================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
OR
[ ] TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO _____
COMMISSION FILE NUMBER 0 - 26728
TALK.COM INC.
(Exact name of registrant as specified in its charter)
DELAWARE 23-2827736
(State of incorporation) (I.R.S. Employer Identification No.)
12020 SUNRISE VALLEY DRIVE, SUITE 250
RESTON, VIRGINIA 20191
(Address of principal executive offices) (Zip Code)
(703) 391-7500
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No____
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
78,021,134 shares of Common Stock, par value of $0.01 per share, were
outstanding as of November 13, 2000.
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<PAGE>
TALK.COM INC. AND SUBSIDIARIES
INDEX
<TABLE>
<CAPTION>
PAGE
----
PART I - FINANCIAL INFORMATION:
Item 1. Financial Statements
<S> <C>
Consolidated Balance Sheets - September 30, 2000 (Unaudited)
and December 31, 1999.............................................................................. 3
Consolidated Statements of Operations - Three and Nine Months Ended September 30,
2000 and 1999(Unaudited)........................................................................... 4
Consolidated Statement of Stockholders' Equity - Nine Months Ended September 30,
2000 (Unaudited)................................................................................... 5
Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2000 and
1999(Unaudited).................................................................................... 6
Notes to Consolidated Financial Statements (Unaudited)............................................. 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.......................................................................... 13
Item 3. Quantitative and Qualitative Disclosures about Market Risk....................................... 21
PART II - OTHER INFORMATION:
Item 2. Changes in Securities and Use of Proceeds......................................................... 22
Item 6. Exhibits and Reports on Form 8-K.................................................................. 22
</TABLE>
2
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
UNAUDITED
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------------- ------------------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 70,436 $ 78,937
Accounts receivable, trade, net of allowance for uncollectible accounts of $23,189
and $5,011, respectively 57,122 59,501
Advances to partitions and notes receivable 1,643 3,600
Prepaid expenses and other current assets 2,837 8,855
------------------- ------------------
Total current assets 132,038 150,893
------------------- ------------------
Property and equipment, net of accumulated depreciation of $20,255 and $13,438,
respectively 81,791 57,335
Intangibles, net 223,204 1,068
Other assets 6,318 5,712
------------------- ------------------
Total assets $443,351 $215,008
=================== ==================
LIABILITIES, CONTINGENCIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable, trade and other $ 75,205 $ 47,965
Partitions 804 1,676
Notes payable 15,907 --
Deferred revenue 1,571 --
Taxes and other 12,823 14,127
------------------- ------------------
Total current liabilities 106,310 63,768
------------------- ------------------
Convertible debt 84,950 84,985
Deferred revenue 15,450 21,000
------------------- ------------------
Total liabilities 206,710 169,753
------------------- ------------------
Commitments and contingencies:
Contingent redemption value of common stock 54,019 5,152
------------------- ------------------
Stockholders' equity:
Preferred stock - $.01 par value per share, 5,000,000 shares authorized; no shares
issued and outstanding -- --
Common stock - $.01 par value per share, 300,000,000 shares authorized; 78,445,134
shares issued and 78,021,134 shares outstanding (66,972,960 shares issued and
64,854,268 shares outstanding in 1999) 784 670
Additional paid-in capital 349,367 208,453
Accumulated deficit (161,581) (139,300)
Common stock in treasury - at cost (5,948) (29,720)
------------------- ------------------
Total stockholders' equity 182,622 40,103
------------------- ------------------
Total liabilities, contingencies and stockholders' equity $443,351 $215,008
=================== ==================
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED - THOUSANDS OF DOLLARS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED
ENDED SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
2000 1999 2000 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Sales $121,254 $140,027 $413,071 $367,738
Cost of sales 72,501 84,604 252,703 231,004
----------- ----------- ----------- -----------
Gross profit 48,753 55,423 160,368 136,734
----------- ----------- ----------- -----------
Operating expenses (income):
General and administrative expenses 18,117 10,609 43,983 28,600
Promotional, marketing and advertising
expenses 57,738 27,698 126,901 63,490
Depreciation and amortization 6,326 1,537 10,168 4,449
Significant other income -- -- -- (2,718)
----------- ----------- ----------- -----------
Total operating expenses 82,181 39,844 181,052 93,821
----------- ----------- ----------- -----------
Operating income (loss) (33,428) 15,579 (20,684) 42,913
Interest income (expense), net (105) (624) 546 (592)
Other expense, net (1,487) (309) (2,143) (1,303)
----------- ----------- ----------- -----------
Income (loss) before income taxes (35,020) 14,646 (22,281) 41,018
Income tax benefit (250) -- -- --
----------- ----------- ----------- -----------
Income (loss) before extraordinary gain (34,770) 14,646 (22,281) 41,018
Extraordinary gain -- 2,233 -- 21,230
----------- ----------- ----------- -----------
Net income (loss) $(34,770) $16,879 $(22,281) $62,248
=========== =========== =========== ===========
Basic earnings (loss) per share:
Income (loss) before extraordinary gain $ (0.48) $ 0.24 $ (0.33) $ 0.68
Extraordinary gain -- 0.04 -- 0.35
----------- ----------- ----------- -----------
Net income (loss) $ (0.48) $ 0.28 $ (0.33) $ 1.03
=========== =========== =========== ===========
Diluted earnings (loss) per share:
Income (loss) before extraordinary gain $ (0.48) $ 0.23 $ (0.33) $ 0.65
Extraordinary gain -- 0.04 -- 0.34
----------- ----------- ----------- -----------
Net income (loss) $ (0.48) $ 0.27 $ (0.33) $ 0.99
=========== =========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000
(UNAUDITED - THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL TREASURY STOCK
-------------------- PAID-IN ACCUMULATED ---------------------------
SHARES AMOUNT CAPITAL DEFICIT SHARES AMOUNT TOTAL
---------- ---------- -------------- --------------- ------------ ------------ -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1, 2000 66,973 $670 $208,453 $(139,300) (2,120) $(29,720) $40,103
Net income (loss) -- -- -- (22,281) -- -- (22,281)
Exercise of common stock options -- -- (2,274) -- 342 4,802 2,528
Proceeds from rights exercised -- -- 1,940 -- 653 9,154 11,094
Issued in connection with
acquisition 11,472 114 187,926 -- 699 9,796 197,836
Warrants issued for consulting -- -- 2,175 -- -- -- 2,175
Issuance of common stock for
convertible debt -- -- 15 -- 2 20 35
Contingent redemption value
of common stock -- -- (48,868) -- -- -- (48,868)
---------- ---------- -------------- --------------- ------------ ------------ -----------
Balance, September 30, 2000
78,445 $784 $349,367 $(161,581) (424) $(5,948) $182,622
========== ========== ============== =============== ============ ============ ===========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED - THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
--------------------------------
2000 1999
-------------- --------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ (22,281) $62,248
Adjustment to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Provision for bad debts 14,544 2,181
Depreciation and amortization 10,168 4,449
Deferred revenue (3,609) (5,550)
Extraordinary gain -- (21,230)
Loss on retirement of assets 68 --
Non-cash consulting expense 121 --
Changes in assets and liabilities, net:
(Increase) decrease in:
Accounts receivable, trade (8,997) (12,772)
Advances to partitions and notes receivable 1,957 (127)
Prepaid expenses and other current assets 6,884 (1,896)
Other assets 2,398 4,084
Increase (decrease) in:
Accounts payables and accrued expenses 13,316 (24,405)
Other liabilities (3,000) (1,850)
-------------- --------------
Net cash provided by operating activities 11,569 5,132
-------------- --------------
Cash flows from investing activities:
Capital expenditures (29,887) (4,671)
Acquisition of intangibles (515) --
Acquisition costs, net of cash acquired (3,285) --
Sale of securities, net -- 89,649
-------------- --------------
Net cash provided by (used in) investing activities (33,687) 84,978
-------------- --------------
Cash flows from financing activities:
Repayment of margin account indebtedness -- (49,621)
Acquisition of convertible debt -- (72,304)
Proceeds from exercise of options and warrants 2,529 24,990
Proceeds from exercise of rights 11,093 --
AOL investment -- 55,000
Repayment of notes payable (5) --
Acquisition of treasury stock -- (7,686)
-------------- --------------
Net cash provided by (used in) financing activities 13,617 (49,621)
-------------- --------------
Net increase (decrease) in cash and cash equivalents (8,501) 40,489
Cash and cash equivalents, beginning of period 78,937 3,063
-------------- --------------
Cash and cash equivalents, end of period $70,436 $ 43,552
============== ==============
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIC PRESENTATION:
The consolidated financial statements include the accounts of Talk.com
Inc. and its wholly owned subsidiaries, (collectively, the "Company") and have
been prepared as if the entities had operated as a single consolidated group
since their respective dates of incorporation, except as noted below. All
intercompany balances and transactions have been eliminated. The consolidated
financial statements include the results of operations of Access One
Communications Corp. ("Access One") from August 9, 2000, when it was acquired by
the Company in a merger transaction that was accounted for under the purchase
method of accounting for business combinations. See Note 6 below.
