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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2000
Commission File No. 0-26728
TALK.COM INC.
(Exact name of registrant as specified in its charter)
DELAWARE 23-2827736
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
12020 SUNRISE VALLEY DRIVE, SUITE 250 20191
RESTON, VIRGINIA (zip code)
(Address of principal executive offices)
(703) 391-7500
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
- ------------------- -----------------------------------------
None Not applicable
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE
RIGHTS TO PURCHASE SERIES A JUNIOR PARTICIPATING PREFERRED STOCK
(Title of class)
Indicate by check mark whether the registrant (1) has filed all
documents and reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports) and (2)
has been subject to such filing requirements for the past 90 days.
Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment of this Form 10-K. [ ]
As of March 29, 2001, the aggregate market value of voting stock held
by non-affiliates of the registrant, based on the average of the high and low
prices of the Common Stock on March 29, 2001 of $1.625 per share as reported on
the Nasdaq National Market, was approximately $123,541,687.75 (calculated by
excluding solely for purposes of this form outstanding shares owned by directors
and executive officers).
As of March 29, 2001, the registrant had issued and outstanding
78,374,387 shares of its Common Stock, par value $.01 per share.
DOCUMENTS INCORPORATED BY REFERENCE
None.
TALK.COM INC.
INDEX TO FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2000
ITEM PAGE
NO. NO.
PART I
1. Business 1
2. Properties 9
3. Legal Proceedings 9
4. Submission of Matters to a Vote of Security Holders 9
PART II
5. Market for Registrant's Common Equity and Related Stockholders Matters 10
6. Selected Consolidated Financial Data 11
7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12
7a. Quantitative and Qualitative Disclosure About Market Risk 17
8. Financial Statements and Supplementary Data 17
9. Changes in and Disagreements with Accountants and Financial Disclosure 41
PART III
10. Directors and Executive Officers of the Registrant 41
11. Executive Compensation 43
12. Security Ownership of Certain Beneficial Owners and Management 47
13. Certain Relationships and Related Transactions 48
PART IV
14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 48
i
PART I
ITEM 1. BUSINESS
OVERVIEW
Talk.com Inc., through its subsidiaries (the "Company" or "Talk.com"),
provides local and long distance telecommunication services to residential and
small business customers throughout the United States. The Company has developed
advanced order processing, provisioning, billing, payment, customer service and
information systems that enable the Company to integrate data and information on
a real time basis into the Company's various operations.
The Company's telecommunication services offerings include local and
long distance telecommunication services, including local services bundled with
long distance services, inbound toll-free service and dedicated private line
services for data transmission. The Company seeks to expand its customer base
through its new direct marketing channels and existing and new marketing
arrangements with business partners and to build a more diverse products and
services portfolio, including non-telecommunication products and services. In
connection with the Company's strategy to diversify its product portfolio and to
bundle local service with its core long distance service offerings the Company
acquired Access One Communications Corp. ("Access One") in August, 2000. Access
One was a private, local telecommunication services provider to nine states in
the southeastern United States.
The Company markets its telecommunication services directly to
customers under its own brand as well as through the brand names of its
marketing partners, including America Online, Inc. ("AOL"). In addition to its
direct marketing channels, consumers and small businesses can subscribe for the
Company's services on the Internet through its web site located at www.talk.com.
The Company owns and maintains its own nationwide long distance
network, which includes Company-owned Lucent 5ESS-2000 switches located in
selected areas throughout the United States. The Company's network carries the
vast majority of its customers' long distance calls. To provide local
telecommunication services to its customers, the Company uses the unbundled
network elements platform ("UNE-P") from, and, to a lesser extent resale
agreements with, the incumbent local exchange carriers ("ILECs"). The Company's
network is further supported by agreements with major interexchange carriers
that provide interconnections among the Company's switches and local carriers'
switches, origination and termination of calls, overflow capacity, international
long distance services and other services that the Company provides to its
customers.
The Company has developed advanced, integrated order processing,
provisioning, billing, payment, customer service and information systems
utilizing state-of-the-art technology. Through dedicated electronic connections
with the Company's long distance network and the ILECs from which the Company
purchases local services, the Company has designed its systems to process, on a
real-time basis, information that is integrated into the Company's various
operations. The Company processes millions of call records each day. In
addition, through its proprietary software, the Company rates, and makes
available on the Internet to its customers, call detail records within minutes
of actual calls.
Talk.com Holding Corp. (formerly, Tel-Save, Inc.), the Company's
predecessor and now its principal operating subsidiary, was incorporated in
Pennsylvania in May 1989. The Company was incorporated in June 1995. The address
of the Company's principal current executive offices is 12020 Sunrise Valley
Drive, Suite 250, Reston, Virginia 20190, and its telephone number is (703)
391-7500. The Company's web address is www.talk.com. Unless the context
otherwise requires, references to the "Company" or to "Talk.com" refer to
Talk.com Inc. and its subsidiaries.
SALES AND MARKETING
The Company conducts its sales and marketing efforts through direct
mail, inbound and outbound telemarketing and agent sales, as well as online,
through its various partners and through the Company's own web site located at
www.talk.com.
In 2000, the Company's sales and marketing efforts focused both on
marketing long distance services and marketing a bundle of local and long
distance telecommunication services directly to customers under its own brand
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and under the brand of its marketing partners, principally AOL. The Company
began offering a bundle of local and long distance telecommunication services in
the second quarter to small business and select residential customers in
Florida, Georgia, North Carolina, South Carolina, Kentucky, Louisiana,
Mississippi, Tennessee, Alabama and New York through the Company's marketing
partnerships and new direct marketing channels. Late in the third quarter of
2000, the Company began offering local telecommunication services in
Pennsylvania and began offering local services in Texas during the fourth
quarter of 2000. Recently, the Company announced that it had begun to offer
local telecommunication services in California and that it expects to continue
to add to the states in which it offers bundled local and long distance
telecommunication services. Of the Company's approximately 1.4 million long
distance subscribers, approximately 1.15 million are AOL subscribers and the
remainder of the customers were obtained through the Company's own direct
marketing or with its other marketing partners. The Company ended the year with
approximately 265,000 bundled lines (local and long distance services) billed
for December 2000.
The Company's rights under its marketing agreement with AOL to market
long distance telecommunication services on AOL on an exclusive basis expire on
June 30, 2003. However, AOL may elect to allow others to market long distance
telecommunication services on AOL after June 30, 2001, provided that the
Company's rights to continue to market its long distance telecommunication
services to AOL subscribers on a non-exclusive basis, with significant marketing
rights, would continue until June 30, 2003. Among the marketing rights available
to the Company under the AOL agreement throughout the term of the agreement
until June 2003 are the following:
o AOL welcome screen advertisements, pop-up advertisements and
other on-screen promotions and advertisements.
o Direct mail to advertise the Company's products to AOL
subscribers, other than subscribers who have elected not to
receive telemarketing calls or other promotional materials
through AOL.
o A program for promoting the Company's products to specified
percentages of AOL subscribers who call AOL's customer inquiry
centers.
o The right (either exclusive or non-exclusive, as the case may
be) to market and sell wireless, local and long distance and
other products and services over the AOL online network.
AOL provided the Company with notice in 2000 that the Company's
exclusivity as to wireless services would terminate on July 1, 2000, although
the Company's right to offer wireless services continues on a non-exclusive
basis. In addition, the Company has the right to market local telecommunication
services bundled with long distance,
Because of the opportunities to offer the bundle of local and long
distance telecommunication services directly to customers and the significant
marketing rights that would continue even were a termination of the long
distance exclusivity period under the AOL agreement to occur, the Company
believes that the early termination of the exclusivity period should not be
detrimental to the Company's business. The Company believes that the exclusivity
opportunity under the AOL agreement already has given the Company a valuable
lead in marketing telecommunication services to AOL subscribers. The value of
this barrier to entry is uncertain, however, because the Company is unable to
predict whether potential competitors would be required, or otherwise be
willing, to invest the substantial sums that the Company believes would be
required to acquire a base of AOL customers for telecommunication services
comparable to the Company's existing base of AOL subscribers.
The Company continues to seek new marketing partners and arrangements
to expand both its opportunities to attract other customers to its services and
the products and services that it offers to its customer base. As part of its
efforts to expand the bundle of services available to its customers, the Company
introduced teleconferencing with real-time document sharing via the Internet,
keyboard calling which allows customers to send free text or voice messages via
the Internet, access to wireless products and services, and voicemail. The
Company continues to offer access to on-line white and yellow pages through a
private label relationship with InfoSpace.com, Inc. and a single click procedure
for "reverse" look up of phone numbers that enables on-line customers to track
and verify their billing information by identifying the name and address
associated with the phone number called.
The Company also provides, as a small and declining portion of its
business, telecommunication services primarily to small and medium-sized
businesses through independent resellers known as partitions.
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TELECOMMUNICATION NETWORK AND SERVICES
Long Distance
To provide its long distance telecommunication services to customers,
the Company predominantly uses its own telecommunication network. The Company
generally uses its long distance network to provide services directly to its end
users and partitions. As of December 31, 2000, the Company provisioned over its
network approximately 95% of the lines using its services.
The Company's network is comprised of equipment and facilities that are
either owned or leased by the Company. The Company contracts for certain
telecommunication services that the Company maintains with a variety of other
carriers. The Company owns, operates and maintains five Lucent 5ESS-2000
switches in its network. These switches are generally considered extremely
reliable and feature the Digital Networking Unit--SONET technology. The Digital
Networking Unit is a switching interface that is designed to increase the
reliability of the 5ESS-2000 and to provide much greater capacity in a
significantly smaller footprint.
The switches are connected to each other by connection lines and
digital cross-connect equipment that the Company owns or leases. See "Service
Agreements with Other Carriers." The Company also has installed lines to connect
its long distance switches to switches owned by various local telecommunication
service carriers. The Company is responsible for maintaining these lines and has
entered into a contract with GTE with respect to the monitoring, servicing and
maintenance of this equipment.
The access charges that the Company pays to local exchange carriers to
connect customers to the Company's network represent a substantial portion of
the total cost of providing long distance services over its network. As a result
of regulatory changes and the increasing competitiveness of the local service
market, it is expected that access charges will decrease, but there is no
assurance that this decrease will occur. In any event, savings from any such
decreases may be offset by universal service contributions imposed on carriers,
including the Company. See "Competition" and "Regulation".
In addition, the Company maintains contracts with other carriers that
provide the Company with a variety of other services. See "Service Agreements
with Other Carriers." These contracts include services for assisting with the
overflow of telecommunication traffic over its network, for carrying calls
internationally and for providing directory assistance and other operator
assisted calls. The combination of these contracts permits the Company to obtain
a particular type of service from more than one carrier at a given time and
gives the Company the flexibility to seek the best rates available for a
particular service at a given time.
The fact that the Company operates its own switches subjects the
Company to risk of significant interruption. Fires or natural disasters, for
example, could cause damage to the Company's switching equipment or to
transmission facilities connecting its switches. Any interruption in the
Company's services over its network caused by such damage could have a material
adverse impact on the Company's financial condition and results of operations.
In such circumstances, the Company could attempt to minimize the interruption of
its service by carrying traffic through its overflow and resale arrangements
with other carriers.
The Company has continued to expand the capacity of its network to meet
increased demand and believes that such capacity may be further expanded at
reasonable cost to meet the Company's needs in the foreseeable future, including
expansion resulting from the Company's growth of its business partnerships and
its own web site.
Service Agreements with Other Carriers
The Company historically obtained services from AT&T through multiple
contract tariffs. With the deployment of its network, the Company requires fewer
such services from that carrier to sell its services. Instead of relying
exclusively on AT&T, the Company has entered into contracts with various other
long distance and local carriers of telecommunication services for both its
network and reselling operations. These services enable the Company to:
o Connect the Company's switches to each other
o Connect the Company's switches to the switches of local
telecommunication service carriers
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o Carry overflow traffic during peak calling times
o Connect international calls
o Provide directory assistance and other operator assisted
services
With respect to connections to local carriers, overflow, international
and operator assisted services, the Company maintains contracts with more than
one carrier for each of these services. The Company believes that it is no
longer dependent upon any single carrier for these services. Currently, many
price differences exist in the market for purchasing these services in bulk. For
example, one carrier may offer the lowest international rates to one country
while another offers the lowest rates to a different country. Under the terms of
the Company's contracts with its various carriers, the Company is able to choose
which services and in what volume (with some minimum commitments) the Company
wishes to obtain the services from each carrier. This flexibility enables the
Company to minimize its costs for such services by purchasing those services
that offer the Company the best rates at a given time.
In February 1999, the Company entered into a new Master Carrier
Agreement with AT&T. The agreement, which has since been amended from time to
time, provides the Company with a variety of services, including transmission
facilities to connect the Company's network switches as well as services for
international calls, local traffic, international calling cards, overflow
traffic and operator assisted calls. Consistent with the Company's desire to
expand the sources of its network services, the new contract eliminated a
requirement for the Company to purchase the majority of its requirements for
these services from AT&T and replaced it with a requirement for the Company to
purchase minimum dollar amounts of services from AT&T during the term of the
agreement. The Company does not anticipate any difficulty in satisfying these
minimum requirements.
Local
The Company uses the unbundled network element platform, or UNE-P,
from, and, to a lesser extent, resale agreements with, the incumbent local
exchange carriers, or ILECs, to provide local telephone services to its
customers.
On November 5, 1999, the Federal Communications Commission ("FCC")
released an order reconfirming that ILECs nationwide must offer to competitors,
in an individual or combined form, a series of unbundled network elements that
comprise the most important facilities, features, functions, and capabilities of
an incumbent local carrier's network. The price at which such elements are
offered must correspond to the forward-looking cost of providing these elements.
When offered in the combination known as UNE-P, these piece-parts include the
loop and switching elements needed to provide local telephone service to a
customer. Although ILECs have a general obligation to provide UNE-P, the
obligation is limited in the central business districts of the top 50
metropolitan statistical areas of the nation. In such markets, the obligation to
provide UNE-P currently is limited to carriers serving customers with less than
four telephone lines. The FCC is currently reviewing whether to expand or
further restrict the availability of UNE-P and the availability of combinations
of network elements, including UNE-P, is being challenged in the courts.
The Company uses UNE-P to provide local telecommunication services
primarily to residential and small business customers, and the Company expects
that its experience in providing local telephone service will facilitate
nationwide delivery of this product. Because the Company's current focus is on
residential and small business markets, the restriction on UNE-P availability in
the central business districts of the top 50 metropolitan statistical areas has
not been a major impediment to its operations to date.
Providing local telephone service through use of UNE-P provides the
Company with significant advantages. Foremost, UNE-P allows the Company to offer
local telephone service to customers located virtually anywhere without
deploying costly local switching facilities. The Company is able to minimize
current capital expenditures and at the same time maintain network and service
design flexibility for the next generation of telecommunication technology.
In addition, by providing local telephone service using UNE-P, the
Company believes it can realize significantly higher margins than competitors
that provide service by reselling the retail services of incumbent local
carriers. However, in some instances such as customers having high usage
volumes, resale may provide the Company with more attractive pricing than the
use of UNE-P. The Company is not required to pay local network access fees to
ILECs in some instances, and the Company often is entitled to collect local
network access fees from other companies for delivering calls to the Company's
local telephone customers. Importantly, use of UNE-P also
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enables the Company to control the underlying network platform used to provide
local telecommunication services, which enables the Company to create and deploy
innovative products and service applications.
The Company's UNE-P deployment strategy presents several risks. In
providing local telephone service using UNE-P, the Company must rely on the
availability of network elements in combined form from ILECs, the Company's main
competitors. The continued ability to obtain those network elements in the
configuration known as UNE-P depends on FCC and state regulatory rulings that
require ILECs to make UNE-P available to carriers. If those rules were modified
or eliminated, the ability to provide local service to customers using UNE-P
could be materially adversely affected. The FCC has been asked by several
incumbent telephone companies to reconsider its order directing them to provide
UNE-P. In addition, ILECs have appealed the FCC's requirement that they provide
UNE-P to a federal appeals court, asking the court to overturn the FCC's
decision.
Changes in the cost of the network elements that comprise UNE-P also
could materially adversely affect the viability of using UNE-P to provide local
service. Last year, a U.S. Court of Appeals partially set aside FCC rules
prescribing how ILECs must set rates for network elements, including UNE-P. That
decision, which is on appeal to the U.S. Supreme Court, could ultimately lead
ILECs to increase the prices of network elements, which would adversely impact
the Company. Indeed, before the U.S. Supreme Court, ILECs are asking that the
FCC's requirement that network element prices be established using forward
looking costs be reversed entirely. If successful, such an appeal likely would
lead to a substantial increase in network element prices. If the court rejects
the FCC's pricing methodology and that methodology ultimately is replaced with a
methodology that imposes higher rates for network elements, the economic
efficiency of UNE-P would suffer. Similarly, state commissions have the
authority to review and modify the prices paid for unbundled network elements,
and a state commission decision to change the prices of the local loop and
switching elements could materially affect the Company's ability to use UNE-P to
provide local service. In addition, state commissions currently are implementing
FCC rules that require incumbent telephone companies to file rates for UNE-Ps
that are deaveraged by geographic density zone. Such geographic rate deaveraging
could result in rates which make use of UNE-P unattractive or uneconomic in less
dense geographic areas.
With these and other considerations in mind, the Company believes that
UNE-P provides it with a cost-effective means of adding innovative local service
components to its existing long distance product offerings. The Company is
utilizing its resources and its operational experience providing local
telecommunication services to continue a national roll-out of the bundle of long
distance and local service using UNE-P. The Company beleive that this will give
it a first-mover advantage in delivering a bundled package of local and long
distance telecommunication services to residential and small business consumers.
INFORMATION AND BILLING SERVICES
The Company has developed advanced integrated order processing,
provisioning, billing, payment, customer service and information systems
utilizing state-of-the-art technology. Through dedicated electronic connections
with its long distance network and the ILECs from which the Company purchases
local services, the Company has designed its systems to process information on a
"real time" basis. The Company processes millions of call records each day.
