the three months ended March 31, 2006 and 2005 have been
prepared by the Company and are unaudited. In the opinion of management, the
unaudited interim condensed consolidated financial statements have been prepared
on the same basis as the annual consolidated financial statements and reflect
all adjustments, which include only normal recurring adjustments, necessary to
present fairly the consolidated financial position of EasyLink Services as of
March 31, 2006 and the consolidated results of operations and consolidated cash
flows for the three months ended March 31, 2006 and 2005. The results of
operations for any interim period are not necessarily indicative of the results
of operations for any other future interim period or for a full fiscal year. The
condensed consolidated balance sheet at December 31, 2005 has been derived from
audited consolidated financial statements at that date.
Certain information and note disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to the Securities and Exchange
Commission's rules and regulations. It is suggested that these unaudited interim
condensed consolidated financial statements be read in conjunction with the
Company's audited consolidated financial statements and notes thereto for the
year ended December 31, 2005 as included in the Company's Form 10-K filed with
the Securities and Exchange Commission on March 31, 2006 (the "2005 10-K").
(c) Liquidity, Going Concern and Management's Plan
For each of the years ended December 31, 2005 and 2004, the Company received
reports from its independent registered public accounting firms containing an
explanatory paragraph stating that the Company has a working capital deficiency,
an accumulated deficit and declining revenues that raise substantial doubt about
the Company's ability to continue as a going concern. The unaudited condensed
consolidated financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or the amounts and
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern. Management's plan in regards to these
matters is described in Note 1(B) to the Company's consolidated financial
statements for the year ended December 31, 2005 as included in the Company's
2005 10-K. Management believes the Company's ability to continue as a going
concern is dependent upon its ability to generate sufficient cash flow to meet
its obligations on a timely basis, to obtain additional financing or refinancing
as may be required and ultimately to achieve continued profitable operations. In
April 2006, the Company raised $5.4 million from the sale of approximately 9
million shares of its Class A common stock. $3 million of the proceeds were
used to make a required prepayment on the Company's outstanding debt and the
balance of $2.4 million will be used for working capital purposes.
6
(d) Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of the Company and
its wholly-owned or majority-owned subsidiaries from the dates of acquisition.
All significant intercompany accounts and transactions have been eliminated in
consolidation.
The net liabilities of WORLD.com, a wholly owned subsidiary, and its majority
owned subsidiaries, are reported as discontinued operations in the consolidated
balance sheets as of March 31, 2006 and December 31, 2005 as a result of the
sale and discontinuance of the operations of this business in 2001.
(e) Use of Estimates
The preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities and the
reported amounts of revenues and expenses. These estimates and assumptions
relate to the estimates of collectibility of accounts receivable, the
realization of goodwill and other intangibles, accruals and other factors.
Actual results could differ from those estimates.
(f) Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable represent trade receivables billed to customers in arrears
on a monthly basis. Receivables are recorded in the period the related revenues
are earned and, generally, are collected within a short time period. The Company
does not require collateral from its customers and any balances over 30 days old
are considered past due.
The allowance for doubtful accounts is based upon the Company's assessment of
the collectibility of customer accounts receivable. The Company regularly
reviews the allowance by considering factors such as historical experience,
credit quality, the age of accounts receivable balances and current economic
conditions that may affect a customer's ability to pay.
(g) Financial Instruments and Concentration of Credit Risk
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist of cash and cash equivalents, accounts
receivable and notes payable. At March 31, 2006 and December 31, 2005, the fair
value of cash and cash equivalents and accounts receivable approximated their
financial statement carrying amount because of the short-term maturity of these
instruments. The recorded values of loans and notes payable approximate their
fair values as interest approximates market rates.
Credit is extended to customers based on the evaluation of their financial
condition and collateral is not required. The Company performs ongoing credit
assessments of its customers and maintains an allowance for doubtful accounts.
No single customer exceeded 10% of total revenues for the three months ended
March 31, 2006 and 2005 and no accounts receivable from a single customer
exceeded 10% of total accounts receivable as of March 31, 2006 and December 31,
2005. Revenues from the Company's five largest customers amounted to $2.1
million and $2.3 million for the three months ended March 31, 2006 and 2005,
respectively and accounted for an aggregate of 11% of the Company's total
revenues for both periods.
(h) Stock-Based Compensation Plans
In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS
123 (revised 2004), "Share-Based Payment" (SFAS 123(R)) which replaces SFAS 123,
"Accounting for Stock-Based Compensation," and supersedes APB Opinion No. 25,
"Accounting for Stock Issued to Employees. Among other items, SFAS 123(R)
eliminates the use of APB 25 and the intrinsic method of accounting, and
requires all share-based payments, including grants of employee stock options,
to be recognized in the financial statements based on their fair values. SFAS
123(R) is effective for public companies beginning with the first annual period
that begins after June 15, 2005. In December, 2005 the Company accelerated the
vesting of all current employee options with an exercise price in excess of
$0.92 per share to avoid the recording of expense related to those options in
2006 when the Company adopted FAS123R and periods thereafter. The Company
adopted SFAS 123(R) in the first quarter of 2006 and in accordance with its
provisions recognized compensation expense amounting to approximately $162,000
for all share-based payments, including employee stock options based on the
grant-date fair value of those awards, for the three months ended March 31,
2006.
7
Executive incentive compensation plan
The Company adopted an executive incentive compensation plan for 2006 that
provides for the payment of bonuses through the issuance of up to 800,000 shares
of its Class A common stock reserved for issuance under the Company's 2005 Stock
and Incentive Plan to executives and director level employees based on the
achievement of certain Company performance criteria for the year. If the
incentive compensation awards calculated in accordance with the plan exceed the
market value of the 800,000 shares of stock at the distribution date,
anticipated to be shortly after the end of the year, the Company may pay the
balance in cash within certain specified limitations. For the three months ended
March 31, 2006 the Company recorded $132,000 of expense as a liability under the
incentive compensation plan based on the Company's performance against the plan
criteria for the period and based upon the market price of the stock as of that
date.
Stock option plans
The Company has adopted several stock option plans and assumed the plans of
entities it had acquired in prior periods. Under the Company's stock option
plans available for future awards including the 2005 Stock and Incentive Plan, a
total of 6,125,000 shares were originally reserved for awards and 1,362,000
shares are available for future awards as of March 31, 2006. Options granted
under the plans have exercise prices equal to fair market value of the Company's
stock at the time of grant and generally expire within 10 years. The Company
issues shares of its authorized but previously unissued Class A common stock
upon the exercise of any options. Compensation expense was recorded for the
Company's stock option plans in accordance with the modified prospective method
as per SFAS 123(R) and amounted to approximately $30,000 for the three months
ended March 31, 2006. If the fair-value-based method in accordance with SFAS
123(R) had been applied to all option grants outstanding as of March 31, 2006,
the effect on compensation expense would have been immaterial and there would
have been no effect on the resulting proforma basic and diluted net loss per
share. There was approximately $454,000 of total unrecognized compensation cost
related to nonvested options as of March 31, 2006 that will be recognized over
the next four years. All amounts specified as compensation expense are net of
the related tax effect, which amounted to zero as the Company records a full
valuation allowance against its net deferred tax assets. See note 5.
The fair value of option grants made in the three months ended March 31, 2006,
amounting to approximately $64,000, is estimated as of the date of grant using
the Black Scholes method option-pricing model with the following assumptions:
dividend yield of zero (0) percent, average risk-free interest rate of 3.9%,
expected term of 6 years and expected volatility of 104%.
A summary of the Company's stock option activity and weighted average exercise
prices during the three months ended March 31, 2006 is as follows:
Weighted Average
Options Exercise Price
Options outstanding at January 1, 2006 5,152,135 $3.42
Options granted 100,000 $0.78
Options canceled or expired (52,936) $54.48
---------- ----------
Options outstanding at March 31, 2006 5,199,199 $2.85
8
The following table summarizes information about stock options outstanding and
exercisable at March 31, 2006:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------- ---------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
------ ----------- ----------- --------- ----------- -------
$0.53 - 0.79....................... 556,400 7.8 $ .61 357,650 $ 0.53
$0.81 - 1.15....................... 1,515,614 7.2 $ .97 1,059,997 $ 1.00
$1.23 - 1.75....................... 2,021,050 7.5 $ 1.28 1,967,611 $ 1.28
$1.88 - 2.80....................... 562,721 5.4 $ 2.16 562,564 $ 2.16
$3.00 - 4.20....................... 41,203 5.5 $ 3.91 41,203 $ 3.91
$4.80 - 7.19....................... 30,980 1.9 $ 5.22 30,980 $ 5.22
$7.50 - 10.94...................... 18,665 1.6 $ 9.71 18,665 $ 9.71
$12.81 - 16.88..................... 377,966 4.0 $ 15.03 377,966 $ 15.03
$20.00 - 20.00..................... 8,182 1.8 $ 20.00 8,182 $ 20.00
$32.44 - 35.00..................... 42,638 1.9 $ 34.99 42,638 $ 34.99
$50.00 - 64.10..................... 22,359 3.0 $ 50.27 22,359 $ 50.27
$118.60-175.00..................... 1,421 3.9 $ 167.35 1,421 $ 167.35
----------------------------------- --------- --- - ------- ---------- ------
5,199,199 6.8 $ 2.85 4,491,236 $ 3.16
========= === ============ ========= ============
The Company had previously adopted the disclosure provisions of SFAS No. 148 as
of December 31, 2002 and continued to apply the measurement provisions of APB
25. Under APB Opinion No. 25, compensation expense was recognized based upon the
difference, if any, at the measurement date between the market value of the
stock and the option exercise price. The measurement date is the date at which
both the number of options and the exercise price for each option are known. The
following table illustrates the effect on net loss and net loss per share for
the three months ended March 31, 2005 if the Company had applied the fair value
recognition provisions of SFAS No. 123 to stock-based employee compensation. The
fair value of each option grant was estimated using the Black Scholes method
option pricing model with the following assumptions for grants made in 2005:
dividend yield of zero (0) percent, average risk-free interest rate of 3.9%,
expected life of 5 years and volatility of 119%.
