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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2007
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 000-26371
EASYLINK SERVICES CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 13-3787073
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
33 KNIGHTSBRIDGE ROAD, PISCATAWAY, NJ 08854
(Address of Principal Executive Offices) (Zip Code)
(732) 652-3500
(Registrant's Telephone Number Including Area Code)
Indicate by check whether the registrant: (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer.
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Common stock outstanding as of April 30, 2007: Class A common stock, $0.01 par
value, 11,006,505 shares.
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EASYLINK SERVICES CORPORATION
MARCH 31, 2007
FORM 10-Q
INDEX
PAGE
NUMBER
------
PART I: FINANCIAL INFORMATION
Item 1: Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets as of March 31, 2007
(unaudited) and December 31, 2006........................... 3
Unaudited Condensed Consolidated Statements of Operations
for the three months ended March 31, 2007 and 2006.......... 4
Unaudited Condensed Consolidated Statements of Cash Flows
for the three months ended March 31, 2007 and 2006.......... 5
Notes to Unaudited Interim Condensed Consolidated Financial
Statements.................................................. 6
Item 2: Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 10
Item 3: Quantitative and Qualitative Disclosures about Market Risk.. 12
Item 4: Controls and Procedures..................................... 13
PART II: OTHER INFORMATION
Item 1: Legal Proceedings........................................... 13
Item 1A: Risk Factors................................................ 13
Item 2: Unregistered Sales of Equity Securities and Use of
Proceeds.................................................... 14
Item 3: Defaults Upon Senior Securities............................. 14
Item 4: Submission of Matters to a Vote of Security Holders......... 14
Item 5: Other Information........................................... 14
Item 6: Exhibits.................................................... 14
Signature............................................................... 15
2
EASYLINK SERVICES CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
MAR 31, DEC 31,
2007 2006
----------- ---------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents ................................................. $ 5,289 $ 6,707
Accounts receivable, net of allowance for doubtful accounts
of $1,052 and $1,605 as of March 31, 2007 and
December 31, 2006, respectively ........................................ 10,943 10,725
Prepaid expenses and other current assets ................................. 2,701 2,511
--------- ---------
Total current assets ...................................................... 18,933 19,943
Property and equipment, net ............................................... 9,212 9,703
Goodwill, net ............................................................. 6,213 6,213
Other intangible assets, net .............................................. 4,993 5,069
Other assets .............................................................. 213 305
--------- ---------
Total assets .............................................................. $ 39,564 $ 41,233
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable .......................................................... $ 5,898 $ 5,810
Accrued expenses .......................................................... 8,900 10,299
Loans and notes payable ................................................... 3,808 4,413
Other current liabilities ................................................. 1,428 1,363
--------- ---------
Total current liabilities ................................................. 20,034 21,885
Other long term liabilities ............................................... 1,027 1,186
--------- ---------
Total liabilities ......................................................... 21,061 23,071
--------- ---------
Stockholders' equity:
Common stock:
Class A--500,000,000 shares authorized at March 31, 2007 and
December 31, 2006, 10,999,213 and 10,967,648 shares issued
and outstanding at March 31, 2007 and December 31, 2006, respectively .. 110 110
Additional paid-in capital ................................................ 560,890 560,690
Accumulated other comprehensive loss ...................................... (880) (833)
Accumulated deficit ....................................................... (541,617) (541,805)
--------- ---------
Total stockholders' equity ................................................ 18,503 18,162
--------- ---------
Commitments and contingencies
Total liabilities and stockholders' equity ................................ $ 39,564 $ 41,233
========= =========
See accompanying notes to unaudited condensed consolidated financial statements.
