-----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, KxvrvQAijqpX1FUHIDVXdsz0Vhk8u69UFtGHMij2NzcaId0IpztcRV3Qrg/F4f+I PnmClBcZV3/TiuGcsvo8Xg== 0001005150-00-000598.txt : 20000501 0001005150-00-000598.hdr.sgml : 20000501 ACCESSION NUMBER: 0001005150-00-000598 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000428 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/A SEC ACT: SEC FILE NUMBER: 000-26728 FILM NUMBER: 613783 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/A 1 FORM 10-K/A SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------- FORM 10-K/A AMENDMENT NO. 1 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1999 Commission File No. 0-26728 TALK.COM INC. (Exact name of registrant as specified in its charter) DELAWARE 23-2827736 -------- ---------- (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. 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 taxes 57,699 (268,048) (34,336) 32,373 18,032 Provision (benefit) for income taxes (1)(2) -- 40,388 (13,391) 12,205 7,213 Income (loss) before extraordinary gain (1) 57,699 (308,436) (20,945) 20,168 10,819 Extraordinary gain (from extinguishments of debt) 21,230 87,110 -- -- -- Net income (loss)(1) $ 78,929 $(221,326) $ (20,945) $ 20,168 $ 10,819 Income (loss) before extraordinary gain per share - Basic (1) $ 0.94 $ (5.20) $ (0.33) $ 0.38 $ 0.34 Extraordinary gain per share - Basic $ 0.35 $ 1.47 -- -- -- Net income (loss) per share - Basic (1) $ 1.29 $ (3.73) $ (0.33) $ 0.38 $ 0.34 Weighted average common shares outstanding - Basic 61,187 59,283 64,168 52,650 31,422 Income (loss) before extraordinary gain per share - Diluted (1) $ 0.90 $ (5.20) $ (0.33) $ 0.35 $ 0.32 Extraordinary gain per share - Diluted $ 0.33 $ 1.47 -- -- -- Net income (loss) per share - Diluted (1) $ 1.23 $ (3.73) $ (0.33) $ 0.35 $ 0.32 Weighted average common and common equivalent shares outstanding - Diluted 64,415 59,283 64,168 57,002 33,605 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. 1 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. 2 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 3 gains and profit sharing payments to AOL. The Company agreed to fixed quarterly payments ranging from $10 - $15 million during the exclusivity period of the agreement and AOL agreed to contribute up to $4.0 million per quarter for offline marketing. As a result of the amendment, the Company wrote off prepaid AOL, CompuServe and other marketing-related expenses of $37.6 million. In connection with hiring a new Chairman and Chief Executive Officer and several other key executive personnel and severance payments relating to this change in management, the Company incurred $12.7 million of incentive and severance expense. The Company acquired ADS Holdings, Inc. (formerly Symetrics, Inc.), a manufacturer of digital telephone switching equipment, in January 1998 for $18.6 million. The Company planned to complete development of a digital switch to provide state of the art features for use in the Company's operations as a competitive local exchange carrier. The Company allocated $21 million of the acquisition cost to purchased research and development expense in the first quarter of 1998 and continued to invest in additional research and development throughout 1998. In November 1997, the Company acquired Compco, Inc, a provider of communications software in the college and university marketplace for $13.7 million which exceeded the net assets acquired by $10.6 million. In the fourth quarter of 1998, the Company decided to sell the assets of ADS Holdings, Inc. and to delay entry into the college and university marketplace. As a result, the assets of ADS Holdings, Inc. and Compco, Inc. were written down to expected realizable value. The Company recorded $15 million relating to the impairment of these assets and reclassified the $22.2 million of research and development expense to significant other charges. In the fourth quarter of 1998, the Company reconfigured its telecommunications network, OBN, to provide for fiber optic connections among its switches and incurred $3.5 million of expense. Investment and Other Income (Expense), Net. Investment and other income (expense), net was $(11.2) million in 1998 versus $50.7 million in 1997. During 1998, investment and other income (expense), net consists primarily of investment income and trading losses of $11.0 million offset by interest expense related to the Company's Convertible Notes of $22.2 million. Provision for Income Taxes. The Company had recorded net deferred tax assets at December 31, 1997 and March 31,1998 primarily representing net operating loss carry-forwards and other temporary differences because the Company believed that no valuation allowance was required for these assets due to future reversals of existing taxable temporary differences and expectation that the Company will generate taxable income in future years. In June 1998, the Company decided to make substantial marketing and advertising expenditures to establish a broad base of online customers from AOL's membership. As discussed above, these expenditures led to a significant loss for 1998. In view of these losses, the uncertainties resulting from intense competition in the telecommunications industry and the lack of any assurance that the Company will realize any of the tax benefits, the Company decided in June 1998 to provide a 100% valuation allowance for the previously recorded deferred tax benefits and to provide a 100% valuation allowance for the current and future tax benefits resulting from the 1998 loss. Valuation allowances of approximately $115.0 million were included in provision for income taxes, for the year ended December 31, 1998. Extraordinary Gain. During 1998, the Company recorded an extraordinary gain of $87.1 million in connection with the acquisition of the Company's convertible debt at a discount. LIQUIDITY AND CAPITAL RESOURCES The Company's working capital was $87.1 million and $13.1 million at December 31, 1999 and 1998, respectively. This increase in working capital is primarily a result of the cash generated from the Company's operations and the exercise of stock options. In addition the Company received $11.1 million in 2000 in connection with the exercise of outstanding Common Stock rights prior to their expiration in February 2000. 4 The Company expended an aggregate of $132.9 million and $429.9 million of cash, Common Stock and other consideration for the repurchased outstanding securities during 1999 and 1998 respectively. During 1999 the Company repurchased an aggregate principal amount of $157.4 million of Convertible Notes. The Company (a) purchased from Daniel Borislow, the Company's former Chairman and Chief Executive Officer, and two trusts for the benefit of Mr. Borislow's children $85,857,000 aggregate principal amount of the Company's Convertible Notes for $72.3 million in cash; (b) exchanged the $53.7 million remaining on certain WorldxChange Notes payable to the Company with a trust for the benefit of Mr. Borislow's children for $62,545,000 aggregate principal amount of the Company's Convertible Notes and (c) purchased $9,000,000 aggregate principal amount of the Company's Convertible Notes for $6.9 million in Common Stock. As of December 31, 1999, the Company had reduced the principal amount outstanding of its Convertible Notes to $85.0 million ($66.9 million of 4 1/2% notes and $18.1 million of 5% notes). During 1999 the Company also purchased from Mr. Borislow approximately 639,000 shares of Common Stock for approximately $7.7 million with proceeds from the exercise of stock options pursuant to agreements with Mr. Borislow. During 1998, the Company repurchased approximately 18.8 million shares for an aggregate of $265.1 million ($239.9 million cash and $25.2 million in other consideration) and repurchased approximately $257.6 million principal amount of the Company's Convertible Notes for approximately $164.8 million ($86.3 million in cash, $69.5 million in Common Stock and $9.0 million in other consideration). The Company invested $6.5 million in capital equipment during 1999. On January 5, 1999, pursuant to an Investment Agreement between AOL and the Company, AOL made a significant equity investment in the Company, acquiring 4,121,372 shares of Common Stock for $55.0 million in cash and the surrender of rights to acquire up to 5,076,016 shares of Common Stock pursuant to various warrants held by AOL. Under the terms of the Investment Agreement with AOL, the Company has agreed to reimburse AOL for losses AOL may incur on the sale of any of the 4,121,372 shares during the period from June 1, 1999 through September 30, 2000. The reimbursement amount would be determined by multiplying the number of shares, if any, that AOL sells during the applicable period by the difference between the purchase price per share paid by AOL, or $19 per share, and the price per share that AOL sells the shares for, if less than $19 per share. The reimbursement amount may not exceed $14 per share for 2,894,737 shares or $11 per share for 1,226,635 shares. Accordingly, the maximum amount payable to AOL as reimbursement on the sale of AOL's shares would be approximately $54.0 million plus AOL's reasonable expenses incurred in connection with the sale. The Company has the option of issuing a six-month 10% note payable to AOL to satisfy the reimbursement amount or other amounts payable on exercise of its first refusal rights. Assuming AOL were to sell all of its shares subject to the Company reimbursement obligation at the closing price of Common Stock as of March 20, 2000, the reimbursement amount would be approximately $20.3 million. AOL also has the right, on termination of the Company's long distance exclusivity under its marketing agreement with AOL to require the Company to repurchase warrants held by AOL to purchase 2,721,984 shares Common Stock for $36.3 million, which repurchase price can be paid in Common