EasyLink Services International (ESIC) 10-Q 2009 Q3 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended April 30, 2009

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                    to                    

Commission File Number: 000-24996

EasyLink Services International Corporation

(Exact Name of Registrant as Specified in Its Charter)

Delaware	13-3645702
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)
6025 The Corners Parkway, Suite 100
Norcross, Georgia	30092
(Address of Principal Executive Offices)	(Zip Code)

Registrant’s telephone number, including area code:(678) 533-8000

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. Yesþ Noo

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yeso Noo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filero Accelerated filero Non-acceleratedo Smaller reporting companyþ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ

As of May 28, 2009 the issuer had outstanding 26,244,506 shares of class A common stock.

EASYLINK SERVICES INTERNATIONAL CORPORATION
INDEX TO FORM 10-Q

	Page
PART I FINANCIAL INFORMATION		1
Item 1: Financial Statements		1
Condensed Consolidated Balance Sheets as of April 30, 2009 and July 31, 2008 (Unaudited)		1
Condensed Consolidated Statements of Operations for the three and nine months ended April 30, 2009 and 2008 (Unaudited)		2
Condensed Consolidated Statements of Cash Flows for the nine months ended April 30, 2009 and 2008 (Unaudited)		3
Notes to Condensed Consolidated Financial Statements (Unaudited)		4
Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations		11
Item 3: Quantitative and Qualitative Disclosures about Market Risk		18
Item 4T: Controls and Procedures		18
PART II OTHER INFORMATION		19
Item 1: Legal Proceedings		19
Item 1A: Risk Factors		19
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds		19
Item 3: Defaults Upon Senior Securities		20
Item 4: Submission of Matters to a Vote of Security Holders		20
Item 5: Other Information		20
Item 6: Exhibits		20
Signatures		22
Exhibit 3(i).1
Exhibit 3(i).2
Exhibit 3(i).3
Exhibit 3(i).4
Exhibit 3(i).5
Exhibit 3(i).6
Exhibit 3(i).7
Exhibit 3(i).8
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Condensed Consolidated Balance Sheets as of April 30, 2009 and July 31, 2008 (Unaudited)

	April 30,			July 31,
	2009			2008
ASSETS
Current assets:
Cash and cash equivalents	$	9,724,752		$	32,091,005
Accounts receivable, net		12,342,036			13,575,782
Prepaid expenses and other current assets		3,205,727			5,414,192
Total current assets		25,272,515			51,080,979
Property and equipment, net		8,788,815			8,551,927
Goodwill		36,206,639			40,209,960
Other intangible assets, net		23,811,872			27,742,466
Other assets		4,569,689			3,939,467
Total assets	$	98,649,530		$	131,524,799
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	3,185,336		$	2,820,744
Notes payable — current		9,583,333			7,052,313
Accrued expenses		6,593,180			10,683,206
Other current liabilities		1,414,490			1,861,869
Total current liabilities		20,776,339			22,418,132
Notes Payable		27,311,690			47,497,402
Other liabilities		679,153			1,005,505
Total liabilities		48,767,182			70,921,039
Commitments and contingencies
Stockholders’ Equity:
Series C Preferred Stock — par value $.01 per share, 44.76 votes per share; 5,000 shares issued and 5,000 outstanding (liquidation value of $5,065,753 at April 2009 and $5,116,393 at July 2008)		50			50
Common stock:
class A — par value $.01 per share, 300,000,000 shares authorized, one vote per share; 25,256,427 shares issued and 24,256,427 outstanding for April 2009 and 25,125,088 shares issued and 25,015,838 outstanding for July 2008		252,564			251,251
Additional paid-in capital		126,048,727			125,457,794
Treasury stock — 1,000,000 shares as of April 2009 and 109,250 shares at July 2008		(2,122,288	)		(303,325	)
Accumulated other comprehensive loss		(2,623,861	)		(1,063,266	)
Accumulated deficit		(71,672,844	)		(63,738,744	)
Total stockholders’ equity		49,882,348			60,603,760
Total liabilities and stockholders’ equity	$	98,649,530		$	131,524,799

See notes to condensed consolidated financial statements.

1

Condensed Consolidated Statements of Operations for the three and nine months ended April 30, 2009 and 2008
(Unaudited)

	Three Months Ended						Nine Months Ended
	April 30,						April 30,
	2009			2008			2009			2008
Service revenue	$	21,038,978		$	23,599,696		$	64,710,039		$	68,236,367
Cost of services		6,501,061			6,701,442			19,022,699			19,745,758
Gross profit		14,537,917			16,898,254			45,687,340			48,490,609
Operating expenses:
Product development and enhancement		1,774,455			2,111,513			5,901,783			5,983,735
Selling and marketing		3,124,099			2,897,718			9,780,627			8,207,447
General and administrative		6,758,521			7,367,411			22,648,639			21,918,906
Goodwill and intangible impairment		—			—			4,245,914			—
Operating income		2,880,842			4,521,612			3,110,377			12,380,521
Other income (expense):
Interest and investment income		10,901			163,160			152,684			595,836
Interest expense		(1,584,575	)		(2,306,541	)		(10,603,230	)		(10,464,847	)
Equity in losses of investment		—			—			—			(930,269	)
Foreign exchange gain		167,663			128,292			303,813			914,214
Other income		1,247			11,209			99,812			89,359
Income (loss) before income taxes		1,476,078			2,517,732			(6,936,544	)		2,584,814
Provision (Benefit) for income taxes		239,890			(4,418,376	)		995,159			(5,612,515	)
Net income (loss)		1,236,188			6,936,108			(7,931,703	)		8,197,329
Dividends on preferred stock		(48,767	)		(49,180	)		(149,360	)		(149,956	)
Net income (loss) attributable to common stockholders	$	1,187,421		$	6,886,928		$	(8,081,063	)	$	8,047,373
Basic income (loss) per common share	$	0.05		$	0.28		$	(0.33	)	$	0.33
Diluted income (loss) per common share	$	0.05		$	0.17		$	(0.33	)	$	0.29
Anti-dilutive stock options, restricted stock, warrants, Series A and Series B Convertible Notes and Series C preferred stock		23,733,691			5,793,178			22,506,043			5,625,675
Weighted average number of common shares outstanding — basic		24,243,183			24,604,376			24,460,449			24,318,536
Weighted average number of common shares outstanding — diluted		24,670,190			48,852,869			24,460,449			48,844,713

See notes to condensed consolidated financial statements.

2

Condensed Consolidated Statements of Cash Flows for the nine months ended April 30, 2009 and 2008
(Unaudited)

	Nine Months Ended April 30,
	2009			2008
Cash flows from operating activities:
Net income (loss)	$	(7,931,703	)	$	8,197,329
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		6,468,531			6,303,225
Bad debt expense		886,621			373,691
Amortization of discount and other non-cash interest expense		6,283,810			6,963,998
Non-cash charges for equity instruments issued for compensation and services		738,832			345,852
Non-cash equity in losses of investment and other non-cash items		77,731			1,058,360
Release of Valuation Reserve		—			(4,396,995	)
Goodwill and intangible asset impairment		4,245,914			—
Changes in assets and liabilities, net of effects from acquisition:
Accounts receivable		132,897			(1,480,075	)
Prepaid expenses and other assets		1,983,235			466,745
Accounts payable		685,950			149,293
Accrued expenses		(4,416,827	)		(8,141,307	)
Other liabilities		(1,371,375	)		(4,156,298	)
Net cash provided by operating activities		7,783,616			5,683,818
Cash flows from investing activities:
Payment for purchase of acquisitions, net of cash acquired		—			(53,453,874	)
Payment for investments		—			(429,919	)
Sale of Business		—			4,504,477
Purchases of intellectual property and equipment		(3,211,356	)		(957,291	)
Other		53,924			18,233
Net cash used in investing activities		(3,157,432	)		(50,318,374	)
Cash flows from financing activities:
Proceeds from sale of stock and exercise of options and warrants		2,774			6,629,702
Proceeds from borrowings for acquisition		—			59,788,117
Payment of dividends		(200,000	)
Purchase of treasury stock		(1,818,963	)		—
Net repayments of notes payable		(23,938,502	)		—
Net cash (used in) provided by financing activities		(25,954,691	)		66,417,819
Effect of foreign exchange rate changes on cash and cash equivalents		(1,037,746	)		(47,910	)
Net (decrease) increase in cash and cash equivalents		(22,366,253	)		21,735,353
Cash and cash equivalents, beginning of period		32,091,005			5,444,176
Cash and cash equivalents, end of period	$	9,724,752		$	27,179,529

See notes to condensed consolidated financial statements.