3
EASYLINK SERVICES CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
THREE MONTHS ENDED MARCH 31,
----------------------------
2007 2006
----------- ----------
Revenues ......................................... $ 18,759 $ 18,461
Cost of revenues ................................. 6,901 7,463
----------- ----------
Gross profit ..................................... 11,858 10,998
----------- ----------
Operating expenses:
Sales and marketing .............................. 3,640 4,555
General and administrative ....................... 5,672 5,126
Product development .............................. 1,781 1,747
----------- ----------
11,093 11,428
----------- ----------
Income (loss) from operations .................... 765 (430)
----------- ----------
Other income (expense), net:
Interest income .................................. 46 47
Interest expense ................................. (178) (405)
Other, net ....................................... 44 63
----------- ----------
Total other income (expense), net ................ (88) (295)
----------- ----------
Income (loss) before income taxes ................ 677 (725)
Provision (credit) for income taxes .............. 381 (349)
----------- ----------
Net income (loss) ................................ $ 296 $ (376)
----------- ----------
Basic and diluted net income (loss) per share .... $ 0.03 $ (0.04)
=========== ==========
Basic weighted-average shares outstanding ........ 10,983,875 9,060,644
=========== ==========
Diluted weighted-average shares outstanding ...... 11,036,105 9,060,644
=========== ==========
See accompanying notes to unaudited condensed consolidated financial statements.
4
EASYLINK SERVICES CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
------------------
2007 2006
-------- -------
Cash flows from operating activities:
Net income (loss) .............................................................. $ 296 $ (376)
Adjustments to reconcile net income (loss) to net cash used in operating
activities:
Depreciation ................................................................ 701 727
Amortization ................................................................ 77 402
Issuance of shares as matching contributions to employee benefit plans ...... 135 108
Other ....................................................................... (157) 26
Changes in operating assets and liabilities:
Accounts receivable, net .................................................... 71 (10)
Prepaid expenses and other assets ........................................... (166) 92
Accounts payable, accrued expenses and other liabilities .................... (1,504) (1,035)
-------- -------
Net cash used in operating activities .......................................... (547) (66)
-------- -------
Cash flows from investing activities:
Purchases of property and equipment ............................................ (202) (395)
-------- -------
Net cash used in investing activities .......................................... (202) (395)
-------- -------
Cash flows from financing activities:
Proceeds of bank loan advances ................................................. 10,546 --
Payments of bank loan advances ................................................. (11,151) (950)
Principal payments of notes payable ............................................ -- (600)
Other .......................................................................... (10) (4)
-------- -------
Net cash used in financing activities .......................................... (615) (1,554)
-------- -------
Effect of foreign exchange rate changes on cash and cash equivalents ........... (54) (177)
-------- -------
Net decrease in cash and cash equivalents ...................................... (1,418) (2,192)
Cash and cash equivalents at beginning of the period ........................... 6,707 6,282
-------- -------
Cash and cash equivalents at the end of the period ............................. $ 5,289 $ 4,090
======== =======
Supplemental disclosure of cash flow information:
Cash paid for interest ......................................................... $ 98 $ 396
Cash paid for taxes ............................................................ $ 22 $ 189
See accompanying notes to unaudited condensed consolidated financial statements.
5
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
(a) Summary of Operations
EasyLink Services Corporation (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; and Transaction Delivery Services
consisting of electronic data interchange or "EDI," and production messaging
services utilizing email, fax and telex.
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 the United Kingdom).
(b) Liquidity
For the year ended December 31, 2005, the report from the Company's independent
registered public accountants contained an explanatory paragraph stating that
the Company had a working capital deficiency and an accumulated deficit among
other factors that raised substantial doubt about its ability to continue as a
going concern. During 2006 the Company completed an equity financing for $5.4
million and entered into a new $6.0 million credit facility with CAPCO Financial
Company, a division of Greater Bay Bank, N.A. ("CAPCO") that is subject to a
maximum of 80% of certain accounts receivable of the Company but with no
financial covenants. These financial developments along with the continuing
implementation of cost reduction measures instituted by management have
strengthened the Company's liquidity and financial position. In the three months
ended March 31, 2007 revenues increased in comparison to revenues for both the
same period in 2006 and for the most recent prior quarter. Net income was
$296,000 for the three months ended March 31, 2007 in comparison to a net loss
of $(376,000) for the same period in 2006. Debt balances were reduced to $3.8
million at March 31, 2007 and $4.4 million at December 31, 2006 from $10.6
million at December 31, 2005 resulting in lower interest costs in the current
quarter and future periods. The Company does not expect to repay the total debt
balance in 2007, but it is classified as a current liability in accordance with
generally accepted accounting principals as the facility is subject to a credit
review by CAPCO during 2007. In addition, the Company's working capital deficit
decreased to $1.1 million at March 31, 2007 and $1.9 million as of December 31,
2006 in comparison to $9.5 million at December 31, 2005. For the year ended
December 31, 2006, the audit report from the Company's independent registered
public accountants did not contain a going concern explanatory paragraph.