($ in thousands, except per share amounts)
Net loss:
Net loss, as reported.................................. $(2,741)
Deduct: total stock based employee compensation
determined under the fair value method for all
awards, net of tax..................................... (150)
-----
Pro forma net loss..................................... $(2,891)
========
Basic and diluted net loss per share:
Net loss per share, as reported........................ $(0.07)
Deduct: total stock based employee compensation
determined under the fair value method for all
awards, net of tax..................................... (0.00)
-----
Pro forma net loss per share........................... $(0.07)
=======
(i) Basic and Diluted Net Income (Loss) Per Share
9
Net income (loss) per share is presented in accordance with the provisions of
SFAS No. 128, "Earnings Per Share", and the Securities and Exchange Commission
Staff Accounting Bulletin No. 98. Under SFAS No. 128, basic Earnings per Share
("EPS") excludes dilution for common stock equivalents and is computed by
dividing income or loss available to common shareholders by the weighted average
number of common shares outstanding for the period. Diluted EPS reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock and resulted in the
issuance of common stock. Diluted net loss per share for the three months ended
March 31, 2006 and 2005 exclude the effects of employee options to purchase
5,199,199 and 4,828,474 shares of common stock, respectively and 798,523 common
stock warrants in each period, as their inclusion would be antidilutive.
(2) RESTATEMENT OF 2005 FINANCIAL STATEMENTS
The Company restated its previously issued financial statements for the quarter
ended March 31, 2005. The Company's determination to restate these previously
issued financial statements and the impact of the restatement on the statement
of operations for the three months ended March 31, 2005 included the following
items:
1 The liability for telecommunications services costs of the Company's
United Kingdom subsidiary was overstated. The Company revised its
methodology to more accurately estimate its liability resulting in a
decrease in the estimated liability of $548,000 as of March 31, 2005
and an increase in related cost of service of $55,000 for the three
months ended March 31, 2005.
2. The Company had recorded accruals for certain assessed Federal
regulatory fees in prior years although the amount of such assessment
was disputed by the Company. Based upon revised assessments received by
the Company in the 4th quarter of 2004 and the first quarter of 2005,
the amounts of such accruals were in excess of the revised assessment.
However, the Company did not timely adjust the recorded liability for
this change in circumstances. The amount of the accrual no longer
required and adjusted for in the restatement is $314,000 as of March
31, 2005 and the related decrease in expenses for the three months then
ended is $18,000.
3. The Company evaluated its liability in connection with a New York State
sales tax audit of one of its operating subsidiaries for 2001 through
2004 and determined that the estimated liability for these taxes should
be increased by $102,000 as of March 31, 2005 including $12,000 of
related expenses recorded in the three months ended March 31, 2005.
4. The Company had recorded the cost of a separation agreement with its
former President of the international division at face value. Since
$1.9 million of the cost is payable over three years, the cost should
have been recorded at its present value. The restatement includes the
reduction in the separation agreement cost of $163,000 and $17,000 of
imputed interest expense for the three months ended March 31, 2005.
5. The Company incorrectly calculated the net operating loss carry
forwards of its United Kingdom subsidiaries as of December 31, 2004
resulting in the under-accrual of foreign income taxes of $555,000 as
of March 31, 2005 including $260,000 of related income tax expense for
the three months ended March 31, 2005.
6. The restatement also includes the recording of adjustments in prior
periods that were not previously recorded because, in each case and in
the aggregate, the amount of these errors was not material to the
Company's consolidated financial statements.
10
The following schedules show the impact of the restatement on the relevant
captions from the Company's condensed consolidated financial statements;
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2005
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
AS PREVIOUSLY AS
REPORTED RESTATED
-------- --------
Revenues.................................... $ 20,378 $ 20,378
Cost of revenues............................ 7,714 7,769
--------- ---------
Gross profit................................ 12,664 12,609
--------- ---------
Operating Expenses:
Sales and marketing......................... 5,129 5,129
General and administrative.................. 5,650 5,600
Product development......................... 1,700 1,700
Separation agreement costs.................. 2,475 2,312
Amortization of intangible assets........... 517 517
--------- ---------
15,471 15,258
Loss from operations........................ (2,807) (2,649)
--------- ---------
Other income (expense), net:
Interest income............................. 202 25
Interest expense............................ (306) (323)
Other, net.................................. (44) 21
--------- ---------
Total other income (expense), net........... (148) (277)
--------- ---------
Loss before income taxes.................... (2,955) (2,926)
Credit for income taxes..................... (450) (185)
Net loss.................................... $ (2,505) $ (2,741)
========== ==========
Basic and diluted net loss per share........ $ (0.06) $ (0.06)
========== ===========
11
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2005
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
AS PREVIOUSLY AS
REPORTED RESTATED
------------ ---------
Net cash used in operating activities....... $ (1,314) $ (1,364)
------------ ------------
Net cash used in investing activities....... (1,732) (1,675)
------------ ------------
Net cash used in financing activities....... (1,100) (1,131)
------------ ------------
Effect of foreign exchange rate changes
On cash and cash equivalents............. (82) 26
------------ ------------
Net decrease in cash and cash equivalents... (4,228) (4,144)
------------ ------------
(3) LOANS AND NOTES PAYABLE
Loans and notes payable include the following, in thousands:
Mar 31, 2006 Dec 31, 2005
------------ ------------
Term loan payable $9,000 $9,600
Advances ---- 950
--------- --------
Total loans and notes payable $9,000 $10,550
========= =======
The Term loan payable is part of a $15 million credit facility with Wells Fargo
Foothill, Inc. (a subsidiary of Wells Fargo Bank). The Term loan is payable
monthly over 60 months with interest payable monthly at the rate of 3.75% over
the Wells Fargo prime rate, which was 7.75% as of March 31, 2006. As part of the
original credit facility the Company can also draw down capital advances up to
$7.5 million based on certain circumstances and within certain specified
limitations. The credit facility includes certain affirmative and restrictive
covenants, including maintenance of quarterly levels of EBITDA.
On February 27, 2006 the Company entered into an amendment to the Credit
Agreement establishing revised cumulative monthly EBITDA covenants but
eliminating the Company's ability to draw down any future Advances and also
requiring the Company to pay the outstanding Advances balance of $950,000. The
amendment also requires the Company to obtain at least $4.0 million in new
subordinated debt or equity financing and to prepay $3.0 million of the Term
Loan, both by May 1, 2006. The Company repaid the $950,000 in Advances in
February 2006. In April, 2006, the Company completed an equity financing with
certain existing shareholders and management for the sale of approximately 9
million shares of Class A common stock for $5.4 million and made the required $3
million prepayment on the Term Loan. Contemporaneous with the prepayment, the
Company and Wells Fargo Foothill entered into another amendment to the Credit
Agreement providing for adjustment of the EBITDA covenant in 2006 and 2007 by
permitting certain additional spending by the Company in the aggregate amount of
$1.4 million under certain conditions. However, since the Company's ability to
meet the original and revised EBITDA covenants was uncertain as of March 31,
2006, the total outstanding obligations under the credit agreement have been
included in current liabilities in the consolidated balance sheets as of March
31, 2006 and December 31, 2005.
12
(4) SEPARATION AGREEMENT
In January 2005, the Company entered into a Separation Agreement with George Abi
Zeid, its former President of the International division, wherein Mr. Abi Zeid
resigned as an officer and director of the Company. Under the agreement, the
Company agreed to pay Mr. Abi Zeid $240,000 as a severance payment on the
effective date of his resignation and $1,960,000 in equal installments over
three years in consideration of the non-compete and other covenants contained in
the agreement. In connection with the agreement, the Company also agreed to pay
$200,000 of severance payments to two other former employees of the Company. As
of March 31, 2006 and December 31, 2005, $583,000 and $565,000, respectively,
related to the agreement are included in accrued expenses and $539,000 and
$672,000, respectively, are included in other long term liabilities.
(5) INCOME TAXES
The Company has recorded its provision (credit) for income taxes in the three
months ended March 31, 2006 and 2005 using the actual effective tax rates. The
Company has determined that this method yields a more reliable estimated tax
provision (credit) due to the inclusion of a full valuation allowance on the
Company's net deferred tax assets in the current and prior periods. Accordingly,
the Company is not in a position to project an annual effective tax rate for the
year ended December 31, 2006 but will update the actual 2006 quarterly effective
tax rate in subsequent reporting periods. For the three months ended March 31,
2006 and 2005, the Company calculated its actual effective tax rate to be 48%
and 6%, respectively. The effective rates for 2006 and 2005 vary from the
standard tax rates primarily due to the utilization of available net operating
losses for income tax purposes which were previously subject to a valuation
allowance.
