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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 0-26371
EASYLINK SERVICES CORPORATION
(Exact Name of Registrant as Specified in Charter)
Delaware 13-3787073
(State or other Jurisdiction of) (I.R.S. Employer
Incorporation or Organization) Identification No.)
33 Knightsbridge Road, Piscataway, NJ 08854
(Address of Principal Executive Office) (Zip Code)
(732) 652-3500
(Registrant's Telephone Number Including Area Code)
Indicate by check whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes [ ] No [X]
Common stock outstanding at August 1, 2003: Class A common stock $0.01 par value
42,311,104 shares, and Class B common stock $0.01 par value 1,000,000 shares.
EASYLINK SERVICES CORPORATION
JUNE 30, 2003
FORM 10-Q
INDEX
Page
Number
PART I: FINANCIAL INFORMATION
Item 1: Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets as of June 30,
2003 (unaudited) and December 31, 2002............................................................ 3
Unaudited Condensed Consolidated Statements of Operations for the
three months ended June 30, 2003 and 2002......................................................... 4
Unaudited Condensed Consolidated Statements of Operations for the
six months ended June 30, 2003 and 2002........................................................... 5
Unaudited Condensed Consolidated Statements of Cash Flows for the
six months ended June 30, 2003 and 2002........................................................... 6
Notes to Unaudited Interim Condensed Consolidated Financial Statements............................ 8
Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations............. 14
Item 3: Qualitative and Quantitative Disclosure about Market Risk......................................... 17
Item 4: Controls and Procedures........................................................................... 27
PART II: OTHER INFORMATION
Item 1: Legal Proceedings................................................................................. 27
Item 2: Changes in Securities and Use of Proceeds......................................................... 27
Item 4: Submission of Matters to a Vote of Security Holders............................................... 28
Item 5: Other Information................................................................................. 28
Item 6: Exhibits and Reports on Form 8-K.................................................................. 28
Signatures ................................................................................................... 29
Exhibits
-2-
ITEM 1 CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
EasyLink Services Corporation
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
June 30, December 31,
2003 2002
--------------- ---------------
(unaudited) Note 1(b)
ASSETS
Current assets:
Cash and cash equivalents ........................................................... $ 5,897 $ 9,554
Accounts receivable, net of allowance for doubtful accounts
$7,130 and $8,052 as of June 30, 2003 and December 31, 2002, respectively ........... 12,351 11,938
Prepaid expenses and other current assets ........................................... 1,955 2,019
--------------- ---------------
Total current assets ................................................................ 20,203 23,511
--------------- ---------------
Property and equipment, net ......................................................... 13,540 14,833
Goodwill, net ....................................................................... 6,266 6,266
Other intangible assets, net ........................................................ 12,985 14,548
Other assets ........................................................................ 1,352 1,853
--------------- ---------------
Total assets ........................................................................ $ 54,346 $ 61,011
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable .................................................................... $ 11,013 $ 10,235
Accrued expenses .................................................................... 18,286 20,853
Restructuring reserves payable ...................................................... 1,785 2,362
Current portion of capital lease obligations ........................................ 287 413
Current portion of notes payable .................................................... 4,778 4,152
Current portion of capitalized interest on notes payable ............................ 2,296 4,283
Deferred revenue .................................................................... 337 616
Other current liabilities ........................................................... 547 563
Net liabilities of discontinued operations .......................................... 51 360
--------------- ---------------
Total current liabilities ........................................................... 39,380 43,837
--------------- ---------------
Capital lease obligations, less current portion ..................................... 93 196
Capitalized interest on notes payable, less current portion ......................... 3,034 7,402
Notes payable, less current portion ................................................. 9,876 71,398
--------------- ---------------
Total liabilities ................................................................... 52,383 122,833
--------------- ---------------
Stockholders' equity (deficit):
Common stock, $0.01 par value; 510,000,000 shares authorized at June 30, 2003
and December 31, 2002, respectively:
Class A--500,000,000 shares authorized at June 30, 2003 and December 31, 2002;
42,049,608 and 16,129,318 shares issued and outstanding at
June 30, 2003 and December 31, 2002, respectively ................................. 420 161
Class B--10,000,000 shares authorized at June 30, 2003 and December 31, 2002,
respectively, 1,000,000 issued and outstanding at June 30, 2003 and
December 31, 2002 ................................................................. 10 10
Additional paid-in capital .......................................................... 551,319 537,544
Accumulated other comprehensive loss ................................................ (167) (246)
Accumulated deficit ................................................................. (549,619) (599,291)
--------------- ---------------
Total stockholders' equity (deficit) ................................................ 1,963 (61,822)
--------------- ---------------
Commitments and contingencies
Total liabilities and stockholders' equity (deficit) ................................ $ 54,346 $ 61,011
=============== ===============
See accompanying notes to unaudited condensed
consolidated financial statements.
-3-
EasyLink Services Corporation
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
(unaudited)
Three Months Ended June 30,
-----------------------------------
2003 2002
--------------- ---------------
Revenues ............................................................................ $ 25,802 $ 30,029
Cost of revenues .................................................................... 13,361 14,282
--------------- ---------------
Gross profit ........................................................................ 12,441 15,747
--------------- ---------------
Sales and marketing expenses ........................................................ 4,288 5,308
General and administrative expenses ................................................. 6,275 7,145
Product development expenses ........................................................ 1,707 1,566
Amortization of intangible assets ................................................... 517 1,687
--------------- ---------------
12,787 15,706
--------------- ---------------
(Loss) income from operations ....................................................... (346) 41
--------------- ---------------
Other income (expense):
Interest income ..................................................................... 6 35
Interest expense .................................................................... (343) (1,331)
Gain on debt restructurings and settlements ......................................... 47,026 --
Other, net .......................................................................... 33 (24)
--------------- ---------------
Total other income (expense), net ................................................... 46,722 (1,320)
--------------- ---------------
Net income (loss) ................................................................... $ 46,376 $ (1,279)
=============== ===============
Basic and diluted net income (loss) per share:
Net income (loss) ................................................................... $ 1.28 $ (0.08)
=============== ===============
Weighted-average basic and diluted shares outstanding* .............................. 36,126,806 16,541,485
=============== ===============
*Common stock equivalents are anti-dilutive for all periods presented.
See accompanying notes to unaudited condensed
consolidated financial statements.
-4-
EasyLink Services Corporation
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
(unaudited)
Six Months Ended June 30,
-----------------------------------
2003 2002
--------------- ---------------
Revenues ............................................................................ $ 51,544 $ 60,334
Cost of revenues .................................................................... 27,068 30,154
--------------- ---------------
Gross profit ........................................................................ 24,476 30,180
--------------- ---------------
Sales and marketing expenses ........................................................ 9,671 10,620
General and administrative expenses ................................................. 13,015 14,417
Product development expenses ........................................................ 3,663 3,339
Amortization of intangible assets ................................................... 1,033 3,376
--------------- ---------------
27,382 31,752
--------------- ---------------
Loss from operations ................................................................ (2,906) (1,572)
--------------- ---------------
Other income (expense):
Interest income ..................................................................... 25 147
Interest expense .................................................................... (1,098) (2,491)
Gain on debt restructurings and settlements ......................................... 53,666 --
Other, net .......................................................................... (10) (15)
--------------- ---------------
Total other income (expense), net ................................................... 52,583 (2,359)
--------------- ---------------
Net income (loss) ................................................................... $ 49,677 $ (3,931)
=============== ===============
Basic and diluted net income (loss) per share:
Net income (loss) ................................................................... $ 1.85 $ (0.24)
=============== ===============
Weighted-average basic and diluted shares outstanding* .............................. 26,899,659 16,354,879
=============== ===============
*Common stock equivalents are anti-dilutive for all periods presented.
See accompanying notes to unaudited condensed
consolidated financial statements.
-5-
EasyLink Services Corporation
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
Six Months Ended June 30,
-----------------------------------
2003 2002
--------------- ---------------
Cash flows from operating activities:
Net income (loss) ................................................................... $ 49,677 $ (3,931)
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Non-cash interest ................................................................... 120 1,464
Depreciation and amortization ....................................................... 4,683 5,033
Amortization of intangible assets ................................................... 1,564 4,052
Provision for doubtful accounts ..................................................... 106 1,668
Provision for restructuring and impairments ......................................... -- (364)
Gain on debt restructuring and settlements .......................................... (53,666) --
Issuance of shares as matching contributions to employee benefit plans .............. 232 224
Other ............................................................................... 159 138
Changes in operating assets and liabilities:
Accounts receivable .............................................................. (519) 4,570
Prepaid expenses and other current assets ........................................ 65 (975)
Other assets ..................................................................... 178 200
Accounts payable, accrued expenses and other current liabilities ................. (39) (10,456)
Deferred revenue ................................................................. (279) (314)
--------------- ---------------
Net cash provided by operating activities ........................................... 2,281 1,309
--------------- ---------------
Cash flows from investing activities:
Purchases of property and equipment, including capitalized software ................. (3,479) (1,450)
--------------- ---------------
Net cash used in investing activities ............................................... (3,479) (1,450)
--------------- ---------------
Cash used in financing activities:
Payments under capital lease obligations ............................................ (229) (337)
Interest payments on restructured notes ............................................. -- (362)
Payments of notes payable ........................................................... (3,308) (72)
Proceeds from issuance of Class A common stock ...................................... 1,000 --
--------------- ---------------
Net cash used in financing activities ............................................... (2,537) (771)
--------------- ---------------
Effect of foreign exchange rate changes on cash and cash equivalents ................ 78 (24)
--------------- ---------------
Net decrease in cash and cash equivalents ........................................... (3,657) (936)
Cash used in discontinued operations ................................................ -- (300)
Cash and cash equivalents at beginning of the period ................................ 9,554 13,278
--------------- ---------------
Cash and cash equivalents at the end of the period .................................. $ 5,897 $ 12,042
=============== ===============
Supplemental disclosure of interest paid and non-cash information:
During the six months ended June 30, 2003 and 2002, the Company paid
approximately $35 thousand and $1.3 million, respectively, for interest. In
addition, the Company issued 261,178 and 574,634 shares of Class A common stock
valued at approximately $151 thousand and $1.5 million, respectively, as payment
for interest in lieu of cash during the six months ended June 30, 2003 and 2002
(see Note 2).
During the six months ended June 30, 2003, the Company issued shares of Class A
common stock as follows:
The Company issued 23,405,037 shares of Class A common stock in connection with
the cancellation of debt. These shares were valued at approximately $12.7
million (See Note 2).
The Company issued 381,696 shares of Class A common stock valued at
approximately $232 thousand in connection with matching contributions to its
401(k) plan.
-6-
During the six months ended June 30, 2002, the Company issued shares of Class A
common stock as follows:
The Company issued 102,705 shares of Class A common stock valued at
approximately $224 thousand in connection with matching contributions to its
401(k) plan.
The Company issued 56,075 shares of Class A common stock valued at approximately
$314 thousand in connection with the divestiture of a subsidiary of the
Company's India.com subsidiary.
The Company issued 36,232 shares of Class A common stock valued at approximately
$203 thousand in connection with the settlement of an indemnification obligation
arising out of the sale of Asia.com's eLong.com business. The indemnification
obligation arose out of a contingent payment obligation owed by eLong.com to the
sellers of a business purchased by eLong.com.
The Company issued 11,549 shares of Class A common stock valued at approximately
$73 thousand in payment of a bonus to an employee.
The Company issued 21,016 shares of Class A common stock valued at approximately
$78 thousand to a consultant in payment of consulting fees.
The Company issued 7,716 shares of Class A common stock valued at approximately
$11 thousand in connection with a severance agreement.
The Company issued 106,534 shares of Class A common stock valued at
approximately $100 thousand in settlement of a vendor obligation.
Non-cash financing activities:
During the six months ended June 30, 2002, the Company issued 100,000 shares of
Class A common stock in connection with the March 20, 2001 private placement.
See accompanying notes to unaudited condensed
consolidated financial statements.
-7-
EasyLink Services Corporation
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Operations and Significant Accounting Policies
(a) Summary of Operations
The Company offers a broad range of information exchange services to businesses
and service providers, including transaction delivery and management services
such as electronic data interchange or "EDI," production messaging services
utilizing email, fax and telex; integrated desktop messaging services; document
capture and management services and services that protect corporate e-mail
systems such as virus protection, spam control and content filtering services.
(b) Unaudited Interim Condensed Consolidated Financial Information
The accompanying interim condensed consolidated financial statements as of June
30, 2003 and for the three and six months ended June 30, 2003 and 2002 have been
prepared by the Company and are unaudited. In the opinion of management, the
unaudited interim condensed consolidated financial statements have been prepared
on the same basis as the annual consolidated financial statements and reflect
all adjustments, which include only normal recurring adjustments, necessary to
present fairly the consolidated financial position of EasyLink Services as of
June 30, 2003 and the consolidated results of operations and cash flows for the
interim periods ended June 30, 2003 and 2002. The results of operations for any
interim period are not necessarily indicative of the results of operations for
any other future interim period or for a full fiscal year. The condensed
consolidated balance sheet at December 31, 2002 has been derived from audited
consolidated financial statements at that date.
