UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 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 JUNE 30, 2006
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
COMMISSION FILE NUMBER 000-26371
EASYLINK SERVICES CORPORATION
(Exact Name of Registrant as Specified in Its 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 Offices) (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. [X] Yes [_] No
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
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 [X] No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common stock outstanding at July 25, 2006: Class A common stock $0.01 par value
54,455,815 shares.
EASYLINK SERVICES CORPORATION
JUNE 30, 2006
FORM 10-Q
INDEX
PAGE
NUMBER
------
PART I: FINANCIAL INFORMATION
Item 1: Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets as of June 30, 2006
(unaudited) and December 31, 2005............................. 3
Unaudited Condensed Consolidated Statements of Operations for
the three months ended June 30, 2006 and 2005................. 4
Unaudited Condensed Consolidated Statements of Operations for
the six months ended June 30, 2006 and 2005................... 5
Unaudited Condensed Consolidated Statements of Cash Flows for
the six months ended June 30, 2006 and 2005.................. 6
Notes to Unaudited Condensed Consolidated Financial
Statements.................................................... 7
Item 2: Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 14
Item 3: Quantitative and Qualitative Disclosures About Market Risk.... 18
Item 4: Controls and Procedures....................................... 18
PART II: OTHER INFORMATION
Item 1: Legal Proceedings............................................. 19
Item 1A: Risk Factors.................................................. 20
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds... 21
Item 4: Submission of Matters to a Vote of Security Holders........... 22
Item 6: Exhibits...................................................... 23
Signatures............................................................. 24
2
EasyLink Services Corporation
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
June 30, December 31,
2006 2005
----------- ------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents.................................................. $ 6,265 $ 6,282
Accounts receivable, net of allowance for doubtful accounts of $2,083 and
$2,330 as of June 30, 2006 and December 31, 2005, respectively............. 12,033 11,416
Prepaid expenses and other current assets.................................. 2,551 2,653
--------- ---------
Total current assets....................................................... 20,849 20,351
Property and equipment, net................................................ 9,711 10,252
Goodwill, net.............................................................. 6,213 6,213
Other intangible assets, net............................................... 5,779 6,264
Other assets............................................................... 876 895
--------- ---------
Total assets............................................................... $ 43,428 $ 43,975
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable........................................................... $ 5,735 $ 6,464
Accrued expenses........................................................... 10,085 10,432
Loans and notes payable.................................................... 5,400 10,550
Other current liabilities.................................................. 2,155 1,467
Net liabilities of discontinued operations................................. 928 928
--------- ---------
Total current liabilities.................................................. 24,303 29,841
Long term liabilities...................................................... 1,574 1,753
--------- ---------
Total liabilities.......................................................... 25,877 31,594
--------- ---------
Stockholders' equity:
Common stock:
Class A--500,000,000 shares authorized at June 30, 2006 and December 31,
2005, 54,501,867 and 45,225,130 shares issued and outstanding at June
30, 2006 and December 31, 2005, respectively............................... 545 452
Additional paid-in capital................................................. 559,937 554,337
Accumulated other comprehensive loss....................................... (730) (670)
Accumulated deficit........................................................ (542,201) (541,738)
--------- ---------
Total stockholders' equity................................................. 17,551 12,381
--------- ---------
Commitments and contingencies
Total liabilities and stockholders' equity................................. $ 43,428 $ 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 June 30,
---------------------------
2006 2005
----------- -----------
Revenues.......................................... $ 18,852 $ 20,070
Cost of revenues.................................. 7,895 6,986
----------- -----------
Gross profit...................................... 10,957 13,084
----------- -----------
Operating expenses:
Sales and marketing............................... 4,504 4,865
General and administrative........................ 4,622 4,574
Product development............................... 1,736 1,698
Amortization of intangible assets................. 43 517
----------- -----------
10,905 11,654
----------- -----------
Income from operations............................ 52 1,430
----------- -----------
Other income (expense), net:
Interest income................................... 62 28
Interest expense.................................. (239) (335)
Other, net........................................ 112 (67)
----------- -----------
Total other income (expense), net................. (65) (374)
----------- -----------
Income (loss) before income taxes................. (13) 1,056
Provision for income taxes........................ 76 290
----------- -----------
Net income (loss)................................. $ (89) $ 766
=========== ===========
Basic and diluted net income (loss) per share..... $ (0.00) $ 0.02
=========== ===========
Weighted-average basic shares outstanding......... 52,444,432 44,466,419
=========== ===========
Weighted-average diluted shares outstanding....... 52,444,432 44,665,264
=========== ===========
See accompanying notes to unaudited condensed consolidated financial statements.
