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EX-31.2 - EX-31.2 - EASYLINK SERVICES INTERNATIONAL CORPv205480_ex31-2.htm
EX-32.2 - EX-32.2 - EASYLINK SERVICES INTERNATIONAL CORPv205480_ex32-2.htm
EX-31.1 - EX-31.1 - EASYLINK SERVICES INTERNATIONAL CORPv205480_ex31-1.htm
EX-32.1 - EX-32.1 - EASYLINK SERVICES INTERNATIONAL CORPv205480_ex32-1.htm



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC20549

FORM 10-Q

(Mark One)

þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
   
 
For the quarterly period ended October 31, 2010
   
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
   
For the transition period from ___ to ___
 
Commission File Number: 001-34446


EasyLink Services International Corporation
(Exact Name of Registrant as Specified in Its Charter)

Delaware
13-3645702
(State or Other Jurisdiction of Incorporation or Organization)
(I.R.S. Employer Identification No.)
   
6025 The Corners Parkway, Suite 100
 
Norcross, Georgia
30092
(Address of Principal Executive Offices)
(Zip Code)

Registrant’s telephone number, including area code: (678) 533-8000

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this Chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o
Accelerated filer o
Non-accelerated o
Smaller reporting company þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

As of November 30, 2010, the issuer had outstanding 29,318,324 shares of class A common stock. 
 


  
 
 

 

EASYLINK SERVICES INTERNATIONAL CORPORATION
INDEX TO FORM 10-Q

   
Page
PART I FINANCIAL INFORMATION
   
     
Item 1.   Financial Statements
 
1
     
Condensed Consolidated Balance Sheets as of October 31, 2010 (Unaudited) and July 31, 2010
 
1
     
Condensed Consolidated Statements of Operations for the three months ended October 31, 2010 and 2009 (Unaudited)
 
2
     
Condensed Consolidated Statements of Cash Flows for the three months ended October 31, 2010 and 2009 (Unaudited)
 
3
     
Notes to Condensed Consolidated Financial Statements (Unaudited)
 
4
     
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
13
     
Item 3.   Quantitative and Qualitative Disclosures about Market Risk
 
18
     
Item 4T.  Controls and Procedures
 
18
     
PART II OTHER INFORMATION
   
     
Item 1.   Legal Proceedings
 
19
     
Item 1A.  Risk Factors
 
19
     
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds
 
20
     
Item 3.   Defaults Upon Senior Securities
 
20
     
Item 4.   [Removed and Reserved]
 
20
     
Item 5.   Other Information
 
20
     
Item 6.   Exhibits
 
21
     
Signatures
 
22

 
 

 
 
PARTI. FINANCIAL INFORMATION

Item 1. Financial Statements

Condensed Consolidated Balance Sheets as of October 31, 2010 and July 31, 2010 (Unaudited)

   
October 31,
2010
   
July 31,
2010
 
             
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 18,084,541     $ 20,474,709  
Accounts receivable, net of allowance for doubtful accounts and allowance for sales returns and allowances of $1,920,556 and $1,662,502, respectively
    30,869,495       11,480,688  
Prepaid expenses and other current assets
    3,627,507       1,865,013  
Deferred tax asset
    6,602,064       6,597,983  
Total current assets
    59,183,607       40,418,393  
                 
Property and equipment, net of accumulated depreciation of $17,205,845 and $16,379,755, respectively
    20,895,100       5,521,146  
Goodwill
    62,776,775       34,454,935  
Other intangible assets, net
    67,126,403       15,874,281  
Deferred tax asset, net of valuation allowance
    7,134,343       7,588,257  
Other assets
    1,104,414       629,261  
Total assets
  $ 218,220,642     $ 104,486,273  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Accounts payable
  $ 7,520,394     $ 2,310,168  
Notes payable
    27,901,860       15,257,852  
Accrued expenses
    20,156,206       8,740,386  
Accrued dividends, deferred revenue and other current liabilities
    1,622,747       1,497,174  
Total current liabilities
    57,201,207       27,805,580  
                 
Notes payable, long term
    92,113,782       9,684,263  
Other liabilities
    790,998       285,017  
Total liabilities
    150,105,987       37,774,860  
                 
Commitments and contingencies
               
Stockholders’ Equity:
               
Preferred stock:
               
Series C Preferred Stock — par value $.01 per share, 5,000,000 shares authorized, 44.76 votes per share; 5,000 shares issued and 5,000 outstanding (liquidation value of $5,166,575 at October 2010 and $5,116,164 at July 2010)
    50       50  
Common stock:
               
Class A — par value $.01 per share, 300,000,000 shares authorized, one vote per share; 30,297,802 and 30,255,293 shares issued at October 31, 2010 and July 31, 2010, respectively
    302,978       302,553  
Additional paid-in capital
    133,014,068       132,798,748  
Treasury stock — 1,000,000 shares as of October 2010 and July 2010
    (2,122,288 )     (2,122,288 )
Accumulated other comprehensive loss
    (5,576,428 )     (5,796,782 )
Accumulated deficit
    (57,503,725 )     (58,470,868 )
Total stockholders’ equity
    68,114,655       66,711,413  
                 
Total liabilities and stockholders’ equity
  $ 218,220,642     $ 104,486,273  

See notes to condensed consolidated financial statements.
 
 
1

 

Condensed Consolidated Statements of Operations for the three months ended October 31, 2010 and 2009 (Unaudited)
 
   
Three Months Ended
October 31,
 
   
2010
   
2009
 
             
Service revenues, net
  $ 22,735,880     $ 20,498,141  
Cost of services
    6,591,278       6,086,865  
Gross profit
    16,144,602       14,411,276  
                 
Operating expenses:
               
Product development and enhancement
    1,938,151       1,858,874  
Selling and marketing
    2,957,710       3,269,434  
General and administrative
    9,186,665       7,222,582  
                 
Operating income
    2,062,076       2,060,386  
                 
Other income (expense):
               
Interest and investment income
    3,547       7,336  
Interest expense
    (813,096 )     (493,832 )
Foreign exchange gain
    185,837       279,950  
Other income
    121,542       54,006  
      (502,170 )     (152,540 )
                 
Income before income taxes
    1,559,906       1,907,846  
Provision for income taxes
    592,764       543,860  
Net income
    967,142       1,363,986  
                 
Dividends on preferred stock
    (50,411 )     (216,187 )
Net income attributable to common stockholders
  $ 916,731     $ 1,147,799  
                 
Basic income per common share
  $ .03     $ .04  
                 
Diluted income per common share
  $ .03     $ .04  
                 
Anti-dilutive stock options, restricted stock, warrants, and Series C preferred stock
    1,446,451       4,184,714  
                 
Weighted average number of common shares outstanding — basic
    29,260,600       26,269,172  
                 
Weighted average number of common shares outstanding — diluted
    30,217,739       29,415,574  
 
See notes to condensed consolidated financial statements.
 
