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 September 30, 2001 Commission File Number 000-20364
EPRESENCE, INC.
(Exact name of registrant as specified in its charter)
MASSACHUSETTS 04-2798394
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
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 |_|
Number of shares outstanding of each of the issuer's classes of Common Stock as
of October 31, 2001:
Class Number of Shares Outstanding
----- ----------------------------
Common Stock, par value $.01 per share 23,091,754
1
EPRESENCE, INC.
INDEX
Page Number
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets 3
September 30, 2001, December 31, 2000 and pro forma
December 31, 2000
Consolidated Statements of Operations 4
Three and nine months ended September 30, 2001 and 2000
and pro forma September 30, 2001 and 2000
Consolidated Statements of Cash Flows 5
Nine months ended September 30, 2001 and 2000 and pro forma
September 31 and 2000
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial 10
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About 15
Market Risk
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 16
SIGNATURE 17
EXHIBIT INDEX 18
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
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EPRESENCE, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE AND PAR AMOUNTS)
(See Note A)
December
September December 31, 2000
30, 2001 31, 2000 Pro forma
(unaudited) (audited) (unaudited)
----------- --------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 30,509 $ 39,726 $ 20,953
Marketable securities 9,185 104,207 52,210
Accounts receivable, less allowances of $2,135, $1,278 and $876, respectively 9,479 20,016 12,867
Other current assets 5,908 14,293 6,813
-------- -------- --------
Total current assets 55,081 178,242 92,843
Property and equipment, net 3,519 5,636 4,207
Marketable securities 24,003 8,249 8,249
Deferred tax asset 366 13,265 13,265
Goodwill, net of accumulated amortization of $4,441, $2,263 and $2,217, respectively 15,223 29,330 27,090
Investment in unconsolidated affiliate 28,825 -- 34,658
Other assets, net of accumulated amortization of $0, $876 and $0, respectively 92 9,708 218
-------- -------- --------
Total assets $127,109 $244,430 $180,530
======== ======== ========
LIABILITIES
Current liabilities:
Accounts payable $ 2,851 $ 4,561 $ 3,273
Accrued compensation 3,306 5,136 4,402
Accrued expenses 6,244 7,577 5,077
Income taxes payable 785 737 737
Deferred revenue 2,937 4,723 3,211
Long-term debt, current portion -- -- 204
-------- -------- --------
Total current liabilities 16,123 22,734 16,904
Long-term debt -- 2,000 --
Deferred tax liability 366 13,947 13,947
Minority interests in consolidated subsidiaries -- 56,070 --
SHAREHOLDERS' EQUITY
Common stock, $.01 par value; authorized 100,000,000 shares; issued and
outstanding 26,299,254, 26,063,646 and 26,063,646 shares, respectively 263 261 261
Additional paid-in capital 149,746 144,725 145,093
Unearned compensation (1,351) (2,743) (2,743)
Accumulated (deficit)/earnings (4,593) 11,619 11,619
Accumulated other comprehensive income 543 24,547 24,179
Treasury stock at cost; 3,136,700, 1,893,000 and 1,893,000 shares, respectively (33,988) (28,730) (28,730)
-------- -------- --------
Total shareholders' equity 110,620 149,679 149,679
-------- -------- --------
Total liabilities and shareholders' equity $127,109 $244,430 $180,530
======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
3
EPRESENCE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER SHARE DATA)
(unaudited)
Three Months Ended September 30, Nine Months Ended September 30,
(See Note A) (See Note A)
2000 2000
2001 2000 Pro forma 2001 2000 Pro forma
--------- -------- --------- --------- -------- ---------
Revenues $ 10,712 $ 22,705 $ 17,005 $ 39,794 $ 57,933 $ 43,649
Cost of services 8,276 10,354 9,372 27,689 26,843 23,895
-------- ------- ------- -------- -------- -------
Gross profit 2,436 12,351 7,633 12,105 31,090 19,754
Operating expenses:
Sales and marketing 3,914 12,908 6,011 14,151 35,887 14,609
General and administrative 3,397 4,652 3,774 11,737 13,235 10,817
Product development -- 936 -- -- 2,421 --
Amortization of goodwill and intangibles 680 732 732 2,223 1,485 1,485
Impairment of goodwill 12,364 -- -- 12,364 -- --
Other charges 750 -- -- 4,750 -- --
-------- ------- ------- -------- -------- -------
Total operating expenses 21,105 19,228 10,517 45,225 53,028 26,911
-------- ------- ------- -------- -------- -------
Operating loss from operations (18,669) (6,877) (2,884) (33,120) (21,938) (7,157)
Other income/(expense):
Interest income 677 2,251 761 2,339 5,587 2,398
Interest expense (3) (7) (7) (16) (59) (51)
Other, net (194) 1,141 (335) 37,202 49,875 43,937
-------- ------- ------- -------- -------- -------
Total other income 480 3,385 419 39,525 55,403 46,284
-------- ------- ------- -------- -------- -------
(Loss)/income from operations before income
taxes and loss from unconsolidated affiliate (18,189) (3,492) (2,465) 6,405 33,465 39,127
Loss from unconsolidated affiliate (4,705) -- (1,027) (9,749) -- (5,662)
-------- ------- ------- -------- -------- -------
(Loss)/income before income taxes (22,894) (3,492) (3,492) (3,344) 33,465 33,465
Provision/(benefit) for income taxes 3,484 (1,674) (1,674) 12,868 16,071 16,071
-------- ------- ------- -------- -------- -------
Net (loss)/income $(26,378) $(1,818) $(1,818) $(16,212) $ 17,394 $17,394
======== ======= ======= ======== ======== =======
Net (loss)/income per share:
Basic $ (1.16) $ (0.08) $ (0.08) $ (0.70) $ 0.74 $ 0.74
======== ======= ======= ======== ======== =======
Diluted $ (1.16) $ (0.08) $ (0.08) $ (0.70) $ 0.65 $ 0.65
======== ======= ======= ======== ======== =======
Weighted average number of common shares:
Basic 22,774 23,867 23,867 23,144 23,589 23,589
======== ======= ======= ======== ======== =======
Diluted 22,774 23,867 23,867 23,144 26,795 26,795
======== ======= ======= ======== ======== =======
The accompanying notes are an integral part of the consolidated financial
statements.