Stock or cash or (provided that some portion of the repurchase price may be payable in a quarterly amortizing, two-year promissory note of the Company if the repurchase price exceeds the then current valuation of the warrant being repurchased). The Company has pledged the stock of its subsidiaries and has agreed to fund an escrow account of up to $35 million from 50% of the proceeds of any debt financing, other than a bank, receivable or other asset based financing of up to $50 million, to secure its obligations under the Investment Agreement with AOL. Mr. Borislow has agreed to guarantee up to $20,000,000 of the Company's reimbursement obligations under the Investment Agreement with AOL. As previously reported, the Company was subject to certain restrictions under a registration rights agreement between the Company and Mr. Borislow that could have affected the Company's ability to raise capital and engage in other types of financing transactions. As of December 31, 1999, Mr. Borislow and the two trusts for the benefit of Mr. Borislow's children, which have the ability to distribute Common Stock to Mr. Borislow, held in the aggregate less than 2% of the outstanding Common Stock. Accordingly, the Company believes that the restrictions no longer apply to the Company. The Company generally does not have a significant concentration of credit risk with respect to accounts receivable due to the large number of end users comprising the Company's customer base and their dispersion across different geographic regions. The Company maintains reserves for potential credit losses and, to date, such losses have been within the Company's expectations. The Company does not, and has not historically, required significant amounts of working capital for its day-to-day operations. The Company believes that its current cash position and the cash flow expected to be generated from operations will be sufficient to fund its capital expenditures, working capital and other cash requirements for at least the next twelve months. The Company also believes that, assuming the current market 5 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. 6 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 7 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 8 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 of $5,011 and $1,669, respectively 59,501 46,587 Advances to partitions and notes receivable 3,600 1,870 Prepaid expenses and other current assets 8,855 8,600 - ---------------------------------------------------------------------------- --------- --------- Total current assets 150,893 149,769 Property and equipment, net 57,335 56,703 Intangibles, net 1,068 1,150 Other assets 5,712 64,938 - ---------------------------------------------------------------------------- --------- --------- Total assets $ 215,008 $ 272,560 - ---------------------------------------------------------------------------- --------- --------- Liabilities, Contingent Redemption Value of Common Stock and Stockholders' Equity (Deficit) Current: Margin account indebtedness $ -- $ 49,621 Accounts payable and accrued expenses: Trade 47,965 64,794 Partitions 1,676 4,380 Taxes and other 14,127 17,913 - ---------------------------------------------------------------------------- --------- --------- Total current liabilities 63,768 136,708 Convertible debt 84,985 242,387 Deferred revenue 21,000 28,400 Other liabilities -- 1,850 - ---------------------------------------------------------------------------- --------- --------- Total liabilities 169,753 409,345 - ---------------------------------------------------------------------------- --------- --------- Commitments and Contingencies Contingent redemption value of common stock 5,152 -- - ---------------------------------------------------------------------------- --------- --------- Stockholders' equity (deficit): Preferred stock, $.01 par value, 5,000,000 shares authorized; no shares outstanding -- -- Common stock - $.01 par value, 300,000,000 shares authorized; 66,972,960 and 66,934,635 shaares issued, respectively 670 669 Additional paid-in capital 208,453 265,325 Deficit (139,300) (218,229) Treasury stock (29,720) (184,550) - ---------------------------------------------------------------------------- --------- --------- Total stockholders' equity (deficit) 40,103 (136,785) - ---------------------------------------------------------------------------- --------- --------- Total liabilities, contingent redemption value of common stock and stockholders' equity (deficit) $ 215,008 $ 272,560 - ---------------------------------------------------------------------------- --------- ---------
See accompanying notes to consolidated financial statements. 9 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. 10 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. 11 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. 12 TALK.COM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 -- SUMMARY OF ACCOUNTING POLICIES (a) Business Talk.com Inc., a Delaware corporation, together with its consolidated subsidiaries (the "Company"), provides telecommunications services, primarily long distance, throughout the United States to increasing numbers of residential customers and to small and medium-sized businesses. The Company's long distance service offerings include outbound service, inbound toll-free 800 service and dedicated private line services for data. The Company sells these services through its relationships with marketing partners, its web site located at www.talk.com, as well as through partitions, which are independent marketing companies. (b) Basis of financial statements presentation The consolidated financial statements include the accounts of Talk.com Inc. and its wholly-owned subsidiaries and have been prepared as if the entities had operated as a single consolidated group since their respective dates of incorporation. All intercompany balances and transactions have been eliminated. In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain amounts relating to 1997 have been reclassified to conform to the current year presentation. (c) Recognition of revenue The Company recognizes revenue upon completion of telephone calls by end users. Allowances are provided for estimated uncollectible usage. (d) Cash and cash equivalents The Company considers all temporary cash investments purchased with a maturity of three months or less to be cash equivalents. (e) Marketable securities Securities bought and held principally for the purpose of selling them in the near term are classified as "trading securities" and are carried at market. Unrealized holding gains and losses (determined by specific identification) on investments classified as "trading securities" are included in earnings. (f) Advances to partitions and notes receivable The Company made advances to partitions to support their marketing activities. The advances are secured by partition assets, including contracts with end users and collections thereon. (g) Property and equipment and depreciation Property and equipment are recorded at cost. Depreciation and amortization is calculated using the straight-line method over the estimated useful lives of the assets, as follows: Buildings and building improvements 39 years Switching equipment 15 years Equipment and other 5-7 years 13 TALK.COM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (h) Intangibles and amortization Intangibles of $1,068,000 and $1,150,000 at December 31, 1999 and 1998, respectively, represent goodwill arising from a business acquisition. Amortization is computed on a straight-line basis over the estimated useful life of the intangible, which is 15 years. (i) Deferred revenue Deferred revenue is recorded for a non-refundable prepayment received in 1997 in connection with an amended telecommunications services agreement with Shared Technologies Fairchild, Inc. and is amortized over the five-year term of the agreement. This agreement is terminable by either party on thirty days notice. Termination by either party would accelerate recognition of the deferred revenue. (j) Long-lived assets The Company adopted Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting For the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" as of January 1, 1996. Certain of the Company's long-lived assets were considered impaired at December 31, 1998 (Note 3). There was no additional impairment as of December 31, 1999. (k) Income taxes Since 1998, the Company has provided a full valuation allowance for deferred tax assets and liabilities for the estimated future tax effects attributable to temporary differences between the basis of assets and liabilities for financial and tax reporting purposes (Note 11). (l) Net income (loss) per share Basic earnings per share includes no dilution and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflect, in periods in which they have a dilutive effect, the effect of common shares issuable upon exercise of stock options and conversion of convertible debt. The computation of basic net income per share is based on the weighted average number of common shares outstanding during the period. In 1999, diluted earnings per share also includes the effect of 3,195,076 common shares, issuable upon exercise of common stock options and warrants. All references in the consolidated financial statements with regard to average number of Common Stock and related per share amounts have been calculated giving retroactive effect to stock splits. (m) Financial instruments and risk concentration Financial instruments that potentially subject the Company to concentrations of credit risk are cash investments for which the Company believes no significant concentration of credit risk exists with respect to these cash investments and marketable securities. The carrying values of accounts receivable, advances to partitions and notes receivable, accounts payable and accrued expenses approximate fair values. Convertible debt is recorded at face amount but such debt has traded in the open market at substantial discounts to face amount (Note 6). At December 31, 1999 the market value of the convertible debt was approximately 83% of face amount. 