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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 quarterly period ended June 30, 2000
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)
1919 South Bascom Avenue
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, $0.001 par value,
outstanding at August 10, 2000 was 24,985,189.
_______________________________________________________________________________
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TALK CITY, INC.
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PAGE NUMBER
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<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Condensed Financial Statements:
Unaudited Condensed Balance Sheets at June 30, 2000 and December 31, 1999 3
Unaudited Condensed Statements of Operations for the three and six months
ended June 30, 2000 and 1999 4
Unaudited Condensed Statements of Cash Flows for the six months ended June
30, 2000 and 1999 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 25
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 6. Exhibits and Reports on Form 8-K 26
Signatures 28
</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,
2000 1999
------------------ ------------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 17,191 $ 14,112
Short term investments 13,956 41,541
Accounts receivable, net 4,953 3,533
Prepaid expenses and other current assets 971 1,772
------------------ ------------------
Total current assets 37,071 60,958
Property and equipment, net 9,393 5,689
Other assets 8,179 7,880
Goodwill, net 3,075 -
------------------ ------------------
Total assets $ 57,718 $ 74,527
================== ==================
Liabilities and Stockholders' Equity
Current liabilities:
Notes payable, current portion $ 127 $ 154
Accounts payable 1,366 3,977
Accrued liabilities 3,942 3,302
Deferred revenue 932 664
------------------ ------------------
Total current liabilities 6,367 8,097
Notes payable, less current portion 61 107
------------------ ------------------
Total liabilities 6,428 8,204
Stockholders' equity:
Common stock 25 24
Additional paid-in-capital 135,519 131,306
Deferred stock based compensation (389) (550)
Notes receivable from stockholders (969) (992)
Accumulated deficit (82,896) (63,465)
------------------ ------------------
Total stockholders' equity 51,290 66,323
------------------ ------------------
Total liabilities and stockholders' equity $ 57,718 $ 74,527
================== ==================
</TABLE>
See accompanying notes to the condensed financial statements.
3
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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,
2000 1999 2000 1999
-------------- -------------- -------------- -------------
<S> <C> <C> <C> <C>
Revenues:
Business services $ 2,102 $ 410 $ 3,674 $ 767
Advertising and sponsorships 2,405 990 4,368 1,613
-------------- -------------- -------------- -------------
Total revenue 4,507 1,400 8,042 2,380
Cost of revenue 4,118 1,953 7,737 3,298
-------------- -------------- -------------- -------------
Gross margin 389 (553) 305 (918)
Operating expenses:
Product development 1,935 1,011 3,700 1,798
Sales and marketing 4,629 4,678 9,563 8,195
General and administrative 2,766 1,137 5,817 2,111
Restructuring charges 469 - 469 -
Noncash advertising and promotional charges 443 7,921 1,161 9,331
Amortization of goodwill 171 - 342 -
Total operating expenses 10,413 14,747 21,052 21,435
-------------- -------------- -------------- -------------
Loss from operations (10,024) (15,300) (20,747) (22,353)
Interest income, net 595 300 1,316 454
-------------- -------------- -------------- -------------
Net loss (9,429) (15,000) (19,431) (21,899)
Accretion of discount related to redeemable
convertible preferred stock and warrants - 71 - 143
-------------- -------------- -------------- -------------
Net loss applicable to common stockholders $ (9,429) $(15,071) $(19,431) $(22,042)
============== ============== ============== =============
Basic and diluted net loss per common share $ (0.38) $ (4.00) $ (0.79) $ (5.93)
============== ============== ============== =============
Weighted average basic and diluted common
shares outstanding 24,806 3,766 24,668 3,714
============== ============== ============== =============
</TABLE>
See accompanying notes to the condensed financial statements.
4
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TALK CITY, INC.
UNAUDITED CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Six Months Ended
--------------------------------------
June 30, June 30,
2000 1999
---------------- ----------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(19,431) $(21,899)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 1,865 380
Loss on sale of property and equipment 15 -
Stock compensation expense 161 348
Noncash advertising and promotional charges 1,161 9,331
Provision for accounts receivable allowance 195 -
Changes in operating assets and liabilities:
Accounts receivable (1,615) (1,267)
Prepaid expenses and other current assets 801 (1,133)
Accounts payable (2,611) 1,145
Accrued liabilities 640 1,280
Deferred revenue 268 350
---------------- ----------------
Net cash used in operating activities (18,551) (11,465)
---------------- ----------------
Cash flows from investing activities:
Purchases of property and equipment (5,261) (1,590)
Proceeds from sale of property and equipment 19 -
Cash paid for acquisition of Research Connections, Inc., net of cash acquired (417) -
Purchases of short-term investments (4,285) (9,769)
Proceeds from sale of short-term investments 31,870 1,800
Other assets (1,460) (49)
---------------- ----------------
Net cash provided by (used in) used in investing activities 20,466 (9,608)
---------------- ----------------
Cash flows from financing activities:
Proceeds from sale of redeemable preferred stock, net of issuance costs - 19,956
Proceeds from stock option and warrant exercises 1,212 22
Proceeds from repayment of stockholders' notes receivable 25 -
Repayment of notes payable (73) (73)
---------------- ----------------
Net cash provided by financing activities 1,164 19,905
---------------- ----------------
Net increase (decrease) in cash and cash equivalents 3,079 (1,168)
Cash and cash equivalents at beginning of period 14,112 8,697
---------------- ----------------
Cash and cash equivalents at end of period $ 17,191 $ 7,529
================ ================
Cash paid during the period for interest $ 23 $ 44
================ ================
Supplemental disclosure of noncash financing activities:
Common stock issuance for acquisition of Research Connections, Inc. $ 3,000 $ -
================ ================
Accretion of redeemable convertible preferred stock and warrants $ - $ 144
================ ================
Common stock issued for notes receivable, net of repurchases $ - $ 618
================ ================
Issuance of stock and warrants for advertising and promotional
services $ - $ 12,269
================ ================
Deferred compensation related to option grants $ - $ 715
================ ================
</TABLE>
See accompanying notes to the condensed financial statements.
5
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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 except as described in Note 3, necessary for a fair
presentation of the financial position at June 30, 2000 and the operating
results and cash flows for the three and six months ended June 30, 2000 and
1999. The condensed balance sheet at December 31, 1999 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, 2000 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 Annual Report on Form 10-K filed with the Securities and Exchange
Commission on March 28, 2000.