4
EPRESENCE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(unaudited)
Nine Months Ended September 30,
(See Note A)
2000
2001 2000 Pro forma
--------- --------- ---------
Cash flows from operating activities:
Net (loss)/income $(16,212) $ 17,394 $ 17,394
Adjustments to reconcile net (loss)/income to net cash used in operating activities:
Gain on sale of investments (38,678) (44,556) (44,556)
Depreciation and amortization 3,935 3,452 2,747
Investment in unconsolidated affiliate 9,749 -- 5,865
Minority interest -- (5,997) --
Non-cash advertising and promotion -- 8,794 --
Loss on disposal of assets 1,179 -- --
Loss on sale of subsidiary 828 -- --
Amortization of unearned compensation 1,392 420 420
Other charges 3,042 -- --
Impairment of goodwill 12,364 -- --
Deferred income taxes (682) (1,479) (1,479)
Changes in operating assets and liabilities:
Accounts receivable 2,883 (2,819) (24)
Other current assets 726 (5,264) (4,218)
Other non-current assets 218 (722) (966)
Accounts payable and accrued compensation and expenses (4,221) (2,008) (2,933)
Deferred revenue (217) (362) (1,616)
-------- -------- --------
Net cash used in operating activities (23,694) (33,147) (29,366)
Cash flows from investing activities:
Capital expenditures (1,695) (2,842) (2,044)
Proceeds from investment 39,266 45,278 45,278
Acquisition of goodwill (2,144) (25,959) (25,959)
Proceeds from marketable securities, net 3,172 (44,991) 3,515
-------- -------- --------
Net cash provided by/(used in) investing activities 38,599 (28,514) 20,790
Cash flows from financing activities:
Sale of equity in subsidiary, net -- 86,842 --
Purchase of treasury stock (5,258) -- --
Proceeds from stock plan purchases, stock options
and warrants 120 2,538 1,976
-------- -------- --------
Net cash (used in)/provided by financing activities (5,138) 89,380 1,976
Effect of exchange rate changes on cash and cash equivalents (211) 165 70
-------- -------- --------
Net increase/(decrease) in cash and cash equivalents 9,556 27,884 (6,530)
Cash and cash equivalents at beginning of the period 20,953 29,920 26,453
-------- -------- --------
Cash and cash equivalents at end of the period $ 30,509 $ 57,804 $ 19,923
======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
5
EPRESENCE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. BASIS OF PRESENTATION:
The accompanying unaudited consolidated financial statements include the
accounts of ePresence, Inc. (the "Company") and its subsidiaries as of
September 30, 2001 and for the three and nine months ended September 30,
2001, and have been prepared by the Company in accordance with generally
accepted accounting principles. In the opinion of management, the
accompanying unaudited consolidated financial statements contain all
adjustments, consisting only of those of a normal recurring nature,
necessary for a fair presentation of the Company's financial position,
results of operations and cash flows at the dates and for the periods
indicated. While the Company believes that the disclosures presented are
adequate to make the information not misleading, these consolidated
financial statements should be read in conjunction with the consolidated
financial statements and related notes included in the Company's 2000
Annual Report to Stockholders and Annual Report on Form 10-K. The results
of operations for the three-month and nine-month periods ended September
30, 2001 are not necessarily indicative of the results expected for the
full fiscal year or any future interim period.
In March 2000, Switchboard Incorporated ("Switchboard") consummated an
initial public offering. Pre-offering, the Company owned approximately 53%
of Switchboard's outstanding common stock, and post-offering the Company
owned approximately 41% of Switchboard's outstanding common stock. At
September 30, 2001, the Company owned approximately 38% of Switchboard's
outstanding common stock. Due to the Company's prior control of the
Switchboard Board of Directors through the Switchboard Voting Rights
Agreement dated as of June 30, 1999 that allowed the Company to have a
majority vote, Switchboard's results were consolidated as part of the
Company's financial results through December 31, 2000. In January 2001,
the Company, Viacom Inc. ("Viacom") and Switchboard agreed to terminate
such Voting Agreement. As a result, the Company no longer controlled the
Switchboard Board of Directors. Accordingly, on January 1, 2001, the
Company began accounting for its investment in Switchboard under the
equity method. As a result, the Company's pro rata share of Switchboard's
net loss for the three months and nine months ended September 30, 2001 is
presented separately in the Company's unaudited Consolidated Statement of
Operations for the three months and nine months ended September 30, 2001.