14 TALK.COM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (n) Stock-based compensation The Company accounts for its stock option awards under the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." Under the intrinsic value based method, compensation cost is the excess, if any, of the quoted market price of the stock at grant date or other measurement date over the amount an employee must pay to acquire the stock. The Company makes pro forma disclosures of net income and earnings per share as if the fair value based method of accounting had been applied as required by SFAS No. 123, "Accounting for Stock-Based Compensation" (Note 10). (o) Comprehensive income The Company has no items of comprehensive income or expense. Accordingly, the Company's comprehensive income and net income are equal for all periods presented. (p) New Accounting Pronouncements In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which requires entities to recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. SFAS No. 133, as amended by SFAS No. 137, is effective for all fiscal years beginning after June 15, 2000. The Company anticipates that the new standard will have no effect on its financial statements. NOTE 2 -- AOL AGREEMENTS In conjunction with the initial Telecommunications Marketing Agreement (the "AOL Agreement") with AOL, the Company paid AOL a total of $100 million and issued two warrants to purchase shares of the Company's stock. The first warrant (the "First Warrant") provided for the purchase, at an exercise price of $15.50 per share, of up to 5,000,000 shares. The second warrant (the "Second Warrant") provided for the purchase, at an exercise price of $14.00 per share, of up to 7,000,000 shares, which was to vest, based on the number of subscribers to the Company's service. With the Second Warrant, as vesting occurred, the fair value of the incremental vested portion of the warrant was charged to expense in the consolidated statement of operations. In 1998, the Company issued a warrant to purchase 1,000,000 shares (the "Further Warrant") to AOL in exchange for a one year extension of the AOL Agreement. As of December 31, 1997 the Second Warrant was vested as to approximately 120,000 shares and $1,200,000 was charged to expense in the 1997 consolidated statement of operations. The $100 million cash payment, the $20.0 million value of the First Warrant and $0.6 million of agreement related costs was accounted for as follows: (i) $35.9 million was charged to expense ratably over the period from the signing of the initial AOL agreement to December 31, 1997, as payment for certain exclusivity rights for that period; (ii) $13.2 million was treated as production of advertising costs and was charged to expense on October 9, 1997, which was the Commercial Launch Date; and (iii) $71.5 million, the balance of the cash payment and the value of the First Warrant and the initial AOL agreement related costs, represents the combined value of advertising and exclusivities which extend over the term of the AOL Agreement and was recognized ratably after the Commercial Launch Date as advertising services were received. For the year ended December 31, 1997, the Company recognized $57.0 million of expense, related to items discussed above, which is included in promotional, marketing and advertising expenses. The Company has negotiated a number of amendments to its agreements with AOL based on the experience gained by the Company in the marketing and sale of telecommunications services to AOL subscribers since the inception of the agreements. A substantial amendment to the AOL agreement in January 1999 in which the Company agreed to fixed quarterly payments ranging from $10 to $15 million during the long distance exclusivity period of the agreement resulted in: the elimination of the Company's obligation to make bounty and profit-sharing payments to AOL; altering of the terms of the online and offline marketing arrangements between the Company and AOL; extension of the term of the AOL agreement, including the exclusivity period, until June 2003, although AOL can end the Company's long distance exclusivity period on or after June 2000 by foregoing the fixed 15 TALK.COM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) quarterly payments described above; elimination of AOL's rights to receive further warrants to purchase Common Stock based upon customers gained from the AOL subscriber base; AOL's contribution of up to $4.0 million per quarter for offline marketing; and establishment of the framework for the Company to offer additional services and products to AOL subscribers. In 1998, as a result of the January 1999 amendment, the Company wrote off $37.6 million of prepaid AOL, CompuServe and other marketing-related expenses, included in significant other charges (Note 3). On January 5, 1999, pursuant to an Investment Agreement between AOL and the Company, AOL purchased a total of 4,121,372 shares of Common Stock of the Company for $55.0 million in cash and the surrender of rights to purchase 5,076,016 shares of Common Stock of the Company pursuant to various warrants held by AOL. AOL agreed to end further vesting under the outstanding performance warrant and retained vested warrants exercisable for 2,721,984 shares of Common Stock. (Notes 9 and 10). NOTE 3 -- SIGNIFICANT OTHER CHARGES (INCOME) Significant other income in 1999 includes a gain of $2.7 million on the sale of certain business units of TSFL Holdings, Inc. (formerly Symetrics Industries, Inc.). Significant other charges in 1998 includes $91.0 million of expenses incurred in the fourth quarter of 1998 related to changes in the Company's basic business operations. As discussed in Note 2 above, the Company negotiated substantial amendments to its agreements with AOL which, among other things, reduced the amount of online advertising to which the Company was entitled to over the remaining term of the agreement and eliminated payments and issuance of warrants to AOL for customer gains and profit sharing payments to AOL. The Company agreed to fixed quarterly payments ranging from $10 - $15 million per quarter during the exclusivity period of the agreement and AOL agreed to contribute up to $4.0 million per quarter for offline marketing. As a result of the amendments, the Company wrote off prepaid AOL, CompuServe and other marketing-related expenses of $37.6 million. In connection with hiring a new Chairman and Chief Executive Officer and several other key executive personnel and severance payments relating to this change in management, the Company incurred $12.7 million of incentive and severance expense. The Company acquired ADS Holdings, Inc. (formerly Symetrics, Inc.), a manufacturer of digital telephone switching equipment, in January 1998 for $18.6 million. The Company planned to complete development of the digital switch to provide state of the art features for use in the Company's operations as a competitive local exchange carrier. The Company allocated $21 million of the acquisition cost to purchased research and development expense in the first quarter of 1998 and continued to invest in additional research and development throughout 1998. In November 1997, the Company acquired Compco, Inc, a provider of communications software in the college and university marketplace for $13.7 million, which exceeded the net assets acquired by $10.6 million. In the fourth quarter of 1998, the Company decided to sell the assets of ADS Holdings, Inc. and to delay entry into the college and university marketplace. As a result, the assets of ADS Holdings, Inc. and Compco, Inc. were written down to expected realizable value. The Company recorded $15 million relating to the impairment of these assets and reclassified $22.2 million of research and development expense to significant other charges. In the fourth quarter of 1998, the Company reconfigured its telecommunications network, OBN, to provide for fiber optic connections among its switches and incurred $3.5 million of expense. The Company determined in the second quarter of 1997 to de-emphasize the use of direct marketing to solicit customers for the Company and to focus the majority of its existing direct marketing resources on customer service and support for the marketing operations of its carrier partitions, on a fee basis. The Company recognized fees of $8.1 million for the year ended December 31, 1997, included in other income, from the services net of related costs of $14.6 million for the year ended December 31, 1997. 