Through its proprietary software the Company rates and makes available on the
Internet to its customers call detail records within minutes of actual calls.
The Company recently completed a $40 million capital investment in its order
processing, provisioning, billing, payment, customer service and information
systems. The Company's technology investment includes state of the art UNIX
servers and database storage systems, back-up and replications systems,
interactive voice response and predictive dialing technology, end user
equipment, e-commerce data exchange and advanced inbound call switching.
The Company maintains its own web site at www.talk.com as well as sites
on the AOL online network to provide for customer sign-up and to provide
customers and potential customers with information about the Company's products
and services as well as billing information and customer service. The Company
provides these services and features using the Company's web-enabled
technologies that allow it to offer its customers:
o Detailed rate schedules and product and service related
information.
o Online sign-up for the Company's telecommunication services.
o Credit card billing.
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o Real-time and 24 x 7 billing services and online information,
providing customers with up to the hour billing information.
With the development of the Company's advanced sign up and billing systems,
customers can purchase the Company's telecommunication and other products or
services while online through the Company's own web site or AOL's network. The
Company employs its own proprietary provisioning and billing systems to enable
efficient provisioning of a customer, online billing and credit card payment.
The Company's billing system enables a customer to view his or her bill online
or over the Internet on a real-time basis with the call detail and cost for most
calls posted within minutes after a customer completes a call. The Company
believes this online service provides the most current information to customers
offered by any telecommunication company and a competitive advantage. The
Company also acquires billing and customer care services from other carriers and
third party vendors. In connection with the initial deployment of its integrated
information system and the bundle of local and long distance service offerings,
the Company experienced delays in the provisioning and billing of customers. The
Company believes that it has since corrected these problems but if the Company
is unable to timely provision or timely and accurately bill its customers it may
have an adverse effect upon the Company.
The information functions of the system are designed to provide easy
access to all information about an end user, including volume and patterns of
use. This information can be used to identify emerging end user trends and to
respond with services to meet end users' changing needs. This information also
allows the Company and its partitions to identify unusual or declining use by an
individual end user, which may indicate fraud or that an end user is switching
its service to a competitor. FCC rules, however, may limit the Company's use of
customer proprietary network information. See "Regulation."
COMPETITION
The telecommunication industry is highly competitive. Major
participants in the industry regularly introduce new services and marketing
activities. Competition in the telecommunication industry is based upon pricing,
customer service, billing services and perceived quality. The Company competes
against numerous telecommunication companies that offer essentially the same
services as the Company does. Several of the Company's competitors are
substantially larger and have greater financial, technical and marketing
resources than the Company does. The Company's success will depend upon its
continued ability to provide high quality, high value services at prices
generally competitive with, or lower than, those charged by the Company's
competitors.
The major carriers have targeted price plans at residential customers -
the Company's primary target market under its various direct marketing channels,
marketing agreements with its various partners and its Internet offering -- with
significantly simplified rate structures and with bundles of wireless services
and local services with long distance, which may lower overall local and long
distance prices. Competition is fierce for the small to medium-sized businesses
that the Company also serves. Additional pricing pressure may also come from the
introduction of new technologies, such as Internet telephony, which seek to
provide voice communications at a cost below that of traditional
circuit-switched long distance service. Reductions in prices charged by
competitors may have a material adverse effect on the Company. In addition, the
ability of competitors to develop online billing and information systems that
are comparable to the Company's systems may have a material adverse effect on
the Company.
Consolidation and alliances across geographic regions and in the local
and long distance market and across industry segments may also intensify
competition from significantly larger, well-capitalized carriers.
Allegedly to combat "slamming," the unauthorized conversion of a
customer's preselected telecommunication carrier, many local exchange carriers
have initiated "PIC freeze" programs that, once selected by the customer,
require a customer seeking to change long distance or local carriers to contact
the local carrier directly instead of having the long distance or local carrier
contact the local carrier on the customer's behalf. Many local carriers have
imposed burdensome requirements on customers seeking to lift PIC freezes and
change carriers, and thereby make it difficult for customers to switch to the
Company's telecommunication services. Such activities could have an adverse
effect on the Company.
The entry of the Bell operating companies into the long distance market
may further heighten competition. Under the Telecommunications Act of 1996, the
Bell operating companies were authorized to provide long distance service that
originates outside their traditional services areas, and may gain authority to
provide long distance service that originates within their region after
satisfying certain market opening conditions. While currently only Verizon and
SBC Communications, Inc. have entered the long distance market, a number of
others have made
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proposals to offer such services. Bell operating company entry into the long
distance market means new competition from well-capitalized, well-known
companies that have the capacity to "bundle" other services, such as local and
wireless telephone services, Internet access and cable television, with long
distance telephone services. While the Telecommunications Act includes certain
safeguards against anti-competitive conduct by the Bell operating companies, it
is impossible to predict whether such safeguards will be adequate or what effect
such conduct would have on the Company. Because of the Bell operating companies'
name recognition in their existing markets, the established relationships that
they have with their existing local service customers, and their ability to take
advantage of those relationships, as well as the possibility of interpretations
of the Telecommunications Act favorable to the Bell operating companies, it may
be more difficult for other providers of long distance and local
telecommunication services, such as the Company, to compete.
In addition, the telecommunication industry is characterized by: rapid
technological change, frequent new service introductions, intense competition on
pricing, and evolving industry standards. The Company's inability to anticipate
these changes and to respond quickly by offering services that meet or compete
with these evolving standards could negatively affect its chances for success.
There can be no assurance that the Company will have sufficient resources to
make the necessary investments or to introduce new services that would satisfy
an expanded range of customer needs. Any failure by the Company to obtain new
technology could cause the Company to lose customers and market share and could
hamper the Company's ability to attract new customers.
REGULATION
The Company's provision of telecommunication services is subject to
government regulation. The FCC regulates interstate and international
telecommunications, while the state commissions regulate telecommunications that
originate and terminate within the same state. Changes in existing regulations
could have a material adverse effect on the Company.
The Company's marketing of telecommunication services over the
Internet, directly or with its current marketing partners, the Company's other
current and past direct marketing efforts, and the marketing efforts of the
Company's partitions all require compliance with relevant federal and state
regulations that govern the sale of telecommunication services. The FCC and some
states have rules that prohibit switching a customer from one carrier to another
without the customer's express consent and specify how that consent must be
obtained and verified. Most states also have consumer protection laws that
further define the framework within which the Company's marketing activities
must be conducted. While directed at curbing abusive marketing practices, unless
these rules are carefully designed and enforced, they can have the incidental
effect of entrenching incumbent carriers and hindering the growth of new
competitors, such as the Company.
The Company's marketing efforts are carried out through a variety of
direct marketing programs, including inbound and outbound telemarketing, direct
mail and agent sales, as well as online marketing initiatives. Restrictions on
the marketing of telecommunication services are becoming stricter in the wake of
widespread consumer complaints throughout the industry about "slamming" (the
unauthorized conversion of a customer's preselected telecommunication carrier)
and "cramming" (the unauthorized provision of additional telecommunication
services). The Telecommunications Act strengthened penalties against slamming,
and the FCC issued and updated rules tightening federal requirements for the
verification of orders for telecommunication services and establishing
additional financial penalties for slamming. In addition, many states have been
active in restricting marketing through new legislation and regulation, as well
as through enhanced enforcement activities. The constraints of federal and state
regulation, as well as increased FCC, Federal Trade Commission and state
enforcement attention, could limit the scope and the success of the Company's
marketing efforts and subject them to enforcement action which may have an
adverse effect on the Company.
Statutes and regulations designed to protect consumer privacy also may
have the incidental effect of hindering the growth of newer telecommunication
carriers such as the Company. For example, the FCC rules that restrict the use
of "customer proprietary network information" (information that a carrier
obtains about its customers through their use of the carrier's services) may
make it more difficult for the Company to market additional telecommunication
services (such as local and wireless), as well as other services and products,
to its existing customers.
The FCC requires the Company and other providers of telecommunication
services to contribute to the universal service fund, which helps to subsidize
the provision of local telecommunication services and other services to
low-income consumers, schools, libraries, health care providers, and rural and
insular areas that are costly to
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serve. The Company's mandatory contributions to the universal service fund could
increase over time, and some of the Company's potential competitors (such as
providers of Internet telephony) are not currently, and in the future may not
be, required to contribute to the universal service fund.
The FCC imposes additional reporting, accounting, record-keeping and
other regulatory obligations on the Company. The Company must offer interstate
services under rates, terms and conditions that are just, reasonable and not
unreasonably discriminatory. The Company currently must file tariffs listing the
rates, terms and conditions of the Company's service, although the FCC has
decided to abolish most such domestic tariff filing requirements later this year
and instead mandate the posting of similar information on the Internet or
elsewhere. Although the Company's FCC tariffs, and the rates and charges they
specify, are subject to review, they are presumed to be lawful and have never
been formally contested by customers or other consumers. The Company may be
subject to forfeitures and other penalties if it violates the FCC's rules.
The vast majority of the states require the Company to apply for
certification to provide local and intrastate telecommunication services, or at
least to register or to be found exempt from regulation, before commencing
intrastate service. The vast majority of states also require the Company to file
and maintain detailed tariffs listing its rates for intrastate service. Many
states also impose various reporting requirements and/or require prior approval
for transfers of control of certified carriers, corporate reorganizations,
acquisitions of telecommunication operations, assignments of carrier assets,
including subscriber bases, carrier stock offerings and incurrence by carriers
of significant debt obligations. Certificates of authority can generally be
conditioned, modified, canceled, terminated or revoked by state regulatory
authorities for failure to comply with state law and the rules, regulations and
policies of the state regulatory authorities. Fines and other penalties,
including the return of all monies received for intrastate traffic from
residents of a state, may be imposed for such violations. State regulatory
authorities may also place burdensome requirements on telecommunication
companies seeking transfers of control for licenses and the like.
The Company's partitions are also subject to the same federal and state
regulations as the Company, and any change in those regulations, or any
enforcement action, could adversely affect the partitions and their demand for
the Company's services. Generally, partitions purchase services from the Company
and resell these services under non-exclusive agreements with the Company. Such
partitions comprise a small and declining portion of the Company's business.
Provisions in the Company's agreements with these partitions require them to
comply with federal and state statutes and regulations, including those
regulating telemarketing. Because they are independent partitions, however, the
Company cannot control their activities. The Company also cannot predict the
extent of their compliance with applicable regulations. Federal and state
regulatory authorities have, in the past, tried to hold the Company liable for
activities of these partitions. There can be no assurance that the use of these
partitions will not subject the Company to future liabilities. Similarly, there
can be no assurance that the use of direct marketing channels, including
telemarketing, will not subject the Company to future liabilities. The Company's
alleged marketing activities as well as alleged actions taken by partitions have
subjected the Company to investigations or enforcement actions by government
authorities. To the extent that the Company makes additional telecommunication
service offerings, the Company may encounter additional regulatory review and
constraints.
The Telecommunications Act provides for a significant deregulation of
the domestic telecommunication industry, including the long distance industry.
The Telecommunications Act remains subject to judicial review and additional FCC
rulemaking, and thus it is difficult to predict what effect the legislation will
have on the Company and its operations. There are currently many regulatory
actions underway and being contemplated by federal and state authorities
regarding interconnection pricing and other issues that could result in
significant changes to the business conditions in the telecommunication
industry. In addition, there has been discussion in Congress of modifying the
Telecommunications Act in ways that could prove detrimental to the Company.
Notably, the Telecommunications Act set up a framework by which Bell
operating companies could begin providing long distance services to their
customers in areas where they allegedly provide local telecommunications
services. Acting under this authority, the FCC already has granted interstate
long distance service authority to Verizon for the State of New York and SBC
Communications for the States of Texas, Kansas and Oklahoma. The Company
anticipates that other regional Bell operating companies shall seek to obtain
similar authority on a state-by-state basis. These actions are likely to
increase competition within the affected states.
EMPLOYEES
As of December 31, 2000, the Company employed approximately 1,910
persons. The Company considers relations with its employees to be good.
-8-
ITEM 2. PROPERTIES
The Company leases an approximately 8,000 square foot facility in
Reston, Virginia, that serves as the Company's headquarters and is where a
significant number of the Company's executives and marketing personnel are
located. The Company owns an approximately 24,000 square foot facility in New
Hope, Pennsylvania where the Company's finance, legal and programming personnel
are located. The Company also leases properties in the cities in which switches
for its network have been installed.
With respect to the Company's customer service operations, the Company
owns a 32,000 square foot facility located in Clearwater, Florida. The Company
also leases the following facilities for customer service operations: an
approximately 29,000 square foot facility in Orlando, Florida, and an
approximately 39,000 square foot facility in Fort Lauderdale, Florida.
ITEM 3. 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 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.
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
-9-
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock, $.01 par value per share ("Common Stock"),
is traded on the Nasdaq National Market under the symbol "TALK". High and low
quotations listed below are actual closing sales prices as quoted on the Nasdaq
National Market:
COMMON STOCK PRICE RANGE OF COMMON STOCK
- ------------ ---------------------------
HIGH LOW
---- ---
1999
First Quarter 19 5/8 8 1/16
Second Quarter 14 1/4 9 7/8
Third Quarter 12 29/32 8 11/16
Fourth Quarter 18 15/16 11 1/8
2000
First Quarter 20 5/8 13 7/16
Second Quarter 16 1/2 5 5/8
Third Quarter 8 1/16 4 1/4
Fourth Quarter 4 13/16 9/16
2001
First Quarter (through March 29, 2001) 2 17/32 1 9/32
As of March 29, 2001, there were approximately 1,016 record holders of
Common Stock.
The Company has never declared or paid any cash dividends on its
capital stock. The Company currently intends generally to retain future earnings
to finance the growth and development of its business and, therefore, does not
anticipate paying cash dividends in the foreseeable future. In addition, the
Company's guarantee to MCG Finance Corporation prohibits the Company paying any
dividends on its capital stock.
-10-
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data should be read in conjunction
with, and are qualified in their entirety by, "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Company's
Consolidated Financial Statements included elsewhere in this Form 10-K.
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------
2000 1999 1998 1997 1996
--------- --------- ----------- ---------- -----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
CONSOLIDATED STATEMENTS OF INCOME DATA:
Sales $ 544,548 $ 516,548 $ 448,600 $ 304,768 $ 232,424
Cost of sales 292,931 289,029 321,215 285,145 200,249
Gross profit 251,617 227,519 127,385 19,623 32,175
General and administrative expenses 65,360 39,954 39,393 29,221 7,577
Provision for doubtful accounts 53,772 28,250 37,789 9,339 348
Promotional, marketing and advertising 170,864 96,264 210,552 60,685 --
Depreciation and amortization 19,257 6,214 5,499 5,429 2,462
Significant other charges (income) -- (2,718) 91,025 -- --
Operating income (loss) (57,636) 59,555 (256,873) (85,051) 21,788
Interest (income) expense, net 438 741 (9,692) (19,081) (7,053)
Other (income) expense, net 3,822 1,115 20,867 (31,634) (3,532)
Income (loss) before provision (benefit) for
income taxes (61,896) 57,699 (268,048) (34,336) 32,373
Provision (benefit) for income taxes (1) -- -- 40,388 (13,391) 12,205
Income (loss) before extraordinary gain (61,896) 57,699 (308,436) (20,945) 20,168
Extraordinary gain (from extinguishments of debt) -- 21,230 87,110 -- --
Net income (loss) $ (61,896) $ 78,929 $(221,326) $ (20,945) $ 20,168
Income (loss) before extraordinary gain per share - Basic $ (0.88) $ 0.94 $ (5.20) $ (0.33) $ 0.38
Extraordinary gain per share - Basic -- 0.35 $ 1.47 -- --
Net income (loss) per share - Basic $ (0.88) $ 1.29 $ (3.73) $ (0.33) $ 0.38
Weighted average common shares outstanding - Basic 70,527 61,187 59,283 64,168 52,650
Income (loss) before extraordinary gain per
share - Diluted $ (0.88) $ 0.90 $ (5.20) $ (0.33) $ 0.35
Extraordinary gain per share - Diluted -- 0.33 $ 1.47 -- --
Net income (loss) per share - Diluted $ (0.88) $ 1.23 $ (3.73) $ (0.33) $ 0.35
Weighted average common and common equivalent
shares outstanding - Diluted 70,527 64,415 59,283 64,168 57,002
AT DECEMBER 31,
---------------------------------------------------------------
2000 1999 1998 1997 1996
--------- --------- ----------- ---------- -----------
(IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA:
Working capital(2) $ 9,929 $ 87,125 $ 13,061 $ 634,788 $ 175,597
Total assets 407,749 215,008 272,560 814,891 257,008
Convertible debt 84,945 84,985 242,387 500,000 --
Long-term debt 18,750 -- -- -- --
Total stockholders' equity (deficit) 82,700 (69,375) (136,785) 222,828 230,720
(1) The provision for income taxes in 1998 represents a valuation allowance for deferred tax assets recorded in prior periods
and current tax benefits that may result from the 1998 loss. The Company provided the valuation allowances in view of the
loss incurred in 1998, the uncertainties resulting from intense competition in the telecommunication industry and the lack
of any assurance that the Company will realize any tax benefits. The Company has continued to provide a valuation allowance
against its deferred tax assets at December 31, 2000 and December 31, 1999.
(2) Working capital is current assets less current liabilities net of deferred revenue.
