Item 2. Properties
Our principal administrative, sales, marketing, product development and programming offices are located in a single facility in Campbell, California of approximately 56,000 square feet held under a lease which expires in March 2009. In addition to this facility, as of December 31, 2000 we also leased 7,100 square feet of office space in Westfield, New Jersey under a lease that expires in July 2005, and 3,500 square feet in Newton Center, Massachusetts under a lease expiring in August 2005. As of December 31, 2000, we also leased sales office space elsewhere in the United States as follows: a 6,000 square foot facility in New York consisting of two office suites of approximately 3,000 square feet each under a lease that expires in March 2004; a 4,000 square foot facility in Chicago under a lease that expires in August 2004 and a 4,000 square foot facility in San Francisco under a lease that expires in June 2004.
Subsequent to December 31, 2000, we have terminated our leases for office space in Chicago, San Francisco as well as one of our two suites in New York City. See Note 16 in the notes to our financial statements regarding subsequent events.
Item 3.
Item 3. Legal Proceedings
We are not currently subject to any material legal proceedings. We may from time to time become a party to various legal proceedings in the ordinary course of business.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of our stockholders, through the solicitation of proxies or otherwise, during the fourth quarter of fiscal year 2000.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Market Information
Talk City's common stock is traded on the Nasdaq National Market under the symbol "TCTY." The following table sets forth the range of the high and low closing sale prices by quarter as reported on the Nasdaq National Market since July 20, 1999, the date our Common Stock commenced public trading.
As previously announced by the Company in its Form 8-K filed with the Securities and Exchange Commission on December 5, 2000, it is not currently in compliance with Nasdaq's minimum bid price requirement. In addition, subsequent to that date, we were advised by Nasdaq that the Company is not in compliance with its minimum capitalization requirements. The delisting action, however, has been stayed pending the outcome of an oral hearing before the Nasdaq Listing Qualifications Panel requested by the Company. The hearing was held on March 29, 2001 in Washington, D.C. In the event the appeal is denied, the Company's stock will be delisted from the Nasdaq National Market and will instead trade on the over-the-counter market.
On April 2, 2001, there were approximately 6,100 stockholders of record of Talk City's common stock.
Dividends
We have never paid cash dividends on our common stock. We intend to retain our earnings for use in our business and, therefore, do not anticipate paying any cash dividends on our common stock.
Recent Sales of Unregistered Securities
None.
Use of Proceeds From Sales of Registered Securities
On July 20, 1999, Talk City consummated the IPO of its Common Stock. The shares of Common Stock sold in the offering were registered under the Securities Act on a Registration Statement on Form S-1 (the "Registration Statement") which was declared effective by the SEC on July 19, 1999 (file number 333-77455). The aggregate offering amount registered pursuant to the IPO was $61.2 million. After deducting the underwriting discounts and commissions of $4,284,000, and the IPO expenses of $1,487,000, the net proceeds from the IPO were approximately $55.4 million.
From January 1, 2000 through December 31, 2000, Talk City has applied proceeds from the IPO as follows:
The foregoing amounts represents the Company's best estimates of its use of proceeds for the period indicated.
Item 6.
Item 6. Selected Consolidated Financial Data
The following selected financial data should be read in conjunction with our Financial Statements and Notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
This section contains 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. These forward-looking statements represent our expectations or beliefs concerning future events and include statements regarding our expectations or beliefs that: we will incur additional operating losses for the foreseeable future; network and syndication revenues will decline in absolute dollars and as a percentage of total revenues in the future as the Company focuses on community solution services, event services and market research; cost of revenues will decrease in absolute dollars as a result of the anticipated cost savings pursuant to the restructurings; product development expenses will decrease in absolute dollars as a result of the anticipated cost savings pursuant to the restructurings; sales and marketing expenses will decrease in absolute dollars as a result of the anticipated cost savings pursuant to the restructurings; general and administrative expenses will stay flat or decrease slightly in absolute dollars; DSOs will fluctuate significantly in future quarters and may increase; our expenditures will continue to increase for the foreseeable future; we will continue to evaluate possible acquisitions and investments in other businesses; our available cash and cash equivalents will be sufficient to meet our anticipated needs for working capital and capital expenditures in the next six to nine months; and our need to raise additional funds in order to meet our operating and other needs. Actual results could differ materially from those projected in the forward-looking statements as a result of known and unknown risk factors and uncertainties, and you should not rely on these forward-looking statements. Such factors may include, but are not necessarily limited to: whether we will continue to incur significant losses and our ability to generate increased revenues; the success of our recent restructuring; the feasibility of incurring more dilution by selling equity in our Company; and our ability to grow our business. In addition to the foregoing, please see the section beginning on page seven of this report entitled "Risk Factors That May Affect Results of Operations and Financial Condition" for a description of those factors that might cause actual results to differ from those projected in the forward-looking statements herein.
Overview
We provide online communities and customer relationship management for businesses and consumers. From inception through December 2000, our operating activities have primarily been focused on:
. developing the quality environment of our services;
. expanding the audience and usage of our services;
. establishing operating relationships with our network participants;
. building sales momentum and developing programs and content to market the Talk City brand name and attract users to our sites;
. developing a comprehensive computer software and hardware infrastructure;
. recruiting personnel; and
. raising capital.
To date, substantially all of our revenues have been derived from the sale of our online marketing services, advertising and sponsorships. Our online marketing services include designing customized communities, producing online events, conducting online market research and facilitating online meetings. These services help businesses develop and expand online relationships with customers, suppliers and employees. Revenues derived from online marketing services are recognized ratably over the term of the contract period which coincides with when the services are performed, provided that the collection of the receivable is probable.
Advertising and sponsorship revenues are derived from two sources. Advertising revenues generally come from short-term banner advertisement contracts. Sponsorship revenues come from contracts under which we offer a combination of custom programming, prominent logo placement, other onsite promotions and additional banner ads. Our advertising and sponsorship clients enter into short-term agreements pursuant to which they generally receive a guaranteed number of advertising impressions on our site. Advertising and sponsorship revenues are recognized in the period in which the advertisement is displayed or the sponsorship event is run, provided that no significant obligations remain, at the lesser of the ratio of impressions delivered over total guaranteed impressions or on a straight-line basis over the term of the contract. In some cases, where we contract with third party sales representative firms to sell advertising revenues, we recognize revenues net of the commissions paid.
Cost of revenues include payroll and related expenses associated with content and production personnel who conduct online market research, implement customized communities, and produce online events. Also included are moderator costs, Internet communication charges and server-related costs to support our Web site.
Operating expenses consist primarily of product development, sales and marketing, general and administrative and interest expenses. Product development expenses consist primarily of salaries, payroll taxes and benefits and expenditures related to software development, quality engineering and product marketing. Sales and marketing expenses consist primarily of advertising and promotion costs, salaries, commissions and other related costs of internal sales and marketing personnel and program expenses, public relations costs and other marketing expenses. General and administrative expenses consist of salaries, payroll taxes and benefits and related costs for general corporate functions, including executive management, finance, human resources, facilities, legal and fees for other professional services.
Sales and marketing expenses exclude noncash advertising and promotional charges related to our advertising on the NBC television network and in magazines owned by Hearst along with promotional services attributable to the operating agreements with NBC. These advertising activities are paid for through noncash in-kind investments. This in-kind program includes $7.2 million of television commercials and print ads valued at rates discounted from the rate card to be incurred from 1998 through 2001. After December 31, 2000, noncash charges of $2.2 million will be charged to operations as the related advertising is run or promotional services are received, all of which we expect will be charged to operations during the year ended December 31, 2001. These amounts were determined based on the fair value of our common stock and warrants exchanged for the services received. See Note 10 of the notes to our financial statements.
