================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2000
OR
[ ] TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO _____
COMMISSION FILE NUMBER 0 - 26728
TALK.COM INC.
(Exact name of registrant as specified in its charter)
DELAWARE 23-2827736
(State of incorporation) (I.R.S. Employer Identification No.)
12020 SUNRISE VALLEY DRIVE, SUITE 250, RESTON, VIRGINIA 20191
(Address of principal executive offices) (Zip Code)
(703) 391-7500
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
65,819,573 shares of Common Stock, par value of $0.01 per share, were
issued and outstanding as of May 2, 2000.
================================================================================
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I - FINANCIAL INFORMATION:
Item 1. Consolidated Financial Statements:
Consolidated Balance Sheets - March 31, 2000 (unaudited)
and December 31, 1999 ............................................................................. 3
Consolidated Statements of Operations - Three Months Ended March 31, 2000 and 1999 (unaudited)..... 4
Consolidated Statement of Stockholders' Equity - Three Months Ended March 31, 2000 (unaudited).... 5
Consolidated Statements of Cash Flows - Three Months Ended March 31, 2000 and 1999 (unaudited)..... 6
Notes to Consolidated Financial Statements (unaudited) ............................................ 7
Item 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations ......................................................................... 11
PART II - OTHER INFORMATION:
Item 6. Exhibits and Reports on Form 8K .................................................................. 17
</TABLE>
(a) Exhibits
(b) Reports on Form 8-K
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENT
TALK.COM INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT FOR SHARE DATA)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
2000 1999
------------ ----------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 88,440 $ 78,937
Accounts receivable, trade, net of allowance for uncollectible accounts of $7,620
and $5,011, respectively 64,819 59,501
Advances to partitions and notes receivable 2,798 3,600
Prepaid expenses and other current assets 4,669 8,855
--------- ---------
Total current assets 160,726 150,893
--------- ---------
Property and equipment, net 65,280 57,335
Intangibles, net 1,213 1,068
Other assets 4,817 5,712
--------- ---------
Total assets $ 232,036 $ 215,008
========= =========
LIABILITIES, CONTINGENCIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses:
Trade and other $ 45,895 $ 47,965
Partitions 1,788 1,676
Taxes and other 8,109 14,127
--------- ---------
Total current liabilities 55,792 63,768
--------- ---------
Convertible debt 84,950 84,985
Deferred revenue 19,150 21,000
--------- ---------
Total liabilities 159,892 169,753
--------- ---------
Commitments and contingencies
Contingent redemption value of common stock 12,364 5,152
Stockholders' equity:
Preferred stock - $.01 par value, 5,000,000 shares authorized; no shares
outstanding -- --
Common stock - $.01 par value, 300,000,000 shares authorized;
66,972,960 shares issued 670 670
Additional paid-in capital 201,209 208,453
Accumulated deficit (125,920) (139,300)
Treasury stock, at cost (16,179) (29,720)
--------- ---------
Total stockholders' equity 59,780 40,103
--------- ---------
Total liabilities, contingent redemption value of common stock
and stockholders' equity $ 232,036 $ 215,008
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS
ENDED MARCH 31,
---------------------------------------
2000 1999
--------------- ---------------
<S> <C> <C>
Sales $156,059 $110,572
Cost of sales 91,691 73,843
--------------- ---------------
Gross profit 64,368 36,729
--------------- ---------------
Operating expenses (income):
General and administrative expenses 12,178 9,543
Promotional, marketing and advertising expenses 36,651 14,598
Depreciation and amortization 1,856 1,451
Significant other income -- (1,218)
--------------- ---------------
Total operating expenses 50,685 24,374
--------------- ---------------
Operating income 13,683 12,355
Interest income, net 290 657
Other expense, net (343) (678)
--------------- ---------------
Income before income taxes 13,630 12,334
Provision for income taxes 250 --
--------------- ---------------
Income before extraordinary gain 13,380 12,334
Extraordinary gain -- 18,997
--------------- ---------------
Net income $13,380 $31,331
=============== ===============
- ----------------------------------------------------------------------------------------------------------
Basic earnings per share:
Income before extraordinary gain $ 0.20 $ 0.21
Extraordinary gain -- 0.32
--------------- ---------------
Net income $ 0.20 $ 0.53
=============== ===============
Weighted average common shares outstanding 65,302 58,909
=============== ===============
Diluted earnings per share:
Income before extraordinary gain $ 0.20 $ 0.20
Extraordinary gain -- 0.30
--------------- ---------------
Net income $ 0.20 $ 0.50
=============== ===============
Weighted average common and common equivalent shares
outstanding 68,401 62,335
=============== ===============
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2000
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL TREASURY STOCK
-------------------------- PAID-IN ACCUMULATED ----------------------
SHARES AMOUNT CAPITAL DEFICIT SHARES AMOUNT TOTAL
---------- ------------ ------------- ---------------- --------- ---------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1, 2000 66,973 $670 $208,453 $(139,300) (2,120) $(29,720) $40,103
Net income -- -- -- 13,380 -- -- 13,380
Exercise of common stock
options -- -- (1,986) -- 312 4,367 2,381
Proceeds from rights
exercised -- -- 1,939 -- 653 9,154 11,093