16 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 17 TALK.COM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) benefit of Mr. Borislow's children, $85,857,000 aggregate principal amount of the Company's Convertible Notes for $72.3 million in cash; (b) exchanged the remaining $53.7 million principal amount of subordinated notes of Communication TeleSystems International d/b/a WorldxChange Communications, which were included in other assets at December 31, 1998, to a trust for the benefit of Mr. Borislow's children for $62,545,000 aggregate principal amount of the Company's Convertible Notes and (c) purchased $9,000,000 aggregate principal amount of the Company's Convertible Notes for $6.9 million in Common Stock. The 2002 Convertible Notes and 2004 Convertible Notes that were reacquired by the Company during 1999 were reacquired at a $21.2 million discount from face amount. This amount is reported as an extraordinary gain in the consolidated statement of operations. NOTE 7 -- RELATED PARTY TRANSACTIONS On January 5, 1999, Mr. Daniel Borislow, a founder of the Company and its Chairman of the Board and Chief Executive Officer, resigned as a director and officer of the Company. The Company entered into various agreements and engaged in various transactions with Mr. Borislow and certain entities in which he or his family had an interest. The Company paid $1.0 million to Mr. Borislow, assigned certain automobiles to him, and continued certain of his health and medical benefits and director and officer insurance. The Company also agreed that, so long as Mr. Borislow owns beneficially at least two percent (2%) of the Common Stock (on a fully diluted basis), Mr. Borislow and trusts for the benefit of his children would be entitled to: registration rights with respect to their shares of Common Stock, the right to require the Company to use a portion of proceeds from any public or private sale of debt securities, excluding borrowings from a commercial bank or other financial institution, by the Company to repurchase debt securities of the Company owned by Mr. Borislow or the trusts for the benefit of his children and the right to require the Company to use the proceeds from the exercise of stock options or rights to repurchase Common Stock owned by Mr. Borislow or the trusts for the benefit of his children. The Company also agreed that, so long as Mr. Borislow had such beneficial ownership, the Company would not, without the prior written consent of Mr. Borislow and subject to certain exceptions: (a) engage in certain significant corporate transactions, including the sale or encumbrance of substantially all of its assets, mergers and consolidations and certain material acquisitions, or, (b) for a period of 18 months from the agreement date, offer or sell any of its Common Stock unless and until Mr. Borislow and the trusts have sold or otherwise disposed of all of the shares of Common Stock held by him on the agreement date. In turn, Mr. Borislow terminated his employment with the Company and agreed not to compete with the Company for at least one year. Mr. Borislow also agreed to guarantee up to $20.0 million of the Company's obligations in connection with the AOL investment noted above. Effective December 31, 1998, the Company, in exchange for a total of 783,706 shares of Common Stock, (i) sold to Jimlew Capital, L.L.C., a company owned by Mr. Borislow, (a) all of the capital stock of Emergency Transportation Corporation (a wholly owned subsidiary of the Company, the primary asset of which was an interest in a jet airplane), valued at approximately $8.7 million, and (b) all of the real property constituting the Company's facilities in New Hope, Pennsylvania, valued at approximately $2.0 million, and (ii) released Mr. Borislow from an obligation for approximately $4.7 million borrowed from the Company. Mr. Borislow agreed to lease to the Company a portion of the headquarters property at a base monthly rent of $12,500. The Company had previously determined that it would be desirable to dispose of these assets and accordingly believed that the ownership of these assets was not required for the continued operation of the Company's business. The subsidiary stock and the real property were valued based on the book value of these assets, which the management of the Company believes approximated the fair market value of these assets on the date of exchange. The Common Stock exchanged for the assets was valued at its market value on the date of the exchanges. On January 6, 2000, the Company repurchased the real property constituting the Company's facilities in New Hope, Pennsylvania for $2.5 million. Effective December 31, 1998, the Company, in exchange for a total of 498,435 shares of Common Stock and $10,007,000 aggregate principal amount of the Company's Convertible Notes, released certain officers, directors and employees from obligations for approximately $9.8 million and $9.0 million, respectively, borrowed from the Company. Also during 1999, in addition to the transactions between the Company and Mr. Borislow or the trusts for his children involving the 2002 and 2004 Convertible Notes, which transactions are described in Note 6 and 18 TALK.COM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) included in this Note by this reference, the Company purchased from Mr. Borislow approximately 639,000 shares of Common Stock for approximately $7.7 million with proceeds from the exercise of stock options by other employees pursuant to the agreements with Mr. Borislow as described above. At December 31, 1998, executive officers of the Company had outstanding loans from the Company of $4,237,000 which were repaid during the first quarter of 1999. NOTE 8 -- LEGAL PROCEEDINGS On June 16, 1998, a purported shareholder class action was filed in the United States District Court for the Eastern District of Pennsylvania against the Company and certain of its officers alleging violation of the securities laws in connection with certain disclosures made by the Company in its public filings and seeking unspecified damages. Thereafter, additional lawsuits making substantially the same allegations were filed by other plaintiffs in the same court. At this point, no classes have been certified. A motion to dismiss was recently granted as to certain officers of the Company and denied as to the Company. There are currently no officers of the Company who are a party to these actions. The Company believes the allegations in the complaints are without merit and intends to defend the litigations vigorously. The Company also is a party to certain legal actions arising in the ordinary course of business. The Company believes that the ultimate outcome of the foregoing actions will not result in liability that would have a material adverse effect on the Company's financial condition or results of operations. NOTE 9 -- STOCKHOLDERS' EQUITY (a) Stock Splits On January 3, 1997, the Company's Board of Directors approved a two-for-one split of the Common Stock in the form of a 100% stock dividend. The additional shares resulting from the stock split were distributed on January 31, 1997 to all stockholders of record at the close of business on January 17, 1997. This stock split has been reflected in the financial statements for all periods presented. (b) Authorized Shares During 1997, the Board of Directors and stockholders approved the increase in the number of authorized shares of the Common Stock to 300,000,000 shares. (c) Contingent Redemption Value of Common Stock On January 5, 1999, pursuant to an Investment Agreement between AOL and the Company, AOL acquired 4,121,372 shares of Common Stock for $55.0 million in cash and the surrender of rights to acquire up to 5,076,016 shares of Common Stock pursuant to various warrants held by AOL. Under the terms of the Investment Agreement with AOL, the Company has agreed to reimburse AOL for losses AOL may incur on the sale of any of the 4,121,372 shares during the period from June 1, 1999 through September 30, 2000. The Company has the first right to purchase any of the 4,121,372 shares of Common Stock at the market value on the day that AOL notifies the Company of its intent to sell any of the shares plus an amount, if any, equal to the Company's reimbursement obligation described below. The reimbursement amount would be determined by multiplying the number of shares, if any, that AOL sells during the applicable period by the difference between the purchase price per share paid by AOL, or $19 per share, and the price per share that AOL sells the shares for, if less than $19 per share. The reimbursement amount may not exceed $14 per share for 2,894,737 shares or $11 per share for 1,226,635 shares. Accordingly, the maximum amount payable to AOL as reimbursement on the sale of AOL's shares would be approximately $54.0 million plus AOL's reasonable expenses incurred in connection with the sale. The Company has the option of issuing a six-month 10% note payable to AOL to satisfy the reimbursement amount or other amounts payable on exercise of its first refusal rights. Assuming AOL were to sell all of its shares subject to the Company's reimbursement obligation at the closing price of Common Stock as of December 31, 1999, the reimbursement amount would be approximately $5.2 million. At December 31, 1999, the Company recorded $5.2 million for the contingent redemption value of this Common Stock with a corresponding reduction in additional paid-in capital. AOL also has the right on termination of long distance exclusivity under the AOL marketing 19 TALK.COM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) agreements to require the Company to repurchase the warrants to purchase 2,721,984 shares of Common Stock of the Company held by AOL for an aggregate price of $36.3 million, which repurchase price can be paid in Common Stock or cash (provided that some portion of the repurchase price may be payable in a quarterly amortization, two-year promissory note of the Company if the repurchase price exceeds the then current valuation of the warrants being repurchased). AOL can end the Company's long distance exclusivity period on or after June 30, 2000 by foregoing certain fixed quarterly payments. The Company has pledged the stock of its subsidiaries and has agreed to fund an escrow account of up to $35 million from 50% of the proceeds of any debt financing, other than a bank, receivable or other asset based financing of up to $50 million, to secure its obligations under the Investment Agreement with AOL. AOL has agreed that it will subordinate its security interests to permit the securitization of certain future financings by the Company. Mr. Borislow has agreed to guarantee up to $20,000,000 of the Company's reimbursement obligations under the Investment Agreement with AOL. (d) Restriction on Future Sales of Common Stock As previously reported, the Company was subject to certain restrictions under a registration rights agreement between the Company and Mr. Borislow that could have affected the Company's ability to raise capital and engage in other types of financing