The Company's pro rata share of Switchboard's equity at September 30, 2001
is included in the investment in unconsolidated affiliate and additional
paid-in capital in the Company's unaudited Consolidated Balance Sheet at
September 30, 2001. For comparative purposes, the Company has included a
pro forma equity method unaudited Consolidated Balance Sheet as of
December 31, 2000, a pro forma equity method unaudited Consolidated
Statement of Operations for the three months and nine months ended
September 30, 2000 and a pro forma equity method unaudited Consolidated
Statement of Cash Flows for the nine months ended September 30, 2000, on a
consistent basis with the current period.
6
B. BASIC AND DILUTED EARNINGS PER SHARE:
Basic earnings per share are based upon the weighted average number of
common shares outstanding during the period. Diluted earnings per share
include the dilution of weighted average potential common shares
outstanding during the period. Potential common shares result from the
assumed exercise of outstanding stock options and warrants, the proceeds
of which are then assumed to have been used to repurchase outstanding
common stock using the treasury stock method, and the conversion of
preferred stock using the if converted method. The following table
reconciles the numerator and denominator of the basic and diluted earnings
per share computations shown on the unaudited Consolidated Statements of
Operations:
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
---- ---- ---- ----
(in thousands except per share data)
Basic earnings per share Numerator:
Net (loss)/income $(26,378) $(1,818) $(16,212) $17,394
Denominator:
Weighted average common shares outstanding 22,774 23,867 23,144 23,589
-------- ------- -------- -------
Basic earnings per share $ (1.16) $ (0.08) $ (0.70) $ 0.74
======== ======= ======== =======
Diluted earnings per share Numerator:
Net (loss)/income $(26,378) $(1,818) $(16,212) $17,394
Denominator:
Weighted average common shares outstanding 22,774 23,867 23,144 23,589
Weighted average potential common shares -- -- -- 3,206
-------- ------- -------- -------
Total shares 22,774 23,867 23,144 26,795
-------- ------- -------- -------
Diluted earnings per share $ (1.16) $ (0.08) $ (0.70) $ 0.65
======== ======= ======== =======
Options and warrants to purchase 3,977,126 and 1,305,056 shares of common
stock outstanding during the three months ended September 30, 2001 and
September 30, 2000, respectively, were excluded from the calculation of
diluted net loss per share, as the effect of their inclusion would have
been anti-dilutive. Options and warrants to purchase 2,841,376 shares of
common stock outstanding during the nine months ended September 30, 2001
were excluded from the calculation of diluted net loss per share, as the
effect of their inclusion would have been anti-dilutive. Options and
warrants to purchase 2,782,487 shares of common stock outstanding during
the nine months ended September 30, 2000, were excluded from the
calculation of diluted net income per share because the exercise price of
those options and warrants outstanding exceed the average market price of
the Company's common stock during the respective periods.
C. COMPREHENSIVE INCOME:
Other comprehensive income includes unrealized gains or losses on the
Company's available-for-sale investments and foreign currency translation
adjustments.
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
---- ---- ---- ----
(in thousands)
Net (loss)/income $(26,378) $(1,818) $(16,212) $ 17,394
Unrealized gain/(loss) on marketable securities 230 251 (23,879) (24,786)
Translation adjustment 73 (94) (125) (181)
-------- ------- -------- --------
$(26,075) $(1,661) $(40,216) $ (7,573)
========= ======== ======== ========
7
D. OTHER CHARGES:
In June 2001, as part of the Company's plan to implement cost-cutting
measures, the Company recorded a net pre-tax charge of $4,000,000 related
to a workforce reduction of approximately 20%, office closures and asset
write-offs as further described below. The Company expects to use
$3,400,000 of cash related to these activities.
In September 2001, as part of the Company's plan to reduce costs in its
web solutions business, the Company recorded a net pre-tax charge of
$750,000 related to a workforce reduction of approximately 5%, bad debt
write-offs and asset write-offs as further described below. The Company
expects to use $255,000 of cash related to these activities.
At September 30, 2001, the Company had utilized approximately $2,173,000
in total of the combined liability of which $1,324,000 was severance
related costs, and the remainder related to office closures asset write-
offs and bad debt write-offs. The remaining liability at September 30,
2001 was approximately $2,577,000 of which $1,929,000 is expected to be
cash related expenditures. The Company anticipates that it will charge a
substantial portion of the remaining expenses by the end of fiscal year
2001.
In May 2001, the Company closed its office in The Netherlands and booked a
charge as part of other charges for the costs to close its Netherlands
subsidiary.
The following is a table outlining the year-to-date other charges
activity:
Nine Months Ended September 30, 2001
(in thousands)
Total Cash Non-cash Accrual
Other Charges Payments Charges Balance
------ ------ ---- ------
Staff reductions $2,037 $1,324 $ -- $ 713
Office closures and other costs 1,648 239 -- 1,409
Bad debts 450 -- -- 450
Asset write-offs 615 143 467 5
------ ------ ---- ------
$4,750 $1,706 $467 $2,577
====== ====== ==== ======
E. SALE OF SUBSIDIARY:
On March 22, 2001, the Company sold its Australian subsidiary to an
Australian-based company. The Company exchanged its shares in the
Australian subsidiary for a 10% interest in the acquiring company. The
Company recorded a $1,039,000 loss as a result of the transaction.
