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, 2001
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.)
399 Thornall Street, Edison, NJ 08837
(Address of Principal Executive Office) (Zip Code)
(732) 906-2000
(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 |_|
Common stock outstanding at July 31, 2001: Class A common stock $0.01 par value
80,769,053 shares, and Class B common stock $0.01 par value 10,000,000 shares.
EASYLINK SERVICES CORPORATION
JUNE 30, 2001
FORM 10-Q
INDEX
Page
Number
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PART I: FINANCIAL INFORMATION
Item 1: Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets as of June 30,
2001 (unaudited) and December 31, 2000.............................................................. 2
Unaudited Condensed Consolidated Statements of Operations for the
three months ended June 30, 2001 and 2000........................................................... 3
Unaudited Condensed Consolidated Statements of Operations for the
six months ended June 30, 2001 and 2000............................................................. 4
Unaudited Condensed Consolidated Statements of Cash Flows for the
six months ended June 30, 2001 and 2000............................................................. 5
Notes to Unaudited Interim Condensed Consolidated Financial Statements.............................. 7
Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations............... 23
Item 3: Qualitative and Quantitative Disclosure about Market Risk........................................... 34
PART II: OTHER INFORMATION
Item 1: Legal Proceedings................................................................................. 45
Item 2: Changes in Securities and Use of Proceeds........................................................... 45
Item 4: Submission of Matters to a Vote of Security Holders................................................. 46
Item 6: Exhibits and Reports on Form 8-K.................................................................... 46
Item 7: Signatures.......................................................................................... 47
EASYLINK SERVICES CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
June 30, December 31,
2001 2000
---- ----
(unaudited) NOTE 1(B)
ASSETS
Current assets:
Cash and cash equivalents............................................................. $11,951 $7,409
Marketable securities................................................................. 20 22,202
Accounts receivable, net of allowances of $10,293 and $887 at June 30, 2001 and
December 31, 2000, respectively.................................................. 24,368 13,727
Prepaid expenses and other current assets............................................. 4,067 2,783
----- -----
Total current assets...................................................... 40,406 46,121
Property and equipment, net........................................................... 29,045 50,916
Domain assets available for sale...................................................... 592 6,975
Partner advances, net................................................................. -- 3,841
Investments........................................................................... 4,119 14,851
Goodwill and other intangible assets, net............................................. 191,120 200,994
Restricted investment................................................................. 628 1,710
Debt issuance costs, net.............................................................. 596 3,089
Other................................................................................. 1,441 1,764
----- -----
Total assets.............................................................. $267,947 $330,261
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payables..................................................................... $21,334 $15,465
Accrued expenses...................................................................... 40,943 25,888
Restructuring reserve................................................................. 1,793 4,048
Current portion of capital lease obligations.......................................... 20,676 11,443
Current portion of domain asset purchase obligations.................................. 39 39
Current portion of notes payable...................................................... 17,695 1,861
Deferred revenue...................................................................... 819 1,925
Other current liabilities............................................................. 1,441 1,142
----- -----
Total current liabilities............................................ 104,740 61,811
Capital lease obligations, less current portion....................................... 171 14,319
Domain asset purchase obligations, less current portion............................... 85 85
Deferred revenue, less current portion................................................ 155 775
Notes payable, less current portion................................................... 95,794 100,321
------ -------
Total liabilities.................................................... 200,945 177,311
Minority interest..................................................................... 14,358 14,204
Commitments and contingencies
Stockholders' equity:
Common stock, $0.01 par value; 160,000,000 shares authorized:
Class A--150,000,000 shares authorized; 79,688,252 and
51,789,201 shares issued and outstanding at June 30, 2001
and December 31, 2000, respectively....................................... 797 518
Class B--10,000,000 shares authorized, issued and outstanding
at June 30, 2001 and December 31, 2000 with an aggregate liquidation
preference of $1,000...................................................... 100 100
Additional paid-in capital............................................................ 487,242 445,675
Subscriptions receivable.............................................................. -- (33)
Deferred compensation................................................................. (297) (214)
Accumulated other comprehensive loss.................................................. (357) (137)
Accumulated deficit................................................................... (434,841) (307,163)
--------- ---------
Total stockholders' equity........................................... 52,644 138,746
------ -------
Total liabilities and stockholders' equity........................... $267,947 $330,261
======== ========
See accompanying notes to unaudited condensed consolidated financial statements.
2
EASYLINK SERVICES CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
Three Months Ended June 30,
---------------------------
2001 2000
---- ----
Revenues
Messaging.............................................. $33,858 $13,592
Domain development (WORLD.com)......................... 2,169 1,431
----- -----
Total revenues................................ 36,027 15,023
Operating expenses:
Cost of revenues
Messaging.............................................. $22,122 $12,435
Domain development (WORLD.com)......................... 2,156 1,460
----- -----
Total cost of revenues........................ 24,278 13,895
------ ------
Sales and marketing.................................... 8,158 16,864
General and administrative............................. 13,611 9,724
Product development.................................... 2,786 5,540
Amortization of goodwill and other intangible assets 13,033 16,733
Impairment of intangibles and other assets............. 6,676 --
Restructuring charges.................................. 17,594 --
Loss on sale of business............................... 264 --
------ ------
Total operating expenses...................... 86,400 62,756
------ ------
Loss from operations................. (50,373) (47,733)
------- -------
Other income (expense):
Interest income........................................ 142 1,542
Interest expense....................................... (2,459) (2,302)
Impairment of investments.............................. (7,463) --
Other, net............................................. 122 --
------ ------
Total other (expense) income, net............. (9,658) (760)
------ ----
Loss before minority interest and extraordinary gain (60,031) (48,493)
------- -------
Minority interest...................................... (154) 596
---- ---
Loss before extraordinary gain......................... (60,185) (47,897)
------- -------
Extraordinary gain on conversion of convertible notes 1,079 --
----- --
Net loss............................................... $(59,106) $(47,897)
======== ========
Net loss per share - basic and diluted:
Loss before extraordinary gain......................... $(0.68) $(0.84)
Extraordinary gain..................................... 0.01 --
---- --
Net loss .............................................. $(0.67) $(0.84)
====== ======
Weighted-average basic and diluted shares outstanding 87,929,337 57,361,379
========== ==========
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)
Six Months Ended June 30,
-------------------------
2001 2000
---- ----
Revenues
Messaging.............................................. $53,580 $23,543
Domain development (WORLD.com)......................... 4,793 1,431
------- -------
Total revenues................................ 58,373 24,974
------ ------
Operating expenses:
Cost of revenues
Messaging.............................................. $40,256 $22,278
Domain development (WORLD.com)......................... 5,060 1,478
----- -----
Total cost of revenues........................ 45,316 23,756
------ ------
Sales and marketing.................................... 20,543 31,832
General and administrative............................. 25,453 18,396
Product development.................................... 6,248 9,131
Amortization of goodwill and other intangible assets 28,836 24,567
Write-off of acquired in-process technology............ -- 7,650
Impairment of intangible and other assets.............. 10,243 --
Restructuring charges.................................. 72,013 --
Loss on sales of businesses............................ 2,591 --
----- --
Total operating expenses...................... 211,243 115,332
------- ----
Loss from operations................. (152,870) (90,358)
--------- --------
Other income (expense):
Interest income........................................ 486 3,366
Interest expense....................................... (5,631) (4,109)
Impairment of investments.............................. (10,131) --
Other, net............................................. 196 --
------ ------
Total other (expense) income, net............. (15,080) (743)
-------
Loss before minority interest and extraordinary gain (167,950) (91,101)
-------- -------
Minority interest...................................... (154) 660
---- ---
Loss before extraordinary gain......................... (168,104) (90,441)
-------- -------
Extraordinary gain on conversion of convertible notes 40,428 --
------ ------
Net loss............................................... $(127,676) $(90,441)
========= ========
Net loss per share - basic and diluted:
Loss before extraordinary gain......................... $(2.12) $(1.70)
Extraordinary gain..................................... 0.51 --
------ ------
Net loss............................................... $(1.61) $(1.70)
====== ======
Weighted-average basic and diluted shares outstanding 79,276,924 53,352,500
========== ==========
See accompanying notes to unaudited condensed consolidated financial statements.
4
EASYLINK SERVICES CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
Six Months Ended June 30,
-------------------------
2001 2000
---- ----
Cash flows from operating activities:
Net loss........................................................................ $(127,676) $(90,441)
Adjustments to reconcile net loss to net cash used in operating activities:
Non-cash charges related to partner agreements....................... 2,304 8,260
Depreciation and amortization........................................ 13,488 6,786
Amortization of goodwill and other intangible assets................. 28,836 24,567
Amortization of domain assets........................................ 661 924
Amortization of deferred compensation................................ 213 240
Provision for restructuring and impairments.......................... 87,981 --
Provision for doubtful accounts...................................... 2,421 255
Amortization of debt issuance costs.................................. 292 309
Write-off of acquired in-process technology.......................... -- 7,650
Non-cash advertising................................................. -- (125)
Issuance of common stock in lieu of compensation..................... -- 1,800
Loss on the sale of businesses....................................... 2,591 --
Non-cash interest.................................................... 206 --
Extraordinary gain on conversion of convertible notes................ (40,428) --
Minority interest.................................................... 154 (660)
Changes in operating assets and liabilities, net of effect of acquisitions and
dispositions:
Accounts receivable.................................................. 7,860 (3,676)
Proceeds from sales of marketable securities......................... 22,120 17,916
Purchases of marketable securities................................... -- (48,191)
Prepaid expenses and other current assets............................ 2,807 (444)
Other assets......................................................... 258 (887)
Accounts payable, accrued expenses and other current liabilities..... 4,034 4,524
Deferred revenue..................................................... (743) 628
----- -------
Net cash provided by (used) in operating activities............. 7,379 (70,565)
----- -------
Cash flows from investing activities:
Purchases of domain assets...................................................... -- (28)
Notes receivable................................................................ -- (2,000)
Proceeds from sale leaseback.................................................... -- 631
Purchases of restricted investments............................................. (4) (54)
Purchases of intangible assets.................................................. (964) (1,433)
Purchase of investments......................................................... -- (3,000)
Purchases of property and equipment............................................. (1,387) (4,638)
Payments to employees of an acquired company.................................... -- 200
Proceeds from sale of businesses................................................ 4,641 --
Cash (paid for)/received from acquisitions, net................................. (15,876) 1,906
------- ----
Net cash used in investing activities........................... (13,590) (8,416)
------- ------
Cash flows from financing activities:
Proceeds from issuance of Class A common stock.................................. 3,000 --
Proceeds from issuance of Class A common stock in connection with the
exercise and purchase of warrants and options........................ 10 1,783
Issuance of shares for employee 401(k) plan..................................... 243 241
Proceeds from issuance of senior convertible notes, net......................... 14,110 --
Proceeds from issuance of convertible notes, net................................ -- 96,050
Payments under capital lease obligations........................................ (4,585) (2,959)
Principal payments of notes payable............................................. (1,867) (4,230)
Proceeds from sale of subsidiary interest....................................... -- 2,000
Payments under domain asset purchase obligations................................ -- (276)
------ ------
Net cash provided by financing activities....................... 10,911 92,609
------ ------
Effect of foreign exchange rate changes on cash and cash equivalents............ (158) --
Net increase in cash and cash equivalents....................................... 4,542 13,628
Cash and cash equivalents at beginning of the period............................ 7,409 36,870
----- ------
Cash and cash equivalents at the end of the period.............................. $11,951 $50,498
======= =======
5
Supplemental disclosure of non-cash information:
During the six months ended June 30, 2001 and 2000, the Company paid
approximately $5.8 million and $1.1 million, respectively, for
interest. Through the issuance of Class A common stock, the Company
paid approximately $237,000 in interest for the six months ended June
30, 2001.
During the six months ended June 30, 2001, the Company issued 614,749
shares of Class A common stock valued at approximately $655,000 to
certain former employees of Asia.com and India.com as severance
payments.
During the six months ended June 30, 2000, the Company issued 104,347
shares of Class A common stock valued at approximately $1.8 million
to an employee in lieu of compensation.
During the six months ended June 30, 2001, the Company issued 604,230
shares of Class A common stock valued at approximately $381,000 in
settlement of a vendor obligation.
During the six months ended June 30, 2001, the Company issued 317,460
shares of Class A common stock valued at approximately $200,000 as
payment related to the sale of its advertising network.
During the six months ended June 30, 2001, the Company issued
1,620,833 shares of Class A common stock valued at approximately $1.3
million as payment for a contingent settlement obligation.
During the six months ended June 30, 2001, the Company issued 275,000
shares of Class A common stock valued at $189,000 for a settlement
obligation associated with the sale of a business.
Non-cash investing activities:
During the six months ended June 30, 2001 and 2000, the Company
issued 222,222 and 1,158,747 shares of its Class A common stock,
respectively, in connection with certain investments. These
transactions resulted in non-cash investing activities of $285,000
and $10.1 million, respectively (see Note 3).
During the six months ended June 30, 2001 and 2000, the Company
issued 18,962,176 shares and 11,869,575 shares of its Class A common
stock in connection with certain acquisitions. These transactions
resulted in non-cash investing activities of $31.1 million and $214.4
million, respectively (see Note 2)
Non-cash financing activities:
The Company entered into various capital leases for computer
equipment. These capital lease obligations resulted in non-cash
financing activities aggregating $10.4 million for the six months
ended June 30, 2000.
See accompanying notes to unaudited condensed consolidated financial statements.
6
EASYLINK SERVICES CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
(A) Summary of Operations
On April 2, 2001, the Company changed its name to EasyLink Services Corporation.
The name change was made to help create a corporate identity tied to the
Company's focus on outsourced messaging services.
EasyLink Services Corporation, ("EasyLink" or the "Company"), formerly Mail.com,
Inc., is a global provider of outsourced messaging services to enterprises and
service providers. Upon the completion of the Company's acquisition of Swift
Telecommunications, Inc. ("Swift Telecommunications") on February 23, 2001, the
Company combined the businesses of Mail.com Business Messaging Services, Swift
Telecommunications and the Easylink Services business acquired from AT&T Corp.
by Swift Telecommunications. As a result of this combination, Easylink Services
Corporation offers a range of messaging services to businesses and service
providers, including managed e-mail and groupware hosting services; services
that help protect corporate e-mail systems such as virus protection, spam
control and content filtering services; message delivery services such as
electronic data interchange or "EDI," telex, desktop fax, broadcast and
production messaging services; and professional messaging services and support.
Until March 30, 2001, the Company also operated an advertising network business.
On October 26, 2000, the Company announced its intention to sell this business
in order to focus exclusively on the Company's established outsourced messaging
business. On March 30, 2001, the Company completed the sale of the advertising
network business to Net2Phone, Inc. Included in the sale were the Company's
rights to provide e-mail-based advertising and permission marketing solutions to
advertisers, as well as the Company's rights to provide e-mail services directly
to consumers at the www.mail.com Web site and in partnership with other Web
sites. (See note 2).
In March 2000, the Company formed WORLD.com, Inc. in order to develop the
Company's portfolio of domain names into independent Web properties, and
subsequently acquired or formed its subsidiaries Asia.com, Inc. and India.com,
Inc. in which WORLD.com is the majority owner. In November 2000, the Company
announced its intention to sell all assets not related to its core outsourced
messaging business, including Asia.com, Inc., India.com, Inc. and its portfolio
of domain names. On May 3, 2001, the Company's majority owned subsidiary
Asia.com, Inc. sold its business to an investor group. (See note 2).
(B) Unaudited Interim Condensed Consolidated Financial Information
The accompanying interim condensed consolidated financial statements as of June
30, 2001 and for the three and six month periods ended June 30, 2001 and 2000
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, 2001 and the consolidated results of operations
and cash flows for the interim periods ended June 30, 2001 and 2000. 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, 2000 has been
derived from audited consolidated financial statements at that date.
Certain information and note disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to the Securities and Exchange
Commission's rules and regulations. It is suggested that these unaudited interim
condensed consolidated financial statements be read in conjunction with the
Company's audited consolidated financial statements and notes thereto for the
year ended December 31, 2000 as included in the Company's Form 10-K filed with
the Securities and Exchange Commission on April 2, 2001.
(C) 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 collectiblility of accounts receivable, the
realization of goodwill and other intangibles, accruals and other factors.
Actual results could differ from those estimates.
(D) Principles of Consolidation
The consolidated financial statements include the accounts of EasyLink and its
subsidiaries from the dates of acquisition. WORLD.com, a wholly owned
subsidiary, along with EasyLink, owns 92% of Asia.com, Inc. (whose business was
sold on May 3, 2001) and 89% of India.com, Inc. (see Notes 2 and 12). Swift
Telecommunications Inc., a wholly owned subsidiary of EasyLink, owns 75% of a
company located in Singapore and of a company located in Malaysia. The interests
of shareholders other than EasyLink are recorded as minority interests in the
accompanying condensed consolidated statements of operations and condensed
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 balances and transactions have been eliminated in
consolidation.
(E) Domain Assets and Registration Fees
7
A domain name is the part of an email address that comes after the @ sign (for
example, if membername@mail.com is the e-mail address then "mail.com" is the
domain name). Domain assets represent the purchase of domain names and were
amortized using the straight-line method over their economic useful lives, which
had been estimated to be five years. Domain assets were recorded at cost. Domain
assets acquired in exchange for future payment obligations were recorded at the
net present value of such payments using a discount rate of 8.5%. The associated
payment obligation was also recorded at the net present value of the payment
obligations. Payment terms varied from two to seven years. Amortization of
domain assets were charged to cost of revenues if they were being used or were
available for sale and to sales and marketing if designated for new business
development. The Company's policy is to evaluate its domain assets prior to
paying its annual registration renewal fees.
The Company pays domain name registration fees in advance to InterNIC, a
cooperative activity between the US government and Network Solutions, Inc.,
which is the national registry for domain names in the US. Payment of these fees
ensures legal ownership and registration of domain names. The initial
registration period is for a two-year period with subsequent one-year renewal
periods. These costs were deferred and amortized over the related registration
period.
During the first quarter of 2001, the e-mail addresses for many of the domain
names were sold to Net2Phone as part of the sale of the advertising network (see
note 2). The net carrying value of these assets at the time of sale was
approximately $2.3 million. As a result of this and eroding market conditions
for domain assets, management determined that the carrying value of many of the
domain names retained by the Company were impaired and recorded an impairment
charge of $3.4 million to reduce the carrying value of these assets to
anticipated values to be received from a third party.
All domain assets are classified as available for sale at June 30, 2001 and are
no longer being amortized.
(F) Revenue Recognition
The Company's business messaging services include managed e-mail and groupware
hosting services; services that help protect corporate e-mail systems such as
virus protection, spam control and content filtering services; message delivery
services such as electronic data interchange or "EDI," telex, desktop fax,
broadcast and production messaging services; and professional messaging services
and support. The Company derives revenues from monthly per-user or per-message
fees for managed e-mail and groupware hosting and virus protection, spam control
and content filtering services; monthly per-message and usage-based charges for
our message delivery services; and license and consulting fees for our
professional services.
Revenue from e-mail and groupware hosting services, virus protection, spam
control and content filtering services, message delivery services and
professional 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
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, because the customer has the option of hosting the software themselves
or contracting with an unrelated third party to host the software, the hosting
fee is ratably recognized over the hosting period in accordance with Emerging
Issues Task Force No. 00-3, Applications of AICPA Statement of Position 97-2 to
Arrangements That Involve the Right to Use Software on Another Entity's
Hardware.
The Company also enters into supplier arrangements providing bulk messaging
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.
Prior to its sale on March 30, 2001 (see Note 2), advertising revenues were
derived principally from the sale of banner advertisements. Other advertising
revenue sources included up-front placement fees and promotions. The Company's
advertising products consisted of banner advertisements that appeared on pages
within the Company's properties, promotional sponsorships that were typically
focused on a particular event and merchant buttons on targeted advertising
inventory encouraging users to complete a transaction.
The Company also traded advertisements on its Web properties in exchange for
advertisements on the Internet sites of other companies. Barter revenue, which
is a component of advertising revenue, amounted to $563,000 and $434,000 for the
six months ended June 30, 2001 and 2000, respectively. For the six months ended
June 30, 2001 and 2000, barter expenses, which are a component of cost of
revenues, were approximately $563,000 and $282,000, respectively.
Domain development revenues include revenues generated by WORLD.com and consist
primarily of sales of information technology products. Revenue is recognized at
the time of the sale. Revenues are also generated from system integration and
website development for other companies, advertising and commissions for booking
travel arrangements. Revenues are recognized using the percentage of completion
method for system integration projects. Advertising revenue is recognized as the
advertisements are run and commission revenue is recognized on a net basis as
the travel services are performed. On November 2, 2000, the Company announced
its plans to all assets not related to its core outsourced messaging business,
including its Asia.com Inc., and India.com Inc. subsidiaries, and its portfolio
of category-defining domain names. On May 3, 2001, the Company's majority owned
subsidiary Asia.com, Inc. sold its business to an investor group (see note 2).
Deferred revenue represents payments that have been received in advance of
services being performed.
(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, marketable securities, accounts receivable, notes payable and
convertible notes payable. At June 30, 2001 and December 31, 2000, the
8
fair value of cash, cash equivalents, restricted investments, marketable
securities 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 senior convertible notes payable
approximate their fair values, as interest approximates market rates with the
exception of the Convertible Subordinated Notes payable which had an estimated
fair value of $4 million and $13 million at June 30, 2001 and December 31, 2000,
respectively, based upon quoted market prices when compared to their carrying
values of $24.9 million and $100 million at June 30, 2001 and December 31, 2000,
respectively.
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.
The Company has not experienced any significant credit loss to date.
No single customer exceeded 10% of either total revenue or accounts receivable
as of and for the three months ended June 30, 2001 or 2000. Revenues from the
Company's five largest customers accounted for an aggregate of 6 % and 11% of
the Company's total revenues for the six months ended June 30, 2001 and 2000,
respectively. One customer accounted for 10% of the accounts receivable at
December 31, 2000. Subsequent to December 31, 2000, that customer, Swift
Telecommunications Inc., was acquired by the Company (see Note 2).
(H) Basic and Diluted Net Loss Per Share
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 loss per share is equal to basic loss per share since
all common stock equivalents are anti-dilutive for each of the periods
presented. Diluted net loss per share for the periods ended June 30, 2001 and
2000 does not include shares issuable upon exercise of employee stock options
and warrants and upon conversion of convertible notes.
(I) Accounting for Impairment of Long-Lived Assets
The Company assesses the need to record impairment losses on long-lived assets,
including intangible assets, used in operations when indicators of impairment
are present. 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, the Company re-evaluates 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. It is reasonably possible that the impairment factors evaluated by
management will change in subsequent periods, given that the Company operates in
a volatile business environment. This could result in material impairment
charges in the future (see Note 9).
(J) Restructuring Activities
Restructuring activities are accounted for in accordance with the guidance
provided in the consensus opinion of the Emerging Issues Task Force ("EITF") in
connection with EITF Issue 94-3 ("EITF 94-3"). EITF 94-3 generally requires,
with respect to the recognition of severance expenses, management approval of
the restructuring plan, the determination of the employees to be terminated, and
communication of benefit arrangement to employees (see Note 9).