The consolidated financial statements and related notes thereto as of
September 30, 2000 and for the three and nine months ended September 30, 2000
and 1999 are presented as unaudited but in the opinion of management include all
adjustments necessary to present fairly the information set forth therein. These
adjustments consist solely of normal recurring accruals. The consolidated
balance sheet information for December 31, 1999 was derived from the audited
financial statements included in the Company's Form 10-K, as amended. These
interim financial statements should be read in conjunction with the Form 10-K
report, as amended. The interim results are not necessarily indicative of the
results for any future periods. Certain prior year amounts have been
reclassified for comparative purposes.
Statement of Financial Accounting Standards No. 133 "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133"), 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. 138, becomes effective for all fiscal years beginning after December
31, 2000. The Company anticipates that the new standard will have no effect on
its financial statements.
The Securities and Exchange Commission issued Staff Accounting Bulletin No.
101 "Revenue Recognition in Financial Statements ("SAB 101") that became
effective for the Company in the fourth quarter of 2000. SAB 101 addresses
revenue recognition policies and practices of companies that report to the SEC.
The Company believes its revenue recognition policies and practices comply with
SAB 101.
2. AOL AGREEMENTS:
Since 1997, the Company has negotiated a number of agreements and
amendments to its agreements with America Online Inc. ("AOL") for the marketing
and sale of telecommunications services to AOL subscribers. A substantial
amendment to the AOL agreement in January 1999 provided for: quarterly payments
by the Company to AOL during the long distance exclusivity period of the
agreement, with fixed quarterly payments ranging from $10.0 to $15.0 million
($19.0 million after July 1, 2000 if AOL elects to provide certain additional
marketing and promotions to the Company) until June 30, 2001 and quarterly
payments thereafter at a fixed 5% of the Company's marginable long distance
revenues from AOL subscribers in the quarter under the agreement; quarterly
payments by the Company to AOL, after termination of the long distance
exclusivity period and so long as AOL continues to provide certain levels of
marketing and promotions to the Company under the agreement, at an annual
declining fixed percentage of the Company's marginable long distance revenues
from AOL subscribers under the agreement, starting at 5% and declining by one
percentage point each year to 1%; the elimination of the Company's obligation to
make bounty and current profit-sharing payments to AOL; alteration of the terms
of the online and offline marketing arrangements between the Company and AOL;
extension of the term of the AOL agreement, including the exclusivity period,
until June 30, 2003, although AOL has the right, in each year beginning in 2000,
to elect, on or before May 1 of such year, to end the Company's long distance
exclusivity period as of June 30 of such year; elimination of AOL's rights to
receive further warrants to purchase Common Stock based upon customers gained
from the AOL subscriber base; AOL's contribution of up to $4.0 million (up to
$6.0 million if the Company pays $19.0 million as noted above) per quarter for
offline marketing; and establishment of the framework for the Company to offer
additional services and products to AOL subscribers. By an amendment dated as of
June 30, 2000, AOL agreed to give the Company a $1.0 million credit in each of
the second and third quarters of 2000 against amounts otherwise payable by the
Company under the AOL agreement. By a further amendment dated as of August 1,
2000, in consideration of AOL's agreement to provide certain additional
marketing in the last five months of 2000, the Company agreed to make additional
payments to AOL of $3.0 million in August, 2000 and $1.0 million
7
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
in each of the months in the fourth quarter of 2000, which amounts will be
credited against the Company's payment obligations in any quarter for which the
Company is required to pay at the quarterly rate of $19.0 million, as discussed
above.
AOL did not elect to exercise its right to terminate the long distance
exclusivity as of June 30, 2000 and, accordingly, the exclusivity period for
long distance will continue through at least June 30, 2001. AOL did provide the
Company with notice that its exclusivity as to wireless services would terminate
on July 1, 2000, although the Company's right to offer wireless services will
continue on a non-exclusive basis.
On January 5, 1999, pursuant to an Investment Agreement between AOL and the
Company, AOL purchased a total of 4,121,372 shares of Common Stock of the
Company for $55.0 million in cash and the surrender of rights to purchase
5,076,016 shares of Common Stock of the Company pursuant to various warrants
held by AOL. AOL agreed to end further vesting under the outstanding performance
warrant and retained vested warrants exercisable for 2,721,984 shares of Common
Stock. See Note 4 below for a discussion of certain reimbursement obligations of
the Company in favor of AOL.
3. RELATED PARTY TRANSACTIONS:
On January 5, 1999, Mr. Daniel Borislow, a founder of the Company and its
Chairman of the Board and Chief Executive Officer, resigned as a director and
officer of the Company. The Company entered into various agreements and engaged
in various transactions with Mr. Borislow and certain entities in which he or
his family had an interest.
In connection with Mr. Borislow's resignation, the Company paid $1.0
million to Mr. Borislow, assigned certain automobiles to him, and continued
certain of his health and medical benefits and director and officer insurance.
The Company also agreed that, so long as Mr. Borislow owned beneficially at
least two percent (2%) of the Common Stock (on a fully diluted basis), Mr.