The results of operations for the three and six months ended June 30,
2000 are not necessarily indicative of the results that may be expected for
future quarters or the year ending December 31, 2000.
2. NATURE OF OPERATIONS
Talk City was incorporated in the state of California in March 1996 and
reincorporated in the state of Delaware in July 1999. Talk City is a
provider of online marketing services for businesses. 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
interactive events, conducting online market research and providing
outsourced chat and event feeds through advertising and network services.
As part of its network services, 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
its marketing 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, 2000. The
Company had an accumulated deficit of $82.9 million at June 30, 2000.
3. ACQUISITION OF RESEARCH CONNECTIONS, INC.
On January 3, 2000, the Company acquired Research Connections, Inc.
("RCI"), a privately-held online market research company. The Company paid
$500,000 in cash and issued 242,424 shares of its Common Stock, with an
approximate fair market value of $3 million, in exchange for all
outstanding shares of RCI. The fair market value was based on the
Company's closing price of its Common Stock on December 15, 1999 which is
the date the Company and RCI mutually agreed to the significant terms and
conditions of the merger. The cash consideration of $500,000 was due as
follows: $250,000 was paid on January 3, 2000; $125,000 was paid on April
3, 2000; and $125,000 was paid on July 3, 2000. In addition, contingent
cash consideration of $1.5 million, subject to an employment agreement with
the former sole shareholder of RCI, was placed into an escrow fund and
recorded as restricted cash in Other Assets. Funds will be released over
four years with 25% released on January 3, 2001 and the remainder released
evenly over the following 36 months. In the event the shareholder is
terminated for cause or voluntarily leaves employment of the Company, then
all remaining cash in the escrow fund shall be forfeited to the Company and
the shareholder
6
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will have no further right to such cash. The Company will record the cash
consideration of $1.5 million as compensation expense as the funds are
released from escrow.
The Company accounted for the acquisition of RCI pursuant to the purchase
method of accounting. Thus, the results of operations of RCI and the fair
value of the assets acquired and liabilities assumed was included in the
Company's financial statements beginning on the acquisition date. The
allocation of the purchase price of $3.5 million resulted in cash and other
assets of approximately $100,000 and goodwill of approximately $3.4
million, which was capitalized and is being amortized on a straight line
basis over five years.
4. 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 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 dated October 30, 1998;
. 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,
. A warrant to purchase 130,556 shares of Series D Stock in exchange for
and upon cancellation of the previous warrant issued to NBC pursuant to
the advertising agreement dated August 21, 1998.
All the warrants and Preferred Stock issued pursuant to the above are
noncancelable and nonforfeitable. Accordingly, the fair market value of
these instruments was measured and fixed on the date of their respective
issuance. The fair market value was recorded in Other Assets and is being
charged to operations as the advertisements are run. The fair market
values attributable to the amended NBC and Hearst agreements were based on
the fair value of the Series E Redeemable Convertible Preferred Stock
issued at $8.00 per share on April 15, 1999. As of June 30, 2000, of the
$8.2 million in Other Assets, $3.4 million relates to the advertising and
operating agreements and will continue to be charged to operations as the
related advertising is run or amortized over the remaining term of the
respective operating agreements. Of the $3.4 million, $2.4 million relates
to the Hearst advertising agreement and $1.0 million relates to the NBC
operating agreements. The Company incurred noncash advertising and
promotional charges of approximately $443,000 and $1.2 million for the
three and six months ended June 30, 2000, respectively.
In connection with the Company's Initial Public Offering, effective July
19, 1999 (the "IPO"), the Preferred Stock issued in the above arrangements
was converted to Common Stock at their respective ratios. In addition, the
warrants are exercisable into shares of Common Stock, determined based on
the respective conversion ratios.
7
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5. ACCRUED LIABILITIES
Accrued liabilities consist of:
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
--------------- ---------------
(In thousands)
<S> <C> <C>
Accrued compensation and benefits $ 974 $ 953
Accrued sales and marketing expenses 971 987
Accrued moderator expenses 420 390
Other accrued liabilities 1,577 972
--------------- ---------------
$3,942 $3,302
=============== ===============
</TABLE>
6. 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 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 North
America. For the three and six months ended June 30, 2000, none of the
Company's clients were responsible for more than 8% of its revenue. Total
receivables from one individual client were $735,000 and $0 on June 30,
2000 and December 31, 1999, respectively.
7. COMPREHENSIVE INCOME (LOSS)
Comprehensive loss for the three and six months ended June 30, 2000 and
1999 equaled the net loss.
8. NET LOSS PER COMMON SHARE
Diluted net loss per common share does not include the effects of the
following potentially dilutive securities as of June 30, 2000 and 1999:
<TABLE>
<CAPTION>
June 30, June 30,
2000 1999
------------- ------------
(In thousands)
<S> <C> <C>
Common Stock Options 3,630 507
Common Stock Warrants 991 1,318
Unvested Common Stock Subject to Repurchase 107 489
Redeemable Convertible Preferred Stock -- 14,780
------------- ------------
4,728 17,094
============= ============
</TABLE>
The average exercise price of the Common Stock Options is $10.63 and
$1.03 as of June 30, 2000 and June 30, 1999, respectively. The average
exercise price of the Common Stock Warrants is $5.83 and $5.27 as of June
30, 2000 and June 30, 1999, respectively.
9. RECENTLY ISSUED ACCOUNTING STANDARDS
In March 2000, the Emerging Issues Task Force ("EITF") issued Statement
No. 00-2, "Accounting for Web Site Development Costs." EITF 00-2
establishes accounting and reporting standards for capitalization of Web
site development costs in accordance with Statement of Accounting Principle
No. 98-1. EITF No. 00-2 is effective for Web site development costs
incurred for fiscal quarters beginning after June 30, 2000. The Company is
currently evaluating the impact of this interpretation on its financial
statements.
8
<PAGE>
In March 2000, the Financial Accounting Standards Board ("FASB") issued
Financial Interpretation No. 44 ("FIN 44"). FIN 44 clarifies certain
issues in the application of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees." FIN 44 is effective July 1,
2000 and is to be applied on a prospective basis for certain specific
events that occur after either December 31, 1998 or January 12, 2000. This
interpretation is not expected to have a material impact on Talk City.