transactions. As of December 31, 1999, Mr. Borislow and the two trusts for the benefit of Mr. Borislow's children, which have the ability to distribute Common Stock to Mr. Borislow, held less than an aggregate of 2% of the outstanding Common Stock. Accordingly, the Company believes that the restrictions no longer apply to the Company. (e) Stockholders Rights Plan On August 19, 1999, the Company adopted a Stockholders Rights Plan designed to deter coercive takeover tactics and prevent an acquirer from gaining control of the Company without offering a fair price to all of the Company's stockholders. Under the terms of the plan, preferred stock purchase rights were distributed as a dividend at the rate of one right for each share of Common Stock of the Company held as of the close of business on August 30, 1999. Until the rights become exercisable, Common Stock issued by the Company will also have one right attached. Each right will entitle holders to buy one three-hundredth of a share of Series A Junior Participating Preferred Stock of the Company at an exercise price of $55. Each right will thereafter entitle the holder to receive upon exercise Common Stock (or, in certain circumstances, cash, property or other securities of the Company) having a value equal to two times the exercise price of the right. The rights will be exercisable only if a person or group acquires beneficial ownership of 20% or more of Common Stock or announces a tender or exchange offer which would result in such person or group owning 20% or more of Common Stock, or if the Board of Directors declares that a 15% or more stockholder has become an "adverse person" as defined in the plan. The Company, except as otherwise provided in the plan, will generally be able to redeem the rights at $0.001 per right at any time during a ten-day period following public announcement that a 20% position in the Company has been acquired or after the Company's Board of Directors declares that a 15% or more stockholder has become an "adverse person." The rights are not exercisable until the expiration of the redemption period. The rights will expire on August 19, 2009, subject to extension by the Board of Directors. 20 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)
21 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
22 TALK.COM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (b) AOL Warrants On January 5, 1999, after the repurchase from AOL of warrants to purchase 5,076,016 shares of Common Stock, warrants to purchase 2,721,984 shares of Common Stock were held by AOL and were outstanding and currently exercisable, with exercise prices from $14.00 to $22.25 and a weighted average exercise price of $17.03. AOL has the right, commencing on termination of the long distance exclusivity under the AOL marketing agreement up until January 5, 2003, to require the Company to repurchase all or any portion of these warrants at prices (the "Put Prices") ranging from $10.45 to $16.82 per warrant ($36,324,002 aggregate amount). In the event AOL requires repurchase of the warrants, the Company at its election may pay AOL in cash or in shares of Common Stock based on the then current market price for such stock. The Company may also elect to issue a 10% two-year note for a defined portion of the repurchase price if the repurchase price exceeds the then current valuation of the warrants being repurchased. The Company can require AOL to exercise its warrants at any time the market price of Common Stock equals or exceeds two times the then call amount for such warrants. The call amount of a warrant is the Put Price for the warrant increased at a semi-annually compounded rate of 5% on January 5, 1999 and on each six month anniversary thereafter. The Company has certain reimbursement obligations in the event that it requires AOL to exercise its warrants. (c) Other Warrants At December 31, 1996, the Company had warrant agreements with certain partitions and the underwriter for its IPO. All warrants were issued with exercise prices equal to or above the market price of the underlying stock at the date of the grant. These warrants are accounted for based on their fair value. At December 31, 1996, 3,712,000 warrants were outstanding with exercise prices ranging from $4.67 to $5.73 and an average weighted exercise price of $5.00 and 600,000 which were currently exercisable at a weighted exercise price of $5.73. The remaining warrants were exercisable over a one to two year period beginning in January 1997. In January 1997, 800,000 of these warrants were purchased by the Company and recorded as a reduction in additional paid-in capital and 2,662,000 warrants were exercised. The 250,000 warrants issued to the underwriter for the Company's IPO that were outstanding at December 31, 1997 were exercised in 1998. (d) Rights The Board of Directors had approved an offering of up to 3,523,285 shares of its Common Stock, $.01 par value, to holders of record of Common Stock and holders of record of options or warrants to purchase Common Stock at the close of business on December 31, 1998. The shares were offered pursuant to nontransferable rights to subscribe for and purchase shares of Common Stock at a price of $17.00 per share. Holders of record on the record date, were eligible to receive one such nontransferable right for every 20 shares of Common Stock or underlying options or warrants held on the record date, as applicable. As of December 31, 1999, 38,325 rights totaling $651,525 were exercised, and 652,547 rights totaling $11,093,299 were exercised in 2000. These rights expired on February 12, 2000. NOTE 11 -- INCOME TAXES The Company reports the effects of income taxes under SFAS No. 109, "Accounting for Income Taxes". The objective of income tax reporting is to recognize (a) the amount of taxes payable or refundable for the current year and (b) deferred tax liabilities and assets for the future tax consequences of events that have been recognized in the financial statements or tax returns. Under SFAS No. 109, the measurement of deferred tax assets is reduced, if necessary, by the amount of any tax benefits that, based on available evidence, are not expected to be realized. Realization of deferred tax assets is determined on a more-likely-than-not basis. The Company considers all available evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance is needed for some portion or all of a net deferred tax asset. Judgment is used in considering the relative impact of negative and positive evidence. In arriving at these judgments, the weight given to the potential effect of negative and positive evidence is commensurate with the extent to which it can be objectively verified. 23 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)% ======== ==== ======== ==== ======== ====
24 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. 25 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)
26 TALK.COM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) NOTE 14 - EMPLOYEE BENEFIT PLANS During 1999, the Company established an Employee Savings Plan that permits eligible employees to contribute funds on a pre-tax basis. The Plan qualifies as a deferred salary arrangement under Section 401(k) of the Internal Revenue Code. Eligible employees may contribute up to 6% of their compensation (subject to Internal Revenue Code limitations). The Plan allows employees to choose among a variety of investment alternatives. The Company does not contribute to the Plan. No administration costs were incurred during 1999. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT DIRECTORS The following sets forth certain biographical information, present occupation and business experience for the past five years for each of the nominees for election as a director and the continuing Class I and Class III directors. CLASS I: DIRECTORS WHOSE TERMS EXPIRE IN 2001 GABRIEL BATTISTA, AGE 55. Mr. Battista became a director and the Chairman of the Board, Chief Executive Officer and President of the Company on January 5, 1999. Prior to joining the Company, Mr. Battista served as Chief Executive Officer of Network Solutions Inc., an Internet domain name registration company. Prior to joining Network Solutions, Mr. Battista served from 1995 to 1996 as CEO and from 1991 to 1995 as President and Chief Operating Officer of Cable & Wireless, Inc., the nation's largest telecommunications provider exclusively serving businesses. His career also includes management positions at US Sprint, GTE Telenet and General Electric Information Services, Mr. Battista also serves as a director of Axent Technologies, Inc., Capitol College, Systems & Computer Technology Corporation (SCT) and Online Technologies Group, Inc. (OTG). RONALD R. THOMA, AGE 62. Mr. Thoma currently serves as Executive Vice President of Crown Cork and Seal Company, Inc. where he has been employed since 1955. Mr. Thoma has served as a director of the Company since 1995. CLASS II: DIRECTOR WHOSE TERM EXPIRES IN 2000 ARTHUR J. MARKS, AGE 55, has been a director of the Company since August 1999. He has been a General Partner of New Enterprise Associates, a venture capital firm, since 1984. Mr. Marks serves as a director of three publicly traded software companies, Object Design Inc., Epicor Software Corp. and Progress Software Corp., as well as a number of privately-held companies. CLASS III: DIRECTOR WHOSE TERM EXPIRES IN 2002 MARK S. FOWLER, AGE 57, has been a director of the Company since September 1999. From 1981 to 1987 he was the Chairman of the Federal Communications Commission. From 1987 to 1994, Mr. Fowler was Senior Communications Counsel at Latham & Watkins, a law firm. From 1991 to 1994, he was the founder, Chairman and CEO of PowerFone Holdings Inc., a telecommunications company. In 1994, he founded and since then has served as Chairman of UniSite, a developer of antenna sites for use by multiple wireless operators. Mr. Fowler is also a founder and serves as Chairman of the Board of Directors of AssureSat, Inc., an operator of telecommunications satellites. COMPENSATION OF DIRECTORS The Company currently pays non-employee directors an annual retainer of $10,000. The Compensation Committee approved grants of options to purchase 30,000 shares of Common Stock under the 1998 Long Term Incentive Plan at the market value on the date of grant to Mr. Marks and Mr. Fowler, non-employee directors who were elected to fill vacancies on the Board in August and September of 1999, respectively. Non-employee directors are reimbursed for reasonable expenses incurred in connection with attendance at Board meetings or meetings of committees thereof. 