SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A
AMENDMENT NO. 1
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1999
Commission File No. 0-26728
TALK.COM INC.
(Exact name of registrant as specified in its charter)
DELAWARE 23-2827736
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
12020 SUNRISE VALLEY DRIVE, SUITE 250 20191
RESTON, VIRGINIA (zip code)
(Address of principal executive offices)
(703) 391-7500
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
None Not applicable
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE
RIGHTS TO PURCHASE SERIES A JUNIOR PARTICIPATING PREFERRED STOCK
(Title of class)
Indicate by check mark whether the registrant (1) has filed all documents
and 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 by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment of this
Form 10-K. [X]
As of March 20, 2000, the aggregate market value of voting stock held by
non-affiliates of the registrant, based on the average of the high and low
prices of the Common Stock on March 20, 2000 of $14.78 per share as reported on
the Nasdaq National Market, was approximately $967,913,861 (calculated by
excluding solely for purposes of this form outstanding shares owned by directors
and executive officers).
As of March 20, 2000, the registrant had issued and outstanding 65,789,152
shares of its Common Stock, par value $.01 per share.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement for the 2000 Annual
Meeting of Stockholders are incorporated by reference into Part III of this Form
10-K.
<PAGE>
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data should be read in conjunction
with, and are qualified in their entirety by, "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Company's
Consolidated Financial Statements included elsewhere in this Form 10-K.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENTS OF INCOME DATA:
Sales $ 516,548 $ 448,600 $ 304,768 $ 232,424 $ 180,102
Cost of sales 320,751 361,957 294,484 200,597 156,121
Gross profit 195,797 86,643 10,284 31,827 23,981
General and administrative expenses 42,696 41,939 34,650 10,039 6,280
Promotional, marketing and advertising 96,264 210,552 60,685 -- --
Significant other charges (income) (2,718) 91,025 -- -- --
Operating income (loss) 59,555 (256,873) (85,051) 21,788 17,701
Investment and other income (expense), net (1,856) (11,175) 50,715 10,585 331
Income (loss) before provision (benefit) for income taxes 57,699 (268,048) (34,336) 32,373 18,032
Provision (benefit) for income taxes (1)(2) -- 40,388 (13,391) 12,205 7,213
Income (loss) before extraordinary gain (1) 57,699 (308,436) (20,945) 20,168 10,819
Extraordinary gain (from extinguishments of debt) 21,230 87,110 -- -- --
Net income (loss)(1) $ 78,929 $(221,326) $ (20,945) $ 20,168 $ 10,819
Income (loss) before extraordinary gain per share -
Basic (1) $ 0.94 $ (5.20) $ (0.33) $ 0.38 $ 0.34
Extraordinary gain per share - Basic $ 0.35 $ 1.47 -- -- --
Net income (loss) per share - Basic (1) $ 1.29 $ (3.73) $ (0.33) $ 0.38 $ 0.34
Weighted average common shares outstanding - Basic 61,187 59,283 64,168 52,650 31,422
Income (loss) before extraordinary gain
per share - Diluted (1) $ 0.90 $ (5.20) $ (0.33) $ 0.35 $ 0.32
Extraordinary gain per share - Diluted $ 0.33 $ 1.47 -- -- --
Net income (loss) per share - Diluted (1) $ 1.23 $ (3.73) $ (0.33) $ 0.35 $ 0.32
Weighted average common and common equivalent shares
outstanding - Diluted 64,415 59,283 64,168 57,002 33,605
<CAPTION>
AT DECEMBER 31,
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Working capital $ 87,125 $ 13,061 $ 634,788 $ 175,597 $ 38,171
Total assets 215,008 272,560 814,891 257,008 71,388
Convertible debt 84,985 242,387 500,000 -- --
Total stockholders' equity (deficit) 40,103 (136,785) 222,828 230,720 41,314
</TABLE>
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(1) For the period ended September 19, 1995, Talk.com Holding Corp., the
predecessor corporation to the Company ("Predecessor Corporation") elected
to report as an S corporation for federal and state income tax purposes.
Accordingly, the Predecessor Corporation's stockholders included their
respective shares of the Company's taxable income in their individual
income tax returns. The pro forma income taxes reflect the taxes that would
have been accrued if the Company had elected to report as a C corporation.
(2) The provision for income taxes in 1998 represents a valuation allowance for
deferred tax assets recorded in prior periods and current tax benefits that
may result from the 1998 loss. The Company provided the valuation
allowances in view of the loss incurred in 1998, the uncertainties
resulting from intense competition in the telecommunications industry and
the lack of any assurance that the Company will realize any tax benefits.
The Company has continued to provide a valuation allowance against its
deferred tax assets at December 31, 1999.
1
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
Consolidated Financial Statements included elsewhere in this Form 10-K.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated certain financial
data as a percentage of sales:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Sales 100.0% 100.0% 100.0%
Cost of sales 62.1 80.7 96.6
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Gross profit 37.9 19.3 3.4
General and administrative expenses 8.3 9.3 11.4
Promotional, marketing and advertising expenses 18.6 46.9 19.9
Significant other charges (income) (0.5) 20.3 --
----- ----- -----
Operating income (loss) 11.5 (57.2) (27.9)
Investment and other income (expense), net (0.4) (2.5) 16.6
----- ----- -----
Income (loss) before income taxes 11.1 (59.7) (11.3)
Provision (benefit) for income taxes -- 9.0 (4.4)
----- ----- -----
Income (loss) before extraordinary gain 11.1 (68.7) (6.9)
Extraordinary gain 4.1 19.4 --
----- ----- -----
Net income (loss) 15.2% (49.3)% (6.9)%
===== ===== =====
</TABLE>
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
Sales. Sales increased by 15.1% to $516.5 million in 1999 from $448.6
million in 1998. The increase in sales primarily reflected an increase in the
number of online customers. The increase in online sales was partially offset by
a decrease in the Company's other sales. The Company has increased the number of
agreements it has with marketing partners, which have significantly contributed
to the rate of growth in the online business. Online sales could be affected
adversely by the intense competition in this industry and have continued to be
affected adversely by the PIC freezes implemented by the local telephone
companies. There can be no assurance that the Company will continue to increase
sales on a quarter-to-quarter or year-to-year basis.
A significant percentage of the Company's revenues in 1999 and 1998 were
derived from long distance telecommunications services provided to customers who
were obtained under the AOL agreement. While the Company's rights to market
exclusively under the AOL agreement do not expire until June 30, 2003, AOL has
the right to elect to permit others to market long distance telecommunications
services after June 30, 2000 to AOL's subscribers and forego its rights to fixed
annual payments from the Company, which would be at least $60 million in the 12
months ending June 30, 2001. 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. The Company is unable to predict what the consequences of such a
termination of its exclusive rights, with the corresponding release from the
fixed payments, would be. The Company believes that it could retain a
substantial portion of its existing base and continue to attract new customers
by continuing to be competitive on service and price. The Company also would
continue to market its services to the AOL subscribers and to continue its
efforts to expand its non-AOL base of online customers. However, 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.
Cost of Sales. Cost of sales decreased by 11.4% to $320.8 million in 1999
from $362.0 million in 1998. This 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.
Gross Margin. Gross margin increased to 37.9% in 1999 from 19.3% in 1998.
The increase in gross margin was primarily due to lower network usage costs for
OBN services on a per minute basis, lower partition costs due to the decrease in
other sales, as noted above, and lower bad debt expense.
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General and Administrative Expenses. General and administrative expenses
increased by 1.8% to $42.7 million in 1999 from $41.9 million in 1998, but
decreased as a percentage of sales. The increase in general and administrative
expenses 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 fees for professional services.
Promotional, Marketing, and Advertising Expenses. During 1999, the Company
incurred $96.3 million of promotional, marketing and advertising expense to
expand its online customer base. During 1998, the Company incurred $210.6
million of promotional, marketing and advertising expense, including $49.7
million related to the AOL Agreement, $22.0 million for the performance warrants
issued to AOL during 1998, and $138.9 million of promotional, marketing and
advertising expense to expand its online customer base.
Significant Other Charges (Income). During 1999, the Company sold the
business units of TSFL Holdings, Inc. (formerly Symetrics Industries, Inc.),
resulting in a gain of $2.7 million which was included in significant other
charges (income). During 1998, the Company allocated $21.0 million of the
acquisition cost of TSFL Holdings, Inc. to purchased research and development
expense, which was included in significant other charges (income).
Investment and Other Income (Expense), Net. Investment and other income
(expense), net was $(1.9) million in 1999 versus $(11.2) in 1998. During 1999,
investment and other income (expense), net consists primarily of interest income
offset by interest expense related to the Company's convertible debt.
Extraordinary Gain. During 1999, the Company recorded an extraordinary gain
of $21.2 million from the acquisition of the Company's convertible debt at a
discount from its aggregate principal amount.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
Sales. Sales increased by 47.2% to $448.6 million in 1998 from $304.8
million in 1997. The increase in sales resulted primarily from the Company's
marketing campaign directed at generating new customers under the AOL agreement.
This AOL-related sales increase offset a decrease in the Company's non-AOL
sales, and reflected, to a lesser extent, the Company's focus on marketing under
the AOL agreement.
Cost of Sales. Cost of sales increased by 22.9% to $362.0 million in 1998
from $294.5 million in 1997 as a result of increased sales offset by certain
charges in 1997, totaling $41.5 million, discussed below.
Gross Margin. Gross margin increased to 19.3% in 1998 from 17.0%, excluding
certain charges totaling $41.5 million (as described below) in 1997. The
increase in gross margin was primarily due to lower network usage costs for OBN
services and lower local and international access charges, in each case on a per
call basis.
General and Administrative Expenses. General and administrative expenses
increased by 21.0% to $41.9 million in 1998 from $34.7 million in 1997. The
increase in general and administrative expenses was due primarily to the costs
associated with hiring additional personnel to support the Company's continuing
growth, the general and administrative expense incurred as a result of the
acquisitions of Compco, Inc. and ADS Holdings, Inc. which were acquired in
November 1997 and January 1998, respectively, and increased fees for
professional services.
Promotional, Marketing and Advertising Expense -- Primarily AOL. During
1998 the Company incurred $210.6 million of expenses to expand its online
customer base. These expenses included $49.7 million for online advertising
under the AOL Agreement, $22.0 million for the value of performance warrants
granted to AOL for net customer gains and $138.9 for offline advertising. During
1997, the Company incurred $60.7 million that consisted of $35.9 million for
exclusivity under the AOL Agreement, $13.2 million for production of
advertising, $7.9 million for online advertising for the fourth quarter of 1997,
$1.2 million representing the value of performance warrants paid to AOL for net
customer gains and $2.5 million for other advertising.
Significant Other Charges. Significant other charges consist of $91.0
million of expenses incurred in the fourth quarter of 1998 related to changes in
the Company's basic business operations.
In January 1999, the Company negotiated substantial amendments to the AOL
and CompuServe agreements that, among other things, reduced the amount of online
advertising to which the Company was entitled to over the remaining term of the
agreement and eliminated payments and issuance of warrants to AOL for customer
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<PAGE>
gains and profit sharing payments to AOL. The Company agreed to fixed quarterly
payments ranging from $10 - $15 million during the exclusivity period of the
agreement and AOL agreed to contribute up to $4.0 million per quarter for
offline marketing. As a result of the amendment, the Company wrote off prepaid
AOL, CompuServe and other marketing-related expenses of $37.6 million.
In connection with hiring a new Chairman and Chief Executive Officer and
several other key executive personnel and severance payments relating to this
change in management, the Company incurred $12.7 million of incentive and
severance expense.