In December 1999, the Securities and Exchange Commission ("SEC") staff
issued Staff Accounting Bulletin ("SAB") 101, Revenue Recognition in
Financial Statements, as amended by SAB 101A and SAB101B. The SAB
summarizes the SEC's views in applying generally accepted accounting
principles to revenue recognition in financial statements. In June 2000,
the SEC issued SAB 101B, which requires companies to comply with the SAB no
later than the fourth quarter of the fiscal year beginning after December
15, 1999. The company believes that the adoption of SAB 101 will not
materially impact the Company's financial position or results of
operations.
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities." SFAS
No. 133 establishes accounting and reporting standards for derivative
instruments, including derivative instruments embedded in other contracts,
and for hedging activities. The Company believes the adoption of SFAS No.
133 will not have a material effect on its results of operations, financial
position or cash flows. This statement will be effective for the Company
beginning January 1, 2001.
10. RESTRUCTURING CHARGES
In June 2000, the Company underwent a restructuring of operations to more
clearly focus Talk City as an online marketing services provider (the
"Restructuring"). Pursuant to the Restructuring, Talk City intends to
focus on four main areas of online business, including (i) live event
services, (ii) market research services, (iii) community solutions and (iv)
advertising and network services, for businesses. As a result of the
Restructuring, the Company reduced its total headcount by 35 employees, or
approximately 15% of its total workforce. The Unaudited Condensed
Statement of Operations for the three and six months ended June 30, 2000
includes a charge of approximately $469,000, related to the Restructuring.
Such amount consists of approximately $290,000 for employee severance and
other related costs and $179,000 for the markdown of inventory.
Substantially all liabilities related to the Restructuring were paid as of
June 30, 2000.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
This report contains "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended (the "Securities Act"),
Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange
Act") and the Private Securities Litigation Reform Act of 1995. Actual
results may differ materially from those projected in the forward-looking
statements as a result of various factors, including the Company's ability to
increase the number of its online marketing services clients, expand its
online marketing services offerings and effectively implement these services,
increase revenues, maintain or improve the number or quality of network
participants and customers, attract and retain key personnel and compete
successfully in the marketplace, as well as other factors set forth under
"Factors That May Affect Results" and elsewhere in this report. 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.
9
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Overview
The Company provides online marketing services for businesses. From
inception through June 2000, the Company's operating activities have primarily
been focused on:
. developing and expanding its online marketing services offerings and
client base;
. establishing operating relationships with its network participants;
. expanding the audience and usage of its services;
. building sales momentum and developing programs and content to enhance
its network services;
. developing the quality environment of its services;
. recruiting personnel;
. developing a comprehensive computer software and hardware
infrastructure; and
. 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 fully integrated, customized communities,
interactive online event services, online research services, and outsourced
chat and event network services. These services help businesses develop and
expand online relationships with customers, suppliers and employees.
Revenues, including setup or upfront fees, derived from business services are
recognized ratably over the term of the contract period or upon completion of
the online event or market research project, 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 the
Company's network 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.
Cost of revenues include content costs, payroll and related expenses for
the editorial staff, Web site design and production staff, moderator costs,
Internet connection charges and depreciation and maintenance costs necessary
to support the Company's Web sites. In addition, cost of revenues include
expenses associated with conducting online market research, producing online
business events and implementing customized business communities.
Operating expenses consist primarily of product development, sales and
marketing, general and administrative and interest expenses. Product
development expenses consist primarily of salaries, payroll taxes, benefits
and related expenditures for technology, software development, project
management and support personnel. Sales and marketing expenses consist
primarily of advertising and promotion costs, salaries, commissions and other
related costs of internal sales and marketing personnel and program expenses,
public relations costs and other marketing expenses. 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 fees for other professional
services.
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.
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After June 30, 2000, noncash charges of $3.4 million will continue to be
charged to operations as the related advertising is run or amortized over the
remaining term of the respective operating or advertising agreements. Of the
$3.4 million, $2.4 million relates to the Hearst advertising agreement and
$1.0 million relates to the NBC operating agreements. These amounts were
determined based on the fair market 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, $40.1 million in 1999 and $19.4 million for the six
months ended June 30, 2000. At June 30, 2000, Talk City had an accumulated
deficit of $82.9 million. These losses include noncash advertising and
promotional charges of $15.2 million through June 30, 2000. The Company
anticipates that it will incur additional operating losses for the foreseeable
future. The Company's anticipation that it will incur additional operating
losses for the forseeable future is a forward-looking statement.
In June 2000, the Company underwent a Restructuring of operations to more
clearly focus Talk City as an online marketing services provider. Pursuant to
the Restructuring, Talk City intends to focus on four main areas of online
business, including (i) live event services, (ii) market research services,
(iii) community solutions and (iv) advertising and network services, for
businesses. As a result of the Restructuring, the Company reduced its total
headcount by 35 employees, or approximately 15% of its total workforce. The
Unaudited Condensed Statement of Operations for the three and six months ended
June 30, 2000 includes a charge of approximately $469,000, related to the
Restructuring. Such amount consists of approximately $290,000 for employee
severance and other related costs and $179,000 for the markdown of inventory.
Substantially all liabilities related to the Restructuring were paid as of
June 30, 2000.
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,
------------------ -------------------
2000 1999 2000 1999
----- ----- ----- -----
<S> <C> <C> <C> <C>
Net revenue 100 % 100 % 100 % 100 %
Cost of revenue 91 140 96 139
----- ------- ----- -----
Gross margin 9 (40) 4 (39)
Operating expenses:
Product development 43 72 46 75
Sales and marketing 103 334 119 344
General and administrative 61 81 72 89
Restructuring charges 10 -- 6 --
Noncash advertising and promotional charges 10 566 15 392
Amortization of goodwill 4 -- 4 --
----- ------- ----- -----
Total operating expenses 231 1,053 262 900
----- ------- ----- -----
Operating loss (222) (1,093) (258) (939)
Interest income, net 13 22 16 19
----- ------- ----- -----
Net loss (209)% (1,071)% (242)% (920)%
===== ======= ===== =====
</TABLE>
Net Revenue. Net revenue increased 222% to approximately $4.5 million for
the three months ended June 30, 2000 from $1.4 million for the three months
ended June 30, 1999, an increase of approximately $3.1 million. Net revenue
increased 238% to approximately $8.0 million for the six months ended June 30,
2000 from $2.4 million for the six months ended June 30, 1999. This increase
was primarily due to the expansion of the
11
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Company's sales force, an increased number of marketing services projects as a
result of a broader and more extensive marketing services product portfolio,
an increased number of advertisers and continued growth in the number of chat
hours and user volume. Substantially all of Talk City's revenue is derived
within North America.