F. SALE OF INVESTMENT:
In 1996, the Company made an equity investment of approximately $2,001,000
in Software.com, Inc., a company which supplies Internet messaging
solutions to services providers. On November 17, 2000, Software.com and
Phone.com merged and began doing business as Openwave Systems, Inc.
("Openwave"). In January 2001, the Company liquidated its Openwave
position for net proceeds of approximately $39,266,000.
8
G. STOCK REPURCHASE:
In December 2000, the Board of Directors of ePresence authorized the
repurchase of up to $10,000,000 of its common stock on the open market.
Repurchases of stock will be at management's discretion, depending upon
acceptable prices and availability. Funds used in the repurchase of shares
will come from ePresence's existing cash and investment balances along
with cash generated from operations. As of September 30, 2001, the Company
had expended $5,424,000 toward stock repurchases since inception of this
program.
H. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS:
In July 2001, the FASB issued SFAS No. 141, "Business Combinations," and
SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS 141 requires
that all business combinations be accounted for under the purchase method
only and that certain acquired intangible assets in a business combination
be recognized as assets apart from goodwill. SFAS 142 requires that
ratable amortization of goodwill be replaced with periodic tests of the
goodwill's impairment and that intangible assets other than goodwill be
amortized over their useful lives. SFAS 141 is effective for all business
combinations initiated after June 30, 2001 and for all business
combinations accounted for by the purchase method for which the date of
acquisition is after June 30, 2001. The provisions of SFAS 142 will be
effective for fiscal years beginning after December 15, 2001, and will
thus be adopted by the Company, as required, in fiscal year 2002. The
impact of SFAS 141 and SFAS 142 on the Company's financial statements has
not yet been determined.
I. IMPAIRMENT OF GOODWILL:
Due to the decline in current business conditions, we initiated a cost
savings program and realigned resources to focus on profit contribution
and core opportunities. Based upon impairment analyses which indicated
that the carrying amount of the goodwill and purchased intangible assets
would not be fully recovered through estimated undiscounted future
operating cash flows, a charge of $12,364,000 was recorded for the quarter
ended September 30, 2001 related to the impairment of goodwill measured
as the amount by which the carrying amount exceeded the present value of
the estimated future cash flows for goodwill.
J. DEFERRED TAX VALUATION ALLOWANCE:
The Company recorded no tax benefit on its operating losses for the
quarter ended September 30, 2001, due to the uncertainty of its
realization. A full valuation allowance has been provided against that net
deferred tax asset. Due to the recognition of this valuation allowance, we
recognized an income tax provision of $3,484,000.
K. SUBSEQUENT EVENT:
In August 2001, Switchboard entered into a restructuring agreement with
Viacom, under which, among other things, Switchboard agreed to terminate
its right to the placement of advertising on Viacom's CBS properties with
an expected net present value of approximately $44,500,000 in exchange
for, primarily, the reconveyance by Viacom to Switchboard of approximately
7,500,000, shares of Switchboard's common stock, the cancellation of
warrants held by Viacom to purchase 533,469 shares of Switchboard's common
stock and the reconveyance to Switchboard of the one outstanding share of
Switchboard's series E special voting preferred stock. In addition, as
part of the restructuring of Switchboard's relationship with Viacom, its
license to use specified CBS trademarks will terminate on a date no later
than three months after the closing of the transactions contemplated by
Switchboard's restructuring agreement with Viacom and the Company.
On October 26, 2001, Switchboard obtained approval for the restructuring
agreement by its stockholders and closed the contemplated transactions.
At the closing, the two individuals who had been elected directors by
Viacom pursuant to Viacom's rights as the holder of Switchboard's special
voting preferred stock resigned as directors of Switchboard. Due to the
reduction in the number of outstanding shares of Switchboard's stock
associated with the closing, the Company became Switchboard's majority
stockholder, owning approximately 54% of Switchboard's outstanding stock.
In connection with the termination of its advertising and promotion
agreement with Viacom, Switchboard will report a one-time, non-cash
accounting loss equal to approximately $22,200,000 in the fourth quarter
of this year, which will be reported as other income and expense in
Switchboard's statement of operations. The non-cash accounting loss
results from the difference between the net present value of Switchboard's
remaining advertising rights with Viacom, which were terminated, and the
value of the shares of Switchboard's common and preferred stock reconveyed
and the warrants cancelled.
In addition, in October 2001, Switchboard announced a restructuring of its
operations. As a result of the restructuring, Switchboard expects to
record a pre-tax restructuring charge of approximately $5,000,000 to
$7,000,000 in the three months ending December 31, 2001. The
restructuring charge will provide for certain facility closures, asset
impairments and infrastructure actions.
