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 SEPTEMBER 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 October 31, 2006: Class A common stock $0.01 par
value 10,944,507 shares.
1
EASYLINK SERVICES CORPORATION
SEPTEMBER 30, 2006
FORM 10-Q
INDEX
PAGE
NUMBER
------
PART I: FINANCIAL INFORMATION
Item 1: Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets as of September 30, 2006
(unaudited) and December 31, 2005................................. 3
Unaudited Condensed Consolidated Statements of Operations for
the three months ended September 30, 2006 and 2005................ 4
Unaudited Condensed Consolidated Statements of Operations for
the nine months ended September 30, 2006 and 2005................. 5
Unaudited Condensed Consolidated Statements of Cash Flows for
the nine months ended September 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......................................... 13
Item 3: Quantitative and Qualitative Disclosures About Market Risk....... 16
Item 4: Controls and Procedures.......................................... 17
PART II: OTHER INFORMATION
Item 1: Legal Proceedings................................................ 17
Item 1A: Risk Factors..................................................... 17
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds...... 18
Item 4: Submission of Matters to a Vote of Security Holders.............. 18
Item 6: Exhibits......................................................... 19
Signatures................................................................ 20
2
EasyLink Services Corporation
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
September 30, December 31,
2006 2005
------------- -------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents.................................................. $ 6,172 $ 6,282
Accounts receivable, net of allowance for doubtful accounts of $1,864 and
$2,330 as of September 30, 2006 and December 31, 2005, respectively........ 10,829 11,416
Prepaid expenses and other current assets.................................. 2,798 2,653
--------- ---------
Total current assets....................................................... 19,799 20,351
Property and equipment, net................................................ 9,577 10,252
Goodwill, net.............................................................. 6,213 6,213
Other intangible assets, net............................................... 5,698 6,264
Other assets............................................................... 221 895
--------- ---------
Total assets............................................................... $ 41,508 $ 43,975
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable........................................................... $ 5,320 $ 6,464
Accrued expenses........................................................... 9,756 10,432
Loans and notes payable.................................................... 5,421 10,550
Other current liabilities.................................................. 1,315 2,395
--------- ---------
Total current liabilities.................................................. 21,812 29,841
Long term liabilities...................................................... 1,388 1,753
--------- ---------
Total liabilities.......................................................... 23,200 31,594
--------- ---------
Stockholders' equity:
Common stock:
Class A--500,000,000 shares authorized at September 30, 2006 and December 31,
2005, 10,939,771 and 9,045,026 shares issued and outstanding at September
30, 2006 and December 31, 2005, respectively............................... 109 90
Additional paid-in capital................................................. 560,540 554,699
Accumulated other comprehensive loss....................................... (635) (670)
Accumulated deficit........................................................ (541,706) (541,738)
--------- ---------
Total stockholders' equity................................................. 18,308 12,381
--------- ---------
Commitments and contingencies
Total liabilities and stockholders' equity................................. $ 41,508 $ 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 September 30,
--------------------------------
2006 2005
----------- -----------
Revenues ........................................................ $ 18,689 $ 19,701
Cost of revenues ................................................ 6,872 8,169
------------ ------------
Gross profit .................................................... 11,817 11,532
------------ ------------
Operating expenses:
Sales and marketing ............................................. 4,698 4,732
General and administrative ...................................... 4,925 5,206
Product development ............................................. 1,775 1,696
Amortization of intangible assets ............................... 43 517
Loss on sale of fax businesses .................................. --- 250
------------ ------------
11,441 12,401
------------ ------------
Income (loss) from operations ................................... 376 (869)
------------ ------------
Other income (expense), net:
Interest income ................................................. 58 30
Interest expense ................................................ (693) (336)
Gain on domain names repurchase agreement ....................... --- 1,907
Other, net ...................................................... 112 (453)
------------ ------------
Total other income (expense), net ............................... (523) 1,148
------------ ------------
Income (loss) before income taxes ............................... (147) 279
Provision (credit) for income taxes ............................. 284 (65)
------------ ------------
Income (loss) from continuing operations ........................ (431) 344
Income from discontinued operations ............................. 928 ---
------------ ------------
Net income ...................................................... $ 497 $ 344
============ ============
Basic and diluted net income (loss) per share:
Income (loss) per share from continuing operations .............. $ (0.04) $ 0.04
Income per share from discontinued operations ................... 0.08 ---
------------ ------------
Net income per share ............................................ $ 0.04 $ 0.04
============ ============
Weighted-average basic shares outstanding ....................... 10,919,416 8,974,758
============ ============
Weighted-average diluted shares outstanding ..................... 10,930,313 9,007,288
============ ============
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)
Nine Months Ended September 30,
-------------------------------
2006 2005
------------ ------------
