UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
(AMENDMENT NO. 1)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004
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 its Charter)
DELAWARE 13-3787073
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
33 Knightsbridge Road, Piscataway, NJ 08854
(Address of Principal Executive Office) (Zip Code)
(732) 652-3500
(Registrant's Telephone Number Including Area Code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
Title of Each Class Name of Exchange on Which Registered
None.
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
Title of Each Class Name of Exchange on Which Registered
Class A Common Stock, $0.01 par value NASDAQ National Market
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [X ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [ ] No [X]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of June 30, 2004 was $54,532,432. Solely for purposes of this
calculation, the aggregate voting stock held by non-affiliates has been assumed
to be equal to the number of outstanding shares of Class A common stock
excluding shares held by all directors and executive officers of the Company and
by holders of shares representing more than 10% of the outstanding Class A
common stock of the Company.
Indicate the number of outstanding shares of each of the registrants' classes of
common stock as of October 31, 2005: Class A common stock, 45,151,329 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2005 Annual Meeting of Shareholders are
incorporated by reference into Part III of this Form 10-K.
EXPLANATORY NOTES
This Amendment No.1 on Form 10-K/A to the Company's Annual Report on Form 10-K
for the year ended December 31, 2004, originally filed with the Securities and
Exchange Commission on April 12, 2005, is being filed for the purpose of
restating our consolidated financial statements as of December 31, 2004 and for
the year then ended, and for each quarter in 2004. See Note 2 to the
Consolidated Financial Statements for further details of the restatement. Items
5, 6, 7, 8, and 9A have been updated for the effects of the restatement and are
included in this Amendment No. 1. In addition, Item 7A included herein has been
revised to include additional information.
This Amendment No. 1 on Form 10-K/A does not reflect events occurring after the
filing of the original Annual Report on Form 10-K on April 12, 2005, or modify
or update the disclosure presented in the original Annual Report on Form 10-K,
except to reflect the revisions as described herein.
TABLE OF CONTENTS
Item No. Page No.
6. Consolidated Selected Financial Data.............................. 3
7. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 4
7A. Quantitative and Qualitative Disclosures About Market Risk........ 13
8. Consolidated Financial Statements and Supplementary Data.......... 14
9A. Controls and Procedures........................................... 46
Signatures............................................................ 48
This report on Form 10-K/A has not been approved or disapproved by the
Securities and Exchange Commission nor has the Commission passed upon the
accuracy or adequacy of this report.
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 our Annual
Report on Form 10-K filed on April 12, 2005 and subsequent filings with the
Securities and Exchange Commission. EasyLink Services 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," "EasyLink," "EasyLink Services," the "Company" and similar
terms refer to EasyLink Services Corporation and its direct and indirect
subsidiaries.
2
ITEM 6 CONSOLIDATED SELECTED FINANCIAL DATA
The following consolidated selected financial data should be read in conjunction
with the consolidated financial statements and the notes to these statements and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" elsewhere in this document. 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 raises 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.
We believe that due to the many acquisitions and dispositions, goodwill and
intangibles impairment charges and debt restructuring gains that occurred during
the period from 2000 through 2004, the period to period comparisons for 2000
through 2004 are not meaningful and should not be relied upon as indicative of
future performance.
Five Year Summary of Selected Financial Data (in thousands, except per share and
employee data)
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(restated)(2)
Consolidated Statement of Operations Data
for the Year Ended December 31,
Revenues................................................ $91,840 $101,347 $114,354 $123,929 $52,698
Total cost of revenues and operating expenses (a)....... 82,754 102,264 201,287 296,170 204,196
Income (loss) from operations........................... 9,086 (917) (86,933) (172,241) (151,498)
Total other income (expense), net (b)................... 1,004 52,803 1,088 28,203 (7,405)
Loss from discontinued operations....................... -- (938) -- (63,027) (70,624)
Extraordinary gain...................................... -- -- -- 782 --
Net income (loss)....................................... 7,690 50,948 (85,845) (206,283) (229,527)
Basic net income(loss) per common share:
Income(loss) from continuing operations................. $0.17 $1.47 (5.13) (15.26) (27.79)
Loss from discontinued operations....................... -- (0.03) -- (6.68) (12.35)
Extraordinary gain...................................... -- -- -- 0.09 --
-- -- -- ---- --
Basic net income (loss) per common share................ $0.17 $1.44 $(5.13) $(21.85) $(40.14)
===== ===== ======= ======== ========
Diluted net income(loss) per common share:
Income(loss) from continuing operations................. $0.17 $1.46 (5.13) (15.26) (27.79)
Loss from discontinued operations....................... -- (0.03) -- (6.68) (12.35)
Extraordinary gain...................................... -- -- -- 0.09 --
-- -- -- ---- --
Diluted net income(loss) per common share............... $0.17 $1.43 $(5.13) $(21.85) $(40.14)
===== ===== ======= ======== ========
Weighted average basic shares outstanding............... 44,004 35,402 16,733 9,442 5,718
Weighted average diluted shares outstanding............. 44,891 35,654 16,733 9,442 5,718
Consolidated Balance Sheet Data at December 31,
Cash and cash equivalents............................... 12,216 6,623 9,554 13,278 4,331
Marketable securities................................... 2,023 -- -- -- 12,595
Total current assets.................................... 26,644 19,813 23,511 36,900 86,490
Property and equipment, net............................. 8,071 10,641 14,833 21,956 38,997
Goodwill and other intangible assets, net............... 14,862 17,895 20,814 107,937 154,804
Total assets............................................ 50,345 49,411 61,011 170,242 306,917
Total current liabilities............................... 26,675 31,575 43,126 54,494 54,242
Long-term capital lease obligations..................... 43 37 196 566 12,638
Capitalized interest on notes payable, less current
portion -- 956 7,402 13,750 --
Long-term notes payable................................. 9,600 10,511 71,398 80,923 100,321
Total stockholders' equity (deficit).................... 12,970 4,412 (61,822) 20,503 138,935
Number of employees at December 31,..................... 469 483 572 587 1,401
--- --- --- --- -----
3
(a) Included in operating expenses are:
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(restated)
Amortization of goodwill and other intangible
assets (1)............................................... 2,284 2,919 6,751 52,068 39,977
Write-off of acquired in-process technology.............. -- -- -- -- 7,650
Impairment of intangible assets.......................... 750 -- 78,784 62,200 --
Restructuring charges (credits).......................... (350) 1,478 2,320 25,337 5,338
(Gain) loss on sale of businesses/Mailwatch service
line..................................................... (5,017) -- (426) 1,804 --
(b) Included in other income (expense), net are:
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(restated)
Interest income......................................... 247 36 189 565 4,686
Interest expense........................................ (517) (1,390) (4,785) (10,383) (9,791)
Gain on debt restructuring and settlements.............. 984 54,078 6,558 47,960 --
Impairment of investments............................... -- -- (1,515) (10,131) (200)
Loss on equity investment............................... -- -- -- -- (2,100)
Other, net.............................................. 290 79 641 192 --
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations" for a discussion of factors that affect the comparability of the
selected financial data in the years presented above.
(1) The Company adopted SFAS No. 142 " Goodwill and Other Intangible Assets" as
of January 1, 2002, as discussed in Note 5.
(2) See note 2 to the consolidated financial statements.
ITEM 7 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 consolidated financial
statements and the related notes included elsewhere in this annual 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 approved the restatement of 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
(see note 2 to the consolidated financial statements):
1 The liability for telecommunication services costs of the Company's
United Kingdom subsidiary was over-stated. The Company has revised its
methodology to more accurately estimate this liability resulting in a
decrease in the estimated liability and related costs of revenues of
$603,000 for 2004.
2. The Company had recorded accruals for certain assessed Federal
regulatory fees in prior years although the amounts of such assessments
were disputed by the Company. Based upon revised assessments received by
the Company in the 4th quarter of 2004, the amounts of such accruals
were in excess of the revised assessments. 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 $296,000.
3. The Company has determined that it did not properly account for certain
equipment purchased in prior years. As a result the Company has recorded
$47,000 in additional depreciation expense in 2004 related to these
assets.
4. 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 have been increased in the 4th quarter
of 2004 based on a tax assessment received in 2005 but prior to the
issuance of the Company's Form 10K for the year ended December 31, 2004.
The increase in the estimated liability is $90,000.
5. The Company incorrectly calculated the net operating loss carry forwards
of its United Kingdom subsidiaries as of December 31, 2003 resulting in
the under accrual of foreign income tax liabilities of $295,000 in 2004.
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 December 31, 2004. As a result, the accumulated other
comprehensive loss account included in stockholders' equity at December
31, 2004 has been increased by $166,000 and accrued expenses has been
reduced by such amount.
4
The effects of the adjustments on the statements of operations are summarized in
the following financial results tables:
----------------------------------------------------------------------------------------------
First Quarter Second Quarter
Three months ended Three months ended Six months ended
---------------------------- ---------------------------- ----------------------------
As As As
Previously As Previously As Previously As
Reported Restated Reported Restated Reported Restated
------------- ----------- ------------ ----------- ------------ ------------
Revenues $24,336 $24,336 $24,053 $24,053 $48,390 $48,390
Income from operations 870 1,201 1,694 1,939 2,565 3,141
Income before income taxes 883 1,214 1,464 1,709 2,348 2,924
Provision for income taxes 30 55 170 160 200 215
Net income 853 1,159 1,294 1,549 2,148 2,709
------------- ----------- ------------ ----------- ------------ -----------
Basic net income per share $0.02 $0.03 $0.03 $0.04 $0.05 $0.06
Diluted net income per share $0.02 $0.03 $0.03 $0.03 $0.05 $0.06
------------------------------------------------------------
Third Quarter
Three months ended Nine months ended
--------------------------- ----------------------------
As As
Previously As Previously As
Reported Restated Reported Restated
------------- ----------- ------------- -----------
Revenues $22,509 $22,509 $70,899 $70,899
Income from operations 6,057 5,897 8,623 9,039
Income before income taxes 6,041 5,881 8,389 8,805
Provision for income taxes 1,550 1,665 1,750 1,880
Net income 4,491 4,216 6,639 6,925
------------- ----------- ------------- -----------
Basic net income per share $0.10 $0.10 $0.15 $0.16
Diluted net income per share $0.10 $0.09 $0.15 $0.15
---------------------------------------------------------------
Fourth Quarter
Three months ended Twelve months ended
------------------------------- ---------------------------
As As
Previously As Previously As
Reported Restated Reported Restated
--------------- ------------ ------------ -----------
Revenues $20,941 $20,941 $91,840 $91,840
Income from operations 54 48 8,677 9,086
Income before income taxes 1,113 1,285 9,502 10,090
Provision for income taxes 150 520 1,900 2,400
Net income 963 765 7,602 7,690
--------------- ------------ ------------ -----------
Basic net income per share $0.02 $0.02 $0.17 $0.17
Diluted net income per share $0.02 $0.02 $0.17 $0.17
5
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 will
also 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 service known as EasyLink
Production Messaging PM2.0 Service. See Part I, Item 1, "Business - Company
Overview" contained in this Form 10-K. 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.
REVENUES
For the year ended December 31, 2004 total revenues were $91.8 million in
comparison to $101.3 million in 2003 and $114.4 million in 2002. As detailed in
the schedule below the declines in revenue in 2004 and 2003 as compared to the
prior years were attributable to (1) lower revenues in our Transaction Delivery
Services amounting to $11.3 million or 13% in 2004 as compared to 2003 and $16.0
million or 15% in 2003 as compared to 2002; and (2) $2.2 million in lower
MailWatch revenues in 2004 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 $4.0 million in 2004 representing 48% growth
over 2003 and $2.5 million representing 42% growth in 2003 as compared to 2002.
PERCENT CHANGE
--------------
2004 2003
2004 2003 2002 VS. 2003 VS. 2002
---- ---- ---- -------- --------
Transaction Management Services $12,304 $8,334 $5,852 48% 42%
Transaction Delivery Services 77,063 88,348 104,308 (13)% (15)%
MailWatch 2,473 4,665 4,194 (47)% 11%
----- ----- ----- ----- ---
$91,840 $101,347 $114,354 (9)% (11)%
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.
OPERATING RESULTS
Our operating results have continued to improve in 2004 and 2003 even though
revenues declined in comparison to prior years. Income from operations amounted
to $9.1 million (including $5.0 million of gains on the sale of our MailWatch
service line and our domain assets) in 2004 in comparison to losses from
operations of $(0.9) million in 2003 and $(86.9) million in 2002. The 2002 loss
included $78.8 million in impairment of intangible asset charges. Income from
continuing operations amounted to $7.7 million in 2004 in comparison to $51.9
million in 2003 but the prior year's results included $54.1 million in gains on
debt restructuring and settlements while 2004 included only $1.0 million in such
gains. Inclusive of the impairment charges, the net loss in 2002 amounted to
$(85.8) million.
We have heightened our efforts to increase revenues from Transaction Management
Services during the fourth quarter of 2004 and during 2005 to date by hiring
additional sales and marketing personnel and undertaking certain promotional
programs. While other costs have been reduced, we expect that our overall
results for 2005 will be negatively impacted by this effort and we expect that
results for the year will fall short of 2004's results. Furthermore, we will
record approximately $1.6 million of charges, net of taxes, in 2005 for the
separation agreement with our former President of the International division and
severance expenses related to restructuring certain operations.
Our prospects should be considered in light of risks described in the section of
this report entitled "Risk Factors That May Affect Future Results."
CRITICAL ACCOUNTING POLICIES
In response to the Securities & Exchange Commission's (SEC) Release No. 33-8040,
"Cautionary Advice Regarding Disclosure About Critical Accounting Policies," we
have identified the most critical accounting principles upon which our financial
reporting depends. Critical principles were determined by considering accounting
policies that involve the most complex or subjective decisions or assessments.
The most critical accounting policies were identified to be those related to
accounts receivable, long-lived assets and intangible assets, contingencies and
litigation, and restructurings.
ACCOUNTS RECEIVABLE
We perform ongoing credit evaluations of our customers and adjust credit limits
based upon payment history and the customer's current credit worthiness, as
determined by a review of their current credit information. We continuously
monitor collections and payments from our customers and maintain a provision for
estimated credit losses based upon historical experience and any specific
customer collection issues that have been identified. While such credit losses
have historically been within our expectations and the provisions established,
we cannot guarantee that we will continue to experience the same credit loss
rates that have been experienced in the past.
6
IMPAIRMENT OF LONG-LIVED ASSETS
Effective January 1, 2002, we adopted SFAS No. 142, "Goodwill and Other
Intangible Assets" and SFAS No. 144, "Accounting for the Impairment or Disposal
of Long-Lived Assets". SFAS 142 eliminates the amortization of goodwill and
indefinite-lived intangible assets, addresses the amortization of intangible
assets with finite lives and addresses impairment testing and recognition for
goodwill and indefinite-lived intangible assets. SFAS No. 144 establishes a
single model for the impairment of long-lived assets. We assess goodwill and
indefinite-lived intangibles for impairment annually unless events occur that
require more frequent reviews. Long-lived assets, including amortizable
intangibles, are tested for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Discounted cash flow analyses are used to assess indefinite-lived
intangible impairment while undiscounted cash flow analyses are used to assess
long-lived asset impairment. If an assessment indicates impairment, the impaired
asset is written down to its fair market value based on the best information
available. Estimated fair market value is generally measured with discounted
estimated future cash flows. Considerable management judgment is necessary to
estimate undiscounted and discounted future cash flows. Assumptions used for
these cash flows are consistent with internal forecasts. On an on-going basis,
management reviews the value and period of amortization or depreciation of
long-lived assets, including goodwill and other intangible assets. During this
review, we reevaluate the significant assumptions used in determining the
original cost of long-lived assets. Although the assumptions may vary from
transaction to transaction, they generally include revenue growth, operating
results, cash flows and other indicators of value. Management then determines
whether there has been an 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.