(6) COMMITMENTS AND CONTINGENCIES
Master Carrier Agreement
In July 2005, the Company entered into a new Master Carrier Agreement (the "2005
MCA") with AT&T for the purchase of all data, internet and switched services
superceding a similar previous agreement. Under the 2005 MCA the Company has a
minimum purchase commitment of $5 million over the two year term of the
agreement. The 2005 MCA also contains the same termination charge of 50% of the
unsatisfied minimum purchase commitment that was included in the original
agreement.
Other Telecommunication Services
The Company has committed to purchase from Verizon Business (formerly MCI
Worldcom) a minimum of $900,000 per year in other telecommunication services
through March 2007.
Legal Proceedings
As previously announced, the Second Circuit Court of Appeals vacated the
judgment previously entered against the Company in the amount of $931,000 in the
broker litigation and remanded the case to the District Court for one further
finding. Upon consideration of the issue remanded, on April 18, 2006, the
District Court of the Southern District of New York issued a decision to enter
judgment in favor of the Company, which was entered on April 26, 2006. On or
about May 9, 2006, the broker filed a motion to amend judgment and/or order a
new trial.
(7) STOCKHOLDERS' EQUITY
COMMON STOCK
During the three months ended March 31, 2006, the company issued 136,346 shares
of Class A common stock valued at approximately $108,000 in connection with
matching contributions to its 401K plan.
13
COMPREHENSIVE LOSS
Comprehensive income (loss) for the three months ended March 31, 2006 and 2005
was as follows:
($ in thousands)
2006 2005
----- ------
Net loss $(376) $(2,741)
Foreign currency translation (144) 25
Unrealized holding gains (losses) on marketable securities --- (133)
------- -------
Comprehensive loss $ (520) $(2,849)
======= ========
(8) SUBSEQUENT EVENTS/RELATED PARTIES
In April 2006, the Company completed an equity financing with certain existing
shareholders and management for the sale of approximately 9 million shares of
Class A common stock for $5.4 million and made a required $3 million prepayment
on its Term Loan payable to Wells Fargo. See Note 3.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion and analysis of the financial condition and results of
operations should be read in conjunction with our consolidated financial
statements and the related notes included elsewhere in this quarterly report.
OVERVIEW
We are a provider of services that facilitate the electronic exchange of
information between enterprises, their trading communities and their customers.
On an average business day, we handle approximately one million transactions
that are integral to the movement of money, materials, products and people in
the global economy such as insurance claims, trade and travel confirmations,
purchase orders, invoices, shipping notices and funds transfers, among many
others. We offer a broad range of information exchange services to businesses
and service providers, including Transaction Management Services and Transaction
Delivery Services. Transaction Management Services consist of integrated desktop
messaging services and document capture and management services such as fax to
database, fax to data and data conversion services. Beginning in 2005, we also
began to offer as a Transaction Management Service an enhanced production
messaging service that we call EasyLink Production Messaging PM2.0 Service.
Transaction Delivery Services consist of electronic data interchange or "EDI,"
and basic production messaging services utilizing email, fax and telex. As part
of our strategy, we will seek to upgrade customers who are using our basic
production messaging service to our enhanced production messaging, EasyLink
Production Messaging PM2.0 Service.
OPERATING RESULTS
For the three months ended March 31, 2006, we reported an operating loss of $0.4
million and a net loss of $0.4 million. The operating loss and net loss for the
same period in 2005 were $2.6 million and $2.7 million, respectively. In
comparing the results for the three months ended March 31, 2006 to the three
months ended March 31, 2005, revenues were down by $1.9 million with a resulting
lower gross margin of $1.6 million. In the 2005 quarter we recorded $2.3 million
of costs related to the Separation Agreement with the former President of our
international division.
14
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements and related disclosures in conformity
with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, revenues and expenses and the disclosure of contingent
assets and liabilities. We believe that of our significant accounting policies,
those related to accounts receivable net of allowance for doubtful accounts,
long-lived assets and intangible assets and contingencies and litigation
represent the most critical estimates and assumptions that affect our financial
condition and results of operations as reported in our financial statements.
RESULTS OF OPERATIONS - THREE MONTHS ENDED MARCH 31, 2006 COMPARED TO THE THREE
MONTHS ENDED MARCH 31, 2005
REVENUES
For the quarter ended March 31, 2006 total revenues were $18.5 million in
comparison to $20.4 million for the same period in 2005. As detailed in the
schedule below the decline in revenue is attributable to (1) lower revenues in
our Transaction Delivery Services amounting to $2.8 million or a 17% decline
partially offset by increased revenues in our Transaction Management Services of
$0.9 million representing 24% growth over 2005.
Change
2006 2005 $ %
---- ---- - -
Transaction Management Services $ 4,602 $ 3,702 $ 900 24%
Transaction Delivery Services 13,859 16,676 (2,817) (17)%
------ ------ ------ ----
$18,461 $20,378 $(1,917) ( 9)%
Transaction Delivery Services have been continually impacted by pricing
pressures in the telecommunications market and by technological factors that
replace or reduce the deployment of such services by our customers. These
factors have led to lower volumes, negotiated individual customer price
reductions at the time of service contract renewals and the loss of certain
customers. Although we have focused efforts on stabilizing this revenue stream,
we believe the trend will continue throughout 2006. We will seek to expand our
newer Transaction Management Services and to upgrade customers who are using our
basic production messaging services to our enhanced production messaging
service, EasyLink Production Messaging PM2.0 Service, to offset the declines.
COST OF REVENUES
Cost of revenues for the three months ended March 31, 2006 decreased to $7.5
million from $7.8 million in the same period of 2005 but, as a percentage of
revenues, these costs increased to 40% in 2006 as compared to 38% in 2005. The
higher cost percentage resulted largely from additional costs incurred during
the current quarter as part of the migration of part of our operations network
to the Company's new data center at its headquarters location. Cost of revenues
are expected to remain at the current level until the migration is completed in
the later part of 2006.
Cost of revenues consists primarily of costs incurred in the delivery and
support of our services, including depreciation of equipment used in our
computer systems, software license costs, tele-housing costs, the cost of
telecommunications services including local access charges, leased network
backbone circuit costs, toll-free number and usage charges and long distance
domestic and international termination charges, and personnel costs associated
with our systems and databases.
SALES AND MARKETING EXPENSES
Sales and marketing expenses decreased to $4.6 million in the three months ended
March 31, 2006 from $5.1 million in the same period of 2005. The lower costs
mostly relate to our international operations where we made headcount reductions
as part of a reorganization of the division. In the United States, where our
focus is on expanding Transaction Management Services, spending has remained
comparable from period to period. We expect these expenses to continue at the
current level throughout 2006.
15
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were $4.8 million in the three months ended
March 31, 2006 as compared to $5.6 million in the same period of 2005. The lower
cost resulting from a lower headcount largely in our international operations as
the Company reorganized its international management group following the
separation of the President of the international division in February, 2005. We
anticipate general and administrative expenses in total for the balance of 2006
to be comparable to the results for the three months ended March 31, 2006. These
expenses include all costs for our executive, finance and accounting, customer
billing and support, human resources and other headquarters office functions.
Bad debt expenses, legal and accounting fees, insurance and office rent are
other significant costs included in this category.
PRODUCT DEVELOPMENT EXPENSES
Product development costs, which consist primarily of personnel and consultants'
time and expense to research, conceptualize, and test product launches and
enhancements to our products, were $1.7 million for the three months ended March
31, 2006 and 2005. We anticipate that spending for product development will be
comparable to this level throughout 2006 as a result of our efforts to expand
the development of the new Transaction Management services.
LIQUIDITY AND CAPITAL RESOURCES
Our cash and cash equivalent balances decreased by $2.2 million during the three
months ended March 31, 2006 and our working capital deficit was $9.2 million
partially due to the classification of our total debt outstanding to Wells Fargo
Foothill as a current liability as a result of the uncertainty as of March 31,
2006 of complying with certain loan covenants. As of March 31, 2006, $5.4
million of the loan balance was payable within one year and $3.6 million of the
loan balance represents the classification of the debt balance that is due after
one year in current liabilities. During the current quarter our cash used in
operations only amounted to $66,000 but we also spent $395,000 on capital
expenditures largely related to the continued build out of our new data center
and we paid $1.6 million in principal debt payments and advance repayments as
required by the amended Credit Agreement with Wells Fargo Foothill. Subsequent
to March 31, 2006, we completed an equity financing of $5.4 million for the sale
of approximately 9 million shares of our Class A common stock. $3 million of the
proceeds were used to prepay a portion of the outstanding Term Loan with Wells
Fargo Foothill as required by the amended Credit Agreement and $2.4 million will
be used for working capital purposes.
For each of the years ended December 31, 2005 and 2004, we received reports from
our independent registered public accounting firms containing an explanatory
paragraph stating that we have a working capital deficiency, an accumulated
deficit and declining revenues that raise substantial doubt about our ability to
continue as a going concern. Management's plans in regard to this matter are
described in Note 1(B) to our annual consolidated financial statements as
included in our 2005 10-K. Our condensed consolidated financial statements do
not include any adjustments relating to the recoverability and classification of
recorded asset amounts or the amounts and classification of liabilities that
might be necessary should we be unable to continue as a going concern. If the
Company's cash flow is not sufficient, we may need additional financing to meet
our debt service and other cash requirements. However, if we are unable to raise
additional financing, restructure or settle additional outstanding debt or
generate sufficient cash flow, we may be unable to continue as a going concern.
Management believes the Company's ability to continue as a going concern is
dependent upon its ability to generate sufficient cash flow to meet its
obligations on a timely basis, to obtain additional financing or refinancing as
may be required, and to maintain profitable operations.