(H) Foreign Currency
The functional currencies of the Company's foreign subsidiaries are their
respective local currencies. The financial statements are maintained in local
currencies and are translated to United States dollars using period-end rates of
exchange for assets and liabilities and average rates during the period for
revenues, cost of revenues and expenses. Translation gains and losses are
included in accumulated other comprehensive loss as a separate component of
stockholders' equity. Net gains and losses from foreign currency transactions
are included in the unaudited condensed consolidated statements of operations
and were not significant.
(I) Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133
establishes accounting and reporting standards for derivative instruments,
including derivative instruments embedded in other contracts, and for hedging
activities. During June 1999, SFAS No. 137 was issued which delayed the
effective date of SFAS No. 133. SFAS No. 137 is effective for all fiscal
quarters of fiscal years beginning after June 15, 2000. The Company's adoption
of this statement in the first quarter of 2001 did not have a significant impact
on the Company's financial statements as it does not currently use derivative
instruments or hedging activities.
In July 2001, the FASB issued Statement No. 141, Business Combinations, and
Statement No. 142, Goodwill and Other Intangible Assets. Statement 141 requires
that the purchase method of accounting be used for all business combinations
initiated after June 30, 2001 as well as all purchase method business
combinations completed after June 30, 2001. Statement 141 also specifies
criteria intangible assets acquired in a purchase method business combination
must meet to be recognized and reported apart from goodwill, noting that any
purchase price allocable to an assembled workforce may not be accounted for
separately. Statement 142 will require that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead tested for
impairment at least annually in accordance with the provisions of Statement 142.
Statement 142 will also require that intangible assets with definite useful
lives be amortized over their respective estimated useful lives to their
estimated residual values, and reviewed for impairment in accordance with SFAS
No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of.
9
The Company is required to adopt the provisions of Statement 141 immediately and
Statement 142 effective January 1, 2002. Furthermore, any goodwill and any
intangible asset determined to have an indefinite useful life that are acquired
in a purchase business combination completed after June 30, 2001 will not be
amortized, but will continue to be evaluated for impairment in accordance with
the appropriate pre-Statement 142 accounting literature. Goodwill and intangible
assets acquired in business combinations completed before July 1, 2001 will
continue to be amortized prior to the adoption of Statement 142.
Statement 141 will require, upon adoption of Statement 142, that the Company
evaluate its existing intangible assets and goodwill that were acquired in a
prior purchase business combination, and to make any necessary reclassifications
in order to conform with the new criteria in Statement 141 for recognition apart
from goodwill. Upon adoption of Statement 142, the Company will be required to
reassess the useful lives and residual values of all intangible assets acquired
in purchase business combinations, and make any necessary amortization period
adjustments by the end of the first interim period after adoption. In addition,
to the extent an intangible asset is identified as having an indefinite useful
life, the Company will be required to test the intangible asset for impairment
in accordance with the provisions of Statement 142 within the first interim
period. Any impairment loss will be measured as of the date of adoption and
recognized as the cumulative effect of a change in accounting principle in the
first interim period.
In connection with the transitional goodwill impairment evaluation, Statement
142 will require the Company to perform an assessment of whether there is an
indication that goodwill is impaired as of the date of adoption. To accomplish
this the Company must identify its reporting units and determine the carrying
value of each reporting unit by assigning the assets and liabilities, including
the existing goodwill and intangible assets, to those reporting units as of the
date of adoption. The Company will then have up to six months from the date of
adoption to determine the fair value of each reporting unit and compare it to
the reporting unit's carrying amount. To the extent a reporting unit's carrying
amount exceeds its fair value, an indication exists that the reporting unit's
goodwill may be impaired and the Company must perform the second step of the
transitional impairment test. In the second step, the Company must compare the
implied fair value of the reporting unit's goodwill, determined by allocating
the reporting unit's fair value to all of it assets (recognized and
unrecognized) and liabilities in a manner similar to a purchase price allocation
in accordance with Statement 141, to its carrying amount, both of which would be
measured as of the date of adoption. This second step is required to be
completed as soon as possible, but no later than the end of the year of
adoption. Any transitional impairment loss will be recognized as the cumulative
effect of a change in accounting principle in the Company's statement of
earnings.
As of the date of adoption, the Company expects to have unamortized goodwill and
other intangible assets in the amount of $165.5 million, which will be subject
to the transition provisions of Statements 141 and 142. Amortization expense
related to goodwill and other intangible assets was $28.8 million and $60.8
million for the six months ended June 30, 2001 and year ended December 31, 2000,
respectively. Because of the extensive effort needed to comply with adopting
Statements 141 and 142, it is not practicable to reasonably estimate the impact
of adopting these Statements on the Company's financial statements at the date
of this report, including whether any transitional impairment losses will be
required to be recognized as the cumulative effect of a change in accounting
principle.
(2) ACQUISITIONS AND DISPOSITIONS
SWIFT TELECOMMUNICATIONS, INC. AND EASYLINK SERVICES
On January 31, 2001, the Company and Swift Telecommunications, Inc. ("STI"), a
New York Corporation, entered into an Agreement and Plan of Merger ("Merger
Agreement"). On February 23, 2001, the Company completed the acquisition of STI.
On January 31, 2001, and concurrent with the execution and delivery of the
Merger Agreement, STI acquired from AT&T Corp. its EasyLink Services business
("EasyLink Services"). On April 2, 2001, Mail.com changed its name to EasyLink
Services Corporation (formerly Mail.com, Inc., the "Company" or "EasyLink").
STI together with its newly acquired EasyLink Services business is a global
provider of messaging services such as electronic data interchange, e-mail, fax
and telex.
At the closing of the acquisition by STI of the EasyLink Services business from
AT&T, the Company advanced $14 million to STI in the form of a loan, the
proceeds of which were used to fund part of the $15 million cash portion of the
purchase price to AT&T. Upon the closing of the acquisition of STI, the Company
assumed a $35 million note issued by STI to AT&T. The $35 million note is
secured by the assets of STI, including the EasyLink Services business, and the
shares of EasyLink Class A common stock issued to the sole shareholder in the
merger. The AT&T note is payable in equal monthly installments over four years
and bears interest at the rate of 10% per annum for the first six months of the
note. Thereafter the rate is adjusted every six months equal to 1% plus the
prime rate as listed in the Wall Street Journal on such date of adjustment. In
the event of a non payment after such payment is due, the remainder of the
unpaid balance shall accrue interest at a rate of 3% per annum above the rate
previously described. The note is subject to mandatory prepayment upon the sale
of specified assets of STI, including the EasyLink Services business, and in
certain other events. The note also contains certain customary covenants and
events of default, including limitations on the ability of EasyLink to incur
additional indebtedness and to incur additional liens on the STI and EasyLink
assets. AT&T has granted the Company the right to defer payments due in June
2001 under the note pending successful completion of discussions to restructure
the indebtedness under the note. As of June 30, 2001, interest on the unpaid
balance is accruing at a rate of 13% per annum. AT&T may terminate the deferral
upon written notice at any time prior to implementation of any restructuring
agreement.
Upon the closing of the acquisition of STI, the Company paid to the sole
shareholder of STI $835,000 in cash and issued an unsecured note for $9,188,000
and 18,766,176 shares of EasyLink Class A common stock as consideration for the
acquisition of STI valued at $30.8 million. The value of the common stock issued
to STI is based on the average market price of EasyLink's common stock, as
quoted on the Nasdaq national market, for the two days immediately prior to, the
day of, and the two days immediately after the announcement of the transaction
on February 8, 2001. The $9,188,000 note will be payable in four equal
semi-annual installments over two years and may be prepaid in whole or in part
at any time and from time to time without payment of premium or penalty. The
note is non-interest bearing unless the Company fails to make a required payment
within 30 days after the due date therefore. Thereafter, the note will bear
interest at the rate of 1% per month. The note also contains certain customary
covenants and events of default. The former shareholder of STI, who is now an
officer of the Company, has granted the Company the right to defer current
payments under the note pending successful completion of discussions to
restructure the indebtedness under the note. The holder of the note may
terminate the deferral upon written notice at any time prior to implementation
of any restructuring agreement (see Note 12).
10
The cash portion of the merger consideration and the reimbursement of payments
made by the sole shareholder of STI were funded out EasyLink's available cash
generated from operations and from the proceeds received by the Company on
January 8, 2001 from the issuance of $10.3 million of 10% Senior Convertible
Notes due January 8, 2006.
The Company allocated a portion of the purchase price to the fair market value
of the acquired assets and liabilities assumed of STI and the EasyLink Services
business. The excess of the purchase price over the fair market value of the
acquired assets and liabilities assumed of STI and the EasyLink Services
business has been allocated to goodwill ($24 million), assembled workforce ($3
million), technology ($11 million), trademarks ($16 million) and customer lists
($11 million). Goodwill, trademarks and customer lists are being amortized over
a period of 10 years, the expected estimated period of benefit, and assembled
workforce and technology are being amortized over 5 years, the estimated period
of benefit. The purchase price that was allocated was based upon the final
outcome of the valuation and appraisals of the fair value of the acquired assets
and assumed liabilities at the date of acquisition, as well as the
identification and valuation of certain intangible assets such as customer
lists, in-place workforce, technology and trademarks, etc. The fair value of the
technology, assembled workforce, trademarks, customer lists and goodwill was
determined by management using the excess earnings method, a risk-adjusted cost
approach and the residual method, respectively. Amortization expense for the
three and six months ended June 30, 2001 was approximately $2 million and $2.7
million, respectively.
Additionally, upon the closing of the STI acquisition, the President and sole
shareholder of STI entered into an employment agreement with the Company and
became President of International Operations as well as a member of the
Company's Board of Directors.
The consideration paid by EasyLink was determined as a result of negotiations
between EasyLink and STI.
During January 2001, STI purchased the real time fax business from Xpedite
Systems, Inc. located in Singapore and Malaysia (these two subsidiaries conduct
business under the name "Xtreme") for approximately $500,000 in cash.
As part of the transaction with STI, the Company entered into a letter agreement
to acquire Telecom International, Inc. (which is an affiliate of STI through its
sole shareholder and conducts business under the name "AlphaTel") and the 25%
minority interests in two STI subsidiaries that operate the businesses acquired
from Xpedite Systems, Inc. for $164,705 in cash, promissory notes in the
aggregate principal amount of approximately $1.8 million and 3.7 million shares
of EasyLink Class A common stock. These additional transactions are subject to
satisfactory completion of due diligence, execution and delivery of definitive
documentation, receipt of regulatory approvals and other customary conditions.
Sale of Advertising Network
On March 30, 2001, the Company sold its advertising network to Net2Phone, Inc.
Net2Phone paid the Company $3 million in cash upon the closing. The Company
received an additional $500,000 in April 2001 based upon the achievement of
certain milestones by the Company. The consideration paid to EasyLink was
determined as a result of negotiations between Net2Phone, Inc. and EasyLink. In
connection with the sale, the parties entered into a hosting agreement whereby
the Company will receive payments for hosting the consumer mailboxes for a
minimum of one year. During the second quarter of 2001, the Company has
completed the migration of the hosting of these consumer mailboxes to a third
party provider whom we pay for this service. As a result of the sale, the
Company transferred net assets, including certain domain names and partner
agreements (see Notes 1(E) and 5), and liabilities related to the advertising
network to Net2Phone, and recorded a loss on the sale of the advertising network
of $2.3 million.
NetMoves
On February 8, 2000, the Company acquired NetMoves Corporation ("NetMoves") for
approximately $168.3 million including acquisition costs. Pursuant to the
merger, NetMoves stockholders received 0.385336 of a share of EasyLink Class A
common stock for each issued and outstanding share of NetMoves common stock. The
consideration payable by EasyLink in connection with the acquisition of NetMoves
consisted of the following:
6,343,904 shares of EasyLink Class A common stock valued at
approximately $145.7 million based upon the average trading price before
and after the date the agreement was signed and announced (December 13,
1999) at $22.96 per share;
The assumption by EasyLink of options to purchase shares of NetMoves'
common stock, par value of $.01 per share, exchanged for options to
purchase approximately 1.0 million shares of EasyLink Class A common
stock. The options were valued at approximately $19.4 million based on
the Black-Scholes pricing model with a 111% volatility factor, a
weighted average term of 4.75 years, an exercise price of $6.69 per
share and a fair value of $22.96 per share. Such options have an
aggregate exercise price of approximately $6.6 million.
The assumption by EasyLink of warrants to purchase shares of NetMoves'
common stock, par value of $.01 per share, exchanged for warrants to
purchase approximately 58,000 shares of EasyLink Class A common stock.
The warrants were valued at approximately $1.1 million based on the
Black-Scholes pricing model with a 111% volatility factor, a weighted
average term of 10 years, an exercise price of $8.64 per share and a
fair value of $22.96 per share. Such warrants have an aggregate exercise
price of approximately $496,000; and
Acquisition costs of approximately $2.1 million related to the merger.
The acquisition has been accounted for using the purchase method of accounting.
Easylink has allocated a portion of the purchase price to the fair market value
of the acquired assets and assumed liabilities of NetMoves as of February 8,
2000. The excess of the purchase price over the fair market value of the
acquired assets and assumed liabilities of NetMoves has been allocated to
goodwill ($147.1 million), assembled employee workforce ($3.1 million) and
technology ($5.5 million). Goodwill is being amortized over a period of 5 years;
the expected estimated period of benefit, and assembled employee workforce and
technology are being amortized over a period of 3 years, the expected estimated
period of benefit. The fair value of the technology, assembled workforce and
goodwill was determined by management using the excess earnings method, a
risk-adjusted cost approach and the residual method, respectively.
In performing the purchase price allocation, the Company considered, among other
factors, the attrition rate of the active users of the technology at the date of
acquisition and the research and development projects in-process at the date of
acquisition. With regard to the in-process research and
11
development projects, the Company considered, among other factors the stage of
development of each project at the time of acquisition, the importance of each
project to the overall development plan, and the projected incremental cash
flows from the projects when completed and any associated risks. Associated
risks included the inherent difficulties and uncertainties in completing each
project and thereby achieving technological feasibility and risks related to the
impact of potential changes in future target markets.
Approximately $7.7 million of the purchase price of NetMoves was allocated to
in-process technology based upon a management determination that the new
versions of the various fax technologies acquired from NetMoves had not been
developed into the platform required by EasyLink as of the acquisition date. The
fair value of acquired existing and in-process technologies was determined by
management using a risk-adjusted income valuation approach with a discount rate
of approximately 30%. As a result, EasyLink was required to expend significant
capital expenditures to successfully integrate and develop the new versions of
various fax technologies, for which there was considerable risk that such
technologies will not be successfully developed, and if such technologies are
not successfully developed, there will be no alternative use for the
technologies. The various fax technologies are enabling technologies for fax
communications and include message management and reporting. Accordingly, on the
date of acquisition, EasyLink's statements of operations reflected a write-off
of the amount of the purchase price allocated to in-process technology of
approximately $7.7 million.
The Company allocated two projects to in-process technology: FaxMailer and
Production Fax. FaxMailer is an email based Internet fax service that enables
the user to send a fax from their PC to the recipient's fax number. Production
Fax allows users to fax documents using SMTP, SNA, RJE, FTP or other standard
protocols, without any additional software, hardware or changes to existing
systems or networks. The $7.7 million referred to above represents the portion
of purchase price allocated to these two projects. These projects, or in-process
technology, were 83% complete at the date of acquisition. The percentage of
completion was determined by the quotient of the (i) costs incurred to date
divided by (ii) the total development costs for the new technologies.
EasyLink intends to incur in excess of approximately $12.0 million related
primarily to salaries, to develop the in-process technology into commercially
viable products over the next year. Remaining development efforts are focused on
addressing security issues, architecture stability and electronic commerce
capabilities, and completion of these projects will be necessary before revenues
are produced. EasyLink expects to begin to benefit from the purchased in-process
research and development by its fiscal year 2000. If these projects are not
successfully developed, EasyLink may not realize the value assigned to the
in-process research and development projects.
In addition to the rollover of existing options contemplated by the merger
agreement, NetMoves' former President, Chief Executive Officer and Chairman of
the board of directors, as an employee of EasyLink received 231,201 options from
the Company on February 8, 2000 to purchase EasyLink Class A common stock with
an exercise price equal to $17.50 per share, the then fair value of EasyLink's
Class A common stock. All such options were issued immediately after the
NetMoves acquisition.
eLong.com, Inc.
On March 14, 2000, EasyLink acquired eLong.com, Inc., a Delaware corporation
("eLong.com") for approximately $62 million including acquisition costs of
$365,000. eLong.com, through its wholly owned subsidiary in the People's
Republic of China ("PRC"), operates the Web Site www.eLong.com, which is a
provider of local content and other internet services. Concurrently with the
merger, eLong.com changed its name to Asia.com, Inc. ("Asia.com"). In the
merger, EasyLink issued to the former stockholders of eLong.com an aggregate of
3,599,491 shares of EasyLink Class A common stock valued at approximately $57.2
million, based upon the Company's average trading price at the date of
acquisition. All outstanding options to purchase eLong.com common stock were
converted into options to purchase an aggregate of 279,289 shares of EasyLink
Class A common stock. The value of the options was approximately $4.4 million
based on the Black-Scholes pricing model with a 110% volatility factor, a term
of 10 years, a weighted average exercise price of $1.24 per share and a weighted
average fair value of $15.69 per share.
The acquisition has been accounted for as a purchase business combination. The
excess of the purchase price over the fair market value of the acquired assets
and assumed liabilities of Asia.com has been allocated to goodwill ($62
million). Goodwill is being amortized over a period of 3 years, the expected
estimated period of benefit. During the fourth quarter of 2000, approximately
$7.8 million of goodwill was written off as it was determined that the carrying
value had become permanently impaired as a result of the November 2, 2000
decision, as approved by the Board of Directors, to sell all assets not related
to its core outsourcing business, including its Asia-based businesses.
Additionally, as a result of the continued eroding market conditions in Asia and
the decision to accelerate the divestiture during the first quarter of 2001,
approximately $35 million of goodwill was written-off as it was determined that
the carrying value of the remaining goodwill had been permanently impaired.
After giving effect to the write off, the net goodwill balance was reduced to
$0.
In addition, EasyLink was obligated to issue up to an additional 719,899 shares
of its Class A common stock in the aggregate to the former stockholders of
eLong.com if EasyLink or Asia.com acquired less than $50.0 million in value of
businesses engaged in developing, marketing or providing consumer or business
internet portals and related services focused on the Asian market or a portion
thereof, or businesses in furtherance of such a business, prior to March 14,
2001. On May 3, 2001, in connection with the sale of eLong.com., the Company
settled this obligation by issuing 75,000 shares of its Class A common stock
valued at $51,000 to some of the former stockholders of eLong.com. The Company
accounted for this transaction as part of the loss on the sale of eLong.com,
Inc. (see below).
In the Merger, certain former stockholders of eLong.com retained shares of Class
A common stock of Asia.com, representing approximately 4.0% of the outstanding
common stock of Asia.com. Under a Contribution Agreement with Asia.com, these
stockholders contributed an aggregate of $2.0 million in cash to Asia.com in
exchange for additional shares of Class A common stock of Asia.com, representing
approximately 1.9% of the outstanding common stock of Asia.com. Pursuant to the
Contribution Agreement, EasyLink (1) contributed to Asia.com the domain names
Asia.com and Singapore.com and $10.0 million in cash and (2) agreed to
contribute to Asia.com up to an additional $10.0 million in cash over the next
12 months and to issue, at the request of Asia.com, up to an aggregate of
242,424 shares of EasyLink Class A common stock for future acquisitions. See
also "Asia.com Acquisitions", below. As a result of the transactions effected
pursuant to the Merger Agreement and the Contribution Agreement, the Company
initially owned shares of Class B common stock of Asia.com representing
approximately 94.1% of the outstanding common stock of Asia.com. Easylink's
ownership percentage decreased to 92% as of December 31, 2000. Asia.com granted
to management employees of Asia.com
12
options to purchase Class A common stock of Asia.com representing, as of
December 31, 2000, 9% of the outstanding shares of common stock after giving
effect to the exercise of such options.
Sale of eLong.com, Inc
On May 3, 2001, the Company's majority owned subsidiary Asia.com, Inc. sold its
business to an investor group. Under the terms of the sale, the buyer paid
Asia.com $1.5 million and assumed eLong.com liabilities of approximately $1.5
million. The consideration paid was determined as a result of negotiations
between the buyer and EasyLink. In addition, the Company issued 200,000 shares
of its Class A common stock valued at $138,000 in exchange for the cancellation
of certain options granted to the former owners of eLong.com. The Company
accounted for this transaction as part of the sale of the business of Asia.com.
As a result of the sale, the Company recorded a loss on the sale of eLong.com,
Inc. of $264,000.
Asian Impairment Charges
The Company's management performs on-going business reviews and, based on
quantitative and qualitative measures, assesses the need to record impairment
losses on long-lived assets used in operations when impairment indicators are
present. Where impairment indicators were identified, management determined the
amount of the impairment charge by comparing the carrying value of goodwill and
other long-lived assets to their fair values. These evaluations of impairments
are based upon an achievement of business plan objectives and milestones of each
business, the fair value of each ownership interest relative to its carrying
value, the financial condition and prospects of the business and other relevant
factors. The business plan objectives and milestones that are considered include
among others, those related to financial performance, such as achievement of
planned financial results and completion of capital raising activities, if any,
and those that are not primarily financial in nature, such as launching or
enhancements of a web site or product, the hiring of key employees, the number
of people who have registered to be part of the associated business's web
community, and the number of visitors to the associated business's web site per
month. Management determines fair value based on the market approach, which
includes analysis of market price multiples of companies engaged in lines of
business similar to the business being evaluated. The market price multiples are
selected and applied to the business based on the relative performance, future
prospects and risk profile of the business in comparison to the guideline
companies. As a result, during management's quarterly review of the value and
periods of amortization of both goodwill and other long-lived assets, it was
determined that the carrying value of goodwill and certain other intangible
assets were not fully recoverable.
The business for which impairment charges were recorded (eLong.com) operates in
the Chinese portal market, which has experienced a significant and continuing
decline in revenue multiples over the past several quarters in comparison to the
metrics in place at the time the acquisition was valued. In addition, both
Chinese and US portals have experienced declines in operation and financial
metrics over the past several quarters, primarily due to the continued weak
overall demand of on-line advertising and marketing services combined with lower
than expected e-commerce transactions, in comparison to metrics forecasted at
the time of their respective acquisitions. These factors significantly impacted
current projected revenue generated from this business. The impairment analysis
considered that this business was recently acquired and that the intangible
assets recorded upon acquisition of this business were being amortized over a
three-year useful life. The amount of the impairment charge was determined by
comparing the carrying value of goodwill and other long-lived assets to fair
value at December 31, 2000. The methodology used to test for and measure the
amount of impairment was based on the same methodology the Company used during
its initial acquisition value of eLong.com. As a result management determined
that the carrying value of eLong.com should be adjusted. Accordingly, during the
fourth quarter of 2000, the Company recorded an impairment charge of
approximately $7.8 million to adjust the carrying value of eLong.com.
Additionally, during the first quarter of 2001, the Company recorded an
additional impairment charge of approximately $35 million to further adjust the
carrying value of eLong.com as noted above. After giving effect to the
impairment charges, the net goodwill balance was reduced to $0. The impairment
results from the deteriorating market conditions in Asia and the November 2,
2000 decision, as approved by the Board of Directors, to sell all assets not
related to its core outsourcing business, including its Asia-based businesses.
