SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
(Amendment No. 1)
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2005
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-26371
EASYLINK SERVICES CORPORATION
(Exact Name of Registrant as Specified in Charter)
Delaware 13-3787073
(State or other Jurisdiction of) (I.R.S. Employer
Incorporation or Organization) Identification No.)
33 Knightsbridge Road, Piscataway, NJ 08854
(Address of Principal Executive Office) (Zip Code)
(732) 652-3500
(Registrant's Telephone Number Including Area Code)
Indicate by check whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |_| No |X|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes [ ] No [X]
Common stock outstanding at October 31, 2005: Class A common stock $0.01 par
value 45,151,329 shares.
EASYLINK SERVICES CORPORATION
MARCH 31, 2005
FORM 10-Q/A
EXPLANATORY NOTES
This Amendment No.1 on Form 10-Q/A to the Company's Quarterly Report on Form
10-Q for the three months ended March 31, 2005, originally filed with the
Securities and Exchange Commission on May 16, 2005, is being filed for the
purpose of restating our consolidated financial statements as of March 31, 2005
and for the three months then ended. See Note 2 to the Condensed Consolidated
Financial Statements for further details of the restatement. Items 1, 2, and 4
have been updated for the effects of the restatement and are included in this
Amendment No. 1. In addition, Item 3 included herein has been revised to include
additional information.
This Amendment No. 1 on Form 10-Q/A does not reflect events occurring after the
filing of the original Quarterly Report on Form 10-Q on May 16, 2005, or modify
or update the disclosure presented in the original Quarterly Report on Form
10-Q, except to reflect the revisions as described herein.
INDEX
Page
Number
------
PART I: FINANCIAL INFORMATION
Item 1: Condensed Consolidated Financial Statements:
Restated Condensed Consolidated Balance Sheets as of March 31,
2005 (restated) (unaudited) and December 31, 2004....................................3
Restated Unaudited Condensed Consolidated Statements of Operations for the
three months ended March 31, 2005 and 2004...........................................4
Restated Unaudited Condensed Consolidated Statements of Cash Flows for the
three months ended March 31, 2005 and 2004...........................................5
Notes to Unaudited Interim Condensed Consolidated Financial
Statements...........................................................................7
Item 2: Management's Discussion and Analysis of Financial Condition and
Results of Operations.............................................................. 15
Item 3: Qualitative and Quantitative Disclosure about Market Risk.......................... 19
Item 4: Controls and Procedures............................................................ 20
PART II: OTHER INFORMATION
Item 6: Exhibits........................................................................... 21
Signatures.................................................................................... 22
-2-
EasyLink Services Corporation
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
(Unaudited)
March 31, December 31,
2005 2004
---- ----
(restated) (restated)
ASSETS
Current assets:
Cash and cash equivalents.................................................. $8,072 $12,216
Marketable securities...................................................... 1,893 2,023
Accounts receivable, net of allowance for doubtful accounts of $3,363 and
$3,950 as of March 31, 2005 and December 31, 2004, respectively............ 10,234 9,564
Prepaid expenses and other current assets.................................. 2,252 2,841
----- ----
Total current assets....................................................... 22,451 26,644
------ ------
Property and equipment, net................................................ 8,862 8,071
Goodwill, net.............................................................. 6,266 6,266
Other intangible assets, net............................................... 8,004 8,596
Other assets............................................................... 754 768
-------- --------
Total assets............................................................... $46,337 $50,345
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable........................................................... $7,007 $6,471
Accrued expenses........................................................... 11,654 13,652
Restructuring reserves payable............................................. 708 728
Current portion of loans and notes payable................................. 3,350 3,825
Other current liabilities.................................................. 1,511 1,471
Net liabilities of discontinued operations................................. 528 528
-------- --------
Total current liabilities.................................................. 24,758 26,675
------ ------
Loans and notes payable, less current portion.............................. 9,000 9,600
Other long term liabilities................................................ 2,245 1,100
------- ---------
Total liabilities.......................................................... 36,003 37,375
------- ------
Stockholders' equity:
Common stock:
Class A--500,000,000 shares authorized at March 31, 2005 and December 31, 2004,
44,393,527 and 44,174,459 shares issued and outstanding at
March 31, 2005 and December 31, 2004, respectively......................... 446 441
Class B--10,000,000 shares authorized at March 31, 2005 and December 31,
2004, 0 issued and outstanding at March 31, 2005 and December 31, 2004..... -- --
Additional paid-in capital................................................. 553,628 553,420
Accumulated other comprehensive loss....................................... (346) (238)
Accumulated deficit........................................................ (543,394) (540,653)
--------- ---------
Total stockholders' equity................................................. 10,334 12,970
--------- ---------
Commitments and contingencies
Total liabilities and stockholders' equity................................. $46,337 $50,345
======= =======
See accompanying notes to unaudited condensed consolidated financial statements.
-3-
EasyLink Services Corporation
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
(unaudited)
Three Months Ended March 31,
----------------------------
2005 2004
---------- ----------
(restated) (restated)
Revenues................................................................... $20,378 $24,336
Cost of revenues........................................................... 7,769 9,976
---------- ----------
Gross profit............................................................... 12,609 14,360
---------- ----------
Operating Expenses:
Sales and marketing........................................................ 5,129 4,531
General and administrative................................................. 5,600 6,402
Product development........................................................ 1,700 1,709
Separation agreement costs................................................. 2,312 --
Amortization of intangible assets.......................................... 517 517
---------- ----------
15,258 13,159
Income (loss) from operations.............................................. (2,649) 1,201
---------- ----------
Other income (expense), net:
Interest income............................................................ 25 10
Interest expense........................................................... (323) (130)
Other, net................................................................. 21 133
---------- ----------
Total other income (expense), net.......................................... (277) 13
---------- ----------
Income (loss) before income taxes.......................................... (2,926) 1,214
Provision (credit) for income taxes........................................ (185) 55
---------- ----------
Net income (loss).......................................................... $(2,741) $1,159
========== ==========
Basic and diluted net income (loss) per share.............................. $ (0.06) $0.03
========== ==========
Weighted-average basic shares outstanding.................................. 44,240,317 43,861,610
========== ==========
Weighted-average diluted shares outstanding................................ 44,240,317 44,979,983
========== ==========
See accompanying notes to unaudited condensed consolidated financial statements.
