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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 3O, 2007
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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. Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer or a non-accelerated filer.
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Common stock outstanding as of July 31, 2007: Class A common stock, $0.01
par value, 11,045,750 shares.
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EASYLINK SERVICES CORPORATION
JUNE 30, 2007
FORM 10-Q
INDEX
PAGE
NUMBER
------
PART I: FINANCIAL INFORMATION
Item 1: Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets as of June 30, 2007
(unaudited) and December 31, 2006........................... 3
Unaudited Condensed Consolidated Statements of Operations
for the three months ended June 30, 2007 and 2006........... 4
Unaudited Condensed Consolidated Statements of Operations
for the six months ended June 30, 2007 and 2006............. 5
Unaudited Condensed Consolidated Statements of Cash Flows
for the six months ended June 30, 2007 and 2006............. 6
Notes to Unaudited Interim Condensed Consolidated Financial
Statements.................................................. 7
Item 2: Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 11
Item 3: Quantitative and Qualitative Disclosures about Market Risk.. 15
Item 4: Controls and Procedures..................................... 15
PART II: OTHER INFORMATION
Item 1: Legal Proceedings........................................... 16
Item 1A: Risk Factors................................................ 16
Item 2: Unregistered Sales of Equity Securities and Use of
Proceeds.................................................... 17
Item 3: Defaults Upon Senior Securities............................. 17
Item 4: Submission of Matters to a Vote of Security Holders......... 17
Item 5: Other Information........................................... 17
Item 6: Exhibits.................................................... 17
Signatures............................................................. 18
2
EASYLINK SERVICES CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
JUN 30, DEC 31,
2007 2006
----------- ---------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents ................................................ $ 5,536 $ 6,707
Accounts receivable, net of allowance for doubtful accounts
of $1,008 and $1,605 as of June 30, 2007 and
December 31, 2006, respectively ....................................... 10,613 10,725
Prepaid expenses and other current assets ................................ 2,803 2,511
--------- ---------
Total current assets ..................................................... 18,952 19,943
Property and equipment, net............................................... 9,075 9,703
Goodwill, net ............................................................ 6,213 6,213
Other intangible assets, net ............................................. 4,917 5,069
Other assets.............................................................. 192 305
--------- ---------
Total assets.............................................................. $ 39,349 $ 41,233
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ......................................................... $ 5,586 $ 5,810
Accrued expenses ......................................................... 10,542 10,299
Loans and notes payable .................................................. 1,913 4,413
Other current liabilities ................................................ 957 1,363
--------- ---------
Total current liabilities ................................................ 18,998 21,885
Other long term liabilities............................................... 805 1,186
--------- ---------
Total liabilities ........................................................ 19,803 23,071
--------- ---------
Stockholders' equity:
Common stock:
Class A--500,000,000 shares authorized at June 30, 2007 and
December 31, 2006, 11,033,848 and 10,967,648 shares issued
and outstanding at June 30, 2007 and December 31, 2006, respectively .. 110 110
Additional paid-in capital ............................................... 561,118 560,690
Accumulated other comprehensive loss...................................... (830) (833)
Accumulated deficit....................................................... (540,852) (541,805)
--------- ---------
Total stockholders' equity ............................................... 19,546 18,162
--------- ---------
Commitments and contingencies
Total liabilities and stockholders' equity................................ $ 39,349 $ 41,233
========= =========
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,
---------------------------
2007 2006
----------- -----------
Revenues ......................................... $ 19,091 $ 18,852
Cost of revenues ................................. 6,905 7,895
----------- -----------
Gross profit ..................................... 12,186 10,957
----------- -----------
Operating expenses:
Sales and marketing .............................. 3,560 4,504
General and administrative ....................... 5,616 4,665
Product development .............................. 1,842 1,736