 
2

 

Condensed Consolidated Statements of Cash Flows for the three months ended October 31, 2010 and 2009
(Unaudited)
 
   
Three Months Ended October 31,
 
   
2010
   
2009
 
             
Cash flows from operating activities:
           
Net income
  $ 967,142     $ 1,363,986  
Adjustments to reconcile net income  to net cash provided by operating activities:
               
Depreciation and amortization
    2,208,504       2,056,778  
Bad debt expense
    48,295       106,926  
Amortization of discount and other non-cash interest expense
    496,196       148,287  
Deferred tax expense
    449,833       477,000  
Non-cash charges for equity instruments issued for compensation and services
    266,159       235,915  
Non-cash equity in losses of investment and other non-cash items
          130  
Changes in assets and liabilities
               
Accounts receivable
    (2,939,555 )     (432,737 )
Prepaid expenses and other assets
    (96,042 )     257,391  
Accounts payable
    1,548,553       (290,763 )
Accrued expenses
    2,171,905       602,214  
Other liabilities
    (200,493 )     (182,413 )
Net cash provided by operating activities
    4,920,497       4,342,714  
                 
                 
Cash flows from investing activities:
               
Purchases of property and equipment
    (173,956 )     (297,078 )
Acquisition, net of cash acquired
    (101,514,250        
Net cash used in investing activities
    (101,688,206 )     (297,078 )
                 
Cash flows from financing activities:
               
Borrowings of notes payable
    122,000,000        
Repayments of notes payable and capital lease
    (27,621,851 )     (7.082 )
Net cash (used in) financing activities
    94,378,149       (7,082 )
                 
Effect of foreign exchange rate changes on cash and cash equivalents
    (608 )     (113,369 )
Net (decrease) increase in cash and cash equivalents
    (2,390,168 )     3,925,185  
                 
Cash and cash equivalents, beginning of period
    20,474,709       10,972,365  
Cash and cash equivalents, end of period
  $ 18,084,541     $ 14,897,550  
 
See notes to condensed consolidated financial statements.
 
 
3

 

EASYLINK SERVICES INTERNATIONAL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)

1. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements of EasyLink Services International Corporation (referred to as “EasyLink,” the “Company,” “we,” “our” or “us”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. In the opinion of management, such statements include all adjustments (consisting only of normal recurring adjustments) necessary for the fair presentation of our financial position, results of operations and cash flows as of the dates and for the periods indicated. Pursuant to the requirements of the Securities and Exchange Commission (“SEC”) applicable to Quarterly Reports on Form 10-Q, the accompanying financial statements do not include all disclosures required by GAAP for annual financial statements. While we believe the disclosures presented are adequate to make the information not misleading, these unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended July 31, 2010.

The condensed consolidated balance sheet as of July 31, 2010 has been derived from the audited consolidated financial statements as of that date.

Operating results for the three–month period ended October 31, 2010 are not necessarily indicative of the results that may be expected for the fiscal year ending July 31, 2011 or any future period.

Principles of consolidation and basis of presentation

The consolidated financial statements include the accounts of EasyLink and our wholly-owned subsidiaries. All significant intercompany transactions have been eliminated in consolidation.

Recently Adopted Accounting Pronouncements

In January 2010, the FASB issued ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.  This ASU requires reporting entities to make new disclosures about recurring or nonrecurring fair-value measurements including significant transfers into and out of Level 1 and Level 2 fair-value measurements and information about purchases, sales, issuances, and settlements on a gross reconciliation of Level 3 fair-value measurements.  This ASU also clarifies existing fair-value measurement disclosure guidance about the level of disaggregation, inputs, and valuation techniques.  This ASU is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements.  Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years.  Early adoption is permitted.  The adoption of the applicable portions of this ASU did not have a material effect on the Company's consolidated financial statements.  The Company is currently evaluating the impact that the adoption of the remainder of this guidance might have on its consolidated financial statement disclosures in the first quarter of fiscal 2012.

In October 2009, the FASB issued ASU No. 2009-13, which amends ASC 605-25, Revenue Recognition; Multiple-Element Arrangements.  These amendments provide clarification on whether multiple deliverables exist, how the arrangement should be separated, and the consideration allocated.  An entity is required to allocate revenue in an arrangement using estimated selling prices of deliverables in the absence of vendor-specific objective evidence or third-party evidence of selling price. These amendments also eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method.  These amendments significantly expand the disclosure requirements for multiple-deliverable revenue arrangements.  These provisions are to be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with earlier application permitted.  The Company is currently evaluating the impact of these amendments on its consolidated financial statements.

 
4

 

 
In October 2009, the FASB issued ASU No.2009-14 Software (Topic 985) “Certain Revenue Arrangements That Include Software Elements – a consensus of the FASB Emerging Issues Task Force”.  This ASU is only effective for fiscal years beginning on or after June 15, 2010.  We have determined that the ASU did not have a material impact on our financial statements.

2. ACQUISITION

Xpedite Business

On October 21, 2010 we acquired the iSend and iNotify advanced messaging businesses (the “Xpedite Business”) from Premiere Global Services, Inc. (“PGI”) for $105 million in cash, through the purchase of PGI’s wholly-owned subsidiaries, Xpedite Systems, LLC and Premiere Global Services (UK) Limited and certain related assets owned by PGI’s subsidiary Premiere Conferencing (Canada) Limited.  We paid for the acquisition with $5 million of cash on hand and a new credit facility consisting of a $110 million term loan and a $20 million revolving loan (the “2010 Loans”), of which $12 million of the revolving loan was drawn upon to refinance our existing credit facility indebtedness.  The 2010 Loans call for quarterly payments of $4,125,000 with interest and a final balloon payment in 2014, with interest, which commence on January 31, 2011.
 
The 2010 Loans are secured by substantially all of the US assets of the Company and guarantees by certain of the international subsidiaries of the Company and related pledges of a portion of the stock of certain of the international subsidaries.
 
