<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Form 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- EXCHANGE ACT OF 1934
For the quarter ended March 31, 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 May 5, 2000 was 24,988,211.
- --------------------------------------------------------------------------------
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TALK CITY, INC.
FORM 10-Q
INDEX
PAGE NUMBER
-----------
PART I. FINANCIAL INFORMATION
Item 1. Condensed Financial Statements:
Unaudited Condensed Balance Sheets at March 31, 2000
and December 31, 1999 3
Unaudited Condensed Statements of Operations for the three
months ended March 31, 2000 and 1999 4
Unaudited Condensed Statements of Cash Flows for the three
months ended March 31, 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 6. Exhibits and Reports on Form 8-K 26
Signatures 28
2
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Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
TALK CITY, INC.
UNAUDITED CONDENSED BALANCE SHEETS
(in thousands)
March 31, December 31,
2000 1999
------------ ------------
Assets
Current assets:
Cash and cash equivalents $ 25,089 $ 14,112
Short term investments 18,546 41,541
Accounts receivable, net 3,726 3,533
Prepaid expenses and other current assets 828 1,772
------------ ------------
Total current assets 48,189 60,958
Property and equipment, net 8,357 5,689
Other assets 8,663 7,880
Goodwill, net 3,246 -
------------ ------------
Total assets $ 68,455 $ 74,527
============ ============
Liabilities and Stockholders' Equity
Current liabilities:
Notes payable, current portion $ 146 $ 154
Accounts payable 2,917 3,977
Accrued liabilities 3,980 3,302
Deferred revenue 1,083 664
------------ ------------
Total current liabilities 8,126 8,097
Notes payable, less current portion 79 107
------------ ------------
Total liabilities 8,205 8,204
Stockholders' equity:
Common stock 25 24
Additional paid-in-capital 135,145 131,306
Deferred stock based compensation (472) (550)
Notes receivable from stockholders (981) (992)
Accumulated deficit (73,467) (63,465)
------------ ------------
Total stockholders' equity 60,250 66,323
------------ ------------
Total liabilities and stockholders' equity $ 68,455 $ 74,527
============ ============
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
-----------------------------------------
March 31, March 31,
2000 1999
---------------- ----------------
<S> <C> <C>
Revenues:
Business services $ 1,572 $ 357
Advertising and sponsorships 1,963 623
---------------- ----------------
Total revenue 3,535 980
Cost of revenue 3,619 1,345
---------------- ----------------
Gross margin (84) (365)
Operating expenses:
Product development 1,765 758
Sales and marketing 4,934 3,546
General and administrative 3,051 974
Noncash advertising and promotional charges 718 1,410
Amortization of goodwill 171 --
Total operating expenses 10,639 6,688
---------------- ----------------
Loss from operations (10,723) (7,053)
Interest income, net 721 154
---------------- ----------------
Net loss (10,002) (6,899)
Accretion of discount related to redeemable
convertible preferred stock and warrants -- 72
---------------- ----------------
Net loss applicable to common stockholders $ (10,002) $ (6,971)
================ ================
Basic and diluted net loss per common share $ (0.41) $ (1.90)
================ ================
Weighted average basic and diluted common shares
outstanding 24,530 3,661
================ ================
</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>
Three Months Ended
--------------------------------
March 31, March 31,
2000 1999
------------- ------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (10,002) $ (6,899)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 861 162
Loss on sale of property and equipment 15 -
Stock compensation expense 78 169
Noncash advertising and promotional charges 717 1,410
Provision for accounts receivable allowance 60 -
Changes in operating assets and liabilities:
Accounts receivable (253) (449)
Prepaid expenses and other current assets 944 (47)
Accounts payable (1,060) 647
Accrued liabilities 678 358
Deferred revenue 419 -
------------- ------------
Net cash used in operating activities (7,543) (4,649)
------------- ------------
Cash flows from investing activities:
Purchases of property and equipment (3,392) (531)
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) -
Proceeds from sale of short-term investments 27,280 -
Other assets (1,500) (4)
------------- ------------
Net cash provided by (used in) used in investing activities 17,705 (535)
------------- ------------
Cash flows from financing activities:
Proceeds from stock option and warrant exercises 842 -
Proceeds from repayment of stockholders' notes receivable 9 -
Repayment of notes payable (36) (29)
------------- ------------
Net cash provided by (used in) financing activities 815 (29)
------------- ------------
Net increase (decrease) in cash and cash equivalents 10,977 (5,213)
Cash and cash equivalents at beginning of period 14,112 8,697
------------- ------------
Cash and cash equivalents at end of period $ 5,089 $3,484
============= ============
Cash paid during the period for interest $ 13 $16
============= ============
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 $ - $ 72
============= ============
Common stock issued for notes receivable, net of repurchases $ - $ 618
============= ============
Issuance of stock and warrants for advertising and promotional services $ - $ 904
============= ============
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 March 31, 2000 and the operating results and
cash flows for the three months ended March 31, 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 March 31, 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 months ended March 31, 2000 is
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 communities and interactive services for
businesses and consumers. The Company offers businesses a wide range of
services to help them develop and expand online relationships with
customers, suppliers and employees. These services include designing
fully integrated, customized communities, producing online events and
conducting online market research. For consumers, the Company operates
a network of online communities located at www.talkcity.com. These
----------------
communities offer services such as moderated chat, home pages, special
event production, message boards and online event guides. The Company
generates revenues by selling business services and advertising and
sponsorships on its Web sites to corporations of various sizes within
several industries. Talk City has incurred operating losses since
inception through March 31, 2000. The Company had an accumulated
deficit of $73.5 million at March 31, 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 is due as follows: $250,000 was
paid on January 3, 2000; $125,000 was paid on April 3, 2000; and $125,000
will be paid on July 3, 2000. In addition, contingent cash consideration of
$1.5 million, subject to an employment agreement with the 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 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.