Asia.com Acquisitions
During the second quarter of 2000, Asia.com acquired three companies for
approximately $18.4 million, including acquisition costs. Payment consisted of
cash approximating $500,000, 1,926,180 shares of EasyLink Class A common stock
valued at approximately $11.6 million and 4,673,448 shares of Asia.com Class A
common stock valued at approximately $6.1 million, all of which were based upon
the Company's average trading price at the date of acquisition. These
acquisitions have been accounted for as purchase business combinations. The
excess of the purchase price over the fair market value has been allocated to
goodwill ($17.8 million) and is being amortized over a period of three years,
the expected estimated period of benefit. During the fourth quarter of 2000,
approximately $12 million of goodwill was written off as the Company determined
that the carrying value of the goodwill associated with one of these
acquisitions, focused in the wireless sector had become permanently impaired.
During the first quarter of 2001, an additional $3.1 million of goodwill was
written off as a restructuring charge as the Company determined that the
carrying value of the goodwill associated with the acquisition focused in the
wireless sector had become permanently impaired. After giving effect to the
write-off, the net goodwill balance was reduced to $0. The impairment charge
resulted from the deteriorating market conditions in Asia and the November 2,
2000 decision, as approved by the Board of Directors, to sell all assets not
related to its core outsourcing business, including its Asia-based businesses.
Under a purchase agreement associated with one of these acquisitions, the
Company agreed to pay a contingent payment of up to $5 million if certain
wireless revenue targets were achieved after the closing. The contingent payment
is payable in EasyLink Class A common stock, cash or, under certain
circumstances, Asia.com Class A common stock. Since Asia.com is no longer
pursuing its wireless business, management does not expect to achieve these
wireless revenue targets and, accordingly, does not expect to issue any
additional consideration.
Under a purchase agreement associated with another of these acquisitions,
Asia.com committed to deliver to the seller additional shares of EasyLink Class
A common stock based upon the achievement of certain business objectives.
Pursuant to this arrangement, the Company may be obligated to issue up to
approximately 464,000 shares of its Class A common stock to satisfy this
commitment.
Mauritius Entity
13
On March 31, 2000, the Company acquired 100% of a Mauritius entity, which in
turn owned 80% of an Indian subsidiary. The terms were $400,000 in cash and a $1
million 7% note payable one year from closing. The acquisition was accounted for
as a purchase business combination. The excess of the purchase price over the
fair market value of the assets acquired and assumed liabilities of the
Mauritius entity has been allocated to goodwill ($2.1 million). Goodwill was
being amortized over a period of five years, the expected estimated period of
benefit. See Note 12 for information on the resolution of the note payable.
In June 2000, the Company acquired, through the Mauritius entity, the remaining
20% of the Indian subsidiary for $2.2 million. The acquisition was accounted for
as a purchase business combination. The excess of the purchase price over the
fair market value of the assets acquired has been allocated to goodwill ($2.2
million), and was being amortized over a period of five years, the expected
estimated period of benefit. During the second quarter of 2001, management
determined that the value of the goodwill associated with the Mauritius entity
had become impaired, based upon the proceeds, if any, expected upon the sale of
India.com. As a result, the Company wrote off approximately $3.2 million of
goodwill. After giving effect to the write-off, the net goodwill balance was
reduced to $0.
In connection with the Mauritius acquisition, the Company incurred a $1.8
million charge related to the issuance of 104,347 shares of Class A common
stock, as compensation for services performed, $200,000 cash and an additional
$200,000 payable in EasyLink Class A common stock as compensation for employees
in June 2000.
India Acquisition
During the second quarter of 2001, the Company acquired a US and India based
company for approximately $600,000, including acquisition costs. The terms were
$300,000 in cash and 196,000 shares of EasyLink Class A common stock valued at
approximately $273,000 based upon our average trading price surrounding the date
of acquisition. The acquisition was accounted for as a purchase business
combination. The excess of the purchase price over the fair market value of the
assets acquired and assumed liabilities has been allocated to goodwill
($831,000), which is being amortized over a period of three years, the expected
estimated period of benefit.
TCOM
During the first quarter of 2001, management determined that a portion of the
carrying value of the other intangible assets associated with TCOM had become
impaired due to the restructuring of the workforce that had generated those
intangible assets upon acquisition in October 1999. As a result a restructuring
charge of $4.3 million was recorded.
During the second quarter of 2001, the Company settled a contingent obligation
with the former owners of TCOM by issuing 1,620,333 shares of its Class A common
stock valued at approximately $1.3 million and paying cash of $300,000. The
Company determined that the value of the other intangible assets, primarily
workforce, had become further impaired due to the resignation of the remaining
workforce, and accordingly recorded an impairment charge of approximately $1.3
million during the second quarter of 2001. After giving effect to the write-off,
the net goodwill balance was reduced to $0.
Messaging Acquisitions
During the third quarter of 2000, the Company acquired two companies by issuing
710,195 shares of its Class A common stock valued at approximately $4.3 million
based upon the Company's average trading price at the date of acquisition. These
acquisitions were accounted for a s a purchase business combination. During the
second quarter of 2001, approximately $826,000 of goodwill was written off as
the management determined that the carrying value of the goodwill associated
with one of these acquisitions had become permanently impaired. After giving
effect to the write-off, the net goodwill balance associated attributable to
that acquisition was reduced to $0.
Pro Forma Information
The following unaudited pro forma consolidated amounts give effect to the
acquisitions made after January 1, 2000 as if they had occurred on January 1,
2000, by consolidating their results of operations with the results of EasyLink
for the three and six months ended June 30, 2001 and 2000. Consolidated results
are not necessarily indicative of the operating results that would have been
achieved had the transactions been in effect as of the beginning of the periods
presented and should not be construed as being representative of future
operating results.
Three Months Ended
June 30,
--------
(In Thousands, Except Per Share Amounts)
2001 2000
---- ----
Revenues........................................................ $35,661 $ 54,103
Loss before extraordinary gain.................................. $(58,781) $(46,617)
Extraordinary gain.............................................. $1,079 --
Net loss........................................................ $(57,702) $(46,617)
Net loss per share - basic and diluted:
Loss before extraordinary gain.................................. $(0.67) $(0.61)
Extraordinary gain.............................................. $0.01 $--
Net loss........................................................ $(0.66) $(0.61)
Weighted average shares used in calculation (1) 87,981 77,034
14
Six Months Ended
June 30,
(In Thousands, Except Per Share Amounts)
2001 2000
---- ----
Revenues........................................................ $72,846 $ 106,469
Loss before extraordinary gain.................................. $(166,537) $(100,420)
Extraordinary gain.............................................. $40,428 --
Net loss........................................................ $(126,109) $(100,420)
Net loss per share -basic and diluted:
Loss before extraordinary gain.................................. $(1.96) $(1.35)
Extraordinary gain.............................................. $0.48 $--
Net loss........................................................ $(1.48) $(1.35)
Weighted average shares used calculation (1) 84,895 74,559
(1) The Company computes net loss per share in accordance with
provisions of SFAS No. 128, "Earnings per Share". Basic net loss per
share is computed by dividing the net loss for the period by the
weighted-average number of common shares outstanding during the period.
The calculation of the weighted average number of shares outstanding
assumes that 26,016,831 shares of EasyLink's common stock issued in
connection with its acquisitions were outstanding for the entire period
or date of inception, if later. The weighted average common shares used
to compute pro forma basic net loss per share includes the actual
weighted average common shares outstanding for the periods presented,
respectively, plus the common shares issued in connection with the
acquisitions from January 1, 2000 or date of inception if later. Diluted
net loss per share is equal to basic net loss per share as common stock
issuable upon exercise of the Company's employee stock options and upon
exercise of outstanding warrants are not included because they are
antidilutive. In future periods, the weighted-average shares used to
compute diluted earnings per share will include the incremental shares
of common stock relating to outstanding options and warrants to the
extent such incremental shares are dilutive.
(3) Investments
The Company assesses the need to record impairment losses on investments and
records such losses when the impairment of an investment is determined to be
other-than-temporary.
On March 16, 2000, the Company acquired a domain name and made a 10% investment
in Software Tool and Die, a Massachusetts company, in exchange for $2.0 million
in cash and 185,686 shares of its Class A common stock valued at approximately
$2.9 million. Software Tool and Die is an Internet Service Provider and provides
Web hosting services. The Company concluded that the carrying value of this
cost-based investment was permanently impaired based on the achievement of
business plan objectives and milestones and the fair value of the investment
relative to its carrying value. During the fourth quarter of 2000, the Company
recorded an impairment charge of $4.2 million due to an other-than-temporary
decline in the value of this investment.
On July 25, 2000, EasyLink entered into a strategic relationship with
BulletN.net, Inc. The investment has been accounted for under the cost method of
accounting, as EasyLink owns less than 20% of the outstanding stock of
BulletN.net. As part of this agreement BulletN.net issued 666,667 shares of its
common stock and a warrant to purchase up to 666,667 shares of BulletN.net
common stock at $3.75 per share to EasyLink in exchange for 364,431 shares of
EasyLink Class A common stock valued at approximately $3.1 million. The Company
concluded that the carrying value of this cost-based investment was permanently
impaired based on the achievement of business plan objectives and milestones and
the fair value of the investment relative to its carrying value. During the
first quarter of 2001, the Company recorded an impairment charge of $2.6 million
due to an other-than-temporary decline in the value of this investment. This
amount is included in impairment of investments within other income (expense) in
the March 31, 2001 statement of operations. On March 1, 2001, in consideration
of the exchange and cancellation of the 666,667 warrants and the waiver of
certain anti-dilution rights, the Company received a new warrant to purchase
266,667 shares of BulletN.net common stock at $1 per share.
During 1999, the Company acquired an equity interest in 3Cube, Inc. ("3Cube"),
which was accounted for under the cost method. Under the agreement, the Company
paid $1.0 million in cash and issued 80,083 of its Class A common stock, valued
at approximately $2.0 million, in exchange for 307,444 shares of 3Cube
convertible preferred stock which represents an equity interest of less than 20%
of 3Cube. On June 30, 2000, the Company made an additional investment in 3Cube,
Inc. by issuing 255,049 shares of Class A common stock valued at approximately
$1.5 million in exchange for 50,411 shares of 3Cube Series C Preferred Stock. At
December 31, 2000, EasyLink owned preferred stock of 3Cube, representing an
ownership interest of 21% of the combined common and preferred stock outstanding
of 3Cube, Inc. Accordingly, the Company now accounts for this investment under
the equity method of accounting. The change from the cost method to the equity
method of accounting resulted in a decrease of the carrying value of the
investment by $2.1 million. In addition, as a result of sequential declines in
operating results of 3Cube, management made an assessment of the carrying value
of its equity investment and determined that it was in excess of its estimated
fair value. Accordingly, in December 2000, EasyLink wrote down the value of its
investment in 3Cube by $200,000 as it determined that the decline in its value
was other-than-temporary. During the first quarter of 2001, the Company further
reduced its investment in 3Cube by $59,000 to $2 million, representing the value
the Company received in August 2001 upon the liquidation of its investment.
On April 17, 2000, in exchange for $500,000 in cash, the Company acquired
certain source code technologies, trademarks and related contracts relating to
the InTandem collaboration product ("InTandem") from IntraACTIVE, Inc., a
Delaware corporation (now named Bantu, Inc., "Bantu"). On the same date, the
Company also paid Bantu an upfront fee of $500,000 for further development and
support of the InTandem product. On the same date, pursuant to a Common Stock
Purchase Agreement, the Company acquired shares of common stock of Bantu
representing approximately 4.6 % of Bantu's outstanding capital stock in
exchange for $1 million in cash and 462,963 shares of its Class A common stock,
15
valued at approximately $3.6 million. Pursuant to the Common Stock Purchase
Agreement, the Company also agreed to invest up to an additional $8 million in
the form of shares of its Class A Common stock in Bantu in three separate
increments of $4 million, $2 million and $2 million, respectively, based upon
the achievement of certain milestones in exchange for additional shares of Bantu
common stock representing 3.7%, 1.85% and 1.85%, respectively, of the
outstanding common stock of Bantu as of April 17, 2000. The number of shares of
the Company's Class A common stock issuable at each closing will be based on the
greater of $9 per share and the average of the closing prices of the Company's
Class A common stock over the five trading days prior to such closing date. In
July 2000, the Company issued an additional 92,593 shares of its Class A common
stock valued at approximately $590,000 to Bantu in accordance with a true-up
provision in the Common Stock Purchase Agreement. In September 2000, the Company
issued an additional 444,444 shares of its Class A common stock valued at
approximately $2.9 million as payment for the achievement of a milestone
indicated above. In January 2001, the Company issued an additional 222,222
shares of its Class A common stock valued at approximately $285,000 as payment
for the achieved milestone indicated above. The Company accounts for this
investment under the cost method. During the second quarter of 2001, management
made an assessment of the carrying value of its investment, based upon an
incremental investment made by a third party, and determined that the carrying
value of this cost-based investment was permanently impaired as it was in excess
of its estimated fair value. Accordingly, EasyLink wrote down the value of its
investment in Bantu by $7.3 million as it determined that the decline in its
value was other-than-temporary.
On June 30, 2000, the Company received 35,714 shares of common stock of
Onview.com valued at $125,000 as payment for the Company's advertising services.
During the second quarter of 2001, the Company determined that the value of this
investment had become permanently impaired and recorded an impairment charge of
$125,000.
(4) Notes Payable
On January 26, 2000, the Company issued $100 million of 7% Convertible
Subordinated Notes ("the Notes"). Interest on the Notes is payable on February 1
and August 1 of each year, beginning on August 1, 2000. The Notes are
convertible by holders into shares of EasyLink Class A common stock at a
conversion price of $18.95 per share (subject to adjustment in certain events)
beginning 90 days following the issuance of the Notes.
The notes will mature on February 1, 2005. Prior to February 5, 2003 the Notes
may be redeemed at the Company's option ("the Provisional Redemption"), in whole
or in part, at any time or from time to time, at certain redemption prices, plus
accrued and unpaid interest to the date of redemption if the closing price of
the Class A common stock shall have equaled or exceeded specified percentages of
the conversion price then in effect for at least 20 out of 30 consecutive days
on which the NASDAQ national market is open for the transaction of business
prior to the date of mailing the notice of Provisional Redemption. Upon any
Provisional Redemption, the Company will be obligated to make an additional
payment in an amount equal to the present value of the aggregate value of the
interest payments that would thereafter have been payable on the notes from the
Provisional Redemption Date to, but not including, February 5, 2003. The present
value will be calculated using the bond equivalent yield on U.S. Treasury notes
or bills having a term nearest the length to that of the additional period as of
the day immediately preceding the date on which a notice of Provisional
Redemption is mailed.
On or after February 5, 2003, the Notes may be redeemed at the Company's option,
in whole or in part, in cash at the specified redemption prices, plus accrued
interest to the date of redemption.
In connection with the issuance of these Notes, the Company incurred
approximately $3.8 million of debt issuance costs. Such costs have been
capitalized and are being amortized ratably over the original term of the Notes.
As a result of the exchange note agreements entered into and discussed below,
the Company recorded a charge of $2.2 million to reduce debt issuance costs
relating to that portion of the notes that were exchanged. This charge has been
netted against the extraordinary gain on exchange of convertible notes, included
in the 2001 statements of operations.
On February 1, 2001, the Company entered into a note exchange agreement (the
"Note Exchange Agreement"). Under the terms of the agreement, EasyLink issued
$11,694,000 principal amount of a new series of 10% Senior Convertible Notes due
January 8, 2006 in exchange for the cancellation of $38,980,000 principal amount
of its 7% Convertible Subordinated Notes due February 1, 2005.
On February 8, 2001, the Company entered into an additional note exchange
agreement. Under the terms of the agreement, EasyLink issued $4,665,000
principal amount of a new series of 10% Senior Convertible Notes due January 8,
2006 in exchange for the cancellation of $15,550,000 principal amount of its 7%
Convertible Subordinated Notes due February 1, 2005.
On February 14, 2001, the Company entered into an additional note exchange
agreement. Under the terms of the agreement, EasyLink issued $7,481,250
principal amount of a new series of 10% Senior Convertible Notes due January 8,
2006 in exchange for the cancellation of $21,375,000 principal amount of its 7%
Convertible Subordinated Notes due February 1, 2005 (the "Subordinated Notes").
Pursuant to this note exchange agreement, on or about May 23, 2001, $2,531,250
in principal amount of these Senior Convertible Notes were exchanged for
1,420,714 shares of Class A common stock (the "Exchange Shares") leaving
$4,950,000 in principal amount of this series of Senior Convertible Notes
outstanding.
The Senior Convertible Notes issuable under the February 1, February 8 and
February 14 note exchange agreements (the "Exchange Notes") are unsecured, joint
and several obligations of the Companies.
The Exchange Notes bear interest semi-annually at the rate of 10% per annum. One
half of each interest payment is payable in cash and one half is payable in
shares of EasyLink Class A common stock, par value $.01 per share ("Class A
common stock"), until 18 months after the closing date of the financing.
Thereafter, one half of each interest payment may be paid in shares of Class A
common stock at the option of the Companies. For purposes of determining the
number of shares issuable upon payment of interest in shares of Class A common
stock, such shares will be deemed to have a value equal to the applicable
conversion price at the time of payment.
$11,694,000 of the Exchange Notes is convertible at any time at the option of
the holder into Class A common stock at an initial conversion price equal to
$1.30 per share. The conversion price is subject to anti-dilution adjustments.
16
$4,665,000 of the Exchange Notes is convertible at any time at the option of the
holder into Class A common stock at an initial conversion price equal to $1.75
per share. The conversion price is subject to anti-dilution adjustments.
$7,481,250 of the Exchange Notes is convertible at any time at the option of the
holder into Class A common stock at an initial conversion price equal to $1.50
per share. Also, $2,531,250 of the Exchange Notes was cancelled in exchange for
the issuance of Exchange Shares as described above. The conversion price is
subject to anti-dilution adjustments.
The Companies may, at their option, prepay the Exchange Notes, in whole or in
part, at any time (i) on or after the third anniversary of the closing date of
the financing, (ii) if the closing price of the Class A common stock on the
NASDAQ stock market, or other securities market on which the Class A common
stock is then traded, is at or above $5.00 per share (such amount to be
appropriately adjusted in the event of a stock split, stock dividend, stock
combination or recapitalization or similar event having a similar effect) for 30
consecutive trading days or (iii) EasyLink desires to effect a merger,
consolidation or sale of all or substantially all of its assets in a manner that
is prohibited by the Note Purchase Agreement between EasyLink and the initial
purchasers of the Exchange Notes (the "Note Purchase Agreement") and the holders
of the Exchange Notes fail to consent to a waiver of such prohibition to permit
such merger, consolidation or sale.
All of the above exchange transactions (other than the exchange of $2,531,250 of
the Senior Convertible Notes described above, which closed on or about May 23,
2001) under the Exchange Note Agreements closed on March 28, 2001.
The above exchange transactions have been accounted for in accordance with
Financial Accounting Standards Board Statement No. 15, "Accounting by Debtors
and Creditors for Troubled Debt Restructurings." As a result of these exchanges,
the Company recorded a $40.4 million extraordinary gain on the exchange of
convertible notes during the six months ended June 30, 2001.
Because the total future cash payments specified by the new terms of the
Exchange Notes, including both payments designated as interest and those
designated as face amount, are less than the carrying amount of the Notes, the
Company was required to reduce the carrying amount of the Notes, to an amount
equal to the total future cash payments specified by the new terms and
recognized a gain on exchange of payables equal to the amount of the reduction,
less the applicable deferred financing costs associated with the original $100
million 7% Convertible Subordinated Notes of $2.2 million and new financing
costs of $40,000.
In future periods, all payments under the terms of the Exchange Notes shall be
accounted for as reductions of the carrying amount of the Exchange Notes, and no
interest expense shall be recognized on the Exchange Notes for any period
between the exchange dates and maturity dates of the Exchange Notes.
On January 8, 2001, the Company issued $10 million (subsequently increased to
$10.26 million) of 10% Senior Convertible Notes due January 8, 2006 to an
investor group. On March 19, 2001, the Company completed the issuance of $3.9
million principal amount of 10% Senior Convertible Notes due January 8, 2006
(together with the notes issued pursuant to the January 8, 2001 agreement, (the
"Notes") to certain private investors. The Notes are unsecured, joint and
several obligations of EasyLink and its subsidiaries Mail.com Business Messaging
Services, Inc. and The Allegro Group, Inc. (collectively, the "Companies").
The Notes bear interest, payable semi-annually, at the rate of 10% per annum.
One half of each interest payment is payable in cash and one half is payable in
shares of EasyLink Class A common stock ("Class A common stock"), until 18
months after the closing date of the financing. Thereafter, one half of each
interest payment may be paid in shares of Class A common stock at the option of
the Companies. For purposes of determining the number of shares issuable upon
payment of interest in shares of Class A common stock, such shares will be
deemed to have a value equal to the applicable conversion price at the time of
payment.
The Companies may, at their option, prepay the Notes, in whole or in part, at
any time (i) on or after the third anniversary of the closing date of the
financing, (ii) if the closing price of the Class A common stock on the NASDAQ
stock market, or other securities market on which the Class A common stock is
then traded, is at or above $5.00 per share (such amount to be appropriately
adjusted in the event of a stock split, stock dividend, stock combination or
recapitalization or similar event having a similar effect) for 30 consecutive
trading days or (iii) EasyLink desires to effect a merger, consolidation or sale
of all or substantially all of its assets in a manner that is prohibited by the
Note Purchase Agreement dated as of March 13, 2001 between EasyLink and the
initial purchasers of the Notes and the holders of the Notes fail to consent to
a waiver of such prohibition to permit such merger, consolidation or sale.
Each of the Notes is convertible at any time at the option of the holder into
Class A common stock at an initial conversion price equal to $1.00 per share.
The conversion price is subject to anti-dilution adjustments.
The net proceeds from this financing will be used for working capital and other
general corporate purposes.
The $10.26 million principal amount of Notes issued pursuant to the January 8,
2001 agreement are secured by a pledge of the Company's and its wholly-owned
subsidiary WORLD.com, Inc.'s share interest in its majority owned subsidiary
India.com, Inc. The security interest will be released, among other
circumstances, (i) upon repayment of the Notes and accrued interest thereon,
(ii) upon a sale, transfer or other disposition of the shares as permitted under
the Note Purchase Agreement and the prepayment of Notes as become subject to
prepayment in accordance with the Note Purchase Agreement, or (iii) if EasyLink
raises at least $35 million in cash proceeds from the sale of assets (including
the pledged shares) or from the issuance of certain additional debt or equity
financings on or before April 30, 2001.
The net proceeds of the issuance of the $10.26 million principal amount of Notes
issued pursuant to the January 8, 2001 agreement were used to fund a portion of
the purchase price payable by Swift Telecommunications, Inc. for the acquisition
of the AT&T EasyLink Services business and for working capital and other general
corporate purposes.
17
In connection with the issuance of the Notes, the Company granted to the
investor group the right to designate one director to the Board of Directors for
so long as the investor group and certain other parties associated with it own a
specified number of shares of Class A common stock on a fully diluted basis (the
"Designation Agreement"). Pursuant to the Designation Agreement, the Board of
Directors appointed a director to the Board of EasyLink effective upon the
closing of the financing.
