UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2003.
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 000-28871
SWITCHBOARD INCORPORATED
(Exact Name of Registrant as Specified in Its Charter)
Delaware 04-3321134
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
120 FLANDERS ROAD
WESTBORO, MASSACHUSETTS 01581
(Address of Principal Executive Offices) (ZIP Code)
Registrant's telephone number, including area code: 508-898-8000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value per share
(Title of Class)
Indicate by check mark 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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
As of June 30, 2003, the aggregate market value of the voting common stock
held by non-affiliates of the registrant was approximately $31,353,000
(reference is made to Part II, Item 5 of this Annual Report on Form 10-K for the
statement of assumptions upon which this calculation is based). The registrant
has no shares of non-voting common stock authorized or outstanding.
On March 5, 2004, there were 19,203,941 shares of the registrant's common
stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Definitive Proxy Statement for its 2004 Annual
Meeting of Stockholders are incorporated by reference into Part III herein. With
the exception of the portions of that proxy statement expressly incorporated
herein by reference, such document shall not be deemed filed as part hereof.
FORWARD LOOKING STATEMENTS
This Annual Report on Form 10-K includes forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934 that are subject to a number of risks and
uncertainties. All statements, other than statements of historical fact,
included in this Annual Report on Form 10-K regarding our strategy, future
operations, financial position, estimated revenues, projected costs, prospects,
plans and objectives of management are forward-looking statements. When used in
this Annual Report on Form 10-K, the words "will", "believe", "anticipate",
"intend", "estimate", "expect", "project" and similar expressions are intended
to identify forward-looking statements, although not all forward-looking
statements contain these identifying words. We cannot guarantee future results,
levels of activity, performance or achievements and you should not place undue
reliance on our forward-looking statements. Our forward-looking statements do
not reflect the potential impact of any future successful or unsuccessful
acquisitions, mergers, dispositions, joint ventures or strategic alliances. Our
actual results could differ materially from those anticipated in these
forward-looking statements as a result of various factors, including the risks
described in "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Factors Affecting Operating Results, Business Prospects
and Market Price of Stock" and elsewhere in this Annual Report on Form 10-K. The
forward-looking statements provided by us in this Annual Report on Form 10-K
represent our estimates as of the date this report is filed with the SEC. We
anticipate that subsequent events and developments will cause our estimates to
change. However, while we may elect to update our forward-looking statements in
the future we specifically disclaim any obligation to do so. Our forward-looking
statements should not be relied upon as representing our estimates as of any
date subsequent to the date this report is filed with the SEC.
This Annual Report on Form 10-K also contains estimates made by independent
parties and by us relating to market size and growth and other industry data.
These estimates involve a number of assumptions and limitations, and you are
cautioned not to give undue weight to such estimates. We have not independently
verified the accuracy of the estimates made by third parties. In addition,
projections, assumptions and estimates of our future performance and the future
performance of the industries in which we operate are necessarily subject to a
high degree of uncertainty and risk due to a variety of factors, including those
described in "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Factors Affecting Operating Results, Business Prospects
and Market Price of Stock" and elsewhere in this Annual Report on Form 10-K.
These and other factors could cause results to differ materially from those
expressed in the estimates made by the independent parties and by us.
WEBSITE ADDRESS
Our website address is www.switchboard.com. References herein to
www.switchboard.com, switchboard.com, any variations of the foregoing or any
other uniform resource locator, or URL, are inactive textual references only.
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The information on our website or at any other URL is not incorporated by
reference herein and should not be considered to be a part of this document. We
make available through our website, free of charge, our Annual Reports on Form
10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and
amendments to those reports, filed or furnished pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably
practicable after such reports are electronically filed with, or furnished to,
the SEC. These reports may be accessed through the website's investor
information page.
SERVICE MARKS
Switchboard, Ad Studio, MapsOnUs, My Corner, My Studio, SideClick, Think
Outside the Book and What's Nearby are registered service marks of Switchboard
Incorporated. Deals Nearby, Envenue, It's the Yellow Pages. Electrified.,
Nearbuy, Switchboard Matrix, LocalClicks and LocalCalls are service marks of
Switchboard Incorporated. Other product, company or organization names cited
herein may be service marks, trademarks or trade names of their respective
companies or organizations.
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SWITCHBOARD INCORPORATED
2003 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Part I
Item 1. Business 5
Item 2. Properties 14
Item 3 Legal Proceedings 14
Item 4. Submission of Matters to a Vote of Security Holders 14
Executive Officers of the Registrant 15
Part II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters 16
and Issuer Purchases of Equity Securities
Item 6. Selected Financial Data 17
Item 7. Management's Discussion and Analysis of Financial 18
Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 38
Item 8. Financial Statements and Supplementary Data 39
Item 9. Changes in and Disagreements with Accountants on Accounting and 63
Financial Disclosure
Item 9A. Controls and Procedures 63
Part III
Item 10. Directors and Executive Officers of the Registrant. 63
Item 11. Executive Compensation 63
Item 12. Security Ownership of Certain Beneficial Owners and 64
Management and Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions 64
Item 14. Principal Accountant Fees and Services 64
Part IV.
Item 15. Exhibits, Financial Statement Schedules and Reports on 64
Form 8-K
Signatures 67
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PART I
ITEM 1. BUSINESS
We are a leading provider of local online advertising products, enabled by
our innovative, consumer-oriented online yellow and white pages directory
technology. We generate revenue primarily from merchant and national advertisers
that pay to advertise in the Switchboard-powered directories of our licensees
and/or in our directory. Licensees of our yellow pages directory technology
include Internet portals, traditional yellow pages publishers and newspaper
publishers.
Through our website, and our licensee network of Switchboard-powered yellow
pages directory websites, we provide merchant and national advertisers with a
way to connect with local consumers, thus helping these businesses establish and
grow their online presence. As with the traditional paper-based yellow pages,
merchants that advertise directly with us or through one of our licensees are
able to get their message in front of consumers at the time they are looking for
that merchant's products or services on the Internet.
We are a Delaware corporation that commenced operations in February 1996.
From our inception in February 1996 until our initial public offering in March
2000, we were a unit and later a subsidiary of ePresence, Inc. (formerly Banyan
Worldwide). We acquired MapsOnUs(TM) (www.mapsonus.com) in 1998. MapsOnUs
provides advanced mapping and driving directions throughout the United States.
We have integrated the MapsOnUs technology and mapping services as an additional
component of our suite of proprietary software products that comprise our
directory technology. Our total net revenue was $15.2 million during 2003, $11.7
million during 2002 and $9.3 million during 2001. During 2003 we recorded net
income of $2.1 million, or $0.10 per share. During 2002 we recorded a net loss
of $4.0 million, or $0.21 per share. During 2001, we recorded a net loss of
$66.8 million, or $2.83 per share. As of December 31, 2003, 2002 and 2001, our
total assets were $59.5 million, $57.8 million and $65.8 million, respectively.
On March 26, 2004, we announced a definitive agreement to merge with a
wholly-owned subsidiary of Infospace, Inc., or "Infospace," a diversified
technology and services company that develops Internet and wireless solutions
headquartered in Bellevue, Washington. Upon consummation of the merger,
Switchboard will be a wholly-owned subsidiary of Infospace. Each share of
Switchboard common stock will be converted into a right to receive $7.75 in
cash, without interest, upon consummation of the merger. The merger is expected
to close during the second half of 2004, and is subject to customary closing
conditions, including receipt of Switchboard and ePresence, Inc. shareholder, as
well as regulatory, approvals. See "Factors Affecting Operating Results,
Business Prospects and Market Price of Stock - Risks Resulting from our
Announced Merger Agreement with Infospace" for more information concerning this
announcement.
We intend to file a proxy statement in connection with the proposed
acquisition of Switchboard by InfoSpace. Investors and security holders are
urged to read these filings when they become available because they will contain
important information about the proposed acquisition. Investors and security
holders may obtain free copies of these documents (when they are available) and
other documents filed with the Securities and Exchange Commission at the
Securities and Exchange Commission's web site at www.sec.gov. Investors and
security holders may obtain free copies of the documents filed by Switchboard
with the Securities and Exchange Commission by contacting Switchboard Investor
Relations at 120 Flanders Road, Westborough, Massachusetts 01581, (508)
898-8200. In addition, investors and security holders may read and copy any
reports, statements and other information filed by Switchboard at the SEC public
reference room at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call
the SEC at (800) SEC-0330 for further information on the public reference room.
Switchboard and InfoSpace and their respective directors and executive
officers may be deemed to be participants in the solicitation of proxies from
the stockholders of Switchboard and ePresence in connection with the proposed
acquisition. Certain officers and directors of Switchboard have interests in the
proposed acquisition, including their ownership of Switchboard common stock, and
their interests will be described in the proxy statement of Switchboard when it
becomes available.
Additional information regarding the directors and executive officers of
Switchboard is included in Part III, Item 10 below. Additional information
regarding the directors and executive officers of InfoSpace is included in
InfoSpace's proxy statement for its 2003 Annual Meeting of Stockholders, which
was filed with the Securities and Exchange Commission on April 21, 2003, and the
supplement to its proxy statement, which was filed with the Securities and
Exchange Commission on May 5, 2003. These documents are available free of charge
by contacting InfoSpace Investor Relations at (866) 438-4677. All of the
documents filed by Switchboard and InfoSpace with the SEC are available free of
charge at the Securities and Exchange Commission's web site at www.sec.gov.
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We have included the web address of the SEC as an inactive textual
reference only. Except as specifically incorporated by reference into this
Report, information on that website is not part of this Report.
Our Market Opportunity
For decades, yellow pages directories have been a primary source of local
merchant information for consumers. According to The Kelsey Group ("Kelsey"), an
authority on local and personalized commerce intelligence, the yellow pages
industry generates an estimated $14 billion in annual advertising sales in the
United States, and $25 billion worldwide. Kelsey reports that while most of that
market still purchases yellow pages advertising in traditional printed form, the
industry is experiencing a migration from paper to online searches. According to
Kelsey, approximately 30% of total local business searches in both print and
online directional media were interactive in 2002 compared to approximately 15%
in 2001 and 9% in 2000. Kelsey expects that this trend will continue and
projects that interactive searches will account for 45% of usage by 2006. As the
volume of directory references made online continues to grow, we believe that
merchants will continue to shift marketing expenditures away from print yellow
pages and towards online yellow pages providers. Kelsey further reports that the
online directional media market, which generated $337 million in 2002, is
forecasted to reach $2 billion by 2006.
An online presence is important for merchants of all sizes, regardless of
whether the merchant actually sells its products and services over the Internet.