6
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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 March 31, 2000, $3.8 million remains in
Other Assets and will continue to be charged to operations as the related
advertising is run or amortized over the remaining term of the respective
operating agreements. Of the $3.8 million, $2.6 million relates to the
Hearst advertising agreement and $1.2 million relates to the NBC operating
agreements. The Company incurred noncash advertising and promotional charges
of approximately $718,000 and $1.4 million for the three months ended March
31, 2000 and 1999, respectively.
In connection with the Company's 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.
5. ACCRUED LIABILITIES
Accrued liabilities consist of: March 31, December 31,
2000 1999
----------------- ----------------
(In thousands)
Accrued compensation and benefits $1,521 $ 953
Accrued sales and marketing expenses 591 987
Accrued moderator expenses 407 390
Other accrued liabilities 1,461 972
----------------- ----------------
$ 3,980 $ 3,302
================= ================
7
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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 the United
States. Revenue from one major customer was $381,000 and $272,000 for the
three months ended March 31, 2000 and 1999, respectively. Total receivables
from this customer were $417,000 at March 31, 2000 and $377,000 at
December 31, 1999.
7. COMPREHENSIVE INCOME (LOSS)
Comprehensive loss for the three months ended March 31, 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 March 31, 2000 and 1999:
March 31, March 31,
2000 1999
-------------- -------------
(In thousands)
Common Stock Options 2,468 395
Common Stock Warrants 991 1,306
Restricted Common Stock 264 817
Redeemable Convertible Preferred Stock - 11,081
-------------- -------------
3,723 13,599
============== =============
The average exercise price of the Common Stock Options is $4.11 and
$0.33 as of March 31, 2000 and 1999, respectively. The average exercise
price of the Common Stock Warrants is $5.83 and $5.25 as of March 31,
2000 and 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.
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. The SAB summarizes the SEC's views in applying
generally accepted accounting principles to revenue recognition in financial
statements and requires companies to comply with the SAB no later than the
second quarter of the fiscal year beginning after December 15, 1999. The
Company adopted SAB 101 on January 1, 2000. The adoption of SAB 101 has not
materially impacted the Company's results of operations for the three months
ended March 31, 2000.
8
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Certain statements contained herein constitute "forward looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended (the
"Securities Act") and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). These forward looking statements can be identified
by the use of predictive, future-tense or forward-looking terminology, such as
"believes", "expects," "anticipates," "estimates," "plans," "may," "intends,"
"will," or similar terms. Such statements include statements concerning the
Company's ability to increase the number of business services clients, expand
its business services offerings and effectively implement these services,
increase advertising and sponsorship revenues, improve or maintain audience or
volume measurement metrics, maintain differentiation from other online community
providers, maintain or improve the number or quality of network participants and
customers, attract and retain key personnel and compete successfully in the
marketplace. Actual results may differ materially from those projected in the
forward-looking statements as a result of various factors set forth under
"Factors That May Affect Results" and elsewhere in this report. These
forward-looking statements speak only as of the date hereof. Talk City does not
undertake any obligation to publicly update any forward-looking statement to
reflect events or circumstances after the date on which any such statement is
made or to reflect the occurrence of unanticipated events.
The following discussion of financial condition and results of operations of
the Company should also be read in conjunction with the financial statements and
notes thereto and "Factors That May Affect Results", both of which are included
elsewhere in this report.
Overview
The Company provides online communities and interactive services for
businesses and consumers. From inception through March 2000, the Company's
operating activities have primarily been focused on:
. developing and expanding its business services offerings and clients;
. establishing operating relationships with its network participants;
. expanding the audience and usage of its services;
. building sales momentum and developing programs and content to market
the Talk City brand name and attract users to its sites;
. 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 customized communities, producing online
events and conducting online market research. 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 Web 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.
9
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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 site. 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. After March 31, 2000, noncash
charges of $3.8 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 $3.8 million, $2.6 million relates
to the Hearst advertising agreement and $1.2 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 $10.0 million for the three
months ended March 31, 2000. These losses include noncash advertising and
promotional charges of $14.8 million through March 31, 2000. At March 31, 2000,
Talk City had an accumulated deficit of $73.5 million. The Company anticipates
that it will incur additional operating losses for the foreseeable future.
10
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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:
Three Months Ended
March 31,
---------
2000 1999
---- ----
Net revenue 100 % 100 %
Cost of revenue 102 137
------ ------
Gross margin (2) (37)
Operating expenses:
Product development 50 77
Sales and marketing 140 362
General and administrative 86 99
Noncash advertising and promotional charges 20 144
Amortization of goodwill 5 --
------ ------
Total operating expenses 301 682
------ ------
Operating loss (303) (719)
Interest income, net 20 16
------ ------
Net loss (283)% (703)%
====== ======
Net Revenue. Net revenue increased 261% to $3.5 million for the three months
ended March 31, 2000 from $980,000 for the three months ended March 31, 1999, an
increase of approximately $2.5 million. The increase was primarily due to the
expansion of the Company's sales force, an increased number of business services
projects as a result of a broader and more extensive business 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 business services
revenue was $3.6 million, or 102% of total revenue, for the three months ended
March 31, 2000. Cost of advertising, sponsorship and business services revenue
was $1.3 million, or 137% of total revenue, for the three months ended March 31,
1999. Cost of revenue, as a percent of total revenue, decreased due to a growth
in revenue of approximately $2.6 million over the prior period. Cost of revenue
for the three months ended March 31, 2000 increased in absolute dollars by $2.3
million 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
March 31, 2000 and 1999 were approximately $1.8 million, or 50% of total
revenue, and $758,000, or 77% of total revenue, respectively. 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 business services product portfolio and enhance the
functionality of the Company's Web sites. Talk City expects that product
development will increase for the foreseeable future as it continues to hire
additional personnel, develop and increase the functionality of its business
services products and enhance the quality and functionality of its Web sites.
