SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
| For the quarter ended June 30, 2003 | Commission File Number 000-20364 | |
EPRESENCE, INC.
(Exact name of registrant as specified in its charter)
| MASSACHUSETTS | 04-2798394 | |
| (State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
120 FLANDERS ROAD
WESTBORO, MASSACHUSETTS 01581
(Address of principal executive offices)
(508) 898-1000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes ¨ No x
Number of shares outstanding of each of the issuer’s classes of Common Stock as of July 31, 2003:
| Class |
Number of Shares Outstanding | |
| Common Stock, par value $.01 per share | 22,654,227 |
QUARTERLY REPORT ON FORM 10-Q
INDEX
| Page Number | ||||
| PART I. | FINANCIAL INFORMATION |
|||
| Item 1. | Financial Statements |
|||
| Consolidated Balance Sheets June 30, 2003 and December 31, 2002 |
3 | |||
| Consolidated Statements of Operations Three and Six months ended June 30, 2003 and 2002 |
4 | |||
| Consolidated Statements of Cash Flows Six months ended June 30, 2003 and 2002 |
5 | |||
| 6 | ||||
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
10 | ||
| Item 3. | 17 | |||
| Item 4. | 17 | |||
| PART II. | OTHER INFORMATION |
|||
| Item 6. | 18 | |||
| SIGNATURE | 18 | |||
| EXHIBIT INDEX | 19 | |||
This Quarterly Report on Form 10-Q contains forward-looking statements, including information with respect to the Company’s plans and strategy for its business. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words “believes”, “anticipates”, “plans”, “expects” and similar expressions are intended to identify forward-looking statements. There are a number of important factors that could cause actual events or the Company’s actual results to differ materially from those indicated by such forward-looking statements. These factors include, without limitation, those set forth below under the caption “Factors Affecting Future Operating Results” included under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part I, Item 2 of this Quarterly Report on Form 10-Q.
2
Item 1. FINANCIAL STATEMENTS
EPRESENCE, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS)
| June 30, 2003 |
December 31, 2002 |
|||||||
| (unaudited) | (audited) | |||||||
| ASSETS |
||||||||
| Cash and cash equivalents |
$ | 74,158 | $ | 73,195 | ||||
| Restricted cash |
36 | 1,640 | ||||||
| Marketable securities |
17,958 | 16,533 | ||||||
| Accounts receivable, net of allowances of $1,286 and $1,330, respectively |
4,705 | 4,872 | ||||||
| Other current assets |
2,479 | 1,875 | ||||||
| Total current assets |
99,336 | 98,115 | ||||||
| Marketable securities |
4,308 | 13,902 | ||||||
| Property and equipment, net |
2,435 | 3,271 | ||||||
| Other assets |
1,118 | 1,131 | ||||||
| TOTAL ASSETS |
$ | 107,197 | $ | 116,419 | ||||
| LIABILITIES |
||||||||
| Accounts payable |
$ | 1,860 | $ | 1,927 | ||||
| Accrued expenses |
7,586 | 8,522 | ||||||
| Other current liabilities |
420 | 448 | ||||||
| Deferred revenue |
1,666 | 1,608 | ||||||
| Current portion of long-term debt |
— | 2,699 | ||||||
| Total current liabilities |
11,532 | 15,204 | ||||||
| Long-term debt, net of current portion |
— | 1,124 | ||||||
| Minority interests in consolidated subsidiaries |
24,885 | 24,522 | ||||||
| SHAREHOLDERS’ EQUITY |
||||||||
| Convertible preferred stock, $.01 par value; authorized - 1,000,000 shares; none issued |
— | — | ||||||
| Common stock, $.01 par value; authorized - 100,000,000 shares; issued 26,332,027 shares |
263 | 263 | ||||||
| Additional paid-in capital |
171,986 | 172,014 | ||||||
| Unearned compensation |
(225 | ) | (592 | ) | ||||
| Accumulated deficit |
(65,445 | ) | (60,420 | ) | ||||
| Accumulated other comprehensive income |
180 | 283 | ||||||
| Treasury stock; 3,677,800 shares at cost |
(35,979 | ) | (35,979 | ) | ||||
| Total shareholders’ equity |
70,780 | 75,569 | ||||||
| TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY |
$ | 107,197 | $ | 116,419 | ||||
The accompanying notes are an integral part of the consolidated financial statements.
3
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
(unaudited)
| Three Months Ended June 30, |
Six Months Ended June 30, |
|||||||||||||||
| 2003 |
2002 |
2003 |
2002 |
|||||||||||||
| Revenues: |
||||||||||||||||
| Services |
$ | 4,314 | $ | 8,952 | $ | 8,485 | $ | 19,245 | ||||||||
| Switchboard |
3,974 | 2,068 | 7,315 | 4,988 | ||||||||||||
| Total revenues |
8,288 | 11,020 | 15,800 | 24,233 | ||||||||||||
| Cost of Revenues: |
||||||||||||||||
| Services |
2,871 | 5,729 | 6,121 | 12,728 | ||||||||||||
| Switchboard |
814 | 1,112 | 1,521 | 2,030 | ||||||||||||
| Total cost of revenues |
3,685 | 6,841 | 7,642 | 14,758 | ||||||||||||
| Gross profit |
4,603 | 4,179 | 8,158 | 9,475 | ||||||||||||
| Operating expenses: |
||||||||||||||||
| Sales and marketing |
2,257 | 3,855 | 5,126 | 8,300 | ||||||||||||
| Product development |
1,121 | 1,317 | 2,235 | 2,822 | ||||||||||||
| General and administrative |
3,403 | 3,646 | 6,392 | 7,575 | ||||||||||||
| Restructure charges |
(35 | ) | — | (35 | ) | 4,000 | ||||||||||
| Total operating expenses |
6,746 | 8,818 | 13,718 | 22,697 | ||||||||||||
| Loss from operations |
(2,143 | ) | (4,639 | ) | (5,560 | ) | (13,222 | ) | ||||||||
| Other income/(expense): |
||||||||||||||||
| Interest income, net |
376 | 1,281 | 818 | 2,394 | ||||||||||||
| Minority interest in Switchboard (income) losses |
(254 | ) | 648 | (281 | ) | 1,126 | ||||||||||
| Other, net |
(43 | ) | 86 | 20 | 124 | |||||||||||
| Total other income |
79 | 2,015 | 557 | 3,644 | ||||||||||||
| Net loss before income taxes |
(2,064 | ) | (2,624 | ) | (5,003 | ) | (9,578 | ) | ||||||||
| Provision for income taxes |
12 | 83 | 22 | 95 | ||||||||||||
| Net loss |
$ | (2,076 | ) | $ | (2,707 | ) | $ | (5,025 | ) | $ | (9,673 | ) | ||||
| Basic and diluted net loss per share |
$ | (0.09 | ) | $ | (0.12 | ) | $ | (0.23 | ) | $ | (0.43 | ) | ||||
| Basic and diluted weighted average number of common shares |
22,294 | 22,231 | 22,294 | 22,282 | ||||||||||||
The accompanying notes are an integral part of the consolidated financial statements.