----------- -----------
11,018 10,905
----------- -----------
Income from operations ........................... 1,168 52
----------- -----------
Other income (expense), net:
Interest income .................................. 85 62
Interest expense ................................. (169) (239)
Other, net ....................................... 17 112
----------- -----------
Total other income (expense), net ................ (67) (65)
----------- -----------
Income (loss) before income taxes ................ 1,101 (13)
Provision for income taxes ....................... 336 76
----------- -----------
Net income (loss) ................................ $ 765 $ (89)
=========== ===========
Basic and diluted net income (loss) per share .... $ 0.07 $ (0.01)
=========== ===========
Basic weighted-average shares outstanding ........ 11,013,596 10,488,886
=========== ===========
Diluted weighted-average shares outstanding ...... 11,116,013 10,488,886
=========== ===========
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,
-------------------------
2007 2006
----------- ----------
Revenues .......................................... $ 37,850 $ 37,313
Cost of revenues .................................. 13,806 15,358
----------- ----------
Gross profit ...................................... 24,044 21,955
----------- ----------
Operating expenses:
Sales and marketing ............................... 7,200 9,059
General and administrative ........................ 11,288 9,794
Product development ............................... 3,623 3,482
----------- ----------
22,111 22,335
----------- ----------
Income (loss) from operations ..................... 1,933 (380)
----------- ----------
Other income (expense), net:
Interest income ................................... 131 109
Interest expense .................................. (347) (643)
Other, net ........................................ 60 177
----------- ----------
Total other income (expense), net ................. (156) (357)
----------- ----------
Income (loss) before income taxes ................. 1,777 (737)
Provision (credit) for income taxes ............... 716 (273)
----------- ----------
Net income (loss) ................................. $ 1,061 $ (464)
=========== ==========
Basic and diluted net income (loss) per share ..... $ 0.10 $ (0.05)
=========== ==========
Basic weighted-average shares outstanding ......... 10,998,817 9,778,835
=========== ==========
Diluted weighted-average shares outstanding ....... 11,073,306 9,778,835
=========== ==========
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,
------------------
2007 2006
-------- -------
Cash flows from operating activities:
Net income (loss) .......................................................... $ 1,061 $ (464)
Adjustments to reconcile net income (loss) to net cash used in operating
activities:
Depreciation ............................................................ 1,404 1,421
Amortization ............................................................ 153 485
Issuance of shares as matching contributions to employee benefit plans .. 234 218
Provision (credit) for doubtful accounts................................. (319) 33
Other ................................................................... 264 57
Changes in operating assets and liabilities:
Accounts receivable, net ................................................ 431 (650)
Prepaid expenses and other assets ....................................... (316) 86
Accounts payable, accrued expenses and other liabilities ................ (854) (543)
-------- -------
Net cash provided by operating activities .................................. 2,058 643
-------- -------
Cash flows from investing activities:
Purchases of property and equipment ........................................ (755) (812)
-------- -------
Net cash used in investing activities ...................................... (755) (812)
-------- -------
Cash flows from financing activities:
Proceeds of bank loan advances ............................................. 19,685 --
Payments of bank loan advances ............................................. (22,185) (950)
Principal payments of notes payable ........................................ -- (4,200)
Proceeds from issuance of stock ............................................ 69 5,405
Other ...................................................................... (15) (25)
-------- -------
Net cash provided by (used in) financing activities ........................ (2,446) 230
-------- -------
Effect of foreign exchange rate changes on cash and cash equivalents ....... (28) (78)
-------- -------
Net decrease in cash and cash equivalents .................................. (1,171) (17)
Cash and cash equivalents at beginning of the period ....................... 6,707 6,282
-------- -------
Cash and cash equivalents at end of the period ............................. $ 5,536 $ 6,265
======== =======
Supplemental disclosure of cash flow information:
Cash paid for interest ..................................................... $ 193 $ 633
Cash paid for taxes ........................................................ $ 24 $ 47
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 the United Kingdom).