Sales and Marketing. Sales and marketing expenses for the three months ended
March 31, 2000 and 1999 were approximately $4.9 million, or 140% of total
revenue, and approximately $3.5 million, or 362% of total revenue, respectively.
The increase in absolute dollars in sales and marketing expenses was primarily
attributable to 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 during
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the second half of 1999. Talk City expects that sales and marketing expenses
will increase for the foreseeable future as it continues to expand its internal
sales force, hires additional marketing personnel and increases expenditures for
promotion and marketing of its business services products.
General and Administrative. General and administrative expenses for the
three months ended March 31, 2000 and 1999 were approximately $3.1 million, or
86% of total revenue, and $974,000, or 99% 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 increase in the future as it continues to
hire additional personnel and incur additional costs related to the growth of
its business and operations as a public company.
Noncash Advertising and Promotional Charges. Noncash advertising and
promotional charges for the three months ended March 31, 2000 and 1999 were
$717,000, or 20% of total revenue, and approximately $1.4 million, or 144% of
total revenue, respectively. The decrease in noncash and promotional charges for
the three months ended March 31, 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 $171,000 as
of March 31, 2000. This amortization is 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 March 31, 2000 and
1999 was $721,000 and approximately $154,000, respectively. The increase in
interest income, net was primarily due to higher average investment balances
during the three months ended March 31, 2000 as a result of the Company's
private placement in April 1999 of Preferred Stock, with aggregate net proceeds
of approximately $20.0 million, and 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.
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
March 31, 2000, the Company had approximately $25.1 million in cash and cash
equivalents and approximately $18.5 million in short-term investments.
Net cash used in operating activities was approximately $7.5 million and
$4.6 million for the three months ended March 31, 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.
Net cash provided by investing activities was approximately $17.7 million
and net cash used in investing activities was $535,000 for the three months
ended March 31, 2000 and 1999, respectively. Cash provided by investing
activities for the three months ended March 31, 2000 consisted of approximately
$27.3 million in sales of short-term investments partially offset by
approximately $3.4 million in purchases of equipment, approximately $4.3 million
in purchases of short-term investments and $1.5 million placed into an escrow
fund
12
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for an employment agreement with the 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 began to purchase additional servers for
its co-location server site which is expected to be operational in the second
quarter of 2000.
Net cash provided by financing activities was approximately $815,000 and net
cash used in financing activities was $29,000 for the three months ended March
31, 2000 and 1999, respectively. Net cash provided by financing activities for
the three months ended March 31, 2000 consisted primarily of net proceeds of
$842,000 from stock option and warrant exercises partially offset by principal
payments on notes payable. Net cash used in financing activities for the three
months ended March 31, 1999 consisted of principal payments on notes payable.
As of March 31, 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 $18.4 million as of
March 31, 2000.
In May 1998, Talk City obtained an equipment line of credit with a financial
institution in the amount of $2.0 million. This line of credit is secured by the
Company's fixed assets and has a four year term that expires in April 2002. As
of March 31, 2000, the amount outstanding under this line of credit was
$225,000.
Talk City's capital requirements depend on numerous factors, including
market acceptance of its business services, the resources the Company allocates
to its community network, marketing and selling its services, brand promotions
and other factors. The Company has experienced substantial increases in its
expenditures since its inception consistent with growth in its operations and
personnel, and the Company anticipates that its expenditures will continue to
increase for the foreseeable future. Additionally, the Company will continue to
evaluate possible acquisitions of or investments in complementary businesses,
technologies, services or products and plans to expand its sales and marketing
programs. Talk City currently believes that its available cash and cash
equivalents will be sufficient to meet its anticipated needs for working capital
and capital expenditures for at least the next 18 months. The Company may need
to raise additional funds, however, in order to fund more rapid expansion,
including significant increases in personnel and office facilities; to develop
new or enhance existing services or products; to respond to competitive
pressures; or to acquire or invest in complementary businesses, technologies,
services or products. In addition, in order to meet its long term liquidity
needs, the Company may need to raise additional funds, establish a credit
facility or seek other financing arrangements. Additional funding may not be
available on favorable terms or at all.
Factors That May Affect Results
Talk City has incurred losses since inception and it may be unable to achieve
profitability or generate positive cash flow
Talk City incurred net losses of $1.3 million in 1996, $6.4 million in 1997,
$15.7 million in 1998, $40.1 million in 1999 and $10.0 million for the three
months ended March 31, 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 business services clients;
. increase its sales and marketing activities, including increasing the
number of its sales personnel;
. expand its content and community offerings for its users;
. expand its moderator network; or
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. introduce e-commerce services.
Talk City expects to continue to incur significant operating expenditures,
as well as noncash advertising and promotional charges, and as a result the
Company will need to generate significant revenues to achieve and maintain
profitability. As of March 31, 2000, Talk City had an accumulated deficit of
approximately $73.5 million, including noncash advertising and promotional
charges of $14.8 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
It is likely that the Company's operating results in one or more future
quarters may be below the expectations of its investors, and as a result the
price of its Common Stock could decline. Talk City expects that its quarterly
operating results will continue to fluctuate significantly and be affected by
many factors, the more important of which include:
. its dependence on increased business services and advertising and
sponsorship revenues;
. expansion of its sales force;
. the length of its sales cycle, particularly its business services sales
cycle;
. its ability to increase its audience of loyal, engaged users;
. management of growth; and
. potential technical difficulties or system down time affecting the
Internet generally or the Company specifically.