(c) Unaudited Interim Condensed Consolidated Financial Information
The accompanying interim condensed consolidated financial statements as of March
31, 2007 and for the three months ended March 31, 2007 and 2006 have been
prepared by the Company and are unaudited. In the opinion of management, the
unaudited interim condensed consolidated financial statements have been prepared
on the same basis as the annual consolidated financial statements and reflect
all adjustments, which include only normal recurring adjustments, necessary to
present fairly the consolidated financial position of the Company as of March
31, 2007 and the consolidated results of operations and consolidated cash flows
for the three months ended March 31, 2007 and 2006. The results of operations
for any interim period are not necessarily indicative of the results of
operations for any other future interim period or for a full fiscal year. The
condensed consolidated balance sheet at December 31, 2006 has been derived from
audited consolidated financial statements at that date.
Certain information and note disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to the Securities and Exchange
Commission's rules and regulations. It is suggested that these unaudited interim
condensed consolidated financial statements be read in conjunction with the
Company's audited consolidated financial statements and notes thereto
6
for the year ended December 31, 2006 as included in the Company's Form 10-K
filed with the Securities and Exchange Commission on March 27, 2007 (the "2006
10-K").
(d) 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 significant intercompany accounts and transactions have been eliminated in
consolidation.
Effective August 28, 2006, the Company authorized and implemented a 1-for-5
reverse stock split of all issued and outstanding Class A common 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.
(e) 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.
(f) Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable represent trade receivables billed to customers in arrears
on a monthly basis. Receivables are recorded in the period the related revenues
are earned and, generally, are collected within a short time period. The Company
does not require collateral from its customers and any balances over 30 days old
are considered past due.
The allowance for doubtful accounts is based upon the Company's assessment of
the collectibility of customer accounts receivable. The Company regularly
reviews the allowance by considering factors such as historical experience,
credit quality, the age of accounts receivable balances and current economic
conditions that may affect a customer's ability to pay. Based upon the
continuing favorable trend in actual bad debts incurred and past due receivable
balances, the Company modified its method of estimating future bad debts and
reversed approximately $0.3 million of its previously recorded allowance for
doubtful accounts in the three months ended March 31, 2007.
(g) Financial Instruments and Concentration of Credit Risk
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist of cash and cash equivalents, accounts
receivable and notes payable. At March 31, 2007 and December 31, 2006, the fair
value of cash and cash equivalents and accounts receivable approximated their
financial statement carrying amount because of the short-term maturity of these
instruments. Loans and notes payable are subject to interest rate fluctuations
based on movements in the prime rate. Accordingly, the recorded values of loans
and notes payable approximate their fair values as interest approximates market
rates.
The Company holds cash and cash equivalents at several major financial
institutions in amounts which often exceed FDIC insured limits. The Company also
has $2.3 million in foreign bank accounts as of March 31, 2007 that are not
insured. The Company has not experienced any losses due to such concentration of
credit risk.
Credit is extended to customers based on the evaluation of their financial
condition and collateral is not required. The Company performs ongoing credit
assessments of its customers and maintains an allowance for doubtful accounts.
