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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Form 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
--- EXCHANGE ACT OF 1934
For the quarter ended June 30,1999 or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
___ EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number 333-77455
TALK CITY, INC.
(Exact name of Registrant as specified in its charter)
Delaware 77-0426524
------------------------------- -------------------------------
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
307 Orchard City Drive, Suite 350
Campbell, California 95008
--------------------------------- -------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (408) 871-5200
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
--- ---
The number of shares of the Registrant's Common Stock, $.001 par value,
outstanding at September 2, 1999 was 24,328,302.
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<PAGE>
TALK CITY, INC.
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PAGE NUMBER
-----------
PART I. FINANCIAL INFORMATION
Item 1. Condensed Financial Statements:
<S> <C> <C>
Unaudited Condensed Balance Sheets at June 30, 1999
and December 31, 1998 3
Unaudited Condensed Statements of Operations for the three
months ended and six months ended June 30, 1999 and 1998 4
Unaudited Condensed Statements of Cash Flows for the six
months ended June 30, 1999 and 1998 5
Notes to Unaudited Condensed Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures about Market Risk 25
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 26
Item 4. Submission of Matters to a Vote of Security Holders 27
Item 6. Exhibits and Reports on Form 8-K 28
Signatures 29
</TABLE>
2
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Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
TALK CITY, INC.
UNAUDITED CONDENSED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
----------------- -----------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 7,529 $ 8,697
Short term investments 13,709 5,740
Accounts receivable, net 2,030 763
Prepaid expenses and other current assets 1,133 -
----------------- -----------------
Total current assets 24,401 15,200
Property and equipment, net 2,209 999
Other assets 6,194 2,291
----------------- -----------------
Total assets $ 32,804 $ 18,490
================= =================
Liabilities and Stockholders' Deficit
Current liabilities:
Accounts payable $ 2,350 $ 1,205
Accrued liabilities 1,600 320
Deferred revenue 405 55
Notes payable, current portion 139 127
----------------- -----------------
Total current liabilities 4,494 1,707
Notes payable, less current portion 188 273
----------------- -----------------
Total liabilities 4,682 1,980
Redeemable convertible preferred stock 71,366 38,973
Stockholders' deficit:
Common stock 4 4
Additional paid-in-capital 3,895 1,792
Deferred compensation (965) (598)
Notes receivable from stockholders (920) (303)
Accumulated deficit (45,258) (23,358)
----------------- -----------------
Total stockholders' deficit (43,244) (22,463)
----------------- -----------------
Total liabilities and stockholders' deficit $ 32,804 $ 18,490
================= =================
</TABLE>
See accompanying notes to the condensed financial statements.
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TALK CITY, INC.
UNAUDITED CONDENSED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
----------------------------------- -----------------------------------
June 30, June 30, June 30, June 30,
1999 1998 1999 1998
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Revenues:
Business services $ 410 $ 66 $ 767 $ 126
Advertising and sponsorships 990 202 1,613 267
--------------- --------------- --------------- ---------------
Total revenues 1,400 268 2,380 393
Operating expenses:
Product development and programming 3,379 1,298 5,603 2,473
Sales and marketing 4,263 697 7,688 1,173
General and administrative 1,137 338 2,111 674
Noncash advertising and promotional charges 7,921 118 9,331 1,157
--------------- --------------- --------------- ---------------
Total operating expenses 16,700 2,451 24,733 5,477
--------------- --------------- --------------- ---------------
Loss from operations (15,300) (2,183) (22,353) (5,084)
Interest income (expense), net 300 (251) 454 (241)
--------------- --------------- --------------- ---------------
Net loss (15,000) (2,434) (21,899) (5,325)
Accretion of dicount related to redeemable
convertible preferred stock and warrants 71 20 143 40
--------------- --------------- --------------- ---------------
Net loss applicable to common stockholders $(15,071) $(2,454) $(22,042) $(5,365)
=============== =============== =============== ===============
Basic and diluted net loss per common share $(4.00) $ (0.72) $ (5.93) $ (1.59)
=============== =============== =============== ===============
Weighted average basic and diluted common shares
outstanding 3,766 3,417 3,714 3,375
=============== =============== =============== ===============
</TABLE>
See accompanying notes to the condensed financial statements.
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TALK CITY, INC.
UNAUDITED CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Six Months Ended
-----------------------------------------
June 30, June 30,
1999 1998
----------------- -----------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(21,899) $(5,325)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 380 145
Stock compensation expense 348 116
Common stock warrants issued pursuant to loan financing - 236
Noncash advertising and promotional charges 9,331 1,157
Changes in operating assets and liabilities:
Accounts receivable (1,267) (203)
Prepaid expenses and other current assets (1,133) (18)
Other assets (49) (2)
Accounts payable 1,145 108
Accrued liabilities 1,280 5
Deferred revenue 350 70
----------- ----------
Net cash used in operating activities (11,514) (3,711)
----------- ----------
Cash flows from investing activities:
Purchases of property and equipment (1,590) (232)
Purchases of short-term investments (9,769) -
Proceeds from sale of short-term investments 1,800 -
----------- ----------
Net cash used in investing activities (9,559) (232)
----------- ----------
Cash flows from financing activities:
Proceeds from sale of redeemable preferred stock, net of issuance costs 19,956 -
Proceeds from loan financing, net of issuance costs - 1,827
Proceeds from stock option and warrant exercises 22 -
Proceeds from notes payable - 491
Repayment of notes payable (73) (29)
----------- ----------
Net cash provided by financing activities 19,905 2,289
----------- ----------
Net decrease in cash and cash equivalents (1,168) (1,654)
Cash and cash equivalents at beginning of period 8,697 2,055
----------- ----------
Cash and cash equivalents at end of period $ 7,529 $ 401
=========== ==========
Cash paid during the period for interest $ 44 $ 8
=========== ==========
Supplemental disclosure of noncash financing activities:
Accretion of redeemable convertible preferred stock and warrants $ 144 $ 40
=========== ==========
Common stock issued for notes receivable $ 618 $ 125
=========== ==========
Issuance of stock and warrants for advertising and promotional
services $ 12,269 $ 1,944
=========== ==========
Deferred compensation related to option grants $ 715 $ 407
=========== ==========
</TABLE>
See accompanying notes to the condensed financial statements.
5
<PAGE>
TALK CITY, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The condensed financial statements have been prepared by Talk City, Inc.,
pursuant to the rules and regulations of the Securities and Exchange Commission
and include the accounts of Talk City, Inc. ("Talk City" or the "Company").
Certain information and footnote disclosures, normally included in financial
statements prepared in accordance with generally accepted accounting principles,
have been condensed or omitted pursuant to such rules and regulations. In the
opinion of the Company, the unaudited financial statements reflect all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair presentation of the financial position at June 30, 1999 and the operating
results and cash flows for the three months and six months ended June 30, 1999
and 1998. The condensed balance sheet at December 31, 1998 has been derived from
audited financial statements as of that date. Certain reclassifications have
been made to the prior years' financial statements to conform to the June 30,
1999 presentation. These financial statements and notes should be read in
conjunction with the Company's audited consolidated financial statements and
notes thereto included in the Company's Registration Statement on Form S-1 filed
with the Securities and Exchange Commission.
The results of operations for the three and six months ended June 30, 1999
are not necessarily indicative of the results that may be expected for future
quarters or the year ending December 31, 1999.
2. NATURE OF OPERATIONS
Talk City was incorporated in the state of California in March 1996 and is
a provider of online communities and interactive services for businesses and
consumers. The Company offers businesses a wide range of services to help them
develop and expand online relationships with customers, suppliers and employees.
These services include designing fully integrated, customized communities,
producing online events, conducting online market research and facilitating
online meetings. For consumers, the Company operates a network of online
communities located at www.talkcity.com. These communities offer services such
----------------
as moderated chat, home pages, special event production, message boards and
online event guides. The Company generates revenues by selling business services
and advertising and sponsorships on its Web sites to corporations of various
sizes within several industries. Talk City has incurred operating losses since
inception through June 30, 1999. The Company had an accumulated deficit of $45.3
million at June 30, 1999.
3. ADVERTISING AND OPERATING AGREEMENTS
On April 15, 1999, certain advertising and operating agreements with the
National Broadcasting Company, Inc. ("NBC") and Hearst Communications, Inc.
("Hearst") were amended to effect the immediate issuance of the warrants and
shares of Preferred Stock as follows:
. 600,000 shares of Series D Preferred Stock ("Series D Stock") and
warrants to purchase 266,667 shares of Series D Stock pursuant to the
NBC advertising agreement dated August 21, 1998;
. 750,000 shares of Series D Stock pursuant to the Hearst advertising
agreement;
. A warrant to purchase 375,000 shares of Common Stock in exchange for and
upon cancellation of the previous warrant issued to NBC pursuant to the
operating agreement dated February 27, 1998; and,
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. Warrants to purchase 130,556 shares of Series D Stock in exchange for
and upon cancellation of the previous warrants issued to NBC pursuant to
the operating agreement dated August 21, 1998.