27 EXECUTIVE OFFICERS The required information is set forth at the end of Part I of this 10-K. In addition, the following sets forth certain biographical information for the two new officers. KENNETH G. BARITZ. Mr. Baritz became President of the Company in April, 2000. Prior to joining the Company, he served as Chairman and Chief Executive Officer of Access One, a telecommunications service provider, from June, 1997 through April, 2000. Prior to joining Access One, Mr. Baritz was Chairman/Chief Executive Officer of AMNEX, Inc., a telecommunications company, from January 1994 to March 1997, and a director from October 1992 through March 1997. KEVIN GRIFFO. Mr. Griffo became the Executive Vice President of the Company in April, 2000. Prior to joining the Company, he served as President and Chief Operating Officer of Access One, a telecommunications service provider, from January, 1998 through April, 2000. Prior to joining Access One, Mr. Griffo was employed by AMNEX, Inc., a telecommunications company, from January 1995 to December 1997, holding various positions including Chief Operating Officer and President of AMNEX's Telecommunications Division. Prior to joining AMNEX, he was a southeastern regional Vice President for LDDS WorldCom, a long-distance carrier, from August 1992 to December 1994. COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT Under Section 16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), the Company's directors and certain officers and persons who are the beneficial owners of more than 10 percent of the Common Stock are required to report their ownership of the Common Stock, options and certain related securities and any changes in that ownership to the SEC. Specific due dates for these reports have been established, and the Company is required to report in this proxy statement any failure to file by such dates in 1999. The Company believes that all of the required filings have been made in a timely manner. In making this statement, the Company has relied on copies of the reporting forms received by it. ITEM 11. EXECUTIVE COMPENSATION SUMMARY OF CASH AND CERTAIN OTHER COMPENSATION The following table sets forth information for the fiscal years ended December 31, 1999, 1998 and 1997 as to the compensation paid by the Company to the Chief Executive Officer for services rendered and the four other most highly compensated executive officers of the Company whose annual salary and bonus exceeded $100,000 (the "Named Executives"). 28 SUMMARY COMPENSATION TABLE
LONG TERM ANNUAL COMPENSATION COMPENSATION ------------------- ------------ SECURITIES UNDERLYING NAME AND OPTIONS/SARS PRINCIPAL POSITION YEAR SALARY (1) BONUS (1) (2)(3) - ------------------ ---- ---------- --------- ------ GABRIEL BATTISTA, Chairman, Chief Executive Officer and President...............................1999 $1,500,000 (4) $ 750,000 -- 1998 -- $3,000,000 (5) 1,650,000 1997 -- -- -- MICHAEL FERZACCA, Executive Vice President - Sales............1999 $ 300,000 $ 250,000 -- 1998 $ -- $1,313,125 (6) 350,000 1997 $ -- $ -- -- ALOYSIUS T. LAWN, IV, Executive Vice President - .................1999 $ 233,269 $ 150,000 210,000 General Counsel and Secretary 1998 $ 150,000 $ 120,336 (7) 50,000 1997 $ 150,000 $ 5,929 (7) -- EDWARD B. MEYERCORD, III, Executive Vice President - Chief Financial Officer and Treasurer...............................1999 $ 225,385 $ 150,000 450,000 1998 $ 200,000 $ 128,338 (7) -- 1997 $ 210,000 $ 150,000 -- GEORGE VINALL, Executive Vice President - Business Development........................1999 $ 200,000 $ 150,000 -- 1998 $ -- $ 175,000 (8) 240,000 1997 $ -- $ -- --
- ---------- (1) The costs of certain benefits are not included because they did not exceed, in the case of each Named Executive, the lesser of $50,000 or 10% of the total annual salary and bonus reported in the above table. (2) As adjusted to reflect a three-for-two stock split in the form of a stock dividend effective as of March 15, 1996 and a two-for-one stock split in the form of a stock dividend effective as of January 31, 1997. (3) Consists of options to purchase the Common Stock granted pursuant to the Plan. In 1998, Mr. Battista was granted options that vest over three years to purchase 1,000,000 shares of the Company's Common Stock at an exercise price of $10.4375 per share, and options that vested immediately upon execution of the employment agreement to purchase an additional 650,000 shares at an exercise price of $7.00 per share. In 1998, Mr. Ferzacca was granted options that vest over three years to purchase 350,000 shares of the Company's Common Stock at an exercise price of $8.5625 per share. In 1999, Mr. Lawn was granted options that vest over three years to purchase 210,000 shares of the Company's Common Stock at an exercise price of $9.88 per share, and in 1998, was granted options to purchase 50,000 shares at an exercise price of $5.75 per share. In 1999, Mr. Meyercord, III was granted options that vest over three years to purchase 450,000 shares of the Company's Common Stock at an exercise price of $15.94 per share. In 1998, Mr. Vinall was granted options that vest over three years to purchase 240,000 shares of the Company's Common Stock at an exercise price of $8.5625 per share. (4) Mr. Battista's salary for 1999 included a prepayment of $1,000,000 representing a $500,000 salary for both the years 2000 and 2001. (5) Mr. Battista received a cash sign-on bonus of $3,000,000, which was paid in December 1998. (6) Mr. Ferzacca received a cash sign-on bonus of $200,000 and 130,000 shares of the Company's common stock with a fair market price per share on the date of grant of $8.5625 and an aggregate value of $1,113,125, which was paid and issued, respectively in December 1998. (7) Bonus paid in shares of Common Stock and in-kind property valued in each case at the then current market value. (8) Mr. Vinall received a cash sign-on bonus of $175,000, which was paid in December 1998. 29 STOCK OPTION GRANTS The following table sets forth further information regarding grants of options to purchase Common Stock made by the Company during the fiscal year ended December 31, 1999 to the Named Executives. OPTION/SAR GRANTS IN LAST FISCAL YEAR
POTENTIAL REALIZABLE PERCENT OF TOTAL VALUE AT ASSUME NUMBER OF SECURITIES OPTIONS/SARS EXERCISE ANNUAL RATES OF STOCK UNDERLYING GRANTED TO PRICE PER OPTION TERM (2) OPTIONS/SARS EMPLOYEES IN SHARE EXPIRATION --------------- NAME GRANTED (1) 1999 ($SHARES) DATE 5%($) 10%($) ---- ----------- ---- --------- ---- ----- ------ Gabriel Battista.............. -- -- -- -- -- -- Michael Ferzacca.............. -- -- -- -- -- -- Aloysius T. Lawn, IV.......... 210,000 5.9 9.88 4/1/09 $1,304,831 $ 3,306,697 Edward B. Meyercord, III...... 450,000 12.8 15.94 11/1/09 $4,511,061 $11,431,915 George Vinall................. -- -- -- -- -- --
- ---------- (1) All options to Named Executive Officers in 1999 were granted under the Plan. (2) Disclosure of the 5% and 10% assumed annual compound rates of stock appreciation are mandated by the rules of the SEC and do not represent the Company's estimate or projection of future common stock prices. The actual value realized may be greater or less than the potential realizable value set forth in the table. The following table sets forth further information concerning the 1999 year-end value of unexercised in-the-money options held by each of the Named Executives. AGGREGATED OPTION/SAR EXERCISES AND FISCAL YEAR-END OPTION/SAR VALUES
NUMBER OF SECURITIES UNDERLYING UNEXERCISED VALUE OF UNEXERCISED OPTIONS/SARS IN-THE-MONEY OPTIONS/SARS AT AT FISCAL YEAR-END (#) FISCAL YEAR-END($)(1) ---------------------- --------------------- SHARES ACQUIRED VALUE EXERCISABLE/ EXERCISABLE/ NAME ON EXERCISE REALIZED UNEXERCISABLE UNEXERCISABLE ---- ----------- -------- ------------- ------------- Gabriel Battista.................... -- -- 983,333/666,667 $9,424,998/$4,875,002 Michael Ferzacca.................... -- -- 116,667/233,333 $1,071,878/$2,143,747 Aloysius T. Lawn, IV................ -- -- 50,000/210,000 $600,000/$1,652,700 Edward B. Meyercord, III............ 800,000 $5,793,800 0/450,000 $0/$814,500 George Vinall....................... -- -- 80,000/160,000 $735,000/$1,470,000