The Company acquired ADS Holdings, Inc. (formerly Symetrics, Inc.), a
manufacturer of digital telephone switching equipment, in January 1998 for $18.6
million. The Company planned to complete development of a digital switch to
provide state of the art features for use in the Company's operations as a
competitive local exchange carrier. The Company allocated $21 million of the
acquisition cost to purchased research and development expense in the first
quarter of 1998 and continued to invest in additional research and development
throughout 1998. In November 1997, the Company acquired Compco, Inc, a provider
of communications software in the college and university marketplace for $13.7
million which exceeded the net assets acquired by $10.6 million. In the fourth
quarter of 1998, the Company decided to sell the assets of ADS Holdings, Inc.
and to delay entry into the college and university marketplace. As a result, the
assets of ADS Holdings, Inc. and Compco, Inc. were written down to expected
realizable value. The Company recorded $15 million relating to the impairment of
these assets and reclassified the $22.2 million of research and development
expense to significant other charges.
In the fourth quarter of 1998, the Company reconfigured its
telecommunications network, OBN, to provide for fiber optic connections among
its switches and incurred $3.5 million of expense.
Investment and Other Income (Expense), Net. Investment and other income
(expense), net was $(11.2) million in 1998 versus $50.7 million in 1997. During
1998, investment and other income (expense), net consists primarily of
investment income and trading losses of $11.0 million offset by interest expense
related to the Company's Convertible Notes of $22.2 million.
Provision for Income Taxes. The Company had recorded net deferred tax
assets at December 31, 1997 and March 31,1998 primarily representing net
operating loss carry-forwards and other temporary differences because the
Company believed that no valuation allowance was required for these assets due
to future reversals of existing taxable temporary differences and expectation
that the Company will generate taxable income in future years. In June 1998, the
Company decided to make substantial marketing and advertising expenditures to
establish a broad base of online customers from AOL's membership. As discussed
above, these expenditures led to a significant loss for 1998. In view of these
losses, the uncertainties resulting from intense competition in the
telecommunications industry and the lack of any assurance that the Company will
realize any of the tax benefits, the Company decided in June 1998 to provide a
100% valuation allowance for the previously recorded deferred tax benefits and
to provide a 100% valuation allowance for the current and future tax benefits
resulting from the 1998 loss. Valuation allowances of approximately $115.0
million were included in provision for income taxes, for the year ended December
31, 1998.
Extraordinary Gain. During 1998, the Company recorded an extraordinary gain
of $87.1 million in connection with the acquisition of the Company's convertible
debt at a discount.
LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital was $87.1 million and $13.1 million at
December 31, 1999 and 1998, respectively. This increase in working capital is
primarily a result of the cash generated from the Company's operations and the
exercise of stock options. In addition the Company received $11.1 million in
2000 in connection with the exercise of outstanding Common Stock rights prior to
their expiration in February 2000.
4
<PAGE>
The Company expended an aggregate of $132.9 million and $429.9 million of
cash, Common Stock and other consideration for the repurchased outstanding
securities during 1999 and 1998 respectively. During 1999 the Company
repurchased an aggregate principal amount of $157.4 million of Convertible
Notes. The Company (a) purchased from Daniel Borislow, the Company's former
Chairman and Chief Executive Officer, and two trusts for the benefit of Mr.
Borislow's children $85,857,000 aggregate principal amount of the Company's
Convertible Notes for $72.3 million in cash; (b) exchanged the $53.7 million
remaining on certain WorldxChange Notes payable to the Company with a trust for
the benefit of Mr. Borislow's children for $62,545,000 aggregate principal
amount of the Company's Convertible Notes and (c) purchased $9,000,000 aggregate
principal amount of the Company's Convertible Notes for $6.9 million in Common
Stock. As of December 31, 1999, the Company had reduced the principal amount
outstanding of its Convertible Notes to $85.0 million ($66.9 million of 4 1/2%
notes and $18.1 million of 5% notes). During 1999 the Company also purchased
from Mr. Borislow approximately 639,000 shares of Common Stock for approximately
$7.7 million with proceeds from the exercise of stock options pursuant to
agreements with Mr. Borislow. During 1998, the Company repurchased approximately
18.8 million shares for an aggregate of $265.1 million ($239.9 million cash and
$25.2 million in other consideration) and repurchased approximately $257.6
million principal amount of the Company's Convertible Notes for approximately
$164.8 million ($86.3 million in cash, $69.5 million in Common Stock and $9.0
million in other consideration).
The Company invested $6.5 million in capital equipment during 1999.
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. 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
March 20, 2000, the reimbursement amount would be approximately $20.3 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 Common Stock for
$36.3 million, which repurchase price can be paid in Common Stock or cash or
(provided that some portion of the repurchase price may be payable in a
quarterly amortizing, two-year promissory note of the Company if the repurchase
price exceeds the then current valuation of the warrant being repurchased). The
Company has pledged the stock of its subsidiaries and has agreed to fund an
escrow account of up to $35 million from 50% of the proceeds of any debt
financing, other than a bank, receivable or other asset based financing of up to
$50 million, to secure its obligations under the Investment Agreement with AOL.
Mr. Borislow has agreed to guarantee up to $20,000,000 of the Company's
reimbursement obligations under the Investment Agreement with AOL.
As previously reported, the Company was subject to certain restrictions
under a registration rights agreement between the Company and Mr. Borislow that
could have affected the Company's ability to raise capital and engage in other
types of financing transactions. As of December 31, 1999, 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 in the aggregate less than 2% of
the outstanding Common Stock. Accordingly, the Company believes that the
restrictions no longer apply to the Company.
The Company generally does not have a significant concentration of credit
risk with respect to 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 for at least the next twelve months. The Company
also believes that, assuming the current market
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<PAGE>
price of its Common Stock, its cash flow from operations will be sufficient to
fund any reimbursement amount in the event that AOL elects to sell its shares of
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.
* * * * *
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.
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, and changes in
government policy, regulation and enforcement. The Company undertakes no
obligation to update its forward-looking statements.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
TALK.COM INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
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Report of Independent Certified Public Accountants 18
Consolidated balance sheets as of December 31, 1999 and 1998 19
Consolidated statements of operations for the years ended December
31, 1999, 1998 and 1997 20
Consolidated statements of stockholders' equity (deficit) for the years
ended December 31, 1999, 1998 and 1997 21
Consolidated statements of cash flows for the years ended December
31, 1999, 1998 and 1997 22
Notes to consolidated financial statements 23-37
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REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors
and Stockholders of Talk.com Inc.
We have audited the accompanying consolidated balance sheets of Talk.com
Inc. and subsidiaries as of December 31, 1999 and 1998, and the related
consolidated statements of operations, stockholders' equity (deficit) and cash
flows for each of the three years in the period ended December 31, 1999. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Talk.com
Inc. and subsidiaries as of December 31, 1999 and 1998, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1999, in conformity with generally accepted accounting principles.
BDO Seidman, LLP
New York, New York
February 7, 2000
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TALK.COM INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT FOR SHARE DATA)
<TABLE>
<CAPTION>
December 31,
----------------------------
1999 1998
---- ----
Assets
<S> <C> <C>
Current:
Cash and cash equivalents $ 78,937 $ 3,063
Marketable securities -- 89,649
Accounts receivable, trade, net of allowance for uncollectible
of $5,011 and $1,669, respectively 59,501 46,587
Advances to partitions and notes receivable 3,600 1,870
Prepaid expenses and other current assets 8,855 8,600
- ---------------------------------------------------------------------------- --------- ---------
Total current assets 150,893 149,769
Property and equipment, net 57,335 56,703
Intangibles, net 1,068 1,150
Other assets 5,712 64,938
- ---------------------------------------------------------------------------- --------- ---------
Total assets $ 215,008 $ 272,560
- ---------------------------------------------------------------------------- --------- ---------
Liabilities, Contingent Redemption Value of Common Stock and
Stockholders' Equity (Deficit)
Current:
Margin account indebtedness $ -- $ 49,621
Accounts payable and accrued expenses:
Trade 47,965 64,794
Partitions 1,676 4,380
Taxes and other 14,127 17,913
- ---------------------------------------------------------------------------- --------- ---------
Total current liabilities 63,768 136,708
Convertible debt 84,985 242,387
Deferred revenue 21,000 28,400
Other liabilities -- 1,850
- ---------------------------------------------------------------------------- --------- ---------
Total liabilities 169,753 409,345
- ---------------------------------------------------------------------------- --------- ---------
Commitments and Contingencies
Contingent redemption value of common stock 5,152 --
- ---------------------------------------------------------------------------- --------- ---------
Stockholders' equity (deficit):
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 and 66,934,635 shaares issued, respectively 670 669
Additional paid-in capital 208,453 265,325
Deficit (139,300) (218,229)
Treasury stock (29,720) (184,550)
- ---------------------------------------------------------------------------- --------- ---------
Total stockholders' equity (deficit) 40,103 (136,785)
- ---------------------------------------------------------------------------- --------- ---------
Total liabilities, contingent redemption value of common stock and
stockholders' equity (deficit) $ 215,008 $ 272,560
- ---------------------------------------------------------------------------- --------- ---------
</TABLE>
See accompanying notes to consolidated financial statements.