The Credit Agreement for the 2010 Loans contains usual and customary covenants for financings of this type, including, among other things: (i) requirements to deliver financial statements, other reports and notices; (ii) restrictions on additional indebtedness; (iii) restrictions on dividends, distributions and redemptions of equity and repayment of subordinated indebtedness; (iv) restrictions on liens; (v) restrictions on making certain payments; (vi) restrictions on investments; (vii) restrictions on asset dispositions and other fundamental changes; and (viii) restrictions on transactions with affiliates. In addition, the Credit Agreement contains certain financial covenants, including, among other things: (i) a maximum leverage ratio; (ii) a minimum fixed charge coverage ratio; (iii) a minimum amount of consolidated adjusted EBITDA; (iv) a minimum amount of liquidity; and (v) a maximum amount of capital expenditures. Without the permission of the Lenders, our ability to complete material acquisitions will be restricted.  A default on any of these restrictions and covenants will cause, in certain circumstances, the amounts due under such agreements to become due and payable upon demand.

In order to close the Xpedite acquisition, we spent approximately $3.8 million, of which approximately $1.6 million was expensed as occurred and approximately $2.2 million was recorded as a discount to the term loan and will be amortized over the same period as the term loan.

An adjustment to the purchase price will be made based on the working capital of the acquired business at the acquisition date as defined in the Security and Asset Purchase Agreement dated October 21, 2010 entered into in connection with the acquisition of the Xpedite Business.  If the working capital is less than $6.4 million, PGI will pay for the shortfall.  If the working capital is greater than $6.4 million we will be required to pay the surplus to PGI up to $2.0 million.  As of the end of the quarter management expects that we will be required to pay PGI the $2.0 million for the working capital adjustment.

 
5

 

2. ACQUISITION (Continued)

The following table provides the estimated fair value of assets acquired and liabilities assumed in the Xpedite Business acquisition.  The preliminary purchase price allocation is based on the estimated fair value of assets acquired and liabilities assumed:

Cash
  $ 5,485,750  
Accounts receivable
    16,389,901  
Prepaid expenses and other current assets
    1,883,623  
Fixed assets
    16,086,492  
Intangible assets — customer relationships
    34,800,000  
Intangible assets — software
    16,400,000  
Intangible assets — non-competes
    1,200,000  
Other Assets
    300,493  
Accounts payable and Accrued Expenses
    (12,791,105 )
Other current liabilities
    (197,258 )
Capital leases
    (199,182 )
Long term liabilities
    (543,157 )
Fair value of net assets acquired
    78,815,557  
Goodwill
    28,184,443  
Total purchase price
  $ 107,000,000  

Estimates of acquired intangible assets are as follows:
Acquired Intangible Assets
 
Estimated 
Fair Value
   
Weighted Average
Estimated 
Useful Life (yrs)
 
Customer Relationships
  $ 34,800,000      
10-12
 
Internally developed software
    16,400,000      
8-10
 
Non-competes
    1,200,000      
5
 
Goodwill
    28,184,443    
Non-amortizable
 

As part of the allocation of the purchase price, using an independent valuation expert’s preliminary results, the Company has recorded certain tangible assets, intangible assets and goodwill. The preliminary results are subject to adjustment upon finalization of the valuation. The final allocation price could differ materially from the preliminary allocation. Any subsequent changes to the purchase price allocation that result in material changes to our consolidated financial results will be adjusted retrospectively.

The Goodwill and Intangibles acquired in the Xpedite acquisition were all related to the On Demand business segment.
 
 
6

 

 
2. ACQUISITION (Continued)

Pro Forma Financial Information

The pro forma statements below are for the combined entities and demonstrate the statement of operations as if the transaction had occurred as of the beginning of the quarters ended October 31, 2009.  The statements for the Xpedite Business are based on carve-out financial statements provided by PGI, and as such, reflect expenses incurred by PGI in order to support their management structure and includes allocations deemed reasonable by PGI’s management.

Pro Forma Consolidated Combined Statement of Operations
(in thousands)
   
Three Months Ended
October 31,
 
   
2010
   
2009
 
             
Service revenues, net
  $ 48,125     $ 52,772  
Cost of services
    16,660       19,454  
Gross profit
    31,465       33,318  
                 
Operating expenses:
               
Product development and enhancement
    3,021       3,439  
Selling and marketing
    8,671       10,368  
General and administrative
    23,733       29,248  
                 
Operating income
    (3,960 )     (9,737 )
                 
Other income (expense):
               
Interest expense, net
    (1,340 )     (1,412 )
Foreign exchange gain
    208       340  
Other income
    122       54  
Income before income taxes
    (4,970 )     (10,755 )
Benefit for income taxes
    (1,889 )     (3,011 )
Net income
    (3,081 )     (7,744 )
                 
Dividends on preferred stock
    (50 )     (216 )
Net income attributable to common stockholders
  $ (3,131 )   $ (7,960 )
                 
Basic income per common share
  $ (0.11 )   $ (0.30 )
                 
Diluted income per common share
  $ (0.11 )   $ (0.30 )
                 
Weighted average number of common shares outstanding — basic
    29,261       26,269  
                 
Weighted average number of common shares outstanding — diluted
    29,261       29,269  
 
The pro forma statements reflect the results of operations for the Company for its fiscal quarters ended October 31, 2010 and 2009, and the results of operations for the Xpedite Business for its fiscal quarters ended September 30, 2010 and 2009. The pro forma adjustments used to prepare the statements above, include the removal of intercompany interest between the Xpedite Business and PGI of $0 in 2009 and $71,000 in 2010 as well as the removal of the amortization of the intangible assets for the Xpedite Business due to the revaluation of intangibles that was performed subsequent to the acquisition of $29,000 in 2009 and $23,000 in 2010.  In addition to the removal of expenses for the Xpedite Business, interest expense has been increased by $926,000 in 2009 and $561,000 in 2010 to reflect the new debt agreement and amortization of the intangibles has been increased by $1,306,000 for 2009 and 2010 in order to reflect the new value of the intangibles subsequent to the acquisition date.

 
7

 

 
2. ACQUISITION (Continued)
 
For the 10 day period ending October 31, 2010 the Xpedite Business provided approximately $474K in net income for the On Demand business segment, which consisted of approximately $2.9 million in gross revenue and $2.4 million in expenses.