Cost of Revenue. Cost of advertising, sponsorship and marketing services
revenue was $4.1 million, or 91% of total revenue, for the three months ended
June 30, 2000 compared to $2.0 million, or 140% of total revenue, for the
three months ended June 30, 1999. Cost of advertising, sponsorship and
business services revenue for the six months ended June 30, 2000 was
approximately $7.7 million, or 96% of total revenue compared to $3.3 million
or 139% of total revenue for the six months ended June 30, 1999. Cost of
revenue increased in absolute dollars by $2.2 and $4.4 million compared to the
same periods in the prior years due to increased personnel-related costs, the
hiring of more moderators, Internet connection fees and server related
expenses associated with conducting additional online events and market
research studies, as well as supporting the increased traffic to the Company's
Web sites.
Product Development. Product development expenses for the three months
ended June 30, 2000 and 1999 were approximately $1.9 million, or 43% of total
revenue, and $1.0 million, or 72% of total revenue, respectively. Product
development expenses for the six months ended June 30, 2000 and 1999 were $3.7
million, or 46% of revenue, and $1.8 million, or 75% of revenue. The increase
in absolute dollars was primarily attributable to additional personnel-related
costs and consulting fees associated with developing products and software to
expand the Company's marketing services product portfolio and enhance the
functionality of the Company's Web sites. Talk City expects that product
development expenses will increase for the foreseeable future as it continues
to hire additional personnel, develop and increase the functionality of its
marketing services products, especially due to the Restructuring, and enhance
the quality and functionality of its Web sites. The Company's expectation
regarding increases in product development expenses in the future is a
forward-looking statement.
Sales and Marketing. Sales and marketing expenses for the three months
ended June 30, 2000 and 1999 were approximately $4.6 million, or 103% of total
revenue, and approximately $4.7 million, or 334% of total revenue,
respectively. Sales and marketing expenses for the six months ended June 30,
2000 and 1999 were approximately $9.6 million, or 119% of revenue, and $8.2
million, or 344% of revenue, respectively. The decrease in absolute dollars
in sales and marketing expenses for the quarter was primarily attributable to
a decrease in online advertising expenses partially offset by an increase in
sales personnel, commissions and expenses associated with expanding the
Company's New York City office and opening sales offices in Chicago, San
Francisco and Los Angeles. Talk City expects that sales and marketing
expenses will decrease in absolute dollars in the foreseeable future as it
reduces creative development, print advertising, online advertising and other
promotional marketing expenses, as well as lowers headcount related expenses
as a result of the Restructuring. The Company's expectation regarding
decreases in sales and marketing expenses in the future is a forward-looking
statement.
General and Administrative. General and administrative expenses for the
three months ended June 30, 2000 and 1999 were approximately $2.7 million, or
61% of total revenue, and $1.1 million, or 81% of total revenue, respectively.
General and administrative expenses for the six months ended June 30, 2000 and
1999 were approximately $5.8 million, or 72% of total revenue, and $2.1
million, or 89% of total revenue, respectively. The 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 the Company's infrastructure and
increased rent and operating costs relating to its new corporate headquarters.
The increase was also due to costs associated with operating as a public
company, such as directors' and officers' liability insurance, investor
relations and professional service fees. The Company expects general and
administrative expenses to remain relatively constant in absolute dollars as
the Company's operating infrastructure is substantially complete. The
Company's statement regarding general and administrative expenses remaining
relatively constant is a forward-looking statement.
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Noncash Advertising and Promotional Charges. Noncash advertising and
promotional charges for the three months ended June 30, 2000 and 1999 were
$443,000, or 10% of total revenue, and $7.9 million, or 566% of total revenue,
respectively. Noncash advertising and promotional charges for the six months
ended June 30, 2000 and 1999 were approximately $1.2 million, or 14% of total
revenue, and $9.3 million, or 392% of total revenue, respectively. The
decrease in noncash and promotional charges for the three months and six
months ended June 30, 2000 was primarily due to the full utilization, as of
June 30, 1999, of advertising provided under the NBC advertising agreements.
Amortization of Goodwill. The Company recorded amortization of $342,000
through June 30, 2000. This amortization was recorded in connection with the
acquisition of RCI in January 2000. The goodwill of approximately $3.4
million related to this acquisition is being amortized over the expected
period of benefit of five years. There was no similar charge in 1999.
Interest Income, Net. Interest income, net includes income from Talk
City's cash and investments and expenses related to its equipment financing
obligations. Interest income, net for the three months ended June 30, 2000
and 1999 was approximately $595,000 and $300,000, respectively. Interest
income, net for the six months ended June 30, 2000 and 1999 was approximately
$1.3 million and $454,000, respectively. The increase in interest income, net
was primarily due to higher average investment balances as a result of the
Company's IPO in July 1999 with net proceeds of approximately $55.4 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 evaluates the realizability
of the deferred tax assets on a quarterly basis.
Restructuring. Pursuant to the Restructuring, and the associated reduction
in workforce of 35 employees, or approximately 15% of the total workforce, the
Unaudited Condensed Statement of Operations for the three and six months ended
June 30, 2000 includes a charge of approximately $469,000. This charge
consists of approximately $290,000 for employee severance and other related
costs and $179,000 for the markdown of inventory. Substantially all
liabilities related to the Restructuring were paid as of June 30, 2000. Such
Restructuring charges represent 10% and 6% of revenue for the three and six
months ended June 30, 2000, respectively. There was no similar charge in
1999. While Talk City does not project any further expenses related to the
Restructuring, it cannot be certain that additional expenditures or charges
will not be required in the future. In addition, Talk City cannot be certain
that its Restructuring will be successfully accepted or adopted by the market,
including its current investors or security analysts, the Company's current or
potential business or consumer clients, the Company's current or potential
network participants, or its current or potential advertisers. If the
Restructuring is not accepted or adopted by parties above, among others, our
business could be adversely affected. The above discussion regarding the
potential for additional Restructuring charges or expenditures and
nonacceptance by the market and other entities or individuals of the
Restructuring is a forward-looking statement.
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, its
IPO in July 1999 and, to a lesser extent, through equipment financing. As of
June 30, 2000, the Company had approximately $17.2 million in cash and cash
equivalents and approximately $14.0 million in short-term investments.
