UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, D.C. 20549





FORM 10-Q


(Mark One)





þQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended April 30, 2011or ̈TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from _____  to  _____





Commission File Number: 001-34446








EasyLink Services International Corporation


(Exact Name of Registrant as Specified in Its Charter)


Delaware13-3645702(State or Other Jurisdiction of Incorporation or Organization)(I.R.S. Employer Identification No.)6025 The Corners Parkway, Suite 100Norcross, Georgia30092(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. Yes þ No  ̈





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 (§232.405 of this Chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  ̈ No  ̈





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 fileroAccelerated fileroNon-accelerated fileroSmaller reporting companyþ





Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ̈ No þ





As of May 31, 2011, the issuer had outstanding 30,400,083 shares of class A common stock.





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EASYLINK SERVICES INTERNATIONAL CORPORATION


INDEX TO FORM 10-Q





PagePART I FINANCIAL INFORMATIONItem 1.   Financial Statements (Unaudited)1Condensed Consolidated Balance Sheets as of April 30, 2011 and July 31, 20101Condensed Consolidated Statements of Operations for the three and nine months ended April 30, 2011 and 20102Condensed Consolidated Statements of Cash Flows for the nine months ended April 30, 2011 and 20103Notes to Condensed Consolidated Financial Statements4Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations15Item 3.   Quantitative and Qualitative Disclosures about Market Risk21Item 4.  Controls and Procedures21PART II OTHER INFORMATIONItem 1.   Legal Proceedings22Item 1A.  Risk Factors23Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds23Item 3.   Defaults Upon Senior Securities23Item 4.   [Removed and Reserved]23Item 5.   Other Information23Item 6.   Exhibits24Signatures25








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PART I. FINANCIAL INFORMATION





Item 1. Financial Statements





EASYLINK SERVICES INTERNATIONAL CORPORATION


Condensed Consolidated Balance Sheets


As of April 30, 2011 and July 31, 2010


(Unaudited)


April 30, 2011July 31, 2010ASSETSCurrent assets:Cash and cash equivalents$27,927,647$20,474,709Accounts receivable, net of allowance for doubtful accounts and allowance for sales returns and allowances of $2,685,285 and $1,662,502, respectively32,316,50611,480,688Prepaid expenses and other current assets7,252,4071,865,013Deferred tax asset5,818,5456,597,983Total current assets73,315,10540,418,393Property and equipment, net of accumulated depreciation of $20,333,508 and $16,379,755, respectively8,705,5895,521,146Goodwill67,421,04534,454,935Other intangible assets, net70,738,99515,874,281Deferred tax asset, net of valuation allowance4,264,6307,588,257Other assets656,760629,261Total assets$225,102,124$104,486,273LIABILITIES AND STOCKHOLDERS’ EQUITYCurrent liabilities:Accounts payable$6,397,148$2,310,168Notes payable32,066,47715,257,852Accrued expenses18,464,5358,740,386Accrued dividends, deferred revenue and other current liabilities4,477,7751,497,174Total current liabilities61,405,93527,805,580Notes payable, long term84,151,4909,684,263Other liabilities634,045285,017Total liabilities146,191,47037,774,860Commitments and contingenciesStockholders’ Equity:Preferred stock:Series C Preferred Stock — par value $.01 per share, 5,000,000 shares authorized, 44.76 votes per share; 5,000 shares issued and 5,000 outstanding at July 31, 2010 (liquidation value of $5,116,164), no shares issued or outstanding at April 30, 2011—50Common stock:Class A — par value $.01 per share, 300,000,000 shares authorized, one vote per share; 31,314,860 and 30,255,293 shares issued at April 30, 2011 and July 31, 2010, respectively313,148302,553Additional paid-in capital134,204,369132,798,748Treasury stock — 1,000,000 shares as of April 30, 2011 and July 31, 2010(2,122,288)(2,122,288)Accumulated other comprehensive loss(3,259,525)(5,796,782)Accumulated deficit(50,225,050)(58,470,868)Total stockholders’ equity78,910,65466,711,413Total liabilities and stockholders’ equity$225,102,124$104,486,273





See accompanying notes which are an integral part of these condensed consolidated financial statements.


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EASYLINK SERVICES INTERNATIONAL CORPORATION


Condensed Consolidated Statements of Operations


For the three and nine months ended April 30, 2011 and 2010


(Unaudited)





Three MonthsNine Months2011201020112010Service revenues, net$47,781,844$20,593,015$117,942,265$61,495,091Cost of services16,387,9695,509,15340,473,06217,272,572Gross profit31,393,87515,083,86277,469,20344,222,519Operating expenses:Product development and enhancement3,337,8071,884,2108,833,3875,499,576Selling and marketing6,749,7843,086,87116,483,0009,584,468General and administrative12,841,4796,764,56932,829,38420,633,593Acquisition and integration related——2,414,914—Total Operating expenses22,929,07011,735,65060,560,68535,717,637Operating income8,464,8053,348,21216,908,5188,504,882Other income (expense):Interest expense(1,651,449)(336,123)(4,062,632)(1,263,681)Other non-operating income163,385289,861497,612526,483Total Other income (expense)(1,488,064)(46,262)(3,565,020)(737,198)Income before income taxes6,976,7413,301,95013,343,4987,767,684Provision for income taxes2,637,1031,312,8905,097,6803,107,073Net Income4,339,6381,989,0608,245,8184,660,611Dividends on preferred stock—(209,138)(2,012,389)(641,513)Net income attributable to common stockholders$4,339,638$1,779,922$6,233,429$4,019,098Basic income per common share$0.14$0.06$0.21$0.15Diluted income per common share$0.13$0.06$0.20$0.14Anti-dilutive stock options, restricted stock, warrants, and Series C preferred stock720,9582,532,133351,0244,036,102Weighted average number of common shares outstanding – basic30,183,72529,109,50929,624,78527,198,772Weighted average number of common shares outstanding –diluted32,295,92629,793,24531,352,80029,519,215





See accompanying notes which are an integral part of these condensed consolidated financial statements.


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EASYLINK SERVICES INTERNATIONAL CORPORATION


Condensed Consolidated Statements of Cash Flows


For the nine months ended April 30, 2011 and 2010


(Unaudited)





Nine Months20112010Cash flows from operating activities:Net income$8,245,818$4,660,611Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization9,954,8636,147,498Bad debt expense1,000,879367,614Amortization of discount and other non-cash interest expense849,186404,161Deferred tax expense4,381,9312,924,508Non-cash charges for equity instruments issued for compensation and services926,550673,626Non-cash equity in losses of investment and other non-cash items—105,351Changes in assets and liabilitiesAccounts receivable(5,446,797)(2,221,244)Prepaid expenses and other assets(3,281,788)1,077,625Accounts payable489,184(330,114)Accrued expenses502,303182,248Other liabilities1,671,639(720,067)Net cash provided by operating activities19,293,76813,271,817Cash flows from investing activities:Purchases of property and equipment(1,696,166)(866,622)Acquisition, net of cash acquired(101,166,370)—Net cash used in investing activities(102,862,536)(866,622)Cash flows from financing activities:Proceeds from sale of stock and exercise of options569,859144,750Borrowings of notes payable122,000,000—Repayments of notes payable and capital lease(31,769,382)(7,510,688)Dividends paid(200,000)(200,000)Net cash provided (used) financing activities90,600,477(7,565,938)Effect of foreign exchange rate changes on cash and cash equivalents421,229(167,734)Net increase in cash and cash equivalents7,452,9384,671,523Cash and cash equivalents, beginning of period20,474,70910,972,365Cash and cash equivalents, end of period$27,927,647$15,643,888





See accompanying notes which are an integral part of these condensed consolidated financial statements.