3. ACQUIRED INTANGIBLE ASSETS AND GOODWILL

Intangible assets net of accumulated amortization are summarized as follows:

   
Weighted average
amortization
period (years)
   
 
October 31, 2010
   
 
July 31, 2010
 
                   
Purchased customer relationships
 
6-12
    $ 52,726,101     $ 17,853,802  
Internally developed systems
 
4-10
      26,974,244       10,516,331  
Non-Competes
 
5
      1,200,000        
Trade names
 
<1
      3,745,539       3,733,670  
Intangible assets, gross
          $ 84,645,884     $ 32,103,803  
Less accumulated amortization:
                       
Purchased customer relationships
          $ (8,093,155 )     (7,437,966 )
Internally developed systems
            (9,259,953 )     (8,640,564 )
Non-Competes
            (6,452 )      
Trade names
            (159,921 )     (150,992 )
Accumulated amortization
            (17,519,481 )     (16.229,522 )
Intangible assets, net
          $ 67,126,403     $ 15,874,281  
 
Trade names in the amount of $3,495,539 are not amortizable.
 
The changes in the carrying amount of intangible assets for the quarter ended October 31, 2010 is as follows:
 
Balance at July 31, 2010
  $ 15,874,281  
         
Purchases of customer relationships
    34,800,000  
Purchase of internally developed software
    16,400,000  
Purchase of non-competes
    1,200,000  
Intangible amortization
    (1,318,375 )
Foreign currency effect
    170,497  
Balance at October 31, 2010
  $ 67,126,403  

 
The changes in the carrying amount of goodwill for the quarter ended October 31, 2010 as follows:
 
Balance at July 31, 2010
  $ 34,454,935  
         
Goodwill purchased
    28,184,443  
Foreign currency effect
    137,397  
Balance at October 31, 2010
  $ 62,776,775  

 
8

 

4. NOTES PAYABLE
 
Long term debt and capital lease obligations at October 31, 2010 and July 31, 2010 are as follows:
 
   
October 31, 2010
   
July 31, 2010
 
             
Term Loan
  $ 110,000,000     $ 25,416,667  
Revolving Line of Credit
    12,000,000        
Capital Leases
    199,182        
Subtotal
    122,199,182       25,416,667  
Less current portion of capital leases
    91,261        
Less debt discount
    2,183,540       474,552  
Less current portion of long term debt
    27,810,599       15,257,852  
Long term debt
  $ 92,113,782     $ 9,684,263  

On October 21, 2010 we acquired the Xpedite Business for $105 million in cash.  We paid for the acquisition with $5 million of cash on hand and a new credit facility consisting of a $110 million term loan and a $20 million revolving loan, which also refinanced our existing credit facility indebtedness.  The 2010 Loans call for quarterly payments of $4,125,000 with interest and a final balloon payment in 2014, with interest, which commence on January 31, 2011.
 
The debt discount consists of bank fees associated with the closing of the 2010 loans totaling approximately $2.2 million.  The other expenses related to the 2010 acquisitions were expensed as incurred in accordance with ASC 805 Business Combinations and total approximately $1.6 million.
 
The Credit Agreement for the 2010 Loans contains usual and customary covenants for financings of this type, including, among other things: (i) requirements to deliver financial statements, other reports and notices; (ii) restrictions on additional indebtedness; (iii) restrictions on dividends, distributions and redemptions of equity and repayment of subordinated indebtedness; (iv) restrictions on liens; (v) restrictions on making certain payments; (vi) restrictions on investments; (vii) restrictions on asset dispositions and other fundamental changes; and (viii) restrictions on transactions with affiliates.  In addition, the Credit Agreement contains certain financial covenants, including, among other things: (i) a maximum leverage ratio; (ii) a minimum fixed charge coverage ratio; (iii) a minimum amount of consolidated adjusted EBITDA; (iv)a minimum amount of liquidity; and (v) a maximum amount of capital expenditures. Without the permission of the Lenders, our ability to complete material acquisitions will be restricted.  A default on any of these restrictions and covenants will cause, in certain circumstances, the amounts due under such agreements to become due and payable upon demand.

Borrowings under the Credit Agreement bear interest, at the Company’s election, at a rate tied to one of the following rates, in each case plus a specified margin: (i) the higher of (1) the Administrative Agent’s prime lending rate, (2) the U.S. Federal Funds Rate plus 0.5%, and (3) adjusted one-month LIBOR plus 1.0%; (ii) adjusted LIBOR for the interest period of such borrowing; and (iii) a LIBOR index rate. The interest margin for each such type of borrowing varies from 1.75% to 4.50%, depending on the Company’s consolidated leverage ratio at the time of such borrowing.

5. STOCKHOLDERS’ EQUITY

Dividends

The holders of the outstanding shares of our series C preferred stock are entitled to receive a 4% per share annual cumulative dividend payable in cash or shares of common stock at our option.  Dividends accrue and are cumulative on a daily basis, whether or not earned or declared.  The series C preferred stock has a par value of $0.01 and a liquidation value of $1,000 per share.

 
9

 

5. STOCKHOLDERS’ EQUITY (Continued)
 
As of October 31, 2010 and July 31, 2010, accrued dividends, for the series C preferred stock, of $166,575 and $116,164, respectively, were included in accrued expenses on our balance sheet. Total liquidation preferences of the series C preferred stock were $5,166,575 and $5,116,164 at October 31, 2010 and July 31, 2010, respectively.

6. FAIR VALUE REPORTING

GAAP clarifies that fair value is an exit price, representing the amount that would be received upon sale of an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, GAAP establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

Level 1 — Observable inputs such as quoted prices in active market;

Level 2 — Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and

Level 3 — Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis at October 31, 2010:

   
Quoted Prices in
Active Markets
for Identical
Assets
(Liabilities)
(Level 1)
   
 
Significant
Other
Observable
Inputs (Level 2)
   
 
 
Significant
Unobservable
Inputs (Level 3)
   
 
 
 
 
Carrying Amount
 
Cash
  $ 15,070,141                 $ 15,070,141  
Cash Equivalents
  $ 3,014,400                 $ 3,014,400  
Notes Payable
              $ (120,865,058 )   $ (120,015,642 )

The carrying amount of the notes payable contains a $2,183,540 discount. Management believes that the assets can be liquidated without restriction.

 
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7. COMMITMENTS AND CONTINGENCIES

Litigation

From time to time, we may be party to various legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business.  While the outcome of these matters cannot be predicted with certainty, we do not believe that the outcome of any of these claims or any of the legal matters mentioned elsewhere in this Quarterly Report will have a material adverse effect on our consolidated financial position, results of operations or cash flow.