4
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(unaudited)
| Six Months Ended June 30, |
||||||||
| 2003 |
2002 |
|||||||
| Cash Flows from Operating Activities: |
||||||||
| Net loss |
$ | (5,025 | ) | $ | (9,673 | ) | ||
| Adjustments to reconcile net income to net cash used in operating activities: |
||||||||
| Gain on sale of investments |
— | (402 | ) | |||||
| Depreciation and amortization |
1,006 | 1,706 | ||||||
| Minority interest |
281 | (1,126 | ) | |||||
| Loss on disposal of assets |
1 | 212 | ||||||
| Restructuring and other charges, non-cash portion |
— | 800 | ||||||
| Amortization of unearned compensation |
367 | 614 | ||||||
| Amortization of AOL assets |
— | 2,049 | ||||||
| Changes in operating assets and liabilities: |
||||||||
| Accounts receivable |
172 | 4,696 | ||||||
| Income tax receivable |
— | 1,228 | ||||||
| Other current assets |
(603 | ) | 2,389 | |||||
| Other non-current assets |
13 | 101 | ||||||
| Accounts payable and accrued expenses |
(971 | ) | (6,079 | ) | ||||
| Payment on AOL Directory Agreement |
— | (2,000 | ) | |||||
| Deferred revenue |
57 | (2,793 | ) | |||||
| Net cash used in operating activities |
(4,702 | ) | (8,278 | ) | ||||
| Cash Flows from Investing Activities: |
||||||||
| Purchases of property and equipment |
(172 | ) | (867 | ) | ||||
| Decrease (increase) in restricted cash |
1,602 | (1,162 | ) | |||||
| Proceeds from marketable securities, net |
8,065 | 39,141 | ||||||
| Net cash provided by investing activities |
9,495 | 37,112 | ||||||
| Cash Flows from Financing Activities: |
||||||||
| (Payments on) proceeds from debt |
(2,223 | ) | 1,623 | |||||
| Purchase of treasury stock |
— | (2,329 | ) | |||||
| Settlement of Envenue liability |
(1,700 | ) | — | |||||
| Proceeds from issuance of common stock |
91 | 328 | ||||||
| Net cash used in financing activities |
(3,832 | ) | (378 | ) | ||||
| Effect of exchange rate changes on cash and cash equivalents |
2 | (9 | ) | |||||
| Net increase in cash and cash equivalents |
963 | 28,447 | ||||||
| Cash and cash equivalents at beginning of the period |
73,195 | 33,022 | ||||||
| Cash and cash equivalents at end of the period |
$ | 74,158 | $ | 61,469 | ||||
| Supplemental Disclosures of Cash Flow Information: |
||||||||
| Non-cash financing activity: |
||||||||
| Note receivable from officer for issuance of common stock of subsidiary |
$ | — | $ | 1,449 | ||||
| Asset and liability related to Directory Agreement |
$ | — | $ | 12,000 | ||||
The accompanying notes are an integral part of the consolidated financial statements.
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
ePresence, Inc., (“the Company”), has two reportable segments: services and Switchboard. The Company’s reportable segments are managed separately as they are separately traded public companies, and market and distribute distinct products and services. ePresence is a leading consulting and systems integration company delivering Security and Identity Management (“SIM”) solutions that help companies reduce cost, enhance security, improve service and increase revenues. Identity management promotes effective management of users and access to the right information across information technology (“IT”) environments, creating context and common infrastructure across distributed constituencies, business processes and applications. The Company’s primary service offerings blend the elements of security and identity management, which include enterprise directory and security services, meta-directory services, access and password management services, single sign-on services, electronic provisioning services, IT platform services, and managed operational and remote access services. The Company’s Switchboard segment is organized as a subsidiary, Switchboard Incorporated (“Switchboard”). Switchboard is a provider of web-hosted directory technologies and customized yellow pages platforms to yellow pages publishers, newspaper publishers and Internet portals that offer online local directory advertising solutions to national retailers and brick and mortar merchants across a full range of Internet and wireless platforms. Switchboard offers a broad range of functions, content and services, including yellow and white pages, product searching, location-based searching and interactive maps and driving directions. The Company consolidates Switchboard’s revenues, expenses and other income and expense in the Company’s consolidated statement of operations, while the minority interest in Switchboard is eliminated through consolidated other income and expense. In addition, Switchboard’s assets and liabilities are consolidated in the Company’s Consolidated Balance Sheet as of June 30, 2003 and December 31, 2002. At June 30, 2003, the Company owned 9,802,421 shares or an approximate 52% equity interest of Switchboard’s outstanding common stock.
The unaudited consolidated financial statements presented herein have been prepared in accordance with the instructions to Form 10-Q, certain information and note disclosures normally included in financial statements prepared in accordance with GAAP in the U.S. have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Form 10-K, Commission File No. 000-20364, that was filed with the Securities and Exchange Commission on March 28, 2003. In the opinion of management, the accompanying consolidated financial statements include all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the Company’s financial position and results of operations.
NOTE 2. STOCK-BASED COMPENSATION
In accordance with SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, the following tables illustrate the assumptions used and the effect on net loss and net loss per share if the Company had applied the fair value recognition provisions of SFAS No. 123 for all employee stock options granted using the Black-Scholes option pricing model prescribed by SFAS No. 123 (in thousands except per share amounts).
| Three Months Ended June 30, |
Six Months Ended June 30, |
|||||||||||||||
| 2003 |
2002 |
2003 |
2002 |
|||||||||||||
| Net loss as reported |
$ | (2,076 | ) | $ | (2,707 | ) | $ | (5,025 | ) | $ | (9,673 | ) | ||||
| Add: Stock-based employee compensation expense included in reported net loss |
166 | 253 | 332 | 575 | ||||||||||||
| Less: Total stock-based compensation expense determined under fair value based method for all awards |
(1,188 | ) | (2,444 | ) | (2,670 | ) | (3,267 | ) | ||||||||
| Pro forma net loss |
$ | (3,098 | ) | $ | (4,898 | ) | $ | (7,363 | ) | $ | (12,365 | ) | ||||
| Basic and diluted loss per share as reported |
$ | (0.09 | ) | $ | (0.12 | ) | $ | (0.23 | ) | $ | (0.43 | ) | ||||
| Pro forma basic and diluted loss per share |
$ | (0.14 | ) | $ | (0.22 | ) | $ | (0.33 | ) | $ | (0.55 | ) | ||||
6
NOTE 3. CASH EQUIVALENTS AND MARKETABLE SECURITIES
In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115 “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”), the Company classifies all of its marketable debt and equity securities as available for sale securities. These securities are valued at their fair value. Unrealized holding gains and losses are reported as a net amount in accumulated other comprehensive income, a separate component of shareholders’ equity.