No single customer exceeded 10% of total revenues for the three months ended
March 31, 2007 and 2006 and no accounts receivable from a single customer
exceeded 10% of total accounts receivable as of March 31, 2007 and December 31,
2006. Revenues from the Company's five largest customers amounted to $2.9
million and $2.1 million for the three months ended March 31, 2007 and 2006,
respectively, and accounted for an aggregate of 15% and 11%, respectively, of
the Company's total revenues for those periods.
(h) Stock-Based Compensation Plans
In the first quarter of 2006, the Company adopted the provisions of, and
accounts for stock-based compensation, in accordance with Financial Accounting
Standards Board ("FASB") Statement of Financial Accounting Standards No.
123-revised 2004, "Share-Based Payment" (SFAS 123R). Under the fair-value
recognition provisions of SFAS 123R, stock-based compensation is measured at the
grant date based on the fair value of the award and is recognized
7
as expense on a straight line basis over the requisite service period, which is
the vesting period. Compensation expense related to stock options and restricted
stock awards for the three months ended March 31, 2007 and 2006 amounted to
$63,000 and $30,000, respectively. No stock option or restricted stock awards
were made in the three months ended March 31, 2007.
(i) Basic and diluted net income per share
Basic net income (loss) per share is computed by dividing income or loss
available to common shareholders by the weighted average number of common shares
outstanding for the period. Diluted net income per share for the three months
ended March 31, 2007 is calculated, including the dilutive effect of stock
options, using the treasury stock method. No adjustment to the weighted average
shares outstanding is reflected in the calculation for the three months ended
March 31, 2006 as all common stock equivalents are dilutive.
The following table reconciles basic and diluted weighted average shares for the
three months ended March 31, 2007:
Basic weighted average number of shares outstanding 10,983,875
Dilutive effect of stock options 52,230
----------
Diluted weighted average number of shares outstanding 11,036,105
(j) Recent Accounting Pronouncements
In September 2006, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 157, "Fair Value Measurements". SFAS No. 157 clarifies the
principle that fair value should be based on the assumptions market participants
would use when pricing an asset or liability and establishes a fair value
hierarchy that prioritizes the information used to develop those assumptions.
SFAS No. 157 requires fair value measurements to be separately disclosed by
level within the fair value hierarchy. SFAS No. 157 is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years. The Company is currently evaluating
the impact of adopting SFAS No. 157 on its future results of operations and
financial condition on January 1, 2008
(2) LOANS AND NOTES PAYABLE
Loans and notes payable as of March 31, 2007 and December 31, 2006 represent
outstanding advances under a $6.0 million credit facility with CAPCO Financial
Company, a division of Greater Bay Bank N.A. ("CAPCO"), entered into in July
2006. The facility provides for advances, subject to a maximum of 80% of certain
accounts receivable of the Company, that bear interest at the rate of 2% over
the prime rate of Greater Bay Bank. The facility has an initial term of 24
months, but can be terminated by CAPCO after 12 months upon 90 days prior
written notice if the Company should fail to meet CAPCO's then existing
underwriting credit criteria. All assets of the Company in the United States are
pledged as collateral to CAPCO but there are no financial covenants under the
facility. As of March 31, 2007 the interest rate on the outstanding advances was
10.25% and $1,055,000 was available under the facility for additional advances.
(3) INCOME TAXES
The Company has recorded its provision (credit) for income taxes in the three
months ended March 31, 2007 based on the anticipated effective tax rate for the
year. For the three months ended March 31, 2006 the Company recorded its
provision (credit) using the actual effective tax rate. The Company had
determined that this method yielded a more reliable estimated tax provision
(credit) due to the inclusion of a full valuation allowance on the Company's net
deferred tax assets in that period. Accordingly, the Company was not in a
position to project an annual effective tax rate for the year ended December 31,
2006. The effective rates for 2007 and 2006 vary from the standard tax rates
primarily due to the recording of a full valuation allowance against the
Company's available Federal, state and certain foreign net operating losses.