In June 2008, j2 Global Communications, Inc. (“j2”) brought a patent infringement lawsuit against us, alleging that we infringe upon three of j2's patents, U.S. Patent Nos. 6,597,688, 7,020,132 and 6,208,638.  The case is pending  in the U.S. District Court for the Central District of California and is currently in the discovery phase. We have denied infringing any of the j2 patents and have filed a counterclaim seeking a declaratory judgment that the j2 patents are invalid. The case is scheduled for trial in July 2011.
  
In connection with the termination of an agreement to sell the portal operations of our discontinued India.com business, one of our subsidiaries is party to pending litigation (India.com v. Dalal). Judgment was entered against the subsidiary in the amount of $1,482,347.  We are pursuing an appeal in the U.S. Court of Appeals for the Second Circuit and expect a decision toward the end of 2010 or early 2011.  

As a result of a New York state sales tax audit completed in 2005 of EasyLink Services International, Inc., a dissolved subsidiary of EasyLink Services Corporation, EasyLink Services International, Inc. was assessed approximately $450,000 in tax, interest, and penalties on sales for the sales tax period beginning March 1, 2001 and ending May 31, 2004.  EasyLink Services International, Inc. appealed the assessment administratively to the New York Division of Tax Appeals, which resulted in an opinion in 2008 in favor of EasyLink Services International, Inc.  In late July 2009, after appeal by the New York Department of Taxation and Finance, the decision was reversed by the administrative New York Tax Appeals Tribunal and remanded back to the administrative law judge to determine allocation and penalty issues.  On remand, the Administrative Law Judge upheld Tax Department's position on the allocation issues but agreed with EasyLink on the penalty issues and cancelled all penalties.  The Administrative Law Judge's decision on remand is now being appealed back to the Tribunal.

The outcome of litigation cannot be assured, and despite management’s views of the merits of any litigation, or the reasonableness of our estimates and reserves, our cash balances could nonetheless be materially affected by an adverse judgment.  In accordance with ASC 450, Contingencies, we believe we have adequately reserved for the contingencies arising from the above legal matters where an outcome was deemed to be probable and the loss amount could be reasonably estimated.  As such, we do not believe that the anticipated outcome of the aforementioned proceedings will have a materially adverse impact on our financial condition, cash flows or results of operations.

 
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8. INTERIM SEGMENT DISCLOSURES

Our operations are divided into two business segments, which are defined as follows:

Supply Chain Messaging Segment (“Supply Chain”), which includes all our electronic data interchange (“EDI”) and telex services.

On Demand Messaging Segment (“On Demand”), which includes all fax, e-mail, document capture and management (“DCM”), workflow and Notify services

The table below summarizes information about operations for the fiscal quarters ended October 31, 2010 and 2009 which includes 10 days of operations of the recently acquired Xpedite Business:

   
Supply Chain
   
On Demand
   
Total
 
Quarter Ended October 31, 2010
                 
Revenue from external customers
  $ 9,781,393     $ 12,954,487     $ 22,735,880  
Segment gross profit
  $ 7,245,919     $ 8,898,683     $ 16,144,602  

The following is a reconciliation of operating segment income to net income for the quarter ended October 31, 2010:

Segment gross profit
  $ 16,144,602  
Corporate expenses
    14,082,526  
Operating income
    2,062,076  
Other income (expense), net
    (502,170 )
Income before income taxes
    1,559,906  
Income tax expense
    592,764  
Net income
  $ 967,142  


   
Supply Chain
   
On Demand
   
Total
 
Quarter Ended October 31, 2009
                 
Revenue from external customers
  $ 10,571,248     $ 9,926,893     $ 20,498,141  
Segment gross profit
  $ 7,776,926     $ 6,634,350     $ 14,411,276  

The following is a reconciliation of operating segment income to net income for the quarter ended October 31, 2009:

Segment gross profit
  $   14,411,276  
Corporate expenses
    12,350,890  
Operating income
    2,060,386  
Other income (expense), net
    (152,540 )
Income before income taxes
    1,907,846  
Income tax expense
    543,860  
Net income
  $ 1,363,986  
 
 
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Statement Disclaimer

All statements other than statements of historical facts included in this Quarterly Report regarding our financial position, business strategy and plans and objectives of management for future operations are forward-looking statements. These forward-looking statements are based on the beliefs of management, as well as assumptions made by and information currently available to management. When used in this quarterly report, the words “anticipate,” “believe,” “estimate,” “expect,” “may,” “will,” “hope,” “continue” and “intend,” and words or phrases of similar import, as they relate to our financial position, business strategy and plans, or objectives of management, are intended to identify forward-looking statements. These statements reflect our current view with respect to future events and are subject to risks, uncertainties and assumptions related to various factors, including, without limitation, those described in Item 1A of Part II of this Quarterly Report under the heading “Risk Factors” and in our registration statements and periodic reports filed with the SEC under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Securities Act of 1933, as amended (the “Securities Act”).

Although we believe that our expectations are reasonable, we cannot assure you that our expectations will prove to be correct. Should any one or more of these risks or uncertainties materialize, or should any underlying assumptions prove incorrect, actual results may vary materially from those described in this Quarterly Report as anticipated, believed, estimated, expected, hoped or intended.

Business Overview

We are a global provider of value added services that facilitate the electronic exchange of documents and information between enterprises, their trading communities and their customers. We deliver most of our services through a global IP network, which hosts our applications on enterprise-class platforms that are comprised of server and network operations centers located worldwide.

Our core services include EDI services, fax services, telex services and other services that are integral to the movement of money, materials, products, people and information in the global economy including documents such as insurance claims, trade and travel confirmations, purchase orders, invoices, shipping notices and funds transfers that help our customers to be more efficient and mobile. Our operations include two business segments defined as follows:

 
·
Supply Chain segment, which includes all our EDI and telex services.

 
·
On Demand segment, which includes all fax, e-mail, DCM, workflow and Notify (which includes the acquired Xpedite Business) services.

Global macro economic trends are important barometers for our business. Changes in the level of economic activity are reflected directly in the volumes of our services used by our customers in both segments of our business. As the United States and global economies have experienced recession, we have seen a decrease in the volume of demand for our services from existing customers, as well as increasing pricing pressure and customer bankruptcies and reorganizations. However, extended economic slowdowns can possibly improve customer acquisition opportunities as larger companies look to outsource business functions in our service segments to reduce internal costs. We expect volume trends to reverse when and as the United States and global economies move into a more robust recovery and current unemployment levels begin to decline. Our management has taken steps to adjust our cost structure to reflect the decrease in demand for our services, which steps have positively impacted our profitability.  However, there can be no assurance that we can achieve further offsetting cost reductions if revenue was to drop significantly.