- ---------- (1) Calculated as the difference between the exercise/base price of the options/SARs and a year-end fair market value of the underlying securities equal to $17.75. 30 EMPLOYMENT CONTRACTS Gabriel Battista is party to an employment agreement with the Company that expires on December 31, 2001. Under the terms of the agreement, Mr. Battista received a signing bonus of $3,000,000 and is entitled to an annual salary of $500,000, payable in advance, plus a discretionary bonus. Mr. Battista is also entitled to other benefits and perquisites. In addition, Mr. Battista was granted options that vest over three years to purchase 1,000,000 shares of the Company's Common Stock at an exercise price of $10.4375 per share, and options that vested immediately upon execution of the agreement to purchase an additional 650,000 shares at an exercise price of $7.00 per share. In the event of certain transactions (including an acquisition of the Company's assets, a merger into another entity or a transaction that results in the Company's Common Stock no longer being required to be registered under the Securities and Exchange Act of 1934), Mr. Battista will receive an additional bonus of $1,000,000 if the price per share for the Company's Common Stock in such transaction was less than or equal to $20.00 per share, or $3,000,000 if the consideration is greater than $20.00 per share. In addition, upon a change in control of the Company, all of Mr. Battista's options immediately vest. Edward B. Meyercord, III entered into a five-year employment agreement with the Company effective as of September 5, 1996. Under the contract, Mr. Meyercord is entitled to a minimum annual base salary of $300,000 for each year. Michael Ferzacca entered into a three-year employment agreement with the Company effective as of December 28, 1998. Under the contract, Mr. Ferzacca is entitled to minimum annual base salary of $300,000 for each year. Mr. Ferzacca was granted an option to purchase 350,000 shares of the Common Stock of the Company at an exercise price of $8 9/16 per share. Aloysius T. Lawn entered into a two-year employment agreement with the Company effective as of December 1, 1998. Under the contract, Mr. Lawn is entitled to a minimum annual base salary of $250,000 for each year. Mr. Lawn was granted an option to purchase 50,000 shares of the Common Stock of the Company at an exercise price of $5.75 per share. George Vinall entered into a three-year employment agreement with the Company effective as of December 28, 1998. Under the contract, Mr. Vinall is entitled to a minimum annual base salary of $250,000 for each year. Mr. Vinall was granted an option to purchase 240,000 shares of the Common Stock of the Company at an exercise price of $8 9/16 per share. Each of the agreements for Messrs. Ferzacca, Lawn and Vinall provide for immediate vesting of options in event of a "change in control" (as defined in the agreements) and provide for severance benefits in the event employment is terminated by the Company without cause prior to the end of the term. Each of the above-described agreements require each of the executives to maintain the confidentiality of Company information and assign inventions to the Company. In addition, each of such executive officers has agreed that such person will not compete with the Company by engaging in any capacity in any business that is competitive with the business of the Company during the term of his respective agreement and thereafter for specified periods. 31 COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION None. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information known to the Company with respect to beneficial ownership of the Company's Common Stock as of April 26, 2000 (except as otherwise noted) by (i) each stockholder who is known by the Company to own beneficially more than five percent of the outstanding Common Stock, (ii) each of the Company's directors, (iii) each of the executive officers named below and (iv) all current directors and executive officers of the Company as a group. Except as otherwise indicated below, the Company believes that the beneficial owners of the Common Stock listed below have sole investment and voting power with respect to such shares. 32
NUMBER OF PERCENT OF SHARES SHARES BENEFICIALLY BENEFICIALLY NAME OF BENEFICIAL OWNER OR IDENTITY OF GROUP OWNED(1) OWNED -------- ----- Massachusetts Financial Services Company................. 7,309,000(2) 11.1% 500 Boylston Street Boston, Massachusetts 02116 America Online, Inc...................................... 6,843,356(3) 9.9% 22000 AOL Way Dulles, Virginia 20166 FMR Corp................................................. 3,270,825(4) 4.9% 82 Devonshire Street Boston, Massachusetts 02109 Legg Mason, Inc.......................................... 5,997,900(7)(9) 9.1% 100 Light Street P.O. Box 1476 Baltimore, MD 21203 Paul Rosenberg........................................... 5,759,985(5) 8.7% 650 N.E. 5th Avenue Boca Raton, Fl 33432 Geocapital, LLC.......................................... 3,966,560(7) 6.0% 767 Fifth Avenue, 45th Floor New York , New York 10153 Gabriel Battista......................................... 1,003,334(8) 1.5% Edward B. Meyercord, III................................. 106,131 * Aloysius T. Lawn, IV..................................... 198,650(8) * Michael Ferzacca......................................... 66,667(8) * George Vinall............................................ 80,000(8) * Ronald R. Thoma.......................................... 97,934(8) * Arthur J. Marks.......................................... 25,000(6) * Mark S. Fowler........................................... 20,000 * All directors and executive officers as a group (12 persons).............................................. 1,766,957 2.5%
- ---------- * Less than 1% (1) The securities "beneficially owned" by a person are determined in accordance with the definition of "beneficial ownership" set forth in the regulations of the Commission and, accordingly, may include securities owned by or for, among others, the spouse, children or certain other relatives of such person. The same shares may be beneficially owned by more than one person. Beneficial ownership may be disclaimed as to certain of the securities. (2) Massachusetts Financial Services Company ("MFS"), an investment adviser, filed an amendment to a Schedule 13G with the Commission on June 15, 1999 (the "MFS 13G"), in which it reported beneficial ownership of 7,309,000 shares, 6,471,100 of which are also beneficially owned by MFS Series Trust II-MFS Emerging Growth Fund, an investment company, and 837,900 of which are also owned by certain non-reporting entities as well as MFS. The foregoing information is derived from the MFS 13G. (3) The foregoing information is derived from the Schedule 13G filed by America Online, Inc. on January 15, 1999. (4) The foregoing information is derived from Schedule 13D filed by FMR Corp. on December 10, 1999. (5) The foregoing information is derived from the Schedule 13D filed by Paul Rosenberg, the Rosenberg Family Limited Partnership, PBR, Inc. and the New Millennium Charitable Foundation on January 12, 1999. (6) Excludes 69,241 shares of Common Stock held by Valhalla Capital Management, a general partnership of which Mr. Mark's spouse serves as general partner. Also excludes shares of Common Stock held in various client accounts managed by Mr. Mark's spouse. Mr. Marks disclaims beneficial ownership of such shares of Common Stock. 33 (7) The foregoing information was provided to the Company. (8) Includes shares of Common Stock that could be acquired upon exercise of vested options. (9) Includes 5,500,000 shares of Common Stock beneficially owned by Legg Mason Special Investment Trust and 497,900 shares beneficially owned by Legg Mason Capital Management, Inc. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS None. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this Annual Report on Form 10-K. 1. Consolidated Financial Statements: The Consolidated Financial Statements filed as part of this Form 10-K are listed in the "Index to Consolidated Financial Statements" in Item 8. 2. Consolidated Financial Statement Schedule: The Consolidated Financial Statement Schedule filed as part of this report is listed in the "Index to S-X Schedule." Schedules other than those listed in the accompanying Index to S-X Schedule are omitted for the reason that they are either not required, not applicable or the required information is included in the Consolidated Financial Statements or notes thereto. 34 TALK.COM INC. AND SUBSIDIARIES INDEX TO S-X SCHEDULE PAGE ---- Report of Independent Certified Public Accountants .......... 40 Schedule II -- Valuation & Qualifying Accounts .............. 41 35 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Board of Directors and Stockholders of Talk.com Inc. The audits referred to in our report dated February 7, 2000, relating to the consolidated financial statements of Talk.com Inc. and subsidiaries, which is contained in Item 8 of this Form 10-K, included the audits of the financial statement schedule listed in the accompanying index for each of the three years in the period ended December 31, 1999. This financial statement schedule is the responsibility of management. Our responsibility is to express an opinion on this schedule based on our audits. In our opinion, the financial statement Schedule II -- Valuation and Qualifying Accounts, presents fairly, in all material respects, the information set forth therein. BDO Seidman, LLP New York, New York February 7, 2000 36 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 ======= ======= ======== =======