All the warrants and Preferred Stock issued pursuant to the above are
noncancelable and nonforfeitable. Accordingly, the fair value of these
instruments was measured and recorded in April 1999. As of June 30, 1999, $6.1
million remains in Other Assets and will continue to be charged to operations as
the related advertising is run or amortized over the remaining term of the
respective agreements. Of the $6.1 million, $4.0 million relates to the
advertising agreements and $2.1 million relates to the operating agreements. The
Company incurred noncash advertising and promotional charges of approximately
$7.9 million and $9.3 million for the three and six months ended June 30, 1999,
respectively.
4. SERIES E REDEEMABLE CONVERTIBLE PREFERRED STOCK
On April 15, 1999, the Company issued 2,499,882 shares of Series E
Redeemable Convertible Preferred Stock (Series E) at a purchase price of $8.00
per share for total proceeds of approximately $20.0 million. Holders of Series E
Preferred Stock are entitled to receive annual noncumulative dividends at the
rate of $0.32 per share. Each outstanding share is convertible on a one for one
basis. Upon liquidation, the holders of Series E Preferred Stock are entitled to
receive $8.00 per share. Holders of Series E are subject to all the rights and
preferences of the previously issued Preferred Stock.
5. STOCK OPTION PLANS
The Board of Directors, (the "Board"), approved, on April 23, 1999, the
1999 Employee Stock Purchase Plan. The Common Stock available for sale under the
plan is 500,000 plus an annual increase to be added on the first day of the
Company's fiscal year beginning in 2000 equal to the lesser of (i) 500,000
shares, (ii) 2% of the outstanding shares of Common Stock on such date, or (iii)
a lesser amount determined by the Board.
The Board also approved a 1999 Director Option Plan reserving 250,000
shares of Common Stock for issuance thereunder and an amendment and restatement
to the 1996 Plan increasing the shares of Common Stock reserved for issuance
thereunder by 750,000. The amendment and restatement of the 1996 Stock Option
Plan (the "1996 Plan") also provides for the automatic annual increase in the
number of shares reserved for issuance under the 1996 Plan by the lesser of (i)
750,000 shares, (ii) 4% of the then outstanding shares of Common Stock on such
date, (iii) or a lesser amount determined by the Board.
6. ACCRUED LIABILITIES
Accrued liabilities consist of:
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
---------------- -----------------
(In thousands)
<S> <C> <C>
Accrued sales and marketing expenses $ 738 $ -
Accrued compensation and benefits 629 202
Other accrued liabilities 233 118
---------------- -----------------
$1,600 $ 320
================ =================
</TABLE>
7. SEGMENT REPORTING
The Company has one operating segment because it is not organized by
multiple segments for purposes of making operating decisions or assessing
performance. The chief operating decision maker evaluates
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performance, makes operating decisions, and allocates resources based on
financial data consistent with the presentation in the accompanying financial
statements.
The Company's operations and assets are based in the United States, and its
revenues have substantially all been earned from customers in the United States.
In addition, revenues from two major customers were $556,000, and $87,000 for
the six months ended June 30, 1999 and 1998, respectively. Total receivables
from these customers were $487,000 at June 30, 1999 and $343,000 at December 31,
1998.
8. COMPREHENSIVE INCOME (LOSS)
Comprehensive loss for the three and six months ended June 30, 1999 and
1998 approximated net loss.
9. NET LOSS PER COMMON SHARE
Diluted net loss per common share for the three months ended June 30, 1999
and 1998 does not include the effects of options to purchase 507,202 and 220,301
shares of Common Stock, respectively; warrants to purchase 1,318,246 and 550,300
shares of Common Stock, respectively; and 14,779,791 and 4,044,785 shares of
Convertible Preferred Stock on an "as if" converted basis, respectively.
10. RECENTLY ISSUED ACCOUNTING STANDARDS
In March 1998, the American Institute of Certified Public Accountants
issued SOP 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use." SOP 98-1 is effective for financial statements for
years beginning after December 15, 1998. SOP 98-1 provides guidance over
accounting for computer software developed or obtained for internal use
including the requirement to capitalize specified costs and amortization of such
costs. The adoption of this standard did not have a material effect on the
Company's capitalization policy for the six months ended June 30, 1999.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards for derivative instruments embedded in other contracts, and
for hedging activities. SFAS No. 133 is effective for all fiscal quarters of
fiscal years beginning after June 15, 2000. The Company currently does not have
any derivative instruments or hedging activities. Therefore, this statement does
not have a material impact on Talk City.
11. SUBSEQUENT EVENTS
(a) Initial Public Offering
The Company completed its initial public offering ("IPO") of
approximately 5.1 million shares of Common Stock including 100,000 shares
of the underwriters over-allotment option on July 20, 1999 and raised
approximately $56 million net of offering costs. Talk City is listed on
the Nasdaq National Market under the symbol "TCTY." Upon the closing of
the IPO, all of the outstanding shares of the Company's Convertible
Preferred Stock automatically converted into shares of Common Stock based
on the respective conversion ratios.
The following unaudited pro forma financial information presents the
financial position of the Company as if the issuance of the 5.1 million
Common shares of the IPO and the conversion of the redeemable convertible
preferred stock occurred on June 30, 1999:
8
<PAGE>
<TABLE>
<CAPTION>
As of June 30, 1999
--------------------------------------
Actual Pro Forma
----------------- ----------------
<S> <C> <C>
Balance Sheet Data:
Cash, cash equivalents and short-term investments 21,238 77,238
Working capital 19,907 75,907
Total assets 32,804 88,804
Long-term obligations, net of current portion 188 188
Redeemable convertible preferred stock 71,366 --
Total stockholders' equity (deficit) (43,244) 84,122
</TABLE>
(b) Reverse Stock Split and Reincorporation
On July 12, 1999 the Company effected a one for two reverse stock
split of the Company's Common Stock and Preferred Stock and a
reincorporation of the Company into the State of Delaware. As part of the
reincorporation, the Common Stock par value was adjusted to equal $0.001
per share and the number of common shares authorized was increased to
100,000,000, effective prior to the closing of the Company's IPO. The share
information in the accompanying financial statements has been retroactively
restated to reflect the effect of the reverse stock split for all periods
presented.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Certain statements contained herein constitute "forward looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended (the
"Securities Act") and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). These forward looking statements can be identified
by the use of predictive, future-tense or forward-looking terminology, such as
"believes", "expects," "anticipates," "estimates," "plans," "may," "intends,"
"will," or similar terms. Such statements include statements concerning the
Company's ability to increase the number of business services clients, expand
its business services offerings and effectively implement these services,
increase advertising and sponsorship revenues, improve or maintain audience or
traffic measurement metrics, maintain differentiation from other online
community providers, maintain or improve the number or quality of network
participants and customers. Actual results may differ materially from those
projected in the forward-looking statements as a result of various factors set
forth under "Factors That May Affect Results" and elsewhere in this report.
These forward-looking statements speak only as of the date hereof. Talk City
does not undertake any obligation to publicly update any forward-looking
statement to reflect events or circumstances after the date on which any such
statement is made or to reflect the occurrence of unanticipated events.
The following discussion of financial condition and results of operations
of the Company should also be read in conjunction with the financial statements
and notes thereto and "Factors That May Affect Results", both of which are
included elsewhere in this report.
Overview
The Company provides online communities and interactive services for
businesses and consumers. From inception through June 1999, the Company's
operating activities have primarily been focused on:
. developing the quality environment of its services;
. expanding the audience and usage of its services;
. establishing operating relationships with its network participants;
. building sales momentum and developing programs and content to market
the Talk City brand name and attract users to its sites;
. developing a comprehensive computer software and hardware
infrastructure;
. recruiting personnel; and
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. raising capital.
To date, substantially all of Talk City's revenues have been derived from
the sale of its business services, advertising and sponsorships. Talk City's
business services include designing customized communities, producing online
events, conducting online market research and facilitating online meetings.
These services help businesses develop and expand online relationships with
customers, suppliers and employees. Revenues derived from business services are
recognized ratably over the term of the contract period, provided that the
collection of the receivable is probable.
Advertising and sponsorship revenues are derived from two sources.
Advertising revenues generally come from short-term banner advertisement
contracts. Sponsorship revenues come from contracts under which the Company
offers a combination of custom programming, prominent logo placement, other
onsite promotions and additional banner ads. Talk City's advertising and
sponsorship clients enter into short-term agreements pursuant to which they
generally receive a guaranteed number of advertising impressions on its sites.
Advertising and sponsorship revenues are recognized in the period in which the
advertisement is displayed or the sponsorship event is run, provided that no
significant obligations remain, at the lesser of the ratio of impressions
delivered over total guaranteed impressions or on a straight-line basis over the
term of the contract. In some cases, where Talk City contracts with sales
representative firms to sell advertising revenues, Talk City recognizes revenues
net of the commissions paid.