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EASYLINK SERVICES INTERNATIONAL CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

1. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements of EasyLink Services International Corporation (referred to as “EasyLink,” the “Company,” “we,” “our” or “us”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. In the opinion of management, such statements include all adjustments (consisting only of normal recurring adjustments) necessary for the fair presentation of our financial position, results of operations and cash flows as of the dates and for the periods indicated. Pursuant to the requirements of the Securities and Exchange Commission (“SEC”) applicable to Quarterly Reports on Form 10-Q, the accompanying financial statements do not include all disclosures required by GAAP for annual financial statements. While we believe the disclosures presented are adequate to make the information not misleading, these unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended July 31, 2008.

The condensed consolidated balance sheet as of July 31, 2008 has been derived from the audited consolidated financial statements as of that date.

Operating results for the three and nine-month periods ended April 30, 2009 are not necessarily indicative of the results that may be expected for the fiscal year ending July 31, 2009 or any future period.

Principles of consolidation and basis of presentation

The consolidated financial statements include the accounts of EasyLink and our wholly-owned subsidiaries. All significant intercompany transactions have been eliminated in consolidation.

Recently adopted accounting pronouncements

We adopted Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS 157”) effective August 1, 2008. SFAS 157 provides a single definition of fair value and a hierarchical framework for measuring it, as well as establishing additional disclosure requirements about the use of fair value to measure assets and liabilities. SFAS 157 did not have a material impact on our financial statements. In February 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) 157-2, “Effective Date of FASB Statement No. 157,” which delays the effective date of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually).

We adopted SFAS No. 159, “The Fair Value Option for Financial Assets and Liabilities” (“SFAS 159”) effective August 1, 2008. SFAS 159 provides the option to report certain financial assets and liabilities at fair value, with the intent to mitigate volatility in financial reporting that can occur when related assets and liabilities are recorded on different bases. SFAS 159 did not have a material impact on our financial statements.

We adopted SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an Amendment to ARB No. 51” (“SFAS 160”) effective August 1, 2008. Under the provisions of SFAS 160, a noncontrolling interest in a subsidiary, or minority interest, must be classified as equity, and the amount of consolidated net income specifically attributable to the minority interest must be clearly identified in the consolidated statement of operations. SFAS 160 also requires consistency in the manner of reporting changes in the parent’s ownership interest and requires fair value measurement of any noncontrolling interest retained in a deconsolidation. SFAS No. 160 did not have a material impact on our financial statements.

We adopted SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133” (“SFAS 161”) effective November 15, 2008, which requires additional disclosures about the objectives of the derivative instruments and hedging activities, the method of accounting for such instruments under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” and its related interpretations, and a tabular disclosure of the effects of such instruments and related hedged items on our financial position, financial performance, and cash flows.

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Recent accounting pronouncements not yet adopted

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles.” This Statement identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with GAAP (the “GAAP hierarchy”). This statement is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board (“PCAOB”) amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.” The PCAOB does not expect that this Statement will result in a change in current practice. However, transition provisions have been provided in the unusual circumstance that the application of the provisions of this Statement results in a change in practice.

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations”. SFAS No.141(R) significantly changes the accounting for business combinations for which the acquisition date is on or after January 1, 2009, by requiring an acquiring entity to recognize all the assets acquired and liabilities assumed in a business combination at the acquisition-date fair value. Additionally, SFAS No. 141(R) modifies the accounting treatment for certain specified items related to business combinations (e.g., acquisition-related costs, restructuring costs, research and development assets and changes in valuation allowances for deferred tax assets), and requires a substantial number of new disclosures. SFAS No. 141(R) is effective for us for business combinations for which the acquisition date is on or after August 1, 2009, and earlier adoption is prohibited. SFAS No. 141(R) is not expected to have a significant impact on our financial statements.

In June 2008, the FASB ratified EITF Issue No. 07-5, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock”(“EITF No. 07-5”). EITF No. 07-5 requires entities to evaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock using a two step process in order to further clarify guidance under SFAS No. 133. EITF No. 07-5 is effective for us on August 1, 2009. We are in the process of reviewing our outstanding warrants to determine the impact on our financial statements.

2. ACQUIRED INTANGIBLE ASSETS

Intangible assets net of accumulated amortization are summarized as follows:

	Weighted average
	amortization
	period (years)		April 30, 2009		July 31, 2008
Purchased customer relationships		6-8	$	14,430,831	$	16,634,932
Internally developed systems		4		5,602,390		7,752,097
Tradenames		<1		3,778,651		3,355,437
Intangible assets, net			$	23,811,872	$	27,742,466

Tradenames from our acquisition of EasyLink Services Corporation (“ESC”) in the amount of $3,185,000 have been determined to have an indefinite life and therefore are not amortizable.

On August 26, 2008, we purchased a domain name and mark for $450,000 to support services under the On Demand Messaging segment.

At the end of the second quarter of fiscal 2009 we determined that certain intangible assets and goodwill were partially impaired. As a result of this interim test work, we have recorded an impairment write-down of approximately $84,000 on internally developed systems and approximately $304,000 on purchased customer relationships. In addition, we also recorded an impairment write-down of approximately $3.9 million in goodwill. The total aggregate non-cash impairment write-down of approximately $4.2 million relates to the original valuations given these intangibles from past acquisitions, all of them related to managed electronic data interchange (“EDI”) services in the Supply Chain Messaging segment. These services were weighted toward the retail sector of the economy, which has experienced a serious downturn in revenue resulting in reduced transaction volumes as well as the bankruptcies of multiple customers. While we believe volumes may return when the economy recovers and no single customer bankruptcy was material, the fair value test as measured by future estimated cash flows could not support the current valuations of these intangibles on our balance sheet. There have not been any additional indicators of impairment and we have determined that no additional impairment was necessary for the third quarter.

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3. NOTES PAYABLE

Under provisions of the Securities Purchase Agreement (“SPA”) and the Series A and Series B Notes (the “Notes”) issued to entities under control of York Capital Management (“York”) during fiscal 2008, we are obligated to offer to prepay a portion of the principle of the Notes subject to a twenty-five percent (25%) prepayment penalty if we accumulate more than $15 million in cash and cash equivalents at the end of any fiscal quarter (“Excess Cash Flow”), with the amount of the prepayment set at 50% of the Excess Cash Flow. On October 31, 2008, York accepted our offer for the fiscal quarter ended July 31, 2007, and we paid $6,808,845 in principal prepayment and a penalty of $1,702,211, which was recorded as interest expense.

On December 31, 2008, we executed a fourth amendment to the SPA that provided for an immediate prepayment of $12.0 million of Series A note principal without penalty and for the suspension of the financial covenant requiring a minimum quarterly revenue of $22.5 million per quarter for the fiscal quarters ended January 31, 2009 and April 30, 2009.

As of April 30, 2009 we would have not been in compliance with the revenue covenant of the York SPA and would have been in violation of that covenant had it not been for the fourth amendment to the SPA.

