-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Lee5PKPpnY4y3SBEiZUIHR7AjpOjNqlbNL+6p4h3oyZfweqjG5/cZhZDEDN04NSl jdEnCZlEN9avmE3OpfmZtQ== 0001005150-00-000370.txt : 20000324 0001005150-00-000370.hdr.sgml : 20000324 ACCESSION NUMBER: 0001005150-00-000370 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000323 FILER: COMPANY DATA: COMPANY CONFORMED NAME: TALK COM CENTRAL INDEX KEY: 0000948545 STANDARD INDUSTRIAL CLASSIFICATION: RADIO TELEPHONE COMMUNICATIONS [4812] IRS NUMBER: 232827736 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-26728 FILM NUMBER: 576010 BUSINESS ADDRESS: STREET 1: 12020 SUNRISE VALLEY DRIVE CITY: RESTON STATE: VA ZIP: 22091 BUSINESS PHONE: 2158621500 MAIL ADDRESS: STREET 1: 12020 SUNRISE VALLEY DRIVE CITY: RESTON STATE: VA ZIP: 22091 FORMER COMPANY: FORMER CONFORMED NAME: TEL SAVE COM INC DATE OF NAME CHANGE: 19981117 FORMER COMPANY: FORMER CONFORMED NAME: TEL SAVE HOLDINGS INC DATE OF NAME CHANGE: 19950726 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------- 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, 1999 Commission File No. 0-26728 TALK.COM INC. (Exact name of registrant as specified in its charter) DELAWARE 23-2827736 -------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 12020 SUNRISE VALLEY DRIVE, SUITE 250 20191 RESTON, VIRGINIA (zip code) (Address of principal executive offices) (703) 391-7500 (Registrant's telephone number, including area code) SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED ------------------- ----------------------------------------- None Not applicable SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK, PAR VALUE $.01 PER SHARE RIGHTS TO PURCHASE SERIES A JUNIOR PARTICIPATING PREFERRED STOCK (Title of class) Indicate by check mark whether the registrant (1) has filed all documents and reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K. [X] As of March 20, 2000, the aggregate market value of voting stock held by non-affiliates of the registrant, based on the average of the high and low prices of the Common Stock on March 20, 2000 of $14.78 per share as reported on the Nasdaq National Market, was approximately $967,913,861 (calculated by excluding solely for purposes of this form outstanding shares owned by directors and executive officers). As of March 20, 2000, the registrant had issued and outstanding 65,789,152 shares of its Common Stock, par value $.01 per share. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive proxy statement for the 2000 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K. TALK.COM INC. INDEX TO FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1999 ITEM NO. PAGE NO. PART I 1. Business 1 2. Properties 8 3. Legal Proceedings 8 4. Submission of Matters to a Vote of Security Holders 8 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 8. Financial Statements and Supplementary Data 17 9. Changes in and Disagreements with Accountants and Financial Disclosure 38 PART III 10. Directors and Executive Officers of the Registrant 38 11. Executive Compensation 38 12. Security Ownership of Certain Beneficial Owners and Management 38 13. Certain Relationships and Related Transactions 38 PART IV 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 38 i PART I ITEM 1. BUSINESS OVERVIEW Talk.com Inc. through its subsidiaries, (the "Company" or "Talk.com") provides telecommunications services to residential and business customers throughout the United States, primarily to residential consumers through its e-commerce platform. The Company believes that it currently has the largest share of the e-commerce market for traditional long distance services. The Company's e-commerce platform is built around the Company's advanced online and web-enabled customer care, billing and information systems. The Company's telecommunication services offerings include long distance outbound service, inbound toll-free service and dedicated private line services for data. The Company has stated that it will continue to seek to leverage its e-commerce business platform to expand its customer base through existing and new marketing arrangements with new business partners and to build a diverse products and services portfolio, including non-telecommunications products and services. The Company markets its telecommunications services through its marketing agreements with various partners including America Online, Inc. ("AOL"), Prodigy Communications Corporation, Direct Merchants Bank, First USA Bank and CompuServe and on the Internet through its web site located at www.talk.com. The Company also sells its services on a wholesale basis. Talk.com carries a majority of its customers' calls over its own network. The Company's network includes Company-owned Lucent 5ESS-2000 switches located in selected areas throughout the United States. The 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 also developed and integrated into its network sophisticated information and billing systems that allow the Company to manage its network efficiently and to provide its customers with high quality customer care and billing systems. 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 both online, through its various partners and the Company's own web site located at www.talk.com, as well as through traditional channels, such as direct mail, telemarketing, independent resellers and partition arrangements. In 1999, the Company's sales and marketing efforts focused both on continuing the recruiting of AOL subscribers as customers of its telecommunications services under its 1997 marketing agreement with AOL and on establishing marketing agreements with new business partners such as Prodigy Communications Corporation, Wired Digital, Direct Sales International, Schoolcash.com, E*Trade, Direct Merchants Bank and First USA Bank. During 1998, the Company invested substantial sums for marketing under the AOL agreement to establish quickly its subscriber base of AOL customers as part of the Company's developing e-commerce strategy. Of the Company's approximately 1.5 million long distance online customers at the end of 1999, approximately 1.4 million were AOL subscribers and the others were customers obtained through the Company's own direct marketing or with its other marketing partners. At the end of 1998 virtually all of the Company's online customers were AOL subscribers. 1 During 1999, the Company's marketing efforts were carried out primarily through online marketing initiatives and through a variety of direct marketing programs targeting the customers of its marketing partners as subscribers. In addition, for those customers that have not subscribed to the Company's services online or through direct mail, the Company has a program with AOL and certain of its other marketing partners for the referral of customers by such partners directly to the Company's telephone service centers. 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 e-commerce customers: o Detailed rate schedules and product and service related information. o Online sign-up for the Company's telecommunications services. o Credit card billing. 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 telecommunications and other products or services while online on AOL's network or through the Company's own web site. The Company employs its own proprietary billing systems to enable online billing and credit card payment, eliminating the need for costly paper billing. 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 that its online billing systems provide it with a competitive advantage in the online market for telecommunications services. The Company's rights to market long distance and wireless telecommunications services on AOL on an exclusive basis expire on June 30, 2003. However, AOL may elect after June 30, 2000 to allow others to market long distance and wireless telecommunications services on AOL if AOL elects to forego the fixed annual payments from the Company under the AOL agreement (at least $60 million in the 12 months ending June 30, 2001). Under the agreement the Company is entitled to continue marketing its products and services on AOL through June 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) to market and sell wireless, local (if the Company begins marketing it under the AOL agreement before the end of the long distance exclusivity period) and long distance and other products and services over the AOL online network. Because of significant marketing rights that would continue even were a termination of the exclusivity period under the AOL agreement to occur, the Company is unable to determine at this date whether the early termination of the exclusivity period and the release of the Company's obligation to make the fixed payments to AOL will be beneficial or 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 telecommunications services to AOL subscribers. However, the Company is unable to predict: (1) whether potential 2 competitors of the Company will be willing to pay the substantial sums that the Company believes would be required to compensate AOL for foregoing the fixed payments to be paid by the Company during the long distance exclusivity period; or (2) 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 telecommunications services comparable to the Company's existing base of AOL subscribers. The Company continues to seek new marketing partners and arrangements to expand its opportunities to attract other customers to its services and the products and services that it offers to its expanding customer base. In 1999, the Company entered into several new marketing arrangements, including those with Prodigy Communications Corporation, First USA Bank and Direct Merchants Bank, under which the Company will offer its telecommunications services to their subscribers and customers. Also in 1999, as part of its efforts to expand the bundle of services available to its Internet customers, the Company introduced two new web based enhancements of the Company's core telecommunications services - 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. In addition, the Company has gained approval from Internet Corporation for Assigned Names and Numbers (ICANN) and the necessary certification from Network Solutions, Inc. thereby enabling the Company to assign web domain names ending in .com, .net, and .org to its customers. The Company plans to waive the underlying fees required for domain name registration for customers who use the Company's telecommunications services. Customers who prefer domain names on an unbundled basis will be charged market rates. Late in 1999, the Company announced that it would commence leasing local lines for resale, specifically targeting small and medium-sized businesses, which would represent the first major expansion of the Company's portfolio of telecommunication services. In addition, the Company expects to offer local calling to consumers in 2000. The Company expects that it initially will offer the local service to customers reached through its various marketing agreements, bundling the local service with its existing long distance telecommunications service offerings. Talk.com also provides, as a declining portion of its business, telecommunications services through independent resellers, primarily to small and medium-sized businesses. Although the Company still serves many customers in this manner, such partitions no longer comprise a majority of the Company's business as they once did. THE COMPANY'S NETWORK To provide its long distance telecommunications services to customers, the Company predominantly uses its own telecommunications network, One Better Net or "OBN". The Company generally uses OBN to provide services directly to its end users and partitions. As of December 31, 1999, the Company provisioned over OBN more than 90% of the lines using its services. Controlling its own network provides the Company with advantages compared to when the Company operated strictly as a reseller of the telecommunications services of other carriers, including lower costs of providing long distance services to its customers and greater control over those costs. This control allows the Company to manage its growth as a telecommunications service provider and to target its marketing efforts according to the overhead costs of delivering its services. Structure of the Network The Company's network is comprised of equipment and facilities that is either owned or leased by the Company and contracts for certain telecommunications 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. 3 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 OBN switches to switches owned by various local telecommunications 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 OBN. 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 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 it with a variety of other services. See "Service Agreements with Other Carriers." These contracts include services for assisting with the overflow of telecommunications traffic over OBN, 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 OBN 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 OBN 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 OBN, 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 telecommunications services for both its OBN and reselling operations. These services enable the Company to: o Connect the Company's OBN switches to each other o Connect the Company's switches to the switches of local telecommunications service carriers 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. 4 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 OBN 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. Information and Billing Services In connection with its online billing area under its agreement with AOL, the Company developed advanced online billing and information systems. In March 1999, the Company began providing its non-AOL customers with online access to billing information through its website (www.talk.com), which enables customers to view their billing information and call detail within minutes of completing a call. The Company believes this online service provides the most current information to customers offered by any telecommunications company. The Company also acquires billing and customer care services from other carriers and third party vendors. The Company provides to each partition computerized management systems that control order processing, accounts receivable, billing and status information in a streamlined fashion. Furthermore, when applicable, the systems interface with third party billing systems for order processing and billing services. Enhancements and additional features are provided as needed. 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, which information can be used to identify emerging end user trends and to respond with services to meet end users' changing needs. Such 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 Competition is intense in the long distance industry, even as the market continues to expand. Based on published FCC estimates, toll service revenues of U.S. long distance carriers have grown from $38.8 billion in 1984 to $88.6 billion in 1997. Although the Company believes that it has the human and technical resources to compete effectively, the Company's success will depend upon its continued ability to profitably provide high quality, high value services at prices generally competitive with, or lower than, those of its competitors. The Company has numerous competitors, many of which are substantially larger and have greater financial, technical and marketing resources than the Company. Three large carriers, AT&T, MCI WorldCom and Sprint, generate approximately 80% of aggregate revenue in the U.S. long distance industry. Approximately 140 other carriers account for the remainder of the long distance market. The aggregate market share (based on operating revenues) of all long distance carriers other than AT&T, MCI WorldCom and Sprint has grown from 2.6% in 1984 to 19.8% in 1997. During the same period, the market share of AT&T declined from 90.1% to 44.5%. The long distance market is subject to pricing pressure. The major carriers have targeted price plans at residential customers (the Company's primary target market under its various marketing agreements 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 long distance prices. Competition is fierce for the small to medium-sized businesses that the Company also serves. Additional pricing pressure may come from the introduction of new technologies, such as an 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. 5 The Company also competes on the basis of the quality of customer service that it provides to end users. The Company believes that its online and web-enabled billing and information systems have been an important factor in attracting customers and will be an important factor in determining the success of its overall e-commerce initiatives. There can be no assurance that competitors will not develop online billing and information systems that are comparable to the Company's systems. The entry of the Bell operating companies ("BOCs") into the long distance market may further heighten competition. Under the Telecommunications Act of 1996, the BOCs 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. The Federal Communications Commission, the Department of Justice and state regulators have been working with the BOCs to ensure they satisfy the conditions. As of late 1999, certain BOCs' have entered the long distance market in some states, including Bell Atlantic in New York State. BOC 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 BOCs, it is impossible to predict whether such safeguards will be adequate or what effect such conduct would have on the Company. Because of the BOCs' 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 BOCs, it may be more difficult for other providers of long distance services, such as the Company, to compete. Consolidation and alliances across geographic regions (e.g., Bell Atlantic/Nynex/GTE and SBC/Pacific Telesis Group/SNET/Ameritech) and in the long distance market (e.g., MCI/WorldCom/Sprint domestically and AT&T/British Telecom internationally) and across industry segments (e.g., AT&T/TCI/Media One) may also intensify competition from significantly larger, well-capitalized carriers. Such consolidation and alliances are providing some of the Company's competitors with the capacity to offer a "bundle" of services, including local, long distance and wireless telephone service, as well as Internet access and cable television service. The competitive telecommunications marketplace is marked by a high rate of customer attrition. The Company's competitors engage in national advertising campaigns and telemarketing programs and offer cash payments and other incentives to the Company's end users, who are not obligated to purchase any minimum usage amount and can discontinue service, without penalty, at any time. There can be no assurance that the Company will be able to continue to replenish its end user base, and failure to do so would have a material adverse effect on the Company. The Company's online marketing and provision of telecommunications services has been widely imitated by competitors on the Internet, and through their own web site offerings, numerous competitors now offer, over the Internet and on their own web sites, or through links from other web sites sign-up and billing and automatic payment through a credit card. The Company believes that its real-time, online billing system is unique in the marketplace and currently gives the Company a competitive advantage in the e-commerce market for telecommunications services. There can be no assurance, however, that potential competitors will not develop comparable billing and information systems. Any new telecommunications services, such as wireless and local services, offered by the Company would face the same competitive pressures that affect the Company's existing services. The Company faces competition not only from other providers of presubscribed long distance service, but also from dial-around long distance service and prepaid long distance calling cards. One of the Company's principal competitors, AT&T, is also a major supplier of services to the Company. The Company links some of its switching equipment with transmission facilities and services purchased or leased from AT&T and resells services obtained from AT&T. The Company also utilizes AT&T and AT&T's College and University Systems to provide certain billing services. 6 REGULATION The Company's provision of communications services is subject to government regulation. The Federal Communications Commission regulates interstate and international telecommunications, while the states 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 telecommunications 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 telecommunications services. The FCC and some states have rules that prohibit switching a customer from one long distance 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 carefully designed and enforced, such rules can have the incidental effect of entrenching incumbent carriers and hindering the growth of new competitors, such as the Company. Restrictions on the marketing of telecommunications services are becoming stricter in the wake of widespread consumer complaints throughout the industry about "slamming" (the unauthorized conversion of a customer's preselected telecommunications carrier) and "cramming" (the unauthorized provision of additional telecommunications services). The Telecommunications Act of 1996 strengthened penalties against slamming, and the FCC issued and updated rules tightening federal requirements for the verification of orders for telecommunications services and establishing additional financial penalties for slamming. The FCC continues to review its rules and determine whether sales of telecommunications services made over the Internet must also be verified through a telephone call or other off-line method. 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, FTC and state enforcement attention, could limit the scope and the success of the Company's and its partitions' marketing efforts and subject them to enforcement action. The FCC has granted interstate long distance service authority to Bell Atlantic under Section 271 of the Telecommunications Act of 1996 from the State of New York. Other Regional Bell operating companies shall seek to obtain similar authority on a state-by-state basis. These actions may increase competition within the affected states. Allegedly to combat slamming, many local exchange carriers have initiated "PIC freeze" programs that, once selected by the customer, require a customer seeking to change long distance carriers to contact the local carrier directly instead of having the long distance 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 made it difficult for customers to switch to the Company's long distance service. Statutes and regulations designed to protect consumer privacy also may have the incidental effect of hindering the growth of newer telecommunications 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 telecommunications services (such as local and wireless), as well as other services and products, to its existing customers, if and when the Company begins to offer such services and products. The FCC requires the Company and other providers of telecommunications services to contribute to the universal service fund, which helps to subsidize the provision of local telecommunications services and other services to low-income consumers, schools, libraries, health care providers, and rural and insular areas that are costly to 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 must file tariffs listing the rates, terms and conditions of the 7 Company's service, but the FCC has proposed to abolish some tariff filing requirements and instead mandate the posting of similar information on the Internet. Although the Company's tariffs, and the rates and charges they specify, are subject to FCC review, they are presumed to be lawful and have never been contested. 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 intrastate telecommunications 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 telecommunications 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 telecommunications 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. Actions taken by partitions may also expose the Company to investigations or enforcement actions by government authorities. To the extent that the Company makes additional telecommunications service offerings, the Company may encounter additional regulatory constraints. EMPLOYEES As of December 31, 1999, the Company employed 861 persons. The Company considers relations with its employees to be good. ITEM 2. PROPERTIES The Company leases an approximately 5,000 square foot facility in Reston, Virginia, that serves as the Company's headquarters and is where a majority 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 OBN 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. 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. At this point, no classes have been certified. A motion to dismiss was granted as to certain officers of the Company and denied as to the Company. There are currently no officers of the Company who are parties to these actions. The Company believes the allegations in the complaints are without merit and intends to defend the litigations vigorously. The Company also is a party to certain legal actions arising in the ordinary course of business. The Company believes that the ultimate outcome of the foregoing actions will not result in liability that would have a material adverse effect on the Company's financial condition or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Information required by Item 4 of this Form 10-K is incorporated by reference to the Company's report on Form 10-Q for the quarter ended September 30, 1999. 8 EXECUTIVE OFFICERS The executive officers of the Company as of March 20, 2000 were as follows:
NAME AGE POSITION - ---------------------------------------- ------- ---------------------------------------------------------------- Gabriel Battista 55 Chairman of the Board, Chief Executive Officer, President and Director Michael Ferzacca 42 Executive Vice President - Sales Janet C. Kirschner 46 Controller Aloysius T. Lawn, IV 41 Executive Vice President - General Counsel and Secretary Edward B. Meyercord, III 34 Executive Vice President - Chief Financial Officer and Treasurer Vincent W. Talbert 32 Executive Vice President - Marketing George Vinall 44 Executive Vice President - Business Development
GABRIEL BATTISTA. Mr. Battista joined the Company as its President, Chairman and Chief Executive Officer in January of 1999. Prior to joining the Company, Mr. Battista served as Chief Executive Officer of Network Solutions Inc., an Internet domain name registration company. Prior to joining Network Solutions, Mr. Battista served both as CEO and as President and Chief Operating Officer of Cable & Wireless, Inc., a telecommunications provider. His career also included management positions at US Sprint, GTE Telenet and General Electric Information Services. Mr. Battista serves as a director of Axent Technologies, Inc., Capitol College, Systems & Computer Technology Corporation (SCT), Online Technologies Group, Inc. (OTG) and VIA Net.works. MICHAEL FERZACCA. Mr. Ferzacca joined the Company in January of 1999. He was formerly Executive Vice President, Sales and Marketing for Pacific Gateway Exchange (a telecommunications company) before joining the Company. Prior to that, Mr. Ferzacca served in various roles at Cable & Wireless USA, a telecommunications provider, including manager of the Alternative Channels Division and Co-Chief Operating Officer. JANET C. KIRSCHNER. Mrs. Kirschner joined the Company in November 1999. Prior to joining the company, Mrs. Kirschner spent 16 years in corporate accounting with Bell Atlantic as a director in senior level positions, including corporate tax, internal auditing, financial systems implementation and business controls. Before her tenure with Bell Atlantic, she served six years as a manager and senior accountant for PriceWaterhouseCoopers, formerly Coopers & Lybrand. Mrs. Kirschner is a Certified Public Accountant. 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. EDWARD B. MEYERCORD, III. Mr. Meyercord currently serves as the Executive Vice President - Chief Financial 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. VINCENT W. TALBERT. Mr. Talbert joined the Company in the spring of 1999. Before joining the Company, Mr. Talbert was Senior Vice President of Internet marketing for First USA Bank where he was both the co-founder and co-leader of the Internet Marketing Group. Prior to First USA, Mr. Talbert worked for Citibank in its Credit Card Division. 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 telecommunications provider. 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 ---- --- 1998 First Quarter 30 19 1/4 Second Quarter 24 5/16 13 9/16 Third Quarter 19 3/8 9 1/16 Fourth Quarter 19 3/8 4 23/32 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 (through March 20, 2000) 20 1/8 14 1/16
As of March 17, 2000, there were approximately 379 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. 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, ----------------------- 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) CONSOLIDATED STATEMENTS OF INCOME DATA: Sales $ 516,548 $ 448,600 $ 304,768 $ 232,424 $ 180,102 Cost of sales 320,751 361,957 294,484 200,597 156,121 Gross profit 195,797 86,643 10,284 31,827 23,981 General and administrative expenses 42,696 41,939 34,650 10,039 6,280 Promotional, marketing and advertising 96,264 210,552 60,685 -- -- Significant other charges (income) (2,718) 91,025 -- -- -- Operating income (loss) 59,555 (256,873) (85,051) 21,788 17,701 Investment and other income (expense), net (1,856) (11,175) 50,715 10,585 331 Income (loss) before provision (benefit) for income 57,699 (268,048) (34,336) 32,373 18,032 Provision (benefit) for income taxes (1)(2) -- 40,388 (13,391) 12,205 7,213 Income (loss) before extraordinary gain (1) 57,699 (308,436) (20,945) 20,168 10,819 Extraordinary gain (from extinguishments of debt) 21,230 87,110 -- -- -- Net income (loss)(1) $ 78,929 $(221,326) $ (20,945) $ 20,168 $ 10,819 Income (loss) before extraordinary gain per share - Basic (1) $ 0.94 $ (5.20) $ (0.33) $ 0.38 $ 0.34 Extraordinary gain per share - Basic $ 0.35 $ 1.47 -- -- -- Net income (loss) per share - Basic (1) $ 1.29 $ (3.73) $ (0.33) $ 0.38 $ 0.34 Weighted average common shares outstanding - Basic 61,187 59,283 64,168 52,650 31,422 Income (loss) before extraordinary gain per share - Diluted (1) $ 0.90 $ (5.20) $ (0.33) $ 0.35 $ 0.32 Extraordinary gain per share - Diluted $ 0.33 $ 1.47 -- -- -- Net income (loss) per share - Diluted (1) $ 1.23 $ (3.73) $ (0.33) $ 0.35 $ 0.32 Weighted average common and common equivalent shares outstanding - Diluted 64,415 59,283 64,168 57,002 33,605 AT DECEMBER 31, 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- (IN THOUSANDS) CONSOLIDATED BALANCE SHEET DATA: Working capital $ 87,125 $ 13,061 $ 634,788 $ 175,597 $ 38,171 Total assets 215,008 272,560 814,891 257,008 71,388 Convertible debt 84,985 242,387 500,000 -- -- Total stockholders' equity (deficit) 40,103 (136,785) 222,828 230,720 41,314
- ---------- (1) For the period ended September 19, 1995, Talk.com Holding Corp., the predecessor corporation to the Company ("Predecessor Corporation") elected to report as an S corporation for federal and state income tax purposes. Accordingly, the Predecessor Corporation's stockholders included their respective shares of the Company's taxable income in their individual income tax returns. The pro forma income taxes reflect the taxes that would have been accrued if the Company had elected to report as a C corporation. (2) The provision for income taxes in 1998 represents a valuation allowance for deferred tax assets recorded in prior periods and current tax benefits that may result from the 1998 loss. The Company provided the valuation allowances in view of the loss incurred in 1998, the uncertainties resulting from intense competition in the telecommunications industry and the lack of any assurance that the Company will realize any tax benefits. The Company has continued to provide a valuation allowance against its deferred tax assets at December 31, 1999. 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:
1999 1998 1997 ---- ---- ---- Sales 100.0% 100.0% 100.0% Cost of sales 62.1 80.7 96.6 ----- ----- ----- Gross profit 37.9 19.3 3.4 General and administrative expenses 8.3 9.3 11.4 Promotional, marketing and advertising expenses 18.6 46.9 19.9 Significant other charges (income) (0.5) 20.3 -- ----- ----- ----- Operating income (loss) 11.5 (57.2) (27.9) Investment and other income (expense), net (0.4) (2.5) 16.6 ----- ----- ----- Income (loss) before income taxes 11.1 (59.7) (11.3) Provision (benefit) for income taxes -- 9.0 (4.4) ----- ----- ----- Income (loss) before extraordinary gain 11.1 (68.7) (6.9) Extraordinary gain 4.1 19.4 -- ----- ----- ----- Net income (loss) 15.2% (49.3)% (6.9)% ===== ===== =====
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998 Sales. Sales increased by 15.1% to $516.5 million in 1999 from $448.6 million in 1998. The increase in sales primarily reflected an increase in the number of online customers. The increase in online sales was partially offset by a decrease in the Company's other sales. The Company has increased the number of agreements it has with marketing partners, which have significantly contributed to the rate of growth in the online business. Online sales could be affected adversely by the intense competition in this industry and have continued to be affected adversely by the PIC freezes implemented by the local telephone companies. There can be no assurance that the Company will continue to increase sales on a quarter-to-quarter or year-to-year basis. A significant percentage of the Company's revenues in 1999 and 1998 were derived from long distance telecommunications services provided to customers who were obtained under the AOL agreement. While the Company's rights to market exclusively under the AOL agreement do not expire until June 30, 2003, AOL has the right to elect to permit others to market long distance telecommunications services after June 30, 2000 to AOL's subscribers and forego its rights to fixed annual payments from the Company, which would be at least $60 million in the 12 months ending June 30, 2001. Notwithstanding any such AOL election, the Company's rights to continue to market its services to AOL subscribers on a non-exclusive basis, but with significant marketing rights, would continue until June 30, 2003. The Company is unable to predict what the consequences of such a termination of its exclusive rights, with the corresponding release from the fixed payments, would be. The Company believes that it could retain a substantial portion of its existing base and continue to attract new customers by continuing to be competitive on service and price. The Company also would continue to market its services to the AOL subscribers and to continue its efforts to expand its non-AOL base of online customers. However, a significant decline in its AOL subscribers that is not offset by growth in non-AOL subscribers could have a significant effect on the Company's results of operations and cash flow. Cost of Sales. Cost of sales decreased by 11.4% to $320.8 million in 1999 from $362.0 million in 1998. This decrease was primarily due to lower network usage costs for services on the Company's OBN network on a per minute basis and lower partition costs due to the decrease in other sales, as noted above. Gross Margin. Gross margin increased to 37.9% in 1999 from 19.3% in 1998. The increase in gross margin was primarily due to lower network usage costs for OBN services on a per minute basis, lower partition costs due to the decrease in other sales, as noted above, and lower bad debt expense. 12 General and Administrative Expenses. General and administrative expenses increased by 1.8% to $42.7 million in 1999 from $41.9 million in 1998, but decreased as a percentage of sales. The increase in general and administrative expenses was due primarily to increased costs associated with hiring additional personnel to support the Company's continuing growth, offset in part by the elimination of general and administrative expenses of TSFL Holdings, Inc. (as discussed below) and decreased fees for professional services. Promotional, Marketing, and Advertising Expenses. During 1999, the Company incurred $96.3 million of promotional, marketing and advertising expense to expand its online customer base. During 1998, the Company incurred $210.6 million of promotional, marketing and advertising expense, including $49.7 million related to the AOL Agreement, $22.0 million for the performance warrants issued to AOL during 1998, and $138.9 million of promotional, marketing and advertising expense to expand its online customer base. Significant Other Charges (Income). During 1999, the Company sold the business units of TSFL Holdings, Inc. (formerly Symetrics Industries, Inc.), resulting in a gain of $2.7 million which was included in significant other charges (income). During 1998, the Company allocated $21.0 million of the acquisition cost of TSFL Holdings, Inc. to purchased research and development expense, which was included in significant other charges (income). Investment and Other Income (Expense), Net. Investment and other income (expense), net was $(1.9) million in 1999 versus $(11.2) in 1998. During 1999, investment and other income (expense), net consists primarily of interest income offset by interest expense related to the Company's convertible debt. Extraordinary Gain. During 1999, the Company recorded an extraordinary gain of $21.2 million from the acquisition of the Company's convertible debt at a discount from its aggregate principal amount. YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997 Sales. Sales increased by 47.2% to $448.6 million in 1998 from $304.8 million in 1997. The increase in sales resulted primarily from the Company's marketing campaign directed at generating new customers under the AOL agreement. This AOL-related sales increase offset a decrease in the Company's non-AOL sales, and reflected, to a lesser extent, the Company's focus on marketing under the AOL agreement. Cost of Sales. Cost of sales increased by 22.9% to $362.0 million in 1998 from $294.5 million in 1997 as a result of increased sales offset by certain charges in 1997, totaling $41.5 million, discussed below. Gross Margin. Gross margin increased to 19.3% in 1998 from 17.0%, excluding certain charges totaling $41.5 million (as described below) in 1997. The increase in gross margin was primarily due to lower network usage costs for OBN services and lower local and international access charges, in each case on a per call basis. General and Administrative Expenses. General and administrative expenses increased by 21.0% to $41.9 million in 1998 from $34.7 million in 1997. The increase in general and administrative expenses was due primarily to the costs associated with hiring additional personnel to support the Company's continuing growth, the general and administrative expense incurred as a result of the acquisitions of Compco, Inc. and ADS Holdings, Inc. which were acquired in November 1997 and January 1998, respectively, and increased fees for professional services. Promotional, Marketing and Advertising Expense -- Primarily AOL. During 1998 the Company incurred $210.6 million of expenses to expand its online customer base. These expenses included $49.7 million for online advertising under the AOL Agreement, $22.0 million for the value of performance warrants granted to AOL for net customer gains and $138.9 for offline advertising. During 1997, the Company incurred $60.7 million that consisted of $35.9 million for exclusivity under the AOL Agreement, $13.2 million for production of advertising, $7.9 million for online advertising for the fourth quarter of 1997, $1.2 million representing the value of performance warrants paid to AOL for net customer gains and $2.5 million for other advertising. Significant Other Charges. Significant other charges consist of $91.0 million of expenses incurred in the fourth quarter of 1998 related to changes in the Company's basic business operations. In January 1999, the Company negotiated substantial amendments to the AOL and CompuServe agreements that, among other things, reduced the amount of online advertising to which the Company was entitled to over the remaining term of the agreement and eliminated payments and issuance of warrants to AOL for customer 13 gains and profit sharing payments to AOL. The Company agreed to fixed quarterly payments ranging from $10 - $15 million during the exclusivity period of the agreement and AOL agreed to contribute up to $4.0 million per quarter for offline marketing. As a result of the amendment, the Company wrote off prepaid AOL, CompuServe and other marketing-related expenses of $37.6 million. In connection with hiring a new Chairman and Chief Executive Officer and several other key executive personnel and severance payments relating to this change in management, the Company incurred $12.7 million of incentive and severance expense. The Company acquired ADS Holdings, Inc. (formerly Symetrics, Inc.), a manufacturer of digital telephone switching equipment, in January 1998 for $18.6 million. The Company planned to complete development of a digital switch to provide state of the art features for use in the Company's operations as a competitive local exchange carrier. The Company allocated $21 million of the acquisition cost to purchased research and development expense in the first quarter of 1998 and continued to invest in additional research and development throughout 1998. In November 1997, the Company acquired Compco, Inc, a provider of communications software in the college and university marketplace for $13.7 million which exceeded the net assets acquired by $10.6 million. In the fourth quarter of 1998, the Company decided to sell the assets of ADS Holdings, Inc. and to delay entry into the college and university marketplace. As a result, the assets of ADS Holdings, Inc. and Compco, Inc. were written down to expected realizable value. The Company recorded $15 million relating to the impairment of these assets and reclassified the $22.2 million of research and development expense to significant other charges. In the fourth quarter of 1998, the Company reconfigured its telecommunications network, OBN, to provide for fiber optic connections among its switches and incurred $3.5 million of expense. Investment and Other Income (Expense), Net. Investment and other income (expense), net was $(11.2) million in 1998 versus $50.7 million in 1997. During 1998, investment and other income (expense), net consists primarily of investment income and trading losses of $11.0 million offset by interest expense related to the Company's Convertible Notes of $22.2 million. Provision for Income Taxes. The Company had recorded net deferred tax assets at December 31, 1997 and March 31,1998 primarily representing net operating loss carry-forwards and other temporary differences because the Company believed that no valuation allowance was required for these assets due to future reversals of existing taxable temporary differences and expectation that the Company will generate taxable income in future years. In June 1998, the Company decided to make substantial marketing and advertising expenditures to establish a broad base of online customers from AOL's membership. As discussed above, these expenditures led to a significant loss for 1998. In view of these losses, the uncertainties resulting from intense competition in the telecommunications industry and the lack of any assurance that the Company will realize any of the tax benefits, the Company decided in June 1998 to provide a 100% valuation allowance for the previously recorded deferred tax benefits and to provide a 100% valuation allowance for the current and future tax benefits resulting from the 1998 loss. Valuation allowances of approximately $115.0 million were included in provision for income taxes, for the year ended December 31, 1998. Extraordinary Gain. During 1998, the Company recorded an extraordinary gain of $87.1 million in connection with the acquisition of the Company's convertible debt at a discount. LIQUIDITY AND CAPITAL RESOURCES The Company's working capital was $87.1 million and $13.1 million at December 31, 1999 and 1998, respectively. This increase in working capital is primarily a result of the cash generated from the Company's operations and the exercise of stock options. In addition the Company received $11.1 million in 2000 in connection with the exercise of outstanding Common Stock rights prior to their expiration in February 2000. 14 The Company expended an aggregate of $132.9 million and $429.9 million of cash, Common Stock and other consideration for the repurchased outstanding securities during 1999 and 1998 respectively. During 1999 the Company repurchased an aggregate principal amount of $157.4 million of Convertible Notes. The Company (a) purchased from Daniel Borislow, the Company's former Chairman and Chief Executive Officer, and two trusts for the benefit of Mr. Borislow's children $85,857,000 aggregate principal amount of the Company's Convertible Notes for $72.3 million in cash; (b) exchanged the $53.7 million remaining on certain WorldxChange Notes payable to the Company with a trust for the benefit of Mr. Borislow's children for $62,545,000 aggregate principal amount of the Company's Convertible Notes and (c) purchased $9,000,000 aggregate principal amount of the Company's Convertible Notes for $6.9 million in Common Stock. As of December 31, 1999, the Company had reduced the principal amount outstanding of its Convertible Notes to $85.0 million ($66.9 million of 4 1/2% notes and $18.1 million of 5% notes). During 1999 the Company also purchased from Mr. Borislow approximately 639,000 shares of Common Stock for approximately $7.7 million with proceeds from the exercise of stock options pursuant to agreements with Mr. Borislow. During 1998, the Company repurchased approximately 18.8 million shares for an aggregate of $265.1 million ($239.9 million cash and $25.2 million in other consideration) and repurchased approximately $257.6 million principal amount of the Company's Convertible Notes for approximately $164.8 million ($86.3 million in cash, $69.5 million in Common Stock and $9.0 million in other consideration). The Company invested $6.5 million in capital equipment during 1999. On January 5, 1999, pursuant to an Investment Agreement between AOL and the Company, AOL made a significant equity investment in the Company, acquiring 4,121,372 shares of Common Stock for $55.0 million in cash and the surrender of rights to acquire up to 5,076,016 shares of Common Stock pursuant to various warrants held by AOL. Under the terms of the Investment Agreement with AOL, the Company has agreed to reimburse AOL for losses AOL may incur on the sale of any of the 4,121,372 shares during the period from June 1, 1999 through September 30, 2000. The reimbursement amount would be determined by multiplying the number of shares, if any, that AOL sells during the applicable period by the difference between the purchase price per share paid by AOL, or $19 per share, and the price per share that AOL sells the shares for, if less than $19 per share. The reimbursement amount may not exceed $14 per share for 2,894,737 shares or $11 per share for 1,226,635 shares. Accordingly, the maximum amount payable to AOL as reimbursement on the sale of AOL's shares would be approximately $54.0 million plus AOL's reasonable expenses incurred in connection with the sale. The Company has the option of issuing a six-month 10% note payable to AOL to satisfy the reimbursement amount or other amounts payable on exercise of its first refusal rights. Assuming AOL were to sell all of its shares subject to the Company reimbursement obligation at the closing price of Common Stock as of March 20, 2000, the reimbursement amount would be approximately $20.3 million. AOL also has the right, on termination of the Company's long distance exclusivity under its marketing agreement with AOL to require the Company to repurchase warrants held by AOL to purchase 2,721,984 shares Common Stock for $36.3 million, which repurchase price can be paid in Common Stock, cash or a quarterly amortizing, two-year promissory note of the Company. The Company has pledged the stock of its subsidiaries and has agreed to fund an escrow account of up to $35 million from 50% of the proceeds of any debt financing, other than a bank, receivable or other asset based financing of up to $50 million, to secure its obligations under the Investment Agreement with AOL. Mr. Borislow has agreed to guarantee up to $20,000,000 of the Company's reimbursement obligations under the Investment Agreement with AOL. As previously reported, the Company was subject to certain restrictions under a registration rights agreement between the Company and Mr. Borislow that could have affected the Company's ability to raise capital and engage in other types of financing transactions. As of December 31, 1999, Mr. Borislow and the two trusts for the benefit of Mr. Borislow's children, which have the ability to distribute Common Stock to Mr. Borislow, held in the aggregate less than 2% of the outstanding Common Stock. Accordingly, the Company believes that the restrictions no longer apply to the Company. The Company generally does not have a significant concentration of credit risk with respect to accounts receivable due to the large number of end users comprising the Company's customer base and their dispersion across different geographic regions. The Company maintains reserves for potential credit losses and, to date, such losses have been within the Company's expectations. The Company does not, and has not historically, required significant amounts of working capital for its day-to-day operations. The Company believes that its current cash position and the cash flow expected to be generated from operations will be sufficient to fund its capital expenditures, working capital and other cash requirements for at least the next twelve months. The Company also believes that, assuming the current market 15 price of its Common Stock, its cash flow from operations will be sufficient to fund any reimbursement amount in the event that AOL elects to sell its shares of Common Stock at a price below $19 per share and that, alternatively, it has the ability to obtain the necessary financing to fund its obligations under the AOL Investment Agreement. Should the Company seek to raise additional capital, there can be no assurance that, given current market conditions, the Company would be able to raise such additional capital on terms acceptable to the Company. YEAR 2000 The "Year 2000 issue" refers to the potential harm from computer programs that fail due to misidentification of dates after January 1, 2000. The Company did not encounter any disruptions in service or operations as a result of Year 2000 computer programming. The Company did not separately identify costs incurred in connection with its Year 2000 compliance activities. The Company did not believe such costs to be significant because they generally have been incurred in the normal course of internally modifying and updating the Company's software programs. Future expenditures are not expected to be significant and will be funded out of operating cash flows. * * * * * Certain of the statements contained herein may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such statements are identified by the use of forward-looking words or phrases, including, but not limited to, "estimates," "expects," "expected," "anticipates," and "anticipated." These forward-looking statements are based on the Company's current expectations. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, there can be no assurance that such expectations will prove to have been correct. Forward-looking statements involve risks and uncertainties and the Company's actual results could differ materially from the Company's expectations. Important factors that could cause such actual results to differ materially include, among others, adverse developments in the Company's relationship with AOL, increased price competition for long distance services, failure of the marketing of long distance services under its agreement with its various marketing partners, attrition in the number of end users, and changes in government policy, regulation and enforcement. The Company undertakes no obligation to update its forward-looking statements. 16 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA TALK.COM INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PAGE ---- Report of Independent Certified Public Accountants 18 Consolidated balance sheets as of December 31, 1999 and 1998 19 Consolidated statements of operations for the years ended December 31, 1999, 1998 and 1997 20 Consolidated statements of stockholders' equity (deficit) for the years ended December 31, 1999, 1998 and 1997 21 Consolidated statements of cash flows for the years ended December 31, 1999, 1998 and 1997 22 Notes to consolidated financial statements 23-37 17 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Board of Directors and Stockholders of Talk.com Inc. We have audited the accompanying consolidated balance sheets of Talk.com Inc. and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of operations, stockholders' equity (deficit) and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Talk.com Inc. and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with generally accepted accounting principles. BDO Seidman, LLP New York, New York February 7, 2000 18 TALK.COM INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT FOR SHARE DATA)
December 31, ---------------------------- 1999 1998 ---- ---- Assets Current: Cash and cash equivalents $ 78,937 $ 3,063 Marketable securities -- 89,649 Accounts receivable, trade, net of allowance for uncollectible 59,501 46,587 Advances to partitions and notes receivable 3,600 1,870 Prepaid expenses and other current assets 8,855 8,600 - ---------------------------------------------------------------------------- --------- --------- Total current assets 150,893 149,769 Property and equipment, net 57,335 56,703 Intangibles, net 1,068 1,150 Other assets 5,712 64,938 - ---------------------------------------------------------------------------- --------- --------- Total assets $ 215,008 $ 272,560 - ---------------------------------------------------------------------------- --------- --------- Liabilities, Contingent Redemption Value of Common Stock and Stockholders' Equity (Deficit) Current: Margin account indebtedness $ -- $ 49,621 Accounts payable and accrued expenses: Trade 47,965 64,794 Partitions 1,676 4,380 Taxes and other 14,127 17,913 - ---------------------------------------------------------------------------- --------- --------- Total current liabilities 63,768 136,708 Convertible debt 84,985 242,387 Deferred revenue 21,000 28,400 Other liabilities -- 1,850 - ---------------------------------------------------------------------------- --------- --------- Total liabilities 169,753 409,345 - ---------------------------------------------------------------------------- --------- --------- Commitments and Contingencies Contingent redemption value of common stock 5,152 -- - ---------------------------------------------------------------------------- --------- --------- Stockholders' equity (deficit): Preferred stock, $.01 par value, 5,000,000 shares authorized; no shares outstanding -- -- Common stock - $.01 par value, 300,000,000 shares authorized; 670 669 Additional paid-in capital 208,453 265,325 Deficit (139,300) (218,229) Treasury stock (29,720) (184,550) - ---------------------------------------------------------------------------- --------- --------- Total stockholders' equity (deficit) 40,103 (136,785) - ---------------------------------------------------------------------------- --------- --------- Total liabilities, contingent redemption value of common stock and stockholders' equity (deficit) $ 215,008 $ 272,560 - ---------------------------------------------------------------------------- --------- ---------
See accompanying notes to consolidated financial statements. 19 TALK.COM INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
YEAR ENDED DECEMBER 31, ----------------------------------------------- 1999 1998 1997 ---- ---- ---- Sales $ 516,548 $ 448,600 $ 304,768 Cost of sales 320,751 361,957 294,484 --------- --------- --------- Gross profit 195,797 86,643 10,284 General and administrative expenses 42,696 41,939 34,650 Promotional, marketing and advertising expenses 96,264 210,552 60,685 Significant other charges (income) (2,718) 91,025 -- --------- --------- --------- Operating income (loss) 59,555 (256,873) (85,051) Investment and other income (expense), net (1,856) (11,175) 50,715 --------- --------- --------- Income (loss) before provision (benefit) for income taxes 57,699 (268,048) (34,336) Provision (benefit) for income taxes -- 40,388 (13,391) --------- --------- --------- Income (loss) before extraordinary gain 57,699 (308,436) (20,945) Extraordinary gain from extinguishment of debt 21,230 87,110 -- --------- --------- --------- Net income (loss) $ 78,929 $(221,326) $ (20,945) ========= ========= ========= Income (loss) before extraordinary gain per share - Basic $ 0.94 $ (5.20) $ (0.33) Extraordinary gain per share - Basic 0.35 1.47 -- --------- --------- --------- Net income (loss) per share - Basic $ 1.29 $ (3.73) $ (0.33) ========= ========= ========= Weighted average common shares outstanding - Basic 61,187 59,283 64,168 ========= ========= ========= Income (loss) before extraordinary gain per share - Diluted $ 0.90 $ (5.20) $ (0.33) Extraordinary gain per share - Diluted 0.33 1.47 -- --------- --------- --------- Net income (loss) per share - Diluted $ 1.23 $ (3.73) $ (0.33) ========= ========= ========= Weighted average common and common equivalent shares outstanding - Diluted 64,415 59,283 64,168 ========= ========= =========
See accompanying notes to consolidated financial statements. 20 TALK.COM INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (IN THOUSANDS)
COMMON STOCK ADDITIONAL TREASURY STOCK ---------------------- PAID-IN ACCUMULATED ----------------------- SHARES AMOUNT CAPITAL DEFICIT SHARES AMOUNT TOTAL --------- --------- ----------- ----------- ----------- ---------- ----------- Balance, January 1, 1997 62,238 $ 622 $ 210,616 $ 24,042 (428) $ (4,560) $ 230,720 Net loss -- -- -- (20,945) -- -- (20,945) Issuance of warrants to AOL -- -- 21,200 -- -- -- 21,200 Issuance of common stock for acquired businesses 141 1 2,217 -- -- -- 2,218 Exercise of common stock warrants 2,662 27 11,977 -- -- -- 12,004 Exercise of common stock options 2,209 22 9,318 -- -- -- 9,340 Purchase of common stock warrants -- -- (4,400) -- -- -- (4,400) Issuance of common stock options for compensation -- -- 13,372 -- -- -- 13,372 Acquisition of treasury stock -- -- -- -- (3,520) (71,959) (71,959) Issuance of treasury stock for acquired businesses -- -- 1,999 -- 340 3,626 5,625 Income tax benefit related to exercise of common stock options and warrants -- -- 25,653 -- -- -- 25,653 --------- --------- --------- --------- --------- --------- --------- Balance, December 31, 1997 67,250 672 291,952 3,097 (3,608) (72,893) 222,828 Net loss -- -- -- (221,326) -- -- (221,326) Issuance of warrants to AOL -- -- 33,086 -- -- -- 33,086 Exercise of common stock warrants -- -- (3,620) -- 250 5,052 1,432 Exercise of common stock options -- -- (41,493) -- 2,853 55,550 14,057 Exercise of AOL warrants -- -- (7,693) -- 381 7,693 -- Retirement of common stock (315) (3) (1,467) -- -- -- (1,470) Acquisition of treasury stock -- -- -- -- (18,809) (265,054) (265,054) Issuance of common stock and options for compenstion -- -- (3,123) -- 895 13,224 10,101 Issuance of common stock for convertible debt -- -- (2,317) -- 5,089 71,878 69,561 --------- --------- --------- --------- --------- --------- --------- Balance, December 31, 1998 66,935 669 265,325 (218,229) (12,949) (184,550) (136,785) Net income -- -- -- 78,929 -- -- 78,929 AOL investment -- -- (3,730) -- 4,121 58,730 55,000 Exercise of common stock options -- -- (47,313) -- 6,773 95,600 48,287 Exercise of common stock rights 38 1 651 -- -- -- 652 Acquisition of treasury stock -- -- -- -- (639) (7,686) (7,686) Issuance of common stock for convertible debt -- -- (1,328) -- 574 8,186 6,858 Contingent redemption value of common stock -- -- (5,152) -- -- -- (5,152) -------- --------- --------- --------- --------- --------- --------- Balance, December 31, 1999 66,973 $ 670 $ 208,453 $(139,300) (2,120) $ (29,720) $ 40,103 ========= ========= ========= ========= ========= ========= =========
See accompanying notes to consolidated financial statements. 21 TALK.COM INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED DECEMBER 31, --------------------------------------------- 1999 1998 1997 ------------- ----------- ------------- Cash flows from operating activities: Net income (loss) $ 78,929 $(221,326) $ (20,945) Adjustment to reconcile net income (loss) to net cash provided by (used in) operating activities: Unrealized loss on securities -- -- 1,865 Provision for bad debts 3,480 (235) 1,579 Depreciation and amortization 5,956 5,499 5,429 Vested AOL warrants and amortization of prepaid AOL marketing costs -- 71,665 58,185 Charge for customer acquisition costs -- -- 11,550 Significant other charges -- 55,034 -- Write-off of intangibles -- -- 23,032 Realization of deferred revenue (7,400) (7,400) -- Compensation charges -- 8,402 13,372 Income tax benefit related to exercise of options and warrants -- -- 25,653 Valuation allowance for deferred tax assets -- 40,388 -- Extraordinary gain from extinguishment of debt (21,230) (87,110) -- Increase (decrease) in: Accounts receivable, trade (16,256) (1,250) (26,048) Advances to partitions and notes receivable (1,730) 24,241 (12,700) Prepaid AOL marketing costs -- -- (100,564) Prepaid expenses and other current assets (254) (23,712) (38,259) Other assets 2,215 (49,127) (20,769) Increase (decrease) in: Accounts payable and accrued expenses (23,457) 56,419 9,608 Deferred revenue -- -- 35,800 Other liabilities (1,850) (1,302) -- - --------------------------------------------------------------------------- --------- --------- --------- Net cash provided by (used in) operating activities 18,403 (129,814) (33,212) - --------------------------------------------------------------------------- --------- --------- --------- Cash flows from investing activities: Acquisition of intangibles -- (285) (9,293) Acquisition of Symetrics Industries, Inc. -- (26,707) -- Capital expenditures, net (6,506) (16,928) (28,876) Securities sold short -- (21,087) 17,700 Due from broker -- 21,087 (20,220) Sale (purchase) of marketable securities, net 89,649 122,620 (62,377) - --------------------------------------------------------------------------- --------- --------- --------- Net cash provided by (used in) investing activities 83,143 78,700 (103,066) - --------------------------------------------------------------------------- --------- --------- --------- Cash flows from financing activities: Repayment of margin account indebtedness (49,621) -- -- Proceeds from margin account indebtedness -- 49,621 -- Proceeds from sale of convertible debt -- -- 500,000 Acquisition of convertible debt (72,304) (86,301) -- Proceeds from exercise of options and warrants 48,287 15,489 21,344 Purchase of common stock warrants -- -- (4,400) AOL investment 55,000 -- -- Retirement of common stock -- (1,470) -- Proceeds from exercise of common stock rights 652 -- -- Acquisition of treasury stock (7,686) (239,892) (71,959) - --------------------------------------------------------------------------- --------- --------- --------- Net cash (used in) provided by financing activities (25,672) (262,553) 444,985 - --------------------------------------------------------------------------- --------- --------- --------- Net increase (decrease) in cash and cash equivalents 75,874 (313,667) 308,707 Cash and cash equivalents, beginning of year 3,063 316,730 8,023 - --------------------------------------------------------------------------- --------- --------- --------- Cash and cash equivalents, end of year $ 78,937 $ 3,063 $ 316,730 - --------------------------------------------------------------------------- --------- --------- ---------
See accompanying notes to consolidated financial statements. 22 TALK.COM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 -- SUMMARY OF ACCOUNTING POLICIES (a) Business Talk.com Inc., a Delaware corporation, together with its consolidated subsidiaries (the "Company"), provides telecommunications services, primarily long distance, throughout the United States to increasing numbers of residential customers and to small and medium-sized businesses. The Company's long distance service offerings include outbound service, inbound toll-free 800 service and dedicated private line services for data. The Company sells these services through its relationships with marketing partners, its web site located at www.talk.com, as well as through partitions, which are independent marketing companies. (b) Basis of financial statements presentation The consolidated financial statements include the accounts of Talk.com Inc. and its wholly-owned subsidiaries and have been prepared as if the entities had operated as a single consolidated group since their respective dates of incorporation. All intercompany balances and transactions have been eliminated. In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain amounts relating to 1997 have been reclassified to conform to the current year presentation. (c) Recognition of revenue The Company recognizes revenue upon completion of telephone calls by end users. Allowances are provided for estimated uncollectible usage. (d) Cash and cash equivalents The Company considers all temporary cash investments purchased with a maturity of three months or less to be cash equivalents. (e) Marketable securities Securities bought and held principally for the purpose of selling them in the near term are classified as "trading securities" and are carried at market. Unrealized holding gains and losses (determined by specific identification) on investments classified as "trading securities" are included in earnings. (f) Advances to partitions and notes receivable The Company made advances to partitions to support their marketing activities. The advances are secured by partition assets, including contracts with end users and collections thereon. (g) Property and equipment and depreciation Property and equipment are recorded at cost. Depreciation and amortization is calculated using the straight-line method over the estimated useful lives of the assets, as follows: Buildings and building improvements 39 years Switching equipment 15 years Equipment and other 5-7 years 23 TALK.COM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (h) Intangibles and amortization Intangibles of $1,068,000 and $1,150,000 at December 31, 1999 and 1998, respectively, represent goodwill arising from a business acquisition. Amortization is computed on a straight-line basis over the estimated useful life of the intangible, which is 15 years. (i) Deferred revenue Deferred revenue is recorded for a non-refundable prepayment received in 1997 in connection with an amended telecommunications services agreement with Shared Technologies Fairchild, Inc. and is amortized over the five-year term of the agreement. This agreement is terminable by either party on thirty days notice. Termination by either party would accelerate recognition of the deferred revenue. (j) Long-lived assets The Company adopted Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting For the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" as of January 1, 1996. Certain of the Company's long-lived assets were considered impaired at December 31, 1998 (Note 3). There was no additional impairment as of December 31, 1999. (k) Income taxes Since 1998, the Company has provided a full valuation allowance for deferred tax assets and liabilities for the estimated future tax effects attributable to temporary differences between the basis of assets and liabilities for financial and tax reporting purposes (Note 10). (l) Net income (loss) per share Basic earnings per share includes no dilution and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflect, in periods in which they have a dilutive effect, the effect of common shares issuable upon exercise of stock options and conversion of convertible debt. The computation of basic net income per share is based on the weighted average number of common shares outstanding during the period. In 1999, diluted earnings per share also includes the effect of 3,195,076 common shares, issuable upon exercise of common stock options and warrants. All references in the consolidated financial statements with regard to average number of Common Stock and related per share amounts have been calculated giving retroactive effect to stock splits. (m) Financial instruments and risk concentration Financial instruments that potentially subject the Company to concentrations of credit risk are cash investments for which the Company believes no significant concentration of credit risk exists with respect to these cash investments and marketable securities. The carrying values of accounts receivable, advances to partitions and notes receivable, accounts payable and accrued expenses approximate fair values. Convertible debt is recorded at face amount but such debt has traded in the open market at substantial discounts to face amount (Note 6). At December 31, 1999 the market value of the convertible debt was approximately 83% of face amount. 