-11-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
Consolidated Financial Statements included elsewhere in this Form 10-K.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated certain
financial data as a percentage of sales:
2000 1999 1998
---- ---- ----
Sales 100.0% 100.0% 100.0%
Cost of sales 53.8 56.0 71.6
----- ----- -----
Gross profit 46.2 44.0 28.4
General and administrative expenses 12.0 7.7 8.8
Provision for doubtful accounts 9.9 5.5 8.4
Promotional, marketing and advertising expenses 31.4 18.6 46.9
Depreciation and amortization 3.5 1.2 1.2
Significant other charges (income) -- (0.5) 20.3
----- ----- -----
Operating income (loss) (10.6) 11.5 (57.2)
Interest (income) expense, net 0.1 0.2 (2.2)
Other (income) expense, net 0.7 0.2 4.7
----- ----- -----
Income (loss) before income taxes (11.4) 11.1 (59.7)
Provision (benefit) for income taxes -- -- 9.0
----- ----- -----
Income (loss) before extraordinary gain (11.4) 11.1 (68.7)
Extraordinary gain -- 4.1 19.4
----- ----- -----
Net income (loss) (11.4)% 15.2% (49.3)%
===== ===== =====
YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999
Sales. Sales increased by 5.4% to $544.5 million in 2000 from $516.5
million in 1999. The increase in sales primarily reflected the Company's entry
into the local telecommunication market by offering local telecommunication
services bundled with long distance services and the resulting increase in sales
from new bundled customers and the revenues of Access One since the date of its
acquisition by the Company. The increase in local sales was offset during 2000
by the Company's election to exit the international wholesale business, a
decline in the number of long distance customers and a decrease in the Company's
other sales. The Company elected to exit the international wholesale business
because of the low gross profit margins associated therewith. During the second
quarter of 2000, there was also 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. There can be no assurance that the Company will
continue to increase sales on a quarter-to-quarter or year-to-year basis.
A significant percentage of the Company's revenues in 2000 and 1999 was
derived from long distance telecommunication 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 to elect, on
or before May 1 of such year, to permit others to market long distance
telecommunication 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 to AOL of at least $15.0 million
through June 30, 2001. 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 to increase
its efforts outside of AOL to expand its base of bundled and long distance
customers as discussed above.
-12-
Cost of Sales. Cost of sales increased by 1.4% to $292.9 million in
2000 from $289.0 million in 1999. The increases were primarily due to additional
cost of sales relating to the growth of the local business and the cost of sales
of Access One since the date of its acquisition by the Company. The increase in
cost of sales was offset by a decrease in network costs as a result of exiting
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.
Gross Profit. Gross profit increased by 10.6% in 2000 to $251.6 million
from $227.5 million in 1999. As a percentage of sales, gross profit increased in
2000 to 46.2% as compared to 44.0% for 1999. The increase in 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 doubtful accounts
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 63.5% to $65.4 million in 2000 from $40.0 million in 1999.
As a percentage of sales, general and administrative expenses increased in 2000
to 12.0% as compared to 7.7% for 1999. The increase in general and
administrative expenses was due primarily to increased costs associated with
hiring additional personnel 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 its acquisition by the Company.
Provision for Doubtful Accounts. Provisions for doubtful accounts
increased by 90.1% to $53.8 million in 2000 from $28.3 million in 1999. As a
percentage of sales, provision for doubtful accounts increased in 2000 to 9.9%
as compared to 5.5% for 1999. The increase in provision for doubtful accounts
was due to the provision for certain aged receivables that are now deemed not
collectible and a change in reserve estimates regarding the Company's non-AOL
long distance marketing partners.
Promotional, Marketing and Advertising Expenses. During 2000, the
Company incurred $170.9 million of promotional, marketing and advertising
expense as compared to $96.3 million in 1999, a 77.5% increase. As a percentage
of sales, promotional, marketing and advertising expenses increased in 2000 to
31.4% as compared to 18.6% for 1999. This increase relates to the Company's
efforts to expand its long distance and local bundled customer base as well as
higher promotional costs, an increase in fixed payments to AOL and the addition
of Access One marketing and promotional expenses since the date of its
acquisition by the Company. The Company expects to continue to incur marketing
and promotional expenses as it implements its plans to pursue subscribers to its
bundle of local and long distance telecommunication service, particularly
non-AOL customers. Fixed payments to AOL 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 were $17.0
million in the third quarter of 2000 and $18.0 million for the fourth quarter of
2000. Fixed payments to AOL in 2000 were $59.0 million compared to $40.0 million
in 1999.
Depreciation and Amortization. Depreciation and amortization for 2000
was $19.3 million, an increase of $13.1 million compared to $6.2 million in
1999. As a percentage of sales, depreciation and amortization increased in 2000
to 3.5% as compared to 1.2% for 1999. This increase is due primarily to the
amortization of the goodwill recorded upon the Access One acquisition ($9.4
million of amortization for 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 acquisition of Access One. The excess of the
purchase price over the fair value of the net assets acquired in the Access One
acquisition was approximately $225.9 million and has been recorded as goodwill
and intangible assets, which is being amortized on a straight-line basis.
Intangibles consist of a service mark and purchased customer accounts and
workforce.
Significant Other Charges (Income). During 1999, the Company sold the
business units of TSFL Holdings, Inc. (formerly Symetrics Industries, Inc.),
resulting in a gain of $2.7 million, which was included in significant other
charges (income).
Interest Income. Interest income was $4.9 million in 2000 versus $3.9
million in 1999. During 2000, the interest income increase related to the
Company's average cash balance, which was higher during 2000.
-13-
Interest Expense. Interest expense was $5.3 million in 2000 versus $4.6
million in 1999. The increase is due to interest on debt assumed with the
acquisition of Access One and interest on additional borrowings by the Company
in 2000.
Extraordinary Gain. During 1999, the Company recorded an extraordinary
gain of $21.2 million from the acquisition of the Company's convertible debt at
a discount from its aggregate principal amount.
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
Sales. Sales increased by 15.1% to $516.5 million in 1999 from $448.6
million in 1998. The increase in sales primarily reflected an increase in the
number of long distance customers. The increase in these long distance sales was
partially offset by a decrease in the Company's other sales (partitions). In
1999, the Company increased the number of agreements it had with marketing
partners, which significantly contributed to the rate of growth in the long
distance business.
Cost of Sales. Cost of sales decreased by 10.0% to $289.0 million in
1999 from $321.2 million in 1998. This decrease was primarily due to lower
network usage costs for services on the Company's OBN network on a per minute
basis and lower partition costs due to the decrease in other sales, as noted
above.
Gross Profit. Gross profit increased to 44.0% in 1999 from 28.4% in
1998. The increase in gross profit 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 1.4% to $39.9 million in 1999 from $39.4 million in 1998,
but decreased as a percentage of sales. The increase in general and
administrative expenses was due primarily to increased costs associated with
hiring additional personnel to support the Company's continuing growth, offset
in part by the elimination of general and administrative expenses of TSFL
Holdings, Inc. (as discussed below) and decreased fees for professional
services.
Provision for Doubtful Accounts. Provisions for doubtful accounts
decreased by 25.2% to $28.3 million in 1999 from $37.8 million in 1998. As a
percentage of sales, provision for doubtful accounts decreased in 1999 to 5.5%
as compared to 8.4% for 1998.
Promotional, Marketing, and Advertising Expenses. During 1999, the
Company incurred $96.3 million of promotional, marketing and advertising expense
to expand its long distance customer base, primarily AOL. During 1998, the
Company incurred $210.6 million of promotional, marketing and advertising
expense, including $49.7 million related to the AOL Agreement, $22.0 million for
the performance warrants issued to AOL during 1998, and $138.9 million of
promotional, marketing and advertising expense to expand its long distance
customer base.
Significant Other Charges (Income). During 1999, the Company sold the
business units of TSFL Holdings, Inc. (formerly Symetrics Industries, Inc.),
resulting in a gain of $2.7 million, which was included in significant other
charges (income). For 1998, significant other charges consists of $91.0 million
of expense incurred in the fourth quarter related to changes in the Company's
basic business operations.
Interest Income. Interest income was $3.9 million in 1999 versus $38.9
million in 1998. During 1999, interest income decreased due to a significant
decline in cash and marketable securities.
Interest Expense. Interest expense was $4.6 million in 1999 versus
$29.2 million in 1998. During 1999, interest expense decreased due to the
Company's reacquisition of convertible debt.
Other Expenses, Net. For 1998, other expenses primarily included losses
on investments.
Extraordinary Gain. During 1999, the Company recorded an extraordinary
gain of $21.2 million from the acquisition of the Company's convertible debt at
a discount from its aggregate principal amount.
-14-
LIQUIDITY AND CAPITAL RESOURCES
The Company had $40.6 million of cash and cash equivalents as of
December 31, 2000, and $78.9 million as of December 31, 1999. The decrease in
cash is primarily the result of $34.9 million in capital expenditures for the
purchase of property and equipment, related primarily to the expansion of the
business discussed above, and of the use of $14.9 million in cash in the
Company's operations, principally for the promotional, marketing and advertising
expenses that the Company incurred to support its efforts to expand its customer
base, which decreases were partially offset by 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 used in operating activities was $14.9 million for 2000. Net
cash provided by operating activities was $18.4 million for 1999. For 2000, the
major contributors to the net cash used in operating activities were a decrease
in prepaid expenses and other current assets of $7.7 million, an increase in
accounts payable and accrued expenses of $12.8 million and adjustments to net
income for non-cash items of $22.5 million excluding the provision for doubtful
accounts. This was offset by a net loss of $61.9 million, and an increase in net
trade accounts receivable of $43.4 million. For 1999, net cash provided by
operating activities was mainly generated by net income of $78.9 offset by a
reduction in accounts payable and accrued expenses of $23.5 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 $41.0 million.
Net cash used in investing activities of $39.0 million related
primarily to the purchase of property, equipment and intangibles during 2000.
For 1999, the net cash provided by investing activities was mainly from the sale
of marketable securities of $89.6 million.
The $15.6 million net cash provided by financing activities for 2000
was received primarily from the exercise of employee stock options and common
stock purchase rights. For 1999, the net cash used in financing activities
totaled $25.7 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 $48.3 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. 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. The Company also received a letter from AOL dated as of
August 2, 2000 confirming that AOL did not intend to exercise such rights to
reimbursement for shortfalls earlier than December 31, 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 March 29, 2001, the reimbursement
amount would be approximately $54.0 million.
In addition, 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). In addition, upon the occurrence of certain events, including
material defaults by the Company in its AOL agreements and a "change of control"
of the Company, the Company may be required to repurchase for cash all of the
shares held by AOL for $78.3 million ($19 per share), and the warrants for $36.3
million. 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
-15-
other asset based financing of up to $50.0 million, to secure its obligations
under the Investment Agreement with AOL.
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 increase in provision for doubtful
accounts was due to the provision for certain aged receivables that are now
deemed not collectible and a change in reserve estimates regarding the Company's
non-AOL long distance marketing partners. 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 approximately $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 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-type 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 collateralized 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 to purchase 300,000
shares of its common stock at $4.36 per share, 150,000 of which vested on
December 31, 2000 and the balance of which will vest if the Company fails to
exceed certain EBITDA thresholds for the fiscal quarter ended March 31, 2001. On
October 20, 2000, the Company borrowed $20.0 million under the term loan
facility, of which 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 that 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.
Potential Effect of Recent Accounting Pronouncements
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 not have a material
effect on its financial statements.
The Financial Accounting Standards Board (FASB) Emerging Issues Task
Force (EITF) has issued Abstract No. 00-19, "Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company's Own Stock" which
addresses how such contracts should be classified and measured by the Company.
Under this issue, contracts that require net-cash settlement would be initially
classified as assets or liabilities, then measured at fair value, with changes
in fair value reported in earnings and disclosed in the financial statements as
long as the contracts remain classified as assets or liabilities. If contracts
classified as assets or liabilities are ultimately settled in shares, any gains
or losses on those contracts should continue to be included in earnings. This
abstract is effective for all contracts that remain outstanding at June 30,
2001, and presented that date as a cumulative effect of a change in accounting
principle. Assuming there is no change in the Company's outstanding agreements
prior to June 30, 2001, the cumulative effect of the adoption of this change in
accounting principal could result in a non-cash charge to earnings in excess of
$40 million in the quarter ended June 30, 2001.
* * * * * * *
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 and in Part I of this Report, important factors that could cause such
actual results to differ materially include, among others, increased price
competition for long distance and local services, failure of the
-16-
marketing of the bundle of local and long distance services and long distance
services under its agreements with its various marketing partners and its direct
marketing channels, attrition in the number of end users, adverse developments
in the Company's relationship with its marketing partners, failure or
difficulties in managing the Company's growth, including attracting and
retaining of qualified personnel, failure of the Company to expand its offering
of local bundled services to new states, failure to provide timely and accurate
billing information to customers, interruption in the Company's network and
information systems, and changes in government policy, regulation and
enforcement. The Company undertakes no obligation to update its forward-looking
statements.
ITEM 7A. 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 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 doe 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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
TALK.COM INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----------
Reports of Independent Accountants 18
Consolidated balance sheets as of December 31, 2000 and 1999 20
Consolidated statements of operations for the years ended December 31, 2000, 1999 and 1998 21
Consolidated statements of stockholders' equity (deficit) for the years ended December 31, 2000, 1999 and 1998 22
Consolidated statements of cash flows for the years ended December 31, 2000, 1999 and 1998 23
Notes to consolidated financial statements 24
-17-
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Talk.com Inc.:
In our opinion, the accompanying consolidated balance sheet as of December 31,
2000 and the related consolidated statements of operations, of stockholders'
(deficit) equity and of cash flows present fairly, in all material respects, the
financial position of Talk.com Inc. and its subsidiaries at December 31, 2000,
and the results of their operations and their cash flows for the year then ended
in conformity with accounting principles generally accepted in the United States
of America. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audit. We conducted our audit of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
PricewaterhouseCoopers LLP (signed)
Philadelphia, Pennsylvania
February 27, 2001
-18-
Report of Independent Accountants
To the Board of Directors
and Stockholders of Talk.com Inc.
We have audited the accompanying consolidated balance sheet of Talk.com
Inc. and subsidiaries as of December 31, 1999, and the related consolidated
statements of operations, stockholders' equity (deficit) and cash flows for each
of the two years in the period ended December 31, 1999. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amount and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Talk.com
Inc. and subsidiaries as of December 31, 1999, and the results of their
operations and their cash flows for each of the two years in the period ended
December 31, 1999, in conformity with accounting principles generally accepted
in the United States of America.
BDO Seidman, LLP
New York, New York
February 7, 2000
-19-
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT FOR SHARE DATA)
December 31,
-----------------------------
2000 1999
--------- ---------
Assets
Current assets:
Cash and cash equivalents $ 40,604 $ 78,937
Accounts receivable, trade, net of allowance for uncollectible
accounts of $29,459 and $5,021, respectively 53,637 59,501
Advances to partitions and notes receivable 1,780 3,600
Prepaid expenses and other current assets 1,182 8,855
--------- ---------
Total current assets 97,203 150,893
Property and equipment, net 83,656 57,335
Goodwill and intangibles, net 218,639 1,068
Other assets 8,251 5,712
--------- ---------
Total assets $ 407,749 $ 215,008
========= =========
Liabilities, Contingent Redemption Value of Warrants and Common Stock and
Stockholders' Equity (Deficit)
Current liabilities:
Accounts payable, trade and other $ 70,432 $ 47,965
Partitions 362 1,676
Sales, Use and Excise taxes 7,935 7,851
Other payables 5,723 6,276
Deferred revenue 12,997 7,400
Notes payable and current portion of long-term debt 2,822 --
--------- ---------
Total current liabilities 100,271 71,168
Convertible debt 84,945 84,985
Deferred revenue 6,200 13,600
Long-term debt 18,750 --
Other liabilities 253 --
--------- ---------
Total liabilities 210,419 169,753
--------- ---------
Commitments and Contingencies
Contingent redemption value of warrants 36,324 36,324
Contingent redemption value of common stock 78,306 78,306
Stockholders' equity (deficit):
Preferred stock, $.01 par value, 5,000,000 shares authorized; no
shares outstanding -- --
Common stock - $.01 par value, 300,000,000 shares authorized;
78,445,134 and 66,972,960 issued and outstanding, respectively 784 670
Additional paid-in capital 286,963 98,975
Deficit (201,196) (139,300)
Treasury stock, 274 and 2,120 shares, at cost (3,851) (29,720)
--------- ---------
Total stockholders' equity (deficit) 82,700 (69,375)
--------- ---------
Total liabilities, contingent redemption value of warrants and
common stock and stockholders' equity (deficit) $ 407,749 $ 215,008
========= =========
See accompanying notes to consolidated financial statements.
-20-
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
YEAR ENDED DECEMBER 31,
-----------------------------------------------
2000 1999 1998
--------- --------- ---------
Sales $ 544,548 $ 516,548 $ 448,600
Cost of sales 292,931 289,029 321,215
--------- --------- ---------
Gross profit 251,617 227,519 127,385
General and administrative expenses 65,360 39,954 39,393
Provision for doubtful accounts 53,772 28,250 37,789
Promotional, marketing and advertising expenses 170,864 96,264 210,552
Depreciation and amortization 19,257 6,214 5,499
Significant other charges (income) -- (2,718) 91,025
--------- --------- ---------
Operating income (loss) (57,636) 59,555 (256,873)
Interest (income) (4,859) (3,875) (38,876)
Interest expense 5,297 4,616 29,184
Other expense, net 3,822 1,115 20,867
--------- --------- ---------
Income (loss) before provision for income taxes (61,896) 57,699 (268,048)
Provision for income taxes -- -- 40,388
--------- --------- ---------
Income (loss) before extraordinary gain (61,896) 57,699 (308,436)
Extraordinary gain from extinguishment of debt -- 21,230 87,110
--------- --------- ---------
Net income (loss) $ (61,896) $ 78,929 $(221,326)
========= ========= =========
Income (loss) before extraordinary gain per share - Basic $ (0.88) $ 0.94 $ (5.20)
Extraordinary gain per share - Basic -- 0.35 1.47
--------- --------- ---------
Net income (loss) per share - Basic $ (0.88) $ 1.29 $ (3.73)
========= ========= =========
Weighted average common shares
outstanding - Basic 70,527 61,187 59,283
========= ========= =========
Income (loss) before extraordinary gain per share - Diluted $ (0.88) $ 0.90 $ (5.20)
Extraordinary gain per share - Diluted -- 0.33 1.47
--------- --------- ---------
Net income (loss) per share - Diluted $ (0.88) $ 1.23 $ (3.73)
========= ========= =========
Weighted average common and common equivalent shares
outstanding - Diluted 70,527 64,415 59,283
========= ========= =========
See accompanying notes to consolidated financial statements.