On March 17, 2009, we entered into a non-binding term sheet with York for a proposed refinancing of the Notes. Under the term sheet, the outstanding Notes, Additional Investment Rights and the Warrant to purchase 4,156,448 of class A common stock (“Common Stock”) would be refinanced by a $30 million cash payment, the issuance of 1,980,426 shares of Common Stock, a warrant to purchase 2,841,892 shares of Common Stock and the issuance of up to 10,000 shares of Series E Preferred Stock with a liquidation preference of $1,000 per share. As a result of the refinancing, the Notes would be deemed paid in full without a prepayment penalty and the existing Additional Investment Rights and Warrants would be cancelled.

As of May 19, 2009 we entered into a Securities Exchange Agreement with York that paid-off the Notes per the term sheet for (i) a cash payment from us of $30 million funded from the proceeds of a new term loan, (ii) a cash payment from us of approximately $343,000 for all accrued but unpaid interest on the Notes funded from our working capital, (iii) 1,980,426 newly issued shares of our class A common stock, (iv) warrants to purchase 2,841,892 additional shares of our class A common stock at $0.01 per share and (v) 6,577 newly issued shares of our newly created series E redeemable preferred stock. In accordance with SFAS No. 6 “Classification of Short-Term Obligations Expected to Be Refinanced”, we classified a portion of the Notes as long term. Please see footnote 10, Subsequent Events, for more information regarding the transaction.

4. STOCKHOLDERS’ EQUITY

Dividends

The holders of the outstanding shares of our Series C preferred stock are entitled to receive a 4% per share annual cumulative dividend payable in cash or shares of common stock at our option. The 2008 annual dividends were paid on February 11, 2009. Dividends accrue and are cumulative on a daily basis, whether or not earned or declared.

As of April 30, 2009 and July 31, 2008, accrued dividends of $65,753 and $116,393, respectively, were included in accrued expenses on our balance sheet. A dividend of $200,000 was paid during the third quarter of 2009. Total liquidation preferences of the Series C preferred stock were $5,065,753 and $5,116,393 at April 30, 2009 and July 31, 2008, respectively.

6

Share Repurchases

Under resolutions adopted by our Board of Directors, and with the approval of York under the third amendment dated May 1, 2008 to the SPA entered into with York, we had the authorization to repurchase up to 1,000,000 shares of our class A common stock through December 31, 2008. All such repurchases were required to be made in accordance with Rule 10b-18 promulgated by the SEC pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”). As of April 30, 2009, we had repurchased 1,000,000 shares at a cost of $2,122,288. Repurchases are recorded under the cost method and are classified as Treasury Stock. During the nine months ended April 30, 2009, we repurchased the following shares of common stock under the above-described plan:

					Total Number of		Maximum
	Total				Shares		Number of Shares
	Number of		Average		Purchased as		that May Yet be
	Shares		Price Paid		Part of Publicly		Purchased Under
Period	Purchased		per Share		Announced Plan		the Plan
Balance as of July 31, 2008		109,250	$	2.78		109,250		890,750
October 1 to 31		636,600	$	2.08		636,600		254,150
November 1 to 30		245,000	$	1.96		245,000		9,150
December 1 to 31		9,150	$	1.72		9,150		—
Total		1,000,000	$	2.12		1,000,000

5. INCOME TAXES

At April 30, 2009, the Company had total gross deferred tax assets of approximately $39.3 million, with a corresponding valuation allowance of $26.1 million, for a net asset of $13.2 million. We have deferred tax liabilities of approximately $8.7 million. These deferred taxes net to an asset balance of approximately $4.5 million, with $0.6 million classified as current and $3.9 million classified as long term. The tax assets principally relate to federal net operating loss carryforwards that expire from 2018 through 2029 and to a lesser extent book to tax timing differences. There are significant differences between the book losses and the taxable income for the nine month period ended April 30, 2009 due to the non-cash interest accretion of the debt discount and the goodwill and intangible impairment that was recorded during the second quarter.

The Company complies with FASB Interpretation 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). Pursuant to FIN 48, a tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The charge for taxation is based on the results for the year as adjusted for items that are non-assessable or disallowed. The charge is calculated using tax rates that have been enacted or substantively enacted by the balance sheet date. At April 30, 2009, the Company had no material unrecognized tax benefits based on the provisions of FIN 48.

6. FAIR VALUE REPORTING

The Company adopted SFAS No. 157 for financial assets and liabilities on August 1, 2008. SFAS No. 157 clarifies that fair value is an exit price, representing the amount that would be received upon sale of an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, SFAS No. 157 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

• Level 1 — Observable inputs such as quoted prices in active market;

• Level 2 — Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and

• Level 3 — Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

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The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis at April 30, 2009, consistent with the fair value hierarchy provisions of SFAS No. 157:

	Quoted Prices in
	Active Markets
	for Identical		Significant
	Assets		Other		Significant
	(Liabilities)		Observable		Unobservable
	(Level 1)		Inputs (Level 2)		Inputs (Level 3)			Carrying Amount
Cash	$	8,719,488		—		—		$	8,719,488
Cash Equivalents	$	1,005,264		—		—		$	1,005,264
Notes Payable		—		—		(46,333,877	)		(36,895,023	)

The carrying amount of the notes payable contains a $9,286,057 discount. Management believes that the assets can be liquidated without restriction.

7. COMMITMENTS AND CONTINGENCIES

New York State Sales Tax Assessment

As a result of a New York state sales tax audit completed in 2005 of EasyLink Services International, Inc., a dissolved subsidiary of ESC, we were assessed New York sales taxes, penalties and interest on revenue for the period of March 1, 2001 through May 31, 2004. Fax and telex services that were intrastate rather than interstate would have been subject to tax in New York if deemed to be “telecommunications services.” Our fax and telex services provide enhanced services to customers as opposed to mere transport, thereby distinguishing those services from “telecommunications services.” As a consequence, we believe that none of our fax or telex services are “telecommunications services” or are intrastate in nature, and that none of these revenues should be subject to New York state sales or local taxes.

A ruling in our favor was received on June 26, 2008. However, the state of New York has appealed, and the New York State Tax Appeals Tribunal (the “Tribunal”) heard oral arguments in the appeal on January 28, 2009. We are awaiting the Tribunal’s final decision and continue to carry an accrual of $368,000 in respect of this assessment as of April 30, 2009.

Litigation

On June 26, 2008, j2 Global Communications, Inc. (“j2”) brought a patent infringement lawsuit against us in the U.S. District Court for the Eastern District of Texas. j2’s Complaint alleges that we infringed upon two of j2’s patents, U.S. Patent Nos. 6,597,688 and 7,020,132. Such patents involve a scaleable methodology for transforming e-mails and other messages into a format capable of being sent by facsimile to locations worldwide. In its complaint, j2 seeks lost profits but did not specify an amount of damages. We filed an Answer and Counterclaim, seeking to invalidate the patents on August 20, 2008 and also denying any infringement upon and the validity of both patents. The case is has been transferred to the Central District of California, and a new trial schedule will be arranged.

In connection with the termination of an agreement to sell the portal operations of our discontinued India.com business, one of our subsidiaries is party to pending litigation (India.com v. Dalal) that is now on appeal before the U.S. Court of Appeals for the Second Circuit (the “Court”). Due to an administrative error by the Court in connection with plaintiff’s papers, the plaintiff’s appeal of a previous decision in favor of the Company remained dormant until March 2007. Eventually, the Court discovered its error and allowed the plaintiff’s appeal to proceed. The matter was fully briefed and oral argument took place on March 13, 2009. By Summary Opinion dated April 28, 2009, the Court reversed the District Court’s ruling in favor of the Company and a portion of its prior Opinion. On May 12, 2009, the Company filed a Petition for Panel Rehearing and a Rehearing in En Banc and that is still pending.