Sales and marketing expenses exclude noncash advertising and promotional
charges related to Talk City's advertising on the NBC television network and in
magazines owned by Hearst. These advertising activities are paid for through
noncash in-kind investments. This in-kind program includes $7.2 million of
television commercials and print ads valued at rates discounted from the rate
card to be incurred from 1998 through 2001. After June 30, 1999, noncash charges
of $6.1 million will be charged to operations as the related advertising is run
or promotional services are received. These amounts were determined based on the
fair value of the Company's Common Stock and warrants exchanged for the services
received.
The Company incurred losses of $1.3 million in 1996, $6.4 million in 1997,
$15.7 million in 1998 and $21.9 million for the six months ended June 30, 1999.
These losses include noncash advertising and promotional charges of $12.2
million through June 30, 1999. At June 30, 1999, Talk City had an accumulated
deficit of $45.3 million. The Company anticipates that it will incur additional
operating losses for the foreseeable future.
Results of Operations
The following table sets forth, for the periods indicated, the percentage
of net revenue represented by certain items reflected in Talk City's Condensed
Financial Statements:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net revenue 100 % 100 % 100 % 100 %
Operating expenses:
Product development and programming 241 484 235 629
Sales and marketing 305 260 323 299
General and administrative 81 126 89 172
Noncash advertising and promotional charges 566 44 392 294
-------- ----- ----- -------
Total operating expenses 1,193 914 1,039 1,394
-------- ----- ----- -------
Operating loss (1,093) (814) (939) (1,294)
Interest income (expense), net 22 (94) 19 (61)
-------- ----- ----- -------
Net loss (1,071)% (908)% (920)% (1,355)%
======== ===== ===== =======
</TABLE>
Net Revenue. Net revenue increased 422% to $1.4 million for the three
months ended June 30, 1999 from $268,000 for the three months ended June 30,
1998, an increase of approximately $1.1 million. Net revenue increased 506% to
approximately $2.4 million for the six months ended June 30, 1999 from
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$393,000 for the six months ended June 30, 1998, an increase of approximately
$2.0 million. These increases were primarily due to the expansion of the
Company's sales force, a broader and more extensive business services product
portfolio, and substantial growth in the Company's reach and user volume to its
Web sites. Substantially all of Talk City's revenue is derived within North
America.
Product Development and Programming. Product development and programming
expenses consist primarily of salaries, payroll taxes and benefits and
expenditures related to editorial content, community management and support
personnel, server hosting costs and software development and operations
expenses. Product development and programming expenses for the three and six
months ended June 30, 1999 were approximately $3.4 million, or 241% of total
revenues, and approximately $5.6 million, or 235% of total revenues,
respectively. Product development and programming expenses for the three and six
months ended June 30, 1998 were $1.3 million, or 484% of total revenues, and
approximately $2.5 million, or 629% of total revenues, respectively. The period
to period increase in absolute dollars was primarily attributable to additional
personnel-related costs, an increase in the number of chat moderators and an
increase in independent contractor and consulting costs associated with the
increased number of supervised chats the Company conducted and the enhancement
of the functionality of its Web sites.
Sales and Marketing. Sales and marketing expenses consist primarily of
salaries, commissions and other related costs of internal sales and marketing
personnel, advertising and promotion costs, program expenses, public relations
costs and other marketing expenses. Sales and marketing expenses for the three
and six months ended June 30, 1999 were approximately $4.3 million, or 305% of
total revenues, and approximately $7.7 million, or 323% of total revenues,
respectively. Sales and marketing expenses for the three and six months ended
June 30, 1998 were $697,000, or 260% of total revenues, and approximately $1.2
million, or 299% of total revenues, respectively. The period to period increase
in absolute dollars in sales and marketing expenses was primarily attributable
to an increase in sales and marketing personnel and related expenses required to
implement Talk City's branding and promotional campaigns as well as its
marketing campaign related to the movie "Star Wars - The Phantom Menace". Talk
City expects that sales and marketing expenses will increase for the foreseeable
future as it expands its internal sales force, hires additional marketing
personnel, and increases expenditures for branding, promotion and marketing.
General and Administrative. General and administrative expenses consist of
salaries, payroll taxes and benefits and related costs for general corporate
functions, including executive management, finance, human resources, facilities,
legal and other professional service fees. General and administrative expenses
for the three and six months ended June 30, 1999 were approximately $1.1
million, or 81% of total revenues, and approximately $2.1 million, or 89% of
total revenues, respectively. General and administrative expenses for the three
and six months ended June 30, 1998 were $338,000, or 126% of total revenues, and
approximately $674,000, or 172% of total revenues, respectively. The period to
period increase in absolute dollars in general and administrative expenses was
primarily attributable to an increase in personnel-related and recruiting costs
associated with increased staffing in order to build our infrastructure as well
as increases in professional fees. The Company expects general and
administrative expenses to increase in the future as it hires additional
personnel, expands its facilities and incurs additional costs related to the
growth of its business and operations as a public company.
Noncash Advertising and Promotional Charges. Noncash advertising and
promotional charges for the three and six months ended June 30, 1999 were
approximately $7.9 million, or 566% of total revenues, and approximately $9.3
million, or 392% of total revenues, respectively. Noncash advertising and
promotional charges for the three and six months ended June 30, 1998 were
$118,000, or 44% of total revenues, and approximately $1.2 million, or 294% of
total revenues, respectively. The increases were primarly attributable to the
NBC and Hearst advertising agreements of which approximately $7.6 million and
$8.3 million in advertising charges were incurred for the three and six months
ended June 30, 1999, respectively.
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Interest Income (Expense), Net. Interest income (expense), net includes
income from Talk City's cash and investments and expenses related to its
equipment financing obligations. Interest income, net for the three and six
months ended June 30, 1999 was approximately $300,000, or 22% of total revenues,
and approximately $454,000, or 19% of total revenues, respectively. Interest
expense, net for the three and six months ended June 30, 1998 was $251,000, or
94% of total revenues, and approximately $241,000, or 61% of total revenues,
respectively. The period to period increases in interest income, net were
primarily due to higher average investment balances during the three and six
months ended June 30, 1999 as a result of the Company's private placement in
April 1999 of Preferred Stock with aggregate gross proceeds of approximately
$20.0 million.
Income Taxes. FASB Statement No. 109 provides for the recognition of
deferred tax assets if realization of such assets is more likely than not. Based
upon historical operating performance and the reported cumulative net losses in
all prior years, Talk City has provided a full valuation allowance against its
net deferred tax assets. The Company will evaluate the realizability of the
deferred tax assets on a quarterly basis.
Liquidity and Capital Resources
Since Talk City's inception in March 1996, the Company has financed its
operations primarily through the private placement of its Preferred Stock and,
to a lesser extent, through equipment financing. As of June 30, 1999, the
Company had approximately $7.5 million in cash and cash equivalents and
approximately $13.7 million in short-term investments.
Net cash used in operating activities was approximately $11.5 million and
$3.7 million for the six months ended June 30, 1999, and June 30, 1998,
respectively. Cash used in operating activities in each of these periods was
primarily the result of net operating losses and increases in accounts
receivable and prepaid expenses, partially offset by noncash advertising
expenses and increases in accrued expenses and accounts payable.
Net cash used in investing activities was approximately $9.6 million and
$231,000 for the six months ended June 30, 1999 and June 30, 1998, respectively.
Cash used in investing activities for the six months ended June 30, 1999
consisted of approximately $9.8 million in purchases of short-term investments
and $1.6 million in purchases of equipment partially offset by proceeds of $1.8
million from sales of short-term investments. The increase in investment
purchases was due to the investment of proceeds from the Company's private
placement of Preferred Stock in April 1999. The increase in purchases of
property and equipment was due to the Company's growth in operations and server
requirements.
Net cash provided by financing activities was approximately $19.9 million
and $2.3 million for the six months ended June 30, 1999 and 1998, respectively.
Net cash provided by financing activities for the six months ended June 30, 1999
consisted primarily of net proceeds of approximatley $20.0 from the private
placement of Preferred Stock in April 1999 partially offset by principal
payments on notes payable. Net cash provided by financing activities for the six
months ended June 30, 1998 consisted primarily of net proceeds from bridge loan
and equipment financing.
As of June 30, 1999, the Company's principal commitments consisted of
obligations outstanding under operating leases. Although Talk City has no
material commitments for capital expenditures, the Company anticipates a
substantial increase in its capital expenditures and lease commitments
consistent with its anticipated growth in operations, infrastructure and
personnel.
In May 1998, Talk City obtained an equipment line of credit with a
financial institution in the amount of $2.0 million. This line of credit is
secured by the Company's fixed assets and has a three year term that expires in
April 2002. As of June 30, 1999, the amount outstanding under this line of
credit was $328,000.