CONTINGENCIES AND LITIGATION
We evaluate contingent liabilities including threatened or pending litigation in
accordance with SFAS No. 5, "Accounting for Contingencies" and record accruals
when the outcome of these matters is deemed probable and the liability is
reasonably estimable. We make these assessments based on the facts and
circumstances and in some instances based in part on the advice of outside legal
counsel.
RESTRUCTURING ACTIVITIES
Restructuring activities are accounted for in accordance with SFAS No. 146 and,
in 2003 and 2002, relate to the relocation and consolidation of our New Jersey
office facilities into one location and a similar consolidation of our office
facilities in England. The restructuring charges are comprised of abandonment
costs with respect to leases, including the write-off of leasehold improvements.
We continually evaluate the amounts established in the restructuring reserve so
that amounts originally recorded in 2002 were increased in 2003 based on market
conditions for subleasing the abandoned facilities. In 2004, mostly due to a
settlement of liability related to one of our abandoned locations, $350,000 of
restructuring charges was reversed. Our obligations for the remaining abandoned
locations terminate in September 2005 and February 2006.
7
RESULTS OF OPERATIONS - 2004, 2003 AND 2002
PERCENT CHANGE
--------------
2004 2003
2004 2003 2002 VS. 2003 VS. 2002
---- ---- ---- -------- --------
(restated) (restated)
Revenues................................................. $91,840 $101,347 $114,354 (9.4)% (11.4)%
Cost of revenues......................................... 36,129 49,553 57,601 (27.1)% (14.0)%
------ ------ ------ ------- -------
Gross Margin............................................. 55,711 51,794 56,753 7.6% (8.7)%
% of Revenue............................................. 61% 51% 50%
Operating expenses:
Sales and marketing...................................... 18,715 18,379 20,151 1.8% (8.8)%
General and administrative............................... 23,731 24,405 28,694 (2.8)% (14.9)%
Product development...................................... 6,730 6,383 7,412 5.4% (13.9)%
Amortization of intangible assets........................ 2,066 2,066 6,751 ---- (69.4)%
Impairment of intangible assets.......................... 750 --- 78,784
Restructuring charges (credits).......................... (350) 1,478 2,320
Gain on sale of businesses/MailWatch service line........ (5,017) --- (426)
------- --- -----
46,625 52,711 143,686
------ ------ -------
INCOME (LOSS) FROM OPERATIONS............................ 9,086 (917) (86,933)
Other income (expense), net:
Gain on debt restructuring and settlements............... 984 54,078 6,558
Interest income (expense), net........................... (270) (1,354) (4,596)
Other.................................................... 290 79 (874)
--- -- -----
1,004 52,803 1,088
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE
INCOME TAXES............................................. 10,090 51,886 (85,845)
Provision for income taxes............................... 2,400 --- ---
----- --- ---
INCOME (LOSS) FROM CONTINUING OPERATIONS................. 7,690 51,886 (85,845)
===== ====== ========
8
RESULTS OF OPERATIONS - 2004 AND 2003
REVENUES
Revenues in 2004 were $91.8 million as compared to $101.3 million in 2003. The
decrease of $9.5 million was due primarily to reduced revenues in our
Transaction Delivery services, as a result of lower volumes and negotiated
individual customer price reductions and loss of certain customers and $2.2
million in lower MailWatch revenues as a result of the sale of this service line
on July 31, 2004. The reduced revenues were partially offset by a $4.0 million
increase in Transaction Management services. We anticipate that our revenues
derived from our Transaction Delivery services will continue to decline, while
our Transaction Management services revenue is expected to increase in 2005.
COST OF REVENUES
Cost of revenues for 2004 decreased to $36.1 million from $49.6 million in 2003.
As a percentage of revenues these costs decreased to 39% in 2004 as compared to
49% in 2003. Cost of revenue reflects a decrease in costs as a percentage of
revenue equal to 3% due to depreciation charges and decrease in other costs as a
percentage of revenues equal to 7%. Reduction in other costs include savings
from continuing cost reduction programs in network operations, lower telecom
rates, favorable settlement dispute, favorable adjustments of prior period cost
estimates, 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 $18.7 million from $18.4 million in
2003. The increased expense relates to our increased staff and promotional
program spending particularly in the latter part of 2004, 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 $23.7 million in 2004 as compared to
$24.4 million in 2003. While certain cost components may vary, we anticipate
general and administrative expenses in total to be comparable to 2004 levels.
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 $6.7 million for 2004 as compared to $6.4
million in 2003. We anticipate that spending for product development will
increase over 2004 in connection with the expansion of the development of the
new Transaction Management services and the continuing development of other
services.
RESTRUCTURING CHARGES
During the year ended December 31, 2003, the Company recorded additional
restructuring charges of $1.5 million for net abandonment costs on U.S. leases
as estimated sublease rentals were reduced due to deteriorating market
conditions for subleasing the vacant facilities and a negotiated settlement of
lease obligations in England. During 2004 these estimates were revised again,
largely due to a favorable negotiated settlement of liability on one lease,
resulting in the reversal of restructuring charges of $350,000.
AMORTIZATION OF INTANGIBLE ASSETS
As of January 1, 2002, the Company adopted FASB No. 142, "Goodwill and Other
Intangibles". Statement No. 142 requires companies to no longer amortize
goodwill but instead to test goodwill for impairment on an annual basis.
Accordingly, we did not amortize any goodwill during the years ended December
31, 2004 and 2003 respectively. We completed an impairment assessment in the 4th
quarter of 2004 with the assistance of an independent appraiser and determined
that an impairment of trademarks had occurred. Accordingly we recorded a
$750,000 charge in 2004. The value of the trademark is based upon the company's
ability to continue to generate revenues at comparable levels and based upon
certain other assumptions. Significant declines in revenues or changes in
assumptions could negatively impact the value of the trademark. Our annual
assessment for 2003 did not result in any impairment.
INTEREST INCOME (EXPENSE), NET
Interest income(expense), net for 2004 was $270,000 of expense as compared to
$1.4 million of expense during 2003. The decrease was primarily due to
reductions in the total debt balances outstanding as a result of the debt
restructurings and settlements completed in 2003 and principal amortization in
2004.
9
GAIN ON DEBT RESTRUCTURINGS AND SETTLEMENTS
In December 2004 we paid off all of the Company's previously existing secured
debt with part of the proceeds of a new $12 million Term Loan from Wells Fargo.
As a result, we recorded a gain of $1.0 million from the reversal of interest
previously capitalized related to the retired debt. During 2003, we eliminated
$63.0 million of indebtedness in exchange for the payment of $3.1 million in
cash and the issuance of 23.9 million shares of Class A common stock valued at
$13.6 million pursuant to our announced efforts to eliminate substantially all
of our outstanding indebtedness. After reversing $6.5 million of previously
capitalized interest and $2.4 million of accrued interest net of debt issuance
costs, we recorded total gains of $54.1 million on these transactions.
The elimination of outstanding debt in 2003 resulted in substantial income from
cancellation of debt for income tax purposes. We intend to minimize the income
tax payable as a result of the restructuring by, among other things, offsetting
the income with our historical net operating losses and otherwise reducing the
income in accordance with applicable income tax rules. We do not expect to incur
any material current income tax liability from the elimination of this debt,
although the relevant tax authorities may challenge our income tax positions.
RESULTS OF OPERATIONS - 2003 AND 2002
REVENUES
Revenues in 2003 were $101.3 million as compared to $114.4 million in 2002. The
decrease of $13.1 million was due primarily to reduced revenues in our
production messaging services, which include fax, telex and email hosting, as a
result of lower volumes and negotiated individual customer price reductions and
loss of certain customers. Revenues consist almost entirely of revenues from
providing information exchange services to businesses and are derived from
electronic data interchange services or "EDI"; production messaging services;
integrated desktop messaging services; boundary and managed email services; and
other services.
COST OF REVENUES
Cost of revenues for 2003 decreased to $49.6 million from $57.6 million in 2002.
As a percentage of revenues these costs decreased to 48.9% in 2003 as compared
to 50.0% in 2002. However, the 2003 costs are net of a $1.2 million (1.2% of
revenues) reversal of previously accrued telecom costs as a result of a
negotiated agreement with one of the company's providers. Without the reversal,
costs as a percentage of revenue would have remained unchanged at 50%. Cost of
revenue reflects a decrease in costs as a percentage of revenue equal to 2% due
to depreciation charges and an increase in other costs as a percentage of
revenues equal to 2% due to fixed network expenses and fixed telecom expenses.
Reductions in costs from continuing cost reduction programs in network
operations, telecom rates, reductions in facilities, including reducing the
number of circuits, and reduced variable telecom charges consistent with reduced
customer volumes also reduced total 2003 costs in comparison to 2002.
Cost of revenues consists primarily of costs incurred in the delivery and
support of our services, including depreciation of equipment used in our
computer systems, the cost of telecommunications services including local access
charges, leased network backbone circuit costs and long distance domestic and
international termination charges, and personnel costs associated with our
systems and databases.
SALES AND MARKETING EXPENSES
Sales and marketing expenses were $18.4 million and $20.2 million in 2003 and
2002, respectively. Included in this category are costs related to salaries and
commissions for sales, marketing, and business development personnel. Also
included are costs for promotional programs, trade shows and marketing
materials. The cost decrease of $1.8 million is primarily the result of lower
staffing levels in 2003.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were $24.4 million in 2003 as compared to
$28.7 million in 2002. The $4.3 million decrease is the net impact of various
cost component changes but the most significant reduction was $2.6 million in
our provision for bad debts as a result of improved collection and credit
activities.
PRODUCT DEVELOPMENT EXPENSES
Product development costs, which consist primarily of personnel and consultants'
time and expense to research, conceptualize, and test product launches and
enhancements to our products, were $6.4 million for 2003 as compared to $7.4
million in 2002. The net decrease in costs mostly relates to lower consultants
costs and lower salaries attributable to fewer employees.
RESTRUCTURING CHARGES
During the year ended December 31, 2002, restructuring charges of $2.3 million
were recorded by the Company. The Company's restructuring initiatives are
related to the relocation and consolidation of its New Jersey office facilities
into one location which was completed in 2003 and a similar consolidation of
facilities for our operations in England. The restructuring charges are
comprised of net abandonment cost with respect to leases and the write-off of
leasehold improvements. During the year ended December 31, 2003, the Company
recorded additional restructuring charges of $1.5 million for net abandonment
costs on U.S. leases as estimated sublease rentals were reduced due to
deteriorating market conditions for subleasing the vacant facilities and a
negotiated settlement of lease obligations in England.
GAIN ON SALE OF BUSINESS
In 2002, the Company recorded a $300,000 gain attributable to the sale of
customer contracts for hosted email services (NIMS) and a $126,000 gain
attributable to the sale of a software and consulting business in Europe.
10
AMORTIZATION OF OTHER INTANGIBLE ASSETS
As of January 1, 2002, the Company adopted FASB No. 142, "Goodwill and Other
Intangibles". Statement No. 142 requires companies to no longer amortize
goodwill but instead to test goodwill for impairment on an annual basis.
Accordingly, we did not amortize any goodwill during the years ended December
31, 2003 and 2002 respectively. We completed an impairment assessment in the 4th
quarter of 2002 with the assistance of an independent appraiser and determined
that an impairment of goodwill had occurred. Based on a subsequent fair value
analysis of the Company's goodwill, other intangible assets and other long-lived
assets, we recorded an aggregate impairment of $78.8 million in the 4th quarter
of 2002. The impairment of the other intangible assets reduced the basis for
future amortization charges resulting in the $4.7 million decrease in
amortization charges for 2003 in comparison to 2002. Total charges are $2.1
million and $6.8 million in 2003 and 2002, respectively.
OTHER INCOME (EXPENSE), NET
Interest income for 2003 was $36,000 as compared to $189,000 during 2002. The
decrease was due to lower cash balances and lower interest rates on temporary
investments.
Interest expense was $1.4 million in 2003 as compared to $4.8 million in 2002.
The decrease was primarily due to reductions in the total debt balances
outstanding as a result of the debt restructurings and settlements completed in
2003 and 2002.
GAIN ON DEBT RESTRUCTURINGS AND SETTLEMENTS
During 2003, we eliminated $63.0 million of indebtedness in exchange for the
payment of $3.1 million in cash and the issuance of 23.9 million shares of Class
A common stock valued at $13.6 million pursuant to our announced efforts to
eliminate substantially all of our outstanding indebtedness. After reversing
$6.5 million of previously capitalized interest and $2.4 million of accrued
interest net of debt issuance costs, we recorded total gains of $54.1 million on
these transactions.
In 2002, we eliminated $5.5 million of indebtedness in exchange for the payment
of $0.6 million in cash and the issuance of 5,415 shares of Class A common stock
valued at $6,000 pursuant to our announced efforts to eliminate substantially
all of our outstanding indebtedness. After reversing $1.7 million of previously
capitalized interest, we recorded a gain of $6.6 million on these transactions.
The elimination of outstanding debt resulted in substantial income from
cancellation of debt for income tax purposes. We intend to minimize the income
tax payable as a result of the restructuring by, among other things, offsetting
the income with our historical net operating losses and otherwise reducing the
income in accordance with applicable income tax rules. We do not expect to incur
any material current income tax liability from the elimination of this debt,
although the relevant tax authorities may challenge our income tax positions.
LOSS FROM DISCONTINUED OPERATIONS
In September 2003, a previously vacated judgment in the amount of $931,000 was
reinstated against the Company in connection with the Company's suit against a
broker engaged by the Company in connection with the proposed sale of the portal
operations of its discontinued India.com business and the broker's counterclaim
against the company. The judgment and related costs, net of previously recorded
reserves, is reflected as the loss from discontinued operations in 2003
Consolidated Statement of Operations. See Note 18 - Commitments and
Contingencies - Legal Proceedings for additional information.
LIQUIDITY AND CAPITAL RESOURCES
We have 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. At December 31, 2004 our cash and cash equivalents
amounted to $12.2 million, a $5.7 million increase in comparison to balances on
hand at December 31, 2003. At year end 2004 we had a working capital deficit of
$31,000 in comparison to working capital deficits of $11.8 million at December
31, 2003 and $19.6 million at December 31, 2002. In addition, our stockholders
equity reached $13.0 million at December 31, 2004 from $4.4 million at December
31, 2003 and from a deficit of $61.8 million at December 31, 2002.
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. 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, in December 2004 and 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. See Note 7 -
Loans and Notes Payable for a description of the Wells Fargo Foothill credit
facility.
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.
11
Cash provided from operations amounted to $6.0 million and $7.7 million for the
years ended December 31, 2004 and 2003, respectively. Although we anticipate
that our operating results for 2005 will approximate these levels, we expect to
increase spending for capital expenditures requiring the use of available funds.