Revenues ................................................... $ 56,001 $ 60,149
Cost of revenues ........................................... 22,230 22,925
------------ ------------
Gross profit ............................................... 33,771 37,224
------------ ------------
Operating expenses:
Sales and marketing ........................................ 13,757 14,726
General and administrative ................................. 14,316 15,390
Product development ........................................ 5,258 5,094
Separation agreement costs ................................. -- 2,312
Amortization of intangible assets .......................... 444 1,551
Loss on sale of fax businesses ............................. -- 250
------------ ------------
33,775 39,323
------------ ------------
Loss from operations ....................................... (4) (2,099)
------------ ------------
Other income (expense), net:
Interest income ............................................ 166 83
Interest expense ........................................... (1,335) (994)
Gain on domain names repurchase agreement .................. --- 1,907
Other, net ................................................. 288 (489)
------------ ------------
Total other income (expense), net .......................... (881) 507
------------ ------------
Loss before income taxes ................................... (885) (1,592)
Provision for income taxes ................................. 11 40
------------ ------------
Net loss from continuing operations ........................ (896) (1,632)
Income from discontinued operations ........................ 928 ---
------------ ------------
Net income (loss) .......................................... $ 32 $ (1,632)
============ ============
Basic and diluted net income (loss) per share:
Income (loss) per share from continuing operations ......... $ (0.09) $ (0.18)
Income per share from discontinued operations .............. 0.09 ---
------------ ------------
Net loss per share ......................................... $ --- $ (0.18)
============ ============
Weighted-average basic shares outstanding .................. 10,163,206 8,905,832
============ ============
Weighted-average diluted shares outstanding ................ 10,183,128 8,905,832
============ ============
See accompanying notes to unaudited condensed consolidated financial statements.
5
EasyLink Services Corporation
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Nine Months Ended September 30,
---------------------------------
2006 2005
---------- ---------
Cash flows from operating activities:
Net income (loss)......................................................... $ 32 $ (1,632)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Income from discontinued operations - reversal of litigation
reserve ............................................................... (928) ---
Depreciation .......................................................... 2,127 2,426
Amortization of intangible assets ..................................... 566 1,762
Loss on sale of marketable securities ................................. --- 469
Loss on sale of fax businesses ........................................ --- 250
Gain on sale of domain names repurchase agreement ..................... --- (1,907)
Debt termination fee .................................................. 300 ---
Issuance of shares as matching contributions to employee benefit
plans ................................................................. 345 374
Separation agreement costs ............................................ --- 2,312
Other ................................................................. 337 112
Changes in operating assets and liabilities of continuing operations:
Accounts receivable ................................................... 782 305
Prepaid expenses and other assets ..................................... 111 201
Accounts payable, accrued expenses and other liabilities .............. (2,297) (4,214)
-------- --------
Net cash provided by operating activities -- continuing
operations ............................................................... 1,375 458
Net cash provided by operating activities -- discontinued
operations ............................................................... --- 400
-------- --------
Net cash provided by operating activities ................................ 1,375 858
-------- --------
Cash flows from investing activities:
Purchases of property and equipment, including capitalized
software ................................................................. (1,558) (3,798)
Proceeds from sale of marketable securities .............................. --- 1,021
Proceeds from domain names repurchase agreement .......................... 500 830
Cash paid for Quickstream acquisition .................................... --- (342)
-------- --------
Net cash used in investing activities .................................... (1,058) (2,289)
-------- --------
Cash flows from financing activities:
Proceeds of loan advances ................................................ 13,700 1,900
Payment of loan advances ................................................. (9,229) (950)
Debt termination fee and deferred debt issuance costs .................... (645) ---
Payments under capital lease obligations ................................. (42) (324)
Proceeds from issuance of stock .......................................... 5,405 96
Principal payments of notes payable ...................................... (9,600) (3,225)
-------- --------
Net cash used in financing activities .................................... (411) (2,503)
-------- --------
Effect of foreign exchange rate changes on cash and cash equivalents ..... (16) 101
-------- --------
Net decrease in cash and cash equivalents ................................ (110) (3,833)
Cash and cash equivalents at beginning of the period ..................... 6,282 12,216
-------- --------
Cash and cash equivalents at end of the period ........................... $ 6,172 $ 8,383
======== ========
Supplemental disclosure of cash flow information:
Cash paid for interest ................................................... $ 835 $ 290
Net cash paid for taxes .................................................. $ 37 $ 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
September 30, 2006 and for the three and nine month periods ended September 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 September 30, 2006 and the consolidated results of
operations and cash flows for the interim periods ended September 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) Reverse Stock Split
Effective August 28, 2006, the Company authorized and implemented a 1-for-5
reverse stock split of all issued and outstanding Class A common stock.