24 TALK.COM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (n) Stock-based compensation The Company accounts for its stock option awards under the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." Under the intrinsic value based method, compensation cost is the excess, if any, of the quoted market price of the stock at grant date or other measurement date over the amount an employee must pay to acquire the stock. The Company makes pro forma disclosures of net income and earnings per share as if the fair value based method of accounting had been applied as required by SFAS No. 123, "Accounting for Stock-Based Compensation" (Note 10). (o) Comprehensive income The Company has no items of comprehensive income or expense. Accordingly, the Company's comprehensive income and net income are equal for all periods presented. (p) New Accounting Pronouncements In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which requires entities to recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. SFAS No. 133, as amended by SFAS No. 137, is effective for all fiscal years beginning after June 15, 2000. The Company anticipates that the new standard will have no effect on its financial statements. NOTE 2 -- AOL AGREEMENTS In conjunction with the initial Telecommunications Marketing Agreement (the "AOL Agreement") with AOL, the Company paid AOL a total of $100 million and issued two warrants to purchase shares of the Company's stock. The first warrant (the "First Warrant") provided for the purchase, at an exercise price of $15.50 per share, of up to 5,000,000 shares. The second warrant (the "Second Warrant") provided for the purchase, at an exercise price of $14.00 per share, of up to 7,000,000 shares, which was to vest, based on the number of subscribers to the Company's service. With the Second Warrant, as vesting occurred, the fair value of the incremental vested portion of the warrant was charged to expense in the consolidated statement of operations. In 1998, the Company issued a warrant to purchase 1,000,000 shares (the "Further Warrant") to AOL in exchange for a one year extension of the AOL Agreement. As of December 31, 1997 the Second Warrant was vested as to approximately 120,000 shares and $1,200,000 was charged to expense in the 1997 consolidated statement of operations. The $100 million cash payment, the $20.0 million value of the First Warrant and $0.6 million of agreement related costs was accounted for as follows: (i) $35.9 million was charged to expense ratably over the period from the signing of the initial AOL agreement to December 31, 1997, as payment for certain exclusivity rights for that period; (ii) $13.2 million was treated as production of advertising costs and was charged to expense on October 9, 1997, which was the Commercial Launch Date; and (iii) $71.5 million, the balance of the cash payment and the value of the First Warrant and the initial AOL agreement related costs, represents the combined value of advertising and exclusivities which extend over the term of the AOL Agreement and was recognized ratably after the Commercial Launch Date as advertising services were received. For the year ended December 31, 1997, the Company recognized $57.0 million of expense, related to items discussed above, which is included in promotional, marketing and advertising expenses. The Company has negotiated a number of amendments to its agreements with AOL based on the experience gained by the Company in the marketing and sale of telecommunications services to AOL subscribers since the inception of the agreements. A substantial amendment to the AOL agreement in January 1999 in which the Company agreed to fixed quarterly payments ranging from $10 to $15 million during the long distance exclusivity period of the agreement resulted in: the elimination of the Company's obligation to make bounty and profit-sharing payments to AOL; altering of the terms of the online and offline marketing arrangements between the Company and AOL; extension of the term of the AOL agreement, including the exclusivity period, until June 2003, although AOL can end the Company's long distance exclusivity period on or after June 2000 by foregoing the fixed 25 TALK.COM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) quarterly payments described above; elimination of AOL's rights to receive further warrants to purchase Common Stock based upon customers gained from the AOL subscriber base; AOL's contribution of up to $4.0 million per quarter for offline marketing; and establishment of the framework for the Company to offer additional services and products to AOL subscribers. In 1998, as a result of the January 1999 amendment, the Company wrote off $37.6 million of prepaid AOL, CompuServe and other marketing-related expenses, included in significant other charges (Note 3). On January 5, 1999, pursuant to an Investment Agreement between AOL and the Company, AOL purchased a total of 4,121,372 shares of Common Stock of the Company for $55.0 million in cash and the surrender of rights to purchase 5,076,016 shares of Common Stock of the Company pursuant to various warrants held by AOL. AOL agreed to end further vesting under the outstanding performance warrant and retained vested warrants exercisable for 2,721,984 shares of Common Stock. (Notes 9 and 10). NOTE 3 -- SIGNIFICANT OTHER CHARGES (INCOME) Significant other income in 1999 includes a gain of $2.7 million on the sale of certain business units of TSFL Holdings, Inc. (formerly Symetrics Industries, Inc.). Significant other charges in 1998 includes $91.0 million of expenses incurred in the fourth quarter of 1998 related to changes in the Company's basic business operations. As discussed in Note 2 above, the Company negotiated substantial amendments to its agreements with AOL which, among other things, reduced the amount of online advertising to which the Company was entitled to over the remaining term of the agreement and eliminated payments and issuance of warrants to AOL for customer gains and profit sharing payments to AOL. The Company agreed to fixed quarterly payments ranging from $10 - $15 million per quarter during the exclusivity period of the agreement and AOL agreed to contribute up to $4.0 million per quarter for offline marketing. As a result of the amendments, the Company wrote off prepaid AOL, CompuServe and other marketing-related expenses of $37.6 million. In connection with hiring a new Chairman and Chief Executive Officer and several other key executive personnel and severance payments relating to this change in management, the Company incurred $12.7 million of incentive and severance expense. The Company acquired ADS Holdings, Inc. (formerly Symetrics, Inc.), a manufacturer of digital telephone switching equipment, in January 1998 for $18.6 million. The Company planned to complete development of the digital switch to provide state of the art features for use in the Company's operations as a competitive local exchange carrier. The Company allocated $21 million of the acquisition cost to purchased research and development expense in the first quarter of 1998 and continued to invest in additional research and development throughout 1998. In November 1997, the Company acquired Compco, Inc, a provider of communications software in the college and university marketplace for $13.7 million, which exceeded the net assets acquired by $10.6 million. In the fourth quarter of 1998, the Company decided to sell the assets of ADS Holdings, Inc. and to delay entry into the college and university marketplace. As a result, the assets of ADS Holdings, Inc. and Compco, Inc. were written down to expected realizable value. The Company recorded $15 million relating to the impairment of these assets and reclassified $22.2 million of research and development expense to significant other charges. In the fourth quarter of 1998, the Company reconfigured its telecommunications network, OBN, to provide for fiber optic connections among its switches and incurred $3.5 million of expense. The Company determined in the second quarter of 1997 to de-emphasize the use of direct marketing to solicit customers for the Company and to focus the majority of its existing direct marketing resources on customer service and support for the marketing operations of its carrier partitions, on a fee basis. The Company recognized fees of $8.1 million for the year ended December 31, 1997, included in other income, from the services net of related costs of $14.6 million for the year ended December 31, 1997. 26 TALK.COM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) The Company recorded a one-time charge of $11.5 million as cost of sales in the quarter ended June 30, 1997, primarily as a result of the Company changing its accounting for customer acquisition costs to expense them in the period incurred versus the Company's prior treatment of capitalizing customer acquisition costs and amortizing them over a six month period. In October 1997, the Company decided to discontinue its internal telemarketing operations which were primarily conducted through American Business Alliance (which was acquired by the Company in December 1996), as part of its restructuring of its sales and marketing efforts, and wrote-off, as cost of sales, approximately $23.0 million of intangible assets. NOTE 4 -- MAJOR PARTITIONS During 1997, one Partition accounted for approximately 13% of the Company's total sales. There were no Partitions that accounted for more than 10% of the Company's total sales in 1999 or 1998. NOTE 5 -- PROPERTY AND EQUIPMENT
DECEMBER 31, --------------------------------- 1999 1998 --------------------------------- (IN THOUSANDS) Land $ 80 $ 80 Buildings and building improvements 2,801 2,639 Switching equipment 53,101 50,481 Equipment and other 14,791 11,067 -------- -------- 70,773 64,267 Less: Accumulated depreciation (13,438) (7,564) --------- --------- $57,335 $56,703 ======= =======
NOTE 6 -- CONVERTIBLE DEBT In September 1997, the Company sold $300 million of 4 1/2% Convertible Subordinated Notes that mature on September 15, 2002 (the "2002 Convertible Notes"). Interest on the 2002 Convertible Notes is due and payable semiannually on March 15 and September 15 of each year. The 2002 Convertible Notes are convertible, at the option of the holder thereof, at any time after December 9, 1997 and prior to maturity, unless previously redeemed, into shares of the Company's Common Stock at a conversion price of $24.5409 per share, as adjusted for the dilutive effect of the exercise of rights pursuant to the Company's rights offering (Note 9). The 2002 Convertible Notes are redeemable, in whole or in part, at the Company's option, at any time on or after September 15, 2000 at 101.80% of par prior to September 14, 2001 and 100.90% of par thereafter. During 1999 and 1998, the Company reacquired $80,650,000 and $152,458,000, respectively, principal amount of the 2002 Convertible Notes and $66,892,000 principal amount remained outstanding at December 31, 1999. In December 1997, the Company sold $200 million of 5% Convertible Subordinated Notes that mature on December 15, 2004 (the "2004 Convertible Notes"). Interest on the 2004 Convertible Notes is due and payable semiannually on June 15 and December 15 of each year. The 2004 Convertible Notes are convertible, at the option of the holder thereof, at any time after March 5, 1998 and prior to maturity, unless previously redeemed, into shares of the Company's Common Stock at a conversion price of $25.3835 per share, as adjusted for the dilutive effect of the exercise of rights pursuant to the Company's rights offering (Note 9). The 2004 Convertible Notes are redeemable, in whole or in part at the Company's option, at any time on or after December 15, 2002 at 101.43% of par prior to December 14, 2003 and 100.71% of par thereafter. During 1999 and 1998, the Company reacquired $76,752,000 and $105,155,000, respectively, face amount of the 2004 Convertible Notes and $18,093,000 principal amount remained outstanding at December 31, 1999. The 2002 Convertible Notes and 2004 Convertible Notes that were reacquired by the Company in 1998 were reacquired at an $87.1 million discount from face amount. This amount is reported as an extraordinary gain in the consolidated statement of operations. During 1999, the Company (a) purchased from Mr. Daniel Borislow, a founder of the Company and its Chairman of the Board and Chief Executive Officer until he resigned on January 5, 1999, and two trusts for the 27 TALK.COM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) benefit of Mr. Borislow's children, $85,857,000 aggregate principal amount of the Company's Convertible Notes for $72.3 million in cash; (b) exchanged the remaining $53.7 million principal amount of subordinated notes of Communication TeleSystems International d/b/a WorldxChange Communications, which were included in other assets at December 31, 1998, to a trust for the benefit of Mr. Borislow's children for $62,545,000 aggregate principal amount of the Company's Convertible Notes and (c) purchased $9,000,000 aggregate principal amount of the Company's Convertible Notes for $6.9 million in Common Stock. The 2002 Convertible Notes and 2004 Convertible Notes that were reacquired by the Company during 1999 were reacquired at a $21.2 million discount from face amount. This amount is reported as an extraordinary gain in the consolidated statement of operations. NOTE 7 -- RELATED PARTY TRANSACTIONS On January 5, 1999, Mr. Daniel Borislow, a founder of the Company and its Chairman of the Board and Chief Executive Officer, resigned as a director and officer of the Company. The Company entered into various agreements and engaged in various transactions with Mr. Borislow and certain entities in which he or his family had an interest. The Company paid $1.0 million to Mr. Borislow, assigned certain automobiles to him, and continued certain of his health and medical benefits and director and officer insurance. The Company also agreed that, so long as Mr. Borislow owns beneficially at least two percent (2%) of the Common Stock (on a fully diluted basis), Mr. Borislow and trusts for the benefit of his children would be entitled to: registration rights with respect to their shares of Common Stock, the right to require the Company to use a portion of proceeds from any public or private sale of debt securities, excluding borrowings from a commercial bank or other financial institution, by the Company to repurchase debt securities of the Company owned by Mr. Borislow or the trusts for the benefit of his children and the right to require the Company to use the proceeds from the exercise of stock options or rights to repurchase Common Stock owned by Mr. Borislow or the trusts for the benefit of his children. The Company also agreed that, so long as Mr. Borislow had such beneficial ownership, the Company would not, without the prior written consent of Mr. Borislow and subject to certain exceptions: (a) engage in certain significant corporate transactions, including the sale or encumbrance of substantially all of its assets, mergers and consolidations and certain material acquisitions, or, (b) for a period of 18 months from the agreement date, offer or sell any of its Common Stock unless and until Mr. Borislow and the trusts have sold or otherwise disposed of all of the shares of Common Stock held by him on the agreement date. In turn, Mr. Borislow terminated his employment with the Company and agreed not to compete with the Company for at least one year. Mr. Borislow also agreed to guarantee up to $20.0 million of the Company's obligations in connection with the AOL investment noted above. Effective December 31, 1998, the Company, in exchange for a total of 783,706 shares of Common Stock, (i) sold to Jimlew Capital, L.L.C., a company owned by Mr. Borislow, (a) all of the capital stock of Emergency Transportation Corporation (a wholly owned subsidiary of the Company, the primary asset of which was an interest in a jet airplane), valued at approximately $8.7 million, and (b) all of the real property constituting the Company's facilities in New Hope, Pennsylvania, valued at approximately $2.0 million, and (ii) released Mr. Borislow from an obligation for approximately $4.7 million borrowed from the Company. Mr. Borislow agreed to lease to the Company a portion of the headquarters property at a base monthly rent of $12,500. The Company had previously determined that it would be desirable to dispose of these assets and accordingly believed that the ownership of these assets was not required for the continued operation of the Company's business. The subsidiary stock and the real property were valued based on the book value of these assets, which the management of the Company believes approximated the fair market value of these assets on the date of exchange. The Common Stock exchanged for the assets was valued at its market value on the date of the exchanges. On January 6, 2000, the Company repurchased the real property constituting the Company's facilities in New Hope, Pennsylvania for $2.5 million. Effective December 31, 1998, the Company, in exchange for a total of 498,435 shares of Common Stock and $10,007,000 aggregate principal amount of the Company's Convertible Notes, released certain officers, directors and employees from obligations for approximately $9.8 million and $9.0 million, respectively, borrowed from the Company. Also during 1999, in addition to the transactions between the Company and Mr. Borislow or the trusts for his children involving the 2002 and 2004 Convertible Notes, which transactions are described in Note 6 and 28 TALK.COM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) included in this Note by this reference, the Company purchased from Mr. Borislow approximately 639,000 shares of Common Stock for approximately $7.7 million with proceeds from the exercise of stock options by other employees pursuant to the agreements with Mr. Borislow as described above. At December 31, 1998, executive officers of the Company had outstanding loans from the Company of $4,237,000 which were repaid during the first quarter of 1999. NOTE 8 -- LEGAL PROCEEDINGS On June 16, 1998, a purported shareholder class action was filed in the United States District Court for the Eastern District of Pennsylvania against the Company and certain of its officers alleging violation of the securities laws in connection with certain disclosures made by the Company in its public filings and seeking unspecified damages. Thereafter, additional lawsuits making substantially the same allegations were filed by other plaintiffs in the same court. At this point, no classes have been certified. A motion to dismiss was recently granted as to certain officers of the Company and denied as to the Company. There are currently no officers of the Company who are a party to these actions. The Company believes the allegations in the complaints are without merit and intends to defend the litigations vigorously. The Company also is a party to certain legal actions arising in the ordinary course of business. The Company believes that the ultimate outcome of the foregoing actions will not result in liability that would have a material adverse effect on the Company's financial condition or results of operations. NOTE 9 -- STOCKHOLDERS' EQUITY (a) Stock Splits On January 3, 1997, the Company's Board of Directors approved a two-for-one split of the Common Stock in the form of a 100% stock dividend. The additional shares resulting from the stock split were distributed on January 31, 1997 to all stockholders of record at the close of business on January 17, 1997. This stock split has been reflected in the financial statements for all periods presented. (b) Authorized Shares During 1997, the Board of Directors and stockholders approved the increase in the number of authorized shares of the Common Stock to 300,000,000 shares. (c) Contingent Redemption Value of Common Stock On January 5, 1999, pursuant to an Investment Agreement between AOL and the Company, AOL acquired 4,121,372 shares of Common Stock for $55.0 million in cash and the surrender of rights to acquire up to 5,076,016 shares of Common Stock pursuant to various warrants held by AOL. Under the terms of the Investment Agreement with AOL, the Company has agreed to reimburse AOL for losses AOL may incur on the sale of any of the 4,121,372 shares during the period from June 1, 1999 through September 30, 2000. The Company has the first right to purchase any of the 4,121,372 shares of Common Stock at the market value on the day that AOL notifies the Company of its intent to sell any of the shares plus an amount, if any, equal to the Company's reimbursement obligation described below. The reimbursement amount would be determined by multiplying the number of shares, if any, that AOL sells during the applicable period by the difference between the purchase price per share paid by AOL, or $19 per share, and the price per share that AOL sells the shares for, if less than $19 per share. The reimbursement amount may not exceed $14 per share for 2,894,737 shares or $11 per share for 1,226,635 shares. Accordingly, the maximum amount payable to AOL as reimbursement on the sale of AOL's shares would be approximately $54.0 million plus AOL's reasonable expenses incurred in connection with the sale. The Company has the option of issuing a six-month 10% note payable to AOL to satisfy the reimbursement amount or other amounts payable on exercise of its first refusal rights. Assuming AOL were to sell all of its shares subject to the Company's reimbursement obligation at the closing price of Common Stock as of December 31, 1999, the reimbursement amount would be approximately $5.2 million. At December 31, 1999, the Company recorded $5.2 million for the contingent redemption value of this Common Stock with a corresponding reduction in additional paid-in capital. AOL also has the right on termination of long distance exclusivity under the AOL marketing 29 TALK.COM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) agreements to require the Company to repurchase the warrants to purchase 2,721,984 shares of Common Stock of the Company held by AOL for an aggregate price of $36.3 million, which repurchase price can be paid in Common Stock, cash or a quarterly amortization, two-year promissory note of the Company. AOL can end the Company's long distance exclusivity period on or after June 30, 2000 by foregoing certain fixed quarterly payments. The Company has pledged the stock of its subsidiaries and has agreed to fund an escrow account of up to $35 million from 50% of the proceeds of any debt financing, other than a bank, receivable or other asset based financing of up to $50 million, to secure its obligations under the Investment Agreement with AOL. AOL has agreed that it will subordinate its security interests to permit the securitization of certain future financings by the Company. Mr. Borislow has agreed to guarantee up to $20,000,000 of the Company's reimbursement obligations under the Investment Agreement with AOL. (d) Restriction on Future Sales of Common Stock As previously reported, the Company was subject to certain restrictions under a registration rights agreement between the Company and Mr. Borislow that could have affected the Company's ability to raise capital and engage in other types of financing transactions. As of December 31, 1999, Mr. Borislow and the two trusts for the benefit of Mr. Borislow's children, which have the ability to distribute Common Stock to Mr. Borislow, held less than an aggregate of 2% of the outstanding Common Stock. Accordingly, the Company believes that the restrictions no longer apply to the Company. (e) Stockholders Rights Plan On August 19, 1999, the Company adopted a Stockholders Rights Plan designed to deter coercive takeover tactics and prevent an acquirer from gaining control of the Company without offering a fair price to all of the Company's stockholders. Under the terms of the plan, preferred stock purchase rights were distributed as a dividend at the rate of one right for each share of Common Stock of the Company held as of the close of business on August 30, 1999. Until the rights become exercisable, Common Stock issued by the Company will also have one right attached. Each right will entitle holders to buy one three-hundredth of a share of Series A Junior Participating Preferred Stock of the Company at an exercise price of $55. Each right will thereafter entitle the holder to receive upon exercise Common Stock (or, in certain circumstances, cash, property or other securities of the Company) having a value equal to two times the exercise price of the right. The rights will be exercisable only if a person or group acquires beneficial ownership of 20% or more of Common Stock or announces a tender or exchange offer which would result in such person or group owning 20% or more of Common Stock, or if the Board of Directors declares that a 15% or more stockholder has become an "adverse person" as defined in the plan. The Company, except as otherwise provided in the plan, will generally be able to redeem the rights at $0.001 per right at any time during a ten-day period following public announcement that a 20% position in the Company has been acquired or after the Company's Board of Directors declares that a 15% or more stockholder has become an "adverse person." The rights are not exercisable until the expiration of the redemption period. The rights will expire on August 19, 2009, subject to extension by the Board of Directors. 30 TALK.COM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) NOTE 10 -- STOCK OPTIONS, WARRANTS AND RIGHTS (a) Stock Options The Company has non-qualified stock option agreements with most of its key employees. In 1997, 1998 and 1999, the Company granted certain employees and non-employee directors of the Company 2,801,000, 5,535,000 and 3,549,500, respectively, non-qualified options to purchase shares of Common Stock. These options generally become exercisable from one to three years from the date of the grant. In 1997, the Company recognized $13,371,785 of compensation expenses related to the grant of options and the purchase by an executive officer of shares of Common Stock of the Company's stock at prices below the quoted market price at date of grant and purchase date, respectively. In 1998, the Company recognized $3.3 million of compensation expenses relating to the grant of 650,000 options to purchase shares of the Company's Common Stock at prices below the quoted market price at the dates of grant or issuance and the issuance of 135,000 shares of the Company's stock. SFAS No. 123, "Accounting for Stock-Based Compensation," requires the Company to provide pro forma information regarding net income and earnings per share as if compensation cost for the Company's stock options had been determined in accordance with the fair value-based method prescribed in SFAS No. 123. The Company estimates the fair value of each stock option at the grant date by using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 1997, 1998 and 1999, respectively: no dividends paid for all years; expected volatility of 55.8% in 1997, 65% in 1998 and 108% in 1999; weighted average risk-free interest rates of 5.49% for 1997, 4.59% for 1998, 5.38% for the first six months of 1999, and 5.85% for the latter six months of 1999; and expected lives of 1 to 10 years. Under the accounting provisions of SFAS No. 123, the Company's net income (loss) and earnings (loss) per share would have been reduced (increased) to the pro forma amounts indicated below.