9
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Sales $ 516,548 $ 448,600 $ 304,768
Cost of sales 320,751 361,957 294,484
--------- --------- ---------
Gross profit 195,797 86,643 10,284
General and administrative expenses 42,696 41,939 34,650
Promotional, marketing and advertising expenses 96,264 210,552 60,685
Significant other charges (income) (2,718) 91,025 --
--------- --------- ---------
Operating income (loss) 59,555 (256,873) (85,051)
Investment and other income (expense), net (1,856) (11,175) 50,715
--------- --------- ---------
Income (loss) before provision (benefit) for income taxes 57,699 (268,048) (34,336)
Provision (benefit) for income taxes -- 40,388 (13,391)
--------- --------- ---------
Income (loss) before extraordinary gain 57,699 (308,436) (20,945)
Extraordinary gain from extinguishment of debt 21,230 87,110 --
--------- --------- ---------
Net income (loss) $ 78,929 $(221,326) $ (20,945)
========= ========= =========
Income (loss) before extraordinary gain per share - Basic $ 0.94 $ (5.20) $ (0.33)
Extraordinary gain per share - Basic 0.35 1.47 --
--------- --------- ---------
Net income (loss) per share - Basic $ 1.29 $ (3.73) $ (0.33)
========= ========= =========
Weighted average common shares
outstanding - Basic 61,187 59,283 64,168
========= ========= =========
Income (loss) before extraordinary gain per share - Diluted $ 0.90 $ (5.20) $ (0.33)
Extraordinary gain per share - Diluted 0.33 1.47 --
--------- --------- ---------
Net income (loss) per share - Diluted $ 1.23 $ (3.73) $ (0.33)
========= ========= =========
Weighted average common and common equivalent shares
outstanding - Diluted 64,415 59,283 64,168
========= ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
10
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS)
<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, 1997 62,238 $ 622 $ 210,616 $ 24,042 (428) $ (4,560) $ 230,720
Net loss -- -- -- (20,945) -- -- (20,945)
Issuance of warrants to AOL -- -- 21,200 -- -- -- 21,200
Issuance of common stock for
acquired businesses 141 1 2,217 -- -- -- 2,218
Exercise of common stock warrants 2,662 27 11,977 -- -- -- 12,004
Exercise of common stock options 2,209 22 9,318 -- -- -- 9,340
Purchase of common stock warrants -- -- (4,400) -- -- -- (4,400)
Issuance of common stock options
for compensation -- -- 13,372 -- -- -- 13,372
Acquisition of treasury stock -- -- -- -- (3,520) (71,959) (71,959)
Issuance of treasury stock for
acquired businesses -- -- 1,999 -- 340 3,626 5,625
Income tax benefit related to
exercise of common stock
options and warrants -- -- 25,653 -- -- -- 25,653
--------- --------- --------- --------- --------- --------- ---------
Balance, December 31, 1997 67,250 672 291,952 3,097 (3,608) (72,893) 222,828
Net loss -- -- -- (221,326) -- -- (221,326)
Issuance of warrants to AOL -- -- 33,086 -- -- -- 33,086
Exercise of common stock
warrants -- -- (3,620) -- 250 5,052 1,432
Exercise of common stock options -- -- (41,493) -- 2,853 55,550 14,057
Exercise of AOL warrants -- -- (7,693) -- 381 7,693 --
Retirement of common stock (315) (3) (1,467) -- -- -- (1,470)
Acquisition of treasury stock -- -- -- -- (18,809) (265,054) (265,054)
Issuance of common stock and
options for compenstion -- -- (3,123) -- 895 13,224 10,101
Issuance of common stock for
convertible debt -- -- (2,317) -- 5,089 71,878 69,561
--------- --------- --------- --------- --------- --------- ---------
Balance, December 31, 1998 66,935 669 265,325 (218,229) (12,949) (184,550) (136,785)
Net income -- -- -- 78,929 -- -- 78,929
AOL investment -- -- (3,730) -- 4,121 58,730 55,000
Exercise of common stock options -- -- (47,313) -- 6,773 95,600 48,287
Exercise of common stock rights 38 1 651 -- -- -- 652
Acquisition of treasury stock -- -- -- -- (639) (7,686) (7,686)
Issuance of common stock for
convertible debt -- -- (1,328) -- 574 8,186 6,858
Contingent redemption value of
common stock -- -- (5,152) -- -- -- (5,152)
-------- --------- --------- --------- --------- --------- ---------
Balance, December 31, 1999 66,973 $ 670 $ 208,453 $(139,300) (2,120) $ (29,720) $ 40,103
========= ========= ========= ========= ========= ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
11
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------
1999 1998 1997
------------- ----------- -------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 78,929 $(221,326) $ (20,945)
Adjustment to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Unrealized loss on securities -- -- 1,865
Provision for bad debts 3,480 (235) 1,579
Depreciation and amortization 5,956 5,499 5,429
Vested AOL warrants and amortization of prepaid AOL marketing costs -- 71,665 58,185
Charge for customer acquisition costs -- -- 11,550
Significant other charges -- 55,034 --
Write-off of intangibles -- -- 23,032
Realization of deferred revenue (7,400) (7,400) --
Compensation charges -- 8,402 13,372
Income tax benefit related to exercise of options and warrants -- -- 25,653
Valuation allowance for deferred tax assets -- 40,388 --
Extraordinary gain from extinguishment of debt (21,230) (87,110) --
Increase (decrease) in:
Accounts receivable, trade (16,256) (1,250) (26,048)
Advances to partitions and notes receivable (1,730) 24,241 (12,700)
Prepaid AOL marketing costs -- -- (100,564)
Prepaid expenses and other current assets (254) (23,712) (38,259)
Other assets 2,215 (49,127) (20,769)
Increase (decrease) in:
Accounts payable and accrued expenses (23,457) 56,419 9,608
Deferred revenue -- -- 35,800
Other liabilities (1,850) (1,302) --
- --------------------------------------------------------------------------- --------- --------- ---------
Net cash provided by (used in) operating activities 18,403 (129,814) (33,212)
- --------------------------------------------------------------------------- --------- --------- ---------
Cash flows from investing activities:
Acquisition of intangibles -- (285) (9,293)
Acquisition of Symetrics Industries, Inc. -- (26,707) --
Capital expenditures, net (6,506) (16,928) (28,876)
Securities sold short -- (21,087) 17,700
Due from broker -- 21,087 (20,220)
Sale (purchase) of marketable securities, net 89,649 122,620 (62,377)
- --------------------------------------------------------------------------- --------- --------- ---------
Net cash provided by (used in) investing activities 83,143 78,700 (103,066)
- --------------------------------------------------------------------------- --------- --------- ---------
Cash flows from financing activities:
Repayment of margin account indebtedness (49,621) -- --
Proceeds from margin account indebtedness -- 49,621 --
Proceeds from sale of convertible debt -- -- 500,000
Acquisition of convertible debt (72,304) (86,301) --
Proceeds from exercise of options and warrants 48,287 15,489 21,344
Purchase of common stock warrants -- -- (4,400)
AOL investment 55,000 -- --
Retirement of common stock -- (1,470) --
Proceeds from exercise of common stock rights 652 -- --
Acquisition of treasury stock (7,686) (239,892) (71,959)
- --------------------------------------------------------------------------- --------- --------- ---------
Net cash (used in) provided by financing activities (25,672) (262,553) 444,985
- --------------------------------------------------------------------------- --------- --------- ---------
Net increase (decrease) in cash and cash equivalents 75,874 (313,667) 308,707
Cash and cash equivalents, beginning of year 3,063 316,730 8,023
- --------------------------------------------------------------------------- --------- --------- ---------
Cash and cash equivalents, end of year $ 78,937 $ 3,063 $ 316,730
- --------------------------------------------------------------------------- --------- --------- ---------
</TABLE>
See accompanying notes to consolidated financial statements.
12
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- SUMMARY OF ACCOUNTING POLICIES
(a) Business
Talk.com Inc., a Delaware corporation, together with its consolidated
subsidiaries (the "Company"), provides telecommunications services, primarily
long distance, throughout the United States to increasing numbers of residential
customers and to small and medium-sized businesses. The Company's long distance
service offerings include outbound service, inbound toll-free 800 service and
dedicated private line services for data. The Company sells these services
through its relationships with marketing partners, its web site located at
www.talk.com, as well as through partitions, which are independent marketing
companies.
(b) Basis of financial statements presentation
The consolidated financial statements include the accounts of Talk.com Inc.
and its wholly-owned subsidiaries 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.
In preparing financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
Certain amounts relating to 1997 have been reclassified to conform to the
current year presentation.
(c) Recognition of revenue
The Company recognizes revenue upon completion of telephone calls by end
users. Allowances are provided for estimated uncollectible usage.
(d) Cash and cash equivalents
The Company considers all temporary cash investments purchased with a
maturity of three months or less to be cash equivalents.
(e) Marketable securities
Securities bought and held principally for the purpose of selling them in
the near term are classified as "trading securities" and are carried at market.
Unrealized holding gains and losses (determined by specific identification) on
investments classified as "trading securities" are included in earnings.
(f) Advances to partitions and notes receivable
The Company made advances to partitions to support their marketing
activities. The advances are secured by partition assets, including contracts
with end users and collections thereon.
(g) Property and equipment and depreciation
Property and equipment are recorded at cost. Depreciation and amortization
is calculated using the straight-line method over the estimated useful lives of
the assets, as follows:
Buildings and building improvements 39 years
Switching equipment 15 years
Equipment and other 5-7 years
13
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(h) Intangibles and amortization
Intangibles of $1,068,000 and $1,150,000 at December 31, 1999 and 1998,
respectively, represent goodwill arising from a business acquisition.
Amortization is computed on a straight-line basis over the estimated useful life
of the intangible, which is 15 years.
(i) Deferred revenue
Deferred revenue is recorded for a non-refundable prepayment received in
1997 in connection with an amended telecommunications services agreement with
Shared Technologies Fairchild, Inc. and is amortized over the five-year term of
the agreement. This agreement is terminable by either party on thirty days
notice. Termination by either party would accelerate recognition of the deferred
revenue.
(j) Long-lived assets
The Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 121, "Accounting For the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of" as of January 1, 1996. Certain of the Company's
long-lived assets were considered impaired at December 31, 1998 (Note 3). There
was no additional impairment as of December 31, 1999.
(k) Income taxes
Since 1998, the Company has provided a full valuation allowance for
deferred tax assets and liabilities for the estimated future tax effects
attributable to temporary differences between the basis of assets and
liabilities for financial and tax reporting purposes (Note 11).
(l) Net income (loss) per share
Basic earnings per share includes no dilution and is computed by dividing
income available to common shareholders by the weighted average number of common
shares outstanding for the period. Diluted earnings per share reflect, in
periods in which they have a dilutive effect, the effect of common shares
issuable upon exercise of stock options and conversion of convertible debt.
The computation of basic net income per share is based on the weighted
average number of common shares outstanding during the period. In 1999, diluted
earnings per share also includes the effect of 3,195,076 common shares, issuable
upon exercise of common stock options and warrants.
All references in the consolidated financial statements with regard to
average number of Common Stock and related per share amounts have been
calculated giving retroactive effect to stock splits.
(m) Financial instruments and risk concentration
Financial instruments that potentially subject the Company to
concentrations of credit risk are cash investments for which the Company
believes no significant concentration of credit risk exists with respect to
these cash investments and marketable securities.
The carrying values of accounts receivable, advances to partitions and
notes receivable, accounts payable and accrued expenses approximate fair values.
Convertible debt is recorded at face amount but such debt has traded in the open
market at substantial discounts to face amount (Note 6). At December 31, 1999
the market value of the convertible debt was approximately 83% of face amount.
14
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(n) Stock-based compensation
The Company accounts for its stock option awards under the intrinsic value
based method of accounting prescribed by Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees." Under the intrinsic value based
method, compensation cost is the excess, if any, of the quoted market price of
the stock at grant date or other measurement date over the amount an employee
must pay to acquire the stock. The Company makes pro forma disclosures of net
income and earnings per share as if the fair value based method of accounting
had been applied as required by SFAS No. 123, "Accounting for Stock-Based
Compensation" (Note 10).
(o) Comprehensive income
The Company has no items of comprehensive income or expense. Accordingly,
the Company's comprehensive income and net income are equal for all periods
presented.
(p) New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which requires
entities to recognize all derivatives as either assets or liabilities in the
balance sheet and measure those instruments at fair value. SFAS No. 133, as
amended by SFAS No. 137, is effective for all fiscal years beginning after June
15, 2000. The Company anticipates that the new standard will have no effect on
its financial statements.
NOTE 2 -- AOL AGREEMENTS
In conjunction with the initial Telecommunications Marketing Agreement (the
"AOL Agreement") with AOL, the Company paid AOL a total of $100 million and
issued two warrants to purchase shares of the Company's stock. The first warrant
(the "First Warrant") provided for the purchase, at an exercise price of $15.50
per share, of up to 5,000,000 shares. The second warrant (the "Second Warrant")
provided for the purchase, at an exercise price of $14.00 per share, of up to
7,000,000 shares, which was to vest, based on the number of subscribers to the
Company's service. With the Second Warrant, as vesting occurred, the fair value
of the incremental vested portion of the warrant was charged to expense in the
consolidated statement of operations. In 1998, the Company issued a warrant to
purchase 1,000,000 shares (the "Further Warrant") to AOL in exchange for a one
year extension of the AOL Agreement. As of December 31, 1997 the Second Warrant
was vested as to approximately 120,000 shares and $1,200,000 was charged to
expense in the 1997 consolidated statement of operations.
The $100 million cash payment, the $20.0 million value of the First Warrant
and $0.6 million of agreement related costs was accounted for as follows: (i)
$35.9 million was charged to expense ratably over the period from the signing of
the initial AOL agreement to December 31, 1997, as payment for certain
exclusivity rights for that period; (ii) $13.2 million was treated as production
of advertising costs and was charged to expense on October 9, 1997, which was
the Commercial Launch Date; and (iii) $71.5 million, the balance of the cash
payment and the value of the First Warrant and the initial AOL agreement related
costs, represents the combined value of advertising and exclusivities which
extend over the term of the AOL Agreement and was recognized ratably after the
Commercial Launch Date as advertising services were received. For the year ended
December 31, 1997, the Company recognized $57.0 million of expense, related to
items discussed above, which is included in promotional, marketing and
advertising expenses.
The Company has negotiated a number of amendments to its agreements with
AOL based on the experience gained by the Company in the marketing and sale of
telecommunications services to AOL subscribers since the inception of the
agreements. A substantial amendment to the AOL agreement in January 1999 in
which the Company agreed to fixed quarterly payments ranging from $10 to $15
million during the long distance exclusivity period of the agreement resulted
in: the elimination of the Company's obligation to make bounty and
profit-sharing payments to AOL; altering 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 2003, although AOL
can end the Company's long distance exclusivity period on or after June 2000 by
foregoing the fixed
15
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
quarterly payments described above; 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 per quarter for
offline marketing; and establishment of the framework for the Company to offer
additional services and products to AOL subscribers. In 1998, as a result of the
January 1999 amendment, the Company wrote off $37.6 million of prepaid AOL,
CompuServe and other marketing-related expenses, included in significant other
charges (Note 3).
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. (Notes 9 and 10).