For each of the years ended December 31, 2002, 2001 and 2000, the Company
received a report from its independent accountants containing an explanatory
paragraph stating that the Company suffered recurring losses from operations
since inception and has a working capital deficiency that raises substantial
doubt about the Company's ability to continue as a going concern. The unaudited
condensed consolidated financial statements do not include any adjustments
relating to the recoverability and classification of recorded asset amounts or
the amounts and classification of liabilities that might be necessary should the
Company be unable to continue as a going concern. Management believes the
Company's ability to continue as a going concern is dependent upon its ability
to generate sufficient cash flow to meet its obligations on a timely basis, to
obtain additional financing or refinancing as may be required, to restructure or
eliminate its remaining indebtedness for borrowed money and ultimately to
achieve profitable operations. As part of this process, management is continuing
its efforts to further reduce total operating costs. In addition, as part of the
Company's announced efforts that it was actively seeking to eliminate
substantially all of its outstanding indebtedness, the Company eliminated $61.8
million in principal amount of debt and capitalized interest during the six
months ended June 30, 2003 in exchange for $3.1 million in cash and the issuance
of 23.4 million shares of Class A common stock valued at $12.6 million. The
Company also entered into agreements to repay an outstanding note in the
principal amount of $115,000 and accrued interest obligations in the aggregate
amount of $959,000 over the next three years, which accrued interest obligations
include $284,000 due to George Abi Zeid, a director and officer of the Company
and the former sole shareholder of STI. See Note 3 for additional infromation.
The Company has eliminated an additional $316,510 principal amount of
indebtedness since June 30, 2003 and is seeking to eliminate substantially all
of its remaining indebtedness for borrowed money. No assurance can be given that
the Company will be able to successfully complete the elimination of any other
indebtedness on favorable terms or at all.
Certain information and note disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to the Securities and Exchange
Commission's rules and regulations. It is suggested that these unaudited interim
condensed consolidated financial statements be read in conjunction with the
Company's audited consolidated financial statements and notes thereto for the
year ended December 31, 2002 as included in the Company's Form 10-K filed with
the Securities and Exchange Commission on March 31, 2003.
(c) Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of the Company and
its wholly-owned or majority-owned subsidiaries from the dates of acquisition.
All other investments over which the Company does not have the ability to
control or exercise significant influence are accounted for under the cost
method. The interest of shareholders other than those of EasyLink is recorded as
minority interest in the accompanying consolidated statements of operations and
consolidated balance sheets. When losses applicable to minority interest holders
in a subsidiary exceed the minority interest in the equity capital of the
subsidiary, these losses are included in the Company's results, as the minority
interest holder has no obligation to provide further financing to the
subsidiary. All significant intercompany accounts and transactions have been
eliminated in consolidation.
The net liabilities of WORLD.com, a wholly owned subsidiary, and its majority
owned subsidiaries, are reported as discontinued operations in the consolidated
balance sheets as of June 30, 2003 and December 31, 2002 as a result of the sale
or discontinuance of the operations of this business in 2001.
Effective January 23, 2002, the Company authorized and implemented a 10-for-1
reverse stock split of all issued and outstanding stock. Accordingly, all issued
and outstanding share and per share amounts in the accompanying consolidated
financial statements that predate the reverse stock split have been
retroactively restated to reflect the reverse stock split.
-8-
(d) Use of Estimates
The preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities and the
reported amounts of revenues and expenses. These estimates and assumptions
relate to the estimates of collectibility of accounts receivable, the
realization of goodwill and other intangibles, accruals and other factors.
Actual results could differ from those estimates.
(e) Accounting for Impairment of Long-Lived and Intangible Assets
Effective January 1, 2002, we adopted SFAS No. 142, "Goodwill and Other
Intangible Assets" and SFAS No. 144, "Accounting for the Impairment or Disposal
of Long-Lived Assets". SFAS 142 eliminates the amortization of goodwill and
indefinite-lived intangible assets, addresses the amortization of intangible
assets with finite lives and addresses impairment testing and recognition for
goodwill and intangible assets. SFAS No. 144 establishes a single model for the
impairment of long-lived assets. We assess goodwill for impairment annually
unless events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Discounted cash flow analyses are used to
assess nonamortizable intangible impairment while undiscounted cash flow
analyses are used to assess long-lived asset impairment. If an assessment
indicates an impairment, the impaired asset is written down to its fair market
value based on the best information available. Estimated fair market value is
generally measured with discounted estimated cash flows. Considerable management
judgement is necessary to estimate undiscounted and discounted future cash
flows. Assumptions used for these cash flows are consistent with internal
forecasts. On an on-going basis, management reviews the value and period of
amortization or depreciation of long-lived assets, including goodwill and other
intangible assets. During this review, we reevaluate the significant assumptions
used in determining the original cost of long-lived assets. Although the
assumptions may vary from transaction to transaction, they generally include
revenue growth, operating results, cash flows and other indicators of value.
Management then determines whether there has been a permanent impairment of the
value of long-lived assets based upon events or circumstances, which have
occurred since acquisition. The impairment policy is consistently applied in
evaluating impairment for each of the Company's wholly owned subsidiaries and
investments.
(f) Revenue Recognition
The Company's information exchange services include transaction delivery and
management services such as electronic data interchange or "EDI," production
messaging services utilizing email, fax and telex; integrated desktop messaging
services; document capture and management services; and services that protect
corporate e-mail systems such as virus protection, spam control and content
filtering services. The Company derives revenues from monthly per-message and
usage-based charges for its transaction delivery and management services; from
monthly per-user or per-message fees for managed e-mail and groupware hosting
and virus protection, spam control and content filtering services, and license
and consulting fees for our professional services. Revenue from services is
recognized as the services are performed.
Facsimile license revenue is recognized over the average estimated customer life
of 3 years. The Company also licenses software under noncancellable license
agreements. License fee revenues are recognized when a noncancellable license
fee is in force, the product has been delivered and accepted, the license fee is
fixed, vendor specific objective evidence exists for the undelivered element and
collectibility is reasonably assured. Maintenance and support revenues are
deferred and recognized ratably over the term of the related agreements. The
Company also may host the software if requested by the customer. The customer
has the option to decide who hosts the application. If the Company provides the
hosting, revenue from hosting is ratably recognized over the hosting periods.
Pursuant to Emerging Issues Task Force 00-3, "Application of AICPA Statement of
Position 97-2 to Arrangements That Include the Right to Use Software on Another
Entity's Hardware", if the customer has the option of hosting the software
itself or contracting with an unrelated third party to host the software, the
hosting fee is ratably recognized over the hosting period.
The Company also enters into supplier arrangements providing bulk services, at a
fixed price and minimum quantity to certain customers for a specified period of
time. Revenues earned under such arrangements are recognized over the term of
the arrangement assuming collection of the resultant receivable is probable.
Deferred revenue represents payments that have been received in advance of the
services being performed.
Other revenues include revenues from (i) the sale of domain names, which are
recognized at the time when the ownership of the domain name is transferred
provided that no significant Company obligation remains and collection of the
resulting receivable is probable and (ii) the licensing of domain names wherein
revenue is recognized ratably over the license period. To date, such revenues
have not been material.
(g) Financial Instruments and Concentration of Credit Risk
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist of cash, cash equivalents, restricted
investments, accounts receivable, notes payable and convertible notes payable.
At June 30, 2003 and December 31, 2002, the fair value of cash, cash
equivalents, restricted investments and accounts receivable approximated their
financial statement carrying amount because of the short-term maturity of these
instruments. The recorded values of notes payable and convertible notes payable
approximate their fair values, as interest approximates market rates with the
exception of the Convertible Subordinated Notes payable with a carrying value of
$2.3 million and $24.1 million at June 30, 2003 and December 31, 2002,
respectively, which had an estimated fair value of $0.6 million and $6.0 million
at June 30, 2003 and December 31, 2002, respectively, based upon quoted market
prices.
Credit is extended to customers based on the evaluation of their financial
condition and collateral is not required. The Company performs ongoing credit
assessments of its customers and maintains an allowance for doubtful accounts.
No single customer exceeded 10% of either total revenues or accounts receivable
as of and for the three and six month periods ended June 30, 2003. Revenues from
the Company's five largest customers accounted for an aggregate of 8% of the
Company's total revenues for the six months ended June 30, 2003 and 2002.
-9-
(h) Basic and Diluted Net Income (Loss) Per Share
Net income (loss) per share is presented in accordance with the provisions of
SFAS No. 128, "Earnings Per Share", and the Securities and Exchange Commission
Staff Accounting Bulletin No. 98. Under SFAS No. 128, basic Earnings per Share
("EPS") excludes dilution for common stock equivalents and is computed by
dividing income or loss available to common shareholders by the weighted average
number of common shares outstanding for the period. Diluted EPS reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock and resulted in the
issuance of common stock. Diluted net income (loss) per share for the three and
six month periods ended June 30, 2003 and 2002 is equal to basic net income
(loss) per share since all common stock equivalents are anti-dilutive for each
of the periods presented.
At June 30, 2003 and 2002, the Company had common stock equivalents of
approximately 4.8 million and 8.2 million shares respectively, related to stock
options, warrants and convertible debt, that were not included in the
computation of net income (loss) per share because they were antidilutive.
(i) Stock Based Compensation
In December 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation
- - Transition and Disclosure" ("SFAS 148"). SFAS 148 provides alternative methods
of transition for a voluntary change to the fair value method of accounting for
stock-based employee compensation as originally provided by SFAS No. 123
"Accounting for Stock-Based Compensation". Additionally, SFAS 148 amends the
disclosure requirements of SFAS No. 123 to require prominent disclosure in both
the annual and interim financial statements about the method used in reporting
results. The transitional requirements of SFAS No. 148 are effective for all
financial statements for fiscal years ending after December 31, 2002. We adopted
the disclosure portion of this statement in 2003. The application of the
disclosure portion of this standard will have no impact on the Company's
consolidated financial position or results of operations. The Financial
Accounting Standards Board recently indicated that they will require stock-based
employee compensation to be recorded as a charge to earnings beginning in 2004.
The Company will continue to monitor its progress on the issuance of this
standard as well as evaluate its position with respect to current guidance.
As allowed by SFAS No. 123, Accounting for Stock-Based Compensation, as amended
by SFAS No. 148, the Company has retained the compensation measurement
principles of Accounting Principles Board (APB) Opinion No. 25, Accounting for
Stock Issued to Employees, and its related interpretations for stock options.
SFAS No. 148 also requires more prominent and more frequent disclosures in both
interim and annual financial statements about the method of accounting for
stock-based compensation and the effect of the method used on reporting results.
The Company adopted the disclosure provisions of SFAS No. 148 as of December 31,
2002 and continues to apply the measurement provisions of APB 25. Under APB
Opinion No. 25, compensation expense is recognized based upon the difference, if
any, at the measurement date between the market value of the stock and the
option exercise price. The measurement date is the date at which both the number
of options and the exercise price for each option are known. The following table
illustrates the effect on net income (loss) and net income (loss) per share if
the Company had applied the fair value recognition provisions of SFAS No. 123 to
stock-based employee compensation.
($in thousands, except per share amounts) For the three months For the six months
ended June 30, ended June 30,
----------------------------------- -----------------------------------
2003 2002 2003 2002
--------------- --------------- --------------- ---------------
Net income (loss):
As reported ...................................... $ 46,376 $ (1,279) $ 49,677 $ (3,931)
Deduct: total stock based employee compensation
determined under the fair value method ........ (2,407) (2,677) (5,553) (5,522)
--------------- --------------- --------------- ---------------
Pro forma ........................................ $ 43,969 $ (3,956) $ 44,124 $ (9,453)
Basic and diluted net income (loss) per share:
As reported ...................................... $ 1.28 $ (0.08) $ 1.85 $ (0.24)
Pro forma ........................................ $ 1.22 $ (0.24) $ 1.64 $ (0.58)
The resulting effect on the pro forma net income (loss) disclosed for the three
and six month periods ended June 30, 2003 and 2002 is not likely to be
representative of the effects of the net income (loss) on a pro forma basis in
future years, because the pro forma results include only the impact of grants
issued to date and related vesting, while subsequent years will include
additional grants and vesting. For purposes of pro-forma disclosure, the
estimated fair value of the options is amortized to expense over the options'
vesting period.
(j) Comprehensive Income (Loss)
The components of comprehensive income (loss) consist of the following:
For the three months For the six months
ended June 30, ended June 30,
----------------------------------- -----------------------------------
2003 2002 2003 2002
--------------- --------------- --------------- ---------------
Net income (loss) $ 46,376 $ (1,279) $ 49,677 $ (3,931)
Other comprehensive gain:
Foreign currency translation adjustments (195) (169) 78 (24)
--------------- --------------- --------------- ---------------
Comprehensive income (loss) $ 46,181 $ (1,448) $ 49,755 $ (3,955)
=============== =============== =============== ===============
-10-
Accumulated other comprehensive loss at June 30, 2003 and December 31, 2002
solely consists of foreign currency translation adjustments.
(k) Recent Accounting Pronouncements
In November 2002, the FASB issued FIN 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others." FIN 45 elaborates on the existing disclosure requirements for most
guarantees, including residual value guarantees issued in conjunction with
operating lease agreements. It also clarifies that at the time a company issues
a guarantee the company must recognize an initial liability for the fair value
of the obligation it assumes under that guarantee and must disclose that
information in its interim and annual financial statements. The initial
recognition and measurement provisions apply on a prospective basis to
guarantees issued or modified after December 31, 2002. The disclosure
requirements are effective for financial statements or interim or annual periods
ending after December 15, 2002. The adoption of FIN 45 did not have a
significant impact on the Company's financial position and results of
operations.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest
Entities." FIN 46 requires a variable interest entity to be consolidated by a
company if that company is subject to a majority of the risk of loss from the
variable interest entity's activities or entitled to receive a majority of the
entity's residual returns or both. A variable interest entity is a corporation,
partnership, trust, or any other legal structures used for business purposes
that either (a) does not have equity investors with voting rights or (b) has
equity investors that do not provide sufficient financial resources for the
entity to support its activities. A variable interest entity often holds
financial assets, including loans or receivables, real estate or other property.