We incurred losses of $41.6 million in 2000, $40.1 million in 1999, $15.7 million in 1998, $6.4 million in 1997, and $1.3 million in 1996. These losses include noncash advertising and promotional charges of $16.4 million through December 31, 2000. At December 31, 2000, we had an accumulated deficit of $105.1 million. We anticipate that we will incur additional operating losses for the foreseeable future.
Results of Operations
The following table sets forth, for the periods indicated, the percentage of total revenues represented by certain items reflected in our results of operations:
Years Ended December 31, 2000, 1999 and 1998
Revenues. Total revenues were $14.8 million in 2000, $7.7 million in 1999 and $1.5 million in 1998. Network and syndication revenues were $6.8 million, or 46% of total revenues, in 2000, $5.4 million, or 70% of total revenues, in 1999 and $999,000, or 69% of total revenues, in 1998. Community solution services revenues were $3.2 million, or 21% of total revenues, in 2000, $1.1 million, or 15% of total revenues, in 1999 and $315,000, or 22% of total revenues, in 1998. Event services revenues were $3.2 million, or 21% of total revenues, in 2000, $817,000, or 10% of total revenues, in 1999, and $32,000, or 2% of total revenues, in 1998. Market research revenues were $1.7 million, or 12% of total revenues, in 2000, $377,000, or 5% of total revenues, in 1999, and $107,000, or 7% of total revenues, in 1998. The increases in total revenues from 1998 to 1999 and from 1999 to 2000 were primarily due to increases in the number of business clients and advertisers, as well as increases in our user volume and expansion of our consumer and online marketing services offerings. While network and syndication revenues increased for the year ended December 31, 2000 as compared to same period in 1999, network and syndication revenues declined sequentially from the quarter ended March 31, 2000 through the quarter ended December 31, 2000. The Company expects the network and syndication revenues will decline in absolute dollars and as a percentage of total revenues in the future as the Company focuses on community solution services, event services and market research.
Cost of Revenues. Cost of revenues were $16.1 million, or 108% of total revenues, in 2000, $8.9 million, or 116% of total revenues, in 1999 and $3.6 million, or 246% of total revenues, in 1998. The
increase in absolute dollars of cost of revenues from 1999 to 2000 was due to higher server-related expenses associated with conducting additional online events and market research studies of $2.5 million, $1.3 million associated with market research production, $0.9 million attributable to higher online hosting costs, and the balance primarily attributable personnel costs associated with the production of our services. The increase from 1998 to 1999 was due to Internet connection fees and server related expenses associated with conducting additional online events and market research studies of $0.6 million, as well as an increase in chat hosting of $2.2 million associated with the rapid growth in user volume from our supervised chats. Cost of revenues as a percentage of total revenues decreased in all periods due to growth in total revenues. We expect that cost of revenues will decrease in absolute dollars as a result of the anticipated cost savings pursuant to the restructurings.
Operating Expenses:
Product Development. Product development expenses were $8.0, or 54% of total revenues, in 2000, $4.8 million, or 61% of total revenues, in 1999, and $1.5 million, or 101% of total revenues, in 1998. The increase in absolute dollars in product development from 1999 to 2000 was primarily attributable to an increase in personnel and recruiting-related costs to support the development and broadening of our line of products. The increase in absolute dollars in product development and programming from 1998 to 1999 was primarily attributable to an increase in engineering personnel costs. Product development expenses as a percentage of total revenues decreased in all periods due to growth in total revenues. We expect that product development expenses will decrease in absolute dollars as a result of the anticipated cost savings pursuant to the restructurings.
Sales and Marketing. Sales and marketing expenses were $15.3 million, or 103% of total revenues, in 2000, $19.6 million, or 253% of total revenues, in 1999, and $7.0 million, or 483% of total revenues, in 1998. The decrease in sales and marketing expenses from 1999 to 2000 was primarily attributable to a decrease of approximately $7.0 million associated with advertising, partially offset by an increase in sales and marketing personnel and commission-related costs of $1.9 million and an increase of $0.5 million in facilities related charges as we expanded our sales force. The increase in sales and marketing expenses from 1998 to 1999 was primarily attributable to an increase of approximately $5.9 million associated with the development and implementation of our branding, promotion and marketing campaigns and an increase in sales personnel and commission-related costs of $2.8 million as a result of implementing our sales and marketing strategy. Sales and marketing expenses as a percentage of total revenues decreased in all periods due to growth in total revenues. We expect that sales and marketing expenses will decrease in absolute dollars as a result of the anticipated cost savings pursuant to the restructurings.
General and Administrative. General and administrative expenses were $12.0 million, or 81% of total revenues, in 2000, $5.7 million, or 74% of total revenues, in 1999, and $1.8 million, or 124% of total revenues, in 1998. The increase in general and administrative expenses from 1999 to 2000 was primarily due to costs of $2.6 million associated with moving the corporate headquarters, an increase in the allowance for doubtful accounts of $1.5 million, increased personnel costs of $1.2 million and increased costs of $1.0 million incurred in operating as a public company for the entire year in 2000. The increase in general and administrative expenses from 1998 to 1999 was primarily due to stock-based compensation expense of $763,000 related to the issuance of stock options and personnel and recruiting-related expenses of $1 million. In addition, we incurred an increase in legal, accounting and insurance fees of $540,000 due to increased expenses associated with becoming a public company in July 1999 and an increase in facilities expenses of $740,000 in order to support the growth of our business. General and administrative expenses increased in 2000 as a percentage of revenues as a result of the higher expenses associated with the new headquarters and the public company costs. General and administrative expenses as a percentage of revenues decreased in 1999 due to the growth in total revenues. We expect that general and administrative expenses will remain constant or decrease slightly in absolute dollars in the future.
Noncash Advertising and Promotional Charges. We incurred charges of $2.4 million, or 16% of total revenues, for 2000, $11.2 million, or 144% of total revenues, for 1999 and $2.9 million, or 199% of total revenues, in 1998 representing noncash in-kind expenses associated with the advertising and operating agreements with NBC and Hearst.
Interest Income (Expense), Net. Net interest income was $2.2 million, or 14% of total revenues, in 2000, $2.3 million, or 29% of total revenues, in 1999, and net interest expense was $367,000, or 25% of total revenues, in 1998. Interest income decreased in 2000 compared to 1999 as a result of lower average cash and cash equivalents and investment balances due to the consumption of cash to fund ongoing operations. Interest income increased in 1999 compared to 1998 due to higher cash equivalent and investment balances as a result of proceeds received from sale of preferred stock in April 1999 and our initial public offering of common stock in July 1999. We incurred interest expense in 1998 as a result of our convertible loan financing in 1998.
Income Taxes. Management has established a full valuation allowance against its net deferred tax assets because it is more likely than not that sufficient taxable income will not be generated to utilize those deferred tax assets.
Financial Condition
Our total assets were $34.8 million and $74.5 million at December 31, 2000 and 1999, respectively, representing a decrease of $39.7 million, or 53%. This decrease was primarily due to the consumption of cash during 2000 to fund ongoing operations. As of December 31, 2000, we had $14.0 million of cash and cash equivalents and short-term investments, as compared to $53.5 million as of December 31, 1999.
Our accounts receivable balance, net of allowance for doubtful accounts, was $2.6 million and $3.5 million as of December 31, 2000 and 1999, respectively, representing a decrease of $0.9 million, or 26%. This decrease was principally a result of an increase in the allowance for doubtful accounts reserve. Days sales outstanding, or DSO, in accounts receivable was 101 days and 81 days as of December 31, 2000 and 1999, respectively. We expect DSO will fluctuate significantly in future quarters, and may even increase.