 
13

 
On October 21, 2010, we acquired the iSend and iNotify advanced messaging businesses (the “Xpedite Business”) from Premiere Global Services, Inc. (“PGI”) for $105 million in cash, through the purchase of PGI’s wholly-owned subsidiaries Xpedite Systems, LLC and Premiere Global Services (UK) Limited and certain related assets owned by PGI’s subsidiary Premiere Conferencing (Canada) Limited.  We paid for the acquisition with $5 million of cash on hand and a new credit facility consisting of a $110 million term loan and a $20 million revolving loan, which also refinanced our existing credit facility indebtedness.  The operating results of the Xpedite Business are included in the financial results for our first fiscal quarter only from the date of acquisition.  The Xpedite Business is expected to significantly increase our revenue in our On Demand segment, with related impacts on the cost of revenue and other items in our results of operations, compared to prior periods.  The integration of the Xpedite Business and the servicing of the acquisition debt will be important drivers of our financial results in future reporting periods.

Approximately 25% of our quarterly revenue in the current quarter came from international operations, and this ratio will increase in future periods due to the acquisition of the Xpedite Business and the inclusion of its operations for full reporting periods.  Accordingly, our revenue can vary based on the performance of non-US economies and on the prevailing exchange rates of the relevant currencies (principally, the Euro, the British pound, and the Japanese yen) compared to the US dollar.

We have grown our business significantly through acquisitions in recent years. We continue to seek to reap the benefits of those acquisitions through the integration and consolidation of operations and the cross-selling of services across the combined customer base. The current economic climate may provide additional opportunities for consolidative or synergistic acquisitions.

Critical Accounting Policies and Significant Use of Estimates in Financial Statements

The discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenue and expenses. We consider certain accounting policies related to revenue recognition, valuation of acquired intangibles and impairment of long-lived assets, including goodwill to be critical policies due to the estimation process involved in each. Management discusses its estimates and judgments with the Audit Committee of our Board of Directors.

We discuss our critical accounting policies in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, in our Annual Report on Form 10-K for the year ended July 31, 2010. There have been no significant changes in our critical accounting policies since July 31, 2010.

 
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Three Months Ended October 31, 2010 Compared with the Three Months Ended October 31, 2009
Results of Operations

The following table reflects consolidated operating data by reported segment including 10 days of revenue and expense contributed by the Xpedite Business which was acquired on October 21, 2010.  All significant intersegment activity has been eliminated. Accordingly, the segment results below exclude the effect of transactions with our subsidiaries.  The Xpedite Business provided approximately $474,000 in net income for the On Demand business segment, which consisted of approximately $2.8 million in gross revenue and $2.4 million in expenses.

   
Three Months Ended October 31,
 
   
2010
   
2009
   
Variance
 
Revenue:
                 
Supply Chain Messaging
                 
EDI Services
  $ 8,084,158     $ 8,434,060     $ (349,902 )
Telex Services
    1,697,235       2,137,188       (439,953 )
Total Supply Chain Messaging
    9,781,393       10,571,248       (789,855 )
                         
On Demand Messaging
                       
Fax Services
    11,188.323       8,087,207       3,101,116  
DCM Services
    497,408       515,231       (17,823 )
Other Services
    1,268,756       1,324,455       (55,699 )
Total On Demand Messaging
    12,954,487       9,926,893       3,027,594  
                         
Total Revenue:
    22,735,880       20,498,141       2,237,739  
                         
Cost of Revenue:
                       
Supply Chain Messaging
    2,535,474       2,794,322       (258,848 )
On Demand Messaging
    4,055,804       3,292,543       763,261  
Total Cost of Revenue
    6,591,278       6,086,865       504,413  
                         
Gross Margin:
                       
Supply Chain Messaging
    7,245,919       7,776,926       (531,007 )
On Demand Messaging
    8,898,683       6,634,350       2,264,333  
Total Gross Margin
    16,144,602       14,411,276       1,733,326  
                         
Product Development and Enhancement
    1,938,151       1,858,874       79,277  
Selling and Marketing
    2,957,710       3,269,434       (311,724 )
General and Administrative
    9,186,665       7,222,582       1,964,083  
Total product, selling and G&A expenses
    14,082,526       12,350,890       1,731,636  
                         
Other (expense) income
    (502,170 )     (152,540 )     (349,630 )
Income  before income taxes
  $ 1,559,906     $ 1,907,846     $ (347,940 )

 
15

 

Revenue — Total revenue for the three months ended October 31, 2010 was approximately $22.7 million, an increase of approximately $2.2 million or 10.9%, as compared to the three-month period ended October 31, 2009. This increase in revenue is primarily due to the acquisition of the Xpedite Business on October 21, 2010.

The Supply Chain Messaging segment decreased approximately $790,000, or 7.5%, from the three-month period ended October 31, 2009, as compared to the three-month period ended  October 31, 2010, due to a decrease of approximately $350,000 (a 4.1% decrease)  in EDI services due to lower customer volumes in the current economic environment and a decrease of approximately $440,000 (a 20.6% decrease) in Telex services due to decreased customer volumes resulting from a switch to technologies with enhanced features.

The On Demand Messaging segment increased approximately $3.0 million, or 30.4%, from the three-month period ended October 31, 2009, as compared to the three-month period ended  October 31, 2010, due to an increase of approximately $3.1 million (a 38.3% increase) for fax services.  The fax revenue related to the acquisition of the Xpedite Business was approximately $2.9 million.  The increase in revenue was partially offset by decreases of approximately $18,000 (a 3.5% decrease) for DCM services and approximately $55,000 (a 4.2% decrease) in other revenue.

Cost of Revenue — Total cost of revenue increased approximately $504,000, or 8.2%, from the three-month period ended October 31, 2009, as compared to the three-month period ended October 31, 2010.  The Xpedite Business contributed approximately $1.1 million, or 21.0%, to the cost of revenue and building related expenses increased approximately $109,000 (a 47.3% increase) due to additional co-location facility expenses.  These increases were partially offset by reductions in labor and related expenses of approximately $95,000 (a 6.3% decrease) including approximately $541,000 (an 18.7% decrease) in telecom related expenses, and approximately $117,000 in reduced equipment expense (a 13.0 % decrease).  The decreases were related to cost cutting efforts by management and reduced telecom expenses due to decreased customer traffic.