4
EasyLink Services Corporation
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
Six Months Ended June 30,
-------------------------
2006 2005
----------- -----------
Revenues.......................................... $ 37,313 $ 40,448
Cost of revenues.................................. 15,358 14,756
----------- -----------
Gross profit...................................... 21,955 25,692
----------- -----------
Operating expenses:
Sales and marketing............................... 9,059 9,994
General and administrative........................ 9,392 10,184
Product development............................... 3,482 3,398
Separation agreement costs........................ -- 2,312
Amortization of intangible assets................. 402 1,035
----------- -----------
22,335 26,923
----------- -----------
Loss from operations.............................. (380) (1,231)
----------- -----------
Other income (expense), net:
Interest income................................... 109 53
Interest expense.................................. (643) (658)
Other, net........................................ 177 (36)
----------- -----------
Total other income (expense), net................. (357) (641)
----------- -----------
Loss before income taxes.......................... (737) (1,872)
Provision (credit) for income taxes............... (273) 105
----------- -----------
Net loss.......................................... $ (464) $ (1,977)
=========== ===========
Basic and diluted net loss per share.............. $ (0.01) $ (0.04)
=========== ===========
Weighted-average basic shares outstanding......... 48,894,173 44,353,992
=========== ===========
Weighted-average diluted shares outstanding....... 48,894,173 44,353,992
=========== ===========
See accompanying notes to unaudited condensed consolidated financial statements.
5
EasyLink Services Corporation
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Six Months Ended June 30,
-------------------------
2006 2005
------- ---------
(revised)
Cash flows from operating activities:
Net loss........................................... $ (464) $(1,977)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation.................................... 1,421 1,715
Amortization of intangible assets............... 485 1,182
Issuance of shares as matching contributions to
employee benefit plans....................... 218 247
Separation agreement Costs...................... -- 2,312
Other........................................... 90 (66)
Changes in operating assets and liabilities:
Accounts receivable............................. (650) (589)
Prepaid expenses and other current assets....... 86 336
Accounts payable, accrued expenses and other
liabilities.................................. (543) (3,908)
------- -------
Net cash provided by (used in) operating
activities -- continuing operations............. 643 (748)
------- -------
Net cash provided by operating
activities -- discontinued operations........... -- 400
------- -------
Net cash provided by (used in) operating
activities...................................... 643 (348)
------- -------
Cash flows from investing activities:
Purchases of property and equipment, including
capitalized software............................ (812) (3,089)
------- -------
Net cash used in investing activities.............. (812) (3,089)
------- -------
Cash flows from financing activities:
Proceeds of bank loan advances..................... -- 950
Repayment of bank loan advances.................... (950) --
Payments under capital lease obligations........... (25) (271)
Proceeds from issuance of stock.................... 5,405 96
Principal payments of notes payable................ (4,200) (2,625)
------- -------
Net cash provided by (used in) financing
activities 230 (1,850)
------- -------
Effect of foreign exchange rate changes on cash and
cash equivalents................................ (78) 143
------- -------
Net decrease in cash and cash equivalents.......... (17) (5,144)
Cash and cash equivalents at beginning of the
period.......................................... 6,282 12,216
------- -------
Cash and cash equivalents at end of the period..... $ 6,265 $ 7,072
======= =======
Supplemental disclosure of cash flow information:
Cash paid for interest............................. $ 633 $ 290
Net cash paid for taxes............................ $ 47 $ 134
Purchase of property, plant and equipment through
capital lease obligations.......................... -- $ 91
See accompanying notes to unaudited condensed consolidated financial statements.
6
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
(a) Summary of Operations
Easylink Services Corporation (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 June
30, 2006 and for the three and six month periods ended June 30, 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
the Company as of June 30, 2006 and the consolidated results of operations and
cash flows for the interim periods ended June 30, 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 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 is for working capital purposes.
7
Subsequent to June 30, 2006 the Company entered into a new $6 million credit
facility with CAPCO Financial Company, a division of Greater Bay Bank N.A.
("CAPCO"). Advances under the new facility are limited to 80% to 85% of certain
of the Company's accounts receivable. On July 27, 2006 the Company drew down an
initial advance of $5.9 million and used the funds to pay off its existing loan
balance with Wells Fargo, along with other fees and expenses. The Wells Fargo
loan facility was terminated upon payoff. See Note 3.
(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 June 30, 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) Revenue Recognition
The Company derives revenues from monthly fees and usage-based charges for its
transaction delivery and management services and from license fees. Revenue from
services is recognized as the services are performed. Facsimile license revenue
is recognized over the average estimated customer life of 3 years.