Due to the reduction in the number of outstanding shares of Switchboard's
stock associated with the closing, the Company became Switchboard's
majority stockholder and beneficial owner of approximately 54% of
Switchboard's outstanding stock. This ownership percentage could result in
the Company accounting for its investment in Switchboard under the
consolidation method of accounting in subsequent quarters. If the
consolidation method of accounting is used by the Company, Switchboard's
revenues, expenses and other income and expense would be consolidated in
the Company's Consolidated Statement of Operations while the minority
interest in Switchboard would be eliminated through consolidated other
income and expense and Switchboard's assets and liabilities would also be
consolidated in the Company's Consolidated Balance Sheet as of December
31, 2001.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
PRO FORMA EQUITY METHOD PRESENTATION
In March 2000, Switchboard consummated an initial public offering. Pre-
offering, the Company owned approximately 53% of Switchboard's outstanding
common stock, and post-offering the Company owned approximately 41% of
Switchboard's outstanding common stock. At September 30, 2001, the Company
owned approximately 38% of Switchboard's outstanding common stock. Due to
the Company's prior control of the Switchboard Board of Directors through
the Switchboard Voting Rights Agreement dated as of June 30, 1999 that
allowed the Company to have a majority vote, Switchboard's results were
consolidated as part of the Company's financial results through December
31, 2000. In January 2001, the Company, Viacom and Switchboard agreed to
terminate such Voting Agreement. As a result, the Company no longer
controlled the Switchboard Board of Directors.
Accordingly, on January 1, 2001, the Company began accounting for its
investment in Switchboard under the equity method. As a result, the
Company's pro rata share of Switchboard's net loss for the three months
and nine months ended September 30, 2001 is presented separately in the
Company's unaudited Consolidated Statement of Operations for the three
months and nine months ended September 30, 2001. The Company's pro rata
share of Switchboard's equity at September 30, 2001 is included in the
investment in unconsolidated affiliate and additional paid-in capital in
the Company's unaudited Consolidated Balance Sheet at September 30, 2001.
For comparative purposes, the Company has included a pro forma equity
method unaudited Consolidated Balance Sheet as of December 31, 2000, a
pro forma equity method unaudited Consolidated Statement of Operations for
the three months and nine months ended September 30, 2000 and a pro forma
equity method unaudited Consolidated Statement of Cash Flows for the nine
months ended September 30, 2000, on a consistent basis with the current
period.
GENERAL
As a result of unfavorable economic conditions, and resultant lengthened
sales cycles and decreased and deferred technology spending for many of
our customers and potential customers we implemented a cost-reduction
program in the second quarter of 2001 to better align the Company's
resources with current revenue expectations. The cost-reduction program
includes staff reductions, office closures and asset write-offs.
In the third quarter of 2001, we experienced lower than anticipated
revenue from our web solutions business. Accordingly, in September 2001,
we recorded a charge of $0.8 million related to a workforce reduction of
approximately 5%, bad debt write-offs and asset write-offs. The charge was
composed of $0.3 million for severance costs, $0.1 for asset write-offs
and $0.4 million for bad debt write-offs. The Company expects to use $0.3
million of cash related to these activities.
At September 30, 2001, the Company had utilized approximately $2.2 million
in total of the combined liability for severance related costs, office
closures, asset write-offs and bad debt write-offs. The remaining
liability at September 30, 2001 is approximately $2.6 million, of which
$1.9 million is expected to be cash related expenditures. The Company
anticipates that it will charge a substantial portion of the remaining
expenses by the end of fiscal year 2001.
Total revenues for the three-month periods ended September 30, 2001 and
2000 were $10.7 million and $17.0 million, respectively. The decrease in
2001 was principally due to the sale of our Australian subsidiary in March
2001 and closing of our operation in The Netherlands in May 2001 and lower
revenues from our web solutions business. Total revenues for the
nine-month periods ended September 30, 2001 and 2000 were $39.8 million
and $43.7 million, respectively. The decrease in 2001 was principally due
to the sale of our Australian subsidiary, the closing of our operation in
The Netherlands and lower revenues from our web solutions business.
International revenues for the three-month periods ended September 30,
2001 and 2000 were $0.8 million and $2.8 million, respectively.
International revenues for the nine-month periods ended September 30, 2001
and 2000 were $4.4 million and $6.7 million, respectively. The decreases
in 2001 were due primarily to the sale of our Australian subsidiary in
March 2001 and the closing of our subsidiary in The Netherlands in May
2001. Accordingly, for the remainder of 2001, we anticipate that our
international revenues will be lower in absolute dollars and as a
percentage of total revenues when compared to the corresponding periods in
the prior year. International revenues accounted for 8% and 16% of total
revenues for the three-month periods ended September 30, 2001 and 2000,
respectively, and 11% and 15% of total revenues for the nine-month periods
ended September 30, 2001 and 2000.
10
Cost of services were $8.3 million and $27.7 million for the three-month
and nine-month periods ended September 30, 2001, respectively, compared
with $9.4 and $23.9 for the corresponding periods in 2000. The decrease
for the three-month comparative was primarily due to lower international
costs of services due to the sale of our Australian subsidiary and the
closing of our operation in The Netherlands. The increase for the
nine-month comparative was primarily due to staffing increases in the
second half of 2000 in anticipation of continued expansion of our
consulting business as well as increases in third-party product costs
incurred as part of select consultancy engagements. Cost of services as a
percentage of revenues were 77% and 70% for the three-month and nine-month
periods ended September 30, 2001, respectively, as compared to 55% for
both of the corresponding periods in the prior year primarily due to
lower revenues for our web solutions business in the three-month period
ended September 30, 2001.