Gross Profit and Gross Margin — Gross profit increased approximately $1.7 million, or 12.0%, from the three-month period ended October 31, 2009, as compared to the three-month period ended October 31, 2010.  The gross margin for the legacy business was relatively flat for the period due to reduced expenses which offset the reduced revenues.  The Xpedite Business contributed a gross margin of approximately $1.7 million.

Product Development — Product development costs increased approximately $79,000, or 4.3%, from the three-month period ended October 31, 2009, as compared to the three-month period ended October 31, 2010.  The Xpedite Business contributed approximately $204,000, or 10.5%, to the product development expense and other expenses increased by approximately $17,000 (an 87.1% increase).  These increases were partially offset by a reduction in labor and related expenses of $119,000 (a 6.6% decrease) and approximately $24,000 in reduced equipment expense (a 56.2% decrease) due to decreased maintenance expenses.

Selling and Marketing — Selling and marketing expenses decreased approximately $312,000, or 9.5%, from the three-month period ended October 31, 2009, as compared to the three-month period ended  October 31, 2010. These decreased costs consisted mainly of a reduction in labor and related expenses of $441,000 (a 19.7% decrease), a decrease in outside professional services of approximately $258,000 (a 42.6% decrease), a decrease of approximately $25,000 (a 10.4% decrease) in travel related costs, and a decrease of approximately $24,000 (a 26.7% decrease) in marketing expenses, and a decrease of approximately $16,000 (a 28.4% decrease) in building related expenses.  The reductions were partially offset by the Xpedite Business which contributed approximately $457,000, or 15.4%, of expense.  The reductions are due to head count cost saving measures implemented by management and reduced commissions paid for inside and outside sales.

General and Administrative— General and administrative expenses increased approximately $2.0 million, or 27.5%, from the three-month period ended October 31, 2009, as compared to the three-month period ended  October 31, 2010. The increase in expenses was attributed to an approximate $1.6 million charge for professional fees related to the Xpedite Business and approximately $309,000 (an 11.9% increase) in labor and related expenses.  In addition, the Xpedite Business contributed approximately $600,000 in expense for the period.  These increases were partially offset by a decrease of approximately $197,000 (an 11.9% decrease) in equipment expense for reduced hardware and software maintenance, a decrease of approximately $173,000 (an 18.9% decrease) in building related expenses for rent, and a decrease of approximately $129,000 (a 9.3% decrease) in outside professional fees.

 
16

 

Operating Income — Operating income was essentially flat from the three-month period ended October 31, 2009, as compared to the three-month period ended October 31, 2010  The $1.9 million of acquisition related expenses were partially offset by reduced operating expenses and the approximate $494,000 in operating income contributed by the Xpedite business for the 10 day period.

Other Income (Expense) — Other expenses for the three-month period ended October 31, 2010 consist mainly of net interest expense of approximately $810,000 which included approximately $314,000 in net cash interest expense and approximately $496,000 in non-cash interest expense which mainly consisted of the accelerated amortization of the discount on our previous credit facility that refinanced in connection with the 2010 Loan used to purchase the Xpedite business. These expenses were partially offset by $186,000 in foreign exchange gains and $122,000 in other income.

Net income — Net income decreased approximately $397,000, or 29.1%, from the three-month period ended October 31, 2009, as compared to the three-month period ended October 31, 2010, due primarily to the increase in net interest expense.

Liquidity and Capital Resources

Our principal source of liquidity consists of cash generated from operations. As the majority of our revenue is reoccurring under contract, it is primarily affected by the volumes incurred by the customer using the underlying messaging service. Operating expenses are primarily driven by labor and telecom costs which are directly tied to customer utilization of messaging services. Cash and cash equivalents decreased approximately $2.4 million to a total balance of approximately $18.1 million as of October 2010 from approximately $20.5 million as of July 31, 2010. This decrease in cash was primarily caused by approximately $2.2 million in net cash used for the bank fees related to the purchase of the Xpedite Business.

Our liquidity will be affected by the new credit facility consisting of a $110 million term loan and a $20 million revolving loan (of which $12 million is outstanding) (the “2010 Loans”), which refinanced our existing credit facility.  The 2010 Loans call for quarterly payments of $4,125,000 with interest and a final balloon payment in 2014, with interest, which commence on January 31, 2011.
 
The Credit Agreement for the 2010 Loans contains usual and customary covenants for financings of this type, including, among other things: (i) requirements to deliver financial statements, other reports and notices; (ii) restrictions on additional indebtedness; (iii) restrictions on dividends, distributions and redemptions of equity and repayment of subordinated indebtedness; (iv) restrictions on liens; (v) restrictions on making certain payments; (vi) restrictions on investments; (vii) restrictions on asset dispositions and other fundamental changes; and (viii) restrictions on transactions with affiliates.In addition, the Credit Agreement contains certain financial covenants, including, among other things: (i) a maximum leverage ratio; (ii) a minimum fixed charge coverage ratio; (iii) a minimum amount of consolidated adjusted EBITDA; (iv) a minimum amount of liquidity; and (v) a maximum amount of capital expenditures. Without the permission of the Lenders, our ability to complete material acquisitions will be restricted.  A default on any of these restrictions and covenants will cause, in certain circumstances, the amounts due under such agreements to become due and payable upon demand.

Borrowings under the Credit Agreement bear interest, at the Company’s election, at a rate tied to one of the following rates, in each case plus a specified margin: (i) the higher of (1) the Administrative Agent’s prime lending rate, (2) the U.S. Federal Funds Rate plus 0.5%, and (3) adjusted one-month LIBOR plus 1.0%; (ii) adjusted LIBOR for the interest period of such borrowing; and (iii) a LIBOR index rate. The interest margin for each such type of borrowing varies from 1.75% to 4.50%, depending on the Company’s consolidated leverage ratio at the time of such borrowing.

An adjustment to the purchase price of the Xpedite Business will be made during the second quarter of 2011 based on the working capital of the acquired entity at the acquisition date as defined in the Security and Asset Purchase Agreement dated October 21, 2010 entered into in connection with the acquisition of the Xpedite Business.  If the working capital is less than $6.4 million, PGI will pay for the shortfall.  If the working capital is greater than $6.4 million we will be required to pay the surplus to PGI up to$2.0 million.  Upon the review of the quarterly numbers management believes that we will owe PGI the $2.0 million for the working capital.
 