During the second quarter of 2001, the Company issued an aggregate of $550,000,
10% Senior Convertible Notes Due January 8, 2006 to certain vendors in exchange
for settlement of its obligations to those vendors. Terms of the notes are
similar to those notes that were issued on January 8, 2001.
In connection with the acquisition of STI, the Company assumed a $35 million
note from STI and issued a $9.2 million unsecured note to the former shareholder
of STI as partial payment (see Note 2 for additional information). See Note 12 -
Restrucuring of certain debt and lease obligations.
Notes payable include the following, in thousands
June 30, 2001 December 31, 2000
------------- -----------------
1997 16% Convertible Note Due December 2001 $20 $91
1998 Floating rate note payable due March 2001 - 50
1998 9.25% note payable due March 2001 - 15
1998 16% Note payable due June 2002 344 497
1999 16% Note payable due December 2003 393 529
2000 7% note payable due March 2001 1,000 1,000
2000 7% Convertible Subordinated Notes due February 2005 24,095 100,000
2001 10% Senior Convertible Notes due January 2006 44,624 --
2001 10% Note due February 2005 33,540 --
2001 Non interest bearing note payable to former shareholder of STI 7,660 --
2001 Non interest bearing note payable to former shareholder of STI 1,813 --
----- --
Total Notes Payable 113,489 102,182
Less current portion 17,695 1,861
------ -----
Non current portion $95,794 $100,321
======= ========
See Note 12 - Restrucuring of certain debt and lease obligations
(5) Partner Agreements
The Company had entered into many partner agreements that were associated with
the Company's advertising network. Included in these agreements were percentage
of revenue sharing agreements, miscellaneous fees and other customer acquisition
costs with EasyLink partners. The revenue sharing agreements varied for each
party but typically were based on selected revenues, as defined, or on a per
sign-up basis.
In August 1998, the Company entered into a two-year agreement with CNN. In
consideration of the advertising, subscription and customer acquisition
opportunities, CNN received 253,532 shares of Class A common stock upon the
commencement of the contract at $3.50 per share, the fair market value of
EasyLink's common stock on the date of grant, or $887,000. CNN also had the
right to receive a portion of the Company's selected revenues under the
agreement, as defined. The value of the stock issuance was recorded in the
balance sheet as partner advances and was amortized ratably to amortization
expense over the contract term. The launch of the services coincided with the
contract date. The Company recorded approximately $111,000 and $222,000 of
amortization expense for the three and six-month periods ended June 30, 2000.
Prior to May 1, 1999, the Company was required to issue to CNET, Snap and NBC
Multimedia shares of its Class A common stock for each member who registers at
their sites. On May 1, 1999, the Company entered into an agreement to settle in
full its contingent obligation to issue shares of its Class A common stock to
CNET, Snap and NBC Multimedia as described above. Pursuant to this agreement,
the Company issued upon the closing of its initial public offering in June 1999,
2,368,907 shares of Class A common stock at a value of $7.00 per share in the
aggregate to CNET and Snap and 210,000 shares of Class A common stock at a value
of $7.00 per share to NBC Multimedia. The Company capitalized $18 million in
connection with the issuance of these shares and has ratably amortized the
amount over the period from the closing of the initial public offering (June 23,
1999) through May 2001. The Company recorded approximately $2.3 million of
amortization expense for the three months ended June 30, 2000 and $2.3 million
and $4.6 million for the six months ended June 30, 2001 and 2000, respectively.
The remaining $1.5 million of unamortized costs were written off as a part of
the loss on the sale of the advertising network during the first quarter of
2001.
(6) Leases
On March 30, 2000, the Company entered into a $12 million Master Lease Agreement
with GATX Technology Services Corporation ("GATX") for equipment lease financing
(hardware and software). Terms of individual leases signed under the Master
Lease Agreement will call for a 36-month lease term with rent payable monthly in
advance. The effective interest rate is 12.1% and is adjustable based on prime.
GATX holds a first priority security interest in the equipment under the
facility. For certain leases entered into under the $12 million master lease
agreement, the Company has exercised an option to extend the term for an
additional 24 months.
Under the terms of the Master Lease Agreement, the Company has the option to
purchase the equipment at the then fair market value of the equipment at lease
expiration. In December 2000, GATX reduced the $12 million line to $10.4
million. The amount that was outstanding at June 30, 2001 was $8.1 million.
On March 31, 2000, the Company entered into a $2 million Master Lease Agreement
with Leasing Technologies International, Inc. The lease line provides for the
lease of new, brand name computers, office automation and other equipment. Terms
of individual leases signed under the Master Lease Agreement call for a 36-month
lease term, rent payable monthly in advance. The effective interest rate is
14.7% and is adjustable based on
18
prime. In addition, a security deposit equal to one month's rent is payable at
each individual lease inception. In December 2000, Leasing Technologies reduced
the $2 million line to $1.2 million. The amount that was drawn down and
outstanding at June 30, 2001 was $874,000.
Under the terms of the Master Lease Agreement, at the end of the lease term, the
Company has the option to either purchase or return the equipment at a set
percent of the original price, or extend the lease term by twelve months. In the
latter case, the lease terms provide for a discounted monthly rental and a
bargain purchase option at the expiration of the twelve-month extension.
Approximately $21 million of our outstanding lease obligations have been
classified as current liabilities. The lessors under such lease obligations have
permitted the Company to defer current payments under such obligations pending
satisfactory completion of negotiations with such lessors and certain other
creditors for the restructuring of these obligations and certain other debt. If
the restructuring is successfully completed, any remaining portion of these
obligations that are due and payable more than 12 months after the closing of
the restructuring will be reclassified from short-term to long-term liabilities
(See Note 12 - Restrucuring of certain debt and lease obligations).
(7) Warrants
In June 2001, the Company issued warrants to purchase 500,000 shares of EasyLink
Class A common stock, 250,000 to each of two individuals associated with an
investment bank that is assisting the Company in raising funds through a private
placement. The warrants shall vest and become exercisable by each holder in two
separate tranches: (i) 125,000 shares of EasyLink Class A common stock shall
vest immediately on the date that the investment bank initiates marketing of,
and presents to its sales force in connection with, the proposed private
placement on behalf of the Company; and (ii) an additional 125,000 shares of
common stock shall vest upon the earlier of: (i) at the discretion of the
management of the Company, on the date that is sixty days after the date hereof;
or (ii) the consummation of a transaction by the Company with a strategic
partner. The Company recorded a deferred cost of approximately $115,000 in the
aggregate as a result of the issuance of these warrants and will amortize them
as services are rendered are over the vesting period, as appropriate.
Under a letter agreement dated May 26, 1999, AT&T Corp. ("AT&T") and the Company
agreed to negotiate in good faith to complete definitive agreements to establish
a strategic relationship. On July 26, 1999, the Company entered into an interim
agreement to provide the Company's e-mail services as part of a package of AT&T
or third party branded communication services that AT&T may offer to some of its
small business customers. The Company did not enter into a definitive agreement
to establish the proposed strategic relationship, and, effective March 30, 2000,
the May 26, 1999 letter agreement and the July 26, 1999 interim agreement were
terminated. Under the May 26, 1999 letter agreement, EasyLink issued warrants to
purchase 1.0 million shares of Class A common stock at $11.00 per share. AT&T
had the option to exercise the warrants at any time on or before December 31,
2000. Since AT&T did not exercise the warrants on or before December 31, 2000,
the warrants expired and were cancelled.
The Company recorded a deferred cost of approximately $4.3 million in the
aggregate as a result of the issuance of these warrants to AT&T. As a result of
the termination of the May 26 letter agreement and the July 26 interim
agreement, $3.3 million of deferred costs were expensed during the first quarter
of 2000.
(8) Business Segments
The Company's two business segments are Messaging and Domain Development, the
latter being attributable to the formation of WORLD.com. The following table
presents summarized financial information related to the business segments for
the three and six months ended June 30, 2001 and 2000, in thousands:
Three Months Ended June 30,
2001 2000
---- ----
Revenue:
Messaging........................................................... $33,858 $13,592
Domain development.................................................. 2,169 1,431
------- -------
Total revenue........................................... $36,027 $15,023
======= =======
Cost of revenues:
Total Messaging..................................................... $22,122 $12,435
Domain development.................................................. 2,156 1,460
----- -----
Total cost of revenue................................... $24,278 $,13,895
======= ========
Operating expenses, excluding cost of revenue
Messaging............................................... $50,044 $36,890
Domain development...................................... 12,078 11,971
------- -------
Total operating expenses, excluding cost of revenue $62,122 $48,861
======= =======
Six Months Ended June 30,
2001 2000
---- ----
Revenue:
Messaging........................................................... $53,580 $23,543
Domain development.................................................. 4,793 1,431
------- ------
Total revenue........................................... $58,373 $24,974
======= =======
Cost of revenues:
Total Messaging..................................................... $40,256 $22,278
Domain development.................................................. 5,060 1,478
------- -------
Total cost of revenue................................... $45,316 $23,756
======= =======
Operating expenses, excluding cost of revenue
Messaging............................................... $ 65,893 $76,003
Domain development...................................... 100,034 15,573
-------- -------
Total operating expenses, excluding cost of revenue $165,927 $91,576
======== =======
19
The following table reconciles total assets for business segments to
consolidated assets, in thousands:
June 30, December 31,
2001 2000
---- ----
Identifiable Assets
Messaging............................. $258,664 $252,575
Domain development.................... 6,363 74,491
Inter-segment eliminations 2,920 3,195
-------- --------
Consolidated assets................... $267,947 $330,261
======== ========
The following table presents certain segment information, in thousands:
Domain
Messaging Development Total
Three months ended June 30, 2001
Restructuring charges............... $13,098 4,496 $17,594
Impairment charges.................. $9,612 4,527 $14,139
Loss on sale of businesses $ -- 264 $264
Domain
Messaging Development Total
Six months ended June 30, 2001
Restructuring charges............... $25,338 46,675 $72,013
Impairment charges.................. $12,280 8,094 $20,374
Loss on sale of businesses.......... $2,327 264 $2,591
(9) Restructuring Charges
During the six months ended June 30, 2001, a restructuring charge of $72.0
million was recorded by the Company in accordance with the provisions of EITF
94-3, and Staff Accounting Bulletin 100. The Company's restructuring initiatives
are related to our strategic decisions to exit the consumer messaging business
and WORLD.com business and to focus on the Company's outsourced messaging
business.
During the first half of 2001, the Company's restructuring program included an
incremental reduction in the workforce of approximately 150 employees. In
addition, asset disposals of $68.6 million reflect write-downs of goodwill and
other intangible assets of $44.5 million primarily in connection with
management's decision to sell its WORLD.com properties, the majority of which
related to its Asian portal businesses (see Note 2), and a write-down of $24.1
million of excess fixed assets and other assets to their net realizable values.
The following sets forth the activity in the Company's restructuring reserve (in
thousands):
Beginning Current year- Current year- Ending
balance provision utilization balance
------- --------- ----------- -------
Employee termination
benefits................ $559 $2,376 $2,324 $611
Lease abandonments 3,136 1,034 3,030 1,140
Asset disposals....... -- 68,601 68,601 --
Other exit costs...... 353 2 313 42
------ ------- ------- ------
$4,048 $72,013 $74,268 $1,793
====== ======= ======= ======
(10) India.com Financing
During the third quarter of 2000, India.com, Inc. a then wholly-owned subsidiary
of EasyLink, issued 13,657,692 shares of Series A convertible preferred stock to
private investors valued at $14.2 million. These shares are convertible into
India.com Class A common stock at the initial purchase price of the preferred
shares, subject to certain anti-dilution adjustments. In addition, the preferred
share conversion price is also subject to reduction if the effective sales price
in India.com's next significant equity financing does not represent a 33%
premium to the current conversion price. The Company will measure the contingent
beneficial conversion feature at the commitment date and treat this feature as a
preferred dividend but will not recognize this preferred dividend in earnings
until the contingency is resolved, if ever. Under the terms of an exchange
agreement entered into at the time of the financing, the holders of the Series A
convertible exchangeable preferred stock were entitled to a one time right
exercisable during the 60
20
days after September 13, 2001 to exchange these shares for the number of shares
of EasyLink Class A common stock equal to the original purchase price of such
shares divided by the lesser of the market price of EasyLink's Class A common
stock on September 13, 2001 (but not less than $4.50) and $6.00. This exchange
right has since been modified as described below.
The Company entered into a Bridge Funding and Amendment Agreement (the "Bridge
Funding Agreement"). Under the Bridge Funding Agreement, the Company may borrow
up to $5 million from its majority-owned subsidiary India.com pursuant to a
bridge note (the "Bridge Note"). Under the Bridge Funding Agreement, the Company
committed to issue to India.com warrants to purchase 200,000 shares of
EasyLink's Class A common stock at an exercise price of $1.30 per share in
consideration of the commitment under the Bridge Funding Agreement. In addition,
India.com was entitled to receive warrants to purchase an additional 160,000
shares of EasyLink Class A common stock for each $1 million drawn down by the
Company under the Bridge Funding Agreement. As of June 30, 2001, $5 million has
been drawn down and an additional 800,000 warrants have been issued at exercise
prices ranging from $0.62 to $1.40 per warrant.
If drawn upon, any outstanding amounts must be repaid on or before 120 days
after the initial advance of funds and out of the proceeds of certain other
fundings of the Company. Advances under the Bridge Note will bear interest at
the rate of 10% per annum. If payments are not made on the Bridge Note when due,
the Bridge Note bears additional interest at the rate of 1% per month and
warrants to purchase additional shares of EasyLink Class A common stock at the
rate of 100,000 shares per month are issued until the payment is made.
Obligations under the Bridge Note will be secured by the Company's and
WORLD.com's shares of India.com.
Any additional warrants issued pursuant to the Bridge Funding Agreement as
described above will have an exercise price based upon the market price of the
underlying EasyLink Class A common stock around the time such warrants are
issued. The number of shares issuable upon exercise of the warrants and the
exercise price of the warrants are subject to adjustment for stock splits, stock
dividends, stock combinations and reclassifications. The exercise price for all
of the warrants may be paid in cash or by exchanging warrants to purchase a
number of underlying shares having an aggregate value based on the market price
around the time of exercise equal to the exercise price. All of the warrants
expire February 2, 2004.
In consideration of the commitments under the Bridge Funding Agreement, the
Company agreed to reduce the minimum price at which the holders of shares of
Series A Convertible Exchangeable Preferred Stock of India.com (the "India
Preferred Stock") may exchange such shares for EasyLink Class A common stock.
Under the Exchange Agreement dated September 13, 2000, the holders of India
Preferred Stock had a one-time right during the sixty-day period commencing
September 13, 2001 to exchange shares of India Preferred Stock for EasyLink
Class A common stock based on the original purchase price for the India
Preferred Stock divided by the market price of EasyLink stock on September 13,
2001, subject to a floor on the exchange price of $4.50 and a cap of $6.00. The
aggregate original purchase price for the India Preferred Stock was $14.2
million. In consideration of the Bridge Funding Agreement, the period during
which the one-time exchange right may be exercised was changed from the 60-day
period immediately after September 13, 2001 to the 60-day period immediately
after December 31, 2001. In addition, the floor price at which shares of
EasyLink Class A common stock may be issued upon the exchange was reduced from
$4.50 per share to $3.00 per share immediately and will be further reduced to
$1.25 per share for a percentage of the total number of shares of India
Preferred Stock that is equal to the percentage of the Bridge Note drawn down.
Please see Note 12 for subsequent information regarding the cancellation of
these warrants and repayment obligations.
(11) Private Placement of Common Stock
On March 20, 2001, the Company completed a private placement of 3,000,000 shares
of Class A common stock (the "Common Shares") to a private investor for an
aggregate price of $3,000,000. Pursuant to the Common Stock Purchase Agreement
dated as of March 13, 2001 between EasyLink and the private investor and subject
to the effectiveness of a registration statement covering shares of Class A
common stock issuable upon conversion of certain EasyLink convertible notes,
EasyLink is obligated to issue an additional 1,000,000 shares of Class A common
stock to the private investor if the closing price of the Company's Class A
common stock is not at or above $10 per share for at least five consecutive
trading days during 2001.
(12) Subsequent Events
Issuance of Common Stock
On July 6, 2001, the Company paid approximately $187,000 and issued 400,000
shares of its Class A common stock valued at $204,000 to a former landlord as
settlement for a default of rental payments and for the release of the Company
from its former headquarters' lease.
Amendment of India.com, Inc. Exchange Agreement
Pursuant to an Exchange Agreement Amendment entered into on July 17,2001 (the
"Exchange Agreement Amendment") between EasyLink Services Corporation (the
"Company" or "EasyLink") and the holders of shares of Series A Convertible
Exchangeable Preferred Stock of the Company's majority-owned subsidiary
India.com, Inc. (the "India Preferred Stock"), the holders of 99.3% of the
outstanding shares of India Preferred Stock have exercised their right to
exchange their shares of India Preferred Stock for shares of the Company's Class
A common stock on the terms described herein. The Company entered into the
Exchange Agreement Amendment in connection with the elimination of its
obligations under the $5 million aggregate principal amount of bridge notes and
warrants to purchase an aggregate of 1 million shares of the Company's Class A
common stock issued to India.com.
Under the Exchange Agreement originally dated September 13, 2000, as amended as
of February 5, 2001, the holders of shares of the India Preferred Stock had a
right during the period from September 13, 2001 until December 31,2001 to
exchange shares of India Preferred Stock for EasyLink Class A common stock based
on the original purchase price for the India Preferred Stock divided by the
market price of EasyLink stock on September 13, 2001, subject to a floor on the
exchange price of $1.25 and a cap of $6.00. The aggregate original purchase
price for the India Preferred Stock was $14.2 million.
21
Pursuant to a Bridge Funding Agreement dated as of February 5, 2001, the Company
issued to India.com $5 million in bridge notes and issued warrants to purchase
1,000,000 shares of EasyLink Class A common stock in exchange for $5 million of
advances from India.com.
The Company entered into the Exchange Agreement Amendment on July 17, 2001 in
connection with the elimination of the Company's obligations under the
$5 million aggregate principal amount of bridge notes and warrants to purchase
an aggregate of 1 million shares of the Company's Class A common stock issued to
India.com. Pursuant to the Exchange Agreement Amendment, the holders of 99.3% of
the outstanding shares of India Preferred Stock have agreed to exercise the
exchange right immediately based on the average of the closing market prices of
EasyLink stock over the five trading days ending on September 13, 2001, subject
to a floor on the exchange price of $1.00 and a cap of $3.00 and subject to
adjustment in certain circumstances. In addition, if the shares of Class A
common stock issued in the exchange have not been registered for resale under an
effective registration statement by December 31, 2001, EasyLink has agreed to
issue to the former holders of India Preferred Stock an aggregate of 100,000
shares of its Class A common stock per month for each month after December
31, 2001 until the earlier of (i) the effectiveness of such a registration
statement and (ii) the date on which such shares are eligible for resale
pursuant to Rule 144 promulgated under the Securities Act. Based on the floor
exchange price of $1.00 per share, the maximum number of shares the Company
would expect to issue is approximately 14.2 million shares of Class A common
stock.
The consummation of the above exchange on or after September 13, 2001 is subject
to compliance with NASDAQ requirements.
Acquisition of GN Comtext
On July 12, 2001, the Company entered into an agreement to acquire the assets of
GN Comtext ("GN") for $1. Also an agreement calling for $3 million annual
telecom services through July 2003 between the Company and GN will be cancelled.
Additionally, the Company will receive a $1 million unsecured interest free loan
from the former parent company of GN, payable on December 31, 2001; will receive
approximately $175,000 for transition services during the third quarter of 2001
and will collect and retain a percentage of certain accounts receivable
collected on behalf of GN. GN Comtext offers value-added messaging services to
over 3000 customers ranging from small business to multi-national companies
around the world.
Multiple Zones, Inc. Promissory Note
On July 13, 2001, EasyLink entered into an agreement with Multiple Zones, Inc.
regarding payment of a $1 million promissory note. Pursuant to the agreement,
EasyLink paid Multiple Zones, Inc. $200,000 in cash on July 16, 2001.
Additionally, $400,000 of the original promissory note shall be converted into
shares of EasyLink Class A common stock, the number of shares to be issued shall
be determined based upon the average sales price of the Class A Common Stock
over the ten (10) trading days immediately preceding the earlier of (a) the
filing of a registration statement for the resale of the shares, and (b) the
date on which EasyLink enables Multiple Zones to resell the shares or receive
the economic benefit of such resale, but in any event shall not exceed 1,250,000
shares (such number to be appropriately adjusted in the event of any stock
split, stock dividend or stock combination having similar effect). EasyLink
shall undertake to file an S-3 registration statement with the United States
Securities and Exchange Commission ("SEC"), or such other registration statement
as necessary to register the Settlement Shares with the SEC to permit public
resale of those shares by Multiple Zones as soon as practicable after execution
of the Settlement Agreement, but in no event later than September 30, 2001. An
additional payment of $430,000 shall be paid to Multiple Zones upon the earlier
of (i) the closing of the sale of Multiple Zones Mauritius, Ltd. or Multiple
Zones Pvt., Ltd. or their respective successors; or (ii) September 30, 2001.
Restructuring of Certain Debt and Lease Obligations
The Company has entered into debt restructuring negotiations with AT&T with
respect to its promissory note in the outstanding principal amount of $33.5
million, George Abi Zeid (the former sole shareholder of STI and a current
director and officer of EasyLink) with respect to his promissory note in the
outstanding principal amount of $9.2 million and lessors under approximately
$21 million of lease obligations. AT&T, Mr. Abi Zeid and the lessors have
permitted the Company to defer current payments under these notes and lease
obligations pending successful completion of the debt restructuring negotiations
and satisfaction of all conditions precedent to the implementation of any
restructuring. AT&T, Mr. Abi Zeid and the lessors may terminate the deferrals at
any time prior to implementation of definitive restructuring agreements. No
assurance can be given that the Company will successfully complete the proposed
debt restructurings on acceptable terms or at all.
On August 13, 2001, EasyLink entered into a Modification Agreement with one of
its lessors with respect to approximately $8.6 million of lease obligations.
Under the terms of the agreement, (i) EasyLink is obligated to return the leased
equipment subject to item (ii) at EasyLink's expense within 60 days; (ii)
EasyLink has agreed to purchase for 15% of the original equipment cost any and
all of the leased assets that the lessor does not request to be returned by
August 31, 2001, with payment being made no later than the earlier of the
completion of certain capital raising or October 31, 2001 and (iii) subject to
satisfaction of the conditions described below for completion of the further
restructuring of the lease obligations, all present and future payment
obligations under the lease have been converted into a promissory note in the
principal amount of approximately $8.6 million, payable on demand after October
31, 2001, bearing interest at an annual rate of 12%.
If EasyLink (i) raises a minimum of $10 million of capital by October 31, 2001
and (ii) enters into restructuring agreements with AT&T with respect to its
outstanding note, George Abi Zeid with respect to his outstanding note and
lessors holding substantially all of its equipment lease obligations on terms
and conditions taken as a whole that are not more favorable to such parties than
the terms of the Modification Agreement, then the $8.6 million promissory note
issued pursuant to the Modification Agreement will be converted into (i) a
convertible promissory note (the "Note") in the reduced principal amount of
approximately $2.6 million, (ii) 2,510,000 shares of EasyLink Class A common
stock and (iii) warrants to purchase 2,510,000 shares of EasyLink Class A common
stock. The Note will be due June 1, 2006 and will bear interest at the rate of
12% per annum, payable semi-annually commencing on the third anniversary. The
Note will be convertible into shares of EasyLink Class A common stock at an
exercise price of $1.00 per share at any time during the term of the Note.