On May 3, 2007, the Company entered into a definitive agreement with Internet
Commerce Corporation ("ICC") for ICC to acquire the Company. Under the terms of
the merger agreement, ICC will pay $5.80 per share in cash for all of the
Company's outstanding Class A common stock. The merger is expected to be
completed in the third quarter of 2007, subject to customary closing conditions
as well as stockholder approval from both companies. In the three and six month
periods ended June 30, 2007, costs of approximately $0.7 million and $1.4
million, respectively, were incurred by the Company related to the ICC merger
agreement and the review of strategic alternatives undertaken prior thereto.
(b) Liquidity
For the year ended December 31, 2005, the report from the Company's independent
registered public accountants contained an explanatory paragraph stating that
the Company had a working capital deficiency and an accumulated deficit among
other factors that raised substantial doubt about its ability to continue as a
going concern. During 2006 the Company completed an equity financing for $5.4
million and entered into a new $6.0 million credit facility with CAPCO Financial
Company, a division of Greater Bay Bank, N.A. ("CAPCO") that is subject to a
maximum of 80% of certain accounts receivable of the Company but with no
financial covenants. These financial developments along with the continuing
implementation of cost reduction measures instituted by management have
strengthened the Company's liquidity and financial position. For the six months
ended June 30, 2007 revenues increased in comparison to revenues for both the
same period in 2006 and for the most recent prior quarter. Net income was $1.1
million for the six months ended June 30, 2007 in comparison to a net loss of
$(464,000) for the same period in 2006. Debt balances were reduced to $1.9
million at June 30, 2007 from $4.4 million at December 31, 2006 and from $10.6
million at December 31, 2005 resulting in lower interest costs. In addition, the
Company's working capital deficit decreased to $46,000 at June 30, 2007 from
$1.9 million as of December 31, 2006 and from $9.5 million at December 31, 2005.
For the year ended December 31, 2006, the audit report from the Company's
independent registered public accountants did not contain a going concern
explanatory paragraph.
(c) Unaudited Interim Condensed Consolidated Financial Information
The accompanying interim condensed consolidated financial statements as of June
30, 2007 and for the three and six month periods ended June 30, 2007 and 2006
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, 2007 and the consolidated results of operations and
consolidated cash flows for the three and six month periods ended June 30, 2007
and 2006. The results of operations for any interim period are not necessarily
indicative of the results of operations for any other future interim period or
7
for a full fiscal year. The condensed consolidated balance sheet at December 31,
2006 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, 2006 as included in the Company's Form 10-K filed with
the Securities and Exchange Commission on March 27, 2007 (the "2006 10-K").
(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.
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.
(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. Based upon the
continuing favorable trend in actual bad debts incurred and past due receivable
balances, the Company modified its method of estimating future bad debts and
reversed approximately $0.3 million of its previously recorded allowance for
doubtful accounts in the six month period ended June 30, 2007.
(g) Financial Instruments and Concentration of Credit Risk
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist of cash and cash equivalents, accounts
receivable and notes payable. At June 30, 2007 and December 31, 2006, 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. Loans and notes payable are subject to interest rate fluctuations
based on movements in the prime rate. Accordingly, the recorded values of loans
and notes payable approximate their fair values as interest approximates market
rates.
The Company holds cash and cash equivalents at several major financial
institutions in amounts which often exceed FDIC insured limits. The Company also
has $2.6 million in foreign bank accounts as of June 30, 2007 that are not
8
insured. The Company has not experienced any losses due to such concentration of
credit risk.
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, 2007 and 2006 and no accounts receivable from a single
customer exceeded 10% of total accounts receivable as of June 30, 2007 and
December 31, 2006. Revenues from the Company's five largest customers amounted
to $2.8 million and $5.7 million for the three and six month periods ended June
30, 2007 and $2.4 million and $4.8 million for the three and six month periods
ended June 30, 2006, respectively.