A variable interest entity may be essentially passive or it may engage in
research and development or other activities on behalf of another company. The
consolidation requirements of FIN 46 apply immediately to variable interest
entities created after January 31, 2003. The consolidation requirements apply to
older entities in the first fiscal year or interim period beginning after June
15, 2003. Certain of the disclosure requirements apply to all financial
statements issued after January 31, 2003, regardless of when the variable
interest entity was established. The Company has evaluated the impact of FIN 46
and does not believe that it will have any impact on the Company's financial
position or results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of SFAS No. 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. In particular, this Statement clarifies under what circumstances a
contract with an initial net investment meets the characteristic of a
derivative. It also clarifies when a derivative contains a financing component
that warrants special reporting in the statement of cash flows. SFAS No. 149 is
generally effective for contracts entered into or modified after June 30, 2003
and is not expected to have an impact on the Company's financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for how a company classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify certain financial instruments as a liability
(or as an asset in some circumstances). SFAS No. 150 is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003. The adoption of SFAS No. 150 did not have an impact on the Company's
financial statements.
(2) Notes Payable
During the quarter ended June 30, 2003, the Company entered into a series of
transactions with debt holders to eliminate a total of $54.7 million of
indebtedness in exchange for cash payments of $2.3 million and, the issuance of
22.3 million shares of Class A common stock valued at $12.1 million. The
eliminated debt included $19.8 million of 7% Convertible Subordinated Notes, due
February 2005, $28.5 million of 10% Senior Convertible Notes, due January 2006,
a $2.7 million note payable to the former shareholder of STI (who is an officer
and director of the Company), $3.3 million of Restructure notes due in 13
quarterly payments beginning in June 2003 and $0.5 million in other
indebtedness. The Company also entered into agreements to repay an outstanding
note in the principal amount of $115,000 and accrued interest obligations in the
aggregate amount of $959,000 over the next three years, which accrued interest
includes $284,000 due to George Abi Zeid, a director and officer of the Company
and the former sole shareholder of STI. In addition, after eliminating $5.8
million of previously capitalized interest, $2.4 million of accrued interest,
and $0.2 million of debt issuance costs on the eliminated notes, these
transactions resulted in a gain of $47.0 million. Also, the transactions
relating to the previous $115,000 note and $959,000 of accrued interest have
been accounted for in accordance with Financial Accounting Standards Board
Statement No. 15, "Accounting by Debtors and Creditors for Troubled Debt
Restructurings."
On April 30, 2003, to partially fund the cash used in the debt elimination
transactions, the Company issued 1.9 million shares of Class A common stock in a
private placement to Federal Partners L.P. in exchange for $1.0 million.
During the quarter ended March 31, 2003, the Company entered into separate
transactions with debt holders eliminating $7.1 million in indebtedness
including $2.0 million of 7% Convertible Subordinated Notes, due February 2005,
$2.6 million of 10% Senior Convertible Notes, due January 2006, $2.0 million of
12% Restructure Notes due in 13 quarterly payments beginning June 2003 and $0.5
million of Restructuring balloon payments due October 2004. The Company paid the
debt holders $786,000 in cash and issued 1.1 million shares of Class A common
stock valued at $501,000 in connection with the transactions. In addition, after
eliminating $685,000 of previously capitalized interest, $227,000 of accrued
interest, debt issuance costs of $26,000 related to certain of the eliminated
indebtedness, the Company recorded total gains of $6.6 million on the
elimination of debt in the quarter.
-11-
The elimination of outstanding debt will result in substantial income from
cancellation of debt for income tax purposes. The Company intends to minimize
its income tax payable as a result of the restructuring by, among other things,
offsetting the income with its historical net operating losses and otherwise
reducing the income in accordance with applicable income tax rules. As a result,
the Company does not expect to incur any material current income tax liability
from the elimination of this debt. However, the relevant tax authorities may
challenge the Company's income tax positions. No assurance can be given that the
Company will be able to offset or otherwise reduce all or any of the
cancellation of debt income resulting from the elimination of debt in 2003. If
the Company is not able to offset or otherwise reduce the cancellation of debt
income, the Company may incur material income tax liabilities as a result of the
elimination of debt and the Company may be unable to pay these liabilities.
-12-
Notes payable include the following, in thousands:
June 30, 2003 December 31, 2002
-------------------------- --------------------------
Capitalized Capitalized
Interest Principal Interest Principal
------------ --------- ------------ ----------
2000 7% Convertible Subordinated Notes due
February 2005 $ -- $ 2,315 $ -- $ 24,095
2001 10% Senior Convertible Notes due January 2006 -- -- 5,528 31,059
2001 12% AT&T restructure note due in 13 quarterly
payments beginning June 2003 5,160 10,000 5,160 10,000
2001 12% Note payable to former shareholder of
STI due in 13 quarterly payments
beginning June 2003 -- -- 997 2,683
2003 12% Note payable to former shareholder of
STI due in 12 monthly payments
beginning June 2003 16 260 -- --
2001 12% Restructure notes due in 13 quarterly
payments beginning June 2003 -- 761 -- 6,132
2003 12% Note payable due in 13 quarterly
payments beginning June 2003 154 790 -- --
2001 Restructuring balloon payments due October 2004 -- 379 -- 795
Other -- 149 -- 786
----------- --------- -------- ---------
Total notes payable and capitalized interest 5,330 14,654 11,685 75,550
Less current portion 2,296 4,778 4,283 4,152
---------- --------- -------- ---------
Non current portion $ 3,034 $ 9,876 $ 7,402 $ 71,398
========== ========= ======== =========
(3) Commitments and Contingencies
Master Carrier Agreement
In connection with the acquisition of the EasyLink Services business from AT&T
Corp., the Company entered into a Master Carrier Agreement with AT&T. Under this
agreement, AT&T will provide the Company with a variety of telecommunications
services that are required in connection with the provision of the Company's
services. The term of the agreement for network connection services is 36 months
through May 2005 and the term of the agreement for private line and satellite
services is 36 months through February 2004. Under the agreement, the Company
has a minimum revenue commitment for network connection services equal to $3
million for each of the three years of the contract. In addition, we have a
minimum revenue commitment for private line and satellite services equal to
$375,000 per month during the three-year term. If the Company terminates the
network connection services or the private line and satellite services prior to
the end of the term or AT&T terminates the services for the Company's breach,
the Company must pay to AT&T a termination charge equal to 50% of the
unsatisfied minimum revenue commitment for these services for the period in
which termination occurs plus 50% of the minimum revenue commitment for each
remaining commitment period in the term.
Other Telecommunications Services
The Company has committed to purchase from MCI Worldcom a minimum of $75,000 per
month in other telecommunications services through January 2005.
Legal Proceedings
On July 31, 2003, the Company filed a complaint in a new action against AT&T
Corp., PTEK Holdings, Inc. and PTEK's subsidiary Xpedite Systems, Inc. in the
Superior Court of New Jersey - Law Division, Middlesex County (the "New
Action"), and filed a notice of appeal with the Superior Court of New Jersey -
Appellate Division relating to the decision of the Chancery Court to dismiss
EasyLink's original action against AT&T and PTEK (the "Appeal"). The New Action,
among other relief, seeks a declaratory judgment that the agreement between AT&T
and PTEK violates contractual agreements between the Company and AT&T and that
their agreement is void and seeks damages for breach of contract, breach of
fiduciary duty, unfair competition, breach of confidentiality obligations and
tortious interference.
This matter arises out of the February 27, 2003 announcement by PTEK Holdings,
Inc. ("PTEK"), one of the Company's principal competitors, that it had entered
into an agreement with AT&T to purchase 1,423,980 shares of outstanding Class A
common stock of the Company held by AT&T and a $10 million promissory note of
the Company held by AT&T and related actions of AT&T, PTEK and Xpedite. In
response to PTEK's announcement, the Company commenced on March 17, 2003 an
action against AT&T, PTEK and Xpedite (the "Original Action"). The Original
Action sought, among other things, to enjoin AT&T from selling the promissory
note held by AT&T to PTEK, to compel AT&T to participate in the Company's
current debt restructuring and to enjoin PTEK and Xpedite from contacting the
Company's creditors and making false statements to the Company's customers and
creditors regarding the Company and its financial position. AT&T Corp. and PTEK
filed a motion to dismiss EasyLink's complaint in the Original Action or,
alternatively, to transfer the action to the Law Division. On June 26, 2003, the
Court dismissed the claims made in EasyLink's Original Action, but indicated
that EasyLink may file a new complaint as part of a new action. Accordingly, the
Company has filed the New Action and the Appeal in order to pursue its rights
and remedies. No assurance can be given as to the outcome of this matter. See
Note 1(b) and Item 3, "Risk factors that may affect future results".
If the Company is unable to complete the elimination of its remaining debt,
including the promissory note payable to AT&T, on favorable terms, the Company
may not be able to pay interest and other amounts due on its outstanding
indebtedness, or other obligations, on the scheduled dates or at all. If the
Company's cash flow and cash balances are inadequate to meet its obligations, it
could have substantial liquidity problems. If the Company is unable to generate
sufficient cash flow or otherwise obtain funds necessary to make required
payments, or if it otherwise fails to comply with any covenants in its
indebtedness, the Company would be in default under these obligations, which
would permit these lenders to accelerate the maturity of the obligations and
could cause defaults under the indebtedness. Any such default could have a
material adverse effect on the Company's business, results of operations and
financial condition. No assurance can be given that the Company would be able to
repay amounts due on its indebtedness if payment of the indebtedness were
accelerated following the occurrence of an event of default under, or certain
other events specified in, the agreements governing the outstanding indebtedness
and capital leases, including any deemed sale of all or substantially all
Company assets.
-13-
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
We make forward-looking statements within the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995 throughout this report. These
statements relate to our future plans, objectives, expectations and intentions.
These statements may be identified by the use of words such as "expects,"
"anticipates," "intends," "believes," "estimates," "plans" and similar
expressions. Our actual results could differ materially from those discussed in
these statements. Factors that could contribute to such differences include, but
are not limited to, those discussed in the "Risk Factors" section of this
report. EasyLink Services Corporation undertakes no obligation to update
publicly any forward-looking statements for any reason even if new information
becomes available or other events occur in the future.
Unless otherwise indicated or the context otherwise requires, all references to
"we," "us," "our" and similar terms refer to EasyLink Services Corporation and
its direct and indirect subsidiaries.
Overview
We are a provider of services that power the electronic exchange of information
between enterprises, their trading communities and their customers. Every
business day, we handle over 800,000 transactions that are integral to the
movement of money, materials, products and people in the global economy such as
insurance claims, trade and travel confirmations, purchase orders, invoices,
shipping notices and funds transfers, among many others. We offer a broad range
of information exchange services to businesses and service providers, including
electronic data interchange services or "EDI"; production messaging services;
integrated desktop messaging services; document capture and management services;
boundary and managed email services; and other services largely consisting of
legacy real time fax services.
For the six months ended June 30, 2003, total revenues were $51.5 million
compared to $60.3 million for the six months ended June 30, 2002. Net income was
$49.7 million for the six months ended June 30, 2003 as compared to a net loss
of $3.9 million for the six months ended June 30, 2002. The 2003 results
included gains on debt restructuring and settlements of $53.7 million.
We derive revenues primarily from monthly per-message and usage-based charges
for our EDI, production messaging and integrated desktop messaging services; and
monthly per-user or per-message fees for managed e-mail and groupware hosting
services and virus protection, spam control and content filtering services. Our
services generate revenue in a number of different ways. We charge our EDI
customers per message. Customers of our production messaging services pay
consulting fees based upon the level of integration work and set-up requirements
plus per-page or per-minute usage charges, depending on the delivery method, for
all messages successfully delivered by our network. Customers who purchase our
integrated desktop messaging services pay initial site license fees based on the
number of user seats being deployed plus per page usage charges for all faxes
successfully delivered by our network. For our e-mail and groupware hosting
services, customers are billed monthly based upon the number of mailboxes set up
and for additional features that they may purchase. For our virus protection,
spam and content filtering services, we charge customers either a monthly fee
per user or per message charges. Revenue from services is recognized as the
services are performed. Facsimile software license revenue is recognized over
the average estimated customer life of 3 years.
In light of our limited operating history, we believe that period-to-period
comparisons of our revenues and operating results are not meaningful and should
not be relied upon as indications of future performance. However, we do believe
that the our revenues and operating results in future periods will be more
comparable to the results for the three and six month periods ended June 30,
2003.
Although our revenues for the quarters ended June 30, 2003, March 31, 2003 and
December 31, 2002 have been stable, we have experienced declines in revenues for
the three and six month periods ended June 30, 2003 as compared to the
comparable periods ended June 30, 2002. See "Results Of Operations Three Months
Ended June 30, 2003 and 2002" and "Results of Operations Six Months Ended June
30, 2003 and 2002". The decrease primarily occurred in our production messaging
services, which include fax, telex and email hosting, as a result of lower
volumes and negotiated customer price reductions. We expect that the declines in
revenues from production messaging services may continue in the future. Our
strategy to grow revenues and to mitigate the effects of this decline includes
the sale of existing and new services to our large base of existing customers,
as well as offering our services to new customers. Among the new services that
we have recently introduced are trading community enablement services such as
Web EDI and document capture and management services. See "Item 1. Business -
Our Business Services" contained in our Form 10K filed March 31, 2003.