EasyLink may irrevocably elect, within 30 days written notice, to prepay any of
the outstanding balance of the Note or any portion thereof plus accrued interest
for cash. EasyLink is required to file a registration statement covering the
resale of the shares and shares issuable upon exercise of the warrants within 45
days from closing. The warrants will have an expiration date 10 years from the
date of issuance and will have an exercise price equal to the average of the
closing price of the Class A common stock over the 30 trading days ending two
days before the closing of the restructuring.
22
The Company has entered into discussions with its other equipment lessors, AT&T
and Mr. Abi Zeid regarding the proposed restructuring of their lease or debt
obligations under terms and conditions similar to the terms and conditions under
the Modification Agreement. No assurance can be given that the Company will
successfully complete its proposed debt and lease restructuring on acceptable
terms or at all or that it will be able to meet the conditions precedent to
implement the proposed restructuring under the Modification Agreement described
above or any similar agreement entered into with any other party.
Special Meeting of Stockholders
The Company has called a special meeting of stockholders to be held on August
29, 2001 to consider nine separate amendments to amend the Amended and Restated
Certificate of Incorporation, as amended, to enable the Company to effect one or
more reverse stock splits, ranging from a one-for-two reverse split to a
one-for-ten reverse split of all of the Company's Class A common stock and Class
B common stock in order to seek to maintain the listing of its Class A common
stock on the NASDAQ National Market and to facilitate the Company's ability to
raise additional equity capital. If approved by the Company's stockholders at
the special meeting, the Board of Directors of the Company may implement one or
more of or abandon any or all of the proposed amendments until 8 months after
the special meeting.
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
On April 2, 2001, we changed our name to EasyLink Services Corporation. The name
change was made to help create a corporate identity tied to our focus on
outsourced messaging services.
EasyLink Services Corporation, formerly Mail.com, Inc., is a leading global
provider of outsourced messaging services to enterprises and service providers.
Upon the completion of our acquisition of Swift Telecommunications, Inc. on
February 23, 2001, we combined the businesses of Mail.com Business Messaging
Services, Swift Telecommunications and the Easylink Services business acquired
from AT&T Corp. by Swift Telecommunications. As a result of this combination,
Easylink Services Corporation offers a comprehensive portfolio of messaging
services to thousands of business customers worldwide. We offer a broad range of
messaging services to businesses and service providers, including managed e-mail
and groupware hosting services; services that protect corporate e-mail systems
such as virus protection, spam control and content filtering services; message
delivery services such as electronic data interchange or "EDI," telex, desktop
fax, broadcast and production messaging services; and professional messaging
services and support.
We derive revenues from monthly per-user or per-message fees for managed e-mail
and groupware hosting and virus protection, spam control and content filtering
services; monthly per-message and usage-based charges for our message delivery
services; and license and consulting fees for our professional services.
Revenue from e-mail and groupware hosting services, virus protection, spam
control and content filtering services, message delivery services and
professional services is recognized as the services are performed. Facsimile
license revenue is recognized over the average estimated customer life of 3
years.
Until March 30, 2001, we also offered advertising services and consumer e-mail
services to Web sites, ISP's and direct to consumers. In this market, we
provided Web-based e-mail services or WebMail to Internet Service Providers
(ISPs) including several of the world's top ISPs, and we partnered with top
branded Web sites to provide WebMail services to their users. In addition, we
served the market directly through our flagship web site www.mail.com. On
October 26, 2000, the Company announced its intention to sell its advertising
network business and stated that it will focus exclusively on its established
outsourced messaging business. The Company also announced that as a result of
its decision to focus on its outsourced messaging business, it is streamlining
the organization, taking advantage of lower cost areas and further integrating
its technological and operational infrastructures. On March 30, 2001, we
completed the sale of our advertising network and consumer e-mail business to
Net2Phone for $3 million in cash at the closing and on April 13, 2001, received
an additional $500,000 based upon the achievement of certain milestones by
EasyLink. In connection with the sale, we entered into a hosting agreement under
which we will host or arrange to host the consumer e-mailboxes for Net2Phone for
a minimum of one year. During the second quarter of 2001, we completed the
migration of the hosting of these consumer e-mailboxes to a third party provider
whom we pay for this service.
In March 2000, EasyLink formed WORLD.com to develop the Company's extensive
portfolio of domain names into major Web properties, such as Asia.com and
India.com, which serve the worldwide business-to-business and
business-to-consumer marketplace. Through its subsidiaries, WORLD.com generates
revenues primarily from sales of information technology products, system
integration and website development for other companies, advertising related
sales and commissions earned from booking travel arrangements. On November 2,
2000, the Company announced that it will sell all assets not related to its core
outsourced messaging business, including its Asia.com, Inc., and India.com, Inc.
subsidiaries, and its portfolio of category-defining domain names. On May 3,
2001, the Company's majority owned subsidiary Asia.com, Inc. sold its business
to an investor group. See Notes 1 and 2 to our unaudited condensed consolidated
financial statements for additional information.
23
For the quarter ended June 30, 2001, total revenues were $36 million compared to
$15 million for the quarter ended June 30, 2000. Net loss was $59.1 million for
the quarter ended June 30, 2001 as compared to $47.9 million for the quarter
ended June 30, 2000. For the six months ended June 30, 2001, total revenues were
$58.4 million compared to $25 million for the six months ended June 30, 2000.
Net loss was $127.7 million for the six months ended June 30, 2001 as compared
to $90.4 million for the six months ended June 30, 2000.
During the first six months of 2001, we generated approximately 89% of our
revenues from business messaging services and approximately 3% of our revenue
from the advertising network business. We also generated approximately 8% of our
revenues from the sales of information technology products and the provision of
local content and other Internet services associated with WORLD.com. During the
first six months of 2000, we generated approximately 52% of our revenues from
business messaging services, approximately 42% of our revenue from the
advertising network business and approximately 6% of our revenues from the sales
of information technology products and the provision of local content and other
Internet services associated with WORLD.com.
For the six months ended June 30, 2001 and 2000, approximately $54 million and
$11 million, respectively, of our revenue was generated from companies we
acquired since January 1, 2000. As indicated in Note 1 of the notes to our
unaudited condensed consolidated financial statements, in the future, our focus
will be centered exclusively on the outsourced business messaging market.
Prior to March 30, 2001, advertising revenues were derived principally from the
sale of banner advertisements. Other advertising revenue sources included
up-front placement fees and promotions. The Company's advertising products
consisted of banner advertisements that appeared on pages within the Company's
properties, promotional sponsorships that were typically focused on a particular
event and merchant buttons on targeted advertising inventory encouraging users
to complete a transaction.
The Company also traded advertisements on its Web properties in exchange for
advertisements on the Internet sites of other companies. Barter revenue, which
is a component of advertising revenue, amounted to $563,000 and $434,000 for the
six months ended June 30, 2001 and 2000, respectively. For the six months ended
June 30, 2001 and 2000, barter expenses, which are a component of cost of
revenues, were approximately $563,000 and $282,000, respectively.
Domain development revenues include revenues generated by WORLD.com and consist
primarily of sales of information technology products. Revenues are also
generated from system integration and website development, advertising, and
commissions from booking travel arrangements. Revenues for the quarter ended
June 30, 2001 were $2.2 million and compared to $1.4 million in the quarter
ended June 30, 2000. For the six months ended June 30, 2001 domain development
revenues were $4.8 million as compared to $1.4 million for the prior year
period. On May 3, 2001, the Company's majority owned subsidiary Asia.com, Inc.
sold its business to an investor group for $1.5 million in cash and assumed $1.5
million of liabilities.
Although we have experienced substantial growth in revenues in recent periods,
we have incurred substantial operating losses since inception and will continue
to incur substantial losses for the foreseeable future. As of June 30, 2001, we
had an accumulated deficit of approximately $434.8 million.
In light of the evolving nature of our business and 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. We do not believe that our historical growth
rates are indicative of future results.
Our prospects should be considered in light of risks, expenses and difficulties
encountered by companies in the early stages of development, particularly
companies in the rapidly evolving Internet market. See "Risk Factors That May
Affect Future Results".
STOCK AND WARRANT ISSUANCES
During the six months ended June 30, 2001, the Company issued 614,749 shares of
Class A common stock to certain former employees of Asia.com and India.com as
severance payments valued at approximately $655,000.
During the quarter ended June 30, 2001 we issued 317,460 shares and 604,230
shares, respectively of our Class A common stock to an investment bank as
payment for services rendered in connection with the sale of our advertising
network and to a vendor as payment for services.
In June 2001, we issued warrants to purchase 500,000 shares of EasyLink Class A
common stock, 250,000 to each of two individuals associated with an investment
bank that is assisting the Company in raising funds through a private placement.
The warrants shall vest and become exercisable by each holder in two separate
tranches: (i) 125,000 shares of EasyLink Class A common stock shall vest
immediately on the date that the investment bank initiates marketing of, and
presents to its sales force in connection with, the proposed private placement
on behalf of the Company; and (ii) an additional 125,000 shares of Common Stock
shall vest upon the earlier of: (i) at the discretion of the management of the
Company, on the date that is sixty days after the date hereof; or (ii) the
consummation of a transaction by the Company with a strategic partner. We
recorded a deferred cost of approximately $115,000 in the aggregate as a result
of the issuance of these warrants and will amortize them as services are
rendered are over the vesting period, as appropriate.
Under an agreement with CNN entered into August 1998, we issued 253,532 shares
of our Class A common stock upon execution of a contract in August 1998. We
agreed to issue the shares in anticipation of CNN's fulfillment of promotional
obligations under the contract. We capitalized approximately $887,000 as a
partner advance, the market value of the stock we issued and then amortized that
amount over the length of the contract. During the three and six month periods
ended June 30, 2000 we recorded approximately $111,000 and $222,000,
respectively, of amortization expense for this agreement and this amount is
included in sales and marketing expenses.
Prior to May 1, 1999, we were required to issue to CNET, Snap and NBC Multimedia
shares of our Class A common stock for each member who registers at their sites.
On May 1, 1999, we entered into an agreement to settle in full its contingent
obligation to issue shares of our Class A common
24
stock to CNET, Snap and NBC Multimedia as described above. Pursuant to this
agreement, we issued upon the closing of our initial public offering in June
1999, 2,368,907 shares of Class A common stock at a value of $7.00 per share in
the aggregate to CNET and Snap and 210,000 shares of Class A common stock at a
value of $7.00 per share to NBC Multimedia. We capitalized $18 million in
connection with the issuance of these shares and are ratably amortizing the
amount over the period from the closing of the initial public offering (June 23,
1999) through May 2001. We recorded approximately $2.3 million of amortization
expense for the three months ended June 30, 2000. For the six months ended June
30, 2001 and 2000, we recorded approximately $2.3 million and $4.6 million of
amortization expense. The remaining $1.5 million of unamortized costs were
written off as a part of the loss on the sale of the advertising network.
Under a letter agreement and interim agreement dated May 26, 1999 and July 26,
1999, respectively, AT&T Corp. ("AT&T") and we agreed to negotiate in good faith
to complete definitive agreements to establish a strategic relationship. We have
not entered into a definitive agreement to establish the proposed strategic
relationship, and, effective March 30, 2000, the letter agreement and the
Interim Agreement were terminated. Under the May 26, 1999 letter agreement, we
issued warrants to purchase 1.0 million shares of Class A common stock at $11.00
per share. AT&T had the option to exercise the warrants at any time on or before
December 31, 2000. Since AT&T did not exercise the warrants on or before
December 31, 2000, the warrants expired and were cancelled.
We recorded a deferred cost of approximately $4.3 million in the aggregate as a
result of the issuance of these warrants to AT&T. As a result of the termination
of the May 26 letter agreement and the July 26 interim agreement, the remaining
unamortized portion of deferred costs of $3.3 million was expensed during the
first quarter of 2000.
During the six months ended June 30, 2000, the Company issued 104,347 shares of
Class A common stock valued at approximately $1.8 million to an employee in lieu
of compensation.
ACQUISITIONS, INVESTMENTS AND DIVESTITURES
On February 23, 2001, we acquired Swift Telecommunications, Inc., ("STI"). In
January 2001, STI acquired the EasyLink Services business ("EasyLink Services")
from AT&T Corp. STI, together with its newly acquired EasyLink Services
business, is a global provider of messaging services such as telex, fax,
electronic data interchange and e-mail.
At the closing of the acquisition by STI of the EasyLink Services business from
AT&T, we advanced $14 million to STI in the form of a loan, the proceeds of
which were used to fund part of the cash portion of the purchase price to AT&T.
Upon the closing of the acquisition of STI, we assumed a $35 million note issued
by STI to AT&T. The $35 million note is secured by the assets of STI, including
the EasyLink Services business, and the shares of the Company's Class A common
stock to be issued to the sole shareholder in the Merger. The note is payable in
equal monthly installments over four years and bears interest at the rate of 10%
per annum for the first six months of the note. Thereafter the rate is adjusted
every six months equal to 1% plus the prime rate as listed in the Wall Street
Journal on such date of adjustment. In the event of a non payment after such
payment is due, the remainder of the unpaid balance shall accrue interest at a
rate of 3% per annum above the rate previously described. The note is subject to
mandatory prepayment upon the sale of specified assets of STI, including the
EasyLink Services business, and in certain other events. The note also contains
certain customary covenants and events of default, including limitations on our
ability to incur additional indebtedness and to incur additional liens on the
STI and EasyLink assets. AT&T has granted us the right to defer current payments
under the note pending successful completion of discussions to restructure the
indebtedness under the note. As of June 30, 2001, interest on the unpaid balance
is accruing at a rate of 13% per annum. AT&T may terminate the deferral upon
written notice at any time prior to implementation of any restructuring
agreement.
Upon the closing of the acquisition of STI, we paid to the sole shareholder of
STI $835,294 in cash and issued an unsecured note for approximately $9.2 million
and 18,766,176 shares of the Company's Class A common stock valued at
approximately $30.8 million as the purchase price for the acquisition of STI. We
will also pay additional consideration to the sole shareholder of STI equal to
the amount of the net proceeds, after satisfaction of certain liabilities of STI
and its subsidiaries, from the sale or liquidation of the assets of one of STI's
subsidiaries. We also reimbursed the sole shareholder of STI for a $1.5 million
advance made to STI, the proceeds of which were used to fund the balance of the
cash portion of the purchase price for STI's acquisition of the EasyLink
Services business and certain other obligations to AT&T. The $9.2 million note
will be payable in four equal semi-annual installments over two years and may be
prepaid in whole or in part at any time and from time to time without payment of
premium or penalty. The note will be non-interest bearing unless we fail to make
a required payment within 30 days after the due date therefore. Thereafter, the
note will bear interest at the rate of 1% per month. The note also contains
certain customary events of default. The former sole shareholder of STI, who is
now an officer of the Company, has granted us the right to defer current
payments under the note pending successful completion of discussions to
restructure the indebtedness under the note. The holder of the note may
terminate the deferral upon written notice at any time prior to implementation
of any restructuring agreement.
As part of the transaction with STI, we also agreed to acquire Telecom
International, Inc. (which is an affiliate of STI and conducts business under
the name "AlphaTel") and the 25% minority interests in two STI subsidiaries for
$164,705 in cash, promissory notes in the aggregate principal amount of
approximately $1.8 million and 3.7 million shares of EasyLink Class A common
stock. These additional transactions are subject to execution and delivery of
definitive documentation, satisfactory completion of due diligence, receipt of
regulatory approvals and other customary conditions.
During the second quarter of 2001, we acquired a US and India based company for
approximately $600,000, including acquisition costs. The terms were $300,000 in
cash and 196,000 shares of EasyLink Class A common stock valued at approximately
$273,000, based upon our average trading price surrounding the date of
acquisition. The excess of the purchase price over the fair market value of the
assets acquired and assumed liabilities has been allocated to goodwill
($831,000), which is being amortized over a period of three years, the expected
period of benefit. The acquisition was accounted for as a purchase business
combination.
On February 8, 2000, we acquired NetMoves Corporation ("NetMoves"), a provider
of Internet fax transmission services for approximately $168.3 million including
acquisition costs of approximately $2.1 million. The acquisition was accounted
for as a purchase business combination. We issued 6,343,904 shares of Class A
common stock valued at approximately $145.7 million based upon our average
trading price at the date of acquisition. In
25
addition, we assumed outstanding options and warrants of NetMoves which
represent the right to purchase 962,443 shares and 57,343 shares respectively,
of our Class A common stock at weighted average exercise prices of $6.69 and
$8.64, respectively. The options and warrants were valued at an aggregate of
approximately $20.5 million.
NetMoves (now named EasyLink Services USA, Inc.) designs, develops and markets
to businesses a variety of Internet document delivery services, including
e-mail-to-fax, fax-to-e-mail, fax-to-fax and broadcast fax services. This
acquisition enhanced our presence in the domestic and international business
service market, provided us with an established sales force and international
distribution channels and expanded our offering of Internet-based messaging
services.
On March 14, 2000, we acquired eLong.com, Inc., a Delaware corporation
("eLong.com") for approximately $62 million including acquisition costs of
approximately $365,000. eLong.com, through its wholly owned subsidiary in the
People's Republic of China, operates the Web Site www.eLong.com, which is a
provider of local content and other internet services. The acquisition was
accounted for as a purchase business combination. Concurrently with the merger,
eLong.com changed its name to Asia.com, Inc. ("Asia.com"). In the merger, we
issued to the former stockholders of eLong.com an aggregate of 3,599,491 shares
of EasyLink Class A common stock valued at approximately $57.2 million, based
upon our average trading at the date of acquisition. All outstanding options to
purchase eLong.com common stock were converted into options to purchase an
aggregate of 279,289 shares of EasyLink Class A common stock. The options were
valued at approximately $4.4 million.
During the fourth quarter of 2000, we wrote off approximately $7.8 million of
goodwill, as it was determined that the carrying value had become permanently
impaired as a result of our November 2, 2000 decision, as approved by the Board
of Directors, to sell all assets not related to its core outsourcing business,
including its Asia-based businesses. Additionally, as a result of the continued
eroding market conditions in Asia and the decision to accelerate the divestiture
during the first quarter of 2001, approximately $35 million of goodwill was
written-off as it was determined that the carrying vale of the remaining
goodwill had been permanently impaired. After giving effect to the write off,
the net goodwill balance was reduced to $0. Please see the discussion on
Impairment Charges included in the Results of Operations and Liquidity and
Capital Resources sections below for additional information.
In addition, we were obligated to issue up to an additional 719,899 shares of
EasyLink Class A common stock in the aggregate to the former stockholders of
eLong.com if EasyLink or Asia.com acquires less than $50.0 million in value of
businesses engaged in developing, marketing or providing consumer or business
internet portals and related services focused on the Asian market or a portion
thereof, or businesses in furtherance of such a business, prior to March 14,
2001. On May 3, 2001, in connection with the sale of eLong.com, we settled this
obligation by issuing 75,000 shares of our Class A common stock valued at
$51,000 to the former stockholders of eLong.com. We accounted for this
transaction as part of the loss on the sale of Asia.com.
In the merger, certain former stockholders of eLong.com retained shares of Class
A common stock of Asia.com representing approximately 4.0% of the outstanding
common stock of Asia.com. Under a separate Contribution Agreement with Asia.com
these stockholders contributed an aggregate of $2.0 million in cash to Asia.com
in exchange for additional shares of Class A common stock of Asia.com,
representing approximately 1.9% of the outstanding common stock of Asia.com.
Pursuant to the Contribution Agreement, we (1) contributed to Asia.com the
domain names Asia.com and Singapore.com and $10.0 million in cash and (2) agreed
to contribute to Asia.com up to an additional $10.0 million in cash over the
next 12 months and to issue, at the request of Asia.com, up to an aggregate of
242,424 shares of EasyLink Class A common stock for future acquisitions. As a
result of the transactions effected pursuant to the Merger Agreement and the
Contribution Agreement, EasyLink initially owned shares of Class B common stock
of Asia.com representing approximately 94.1% of the outstanding common stock of
Asia.com. Our ownership percentage decreased to 92% as of December 31, 2000.
Asia.com granted to management employees of Asia.com options to purchase Class A
common stock of Asia.com representing, as of December 31, 2000, 9% of the
outstanding shares of common stock after giving effect to the exercise of such
options.
On May 3, 2001, our majority owned subsidiary Asia.com, Inc. sold its business
to an investor group. Under the terms of the sale, the buyer paid Asia.com $1.5
million and assumed eLong.com liabilities of approximately $1.5 million. The
consideration paid was determined as a result of negotiations between the buyer
and EasyLink. In addition the Company issued 200,000 shares of its Class A
common stock valued at approximately $138,000 to certain former shareholders in
exchange for the cancellation of options issued upon the purchase of eLong.com,
as described above. We accounted for this transaction as part of the sale of the
business of Asia.com. As a result of the sale, we recorded a loss on the sale of
eLong.com, Inc. of approximately $264,000.
During the first quarter of 2001, management determined that a portion of the
carrying value of the other intangible assets associated with TCOM had become
impaired due to the restructuring of the workforce that had generated those
intangible assets upon acquisition in October 1999. As a result a restructuring
charge of $4.3 million was recorded. During the second quarter of 2001, we
settled a contingent obligation with the former owners of TCOM by issuing
1,620,333 shares of its Class A common stock valued at approximately $1.3
million and paying cash of $300,000. We determined that the value of the other
intangible assets, primarily workforce, had become further impaired due to the
resignation of the remaining workforce, and accordingly recorded an impairment
charge of approximately $1.3 million during the second quarter of 2001. After
giving effect to the write-off, the net goodwill balance was reduced to $0.
On March 16, 2000, in exchange for $2 million in cash and 185,686 shares of our
Class A common stock valued at approximately $2.9 million, we acquired a domain
name from and made a 10% investment in Software Tool and Die, a Massachusetts
Corporation. Software Tool and Die is an Internet Service Provider and provides
Web hosting services. We concluded that the carrying value of this cost-based
investment was permanently impaired based on the achievement of business plan
objectives and milestones and the fair value of the investment relative to our
carrying value. During the fourth quarter of 2000, we recorded an impairment
charge of $4.2 million due to an other-than-temporary decline in the value of
this investment due to the decrease in net book value of the investment caused
by its losses. This amount is included in impairment of investments within other
income (expense) in our 2000 statement of operations. Please see the section on
Impairment Charges included in the Results of Operations section below for
additional information.
26
On March 31, 2000, we acquired a Mauritius entity, which in turn owned 80% of an
Indian subsidiary, to facilitate future investments in India. The terms were
$400,000 in cash and a $1 million 7% note payable due one year from closing. In
June 2000, the Company acquired through the Mauritius entity the remaining 20%
of the Indian subsidiary for $2.2 million in cash. In connection with this
acquisition, we incurred a $1.8 million charge related to the issuance of
104,347 shares of Class A common stock, as compensation for services performed,
and in June 2000, we paid $200,000 cash and an additional $200,000 payable in
our Class A common stock as compensation for employees. During the second
quarter of 2001, management determined that the value of the goodwill associated
with the Mauritius entity had become impaired, based upon the expected proceeds
of the sale of India.com. As a result the Company wrote off approximately $3.2
million of goodwill. After giving effect to the write-off, the net goodwill
balance was reduced to $0.