(h) Stock-Based Compensation Plans
In the first quarter of 2006, the Company adopted the provisions of, and
accounts for stock-based compensation, in accordance with Financial Accounting
Standards Board ("FASB") Statement of Financial Accounting Standards
No.123-revised 2004, "Share-Based Payment" (SFAS 123R). Under the fair-value
recognition provisions of SFAS 123R, stock-based compensation is measured at the
grant date based on the fair value of the award and is recognized as expense on
a straight line basis over the requisite service period, which is the vesting
period. Compensation expense related to stock options and restricted stock
awards for the three months ended June 30, 2007 and 2006 amounted to $62,000 and
$42,000, respectively. Compensation expense related to stock options and
restricted stock awards for the six months ended June 30, 2007 and 2006 amounted
to $125,000 and $72,000, respectively. No stock option or restricted stock
awards were made in the three or six month periods ended June 30, 2007.
(i) Basic and diluted net income per share
Basic net income (loss) per share is computed by dividing income or loss
available to common shareholders by the weighted average number of common shares
outstanding for the period. Diluted net income per share for the three and six
month periods ended June 30, 2007 are calculated, including the dilutive effect
of stock options, using the treasury stock method. No adjustment to the weighted
average shares outstanding is reflected in the calculation for the three and six
month periods ended June 30, 2006 as all common stock equivalents are dilutive.
The following table reconciles basic and diluted weighted average shares for the
three and six month periods ended June 30, 2007:
Three months Six months
then ended then ended
------------ ----------
Basic weighted average shares outstanding 11,013,596 10,998,817
Dilutive effect of stock options 102,417 74,489
---------- ----------
Diluted weighted average shares outstanding 11,116,013 11,073,306
(j) Recent Accounting Pronouncements
In September 2006, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 157, "Fair Value Measurements" ("SFAS No. 157"). 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.
9
(2) LOANS AND NOTES PAYABLE
Loans and notes payable as of June 30, 2007 and December 31, 2006 represent
outstanding advances under a $6.0 million credit facility with CAPCO Financial
Company, a division of Greater Bay Bank N.A. ("CAPCO"), entered into in July
2006. The facility provides for advances, subject to a maximum of 80% 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 CAPCO but there are no financial covenants under the
facility. As of June 30, 2007 the interest rate on the outstanding advances was
10.25% and $2.6 million was available under the facility for additional
advances.
On July 20, 2007 the Company entered into an amendment of the CAPCO agreement
that extended the term of the facility through September 22, 2007 without a
credit review for a reduced line of $5.0 million.
(3) INCOME TAXES
The Company has recorded its provision (credit) for income taxes in the three
and six month periods ended June 30, 2007 based on the anticipated effective tax
rate for the year. For the three and six month periods ended June 30, 2006 the
Company recorded its provision (credit) using the actual effective tax rate. The
Company had determined that this method yielded 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 that period. Accordingly, the Company was
not in a position to project an annual effective tax rate for the year ended
December 31, 2006. The effective rates for 2007 and 2006 vary from the standard
tax rates primarily due to the recording of a full valuation allowance against
the Company's available Federal, state and certain foreign net operating losses.
The Company adopted the provisions of FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109 ("FIN
48") on January 1, 2007. 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.
As a result of the implementation of FIN48, the Company recognized an increase
in the liability for unrecognized tax benefits of approximately $65,000 and
$43,000 of accrued interest through reductions to the January 1, 2007 balance of
retained earnings. In total, unrecognized tax benefits amounted to approximately
$562,000 at January 1, 2007. Of this amount, approximately $497,000, if not
assessed, will be recorded as a reduction in income tax expense in the fourth
quarter of 2007.
The Company and its US subsidiaries file consolidated income tax returns in the
US federal jurisdiction and consolidated or separate tax returns in various
states. The Company's foreign subsidiaries file tax returns in the foreign
jurisdictions that they operate in. The Company is no longer subject to US
federal or state income tax examinations by tax authorities for 2002 or years
prior thereto. In the United Kingdom, where the Company's most significant
foreign operations are conducted, the Company is no longer subject to
examinations by tax authorities for 2003 or years prior thereto. The Internal
Revenue Service commenced an examination of the Company's US income tax returns
for 2003 and 2004 during 2006 that is anticipated to be completed during 2007.