We estimate spending $6.0 million for capital expenditures in 2005, mostly
related to the build out of a new network center at our corporate office
location in Piscataway, NJ and the migration of customer messaging to the new
facility from a leased AT&T location. The new network installation is expected
to result in reduced network operating costs once the migration is completed in
the first quarter of 2006. Capital expenditures amounted to $3.2 million
(including $0.6 million under capital leases) in 2003 and $4.2 million in 2002.
Other major uses of cash in 2005 are approximately $4.0 million in payments of
principal on our outstanding debt. The 2005 principal payments consist of the
payment of $1.4 million on February 1, 2005 for the maturity of the remaining 7%
convertible subordinated notes and the monthly amortization of the new $12
million term loan from Wells Fargo. The covenants of the credit facility
restrict the amount of our capital expenditures to $6.0 million in 2005 and $4.0
million per year thereafter. The Company did not meet the $3 million limitation
on capital expenditures in 2004; however, Wells Fargo granted a waiver of the
covenant. The credit facility also requires that our operations have minimum
EBITDA results on a quarterly and annual basis. On March 31, 2005, the Company
and Wells Fargo reached an agreement to modify the EBITDA covenant calculation
to exclude from the calculation the amount of the George Abi Zeid settlement
charges of $2.475 million. Failure to comply with these minimum requirements
could result in the acceleration of the payment of the term loan as well as any
future revolving credit advances made under the agreement. The credit facility
also restricts the incurrence of indebtedness. The Company currently expects to
be in compliance with its covenant requirements, as revised, during the year
ending December 31, 2005.
For each of the years ended December 31, 2004, 2003 and 2002, 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.
CONTRACTUAL OBLIGATIONS
Below is a table that presents our contractual obligations and commitments at
December 31, 2004:
Payments due by period (in thousands)
LESS THAN AFTER
TOTAL ONE YEAR 1-3 YEARS 4-5 YEARS 5 YEARS
----- -------- --------- --------- -------
Long-term debt obligations $13,425 $3,825 $4,800 $4,800 -
Operating lease obligations 12,917 2,917 3,760 2,476 $3,764
Purchase obligations mostly consisting of
telecommunication contract commitments 4,521 4,080 441 - -
Other long term liabilities 211 - 211 - -
--- - --- - -
$31,074 $10,822 $9,212 $7,276 $3,764
We do not have any off-balance sheet arrangements that have or are reasonably
likely to have a current or future effect on our financial condition, changes in
financial position, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources that are material to investors.
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 Company will adopt SFAS 123(R) in 2005 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 (p) for the proforma effect of
SFAS 123.
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.
12
ITEM 7A. 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 the United Kingdom) and, to a lesser extent, in
Singapore, Malaysia 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 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 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 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 any
working capital advances drawn down on the facility. 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 interest costs of $107,000 for the year ended December 31, 2005
related to the Term Loan. 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.
13
ITEM 8 CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
EASYLINK SERVICES CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
Independent Registered Public Accountants' Report..................... 15
Consolidated Balance Sheets as of December 31, 2004
(restated) and 2003................................................. 16
Consolidated Statements of Operations for the years
ended December 31, 2004 (restated), 2003, and 2002.................. 17
Consolidated Statements of Stockholders' Equity (Deficit)
and Comprehensive Income (Loss) for the years
ended December 31, 2004 (restated), 2003 and 2002................... 18
Consolidated Statements of Cash Flows for the years
ended December 31, 2004 (restated), 2003 and 2002................... 22
Notes to Consolidated Financial Statements............................ 24
14
INDEPENDENT REGISTERED PUBLIC ACCOUNTANTS' REPORT
The Board of Directors
EasyLink Services Corporation:
We have audited the accompanying consolidated balance sheets of EasyLink
Services Corporation and subsidiaries as of December 31, 2004 and 2003, and the
related consolidated statements of operations, stockholders' equity (deficit)
and comprehensive income (loss), and cash flows for each of the years in the
three-year period ended December 31, 2004. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with the auditing standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of EasyLink Services
Corporation and subsidiaries as of December 31, 2004 and 2003, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 2004 in conformity with US generally accepted
accounting principles.
As discussed in Note 2, the consolidated financial statements as of December 31,
2004 and for the year then ended have been restated.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1(b) to
the consolidated financial statements, 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.
/s/KPMG LLP
New York, New York
April 11, 2005, except as to Note 2, which is as of December 5, 2005.
15
EasyLink Services Corporation
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
DECEMBER 31,
------------
2004 2003
---- ----
(restated)
ASSETS
Current assets:
Cash and cash equivalents................................................................. $12,216 $6,623
Marketable securities..................................................................... 2,023 --
Accounts receivable, net of allowance for doubtful accounts of $3,950 and
$4,824 as of December 31, 2004 and 2003, respectively..................................... 9,564 11,430
Prepaid expenses and other current assets................................................. 2,841 1,760
----- -----
Total current assets...................................................................... 26,644 19,813
------ ------
Property and equipment, net............................................................... 8,071 10,641
Goodwill, net............................................................................. 6,266 6,266
Other intangible assets, net.............................................................. 8,596 11,629
Other assets.............................................................................. 768 1,062
--- -----
Total assets.............................................................................. $50,345 $49,411
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................................................... $6,471 $9,082
Accrued expenses.......................................................................... 13,652 14,336
Restructuring reserves payable............................................................ 728 1,894
Current portion of notes payable.......................................................... 3,825 2,957
Current portion of capitalized interest on notes payable.................................. -- 1,040
Other current liabilities................................................................. 1,471 1,438
Net liabilities of discontinued operations................................................ 528 828
--- ---
Total current liabilities................................................................. 26,675 31,575
------ ------
Notes payable, less current portion....................................................... 9,600 10,511
Capitalized interest on notes payable, less current portion............................... -- 956
Other long term liabilities............................................................... 1,100 1,957
------ -----
Total liabilities......................................................................... 37,375 44,999
------ ------
Stockholders' equity:
Common stock, $0.01 par value; 510,000,000 shares authorized at December 31,
2004 and 2003: Class A--500,000,000 shares authorized at December 31, 2004 and
2003, 44,174,459 and 42,821,500 shares issued and outstanding at
December 31, 2004 and 2003, respectively.................................................. 441 428
Class B--10,000,000 shares authorized at December 31, 2004 and 2003,
0 and 1,000,000 issued and outstanding at
December 31, 2004 and 2003, respectively.................................................. -- 10
Additional paid-in capital................................................................ 553,420 552,589
Accumulated other comprehensive loss...................................................... (238) (272)
Accumulated deficit....................................................................... (540,653) (548,343)
--------- ---------
Total stockholders' equity................................................................ 12,970 4,412
------ -----
Commitments and contingencies
Total liabilities and stockholders' equity................................................ $50,345 $49,411
======= =======
See accompanying notes to consolidated financial statements.
16
EasyLink Services Corporation
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
YEAR ENDED DECEMBER 31,
-----------------------
2004 2003 2002
---- ---- ----
(restated)
Revenues............................................................... $91,840 $101,347 $114,354
Operating expenses:
Cost of revenues....................................................... 36,129 49,553 57,601
------ ------ ------
Gross profit........................................................... 55,711 51,794 56,753
------ ------ ------
Sales and marketing.................................................... 18,715 18,379 20,151
General and administrative............................................. 23,731 24,405 28,694
Product development.................................................... 6,730 6,383 7,412
Amortization of intangible assets...................................... 2,066 2,066 6,751
Impairment of intangible assets........................................ 750 -- 78,784
Restructuring charges (credits)........................................ (350) 1,478 2,320
Gain on sale of businesses/Mailwatch service line...................... (5,017) -- (426)
------- -- -----
46,625 52,711 143,686
------ ------ -------
Income (loss) from operations.......................................... 9,086 (917) (86,933)
----- ----- --------
Other income (expense):
Interest income........................................................ 247 36 189
Interest expense....................................................... (517) (1,390) (4,785)
Gain on debt restructuring and settlements............................. 984 54,078 6,558
Impairment of investments.............................................. -- -- (1,515)
Other, net............................................................. 290 79 641
--- -- ---
Total other income, net................................................ 1,004 52,803 1,088
----- ------ -----
Income from continuing operations before income taxes.................. 10,090 51,886 (85,845)
Provision for income taxes............................................. 2,400 -- --
-- --
Income (loss) from continuing operations............................... 7,690 51,886 (85,845)
----- ------ --------
Loss from discontinued operations...................................... -- (938) --
-- ----- --
Net income (loss)...................................................... $7,690 $50,948 $(85,845)
====== ======= =========
Basic net income (loss) per share:
Income (loss) from continuing operations............................... $0.17 $1.47 $(5.13)
Loss from discontinued operations...................................... -- (0.03) --
-- ------ --
Basic net income (loss) per share...................................... $0.17 $1.44 $(5.13)
===== ===== =======
Diluted net income (loss) per share:
Income (loss) from continuing operations............................... $0.17 $1.46 $(5.13)
Loss from discontinued operations...................................... -- (0.03) --
-- ------ --
Diluted net income (loss) per share.................................... $0.17 $1.43 $(5.13)
===== ===== =======
Weighted-average basic shares outstanding 44,004,271 35,401,809 16,732,793
========== ========== ==========
Weighted-average diluted shares outstanding............................ 44,891,039 35,653,336 16,732,793
========== ========== ==========
See accompanying notes to consolidated financial statements.
17
EasyLink Services Corporation
Consolidated Statement of Stockholders' Equity (Deficit) and Comprehensive
Income (Loss)
(in thousands, except share data)
CLASS A COMMON CLASS B COMMON
STOCK STOCK ADDITIONAL
------------------ ------------------ PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
------ ------ ------ ------ -------
Balance at December 31, 2001 14,580,211 $146 1,000,000 $10 $533,878
Net loss - - - - -
Cumulative foreign currency translation - - - - -
Comprehensive loss - - - - -
Issuance of Class A common stock in connection
with 401(k) plan 314,642 3 - - 434
Issuance of Class A common stock to certain employees - - - - -
Issuance of Class A common stock in connection with
employee terminations 19,265 - - - 84
Issuance of Class A common stock in connection with
private placement 100,000 1 - - (1)
Issuance of Class A common stock in connection with
MyIndia.com contingent liability 6,534 - - - 6
Issuance of Class A common stock in connection with
MyIndia.com sale 56,075 1 - - 314
Issuance of Class A common stock in connection with
vendor settlements 106,534 1 - - 103
Issuance of Class A common stock issued to Lohoo 36,232 - - - 203
Issuance of Class A common stock to third party
vendors 21,016 - - - 78
Issuance of Class A common stock in lieu of cash
interest on debt 888,810 9 - - 1,821
Interest expense related to Senior Convertible
notes payable in common stock - - - - 330
Interest expense related to Capitalized Interest - - - - 294
- - - - ---
Balance at December 31, 2002 16,129,319 $161 1,000,000 $10 $537,544
========== ==== ========= === ========
See accompanying notes to consolidated financial statements.
18
ACCUMULATED TOTAL
OTHER STOCKHOLDERS'
DEFERRED COMPREHENSIVE ACCUMULATED (DEFICIT)/
COMPENSATION LOSS DEFICIT EQUITY
------------ ---- ------- ------
Balance at December 31, 2001 $(42) $(37) $(513,446) $20,509
Net loss - - (85,845) (85,845)
Cumulative foreign currency translation - (209) - (208)
- ----- - -----
Comprehensive loss - (209) (85,845) (86,054)
- ----- -------- --------
Issuance of Class A common stock in connection
with 401(k) plan - - - 437
Issuance of Class A common stock to certain employees 42 - - 42
Issuance of Class A common stock in connection with
employee termination - - - 84
Issuance of Class A common stock in connection with
MyIndia.com contingent liability - - - 6
Issuance of Class A common stock in connection with
MyIndia.com sale - - - 315
Issuance of Class A common stock in connection with
vendor settlements - - - 104
Issuance of Class A common stock issued to Lohoo - - - 203
Issuance of Class A common stock to third party vendors - - - 78
Issuance of Class A common stock in lieu of cash
interest on debt - - - 1,830
Interest expense related to Senior Convertible
Notes payable in common stock - - - 330
Interest expense related to Capitalized Interest - - - 294
- - - ---
Balance at December 31, 2002 - $(246) $(599,291) $(61,822)
= ====== ========== =========
See accompanying notes to consolidated financial statements.
19
EasyLink Services Corporation
Consolidated Statement of Stockholders' Equity (Deficit) and Comprehensive
Income (Loss)
(in thousands, except share data) (continued)
CLASS A COMMON CLASS B COMMON
STOCK STOCK ADDITIONAL
---------------------- ----------------------- PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
------ ------ ------ ------ -------
Balance at December 31, 2002 16,129,319 $161 1,000,000 $10 $537,544
Net income - - - - -
Cumulative foreign
currency translation - - - - -
Comprehensive income - - - - -
Issuance of Class A common stock in
connection with 401(k) plan 531,545 5 - - 486
Issuance of Class A common stock in
connection with private placement 1,923,077 19 - - 981
Issuance of Class A common stock in
connection with cancellation of debt 23,881,705 239 - - 13,328
Issuance of Class A common stock in
lieu of cash interest on debt 284,304 3 - - 181
Proceeds from the exercise of stock
options 71,550 1 - - 69
Balance at December 31, 2003 42,821,500 $428 1,000,000 $10 $552,589
Net income (restated) - - - - -
Unrealized holding gains on marketable
securities - - - - -
Cumulative foreign currency
translation (restated) - - - - -
Comprehensive income (restated) - - - - -
Issuance of Class A common stock in
connection with 401(k) plan 273,129 3 - - 397
Issuance of Class A common stock in
connection with employee terminations - - - - 150
Issuance of Class A common stock in
lieu of cash interest on debt 35,530 - - - 48
Proceeds from the exercise of stock
options 44,300 - - - 32
Conversion of Class B common stock
to Class A common stock 1,000,000 10 (1,000,000) (10) -
Other ---------- ---- --------- -- 204
- - - - ---
Balance at December 31, 2004 (restated) 44,174,459 $441 - $- $553,420
========== ==== ========= == ========
See accompanying notes to consolidated financial statements.
20
ACCUMULATED TOTAL
OTHER STOCKHOLDERS'
DEFERRED COMPREHENSIVE ACCUMULATED (DEFICIT)/
COMPENSATION LOSS DEFICIT EQUITY
------------ ---- ------- ------
Balance at December 31, 2002 $- $(246) $(599,291) $(61,822)
Net income - - 50,948 50,948
Cumulative foreign currency translation - (26) - (20)
- ---- - ----
Comprehensive income - (26) 50,948 50,928
- ---- ------ ------
Issuance of Class A common stock in connection
with 401(k) plan - - - 492
Issuance of Class A common stock in connection with
private placement - - - 1,000
Issuance of Class A common stock in connection with
cancellation of debt - - - 13,567
Issuance of Class A common stock in lieu of
cash interest on debt - - - 184
Proceeds from the exercise of stock options - - - 70
- - - --
Balance at December 31, 2003 - $(272) $(548,343) $4,412
Net income (restated) - - 7,690 7,690
Unrealized holding gains on marketable securities - 529 - 529
Cumulative foreign currency translation (restated) - (495) - (495)
- ----- - -----
Comprehensive income (restated) - 34 7,690 7,724
- ---- ----- -----
Issuance of Class A common stock in connection
with 401(k) plan - - - 400
Issuance of Class A common stock in
connection with employee termination - - - 150
Issuance of Class A common stock in
lieu of cash interest on debt - - - 48
Proceeds from the exercise of stock options - - - 32
Conversion of Class B common stock
to Class A common stock - - - -
Other - - - 204
- - - ---
Balance at December 31, 2004 (restated) - $(238) $(540,653) $12,970
= ====== ========== =======
See accompanying notes to consolidated financial statements.