On April 17, 2000, in exchange for $500,000 in cash, the Company acquired
certain source code technologies, trademarks and related contracts relating to
the InTandem collaboration product ("InTandem") from IntraACTIVE, Inc., a
Delaware corporation (now named Bantu, Inc., "Bantu"). On the same date, the
Company also paid Bantu an upfront fee of $500,000 for further development and
support of the InTandem product. On the same date, pursuant to a Common Stock
Purchase Agreement, the Company acquired shares of common stock of Bantu
representing approximately 4.6% of Bantu's outstanding capital stock in
exchange for $1 million in cash and 462,963 shares of our Class A common stock,
valued at approximately $3.6 million. Pursuant to the Common Stock Purchase
Agreement, the Company also agreed to invest up to an additional $8 million in
the form of shares of our Class A Common stock in Bantu in three separate
increments of $4 million, $2 million and $2 million, respectively, based upon
the achievement of certain milestones in exchange for additional shares of Bantu
common stock representing 3.7%, 1.85% and 1.85%, respectively, of the
outstanding common stock of Bantu as of April 17, 2000. The number of shares of
the Company's Class A common stock issuable at each closing will be based on the
greater of $9 per share and the average of the closing prices of the Company's
Class A common stock over the five trading days prior to such closing date. In
July 2000, the Company issued an additional 92,593 shares of the Company's Class
A common stock valued at approximately $590,000 to Bantu in accordance with a
true-up provision in the Common Stock Purchase Agreement. In September 2000, the
Company issued an additional 444,444 shares of our Class A common stock valued
at approximately $2.9 million as payment for the achievement of a milestone
indicated above. In January 2001, the Company issued an additional 222,222
shares of our Class A common stock valued at approximately $285,000 as payment
for the achieved milestone indicated above. The Company accounts for this
investment under the cost method. During the second quarter of 2001, management
made an assessment of the carrying value of its investment, based upon an
incremental investment by a third party, and determined that the carrying value
of this cost-based investment was permanently impaired as it was in excess of
its estimated fair value. Accordingly, we wrote down the value of its investment
in Bantu by $7.3 million as we determined that the decline in its value was
other-than-temporary.
During the second quarter of 2000, Asia.com acquired three companies for
approximately $18.4 million, including acquisition costs. Payments consisted of
cash approximating $500,000, 1,926,180 shares of our Class A common stock valued
at approximately $11.6 million and 4,673,448 shares of Asia.com Class A common
stock valued at approximately $6.1 million, all of which were based upon our
average trading price on the dates of acquisition. During the fourth quarter of
2000, approximately $12 million of goodwill was written off as we determined
that the carrying value of the goodwill associated with one of these
acquisitions focused on the wireless sector had become permanently impaired as a
result of our November 2, 2000 decision, as approved by the Board of Directors,
to sell all assets not related to its core outsourcing business, including its
Asia-based businesses. During the first quarter of 2001, an additional $3.1
million was written off as we determined that the carrying value of the goodwill
associated with the acquisition focused on the wireless sector had become
permanently impaired. After giving effect to the write-off, the net goodwill
balance was reduced to $0. Please see the discussion on Restructuring Charges
included in the Results of Operations section below for additional information.
Under a stock purchase agreement associated with one of the Asia.com
acquisitions, we agreed to pay a contingent payment of up to $5 million if
certain wireless revenue targets are reached after the closing. The contingent
payment was payable shares of our Class A common stock, cash or, under certain
circumstances, Asia.com Class A common stock. Since Asia.com is no longer
pursuing its wireless business, management does not expect to achieve these
wireless revenue targets and, accordingly, does not expect to issue any
additional consideration.
On July 14, 1999, we purchased an equity interest in 3Cube, Inc ("3Cube"). Under
the agreement, we paid $1.0 million in cash and issued 80,083 shares of our
Class A common stock, valued at approximately $2.0 million, in exchange for
307,444 shares of 3Cube convertible preferred stock, which represents an equity
interest of less than 20% in 3Cube. We recorded this transaction under the cost
method. This agreement also included a technology licensing arrangement, whereby
3Cube agreed to integrate its Internet facsimile technology into our email
service across our partner network. On June 30, 2000, the Company made an
additional investment in 3Cube by issuing 255,049 shares of Class A common stock
valued at approximately $1.5 million in exchange for 50,411 shares of 3Cube
Series C Preferred Stock. As of December 31, 2000 we owned preferred stock of
3Cube representing an ownership interest of 21% of the combined common and
preferred stock outstanding of 3Cube. Accordingly, we now account for this
investment under the equity method of accounting. Under the equity method, our
proportionate share of each investee's operating losses and amortization of the
investor's net excess investment over its equity in each investee's net assets
is included in loss on equity investments. The effect of this change from the
cost method to the equity method of accounting resulted in a decrease of the
carrying value of the investment by $2.1 million. In addition, in December 2000,
we wrote down the value of our investment in 3Cube by $200,000 as it was
determined that the decline in its value was other-than-temporary. During the
first quarter of 2001, we further reduced our investment in 3Cube by $59,000 to
$2 million, representing the amount we received upon the sale of our investment
in August 2001.
On July 25, 2000, we entered into a strategic relationship with BulletN.net,
Inc. The investment has been accounted for under the cost method of accounting,
as we own less than 20% of the outstanding stock of BulletN.net. As part of this
agreement BulletN.net issued 666,667 shares of its common stock and a warrant to
purchase up to 666,667 shares of BulletN.net common stock to us in exchange for
364,431 shares of our Class A common stock valued at approximately $3.1 million.
We concluded that the carrying value of this cost-based investment was
permanently impaired based on the achievement of business plan objectives and
milestones and the fair value of the investment relative to its carrying value.
During the first quarter of 2001, we recorded an impairment charge of $2.6
million due to an other-than-temporary decline in the value of this investment.
This amount is included in impairment of investments within other income
(expense) in the March 31, 2001 statement of operations. On March 1, 2001, in
consideration of the exchange and cancellation of the 666,667 warrants at $3.75
per share and the waiver of certain anti-dilution rights, we received a new
warrant to purchase 266,667 shares of BulletN.net common stock at $1.00 per
share.
27
On June 30, 2000, the Company received 35,714 shares of common stock of
Onview.com valued at $125,000 as payment for the Company's advertising services.
During the second quarter of 2001, the Company determined that the value of this
investment had become permanently impaired and recorded an impairment charge of
$125,000.
DEFERRED COMPENSATION
We have recorded amortization of deferred compensation of approximately $0 and
$91,000 for the quarter ended June 30, 2001 and 2000, respectively, in
connection with the grant of stock options to one of our officers. For the six
months ended June 30, 2001 and 2000, we recorded $0 and $183,000 of amortization
expense. This deferral, which totaled $1.1 million at the date of the grant,
represented the difference between the deemed fair value of our common stock for
accounting purposes and the exercise price of the options at the date of grant.
This amount is represented as a reduction of stockholders' equity and amortized
over the three-year vesting period. Amortization of deferred stock compensation
is charged to sales and marketing expense on the statement of operations. During
the fourth quarter of 2000, the officer's employment terminated and the
remaining $387,000 of unamortized deferred compensation was charged to
additional paid in capital, representing forfeited options.
During the second quarter of 1999, we issued 105,150 and 5,000 stock options to
certain employees at $5.00 per share. The fair value of our common stock on the
dates of grant was $11 and $7 per share, respectively. Accordingly, we recorded
deferred compensation of approximately $641,000 in connection with these
options. At March 31, 2001, all of the employees' employment was terminated and
the remaining unamortized deferred compensation of $141,000 was charged to
additional paid in capital, representing forfeited options.
As a result of our acquisition of the EasyLink services business from AT&T in
February 2001, we recorded deferred compensation of approximately $509,000
associated with the issuance of our Class A common stock to certain employees.
Amortization of deferred compensation associated with this issuance was
approximately $127,000 and $212,000 for the three and six months ended June 30,
2001.
RESULTS OF OPERATIONS THREE AND SIX MONTHS ENDED JUNE 30, 2001 AND 2000
Revenue
Revenues for the three months ended June 30, 2001 were $36 million, as compared
to $15 million for the comparable period in 2000. Revenues for the six months
ended June 30, 2001 were $58.4 million as compared to $25 million for the
comparable period in 2000. The increases were due primarily to revenues
generated from the business messaging market as well as revenues associated with
our acquisition of STI on February 23, 2001. The second quarter of 2001 reflects
a full quarter of revenues from STI.
Business messaging revenues for the three months ended June 30, 2001 were $33.9
million as compared to $7.4 million for the comparable period of 2000. For the
six months ended June 30, 2001 and 2000, business messaging revenues were $51.9
million and 12.1 million, respectively. Business messaging revenues were derived
from managed e-mail and groupware hosting services; services that protect
corporate e-mail systems such as virus protection, spam control and content
filtering services; message delivery services such as electronic data
interchange or "EDI," telex, desktop fax, broadcast and production messaging
services; and professional messaging services and support.
Advertising network revenues for the three months ended June 30, 2001 were $0 as
compared to $5.9 million for the three months ended June 30, 2000. For the first
six months of 2001 advertising network revenues were $1.7 million as compared to
$10.5 million for the comparable period of 2000. On March 30, 2001, we sold our
advertising network to Net2Phone, Inc. Net2Phone paid us $3 million in cash at
the closing and on April 13, 2001, received an additional $500,000 based upon
the achievement of certain milestones by us. In connection with the sale the
parties entered into a hosting agreement whereby we will receive payments for
hosting the consumer mailboxes for a minimum of one year. During the second
quarter of 2001, we have completed the migration of the hosting of these
consumer mailboxes to a third party provider whom we pay for this service.
Advertising network revenues were derived principally from the sale of banner
advertisements. Other advertising revenue sources included up-front placement
fees and promotions. The Company's advertising products consisted of banner
advertisements that appeared on pages within the Company's properties,
promotional sponsorships that were typically focused on a particular event and
merchant buttons on targeted advertising inventory encouraging users to complete
a transaction.
The Company also traded advertisements on its Web properties in exchange for
advertisements on the Internet sites of other companies. Barter revenue, which
is a component of advertising revenue, amounted to $563,000 and $434,000 for the
six months ended June 30, 2001 and 2000. For the six months ended June 30, 2001
and 2000, barter expenses, which are a component of cost of revenues, were
approximately $563,000 and $282,000, respectively.
Domain development revenues were $2.2 million for the quarter ended June 30,
2001 as compared to $1.4 million for the quarter ended June 30, 2000. Domain
development revenues were $4.8 million for the six months ended June 30, 2001 as
compared to $1.4 million for the six months ended June 30, 2000. On May 3, 2001,
the Company's majority owned subsidiary Asia.com, Inc. sold its business to an
investor group. As a result, revenues associated with domain development will
decline in the future.
OPERATING EXPENSES
Cost of Revenues
Cost of revenues for the three months ended June 30, 2001 was $24.3 million, as
compared to $13.9 million for the comparable period in 2000. For the six months
ended June 30, 2001 cost of revenues were $45.3 million as compared to $23.8
million in the comparable period of 2000. The increase in costs reflects the
effects of increased revenue and higher margin products associated with our
acquisition of Swift Telecommunications Inc. and the EasyLink Services
businesses in February 2001. Gross margin for the three months ended June 30,
2001 improved to 33% as compared to 8% for the comparable period of 2000. Gross
margin for the six months ended June 30, 2001 improved to 22% as compared to 5%
for the
28
comparable period of 2000. Cost of revenues consists primarily of costs incurred
in the delivery and support of our facsimile 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, databases and graphics as well as our e-mail
service. Cost of revenues also includes costs associated with licensing third
party network software. In addition, as it related to our advertising network,
we reported the cost of barter trades, amortization of certain domain assets in
cost of revenues. For the three and six month periods ended June 30, 2001, cost
of revenues reflects costs associated with Swift Telecommunications, Inc. and
the EasyLink Services business which were acquired in February 2001, as well as
a full six months of costs associated with NetMoves, which was acquired in
February 2000 as well as WORLD.com, which we commenced during the first quarter
of 2000. For the three and six months ended June 30, 2000, cost of revenues
includes costs associated with our advertising network that was sold in March
2001 as well as the Asia.com business on May 3, 2001. During the first six
months of 2001, barter expense was approximately $563,000 as compared to
$282,000 during the comparable period in 2000. We anticipate that cost of
revenues associated with our outsourced messaging business will increase.
Sales and Marketing Expenses
Sales and marketing expenses were $8.2 million for the three months ended June
30, 2001 as compared to $16.9 million for the comparable period in 2000. For the
six months ended June 30, 2001 and 2000, sales and marketing costs were $20.5
million and 31.8 million, respectively. The $8.7 million and $11.3 million
decreases was primarily due to the reduction and eventual elimination of
expenditures associated with our advertising network in anticipation of and
eventual sale of that business on March 30, 2001 and the sale of our Asia.com
business on May 3, 2001. Partially offsetting these reductions was an increase
in expenses as a result of the acquisition of STI. Included in this category are
costs related to salaries and commissions for sales, marketing, and business
development personnel. Prior to the sale of our advertising network, this
category included costs associated with various advertising campaigns to build
our brand. One of the primary components of sales and marketing expenses were
customer acquisition costs related to our advertising network. Such costs were
$1.4 million in the first six months of 2000. We are no longer incurring such
costs in 2001. An amendment to the CNET, Snap and NBC agreement signed during
the second quarter of 1999 eliminated the monthly issuance of shares, but
required us to issue shares under the contract simultaneously with our initial
public offering in June 1999. The value of these shares ($18.1 million) was
being amortized over the subsequent two-year period. We recorded approximately
$2.3 million of amortization expense in connection with the issuance of these
shares during the three-month period ended June 30, 2000. Amortization expense
for the six months ended June 30, 2001 and 2000 was $2.3 million and $4.6
million, respectively. We also recorded $0, and $111,000 in amortization of
partner advances of shares to CNN for the quarter ended June 30, 2001 and 2000,
respectively. Amortization expense for the six months ended June 30, 2001 and
2000 was $0 and 222,000, respectively. As previously mentioned, during the first
quarter of 2000, the Company expensed $3.3 million of deferred costs related to
the AT&T warrants. We anticipate that sales and marketing costs will decrease in
the future.
General and Administrative
General and administrative expenses were $13.6 million during the three months
ended June 30, 2001 as compared to $9.7 million during the comparable period of
2000. For the six months ended June 30, 2001, general and administrative costs
were $25.5 million as compared to $18.4 million for the six months ended June
30, 2000. The $3.9 million and $7.1 million increase was attributable to higher
costs associated with our acquisition of STI and the EasyLink Services business
in February 2001, partially offset by reductions in expenses associated with our
advertising network in anticipation of and eventual sale of that business on
March 30, 2001 and the sale of our Asia.com business on May 3, 2001. At June 30,
2001, the number of employees was approximately 859, as compared to 1,229 at
June 30, 2000. General and administrative expenses consist primarily of
compensation and other employee costs including customer support and other
corporate functions as well our provision for doubtful accounts and overhead
expenses.
In connection with the Mauritius acquisition made during the first quarter of
2000, we incurred a $1.8 million charge related to the issuance of 104,347
shares of Class A common stock as compensation for services performed. We
anticipate that general and administrative costs will decrease in subsequent
periods showing the effect of transitioning support services from AT&T and
integrating them with our internal services.
Product Development
Product development costs were $2.8 million for the three months ended June 30,
2001 as compared to $5.5 million in comparable period of 2000. For the six
months ended June 30, 2001, product development costs were $6.2 million as
compared to $9.1 million for the six months ended June 30, 2000. Product
development costs consist primarily of personnel and consultants' time and
expense to research, conceptualize, and test product launches and enhancements
to e-mail products and our partners' and our e-mail web site. The decreases of
$2.7 million and $2.9 million reflect the reduction of expenditures associated
with outsourcing our consumer email platform to a third party and the sale of
our Asia.com business on May 3, 2001. We anticipate that product development
costs will remain steady in future periods.
Amortization of Goodwill and Other Intangible Assets and Write-off of Acquired
In-Process Technology
Goodwill represents the excess of the purchase price over the fair market value
of the net assets acquired and is being amortized over a 3 to 10 year period.
Amortization of goodwill and other intangible assets for the three months ended
June 30, 2001 was $13.0 million as compared to $16.7 for the three months ended
June 30, 2000. Amortization of goodwill and other intangible assets for the six
months ended June 30, 2001 was $28.8 million as compared to $24.6 million for
the comparable period of 2000. The write-off of acquired in-process technology
of $7.7 million was attributable to our acquisition of NetMoves in February
2000.
Restructuring Charges
During the first six months of 2001, we recorded a restructuring charge of $72.0
million in accordance with the provisions of EITF 94-3, and Staff Accounting
Bulletin 100. Our restructuring initiatives are related to our strategic
decisions to exit the consumer messaging business and WORLD.com business and to
focus on the Company's outsourced messaging business.
29
During the first half of 2001, the Company's restructuring program included an
incremental reduction in the workforce of approximately 150 employees. Asset
disposals of $68.6 million reflect write-downs of goodwill and other intangible
assets of $44.5 million primarily in connection with management's decision to
sell its WORLD.com properties, the majority of which related to its Asian portal
business (see Note 2), and a write-down of $24.1 million of excess fixed assets
and other assets to their net realizable values.
The following sets forth the activity in the Company's restructuring reserve (in
thousands):
Beginning Current year- Current year- Ending
balance provision utilization balance
------- ------------- ----------- -------
Employee termination benefits .................... $ 559 $ 2,376 $ 2,324 $ 611
Lease abandonments ............................... 3,136 1,034 3,030 1,140
Asset disposals .................................. -- 68,601 68,601 --
Other exit costs ................................. 353 2 313 42
-------- ------------ ------------ ------------
$ 4,048 $ 72,013 $ 74,268 $ 1,793
======== ============ ============ ============
Impairment Charges
The Company's management performs on-going business reviews and, based on
quantitative and qualitative measures, assesses the need to record impairment
losses on long-lived assets used in operations when impairment indicators are
present.
Where impairment indicators were identified, management determined the amount of
the impairment charge by comparing the carrying value of goodwill and other
long-lived assets to their fair values. These evaluations of impairments are
based upon an achievement of business plan objectives and milestones of each
business, the fair value of each ownership interest relative to its carrying
value, the financial condition and prospects of the business and other relevant
factors. The business plan objectives and milestones that are considered include
among others, those related to financial performance, such as achievement of
planned financial results and completion of capital raising activities, if any,
and those that are not primarily financial in nature, such as launching or
enhancements of a web site or product, the hiring of key employees, the number
of people who have registered to be part of the associated business' web
community, and the number of visitors to the associated business' web site per
month. Management determines fair value based on the market approach, which
includes analysis of market price multiples of companies engaged in lines of
business similar to the business being evaluated. The market price multiples are
selected and applied to the business based on the relative performance, future
prospects and risk profile of the business in comparison to the guideline
companies. As a result, during management's quarterly review of the value and
periods of amortization of both goodwill and other long-lived assets, it was
determined that the carrying value of goodwill and certain other intangible
assets were not fully recoverable.
The e-mail addresses for many of the domains were sold to Net2Phone as part of
the sale of the advertising network. As a result of this and eroding market
conditions, management determined that the carrying value of many of these
domains were impaired and recorded an impairment charge of $3.4 million to
reduce the carrying value of these assets to anticipated values to be received
from a third party in the first quarter of 2001.
During the second quarter of 2001, we recorded additional impairment charges of
approximately $6.7 million as management determined that the carrying value of
certain intangible and other assets were permanently impaired. This charge is
comprised of write-downs to intangible assets, primarily workforce, of TCOM
valued at $1.3 million, goodwill associated with India.com of $3.4 million and
goodwill associated with a messaging acquisition of $826,000 and certain fixed
and other assets related to India.com of $1.2 million.
Loss on Sale of Businesses
This represents a $2.3 million loss attributable to the sale of our advertising
network that was sold on March 30, 2001 and a $264,000 loss on the sale of the
Asia.com business that was sold on May 3, 2001.
Other Income (Expense), Net
Interest income for the three months ended June 30, 2001 was $142,000 as
compared to $1.5 million during the comparable period of 2000. Interest income
for the six months ended June 30, 2001 was $486,000 as compared to $3.4 million
during the comparable period of 2000. The decreases were due to lower cash
balances.
Interest expense was $2.5 million for the three months ended June 30, 2001 as
compared to $2.3 million in the comparable period of 2000. Interest expense was
$5.6 million for the six months ended June 30, 2001 as compared to $4.1 million
in the comparable period of 2000. The increase was primarily due to our
convertible note offering in January 2000, notes payable in conjunction with our
acquisition of STI in February 2000, the issuance of senior convertible notes
during the first quarter of 2001 as well as capital lease obligations. Most of
our computer equipment purchases were financed under capital leases.
As indicated above, management performs on-going business reviews and, based on
quantitative and qualitative measures, assesses the need to record impairment
losses on its investments when impairment indicators are present. Management
determined that the decline in value of one of its cost investments was
other-than-temporary and recorded an impairment charge of $2.6 million for the
quarter ended March 31, 2001. Additionally we recorded an impairment charge of
$59,000 relating to an equity investment, as management determined that the
decline in the value of its investment was other-than-temporary. During the
second quarter of 2001, we recorded additional impairment charges of
approximately $7.5 million as management determined that the carrying value of
certain cost investments were permanently impaired.
30
Extraordinary Gain on Conversion of Convertible Notes
On March 28, 2001, we completed the issuance of $23,840,250 principal amount of
10% Senior Convertible Notes ("Exchange Notes") in exchange for the cancellation
of $75,905,000 principal amount of 7% Convertible Subordinated Notes (the
"Notes") The above exchange transactions have been accounted for in accordance
with Financial Accounting Standards Board Statement No. 15, "Accounting by
Debtors and Creditors for Troubled Debt Restructurings." On May 23, 2001, an
additional $2,531,250 of 10% Senior Convertible Notes were exchanged for
1,420,713 shares of our Class A common stock. As a result of these exchanges, we
recorded a $1.1 million and $40.4 million extraordinary gain on the exchange of
convertible notes during the quarter and six months ended June 30, 2001. (See
also Note 4.)
Liquidity and Capital Resources
Sources of Financing
Since our inception, we have obtained financing through private placements of
convertible debt and equity securities, equipment leases, our initial public
offering including the exercise of the over-allotment option and through a
convertible debt offering.
During the first six months of 2001, we raised approximately $14.2 million
dollars from the issuance of 10% Senior Convertible Notes and $3 million from
the issuance of Class A common stock.
On February 14, 2001, we announced that we entered into a bridge funding and
amendment agreement that would allow us to borrow up to $5 million from our
majority-owned subsidiary India.com pursuant to a bridge note. As of June 30,
2001, we borrowed $5 million under this agreement. In connection with settling
the obligations under the Exchange Agreement with the minority investors in
India.com, we have subsequently eliminated our obligations under the outstanding
bridge notes in the aggregate principal amount of $5 million and the outstanding
warrants issued to India.com to purchase 1 million shares of our Class A common
stock. See note 12 to our condensed consolidated financial statements.