-4-
EasyLink Services Corporation
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
Three Months Ended March 31,
2005 2004
---------- ---------
(restated) (restated)
Cash flows from operating activities:
Net income (loss) $ (2,741) $1,159
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Depreciation 948 1,577
Amortization of intangible assets 592 676
Provision for doubtful accounts 95 338
Issuance of shares as matching contributions to employee
benefit plans 123 119
Other 41 175
Changes in operating assets and liabilities:
Accounts receivable, net (765) 126
Prepaid expenses and other current assets 589 (383)
Other assets (3) (31)
Accounts payable, accrued expenses and other liabilities (243) (2,630)
---------- ---------
Net cash provided by (used in) operating activities (1,364) 1,127
---------- ---------
Cash flows from investing activities:
Purchases of property and equipment, including capitalized software (1,675) (449)
---------- ---------
Net cash used in investing activities (1,675) (449)
---------- ---------
Cash flows from financing activities:
Proceeds of bank loan advances 950 --
Payments under capital lease obligations (146) (41)
Proceeds from issuance of stock 90 --
Principal payments of notes payable (2,025) (605)
Payments of capitalized interest --- (266)
---------- ---------
Net cash used in financing activities (1,131) (912)
---------- ---------
Effect of foreign exchange rate changes
on cash and cash equivalents 26 (90)
---------- ---------
Cash used in discontinued operations -- (150)
---------- ---------
Net decrease in cash and cash equivalents (4,144) (474)
Cash and cash equivalents at beginning of the period 12,216 6,623
---------- ---------
Cash and cash equivalents at the end of the period $ 8,072 $6,149
========== =========
Supplemental disclosure of cash flow information:
Cash paid for interest $ 281 $ 235
Net cash paid for taxes $ 134 $ 11
Purchase of property, plant and equipment through
capital lease obligations $ 91 $ --
-5-
Supplemental disclosure of non-cash information:
During the three months ended March 31, 2005, the Company issued shares of Class
A common stock as follows:
The Company issued 99,568 shares of Class A common stock valued at
approximately $123,000 in connection with matching contributions to its
401(k) plan.
The Company issued 119,500 shares of Class A common stock valued at
approximately $90,000 in connection with the exercise of employee stock
options.
During the three months ended March 31, 2004, the Company issued shares of Class
A common stock as follows:
The Company issued 8,001 shares of Class A common stock valued at
approximately $13,000 as payment for interest in lieu of cash.
The Company issued 75,592 shares of Class A common stock valued at
approximately $119,000 in connection with matching contributions to its
401(k) plan.
The Company issued 99,500 shares of Class A common stock valued at
approximately $149,000 to a former employee of the Company pursuant to
the settlement of a commitment to the employee to issue such shares
originally entered into in 2001.
See accompanying notes to unaudited condensed consolidated financial statements.
-6-
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
(a) Summary of Operations
The Company offers a broad range of information exchange services to businesses
and service providers, including Transaction Management Services consisting of
integrated desktop messaging services and document capture and management
services such as fax to database, fax to data and data conversion services;
Transaction Delivery Services consisting of electronic data interchange or
"EDI," and production messaging services utilizing email, fax and telex; and,
through July 31, 2004, services that protect corporate e-mail systems such as
virus protection, spam control and content filtering services (the Mailwatch
service line).
The Company operates in a single industry segment, business communication
services. Although the Company provides various major service offerings, many
customers employ multiple services using the same access and network facilities.
Similarly, network operations and customer support services are provided across
various services. Accordingly, allocation of expenses and reporting of operating
results by individual services would be impractical and arbitrary. Services are
provided in the United States and certain other regions in the world
(predominantly in the United Kingdom).
(b) Unaudited Interim Condensed Consolidated Financial Information
The accompanying interim condensed consolidated financial statements as of March
31, 2005 and for the three months ended March 31, 2005 and 2004, as
restated,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 March 31, 2005 and the consolidated results of
operations and cash flows for the three months ended March 31, 2005 and 2004.
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, 2004, as
restated, has been derived from audited consolidated financial statements at
that date.
For each of the years ended December 31, 2004 and 2003, the Company received a
report from its independent registered public accountants containing an
explanatory paragraph stating that the Company has a working capital deficiency
and an accumulated deficit that raises substantial doubt about the Company's
ability to continue as a going concern. The unaudited condensed consolidated
financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or the amounts and
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern. Management believes the Company's ability
to continue as a going concern is dependent upon its ability to generate
sufficient cash flow to meet its obligations on a timely basis, to obtain
additional financing or refinancing as may be required and ultimately to achieve
continued profitable operations.
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, 2004 as included in the Company's Form 10-K/A filed with
the Securities and Exchange Commission on December 8, 2005.
(c) Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of the Company and
its wholly-owned or majority-owned subsidiaries from the dates of acquisition.
All other investments that the Company does not have the ability to control or
over which it does not exercise significant influence are accounted for under
the cost method. The interest of shareholders other than those of EasyLink is
recorded as minority interest in the accompanying consolidated statements of
operations and consolidated balance sheets. When losses applicable to minority
interest holders in a subsidiary exceed the minority interest in the equity
capital of the subsidiary, these losses are included in the Company's results,
as the minority interest holder has no obligation to provide further financing
to the subsidiary. All significant intercompany accounts and transactions have
been eliminated in consolidation.
-7-
The net liabilities of WORLD.com, a wholly owned subsidiary, and its majority
owned subsidiaries, are reported as discontinued operations in the consolidated
balance sheets as of March 31, 2005 and December 31, 2004 as a result of the
sale and discontinuance of the operations of this business in 2001.
(d) Use of Estimates
The preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities and the
reported amounts of revenues and expenses. These estimates and assumptions
relate to the estimates of collectibility of accounts receivable, the
realization of goodwill and other intangibles, accruals and other factors.
Actual results could differ from those estimates.
(e) Revenue Recognition
The Company's services include Transaction Management Services consisting of
integrated desktop messaging services and document capture and management
services such as fax to database, fax to data and data conversion services;
Transaction Delivery Services consisting of electronic data interchange or
"EDI," and production messaging services utilizing email, fax and telex; and,
through July 31, 2004, services that protect corporate e-mail systems such as
virus protection, spam control and content filtering services (the Mailwatch
service line). The Company derives revenues from monthly fees and usage-based
charges for its transaction delivery and management services; and from license
fees. Revenue from services is recognized as the services are performed.
Facsimile license revenue is recognized over the average estimated customer life
of 3 years.