Borislow and trusts for the benefit of his children would be entitled to:
registration rights with respect to their shares of Common Stock, the right to
require the Company to use a portion of proceeds from any public or private sale
of debt securities, excluding borrowings from a commercial bank or other
financial institution, by the Company to repurchase debt securities of the
Company owned by Mr. Borislow or the trusts for the benefit of his children, and
the right to require the Company to use the proceeds from the exercise of stock
options by other employees or the exercise of 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
discussed in Note 4. As of September 30, 2000, Mr. Borislow and the two trusts
for the benefit of Mr. Borislow's children, which have the ability to distribute
Common Stock to Mr. Borislow, held less than an aggregate of 2% of the
outstanding Common Stock. Accordingly, the Company believes that the
restrictions described above no longer apply to the Company.
During 1999, the Company (a) purchased from Mr. Borislow, and two trusts
for the benefit of Mr. Borislow's children, $85.9 million aggregate principal
amount of the Company's Convertible Notes for $72.3 million in cash; (b)
exchanged the remaining $53.7 million principal amount of subordinated notes of
Communication TeleSystems International d/b/a WorldxChange Communications, which
were included in other assets at December 31, 1998, to a trust for the benefit
of Mr. Borislow's children for $62.5 million aggregate principal amount of the
Company's Convertible Notes and (c) purchased $9.0 million aggregate principal
amount of the Company's Convertible Notes for $6.9 million in Common Stock. Also
during 1999, pursuant to the agreements with Mr. Borislow as described above the
Company purchased from Mr. Borislow approximately 639,000 shares of Common Stock
for approximately $7.7 million with proceeds from the exercise of stock options
by other employees.
8
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
On January 6, 2000, the Company repurchased from Mr. Borislow for $2.5
million real property previously sold to Mr. Borislow constituting the Company's
facilities in New Hope, Pennsylvania.
4. STOCKHOLDERS' EQUITY:
CONTINGENT REDEMPTION VALUE OF COMMON STOCK
Under the terms of the Investment Agreement with AOL (see Note 2 above),
the Company agreed to reimburse AOL for losses AOL may incur on the sale of any
of the shares of Common Stock held by AOL during the period from June 1, 1999
through September 30, 2000. The Company has the first right to purchase any of
the shares of Company common stock held by AOL at the market value on the day
that AOL notifies the Company of its intent to sell any of the shares plus an
amount, if any, equal to the Company's reimbursement obligation described below.
The reimbursement amount would be determined by multiplying the number of
shares, if any, that AOL sells during the applicable period by the difference
between the purchase price per share paid by AOL, or $19 per share, and the
price per share that AOL sells the shares for, if less than $19 per share. The
reimbursement amount may not exceed $14 per share for 2,894,737 shares and $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.
By an amendment dated as of August 2, 2000, the period during which AOL may
exercise its rights to reimbursement for losses on the sale of stock, as
described above, was extended from September 30, 2000 to September 30, 2001.
Also as of August 2, 2000, the Company received a letter from AOL confirming
that AOL does not intend to exercise such rights to reimbursement for shortfalls
earlier than December 31, 2000.
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
September 30, 2000, the reimbursement amount would be approximately $54.0
million. At September 30, 2000, the Company recorded $54.0 million for the
contingent redemption value of this Common Stock with a corresponding reduction
in additional paid-in capital. AOL also has the right on termination of long
distance exclusivity under the AOL marketing agreements to require the Company
to repurchase the warrants to purchase 2,721,984 shares of Common Stock of the
Company held by AOL for an aggregate price of $36.3 million, which repurchase
price can be paid in Common Stock or cash (provided that some portion of the
repurchase price may be payable in a quarterly amortization, two-year promissory
note of the Company if the repurchase price exceeds the then current valuation
of the warrants being purchased). AOL did not elect to terminate the long
distance exclusivity as of June 30, 2000, but can so elect as of June 30, 2001
and 2002. The Company has pledged the stock of its subsidiaries and has agreed
to fund an escrow account of up to $35.0 million from 50% of the proceeds of any
debt financing, other than a bank, receivable or other asset based financing of
up to $50.0 million, to secure its obligations under the Investment Agreement
with AOL. AOL has agreed that it will subordinate its security interests to
permit the securitization of certain future financings by the Company. Mr.
Borislow has agreed to guarantee up to $20.0 million of the Company's
reimbursement obligations under the Investment Agreement with AOL.
5. LEGAL PROCEEDINGS:
On June 16, 1998, a purported shareholder class action was filed in the
United States District Court for the Eastern District of Pennsylvania against
the Company and certain of its officers alleging violation of the securities
laws in connection with certain disclosures made by the Company in its public
filings and seeking unspecified damages. Thereafter, additional lawsuits making
substantially the same allegations were filed by other plaintiffs in the same
court. A motion to dismiss was granted as to certain officers of the Company and
denied as to the Company. There are currently no officers of the Company who are
a party to these actions. On July 19, 2000 a class was certified. 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 and regulatory investigations arising in the ordinary course of
business.
9
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The Company believes that the ultimate outcome of the foregoing actions
will not result in liability that would have a material adverse effect on the
Company's financial condition or results of operations.
6. ACQUISITION:
On August 9, 2000, a wholly owned subsidiary of the Company merged with and
into Access One Communications Corp., a New Jersey corporation ("Access One"),
pursuant to the Agreement and Plan of Merger, dated as of March 24, 2000,
between the Company and Access One. Access One was a private, local
telecommunications service provider to nine states in the southeastern United
States. As a result of such merger, Access One became a wholly owned subsidiary
of the Company and Access One stockholders received 0.571428 shares of the
Company's common stock in exchange for each share of Access One common stock
held by such stockholders at the effective time of the merger, or an aggregate
of approximately 12.2 million shares of the Company's common stock, and
outstanding options and warrants to purchase shares of Access One common stock
converted to options and warrants to purchase an aggregate of 2.1 million shares
of the Company's common stock. The total purchase price was approximately $201.3
million and the merger was accounted for under the purchase method of accounting
for business combinations. Accordingly, the consolidated financial statements
include the results of operations of Access One from the merger date. The merger
resulted in the recording of intangible assets of approximately $224.6 million,
which are being amortized on a straight-line basis over their expected benefit
period of 10 years. As of September 30, 2000, the Company had $15.9 million of
notes payable outstanding, which were acquired as part of the acquisition of
Access One.
The following unaudited pro forma information presents a summary of the
consolidated results of operations of the Company as if the Access One merger
had taken place at the beginning of the periods presented.
<TABLE>
<CAPTION>
(In thousands, except share data)
Nine Months Ended September 30,
------------------------------------------
2000 1999
---- ----
<S> <C> <C>
Sales $444,277 $388,026
Income (loss) before extraordinary gain $(45,409) $15,226
Extraordinary gain -- 21,230
----------------- -----------------
Net income (loss) $(45,409) $36,456
================= =================
Basic earnings (loss) per common share:
Income (loss) before extraordinary gain $ (0.58) $0.21
Net income (loss) $ (0.58) $0.50
Diluted earnings (loss) per common share:
Income (loss) before extraordinary gain $ (0.58) $0.20
Net income (loss) $ (0.58) $0.48
</TABLE>
The pro forma consolidated results of operations include adjustments to give
effect to amortization of intangibles, consulting fees and shares of common
stock issued. These unaudited pro forma results have been prepared for
comparative purposes only and do not purport to be indicative of the results of
operations which actually would have occurred had the merger been made at the
beginning of the periods presented or the future results of the combined
operations.