These factors are described in more detail in the risk factors described
below. Many of these factors are beyond the Company's control.
Talk City's revenue model is new and unproven and the Company must continue to
generate and develop multiple revenue streams
The success of the Company's revenue model will depend on its ability to
generate multiple revenue streams through its community network. To be
successful, Talk City must, among other things, develop and market products and
services that achieve broad market acceptance by its business clients, users and
advertisers. Talk City's inability to generate multiple revenue streams will
contribute to its not achieving profitability and may cause its accumulated
deficit to increase.
Revenue growth in prior periods may not be indicative of future growth
The Company achieved significant revenue growth in 1999 as well as the three
months ended March 31, 2000. Its limited operating history makes prediction of
future growth difficult. Accurate predictions of future growth are also
difficult because of the rapid changes in its markets as a result of increased
competition, evolving technology and customers' 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 business services
revenues
Talk City derives a substantial portion of its revenues from the sale of
business services and it expects to continue to rely on these revenues for the
foreseeable future. If the Company does not continue to develop business
services revenues, its revenues may not meet its expectations or may decline and
Talk City will need to revise its revenue model to reflect this. Business
services represented 12% of its total revenues in 1997, 36% of its total
revenues in 1998, 33% of its total revenues in 1999 and 44% of its total
revenues in the three months ended March 31, 2000. The Company's growth and
future success will depend on its ability to increase the
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number of its business services clients, expand its business services offerings,
effectively implement these services and increase the average revenue per
project and per client. Talk City's ability to generate significant business
services revenues will also depend, in part, on its ability to create new
business services offerings without diluting the value of its existing programs.
Talk City has only recently begun to hire business services sales personnel and
intends to hire additional business service personnel in the near future.
Talk City's growth will depend upon the acceptance of the Internet as an
attractive medium for its business services clients
Talk City's current and potential business clients must accept the Internet
as an attractive and sustainable substitute medium for the traditional methods
to which they are accustomed. The market for business services may not continue
to develop and may not be sustainable. The Internet as a business services
solution has not been available for a sufficient period of time for the Company
to gauge its effectiveness as compared with traditional methods, such as trade
shows, phone and mail surveys and video conferencing.
Talk City recently launched its marketing campaign to increase awareness of its
business services offerings, with no guarantee of success, which could decrease
our results of operations
Talk City recently began its "We Helped" marketing campaign to increase the
industry's awareness of its business services offerings. If this campaign does
not increase awareness or generate sales of the Company's business services at
the level it anticipates, or at all, the Company's limited sales and marketing
resources will have been expended with no increase in its revenues, which could
decrease its results of operations. In addition, if the Company's campaign is
not successful, its sales and marketing personnel will have been diverted and
focused on this failed campaign when they could have been focused on other
activities, such as sales and marketing efforts towards its advertisers and
sponsors or network participants.
Talk City relies heavily on advertising and sponsorship revenues, and if its
advertising and sponsorship revenues decline due to lack of acceptance of the
Internet as an advertising medium, its business will not grow or will decrease
Talk City 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 56% of its revenue for the three months ended March 31,
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 customers have little or no experience using the Internet for
advertising purposes and they have allocated only a limited portion of their
advertising budgets to Internet advertising. Use of the Internet by consumers is
at a very early stage of development and market acceptance of the Internet as a
medium for advertising is subject to a high level of uncertainty. No standards
are widely accepted to measure the effectiveness of Internet advertising. If
these standards do not develop, existing sponsors or advertisers may not
continue their current level of Internet-based programming, and sponsors or
advertisers who are not currently advertising on the Internet may be reluctant
to do so.
If Talk City does not provide its advertisers with the guaranteed number of
impressions required by its contracts with them, its reputation would be harmed
and its advertising inventory would be decreased
The terms of the Company's advertising contracts generally range from one
week to 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 would 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
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not met, Talk City defers recognition of the corresponding revenues until
guaranteed impression levels are achieved.
Talk City relies on its network participants for user volume and increased
revenues
Talk City's network participants currently drive approximately 66% of the
volume of the Company's sites, which is defined as the number of Internet page
views or Internet advertisement views seen by its users. The volume is
considered to be "driven" by the network participant if the user comes to the
Company's sites via the participant's 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 66% 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 three months ended March 31,
2000, approximately 33% 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 33% of its advertising and sponsorship revenue.
Talk City would need to replace these revenues with increased revenues from its
business services. For the three months ended March 31, 2000, none of the
Company's network participants individually drove volume responsible for more
than 10% of its advertising and sponsorship revenue, except WebTV Network which
was responsible for approximately 19% of its advertising and sponsorship revenue
for the quarter.
Talk City relies on WebTV Network for a substantial amount of its volume and
revenues, and if its contract with WebTV Network were not renewed or terminated,
the Company would need to replace this volume and revenues through other sources
Talk City has a two-year contract with WebTV Network which runs through July
2000. If this contract were to be terminated or not renewed, the Company could
lose as much as 43% of its volume. The Company would need to replace this volume
with volume from its other network participants, through the growth of its sites
or with volume generated through other means, such as increased marketing, any
of which would result in an unexpected diversion of management efforts or
increased operating expenses. In addition, if Talk City were unable to replace
this volume, the Company may be unable to replace the 19% of its advertising and
sponsorship revenues generated by WebTV Network.
Talk City recently 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 recent acquisition of RCI, an online market research company,
will only be successful if the Company is able to integrate its operations with
its own, which could substantially divert attention from the day-to-day
operations of the combined company. The diversion of the attention of
management, especially its Vice President of Business Services and other key
business services sales personnel, and any difficulties encountered in the
transition process could cause the revenues and operating results of the
combined company to decline. The Company must successfully integrate RCI's
services offerings, specifically online market research, with its own.