Accordingly all issued and outstanding share and per share amounts in the
accompanying consolidated financial statements have been retroactively restated
to reflect the reverse stock split.
(d) 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
1.8 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.
In July 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.
7
(e) 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.
(f) 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.
(g) 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.
(h) 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 and nine month periods ended September 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 is being 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 three and nine month periods ended September 30, 2006 amounted
to $742,000 and $866,000, respectively. The balance of the sale, amounting to
$124,000, will be recorded as revenue in the three months ending December 31,
2006.
(i) 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 September 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 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 and nine month
periods ended September 30, 2006 and 2005 and no account receivable from a
single customer exceeded 10% of total accounts receivable as of September 30,
2006 and December 31, 2005. Revenues from the Company's five largest customers
accounted for an aggregate 15% and 13% of the Company's total revenues for the
three months ended September 30, 2006 and 2005, respectively, and 13% and 11%
for the nine months ended September 30, 2006 and 2005, respectively.
(j) 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
$170,000, including $132,000 for the executive incentive compensation plan and
$38,000 for employee stock options, was expensed in the three months ended
September 30, 2006 and a total of $523,000, including $413,000 for the executive
incentive compensation plan and $110,000 for employee stock options, was
expensed in the nine months ended September 30, 2006.
8
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 160,000 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 160,000 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
$132,000 and $413,000 of expense for the three and nine months ended September
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 400,000 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 had been sold thereunder as of September 30, 2006.
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 1,615,000 shares were originally reserved for awards, of which
700,000 shares are available for future awards as of September 30, 2006. In
2006, the 2005 Stock and Incentive Plan was amended to increase shares available
for grant from 200,000 to 600,000. 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 $38,000 and $110,000 for the three and nine month
periods ended September 30, 2006 respectively. If the fair-value-based method in
accordance with SFAS 123(R) had been applied to all option grants outstanding as
of September 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 $430,000 of total
unrecognized compensation cost related to nonvested options as of September 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 7.