10
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
7. PER SHARE DATA:
Basic earnings per common share is calculated using the average shares of
common stock outstanding, while diluted earnings per common share reflects the
potential dilution that could occur if stock options and warrants were
exercised. Earnings per share are computed as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------- ---------------------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Income (loss) before extraordinary gain $(34,770) $14,646 $(22,281) $41,018
Extraordinary gain -- 2,233 -- 21,230
------------- --------------- -------------- --------------
Net income (loss) $(34,770) $16,879 $(22,281) $62,248
============= =============== ============== ==============
Average shares of common stock outstanding
used to compute basic earnings per common
share 72,839 61,343 68,005 60,233
Additional common shares to be issued
assuming exercise of stock options and
warrants, net of shares assumed reacquired -- 2,137 -- 2,860
------------- --------------- -------------- --------------
Shares used to compute dilutive effect of
stock options 72,839 63,480 68,005 63,093
============= =============== ============== ==============
Basic earnings (loss) per share:
Income (loss) before extraordinary gain $(0.48) $ 0.24 $(0.33) $ 0.68
0.04 0.35
Extraordinary gain -- --
------------- --------------- -------------- --------------
Net income (loss) $(0.48) $ 0.28 $(0.33) $ 1.03
============= =============== ============== ==============
Diluted earnings (loss) per share:
Income (loss) before extraordinary gain $ (0.48) $ 0.23 $(0.33) $ 0.65
Extraordinary gain -- 0.04 -- 0.34
------------- --------------- -------------- --------------
Net income (loss) $ (0.48) $ 0.27 $(0.33) $ 0.99
============= =============== ============== ==============
</TABLE>
The diluted share basis for the three months and nine months ended September 30,
2000 excludes incremental shares related to stock options and warrants of
633,304 and 1,557,978, respectively. These shares are excluded due to their
antidilutive effect as a result of the Company's net loss.
8. SUBSEQUENT EVENTS:
On October 20, 2000, certain subsidiaries of the Company entered into a
Credit Facility Agreement with MCG Finance Corporation providing for a term loan
of up to $20.0 million and a line of credit facility permitting such
subsidiaries to borrow up to an additional $30.0 million. The effectiveness of
the line of credit facility is subject, among other things, to the successful
syndication of that facility, which is expected to occur in 2001. Loans under
the Credit Facility Agreement bear interest at a rate equal to either (a) the
Prime Rate, as published by the Board of Governors of the Federal Reserve
System, or (b) LIBOR, plus, in each case, the applicable margin. The applicable
margin will initially be 2.5% for borrowings accruing interest at the Prime Rate
and 4% for borrowings accruing interest at LIBOR; after December 31, 2000, the
applicable margin will be based on the ratio of funded debt to trailing
twelve-month operating cash flow, determined on a consolidated basis, and will
vary from 2.0% to 2.5% for borrowings accruing interest at the Prime Rate and
from 3.5% to 4.0% for borrowings accruing interest at LIBOR. The Credit Facility
Agreement subjects the Company and its subsidiaries to certain restrictions and
covenants
11
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
related to, among other things, liquidity, per-subscriber revenue, subscriber
acquisition costs, leverage ratio and interest coverage ratio requirements. The
credit facilities under the Credit Facility Agreement terminate on June 30,
2001, but can be extended at the Company's election up to June 30, 2005 for the
term loan facility and up to June 30, 2003 for the line of credit facility. The
principal of the term loan is required to be repaid in quarterly installments of
$1.25 million on the last calendar day of each fiscal quarter, commencing on
September 30, 2001. The loans under the Credit Facility Agreement are secured by
a pledge of all of the assets of the subsidiaries of the Company that are
parties to that agreement. In addition, the Company has guaranteed the
obligations of those subsidiaries under the Credit Facility Agreement and
related documents; the Company's guarantee subjects the Company to certain
restrictions and covenants, including a prohibition against the payment of
dividends in respect of the Company's equity securities, except under certain
limited circumstances. Upon its execution of the Credit Facility Agreement, the
Company issued warrants for 300,000 shares of its common stock, which become
exercisable at $4.36 per share, if the Company fails to exceed certain EBITDA
thresholds for the fiscal quarters ended December 31, 2000 and March 31, 2001.
The Company is also required to issue warrants exercisable for an additional
300,000 shares of common stock (exercisable immediately) on the date on which
the line of credit facility is successfully syndicated (provided such date
occurs prior to March 31, 2001). On October 20, 2000, the Company borrowed $20.0
million under the term loan facility (approximately $15.0 million was used to
repay indebtedness of Access One).
12
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS:
OVERVIEW
Talk.com Inc., through its subsidiaries, provides telecommunications
services to residential and small business customers throughout the United
States, primarily through its electronic billing and customer service platform.
Talk.com Inc. and its subsidiaries are sometimes together referred to as the
"Company" and as "Talk.com".
The Company's telecommunications service offerings include long
distance and local outbound service, including local services bundled with long
distance services, internet service, inbound toll-free service and dedicated
private line services for data. On August 9, 2000, a wholly owned subsidiary of
the Company merged with and into Access One Communications Corp. ("Access One"),
a New Jersey corporation, pursuant to the Agreement and Plan of Merger, dated as
of March 24, 2000, between the Company and Access One. Access One was a private,
local telecommunications service provider to nine states in the southeastern
United States. As a result of the merger, Access One became a wholly owned
subsidiary of the Company and Access One stockholders received 0.571428 shares
of the Company's common stock in exchange for each share of Access One common
stock held by such stockholders at the effective time of the merger, or an
aggregate of approximately 12.2 million shares of the Company's common stock,
and outstanding options and warrants to purchase shares of Access One common
stock converted to options and warrants to purchase an aggregate of 2.1 million
shares of the Company's common stock. Using a March 2000 agreement with Access
One, the Company began offering local telecommunication service in Florida,
Georgia, North Carolina, South Carolina, Kentucky, Louisiana, Mississippi,
Tennessee, Alabama and New York in the second quarter of 2000. In the second
quarter of 2000, the Company also began offering a bundle of long distance and
local service to small business and select residential customers in the nine
southeastern states serviced by Access One, through the Company's marketing
partnerships and new direct channels. Late in the third quarter of 2000, the
Company began offering local telecommunication services in Pennsylvania. The
Company expects to continue to add to the states in which it offers local and
bundled local and long distance telecommunication services.
The Company believes that it has an opportunity to capture additional
market share and accelerate future growth through its offerings of local and
bundled local and long distance telecommunications services. In connection with
its rollout of local services, the Company anticipates that the higher level of
marketing and promotional expenditures during the first nine months of 2000
compared to 1999 will continue. However, the marketing and promotional
expenditures for the fourth quarter of 2000 are expected to decrease on an
absolute basis and as a percentage of revenue as compared to the third quarter
of 2000. With the extension of the Company's long distance exclusivity period
with AOL until at least June 2001, the Company also will continue to expend
significant marketing dollars with AOL. The Company believes that, primarily
because of these marketing and advertising expenditures, it will report a net
loss for the fourth quarter of 2000 and the full year 2000. Notwithstanding the
foregoing, the Company expects its EBITDA loss in the fourth quarter of 2000 to
be substantially less than for the third quarter of 2000 and that it will
achieve EBITDA breakeven in the first quarter of 2001. EBITDA means net income
or loss adjusted to eliminate interest income and expense, taxes, depreciation
and amortization.