Our prospects should be considered in light of risks described in the section of
this report entitled "Risk Factors That May Affect Future Results."
Critical Accounting Policies
In response to the Securities & Exchange Commission's (SEC) Release No. 33-8040,
"Cautionary Advice Regarding Disclosure About Critical Accounting Policies," we
have identified the most critical accounting principles upon which our financial
status depends. Critical principles were determined by considering accounting
policies that involve the most complex or subjective decisions or assessments.
The most critical accounting policies were identified to be those related to
revenue recognition, accounts receivable, impairment of long lived assets,
contingencies and litigation and restructuring activities. For a detailed
discussion of these and other accounting policies, see Note 1 in the Notes to
the Consolidated Financial Statements in the Company's Form 10-K for the year
ended December 31, 2002.
-14-
Results of operations three months ended June 30, 2003 and 2002
Revenues
Revenues for the three months ended June 30, 2003 were $25.8 million, as
compared to $30.0 million for the comparable period in 2002. The decrease of
$4.2 million was due primarily to reduced revenues in our production messaging
services, which include fax, telex and email hosting, as a result of lower
volumes and negotiated customer price reductions. Revenues in the 2003 and 2002
quarters consist almost entirely of revenues from providing information exchange
services to businesses and are derived from electronic data interchange services
or "EDI"; production messaging services; integrated desktop messaging services;
boundary and managed email services; and other services largely consisting of
legacy real time fax services.
Cost of Revenues
Cost of revenues for the three months ended June 30, 2003 decreased to $13.4
million as compared to $14.3 million for the comparable period in 2002. However,
as a percentage of revenues these costs increased to 51.8% in the 2003 quarter
as compared to 47.6% of revenues in the comparable 2002 quarter. Costs increased
as a percentage of revenues because of the fixed network expenses and fixed
telecom facilities costs included in costs of revenues while revenues decreased
from period to period. The 2002 quarter also included a reversal of $0.5 million
of prior years' cash bonus accruals (based on the Company's decision to
eliminate these bonuses).
Cost of revenues consists primarily of costs incurred in the delivery and
support of our services, including depreciation of equipment used in our
computer systems, the cost of telecommunications services including local access
charges, leased network backbone circuit costs and long distance domestic and
international termination charges, and personnel costs associated with our
systems and databases as well as our e-mail service.
Sales and Marketing Expenses
Sales and marketing expenses were $4.3 million and $5.3 million for the three
months ended June 30, 2003 and 2002, respectively. Included in this category are
costs related to salaries and commissions for sales, marketing, and business
development personnel. Also included are costs for promotional programs, trade
shows and marketing materials. The lower costs in the 2003 quarter were the
result of reduced staffing in each of the functional areas net of the reversal
of $0.3 million of prior years' cash bonus accruals in 2002.
General and Administrative Expenses
General and administrative expenses were $6.3 million during the three months
ended June 30, 2003 as compared to $7.1 million during the comparable period of
2002. The $0.8 million decrease is the net impact of various cost component
changes but the most significant changes from period to period were a reduction
of $0.9 million in our provision for bad debts as a result of improved
collection and credit activities and the impact of the reversal of $0.6 million
of prior years' cash bonus accruals in 2002.
Product Development Expenses
Product development costs, which consist primarily of personnel and consultants'
time and expense to research, conceptualize, and test product launches and
enhancements to our products, were $1.7 million for the three months ended June
30, 2003 as compared to $1.6 million in comparable period of 2002. The net
increase in costs actually reflects a decrease in personnel and consultants
costs of approximately $0.2 million in the quarter ended June 30, 2003 as
compared to the quarter ended June 30, 2002 which was reduced by the reversal of
$0.3 million of prior years' accrued employee cash bonuses related to that
group.
Amortization of Other Intangible Assets
As of January 1, 2002, the Company adopted FASB No. 142, "Goodwill and Other
Intangibles". Statement No. 142 requires companies to no longer amortize
goodwill but instead test goodwill for impairment on an annual basis.
Accordingly, we did not amortize any goodwill during the three and six months
ended June 30, 2003 and 2002, respectively. We completed an impairment
assessment in the 4th quarter of 2002 with the assistance of an independent
appraiser and determined that an impairment of goodwill had occurred. Based on a
subsequent fair value analysis of the Company's goodwill, other intangible
assets and other long-lived assets, we recorded an aggregate impairment of $78.8
million in the 4th quarter of 2002. The impairment of the other intangible
assets reduced the basis for future amortization charges resulting in the $1.2
million decrease in amortization charges. Current period charges are $0.5
million in the quarter ended June 30, 2003 as compared to $1.7 million in the
same period of 2002.
Other Income (Expense), Net
Interest income for the three months ended June 30, 2003 was $6,000 as compared
to $35,000 during the comparable period of 2002. The decrease was due to lower
cash balances and lower interest rates on temporary investments.
Interest expense was $0.3 million for the three months ended June 30, 2003 as
compared to $1.3 million in the comparable period of 2002. The decrease was
primarily due to reductions in the total debt balances outstanding during the
quarter ended June 30, 2003 as compared to the same quarter in 2002 as a result
of the debt restructurings and settlements completed through June 30, 2003.
-15-
Gain on Debt Restructurings and Settlements
In the three months ended June 30, 2003, we eliminated $54.7 million of
indebtedness in exchange for the payment of $2.3 million in cash and the
issuance of 22.3 million shares of Class A common stock valued at $12.1 million
pursuant to our announced efforts to eliminate substantially all of our
outstanding indebtedness. After reversing $5.8 million of previously capitalized
interest and $2.2 million of accrued interest net of debt issuance costs, we
recorded a gain of $47.0 million on these transactions.
The elimination of outstanding debt will result in substantial income from
cancellation of debt for income tax purposes. We intend to minimize the income
tax payable as a result of the restructuring by, among other things, offsetting
the income with our historical net operating losses and otherwise reducing the
income in accordance with applicable income tax rules. As a result, we do not
expect to incur any material current income tax liability from the elimination
of this debt. However, the relevant tax authorities may challenge our income tax
positions. No assurance can be given that we will be able to offset or otherwise
reduce all or any of the cancellation of debt income resulting from the
elimination of debt in 2003. If we are not able to offset or otherwise reduce
the cancellation of debt income, we may incur material income tax liabilities as
a result of the elimination of debt and we may be unable to pay these
liabilities.
Results of operations six months ended June 30, 2003 and 2002
Revenues
Revenues for the six months ended June 30, 2003 were $51.5 million, as compared
to $60.3 million for the comparable period in 2002. The decrease of $8.8 million
was due primarily to reduced revenues in our production messaging services,
which include fax, telex and email hosting, as a result of lower volumes and
negotiated customer price reductions. Revenues in the 2003 and 2002 periods
consist almost entirely of revenues from providing information exchange services
to businesses and are derived from electronic data interchange services or
`EDI"; production messaging services; integrated desktop messaging services;
boundary and managed email services; and other services largely consisting of
legacy real time fax services.
Cost of Revenues
Cost of revenues for the six months ended June 30, 2003 decreased to $27.1
million as compared to $30.2 million for the comparable period in 2002. However,
as a percentage of revenues these costs increased to 52.5% in 2003 as compared
to 50.0% of revenues in the comparable 2002 period. The reduction in costs
resulted from continuing cost reduction programs and reduced variable telecom
charges consistent with reduced customer volumes. Costs increased as a
percentage of revenues because of the fixed network expenses and fixed telecom
facilities costs included in costs of revenues while revenues decreased from
period to period.
Cost of revenues consists primarily of costs incurred in the delivery and
support of our services, including depreciation of equipment used in our
computer systems, the cost of telecommunications services including local access
charges, leased network backbone circuit costs and long distance domestic and
international termination charges, and personnel costs associated with our
systems and databases.
Sales and Marketing Expenses
Sales and marketing expenses were $9.7 million and $10.6 million for the six
months ended June 30, 2003 and 2002, respectively. Included in this category are
costs related to salaries and commissions for sales, marketing, and business
development personnel. Also included are costs for promotional programs, trade
shows and marketing materials. The cost decrease of $0.9 million is a result of
lower staffing levels in 2003.
General and Administrative Expenses
General and administrative expenses were $13.0 million during the six months
ended June 30, 2003 as compared to $14.4 million during the comparable period of
2002. The $1.4 million decrease is the net impact of various cost component
changes but the most significant from period to period was a reduction of $1.6
million in our provision for bad debts as a result of improved collection and
credit activities.
Product Development Expenses
Product development costs, which consist primarily of personnel and consultants'
time and expense to research, conceptualize, and test product launches and
enhancements to our products, were $3.7 million for the six months ended June
30, 2003 as compared to $3.3 million in comparable period of 2002. We have
currently increased development spending to continue the enhancements to our
newer products introduced in the second half of 2002. The six month period
results for 2002 also included a reversal of $0.3 million of prior years'
accrued employee cash bonuses.
Amortization of Other Intangible Assets
As of January 1, 2002, the Company adopted FASB No. 142, "Goodwill and Other
Intangibles". Statement No. 142 requires companies to no longer amortize
goodwill but instead test goodwill for impairment on an annual basis.
Accordingly, we did not amortize any goodwill during the three months ended
March 31, 2003 and 2002 respectively. We completed an impairment assessment in
the 4th quarter of 2002 with the assistance of an independent appraiser and
determined that an impairment of goodwill had occurred. Based on a subsequent
fair value analysis of the Company's goodwill, other intangible assets and other
long-lived assets, we recorded an aggregate impairment of $78.8 million in the
4th quarter of 2002. The impairment of the other intangible assets reduced the
basis for future amortization charges resulting in the $2.4 million decrease in
amortization charges. Current period charges are $1.0 million in the six months
ended June 30, 2003 as compared to $3.4 million in the same period of 2002.
Other Income (Expense), Net
Interest income for the six months ended June 30, 2003 was $25,000 as compared
to $147,000 during the comparable period of 2002. The decrease was due to lower
cash balances and lower interest rates on temporary investments.
-16-
Interest expense was $1.1 million for the six months ended June 30, 2003 as
compared to $2.5 million in the comparable period of 2002. The decrease was
primarily due to reductions in the total debt balances outstanding during the
six months ended June 30, 2003 as compared to the same period in 2002 as a
result of the debt restructurings and settlements completed through June 30,
2003.
Gain on Debt Restructurings and Settlements
In the six months ended June 30, 2003, we eliminated $61.3 million of
indebtedness in exchange for the payment of $3.0 million in cash and the
issuance of 23.4 million shares of Class A common stock valued at $12.7 million
pursuant to our announced efforts to eliminate substantially all of our
outstanding indebtedness. After reversing $6.5 million of previously capitalized
interest and $2.4 million of accrued interest net of debt issuance costs, we
recorded total gains of $53.7 million on these transactions.
Liquidity and capital resources
Net cash provided by operating activities was $2.3 million for the six months
ended June 30, 2003 in comparison to $1.3 million in cash provided from
operating activities for the comparable period in 2002. Net income (loss) from
period to period increased by $53.6 million from a loss of $3.9 million in 2002
to net income of $49.7 million in 2003. The cash provided by operating activity
increased by $1.0 million, after accounting for the following 2003 items; $53.7
million in gains on debt restructuring and settlements, a $1.3 million decrease
in non cash interest, a $2.5 million decrease in amortization of intangibles
assets, a $1.6 million decrease in the provision for doubtful accounts, and a
net increase of $6.4 million in cash provided by the changes in operating assets
and liabilities. The $1.3 million decrease in non cash interest was a result of
interest payments being deferred as part of the Company's debt settlement
negotiations. The $2.5 million decrease in amortization of intangible assets in
2003, was mainly due to an impairment charge recorded during the quarter ended
December 31, 2002.
Net cash used in investing activities for purchases of property and equipment
was $3.5 million and $1.5 million for the six months ended June 30, 2003 and
2002, respectively. The expenditures in the 2003 period included $1.9 million
related to the consolidation of our New Jersey office facilities into a single
location.
Net cash used in financing activities was $2.5 million for the six months ended
June 30, 2003 as compared to cash used of $0.8 million for the six months ended
June 30, 2002. The 2003 activity includes $3.3 million in debt principal
payments and payments to extinguish debt in connection with the previously
mentioned debt elimination transactions and the proceeds of $1.0 million from
the issuance of 1.9 million shares of Class A Common Stock in a private
placement. In the 2002 period, $0.4 million of interest payments on restructured
notes were made.
At June 30, 2003, we had $5.9 million of cash and cash equivalents.
For the years ended December 31, 2002, 2001 and 2000, we received a report from
our independent accountants containing an explanatory paragraph stating that we
suffered recurring losses from operations since inception and have a working
capital deficiency that raise substantial doubt about our ability to continue as
a going concern. As of June 30, 2003, the Company had $7.1 million of notes
payable and capitalized interest payable within one year. Although the Company
has substantially reduced its outstanding debt obligations, cash payments of
principal and interest due within one year from June 30, 2003, amount to $6.6
million. If the Company's cash flow is not sufficient we may need additional
financing to meet this debt service requirement and other cash requirements for
our operations. However, if we are unable to raise additional financing,
restructure or settle additional outstanding debt or generate sufficient cash
flow, we may be unable to continue as a going concern.