During the three months ended June 30, 2006 the Company recorded revenue related
to the sale, including training and support services, of a license to the source
code of its Quickstream software. The revenue related to this transaction will
be recognized over the contractual customer support period of four months in
accordance with the provisions of AICPA Statement of Position (SOP) 97-2
(Software Revenue Recognition). The amount of revenue recorded in the second
quarter was $124,000 and the balance of the sale, amounting to $866,000, will be
recorded as revenue in subsequent periods.
(h) 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 June 30, 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 notes payable approximate their fair values,
as interest approximates market rates.
8
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 and six month
periods ended June 30, 2006 and 2005 and no account receivable from a single
customer exceeded 10% of total accounts receivable as of June 30, 2006 and
December 31, 2005. Revenues from the Company's five largest customers accounted
for an aggregate 13% of the Company's total revenues for the three and six
months ended June 30, 2006 and 12% for the three and six months ended June 30,
2005.
(i) 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 ("ABP 25"). 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 $.92
per share to avoid the recording of expense related to those options in 2006
when the Company adopted SFAS 123(R) and periods thereafter. The Company adopted
SFAS 123(R) in the first quarter of 2006 and in accordance with its provisions
recognized compensation expense for all share-based payments, including employee
stock options based on the grant-date fair value of those awards. A total of
$191,000, including $149,000 for the executive incentive compensation plan and
$42,000 for employee stock options, was expensed in the three months ended June
30, 2006 and a total of $353,000, including $281,000 for the for the executive
incentive compensation plan and $72,000 for employee stock options, was expensed
in the six months ended June 30, 2006.
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. The Company recorded
$149,000 and $281,000 of expense for the three and six months ended June 30,
2006 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.
Employee stock purchase plan
On June 20, 2006, the stockholders of the Company approved the EasyLink Services
Corporation Employee Stock Purchase Plan (the "ESPP"). The purpose of the ESPP
is to provide an incentive to a broad-based group of the Company's employees to
acquire a proprietary interest in the Company, to continue their positions with
the Company and to increase their efforts on the Company's behalf. An aggregate
of 2,000,000 shares of Class A common stock has been reserved for issuance under
the ESPP. The Company has not yet implemented the ESPP and, accordingly, no
shares of stock have been sold thereunder.
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 a total of 8,075,000 shares were originally reserved for awards, of which
3,258,231 shares are available for future awards as of June 30, 2006. In 2006,
the 2005 Stock and Incentive Plan was amended to increase shares available for
grant from 1 million to 3 million. 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 7 to 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 $42,000 and $72,000 for the three and six month
periods ended June 30, 2006 respectively. If the fair-value-based method in
9
accordance with SFAS 123(R) had been applied to all option grants outstanding as
of June 30, 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 $468,000 of total unrecognized
compensation cost related to nonvested options as of June 30, 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 and six months ended June 30,
2006, amounting to approximately $55,000 and $119,000 respectively are estimated
as of the date of grant using the Black Scholes method option-pricing model with
the following assumptions: dividend yield of 0%, average risk-free interest rate
of 4.7%, expected life of 6 years and volatility of 104%.
A summary of the Company's stock option activity and weighted average exercise
prices during the six months ended June 30, 2006 is as follows:
Weighted Average
Options Exercise Price
--------- ----------------
Options outstanding at January 1, 2006 5,152,135 $ 3.42
Options granted 200,000 $ 0.71
Options canceled or expired (145,809) $20.76
--------- ------
Options outstanding at June 30, 2006 5,206,326 $ 2.83
The following table summarizes information about stock options outstanding and
exercisable at June 30, 2006.
Options Outstanding Options Exercisable
Actual ------------------------------------------------- ------------------------------
Range of Number Weighted-Average Number
Exercise Prices Outstanding Remaining Weighted-Average Exercisable Weighted-Average
150% increment at 06/30/06 Contractual Life Exercise Price at 06/30/06 Exercise Price
--------------- ----------- ---------------- ---------------- ----------- ----------------
$0.53- 0.79 656,400 7.6 $ 0.62 367,650 $ 0.54
$0.81- 1.15 1,425,613 7.4 $ 0.97 1,000,613 $ 1.00
$1.23- 1.75 2,021,050 7.2 $ 1.28 1,969,800 $ 1.28
$1.88- 2.80 562,321 5.2 $ 2.16 562,321 $ 2.16
$3.00- 4.20 41,203 5.3 $ 3.91 41,203 $ 3.91
$4.80- 7.19 30,980 1.6 $ 5.22 30,980 $ 5.22
$7.50- 10.94 18,665 1.3 $ 9.71 18,665 $ 9.71
$12.81- 16.88 375,994 3.8 $ 15.02 375,994 $ 15.02
$20.00- 20.00 8,182 1.5 $ 20.00 8,182 $ 20.00
$32.44- 35.00 42,638 1.6 $ 34.99 42,638 $ 34.99
$50.00- 64.10 21,859 2.7 $ 50.22 21,859 $ 50.22
$118.60-175.00 1,421 3.6 $167.35 1,421 $167.35
-------------- --------- --- ------- --------- -------
$0.53-175.00 5,206,326 6.7 $ 2.83 4,441,326 $ 3.17
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 and six months ended June 30, 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 0%, average risk-free interest rate of 3.9%,
expected life of 5 years and volatility of 119%.