In the six months ended June 30, 2003 and 2002, purchases of marketable securities were $18,585,000 and $33,740,000 respectively. In the six months ended June 30, 2003 and 2002, proceeds from sales and maturities of marketable securities were $26,650,000 and $72,881,000, respectively.
In the six months ended June 30, 2003 and 2002, the Company recorded a realized gain on marketable securities of $12,000 and $652,000, respectively. In the six months ended June 30, 2003, the Company recorded a realized losses on marketable securities of $1,000.
NOTE 4. RESTRUCTURING AND SPECIAL CHARGES
The following table summarizes activity related to restructuring and other charges:
| Six Months Ended June 30, 2003 | ||||||||||||||
| (in thousands) | ||||||||||||||
| Accrual/ | Adjustments | Accrual/ | ||||||||||||
| Reserve | To | Reserve | ||||||||||||
| Balance | Previous | Cash | Balance | |||||||||||
| 12/31/02 |
Estimates |
Payments |
06/30/03 | |||||||||||
| Staff reductions |
$ | 843 | $ | (35 | ) | $ | (385 | ) | $ | 423 | ||||
| Office closures, asset write-offs and other costs |
2,353 | — | (271 | ) | 2,082 | |||||||||
| $ | 3,196 | $ | (35 | ) | $ | (656 | ) | $ | 2,505 | |||||
NOTE 5. BASIC AND DILUTED LOSS PER SHARE
Basic loss per share is based upon the weighted average number of common shares outstanding during the period. Diluted loss per share is the same as basic loss per share because to include the dilutive effect of potential common shares outstanding during the period would be antidilutive.
Options to purchase 3,697,333 and 2,685,290 shares of common stock outstanding during the three months ended June 30, 2003 and 2002, respectively, were excluded from the calculation of diluted earnings per share, as their effect would have been antidilutive. Options to purchase 4,339,218 and 2,811,790 shares of common stock outstanding during the six months ended June 30, 2003 and 2002, respectively, were excluded from the calculation of diluted earnings per share, as their effect would have been antidilutive.
NOTE 6. COMPREHENSIVE LOSS
Other comprehensive loss includes unrealized gains or losses on the Company’s available-for-sale investments and foreign currency translation adjustments (in thousands).
| Three Months Ended | Three Months Ended June 30, |
Six Months Ended June 30, |
||||||||||||||
| 2003 |
2002 |
2003 |
2002 |
|||||||||||||
| Net loss |
$ | (2,076 | ) | $ | (2,707 | ) | $ | (5,025 | ) | $ | (9,673 | ) | ||||
| Unrealized loss on marketable securities |
(45 | ) | (432 | ) | (103 | ) | (1,117 | ) | ||||||||
| Translation adjustment |
— | 35 | — | — | ||||||||||||
| Comprehensive loss |
$ | (2,121 | ) | $ | (3,104 | ) | $ | (5,128 | ) | $ | (10,790 | ) | ||||
7
NOTE 7. SEGMENT INFORMATION
As described in Note 1, the Company has two reportable segments: services and Switchboard. Significant financial information relative to the Company’s reportable segments is as follows (in thousands):
| Three Months Ended June 30, |
Six Months Ended June 30, |
|||||||||||||||
| 2003 |
2002 |
2003 |
2002 |
|||||||||||||
| Services |
||||||||||||||||
| Revenues |
$ | 4,314 | $ | 8,952 | $ | 8,485 | $ | 19,245 | ||||||||
| Cost of Revenues |
2,871 | 5,729 | 6,121 | 12,728 | ||||||||||||
| Gross Profit |
1,443 | 3,223 | 2,364 | 6,517 | ||||||||||||
| Operating Expenses: |
||||||||||||||||
| Sales and marketing |
1,572 | 2,710 | 3,599 | 5,728 | ||||||||||||
| General and administrative |
2,381 | 2,923 | 4,566 | 6,145 | ||||||||||||
| Restructuring and other charges |
— | — | — | 4,000 | ||||||||||||
| Operating Expenses |
3,953 | 5,633 | 8,165 | 15,873 | ||||||||||||
| Operating loss |
$ | (2,510 | ) | $ | (2,410 | ) | $ | (5,801 | ) | $ | (9,356 | ) | ||||
| Three Months Ended June 30, |
Six Months Ended June 30, |
|||||||||||||||
| 2003 |
2002 |
2003 |
2002 |
|||||||||||||
| Switchboard: |
||||||||||||||||
| Revenues |
$ | 3,974 | $ | 2,068 | $ | 7,315 | $ | 4,988 | ||||||||
| Cost of Revenues |
814 | 1,112 | 1,521 | 2,030 | ||||||||||||
| Gross Profit |
3,160 | 956 | 5,794 | 2,958 | ||||||||||||
| Operating Expenses: |
||||||||||||||||
| Sales and marketing |
685 | 1,145 | 1,527 | 2,572 | ||||||||||||
| Product development |
1,121 | 1,317 | 2,235 | 2,822 | ||||||||||||
| General and administrative |
1,022 | 723 | 1,826 | 1,430 | ||||||||||||
| Restructuring and other charges |
(35 | ) | — | (35 | ) | — | ||||||||||
| Operating Expenses |
2,793 | 3,185 | 5,553 | 6,824 | ||||||||||||
| Operating income/(loss) |
$ | 367 | $ | (2,229 | ) | $ | 241 | $ | (3,866 | ) | ||||||
8
NOTE 8. AOL ALLIANCE
Amortization of AOL assets totaled $946,000 and $2,000,000 in the three and six months ended June 30, 2002, respectively. There was no amortization of AOL assets in the three and six months ended June 30, 2003. Throughout the remaining initial term of the amended agreement, Switchboard will no longer record amortization of consideration given to AOL as these assets are now fully amortized and no further consideration is due AOL. Amortization of assets related to AOL has been reflected as a reduction of revenue in accordance with Emerging Issues Task Force (“EITF”) 01-9.
Net revenue recognized from AOL was $1,800,000, or 46% of net Switchboard revenue, and $3,400,000, or 47% of net Switchboard revenue, for the three and six months ended June 30, 2003, respectively. Net revenue recognized from AOL, including amortization of consideration given to AOL, was $424,000, or 21% of net Switchboard revenue, and $1,300,000, or 27% of net Switchboard revenue, for the three and six months ended June 30, 2002, respectively. Net amounts due from AOL included in accounts receivable at June 30, 2003 and December 31, 2002 were $1,100,000 and $549,000, respectively. As of June 30, 2003, AOL beneficially owned 7.9% of Switchboard ‘s outstanding common stock.