Our unaudited condensed consolidated financial statements do not include any
adjustments relating to the recoverability and classification of recorded asset
amounts or the amounts and classification of liabilities that might be necessary
should we be unable to continue as a going concern. We believe our ability to
continue as a going concern is dependent upon our ability to generate sufficient
cash flow to meet our obligations on a timely basis, to obtain additional
financing or refinancing as may be required, and ultimately to achieve
profitable operations. Management is continuing the process of further reducing
operating costs and increasing its sales efforts. There can be no assurance that
the Company will be successful in these efforts.
Sales of additional equity securities could result in additional dilution to our
stockholders. In addition, on an ongoing basis, we continue to evaluate
potential acquisitions to complement our business messaging services. In order
to complete these potential acquisitions, we may need additional equity or debt
financing in the future.
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk, primarily from changes in interest rates,
foreign exchange rates and credit risk. The Company maintains continuing
operations in Europe (mostly in England) and, to a lesser extent, in Singapore
and Malaysia. Fluctuations in exchange rates may have an adverse effect on the
Company's results of operations and could also result in exchange losses. The
impact of future rate fluctuations cannot be predicted adequately. To date the
Company has not sought to hedge the risks associated with fluctuations in
exchange rates.
Market Risk - Our accounts receivables are subject, in the normal course of
business, to collection risks. We regularly assess these risks and have
established policies and business practices to protect against the adverse
effects of collection risks. As a result we do not anticipate any material
losses in this area.
Interest Rate Risk - Interest rate risk refers to fluctuations in the value of a
security resulting from changes in the general level of interest rates.
Investments that are classified as cash and cash and equivalents have original
maturities of three months or less. Changes in the market's interest rates do
not affect the value of these investments. Marketable securities are comprised
of U.S. Treasury Notes and are classified as available-for-sale and subject to
interest rate fluctuations.
-17-
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
We have only a limited operating history and some of our services are in a new
and unproven industry.
We have only a limited operating history upon which you can evaluate our
business and our prospects. Easylink was incorporated under the name Globecomm,
Inc. in 1994 in the State of Delaware. We launched our business by offering a
commercial email service in November 1996 under the name iName. We changed our
company name to Mail.com, Inc. in January 1999. In February 2000, we acquired
NetMoves Corporation, a provider of a variety of transaction delivery services
to businesses. In March 2000, we formed WORLD.com to develop and operate our
domain name properties as independent Web sites. In the fourth quarter of 2000,
we announced our intention to focus exclusively on the business market and to
sell all assets not related to this business. In February 2001, we acquired
Swift Telecommunications, Inc. which had contemporaneously acquired the EasyLink
Services business from AT&T Corp. The EasyLink Services business is a provider
of transaction delivery services such as electronic data interchange or EDI and
production messaging services. Swift was a provider of production messaging
services, principally telex services. On March 30, 2001, we announced that we
had sold our advertising network business to Net2Phone, Inc., and on May 3, 2001
our Asia.com, Inc. subsidiary completed the sale of its business. In October
2001, we sold a subsidiary of India.com, Inc. and have since ceased the conduct
of the portal operations of India.com, Inc. In January 2002, we announced our
strategy to expand our position in the transaction delivery segment of the
electronic commerce market and to begin to offer to our large customer base
related transaction management services that automate more components of our
customers' business processes. In 2002, we commercially introduced two such
services - Trading Community Enablement and Management Services and Document
Capture and Management Services. Our success will depend in part upon our
ability to maintain or expand our sales of transaction delivery services such as
EDI, production messaging and integrated desktop messaging to enterprises, our
ability to successfully develop transaction management services, the development
of a viable market for fee-based transaction delivery and transaction management
services on an outsourced basis and our ability to compete successfully in those
markets. For the reasons discussed in more detail below, there are substantial
obstacles to our achieving and sustaining profitability.
We have incurred losses since inception.
We have not achieved profitability in any fiscal year, and we may not be able to
achieve or sustain profitability. We incurred a net loss of $85.8 million for
the year ended December 31, 2002. We had net income of $46.4 million and $49.7
million, respectively, for the three and six months periods ended June 30, 2003;
however, these amounts included $47.0 million and $53.7 million, respectively,
of gains on debt restructuring and settlements. We had an accumulated deficit of
$549.6 million as of June 30, 2003. We intend to upgrade and enhance our
technology, continue our international expansion, and improve and expand our
management information and other internal systems. We intend to continue to make
strategic acquisitions and investments where resources permit, which may result
in significant amortization of intangibles and other expenses or a later
impairment charge arising out of the write-off of goodwill booked as a result of
such acquisitions or investments. We are making these expenditures in
anticipation of higher revenues, but there will be a delay in realizing higher
revenues even if we are successful. We have experienced declining revenues for
the year ended December 31, 2002 as compared to the comparable period ended
December 31, 2001 and for the three and six months periods ended June 30, 2003
as compared to the comparable periods ended June 30, 2002. See Part II, Item 7:
Management's Discussion and Analysis of Financial Condition and Results of
Operations contained in our Form 10-K filed March 31, 2003 and Part I, Item 2:
Management's Discussion and Analysis of Financial Condition and Results of
Operations contained herein. If we do not succeed in substantially increasing
our revenues or integrating the EasyLink Services and Swift businesses with our
historical business, our losses may continue.
If we are unable to raise necessary capital in the future, we may be unable to
invest in the growth of our business or fund necessary expenditures.
We may need to raise additional capital in the future. See Part I. Item 2 -
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources. At June 30, 2003, we had $5.9
million of cash and cash equivalents. Our principal commitments consist of
subordinated convertible notes, senior convertible notes, notes payable,
obligations under capital leases, accounts payable and other current
obligations, commitments for capital expenditures and commitments for
telecommunications services. For each of the three years ended December 31,
2002, 2001 and 2000, we received a report from our independent accountants
containing an explanatory paragraph stating that we suffered recurring losses
from operations since inception and have a working capital deficiency that raise
substantial doubt about our ability to continue as a going concern. We may need
additional financing to invest in the growth of our business and to pay other
obligations, and the availability of such financing when needed, on terms
acceptable to us, or at all, is uncertain. See "Risk Factors - We have incurred
significant indebtedness for money borrowed, and we may be unable to pay debt
service on this indebtedness." If we are unable to raise additional financing,
generate sufficient cash flow, or restructure our debt obligations before they
become due and payable, we may be unable to continue as a going concern.
If we raise additional funds by issuing equity securities or debt convertible
into equity securities, stockholders may experience significant dilution of
their ownership interest. The amount of dilution resulting from issuance of
additional shares of Class A common stock and securities convertible into Class
A common stock and the potential dilution that may result from future issuances
has significantly increased in light of the decline in our stock price.
Moreover, we could issue preferred stock that has rights senior to those of the
Class A common stock. Some of our stockholders have registration rights that
could interfere with our ability to raise needed capital. If we raise funds by
issuing debt, our lenders may place limitations on our operations, including our
ability to pay dividends.
We have incurred significant indebtedness for money borrowed, and we may be
unable to pay debt service on this indebtedness.
After giving effect to the elimination of debt through June 30, 2003, we have
outstanding $2.3 million in subordinated convertible notes due in 2005; $12.4
million in principal amount of notes and other obligations due in installments
beginning in June 2003; approximately $5.3 million in accrued interest
obligations payable over one to three years through 2006; and obligations under
capital leases and commitments for telecommunications services. We currently
have $6.6 million in principal and cash interest payments due during the twelve
month period after June 30, 2003. We had an operating loss and negative cash
flow for the year ended December 31, 2002. In addition, we have a substantial
amount of outstanding accounts payable and other obligations. Accordingly, cash
generated by our operations would have been insufficient to pay the amount of
principal and interest payable annually on our outstanding indebtedness or to
pay our other obligations.
-18-
We have eliminated an additional $316,510 principal amount of indebtedness since
June 30, 2003 and are seeking to eliminate substantially all of our remaining
indebtedness for borrowed money. We cannot assure you that we will be able to
successfully complete the elimination of any other indebtedness that we are
seeking to eliminate on favorable terms or at all. On July 31, 2003, the Company
filed a complaint in a new action against AT&T Corp., PTEK Holdings, Inc. and
PTEK's subsidiary Xpedite Systems, Inc. in the Superior Court of New Jersey -
Law Division, Middlesex County (the "New Action"), and filed a notice of appeal
with the Superior Court of New Jersey - Appellate Division relating to the
decision of the Chancery Court to dismiss EasyLink's original action against
AT&T and PTEK (the "Appeal").. See Part II, Item 1, Legal Proceedings. EasyLink
believes that if the sale of the note to PTEK is permitted to occur and AT&T is
not compelled to participate in EasyLink's debt restructuring, EasyLink may be
unable to meet some or all of the payments on this debt or its available cash
will be significantly constrained. Easylink has a variety of commercial
relationships with AT&T, and this dispute may have an adverse effect on these
relationships.
If we are unable to complete the elimination of our remaining debt on favorable
terms, we cannot assure you that we will be able to pay interest and other
amounts due on our outstanding indebtedness, or our other obligations, on the
scheduled dates or at all. If our cash flow and cash balances are inadequate to
meet our obligations, we could face substantial liquidity problems. If we are
unable to generate sufficient cash flow or otherwise obtain funds necessary to
make required payments, or if we otherwise fail to comply with any covenants in
our indebtedness, we would be in default under these obligations, which would
permit these lenders to accelerate the maturity of the obligations and could
cause defaults under our indebtedness. Any such default could have a material
adverse effect on our business, results of operations and financial condition.
We cannot assure you that we would be able to repay amounts due on our
indebtedness if payment of the indebtedness were accelerated following the
occurrence of an event of default under, or certain other events specified in,
the agreements governing our outstanding indebtedness and capital leases,
including any deemed sale of all or substantially all of our assets.
The elimination of outstanding debt pursuant to our debt restructuring strategy
will result in substantial cancellation of debt income for income tax purposes.
We intend to minimize income tax payable as a result of the restructuring by,
among other things, offsetting the income with our historical net operating
losses and otherwise reducing the income in accordance with applicable income
tax rules. As result, we do not expect to incur any material current income tax
liability as a result of the elimination of this debt. However, the relevant tax
authorities may challenge our income tax positions, including the use of our
historical net operating losses to offset some or all of the cancellation of
debt income and the application of the income tax rules reducing the
cancellation of debt income. No assurance can be given that we will be able to
offset or otherwise reduce all or any of the cancellation of debt income
resulting from the elimination of debt pursuant to our debt restructuring. If we
are not able to offset or otherwise reduce the cancellation of debt income, we
may incur material income tax liabilities as a result of the elimination of debt
and we may be unable to pay these liabilities.
We may incur substantial additional indebtedness in the future. The level of our
indebtedness, among other things, could (1) make it difficult for us to make
payments on our indebtedness, (2) make it difficult to obtain any necessary
financing in the future for working capital, capital expenditures, debt service
requirements or other purposes, (3) limit our flexibility in planning for, or
reacting to changes in, our business, and (4) make us more vulnerable in the
event of a downturn in our business.
We intend to continue to acquire, or make strategic investments in, other
businesses and acquire or license technology and other assets and we may have
difficulty integrating these businesses or generating an acceptable return.
We have completed a number of acquisitions and strategic investments since our
initial public offering. For example, we acquired NetMoves Corporation, a
provider of production messaging services and integrated desktop messaging
services to businesses, and The Allegro Group, Inc., a provider of email and
email related services, such as virus blocking and content screening, to
businesses. We also acquired Swift Telecommunications, Inc. and the EasyLink
Services business that it had contemporaneously acquired from AT&T Corp. We will
continue our efforts to acquire or make strategic investments in businesses and
to acquire or license technology and other assets, and any of these acquisitions
may be material to us. We cannot assure you that acquisition or licensing
opportunities will continue to be available on terms acceptable to us or at all.
Such acquisitions involve risks, including:
- inability to raise the required capital;
- difficulty in assimilating the acquired operations and personnel;
- inability to retain any acquired member or customer accounts;
- disruption of our ongoing business;
- the need for additional capital to fund losses of acquired
businesses;
- inability to successfully incorporate acquired technology into our
service offerings and maintain uniform standards, controls,
procedures and policies; and
- lack of the necessary experience to enter new markets.
We may not successfully overcome problems encountered in connection with
potential acquisitions. In addition, an acquisition could materially impair our
operating results by diluting our stockholders' equity, causing us to incur
additional debt or requiring us to amortize acquisition expenses and acquired
assets or to incur impairment charges as a result of the write-off of goodwill
booked as a result of such acquisition.
-19-
We may be unable to successfully complete the migration of the network relating
to our business acquired from AT&T off of AT&T premises.
On February 23, 2001, we completed the acquisition of Swift Telecommunications,
Inc. which had contemporaneously acquired the EasyLink Services business of AT&T
Corp. The EasyLink Services business acquired from AT&T provides a variety of
transaction delivery services. This business was a division of AT&T and was not
a separate independent operating entity. We hired only a portion of the
employees of the business.
Under a Transition Services Agreement entered into in connection with the
acquisition, AT&T agreed to provide us with a variety of services to enable us
to continue to operate the business pending the transition to EasyLink. We have
successfully transitioned virtually all of these services provided by AT&T under
the Transition Services Agreement to ourselves, including customer service,
network operations center, telex switching equipment and services and office
space in a variety of locations. However, the network for the portion of this
business relating to EDI, fax and email services continues to reside on AT&T's
premises, but is being operated and maintained by EasyLink. We plan to migrate
our network off of AT&T's premises to EasyLink's premises over the next two
years.