Issuance of common stock
for convertible debt -- -- 15 -- 2 20 35
Contingent redemption
value of common stock -- -- (7,212) -- -- -- (7,212)
---------- ------------ ------------- ---------------- --------- ---------- --------
Balance, March 31, 2000 66,973 $670 $201,209 $(125,920) (1,153) $(16,179) $59,780
========== ============ ============= ================ ========= ========== =========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS
ENDED MARCH 31,
--------------------------------
2000 1999
------------- ---------------
<S> <C> <C>
Cash flows from operating activities:
Net income $13,380 $31,331
Adjustment to reconcile net income to net cash provided by (used in)
operating activities:
Provision for bad debts 2,616 (79)
Depreciation and amortization 1,856 1,451
Deferred revenue (1,850) (1,850)
Extraordinary gain -- (18,997)
Changes in assets and liabilities, net:
(Increase) decrease in:
Accounts receivable, trade (7,927) 3,564
Advances to partitions and notes receivable 802 720
Prepaid expenses and other current assets 4,186 1,707
Other assets 895 536
Increase (decrease) in:
Accounts payables and accrued expenses (7,983) (25,893)
Other liabilities -- (1,850)
------------- ---------------
Net cash provided by (used in) operating activities 5,975 (9,360)
------------- ---------------
Cash flows from investing activities:
Capital expenditures (9,781) (2,263)
Acquisition of intangibles (165) --
Sale of securities, net -- 89,649
------------- ---------------
Net cash provided by (used in) investing activities (9,946) 87,386
------------- ---------------
Cash flows from financing activities:
Repayment of margin account indebtedness -- (49,621)
Acquisition of convertible debt -- (65,423)
Proceeds from exercise of options and warrants 2,381 10,019
AOL investment -- 55,000
Proceeds from rights exercised 11,093 --
------------- ---------------
Net cash provided by (used in) financing activities 13,474 (50,025)
------------- ---------------
Net increase in cash and cash equivalents 9,503 28,001
Cash and cash equivalents, beginning of period 78,937 3,063
------------- ---------------
Cash and cash equivalents, end of period $ 88,440 $ 31,064
============= ===============
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIC PRESENTATION:
The consolidated financial statements include the accounts of Talk.com Inc.
and its wholly-owned subsidiaries, (the "Company") and have been prepared as if
the entities had operated as a single consolidated group since their respective
dates of incorporation. All intercompany balances and transactions have been
eliminated.
The consolidated financial statements and related notes thereto as of March
31, 2000 and for the three months ended March 31, 2000 and 1999 are presented as
unaudited but in the opinion of management include all adjustments necessary to
present fairly the information set forth therein. These adjustments consist
solely of normal recurring accruals. The consolidated balance sheet information
for December 31, 1999 was derived from the audited financial statements included
in the Company's Form 10-K, as amended. These interim financial statements
should be read in conjunction with the Form 10-K report, as amended. The interim
results are not necessarily indicative of the results for any future periods.
2. AOL AGREEMENTS:
Since 1997, the Company has negotiated a number of agreements and
amendments to its agreements with America Online Inc. ("AOL") for the marketing
and sale of telecommunications services to AOL subscribers. A substantial
amendment to the AOL agreement in January 1999 provided for: quarterly payments
by the Company to AOL during the long distance exclusivity period of the
agreement, with fixed quarterly payments ranging from $10.0 to $15.0 million
($19.0 million after July 1, 2000 if AOL elects to provide certain additional
marketing and promotions to the Company) until June 30, 2001 and quarterly
payments thereafter at a fixed 5% of the Company's long distance revenues from
AOL subscribers in the quarter under the agreement; quarterly payments by the
Company to AOL, after termination of the long distance exclusivity period and so
long as AOL continues to provide certain levels of marketing and promotions to
the Company under the agreement, at an annual declining fixed percentage of the
Company's long distance revenues from AOL subscribers under the agreement,
starting at 5% and declining by one percentage point each year to 1%; the
elimination of the Company's obligation to make bounty and current
profit-sharing payments to AOL; alteration of the terms of the online and
offline marketing arrangements between the Company and AOL; extension of the
term of the AOL agreement, including the exclusivity period, until June 30,
2003, although AOL has the right, in each year beginning in 2000, to elect, on
or before May 1 of such year, to end the Company's long distance exclusivity
period as of June 30 of such year; elimination of AOL's rights to receive
further warrants to purchase Common Stock based upon customers gained from the
AOL subscriber base; AOL's contribution of up to $4.0 million (up to $6.0
million if the Company pays $19.0 million as noted above) per quarter for
offline marketing; and establishment of the framework for the Company to offer
additional services and products to AOL subscribers. AOL did not elect to
exercise its right to terminate the long distance exclusivity as of June 30,
2000 and, accordingly, the exclusivity period for long distance will continue
through at least June 30, 2001. AOL did provide the Company notice that its
exclusivity as to wireless services would terminate on July 1, 2000, although
the Company's right to offer wireless services will continue on a non-exclusive
basis.