(f) 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, accounts
receivable, notes payable and convertible notes payable. At March 31, 2005 and
December 31, 2004, the fair value of cash, cash equivalents, and accounts
receivable approximated their financial statement carrying amount because of the
short-term maturity of these instruments. The recorded values of notes payable
and convertible notes payable approximate their fair values, as interest
approximates market rates with the exception of the Convertible Subordinated
Notes payable with a carrying value of $1.4 million at December 31, 2004.
However, as these notes were paid on their maturity date of February 1, 2005,
management estimated that their fair value approximated their carrying value at
December 31, 2004.
Credit is extended to customers based on the evaluation of their financial
condition and collateral is not required. The Company performs ongoing credit
assessments of its customers and maintains an allowance for doubtful accounts.
No single customer exceeded 10% of total revenues for the three months ended
March 31, 2005 and 2004 and no account receivable from any single customer
exceeded 10% of total accounts receivable as of March 31, 2005 or December 31,
2004. Revenues from the Company's five largest customers accounted for an
aggregate 11% and 10% of the Company's total revenues for the three months ended
March 31, 2005 and 2004, respectively.
-8-
(g) Basic and Diluted Net Income (Loss) Per Share
Net income (loss) per share is presented in accordance with the provisions of
SFAS No. 128, "Earnings Per Share", and the Securities and Exchange Commission
Staff Accounting Bulletin No. 98. Under SFAS No. 128, basic Earnings per Share
("EPS") excludes dilution for common stock equivalents and is computed by
dividing income or loss available to common shareholders by the weighted average
number of common shares outstanding for the period. Diluted EPS reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock and resulted in the
issuance of common stock. Although diluted net income per share for the three
months ended March 31, 2004 is equal to basic net income per share, the amounts
for the three month period include the effect of employee options to purchase
3.5 million shares of common stock.
(h) Stock-Based Compensation Plans
As allowed by SFAS No. 123, Accounting for Stock-Based Compensation, as amended
by SFAS No. 148, we have retained the compensation measurement principles of
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees, and its related interpretations for stock options. SFAS No. 148 also
requires more prominent and more frequent disclosures in both interim and annual
financial statements about the method of accounting for stock-based compensation
and the effect of the method used on reporting results. We adopted the
disclosure provisions of SFAS No. 148 as of December 31, 2002 and continue to
apply the measurement provisions of APB 25. Under APB Opinion No. 25,
compensation expense is recognized based upon the difference, if any, at the
measurement date between the market value of the stock and the option exercise
price. The measurement date is the date at which both the number of options and
the exercise price for each option are known. The following table illustrates
the effect on net income and net income per share if we had applied the fair
value recognition provisions of SFAS No. 123 to stock-based employee
compensation.
($ in thousands, except per share amounts) For the three months
ended March 31,
------------------------
2005 2004
--------- ----------
(restated) (restated)
Net income (loss):
Net income (loss), as reported......................... $ (2,741) $1,159
Deduct: total stock based employee compensation
determined under the fair value method for all
awards, net of tax..................................... (150) (1,770)
--------- ----------
Pro forma net income (loss)............................ $(2,891) $(611)
========= ==========
Basic and diluted net income (loss) per share:
Net income (loss) per share, as reported............... $(0.07) $0.03
Deduct: total stock based employee compensation
determined under the fair value method for all
awards, net of tax..................................... (0.00) (0.04)
--------- ----------
Pro forma net income (loss) per share.................. $(0.07) $(0.01)
========= ==========
The resulting effect on the pro forma net income (loss) disclosed for the three
month ended March 31, 2005 and 2004 is not likely to be representative of the
effects on the net income (loss) on a pro forma basis in future years, because
the pro forma results include only the impact of grants issued to date and
related vesting, while subsequent years will include additional grants and
vesting. For purposes of pro-forma disclosure, the estimated fair value of the
options is amortized to expense over the options' vesting period.
(i) Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS
123 (revised 2004), "Share-Based Payment" (SFAS 123(R)) which replaces SFAS 123,
"Accounting for Stock-Based Compensation," and supersedes APB Opinion No. 25,
"Accounting for Stock Issued to Employees. Among other items, SFAS 123(R)
eliminates the use of APB 25 and the intrinsic method of accounting, and
requires all share-based payments, including grants of employee stock options,
to be recognized in the financial statements based on their fair values. SFAS
123(R) is effective for public companies beginning with the first annual period
that begins after June 15, 2005. Accordingly, the Company will adopt SFAS 123(R)
in 2006 and in accordance with its provisions will recognize compensation
expense for all share-based payments and employee stock options based on the
grant-date fair value of those awards. While the Company currently provides the
pro forma disclosures required by SFAS No. 148, "Accounting for Stock- Based
Compensation -Transition and Disclosure," on a quarterly basis (See Note h -
"Stock-Based Compensation"), it is currently evaluating the impact this
statement will have on its consolidated financial statements.
-9-
In December 2004, the FASB issued FASB Staff Position, 109-1 ("FSP FAS 109-1"),
"Application of FASB Statement No. 109, "Accounting for Income Taxes," to the
Tax Deduction on Qualified Production Activities Provided by the American Jobs
Creation Act of 2004". In FSP FAS 109-1, the FASB concluded that the tax relief
(special tax deduction for domestic manufacturing) from this legislation should
be accounted for as a "special deduction" instead of a tax rate reduction. The
guidance in FSP FAS 109-1 was effective December 21, 2004 and had no impact on
the Company's results of operations or its financial position.
In December 2004, the FASB issued FSP FAS 109-2, "Accounting and Disclosure
Guidance for the Foreign Earnings Repatriation Provision within the American
Jobs Creation Act of 2004". The American Jobs Creation Act of 2004 introduces a
special one-time dividends received deduction on the repatriation of certain
foreign earnings to a U.S. taxpayer (repatriation provision), provided certain
criteria are met. FSP FAS 109-2 gives a company additional time to evaluate the
effects of the legislation on any plan for reinvestment or repatriation of
foreign earnings for purposes of applying SFAS No. 109, Accounting for Income
Taxes. The deduction is subject to a number of limitations, and uncertainty
remains as to how to interpret numerous provisions in the Act. As such, the
Company is not in a position to decide on whether, and to what extent, it might
repatriate foreign earnings that have not yet been remitted to the U.S. based on
its analysis to date. The Company is currently evaluating the impact this
statement will have on its consolidated financial statements.