YEAR ENDED DECEMBER 31, 1999 (IN THOUSANDS, EXCEPT FOR PER SHARE DATA) 1999 1998 1997 NET INCOME (LOSS): As reported $78,929 $(221,326) $(20,945) Pro forma $68,851 $(244,487) $(30,942) BASIC EARNINGS (LOSS) PER SHARE: As reported $ 1.29 $ (3.73) $ (0.33) Pro forma $ 1.13 $ (4.12) $ (0.48) DILUTED EARNINGS (LOSS) PER SHARE: As reported $ 1.23 $ (3.73) $ (0.33) Pro forma $ 1.07 $ (4.12) $ (0.48)
31 TALK.COM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) The following tables contain information on stock options for the three-year period ended December 31, 1999:
EXERCISE WEIGHTED OPTIONS PRICE RANGE AVERAGE SHARES PER SHARE EXERCISE PRICE ---------------- --------------- ------------------- Outstanding, December 31, 1996 8,983,800 $ .32-$12.00 $ 6.54 Granted 2,801,000 $5.67-$22.06 $16.02 Exercised (2,208,812) $ .32-$12.78 $ 4.25 Cancelled (690,000) $5.67-13.25 $11.98 --------- ------------ ------ Outstanding, December 31, 1997 8,885,988 $ .32-$22.06 $ 9.26 Granted 5,535,000 $5.75-$10.44 $ 7.18 Exercised (2,853,178) $ .32-13.63 $ 4.93 Cancelled (1,337,000) $5.75-17.50 $13.01 --------- ------------ ------ Outstanding, December 31, 1998 10,230,810 $4.08-$14.00 $ 7.34 Granted 3,549,500 $8.75-$17.25 $11.63 Exercised (6,773,378) $4.08-12.78 $ 7.13 Cancelled (158,000) $5.75-11.69 $ 9.67 --------- ------------ ------ Outstanding, December 31, 1999 6,848,932 $4.58-$17.25 $ 9.72 ========= ============ ====== EXERCISE WEIGHTED OPTIONS PRICE RANGE AVERAGE EXERCISABLE AT: SHARES PER SHARE EXERCISE PRICE ---------------- --------------- ------------------- 1997 3,866,987 $ .32-$14.50 $7.24 1998 4,571,475 $4.08-$12.78 $7.39 1999 2,541,095 $4.58-$14.00 $7.67 WEIGHTED AVERAGE OPTIONS GRANTED: FAIR VALUE ------------------- 1997 $6.99 1998 $4.83 1999 $9.71
The following table summarizes information about stock options outstanding at December 31, 1999:
$4.58-$7.00 $7.01-$10.00 $10.01-$13.00 $13.01-$17.25 ------------- -------------- --------------- --------------- OUTSTANDING OPTIONS: Number outstanding at December 31, 1999 1,767,617 1,595,315 2,543,000 943,000 Weighted-average remaining Contractual life (years) 3.68 8.33 6.53 9.86 Weighted-average exercise price $ 6.17 $ 9.03 $ 10.51 $ 15.38 EXERCISABLE OPTIONS: Number outstanding at December 31, 1999 1,483,450 604,312 433,333 20,000 Weighted-average exercise price $ 6.25 $ 9.00 $ 10.37 $ 14.00
32 TALK.COM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (b) AOL Warrants On January 5, 1999, after the repurchase from AOL of warrants to purchase 5,076,016 shares of Common Stock, warrants to purchase 2,721,984 shares of Common Stock were held by AOL and were outstanding and currently exercisable, with exercise prices from $14.00 to $22.25 and a weighted average exercise price of $17.03. AOL has the right, commencing on termination of the long distance exclusivity under the AOL marketing agreement up until January 5, 2003, to require the Company to repurchase all or any portion of these warrants at prices (the "Put Prices") ranging from $10.45 to $16.82 per warrant ($36,324,002 aggregate amount). In the event AOL requires repurchase of the warrants, the Company at its election may pay AOL in cash or in shares of Common Stock based on the then current market price for such stock. The Company may also elect to issue a 10% two-year note for a defined portion of the repurchase price. The Company can require AOL to exercise its warrants at any time the market price of Common Stock equals or exceeds two times the then call amount for such warrants. The call amount of a warrant is the Put Price for the warrant increased at a semi-annually compounded rate of 5% on January 5, 1999 and on each six month anniversary thereafter. The Company has certain reimbursement obligations in the event that it requires AOL to exercise its warrants. (c) Other Warrants At December 31, 1996, the Company had warrant agreements with certain partitions and the underwriter for its IPO. All warrants were issued with exercise prices equal to or above the market price of the underlying stock at the date of the grant. These warrants are accounted for based on their fair value. At December 31, 1996, 3,712,000 warrants were outstanding with exercise prices ranging from $4.67 to $5.73 and an average weighted exercise price of $5.00 and 600,000 which were currently exercisable at a weighted exercise price of $5.73. The remaining warrants were exercisable over a one to two year period beginning in January 1997. In January 1997, 800,000 of these warrants were purchased by the Company and recorded as a reduction in additional paid-in capital and 2,662,000 warrants were exercised. The 250,000 warrants issued to the underwriter for the Company's IPO that were outstanding at December 31, 1997 were exercised in 1998. (d) Rights The Board of Directors had approved an offering of up to 3,523,285 shares of its Common Stock, $.01 par value, to holders of record of Common Stock and holders of record of options or warrants to purchase Common Stock at the close of business on December 31, 1998. The shares were offered pursuant to nontransferable rights to subscribe for and purchase shares of Common Stock at a price of $17.00 per share. Holders of record on the record date, were eligible to receive one such nontransferable right for every 20 shares of Common Stock or underlying options or warrants held on the record date, as applicable. As of December 31, 1999, 38,325 rights totaling $651,525 were exercised, and 652,547 rights totaling $11,093,299 were exercised in 2000. These rights expired on February 12, 2000. NOTE 11 -- INCOME TAXES The Company reports the effects of income taxes under SFAS No. 109, "Accounting for Income Taxes". The objective of income tax reporting is to recognize (a) the amount of taxes payable or refundable for the current year and (b) deferred tax liabilities and assets for the future tax consequences of events that have been recognized in the financial statements or tax returns. Under SFAS No. 109, the measurement of deferred tax assets is reduced, if necessary, by the amount of any tax benefits that, based on available evidence, are not expected to be realized. Realization of deferred tax assets is determined on a more-likely-than-not basis. The Company considers all available evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance is needed for some portion or all of a net deferred tax asset. Judgment is used in considering the relative impact of negative and positive evidence. In arriving at these judgments, the weight given to the potential effect of negative and positive evidence is commensurate with the extent to which it can be objectively verified. 33 TALK.COM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) The Company had net deferred tax assets of approximately $40.4 million at December 31, 1997. The Company determined that no valuation allowance was necessary at December 31, 1997 because, among other factors, income, which it believed would be indicative of future operations, had been generated in recent years, with the exception of 1997. The loss incurred in 1997 was primarily attributable to amortization of the AOL marketing agreement. During 1998, the Company continued to incur significant promotional, marketing and advertising expenses attributable to its efforts to increase the customer base. Moreover, competitive factors intensified during the period making gains in subscriber base more costly and more time consuming. Accordingly, the Company provided a valuation allowance against its deferred tax assets at December 31, 1998. The valuation allowance also eliminated the net deferred tax asset that had been recognized in previous periods. The valuation allowance increased the net loss for the period by approximately $40.4 million. The Company has continued to provide a valuation allowance against its deferred tax assets at December 31, 1999. The provision (benefit) for income taxes for the years ended December 31, 1999, 1998 and 1997 consisted of the following:
YEAR ENDED DECEMBER 31, ------------------------------------------------------- 1999 1998 1997 ---- ---- ---- (IN THOUSANDS) Current: Federal $ -- $ -- $ -- State and local -- -- -- -------- -------- -------- Total current: -- -- -- Deferred: Federal -- 34,140 (11,111) State and local -- 6,248 (2,280) -------- -------- -------- Total deferred -- 40,388 (13,391) -------- -------- -------- $ -- $ 40,388 $(13,391) ======== ======== ========
A reconciliation of the Federal statutory rate to the provision (benefit) for income taxes is as follows:
YEAR ENDED DECEMBER 31, ---------------------------------------------------------------------------------- 1999 1998 1997 ------------------------- ----------------------- -------------------------- (IN THOUSANDS) Federal income taxes computed at the statutory rate $ 27,625 35.0% $(63,328) (35.0)% $(12,018) (35.0)% Increase (decrease): State income taxes less Federal benefit 3,157 4.0 (7,780) (4.3) (1,482) (4.3) Valuation allowance for deferred tax assets existing at beginning of year -- -- 40,388 22.3 -- -- Valuation allowance changes affecting the provision for income taxes (31,000) (39.3) 68,612 37.9 -- -- Other 218 .3 2,496 1.4 109 .3 -------- ---- -------- ---- -------- ---- Total provision (benefit) for income taxes $ -- -- $ 40,388 22.3% $(13,391) (39.0)% ======== ==== ======== ==== ======== ====
34 TALK.COM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) Deferred tax (assets) liabilities at December 31, 1999, 1998 and 1997 are comprised of the following elements:
YEAR ENDED DECEMBER 31, ----------------------------------- 1999 1998 ----------- ------------ (IN THOUSANDS) Net operating loss carryforwards $ (71,000) $ (65,000) Deferred revenue taxable currently (8,000) (11,000) Compensation for options granted below market price (1,000) (6,000) Allowance for uncollectible accounts (3,000) (7,000) Federal and state taxes resulting from cash to accrual basis for tax reporting -- -- Warrants issued for compensation (9,000) (18,000) Depreciation and amortization 8,000 5,000 Accruals not currently deductible (2,000) (5,000) Unrealized loss on investments -- (3,000) Net capital loss carryforwards (8,000) (5,000) --------- --------- Deferred tax (assets) liabilities, net (94,000) (115,000) Less valuation allowance 94,000 115,000 --------- --------- Net deferred tax $ -- $ -- ========= =========
The Company has net operating loss carryforwards for tax purposes and other deferred tax benefits that are available to offset future taxable income. Only a portion of the net operating loss carryforwards are attributable to operating activities. The remainder of the net operating loss carryforwards are attributable to tax deductions related to the exercise of stock options. In accounting for income taxes, the Company recognizes the tax benefits from current stock option deductions after utilization of net operating loss carryforwards from operations (i.e., net operating loss carryforwards determined without deductions for exercised stock options) to reduce income tax expense. Because stock option deductions are not recognized as an expense for financial reporting purposes, the tax benefit of stock option deductions must be credited to additional paid-in capital with an offsetting income tax expense recorded in the statement of operations. The Company's deferred tax asset related to operations, net capital loss carryforwards and exercised stock options amounted to $70.0 million, $8.0 million and $16.0 million, respectively at December 31, 1999. At December 31, 1999, a valuation allowance has been provided against the deferred tax assets since management cannot predict, based on the weight of available evidence, that it is more likely than not that such assets will be ultimately realized. Internal Revenue Code Section 382 provides for the limitation on the use of net operating loss carryforwards in years subsequent to a more than 50% cumulative change in ownership. A more than 50% cumulative change in ownership occurred on August 31, 1998, resulting in annual limitations of approximately $42.0 million on the utilization of net operating loss carry forwards as of that date. Of the Company's net operating loss carryforwards of $183.1 million at December 31, 1999, $68.6 million are subject to this annual limitation subsequent to 1999. The remaining net operating loss carryforwards of $114.5 million are not subject to this limitation. 35 TALK.COM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) NOTE 12 -- STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, ------------------------------------------------------ 1999 1998 1997 --------------- ---------------- --------------- (IN THOUSANDS) Supplemental disclosure of cash flow information: Cash paid for interest $4,218 $28,695 $915
During 1999, the Company issued 574,482 shares of Common Stock with a value of approximately $6.9 million (Note 6), in connection with the repurchase of the Company's Convertible Notes. Also, during 1999, the Company assigned to a trust for the benefit of Mr. Borislow's children the Company's interest in $53,700,000 principal amount of subordinated notes of Communications TeleSystems International d/b/a WorldXChange Communications, in exchange for $62,545,000 aggregate principal amount of the Company's Convertible Notes (Note 6). In addition, the Company recorded $5.2 million for the contingent redemption value of the AOL warrant with a corresponding reduction in additional paid in capital. During 1998, the Company, in exchange for a total of 783,706 shares of Common Stock, sold certain assets to Mr. Borislow and released Mr. Borislow from an obligation borrowed from the Company (Note 7). The Company also, in exchange for a total of 498,435 shares of Common Stock and $10,007,000 aggregate principal amount of the Company's Convertible Notes, released certain officers, directors and employees from obligations borrowed from the Company (Note 7). In connection with the repurchase of the Company's Convertible Notes, the Company issued 5,084,483 shares of Common Stock with a value of approximately $69.5 million. During 1997, the Company recorded an asset of $20,000,000 in connection with the issuance of warrants to AOL (Note 2). In connection with the acquisition of Compco in 1997, the Company issued 339,982 shares of Common Stock with a value of $5,625,000. NOTE 13 -- QUARTERLY FINANCIAL DATA (UNAUDITED)
FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER ------------ ------------ ------------- ------------ (IN THOUSANDS, EXCEPT FOR PER SHARE DATA) 1999 Sales $110,572 $117,139 $140,027 $148,811 Gross profit 35,874 43,721 54,551 61,652 Operating income 12,355 14,979 15,579 16,642 Income before extraordinary gain 12,334 14,038 14,646 16,682 Net income 31,331 14,038 16,879 16,682 Income before extraordinary gain per share - Diluted 0.20 0.22 0.23 0.25 Net income per share - Diluted 0.50 0.22 0.27 0.25 1998 Sales $ 91,146 $111,098 $122,525 $123,831 Gross profit 14,566 18,040 22,736 31,301 Operating loss (63,702) (30,049) (96,047) (67,075) Loss before extraordinary gain (41,795) (96,154) (92,296) (78,191) Net loss (41,795) (96,154) (41,734) (41,643) Loss before extraordinary gain per share - Diluted (0.65) (1.49) (1.58) (1.56) Net loss per share - Diluted (0.65) (1.49) (0.71) (0.83)
36 TALK.COM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) NOTE 14 - EMPLOYEE BENEFIT PLANS During 1999, the Company established an Employee Savings Plan that permits eligible employees to contribute funds on a pre-tax basis. The Plan qualifies as a deferred salary arrangement under Section 401(k) of the Internal Revenue Code. Eligible employees may contribute up to 6% of their compensation (subject to Internal Revenue Code limitations). The Plan allows employees to choose among a variety of investment alternatives. The Company does not contribute to the Plan. No administration costs were incurred during 1999. 37 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10 THROUGH 13 Information required by Part III (Items 10 through 13) of this Form 10-K is incorporated by reference to the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on May 18, 2000 which will be filed with the Securities and Exchange Commission not later than 120 days after the end of the fiscal year to which this Form 10-K relates. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this Annual Report on Form 10-K. 1. Consolidated Financial Statements: The Consolidated Financial Statements filed as part of this Form 10-K are listed in the "Index to Consolidated Financial Statements" in Item 8. 2. Consolidated Financial Statement Schedule: The Consolidated Financial Statement Schedule filed as part of this report is listed in the "Index to S-X Schedule." Schedules other than those listed in the accompanying Index to S-X Schedule are omitted for the reason that they are either not required, not applicable or the required information is included in the Consolidated Financial Statements or notes thereto. 38 TALK.COM INC. AND SUBSIDIARIES INDEX TO S-X SCHEDULE PAGE ---- Report of Independent Certified Public Accountants .......... 40 Schedule II -- Valuation & Qualifying Accounts .............. 41 39 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Board of Directors and Stockholders of Talk.com Inc. The audits referred to in our report dated February 7, 2000, relating to the consolidated financial statements of Talk.com Inc. and subsidiaries, which is contained in Item 8 of this Form 10-K, included the audits of the financial statement schedule listed in the accompanying index for each of the three years in the period ended December 31, 1999. This financial statement schedule is the responsibility of management. Our responsibility is to express an opinion on this schedule based on our audits. In our opinion, the financial statement Schedule II -- Valuation and Qualifying Accounts, presents fairly, in all material respects, the information set forth therein. BDO Seidman, LLP New York, New York February 7, 2000 40 TALK.COM INC. AND SUBSIDIARIES 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, 1999: Reserve and allowances deducted from asset accounts: Allowance for uncollectible accounts $ 1,669 $25,538 $(22,196) $ 5,011 ======= ======== ======== ======= YEAR ENDED DECEMBER 31, 1998: Reserve and allowances deducted from asset accounts: Allowance for uncollectible accounts $ 2,419 $20,593 $(21,343) $ 1,669 ======= ======= ======== ======= YEAR ENDED DECEMBER 31, 1997: Reserve and allowances deducted from asset accounts: Allowance for uncollectible accounts $ 987 $ 9,784 $ (8,352) $ 2,419 ======= ======= ======== =======
41 (3) EXHIBITS: EXHIBIT NUMBER DESCRIPTION 3.1 Composite form of Amended and Restated Certificate of Incorporation of the Company, as amended through April 26, 1999 (incorporated by reference to Exhibit 3.1 to the Company's report on Form 10-Q for the quarter ended March 31, 1999). 3.2 Bylaws of the Company (incorporated by reference to Exhibit 3.2 to the Company's registration statement on Form S-1 (File No. 33-94940)). 3.3 Certificate of Designation of Series A Junior Participating Preferred Stock of Company dated August 27, 1999 (incorporated by reference to Exhibit A to Exhibit 1 to the Company's registration statement on Form 8-A (File No. 000-26728)). 10.1 Employment Agreement between the Company and Aloysius T. Lawn, IV dated October 13, 1998 (incorporated by reference to Exhibit 10.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998).* 10.2 Employment Agreement between the Company and Edward B. Meyercord, III (incorporated by reference to Exhibit 10.6 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996).* 10.3 Indemnification Agreement between the Company and Aloysius T. Lawn, IV (incorporated by reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995). 10.4 Indemnification Agreement between the Company and Edward B. Meyercord, III (incorporated by reference to Exhibit 10.14 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996). 10.5 Tel-Save Holdings, Inc. 1995 Employee Stock Option Plan (incorporated by reference to Exhibit 10.15 to the Company's registration statement on Form S-1 (File No. 33-94940)).* 10.6 Telecommunications Marketing Agreement by and among the Company, Tel-Save, Inc. and America Online, Inc., dated February 22, 1997 (incorporated by reference to Exhibit 10.32 to the Company's Form 10-K for the year ended December 31, 1996).+ 10.7 Amendment No. 1, dated as of January 25, 1998, to the Telecommunications Marketing Agreement dated as of February 22, 1997 by and among the Company, Tel-Save, Inc. and America Online, Inc. (incorporated by reference to Exhibit 10.31 to the Company's Form 10-K for the year ended December 31, 1997).+ 10.8 Amendment No. 2, dated May 14, 1998, among the Company, Tel-Save, Inc. and America Online, Inc., which amends that certain Telecommunications Marketing Agreement, dated as of February 22, 1997, as corrected and amended by letter, dated April 23, 1997, and amended by an Amendment No. 1, dated January 25, 1998 (incorporated by reference to Exhibit 10.1 to the Company's quarterly report on Form 10-Q, dated August 14, 1998).+ 42 10.9 Amendment No. 3, effective as of October 1, 1998, among the Company, Tel-Save, Inc. and America Online, Inc., which amends that certain Telecommunications Marketing Agreement, dated as of February 22, 1997, as corrected and amended by letter, dated April 23, 1997, and amended by an Amendment No. 1, dated January 25, 1998, and an Amendment No. 2, dated May 14, 1998 (incorporated by reference to Exhibit 10.22 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998).+ 10.10 Letter dated August 25, 1999 from America Online, Inc. to the Company (incorporated by reference to Exhibit 99.2 to the Company's Current Report on Form 8-K dated August 27, 1999). 10.11 Indenture dated as of September 9, 1997 between the Company and First Trust of New York, N.A. (incorporated by reference to Exhibit 4.3 to the Company's registration statement on Form S-3 (File No. 333-39787)). 10.12 Indenture dated as of December 10, 1997 between the Company and First Trust of New York, N.A. (incorporated by reference to Exhibit 10.34 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997). 10.13 Employment Agreement, dated as of November 13, 1998, between the Company and Gabriel Battista (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K dated January 20, 1999).* 10.14 Indemnification Agreement, dated as of December 28, 1998, between the Company and Gabriel Battista (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K dated January 20, 1999). 10.15 Stock Option Agreement, dated as of November 13, 1998, between the Company and Gabriel Battista (incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K dated January 20, 1999).* 10.16 Stock Option Agreement, dated as of November 13, 1998, between the Company and Gabriel Battista (incorporated by reference to Exhibit 10.4 to the Company's Current Report on Form 8-K dated January 20, 1999).* 10.17 Severance Agreement, dated as of December 31, 1998, between the Company and Daniel Borislow (incorporated by reference to Exhibit 10.5 to the Company's Current Report on Form 8-K dated January 20, 1999).* 10.18 Exchange Agreement, dated as of December 31, 1998, among the Company, Tel-Save, Inc. and Mark Pavol, as Trustee of that certain D&K Grantor Retained Annuity Trust dated June 15, 1998 (incorporated by reference to Exhibit 10.7 to the Company's Current Report on Form 8-K dated January 20, 1999). 10.19 Modification of the Exchange Agreement, dated ___________, 1999, by and among the Company, Tel-Save, Inc. and Mark Pavol (incorporated by reference to Exhibit 10.34 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 10.20 Registration Rights Agreement, dated as of December 31, 1998, among the Company, Daniel Borislow, Mark Pavol, as Trustee of that certain D&K Grantor Retained Annuity Trust, dated June 15, 1998 and the Trustee of that certain D&K Grantor Retained Annuity Trust II (incorporated by reference to Exhibit 10.8 to the Company's Current Report on Form 8-K dated January 20, 1999). 10.21 Amendment of Registration Rights Agreement dated as of March 18, 1999, by and among the Company, Daniel M. Borislow, and Seth Tobias (incorporated by reference to Exhibit 10.36 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 10.22 Amendment of Registration Rights Agreement dated as of March 18, 1999, by and among the Company and Mark Pavol (incorporated by reference to Exhibit 10.37 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 43 10.23 1998 Long-Term Incentive Plan of the Company (incorporated by reference to Exhibit 10.14 to the Company's Current Report on Form 8-K dated January 20, 1999).* 10.24 Investment Agreement, dated as of December 31, 1998, as amended on February 22, 1999, among the Company, America Online, Inc., and, solely for purposes of Sections 4.5, 4.6 and 7.3(g) thereof, Daniel Borislow, and solely for purposes of Section 4.12 thereof, Tel-Save, Inc. and the D&K Retained Annuity Trust dated June 15, 1998 by Mark Pavol, Trustee (incorporated by reference to Exhibit 10.41 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998.). 10.25 Registration Rights Agreement, dated as of January 5, 1999, between the Company and America Online, Inc. (incorporated by reference to Exhibit 10.42 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 10.26 Sublease Agreement, dated January ___, 1997, by and between Gemini Air Cargo, LLC and RMS International, Inc. (incorporated by reference to Exhibit 10.43 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 10.27 Sublease Agreement, dated as of January 20, 1999, by and between RMS International and Tel-Save, Inc. (incorporated by reference to Exhibit 10.44 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 10.28 Lease by and between Aetna Life Insurance Company and Potomac Financial Group, L.L.C. (incorporated by reference to Exhibit 10.45 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 10.29 Agreement, effective as of February 28, 1999, by and among the Company, Communication Telesystems International, d.b.a. WorldxChange Communications, Tel-Save, Inc., Mark Pavol, Roger B. Abbott and Rosalind Abbott, and Edward Soren (incorporated by reference to Exhibit 10.46 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 10.30 Form of Indemnification Agreement, dated as of January 5, 1999, for each of George Vinall, Michael Ferzacca and Norris M. Hall, III (incorporated by reference to Exhibit 10.50 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 10.31 Form of Non-Qualified Stock Option Agreement, dated as of December 16, 1998, for each of George Vinall, Michael Ferzacca and Norris M. Hall, III (incorporated by reference to Exhibit 10.51 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998).* 10.32 Employment Agreement, dated as of December 16, 1998, between the Company and Michael Ferzacca (incorporated by reference to Exhibit 10.60 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998).* 10.33 Employment Agreement, dated as of December 16, 1998, between the Company and Norris M. Hall, III (incorporated by reference to Exhibit 10.61 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998).* 10.34 Employment Agreement, dated as of December 16, 1998, between the Company and George Vinall (incorporated by reference to Exhibit 10.62 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998).* 10.35 Rights Agreement dated as of August 19, 1999 by and between the Company and First City Transfer Company, as Rights Agent (incorporated by reference to Exhibit 1 to the Company's registration statement on Form 8-A (File No. 000-26728)). 10.36 Employment Agreement by and among Vincent W. Talbert, the Company and Talk.com Holding Corp. dated as of June 8, 1999 (incorporated by reference to Exhibit 10.1 to the Company's report on Form 10-Q for the quarter ended June 30, 1999).* 44 10.37 Indemnification Agreement by and between Vincent W. Talbert and the Company dated as of June 8, 1999 (incorporated by reference to Exhibit 10.2 to the Company's report on Form 10-Q for the quarter ended June 30, 1999). 10.38 Non-Qualified Stock Option Agreement by and between Vincent W. Talbert and the Company dated as of June 8, 1999 (incorporated by reference to Exhibit 10.3 to the Company's report on Form 10-Q for the quarter ended June 30, 1999).* 10.39 Employment Agreement by and between Janet C. Kirschner and the Company dated as of October 14, 1999.* 10.40 Indemnification Agreement by and between Janet C. Kirschner and the Company dated as of October 14, 1999. 10.41 Non-Qualified Stock Option Agreement by and between Janet C. Kirschner and the Company dated as of October 14, 1999.* 11.1 Net Income Per Share Calculation. 21.1 Subsidiaries of the Company. 23.1 Consent of BDO Seidman, LLP. 27 Financial Data Schedule. - --------- * Management contract or compensatory plan or arrangement. + Confidential treatment previously has been granted for a portion of this exhibit. (b) Reports on Form 8-K. No Current Reports on Form 8-K were filed by the Company during the three months ended December 31, 1999. 45 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 22, 2000 TALK.COM INC. By: /s/ Gabriel Battista ----------------------------------- Gabriel Battista Chairman of the Board of Directors, Chief Executive Officer, President 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 /s/ Gabriel Battista Chairman of the Board March 22, 2000 - ------------------------------------ of Directors, Chief Executive Officer and Gabriel Battista Director (Principal Executive Officer) /s/ Edward B. Meyercord, III Chief Financial Officer March 22, 2000 - ------------------------------------ (Principal Financial Officer) Edward B. Meyercord, III /s/ Janet C. Kirschner Controller (Principal Accounting Officer) March 22, 2000 - ------------------------------------ Janet C. Kirschner /s/ Mark S. Fowler Director March 22, 2000 - ------------------------------------ Mark S. Fowler /s/ Arthur J. Marks Director March 22, 2000 - ------------------------------------ Arthur J. Marks /s/ Ronald R. Thoma Director March 22, 2000 - ------------------------------------ Ronald R. Thoma