There were no option grants made during the three months ended September 30,
2006. The fair value of option grants made in the nine months ended September
30, 2006, amounting to approximately $119,000, 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 nine months ended September 30, 2006 is as follows:
Weighted Average
Options Exercise Price
--------- ----------------
Options outstanding at January 1, 2006 ........ 1,030,427 $17.10
Options granted ............................... 40,000 $ 3.55
Vested Options Exercised ...................... (1,000) $ 2.67
Options canceled or expired ................... (81,369) $47.45
---------- ------
Options outstanding at September 30, 2006 ..... 988,058 $14.00
9
The following table summarizes information about stock options outstanding and
exercisable at September 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 09/30/06 Contractual Life Exercise Price at 09/30/06 Exercise Price
--------------- ----------- ---------------- ---------------- ----------- ----------------
$ 2.65 - 3.95 125,880 7.4 $ 3.11 74,130 $ 2.78
$ 4.05 - 5.75 273,383 7.1 $ 4.83 204,633 $ 4.95
$ 6.15 - 8.75 382,610 6.9 $ 6.38 372,796 $ 6.38
$ 9.40 - 14.00 105,301 4.9 $ 10.78 105,301 $ 10.78
$15.00 - 21.00 7,959 5.0 $ 19.55 7,959 $ 19.55
$24.00 - 35.95 6,145 1.3 $ 26.05 6,145 $ 26.05
$37.50 - 54.70 3,393 0.7 $ 49.66 3,393 $ 49.66
$64.05 - 84.40 68,607 3.6 $ 74.23 68,607 $ 74.23
$100.00 - 100.00 1,636 1.3 $100.00 1,636 $100.00
$162.20 - 875.00 13,144 1.8 $213.60 13,144 $213.60
---------------- --------- --- ------- --------- -------
$2.65- 875.00 988,058 6.5 $ 14.00 857,744 $ 15.49
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 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 income (loss) and net income (loss) per share for
the three and nine months ended September 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%.
($ in thousands, except per share amounts) For the three months For the nine months
ended Sept. 30, 2005 ended Sept. 30, 2005
--------------------- --------------------
Net income (loss):
Net income (loss), as reported......................... $ 344 $(1,632)
Deduct: total stock based employee compensation
determined under the fair value method for all
awards, net of tax..................................... (197) (508)
------ -------
Pro forma net income (loss)............................ $ 147 $(2,140)
====== =======
Basic net income (loss) per share:
Net income (loss) per share, as reported............... $ 0.04 $ (0.18)
Deduct: total stock based employee compensation
determined under the fair value method for all
awards, net of tax..................................... (0.02) (0.06)
------ -------
Pro forma net income (loss) per share.................. 0.02 (0.24)
====== =======
Diluted net income (loss) per share:
Net income (loss) per share, as reported............... $ 0.04 $ (0.18)
Deduct: total stock based employee compensation
determined under the fair value method for all
awards, net of tax..................................... (0.02) (0.06)
------ -------
Pro forma net income (loss) per share.................. $ 0.02 ($0.24)
====== =======
(k) 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.
10
In September 2006, the FASB issued Statement of Financial Accounting
Standards ("SFAS") No. 157, "Fair Value Measurements". SFAS No. 157 clarifies
the principle that fair value should be based on the assumptions market
participants would use when pricing an asset or liability and establishes a fair
value hierarchy that prioritizes the information used to develop those
assumptions. SFAS No. 157 requires fair value measurements to be separately
disclosed by level within the fair value hierarchy. SFAS No. 157 is effective
for financial statements issued for fiscal years beginning after November 15,
2007, and interim periods within those fiscal years. The Company is currently
evaluating the impact of adopting SFAS No. 157 on its future results of
operations and financial condition on January 1, 2008.
In September 2006, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") No. 108, "Considering the Effects of Prior Year
Misstatements When Quantifying Misstatements in Current Year Financial
Statements". SAB No. 108 provides interpretive guidance on the consideration of
the effects of prior year misstatements in quantifying current year
misstatements for the purpose of assessing materiality. SAB No. 108 is effective
for fiscal years ending after November 15, 2006. The Company is currently
evaluating the impact of adopting SAB No. 108 on its future results of
operations and financial condition upon its adoption in the fourth quarter of
2006.
(2) INCOME FROM DISCONTINUED OPERATIONS
The Company had previously provided a reserve of $928,000 for an unfavorable
judgment related to its discontinued World.com operations. The judgment was
reversed upon appeal by the Company and, after a lower court's consideration and
a favorable decision on a limited scope question specified by the appeals court,
the reserve was reversed in the current period. Although the other party has
filed a motion with the appeals court to overturn the decision, management
believes there is only a remote possibility that an unfavorable outcome to this
matter will occur.