Sales and marketing expenses were $3.9 million and $14.2 million for the
three-month and nine-month periods ended September 30, 2001, respectively,
compared with $6.0 and $14.6 for the corresponding periods in 2000. These
decreases were due primarily to cost reduction initiatives related to the
sale of our business in Australia and the closing of our operations in
The Netherlands, and the occurance of branding initiatives in 2000. Sales
and marketing expenses as a percentage of revenues were 37% and 36% for
the three-month and nine-month periods ended September 30, 2001,
respectively, as compared to 35% and 33%, respectively, for both of the
corresponding periods in the prior year.
General and administrative expenses were $3.4 million and $11.7 million
for the three-month and nine-month periods ended September 30, 2001,
respectively, compared with $3.8 and $10.8 for the corresponding periods
in 2000. The decrease for the three-month period comparative was primarily
attributable to cost reduction initiatives. The increase for the
nine-month period comparative was primarily attributable to additional
salaries and depreciation expenses related to the companies we acquired
in 2000 as well as an incremental bad debt provision. General and
administrative expenses as a percentage of revenues were 32% and 29% for
the three-month and nine-month periods ended September 30, 2001,
respectively, as compared to 22% and 25%, respectively, for the
corresponding periods in the prior year.
Amortization of goodwill expenses were $0.7 million and $2.2 million for
the three-month and nine-month periods ended September 30, 2001,
respectively, compared with $0.7 million and $1.5 million for the
corresponding periods in 2000. The increase for the nine-month period
comparative was due to the acquisition of two services companies in the
first and second quarters of 2000. Amortization of goodwill expenses as a
percentage of revenues were 6% for both the three-month and nine-month
periods ended September 30, 2001, respectively, as compared to 4% and 3%
for the corresponding periods in the prior year. During the quarter
ended September 30, 2001, using the discounted cash flow method, we
determined that the carrying value of goodwill recorded in connection
with prior acquisitions was impaired. An impairment charge totaling $12.4
million was recorded during the quarter ended September 30, 2001,
reflecting the amount by which the carrying amount of the assets exceeded
their respective fair values. There can be no assurance that we will not
experience similar impairment losses in the future. Any such loss could
adversely and materially impact our results of operations and financial
condition.
Other charges were $0.8 million and $4.8 million for the three-month and
nine-month periods ended September 30, 2001, respectively, compared with
no other charges for the corresponding periods in 2000. These increases
were due to the costs charged in association with the reduction of our web
solutions business workforce by approximately 5%, office closings, asset
write-offs and bad debt write-offs. Other charges as a percentage of
revenues were 7% and 12% for the three-month and nine-month periods ended
September 30, 2001, respectively, as compared to no other charges for the
corresponding periods in the prior year.
Other income was $0.5 million and $39.5 million for the three-month and
nine-month periods ended September 30, 2001, respectively, compared with
$0.4 and $46.3 for the corresponding periods in 2000. The decrease for the
nine-month period comparative was due primarily to a gain of approximately
$38.7 million from the sale of shares in Openwave in the nine-month period
ended September 30, 2001 as compared to a gain of approximately $44.6
million from the sale of shares in Software.com in the nine-month period
ended September 30, 2000.
Losses from unconsolidated affiliate were $4.7 million and $9.7 million
for the three-month and nine-month periods ended September 30, 2001,
respectively, compared with $1.0 and $5.7 for the corresponding periods in
2000. These increases were due to increases in the unconsolidated
affiliate's net loss for the three-month and nine-month periods ended
September 30, 2001, compared to the corresponding periods in 2000.
Our effective tax rate for the three-month and nine-month periods ended
September 30, 2001 and 2000 were negatively impacted by our
deconsolidation of Switchboard for tax purposes upon our percentage
ownership change on September 30, 1999. No tax provision, other than that
required for foreign income and foreign withholding taxes, was recorded
for the three-month and nine-month periods ended September 30, 2001 and
2000, due to our previously recorded net operating losses. The Company
recorded no tax benefit on its operating losses for the quarter ended
September 30, 2001, due to the uncertainty of its realization. A full
valuation allowance has been provided against such net deferred tax asset.
Due to the recognition of this valuation allowance, we recognized an
income tax provision of $3.5 million in the three-month period ended
September 30, 2001.
11
LIQUIDITY AND CAPITAL RESOURCES
Working capital decreased from $75.9 million at December 31, 2000 to $39.0
million at September 30, 2001. This decrease was primarily due to
repositioning approximately $15.8 million in marketable securities to a
long-term position, $16.0 million operating loss, excluding other charges
and impairment of goodwill, and $5.3 million in treasury stock
repurchases. This decrease was offset by various operating, investing and
financing activities. At September 30, 2001, cash and cash equivalents
combined with marketable securities were $63.7 million, compared with
$81.4 million at December 31, 2000. Cash and cash equivalents increased
$9.6 million from December 31, 2000 resulting in a cash balance of $30.5
million at September 30, 2001.
During the nine months ended September 30, 2000, we sold shares of
Software.com common stock resulting in a net realized gain of
approximately $44.6 million. On November 17, 2000, Software.com and
Phone.com merged and began doing business as Openwave Systems, Inc.