16
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk from fluctuations in interest rates,
foreign exchange rates and credit risk. The Company maintains continuing
operations in Europe (mostly in England) and, to a lesser extent, in Singapore,
Malaysia, India and Brazil. Fluctuations in exchange rates may have an adverse
effect on the Company's results of operations and could also result in exchange
losses. The impact of future rate fluctuations cannot be predicted adequately.
To date, the Company has not sought to hedge the risks associated with
fluctuations in exchange rates.
Market Risk - Our accounts receivable are subject, in the normal course of
business, to collection risks. We regularly assess these risks and have
established policies and business practices to protect against the adverse
effects of collection risks. As a result, we do not anticipate any material
losses in excess of the allowance for doubtful accounts.
Interest Rate Risk - Interest rate risk refers to fluctuations in the value of a
security resulting from changes in the general level of interest rates.
Investments that are classified as cash and cash equivalents have original
maturities of three months or less. Changes in the market's interest rates do
not affect the value of these investments. In December 2004 we entered into a
variable interest rate credit agreement with Wells Fargo that creates an
interest rate risk for the Company on the $9 million balance of its Term Loan as
of march 31, 2006. The impact of this risk assuming the current amortization
schedule of the outstanding Term Loan and a hypothetical shift of 1% in interest
rates would be an increase or decrease, as applicable, in annual interest costs
of $52,000 related to this debt. The Company has considered the use of interest
rate swaps and similar transactions to minimize this risk but has not entered
into any such arrangements to date. The Company intends to continue to evaluate
this risk and the cost and possible implementation of such arrangements in the
future.
ITEM 4 CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures designed to ensure that
information required to be disclosed by the Company in the reports that it files
or submits under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Commission's rules and forms.
Disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e)
under the Exchange Act, include controls and procedures designed to ensure that
information required to be disclosed by the company in the reports we file or
submit under the Exchange Act is accumulated and communicated to our Company's
management, including our chief executive officer and chief financial officer,
as appropriate, to allow timely decisions regarding required disclosure. It
should be noted that any system of controls, however well designed and operated,
can provide only reasonable, and not absolute, assurance that the objectives of
the system are met.
As required by Securities and Exchange Commission rules, we have evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures as of the end of the period covered by this quarterly report. This
evaluation was carried out under the supervision and with the participation of
our management, including our principal executive officer and principal
financial officer. Based on this evaluation, these officers have concluded that,
in light of the material weaknesses described below and the status of the
Company's ongoing efforts to remediate such weaknesses, as of March 31, 2006,
the Company's disclosure controls and procedures were not effective.
Changes in Internal Control Over Financial Reporting
17
Since November 2005, we have been implementing the changes in our internal
control over financial reporting described below in this Item 4 to address
certain identified material weaknesses. As a result of the errors described in
Note 2 to the consolidated financial statements included in this report and that
underlie the restatement of our financial statements for the quarter ended March
31, 2005, the Company identified the following material weaknesses in its
internal control over financial reporting:
1. As of March 31, 2005, the Company did not have the appropriate level of
expertise to properly calculate and review its accounting for income
taxes in its foreign subsidiaries. Specifically, the Company estimated
its UK subsidiaries' UK income tax liability based on information
contained in its statutory reports. These reports incorrectly stated the
amount of net operating losses available to the UK subsidiaries as of
December 31, 2003. The Company did not have the appropriate control
procedures to determine the accuracy of the net operating loss
information contained in the statutory reports. This control deficiency
resulted in the restatement of the Company's consolidated financial
statements at December 31, 2004 and for the year then ended and at March
31, 2005 and for the three months then ended.
2. As of March 31, 2005, the Company did not maintain effective controls
over the accounting for and review of certain accounts because it did not
have adequate personnel with sufficient expertise and adequate review and
reconciliation procedures to correctly account for such transactions in
accordance with generally accepted accounting principles. These accounts
included certain accrued expense liabilities, fixed assets, accumulated
depreciation, currency translation gains and losses and related costs and
expenses. This control deficiency contributed to the restatement of the
Company's consolidated financial statements at December 31, 2004 and for
the year then ended and at March 31, 2005 and for the three months then
ended.
Remediation Measures for Identified Material Weaknesses
During November, 2005, we made the following changes in our internal control
over financial reporting to remediate the material weaknesses related to the
accounting for foreign income taxes, certain expense liabilities, currency
translation gains and losses, fixed assets, depreciation expense and cost of
revenues:
1. Hired additional accounting personnel in both our domestic and
international finance offices with the appropriate background and
certification.
2. Expanded the existing balance sheet review process by increasing the
accounts and items selected for a more detailed review.
3. Enhanced the levels of review for the quarterly and annual income
tax provision.
We are continuing to monitor and enhance these changes in order to insure that
our disclosure controls and procedures are effective in future periods.
18
PART II OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
As previously announced, the Second Circuit Court of Appeals vacated the
judgment previously entered against the Company in the amount of $931,000 in the
broker litigation and remanded the case to the District Court for one further
finding. Upon consideration of the issue remanded, on April 18, 2006, the
District Court of the Southern District of New York issued a decision to enter
judgment in favor of the Company, which was entered on April 26, 2006. On or
about May 9, 2006, the broker filed a motion to amend judgment and/or order a
new trial.
ITEM 1A: RISK FACTORS
WE HAVE INCURRED LOSSES FROM OPERATIONS IN PRIOR YEARS.
We incurred a net loss of $1.1 million and a loss from operations of $2.0
million in 2005. We achieved income from operations for a full fiscal year for
the first time in 2004. We had net income of $50.9 million for the year ended
December 31, 2003; however, the net income for 2003 included $54.1 million of
gains on debt restructuring and settlements. For years prior to 2003 and since
our inception in 1999 we incurred net losses in every year. As a result, we had
an accumulated deficit of $541.7 million as of December 31, 2005.
We have experienced declining revenues in each of the years ended December 31,
2005, 2004 and 2003 as compared to the prior year. See Part II, Item 7:
Management's Discussion and Analysis of Financial Condition and Results of
Operations of our Annual Report on Form 10-K and subsequent filings with the
SEC. If we do not succeed in maintaining or increasing our revenues, our losses
may continue.
IF OUR REVENUES DECLINE AND WE ARE UNABLE TO GENERATE SUFFICIENT CASH FLOW, WE
MAY BE UNABLE TO PAY DEBT SERVICE ON OUR INDEBTEDNESS OR COMPLY WITH APPLICABLE
COVENANTS.
As of April 30, 2006, we had outstanding indebtedness under our credit facility
of $5.8 million payable over the next 29 months; obligations under office space
leases; and commitments for telecommunications services. We currently have $2.4
million in principal payments and additional amounts in interest payments due
during the twelve month period after April 30, 2006. Our credit facility with
Wells Fargo requires us to maintain minimum specified levels of EBITDA and
prohibits us from incurring capital expenditures in excess of specified amounts.
The credit agreement also requires that we maintain a minimum cash balance of
$1.5 million in a specified account and at least $3.5 million of eligible
accounts receivable availability. See "Management's Discussion and Analysis -
Liquidity and Capital Resources" contained in our Annual Report on Form 10-K and
subsequent filings with the SEC.
If our revenues decline and we are not able to correspondingly reduce expenses,
we cannot assure you that we will be able to pay interest and other amounts due
on our outstanding indebtedness, or our other obligations, on the scheduled
dates or at all. If our cash flow and cash balances are inadequate to meet our
obligations, we could face substantial liquidity problems. If we are unable to
generate sufficient cash flow or otherwise obtain funds necessary to make
required payments, or if we otherwise fail to comply with any covenants in our
credit agreement such as the EBITDA, minimum cash balance, eligible accounts
receivable availability or capital expenditures covenants, we would be in
default under these obligations, which would permit our lender to accelerate the
maturity of the obligations.
Any such default could have a material adverse effect on our business, results
of operations and financial condition. We cannot assure you that we would be
able to repay amounts due on our indebtedness if payment of the indebtedness
were accelerated following the occurrence of an event of default under, or
certain other events specified in, the agreements governing our outstanding
indebtedness and capital leases.
19
The elimination of outstanding debt pursuant to our debt restructuring completed
in 2003 and prior years resulted in substantial cancellation of debt income for
income tax purposes. We minimized income tax payable as a result of the
restructuring by, among other things, offsetting the income with our historical
net operating losses and otherwise reducing the income in accordance with
applicable income tax rules. As a result, we did not incur any material current
income tax liability from the elimination of this debt. However, the relevant
tax authorities may challenge our income tax positions, including the use of our
historical net operating losses to offset some or all of the cancellation of
debt income and the application of the income tax rules reducing the
cancellation of debt income. If we are not able to offset or otherwise reduce
the cancellation of debt income, we may incur material income tax liabilities as
a result of the elimination of debt and we may be unable to pay these
liabilities.
We may incur substantial additional indebtedness in the future. The level of our
indebtedness, among other things, could (1) make it difficult for us to make
payments on our indebtedness, (2) make it difficult to obtain any necessary
financing in the future for working capital, capital expenditures, debt service
requirements or other purposes, (3) limit our flexibility in planning for, or
reacting to changes in, our business, and (4) make us more vulnerable in the
event of a downturn in our business.
WE MAY NEED TO RAISE CAPITAL IN THE FUTURE TO INVEST IN THE GROWTH OF OUR
BUSINESS AND TO FUND NECESSARY EXPENDITURES.