(3) LOANS AND NOTES PAYABLE
Loans and notes payable include the following, in thousands:
September 30, 2006 Dec. 31, 2005
------------------ -------------
Advances ........................... $ 5,421 950
Term loan payable .................. --- $ 9,600
------- -------
Total loans and notes payable ...... $ 5,421 $10,550
======= =======
Advances payable at September 30, 2006 represent the Company's outstanding
balance under a new $6.0 million credit facility with CAPCO entered into in July
2006. 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. Accordingly, the debt has been classified as a
current liability. All assets of the Company in the United States are pledged as
collateral to CAPCO 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 then outstanding loan balance with Wells Fargo
Foothill (a subsidiary of Wells Fargo Bank), along with other related fees and
expenses. Costs incurred with the new financing, amounting to $345,000, have
been recorded as deferred financing costs and are being expensed over the
minimum term of fifteen months. As of September 30, 2006, $146,000 was available
under the facility for additional advances.
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 1.8 million shares of Class A common stock for $5.4 million and
made the required $3 million prepayment on the term loan. However, since the
Company's ability to meet the original and revised EBITDA covenants was
uncertain as of December 31, 2005, the total outstanding obligations under the
credit agreement were included in current liabilities in the consolidated
balance sheet as of that date.
11
The Advances payable and Term loan payable as of December 31, 2005 were part of
a $15 million credit facility with Wells Fargo. The Term loan was payable
monthly over 60 months with interest payable monthly at the rate of 3.75% over
the Wells Fargo prime rate. 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
included certain affirmative and restrictive covenants, including maintenance of
quarterly levels of EBITDA.
(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 September 30, 2006 and December 31, 2005, $600,000 and $565,000,
respectively, related to the agreement are included in accrued expenses and
$235,000 and $672,000, respectively, are included in other long term
liabilities.
(5) SALE OF FAX BUSINESSES IN SINGAPORE AND MALAYSIA
In September 2005, the Company entered into two separate agreements for the sale
of its fax businesses, including the customer bases and customer premise
equipment, in Singapore and Malaysia. Consideration for the sales is based on
future revenues and, net of future costs, for the Malaysia transaction. Because
of the contingent nature of the proceeds, the Company records these amounts as
received. For the three and nine month periods ended September 30, 2006, the
Company recorded proceeds of $48,000 and $117,000, respectively, as other
income. During the quarter ended September 30, 2005 the Company recorded a loss
on the sales of $250,000 representing the net book value of the businesses at
dates of sales.
(6) GAIN ON DOMAIN NAMES REPURCHASE AGREEMENT
In August 2005, the Company entered into an agreement to terminate its option to
purchase back the internet domain names it sold to its former Chairman in
December 2004 and to terminate its right to receive a share of the revenues from
the domain names for four years under the original agreement. The total
consideration amounted to $2 million consisting of $700,000 in cash, a
$1,130,000 non-interest bearing note and cancellation of $170,000 in severance
payments due to the former Chairman. The transaction resulted in a gain of
$1,907,000 after recording the note payable at its estimated fair value. The
Company received $500,000 and $130,000 of payments on the note in the nine
months ended September 30, 2006 and 2005, respectively. At September 30, 2006
the note balance of approximately $500,000, net of imputed interest, due August
2007 is included in other current assets.
(7) INCOME TAXES
The Company has recorded its provision (credit) for income taxes in the three
and nine month periods ended September 30, 2006 and 2005 based on anticipated
effective tax rates for the respective full years as the Company believes it can
reasonably estimate such effective tax rates given nine months of actual
history. Through June 30, 2006, the Company recorded its provision (credit) for
income taxes using the actual effective tax rates as it determined that this
method yielded a more reliable estimated provision (credit) due to the inclusion
of a full valuation allowance on the Company's net deferred tax assets. 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.
(8) STOCKHOLDERS' EQUITY
Common Stock
During the nine months ended September 30, 2006 the Company issued 97,522 shares
of Class A common stock valued at approximately $345,000 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 1.8 million shares of
Class A common stock valued at approximately $5.4 million.
In August 2006, the Company implemented a 1 for 5 reverse stock split of all
issued and outstanding Class A common stock which has been reflected in the
financial statements for all periods presented.