NOTE 9. NOTE RECEIVABLE FOR THE ISSUANCE OF SWITCHBOARD RESTRICTED COMMON STOCK
In January 2002, Switchboard recorded a note receivable from its Chief Executive Officer, who is also a member of its Board of Directors, for approximately $1,400,000 arising from the financing of a purchase of 450,000 shares of its common stock as restricted stock by that individual. As of June 30, 2003, 225,000 of such shares were unvested and restricted from transfer. On each of January 4, 2004, 2005 and 2006, 75,000 of these restricted shares vest, respectively. The note bears interest at a rate of 4.875%, which was deemed to be fair market value at the time of the issuance of the note, compounding annually and is 100% recourse as to principal and interest. The note is payable upon the earlier of the occurrence of the sale of all or part of the shares by the issuer of the note, 90 days from the date the issuer ceases to be affiliated with Switchboard or January 4, 2008. At June 30, 2003, Switchboard has recorded $1,600,000 in principal and interest as a note receivable classified within stockholders’ equity. During the three and six months ended June 30, 2003, Switchboard recorded $19,000 and $37,000 in interest income resulting from this note receivable, respectively. During the three and six months ended June 30, 2002, the Company recorded $18,000 and $35,000 in interest income resulting from this note receivable, respectively.
NOTE 10. PAYABLE RELATED TO ACQUISITION
In November 2000, Switchboard acquired Envenue, Inc. (“Envenue”), a wireless provider of advanced searching technologies designed to drive leads to traditional retailers. The total purchase price included consideration of $2,000,000 in cash to be paid on or before May 24, 2002, which Switchboard classified as a payable related to acquisition within current liabilities. Switchboard did not pay the $2,000,000 on or before May 24, 2002, as it was involved in a contractual dispute with the previous owners of Envenue. In June 2002, Switchboard placed $2,000,000 into an escrow account, which was to be held until the resolution of this dispute. In October 2002, Switchboard paid $410,000 out of the escrowed funds, representing the undisputed portion of the purchase price plus interest from the original maturity date to the former stockholders of Envenue. The remaining $1,600,000 of the purchase price was classified separately in the accompanying financial statements as of December 31, 2002. Switchboard recorded $1,600,000 as restricted cash at December 31, 2002 related to the cash held in escrow. In June 2003, Switchboard paid the former owners of Envenue $1,700,000 to settle all claims related to the acquisition of Envenue. As a result, Switchboard no longer has funds in escrow related to the matter.
NOTE 11. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENT
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (“SFAS No. 150”). SFAS No. 150 affects the issuer’s accounting for three types of freestanding financial instruments. SFAS No. 150 also requires disclosures about alternative ways of settling the instruments and the capital structure of entities, all of whose shares are mandatorily redeemable. This statement is effective for financial 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, except for mandatorily redeemable financial instruments of nonpublic entities, for which it is effective for the first fiscal period beginning after December 31, 2003. It is to be implemented by reporting the cumulative effect of a change in an accounting principle for financial instruments created before the issuance date of the statement and still existing at the beginning of the interim period of adoption. Restatement is not permitted. The Company does not expect the adoption of SFAS No. 150 to have a material impact on its consolidated results of operations, financial position and cash flows
9
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
METHOD OF PRESENTATION
ePresence, Inc. has two reportable segments: services and Switchboard. These segments are managed separately as they are separately traded public companies and market and distribute distinct products and services. ePresence’s services business is a leading consulting and systems integration company delivering Security and Identity Management (“SIM”) solutions that help companies reduce cost, enhance security, improve service and increase revenues. Identity management promotes effective management of users and access to the right information across IT environments, creating context and common infrastructure across distributed constituencies, business processes and applications. Our primary service offerings blend the elements of security and identity management, which include enterprise directory and security services, meta-directory services, access and password management services, single sign-on services, electronic provisioning services, information technology platform services, and managed operational and remote access services. Our Switchboard segment is organized as a subsidiary, Switchboard Incorporated (“Switchboard”). Switchboard is a provider of web-hosted directory technologies and customized yellow pages platforms to yellow pages publishers, newspaper publishers and Internet portals that offer online local directory advertising solutions to national retailers and brick and mortar merchants across a full range of Internet and wireless platforms. Switchboard offers a broad range of functions, content and services, including yellow and white pages, product searching, location-based searching and interactive maps and driving directions. We consolidate Switchboard’s revenues, expenses and other income and expense in our consolidated statement of operations, while the minority interest in Switchboard is eliminated through consolidated other income and expense. In addition, Switchboard’s assets and liabilities are consolidated in our Consolidated Balance Sheet as of June 30, 2003 and December 31, 2002. At June 30, 2003, we owned 9,802,421 shares or an approximate 52% equity interest of Switchboard’s outstanding common stock.
RESULTS OF OPERATIONS
Services Revenues
Services revenues for the three-month period ended June 30, 2003 decreased 52% to $4.3 million, compared with $9.0 million for the corresponding period in 2002. Services revenues for the six-month period ended June 30, 2003 decreased 56% to $8.5 million, compared with $19.2 million for the corresponding period in 2002.
Of the $4.6 million and $10.8 million declines for the three and six-month periods ended June 30, 2003, consulting services decreased $3.1 million or 52% and $6.2 million or 52%, respectively. Third party product revenues declined $1.3 million or 100% and $3.4 million or 98%, respectively. Managed services revenues declined $0.3 million or 17% and $1.2 million or 30% for the three and six-month periods ended June 30, 2003. The decrease in 2003 for the consulting and third party product was principally due to unfavorable economic conditions leading to decreased and deferred technology spending and related deployments. For the six months ended June 30, 2003, consulting and third party revenue was also impacted by declines in revenues from our portal solutions business and our operations in Germany and the United Kingdom, which we exited in 2002. The decrease in managed services revenue for 2003 was principally due to a decline in our legacy support services and was in part offset by increased revenues derived from our remote access managed services offerings.
Services Gross Profit
Gross profit for services for the three-month period ended June 30, 2003 was 33%, or $1.4 million, compared with 36%, or $3.2 million, for the corresponding period in 2002. Gross profit for services for the six-month period ended June 30, 2003 was 28%, or $2.4 million, compared with 34%, or $6.5 million, for the corresponding period in 2002. The decreases in gross profit dollars and percentages in 2003 were primarily due to decreases in revenues noted above, mitigated, in part, by reductions in cost of services, which decreased at a slower pace than revenues. Cost of services revenues consists primarily of direct costs (i.e., compensation) of consulting delivery personnel and third-party product costs.