The Company recognizes accrued interest related to unrecognized tax benefits in
interest expense and records penalties as general and administrative operating
expenses. As of January 1, 2007 total accrued interest and penalties related to
unrecognized tax benefits amounted to approximately $84,000.
10
(4) STOCKHOLDERS' EQUITY
COMMON STOCK
During the six months ended June 30, 2007, the Company issued 48,699 shares of
Class A common stock valued at approximately $234,000 in connection with
matching contributions to its 401K plan. In addition, the Company issued 17,500
shares of Class A common stock for approximately $69,000 upon the exercise of
stock options by employees.
COMPREHENSIVE LOSS
Comprehensive income (loss) for the three and six month periods ended June 30,
2007 and 2006 was as follows:
($ in thousands)
Three months Six months
ended June 30, ended June 30,
-------------- --------------
2007 2006 2007 2006
----- ---- ------ -----
Net income (loss) ............. $ 765 $(89) $1,061 $(464)
Foreign currency translation .. (47) 84 3 (60)
----- ---- ------ -----
Comprehensive income (loss) ... $ 718 $ (5) $1,064 $(524)
===== ==== ====== =====
(5) COMMITMENTS AND CONTINGENCIES
LEGAL PROCEEDINGS
On February 8, 2007, the Company settled the litigation entitled Dynamic Depth,
Inc. v. EasyLink Services Corporation, in which Dynamic Depth, Inc. claimed
infringement by the Company of a patent related to automatic OCR-based routing.
The terms of the settlement are confidential but did not have a material effect
on the financial statements of the Company for the six months ended June 30,
2007. As a result of the settlement, Dynamic Depth, Inc. agreed that it would
take no further legal action nor bring any future charge of infringement of the
related patent against the Company.
(6) SUBSEQUENT EVENT
On July 20, 2007 the Company entered into an amendment of the CAPCO agreement
that extended the term of the facility through September 22, 2007 without a
credit review for a reduced line of $5.0 million.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion and analysis of the financial condition and results of
operations should be read in conjunction with our consolidated financial
statements and the related notes included elsewhere in this quarterly report.
OVERVIEW
We are a provider of services that facilitate the electronic exchange of
information between enterprises, their trading communities and their customers.
On an average business day, we handle approximately one million transactions
that are integral to the movement of money, materials, products and people in
the global economy, such as insurance claims, trade and travel confirmations,
purchase orders, invoices, shipping notices and funds transfers, among many
others. We offer a broad range of information exchange services to businesses
and service providers, including Transaction Management Services and Transaction
Delivery Services. Transaction Management Services consist of integrated desktop
messaging services and document capture and management services such as fax to
database, fax to data and data conversion services.
11
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.
On May 3, 2007 we announced that we had entered into a definitive merger
agreement with ICC for ICC to acquire us. Under the terms of the merger
agreement, ICC will pay $5.80 per share in cash for all of our outstanding Class
A common stock. The merger is expected to be completed in the third quarter of
2007, subject to customary closing conditions as well as stockholder approval
from both companies.
OPERATING RESULTS
For the six months ended June 30, 2007, we reported income from operations and
net income of $1.9 million and $1.1 million, respectively, in comparison to a
loss from operations and a net loss of $0.4 million and $0.5 million,
respectively, for the same period in 2006. In addition, our revenues increased
by $0.5 million in the six months ended June 30, 2007 as compared to the same
period in 2006. The increase in revenues occurred in both the first and second
quarters of 2007 and was the first time we have reported such a year-over-year
period growth for our continuing operations since the first quarter of 2002.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements and related disclosures in conformity
with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, revenues and expenses and the disclosure of contingent
assets and liabilities. We believe that of our significant accounting policies,
those related to accounts receivable net of allowance for doubtful accounts,
long-lived assets and intangible assets and contingencies and litigation
represent the most critical estimates and assumptions that affect our financial
condition and results of operations as reported in our financial statements.