46 EX-10.39 2 EXHIBIT 10.39 EXHIBIT 10.39 EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT ("Agreement") is made and entered into as of the 14th day of October, 1999 among Talk.com Inc., a Delaware corporation ("Talk.com") and Talk.com Holding Corp., a Pennsylvania corporation and a wholly owned subsidiary of Talk.com Inc. (the "Company") and Janet Kirschner ("Employee"). WHEREAS, Talk.com and Company desires to employ Employee as Controller of Talk.com and the Company and in certain other capacities, and Employee desires to be employed by Talk.com and Company; and WHEREAS, Talk.com and Company and Employee desire to enter into this Agreement that sets forth the terms and conditions of said employment. NOW THEREFORE, in consideration of the foregoing, the mutual covenants set forth herein and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the undersigned hereby agree as follows: 1. Employment. Company agrees to employ Employee, and Employee accepts such employment and agrees to serve Company, on the terms and conditions set forth herein. Except as otherwise specifically provided herein, Employee's employment shall be subject to the employment policies and practices of Company in effect from time to time during the term of Employee's employment hereunder (including, without limitation, its practices as to tax reporting and withholding). 2. Term of Agreement. The term of Employee's employment hereunder shall commence on November 15, 1999 (the "Commencement Date") and shall continue in effect for a period of five years thereafter, except as hereinafter provided (the "Term"). Employee agrees to and shall present herself at the offices of Company in New Hope, Pennsylvania prepared to commence performing her duties hereunder on or before the Commencement Date. 3. Positions and Duties. 3.1 Officer Positions. Except as may otherwise be agreed upon between Company and Employee, Employee shall perform such duties and have such responsibilities as Controller and such other duties and responsibilities consistent with the foregoing duties and responsibilities as may be reasonably assigned or delegated to him from time to time by Company's Chief Executive Officer or Company's Board of Directors (the "Board"), including, without limitation, service as an employee, officer or director of affiliates (as that term is defined in Rule 405 under the Securities Act of 1933, as amended (the "Act")) (hereinafter, "Affiliates") of Company, without additional compensation. References in this Agreement to Employee's employment with Company shall be deemed to refer to employment with Company and/or, as the case may be, an Affiliate, as the context requires. Employee shall perform her duties and responsibilities to the best of her abilities hereunder in a diligent, trustworthy, businesslike and efficient manner. Employee shall devote substantially all of her working time and efforts to the business and affairs of Company; provided, however, that nothing in this Agreement shall preclude Employee from (a) engaging in charitable activities and community affairs, and (b) managing her personal investments and affairs (subject to the limitations in Section 10 hereof. 4. Compensation and Related Matters. 4.1 Base Salary. During the Term, Company shall pay to Employee a base salary ("Base Salary") at the rate of One Hundred Fifty Thousand Dollars ($150,000) per year, which Base Salary shall be paid to Employee in accordance with Company's usual and customary payroll practices. 4.2 Benefit Plans and Arrangements. Employee shall be entitled to participate in and to receive benefits under Company's employee benefit plans and arrangements (including, but not limited to, bonus plans) as are made available to the Company's senior executive officers during the Term, which employee benefit plans and arrangements may be altered from time to time at the discretion of the Board (the "Benefits"). Employee acknowledges and agrees that bonuses, annual or otherwise, are performance based and discretionary with the Board of Directors or a Committee thereof. 4.3 Perquisites. During the Term, Employee shall be entitled to receive fringe benefits as are made available to Company's senior executive officers. 4.4 Expenses. Company shall promptly reimburse Employee for all out-of-pocket expenses related to Company's business that are actually paid or incurred by him in the performance of her services under this Agreement and that are incurred, reported and documented in accordance with Company's policies. In addition, during the Term, Company will provide Employee with an automobile or an automobile allowance, as Company shall determine, and if the Company determines to provide Employee with an automobile, Company shall keep such automobile fully insured in accordance with Company's practices for similarly situated employees. 4.5 Stock Options. (a) Grant of Options. Effective on the date hereof, Employee shall be granted an award of an option to purchase 150,000 shares of the Common Stock (the "Option") in accordance with the stock option agreement in substantially in the form thereof attached hereto as Exhibit A. The Option shall have an exercise price equal to $11 1/8, which is equal to the fair market value (as defined below) of the Common Stock on the date hereof. The Option expires on the tenth anniversary of the date hereof and shall vest and become exercisable, subject to accelerated vesting in the event of a Change in Control (defined as provided below) of Company in installments, as follows: (i) options with respect to 50,000 shares of Common Stock shall vest and become exercisable on the first anniversary of the date hereof; (ii) options with respect to 50,000 shares of Common Stock shall vest and become exercisable on the second anniversary of the date hereof and (iii) options with respect to 50,000 shares of Common Stock shall vest and become exercisable on the third anniversary of the date hereof. In the event of a Change in Control of Company, all of the options issued under the Option which are not then vested and exercisable shall immediately become vested and exercisable. The fair market value of Common Stock for purposes of this Agreement shall mean the last reported sale price of a share of the Common Stock on the Nasdaq National Market System preceding the date in question or if no sale took place on such day, such last reported sale price on the then next preceding date on which such sale took place. For the purposes of this Agreement, a "Change of Control" shall be deemed to have occurred if: 2 (i) any Person (as defined in Section 3(a)(9) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")), other than the Company, becomes the Beneficial Owner (as defined in Rule 13d-3 under the Exchange Act; provided, that a Person shall be deemed to be the Beneficial Owner of all shares that any such Person has the right to acquire pursuant to any agreement or arrangement or upon exercise of conversion rights, warrants, options or otherwise, without regard to the 60 day period referred to in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company or any Significant Subsidiary (as defined below) representing 50% or more of the combined voting power of the Company's, or such subsidiary's, as the case may be, then outstanding securities; (ii) during any period of two years, individuals who at the beginning of such period constitute the Board and any new director (other than a director designated by a person who has entered into an agreement with the Company to effect a transaction described in clauses (i), (iii), or (iv) of this Section 2(a)) whose election by the Board or nomination for election by stockholders was approved by a vote of at least two-thirds (2/3) of the directors then still in office who either were directors at the beginning of the two-year period or whose election or nomination for election was previously so approved, but excluding for this purpose any such new director whose initial assumption of office occurs as a result of either an actual or threatened election contest or other actual or threatened solicitation of proxies or consents by or on behalf of an individual, corporation, partnership, group, association or other entity other than the Board, cease for any reason to constitute at least a majority of the Board of either or the Company or a Significant Subsidiary; 3 (iii) the consummation of a merger or consolidation of the Company or any subsidiary of the Company owning directly or indirectly all or substantially all of the consolidated assets of the Company (a "Significant Subsidiary") with any other entity, other than a merger or consolidation which would result in the voting securities of the Company or a Significant Subsidiary outstanding immediately prior thereto continuing to represent more than fifty percent (50%) of the combined voting power of the surviving or resulting entity outstanding immediately after such merger or consolidation; (v) (iv) the shareholders of the Company approve a plan or agreement for the sale or disposition of fifty percent (50%) or more of the consolidated assets of the Company in which case the Board shall determine the effective date of the Change of Control resulting therefrom; and (vi) any other event occurs which the Board determines, in its discretion, would materially alter, the structure of the Company or its ownership. (b) Registration Statement. Company will file with the Securities and Exchange Commission and any applicable state securities regulatory authorities a Registration Statement on the applicable form to register the resale of the Award and Form S-8 (or if unavailable, a registration statement on Form S-3) to register the shares issuable upon exercise of the Option under the Act and any applicable state securities or "Blue Sky" laws as soon as practicable after the date hereof. Notwithstanding the foregoing, Company shall be entitled to postpone for a reasonable period of time the filing or the effectiveness of such registration statement if the Board shall determine in good faith that such filing or effectiveness would be materially detrimental to the Company's business interests. 4.6 Bonuses. Company shall pay Employee on January 3, 2000 the sum of Seventy-Five Thousand Dollars ($75,000). 5. Termination. The Term of Employee's employment hereunder may be terminated under the following circumstances: 4 5.1 Death. The Term of Employee's employment hereunder shall terminate upon her death. 5.2 Disability. If Employee becomes physically or mentally disabled during the term hereof so that he is unable to perform services required of him pursuant to this Agreement for an aggregate of six (6) months in any twelve (12) month period (a `Disability"), Company, at its option, may terminate Employee's employment hereunder. 5.3 Cause. Upon written notice, Company may terminate Employee's employment hereunder for Cause (as defined below). For purposes of this Agreement, Company shall have "Cause" to terminate Employee's employment hereunder upon (a) a material breach by Employee of any material provision of this Agreement, (b) willful misconduct by Employee in connection with misappropriating any funds or property of Company, (c) attempting to obtain any personal profit from any transaction in which Employee has an interest that is adverse to the interests of Company without prior written disclosure thereof to the Board or (d) Employee's gross neglect in the performance of the duties required to be performed by Employee under this Agreement. 5.4 By Employee. Employee may terminate her employment hereunder: (a) Upon sixty (60) days' prior written notice to Company, provided that, upon the giving of such notice by Employee, Company may establish an earlier date for such termination under this Section 5.4 (a). (b) For Good Reason (as defined below) immediately and with notice to Company. "Good Reason" for termination by Employee shall include, but is not limited to, the following: (i) Material breach of any provision of this Agreement by Company, which breach shall not have been cured by Company within thirty (30) days of receipt of written notice of said material breach; (ii) Failure by Company to maintain Employee in a position commensurate with that referred to in Section 3 of this Agreement; or (iii) The assignment to Employee of any duties inconsistent with Employee's position, authority, duties or responsibilities as contemplated by Section 3 hereof or any other action by Company that results in a diminution of such position, authority, duties or responsibilities. 5.5 Without Cause. Company may otherwise terminate the Term of Employee's employment at any time upon written notice to Employee. 5 6. Compensation In the Event of Termination. In the event that Employee's employment hereunder terminates prior to the end of the Term, Company shall make payments to Employee as set forth below: 6.1 By Employee for Good Reason; By Company Without Cause. In the event that Employee's employment hereunder is terminated by Company without Cause or by Employee for Good Reason, then the Company shall (a) pay to Employee all amounts due to Employee pursuant to any bonus that was due to Employee as of the date of such termination, pursuant to the terms of such bonus (a "Due Bonus"), (b) continue to pay to Employee the Base Salary and Benefits to which Employee would be entitled hereunder in the manner provided for herein for the period of time ending on the earlier of the date when the Term would otherwise have expired in accordance with Section 2 hereof and the second anniversary of the date of such termination, (c) reimburse Employee for expenses that may have been incurred, but which have not been paid as of the date of termination, subject to the requirements of Section 4.4 hereof and (d) one hundred percent (100%) of the outstanding stock options granted to the Employee that are unvested shall immediately vest and become exercisable. 6.2 By Company for Cause; By Employee Without Good Reason. In the event that Company shall terminate Employee's employment hereunder for Cause pursuant to Section 5.3 hereof or Employee shall terminate her employment hereunder without Good Reason, all compensation and Benefits, as specified in Section 4 of this Agreement, theretofore payable or provided to Employee shall cease to be payable or provided, except for any Due Bonus and any Benefits that may have been due and payable but that have not been paid as of the date of termination and reimbursement of expenses that may have been incurred, but which have not been paid as of the date of termination, subject to the requirements of Section 4.4 hereof. 6.3 Death. In the event of Employee's death, Company shall not be obligated to pay Employee or her estate or beneficiaries any compensation except for (a) any Due Bonus or any Benefits that may have been earned and are due and payable as of the date of death, but which have not been paid as of such date, (b) reimbursement of expenses that may have been incurred, but which have not been paid as of the date of death, subject to the requirements of Section 4.4 hereof, and (c) all outstanding stock options granted to Employee that are unvested shall immediately vest and become exercisable and Employee's estate or beneficiaries, as the case may be, shall have the right to exercise any of such stock options during the period commencing on the date of death and ending on the second anniversary of the date of such termination or for the remainder of the period set forth in the option agreement applicable to the option in question (the "Exercise Period'), if less. 6.4 Disability. In the event of Employee's Disability, Company shall not be obligated to pay Employee or her estate or beneficiaries any additional compensation except for: (a) any Due Bonus and Benefits that may have been earned and are due and payable as of the date of such Disability, but which have not been paid as of such date, and (b) reimbursement for expenses that may have been incurred but which have not been paid as of the date of Disability, subject to the requirements of Section 4.4 hereof. Upon termination due to Disability, fifty percent (50%) of the outstanding stock options granted to Employee that are unvested shall immediately vest and become exercisable and Employee or her estate or beneficiaries, as the case may be, shall have the right to exercise any of such stock options during the period commencing on the date of Disability and ending on the second anniversary of the date of the Disability or for the remainder of Exercise Period, if less. 6 6.5 No Mitigation. In the event of any termination of employment under Section 5 hereof, Employee shall be under no obligation to seek other employment; provided; however, that to the extent that Employee does obtain other employment subsequent to the termination of Employee's employment hereunder, the obligations of Company to pay Benefits (which is defined in Section 4.2 of this Agreement and the term "Benefits" does not include Options granted pursuant to Section 4.5 of this Agreement for purposes of this Section 6.5) under this Agreement from and after the date of commencement of such other employment shall terminate. 7. Unauthorized Disclosure. Employee shall not, without the prior written consent of Company, disclose or use in any way, either during Employee's employment with Company or thereafter, except as required in the course of such employment, any confidential business or technical information or trade secret acquired in the course of such employment, whether or not conceived of or prepared by him, which is related to any service or business of Company or any Affiliate; provided, however, that the foregoing shall not apply to (a) information that is not unique to the Company or that is generally known to the industry or the public other than as a result of Employee's breach of this covenant, (b) information known to Employee other than from information provided by Company or (c) information that Employee is required to disclose to, or by, any governmental or judicial authority; provided, however, if Employee should be required in the course of judicial or other governmental proceedings to disclose any information, Employee shall give Company prompt written notice thereof so that Company may seek an appropriate protective order and/or waive in writing compliance with the confidentiality provisions of this Agreement. If, in the absence of a protective order or the receipt of a waiver by Company, Employee is compelled to disclose information to, or pursuant to the requirements of, a court or other governmental authority, Employee may disclose such information to such court or other governmental authority without liability to any other party hereto. 8. Tangible Items. All files, records, documents, manuals, books, forms, reports, memoranda, studies, data, calculations, recordings and correspondence, in whatever form they may exist, and all copies, abstracts and summaries of the foregoing and all physical items related to the business of Company and its affiliates, other than merely personal items, whether of a public nature or not, and whether prepared by Employee or not, and which are received by Employee from, or on behalf of Company or an Affiliate in the course of her employment hereunder are and shall remain the exclusive property of Company and any such Affiliate and shall not be removed from the premises of the Company or such Affiliate, as the case may be, except as required in the course of Employee's employment hereunder, without the prior written consent of the Company's Chief Executive Officer or the Board, and the same shall be promptly returned by Employee upon the termination of Employee's employment with Company or at any time prior thereto upon the request of the Company's Chief Executive Officer or the Board. 7 9. Inventions and Patents. Employee agrees that all inventions, innovations, improvements, developments, methods, designs, analyses, drawings, reports, and all similar or related information that relates to Company's actual or anticipated business, research and development or existing or future products or services and that are conceived, developed or made by or at the direction of Employee while Employee is employed by Company will be owned by Company. Employee also agrees to promptly perform, at the expense of Company, all reasonable actions (whether before, during or after the Term) necessary to establish and confirm such ownership. 10. Certain Restrictive Covenants. During the Term, and for a period ending twelve (12) months after the earlier of Employee's termination of employment hereunder, Employee agrees that he will not act, either directly or indirectly, as a partner, officer, director, substantial stockholder (an equity interest of 5% or more) or employee of, or render advisory or other services for, or in connection with, or become interested in, or make any substantial financial investment in any firm, corporation, business entity or business enterprise that is a provider of telecommunication services that competes with Employer (each, a "Competitor"), except with the express written consent of the Board which shall not be unreasonably withheld. Employee further agrees that in the event of the termination of her employment under Section 5 hereof, for a period of twelve (12) months thereafter, she will not, directly or indirectly, employ, offer to employ, or actively interfere with the relationship of Company or an Affiliate with, any employee of Company or any employee of any Affiliate. 11. Employee Representations and Covenants. Employee hereby represents, warrants and covenants to Company that (a) the execution, delivery and performance of this Agreement by Employee does not and will not conflict with, breach, violate or cause a default under any employment, non-competition or confidentiality contract or agreement, instrument; order, judgment or decree to which Employee is a party or by which he is bound; (b) Employee, in performing this Agreement and the duties of Employee's employment with Company, will not disclose or utilize any trade secrets of a former employer, unless Employee has first obtained express written authorization from any such former employer for their disclosure or use; (c) Employee has not brought, and will not bring to Company, any documents, records, information or other materials of a former employer that are not generally available to the public, unless Employee has first obtained express written authorization from any such former employer for their possession and use; and (d) upon the execution and delivery of this Agreement by Company, this Agreement shall be the valid and binding obligation of Employee, enforceable in accordance with its terms, subject to applicable bankruptcy, insolvency and similar laws affecting the rights of creditors generally. 12. Company Representations. Company represents and warrants (a) that it is duly authorized and empowered to enter into this Agreement, (b) the execution, delivery and performance of this Agreement by Company does not and will not conflict with, breach, violate or cause a default under any contract, agreement, instrument, order, judgment or decree to which Company is a party or by which it is bound, and (c) upon the execution and delivery of this Agreement by Employee, this Agreement shall be the valid and binding obligation of Company, enforceable in accordance with its terms, subject to applicable bankruptcy, insolvency and similar laws affecting the rights of creditor generally. 13. Indemnification. Prior to the Commencement Date, Company and Employee shall enter into an indemnification agreement in a form mutually acceptable to Company and Employee and containing terms no less favorable to Employee than those contained in any indemnification or similar agreement currently in effect between Company and any of its officers. 14. Remedies. Employee acknowledges that the restrictions and agreements contained in this Agreement are reasonable and necessary to protect the legitimate interests of Company, and that any violation of this Agreement will cause substantial and irreparable injury to Company that would not be quantifiable and for which no adequate remedy would exist at law and agrees that injunctive relief, in addition to all other remedies, shall be available therefor. 15. Effect of Agreement on Other Benefits. Except as specifically provided in this Agreement, the existence of this Agreement shall not be interpreted to preclude, prohibit or restrict Employee's participation in any other employee benefit plan or other plans or programs provided to officers, directors or employees of Company. 