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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------------------
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
--- ---
COMMISSION FILE NUMBER 0 - 26728
TALK AMERICA HOLDINGS, 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 by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
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.
26,177,651 shares of Common Stock, par value of $0.01 per share, were
issued and outstanding as of May 9, 2003.
TALK AMERICA HOLDINGS, INC. AND SUBSIDIARIES
INDEX
PAGE
----
PART I - FINANCIAL INFORMATION:
Item 1. Consolidated Financial Statements:
Consolidated Statements of Operations - Three Months
Ended March 31, 2003 and 2002 (unaudited) 3
Consolidated Balance Sheets - March 31, 2003 (unaudited)
and December 31, 2002 4
Consolidated Statements of Stockholders' Equity - Three
Months Ended March 31, 2003 (unaudited) 5
Consolidated Statements of Cash Flows - Three Months Ended
March 31, 2003 and 2002 (unaudited) 6
Notes to Consolidated Financial Statements (unaudited) 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosure About Market Risk 20
Item 4. Controls and Procedures 21
PART II - OTHER INFORMATION:
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits 22
(b) Reports on Form 8-K 22
2
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
TALK AMERICA HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
----------------------
2003 2002
--------- ----------
Sales $ 87,843 $ 79,447
Costs and expenses:
Network and line costs 43,884 40,219
General and administrative expenses 13,465 14,561
Provision for doubtful accounts 2,223 4,007
Sales and marketing expenses 8,785 5,895
Depreciation and amortization 4,307 4,443
--------- ----------
Total costs and expenses 72,664 69,125
--------- ----------
Operating income 15,179 10,322
Other income (expense):
Interest income 110 89
Interest expense (2,479) (1,474)
Other income (expense), net 2,151 (807)
--------- ----------
Income before provision for income taxes 14,961 8,130
Provision for income taxes 5,835 --
--------- ----------
Net income $ 9,126 $ 8,130
========= ==========
Income per share - Basic:
Net income per share $ 0.35 $ 0.30
========= ==========
Weighted average common shares outstanding 26,376 27,185
========= ==========
Income per share - Diluted:
Net income per share $ 0.32 $ 0.28
========= ==========
Weighted average common and common equivalent
shares outstanding 29,940 29,460
========= ==========
See accompanying notes to consolidated financial statements.
3
TALK AMERICA HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE DATA)
(UNAUDITED)
MARCH 31, DECEMBER 31,
2003 2002
------------- ------------
ASSETS
Current assets:
Cash and cash equivalents $ 29,046 $ 33,588
Accounts receivable, trade (net of allowance for uncollectible accounts of
7,349 and $7,821 at March 31, 2003 and December 31, 2002, respectively) 30,963 27,843
Deferred income taxes 16,765 17,500
Prepaid expenses and other current assets 1,810 2,330
------------- -----------
Total current assets 78,584 81,261
Property and equipment, net 66,277 66,915
Goodwill 19,503 19,503
Intangibles, net 6,667 7,379
Deferred income taxes -- 4,800
Other assets 7,020 7,653
------------- -----------
$ 178,051 $ 187,511
============= ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 33,332 $ 30,588
Sales, use and excise taxes 11,772 11,439
Deferred revenue 7,634 6,480
Current portion of long-term debt 62 61
Accrued compensation 3,358 5,609
Other current liabilities 6,464 9,013
------------- -----------
Total current liabilities 62,622 63,190
------------- -----------
Long-term debt:
8% Secured convertible notes due 2006 26,552 30,150
12% Senior subordinated notes due 2007 56,620 65,970
8% Convertible senior subordinated notes due 2007 (includes future accrued
interest of $1,151 and $1,216 at March 31, 2003 and December 31, 2002,
respectively) 3,973 4,038
5% Convertible subordinated notes due 2004 670 670
Other long-term debt 11 27
------------- -----------
Total long-term debt 87,826 100,855
------------- -----------
Commitments and contingencies
Stockholders' equity:
Preferred stock - $.01 par value, 5,000,000 shares authorized; no shares
outstanding -- --
Common stock - $.01 par value, 100,000,000 shares authorized;
26,161,437 and 27,469,593 shares issued and outstanding at March 31, 2003
and December 31, 2002, respectively 275 275
Treasury stock - $.01 par value, 1,315,789 shares at March 31, 2003 (5,000) --
Additional paid-in capital 352,003 351,992
Accumulated deficit (319,675) (328,801)
----------- ------------
Total stockholders' equity 27,603 23,466
----------- ------------
$ 178,051 $ 187,511
=========== ============
See accompanying notes to consolidated financial statements.
4
TALK AMERICA HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
(UNAUDITED)
COMMON STOCK ADDITIONAL TREASURY STOCK
------------------- PAID-IN ACCUMULATED -----------------
SHARES AMOUNT CAPITAL DEFICIT SHARES AMOUNT TOTAL
------- -------- ---------- ----------- ------ -------- --------
Balance, December 31, 2002 27,470 $ 275 $ 351,992 $ (328,801) -- $ -- $23,466
Net income -- -- -- 9,126 -- -- 9,126
Acquisition of treasury stock -- -- -- -- 1,316 (5,000) (5,000)
Exercise of common stock
options 7 -- 11 -- -- -- 11
------- -------- ---------- ----------- ------ -------- --------
Balance, March 31, 2003 27,477 $ 275 $ 352,003 $ (319,675) 1,316 $(5,000) $27,603
======= ======== ========== =========== ====== ======== ========
5
TALK AMERICA HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
----------------------
2003 2002
--------- ----------
Cash flows from operating activities:
Net income $ 9,126 $ 8,130
Reconciliation of net income to net cash provided by (used in)
operating activities:
Provision for doubtful accounts 2,223 4,007
Depreciation and amortization 4,307 4,443
Loss on sale and retirement of assets -- 205
Deferred income taxes 5,535 --
Other non-cash charges (benefits) (2,219) 84
Changes in assets and liabilities:
Accounts receivable, trade (5,343) (582)
Prepaid expenses and other current assets 435 192
Other assets 1,114 120
Accounts payable and accrued expenses 494 (10,349)
Deferred revenue 1,154 (1,655)
Sales, use and excise taxes 332 (710)
Other liabilities (2,550) 682
--------- ----------
Net cash provided by operating activities 14,608 4,567
--------- ----------
Cash flows from investing activities:
Capital expenditures (2,691) (167)
Capitalized software development costs (663) (570)
Acquisition of intangibles -- (50)
--------- ----------
Net cash used in investing activities (3,354) (787)
--------- ----------
Cash flows from financing activities:
Payments of borrowings -- (1,336)
Acquisition of convertible debt and senior notes (10,793) (1,227)
Payment of capital lease obligations (16) (422)
Proceeds from exercise of stock options and warrants 12 --
Repurchase of common stock (5,000) --
--------- ----------
Net cash used in financing activities (15,797) (2,985)
--------- ----------
Net increase (decrease) in cash and cash equivalents (4,543) 795
Cash and cash equivalents, beginning of period 33,589 22,100
--------- ----------
Cash and cash equivalents, end of period $ 29,046 $ 22,895
========= ==========
See accompanying notes to consolidated financial statements.