Our total current liabilities were $5.1 million and $8.1 million as of December 31, 2000 and 1999 respectively, representing a decrease of 38%. This decrease consists primarily of a decrease in accounts payable, and accrued liabilities. The decrease in accounts payable and accrued liabilities was primarily due to decreases in balances associated with the move to the corporate headquarters at the end of 1999 as well as lower accrued marketing liabilities. The increase in deferred revenues at December 31, 2000 was due to the increase in our fee-based marketing services revenues in the fourth quarter of 2000, which grew 86% from the same period in 1999.
Liquidity and Capital Resources
Since our inception in March 1996, we have financed our operations primarily through the private placement of our preferred stock, our initial public offering in July 1999 and, to a lesser extent, through equipment financing. As of December 31, 2000, we had approximately $7.0 million in cash and cash equivalents and approximately $7.0 million in short-term investments.
Our capital requirements depend on numerous factors, including market acceptance of our services, the resources we allocate to our community network, marketing and selling our services, brand promotions and other factors. We have experienced substantial increases in our expenditures since inception consistent with growth in our operations and personnel. Additionally, we will continue to evaluate possible acquisitions of and investments in complementary businesses, technologies, services or products and to expand our sales and marketing programs. We believe that our available cash and cash equivalents
will be sufficient to meet our anticipated needs for working capital and capital expenditures for at least the next six to nine months. Thereafter, we may need to raise additional funds in order to meet our operating needs, to fund expansion, to develop new or enhance existing services or products, to respond to competitive pressures, or to acquire or invest in complementary businesses, technologies, services or products. In addition, in order to meet our long term liquidity needs, we may need to raise additional funds, establish a credit facility or seek other financing arrangements. Additional funding may not be available on favorable terms or at all.
Net cash used in operating activities was approximately $32.3 million, $25.2 million and $11.0 million for the years ended December 31, 2000, 1999 and 1998, respectively, representing increases of $7.1 million, or 28%, from 1999 to 2000, and $14.2 million, or 129% from 1998 to 1999. Cash used in operating activities in each of these periods was primarily the result of funding our business growth and ongoing operations.
Net cash provided by investing activities was approximately $23.8 million for the year ended December 31, 2000. Net cash used in investing activities was approximately $44.9 million and $6.5 million for the years ended December 31, 1999 and 1998, respectively. Our investing activities have consisted primarily of purchases and sales of short-term investments, purchases of property and equipment, a cost investment in SocialNet.com, and the acquisition of Research Connections, Inc. Net sales of short-term investments were $32.5 million for the year ended December 31, 2000. The net sales of short-term investments were used to fund the cash requirements of the ongoing operating activities. Net purchases of short-term investments were $35.8 million and $5.7 million for the years ended December 31, 1999, and 1998, respectively. The increases in short- term investment purchases were due to the investment of proceeds from our private placement of preferred stock in August 1998, private placement of preferred stock in April 1999 and initial public offering in July 1999. Property and equipment acquisitions totaled $6.7 million, $5.8 million and $797,000 for the years ended December 31, 2000, 1999, and 1998. The increase in acquisitions of property and equipment from 1999 to 2000 was due to our growth in operations, as well as the establishment of a new server location. The increase in acquisitions of property and equipment from 1998 to 1999 was due to our growth in operations, server requirements and opening of sales offices in San Francisco and Chicago, as well as the expansion of our New York City sales office. On December 21, 1999, we made a $3 million cost investment in SocialNet, Inc. in exchange for 1,554,404 shares of Series C Preferred Stock, representing approximately 7.6% of the fully diluted shares outstanding of SocialNet, Inc. as of the investment date. As of December 31, 2001, the book value of the SocialNet, Inc. investment has been reduced to $0 due to impairment.
Net cash provided by financing activities was approximately $1.4 million, $75.6 million and $24.2 million for the years ended December 31, 2000, 1999 and 1998, respectively. Net cash provided by financing in the year ended December 31, 2000 was primarily the result of proceeds from the issuance of common stock from the exercise of stock options and warrants. In the year ended December 31, 1999, cash provided consisted primarily of net proceeds of approximately $20 million from the private placement of preferred stock in April 1999 and approximately $55.4 million from our initial public offering in July 1999, partially offset by principal payments on notes payable. Net cash provided by financing activities for the year ended December 31, 1998 consisted primarily of the private placement of Series D Preferred Stock with net proceeds of approximately $21.2 million in August and September 1998 and net proceeds of $2.9 million from our convertible loan financing.
As of December 31, 2000, our principal commitments consisted of obligations outstanding under non-cancelable operating leases. In October 1999, we signed a nine-year, three and one-half month lease for a new 56,000 square foot corporate headquarters in Campbell, California, which commenced on December 15, 1999. The Company is required to provide a $2,100,000 letter of credit as security for the lease. Under the lease agreement, the letter of credit may be reduced by $300,000 per year after every twelve months through December 14, 2005, provided no default has occurred. As of December 31, 2000, a
$1,800,000 certificate of deposit with a one year maturity is held as collateral by a bank for guarantee of the letter of credit. The certificate of deposit is included in Other Assets. Future minimum lease payments under all non-cancelable operating leases total $15.9 million. This balance reflects the effect of the termination of the leases for sales office space in Chicago, San Francisco and New York subsequent to December 31, 2000, which reduced the future minimum lease payments by approximately $1.0 million. See Note 16 of the notes to our financial statements.
In May 1998, we obtained an equipment line of credit with a financial institution in the amount of $2.0 million. This line of credit is secured by our fixed assets and has a four-year term that expires in April 2002. As of December 31, 2000, the amount outstanding under this line of credit was $107,000.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including derivative instruments embedded in other contracts, and for hedging activities. The Company believes the adoption of SFAS No. 133 will not have a material effect on its results of operations, financial position or cash flows. This statement will be effective for the Company beginning January 1, 2001.
Item 7a.
Item 7a. Quantitative and Qualitative Disclosures about Market Risk
Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. We do not use derivative financial instruments in our investment portfolio. We place our investments with high quality issuers and, by policy, limit the amount of credit risk exposure to any one issuer. We are averse to principal loss and ensure the safety and preservation of our invested funds by limiting default, market and reinvestment risk. We classify our cash equivalents and short-term investments as "fixed rate" if the rate of return on such instruments remains fixed over their term. These "fixed rate" investments include fixed-rate commercial paper and corporate notes. We classify our cash equivalents and short-term investments as "variable rate" if the rate of return on such investments varies based on the change in a predetermined index or set of indices during their term. These "variable rate" investments primarily include money market funds held at two securities brokers.
As of December 31, 2000, the contractual maturities of all debt securities in the Company's portfolio were less than one year. The table below presents the amounts and related weighted average interest rates of our investment portfolio at December 31, 2000:
Item 8.
Item 8. Financial Statements and Supplementary Data
Report of KPMG LLP, Independent Auditors
The Board of Directors and Stockholders Talk City, Inc.:
We have audited the accompanying balance sheets of Talk City, Inc. (the Company), as of December 31, 2000 and 1999, and the related statements of operations, redeemable convertible preferred stock and stockholders' equity (deficit), and cash flows for each of the years in the three-year period ended December 31, 2000. In connection with our audits of the financial statements, we have also audited the accompanying financial statement schedule. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the 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 financial statements referred to above present fairly, in all material respects, the financial position of Talk City, Inc. as of December 31, 2000 and 1999, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in note 15 to the financial statements, the Company's recurring net losses, amounts of cash used in operating activities, and accumulated deficit raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in note 15. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ KPMG, LLP
Mountain View, California February 2, 2001, except as to Note 16 which is as of March 16, 2001
Talk City, Inc.
Balance Sheets (in thousands, except share and par value amounts)
See accompanying notes to financial statements.
Talk City, Inc.
Statements of Operations (in thousands, except per share amounts)
See accompanying notes to financial statements.
Talk City, Inc.
Statements of Redeemable Convertible Preferred Stock and Stockholders' Equity (Deficit) (in thousands, except share amounts)
See accompanying notes to financial statements.