Talk City's capital requirements depend on numerous factors, including
market acceptance of its services, the resources the Company allocates to its
community network, marketing and selling its services, brand promotions and
other factors. The Company has experienced substantial increases in its
expenditures since its
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inception consistent with growth in its operations and personnel, and the
Company anticipates that its expenditures will continue to increase for the
foreseeable future. Additionally, the Company will continue to evaluate possible
acquisitions of or investments in complementary businesses, technologies,
services or products and plans to expand its sales and marketing programs. Talk
City currently believes that its available cash and cash equivalents combined
with the net proceeds from its initial public offering will be sufficient to
meet its anticipated needs for working capital and capital expenditures for at
least the next 18 months. The Company may need to raise additional funds,
however, in order to fund more rapid expansion, including significant increases
in personnel and office facilities; to develop new or enhance existing services
or products; to respond to competitive pressures; or to acquire or invest in
complementary businesses, technologies, services or products. In addition, in
order to meet its long term liquidity needs, the Company may need to raise
additional funds, establish a credit facility or seek other financing
arrangements. Additional funding may not be available on favorable terms or at
all.
The Company completed its initial public offering of approximately 5.1
million shares of Common Stock including 100,000 shares of the underwriters'
over-allotment option on July 20, 1999 and raised approximately $56 million net
of offering costs.
Year 2000 Readiness Disclosure
Talk City may be exposed to a loss of revenues and its operating expenses
could increase if the systems on which the Company is dependent to conduct its
operations are not year 2000 compliant. The Company's potential areas of
exposure include products purchased from third parties, information technology,
including computers and software, and non-information technology, including
telephone systems and other equipment used internally. The reasonably likely
worst case scenario for year 2000 issues would be if a significant defect exists
in key hardware or software and if a solution for such a problem were not
immediately available. If a problem is detected in these subsystems during the
Company's year 2000 compliance testing process, these components will need to be
revised or replaced.
Talk City does not currently have a contingency plan to deal with the
worst-case scenario that might occur if technologies it is dependent upon are
not year 2000 compliant and fail to operate effectively after the year 2000. The
Company intends to develop a plan for this scenario upon the completion of its
compliance assessment plan. This contingency plan is expected to be completed by
the third quarter of 1999.
All areas that are vital to the Company's operations are being tested and
validated for year 2000 compliance. Talk City expects to complete its year 2000
compliance assessment plan in the third quarter of 1999 and its compliance
testing and related documentation by the end of the third quarter. Until the
Company's assessment is completed, it will not be able to evaluate whether its
systems will need to be revised or replaced, or the cost involved. Talk City has
contacted all its major third party vendors, the majority of whom have
represented that they are year 2000 compliant. To the extent that vendors fail
to provide certification that they are year 2000 compliant, Talk City will seek
to terminate and replace those relationships. At this point in our assessment,
the Company is not aware of any year 2000 problems relating to these systems
which would have a material effect on its business or financial condition,
without taking into account its efforts to avoid these problems.
The Company does not expect to spend more than $100,000 to assess and
remediate the year 2000 problem based on the size of its operations, the
percentage of its vendors that are standard to its industry and the lack of
dependency on older legacy software in its production systems.
In the event that the Company's production and operational facilities that
support its Web sites are not year 2000 compliant, portions of its Web sites may
become inaccessible. A prolonged disruption in the Company's operations could
cause its business clients and network participants to stop doing business with
the Company. Talk City's review of its systems has shown that there is no single
application that would make its Web sites totally unavailable and the Company
believes that it can quickly address any difficulties that may arise. In the
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event that the Company's Web-hosting facilities are not year 2000 compliant, its
Web sites would be unavailable and Talk City would not be able to deliver
services to its users.
If the Company's present efforts to address the year 2000 compliance issues
are not successful, or if distributors, suppliers and other third parties with
whom the Company conducts business do not successfully address such issues, its
business could be significantly disrupted.
The discussion of the Company's efforts and expectations relating to year
2000 compliance are forward-looking statements. Talk City's ability to achieve
year 2000 compliance and the level of incremental costs associated therewith,
could be adversely affected by, among other things, the availability and cost
of programming and testing resources, third party suppliers' ability to modify
proprietary software, and unanticipated problems identified in the ongoing
compliance review.
Factors That May Affect Results
Talk City has incurred losses since inception and it may be unable to achieve
profitability or generate positive cash flow
Talk City incurred net losses of $1.3 million in 1996, $6.4 million in
1997, $15.7 million in 1998 and $21.9 million for the six months ended June 30,
1999 and it may be unable to achieve profitability in the future. If the Company
continues to incur net losses in future periods, it may be unable to achieve one
or more key elements of its strategy, including the following:
. increase the number of business services personnel;
. increase its sales and marketing activities, including increasing the
number of its sales personnel;
. expand its content and community offerings for its consumers;
. expand its moderator network; or
. introduce additional ecommerce services.
Talk City expects to continue to incur significant operating expenditures,
as well as noncash advertising and promotional charges, and as a result the
Company will need to generate significant revenues to achieve and maintain
profitability. As of June 30, 1999, Talk City had an accumulated deficit of
approximately $45.3 million, including noncash advertising and promotional
charges of $12.2 million. The Company may not achieve profitability if its
revenues increase more slowly than it expects, or if operating expenses exceed
its expectations or cannot be adjusted to compensate for lower than expected
revenues. If the Company does achieve profitability, it may be unable to sustain
or increase profitability on a quarterly or annual basis. Any of the factors
discussed above could cause its stock price to decline.
Fluctuations in quarterly operating results may cause the stock price to decline
It is likely that the Company's operating results in one or more future
quarters may be below the expectations of its investors, and as a result the
price of its common stock could decline. Talk City expects that its quarterly
operating results will continue to fluctuate significantly and be affected by
many factors, the more important of which include:
. its dependence on increased business services and advertising and
sponsorship revenues;
. expansion of its sales force;
. the length of its sales cycle, particularly its business services sales
cycle;
. its ability to increase its audience of loyal, engaged users;
. management of growth; and
. potential technical difficulties or system down time affecting the
Internet generally or the Company specifically.
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These factors are described in more detail in the risk factors described
below. Many of these factors are beyond the Company's control.
Talk City's revenue model is new and unproven and the Company must continue to
generate and develop multiple revenue streams
The success of the Company's revenue model will depend on its ability to
generate multiple revenue streams through its community network. To be
successful, Talk City must, among other things, develop and market products and
services that achieve broad market acceptance by its users, business clients and
advertisers. Talk City's inability to generate multiple revenue streams will
contribute to its not achieving profitability and may cause its accumulated
deficit to increase.
Revenue growth in prior periods may not be indicative of future growth
The Company achieved significant revenue growth in 1998 as well as the six
months ended June 30, 1999. Its limited operating history makes prediction of
future growth difficult. Accurate predictions of future growth are also
difficult because of the rapid changes in its markets. Accordingly, investors
should not rely on past revenue growth as a prediction of future growth.
Talk City's growth will depend on its ability to increase its business
services revenues
Talk City derives a substantial portion of its revenues from the sale of
business services and it expects to continue to rely on these revenues for the
foreseeable future. If the Company does not continue to develop business
services revenues, its revenues may not meet its expectations or may decline and
Talk City will need to revise its revenue model to reflect this. Business
services represented 12% of its total revenues in 1997, 36% of its total
revenues in 1998 and 32% of its total revenues in the six months ended June 30,
1999. The Company's growth and future success will depend on its ability to
increase the number of its business services clients, expand its business
services offerings, effectively implement these services and increase the
average revenue per project and per client. Talk City's ability to generate
significant business services revenues will also depend, in part, on its ability
to create new business services offerings without diluting the value of its
existing programs. Talk City has only recently begun to hire business services
sales personnel.
Talk City's growth will depend upon the acceptance of the Internet as an
attractive medium for its business services clients
Talk City's current and potential business clients must accept the Internet
as an attractive and sustainable substitute medium for the traditional methods
to which they are accustomed. The market for business services may not continue
to develop and may not be sustainable. The Internet as a business services
solution has not been available for a sufficient period of time for the Company
to gauge its effectiveness as compared with traditional methods, such as trade
shows, phone and mail surveys and video conferencing.
Talk City relies heavily on advertising and sponsorship revenues, and if its
advertising and sponsorship revenues decline due to lack of acceptance of the
Internet as an advertising medium, its business will not grow or will decrease
Talk City currently derives a substantial portion of its revenues from
sponsorships and advertising and expects to continue to do so. As a result, the
Company's success is highly dependent on the increased use of the Internet as
an advertising medium. Talk City's business will not grow or will decrease if
the market for Internet advertising fails to develop or develops slower than
expected. Most of its current or potential advertising customers have little
or no experience using the Internet for advertising purposes and they have
allocated only a limited portion of their advertising budgets to Internet
advertising. Use of the Internet by consumers is at a very
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early stage of development and market acceptance of the Internet as a medium for
advertising is subject to a high level of uncertainty. No standards are widely
accepted to measure the effectiveness of Internet advertising. If these
standards do not develop, existing sponsors or advertisers may not continue
their current level of Internet-based programming, and sponsors or advertisers
who are not currently advertising on the Internet may be reluctant to do so.