6
TALK AMERICA HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ACCOUNTING POLICIES
(A) BASIS OF FINANCIAL STATEMENTS PRESENTATION
The consolidated financial statements include the accounts of Talk America
Holdings, Inc. and its wholly owned subsidiaries (collectively, the "Company").
All intercompany balances and transactions have been eliminated.
The consolidated financial statements and related notes thereto as of March
31, 2003 and for the three months ended March 31, 2003 and March 31, 2002 are
presented as unaudited, but in the opinion of management include all adjustments
necessary to present fairly the information set forth therein. The consolidated
balance sheet information for December 31, 2002 was derived from the audited
financial statements included in the Company's Annual Report on Form 10-K for
the year ended December 31, 2002 filed March 31, 2003. These interim financial
statements should be read in conjunction with the Company's Annual Report on
Form 10-K for the year ended December 31, 2002. The interim results are not
necessarily indicative of the results for any future periods. Certain prior
year amounts have been reclassified for comparative purposes.
(B) RISKS AND UNCERTAINTIES
Future results of operations involve a number of risks and uncertainties.
Factors that could affect future operating results and cash flows, and cause
actual results to vary materially from historical results include, but are not
limited to:
- Failure or difficulties in managing the Company's operations,
including attracting and retaining qualified personnel
- Dependence on the availability and functionality of RBOCs' networks as
they relate to the unbundled network element platform
- Increased price competition in local and long distance services and
overall competition within the telecommunications industry
- Interruption or failure of, or failure to manage, the Company's
network and technology and information systems
- Changes in government policy, regulation and enforcement or adverse
judicial or administrative interpretations and rulings or legislative
action relating to regulations and enforcement, including, but not
limited to, changes that affect the continued availability of the
unbundled network element platform of the local exchange carriers
network.
- Failure of the marketing of the Company's bundle of local and long
distance services
- Inability to adapt to technological change
- Failure to manage the nonpayment of amounts due the Company from its
customers from bundled and long distance services
- Attrition in the number of end users
- Failure of the Company to be able to expand its active offering of
local bundled services in a greater number of states
- Adverse determinations in certain litigation matters
- Failure of the Company to provide adequate customer service
Negative developments in these areas could have a material effect on the
Company's business, financial condition and results of operations.
7
(C) NEW ACCOUNTING PRONOUNCEMENTS
In November 2002, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN
45"), an interpretation of FASB Statement No. 5, "Accounting for Contingencies."
This interpretation elaborates on the disclosures to be made by a guarantor in
its interim and annual financial statements about its obligations under certain
guarantees that it has issued. It also clarifies that a guarantor is required to
recognize, at the inception of certain guarantees, a liability for the fair
value of the obligation undertaken in issuing the guarantees. This
interpretation is effective on a prospective basis for guarantees issued or
modified after December 31, 2002 and for financial statements of interim or
annual periods ending after December 15, 2002. The Company historically has
been, and currently is, party to various agreements that obligate the Company to
indemnify other parties in certain situations, primarily for litigation or
regulatory claims arising from activities conducted pursuant to the agreements.
These agreements generally include, but are not limited to, agreements with
other carriers, marketing agreements, licensing agreements, lease agreements,
underwriting agreements and employment related agreements. The adoption of this
standard did not have a material impact on the Company's consolidated financial
statements for the three months ended March 31, 2003.
NOTE 2. DEBT
(A) 12% SENIOR SUBORDINATED NOTES DUE 2007 AND 8% CONVERTIBLE SENIOR
SUBORDINATED NOTES DUE 2007
Effective April 4, 2002, the Company completed the exchange of $57.9
million of the $61.8 million outstanding principal balance of its 4-1/2%
Convertible Subordinated Notes due September 15, 2002 ("4-1/2% Convertible
Subordinated Notes") into $53.2 million of new 12% Senior Subordinated PIK Notes
due August 2007 ("12% Senior Subordinated Notes") and $2.8 million of new 8%
Convertible Senior Subordinated Notes due August 2007 ("8% Convertible Senior
Subordinated Notes") and cash paid of $0.5 million. In addition, the Company
exchanged $17.4 million of the $18.1 million outstanding principal balance of
its 5% Convertible Subordinated Notes ("5% Convertible Subordinated Notes") that
mature on December 15, 2004 into $17.4 million of the new 12% Senior
Subordinated Notes.
The new 12% Senior Subordinated Notes accrue interest at a rate of 12% per
year on the principal amount, payable semiannually on February 15 and August 15,
beginning on August 15, 2002. Interest is payable in cash, except that the
Company may, at its option, pay up to one-third of the interest due on any
interest payment date through and including the August 15, 2004 interest payment
date in additional 12% Senior Subordinated Notes. The new 8% Convertible Senior
Subordinated Notes accrue interest at a rate of 8% per year on the principal
amount, also payable semiannually on February 15 and August 15, and are
convertible, at the option of the holder, into common stock at $15.00 per share.
The 12% Senior Subordinated Notes and 8% Convertible Senior Subordinated Notes
are redeemable at any time at the option of the Company at par value plus
accrued interest to the redemption date. The AOL Restructuring Agreement
discussed below obligates the Company to redeem 8% Secured Convertible Notes
upon the redemption of subordinated debt. As of March 31, 2003, the Company had
$56.6 and $2.8 million principal amount outstanding of the 12% Senior
Subordinated Notes and 8% Convertible Senior Subordinated Notes, respectively.
As of March 31, 2002, prior to the exchange, $61.8 million principal amount of
the 4-1/2% Notes and $18.1 million principal amount of the 5% Notes remained
outstanding.
In accordance with SFAS No. 15, "Accounting by Debtors and Creditors for
Troubled Debt Restructurings," the exchange of the 4-1/2% Convertible
Subordinated Notes into $53.2 million of the 12% Senior Subordinated Notes and
$2.8 million of the 8% Convertible Senior Subordinated Notes was accounted for
as a troubled debt restructuring. Since the total liability of $57.4 million
($57.9 million of principal as of the exchange date, less cash payments of $0.5
million) is less than the future cash flows to holders of 8% Convertible Senior
Subordinated Notes and 12% Senior Subordinated Notes of $91.5 million
(representing the $56.0 million of principal and $35.5 million of future
interest expense), the liability remained on the balance sheet at $57.4 million
as long-term debt. The difference of $1.4 million between principal and the
carrying amount is being recognized as a reduction of interest expense over the
life of the new notes.