Services Operating Expenses
Sales and marketing expenses for services decreased 42% to $1.6 million for the three-month period ended June 30, 2003, compared with $2.7 million for the corresponding period in 2002. Sales and marketing expenses for services decreased 37% to $3.6 million for the six-month period ended June 30, 2003, compared with $5.7 million for the corresponding period in 2002. The decreases in 2003 were due primarily the effects of our previous restructurings that resulted in cost reductions in our domestic and international operations, principally due to staff reductions in the domestic operations including our portal solutions
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business as well as the closing of our operations in Germany and the United Kingdom. Sales and marketing expenses as a percentage of services revenues were 36% and 30% for the three-month periods ended June 30, 2003 and 2002, respectively. Sales and marketing expenses as a percentage of services revenues were 42% and 30% for the six-month periods ended June 30, 2003 and 2002, respectively. Sales and marketing expenses consist primarily of salaries, associated employee benefits and travel expenses of sales and marketing personnel and promotional expenses.
General and administrative expenses for services decreased 19% to $2.4 million for the three-month period ended June 30, 2003, compared with $2.9 million for the corresponding period in 2002. General and administrative expenses for services decreased 26% to $4.6 million for the six-month period ended June 30, 2003, compared with $6.1 million for the corresponding period in 2002. The decreases in 2003 were primarily attributable to the effects of our previous restructurings that resulted in a reduction in facility costs and lower depreciation expense as well as staff reductions and related costs and lower bad debt expense. General and administrative expenses as a percentage of services revenues were 55% and 33% for the three-month periods ended June 30, 2003 and 2002, respectively. General and administrative expenses as a percentage of services revenues were 54% and 32% for the six-month periods ended June 30, 2003 and 2002, respectively. General and administrative expenses consist primarily of compensation, benefits and travel costs for employees in management, finance, human resources, information services and legal groups, recruiting and training costs for delivery personnel and facilities and depreciation expenses.
Services Restructuring Charges
In the three months ended March 31, 2002, as part of our plan to focus on cost reductions while transitioning to a sales model that aims to lower our cost of sales and capitalize on the strength of our relationships with industry leaders, we recorded total pre-tax charges of $4.0 million. The restructurings were focused principally on the closure of our offices in Germany and the United Kingdom and reductions in our marketing and general and administrative functions. These charges included workforce reductions of approximately 44 positions, office closures and asset write-offs.
In the three months ended December 31, 2002, as part of our continuing plan to implement cost-cutting measures, we recorded total pre-tax charges of $1.1 million for services restructuring activities. The reductions were focused principally on reductions in our marketing and general and administrative functions, and the elimination of several senior management positions. These charges included workforce reductions of approximately 31 positions and office closures.
At June 30, 2003, we had utilized approximately $3.1 million in total of the liability of which $1.3 million was severance related costs, with the remainder related to office closures and asset write-offs. The remaining 2002 liability at June 30, 2003 was approximately $2.0 million, the majority of which is cash related. We anticipate that we will utilize a substantial portion of the remaining liability by the end of fiscal year 2003. See Note 4, Restructuring Charges, in the Company’s Notes to Consolidated Financial Statements.
Switchboard Revenues
Switchboard net revenue increased 92% to $4.0 million for the three months ended June 30, 2003, compared with $2.1 million for the corresponding period in 2002. Net revenue increased 47% to $7.3 million for the six months ended June 30, 2003, compared with $5.0 million for the corresponding period in 2002. The increases for both the three and six months ended June 30, 2003 consisted primarily of an increase in net merchant network revenue, as well as an increase in national advertising and site sponsorship revenue.
Switchboard net merchant network revenue increased 99% to $3.5 million for the three months ended June 30, 2003, compared with $1.8 million for the corresponding period in 2002. Net merchant network revenue increased 48% to $6.5 million for the six months ended June 30, 2003, compared with $4.4 million for the corresponding period in 2002. The increase in net merchant network revenue for both the three and six months ended June 30, 2003 was primarily due to a reduction in amortization of consideration given to AOL as a result of the elimination of such amortization in August 2002 upon the amendment to the Directory Agreement with AOL. The increase in net merchant network revenue in the three months ended June 30, 2003 was also attributable to an increase in licensing revenue from new and existing merchant network alliance partners, including AOL, as well as an increase in engineering and other services revenue. The increase in net merchant network revenue in the six months ended June 30, 2003 was also attributable to an increase in engineering and other services revenue, as well as additional licensing revenue from new merchant network alliance partners. Offsetting these increases in the six-month period ended June 30, 2003 was a decrease in licensing revenue from AOL, primarily as a result of significantly reduced nationally oriented merchant advertising sales by AOL, as well as a reduction in the percentage by which Switchboard shares in directory revenue generated by AOL under the Directory Agreement based upon the achievement of a predetermined cumulative revenue milestone.
Switchboard’s national advertising and site sponsorship revenue increased 51% to $0.5 million for the three months ended June 30, 2003, compared with $0.3 million for the corresponding period in 2002. National advertising and site sponsorship revenue
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increased 40% to $0.8 million for the six months ended June 30, 2003, compared with $0.6 million for the corresponding period in 2002. The increase in national advertising and site sponsorship revenue for both the three and six months ended June 30, 2003 resulted primarily from the addition of new customers and an increase in revenue from existing customers due to additional advertising placements on Switchboard’s site, as well as an increase in traffic to Switchboard’s Web site.
Switchboard Gross Profit
Switchboard gross profit increased 231% to $3.2 million, or 80% of net revenue, for the three months ended June 30, 2003, compared with $1.0 million, or 46% of net revenue, for the corresponding period in 2002. Gross profit increased 96% to $5.8 million, or 79% of net revenue, in the six months ended June 30, 2003, compared with $3.0 million, or 59% of net revenue, for the corresponding period in 2002. The increases in gross profit dollars and percentage for the three and six months ended June 30, 2003 were primarily due to the reduction in the amortization of consideration given to AOL discussed above.
Switchboard Operating Expenses
Sales and marketing expenses decreased 40% to $0.7 million for the three months ended June 30, 2003, compared with $1.1 million for the corresponding period in 2002. Sales and marketing expenses decreased 41% to $1.5 million for the six months ended June 30, 2003, compared with $2.6 million for the corresponding period in 2002. The decrease for the three months ended June 30, 2003 was primarily related to a reduction of expense resulting from an amount collected from AOL related to the final settlement of Switchboard’s prior agreement with AOL, which was terminated in March 1999. Sales and marketing expenses also decreased in the three months ended June 30, 2003 as a result of a decrease in merchant program expenses and decreases in public relations expenses and provisions for bad debts, offset in part by an increase in employee compensation and benefits. The decrease for the six months ended June 30, 2003 was primarily related to a decrease in merchant program expenses, collections from AOL, a decrease in public relations expenses and a decrease in employee compensation and benefits.
Research and development expenses decreased 15% to $1.1 million for the three months ended June 30, 2003, compared with $1.3 million for the corresponding period in 2002. Research and development expenses decreased 21% to $2.2 million for the six months ended June 30, 2003, compared with $2.8 million for the corresponding period in 2002. The decrease for the three months ended June 30, 2003 was due primarily to decreases in salaries and benefits associated with the delivery of engineering services which are classified as cost of revenue, depreciation, facilities expense and other employee compensation and benefits. The decrease for the six months ended June 30, 2003 was due primarily to a decrease in outside consulting fees, a decrease in salaries and benefits associated with the delivery of engineering services which are classified as cost of revenue, a decrease in other employee compensation and benefits and a decrease in facilities expense.