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EASYLINK SERVICES INTERNATIONAL CORPORATION


Notes to Condensed Consolidated Financial Statements


(Unaudited)





1. BASIS OF PRESENTATION





These condensed consolidated financial statements of EasyLink Services International Corporation (referred to as “EasyLink,” the “Company,” “we,” “our” or “us”) have been prepared by the Company, without audit, pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) and, in the opinion of the Company, include all adjustments (which are normal and recurring in nature) necessary to present fairly the financial position of the Company at April 30, 2011 and July 31, 2010 , and the results of operations for the three and nine months ended April 30, 2011 and 2010 and the cash flows for the nine months ended April 30, 2011 and 2010 . Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to such SEC rules and regulations. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended July 31, 2010 .


Operating results for the three and nine months ended April 30, 2011 are not necessarily indicative of the results that may be expected for the fiscal year ending July 31, 2011 ("Fiscal 2011") or any future period.





Principles of consolidation and basis of presentation


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





Recently Adopted Accounting Pronouncements


In May 2011, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2011-04, Fair Value Measurement  (Topic 820) . This ASU is intended to create consistency between U.S. GAAP and International Financial Reporting Standards on the definition of fair value and on the guidance on how to measure fair value and on what to disclose about fair value measurements. This ASU will be effective for financial statements issued for fiscal periods beginning after December 15, 2011, with early adoption prohibited for public entities.  The Company is currently evaluating the impact ASU 2011-04 will have on its consolidated financial statements.


In December 2010, the FASB issued ASU No. 2010-29 Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations , which amends the Accounting Standards Codification ("ASC"), to require any public entity that enters into business combinations that are material on an individual or aggregate basis and presents comparative financial statements, to disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. This guidance is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. We have implemented these provisions for the  acquisitions completed beginning in Fiscal 2011.


In January 2010, the FASB issued ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements .  This ASU requires reporting entities to make new disclosures about recurring or nonrecurring fair-value measurements including significant transfers into and out of Level 1 and Level 2 fair-value measurements and information about purchases, sales, issuances, and settlements on a gross reconciliation of Level 3 fair-value measurements.  This ASU also clarifies existing fair-value measurement disclosure guidance about the level of disaggregation, inputs, and valuation techniques.  This ASU is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements.  Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years.  Early adoption is permitted.  The adoption of the applicable portions of this ASU did not have a material effect on the Company's consolidated financial statements.  The Company is currently evaluating the impact that the adoption of the remainder of this guidance might have on its consolidated financial statement disclosures in the first quarter of fiscal 2012.


In October 2009, the FASB issued ASU No.2009-14, Software (Topic 985):  Certain Revenue Arrangements That Include Software Elements – a consensus of the FASB Emerging Issues Task Force .  This ASU is only effective for fiscal years beginning on or after June 15, 2010.  The Company has determined that the ASU did not have a material impact on its financial statements.


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EASYLINK SERVICES INTERNATIONAL CORPORATION
 Notes to Condensed Consolidated Financial Statements
 (Unaudited)


2. ACQUISITION





Xpedite Business





On October 21, 2010 the Company acquired the iSend and iNotify advanced messaging businesses (the “Xpedite Business”) from Premiere Global Services, Inc. (“PGI”) for $105.0 million in cash, through the purchase of PGI’s wholly-owned subsidiaries Xpedite Systems, LLC and Premiere Global Services (UK) Limited and certain related assets owned by PGI’s subsidiary Premiere Conferencing (Canada) Limited.  The Company and PGI agreed on an adjustment to the purchase price of $1.8 million during the nine month period ended April 30, 2011 , based on the working capital of the acquired business at the acquisition date as defined in the Securities and Asset Purchase Agreement dated October 21, 2010 pursuant to which the Company acquired the Xpedite Business. The Company paid the $1.8 million to PGI on February 16, 2011.  The total purchase price of the Xpedite Business was $106.8 million.  The Company paid for the acquisition with $6.8 million of cash on hand and a new credit facility consisting of a $110.0 million term loan (the “Term Loan”) and a $20.0 million revolving loan (together, the “2010 Loans”), of which $12.0 million of the revolving loan was drawn upon to refinance the Company's existing credit facility indebtedness.  The 2010 Loans call for quarterly payments of approximately $4.1 million with interest and a final balloon payment in 2014, with interest, which commenced on January 31, 2011.





The 2010 Loans are secured by substantially all of the U.S. assets of the Company and guarantees by certain of the international subsidiaries of the Company and related pledges of a portion of the stock of certain of the international subsidiaries. See Note 4, Debt, for additional information regarding the 2010 Loans.





The Company incurred $4.6 million of transaction costs related to the Xpedite acquisition, of which $2.4 million was expensed as incurred in accordance with ASC Topic 805, Business Combinations (“ASC 805”) in the nine months ended April 30, 2011 ,  and $2.2 million was recorded as a discount to the Term Loan and will be amortized over the same period as the Term Loan.





In accordance with ASC 805, the Company accounted for the acquisition by applying the acquisition method of accounting. The acquisition method of accounting requires that the consideration transferred in a business combination be measured at fair value as of the closing date of the acquisition.





Impact on Results of Operations


The results of  the Xpedite Business  since  October 21, 2010 are included in the Company's Condensed Consolidated Statements of Operations (Unaudited).  The financial results are reported in the On Demand segment.  See Note 10, Segment Results for information regarding the Company's segments.  The Xpedite Business contributed $28.5 million and $59.5 million in service revenues and $6.2 million and $9.5 million of net income for the three and nine months ended April 30, 2011 , respectively.





Preliminary Purchase Price Allocation


The following table provides the estimated fair value of assets acquired and liabilities assumed in the Xpedite Business acquisition.  The preliminary purchase price allocation is based on the estimated fair value at October 21, 2010 of assets acquired and liabilities assumed:





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EASYLINK SERVICES INTERNATIONAL CORPORATION
 Notes to Condensed Consolidated Financial Statements
 (Unaudited)


2. ACQUISITION (Continued)


Cash$5,633,630Accounts receivable16,389,901Prepaid expenses and other current assets1,833,620Property and equipment4,803,865Goodwill31,712,226Intangible assets — customer relationships40,800,000Intangible assets — software18,100,000Intangible assets — non-competition agreements1,200,000Other Assets300,493Total assets acquired120,773,735Accounts payable and Accrued Expenses12,781,345Other current liabilities197,258Capital leases199,182Long term liabilities795,950Total liabilities assumed13,973,735Net assets acquired$106,800,000


Note: During the three months ended April 30, 2011, an adjustment of $(11.3) million was recorded to adjust the net book value of property and equipment to fair value giving consideration to their highest and best use. Key assumptions used in the valuation of the Company’s property and equipment were based on a depreciated replacement cost approach.





Estimates of acquired intangible assets are as follows:


EstimatedFair ValueWeightedAverageEstimatedUseful Life (yrs)Customer Relationships$40,800,00010-12Internally developed software18,100,0008-10Non-competition agreements1,200,0005Goodwill31,712,226Non-amortizable





The excess of the purchase price over the preliminary net tangible assets and intangible assets was recorded as goodwill. The


preliminary allocation of the purchase price was based upon a valuation for which the estimates and assumptions are subject to change within the measurement period (up to one year from the acquisition date). The final allocation price could differ materially from the preliminary allocation. Any subsequent changes to the purchase price allocation that result in material changes to the Company’s consolidated financial results will be adjusted retrospectively.





The goodwill and intangible assets acquired in the Xpedite Business acquisition were all related to the On Demand business segment.  See Note 10, Segment Results, for additional information regarding the Company’s On Demand business segment.