Talk City, Inc.
Statements of Cash Flows (in thousands)
Talk City, Inc.
Statements of Cash Flows (continued) (in thousands)
See accompanying notes to financial statements
Talk City, Inc.
Notes to Financial Statements
(1) Description of Business and Nature of Operations
Talk City, Inc., incorporated in March 1996, is a leading provider of online affinity marketing services. The Company helps companies use their Web sites to bring their customers together into communities, which significantly reduces marketing and support costs, increases revenue, and strengthens customer relationships. The Company offers businesses a wide range of services which include: consulting services; market research services; live online events and webcasts; software applications such as online discussion boards and online customer support tools; and community moderation services; as well as advertising services. The Company also operates one of the largest community Web sites in the world at www.talkcity.com. ----------------
(2) Summary of Significant Accounting Policies
(a) Revenue Recognition
To date, the Company's revenues have been derived primarily from the sale of online marketing services and sponsorship and advertising contracts.
Revenues from network and syndication services are generally derived from short-term banner advertisement and sponsorship contracts under which the Company offers a combination of custom programming, prominent logo placement, other onsite promotions and additional banner ads. Talk City's clients for network and syndication services enter into short-term agreements pursuant to which they generally receive a guaranteed number of advertising impressions on the Company's network sites. Revenues from network and syndication services are recognized in the period in which the advertisement is displayed, or the event is run, provided that no significant obligations remain, at the lesser of the ratio of impressions delivered over total guaranteed impressions or on a straight-line basis over the term of the contract
Sponsorship contracts integrate traditional advertising with content designed to support broad marketing objectives, including brand promotion, awareness, and product introductions. Advertising revenues are derived principally from short-term advertising contracts in which the Company delivers banner advertisements on its online properties over a specified period of time for a fixed fee. The Company's contracts typically are short- term agreements that guarantee a minimum number of impressions or pages to be delivered to users over a specified period of time. Revenues from these contracts are recognized in the period in which the advertisement is displayed or the event is run, provided that no significant Company obligations remain. The amount of revenue recognized each period is based on the lesser of the ratio of impressions delivered over total guaranteed impressions or the ratable amortization over the term of the contract.
In certain instances where the Company contracts with third party sales agents for the sale of advertising, the Company recognizes the revenues from such transactions net of the related commission paid to the agent.
Talk City's event services primarily include the setup and production of live, online, interactive events for the Company's clients. Revenues from the event services are recognized as the events are run or ratably over the term of the contract.
Market research services consist of the production and delivery of online market research surveys and focus groups. Revenue is recognized at the lesser of the estimated percentage of project completion or on a straight-line basis over the term of the contract.
Community solution services revenues are derived principally from contracts relating to one or more events and contracts for a period of time up to two years in which the Company designs customized communities, produces online events, conducts market research, and facilitates online discussion boards for customers. Community solution services revenues are recognized as the events are run or ratably over the term of the contract period which coincides with when the services are performed, provided that collection of the receivable is probable.
In December 1999, the Securities and Exchange Commission (the "SEC") issued Staff Accounting Bulletin No. 101 ("SAB 101") "Revenue Recognition in Financial Statements." SAB 101 summarizes certain of the SEC's views in applying accounting principles generally accepted in the United States of America to revenue recognition in financial statements. In March 2000, the SEC issued SAB 101A, which delayed the implementation of SAB 101. In June 2000, the SEC issued SAB 101B, which further delayed the implementation date of SAB 101. We adopted SAB 101 beginning October 1, 2000. The adoption of SAB 101 did not have a material impact on our financial position or results of operations.
(b) Cash Equivalents
All highly-liquid financial instruments purchased with an original maturity of three months or less are reported as cash equivalents.
(c) Short-term Investments
Marketable securities are stated at fair value at the balance sheet date. By policy, the Company invests primarily in high-grade marketable securities. Marketable securities are classified as available-for-sale securities under the provisions of Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities."
Management determines the appropriate classification of its investments in marketable securities at the time of purchase and reevaluates such determination at each balance sheet date. The Company has classified its marketable securities as available-for-sale, which are carried at fair value, with unrealized gains and losses, net of tax, reported as a separate component of stockholders' equity. At December 31, 2000 and 1999, the fair value of marketable securities (consisting primarily of commercial paper, corporate notes and market auction securities) approximates their cost. Therefore, no unrealized gain or loss has been recorded. Realized gains and losses have not been material for any period presented.
(d) Fair Values of Financial Instruments
The Company has the following financial instruments: cash and cash equivalents, short-term investments, accounts receivable, accounts payable, accrued liabilities, long-term debt and a standby letter of credit. The carrying value of cash and cash equivalents, short-term investments, accounts receivable, accounts payable and accrued liabilities approximates fair value based on liquidity of these financial instruments or based on their short-term nature. The carrying value of long-term debt and the standby letter of credit approximates fair value based on the market interest rates available to the Company for debt of similar risk and maturities. The Company does not have any foreign currency hedging or other derivative financial instruments as of December 31, 2000.
(e) Property and Equipment
Property and equipment are carried at cost less accumulated depreciation and amortization. Depreciation of property and equipment is calculated using the straight-line method over the estimated useful lives of the equipment, generally ranging from three to five years. Leasehold improvements are amortized over the shorter of their estimated useful lives or the related lease life, generally ranging from three to six years.
(f) Long Lived Assets
The Company reviews its long-lived assets, including goodwill, for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Recoverability of assets held and used is measured by a comparison of the carrying amount of the asset to future undiscounted net cash flows expected to be generated by the asset. If such amounts are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
(g) Product Development
Product development expenses consist primarily of salaries, payroll taxes, benefits and related expenditures for technology, software development, project management and support personnel. Costs related to the development of new products and enhancements to existing products are charged to operations as incurred. Software development costs are required to be capitalized when a product's technological feasibility has been established by completion of a working model of the product. To date, completion of a working model of the Company's products and general release have substantially coincided. As a result, the Company has not capitalized any software development costs because such costs have not been significant.
(h) Advertising and Marketing Expense
The cost of advertising is expensed as incurred. Advertising costs were $6,769,000, $22,606,000, and $7,410,000, for the years ended December 31, 2000, 1999 and 1998, respectively. For the years ended December 31, 2000, 1999 and 1998, these costs included, $2,388,000, $11,162,000, and $2,890,000, respectively, of noncash advertising and promotional charges pursuant to the NBC and Hearst advertising and operating agreements. See Note 10--Advertising and Operating Agreements.
(i) Income Taxes
The Company accounts for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes" which utilizes the liability method of accounting for income taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.
(j) Stock-Based Compensation
The Company accounts for its stock-based compensation arrangements with employees using the intrinsic-value method pursuant to Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees." As such, compensation expense is recorded on the date of grant when the fair value of the underlying common stock exceeds the exercise price for stock options or the purchase price for the issuance or sales of common stock. Pursuant to SFAS No. 123, the Company discloses the pro forma effects of using the fair value method of accounting for stock-based compensation arrangements.
Effective July 1, 2000, the Company has adopted the Financial Accounting Standards Board Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation--an Interpretation of APB No. 25" ("FIN 44"). FIN No. 44 clarifies the application of Opinion No. 25 for certain issues including: (a) the definition of employees for purposes of applying Opinion No. 25, (b) the criteria for determining whether a plan qualifies as a noncompensatory plan, (c) the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and (d) the accounting for an exchange of stock compensation awards in a business combination. The Company's adoption of FIN No. 44 has not had a material impact on its financial statements, cashflows, or results of operations. See Note 6--Capitalization.
The Company accounts for stock-based compensation arrangements with nonemployees in accordance with the Emerging Issues Task Force Abstract (EITF) No. 96-18, "Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services." Accordingly, unvested options held by nonemployees are subject to revaluation at each balance sheet date based on the then current fair market value.