General and administrative expenses increased 41% to $1.0 million for the three months ended June 30, 2003, compared with $0.7 million for the corresponding period in 2002. General and administrative expenses increased 28% to $1.8 million for the six months ended June 30, 2003, compared with $1.4 million for the corresponding period in 2002. The increase for the three months ended June 30, 2003 was primarily due to an increase in professional services and an increase in employee compensation and benefits, offset in part by a decrease in insurance expense and provisions for excise taxes. The increase for the six months ended June 30, 2003 was primarily due to increases in professional services, employee compensation and benefits and unallocated occupancy costs, offset in part by a decrease in insurance expense.
In the three months ended June 30, 2003, Switchboard recorded the reversal of $35,000 in excess restructuring reserves. This reversal resulted from a revision of an estimate of the compensation amount for a terminated employee for which Switchboard had reserved as part of Switchboard’s 2001 special charges. It was determined in the three months ended June 30, 2003 that the reserve for this compensation was no longer required. As of June 30, 2003, Switchboard had a remaining liability of $14,000 for the 2001 special charges related primarily to Switchboard’s remaining net lease obligations for a closed facility.
Consolidated Other Income and Income Taxes
Consolidated other income was $0.1 million for the three-month period ended June 30, 2003 and $2.0 million for the corresponding period in 2002. Consolidated other income was $0.6 million for the six-month period ended June 30, 2003 and $3.6 million for the corresponding period in 2002.
The decrease in 2003 is due primarily to a decrease in interest income earned as a result of a decline in interest rates and reduced funds available for investment as well as a reduction in our minority interest in Switchboard.
We recorded no tax benefit on our operating losses for the three months ended June 30, 2003 and 2002 due to the uncertainty of its realization. The provision for income taxes in 2003 is for taxes related to our securities corporation as well as other state minimum taxes.
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LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2003, consolidated cash, cash equivalents, marketable securities and restricted cash were $96.5 million, of which $46.1 million was held by ePresence and $50.3 million was held by Switchboard. At December 31, 2002, consolidated cash, cash equivalents, marketable securities and restricted cash were $105.3 million, of which $51.4 million was held by ePresence and $53.9 million was held by Switchboard. Consolidated working capital increased from $82.9 million at December 31, 2002 to $87.8 million at June 30, 2003. Cash and cash equivalents increased $1.0 million resulting in a consolidated balance of $74.2 million at June 30, 2003. This increase was primarily due to net cash used in operating activities of $4.7 million, net cash used in financing activities of $3.8 million and net cash provided by investing activities of $9.5 million.
Net cash used in operating activities for the six-month period ended June 30, 2003 of $4.7 million, was primarily due to a net loss of $5.0 million, a decrease in accounts payable and accrued expenses of $1.0 million and a decrease in other current assets of $0.6 million. These decreases were offset in part by depreciation and amortization of $1.0 million, an increase in amortization of unearned compensation of $0.4 million and $0.3 million for the change in minority interest in Switchboard.
Net cash used in financing activities for the six-month period ended June 30, 2003 of $3.8 million was primarily due to payments on Switchboard’s notes payable of $2.2 million, and a payment of $1.7 million related to Switchboard’s settlement of its litigation with the former stockholders of Envenue Inc. (“Envenue”).
Net cash provided by investing activities for the six-month period ended June 30, 2003 of $9.5 million was primarily due to net proceeds from marketable securities of $8.0 million and a decrease of $1.6 million in restricted cash.
On December 18, 2000, the Board of Directors of ePresence authorized the repurchase of up to $10.0 million of its common stock on the open market. Repurchases of stock are at management’s discretion, depending upon acceptable prices and availability. Funds used in the repurchase of shares come from our existing cash and investment balances along with cash generated from operations. As of June 30, 2003, we have expended $7.4 million toward stock repurchases pursuant to this repurchase program.
On November 7, 2002, we entered into a $10.0 million revolving line of credit with Silicon Valley Bank (“SVB”), that provides for borrowings at SVB’s prime rate. This credit agreement has a one-year term and contains covenants relating to the maintenance of certain financial ratios. We had no borrowings under this line of credit outstanding at June 30, 2003.
In June 2002, Switchboard entered into a loan and security agreement (the “SVB Financing Agreement”) with Silicon Valley Bank (“SVB”), under which Switchboard had the ability to borrow up to $4.0 million for the purchase of equipment. Amounts borrowed under the facility accrued interest at a rate equal to prime plus 0.25%, and were to have been repaid monthly over a 30-month period. Switchboard had utilized $2.7 million of this facility through borrowings that occurred in June and September 2002. The SVB Financing Agreement also provided for a $1.0 million revolving line of credit. Switchboard did not borrow any amounts under the revolving line of credit. Switchboard’s ability to borrow additional amounts under the SVB Financing Agreement expired on May 30, 2003. In May 2003, Switchboard paid SVB $1.8 million in satisfaction of Switchboard’s outstanding borrowings under the loan facility. Switchboard is no longer required to maintain minimum amounts in deposit or investment accounts at SVB, as the SVB Financing Agreement has expired and any outstanding borrowings have been repaid in full.
In November 2000, Switchboard acquired Envenue, a wireless provider of advanced searching technologies designed to drive leads to traditional retailers. The total purchase price included consideration of $2.0 million in cash to be paid on or before May 24, 2002, which Switchboard classified as a payable related to acquisition within current liabilities. Switchboard did not pay the $2.0 million on or before May 24, 2002, as Switchboard was involved in a contractual dispute with the previous owners of Envenue. In June 2002, Switchboard placed $2.0 million into an escrow account, which was to be held until the resolution of this dispute. In October 2002, Switchboard paid $0.4 million out of the escrowed funds, representing the undisputed portion of the purchase price plus interest from the original maturity date to the former stockholders of Envenue. The remaining $1.6 million of the purchase price was classified separately in the accompanying financial statements as of December 31, 2002. Switchboard recorded $1.6 million as restricted cash at December 31, 2002 related to the cash held in escrow. In June 2003, Switchboard paid the former stockholders of Envenue $1.7 million to settle all claims related to the acquisition of Envenue. As a result, Switchboard no longer has funds in escrow related to the matter.
We believe that existing cash and marketable securities, combined with cash expected to be generated from operations, will be sufficient to fund our operations through at least the next twelve months.