During the first six months of 2001, we took additional actions to further
reduce our cash burn. These actions included additional staff layoffs in some of
our businesses as well as the completion of and anticipated completion of the
sale of certain of our businesses. Accordingly, we incurred additional
restructuring and impairment charges to reduce the value of certain of our
acquisitions and investments. This is due to the continuous and prolonged
decline in valuations of Chinese and U.S. business and consumer portals,
including revenue multiples, as well as the lack of capital funding available to
Internet-related businesses in order to fund their operating losses, and
continual investments that their management teams believe are necessary to
sustain operations. Such charges amounted to $72.0 million, of which
approximately $2 million was cash charges. Most of these charges covered
additional write-downs of tangible and intangible assets and the carrying value
of certain investments.
During the first six months of 2001, Asia.com sold its business for $1.5 million
in cash and the assumption of $1.5 million of liabilities and we sold our
advertising network business for $3 million in cash at the closing plus an
additional $500,000 in April 2001 based upon the achievement of certain
milestones by us.
On March 28, 2001, we completed the issuance of an aggregate of $23,840,250
principal amount of senior convertible notes in exchange for the cancellation of
$75.9 million principal amount of 7% Convertible Subordinated Notes. On May 23,
2001, $2.5 million of the Senior Convertible Notes were exchanged for the
issuance of 1,420,714 shares of Class A common stock in accordance with the
original exchange agreement. The reduction in outstanding indebtedness, together
with the ability to pay up to one-half of interest on the Senior Convertible
Notes in shares of Class A common stock, will reduce our cash interest
requirements.
In January 2000, we received net proceeds of $96.1 million from our convertible
debt offering. We also financed the majority of our capital expenditures through
lease lines.
On March 30, 2000, we entered into a $12 million Master Lease Agreement with
GATX Technology Services Corporation ("GATX") for equipment lease financing
(hardware and software). In December 2000, GATX reduced the $12 million line to
$10.4 million. The amount that was outstanding at June 30, 2001 was $8.1
million.
On March 31, 2000, we entered into a $2 million Master Lease Agreement with
Leasing Technologies International, Inc ("Leasing Technologies"). The lease line
provides for the lease of new computers, office automation and other equipment.
In December 2000, Leasing Technologies reduced the $2 million line to $1.2
million. The amount that was outstanding at June 30, 2001 was $874,000.
Proposed Restructuring of Certain Debt and Lease Obligations
We have entered into debt restructuring negotiations with AT&T with respect to
its promissory note in the outstanding principal amount of $33.5 million, George
Abi Zeid (the former sole shareholder of STI and a current director and officer
of EasyLink) with respect to his promissory note in the outstanding principal
amount of $9.2 million and lessors under approximately $21 million of lease
obligations. AT&T, Mr. Abi Zeid and the lessors have permitted us to defer
current payments under these notes and lease obligations pending successful
completion of the debt restructuring negotiations and satisfaction of all
conditions precedent to the implementation of any restructuring. AT&T, Mr. Abi
Zeid and the lessors may terminate the deferrals at any time prior to
implementation of definitive restructuring agreements. No assurance can be given
that we will successfully complete the proposed debt restructurings on
acceptable terms or at all.
On August 13, 2001, we entered into a Modification Agreement with one of our
lessors with respect to approximately $8.6 million of lease obligations. Under
the terms of the agreement, (i) we are obligated to return the leased equipment
at our expense within 60 days; (ii) we have agreed to purchase for 15% of the
original equipment cost any and all of the leased assets that the lessor does
not request to be returned by August 31, 2001, with payment being made no later
than the earlier of the completion of certain capital raising or October 31,
2001 and (iii) all present and future
31
payment obligations under the lease have been converted into a promissory note
in the principal amount of approximately $8.6 million, payable on demand after
October 31, 2001, bearing interest at an annual rate of 12%.
If we (i) raise a minimum of $10 million of capital by October 31, 2001 and (ii)
enter into restructuring agreements with AT&T with respect to its outstanding
note, George Abi Zeid with respect to his outstanding note and lessors holding
substantially all of its equipment lease obligations on terms and conditions
taken as a whole that are not more favorable to such parties than the terms of
the Modification Agreement, then the $8.6 million promissory note issued
pursuant to the Modification Agreement will be converted into (i) a convertible
promissory note (the "Note") in the reduced principal amount of approximately
$2.6 million, (ii) 2,510,000 shares of EasyLink Class A common stock and (iii)
warrants to purchase 2,510,000 shares of EasyLink Class A common stock. The Note
will be due June 1, 2006 and will bear interest at the rate of 12% per annum,
payable semi-annually commencing on the third anniversary. The Note will be
convertible into shares of EasyLink Class A common stock at an exercise price of
$1.00 per share at any time during the term of the Note. We may irrevocably
elect, within 30 days written notice, to prepay any the outstanding balance of
the Note or any portion thereof plus accrued interest for cash. We are required
to file a registration statement covering the resale of the shares and shares
issuable upon exercise of the warrants within 45 days from closing. The warrants
will have an expiration date 10 years from the date of issuance and will have an
exercise price equal to the average of the closing price of the Class A common
stock over the 30 trading days ending two days before the closing of the
restructuring.
We have entered into discussions with our other equipment lessors, AT&T and Mr.
Abi Zeid regarding the proposed restructuring of their lease or debt obligations
under terms and conditions similar to the terms and conditions under the
Modification Agreement. No assurance can be given that we will successfully
complete the proposed debt and lease restructurings on acceptable terms or at
all or that we will be able to meet the conditions precedent to implement the
proposed restructuring under the Modification Agreement described above or any
similar agreement entered into with any other party.
Nasdaq Compliance
On July 27, 2001 we received a NASDAQ Staff Determination indicating that we
have failed to regain compliance with the $1.00 minimum bid price requirement
for continued listing. Our common stock is therefore potentially subject to
delisting from the Nasdaq National Market. On September 7, 2001, we will attend
a hearing before the Nasdaq Listing Qualifications Panel to review the Staff
Determination. Our stock will continue to be listed on the Nasdaq National
Market unless the Panel does not grant our request for an extension of time to
regain compliance with the minimum bid price requirement. At the hearing, we
intend to review a plan that we believe will demonstrate our ability to regain
compliance with the $1.00 minimum bid price requirement. The presentation will
include, among other factors, the significant progress that we have made in
implementing our business plan, debt restructuring and financing initiatives and
a proposed reverse stock split. Subject to compliance with applicable regulatory
requirements, we have scheduled a special meeting of stockholders for August 29,
2001 for the purpose of approving a reverse stock split. There can be no
assurance the Panel will grant our request for continued listing. A decision by
the Panel is typically provided within four weeks of the hearing.
Cash Flow Statement Analysis and Future Cash Requirments
Net cash provided by operating activities was $7.4 million for the six months
ended June 30, 2001, and net cash used in operating activities was $70.6 million
for the six months ended June 30, 2000. Cash provided by operating activities
was impacted by the net loss from operations and the extraordinary gain on the
conversion of convertible notes, offset by non-cash charges principally related
to the amortization of partner advances, depreciation and amortization of fixed
assets, amortization of goodwill and other intangible assets, proceeds from the
sales and maturities of marketable securities, the provision for restructuring
and impairments, and changes in operating assets and liabilities. In 2000, cash
used in operating activities was impacted by the net loss from operations and
changes in operating assets and liabilities, offset in part by the write-off of
in-process technology, non-cash charges related to partner agreements and
depreciation and amortization of fixed assets and intangible assets.
Net cash used in investing activities was $13.6 million for the six months ended
June 30, 2001 and $8.4 million for the six months ended June 30, 2000. In 2001,
net cash used in investing activities consisted primarily of purchases of
property and equipment, and net cash paid for acquisitions, partially offset by
the proceeds received from the sale of our advertising network and Asia.com
businesses. In 2000, net cash used in investing activities was impacted by
purchases of property and equipment, purchases of investments and an increase in
notes receivable, partially offset by the net cash received from acquisitions.
Net cash provided by financing activities was $10.9 million for the six months
ended June 30, 2001 and $92.6 million for the six months ended June 30, 2000.
During the first six months of 2001, we received $14.1 million from the issuance
of senior convertible notes and $3.0 million from the issuance of our Class A
Common Stock. During the first six months of 2000, we received $96.1 million
from the issuance of convertible notes, $1.8 million in proceeds from the
issuance of Class A common stock in connection with the exercise and purchase of
options and warrants, partially offset by payments of capital lease obligations
of $3 million and principal payments of notes payable of $4.2 million.
At June 30, 2001, the Company maintained approximately $628,000 in letters of
credit ("LC") with various parties. These LC's are related to the leasing of
telecommunications equipment and for consulting services. Through June 30, 2001,
there were no drawings under the LC.
At June 30, 2001, we had $12 million of cash and cash equivalents and $20,000 of
marketable securities. Our principal commitments consist of subordinated
convertible notes, senior convertible notes, notes payable, obligations under
capital leases, domain asset purchase obligations, accounts payable and other
current obligations and commitments for capital expenditures. For the year ended
December 31, 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 incurred
a net loss of $127.7 million for the six months ended June 30, 2001, and have an
accumulated deficit of $434.8 million as of June 30, 2001. We believe that we
will need additional financing to meet cash requirements and the availability of
such financing when needed, on terms acceptable to us, or if at all, is
uncertain. If we are unable to raise additional financing or generate sufficient
cash flow, we may be unable to continue as a going concern.
32
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. During the first quarter of 2001, we raised $16.9 million
through the sale of senior debt securities and common equity. We also acquired
STI and EasyLink Services, requiring a cash outlay of $16 million. Management
believes that this acquisition significantly enhances the scale of our customer
base and global network. Management has implemented internal actions to improve
our operations and liquidity including a reduction of our workforce, closure of
some of our businesses operating with negative cash flows, and we sold our
advertising network for $3 million. On May 3, 2001, our majority owned
subsidiary Asia.com sold its business to an investor group that paid $1.5
million in cash and assumed Asia.com liabilities of approximately $1.5 million.
After satisfaction of other Asia.com liabilities and pro rata distributions to
other minority investors in Asia.com, we received proceeds from the sale of
approximately $1.1 million. Management continues the process of further reducing
operating costs, increasing our sales efforts with a new combined sales force
and seeking financing that is acceptable to us.
Sales or issuances of additional equity securities, including as a result of the
proposed debt and lease restructurings described above, 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.
In addition, we previously announced that we will seek to sell all assets not
related to our core outsourced messaging business, including our India.com, Inc.
subsidiary, and our portfolio of domain names. No assurance can be given that
the company will be successful in selling India.com, Inc. or these domain names
or as to the timing of such sales or otherwise raising the amount of capital
needed to fund our operations. The proceeds from the sale of these assets may
not supply enough cash to fund our operations, and we may experience delays in
the completion of these sales or receiving or converting into cash the
consideration received in these sales.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133
establishes accounting and reporting standards for derivative instruments,
including derivative instruments embedded in other contracts, and for hedging
activities. During June 1999, SFAS No. 137 was issued which delayed the
effective date of SFAS No. 133. SFAS No. 137 is effective for all fiscal
quarters of fiscal years beginning after June 15, 2000. The Company's adoption
of this statement in the first quarter of 2001 did not have a significant impact
on the Company's financial statements as it does not currently use derivative
instruments or hedging activities.
In July 2001, the FASB issued Statement No. 141, Business Combinations, and
Statement No. 142, Goodwill and Other Intangible Assets. Statement 141 requires
that the purchase method of accounting be used for all business combinations
initiated after June 30, 2001 as well as all purchase method business
combinations completed after June 30, 2001. Statement 141 also specifies
criteria intangible assets acquired in a purchase method business combination
must meet to be recognized and reported apart from goodwill, noting that any
purchase price allocable to an assembled workforce may not be accounted for
separately. Statement 142 will require that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead tested for
impairment at least annually in accordance with the provisions of Statement 142.
Statement 142 will also require that intangible assets with definite useful
lives be amortized over their respective estimated useful lives to their
estimated residual values, and reviewed for impairment in accordance with SFAS
No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of.
The Company is required to adopt the provisions of Statement 141 immediately,
except with regard to business combinations initiated prior to July 1, 2001,
which it expects to account for using the pooling-of-interests method, and
Statement 142 effective January 1, 2002.* Furthermore, any goodwill and any
intangible asset determined to have an indefinite useful life that are acquired
in a purchase business combination completed after June 30, 2001 will not be
amortized, but will continue to be evaluated for impairment in accordance with
the appropriate pre-Statement 142 accounting literature. Goodwill and intangible
assets acquired in business combinations completed before July 1, 2001 will
continue to be amortized prior to the adoption of Statement 142.
Statement 141 will require upon adoption of Statement 142, that the Company
evaluate its existing intangible assets and goodwill that were acquired in a
prior purchase business combination, and to make any necessary reclassifications
in order to conform with the new criteria in Statement 141 for recognition apart
from goodwill. Upon adoption of Statement 142, the Company will be required to
reassess the useful lives and residual values of all intangible assets acquired
in purchase business combinations, and make any necessary amortization period
adjustments by the end of the first interim period after adoption. In addition,
to the extent an intangible asset is identified as having an indefinite useful
life, the Company will be required to test the intangible asset for impairment
in accordance with the provisions of Statement 142 within the first interim
period. Any impairment loss will be measured as of the date of adoption and
recognized as the cumulative effect of a change in accounting principle in the
first interim period.
In connection with the transitional goodwill impairment evaluation, Statement
142 will require the Company to perform an assessment of whether there is an
indication that goodwill [and equity-method goodwill] is impaired as of the date
of adoption. To accomplish this the Company must identify its reporting units
and determine the carrying value of each reporting unit by assigning the assets
and liabilities, including the existing goodwill and intangible assets, to those
reporting units as of the date of adoption. The Company will then have up to six
months from the date of adoption to determine the fair value of each reporting
unit and compare it to the reporting unit's carrying amount. To the extent a
reporting unit's carrying amount exceeds its fair value, an indication exists
that the reporting unit's goodwill may be impaired and the Company must perform
the second step of the transitional impairment test. In the second step, the
Company must compare the implied fair value of the reporting unit's goodwill,
determined by allocating the reporting unit's fair value to all of it assets
(recognized and unrecognized) and liabilities in a manner similar to a purchase
price allocation in accordance with Statement 141, to its carrying amount, both
of which would be measured as of the date of adoption. This second step is
required to be completed as soon as possible, but no later than the end of the
year of adoption. Any transitional impairment loss will be recognized as the
cumulative effect of a change in accounting principle in the Company's statement
of earnings.
33
As of the date of adoption, the Company expects to have unamortized goodwill and
other intangible assets in the amount of $165.5 million, which will be subject
to the transition provisions of Statements 141 and 142. Amortization expense
related to goodwill and other intangible assets was $28.8 million and $60.8
million for the six months ended June 30, 2001 and for the year ended December
31, 2000 respectively. Because of the extensive effort needed to comply with
adopting Statements 141 and 142, it is not practicable to reasonably estimate
the impact of adopting these Statements on the Company's financial statements at
the date of this report, including whether any transitional impairment losses
will be required to be recognized as the cumulative effect of a change in
accounting principle.
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 operations in the
Peoples Republic of China and India. 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.
Risk Factors That May Affect Future Results
Before you invest in our Class A common stock, you should carefully consider the
risks described below and the other information included or incorporated by
reference in this prospectus.
We Have Only a Limited Operating History, We Are Involved in a New and Unproven
Industry and We Have Determined To Focus On Our Core Outsourced Messaging
Business.
We have only a limited operating history upon which you can evaluate our
business and our prospects. We have offered a commercial email service since
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 Internet message 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 our outsourced messaging business 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 outsourced e-mail services and of message delivery services such as
electronic data interchange or EDI, fax and telex services. Swift is a provider
of 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. Our success will depend in
part upon our ability to maintain or expand our sales of message delivery
services such as EDI and fax services to enterprises, the development of a
viable market for fee-based e-mail and groupware services on an outsourced
basis, our ability to compete successfully in those markets and our ability to
successfully sell our non-core assets on favorable terms. For the reasons
discussed in more detail below, there are substantial obstacles to our achieving
and sustaining profitability.
We Have Incurred Losses Since Inception and Expect to Incur Substantial Losses
in the Future.
We have generated only limited revenues to date. We have not achieved
profitability in any period, and we may not be able to achieve or sustain
profitability. We incurred a net loss of $127.7 million for the first six months
of 2001 and $229.5 million for the year ended December 31, 2000. We had an
accumulated deficit of $434.8 million as of June 30, 2001. We expect to continue
to incur substantial net losses and negative operating cash flow for the
foreseeable future. We intend to expand our sales and marketing operations,
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, which may
result in significant amortization of goodwill and other expenses. 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. If we do not succeed in
substantially increasing our revenues or integrating the EasyLink Services and
Swift businesses with our historical business, our losses will continue
indefinitely and will increase.
If We Are Unable to Raise Necessary Capital in the Future, We May Be Unable to
Fund Necessary Expenditures.
We anticipate the need to raise additional capital in the near 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, 2001, we
had $12.0 million of cash and cash equivalents and $20,000 of marketable
securities. Our principal commitments consist of subordinated convertible notes,
senior convertible notes, notes payable, obligations under capital leases,
domain asset purchase obligations, accounts payable and other current
obligations and commitments for capital expenditures. For the year ended
December 31, 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
34
ability to continue as a going concern. We believe that we will need additional
financing to meet cash requirements for our operations, and the availability of
such financing when needed, on terms acceptable to us, or if at all, is
uncertain. Moreover, we believe that our ability to raise additional funds may
be depend on the successful completion of the proposed restructuring of our
outstanding debt and lease obligations. See "Risk Factors That May Affect Future
Results - We May Be Unable to Pay Debt Service on Our Indebtedness for Money
Borrowed and Other Obligations." If we are unable to raise additional financing
or generate sufficient cash flow, 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 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. If the proposed
restructurings of certain of our debt and lease obligations is successful, we
will issue a substantial amount of additional Class A common stock and
securities convertible into or exerciseable for shares of Class A common stock.
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 Intend to Sell All of Our Assets Not Related to Our Core Outsourced Messaging
Business But May Experience Difficulty Completing Any or All of Such Sales on
Favorable Terms or At All.
We recently announced our intention to sell all of our non-core assets,
including our advertising network business, our Asia.com, Inc. and India.com,
Inc. subsidiaries and our portfolio of Internet domain names. On March 30, 2001,
we completed the sale of our advertising network business to Net2Phone. On May
3, 2001, our Asia.com, Inc. subsidiary completed the sale of its business. We
cannot assure you that we will be able to sell all or any of our remaining
non-core assets on favorable terms or at all. We also cannot assure you as to
the timing or the terms and conditions of the sale of any of these assets or the
form or amount of consideration (if any) that may be received. The realizable
value of these assets may ultimately prove to be less than the carrying value
currently reflected in our consolidated financial statements. Moreover, if the
sales are not successfully completed, the market price of our common stock may
decline to the extent that the current market price reflects a market assumption
that such sales will be successfully completed. To the extent that we receive
non-cash consideration in any of these sales, we may not be able to liquidate
this consideration or otherwise turn it into cash for a period of time after we
receive it or at all.
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 a variety of message delivery 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:
o inability to raise the required capital;
o difficulty in assimilating the acquired operations and
personnel;
o inability to retain any acquired member or customer accounts;
o disruption of our ongoing business;
o the need for additional capital to fund losses of acquired
businesses;
o inability to successfully incorporate acquired technology into
our service offerings and maintain uniform standards,
controls, procedures and policies; and
o 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.
We May Be Unable to Successfully Integrate the EasyLink Services Business
Acquired From AT&T.
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
messaging services such as e-mail, EDI, fax and telex 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. The messaging network for
this business resides on AT&T's managed network and is being operated and
maintained for EasyLink by AT&T pursuant to a Transition Services Agreement. In
addition, AT&T will continue to provide a variety of business and administrative
functions for the business. We plan to migrate off the AT&T network to the
EasyLink network and to assume responsibility for these other functions over the
next two years.
35
Under the Transition Services Agreement, we are purchasing a variety of services
from AT&T to enable us to continue to operate the business pending the
transition to EasyLink. See Part I. Item 1. Business -- Transition Services
Agreement and Master Carrier Agreement with AT&T Corp. -- in our Form 10-K for
the year ended December 31, 2000 filed on April 2, 2001.
We cannot assure you that we will be able to successfully transition the
EasyLink Services network and other operations from AT&T to us, or successfully
integrate them into our operations, in a timely manner or without incurring
substantial unforeseen expense. Even if successfully transitioned and
integrated, we may be unable to operate the business at expense levels that are
ultimately profitable for us. Our inability to successfully transition,
integrate or operate the network and operations of the EasyLink Services
business will result in a material adverse effect on our business, results of
operations and financial condition.
We Have Incurred Significant Indebtedness For Money Borrowed.
As of June 30, 2001, we had approximately $134.3 million principal amount of
outstanding indebtedness for borrowed money and capital leases. 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 May Be Unable to Pay Debt Service on Our Indebtedness for Money Borrowed and
Other Obligations.
We had an operating loss and negative cash flow during the first six months of
2001 and for the year ended December 31, 2000 and expect to incur substantial
losses and negative cash flows for the foreseeable future. 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 interest payable annually on our outstanding indebtedness or
to pay our other obligations. 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. We cannot assure you that the proposed sale of our remaining
non-core assets will not negatively impact our cash flow available to service
our debt. 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 indenture for the convertible notes, including any deemed sale
of all or substantially all of our assets.
The Company has entered into debt restructuring negotiations with AT&T with
respect to its promissory note in the outstanding principal amount of $33.5
million, George Abi Zeid (the former sole shareholder of STI and a current
director and officer of EasyLink) with respect to his promissory note in the
outstanding principal amount of $9.2 million and lessors under approximately $22
million of lease obligations. AT&T, Mr. Abi Zeid and the lessors have permitted
the Company to defer current payments under these notes and lease obligations
pending successful completion of the debt restructuring negotiations and
satisfaction of all conditions precedent to the implementation of any
restructuring. AT&T, Mr. Abi Zeid and the lessors may terminate the deferrals at
any time prior to implementation of definitive restructuring agreements. No
assurance can be given that the Company will successfully complete the proposed
debt restructurings on acceptable terms or at all.
On August 13, 2001, EasyLink entered into a Modification Agreement with one of
its lessors with respect to approximately $8.6 million of lease obligations. See
"Part I. Item 2 -- Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Liquidity and Capital Resources." The Company has
entered into discussions with its other equipment lessors, AT&T and Mr. Abi Zeid
regarding the proposed restructuring of their lease or debt obligations under
terms and conditions similar to the terms and conditions under the Modification
Agreement. No assurance can be given that the Company will successfully complete
its proposed debt and lease restructuring on acceptable terms or at all or that
it will be able to meet the conditions precedent to implement the proposed
restructuring under the Modification Agreement described above or any similar
agreement entered into with any other party.
Outsourcing of E-mail and Groupware Services and Message Delivery 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 the best message
delivery services today and by offering these customers managed e-mail and other
messaging services in the future. The market for managed e-mail, groupware
services and other messaging services such as virus protection, spam control and
content filtering services and professional messaging services is only beginning
to develop. Our success will depend on the continued expansion of the market for
outsourced message delivery services such as EDI and fax services and the
development of viable markets for the outsourcing of managed e-mail and
groupware services, services to protect corporate e-mail systems from viruses,
spam and offensive content and related professional messaging services. Each of
these developments is somewhat speculative.