("Openwave"). During the nine months ended September 30, 2001, we sold
shares of Openwave common stock resulting in a net realized gain of
approximately $38.7 million.
In January 2000, we acquired ePresence, Inc. (now the Company's web
solution business), a privately held e-business services company based in
Red Bank, New Jersey that specialized in web-design, development and
integration. The estimated purchase price of the acquisition is
approximately $12.6 million comprised of cash and our common stock. The
acquisition is accounted for using the purchase method of accounting.
In May 2000, we acquired Strategic Network Designs, Inc. a privately held
e-business services company based in Clark, New Jersey, that specialized
in customer relationship management, e-mobility, wireless and custom
application solutions. The total purchase price of the acquisition was
$22.5 million, comprised of cash and our common stock. The transaction has
been accounted for using the purchase method of accounting.
The Company has a $10.0 million line of credit agreement with Fleet
National Bank. We had no borrowings under the line of credit outstanding
at September 30, 2001.
In December 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 will be at management's discretion, depending upon
acceptable prices and availability. Funds used in the repurchase of shares
will come from ePresence's existing cash and investment balances along
with cash generated from operations. As of September 30, 2001, the Company
had expended $5.4 million toward stock repurchases.
In the three-month period ended June 30, 2001, we recorded a charge of
$4.0 million for the reduction of staff, facilities closures and asset
write-offs. We anticipate expending approximately $3.4 million in cash.
Through September 30, 2001, we have expended $1.7 million with respect to
this charge.
In the three-month period ended September 2001, we recorded a charge of
$0.8 million for the reduction of staff, bad debt write-offs and asset
write-offs related to our web solutions business. We anticipate expending
approximately $0.3 million in cash. Through September 30, 2001, we have
expended no cash with respect to this charge.
We believe that existing cash and marketable securities, combined with
cash expected to be generated from operations, will be sufficient to fund
the Company's operations through at least the next twelve months.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In July 2001, the FASB issued SFAS No. 141, "Business Combinations," and
SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS 141 requires
that all business combinations be accounted for under the purchase method
only and that certain acquired intangible assets in a business combination
be recognized as assets apart from goodwill. SFAS 142 requires that
ratable amortization of goodwill be replaced with periodic tests of the
goodwill's impairment and that intangible assets other than goodwill be
amortized over their useful lives. SFAS 141 is effective for all business
combinations initiated after June 30, 2001 and for all business
combinations accounted for by the purchase method for which the date of
acquisition is after June 30, 2001. The provisions of SFAS 142 will be
effective for fiscal years beginning after December 15, 2001, and will
thus be adopted by the Company, as required, in fiscal year 2002. The
impact of SFAS 141 and SFAS 142 on the Company's financial statements has
not yet been determined.
12
FACTORS AFFECTING FUTURE OPERATING RESULTS
Certain of the information contained in this 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, anticipated expenditures, the anticipated effects of
our cost reduction measures and the discontinuation of our Australian and
Dutch operations, the deconsolidation of Switchboard 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 recent stock market decline and broad economic slowdown has affected
the demand for consulting services, lengthened the sales cycles and caused
decreased technology spending for many of our customers and potential
customers. These events could have a material effect on us, including,
without limitation, on our future revenues and earnings.
The Company has undertaken strategic initiatives to grow its business
while reducing costs. Any failure of these initiatives could have a
material adverse effect on us.
In October 1999, we announced a plan to exit our software business. Until
the fourth quarter of 1998, a majority of our revenues were attributable
to the software business. While we have continued to provide consulting
services to our customers, we no longer market software, nor have we
advanced our software technology through product development. 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. There can
be no assurance we will be successful in our strategic focus on services,
including e-services.
As part of our strategic focus on services, on January 11, 1999, we
announced a global alliance with Microsoft Corporation ("Microsoft") to
deliver integrated messaging, networking and Internet solutions and the
collaboration on the design and implementation of packaged services,
solutions and support offerings based on Microsoft's enterprise platform.
The agreement contains various obligations and milestones that must be met
by us, including the certification of 500 Microsoft-trained professionals.
On July 23, 2001, Microsoft and ePresence signed an amendment to the
alliance agreement, which among other things, waives the requirement for
any further certifications or milestones.
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.
During 2000 and 2001 we entered into a number of partnerships and
alliances with software vendors under which the Company provides services
around such vendors' products. Any failure of these alliances to generate
the anticipated level of sales, or 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. Competition for qualified personnel is intense, and
there can be no assurance we will be able to attract and retain qualified
management and other key employees.
In 1999, we announced our intention to acquire additional professional
services companies in an attempt to strengthen our expanding consulting
services business activities. In 2000, we completed two acquisitions,
described in "Liquidity and Capital Resources" under Item 2 herein. Any
failure by us to effectively identify and acquire additional companies,
integrate and assimilate acquired companies, and any failure of acquired
companies to perform as expected, could have a material adverse effect on
us.
In the three-month periods ended September 30, 2001 and 2000,
international revenues accounted for 8% and 15%, respectively, of the
Company's revenues. International revenues may be adversely affected by
factors such as local or global economic conditions, political
uncertainty, currency fluctuations and governmental regulation. For
example, our results of operations in 1998 were adversely affected by
global economic uncertainty, and in particular, the financial market
instability in Asia. There can be no assurance such uncertainty will not
continue to adversely affect our operating results. In addition, there can
be no assurance that the termination of the Company's operations in
Australia and The Netherlands will positively affect our operating
results.