According to 2002 research conducted by Pew Internet & American Life Project, if
a merchant provides product and/or service information online, even if it does
not sell products online, nearly half of all Americans would be more likely to
go to the physical store to transact business. Online yellow pages are a
resource that merchants can use to cost-effectively establish an online presence
and provide easy access to information to consumers who are actively searching
for merchants that meet their product and service needs. According to the 2003
Yellow Pages Industry Usage Study released by the Yellow Pages Integrated Media
Association, conducted by Knowledge Networks, 66% of online yellow pages users
make or intend to make a purchase after referring to Internet yellow pages.
Further, one of the fastest growing segments of online advertising is paid
search. Online advertising through paid search generally takes two forms: (1)
"Pay for placement," whereby advertisers pay to have their advertisements
prominently displayed within a search engine database; or (2) "Pay for
performance," whereby advertisers pay online media companies every time a user
clicks on a link to its website. A key driver of demand for paid placement and
pay for performance advertising is the improved ability for advertisers to
better manage the effectiveness of their online advertising versus other forms
of advertising. According to PricewaterhouseCoopers IAB Internet Advertising
Revenue Report, paid search accounted for 15% of the $6 billion of online
advertising spending in 2002, compared to only 4% in 2001. Many of the companies
that develop these search engines have publicly stated their emerging interest
in the local online advertising market, and the application of the "pay for
performance" model to this market.
Market research continues to reinforce the increasing role that Internet
promotion plays in stimulating online and offline transactions for merchants. We
believe that as a leading provider of local online advertising solutions and
yellow and white pages directories, we are well positioned to capitalize on this
opportunity through our branded website and our network of current and future
licensees.
Our Business
Merchant and national advertisers pay to advertise in the
Switchboard-powered directory websites of our licensees and/or in our own
directory website. Consumers access our directory technology through one of the
Internet brands of our licensees or through our website, www.switchboard.com, to
locate business and residential information locally and nationally. The sales
forces of our licensees, our own direct sales force and third party sales
channels sell the advertising placed in Switchboard-powered directories. Our
directory technology creates powerful advertising opportunities for merchant and
national advertisers, and the merchant information creates a useful experience
for consumers that drives more user traffic to our own website, and to the
websites of our licensees. By increasing our consumer audience, we, in turn,
increase the value and reach of our advertising products.
Our Advertising Products
We offer a variety of advertising products tailored to the needs of small
local businesses, large national advertisers, online retailers and other
advertisers seeking increased online exposure.
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Subscriptions for Prominent Placement - We offer merchants prominent
placement in our directory and the directories of our licensees. Prominent
placement advertisements enable merchants to have their listing data presented
ahead of non paying merchant listings included in our database, and/or enhance
their listing with additional information that may include links to their
website. It also allows advertisers to expand the geographic and category reach
of their business information. Merchants typically pay a monthly subscription
fee for prominent listings.
Local Performance Based Advertising (LocalClicks(TM)) - We continue to
evolve the concept of a traditional print directory into an interactive and
dynamic medium interconnecting consumers with merchant and national advertisers.
In August 2003, we announced the launch of our new LocalClicks advertising
product. The LocalClicks product introduces performance-based advertising within
the Switchboard.com yellow pages. The LocalClicks product integrates paid links
into yellow pages results, connecting consumers directly from yellow pages
business listings to extended business information, business services, and
products available for online purchase. LocalClicks permits national businesses
that have a local business presence to embed links into each of their affiliated
local business listings. For example, an auto manufacturer can place links to a
newly introduced car website into the business listings of all of its
dealerships nationwide. With a single ad purchase, they create thousands of
click-able opportunities for consumers searching for dealerships locally.
Merchants typically pay a fixed fee for each time a consumer clicks on the
LocalClicks links.
Content-Targeted Advertising - Advertisers pay for clicks to their websites
from links that are delivered in conjunction with a consumer's search query. The
consumer's search query contains terms that indicate what the consumer appears
to be searching for, including the type of product or services and location. We
call this contextual relevance. In addition to delivering the online yellow page
listings that the consumer is searching for, using our proprietary enhanced
merchant information (rich data that we have gathered about a merchant's product
and service offerings), we are able to serve contextually relevant
advertisements on yellow pages results and a variety of other pages throughout
the Switchboard.com website. Through our agreement with Google Inc. announced in
July 2003, we offer contextually relevant advertisements on our website through
the Google AdSense(TM) program. Google AdSense uses proprietary technology to
deliver dynamically generated ads targeted to the content of our online yellow
page listings. For example, when a consumer performs a yellow pages search and a
results page is displayed to the consumer, Google analyzes extensive information
about the category, the location, and the content associated with merchant
listings that satisfy the search. Google matches keywords from our local
merchant data with advertisers in their database, and returns the appropriate
advertisements for presentation alongside the yellow pages search results. Our
extensive local content enables Google's advertisers to reach a very targeted
audience through our relevant yellow pages search results. Google pays us a
share of the revenue generated whenever a user clicks on one of these ads.
National Banner and Site Sponsorship Advertising - We sell traditional
site-wide banner and category-specific banner programs on the Switchboard.com
website, and the directories of some of our licensees, primarily in the white
pages area of our online directory. We also sell sponsorship programs on a
site-wide basis or for various categories. Sponsorships are advertisements that
do not rotate with other advertisers and are prominently displayed on our
website. Customers typically pay us based on the number of page visits we
deliver to consumers or the number of times consumers click on their
advertisements.
As a service to some of our licensees and local merchant customers, we have
historically provided complementary services such as small business website
hosting. However, we do not emphasize such services today. In addition, we also
customize our MapsOnUs maps and driving directions content for licensing to a
number of online destinations but such licensing is not a primary product
offering and is not a material revenue source.
Selling Our Advertising Products
Sales channels for our online advertising products include the sales forces
of our directory technology licensees, our own direct sales force, and third
party sales channels.
Directory Technology Licensees - We provide a complete online yellow pages
solution, which we refer to as our directory technology, for companies
strategically focused on developing a successful online directory business under
their own brands. We license our directory technology to Internet portals,
traditional yellow pages publishers and newspaper publishers. Our suite of
advertising products are built around a proprietary merchant database and search
technology, as well as full-featured advertising and merchant management tools.
The full suite of advertising products included in our directory products enable
our licensees to offer merchants local online advertising products and yellow
and white pages services. Our directory technology is fully integrated to meet
the needs of our licensees, their merchant customers and the millions of
consumers that utilize the Switchboard-powered directory embedded in their
websites.
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Our licensees typically pay us a setup fee for the creation and
modification of a web-hosted online yellow and white pages directory. In
addition to a setup fee, our licensees typically pay us a royalty in the form of
a fixed fee-per-merchant based on the number of merchant advertisements promoted
in their platform, or a percentage of revenue generated from those merchant
advertisements. Further, our licensees can offer their advertisers placement in
our www.switchboard.com website for an incremental fee. Licensing our technology
in this way enables us to accelerate and share in the growth of local online
advertising as traditional yellow pages advertisers spend more online.
Our largest and most significant licensee is AOL. We maintain and manage a
customized online directory in a separate and distinct web-hosted environment
for AOL. Prior to October 1, 2003, AOL paid us a percentage of revenue for
advertisements placed in their online directory and engineering service fees on
a time and materials basis for customized modifications they requested to their
directory technology. Beginning October 1, 2003, AOL pays us $4.8 million
annually in monthly installments to provide, maintain and customize their
directory platform through December 2005. In addition, AOL and Switchboard are
able to sell and share revenue on advertising products offering merchant and
national advertisers access to the combined consumer audience of both the AOL
and Switchboard yellow pages directories. AOL constituted approximately 41.2% of
our net revenue in 2003 and approximately 41.8% of our net revenue in 2002. AOL
beneficially owned approximately 7.8% of our common stock as of March 5, 2004.
We anticipate that AOL will continue to represent a significant percentage of
our revenue in 2004 and will be a material component of our overall business.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Significant Relationship" for more information.
Direct and Third Party Sales - We also sell directory advertisements into
the Switchboard.com website through direct and third party sales forces. We have
a small, dedicated direct sales force that focuses on selling our advertising
products primarily to national and e-commerce advertisers. We currently intend
to spend an additional $2.5 million during 2004 as compared to 2003, to support
direct sales. However, our level of spending in this area may increase or
decrease depending on the success of this initiative, and as we become more
experienced in managing a significant direct sales effort. We also utilize third
party sales channels, including yellow pages publishers, telemarketing
companies, and Certified Marketing Representatives (advertising agencies that
specialize in placing yellow pages advertisements). For example, we have an
agreement with Monstermoving Inc. that provides them with the ability to sell
directory advertising services on the Switchboard.com website. Under the
agreement, each Monstermoving customer that renews its online subscription will
have an advertisement included on the Switchboard.com site, and Monstermoving
will pay us a fee for each of those customers.
The Audience for Our Advertising Products
Our licensees each have their own respective online audiences, or consumer
reach, and the advertisements they sell into their Switchboard-powered
directories are made visible to those audiences.
Furthermore, our own website, www.switchboard.com, is one of the leading
destinations on the Internet where consumers search for local merchants.
Switchboard.com has grown significantly since its inception. As a result, many
advertisers looking for effective and efficient forms of local online
advertising desire placement in the www.switchboard.com directory. According to
Nielsen//NetRatings, our websites served more than 6.1 million unique visitors
from home and work during January 2004.
Directory advertisements sold into Switchboard.com are typically made
visible to the combined audience of the Switchboard.com directory, and the
directories of a subset of our licensees who agree to display, in their
Switchboard-powered directories, advertisements sold by Switchboard and other
sales forces. By participating in this network, these licensees can offer their
users a broader base of merchant information, which, in turn, makes their
directories more useful to their users. The combined audience of
www.switchboard.com and these licensees adds overall value for our advertisers.
Our Strategy
We believe that our business opportunity and prospects rely on the overall
growth in the market for local online advertising and yellow pages advertising,
our ability to attract increasing numbers of paying merchant and national
advertisers either directly or through our licensees, our ability to drive
quality leads to merchants, and our ability to innovate our product and service
offerings to meet consumer and merchant demands. We intend to grow our business
by focusing on the following key strategies:
Promote the Development of Local Online Advertising Products and the Online
Yellow Pages Market - We have sought to accelerate market adoption of online
yellow pages advertising by licensing our directory technology to major media
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companies, including traditional yellow pages publishers, newspaper publishers
and Internet portals. We have pursued this strategy on a private label and
co-branded basis to supplement our initiatives in promoting the Switchboard
brand. We also participate in industry trade groups to broaden adoption of the
online yellow pages advertising media. We seek to continue these efforts to grow
the overall market opportunity for the online yellow pages category and local
online advertising in general.