21
EasyLink Services Corporation
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
YEAR ENDED DECEMBER 31,
-----------------------
2004 2003 2002
---- ---- ----
(restated)
Cash flows from operating activities:
Net income (loss).................................................... $7,690 $50,948 $(85,845)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Loss from discontinued operations.................................... - 938 -
Depreciation and amortization........................................ 5,041 8,295 10,417
Amortization of other intangible assets.............................. 2,284 2,919 8,039
Non-cash interest.................................................... 48 184 1,830
Provision for doubtful accounts...................................... 450 1 2,596
Provision for restructuring charges (credits)........................ (350) 1,478 2,320
Gain on debt restructuring and settlements........................... (984) (54,078) (6,558)
Issuance of shares as matching contributions to employee
benefit plans........................................................ 400 492 437
Other non-cash charges............................................... 168 65 208
Write-off of fixed assets............................................ 6 119 204
Gain on sale of businesses/Mailwatch service line.................... (5,017) - (426)
Impairments of goodwill and intangibles.............................. 750 - 78,784
Impairments of investments........................................... - - 1,515
Changes in operating assets and liabilities:
Marketable securities................................................ (1,502)
Accounts receivable, net............................................. 1,416 508 7,278
Prepaid expenses and other current assets............................ 290 260 (210)
Other assets......................................................... 265 460 (83)
Accounts payable, accrued expenses and other
current liabilities.................................................. (5,001) (4,931) (18,346)
------- ------- --------
Net cash provided by operating activities............................ 5,954 7,658 2,160
----- ----- -----
Cash flows from investing activities:
Purchases of property and equipment, including
capitalized software................................................. (2,564) (4,214) (3,498)
Proceeds from sale of businesses/Mailwatch service line.............. 3,500 - 426
Proceeds from sale of assets......................................... 1,000 - -
----- - -
Net cash provided by (used in) investing activities.................. 1,936 (4,214) (3,072)
----- ------- -------
Cash flows from financing activities:
Net proceeds from issuance of Class A common stock................... - 1,000 -
Net proceeds from issuance of Class A common stock upon
exercise of employee stock options................................... 32 70 -
Payments under capital lease obligations............................. (472) (426) (585)
Proceeds from notes payable.......................................... 12,000 - -
Principal payments of notes payable.................................. (12,053) (5,793) (821)
Interest payments on restructured notes and capitalized interest. (1,009) (843) (897)
------- ----- -----
Net cash used in financing activities................................ (1,502) (5,992) (2,303)
------- ------- -------
Effect of foreign exchange rate changes on cash
and cash equivalents................................................. (495) (27) (209)
----- ---- -----
Cash used in discontinued operations................................. (300) (356) (300)
----- ----- -----
Net increase (decrease) in cash and cash equivalents................. 5,593 (2,931) (3,724)
Cash and cash equivalents at beginning of the year................... 6,623 9,554 13,278
----- ----- ------
Cash and cash equivalents at the end of the year..................... $12,216 $6,623 $9,554
======= ====== ======
Supplemental disclosures of cash flow information:
Cash paid for interest............................................... $497 $691 $3,138
Net cash paid for taxes.............................................. $173 $48 $31
Purchases of property, plant and equipment through capital
lease obligations.................................................... $649
See accompanying notes to consolidated financial statements.
22
SUPPLEMENTAL DISCLOSURE OF NON-CASH INFORMATION:
During the three years ended December 31, 2004, 2003, and 2002, the Company paid
approximately $0.5 million, $0.7 million and $3.1 million, respectively, for
interest. In addition, the Company issued 35,530, 284,304 and 888,810 shares of
Class A common stock valued at approximately $48,000, $184,000 and $1.8 million,
respectively, as payment of interest in lieu of cash for the years ended
December 31, 2004, 2003 and 2002, respectively.
During the year ended December 31, 2002, the Company issued 98,841 shares of its
Class A common stock valued at approximately $524,000, in connection with
certain settlement obligations.
During the year ended December 31, 2002 the Company issued 127,550 shares of its
Class A common stock valued at approximately $182,000, in connection with the
settlement of vendor obligations.
During the years ended December 31, 2004, 2003 and 2002, the Company issued
273,129, 531,545 and 314,642 shares, respectively, in connection with matching
contributions to its 401K plan. These shares were valued at approximately
$400,000, $492,000 and $437,000, respectively.
NON-CASH INVESTING ACTIVITIES:
No shares were issued in connection with non-cash investing activities during
the years ended December 31, 2004, 2003 and 2002.
NON-CASH FINANCING ACTIVITIES:
During the year ended December 31, 2003, the company issued 23,881,705 shares of
Class A common stock in connection with its cancellation of debt. This resulted
in non-cash financing activities of $13.57 million (See Note 7). The Company
entered into various capital leases for computer equipment. These capital lease
obligations resulted in non - cash financing activities of $649,000 during 2004.
23
EASYLINK SERVICES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
(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) CONSOLIDATED RESULTS OF OPERATIONS AND MANAGEMENT'S PLAN
The accompanying consolidated financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the satisfaction
of liabilities in the normal course of business. The Company has a working
capital deficiency and an accumulated deficit that raise substantial doubt about
its ability to continue as a going concern. The Company may need additional
financing to meet cash requirements for its operations. If the Company is unable
to generate sufficient cash flow or raise additional financing, the Company may
be unable to continue as a going concern.
The accompanying consolidated financial statements do not include any adjustment
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 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, $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.
(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
exercise significant influence over 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.
WORLD.com, a wholly owned subsidiary, and its majority-owned subsidiaries have
been reflected as discontinued operations in the accompanying financial
statements. In September 2003, a previously vacated judgment in the amount of
$931,000 was reinstated against the Company in connection with a suit against a
broker engaged by the Company to sell the portal operations of its discontinued
India.com business and the broker's counterclaim thereof. The judgment and
related costs, net of reserves, are reflected in the loss from discontinued
operations in the consolidated statement of operations for the year ended
December 31, 2003.
Effective January 23, 2002, the Company authorized and implemented a 10-for-1
reverse stock split of all issued and outstanding stock. Accordingly, all issued
and outstanding share and per share amounts in the accompanying consolidated
financial statements have been retroactively restated to reflect the reverse
stock split.
(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.
24
(E) CASH AND CASH EQUIVALENTS
The Company considers all highly liquid securities, with original maturities of
three months or less when acquired, to be cash equivalents.
(F) MARKETABLE SECURITIES
All of the Company's marketable securities are classified as available-for-sale
securities with unrealized gains and losses excluded from earnings and reflected
as a separate component of stockholders' equity.
(G) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is calculated using the
straight-line method over the estimated useful lives of the related assets,
generally ranging from three to five years. Property and equipment under capital
leases are stated at the present value of minimum lease payments and are
amortized using the straight-line method over the shorter of the lease term or
the estimated useful lives of the assets. Leasehold improvements are amortized
using the straight-line method over the estimated useful lives of the assets or
the term of the lease, whichever is shorter.
(H) INVESTMENTS
Investments in which the Company owns less than 20% of a company's stock and
does not have the ability to exercise significant influence are accounted for on
the cost basis. Such investments are stated at the lower of cost or market value
and are included in other non current assets on the balance sheet. The equity
method of accounting is used for companies and other investments in which the
Company has significant influence; generally this represents common stock
ownership of at least 20% but not more than 50%. Under the equity method, the
Company's proportionate share of each investee's operating losses is included in
loss on equity investments within the Statement of Operations. These investments
are included in other non current assets on the balance sheet. The Company
assesses the need to record impairment losses on investments and records such
losses when the impairment is determined to be other-than-temporary. These
losses are included in other income (expense) in the Statement of Operations. In
2002, the Company wrote down the value of two of its investments by $1.5 million
due to the other than temporary decline in their values. As a result, all of the
Company's investments have been written down to minimal amounts.
(I) ACCOUNTING FOR IMPAIRMENT OF LONG-LIVED AND INTANGIBLE ASSETS
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other
Intangible Assets" and SFAS No. 144, "Accounting for the Impairment or Disposal
of Long-Lived Asset". SFAS 142 eliminates the amortization of goodwill and
indefinite-lived intangible assets, addresses the amortization of intangible
assets with finite lives and addresses impairment testing and recognition for
goodwill and indefinite-lived intangible assets. SFAS No. 144 establishes a
single model for the impairment of long-lived assets including intangible assets
with finite lives. The Company assesses goodwill and indefinite-lived intangible
assets for impairment annually unless events occur that require more frequent
reviews. Long-lived assets, including amortizable intangibles, are tested for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Discounted cash flow
analyses are used to assess indefinite-lived intangible asset impairment while
undiscounted cash flow analyses are used to assess finite lived intangibles and
other long-lived asset impairment. If an assessment indicates impairment, the
impaired asset is written down to its fair market value based on the best
information available. Estimated fair market value is generally measured with
discounted estimated future cash flows. Considerable management judgment is
necessary to estimate undiscounted and discounted future cash flows. Assumptions
used for these cash flows are consistent with internal forecasts. On an ongoing
basis, management reviews the value and period of amortization or depreciation
of long-lived assets, including other intangible assets. During this review, the
significant assumptions used in determining the original cost of long-lived
assets are reevaluated. 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 an 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.
(J) INTANGIBLE ASSETS
Intangible assets include goodwill, trademark, customer lists, technology and
other intangibles. Goodwill represents the excess of the purchase price of
acquired businesses over the estimated fair value of the tangible and
identifiable intangible net assets acquired. Trademark is deemed to have
indefinite life and therefore is not amortized. Customer lists are being
amortized on a straight-line basis over ten years. Technology is being amortized
on a straight-line basis over its estimated useful lives from three to five
years. See note 6.
(K) INCOME TAXES
Income taxes are accounted for under the asset and liability method. Under this
method, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in results of operations in the period that
the tax change occurs. Valuation allowances are established, when necessary, to
reduce deferred tax assets to the amount expected to be realized.
(L) REVENUE RECOGNITION
The Company's business communication 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; 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 help 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 all its services and from license fees for integrated
desktop messaging. Revenues for services are recognized as performed. License
revenue is recognized over the average estimated customer life of 3 years.
25
Other revenues consist of revenues from the licensing of domain names wherein
revenue is recognized ratably over the license period. Such revenues amounted to
$392,000, $475,000 and $480,000 in 2004, 2003 and 2002, respectively. In
December, 2004, the Company sold its domain name assets to the former Chairman
of the Board of Directors. See Note 4.
(M) PRODUCT DEVELOPMENT COSTS
Product development costs consist primarily of personnel and consultants' time
and expense to research, conceptualize, and test product launches and
enhancements to each of the Company's services. Such costs are expensed as
incurred.
(N) SALES AND MARKETING COSTS
The primary component of sales and marketing expenses are salaries and
commissions for sales, marketing, and business development personnel. The
Company expenses the cost of advertising and promoting its services as incurred.
(O) 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 December 31, 2004
and 2003, the fair value of cash, cash equivalents, marketable securities and
accounts receivable approximated their financial statement carrying amount
because of the short-term maturity of these instruments. The recorded values of
loans payable, 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 $1.4 million.
However, as these notes are payable in February 2005, management estimates that
their fair value approximates their carrying value.
Credit is extended to customers based on the evaluation of their financial
condition and collateral is not required. The Company performs ongoing credit
assessments of its customers and maintains an allowance for doubtful accounts.
No single customer exceeded 10% of either total revenues or accounts receivable
in 2004, 2003 or 2002. Revenues from the Company's five largest customers
accounted for an aggregate of 10%, 7% and 6% of the Company's total revenues in
2004, 2003 and 2002, respectively.
(P) STOCK-BASED COMPENSATION PLANS
In 2004, 2003 and 2002, the Company had stock option plans, which are described
more fully in Note 13. As allowed by SFAS No. 123, Accounting for Stock-Based
Compensation, as amended by SFAS No. 148, the Company has retained the
compensation measurement principles of Accounting Principles Board (APB) Opinion
No. 25, Accounting for Stock Issued to Employees, and its related
interpretations for stock options. The Company adopted the disclosure provisions
of SFAS No. 148 as of December 31, 2002 and continues to apply the measurement
provisions of APB 25. Under APB Opinion No. 25, compensation expense is
recognized based upon the difference, if any, at the measurement date between
the market value of the stock and the option exercise price. The measurement
date is the date at which both the number of options and the exercise price for
each option are known. The following table illustrates the effect on net income
(loss) and net income (loss) per share if the fair value recognition provisions
of SFAS No. 123 had been applied to stock-based employee compensation.
($IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) FOR THE YEAR ENDED DECEMBER 31,
-------------------------------
2004 2003 2002
---- ---- ----
(restated)
Net income (loss):
Income (loss) from continuing operations, as reported.............. $7,690 $51,886 $(85,845)
Deduct total stock based employee compensation expense
determined under the fair value method for all awards,
net of tax......................................................... (2,769) (8,394) (9,343)
------- ------- -------
Pro forma income (loss) from continuing operations................. $4,921 43,492 (95,188)
Loss from discontinued operations.................................. - $(938) -
- ------ -
Proforma net income (loss)......................................... $4,921 $42,554 $(95,188)
====== ======= =========
Basic net income (loss) per share:
Income (loss) from continuing operations as reported............... $0.17 $1.47 $(5.13)
Deduct total stock based employee compensation
expense determined under the fair value method for
all awards, net of tax............................................. $(0.06) $(0.24) $(0.56)
------- ------- -------
Pro forma income (loss) from continuing operations................. $0.11 $1.23 $(5.69)
Loss from discontinued operations.................................. - $(0.03) -
- ------- -
Proforma basic net income (loss)................................... $0.11 $1.20 $(5.69)
===== ===== =======
26
2004 2003 2002
---- ---- ----
(restated)
Diluted net income (loss) per share:
Income (loss) from continuing operations as reported............... $0.17 $1.46 $(5.13)
Deduct total stock based employee compensation
Expense determined under the fair value method for
all awards, net of tax............................................. $(0.06) $(0.24) $(0.56)
------- ------- -------
Pro forma income (loss) from continuing operations................. $0.11 $1.22 $(5.69)
Loss from discontinued operations.................................. - $(0.03) -
- ------- -
Proforma diluted net income (loss)................................. $0.11 $1.19 $(5.69)
===== ===== =======
The resulting effect on the pro forma net income (loss) disclosed for the years
ended December 31, 2004, 2003 and 2002 is not likely to be representative of the
effects of the net loss on a pro forma basis in future years, because the pro
forma results include the impact of three, four and five years, respectively, of
grants and related vesting of option prices ranging from $0.53 per share to
$294.80 per share. Subsequent years will include additional grants at the then
current stock prices and vesting. For purposes of pro-forma disclosure, the
estimated fair value of the options is amortized to expense over the options'
vesting period.