The Company reacquired $9.4 million of 12% Senior Subordinated Notes
during the three months ended March 31, 2003 at a $2.2 million discount from
face amount. This amount, in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 145, "Rescission of FASB Statements No. 4, 44, and 64,
8
Amendment of FASB Statements No. 13, and Technical Corrections as of April
2002," is reported as other income in the consolidated statement of operations.
There was no such item in the comparable period. In the second quarter of 2003
through May 14, the Company has reacquired an additional $4.1 million of 12%
Senior Subordinated Notes at a $0.2 million discount from face amount.
(B) 5% CONVERTIBLE SUBORDINATED NOTES DUE 2004
As of March 31, 2003, the Company had $0.7 million principal amount
outstanding of its 5% Convertible Subordinated Notes that mature on December 15,
2004. Interest on these notes is due and payable semiannually on June 15 and
December 15. The notes are convertible, at the option of the holder, at a
conversion price of $76.14 per share. The 5% Convertible Subordinated Notes are
redeemable, in whole or in part at the Company's option, at 101.43% of par prior
to December 14, 2003 and 100.71% of par thereafter.
(C) 8% SECURED CONVERTIBLE NOTES DUE 2006
In September 2001, the Company restructured its financial obligations with
America Online, Inc. ("AOL") that arose under the Investment Agreement entered
into on January 5, 1999 and, effective September 30, 2001, also ended its
marketing relationship with AOL (collectively the "AOL Restructuring"). In
connection with the AOL Restructuring, the Company and AOL entered into a
Restructuring Agreement pursuant to which the Company issued to AOL $54.0
million principal amount of its 8% Secured Convertible Notes. The 8% Secured
Convertible Notes were issued in exchange for a release of the Company's
reimbursement obligations under the Investment Agreement. AOL, in lieu of any
other payment for the early discontinuance of the marketing relationship, paid
the Company, at the time of the AOL Restructuring, $20.0 million by surrender
and cancellation of $20.0 million principal amount of the 8% Secured Convertible
Notes delivered to AOL, thereby reducing the outstanding principal amount of the
8% Secured Convertible Notes to $34.0 million.
The 8% Secured Convertible Notes are convertible into shares of the
Company's common stock at the rate of $15.00 per share and may be redeemed by
the Company at any time without premium. The 8% Secured Convertible Notes accrue
interest at the rate of 8% per year on the principal amount, payable
semiannually on January 1 and July 1. The 8% Secured Convertible Notes are
guaranteed by the Company's principal operating subsidiaries and are secured by
a pledge of the Company's and the subsidiaries' assets. In addition, AOL, as
the holder of the 8% Secured Convertible Notes, entered into an intercreditor
agreement with the lender under the Company's existing secured credit facility,
which survives the early retirement of debt under the Company's Senior Credit
Facility.
On December 23, 2002, by letter agreement, the Company and AOL amended
certain provisions of the Restructuring Agreement between them (the
"Amendment"). Pursuant to the Amendment, the maturity date for the 8% Secured
Convertible Notes issued under the Restructuring Agreement was advanced to
September 19, 2006 (four days later than the first date of mandatory redemption
at the option of the holder) from 2011, and the Company's right to elect to pay
a portion (50%) of the interest on the 8% Secured Convertible Notes in kind
rather than in cash was eliminated.
In addition, the Amendment provided that certain limitations on the
Company's purchase of its outstanding subordinated indebtedness ("Sub Debt") and
common stock were amended, to permit the Company, through September 30, 2003,
to: (i) repurchase outstanding Sub Debt provided it does not pay more than 80%
of the face amount and, for every dollar used to repurchase Sub Debt, it
repurchases $0.50 of principal amount of 8% Secured Convertible Notes from AOL;
and (ii) purchase shares of its common stock, provided it purchases the shares
at or below market value and it concurrently purchases an equal number of shares
of common stock from AOL. The aggregate amount that the Company may utilize with
respect to both the repurchase of Sub Debt and of common stock cannot exceed $10
million.
As a consequence of the Amendment and the repurchase of $4.1 million of the
8% Secured Convertible Notes in the fourth quarter of 2002, the Company recorded
an extraordinary non-cash gain of $28.9 million from the decrease in the future
accrued interest relating to the 8% Secured Convertible Notes which was
reflected as a $28.9 million reduction in long-term debt. As a further
consequence, the Company began recording the interest expense associated with
the 8% Secured Convertible Notes in its consolidated statement of operations.
9
In the quarter ended March 31, 2003, the Company repurchased $3.6 million
of the 8% Secured Convertible Notes. In addition, the Company purchased
1,315,789 of its common shares from AOL at a per share price of $3.80, the
average closing price for the five days ended January 15, 2003. As of March 31,
2003, the aggregate amount remaining that the Company may utilize with respect
to the repurchase of both Sub Debt and common stock under the terms of the
Amendment was $1.4 million.
In the second quarter of 2003, through May 14, in connection with its
acquisition of $4.1 million principal amount of 12% Senior Subordinated Notes,
as discussed above, the Company has reacquired an additional $4.1 million of 8%
Secured Convertible Notes at par, leaving outstanding $22.5 million principal
amount of the 8% Secured Convertible Notes.
NOTE 3. LEGAL PROCEEDINGS
The Company is party to a number of legal actions and proceedings,
including purported class actions, arising from the Company's provision and
marketing of telecommunications services, as well as certain legal actions and
regulatory investigations and enforcement proceedings arising in the ordinary
course of business. Recently, the Company has been made aware that AOL has
agreed to settle a class action case for approximately $10 million; the claims
in the case allegedly relate to marketing activities conducted pursuant to the
Telecommunications Marketing Agreement, by and between the Company, Talk America
Inc. and AOL, dated as of February 22, 1997, as amended (the "Marketing
Agreement"). AOL has asserted that the Company is required to indemnify AOL in
this matter under the terms of the Marketing Agreement and advised that it will
seek such indemnification from the Company. The Company believes that it does
not have an obligation to indemnify AOL in this matter and that any claim by AOL
for this indemnification would be without merit. The Company intends, if AOL
pursues a claim for indemnification under the Marketing Agreement, to defend the
claim vigorously. 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 4. STOCK-BASED COMPENSATION
The following disclosure complies with the adoption of SFAS No. 123,
amended by SFAS No. 148, "Accounting for Stock-Based Compensation - Transition
and Disclosure - an amendment of FASB Statement No. 123," and includes pro forma
net loss as if the fair value based method of accounting had been applied:
Three Months Ended March 31,
----------------------------
2003 2002
------------ ------------
Net income as reported $9,126 $8,130
Stock-based employee compensation
expense included in reported
net income -- --
Total stock-based employee
compensation expense determined
under fair value based method
for all options 206 1,246
------------ ------------
Pro forma net income $8,920 $6,884
============ ============
Three Months Ended March 31,
----------------------------
2003 2002
------------ ------------
BASIC EARNINGS PER SHARE:
As reported $0.35 $0.30
Pro forma $0.34 $0.25
DILUTED EARNINGS PER SHARE:
As reported $0.32 $0.28
Pro forma $0.31 $0.23
For purposes of pro forma disclosures under SFAS 123, the estimated fair
value of the options is assumed to be amortized to expense over the options'
vesting period. The fair value of the options granted has been estimated at the
10
various dates of the grants using the Black-Scholes option-pricing model with
the following assumptions:
- Fair market value based on the Company's closing common stock price on
the date the option is granted;
- Risk-free interest rate based on the weighted averaged 5 year U.S.
treasury note strip rates;
- Volatility based on the historical stock price over the expected term
(5 years);
- No expected dividend yield based on future dividend payment plans.