10
($ in thousands, except per share amounts) For the three months For the six months
ended June 30, 2005 ended June 30, 2005
-------------------- -------------------
Net income (loss):
Net income (loss), as reported ................... $ 766 $(1,977)
Deduct: total stock based employee compensation
determined under the fair value method for all
awards, net of tax ......................... (161) (311)
------ -------
Pro forma net income (loss) ...................... $ 605 $(2,288)
====== =======
Basic and diluted net income (loss) per share:
Net income (loss) per share, as reported ......... $ 0.02 $ (0.04)
Deduct: total stock based employee compensation
determined under the fair value method for all
awards, net of tax ......................... (0.01) (0.01)
------ -------
Pro forma net income (loss) per share ............ $ 0.01 $ (0.05)
====== =======
(j) Recent Accounting Pronouncements
In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109 ("FIN
48"). FIN 48 provides recognition criteria and a related measurement model for
tax positions taken by companies. In accordance with FIN 48, a tax position is a
position in a previously filed tax return or a position expected to be taken in
a future tax filing that is reflected in measuring current or deferred income
tax assets and liabilities. Tax positions shall be recognized only when it is
more likely than not (likelihood of greater than 50%), based on technical
merits, that the position will be sustained upon examination. Tax positions that
meet the more likely than not threshold should be measured using a probability
weighted approach as the largest amount of tax benefit that is greater than 50%
likely of being realized upon settlement. FIN 48 is effective for fiscal years
beginning after December 15, 2006 and the Company will adopt FIN 48 as of
January 1, 2007. The Company is currently evaluating the provisions of FIN 48 to
determine the potential impact, if any, the adoption will have on the Company's
financial statements.
(2) CARRIER SETTLEMENT AGREEMENT
In November 2005, the Company entered into a Settlement Agreement with Verizon
Business, formerly MCI ("MCI"), related to certain accounts receivable and
accounts payable balances with MCI that were outstanding prior to MCI's
bankruptcy filing in 2002. The agreement also included a settlement of claims
made by the Company that MCI had charged, and the Company had paid, amounts for
telecommunications services from MCI in excess of the contracted rates prior to
the bankruptcy filing. As a result of the settlement, the Company recorded a
$110,000 reduction of its bad debt expense representing the recovery of the
accounts receivable balance from MCI and recorded a reduction in its cost of
service for $540,000 representing the recovery of charges stemming from its
claim of excess telecommunication charges by MCI in the quarter ended June 30,
2005.
(3) LOANS AND NOTES PAYABLE
11
Loans and notes payable include the following, in thousands:
June 30, 2006 Dec. 31, 2005
------------- -------------
Term loan payable $5,400 $ 9,600
Advances -- 950
------- -------
Total loans and notes payable 5,400 10,550
======= =======
The Term loan payable as of June 30, 2006 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 8.25% as of June 30,
2006. As part of the original credit facility the Company could 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 with Wells Fargo 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 required 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 June 30, 2006 and December 31, 2005, the total outstanding
obligations under the credit agreement have been included in current liabilities
in the consolidated balance sheets.
Subsequent to June 30, 2006 the Company entered into a new $6.0 million credit
facility with CAPCO. The facility provides for advances, subject to a maximum of
80% to 85% of certain accounts receivable of the Company, that bear interest at
the rate of 2% over the prime rate of Greater Bay Bank. The facility has an
initial term of 24 months, but can be terminated by CAPCO after 12 months upon
90 days prior written notice if the Company should fail to meet CAPCO's then
existing underwriting credit criteria. All assets of the Company in the United
States are pledged as collateral to CACPO but there are no financial covenants
under the new facility. On July 27, 2006 the Company drew down an initial
advance of $5.9 million and used the proceeds to pay off the outstanding loan
balance with Wells Fargo, along with other related fees and expenses.
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 June 30, 2006 and December 31, 2005, $591,000 and $565,000, respectively,
related to the agreement are included in accrued expenses and $388,000 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
and six month periods ended June 30, 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 June 30, 2006 and 2005, the Company calculated its actual
effective tax rate to be 584% and 27%, respectively. For the six months ended
June 30, 2006 and 2005, the Company calculated its actual effective tax rate to
be 37% and 6%, respectively. The effective rates for the periods in 2006 and
2005 vary from the standard tax rates primarily due to (1) losses in foreign
entities for which the Company has no available tax credits; (2) the utilization
of available net operating losses for income tax purposes which were previously
subject to a valuation allowance; and (3) state income taxes, including minimum
taxes, of the Company and certain United States entities of the Company that
cannot be reduced by net operating losses or losses in other United States
entities of the Company.