In addition, integrating personnel with disparate business backgrounds and
corporate cultures may be difficult. Further, this integration must occur at a
time when the Company is significantly increasing its focus and sales and
marketing efforts on its business services, including online market research
sales. The sales personnel of RCI must effectively work with Talk City's
personnel for this to be successful. It is possible that neither Talk City nor
RCI will retain key management and sales personnel.
The acquisition of RCI 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
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development efforts. This may result in the delay or cancellation of orders, a
significant decrease in Talk City's business services revenues and limit its
ability to implement its business strategy.
Talk City recently 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 uncertain sales cycle may cause the Company to incur substantial
expenses and expend management time without generating the corresponding
revenues which would slow its cash flow
Talk City's sales cycle, particularly with its business clients, is
generally lengthy and uncertain. During the sales cycle, the Company may expend
substantial funds and management resources without generating corresponding
revenues. The time between the date of its initial contact with a potential
client and the execution of a contract with that potential client typically
ranges from a few weeks for smaller agreements to several months for larger
agreements. Its sales cycle is also subject to delays as a result of factors
over which the Company has little or no control, including the following:
. budgetary constraints;
. internal acceptance reviews;
. the success and continued internal support of advertisers', business
services clients' and network participants' own development efforts; and
. the possibility of cancellation or delay of projects by advertisers,
business services clients or network participants.
The length and uncertainty of its sales cycle also may harm its billing and
collection efforts. The length of the sales cycle prevents the Company from
rendering its services on a more accelerated basis, which slows its cash flow
and reduces its ability to fund the expenditures the Company incurs during the
sales cycle.
Talk City depends on its users for content, promotion and sustaining an engaged
audience, and if its users become dissatisfied or do not become engaged with its
service, the Company would need to increase its expenditures for these
activities
Talk City depends largely on its users for content, word-of-mouth promotion
and for sustaining an involved audience for its advertisers and, to a lesser
extent, its business clients. If its users become dissatisfied or do not become
engaged with its service, they will not generate significant content or promote
its sites and the Company will have to increase the expenditure of its own
resources for these activities. In addition, dissatisfied or disengaged users
would not continue to attract other users to the Company's sites. Loss of its
users and failure to increase its number of engaged users would hurt the
Company's efforts to generate increased revenues. The Company's users may become
dissatisfied with its service as a result of the increased focus on
commercialization of its services due to their continued exposure to advertising
or e-commerce activities on its sites or the use of their information for
commercial purposes. Talk City's users may also become dissatisfied with its
service if the Company does not maintain its structured environment, if it
experiences system failures or it does not continually upgrade its software
functionality. In addition, users may visit its community for a single event,
such as a live event regarding the Grammy Awards, or to explore its community
and not return.
Talk City depends on its trained community leaders and moderators to engage
its users and maintain its structured and moderated programming
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Talk City depends on its network of trained community leaders and
moderators, which consisted of approximately 2,000 individuals as of March 31,
2000, to draw its users into its community and maintain its structured and
moderated programming. Most of its trained community leaders and moderators are
volunteers. These people volunteer because they like to meet and help people
from all over the world, enjoy the recognition they receive in a community
leadership position and generally have fun participating in such a novel form of
communication. As the Internet evolves and online communication becomes more
common, its trained community leaders and moderators may view moderating as less
exciting or less of a novelty than it is now. Loss of its trained community
leaders and moderators, or loss of its ability to attract these individuals to
its service, would cause the Company to implement new programs to engage its
users and maintain its structured environment. The implementation of these new
programs would cause the Company to expend unexpected management time and
resources which would increase its operating expenses.
Maintaining and promoting Talk City's brand identity is a critical aspect of
maintaining and expanding its user base, business clients and the number of its
network participants
We intend to continue our financial commitment to the maintenance and
promotion of our brand loyalty through advertising campaigns in several forms of
media, including television, print and billboards. These campaigns may not
successfully enhance our brand, and we may incur excessive expenses in
connection with our efforts to promote and maintain our brand without generating
a corresponding increase in revenues, which would contribute to our not
achieving profitability. We spent approximately $7.4 million in 1998 and $11.4
million in 1999 on these activities. We expect to spend over $7.8 million in
fiscal year 2000, consisting of a combination of cash and noncash in-kind
advertising. The amounts include co-branding, ingredient branding, where the
Talk City brand receives a less prominent position than the brand, usually as an
ingredient of the overall service offered, such as "chat powered by Talk City,"
and other marketing activities with our network. These other marketing
activities will consist of activities in which we work with our network
participants to promote the services in a way which highlights both brands'
involvement in the services offered.
Promotion and enhancement of our brand also will depend, in part, on our
ability to continue to provide a clean, well lighted community experience.
The value of our brand could diminish if businesses, users, network
participants and advertisers do not perceive the www.business.talkcity.com
business experience or www.talkcity.com community experience to be of high
quality or if we introduce new services or enter into new business ventures
that are not well received.
Talk City is growing rapidly and must effectively manage and support its growth
in order for its business strategy to succeed
Talk City has grown rapidly and will need to continue to grow in all areas
of operation in order to execute its business strategy. Managing and sustaining
its growth will place significant demands on management as well as on its
administrative, operational and financial systems and controls. If the Company
is unable to do this effectively, the Company would have to divert resources
such as management time away from the continued growth of its business and
implementation of its business strategy. Talk City had 82 employees as of March
31, 1999 compared to 225 employees as of March 31, 2000. The Company anticipates
further significant increases in the number of its employees, especially in its
sales, marketing and engineering departments, in order to increase its business
services and advertising revenues and enhance the content and functionality of
its Web sites. This rapid growth caused the Company to outgrow its previous
office facilities sooner than it expected. Accordingly, Talk City has relocated
its corporate headquarters to a 56,000 square foot facility in Campbell,
California.