The fair value of each option grant is estimated on the date of grant using the
Black Scholes method option-pricing model with the following assumptions used
for grants made in 2004: dividend yield of zero (0%) percent, average risk-free
rate interest rate of 3.4%, expected life of 5 years and volatility of 119%,
2003: dividend yield of zero (0%) percent, average risk-free rate interest rate
of 3.0%, expected life of 5 years and volatility of 123%, 2002: dividend yield
of zero (0%) percent, average risk-free interest rate of 4.1%, expected life of
5 years and volatility of 120%.
(Q) BASIC AND DILUTED NET INCOME (LOSS) PER SHARE
Net income (loss) per share is presented in accordance with the provisions of
SFAS No. 128, "Earnings Per Share", and the Securities and Exchange Commission
Staff Accounting Bulletin No. 98. Under SFAS No. 128, basic Earnings per Share
("EPS") excludes dilution for common stock equivalents and is computed by
dividing income or loss available to common shareholders by the weighted average
number of common shares outstanding for the period. Diluted EPS reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock and resulted in the
issuance of common stock.
Diluted net income per common share for the years ended December 31, 2004 and
2003 include the effect of employee options to purchase 886,765 and 251,527
shares of common stock, respectively. Diluted net loss per share is equal to
basic loss per share for the year ended December 31, 2002, since all common
stock equivalents are anti-dilutive for this period.
Diluted net income (loss) per common share for the years ended December 31,
2004, 2003 and 2002, does not include the effects of employee options to
purchase 1,524,086, 1,429,516 and 2,773,446 shares of common stock,
respectively, and 798,523, 798,523 and 1,843,982 common stock warrants,
respectively, as their inclusion would be antidilutive. Similarly, the
computation of diluted net loss per share for 2002 excludes the effect of shares
issuable upon the conversion of any outstanding Convertible Notes at December
31, 2002.
(R) COMPUTER SOFTWARE
Capitalized computer software is recorded in accordance with the American
Institute of Certified Public Accountants Statement of Position ("SOP") 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use" and is depreciated using the straight-line method over the
estimated useful life of the software, generally 3 years. SOP 98-1 provides
guidance for determining whether computer software is internal-use software and
guidance on accounting for the proceeds of computer software originally
developed or obtained for internal use and then subsequently sold to the public.
It also provides guidance on capitalization of the costs incurred for computer
software developed or obtained for internal use.
(S) RECENT ACCOUNTING PRONOUNCEMENTS
In July 2002, Statement of Financial Accounting Standards No. 146, "Accounting
for Costs Associated with Exit or Disposal Activities" ("Statement 146") was
issued. This Statement addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies Emerging Issues Task
Force Issue ("EITF") 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." The principal difference between Statement
146 and EITF 94-3 relates to the timing of liability recognition. Under
Statement 146, a liability for a cost associated with an exit or disposal
activity is recognized when the liability is incurred. Under EITF 94-3, a
liability for an exit cost was recognized at the date of an entity's commitment
to an exit plan. The provisions of Statement 146 are effective for exit or
disposal activities that are initiated after December 31, 2002. The adoption of
this statement did not have a material impact on the Company's financial
position or results of operations.
In November 2002, the FASB issued FIN 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others." FIN 45 elaborates on the existing disclosure requirements for most
guarantees, including residual value guarantees issued in conjunction with
operating lease agreements. It also clarifies that at the time a company issues
a guarantee the company must recognize an initial liability for the fair value
of the obligation it assumes under that guarantee and must disclose that
information in its interim and annual financial statements. The initial
recognition and measurement provisions apply on a prospective basis to
guarantees issued or modified after December 31, 2002. The disclosure
requirements are effective for financial statements or interim or annual periods
ending after December 15, 2002. The adoption of FIN 45 did not materially impact
the Company's financial position and results of operations.
27
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities", and amended the interpretation
with FIN 46(R) in December 2003. This interpretation and its amendment set forth
a requirement for an investor with a majority of the variable interests in a
variable interest entity ("VIE") to consolidate the entity and also requires
majority and significant variable interest investors to provide certain
disclosures. A VIE is an entity in which the equity investors do not have a
controlling interest, or the equity investment at risk is insufficient to
finance the entity's activities without receiving additional subordinated
financial support from the other parties. The provisions of FIN 46 were
effective immediately for all arrangements entered into with new VIEs created
after January 31, 2003. The Company has not entered into any arrangements with
VIEs after January 31, 2003. For arrangements entered into with VIEs created
prior to January 31, 2003, the provisions of FIN 46 have been delayed to the
first interim or annual period beginning after December 15, 2003. The Company
has evaluated the impact of adoption of FIN 46(R) for its arrangements created
before January 31, 2003. The adoption of this standard did not materially impact
the Company's financial statements.
In April 2003, the FASB issued SFAS No. 149, "Amendment of SFAS No. 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. In particular, this Statement clarifies under what circumstances a
contract with an initial net investment meets the characteristic of a
derivative. It also clarifies when a derivative contains a financing component
that warrants special reporting in the statement of cash flows. SFAS No. 149 is
generally effective for contracts entered into or modified after June 30, 2003
and did not materially impact the Company's financial statements.
In May 2003, the FASB issued Statement of Financial Accounting Standard No. 150
("SFAS 150"), "Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity", which establishes standards for how an issuer
classifies and measures certain financial instruments with characteristics of
both liabilities and equity. The provisions of SFAS 150 are effective
immediately for all instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003. The adoption of this standard did not have an effect on the
Company's financial statements.
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 Company will adopt SFAS 123(R) in 2005 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 (p) for the proforma effect of
SFAS 123.
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 expects to be in a position to finalize its
assessment by December 31, 2005.
In September 2004, the Emerging Issues Task Force ("EITF") of the FASB reached a
consensus on EITF Issue No. 04-08, "The Effect of Contingently Convertible Debt
on Diluted Earnings Per Share," which requires the shares issuable under
contingently convertible debt, such as the Company's convertible subordinated
debentures, to be included in diluted earnings per share computations,
regardless of whether the contingency had been met, if the effect would be
dilutive to the earnings per share calculation. The provisions are effective for
reporting periods ending after December 15, 2004. If the impact is dilutive, all
prior period earnings per share amounts presented are required to be restated to
conform to the provisions of the EITF. The Company adopted this rule during the
fourth quarter of 2004 and there was no effect on diluted income (loss) per
share for all periods presented since the effect was anti-dilutive to the
earnings per share calculation.
(T) 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 (deficit). Gains and losses from foreign currency
transactions are included in consolidated statements of operations and were not
significant.
28
(2) RESTATEMENT OF 2004 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 telecommunication services costs of the Company's
United Kingdom subsidiary was over-stated. The Company has revised its
methodology to more accurately estimate this liability resulting in a
decrease in the estimated liability and related costs of revenues of
$603,000 for 2004.
2. The Company had recorded accruals for certain assessed Federal
regulatory fees in prior years although the amounts of such assessments
were disputed by the Company. Based upon revised assessments received by
the Company in the 4th quarter of 2004, the amounts of such accruals
were in excess of the revised assessments. 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 $296,000.
3. The Company has determined that it did not properly account for certain
equipment purchased in prior years. As a result the Company has recorded
$47,000 in additional depreciation expense in 2004 related to these
assets.
4. 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 have been increased in the 4th quarter
of 2004 based on a tax assessment received in 2005 but prior to the
issuance of the Company's Form 10K for the year ended December 31, 2004.
The increase in the estimated liability is $90,000.
5. The Company incorrectly calculated the net operating loss carry forwards
of its United Kingdom subsidiaries as of December 31, 2003 resulting in
the under accrual of foreign income tax liabilities of $295,000 in 2004.
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 December 31, 2004. As a result, the accumulated other
comprehensive loss account included in stockholders' equity at December
31, 2004 has been increased by $166,000 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 consolidated financial statements as of December 31,
2004 and for the year then ended.
29
CONSOLIDATED BALANCE SHEET
AS OF DECEMBER 31, 2004
ADJUSTMENTS
AS PREVIOUSLY
REPORTED AMOUNT NO. AS RESTATED
-------- ------ --- -----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $12,300 (84) 6 $12,216
Marketable securities 2,023 2,023
Accounts receivable, net of allowance for
doubtful accounts 9,624 (60) 6 9,564
Prepaid expenses and other current assets 2,578 263 6 2,841
----- -----
TOTAL CURRENT ASSETS 26,525 26,644
Property and equipment net 8,125 (54) 3,6 8,071
Goodwill, net 6,266 6,266
Other intangible assets, net 8,846 (250) 6 8,596
Other assets 764 4 768
----- -----
TOTAL ASSETS 50,526 (181) 50,345
====== ===== ======
LIABILITIES AND STOCKHOLDERS EQUITY
CURRENT LIABILITIES:
Accounts payable $6,523 (52) 6 $6,471
Accrued expense 13,891 (239) 1,2,4,5,6,7 13,652
Restructuring reserves payable 728 728
Current portion of notes payable 3,825 3,825
Other current liabilities 1,408 63 6 1,471
Net liabilities of discontinued operations 528 528
----- -----
TOTAL CURRENT LIABILITIES 26,903 26,675
Notes payable, less current portion 9,600 9,600
Other long term liabilities 975 125 6 1,100
---- -----
TOTAL LIABILITIES 37,478 (103) 37,375
STOCKHOLDERS' EQUITY
Common stock 441 441
Additional paid-in-capital 553,420 553,420
Accumulated other comprehensive loss (72) (166) 6,7 (238)
Accumulated deficit (540,741) 88 (540,653)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 13,048 (78) 12,970
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY 50,526 (181) 50,345
====== ===== ======
30
CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2004
ADJUSTMENTS
AS PREVIOUSLY
REPORTED AMOUNT NO. AS RESTATED
-------- ------ --- -----------
TOTAL REVENUES $91,840 $91,840
Operating expenses:
Cost of revenues 36,725 (596) 1,6 36,129
------- ----- ------
GROSS PROFIT 55,115 596 55,711
Sales and marketing 18,715 18,715
General and administrative 23,794 (63) 2,3,4,6 23,731
Product development: 6,730 6,730
Amortization of Intangibles 2,066 2,066
Restructuring Charge (350) (350)
Impairment of intangible assets 500 250 6 750
Gain on sale of buisnesses/MailWatch service line (5,017) (5,017)
------- -------
46,438 187 46,625
INCOME FROM OPERATIONS 8,677 409 9,086
Interest income 70 177 6 247
Interest expense (517) (517)
Other income (expense) 288 2 6 290
Gain on settlement of debt 984 984
---- ---
INCOME BEFORE INCOME TAXES 9,502 588 10,090
------ ------
Provision for income taxes 1,900 500 5,6 2,400
------ -----
NET INCOME $7,602 $88 $7,690
======= === ======
BASIC NET INCOME PER SHARE $0.17 $0.00 $0.17
====== ====== =====
DILUTED NET INCOME PER SHARE $0.17 $0.00 $0.17
====== ====== =====
COMPREHENSIVE INCOME $7,802 $ (78) $7,724
======= ====== ======
31
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2004
ADJUSTMENTS
AS PREVIOUSLY
REPORTED AMOUNT NO. AS RESTATED
-------- ------ --- -----------
NET CASH PROVIDED BY OPERATING
ACTIVITIES $6,278 $(324) $5,954
====== ===== ======
NET CASH PROVIDED BY INVESTING
ACTIVITIES 1,530 406 1,936
====== ===== ======
NET CASH USED IN FINANCING
ACTIVITIES (1,502) - (1,502)
====== ===== ======
NET INCREASE IN CASH AND CASH
EQUIVALENTS 5,977 (84) 5,893
====== ===== ======
32
(3) SALE OF BUSINESSES/MAILWATCH SERVICE LINE
On September 20, 2002, the Company sold its customer contracts related to its
email hosting service ("NIMS") line to Call Sciences, Inc. Call Sciences paid
$300,000 in cash upon closing. In connection with the sale, the parties entered
into a transition services agreement whereby the Company would receive payments
for services rendered during the 2 month period following the close. As a result
of the sale, the Company transferred the customer contracts and recorded a gain
on the sale of NIMS of $300,000. In October 2002, the Company sold for $126,000
a software and consulting business in England that was previously acquired in an
earlier acquisition. The full purchase price was recorded as a gain as the net
book value of assets transferred was zero.
On July 31, 2004, the Company sold its MailWatch service line to Infocrossing,
Inc. for total consideration of approximately $5.0 million, including $3.5
million in cash and 123,193 shares of Infocrossing's common stock valued at
approximately $1.5 million. The sale resulted in a gain of $4.1 million before
income taxes. The Infocrossing stock is reported at market value in the December
31, 2004 balance sheet and the unrealized gain related thereto of $521,000 is
included in the accumulated other comprehensive gain(loss) account in
stockholders' equity.
(4) SALE OF INTERNET DOMAIN NAMES
In December 2004, the Company sold its internet domain name portfolio and
related assets to its former Chairman of the Board of Directors for $1 million
and recognized a gain of $891,000 on the transaction. In addition to the initial
purchase price, the Company will receive 15% of all revenues related to the
purchased domain names during the second and third years following the sale and
10% of all such revenues in the fourth and fifth years. The Company also has the
option to purchase back substantially all the domain names for $4.5 million at
any time during the fourth and fifth years.
The former Chairman resigned as an employee of the Company and member of the
Board of Directors on the same day as the domain name sale was completed.
Furthermore, he agreed to the conversion of all his one million shares of 10 for
1 super-voting Class B common stock into 1 for 1 standard voting Class A common
stock. As a result, there are no Class B shares outstanding as of December 31,
2004.
(5) PROPERTY AND EQUIPMENT
Property and equipment, net of accumulated depreciation and amortization, are
stated at cost or allocated fair value and are summarized as follows, in
thousands:
DECEMBER 31,
2004 2003
---- ----
restated
Computer equipment and software....................... $40,103 $40,878
Furniture and fixtures................................ 1,589 1,589
Web development....................................... 181 181
Leasehold improvements................................ 2,282 2,187
----- -----
Subtotal.............................................. 44,155 44,835
Less accumulated depreciation and amortization........ 36,084 34,194
------ ------
Property and equipment, net........................... $8,071 $10,641
====== =======
Depreciation and amortization expense of property and equipment totaled $5.0
million, $8.3 million and $10.4 million for the years ended December 31, 2004,
2003 and 2002, respectively.
(6) GOODWILL AND INTANGIBLE ASSETS
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
("SFAS 142"). SFAS 142 requires 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 also requires that intangible assets with finite useful lives be
amortized over their respective estimated useful lives to their estimated
residual values, and reviewed for impairment in accordance with SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of" ("SFAS 144"). The Company adopted the
provisions of SFAS 142 effective January 1, 2002.
As of January 1, 2002, the date of adoption, the Company had unamortized
goodwill in the amount of $68.8 million, which was subject to the transition
provisions of SFAS 142. During the quarter ended June 30, 2002, the Company
completed its assessment with the assistance of an independent appraiser and
determined that there was no impairment as of January 1, 2002. During the
quarter ended December 31, 2002, the Company completed a new assessment with the
assistance of an independent appraiser and determined that there was an
impairment. Accordingly, a fair value analysis was performed on the Company's
goodwill, intangible assets and other long lived assets which resulted in an
aggregate impairment charge of $78.8 million, allocated as follows: $7.5
million-trademarks, $7.6 million-customer base, $1.1 million-technology, and
$62.6 million-goodwill.