On January 5, 1999, pursuant to an Investment Agreement between AOL and the
Company, AOL purchased a total of 4,121,372 shares of Common Stock of the
Company for $55.0 million in cash and the surrender of rights to purchase
5,076,016 shares of Common Stock of the Company pursuant to various warrants
held by AOL. AOL agreed to end further vesting under the outstanding performance
warrant and retained vested warrants exercisable for 2,721,984 shares of Common
Stock. See Note 4 for a discussion of certain reimbursement obligations of the
Company in favor of AOL.
3. RELATED PARTY TRANSACTIONS:
On January 5, 1999, Mr. Daniel Borislow, a founder of the Company and its
Chairman of the Board and Chief Executive Officer, resigned as a director and
officer of the Company. The Company entered into various agreements and engaged
in various transactions with Mr. Borislow and certain entities in which he or
his family had an interest.
7
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In connection with Mr. Borislow's resignations, the Company paid $1.0
million to Mr. Borislow, assigned certain automobiles to him, and continued
certain of his health and medical benefits and director and officer insurance.
The Company also agreed that, so long as Mr. Borislow owned beneficially at
least two percent (2%) of the Common Stock (on a fully diluted basis), Mr.
Borislow and trusts for the benefit of his children would be entitled to:
registration rights with respect to their shares of Common Stock, the right to
require the Company to use a portion of proceeds from any public or private sale
of debt securities, excluding borrowings from a commercial bank or other
financial institution, by the Company to repurchase debt securities of the
Company owned by Mr. Borislow or the trusts for the benefit of his children, and
the right to require the Company to use the proceeds from the exercise of stock
options by other employees or rights, to repurchase Common Stock owned by Mr.
Borislow or the trusts for the benefit of his children. The Company also agreed
that, so long as Mr. Borislow had such beneficial ownership, the Company would
not, without the prior written consent of Mr. Borislow and subject to certain
exceptions: (a) engage in certain significant corporate transactions, including
the sale or encumbrance of substantially all of its assets, mergers and
consolidations and certain material acquisitions, or, (b) for a period of 18
months from the agreement date, offer or sell any of its Common Stock unless and
until Mr. Borislow and the trusts have sold or otherwise disposed of all of the
shares of Common Stock held by him on the agreement date. In turn, Mr. Borislow
terminated his employment with the Company and agreed not to compete with the
Company for at least one year. Mr. Borislow also agreed to guarantee up to $20.0
million of the Company's obligations in connection with the AOL investment noted
above. As of March 31, 2000, Mr. Borislow and the two trusts for the benefit of
Mr. Borislow's children, which have the ability to distribute Common Stock to
Mr. Borislow, held less than an aggregate of 2% of the outstanding Common Stock.
Accordingly, the Company believes that the restrictions described above no
longer apply to the Company
During 1999, the Company (a) purchased from Mr. Borislow and two trusts for
the benefit of Mr. Borislow's children, $85.9 million aggregate principal amount
of the Company's Convertible Notes for $72.3 million in cash; (b) exchanged the
remaining $53.7 million principal amount of subordinated notes of Communication
TeleSystems International d/b/a WorldxChange Communications, which were included
in other assets at December 31, 1998, to a trust for the benefit of Mr.
Borislow's children for $62.5 million aggregate principal amount of the
Company's Convertible Notes and (c) purchased $9.0 million aggregate principal
amount of the Company's Convertible Notes for $6.9 million in Common Stock. Also
during 1999, pursuant to the agreements with Mr. Borislow as described above,
the Company purchased from Mr. Borislow approximately 639,000 shares of Common
Stock for approximately $7.7 million with proceeds from the exercise of stock
options by other employees.
On January 6, 2000, the Company repurchased from Mr. Borislow real property
previously sold to Mr. Borislow constituting the Company's facilities in New
Hope, Pennsylvania for $2.5 million.
4. STOCKHOLDERS' EQUITY:
CONTINGENT REDEMPTION VALUE OF COMMON STOCK
Under the terms of the Investment Agreement with AOL (see Note 2 above),
the Company has agreed to reimburse AOL for losses AOL may incur on the sale of
any of the shares of Common Stock held by AOL during the period from June 1,
1999 through September 30, 2000. The Company has the first right to purchase any
of the shares of Common Stock held by AOL at the market value on the day that
AOL notifies the Company of its intent to sell any of the shares plus an amount,
if any, equal to the Company's reimbursement obligation described below. The
reimbursement amount would be determined by multiplying the number of shares, if
any, that AOL sells during the applicable period by the difference between the
purchase price per share paid by AOL, or $19 per share, and the price per share
that AOL sells the shares for, if less than $19 per share. The reimbursement
amount may not exceed $14 per share for 2,894,737 shares or $11 per share for
1,226,635 shares. Accordingly, the maximum amount payable to AOL as
reimbursement on the sale of AOL's shares would be approximately $54.0 million
plus AOL's reasonable expenses incurred in connection with the sale.
8
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The Company has the option of issuing a six-month 10% note payable to AOL
to satisfy the reimbursement amount or other amounts payable on exercise of its
first refusal rights. Assuming AOL were to sell all of its shares subject to the
Company's reimbursement obligation at the closing price of Common Stock as of
March 31, 2000, the reimbursement amount would be approximately $12.4 million.