We may need to raise additional capital in the future. See Part I. Item 7 -
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources contained in our Annual Report on
Form 10-K and subsequent filings with the SEC. At March 31, 2006, we had $4.1
million of cash and cash equivalents. Our principal fixed commitments consist of
obligations under a credit agreement, obligations under capital leases,
obligations under office space leases, accounts payable and other current
obligations, commitments for capital expenditures and commitments for
telecommunications services. We may need additional financing to invest in the
growth of our business and to pay other obligations, and the availability of
such financing when needed, on terms acceptable to us, or at all, is uncertain.
See "Risk Factors - We have incurred significant indebtedness for money
borrowed, and we may be unable to pay debt service on this indebtedness." If we
are unable to raise additional financing, generate sufficient cash flow, or
restructure our debt obligations before they become due and payable, we may be
unable to continue as a going concern.
If we raise additional funds by issuing equity securities or debt convertible
into equity securities, stockholders may experience significant dilution of
their ownership interest. The amount of dilution resulting from issuance of
additional shares of Class A common stock and securities convertible into Class
A common stock and the potential dilution that may result from future issuances
has significantly increased in light of the decline in our stock price.
Moreover, we could issue preferred stock that has rights senior to those of the
Class A common stock. Some of our stockholders have registration rights that
could interfere with our ability to raise needed capital. If we raise funds by
issuing debt, our lenders may place limitations on our operations, including our
ability to pay dividends, although we do not anticipate paying any cash
dividends on our stock in the foreseeable future.
WHERE RESOURCES PERMIT, WE INTEND TO CONTINUE TO ACQUIRE, OR MAKE STRATEGIC
INVESTMENTS IN, OTHER BUSINESSES AND ACQUIRE OR LICENSE TECHNOLOGY AND OTHER
ASSETS AND WE MAY HAVE DIFFICULTY INTEGRATING THESE BUSINESSES OR GENERATING AN
ACCEPTABLE RETURN.
We have completed a number of acquisitions and strategic investments since our
initial public offering in 1999. For example, we acquired NetMoves Corporation,
a provider of production messaging services and integrated desktop messaging
services to businesses. We also acquired Swift Telecommunications, Inc. and the
EasyLink Services business that it had contemporaneously acquired from AT&T
Corp. On August 1, 2005, we acquired Quickstream Software, Inc. Where resources
permit, we will continue our efforts to acquire or make strategic investments in
businesses and to acquire or license technology and other assets, and any of
these acquisitions may be material to us. We cannot assure you that acquisition
or licensing opportunities will continue to be available on terms acceptable to
us or at all. Such acquisitions involve risks, including:
20
- inability to raise the required capital;
- difficulty in assimilating the acquired operations and personnel;
- inability to retain any acquired member or customer accounts;
- disruption of our ongoing business;
- the need for additional capital to fund losses of acquired businesses;
- inability to successfully incorporate acquired technology into our service
offerings and maintain uniform standards, controls, procedures and policies; and
- lack of the necessary experience to enter new markets.
We may not successfully overcome problems encountered in connection with
potential acquisitions. In addition, an acquisition could materially impair our
operating results by diluting our stockholders' equity, causing us to incur
additional debt or requiring us to incur acquisition expenses or amortize or
depreciate acquired intangible and tangible assets or to incur impairment
charges as a result of the write-off of assets, including goodwill, recorded as
a result of such acquisition.
WE MAY BE UNABLE TO SUCCESSFULLY COMPLETE THE MIGRATION OF THE NETWORK RELATING
TO OUR BUSINESS ACQUIRED FROM AT&T OFF OF AT&T PREMISES.
The network for the portion of our business relating to EDI, fax and email
services continues to reside on AT&T's premises under an agreement with AT&T,
but is being operated and maintained by EasyLink. This agreement expires on June
30, 2006, and AT&T has informed us that they will not extend the agreement
beyond this date. As a result, we have built a new network center at our
corporate headquarters located in Piscataway, New Jersey and have commenced the
migration of these operations to this center. If we are unable to complete the
migration of all of these operations and affected customers by June 30, 2006, we
will seek to enter into alternative arrangements with AT&T to accommodate any
remaining operations. We currently expect that we will be able to relocate
substantially all of our operations by this date and that will complete the
relocation of any remaining operations within a short time thereafter.
We cannot assure you that we will be able to successfully migrate the remaining
EasyLink Services customers or network from AT&T's premises to our own premises,
or successfully integrate them into our operations, in a timely manner or
without incurring substantial unforeseen expense or without service interruption
to our customers. Even if successfully migrated, we may be unable to operate the
business at expense levels that are ultimately profitable for us. We cannot
assure you that we will be able to retain all of the customers of the EasyLink
Services business. Our inability to successfully migrate, integrate or operate
the network and operations, or to retain customers, of the EasyLink Services
business might result in a material adverse effect on our business, results of
operations and financial condition.
OUTSOURCING OF TRANSACTION MANAGEMENT SERVICES MAY NOT PROVE TO BE A VIABLE
BUSINESS.
An important part of our business strategy is to leverage our existing global
customer base and global network by continuing to provide our existing
transaction delivery services and by offering these customers additional
transaction delivery and new transaction management services in the future. The
market for transaction management services is only beginning to develop. Our
success will depend on the development of viable markets for the outsourcing of
new transaction management services which is somewhat speculative.
21
There are significant obstacles to the full development of a sizable market for
the outsourcing of transaction management services. Outsourcing is one of the
principal methods by which we will attempt to reach the size we believe is
necessary to be successful. Security and the reliability of service, however,
are likely to be of concern to enterprises and service providers deciding
whether to outsource their transaction management or to continue to provide it
themselves. These concerns are likely to be particularly strong at larger
businesses and service providers, which are better able to afford the costs of
maintaining their own systems. While we intend to focus exclusively on our
outsourced transaction delivery and transaction management services, we cannot
be sure that we will be able to maintain or expand our business customer base.
In addition, the sales cycle for many of these services is lengthy and could
delay our ability to generate revenues in this market.
OUR STRATEGY OF DEVELOPING AND OFFERING TO EXISTING CUSTOMERS ADDITIONAL
TRANSACTION DELIVERY AND TRANSACTION MANAGEMENT SERVICES MAY BE UNSUCCESSFUL.
As part of our business strategy, we plan to develop and offer to existing
customers additional transaction delivery and transaction management services
that will automate more of our customers' business processes. We cannot assure
you that we will be able to successfully develop these additional services in a
timely manner or at all or, if developed, that our customers will purchase these
services or will purchase them at prices that we wish to charge. Standards for
pricing in the market for new transaction delivery and transaction management
services are not yet well defined and some businesses and service providers may
not be willing to pay the fees we wish to charge. We cannot assure you that the
fees we intend to charge will be sufficient to offset the related costs of
providing these services.
WE MAY FAIL TO MEET MARKET EXPECTATIONS BECAUSE OF FLUCTUATIONS IN OUR QUARTERLY
OPERATING RESULTS, WHICH WOULD CAUSE OUR STOCK PRICE TO DECLINE.
We may experience significant fluctuations in our quarterly results. It is
likely that our operating results in some quarters will be below market
expectations. In this event, the price of our Class A common stock is likely to
decline. The following are among the factors that could cause significant
fluctuations in our operating results:
- incurrence of other cash and non-cash accounting charges, including charges
resulting from acquisitions or dispositions of assets, including from
write-downs of impaired assets;
- increases or decreases in the number of transactions generated by our
customers (such as insurance claims, trade and travel confirmations, purchase
orders, invoices, shipping notices, funds transfers, among others), which is
affected by factors that affect specific customers, the respective industries in
which our customers conduct business and the economy generally;
- non-cash charges associated with the adoption of SFAS 123R, "Share-Based
Payment," which requires the recognition of compensation expense for all
share-based payments and employee stock options beginning in the first quarter
of 2006;
- system outages, delays in obtaining new equipment or problems with planned
upgrades;
- disruption or impairment of the Internet;
22
- demand for outsourced transaction delivery and transaction management
services;
- attracting and retaining customers and maintaining customer satisfaction;
- introduction of new or enhanced services by us or our competitors;
- changes in our pricing policy or that of our competitors;
- changes in governmental regulation of the Internet and transaction delivery
and transaction management services in particular; and
- general economic and market conditions and global political factors.
SEVERAL OF OUR COMPETITORS HAVE SUBSTANTIALLY GREATER RESOURCES, LONGER
OPERATING HISTORIES, LARGER CUSTOMER BASES AND BROADER PRODUCT OFFERINGS.
Our business is, and we believe will continue to be, intensely competitive. See
"Part I Item 1 - Business - Competition" contained in our Annual Report on Form
10-K and subsequent filings with the SEC.
Many of our competitors have greater market presence, engineering and marketing
capabilities, and financial, technological and personnel resources than those
available to us. As a result, they may be able to develop and expand their
communications and network infrastructures more quickly, adapt more swiftly to
new or emerging technologies and changes in customer requirements, take
advantage of acquisition and other opportunities more readily, and devote
greater resources to the marketing and sale of their products and services. In
addition, current and potential competitors have established or may establish
cooperative relationships among themselves or with third parties to increase the
ability of their services to address the needs of our current and prospective
customers. Accordingly, it is possible that new competitors or alliances among
competitors may emerge and rapidly acquire significant market share. In addition
to direct competitors, many of our larger potential customers may seek to
internally fulfill their messaging needs through the deployment of their own on
premises messaging systems.