Based on the evaluation to date, certain fixed assets, amounts for income taxes including deferred tax accounts and the final goodwill allocation are not yet finalized and are subject to change, which could be material. The Company will finalize the amounts recognized as it obtains the information necessary to complete its analysis during the measurement period.





Pro Forma Financial Information





The pro forma statements below are for the combined entities and demonstrate the statement of operations as if the transaction had occurred beginning after July 31, 2009.  The statements for the Xpedite Business are based on carve-out financial statements provided by PGI, and as such, reflect expenses incurred by PGI in order to support their management structure and include allocations deemed reasonable by PGI’s management.


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EASYLINK SERVICES INTERNATIONAL CORPORATION
 Notes to Condensed Consolidated Financial Statements
 (Unaudited)


2. ACQUISITION (Continued)





Pro Forma Consolidated Combined Statement of Operations


(in thousands, except per share amounts)





Three MonthsNine Months2011201020112010Service revenues, net$47,782$50,363$143,332$155,535Cost of services16,38813,72147,37644,791Gross profit31,39436,64295,956110,744Operating expenses:Product development and enhancement3,3383,7039,91810,504Selling and marketing6,7508,90022,19629,329General and administrative12,84113,66647,55858,162Acquisition and integration related——2,415—Total Operating expenses22,92926,26982,08797,995Operating income8,46510,37313,86912,749Other income (expense):Interest expense(1,651)(1,413)(4,576)(4,238)Other income (expense)163149503329Total Other income (expense)(1,488)(1,264)(4,073)(3,909)Income before income taxes6,9779,1099,7968,840Provision (Benefit) for income taxes2,6372,5512,7432,476Net Income4,3406,5587,0536,364Dividends on preferred stock—(209)(2,012)(642)Net income attributable to common stockholders$4,340$6,349$5,041$5,722Basic income per common share$0.14$0.22$0.17$0.21Diluted income per common share$0.13$0.21$0.16$0.19Weighted average number of common shares outstanding – basic30,18429,11029,62527,199Weighted average number of common shares outstanding –diluted32,29629,79331,35329,519





The pro forma statements reflect the results of operations for the Company for the three and nine months ended April 30, 2010 and the nine months ended April 30, 2011 , and the results of operations for the Xpedite Business for the three and nine months ended December 31, 2009 and the nine months ended April 30, 2011 .  The pro forma adjustments used to prepare the








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EASYLINK SERVICES INTERNATIONAL CORPORATION
 Notes to Condensed Consolidated Financial Statements
 (Unaudited)


2. ACQUISITION (Continued)





statements above, include the removal of intercompany interest between the Xpedite Business and PGI of $.1 million in the nine months ended April 30, 2011 . General and administrative expenses have been increased for the amortization expense associated with the fair value adjustment at October 21, 2010 of definite lived intangible assets, for a net adjustment of $1.5 million and $4.4 million in the three and nine months ended April 30, 2010 , respectively, and $1.5 million in the nine months ended April 30, 2011 . In addition, cost of services have been decreased for the depreciation expense associated with the fair value adjustment at October 21, 2010 of  fixed assets, for a net adjustment of $3.0 million and $9.6 million in the three and nine months ended April 30, 2010 , respectively, and $3.2 million in the nine months ended April 30, 2011 . Interest expense has been adjusted to reflect the 2010 Loans for a net increase of $1.1 million and $3.0 million in the three and nine months ended April 30, 2010 , respectively, and $.6 million in the nine months ended April 30, 2011 .





3. GOODWILL AND OTHER INTANGIBLE ASSETS





Intangible assets are summarized as follows:


Weightedaverageamortizationperiod (years)April 30, 2011July 31, 2010Purchased customer relationships6-12$59,731,961$17,853,802Internally developed systems4-1028,742,85810,516,331Non-Competition agreements51,200,000—Trade names<13,770,6583,733,670Intangible assets, gross93,445,47732,103,803Less accumulated amortization:Purchased customer relationships(11,087,688)(7,437,966)Internally developed systems(11,314,556)(8,640,564)Non-Competion agreements(126,460)—Trade names(177,778)(150,992)Accumulated amortization(22,706,482)(16,229,522)Intangible assets, net$70,738,995$15,874,281





Indefinite lived intangible assets not subject to amortization were $3,520,658 and $3,483,670 at April 30, 2011 and July 31, 2010 , respectively.





The Company estimates annual amortization expense for the next five fiscal years will approximate $9.0 million for fiscal year 2011 and $8.0 million thereafter.





The changes in the carrying amount of intangible assets for the nine month period ended April 30, 2011 is as follows:





Balance at July 31, 2010$15,874,281Purchases of customer relationships40,800,000Purchase of internally developed software18,100,000Purchase of non-competion agreements1,200,000Intangible amortization(6,640,140)Foreign currency effect1,404,854Balance at April 30, 2011$70,738,995





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EASYLINK SERVICES INTERNATIONAL CORPORATION
 Notes to Condensed Consolidated Financial Statements
 (Unaudited)


3. GOODWILL AND OTHER INTANGIBLE ASSETS (Continued)





The changes in the carrying amount of goodwill for the nine months ended April 30, 2011 is as follows:





Balance at July 31, 2010$34,454,935Acquisition of Xpedite Business31,712,226Foreign currency effect1,253,884Balance at April 30, 2011$67,421,045





4. DEBT





Long term debt and capital lease obligations at April 30, 2011 and July 31, 2010 are as follows:





April 30, 2011July 31, 2010Term Loan$105,875,000$25,416,667Revolving Line of Credit12,000,000—Capital Leases173,518—Subtotal118,048,51825,416,667Less current portion of capital leases88,128—Less debt discount1,830,550474,552Less current portion of long term debt31,978,35015,257,852Long term debt$84,151,490$9,684,263





The Company acquired the Xpedite Business for $106.8 million in cash.  The Company paid for the acquisition with $6.8 million of cash on hand and a new credit facility consisting of a $110.0 million term loan and a $20.0 million revolving loan, which also refinanced the Company’s existing credit facility indebtedness.  The 2010 Loans call for quarterly payments of approximately $4.1 million with interest and a final balloon payment in 2014, with interest, which commenced on January 31, 2011. See Note 2, Acquisition, for additional information regarding the Xpedite Business acquisition.


The debt discount consists of $2.2 million in bank fees incurred in connection with the issuance of the Term Loan. The discount is being amortized as an adjustment to the carrying value of principal with a corresponding charge to interest expense over the remaining life of the Term Loan. The fees are classified as a reduction to current and long-term liabilities within the accompanying Condensed Consolidated Balance Sheets (Unaudited) and are amortized as an adjustment to interest expense over the remaining life of the Term Loan.


The credit agreement (the "Credit Agreement") for the 2010 Loans contains usual and customary covenants for financings of this type, including,  among other things: (i) requirements to deliver financial statements, other reports and notices; (ii) restrictions on additional indebtedness; (iii) restrictions on dividends, distributions and redemptions of equity and repayment of subordinated indebtedness; (iv) restrictions on liens; (v) restrictions on making certain payments; (vi) restrictions on investments; (vii) restrictions on asset dispositions and other fundamental changes; and (viii) restrictions on transactions with affiliates.  In addition, 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; and (iv) a maximum amount of capital expenditures. Without the permission of the Lenders, our ability to complete material acquisitions will be restricted.  A default on any of these restrictions and covenants will cause, in certain circumstances, the amounts due under such agreements to become due and payable upon demand.