(2) RESTATEMENT OF FINANCIAL STATEMENTS
The Company has restated its previously issued financial statements for the year
ended December 31, 2004, for each quarter in 2004, and for the quarter ended
March 31, 2005. The Company's determination to restate these previously issued
financial statements stems from the following items:
1. The liability for telecommunications services costs of the Company's United
Kingdom subsidiary was overstated. The Company has revised its methodology
to more accurately estimate its liability resulting in a decrease in the
estimated liability of $548,000 as of March 31, 2005 and an increase in
related cost of revenues of $55,000 for the three months ended March 31,
2005.
2. The Company had recorded accruals for certain assessed Federal regulatory
fees in prior years although the amount of such assessment was disputed by
the Company. Based upon revised assessments received by the Company in the
4th quarter of 2004 and the first quarter of 2005, the amounts of such
accruals were in excess of the revised assessment. However, the Company did
not timely adjust the recorded liability for this change in circumstances.
The amount of the accrual no longer required and adjusted for in the
restatement is $314,000 as of March 31, 2005 and the related decrease in
expenses for the three months then ended is $18,000.
3. The Company has evaluated its liability in connection with a New York
State sales tax audit of one of its operating subsidiaries for 2001 through
2004. The company has now determined that the estimated liability for these
taxes should be increased by $102,000 as of March 31, 2005 including
$12,000 of related expenses recorded in the three months ended March 31,
2005.
4. The Company had recorded the cost of a separation agreement with its former
President of the international division at face value. Since $1.9 million
of the cost is payable over three years, the cost should have been recorded
at its present value. The restatement includes the reduction in the
separation agreement cost of $163,000 and $17,000 of imputed interest
expense for the three months ended March 31, 2005.
-10-
5. The Company incorrectly calculated the net operating loss carry forwards of
its United Kingdom subsidiaries as of December 31, 2004 resulting in the
under-accrual of foreign income tax liabilities of $555,000 as of March 31,
2005 including $260,000 of related tax expense in the three months ended
March 31, 2005.
6. The restatement also includes the recording of adjustments in prior periods
that were not recorded in these periods because in each case and in the
aggregate the amount of these errors were not material to the Company's
consolidated financial statements.
7. The Company had incorrectly classified and recorded currency translation
losses at March 31, 2005. As a result, the accumulated other comprehensive
loss account included in stockholders' equity at March 31, 2005 has been
increased by $22,000 and accrued expenses has been reduced by such amount.
The following schedules show the impact of the restatement on the relevant
captions from the Company's condensed consolidated financial statements as of
March 31, 2005 and for the three months then ended and for the three months
ended March 31, 2004.
CONDENSED CONSOLIDATED BALANCE SHEET
MARCH 31, 2005
(In thousands, except share and per share data)
(Unaudited)
As Previously As
Reported Restated
------------- --------
ASSETS
Current assets:
Cash and cash equivalents.................................................. $8,072 $8,072
Marketable securities...................................................... 1,893 1,893
Accounts receivable, net of allowance for doubtful accounts of $3,363 and
$3,950 as of March 31, 2005 and December 31, 2004, respectively............ 10,214 10,234
Prepaid expenses and other current assets.................................. 2,305 2,252
----- ----
Total current assets....................................................... 22,484 22,451
------ ------
Property and equipment, net................................................ 8,909 8,862
Goodwill, net.............................................................. 6,266 6,266
Other intangible assets, net............................................... 8,254 8,004
Other assets............................................................... 750 754
-------- --------
Total assets............................................................... $46,663 $46,337
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable........................................................... $7,072 $7,007
Accrued expenses........................................................... 11,629 11,654
Restructuring reserves payable............................................. 732 708
Current portion of loans and notes payable................................. 3,350 3,350
Other current liabilities.................................................. 1,511 1,511
Net liabilities of discontinued operations................................. 528 528
-------- --------
Total current liabilities.................................................. 24,822 24,758
------ ------
Loans and notes payable, less current portion.............................. 9,000 9,000
Other long term liabilities................................................ 2,308 2,245
------- --------
Total liabilities.......................................................... 36,130 36,003
------ ------
Stockholders' equity:
Class A common stock....................................................... 446 446
Additional paid-in capital................................................. 553,628 553,628
Accumulated other comprehensive loss....................................... (324) (346)
Accumulated deficit........................................................ (543,217) (543,394)
--------- ---------
Total stockholders' equity................................................. 10,533 10,334
------ ------
Commitments and contingencies
Total liabilities and stockholders' equity................................. $46,663 $46,337
======= =======
-11-
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the three months ended March 31, 2005 and 2004
(In thousands, except share and per share data)
(unaudited)
2005 2004
---- ----
As Previously As As Previously As
Reported Restated Reported Restated
------------- ---------- ------------- ----------
Revenues................................................................... $20,378 $20,378 $24,336 $24,336
Cost of revenues........................................................... 7,714 7,769 10,325 9,976
--------- ---------- --------- ----------
Gross profit............................................................... 12,664 12,609 14,011 14,360
--------- ---------- --------- ----------
Operating Expenses:
Sales and marketing........................................................ 5,129 5,129 4,531 4,531
General and administrative................................................. 5,650 5,600 6,384 6,402
Product development........................................................ 1,700 1,700 1,709 1,709
Separation agreement costs................................................. 2,475 2,312 -- --
Amortization of intangible assets.......................................... 517 517 517 517
--------- ---------- --------- ----------
15,471 15,258 13,141 13,159
Income (loss) from operations.............................................. (2,807) (2,649) 870 1,201
--------- ---------- --------- ----------
Other income (expense), net:
Interest income............................................................ 202 25 10 10
Interest expense........................................................... (306) (323) (130) (130)
Other, net................................................................. (44) 21 133 133
--------- ---------- --------- ----------
Total other income (expense), net.......................................... (148) (277) 13 13
--------- ---------- --------- ----------
Income (loss) before income taxes.......................................... (2,955) (2,926) 883 1,214
Provision (credit) for income taxes........................................ (450) (185) 30 55
--------- ---------- --------- ----------
Net income (loss).......................................................... $(2,505) $(2,741) $ 853 $ 1,159
========= ========== ========= ==========
Basic and diluted net income (loss) per share.............................. $ (0.06) $ (0.06) $ 0.02 $ 0.03
========= ========== ========= ==========
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three months ended March 31, 2005 and 2004
(In thousands, except share and per share data)
(unaudited)
2005 2004
---- ----
As Previously As As Previously As
Reported Restated Reported Restated
--------- ---------- --------- ----------
Net cash provided by (used in) operating activities........................ $(1,314) $(1,364) $ 1,127 $ 1,127
--------- ---------- --------- ----------
Net cash used in investing activities...................................... (1,732) (1,675) (449) (449)
--------- ---------- --------- ----------
Net cash used in financing activities...................................... (1,100) (1,131) (912) (912)
--------- ---------- --------- ----------
Effect of foreign exchange rate changes
On cash and cash equivalents (82) 26 (90) (90)
--------- ---------- --------- ----------
Cash used in discontinued operations 0 0 (150) (150)
Net decrease in cash and cash equivalents (4,228) (4,144) (474) (474)
--------- ---------- --------- ----------
-12-
(3) LOANS AND NOTES PAYABLE
Loans and notes payable include the following, in thousands:
March 31, 2005 Dec 31, 2004
-------------- ------------
Term loan payable $11,400 $12,000
7% Convertible Subordinated Notes due February 1, 2005 -- 1,425
------- -------
Total loans and notes payable 11,400 13,425
Less current portion 2,400 3,825
------- -------
Non current portion $9,000 $9,600
======= =======
The Term loan payable is part of a $15 million credit facility entered into by
the Company with Wells Fargo Foothill, Inc. (a subsidiary of Wells Fargo Bank).