13
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
RESULTS OF OPERATIONS
The following table set forth for the periods indicated certain financial data
as a percentage of sales:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED
ENDED SEPTEMBER 30, SEPTEMBER 30,
-------------------------- ---------------------------
2000 1999 2000 1999
---------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 59.8 60.4 61.2 62.8
---------- ----------- ----------- -----------
Gross profit 40.2 39.6 38.8 37.2
---------- ----------- ----------- -----------
Operating expenses (income):
General and administrative expenses 14.9 7.6 10.6 7.8
Promotional, marketing and advertising
expenses 47.6 19.8 30.7 17.3
Depreciation and amortization 5.2 1.1 2.5 1.2
Significant other income -- -- -- (0.8)
---------- ----------- ----------- -----------
Total operating expenses 67.7 28.5 43.8 25.5
---------- ----------- ----------- -----------
Operating income (loss) (27.5) 11.1 (5.0) 11.7
Interest income (expense), net (0.1) (.4) 0.1 (.1)
Other expense, net (1.2) (.2) (0.5) (.4)
---------- ----------- ----------- -----------
Income (loss) before income taxes (28.8) 10.5 (5.4) 11.2
Provision for income taxes 0.2 -- -- --
---------- ----------- ----------- -----------
Income (loss) before extraordinary gain 0.0 10.5 (5.4) 11.2
Extraordinary gain -- 1.6 -- 5.7
---------- ----------- ----------- -----------
Net income (loss) (28.6%) 12.1% (5.4%) 16.9%
========== =========== =========== ===========
</TABLE>
QUARTER ENDED SEPTEMBER 30, 2000 COMPARED TO QUARTER ENDED SEPTEMBER 30, 1999
Sales
Sales decreased by 13.4% to $121.3 million for the quarter ended
September 30, 2000 from $140.0 million for the quarter ended September 30, 1999.
This decrease was a result of the Company's exit from the international
wholesale business, a decline in the number of long distance customers, and a
reduction in the Company's other sales. The Company elected to exit the
international wholesale business, because of the low gross profit margins
associated therewith. The decrease in long distance sales was partially offset
by growth in sales from new local customers and the revenues from Access One
since the date of the merger. During the second quarter of 2000, there was a
significant reduction in the principal marketing opportunity provided to the
Company by AOL, which resulted in a decline in gross additions of new long
distance customers. In addition, the Company instituted new collection
procedures in the first quarter of 2000, which the Company believes contributed
to customer terminations during the introduction period of the new procedures at
a rate greater than the Company's historical churn experience. With the
reduction in long distance sales from the interruption of its primary AOL
marketing channel, increased churn, the exit from the international wholesale
business and the decline in other sales, the Company experienced a reduction in
total sales for the third quarter ended September 30, 2000 from total sales of
$135.8 million in the second quarter of 2000. The Company believes that revenue
from its long distance business will be sequentially flat in the fourth quarter
of 2000 compared to the third quarter of 2000.
While the Company believes it offers competitively priced services,
sales could be adversely affected by the intense competition in this industry.
In addition, the Company's ability to provision long distance and local bundled
services directly affects sales. Growth in the Company's sales of local services
will also be affected by the Company's ability to continue to expand its
offerings of such services to new states and to continue to build share in
existing markets.
14
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
A significant percentage of the Company's revenues in the quarters
ended September 30, 2000 and 1999 were derived from long distance
telecommunications services provided to customers who were obtained under the
AOL agreement and a significant decline in its AOL subscribers that is not
offset by growth in other subscribers could have a significant effect on the
Company's results of operations and cash flow. While the Company's rights to
market long distance exclusively under the AOL agreement do not expire until
June 30, 2003, AOL has the right in each year beginning in 2000, to elect, on or
before May 1 of such year, to permit others to market long distance
telecommunications services after June 30 of such year to AOL's subscribers.
Notwithstanding any such AOL election, the Company's rights to continue to
market its services to AOL subscribers on a non-exclusive basis, but with
significant marketing rights, would continue until June 30, 2003. AOL did not
exercise its right as to 2000 and, accordingly, the exclusivity period for long
distance will continue through at least June 2001 and the Company will be
obliged to make fixed quarterly payments during the year ending June 30, 2001 of
at least $15.0 million ($18.0 million in the last two quarters of 2000 before a
$1 million credit from AOL in the third quarter) to AOL. AOL did elect to
terminate the Company's exclusive right to offer wireless services to AOL
subscribers, but the Company's right to offer wireless services will continue on
a non-exclusive basis. The Company plans to continue to market its
services to AOL subscribers, and also plans, as discussed above, to increase its
efforts to expand its base of long distance and local bundled customers.
Cost of Sales
Cost of sales decreased by 14.3% to $72.5 million in the quarter ended
September 30, 2000 from $84.6 million in the quarter ended September 30, 1999,
and as a percentage of sales, decreased to 59.8% as compared to 60.4% for the
same quarter last year. The decreases were mainly due to a decrease in network
costs as a result of exiting of the international wholesale business, a lower
number of long distance customers, a reduction in local access charges, and a
reduction in primary interexchange carrier charges ("PICC"). In addition,
partition costs and billing costs were lower. The decrease in cost of sales was
offset by an increase in bad debt expense and additional cost of sales relating
to the growth of the local business and the cost of sales of Access One since
the date of merger. The Company provided $3.7 million more in bad debt expense
during the quarter ended September 30, 2000 over the same quarter last year.
This increase is to due to the provision for certain aged receivables that are
now deemed not collectible, and the bad debt expense from Access One since the
date of merger. The Company expects bad debt expense to be flat for the fourth
quarter of 2000 and to decrease for 2001.
Gross Profit
Gross profit increased to 40.2% of sales in the quarter ended
September 30, 2000 from 39.6% in the quarter ended September 30, 1999. The
increase in the gross profit percentage was primarily due to lower network,
partition and billing costs offset by additional provisions for bad debt and
increased cost associated with the growing local business, as noted above. Due
to the growth of local bundled service revenue as a percentage of total revenue,
the early stage of development of the Company's local service initiative,
fluctuations in bad debt expense, as well as the intensification of price
competition for the Company's products, the Company may not continue to
experience an upward trend in gross profits in the future.
General and Administrative Expenses
General and administrative expenses increased by 70.8% to $18.1 million
in the quarter ended September 30, 2000 from $10.6 million in the quarter ended
September 30, 1999. As a percentage of sales, general and administrative
expenses increased to 14.9% for the quarter ended September 30, 2000 from 7.6 %
for the quarter ended September 30, 1999. The increase was due primarily to
increased costs associated with additional personnel hired to support the
Company's growth in the local services business and the additional sales,
provisioning and customer service support for the local customers. The general
and administrative expenses of Access One are also included since the date of
merger.