Attract Increasing Numbers of Paying Merchants - We seek to increase the
number of merchant and national advertisers in our directory and the
Switchboard-powered directories of our licensees. Our sales strategy includes a
number of facets, including seeking to expand the number of licensees of our
directory technology, leveraging third party sales forces, promoting
self-service sign up for merchants and other sales strategies. We may also
embark upon broader direct selling initiatives to local merchants, including
geographically targeted telemarketing and in-person sales. If we pursue such
direct selling, we will evaluate expanding our existing sales and marketing team
and/or contracting with third party marketing firms.
Expand the Audience for Our Advertising Products - Continuing to expand the
number of consumers using our website and the directories we power for licensees
is critical to our ability to provide value to our merchant and national
advertisers. In addition, a large and active base of merchant and national
advertisers will enable us to generate more relevant search results for
consumers. Through various initiatives, we seek to increase the number of
consumers using our directory. Such initiatives may include public relations
activities to increase consumer awareness of online yellow pages and the
Switchboard brand; online advertising campaigns to direct traffic to our
website; word-of-mouth marketing initiatives; increasing the number of licensees
using our yellow pages directory technology; distribution arrangements to
provide our local content to search portals, e-commerce hubs and topic-specific
content sites; and, affiliate programs targeted at attracting usage across
specific segments of the online consumer population.
Innovate New Product and Service Offerings - We believe that our future
success hinges on delivering a superior consumer experience through the
functionality of our website and the directories that we power for our
licensees. By delivering a superior consumer experience, we will enhance the
value to merchants that advertise with us and with our licensees. For example,
through sophisticated searching capabilities and simple user interfaces, we can
connect consumers searching for specific products and services with the local
merchants that provide them. In addition, by continuing to provide our merchant
base with customizable products and comprehensive management tools that make it
easier for individual merchants and our licensees to manage their merchant
advertising efficiently, we seek to increase the revenue opportunity of our
services. We intend to continue to develop new technologies that improve the
functionality of our products and services for consumers, merchants and our
licensees.
Our Online Directory Technology
Our directory technology is comprised of five fully-integrated components
that are utilized for our branded www.switchboard.com website, and that enable
our licensees to develop and manage their online directory business.
Sophisticated Database and Search Engine - We provide a highly scalable,
reliable and high performance directory search engine that we have optimized for
the unique nature of local business directory searches. Through our proprietary
database technology, we are able to easily merge data from multiple sources,
allowing us to provide timely and comprehensive content to our licensees and
users. With the release of our Switchboard MatrixSM technology, we were the
first-to-market with the introduction of searchable online "copy points". Copy
points are enhanced data typically found in paper yellow pages advertising. Copy
points enable merchants to be found via a wide variety of attributes, including
product and service offerings, business hours, specialties, etc., moving beyond
the traditional category / location searching of paper-based or other online
yellow pages offerings. Recent enhancements to our database and search engine
enable users to find local businesses using common words and phrases. Our new
technology "learns", from past user behavior, the yellow pages headings most
frequently associated with these common words and phrases, and provides users
with results that are more relevant to their search.
Customizable Advertising Product Suite - Within the yellow pages directory
we provide a complete suite of local and national advertising products that can
be fully customized to match the unique packaging and pricing requirements of
our licensees. With the introduction of our searchable "copy point" model, we
fully aligned our online advertising products with traditional yellow pages
products, offering similar enhanced data as the printed medium, improving our
ability to streamline our sales efforts.
Comprehensive Merchant Management Tools - We have developed three different
tiers of merchant management software solutions to provide our licensees with
the level of functionality that works most efficiently in coordination with
their existing in-house systems. For licensees looking for a complete merchant
management solution, we provide a comprehensive customer relationship
management, or CRM, package that tracks merchant customer activity, performs
billing functions and manages merchant advertising. Our CRM package also can be
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integrated with other applications to enable customer support representatives to
manage the fulfillment of a variety of products from within a single interface.
For licensees that already possess CRM infrastructure, we provide a secure,
web-based merchant management tool that allows licensees to easily manage
advertising campaigns and merchant collateral within the online yellow pages
technology. Lastly, for licensees that regularly set-up large volumes of
merchant advertisements into the system, we provide a bulk load interface that
allows formatted files containing merchant information and advertising
specifications to be automatically processed.
Cobrandable User Interface - Through ongoing usability testing and close
analysis of consumer use of online yellow pages, we continue to evolve our user
interface and searching capabilities to quickly connect consumers with the most
relevant search results. Through the modular organization of functional elements
of our interface, we can customize the interface's look and feel so that it is
consistent with the look and feel of our licensees' websites and branding. These
modules separate the functional elements from the layout elements, such as site
appearance, thus facilitating rapid development. As we enhance or build new
functional elements, the underlying architecture enables us to deploy these
elements across all of the websites of our licensees without making individual
changes to specific implementation.
MapsOnUs.com - Maps and Directions - Our MapsOnUs technology integrates
maps and driving directions into many areas of our directory technology, and is
also available through our MapsOnUs.com website. Utilizing our MapsOnUs
capabilities, we are able to provide businesses with dealer locators that can be
easily integrated into their websites to help visitors locate the closest
outlet, dealer or franchisee.
Our Technology and Enhanced Merchant Information
We have developed sophisticated technologies that enable rapid
dissemination of information requested by consumers using our website or the
websites of our licensees. These technologies were conceived and developed by a
staff of senior engineers experienced in designing large-scale, distributed
computer systems, a form of computer architecture that divides system
functionality over numerous computers, each known as a server, to enhance
overall system performance and reliability. We also have particular strengths in
the areas of database technologies, advertising management and content
customization.
Directory Technology - We have been affiliated with ePresence (formerly
Banyan Worldwide), a pioneer of directory technology, since our founding in
1996. Directories played a key role in the large-scale, multiple-site
distributed systems deployed by Banyan since 1983. Our founder, Dean Polnerow,
designed and originally developed StreetTalkTM, Banyan's directory service.
Building on this experience to create our own proprietary directory technology,
we created what we believe to be the first national directory of United States
residential information available on the Internet, as well as our innovative and
proprietary yellow pages business directory.
Data Content - We license our base residential and business listings data
content from third parties and then augment it with data that we have gathered
ourselves. There are over 108 million residential and 17 million business
listings included in our database. Currently our primary data source for base
listing information is Acxiom Corporation, and our agreement with Acxiom expires
in December 2005. We augment these base listings with detailed information we
have gathered through our own data compilation efforts, and through local
merchant sales. We have additional data content for over one million merchants
that enables consumers to search on merchant copy points or attributes. In
addition, we purchase the data used in our MapsOnUs services from TeleAtlas
North America, Inc. pursuant to an agreement which expires in February 2005.
Site Design - Our directory technology was designed to provide high levels
of performance, scalability, and reliability. The directory is implemented as a
set of Windows 2000 servers that are organized into groups. Each group of
servers provides different parts of the overall site's functionality and each
type of functionality is provided by more than one group of servers. Individual
servers in a group can be added or removed without affecting the functional
capabilities of the site, and most changes required are managed automatically by
proprietary software that we have developed. This distributed architecture is
designed to be highly scalable, which means that system capacity and
functionality can be easily and inexpensively increased, typically with minimal
or no time-consuming software changes required. It is also designed to be
reliable, which means it is resistant to service interruptions and the
unavailability of one or more servers does not affect the operation of other
servers or the directory as a whole.
We contract with a third party to host and secure the infrastructure for
our directory and the directories of our licensees. Access to the third party
facility is restricted and our infrastructure is physically segregated with
restricted access as well. In addition, we license firewall and anti-virus
security software and monitor site activity to detect unauthorized access to our
technology and information. Although we take these measures to protect access to
our technology and merchant information, we cannot totally eliminate the
possibility of unauthorized access.
10
Database Search Technologies - We have developed technology designed to
quickly exchange information between the groups of servers that provide the
interface consumers use to input their requests for information with the groups
of servers that store the databases of information we use to respond to these
requests. This technology allows data from multiple databases to be accessed and
combined, regardless of its structure or content. This simplifies the
development of new user interfaces and facilitates database updates. Our
database technology helps to maximize website performance through sophisticated
in-memory data structures that are optimized for rapid searching of various
combinations of data elements, and by automatically balancing the tasks being
performed by individual servers.
Our database technology includes sophisticated query management techniques
that enable requests for large amounts of data to be retrieved in segments while
reducing the computer processing time typically associated with these operations
using conventional design techniques. This enables ready access to a large
amount of data stored in any of the databases and results in faster responses to
the user.
Advertising Management and Geographic Targeting - Our advertising placement
technology is used primarily to control the frequency and positioning of
advertisements displayed on our website. This technology rotates merchant
advertisement displays in and out of prime locations on our yellow pages screens
according to priorities specifically purchased by our merchant and banner
advertising customers. We use an automated chain of software programs to
securely facilitate the addition, removal and modification of both individual
ads and large, aggregated volumes of merchant advertising into our yellow pages
directory.
We have also developed a proprietary geographically-targeted advertisement
placement methodology that provides a simple way to allow a merchant to focus
its advertising to the surrounding communities it desires to target. This
technology uses the physical location of a business and a distance measurement
selected by the merchant to automatically determine the appropriate location
targets. These advertisement management tools and processes enable our support
personnel and authorized ad resellers to remotely manage and control national,
regional and local advertising campaigns.
Merge-Purge Data Consistency - Data integrity for business listings and
advertising products is preserved through the application of business rules to
all data change requests (data merging and purging). Data integrity rules are
applied by our merge-purge technology as each data change request attempts to
modify listing and/or advertising data. These rules include low-level data
content and constraint validation, as well as "sales channel" specific rules
that manage the business logic associated with listing and advertisement
attributes. This allows for continuous refreshing of business listing data, and
easy management of all advertising products associated with a given business,
while permitting the best and latest available data to be presented to the
consumer.
Customer Relationship Management - Our web-based CRM tools are specially
designed to help our licensees easily manage many facets of their relationships
with their own merchant customers. The tools provide product definition and
merchant management capabilities for direct selling efforts and indirect sales
channels, including sales management, customer invoicing, credit card
transactions, self-service online advertising sales, account history and
reporting. Product definition capabilities allow each sales channel to combine
our available advertising products into packaged product offerings for their
specific merchant customer base, such as a variety of online advertisement
presentations, coupons, websites, and products fulfilled by third parties, along
with the pricing and discounting features of each advertisement product. The
tools present an access-controlled workflow process that manages and records all
merchant customer interactions, from initial sale and payment processing through
subsequent interaction logging, automatic renewal management and ongoing
reporting.