The Term loan is payable monthly over 60 months with interest payable monthly at
the rate of 3.75% over the Wells Fargo prime rate, which was 5.5% as of March
31, 2005. As part of the credit facility the Company can also draw down capital
advances up to $7.5 million based on certain circumstances and within certain
specified limitations. The credit facility includes certain affirmative and
restrictive covenants, including maintenance of quarterly levels of EBITDA. On
March 31, 2005, the Company entered into an amendment of the credit agreement
whereby it can exclude severance charges related to the Separation agreement
with Mr. George Abi Zeid of up to $2.5 million from the calculation of EBITDA
for covenant compliance purposes.
As of March 31, 2005, the Company had drawn down $950,000 of advances under the
credit facility that are recorded on the condensed consolidated balance sheet as
of that date as loans payable to bank in current liabilities. The advances bear
interest at the rate of 0.75% over the Wells Fargo Bank prime rate. The advance
amount is not included in the above table of long term loans and notes payable.
During the three months ended March 31, 2005 the Company repaid the remaining
outstanding 7% Convertible Subordinated Notes on their maturity date of
February, 1, 2005.
(4) SEPARATION AGREEMENT
In January 2005, the Company entered into a Separation Agreement with George Abi
Zeid, its former President of the International division, wherein Mr. Abi Zeid
resigned as an officer and director of the Company. Under the agreement, the
Company agreed to pay Mr. Abi Zeid $240,000 as a severance payment on the
effective date of his resignation and $1,960,000 in equal installments over
three years in consideration of the non-compete and other covenants contained in
the agreement. In connection with the agreement, the Company also agreed to pay
$200,000 of severance payments to two other former employees of the Company.
-13-
(5) INCOME TAXES
The Company recorded a provision (credit) for Federal and state income taxes in
the three months ended March 31, 2005 and 2004 based on anticipated effective
tax rates for the respective full year. The effective rate varies from standard
tax rates primarily due to the utilization of available net operating loss carry
forwards for Federal and certain state income tax purposes.
The availability of the Company's existing net operating loss carryforwards to
offset income in the current periods and in the future has been determined to be
significantly limited. As a result of numerous historical equity transactions,
the Company has experienced "ownership changes" as defined by Section 382 of the
Internal Revenue Code of 1986, as amended (the "Code") and, accordingly, the
utilization of net operating loss carryforwards is limited under the change in
stock ownership rules of the Code.
(6) COMMITMENTS AND CONTINGENCIES
Master Carrier Agreement
In April 2004, the Company entered into a Data Service Terms and Pricing
attachment ("MCA Attachment") to its Master Carrier Agreement with AT & T for
the purchase of private line and satellite services. Under the MCA Attachment,
the term is for a minimum of 18 months with an option by the Company to extend
the term for an additional 12 months. Under the MCA Attachment, the Company has
a minimum purchase commitment for services equal to $3.6 million during the
initial 18 month period. Similar to the original agreement, if the Company
terminates the MCA Attachment prior to the end of the term or AT&T terminates
the services for the Company's breach, the Company must pay to AT&T a
termination charge equal to 50% of the unsatisfied minimum purchase commitment
for the remaining portion of the term. Under a separate agreement for switched
services from AT&T, the Company has an annual commitment of $120,000 per year
through September 2006. The Company has complied with the commitment through the
annual period ended September 2004.
Other Telecommunication Services
The Company has committed to purchase from MCI Worldcom a minimum of $900,000
per year in other telecommunication services through January 2007.
-14-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion and analysis of the financial condition and results of
operations should be read in conjunction with our condensed consolidated
financial statements and the related notes included elsewhere in this quarterly
report.
The consolidated financial statements included herein have been prepared
assuming that the Company will continue as a going concern. The Company's
independent public accountants have included an explanatory paragraph in their
audit report accompanying the 2004 consolidated financial statements. The
explanatory paragraph states that the Company has a working capital deficiency
and an accumulated deficit that raise substantial doubt about its ability to
continue as a going concern. Management's plans in regard to this matter are
also described in Note 1(b). The consolidated financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
On November 3, 2005, the Company's management recommended, and its Audit
Committee determined, that it would restate its previously issued financial
statements for the year ended December 31, 2004, for each quarter in 2004, and
for the quarter ended March 31, 2005. See note 2, Restatement of Financial
Statements, in the Notes to Unaudited Condensed Financial Statements included in
this document.
The effects of the restatement on the Company's results of operations are
summarized as follows:
For the Three Months Ended March 31,
------------------------------------------------------------
2005 2004
--------------------------- ----------------------------
As As
Previously As Previously As
Reported Restated Reported Restated
------------- ----------- ------------- -----------
Revenues $20,378 $20,378 $24,336 $24,336
Income (loss) from operations (2,807) (2,649) 870 1,201
Income (loss) before income taxes (2,955) (2,926) 883 1,214
Provision (credit) for income taxes (450) (185) 30 55
Net income (loss) (2,505) (2,741) 853 1,159
------------- ----------- ------------- -----------
Basic net income per share $(0.06) $(0.06) $0.02 $0.03
Diluted net income per share $(0.06) $(0.06) $0.02 $0.03
OVERVIEW
We are a provider of services that facilitate the electronic exchange of
information between enterprises, their trading communities and their customers.