NOTE 3 -- SIGNIFICANT OTHER CHARGES (INCOME)
Significant other income in 1999 includes a gain of $2.7 million on the
sale of certain business units of TSFL Holdings, Inc. (formerly Symetrics
Industries, Inc.).
Significant other charges in 1998 includes $91.0 million of expenses
incurred in the fourth quarter of 1998 related to changes in the Company's basic
business operations.
As discussed in Note 2 above, the Company negotiated substantial amendments
to its agreements with AOL which, among other things, reduced the amount of
online advertising to which the Company was entitled to over the remaining term
of the agreement and eliminated payments and issuance of warrants to AOL for
customer gains and profit sharing payments to AOL. The Company agreed to fixed
quarterly payments ranging from $10 - $15 million per quarter during the
exclusivity period of the agreement and AOL agreed to contribute up to $4.0
million per quarter for offline marketing. As a result of the amendments, the
Company wrote off prepaid AOL, CompuServe and other marketing-related expenses
of $37.6 million.
In connection with hiring a new Chairman and Chief Executive Officer and
several other key executive personnel and severance payments relating to this
change in management, the Company incurred $12.7 million of incentive and
severance expense.
The Company acquired ADS Holdings, Inc. (formerly Symetrics, Inc.), a
manufacturer of digital telephone switching equipment, in January 1998 for $18.6
million. The Company planned to complete development of the digital switch to
provide state of the art features for use in the Company's operations as a
competitive local exchange carrier. The Company allocated $21 million of the
acquisition cost to purchased research and development expense in the first
quarter of 1998 and continued to invest in additional research and development
throughout 1998. In November 1997, the Company acquired Compco, Inc, a provider
of communications software in the college and university marketplace for $13.7
million, which exceeded the net assets acquired by $10.6 million. In the fourth
quarter of 1998, the Company decided to sell the assets of ADS Holdings, Inc.
and to delay entry into the college and university marketplace. As a result, the
assets of ADS Holdings, Inc. and Compco, Inc. were written down to expected
realizable value. The Company recorded $15 million relating to the impairment of
these assets and reclassified $22.2 million of research and development expense
to significant other charges.
In the fourth quarter of 1998, the Company reconfigured its
telecommunications network, OBN, to provide for fiber optic connections among
its switches and incurred $3.5 million of expense.
The Company determined in the second quarter of 1997 to de-emphasize the
use of direct marketing to solicit customers for the Company and to focus the
majority of its existing direct marketing resources on customer service and
support for the marketing operations of its carrier partitions, on a fee basis.
The Company recognized fees of $8.1 million for the year ended December 31,
1997, included in other income, from the services net of related costs of $14.6
million for the year ended December 31, 1997.
16
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The Company recorded a one-time charge of $11.5 million as cost of sales in
the quarter ended June 30, 1997, primarily as a result of the Company changing
its accounting for customer acquisition costs to expense them in the period
incurred versus the Company's prior treatment of capitalizing customer
acquisition costs and amortizing them over a six month period.
In October 1997, the Company decided to discontinue its internal
telemarketing operations which were primarily conducted through American
Business Alliance (which was acquired by the Company in December 1996), as part
of its restructuring of its sales and marketing efforts, and wrote-off, as cost
of sales, approximately $23.0 million of intangible assets.
NOTE 4 -- MAJOR PARTITIONS
During 1997, one Partition accounted for approximately 13% of the Company's
total sales. There were no Partitions that accounted for more than 10% of the
Company's total sales in 1999 or 1998.
NOTE 5 -- PROPERTY AND EQUIPMENT
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------
1999 1998
---------------------------------
(IN THOUSANDS)
<S> <C> <C>
Land $ 80 $ 80
Buildings and building improvements 2,801 2,639
Switching equipment 53,101 50,481
Equipment and other 14,791 11,067
-------- --------
70,773 64,267
Less: Accumulated depreciation (13,438) (7,564)
--------- ---------
$57,335 $56,703
======= =======
</TABLE>
NOTE 6 -- CONVERTIBLE DEBT
In September 1997, the Company sold $300 million of 4 1/2% Convertible
Subordinated Notes that mature on September 15, 2002 (the "2002 Convertible
Notes"). Interest on the 2002 Convertible Notes is due and payable semiannually
on March 15 and September 15 of each year. The 2002 Convertible Notes are
convertible, at the option of the holder thereof, at any time after December 9,
1997 and prior to maturity, unless previously redeemed, into shares of the
Company's Common Stock at a conversion price of $24.5409 per share, as adjusted
for the dilutive effect of the exercise of rights pursuant to the Company's
rights offering (Note 9). The 2002 Convertible Notes are redeemable, in whole or
in part, at the Company's option, at any time on or after September 15, 2000 at
101.80% of par prior to September 14, 2001 and 100.90% of par thereafter. During
1999 and 1998, the Company reacquired $80,650,000 and $152,458,000,
respectively, principal amount of the 2002 Convertible Notes and $66,892,000
principal amount remained outstanding at December 31, 1999.
In December 1997, the Company sold $200 million of 5% Convertible
Subordinated Notes that mature on December 15, 2004 (the "2004 Convertible
Notes"). Interest on the 2004 Convertible Notes is due and payable semiannually
on June 15 and December 15 of each year. The 2004 Convertible Notes are
convertible, at the option of the holder thereof, at any time after March 5,
1998 and prior to maturity, unless previously redeemed, into shares of the
Company's Common Stock at a conversion price of $25.3835 per share, as adjusted
for the dilutive effect of the exercise of rights pursuant to the Company's
rights offering (Note 9). The 2004 Convertible Notes are redeemable, in whole or
in part at the Company's option, at any time on or after December 15, 2002 at
101.43% of par prior to December 14, 2003 and 100.71% of par thereafter. During
1999 and 1998, the Company reacquired $76,752,000 and $105,155,000,
respectively, face amount of the 2004 Convertible Notes and $18,093,000
principal amount remained outstanding at December 31, 1999.
The 2002 Convertible Notes and 2004 Convertible Notes that were reacquired
by the Company in 1998 were reacquired at an $87.1 million discount from face
amount. This amount is reported as an extraordinary gain in the consolidated
statement of operations.
During 1999, the Company (a) purchased from Mr. Daniel Borislow, a founder
of the Company and its Chairman of the Board and Chief Executive Officer until
he resigned on January 5, 1999, and two trusts for the
17
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
benefit of Mr. Borislow's children, $85,857,000 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 $62,545,000 aggregate principal amount of the Company's
Convertible Notes and (c) purchased $9,000,000 aggregate principal amount of the
Company's Convertible Notes for $6.9 million in Common Stock.
The 2002 Convertible Notes and 2004 Convertible Notes that were reacquired
by the Company during 1999 were reacquired at a $21.2 million discount from face
amount. This amount is reported as an extraordinary gain in the consolidated
statement of operations.
NOTE 7 -- 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.
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
owns 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 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.
Effective December 31, 1998, the Company, in exchange for a total of
783,706 shares of Common Stock, (i) sold to Jimlew Capital, L.L.C., a company
owned by Mr. Borislow, (a) all of the capital stock of Emergency Transportation
Corporation (a wholly owned subsidiary of the Company, the primary asset of
which was an interest in a jet airplane), valued at approximately $8.7 million,
and (b) all of the real property constituting the Company's facilities in New
Hope, Pennsylvania, valued at approximately $2.0 million, and (ii) released Mr.
Borislow from an obligation for approximately $4.7 million borrowed from the
Company. Mr. Borislow agreed to lease to the Company a portion of the
headquarters property at a base monthly rent of $12,500. The Company had
previously determined that it would be desirable to dispose of these assets and
accordingly believed that the ownership of these assets was not required for the
continued operation of the Company's business. The subsidiary stock and the real
property were valued based on the book value of these assets, which the
management of the Company believes approximated the fair market value of these
assets on the date of exchange. The Common Stock exchanged for the assets was
valued at its market value on the date of the exchanges. On January 6, 2000, the
Company repurchased the real property constituting the Company's facilities in
New Hope, Pennsylvania for $2.5 million.
Effective December 31, 1998, the Company, in exchange for a total of
498,435 shares of Common Stock and $10,007,000 aggregate principal amount of the
Company's Convertible Notes, released certain officers, directors and employees
from obligations for approximately $9.8 million and $9.0 million, respectively,
borrowed from the Company.
Also during 1999, in addition to the transactions between the Company and
Mr. Borislow or the trusts for his children involving the 2002 and 2004
Convertible Notes, which transactions are described in Note 6 and
18
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
included in this Note by this reference, 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 pursuant to the
agreements with Mr. Borislow as described above.
At December 31, 1998, executive officers of the Company had outstanding
loans from the Company of $4,237,000 which were repaid during the first quarter
of 1999.
NOTE 8 -- 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 the same
court. At this point, no classes have been certified. A motion to dismiss was
recently 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.
NOTE 9 -- STOCKHOLDERS' EQUITY
(a) Stock Splits
On January 3, 1997, the Company's Board of Directors approved a two-for-one
split of the Common Stock in the form of a 100% stock dividend. The additional
shares resulting from the stock split were distributed on January 31, 1997 to
all stockholders of record at the close of business on January 17, 1997. This
stock split has been reflected in the financial statements for all periods
presented.
(b) Authorized Shares
During 1997, the Board of Directors and stockholders approved the increase
in the number of authorized shares of the Common Stock to 300,000,000 shares.
(c) Contingent Redemption Value of Common Stock
On January 5, 1999, pursuant to an Investment Agreement between AOL and the
Company, AOL acquired 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. 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 Company has the first right to purchase any
of the 4,121,372 shares of Common Stock 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. 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 December 31,
1999, the reimbursement amount would be approximately $5.2 million. At December
31, 1999, the Company recorded $5.2 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
19
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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
repurchased). AOL can end the Company's long distance exclusivity period on or
after June 30, 2000 by foregoing certain fixed quarterly payments. The Company
has pledged the stock of its subsidiaries and has agreed to fund an escrow
account of up to $35 million from 50% of the proceeds of any debt financing,
other than a bank, receivable or other asset based financing of up to $50
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 $20,000,000 of the Company's reimbursement obligations
under the Investment Agreement with AOL.
(d) Restriction on Future Sales of Common Stock
As previously reported, the Company was subject to certain restrictions
under a registration rights agreement between the Company and Mr. Borislow that
could have affected the Company's ability to raise capital and engage in other
types of financing transactions. As of December 31, 1999, 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 no longer apply to the Company.
(e) 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.
20
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 10 -- STOCK OPTIONS, WARRANTS AND RIGHTS
(a) Stock Options
The Company has non-qualified stock option agreements with most of its key
employees.
In 1997, 1998 and 1999, the Company granted certain employees and
non-employee directors of the Company 2,801,000, 5,535,000 and 3,549,500,
respectively, non-qualified options to purchase shares of Common Stock. These
options generally become exercisable from one to three years from the date of
the grant. In 1997, the Company recognized $13,371,785 of compensation expenses
related to the grant of options and the purchase by an executive officer of
shares of Common Stock of the Company's stock at prices below the quoted market
price at date of grant and purchase date, respectively. In 1998, the Company
recognized $3.3 million of compensation expenses relating to the grant of
650,000 options to purchase shares of the Company's Common Stock at prices below
the quoted market price at the dates of grant or issuance and the issuance of
135,000 shares of the Company's stock.
SFAS No. 123, "Accounting for Stock-Based Compensation," requires the
Company to provide pro forma information regarding net income and earnings per
share as if compensation cost for the Company's stock options had been
determined in accordance with the fair value-based method prescribed in SFAS No.
123. The Company estimates the fair value of each stock option at the grant date
by using the Black-Scholes option-pricing model with the following
weighted-average assumptions used for grants in 1997, 1998 and 1999,
respectively: no dividends paid for all years; expected volatility of 55.8% in
1997, 65% in 1998 and 108% in 1999; weighted average risk-free interest rates of
5.49% for 1997, 4.59% for 1998, 5.38% for the first six months of 1999, and
5.85% for the latter six months of 1999; and expected lives of 1 to 10 years.