11
Our Competition
We compete against numerous companies primarily in three categories of
businesses for local and national advertising dollars and market share, namely:
* Internet-based yellow and white pages directories that do not utilize our
directory website, such as Yahoo! Yellow Pages and Verizon SuperPages;
* Printed yellow and white pages directories that compete with online
offerings for advertiser dollars; and
* Internet-based pay-for-placement and pay-for-performance search engines
and services, such as Google, LookSmart, FindWhat, Yahoo! and Citysearch,
particularly as they begin to expand their offerings to local markets.
We compete with these organizations primarily on the basis of directory
technology, as well as the price and consumer reach of directory advertisements.
Our website is one of the most utilized directory platforms on the
Internet, according to Nielsen//NetRatings, claiming a top 5 spot among category
leaders. We believe that our directory technology has allowed us to secure our
key alliance with AOL as well as alliances with other important customers and,
along with the popularity of www.switchboard.com, has enabled us to capture the
attention of millions of potential consumers. However, we continue to face
competition from many sources both traditional and untraditional, including
companies which have substantially greater resources and name recognition than
we do. Beyond Yahoo! and Verizon, there are numerous national and regional
publishers of online and print yellow pages advertising who compete with us and
our licensees for merchant advertising. We may also face competition from
internal development groups within our existing and prospective customers, some
of which may decide to develop their own proprietary online directory solutions.
Additionally, the increased popularity of paid search, and the interest of the
companies that are leading the segment in expanding their offerings to more
effectively address localized searching and advertising, could begin to blur the
lines between search engines and online directories and add additional
complexities to the market.
As directory references increase online, we believe advertising in an
online directory (versus print) will become increasingly important for
businesses both large and small. As more yellow pages print advertising dollars
are spent on online advertising, we believe that the competition in the online
directory market will intensify. We believe publishers of local online
advertising solutions will seek best-in-class technology and tools to improve
the efficiency of their online operations and to differentiate their online
offerings to merchant and national advertisers. We believe factors that will
enable online directory providers to compete effectively in this environment
include the ability to offer highly functional and scalable technology
solutions, incremental consumer page visits for their merchant and national
advertisers, and tools to ease the management and administration of online
advertising purchases. We further believe that Switchboard is well positioned to
fulfill publishers' needs in these areas.
As online usage grows, companies offering local directories will compete to
bring greater value to online advertisers by further increasing consumer usage
of their directories in these ways:
* speed of results;
* relevance of search results to intent; and
* content breadth and depth.
We believe that structured and highly specialized user interfaces and
database designs tailored to the needs of local advertisers will be an advantage
to easily guide consumers to local service and business information. We believe
that our depth of experience and focus on these areas will play an important
role in making our offerings attractive to users and thus to the merchants that
populate our directories.
We believe our ability to compete successfully over the long-term depends
on many factors. In addition to those discussed above, these factors include
maintaining the quality of content and functionality we provide relative to our
competitors, the cost-effectiveness and reliability of our services relative to
our competitors, and our ability to generate value for local and national
merchants. The market in which we compete is rapidly evolving. To remain
competitive, we believe it is important to continually work towards the
development of new technologies to improve the products and services we offer to
our licensees and merchant customers, as well as to improve the functionality
and utility of our web-hosted directory technology. There can be no assurance
that we will maintain our current competitive advantages or that we will compete
successfully in the market for online directory advertising services in the
future.
12
Our Intellectual Property
Patents, copyrights, service marks, trademarks, trade dress, trade secrets,
and other intellectual property are critical to our success. We rely on a
combination of patent, trademark and copyright law, trade secret protection and
confidentiality, and license agreements with our employees, consultants,
customers, licensees, and others to protect our proprietary rights. All of our
employees have executed confidentiality and assignment of invention agreements.
Prior to disclosing confidential information to third parties, we generally
require them to sign confidentiality or other agreements restricting the use and
disclosure of our confidential information.
As of December 31, 2003, we had seven patents issued by the U.S. Patent and
Trademark Office, three patents issued by the Canadian Intellectual Property
Office, three patent applications pending before the U.S. Patent and Trademark
Office, and two patent applications pending before the Canadian Intellectual
Property Office, all of which relate to the operation, features or performance
of our website. We pursue registration of our key service marks in the United
States and, in some cases, internationally. We currently have registered the
following service marks with the U.S. Patent and Trademark Office: Switchboard,
Envenue, Nearbuy, Think Outside The Book, What's Nearby, My Studio, My Corner,
Sideclick, Ad Studio, Maps On Us, the "Man with Building" design mark and the
"Men with Building" design mark. The following are service marks of Switchboard:
It's the Yellow Pages. Electrified.; LocalClicks; Deals Nearbuy; and,
Switchboard Matrix. Applications are pending for our registration of the
following service marks: LocalClicks and Deals Nearby. However, effective
patent, trademark, service mark, copyright and trade secret protection may not
be available or sought by us in every country in which our services are made
available online. Our patents, trademarks, or other intellectual property rights
may be successfully challenged by others or invalidated through administrative
process or litigation. Further, the validity, enforceability and scope of
protection of proprietary rights in Internet-related industries is uncertain and
still evolving.
We license our proprietary rights, such as patents, trademarks and
copyrighted material, to third parties. Despite our efforts to protect our
proprietary rights, third parties may infringe or misappropriate our rights or
diminish the quality or reputation associated with our brand, which could have a
long-term material adverse affect on our business, results of operations, or
financial condition.
In addition, we license software, content and other intellectual property,
including trademarks, trade secrets, patents, and copyrighted material, from
third parties. In particular, we license residential and business listing data
from Acxiom Corporation under an agreement that expires in December 2005, and
maps and driving directions data and related software from Tele Atlas North
America, Inc. under an agreement that expires in February 2005. Further, some of
the software code underlying Switchboard.com contains software code that is
licensed to us by third parties. If any of these licenses are terminated or
expire, it could have a material adverse effect on our business, results of
operations, or financial condition.
We currently own a number of Internet domain names, including
www.switchboard.com, www.MapsOnUs.com and www.walking-fingers.com. Internet
regulatory bodies generally regulate domain names. The relationship between
regulations governing domain names and laws protecting trademarks and similar
proprietary rights is unclear. Therefore, we could be unable to prevent third
parties from acquiring domain names that infringe or otherwise decrease the
value of our trademarks and other proprietary rights.
Our Research and Development
We employ an engineering staff to develop, test and document the
enhancement of existing, and creation of new, products and services we offer to
our merchant network customers as well as new services and features on our
web-hosted directory platform. The market in which we compete is rapidly
evolving. To remain competitive, we believe it is critical to continually work
towards the development of new technologies to improve the products and services
we offer to our merchant network customers, as well as to improve the
functionality and utility of our web-hosted directory platform. In 2003, we
directed the efforts of our engineering staff primarily on the enhancement of
our Switchboard Matrix directory platform, the compilation and management of
merchant attribute information and the creation of new technology that offers
users more meaningful results when they search for local businesses using common
words and phrases. As of December 31, 2003, we employed a staff of 33 full-time
permanent employees dedicated to research and development activities. Our
research and development expenses have constituted, and we expect they will
continue to constitute for the foreseeable future, a material use of our cash
resources. Research and development expenses were $6.7 million, or 72.2% of net
revenue, $5.4 million, or 46.4% of net revenue and $4.3 million, or 28.1% of net
revenue, in 2001, 2002, and 2003, respectively.
13
Our Employees
As of March 5, 2004, we had 67 full-time employees. Of these employees, 33
are in research and development, 22 in sales and marketing, 3 in site
operations, and 9 in general and administrative. None of our employees are
represented by a labor union. We believe our relations with our employees are
good.
ITEM 2. PROPERTIES
Our principal administrative, sales and marketing, and research and
development facilities are located in Westborough, Massachusetts and consist of
approximately 17,463 square feet under a sublease that expires on September 30,
2005. These facilities have an aggregate annual base rent of approximately
$210,000. We sublease this space from ePresence.
In addition, we lease approximately 120 square feet of office space in
Troy, Michigan for use by a sales person. We also lease 2,782 square feet of
office space in New York City, which we have subleased to a third-party for the
remaining term of our lease with the property owner, which expires on April 28,
2005.
ITEM 3. LEGAL PROCEEDINGS
On November 21, 2001, a putative class action lawsuit was filed in the
United States District Court for the Southern District of New York on behalf of
all persons and entities who purchased or otherwise acquired common stock of
Switchboard from March 2, 2000 through December 6, 2000. The complaint named as
defendants Switchboard, the managing underwriters of our initial public
offering, Douglas J. Greenlaw, Dean Polnerow, and John P. Jewett. Mr. Polnerow
is our President and CEO, and Mr. Greenlaw and Mr. Jewett are former officers of
Switchboard.
An amended complaint was filed on April 20, 2002. The amended complaint
alleges violations of the Securities Act of 1933, as amended, and the Securities
Exchange Act of 1934, as amended, primarily based on the assertion that the
defendants made material false and misleading statements in Switchboard's
registration statement and prospectus filed with the SEC in connection with
Switchboard's initial public offering because of the failure to disclose (a) the
alleged solicitation and receipt of excessive and undisclosed commissions by the
underwriters in connection with the allocation of shares of common stock to
certain investors in Switchboard's public offering and (b) that certain of the
underwriters allegedly had entered into agreements with investors whereby
underwriters agreed to allocate the public offering shares in exchange for which
the investors agreed to make additional purchases of stock in the aftermarket at
pre-determined prices. The amended complaint alleges claims under Sections 11
and 15 of the Securities Act, and Sections 10(b) and 20(a) of the Securities
Exchange Act. The amended complaint seeks damages in an unspecified amount.
In July 2002, Switchboard, Douglas J. Greenlaw, Dean Polnerow and John P.
Jewett joined in an omnibus motion to dismiss challenging the legal sufficiency
of plaintiffs' claims. The motion was filed on behalf of hundreds of issuer and
individual defendants named in similar lawsuits. The plaintiffs opposed the
motion, and the Court heard oral argument on the motion in November 2002. On
February 19, 2003, the court issued its decision on the defendants' motion to
dismiss, granting in part and denying in part the motion as to Switchboard. In
addition, in October 2002, Messrs. Greenlaw, Polnerow and Jewett were dismissed
from this case without prejudice.
In June 2003, the plaintiffs, the issuer defendants and their insurers
agreed on the terms and conditions of a proposed settlement of this case. The
terms and conditions of the proposed settlement have been widely reported in the
press. Our special committee of the board of directors met twice during June
2003 to evaluate the proposed settlement. The committee was advised by outside
counsel on the merits of the proposed settlement. The committee determined that
the settlement was in the best interests of Switchboard and that we should
accept the proposed settlement. There is no guarantee that the settlement will
become final, as it is subject to a number of conditions, including court
approval. We have been informed by outside counsel that all of the non-bankrupt
issuers decided to accept the terms and conditions of the proposed settlement of
this case. We do not believe we will suffer material future losses related to
this lawsuit.