NOTE 5. PER SHARE DATA
Basic earnings per common share for a fiscal period is calculated by
dividing net income by the weighted average number of common share outstanding
during the fiscal period. Diluted earnings per common share is calculated by
adjusting the weighted average number of common shares outstanding and the net
income during the fiscal period for the assumed conversion of all potentially
dilutive stock options, warrants and convertible bonds (and assuming that the
proceeds hypothetically received from the exercise of dilutive stock options are
used to repurchase shares at the Company's average share price during the fiscal
period). For the diluted earnings calculation, the net income is adjusted by
the interest expense on the convertible bonds assumed to be converted. Earnings
per share are computed as follows (in thousands except per share data):
THREE MONTHS ENDED,
-----------------------------
2003 2002
------------ ------------
Net income used to compute basic earnings per share $ 9,126 $ 8,130
Interest expense on convertible bonds, net of tax affect 319 --
------------ ------------
Net income used to compute diluted earnings per share $ 9,445 $ 8,130
============ ============
Average shares of common stock outstanding used to
compute basic earnings per share 26,376 27,185
Additional common shares to be issued assuming exercise
of stock options and warrants (net of shares assumed
reacquired) and conversion of convertible bonds * 3,564 2,275
------------ ------------
Average shares of common and common equivalent stock
outstanding used to compute diluted earnings per share 29,940 29,460
============ ============
Income per share - Basic:
------------ ------------
Net income per share $ 0.35 $ 0.30
============ ============
Weighted average common shares 26,376 27,185
============ ============
Income per share - Diluted:
------------ ------------
Net income per share $ 0.32 $ 0.28
============ ============
Weighted average common and common equivalent shares
outstanding 29,940 29,460
============ ============
* The diluted share basis for the three months ended March 31, 2003 and 2002
excludes 9 and 1,078 shares, respectively, associated with the convertible bonds
and 2,184 and 2,933 shares, respectively, associated with the options and
warrants due to their antidilutive effect.
11
ITEM 2. 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-Q and in
the Company's Annual Report on Form 10-K filed March 31, 2003 and any subsequent
filings. Certain of the statements contained herein may be considered
forward-looking statements. 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 Company's Annual
Report on Form 10-K filed March 31, 2003, the Company's other filings with the
Securities and Exchange Commission and below in the following discussion,
important factors that could cause such actual results to differ materially are
discussed in Note 1 of the Notes to Consolidated Financial Statements, above.
OVERVIEW
The Company provides local and long distance telecommunication services to
residential and small business customers in the United States. The Company has
developed integrated order processing, provisioning, billing, payment,
collection, customer service and information systems. These proprietary
systems, along with attractive wholesale pricing, enable the Company to offer
savings through competitively priced service plans, high-quality service and
simplicity through consolidated billing and responsive customer care.
The Company offers both local and long distance telecommunication services,
primarily a bundled offering of local and long distance voice services, which
are billed to customers in one combined invoice. Local phone services include
local dial tone, various local calling plans that include free member-to-member
calling, and a variety of features such as caller identification, call waiting
and three-way calling. Long distance phone services include traditional 1+ long
distance, international and calling cards. The Company uses the unbundled
network element platform ("UNE-P") of the regional bell operating companies
("RBOCs") network to provide local services and the Company's nationwide network
to provide long distance services. The Federal Communications Commission
("FCC") has recently concluded its triennial review of local phone competition.
Although the text of the order is not yet available, the decision appears to
preserve the Company's ability to use UNE-P for the provision of bundled
telecommunications services pending further market-by-market analyses by the
respective state commissions.
12
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated certain financial
data of the Company as a percentage of sales:
THREE MONTHS ENDED
MARCH 31,
---------------------
2003 2002
--------- ---------
Sales 100.0% 100.0%
Costs and expenses:
Network and line costs 50.0 50.6
General and administrative expenses 15.3 18.3
Provision for doubtful accounts 2.5 5.1
Sales and marketing expenses 10.0 7.4
Depreciation and amortization 4.9 5.6
--------- ---------
Total costs and expenses 82.7 87.0
--------- ---------
Operating income 17.3 13.0
Other income (expense):
Interest income 0.1 0.1
Interest expense (2.8) (1.9)
Other, net 2.4 (1.0)
--------- ---------
Income before income taxes 17.0 10.2
Provision for income taxes 6.6 --
--------- ---------
Net income 10.4% 10.2%
========= =========
QUARTER ENDED MARCH 31, 2003 COMPARED TO QUARTER ENDED MARCH 31, 2002
Sales. Sales increased by 10.6% to $87.8 million for the quarter ended
March 31, 2003 from $79.4 million for the quarter ended March 31, 2002. The
increase in sales is due to higher bundled sales offset by lower long distance
sales resulting from the Company's continued focus, begun in 2000, on its
efforts in the local telecommunication services market by offering local
telecommunication services bundled with long distance services and significantly
reduced sales and marketing related to the long distance product.
The Company's bundled sales for the quarter ended March 31, 2003 were $60.2
million as compared to $35.5 million for the quarter ended March 31, 2002. The
increase in sales was due to higher average bundled lines in 2003 as compared to
2002, partially offset by lower average monthly revenue per customer. The
overall increase resulted from the Company's ongoing strategy to market lower
priced products to be more competitive with incumbent and other competitive
local exchange carriers. The quarter ended March 31, 2003 also reflected both
growth in bundled lines and reductions in customer turnover. The Company had
approximately 402,300 bundled lines as of March 31, 2003 as compared to
approximately 193,700 bundled lines at March 31, 2002. Approximately 269,000 of
the bundled lines at March 31, 2003 were in Michigan. Long term growth in
revenues will depend upon the Company's ability to develop and scale various
marketing programs in additional states or areas, maintain the current level of
customer turnover and maintain operating efficiencies.
The Company's long distance sales decreased to $27.7 million for the
quarter ended March 31, 2003 from $43.9 million for the quarter ended March 31,
2002. The Company's decision to focus on the bundled product, together with
customer turnover, contributed to the decline in long distance customers and
revenues. This decline in long distance customers and revenues is expected to
continue so long as the Company continues to focus its marketing efforts on the
bundled product. Long distance revenues for the quarter ended March 31, 2002
included non-cash amortization of deferred revenue of $1.9 million related to a
telecommunications service agreement entered into in 1997. Deferred revenue
relating to this agreement had been amortized over a five-year period. The
agreement and related amortization terminated in October 2002.