During 2002, economic and market conditions led to forecasts with lower growth
rates and a significantly lower market value of the Company. The methodology
used to determine the business enterprise of the Company was the income
approach, a discounted cash flow valuation method. The discount rate was
determined by using a weighted average cost of capital analysis which was
developed using a capital structure which reflects the representative historical
mix of debt and equity of a group of guideline companies in this business.
Assumptions for normal working capital levels and taxes were also incorporated
in the analysis. The value of the tradename and developed technology was based
on the relief-from-royalty method. This determines the value by quantifying the
cost savings a company enjoys by owning, as opposed to licensing, the intangible
asset. The value of the Company's customer base was also determined through an
income approach.
33
During the quarter ended December 31, 2003, the Company completed its 2003
assessment of its goodwill and indefinite-lived intangible assets with the
assistance of an independent appraiser and determined that there was no further
impairment of these assets. The evaluation employed the same methodology as that
used in the 2002 evaluation.
During the quarter ended December 31, 2004, the Company completed its 2004
assessment of its goodwill and indefinite-lived intangible assets with the
assistance of an independent appraiser and determined that there was an
impairment of its trademark of $750,000. The evaluation employed the same
methodology as that used in the prior years' evaluations.
Included in the Company's balance sheet as of December 31, 2004 and 2003 are the
following (in thousands):
AS OF DECEMBER 31, 2004
-----------------------
(restated)
ACCUMULATED
GROSS COST AMORTIZATION NET
---------- ------------ ---
Intangibles with indefinite lives:
Goodwill.................................................................... $152,659 $(146,393) $6,266
======== ========== ======
Trademarks.................................................................. $15,250 $(10,400) $4,850
======= ========= ======
Intangibles with finite lives:
Technology.................................................................. $16,550 $(14,339) $2,211
Customer lists.............................................................. 11,000 (9,943) 1,057
Software development and licenses........................................... 4,564 (4,086) 478
----- ------- ---
$32,114 $(28,368) $3,746
======= ========= ======
AS OF DECEMBER 31, 2003
-----------------------
ACCUMULATED
GROSS COST AMORTIZATION NET
---------- ------------ ---
Intangibles with indefinite lives:
Goodwill.................................................................... $152,659 $(146,393) $6,266
======== ========== ======
Trademarks.................................................................. 16,000 $(10,400) $5,600
====== ========= ======
Intangibles with finite lives:
Technology.................................................................. $16,550 $(12,445) $4,105
Customer lists.............................................................. 11,000 (9,771) 1,229
Software development and licenses........................................... 4,580 (3,885) 695
----- ------- ---
$32,130 $(26,101) $6,029
======= ========= ======
The Company's estimated amortization expense is $2.3 million, $0.6 million, $0.2
million, $0.2 million, and $0.2 million in 2005, 2006, 2007, 2008 and 2009,
respectively. In accordance with Statement 142, the Company reassessed the
useful lives of all other intangible assets. There were no changes to such lives
and there are no expected residual values associated with these intangible
assets. Customer lists are being amortized on a straight-line basis over ten
years. Technology and software development and licenses are being amortized on a
straight-line basis over their estimated useful lives from two to five years.
(7) ACCRUED EXPENSES
Accrued expenses consist of the following, in thousands:
DECEMBER 31,
2004 2003
---- ----
restated
Carrier charges............................................................................. $3,217 $5,507
Payroll and related costs................................................................... 2,835 2,532
Sales/Use/VAT taxes payable................................................................. 1,300 1,792
Federal and state income taxes payable...................................................... 2,280 --
Professional services, consulting fees and
sales agents' commissions................................................................... 1,581 1,295
Interest.................................................................................... 90 233
Software and hardware maintenance........................................................... 181 168
Other....................................................................................... 2,168 2,809
----- -----
Total....................................................................................... $13,652 $14,336
======= =======
34
(8) LOANS AND NOTES PAYABLE
Loans and notes payable include the following, in thousands:
December 31,
2004 2003
--------- ----------------------------
Capitalized
Principal Interest Principal
--------- ----------- ----------
Term loan payable......................................... $12,000 --- ---
7% Convertible Subordinated Notes,
due February 1, 2005...................................... 1,425 --- $1,425
12% restructure note: as amended and
restated effective September 2003......................... --- 1,884 10,504
12% restructured notes payable quarterly
beginning June 2003....................................... --- 109 1,025
Restructure balloon payment due November, 2004............ --- --- 396
12% restructure note payable to
shareholder............................................... --- 3 118
--- - ---
Total loans and notes payable............................. 13,425 1,996 13,468
Current portion........................................... 3,825 1,040 2,957
----- ----- -----
Long term portion......................................... $9,600 $956 $10,511
====== ==== =======
TERM LOAN PAYABLE
On December 16, 2004 the Company entered into a $15 million credit facility with
Wells Fargo Foothill, Inc. (a subsidiary of Wells Fargo Bank) that includes a
$12 million Term Loan payable monthly over 60 months and the availability of
working capital advances of $3 million initially, increasing to $7.5 million
upon the completion of certain items by the Company subject to limitations
including the maximum outstanding under the facility of $15 million. The credit
facility is secured by a security interest in substantially all of the Company's
assets. $9.5 million of the proceeds from the Term Loan were used by the Company
to repay all outstanding restructure notes. The balance of the proceeds will be
used to repay the outstanding balance of the 7% Convertible Subordinated Notes,
due February 1, 2005 and to fund other cash requirements of the Company's
operations. As a result of the repayment of the restructure notes, $984,000 of
previously capitalized interest was reversed and recognized as a gain on debt
restructurings and settlements. The capitalized interest had been recorded in
2001 at the time of previous debt restructuring in accordance with SFAS No. 15,
"Accounting by Debtors and Creditors for Troubled Debt Restructurings.
Interest on the Term Loan is payable monthly at the rate of 3.75% over the Wells
Fargo Bank prime rate and an annual fee of 1% of the balance outstanding is
payable on each anniversary of the loan. The Term Loan includes certain
mandatory prepayments as follows: (1) beginning with the year ended December 31,
2005, a mandatory prepayment is required for any year in which the Company has
"excess cash flow", as defined in the agreement, equal to the lesser of $400,000
or 25% of the excess cash flow for that year; (2) upon the sale or disposition
of certain assets excluding up to $3,000,000 in proceeds from the sale of domain
names and up to $2,000,000 from the sale of Infocrossing, Inc. stock obtained in
the MailWatch service line sale; (3) upon the receipt of certain extraordinary
funds as defined in the agreement in excess of $1,000,000; and (4) at any time
that total borrowings under the credit facility exceeds one of the following:
$15,000,000, 2 times trailing twelve months EBITDA, 50% of the Company's
enterprise valuation or the amount of accounts receivable collections for
domestic revenues for the preceding 90 days.
Interest on outstanding Advances is payable monthly at the rate of 0.75% over
the Wells Fargo Bank prime rate. A fee of 0.25% per annum is payable monthly on
the amount of available but unused advances and a servicing fee of $2,500 per
month is also payable. Advances are specifically limited to 85% of Eligible
Accounts Receivable which represent all revenues from US customers excluding
certain balances based on the periods such balances are outstanding.
The credit facility includes certain affirmative and restrictive covenants,
including a restriction on the incurrence of indebtedness, a restriction on the
payment of dividends, limitations on capital expenditures and maintenance on
quarterly levels of EBITDA. The Company was not in compliance with the $3
million limitation on capital expenditures for 2004; however, Wells Fargo waived
the covenant. Additionally, on March 31, 2005, the Company entered into an
amendment to the credit agreement whereby it can exclude severance charges
related to the George Abi Zeid settlement of up to $2.475 million from the
calculation of EBITDA for covenant compliance purposes.
35
7% CONVERTIBLE SUBORDINATED NOTES
The 7% Convertible Subordinated Notes outstanding as of December 31, 2004 and
2003 represent the balance outstanding from $100 million in notes issued on
January 26, 2000. The Notes are convertible by holders into shares of EasyLink
Class A common stock at a conversion price of $189.50 per share. Through a
series of exchange, settlement and restructuring transactions completed in 2001
through 2003, the outstanding notes were reduced to the current amount which was
paid on the maturity date of February 1, 2005.
RESTRUCTURE NOTES
On November 27, 2001, the Company completed the restructuring of approximately
$63 million of debt and lease obligations and a related financing in the amount
of approximately $10 million. Under the terms of the debt restructuring, the
Company exchanged an aggregate of approximately $63 million of debt and
equipment lease obligations for an aggregate of approximately $20 million of
restructure notes and obligations due in installments commencing June 2003
through June 2006, 1.97 million shares of Class A Common Stock and warrants to
purchase 1.8 million shares of Class A Common Stock. In addition, the Company
purchased certain leased equipment for an aggregate purchase price of $3.5
million.
The restructure notes accrued interest at a rate of 12% per annum and were
scheduled to mature five years from the date of the debt restructuring. The
Company was able to elect to defer payment of accrued interest on a portion of
the restructure notes until various dates commencing June 2003 and to elect to
pay accrued interest on other restructure notes in shares of Class A common
stock having a market value at the time of payment equal to 120% of the interest
payment due. The Company was not required to make scheduled principal payments
on any of the notes until June 2003.
One restructure note, which was amended and restated effective September 2003,
was originally issued for $10 million to AT&T Corp. in connection with the 2001
debt restructuring. The debt was originally $35 million from the acquisition of
STI, including the EasyLink Services business as purchased from AT&T by STI
shortly before the Company's acquisition. In 2003, AT&T entered into an
agreement to sell the $10 million note and 1.4 million shares of EasyLink Class
A common stock, received by AT&T as part of the debt restructuring, to PTEK
Holdings, Inc. ("PTEK"), one of the Company's principal competitors. Following
the announcement of the agreement, the Company commenced legal proceedings to
enjoin AT&T from selling the note and to assert claims for damages against AT&T
and PTEK. In October 2003 the legal dispute was settled. Under the settlement,
the Company agreed to consent to the transfer of the note and shares from AT&T
to PTEK in exchange for a revised amortization schedule on the note and return
of a warrant to the Company for cancellation. The warrant, also issued in
connection with the 2001 debt restructuring, was for the purchase of 1 million
shares of the Company's Class A common stock at a purchase price of $6.10 per
share. The amended and restated note, amounting to $11.0 million which included
the balance of principal and interest outstanding as of September 1, 2003, was
repayable in quarterly installments of principal and interest of $800,000 with a
final payment of $5.8 million on the June 1, 2006 maturity date.
During 2002, the Company entered into two separate transactions repurchasing
$5.0 million in 10% Senior Convertible Notes and a 12% Senior Restructure Note
and a restructure balloon liability in the amount of $0.5 million for a total of
$0.6 million in cash and 5,415 shares in Class A common stock, valued at
approximately $6,000. The Company recorded a $6.6 million in gains on the
transactions including the reversal of $1.7 million of capitalized interest
related to the repurchased debt.
During 2003, the Company entered into a series of transactions with debt holders
to eliminate a total of $63.0 million of indebtedness in exchange for cash
payments of $3.1 million and, the issuance of 23.9 million shares of Class A
common stock valued at $13.6 million. The eliminated debt included $22.7 million
of 7% Convertible Subordinated Notes, due February 2005, $31.1 million of 10%
Senior Convertible Notes, due January 2006, a $2.7 million note payable to the
former shareholder of STI (who was an officer and director of the Company), $6.0
million of Restructure notes and $0.5 million in other indebtedness. The Company
also entered into agreements to repay an outstanding note in the principal
amount of $115,000 and accrued interest obligations in the aggregate amount of
$959,000 over the next three years, which accrued interest includes $284,000 due
to the former shareholder of STI. In addition, after eliminating $6.5 million of
previously capitalized interest, $2.7 million of accrued interest, and $0.3
million of debt issuance costs on the eliminated notes, these transactions
resulted in a gain of $54.1 million or $1.52 per share on a basic and diluted
basis. Also, the transactions relating to the previous $115,000 note and
$959,000 of accrued interest have been accounted for in accordance with SFAS 15.
(9) DISCONTINUED OPERATIONS
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 was the majority owner. On November 2, 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. Accordingly, World.com has been reflected as a
discontinued operation. Revenues, costs and expenses, assets, liabilities and
cash flows of World.com have been excluded from the respective captions in the
consolidated statement of operations, consolidated balance sheets and
consolidated statements of cash flows and have been reported as "Loss from
discontinued operations," "Net liabilities of discontinued operations," and "Net
cash used in discontinued operations," for all periods presented.
Summarized financial information (In thousands) for the discontinued operation
is as follows:
STATEMENTS OF OPERATIONS DATA
YEAR ENDED DECEMBER 31,
2004 2003 2002
---- ---- ----
Revenues.................................................................... $-- $-- $--
=== === ===
Loss from discontinued operations........................................... $-- $938 $--
=== ==== ===
36
BALANCE SHEET DATA
AS OF DECEMBER 31,
2004 2003
---- ----
Current assets.............................................................. $17 $17
Total assets................................................................ 404 404
Current liabilities......................................................... 740 1,040
Long-term liabilities and minority interest................................. 193 193
Net liabilities of discontinued operations.................................. (528) (828)
(10) LEASES
In addition to capital leases, the Company leases facilities and certain
equipment under agreements accounted for as operating leases. These leases
generally require the Company to pay all executory costs such as maintenance and
insurance. Rent expense for operating leases for the years ending December 31,
2004, 2003 and 2002 was approximately $3.6 million, $4.2 million, and $3.4
million, respectively.
At December 31, 2004, the Company had $507,000 in gross amount of fixed assets
and $67,000 of related accumulated amortization under capital leases. Future
minimum lease payments under the remaining capital leases and non-cancellable
operating leases (with initial or remaining lease terms in excess of one year)
as of December 31, 2004 are as follows, in thousands:
YEAR ENDING DECEMBER 31,
CAPITAL OPERATING
LEASES LEASES
2005........................................................................................ $321 $2,917
2006........................................................................................ 43 2,195
2007........................................................................................ - 1,565
2008........................................................................................ - 1,221
2009........................................................................................ - 1,255
2010 and later.............................................................................. - 3,764
- -----
Total minimum lease payments................................................ $364 $12,917
==== =======
Less current portion of obligations under capital leases.................................... 321
Obligations under capital leases, excluding current portion................................. $43
===
Of the total operating lease commitments as of December 31, 2004 noted above,
$12.0 million is for occupied properties and $0.9 million is for abandoned
properties, which are a component of the restructuring obligation. The balance
for capital leases and related interest as of December 31, 2004 is for computer
equipment and software.