RESULTS OF OPERATIONS - THREE MONTHS ENDED JUNE 30, 2007 COMPARED TO THE THREE
MONTHS ENDED JUNE 30, 2006
REVENUES
For the quarter ended June 30, 2007 total revenues were $19.1 million in
comparison to $18.9 million for the same period in 2006. As detailed in the
schedule below, the increase in revenue is attributable to a $1.9 million
increase in our Transaction Management Services revenues, representing 39%
growth, offset by lower revenues in our EDI and Other Transaction Delivery
Services amounting to a total of $1.7 million or 12% decline.
CHANGE
-------------
2007 2006 $ %
------- ------- ------- ---
Transaction Management Services ...... $ 6,804 $ 4,912 $ 1,892 39%
Transaction Delivery Services EDI .... 4,276 4,712 (436) (9)%
Transaction Delivery Services Other .. 8,011 9,228 (1,217) (13)%
------- ------- ------- ---
$19,091 $18,852 $ 239 1%
The growth in Transaction Management Services is attributable to Integrated
Desktop Messaging ("IDM") revenues from both new customers and from the
expansion of existing customer business along with accelerated growth in our
enhanced production messaging service, PM2.0. Also contributing to the growth is
an increase of $215,000 in our Small Office/Home Office IDM Service, marketed as
RapidFAX.
Transaction Delivery Services have been continually impacted by pricing
12
pressures in the business communications market and by technological factors
that replace or reduce the deployment of such services by our customers. These
factors have led to lower volumes, negotiated individual customer price
reductions at the time of service contract renewals and the loss of certain
customers. Although we have focused efforts on stabilizing this revenue stream,
we believe the trend will continue throughout 2007. We will seek to expand our
newer Transaction Management Services and to upgrade customers who are using our
basic production messaging services to our enhanced production messaging
service, EasyLink Production Messaging PM2.0 Service, to offset the declines.
COST OF REVENUES
Cost of revenues for the three months ended June 30, 2007 decreased to $6.9
million from $7.9 million in the same period of 2006 and, as a percentage of
revenues, these costs decreased to 36% in 2007 as compared to 42% in 2006. The
lower cost and lower percentage of revenues resulted largely from cost savings
realized from the migration and consolidation of certain installations of our
operations network that carry approximately 50% of our revenues to our new data
center at our headquarters location and the reversal of certain telecom expense
accruals amounting to $150,000 for our United Kingdom operation. Cost of
revenues is expected to remain at approximately the same level as that of the
current quarter for the balance of 2007.
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 $3.6 million in the three months ended
June 30, 2007 from $4.5 million in the same period of 2006. The lower costs
reflect cost reduction measures, including headcount reductions and lower
marketing spending, initiated in the latter part of 2006. We expect these
expenses to continue at the current level throughout 2007.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were $5.6 million in the three months ended
June 30, 2007 as compared to $4.7 million in the same period of 2006. The
higher cost is largely attributable to approximately $0.7 million for
investment banker and legal fees associated with the pending merger with ICC.
We expect general and administrative expenses to decrease in subsequent periods
as the amount of additional investment banker and legal fees to be incurred
will be substantially less than that of the current period. General and
administrative 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 June 30, 2007 and 2006, respectively. We anticipate that spending
for product development will be comparable to these levels throughout 2007 as a
result of our continuing efforts to expand the development of our new
Transaction Management Services.
RESULTS OF OPERATIONS - SIX MONTHS ENDED JUNE 30, 2007 COMPARED TO THE SIX
13
MONTHS ENDED JUNE 30, 2006
REVENUES
For the six months ended June 30, 2007 total revenues were $37.9 million in
comparison to $37.3 million for the same period in 2006. As detailed in the
schedule below the increase in revenue is attributable to a $3.6 million
increase in our Transaction Management Services revenues, representing 38%
growth, offset by lower revenues in our EDI and Other Transaction Delivery
Services amounting to a total of $3.1 million or 11% decline.