-21-
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS)
COMMON STOCK ADDITIONAL TREASURY STOCK
---------------------- PAID-IN ACCUMULATED ----------------------
SHARES AMOUNT CAPITAL DEFICIT SHARES AMOUNT TOTAL
--------- --------- --------- --------- --------- --------- ---------
Balance, December 31, 1997 67,250 $ 672 $ 291,952 $ 3,097 (3,608) $ (72,893) $ 222,828
Net (loss) -- -- -- (221,326) -- -- (221,326)
Issuance of warrants to AOL -- -- 33,086 -- -- -- 33,086
Exercise of common stock warrants -- -- (3,620) -- 250 5,052 1,432
Exercise of common stock options -- -- (41,493) -- 2,853 55,550 14,057
Exercise of AOL warrants -- -- (7,693) -- 381 7,693 --
Retirement of common stock (315) (3) (1,467) -- -- -- (1,470)
Acquisition of treasury stock -- -- -- -- (18,809) (265,054) (265,054)
Issuance of common stock and
options for compensation -- -- (3,123) -- 895 13,224 10,101
Issuance of common stock for
convertible debt -- -- (2,317) -- 5,089 71,878 69,561
--------- --------- --------- --------- --------- --------- ---------
Balance, December 31, 1998 66,935 669 265,325 (218,229) (12,949) (184,550) (136,785)
Net income -- -- -- 78,929 -- -- 78,929
AOL investment -- -- (3,730) -- 4,121 58,730 55,000
Exercise of common stock options -- -- (47,313) -- 6,773 95,600 48,287
Exercise of common stock rights 38 1 651 -- -- -- 652
Acquisition of treasury stock -- -- -- -- (639) (7,686) (7,686)
Issuance of common stock for
convertible debt -- -- (1,328) -- 574 8,186 6,858
Contingent redemption value
of common stock and warrants -- -- (114,630) -- -- -- (114,630)
--------- --------- --------- --------- --------- --------- ---------
Balance, December 31, 1999 66,973 $ 670 $ 98,975 $(139,300) (2,120) $ (29,720) $ (69,375)
Net (loss) -- -- -- (61,896) -- -- (61,896)
Exercise of common stock options -- -- (2,274) -- 342 4,802 2,528
Exercise of common stock rights -- -- 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 -- -- 17 -- 3 23 40
Issuance of common stock for
compensation -- -- (1,796) -- 149 2,094 298
--------- --------- --------- --------- --------- --------- ---------
Balance, December 31, 2000 78,445 $ 784 $ 286,963 $(201,196) (274) $ (3,851) $ 82,700
========= ========= ========= ========= ========= ========= =========
See accompanying notes to consolidated financial statements.
-22-
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
-----------------------------------------
2000 1999 1998
--------- --------- ---------
Cash flows from operating activities:
Net income (loss) $ (61,896) $ 78,929 $(221,326)
Reconciliation of net income (loss) to net cash provided by (used in)
operating activities:
Provision for doubtful accounts 53,772 28,250 37,789
Depreciation and amortization 19,257 6,214 5,499
Non-cash compensation 706 -- 8,402
Provision for uncollectible note 2,500 -- --
Loss on retirement of assets 68 -- --
Vested AOL warrants and amortization of prepaid AOL marketing costs -- -- 71,665
Significant other charges -- -- 55,034
Valuation allowance for deferred tax assets -- -- 40,388
Extraordinary gain from extinguishment of debt -- (21,230) (87,110)
Changes in assets and liabilities, net of acquisitions of businesses:
Accounts receivable, trade (43,390) (41,026) (39,274)
Advances to partitions and notes receivable 370 (1,730) 24,241
Prepaid expenses and other current assets 7,696 (254) (23,712)
Other assets (1,252) 1,957 (49,127)
Accounts payable and accrued expenses 12,763 (23,457) 56,419
Deferred revenue (1,433) (7,400) (7,400)
Sales, Use & Excise taxes 84 972 5,370
Other liabilities (4,181) (2,822) (6,672)
--------- --------- ---------
Net cash provided by (used in) operating activities (14,936) 18,403 (129,814)
--------- --------- ---------
Cash flows from investing activities:
Acquisition of intangibles (515) -- (285)
Acquisition of Symetrics Industries, Inc. -- -- (26,707)
Acquisition of Access One, net of cash acquired (3,617) -- --
Capital expenditures (34,862) (6,506) (16,928)
Securities sold short -- -- (21,087)
Due from broker -- -- 21,087
Sale of marketable securities, net -- 89,649 122,620
--------- --------- ---------
Net cash provided by (used in) investing activities (38,994) 83,143 78,700
--------- --------- ---------
Cash flows from financing activities:
Proceeds from borrowings 20,000 -- --
Payments of borrowings (18,025) -- --
Repayment of margin account indebtedness -- (49,621) --
Proceeds from margin account indebtedness -- -- 49,621
Acquisition of convertible debt -- (72,304) (86,301)
Proceeds from exercise of options and warrants 2,528 48,287 15,489
AOL investment -- 55,000 --
Retirement of common stock -- -- (1,470)
Proceeds from exercise of common stock rights 11,094 652 --
Acquisition of treasury stock -- (7,686) (239,892)
--------- --------- ---------
Net cash provided by (used in) financing activities 15,597 (25,672) (262,553)
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents (38,333) 75,874 (313,667)
Cash and cash equivalents, beginning of year 78,937 3,063 316,730
--------- --------- ---------
Cash and cash equivalents, end of year $ 40,604 $ 78,937 $ 3,063
========= ========= =========
See accompanying notes to consolidated financial statements.
-23-
NOTE 1 -- SUMMARY OF ACCOUNTING POLICIES
(a) Business
Talk.com Inc., a Delaware corporation, through its consolidated
subsidiaries (the "Company"), provides telecommunications services to
residential and small business customers throughout the United States. The
Company's telecommunications service offerings include long distance and local
outbound service, including local services bundled with long distance services,
inbound toll-free service and dedicated private line services for data. The
Company sells these services directly to consumers and through its relationships
with marketing partners and its web site located at www.talk.com.
(b) Basis of financial statements presentation
The consolidated financial statements include the accounts of Talk.com
Inc. and its wholly-owned subsidiaries and have been prepared as if the entities
had operated as a single consolidated group since their respective dates of
incorporation. All intercompany balances and transactions have been eliminated.
In preparing financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
Amounts from additional paid-in capital have been reclassified to
contingent redemption value of common stock and warrants issued to AOL, in order
to properly reflect the latter at December 31, 1999. This reclassification did
not have an effect on net income.
Certain amounts in the statements of operations for 1999 and 1998,
primarily the provision for doubtful accounts, have been reclassified to conform
to the current year presentation.
(c) Risks and Uncertainties
Future results of operations involve a number of risks and
uncertainties. Factors that could affect future operating results and cause
actual results to vary materially from historical results include, but are not
limited to:
- Company's business strategy with respect to bundled local and
long distance services may not succeed
- Failure to or difficulties in managing the Company's growth,
including attracting and retaining qualified personnel and
opening up new territories for its services
- Dependency on the availability or functionality of incumbent
local telephone companies' networks, as they relate to the
unbundled network element platform or the resale of such
services
- Increased price competition in local and long distance
services
- Company has significant reimbursement and repurchase
obligations under the Investment Agreement with AOL
- Failure or interruption in the Company's network and
information systems
- Changes in government policy, regulation and enforcement
- Adverse developments in the Company's relationship with its
marketing partners
- Failure of the marketing of the bundle of the Company's local
and long distance services and long distance services under
its direct marketing channels and under its agreements with
its various marketing partners
- Inability to obtain additional capital required to fully
implement business plan
- Inability to adapt to technological change
- Competition in the telecommunications industry
- Inability to manage customer attrition and bad debt expense
- Adverse change in Company's relationship with third party
carriers
Negative developments in these areas could have a material effect on the
Company's business, financial condition and results of operations.
-24-
(d) Recognition of revenue
The Company recognizes revenue upon completion of telephone calls by
end users. Allowances are provided for estimated uncollectible usage.
Deferred revenue represents the unearned portion of local service and
features that are billed a month in advance and a non-refundable prepayment
received in 1997 in connection with an amended telecommunications services
agreement with Shared Technologies Fairchild, Inc., which is amortized over the
five-year term of the agreement. This agreement is terminable by either party on
thirty days notice. Termination by either party would accelerate recognition of
the deferred revenue.
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 procedures comply with
SAB 101.
(e) Cash and cash equivalents
The Company considers all temporary cash investments purchased with a
maturity of three months or less to be cash equivalents.
(f) Advances to partitions and notes receivable
The Company made advances to partitions to support their marketing
activities. The advances are secured by partition assets, including contracts
with end users and collections thereon.
(g) Property and equipment and depreciation
Property and equipment are recorded at cost. Depreciation and
amortization are calculated using the straight-line method over the estimated
useful lives of the assets, as follows:
Buildings and building improvements 39 years
Switching equipment 15 years
Equipment and other 5-7 years
Software 3 years
(h) Goodwill and intangibles
Goodwill and intangibles were approximately $218,639 and $1,068 at
December 31, 2000 and 1999, respectively. Goodwill represents the cost in excess
of net assets of acquired companies and is amortized on a straight-line basis
over periods of 10 and 15 years. Intangibles consist of a service mark and
purchased customer accounts and workforce and are amortized on a straight-line
basis over periods ranging from three to fifteen years. Accumulated amortization
at December 31, 2000 and 1999, was $11,402 and $807, respectively. Amortization
of goodwill and intangibles was $9,680, $82 and $725 in 2000, 1999 and 1998,
respectively. Goodwill, intangibles and related amortization have increased due
to the Access One merger as discussed in Note 3.
(i) Long-lived assets
The Company adopted Statement of Financial Accounting Standards
("SFAS") No. 121, "Accounting For the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of" as of January 1, 1996. Long-lived assets
are reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount may not be recoverable. If the fair value is less than
the carrying amount of the asset, a loss is recognized for the difference.
Certain of the Company's long-lived assets were considered impaired at December
31, 1998 (Note 4). There have been no additional impairments as of December 31,
2000 and 1999.
-25-
(j) Income taxes
Income taxes are accounted for under the asset and liability method.
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.
Since 1998, the Company has provided a full valuation allowance for
deferred tax assets and liabilities for the estimated future tax effects
attributable to temporary differences between the basis of assets and
liabilities for financial and tax reporting purposes (Note 12).
(k) Net income (loss) per share
Basic earnings per share is computed by dividing income available to
common shareholders by the weighted average number of common shares outstanding
for the period. Diluted earnings per share reflects the effect of common shares
issuable upon exercise of stock options and conversion of convertible debt, when
such effect is not antidilutive.
(l) Financial instruments and risk concentration
Financial instruments that potentially subject the Company to
concentrations of credit risk are cash investments. The Company believes no
significant concentration of credit risk exists with respect to these cash
investments.
The carrying values of accounts receivable, advances to partitions and
notes receivable, accounts payable and accrued expenses approximate fair values.
Convertible debt is recorded at face amount but such debt has traded in the open
market at substantial discounts to face amount (Note 7). The market value of the
convertible debt was approximately 61% and 83% of face amount at December 31,
2000 and 1999, respectively
(m) Stock-based compensation
The Company accounts for its stock option awards under the intrinsic
value based method of accounting prescribed by APB Opinion No. 25, "Accounting
for Stock Issued to Employees," and related interpretations including FASB
Interpretation No. 44 "Accounting for Certain Transactions Including Stock
Compensation," an interpretation of APB Opinion No. 25. Under the intrinsic
value based method, compensation cost is the excess, if any, of the quoted
market price of the stock at grant date or other measurement date over the
amount an employee must pay to acquire the stock. The Company makes pro forma
disclosures of net income and earnings per share as if the fair value based
method of accounting had been applied as required by SFAS No. 123, "Accounting
for Stock-Based Compensation" (Note 11).
(n) Comprehensive income
The Company has no items of comprehensive income or expense.
Accordingly, the Company's comprehensive income (loss) and net income (loss) are
equal for all periods presented.
(o) New Accounting Pronouncements
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 not have a material
effect on its financial statements.
The Financial Accounting Standards Board (FASB) Emerging Issues Task
Force (EITF) has issued Abstract No. 00-19, "Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a
-26-
Company's Own Stock," which addresses how such contracts should be classified
and measured by the Company. Under this issue, contracts that require net-cash
settlement would be initially classified as assets or liabilities, then measured
at fair value, with changes in fair value reported in earnings and disclosed in
the financial statements as long as the contracts remain classified as assets or
liabilities. If contracts classified as assets or liabilities are ultimately
settled in shares, any gains or losses on those contracts should continue to be
included in earnings. This abstract is effective for all contracts that remain
outstanding at June 30, 2001, and presented on that date as a cumulative effect
of a change in accounting principle. Assuming there is no change in the
Company's outstanding agreements prior to June 30, 2001, the cumulative effect
of the adoption of this change in accounting principal could result in a noncash
charge to earnings in excess of $40 million in the quarter ended June 30, 2001.
(p) Segment Disclosure
The Company adopted Statement of Financial Accounting Standards No. 131
- - "Disclosures about Segments of an Enterprise and Related information" ("SFAS
131") whose effective date was December 15, 1997. Management believes that the
Company operates as one reportable operating segment.
NOTE 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 in each of the
months in the fourth quarter of 2000, which amounts were to 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.
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 10 below for a discussion of certain contingent reimbursement
obligations of the Company in favor of AOL.
-27-
NOTE 3 -- ACQUISITION
On August 9, 2000, a wholly owned subsidiary of the Company merged with
and into Access One Communications Corp., ("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 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
$201.6 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 $15.9
million and goodwill of $210.0 million, which are being amortized on a
straight-line basis over their expected benefit period. The Company acquired
$19.8 million of notes payable as part of the acquisition of Access One; as of
December 31, 2000 approximately $1.6 million remained outstanding.
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.
(In thousands, except share data)
Twelve Months Ended December 31,
----------------------------------
2000 1999
----------- -----------
Sales $ 575,754 $ 546,122
Income (loss) before extraordinary gain $ (86,424) $ 21,805
Extraordinary gain -- 21,230
----------- -----------
Net income (loss) $ (86,424) $ 43,035
=========== ===========
Basic earnings (loss) per common share:
Income (loss) before extraordinary gain $ (1.08) $ 0.30
Net income (loss) $ (1.08) $ 0.59
Diluted earnings (loss) per common share:
Income (loss) before extraordinary gain $ (1.08) $ 0.28
Net income (loss) $ (1.08) $ 0.55
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.
NOTE 4 -- SIGNIFICANT OTHER CHARGES (INCOME)
Significant other income in 1999 includes a gain of $2.7 million on the
sale of certain business units of TSFL Holdings, Inc. (formerly Symetrics
Industries, Inc.).
Significant other charges in 1998 includes $91.0 million of expenses
incurred in the fourth quarter of 1998 related to changes in the Company's basic
business operations, as discussed below.
As discussed in Note 2 above, the Company negotiated substantial
amendments to its agreements with AOL which, among other things, reduced the
amount of online advertising to which the Company was entitled to over the
remaining term of the agreement and eliminated payments and issuance of warrants
to AOL for customer gains and profit sharing payments to AOL. The Company agreed
to fixed quarterly payments ranging from $10 - $15 million per quarter during
the exclusivity period of the agreement and AOL agreed to contribute up to $4.0
-28-
million per quarter for offline marketing. As a result of the amendments, the
Company wrote off prepaid AOL, CompuServe and other marketing-related expenses
of $37.6 million.
In connection with hiring a new Chairman and Chief Executive Officer
and several other key executive personnel and severance payments relating to
this change in management, the Company incurred $12.7 million of incentive and
severance expense.
The Company acquired ADS Holdings, Inc. (formerly Symetrics, Inc.), a
manufacturer of digital telephone switching equipment, in January 1998 for $18.6
million. The Company planned to complete development of the digital switch to
provide state of the art features for use in the Company's operations as a
competitive local exchange carrier. The Company allocated $21 million of the
acquisition cost to purchased research and development expense in the first
quarter of 1998 and continued to invest in additional research and development
throughout 1998. In November 1997, the Company acquired Compco, Inc, a provider
of communications software in the college and university marketplace for $13.7
million, which exceeded the net assets acquired by $10.6 million.
In the fourth quarter of 1998, the Company decided to sell the assets
of ADS Holdings, Inc. and to delay entry into the college and university
marketplace. As a result, the assets of ADS Holdings, Inc. and Compco, Inc. were
written down to expected realizable value. The Company recorded $15.0 million
relating to the impairment of these assets and reclassified $22.2 million of
research and development expense to significant other charges.
In the fourth quarter of 1998, the Company reconfigured its
telecommunications network, OBN, to provide for fiber optic connections among
its switches and incurred $3.5 million of expense.
NOTE 5. -- LEASES
The Company leases office space and equipment under operating lease
agreements. Certain leases contain renewal options and purchase options, and
generally provide that the Company shall pay for insurance, taxes and
maintenance. Total rent expense for all operating leases for the years ended
December 31, 2000, 1999 and 1998 was $1.37, $1.04, and $0.77 million,
respectively. As of December 31, 2000, the Company had future minimum annual
lease obligations under leases with noncancellable lease terms in excess of one
year as follows:
Year (in Thousands)
2001 .............................................. $1,663
2002 .............................................. 1,632
2003 .............................................. 1,605
2004 .............................................. 1,565
2005 .............................................. 1,416
Thereafter ........................................ 1,424
------
$9,305
======
-29-
NOTE 6 -- PROPERTY AND EQUIPMENT
The following is a summary of property and equipment - at cost, less
accumulated depreciation.