Borrowings under the Credit Agreement bear interest, at the Company’s election, at a rate tied to one of the following rates, in each case plus a specified margin: (i) the higher of (1) the Administrative Agent’s prime lending rate, (2) the U.S. Federal Funds Rate plus 0.5%, and (3) adjusted one-month LIBOR plus 1.0%; (ii) adjusted LIBOR for the interest period of such borrowing; and (iii) a LIBOR index rate. The interest margin for each such type of borrowing varies from 1.75% to 4.50%, depending on the Company’s consolidated leverage ratio at the time of such borrowing.  As of April 30, 2011 the interest rate was approximately 4.48%


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EASYLINK SERVICES INTERNATIONAL CORPORATION
 Notes to Condensed Consolidated Financial Statements
 (Unaudited)


4. DEBT (Continued)





At April 30, 2011 , the Company was in compliance with all covenants under the Credit Agreement.


On February 7, 2011, the Company entered into an interest rate swap (“Swap”) as required by the Credit Agreement for fifty percent (50%) of the then outstanding balance on the Term Loan, which amounted to $52.9 million. The Swap was fixed at an interest rate of 1.83% and was designated as a cash flow hedge with the changes in fair value of the Swap to be recorded in accumulated other comprehensive loss ("AOCI") and as a derivative hedge asset or liability, as applicable. The Swap is designed to always cover 50% of the then outstanding Term Loan balance and will be reduced in amount as the Term Loan is paid down, maturing in October 2014.  See Note 7, Derivative Financial Instruments, for additional information regarding the Swap.





5. STOCKHOLDERS’ EQUITY





Dividends





The holders of the outstanding shares of the Company’s series C preferred stock were entitled to receive a 4% per share annual cumulative dividend payable in cash or shares of common stock at our option.  Dividends accrue and are cumulative on a daily basis, whether or not earned or declared.  At July 31, 2010 , accrued dividends, for the series C preferred stock, of $.1 million, was included in accrued expenses on the Company’s balance sheet. Total liquidation preferences of the series C preferred stock was $5.1 million.





On January 20, 2011, the Company materially modified the rights of the Company’s series C preferred stock by filing a Certificate of Amendment (the “Series C Amendment”) to the Company’s Certificate of Incorporation relating to the Certificate of Powers, Designations, Preferences and Relative, Participating, Optional and Other Special Rights of the Series C Convertible Redeemable Preferred Stock, dated January 5, 2000.  The Series C Amendment modified the terms of the series C preferred stock by (i) adjusting the conversion price of the series C preferred stock from $22.34 to $7.14, and (ii) causing all of the outstanding shares of Series C Stock to be converted into shares of the Company’s class A common stock upon the filing of the Series C Amendment at the $7.14 conversion price, which resulted in the issuance of 700,000 shares of the Company’s class A common stock to the holder of the series C preferred stock.





Under generally accepted accounting principles in the U.S., the difference between the fair market value of the class A common stock the holder of the series C preferred stock would have received under the old conversion terms and the fair market value of the class A common stock actually received upon conversion under the new terms must be recorded as a dividend.  As a result, the Company recorded a one-time non-cash dividend of approximately $1.96 million upon conversion of the series C preferred shares into class A common stock.





6. OTHER COMPREHENSIVE INCOME





Comprehensive income and the components of other comprehensive income, net of tax, for the three and nine months ended April 30, 2011 and 2010 are as follows:





Three MonthsNine Months2011201020112010Net Income$4,339,638$1,989,060$8,245,818$4,660,611Other comprehensive income:Foreign currency translation2,695,084(1,010,256)3,036,205(2,008,222)Net unrealized gain (loss) on derivative instrument(777,813)—(777,813)—Tax impacts of changes in other comprehensive income balances278,865—278,865—Net change to derive comprehensive income for the period2,196,136(1,010,256)2,537,257(2,008,222)Comprehensive income$6,535,774$978,804$10,783,075$2,652,389





Net exchange gains or losses resulting from the translation of assets and liabilities of foreign subsidiaries are accumulated


10


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EASYLINK SERVICES INTERNATIONAL CORPORATION
 Notes to Condensed Consolidated Financial Statements
 (Unaudited)


6. OTHER COMPREHENSIVE INCOME (Continued)





in the AOCI section of Shareholders' equity. Also included are the effects of exchange rate changes on intercompany balances of a long-term nature and transactions related to the Swap. The changes in accumulated foreign currency translation for the


three and nine months ended April 30, 2011 and 2010 were primarily attributable to the impact of translation of the net assets of the Company's international operations, primarily denominated in Japanese yen, Pounds Sterling and Euros.





7. DERIVATIVE FINANCIAL INSTRUMENTS





The Swap is a derivative financial instrument used by the Company principally in the management of its interest rate. We determined that the Swap qualifies for cash flow hedge accounting treatment in accordance with ASC Topic 815 : Derivatives and Hedging (“ASC 815”). The Swap is the only derivative financial instrument that we have designated as a hedging instrument.  See Note 4, Debt, for additional information regarding the Swap.





When hedge accounting is elected at inception, the Company formally designates the financial instrument as a hedge of a specific underlying exposure if certain criteria are met, and documents both the risk management objectives and strategies for undertaking the hedge. The Company formally assesses both at the inception and at least quarterly thereafter, whether the financial instruments that are used in hedging transactions are effective at offsetting changes in the forecasted cash flows of the related underlying exposure. Because of the high degree of effectiveness between the hedging instrument and the underlying exposure being hedged, fluctuations in the value of the derivative instruments are generally offset by changes in the forecasted cash flows of the underlying exposures being hedged. For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative is reported as a component of AOCI and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings.  Any ineffective portion of a financial instrument’s change in fair value is immediately recognized in earnings.





At April 30, 2011, the outstanding Swap had a notional principal amount of $50.9 million.





The derivative net loss on this contract recorded in AOCI by the Company at April 30, 2011 was $.8 million, net of tax benefit of $.3 million.  At April 30, 2011, the portion of derivative net losses estimated to be reclassified from AOCI into earnings by the Company over the next 12 months is $.7 million, net of tax benefit of $.3 million.





The Company’s fair value of outstanding derivative contracts recorded as liabilities in the accompanying Condensed Consolidated Balance Sheets (Unaudited) were as follows:


Derivatives designated as hedging instruments under ASC 815:Balance Sheet LocationApril 30, 2011July 31, 2010Interest rate swapOther current liabilities$673,309$—Interest rate swapOther liabilities104,504—Total liabilities designated as hedging instruments under ASC 815$777,813$—





The following table summarizes the impact of derivative instruments on Interest expense in the accompanying Condensed Consolidated Statements of Operations (Unaudited) for the three and nine months ended April 30, 2011, pretax:


Derivatives designated as hedging instruments under ASC 815:Statement of Operations LocationAmount ofGain (Loss)Reclassified fromAOCI intoIncome(Effective Portion)Amount ofGain (Loss)Recognized inIncome onDerivatives(Ineffective Portion)Interest rate contractInterest expense$(192,015)$—





11


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EASYLINK SERVICES INTERNATIONAL CORPORATION
 Notes to Condensed Consolidated Financial Statements
 (Unaudited)


8. FAIR VALUE REPORTING





ASC Topic 820, Fair Value Measurements and Disclosures (“ASC 820”) requires 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. The valuation techniques required by ASC 820 are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect market assumptions made by the Company. These two types of inputs create the following fair value hierarchy:





|  |                                                                    
|- | -------------------------------------------------------------------
|• | 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.




The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis at April 30, 2011 :





Quoted Prices inActive Marketsfor IdenticalAssets/Liabilities(Level 1)SignificantOtherObservableInputs (Level 2)SignificantUnobservableInputs (Level 3)CarryingAmountAssets:Cash$27,849,745——$27,849,745Cash Equivalents77,902——77,902Total Assets$27,927,647$27,927,647Liabilities:Interest Rate Swap$—777,813—$777,813Notes Payable——106,916,556116,217,968Total Liabilities$—777,813106,916,556$116,995,781





The carrying amount of the notes payable contains a $1.8 million discount. The Company believes that the assets can be liquidated without restriction.