If Talk City does not provide its advertisers with the guaranteed number of
impressions required by its contracts with them, its reputation would be
harmed and its advertising inventory would be decreased
The terms of the Company's advertising contracts generally range from one
week to six months. Talk City's advertising contracts guarantee the advertiser a
minimum number of impressions, or times that an advertisement is seen by users
of its sites. If minimum impression levels are not achieved for any reason, the
Company may be required to provide additional impressions after the contract
term which could reduce the availability of advertising inventory for its other
current and potential advertisers. Continued inability to deliver the guaranteed
number of impressions to its advertisers would hurt its reputation and could
cause its current as well as potential advertisers to not advertise on its
sites. If minimum guaranteed impressions are not met, Talk City defers
recognition of the corresponding revenues until guaranteed impression levels are
achieved.
Talk City relies on its network participants for user volume and increased
revenues
Talk City's network participants currently drive approximately 54% of the
volume of its sites, which is defined as the number of Internet page views or
Internet advertisement views seen by its users. The volume is considered to be
"driven" by the network participant if the user comes to its sites via the
participant's site. If the Company were to terminate or otherwise lose the
benefit of all of its network participant contracts, it would risk losing as
much as 54% of its volume. Talk City's network participant contracts typically
have terms of six months to three years each.
In addition, Talk City sells advertisements based on the volume of its
sites, a portion of which volume is provided by its network participants. Of its
total revenues for the quarter ended June 30, 1999, approximately 27% were
generated through advertisements that ran based on volume provided by its
network participants. If the Company were to terminate or otherwise lose the
benefit of all of its network participant contracts, the Company could lose as
much as 27% of its revenues. Talk City would need to replace these revenues with
increased revenues from its other product lines, such as business services or
ecommerce. For the quarter ended June 30, 1999, none of its network participants
individually drove volume responsible for more than 2% of its revenues, except
WebTV Network which was responsible for approximately 21% of its revenues for
that quarter.
Talk City relies on WebTV Network for a substantial amount of its volume and
revenues, and if its contract with WebTV Network were not renewed or
terminated, the Company would need to replace this volume and revenues through
other sources
Talk City has a two year contract with WebTV Network which runs through
July 2000. If this contract were to be terminated or not renewed, the Company
could lose as much as 46% of its volume. Talk City would need to replace this
volume with volume from its other network participants, through the growth of
its sites or with volume generated through other means, such as increased
marketing, any of which would result in an unexpected diversion of management
efforts or increased operating expenses. If the Company were unable to replace
this volume, Talk City would also be unable to replace the 20% of its revenues
lost from WebTV Network as well. For the year ended 1998, none of its network
participants individually drove more than 2% of its volume, except WebTV Network
which was responsible for approximately 24% of its volume. For the quarter ended
June 30, 1999, none of its network participants individually drove more than 2%
of its volume, except for WebTV Network which was responsible for approximately
46% of its volume. In addition, WebTV
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Network was responsible for approximately 13% and 20% of its revenues for the
year ended 1998 and the six months ended June 30, 1999, respectively.
Talk City's uncertain sales cycle may cause the Company to incur substantial
expenses and expend management time without generating the corresponding
revenues which would slow its cash flow
Talk City's sales cycle, particularly with its business clients, is
generally lengthy and uncertain. During the sales cycle, the Company may
expend substantial funds and management resources without generating
corresponding revenues. The time between the date of its initial contact with
a potential client and the execution of a contract with that potential client
typically ranges from a few weeks for smaller agreements to several months for
larger agreements. Its sales cycle is also subject to delays as a result of
factors over which the Company has little or no control, including the
following:
. budgetary constraints;
. internal acceptance reviews;
. the success and continued internal support of advertisers', business
services clients' and network participants' own development efforts; and
. the possibility of cancellation or delay of projects by advertisers,
business services clients or network participants.
The length and uncertainty of its sales cycle also may harm its billing and
collection efforts. The length of the sales cycle prevents the Company from
rendering its services on a more accelerated basis, which slows its cash flow
and reduces its ability to fund the expenditures the Company incurs during the
sales cycle.
Talk City depends on its users for content, promotion and sustaining an
engaged audience, and if its users become dissatisfied or do not become
engaged with its service, the Company would need to increase its expenditures
for these activities
Talk City depends largely on its users for content, word-of-mouth promotion
and for sustaining an involved audience for its advertisers and, to a lesser
extent, its business clients. If its users become dissatisfied or do not become
engaged with its service, they will not generate significant content or promote
its site and the Company will have to increase the expenditure of its own
resources for these activities. In addition, dissatisfied or disengaged users
would not continue to attract other users to its site. Loss of its users and
failure to increase its number of engaged users would hurt its efforts to
generate increased revenues. Its users may become dissatisfied with its service
as a result of the increased focus on commercialization of its services due to
their continued exposure to advertising or ecommerce activities on its sites or
the use of their information for commercial purposes. Talk City's users may also
become dissatisfied with its service if the Company does not maintain its
structured environment, if it experiences system failures or it does not
continually upgrade its software functionality. In addition, users may visit its
community for a single event, such as a live event regarding the Grammy Awards,
or to explore its community and not return.
Talk City depends on its trained community leaders and moderators to engage
its users and maintain its structured and moderated programming
Talk City depends on its network of trained community leaders and
moderators, which consisted of approximately 2,000 individuals as of June 30,
1999, to draw its users into its community and maintain its structured and
moderated programming. Most of its trained community leaders and moderators
are volunteers. These people volunteer because they like to meet and help
people from all over the world, enjoy the recognition they receive in a
community leadership position and generally have fun participating in such a
novel form of communication. As the Internet evolves and online communication
becomes more common, its trained community leaders and moderators may view
moderating as less exciting or less of a novelty than it is now. Loss of its
trained community leaders and moderators, or loss of its ability to attract
these individuals to its
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service, would cause the Company to implement new programs to engage its users
and maintain its structured environment. The implementation of these new
programs would cause the Company to expend unexpected management time and
resources which would increase its operating expenses.
Maintaining and promoting Talk City's brand identity is a critical aspect of
maintaining and expanding its user base, business clients and the number of
its network participants
Talk City intends to substantially increase its financial commitment to the
maintenance and promotion of its brand loyalty through advertising campaigns in
several forms of media, including television, print and billboards. These
campaigns may not successfully enhance its brand, and the Company may incur
excessive expenses in connection with its efforts to promote and maintain its
brand without generating a corresponding increase in revenues, which would
contribute to its not achieving profitability. The Company's promotion will
include co-branding, ingredient branding, where the Talk City brand receives a
less prominent position than the brand, usually as an ingredient of the overall
service offered, such as "chat powered by Talk City," and other marketing
activities with its network. These other marketing activities will consist of
activities in which the Company works with its network participants to promote
its services in a way which highlights both brands' involvement in the services
offered.
Promotion and enhancement of its brand also will depend, in part, on its
ability to continue to provide a clean, well lighted community experience. The
value of its brand could diminish if businesses, users, network participants
and advertisers do not perceive the www.talkcity.com community experience to
be of high quality or if the Company introduces new services or enters into
new business ventures that are not well received.
Talk City is growing rapidly and must effectively manage and support its
growth in order for its business strategy to succeed
Talk City has grown rapidly and will need to continue to grow in all areas
of operation in order to execute its business strategy. Managing and sustaining
its growth will place significant demands on management as well as on its
administrative, operational and financial systems and controls. If the Company
is unable to do this effectively, the Company would have to divert resources
away from the continued growth of its business and implementation of its
business strategy, such as management time and its limited revenues. Talk City
had 34 employees as of June 30, 1998 compared to 132 employees as of June 30,
1999. The Company anticipates further significant increases in the number of its
employees, especially in its sales and marketing departments in order to take
full advantage of its relationships with Cox Interactive Media, Inc. ("Cox"),
Hearst and NBC. This rapid growth has caused the Company to outgrow its current
principal office facilities sooner than it expected. As a result, Talk City is
currently considering leasing additional space in the very competitive Silicon
Valley office leasing market.
Talk City's chief executive officer and vice president of community are critical
to its business and they may not remain with the Company in the future
Talk City's future success will depend to a significant extent on the
continued services of Peter Friedman, its Chairman of the Board, Chief Executive
Officer and President, and Jenna Woodul, its Vice President of Community. The
loss of the services of Mr. Friedman or Ms. Woodul could cause the Company to
incur increased operating expenses and divert other senior management time in
searching for their replacements. The loss of their services could also harm its
reputation as its business clients, advertisers and network participants could
become concerned about its future operations. The Company does not have long-
term employment agreements with Mr. Friedman or Ms. Woodul and the Company does
not maintain any key person life insurance policies.
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Talk City must continually attract and retain its sales, technical, marketing
and other personnel or the Company will be unable to execute its business
strategy
Talk City's future success also will depend on its ability to attract,
retain and motivate other highly skilled sales, technical, managerial, marketing
and customer support personnel. Competition for these personnel is intense,
especially in the Internet industry, and the Company may be unable to
successfully attract, integrate or retain sufficiently qualified personnel. The
Company has in the past experienced, and it expects to continue to experience,
difficulty in hiring and retaining highly skilled employees with appropriate
qualifications as a result of its rapid growth and expansion.