12
Accumulated other comprehensive income (loss)
The Company's comprehensive income (loss) as of September 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 nine month periods ended
September 30, 2006 and 2005 is as follows:
Three months Nine months
ended September 30, ended September 30,
------------------- -------------------
2006 2005 2006 2005
------- ------- ------- -------
Net income (loss) .................. $ 497 $ 344 $ 32 $(1,632)
Unrealized holding losses on
marketable securities ........... -- -- -- (520)
Cumulative foreign currency
translation gains (losses) ...... 95 (50) 35 100
------- ------- ------- -------
Comprehensive income (loss) ........ $ 592 $ 294 $ 67 $(2,052)
(9) 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 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 has
filed an answer and counterclaim asserting non-infringement and attacking the
validity and enforceability of the asserted patent. The court has set the
dispute for jury trial on April 10, 2007. The Company will defend itself
vigorously in this litigation but cannot predict its outcome.
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 the District Court of the
Southern District of New York issued a decision to enter judgment in favor of
the Company. The broker filed a motion to amend that judgment and/or order a new
trial. This appeal was denied by the court. The broker has filed another appeal
to overturn the court's decision.
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.
13
OPERATING RESULTS
For the nine months ended September 30, 2006, we reported a loss from continuing
operations of $896,000 in comparison to a loss from continuing operations and a
net loss of $1.6 million for the same period in 2005. The 2006 loss from
continuing operations was offset by income from discontinued operations of
$928,000 resulting in net income of $32,000 for the period. The prior period'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 nine months ended September 30, 2006 to the
nine months ended September 30, 2005, revenues were down by $4.1 million or 6.9%
while cost of revenues only decreased $0.7 million resulting in lower gross
profit of $3.5 million. This reduced gross margin is net of the favorable impact
of approximately $0.8 million in gross profit from the sale of a license of
software in 2006. Cost of revenues did not decrease at a rate that more closely
approximated the rate of decline in revenues because of the fixed nature of
certain of these costs and because of additional costs incurred in 2006 in
connection with the migration of network operations to our new data center.
Reductions in operating expenses in the 2006 period as compared to 2005,
including reduced sales and marketing spending of $1.0 million, reductions in
general and administrative costs of $1.1 million and lower amortization charges
of $1.1 million partially offset the gross profit impact as we attempted to
align our costs with the lower revenues.
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. As included in the 2005 10-K, 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 SEPTEMBER 30, 2006 COMPARED TO THREE
MONTHS ENDED SEPTEMBER 30, 2005
Revenues
For the quarter ended September 30, 2006 total revenues were $18.7 million in
comparison to $19.7 million for the same quarter in 2005. As detailed in the
schedule below the decline in revenue is attributable to lower revenues in the
production messaging or "other" group of services in our Transaction Delivery
Services amounting to $2.3 million or 22% partially offset by increased revenues
in our Transaction Management Services of $1.4 million representing 31% growth
over the same period in 2005. EDI revenues in Transaction Delivery Services were
relatively unchanged from period to period, declining $98,000 or 2%. In the 2006
period, $742,000 of the increase in Transaction Management Services revenue
represents revenue from the license of software accounting for 16% of the 31%
growth. The comparative results are as follows:
Change
2006 2005 $ %
-------- -------- -------- ------
Transaction Management Services $ 5,927 $ 4,513 $ 1,414 31%
Transaction Delivery Services EDI 4,480 4,578 (98) (2)%
Transaction Delivery Services Other 8,282 10,610 (2,328) (22)%
-------- -------- -------- ---
$ 18,689 $ 19,701 $ (1,012) (5)%
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 three months ended September 30, 2006 decreased to $6.9
million from $8.2 million in the same quarter of 2005. As a percentage of
revenues these costs decreased to 37% in 2006 as compared to 41% in 2005. During
the 2006 period we recorded (i) credits of approximately $300,000 upon the
favorable settlement of disputes with certain telecom vendors and (ii) $160,000
of credits for the anticipated refund of Federal excise taxes previously paid on
telecom costs. In addition, the reduced 2006 costs reflect initial savings from
the migration of operations from leased facilities to our new network data
center. Cost of revenues is expected to approximate the current quarter's amount
in total and then further decrease as additional cost savings from the migration
occur but will be offset by the lack of similar credits to those that occurred
in the current period.