Some of our competitors provide a variety of telecommunications services and
other business services, as well as software and hardware solutions, in addition
to transaction delivery or transaction management services. The ability of these
competitors to offer a broader suite of complementary services and software or
hardware may give them a considerable advantage over us.
The level of competition is likely to increase as current competitors increase
the sophistication of their offerings and as new participants enter the market.
In the future, as we expand our service offerings, we expect to encounter
increased competition in the development and delivery of these services. We may
not be able to compete successfully against our current or future competitors.
IT IS DIFFICULT TO RETAIN KEY PERSONNEL AND ATTRACT ADDITIONAL QUALIFIED
EMPLOYEES IN OUR BUSINESS AND THE LOSS OF KEY PERSONNEL AND THE BURDEN OF
ATTRACTING ADDITIONAL QUALIFIED EMPLOYEES MAY IMPEDE THE OPERATION AND GROWTH OF
OUR BUSINESS AND CAUSE OUR REVENUES TO DECLINE.
Our future success depends to a significant extent on the continued service of
our key technical, sales and senior management personnel, but they have no
contractual obligation to remain with us. In particular, our success depends on
the continued service of Thomas F. Murawski, our President and Chief Executive
Officer, and Michael A. Doyle, our Vice President and Chief Financial Officer.
The loss of the services of Messrs. Murawski or of Mr. Doyle, or several other
key employees, would impede the operation and growth of our business.
23
To manage our existing business and handle any future growth, we will have to
attract, retain and motivate additional highly skilled employees. In particular,
we will need to hire and retain qualified sales people if we are to meet our
sales goals. We will also need to hire and retain additional experienced and
skilled technical personnel in order to meet the increasing technical demands of
our expanding business. Competition for employees in messaging-related
businesses is intense. We have in the past experienced, and expect to continue
to experience, difficulty in hiring and retaining employees with appropriate
qualifications.
If we are unable to do so, our management may not be able to effectively manage
our business, exploit opportunities and respond to competitive challenges.
OUR BUSINESS IS HEAVILY DEPENDENT ON TECHNOLOGY, INCLUDING TECHNOLOGY THAT HAS
NOT YET BEEN PROVEN RELIABLE AT HIGH TRAFFIC LEVELS AND TECHNOLOGY THAT WE DO
NOT CONTROL.
The performance of our computer systems is critical to the quality of service we
are able to provide to our customers. If our services are unavailable or fail to
perform to their satisfaction, customers may cease using our service. In
addition, our agreements with several of our customers establish minimum
performance standards. If we fail to meet these standards, our customers could
terminate their relationships with us and assert claims for service fee rebates
or monetary damages.
WE MAY NEED TO UPGRADE SOME OF OUR COMPUTER SYSTEMS TO ACCOMMODATE INCREASES IN
TRAFFIC AND TO ACCOMMODATE INCREASES IN THE USAGE OF OUR SERVICES, BUT WE MAY
NOT BE ABLE TO DO SO WHILE MAINTAINING OUR CURRENT LEVEL OF SERVICE, OR AT ALL.
We must continue to expand and adapt our computer systems as the number of
customers and the amount of information they wish to transmit increases and as
their requirements change, and as we further develop our services. Because we
have only been providing some of our services for a limited time, and because
our computer systems for these services have not been tested at greater
capacities, we cannot guarantee the ability of our computer systems to connect
and manage a substantially larger number of customers or meet the needs of
business customers at high transmission speeds. If we cannot provide the
necessary service while maintaining expected performance, our business would
suffer and our ability to generate revenues through our services would be
impaired.
The expansion and adaptation of our computer systems will require substantial
financial, operational and managerial resources. We may not be able to
accurately project the timing of increases in traffic or other customer
requirements. In addition, the very process of upgrading our computer systems
could cause service disruptions. For example, we may need to take various
elements of the network out of service in order to install some upgrades.
OUR COMPUTER SYSTEMS MAY FAIL AND INTERRUPT OUR SERVICE.
Our customers have in the past experienced interruptions in our services. We
believe that these interruptions will continue to occur from time to time. These
interruptions are due to hardware failures, failures in telecommunications and
other services provided to us by third parties and other computer system
failures. These failures have resulted and may continue to result in significant
disruptions to our service. Some of our operations have redundant switch-over
capability. Although we plan to install backup computers and implement
procedures on other parts of our operations to reduce the impact of future
malfunctions in these systems, the presence of single points of failure in our
network increases the risk of service interruptions. In addition, substantially
all of our computer and communications systems relating to our services are
currently located in Glen Head, New York; Jersey City, New Jersey; Piscataway,
New Jersey; Washington, DC; Bridgeton, Missouri; Dayton, Ohio, and London,
24
England. We currently do not have alternate sites from which we could conduct a
major portion of these operations in the event of a disaster. Our computer and
communications hardware is vulnerable to damage or interruption from fire,
flood, earthquake, power loss, telecommunications failure and similar events.
Our services would be suspended for a significant period of time if any of our
primary data centers was severely damaged or destroyed. We might also lose
customer transaction documents and other customer files, causing significant
customer dissatisfaction and possibly giving rise to claims for monetary
damages. We plan to consolidate over time an increasing portion of our computer
systems and networks, including the migration during 2006 of the network
equipment from the leased AT & T facility and our Glen Head, New York facility
to our corporate headquarters. This consolidation may result in interruptions in
our services to some of our customers.
OUR SERVICES WILL BECOME LESS DESIRABLE OR OBSOLETE IF WE ARE UNABLE TO KEEP UP
WITH THE RAPID CHANGES CHARACTERISTIC OF OUR BUSINESS.
Our success will depend on our ability to enhance our existing services and to
introduce new services in order to adapt to rapidly changing technologies,
industry standards and customer demands. To compete successfully, we will have
to accurately anticipate changes in business demand and add new features to our
services very rapidly. We may not be able to develop or integrate the necessary
technology into our computer systems on a timely basis or without degrading the
performance of our existing services. We cannot be sure that, once integrated,
new technology will function as expected. Delays in introducing effective new
services could cause existing and potential customers to forego use of our
services.
OUR BUSINESS WILL SUFFER IF WE ARE UNABLE TO PROVIDE ADEQUATE SECURITY FOR OUR
SERVICE, OR IF OUR SERVICE IS IMPAIRED BY SECURITY MEASURES IMPOSED BY THIRD
PARTIES.
Security is a critical issue for any outsourced transaction delivery or
transaction management service, and presents a number of challenges for us. If
we are unable to maintain the security of our service, our reputation and our
ability to attract and retain customers may suffer, and we may be exposed to
liability. Third parties may attempt to breach our security or that of our
customers whose networks we may maintain or for whom we provide services. If
they are successful, they could obtain information that is sensitive or
confidential to a customer or otherwise disrupt a customer's operations or
obtain confidential information, including our customer's profiles, passwords,
financial account information, credit card numbers, message content, stored
email or other personal or business information or similar information relating
to our customer's customers. Our customers or their employees or customers may
assert claims for money damages for any breach in our security and any breach
could harm our reputation. Our computers are vulnerable to computer viruses,
physical or electronic break-ins, denial of service attacks and similar
incursions, which could lead to interruptions, delays or loss of data. We expect
to expend significant capital and other resources to license or create
encryption and other technologies to protect against security breaches or to
alleviate problems caused by any breach. Nevertheless, these measures may prove
ineffective. Our failure to prevent security breaches may expose us to liability
and may adversely affect our ability to attract and retain customers and develop
our business market. Security measures taken by others may interfere with the
efficient operation of our service, which may harm our reputation and adversely
impact our ability to attract and retain customers. "Firewalls" and similar
network security software employed by third parties can interfere with the
operation of our services.
Our customers are subject to, and in turn require that their service providers
meet, increasingly strict guidelines for network and operational security. If we
are unable to meet the security requirements of a customer, we may be unable to
obtain or keep their business. This is particularly the case for customers in
the health insurance and financial services industries, which are subject to
legal requirements governing the security and confidentiality of customer
information.
25
WE ARE DEPENDENT ON LICENSED TECHNOLOGY AND THIRD PARTY COMMERCIAL PARTNERS.
We license a significant amount of technology from third parties, including
technology related to our Internet fax services, billing processes and
databases. We also rely on third party commercial partners to provide services
for our trading community enablement services, document capture and management
services and some of our other services. We anticipate that we will need to
license additional technology or to enter into additional commercial
relationships to remain competitive. We may not be able to license these
technologies or to enter into arrangements with prospective commercial partners
on commercially reasonable terms or at all. Third-party licenses and strategic
commercial relationships expose us to increased risks, including risks relating
to the integration of new technology, the diversion of resources from the
development of our own proprietary technology, a greater need to generate
revenues sufficient to offset associated license or service fee costs, and the
possible termination of or failure to renew an important license or other
agreement by the third-party licensor or commercial partner.
IF THE INTERNET AND OTHER THIRD-PARTY NETWORKS ON WHICH WE DEPEND TO DELIVER OUR
SERVICES BECOME INEFFECTIVE AS A MEANS OF TRANSMITTING DATA, THE BENEFITS OF OUR
SERVICE MAY BE SEVERELY UNDERMINED.
Our business depends on the effectiveness of the Internet as a means of
transmitting data. Any deterioration in the performance of the Internet as a
whole could undermine the benefits of our services. We also depend on
telecommunications network suppliers such as AT&T Corporation, Verizon Business
and XO Communications for a variety of telecommunications and Internet services.