From time to time, we are involved in various legal proceedings incidental
to the conduct of our business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
14
EXECUTIVE OFFICERS OF THE REGISTRANT
Our executive officers and their respective ages and positions with
Switchboard as of March 5, 2004 are as follows:
Name Age Position
- ------------------------- --- --------------------------------------------------
Dean Polnerow............ 47 Chief Executive Officer, President and Director
Robert P. Orlando........ 45 Vice President, Chief Financial Officer, Treasurer
and Secretary
James M. Canon........... 52 Vice President, Business Development
Kevin P. Lawler.......... 43 Vice President, Human Resources
James Carrington......... 51 Vice President, Sales
Dean Polnerow founded Switchboard and has served as our President since
March 1998 and as a director since September 1998. Mr. Polnerow has also served
as our Chief Executive Officer since August 21, 2003. From our inception in 1996
to March 1998, Mr. Polnerow served as our Vice President, Product and Business
Development. From 1983 to 1996, Mr. Polnerow served in various capacities,
including as Vice President, Advanced Development, at Banyan Worldwide.
Robert P. Orlando has served as our Vice President, Chief Financial
Officer, Treasurer and Secretary since October 2001. Prior to joining
Switchboard, Mr. Orlando was the Chief Financial Officer and Treasurer of
Virtual Ink Corporation, a designer of hardware and software collaboration
tools, from 2000 to 2001. From 1991 through 2000, Mr. Orlando was the Chief
Financial Officer and Treasurer of Mathsoft, Inc., a provider of math,
engineering and scientific software solutions. Mr. Orlando also held financial
management positions with Bitstream, Inc., Unicco Service Company and Orion
Research, Inc. Previous to these positions, Mr. Orlando served as an auditor for
Arthur Andersen LLP.
James M. Canon has served as our Vice President, Business Development since
March 1998. Prior to his appointment as our Vice President, Business
Development, from 1997 to March 1998, Mr. Canon served in various capacities at
Switchboard, most recently as Director, Product Management. From 1991 to 1997,
Mr. Canon served in various capacities, including as Information Products
Architect, at ePresence.
Kevin P. Lawler has served as our Vice President, Human Resources since May
2000. Prior to joining Switchboard, Mr. Lawler served as Director of Human
Resources at EMC Corporation, an information storage systems provider, from 1999
to 2000. From 1998 to 1999, Mr. Lawler served as Vice President, Human Resources
for Scriptgen Pharmaceuticals Incorporated, a pharmaceuticals company. From 1990
to 1998, Mr. Lawler served as Vice President, Human Resources for Immulogic
Pharmaceutical Corporation, a pharmaceuticals company.
James Carrington has served as our Vice President, Sales since December
2003. Prior to joining Switchboard, Mr. Carrington served in various capacities
at Monster, Inc., formerly TMP Worldwide, a yellow pages advertising agency and
directional marketing company, for 15 years, most recently as Vice President of
Sales of Monstermoving, Inc.
Executive officers are elected annually and serve at the discretion of our
board of directors. No family relationships exist among any of our executive
officers and directors.
15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
Market Data
Our common stock began trading on the NASDAQ National Market under the
symbol "SWBD" on March 2, 2000. Prior to that date there was no established
public trading market for our common stock. The following table sets forth the
range of high and low closing sale prices of our common stock for the periods
indicated, as quoted on the NASDAQ National Market.
PERIOD HIGH LOW
- ----------------------------- ----- -----
FISCAL 2002
First Quarter of Fiscal 2002 $5.32 $3.02
Second Quarter of Fiscal 2002 $6.39 $3.20
Third Quarter of Fiscal 2002 $3.30 $1.08
Fourth Quarter of Fiscal 2002 $3.13 $1.48
FISCAL 2003
First Quarter of Fiscal 2003 $3.19 $2.20
Second Quarter of Fiscal 2003 $4.10 $2.55
Third Quarter of Fiscal 2003 $12.31 $3.55
Fourth Quarter of Fiscal 2003 $11.06 $6.22
As of March 5, 2004, there were 108 holders of record of our common stock.
This number does not include stockholders who hold their shares in "street name"
or through broker or nominee accounts.
The closing per share sale price of our common stock on June 30, 2003 was
$3.60. For purposes of calculating the aggregate market value of the shares of
our common stock held by non-affiliates, as shown on the cover page of this
Annual Report on Form 10-K, we have assumed that all our outstanding shares were
held by non-affiliates, except for the outstanding shares known to us to be
beneficially held by our directors, executive officers, and each person or
entity known to us to own beneficially more than 10% of our outstanding shares
of common stock. However, this should not be deemed to be an admission that all
these persons are, in fact, affiliates of ours, or that there are not other
persons who may be deemed to be affiliates of ours.
We have never paid cash dividends on our common stock. We intend to retain
our earnings for use in our business and, therefore, do not anticipate paying
any cash dividends on our common stock in the foreseeable future.
Use of Proceeds of Initial Public Offering
On March 2, 2000, we made an initial public offering of up to 6,325,000
shares of common stock registered under a Registration Statement on Form S-1
(Registration No. 333-90013), which was declared effective by the Securities and
Exchange Commission on March 1, 2000.
Our total net proceeds from the offering were approximately $86.3 million,
of which $74.8 million was received in March 2000 and $11.5 million was received
in April 2000. All payments of the offering proceeds were to persons other than
directors, officers, general partners of Switchboard or their associates,
persons owning 10% or more of any class of equity securities of Switchboard or
affiliates of Switchboard. Through December 31, 2003, we used approximately
$17.4 million of the proceeds from the offering for working capital purposes, of
which approximately $4.9 million was for the purchase of fixed assets. In
December 2000 we paid $13.0 million of the proceeds to America Online, Inc.
pursuant to the terms of our Directory and Local Advertising Platform Services
Agreement (the "Directory Agreement") entered into with America Online on that
date. In March 2002, we used $1.3 million of the proceeds for the purchase of
386,302 shares of our common stock from Viacom Inc. as treasury stock. In April
2002, we paid America Online $2.0 million upon the execution of the Second
Amendment to the Directory Agreement. In October 2002, we paid the former
stockholders of Envenue, Inc. approximately $410,000, and in June 2003 we paid
the former stockholders of Envenue an additional $1.7 million. As of December
31, 2003, we have invested the remaining net proceeds in interest-bearing, money
market funds and investment-grade securities.
16
ITEM 6. SELECTED FINANCIAL DATA
You should read the selected consolidated financial data together with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our consolidated financial statements and related notes included
in this Annual Report on Form 10-K.
We derived the selected consolidated financial data set forth below as of
December 31, 2003 and 2002 and for the years ended December 31, 2003, 2002 and
2001 from the audited consolidated financial statements of Switchboard included
herein. All other selected consolidated financial data set forth below is
derived from audited financial statements of Switchboard not included herein.
Switchboard's historical results are not necessarily indicative of future
results of operations.
Selected Consolidated Financial Data
(In thousands except per share data)
For the Years Ended December 31,
------------------------------------------------------
2003 2002 2001 (a) 2000 1999
------- ------- -------- -------- -------
Statement of Operations
Gross revenue $15,192 $13,747 $13,326 $20,310 $8,304
Net revenue (b) $15,192 $11,747 $9,278 $19,898 $8,304
Operating income (loss) $1,440 $(5,921) $(69,975) $(20,708) $(8,656)
Net income (loss) attributable to common
Stockholders $2,074 $(3,959) $(66,754) $(17,288) $ (9,744)
Basic net income (loss) per share $0.11 $(0.21) $ (2.83) $ (0.75) $ (0.89)
Diluted net income (loss) per share $0.10 $(0.21) $ (2.83) $ (0.75) $ (0.89)
As of December 31,
------------------------------------------------------
2003 2002 2001 2000 1999
------- ------- -------- ------- -------
Balance Sheet Data
Total assets $59,523 $57,788 $65,835 $98,557 $12,195
Long term obligations $- $1,124 $518 $2,000 $-
Redeemable convertible preferred stock $- $- $- $- $16,320
Total stockholders' equity (deficit) $56,342 $51,087 $56,667 $90,730 $(9,588)
(a) Operating loss and net loss attributable to common stockholders in the
fiscal year ended December 31, 2001 includes a $22.2 million non-cash loss on
Viacom transaction and special charges of $17.3 million.
(b) Net revenue includes, as an offset to revenue, amortization of consideration
given to a customer of $2.0 million in fiscal 2002, $4.0 million in fiscal 2001
and $412,000 in fiscal 2000 in accordance with Emerging Issues Task Force Issue
01-9 "Accounting for Consideration Given by a Vendor to a Customer (Including a
Reseller of the Vendor's Products)."
17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
You should read the following discussion together with the consolidated
financial statements and related notes appearing elsewhere in this Annual Report
on Form 10-K. This Item contains forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933 and Section 21E of the Securities
and Exchange Act of 1934 that involve risks and uncertainties. Actual results
may differ materially from those included in such forward-looking statements.
Factors which could cause actual results to differ materially include those set
forth under "Factors Affecting Our Operating Results, Business Prospects and the
Market Price of Stock", as well as those otherwise discussed in this section and
elsewhere in this Annual Report on Form 10-K. See "Forward Looking Statements."
Overview
In February 1996, when we commenced operations, we derived our revenue
principally from the sale of national banner and site sponsorship advertising on
our directory website, www.switchboard.com. We now primarily derive revenue from
merchant and national advertisers that pay to advertise in the
Switchboard-powered directories of our licensees, and/or on our own website,
www.switchboard.com. We operate in a single segment, but classify our revenue
into two categories, namely net merchant network revenue and national banner and
site sponsorship revenue.
Net merchant network revenue includes revenue from various licensing
agreements with our directory technology licensees. These agreements involve,
generally, (1) a setup fee for engineering work to develop a web-hosted platform
for our licensees which looks and feels like the licensees' own website and
includes our searching functionality, and (2) a royalty in the form of a fixed
fee per merchant based on the number of merchant advertisements promoted in
their directories, or a percentage of revenue generated from those merchant
advertisements. In addition, net merchant network revenue includes engineering
and other fees for services provided to support the directories and programs of
our licensees. Net merchant network revenue also includes revenue from running
priority placement, local performance based, and content targeted advertising in
the Switchboard.com yellow pages directory, and building and hosting websites
for local merchant advertisers. In addition, we paid a total of $15.0 million
and issued 746,260 shares of common stock to AOL in connection with entering
into our Directory Agreement with AOL in 2000. Amortization of the value
attributed to this consideration given to AOL has been included as an offset to
merchant network revenue, as the benefits of such consideration given to AOL are
not separately identifiable from the revenue obtained from AOL. During 2003, net
merchant network revenue comprised approximately 88.4% of our total net revenue
as compared to 87.9% in 2002 and 66.9% in 2001.