FACTORS AFFECTING FUTURE OPERATING RESULTS
Certain of the information contained in this Quarterly Report on Form 10-Q, including, without limitation, information with respect to our plans and strategy for our business, statements relating to the sufficiency of cash and cash equivalent balances,
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anticipated expenditures, the anticipated effects of accounting pronouncements, our cost reduction measures and our sales and marketing and product development efforts, consists of forward-looking statements. Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words “believes,” “expects,” “anticipates,” “plans,” and similar expressions are intended to identify forward-looking statements. Important factors that could cause actual results to differ materially from the forward-looking statements include the following factors:
The continuing broad economic slowdown and global political uncertainty has affected the demand for IT services, lengthened the sales cycles and caused decreased technology spending for many of our customers and potential customers. If companies continue to cancel or delay their business and technology consulting initiatives because of the current economic and political climate, or for other reasons, our business, financial condition and results of operations could be materially adversely affected.
During 2002 we restructured our operations through workforce reductions and office closures. Such restructurings could have an adverse effect on our business, including on our ability to attract and retain customers and employees, and there can be no assurance that we will achieve the anticipated financial benefits of these restructurings. In addition, there can be no assurance that our workforce reductions will not have a material adverse effect on our business and operating results in the future.
Our future success will depend in part upon our ability to continue to grow our services business, enter into new strategic alliances, acquire additional services customers and adapt to changing technologies and customer requirements. Any failure to do so could have a material adverse effect on us. We have a limited operating history as a services company. In addition, the market for our consulting services and the technologies used in our solutions have been changing rapidly and we expect this level of change to continue. If we cannot keep pace with these changes in our marketplace, our business, financial condition and results of operations will suffer. There can be no assurance we will be successful in our strategic focus on services, including SIM services.
We sell our services principally through a direct sales force to customers in a broad range of industries. We do not require collateral or other security to support customer receivables. Conditions affecting any of our clients could cause them to become unable or unwilling to pay us in a timely manner, or at all, for services we have already performed. Our financial results and condition could be adversely affected by credit losses.
We have a number of partnerships and alliances with software vendors under which we provide services around such vendors’ products. Any failure of these alliances to generate the anticipated level of sales, the loss of one or more of these alliances, or the failure to enter into additional strategic alliances, could have a material adverse effect on us.
We are dependent upon the continued services of our key management and technical personnel. In addition, as a services company, our business is particularly dependent on our employees. Competition for qualified personnel is strong, and there can be no assurance we will be able to attract and retain qualified management and other employees.
We were not profitable during 2002, and there can be no assurance we will return to profitability in 2003 or in any future period. Continued losses could have a material adverse effect on our liquidity and capital resources.
Our operating expenses are largely based on anticipated revenue trends, and a high percentage of our expenses, such as personnel and rent, are and will continue to be fixed in the short-term. We may not be able to quickly reduce spending if our revenues are lower than we had projected. As a result, an unanticipated decrease in the number, or an unanticipated slowdown in the scheduling, of our projects may cause significant variations in operating results in any particular quarter and could have a material adverse effect on operations for that quarter. If we do not achieve our expected revenues, our operating results will be below our expectations and the expectations of investors and market analysts, which could cause the price of our common stock to decline. Our quarterly operating results have varied significantly in the past and will likely vary significantly in the future, making it difficult to predict future performance. These variations result from a number of factors, many of which are outside of our control. Because of this difficulty in predicting future performance, our operating results will likely fall below the expectations of securities analysts or investors in some future quarter or quarters. Our failure to meet these expectations would likely adversely affect the market price of our common stock.
The market for our products is highly fragmented and characterized by continuing technological developments, evolving and competing industry standards, and changing customer requirements. We expect competition to persist and intensify in the future. Some of our competitors have longer operating histories and significantly greater financial, technical, marketing and other resources than we do. Many of these companies can also leverage extensive customer bases, have broad customer relationships and have broad industry alliances, including relationships with certain of our current and potential customers. In addition, certain competitors may adopt aggressive pricing policies or may introduce new services. Competitive pressures may make it difficult for us to acquire and retain customers and could require us to reduce the price of our services. We cannot be certain that we will be able to compete successfully with existing or new competitors. Our failure to maintain and enhance our competitive position would limit our ability to retain and increase our market share, resulting in serious harm to our business and operating results.
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Our future success depends on the increased acceptance and use of advanced technologies as a means for conducting commerce and operations. If use of these advanced technologies does not continue to grow, or grows more slowly than expected, our revenue growth could slow or decline and our business, financial condition and results of operations could be materially adversely affected. Businesses may delay adoption of advanced technologies for a number of reasons, including inability to implement and sustain profitable business models using advanced technologies; inadequate network infrastructure or bandwidth; delays in the development or adoption of new technical standards and protocols required to handle increased levels of usage; delays in the development of security and authentication technology necessary to effect secure transmission of confidential information; and failure of companies to meet their customers’ expectations in delivering goods and services using advanced technologies.
Our services rely upon third-party technologies. Our business could be harmed if providers of software and technology utilized in connection with our services ceased to deliver and support reliable products, enhance their current products in a timely fashion or respond to emerging industry standards. In addition, if we or our customers cannot maintain licenses to key third-party software, provision of our services could be delayed until equivalent software could be licensed and integrated into our services, or we might be forced to limit our service offerings. Either alternative could materially adversely affect our business, operating results and financial condition.
Some of our contracts can be canceled by the customer with limited advance notice and without significant penalty. Termination by any customer of a contract for our services could result in a loss of expected revenues and additional expenses for staff which were allocated to that customer’s project. We could be required to maintain underutilized employees who were assigned to the terminated contract. The unexpected cancellation or significant reduction in the scope of any of our large projects could have a material adverse effect on our business, financial condition and results of operations.
A significant portion of our projects are based on fixed-price, fixed-timeframe contracts, rather than contracts in which payment to us is determined on a time and materials basis. Our failure to accurately estimate the resources required for a project, or our failure to complete our contractual obligations in a manner consistent with the project plan upon which our fixed-price, fixed-timeframe contract was based, could adversely affect our overall profitability and could have a material adverse effect on our business, financial condition and results of operations. We have been required to commit unanticipated additional resources to complete projects in the past, which has resulted in losses on those contracts. We will likely experience similar situations in the future and the consequences could be more severe than in the past, due to the increased size and complexity of our engagements. In addition, we may fix the price for some projects at an early stage of the process, which could result in a fixed price that turns out to be too low and, therefore, would adversely affect our business, financial condition and results of operations.
In August 2003, we announced that we had engaged SG Cowen to assist us in the pursuit and evaluation of strategic alternatives. We cannot assure you that we will consummate a strategic transaction. Any strategic transaction could involve a number of risks, including;
| • | difficulties in integrating products, services, operations and personnel of the acquirer and acquiree |
| • | failure to obtain any required stockholder, regulatory or third-party approvals |
| • | loss of customers, suppliers or employees |
| • | diversion of management’s attention from daily business operations |
If we are unable to successfully consummate a strategic transaction or to successfully pursue other alternatives, our future revenues will be uncertain and our business, operating results and financial condition may be materially and adversely affected. Any failure by us to effectively identify and acquire complementary businesses or SIM-focused software, integrate such businesses or software, as the case may be, and any failure of such companies or software to perform as expected could have a material adverse effect on us. Any acquisition for cash could have a significant impact on our liquidity and capital resources, and any acquisition for stock could involve significant dilution for our stockholders.