9. COMMITMENTS AND CONTINGENCIES





Litigation





From time to time, the Company 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, the Company does not believe that the outcome of any of these claims or any of the legal matters mentioned elsewhere in this Quarterly Report on Form 10-Q will have a material adverse effect on its consolidated financial position, results of operations or cash flow.





j2 - In June 2008, j2 Global Communications, Inc. (“j2”) brought a patent infringement lawsuit against the Company, alleging that the Company infringes upon three of j2's patents, U.S. Patent Nos. 6,597,688, 7,020,132 and 6,208,638.  The case is pending in the U.S. District Court for the Central District of California and is currently in the discovery phase. The Company has denied infringing any of the j2 patents and has filed a counterclaim seeking a declaratory judgment that the j2 patents are invalid.  Discovery in the matter is ongoing.  The case is currently scheduled for trial in August 2011, though it is anticipated the trial date will be rescheduled to a later date.





In March 2011, the Company filed a patent infringement lawsuit against j2. The suit, filed in the U.S. District Court for the Northern District of Georgia, alleges that j2 infringes U.S. Patent No. 5,872,640 entitled "Facsimile Form Generation System"


12


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EASYLINK SERVICES INTERNATIONAL CORPORATION
 Notes to Condensed Consolidated Financial Statements
 (Unaudited)


9. COMMITMENTS AND CONTINGENCIES (Continued)





and U.S. Patent No. 7,804,823 entitled "Systems and Methods for Communicating Documents Via an Autonomous Multi-Function Peripheral Device." The Company is seeking monetary damages for past infringement, and injunctive relief prohibiting j2 from continuing to infringe the patents, among other remedies.


In May 2011, after a motion was made by j2 and denied by the Court in the above mentioned lawsuit to add an additional infringement claim for U.S. Patent No. 6,350,066 against the Company, Advanced Messaging Technologies Inc. (“ATS”), which is a wholly-owned subsidiary of j2, brought a new patent infringement lawsuit against the Company in U.S. District Court, Central District of California alleging that the Company infringed U.S. Patent No. 6,350,066.  ATS seeks an injunction, royalties and damages.


Dalal - In connection with the termination of an agreement to sell the portal operations of the Company's discontinued India.com business, one of its subsidiaries was party to litigation (India.com v. Dalal). After numerous appeals, the U.S. Appeals Court for the Second Circuit affirmed the earlier decision of the U.S. District Court for the Southern District of New York.  On May 9, 2011, the Company deposited $1.5 million into the court registry of the U.S. District Court Southern District of New York to satisfy the judgment, interest and costs awarded.





New York state sales tax - As a result of a New York state sales tax audit completed in 2005 of EasyLink Services International, Inc., a dissolved subsidiary of EasyLink Services Corporation, EasyLink Services International, Inc. was assessed approximately $.5 million in tax, interest, and penalties on sales for the sales tax period beginning March 1, 2001 and ending May 31, 2004.  EasyLink Services International, Inc. appealed the assessment administratively to the New York Division of Tax Appeals, which resulted in an opinion in 2008 in favor of EasyLink Services International, Inc.  In late July 2009, after appeal by the New York Department of Taxation and Finance, the decision was reversed by the administrative New York Tax Appeals Tribunal and remanded back to the administrative law judge to determine allocation and penalty issues.  On remand, the Administrative Law Judge upheld the Tax Department's position on the allocation issues but agreed with EasyLink on the penalty issues and cancelled all penalties.  The administrative proceeding is now closed and EasyLink is pursuing a judicial appeal of the July 2009 decision of the Tax Appeals Tribunal.





Retarus, Inc. - In June 2011, the Company and its subsidiary Xpedite Systems LLC filed a lawsuit in the Supreme Court of the State of New York, County of New York, against Retarus, Inc., Donna Tomasino, Francis Toscano and Timothy Valentine asserting claims against Retarus, Inc. for unfair competition, tortious interference with contract, aiding and abetting a breach of duty of loyalty and trust and unjust enrichment, and requesting damages against  Retarus, Inc. and injunctive relief against Retarus, Inc., Donna Tomasino, Francis Toscano and Timothy Valentine.





The outcome of litigation cannot be assured, and despite management's views of the merits of any litigation, or the reasonableness of its estimates and reserves, its cash balances could nonetheless be materially affected by an adverse judgment.  In accordance with ASC Topic 450, Contingencies , the Company believes it has adequately reserved for the contingencies arising from the above legal matters where an outcome was deemed to be reasonably 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.





10. SEGMENT RESULTS





The Company manages its operations in two business segments, which are defined as follows:





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




|  |                                                                                                                                
|- | -------------------------------------------------------------------------------------------------------------------------------
|• | Supply Chain Messaging Segment (“Supply Chain”), which includes all our electronic data interchange (“EDI”) and telex services.

13


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EASYLINK SERVICES INTERNATIONAL CORPORATION
 Notes to Condensed Consolidated Financial Statements
 (Unaudited)


10. SEGMENT RESULTS (Continued)





Segment information for the three and nine months ended April 30, 2011 and 2010 follows:





Three MonthsNine Months2011201020112010Revenue from external customersOn Demand$38,455,526$10,435,770$89,343,978$30,528,698Supply Chain9,326,31810,157,24528,598,28730,966,393Total Service revenues, net$47,781,844$20,593,015$117,942,265$61,495,091











The following is a reconciliation of operating segment income to net income for the three and nine months ended April 30, 2011 and 2010:


Three MonthsNine Months2011201020112010Operating segment incomeOn Demand$24,302,306$7,491,662$56,063,321$21,208,136Supply Chain7,091,5697,592,20021,405,88223,014,383Segment gross profit31,393,87515,083,86277,469,20344,222,519Corporate expenses22,929,07011,735,65060,560,68535,717,637Operating income8,464,8053,348,21216,908,5188,504,882Other income (expense), net(1,488,064)(46,262)(3,565,020)(737,198)Income before income taxes6,976,7413,301,95013,343,4987,767,684Provision for income taxes2,637,1031,312,8905,097,6803,107,073Net income$4,339,638$1,989,060$8,245,818$4,660,611





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





Forward Looking Statement Disclaimer





All statements other than statements of historical facts included in this Quarterly Report on Form 10-Q regarding 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 on Form 10-Q, the words “anticipate,” “believe,” “estimate,” “expect,” “may,” “will,” “hope,” “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 on Form 10-Q under the heading “Risk Factors” and in our registration statements and periodic reports filed with the SEC under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Securities Act of 1933, as amended (the “Securities Act”).





Although we believe that 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 on Form 10-Q as anticipated, believed, estimated, expected, hoped or intended.





Business Overview





We are a leading provider of a comprehensive suite of communication applications that enable enterprises of all sizes to communicate securely and profitably with their customers, trading partners and other third parties. We deliver our cloud based applications-as-a-service through a proprietary business integration network ("BIN") comprised of enterprise-class platforms located in worldwide redundant and highly secure network operations centers.


Our applications include electronic fax services, electronic data interchange (“EDI”) services, multimodal notification services and other communication services that are integral to the movement of money, materials, products, people and information in the global economy including documents such as insurance claims, trade and travel confirmations, purchase orders, invoices, shipping notices and funds transfers that help our customers to be more efficient and mobile. Our BIN provides our customers with scalable on-demand cloud based delivery services that are 100% outsourced, which can be accessed globally and are monitored 24 by 7.