The Company adopted the provisions of FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109 ("FIN
48") on January 1, 2007. FIN 48 provides recognition criteria and a related
measurement model for tax positions taken by companies. In accordance with FIN
48, a tax position is a position in a previously filed tax return or a position
expected to be taken in a future tax filing that is reflected in
8
measuring current or deferred income tax assets and liabilities. Tax positions
shall be recognized only when it is more likely than not (likelihood of greater
than 50%), based on technical merits, that the position will be sustained upon
examination. Tax positions that meet the more likely than not threshold should
be measured using a probability weighted approach as the largest amount of tax
benefit that is greater than 50% likely of being realized upon settlement.
As a result of the implementation of FIN48, the Company recognized an increase
in the liability for unrecognized tax benefits of approximately $65,000 and
$43,000 of accrued interest through reductions to the January 1, 2007 balance of
retained earnings. In total, unrecognized tax benefits amounted to approximately
$562,000 at January 1, 2007. Of this amount, approximately $497,000, if not
assessed, will be recorded as a reduction in income tax expense in the fourth
quarter of 2007.
The Company and its US subsidiaries file consolidated income tax returns in the
US federal jurisdiction and consolidated or separate tax returns in various
states. The Company's foreign subsidiaries file tax returns in the foreign
jurisdictions that they operate in. The Company is no longer subject to US
federal or state income tax examinations by tax authorities for 2002 or years
prior thereto. In the United Kingdom, where the Company's most significant
foreign operations are conducted, the Company is no longer subject to
examinations by tax authorities for 2003 or years prior thereto. The Internal
Revenue Service commenced an examination of the Company's US income tax returns
for 2003 and 2004 during 2006 that is anticipated to be completed during 2007.
The Company recognizes accrued interest related to unrecognized tax benefits in
interest expense and records penalties as general and administrative operating
expenses. As of January 1, 2007 total accrued interest and penalties related to
unrecognized tax benefits amounted to approximately $84,000. For the three
months ended March 31, 2007 approximately $9,000 of accrued interest was
recorded.
(4) STOCKHOLDERS' EQUITY
COMMON STOCK
During the three months ended March 31, 2007, the Company issued 30,665 shares
of Class A common stock valued at approximately $135,000 in connection with
matching contributions to its 401K plan.
COMPREHENSIVE LOSS
Comprehensive income (loss) for the three months ended March 31, 2007 and 2006
was as follows:
($ in thousands)
2007 2006
---- -----
Net income (loss).................. $296 $(376)
Foreign currency translation....... (47) (144)
---- -----
Comprehensive income (loss)........ $249 $(520)
---- -----
9
(5) COMMITMENTS AND CONTINGENCIES
LEGAL PROCEEDINGS
On February 8, 2007, the Company settled the litigation entitled Dynamic Depth,
Inc. vs. EasyLink Services Corporation, in which Dynamic Depth, Inc. claimed
infringement by the Company of a patent related to automatic OCR-based routing.
The terms of the settlement are confidential but did not have a material effect
on the financial statements of the Company as of March 31, 2007 or for the three
months then ended. As a result of the settlement, Dynamic Depth, Inc. agreed
that it would take no further legal action nor bring any future charge of
infringement of the related patent against the Company.
(6) SUBSEQUENT EVENT
On May 3, 2007, the Company entered into a definitive agreement with Internet
Commerce Corporation ("ICC") for ICC to acquire the Company. Under the terms of
the merger agreement, ICC will pay $5.80 per share in cash for all of the
Company's outstanding Class A common stock. The merger is expected to be
completed in the third quarter of 2007, subject to customary closing conditions
and regulatory approvals as well as stockholder approval from both companies. In
the three months ended March 31, 2007, costs of approximately $0.8 million were
incurred by the Company related to the ICC merger agreement and the review of
strategic alternatives undertaken prior thereto.
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 quarterly report.
OVERVIEW
We are a provider of services that facilitate the electronic exchange of
information between enterprises, their trading communities and their customers.