Talk City may be unable to consummate potential acquisitions or investments or
successfully integrate them with its business which would slow its growth
strategy
As part of its continued strategy to expand the range of its community
applications and features, to acquire additional community audiences and to
expand its business services products, the Company may acquire or make
investments in complementary businesses, technologies, services or products if
appropriate opportunities arise. Talk City may be unable to identify suitable
acquisition or investment candidates at reasonable prices or on reasonable
terms. Additionally, regardless of whether suitable candidates are available,
the Company may be unable to consummate future acquisitions or investments,
which could harm its growth strategy. If Talk City does acquire a company or
make other types of acquisitions, the Company could have difficulty integrating
the acquired products, personnel or technologies. These difficulties could
disrupt its ongoing business, distract its management and employees and increase
its expenses.
Talk City will need to raise additional capital to achieve its business
objectives
Talk City will need to raise additional capital to continue to develop its
business. Additional financing may not be available on favorable terms or at
all. If adequate funds are not available or are not available on acceptable
terms, the Company would be unable to continue to develop its business, take
advantage of acquisition opportunities, develop or enhance its services and
products or do one or more of the following:
. expand its business services;
. increase the number of its network participants;
. develop its brand;
. expand its moderator base;
. grow its traffic;
. increase its revenues; or
. respond to competitive pressures.
Talk City's paid moderators could be viewed as employees rather than
independent contractors which could subject the Company to adverse tax and
employee benefit consequences
Talk City treats its paid moderators, consisting of approximately 400
individuals, as independent contractors. The Company's paid moderators sign
independent contractor agreements and are paid a flat monthly fee or per hour.
One or more jurisdictions may deem its paid moderators to be employees rather
than independent contractors and seek to impose taxes, and any applicable
interest and penalties, on the Company. The law regarding the distinction
between independent contractors and employees is not entirely clear. The Company
could be subject to substantial tax and employee benefit liabilities if it were
ultimately determined that its paid moderators are actually employees.
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Talk City's volunteer community leaders could be viewed as employees, which
would substantially increase its operating expenses
If the Company's volunteer community leaders, consisting of approximately
1,500 individuals, were viewed as employees, Talk City could be subject to
payment of back wages and other penalties and its operating expenses could
substantially increase. Former volunteers of America Online, Inc ("AOL").
recently filed a complaint with the Labor Department and a class action lawsuit
claiming they were treated like employees and should have been paid.
System failures or slow downs would harm the Company's reputation and thus
reduce its attractiveness to its current and future business clients, users,
network participants and advertisers
System failures could harm the Company's reputation and reduce its
attractiveness to businesses, users, network participants and advertisers. Talk
City's ability to attract potential business clients, users, network
participants and advertisers to promote its brand will depend significantly on
the performance of its network infrastructure. In addition, a key element of its
strategy is to generate a high level of user volume. An increase in the volume
of user traffic could strain the capacity of its infrastructure, resulting in a
slowing or outage of its services and reduced traffic to its Web sites. Talk
City may be unable to improve its technical infrastructure in relation to
increased user volume. The Company's users depend on Internet service providers,
online service providers and other Web site operators for access to its Web
sites. Many of these providers and operators have also experienced significant
outages in the past, and they could experience outages, delays and other
difficulties due to system failures unrelated to its systems.
Talk City's communications and other computer hardware operations are subject
to disruptions which are out of its control and for which the Company may not
have adequate insurance
Fire, floods, earthquakes, power loss, telecommunications failures, break-
ins and similar events could damage the Company's communications hardware and
other computer hardware operations. These operations are located separate from
its principal offices at Frontier Global Centers facilities in Sunnyvale,
California. In addition, computer viruses, electronic break-ins or other similar
interruptions also could disrupt its Web sites. Talk City's insurance policies
may not adequately compensate the Company for any losses that may occur due to
any failures or interruptions in its systems.
Talk City's business is largely dependent on the development and growth of the
Internet, which may not grow, or if it does grow, may be unable to support the
demands placed on it by this growth
Talk City's market is new and rapidly evolving. The usage of its Web sites,
which drives its volume and in turn its revenues, may not grow if Internet
usage in general does not continue to grow. If Internet usage does continue to
grow, the Internet infrastructure may be unable to support the demands placed
on it by this growth and its performance and reliability may decline. Varying
factors could inhibit future growth in Internet usage, including:
. inadequate network infrastructure;
. security concerns;
. inconsistent quality of service; and
. unavailability of cost effective, high speed service.
Many Web sites have experienced interruptions in their service as a result
of outages and other delays occurring throughout the Internet network
infrastructure. Internet usage, as well as the usage of its Web sites, could
decline or grow at a slower rate than expected if these outages or delays
frequently occur in the future.
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Talk City must keep pace with rapid technological change and the intense
competition of the Internet industry in order to succeed
Talk City's market is characterized by rapidly changing technologies,
frequent new product and service introductions and evolving industry standards.
The recent growth of the Internet and intense competition in the industry
exacerbate these market characteristics. To succeed, Talk City will need to
effectively integrate the various software programs and tools required to
enhance and improve its product offerings and manage its business. Any
enhancements or new services or features must meet the requirements of its
current and prospective users and must achieve significant market acceptance.
The Company's success also will depend on its ability to adapt to rapidly
changing technologies by continually improving the performance features and
reliability of its services. The Company may experience difficulties that could
delay or prevent the successful development, introduction or marketing of new
products and services. Talk City could also incur substantial costs if it needs
to modify its services or infrastructure to adapt to these changes.
Talk City may be liable for misappropriation by others of its users' personal
or credit card information
If third parties were able to penetrate the Company's network security or
otherwise misappropriate its users' personal information or credit card
information, Talk City could be subject to liability. These could include
claims for unauthorized purchases with credit card information, impersonation
or other similar fraud claims.
Talk City may be liable for its use or sale of its users' personal information
Talk City could be subject to liability claims by its users for misuses of
personal information, such as for unauthorized marketing purposes. In addition,
the Federal Trade Commission has been investigating various Internet companies
regarding their use of personal information. The Company could incur additional
expenses if new regulations regarding the use of personal information are
introduced or if its privacy practices are investigated. Talk City currently
uses its users' personal information internally to determine how to improve its
service, applications and features and to target its advertisements and
communications. The Company also uses this information externally to provide its
advertisers with the demographics of its user base. Talk City may, in the
future, sell its user information on an aggregate, not individual, basis.
Talk City may be subject to liability for products sold through its Web sites
Consumers may sue the Company if any of the products that it sells online
are defective, fail to perform properly or injure the user. Liability claims
resulting from the sale of products could require the Company to spend
significant time and money in litigation or to pay significant damages. To date,
Talk City has had very limited experience in the sale of products online and the
development of relationships with manufacturers or suppliers of such products.
The Company plans to develop a range of ecommerce opportunities, such as
shopping events hosted by celebrity guests to promote particular products.
Year 2000 problems with Talk City's internal systems and third-party systems
of its suppliers and Web infrastructure could require significant time and
expense and could reduce its future revenues
Talk City may be exposed to a loss of revenues and its operating expenses
could increase if the systems on which the Company is dependent to conduct its
operations are not year 2000 compliant. The potential areas of exposure include
products purchased from third parties, computers, software telephone systems and
other equipment used internally. The reasonably likely worst case scenario for
year 2000 issues would be if a significant defect exists in key hardware or
software and if a solution for this problem were not immediately available. If a
problem is detected in these subsystems during its year 2000 compliance testing
process, these components will need to be revised or replaced. If the Company's
present efforts to address the year 2000
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compliance issues are not successful, or if suppliers and other third parties
with which the Company does business do not successfully address these issues,
its business could be harmed.
In the event that Talk City's Web-hosting facilities are not year 2000
compliant, its production Web sites would be unavailable and the Company would
be unable to deliver services to its users. In the event that its production and
operational facilities that support its Web sites are not year 2000 compliant,
portions of the Company's Web site may become inaccessible. A prolonged
disruption in Talk City's operations could cause its business clients and
network participants to stop doing business with the Company.
Internet security and concerns could hinder ecommerce
The need to securely transmit confidential information over the Internet
has been a significant barrier to ecommerce and communications over the
Internet. Talk City may incur significant costs to protect against the threat of
security breaches or to alleviate problems caused by breaches like this. The
Company's insurance policies carry coverage limits that may not be adequate to
reimburse for losses caused by security breaches. Any well publicized compromise
of security could deter people from using the Internet or using it to conduct
transactions that involve transmitting confidential information.
Changes in government regulation could limit Talk City's Internet activities
or result in additional costs of doing business on the Internet
Currently, few laws or regulations exist that specifically regulate
communications or commerce on the Internet, but Talk City expects more stringent
laws and regulations to be enacted due to the increasing popularity and use of
the Internet. Any new legislation or regulations or the application of existing
laws and regulations to the Internet could limit user volume and increase
operating expenses. In addition, the application of existing laws to the
Internet is uncertain, may take years to resolve and could expose the Company to
substantial liability for which Talk City might not be indemnified by the
content providers or other third parties. Existing laws and regulations
currently, and new laws and regulations are likely to, address a variety of
issues, including the following:
. user privacy and expression;
. the rights and safety of children;
. intellectual property;
. information security;
. anticompetitive practices;
. the convergence of traditional channels with Internet commerce;
. taxation and pricing; and
. the characteristics and quality of products and services.