(6) STOCKHOLDERS' EQUITY
Common Stock
During the six months ended June 30, 2006 the Company issued 295,623 shares of
Class A common stock valued at approximately $218,000 in connection with
matching contributions to its 401(k) plan.
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 valued at approximately $5.4 million.
Accumulated other comprehensive loss
The Company's comprehensive loss as of June 30, 2006 and 2005 is comprised of
net income (loss), unrealized holding losses on marketable securities, in 2005
only, and cumulative foreign currency translation gains (losses). Comprehensive
income (loss) for the three and six month periods ended June 30, 2006 and 2005
was as follows:
Three months Six months
ended June 30, ended June 30,
-------------- ---------------
2006 2005 2006 2005
----- ------ ----- -------
Net income (loss) $(89) $ 766 $(464) $(1,977)
Unrealized holding losses on
marketable securities -- (388) -- (520)
Cummulative foreign currency
translation gains (losses) 84 126 (60) 151
---- ----- ----- -------
Comprehensive income (loss) $ (5) $ 504 $(524) $(2,346)
13
(7) 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 services superseding several similar
previous agreements. 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
contains a termination charge of 50% of the unsatisfied minimum purchase
commitment.
Other Telecommunication Services
The Company has committed to purchase from Verizon Business (formerly MCI) a
minimum of $900,000 per year in other telecommunication services for two years
through March 2007.
Legal proceedings
On November 14, 2005, a former Turkish-based reseller of the Company named
Arisegroup and its principals filed what purported to be a derivative complaint
on behalf of a recently formed Turkish entity against the Company, certain of
the Company's current and former directors and officers and Swift Comtext
Limited, a UK subsidiary of the Company, in New York. The Company believes that
the allegations against the Company and the individual defendants are without
merit and the Company and, to the Company's knowledge, the other defendants have
not been served within the stipulated time period for such action. Accordingly,
the Company has reversed reserves of approximately $200,000 previously provided
for the disputed amounts related to this claim in the three months ended June
30, 2006.
On August 2, 2006, Dynamic Depth, Inc. filed a complaint against the Company in
the United States District Court for the Central District of California. The
complaint alleges that the systems and methods employed by the Company in
providing its "Fax to E-Mail Plus" and "Fax to Database" services infringe one
or more claims of a patent owned by Dynamic Depth. Dynamic Depth is seeking to
recover damages in an amount "of at least a reasonable royalty". The Company
will defend itself vigorously in this litigation but cannot predict its outcome.
ITEM 2 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 condensed 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 six months ended June 30, 2006, we reported a net loss of $464,000 in
comparison to a net loss of $2.0 million for the same period in 2005. The prior
year's results include a charge of $2.3 million before income taxes (credits)
related to the separation agreement with our former head of the international
division. In comparing the results for the six months ended June 30, 2006 to the
six months ended June 30, 2005, revenues were down by $3.1 million or 7.8% and
cost of revenues increased by $0.6 million resulting in lower gross profit of
$3.7 million. Reductions in sales and marketing spending of $935,000 in the 2006
period as compared to 2005 and reductions in general and administrative costs of
$792,000 partially offset that impact.
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, accruals 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 JUNE 30, 2006 COMPARED TO THREE
MONTHS ENDED JUNE 30, 2005
REVENUES
For the quarter ended June 30, 2006 total revenues were $18.9 million in
comparison to $20.1 million for the same quarter in 2005. As detailed in the
schedule below the decline in revenue is attributable to lower revenues in our
Transaction Delivery Services amounting to $2.1 million or 13% partially offset
by increased revenues in our Transaction Management Services of $911,000
representing 23% growth over 2005.
Change
-------------
2006 2005 $ %
------- ------- ------- ---
Transaction Management Services $ 4,912 $ 4,001 $ 911 23 %
Transaction Delivery Services 13,940 16,069 (2,129) (13)%
------- ------- ------- ---
$18,852 $20,070 $(1,218) (6)%
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. This has 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 are expanding our newer Transaction Management
Services and upgrading 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.
For the three months ended June 30, 2006 Transaction Management Services include
$124,000 from the sale of a non-exclusive license of the Company's Quickstream
software. The balance of the sale, amounting to $866,000, will be recorded in
subsequent periods over the contractual customer support period. $742,000 will
be recorded as revenue in the third quarter of 2006 and $124,000 will be
recorded as revenue in the fourth quarter of 2006.