We also continue to generate revenue from the sale of national banner and
site sponsorship advertising on white and yellow pages, as well as maps pages,
across both www.switchboard.com and the websites of several directory technology
licensees. Such revenue is derived from banner advertisements, sponsorships and
direct electronic mail-based promotions that are sold on either a fixed fee,
cost per thousand impressions or cost per action basis. During 2003,
approximately 11.6% of our net revenue was derived from the sale of national
banner and site sponsorship advertising, as compared to 12.1% in 2002 and 33.1%
in 2001.
Our cost of revenue consists primarily of expenses paid to third parties
under data licensing and website creation and hosting agreements and search
engine database inclusion expense, as well as other direct expenses incurred to
maintain the operations of our website as well as the web-hosted platforms of
our licensees. These direct expenses consist of data communications expenses
related to Internet connectivity charges, salaries and benefits for operations
personnel, equipment costs and related depreciation, costs of running our data
centers, which include rent and utilities, and a pro rata share of occupancy and
information system expenses. Cost of revenue also includes an allocation of
salaries and benefits for employees, as well as expenses resulting from external
consultants, directly associated with the delivery of billable engineering and
other services. Cost of revenue as a percentage of revenue has varied in the
past, primarily because the amount of revenue recognized has varied and has been
spread over relatively fixed costs of revenue.
Our sales and marketing expense consists primarily of employee salaries and
benefits, costs associated with channel marketing programs, collateral
production expenses, third-party commission costs, public relations, market
research, provision for bad debts and a pro rata share of occupancy and
information system expenses.
Our research and development expense consists primarily of employee
salaries and benefits, fees for outside consultants and related costs associated
with the development of new services and features on our web-hosted directory,
the enhancement of existing products, quality assurance, testing, documentation
and a portion of occupancy and information system expenses based on employee
headcount.
18
Our general and administrative expense consists primarily of employee
salaries and benefits and other personnel-related costs for executive and
financial personnel, as well as legal expenses, directors and officers insurance
and accounting costs, and a portion of occupancy and information system expense
based on employee headcount.
Our other income and expense consists primarily of interest income earned
from our investment grade marketable securities and a note receivable from an
officer, realized gains and losses from any sales or early maturities of
marketable securities, losses on the value of a warrant issued to us by one of
our vendors that were determined to be other-than-temporary, losses on the
disposal of fixed assets, interest expense associated primarily with equipment
financing and bank fees.
We have experienced substantial net losses. As of December 31, 2003, we had
an accumulated deficit of $106.7 million resulting from insufficient revenue to
cover the significant costs incurred in the development of our web-hosted
directory technology and the establishment of our corporate infrastructure and
organization.
We are a Delaware corporation that commenced operations in February 1996.
From our inception in February 1996 until our initial public offering in March
2000, we were a unit and later a subsidiary of ePresence, Inc. On March 26,
2004, we announced a definitive agreement to merge with a wholly-owned
subsidiary of Infospace, a diversified technology and services company that
develops Internet and wireless solutions headquartered in Bellevue, Washington.
Upon consummation of the merger, Switchboard will be a wholly-owned subsidiary
of Infospace. Each share of Switchboard common stock will be converted into a
right to receive $7.75 in cash, without interest, upon consummation of the
merger. The merger is expected to close during the second half of 2004, and is
subject to customary closing conditions, including receipt of Switchboard and
ePresence, Inc. shareholder, as well as regulatory, approvals. See "Factors
Affecting Operating Results, Business Prospects and Market Price of Stock -
Risks Resulting from our Announced Merger Agreement with Infospace" for more
information concerning this announcement.
Significant Relationship
Our largest and most significant directory technology licensee is AOL. In
December 2000, we entered into a Directory Agreement with AOL to develop a new
directory and local advertising platform and product set to be featured across
specified AOL properties (the "Directory Platform"). In November 2001, April
2002, August 2002, November 2002 and October 2003, certain terms of the
agreement were amended. Prior to the October 2003 amendment of the Directory
Agreement, we shared with AOL specified directory advertisement revenue. In
general, we received a majority of the first $12.0 million of such directory
advertisement revenue, less approximately $1.0 million of billable engineering
revenue earned from AOL after June 30, 2002, and received a lesser share of any
additional directory advertisement revenue over and above the initial $12.0
million. We paid AOL and recorded an asset of $13.0 million at the signing of
the original Directory Agreement. Following the incorporation of the Directory
Platform on the AOL.com, AOL Service and Digital City properties ("AOL Roll-In")
in January 2002, we recorded a second asset and a liability related to future
payments of $13.0 million. In April 2002, we established an additional asset and
liability of $1.0 million and paid $2.0 million upon the execution of the April
2002 amendment. Under the April 2002 amended agreement, we were scheduled to
make six additional quarterly payments of $2.0 million each, replacing the $13.0
million originally owed upon the AOL Roll-In. The August 2002 amendment, among
other things, eliminated the $12.0 million in remaining additional payments
established in the April 2002 amendment. The November 2002 amendment, among
other things, provided for the delivery of administrative services to AOL for
the management of merchants who signed up for advertising in the AOL yellow
pages using a self-service tool that we created for AOL. We no longer provide
these administrative services to AOL.
AOL committed to pay us at least $2.0 million in consulting or service fees
over the term of the Directory Agreement under a payment schedule which ended in
September 2002, of which AOL paid all $2.0 million and we delivered all $2.0
million in services to AOL. Prior to the October 2003 amendment of the Directory
Agreement, we were required to provide up to 300 hours of engineering services
per month to AOL at no charge, if requested by AOL for the term of the
agreement. These 300 hours were provided to support the Directory Platform, from
which we shared in directory advertising revenue over the term of the agreement.
Any engineering services provided by us in excess of 300 hours per month were
charged to AOL on a time and materials basis. AOL typically exceeded these 300
hours each month. In 2003, 2002 and 2001, AOL consulting and service fees
totaled $2.0 million, $1.5 million and $1.9 million, respectfully.
In October 2003, we amended and restated our agreement with AOL. The
October 2003 amendment, among other things, extended the term of the agreement
for an additional year until December 11, 2005, and provides that we will
receive $4.8 million annually from AOL, payable in monthly increments of
$400,000, in exchange for providing, maintaining and customizing the AOL yellow
pages Directory Platform and inclusion of current AOL merchants in our yellow
pages platform. In addition, the amended agreement creates the opportunity for
both parties to sell advertising products that combine the consumer audience of
19
both AOL's and Switchboard's yellow pages. The revenue sharing arrangement,
based on percentage of AOL merchant subscription revenue that was previously in
effect, has been eliminated.
As part of the consideration for the $4.8 million annual fee, if requested
by AOL, we are obligated to provide AOL with up to 3,000 hours of engineering
services during each fiscal quarter in order to customize and enhance AOL's
directory technology. Accordingly, based on our customary rates we charge for
engineering services, we have bifurcated the $4.8 million annual fee between
licensing and engineering services. We attribute $2.4 million of the $4.8
million annual fee to engineering services, or $600,000 per quarter. Of the
3,000 hours, AOL may carry-over up to 1,000 unused engineering hours into the
next quarter. At no time at the end of any fiscal quarter may the unused hours
carried forward exceed 1,000 hours. Revenue attributable to any unused hours
that are carried forward into the following fiscal quarter are valued using our
standard hourly rates for engineering services and deferred until the hours
carried forward are either used or the right to use them expires. Accordingly,
revenue attributable to the 3,000 hours we are obligated to provide AOL will
range from $400,000 to $800,000 each quarter depending on how AOL decides to
utilize these minimum 3,000 hours. Regardless of how AOL decides to utilize
these 3,000 hours, AOL is obligated to pay us $400,000 each month under the
October 2003 amendment. We will bill AOL on a time and materials basis for any
hours for engineering services provided in excess of the 3,000 we are required
to provide to AOL, and recognize this revenue during the period in which the
engineering services are provided.
As a result of the October 2003 amendment of our agreement with AOL, the
revenue generated from our agreement with AOL decreased from $1.6 million in the
third quarter of 2003 to $1.2 million for the fourth quarter of 2003. Depending
on the amount of engineering services requested by AOL, we anticipate total
revenue in future quarters from AOL to be in the range of $1.0 million to $1.4
million per quarter. We expect future cash flows from AOL under the agreement to
be approximately $1.2 million per quarter.
In the event that the Agreement is terminated pursuant to the terms of the
Agreement, the parties may begin a "Wind-Down Period" for a period of time to be
determined by AOL, up to a maximum of three years from the date of termination.
During the Wind-Down Period, we will continue to provide AOL with directory
technology services, and AOL shall pay us a monthly fee of $250,000 (reduced
from $400,000 per month) and shall also pay us for any engineering hours in
excess of 300 hours per month. We will not be obligated to provide AOL with
3,000 hours of engineering services per quarter during the Wind-Down Period.
In connection with entering into the Directory Agreement, in December 2000,
we issued to AOL 746,260 shares of our common stock, which were restricted from
transfer until the AOL Roll-In, which occurred on January 2, 2002. We also
agreed to issue to AOL an additional 746,260 shares of common stock if the
Directory Agreement continued after two years and a further 746,260 shares of
common stock if the Directory Agreement continued after three years. Pursuant to
the April 2002 amendment, the requirement to issue additional shares upon the
two and three-year continuations was eliminated. If we renew the Directory
Agreement with AOL for at least an additional four years after the current term,
we are required to issue to AOL a warrant to purchase up to 721,385 shares of
common stock at a per share purchase price of $4.32.
The $13.0 million paid and the value of the stock issued to AOL upon the
signing of the Directory Agreement was amortized on a straight-line basis over
the original four-year estimated life of the agreement. As of December 31, 2001,
the remaining unamortized amounts of $11.7 million were written down to zero as
a result of an impairment analysis as of December 31, 2001. We performed an
impairment analysis of our AOL related assets because cumulative revenues earned
through December 31, 2001 were significantly below the expectations we had at
the time we entered into the agreement, and we had incurred a current period and
historical operating loss with respect to our AOL business. This analysis was
performed as part of our restatement of our financial statements for the year
ended December 31, 2001, which occurred in September 2002. However, in
performing this impairment analysis, we were unable to utilize the more
favorable financial implications of the April 2002 and August 2002 amendments as
they had occurred subsequent to the date we had filed our original Annual Report
on Form 10-K for the year ended December 31, 2001 (March 2002). The financial
implications of the April 2002 and August 2002 amendments were developments that
occurred subsequent to the March 2002 filing and, in accordance with existing
accounting standards, could not be considered. If we had been able to utilize
the more favorable financial terms resulting from the April 2002 and August 2002
amendments, our AOL assets may have been considered fully recoverable.