On an average business day, we handle approximately one million transactions
that are integral to the movement of money, materials, products and people in
the global economy, such as insurance claims, trade and travel confirmations,
purchase orders, invoices, shipping notices and funds transfers, among many
others. We offer a broad range of information exchange services to businesses
and service providers, including Transaction Management Services and Transaction
Delivery Services. Transaction Management Services consist of integrated desktop
messaging services and document capture and management services such as fax to
database, fax to data and data conversion services. Beginning in 2005, we also
began to offer as a Transaction Management Service an enhanced production
messaging service that we call EasyLink Production Messaging PM2.0 Service.
Transaction Delivery Services consist of electronic data interchange or "EDI,"
and basic production messaging services utilizing email, fax and telex. As part
of our strategy, we will seek to upgrade customers who are using our basic
production messaging service to our enhanced production messaging, EasyLink
Production Messaging PM2.0 Service.
On May 3, 2007 we announced that we had entered into a definitive merger
agreement with Internet Commerce Corporation ("ICC") for ICC to acquire us.
Under the terms of the merger agreement, ICC will pay $5.80 per share in cash
for all of our outstanding Class A common stock. The merger is expected to be
completed in the third quarter of 2007, subject to customary closing conditions
and regulatory approvals as well as stockholder approval from both companies.
OPERATING RESULTS
For the three months ended March 31, 2007, we reported income from operations
and net income of $0.8 million and $0.3 million, respectively, in comparison to
a loss from operations and a net loss of $0.4 million for the same period in
2006. In addition, our revenues increased by $0.3 million in the first quarter
of 2007 as compared to the same period in 2006. This was the first time we have
reported such a year-over-year period growth for our continuing operations since
the first quarter of 2002.
10
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements and related disclosures in conformity
with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, revenues and expenses and the disclosure of contingent
assets and liabilities. We believe that of our significant accounting policies,
those related to accounts receivable net of allowance for doubtful accounts,
long-lived assets and intangible assets and contingencies and litigation
represent the most critical estimates and assumptions that affect our financial
condition and results of operations as reported in our financial statements.
RESULTS OF OPERATIONS - THREE MONTHS ENDED MARCH 31, 2007 COMPARED TO THE THREE
MONTHS ENDED MARCH 31, 2006
REVENUES
For the quarter ended March 31, 2007 total revenues were $18.8 million in
comparison to $18.5 million for the same period in 2006. As detailed in the
schedule below the increase in revenue is attributable to a $1.7 million
increase in our Transaction Management Services revenues, representing 38%
growth, offset by lower revenues in our EDI and Other Transaction Delivery
Services amounting to a total of $1.4 million or 10% decline.
CHANGE
-------------
2007 2006 $ %
------- ------- ------- ---
Transaction Management Services......... $ 6,347 $ 4,602 $ 1,745 38%
Transaction Delivery Services EDI....... 4,333 4,714 (381) (8)%
Transaction Delivery Services Other..... 8,079 9,145 (1,066) (12)%
------- ------- ------- ---
$18,759 $18,461 $ 298 2%
The growth in Transaction Management Services is attributable to Integrated
Desktop Messaging ("IDM") revenues from both new customers and from the
expansion of existing customer business along with accelerated growth in our
enhanced production messaging service, PM2.0. Also contributing to the growth is
an increase of $217,000 in our Small Office/Home Office IDM Service, marketed as
Rapidfax.
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. These
factors have 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 2007. 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.
COST OF REVENUES
Cost of revenues for the three months ended March 31, 2007 decreased to $6.9
million from $7.5 million in the same period of 2006 and, as a percentage of
revenues, these costs decreased to 37% in 2007 as compared to 40% in 2006. The
lower cost and lower percentage of revenues resulted largely from cost savings
realized from the migration of part of our operations network to our new data
center at our headquarters location and the reversal of certain telecom expense
accruals amounting to $150,000 for our United Kingdom operation. Cost of
revenues is expected to remain at approximately the same level as that of the
current quarter for the balance of 2007.