14
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 amounted to $4.7 million in the three months ended
September 30, 2006 and 2005. Based on cost reduction measures, including
headcount reductions and lower marketing program spending, taken in the current
quarter and the fourth quarter of 2006, these costs are expected to decline in
future periods.
General and Administrative Expenses
General and administrative expenses decreased to $4.9 million in the three
months ended September 30, 2006 from $5.2 million in the same quarter of 2005.
We anticipate general and administrative expenses to be comparable to the 2006
results in ensuing quarterly periods. 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 $1.8 million and $1.7 million for the three
months ended September 30, 2006 and 2005, respectively. We anticipate that
spending for product development will be comparable to these levels through the
balance of 2006 as a result of our continuing efforts to expand the development
of the new Transaction Management Services.
RESULTS OF OPERATIONS - NINE MONTHS ENDED SEPTEMBER 30, 2006 COMPARED TO NINE
MONTHS ENDED SEPTEMBER 30, 2005
Revenues
For the nine months ended September 30, 2006 total revenues were $56.0 million
in comparison to $60.1 million for the same period in 2005. As detailed in the
table below the decline in revenue is attributable to lower revenues in the
production messaging or "other" group of services in our Transaction Delivery
Services amounting to $7.3 million or 21% partially offset by increased revenues
in our Transaction Management Services of $3.2 million representing 26% growth
over the same period in 2005. EDI revenues in Transaction Delivery Services were
relatively unchanged from period to period, declining $110,000 or 1%. In the
2006 period $866,000 of the increase in Transaction Management Services revenue
represents revenue from the license of software accounting for 7% of the 26%
growth. The comparative results are as follows:
Change
2006 2005 $ %
-------- -------- -------- -----
Transaction Management Services $ 15,440 $ 12,217 $ 3,223 26%
Transaction Delivery Services EDI 13,906 14,016 (110) (1)%
Transaction Delivery Services Other 26,655 33,916 (7,261) (21)%
-------- -------- -------- ----
$ 56,001 $ 60,149 $ (4,148) (7)%
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 nine months ended September 30, 2006 decreased to $22.2
million from $22.9 million in the same period of 2005. However, as a percentage
of revenues these costs increased to 40% in 2006 as compared to 38% in 2005. The
higher percentage of revenues are attributable to (i) lower revenues in 2006 and
(ii) additional costs incurred in 2006 in connection with our migration of
operations to our new data center. In both the nine months ended September 30,
2006 and the nine months ended September 30, 2005, we recorded credits of
approximately $0.5 million to cost of revenues. The 2006 credits relate to the
favorable settlement of disputes with certain telecom vendors and the
anticipated refund of Federal excise taxes previously paid on telecom costs. In
2005 the credits relate to the settlement with Verizon Business, formerly MCI
("MCI"), of claims by the Company that we had paid telecom charges by MCI in
excess of contracted rates prior to MCI's bankruptcy filing in 2002.
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.
15
Sales and Marketing Expenses
Sales and marketing expenses decreased to $13.8 million in the nine months ended
September 30, 2006 from $14.7 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 $14.3 million in the nine months ended
September 30, 2006 as compared to $15.4 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, amounted to $5.3 million and $5.1 million for the
nine months ended September 30, 2006 and 2005, respectively.
LIQUIDITY AND CAPITAL RESOURCES
In April 2006 we completed an equity financing of $5.4 million for the sale of
approximately 1.8 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 our cash balance at September 30, 2006 of $6.2
million remained virtually unchanged from the December 31, 2005 balance of $6.3
million. In addition, our working capital deficit decreased to $2.0 million at
September 30, 2006 as compared to $9.5 million at December 31, 2005.
In July 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 then outstanding loan balance with Wells Fargo, along
with other related fees and expenses. At September 30, 2006 advances outstanding
from CAPCO amounted to $5.4 million.
Cash provided from continuing operations amounted to $1.4 million in the current
period. In investing activities, we spent $1.6 million for capital expenditures
and received $0.5 million in partial payment of a note receivable from our 2005
domain name transaction. The net impact of all financing activities, including
those described above, amounted to a decrease in cash of $411,000.
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 the 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 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.
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.
16
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 as of September 30, 2006, the Company's
disclosure controls and procedures were effective.