Promotional, Marketing and Advertising Expenses
During the quarter ended September 30, 2000, the Company incurred $57.8
million in promotional, marketing and advertising expenses as compared to $27.7
million in the quarter ended September 30, 1999. This represents an increase of
108.7% over the same period last year, and relates to the Company's efforts to
expand its long distance and local bundled customer base as well as higher
promotional costs and an increase in fixed payments
15
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
to AOL and the addition of Access One marketing and promotional expenses since
the date of merger. The Company sold over 185,000 lines in the third quarter of
2000 that are expected to be billed in the fourth quarter of 2000. The Company
expects to continue to incur marketing and promotional expenses as it implements
its plans noted above to aggressively pursue local subscribers and line growth,
particularly non-AOL customers. However, fourth quarter 2000 expenses are
expected to be lower than in the third quarter 2000. Fixed payments to AOL have
increased by $3.0 million for both the third and fourth quarters of 2000 in
connection with AOL's agreement to provide certain additional marketing in the
last five months of 2000. After taking into account a third quarter credit from
AOL, fixed payments to AOL in the third quarter of 2000 were $17.0 and will be
$18.0 million for the fourth quarter of 2000.
Depreciation and Amortization
Depreciation and amortization for the quarter ended September 30, 2000
was $6.3 million, an increase of $4.8 million compared to $1.5 million for the
same period in 1999. This increase is due primarily to the amortization of the
goodwill recorded upon the Access One acquisition ($3.7 million of amortization
for the third quarter of 2000), and also reflects the continued purchase of
property and equipment to support the Company's ongoing growth, particularly
with investment in a state-of-the-art billing, provisioning and customer service
system platform, along with additional property, equipment and intangibles that
were acquired by the Company in the Access One merger. The excess of the
purchase price over the fair value of the net assets acquired in the Access One
acquisition was approximately $224.6 million and has been recorded as goodwill,
which is being amortized on a straight-line basis over ten years.
Interest Income (Expense), net
Net interest expense was $105,000 for the quarter ended September 30,
2000 as compared to net interest expense of $624,000 for the quarter ended
September 30, 1999. This represents an decrease of $519,000 from the third
quarter of last year due primarily to the higher level of cash and cash
equivalents and lower debt levels in the 2000 period. Net interest income
consists primarily of interest income earned on cash and cash equivalents offset
by interest expense related to the Company's convertible debt and interest
expense incurred by Access One since the date of the merger.
Other Expense, net
Net other expense was $1.5 million for the quarter ended September 30,
2000 as compared to $309,000 for the quarter ended September 30, 1999. The
increase is due primarily to a $1 million increase in the reserve on a note
receivable.
Provision for Income Taxes
During the quarter ended September 30, 2000, due to an expected loss
for this fiscal year, the Company recorded an income tax benefit of $250,000
that represents a reversal of the provision recorded in the quarter ended March
31, 2000. In the quarter ended March 31, 2000, the Company recorded the
provision relating to the expected payment of federal income taxes on
alternative minimum taxable income for the fiscal year.
Extraordinary Gain
During the quarter ended September 30, 1999 the Company recorded an
extraordinary gain of $2.2 million from the acquisition of the Company's
convertible debt at a discount from its aggregate principal amount.
NINE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1999
Sales
Sales increased by 12.3% to $413.1 million for the nine months ended
September 30, 2000 from $367.7 million for the nine months ended September 30,
1999. This increase was primarily a result of an increase in the number of long
distance customers, growth in new local customers, addition of Access One
revenues since the date of merger, and sales from the international wholesale
business. The Company exited the international wholesale business in the third
quarter, because of the low gross profit margins associated therewith. The
increase in sales was partially
16
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
offset by a decrease in the Company's other sales, as the Company has continued
to focus primarily on developing its long distance and local bundled customer
base. The addition of new marketing partners has contributed to the growth in
sales for the nine months ended September 30, 2000 compared to the same period
for 1999.
As discussed above in the third quarter discussion, during the second
quarter of 2000, there was a significant reduction in the principal marketing
opportunity provided to the Company by AOL, which resulted in a decline in gross
additions of new customers. In addition, the Company instituted new collection
procedures in the first quarter of 2000, which the Company believes contributed
to customer terminations during the introduction period of the new procedures at
a rate greater than the Company's historical churn experience. With the
reduction in long distance sales from the interruption of its primary AOL
marketing channel, increased churn, the exit from the international wholesale
business and the decline in other sales, the Company experienced a reduction in
total sales for the third quarter ended September 30, 2000 from total sales of
$135.8 million in the second quarter of 2000. While the Company believes it
offers competitively priced services, sales could be adversely affected by the
intense competition in this industry. In addition, the Company's ability to
provision long distance and local bundled services directly affects sales.
Growth in the Company's sales of local services will also be affected by the
Company's ability to continue to expand its offerings of such services to new
states and to continue to build share in existing markets.
A significant percentage of the Company's revenues in the nine months
ended September 30, 2000 and 1999 were derived from long distance
telecommunications services provided to customers who were obtained under the
AOL agreement and, as discussed above in the third quarter discussion, a
significant decline in its AOL subscribers that is not offset by growth in other
subscribers could have a significant effect on the Company's results of
operations and cash flow.
Cost of Sales
Cost of sales increased by 9.4% to $252.7 million in the nine months
ended September 30, 2000 from $231.0 million in the nine months ended September
30, 1999. This increase was due to the overall increase in sales for the nine
months ended September 30, 2000 as compared to the same period last year and the
addition of Access One cost of sales since the date of merger. As a percentage
of sales, cost of sales for the nine months in 2000 decreased to 61.2% as
compared to 62.8% for the same period last year. The decrease was primarily due
to lower network usage costs for services on the Company's OBN network on a per
minute basis and lower partition costs due to the decrease in other sales,
offset by increased bad debt and by higher network costs associated with the
international wholesale business, as noted above.
Gross Profit
Gross profit increased to 38.8% of sales in the nine months ended
September 30, 2000 from 37.2% in the nine months ended September 30, 1999. The
increase in the gross profit percentage was primarily due to lower network usage
costs for OBN services on a per minute basis and lower partition costs due to
the decrease in other sales, as noted above.
General and Administrative Expenses
General and administrative expenses increased by 53.8% to $44.0
million in the nine months ended September 30, 2000 from $28.6 million in the
nine months ended September 30, 1999. As a percentage of sales, general and
administrative expenses increased to 10.6% for the nine months ended September
30, 2000 from 7.8 % for the nine months ended September 30, 1999. The increase
was due primarily to costs associated with additional personnel hired to support
the Company's continuing growth in the local services business and the addition
of Access One general and administrative expenses since the date of the merger.
Promotional, Marketing, and Advertising Expenses
During the nine months ended September 30, 2000, the Company incurred
$126.9 million in promotional, marketing and advertising expenses as compared to
$63.5 million in the nine months ended September 30, 1999. This represents an
increase of 99.8% over the same period last year, and relates to the Company's
efforts to expand
17
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
its long distance and local bundled customer base as well as higher promotional
costs and an increase in fixed payments to AOL and the addition of Access One
marketing and promotional expenses since the date of merger.