Under the accounting provisions of SFAS No. 123, the Company's net income
(loss) and earnings (loss) per share would have been reduced (increased) to the
pro forma amounts indicated below.
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1999
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
1999 1998 1997
<S> <C> <C> <C>
NET INCOME (LOSS):
As reported $78,929 $(221,326) $(20,945)
Pro forma $68,851 $(244,487) $(30,942)
BASIC EARNINGS (LOSS) PER SHARE:
As reported $ 1.29 $ (3.73) $ (0.33)
Pro forma $ 1.13 $ (4.12) $ (0.48)
DILUTED EARNINGS (LOSS) PER SHARE:
As reported $ 1.23 $ (3.73) $ (0.33)
Pro forma $ 1.07 $ (4.12) $ (0.48)
</TABLE>
21
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The following tables contain information on stock options for the
three-year period ended December 31, 1999:
<TABLE>
<CAPTION>
EXERCISE WEIGHTED
OPTIONS PRICE RANGE AVERAGE
SHARES PER SHARE EXERCISE PRICE
---------------- --------------- -------------------
<S> <C> <C> <C>
Outstanding, December 31, 1996 8,983,800 $ .32-$12.00 $ 6.54
Granted 2,801,000 $5.67-$22.06 $16.02
Exercised (2,208,812) $ .32-$12.78 $ 4.25
Cancelled (690,000) $5.67-$13.25 $11.98
--------- ------------ ------
Outstanding, December 31, 1997 8,885,988 $ .32-$22.06 $ 9.26
Granted 5,535,000 $5.75-$10.44 $ 7.18
Exercised (2,853,178) $ .32-$13.63 $ 4.93
Cancelled (1,337,000) $5.75-$17.50 $13.01
--------- ------------ ------
Outstanding, December 31, 1998 10,230,810 $4.08-$14.00 $ 7.34
Granted 3,549,500 $8.75-$17.25 $11.63
Exercised (6,773,378) $4.08-$12.78 $ 7.13
Cancelled (158,000) $5.75-$11.69 $ 9.67
--------- ------------ ------
Outstanding, December 31, 1999 6,848,932 $4.58-$17.25 $ 9.72
========= ============ ======
<CAPTION>
EXERCISE WEIGHTED
OPTIONS PRICE RANGE AVERAGE
EXERCISABLE AT: SHARES PER SHARE EXERCISE PRICE
---------------- --------------- -------------------
<S> <C> <C> <C>
1997 3,866,987 $ .32-$14.50 $7.24
1998 4,571,475 $4.08-$12.78 $7.39
1999 2,541,095 $4.58-$14.00 $7.67
<CAPTION>
WEIGHTED
AVERAGE
OPTIONS GRANTED: FAIR VALUE
-------------------
<S> <C>
1997 $6.99
1998 $4.83
1999 $9.71
</TABLE>
The following table summarizes information about stock options outstanding
at December 31, 1999:
<TABLE>
<CAPTION>
$4.58-$7.00 $7.01-$10.00 $10.01-$13.00 $13.01-$17.25
------------- -------------- --------------- ---------------
<S> <C> <C> <C> <C>
OUTSTANDING OPTIONS:
Number outstanding at December 31, 1999 1,767,617 1,595,315 2,543,000 943,000
Weighted-average remaining
Contractual life (years) 3.68 8.33 6.53 9.86
Weighted-average exercise price $ 6.17 $ 9.03 $ 10.51 $ 15.38
EXERCISABLE OPTIONS:
Number outstanding at December 31, 1999 1,483,450 604,312 433,333 20,000
Weighted-average exercise price $ 6.25 $ 9.00 $ 10.37 $ 14.00
</TABLE>
22
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(b) AOL Warrants
On January 5, 1999, after the repurchase from AOL of warrants to purchase
5,076,016 shares of Common Stock, warrants to purchase 2,721,984 shares of
Common Stock were held by AOL and were outstanding and currently exercisable,
with exercise prices from $14.00 to $22.25 and a weighted average exercise price
of $17.03. AOL has the right, commencing on termination of the long distance
exclusivity under the AOL marketing agreement up until January 5, 2003, to
require the Company to repurchase all or any portion of these warrants at prices
(the "Put Prices") ranging from $10.45 to $16.82 per warrant ($36,324,002
aggregate amount). In the event AOL requires repurchase of the warrants, the
Company at its election may pay AOL in cash or in shares of Common Stock based
on the then current market price for such stock. The Company may also elect to
issue a 10% two-year note for a defined portion of the repurchase price if the
repurchase price exceeds the then current valuation of the warrants being
repurchased. The Company can require AOL to exercise its warrants at any time
the market price of Common Stock equals or exceeds two times the then call
amount for such warrants. The call amount of a warrant is the Put Price for the
warrant increased at a semi-annually compounded rate of 5% on January 5, 1999
and on each six month anniversary thereafter. The Company has certain
reimbursement obligations in the event that it requires AOL to exercise its
warrants.
(c) Other Warrants
At December 31, 1996, the Company had warrant agreements with certain
partitions and the underwriter for its IPO. All warrants were issued with
exercise prices equal to or above the market price of the underlying stock at
the date of the grant. These warrants are accounted for based on their fair
value. At December 31, 1996, 3,712,000 warrants were outstanding with exercise
prices ranging from $4.67 to $5.73 and an average weighted exercise price of
$5.00 and 600,000 which were currently exercisable at a weighted exercise price
of $5.73. The remaining warrants were exercisable over a one to two year period
beginning in January 1997. In January 1997, 800,000 of these warrants were
purchased by the Company and recorded as a reduction in additional paid-in
capital and 2,662,000 warrants were exercised. The 250,000 warrants issued to
the underwriter for the Company's IPO that were outstanding at December 31, 1997
were exercised in 1998.
(d) Rights
The Board of Directors had approved an offering of up to 3,523,285 shares
of its Common Stock, $.01 par value, to holders of record of Common Stock and
holders of record of options or warrants to purchase Common Stock at the close
of business on December 31, 1998. The shares were offered pursuant to
nontransferable rights to subscribe for and purchase shares of Common Stock at a
price of $17.00 per share. Holders of record on the record date, were eligible
to receive one such nontransferable right for every 20 shares of Common Stock or
underlying options or warrants held on the record date, as applicable. As of
December 31, 1999, 38,325 rights totaling $651,525 were exercised, and 652,547
rights totaling $11,093,299 were exercised in 2000. These rights expired on
February 12, 2000.
NOTE 11 -- INCOME TAXES
The Company reports the effects of income taxes under SFAS No. 109,
"Accounting for Income Taxes". The objective of income tax reporting is to
recognize (a) the amount of taxes payable or refundable for the current year and
(b) deferred tax liabilities and assets for the future tax consequences of
events that have been recognized in the financial statements or tax returns.
Under SFAS No. 109, the measurement of deferred tax assets is reduced, if
necessary, by the amount of any tax benefits that, based on available evidence,
are not expected to be realized. Realization of deferred tax assets is
determined on a more-likely-than-not basis.
The Company considers all available evidence, both positive and negative,
to determine whether, based on the weight of that evidence, a valuation
allowance is needed for some portion or all of a net deferred tax asset.
Judgment is used in considering the relative impact of negative and positive
evidence. In arriving at these judgments, the weight given to the potential
effect of negative and positive evidence is commensurate with the extent to
which it can be objectively verified.
23
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The Company had net deferred tax assets of approximately $40.4 million at
December 31, 1997. The Company determined that no valuation allowance was
necessary at December 31, 1997 because, among other factors, income, which it
believed would be indicative of future operations, had been generated in recent
years, with the exception of 1997. The loss incurred in 1997 was primarily
attributable to amortization of the AOL marketing agreement.
During 1998, the Company continued to incur significant promotional,
marketing and advertising expenses attributable to its efforts to increase the
customer base. Moreover, competitive factors intensified during the period
making gains in subscriber base more costly and more time consuming.
Accordingly, the Company provided a valuation allowance against its deferred tax
assets at December 31, 1998. The valuation allowance also eliminated the net
deferred tax asset that had been recognized in previous periods. The valuation
allowance increased the net loss for the period by approximately $40.4 million.
The Company has continued to provide a valuation allowance against its deferred
tax assets at December 31, 1999.
The provision (benefit) for income taxes for the years ended December 31,
1999, 1998 and 1997 consisted of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------
1999 1998 1997
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Current:
Federal $ -- $ -- $ --
State and local -- -- --
-------- -------- --------
Total current: -- -- --
Deferred:
Federal -- 34,140 (11,111)
State and local -- 6,248 (2,280)
-------- -------- --------
Total deferred -- 40,388 (13,391)
-------- -------- --------
$ -- $ 40,388 $(13,391)
======== ======== ========
</TABLE>
A reconciliation of the Federal statutory rate to the provision (benefit)
for income taxes is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------------
1999 1998 1997
------------------------- ----------------------- --------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Federal income taxes computed at the
statutory rate $ 27,625 35.0% $(63,328) (35.0)% $(12,018) (35.0)%
Increase (decrease):
State income taxes less Federal benefit 3,157 4.0 (7,780) (4.3) (1,482) (4.3)
Valuation allowance for deferred tax assets
existing at beginning of year -- -- 40,388 22.3 -- --
Valuation allowance changes affecting the
provision for income taxes (31,000) (39.3) 68,612 37.9 -- --
Other 218 .3 2,496 1.4 109 .3
-------- ---- -------- ---- -------- ----
Total provision (benefit) for income taxes $ -- -- $ 40,388 22.3% $(13,391) (39.0)%
======== ==== ======== ==== ======== ====
</TABLE>
24
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Deferred tax (assets) liabilities at December 31, 1999, 1998 and 1997 are
comprised of the following elements:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------
1999 1998
----------- ------------
(IN THOUSANDS)
<S> <C> <C>
Net operating loss carryforwards $ (71,000) $ (65,000)
Deferred revenue taxable currently (8,000) (11,000)
Compensation for options granted below market price (1,000) (6,000)
Allowance for uncollectible accounts (3,000) (7,000)
Federal and state taxes resulting from
cash to accrual basis for tax reporting -- --
Warrants issued for compensation (9,000) (18,000)
Depreciation and amortization 8,000 5,000
Accruals not currently deductible (2,000) (5,000)
Unrealized loss on investments -- (3,000)
Net capital loss carryforwards (8,000) (5,000)
--------- ---------
Deferred tax (assets) liabilities, net (94,000) (115,000)
Less valuation allowance 94,000 115,000
--------- ---------
Net deferred tax $ -- $ --
========= =========
</TABLE>
The Company has net operating loss carryforwards for tax purposes and other
deferred tax benefits that are available to offset future taxable income. Only a
portion of the net operating loss carryforwards are attributable to operating
activities. The remainder of the net operating loss carryforwards are
attributable to tax deductions related to the exercise of stock options.
In accounting for income taxes, the Company recognizes the tax benefits
from current stock option deductions after utilization of net operating loss
carryforwards from operations (i.e., net operating loss carryforwards determined
without deductions for exercised stock options) to reduce income tax expense.
Because stock option deductions are not recognized as an expense for financial
reporting purposes, the tax benefit of stock option deductions must be credited
to additional paid-in capital with an offsetting income tax expense recorded in
the statement of operations.
The Company's deferred tax asset related to operations, net capital loss
carryforwards and exercised stock options amounted to $70.0 million, $8.0
million and $16.0 million, respectively at December 31, 1999.
At December 31, 1999, a valuation allowance has been provided against the
deferred tax assets since management cannot predict, based on the weight of
available evidence, that it is more likely than not that such assets will be
ultimately realized.
Internal Revenue Code Section 382 provides for the limitation on the use of
net operating loss carryforwards in years subsequent to a more than 50%
cumulative change in ownership. A more than 50% cumulative change in ownership
occurred on August 31, 1998, resulting in annual limitations of approximately
$42.0 million on the utilization of net operating loss carry forwards as of that
date. Of the Company's net operating loss carryforwards of $183.1 million at
December 31, 1999, $68.6 million are subject to this annual limitation
subsequent to 1999. The remaining net operating loss carryforwards of $114.5
million are not subject to this limitation.