On an average business day, we handle approximately one million transactions
that are integral to the movement of money, materials, products and people in
the global economy such as insurance claims, trade and travel confirmations,
purchase orders, invoices, shipping notices and funds transfers, among many
others. We offer a broad range of information exchange services to businesses
and service providers, including Transaction Management Services and Transaction
Delivery Services. Transaction Management Services consist of integrated desktop
messaging services and document capture and management services such as fax to
database, fax to data and data conversion services. Beginning in 2005, we also
began to offer as a Transaction Management Service an enhanced production
messaging service that we call EasyLink Production Messaging PM2.0 Service.
Transaction Delivery Services consist of electronic data interchange or "EDI,"
and basic production messaging services utilizing email, fax and telex. As part
of our strategy, we will seek to upgrade customers who are using our basic
production messaging service to our enhanced production messaging, EasyLink
Production Messaging PM2.0 Service. Until July 31, 2004, we also offered
MailWatch services to protect corporate e-mail systems, which included virus
protection, spam control and content filtering services.
-15-
OPERATING RESULTS
For the three months ended March 31, 2005, we reported a net loss of $2.7
million, our first quarterly loss since the quarter ended June 30, 2003. The
current period's results include a charge of $2.3 million before income taxes
(credits) related to the George Abi Zeid Separation agreement but also include
our planned expansion of sales and marketing efforts to promote and sell our
newer Transaction Management Services. In comparing the results for the three
months ended March 31, 2005 to the three months ended March 31, 2004, revenues
were down by $4.0 million with a resulting lower gross margin of $1.8 million.
Although we increased sales and marketing spending by $598,000 in the 2005
quarter as compared to the 2004 quarter, reductions in general and
administrative costs of $802,000 more than offset that impact. Our operating
results had improved throughout 2004 even though revenues declined in comparison
to prior years.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements and related disclosures in conformity
with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, revenues and expenses and the disclosure of contingent
assets and liabilities. We believe that of our significant accounting policies,
those related to accounts receivable net of allowance for doubtful accounts,
long-lived assets and intangible assets, contingencies and litigation, and
restructurings represent the most critical estimates and assumptions that affect
our financial condition and results of operations as reported in our financial
statements.
RESULTS OF OPERATIONS - THREE MONTHS ENDED MARCH 31, 2005 COMPARED TO THE THREE
MONTHS ENDED MARCH 31, 2004
REVENUES
For the quarter ended March 31, 2005 total revenues were $20.4 million in
comparison to $24.3 million for the same period in 2004. As detailed in the
schedule below the decline in revenue is attributable to (1) lower revenues in
our Transaction Delivery Services amounting to $3.9 million or 19% and (2) $1.0
million in lower MailWatch revenues as a result of the sale of this service line
as of July 31, 2004. These declines were partially offset by increased revenues
in our Transaction Management Services of $0.9 million representing 34% growth
over 2004.
Change
------------------------
2005 2004 $ %
--------- --------- --------- ---------
Transaction Management Services $3,702 $2,771 $931 34%
Transaction Delivery Services 16,676 20,543 (3,867) (19)%
MailWatch -- 1,022 (1,022)
--------- --------- --------- ---------
$20,378 $24,336 $(3,958) (16)%
Transaction Delivery Services have been continually impacted by pricing
pressures in the telecommunications market and by technological factors that
replace or reduce the deployment of such services by our customers. This has led
to lower volumes, negotiated individual customer price reductions at the time of
service contract renewals and the loss of certain customers. Although we have
focused efforts on stabilizing this revenue stream, we believe the trend will
continue throughout 2005. We will seek to expand our newer Transaction
Management Services and to upgrade customers who are using our basic production
messaging services to our enhanced production messaging service, EasyLink
Production Messaging PM2.0 Service, to offset the declines so that total company
revenues can be positioned to grow beginning in 2006.
-16-
COST OF REVENUES
Cost of revenues for the three months ended March 31, 2005 decreased to $7.8
million from $10.0 million in the same period of 2004. As a percentage of
revenues these costs decreased to 38% in 2005 as compared to 41% in 2004. Cost
of revenue reflects a decrease in costs as a percentage of revenue as a result
of lower expenses for most items in this cost category including lower
depreciation charges, savings from continuing cost reduction programs in network
operations, lower telecom rates, favorable settlement dispute, reductions in
facilities, including reducing the number of circuits, and reduced variable
telecom charges consistent with reduced customer volumes.
Cost of revenues consists primarily of costs incurred in the delivery and
support of our services, including depreciation of equipment used in our
computer systems, software license costs, tele-housing costs, the cost of
telecommunications services including local access charges, leased network
backbone circuit costs and long distance domestic and international termination
charges, and personnel costs associated with our systems and databases.
SALES AND MARKETING EXPENSES
Sales and marketing expenses increased to $5.1 million in the three months ended
March 31, 2005 from $4.5 million in the same period of 2004. The increased
expense relates to our increased staff and promotional program spending to
expand Transaction Management services. We expect these expenses to continue at
the increased levels throughout 2005 and for total sales and marketing costs to
be higher than that of 2004.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were $5.6 million in the three months ended
March 31, 2005 as compared to $6.4 million in the same period of 2004. We
anticipate general and administrative expenses in total for the balance of 2005
to be comparable to the results for the three months ended March 31, 2005. These
expenses include all costs for our executive, finance and accounting, customer
billing and support, human resources and other headquarters office functions.
Bad debt expenses, legal and accounting fees, insurance and office rent are
other significant costs included in this category. The expenses for the three
months ended March 31, 2005 include $282,000 for payments to be made after March
31, 2005 under an employment agreement with our former Chief Financial Officer.
PRODUCT DEVELOPMENT EXPENSES
Product development costs, which consist primarily of personnel and consultants'
time and expense to research, conceptualize, and test product launches and
enhancements to our products, were $1.7 million for the three months ended March
31, 2005 and 2004. We anticipate that spending for product development will be
comparable to this level throughout 2005 as a result of our efforts to expand
the development of the new Transaction Management services.
OTHER INCOME (EXPENSE), NET
Other income (expense), net was a net other expense of $277,000 in the three
months ended March 31, 2005 as compared to a net other income of $13,000 during
the same period of 2004. The increase of net expense was largely due to
increased interest expense in the current three months from the new Wells Fargo
Term Loan obtained in December 2004. Interest on the Company's previously
outstanding debt, paid off with the Wells Fargo loan proceeds, had been
capitalized in accordance with SFAS No. 15, "Accounting by Debtors and Creditors
for Troubled Debt Restructurings", and did not result in charges in the
statement of operations. This higher interest expense will continue throughout
2005. The net change was also impacted by lower other income items and higher
interest income in the current period.