CHANGE
-------------
2007 2006 $ %
------- ------- ------- ---
Transaction Management Services ...... $13,151 $ 9,514 $ 3,637 38%
Transaction Delivery Services EDI .... 8,609 9,426 (817) (9)%
Transaction Delivery Services Other .. 16,090 18,373 (2,283) (12)%
------- ------- ------- ---
$37,850 $37,313 $ 537 1%
The growth in Transaction Management Services is attributable to Integrated
Desktop Messaging ("IDM") revenues from both new customers and from the
expansion of existing customer business along with accelerated growth in our
enhanced production messaging service, PM2.0. Also contributing to the growth is
an increase of $433,000 in our Small Office/Home Office IDM Service, marketed as
RapidFAX.
Transaction Delivery Services have been continually impacted by pricing
pressures in the business communications market and by technological factors
that replace or reduce the deployment of such services by our customers. These
factors have led to lower volumes, negotiated individual customer price
reductions at the time of service contract renewals and the loss of certain
customers. Although we have focused efforts on stabilizing this revenue stream,
we believe the trend will continue throughout 2007. We will seek to expand our
newer Transaction Management Services and to upgrade customers who are using our
basic production messaging services to our enhanced production messaging
service, EasyLink Production Messaging PM2.0 Service, to offset the declines.
COST OF REVENUES
Cost of revenues for the six months ended June 30, 2007 decreased to $13.8
million from $15.4 million in the same period of 2006 and, as a percentage of
revenues, these costs decreased to 36% in 2007 as compared to 41% in 2006. The
lower cost and lower percentage of revenues resulted largely from cost savings
realized from the migration and consolidation of certain installations of our
operations network that carry approximately 50% of our revenues to our new data
center at our headquarters location and the reversal of certain telecom expense
accruals amounting to $150,000 for our United Kingdom operation.
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 $7.2 million in the six months ended
June 30, 2007 from $9.1 million in the same period of 2006. The lower costs
reflect cost reduction measures, including headcount reductions and lower
marketing spending, initiated in the latter part of 2006.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were $11.3 million in the six months ended
June 30, 2007 as compared to $9.8 million in the same period of 2006. The
14
higher cost includes approximately $1.5 million for investment banker and legal
fees associated with our review of strategic alternatives for our business and
the pending merger with ICC. These additional costs were offset by, among other
changes, the reversal of approximately $0.3 million in bad debt allowances based
upon the continuing favorable trend in actual bad debts incurred and past due
receivable balances. 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 $3.6 million and $3.5 million for the six
months ended June 30, 2007 and 2006, respectively.
LIQUIDITY AND CAPITAL RESOURCES
The current period's net income results have contributed to the continuing
improvement in our liquidity and financial position. Although our cash and cash
equivalent balances decreased by $1.2 million during the six months ended June
30, 2007, our working capital position improved by approximately $1.9 million as
our working capital deficit decreased to $46,000 from $1.9 million at December
31, 2006. We further reduced our outstanding debt balance to $1.9 million to
reduce interest costs. Other cost reduction measures implemented in 2006
resulted in lower operating expenses in the six months ended June 30, 2007
although they were partially offset by payments of costs related to our
strategic review and subsequent merger agreement with ICC. During the current
period cash from operations amounted to $2.1 million and we spent $0.8 million
on capital expenditures and $2.5 million to reduce our outstanding loan balance.