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From time to time we have litigation with other parties involving amounts in controversy that are not material, including actions that we file to recover amounts we believe are owed to us.

The outcome of litigation may not be assured, and despite management’s views of the merits of any litigation, or the reasonableness of our estimates and reserves, our cash balances could nonetheless be materially affected by an adverse judgment. In accordance with SFAS No. 5, “Accounting for Contingencies,” we believe we have adequately reserved for the contingencies arising from the above legal matters where an outcome was deemed to be probable and the loss amount could be reasonably estimated. As such, we do not believe that the anticipated outcome of the aforementioned proceedings will have a materially adverse impact on our financial condition, cash flows or results of operations.

8. INTERIM SEGMENT DISCLOSURES

Our operations are divided into two business segments, which are defined as follows:

• Supply Chain Messaging Segment (“Supply Chain”), which includes all our EDI and telex services.

• On Demand Messaging Segment (“On Demand”), which includes all fax, e-mail, document capture and management (“DCM”) and workflow services.

The table below summarizes information about operations for the fiscal quarters ended April 30, 2009 and 2008:

Quarter Ended April 30, 2009	Supply Chain		On Demand		Total
Revenue from external customers	$	10,348,534	$	10,690,444	$	21,038,978
Segment gross profit	$	7,184,346	$	7,353,571	$	14,537,917

The following is a reconciliation of operating segment income to net income for the quarter ended April 30, 2009:

Segment gross profit	$	14,537,917
Corporate expenses		11,657,075
Operating income		2,880,842
Other income (expense), net		(1,404,764	)
Income before income taxes		1,476,078
Income tax expense		239,890
Net income	$	1,236,188

Quarter Ended April 30, 2008	Supply Chain		On Demand		Total
Revenue from external customers	$	12,317,430	$	11,282,266	$	23,599,696
Segment gross profit	$	9,213,492	$	7,684,762	$	16,898,254

The following is a reconciliation of operating segment income to net income for the quarter ended April 30, 2008:

Segment gross profit	$	16,898,254
Corporate expenses		12,376,642
Operating income		4,521,612
Other income (expense), net		(2,003,880	)
Income before income taxes		2,517,732
Income tax benefit		(4,418,376	)
Net income	$	6,936,108

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The table below summarizes information about operations for the nine months ended April 30, 2009 and 2008:

Nine Months Ended April 30, 2009	Supply Chain		On Demand		Total
Revenue from external customers	$	32,396,416	$	32,313,623	$	64,710,039
Segment gross profit	$	23,449,218	$	22,238,122	$	45,687,340

The following is a reconciliation of operating segment income to net income for the nine months ended April 30, 2009:

Segment gross profit	$	45,687,340
Corporate expenses		38,331,049
Intangible impairment		4,245,914
Operating income		3,110,377
Other income (expense), net		(10,046,921	)
Loss before income taxes		(6,936,544	)
Income tax expense		995,159
Net loss	$	(7,931,703	)

Nine Months Ended April 30, 2008	Supply Chain		On Demand		Total
Revenue from external customers	$	36,246,455	$	31,989,912	$	68,236,367
Segment gross profit	$	26,893,641	$	21,596,968	$	48,490,609

The following is a reconciliation of operating segment income to net income for the nine months ended April 30, 2008:

Segment gross profit	$	48,490,609
Corporate expenses		36,110,088
Operating income		12,380,521
Other income (expense), net		(9,795,707	)
Income before income taxes		2,584,814
Income tax benefit		(5,612,515	)
Net income	$	8,197,329

9. DERIVATIVE FINANCIAL INSTRUMENTS

As of April 30, 2009, we had no known material derivative financial instruments.

10. SUBSEQUENT EVENTS

On May 19, 2009, we entered into a Revolving Credit and Term Loan Agreement (the “Credit Agreement”) with the lenders from time to time party thereto (the “Lenders”), SunTrust Bank, as administrative agent for the Lenders (in such capacity, the “Administrative Agent”), and The Private Bank and Trust Company, as syndication agent. Pursuant to the Credit Agreement, we obtained (i) a term loan (the “Term Loan”) in an aggregate principal amount of $30,000,000, evidenced by Term Notes issued to each of the Lenders (the “Term Notes”), and (ii) a revolving credit and letter of credit facility (the “Revolver”) in a maximum principal amount of up to $2,000,000, evidenced by a Revolving Credit Note issued to SunTrust Bank (the “Revolver Note”).

The Company used the proceeds of the Term Loan to repay a portion of indebtedness owed to York Capital Management, L.P. and certain of its affiliates (collectively, “York Capital”) pursuant to those certain Series A Senior Secured Convertible Notes due August 20, 2011 (the “Series A Notes”) and Series B Senior Secured Convertible Notes due August 20, 2011 (the “Series B Notes”). The Company may use proceeds of the Revolver to: (i) finance working capital needs; (ii) pay certain transaction fees and expenses in connection with the Credit Agreement and the concurrent recapitalization transactions with York Capital described herein; (iii) fund certain acquisitions; (iv) finance capital expenditures; and (v) for general corporate purposes. To date, the Company has not incurred any borrowings under the Revolver.

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The principal amount of the new Term Loan will be due and payable in quarterly installments of $2.5 million beginning on July 31, 2009 and ending on April 30, 2012. The outstanding principal amount of any borrowings under the Revolver will be due and payable on May 19, 2012, subject to an earlier maturity date under certain circumstances.

For further detail please reference the 8-K filed with the SEC on May 21, 2009.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Statement Disclaimer

All statements, trend analyses and other information, other than statements of historical facts, contained in the following discussion related to our financial position, business strategy and plans and objectives of management for future operations are forward-looking statements. These forward-looking statements are based on the beliefs of management, as well as assumptions made by and information currently available to management. When used in this quarterly report, the words “anticipate,” “believe,” “estimate,” “expect,” “may,” “will,” “continue” and “intend,” and words or phrases of similar import, as they relate to our financial position, business strategy and plans, or objectives of management, are intended to identify forward-looking statements. These statements reflect our current view with respect to future events and are subject to risks, uncertainties and assumptions related to various factors, including, without limitation, those described in Item 1A of Part II of this quarterly report under the heading “Risk Factors” and in our registration statements and periodic reports filed with the SEC under the Exchange Act and the Securities Act of 1933, as amended (the “Securities Act”).

Although we believe our expectations are reasonable, we cannot assure you that our expectations will prove to be correct. Should any one or more of these risks or uncertainties materialize, or should any underlying assumptions prove incorrect, actual results may vary materially from those described in this quarterly report as anticipated, believed, estimated, expected or intended.

Executive Summary

EasyLink Services International Corporation is a provider of value added services that facilitate the electronic exchange of documents and information between enterprises, their trading communities and their customers, including electronic data interchange (“EDI”) services, fax services, telex services and the transfer of insurance claims, trade and travel confirmations, purchase orders, invoices, shipping notices and funds. Our revenue stream is based on a volume driven model in which each of our messaging services generates customer billings by the accumulation of some volume measure, whether it be number of pages, number of lines, number of messages, number of minutes or number of kilo-characters. We are also a business-to-business model as almost none of our messaging services are sold directly to consumers. In addition, we are an international business with approximately 25% of our revenue coming from international markets, which is principally denominated in British pounds (“GBP”).

The worldwide economic down turn and volatility in the foreign exchange markets have affected our revenues, particularly in the second and third quarters of fiscal 2009. The reality of decreased business activity worldwide has reduced demand for our services resulting in reduced revenue. Internationally, the foreign exchange effect of the GBP falling from approximately $2.00 United States dollars (“USD”) to the GBP to $1.40 USD to the GBP in the first nine months of this fiscal year has reduced the recognition of international revenue for the Company by approximately 26%. The foreign exchange effect in the third quarter reduced the recognition of international revenue for the Company by approximately 27%. The GBP has begun to rebound against the USD with its value increasing by 13% from $1.43 USD to the GBP at the end of the quarter to $1.62 USD to the GBP by the end of May. The increased value of the GBP to the USD will positively impact our future revenues if the GBP maintains its current value against the USD.