COST OF REVENUES
Cost of revenues for the three months ended June 30, 2006 increased to $7.9
million from $7.0 million in the same quarter of 2005. As a percentage of
revenues these costs increased to 42% in 2006 as compared to 35% in 2005. The
higher costs and higher percentage of revenues are partially attributable to
additional costs incurred in 2006 in connection with our migration of operations
to our new data center and partially due to a credit of $540,000, or 3% of
revenues, in 2005 from the settlement of our claims against Verizon Business
(formerly MCI) for the previous payment of excess carrier charges. Cost of
revenues is expected to remain at the current level until the migration is
completed in the second half 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 $4.5 million in the three months ended
June 30, 2006 from $4.9 million in the same quarter of 2005. The lower costs
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 trends to continue throughout
2006.
15
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were $4.6 million in the three months ended
June 30, 2006 and 2005. We anticipate general and administrative expenses to be
comparable to these results in the ensuing quarterly periods of 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 June
30, 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.
RESULTS OF OPERATIONS - SIX MONTHS ENDED JUNE 30, 2006 COMPARED TO SIX MONTHS
ENDED JUNE 30, 2005
REVENUES
For the six months ended June 30, 2006 total revenues were $37.3 million in
comparison to $40.4 million for the same period in 2005. As detailed in the
schedule below the decline in revenue is attributable to lower revenues in our
Transaction Delivery Services amounting to $4.9 million or 15% partially offset
by increased revenues in our Transaction Management Services of $1.8 million
representing 23% growth over 2005.
Change
--------------
2006 2005 $ %
------- ------- ------- ----
Transaction Management Services $ 9,514 $ 7,704 $ 1,810 23%
Transaction Delivery Services 27,799 32,744 (4,945) (15)%
------- ------- ------- ---
$37,313 $40,448 $(3,135) (8)%
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. This has 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 are expanding our newer Transaction Management
Services and upgrading 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 six months ended June 30, 2006 increased to $15.4
million from $14.8 million in the same period of 2005. As a percentage of
revenues these costs increased to 41% in 2006 as compared to 36% in 2005. The
higher costs and higher percentage of revenues are partially attributable to
additional costs incurred in 2006 in connection with our migration of operations
to our new data center and partially due to a credit of $540,000, or 1.3% of
revenues, in 2005 from the settlement of our claims against Verizon Business
(formerly MCI) for the previous payment of excess carrier charges.
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.
16
SALES AND MARKETING EXPENSES
Sales and marketing expenses decreased to $9.1 million in the six months ended
June 30, 2006 from $10.0 million in the same period of 2005. The lower costs
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.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were $9.4 million in the six months ended
June 30, 2006 as compared to $10.2 million in the same period of 2005. The lower
cost results 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.
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 comparable from period to period as spending
amounted to $3.5 million and $3.4 million for the six months ended June 30, 2006
and 2005, respectively.
LIQUIDITY AND CAPITAL RESOURCES
During the six months ended June 30, 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 our
outstanding Term Loan with Wells Fargo as required by our amended Credit
Agreement and the balance of $2.4 million is for working capital purposes. The
financing increased our cash and cash equivalent position so that the balance at
June 30, 2006 remained unchanged from December 31, 2005 at $6.3 million. In
addition, our working capital deficit decreased to $3.5 million at June 30, 2006
as compared to $9.5 million at December 31, 2005.
Cash provided from operations amounted to $643,000 in the current period while
we spent $812,000 for capital expenditures and the net impact of all financing
activities, including those described above, amounted to an increase in cash of
$230,000.
Subsequent to June 30, 2006 we entered into a new $6.0 million credit facility
with CAPCO. The facility provides for advances, subject to a maximum of 80% to
85% of certain accounts receivable of the Company, that bear interest at the
rate of 2% over the prime rate of Greater Bay Bank. The facility has an initial
term of 24 months, but can be terminated by CAPCO after 12 months upon 90 days'
prior written notice if we should fail to meet CAPCO's then existing
underwriting credit criteria. There are no financial covenants under the new
facility. On July 27, 2006 we drew down an initial advance of $5.9 million and
used the proceeds to pay off the outstanding loan balance with Wells Fargo,
along with other related fees and expenses.
We believe the completed equity financing and the new credit facility have
significantly improved our liquidity and furthermore, we believe our current
cash and cash equivalent balances, the availability of funds under the new CAPCO
credit facility and cash from operations will provide adequate funds for
operating and other planned expenditures and debt service for at least the next
twelve months.
For each of the years ended December 31, 2005 and 2004, we received a report
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 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 our 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 our ability to continue as a going concern is dependent upon
our ability to generate sufficient cash flow to meet our obligations on a timely
basis, to obtain additional financing or refinancing as may be required, and to
maintain profitable operations.