Depreciation and Amortization
Depreciation and amortization for the nine months ended September 30,
2000 was $10.2 million, an increase of 131.8% compared to $4.4 million for the
same period in 1999. This increase is due primarily to the amortization of the
goodwill recorded upon the Access One acquisition ($3.7 million of amortization
for the nine months ended September 30, 2000), and also reflects the continued
purchase of property and equipment to support the Company's ongoing growth,
particularly with investment in a state-of-the-art billing, provisioning and
customer service system platform, along with additional property, equipment and
intangibles that were acquired by the Company in the Access One merger. The
excess of the purchase price over the fair value of the net assets acquired in
the Access One acquisition was approximately $224.6 million and has been
recorded as goodwill, which is being amortized on a straight-line basis over ten
years.
Significant Other Income
During the nine months ended September 30, 1999, the Company sold TSFL
Holdings, Inc. (formerly Symetrics Industries, Inc.), resulting in a gain of
$2.7 million.
Interest Income (Expense), net
Net interest income was $546,000 for the nine months ended September
30, 2000 as compared to net interest expense of $592,000 for the nine months
ended September 30, 1999. This is a decrease in interest expense of $1.1 million
from the nine months of last year due to higher levels of cash and cash
equivalents and lower convertible debt levels in the 2000 period. Net interest
income consists primarily of interest income earned on cash and cash equivalents
offset by interest expense related to the Company's convertible debt and Access
One notes payable since the date of the merger.
Other Expense, net
Net other expense was $2.1 million for the nine months ended September
30, 2000 as compared to $1.3 million for the nine months ended September 30,
1999. This represents a 61.5% increase compared to the nine months of last year.
The increase is due primarily to a $1.0 million increase in the reserve on a
note receivable.
Provision for Income Taxes
Due to an expected loss for this fiscal year, no income tax provision
was booked by the Company in the nine months ended September 30, 2000.
Extraordinary Gain
During the nine months ended September 30, 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.
LIQUIDITY AND CAPITAL RESOURCES
The Company had $70.4 million of cash and cash equivalents as of September
30, 2000, and $78.9 million as of December 31, 1999. The decrease in cash is
primarily a result of $29.9 million in capital expenditures for the purchase of
property and equipment, related primarily to the expansion of the business
discussed above, offset in part by cash generated from the Company's operations
and the receipt of $11.1 million in connection with the exercise of outstanding
Common Stock rights prior to their expiration in February 2000.
Net cash provided by operating activities was $11.6 million for the nine
months ended September 30, 2000. Net cash provided by operating activities was
$5.1 million for the nine months ended September 30, 1999. For the nine months
ended September 30, 2000, the major contributors to the net cash provided by
operating activities were a
18
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
decrease in prepaid expenses and other current assets of $6.9 million, an
increase in accounts payable and accrued expenses of $13.3 million and
adjustments to net income for non-cash items of $21.3 million. This was offset
by a net loss of $22.3 million, an increase in net trade accounts receivable of
$9.0 million and a decrease in other liabilities of $3.0 million. For the nine
months ended September 30, 1999, net cash provided by operating activities was
mainly generated by net income of $62.2 million and a net decrease in other
assets of $4.1, offset by a reduction in accounts payable and accrued expenses
of $24.4 million, an adjustment for the extraordinary gain of $21.2 million
recorded from the acquisition of the Company's convertible debt and an increase
in accounts receivable, trade of $12.8 million.
Net cash used in investing activities of $33.7 million related primarily to
the purchase of property, equipment and intangibles during the nine months ended
September 30, 2000. For the nine months ended September 30, 1999, the net cash
provided by investing activities was mainly from the sale of marketable
securities of $89.6 million.
The $13.6 million net cash provided by financing activities for the nine
months ended September 30, 2000 was received from the exercise of employee stock
options and common stock purchase rights. For the nine months ended September
30, 1999, the net cash used in financing activities totaled $49.6 million. On
January 5, 1999, pursuant to an Investment Agreement between AOL and the
Company, AOL made a significant equity investment in the Company, acquiring
4,121,372 shares of Common Stock for $55.0 million in cash and the surrender of
rights to acquire up to 5,076,016 shares of Common Stock pursuant to various
warrants held by AOL. Additional financing activities generated $25.0 million
from the exercise of employee stock options. These activities in 1999 were
offset by the acquisition of convertible debt of $72.3 million, the repayment of
margin account indebtedness of $49.6 million and the acquisition of treasury
stock of $7.7 million.
Under the terms of the Investment Agreement with AOL, the Company agreed to
reimburse AOL for losses AOL may incur on the sale of any of the 4,121,372
shares of Company common stock held by AOL 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
Company common stock as of November 10, 2000, the reimbursement amount would be
approximately $54.0 million. AOL also has the right, on termination of the
Company's long distance exclusivity under its marketing agreement with AOL, to
require the Company to repurchase warrants held by AOL to purchase 2,721,984
shares of Company common stock for $36.3 million, which repurchase price can be
paid in Common Stock or cash (provided that some portion of the repurchase price
may be payable in a quarterly amortization, two-year promissory note of the
Company if the repurchase price exceeds the then current valuation of the
warrants being purchased). The Company has pledged the stock of its subsidiaries
and has agreed to fund an escrow account of up to $35.0 million from 50% of the
proceeds of any debt financing, other than a bank, receivable or other asset
based financing of up to $50.0 million, to secure its obligations under the
Investment Agreement with AOL. Mr. Daniel Borislow, former Chairman of the Board
and Chief Executive Officer of the Company, has agreed to guarantee up to $20.0
million of the Company's reimbursement obligations under the Investment
Agreement with AOL. By an amendment dated as of August 2, 2000, the period
during which AOL may exercise its rights to reimbursement for losses on the sale
of stock, as described above, was extended from September 30, 2000 to September
20, 2001. Also as of August 2, 2000, the Company received a letter from AOL
confirming that AOL does not intend to exercise such rights to reimbursement for
shortfalls earlier than December 31, 2000.
The Company generally does not have a significant concentration of credit
risk with respect to net trade accounts receivable, due to the large number of
end users comprising the Company's customer base and their dispersion across
different geographic regions. The Company maintains reserves for potential
credit losses and, to date, such losses have been within the Company's
expectations.
At the time of the Company's acquisition of Access One, Access One and its
subsidiaries had $15.0 million of loans outstanding under an existing credit
facility with MCG Finance Corporation. The loans under the credit facility were
secured by a pledge of all of the assets of Access One and its subsidiaries. In
addition, the Company
19
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
guaranteed the obligations of Access One and its subsidiaries under the credit
facility. The $15.0 million loan was repaid on October 20, 2000 when certain
subsidiaries of the Company entered into a Credit Facility Agreement with MCG
Finance Corporation, providing for a term loan of up to $20.0 million and a line
of credit facility permitting such subsidiaries to borrow up to an additional
$30.0 million. The effectiveness of the line of credit facility is subject,
among other things, to the successful syndication of that facility, which is
expected to occur in 2001. The Credit Facility Agreement subjects the Company
and its subsidiaries to certain restrictions and covenants related to, among
other things, liquidity, per-subscriber revenue, subscriber acquisition costs,
leverage ratio and interest coverage ratio requirements. The credit facilities
under the Credit Facility Agreement terminate on June 30, 2001, but can be
extended at the Company's election up to June 30, 2005 for the term loan
facility and up to June 30, 2003 for the line of credit facility. The principal
of the term loan is required to be repaid in quarterly installments of $1.25
million on the last calendar day of each fiscal quarter, commencing on September
30, 2001. The loans under the Credit Facility Agreement are secured by a pledge
of all of the assets of the subsidiaries of the Company that are parties to that
agreement. In addition, the Company has guaranteed the obligations of those
subsidiaries under the Credit Facility Agreement and related documents; the
Company's guarantee subjects the Company to certain restrictions and covenants,
including a prohibition against the payment of dividends in respect of the
Company's equity securities, except under certain limited circumstances. Upon
its execution of the Credit Facility Agreement, the Company issued warrants for
300,000 shares of its common stock, which become exercisable, at $4.36 per
share, if the Company fails to exceed certain EBITDA thresholds for the fiscal
quarters ended December 31, 2000 and March 31, 2001. The Company is also
required to issue warrants exercisable for an additional 300,000 shares of
common stock (exercisable immediately) on the date on which the line of credit
facility is successfully syndicated (provided such date occurs prior to March
31, 2001). On October 20, 2000, the Company borrowed $20.0 million under the
term loan facility (approximately $15.0 million was used to repay the Access One
loans).