Unearned deferred compensation resulting from employee and nonemployee option grants is amortized on an accelerated basis over the vesting period of the individual options, generally four years in accordance with Financial Accounting Standards Board Interpretation No. 28.
(k) Comprehensive Loss
The Company has no significant components of other comprehensive loss, and accordingly, the comprehensive loss is the same as the net loss for all periods.
(l) Net Loss Per Share
Basic net loss per share is computed using the weighted-average number of outstanding shares of common stock. Diluted net loss per share is computed using the weighted-average number of shares of common stock outstanding and, when dilutive, potential common shares from options and warrants to purchase common stock using the treasury stock method and from convertible securities using the if-converted basis. All potential common shares have been excluded from the computation of diluted net loss per share for all periods presented because the effect would have been antidilutive.
Diluted net loss per share does not include the effect of the following antidilutive common equivalent shares (in thousands):
(m) Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management 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 the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
(n) Reverse Stock Split and Reincorporation
On July 12, 1999, the Company effected a one for two reverse stock split of the Company's common stock and preferred stock and a reincorporation of the Company into the state of Delaware. As part of the reincorporation the common stock par value was adjusted to equal $0.001 per share and the number of common shares authorized was increased to 100,000,000. The share information in the accompanying financial statements has been retroactively restated to reflect the effect of this reverse stock split for all periods presented.
(o) Segment Reporting
The Company has one operating segment because it is not organized by multiple segments for purposes of making operating decisions or assessing performance. The chief operating decision maker evaluates performance, makes operating decisions, and allocates resources based on financial data consistent with the presentation in the accompanying financial statements.
(p) Concentration of Credit Risk
Financial instruments which subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents, short term investments and trade accounts receivable. The Company maintains cash and cash equivalents with three domestic financial institutions. From time to time, the Company's cash balances with its financial institutions may exceed Federal Deposit Insurance Corporation insurance limits.
The Company's customers are concentrated in the United States. The Company performs ongoing credit evaluations, generally does not require collateral and establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of customers, historical trends and other information; to date, such losses have been within management's expectations. As of December 31, 2000 and 1999, the allowance for bad debts was $1,719,000 and $254,000, respectively.
The Company's operations and assets are based in the United States, and its revenues have substantially all been earned from customers in the United States. For the year ended December 31, 2000, no single customer represented over 10% of revenues. As of December 31, 2000, total
receivables from a single customer were $373,000. Revenues from one major customer were $947,000 and $319,000 for the years ended December 31, 1999 and 1998, respectively. Total receivables from this customer were $377,000 at December 31, 1999.
(q) Recently Issued Accounting Standards
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including derivative instruments embedded in other contracts, and for hedging activities. The Company believes the adoption of SFAS No. 133 will not have a material effect on its results of operations, financial position or cash flows. This statement will be effective for the Company beginning January 1, 2001.
(r) Reclassifications
Certain reclassifications have been made to the prior years' financial statements to conform to the December 31, 2000 presentation.
(3) Business Combinations
On January 3, 2000, the Company acquired Research Connections, Inc. ("RCI"), a privately-held online market research company. The Company paid $500,000 in cash and issued 242,424 shares of its Common Stock, with an approximate fair market value of $3 million, in exchange for all outstanding shares of RCI. The cash consideration of $500,000 was due as follows: $250,000 was paid on January 3, 2000; $125,000 was paid on April 3, 2000; and $125,000 was paid on July 3, 2000. In addition, contingent cash consideration of $1.5 million, subject to an employment agreement with the former sole shareholder of RCI, was placed into an escrow fund and recorded as restricted cash in Other Assets. Funds will be released over four years with 25% released on January 3, 2001 and the remainder released evenly over the following 36 months. In the event the shareholder is terminated for cause or voluntarily leaves employment of the Company, then all remaining cash in the escrow fund shall be forfeited to the Company and the shareholder will have no further right to such cash. The Company will record the cash consideration of $1.5 million as compensation expense as the funds are released from escrow.
The Company accounted for the acquisition of RCI pursuant to the purchase method of accounting. Thus, the results of operations of RCI and the fair value of the assets acquired and liabilities assumed was included in the Company's financial statements beginning on the acquisition date. The allocation of the purchase price of $3.5 million resulted in cash and other assets of approximately $100,000 and goodwill of approximately $3.4 million, which was capitalized and is being amortized on a straight line basis over five years.
The Company's consolidated statement of operations includes the operations of RCI from January 3, 2000 to December 31, 2000. The unaudited pro forma financial information in the following table illustrates the combined results of the Company's operations and the operations of RCI for the period from January 1, 1999 to December 31, 1999, as if the acquisition of RCI had occurred as of January 1, 1999. The unaudited pro forma financial information is presented for informational purposes and is not necessarily indicative of the results of operations which would have occurred if the Company had constituted a single entity as of January 1, 1999. The unaudited pro forma information is also not necessarily indicative of the future results of the operations of the combined entity.
The proforma net loss includes the Company's net loss of $40,107,000 and RCI's net loss of $73,000 plus a pro forma adjustment of $684,000 to include the amortization expense associated with the goodwill related to the acquisition.
(4) Financial Statement Components
(a) Cash Equivalents and Short-Term Investments
The following is a summary of cash equivalents and short-term investments as of December 31, 2000 and 1999 (in thousands):
As of December 31, 2000 and 1999, the contractual maturities of all debt securities in the Company's portfolio, except auction-rate securities, were less than one year. The contractual maturities for the auction-rate securities exceed 10 years. However, the Company has the option of adjusting the interest rates or liquidating these investments on their respective reset dates, which occur every 90 days or less. Auction rate securities held for more than 90 days are included in short term investments.
(b) Property, Plant and Equipment
Property and equipment consisted of the following as of December 31, 2000 and 1999 (in thousands):
(c) Other Assets
Other assets consisted of the following as of December 31, 2000 and 1999 (in thousands):
(d) Accrued Liabilities
Accrued liabilities consisted of the following as of December 31, 2000 and 1999 (in thousands):
(e) Interest Income (Expense), Net
Included in interest expense in 1998 is the value associated with the common stock warrants issued to the holders of the notes totaling $490,000. See Note 6- - -Capitalization.
(5) Notes Payable
The Company has an equipment line of credit with a financial institution that provides up to $2,000,000 in borrowings, bears interest at a rate determined on the draw date, and currently expires in April 2002. The line of credit is secured by the Company's fixed assets. As of December 31, 2000 and 1999, $107,000 and $261,000, respectively, was outstanding under this agreement with the principal amount due in 48 monthly installments beginning in May 1998. These amounts bear interest at a fixed rate of approximately 20%.
The aggregate principal payments due under the line of credit subsequent to December 31, 2000 are as follows: 2001, $86,000; and 2002, $21,000.
(6) Capitalization
(a) Redeemable Convertible Preferred Stock
A summary of redeemable convertible preferred stock issued by the Company since inception follows:
Each share of the Series A, A1, B, D and E redeemable preferred stock was convertible into common stock at a rate of 1.00 shares of common stock for one share of preferred. Pursuant to antidilution adjustments, the Series C Stock was convertible at a rate of 1.17 shares of common stock for 1 share of Series C Stock. The redeemable preferred stock automatically converted to common stock upon completion of the Company's public offering of common stock in July 1999.
The Company borrowed approximately $2,900,000 under a convertible loan arrangement from April 1998 through August 1998. Advances were at an interest rate of 9% per annum. In connection with the issuance of the Series D Stock in September 1998, notes of $2,572,000, including accrued interest, were converted into 658,476 shares of Series D Stock and the remaining notes were repaid in full.
No dividends have been declared or paid on either the preferred stock or common stock since inception of the Company.