We own 9,802,421 shares of Switchboard’s common stock, which is traded on the NASDAQ National Market. The trading price of Switchboard’s common stock is likely to be volatile and may be influenced by many factors, including, without limitation, variations in financial results, changes in earnings estimates by industry research analysts, the failure or success of branding and strategic initiatives and investors’ perceptions. Volatility in the trading price of Switchboard’s common stock could have a material adverse effect on our financial condition. In addition, due to our level of ownership of Switchboard, the trading price of our common stock is likely to be influenced by the trading price of Switchboard’s common stock. If Switchboard’s trading price declines, the trading price of our common stock will likely decline as well.
Switchboard’s results of operations are consolidated as part of our results of operations. Switchboard, which has a history of incurring net losses, may experience losses in future periods. In addition, Switchboard’s quarterly results of operations have fluctuated significantly in the past and are likely to fluctuate significantly from quarter to quarter in the future. Factors that may cause Switchboard’s results of operations to fluctuate include: the success of Switchboard’s relationship with AOL; the addition
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or loss of relationships with third parties that are Switchboard’s source of new merchants for its local merchant network or that license Switchboard’s services for use on their own web sites; Switchboard’s ability to attract and retain consumers, local merchants and national advertisers to its web site; the amount and timing of expenditures for expansion of Switchboard’s operations, including the hiring of new employees, capital expenditures and related costs; the amount of Switchboard’s expenses, which are largely fixed in the short-term and are partially based on expectations regarding future revenue; Cable & Wireless’ recent announcement that it intends to exit its U.S. operations; Switchboard’s reliance on a small number of customers for a large portion of its revenues; intense competition; undetected software errors; risks associated with the conduct of business on the Internet; costs and risks associated with any acquisition; Switchboard’s ability to attract and retain the services of key executives and other highly skilled managerial and technical personnel; and other factors that may be announced by Switchboard from time to time.
William P. Ferry, our Chairman of the Board, President and Chief Executive Officer, is Switchboard’s Chairman of the Board, and Richard M. Spaulding, our Senior Vice President and Chief Financial Officer, and Robert M. Wadsworth, one of our directors, are directors of Switchboard. Serving as a director of Switchboard and as either a director or an officer of ePresence could create, or appear to create, potential conflicts of interest when those directors and officers are faced with decisions that could have different implications for us than for Switchboard. Such conflicts, or potential conflicts, of interest could hinder or delay our management’s ability to make timely decisions regarding significant matters relating to our business.
Because of the foregoing factors and the other factors we have disclosed from time to time, we believe that period-to-period comparisons of our financial results are not necessarily meaningful and you should not rely upon these comparisons as indicators of our future performance. We expect that our results of operations may fluctuate from period-to-period in the future.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Marketable Securities and Interest Rates
We are exposed to financial market risks, including changes in interest rates. Our marketable securities as of June 30, 2003 are invested in U.S. agencies bonds and notes and repurchase agreements. The majority of our investments have maturities between one and three years. A significant portion of our cash is invested in short-term interest-bearing securities. While we have in the past used hedging contracts to manage exposure to changes in the value of marketable securities, we are not currently a party to any such contract. We may use hedging contracts in the future. The fair value of our investment portfolio or related income would not be significantly impacted by either a 100 basis point increase or decrease in interest rates due mainly to the short-term nature of our investment portfolio. These potential changes are based on sensitivity analysis performed on our balances as of June 30, 2003.
Foreign Currency
Prior to January 1, 2002, our subsidiaries generally used the local currency as the functional currency. Assets and liabilities were translated into U.S. dollars at the period ended exchange rate and income and expense amounts were translated using the average rate prevailing for the period. Adjustments resulting from translation were included in accumulated other comprehensive income.
As of January 1, 2002, our remaining subsidiaries began using the U.S. dollar as the functional currency as we had substantially liquidated our remaining foreign subsidiaries. As a result, the translation gains/losses are included in net loss for 2002. Prior cumulative translation gains/losses within accumulated comprehensive income have been reversed and included in the net loss in 2002. To date, foreign currency exchange rate fluctuations have not had a material effect on our operating results or financial condition.
ITEM 4. CONTROLS AND PROCEDURES
The Company’s principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures, as defined in Exchange Act Rule 13a-14(c), based on their evaluation of such controls and procedures as of June 30, 2003, are effective to ensure that information required to be disclosed by the Company in the reports it files under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and that such information is accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls during the fiscal quarter ended June 30, 2003.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
The exhibits listed on the Exhibit Index immediately preceding such exhibits are filed as part of this report.
Two reports on Form 8-K were filed during the quarter ended June 30, 2003. On April 30, 2003, the Company furnished a Current Report on Form 8-K dated April 30, 2003 under Item 9 containing a copy of the Company’s earnings release for the period ended March 31, 2003 pursuant to Item 12 (Results of Operations and Financial Condition). On May 22, 2003, the Company furnished a Current Report on Form 8-K dated May 22, 2003 under Item 9 containing a copy of the Company’s annual meeting presentation.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
EPRESENCE, INC.
| Date: August 13, 2003 | By: | /s/ RICHARD M. SPAULDING | ||
| Richard M. Spaulding Senior Vice President and Chief Financial Officer, Treasurer and Clerk (Principal Financial Officer and Principal Accounting Officer) |
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| Exhibit Number |
TITLE OF DOCUMENT | |
| 10.1A+ | Amendment No. 6 dated as of May 8, 2003 to the Employment Agreement between the Registrant and William P. Ferry. | |
| 10.2A+ | Amended and Restated Executive Retention Agreement dated as of May 8, 2003 between the Registrant and Richard M. Spaulding. | |
| 10.3A+ | Amended and Restated Executive Retention Agreement dated as of May 8, 2003 between the Registrant and Scott G. Silk. | |
| 10.4A+ | Amended and Restated Executive Retention Agreement dated as of May 8, 2003 between the Registrant and Scott E. Kitlinski. | |
| 10.5A+ | Amended and Restated Executive Retention Agreement dated as of May 8, 2003 between the Registrant and Anthony J. Bellantuoni. | |
| 10.6A+ | Amendment No. 2 to the 2001 Stock Incentive Plan. | |
| 10.7A+ | Amendment No. 6 to the 1992 Director Stock Option Plan. | |
| 31.1 | Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended. | |
| 31.2 | Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended. | |
| 32.1 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| 32.2 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| + | Management contract or compensation plan or arrangement required to be filed as an exhibit pursuant to Item 6(a) of Form 10Q. |
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