Net cash used in operating activities was approximately $18.6 million and
$11.5 million for the six months ended June 30, 2000 and 1999, respectively.
Cash used in operating activities in each of these periods was primarily the
result of net operating losses excluding the effects of noncash advertising
expenses and depreciation and amortization.
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Net cash provided by investing activities was approximately $20.5 million
and net cash used in investing activities was $9.6 million for the six months
ended June 30, 2000 and 1999, respectively. Cash provided by investing
activities for the six months ended June 30, 2000 consisted of approximately
$31.9 million in sales of short-term investments partially offset by
approximately $5.3 million in purchases of equipment, approximately $4.3
million in purchases of short-term investments and $1.5 million placed into an
escrow fund for an employment agreement with the former sole shareholder of
RCI. The increase in purchases of property and equipment was due to leasehold
improvements, furniture and office equipment associated with the Company's new
corporate headquarters. In addition, the Company purchased additional servers
for its co-location server site which will be operational during the third
quarter of 2000. The Company's expectation that the co-location server site
will be operational in the third quarter of 2000 is a forward-looking
statement.
Net cash provided by financing activities was approximately $1.2 million
and $19.9 million for the six months ended June 30, 2000 and 1999,
respectively. Net cash provided by financing activities for the six months
ended June 30, 2000 consisted primarily of net proceeds of approximately $1.2
million from stock option and warrant exercises partially offset by principal
payments on notes payable. Net cash provided by financing activities for the
six months ended June 30, 1999 consisted of proceeds from the Company's
private placement in April 1999 of Preferred Stock.
As of June 30, 2000, the Company's principal commitments consisted of
obligations outstanding under operating leases. In October 1999, the Company
signed a nine-year, three and one-half month lease for a new 56,000 square
foot corporate headquarters in Campbell, California, which commenced on
December 15, 1999. Pursuant to the lease agreement, the Company has provided
a $2,100,000 letter of credit as security for the lease. The letter of credit
may be reduced by specified amounts in the lease agreement after every 12
months through December 14, 2005 provided no default has occurred. Future
minimum lease payments under all non-cancelable operating leases total
approximately $18.8 million as of June 30, 2000.
In May 1998, Talk City obtained an equipment line of credit with a
financial institution in the amount of approximately $2.0 million. This line
of credit is secured by the Company's fixed assets and has a four-year term
that expires in April 2002. As of June 30, 2000, the amount outstanding under
this line of credit was approximately $188,000.
Talk City's capital requirements depend on numerous factors, including
market acceptance of its online marketing services, especially due to the
Restructuring, marketing and selling its online marketing services as a result
of the Restructuring, brand promotions and other factors. The Company has
experienced substantial increases in its expenditures since its inception
consistent with growth in its operations and personnel. Talk City currently
believes that its available cash and cash equivalents 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, to market and promote its
Restructuring, to develop new or enhance existing marketing services or
products, 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.
Factors That May Affect Results
If the recent Restructuring of Talk City designed to increase awareness of and
refocus the Company's business on online marketing services, is not be
accepted, its results of operations may decrease and the business may be
adversely affected
In the later half of June 2000, Talk City began its Restructuring, pursuant
to which it reorganized its business into four main areas of operations,
including online live events services, market research services, community
solutions, and advertising and network services. If the Restructuring does
not increase awareness or generate sales of the Company's online marketing
services at the level it anticipates, or at all, the Company's
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limited management and other resources will have been expended with no
increase in revenue, which could decrease its results of operations, and
otherwise adversely affect the business.
The reduction in workforce related to the Restructuring could result in market
uncertainty and decreased employee morale
The reduction in workforce of Talk City by approximately 15% pursuant to
the Restructuring could result in market concerns about the operations of the
Company. Reductions in workforce sometimes result in operational concerns
about a company in the market and, while the Company's reduction was in
connection with the Restructuring, the Company may not be able to respond
adequately to reports of securities analysts or the market. In addition, the
Company must adequately take the appropriate steps to prevent decreased or to
sustain employee morale due to the reduction in workforce.
Talk City has incurred losses inclusive of noncash charges since inception and
it may be unable to achieve profitability or generate positive cash flow
Talk City incurred net losses of approximately $1.3 million in 1996, $6.4
million in 1997, $15.7 million in 1998, $40.1 million in 1999 and $19.4
million for the six months ended June 30, 2000, 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 online marketing services clients;
. increase its sales activities;
. adequately inform the market about its product positioning; or
. maintain the number of its network participants.
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, 2000, Talk City had an accumulated deficit of
approximately $82.9 million, including noncash advertising and promotional
charges of $15.2 million. The Company may not achieve profitability if its
revenue increases 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
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 online marketing services revenues;
. expansion of its sales force;
. the length of its sales cycle;
. its ability to increase its audience of loyal, engaged clients and
consumers;
. management of growth; and
. potential technical difficulties or system down time affecting the
Internet generally or the Company specifically.
These factors are described in more detail in the risk factors described
below. Many of these factors are beyond the Company's control.
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Revenue growth in prior periods may not be indicative of future growth
The Company achieved significant revenue growth in 1999 as well as the six
months ended June 30, 2000. Its limited operating history makes prediction of
future growth difficult. In addition, due to the Restructuring, the Company
has shifted its focus to its online marketing services which is a new focus of
the Company and it cannot predict its revenue growth as a result. Accurate
predictions of future growth are also difficult because of the rapid changes
in its markets as a result of increased competition, evolving technology and
clients' business requirements. Accordingly, current and potential 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 online marketing
services revenues
Talk City has derived, and will continue to derive, a substantial portion
of its revenues from the sale of online marketing services. If the Company
does not continue to develop online marketing 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. The Company's growth and future success
will depend on its ability to increase the number of its online marketing
services clients, expand its online marketing services offerings, effectively
implement these services and increase the average revenue per project and per
client. Talk City's ability to generate significant online marketing services
revenues will also depend, in part, on its ability to create new online
marketing services offerings without diluting the value of its existing
programs.
Talk City's growth will depend upon the acceptance of the Internet as an
attractive medium for its online marketing 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 online marketing services may
not continue to develop and may not be sustainable. The Internet, as an
online marketing 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 derives a substantial portion of its revenues from sponsorships and
advertising, 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 derives a substantial portion of its revenues from sponsorships
and advertising. Advertising and sponsorship revenue represented 88% of its
total revenue in 1997, 64% of its total revenue in 1998, 67% of its total
revenue in 1999 and 54% of its revenue for the six months ended June 30, 2000.