Our impairment analysis, utilizing the estimated cash flow approach,
assumed revenue and expense assumptions through December 2004, the expiration
date of the Directory Agreement. We assumed annual revenue growth rates of 77%,
135% and 85% under the agreement in 2002, 2003 and 2004, respectively. We also
assumed additional contractually fixed payments to AOL of $39.0 million; a total
of $4.8 million of value associated with two additional contractual stock
20
issuances to AOL of 746,260 shares each, which were to have occurred in December
2002 and 2003; and our estimate of other costs and expenses we would incur to
support our relationship with AOL. We included the future issuance of stock in
our cash flow analysis because it represented an economic resource that we were
contractually required to give to AOL in order to continue to benefit from the
Directory Agreement. If we did not issue the stock to AOL, our cash flows under
the Directory Agreement would have ceased. We valued the additional required
stock issuances using the Black-Scholes option-pricing model, using an expected
volatility of 130%, a risk-free interest rate of 4.3%, dividend yield of 0% and
an expected life of one year and two years for the December 2002 and 2003
issuances, respectively. Our analysis indicated that our AOL assets were
impaired due to the fact that our projected future cash flows from AOL over the
remainder of the term of the agreement were insufficient to support the value of
our AOL related assets. We then measured our impairment by performing an
analysis of our discounted future cash flows under the Directory Agreement. We
utilized the undiscounted cash flows described above and applied a discount
factor of 20% per year. The discount factor represented our estimate of the rate
of return that an investor would expect for an investment of this type. The
magnitude of the discount rate is related to the perceived risk of the
investment. This discounted cash flow analysis indicated that our AOL related
assets were fully impaired as of December 31, 2001.
In January 2002, we established an additional asset and related liability
of $13.0 million as a result of the AOL Roll-In. We performed an impairment
analysis on this AOL asset and determined that it was not impaired as of March
31, 2002. This analysis was performed as part of our restatement of our
financial statements for the three months ended March 31, 2002 that occurred in
September 2002. This impairment analysis included similar assumptions to those
used in the impairment analysis performed in connection with the restatement of
our December 31, 2001 financial statements. In addition, we were able to
consider the favorable financial terms of the April 2002 amendment, as this
occurred prior to the May 2002 original filing of our quarterly results on Form
10-Q for the three months ended March 31, 2002. Our analysis indicated that our
AOL asset was not impaired as of March 31, 2002.
Throughout 2002 we remained committed to the AOL relationship. We continued
to make reduced investments in 2002, in accordance with the April 2002 and
August 2002 amendments, because we believed that continued investment at a
negotiated lower level would still yield significant revenue and corresponding
profit for Switchboard and allow us to, at a minimum, recoup our investments
under the relationship.
In 2002, we recorded amortization based upon the remaining net book
value of our AOL assets established upon the AOL Roll-In and April 2002
amendment on a straight-line basis over the remaining term of the amended
agreement. As a result of the elimination in the August 2002 amendment of the
remaining $12.0 million owed to AOL, an adjustment to amortization of
consideration given to a customer of $482,000 was recorded in August 2002,
offsetting amortization recorded in the period, and the associated asset and
liability with respect to the $12.0 million were eliminated. Amortization of AOL
assets totaled $2.0 million in 2002. There was no amortization of AOL assets in
2003. Throughout the remaining initial term of the amended agreement, we will no
longer record amortization of consideration given to AOL as these assets are now
fully amortized and no further consideration is due to AOL. Amortization of
assets related to AOL has been reflected as a reduction of revenue in accordance
with EITF 01-9.
The following table summarizes revenue and estimated direct expenses
associated with our AOL agreement (in thousands):
Years ended December 31,
-----------------------------------------
2000 2001 2002 2003
----- ------ ------ ------
Revenue:
- --------
Gross AOL revenue $ - $4,074 $6,906 $6,265
Amortization of consideration provided to AOL (412) (4,048) (2,000) -
----- ------ ------ ------
Net AOL revenue $(412) $ 26 $4,906 $6,265
===== ====== ====== ======
Net AOL revenue as a percentage of total
net revenue (2.0)% 0.3% 41.8% 41.2%
Costs and expenses:
- -------------------
Impairment of AOL assets $- $11,723 $ - $ -
Other costs and expenses (a) 40 1,458 582 520
--- ------- ---- ----
Total costs and expenses $40 $13,181 $582 $520
=== ======= ==== ====
(a) Included in other costs and expenses are engineering and other
services expenses directly incurred as a result of our AOL relationship.
Net amounts due from AOL included in accounts receivable December 31, 2002
were $549,000. There were no amounts due from AOL at December 31, 2003. We
anticipate that AOL will continue to represent a significant percentage of our
revenue in 2004 and will be a material component of our overall business. At
March 5, 2004, AOL beneficially owned 7.8% of our outstanding common stock.
21
Critical Accounting Policies and Estimates
We have identified the policies below as critical to the understanding of
our results of operations. Note that our preparation of this Annual Report on
Form 10-K requires us to make estimates and assumptions that affect the reported
amount of assets and liabilities, disclosure of contingent assets and
liabilities at the date of our financial statements and the reported amounts of
revenue and expenses during the reporting period. On an ongoing basis,
management evaluates its estimates and judgments, including those related to
revenue recognition, bad debts, investments, intangible assets, compensation
expenses, third-party commissions, restructuring costs, contingencies and
litigation. Management bases its estimates and judgments on historical
experience and on various other factors that are believed to be reasonable under
the circumstances, the results of which form the basis for making judgments
about the carrying values of assets and liabilities that are not readily
apparent from other sources. Actual results may differ from those estimates.
Critical accounting polices are those policies that are reflective of
significant judgments and uncertainties and potentially result in materially
different results under different assumptions and conditions. We believe our
most critical accounting policies are as follows:
Revenue Recognition
We generate our revenue primarily from merchant advertisement placements
promoted in the Switchboard-powered directories of our licensees, as well as
those placed in our own online yellow pages directory. Generally, we recognize
revenue as services are provided, so long as no significant obligations remain
and collection of the resulting receivable is probable. We believe that we are
able to make reliable judgments regarding the creditworthiness of our customers
based upon historical and current information available to us. Our payment
experience with our customers may not be consistent with past experience. In
addition, the financial condition of these customers may decline in future
periods, the result of which could be our failure to collect invoiced amounts.
Some of these amounts could be material, resulting in an increase in our
provision for bad debts.
We earn revenue from AOL through the provision of platform licensing
services and engineering and other services to AOL. We consider the delivery of
platform licensing services to be a separate earnings process from engineering
and other services and recognize revenue from engineering and other services in
the period during which these services are delivered. Beginning in October 2003,
we receive an annual license fee from AOL. We bifurcate this annual fee between
a platform licensing fee of $2.4 million and an engineering services fee of
$2.4 million. We recognize these platform licensing fees and engineering
services fees as revenue as they are earned. Bifurcating the annual fee between
engineering services and platform licensing required us to make judgments with
respect to the value attributable to each unit. We valued the amount
attributable to engineering services using our standard hourly rates for
providing such engineering services. We attributed the residual value of the
annual license fee to platform licensing fees. Because we bifurcated the annual
fee, we anticipate that during the term of our current agreement with AOL
revenue from platform licensing fees under the agreement will be $600,000 per
quarter and revenue from engineering services under the agreement will be
between $400,000 and $800,000 per quarter depending upon the amount of
engineering services delivered to AOL each quarter. Therefore, we expect total
quarterly revenue from the agreement will vary between $1.0 million and $1.4
million per quarter. Had we determined that we were unable to bifurcate the
annual license fee between platform licensing and engineering services, all of
the revenue we derive from the license fee would have varied in future quarters
based upon our delivery of engineering services to AOL, varying between $800,000
and $1.6 million per quarter.
Concentration of Credit Risk
We invest our cash and cash equivalents primarily in deposits, money market
funds and investment grade securities with financial institutions. We have not
experienced any material realized losses to date on our invested cash. A
potential exposure is a concentration of credit risk in accounts receivable. We
maintain reserves for credit losses and, to date, such losses have been within
our expectations. These expectations are based on historical experience,
analysis of information currently available to us with respect to our customer's
financial position, as well as various other factors. While we believe we can
make reliable estimates of these matters, it is possible that these estimates
may change in the near future due, for example, to changes in market conditions,
other economic factors or issues specific to individual customers. A change in
estimates could negatively affect our results of operations.
22
Impairment of Long Lived Assets
We evaluate the recoverability of our long-lived assets, including that
attributable to our AOL arrangement, annually, or more frequently if events or
changes in circumstances, such as a decline in sales, earnings or cash flows or
material adverse changes in the business climate, indicate the carrying value of
an asset might be impaired.
Should an indicator of impairment exist, we perform a recoverability
assessment based on an undiscounted expected cash flow analysis utilizing
management's best estimate of the future cash flows expected to result from the
use of the asset. Our assumptions related to estimates of future cash flows are
based on historical results of cash flows adjusted for management projections
for future periods taking into account all available evidence at the date of
review. We continually apply our best judgment when applying the impairment
rules to determine the timing of the impairment test, the undiscounted cash
flows used to assess impairment, and the fair value of an impaired long-lived
asset group. We include the future issuance of stock in our cash flow analysis,
as we did in our evaluation of the asset attributable to our AOL arrangement,
because it represents an economic resource that we are contractually required to
give to enjoy the benefits of a long-lived asset. The dynamic economic
environment in which we operate and the resulting assumptions used to estimate
future cash flows impact the outcome of all impairment tests.
If the asset being evaluated for impairment is a contractually based asset,
as is the case in the asset attributable to our AOL arrangement, we utilize the
contractual terms in existence at the time of the impairment analysis to provide
the framework for estimating the future expected cash flows. Accordingly, any
modifications made to the long-lived asset's underlying contract terms that
occur subsequent to the original filing of our financial statements are not
considered in our impairment analysis.
If the sum of these expected future cash flows is less than the carrying
amount of the asset, the asset is considered impaired and the impairment loss is
calculated. The impairment loss is determined as the difference between the
asset's estimated fair value and its carrying value. The fair value is
determined by applying a discount rate to the expected future cash flows unless
there is an observable market for such asset. The discount rate utilized in the
analysis is commensurate with the risks involved.
Considerable management judgment is necessary to estimate future cash flows
and appropriate assumptions; and accordingly, actual results could vary
significantly from such estimates. The use of different assumptions and
judgments could result in a determination that an asset is not impaired. In that
case, an impairment charge would not be recorded in our results of operations
during the relevant period and future results of operations would continue to be
reduced as a result of amortization of the long lived asset.