Our operations are tracked in two business segments defined as follows:





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




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




In order to strengthen and broaden our product offerings and capture market share, we acquired the Xpedite Business from PGI.   Beginning from the October 21, 2010 acquisition date, the operating results of the Xpedite Business are included in the financial results of the Company.   The addition of the Xpedite Business has significantly increased the revenue in our On Demand segment and affected our gross margins with related impacts on the cost of revenue and other expense items with in our results of operations as compared to prior periods.  The integration of the Xpedite Business and the servicing of the acquisition debt will be important drivers of our financial results in future reporting periods.


Approximately 44% and 41% of our services revenue for the three and nine months ended April 30, 2011 , respectively, were from customers outside of the U.S. compared to 25% for the three and nine months ended April 30, 2010 , respectively. The significant increase in international services revenue was due to the acquisition of the Xpedite Business.  Accordingly, our services revenue can fluctuate based on the performance of non-U.S. economies and significant changes in the value of the U.S. dollar in relation to foreign currencies.  Our On Demand international operations are primarily denominated in Japanese Yen, Euros, Pounds Sterling and Australian Dollar.


We have grown our business significantly through acquisitions in recent years. We continue to seek to reap the benefits of those acquisitions through the integration and consolidation of operations and the cross-selling of services across the combined customer base. The current economic climate may provide additional opportunities for consolidative or synergistic acquisitions.











15


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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 generally accepted accounting principles in the United States of America (“GAAP”) and fairly present our financial position and results of operations. 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 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, 2010 . There have been no significant changes in our critical accounting policies since July 31, 2010 .





16


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Fiscal 2011 Quarter Compared to the Fiscal 2010 Quarter





Results of Operations





In this Quarterly Report on Form 10-Q we refer to the three months ended April 30, 2011 as the “Fiscal 2011 Quarter” and the three months ended April 30, 2010 as the “Fiscal 2010 Quarter.”





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





Fiscal Quarter20112010VarianceService revenues, net:On DemandFax Services$28,357,547$8,680,228$19,677,319DCM Services461,383482,546(21,163)Production Email5,110,5261,117,9643,992,562Notification2,791,669—2,791,669Other Services1,734,401155,0321,579,369Total On Demand38,455,52610,435,77028,019,756Supply ChainEDI Services7,808,5758,215,485(406,910)Telex Services1,517,7431,941,760(424,017)Total Supply Chain9,326,31810,157,245(830,927)Total Service revenues, net:47,781,84420,593,01527,188,829Cost of services:On Demand14,153,2202,944,10811,209,112Supply Chain2,234,7492,565,045(330,296)Total Cost of services16,387,9695,509,15310,878,816Gross profit:On Demand24,302,3067,491,66216,810,644Supply Chain7,091,5697,592,200(500,631)Total Gross profit31,393,87515,083,86216,310,013Product development and enhancement3,337,8071,884,2101,453,597Selling and marketing6,749,7843,086,8713,662,913General and administrative12,841,4796,764,5696,076,910Acquisition and integration related———Total Operating expenses22,929,07011,735,65011,193,420Other expense(1,488,064)(46,262)(1,441,802)Income before income taxes$6,976,741$3,301,950$3,674,791








17


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Fiscal 2011 Quarter Highlights





|  |                                                                                                                                           
|- | ------------------------------------------------------------------------------------------------------------------------------------------
|• | Fiscal 2011 third quarter revenue growth of $.4 million when compared to Fiscal 2011 second quarter, driven by On Demand service revenues.




|  |                                                                                                                                                                               
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Service revenue increased $27.2 million, or 132% in Fiscal 2011 Quarter when compared to Fiscal 2010 Quarter, mainly driven by the impact of the Xpedite Business acquisition.




Service revenues, net — Total revenue for the Fiscal 2011 Quarter was $47.8 million , an increase of $27.2 million or 132.0% as compared to the Fiscal 2010 Quarter. The Xpedite Business accounted for a revenue increase of $28.1 million in the On Demand business segment during the Fiscal 2011 Quarter. Foreign currency exchange translation increased revenue in the Fiscal 2011 Quarter by approximately $.2 million.  Supply Chain revenue decreased 0.8 million , or 8.2% , from the Fiscal 2010 Quarter, as compared to the Fiscal 2011 Quarter, due to decreases in EDI and Telex services driven by pricing renegotiations coupled with lost customer accounts.  However, during the past two quarters we have seen increased volumes from our current customer base within certain applications and believe these trends may continue.  As mentioned above, the Xpedite Business contributed $28.1 million of revenue, which is the main driver for the On Demand revenue increase of $28.0 million , or 268.5% , from the Fiscal 2010 Quarter, as compared to the Fiscal 2011 Quarter.


Gross Profit — Gross profit increased $16.3 million , or 108.1% from the Fiscal 2010 Quarter, as compared to the Fiscal 2011 Quarter.  The Xpedite Business contributed $17.6 million in gross profit during the Fiscal  2011 Quarter.  Gross margin for the Fiscal 2011 Quarter decreased to 65.7% from 73.2% in the Fiscal 2011 Quarter.  The decrease of gross margin as a percentage was mainly driven by the change in revenue mix. The On Demand services have grown to 81% of total revenue in the Fiscal 2011 Quarter from 51% in the Fiscal 2010 Quarter. The On Demand services have a higher cost of delivery driven by the telecommunication expenses for fax services. Total cost of services increased $10.9 million , or 197.5% , due to the cost of delivery for the Xpedite Business along with increases in outside professional services and facility related expenses, which were mitigated by reductions in telecom expense and depreciation expense.  In addition, during the Fiscal 2011 Quarter we recorded a reduction of $.4 million to cost of services related to the adjustment of the net book value of property and equipment associated with the Xpedite Business to fair value, based on the acquisition date of October 21, 2010.   See Note 2, Acquisitions on this Form 10-Q for additional information on the adjustment to property and equipment. Foreign currency exchange translation decreased gross profit in the Fiscal 2011 Quarter by approximately $.1 million.


Operating Expenses — Operating expenses for the Fiscal 2011 Quarter totaled $22.9 million versus $11.7 million for the Fiscal 2010 Quarter representing an increase of $11.2 million, or 98.5%. The increase in operating expenses during the Fiscal 2011 Quarter is primarily attributable to the acquisition of the Xpedite Business, which contributed $11.0  million, or 48.1% of operating expenses in the Fiscal 2011 Quarter. As a percentage of total product development and enhancement, selling and marketing and general and administrative expenses, the Xpedite Business contributed 47%, 59% and 43%, respectively.


In the Fiscal 2011 Quarter we recognized approximately $.3 million in savings of employee related expense and third party agent fees associated with our previously announced cost reduction initiatives, which were slightly tempered by increased costs related to the transition service agreement entered into in connection with the purchase of the Xpedite Business coupled with higher stock compensation costs incurred in the Fiscal 2011 Quarter .


In addition, during the Fiscal 2011 Quarter we recorded a decrease of $.7 million to operating expenses related to the adjustment of the net book value of property and equipment associated with the Xpedite Business to fair value, based on the acquisition date of October 21, 2010.   See Note 2, Acquisitions on this Form 10-Q for additional information on the adjustment to property and equipment.


Other Expense — Other expenses for the Fiscal 2011 Quarter consist mainly of net interest expense of approximately $1.7 million, which included $1.3 million in net cash interest expense, $0.2 million in interest expense from the amortization of the discount on the Term Loan and $0.2 million in interest expense associated with the Swap we entered during the Fiscal 2011 Quarter. See Liquidity and Capital Resources for additional information regarding the Swap.   Interest expenses for the Fiscal 2011 Quarter increased $1.2 million from the Fiscal 2010 Quarter, due to the 2010 Loans, entered into in our first fiscal quarter of Fiscal 2011.




