Those laws that do reference the Internet, such as the recently passed
Digital Millennium Copyright Act, have not yet been interpreted by the courts
and their applicability and reach are not defined. The Federal Trade
Commission has submitted proposals to the Internet industry regarding the
rights and safety of children using the Internet and is expected to issue
regulations in this area.
If Internet service providers become regulated in a manner similar to long
distance telephone carriers, Internet growth may grow at a slower pace which
would cause the Company's revenues to decrease
If Internet growth slows due to proposals to regulate Internet service
providers similar to long distance telephone carriers, Talk City user volume
and the demand for its business services would decline which would cause its
revenues to decrease. Increased use of the Internet has burdened the existing
telecommunications infrastructure and led to interruptions in phone service in
areas with high Internet use. Several telecommunications companies and local
telephone carriers, such as Pacific Bell, have petitioned the Federal
Communications Commission to regulate Internet service providers and online
service providers in a manner
22
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similar to long distance telephone carriers and to impose access fees. If this
were to occur, the costs of communicating on the Internet could increase
substantially, potentially slowing the growth in use of the Internet.
Talk City may be subject to liability for publishing or distributing content
over the Internet
Talk City may be subject to claims relating to content that is published on
or downloaded from its sites. The Company also could be subject to liability
for content that is accessible from its Web sites through links to other Web
sites or that is posted by members in chat rooms or bulletin boards. Although
Talk City carries general liability insurance, the Company's insurance may not
cover potential claims of this type, such as defamation or trademark
infringement, or may not be adequate to cover all costs incurred in defense of
potential claims or to indemnify the Company for all liability that may be
imposed. In addition, any claims like this, with or without merit, would result
in the diversion of its financial resources and management personnel.
Current and potential competitors could decrease Talk City's market share and
harm its business
Increases in the number of Web sites competing for the attention and
spending of businesses, users and advertisers could result in price
reductions, reduced margins or loss of market share, any of which could
decrease Talk City's revenues, contribute to the Company not achieving
profitability and hurt its reputation. The barriers to entry in the Internet
services market are low and the Company expects the number of its competitors
to continue to increase. Any company or individual can establish and maintain
a Web site for minimal cost. Talk City competes for business clients, users
and advertisers with numerous companies, including the following:
. online services or Web sites that produce business services, such as
market research, customized communities or online events, including Well
Engaged and Broadcast.com, Inc.;
. online services or Web sites with a focus on community services, such as
AOL, GeoCities, Inc., a subsidiary of Yahoo! Inc. ("Yahoo"), Tripod,
Inc., a subsidiary of Lycos, Inc. ("Lycos"), Delphi, theglobe.com, Inc.,
Xoom Inc., Fortune City, Homestead.com, WBS.net and Angelfire;
. vertical community online services that focus on specific market or
demographic segments, such as iVillage Inc., which is focused on women,
or iTurf, which is focused on teens;
. Web retrieval and other Web portal companies that offer community
applications, such as chat and home pages, as part of their site,
including Excite@Home, Infoseek Corporation, Lycos and Yahoo!; and
. publishers and distributors of traditional media, such as television,
radio and print.
Talk City depends on third-party software to measure user demographics and for
other related services and if this software does not function properly, the
Company would need to purchase new software or write the software themselves,
each of which could cause a temporary disruption in its business
If software purchased from third parties to perform the Company's services
does not function properly or is not updated, it would need to purchase new
software from other third party providers. Even though the third-party software
Talk City currently uses is easily replaced through multiple other third party
providers, or by it writing the necessary software programs themselves, each of
these alternatives would require an unplanned increase in operating expenses and
could cause a one to two month disruption in its business.
It is important to advertisers that Talk City accurately measures the
demographics of its user base and the delivery of advertising impressions on its
Web sites. Companies may choose not to advertise on its Web sites or may be less
willing to pay the fees the Company intends to charge for advertising if they do
not perceive the Company's measurements to be reliable. Talk City has purchased
third-party software from Oracle Corporation and NetGravity, Inc. for these
measurement services. Talk City may be unable to accurately evaluate the
demographic characteristics of its users if the third-party software does not
function properly or is not enhanced to support the Company's needs. Talk City's
ability to deliver its services to its users may also be harmed if
23
<PAGE>
other software the Company has purchased from third parties, such as Microsoft
Exchange for real-time chat and Netscape Web for ad serving and management, is
not reliable or does not function properly.
The Company is dependent on the trademarks "Talk City" and "OnNow" and if
the Company could not use these marks it would need to reimplement its Web
sites and re-build its brand identity
The Company is dependent on the trademarks "Talk City" and "OnNow." The
Company has not yet received trademark registration of "OnNow." If Talk City
was prevented from using the trademarks "Talk City" or "OnNow," it would
need to reimplement its Web sites and devise new hard copy materials, such as
letterhead and merchandise. The Company would also need to re-build its brand
identity with its business clients, users, network participants and
advertisers. Talk City's operating expenses would substantially increase if it
had to re-build its brand identity or reimplement its Web sites.
Possible infringement of Talk City's intellectual property rights by third
parties could substantially increase its operating expenses
Other parties may assert claims of infringement of intellectual property or
other proprietary rights against Talk City. These claims, even if without
merit, could require the Company to expend significant financial and
managerial resources. Furthermore, if claims like this are successful, Talk
City may be required to change its trademarks, alter its content or pay
financial damages, any of which could substantially increase its operating
expenses. The Company also may be required to obtain licenses from others to
refine, develop, market and deliver new services. Talk City may be unable to
obtain any needed license on commercially reasonable terms or at all and
rights granted under any licenses may not be valid and enforceable. Talk City
has been subject to claims and expects to be subject to legal proceedings and
claims from time to time in the ordinary course of its business, including
claims of alleged infringement of trademarks and other intellectual property
rights of third parties by the Company and its licensees.
The allocation of proceeds from Talk City's initial public offering may not
yield significant returns for its stockholders
Talk City's management will have the discretion to allocate the net
proceeds of its offering to uses that its stockholders may not deem desirable.
Pending any specific needs, the Company intends to invest the net proceeds in
short-term, interest-bearing, investment grade securities for an indefinite
period of time. The Company cannot guarantee that any invested proceeds will
yield a significant return.
Talk City's stock price is likely to be extremely volatile as the market for
Internet companies' stock has recently experienced extreme price and volume
fluctuations
The market price of Talk City's Common Stock is likely to be extremely
volatile as the market for Internet-related and technology companies has
experienced extreme price and volume fluctuations in recent months. Despite
the strong pattern of operating losses of Internet-related companies, the
market demand, valuation and trading prices of these companies has
historically been high. At the same time, the share prices of these companies'
stocks have historically been highly volatile and have recorded lows well
below their historical highs. As a result, investors in these companies often
buy the stock at very high prices only to see the price drop substantially a
short time later, resulting in an extreme drop in value in the stock holdings
of these investors. Historically, Talk City has experienced significant
losses, which totaled $15.7 million in 1998 and $21.9 million for the six
months ended June 30, 1999. In addition, the Company has experienced
fluctuations in its volume of users and usage patterns, which could also lead
to extreme volatility of its stock price. Talk City cannot assure you that its
stock will trade at the same levels as other Internet stocks or that Internet
stocks in general will sustain or increase in current market prices.
Volatility in the market price of the Company's Common Stock could result in
securities class action litigation. Any litigation would likely result in
substantial costs and a diversion of management's attention and resources.
24
<PAGE>
Talk City's stock price is likely to be extremely volatile due to broad market
and industry factors beyond its control
Talk City expects its stock price to be subject to wide fluctuations in
response to a variety of factors, including factors beyond its control. These
broad market and industry factors could harm the market price of its Common
Stock, regardless of its performance. These factors include:
. actual or anticipated variations in its quarterly operating results;
. announcements of technological innovations or new programming by the
Company or its competitors;
. conditions or trends in the Internet and online services industries;
. changes in the market valuations of other Internet companies;
. announcements by the Company or its competitors of significant
acquisitions, strategic partnerships, joint ventures or capital
commitments;
. additions or departures of key personnel; and
. sales of substantial amounts of its Common Stock or other securities in
the open market.
General political and economic conditions, such as recession or interest
rate or currency rate fluctuations, also could harm the market price of the
Company's Common Stock.
Exercise of registration rights after the initial public offering could
adversely affect Talk City's stock price
If holders of registration rights exercise those rights after the offering,
a large number of securities could be registered and sold in the public market,
which could result in a decline in the price of the Company's Common Stock. If
the Company were to include in a company-initiated registration shares held by
these holders pursuant to the exercise of their registration rights, Talk City's
ability to raise needed capital could suffer. After the offering, the holders of
24,326,761 shares of Common Stock and warrants to purchase 1,298,946 shares of
Common Stock as of August 31, 1999, which will represent a total of
approximately 80% of the Company's outstanding stock, will be entitled to rights
with respect to registration under the Securities Act of 1933.