DECEMBER 31,
-------------------------------
2000 1999
--------- ---------
Land $ 340 $ 80
Buildings and building/leasehold improvements 6,350 2,956
Switching equipment 57,861 53,101
Software 1,527 --
Equipment and other 42,667 16,961
--------- ---------
108,745 73,098
Less: Accumulated depreciation (25,089) (15,763)
--------- ---------
$ 83,656 $ 57,335
========= =========
For the years ended December 31, 2000, 1999 and 1998, depreciation expense
amounted to $9,574, $5,874 and $4,774, respectively.
NOTE 7 -- DEBT
(a) Convertible Debt
In September 1997, the Company sold $300 million of 4 1/2% Convertible
Subordinated Notes that mature on September 15, 2002 (the "2002 Convertible
Notes"). Interest on the 2002 Convertible Notes is due and payable semiannually
on March 15 and September 15 of each year. The 2002 Convertible Notes are
convertible, at the option of the holder, into shares of the Company's Common
Stock at a conversion price of $24.54 per share, as adjusted for the dilutive
effect of the exercise of rights pursuant to the Company's rights offering (Note
11). The 2002 Convertible Notes are redeemable, in whole or in part, at the
Company's option, at any time on or after September 15, 2000 at 101.80% of par
prior to September 14, 2001 and 100.90% of par thereafter. During 1999 and 1998,
the Company reacquired $80,650 and $152,458, respectively, principal amount of
the 2002 Convertible Notes and $66,852 principal amount remained outstanding at
December 31, 2000.
In December 1997, the Company sold $200 million of 5% Convertible
Subordinated Notes that mature on December 15, 2004 (the "2004 Convertible
Notes"). Interest on the 2004 Convertible Notes is due and payable semiannually
on June 15 and December 15 of each year. The 2004 Convertible Notes are
convertible, at the option of the holder, at a conversion price of $25.38 per
share, as adjusted for the dilutive effect of the exercise of rights pursuant to
the Company's rights offering (Note 11). The 2004 Convertible Notes are
redeemable, in whole or in part at the Company's option, at any time on or after
December 15, 2002 at 101.43% of par prior to December 14, 2003 and 100.71% of
par thereafter. During 1999 and 1998, the Company reacquired $76,752 and
$105,155, respectively, face amount of the 2004 Convertible Notes and $18,093
principal amount remained outstanding at December 31, 2000.
The 2002 Convertible Notes and 2004 Convertible Notes that were
reacquired by the Company in 1998 were reacquired at an $87.1 million discount
from face amount. This amount is reported as an extraordinary gain in the
consolidated statement of operations.
During 1999, the Company (a) purchased from Mr. Daniel Borislow, a
founder of the Company and its Chairman of the Board and Chief Executive Officer
until he resigned on January 5, 1999, and two trusts for the benefit of Mr.
Borislow's children, $85,857 aggregate principal amount of the Company's
Convertible Notes for $72.3 million in cash; (b) exchanged the remaining $53.7
million principal amount of subordinated notes of Communication TeleSystems
International d/b/a WorldxChange Communications, which were included in other
assets at December 31, 1998, to a trust for the benefit of Mr. Borislow's
children for $62,545 aggregate principal amount of the Company's Convertible
Notes and (c) purchased $9,000 aggregate principal amount of the Company's
Convertible Notes for $6.9 million in Common Stock.
-30-
The 2002 Convertible Notes and 2004 Convertible Notes that were
reacquired by the Company during 1999 were reacquired at a $21.2 million
discount from face amount. This amount is reported as an extraordinary gain in
the consolidated statement of operations.
(b) Long-Term Debt
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 availability 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 related to, among other things, liquidity, per-subscriber-type
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. The Company borrowed $20.0 million under the term loan
facility (approximately $15.0 million was used to repay indebtedness of Access
One).
As of December 31, 2000, the required minimum annual principal reduction of
convertible and long-term debt obligations for each of the next five fiscal
years is as follows:
Year Ending December 31, Total
2001 $ 2,822
2002 $ 71,852
2003 $ 5,000
2004 $ 23,093
2005 $ 3,750
--------
$106,517
========
NOTE 8 -- 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 and in connection therewith, 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 addition, 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
-31-
with Mr. Borislow as described above the Company purchased from Mr. Borislow
approximately 639,000 shares of Common Stock for approximately $7.7 million with
proceeds from the exercise of stock options by other employees.
On January 6, 2000, the Company repurchased from Mr. Borislow for $2.5
million real property previously sold to Mr. Borislow constituting the Company's
facilities in New Hope, Pennsylvania.
NOTE 9 -- 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 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.
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 10 -- STOCKHOLDERS' EQUITY
(a) Authorized Shares
During 1997, the Board of Directors and stockholders approved the
increase in the number of authorized shares of the Common Stock to 300,000,000
shares.
(b) Contingent Redemption Value of Warrants
Under the terms of the marketing agreements with AOL (as discussed in
Note 2), AOL has the right on termination of long distance exclusivity 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, cash or a quarterly
amortizing two-year promissory note of the Company. Upon the occurrence of
certain events, including material defaults by the Company in its AOL agreements
and a "change of control" of the Company, the Company may be required to
purchase the warrants for cash. Accordingly, at December 31, 1999 and 2000 the
Company recorded $36.3 million for the contingent redemption value of these
warrants with a corresponding reduction in additional paid-in capital. AOL can
end the Company's long distance exclusivity period on or after June 30, 2001.
(c) Contingent Redemption Value of Common Stock
Under the terms of the Investment Agreement with AOL (as discussed in
Note 2), the Company has agreed to reimburse AOL for losses AOL may incur on the
sale of any of the 4,121,372 shares of Common Stock during the period from June
1, 1999 through September 30, 2001. The Company has the first right to purchase
any of the 4,121,372 shares of Common Stock at the market value on the day that
AOL notifies the Company of its intent to sell any of the shares plus an amount,
if any, equal to the Company's reimbursement obligation described below. The
reimbursement amount would be determined by multiplying the number of shares, if
any, that AOL sells during the applicable period by the difference between the
purchase price per share paid by AOL, or $19 per share, and the price per share
that AOL sells the shares for, if less than $19 per share. The reimbursement
amount may not exceed $14 per share for 2,894,737 shares or $11 per share for
1,226,635 shares. Accordingly, the maximum amount payable to AOL as
-32-
reimbursement on the sale of AOL's shares would be approximately $54.0 million
plus AOL's reasonable expenses incurred in connection with the sale. The Company
has the option of issuing a six-month 10% note payable to AOL to satisfy the
reimbursement amount or other amounts payable on exercise of its first refusal
rights. Assuming AOL were to sell all of its shares subject to the Company's
reimbursement obligation at the closing price of Common Stock as of December 31,
2000, the reimbursement amount would be approximately $54 million. Upon the
occurrence of certain events, including material defaults by the Company under
its AOL agreements and a "change of control" of the Company, the Company also
may be required to repurchase all of the shares at $19 per share. Accordingly,
the Company has recorded $78.3 million for the contingent redemption value of
this Common Stock with a corresponding reduction in additional paid-in capital
at December 31, 2000 and 1999. The Company has pledged the stock of its
subsidiaries and has agreed to fund an escrow account of up to $35 million from
50% of the proceeds of any debt financing, other than a bank, receivable or
other asset based financing of up to $50 million, to secure its obligations
under the Investment Agreement with AOL. AOL has agreed that it will subordinate
its security interests to permit the securitization of certain future financings
by the Company.
(d) Stockholders Rights Plan
On August 19, 1999, the Company adopted a Stockholders Rights Plan
designed to deter coercive takeover tactics and prevent an acquirer from gaining
control of the Company without offering a fair price to all of the Company's
stockholders.
Under the terms of the plan, preferred stock purchase rights were
distributed as a dividend at the rate of one right for each share of Common
Stock of the Company held as of the close of business on August 30, 1999. Until
the rights become exercisable, Common Stock issued by the Company will also have
one right attached. Each right will entitle holders to buy one three-hundredth
of a share of Series A Junior Participating Preferred Stock of the Company at an
exercise price of $55. Each right will thereafter entitle the holder to receive
upon exercise Common Stock (or, in certain circumstances, cash, property or
other securities of the Company) having a value equal to two times the exercise
price of the right.
The rights will be exercisable only if a person or group acquires
beneficial ownership of 20% or more of Common Stock or announces a tender or
exchange offer which would result in such person or group owning 20% or more of
Common Stock, or if the Board of Directors declares that a 15% or more
stockholder has become an "adverse person" as defined in the plan.
The Company, except as otherwise provided in the plan, will generally
be able to redeem the rights at $0.001 per right at any time during a ten-day
period following public announcement that a 20% position in the Company has been
acquired or after the Company's Board of Directors declares that a 15% or more
stockholder has become an "adverse person." The rights are not exercisable until
the expiration of the redemption period. The rights will expire on August 19,
2009, subject to extension by the Board of Directors.
NOTE 11 -- STOCK OPTIONS, WARRANTS AND RIGHTS
(a) Stock Based Compensation Plan
The Company grants stock options under a stock-based incentive
compensation plan (the "Plan"). The Company applies APB Opinion No. 25 and
related Interpretations in accounting for the Plan. SFAS 123 "Accounting for
Stock-Based Compensation," if fully adopted by the Company, would change the
methods the Company applies in recognizing the cost of the Plan. The Company has
adopted the disclosure-only provisions of SFAS 123. Pro forma disclosures as if
the Company adopted the cost recognition provisions of SFAS 123 are presented
below.
Under the Plan, the Company is authorized to issue 5,000,000 shares of
Common Stock pursuant to "Awards" granted in various forms, including incentive
stock options (intended to qualify under Section 422 of the Internal Revenue
Code of 1986, as amended), non-qualified stock options, and other similar
stock-based Awards.
(b) Stock Options
-33-
Stock options granted in 2000 generally have contractual terms of 10
years. The options granted to employees have an exercise price equal to the fair
market value of the stock at grant date. The vast majority of options granted in
2000 vest one-third each year, beginning on the first anniversary of the date of
grant.
In 1998, the Company recognized $3.3 million of compensation expenses
relating to the grant of 650,000 options to purchase shares of the Company's
Common Stock at prices below the quoted market price at the dates of grant or
issuance and the issuance of 135,000 shares of the Company's stock.
Under the accounting provisions of SFAS No. 123, the Company's net
income (loss) and earnings (loss) per share would have been reduced (increased)
to the pro forma amounts indicated below.
YEAR ENDED DECEMBER 31,
--------------------------------------------------
2000 1999 1998
----------- ----------- -----------
NET INCOME (LOSS):
As reported $ (61,896) $ 78,929 $ (221,326)
Pro forma $ (99,420) $ 68,851 $ (244,487)
BASIC EARNINGS (LOSS) PER SHARE:
As reported $ (0.88) $ 1.29 $ (3.73)
Pro forma $ (1.41) $ 1.13 $ (4.12)
DILUTED EARNINGS (LOSS) PER SHARE:
As reported $ (0.88) $ 1.23 $ (3.73)
Pro forma $ (1.41) $ 1.07 $ (4.12)
The fair value was estimated as of the grant date using the
Black-Scholes option pricing model with the following average assumptions:
2000 1999 1998
Risk-free interest rate 6.27% 5.38%/5.85% 4.59%
Dividend yield 0.00% 0.00% 0.00%
Volatility factor 87.46% 108.00% 65%
Expected lives 5 years 1 to 10 years 1 to 10 years
The following tables contain information on stock options for the
three-year period ended December 31, 2000:
EXERCISE WEIGHTED
OPTIONS PRICE RANGE AVERAGE
SHARES PER SHARE EXERCISE PRICE
----------- ------------ --------------
Outstanding, December 31, 1997 8,885,988 $ .32-$22.06 $ 9.26
Granted 5,535,000 $5.75-$10.44 $ 7.18
Exercised (2,853,178) $ .32-13.63 $ 4.93
Cancelled (1,337,000) $ 5.75-17.50 $ 13.01
----------- ------------ -------
Outstanding, December 31, 1998 10,230,810 $4.08-$14.00 $ 7.34
Granted 3,549,500 $8.75-$17.25 $ 11.63
Exercised (6,773,378) $4.08- 12.78 $ 7.13
Cancelled (158,000) $5.75- 11.69 $ 9.67
----------- ------------ -------
Outstanding, December 31, 1999 6,848,932 $4.58-$17.25 $ 9.72
Granted 9,678,809 $1.13-$16.18 $ 7.98
Exercised (342,337) $4.58-$11.94 $ 7.39
Cancelled (1,116,085) $2.63-$15.88 $ 9.03
----------- ------------ -------
Outstanding, December 31, 2000 15,069,319 $0.88-$17.25 $ 8.60
=========== ============ =======
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EXERCISE WEIGHTED
OPTIONS PRICE RANGE AVERAGE
EXERCISABLE AT: SHARES PER SHARE EXERCISE PRICE
--------- ------------- --------------
1998 4,571,475 $4.08-$12.78 $7.39
1999 2,541,095 $4.58-$14.00 $7.67
2000 5,597,573 $0.88-$17.25$ $7.31
WEIGHTED
AVERAGE
OPTIONS GRANTED: FAIR VALUE
--------------
1998 $4.83
1999 $9.71
2000 $6.56
The following table summarizes information about stock options
outstanding at December 31, 2000:
$0.88-$4.57 $4.58-$7.00 $7.01-$10.00 $10.01-$13.00 $13.01-$17.25
----------- ----------- ------------ ------------- -------------
OUTSTANDING OPTIONS:
Number outstanding at December 31, 2000 2,553,970 4,387,624 1,505,391 2,168,334 4,454,000
Weighted-average remaining contractual life (Years) 7.24 7.47 7.08 7.26 9.07
Weighted-average exercise price $ 2.06 $ 5.38 $ 9.20 $ 10.54 $ 14.39
EXERCISABLE OPTIONS:
Number outstanding at December 31, 2000 1,182,904 1,852,432 841,059 1,384,347 336,831
Weighted-average exercise price $ 2.02 $ 6.07 $ 9.12 $ 10.44 $ 15.30
(c) AOL Warrants
On January 5, 1999, after the repurchase from AOL of warrants to
purchase 5,076,016 shares of Common Stock, warrants to purchase 2,721,984 shares
of Common Stock were held by AOL and were outstanding and currently exercisable,
with exercise prices from $14.00 to $22.25 and a weighted average exercise price
of $17.03. AOL has the right, commencing on termination of the long distance
exclusivity under the AOL marketing agreement up until January 5, 2003, to
require the Company to repurchase all or any portion of these warrants at prices
(the "Put Prices") ranging from $10.45 to $16.82 per warrant ($36,324 aggregate
amount). In the event AOL requires repurchase of the warrants, the Company at
its election may pay AOL in cash or in shares of Common Stock based on the then
current market price for such stock. The Company may also elect to issue a 10%
two-year note for a defined portion of the repurchase price. The Company can
require AOL to exercise its warrants at any time the market price of Common
Stock equals or exceeds two times the then call amount for such warrants. The
call amount of a warrant is the Put Price for the warrant increased at a
semi-annually compounded rate of 5% on January 5, 1999 and on each six month
anniversary thereafter. The Company has certain reimbursement obligations in the
event that it requires AOL to exercise its warrants. In addition, upon the
occurrence of certain events, including material defaults by the Company in its
AOL agreements and a "change of control" of the Company, the Company may be
required to purchase the warrants for cash.
(d) Other Warrants
Pursuant to the terms of the Agreement and Plan of Merger, dated as of
March 24, 2000, between a wholly owned subsidiary of the Company and Access One,
the Company assumed certain warrants to purchase shares of
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Access One, which, upon consummation of the Merger, converted to warrants to
purchase an aggregate of 871,4214 shares of the Company common stock at an
exercise price of $2.02. In connection with certain consulting services that MCG
Credit Corporation was to provide to the Company, the Company issued a warrant
to MCG to purchase 300,000 shares of its common stock, which became exercisable
at $4.73. Upon its execution of the Credit Facility Agreement with MCG Finance
Corporation in October 2000, the Company issued warrants to purchase 300,000
shares of its common stock at $4.36 per share, 150,000 of which vested at
December 31, 2000 and the balance will vest if the Company fails to exceed
certain EBITDA thresholds for the fiscal quarter ended March 31, 2001.
(e) Rights
The Board of Directors had approved an offering of up to 3,523,285
shares of its Common Stock, $.01 par value, to holders of record of Common Stock
and holders of record of options or warrants to purchase Common Stock at the
close of business on December 31, 1998. The shares were offered pursuant to
nontransferable rights to subscribe for and purchase shares of Common Stock at a
price of $17.00 per share. Holders of record on the record date, were eligible
to receive one such nontransferable right for every 20 shares of Common Stock or
underlying options or warrants held on the record date, as applicable. As of
December 31, 1999, 38,325 rights totaling $651.5 were exercised, and 652,547
rights totaling $11,093 were exercised in 2000. These rights expired on February
12, 2000.
NOTE 12 -- INCOME TAXES
The Company reports the effects of income taxes under SFAS No. 109,
"Accounting for Income Taxes". The objective of income tax reporting is to
recognize (a) the amount of taxes payable or refundable for the current year and
(b) deferred tax liabilities and assets for the future tax consequences of
events that have been recognized in the financial statements or tax returns.
Under SFAS No. 109, the measurement of deferred tax assets is reduced, if
necessary, by the amount of any tax benefits that, based on available evidence,
are not expected to be realized. Realization of deferred tax assets is
determined on a more-likely-than-not basis.
The Company considers all available evidence, both positive and
negative, to determine whether, based on the weight of that evidence, a
valuation allowance is needed for some portion or all of a net deferred tax
asset. Judgment is used in considering the relative impact of negative and
positive evidence. In arriving at these judgments, the weight given to the
potential effect of negative and positive evidence is commensurate with the
extent to which it can be objectively verified.