We cannot assure you that we will be able to successfully migrate the remaining
EasyLink Services network from AT&T's premises to our own premises, or
successfully integrate them into our operations, in a timely manner or without
incurring substantial unforeseen expense or without service interruption to our
customers. Even if successfully migrated, we may be unable to operate the
business at expense levels that are ultimately profitable for us. We cannot
assure you that we will be able to retain all of the customers of the EasyLink
Services business. Our inability to successfully migrate, integrate or operate
the network and operations, or to retain customers, of the EasyLink Services
business will result in a material adverse effect on our business, results of
operations and financial condition.
Outsourcing of transaction delivery and transaction management services may not
prove to be viable businesses.
An important part of our business strategy is to leverage our existing global
customer base and global network by continuing to provide our existing
transaction delivery services and by offering these customers additional
transaction delivery and new transaction management services in the future. The
market for transaction management services is only beginning to develop. Our
success will depend on the continued expansion of the market for outsourced
transaction delivery services such as EDI, production messaging services and
integrated desktop messaging services and the development of viable markets for
the outsourcing of additional transaction delivery services and new transaction
management services. Each of these developments is somewhat speculative.
There are significant obstacles to the full development of a sizable market for
the outsourcing of transaction delivery and transaction management services.
Outsourcing is one of the principal methods by which we will attempt to reach
the size we believe is necessary to be successful. Security and the reliability
of the Internet, however, are likely to be of concern to enterprises and service
providers deciding whether to outsource their transaction delivery and
transaction management or to continue to provide it themselves. These concerns
are likely to be particularly strong at larger businesses and service providers,
which are better able to afford the costs of maintaining their own systems.
While we intend to focus exclusively on our outsourced transaction delivery and
transaction management services, we cannot be sure that we will be able to
maintain or expand our business customer base. In addition, the sales cycle for
many of these services is lengthy and could delay our ability to generate
revenues in this market.
Our strategy of developing and offering to existing customers additional
transaction delivery and transaction management services may be unsuccessful.
As part of our business strategy, we plan to develop and offer to existing
customers additional transaction delivery and transaction management services
that will automate more of our customers' business processes. We cannot assure
you that we will be able to successfully develop these additional services in a
timely manner or at all or, if developed, that our customers will purchase these
services or will purchase them at prices that we wish to charge. Standards for
pricing in the market for new transaction delivery and transaction management
services are not yet well defined and some businesses and service providers may
not be willing to pay the fees we wish to charge. We cannot assure you that the
fees we intend to charge will be sufficient to offset the related costs of
providing these services.
We may fail to meet market expectations because of fluctuations in our quarterly
operating results, which would cause our stock price to decline.
We may experience significant fluctuations in our quarterly results. It is
likely that our operating results in some quarters will be below market
expectations. In this event, the price of our Class A common stock is likely to
decline.
The following are among the factors that could cause significant fluctuations in
our operating results:
- incurrence of other cash and non-cash accounting charges,
including charges resulting from acquisitions or dispositions of
assets, including from the disposition of our remaining non-core
assets, and write-downs of impaired assets;
- increases or decreases in the number of transactions generated by
our customers (such as insurance claims, trade and travel
confirmations, purchase orders, invoices, shipping notices, funds
transfers, among others), which is affected by factors that affect
specific customers, the respective industries in which our
customers conduct business and the economy generally;
- gains from the restructuring or settlement of debt and other
obligations;
- non-cash charges associated with repriced stock options, if
our stock price rises above $16.90;
- system outages, delays in obtaining new equipment or problems
with planned upgrades;
-20-
- disruption or impairment of the Internet;
- demand for outsourced transaction delivery and transaction
management services;
- attracting and retaining customers and maintaining customer
satisfaction;
- introduction of new or enhanced services by us or our
competitors;
- changes in our pricing policy or that of our competitors;
- changes in governmental regulation of the Internet and transaction
delivery and transaction management services in particular; and
- general economic and market conditions and global political
factors.
Other such factors in our non-core assets include:
- incurrence of additional expenditures without receipt of
offsetting revenues pending the sale of these assets.
We may incur significant stock based compensation charges related to repriced
options if our stock price rises above $16.90.
In light of the decline in our stock price and in an effort to retain our
employee base, on November 14, 2000, the Company offered to certain of its
employees, officers and directors, other than Gerald Gorman, the right to
reprice certain outstanding stock options to an exercise price equal to $16.90
per share, the closing price of the Company's Class A common stock on Nasdaq on
November 14, 2000 as adjusted for our reverse stock split effected on January
23, 2002. Options to purchase 632,799 shares were repriced. The repriced options
vest at the same rate that they would have vested under their original terms. In
March 2000, Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation, an interpretation of APB Opinion No. 25" ("Interpretation"). Among
other issues, this Interpretation clarifies (a) the definition of employee for
purposes of applying Opinion 25, (b) the criteria for determining whether a plan
qualifies as a noncompensatory plan, (c) the accounting consequence of various
modifications to the terms of a previously fixed stock option or award, and (d)
the accounting for an exchange of stock compensation awards in a business
combination. As a result, under the Interpretation, stock options repriced after
December 15, 1998 are subject to variable plan accounting treatment. This
guidance requires the Company to remeasure compensation cost for outstanding
repriced options each reporting period based on changes in the market value of
the underlying common stock. If our stock price rises above the $16.90 exercise
price of the repriced options, this accounting treatment may result in
significant non-cash compensation charges in future periods.
Several of our competitors have substantially greater resources, longer
operating histories, larger customer bases and broader product offerings.
Our business is, and we believe will continue to be, intensely competitive. See
"Part I Item 1 - Business - Competition" in our Form 10-K filed March 31, 2003
and subsequent reports filed with the Securities and Exchange Commission.
Many of our competitors have greater market presence, engineering and marketing
capabilities, and financial, technological and personnel resources than those
available to us. As a result, they may be able to develop and expand their
communications and network infrastructures more quickly, adapt more swiftly to
new or emerging technologies and changes in customer requirements, take
advantage of acquisition and other opportunities more readily, and devote
greater resources to the marketing and sale of their products and services. In
addition, current and potential competitors have established or may establish
cooperative relationships among themselves or with third parties to increase the
ability of their services to address the needs of our current and prospective
customers. Accordingly, it is possible that new competitors or alliances among
competitors may emerge and rapidly acquire significant market share. In addition
to direct competitors, many of our larger potential customers may seek to
internally fulfill their messaging needs through the deployment of their own on
premises messaging systems.
Some of our competitors provide a variety of telecommunications services and
other business services, as well as software and hardware solutions, in addition
to transaction delivery or transaction management services. The ability of these
competitors to offer a broader suite of complementary services and software or
hardware may give them a considerable advantage over us.
The level of competition is likely to increase as current competitors increase
the sophistication of their offerings and as new participants enter the market.
In the future, as we expand our service offerings, we expect to encounter
increased competition in the development and delivery of these services. We may
not be able to compete successfully against our current or future competitors.
We have aggressively expanded our operations in anticipation of continued growth
in our business and as a result of our acquisitions. We have also developed the
technology and infrastructure to offer a range of services in our target market.
This expansion has placed, and we expect it to continue to place, a significant
strain on our managerial, operational and financial resources. If we cannot
manage our growth effectively, our business, operating results and financial
condition will suffer.
It is difficult to retain key personnel and attract additional qualified
employees in our business and the loss of key personnel and the burden of
attracting additional qualified employees may impede the operation and growth of
our business and cause our revenues to decline.
Our future success depends to a significant extent on the continued service of
our key technical, sales and senior management personnel, but they have no
contractual obligation to remain with us. In particular, our success depends on
the continued service of Gerald Gorman, our Chairman, Thomas Murawski, our
President and Chief Executive Officer, George Abi Zeid, our
President-International Operations, and Debra McClister, our Executive Vice
President and Chief Financial Officer. The loss of the services of Messrs.
Gorman, Murawski or Abi Zeid or of Ms. McClister, or several other key
employees, would impede the operation and growth of our business.
-21-
To manage our existing business and handle any future growth, we will have to
attract, retain and motivate additional highly skilled employees. In particular,
we will need to hire and retain qualified sales people if we are to meet our
sales goals. We will also need to hire and retain additional experienced and
skilled technical personnel in order to meet the increasing technical demands of
our expanding business. Competition for employees in messaging-related
businesses is intense. We have in the past experienced, and expect to continue
to experience, difficulty in hiring and retaining employees with appropriate
qualifications. If we are unable to do so, our management may not be able to
effectively manage our business, exploit opportunities and respond to
competitive challenges.
Our business is heavily dependent on technology, including technology that has
not yet been proven reliable at high traffic levels and technology that we do
not control.
The performance of our computer systems is critical to the quality of service we
are able to provide to our customers. If our services are unavailable or fail to
perform to their satisfaction, they may cease using our service. In addition,
our agreements with several of our customers establish minimum performance
standards. If we fail to meet these standards, our customers could terminate
their relationships with us and assert claims for monetary damages.
We may need to upgrade our computer systems to accommodate increases in traffic
and to accommodate increases in the usage of our services, but we may not be
able to do so while maintaining our current level of service, or at all.
We must continue to expand and adapt our computer systems as the number of
customers and the amount of information they wish to transmit increases and as
their requirements change, and as we further develop our services. Because we
have only been providing some of our services for a limited time, and because
our computer systems for these services have not been tested at greater
capacities, we cannot guarantee the ability of our computer systems to connect
and manage a substantially larger number of customers or meet the needs of
business customers at high transmission speeds. If we cannot provide the
necessary service while maintaining expected performance, our business would
suffer and our ability to generate revenues through our services would be
impaired.
The expansion and adaptation of our computer systems will require substantial
financial, operational and managerial resources. We may not be able to
accurately project the timing of increases in traffic or other customer
requirements. In addition, the very process of upgrading our computer systems
could cause service disruptions. For example, we may need to take various
elements of the network out of service in order to install some upgrades.
Our computer systems may fail and interrupt our service.
Our customers have in the past experienced interruptions in our services. We
believe that these interruptions will continue to occur from time to time. These
interruptions are due to hardware failures, failures in telecommunications and
other services provided to us by third parties and other computer system
failures. These failures have resulted and may continue to result in significant
disruptions to our service. Some of our operations have redundant switch-over
capability. Although we plan to install backup computers and implement
procedures on other parts of our operations to reduce the impact of future
malfunctions in these systems, the presence of single points of failure in our
network increases the risk of service interruptions. In addition, substantially
all of our computer and communications systems relating to our services are
currently located in Manhattan, Jersey City, New Jersey, Piscataway, New Jersey,
Washington, DC, Bridgeton, Missouri, Dayton, Ohio, and London, England. We
currently do not have alternate sites from which we could conduct these
operations in the event of a disaster. Our computer and communications hardware
is vulnerable to damage or interruption from fire, flood, earthquake, power
loss, telecommunications failure and similar events. Our services would be
suspended for a significant period of time if any of our primary data centers
was severely damaged or destroyed. We might also lose customer transaction
documents and other customer files, causing significant customer dissatisfaction
and possibly giving rise to claims for monetary damages. As a result of the
recent relocation of our corporate headquarters during the first quarter of
2003, we plan to consolidate over time an increasing portion of our computer
systems and networks at the new location. This consolidation may result in
interruptions in our services to some of our customers.
Our services will become less desirable or obsolete if we are unable to keep up
with the rapid changes characteristic of our business.
Our success will depend on our ability to enhance our existing services and to
introduce new services in order to adapt to rapidly changing technologies,
industry standards and customer demands. To compete successfully, we will have
to accurately anticipate changes in business demand and add new features to our
services very rapidly. We may not be able to integrate the necessary technology
into our computer systems on a timely basis or without degrading the performance
of our existing services. We cannot be sure that, once integrated, new
technology will function as expected. Delays in introducing effective new
services could cause existing and potential customers to forego use of our
services and to use instead those of our competitors.
Our business will suffer if we are unable to provide adequate security for our
service, or if our service is impaired by security measures imposed by third
parties.
Security is a critical issue for any outsourced transaction delivery or
transaction management service, and presents a number of challenges for us.
If we are unable to maintain the security of our service, our reputation and our
ability to attract and retain customers may suffer, and we may be exposed to
liability. Third parties may attempt to breach our security or that of our
customers whose networks we may maintain or for whom we provide services. If
they are successful, they could obtain information that is sensitive or
confidential to a customer or otherwise disrupt a customer's operations or
obtain confidential information, including our customer's profiles, passwords,
financial account information, credit card numbers, stored email or other
personal or business information. Our customers or their employees may assert
claims for money damages for any breach in our security and any breach could
harm our reputation.
-22-
Our computers are vulnerable to computer viruses, physical or electronic
break-ins and similar incursions, which could lead to interruptions, delays or
loss of data. We expect to expend significant capital and other resources to
license or create encryption and other technologies to protect against security
breaches or to alleviate problems caused by any breach. Nevertheless, these
measures may prove ineffective. Our failure to prevent security breaches may
expose us to liability and may adversely affect our ability to attract and
retain customers and develop our business market. Security measures taken by
others may interfere with the efficient operation of our service, which may harm
our reputation, adversely impact our ability to attract and retain customers.
"Firewalls" and similar network security software employed by third parties can
interfere with the operation of our services.
Our customers are subject to, and in turn require that their service providers
meet, increasingly strict guidelines for network and operational security. If we
are unable to meet the security requirements of a customer, we may be unable to
obtain or keep their business.
We are dependent on licensed technology and third party commercial partners.