25
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 12 -- STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1999 1998 1997
--------------- ---------------- ---------------
(IN THOUSANDS)
<S> <C> <C> <C>
Supplemental disclosure of cash flow information:
Cash paid for interest $4,218 $28,695 $915
</TABLE>
During 1999, the Company issued 574,482 shares of Common Stock with a value
of approximately $6.9 million (Note 6), in connection with the repurchase of the
Company's Convertible Notes.
Also, during 1999, the Company assigned to a trust for the benefit of Mr.
Borislow's children the Company's interest in $53,700,000 principal amount of
subordinated notes of Communications TeleSystems International d/b/a
WorldXChange Communications, in exchange for $62,545,000 aggregate principal
amount of the Company's Convertible Notes (Note 6).
In addition, the Company recorded $5.2 million for the contingent
redemption value of the AOL warrant with a corresponding reduction in additional
paid in capital.
During 1998, the Company, in exchange for a total of 783,706 shares of
Common Stock, sold certain assets to Mr. Borislow and released Mr. Borislow from
an obligation borrowed from the Company (Note 7). The Company also, in exchange
for a total of 498,435 shares of Common Stock and $10,007,000 aggregate
principal amount of the Company's Convertible Notes, released certain officers,
directors and employees from obligations borrowed from the Company (Note 7). In
connection with the repurchase of the Company's Convertible Notes, the Company
issued 5,084,483 shares of Common Stock with a value of approximately $69.5
million.
During 1997, the Company recorded an asset of $20,000,000 in connection
with the issuance of warrants to AOL (Note 2). In connection with the
acquisition of Compco in 1997, the Company issued 339,982 shares of Common Stock
with a value of $5,625,000.
NOTE 13 -- QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------------ ------------ ------------- ------------
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
<S> <C> <C> <C> <C>
1999
Sales $110,572 $117,139 $140,027 $148,811
Gross profit 35,874 43,721 54,551 61,652
Operating income 12,355 14,979 15,579 16,642
Income before extraordinary gain 12,334 14,038 14,646 16,682
Net income 31,331 14,038 16,879 16,682
Income before extraordinary gain per share -
Diluted 0.20 0.22 0.23 0.25
Net income per share - Diluted 0.50 0.22 0.27 0.25
1998
Sales $ 91,146 $111,098 $122,525 $123,831
Gross profit 14,566 18,040 22,736 31,301
Operating loss (63,702) (30,049) (96,047) (67,075)
Loss before extraordinary gain (41,795) (96,154) (92,296) (78,191)
Net loss (41,795) (96,154) (41,734) (41,643)
Loss before extraordinary gain per share - Diluted
(0.65) (1.49) (1.58) (1.56)
Net loss per share - Diluted (0.65) (1.49) (0.71) (0.83)
</TABLE>
26
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 14 - EMPLOYEE BENEFIT PLANS
During 1999, the Company established an Employee Savings Plan that permits
eligible employees to contribute funds on a pre-tax basis. The Plan qualifies as
a deferred salary arrangement under Section 401(k) of the Internal Revenue Code.
Eligible employees may contribute up to 6% of their compensation (subject to
Internal Revenue Code limitations). The Plan allows employees to choose among a
variety of investment alternatives. The Company does not contribute to the Plan.
No administration costs were incurred during 1999.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
The following sets forth certain biographical information, present
occupation and business experience for the past five years for each of the
nominees for election as a director and the continuing Class I and Class III
directors.
CLASS I: DIRECTORS WHOSE TERMS EXPIRE IN 2001
GABRIEL BATTISTA, AGE 55. Mr. Battista became a director and the Chairman of the
Board, Chief Executive Officer and President of the Company on January 5, 1999.
Prior to joining the Company, Mr. Battista served as Chief Executive Officer of
Network Solutions Inc., an Internet domain name registration company. Prior to
joining Network Solutions, Mr. Battista served from 1995 to 1996 as CEO and from
1991 to 1995 as President and Chief Operating Officer of Cable & Wireless, Inc.,
the nation's largest telecommunications provider exclusively serving businesses.
His career also includes management positions at US Sprint, GTE Telenet and
General Electric Information Services, Mr. Battista also serves as a director of
Axent Technologies, Inc., Capitol College, Systems & Computer Technology
Corporation (SCT) and Online Technologies Group, Inc. (OTG).
RONALD R. THOMA, AGE 62. Mr. Thoma currently serves as Executive Vice President
of Crown Cork and Seal Company, Inc. where he has been employed since 1955. Mr.
Thoma has served as a director of the Company since 1995.
CLASS II: DIRECTOR WHOSE TERM EXPIRES IN 2000
ARTHUR J. MARKS, AGE 55, has been a director of the Company since August 1999.
He has been a General Partner of New Enterprise Associates, a venture capital
firm, since 1984. Mr. Marks serves as a director of three publicly traded
software companies, Object Design Inc., Epicor Software Corp. and Progress
Software Corp., as well as a number of privately-held companies.
CLASS III: DIRECTOR WHOSE TERM EXPIRES IN 2002
MARK S. FOWLER, AGE 57, has been a director of the Company since September 1999.
From 1981 to 1987 he was the Chairman of the Federal Communications Commission.
From 1987 to 1994, Mr. Fowler was Senior Communications Counsel at Latham &
Watkins, a law firm. From 1991 to 1994, he was the founder, Chairman and CEO of
PowerFone Holdings Inc., a telecommunications company. In 1994, he founded and
since then has served as Chairman of UniSite, a developer of antenna sites for
use by multiple wireless operators. Mr. Fowler is also a founder and serves as
Chairman of the Board of Directors of AssureSat, Inc., an operator of
telecommunications satellites.
COMPENSATION OF DIRECTORS
The Company currently pays non-employee directors an annual retainer of $10,000.
The Compensation Committee approved grants of options to purchase 30,000 shares
of Common Stock under the 1998 Long Term Incentive Plan at the market value on
the date of grant to Mr. Marks and Mr. Fowler, non-employee directors who were
elected to fill vacancies on the Board in August and September of 1999,
respectively. Non-employee directors are reimbursed for reasonable expenses
incurred in connection with attendance at Board meetings or meetings of
committees thereof.
27
<PAGE>
EXECUTIVE OFFICERS
The required information is set forth at the end of Part I of this 10-K. In
addition, the following sets forth certain biographical information for the two
new officers.
KENNETH G. BARITZ. Mr. Baritz became President of the Company in April, 2000.
Prior to joining the Company, he served as Chairman and Chief Executive Officer
of Access One, a telecommunications service provider, from June, 1997 through
April, 2000. Prior to joining Access One, Mr. Baritz was Chairman/Chief
Executive Officer of AMNEX, Inc., a telecommunications company, from January
1994 to March 1997, and a director from October 1992 through March 1997.
KEVIN GRIFFO. Mr. Griffo became the Executive Vice President of the Company in
April, 2000. Prior to joining the Company, he served as President and Chief
Operating Officer of Access One, a telecommunications service provider, from
January, 1998 through April, 2000. Prior to joining Access One, Mr. Griffo was
employed by AMNEX, Inc., a telecommunications company, from January 1995 to
December 1997, holding various positions including Chief Operating Officer and
President of AMNEX's Telecommunications Division. Prior to joining AMNEX, he was
a southeastern regional Vice President for LDDS WorldCom, a long-distance
carrier, from August 1992 to December 1994.
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
Under Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), the Company's directors and certain officers and persons who
are the beneficial owners of more than 10 percent of the Common Stock are
required to report their ownership of the Common Stock, options and certain
related securities and any changes in that ownership to the SEC. Specific due
dates for these reports have been established, and the Company is required to
report in this proxy statement any failure to file by such dates in 1999. The
Company believes that all of the required filings have been made in a timely
manner. In making this statement, the Company has relied on copies of the
reporting forms received by it.
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY OF CASH AND CERTAIN OTHER COMPENSATION
The following table sets forth information for the fiscal years ended December
31, 1999, 1998 and 1997 as to the compensation paid by the Company to the Chief
Executive Officer for services rendered and the four other most highly
compensated executive officers of the Company whose annual salary and bonus
exceeded $100,000 (the "Named Executives").
28
<PAGE>
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
ANNUAL COMPENSATION COMPENSATION
------------------- ------------
SECURITIES
UNDERLYING
NAME AND OPTIONS/SARS
PRINCIPAL POSITION YEAR SALARY (1) BONUS (1) (2)(3)
- ------------------ ---- ---------- --------- ------
<S> <C> <C> <C> <C>
GABRIEL BATTISTA, Chairman,
Chief Executive Officer
and President...............................1999 $1,500,000 (4) $ 750,000 --
1998 -- $3,000,000 (5) 1,650,000
1997 -- -- --
MICHAEL FERZACCA,
Executive Vice President - Sales............1999 $ 300,000 $ 250,000 --
1998 $ -- $1,313,125 (6) 350,000
1997 $ -- $ -- --
ALOYSIUS T. LAWN, IV,
Executive Vice President - .................1999 $ 233,269 $ 150,000 210,000
General Counsel and Secretary 1998 $ 150,000 $ 120,336 (7) 50,000
1997 $ 150,000 $ 5,929 (7) --
EDWARD B. MEYERCORD, III,
Executive Vice President -
Chief Financial Officer
and Treasurer...............................1999 $ 225,385 $ 150,000 450,000
1998 $ 200,000 $ 128,338 (7) --
1997 $ 210,000 $ 150,000 --
GEORGE VINALL,
Executive Vice President -
Business Development........................1999 $ 200,000 $ 150,000 --
1998 $ -- $ 175,000 (8) 240,000
1997 $ -- $ -- --
</TABLE>
- ----------
(1) The costs of certain benefits are not included because they did not exceed,
in the case of each Named Executive, the lesser of $50,000 or 10% of the total
annual salary and bonus reported in the above table.
(2) As adjusted to reflect a three-for-two stock split in the form of a stock
dividend effective as of March 15, 1996 and a two-for-one stock split in the
form of a stock dividend effective as of January 31, 1997.
(3) Consists of options to purchase the Common Stock granted pursuant to the
Plan. In 1998, Mr. Battista was granted options that vest over three years to
purchase 1,000,000 shares of the Company's Common Stock at an exercise price of
$10.4375 per share, and options that vested immediately upon execution of the
employment agreement to purchase an additional 650,000 shares at an exercise
price of $7.00 per share. In 1998, Mr. Ferzacca was granted options that vest
over three years to purchase 350,000 shares of the Company's Common Stock at an
exercise price of $8.5625 per share. In 1999, Mr. Lawn was granted options that
vest over three years to purchase 210,000 shares of the Company's Common Stock
at an exercise price of $9.88 per share, and in 1998, was granted options to
purchase 50,000 shares at an exercise price of $5.75 per share. In 1999, Mr.
Meyercord, III was granted options that vest over three years to purchase
450,000 shares of the Company's Common Stock at an exercise price of $15.94 per
share. In 1998, Mr. Vinall was granted options that vest over three years to
purchase 240,000 shares of the Company's Common Stock at an exercise price of
$8.5625 per share.
(4) Mr. Battista's salary for 1999 included a prepayment of $1,000,000
representing a $500,000 salary for both the years 2000 and 2001.
(5) Mr. Battista received a cash sign-on bonus of $3,000,000, which was paid in
December 1998.
(6) Mr. Ferzacca received a cash sign-on bonus of $200,000 and 130,000 shares of
the Company's common stock with a fair market price per share on the date of
grant of $8.5625 and an aggregate value of $1,113,125, which was paid and
issued, respectively in December 1998.
(7) Bonus paid in shares of Common Stock and in-kind property valued in each
case at the then current market value.
(8) Mr. Vinall received a cash sign-on bonus of $175,000, which was paid in
December 1998.