17
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk, primarily from changes 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. Our Credit Agreement with Wells Fargo
and the new CAPCO credit facility create an interest rate risk for the Company
on all its outstanding debt. The impact of this risk, assuming the current debt
balance remains outstanding and assuming a hypothetical shift of 1% in interest
rates, would be an increase or decrease, as applicable, in annual interest costs
of $54,000. 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 Securities Exchange Act of 1934 (the "Exchange Act"), is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange 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 it files or submits under
the Exchange Act is accumulated and communicated to the Company's management,
including its 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, the Company's
management has evaluated the effectiveness of the design and operation of the
Company's 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 the Company's 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 June 30, 2006, the Company's disclosure controls and
procedures were not effective.
Changes in Internal Control Over Financial Reporting
Since November 2005, the Company has been implementing the changes in its
internal control over financial reporting described below in this Item 4 to
address certain identified material weaknesses which contributed to the
restatement of its 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. The identified material weaknesses in internal control over financial
reporting were as follows:
18
1. 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.
2. 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.
Remediation Measures for Identified Material Weaknesses
During November 2005, the Company made the following changes in its 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 its 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.
The Company is continuing to monitor and enhance these changes in order to
insure that its disclosure controls and procedures are effective in future
periods.
PART II OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
On November 14, 2005, a former Turkish-based reseller of the Company named
Arisegroup and its principals filed what purported to be a derivative complaint
on behalf of a recently formed Turkish entity against the Company, certain of
the Company's current and former directors and officers and Swift Comtext
Limited, a UK subsidiary of the Company, in the Supreme Court of the State of
New York, County of New York. The complaint alleges breach of contract, tortuous
interference with contract, unjust enrichment, conversion, misappropriation of
corporate opportunity, breach of fiduciary duties and fraud in the inducement
and makes a claim for an accounting. The complaint seeks relief in the form of,
among other relief, compensatory damages "in an amount in excess of $5,000,000",
punitive damages "in an amount in excess of $10,000,000," pre-judgment interest
and costs. The complaint arises out of the termination of a reseller/sponsorship
arrangement between Arisegroup and the Company and alleges the defendants agreed
to establish and operate a corporation to conduct and expand the Company's
business in Turkey and that "plaintiffs" would own 50% of the corporation. The
Company believes that the allegations against the Company and the individual
defendants are without merit and the Company and, to the Company's knowledge,
the other defendants have not been served within the stipulated time period for
such action.
On August 2, 2006, Dynamic Depth, Inc. filed a complaint against the Company in
the United States District Court for the Central District of California. The
complaint alleges that the systems and methods employed by the Company in
providing its "Fax to E-Mail Plus" and "Fax to Database" services infringe one
or more claims of a patent owned by Dynamic Depth. Dynamic Depth is seeking to
recover damages in an amount "of at least a reasonable royalty". The Company
will defend itself vigorously in this litigation but cannot predict its outcome.
19
ITEM 1A: RISK FACTORS
Other than discussed below, there have been no material changes to the Risk
Factors as previously disclosed in our Form 10-K for the year ended December 31,
2005 and our Form 10-Q for the quarter ended March 31, 2006.
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 June 30, 2006, we had outstanding indebtedness under our credit facility
of $5.4 million, obligations under office space leases and commitments for
telecommunications services. Subsequent to June 30, 2006, we entered into a new
$6.0 million credit facility with CAPCO. The facility provides for advances,
subject to a maximum of 80% to 85% of certain of our accounts receivable, that
bear interest at the rate of 2% over the prime rate of Greater Bay Bank. The
facility has an initial term of 24 months, but can be terminated by CAPCO after
12 months upon 90 days' prior written notice if we should fail to meet CAPCO's
then existing underwriting credit criteria. There are no financial covenants
under the new facility. On July 27, 2006 we drew down an initial advance of $5.9
million and used the proceeds to pay off the outstanding loan balance with Wells
Fargo, along with other related fees and expenses.
If our revenues decline and we are not able to correspondingly reduce expenses,
there is no assurance 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 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.
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 BE UNABLE TO SUCCESSFULLY COMPLETE THE MIGRATION OF THE NETWORK RELATING
TO OUR BUSINESS ACQUIRED FROM AT&T OFF OF AT&T PREMISES.
A small portion of the network for the part 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 us. This agreement has been
extended after June 30, 2006 to allow us to move the remaining portion of our
operations that still resides on AT&T premises. We built a new network center at
our corporate headquarters located in Piscataway, New Jersey and have
successfully completed the migration of substantially all of these operations to
this center. We expect to complete the migration of the remaining operations and
affected customers by September 30, 2006.