PART II OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
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 has
filed an answer and counterclaim asserting non-infringement and attacking the
validity and enforceability of the asserted patent. The court has set the
dispute for jury trial on April 10, 2007. The Company will defend itself
vigorously in this litigation but cannot predict its outcome.
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, the District Court of the
Southern District of New York issued a decision to enter judgment in favor of
the Company. The broker filed a motion to amend that judgment and/or order a new
trial. This appeal was denied by the court. The broker has filed another appeal
to overturn the court's decision.
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, our Form 10-Q for the quarter ended March 31, 2006 and our Form 10-Q for
the quarter ended June 30, 2006.
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IF OUR REVENUES DECLINE AND WE ARE UNABLE TO GENERATE SUFFICIENT CASH FLOW, WE
MAY BE UNABLE TO PAY DEBT SERVICE ON OUR INDEBTEDNESS.
As of September 30, 2006, we had outstanding indebtedness under our new CAPCO
credit facility of $5.4 million, obligations under office space leases and
commitments for telecommunications services. If our revenues continue to 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. 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.
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, our Federal
income tax returns for 2003 and 2004 are currently being reviewed by the
relevant tax authorities who 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 upon completion of the review, 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.
THE MIGRATION OF THE NETWORK RELATING TO OUR BUSINESS ACQUIRED FROM AT&T HAS
BEEN COMPLETED.
A small portion of the network for the part of our business relating to EDI, fax
and email services resided on AT&T's premises under an agreement with AT&T, but
was being operated and maintained by us. We built a new network center at our
corporate headquarters located in Piscataway, New Jersey and have successfully
completed the migration of these operations and affected customers to this
center during the quarter ended September 30, 2006.
OUR CLASS A COMMON STOCK MEETS THE LISTING REQUIREMENTS OF THE NASDAQ CAPITAL
MARKET.
Our Class A common stock faced potential delisting from the Nasdaq Capital
Market because it did not meet the minimum bid price requirement of $1 during
certain periods in 2006. On August 24, 2006, our stockholders approved the
implementation of a reverse stock split to regain compliance with the minimum
bid price rule. Accordingly, on August 28, 2006 we implemented a 1 for 5 reverse
stock split and the bid price for the Class A common stock increased to amounts
over the $1 minimum since that date. On September 15, 2006, we received notice
from the NASDAQ Capital Market Listing Qualifications staff that we were in
compliance with the minimum bid price requirement and that no further action was
necessary relating to our listing.
ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Recent Sales of Unregistered Securities
During the three months ended September 30, 2006, the Company issued 38,398
shares of Class A common stock valued at approximately $127,000 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.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
A Special Meeting of Shareholders of the Company was held on August 24, 2006 to
consider and vote upon one proposal to approve three separate amendments to the
Company's Amended and Restated Certificate of Incorporation to effect one or
more reverse stock splits, ranging from a one-for-three reverse stock split to a
one-for-seven stock split of all the issued and outstanding shares of the
Company's Class A common stock in order to seek to maintain the listing of the
Class A common stock on the NASDAQ Capital Market and to facilitate the
Company's ability to raise additional equity capital.
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The following are the voting results on each of the matters that were submitted
to the shareholders:
For Withheld Abstain
Proposal No. 1
To approve the proposed amendments to the 47,455,407 684,077 28,004
EasyLink Amended and Restated Certificate of
Incorporation to enable the Company
to effect a one for three reverse stock split
To approve the proposed amendments to the 47,370,560 644,533 152,395
EasyLink Amended and Restated Certificate
of Incorporation to enable the Company
to effect a one for five reverse stock split
To approve the proposed amendments to the 46,980,095 1,090,999 96,394
EasyLink Amended and Restated Certificate
of Incorporation to enable the Company
to effect a one for seven reverse stock split
Proposal No. 2
To approve the adjournment of the Special 47,330,681 723,526 113,281
Meeting to solicit additional proxies in respect
of Proposal No. 1.
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.
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
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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: November 13, 2006 Michael A. Doyle
----------------------- Vice President and Chief
Financial Officer (Principal
financial officer and
duly authorized signatory)
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