During 1998, the Company incurred significant promotional, marketing
and advertising expenses attributable to its efforts to increase the customer
base. Moreover, competitive factors intensified during the period making gains
in subscriber base more costly and more time consuming. Accordingly, the Company
provided a valuation allowance against its deferred tax assets at December 31,
1998. The valuation allowance also eliminated the net deferred tax asset that
had been recognized in previous periods. The valuation allowance increased the
net loss for the period by approximately $40.4 million. At December 31, 2000 and
1999, a valuation allowance has been provided against the deferred tax assets
since management cannot predict, based on the weight of available evidence, that
it is more likely than not that such assets will be ultimately realized. The
Company has continued to provide a valuation allowance against its deferred tax
assets at December 31, 2000.
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The provision for income taxes for the years ended December 31, 2000,
1999 and 1998 consisted of the following:
YEAR ENDED DECEMBER 31,
-----------------------------------
2000 1999 1998
------- ------- -------
Current:
Federal $ -- $ -- $ --
State and local -- -- --
------- ------- -------
Total current: -- -- --
Deferred:
Federal -- -- 34,140
State and local -- -- 6,248
------- ------- -------
Total deferred -- -- 40,388
------- ------- -------
$ -- $ -- $40,388
======= ======= =======
A reconciliation of the Federal statutory rate to the provision
(benefit) for income taxes is as follows:
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------
2000 1999 1998
----------------- ------------------ ------------------
Federal income taxes computed at the statutory rate $(20,657) (35.0)% $ 27,625 35.0% $(63,328) (35.0%)
Increase (decrease):
State income taxes less Federal Benefit (2,361) (4.0) 3,157 4.0 (7,780) (4.3)
Valuation allowance for deferred tax assets
existing at beginning of year -- -- -- -- 40,388 22.3
Valuation allowance changes 19,184 32.5 (31,000) (39.3) 68,612 37.9
Other 3,834 6.5 218 .3 2,496 1.4
-------- ----- -------- ----- -------- -----
Total provision (benefit) for income taxes $ -- -- $ -- -- $ 40,388 22.3%
======== ==== ======== ==== ======== ====
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Deferred tax (assets) liabilities at December 31, 2000 and 1999 are comprised of
the following elements:
YEAR ENDED DECEMBER 31,
----------------------------
2000 1999
--------- ---------
Net operating loss carryforwards $(105,000) $ (71,000)
Deferred revenue taxable currently (5,000) (8,000)
Compensation for options granted below market price (1,000) (1,000)
Allowance for uncollectible accounts (11,000) (3,000)
Warrants issued for compensation 11,000 (9,000)
Depreciation and amortization (1,000) 8,000
Accruals not currently deductible -- (2,000)
Net capital loss carryforwards (9,000) (8,000)
--------- ---------
Deferred tax (assets) liabilities, net (121,000) (94,000)
Less valuation allowance 121,000 94,000
--------- ---------
Net deferred tax $ -- $ --
========= =========
The Company has net operating loss carryforwards for tax purposes and
other deferred tax benefits that are available to offset future taxable income.
Only a portion of the net operating loss carryforwards are attributable to
operating activities. The remainder of the net operating loss carryforwards are
attributable to tax deductions related to the exercise of stock options.
In accounting for income taxes, the Company recognizes the tax benefits
from current stock option deductions after utilization of net operating loss
carryforwards from operations (i.e., net operating loss carryforwards determined
without deductions for exercised stock options) to reduce income tax expense.
Because stock option deductions are not recognized as an expense for financial
reporting purposes, the tax benefit of stock option deductions must be credited
to additional paid-in capital. Such benefit has not been recorded because of the
Company's full valuation allowances.
The Company's deferred tax asset related to operations, net capital
loss carryforwards and exercised stock options amounted to $96.0 million, $9.0
million and $16.0 million, respectively at December 31, 2000.
Internal Revenue Code Section 382 provides for the limitation on the
use of net operating loss carryforwards in years subsequent to a more than 50%
cumulative change in ownership. A more than 50% cumulative change in ownership
occurred on August 31, 1998 and October 26, 1999. As a result, the net operating
loss attributable to offset taxable income is $16.7 million, considering the
effect of both the 1998 and 1999 ownership changes. Of the Company's net
operating loss carryforwards of $271.4 million at December 31, 2000, a portion
is subject to this annual limitation subsequent to 2000.
NOTE 13 -- STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
---------------------------------------------
2000 1999 1998
------- ------- -------
Supplemental disclosure of cash flow information:
Cash paid for interest $ 4,864 $ 4,218 $28,695
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In August 2000, the Company completed the acquisition of Access One.
The Company issued 11,472,174 shares and 698,382 shares of Common Stock and
Treasury Stock, respectively, with a value of approximately $170.4 million in
connection with the acquisition. A summary of the transaction is as follows:
Fair value of assets acquired $ 21,718
Goodwill $ 209,978
Fair value of stock issued $ 170,388
Fair value of options/warrants issued $ 27,448
Liabilities assumed $ 30,243
Cash paid, net of cash acquired $ (3,617)
Also, during 2000, the Company issued 300,000 warrants to MCG with a
value of approximately $2.2 million for a 3-year consulting agreement.
The Company also declared a stock bonus with a value of $706.1 in 2000
to be paid using Treasury Stock. At the election of certain employees, the bonus
payment could be deferred until 2001. Therefore, 149,300 shares and 203,750
shares were issued out of Treasury Stock in 2000 and 2001, respectively.
During 1999, the Company issued 574,482 shares of Common Stock with a
value of approximately $6.9 million (Note 7), in connection with the repurchase
of the Company's Convertible Notes.
Also, during 1999, the Company assigned to a trust for the benefit of
Mr. Borislow's children the Company's interest in $53,700 principal amount of
subordinated notes of Communications TeleSystems International d/b/a
WorldXChange Communications, in exchange for $62,545 aggregate principal amount
of the Company's Convertible Notes (Note 7).
In addition, the Company recorded $114.6 million for the contingent
redemption value of the AOL warrant and common stock with a corresponding
reduction in additional paid in capital.
During 1998, the Company, in exchange for a total of 783,706 shares of
Common Stock, sold certain assets to Mr. Borislow and released Mr. Borislow from
an obligation borrowed from the Company (Note 8). The Company also, in exchange
for a total of 498,435 shares of Common Stock and $10,007 aggregate principal
amount of the Company's Convertible Notes, released certain officers, directors
and employees from obligations borrowed from the Company (Note 8). In connection
with the repurchase of the Company's Convertible Notes, the Company issued
5,084,483 shares of Common Stock with a value of approximately $69.5 million.
NOTE 14 -- QUARTERLY FINANCIAL DATA (UNAUDITED)
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
--------- --------- --------- ---------
2000
----
Sales $ 156,043 $ 135,737 $ 121,233 $ 131,535
Gross profit 69,515 57,573 60,395 64,133
Operating income 13,666 (959) (33,625) (36,718)
Net income 13,380 (891) (34,770) (39,615)
Net income per share - Diluted 0.20 (0.01) (0.48) (0.59)
1999
----
Sales $ 110,572 $ 117,139 $ 140,027 $ 148,811
Gross profit 42,076 52,674 64,051 68,718
Operating income 12,355 14,979 15,579 16,642
Income before extraordinary gain 12,334 14,038 14,646 16,682
Net income 31,331 14,038 16,879 16,682
Income before extraordinary gain per share - Diluted 0.20 0.22 0.23 0.25
Net income per share - Diluted 0.50 0.22 0.27 0.25
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NOTE 15 -- EMPLOYEE BENEFIT PLANS
During 1999, the Company established an Employee Savings Plan that
permits eligible employees to contribute funds on a pre-tax basis. The Plan
qualifies as a deferred salary arrangement under Section 401(k) of the Internal
Revenue Code. Eligible employees may contribute up to 6% of their compensation
(subject to Internal Revenue Code limitations). The Plan allows employees to
choose among a variety of investment alternatives. The Company is not required
to contribute to the Plan. During 2000 the Company elected to contribute $0.11
million to the Plan. No contributions were made during 1999. No significant
administration costs were incurred during 2000 or 1999.
NOTE 16 -- PER SHARE DATA:
Basic earnings per common share is calculated by dividing net income by
the average number of common shares outstanding during the year. Diluted
earnings per common share is calculated by adjusting outstanding shares,
assuming conversion of all potentially dilutive stock options. Earnings per
share are computed as follows:
YEAR ENDED DECEMBER 31,
--------------------------------------------------
2000 1999 1998
----------- ----------- -----------
Income (loss) before extraordinary gain $ (61,896) $ 57,699 $ (308,436)
Extraordinary gain -- 21,230 87,110
----------- ----------- -----------
Net income (loss) $ (61,896) $ 78,929 $ (221,326)
=========== =========== ===========
Average shares of common stock outstanding used
to compute basic earnings per common share 70,527 61,187 59,283
Additional common shares to be issued assuming
exercise of stock options and warrants, net of
shares assumed reacquired -- 3,228 --
----------- ----------- -----------
Shares used to compute dilutive effect of stock options 70,527 64,415 59,283
=========== =========== ===========
Basic earnings (loss) per share:
Income (loss) before extraordinary gain $ (0.88) $ 0.94 $ (5.20)
Extraordinary gain -- 0.35 1.47
----------- ----------- -----------
Net income (loss) $ (0.88) $ 1.29 $ (3.73)
=========== =========== ===========
Diluted earnings (loss) per share:
Income (loss) before extraordinary gain $ (0.88) $ 0.90 $ (5.20)
Extraordinary gain -- 0.33 1.47
----------- ----------- -----------
Net income (loss) $ (0.88) $ 1.23 $ (3.73)
=========== =========== ===========
The diluted share basis for the year ended December 31, 2000 excludes
incremental shares related to stock options and warrants of 1,699,610. These
shares are excluded due to their antidilutive effect as a result of the
Company's net loss.
-40-
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of the Company as of March 29,
2001 were as follows:
NAME AGE POSITION
- ---------------------------------------- ------- ---------------------------------------------------------------------
Gabriel Battista (1) 56 Chairman of the Board of Directors, Chief Executive Officer and
Director
Kenneth G. Baritz (3) 44 President and Director
Mark S. Fowler (2) 58 Director
Kevin D. Griffo 40 Executive Vice President - Sales and Marketing
Aloysius T. Lawn, IV 42 Executive Vice President - General Counsel and Secretary
Arthur J. Marks (3) 56 Director
Edward B. Meyercord, III 35 Chief Operating Officer - Chief Financial Officer and Treasurer
Ronald R. Thoma (1) 66 Director
George Vinall 45 Executive Vice President - Business Development
Thomas Walsh 41 Senior Vice President - Finance
(1) Director whose term expires in 2001.
(2) Director whose term expires in 2002.
(3) Director whose term expires in 2003.
GABRIEL BATTISTA. Mr. Battista currently serves the Company as its Chairman of
the Board of Directors and Chief Executive Officer. Prior to joining the Company
in January of 1999 as a Director and Chief Executive Officer, Mr. Battista
served as Chief Executive Officer of Network Solutions Inc., an Internet domain
name registration company. Prior to joining Network Solutions, Mr. Battista
served both as CEO and as President and Chief Operating Officer of Cable &
Wireless, Inc., a telecommunication provider. His career also included
management positions at US Sprint, GTE Telenet and General Electric Information
Services. Mr. Battista serves as a director of Capitol College, Systems &
Computer Technology Corporation (SCT), Online Technologies Group, Inc. (OTG),
VIA Net.works and 2nd Century Communications, Inc.
KENNETH G. BARITZ. Mr. Baritz has served as President of the Company since March
2000. Mr. Baritz was elected to the Company's Board of Directors on August 9,
2000. Prior to joining the Company, Mr. Baritz served as Chairman and Chief
Executive Officer of Access One from 1997 to 2000. Prior to Access One, Mr.
Baritz served as Chairman and Chief Executive Officer of AMNEX, Inc., a
telecommunications company, and also was a Director of AMNEX from October 1992
through March 1997. Prior to his tenure at AMNEX, Mr. Baritz served as a Vice
President of Bear Stearns & Co., Inc., an investment-banking firm. Mr. Baritz
currently serves on the board of a number of privately held companies.
MARK S. FOWLER. Mr. Fowler has been a director of the Company since September
1999. From 1981 to 1987, he was the Chairman of the FCC. From 1987 to 1994, Mr.
Fowler was Senior Communications Counsel at Latham & Watkins, a law firm, and of
counsel from 1994 to 2000. From 1991 to 1994, he was the founder, Chairman and
Chief Executive Officer of PowerFone Holdings Inc., a telecommunications
company. From 1994 to 2000 he was a founder and chairman of UniSite, Inc., a
developer of antenna sites for use by multiple wireless operators. From
-41-
1999 to date Mr. Fowler has served as a director of Pac-West Telecomm, Inc., a
competitive local exchange carrier. From 1999 to date, Mr. Fowler has served as
a director of Beasley Broadcast Group, a radio broadcasting company. Mr. Fowler
is also a founder and serves as Chairman of the Board of Directors of AssureSat,
Inc., a provider of telecommunications satellite backup services.
KEVIN D. GRIFFO. Mr. Griffo has served as the Company's Executive Vice President
- - Sales and Marketing since March 2000. Prior to joining the Company, Mr. Griffo
was the President and Chief Operating Officer of Access One. Mr. Griffo was also
employed by AMNEX from January 1995 to December 1997, holding various positions,
including Chief Operating Officer and President of AMNEX's Telecommunications
Division. Prior to joining AMNEX, he was southeastern regional Vice President
for LDDS WorldCom from August 1992 to December 1994. In such capacity, Mr.
Griffo had significant operating responsibility, which included responsibility
for operating sales offices and hiring and supervising sales personnel.
ALOYSIUS T. LAWN, IV. Mr. Lawn joined the Company in January 1996 and currently
serves as Executive Vice President - General Counsel and Secretary. Prior to
joining Talk.com, from 1985 through 1995, Mr. Lawn was an attorney in private
practice. Mr. Lawn is a director of Stonepath Group, Inc., a business
development company.
ARTHUR J. MARKS. Mr. Marks has been a director of the Company since August 1999.
He has been a General Partner of New Enterprise Associates, a venture capital
firm, since 1984. Mr. Marks serves as a director of three publicly traded
software companies, Advanced Switching Communications, Epicor Software Corp. and
Progress Software Corp., as well as a number of privately held companies.
EDWARD B. MEYERCORD, III. Mr. Meyercord currently serves as the Chief Financial
Officer, Chief Operating Officer and Treasurer of the Company. He joined the
Company in September of 1996 as the Executive Vice President, Marketing and
Corporate Development. Prior to joining the Company, Mr. Meyercord served as
Vice President in the Global Telecommunications Corporate Finance Group at
Salomon Brothers, Inc., based in New York and prior to Salomon Brothers he
worked in the corporate finance department at Paine Webber Incorporated.
RONALD R. THOMA. Mr. Thoma is currently a business consultant, having retired in
early 2000 as an Executive Vice President of Crown Cork and Seal Company, Inc.,
a manufacturer of packaging products, where he had been employed since 1955. Mr.
Thoma has served as a director of the Company since 1995.
GEORGE VINALL. Mr. Vinall joined the Company in January of 1999 as Executive
Vice President - Business Development. Prior to joining the Company, he served
as President of International Protocol LLC, a telecommunication consulting
business, as General Manager of Cable & Wireless Internet Exchange, an
international Internet service provider, and as Vice President, Regulatory &
Government Affairs of Cable and Wireless North America, a telecommunication
provider.
THOMAS M. WALSH. Mr. Walsh joined the Company in September of 2000 as Senior
Vice President - Finance. Before joining the Company, he served as a director at
Comcast Cellular Communications, a telecommunications company, from 1996 to
1999, and Regional Controller of Southwestern Mobil Systems, a successor
corporation, from 1999 to 2000. Prior to Comcast Cellular Communications he
worked for Call Technology Corporation, a telecommunications company, where he
was responsible for all finance and accounting functions as Chief Financial
Officer. Prior to his tenure with Call Technology Corporation, Mr. Walsh served
as Audit Manager for Ernst & Young. Mr. Walsh is a Certified Public Accountant.
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
Under Section 16(a) of the Securities Exchange Act of 1934, as amended,
the Company's directors and certain officers and persons who are the beneficial
owners of more than 10 percent of the Common Stock of the Company are required
to report their ownership of the Common Stock, options and certain related
securities and any changes in that ownership to the SEC. Specific due dates for
these reports for these reports have been established, and the Company is
required to report any failure to file by such dates in 2000. Mr. Marks' initial
report on Form 3 as to his holdings of shares of common stock of the Company
mistakenly underreported the number of shares then owned by him. Upon discovery
of this mistake a corrective amendment was filed. Otherwise, the Company
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believes that all of the required filings have been made in a timely manner. In
making this statement, the Company has relied on copies of the reporting forms
received by it.
ITEM 11. EXECUTIVE COMPENSATION.
The following table sets forth information for the fiscal years ended
December 31, 2000, 1999 and 1998 as to the compensation for services rendered
paid by the Company to the Chief Executive Officer and to the four other most
highly compensated executive officers of the Company whose annual salary and
bonus exceeded $100,000.
Summary Compensation Table
LONG TERM
ANNUAL COMPENSATION COMPENSATION
-------------------------------------------------- ----------------
SECURITIES
UNDERLYING
Name and Principal Position YEAR SALARY (1) BONUS (1) OPTIONS/SARS
- ---------------------------------------------- ----------- -------------- --------------- ----------------
Gabriel Battista, Chairman of the Board of 2000 --(2) $ 50,000 500,000(3)
Directors and Chief Executive Officer
1999 $1,500,000(2) $ 750,000 --
1998 -- $3,000,000(4) 1,650,000(5)
Edward B. Meyercord, III
Chief Operating Officer, Chief Financial 2000 $ 298,000 $ 30,000 350,000(3)
Officer and Treasurer
1999 $ 225,385 $ 150,000 450,000(6)
1998 $ 200,000 $ 128,338(7) --
Aloysius T. Lawn, IV,
Executive Vice President - General Counsel 2000 $ 260,500 $ 27,500 312,000(3)
and Secretary
1999 $ 233,269 $ 150,000 210,000(6)
1998 $ 150,000 $ 120,336(7) 50,000(6)
Kenneth G. Baritz, President 2000 $ 242,000(8) $ 30,000 1,645,257(5)(9)
1999 $ 121,461(11) -- 100,000(11)
1998 $ 120,960(11) -- --
George Vinall,
Executive Vice President- Business 2000 $ 248,000 $ 25,000 245,000(3)
Development
1999 $ 200,000 $ 150,000 --
1998 -- $ 175,000(10) 240,000(5)
(1) The costs of certain benefits not properly categorized as salary or benefits
are not included because they did not exceed, in the case of any executive
officer named in the table, the lesser of $50,000 or 10% of the total annual
salary and bonus reported in the above table.