The Company does not, and has not historically, required significant
amounts of working capital for its day-to-day operations. The Company believes
that its current cash position and the cash flow expected to be generated from
operations will be sufficient to fund its capital expenditures, working capital
and other cash requirements, including marketing and promotional expenditures
discussed above, for at least the next twelve months. The Company also believes,
based on its existing cash and cash equivalents and its expectations as to
future cash flow from operations, that, should AOL elect during the exercise
period of January 1, 2001 through September 30, 2001 to sell its shares of the
Company's common stock at a price below $19 per share. The Company will have the
ability to obtain the financing necessary to fund such portion of its
reimbursement obligations under the AOL Investment Agreement as it does not fund
from its cash on hand at such time. Should the Company seek to raise additional
capital, however, 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.
SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS
Certain of the statements contained herein may be considered
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such
statements are identified by the use of forward-looking words or phrases,
including, but not limited to, "estimates," "expects," "expected,"
"anticipates," and "anticipated." These forward-looking statements are based on
the Company's current expectations. Although the Company believes that the
expectations reflected in such forward-looking statements are reasonable, there
can be no assurance that such expectations will prove to have been correct.
Forward-looking statements involve risks and uncertainties and the Company's
actual results could differ materially from the Company's expectations. In
addition to those factors discussed in the foregoing Management's Discussion and
Analysis, important factors that could cause such actual results to differ
materially include, among others, adverse developments in the Company's
relationship with its marketing partners, increased price competition for long
distance and local services, failure of the marketing of long distance and local
services under its agreements with its various marketing partners and its direct
marketing channels, attrition in the number of end users, a failure of the
Company to continue to successfully integrate the operations of Access One or
difficulties in managing the larger combined companies, a failure of the
Company's new local services and bundled local and long distance services
initiative, failure of the Company to expand its offering of local and local
bundled services to new states, failure of the Company to manage its growth and
changes in government policy, regulation and enforcement. The Company undertakes
no obligation to update its forward-looking statements.
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TALK.COM INC. AND SUBSIDIARIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the normal course of business, the financial position of the Company is
subject to a variety of risks, such as the collectibility of its accounts
receivable and the recoverability of the carrying values of its long-term
assets. The Company's long-term obligations consist primarily of its own
convertible notes and credit facility. The Company does not presently enter into
any transactions involving derivative financial instruments for risk management
or other purposes due to the stability in interest rates in recent times and
because management does not consider the potential impact of changes in interest
rates to be material.
The Company's available cash balances are invested on a short-term basis
(generally overnight) and, accordingly, are not subject to significant risks
associated with changes in interest rates. Substantially all of the Company's
cash flows are derived from its operations within the United States and the
Company is not subject to market risk associated with changes in foreign
exchange rates.
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TALK.COM INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Rights of Equity Securities
On October 20, 2000, certain subsidiaries of the Company entered into a
Credit Facility Agreement with MCG Finance Corporation. The Company's guarantee
of such subsidiaries' obligations under the Credit Facility Agreement subjects
the Company to certain restrictions and covenants, including a prohibition
against the payment of dividends in respect of the Company's equity securities,
except under certain limited circumstances.
Issuances of Securities
Upon its execution of a Credit Facility Agreement with MCG Finance
Corporation (with its affiliated entities, collectively "MCG") on October 20,
2000, the Company issued warrants for 300,000 shares of its common stock to MCG,
which warrants become exercisable at $4.36 per share if the Company fails to
exceed certain revenue thresholds for the fiscal quarters ended December 31,
2000 and March 31, 2001.
On August 9, 2000, the Company issued currently exercisable warrants to
purchase 300,000 shares of its common stock to MCG in consideration of a
consulting agreement and services provided by MCG thereunder to Access One
Communications Corp. These warrants have an exercise price of $4.73 and expire
on August 8, 2007.
Each of the above issuances was made by the Company in reliance on Section
4(2) of the Securities Act of 1933.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
(a) Exhibits:
<S> <C>
10.1 Employment Agreement between the Company and Thomas M. Walsh dated August 7, 2000. *
10.2 Indemnification Agreement between the Company Thomas M. Walsh dated August 7, 2000. *
10.3 Non-Qualified Stock Option Agreement between the Company and Thomas M. Walsh dated August 7, 2000. *
10.4 Credit Facility Agreement among Talk.com Holding Corp., Access One Communications Corp, certain of their
direct and indirect subsidiaries and MCG Finance Corporation, dated as of October 20, 2000. ++
10.5 Guaranty between Talk.com Inc. in favor of MCG Finance Corporation, dated as of October 20, 2000.
27 Financial Data Schedule
* Management contract or compensatory plan or arrangement.
++ Confidential treatment has been requested for portions of this exhibit.
</TABLE>
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TALK.COM INC. AND SUBSIDIARIES
(b) Reports on Form 8-K:
During the quarter ended September 30, 2000, the Company filed
three Current Reports on Form 8-K reporting on the following:
The Current Report on Form 8-K, dated August 2, 2000, reported
under Item 5. Other Events, an extension of the reimbursement
obligation under the Investment Agreement with America Online,
Inc.
The Current Report on Form 8-K, dated August 9, 2000, reported
on Item 2. Acquisition or Disposition of Assets, that a wholly
owned subsidiary of the Company merged with and into Access One
Communications Corp., a New Jersey corporation ("Access One"),
pursuant to the Agreement and Plan of Merger, dated as of March
24, 2000, between the Company and Access One.
The Current Report on Form 8-K, dated September 8, 2000,
reported under Item 4. Changes in Registrant's Certifying
Accountant the change in the Company's independent certified
public accountants to PricewaterhouseCoopers LLP.
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TALK.COM INC. AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TALK.COM INC.
Date: November 14, 2000 By: /s/ Gabriel Battista
---------------------
Gabriel Battista
Chief Executive Officer
Date: November 14, 2000 By: /s/ Edward B. Meyercord, III
-----------------------------
Edward B. Meyercord, III
Chief Operating Officer and
Chief Financial Officer
Date: November 14, 2000 By: /s/ Janet C. Kirschner
-----------------------
Janet C. Kirschner
Controller
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