(b) Common Stock
The Company completed its initial public offering of approximately 5.1 million shares of Common Stock, including 100,000 shares of the underwriters over-allotment option, on July 23, 1999 (the 100,000 shares of the underwriters over-allotment option was completed on August 24, 1999) and raised approximately $55.4 million, net of offering costs of $5,771,000. Talk City is listed on the NASDAQ National Market under the symbol "TCTY."
Option holders have exercised options to purchase shares of restricted common stock in exchange for stockholder promissory notes. The notes are secured by the underlying shares of common stock and were issued with full recourse rights. The notes bear interest at rates ranging between 6.0% and 6.9% and expire on various dates ranging from November 2006 to January 2008. The Company has the right to repurchase all unvested shares purchased by the notes at the original exercise price in the event of employee termination. The number of shares subject to this repurchase right decreases as the shares vest under the original option terms, generally over four years. As of December 31, 2000, there were 4,917 shares subject to repurchase. These options were exercised at $0.28 per share.
(c) Stock Option Plans and Employee Stock Purchase Plan
The Company's 1996 Stock Option Plan provides for stock options to be granted to employees, independent contractors, officers, and directors. Options are generally granted at an exercise price which approximates 100% of the estimated fair market value per share at the date of grant, as determined by the Company's Board of Directors. All options are granted at the discretion of the Company's Board of Directors and have a term not greater than 10 years from the date of grant. Options issued generally vest ratably over 4 years, 25% one year after the grant date and the remainder at a rate of 1/36 per month thereafter.
The shareholders approved, on May 19, 2000, the Company's Amended and Restated 1996 Stock Option Plan the number of shares of Common Stock authorized for issuance under the 1996 Stock Option Plan by 3,500,000 shares, and to change the annual evergreen increase by a number of shares equal to the lesser of (i) 2,000,000 shares, (ii) 7% of the then outstanding shares of Common Stock, or (iii) a lesser amount determined by the Board.
The Board of Directors approved, on April 23, 1999, a 1999 Director Option Plan reserving 250,000 shares of common stock for issuance and an amendment and restatement to the 1996 Plan increasing the shares of common stock reserved for issuance by 750,000. The amendment and restatement of the 1996 Plan also provides for the automatic annual increase in the number of shares reserved for issuance under the 1996 Plan on the first day of the Company's fiscal year beginning in 2000 by the lesser of 750,000 shares, 4% of the then outstanding shares of common stock or an amount determined by the Board of Directors.
The Board of Directors also approved, on April 23, 1999, the 1999 Employee Stock Purchase Plan ("ESPP"). The common stock available for sale under the plan shall be 500,000 plus an annual increase to be added on the first day of the Company's fiscal year beginning in 2000 equal to the lesser of (i) 500,000 shares, (ii) 2% of the outstanding shares on such date, or (iii) a lesser amount determined by the Board. Qualified employees may elect to have a certain percentage not to exceed 15% of their salary withheld pursuant to the 1999 Plan. The salary withheld is then used to purchase shares of the Company's common stock at a price equal to 85% of the market value of the stock at the beginning of the 24 month offering period or end of the six-month purchase period, whichever is lower. Under this Plan, 398,650 shares were issued during fiscal 2000 representing approximately $558,000 in employee contributions.
A summary of stock option activity follows:
The Company uses the intrinsic value-based method to account for all its employee stock-based compensation arrangements. The Company has recorded deferred stock-based compensation expense of $0, $715,000 and $892,000 relating to options granted during the years ended December 31, 2000, 1999 and 1998, respectively. These amounts represent the difference between the exercise price and the deemed fair value for financial reporting purposes of the Company's common stock during the periods in which such options were granted. Amortization of deferred stock compensation of $195,000, $763,000 and $353,000 was recognized during the years ended December 31, 2000, 1999 and 1998, respectively.
Information regarding the weighted average remaining contractual life and weighted average exercise price of options outstanding and options exercisable as of December 31, 2000, for selected exercise price ranges is as follows:
The following pro forma information regarding stock-based compensation has been determined as if the Company had accounted for its employee stock options and employee stock purchase plan shares under the fair market value method of SFAS 123. The weighted average fair value of employee stock purchase plan shares issued during 2000 was $1.40. The fair value of these options and employee stock purchase plan shares were estimated at the date of grant using the Black Scholes model with the following weighted
average assumptions: (i) a dividend yield of 0% for all periods; (ii) expected volatility of 141% and 96% for employees and nonemployees for 2000 and 1999, 0% for employees and 135% for nonemployees in 1998; (iii) risk-free interest rate of 5.7% in 2000, 5.0% in 1999, and 5.0% in 1998; (iv) an expected life of three years for employees, a contractual life of ten years for nonemployees and six months for shares issued under the employee stock purchase plan.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options vesting periods. The Company's pro forma information is as follows:
Under SFAS 123, compensation expense representing the fair value of the option grant is recognized over the vesting period. The impact on pro forma net loss may not be representative of compensation expense in future years, when the effect of amortization of multiple awards would be reflected in pro forma earnings.
(d) Warrants
In connection with the Series D Preferred Stock issuance, the Company issued warrants to two investment banking firms to purchase 123,830 shares of Series D Stock with an exercise price of $4.00 per share. The warrants are exercisable any time prior to September 14, 2003 and were valued at approximately $438,000 using the Black-Scholes option pricing model. The fair value of the warrants was deemed to be a direct financing cost associated with the Series D Stock issuance and was accreted to Redeemable Convertible Preferred Stock in 1998 and has been presented as an increase in the net loss applicable to common stockholders in the 1999 and 1998 statement of operations.
In connection with the NBC operating and advertising agreements, the Company issued warrants to purchase 375,000 shares of common stock and 522,223 shares of the Series D Stock. See Note 10--Advertising and Operating Agreements.
All of the warrants associated with the Series D Stock were converted into common stock warrants at a conversion ratio of one Series D Stock warrant to one common stock warrant at the time of the Company's IPO.
In connection with the convertible loan financing, the Company issued warrants to purchase 290,300 shares of common stock with an exercise price of $3.00 per share. The warrants may be exercised at any time prior to the fifth anniversary of the issuance of the warrants, ranging from April 2003 through July 2003. The warrants were valued at approximately $490,000 using the Black- Scholes option pricing model. The fair value of the warrants was deemed to be additional interest expense and charged to Interest Income (Expense), Net in 1998.
The following weighted-average assumptions were used in estimating the fair value of the warrants: (i) dividend yield of 0%; (ii) expected volatility of 135% for 1998 and 126% for 1999; (iii) weighted average risk-free interest rates of approximately 5% in 1998 and 6.0% in 1999; and (iv) contractual life of five years.
During 2000, warrants representing 212,972 shares were exercised and warrants representing 751 shares were cancelled. During 1999, warrants representing 278,560 shares were granted, warrants representing 98,928 shares were exercised, and warrants representing 286,039 shares were cancelled. No warrants were exercised during 1998. As of December 31, 2000, 1999 and 1998, warrants outstanding were 991,223, 1,204,946 and 1,311,353, respectively.
(7) Income Taxes
The reconciliation between the amount computed by applying the U.S. federal statutory tax rate of 34% to the net loss and the actual provision for income taxes for the years ended December 31, 2000, 1999 and 1998, follows (in thousands):
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities as of December 31, 2000 and 1999, are as follows (in thousands):
Management has established a full valuation allowance against its net deferred tax assets because it is more likely than not that sufficient taxable income will not be generated during the carryforward period. The net increase in total valuation allowance for the years ended December 31, 2000, 1999, and 1998 was approximately $13,746,000, $15,180,000, and $6,556,000, respectively.
The Company has net operating loss carryforwards for federal and California income tax purposes of approximately $91,912,000, and $43,420,000, respectively, available to reduce future taxable income subject to income taxes. The net operating loss carryforwards expire in various years from 2011 through 2020 for federal income tax purposes and from 2004 through 2010 for California income tax purposes.