In the three-month period ended September 30, 2001, we determined that the
goodwill recorded in connection with the two prior acquisitions was
impaired and recorded a charge. There can be no assurance that we will not
experience similar impairment losses in the future. Any such loss could
adversely and materially impact our results of operations and financial
condition.
We own 9,802,421 shares of Switchboard's common stock, which is traded on
the Nasdaq National Market. The trading
13
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.
Through 2000, Switchboard's results of operations were consolidated as
part of our results of operations. Beginning in 2001, Switchboard's
results of operations have been accounted for under the equity method of
accounting, whereby we have included our pro rata share of Switchboard's
net income or loss as a separate line item in our statement of operations.
As the Company's ownership percentage in Switchboard had increased to 54%
on October 26, 2001, this could result in the Company returning to
consolidation accounting in subsequent quarters regarding its investment
in Switchboard. Switchboard, which has a history of incurring net losses,
expects its net losses to continue through at least 2001 as a result of
planned increases in operating expenses and may never achieve
profitability. 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:
o the addition 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;
o Switchboard's ability to attract and retain consumers, local
merchants and national advertisers to its web site;
o the amount and timing of expenditures for expansion of
Switchboard's operations, including the hiring of new
employees, capital expenditures and related costs;
o technical difficulties or failures affecting Switchboard's
systems or the Internet in general;
o the cost of acquiring, and the availability of, content,
including directory information and maps; and
o Switchboard's expenses, which are largely fixed, particularly
in the short-term, are partially based on expectations
regarding future revenue.
In addition, Switchboard has only a limited operating history and until
March 2000 had no operating history as a stand-alone company and limited
experience in addressing various business challenges without the support
of a corporate parent. It may not be successful as a stand-alone company.
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.
14
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKETEBLE SECURITES
The Company had $33.2 million of marketable securities as of September 30,
2001, which are invested in US agencies, bonds and notes and repurchase
agreements. Each ten percent decrease in the market value of these
securities would decrease the Company's total assets by $3.3 million.
While the Company has in the past used hedging contracts to manage
exposure to changes in the value of marketable securities, the Company is
not currently a party to any such contract. The Company may use hedging
contracts in the future. A significant decline in the value of the
Company's marketable securities would have a material adverse effect on
the Company's financial condition.
INTEREST RATE
The Company is exposed to fluctuations in interest rates. A significant
portion of the Company's cash is invested in short-term interest-bearing
securities. Assuming an average investment level in short-term interest-
bearing securities of $33.5 million (which approximates the average amount
invested in these securities during the nine months ended September 30,
2001), each one percentage point decrease in the applicable interest rate
would result in a $0.3 million decrease in annual investment income. The
Company does not currently use interest rate derivative instruments to
manage exposure to interest rate changes. To date, interest rate
fluctuations have not had a material effect on the Company's operating
results or financial condition.
FOREIGN CURRENCY
Most of the Company's international revenues are denominated in foreign
currencies. During the three months ended September 30, 2001, foreign
currency translation resulted in a $45 thousand decline in net revenues.
During the nine months ended September 30, 2001, foreign currency
translation resulted in a $26 thousand gain in net revenues. The Company's
exposure is mitigated, in part, by the fact that it incurs certain
operating costs in the same foreign currencies in which revenues are
denominated. The Company does not currently use foreign currency hedging
contracts to manage exposure to foreign currency fluctuations. To date,
foreign currency exchange rate fluctuations have not had a material effect
on the Company's operating results or financial condition.
15
PART II - OTHER INFORMATION
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.
During the quarter ended September 30, 2001, the Company filed two reports
on Form 8-K, one dated August 13, 2001 and the other dated September 7,
2001. Each Form 8-K was filed pursuant to Item 9 of Form 8-K and the
August 13, 2001 report was regarding an analysts presentation, and the
September 7, 2001 report was regarding a technology conference
presentation. No other reports on Form 8-K were filed during the quarter
ended September 30, 2001.
16
EPRESENCE, INC.
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: November 14, 2001 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)
17
EXHIBIT INDEX
Exhibit Number Title of Document
- -------------- -----------------
10.1 Secured Promissory Note issued to the Company by Richard M.
Spaulding, dated July 26, 2001
10.2 Secured Promissory Note issued to the Company by Anthony J.
Bellantuoni, dated July 26, 2001
10.3 Secured Promissory Note issued to the Company by Scott G. Silk,
dated July 26, 2001
10.4 Amendment No. 1 to Executive Retention Agreement between the
Company and Richard M. Spaulding dated July 26, 2001
10.5 Amendment No. 1 to Executive Retention Agreement between the
Company and Anthony J. Bellantuoni dated July 26, 2001
10.6 Amendment No. 1 to Employment Letter between the Company and
Scott G. Silk dated July 26, 2001
10.7 Amendment No. 1 to Pledge Agreement between the Company and
Richard M. Spaulding dated July 26, 2001
10.8 Amendment No. 1 to Pledge Agreement between the Company and
Anthony J. Bellantuoni dated July 26, 2001
10.9 Amendment No. 1 to Pledge Agreement between the Company and
Scott G. Silk dated July 26, 2001
18