18


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Nine Months Ended April 30, 2011 Compared to the Nine Months Ended April 30, 2010


Results of Operations





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





Nine Months20112010VarianceService revenues, net:On DemandFax Services$66,650,756$24,885,631$41,765,125DCM Services1,427,8611,519,114(91,253)Production Email11,392,4763,491,4427,901,034Notification6,098,769—6,098,769Other Services3,774,116632,5113,141,605Total On Demand89,343,97830,528,69858,815,280Supply ChainEDI Services23,845,98324,846,669(1,000,686)Telex Services4,752,3046,119,724(1,367,420)Total Supply Chain28,598,28730,966,393(2,368,106)Total Service revenues, net:117,942,26561,495,09156,447,174Cost of services:On Demand33,280,6579,320,56223,960,095Supply Chain7,192,4057,952,010(759,605)Total Cost of services40,473,06217,272,57223,200,490Gross profit:On Demand56,063,32121,208,13634,855,185Supply Chain21,405,88223,014,383(1,608,501)Total Gross profit77,469,20344,222,51933,246,684Product development and enhancement8,833,3875,499,5763,333,811Selling and marketing16,483,0009,584,4686,898,532General and administrative32,829,38420,633,59312,195,791Acquisition and integration related2,414,914—2,414,914Total Operating expenses60,560,68535,717,63724,843,048Other expense(3,565,020)(737,198)(2,827,822)Income before income taxes$13,343,498$7,767,684$5,575,814








Services revenue, net — Total revenue for the nine months ended April 30, 2011 was $117.9 million , an increase of $56.4 million or 91.8% as compared to the nine months ended April 30, 2010 . The Xpedite Business accounted for a revenue increase of $59.0 million in the On Demand business segment during the nine months ended April 30, 2011 . This increase in revenues was offset by a decrease of Supply Chain revenue of $2.4 million or 7.6% . Foreign currency exchange translation slightly decreased


19


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revenue in the nine months ended April 30, 2011 by $0.1million.


During the Fiscal 2011 Quarter, we saw a trend in the growth of existing On Demand customer revenues that combined with new business revenues exceeded the marginal decline in certain of our other applications such as telex.  We are hopeful that the increased activity is an accurate indicator of future performance.





Gross Profit — Gross profit increased $33.2 million , or 75.2% from the nine months ended April 30, 2010 , as compared to the nine months ended April 30, 2011 .  The Xpedite Business contributed approximately $35.4 million, or 45.7%, in the On Demand segment for the nine months ended April, 30, 2011.  Gross margin as a percentage for the nine months ended April 30, 2011 decreased to 65.7% from 71.9% for the nine months ended April 30, 2010 .  The decrease in gross margin is mainly driven by the change in product mix for the On Demand services, which have a higher cost of delivery driven by the telecommunication expenses required for fax services.  The Xpedite Business contributed approximately $24.1 million in additional On Demand cost of services for the nine months ended April 30, 2011.





Operating Expenses — Operating expenses for the nine months ended April 30, 2011 totaled $60.6 million versus $35.7 million for the nine months ended April 30, 2010 representing an increase of $24.8 million , or 69.6%. The increase in operating expenses during the nine months ended April 30, 2011 is primarily attributable to the acquisition of the Xpedite Business, which contributed $24.0 million of operating expenses in the nine months ended April 30, 2011. In addition, we incurred $2.4 million of acquisition and integration related charges directly related to the acquisition during the nine months ended April 30, 2011. Acquisition and integration related charges include professional fees, termination and related costs for transitional and certain other employees, integration related professional fees and other post business combination related expenses associated with the Xpedite Business.


As mentioned in the Fiscal 2011 Quarter, we continue to recognize savings associated with our previously announced cost reduction initiatives; during the nine months ended April 30, 2011 we recognized approximately $1.6 million in savings related to employee expenses and third party agent fees.  These decreases were slightly tempered by increased costs related to the transition service agreement entered into in connection with the purchase of the Xpedite Business coupled with higher stock compensation costs incurred in the nine months ended April 30, 2011.





Other Expense — Other expenses for the nine months ended April 30, 2011 consist mainly of net interest expense of approximately $4.1 million, which included $3.1 million in net cash interest expense, $.8 million in interest expense from the amortization of the discount on the Term Loan and $0.2 million in interest expense associated with the Swap we entered during the Fiscal 2011 Quarter. See Liquidity and Capital Resources for additional information regarding the Swap.  Interest expense for the nine months ended April 30, 2011 increased $2.8 million from the nine months ended April 30, 2010, due to the 2010 Loans, entered into in our first fiscal quarter of Fiscal 2011.





Liquidity and Capital Resources





Our principal source of liquidity consists of cash generated from operations.  Cash and cash equivalents increased approximately $7.5 million to a total balance of $27.9 million as of April 30, 2011 from $20.5 million as of July 31, 2010 .    Our net cash provided by operating activities for the nine months ended April 30, 2011 increased $5.6 million or 42.5%  as compared to the nine months ended April 30, 2010 .  The most significant contributor to the increase in our net cash provided by operating activities is an increase of $3.6 million in our net income, which is primarily attributable to the inclusion of the Xpedite Business from October 21, 2010.  As the majority of our revenue is recurring under contract, it is primarily affected by the volumes incurred by the customer using the underlying messaging application. Operating expenses are primarily driven by labor and telecom costs which are directly tied to customer utilization of messaging services.


Our liquidity will be affected by our current credit facility consisting of a $110.0 million term loan and a $20.0 million revolving loan.  The 2010 Loans call for quarterly payments of $4.1 million with interest and a final balloon payment in 2014, with interest.  At April 30, 2011 there was $12.0 million outstanding on the revolving loan and $105.9 million outstanding on the Term Loan. Under the terms of the Credit Agreement, we made our quarterly payment of $4.1 million along with interest due on May 2, 2011.  Subsequent to April 30, 2011, we also made payments in the amount of $4.0 million on the revolving loan. At June 8, 2011 there was $8.0 million outstanding on the revolving loan and $101.8 million outstanding on the Term Loan.


The Credit Agreement contains usual and customary covenants for financings of this type, including, among other things: (i) requirements to deliver financial statements, other reports and notices; (ii) restrictions on additional indebtedness; (iii) restrictions on dividends, distributions and redemptions of equity and repayment of subordinated indebtedness; (iv) restrictions on liens; (v) restrictions on making certain payments; (vi) restrictions on investments; (vii) restrictions on asset dispositions and other fundamental changes; and (viii) restrictions on transactions with affiliates.  In addition, the Credit Agreement contains certain financial covenants, including, among other things: (i) a maximum leverage ratio; (ii) a minimum fixed charge coverage ratio;


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(iii) a minimum amount of consolidated adjusted EBITDA;  and (iv) a maximum amount of capital expenditures. Without the permission of the Lenders, our ability to complete material acquisitions will be restricted.  A default on any of these restrictions and covenants will cause, in certain circumstances, the amounts due under such agreements to become due and payable upon demand.


Borrowings under the Credit Agreement bear interest, at the Company’s election, at a rate tied to one of the following rates, in each case plus a specified margin: (i) the higher of (1) the Administrative Agent’s prime lending rate, (2) the U.S. Federal Funds Rate plus 0.5%, and (3) adjusted one-month LIBOR plus 1.0%; (ii) adjusted LIBOR for the interest period of such borrowing; and (iii) a LIBOR index rate. The interest margin for each such type of borrowing varies from 1.75% to 4.50%, depending on the Company’s consolidated leverage ratio at the time of such borrowing.  At April 30, 2011, we were in compliance with all covenants under the Credit Agreement.