The down turn in revenue has caused management to accelerate certain cost cutting initiatives. With labor as our largest expense, we reduced headcount in the second quarter and have an active program underway to consolidate our remote locations. We have consolidated our accounting systems into a single platform. We are reducing our reliance on outside consultants, approaching suppliers with requests to reduce current pricing, switching vendors when offered cost savings and reducing capital expenditures when appropriate.

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As increasing revenue remains an important goal, we are continuing our previously announced investment into sales and marketing. We believe there may be opportunities to sell additional services domestically, particularly in our On Demand Messaging segment where desktop faxing offers corporations the opportunity to eliminate fax machines, fax servers and software to realize cost savings. We also continue to build our international sales force where the penetration of both EDI and fax services lags behind that of the United States. We also continue to examine potential acquisitions with a focus on businesses that are immediately accretive in terms of revenue and earnings. However, the Term Loan significantly limits investments and acquisitions that we can make.

Critical Accounting Policies and Significant Use of Estimates in Financial Statements

The discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenue and expenses. We consider certain accounting policies related to revenue recognition, valuation of acquired intangibles and impairment of long-lived assets, including goodwill, and valuation of investments to be critical policies due to the estimation process involved in each. Management discusses its estimates and judgments with the Audit Committee of our Board of Directors.

We discuss our critical accounting policies in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, in our Annual Report on Form 10-K for the year ended July 31, 2008. There have been no significant changes in our critical accounting policies since July 31, 2008.

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Nine Months Ended April 30, 2009 Compared with the Nine Months Ended April 30, 2008

Results of Operations

The following table reflects consolidated operating data by reported segment. All significant intersegment activity has been eliminated. Accordingly, the segment results below exclude the effect of transactions with our subsidiaries.

	Nine Months Ended April 30,
	2009			2008			Variance
Revenue:
Supply Chain Messaging
EDI Services	$	24,996,848		$	27,863,355		$	(2,866,507	)
Telex Services		7,399,568			8,383,100			(983,532	)
Total Supply Chain Messaging		32,396,416			36,246,455			(3,850,039	)
On Demand Messaging
Fax Services		25,883,384			25,452,140			431,244
DCM Services		2,046,495			2,085,282			(38,787	)
Other Services		4,383,744			4,452,490			(68,746	)
Total On Demand Messaging		32,313,623			31,989,912			323,711
Total Revenue:		64,710,039			68,236,367			(3,526,328	)
Cost of Revenue:
Supply Chain Messaging		8,947,198			9,352,814			(405,616	)
On Demand Messaging		10,075,501			10,392,944			(317,443	)
Total Cost of Revenue		19,022,699			19,745,758			(723,059	)
Gross Margin:
Supply Chain Messaging		23,449,218			26,893,641			(3,444,423	)
On Demand Messaging		22,238,122			21,596,968			641,154
Total Gross Margin		45,687,340			48,490,609			(2,803,269	)
Product Development and Enhancement		5,901,783			5,983,735			(81,952	)
Selling and Marketing		9,780,627			8,207,447			1,573,180
General and Administrative		22,648,639			21,918,906			729,733
Goodwill and Intangible Impairment		4,245,914			—			4,245,914
Total product, selling and G&A expenses		42,576,963			36,110,088			6,466,875
Other (expense) income		(10,046,921	)		(9,795,707	)		(251,214	)
Income (loss) before income taxes	$	(6,936,544	)	$	2,584,814		$	(9,521,358	)

Revenue — Total revenue for the nine months ended April 30, 2009 was approximately $64.7 million, a decrease of approximately $3.5 million or 5.2% as compared to the nine-month period ended April 30, 2008. This decrease in revenues is primarily due to a decrease in revenues in the Supply Chain Messaging segment. Both service types in the Supply Chain Messaging segment, EDI Services and Telex Services, saw reductions for the first nine months of 2009 due to customer volume reductions and fluctuations in exchange rates. It is estimated that the customer volume reductions approximated $1.8 million in reduced revenue due to the weakening global economy. It is estimated that fluctuations in foreign currencies, primarily the weakening of the GBP to the USD, totaled approximately $3.0 million in reduced services revenues. Partially offsetting these reduced revenues was the inclusion of a full month of August revenue for ESC in fiscal 2009 of approximately $1.0 million, as opposed to the period beginning August 20, 2007 in the first quarter of fiscal 2008, resulting from the acquisition of ESC as of that date. The increase in the On Demand Messaging segment of approximately $324,000 (a 1.0% increase) is due mainly to an approximately $431,000 or 1.7% increase to Fax Services revenue. This revenue increased due mainly to the inclusion of a full month of August revenue for the On Demand Messaging Segment for ESC in fiscal 2009.

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Cost of Revenue — Total cost of revenue decreased approximately $723,000 or 3.7% from the nine-month period ended April 30, 2008, compared to the nine-month period ended April 30, 200. This decrease is due primarily to approximately $406,000 (a 4.3% reduction) in reduced costs for the Supply Chain Messaging segment due to the reduction of revenues for the segment and the corresponding reduction in variable costs. Telecom costs decreased approximately $236,000 (a 4.7% reduction) for both segments for the nine-month period. Labor and outside contractors costs decreased approximately $561,000 (an 8.3% reduction) during the nine-month period due to a resizing of the business. Partially offsetting these decreases was approximately $51,000 in increased hardware and software maintenance that is the result of a new maintenance program.

Product Development — Product development costs decreased approximately $82,000 or 1.4% from the nine-month period ended April 30, 2008, compared to the nine-month period ended April 30, 2009 due mainly to approximately $329,000 (a 74% reduction) in consultant expenses, $85,000 (a 50% reduction) in office rent and $200,000 in reduced costs that were directly related to a change in foreign currency exchange rates during the period. These reduced costs were partially offset by $163,000 in severances related to restructuring activities that occurred during the second and third quarters of 2009 and approximately $309,000 of increased costs due to the inclusion of a full month of August costs for ESC in fiscal 2009, as opposed to the period beginning August 20, 2007 in the first quarter of fiscal 2008.

Selling and Marketing — Selling and marketing expenses increased approximately $1.6 million or 19.2% from the nine-month period ended April 30, 2008 to the nine-month period ended April 30, 2009, due mainly to severance costs of approximately $251,000 that occurred during the second and third quarters of 2009, approximately $480,000 of increased costs due to the inclusion of a full month of August costs for ESC in fiscal 2009, as opposed to the period beginning August 20, 2007 in the first quarter of fiscal 2008, increased travel expenses of approximately $398,000 (a 115% increase), increased professional fees and outside commissions of approximately $346,000 (a 21.6% increase) and $674,000 (a 13.9% increase) of increased compensation expenses due to the expansion and investment in the sales function. These increased expenses are the result of a focused effort to enhance and expand our sales and marketing activities. Partially offsetting these expenses are approximately $700,000 (a 26% decrease) in reduced costs that were directly related to a change in foreign currency exchange rates during the period.