29
<PAGE>
STOCK OPTION GRANTS
The following table sets forth further information regarding grants of
options to purchase Common Stock made by the Company during the fiscal year
ended December 31, 1999 to the Named Executives.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
PERCENT OF TOTAL VALUE AT ASSUME
NUMBER OF SECURITIES OPTIONS/SARS EXERCISE ANNUAL RATES OF STOCK
UNDERLYING GRANTED TO PRICE PER OPTION TERM (2)
OPTIONS/SARS EMPLOYEES IN SHARE EXPIRATION ---------------
NAME GRANTED (1) 1999 ($SHARES) DATE 5%($) 10%($)
---- ----------- ---- --------- ---- ----- ------
<S> <C> <C> <C> <C> <C> <C>
Gabriel Battista.............. -- -- -- -- -- --
Michael Ferzacca.............. -- -- -- -- -- --
Aloysius T. Lawn, IV.......... 210,000 5.9 9.88 4/1/09 $1,304,831 $ 3,306,697
Edward B. Meyercord, III...... 450,000 12.8 15.94 11/1/09 $4,511,061 $11,431,915
George Vinall................. -- -- -- -- -- --
</TABLE>
- ----------
(1) All options to Named Executive Officers in 1999 were granted under the Plan.
(2) Disclosure of the 5% and 10% assumed annual compound rates of stock
appreciation are mandated by the rules of the SEC and do not represent the
Company's estimate or projection of future common stock prices. The actual value
realized may be greater or less than the potential realizable value set forth in
the table.
The following table sets forth further information concerning the 1999
year-end value of unexercised in-the-money options held by each of the Named
Executives.
AGGREGATED OPTION/SAR EXERCISES AND FISCAL YEAR-END OPTION/SAR VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS/SARS IN-THE-MONEY OPTIONS/SARS AT
AT FISCAL YEAR-END (#) FISCAL YEAR-END($)(1)
---------------------- ---------------------
SHARES
ACQUIRED VALUE EXERCISABLE/ EXERCISABLE/
NAME ON EXERCISE REALIZED UNEXERCISABLE UNEXERCISABLE
---- ----------- -------- ------------- -------------
<S> <C> <C> <C> <C>
Gabriel Battista.................... -- -- 983,333/666,667 $9,424,998/$4,875,002
Michael Ferzacca.................... -- -- 116,667/233,333 $1,071,878/$2,143,747
Aloysius T. Lawn, IV................ -- -- 50,000/210,000 $600,000/$1,652,700
Edward B. Meyercord, III............ 800,000 $5,793,800 0/450,000 $0/$814,500
George Vinall....................... -- -- 80,000/160,000 $735,000/$1,470,000
</TABLE>
- ----------
(1) Calculated as the difference between the exercise/base price of the
options/SARs and a year-end fair market value of the underlying securities equal
to $17.75.
30
<PAGE>
EMPLOYMENT CONTRACTS
Gabriel Battista is party to an employment agreement with the Company that
expires on December 31, 2001. Under the terms of the agreement, Mr. Battista
received a signing bonus of $3,000,000 and is entitled to an annual salary of
$500,000, payable in advance, plus a discretionary bonus. Mr. Battista is also
entitled to other benefits and perquisites. In addition, Mr. Battista was
granted options that vest over three years to purchase 1,000,000 shares of the
Company's Common Stock at an exercise price of $10.4375 per share, and options
that vested immediately upon execution of the agreement to purchase an
additional 650,000 shares at an exercise price of $7.00 per share.
In the event of certain transactions (including an acquisition of the
Company's assets, a merger into another entity or a transaction that results in
the Company's Common Stock no longer being required to be registered under the
Securities and Exchange Act of 1934), Mr. Battista will receive an additional
bonus of $1,000,000 if the price per share for the Company's Common Stock in
such transaction was less than or equal to $20.00 per share, or $3,000,000 if
the consideration is greater than $20.00 per share. In addition, upon a change
in control of the Company, all of Mr. Battista's options immediately vest.
Edward B. Meyercord, III entered into a five-year employment agreement with
the Company effective as of September 5, 1996. Under the contract, Mr. Meyercord
is entitled to a minimum annual base salary of $300,000 for each year.
Michael Ferzacca entered into a three-year employment agreement with the
Company effective as of December 28, 1998. Under the contract, Mr. Ferzacca is
entitled to minimum annual base salary of $300,000 for each year. Mr. Ferzacca
was granted an option to purchase 350,000 shares of the Common Stock of the
Company at an exercise price of $8 9/16 per share.
Aloysius T. Lawn entered into a two-year employment agreement with the
Company effective as of December 1, 1998. Under the contract, Mr. Lawn is
entitled to a minimum annual base salary of $250,000 for each year. Mr. Lawn was
granted an option to purchase 50,000 shares of the Common Stock of the Company
at an exercise price of $5.75 per share.
George Vinall entered into a three-year employment agreement with the
Company effective as of December 28, 1998. Under the contract, Mr. Vinall is
entitled to a minimum annual base salary of $250,000 for each year. Mr. Vinall
was granted an option to purchase 240,000 shares of the Common Stock of the
Company at an exercise price of $8 9/16 per share.
Each of the agreements for Messrs. Ferzacca, Lawn and Vinall provide for
immediate vesting of options in event of a "change in control" (as defined in
the agreements) and provide for severance benefits in the event employment is
terminated by the Company without cause prior to the end of the term.
Each of the above-described agreements require each of the executives to
maintain the confidentiality of Company information and assign inventions to the
Company. In addition, each of such executive officers has agreed that such
person will not compete with the Company by engaging in any capacity in any
business that is competitive with the business of the Company during the term of
his respective agreement and thereafter for specified periods.
31
<PAGE>
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
None.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information known to the Company
with respect to beneficial ownership of the Company's Common Stock as of April
26, 2000 (except as otherwise noted) by (i) each stockholder who is known by the
Company to own beneficially more than five percent of the outstanding Common
Stock, (ii) each of the Company's directors, (iii) each of the executive
officers named below and (iv) all current directors and executive officers of
the Company as a group. Except as otherwise indicated below, the Company
believes that the beneficial owners of the Common Stock listed below have sole
investment and voting power with respect to such shares.
32
<PAGE>
<TABLE>
<CAPTION>
NUMBER OF PERCENT OF
SHARES SHARES
BENEFICIALLY BENEFICIALLY
NAME OF BENEFICIAL OWNER OR IDENTITY OF GROUP OWNED(1) OWNED
-------- -----
<S> <C> <C>
Massachusetts Financial Services Company................. 7,309,000(2) 11.1%
500 Boylston Street
Boston, Massachusetts 02116
America Online, Inc...................................... 6,843,356(3) 9.9%
22000 AOL Way
Dulles, Virginia 20166
FMR Corp................................................. 3,270,825(4) 4.9%
82 Devonshire Street
Boston, Massachusetts 02109
Legg Mason, Inc.......................................... 5,997,900(7)(9) 9.1%
100 Light Street
P.O. Box 1476
Baltimore, MD 21203
Paul Rosenberg........................................... 5,759,985(5) 8.7%
650 N.E. 5th Avenue
Boca Raton, Fl 33432
Geocapital, LLC.......................................... 3,966,560(7) 6.0%
767 Fifth Avenue, 45th Floor
New York , New York 10153
Gabriel Battista......................................... 1,003,334(8) 1.5%
Edward B. Meyercord, III................................. 106,131 *
Aloysius T. Lawn, IV..................................... 198,650(8) *
Michael Ferzacca......................................... 66,667(8) *
George Vinall............................................ 80,000(8) *
Ronald R. Thoma.......................................... 97,934(8) *
Arthur J. Marks.......................................... 25,000(6) *
Mark S. Fowler........................................... 20,000 *
All directors and executive officers as a group
(12 persons).............................................. 1,766,957 2.5%
</TABLE>
- ----------
* Less than 1%
(1) The securities "beneficially owned" by a person are determined in
accordance with the definition of "beneficial ownership" set forth in the
regulations of the Commission and, accordingly, may include securities
owned by or for, among others, the spouse, children or certain other
relatives of such person. The same shares may be beneficially owned by more
than one person. Beneficial ownership may be disclaimed as to certain of
the securities.
(2) Massachusetts Financial Services Company ("MFS"), an investment
adviser, filed an amendment to a Schedule 13G with the Commission on June
15, 1999 (the "MFS 13G"), in which it reported beneficial ownership of
7,309,000 shares, 6,471,100 of which are also beneficially owned by MFS
Series Trust II-MFS Emerging Growth Fund, an investment company, and
837,900 of which are also owned by certain non-reporting entities as well
as MFS. The foregoing information is derived from the MFS 13G.
(3) The foregoing information is derived from the Schedule 13G filed by
America Online, Inc. on January 15, 1999.
(4) The foregoing information is derived from Schedule 13D filed by FMR
Corp. on December 10, 1999.
(5) The foregoing information is derived from the Schedule 13D filed by
Paul Rosenberg, the Rosenberg Family Limited Partnership, PBR, Inc. and the
New Millennium Charitable Foundation on January 12, 1999.
(6) Excludes 69,241 shares of Common Stock held by Valhalla Capital
Management, a general partnership of which Mr. Mark's spouse serves as
general partner. Also excludes shares of Common Stock held in various
client accounts managed by Mr. Mark's spouse. Mr. Marks disclaims
beneficial ownership of such shares of Common Stock.
33
<PAGE>
(7) The foregoing information was provided to the Company.
(8) Includes shares of Common Stock that could be acquired upon exercise of
vested options.
(9) Includes 5,500,000 shares of Common Stock beneficially owned by Legg
Mason Special Investment Trust and 497,900 shares beneficially owned by
Legg Mason Capital Management, Inc.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
None.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Annual Report on
Form 10-K.
1. Consolidated Financial Statements:
The Consolidated Financial Statements filed as part of this Form 10-K are
listed in the "Index to Consolidated Financial Statements" in Item 8.
2. Consolidated Financial Statement Schedule:
The Consolidated Financial Statement Schedule filed as part of this report
is listed in the "Index to S-X Schedule."
Schedules other than those listed in the accompanying Index to S-X Schedule
are omitted for the reason that they are either not required, not applicable or
the required information is included in the Consolidated Financial Statements or
notes thereto.
34
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
INDEX TO S-X SCHEDULE
PAGE
----
Report of Independent Certified Public Accountants .......... 40
Schedule II -- Valuation & Qualifying Accounts .............. 41
35
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors
and Stockholders of Talk.com Inc.
The audits referred to in our report dated February 7, 2000, relating to
the consolidated financial statements of Talk.com Inc. and subsidiaries, which
is contained in Item 8 of this Form 10-K, included the audits of the financial
statement schedule listed in the accompanying index for each of the three years
in the period ended December 31, 1999. This financial statement schedule is the
responsibility of management. Our responsibility is to express an opinion on
this schedule based on our audits.
In our opinion, the financial statement Schedule II -- Valuation and
Qualifying Accounts, presents fairly, in all material respects, the information
set forth therein.
BDO Seidman, LLP
New York, New York
February 7, 2000
36
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE AT ADDITIONS
BEGINNING OF CHARGED TO COSTS DEDUCTIONS FOR BALANCE AT END
DESCRIPTION DEDUCTIONS PERIOD AND EXPENSES WRITE-OFFS OF PERIOD
- ---------------------------------------- ----------------- ------------------- ---------------- -----------------
<S> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1999:
Reserve and allowances deducted from
asset accounts:
Allowance for uncollectible accounts $ 1,669 $25,538 $(22,196) $ 5,011
======= ======== ======== =======
YEAR ENDED DECEMBER 31, 1998:
Reserve and allowances deducted
from asset accounts:
Allowance for uncollectible accounts $ 2,419 $20,593 $(21,343) $ 1,669
======= ======= ======== =======
YEAR ENDED DECEMBER 31, 1997:
Reserve and allowances deducted
from asset accounts:
Allowance for uncollectible accounts $ 987 $ 9,784 $ (8,352) $ 2,419
======= ======= ======== =======
</TABLE>
37
<PAGE>
(3) EXHIBITS:
EXHIBIT
NUMBER DESCRIPTION
3.1 Composite form of Amended and Restated Certificate of Incorporation of
the Company, as amended through April 26, 1999 (incorporated by
reference to Exhibit 3.1 to the Company's report on Form 10-Q for the
quarter ended March 31, 1999).