On February 7, 2011, we entered into the Swap as required by the Credit Agreement for fifty percent (50%) of the then outstanding balance on the Term Loan, which amounted to $52.9 million. The Swap was fixed at an interest rate of 1.83% and was designated as a cash flow hedge with the changes in fair value of the Swap to be recorded in accumulated other comprehensive loss and as a derivative hedge asset or liability, as applicable. The Swap is designed to always cover 50% of the then outstanding Term Loan balance and will be reduced in amount as the Term Loan is paid down, maturing in October 2014.


An adjustment to the purchase price of the Xpedite Business has been made based on the working capital of the acquired business at the acquisition date as defined in the Security and Asset Purchase Agreement dated October 21, 2010 entered into in connection with the acquisition of the Xpedite Business.  During the nine month period ended April 30, 2011 we agreed with PGI to a working capital adjustment of $1.8 million.  We made a payment to PGI on February 16, 2011 in the amount of $1.8 million.


Our accounts receivable increased approximately $20.8 million in the nine months ended April 30, 2011 due to the acquisition of the Xpedite Business.  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 companies.





Item 4. Controls and Procedures





Disclosure Controls and Procedures





Our management has established and maintained disclosure controls and procedures as defined in Exchange Act Rules  13a-15(e) and 15d-15(e) that are designed to provide reasonable assurance that information required to be disclosed in the reports that are filed or submitted under the Exchange Act is recorded, processed, summarized, reported and is accumulated and communicated to our Chief Executive Officer and Chief Financial Officer, as appropriate, by others within the entity to allow timely decisions regarding required disclosure.  Our management, including the Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the disclosure controls and procedures and, based on this evaluation, has concluded that disclosure controls and procedures were effective at a reasonable assurance level as of the end of the period covered by the report.  We continually review the respective disclosure controls and procedures and make changes, as necessary, to ensure the quality of our financial reporting.





Internal Controls over Financial Reporting





There have been no changes in internal control over financial reporting that occurred during the third quarter of fiscal year 2011 that have materially affected, or are reasonably likely to materially affect, our 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 on Form 10-Q will have a material adverse effect on our consolidated financial position, results of operations or cash flow.





j2 - In June 2008, j2 Global Communications, Inc. (“j2”) brought a patent infringement lawsuit against us, alleging that we infringed upon three of j2's patents, U.S. Patent Nos. 6,597,688, 7,020,132 and 6,208,638.  The case is pending in the U.S. District Court for the Central District of California and is currently in the discovery phase. We have denied infringing any of the j2 patents and have filed a counterclaim seeking a declaratory judgment that the j2 patents are invalid.  Discovery in the matter is ongoing.  The case is currently scheduled for trial in August 2011, though it is anticipated the trial date will be rescheduled to a later date.





In March 2011, we filed a patent infringement lawsuit against j2. The suit, filed in the U.S. District Court for the Northern District of Georgia, alleges that j2 infringes U.S. Patent No. 5,872,640 entitled "Facsimile Form Generation System" and U.S. Patent No. 7,804,823 entitled "Systems and Methods for Communicating Documents Via an Autonomous Multi-Function Peripheral Device." We are seeking monetary damages for past infringement, and injunctive relief prohibiting j2 from continuing to infringe the patents, among other remedies.





In May 2011, after a motion was made by j2 and denied by the Court in the above mentioned lawsuit to add an additional infringement claim for U.S. Patent No. 6,350,066 against us, Advanced Messaging Technologies Inc. (“ATS”), which is a wholly-owned subsidiary of j2, brought a new patent infringement lawsuit against us in U.S. District Court, Central District of California alleging that the Company infringed U.S. Patent No. 6,350,066.  ATS seeks an injunction, royalties and damages.





Dalal - In connection with the termination of an agreement to sell the portal operations of our discontinued India.com business, one of our subsidiaries was party to litigation (India.com v. Dalal). After numerous appeals, the U.S. Appeals Court for the Second Circuit affirmed the earlier decision of the U.S. District Court for the Southern District of New York.  On May 9, 2011, we deposited $1.5 million into the court registry of the U.S. District Court Southern District of New York to satisfy the judgment, interest and costs awarded.





New York state sales tax - As a result of a New York state sales tax audit completed in 2005 of EasyLink Services International, Inc., a dissolved subsidiary of EasyLink Services Corporation, EasyLink Services International, Inc. was assessed approximately $.5 million in tax, interest, and penalties on sales for the sales tax period beginning March 1, 2001 and ending May 31, 2004.  EasyLink Services International, Inc. appealed the assessment administratively to the New York Division of Tax Appeals, which resulted in an opinion in 2008 in favor of EasyLink Services International, Inc.  In late July 2009, after appeal by the New York Department of Taxation and Finance, the decision was reversed by the administrative New York Tax Appeals Tribunal and remanded back to the administrative law judge to determine allocation and penalty issues.  On remand, the Administrative Law Judge upheld the Tax Department's position on the allocation issues but agreed with EasyLink on the penalty issues and cancelled all penalties.  The administrative proceeding is now closed and EasyLink is pursuing a judicial appeal of the July 2009 decision of the Tax Appeals Tribunal.





Retarus, Inc. - In June 2011, we and our subsidiary Xpedite Systems LLC filed a lawsuit in the Supreme Court of the State of New York, County of New York, against Retarus, Inc., Donna Tomasino, Francis Toscano and Timothy Valentine asserting claims against Retarus, Inc. for unfair competition, tortious interference with contract, aiding and abetting a breach of duty of loyalty and trust and unjust enrichment, and requesting damages against  Retarus, Inc. and injunctive relief against Retarus, Inc., Donna Tomasino, Francis Toscano and Timothy Valentine.





The outcome of litigation cannot be assured, and despite management’s views of the merits of any litigation, or the reasonableness of its estimates and reserves, its cash balances could nonetheless be materially affected by an adverse judgment.  In accordance with ASC 450, Contingencies , we believe we have adequately reserved for the contingencies arising from the above legal matters where an outcome was deemed to be reasonably 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.





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Item 1A. Risk Factors





The following Risk Factor disclosure updates the risk factors as disclosed in our 2010 Annual Report on Form 10-K previously filed with the SEC.





Revenue from Japan was 18% of the total revenue for the On Demand segment and 15% of total consolidated revenue for the third quarter ended April 30, 2011 . The March 11, 2011 Japanese earthquake and resulting tsunami may affect future Japanese revenue.





Our Japanese operations are located in Tokyo and as of the date of this filing all of our Japanese employees are reported safe and our office and network are operational. However, there can be no assurances that future operations and revenue may not be seriously affected by, among other things, the rolling electrical black outs and  industry wide shutdowns now occurring in Japan as well as the potential of a nuclear reactor disaster occurring at a power plant within one hundred and seventy miles of our Tokyo offices. These occurring or potential events may seriously damage our ability to conduct business in Japan or, in the worst case, cause operations to completely cease, causing a material decrease in our Japanese revenue.





For additional risk factors see those disclosed in our Annual Report on Form 10-K for the year ended July 31, 2010 previously filed with the SEC.





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





None.





Item 3. Defaults Upon Senior Securities





None.





Item 4. [Removed and Reserved]





Item 5. Other Information





None.





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Item 6. Exhibits ExhibitNumberDescription31.1Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2Certification 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.





Da te: June 9, 2011





EASYLINK SERVICES INTERNATIONALCORPORATIONBy:/s/ Glen E. ShipleyGlen E. ShipleyChief Financial Officer


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EXHIBIT INDEX





ExhibitNumberDescription31.1Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


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