37 (3) EXHIBITS: EXHIBIT NUMBER DESCRIPTION 3.1 Composite form of Amended and Restated Certificate of Incorporation of the Company, as amended through April 26, 1999 (incorporated by reference to Exhibit 3.1 to the Company's report on Form 10-Q for the quarter ended March 31, 1999). 3.2 Bylaws of the Company (incorporated by reference to Exhibit 3.2 to the Company's registration statement on Form S-1 (File No. 33-94940)). 3.3 Certificate of Designation of Series A Junior Participating Preferred Stock of Company dated August 27, 1999 (incorporated by reference to Exhibit A to Exhibit 1 to the Company's registration statement on Form 8-A (File No. 000-26728)). 10.1 Employment Agreement between the Company and Aloysius T. Lawn, IV dated October 13, 1998 (incorporated by reference to Exhibit 10.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998).* 10.2 Employment Agreement between the Company and Edward B. Meyercord, III (incorporated by reference to Exhibit 10.6 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996).* 10.3 Indemnification Agreement between the Company and Aloysius T. Lawn, IV (incorporated by reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995). 10.4 Indemnification Agreement between the Company and Edward B. Meyercord, III (incorporated by reference to Exhibit 10.14 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996). 10.5 Tel-Save Holdings, Inc. 1995 Employee Stock Option Plan (incorporated by reference to Exhibit 10.15 to the Company's registration statement on Form S-1 (File No. 33-94940)).* 10.6 Telecommunications Marketing Agreement by and among the Company, Tel-Save, Inc. and America Online, Inc., dated February 22, 1997 (incorporated by reference to Exhibit 10.32 to the Company's Form 10-K for the year ended December 31, 1996).+ 10.7 Amendment No. 1, dated as of January 25, 1998, to the Telecommunications Marketing Agreement dated as of February 22, 1997 by and among the Company, Tel-Save, Inc. and America Online, Inc. (incorporated by reference to Exhibit 10.31 to the Company's Form 10-K for the year ended December 31, 1997).+ 10.8 Amendment No. 2, dated May 14, 1998, among the Company, Tel-Save, Inc. and America Online, Inc., which amends that certain Telecommunications Marketing Agreement, dated as of February 22, 1997, as corrected and amended by letter, dated April 23, 1997, and amended by an Amendment No. 1, dated January 25, 1998 (incorporated by reference to Exhibit 10.1 to the Company's quarterly report on Form 10-Q, dated August 14, 1998).+ 38 10.9 Amendment No. 3, effective as of October 1, 1998, among the Company, Tel-Save, Inc. and America Online, Inc., which amends that certain Telecommunications Marketing Agreement, dated as of February 22, 1997, as corrected and amended by letter, dated April 23, 1997, and amended by an Amendment No. 1, dated January 25, 1998, and an Amendment No. 2, dated May 14, 1998 (incorporated by reference to Exhibit 10.22 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998).+ 10.10 Letter dated August 25, 1999 from America Online, Inc. to the Company (incorporated by reference to Exhibit 99.2 to the Company's Current Report on Form 8-K dated August 27, 1999). 10.11 Indenture dated as of September 9, 1997 between the Company and First Trust of New York, N.A. (incorporated by reference to Exhibit 4.3 to the Company's registration statement on Form S-3 (File No. 333-39787)). 10.12 Indenture dated as of December 10, 1997 between the Company and First Trust of New York, N.A. (incorporated by reference to Exhibit 10.34 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997). 10.13 Employment Agreement, dated as of November 13, 1998, between the Company and Gabriel Battista (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K dated January 20, 1999).* 10.14 Indemnification Agreement, dated as of December 28, 1998, between the Company and Gabriel Battista (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K dated January 20, 1999). 10.15 Stock Option Agreement, dated as of November 13, 1998, between the Company and Gabriel Battista (incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K dated January 20, 1999).* 10.16 Stock Option Agreement, dated as of November 13, 1998, between the Company and Gabriel Battista (incorporated by reference to Exhibit 10.4 to the Company's Current Report on Form 8-K dated January 20, 1999).* 10.17 Severance Agreement, dated as of December 31, 1998, between the Company and Daniel Borislow (incorporated by reference to Exhibit 10.5 to the Company's Current Report on Form 8-K dated January 20, 1999).* 10.18 Exchange Agreement, dated as of December 31, 1998, among the Company, Tel-Save, Inc. and Mark Pavol, as Trustee of that certain D&K Grantor Retained Annuity Trust dated June 15, 1998 (incorporated by reference to Exhibit 10.7 to the Company's Current Report on Form 8-K dated January 20, 1999). 10.19 Modification of the Exchange Agreement, dated ___________, 1999, by and among the Company, Tel-Save, Inc. and Mark Pavol (incorporated by reference to Exhibit 10.34 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 10.20 Registration Rights Agreement, dated as of December 31, 1998, among the Company, Daniel Borislow, Mark Pavol, as Trustee of that certain D&K Grantor Retained Annuity Trust, dated June 15, 1998 and the Trustee of that certain D&K Grantor Retained Annuity Trust II (incorporated by reference to Exhibit 10.8 to the Company's Current Report on Form 8-K dated January 20, 1999). 10.21 Amendment of Registration Rights Agreement dated as of March 18, 1999, by and among the Company, Daniel M. Borislow, and Seth Tobias (incorporated by reference to Exhibit 10.36 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 10.22 Amendment of Registration Rights Agreement dated as of March 18, 1999, by and among the Company and Mark Pavol (incorporated by reference to Exhibit 10.37 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 39 10.23 1998 Long-Term Incentive Plan of the Company (incorporated by reference to Exhibit 10.14 to the Company's Current Report on Form 8-K dated January 20, 1999).* 10.24 Investment Agreement, dated as of December 31, 1998, as amended on February 22, 1999, among the Company, America Online, Inc., and, solely for purposes of Sections 4.5, 4.6 and 7.3(g) thereof, Daniel Borislow, and solely for purposes of Section 4.12 thereof, Tel-Save, Inc. and the D&K Retained Annuity Trust dated June 15, 1998 by Mark Pavol, Trustee (incorporated by reference to Exhibit 10.41 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998.). 10.25 Registration Rights Agreement, dated as of January 5, 1999, between the Company and America Online, Inc. (incorporated by reference to Exhibit 10.42 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 10.26 Sublease Agreement, dated January ___, 1997, by and between Gemini Air Cargo, LLC and RMS International, Inc. (incorporated by reference to Exhibit 10.43 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 10.27 Sublease Agreement, dated as of January 20, 1999, by and between RMS International and Tel-Save, Inc. (incorporated by reference to Exhibit 10.44 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 10.28 Lease by and between Aetna Life Insurance Company and Potomac Financial Group, L.L.C. (incorporated by reference to Exhibit 10.45 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 10.29 Agreement, effective as of February 28, 1999, by and among the Company, Communication Telesystems International, d.b.a. WorldxChange Communications, Tel-Save, Inc., Mark Pavol, Roger B. Abbott and Rosalind Abbott, and Edward Soren (incorporated by reference to Exhibit 10.46 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 10.30 Form of Indemnification Agreement, dated as of January 5, 1999, for each of George Vinall, Michael Ferzacca and Norris M. Hall, III (incorporated by reference to Exhibit 10.50 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 10.31 Form of Non-Qualified Stock Option Agreement, dated as of December 16, 1998, for each of George Vinall, Michael Ferzacca and Norris M. Hall, III (incorporated by reference to Exhibit 10.51 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998).* 10.32 Employment Agreement, dated as of December 16, 1998, between the Company and Michael Ferzacca (incorporated by reference to Exhibit 10.60 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998).* 10.33 Employment Agreement, dated as of December 16, 1998, between the Company and Norris M. Hall, III (incorporated by reference to Exhibit 10.61 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998).* 10.34 Employment Agreement, dated as of December 16, 1998, between the Company and George Vinall (incorporated by reference to Exhibit 10.62 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998).* 10.35 Rights Agreement dated as of August 19, 1999 by and between the Company and First City Transfer Company, as Rights Agent (incorporated by reference to Exhibit 1 to the Company's registration statement on Form 8-A (File No. 000-26728)). 10.36 Employment Agreement by and among Vincent W. Talbert, the Company and Talk.com Holding Corp. dated as of June 8, 1999 (incorporated by reference to Exhibit 10.1 to the Company's report on Form 10-Q for the quarter ended June 30, 1999).* 40 10.37 Indemnification Agreement by and between Vincent W. Talbert and the Company dated as of June 8, 1999 (incorporated by reference to Exhibit 10.2 to the Company's report on Form 10-Q for the quarter ended June 30, 1999). 10.38 Non-Qualified Stock Option Agreement by and between Vincent W. Talbert and the Company dated as of June 8, 1999 (incorporated by reference to Exhibit 10.3 to the Company's report on Form 10-Q for the quarter ended June 30, 1999).* 10.39 Employment Agreement by and between Janet C. Kirschner and the Company dated as of October 14, 1999.*++ 10.40 Indemnification Agreement by and between Janet C. Kirschner and the Company dated as of October 14, 1999.++ 10.41 Non-Qualified Stock Option Agreement by and between Janet C. Kirschner and the Company dated as of October 14, 1999.*++ 11.1 Net Income Per Share Calculation. 21.1 Subsidiaries of the Company.++ 23.1 Consent of BDO Seidman, LLP.++ 27 Financial Data Schedule.++ - --------- * Management contract or compensatory plan or arrangement. + Confidential treatment previously has been granted for a portion of this exhibit. ++ Previously filed with this 10-K. (b) Reports on Form 8-K. No Current Reports on Form 8-K were filed by the Company during the three months ended December 31, 1999. 41 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: April 28, 2000 TALK.COM INC. By: /s/ Gabriel Battista ----------------------------------- Gabriel Battista Chairman of the Board of Directors, Chief Executive Officer, President and Director 42 EX-11.1 2 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 outstanding - Diluted: 64,415 59,283 64,168 ========== ============ ============= Income (loss) before extraordinary gain $ 0.90 $ (5.20) $ (0.33) Extraordinary gain 0.35 1.47 -- ---------- ------------ ------------ Net income (loss) $ 1.23 $ (3.73) $ (0.33) ========== ============ =============
-----END PRIVACY-ENHANCED MESSAGE-----