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
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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.
Talk City must continually attract and retain its sales, engineering, marketing
and other personnel or the Company will be unable to execute its business
strategy
Talk City's future success also will depend on its ability to attract,
retain and motivate highly skilled sales, engineering, and marketing personnel.
Competition for these 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 it 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 would slow its growth
strategy
As part of its continued strategy to expand its business services products,
to expand the range of its community applications and features and to acquire
additional community audiences, the Company may acquire or make investments in
complementary businesses, technologies, services or products if appropriate
opportunities arise. Talk City may be unable to identify suitable acquisition or
investment candidates at reasonable prices or on reasonable terms. Additionally,
regardless of whether suitable candidates are available, the Company may be
unable to consummate future acquisitions or investments, which could harm its
growth strategy. If Talk City does acquire a company or make other types of
acquisitions, the Company could have difficulty integrating the acquired
products, personnel or technologies. These difficulties could disrupt its
ongoing business, distract its management and employees and increase its
expenses.
Talk City's paid moderators could be viewed as employees rather than independent
contractors which could subject the Company to adverse tax and employee benefit
consequences
Talk City treats its paid moderators, consisting of approximately 400
individuals, as independent contractors. The Company's paid moderators sign
independent contractor agreements and are paid a flat monthly fee or per hour.
One or more jurisdictions may deem its paid moderators to be employees rather
than independent contractors and seek to impose taxes, and any applicable
interest and penalties, on the Company. The law regarding the distinction
between independent contractors and employees is not entirely clear. The Company
could be subject to substantial tax and employee benefit liabilities if it were
ultimately determined that its paid moderators are actually employees.
Talk City's volunteer community leaders could be viewed as employees, which
would substantially increase its operating expenses
If the Company's volunteer community leaders, consisting of approximately
1,600 individuals, were viewed as employees, Talk City could be subject to
payment of back wages and other penalties and its operating expenses could
substantially increase. 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
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System failures could harm the Company's reputation and reduce its
attractiveness to businesses, users, network participants and advertisers. Talk
City's ability to attract potential business clients, users, network
participants and advertisers to promote its brand will depend significantly on
the performance of its network infrastructure. In addition, a key element of its
strategy is to generate a high level of user volume. An increase in the volume
of user traffic could strain the capacity of its infrastructure, resulting in a
slowing or outage of its services and reduced traffic to its Web sites. Talk
City may be unable to improve its technical infrastructure in relation to
increased user volume. The Company's users depend on Internet service providers,
online service providers and other Web site operators for access to its Web
sites. Many of these providers and operators have also experienced significant
outages in the past, and they could experience outages, delays and other
difficulties due to system failures unrelated to its systems.
Talk City's communications and other computer hardware operations are subject to
disruptions which are out of its control and for which the Company may not have
adequate insurance
Fire, floods, earthquakes, power loss, telecommunications failures,
break-ins and similar events could damage the Company's communications hardware
and other computer hardware operations. These operations, 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's business is largely dependent on the development and growth of the
Internet, which may not grow, or if it does grow, may be unable to support the
demands placed on it by this growth
Talk City's market is new and rapidly evolving. The usage of its Web sites,
which drives the Company's volume and in turn its revenues, may not grow if
Internet usage in general does not continue to grow. If Internet usage does
continue to grow, the Internet infrastructure may be unable to support the
demands placed on it by this growth and its performance and reliability may
decline. Varying factors could inhibit future growth in Internet usage,
including:
. inadequate network infrastructure;
. security concerns;
. inconsistent quality of service; and
. unavailability of cost effective, high speed service.
Many Web sites have experienced interruptions in their services as a result
of outages and other delays occurring throughout the Internet network
infrastructure. Internet usage, as well as the usage of the Company's Web sites,
could decline or grow at a slower rate than expected if these outages or delays
frequently occur in the future.
Talk City must keep pace with rapid technological change and the intense
competition of the Internet industry in order to succeed
Talk City's market is characterized by rapidly changing technologies,
frequent new product and service introductions and evolving industry standards.
The recent growth of the Internet and intense competition in the industry
exacerbate these market characteristics. To succeed, Talk City will need to
effectively integrate the various software programs and tools required to
enhance and improve its product offerings and manage its business. Any
enhancements or new services or features must meet the requirements of its
current and prospective users and must achieve significant market acceptance.
The Company's success also will depend on its ability to adapt to rapidly
changing technologies by continually improving the performance features and
reliability of its services. The Company may experience difficulties that could
delay or prevent the successful development, introduction or marketing of new
products and services. Talk City could also incur substantial costs if it needs
to modify its services or infrastructure to adapt to these changes.
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Talk City may be liable for misappropriation by others of its users' personal or
credit card information
If third parties were able to penetrate the Company's network security or
otherwise misappropriate its users' personal information or credit card
information, Talk City could be subject to liability. These could include claims
for unauthorized purchases with credit card information, impersonation or other
similar fraud claims.
Talk City may be liable for its use or sale of its users' personal information
Talk City could be subject to liability claims by its users for misuses of
personal information, such as for unauthorized marketing purposes. In addition,
the Federal Trade Commission has 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
service, applications and features and to target its advertisements and
communications. The Company also uses this information externally to provide its
advertisers with the demographics of its user base. Talk City may, in the
future, sell its user information on an aggregate, not individual, basis.