(11) RELATED PARTY TRANSACTIONS
FEDERAL PARTNERS, L.P. FINANCINGS
On January 8, 2001, the Company issued $5,000,000 principal amount of 10% Senior
Convertible Notes due January 8, 2006 to Federal Partners. Stephen Duff, a
director of the Company until November 2004, is Chief Investment Officer of The
Clark Estates, Inc. and is Treasurer of the general partner of, and a limited
partner of, Federal Partners, L.P. The note accrued interest at the rate of 10%
per annum and was payable semi-annually one half in cash and, at the option of
the Company, one half in shares of Class A common stock valued at the conversion
price of $10.00 per share. The Company issued shares to Federal Partners in
payment of interest on this note during 2003, 2002 and 2001. The Clark Estates,
Inc. provides management and administrative services to Federal Partners. On
March 20, 2001, the Company issued to Federal Partners 300,000 shares of our
Class A common stock for a purchase price of $3,000,000, and committed to issue
to Federal Partners an additional 100,000 shares of Class A common stock if the
closing price of our Class A common stock on the principal securities exchange
on which they are traded was not at or above $100 per share for 5 consecutive
days. The additional shares were issued in 2002. As part of the financing
completed on November 27, 2001 in connection with our debt restructuring, the
Company issued to Federal Partners an aggregate of 250,369 shares of Class A
common stock for a purchase price of $1,700,000, and we committed to issue to
Federal Partners an additional 173,632 shares of Class A common stock if the
average of the closing prices of our Class A common stock on Nasdaq was not at
or above $16.00 per share for the 10 consecutive trading days through year end
2001. The additional shares were issued in 2002. Through his limited partnership
interest in Federal Partners, Mr. Duff has an indirect interest in 10,789 of the
shares of Class A common stock held by Federal Partners.
On May 1, 2003, Federal Partners exchanged the $5 million note for 2.5 million
shares of Class A common stock value of approximately $1.4 million. In addition,
on April 30, 2003, Federal Partners purchased 1,923,077 shares of Class A common
stock of EasyLink at a purchase price of $.52 per share or $1 million in the
aggregate. Federal Partners and accounts for which The Clark Estates, Inc.
provides management and administrative services, were beneficial holders as of
May 1, 2003 of 13.02% of the Company's common stock.
37
ACQUISITION OF SWIFT TELECOMMUNICATIONS, INC.
The Company acquired Swift Telecommunications, Inc. on February 23, 2001. George
Abi Zeid was the sole shareholder of Swift Telecommunications, Inc ("STI"). In
connection with the acquisition, Mr. Abi Zeid was elected to the Board of
Directors of the Company and was appointed President - International Operations.
EasyLink paid $835,294 in cash, issued 1,876,618 shares of Class A common stock
valued at $30.8 million and issued a promissory note in the original principal
amount of approximately $9.2 million to Mr. Abi Zeid in payment of the purchase
price for the acquisition payable at the closing. Under the merger agreement,
EasyLink also agreed to pay additional contingent consideration to Mr. Abi Zeid
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. During 2004, pursuant to such agreement the
Company paid Mr. Abi Zeid $320,000 of net proceeds received by the Company.
Pursuant to the debt restructuring completed on November 27, 2001, EasyLink
issued $2,682,964 principal amount of restructure notes, 268,295 shares of Class
A common stock valued at approximately $1.6 million and warrants to purchase
268,295 shares of Class A common stock in exchange for Mr. Abi Zeid's $9.2
million note. On May 1, 2003 in connection with the Company's 2003 debt
restructuring, Mr. Abi Zeid exchanged the promissory note in the principal
amount of $2,682,964 for 1,341,482 shares of Class A common stock valued at
approximately $765,000 and agreed to defer interest payments due to him in the
amount of $283,504, all of which has been paid. See Note 7 - Loans and Notes
Payable.
Subsequent to December 31, 2004 Mr. Abi Zeid resigned as an officer and director
of the Company pursuant to a separation agreement. Under the agreement, the
Company agreed to pay Mr. Abi Zeid $240,000 as a severance payment on the
effective date of his resignation, February 4, 2005, and an aggregate amount of
$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 employees of the Company.
SALE OF INTERNET DOMAIN NAMES
In December 2004, the Company sold its portfolio of Internet domain names and
related assets to Gerald Gorman, the Company's former Chairman and director. See
Note 4.
(12) CAPITAL STOCK
REVERSE STOCK SPLIT
Effective January 23, 2002, the Company authorized and implemented a 1 for 10
reverse stock split. Accordingly, all share and per share amounts in the
accompanying consolidated financial statements have been retroactively restated
to reflect the reverse stock split.
AUTHORIZED SHARES
As of December 31, 2004, the number of authorized shares consist of 500,000,000
shares of Class A common stock, 10,000,000 shares of Class B common stock and
60,000,000 undesignated shares of preferred stock, all with a par value of $0.01
per share.
COMMON STOCK
VOTING RIGHTS
Each share of Class A common stock has one vote per share. Prior to the
conversion into Class A common stock in December 2004, 1 million shares of Class
B common stock, which were owned by the Chairman, had ten votes per share.
PRIVATE PLACEMENT OF COMMON STOCK
On April 30, 2003, the Company completed a private placement of 1,923,077 shares
of Class A common stock for an aggregate price of $1,000,000 to Federal
Partners.
SETTLEMENTS
During 2002, the Company issued 226,391 shares of Class A common stock in
connection with various settlements of certain obligations and for payment of
services rendered valued at $706,000 in the aggregate. The 2002 issuances
included 127,550 shares in connection with vendor settlements and 98,841 shares
related to discontinued operations. In addition, 888,810 shares of Class A
common stock were issued during 2002 in lieu of cash interest payments on Senior
Convertible Notes and subordinated debentures valued at $1.8 million in the
aggregate.
UNDESIGNATED PREFERRED SHARES
The Company is authorized, without further stockholder approval; to issue
authorized but unissued shares of preferred stock in one or more classes or
series. At December 31, 2004 and 2003, 60,000,000 authorized shares of
undesignated preferred stock were available for creation and issuance in this
manner.
38
(13) STOCK OPTIONS
A summary of the Company's stock option activity and weighted average exercise
prices is as follows:
FOR THE YEAR ENDED DECEMBER 31,
2004 2003 2002
---- ---- ----
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
------- ----- ------- ----- ------- -----
Options outstanding at
beginning of period.................... 4,881,980 $4.00 2,773,446 $6.80 1,855,781 $13.51
Options granted........................ 441,000 $1.37 2,470,131 $1.14 1,285,300 $1.04
Options canceled....................... (186,417) $3.92 (290,047) $7.23 (367,732) $20.44
Options exercised...................... (44,300) $0.75 (71,550) $0.98 97 -
-------- ----- -------- ----- -- -
Options outstanding at
end of period.......................... 5,092,263 $3.80 4,881,980 $4.00 2,773,446 $0.67
========= ===== ========= ===== ========= =====
Options exercisable at period end...... 3,318,729 2,200,787 1,174,560
========= ========= =========
Weighted average fair value of
options granted during the
period................................. $0.90 $0.90 $0.93
===== ===== =====
The following table summarizes information about stock options outstanding and
exercisable at December 31, 2004:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
----------- ---- ----- ----------- -----
$0.53-0.70................................... 489,650 7.80 $.54 432,150 $0.53
$0.98-1.45................................... 3,203,527 8.00 $1.18 1,575,030 $1.08
$1.50-2.20................................... 680,404 6.00 $2.12 608,245 $2.17
$2.30-3.40................................... 24,957 7.10 $2.82 17,263 $2.84
$3.80-5.31................................... 96,157 4.20 $4.44 92,230 $4.45
$5.80-8.13................................... 32,723 3.40 $6.20 29,525 $6.20
$9.06-13.44.................................. 218,627 5.10 $12.31 218,377 $12.31
$14.69-20.00................................. 253,785 4.20 $17.00 253,476 $17.00
$23.36-35.00................................. 42,707 3.10 $34.97 42,707 $34.97
$40.00-55.32................................. 28,763 4.30 $51.08 28,763 $51.08
$63.10-74.61................................. 1,544 5.40 $72.39 1,544 $72.39
$118.60-175.00............................... 18,194 5.10 $155.84 18,194 $155.84
$190.00-193.03............................... 957 4.20 $192.71 957 $192.71
$294.80-294.80............................... 268 0.20 $294.80 268 $294.80
--- ---- ------- --- -------
5,092,263 7.20 $3.80 3,318,729 $5.14
========= ==== ===== ========= =====
On November 14, 2000, the Company offered to certain employees, officers and
directors, including the executive mentioned above, other than the chairman, the
right to re-price certain outstanding stock options to an exercise price equal
to $16.90, the closing price of the Company's Class A common stock on NASDAQ on
November 14, 2000. Options to purchase an aggregate of up to 632,799 shares were
repriced. As of December 31, 2001 options to purchase 532,595 shares were
outstanding. The re-priced options will vest at the same rate that they would
have vested under their original terms except that shares issuable upon exercise
of these options were not able to be sold until after November 14, 2001.
Pursuant to FIN 44, since the new exercise price was equal to the fair market
value of the Company's common stock on the new measurement date, the Company did
not record any compensation cost in connection with this program. However,
depending upon movements in the market value of the Company's Class A common
stock, this accounting treatment may result in significant non-cash compensation
charges in future periods. To date, the Company has not recorded any
compensation charge as the fair market value of the Company's common stock has
been below the new exercise price.
(14) EMPLOYEE STOCK AND SAVINGS PLANS
401 (K) PLAN
On January 3, 2000, the Company established a 401(k) Plan ("the plan"). Subject
to Internal Revenue Service Code limitations, participants may contribute from
1% to 15% of pay each pay period on a before tax basis, subject to statutory
limits. Such contributions are fully and immediately vested. The Company will
match 50% of the first 6% of an employee's contribution with shares of Class A
common stock. Vesting of the Company's matching contributions begins at 20%
after the first anniversary of date of hire or plan commencement date, whichever
is later, increasing by 20% each year thereafter through the fifth year until
full vesting occurs. The Company's matching contributions of 273,129, 531,545,
and 314,642 shares of Class A common stock, for the years ended December 31,
2004, 2003 and 2002 resulted in compensation expense of $400,000, $492,000, and
$437,000, respectively.
Due to the acquisition of STI, the Company has various pension plans in other
countries. The participants may contribute from 2.5% to 10.5% of pay each period
on a before tax basis, subject to statutory limits. Such contributions are fully
and immediately vested. The Company will match 4.5% up to 20% of a participant's
contribution. Vesting of the Company's matching contribution is immediate. The
Company's matching contributions for the years ended December 31, 2004, 2003 and
2002 amounted to $344,049, $210,000 and $454,000, respectively.
39
(15) RESTRUCTURING CHARGES
During 2003 and 2002, restructuring charges of $1.5 million and $2.3 million,
respectively, were recorded by the Company related to the relocation and
consolidation of its New Jersey-based office facilities into one location and a
similar consolidation of its office facilities in England. The relocation
process was completed in the first 6 months of 2003. The restructuring charges
are comprised of abandonment costs with respect to leases, including the
write-off of leasehold improvements.
In 2004, based upon revised estimates of the previously recorded abandonment
costs, largely due to a negotiated settlement of liability on one lease,
$350,000 of restructuring charges were reversed.
40
The following sets forth the activity in the Company's restructuring reserve (in
thousands):
FOR THE YEAR ENDED DECEMBER 31, 2004
BEGINNING CURRENT YEAR CURRENT YEAR ENDING
BALANCE PROVISION UTILIZATION BALANCE
(REVERSAL)
Lease abandonments................................................ $2,747 $(350) $(1,494) $903
====== ====== ======== ====
FOR THE YEAR ENDED DECEMBER 31, 2003
BEGINNING CURRENT YEAR CURRENT YEAR ENDING
BALANCE PROVISION UTILIZATION BALANCE
(REVERSAL)
Employee termination benefits..................................... $140 $(129) $(11) -
Lease abandonments................................................ 2,175 1,607 (1,035) 2,747
Other exit costs.................................................. 47 - (47) -
-- - ---- -
$2,362 $1,478 $(1,093) $2,747
====== ====== ======== ======
FOR THE YEAR ENDED DECEMBER 31, 2002
BEGINNING CURRENT YEAR CURRENT YEAR ENDING
BALANCE PROVISION UTILIZATION BALANCE
(REVERSAL)
Employee termination benefits..................................... $228 - $(88) 140
Lease abandonments................................................ 539 2,143 (507) 2,175
Asset disposals................................................... - 162 (162) -
Other exit costs.................................................. 32 15 - 47
-- -- - --
$799 $2,320 $(757) $2,362
==== ====== ====== ======
(16) INCOME TAXES
The provision for income taxes in 2004 consist of the following:
(restated)
Current taxes:
Federal $1735
State 370
Foreign 295
------
$2,400
There is no tax provision for 2003 and 2002 since the Company has incurred
losses for tax purposes in those years and since inception. Although the Company
has tax loss carryforwards which could have offset its taxable income in 2004,
the availability of such net operating loss carryforwards to offset income in
the current period 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. Accordingly, the December 31, 2004 and 2003
deferred tax assets disclosed below have been adjusted to reflect the Section
382 limitation. As of December 31, 2004 and 2003, the Company had approximately
$9.2 million and $10.9 of federal net operating loss carryforward available to
offset future taxable income after considering the limitations under the change
in stock ownership rules of the Code. Such carryforward expires ratably through
2023.
Additionally, the Company had $2.5 million and $4.3 million, respectively, of
foreign net operating loss carryforwards at December 31, 2004 and 2003, which
had no expiration date.
The elimination of outstanding debt in 2003 resulted in substantial income from
cancellation of debt for income tax purposes. The Company intends to minimize
its income tax payable as a result of the restructuring by, among other things,
offsetting the income with its historical net operating losses and otherwise
reducing the income in accordance with applicable income tax rules. Although the
relevant tax authorities may challenge the Company's income tax positions, the
Company does not expect to incur any material current income tax liability from
the elimination of this debt. See Note 18.
The difference between the statutory federal income tax rate and the Company's
effective tax rate for the year ending December 31, 2004 is principally due to
the utilization of federal and state net operating losses. For the year ending
December 31, 2003 reduction of income in accordance with applicable tax rules,
and net operating losses for which no tax benefit was recorded, resulted in the
difference between the statutory federal income tax rate and the Company's
effective tax rate.
41
The effects of temporary differences and tax loss carryforwards that give rise
to significant portions of deferred tax assets and deferred tax liabilities at
December 31, 2004 and 2003 are presented below, in thousands.
DECEMBER 31,
------------
2004 2003
---- ----
(restated)
Deferred tax assets(liabilities):
Net operating loss carryforwards............................................................ $4,416 $5,657
Accounts receivable principally due to allowance for doubtful accounts...................... 1,345 1,576
Plant and equipment, principally due to differences in depreciation......................... 115 (208)
Write down of assets and investments........................................................ (565) (1,263)
Accrued expenses............................................................................ 411 199
Restructuring reserve....................................................................... 361 790
Other....................................................................................... (210) -
----- -
Gross deferred tax assets................................................................... 5,873 6,751
Less: valuation allowance................................................................... (5,873) (6,751)
------- -------
Net deferred tax assets..................................................................... $- $-
== ==
Based upon the level of historical losses and after considering projections for
future taxable income over the periods in which the deferred tax assets are
expected to be deductible, the Company has recorded a full valuation allowance
against its net deferred tax assets, including the remaining net operating loss
carryforward, since it believes that it is not more likely that not that these
assets will be realized.
(17) VALUATION AND QUALIFYING ACCOUNTS
Additions and write-offs charged to the allowance for doubtful accounts is
presented below, in thousands.