We license a significant amount of technology from third parties, including
technology related to our virus protection, spam control and content filtering
services, Internet fax services, billing processes and database. We also rely on
third party commercial partners to provide services for our trading community
enablement services, document capture and management services and some of our
other services. We anticipate that we will need to license additional technology
or to enter into additional commercial relationships to remain competitive. We
may not be able to license these technologies or to enter into arrangements with
prospective commercial partners on commercially reasonable terms or at all.
Third-party licenses and strategic commercial relationships expose us to
increased risks, including risks relating to the integration of new technology,
the diversion of resources from the development of our own proprietary
technology, a greater need to generate revenues sufficient to offset associated
license or service fee costs, and the possible termination of or failure to
renew an important license or other agreement by the third-party licensor or
commercial partner.
If the Internet and other third-party networks on which we depend to deliver our
services become ineffective as a means of transmitting data, the benefits of our
service may be severely undermined.
Our business depends on the effectiveness of the Internet as a means of
transmitting data. The recent growth in the use of the Internet has caused
frequent interruptions and delays in accessing and transmitting data over the
Internet. Any deterioration in the performance of the Internet as a whole could
undermine the benefits of our services. Therefore, our success depends on
improvements being made to the entire Internet infrastructure to alleviate
overloading and congestion. We also depend on telecommunications network
suppliers such as AT&T Corp. and Worldcom for a variety of telecommunications
and Internet services. The network for the EasyLink Services business acquired
from AT&T continues to reside on AT&T's premises. See "Risk Factors - We May Be
Unable to Successfully Integrate the EasyLink Services Business Acquired From
AT&T" above, "Item 1. Business - Technology" in our Form 10-K filed March 31,
2003 and subsequent filings with the Securities and Exchange Commission.
Gerald Gorman and George Abi Zeid collectively beneficially owned as of July 31,
2003 approximately 27% of the total outstanding voting power of EasyLink and
will be able to exert significant influence over any vote of stockholders.
Gerald Gorman, our Chairman, beneficially owned as of July 31, 2003 Class A and
Class B common stock representing approximately 19.44% of the voting power of
our outstanding common stock. Each share of Class B common stock entitles the
holder to 10 votes on any matter submitted to the stockholders. George Abi Zeid,
our President-International Operations and Director, beneficially owned as of
February 28, 2003 Class A common stock representing approximately 7.37% of the
voting power of our outstanding common stock. Based on their voting power as of
July 31, 2003, Mr. Gorman and Mr. Abi Zeid will likely be able to exert
significant influence over the outcome of all matters requiring stockholder
approval, including the election of directors, amendment of our charter and
approval of significant corporate transactions. Mr. Gorman and Mr. Abi Zeid may
be in a position to prevent a change in control of EasyLink even if other
stockholders holding a majority of the voting power of the shares not held by
Mr. Gorman and Mr. Abi Zeid were in favor of the transaction.
We have agreed to permit Federal Partners, L.P., a holder of our senior
convertible notes and Class A common stock, to designate one member of our board
of directors. In addition, in connection with the acquisition of Swift
Telecommunications, Inc., we agreed to appoint George Abi Zeid, the former sole
shareholder of Swift, as a director and as our President of International
Operations.
Our charter contains provisions that could deter or make more expensive a
takeover of EasyLink. These provisions include the ability to issue "blank
check" preferred stock without stockholder approval.
Our goal of building brand identity is likely to be difficult and expensive.
We announced on April 2, 2001 that we have changed our corporate name to
EasyLink Services Corporation to more accurately reflect the strengths,
relationships and solutions that we offer. We believe that a quality brand
identity will be essential if we are to develop our business services market. If
our marketing efforts cost more than anticipated or if we cannot increase our
brand awareness, our losses will increase and our ability to succeed will be
seriously impeded.
Our expansion into international markets is subject to significant risks and our
losses may increase and our operating results may suffer if our revenues from
international operations do not exceed the costs of those operations.
-23-
We intend to continue to expand into international markets and to expend
significant financial and managerial resources to do so. We may not be able to
compete effectively in international markets. If our revenues from international
operations do not exceed the expense of establishing and maintaining these
operations, our losses will increase and our operating results will suffer. We
face significant risks inherent in conducting business internationally, such as:
- uncertain demand in foreign markets for transaction delivery
and transaction management services;
- difficulties and costs of staffing and managing international
operations;
- differing technology standards;
- difficulties in collecting accounts receivable and longer
collection periods;
- economic instability and fluctuations in currency exchange
rates and imposition of currency exchange controls;
- potentially adverse tax consequences;
- regulatory limitations on the activities in which we can engage
and foreign ownership limitations on our ability to hold an
interest in entities through which we wish to conduct business;
- political instability, unexpected changes in regulatory
requirements, and reduced protection for intellectual property
rights in some countries;
- export restrictions, and
- difficulties in enforcing contracts and potentially adverse
consequences.
Regulation of transaction delivery and transaction management services and
Internet use is evolving and may adversely impact our business.
There are currently few laws or regulations that specifically regulate activity
on the Internet. However, laws and regulations may be adopted in the future that
address issues such as user privacy, pricing, and the characteristics and
quality of products and services. For example, the Telecommunications Act of
1996 restricts the types of information and content transmitted over the
Internet. Several telecommunications companies have petitioned the FCC to
regulate ISPs and online service providers in a manner similar to long distance
telephone carriers and to impose access fees on these companies. This could
increase the cost of transmitting data over the Internet. Any new laws or
regulations relating to the Internet could adversely affect our business.
Moreover, the extent to which existing laws relating to issues such as property
ownership, pornography, libel and personal privacy are applicable to the
Internet is uncertain. We could face liability for defamation, copyright, patent
or trademark infringement and other claims based on the content of messages
transmitted over our system. We may also face liability for unsolicited
commercial and other email and fax messages sent by users of our services. We do
not and cannot screen all the content generated and received by users of our
services. Some foreign governments, such as Germany, have enforced laws and
regulations related to content distributed over the Internet that are more
strict than those currently in place in the United States.
A majority of our services are currently classified by the FCC as "information
services," and therefore are exempt from public utility regulation. To the
extent that we are permitted to offer all of our services as a single "bundle of
interrelated products," then the whole bundle is currently exempt from
regulation as a "hybrid service." If considered independent of the bundle,
however, our fax-to-fax services, when conducted over circuit-switched network
lines, and our telex services, qualify as "telecommunications services," and
would thus be subject to federal regulation. Moreover, while the FCC has until
now exercised forbearance in regulating IP communications, it has indicated that
it might regulate certain IP communications as "telecommunications services" in
the future. There can be no assurance that the FCC will not change its
regulatory classification system and thereby subject us to unexpected and
burdensome additional regulation. In addition, a variety of states regulate
certain of our services when provided on an intrastate basis.
We obtained authorizations from the FCC to provide such telecommunications
services in conjunction with our acquisition of these telecommunications
services from NetMoves, and are classified as a "non-dominant interexchange
carrier." While the FCC has generally chosen not to exercise its statutory power
to closely regulate the charges or practices of non-dominant carriers, it will
act upon complaints against such carriers for failure to comply with statutory
obligations or with the FCC's rules, regulations and policies - to the extent
that such services are, in the FCC's view, subject to regulation.
Continued changes in telecommunications regulations may significantly reduce the
cost of domestic and international calls. To the extent that the cost of
domestic and international calls decreases, we will face increased competition
for our fax services which may have a material adverse effect on our business,
financial condition or results in operations.
In connection with the deployment of Internet-capable nodes in countries
throughout the world, we are required to satisfy a variety of foreign regulatory
requirements. We intend to explore and seek to comply with these requirements on
a country-by-country basis as the deployment of Internet-capable fax nodes
continues. There can be no assurance that we will be able to satisfy the
regulatory requirements in each of the countries currently targeted for node
deployment, and the failure to satisfy such requirements may prevent us from
installing Internet-capable fax nodes in such countries. The failure to deploy a
number of such nodes could have a material adverse effect on our business,
operating results and financial condition.
-24-
Our fax nodes and our faxLauncher service utilize encryption technology in
connection with the routing of customer documents through the Internet. The
export of such encryption technology is regulated by the United States
government. We have authority for the export of such encryption technology other
than to Cuba, Iran, Iraq, Libya, North Korea, and Rwanda. Nevertheless, there
can be no assurance that such authority will not be revoked or modified at any
time for any particular jurisdiction or in general. In addition, there can be no
assurance that such export controls, either in their current form or as may be
subsequently enacted, will not limit our ability to distribute our services
outside of the United States or electronically. While we take precautions
against unlawful exportation of our software, the global nature of the Internet
makes it virtually impossible to effectively control the distribution of our
services. Moreover, future Federal or state legislation or regulation may
further limit levels of encryption or authentication technology. Any such export
restrictions, the unlawful exportation of our services, or new legislation or
regulation could have a material adverse effect on our business, financial
condition and results of operations.
The legal structure and scope of operations of our subsidiaries in some foreign
countries may be subject to restrictions which could result in severe limits to
our ability to conduct business in these countries. To the extent that we
develop or offer messaging services in foreign countries, we will be subject to
the laws and regulations of these countries. The laws and regulations relating
to the Internet in many countries are evolving and in many cases are unclear as
to their application. For example, in India, the PRC and other countries we may
be subject to licensing requirements with respect to the activities in which we
propose to engage and we may also be subject to foreign ownership limitations or
other approval requirements that preclude our ownership interests or limit our
ownership interests to up to 49% of the entities through which we propose to
conduct any regulated activities. If these limitations apply to our activities,
including our activities conducted through our subsidiaries, our opportunities
to generate revenue will be reduced, our ability to compete successfully in
these markets will be adversely affected, our ability to raise capital in the
private and public markets may be adversely affected and the value of our
investments and acquisitions in these markets may decline. Moreover, to the
extent we are limited in our ability to engage in certain activities or are
required to contract for these services from a licensed or authorized third
party, our costs of providing our services will increase and our ability to
generate profits may be adversely affected.
Our intellectual property rights are critical to our success, but may be
difficult to protect.
We regard our copyrights, service marks, trademarks, trade secrets, domain names
and similar intellectual property as critical to our success. We rely on
trademark and copyright law, trade secret protection and confidentiality and/or
license agreements with our employees, customers, strategic partners and others
to protect our proprietary rights. Despite our precautions, unauthorized third
parties may improperly obtain and use information that we regard as proprietary.
Third parties may submit false registration data attempting to transfer key
domain names to their control. Our failure to pay annual registration fees for
domain names may result in the loss of these domains to third parties. Third
parties have challenged our rights to use some of our domain names, and we
expect that they will continue to do so, which may affect the value that we can
derive from the planned disposition of the domain names included among our
non-core assets.
The status of United States patent protection for software products is not well
defined and will evolve as additional patents are granted. If we apply for a
patent in the future, we do not know if our application will be issued with the
scope of the claims we seek, if at all. The laws of some foreign countries do
not protect proprietary rights to the same extent as do the laws of the United
States. Our means of protecting our proprietary rights in the United States or
abroad may not be adequate and competitors may independently develop similar
technology.
Third parties may infringe or misappropriate our copyrights, trademarks and
similar proprietary rights. In addition, other parties have asserted and may in
the future assert infringement claims against us. We cannot be certain that our
services do not infringe issued patents. Because patent applications in the
United States are not publicly disclosed until the patent is issued,
applications may have been filed which relate to our services.
We have been and may continue to be subject to legal proceedings and claims from
time to time in the ordinary course of our business, including claims related to
the use of our domain names and claims of alleged infringement of the trademarks
and other intellectual property rights of third parties. Third parties have
challenged our rights to register and use some of our domain names based on
trademark principles and on the Anticybersquatting Consumer Protection Act. If
domain names become more valuable to businesses and other persons, we expect
that third parties will continue to challenge some of our domain names and that
the number of these challenges may increase. In addition, the existing or future
laws of some countries, in particular countries in Europe, may limit or prohibit
the use in those countries or elsewhere of some of our geographic names that
contain the names of a city in those countries or the name of those countries.
Intellectual property litigation is expensive and time-consuming and could
divert management's attention away from running our business. These claims and
the potential for such claims may reduce the value that we can expect to receive
from the disposition of our domain names.
In connection with the sale of our consumer-based email and advertising network
business, we transferred to the buyer the rights to direct the "MX" record, or
the right to direct email messages addressed to domain names owned by us and
used in this business. Although we do not operate the service or have any role
in the delivery of messages sent by users of the service, our position as the
registrant of the domain names used as addresses for email accounts maintained
by such service may subject us to claims from time to time. We could face
liability for defamation, copyright, patent or trademark infringement,
harassment, unsolicited commercial e-mail and other claims based on the content
of the messages transmitted over the service of this business. These claims,
even if without merit, can cause us to incur legal expenses and may divert
management time and resources.
A substantial amount of our common stock may come onto the market in the future,
which could depress our stock price.
Sales of a substantial number of shares of our common stock in the public market
could cause the market price of our Class A common stock to decline. As of July
31, 2003, we had an aggregate of 43,311,104 shares of Class A and Class B common
stock outstanding. As of July 31, 2003, we had options to purchase approximately
3.2 million shares of Class A common stock outstanding. As of July 31, 2003, we
had warrants to purchase 1,843,942 shares of Class A common stock outstanding.
As of July 31, 2003, we had approximately 811,927 shares of Class A common stock
issuable upon conversion of outstanding convertible notes and an indeterminate
number of additional shares of Class A common stock issuable over five years in
payment of interest on $444,857 in principal amount of such notes.