-43-
(2) Under his employment agreement with the Company, Mr. Battista is entitled to
a minimum annual salary of $500,000. Mr. Battista's salary shown for 1999
includes, in addition to the $500,000 annual base salary for 1999, $1,000,000
representing a prepayment of $500,000 in salary for each of the years 2000 and
2001 as provided in Mr. Battista's employment agreement with the Company.
Therefore, no salary was paid to Mr. Battista in 2000.
(3) Options to purchase the Company common stock. The options granted to Messrs.
Battista, Meyercord, Lawn and Vinall were granted under the Company's 2000 Long
Term Incentive Plan. In 2000, Mr. Battista was granted (i) options to purchase
250,000 shares of the Company common stock at an exercise price of $2.00 per
share that vest in five years and (ii) options to purchase 250,000 shares of the
Company common stock at an exercise price of $4.75 per share that vest over
three years. In 2000, Mr. Meyercord was granted (i) options to purchase 150,000
shares of the Company common stock at an exercise price of $2.00 per share that
vest in five years and (ii) options to purchase 200,000 shares of the Company
common stock at an exercise price of $4.75 per share that vest over three years.
In 2000, Mr. Lawn was granted (i) options to purchase 137,500 shares of the
Company common stock at an exercise price of $2.00 per share that vest in five
years, (ii) options to purchase 50,000 shares of the Company common stock at an
exercise price of $2.31 half of which vested upon grant and the remainder of
which vested six months thereafter and (iii) options to purchase 125,000 shares
of the Company common stock at an exercise price of $4.75 per share that vest
over three years. In 2000, Mr. Vinall was granted (i) options to purchase
125,000 shares of the Company common stock at an exercise price of $2.00 per
share that vest in five years and (ii) options to purchase 120,00 shares of the
Company common stock at an exercise price of $4.75 per share that vested upon
grant. Each of the employment agreements for Messrs. Battista, Meyercord, Lawn
and Vinall provide for immediate vesting of options in event of a "change of
control" (as defined in such agreements). The above options that are stated to
vest in five years are subject to earlier vesting upon achievement of certain
financial results by the Company.
(4) Mr. Battista received a cash sign-on bonus of $3,000,000, which was paid in
December 1998.
(5) Options to purchase the Company common stock. The options shown as granted,
except as indicated below, were granted in connection with the hiring of the
respective executive officers. In 1998, Mr. Battista was granted options that
vest over three years to purchase 1 million shares of the Company common stock
at an exercise price of $10.4375 per share, and options that vested immediately
upon execution of his employment agreement to purchase an additional 650,000
shares at an exercise price of $7.00 per share. In 2000, Mr. Baritz was granted
options that vest over three years to purchase 1,300,000 shares of the Company
common stock at an exercise price of $13.69 per share. In 1998, Mr. Vinall was
granted options that vest over three years to purchase 240,000 shares of the
Company common stock at an exercise price of $8.5625 per share.
(6) Options to purchase the Company common stock. The options granted to Messrs.
Meyercord and Lawn were granted under the Company's 1998 Long Term Incentive
Plan. In 1999, Mr. Meyercord was granted options that vest over three years to
purchase 450,000 shares of the Company common stock at an exercise price of
$15.94 per share. In 1999, Mr. Lawn was granted options that vest over three
years to purchase 210,000 shares of the Company common stock at an exercise
price of $9.88 per share, and in 1998, was granted options to purchase 50,000
shares at an exercise price of $5.75 per share.
(7) Bonus paid in shares of the Company common stock and in-kind property
valued, in each case, at the then current market value.
(8) Mr. Baritz commenced his employment with the Company in March, 2000. Prior
to that time he was Chairman and Chief Executive Officer of Access One. On
August 9, 2000 a wholly owned subsidiary of the Company merged with and into
Access One. The amount includes amounts paid to Mr. Baritz by Access One prior
to his commencement of employment with the Company.
(9) Options to purchase the Company common stock. In 2000, Mr. Baritz was
granted under the Company 2000 Long Term Incentive Plan (i) options to purchase
150,000 shares of the Company common stock at an exercise price of $2.00 per
share that vest in five years and (ii) options to purchase 105,000 shares of the
Company common stock at an exercise price of $4.75 per share that vest over
three years. The remainder of the options granted to Mr. Baritz in 2000 were
granted under the 1999 Access One Incentive Option Plan, which plan was assumed
by the Company pursuant to the terms of Access One's acquisition by the Company.
The employment agreement for Mr. Baritz provides for immediate vesting of
options in event of a "change of control" (as defined in the agreement).
-44-
The above options that are stated to vest in five years are subject to earlier
vesting upon achievement of certain financial results by the Company.
(10) Mr. Vinall received a cash sign-on bonus of $175,000, which was paid in
December 1998.
(11) These amounts were paid to Mr. Baritz by Access One where he was Chairman,
Chief Executive Officer and Director.
STOCK OPTION GRANTS
The following table sets forth further information regarding grants of
options to purchase the Company common stock made by the Company during the
fiscal year ended December 31, 2000 to the executive officers named in the
Summary Compensation Table, above.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
Name Number of Percent of Total Exercise Price Expiration Date Potential Realizable Value
Securities Options/SARs per Share at Assumed Annual Rates of
Underlying Granted to Stock Option Term (2)
Options/SARs Employees in
Granted (1) 2000
- ----------------------------------------------------------------------------------------------------------------------------
5%($) 10%($)
------------------------------
Gabriel Battista 250,000 5.16% $2.00 12/12/10 $314,447 $769,871
250,000 $4.75 8/9/10 $746,812 $1,892,569
Edward B. 150,000 3.61% $2.00 12/12/10 $188,668 $478,123
Meyercord, III 200,000 $4.75 8/9/10 $597,450 $1,514,055
Aloysius T. Lawn, IV 137,500 3.22% $2.00 12/12/10 $172,946 $438,279
50,000 $2.31 11/15/05 $31,911 $70,514
125,000 $4.75 8/9/10 $373,406 $946,285
Kenneth G. Baritz 1,300,000 16.99% $13.69 3/24/10 $11,192,438 $28,363,835
105,000 $4.75 8/9/10 $313,661 $794,879
57,143 $2.89 6/15/09 $91,048 $224,256
33,114 $5.78 3/15/10 $120,370 $305,041
150,000 $2.00 12/12/10 $188,668 $478,123
George Vinall 125,000 2.53% $2.00 12/12/10 $157,224 $398,436
120,000 $4.75 8/9/10 $358,470 $908,433
(1) All options granted to Messrs. Battista, Meyercord, Lawn and Vinall in 2000
were granted under the Company 2000 Long Term Incentive Plan. The initial set of
options granted to Mr. Baritz in 2000 were granted pursuant to his entering into
an employment agreement with the Company in March, 2000. The options relating to
105,000 and 150,000 shares were granted under the Company 2000 Long Term
Incentive Plan. The remainder of the options granted to Mr. Baritz in 2000 were
granted under the 1999 Access One Incentive Option Plan, which plan was assumed
by the Company.
(2) Disclosure of the 5% and 10% assumed annual compound rates of stock
appreciation based on exercise prices are mandated by the rules of the SEC and
do not represent the Company's estimate or projection of future common stock
prices. The actual value realized may be greater or less than the potential
realizable value set forth in the table.
None of the executive officers in the Summary Compensation Table above
acquired any shares of the Company upon the exercise of options in 2000. On
December 31, 2000, the exercise prices of all of the options to
-45-
purchase shares of the Company held by each of the executive officers named in
the Summary Compensation Table were above the then market price for the
Company's shares.
EMPLOYMENT CONTRACTS
Gabriel Battista is party to an employment agreement with the Company
that was amended as of March 28, 2001 and now expires on December 31, 2004.
Under the terms of the agreement, as amended, Mr. Battista received a signing
bonus of $3,000,000 and is entitled to an annual salary of $500,000, plus a
discretionary bonus. The initial three years of salary under the agreement was
paid in advance. Mr. Battista is also entitled to other benefits and
perquisites. In addition, upon execution of the original agreement in 1998, Mr.
Battista was granted options that vest over three years to purchase 1,000,000
shares of the Company common stock at an exercise price of $10.4375 per share,
and options that vested immediately upon execution of the agreement to purchase
an additional 650,000 shares at an exercise price of $7.00 per share.
In the event of certain transactions (including an acquisition of the
Company's assets, a merger into another entity or a transaction that results in
the Company common stock no longer being required to be registered under the
Securities Exchange Act of 1934), Mr. Battista will receive an additional bonus
of $1,000,000 if the price per share for the Company common stock in such
transaction was less than or equal to $20.00 per share, or $3,000,000 if the
consideration is greater than $20.00 per share.
Edward B. Meyercord, III entered into a three-year employment agreement
with the Company effective as of March 26, 2001. Under the contract, Mr.
Meyercord is entitled to a minimum annual base salary of $300,000 and certain
other perquisites made available by the Company to its senior executive
officers.
Aloysius T. Lawn, IV entered into a three-year employment agreement
with the Company effective as of March 26, 2001. Under the contract, Mr. Lawn is
entitled to a minimum annual base salary of $275,000 and certain other
perquisites made available by the Company to its senior executive officers.
Kenneth G. Baritz entered into a three-year employment agreement with
the Company effective as of March 24, 2000. Under the contract, Mr. Baritz is
entitled to a minimum annual base salary of $300,000 and certain other
perquisites made available by the Company to its senior executive officers. In
connection with the agreement, Mr. Baritz was granted an option to purchase
1,300,000 shares of the Company common stock at an exercise price of $13.69 per
share.
George Vinall entered into a three-year employment agreement with the
Company effective as of December 28, 1998. Under the contract, Mr. Vinall is
entitled to a minimum annual base salary of $250,000 and certain other
perquisites made available by the Company to its senior executive officers. In
connection with the agreement, Mr. Vinall was granted an option to purchase
240,000 shares of the Company common stock at an exercise price of $8 9/16 per
share.
Each of the employment agreements for Messrs. Battista, Meyercord,
Lawn, Baritz and Vinall provide for immediate vesting of options in event of a
"change of control" (as defined in the agreements) of the Company and provide
for severance benefits in the event employment is terminated by the Company
without cause prior to the end of the term and for a certain period beyond the
end of the term in the event of a "change of control". The severance benefits
are generally the payment of an amount equal to two years' base salary plus the
average annual incentive bonus earned by the executive in the preceding four
years, as well as the continuation of various employee benefits for two years.
Each of the above-described agreements requires the executive to
maintain the confidentiality of the Company information and assign inventions to
the Company. In addition, each of the executive officers has agreed that he will
not compete with the Company by engaging in any capacity in any business that is
competitive with the business of the Company during the term of his respective
agreement and thereafter for specified periods.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
None.
-46-
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth certain information known to the Company
with respect to beneficial ownership of the Company common stock as of March 29,
2001 (except as otherwise noted) by (i) each stockholder who is known by the
Company to own beneficially more than five percent of the outstanding common
stock, (ii) each of the Company's directors and nominees for director, (iii)
each of the executive officers named below and (iv) all current directors and
executive officers of the Company as a group. Except as otherwise indicated
below, the Company believes that the beneficial owners of the common stock
listed below have sole investment and voting power with respect to such shares.
NUMBER OF SHARES PERCENT OF SHARES
NAME OF BENEFICIAL OWNER OR IDENTITY OF GROUP BENEFICIALLY OWNED (1) BENEFICIALLY OWNED
Legg Mason, Inc. 7,678,250 (4) 9.8%
100 Light Street
P. O. Box 1476
Baltimore, MD 21203
AOL Time Warner Inc./America Online, Inc. 6,843,356 (3) 8.4%
75 Rockefeller Plaza
New York, NY 10019
Massachusetts Financial Services Company 6,603,805 (2) 8.4%
500 Boylston Street
Boston, Massachusetts 02116
Paul Rosenberg 5,759,985 (5) 7.7%
650 N. E. 5th Avenue
Boca Raton, Fl 33432
Geocapital LLC 4,221,390 (6) 5.39%
825 Third Avenue
New York, NY 10022
Gabriel Battista 1,416,667 (7) 1.8%
Kenneth G. Baritz 2,285,017 (7) 2.9%
Mark S. Fowler 106,023 (7) *
Arthur J. Marks 194,240 (7) *
Ronald R. Thoma 97,934 (7) *
Edward B. Meyercord, III 281,130 (7) *
Aloysius T. Lawn, IV 278,650 (7) *
George Vinall 280,000 (7) *
All directors and executive officers as a group 5,668,488 (7) 6.8%
(10 persons)
- ---------
* Less than 1%
(1) The securities "beneficially owned" by a person are determined in
accordance with the definition of "beneficial ownership" set forth in
the regulations of the SEC and, accordingly, may include securities
-47-
owned by or for, among others, the spouse, children or certain other
relatives of such person. The same shares may be beneficially owned by
more than one person. Beneficial ownership may be disclaimed as to
certain of the securities.
(2) Massachusetts Financial Services Company ("MFS"), an investment
adviser, filed an amendment to a Schedule 13G with the SEC on February
12, 2001 (the "MFS 13G"), in which it reported beneficial ownership of
6,603,805 shares, 6,025,055 of which are also beneficially owned by MFS
Series Trust II-MFS Emerging Growth Fund, an investment company, and
578,750 of which are also owned by certain non-reporting entities as
well as MFS. The foregoing information is derived from the MFS 13G.
(3) The foregoing information is derived from the Schedule 13G filed by AOL
Time Warner Inc./America Online, Inc. on January 22, 2001.
(4) Includes 6,600,000 shares of the Company common stock beneficially
owned by LMM, LLC, 974,200 shares beneficially owned by Legg Mason
Capital Management, Inc. and 104,050 shares beneficially owned by Legg
Mason Wood Walker, Inc., according to an amendment to a Schedule 13G
filed by Legg Mason Wood Walker, Inc. on March 14, 2001.
(5) The foregoing information is derived from the Schedule 13D/A filed by
Paul Rosenberg, the Rosenberg Family Limited Partnership, PBR, Inc. and
the New Millennium Charitable Foundation on February 12, 1999.
(6) The foregoing information is derived from the Schedule 13G/A filed by
Geocapital, LLC on March 29, 2001.
(7) Includes shares of the Company common stock that could be acquired upon
exercise of options exercisable within 60 days after March 29, 2001.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Not applicable
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Annual
Report on Form 10-K.
1. Consolidated Financial Statements:
The Consolidated Financial Statements filed as part of this Form
10-K are listed in the "Index to Consolidated Financial Statements" in Item 8.
2. Consolidated Financial Statement Schedule:
The Consolidated Financial Statement Schedule filed as part of this
report is listed in the "Index to S-X Schedule."
Schedules other than those listed in the accompanying Index to S-X
Schedule are omitted for the reason that they are either not required, not
applicable or the required information is included in the Consolidated Financial
Statements or notes thereto.
-48-
TALK.COM INC. AND SUBSIDIARIES
INDEX TO S-X SCHEDULE
PAGE
----
Reports of Independent Accountants on Financial Statement Schedule 50
Schedule II -- Valuation & Qualifying Accounts 52
-49-
REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE
To the Board of Directors and
Stockholders of Talk.com Inc.:
Our audit of the consolidated financial statements referred to in our report
dated February 27, 2001 appearing in the 2000 Annual Report to Shareholders of
Talk.com Inc. and its subsidiaries (which report and consolidated financial
statements are incorporated by reference in this Annual Report on Form 10-K)
also included an audit of the financial statement schedule listed in Item
14(a)(2) of this Form 10-K. In our opinion, these financial statement schedule
present fairly, in all material respects, the information set forth therein when
read in conjunction with the related consolidated financial statements.
PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania
February 27, 2001
-50-
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
And Stockholders of Talk.com Inc.
The audits referred to in our report dated February 7, 2000, relating
to the consolidated financial statements of Talk.com Inc. and subsidiaries,
which is contained in Item 8 of this Form 10-K, included the audits of the
financial statement schedule listed in the accompanying index for each of the
two years in the period ended December 31, 1999. This financial statement
schedule is the responsibility of management. Our responsibility is to express
an opinion on this schedule based on our audits.
In our opinion, the financial statement Schedule II - - Valuation and Qualifying
Accounts, presents fairly, in all material respects, the information set forth
therein.
BDO Seidman, LLP
New York, New York
February 7, 2000
-51-
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
BALANCE AT ADDITIONS
BEGINNING OF CHARGED TO COSTS DEDUCTIONS FOR BALANCE AT END
DESCRIPTION DEDUCTIONS PERIOD AND EXPENSES WRITE-OFFS OF PERIOD
- --------------------------------------- ----------------- ------------------ ------------------ -----------------
YEAR ENDED DECEMBER 31, 2000:
Reserve and allowances deducted
from asset accounts:
Allowance for uncollectible accounts $5,021 $53,772 $(29,334) $29,459
====== ======= ========= =======
YEAR ENDED DECEMBER 31, 1999:
Reserve and allowances deducted
from asset accounts:
Allowance for uncollectible accounts $1,669 $28,250 $(24,898) $5,021
====== ======= ========= ======
YEAR ENDED DECEMBER 31, 1998:
Reserve and allowances deducted
from asset accounts: $2,419 $37,789 $(38,539) $1,669
====== ======= ========= ======
Allowance for uncollectible accounts
-52-
(3) EXHIBITS:
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
2.1 Agreement and Plan of Merger, dated as of March 24, 2000, by and among
Talk.com Inc., Aladdin Acquisition Corp. and Access One Communications
Corp., and Amendment thereto, dated as of June 29, 2000, which is
included as Annex A to the Joint Proxy Statement/Prospectus contained
in Registration Statement in Form S-4 (File No. 333-40980)
(incorporated by reference to Exhibit 2.1 to the Company's Registration
Statement in Form S-4 (File No. 333-40980)).