Talk City may be subject to liability for products sold through its Web sites
Consumers may sue the Company if any of the products that it sells online
are defective, fail to perform properly or injure the user. Liability claims
resulting from the sale of products could require the Company to spend
significant time and money in litigation or to pay significant damages. To date,
Talk City has had very limited experience in the sale of products online and the
development of relationships with manufacturers or suppliers of such products.
The Company has developed a range of e-commerce opportunities, such as the Talk
City Company Store and Talk City Shopping Network, which will increase the
Company's potential liability for products sold via the Company's Web sites.
Internet security and concerns could hinder e-commerce
The need to securely transmit confidential information over the Internet has
been a significant barrier to e-commerce and communications over the Internet.
Talk City may incur significant costs to protect against the threat of security
breaches or to alleviate problems caused by breaches like this. The Company's
insurance policies carry coverage limits that may not be adequate to reimburse
for losses caused by security breaches. Any well-publicized compromise of
security could deter people from using the Internet or using it to conduct
transactions that involve transmitting confidential information.
Changes in government regulation could limit Talk City's Internet activities or
result in additional costs of doing business on the Internet
Currently, few laws or regulations exist that specifically regulate
communications or commerce on the Internet, but Talk City expects more stringent
laws and regulations to be enacted due to the increasing popularity and use of
the Internet. Any new legislation or regulations or the application of existing
laws and regulations to the Internet could limit user volume and increase
operating expenses. In addition, the application of existing laws to the
Internet is uncertain, may take years to resolve and could expose the Company to
substantial liability for which Talk City might not be indemnified by the
content providers or other third parties. Existing laws and regulations
currently, and new laws and regulations are likely to, address a variety of
issues, including the following:
. user privacy and expression;
. the rights and safety of children;
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. intellectual property;
. information security;
. anticompetitive practices;
. the convergence of traditional channels with Internet commerce;
. taxation and pricing; and
. the characteristics and quality of products and services.
Those laws that do reference the Internet, such as the Digital Millennium
Copyright Act, have not yet been interpreted by the courts and their
applicability and reach are not defined. The Federal Trade Commission has
submitted proposals to the Internet industry regarding the rights and safety of
children using the Internet and is expected to issue regulations in this area.
If Internet service providers become regulated in a manner similar to long
distance telephone carriers, Internet growth may grow at a slower pace which
would cause the Company's revenues to decrease
If Internet growth slows due to proposals to regulate Internet service
providers similar to long distance telephone carriers, Talk City user volume and
the demand for its business services would decline which would cause its
revenues to decrease. Increased use of the Internet has burdened the existing
telecommunications infrastructure and led to interruptions in phone service in
areas with high Internet use. Several telecommunications companies and local
telephone carriers, such as Pacific Bell, have petitioned the Federal
Communications Commission to regulate Internet service providers and online
service providers in a manner 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 or that is posted by its users in chat rooms or bulletin boards. 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, users 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. The barriers
to entry in the Internet services market are low and the Company expects the
number of its competitors to continue to increase. Any company or individual can
establish and maintain a Web site for minimal cost. Talk City competes for
business clients, users and advertisers with numerous companies, including the
following:
. online services or Web sites that produce business services, such as
market research, customized communities or online events, including
Prospero and Broadcast.com, Inc.;
. online services or Web sites with a focus on community services, such as
AOL, GeoCities, Inc., a subsidiary of Yahoo! Inc. ("Yahoo"), Tripod,
Inc., a subsidiary of Lycos, Inc. ("Lycos"), 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;
. 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.
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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 user base 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 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, users, network participants and advertisers. Talk City's operating
expenses would substantially increase if it had to re-build its brand identity
or reimplement its Web sites.
Possible infringement of Talk City's intellectual property rights by third
parties could substantially increase its operating expenses
Other parties may assert claims of infringement of intellectual property or
other proprietary rights against Talk City. These claims, even if without merit,
could require the Company to expend significant financial and managerial
resources. Furthermore, if claims like this are successful, Talk City may be
required to change its trademarks, alter its content or pay financial damages,
any of which could substantially increase its operating expenses. The Company
also may be required to obtain licenses from others to refine, develop, market
and deliver new services. Talk City may be unable to obtain any needed license
on commercially reasonable terms or at all and rights granted under any licenses
may not be valid and enforceable. Talk City has been subject to claims and
expects to be subject to legal proceedings and claims from time to time in the
ordinary course of its business, including claims of alleged infringement of
trademarks and other intellectual property rights of third parties by the
Company and its licensees.
Talk City's stock price has traded at or below the initial offering price and is
likely to be extremely volatile as the market for Internet companies' stock has
recently experienced extreme price and volume fluctuations
The market price of Talk City's Common Stock has traded at or below the
initial public offering price and may be extremely volatile as the market for
Internet-related and technology companies has experienced extreme price and
volume fluctuations in recent months. Despite the strong pattern of operating
losses of Internet-related companies, the market demand, valuation and trading
prices of these companies has been high. At the same
23
<PAGE>
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 often buy 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 initial public offering, at
times the market price of its Common Stock has 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.
Historically, Talk City has experienced significant losses, which totaled $10.0
million for the three months ended March 31, 2000 and $40.1 million and $15.7
million in 1999 and 1998, respectively. In addition, the Company has experienced
fluctuations in its volume of users and usage patterns, which could lead to a
further decrease, or to extreme volatility, of its stock price. The Company
cannot assure you that its stock price will increase to trade at the same levels
as other Internet stocks or that Internet stocks in general will sustain current
market prices. Volatility in the market price of the Company's Common Stock
could result in securities class action litigation. Any litigation would likely
result in substantial costs and a diversion of management's attention and
resources.