LIQUIDITY AND CAPITAL RESOURCES
Although the current three months ended March 31, 2005 resulted in a net loss of
$2.7 million, we had significantly improved our financial condition in 2004 and
2003 by (1) reducing operating costs by consolidating operations and other cost
reduction programs; (2) restructuring our debt obligations and entering into a
new credit financing with Wells Fargo; and (3) selling our non-core domain
assets and our MailWatch service line.
-17-
In December 2004 we entered into an agreement with Wells Fargo Foothill, Inc., a
subsidiary of Wells Fargo, for a credit facility of $15 million, including a $12
million term loan. In December 2004, we used $9.5 million of the proceeds from
the term loan to pay off all our secured debt, which included a scheduled
balloon payment of $5.8 million in June 2006, and in February 2005 we used an
additional $1.4 million of proceeds to pay off subordinated debt in February
2005. The Wells Fargo term loan is repayable at $200,000 per month for 60 months
although there are mandatory prepayments under certain conditions. The credit
facility also provides for other advances of $3 million initially, but
increasing to $7.5 million upon our meeting certain conditions. We borrowed
approximately $1 million of advances in March 2005 for working capital purposes.
We believe our current cash and cash equivalent balances, the availability of
funds under the credit facility and cash from operations will provide adequate
funds for operating and other planned expenditures and debt service, including
the expansion of our sales and marketing force and our capital spending
programs, for at least the next twelve months.
For each of the years ended December 31, 2004 and 2003, we received a report
from our independent auditors containing an explanatory paragraph stating that
we have a working capital deficiency and an accumulated deficit that raise
substantial doubt about our ability to continue as a going concern. Management's
plans in regard to this matter are described in Note 1(b). Our 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. If the Company's cash flow is not sufficient, we
may need additional financing to meet our debt service and other cash
requirements. However, if we are unable to raise additional financing,
restructure or settle additional outstanding debt or generate sufficient cash
flow, we may be unable to continue as a going concern. Management believes the
Company's ability to continue as a going concern is dependent upon its ability
to generate sufficient cash flow to meet its obligations on a timely basis, to
obtain additional financing or refinancing as may be required, and to maintain
profitable operations. Throughout 2002, 2003 and 2004, management improved the
Company's operations through cost reductions resulting in net cash from
operations of $2.2 million, $7.7 million and $6.0 million, respectively, for
those years. During those years, the Company reduced its working capital deficit
to $19.6 million at year end 2002, to $11.8 million at year end 2003 and to
$31,000 at year end 2004. During 2003, the Company reduced its debt by $63.0
million. In December, 2004, the Company refinanced its remaining secured debt
through a new credit facility with Wells Fargo Foothill, Inc.. Management is
continuing the process of further reducing telecommunications and
network-related operating costs while increasing its sales and marketing
efforts. There can be no assurance that the Company will be successful in these
efforts.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS
123 (revised 2004), "Share-Based Payment" (SFAS 123(R)) which replaces SFAS 123,
"Accounting for Stock-Based Compensation," and supersedes APB Opinion No. 25,
"Accounting for Stock Issued to Employees. Among other items, SFAS 123(R)
eliminates the use of APB 25 and the intrinsic method of accounting, and
requires all share-based payments, including grants of employee stock options,
to be recognized in the financial statements based on their fair values. SFAS
123(R) is effective for public companies beginning with the first interim period
that begins after June 15, 2005. The adoption date was effectively changed to
the first annual period starting after June 15, 2005 by the Securities and
Exchange Commission. As a result, the Company will adopt SFAS 123(R) in 2006 and
in accordance with its provisions will recognize compensation expense for all
share-based payments and employee stock options based on the grant-date fair
value of those awards. The Company is currently evaluating the impact of the
statement on its financial statements. See Note 1 (h) for the proforma effect of
SFAS 123 on the reported net income (loss) for the three months ended March 31,
2005 and 2004.
-18-
In December 2004, the FASB issued FSP FAS 109-2, "Accounting and Disclosure
Guidance for the Foreign Earnings Repatriation Provision within the American
Jobs Creation Act of 2004". The American Jobs Creation Act of 2004 introduces a
special one-time dividends received deduction on the repatriation of certain
foreign earnings to a U.S. taxpayer (repatriation provision), provided certain
criteria are met. FSP FAS 109-2 gives a company additional time to evaluate the
effects of the legislation on any plan for reinvestment or repatriation of
foreign earnings for purposes of applying SFAS No. 109, Accounting for Income
Taxes. The deduction is subject to a number of limitations, and uncertainty
remains as to how to interpret numerous provisions in the Act. As such, the
Company is not in a position to decide on whether, and to what extent, it might
repatriate foreign earnings that have not yet been remitted to the U.S. based on
its analysis to date. The Company expects to be in a position to finalize its
assessment by December 31, 2005.
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk, primarily from changes in interest rates,
foreign exchange rates and credit risk. The Company maintains continuing
operations in Europe (mostly in England) and, to a lesser extent, in Singapore
and Malaysia. Fluctuations in exchange rates may have an adverse effect on the
Company's results of operations and could also result in exchange losses. The
impact of future rate fluctuations cannot be predicted adequately. To date, the
Company has not sought to hedge the risks associated with fluctuations in
exchange rates.
Market Risk - Our accounts receivable are subject, in the normal course of
business, to collection risks. We regularly assess these risks and have
established policies and business practices to protect against the adverse
effects of collection risks. As a result, we do not anticipate any material
losses in excess of the allowance for doubtful accounts.
Interest Rate Risk - Interest rate risk refers to fluctuations in the value of a
security resulting from changes in the general level of interest rates.
Investments that are classified as cash and cash equivalents have original
maturities of three months or less. Changes in the market's interest rates do
not affect the value of these investments. In December 2004 we entered into a
variable interest rate credit agreement with Wells Fargo that creates an
interest rate risk for the Company on the $12 million Term Loan as well as the
working capital advance of $950,000 drawn down on the facility in March 2005.
The impact of this risk assuming the current amortization schedule of the
outstanding Term Loan and a hypothetical shift of 1% in interest rates would be
an increase or decrease, as applicable, in annual interest costs of $111,000
related to the Term Loan and the currently outstanding advance amount. The
Company has considered the use of interest rate swaps and similar transactions
to minimize this risk but has not entered into any such arrangements to date.