The network for the EasyLink Services business acquired from AT&T continues to
reside on AT&T's premises. See "Risk Factors - We may be unable to successfully
complete the migration of the network relating to our business acquired from
AT&T off of AT&T premises" above, and "Item 1. Business - Technology" contained
in our Annual Report on Form 10-K and subsequent filings with the SEC.
OUR INTERNATIONAL OPERATIONS ARE SUBJECT TO SIGNIFICANT RISKS AND OUR OPERATING
RESULTS MAY SUFFER IF OUR REVENUES FROM INTERNATIONAL OPERATIONS DO NOT EXCEED
THE COSTS OF THOSE OPERATIONS.
We operate in international markets. We may not be able to compete effectively
in these markets. If our revenues from international operations do not exceed
the expense of establishing and maintaining these operations, our operating
results will suffer. We face significant risks inherent in conducting business
internationally, such as:
- uncertain demand in foreign markets for transaction delivery and transaction
management services;
- difficulties and costs of staffing and managing international operations;
- differing technology standards;
- difficulties in collecting accounts receivable and longer collection periods;
- economic instability and fluctuations in currency exchange rates and
imposition of currency exchange controls;
- potentially adverse tax consequences;
- regulatory limitations on the activities in which we can engage and foreign
ownership limitations on our ability to hold an interest in entities through
which we wish to conduct business;
- political instability, unexpected changes in regulatory requirements, and
reduced protection for intellectual property rights in some countries;
- export restrictions;
- terrorism; and
- difficulties in enforcing contracts and potentially adverse consequences.
26
REGULATION OF TRANSACTION DELIVERY AND TRANSACTION MANAGEMENT SERVICES AND
INTERNET USE IS EVOLVING AND MAY ADVERSELY IMPACT OUR BUSINESS.
With some exceptions, online activity is not currently subject to U.S. laws and
regulations that differ from those applicable to offline activities. Laws and
regulations have been enacted to regulate activity that occurs only on the
Internet (e.g., laws regulating the sending of unsolicited email advertisements,
electronic signatures, etc.), or to limit the applicability of existing laws and
regulations in the online environment (e.g., limiting copyright and tort
liability for user-provided content). In the future, however, additional laws
and regulations may be adopted at both the state and federal level to address
issues such as, for example, user privacy, data security, marketing, pricing,
and the characteristics and quality of products and services in the online
context specifically.
We believe that our services are "information services" under the
Telecommunications Act of 1996 and existing precedent and therefore would not
currently be subject to traditional U.S. telecommunication services regulation.
However, while the Federal Communications Commission ("FCC") historically has
refrained from extensive regulation of entities that provide service using the
Internet or Internet protocol ("IP"), it has recently begun to impose at least
some regulatory paradigms on such services as they increasingly are used as
substitutes for traditional communications services. For example, the FCC
already has required certain providers of voice over Internet Protocol ("VoIP")
telephony to provide enhanced 911 capability to their customers and to
accommodate requests by law enforcement to permit electronic surveillance. If
upheld in pending appeals, these requirements are likely to create additional
costs. In addition, the FCC is currently considering whether to impose certain
obligations on providers of Internet-based and IP-based services generally,
including but not limited to VoIP. Such potential rules could include
requirements to ensure access for disabled persons, contribute to universal
service funds, and pay for using the public telephone network. Any of these
requirements, if applicable to a given service, could increase the cost of
providing that service. The FCC is also examining whether and how to
differentiate among Internet-based and IP-based services to determine which
services should be subject to particular regulatory obligations. It cannot be
predicted whether such rules will be adopted and, if so, whether they would be
applied to our non-voice services.
Moreover, although the FCC has indicated that it views certain Internet-based
services as being interstate and thus subject to the protection of federal laws
that warrant preemption of state efforts to impose traditional common carrier
regulation on such services, the FCC's efforts are currently under legal
challenge and we cannot predict the outcome of state efforts to regulate such
services or the scope of federal policy to preempt such efforts.
The Company and its customers are subject to laws and regulations protecting
personal and other confidential information in connection with the exchange of
this information by these customers using the Company's services.
At present, in the United States, interactive Internet-based service providers
have substantial legal protection for the transmission of third-party content
that is infringing, defamatory, pornographic, or otherwise illegal. We cannot
guarantee that a U.S. court would not conclude that we do not qualify for these
protections as an interactive service provider. We do not and cannot screen all
of the content generated and received by users of our services or the recipients
of messages delivered through our services. Some foreign governments, such as
Germany and France, have enforced content-related laws and regulations against
Internet service providers.
27
Continued changes in telecommunications regulations may significantly reduce the
cost of domestic and international calls. To the extent that the cost of
domestic and international calls decreases, we will face increased competition
for our fax services which may have a material adverse effect on our business,
financial condition, or results of operations.
As noted above, the FCC is considering whether providers of information services
should be required to contribute to the universal service fund, which was
established to subsidize telecommunications service in rural areas in the United
States but to which only providers of telecommunications services are currently
required to contribute; states may pursue similar inquiries with respect to
their own funds. Apart from that issue, federal and state regulations could
change in a manner that increases the contributions required by
telecommunications carriers, which would in turn increase our costs in
purchasing such telecommunications services. Providers are authorized to pass
their contribution costs on to their customers; our costs for telecommunications
services that we purchase thus reflect these amounts. The contributions are
currently calculated as a percentage of telecommunications services revenues.
Alternative contribution methodologies, such as the imposition of a fee per
telephone line, and other changes have been proposed that could increase these
amounts and thus our costs in purchasing such telecommunications services. If
adopted, these changes may in turn require us to raise the price of one or more
of our services to our customers. No assurance can be given that we will be able
to recover all or part of any increase in costs that may result from these
changes if adopted by the FCC or that such changes will not otherwise adversely
affect the demand for our services.
In connection with the deployment of Internet-capable nodes in countries
throughout the world, we are required to satisfy a variety of foreign regulatory
requirements. We intend to explore and seek to comply with these requirements on
a country-by-country basis as the deployment of Internet-capable fax nodes
continues. There can be no assurance that we will be able to satisfy the
regulatory requirements in each of these countries, and the failure to satisfy
such requirements may prevent us from installing Internet-capable fax nodes in
such countries or require us to limit the functionality of such nodes. The
failure to deploy a number of such nodes could have a material adverse effect on
our business, operating results, and financial condition.
Our fax nodes and telex switches utilize encryption technology. The export of
such encryption technology is regulated by the United States government. We have
authority for the export of such encryption technology other than to countries
such as Cuba, Iran, Libya, Syria, Sudan and North Korea. Nevertheless, there can
be no assurance that such authority will not be revoked or modified at any time
for any particular jurisdiction or in general. In addition, there can be no
assurance that such export controls, either in their current form or as may be
subsequently enacted, will not limit our ability to distribute our services
outside of the United States or electronically. While we take precautions
against unlawful exportation of our software, the global nature of the Internet
makes it virtually impossible to effectively control the distribution of our
services. Moreover, future Federal or state legislation or regulation may
further limit levels of encryption or authentication technology. Any such export
restrictions, the unlawful exportation of our services, or new legislation or
regulation could have a material adverse effect on our business, financial
condition and results of operations.
The legal structure and scope of operations of our subsidiaries in some foreign
countries may be subject to restrictions that could severely limit our ability
to conduct business in these countries. To the extent that we develop or offer
messaging or other services in foreign countries, we will be subject to the laws
and regulations of these countries. The laws and regulations relating to the
Internet and telecommunications services in many countries are evolving and in
many cases are more burdensome than U.S. law and/or unclear as to their
application. For example, in India, the Peoples Republic of China, and other
countries, we may be subject to licensing requirements with respect to the
activities in which we propose to engage and we may also be subject to foreign
ownership limitations or other approval requirements that preclude our ownership
interests or limit our ownership interests to up to specified percentages of the
entities through which we propose to conduct any regulated activities. If these
limitations apply to our activities (including activities conducted through our
subsidiaries), our opportunities to generate revenue will be reduced, our
ability to compete successfully in these markets will be adversely affected, our
ability to raise capital in the private and public markets may be adversely
affected, and the value of our investments and acquisitions in these markets may
decline. Moreover, to the extent we are limited in our ability to engage in
certain activities or are required to contract for these services from a
licensed or authorized third party, our costs of providing our services will
increase and our ability to generate profits may be adversely affected.
28
OUR INTELLECTUAL PROPERTY RIGHTS ARE CRITICAL TO OUR SUCCESS, BUT MAY BE
DIFFICULT TO PROTECT.
We regard our copyrights, service marks, trademarks, trade secrets, domain names
and similar intellectual property as critical to our success. We rely on
trademark and copyright law, trade secret protection and confidentiality and/or
license agreements with our employees, customers, strategic partners and others
to protect our proprietary rights. Despite our precautions, unauthorized third
parties may improperly obtain and use information that we regard as proprietary.
Third parties may submit false registration data attempting to transfer key
domain names to their control. Our failure to pay annual registration fees for
domain names may result in the loss of these domains to third parties.
The status of United States patent protection for software products and services
is not well defined and will evolve as additional patents are granted. The
United States Patent and Trademark Office has filed an office action rejecting
the claims in a patent application that we filed. Although we may continue to
pursue this patent application in its current or a modified form, we do not know
if our application will be issued with the scope of the claims we seek or at
all. The laws of some foreign countries do not protect proprietary rights to the
same extent as do the laws of the United States. Our means of protecting our
proprietary rights in the United States or abroad may not be adequate and
competitors may independently develop similar technology.