General and Administrative — General and administrative expenses increased approximately $730,000 or 3.3% from the nine-month period ended April 30, 2008 to the nine-month period ended April 30, 2009, due mainly to the expensing of approximately $1.5 million incurred with respect to a potential acquisition. These acquisition costs were previously capitalized on the balance sheet, but were expensed during the three months ended October 31, 2008 as we determined that the potential acquisition would not close. In addition to the acquisition costs, there was approximately $760,000 of increased costs due to the inclusion of a full month of August costs for ESC in fiscal 2009, as opposed to the period beginning August 20, 2007 in the first quarter of fiscal 2008, and increased severance costs of approximately $120,000. Offsetting these increased costs was approximately $450,000 of bonuses paid to certain executives upon the closing of the ESC acquisition during the first quarter of 2008 that did not reoccur during the nine-month period ended April 30, 2009, approximately $800,000 of reduced costs that were directly related to a change in foreign currency exchange rates during the period and $303,000 in reduced rent and utility charges.

Intangible Impairment — During the nine-month period ended April 30, 2009 a $4.2 million impairment in the value of the intangible assets and goodwill was recorded in order to state those assets at their fair market value. See financial statement footnote 2 in Item 1 above.

Other Expense — Other expenses for the nine-month period ended April 30, 2009 consist mainly of interest expense of approximately $10.6 million, which includes approximately $6.3 million in non-cash interest for accretion of the debt discount (of which approximately $3.2 million was for early payments on the Notes), approximately $1.7 million for a penalty on a principal prepayment made on our Notes, and approximately $2.6 million in interest expense on the Notes for the nine-month period. The interest expense for 2008 was $10.6 million.

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As of April 30, 2008, we released a portion of our valuation allowance in connection with our use of net operating loss carryforwards to offset estimated taxable income for the fiscal year ended July 31, 2008. This release of valuation allowance resulted in a tax benefit of approximately $4.4 million for the nine months ended April 30, 2008. There were no additional valuation allowance releases during 2009.

Three Months Ended April 30, 2009 Compared with the Three Months Ended April 30, 2008

Results of Operations

The following table reflects consolidated operating data by reported segment. All significant intersegment activity has been eliminated. Accordingly, the segment results below exclude the effect of transactions with our subsidiaries.

	Three Months Ended April 30,
	2009			2008			Variance
Revenue:
Supply Chain Messaging
EDI Services	$	8,029,866		$	9,410,015		$	(1,380,149	)
Telex Services		2,318,668			2,907,415			(588,747	)
Total Supply Chain Messaging		10,348,534			12,317,430			(1,968,896	)
On Demand Messaging
Fax Services		8,550,085			9,045,614			(495,529	)
DCM Services		613,592			708,822			(95,230	)
Other Services		1,526,767			1,527,830			(1,063	)
Total On Demand Messaging		10,690,444			11,282,266			(591,822	)
Total Revenue:		21,038,978			23,599,696			(2,560,718	)
Cost of Revenue:
Supply Chain Messaging		3,164,188			3,103,939			60,249
On Demand Messaging		3,336,873			3,597,503			(260,630	)
Total Cost of Revenue		6,501,061			6,701,442			(200,381	)
Gross Margin:
Supply Chain Messaging		7,184,346			9,213,491			(2,029,145	)
On Demand Messaging		7,353,571			7,684,763			(331,192	)
Total Gross Margin		14,537,917			16,898,254			(2,360,337	)
Product Development and Enhancement		1,774,455			2,111,513			(337,058	)
Selling and Marketing		3,124,099			2,897,718			226,381
General and Administrative		6,758,521			7,367,411			(608,890	)
Total product, selling and G&A expenses		11,657,075			12,376,642			(719,567	)
Other (expense) income		(1,404,764	)		(2,003,880	)		(599,116	)
Income (loss) before income taxes	$	1,476,078		$	2,517,732		$	(1,041,654	)

Revenue — Total revenue for the three months ended April 30, 2009 was approximately $21.0 million, a decrease of approximately $2.6 million or 10.8% as compared to the three-month period ended April 30, 2008. This decrease in revenues is primarily due to reduced customer volume and fluctuating exchange rates in foreign currencies, primarily the weakening of the GBP to the USD. The effect of the exchange rate fluctuation approximated $1.8 million or 27.2% in reduced international revenues on a year to year basis.

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The Supply Chain Messaging segment decreased approximately $2.0 million or 16.0% from the three-month period ended April 30, 2008 as compared to the three-month period ended April 30, 2009, due to approximately $1.4 million in decreased EDI services and $589,000 in reduced Telex services. Included in the amounts above it is estimated that fluctuations in foreign currencies reduced the revenues by approximately $1.1 million with the greatest effect in the Telex services.

The On Demand Messaging segment decreased approximately $592,000 or 5.2% from the three-month period ended April 30, 2008, as compared to the three-month period ended April 30, 2009, due to decreases of approximately $496,000 (a 5.4% decrease) for Fax services and approximately $95,000 (a 13.4% decrease) for DCM services. It is estimated that fluctuations in foreign currencies reduced revenue by approximately $700,000. The decrease was partially offset by increases in the domestic fax business of approximately $627,000 (a 9.0% increase). The decrease in the DCM services was due to pricing changes with our largest customer.

Cost of Revenue — Total cost of revenue decreased approximately $200,000 or 3.1% due mainly to reductions in labor and related expenses of approximately $432,000 (a 19.4% decrease) brought about by the restructuring of the company’s operations. The reduction was partially offset by an approximate $145,000 (a 4.6% increase) increase in telecom expense and an approximate $66,000 (a 3.2% increase) increase in depreciation expense due to infrastructure upgrades.

Product Development — Product development costs decreased approximately $337,000 or 16.0% from the three-month period ended April 30, 2008, compared to the three-month period ended April 30, 2009. These decreased costs consisted mainly of a reduction in labor and benefits of approximately $212,000 (a 10.6% reduction) and an approximate decrease of $133,000 (an 8.8% reduction) for outside professionals and consultants. The decreases were part of the company’s restructuring during the previous quarters for which benefits are now being realized.

Selling and Marketing — Selling and marketing expenses increased approximately $226,000 or 7.8% from the three-month period ended April 30, 2008 to the three-month period ended April 30, 2009, due mainly to increased travel expenses of approximately $73,000 (a 4.7% increase) and increased costs of outside consultants and contractors of approximately $121,000 (a 25.9% increase). In addition, there was an increase in training expenses of approximately $39,000 (a 100% increase). These increased expenses are the result of a focused effort to enhance and expand our sales and marketing activities.

General and Administrative — General and administrative expenses decreased approximately $609,000 or 8.3% from the three-month period ended April 30, 2008 to the three-month period ended April 30, 2009, primarily due to the restructuring of the organization in previous quarters. The expense reductions experienced during the quarter are as follows:

	Amount		%
Compensation & Benefits	$	362,000		12.6
Intangible Amortization due to an impairment in the second quarter		106,000		7.7
Rent		156,000		24.9
Outside Professional Services		50,000		6.0
Taxes		52,000		39.1
Public Relations		43,000		74.8
Insurance		40,000		26.4
Travel		39,000		42.7

These decreases are partially offset by $322,000 in bad debt expenses due primarily to delays or delinquencies in customer payments of $222,000 and reserves for increases in minimum pricing of $100,000.

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Other Expense — Other expenses for the three-month period ended April 30, 2009 consist mainly of interest expense of approximately $1.6 million, which included approximately $1.0 million in non-cash interest for accretion of the debt discount and approximately $677,000 in cash interest expense on the Notes for the fiscal quarter. Interest expense for 2008 was $2.3 million.

As of April 30, 2008, we released a portion of our valuation allowance in connection with our use of net operating loss carryforwards to offset estimated taxable income for the fiscal year ended July 31, 2008. This release of valuation allowance resulted in a tax benefit of approximately $4.4 million for the three months ended April 30, 2008. There were no additional releases of the valuation reserve during 2009.