The Company also has research credit carryforwards for federal and California income tax return purposes of approximately $494,000 and $301,000, respectively, available to reduce future income taxes. The federal research credit carryforward expires beginning in 2011 through 2020. The California research credit carryforward can be utilized indefinitely.
The Internal Revenue Code of 1986 and the California Conformity Act of 1987 substantially restrict the ability of a corporation to utilize existing net operating losses and credits in the event of an "ownership change." The issuances of preferred stock have resulted in multiple ownership changes since inception of
the Company. Approximately $16,800,000 of the federal net operating loss carryforward will be subject to an annual limitation in the amount of $1,700,000. Any unused annual limitation can be carried over and added to the succeeding year's annual limitation within the allowable carryforward period. Future changes in ownership may result in additional limitations.
Included in gross deferred tax assets as of December 31, 2000 is approximately $1,443,000 related to stock options and warrants for which the benefit, when realized will be recorded to equity.
(8) Commitments
The Company leases its facilities under operating leases expiring at various dates through March 2009. In October 1999, the Company signed a nine-year three and one-half month lease for a new 56,000 square foot corporate headquarters in Campbell, California, which commenced on December 15, 1999. The Company is required to provide a $2,100,000 letter of credit as security for the lease. Under the lease agreement, the letter of credit may be reduced by $300,000 per year after every twelve months through December 14, 2005 provided no default has occurred. As of December 31, 2000, a $1,800,000 certificate of deposit with a one year maturity was held as collateral by a bank for guarantee of the letter of credit. The certificate of deposit is included in Other Assets.
Rent expense was approximately $2,490,000, $790,000, and $211,000 for the years ended December 31, 2000, 1999, and 1998, respectively.
The following table details the future minimum lease payments under non- cancelable operating leases as of December 31, 2000 on a pro forma basis, showing the impact of lease cancellations in San Francisco, Chicago and New York that have occurred subsequent to December 31, 2000--see Note 16 regarding subsequent events--(in thousands):
(9) Retirement Plan
Effective January 1997, the Company established a qualified 401(k) Plan (the Plan) available to all employees who meet the Plan's eligibility requirements. Participants may elect to contribute a percentage of their compensation to this Plan up to a statutory maximum amount. The Company may make matching contributions to the Plan on a discretionary basis. The Company has not made any contributions to the Plan in 2000, 1999 or 1998.
(10) Advertising and Operating Agreements
Advertising Agreements
The Company entered into three separate agreements with the National Broadcasting Company ("NBC") whereby NBC provided the Company with advertising time and promoted the Company's
services on television, primarily during prime time programs, in exchange for preferred stock and warrants described as follows:
(i) On April 22, 1998, the Company issued 213,675 shares of Series C Redeemable Convertible Preferred Stock ("Series C Stock") at a price of $4.68 per share in exchange for advertising provided by NBC.
(ii) On August 31, 1998, the Company issued 170,940 shares of Series C Stock at a price of $4.68 per share and warrants to purchase 125,000 shares of Series D redeemable convertible preferred stock ("Series D Stock") with an exercise price of $6.00 per share in exchange for advertising spots provided by NBC. The warrant is exercisable at any time prior to August 31, 2003 and was valued at approximately $425,000 using the Black Scholes option pricing model.
(iii) On August 21, 1998, the Company entered into a letter agreement whereby NBC would provide the Company with the use of advertising spots having an aggregate discounted rate card value of $2,400,000 in exchange for 600,000 shares of Series D Stock with a face value of $4.00 per share and warrants to purchase 266,667 shares of Series D Stock with a weighted average exercise price of $8.44 per share. For every $800,000 in advertising, the Company would issue 200,000 shares of Series D Stock and warrants to purchase 41,667, 125,000 and 100,000 shares of Series D Stock in the first, second, and third tranches, respectively. On April 15, 1999, as NBC had not provided any advertising spots pursuant to this agreement, the Board of Directors amended the agreement with NBC to effect the immediate issuances of 600,000 shares of Series D Stock and warrants to purchase 266,667 shares of Series D Stock. The warrants were valued on April 15, 1999 at approximately $1,871,000 using the Black Scholes option pricing model.
On October 30, 1998, the Company entered into an agreement with the New Media and Technology division of Hearst Communications, Inc. ("Hearst") whereby Hearst would provide advertising space to the Company in selected national publications. The advertising has an aggregate discounted rate card value of $3,000,000 and would be provided in exchange for 750,000 shares of Series D. For every $4.00 of print advertising provided by Hearst, the Company would issue one share of Series D Stock. On April 15, 1999, as Hearst had not provided all the advertising pursuant to this agreement, the Board of Directors amended the agreement with Hearst to effect the immediate issuance of 750,000 shares of Series D Stock.
All the warrants and preferred stock issued pursuant to the above are non- cancelable and non-forfeitable. Accordingly, the fair market value of these instruments was measured and fixed on the date of their respective issuance. The total fair value was recorded in Other Assets and is being charged to operations as the advertisements are run. The fair values attributable to the amended NBC and Hearst agreements were based on the fair value of the Series E Redeemable Convertible Preferred Stock issued at $8.00 per share on April 15, 1999. For the years ended December 31, 2000 and 1999, advertising expense related to these agreements of $1,402,208 and $9,198,000, respectively, was recorded to noncash advertising and promotional charges in the statement of operations. As of December 31, 2000 and 1999, the unamortized value attributable to the non- cancelable stock and warrants of $2,171,000 and $3,007,000, respectively, was recorded in Other Assets.
In connection with the Company's IPO, the preferred stock issued in the above arrangements was converted to common stock at their respective ratios. In addition, the warrants are exercisable into shares of common stock, determined based on the respective conversion ratios.
Operating Agreements
During 1998, the Company entered into two operating agreements with NBC Multimedia whereby the Company and NBC Multimedia agreed to jointly produce, market, and promote the Company's online properties and integrate the Company's and NBC Multimedia's Web sites over a period of two to three years. In connection with these agreements, the Company issued preferred stock and warrants to NBC Multimedia as follows:
(i) The Company executed an operating agreement whereby the Company issued a warrant to purchase 375,000 shares of common stock with an exercise price of $4.00 per share. The warrant is exercisable at any time prior to its expiration in April 2003. Pursuant to the original agreement, of the shares issuable upon exercise of the warrants, 50% and 25% are subject to cancellation, if not previously exercised, in the event NBC Multimedia cancelled the agreement for convenience prior to February 25, 1999 and February 25, 2000, respectively. On April 15, 1999, the Board of Directors amended the operating agreement with NBC to effect the immediate issuance of a non-cancelable warrant to purchase 375,000 shares of common stock in exchange for the previous warrant issued to NBC under this agreement. The warrant was initially valued at approximately $630,000 using the Black-Scholes option pricing model.
(ii) The Company executed an operating agreement whereby the Company issued 500,000 shares of Series D Stock valued at $4.00 per share and a warrant to purchase 130,556 shares of Series D Stock with a weighted average exercise price of $7.66 per share. The warrant is exercisable at any time prior to its expiration in August 2003. Pursuant to the original terms, of the shares issuable upon exercise of the warrant, 25% are subject to cancellation, if not previously exercised, in the event NBC multimedia cancelled the agreement for convenience prior to August 2001. On April 15, 1999, the Board of Directors amended the operating agreement with NBC to effect the immediate issuance of a non-cancelable warrant to purchase 130,556 shares of Series D Stock in exchange for and upon cancellation of the previous warrant issued to NBC under this agreement. The warrant was initially valued at approximately $439,000 using the Black-Scholes option pricing model.