At March 31, 2000, the Company recorded $12.4 million for the contingent
redemption value of this Common Stock with a corresponding reduction in
additional paid-in capital. AOL also has the right on termination of long
distance exclusivity under the AOL marketing agreements to require the Company
to repurchase the warrants to purchase 2,721,984 shares of Common Stock of the
Company held by AOL for an aggregate price of $36.3 million, which repurchase
price can be paid in Common Stock or cash (provided that some portion of the
repurchase price may be payable in a quarterly amortization, two-year promissory
note of the Company if the repurchase price exceeds the then current valuation
of the warrants being purchased). AOL did not elect to terminate the long
distance exclusivity as of June 30, 2000, but can so elect as of June 30, 2001
and 2002. The Company has pledged the stock of its subsidiaries and has agreed
to fund an escrow account of up to $35.0 million from 50% of the proceeds of any
debt financing, other than a bank, receivable or other asset based financing of
up to $50.0 million, to secure its obligations under the Investment Agreement
with AOL. AOL has agreed that it will subordinate its security interests to
permit the securitization of certain future financings by the Company. Mr.
Borislow has agreed to guarantee up to $20.0 million of the Company's
reimbursement obligations under the Investment Agreement with AOL.
STOCKHOLDERS RIGHTS PLAN
On August 19, 1999, the Company adopted a Stockholders Rights Plan designed
to deter coercive takeover tactics and prevent an acquirer from gaining control
of the Company without offering a fair price to all of the Company's
stockholders.
Under the terms of the plan, preferred stock purchase rights were
distributed as a dividend at the rate of one right for each share of Common
Stock of the Company held as of the close of business on August 30, 1999. Until
the rights become exercisable, Common Stock issued by the Company will also have
one right attached. Each right will entitle holders to buy one three-hundredth
of a share of Series A Junior Participating Preferred Stock of the Company at an
exercise price of $55. Each right will thereafter entitle the holder to receive
upon exercise Common Stock (or, in certain circumstances, cash, property or
other securities of the Company) having a value equal to two times the exercise
price of the right.
The rights will be exercisable only if a person or group acquires
beneficial ownership of 20% or more of Common Stock or announces a tender or
exchange offer which would result in such person or group owning 20% or more of
Common Stock, or if the Board of Directors declares that a 15% or more
stockholder has become an "adverse person" as defined in the plan.
The Company, except as otherwise provided in the plan, will generally be
able to redeem the rights at $0.001 per right at any time during a ten-day
period following public announcement that a 20% position in the Company has been
acquired or after the Company's Board of Directors declares that a 15% or more
stockholder has become an "adverse person." The rights are not exercisable until
the expiration of the redemption period. The rights will expire on August 19,
2009, subject to extension by the Board of Directors.
5. LEGAL PROCEEDINGS:
On June 16, 1998, a purported shareholder class action was filed in the
United States District Court for the Eastern District of Pennsylvania against
the Company and certain of its officers alleging violation of the securities
laws in connection with certain disclosures made by the Company in its public
filings and seeking unspecified damages. Thereafter, additional lawsuits making
substantially the same allegations were filed by other plaintiffs in
9
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
the same court. At this point, no classes have been certified. A motion to
dismiss was granted as to certain officers of the Company and denied as to the
Company. There are currently no officers of the Company who are a party to these
actions. The Company believes the allegations in the complaints are without
merit and intends to defend the litigations vigorously. The Company also is a
party to certain legal actions arising in the ordinary course of business.
The Company believes that the ultimate outcome of the foregoing actions
will not result in liability that would have a material adverse effect on the
Company's financial condition or results of operations.
6. PENDING ACQUISITION:
On March 24, 2000, the Company, a wholly owned subsidiary of the Company
("Merger Sub"), and Access One Communications Corp., a New Jersey corporation
("Access One"), entered into an Agreement and Plan of Merger (the "Merger
Agreement"), which provides, among other things, for the merger (the "Merger")
of Merger Sub with and into Access One. Access One is a private, local
telecommunications service provider to nine states in the southeastern United
States. Under the terms of the Merger Agreement, upon consummation of the
Merger, Access One will become a wholly owned subsidiary of the Company and
Access One stockholders will receive 0.571428 shares of the Company's common
stock in exchange for each share of Access One common stock held by such
stockholders at the effective time of the Merger. It is expected that, as a
result of the Merger, shareholders of Access One will receive an aggregate of
approximately 14.3 million shares of the Company's common stock. The transaction
has been approved by the Boards of Directors of both the Company and Access One,
but is contingent upon, among other things, approvals of both the Company's and
Access One's stockholders, certain regulatory approvals (including approval
under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 and certain
telecommunications regulatory approvals) and other customary conditions. Under a
Voting Agreement entered into on March 24, 2000, the holders of approximately
67.8% of Access One's outstanding common stock have agreed to vote in favor of
the Merger. In connection with the Merger, Access One has also entered into a
five-year agreement to provide certain telecommunications services to the
Company and its subsidiaries. Access One has the right to terminate that
agreement if the merger with Talk.com is not consummated. It is also anticipated
that, upon consummation of the Merger, $17.0 million of Access One indebtedness
must be repaid.