There are significant obstacles to the development of a sizable market for
messaging services outsourcing. 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 messaging services 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 messaging services, we
cannot be sure that we will be able to maintain or expand our business customer
base or that we will be able to sell managed messaging services such as e-mail
and groupware hosting services, virus protection, spam control or content
filtering services or professional services to this customer base. In addition,
the sales cycle for managed messaging services such as hosting services is
lengthy and could delay our ability to generate revenues in the managed
messaging services market. As part of our business strategy, we plan to offer
additional outsourced messaging and other services to existing customers. We
cannot assure you that these customers will purchase these services or will
purchase them at prices that we wish to charge. Furthermore, we may not be able
36
to generate significant additional revenues by providing our outsourced e-mail
and groupware services to businesses. Standards for pricing in the business
e-mail and groupware services market 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.
Although we intend to steadily increase our spending and investment to support
our planned growth, our revenues (and some of our costs) will be much less
predictable. This is likely to result in significant fluctuations in our
quarterly results, and to limit the value of quarter-to-quarter comparisons.
Because of our limited operating history, the emerging nature of our industry
and our planned sale of our non-core assets, we anticipate that securities
analysts will have difficulty in accurately forecasting our 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:
o incurrence of other cash and non-cash accounting charges,
including charges resulting from acquisitions or
dispositions of assets, including from the disposition of
non-core assets such as our Asia.com and India.com
subsidiaries, and write-downs of impaired assets;
o non-cash charges associated with repriced stock options;
o system outages, delays in obtaining new equipment or problems
with planned upgrades;
o disruption or impairment of the Internet;
o demand for outsourced messaging services;
o attracting and retaining customers and maintaining customer
satisfaction;
o introduction of new or enhanced services by us or our
competitors;
o changes in our pricing policy or that of our competitors;
o changes in governmental regulation of the Internet and
messaging in particular; and
o general economic and market conditions.
Other such factors in our non-core businesses include:
o incurrence of additional expenditures without receipt of
offsetting revenues pending the sale of these businesses.
We Expect Significant Stock Based Compensation Charges Related to Repriced
Options.
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 the
closing price of the Company's Class A common stock on NASDAQ on November 14,
2000. Options to purchase 6,327,986 shares were repriced. The repriced options
vest at the same rate that they would have vested under their original terms
except that shares issuable upon exercise of these options may not be sold until
after November 14, 2001. 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.
Depending upon movements in the market value of the Company's common stock, 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 for the year ended
December 31, 2000 filed on April 2, 2001."
37
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 business services and products such
as Internet access and other telecommunications services, browser software,
homepage design, Web site hosting and software and hardware solutions in
addition to messaging services. The ability of these competitors to offer a
broader suite of complementary services 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.
Our Rapid Expansion Is Straining Our Existing Resources, and if We Are Not Able
to Manage Our Growth Effectively, Our Business and Operating Results Will
Suffer.
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 the market for
outsourced messaging services. At the same time, we announced our intention to
sell all of our non-core assets, including our advertising network business, our
World.com subsidiaries Asia.com and India.com and our portfolio of domain names.
This expansion and the decision to sell all of our non-core assets 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 or the sale
of non-core assets 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 Chief
Executive Officer, Brad Schrader, our President, 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, Schrader or Abi Zeid or of Ms. McClister, or several other key
employees, would impede the operation and growth of our business.
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 salespeople 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
Messaging 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 messaging services.
Because we have only been providing some of our services such as managed e-mail
and groupware 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 email traffic or other customer
requirements. In addition, the very process of upgrading our computer systems is
likely to cause service disruptions. This is because we will have 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.
38
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, unsolicited bulk emails that
overload our system and other computer system failures. In particular, we have
experienced outages and delays in email delivery and access to our email service
related to disk failures, the implementation of changes to our computer system,
insufficient storage capacity and other problems. These failures have resulted
and may continue to result in significant disruptions to our service. Although
we plan to install backup computers and implement procedures to reduce the
impact of future malfunctions in these systems, the presence of these and other
single points of failure in our network increases the risk of service
interruptions. Some aspects of our computer systems are not redundant. These
include our database system and our email storage system, which stores emails
and other data. In addition, substantially all of our computer and
communications systems relating to our email services other than the systems
located and operated by AT&T Corp. under our Transition Services Agreement with
them are currently located in our primary data centers in Manhattan, Edison, New
Jersey and Dayton, Ohio. 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
stored emails and other customer files, causing significant customer
dissatisfaction and possibly giving rise to claims for monetary damages.
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 and consumer demand and add new
features to our services very rapidly. We also have to regularly upgrade our
software to ensure that it remains compatible with the wide and changing variety
of Web browsers and other software used by our customers. 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 messaging 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.
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 many ISPs, employers and schools can interfere with the operation of
our services.
We are Dependent on Licensed Technology.
We license a significant amount of technology from third parties, including
technology related to our managed e-mail and groupware services, virus
protection, spam control and content filtering services, Internet fax services,
billing processes and database. We anticipate that we will need to license
additional technology to remain competitive. We may not be able to license these
technologies on commercially reasonable terms or at all. Third-party licenses
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 costs, and the possible termination of or failure to renew an
important license by the third-party licensor.
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., Worldcom, MFS, BBN Planet and UUNET for a variety
of telecommunications and Internet services.
Pending the transition of the network and operations for the EasyLink Services
business acquired from AT&T, we are dependent on the services being provided to
us under our Transition Services Agreement with AT&T. See "Risk Factors - We May
Be Unable to Successfully Integrate the EasyLink Services Business Acquired From
AT&T." above and "Item 1. Business - Technology" in our Form 10-K for the year
ended December 31, 2000 filed on April 2, 2001.
39
Gerald Gorman Controls EasyLink and Will Be Able to Prevent A Change of Control.
Gerald Gorman, our Chairman, beneficially owned as of July 31, 2001 Class A and
Class B common stock representing approximately 56% 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. As a result of his
share ownership, Mr. Gorman will be able to determine 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
will be in a position to prevent a change in control of EasyLink even if the
other stockholders 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. In addition, we and Mr. Gorman have agreed to permit our
stockholders who formerly held our preferred stock to designate a total of three
members of our board of directors. Currently, such former holders of our
preferred stock have no designee on our board.
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. We
do not have experience with some of the types of marketing that we are currently
using. 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.
We intend to continue to expand into international markets and to expend
significant financial and managerial resources to do so. We have limited
experience in international operations and 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:
o uncertain demand in foreign markets for messaging services;
o difficulties and costs of staffing and managing international
operations;
o differing technology standards;
o difficulties in collecting accounts receivable and longer
collection periods;
o economic instability and fluctuations in currency exchange
rates and imposition of currency exchange controls;
o potentially adverse tax consequences;
o 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;
o political instability, unexpected changes in regulatory
requirements, and reduced protection for intellectual property
rights in some countries;
o export restrictions, and
o difficulties in enforcing contracts and potentially adverse
consequences.
Regulation of Messaging 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.
40
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 the email or
fax 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. We may be subject to
legal proceedings and damage claims if we are found to have violated laws
relating to email content.
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 forebearance 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 instrastate 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.
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 and this could have a
material adverse effect on our financial position, results of operations and
cash flows. 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
key 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.
41
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 recently enacted 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.
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, 2001, we had an aggregate of 90,769,053 shares of Class A and Class B common
stock outstanding. In addition, we are obligated to issue an additional
1,000,000 shares of our Class A common stock subject to certain conditions if
the closing price of our Class A common stock has not traded at or above $10 per
share for five consecutive days. As of July 31, 2001 we had options to purchase
approximately 12.9 million shares of Class A common stock outstanding. As of
July 31, 2001, we had warrants to purchase 476,871 shares of Class A common
stock outstanding. As of July 31 2001, after giving effect to our recent note
exchanges and senior note issuances, we had approximately 30,798,598 shares of
Class A common stock issuable upon conversion of outstanding senior convertible
notes at exercise prices ranging from $1 per share to $1.75 per share and up to
an additional 7,699,649 shares of Class A common stock issuable over five years
in payment of a portion of the interest on such senior notes. In addition, we
had 1,271,504 shares of Class A common stock issuable upon conversion of our
remaining outstanding 7% Convertible Subordinated Notes due 2005 at an exercise
price of $18.95 per share. In addition, the holders of Series A Preferred Stock
of our India.com subsidiary have agreed to exchange such preferred stock for
shares of our Class A common stock based on the original purchase price of such
stock, which in the aggregate was $14.2 million, divided by the average of the
closing prices of our Class A common stock for the five trading days ending on
September 13, 2001, which price will not be less than $1.00 or more than $3.00.
Accordingly, if the average of the closing prices of our Class A common stock
for the five trading days ending on September 13, 2001 is $1.00 per share or
less, then we would be obligated to issue 14,200,000 shares of Class A common
stock upon completion of this exchange transaction.
Moreover, if the proposed restructurings of certain of our debt and lease
obligations is successful, we will issue a substantial amount of additional
Class A common stock and securities convertible into or exerciseable for shares
of Class A common stock. See "Part I. Item 2 -- Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."
As of July 31, 2001, approximately 61,194,956 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. As of such date,
approximately 29,574,097 shares of Class A common stock will become available
for sale at various later dates upon the expiration of one-year holding periods
or upon the expiration of any other applicable restrictions on resale. We are
likely to issue large amounts of additional Class A common stock, which may also
be sold and which could adversely affect the price of our stock.
As of July 31, 2001, the holders of approximately 27,974,756 shares of
outstanding Class A common stock and the holders of approximately 52,281,622
shares of Class A common stock issuable upon conversion of our outstanding
senior or subordinated convertible notes, issuable in payment of interest over
the next five years on our senior convertible notes, issuable upon exercise of
the exchange right held by holders of India.com preferred stock, issuable upon
exercise of the warrants issued to India.com, and Stonegate warrants, 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 faces 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 and state that a deficiency shall exist if
such minimum bid price remains below $1 for a period of thirty consecutive
business days. In addition, if our stock price is below $5 per share, we must
maintain minimum net tangible assets of at least $4 million. In lieu of the
minimum net tangible assets requirement, under a proposed Nasdaq rule currently
in effect under a "pilot program" until July 1, 2001, we may instead comply with
a $10 million total stockholders' equity requirement. We cannot assure you that
the proposed rule will be adopted or that the pilot program will be extended if
the proposed rule is not adopted by July 1, 2001. The minimum bid price of our
stock has been below $1 during various periods during the fourth quarter of 2000
and the first quarter of 2001 and has been below $1 during the period from March
14, 2001 through July 31, 2001. In addition, as of December 31, 2000, the
company did not have a minimum tangible net assets of $4 million.
42
We received a notice from Nasdaq advising us that if we do not demonstrate
compliance with the $1 minimum bid requirement for at least 10 consecutive
trading days, or a longer period as determined by Nasdaq, on or before July 23,
2001, our Class A common stock will be delisted. On July 27, 2001 we received a
Nasdaq Staff Determination indicating that we have failed to regain compliance
with the $1.00 minimum bid price requirement for continued listing. Our common
stock is therefore potentially subject to delisting from the Nasdaq National
Market. On September 7, 2001, we will attend a hearing before the Nasdaq Listing
Qualifications Panel to review the Staff Determination. Our stock will continue
to be listed on the Nasdaq National Market unless the Panel does not grant our
request for an extension of time to regain compliance with the minimum bid price
requirement. At the hearing, we intend to review a plan that we believe will
demonstrate its ability to regain compliance with the $1.00 minimum bid price
requirement. The presentation will include, among other factors, the significant
progress that we have made in implementing our business plan, debt restructuring
and financing initiatives and a proposed reverse stock split. Subject to
compliance with applicable regulatory requirements, we have scheduled a special
meeting of stockholders for August 29, 2001 for the purpose of approving a
reverse stock split. There can be no assurance the Panel will grant our request
for continued listing. A decision by the Panel is typically provided within four
weeks of the hearing.
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 Internet-related companies have been highly
volatile. A stock's price is often influenced by rapidly changing perceptions
about the future of the Internet 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 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 were 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. In connection with the sale, we
entered into a hosting agreement under which we will host or arrange to host the
consumer e-mailboxes for Net2Phone for a minimum of one year. During the second
quarter of 2001, we completed the migration of the hosting of these consumer
mailboxes to a third party provider whom we pay for this service.
Notwithstanding the migration of the consumer mailboxes to the third party
provider or the assignment of Web site contracts with third parties to
Net2Phone, we may nonetheless remain liable for our obligations under the
hosting contract with Net2Phone and 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 or on the part of Net2Phone under
the third party Web site agreements that are assigned to them.
WE INTEND TO SELL OUR INDIA.COM, INC. SUBSIDIARY AND OUR PORTFOLIO OF DOMAIN
NAMES. UNTIL A SALE OR OTHER DISPOSITION IS COMPLETED, THE FOLLOWING SPECIAL
RISKS WILL CONTINUE TO APPLY TO THESE OPERATIONS:
The Limited Installed Personal Computer Base and High Cost of Accessing the
Internet in India Limits the Pool of Potential Customers for India.Com.
The market penetration rates of personal computers and on-line access in India
are far lower than such rates in the United States. Alternate methods of
obtaining access to the Internet, such as through cable television modems or
set-top boxes for televisions, are currently unavailable in India. There can be
no assurance that the number or penetration rate of personal computers in India
will increase rapidly or at all or that alternate means of accessing the
Internet will develop and become widely available in India.
Our growth is limited by the cost to Indian consumers of obtaining the hardware,
software and communications links necessary to connect to the Internet in India.
If the overall costs required to access the Internet do not significantly
decrease, most of India's population will not be able to afford to use our
services. The failure of a significant number of additional Indian consumers to
obtain affordable access to the Internet would make it very difficult to execute
our business plan.
We Are Relying on Electronic Commerce as a Significant Part of India.com's
Future Revenue, but the Internet Has Not Yet Been Proven as an Effective
Commerce Medium in India.
India.com's revenue growth depends in part on the increasing acceptance and use
of electronic commerce in India. The Internet may not become a viable commercial
marketplace in India for various reasons, many of which are beyond our control,
including:
o inexperience with the Internet as a sales and distribution
channel;
o inadequate development of the necessary infrastructure to
facilitate electronic commerce;
43
o concerns about security, reliability, cost, ease of
deployment, administration and quality of service
associated with conducting business over the Internet; and
o inexperience with credit card usage or with other means of
electronic payment.
Underdeveloped Telecommunications Infrastructure and Unclear Telecommunications
Regulations Have Limited and May Continue to Limit the Growth of the Internet
Market in India.
The telecommunications infrastructure in India is not well developed. The
underdeveloped Internet infrastructure in India has limited the growth of
Internet usage there. If the necessary Internet infrastructure is not developed,
or is not developed on a timely basis, future growth of the Internet in India
will be limited and our business could be harmed.
Our India.Com Business May Be Adversely Affected by Indian Government Regulation
of Internet Companies.
India has recently begun to regulate its Internet sector by making
pronouncements or enacting regulations regarding various Internet activities in
India and the legality of foreign investment in the Indian Internet sector.
There are substantial uncertainties regarding the proper interpretation of
current and future Indian Internet laws and regulations.
The Indian government is attempting to liberalize this sector and has enacted or
is currently considering enacting new legislation in that regard. For example,
Press Note No. 7 (2000 series) dated July 14, 2000, permits 100% foreign
investment in business-to-business e-commerce companies, subject to the
condition that "such investing companies" divest 26% of their equity in favor of
the Indian public in five years, if "these companies" are listed in other parts
of the world. It remains unclear as to whether the referenced listing is of the
Indian subsidiary or of the investor company. For retail e-commerce companies,
51% foreign equity investment is permitted. Press Note No. 8 (2000 series) dated
August 29, 2000, removes the earlier restriction on automatic approvals in cases
where a foreign investor had a previous or existing joint venture or technology
transfer/trademark agreements in the same or allied field in India for all
proposals relating to information technology.
In the telecom sector, the present cap on foreign equity is 49% and a license is
required to provide such services. However, the license required for ISPs has
been waived until October 31, 2003. Also, in Press Note No. 9 (2000 series)
dated September 8, 2000 the Indian government recently permitted 100% foreign
direct investment in relation to certain activities including:
o ISPs not providing gateways (applicable both for satellite and
submarine cables);
o Infrastructure providers providing dark fiber (IP category 1);
o Electronic mail; and
o Voice mail.
However, the above activities are still subject to the 26% divestment
rule, certain security restrictions and other regulations.
The government has also recently passed the Information Technology Act, 2000
which focuses on recognizing and regulating electronic transactions and records,
affecting:
o authentication of digital records;
o legal recognition of electronic records and digital
signatures;
o attribution, acknowledgment and dispatch of electronic
records;
o secure electronic records and digital signatures; and
o regulation of certifying authorities.
More legislation that is presently being discussed is a draft Information
Communication and Entertainment Bill, 2000 ("ICE Bill") that would govern the
rapid convergence of broadcasting, telecommunications and information
technologies. The ICE Bill contemplates the establishment of a Communication
Commission to license and regulate the provision of network facilities, network
services, application services or content application services and ownership of
wireless apparatus.
It is unclear how the ICE Bill, if enacted, or any of the legislation previously
discussed, will affect India.com's business and operations. Further, political
instability could halt or delay the liberalization of the Indian economy and
adversely affect business and economic conditions in India generally and our
business in particular. Although during the past decade, the government of India
has pursued policies of economic liberalization, including significantly
relaxing restrictions on the private sector and further reforms are still
expected under the current policy to promote the
44
information technology and software industries, political uncertainty still
exists and a significant change in India's economic liberalization and
deregulation policies could adversely affect business and economic conditions in
India generally and our India.com business in particular. Our Asia.com and
India.com properties developed by WORLD.com compete with the major business and
consumer portals and other providers of Internet services in the markets in
which they operate.
The interpretation and application of existing Indian laws and regulations and
the possible new laws or regulations have created substantial uncertainties
regarding the legality of existing and future foreign investments in, and the
businesses and activities of, Indian Internet businesses, including our
India.com business. Accordingly, it is possible that the relevant Indian
authorities could, at any time, assert that any portion or all of India.com's
existing or future ownership structure and businesses violates Indian laws and
regulations. It is also possible that the new laws or regulations governing the
Indian Internet sector that may be adopted in the future will prohibit or
restrict foreign investment in, or other aspects of, any of India.com's current
or proposed businesses and operations. In addition, these new laws and
regulations may be retroactively applied to India.com.
If India.com or any of its Indian-based subsidiaries is found to be in violation
of any existing or future Indian laws or regulations, the relevant Indian
authorities would have broad discretion in dealing with such a violation,
including, without limitation, the following:
o levying fines;
o revoking our business license;
o requiring us to restructure our ownership structure or
operations; and
o requiring us to discontinue any portion or all of our Internet
business.
PART II OTHER INFORMATION
Item 1: Legal Proceedings
From time to time we have been, and expect to continue to be, subject to legal
proceedings and claims in the ordinary course of business. These include claims
of alleged infringement of third-party patents, trademarks, copyrights, domain
names and other similar proprietary rights, claims by former employees and other
claims. These claims, even if not meritorious, could require us to expend
significant financial and managerial resources.
The Company has received and expects to continue to receive notices and claims
from certain third parties for disputed and unpaid accounts payable and other
obligations. One of such vendors, Initiative Media Worldwide, Inc. has commenced
legal proceedings in California to collect approximately $2 million alleged to
be owed to it in connection with advertising alleged to have been run on our
behalf. The Company believes that it has appropriately reserved for the amount
of any liability that may arise out of these matters.
Item 2: Changes in Securities and Use of Proceeds
Recent Sales of Unregistered Securities
During the three months ended June 30, 2001, EasyLink issued Class A common
stock in reliance upon the exemption from registration pursuant to Section 4 (2)
of the Securities Act of 1933 or Regulation S promulgated thereunder or
otherwise not subject to registration in various transactions as follows:
During the three months ended June 30, 2001, we issued 188,943 shares of Class A
common stock to employees at a weighted average price of $0.59 per share
representing the Company's matching contribution to its 401(k) plan.
During the three months ended June 30, 2001, we issued 38,690 shares of Class A
common stock as to employees at the price of $0.47 per share representing
employees participation in the Company's employee stock purchase plan.
On April 18, 2001, we issued 1,620,833 shares of Class A common stock to the
former owners of TCOM representing our contingent settlement obligation
associated with the acquisition of that company.
On April 25, 2001 we issued 196,000 shares of Class A common stock associated
with the acquisition of a US and India based company.
On April 27, 2001, we issued 604,230 shares of Class A common stock to a vendor
as payment for services rendered.
On April 27, 2001, we issued 317,460 shares of Class A common stock to an
investment bank as payment for services rendered in connection with the sale of
our advertising network.
On May 3, 2001, we issued 75,000 shares of Class A common stock to the former
owners of Asia.com representing our contingent settlement obligation associated
with the acquisition of that company.
On May 4, 2001, we issued 200,000 shares of Class A common stock to the former
owners of Asia.com in exchange for the cancellation of options issued upon
acquisition of that company.
45
On June 12 we issued 135,375 shares and 1,420,713 shares, respectively of Class
A common stock to certain private investors representing interest due on Senior
Convertible Notes and for the exchange and cancellation of $2,531,250 10% Senior
Convertible Notes
Item 4: Submission of Matters to a Vote of Security Holders
(a) The Annual Meeting of Shareholders was held on May 24, 2001.
(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........................ 156,497,108 - 267,174
Thomas Murawaski..................... 156,509,583 - 254,699
Gary Millin.......................... 156,137,364 - 626,918
George Abi Zeid...................... 156,506,083 - 258,199
William Donaldson.................... 156,142,270 - 622,012
Stephen Duff......................... 156,505,277 - 259,005
Stephen Ketchum...................... 156,123,133 - 641,149
Jack Kuehler......................... 156,502,277 - 262,005
Resolutions
-----------
To approve the EasyLink Services
Corporation 2001 stock option plan... 154,821,182 1,852,550 90,550
Approval of amendment to the Company's
amended and restated certificate of
incorporation, as amended............ 154,356,481 2,344,726 63,075
To ratify the appointment of
KPMG, LLP as independent auditor
for 2001............................. 156,651,439 77,102 35,741
The text of the matters referred to under this Item 4 is set forth in
the Proxy Statement dated April 27, 2000 previously filed with the Commission
and incorporated herein by reference.
ITEM 6 Exhibits and Reports on Form 8-K
The following exhibits are filed as part of this report:
(3)(i) Articles of Incorporation
(a) Certificate of Amendment of Amended and Restated
Certificate of Incorporation, as Amended
(b) Certificate of Ownership and Merger Merging EasyLink
Services Corporation with and into Mail.com, Inc.
(4) Instruments defining the rights of security holders,
including indentures
(v) The Corporation hereby agrees to furnish to the
Commission, upon request, a copy of any instruments
defining the rights of security holders issued by
EasyLink Services Corporation or its subsidiaries.
Reports on Form 8-K - EasyLink Services Corporation filed no reports on Form 8-K
during the three months ended June 30, 2001.
46
ITEM 7
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 MCCLISTER
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Executive Vice President and
Chief Financial Officer
August 14, 2001
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