Liquidity and Capital Resources

Our principal source of liquidity consists of cash generated from operations. As the majority of our revenue is reoccurring under contract, it is primarily affected by the volumes incurred by the customer using the underlying messaging service. Operating expenses are primarily driven by labor and telecom costs and are predictable from headcount and telecom volume usage, which is directly tied to customer utilization of messaging services. Cash and cash equivalents decreased approximately $22.4 million to a total balance of approximately $9.7 million as of April 30, 2009 from approximately $32.1 million as of July 31, 2008. This decrease in cash was primarily caused by approximately $24.1 million in payments of principal on the Notes, a prepayment penalty of approximately $1.7 million on the Notes, approximately $1.8 million in purchases of treasury stock and approximately $3.1 million of fixed asset purchases for infrastructure upgrades. These cashflows were partially offset by approximately $7.7 million in operating cashflow.

In February of 2009, we began to repay the Notes in thirty equal monthly installments of approximately $1.7 million each. These monthly payments represent the single largest use of cash outside of our regular operating expenses. Under the terms of the SPA and the Notes, we must meet certain financial covenants including minimum quarterly revenues of $22.5 million. In December of 2008, the holder of the Notes granted us a waiver of the revenue covenant through the quarter ended April 30, 2009.

Under the terms of the SPA and the Notes, we are required to offer 50% of our consolidated cash balances in excess of $15 million as of the end of each quarter as a prepayment on the Notes. This prepayment is subject to a prepayment penalty. Our cash balance did not exceed $15 million at April 30, 2009.

In addition, on May 19, 2009, we entered into a Securities Exchange Agreement (the “Securities Exchange Agreement”) by and among us and York Capital. Pursuant to the Securities Exchange Agreement, York Capital exchanged all of its outstanding (i) Series A Notes and Series B Notes in an aggregate principal amount of approximately $47 million, (ii) additional investment rights to purchase up to $10,000,000 of additional notes on the same terms as the Series A Notes (the “Additional Investment Rights”) and (iii) warrants to purchase up to 4,156,448 shares of the Company’s class A common stock at a purchase price of $3.34 per share (subject to adjustment in certain circumstances and subject to certain limitations on exercise) (the “Prior Warrants”), for (i) a cash payment from us of $30 million funded from the proceeds of the Term Loan, (ii) a cash payment from us of approximately $343,000 for all accrued but unpaid interest on the Series A Notes and Series B Notes funded from our working capital, (iii) 1,980,426 newly issued shares of our class A common stock (the “Common Shares”), (iv) warrants to purchase 2,841,892 additional shares of our class A common stock for $0.01 per share (the “New Warrants”) and (v) 6,577 newly issued shares of our newly created series E redeemable preferred stock (the “Series E Preferred Shares”).

As a result of the exchange of the Notes, the remaining non-cash discount on the notes of $9,286,058 will be expensed during the fourth quarter of 2009. There was no prepayment penalty for the repayment and there will be no further sweeps of our excess cash position. We are still evaluating the effect of the transaction on our operating results and may have additional charges once our evaluation is complete.

On May 19, 2009, we entered into a Revolving Credit and Term Loan Agreement with the lenders from time to time party thereto, SunTrust Bank, as administrative agent for the Lenders, and The Private Bank and Trust Company, as syndication agent. Pursuant to the Credit Agreement, we obtained (i) a term loan in an aggregate principal amount of $30,000,000, evidenced by Term Notes issued to each of the Lenders, and (ii) a revolving credit and letter of credit facility in a maximum principal amount of up to $2,000,000, evidenced by a Revolving Credit Note issued to SunTrust Bank.

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The principal amount of the new Term Loan will be due and payable in quarterly installments of $2.5 million beginning on July 31, 2009 and ending on April 30, 2012. The outstanding principal amount of any borrowings under the Revolver will be due and payable on May 19, 2012, subject to an earlier maturity date under certain circumstances. The Credit Agreement contains certain financial covenants, including, among other things: (i) a maximum leverage ratio; (ii) a minimum fixed charge coverage ratio; (iii) a minimum amount of consolidated adjusted EBITDA; (iv) a minimum amount of liquidity; and (v) a maximum amount of capital expenditures. These covenants potentially affect our future cash flow by requiring a minimum cash balance of $5,000,000 and limiting our annual capital expenditures to $2,500,000. Failure to meet these covenants would cause a default on the loan, resulting in a minimum of a 200 basis point increase in the interest on the debt and a potential demand for payment. We are currently in compliance with these covenants and anticipate being in compliance for the remainder of the year.

Management believes that existing cash and cash equivalent balances and cash provided from operations will provide sufficient liquidity to meet the operating and capital expenditure needs for existing operations during the next twelve months.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable to smaller reporting entities.

Item 4T. Controls and Procedures

Disclosure Controls and Procedures

ESIC established and maintained disclosure controls and procedures as defined under Rule 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act) to provide reasonable assurance that information required to be disclosed in the reports that are filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported and is accumulated and communicated to the Chief Executive Officer and Chief Financial Officer as appropriate, by others within the company to allow timely decisions regarding required disclosure. The Chief Financial Officer and Chief Executive Officer have evaluated the effectiveness of the disclosure controls and procedures and, based on this evaluation, concluded that disclosure controls and procedures were effective at a reasonable assurance level as of the end of the period covered by the report. ESIC continually reviews the respective disclosure controls and procedures and make changes, as necessary, to ensure the quality of its financial reporting.

Internal Controls

In February 2009, ESIC implemented an integrated business software system throughout the company. The new system is a process improvement initiative designed to improve business effectiveness and the overall system of internal control over financial reporting through further automation and integration of processes. This initiative was considerable in scale, and has resulted in significant changes in ESIC’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the third fiscal quarter that have materially affected, or are reasonably likely to materially affect, its internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, we may be party to various legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these matters cannot be predicted with certainty, we do not believe that the outcome of any of these claims or any of the legal matters mentioned elsewhere in this Quarterly Report will have a material adverse effect on our consolidated financial position, results of operations or cash flow.

On June 26, 2008, j2 Global Communications, Inc. (“j2”) brought a patent infringement lawsuit against us in the U.S. District Court for the Eastern District of Texas. j2’s Complaint alleges that we infringed upon two of j2’s patents, U.S. Patent Nos. 6,597,688 and 7,020,132. Such patents involve a scaleable methodology for transforming e-mails and other messages into a format capable of being sent by facsimile to locations worldwide. In its complaint, j2 seeks lost profits but did not specify an amount of damages. We filed an Answer and Counterclaim, seeking to invalidate the patents on August 20, 2008 and also denying any infringement upon and the validity of both patents. The case is has been transferred to the Central District of California, and a new trial schedule will be arranged.

In connection with the termination of an agreement to sell the portal operations of the our discontinued India.com business, one of our subsidiaries is party to pending litigation (India.com v. Dalal) that is now on appeal before the U.S. Court of Appeals for the Second Circuit (the “Court”). Due to an administrative error by the Court in connection with plaintiff’s papers, the plaintiff’s appeal of a previous decision in favor of the Company remained dormant until March 2007. Eventually, the Court discovered its error and allowed the plaintiff’s appeal to proceed. The matter was fully briefed and oral argument took place on March 13, 2009. By Summary Opinion dated April 28, 2009, the Court reversed the District Court’s ruling in favor of the Company and a portion of its prior Opinion. On May 12, 2009, the Company filed a Petition for Panel Rehearing and a Rehearing in En Banc and that is still pending.

The outcome of litigation may not be assured, and despite management’s views of the merits of any litigation, or the reasonableness of our estimates and reserves, our cash balances could nonetheless be materially affected by an adverse judgment. In accordance with SFAS No. 5, “Accounting for Contingencies,” we believe we have adequately reserved for the contingencies arising from the above legal matters where an outcome was deemed to be probable and the loss amount could be reasonably estimated. As such, we do not believe that the anticipated outcome of the aforementioned proceedings will have a materially adverse impact on our financial condition, cash flows or results of operations.