10
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS:
OVERVIEW
Talk.com Inc. through its subsidiaries, provides telecommunications
services to residential and business customers throughout the United States,
primarily to residential consumers through its e-commerce platform. The
e-commerce platform is built around the Company's advanced online and
web-enabled customer care, billing and information systems. Talk.com Inc. and
its subsidiaries are sometimes together referred to as the "Company" and as
"Talk.com".
The Company's telecommunications service offerings include long
distance outbound service, inbound toll-free service and dedicated private line
services for data. The Company announced late last year that, given the new
regulatory opportunities that have developed, it planned to expand its product
mix by also offering local service bundled with long distance service. On March
27, 2000, the Company announced that it had entered into an agreement to acquire
Access One Communications Corp. in a statutory merger for approximately 14.3
million shares of Company common stock. Access One is a private, Florida-based,
local telecommunications service provider to nine states in the southeastern
United States. The Access One acquisition is subject to approval by the
Company's and Access One's stockholders and to certain regulatory approvals. In
connection with the acquisition agreement, the Company entered into an agreement
under which Access One agreed to provide certain telecommunications services,
including local services, to the Company. Using this agreement, the Company
recently has begun offering local telecommunication service in Florida, Georgia,
North Carolina and New York. The Company also intends to offer a bundle of long
distance and local service to small business and select residential customers in
the nine southeastern states serviced by Access One, through the Company's
marketing partnerships and new direct channels.
The Company believes that it has an opportunity to capture additional
market share and accelerate future growth through its offerings of local and
bundled local and long distance telecommunications services. In connection with
its rollout of local services, the Company anticipates that its marketing and
promotional expenditures will continue to increase on an absolute basis and as a
percentage of revenue during the remainder of the year. With the extension of
the Company's long distance exclusivity period with AOL until at least June
2001, the Company also will continue to expend significant marketing dollars
with AOL. Accordingly, the Company believes that the projected increase in
marketing and advertising expenditures is expected to significantly reduce the
Company's earnings in 2000.
11
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
RESULTS OF OPERATIONS
The following table set forth for the periods indicated certain financial data
as a percentage of sales:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
MARCH 31,
---------------------------
2000 1999
-------- --------
<S> <C> <C>
Sales 100.0% 100.0%
Cost of sales 58.8 66.8
-------- --------
Gross profit 41.2 33.2
-------- --------
Operating expenses (income):
General and administrative expenses 7.8 8.6
Promotional, marketing and advertising expenses 23.5 13.2
Depreciation and amortization 1.2 1.3
Significant other income -- (1.1)
-------- --------
Total operating expenses 32.5 22.0
-------- --------
Operating income 8.7 11.2
Interest income, net .2 .6
Other expense, net (.2) (.6)
-------- --------
Income before income taxes 8.7 11.2
Provision for income taxes .1 --
-------- --------
Income before extraordinary gain 8.6 11.2
Extraordinary gain -- 17.1
-------- --------
Net income 8.6% 28.3%
======== ========
</TABLE>
QUARTER ENDED MARCH 31, 2000 COMPARED TO QUARTER ENDED MARCH 31, 1999
Sales
Sales increased by 41.1% to $156.1 million for the quarter ended March
31, 2000 from $110.6 million for the quarter ended March 31, 1999. This increase
was primarily a result of an increase in the number of online customers and
increased revenue per online customer. The increase in online sales was
partially offset by a decrease in the Company's other sales, including,
partition and dial-around sales, as the Company has continued to focus primarily
on developing its online sales and customer base. The addition of new marketing
partners has contributed to the growth in the online business. While the Company
believes it offers competitively priced services, sales could be adversely
affected by the intense competition in this industry. In addition, the Company's
ability to provision customers, which is adversely affected by PIC freezes
implemented by the local telephone companies, directly affects sales.
Beginning in the second quarter of 2000, there has been a significant
reduction in the principal marketing opportunity provided to the Company by AOL,
which has resulted in a decline in gross additions of new online customers. The
Company expects that this decline will be reflected in a decline in online sales
in the second quarter. In addition, the Company instituted new collection
procedures in the first quarter of 2000, which the Company believes contributed
to customer terminations during the introduction period at a rate greater than
the Company's historical churn experience. With a reduction in the online sales
from the interruption of its primary AOL marketing channel, the increased churn
and the continued decline in other sales (including international wholesale),
the Company expects a reduction in total sales for the second quarter. In
addition to the matters discussed above, there can be no assurance that the
Company will continue to increase sales on a quarter-to-quarter or year-to-year
basis.
12
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
A significant percentage of the Company's revenues in the quarters
ended March 31, 2000 and 1999 were derived from long distance telecommunications
services provided to customers who were obtained under the AOL agreement and a
significant decline in its AOL subscribers that is not offset by growth in
non-AOL subscribers could have a significant effect on the Company's results of
operations and cash flow. While the Company's rights to market long distance
exclusively under the AOL agreement do not expire until June 30, 2003, AOL has
the right in each year beginning in 2000, to elect, on or before May 1 of such
year, to permit others to market long distance telecommunications services after
June 30 of such year to AOL's subscribers. Notwithstanding any such AOL
election, the Company's rights to continue to market its services to AOL
subscribers on a non-exclusive basis, but with significant marketing rights,
would continue until June 30, 2003. AOL did not exercise its right as to 2000
and, accordingly, the exclusivity period for long distance will continue through
at least June 2001 and the Company will be obliged to make fixed quarterly
payments during the year ending June 30, 2001 of at least $15.0 million to AOL.