3.2 Bylaws of the Company (incorporated by reference to Exhibit 3.2 to the
Company's registration statement on Form S-1 (File No. 33-94940)).
3.3 Certificate of Designation of Series A Junior Participating Preferred
Stock of Company dated August 27, 1999 (incorporated by reference to
Exhibit A to Exhibit 1 to the Company's registration statement on Form
8-A (File No. 000-26728)).
10.1 Employment Agreement between the Company and Aloysius T. Lawn, IV dated
October 13, 1998 (incorporated by reference to Exhibit 10.3 to the
Company's Annual Report on Form 10-K for the year ended December 31,
1998).*
10.2 Employment Agreement between the Company and Edward B. Meyercord, III
(incorporated by reference to Exhibit 10.6 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1996).*
10.3 Indemnification Agreement between the Company and Aloysius T. Lawn, IV
(incorporated by reference to Exhibit 10.12 to the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 1995).
10.4 Indemnification Agreement between the Company and Edward B. Meyercord,
III (incorporated by reference to Exhibit 10.14 to the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 1996).
10.5 Tel-Save Holdings, Inc. 1995 Employee Stock Option Plan (incorporated
by reference to Exhibit 10.15 to the Company's registration statement
on Form S-1 (File No. 33-94940)).*
10.6 Telecommunications Marketing Agreement by and among the Company,
Tel-Save, Inc. and America Online, Inc., dated February 22, 1997
(incorporated by reference to Exhibit 10.32 to the Company's Form 10-K
for the year ended December 31, 1996).+
10.7 Amendment No. 1, dated as of January 25, 1998, to the
Telecommunications Marketing Agreement dated as of February 22, 1997 by
and among the Company, Tel-Save, Inc. and America Online, Inc.
(incorporated by reference to Exhibit 10.31 to the Company's Form 10-K
for the year ended December 31, 1997).+
10.8 Amendment No. 2, dated May 14, 1998, among the Company, Tel-Save, Inc.
and America Online, Inc., which amends that certain Telecommunications
Marketing Agreement, dated as of February 22, 1997, as corrected and
amended by letter, dated April 23, 1997, and amended by an Amendment
No. 1, dated January 25, 1998 (incorporated by reference to Exhibit
10.1 to the Company's quarterly report on Form 10-Q, dated August 14,
1998).+
38
<PAGE>
10.9 Amendment No. 3, effective as of October 1, 1998, among the Company,
Tel-Save, Inc. and America Online, Inc., which amends that certain
Telecommunications Marketing Agreement, dated as of February 22, 1997,
as corrected and amended by letter, dated April 23, 1997, and amended
by an Amendment No. 1, dated January 25, 1998, and an Amendment No. 2,
dated May 14, 1998 (incorporated by reference to Exhibit 10.22 to the
Company's Annual Report on Form 10-K for the year ended December 31,
1998).+
10.10 Letter dated August 25, 1999 from America Online, Inc. to the Company
(incorporated by reference to Exhibit 99.2 to the Company's Current
Report on Form 8-K dated August 27, 1999).
10.11 Indenture dated as of September 9, 1997 between the Company and First
Trust of New York, N.A. (incorporated by reference to Exhibit 4.3 to
the Company's registration statement on Form S-3 (File No. 333-39787)).
10.12 Indenture dated as of December 10, 1997 between the Company and First
Trust of New York, N.A. (incorporated by reference to Exhibit 10.34 to
the Company's Annual Report on Form 10-K for the year ended December
31, 1997).
10.13 Employment Agreement, dated as of November 13, 1998, between the
Company and Gabriel Battista (incorporated by reference to Exhibit 10.1
to the Company's Current Report on Form 8-K dated January 20, 1999).*
10.14 Indemnification Agreement, dated as of December 28, 1998, between the
Company and Gabriel Battista (incorporated by reference to Exhibit 10.2
to the Company's Current Report on Form 8-K dated January 20, 1999).
10.15 Stock Option Agreement, dated as of November 13, 1998, between the
Company and Gabriel Battista (incorporated by reference to Exhibit 10.3
to the Company's Current Report on Form 8-K dated January 20, 1999).*
10.16 Stock Option Agreement, dated as of November 13, 1998, between the
Company and Gabriel Battista (incorporated by reference to Exhibit 10.4
to the Company's Current Report on Form 8-K dated January 20, 1999).*
10.17 Severance Agreement, dated as of December 31, 1998, between the Company
and Daniel Borislow (incorporated by reference to Exhibit 10.5 to the
Company's Current Report on Form 8-K dated January 20, 1999).*
10.18 Exchange Agreement, dated as of December 31, 1998, among the Company,
Tel-Save, Inc. and Mark Pavol, as Trustee of that certain D&K Grantor
Retained Annuity Trust dated June 15, 1998 (incorporated by reference
to Exhibit 10.7 to the Company's Current Report on Form 8-K dated
January 20, 1999).
10.19 Modification of the Exchange Agreement, dated ___________, 1999, by and
among the Company, Tel-Save, Inc. and Mark Pavol (incorporated by
reference to Exhibit 10.34 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1998).
10.20 Registration Rights Agreement, dated as of December 31, 1998, among the
Company, Daniel Borislow, Mark Pavol, as Trustee of that certain D&K
Grantor Retained Annuity Trust, dated June 15, 1998 and the Trustee of
that certain D&K Grantor Retained Annuity Trust II (incorporated by
reference to Exhibit 10.8 to the Company's Current Report on Form 8-K
dated January 20, 1999).
10.21 Amendment of Registration Rights Agreement dated as of March 18, 1999,
by and among the Company, Daniel M. Borislow, and Seth Tobias
(incorporated by reference to Exhibit 10.36 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1998).
10.22 Amendment of Registration Rights Agreement dated as of March 18, 1999,
by and among the Company and Mark Pavol (incorporated by reference to
Exhibit 10.37 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1998).
39
<PAGE>
10.23 1998 Long-Term Incentive Plan of the Company (incorporated by reference
to Exhibit 10.14 to the Company's Current Report on Form 8-K dated
January 20, 1999).*
10.24 Investment Agreement, dated as of December 31, 1998, as amended on
February 22, 1999, among the Company, America Online, Inc., and, solely
for purposes of Sections 4.5, 4.6 and 7.3(g) thereof, Daniel Borislow,
and solely for purposes of Section 4.12 thereof, Tel-Save, Inc. and the
D&K Retained Annuity Trust dated June 15, 1998 by Mark Pavol, Trustee
(incorporated by reference to Exhibit 10.41 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1998.).
10.25 Registration Rights Agreement, dated as of January 5, 1999, between the
Company and America Online, Inc. (incorporated by reference to Exhibit
10.42 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1998).
10.26 Sublease Agreement, dated January ___, 1997, by and between Gemini Air
Cargo, LLC and RMS International, Inc. (incorporated by reference to
Exhibit 10.43 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1998).
10.27 Sublease Agreement, dated as of January 20, 1999, by and between RMS
International and Tel-Save, Inc. (incorporated by reference to Exhibit
10.44 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1998).
10.28 Lease by and between Aetna Life Insurance Company and Potomac Financial
Group, L.L.C. (incorporated by reference to Exhibit 10.45 to the
Company's Annual Report on Form 10-K for the year ended December 31,
1998).
10.29 Agreement, effective as of February 28, 1999, by and among the Company,
Communication Telesystems International, d.b.a. WorldxChange
Communications, Tel-Save, Inc., Mark Pavol, Roger B. Abbott and
Rosalind Abbott, and Edward Soren (incorporated by reference to Exhibit
10.46 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1998).
10.30 Form of Indemnification Agreement, dated as of January 5, 1999, for
each of George Vinall, Michael Ferzacca and Norris M. Hall, III
(incorporated by reference to Exhibit 10.50 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1998).
10.31 Form of Non-Qualified Stock Option Agreement, dated as of December 16,
1998, for each of George Vinall, Michael Ferzacca and Norris M. Hall,
III (incorporated by reference to Exhibit 10.51 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1998).*
10.32 Employment Agreement, dated as of December 16, 1998, between the
Company and Michael Ferzacca (incorporated by reference to Exhibit
10.60 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1998).*
10.33 Employment Agreement, dated as of December 16, 1998, between the
Company and Norris M. Hall, III (incorporated by reference to Exhibit
10.61 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1998).*
10.34 Employment Agreement, dated as of December 16, 1998, between the
Company and George Vinall (incorporated by reference to Exhibit 10.62
to the Company's Annual Report on Form 10-K for the year ended December
31, 1998).*
10.35 Rights Agreement dated as of August 19, 1999 by and between the Company
and First City Transfer Company, as Rights Agent (incorporated by
reference to Exhibit 1 to the Company's registration statement on Form
8-A (File No. 000-26728)).
10.36 Employment Agreement by and among Vincent W. Talbert, the Company and
Talk.com Holding Corp. dated as of June 8, 1999 (incorporated by
reference to Exhibit 10.1 to the Company's report on Form 10-Q for the
quarter ended June 30, 1999).*
40
<PAGE>
10.37 Indemnification Agreement by and between Vincent W. Talbert and the
Company dated as of June 8, 1999 (incorporated by reference to Exhibit
10.2 to the Company's report on Form 10-Q for the quarter ended June
30, 1999).
10.38 Non-Qualified Stock Option Agreement by and between Vincent W. Talbert
and the Company dated as of June 8, 1999 (incorporated by reference to
Exhibit 10.3 to the Company's report on Form 10-Q for the quarter ended
June 30, 1999).*
10.39 Employment Agreement by and between Janet C. Kirschner and the Company
dated as of October 14, 1999.*++
10.40 Indemnification Agreement by and between Janet C. Kirschner and the
Company dated as of October 14, 1999.++
10.41 Non-Qualified Stock Option Agreement by and between Janet C. Kirschner
and the Company dated as of October 14, 1999.*++
11.1 Net Income Per Share Calculation.
21.1 Subsidiaries of the Company.++
23.1 Consent of BDO Seidman, LLP.++
27 Financial Data Schedule.++
- ---------
* Management contract or compensatory plan or arrangement.
+ Confidential treatment previously has been granted for a portion of this
exhibit.
++ Previously filed with this 10-K.
(b) Reports on Form 8-K.
No Current Reports on Form 8-K were filed by the Company during the three months
ended December 31, 1999.
41
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Date: April 28, 2000
TALK.COM INC.
By: /s/ Gabriel Battista
-----------------------------------
Gabriel Battista
Chairman of the Board of Directors,
Chief Executive Officer, President
and Director
42
EXHIBIT 11.1
TALK.COM INC. AND SUBSIDIARIES
COMPUTATION OF NET INCOME PER SHARE
(IN THOUSANDS)
<TABLE>
<CAPTION>
For the Year Ended December 31,
----------------------------------------------------
1999 1998 1997
--------------- --------------- -------------
--------------- --------------- -------------
<S> <C> <C> <C>
Income (loss) before extraordinary gain $57,699 $(308,436) $(20,945)
Extraordinary gain 21,230 87,110 --
-------- ----------- -------------
Net income (loss) $78,929 $(221,326) $(20,945)
========== ============ =============
BASIC
Weighted average common shares outstanding - Basic: 61,187 59,283 64,168
========== ============ ============
Income (loss) before extraordinary gain $ 0.94 $ (5.20) $ (0.33)
Extraordinary gain 0.35 1.47 --
---------- ----------- ------------
Net income (loss) $ 1.29 $ (3.73) $ (0.33)
========== ============ =============
DILUTED
Weighted average common and common equivalent
Weighted average shares 61,187 59,283 64,168
Weighted average equivalent shares 3,228 -- --
---------- ------------ ------------
Weighted average common and common equivalent
shares outstanding - Diluted: 64,415 59,283 64,168
========== ============ =============
Income (loss) before extraordinary gain $ 0.90 $ (5.20) $ (0.33)
Extraordinary gain 0.35 1.47 --
---------- ------------ ------------
Net income (loss) $ 1.23 $ (3.73) $ (0.33)
========== ============ =============
</TABLE>