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, toll-free number and usage charges and long distance
domestic and international termination charges, and personnel costs associated
with our systems and databases.
11
SALES AND MARKETING EXPENSES
Sales and marketing expenses decreased to $3.6 million in the three months ended
March 31, 2007 from $4.6 million in the same period of 2006. The lower costs
reflect cost reduction measures, including headcount reductions and lower
marketing spending, initiated in the latter part of 2006. We expect these
expenses to continue at the current level throughout 2007.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were $5.7 million in the three months ended
March 31, 2007 as compared to $5.1 million in the same period of 2006. The
higher cost includes approximately $0.8 million for investment banker and legal
fees associated with our review of strategic alternatives for our business.
These additional costs were offset by, among other changes, the reversal of
approximately $0.3 million in bad debt allowances based upon the continuing
favorable trend in actual bad debts incurred and past due receivable balances.
We anticipate general and administrative expenses for at least the second
quarter of 2007 to be comparable to the results for the current quarter
primarily due to additional fees incurred related to our review of strategic
alternatives and the ICC merger agreement. These expenses include all costs for
our executive, finance and accounting, customer billing and support, human
resources and other headquarters office functions. Bad debt expenses, legal and
accounting fees, insurance and office rent are other significant costs included
in this category.
PRODUCT DEVELOPMENT EXPENSES
Product development costs, which consist primarily of personnel and consultants'
time and expense to research, conceptualize and test product launches and
enhancements to our products, were $1.8 million and $1.7 million for the three
months ended March 31, 2007 and 2006, respectively. We anticipate that spending
for product development will be comparable to these levels throughout 2007 as a
result of our continuing efforts to expand the development of our new
Transaction Management Services.
LIQUIDITY AND CAPITAL RESOURCES
The current period's net income results have contributed to the continuing
improvement in our liquidity and financial position. Although our cash and cash
equivalent balances decreased by $1.4 million during the three months ended
March 31, 2007, our working capital position improved by $0.8 million as our
working capital deficit decreased to $1.1 million at March 31, 2007 from $1.9
million at December 31, 2006. We further reduced our outstanding debt balance to
$3.8 million to reduce interest costs. Other cost reduction measures implemented
in 2006 resulted in lower operating expenses in the first quarter of 2007
although partially offset by payments of costs related to our strategic review
and subsequent merger agreement with ICC. During the current quarter we used
$0.5 million of cash for operations and we spent $0.2 million on capital
expenditures and $0.6 million to reduce our outstanding loan balance.
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk from fluctuations 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, India and Brazil. 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 - The Company's accounts receivable are subject, in the normal
course of business, to collection risks. The Company regularly assesses these
risks and has established policies and business practices to protect against the
adverse effects of collection risks. As a result, the Company does not
anticipate any material losses in excess of the allowance for doubtful accounts.
Interest Rate Risk - Interest rate risk refers to fluctuations in the value of a
security resulting from changes in the general level of interest rates.
Investments that are classified as cash and cash equivalents have original
maturities of three months or less. Changes in the market's interest rates do
not affect the value of these investments. The Company's CAPCO credit facility
is a variable interest rate agreement that creates an interest rate risk on all
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outstanding advances. The impact of this risk assuming the current debt balance
remains outstanding and assuming a hypothetical shift of 1% in interest rates
would be an increase or decrease, as applicable, in annual interest costs of
$38,000. 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.
ITEM 4 CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures designed to ensure that
information required to be disclosed by the Company in the reports that it files
or submits under the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), is recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange 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 that it files
or submits under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission's rules and forms, and is accumulated and communicated to the
Company's management, including its principal chief executive officer and
principal 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, the Company has
evaluated the effectiveness of the design and operation of its disclosure
controls and procedures as of the end of the period covered by this quarterly
report. This evaluation was carried out under the supervision and with the
participation of the Company's management, including its principal executive
officer and principal financial officer. Based on this evaluation, these
officers have concluded that, as of March 31, 2007, the Company's disclosure
controls and procedures were effective.