During the quarter ended March 31, 2003 the Company selectively increased
certain fees and rates related to its long distance and bundled products and
such changes in rates and bill presentation may adversely impact customer
turnover. The Federal Trade Commission and the Federal Communications
13
Commission have proposed rules and regulations governing the creation and
enforcement of national "do not call" databases that could affect the Company's
ability to outbound telemarket, which is currently an important sales channel
for the Company.
Network and Line Costs. Network and line costs increased by 9.1% to $43.9
million for the quarter ended March 31, 2003 from $40.2 million for the quarter
ended March 31, 2002. The increase in costs was primarily due to an increase in
bundled customers, partially offset by a decrease in long distance customers and
favorable resolution of disputes with vendors. As a percentage of sales, network
and line costs decreased to 50.0% for the quarter ended March 31, 2003, as
compared to 50.6% for the quarter ended March 31, 2002. The lower total network
and line costs as a percentage of sales were due primarily to a decrease in the
bundled network and line costs as a percentage of sales for the bundled product.
This decrease was partially offset by a shift in the Company's sales to the
higher cost bundled product. Bundled network and line costs as a percentage of
sales decreased to 53.4% for the quarter ended March 31, 2003, as compared to
63.8% for the quarter ended March 31, 2002. Long distance network and line costs
as a percentage of sales increased to 42.6% for the quarter ended March 31,
2003, as compared to 39.9% for quarter ended March 31, 2002. Network and line
costs for the quarter ended March 31, 2003 included carrier billing credits for
disputed amounts of approximately $0.8 million for bundled and $0.3 million for
long distance network and line costs as compared to approximately $0.6 and $0.2
million, respectively, for the quarter ended March 31, 2002. There are several
factors that could cause network and line costs as a percentage of sales to
increase in the future, including (i) adverse changes to the current rules and
regulations or adverse judicial or administrative interpretations and rulings or
legislative action relating to (a) the FCC's recently concluded triennial review
of local phone competition and the pending market-by-market analyses by the
respective state commissions, or (b) prices the Company pays for UNEs and UNE-P,
(ii) greater absorption of fixed network costs as the Company's long distance
customer base declines, and (iii) certain minimum network service commitments
relating to the Company's long distance network. Changes in the pricing of the
Company's service plans could also cause network and line costs as a percentage
of sales to change in the future. See "Liquidity and Capital Resources, Other
Matters."
General and Administrative Expenses. General and administrative expenses
decreased by 7.5% to $13.5 million, or 15.3% of sales, for the quarter ended
March 31, 2003 from $14.6 million, or 18.3% of sales, for the quarter ended
March 31, 2002. The overall decrease in general and administrative expenses was
due primarily to a reduction in costs associated with collection of delinquent
customer accounts. Due to improved credit screening procedures and internal
collection efforts, the Company has substantially reduced its delinquent
customer account balances and therefore its expenses associated with collection
of these accounts. The decrease was also due to significant workforce reductions
and other cost cutting efforts by the Company as it pursued improvements in
operating efficiencies of the Company's bundled business model. While the
Company expects general and administrative expense as a percentage of sales to
decline as the customer base grows, realization of such efficiencies will be
dependent on the ability of management to continue to control personnel costs in
areas such as customer service and collections. There can be no assurances that
the Company will be able to realize these efficiencies.
Provision for Doubtful Accounts. Provision for doubtful accounts decreased
by 44.5% to $2.2 million for the quarter ended March 31, 2003 from $4.0 million
for the same quarter last year, and, as a percentage of sales, decreased to 2.5%
as compared to 5.1% for the quarter ended March 31, 2002. The provision for
doubtful accounts for the quarter ended March 31, 2002 reflected a benefit from
the reversal of the reserve for doubtful accounts of $1.0 million due to better
than expected collections experience on outstanding accounts receivable at
year-end 2001. The Company continues to experience improved collections results
due to several steps during the third and fourth quarters of 2001 to reduce bad
debt expense, improve the overall credit quality of its customer base and
increase its collections of past due amounts. The benefits of the Company's
actions to reduce bad debt expense and improve the overall credit quality of its
customer base are reflected in the lower bad debt expense for the quarter ended
March 31, 2003. In general, the Company believes that bad debt expense as a
percentage of sales of the Company's long distance customers is lower than that
of its bundled customers because of the relatively greater maturity of the long
distance customer base.
Sales and Marketing Expenses. During the quarter ended March 31, 2003, the
Company incurred $8.8 million of sales and marketing expenses as compared to
$5.9 million for the same quarter last year, a 49.1% increase, and, as a
percentage of sales, an increase to 10% as compared to 7.4% for the quarter
ended March 31, 2002. The increase in expense is primarily attributable to
increased levels of sales and marketing activity to continue the Company's
bundled sales growth. Currently, substantially all of the sales and marketing
expenses relate to the bundled product. Sales and marketing expenses are
expected to increase in 2003 as the Company continues to target growth in the
bundled product and invest in the development of its marketing programs.
14
Depreciation and Amortization. Depreciation and amortization for the
quarter ended March 31, 2003 was $4.3 million, a decrease of $0.1 million
compared to $4.4 million for quarter ended March 31, 2002, and, as a percentage
of sales, decreased to 4.9% as compared to 5.6% for the quarter ended March 31,
2002.
Interest Income. Interest income was $0.1 million for each of the quarter
ended March 31, 2003 and the quarter ended March 31, 2002.
Interest Expense. Interest expense was $2.5 million for the quarter ended
March 31, 2003 as compared to $1.5 million for the quarter ended March 31, 2002.
The increase is due to higher interest expense associated with the issuance of
the Company's 12% Senior Subordinated Notes and 8% Convertible Senior
Subordinated Notes issued in connection with the exchange offer completed on
April 4, 2002 (see Note 2 of Notes to Consolidated Financial Statements). In
addition, as a result of the restructuring agreement with AOL on December 23,
2002, the Company began recording the interest expense associated with the 8%
Secured Convertible Notes on its consolidated statement of operations during the
first quarter ended March 31, 2003. There was no interest expense recorded with
respect to the 8% Secured Convertible Notes in the quarter ended March 31, 2002,
as the notes were accounted for as a troubled debt restructuring. The increase
was partially offset by the retirement on October 4, 2002 by the principal
operating subsidiaries of the Company, prior to maturity, of all the debt
outstanding under the Senior Credit Facility Agreement between the subsidiaries
and MCG Finance Corporation ("MCG") and by the repurchase of 12% Senior
Subordinated Notes and 8% Convertible Senior Subordinated Notes.