Item 1A. Risk Factors

The following Risk Factor disclosure updates the risk factors as disclosed in our 2008 Annual Report on Form 10-K previously filed with the SEC.

Our business is being affected by the global economic slowdown and the rapid changes in foreign exchange rates.The vast majority of our customers are businesses that use our services for business purposes, many in international settings. The global economic turndown now in progress has recently caused the bankruptcy of some of our customers and a prolonged downturn may cause fewer new customers to purchase our services and cause existing customers to use our services less frequently or to cease using our services entirely. In addition, the new found strength of the USD against many foreign currencies and, in particular, the GBP will reduce our revenue as reported in USD. These economic conditions will negatively affect our ability to generate revenue.

Our year end fair value analysis and impairment testing on our current outstanding intangibles and goodwill could lead to additional impairment charges.We will conduct a fair value analysis and impairment test on our existing intangibles at the end of fiscal 2009. There can be no assurances that this analysis and testing will not result in additional non-cash write-offs of existing intangible assets or goodwill.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

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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

Exhibit
Number		Description
	3(i).1	Amended and Restated Certificate of Incorporation of Infosafe Systems, Inc., dated August 27, 1997, as filed with the Secretary of State of Delaware on August 27, 1997.
	3(i).2	Certificate of Merger of Internet Commerce Corporation into Infosafe Systems, Inc., dated September 23, 1998, as filed with the Secretary of State of Delaware on September 23, 1998.
	3(i).3	Certificate of Amendment to the Amended and Restated Certificate of Incorporation of Infosafe Systems, Inc., dated September 23, 1998, as filed with the Secretary of State of Delaware on September 23, 1998.
	3(i).4	Certificate of Powers, Designations, Preferences and Relative, Participating, Optional and Other Special Rights of the Series C Convertible Redeemable Preferred Stock of Internet Commerce Corporation, dated January 5, 2000, as filed with the Secretary of State of Delaware on January 6, 2000.
	3(i).5	Certificate of Powers, Designations, Preferences and Relative, Participating, Optional and Other Special Rights of the Series D Convertible Redeemable Preferred Stock of Internet Commerce Corporation, dated April 29, 2003, as filed with the Secretary of State of Delaware on April 29, 2003.
	3(i).6	Certificate of Ownership and Merger of Internet Commerce Corporation and Enable Corp., dated August 20, 2007, as filed with the Secretary of State of Delaware on August 20, 2007.
	3(i).7	Certificate of Amendment to the Amended and Restated Certificate of Incorporation of EasyLink Services International Corporation, dated August 20, 2007, as filed with the Secretary of State of Delaware on August 22, 2007.
	3(i).8	Certificate of Powers, Designations, Preferences and Relative, Participating, Optional and Other Special Rights of the Series E Redeemable Preferred Stock of EasyLink Services International Corporation, dated May 18, 2009, as filed with the Secretary of State of Delaware on May 18, 2009.
	4.1	Specimen Stock Certificate for Series E Preferred Redeemable Stock. (Incorporated by reference to Exhibit 4.1 to the Company’s Form 8-K (File no. 000-24996), filed on May 21, 2009).
	10.1	Revolving Credit and Term Loan Agreement, dated as of May 19, 2009, among EasyLink Services International Corporation, as Borrower, The Lenders from time to time party thereto, SunTrust Bank, as Administrative Agent and The Private Bank and Trust Company, as Syndication Agent. (Incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K (File no. 000-24996), filed on May 21, 2009).
	10.2	Form of Term Note. (Incorporated by reference to Exhibit 10.2 to the Company’s Form 8-K (File no. 000-24996), filed on May 21, 2009).
	10.3	$2,000,000 Revolving Credit Note among EasyLink Services International Corporation, the Borrower, and the lenders from time to time party there to and SunTrust Bank, dated May 19, 2009. (Incorporated by reference to Exhibit 10.3 to the Company’s Form 8-K (File no. 000-24996), filed on May 21, 2009).

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Exhibit
Number		Description
	10.4	Subsidiary Guaranty Agreement, dated as of May 19, 2009, by and among EasyLink Services International Corporation, the Borrower, each of the subsidiaries of the Borrower listed on Schedule 1 thereto and SunTrust Bank, in its capacity as Administrative Agent. (Incorporated by reference to Exhibit 10.4 to the Company’s Form 8-K (File no. 000-24996), filed on May 21, 2009).
	10.5	Security Agreement, dated as of May 19, 2009, among EasyLink Services International Corporation, the Borrower, the subsidiaries of the Borrower signatory thereto, each of the subsidiaries of the Borrower hereafter a party thereto and SunTrust Bank, as Administrative Agent for the Lenders. (Incorporated by reference to Exhibit 10.5 to the Company’s Form 8-K (File no. 000-24996), filed on May 21, 2009).
	10.6	Stock Pledge Agreement, dated as of May 19, 2009, by EasyLink Services International Corporation, the Borrower, the subsidiaries of the Borrower signatory thereto in favor of SunTrust Bank, as Administrative Agent for the Lenders. (Incorporated by reference to Exhibit 10.6 to the Company’s Form 8-K (File no. 000-24996), filed on May 21, 2009).
	10.7	Securities Exchange Agreement, dated as of May 19, 2009, by and among EasyLink Services International Corporation and each of the Purchasers identified on the signature pages thereto. (Incorporated by reference to Exhibit 10.7 to the Company’s Form 8-K (File no. 000-24996), filed on May 21, 2009).
	10.8	Form of Warrant. (Incorporated by reference to Exhibit 10.8 to the Company’s Form 8-K (File no. 000-24996), filed on May 21, 2009).
	31.1	Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	31.2	Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	32.1	Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	32.2	Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

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.

Date: June 15, 2009

EASYLINK SERVICES INTERNATIONAL CORPORATION
By:	/s/ Glen E. Shipley
	Glen E. Shipley
	Chief Financial Officer

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EXHIBIT INDEX

Exhibit
Number		Description
	3(i).1	Amended and Restated Certificate of Incorporation of Infosafe Systems, Inc., dated August 27, 1997, as filed with the Secretary of State of Delaware on August 27, 1997.
	3(i).2	Certificate of Merger of Internet Commerce Corporation into Infosafe Systems, Inc., dated September 23, 1998, as filed with the Secretary of State of Delaware on September 23, 1998.
	3(i).3	Certificate of Amendment to the Amended and Restated Certificate of Incorporation of Infosafe Systems, Inc., dated September 23, 1998, as filed with the Secretary of State of Delaware on September 23, 1998.
	3(i).4	Certificate of Powers, Designations, Preferences and Relative, Participating, Optional and Other Special Rights of the Series C Convertible Redeemable Preferred Stock of Internet Commerce Corporation, dated January 5, 2000, as filed with the Secretary of State of Delaware on January 6, 2000.
	3(i).5	Certificate of Powers, Designations, Preferences and Relative, Participating, Optional and Other Special Rights of the Series D Convertible Redeemable Preferred Stock of Internet Commerce Corporation, dated April 29, 2003, as filed with the Secretary of State of Delaware on April 29, 2003.
	3(i).6	Certificate of Ownership and Merger of Internet Commerce Corporation and Enable Corp., dated August 20, 2007, as filed with the Secretary of State of Delaware on August 20, 2007.
	3(i).7	Certificate of Amendment to the Amended and Restated Certificate of Incorporation of EasyLink Services International Corporation, dated August 20, 2007, as filed with the Secretary of State of Delaware on August 22, 2007.
	3(i).8	Certificate of Powers, Designations, Preferences and Relative, Participating, Optional and Other Special Rights of the Series E Redeemable Preferred Stock of EasyLink Services International Corporation, dated May 18, 2009, as filed with the Secretary of State of Delaware on May 18, 2009.
	31.1	Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	31.2	Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	32.1	Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	32.2	Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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