PART II OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
As disclosed in the 2006 10-K, on February 8, 2007, the Company settled the
litigation entitled Dynamic Depth, Inc. vs. EasyLink Services Corporation, in
which Dynamic Depth, Inc. claimed infringement by the Company of United States
patent number 5,461,488 related to automatic OCR-based routing. The terms of the
settlement are confidential. As a result of the settlement, Dynamic Depth, Inc.
agreed that it would take no further legal action nor bring any future charge of
infringement of the related patent against the Company. The Company determined
that the terms of the settlement would not have a material effect upon it or its
business.
ITEM 1A: RISK FACTORS
This Item 1A should be read in conjunction with "Item 1A. Risk Factors" in
our 2006 10-K. Other than with respect to the risk factors below, there have
been no material changes from the risk factors disclosed in "Item 1A. Risk
Factors" of our 2006 10-K.
FAILURE TO COMPLETE THE PROPOSED MERGER WITH ICC COULD NEGATIVELY AFFECT US.
On May 3, 2007, we entered into a merger agreement with ICC and its wholly owned
subsidiary, Jets Acquisition Sub, Inc. The merger is subject to adoption of the
merger agreement by our stockholders, approval by ICC's stockholders and other
customary closing conditions. There is no assurance when or if the merger
agreement will be adopted by our stockholders, and there is no assurance that
the other conditions to the completion of the merger will be satisfied. In
connection with the merger, we may be impacted by the following risks:
- the inability to complete the merger due to the failure of our
stockholders to adopt the merger agreement, the failure to obtain
approval by ICC's stockholders, expiration of the waiting period under
the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended,
or the failure to satisfy any other condition to
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completion of the merger;
- the occurrence of any event, change or other circumstances that could
give rise to a termination of the merger agreement;
- the outcome of any legal proceedings that have been or may be
instituted against us, members of our board of directors and others
relating to the merger, including any settlement of such legal
proceedings that may be subject to court approval;
- termination of the merger agreement under certain circumstances would
require us to pay ICC a termination fee of $2.5 million, which could
impair our working capital, erode employee, customer and stockholder
confidence and have a materially adverse effect on our business
prospects;
- a potential decline in the market price of our Class A common stock if
the merger is not consummated;
- Disruption of current plans and operations and the potential
difficulties in attracting and retaining employees as a result of the
merger; and
- the amount of the costs, fees, expenses and charges we have and may
incur related to the merger.
ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Recent Sales of Unregistered Securities
During the three months ended March 31, 2007, the Company issued 30,665 shares
of Class A common stock valued at approximately $135,000 in connection with
matching contributions to its 401(k) plan. These issuances were not subject to
the registration requirements of the Securities Act of 1933, as amended, because
the issuance of the shares was not voluntary and contributory on the part of
employees.
ITEM 3: DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5: OTHER INFORMATION
None
ITEM 6: EXHIBITS
The following exhibits are filed as part of this report:
Exhibit 10.11.1 Amendment To Lease dated April 1, 2007 amending the Lease
Agreement between EasyLink Services Corporation and Software
House International, Inc. (successor to BT Piscataway, LLC)
related to leased premises at the Company's headquarters
located at 33 Knightsbridge Road, Piscataway, New Jersey.
Exhibit 31.1 Rule 13a-14(a)/15d-14(a) Certification of the Chief Executive
Officer
Exhibit 31.2 Rule 13a-14(a)/15d-14(a) Certification of the Chief Financial
Officer
Exhibit 32.1 Section 1350 Certification of the Chief Executive Officer
Exhibit 32.2 Section 1350 Certification of the Chief Financial Officer
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report on Form 10-Q to be signed on its behalf
by the undersigned thereunto duly authorized.
EASYLINK SERVICES CORPORATION
/s/ Michael A. Doyle
----------------------------------------
Michael A. Doyle
Vice President and Chief Financial
Officer
(Principal Financial Officer)
May 14, 2007
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