Other Income and Expense, Net. Net other income was $2.2 million for the
quarter ended March 31, 2003 compared to net other expense of $0.8 million for
the quarter ended March 31, 2002. The amount for the quarter ended March 31,
2003 consists of gains from the repurchase of a portion of the Company's 12%
Senior Subordinated Notes at a discount to par. The amount for the quarter ended
March 31, 2002 primarily consisted of cost in connection with the Company's
restructuring of its convertible subordinated notes (see Note 2 of Notes to
Consolidated Financial Statements).
Provision for Income Taxes. For the quarter ended March 31, 2003, the
Company recorded income tax expense of $5.8 million, an effective tax rate of
39%, but as a result of the application of net operating loss carryforwards,
the Company need only pay accrued alternative minimum taxes and state income
taxes of $0.4 million for income earned in the quarter ended March 31, 2003. At
March 31, 2002, since the amounts and extent of the Company's future earnings
were not determinable with a sufficient degree of probability to recognize the
deferred tax assets in accordance with the requirements of Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes", the
Company recorded a full valuation allowance on the net deferred tax assets and,
as a result, no provision for income taxes was reflected on the statement of
operations. Management will review the valuation allowance during 2003 to
determine whether the remaining valuation allowance should be reversed or
portion thereof. There can be no assurances that the Company will realize the
full benefit of the net operating loss carryforwards on future taxable income
generated by the Company due to the "change of ownership" provisions of the
Internal Revenue Code Section 382 (see "Liquidity and Capital Resources, Other
Matters").
15
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash requirements arise primarily from its subsidiaries'
operational needs, its subsidiaries' capital expenditures and the debt service
obligations of the Company. Since Talk America Holdings, Inc. conducts all of
its operations through its subsidiaries, primarily Talk America Inc., it relies
on dividends, distributions and other payments from its subsidiaries to fund its
obligations.
Contractual obligations of the Company as of March 31, 2003 are summarized
by years to maturity as follows (in thousands):
1 year or 2 - 3 4 - 5
Contractual Obligations (1) Total less Years Years Thereafter
- -------------------------------- --------- --------- ---------- ---------- ------------
Talk America Holdings, Inc.:
- ------------------------------
8% Secured Convertible Notes
due 2006 $ 26,552 $ -- $ -- $ 26,552 $ --
12% Senior Subordinated Notes
due 2007 56,620 -- -- 56,620 --
8% Convertible Senior
Subordinated Notes
due 2007 (2) 3,973 -- -- 3,973 --
5% Convertible Subordinated
Notes due 2004 670 -- 670 -- --
Talk America Inc. and other
subsidiaries:
- --------------------------------
Capital lease obligations 73 62 11 -- --
--------- --------- ---------- ---------- ------------
$ 87,888 $ 62 $ 681 $ 87,145 $ --
Operating leases 4,744 1,626 2,352 619 147
Total Contractual Obligations $ 92,632 $1,688 $3,033 $ 87,764 $ 147
- --------------
(1) Excluded from these contractual obligations are various network service
agreements for long distance services that contain certain minimum usage
commitments. The largest contract establishes pricing and provides for revenue
commitments based upon usage of $52 million for the 18 months ended February
2004 and $40 million for the 9 months ended December 2004. This contract
obligates the Company to pay 65 percent of the shortfall, if any. A separate
contract with a different vendor establishes pricing and provides for annual
minimum payments for the years ended December 31, as follows: 2003 - $6.0
million and 2004 - $3.0 million. While the Company anticipates that it will not
be required to make any shortfall payments under these contracts as a result of
(1) growth in network minutes, (2) the management of traffic flows on its
network, (3) the restructuring of these obligations, and/or (4) the sale of
additional minutes of usage from the wholesale or other long distance markets,
there can be no assurances that the Company will be successful in its efforts.
In addition, these actions will likely cause the Company to experience an
increase in per minute network costs.
(2) The 8% Convertible Senior Subordinated Notes include $2.8 million of
principal and $1.2 million of future accrued interest (see Note 2 of the Notes
to Consolidated Financial Statements).
The Company relies on internally generated funds and cash and cash
equivalents on hand to fund its capital and financing requirements. The Company
had $29.0 million of cash and cash equivalents as of March 31, 2003, and $22.9
million as of March 31, 2002.
Net cash provided by operating activities was $14.6 million for the quarter
ended March 31, 2003 as compared to $4.6 million for the quarter ended March 31,
2002. For the quarter ended March 31, 2003, the major contributors to the net
cash provided by operating activities were net income of $9.1 million and
16
non-cash charges of $10.1 million, primarily consisting of depreciation and
amortization of $4.3 million and deferred income taxes of $5.5 million. Net cash
provided by operating activities also consisted of decreases in prepaid expenses
of $0.4 million, other assets of $1.1 million, primarily from repayment of a
related party loan, and an increase in deferred revenue of $1.1 million for
advance customer billings. These amounts were offset by an increase in accounts
receivable of $5.3 million, a decrease in other liabilities of $2.6 million,
primarily consisting of a reduction of interest payable, and increases in
prepaid expenses and other current and non-current assets of $1.5 million. For
the quarter ended March 31, 2002, the major contributors to the net cash
provided by operating activities were net income of $8.1 million and non-cash
charges of $8.7 million, primarily consisting of provision for doubtful accounts
of $4.0 million, and depreciation and amortization of $4.4 million. These 2002
amounts were offset by an increase in accounts receivable of $0.6 million and a
decrease in accounts payable of $10.3 million.
Net cash used in investing activities was $3.4 million during the quarter
ended March 31, 2003, consisting of capitalized software development costs of
$0.7 million and capital expenditures primarily for the purchase of equipment of
$2.7 million. Net cash used in investing activities of $0.8 million during the
quarter ended March 31, 2002 consisted primarily of capitalized software
development costs of $0.6 million. The remaining balance related to purchase of
property, equipment and intangibles. The Company expects to incur capital
expenditures of between $10 and $12 million and capitalized software development
costs of between $2 and $3 million in 2003.
The FCC has recently concluded its triennial review of local phone
competition. Although the text of the order is not yet available, the decision
appears to preserve the Company's ability to use UNE-P for the provision of
bundled telecommunications services pending further market-by-market analyses by
the respective state commissions. Changes to the current rules and regulations
or adverse judicial or administrative interpretations and rulings or legislative
action relating thereto that result in any curtailment in the availability of or
the prices for the local switching UNE could require the Company to
significantly increase its capital expenditures. (See "Liquidity and Capital
Resources, Other Matters").
Net cash used in financing activities for the quarter ended March 31, 2003
was primarily attributable to repurchases of $9.4 million of the Company's 12%
Senior Subordinated Notes and $3.6 million of the Company's 8% Secured
Convertible Notes, respectively, for a total of $10.8 million. The discount from
face amount is reported as other income in the consolidated statement of
operations for the quarter ended March 31, 2003. In connection with the share
buyback program of $10 million or 2,500,000 shares announced in January 2003,
cash used in financing activities also consisted of the repurchase of 1,315,789
shares of its common shares from AOL at a per share price of $3.80 (the average
closing price for the five days ended January 15, 2003). The aggregate purchase
price was approximately $5.0 million. For the quarter ended March 31, 2002, the
net cash used in financing activities was primarily attributable to payment of
borrowings under the Company's credit facility of $1.3 million, payments under
2011 Convertible Notes of $1.2 million and payments under capital lease
obligations.