-25-
As of July 31, 2003, over 36 million shares of Class A common stock and Class B
common stock were freely tradable, in some cases subject to the volume and
manner of sale limitations contained in Rule 144. Approximately 4.9 million
shares will become freely tradable after October 31, 2003 and the remainder of
our shares of Class A common stock will become available for sale at various
dates upon the expiration of one-year holding periods or upon the expiration of
any other applicable restrictions on resale. We may issue large amounts of
additional Class A common stock, which may also be sold and which could
adversely affect the price of our stock. Approximately 22.5 million of our
outstanding shares were issued in connection with the elimination of debt during
the quarter ended June 30, 2003 and on July 23, 2003. If the holders of these
shares sell large numbers of shares, these holders could cause the price of our
Class A common stock to fall.
As of July 31, 2003, the holders of approximately 8.2 million shares of
outstanding Class A common stock, the holders of 1.8 million shares of Class A
common stock issuable upon exercise of our outstanding warrants and the holders
of approximately 86,189 shares of Class A common stock issuable upon conversion
of our outstanding senior convertible notes had the right, subject to various
conditions, to require us to file registration statements covering their shares,
or to include their shares in registration statements that we may file for
ourselves or for other stockholders. By exercising their registration rights and
selling a large number of shares, these holders could cause the price of the
Class A common stock to fall. An undetermined number of these shares have been
sold publicly pursuant to Rule 144.
Our Class A common stock may be subject to delisting from the Nasdaq National
Market.
Our Class A common stock may face potential delisting from the Nasdaq National
Market which could hurt the liquidity of our Class A common stock. We may be
unable to comply with the standards for continued listing on the Nasdaq National
Market. These standards require, among other things, that our Class A common
stock have a minimum bid price of $1. Specifically, an issuer will be considered
non-compliant with the minimum bid price requirement only if it fails to satisfy
the applicable requirement for any 30 consecutive trading day period. It would
then be afforded a 90 calendar day grace period in which to regain compliance.
In addition, the listing standards require that we maintain compliance with
various other standards, including market capitalization or total assets and
total revenue, number of publicly held shares, which are shares held by persons
who are not officers, directors or beneficial owners of 10% of our outstanding
shares, and market value of publicly held shares. Alternatively, we can comply
with certain other standards, including a $10 million minimum stockholders'
equity requirement. The minimum bid price of our stock was below $1 during
various periods in the fourth quarter of 2000 and the first quarter of 2001 and
was below $1 during the period from March 14, 2001 through January 22, 2002.
On January 23, 2002, we effected a ten-for-one reverse stock split. Although our
stock price exceeded the $1 minimum bid price requirement for a period of time
since our reverse stock split, our stock price was also below $1.00 during the
period from July 10, 2002 through July 26, 2002 and from July 30, 2002 through
August 16, 2002 and from November 18, 2002 until July 11, 2003. Although the
Company regained compliance with the minimum bid price requirement on August 4,
2003 after a hearing before a Nasdaq Listing Qualifications Panel, no assurance
can be given that we will maintain compliance with the minimum bid price
requirement. If we are unable to maintain compliance, we may be subject to
delisting.
We had a total stockholders' equity in the amount of $1.96 million as of June
30, 2003. As a result, we are currently not in compliance with the $10 million
minimum total stockholders' equity requirement. An alternative listing standard
to the minimum total stockholders equity standard requires that we maintain a
minimum market value of our publicly held shares of not less than $15 million.
There can be no assurance that EasyLink will maintain compliance with the
minimum bid price requirement or that it will maintain compliance with the other
listing standards, including the $15 million minimum market value of publicly
held shares requirement.
If our common stock were to be delisted from trading on the Nasdaq National
Market and were neither re-listed thereon nor listed for trading on the Nasdaq
Small Cap Market or other recognized securities exchange, trading, if any, in
the Class A common stock may continue to be conducted on the OTC Bulletin Board
or in the non-Nasdaq over-the-counter market. Delisting would result in limited
release of the market price of the Class A common stock and limited news
coverage of EasyLink and could restrict investors' interest in our Class A
common stock and materially adversely affect the trading market and prices for
our Class A common stock and our ability to issue additional securities or to
secure additional financing.
Our stock price has been volatile and we expect that it will continue to be
volatile.
Our stock price has been volatile since our initial public offering and we
expect that it will continue to be volatile. As discussed above, our financial
results are difficult to predict and could fluctuate significantly. In addition,
the market prices of securities of electronic services companies have been
highly volatile. A stock's price is often influenced by rapidly changing
perceptions about the future of electronic services or the results of other
Internet or technology companies, rather than specific developments relating to
the issuer of that particular stock. As a result of volatility in our stock
price, a securities class action may be brought against us. Class-action
litigation could result in substantial costs and divert our management's
attention and resources.
We may have continuing obligations in connection with the sale of our
advertising network business.
On March 30, 2001, we completed the sale of our advertising network business to
Net2Phone, Inc. Included in the sale was our rights to provide e-mail-based
advertising and permission marketing solutions to advertisers, as well as our
rights to provide e-mail services directly to consumers at the www.mail.com Web
site and in partnership with other Web sites. Net2Phone has subsequently
transferred this business to a third party.
Notwithstanding the sale of this business and the assignment to Net2Phone of our
Web site contracts with third parties, we may nonetheless remain liable for
obligations under some of such third party Web site contracts. Accordingly, we
may have liability if there is a breach on the part of the third party to which
we have migrated the hosting of consumer e-mail boxes or on the part of
Net2Phone or its assignee under the third party Web site agreements that were
assigned to them.
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ITEM 4 CONTROLS AND PROCEDURES
As of the end of the period covered by this Quarterly Report on Form 10-Q, our
management, including our Chief Executive Officer and Chief Financial Officer,
evaluated the effectiveness of EasyLink's "disclosure controls and procedures,"
as that term is defined in Rule 13a-15(e) and 15d-15(e) promulgated under the
Securities and Exchange Act of 1934, as amended (the "Exchange Act"). Based on
that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that the disclosure controls and procedures are effective to ensure
that information required to be disclosed by EasyLink in the reports that we
file or submit under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the SEC's rules and forms, and to
ensure that such information is made known to the Chief Executive Officer and
Chief Financial Officer as appropriate to allow timely decisions regarding
required disclosure. During the period covered by this Quarterly Report on Form
10-Q, there were no changes in our internal control over financial reporting
that have materially affected, or are reasonably likely to materially affect,
the Company's internal control over financial reporting.
PART II OTHER INFORMATION
Item 1: Legal Proceedings
On July 31, 2003, the Company filed a complaint in a new action against AT&T
Corp., PTEK Holdings, Inc. and PTEK's subsidiary Xpedite Systems, Inc. in the
Superior Court of New Jersey - Law Division, Middlesex County (the "New
Action"), and filed a notice of appeal with the Superior Court of New Jersey -
Appellate Division relating to the decision of the Chancery Court to dismiss
EasyLink's original action against AT&T and PTEK (the "Appeal"). The New Action,
among other relief, seeks a declaratory judgment that the agreement between AT&T
and PTEK violates contractual agreements between the Company and AT&T and that
their agreement is void and seeks damages for breach of contract, breach of
fiduciary duty, unfair competition, breach of confidentiality obligations and
tortious interference.
This matter arises out of the February 27, 2003 announcement by PTEK Holdings,
Inc. ("PTEK"), one of the Company's principal competitors, that it had entered
into an agreement with AT&T to purchase 1,423,980 shares of outstanding Class A
common stock of the Company held by AT&T and a $10 million promissory note of
the Company held by AT&T and related actions of AT&T, PTEK and Xpedite. In
response to PTEK's announcement, the Company commenced on March 17, 2003 an
action against AT&T, PTEK and Xpedite (the "Original Action"). The Original
Action sought, among other things, to enjoin AT&T from selling the promissory
note held by AT&T to PTEK, to compel AT&T to participate in the Company's
current debt restructuring and to enjoin PTEK and Xpedite from contacting the
Company's creditors and making false statements to the Company's customers and
creditors regarding the Company and its financial position. AT&T Corp. and PTEK
filed a motion to dismiss EasyLink's complaint in the Original Action or,
alternatively, to transfer the action to the Law Division. On June 26, 2003, the
Court dismissed the claims made in EasyLink's Original Action, but indicated
that EasyLink may file a new complaint as part of a new action. Accordingly, the
Company has filed the New Action and the Appeal in order to pursue its rights
and remedies. No assurance can be given as to the outcome of this matter.
Item 2: Changes in Securities and Use of Proceeds
Recent Sales of Unregistered Securities
During the three months ended June 30, 2003, we issued shares of Class A common
stock as follows:
The Company issued 50,699 shares of Class A common stock valued at
$31,028 for accounting purposes on June 1, 2003 in payment of $25,857
of accrued interest in lieu of cash. The issuance of the shares was
made pursuant to the terms of the underlying notes on which the
interest accrued and not at the election of the holders of the notes.
The issuance of the notes and, therefore, the issuance of the shares in
payment of interest were exempt from registration pursuant to the
private placement exemption contained in Section 4(2) of the Securities
Act because the shares were issued in a transaction not involving a
public offering to investors capable of evaluating the merits and risks
of the investment and not in need of the protections afforded by
registration under the Act.
The Company issued an aggregate of 227,512 shares of Class A common
stock as matching contributions pursuant to its 401(k) plan during the
three months ended June 30, 2003. These issuances were not subject to
the registration requirements of the Securities Act because the
issuance of the shares was not voluntary and contributory on the part
of employees.
The Company issued 1,923,077 shares of Class A common stock on April
30, 2003 in a financing for $1.0 million in cash in connection with the
closing of the Company's May 1, 2003 debt restructuring. The proceeds
were used to fund cash payments required to be made in exchange for
debt eliminated in the debt restructuring. This issuance was exempt
from registration pursuant to the private placement exemption contained
in Section 4(2) of the Securities Act because the shares were issued in
a transaction not involving a public offering to investors capable of
evaluating the merits and risks of the investment and not in need of
the protections afforded by registration under the Act.
During the three months ended June 30, 2003, the Company issued
22,334,855 shares of Class A common stock and notes in the principal
amount of $790,053 and $283,504, respectively, in each case in exchange
for the cancellation of debt. These securities were issued in reliance
on the exemption contained in Section 3(a)(9) of the Securities Act.
The securities were exchanged by the Company with existing security
holders exclusively and no commission or other remuneration was paid or
given directly or indirectly for soliciting the exchange.
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Item 4: Submission of Matters to a Vote of Security Holders
(a) The Annual Meeting of Shareholders was held on August 7, 2003.
(b) Each of the persons named in the Proxy Statement as a nominee for Director
was elected.
(c) The following are the voting results on each of the matters that were
submitted to the shareholders:
Withheld or
For Against Abstain
Election of Directors
Gerald Gorman 33,367,442 3,428,760
Thomas Murawski 33,361,930 3,434,272
George Abi Zeid 33,366,805 3,429,397
Robert Casale 36,697,799 98,403
Stephen Duff 36,697,629 98,573
George Knapp 36,697,719 98,483
Dennis Raney 36,706,145 90,057
Resolutions
To approve the EasyLink Services 22,201,682 4,278,672 9,575
Corporation 2003 Stock Option Plan
The text of the matters referred to under this Item 4 is set forth in the Proxy
Statement dated April 23, 2002 previously filed with the Commission and
incorporated herein by reference.
Item 5 Other Information
On August 13, 2003, the Audit Committee of the Board of Directors re-appointed
KPMG LLP to continue as the Company's independent auditors for the year 2003.
KPMG LLP has served as the Company's independent auditors since 1998.
Item 6 Exhibits and Reports on Form 8-K
The following exhibits are filed as part of this report:
Exhibit 10.1 Amendment No. 1 dated as of August 8, 2003 to Employment
Agreement between Thomas Murawski and the Company.
Exhibit 31.1 Rule 13a-14(a)/15d-14(a) Certification of the Chief
Executive Officer
Exhibit 31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief
Financial Officer
Exhibit 32.1 Section 1350 Certification of the Chief Executive Officer
Exhibit 32.1 Section 1350 Certification of the Chief Financial Officer
Reports on Form 8-K - EasyLink Services Corporation filed the following reports
on Form 8-K during the three months ended June 30, 2003:
On April 23, 2003, the Company filed a Form 8-K disclosing the
scheduling of a hearing before a Nasdaq Listing Qualifications Panel
regarding the Company's continued listing on the Nasdaq National
Market.
On May 2, 2003, the Company filed a Form 8-K announcing the
completion of a debt elimination transaction and the closing of a
financing.
On May 8, 2003, the Company submitted a Form 8-K to furnish its
quarterly earnings announcement pursuant to Item 12 of Form 8-K.
On June 27, 2003, the Company filed a Form 8-K to disclose the
re-scheduling of a hearing before a Nasdaq Listing Qualifications
Panel regarding the Company's continued listing on the Nasdaq
National Market and to update disclosure regarding pending legal
proceedings.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report on Form 10-Q to be signed on its behalf
by the undersigned thereto duly authorized.
EasyLink Services Corporation
/s/ DEBRA L. MCCLISTER
----------------------
Executive Vice President and
Chief Financial Officer
August 14, 2003
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Exhibit Index
Exhibit 10.1 Amendment No. 1 dated as of August 8, 2003 to Employment
Agreement between Thomas Murawski and the Company.
Exhibit 31.1 Rule 13a-14(a)/15d-14(a) Certification of the Chief
Executive Officer
Exhibit 31.2 Rule 13a-14(a)/15d-14(a) Certification of the Chief
Financial Officer
Exhibit 32.1 Section 1350 Certification of the Chief Executive Officer
Exhibit 32.2 Section 1350 Certification of the Chief Financial Officer
-30-