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 the Company's current or potential
advertising clients 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 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
or may be unwilling to pay the current advertising rates, and sponsors or
advertisers who are not currently advertising on the Internet may be reluctant
to do so.
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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 twelve 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
could hurt the Company's 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 drove approximately 55% of the volume of
the Company's Web sites for the six months ended June 30, 2000. Volume 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 the Company's sites via the participant's Web
site. If Talk City was to terminate or otherwise lose the benefit of all of
its network participant contracts, the Company would risk losing as much as
55% of its volume. Talk City's network participant contracts typically have
terms of six months to three years each.
In addition, the Company sells advertisements based on the volume of its
sites, including volume provided by its network participants. Of the
Company's total advertising and sponsorship revenue for the six months ended
June 30, 2000, approximately 24% was generated through advertisements that ran
based on volume provided by its network participants. If Talk City was to
terminate or otherwise lose the benefit of all of its network participant
contracts, the Company could lose as much as 24% of its advertising and
sponsorship revenue. Talk City would need to replace these revenues with
increased revenues from its online marketing services. For the six months
ended June 30, 2000, none of the Company's network participants individually
drove volume responsible for more than 5% of its advertising and sponsorship
revenue, except WebTV Network, a wholly owned subsidiary of Microsoft
Corporation ("WebTV Network"), which was responsible for approximately 16% of
its advertising and sponsorship revenue for the six months ended June 30,
2000.
Talk City relies on WebTV Network for a substantial amount of traffic on its
advertising network and, to a lesser extent its revenue, and if its contract
with WebTV Network was terminated, the Company would need to replace this
volume and revenue through other sources
Talk City recently renewed its contract with WebTV Network for a term of
one year, expiring in July 2001. If this contract were to be terminated, the
Company could lose as much as 33% of the traffic on its advertising network.
The Company would need to replace this volume with volume from its other
network participants, through the growth of its own Web 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. In addition, if Talk City were unable to replace this volume, the
Company may be unable to replace the 16% of its advertising and sponsorship
revenues generated by WebTV Network for the six months ended June 30, 2000.
Talk City acquired RCI and if the Company is not successful in integrating
RCI's operations with its own, the Company's revenue and operating results
could decline
Talk City's acquisition of RCI, an online market research company, in
January 2000 will only be successful if the Company is able to integrate its
operations with its own, which could divert attention from the day-to-day
operations of the combined company. The diversion of the attention of
management and key sales personnel, and any difficulties encountered in the
transition process could cause the revenues and operating results of the
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combined company to decline. The Company must successfully integrate RCI's
services offerings, specifically online market research, with its own.
Further, this integration is occurring as the Company is undergoing its
Restructuring. The online marketing capabilities of RCI must effectively work
and combine with Talk City's new, restructured online market research
component for the integration to be successful. It is possible that neither
Talk City nor RCI will retain key management and sales personnel.
The acquisition of RCI, combined with the Company's Restructuring could
also cause the Company's business clients or clients of RCI to be uncertain
about its ability to support the combined company's services and the direction
of the combined company's development efforts. This may result in the delay
or cancellation of orders, a significant decrease in Talk City's online
marketing services revenues and limit its ability to implement its business
strategy.
Talk City invested in SocialNet, Inc. and its investment could be at risk if
SocialNet, Inc. does not grow as expected, or at all
In December 1999, the Company invested $3.0 million in SocialNet, Inc.
("SocialNet"), an online relationships company, in return for 1,554,404 shares
of Series C Preferred Stock of SocialNet, which represents approximately 7.6%
of SocialNet's outstanding shares. The price per share for the Series C
Preferred Stock was $1.93. Talk City's investment in this start-up company is
at risk if SocialNet does not grow at the level the Company anticipates or at
all. In addition, the benefits to the Company, including enhancing its
demographic targeting, may not be realized if SocialNet fails to perform as
the Company expects or achieve its business strategy. Many of these factors
are out of Talk City's control.
Talk City's variable 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, varies in
length of time. 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', online
marketing services clients' and network participants' own development
efforts; and
. the possibility of cancellation or delay of projects by advertisers,
online marketing 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 might prevent 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 the clients of its online marketing services, including
business clients, advertisers, network participants and end users of its
network, for content, promotion and sustaining an engaged audience, and if its
clients or users become dissatisfied or do not become engaged with its
services, the Company would need to increase its expenditures for these
activities
Talk City depends largely on clients of its online marketing services,
including business clients, advertisers, network participants and end users of
its network, for content, word-of-mouth promotion and for sustaining an
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involved audience for its advertisers and business clients. If such clients
or users become dissatisfied or do not become engaged with its services, they
will not generate significant content or promote its Web sites or services and
the Company will have to increase the expenditure of its own resources for
these activities. In addition, dissatisfied or disengaged clients or users
would not continue to attract other clients or users to the Company's sites.
Loss of its clients or users and failure to increase its number of engaged
clients or users would hurt the Company's efforts to generate increased
revenues. The Company's clients or users may become dissatisfied with its
services as a result of the increased focus on commercialization of its
services due to their continued exposure to advertising activities on its Web
sites or the use of their information for commercial purposes. Talk City's
clients or users may also become dissatisfied with its services if the Company
does not maintain its structured environment, attract quality business
clients, experience system failures or does not continually upgrade its
software functionality.
Talk City depends on its trained community leaders and moderators to engage
its users and maintain its structured and moderated environment
Talk City depends on its network of trained community leaders and
moderators, which consisted of approximately 1,700 active individuals as of
June 30, 2000, to draw its users into its services and maintain its structured
and moderated environment. 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 "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 services, could 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.
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 such as management time away from the continued growth of its
business and implementation of its business strategy. Talk City had 132
employees as of June 30, 1999 compared to 201 employees as of June 30, 2000.
The Company anticipates further significant increases in the number of its
employees, especially in its engineering departments, in order to increase its
online marketing services revenues and enhance the content and functionality
of its Web sites.
Talk City's chief executive officer and senior 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 and Chief
Executive Officer, and Jenna Woodul, its Senior 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, engineering and other
key 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 highly skilled sales, engineering and other key personnel.