Accounting for Stock Based Compensation
We account for stock-based compensation for employees under APB Opinion No.
25, "Accounting for Stock Issued to Employees", and elect the disclosure-only
alternative under SFAS No. 123, "Accounting for Stock-Based Compensation" and
provide the enhanced disclosures as required by SFAS No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure, an amendment of FASB
Statement No. 123". SFAS 148 provides alternative methods of transition for a
voluntary change to a fair value based method of accounting for stock-based
employee compensation. In addition, SFAS 148 amends the disclosure requirements
of SFAS 123 to require prominent disclosures in annual financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. Had we chosen to voluntarily
change to a fair value based method of accounting for stock-based employee
compensation, we would have recorded additional expense in our results of
operations of $1.3 million in 2003, $1.1 million in 2002 and $5.5 million in
2001.
The Financial Accounting Standards Board is currently considering a
proposal that would require companies to change to a fair value based method of
accounting for stock-based employee compensation. If the FASB requires such a
change in accounting for stock-based employee compensation, we may be required
to record the expense associated with the fair value of stock-based employee
compensation in our results of operations in future periods.
We are required in the preparation of the disclosures required under SFAS
148 to make estimates when ascribing a value to stock options granted during the
year. These estimates include, but are not limited to, an estimate of the
average time option grants will be outstanding before they are ultimately
exercised and converted into common stock and an estimate of the future
volatility in the market value of our common stock over that period in which the
option grants are outstanding. These estimates are integral to the valuing of
these option grants. Any changes in these estimates may have a material effect
on the value we ascribe to these option grants. This would in turn affect the
amortization used in the disclosures we make under SFAS 148, which could be
material. Further, the rules governing accounting for option grants continue to
evolve. Should we be required in future periods to include amortization of stock
23
options, such amortization would have a material adverse effect on our results
of operations.
Recently Issued Accounting Pronouncements
In December 2003 the FASB issued Interpretation No. 46 (revised December
2003), "Consolidation of Variable Interest Entities", which addresses how a
business enterprise should evaluate whether it has a controlling financial
interest in an entity through means other than voting rights and accordingly
should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities," which was issued in January 2003.
Switchboard will be required to apply FIN 46R to variable interests in variable
interest entities created after December 31, 2003. The adoption of FIN 46R did
not have a material effect on Switchboard's financial position, results or
operations or cash flows.
Results of Operations
The following table presents consolidated statement of operations
information, as well as consolidated statement of operations information stated
as a percentage of total net revenue:
Change
---------------------------------------
2001 2002 2003 2001 to 2002 2002 to 2003
------------------ ---------------- --------------- ------------------- ----------------
As a % As a % As a %
of net of net of net
Amount revenue Amount revenue Amount revenue Amount % Amount %
-------- ------- ------- ------- ------- ------- --------- ------- ------- -------
Net revenue:
Merchant network.......... $ 6,209 66.9% $10,327 87.9% $13,428 88.4% $ 4,118 66.3% $ 3,101 30.0%
National banner and
site sponsorship......... 3,069 33.1% 1,420 12.1% 1,764 11.6% (1,649) (53.7)% 344 24.2%
-------- ------ ------- ----- ------- ----- -------- ------- ------- -----
Total net revenue......... 9,278 100.0% 11,747 100.0% 15,192 100.0% 2,469 26.6% 3,445 29.3%
Cost of revenue............. 3,518 37.9% 3,744 31.9% 2,925 19.3% 226 6.4% (819) (21.9)%
-------- ------ ------- ----- ------- ----- -------- ------- ------- -----
Gross profit.............. 5,760 62.1% 8,003 68.1% 12,267 80.7% 2,243 38.9% 4,264 53.3%
Sales and marketing......... 24,606 265.2% 4,683 39.9% 3,264 21.5% (19,923) (81.0)% (1,419) (30.3)%
Research and development.... 6,702 72.2% 5,446 46.4% 4,263 28.1% (1,256) (18.7)% (1,183) (21.7)%
General and administrative.. 4,181 45.1% 4,057 34.5% 3,335 22.0% (124) (3.0)% (722) (17.8)%
Amortization of goodwill,
Intangibles and other
assets..................... 719 7.7% - - - - (719) (100.0)% - -
Loss on Viacom transaction.. 22,203 239.3% - - - - (22,203) (100.0)% - -
Special charges (credits)... 17,324 186.7% (262) (2.2)% (35) (0.2)% (17,586) (101.5)% 227 (86.6)%
-------- ------ ------- ----- ------- ----- -------- ------- ------- -----
Total operating expenses.. 75,735 816.3% 13,924 118.5% 10,827 71.3% (61,811) (81.6)% (3,097) (22.2)%
-------- ------ ------- ----- ------- ----- -------- ------- ------- -----
Operating (loss) income... (69,975) (754.2)% (5,921) (50.4)% 1,440 9.5% 64,054 91.5% 7,361 124.3%
Other income, net......... 3,221 34.7% 1,962 16.7% 676 4.4% (1,259) (39.1)% (1,286) (65.5)%
-------- ------ ------- ----- ------- ----- -------- ------- ------- -----
(Loss) income before
income taxes............ (66,754) (719.5)% (3,959) (33.7)% 2,116 13.9% 62,795 (94.1)% 6,075 153.4%
Provision for income
taxes.................... - - - - 42 0.3% - - 42 n/a
-------- ------ ------- ----- ------- ----- -------- ------- ------- -----
Net loss (income)......... $(66,754) (719.5)% $(3,959) (33.7)% $ 2,074 13.7% $ 62,795 (94.1)% $ 6,033 152.4%
======== ====== ======= ===== ======= ===== ======== ======= ======= =====
Net revenue. The increase in net merchant network revenue in both 2003 and
2002 was due primarily to a reduction in amortization of consideration given to
AOL as a result of the elimination of such amortization in August 2002 upon the
amendment to the Directory Agreement with AOL. There was no amortization of
consideration provided to AOL in 2003. Amortization of consideration given to
AOL totaled $2.0 million and $4.0 million in 2002 and 2001, respectively. We do
not expect to incur amortization of consideration given to AOL in the future
during the remainder of the term of our current agreement. The increase in net
merchant network revenue in 2003 was also attributable to an increase in of $2.1
million in licensing revenue from new and existing directory technology
licensees exclusive of AOL. Offsetting these increases in 2003 was a decrease in
gross revenue from AOL of $641,000. The decrease in revenue from AOL was due
primarily to a decrease of $1.2 million in AOL licensing revenue which resulted
primarily from a decrease in the rate by which we shared in directory
advertisement revenue from AOL as a result of the achievement of pre-determined
cumulative revenue milestone, as well as the effects of the October 2003
amendment to the Directory Agreement. The increase in 2002 as compared to 2001
was also attributable to increases in merchant licensing and other services
24
revenues of $2.5 million from AOL as well as our other existing directory
technology licensees, offset in part by a decrease of $488,000 in local merchant
website hosting services.
The increase in national banner and site sponsorship revenue in 2003
resulted primarily from the addition of new customers and an increase in revenue
from existing customers. The increase in revenue from existing customers was due
primarily to an increase in the rate charged to those existing customers and
additional advertising placements on our site, as well as an increase in traffic
to our website. We believe that our increased rates were possible in part due to
the improvement in general demand for national banner and site sponsorship
advertising during 2003. The decreases in national banner and site sponsorship
revenue in 2002 resulted from a decrease in both the number of advertisers on
the site, as well as the per impression fee charged to those customers. We
attribute the 2002 decrease to a decline in general demand for national banner
and site sponsorship on the Internet during 2002, as well as the overall state
of the U.S. economy.
In 2003, 2002 and 2001, AOL accounted for 41.2%, 41.8% and 0.3% of net
revenue, respectively. In the year ended December 31, 2001, one customer
accounted for 11.6% of net revenue. There was no revenue in 2003 or 2002
generated from barter transactions, in which we received promotion in exchange
for promotion on our website. Revenue from barter transactions was 9.0% of net
revenue in 2001.
Cost of revenue. The decrease in cost of revenue in 2003 was primarily
attributable to a decrease of $309,000 in the cost of third-party data, a
decrease of $278,000 in website creation and hosting fees in connection with our
merchant services programs and a decrease of $158,000 in data communications
expense. These decreases in 2003 were offset in part by an increase of $149,000
in search engine database inclusion expense.
In 2002, we incurred an increase of $349,000 in depreciation associated
with additional equipment necessary to support our website and those of our
directory technology licensees; an increase of $177,000 in the cost of
third-party data; and an increase in revenue from lower margin merchant network
services as compared to 2001. These increases were offset in part by a decrease
of $286,000 in third-party website creation and hosting expenses associated with
our merchant programs and a decrease of $216,000 in equipment related expenses
incurred to support our directory and the directories of our licensees.
Gross profit. The increase in gross profit dollars and percentage in 2003
was due primarily to an increase in net revenue being spread over lower costs of
revenue. In 2003, we reduced our fixed costs of revenue by lowering our data
communication expenditures and the cost of obtaining third party data. The
increase in gross profit dollars and percentage in 2002 was primarily due to an
increase in net revenue being spread over relatively fixed costs of revenue,
offset in part by an increase in lower margin merchant network services revenue.
Sales and marketing. The decrease in sales and marketing expense in 2003
was primarily due to a decrease of $591,000 in merchant program expenses and a
$200,000 reduction of expense as a result of a payment from AOL for the final
settlement of our prior agreement with AOL, which was terminated in March 1999.
The decrease in 2003 was also due, to a lesser extent, to decreases of $163,000
in public relations expense and $156,000 in facilities expenses.
The decrease in sales and marketing expense in 2002 as compared to 2001 was
primarily related to the elimination of the non-cash advertising expense related
to our former agreement with Viacom, which accounted for $9.7 million of our
sales and marketing expense during 2001. The decrease in 2002 was also
attributable to decreases of $6.1 million in other corporate marketing program
expenses, $2.0 million in employee salaries and benefits resulting primarily
from actions taken during our corporate restructuring activities in the three
months ended December 31, 2001, $913,000 in provisions for doubtful accounts and
$770,000 in merchant program expenses.
Research and development. The decrease in research and development expense
in 2003 was due primarily to decreases of $456,000 in salaries and benefits,
$251,000 in costs associated with leased facilities as a result of more
favorable lease terms under our agreements with ePresence and $201,000 in
consulting expense. The decrease in 2002 was due primarily to decreases of
$631,000 in outside consulting, $302,000 in employee salaries and benefits,
$163,000 in costs associated with leased facilities primarily as a result of the
elimination of a leased fac