AOL did elect to terminate the Company's exclusive right to offer wireless
services to AOL subscribers, but the Company's right to offer wireless services
will continue on a non-exclusive basis. The Company plans to continue to
aggressively market its services to AOL subscribers, and also plans, as
discussed above, to increase its efforts to expand its non-AOL base of online
customers.
Cost of Sales
Cost of sales increased by 24.2% to $91.7 million in the quarter ended
March 31, 2000 from $73.8 million in the quarter ended March 31, 1999. This
increase was due to the overall increase in sales this quarter as compared to
the same quarter last year. As a percentage of sales, cost of sales has
decreased to 58.8% as compared to 66.8% for the same quarter last year. The
decrease was primarily due to lower network usage costs for services on the
Company's OBN network on a per minute basis and lower partition costs due to the
decrease in other sales, as noted above. Cost of sales as a percentage of sales
increased in the first quarter versus the fourth quarter of 1999.
Gross Profit
Gross profit increased to 41.2% of sales in the quarter ended March 31,
2000 from 33.2% in the quarter ended March 31, 1999. The increase in the gross
profit percentage was primarily due to lower network usage costs for OBN
services on a per minute basis and lower partition costs due to the decrease in
other sales, as noted above. However, there can be no assurance that the Company
will continue to increase gross profits on a quarter-to-quarter or year-to-year
basis due to higher network costs, increased bad debt expense, and reduced
profits on other sales, as well as the intensification of price competition for
the Company's products, which will put downward pressure on gross profits. Gross
profit percentage declined in the first quarter versus the fourth quarter of
1999. The Company expects further declines in gross profit percentage in
connection with the initial rollout of local services and the reduced
profitability of its other sales.
General and Administrative Expenses
General and administrative expenses increased by 27.6% to $12.2 million
in the quarter ended March 31, 2000 from $9.5 million in the quarter ended March
31, 1999, but decreased as a percentage of sales. The increase was due primarily
to increased costs associated with hiring additional personnel to support the
Company's continuing growth, offset in part by the elimination of general and
administrative expenses of TSFL Holdings, Inc. (as discussed below) and
decreased costs for professional services.
Promotional, Marketing, and Advertising Expenses
During the quarter ended March 31, 2000, the Company incurred $36.7
million in promotional, marketing and advertising expenses as compared to $14.6
million in the quarter ended March 31, 1999. This represents an increase of
151.1% over the same period last year, and relates to the Company's continued
effort to expand its online customer base as well as higher promotional expenses
and an increase in the fixed payment to AOL. The Company expects that these
expenses will continue to increase as the Company implements its plans noted
above to aggressively pursue new, local subscribers and line growth,
particularly non-AOL customers. In addition, the fixed payment to AOL for the
twelve-month period ending June 30, 2001 will increase by $3.0 million per
quarter to $15.0 million as of July 1, 2000.
13
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
Depreciation and Amortization
Depreciation and amortization for the quarter ended March 31, 2000 was
$1.9 million, an increase of 27.9% compared to $1.5 million for the same period
in 1999. This increase is related to the continued purchase of property and
equipment to support the Company's ongoing growth.
Significant Other Income
During the quarter ended March 31, 1999, the Company sold a division of
TSFL Holdings, Inc. (formerly Symetrics Industries, Inc.), resulting in a gain
of $1.2 million.
Interest Income, net
Net interest income was $290,000 for the quarter ended March 31, 2000
as compared to $657,000 for the quarter ended March 31, 1999. This represents a
55.9% decrease from the first quarter of last year. Interest income consists
primarily of interest income earned on cash and cash equivalents offset by
interest expense related to the Company's convertible debt.
Other Expense, net
Net other expense was $343,000 for the quarter ended March 31, 2000 as
compared to $678,000 for the quarter ended March 31, 1999. This represents a
49.4% decrease compared to the first quarter of last year.
Provision for Income Taxes
The Company recorded a $250,000 provision for income taxes in the
quarter ended March 31, 2000 related to the expected payment of federal income
taxes on alternative minimum taxable income this fiscal year. Although the
Company had net operating loss carryforwards sufficient to offset expected
taxable income for 2000, the loss carryforwards can only reduce up to 90% of
alternative minimum taxable income.
Extraordinary Gain
During the quarter ended March 31, 1999 the Company recorded an
extraordinary gain of $19.0 million from the acquisition of the Company's
convertible debt at a discount from its aggregate principal amount.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2000, the Company had $88.4 million of cash and cash
equivalents and $64.9 million in net trade accounts receivable. The Company's
working capital was $109.4 million at March 31, 2000 and $87.1 million at
December 31, 1999. This increase in working capital is primarily a result of
cash generated from the Company's operations and the receipt of $11.1 million in
connection with the exercise of outstanding Common Stock rights prior to their
expiration in February 2000, offset in part by $9.8 million in capital
expenditures for the purchase of property and equipment.