Competition for such personnel is intense in the Internet industry, especially
in the very intense Silicon Valley employment market, and the Company may be
unable to successfully attract, integrate or retain sufficiently qualified
personnel. The Company has, in the past, experienced, and expects to continue
to experience difficulty in hiring and retaining highly skilled and qualified
employees, especially engineers, 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 could slow its growth
strategy
As part of its continued strategy to expand its online marketing services,
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
services, personnel or technologies. These difficulties could disrupt its
ongoing business, distract its management and employees, and increase its
expenses.
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 450
individuals as of June 30, 2000, 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.
Talk City's volunteer community leaders could be viewed as employees, which
would substantially increase its operating expenses
If the Company's active volunteer community leaders, consisting of
approximately 1,250 individuals as of June 30, 2000, were viewed as employees,
Talk City could be subject to payment of back wages and other penalties and
its operating expenses could substantially increase. Previously, former
volunteers of America Online, Inc. ("AOL") 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, network participants and advertisers. Talk
City's ability to attract potential business clients, 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 effectively perform its online marketing services for its business clients
in order to increase the usage of its online marketing services by business
clients. Increased usage of the Company's online marketing services 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 usage of its
services. In addition, the Company's users depend on Internet
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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
the Company's 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, which are separate from
its principal offices, are located at GlobalCenter's 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 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 growth of the Internet and intense competition in the industry
exacerbate these market characteristics. In addition, in recent months many
Internet-related companies, similar to Talk City, have consolidated or
restructured in order to remain competitive within the Internet industry. To
succeed, Talk City will need to effectively implement its Restructuring,
integrate the various software programs and tools required to enhance and
improve its service offerings and be accepted by and manage its business. Any
enhancements or new services or features must meet the requirements of its
current and prospective clients 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 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
information
If third parties were able to penetrate the Company's network security or
otherwise misappropriate its users' personal information, Talk City could be
subject to liability. These could include claims for 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 previously investigated 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 services, 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.
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 on the Internet, but Talk City expects more stringent laws and
regulations to be enacted due to the 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
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<PAGE>
volume and increase operating expenses. In addition, the application of
existing laws to the Internet is uncertain and 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;
. information security;
. the convergence of traditional channels with Internet commerce; and
. taxation and pricing.
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's volume and
the demand for its online marketing services would decline which would cause
its revenues to decrease. The 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 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 Web sites. The Company also could be subject to
liability for content that is accessible from its Web sites through links to
other Web sites. Although Talk City carries general liability and multimedia
liability insurance, the Company's insurance may not cover potential claims of
this type 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, consumers and advertisers could result in price
reductions, reduced margins or loss of market share, any of which could
decrease Talk City's revenues and contribute to the Company not achieving
profitability and failing. The barriers to entry in the Internet services
market are low and the Company expects the number of its competitors to
increase. Any company or individual can establish and maintain a Web site for
minimal cost. Talk City competes for business clients, consumers, network
participants and advertisers with numerous companies, including the following:
. online services or Web sites that produce online marketing services,
such as live events, market research or customized community solutions,
including Prospero Technologies Corporation ("Prospero"), Broadcast.com,
Inc., and Greenfield Online;
. 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"), Prospero, 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;
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<PAGE>
. 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, the Company 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 users and the delivery of advertising impressions on its
Web sites. Companies may choose not to advertise on the Company's 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 other software the Company has purchased from third parties,
such as Microsoft Exchange for real-time chat and Netscape Web Servers for ad
serving and management, is not reliable or does not function properly.
Talk City is dependent on the trademark "Talk City" and if the Company could
not use this mark, it would need to reimplement its Web site and re-build its
brand identity
Talk City is dependent on the trademark "Talk City." If the Company were
prevented from using this trademark, 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, 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.
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<PAGE>
Talk City's stock price has recently traded far below the initial offering
price and could remain at such low price or be extremely volatile as the
market for Internet companies' stock has recently decreased and experienced
extreme price and volume fluctuations
The market price of Talk City's Common Stock has traded far below the IPO
price and may remain at such low price or be volatile as the market for
Internet-related companies has experienced extreme price and volume
fluctuations previously and, more recently, has substantially decreased. The
market demand, valuation and trading prices of Internet-related companies has
historically been high. At the same time, the share prices of these
companies' stocks have been highly volatile and have recorded lows well below
their historical highs. As a result, investors in these companies have often
bought the stock at 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. Since Talk City's IPO, the market price of its Common
Stock has substantially traded at or below the initial offering price of
$12.00 per share. If the price per share does not increase, the Company's
investors may incur a substantial loss on their investment. The Company
cannot assure investor that its stock price will increase to trade at the same
levels as other technology stocks. The sustained depression of 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.
Talk City's stock price may continue to be depressed due to broad market and
industry factors beyond its control
Talk City's stock price may continue to be depressed due to a variety of
factors, including factors beyond its control. These broad market and
industry factors could continue to harm the market price of its Common Stock,
regardless of the Company's performance. These factors include:
. announcements of or new programming by the Company or its competitors,
including the Company's announcement of its Restructuring;
. conditions or trends in the Internet services industry;
. changes in the market valuations of Internet companies;
. 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.
If Talk City raises additional capital through the issuance of new securities,
existing stockholders will incur additional dilution
If the Company raises additional capital through the issuance of new
securities, its stockholders will be subject to additional dilution. In
addition, any new securities issued may have rights, preferences or privileges
senior to those securities held by the Company's current stockholders.
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 Company's Board of Directors ("Board"), issues Preferred Stock,
potential acquirers may not make acquisition bids for the Company, the
Company's 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.