20
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 periodic Securities and Exchange Commission reporting
requirements and that we maintain compliance with various other standards.
On August 23, 2005, we received notice from The Nasdaq Stock Market, Inc.
Listing Qualifications Staff that for 30 consecutive trading days the bid price
of our 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 we were unable to regain compliance with the Minimum Bid
Price Rule by the expiration of the original 180 day grace period, or February
21, 2006, we applied to transfer the listing of our common stock from the Nasdaq
National Market to the Nasdaq Capital Market. The Staff of Nasdaq notified us
that our application to transfer our listing to the Nasdaq Capital Market was
approved on February 16, 2006. On February 22, 2006, we received notice from
Nasdaq that it had determined that we were 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, we have until August 21, 2006 to
comply with the $1.00 minimum closing bid price requirement on the Nasdaq
Capital Market. We would be able to regain compliance with the minimum bid price
rule if, at any time before August 21, 2006, the bid price of our 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 us 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 we have demonstrated the ability to maintain long-term compliance. We do
not expect to regain compliance with the Minimum Bid Price Rule on or before
August 21, 2006 and expect to be formally notified of our failure promptly after
August 21, 2006.
The Board of Directors has approved, subject to approval of the Company's
stockholders, the implementation of a reverse stock split to regain compliance
with the Minimum Bid Price Rule. Accordingly, we have scheduled a special
meeting of stockholders for August 24, 2006 to consider and vote on the
proposal. The Company's Board of Directors believes the implementation of the
reverse stock split, if approved by its stockholders, will result in an increase
in the minimum bid price of our Class A Common Stock to above the $1.00 per
share minimum mandated by the Nasdaq Capital Market for continued listing and
enable our Class A Common Stock to continue to trade on the Nasdaq Capital
Market. However, while we believe that implementation of a reverse stock split
is a satisfactory mechanism to achieve compliance with Nasdaq's maintenance
requirements of the Nasdaq Capital Market, there can be no assurance that, even
if the bid price for our Class A Common Stock exceeds the $1.00 minimum
threshold for the mandated period as a result of one or more reverse stock
splits, the Nasdaq Capital Market will deem the Company to be in compliance and
will not delist our Class A Common Stock.
If we are unable regain compliance, or thereafter maintain compliance, with the
$1 minimum bid price requirement, our securities will be subject to delisting
from the Nasdaq Capital Market.
If our common stock were to be delisted from trading on the Nasdaq Capital
Market and were neither re-listed thereon nor listed for trading on another
recognized securities exchange, trading, if any, in our 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 our Class A common stock and limited news coverage of the Company 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.
ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Recent Sales of Unregistered Securities
During the three months ended June 30, 2006, the Company issued 159,277 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 of 1933, as amended because
the issuance of the shares was not voluntary and contributory on the part of
employees.
21
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Annual Meeting of Shareholders of the Company was held on June 20, 2006.
(b) Each of the persons named in the Company's proxy statement as a nominee for
director was elected.
(c) The following are the voting results on each of the matters that were
submitted to the shareholders:
FOR WITHHELD ABSTAIN BROKER NON-VOTE
---------- --------- -------------- ---------------
ELECTION OF DIRECTORS
Robert Casale 43,756,329 328,912 Not applicable Not applicable
Stephen Duff 43,769,526 315,715 Not applicable Not applicable
Peter Holzer 43,753,934 331,307 Not applicable Not applicable
George Knapp 43,751,226 334,015 Not applicable Not applicable
Thomas Murawski 43,720,439 364,802 Not applicable Not applicable
John Petrillo 43,780,415 304,826 Not applicable Not applicable
Dennis Raney 43,657,345 427,896 Not applicable Not applicable
Eric Zahler 43,763,055 322,186 Not applicable Not applicable
PROPOSALS
To approve the amendment to the 19,310,307 1,019,091 31,457 23,724,385
EasyLink Services Corporation
2005 Stock and Incentive Plan
To approve the EasyLink Services 19,602,930 716,548 41,376 23,724,386
Employee Stock Purchase Plan
To ratify the appointment of 43,770,463 285,508 29,269 Not applicable
independent auditors
Based on the above voting results, all of the above proposals were approved at
the meeting. The text of the matters referred to under this Item 4 is set forth
in the definitive proxy statement previously filed with the Securities and
Exchange Commission and incorporated herein by reference.
22
ITEM 6: EXHIBITS
The following exhibits are filed as part of this report:
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 the 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
23
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Easylink Services Corporation
(Registrant)
/s/ Michael A. Doyle
Date: August 11, 2006 ----------------------------------------
Michael A. Doyle
Vice President and Chief Financial
Officer
(Principal financial officer and duly
authorized signatory)
24
EXHIBIT INDEX
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 the 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
25