 
17

 

The accounts receivable increased approximately $19.4 million in the first quarter due primarily to the acquisition of the Xpedite Business which has a balance of approximately $19.3 million as of October 31, 2010.  Management believes that existing cash and cash equivalent balances and cash provided from operations will provide sufficient liquidity to meet the operating and capital expenditure needs for existing operations during the next twelve months.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable to smaller reporting companies.

Item 4T. Controls and Procedures

Disclosure Controls and Procedures

Our management has established and maintained disclosure controls and procedures as defined in Exchange Act Rules  13a-15(e) and 15d-15(e) that are designed to provide reasonable assurance that information required to be disclosed in the reports that are filed or submitted under the Exchange Act is recorded, processed, summarized, reported and is accumulated and communicated to the Chief Executive Officer and Chief Financial Officer, as appropriate, by others within the entity to allow timely decisions regarding required disclosure.  Our management, including the Chief Executive Officer and Chief Financial Officer has evaluated the effectiveness of the disclosure controls and procedures and, based on this evaluation, have concluded that disclosure controls and procedures were effective at a reasonable assurance level as of the end of the period covered by the report.  We continually reviews the respective disclosure controls and procedures and make changes, as necessary, to ensure the quality of our financial reporting.

Internal Controls over Financial Reporting

On October 21, 2010, we acquired the Xpedite Business from Premiere Global Services, Inc.  Our management is in the process of integrating financial accounts of the Xpedite Business into our current financial accounting system.  Our management expects to complete the integration by the end of the second quarter of fiscal year 2011.  This initiative is substantial in scale, and will result in significant changes to our internal control over financial reporting once completed (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that will materially affect, or are reasonably likely to materially affect, its internal control over financial reporting.

There have been no changes in internal control over financial reporting that occurred during the first quarter of fiscal year 2011 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.

 
18

 

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, we may be party to various legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business.  While the outcome of these matters cannot be predicted with certainty, we do not believe that the outcome of any of these claims or any of the legal matters mentioned elsewhere in this Quarterly Report will have a material adverse effect on our consolidated financial position, results of operations or cash flow.

In June 2008, j2 Global Communications, Inc. (“j2”) brought a patent infringement lawsuit against us, alleging that we infringe upon three of j2's patents, U.S. Patent Nos. 6,597,688, 7,020,132 and 6,208,638.  The case is pending in the U.S. District Court for the Central District of California and is currently in the discovery phase. We have denied infringing any of the j2 patents and have filed a counterclaim seeking a declaratory judgment that the j2 patents are invalid. The case is scheduled for trial in July 2011.
  
In connection with the termination of an agreement to sell the portal operations of our discontinued India.com business, one of our subsidiaries is party to pending litigation (India.com v. Dalal). Judgment was entered against the subsidiary in the amount of $1,482,347.  We are pursuing an appeal in the U.S. Court of Appeals for the Second Circuit and expect a decision toward the end of 2010 or early 2011. 

As a result of a New York state sales tax audit completed in 2005 of EasyLink Services International, Inc., a dissolved subsidiary of EasyLink Services Corporation, EasyLink Services International, Inc. was assessed approximately $450,000 in tax, interest, and penalties on sales for the sales tax period beginning March 1, 2001 and ending May 31, 2004.  EasyLink Services International, Inc. appealed the assessment administratively to the New York Division of Tax Appeals, which resulted in an opinion in 2008 in favor of EasyLink Services International, Inc.  In late July 2009, after appeal by the New York Department of Taxation and Finance, the decision was reversed by the administrative New York Tax Appeals Tribunal and remanded back to the administrative law judge to determine allocation and penalty issues.  On remand, the Administrative Law Judge upheld Tax Department's position on the allocation issues but agreed with EasyLink on the penalty issues and cancelled all penalties.  The Administrative Law Judge's decision on remand is now being appealed back to the Tribunal.

The outcome of litigation cannot be assured, and despite management’s views of the merits of any litigation, or the reasonableness of our estimates and reserves, our cash balances could nonetheless be materially affected by an adverse judgment.  In accordance with ASC 450, Contingencies, we believe we have adequately reserved for the contingencies arising from the above legal matters where an outcome was deemed to be probable and the loss amount could be reasonably estimated.  As such, we do not believe that the anticipated outcome of the aforementioned proceedings will have a materially adverse impact on our financial condition, cash flows or results of operations.

Item 1A. Risk Factors
 
The following Risk Factor disclosure updates the risk factors as disclosed in our 2010 Annual Report on Form 10-K previously filed with the SEC.

Acquisitions are central to our growth plan.  If we cannot find, finance and integrate accretive acquisitions, our financial results may suffer.

Our ability to implement our business plan depends on identifying appropriate acquisitions, negotiating accretive financial terms, obtaining additional financing at affordable costs and successfully integrating the acquired businesses.  The shortage of available credit at reasonable costs in fiscal 2009 prevented us from closing a significant transaction and the shortage of available credit at reasonable costs in fiscal 2010 slowed our ability to identify financeable transactions.  If our acquisition efforts are not successful, our business and financial results may suffer.  If we are successful in our acquisition efforts, we expect that we will need to continue to manage and to expand multiple relationships with customers, Internet service providers and other third parties.  We also expect that we will need to continue to improve our financial systems, procedures and controls and will need to expand, train and manage our workforce, particularly our information technology and sales and marketing staffs.  Our acquisition of the Xpedite Business presents all of these challenges, and any failure to meet them may have a material adverse effect on our financial condition, results of operations or cash flow.

 
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For additional risk factors see those disclosed in our Annual Report on Form 10-K for the year ended July 31, 2010 previously filed with the SEC.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. [Removed and Reserved]
 
Item 5. Other Information

None.

 
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Item 6. Exhibits

Exhibit
Number
 
Description
31.1
 
Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
31.2
 
Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
32.1
 
Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
32.2
  
Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 
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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: December 15, 2010

 
EASYLINK SERVICES INTERNATIONAL
 
CORPORATION
     
 
By:
/s/ Glen E. Shipley
 
   
Glen E. Shipley
   
Chief Financial Officer
 
 
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EXHIBIT INDEX

Exhibit
Number
 
Description
31.1
 
Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
31.2
 
Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
32.1
 
Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
32.2
  
Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 
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