8 16. Rights of Employee's Estate. If Employee dies prior to the payment of all amounts due and owing to him under the terms of this Agreement, such amounts shall be paid to such beneficiary or beneficiaries as Employee may have last designated in writing filed with the Secretary of Company or, if Employee has made no beneficiary designation, to Employee's estate. Such designated beneficiary or the executor of Employee's estate, as the case may be, may exercise all of Employee's rights hereunder. If any beneficiary designated by Employee shall predecease Employee, the designation of such beneficiary shall be deemed revoked, and any amounts which would have been payable to such beneficiary shall be paid to Employee's estate. If any designated beneficiary survives Employee, but dies before payment of all amounts due hereunder, such payments shall, unless Employee has designated otherwise, be made to such beneficiary's estate. In the event of Employee's death or judicial determination of her incompetence, reference in this Agreement to Employee shall be deemed where appropriate, to refer to her beneficiary, estate or other legal representative. 17. Severability. It is the intent and understanding of the parties hereto that if, in any action before any court or other tribunal of competent jurisdiction legally empowered to enforce this Agreement, any term, restriction, covenant, or promise is held to be unenforceable as a result of being unreasonable or for any other reason, then such term, restriction, covenant, or promise shall not thereby be terminated, but, that it shall be deemed modified to the extent necessary to make it enforceable by such court or other tribunal and, if it cannot be so modified, that it shall be deemed amended to delete therefrom such provision or portion adjudicated to be invalid or unenforceable, and this agreement shall be deemed to be in full force and effect as so modified and such modification or amendment in any event shall apply only with respect to the operation of this Agreement in the particular jurisdiction in which such adjudication is made. 18. Notices. Any notices or demands given in connection herewith shall be in writing and deemed given when (a) personally delivered, (b) sent by facsimile transmission to a number provided in writing by the addressee and a confirmation of the transmission is received by the sender or (c) two (2) days after being deposited for delivery with a recognized overnight courier, such as Federal Express, and addressed or sent, as the case may be, to the address or facsimile number set forth below or to such other address or facsimile number as such party may in writing designate: If to Employee: Janet Kirschner If to Company: Talk.com Inc. 12020 Sunrise Valley Drive Suite 250 Reston, VA 20190 Attn: General Counsel Fax No.: (703) 391-7525 Either party may change its address for notices by written notice to the other party in accordance with this Section 17. 19. Waiver. No provision of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in a writing executed by Employee and Company. No waiver by any party hereto at any time of any breach by another party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. 20. Governing Law. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of Pennsylvania relating to contracts made and to be performed entirely therein. 21. Headings. The headings in this Agreement are inserted for convenience only and shall have no significance in the interpretation of this Agreement. 22. Successors. Company may not assign any of its rights or obligations under this Agreement hereunder. Employee may assign her rights, but not her obligations, hereunder and all of Employee's rights hereunder shall inure to the benefit of his estate, personal representatives, designees or other legal representatives. All of the rights of Company hereunder shall inure to the benefit of, and be enforceable by the successors of Company. Any person, firm or corporation succeeding to the business of Company by merger, purchase, consolidation or otherwise shall be deemed to have assumed the obligations of Company hereunder; provided, however, that Company shall, notwithstanding such assumption by a successor, remain primarily liable and responsible for the fulfillment of its obligations under this Agreement. 23. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument. 24. Certain Words. As used in this Agreement, the words "herein," "hereunder," "hereof" and similar words shall be deemed to refer to this Agreement in its entirety, and not to any particular provision of this Agreement unless the context clearly requires otherwise. 9 IN WITNESS WHEREOF, each of the parties hereto has executed this Agreement as of the day and year first written above. Talk.com Inc. Talk.com Holding Corp. By: By: ----------------------------- ----------------------------- Name: Name: Title: Title: - ----------------------------- Janet Kirscherner 10 EX-10.40 3 EXHIBIT 10.40 EXHIBIT 10.40 TALK.COM INC. INDEMNIFICATION AGREEMENT This Indemnification Agreement ("Agreement") is made as of October 14, 1999, by and between Talk.com Inc., a Delaware corporation (the "Company"), and Janet Kirschner ("Indemnitee"). WHEREAS, pursuant to that certain employment agreement between the Company, Talk.com Holding Corp. and Indemnitee dated October 14, 1999 (the "Employment Agreement") Indemnitee will commence service, on or prior to October __, 1999 as Controller of the Company and will perform a valuable service in such capacity for the Company; and WHEREAS, the Company desires to attract and retain the services of highly qualified individuals, such as Indemnitee, to serve the Company and, in order to induce Indemnitee to enter into the Employment Agreement, the Company agreed to enter into an agreement with Indemnitee providing for the indemnification of Indemnitee as provided herein. NOW, THEREFORE, in consideration of the foregoing, the mutual covenants set forth herein and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the undersigned hereby agree as follows: 1. Indemnification. (a) Indemnification of Indemnitee. The Company shall indemnify and hold harmless Indemnitee to the fullest extent permitted by law if Indemnitee was or is or becomes a party to, or witness or other participant in, or is threatened to be made a party to, or witness or other participant in, any threatened, pending or completed action, suit, proceeding or alternative dispute resolution mechanism, or any hearing, inquiry or investigation that Indemnitee in good faith believes might lead to the institution of any such action, suit, proceeding or alternative dispute resolution mechanism, whether civil, criminal, administrative, investigative or other (collectively, hereinafter a "Claim") by reason of, or arising in whole or in part out of, any event or occurrence related to the fact that Indemnitee is or was a director, officer, manager, employee, agent, representative or fiduciary of the Company, a subsidiary of the Company (a "Subsidiary") or an affiliate (as defined in Rule 405 under the Securities Act of 1933, as amended) of the Company (an "Affiliate"), or is or was serving at the request of the Company or any Subsidiary or Affiliate as a director, officer, manager, employee, agent, representative or fiduciary of another corporation, limited liability company, partnership, joint venture, employee benefit plan, trust or other entity or enterprise (collectively, an "Other Entity"), or by reason of any action or inaction on the part of Indemnitee while serving in any of such capacities, whether or not the basis of the Claim is an alleged action in an official capacity as a director, officer, manager, employee, agent, representative or fiduciary of the Company, or any Subsidiary, Affiliate or Other Entity (any of the foregoing capacities referenced in this Section 1(a), an "Indemnified Capacity"), against any and all costs, expenses and other amounts actually and reasonably incurred and/or, as the case may be, paid (including, without limitation, attorneys' fees and all other costs, expenses and obligations actually and reasonably incurred in connection with investigating, defending, being a witness in, or otherwise participating in (including on appeal), or preparing to defend, any Claim), and judgements, fines, penalties and amounts paid in connection with the settlement of any Claim and any federal, state, local or foreign taxes imposed on the Indemnitee as a result of the actual or deemed receipt of any payments under this Agreement, including all interest, assessments and other charges paid or payable by the Indemnitee in connection with or in respect of such costs, expenses and other amounts (collectively, hereinafter, the "Expenses"). Without limiting the rights of Indemnitee under Section 2(a) below, the payment of Expenses actually paid by Employee shall be made by the Company as soon as practicable, but in any event no later than thirty (30) days after written demand by Indemnitee therefor is presented to the Company. Any event giving use to the right of Indemnitee to be indemnified hereinafter is referred to herein as an "Indemnifiable Event." (b) Reviewing Party. Notwithstanding the foregoing, (i) the obligations of the Company under Section 1(a) hereof shall be subject to the condition that the Reviewing Party (as defined in Section 10(e) hereof) shall not have determined (in a written opinion, in any case in which the Independent Legal Counsel (as defined in Section 10(d) hereof) is involved) that Indemnitee would not be permitted to be indemnified under applicable law, and (ii) the obligation of the Company to make an advance payment of Expenses to Indemnitee pursuant to Section 2(a) hereof (an "Expense Advance") shall be subject to the condition that, if, when and to the extent that the Reviewing Party determines that Indemnitee would not be permitted to be so indemnified under applicable law, the Company shall be entitled to be reimbursed by Indemnitee (who hereby agrees to so reimburse the Company) for all such amounts theretofore paid; provided, however, that if Indemnitee has commenced or thereafter commences legal proceedings in a court of competent jurisdiction to secure a determination that Indemnitee could be indemnified under applicable law, any determination made by the Reviewing Party that Indemnitee would not be permitted to be indemnified under applicable law shall not be binding and Indemnitee shall not be required to reimburse the Company for any Expense Advance until a final judicial determination is made with respect thereto (as to which all rights of appeal therefrom have been exhausted or lapsed). Indemnitee's obligation to reimburse the Company for any Expense Advance shall be unsecured and no interest shall be charged thereon. If there has not been a Change in Control (as defined in Section 10(c) hereof), the Reviewing Party shall be selected by members of the Board of Directors who are not or were not, as the case may be, a party or parties, as the case may be, to the Claim in respect of which indemnification is sought, and if there has been a Change in Control (other than a Change in Control which has been approved by a majority of the Company's Board of Directors who were directors immediately prior to such Change in Control), the Reviewing Party shall be the Independent Legal Counsel. If, within thirty (30) days after the Company's receipt of written notice from Indemnitee demanding such indemnification (the "30-Day Period") (i) the Reviewing Party determines that Indemnitee substantively would not be permitted to be indemnified in whole or in part under applicable law or makes no determination in that regard or, (ii) Indemnitee shall not have received full indemnification from the Company, Indemnitee shall have the right to commence litigation seeking a determination by a court of competent jurisdiction as to the propriety of indemnification under the circumstances involved or challenging any such determination (or lack thereof) by the Reviewing Party or any aspect thereof, including the legal or factual bases therefor or the failure of the Company to fully indemnify the Indemnitee, and the Company hereby consents to service of process and to appear in any such proceeding and hereby appoints the Secretary of the Company (or, if such office is not filled at a time in question, any Assistant Secretary of the Company or, if such office is not filled at a time in question, any Vice President of the Company - each, a "Service Receiver") as its agent for such service of process. Any determination by the Reviewing Party not otherwise so challenged shall be conclusive and binding on the Company and Indemnitee. (c) Change in Control. The Company agrees that if there is a Change in Control (other than a Change in Control which has been approved by a majority of the Company's Board of Directors who were directors immediately prior to such Change in Control), then, with respect to all matters thereafter arising concerning the rights of Indemnitee to payments of Expenses and Expense Advances under this Agreement or any other agreement or under the Company's Certificate of Incorporation or Bylaws as now or hereafter in effect, the Company shall seek legal advice only from the Independent Legal Counsel. Such counsel, among other things, shall render its written opinion to the Company and Indemnitee as to whether and to what extent Indemnitee would be permitted to be indemnified under applicable law. The Company agrees to pay the reasonable fees of the Independent Legal Counsel referred to above and to fully indemnify such counsel against any and all expenses (including attorneys' fees), claims, liabilities and damages arising out of or relating to this Agreement or its engagement pursuant hereto. 2 (d) Mandatory Payment of Expenses. Notwithstanding any other provision of this Agreement, to the extent that Indemnitee has been successful on the merits or otherwise, including, without limitation, the dismissal of an action without prejudice, in connection with any Claim, Indemnitee shall be indemnified against all Expenses actually and reasonably incurred by Indemnitee in connection therewith. 2. Expenses; Indemnification Procedure. (a)Advancement of Expenses. The Company shall advance all Expenses incurred by Indemnitee so that the Company, and not Indemnitee, shall be obligated to pay such incurred Expenses. The advances of Expenses to be made hereunder shall be paid by the Company to Indemnitee as soon as practicable, but in any event no later than five (5) days after written demand by Indemnitee therefor to the Company. (b) Notice and Cooperation by Indemnitee. Indemnitee shall, as a condition precedent to Indemnitee's right to be indemnified under this Agreement, give the Company notice in writing as soon as practicable of any Claim made against Indemnitee for which indemnification will or could be sought under this Agreement; but the Indemnitee's failure to so notify the Company shall not relieve the Company from any liability that it may have to Indemnitee under this Agreement, except to the extent that the Company is able to establish that its ability to avoid liability under such Claim was prejudiced in a material respect by such failure. Notice to the Company shall be directed to a Service Receiver at the address of the Company shown on the signature page of this Agreement (or such other address as the Company shall designate in writing to Indemnitee). In addition, Indemnitee shall, at the expense of the Company, provide the Company with such information and cooperation with respect to a Claim, or any matters related to such Claim, as it may reasonably require in connection with the indemnification provided for herein and as shall be within Indemnitee's power. Any costs or expenses (including attorneys' fees and disbursements) actually and reasonably incurred by Indemnitee in so cooperating shall be borne by the Company (irrespective of the determination as to Indemnitee's entitlement to indemnification), which shall pay any such amount within fifteen (15) days after receiving a request therefor from Indemnitee, and the Company hereby indemnifies and agrees to hold Indemnitee harmless therefrom. (c) No Presumptions; Burden of Proof. For purposes of this Agreement, the termination of any Claim by judgment, order, settlement (whether with or without court approval) or conviction, or upon a plea of nolo contendere, or its equivalent, shall not create a presumption that Indemnitee did not meet any particular standard of conduct or have any particular belief or that a court has determined that indemnification is not permitted by applicable law. In addition, neither the failure of the Reviewing Party to have made a determination as to whether Indemnitee has met any particular standard of conduct or had any particular belief, nor an actual determination by the Reviewing Party that Indemnitee has not met such standard of conduct or did not have such belief, prior to the commencement of legal proceedings by Indemnitee to secure a judicial determination that Indemnitee should be indemnified under applicable law, shall be a defense to a claim for indemnification by Indemnitee hereunder or create a presumption that Indemnitee has not met any particular standard of conduct or did not have any particular belief. In connection with any determination by the Reviewing Party or otherwise as to whether Indemnitee is entitled to be indemnified hereunder, the burden of proof shall be on the Company to establish that Indemnitee is not so entitled. 3 (d) Notice to Insurers. If, at the time of the receipt by the Company of a notice of a Claim pursuant to Section 2(b) hereof, the Company has one or more policies of liability insurance in effect which may cover such Claim, the Company shall give prompt notice of the commencement of such Claim to the applicable insurer(s) in accordance with the procedures set forth in the applicable policies. The Company shall thereafter take all action necessary or desirable to cause such insurers to pay, on behalf of Indemnitee, all amounts payable as a result of such Claim in accordance with the terms of such policies. (e) Selection of Counsel. In the event that the Company shall be obligated hereunder to pay the Expenses with respect to any Claim, the Company, except as otherwise provided below, shall be entitled to assume the defense of such Claim at its own expense with counsel approved by Indemnitee, upon the delivery to Indemnitee of written notice of its election so to do. Indemnitee's approval of such counsel shall not be unreasonably withheld. After delivery of such notice, approval of such counsel by Indemnitee and the retention of such counsel by the Company, the Company will not be liable to the Indemnitee under this Agreement for any fees of counsel subsequently incurred by the Indemnitee with respect to such Claim, other than as provided below. Indemnitee shall have the right to employ Indemnitee's own counsel in connection with a Claim, but the fees and expenses of such counsel incurred after written notice from the Company of its assumption of the defense thereof shall be at the expense of Indemnitee, unless (i) the employment of counsel by Indemnitee has been previously authorized by the Company, or, following a Change in Control (other than a Change in Control approved by a majority of the members of the Board of Directors who were directors immediately prior to such Change in Control), the employment of counsel by Indemnitee has been approved by the Independent Legal Counsel, (ii) Indemnitee shall have reasonably concluded that there may be a conflict of interest between the Company and Indemnitee in the conduct of any such defense, or (iii) the Company shall not, in fact, have employed or retained or continued to employ or retain counsel to assume the defense of such Claim, in each of which cases the fees and expenses of Indemnitee's counsel shall be at the expense of the Company. The Company shall not be entitled to assume or control the defense of any Claim brought by or on behalf of the Company or as to which the Indemnitee has reached the conclusion that there may be a conflict of interest between the Company and Indemnitee. The Company shall not settle any Claim in any manner which would impose any penalty or limitation on Indemnitee without the Indemnitee's written consent (which approval shall not be unreasonably withheld). 4 (f) Settlement of Claims. The Company shall not be required to indemnify Indemnitee under this Agreement for any amounts paid in settlement of any Claim effected without the Company's written consent; provided, however, that consent by the Company to the settlement of any claim shall not be unreasonably withheld. Notwithstanding the foregoing, however, if a Change in Control has occurred (other than a Change in Control approved by a majority of the members of the Board of Directors who were directors immediately prior to such Change in Control), then the Company shall be required to indemnify Indemnitee for amounts paid in settlement of any Claim if the Independent Legal Counsel has approved such settlement or has not made a determination with respect to such settlement within (30) days after the effective date of such Change in Control. 3. Additional Indemnification Rights; Non-Exclusivity. (a) Scope. The Company hereby agrees to indemnify Indemnitee to the fullest extent permitted by law, notwithstanding that such indemnification is not specifically authorized by the Company's Certificate of Incorporation or Bylaws or by statute. In the event of any change after the date of this Agreement in any applicable law, statute or rule which expands the right of the Company to indemnify Indemnitee, it is the intent of the parties hereto that Indemnitee shall enjoy under this Agreement the greater benefits afforded by such change. In the event of any change in any applicable law, statute or rule which narrows the right of the Company to indemnify the Indemnitee, such change, to the extent not otherwise required by such law, statute or rule to be applied to this Agreement, shall have no effect on this Agreement or the parties' rights and obligations hereunder. (b)Non-Exclusivity. The indemnification provided by this Agreement shall be in addition to any rights to which Indemnitee may be entitled under the Company's Certificate of Incorporation or Bylaws, any agreement, vote of stockholders or directors, the General Corporation Law of the State of Delaware, or otherwise. The indemnification provided under this Agreement shall continue as to Indemnitee for any Indemnifiable Event while serving in an Indemnified Capacity even though Indemnitee may have ceased to serve in such Indemnified Capacity. 4. No Duplication of Payments. The Company shall not be liable under this Agreement to make any payment in connection with any Claim to the extent Indemnitee has otherwise actually received payment (under any insurance policy or otherwise) of the amounts otherwise indemnifiable hereunder. 5 5. Partial Indemnification. If Indemnitee is entitled under any provision of this Agreement to indemnification by the Company for a portion of any of the Expenses in connection with the investigation, appeal or settlement of any Claim, but not for the total amount thereof, the Company shall nevertheless indemnify Indemnitee for such portion of the Expenses. 6. Mutual Acknowledgment. Both the Company and Indemnitee acknowledge that, in certain instances, applicable law or public policy may prohibit the Company from indemnifying Indemnitee under this Agreement or otherwise. Indemnitee understands and acknowledges that the Company has undertaken or may be required in the future to undertake with the Securities and Exchange Commission to submit the question of indemnification to a court in certain circumstances for a determination of the Company's right under public policy to indemnify Indemnitee. 7. Liability Insurance. To the extent the Company or any Subsidiary or Affiliate maintains liability insurance applicable to directors, officers, managers, employees, agents, representatives or fiduciaries of the Company or such Subsidiary or Affiliate (collectively, the "Covered Persons"), Indemnitee shall be covered by such policies in such a manner as to provide Indemnitee the same rights and benefits as are accorded to the most favorably insured of the Covered Persons who is then serving in the same capacity or capacities, as the case may be, as Indemnitee. 8. Exceptions. Any other provision herein to the contrary notwithstanding, the Company shall not be obligated pursuant to the terms of this Agreement: (a) Excluded Action or Omissions. To indemnify Indemnitee for any Expenses resulting from acts, omissions or transactions from which Indemnitee may not be indemnified under applicable law, or for any Expenses resulting from Indemnitee's conduct which is finally adjudged to have been willful misconduct or knowingly fraudulent conduct; (b) Claims Initiated by Indemnitee. To indemnify or advance Expenses to Indemnitee with respect to Claims initiated or brought voluntarily by Indemnitee and not by way of defense, regardless of whether Indemnitee ultimately is determined to be entitled to such indemnification, Expense Advance or insurance recovery, as the case may be, except (i) with respect to proceedings brought to establish or enforce (a) a right to, or for, Expense Advances and/or, as the case may be, (b) any other right of Indemnitee under this Agreement or any other agreement or insurance policy or under the Company's Certificate of Incorporation or Bylaws now or hereafter in effect, (ii) in specific cases, if the Board of Directors has approved the initiation or bringing of such suit or (iii) as otherwise required under applicable law or statute; (c) Lack of Good Faith. To indemnify Indemnitee for any Expenses incurred by Indemnitee with respect to any proceeding instituted by Indemnitee to enforce or interpret this Agreement, if a court of competent jurisdiction determines that each of the material assertions made by the Indemnitee in such proceeding was not made in good faith or was frivolous; or (d) Claims Under Section 16(b). To indemnify Indemnitee for Expenses and the payment of profits arising from the purchase and sale or, sale and purchase, by Indemnitee of securities in violation of Section 16(b) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), or any similar successor statute. 6 9. Period of Limitations. No legal action shall be brought and no cause of action shall be asserted by or in the right of the Company with respect to the matters addressed in this Agreement against Indemnitee, or Indemnitee's estate, spouse, heirs, executors or personal or legal representatives after the expiration of two(2) years from the date of accrual of such cause of action, and any claim or cause of action of the Company shall be extinguished and deemed released unless asserted by the timely filing of a legal action within such two-year period; provided, however, that if any shorter period of limitations is otherwise applicable to any such cause of action, such shorter period shall govern. 