ADDITIONS
BALANCE AT CHARGED TO BALANCE
BEGINNING OF COSTS AND ADDITIONS FROM DEDUCTIONS/ AT END
ALLOWANCE FOR DOUBTFUL ACCOUNTS YEAR EXPENSES ACQUISITIONS WRITE-OFFS OF PERIOD
---- -------- ------------ ---------- ---------
(restated) (restated)
For the year ended December 31, 2002............. $14,547 $2,596 $-- $9,091 $8,052
For the year ended December 31, 2003............. $8,052 $1 $-- $3,229 $4,824
For the year ended December 31, 2004............. $4,824 $450 $-- $1,324 $3,950
(18) COMMITMENTS AND CONTINGENCIES
MASTER CARRIER AGREEMENT
In connection with the acquisition of the EasyLink Services business from AT&T
Corporation in 2001, the Company entered into a Master Carrier Agreement with
AT&T. Under this agreement, AT&T has provided the Company with a variety of
telecommunications services that are required in connection with the provision
of the Company's services. In April, 2004, the Company entered into a Data
Service Terms and Pricing attachment (the "MCA Attachment") to the Master
Carrier Agreement for the renewed purchase of private line and satellite
services for a minimum term of 18 months with an option by the Company to extend
the term up to an additional 12 months. Under the MCA Attachment, the Company
has a minimum purchase commitment for services equal to $3.6 million over the
initial contract period of 18 months. If the Company terminates the network
connection services or the private line and satellite services prior to the end
of the applicable 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 these services for the period in
which termination occurs plus 50% of the minimum purchase commitment for each
remaining commitment period in the term. If the Company decides to exercise the
option at the end of the initial contract period, there is no minimum purchase
commitment and the service term is on a month-to-month basis. During 2003, the
Company entered into a separate agreement for a term of 36 months ending in
September 2006 for switched services from AT&T which includes a minimum revenue
commitment of $120,000 per year. The Company has complied with the annual
minimum revenue commitment for switched services through the annual period
ending September 2004.
OTHER TELECOMMUNICATIONS SERVICES
The Company has committed to purchase from MCI Worldcom a minimum of $900,000
per year in other telecommunications services through January 2007.
LEGAL PROCEEDINGS
From time to time the Company has been, and expects 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; employment
claims; claims alleging unsolicited commercial faxes sent on behalf of the
Company's customers; and contract claims. These claims include claims that some
of the Company's services employ technology covered by third party patents.
These claims, even if not meritorious, could require us to expend significant
financial and managerial resources. No assurance can be given as to the outcome
of one or more claims of this nature. If an infringement claim were determined
in a manner adverse to the Company, it may be required to discontinue use of any
infringing technology, to pay damages and/or to pay ongoing license fees which
would increase the costs of providing service.
42
In connection with the termination of an agreement to sell the portal operations
of the Company's discontinued India.com business, the Company brought suit
against a broker that it had engaged in connection with the proposed sale of the
portal operations alleging, among other things, breach of contract and
misrepresentation. The broker brought a counterclaim against the Company for a
brokerage fee that would have been payable on the closing of the proposed sale.
The court entered a judgment in the amount of $931,000 against the Company. In
response to the judgment, the Company filed a motion to alter the judgment in
which the Company, among other things, requested that the Court vacate the
judgment or reduce the amount of damages. On February 20, 2003, the Court
vacated the original judgment and entered a declaratory judgment in EasyLink's
favor that EasyLink does not owe the broker any fee or other compensation
arising from the failed sale of the portal operations. On March 13, 2003, the
broker filed a motion to amend the judgment or for a new trial requesting, among
other things, re-instatement of the original judgment or, in the alternative, a
new trial. On September 10, 2003, the Court reinstated the previously vacated
judgment in favor of the broker in the original amount of $931,000. The Company
filed for an appeal. The Court has permitted the Company, in lieu of posting an
appeal bond, to place $400,000 into a trust account to provide funds for the
payment of the judgment if upheld on appeal. The Company has paid in full the
$400,000 into the trust account. Oral arguments on the appeal occurred on
September 22, 2004, and the parties await the decision of the Court of Appeals.
No assurance can be given as to the Company's likelihood of success or its
ultimate liability, if any, in connection with this matter.
The Company previously reported that the staff of the US Securities and Exchange
Commission was reviewing certain transactions accounting for approximately $4.8
million of revenue generated by its former advertising network business in 2000,
a year in which the Company reported $61.2 million in total revenue. The Company
announced that it has reached a settlement of the matter with the SEC. Under the
settlement, the Company agreed to the entry of an SEC order requiring that it
cease and desist from violations of certain reporting, record keeping and
internal control provisions of the federal securities laws. The Company settled
without admitting or denying the statements made in the SEC's findings. The
order does not impose any fine or other penalty upon EasyLink and does not
require restatement of any of EasyLink's historical financial statements.
On January 28, 2005, Steven Brin instituted a third party complaint against the
Company and four other companies and two individuals for implied indemnification
and/or contribution. The case was filed in the Circuit Court of Cook County,
Illinois, County Department, Chancery Division, Case No. 03 CH 13062. In the
underlying action against Mr. Brin in the same case, titled Jerold Rawson et al.
v. Steven Brin et al.,the plaintiffs filed a putative class action against Mr.
Brin and the other defendants for allegedly sending or causing to be sent
unsolicited advertisements to telephone facsimile machines in violation of the
federal Telephone Consumer Protection Act, 47 U.S.C. ss. 227, the Illinois
Consumer Fraud and Deceptive Business Practices Act and common law conversion
and trespass. Mr. Brin has denied liability to the plaintiffs. Mr. Brin alleges
in the third party complaint filed against the Company and the other third-party
defendants, however, that, if he is found liable to the plaintiffs in the
underlying complaint, then the Company and the other third party defendants
should be held liable to Mr. Brin for implied indemnification and/or
contribution. The Company has until April 13, 2005 to file its answer or
otherwise plead to the third-party complaint, absent an extension. The plaintiff
in the underlying lawsuit made an offer to the defendants to settle the claim
for $30,000. Although we intend to defend this lawsuit vigorously, we cannot
assure you that our ultimate liabiity, if any, in connection with this matter
will not have a material effect on our results of operations, financial
condition or cash flow.
OTHER
The Company's tax filings may be subject to challenge by various tax
authorities. See Note 15. Although the Company believes its tax positions are in
accordance with the relevant laws and regulations, they may be subject to
interpretation by such authorities. The Company cannot predict whether any
changes to its anticipated tax positions and filings could impact its results of
operations, financial condition or cash flows.
(19) QUARTERLY FINANCIAL INFORMATION - UNAUDITED
Condensed Quarterly Consolidated Statements of Operations (in thousands, except
per share data)
Year 2004
FIRST QUARTER SECOND QUARTER
---------------------- ---------------------------------------------------
Three months ended Three months ended Six months ended
---------------------- ---------------------- --------------------
As As As
Previously Previously Previously
As As As
Reported Restated Reported Restated Reported Restated
-------- -------- -------- -------- -------- --------
Revenues $24,336 $24,336 $24,053 $24,053 $48,390 $48,390
Cost of revenues 10,325 9,976 9,764 9,501 20,090 19,477
------- ------- ------- ------- ------- -------
Gross profit 14,011 14,360 14,289 14,552 28,300 28,913
Operating expenses
General and admin 6,384 6,402 5,681 5,699 12,064 12,101
Other expenses 6,757 6,757 6,914 6,914 13,671 13,671
------- ------- ------- ------- ------- -------
13,141 13,159 12,595 12,613 25,735 25,772
------- ------- ------- ------- ------- -------
Income from operations 870 1,201 1,694 1,939 2,565 3,141
Gain from debt restructuring --- --- --- --- --- ---
Other income(expense), net 13 13 (230) (230) (217) (217)
------- ------- ------- ------- ------- -------
Income before income taxes 883 1,214 1,464 1,709 2,348 2,924
Provision for income taxes 30 55 170 160 200 215
------- ------- ------- ------- ------- -------
Net income $ 853 $ 1,159 $ 1,294 $ 1,549 $ 2,148 $ 2,709
======= ======= ======= ======= ======= =======
Basic net income per share $0.02 $0.03 $0.03 $0.04 $0.05 $0.06
===== ===== ===== ===== ===== =====
Diluted net income per share $0.02 $0.03 $0.03 $0.03 $0.05 $0.06
===== ===== ===== ===== ===== =====
43
THIRD QUARTER
---------------------------------------------------------------------
Three months ended Nine months ended
------------------------------- --------------------------------
As Previously As Previously
Reported As Restated Reported As Restated
------------ ----------- -------- -----------
Revenues $22,509 $22,509 $70,899 $70,899
Cost of revenues 8,428 8,580 28,518 28,057
------ ------ ------- ------
Gross profit 14,081 13,929 42,381 42,842
Operating expenses
General and admin 5,959 5,967 18,024 18,069
Other expenses 2,065 2,065 15,734 15,734
----- ------ ------ ------
8,024 8,032 33,758 33,803
------ ------ ------ ------
Income from operations 6,057 5,897 8,623 9,039
Gain from debt restructuring --- ---
Other income(expense), net (16) (16) (234) (234)
---- ---- ----- -----
Income before income taxes 6,041 5,881 8,389 8,805
Provision for income taxes 1,550 1,665 1,750 1,880
------ ------ ------ -----
Net income $4,491 $4,216 $6,639 $6,925
======= ======= ======= ======
Basic net income per share $0.10 $0.10 $0.15 $0.16
====== ====== ====== =====
Diluted net income per
share $0.10 $0.09 $0.15 $0.15
====== ====== ====== =====
FOURTH QUARTER
---------------------------------------------------------------------
Three months ended Twelve months ended
------------------------------- --------------------------------
As Previously As Previously
Reported As Restated Reported As Restated
------------- ----------- -------- -----------
Revenues $20,941 $20,941 $91,840 $91,840
Cost of revenues 8,207 8,071 36,725 36,129
------ ------ ------- ------
Gross profit 12,734 12,870 55,115 55,711
Operating expenses
General and admin 5,770 5,662 23,794 23,731
Impairment of intangible
assets 500 750 500 750
Other expenses 6,410 6,410 22,144 22,144
12,680 12,822 46,438 46,625
------ ------ ------ ------
Income from operations 54 48 8,677 9,086
Other income(expense), net
Interest income 41 219 70 249
Interest expense (149) (149) (517) (517)
Gain on debt restructuring 984 984 984 984
Other, net 183 183 288 288
--- --- --- ---
1,059 1,237 825 1,004
----- ----- --- ------
Income before income taxes 1,113 1,285 9,502 10,090
Provision for income taxes 150 520 1,900 2,400
---- ---- ------ ------
Net income $963 $765 $7,602 $7,690
===== ===== ======= ======
Basic net income per share $0.02 $0.02 $0.17 $0.17
====== ====== ====== =====
Diluted net income per share $0.02 $0.02 $0.17 $0.17
====== ====== ====== ======
44
Year 2003
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
Revenues......................... $25,742 $25,802 $25,065 $24,738
Cost of revenues................. 13,707 13,361 10,863 11,622
------ ------ ------ ------
Gross profit..................... 12,035 12,441 14,202 13,116
Operating expenses............... 14,595 12,787 12,760 12,571
------ ------ ------ ------
Income(loss)
from operations.................. (2,560) (346) 1,442 545
Gain from debt
restructuring.................... 6,640 47,026 -- 412
Other income/(expense),
net.............................. (778) (304) (75) (116)
----- ----- ---- -----
Income from
continuing operations............ 3,302 46,376 1,367 841
----- ------ ------ -----
Loss from discontinued
operations....................... -- -- (838) (100)
-- -- ---- -----
Net income....................... $3,302 $46,376 $529 $741
====== ======= ==== ====
Basic income (loss) per share:
Income from
continuing operations............ $0.19 $1.28 $0.03 $0.02
Loss from discontinued
operations....................... -- -- (0.02) --
----- ----- ----- -----
Net income....................... $0.19 $1.28 $0.01 $0.02
===== ===== ===== =====
Diluted income (loss) per share:
Income from
continuing operations............ $0.19 $1.28 $0.03 $0.02
Loss from discontinued
operations....................... -- -- (0.02) --
----- ----- ----- -----
Net income....................... $0.19 $1.28 $0.01 $0.02
===== ===== ===== =====
45
Due to changes in the number of shares outstanding, quarterly loss per share
amounts do not necessarily add to the totals for the years.
(20) GEOGRAPHIC DISCLOSURE
GEOGRAPHIC INFORMATION
FOR THE YEARS ENDED
--------------------------------
2004 2003 2002
---- ---- ----
Restated
United States:
Revenues....................................................................... $67,973 $77,019 $89,356
Operating income (loss)........................................................ 7,378 (175) (84,543)
Total assets................................................................... 43,625 49,408 58,704
Long lived assets.............................................................. 22,039 27,585 34,317
All other regions:
Revenues....................................................................... 23,867 24,328 24,998
Operating income (loss)........................................................ 1,708 (742) (2,390)
Total assets................................................................... 6,720 4 2,307
Long lived assets.............................................................. 894 951 1,544
Significant country included in all other regions
United Kingdom:
Revenues....................................................................... 20,516 20,463 20,940
Operating income (loss)........................................................ 2,296 172 (1,798)
Total assets................................................................... 5,544 1,176 2,453
Long lived assets.............................................................. 568 541 938
Geographic data is classified based on the location of the Company's operation
that provides selling and general account maintenance of the customer's
accounts.
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
Not applicable.
ITEM 9A. 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 annual 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 December 31, 2004,
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 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 annual report on this Form 10-K/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.
46
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 consolidated
financial statements included in this report that underlie the restatement of
its financial statements for the year ended December 31, 2004, the Company
identified the following material weaknesses in its internal control over
financial reporting:
1. As of December 31, 2004, 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 for the period ending December 31,
2004.
2. As of December 31, 2004, 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 consolidated financial statements for
the period ending December 31, 2004.
Changes in Internal Control Over Financial Reporting
There were no changes to our internal control over financial reporting
during the fourth quarter ended December 31, 2004 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 9A 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-K for
the year ended December 31, 2004.
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 control 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.
47
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
Exhibits.
23 Consent of KPMG LLP
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, on December 5, 2005.
EasyLink Services Corporation
(Registrant)
By /s/ THOMAS F. MURAWSKI
-------------------------
(Thomas F. Murawski, Chairman, President
and Chief Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities indicated on December 5, 2005.
/s/ THOMAS F. MURAWSKI Chairman, President, Chief Executive
--------------------------- Officer, Director (Principal Executive Officer)
(Thomas F. Murawski)
/s/ MICHAEL A. DOYLE Vice President and Chief Financial
--------------------------- Officer
(Michael A. Doyle) (Principal Accounting and Financial Officer)
/s/ DAVID W. AMBROSIA Executive Vice President, General Counsel
--------------------------- and Secretary
(David Ambrosia)
/s/ ROBERT J. CASALE Director
---------------------------
(Robert J. Casale)
/s/ PETER J. HOLZER Director
---------------------------
(Peter J. Holzer)
/s/ GEORGE F. KNAPP Director
---------------------------
(George F. Knapp)
/s/ JOHN C. PETRILLO Director
---------------------------
(John C. Petrillo)
/s/ DENNIS R. RANEY Director
---------------------------
(Dennis R. Raney)
/s/ ERIC J. ZAHLER Director
---------------------------
(Eric J. Zahler)
48
EXHIBIT INDEX
23 Consent of KPMG LLP
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
49