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.
OTHER MATTERS
The Company's provision of telecommunication services is subject to
government regulation. Changes in existing regulations could have a material
adverse effect on the Company. The Company's local telecommunication services
are provided almost exclusively through the use of RBOC Unbundled Network
Elements ("UNE"), and it is primarily the availability of cost-based UNE rates
that enables the Company to price its local telecommunications services
competitively. On December 12, 2001, the FCC initiated its so-called UNE
Triennial Review rulemaking in which it was to review all UNEs and determine
whether RBOCs should continue to be required to provide them to competitors. The
FCC has recently concluded its Triennial Review of local phone competition.
Although the text of the order is not yet available, the decision appears to
preserve the Company's ability to use UNE-P for the provision of bundled
telecommunications services pending further market-by-market analyses by the
respective state commissions. Changes to the current rules and regulations or
adverse judicial or administrative interpretations and rulings or legislative
action relating thereto that result in any curtailment in the availability of
the local switching UNE or increase in costs that RBOCs may charge for such
elements would materially impair the Company's ability to provide local
telecommunications services. Such changes could eliminate the Company's
capability to provide local telecommunications services entirely unless the
Company is able to utilize another technology, which may not be available or
17
available on economically feasible terms, or the Company purchases, builds and
implements its own local switching network, which would require significant
additional capital expenditures by the Company.
At December 31, 2002, the Company had net operating loss ("NOL")
carryforwards for federal income tax purposes of approximately $262 million. Due
to the "change of ownership" provisions of the Internal Revenue Code Section
382, the availability of the Company's net operating loss and credit
carryforwards may be subject to an annual limitation against taxable income in
future periods if a change of ownership of more than 50% of the value of the
Company's stock should occur within a three-year testing period. Many of the
changes that affect these percentage change determinations, such as changes in
the Company's stock ownership, are outside the Company's control. A
more-than-50% cumulative change in ownership for purposes of the Section 382
limitation occurred on August 31, 1998 and October 26, 1999. As a result of such
changes, certain of the Company's carryforwards are limited. As of December 31,
2002, approximately $15 million of NOL carryforwards were limited to offset
future income. In addition, based on information currently available to the
Company, the Company believes that the change of ownership percentage was
approximately 38% for the currently applicable three-year testing period. If,
during the current three-year testing period, the Company experiences an
additional more-than-50% ownership change under Section 382, the amount of the
NOL carryforward available to offset future taxable income may be further and
substantially reduced. To the extent the Company's ability to use these net
operating loss carryforwards against any future income is limited, its cash flow
available for operations and debt service would be reduced. There can be no
assurance that the Company will realize the full benefit of the carryforwards.
The Company is party to a number of legal actions and proceedings,
including purported class actions, arising from the Company's provision and
marketing of telecommunications services, as well as certain legal actions and
regulatory investigations and enforcement proceedings arising in the ordinary
course of business. Recently, the Company has been made aware that AOL has
agreed to settle a class action case for approximately $10 million; the claims
in the case allegedly relate to marketing activities conducted pursuant to the
Marketing Agreement. AOL has asserted that the Company is required to indemnify
AOL in this matter under the terms of the Marketing Agreement and advised that
it will seek such indemnification from the Company. The Company believes that
it does not have an obligation to indemnify AOL in this matter and that any
claim by AOL for this indemnification would be without merit. The Company
intends, if AOL pursues a claim for indemnification under the Marketing
Agreement, to defend the claim vigorously. 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.
While the Company believes that it has access, albeit limited, to new
capital in the public or private markets to fund its ongoing cash requirements,
there can be no assurance as to the timing, amounts, terms or conditions of any
such new capital or whether it could be obtained on terms acceptable to the
Company. Accordingly, the Company anticipates that its cash requirements
generally must be met from the Company's cash-on-hand and from cash generated
from operations. Based on its current projections for operations, the Company
believes that its cash-on-hand and its cash flow from operations will be
sufficient to fund its currently contemplated capital expenditures, its debt
service obligations, including the increased interest expense of its outstanding
indebtedness, and the expenses of conducting its operations for at least the
next twelve months. However, there can be no assurance that the Company will be
able to realize its projected cash flows from operations, which is subject to
the risks and uncertainties discussed above, or that the Company will not be
required to consider capital expenditures in excess of those currently
contemplated, as discussed above.
CRITICAL ACCOUNTING POLICIES
The Company's discussion and analysis of its financial condition and
results of operations are based upon the Company's consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these financial
statements requires the Company to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. On an on-going basis, the
Company evaluates its estimates, including those related to bad debt, goodwill
and intangible assets, income taxes, contingencies and litigation. The Company
bases its estimates and judgments on historical experience and on various other
assumptions that are believed to be reasonable under the circumstances, the
18
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.
RECOGNITION OF REVENUE
The Company derives its revenues from local and long distance phone
services, primarily local services bundled with long distance services, long
distance services, inbound toll-free service and dedicated private line services
for data transmission. The Company recognizes revenue from voice, data and other
telecommunications related services in the period in which subscriber uses the
related service.
Deferred revenue represents the unearned portion of local telecommunication
services and features that are billed one month in advance. In addition,
deferred revenue at March 31, 2002 included a non-refundable prepayment received
in 1997 in connection with an amended telecommunications services agreement with
Shared Technologies Fairchild, Inc. The payment was amortized over the five-year
term of the agreement, which expired in October 2002. The amount included in
revenue was $1.9 million in the quarter ended March 31, 2002.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
Allowances for doubtful accounts are maintained for estimated losses
resulting from the failure of customers to make required payments on their
accounts. The Company reviews accounts receivable aging trends, historical bad
debt trends, and customer credit-worthiness through customer credit scores,
current economic trends and changes in customer payment history when evaluating
the adequacy of the allowance for doubtful accounts. If the financial condition
of the Company's carriers that pay access charges were to deteriorate, resulting
in an impairment of their ability to make payments, additional allowances may be
required. The Company's accounts receivable balance was $31.0 million, net of
allowance for doubtful accounts of $7.3 million, as of March 31, 2003.
VALUATION OF LONG-LIVED ASSETS AND INTANGIBLE ASSETS WITH A DEFINITE LIFE
The Company reviews the recoverability of the carrying value of long-lived
assets, including intangibles with a definite life, for impairment whenever
events or changes in circumstances indicate that the carrying amount of such
assets may not be recoverable. When such events occur, the Company compares the
carrying amount of the assets to the undiscounted expected future cash flows
from them. Factors the Company considers important that could trigger an
impairment review include the following:
- Significant underperformance relative to historical or projected
future operating results
- Significant changes in the manner of the Company's use of the acquired
assets or the strategy for the Company's overall business
- Significant negative industry or economic trends
- Significant decline in the Company's stock price for a sustained
period and market capitalization relative to net book value
If this comparison indicates there is impairment, the amount of the
impairment loss to be recorded is calculated by the excess of the net assets'
carrying value over its fair value and is typically calculated using discounted
expected future cash flows.