Talk City's undesignated Preferred Stock may inhibit potential acquisition bids
for the Company, cause the market price for its Common Stock to fall and
diminish the voting rights of the holders of its Common Stock
If the Board issues Preferred Stock, potential acquirers may not make
acquisition bids for the Company, the stock price may fall and the voting rights
of existing stockholders may diminish as a result. The Board has the authority
to issue up to 5,000,000 shares of Preferred Stock in one or more series. The
Board can fix the price, rights, preferences, privileges and restrictions of the
Preferred Stock without any further vote or action by the stockholders.
Talk City has anti-takeover defenses that could delay or prevent an acquisition
of the Company
Provisions of Talk City's Certificate of Incorporation, Bylaws and Delaware
law could make it more difficult for a third party to acquire the Company,
even if doing so would be beneficial to the stockholders.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Talk City's exposure to market risk is limited to interest income
sensitivity, which is affected by changes in the general level of U.S.
interest rates, particularly since the majority of its investments are in
short-term variable rate debt securities issued by corporations. The Company
places its investments with high quality issuers and limits the amount of
credit exposure to any one issuer. Due to the nature of its short term
25
<PAGE>
investments, the Company believes that it is not subject to any material
market risk exposure. Talk City does not have any foreign currency hedging or
other derivative financial instruments as of June 30, 1999.
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
(a) From April 1, 1999 to June 30, 1999, the Company issued and sold an
aggregate of 149,498 shares of unregistered Common Stock to 13
officers, employees, former employees and consultants at prices ranging
from $.28 to $5.00 per share, for aggregate cash consideration of
approximately $631,949, of which approximately $625,000 is subject to
outstanding promissory notes payable to the Company. These shares were
sold pursuant to the exercise of options granted by the Board. As to
each officer, employee, former employee and consultant of the Company
who was issued such securities, the Company relied upon Rule 701 of the
Securities Act of 1933, as amended (the "Act"). Each such person
purchased securities of the Company pursuant to a written contract
between such person and the Company. In addition, the Company met the
conditions imposed under Rule 701(b) under the Act.
(b) On April 15, 1999, the Company issued and sold in the aggregate 750,000
shares of unregistered Series D Preferred Stock at a price per share of
$4.00 to Hearst in consideration for the promotion of the Company by
Hearst through publication of advertisements in various Hearst
magazines. The agreed upon consideration to the Company was
$3,000,000. The Company relied upon Section 4(2) of the Act and
Regulation D, Rule 506, in connection with the sale of these shares.
The sale of the Series D Preferred Stock was made in compliance with
all the terms of Rule 501(e) of Regulation D, there were no more than
35 investors, as calculated pursuant to Rule 501(e) of Regulation D,
and each investor who was not an accredited investor represented to the
Company that it had such knowledge and expertise in financial and
business matter that it was capable of evaluating the merits and risks
of the investment.
(c) On April 15, 1999, the Company issued an sold (1) in the aggregate
600,000 shares of unregistered Series D Preferred Stock, at a price per
share of $4.00, and (2) an unregistered warrant to purchase 266,667
shares of unregistered Series D Preferred Stock, to NBC in
consideration for the broadcast by the NBC television network of
advertising spots prepared by the Company over a time period mutually
agreed upon by the Company and NBC. The warrant has the following
exercise prices per share: with respect to 41,667 of the shares, $6.00;
with respect to 125,000 of the shares, $8.00; and with respect to
100,000 of the shares, $10.00. The agreed upon aggregate consideration
to the Company was $4,650,000. The shares and warrant were issued
pursuant to a Series C Preferred Stock, Series D Preferred Stock and
Warrant Purchase Agreement, as amended. The warrant may be exercised
in whole or in part at any time prior to April 19, 2004 and may be
exercised for cash or pursuant to a net exercise provision contained
therein. The Company relied upon Section 4(2) of the Act and
Regulation D, Rule 506, in connection with the sale of the securities.
The sale of the Series D Preferred Stock and warrant was made in
compliance with all of the terms of Rules 501 and 502 of Regulation D,
and each investor who was not an accredited investor represented to the
Company that it had such knowledge and experience in financial and
business matters that it was capable of evaluating the merits and risks
of the investment.
(d) On April 15, 1999, the Company issued and sold in the aggregate
2,499,882 shares of unregistered Series E Preferred Stock at a price
per share of $8.00 to a limited number of investors for aggregate cash
consideration of $19,999,056. The shares were sold pursuant to a
Series E Preferred Stock Purchase Agreement. The sale of the Series E
Preferred Stock was made in compliance with all of the terms of Rules
501 and 502 of Regulation D, there were no more than 35 investors, as
calculated pursuant to Rule 501(e) of Regulation D, and each investor
who was not an accredited investor represented to the Company that it
had such knowledge and experience in financial and business matters
that it was capable of evaluating the merits and risks of the
investment.
26
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(e) On April 23, 1999, the Company issued and sold an unregistered warrant
exercisable for an aggregate of 11,893 shares of unregistered Series E
Preferred Stock, at an exercise price per share of $8.00. The warrant
was issued to Volpe Brown Whelan & Company. The warrant may be
exercised in whole or in part at any time prior to April 23, 2004 and
may be exercised for cash only. The Company relied on Section 4(2) of
the Act and Regulation D, Rule 506 in connection with the sale of the
warrant. The sale of warrants was made in compliance with all of the
terms of Rules 501 and 502 of Regulation D, and each investor who was
not an accredited investor represented to the Company that it had such
knowledge and experience in financial and business matters that it was
capable of evaluating the merits and risks of the investment.
Item 4. Submission of Matters to a Vote of Security Holders.
1. On April 16, 1999, Talk City - California solicited the consent of its
stockholders to approve the following:
(1) The Fourth Amended and Restated Articles of Incorporation of Talk City
- California which, among other changes, (i) approved the increase to
the number of shares of authorized Common Stock of Talk City -
California by 5,000,000 shares to a total of 35,000,000 shares, and
(ii) created a new series of Preferred Stock, designated Series E
Preferred Stock, with an authorized number of shares equal to 2,750,000
shares.
For Against or Withheld Abstain
--- ------------------- -------
12,932,601 0 6,246,922
2. On May 26, 1999, Talk City solicited the consent of its stockholders to
approve the following:
(1) The reincorporation into the State of Delaware, including (i) the
Agreement and Plan of Merger, (ii) the Certificate of Incorporation of
the company, filed on May 11, 1999, (iii) the Bylaws, and (iv) the form
of Indemnification Agreement for the directors and officers of the
company
For Against or Withheld Abstain
--- ------------------- -------
12,842,565 0 6,589,661
(2) A one for two reverse stock split (the "Stock Split") of the
outstanding Common Stock and Preferred Stock of the Company and the
Amended and Restated Certificate of Incorporation of the Company, filed
on July 12, 1999, to (i) effect the Stock Split, (ii) increase the
authorized Common Stock of the Company by 65,000,000 shares to
100,000,000 shares, and (iii) increase the authorized Preferred Stock
by 3,823,549 shares to 45,823,549 to create an aggregate of 5,000,000
shares of "blank check" Preferred Stock.
For Against or Withheld Abstain
--- ------------------- -------
12,842,565 0 6,589,661
(3) The Second Amended and Restated Certificate of Incorporation of the
Company, filed on July 23, 1999, to reflect the conversion and
extinguishment of the outstanding Preferred Stock of the Company upon
the completion of the Company's initial public offering.
For Against or Withheld Abstain
--- ------------------- -------
12,842,565 0 6,589,661
27
<PAGE>
(4) The 1999 Employee Stock Purchase Plan with a share reserve of 500,000
shares of Common Stock.
For Against or Withheld Abstain
--- ------------------- -------
12,842,565 0 6,589,661
(5) The 1999 Director Option Plan with a share reserve of 250,000 shares of
Talk City's Common Stock.
For Against or Withheld Abstain
--- ------------------- -------
12,842,565 0 6,589,661
(6) The amendment and restatement of its 1996 Stock Option Plan to, among
other things, increase the number of shares reserved for issuance under
such Plan by 750,000 shares of its Common Stock to 3,075,000 shares,
with automatic increases annually equal to the lessor of (i) 750,000
shares, (ii) 4% of the outstanding shares on such date, or (iii) a
lesser amount determined by the Board.
For Against or Withheld Abstain
--- ------------------- -------
12,842,565 0 6,589,661
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27.1 Financial Data Schedule (filed only with the electronic submission of
Form 10-Q in accordance with the Edgar requirements)
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the three months
ended June 30, 1999.
28
<PAGE>
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.
TALK CITY, INC.
(Registrant)
/s/ Jeffrey Snetiker
-------------------------------
Jeffrey Snetiker
Senior Vice President, Chief Financial and
Administrative Officer
September 2, 1999
29
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