Net cash provided by operating activities was $6.0 million for the quarter
ended March 31, 2000. Net cash used in operating activities was $9.4 million for
the quarter ended March 31, 1999. For the quarter ended March 31, 2000 the major
contributors to the net cash provided by operating activities were net income of
$13.4 million, a decrease in all other assets of $5.9 million and adjustments to
net income for non-cash items of $2.6 million. This was offset by increases in
both net trade accounts receivable of $7.9 million and accounts payable and
accrued expenses of $8.2 million. For the quarter ended March 31, 1999 net cash
used in operating activities was mainly generated by a reduction in accounts
payable and accrued expenses of $25.9 million and an adjustment for the
extraordinary gain of $19.0 million recorded from the acquisition of the
Company's convertible debt offset by net income of $31.3 million and decreases
in several other assets of $6.5 million.
14
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
Net cash used in investing activities related primarily to the purchase of
property and equipment during the quarter ended March 31, 2000. For the quarter
ended March 31, 1999 the net cash provided by investing activities was mainly
from the sale of marketable securities of $89.6 million.
The net cash provided by financing activities for the quarter ended March
31, 2000 was received from the exercise of stock options and Common Stock rights
for $13.5 million. For the quarter ended March 31, 1999 the net cash used in
financing activities totaled $50.0 million. On January 5, 1999, pursuant to an
Investment Agreement between AOL and the Company, AOL made a significant equity
investment in the Company, acquiring 4,121,372 shares of Common Stock for $55.0
million in cash and the surrender of rights to acquire up to 5,076,016 shares of
Common Stock pursuant to various warrants held by AOL. Additional financing
activities generated $10.0 million from the exercise of stock options. These
activities in 1999 were offset by the acquisition of convertible debt of $65.4
million and the repayment of margin account indebtedness of $49.6 million.
Under the terms of the Investment Agreement with AOL, the Company has
agreed to reimburse AOL for losses AOL may incur on the sale of any of the
4,121,372 shares during the period from June 1, 1999 through September 30, 2000.
The reimbursement amount would be determined by multiplying the number of
shares, if any, that AOL sells during the applicable period by the difference
between the purchase price per share paid by AOL, or $19 per share, and the
price per share that AOL sells the shares for, if less than $19 per share. The
reimbursement amount may not exceed $14 per share for 2,894,737 shares or $11
per share for 1,226,635 shares. Accordingly, the maximum amount payable to AOL
as reimbursement on the sale of AOL's shares would be approximately $54.0
million plus AOL's reasonable expenses incurred in connection with the sale. The
Company has the option of issuing a six-month 10% note payable to AOL to satisfy
the reimbursement amount or other amounts payable on exercise of its first
refusal rights. Assuming AOL were to sell all of its shares subject to the
Company reimbursement obligation at the closing price of Common Stock as of May
8, 2000, the reimbursement amount would be approximately $40.7 million. AOL also
has the right, on termination of the Company's long distance exclusivity under
its marketing agreement with AOL to require the Company to repurchase warrants
held by AOL to purchase 2,721,984 shares of Common Stock for $36.3 million,
which repurchase price can be paid in Common Stock or cash (provided that some
portion of the repurchase price may be payable in a quarterly amortization,
two-year promissory note of the Company if the repurchase price exceeds the then
current valuation of the warrants being purchased). The Company has pledged the
stock of its subsidiaries and has agreed to fund an escrow account of up to
$35.0 million from 50% of the proceeds of any debt financing, other than a bank,
receivable or other asset based financing of up to $50.0 million, to secure its
obligations under the Investment Agreement with AOL. Mr. Daniel Borislow, former
Chairman of the Board and Chief Executive Officer of the Company, has agreed to
guarantee up to $20.0 million of the Company's reimbursement obligations under
the Investment Agreement with AOL.
The Company has previously announced the commitment, subject to the
satisfaction of certain conditions, including execution of definitive
agreements, obtaining regulatory approvals and completion of satisfactory due
diligence, of investment affiliates of Soros Private Equity Partners to invest
$80.0 million in the Company in exchange for 80,000 shares of seven percent
convertible preferred stock of the Company and warrants to acquire 200,000
shares of the Company common stock. These conditions have not yet been satisfied
and there can be no assurance that such investment will be completed or
completed in accordance with the original commitment terms.
Except with respect to receivables from international wholesale sales,
which are conducted with a small number of international wholesale purchasers,
the Company generally does not have a significant concentration of credit risk
with respect to net trade accounts receivable, due to the large number of end
users comprising the Company's customer base and their dispersion across
different geographic regions. The Company maintains reserves for potential
credit losses and, to date, such losses have been within the Company's
expectations.