GOODWILL
Goodwill represents the cost in excess of net assets of acquired companies.
Effective January 1, 2002, with the adoption of SFAS No. 142, goodwill
(comprised of goodwill acquired in the Access One acquisition in August 2000)
will not be amortized, but rather will be tested for impairment annually, and
will be tested for impairment between annual tests if an event occurs or
circumstances change that would indicate the carrying amount may be impaired.
Prior to January 1, 2002, goodwill and intangibles were amortized on a
straight-line basis over periods ranging from 5 years to 15 years. Impairment
testing for goodwill is performed at a reporting unit level; the Company
determined that it has one reporting unit under the guidance of SFAS No. 142. An
impairment loss would generally be recognized when the carrying amount of the
reporting unit's net assets exceeds the estimated fair value of the reporting
unit. Prior to January 1, 2002, goodwill was tested for impairment in a manner
consistent with long-lived assets and intangible assets with a definite life.
19
SOFTWARE DEVELOPMENT COSTS
Direct development costs associated with internal-use computer software are
accounted for under Statement of Position 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use," and are capitalized
including external direct costs of material and services and payroll costs for
employees devoting time to the software projects. Costs incurred during the
preliminary project stage, as well as for maintenance and training, are expensed
as incurred. Amortization is provided on a straight-line basis over the shorter
of 3 years or the estimated useful life of the software.
INCOME TAXES
Income taxes are accounted for under the asset and liability method. During
the quarter ended March 31, 2003, the Company recorded income taxes at a rate
equal to the Company's combined federal and state effective rates. However, to
the extent of available net operating loss carryforwards, the Company is
shielded from paying cash income taxes for several years, other than alternative
minimum taxes and some state taxes.
Deferred tax assets and liabilities are recognized for the estimated future
tax consequences attributable to the differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates in effect for the year in which
those temporary differences are expected to be recovered or settled.
The Company recorded a valuation allowance to reduce its deferred tax
assets in an amount that is more likely than not to be realized. The Company
provided a valuation allowance of $66.7 million for the net deferred tax assets
for the estimated future tax effects attributable to temporary differences
between the basis of assets and liabilities for financial and tax reporting
purposes as of March 31, 2003. In the event the Company were to determine that
it would be able to realize all deferred tax assets in the future in excess of
its net recorded amount, an adjustment to the deferred tax asset would increase
income in the period such determination was made. In 2002, as part of the
Company's 2003 budgeting process, management evaluated the deferred tax
valuation allowance and determined that a portion of this valuation allowance
should be reversed, resulting in a non-cash deferred income tax benefit of $22.3
million. Management will evaluate the deferred tax valuation allowance again in
2003 to determine whether the remaining valuation allowance or portion thereof
should be reversed.
LEGAL PROCEEDINGS
The Company is a party to a number of legal actions and proceedings arising
from the Company's provision and marketing of telecommunications services, as
well as certain legal actions and regulatory investigations and enforcement
proceedings arising in the ordinary course of business. Management's current
estimated range of liability related to some of the pending litigation is based
on claims for which management can estimate the amount and range of loss. The
Company recorded the minimum estimated liability related to those claims, where
there is a range of loss. Because of the uncertainties related to both the
amount and range of loss on the remaining pending litigation, management is
unable to make a reasonable estimate of the liability that could result from an
unfavorable outcome. As additional information becomes available, the Company
will assess the potential liability related to the Company's pending litigation
and revise its estimates. Such revisions in the Company's estimates of the
potential liability could materially affect its results of operations and
financial position.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE 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 receivability of the carrying values of its long-term assets.
The Company's long-term obligations consist primarily of long term debt with
fixed interest rates. The Company does not presently enter into any transactions
involving derivative financial instruments for risk management or other
purposes.
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
20
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.
ITEM 4. CONTROLS AND PROCEDURES
Within the 90-day period prior to the filing of this report, an evaluation
was carried out under the supervision and with the participation of the
Company's management, including the Chief Executive Officer ("CEO") and Chief
Financial Officer ("CFO"), of the effectiveness of the Company's disclosure
controls and procedures. Based on that evaluation, the CEO and CFO have
concluded that the Company's disclosure controls and procedures are effective to
ensure that information required to be disclosed by the Company in reports that
it files or submits under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods specified in
Securities and Exchange Commission rules and forms. Subsequent to the date of
their evaluation, there were no significant changes in the Company's internal
controls or in other factors that could significantly affect the disclosure
controls, including any corrective actions with regard to significant
deficiencies and material weaknesses.
21
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 Employment Agreement between the Company and Helen Manich dated April
14, 2003 (filed herewith).*
10.2 Indemnification Agreement between the Company and Helen Manich dated
April 14, 2003 (filed herewith).*
10.3 Amendment to Employment Agreement for Kevin Griffo dated April 10, 2003
(filed herewith).*
10.4 Amendment to Employment Agreement for Warren Brasselle dated May 14,
2002 (filed herewith).*
99.1 Certification of Gabriel Battista Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished
to the Commission herewith).
99.2 Certification of David G. Zahka Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished to
the Commission herewith).
* Management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K
The following Current Reports on Form 8-K were filed by the Company during
the three months ended March 31, 2003
1. Current Report on Form 8-K dated January 20, 2003, reporting
authorization of a share buyback program and the waiver of certain provisions of
the Company's Restructuring Agreement with America Online, Inc.
2. Current Report on Form 8-K dated February 6, 2003, furnishing the
Company's earnings press release for the quarter and year ended December 31,
2002.
22
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 AMERICA HOLDINGS, INC.
Date: May 14, 2003 By: /s/ Gabriel Battista
------------------------
Gabriel Battista
Chairman of the Board of Directors,
Chief Executive Officer and Director
Date: May 14, 2003 By: /s/ David G. Zahka
------------------------
David G. Zahka
Chief Financial Officer
(Principal Financial Officer)
Date: May 14, 2003 By: /s/ Thomas M. Walsh
------------------------
Thomas M. Walsh
Senior Vice President - Finance
(Principal Accounting Officer)
23
CERTIFICATIONS
--------------
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, Gabriel Battista, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Talk America
Holdings, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
May 14, 2003
/s/ Gabriel Battista
- ----------------------
Gabriel Battista
Chief Executive Officer
24
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, David G. Zahka, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Talk America
Holdings, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
May 14, 2003
/s/ David G. Zahka
- ---------------------
David G. Zahka
Chief Financial Officer
25