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk from fluctuations in interest rates, foreign
exchange rates and credit risk. We maintain continuing operations in Europe
(mostly in the United Kingdom) and, to a lesser extent, in Singapore, Malaysia,
India and Brazil. Fluctuations in exchange rates may have an adverse effect on
our results of operations and could also result in exchange losses. The impact
of future rate fluctuations cannot be predicted adequately. To date, we have 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 CAPCO credit facility is a
variable interest rate agreement that creates an interest rate risk on all
outstanding advances. 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
$19,000. We have considered the use of interest rate swaps and similar
transactions to minimize this risk but have not entered into any such
arrangements to date. We intend 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
We maintain disclosure controls and procedures designed to ensure that
information required to be disclosed by us in the reports that we file or submit
under the Securities Exchange Act of 1934, as amended (the "Exchange
15
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 us in the reports that we file or submit
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in the Securities and Exchange Commission's rules and
forms, and is accumulated and communicated to management, including our
principal chief executive officer and principal financial officer, as
appropriate, to allow timely decisions regarding required disclosure. It should
be noted that any system of controls, however well designed and operated, can
provide only reasonable, and not absolute, assurance that the objectives of the
system are met.
As required by Securities and Exchange Commission rules, we have evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures as of the end of the period covered by this quarterly report. This
evaluation was carried out under the supervision and with the participation of
our management, including our principal executive officer and principal
financial officer. Based on this evaluation, these officers have concluded that,
as of June 30, 2007, our disclosure controls and procedures were effective.
PART II OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
None
ITEM 1A: RISK FACTORS
This Item 1A should be read in conjunction with "Item 1A. Risk Factors" in our
2006 10-K and in our Form 10-Q for the quarter ended March 31, 2007. Other than
with respect to the risk factors below, there have been no material changes from
the risk factors disclosed in "Item 1A. Risk Factors" of our 2006 10-K and our
Form 10-Q for the quarter ended March 31, 2007.
FAILURE TO COMPLETE THE PROPOSED MERGER WITH ICC COULD NEGATIVELY AFFECT US.
On May 3, 2007, we entered into a merger agreement with ICC and its wholly owned
subsidiary, Jets Acquisition Sub, Inc. The merger is subject to adoption of the
merger agreement by our stockholders, approval by ICC's stockholders and other
customary closing conditions. There is no assurance when or if the merger
agreement will be adopted by our stockholders, and there is no assurance that
the other conditions to the completion of the merger will be satisfied. In
connection with the merger, we may be impacted by the following risks:
- the inability to complete the merger due to the failure of our
stockholders to adopt the merger agreement, the failure to obtain
approval by ICC's stockholders or the failure to satisfy any other
condition to completion of the merger;
- the occurrence of any event, change or other circumstances that could
give rise to a termination of the merger agreement;
- the outcome of any legal proceedings that have been or may be
instituted against us, members of our board of directors and others
relating to the merger, including any settlement of these legal
proceedings that may be subject to court approval;
- termination of the merger agreement under certain circumstances would
require us to pay ICC a termination fee of $2.5 million, which could
impair our working capital, erode employee, customer and stockholder
confidence and have a materially adverse effect on our business
prospects;
- a potential decline in the market price of our Class A common stock if
the merger is not consummated;
- Disruption of current plans and operations and the potential
16
difficulties in attracting and retaining employees as a result of the
merger; and
- the amount of the costs, fees, expenses and charges we have and may
incur related to the merger.
ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Recent Sales of Unregistered Securities
During the three months ended June 30, 2007, we issued 18,034 shares of Class A
common stock valued at approximately $99,000 in connection with matching
contributions to our 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 3: DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5: OTHER INFORMATION
None
ITEM 6: EXHIBITS
The following exhibits are filed as part of this report:
Exhibit 10.1 Amendment # 1, effective July 20, 2007, to Contract of
Sale/Security Agreement between EasyLink Services Corporation,
EasyLink Services USA, Inc. and Greater Bay Business Funding
(formerly CAPCO Financial Company), a division of Greater Bay
Bank, N.A.
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
17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report on Form 10-Q to be signed on its behalf
by the undersigned thereunto duly authorized.
EASYLINK SERVICES CORPORATION
/s/ Michael A. Doyle
----------------------------------------
Michael A. Doyle
Vice President and Chief Financial
Officer
(Principal Financial Officer)
August 7, 2007
18