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<PAGE>
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 for changes in interest rates relates
primarily to its investment portfolio. The Company does not use derivative
financial instruments in its investment portfolio. Talk City places its
investments with high quality issuers and, by policy, limits the amount of
credit risk exposure to any one issuer. The Company is averse to principal
loss and ensures the safety and preservation of its invested funds by limiting
default, market and reinvestment risk. Talk City classifies its cash
equivalents and short-term investments as "fixed rate" if the rate of return
on such instruments remains fixed over their term. These "fixed rate"
investments include fixed rate commercial paper, corporate notes, and market
auction preferred securities. We classify our cash equivalents and short-term
investments as "variable rate" if the rate of return on such investments
varies based on the change in a predetermined index or set of indices during
their term. These "variable rate" investments primarily include money market
accounts held at various securities brokers and banks. The table below
presents the amounts and related weighted average interest rates of the
Company's investment portfolio at June 30, 2000:
<TABLE>
<CAPTION>
Average Book Fair
Interest Rate Value Value
------------------ ---------------- -----------------
<S> <C> <C> <C>
Cash equivalents:
Fixed rate 6.59% $ 5,259 $ 5,259
Variable rate 6.64% 6,901 6,901
Short-term investments:
Fixed rate 6.08% 11,134 11,134
Variable rate 6.59% 2,821 2,821
</TABLE>
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
d) Use of Proceeds from Sales of Registered Securities
-- ---------------------------------------------------
On July 20, 1999, Talk City consummated the IPO of its Common
Stock. The shares of Common Stock sold in the offering were
registered under the Securities Act on a Registration Statement on
Form S-1 (the "Registration Statement") which was declared
effective by the SEC on July 19, 1999 (file number 333-77455). The
aggregate offering amount registered pursuant to the IPO was $61.2
million. After deducting the underwriting discounts and
commissions of $4,284,000, and the IPO expenses of $1,487,000, the
net proceeds from the IPO were approximately $55.4 million.
From April 1, 2000 through June 30, 2000, Talk City has applied
proceeds from the IPO as follows:
Restructuring payments: $0.4 million
Purchase of property and equipment: $1.9 million
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<PAGE>
Working capital: $9.0 million
The foregoing amounts represents the Company's best estimates
of its use of proceeds for the period indicated.
Item 4 Securities of Matter to a Vote of Security Holders
On May 19, 2000, the Company held its annual meeting of stockholders at its
principal offices in Campbell, CA. At such meeting, the following matters
were voted upon by the Company's stockholders, with the resultant votes:
<TABLE>
<CAPTION>
Matter Votes For Votes Against Votes Withheld Abstentions Broker Non-Votes
----------------------------------------- ------------- --------------- ----------------- ------------- ------------------
<S> <C> <C> <C> <C> <C>
1. Election of Kenneth A. Bronfin as a 21,361,458 0 N/A 44,162 N/A
director
2. Election of Thomas P. Hirschfeld as 21,361,057 0 N/A 44,563 N/A
a director
3. Ratify KPMG, LLP as independent 21,370,367 10,710 N/A 24,543 N/A
public accountants to the company
4. Ratify an amendment to the Company's 14,913,459 1,290,212 N/A 816,448 N/A
Amended and Restated 1996 Stock Option
Plan (the "Plan") to (i) increase the
reserve hereunder by 3,500,000 shares
of Common Stock, and (ii) change the
annual automatic increase under the
Plan to the lesser of (i) 2,000,000
shares, (ii) 7% of the then outstanding
shares of Common Stock, and (iii) a
lesser amount determined by the Board
of Directors of the Company
</TABLE>
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
<TABLE>
<S> <C>
2.1 Agreement and Plan of Reorganization between the Company and Research Connections,
Inc., dated January 3, 2000.***
3.2 Second Amended and Restated Certificate of Incorporation of the Company.*
3.3 Bylaws of the Company.*
4.1 Form of the Company's Common Stock certificate.*
4.2 Third Amended and Restated Shareholders Rights Agreement, dated April 23, 1999, between
the Company and the parties named therein, as amended on May 26, 1999.*
10.1 Form of Indemnification Agreement entered into by the Company with each of its
directors and executive officers.*
10.2 1996A Stock Option Plan and related agreements.*
10.3 Amended and Restated 1996 Stock Option Plan and related agreements.*
10.4 1999 Employee Stock Purchase Plan.*
</TABLE>
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<PAGE>
<TABLE>
<S> <C>
10.5 1999 Director Option Plan.*
10.6 Office Lease Agreement, dated May 21, 1997, by and between the Company and The
Manufacturers Life Insurance Company (U.S.A.).*
10.7 Office Lease Agreement, dated February 28, 1999, by and between the Company and SLG
Graybar LLC.*
10.8 Repurchase Agreement, dated November 20, 1996, as amended, by and between the Company
and Peter H. Friedman.*
10.9 Repurchase Agreement, dated November 20, 1996, as amended, by and between the Company
and Jenna Woodul.*
10.10 Stock Option Agreement, dated March 1, 1999, by and between the Company and Jeffrey
Snetiker.*
10.11 Master Service Agreement, dated April 19, 1999, by and between the Company and Frontier
GlobalCenter.*
10.12 Network Affiliation Agreement, dated March 1, 1998 by and between the Company and 24/7
Media Inc.*
10.13 Content and Services Agreement, effective July 19, 1998, by and between the Company and
WebTV Networks, Inc., as amended on July 27, 2000.
10.14 Contract, dated May 13, 1997, by and between the Company and NFO Research.*
10.15 Operating Agreement, dated August 24, 1998, by and between the Company and Cox
Interactive Media, Inc.*
10.16 Hearst-Talk City Operating Agreement, dated April 20, 1999, by and between the Company
and Hearst New Media and Technology division, a division of Hearst Communications, Inc.*
10.17 Series D Preferred Stock Purchase Agreement, dated October 30, 1998, by and between the
Company and Hearst Communications, Inc., Hearst New Media & Technology division, as
amended on April 15, 1999.*
10.18 NBC-Talk City Chat Services Agreement, dated August 21, 1998, by and between the
Company and NBC Multimedia, Inc., as amended on April 19, 1999.*
10.19 Letter Agreement, dated February 25, 1998, by and between the Company and NBC
Multimedia, Inc., as amended on July 27, 1998 and April 19, 1999.*
10.21 Lease Agreement, dated May 5, 1999, by and between the Company and Pruneyard
Associates, LLC.*
10.22 Sublease Agreement, Second Amendment to Lease and Consent to Sublease Agreement, and
Tri-Party Construction Agreement dated October 20, 1999, by and between the Company,
Compuware Corporation and Pruneyard Associates, LLC.**
27.1 Financial Data Schedule (filed only with the electronic submission of Form 10-Q in
accordance with the Edgar requirements).
</TABLE>
______________
* Incorporated by reference from the Company's 424(b) Prospectus, dated July
19, 1999, as declared effective by the Securities and Exchange Commission
on July 19, 1999.
** Incorporated by reference from the Company's Quarterly Report on Form
10-Q for the period ended September 30, 1999.
*** Incorporated by reference from the Company's Annual Report on Form 10-K
for the period ended December 31, 1999.
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the three months
ended June 30, 2000.
27
<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
(principal financial or chief financial officer and duly authorized signatory)
August 10, 2000
28