The Company does not, and has not historically, required significant
amounts of working capital for its day-to-day operations. The Company believes
that its current cash position and the cash flow expected to be generated from
operations will be sufficient to fund its capital expenditures, working capital
and other cash requirements, including the increased marketing and promotional
expenditures discussed above, for at least the next twelve months. The Company
15
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
also believes that, assuming the current market price of its common stock, its
existing cash and its cash flow from operations will be sufficient to fund any
reimbursement amount in the event that AOL elects to sell its shares of the
Company's common stock at a price below $19 per share and that, alternatively,
it has the ability to obtain the necessary financing to fund its obligations
under the AOL Investment Agreement. Should the Company seek to raise additional
capital, there can be no assurance that, given current market conditions, the
Company would be able to raise such additional capital on terms acceptable to
the Company.
YEAR 2000
The "Year 2000 issue" refers to the potential harm from computer programs
that fail due to misidentification of dates after January 1, 2000. The Company
did not encounter any disruptions in service or operations as a result of Year
2000 computer programming. The Company did not separately identify costs
incurred in connection with its Year 2000 compliance activities. The Company did
not believe such costs to be significant because they generally have been
incurred in the normal course of internally modifying and updating the Company's
software programs. Future expenditures are not expected to be significant and
will be funded out of operating cash flows.
SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS
Certain of the statements contained herein may be considered
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such
statements are identified by the use of forward-looking words or phrases,
including, but not limited to, "estimates," "expects," "expected,"
"anticipates," and "anticipated." These forward-looking statements are based on
the Company's current expectations. Although the Company believes that the
expectations reflected in such forward-looking statements are reasonable, there
can be no assurance that such expectations will prove to have been correct.
Forward-looking statements involve risks and uncertainties and the Company's
actual results could differ materially from the Company's expectations. In
addition to those factors discussed in the foregoing Management's Discussion and
Analysis, important factors that could cause such actual results to differ
materially include, among others, adverse developments in the Company's
relationship with AOL, increased price competition for long distance services,
failure of the marketing of long distance services under its agreement with its
various marketing partners, attrition in the number of end users, a failure of
the Company's new local services and bundled local and long distance services
initiative and changes in government policy, regulation and enforcement. The
Company undertakes no obligation to update its forward-looking statements.
16
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
11 Computation of Net Income Per Share
27 Financial Data Schedule
(b) Reports on Form 8-K:
The Company filed no Current Reports on Form 8-K during the
three months ended March 31, 2000.
17
<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.COM INC.
Date: May 15, 2000 By: /s/ Gabriel Battista
---------------------
Gabriel Battista
Chief Executive Officer
Date: May 15, 2000 By: /s/ Edward B. Meyercord, III
-----------------------------
Edward B. Meyercord, III
Chief Financial Officer
Date: May 15, 2000 By: /s/ Janet C. Kirschner
-----------------------
Janet C. Kirschner
Controller
18
EXHIBIT 11
TALK.COM INC. AND SUBSIDIARIES
COMPUTATION OF NET INCOME PER SHARE
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
MARCH 31,
-------------------------------
2000 1999
------------- --- -------------
<S> <C> <C>
Income before extraordinary gain $13,380 $12,334
Extraordinary gain -- 18,997
------------- -------------
Net income $13,380 $31,331
============= =============
BASIC:
Weighted average common shares outstanding 65,302 58,909
============= =============
Income before extraordinary gain $ 0.20 $ 0.21
Extraordinary gain -- 0.32
------------- -------------
Net income $ 0.20 $ 0.53
============= =============
DILUTED:
Weighted average common and common equivalent shares outstanding:
Weighted average shares 65,302 58,909
Effect of assumed conversion of common stock options 3,099 3,426
------------- -------------
Weighted average common and common equivalent shares 68,401 62,335
============= =============
Income before extraordinary gain $ 0.20 $ 0.20
Extraordinary gain -- 0.30
------------- -------------
Net income $ 0.20 $ 0.50
============= =============
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
UNAUDITED CONSOLIDATED BALANCE SHEET AS OF MARCH, 2000 AND THE UNAUDITED
CONSOLIDATED STATEMENT OF INCOME FOR THE THREE MONTHS ENDED MARCH 31, 2000 OF
TALK.COM INC. AND SUBSIDIARIES AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1
<CURRENCY> US-DOLLAR
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-31-2000
<EXCHANGE-RATE> 1
<CASH> 88,440,000
<SECURITIES> 0
<RECEIVABLES> 72,439,000
<ALLOWANCES> 7,620,000
<INVENTORY> 0
<CURRENT-ASSETS> 160,726,000
<PP&E> 80,505,000
<DEPRECIATION> 15,225,000
<TOTAL-ASSETS> 232,036,000
<CURRENT-LIABILITIES> 55,792,000
<BONDS> 0
0
0
<COMMON> 670,000
<OTHER-SE> 59,110,000
<TOTAL-LIABILITY-AND-EQUITY> 232,036,000
<SALES> 0
<TOTAL-REVENUES> 156,059,000
<CGS> 0
<TOTAL-COSTS> 91,691,000
<OTHER-EXPENSES> 50,685,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 979,000
<INCOME-PRETAX> 13,630,000
<INCOME-TAX> 250,000
<INCOME-CONTINUING> 13,380,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 13,380,000
<EPS-BASIC> 0.20
<EPS-DILUTED> 0.20
</TABLE>