10. Construction of Certain Phrases. (a) Company. For purposes of this Agreement, references to the "Company" shall include, in addition to the resulting entity, any constituent entity (including any constituent of a constituent) absorbed in a consolidation or merger which, if its separate existence had continued, would have had power and authority to indemnify its directors, officers, managers, employees, agents, representation or fiduciaries, so that if Indemnitee is or was a director, officer, employee, agent or fiduciary of such constituent corporation, or is or was serving at the request of such constituent corporation as a director, officer, manager, employee, agent or fiduciary of an Other Entity, Indemnitee shall stand in the same position under the provisions of this Agreement with respect to the resulting or surviving entity as Indemnitee would have stood with respect to such constituent entity if its separate existence had continued. The consummation of any transaction described in this Section 10(a) shall be subject to the requirements of Section 12, below. (b) Miscellaneous Terms. For purposes of this Agreement, references to "fines" shall include any excise taxes assessed on Indemnitee with respect to an employee benefit plan; and references to "serving at the request of the Company or any Subsidiary or Affiliate" or words of similar import shall include any service as a director, officer, manager, employee, agent, representative or fiduciary of the Company which imposes duties on, or involves services by, such director, officer, manager, employee, representative, agent or fiduciary with respect to an employee benefit plan, or its participants or its beneficiaries; and if Indemnitee acted in good faith and in a manner Indemnitee reasonably believed to be in the interest of the participants and beneficiaries of an employee benefit plan, Indemnitee shall be deemed to have acted in a manner "not opposed to the best interests of the Company" as referred to in this Agreement or under any applicable law or statute. (c) Change in Control. For purposes of this Agreement, a "Change in Control" shall be deemed to have occurred if (i) any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act), other than a trustee or other fiduciary holding securities under an employee benefit plan of the Company or a corporation owned directly or indirectly by the stockholders of the Company in substantially the same proportions as their ownership of stock of the Company, is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of Voting Securities (as defined below) of the Company representing more than twenty percent (20%) of the total voting power represented by the Company's then outstanding Voting Securities, (ii) during any period of two (2) consecutive years, individuals who at the beginning of such period constitute the Board of Directors of the Company and any new director (other than a director designated by a person who has entered into an agreement with the Company to effect a transaction described in clauses (i), (iii) and (iv) of this Section 10(c)) whose election by the Board of Directors or nomination for election by the Company's stockholders was approved by a vote of at least two-thirds (2/3) of the directors then still in office who either were directors at the beginning of the period or whose election or nomination for election was previously so approved, cease for any reason to constitute a majority thereof, or (iii) the stockholders of the Company approve a merger or consolidation of the Company with any other corporation other than a merger or consolidation which would result in the Voting Securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into Voting Securities of the surviving entity) at least 80% of the total voting power of the resulting or surviving entity outstanding immediately after such merger or consolidation, or (iv) the stockholders of the Company approve a plan of complete liquidation of the Company or an agreement for the sale or disposition by the Company (in one transaction or a series of transactions) of all or substantially all of the Company's assets. For purposes of this Agreement, "Voting Securities" shall mean any securities the holders of which vote generally in the election of directors. 7 (d) Independent Legal Counsel. For purposes of this Agreement, "Independent Legal Counsel" shall mean an attorney or firm of attorneys, who shall not have otherwise performed services for the Company or Indemnitee within the then prior three years (other than with respect to matters concerning the rights of Indemnitee under this Agreement, or of other indemnitees under similar indemnity agreements) selected by the Company and approved by Indemnitee in writing, which approval shall not be unreasonably withheld. Notwithstanding the foregoing, the term "Independent Legal Counsel" shall not include any firm or person who, under the applicable standards of professional conduct then prevailing, would have a conflict of interest in representing either the Company or Indemnitee in an action to determine Indemnitee's right to indemnification under this Agreement. (e) Reviewing Party. For purposes of this Agreement, a "Reviewing Party" shall mean (i) any person or group of persons consisting of a member or members of the Company's Board of Directors and/or, as the case may be, or any other person appointed by the Board of Directors who is not a party to the particular Claim for which Indemnitee is seeking indemnification, or (ii) Independent Legal Counsel. 11. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall constitute an original and all of which, together, shall constitute one and the same document. 12. Binding Effect; Successors and Assigns. This Agreement shall be binding upon and inure to the benefit of and be enforceable by the parties hereto and their respective successors and permitted assigns, heirs and personal and legal representatives. The Company may not assign its obligations under this Agreement to any individual or entity except by operation of law to an entity acquiring all or substantially all of the business and/or, as the case may be, assets of the Company (a "Successor") and, in any such case, the Company shall continue to be obligated hereunder. The Company shall require and cause any Successor by written agreement in form and substance satisfactory to Indemnitee, expressly to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform if no such succession had taken place. This Agreement shall continue in effect regardless of whether Indemnitee continues to serve in an Indemnified Capacity. 8 13. Attorneys' Fees. In the event that any action is instituted by Indemnitee in a court of competent jurisdiction under this Agreement or under any liability insurance policies maintained by the Company to enforce, or interpret any of the terms hereof or thereof, Indemnitee shall be entitled to be paid all Expenses actually and reasonably incurred by Indemnitee with respect to such action, regardless of whether Indemnitee is ultimately successful in such action, and shall be entitled to an advance of such Expenses in the manner provided in Section 2 (a), above, with respect to such action, unless, as a part of such action, the court in which such action is brought determines that each of the material assertions made by Indemnitee as a basis for such action was not made in good faith or was frivolous. In the event of an action instituted by or in the name of the Company under this Agreement to enforce or interpret any of the terms of this Agreement, Indemnitee shall be entitled to be paid all Expenses actually and reasonably incurred by Indemnitee in defense of such action (including costs and expenses incurred with respect to Indemnitee's counterclaims and cross-claims made in such action), and shall be entitled to an advance of such Expenses in the manner provided in Section 2 (a), above, with respect to such action, unless as a part of such action such court determines that each of Indemnitee's material defenses to such action were made in bad faith or were frivolous. 14. Notice. Any notices or demands given in connection herewith shall be in writing and deemed given when (a) personally delivered, (b) sent by facsimile transmission to a number provided in writing by the addressee and a confirmation of the transmission is received by the sender or (c) two (2) days after being deposited for delivery with a recognized overnight courier, such as Fed Ex, and addressed or sent, as the case may be, to the address or facsimile number set forth below or to such other address or facsimile number as such party may in writing designate: If to Indemnitee: Janet Kirschner If to Company: Talk.com Inc. 12020 Sunrise Valley Drive Suite 250 Reston, VA 20190 Attn: Secretary 15. Consent to Jurisdiction. The Company and Indemnitee each hereby irrevocably consent to the jurisdiction of the courts of the Commonwealth of Pennsylvania for all purposes in connection with any action or proceeding which arises out of or relates to this Agreement and agree that any action instituted under this Agreement shall be commenced, prosecuted and continued only in the courts of the Commonwealth of Pennsylvania in and for the County of Philadelphia, which shall be the exclusive and only proper forum for adjudicating such a claim. 16. Severability. The provisions of this Agreement shall be severable in the event that any of the provisions hereof (including any provision within a single section, paragraph or sentence) are held by a court of competent jurisdiction to be invalid, void or otherwise unenforceable, and the remaining provisions shall remain enforceable to the fullest extent permitted by law. Furthermore, to the fullest extent possible, the provisions of this Agreement (including, without limitation, each portion of this Agreement containing any provision held to be invalid, void or otherwise unenforceable, that is not itself held to be invalid, void or unenforceable) shall be construed so as to give effect to the intent manifested by the provision held invalid, illegal or unenforceable. 9 17. Choice of Law. This Agreement shall be governed by and its provisions construed and enforced in accordance with the laws of the State of Delaware, without regard to the conflict of laws principles thereof. 18. Subrogation. In the event of payment to, or on behalf of Indemnitee under this Agreement, the Company shall be subrogated to the extent of such payment to all of the rights of recovery of Indemnitee, who shall, at Company's expense, execute all documents required and shall do all acts that may be necessary to secure such rights and to enable the Company effectively to bring suit to enforce such rights. 19. Amendment and Termination. No amendment, modification, termination or cancellation of this Agreement shall be effective unless it is in writing signed by both of the parties hereto. No waiver of any of the provisions of this Agreement shall be deemed to, or shall constitute a waiver of, any other provisions hereof (whether or not similar thereto), nor shall such waiver constitute a continuing waiver. Except as specifically set forth herein, no failure to exercise, or any delay in exercising, any right or remedy hereunder shall constitute a waiver thereof. 20. Integration and Entire Agreement. This Agreement sets forth the entire understanding between the parties hereto and supersedes all previous written and oral negotiations, commitments, understandings and agreements relating to the subject matter hereof between the parties hereto. 21. No Construction as Employment Agreement. Nothing contained in this Agreement shall be construed as giving Indemnitee any right to be retained in the employ of the Company or any Subsidiaries. 22. Certain Words. As used in this Agreement, the words "herein," "hereunder," "hereof" and similar words shall be deemed to refer to this Agreement in its entirety, and not to any particular provision of this Agreement unless the context clearly requires otherwise. 10 IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first above written. TALK.COM INC. By: ----------------------------- Title: -------------------------- AGREED TO AND ACCEPTED INDEMNITEE: - ------------------------------ Janet Kirschner 11 EX-10.41 4 EXHIBIT 10.41 EXHIBIT 10.41 NON-QUALIFIED STOCK OPTION AGREEMENT To: Janet Kirschner ("Employee") ----------------------------------------------------------------------- Name ----------------------------------------------------------------------- Address Date of Grant: October 14, 1999 ---------------- Exercise Price: $11 1/8 per share ----------------- Employee is hereby granted the option described below, effective as of the above date of grant, to purchase shares of common stock, $.01 par value per share ("Stock"), of Talk.com, Inc. (the "Company") at the exercise price shown above. Capitalized terms used herein without definition have the meanings assigned in the employment agreement dated as of the above date of grant between the Company, Talk.com Holding Corp. and Employee (the "Employment Agreement"). 1. Employee is hereby granted options to purchase 150,000 shares of Stock (the "Option"). The Option shall have an exercise price equal to eleven dollars and 1/8 ($11.125) per share (the "Exercise Price") and, subject to Section 2, below, shall vest with respect to the indicated number of shares of Stock according to the following schedule: (a) fifty thousand (50,000) shares of Stock shall vest and become exercisable upon the first anniversary of the date of grant. (b) fifty thousand (50,000) shares of Stock shall vest and become exercisable upon the second anniversary of the date of grant. (c) fifty thousand (50,000) shares of Stock shall vest and become exercisable upon the third anniversary of the date of grant. (d) Notwithstanding the foregoing, (i) any portion of the Option that was not previously vested and exercisable shall become fully vested and exercisable on the effective date of any termination of the employment of Employee under the Employment Agreement by the Company without Cause (as defined in Section 6.3 of the Employment Agreement) or by Employee for Good Reason (as defined in Section 6.4(b) of the Employment Agreement) and (ii) the Board of Directors of the Company (the "Board") or its designees may accelerate or waive the aforesaid scheduled vesting dates with respect to any or all of the shares of Stock covered by the Option. 2. In the event of a "Change in Control" (as hereafter defined) of the Company, any portion of the Option that was not previously vested and exercisable on the effective date of the Change in Control, shall become fully vested and exercisable on such effective date of such Change in Control. A "Change in Control" shall be deemed to have occurred upon the happening of any of the following events: (a) any Person (as defined in Section 3(a)(9) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")), other than the Company, becomes the Beneficial Owner (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company or any Significant Subsidiary (as defined below) representing fifty percent (50%) or more of the combined voting power of the Company's, or such Significant Subsidiary's, as the case may be, then outstanding securities; provided, that a Person shall be deemed to be the Beneficial Owner of all shares that any such Person has the right to acquire pursuant to any agreement or arrangement or upon exercise of conversion rights, warrants, options or otherwise, without regard to the sixty (60)-day period referred to in Rule 13d-3 under the Exchange Act); (b) during any period of two years, individuals who at the beginning of such period constitute the Board and any new director (other than a director designated by a person who has entered into an agreement with the Company to effect a transaction described in clauses (a), (b) or (d) of this Section 2) whose election by the Board or nomination for election by stockholders was approved by a vote of at least two-thirds (2/3) of the directors then still in office who either were directors at the beginning of the two-year period or whose election or nomination for election was previously so approved, but excluding for this purpose any such new director whose initial assumption of office occurs as a result of either an actual or threatened election contest or other actual or threatened solicitation of proxies or consents by or on behalf of an individual, corporation, partnership, group, association or other entity other than the Board, cease for any reason to constitute at least a majority of the Board of either or the Company or a Significant Subsidiary; (c) the consummation of a merger or consolidation of the Company or any subsidiary of the Company owning directly or indirectly all or substantially all of the consolidated assets of the Company ( a "Significant Subsidiary") with any other entity, other than a merger or consolidation which would result in the voting securities of the Company or a Significant Subsidiary outstanding immediately prior thereto continuing to represent more than fifty percent (50%) of the combined voting power of the surviving or resulting entity outstanding immediately after such merger or consolidation; (d) the shareholders of the Company approve a plan or agreement for the sale or disposition of fifty percent (50%) or more of the consolidated assets of the Company in which case the Board shall determine the effective date of the Change of Control resulting therefrom; 2 (e) any other event occurs which the Board determines, in its discretion, would materially alter, the structure of the Company or its ownership; and 3. Employee may exercise the Option by giving written notice to the Secretary of the Company on forms supplied by the Company at its then principal executive office, accompanied by payment of the Exercise Price for the total number of shares specified to be purchased by Employee. The payment may be in any of the following forms: (a) cash, which may be evidenced by a check and includes cash received from a so-called "cashless exercise" of the Option; (b) certificates representing shares of Stock, which will be valued at the fair market value (as defined in the Employment Agreement) per share of the Stock on the date of the Option exercise in question, accompanied by an assignment of such Stock to the Company; or (c) any combination of cash and Stock valued as provided in clause (b), immediately above. Any assignment of Stock shall be in a form and substance satisfactory to the Secretary of the Company, including guarantees of signature(s) and payment of all transfer taxes, if the Secretary of the Company deems such guarantees necessary or desirable. 4. The Option will, to the extent not previously exercised by Employee, expire on October 13, 2009. 5. In the event of any change in the outstanding shares of the Stock by reason of a stock dividend, stock split, consolidation, transfer of assets, reorganization, conversion or what the Board deems in its reasonable discretion to be similar circumstances, the number and kind of shares of Stock subject to the Option and the Exercise Price shall be appropriately adjusted in a manner to be determined in the reasonable discretion of the Board. 6. The Option is not transferable otherwise than by will or the laws of descent and distribution, and is exercisable during Employee's lifetime only by Employee, including, for this purpose, Employee's legal guardian or custodian in the event of the disability of Employee. Until the Exercise Price has been paid in full pursuant to due exercise of this Option and certificate(s) representing Employee's ownership of the purchased shares are issued to Employee, Employee does not have any rights as a shareholder of the Company. The Company reserves the right not to deliver to Employee the certificate(s) representing shares purchased by virtue of the exercise of the Option during any period of time in which the Company deems, based on the written opinion of its counsel, that such delivery would violate a federal, state, local or securities exchange rule, regulation or law. 7. Notwithstanding anything to the contrary contained herein, the Option is not exercisable: (a) During any period of time in which the Company deems, based on the written opinion of its counsel, that the exercisability of the Option, the offer to sell the shares underlying the Option, or the sale thereof, would violate a federal, state, local or securities exchange rule, regulation or law; or 3 (b) Until Employee has paid or made suitable arrangements to pay all federal, state and local income tax withholding required to be withheld by the Company in connection with the Option exercise. 8. The following two paragraphs shall be applicable if, on a date of exercise of the Option, the Stock to be purchased pursuant to such exercise has not been registered under the Securities Act of 1933, as amended (the "Act"), and under applicable state securities laws, and shall continue to be applicable for so long as such registration has not occurred: (a) Employee hereby agrees, warrants and represents that he will acquire the Stock to be issued hereunder for his own account for investment purposes only, and not with a view to, or in connection with, any resale or other distribution of any shares of such Stock, except as hereafter permitted. Employee further agrees that he will not at any time make any offer, sale, transfer, pledge or other disposition of such Stock to be issued hereunder without an effective registration statement under the Act, and under any applicable state securities laws or an opinion of counsel acceptable to the Company to the effect that the proposed transaction will be exempt from such registration. Employee shall execute such instruments, representations, acknowledgments and agreements as the Company may, in its sole discretion, deem advisable to avoid any violation of federal, state, local or securities exchange rule, regulation or law. (b) The certificates for Stock to be issued to Employee hereunder shall bear the following legend: "The shares represented by this certificate have not been registered under the Securities Act of 1933, as amended, or under applicable state securities laws. The shares have been acquired for investment and may not be offered, sold, transferred, pledged or otherwise disposed of without an effective registration statement under the Securities Act of 1933, as amended, and under any applicable state securities laws or an opinion of counsel acceptable to the Company that the proposed transaction will be exempt from such registration." The foregoing legend shall be removed upon registration of the legended shares under the Act and under any applicable state laws or upon receipt of an opinion of counsel acceptable to the Company that said registration is no longer required. 9. The sole purpose of the agreements, warranties, representations and legend set forth in the two immediately preceding paragraphs is to prevent violations of the Act, and any applicable state securities laws. 10. It is the intention of the Company and Employee that the Option shall not be an "Incentive Stock Option" as that term is used in Section 422 of the Internal Revenue Code of 1986, as amended, and the regulations thereunder. The Option is not granted pursuant to any stock option plan. 4 11. This agreement and the Employment Agreement constitute the entire understanding between the Company and Employee with respect to the subject matter hereof and no amendment, modification or waiver of this agreement, in whole or in part, shall be binding upon the Company or Employee unless in writing and signed by the Executive Vice President of the Company and Employee. This agreement and the performances of the parties hereunder shall be construed in accordance with, and governed by the laws of, the Commonwealth of Pennsylvania. Employee shall sign a copy of this agreement and return it to the Company's Secretary, thereby indicating Employee's understanding of, and agreement with its terms and conditions. TALK.COM INC, By: --------------------------------- 5 I hereby acknowledge receipt of a copy of the foregoing stock option agreement and, having read it, hereby signify my understanding of, and my agreement with, its terms and conditions. October 14, 1999 - ------------------------------ ------------------------------ Janet Kirschner (Date) 6 EX-11.1 5 EXHIBIT 11.1 EXHIBIT 11.1 TALK.COM INC. AND SUBSIDIARIES COMPUTATION OF NET INCOME PER SHARE (IN THOUSANDS)
For the Year Ended December 31, ---------------------------------------------------- 1999 1998 1997 --------------- --------------- ------------- --------------- --------------- ------------- Income (loss) before extraordinary gain $57,699 $(308,436) $(20,945) Extraordinary gain 21,230 87,110 -- -------- ----------- ------------- Net income (loss) $78,929 $(221,326) $(20,945) ========== ============ ============= BASIC Weighted average common shares outstanding - Basic: 61,187 59,283 64,168 ========== ============ ============ Income (loss) before extraordinary gain $ 0.94 $ (5.20) $ (0.33) Extraordinary gain 0.35 1.47 -- ---------- ----------- ------------ Net income (loss) $ 1.29 $ (3.73) $ (0.33) ========== ============ ============= DILUTED Weighted average common and common equivalent Weighted average shares 61,187 59,283 64,168 Weighted average equivalent shares 3,228 -- -- ---------- ------------ ------------ Weighted average common and common equivalent shares - Diluted 64,415 59,283 64,168 ========== ============ ============= Income (loss) before extraordinary gain $ 0.90 $ (5.20) $ (0.33) Extraordinary gain 0.35 1.47 -- ---------- ------------ ------------ Net income (loss) $ 1.23 $ (3.73) $ (0.33) ========== ============ =============
EX-22.1 6 EXHIBIT 22.1 EXHIBIT 22.1 List of Subsidiaries of the Company Talk.com Holding Corp. Compco, Inc. Tel-Save Holdings of Virginia, Inc. TSFL Holding Corp. TC Services Holding Co., Inc. EX-23.1 7 EXHIBIT 23.1 EXHIBIT 23.1 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Talk.com Inc. Reston, Virginia We hereby consent to the incorporation by reference in the Prospectus constituting a part of the Registration Statements on Forms S-8, Nos. 333-04479, 333-05923, 333-42111, 333-71025 and 333-88451 and Forms S-3, Nos. 333-14549, 333-23193, 333-39787, 333-49825, 333-65397, 333-66287, 333-69737, 333-72357 and 333-84017, of our reports dated February 7, 2000, relating to the consolidated financial statements and schedule of Talk.com Inc. and subsidiaries (the "Company") appearing in the Company's Annual Report on Form 10-K for year ended December 31, 1999. We also consent to the reference to us under the caption "Experts" in the Prospectuses. BDO Seidman, LLP New York, New York March 20, 2000 EX-27 8 FDS --
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1999 AND THE CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1999 OF TALK.COM INC. AND SUBSIDIARIES AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 000948545 TALK.COM INC. 1 US-DOLLARS 12-MOS DEC-31-1999 JAN-01-1999 DEC-31-1999 1 $78,937,000 0 64,512,000 5,011,000 0 150,893,000 70,773,000 13,438,000 215,008,000 63,768,000 0 0 0 670,000 39,433,000 215,008,000 0 516,548,000 0 320,751,000 136,242,000 0 4,667,000 57,699,000 0 57,699,000 0 21,230,000 0 78,929,000 1.29 1.23
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