In accordance with EITF 96-18, the warrants subject to cancellation were required to be revalued at each balance sheet date based on the current fair value through the date the related cancellation or repurchase rights lapsed. As a result of the amendments described above, the value of the warrants that were initially subject to cancellation was fixed and measured on April 15, 1999 based on the Series E Redeemable Preferred Stock price per share. The fair value of the Series D Stock of $2,000,000 and the fair value of the warrants of $2,179,000 issued in connection with the operating agreements was recorded in Other Assets and is being amortized over the remaining term of the respective operating agreements, which coincides with when the services are received. For the years ended December 31, 2000 and 1999, amortization expense related to these agreements of $986,000 and $1,964,000, respectively, was recorded to noncash advertising and promotional charges in the statement of operations. As of December 31, 2000 and 1999, the unamortized value attributable to the non- cancelable preferred stock and warrants of $567,000 and $1,552,000, respectively, was recorded in Other Assets.
(11) Related Party Transactions
On December 21, 1999, the Company entered into a Series C Preferred Stock Agreement with SocialNet, Inc. ("SocialNet"), a privately held corporation. In accordance with the Series C Preferred Stock Agreement, the Company purchased 1,554,404 shares of Series C Preferred Stock of SocialNet, representing a 7.6% ownership interest in SocialNet, for $3.0 million. The Company accounts for this investment under the cost method. As of December 31, 2000, management determined that the value of this asset was impaired and wrote-off the entire investment as an unrealized loss on minority investment.
The Company recorded $446,000 and $129,000 in revenues for the sale of services to SocialNet in 2000 and 1999, respectively. Accounts receivable from SocialNet were $75,000 and $30,000 at December 31, 2000 and 1999, respectively.
In 2000, 1999 and 1998, the Company recorded revenue totaling $455,000, $569,000 and $92,000, respectively, for the sale of services to various stockholders of the Company. As of December 31, 2000 and 1999, accounts receivable from the stockholders were $124,000 and $192,000, respectively. Accounts payable to stockholders were $23,000 and $22,000 at December 31, 2000 and 1999, respectively.
(12) Network Participants
As of December 31, 2000, the Company's community included approximately 35 network participants with whom it produces co-branded versions of Talk City for over 50 Internet sites. The network participants consist of three types of companies: major media, Internet service providers and Internet content. Through its network participants, the Company receives user volume driven by the network participants. The volume is considered to be "driven" by a network participant if the user comes to the Company's site via a participant's site. For the year ended December 31, 2000, approximately 22% of the Company's advertising and sponsorship revenues were based on volume driven by its network participants. During this period, one network participant was responsible for approximately 14% of the Company's advertising and sponsorship revenue. If the Company were to terminate or otherwise lose the benefit of its network participants, the Company could be at risk of being unable to replace the network participant's volume and associated advertising and sponsorship revenues which could have a negative impact on the Company's operating results.
(13) Restructuring Charges
In June 2000, the Company underwent a restructuring of operations to more clearly focus Talk City as an online marketing services provider. As a result of the this restructuring, the Company reduced its total headcount by 35 employees, or approximately 15% of its total workforce. In December 2000, the Company underwent a separate restructuring to further align the Company on selling and implementing fee-based services. As a result of the December restructuring, the Company reduced its total headcount by 55 employees, or 30% of the total workforce. The Statement of Operations for the period ended December 31, 2000 includes a charge of approximately $1,237,000, related to these restructurings. Such amount consists of approximately $1,058,000 for employee severance and other related costs and $179,000 for the markdown of inventory. Substantially all liabilities related to these restructurings were paid as of December 31, 2000.
(14) Quarterly Results of Operations (Unaudited)
The following unaudited table presents certain statement of operations data for our eight most recent quarters ended December 31, 2000. In management's opinion, this unaudited information has been prepared on the same basis as the audited annual financial statements and includes all adjustments, consisting only of normal recurring adjustments, necessary for fair presentation of the unaudited information for the quarters presented. This information should be read in conjunction with our financial statements, including the notes thereto, included elsewhere herein. The results of operations for any quarter are not necessarily indicative of results that may be expected for any future periods.
(15) Liquidity
The Company's financial statements have been prepared assuming that the Company will continue as a going concern. Since inception, the Company's recurring net losses, cash used in operating activities and accumulated deficit require the Company to obtain additional cash to sustain its operations throughout 2001. The Company presently has not secured future funding commitments but is currently in discussions with third parties to obtain additional funding. At this time, however, no formal agreements have been finalized. Recovery of the carrying amounts of certain assets, including property, equipment and goodwill, is dependent on obtaining additional capital.
(16) Subsequent Events
Through March, 2001, the Company entered into definitive agreements with various lessors to terminate the operating lease agreements for the office space in Chicago, San Francisco and one suite in New York City. As a result of these terminations, the Company's obligations under non-cancelable operating leases were reduced by approximately $1.0 million.
On March 16, 2001, the Company announced a further restructuring to recognize changes in the economic environment and complete its transition to a 100% fee- based marketing services model. The restructuring included a reduction in workforce of approximately 40 people or 30% of the total workforce. This step, along with other cost cutting measures, are expected to significantly reduce operating expenses in 2001. The Company expects to record an additional restructuring charge of approximately $225,000 in the March 31, 2001 quarter.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
We will furnish to the Securities and Exchange Commission a definitive Proxy Statement (the "Proxy Statement") not later than 120 days after the close of the fiscal year ended December 31, 2000. The information required by this item is incorporated herein by reference to the Proxy Statement.
Item 11.
Item 11. Executive Compensation
The information required by this item is incorporated herein by reference to the Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this item is incorporated herein by reference to the Proxy Statement.
Item 13.
Item 13. Certain Relationships and Related Transactions
The information required by this item is incorporated herein by reference to the Proxy Statement.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K
Item 14a. List of Documents
1. Financial Statements
The financial statements of the Company as set forth under Item 8 of this Annual Report on Form 10-K on are presented herein at the pages noted.
2. Financial Statement Schedules.
The financial statement schedule for the years ended December 31, 2000, 1999 and 1998 is presented following the exhibits attached hereto and should be read in conjunction with the financial statements of Talk City, Inc. filed as part of this Annual Report on Form 10-K.
3. Exhibits.
The exhibits set forth below, and listed on the accompanying index to exhibits, are filed as part of, or incorporated by reference into, this Annual Report on Form 10-K.
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Item 14b. Reports on Form 8-K.
On December 5, 2000, the Company filed a Report on Form 8-K on which it disclosed: (i) the resignation of John Sculley from the Board of Directors, and (ii) the receipt of correspondence from the Nasdaq Stock Market, Inc. regarding the potential delisting of the Company's shares from the Nasdaq National Market.
On February 12, 2001, the Company filed a Report on Form 8-K disclosing the resignation of Thomas P. Hirschfeld and Joseph A. Graziano from the Board of Directors, effective January 1, 2001.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in Santa Clara, State of California, on the Second day of April, 2001.
TALK CITY ---------
By: /s/ Peter Friedman ------------------- Name: Peter Friedman Title: Chief Executive Officer and Chairman of the Board
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints Peter H. Friedman and V. David Watkins each of them acting individually, as his attorneys-in-fact, each with full power of substitution, for him in any and all capacities, to sign any and all amendments to this report, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming our signatures as they may be signed by our said attorney to any and all amendments said report.
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act, this report has been signed by the following persons in the capacities and on the dates indicated:
Item 14c. Exhibits
EXHIBIT INDEX
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Item 14d. Financial Statement Schedule.
The following financial statement schedule for the years ended December 31, 2000, 1999 and 1998 should be read in conjunction with the financial statements of Talk City, Inc. filed as part of this Annual Report on Form 10-K.
Schedule II - Valuation and Qualifying Accounts
(1) Charges to revenue, net (2) Uncollectible accounts written off, net of recoveries