Third parties may infringe or misappropriate our copyrights, trademarks and
similar proprietary rights. In addition, other parties have asserted and may in
the future assert infringement claims against us. We cannot be certain that our
services do not infringe issued patents. Because patent applications in the
United States are not publicly disclosed until the patent is issued,
applications may have been filed which relate to our services.
We have been and may continue to be subject to legal proceedings and claims from
time to time in the ordinary course of our business, including claims related to
the use of our domain names and claims of alleged infringement of the trademarks
and other intellectual property rights of third parties.
WE MAY INCUR EXPENSES AND LIABILITIES AS A RESULT OF PENDING LEGAL PROCEEDINGS.
The Company is involved in legal proceedings from time to time that may result
in additional expenses or liability. See "Legal Proceedings" contained in Part
I, Item 3 of our Annual Report on Form 10-K and subsequent filings with the SEC.
Although the Company intends to pursue its defense of these matters vigorously,
no assurance can be given that the Company's efforts will be successful. To the
extent that the Company is not successful in the remand proceeding, it may be
required to pay any judgment that may be rendered in such proceeding. Although
we intend to defend vigorously these matters, we cannot assure you that our
ultimate liability, if any, in connection with these matters will not have a
material adverse effect on our results of operations, financial condition or
cash flows.
A SUBSTANTIAL AMOUNT OF OUR COMMON STOCK MAY COME ONTO THE MARKET IN THE FUTURE,
WHICH COULD DEPRESS OUR STOCK PRICE.
Sales of a substantial number of shares of our common stock in the public market
could cause the market price of our Class A common stock to decline. As of April
25, 2006, we had an aggregate of 54,342,436 shares of Class A common stock
outstanding. As of March 31, 2006, we had options to purchase 5.2 million shares
of Class A common stock outstanding and warrants to purchase 798,523 shares of
Class A common stock outstanding.
29
Substantially all of the shares of our outstanding Class A common stock, other
than the 9 million shares issued in the April 13, 2006 private placement, were
freely tradable, in some cases subject to the volume and manner of sale
limitations contained in Rule 144. We are required to file on before December
31, 2006 a registration statement covering the resale of the 9 million shares
issued on April 13, 2006, and these shares may be sold after the registration
statement becomes effective. We may issue large amounts of additional Class A
common stock, which may also be sold and which could adversely affect the price
of our stock. Approximately 23.6 million of our outstanding shares were issued
in connection with the elimination of debt during the nine months ended
September 30, 2003. If the holders of these shares sell large numbers of shares,
these holders could cause the price of our Class A common stock to fall.
OUR CLASS A COMMON STOCK MAY BE SUBJECT TO DELISTING FROM THE NASDAQ CAPITAL
MARKET.
Our Class A common stock faces potential delisting from the Nasdaq Capital
Market which could hurt the liquidity of our Class A common stock. We may be
unable to comply with the standards for continued listing on the Nasdaq Capital
Market. These standards require, among other things, that our Class A common
stock have a minimum bid price of $1. In addition, the listing standards require
that we comply with our SEC periodic reporting requirements and that we maintain
compliance with various other standards.
On August 23, 2005, the Company received notice from The NASDAQ Stock Market,
Inc. Listing Qualifications Staff that for 30 consecutive trading days the bid
price of its common stock closed below the minimum $1.00 per share required for
continued inclusion under Nasdaq Marketplace Rule 4450(a)(5) (the "Minimum Bid
Price Rule"). Because the Company was unable to regain compliance with the
Minimum Bid Price Rule by the expiration of the original 180 day grace period,
or February 21, 2006, the Company applied to transfer the listing of its common
stock from the NASDAQ National Market to the NASDAQ Capital Market. The Staff of
NASDAQ notified EasyLink that its application to transfer its listing to the
NASDAQ Capital Market was approved on February 16, 2006. On February 22, 2006,
EasyLink received notice from NASDAQ that it had determined that EasyLink was
entitled to the additional 180 day grace period to regain compliance with
NASDAQ's $1 minimum bid price requirement. As a result of the determination,
EasyLink will have until August 21, 2006 to comply with the $1.00 minimum
closing bid price requirement on the Nasdaq Capital Market. The Company may
regain compliance with the minimum bid price rule if, at any time before August
21, 2006, the bid price of its common stock closes at $1.00 per share or more
for a minimum of ten consecutive trading days. The NASDAQ staff may, in its
discretion, require the Company to maintain a bid price of at least $1.00 per
share for a period in excess of ten consecutive business days (but generally no
more than 20 consecutive business days) before determining that the Company has
demonstrated the ability to maintain long-term compliance.
No assurance can be given that the Company will be able to regain compliance
with the Minimum Bid Price Rule by August 21, 2006.
If the Company is unable regain compliance with the $1 minimum bid price
requirement, its securities will be subject to delisting from the Nasdaq
National Market.
If our common stock were to be delisted from trading on the Capital Market and
were neither re-listed thereon nor listed for trading on another recognized
securities exchange, trading, if any, in the Class A common stock may continue
to be conducted on the OTC Bulletin Board or in the non-Nasdaq over-the-counter
market. Delisting would result in limited release of the market price of the
Class A common stock and limited news coverage of EasyLink and could restrict
investors' interest in our Class A common stock and materially adversely affect
the trading market and prices for our Class A common stock and our ability to
issue additional securities or to secure additional financing.
30
OUR STOCK PRICE HAS BEEN VOLATILE AND WE EXPECT THAT IT WILL CONTINUE TO BE
VOLATILE.
Our stock price has been volatile since our initial public offering and we
expect that it will continue to be volatile. As discussed above, our financial
results are difficult to predict and could fluctuate significantly. In addition,
the market prices of securities of electronic services companies have been
highly volatile. A stock's price is often influenced by rapidly changing
perceptions about the future of electronic services or the results of other
Internet or technology companies, rather than specific developments relating to
the issuer of that particular stock. As a result of volatility in our stock
price, a securities class action may be brought against us. Class-action
litigation could result in substantial costs and divert our management's
attention and resources.
WE MAY BE EXPOSED TO POTENTIAL RISKS RELATING TO OUR INTERNAL CONTROLS OVER
FINANCIAL REPORTING AND OUR ABILITY TO HAVE THOSE CONTROLS ATTESTED TO BY OUR
INDEPENDENT AUDITORS.
As directed by Section 404 of the Sarbanes-Oxley Act of 2002 ("SOX 404"), the
Securities and Exchange Commission adopted rules requiring public companies to
include a report of management on the company's internal controls over financial
reporting in their annual reports, including Form 10-KSB. In addition, the
independent registered public accounting firm auditing a company's financial
statements must also attest to and report on management's assessment of the
effectiveness of the company's internal controls over financial reporting as
well as the operating effectiveness of the company's internal controls. We were
not subject to these requirements for the year ended December 31, 2005 or 2004.
We have commenced the process of planning for the implementation of Section 404
reporting.
While we expect to expend significant resources in developing the necessary
documentation and testing procedures required by SOX 404, there is a risk that
we will not comply with all of the requirements imposed thereby. We can not
assure you that we will receive a positive attestation from our independent
auditors. In the event we identify significant deficiencies or material
weaknesses in our internal controls that we cannot remediate in a timely manner
or we are unable to receive a positive attestation from our independent auditors
with respect to our internal controls, investors and others may lose confidence
in the reliability of our financial statements, our stock price may decline and
our ability to obtain equity or debt financing could suffer.
ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Recent Sales of Unregistered Securities
During the three months ended March 31, 2006, the Company issued 136,346 shares
of Class A common stock valued at approximately $109,000 in connection with
matching contributions to its 401(k) plan. These issuances were not subject to
the registration requirements of the Securities Act because the issuance of the
shares was not voluntary and contributory on the part of employees.
ITEM 3: DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5: OTHER INFORMATION
None
31
ITEM 6: EXHIBITS
The following exhibits are filed as part of this report:
Exhibit 10.1+ Common Stock Purchase Agreement dated as of April
13, 2006 between EasyLink Services Corporation
and the investors named therein
Exhibit 10.2 Registration Rights Agreement dated as of April
13, 2006 between EasyLink Services
Corporation and the investors named therein
Exhibit 31.1 Rule 13a-14(a)/15d-14(a) Certification of the Chief
Executive Officer
Exhibit 31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief
Financial Officer
Exhibit 32.1 Section 1350 Certification of the Chief Executive
Officer
Exhibit 32.2 Section 1350 Certification of the Chief Financial
Officer
+ Disclosure schedules and other attachments are
omitted, but will be furnished supplementally to the
Commission upon request.
32
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report on Form 10-Q to be signed on its behalf
by the undersigned thereto duly authorized.
EasyLink Services Corporation
/s/ Michael A. Doyle
--------------------
Michael A. Doyle
Vice President and Chief Financial Officer
May 15, 2006
33
Exhibit Index
Exhibit 10.1+ Common Stock Purchase Agreement dated as of April
13, 2006 between EasyLink Services Corporation
and the investors named therein
Exhibit 10.2 Registration Rights Agreement dated as of April
13, 2006 between EasyLink Services Corporation
and the investors named therein
Exhibit 31.1 Rule 13a-14(a)/15d-14(a) Certification of the Chief
Executive Officer
Exhibit 31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief
Financial Officer
Exhibit 32.1 Section 1350 Certification of the Chief Executive
Officer
Exhibit 32.2 Section 1350 Certification of the Chief Financial
Officer
+ Disclosure schedules and other attachments are
omitted, but will be furnished supplementally to the
Commission upon request.