Talk City's stock price is likely to be extremely volatile due to broad market
and industry factors beyond its control
Talk City's stock price is subject to wide fluctuations in response to a
variety of factors, including factors beyond its control. These broad market and
industry factors could harm the market price of its Common Stock, regardless of
the Company's performance. These factors include:
. actual or anticipated variations in its quarterly operating results;
. announcements of technological innovations or new programming by the
Company or its competitors;
. conditions or trends in the Internet and online services industries;
. changes in the market valuations of other Internet companies;
. announcements by the Company or its competitors of significant
acquisitions, strategic partnerships, joint ventures or capital
commitments;
. additions or departures of key personnel; and
. sales of substantial amounts of its Common Stock or other securities in
the open market.
General political and economic conditions, such as recession or interest
rate or currency rate fluctuations, also could harm the market price of the
Company's Common Stock.
If Talk City raises additional capital through the issuance of new securities,
existing shareholders 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 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.
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.
24
<PAGE>
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 March 31, 2000:
Average Book Fair
Interest Rate Value Value
----------------- ----------- ----------------
Cash equivalents:
Fixed rate 6.00% $ 9,783 $ 9,783
Variable rate 6.12% 13,640 13,640
Short-term investments:
Fixed rate 5.95% 12,371 12,371
Variable rate 6.05% 6,175 6,175
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
a) Recent Sales of Unregistered Securities
---------------------------------------
On January 3, 2000 the Company issued 242,424 shares of its Common
Stock, at an agreed upon price per share of $12.38, to the sole
shareholder of RCI, in consideration for the acquisition of RCI by
the Company. The agreed upon aggregate consideration to RCI was $3.0
million. The shares were issued pursuant to a plan of reorganization
agreement. The Company relied upon Section 4(2) of the Securities
Act and Regulation D, Rule 506, in connection with the issuance of
these securities. The issuance of the Common Stock was made in
compliance with all of the terms of Rules 501 and 502 of Regulation
D, there were no more than 35 investors, as calculated pursuant to
Rule 501(e) of Regulation D, and each investor, who was not an
accredited investor, represented to the Company that it had such
knowledge and experience in financial business matters that it was
capable of evaluating the merits and risks of the investment.
d) Use of Proceeds from Sales of Registered Securities
---------------------------------------------------
On July 20, 1999, Talk City consummated the IPO of its Common Stock,
$0.001 par value per share. The managing underwriters in the
offering were Lehman Brothers, Inc., U.S. Bancorp Piper Jaffray,
Volpe Brown Whelan & Company, and E*Trade Securities, Inc., (the
"Underwriters"). 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). All
5.1 million shares of Common Stock registered under the Registration
Statement, including 100,000 shares
25
<PAGE>
covered by an over-allotment option that was exercised by the
Underwriters, were sold at a price to the public of $12.00 per
share. The aggregate offering amount registered 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 to
us from our IPO were approximately $55.4 million.
From the time of receipt through December 31, 1999, Talk City
used the net proceeds of approximately $55.4 million from its IPO to
invest in short-term, interest bearing, investment grade securities
and has used its existing cash balances to fund the general
operations of the Company. From January 1, 2000 through March 31,
2000, we have applied $12 million of proceeds from the IPO as
follows:
Acquisition of Research Connections, Inc.: $1.9 million
Purchase of property and equipment: $3.4 million
Working capital: $6.7 million
The foregoing amounts represents the Company's best estimates of
its use of proceeds for the period indicated. None of the net
offering proceeds were paid, and none of the offerings' expenses
were for payments, directly or indirectly to directors, officers or
general partners of Talk City or its associates, persons owning
10% or more of any class of its securities, or affiliates of the
Company.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
2.1 Agreement and Plan of Reorganization between the registrant 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 registrant.*
4.1 Form of registrant's Common Stock certificate.*
4.2 Third Amended and Restated Shareholders Rights Agreement, dated
April 23, 1999, between the registrant and the parties named
therein, as amended on May 26, 1999.*
10.1 Form of Indemnification Agreement entered into by the registrant
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.*
10.5 1999 Director Option Plan.*
10.6 Office Lease Agreement, dated May 21, 1997, by and between the
registrant and The Manufacturers Life Insurance Company (U.S.A.).*
10.7 Office Lease Agreement, dated February 28, 1999, by and between
the registrant and SLG Graybar LLC.*
10.8 Repurchase Agreement, dated November 20, 1996, as amended, by and
between the registrant and Peter H. Friedman.*
10.9 Repurchase Agreement, dated November 20, 1996, as amended, by and
between the registrant and Jenna Woodul.*
26
<PAGE>
10.10 Stock Option Agreement, dated March 1, 1999, by and between the
registrant and Jeffrey Snetiker.*
10.11 Master Service Agreement, dated April 19, 1999, by and between the
registrant and Frontier GlobalCenter.*
10.12 Network Affiliation Agreement, dated March 1, 1998 by and between
the registrant and 24/7 Media Inc.*
10.13 Content and Services Agreement, effective July 19, 1998, by and
between the registrant and WebTV Networks, Inc.*
10.14 Contract, dated May 13, 1997, by and between the registrant and
NFO Research.*
10.15 Operating Agreement, dated August 24, 1998, by and between the
registrant and Cox Interactive Media, Inc.*
10.16 Hearst-Talk City Operating Agreement, dated April 20, 1999, by and
between the registrant 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 registrant 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 registrant and NBC Multimedia, Inc., as amended on
April 19, 1999.*
10.19 Letter Agreement, dated February 25, 1998, by and between the
registrant 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 registrant
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 registrant, 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).
--------------
* Incorporated by reference from registrant'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 registrant's Quarterly Report on Form
10-Q for the period ended September 30, 1999.
*** Incorporated by reference from the registrant'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 March 31, 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
May 12, 2000
28
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