The Company intends to continue to evaluate this risk and the cost and possible
implementation of such arrangements in the future.
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
In the last sentence of the first paragraph under the caption "WE HAVE INCURRED
LOSSES FROM OPERATIONS IN PRIOR YEARS," the reference in the second to last
sentence to "net loss of $2.5 million and a loss from operations of $2.8
million" is changed to "net loss of $2.7 million and a loss from operations of
$2.6 million."
In the first sentence of the second paragraph under the caption "OUR CLASS A
COMMON STOCK MAY BE SUBJECT TO DELISTING FROM THE NASDAQ NATIONAL MARKET.," the
reference to "total stockholders' equity in the amount of $10.5 million as of
March 31, 2005" is changed to "total stockholders' equity in the amount of $10.3
million as of March 31, 2005."
-19-
ITEM 4 CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures designed to ensure that
information required to be disclosed by the Company in the reports that it files
or submits under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Commission's rules and forms.
Disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e)
under the Exchange Act, include controls and procedures designed to ensure that
information required to be disclosed by the company in the reports we file or
submit under the Exchange Act is accumulated and communicated to our Company's
management, including our chief executive officer and chief financial officer,
as appropriate, to allow timely decisions regarding required disclosure. It
should be noted that any system of controls, however well designed and operated,
can provide only reasonable, and not absolute, assurance that the objectives of
the system are met.
As required by Securities and Exchange Commission rules, we have evaluated
the effectiveness of the design and operation of our disclosure controls and
procedures as of the end of the period covered by this quarterly report. This
evaluation was carried out under the supervision and with the participation of
our management, including our principal executive officer and principal
financial officer. Based on this evaluation, these officers have concluded that,
in light of the material weaknesses described below, as of March 31, 2005, the
Company's disclosure controls and procedures were not effective.
As a result of these control deficiencies, management performed additional
procedures to ensure that the Company's condensed consolidated financial
statements are prepared in accordance with accounting principles generally
accepted in the United States. Accordingly, the Company believes that the
financial statements included in the Company's quarterly report on this Form
10-Q/A fairly present in all material respects the Company's financial
condition, results of operations and cash flows for the periods presented in
accordance with accounting principles generally accepted in the United States.
Our management is responsible for establishing and maintaining adequate
internal control over financial reporting, as such term is defined in Exchange
Act Rule 13a-15(f). Internal control over financial reporting is a process
designed under the supervision of the principal executive and principal
financial officers to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
reporting purposes in accordance with generally accepted accounting principles.
A material weakness is a control deficiency, or combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected. As a result of the errors described in Note 2 to the condensed
consolidated financial statements included in this report that underlie the
restatement of its financial statements for the year ended December 31, 2004 and
the quarter ended March 31, 2005, the Company identified the following material
weaknesses in its internal control over financial reporting:
1. As of March 31, 2005, the Company did not have the appropriate level of
expertise to properly calculate and review its accounting for income taxes
in its foreign subsidiaries. Specifically, the Company estimated its UK
subsidiaries' UK income tax liability based on information contained in its
statutory reports. These reports incorrectly stated the amount of net
operating losses for income tax purposes available to the UK subsidiaries
as of December 31, 2003. The Company did not have the appropriate control
procedures to determine the accuracy of the net operating loss information
contained in the statutory reports. This control deficiency contributed to
the restatement of the Company's consolidated financial statements at
March 31, 2005 and for the three months then ended.
2. As of March 31, 2005, the Company did not maintain effective controls over
the accounting for and review of certain accounts because it did not have
adequate personnel with sufficient expertise and adequate review and
reconciliation procedures to correctly account for these items in
accordance with generally accepted accounting principles. These accounts
included certain accrued expense liabilities, fixed assets, accumulated
depreciation, currency translation gains and losses and related costs and
expenses. This control deficiency contributed to the restatement of the
Company's condensed consolidated financial statements for the three months
ended March 31, 2005.
-20-
Changes in Internal Control Over Financial Reporting
There were no changes to our internal control over financial reporting
during the quarter ended March 31, 2005 that materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting. During November 2005, we implemented the changes in our internal
control over financial reporting described below in this Item 4 to address the
identified material weaknesses in connection with the preparation of our
restated financial statements included in this Amendment No. 1 to Form 10-Q for
the three months ended March 31, 2005.
Remediation Measures for Identified Material Weaknesses
During November, 2005, we made the following changes in our internal
control over financial reporting in an effort to remediate the material
weaknesses related to the accounting for foreign income taxes, certain expense
liabilities, currency translation gains and losses, fixed assets, depreciation
expense and cost of revenues:
1. Hired additional accounting personnel in both our domestic and
international finance offices with the appropriate background and
certification.
2. Expanded the existing balance sheet review process by increasing the
accounts and items selected for a more detailed review.
3. Enhanced the levels of review for the quarterly and annual income tax
provision.
Although we believe the steps taken to date have improved the design
effectiveness of our control over the accounting for foreign income taxes,
certain expense liabilities, currency translation gains and losses, fixed
assets, depreciation expense and cost of revenues, we have not completed our
review and testing of the corrective processes and procedures. Accordingly, we
will continue to monitor the effectiveness of our internal controls over
financial reporting relating to the review of our accounting for foreign income
taxes, certain expense liabilities, currency translation gains and losses, fixed
assets, depreciation expense and cost of revenues.
PART II OTHER INFORMATION
ITEM 6: EXHIBITS
The following exhibits are filed as part of this report:
Exhibit 31.1 Rule 13a-14(a)/15d-14(a) Certification of the Chief
Executive Officer
Exhibit 31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial
Officer
Exhibit 32.1 Section 1350 Certification of the Chief Executive Officer
Exhibit 32.2 Section 1350 Certification of the Chief Financial Officer
-21-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Amendment No. 1 to Quarterly Report on Form
10-Q/A to be signed on its behalf by the undersigned thereto duly authorized.
EasyLink Services Corporation
/s/ Michael A. Doyle
------------------------------------------
Michael A. Doyle
Vice President and Chief Financial Officer
December 5, 2005
-22-
Exhibit Index
Exhibit 31.1 Rule 13a-14(a)/15d-14(a) Certification of the Chief
Executive Officer
Exhibit 31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial
Officer
Exhibit 32.1 Section 1350 Certification of the Chief Executive Officer
Exhibit 32.2 Section 1350 Certification of the Chief Financial Officer