3.1 Composite form of Amended and Restated Certificate of Incorporation of
the Company, as amended through April 26, 1999 (incorporated by
reference to Exhibit 3.1 to the Company's report on Form 10-Q for the
quarter ended March 31, 1999).
3.2 Bylaws of the Company (incorporated by reference to Exhibit 3.2 to the
Company's registration statement on Form S-1 (File No. 33-94940)).
3.3 Certificate of Designation of Series A Junior Participating Preferred
Stock of Company dated August 27, 1999 (incorporated by reference to
Exhibit A to Exhibit 1 to the Company's registration statement on Form
8-A (File No. 000-26728)).
4.1 Specimen of Talk.com Inc. common stock certificate (incorporated by
reference to Exhibit 4.1 to the Company's Registration Statement on
Form S-4 (File No. 333-40980)).
4.2 Form of Warrant Agreement for Elec Communications, Kenneth Baritz, Joel
Dupre, Keith Minella, Rafael Scolari, and William Rogers dated August
9, 2000 (filed herewith).
4.3 Form of Warrant Agreement for MCG Credit Corporation dated August 9,
2000 (filed herewith).
4.4 Form of Warrant Agreement for MCG Credit Corporation dated October 20,
2000 (filed herewith).
4.5 Form of Warrant Agreement for MCG Finance Corporation dated October 20,
2000 (filed herewith).
10.1 Employment Agreement between the Company and Aloysius T. Lawn, IV dated
March 28, 2001 (filed herewith).*
10.2 Employment Agreement between the Company and Edward B. Meyercord, III
dated March 28, 2001 (filed herewith).*
10.3 Indemnification Agreement between the Company and Aloysius T. Lawn, IV
dated March 28, 2001(filed herewith). *
10.4 Indemnification Agreement between the Company and Edward B. Meyercord,
III (incorporated by reference to Exhibit 10.14 to the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 1996). *
10.5 Tel-Save Holdings, Inc. 1995 Employee Stock Option Plan (incorporated
by reference to Exhibit 10.15 to the Company's registration statement
on Form S-1 (File No. 33-94940)).*
-53-
10.6 Telecommunications Marketing Agreement by and among the Company,
Tel-Save, Inc. and America Online, Inc., dated February 22, 1997
(incorporated by reference to Exhibit 10.32 to the Company's Form 10-K
for the year ended December 31, 1996).+
10.7 Amendment No. 1, dated as of January 25, 1998, to the
Telecommunications Marketing Agreement dated as of February 22, 1997 by
and among the Company, Tel-Save, Inc. and America Online, Inc.
(incorporated by reference to Exhibit 10.31 to the Company's Form 10-K
for the year ended December 31, 1997).+
10.8 Amendment No. 2, dated May 14, 1998, among the Company, Tel-Save, Inc.
and America Online, Inc., which amends that certain Telecommunications
Marketing Agreement, dated as of February 22, 1997, as corrected and
amended by letter, dated April 23, 1997, and amended by an Amendment
No. 1, dated January 25, 1998 (incorporated by reference to Exhibit
10.1 to the Company's quarterly report on Form 10-Q, dated August 14,
1998).+
10.9 Amendment No. 3, effective as of October 1, 1998, among the Company,
Tel-Save, Inc. and America Online, Inc., which amends that certain
Telecommunications Marketing Agreement, dated as of February 22, 1997,
as corrected and amended by letter, dated April 23, 1997, and amended
by an Amendment No. 1, dated January 25, 1998, and an Amendment No. 2,
dated May 14, 1998 (incorporated by reference to Exhibit 10.22 to the
Company's Annual Report on Form 10-K for the year ended December 31,
1998).+
10.10 Amendment No. 4, effective as of June 30, 2000, among the Company,
Talk.com Holding Corp. and America Online, Inc., which amends that
certain Telecommunications Marketing Agreement, dated as of February
22, 1997, as corrected and amended by letter, dated April 23, 1997, and
amended by an Amendment No. 1, dated January 25, 1998, an Amendment No.
2, dated May 14, 1998, and an Amendment No. 3, effective October 1,
1998 (incorporated by reference to Exhibit 10.1 to Talk.com's Quarterly
Report on Form 10-Q dated August 14, 2000).+
10.11 Amendment No. 5, effective as of August 1, 2000, among the Company,
Talk.com Holding Corp. and America Online, Inc., which amends that
certain Telecommunications Marketing Agreement, dated as of February
22, 1997, as corrected and amended by letter, dated April 23, 1997, and
amended by an Amendment No. 1, dated January 25, 1998, an Amendment No.
2, dated May 14, 1998, an Amendment No. 3, effective October 1, 1998,
and an Amendment No. 4, effective June 30, 2000 (incorporated by
reference to Exhibit 10.3 to Talk.com's Quarterly Report on Form 10-Q
dated August 14, 2000).+
10.12 Letter dated August 25, 1999 from America Online, Inc. to the Company
(incorporated by reference to Exhibit 99.2 to the Company's Current
Report on Form 8-K dated August 27, 1999).
10.13 Indenture dated as of September 9, 1997 between the Company and First
Trust of New York, N.A. (incorporated by reference to Exhibit 4.3 to
the Company's registration statement on Form S-3 (File No. 333-39787)).
10.14 Indenture dated as of December 10, 1997 between the Company and First
Trust of New York, N.A. (incorporated by reference to Exhibit 10.34 to
the Company's Annual Report on Form 10-K for the year ended December
31, 1997).
10.15 Employment Agreement, dated as of November 13, 1998, between the
Company and Gabriel Battista (incorporated by reference to Exhibit 10.1
to the Company's Current Report on Form 8-K dated January 20, 1999).*
10.16 Amendment to Employment Agreement, dated March 28, 2001, between the
Company and Gabriel Battista (filed herewith).*
10.17 Indemnification Agreement, dated as of December 28, 1998, between the
Company and Gabriel Battista (incorporated by reference to Exhibit 10.2
to the Company's Current Report on Form 8-K dated January 20, 1999). *
-54-
10.18 Stock Option Agreement, dated as of November 13, 1998, between the
Company and Gabriel Battista (incorporated by reference to Exhibit 10.3
to the Company's Current Report on Form 8-K dated January 20, 1999).*
10.19 Stock Option Agreement, dated as of November 13, 1998, between the
Company and Gabriel Battista (incorporated by reference to Exhibit 10.4
to the Company's Current Report on Form 8-K dated January 20, 1999).*
10.20 Severance Agreement, dated as of December 31, 1998, between the Company
and Daniel Borislow (incorporated by reference to Exhibit 10.5 to the
Company's Current Report on Form 8-K dated January 20, 1999).
10.21 Exchange Agreement, dated as of December 31, 1998, among the Company,
Tel-Save, Inc. and Mark Pavol, as Trustee of that certain D&K Grantor
Retained Annuity Trust dated June 15, 1998 (incorporated by reference
to Exhibit 10.7 to the Company's Current Report on Form 8-K dated
January 20, 1999).
10.22 Modification of the Exchange Agreement, dated March 15, 1999, by and
among the Company, Tel-Save, Inc. and Mark Pavol (incorporated by
reference to Exhibit 10.34 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1998).
10.23 Registration Rights Agreement, dated as of December 31, 1998, among the
Company, Daniel Borislow, Mark Pavol, as Trustee of that certain D&K
Grantor Retained Annuity Trust, dated June 15, 1998 and the Trustee of
that certain D&K Grantor Retained Annuity Trust II (incorporated by
reference to Exhibit 10.8 to the Company's Current Report on Form 8-K
dated January 20, 1999).
10.24 Amendment of Registration Rights Agreement dated as of March 18, 1999,
by and among the Company, Daniel M. Borislow, and Seth Tobias
(incorporated by reference to Exhibit 10.36 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1998).
10.25 Amendment of Registration Rights Agreement dated as of March 18, 1999,
by and among the Company and Mark Pavol (incorporated by reference to
Exhibit 10.37 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1998).
10.26 1998 Long-Term Incentive Plan of the Company (incorporated by reference
to Exhibit 10.14 to the Company's Current Report on Form 8-K dated
January 20, 1999).*
10.27 Investment Agreement, dated as of December 31, 1998, as amended on
February 22, 1999, among the Company, America Online, Inc., and, solely
for purposes of Sections 4.5, 4.6 and 7.3(g) thereof, Daniel Borislow,
and solely for purposes of Section 4.12 thereof, Tel-Save, Inc. and the
D&K Retained Annuity Trust dated June 15, 1998 by Mark Pavol, Trustee
(incorporated by reference to Exhibit 10.41 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1998.).
10.28 Registration Rights Agreement, dated as of January 5, 1999, between the
Company and America Online, Inc. (incorporated by reference to Exhibit
10.42 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1998).
10.29 Indemnification Agreement, effective as of March 24, 2000 by Talk.com
Inc. and Access One Communications Corp. which is included as Annex C
to the Joint Proxy Statement/Prospectus contained in Registration
Statement in Form S-4 (File No. 333-40980) (incorporated by reference
to Exhibit 2.1 to the Company's Registration Statement in Form S-4
(File No. 333-40980)).
10.30 Form of Escrow Agreement effective August 9, 2000 by and among Talk.com
Inc., Aladdin Acquisition Corp. and Access One Communications Corp.
which is included as Annex D to the Joint Proxy Statement/Prospectus
contained in Registration Statement in Form S-4 (File No. 333-40980)
(incorporated by reference to Exhibit 2.1 to the Company's Registration
Statement in Form S-4 (File No. 333-40980)).
-55-
10.31 Employment Agreement between the Company and Kenneth G. Baritz dated
March 24, 2000 (incorporated by reference to Exhibit 10.5 to the
Company's Registration Statement in Form S-4 (File No. 333-40980)).*
10.32 Employment Agreement between the Company and Kevin Griffo dated March
24, 2000 (incorporated by reference to Exhibit 10.7 to the Company's
Registration Statement in Form S-4 (File No. 333-40980)).*
10.33 Sublease Agreement, dated January ___, 1997, by and between Gemini Air
Cargo, LLC and RMS International, Inc. (incorporated by reference to
Exhibit 10.43 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1998).
10.34 Sublease Agreement, dated as of January 20, 1999, by and between RMS
International and Tel-Save, Inc. (incorporated by reference to Exhibit
10.44 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1998).
10.35 Lease by and between Aetna Life Insurance Company and Potomac Financial
Group, L.L.C. (incorporated by reference to Exhibit 10.45 to the
Company's Annual Report on Form 10-K for the year ended December 31,
1998).
10.36 Agreement, effective as of February 28, 1999, by and among the Company,
Communication Telesystems International, d.b.a. WorldxChange
Communications, Tel-Save, Inc., Mark Pavol Roger B. Abbott and Rosalind
Abbott, and Edward Soren (incorporated by reference to Exhibit 10.46 to
the Company's Annual Report on Form 10-K for the year ended December
31, 1998).
10.37 Form of Indemnification Agreement, dated as of January 5, 1999, for
George Vinall (incorporated by reference to Exhibit 10.50 to the
Company's Annual Report on Form 10-K for the year ended December 31,
1998). *
10.38 Form of Non-Qualified Stock Option Agreement, dated as of December 16,
1998, for George Vinall, (incorporated by reference to Exhibit 10.51 to
the Company's Annual Report on Form 10-K for the year ended December
31, 1998).*
10.39 2000 Long-Term Incentive Plan (incorporated by reference to Exhibit
10.31 to the Company's Registration Statement on Form S-4 (No.
333-40980)). *
10.40 Form of Non-Qualified Stock Option Agreement, dated December 12, 2000,
for each of Gabriel Battista, Kenneth Baritz, Kevin Griffo, Aloysius T.
Lawn IV, Edward B. Meyercord, III, and George Vinall (filed herewith).*
10.41 Employment Agreement, dated as of December 16, 1998, between the
Company and George Vinall (incorporated by reference to Exhibit 10.62
to the Company's Annual Report on Form 10-K for the year ended December
31, 1998).*
10.42 Rights Agreement dated as of August 19, 1999 by and between the Company
and First City Transfer Company, as Rights Agent (incorporated by
reference to Exhibit 1 to the Company's registration statement on Form
8-A (File No. 000-26728)).
10.43 Amendment to Employment Agreement for Kenneth Baritz dated March 28,
2001 (filed herewith).*
10.44 Interconnect Agreement between BellSouth and The Other Phone Company
(incorporated by reference to Exhibit 10.47 to the Company's
Registration Statement in Form S-4 (File No. 333-40980)).
10.45 Agreement and Plan of Merger dated October 15, 1999, among Access One
Communications Corp., OmniCall Acquisition Corp. and OmniCall, Inc.
(incorporated by reference to Exhibit 10.48 to the Company's
Registration Statement in Form S-4 (File No. 333-40980)).
10.46 Agreement between Talk.com Holding Corp. and BellSouth
Telecommunications, Inc., dated May 22, 2000 (filed herewith).
-56-
10.47 Amendment to Interconnection Agreement between Talk.com Holding Corp.
and BellSouth Telecommunications, Inc., dated December 26, 2000 (filed
herewith).
10.48 Credit Facility Agreement, among Talk.com Holding Corp., Access One
Communications Corp. and certain of their direct and indirect
subsidiaries and MCG Finance Corporation dated as of October 20, 2000
(incorporated by reference to Exhibit 10.4 to Talk.com's Quarterly
Report of Form 10-Q dated November 14, 2000).
10.49 Guaranty between the Company and MCG Finance Corporation, dated as of
October 20, 2000 (incorporated by reference to Exhibit 10.5 to
Talk.com's Quarterly Report of Form 10-Q dated November 14, 2000).
10.50 Consulting Agreement dated as of July 5, 2000 between MCG Credit
Corporation and Access One Communications Corp. (incorporated by
reference to Exhibit 10.55 to the Company's Registration Statement in
Form S-4 (File No. 333-40980)).
10.51 Employment Agreement by and between Thomas M. Walsh and the Company
dated as of August 7, 2000 (incorporated by reference to Exhibit 10.1
to the Company's Quarterly Report on Form 10-Q dated November 14,
2000).*
10.52 Indemnification Agreement by and between Thomas M. Walsh and the
Company dated as of August 7, 2000 (incorporated by reference to
Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q dated
November 14, 2000).*
10.53 Non-Qualified Stock Option Agreement by and Thomas M. Walsh and the
Company dated as of August 7, 2000 (incorporated by reference to
Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q dated
November 14, 2000).*
10.54 Lease by and between Talk.com Holding Corp. and University Science
Center, Inc. dated April 10, 2000 (filed herewith).
10.55 Lease by and between The Other Phone Company, dba Access One
Communications and University Science Center, Inc. dated December 8,
1999 (filed herewith).
10.56 Lease by and between Talk.com Holding Corp. and Saw-Ban, Ltd. dated May
11, 2000 (filed herewith).
10.57 Letter dated August 2, 2000 from America Online, Inc. to the Company
(incorporated by reference to Exhibit 99.2 to the Company's Current
Report on Form 8-K dated August 3, 2000).
10.58 Restated Access One Communications Corp. 1997 Stock Option Plan
(incorporated by reference to Exhibit 4.2 to the Company's registration
statement on Form S-8 (File No. 333-52166).
10.59 Restated Access One Communications Corp. 1999 Stock Option Plan
(incorporated by reference to Exhibit 4.3 to the Company's registration
statement on Form S-8 (File No. 333-52166).
10.60 Amendment to Employment Agreement for Kevin Griffo dated March 28, 2001
(filed herewith).*
10.61 Amendment to Employment Agreement for George Vinall dated March 28,
2001 (filed herewith).*
10.62 Second Amendment to Investment Agreement dated as of August 2, 2000
between the Company and America Online, Inc. (incorporated by reference
to Exhibit 99.1 to the Company's Current Report on Form 8-K dated
August 3, 2000).
11.1 Net Income Per Share Calculation.
21.1 Subsidiaries of the Company.
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23.1 Consent of Pricewaterhouse Coopers LLP.
23.2 Consent of BDO Seidman.
27 Financial Data Schedule.
- ---------
* Management contract or compensatory plan or arrangement.
+ Confidential treatment previously has been granted for a portion of this
exhibit.
(b) Reports on Form 8-K.
No Current Reports on Form 8-K were filed by the Company during the three months
ended December 31, 2000.
-58-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
Date: March 30, 2001
TALK.COM INC.
By: Gabriel Battista /s/
-------------------------
Gabriel Battista
Chairman of the Board of Directors,
Chief Executive Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons on behalf of the registrant
in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
Gabriel Battista /s/ Chairman of the Board March 30, 2001
- ------------------------------------ of Directors, Chief Executive Officer and
Gabriel Battista Director (Principal Executive Officer)
Edward B. Meyercord III /s/ Chief Financial Officer March 30, 2001
- ------------------------------------ (Principal Financial Officer)
Edward B. Meyercord, III
Thomas M. Walsh /s/ Vice President - Finance March 30, 2001
- ------------------------------------ (Principal Accounting Officer)
Thomas M. Walsh
Kenneth G. Baritz /s/ Director March 30, 2001
- ------------------------------------
Kenneth G. Baritz
Mark S. Fowler /s/ Director March 30, 2001
- ------------------------------------
Mark S. Fowler
Arthur J. Marks /s/ Director March 30, 2001
- ------------------------------------
Arthur J. Marks
Ronald R. Thoma /s/ Director March 30, 2001
- ------------------------------------
Ronald R. Thoma
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