Talk America Holdings, Inc.

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Talk America Holdings, Inc.

12020 Sunrise Valley Drive, Suite 250
Reston, Virginia 20191
U.S.A.
Telephone: (703) 391-7500
Fax: (703) 391-7525
Web site: http://www.talk.com

Public Company
Incorporated: 1989 as Tel-Save Inc.
Employees: 1,300
Sales: $382.7 million (2003)
Stock Exchanges: NASDAQ
Ticker Symbol: TALK
NAIC: 517110 Wired Telecommunications Carriers; 517910 Other Telecommunications

Talk America Holdings, Inc., sells local and long-distance telephone services in 25 states, primarily in Georgia, Louisiana, Michigan, Pennsylvania, Ohio, and Texas. In a business climate of falling long-distance rates, Talk America has transformed itself from a reseller of long-distance to a provider of facilities-based long-distance services to a bundler of local and long-distance services. The company carries most of the traffic on its own network of switches and other owned or leased facilities. Talk America also has grown through using the Internet as its principal marketing tool, attributing much of its subscriber base to a former promotional marketing agreement with America Online, Inc., which was terminated in 2001.

Origins

Talk America was originally founded in 1989 under the name Tel-Save Inc. by former cable construction veteran Daniel Borislow to resell AT&T long-distance services. Within several years, Tel-Save became one of AT&T's largest wholesalers, offering steep discounts on selected services for companies with dedicated and switched access. In 1994, company president Borislow and ten Tel-Save employees became ensnared in a scandal involving illegal campaign contributions to U.S. Congressman Jim Greenwood. Each had donated $1,000 to Greenwood's campaign committee on the same day, raising the specter that Borislow was trying to buy influence from Greenwood, who sat on a powerful House committee that oversaw regulations governing the contentious telecommunications industry. After a probe by the Federal Election Commission (FEC), the eleven Tel-Save associates agreed to pay a $30,000 civil penalty for illegal campaign contributions. The FEC concluded that Borislow knowingly and willfully violated federal campaign law by laundering a corporate contribution through individuals.

A Name Change and an Innovative Marketing Deal

In 1995, the company went public, changing its name to Tel-Save Holdings. By this time, the company was providing long-distance telecommunications services to more than 215,000 small and medium-sized businesses located throughout the United States. Most of Tel-Save's success relied on riding the coat tails of AT&T, which under the 1984 consent decree was mandated to provide other companies "equal access" to its long-distance facilities. With the Federal Communications Commission (FCC) considering rewriting the regulations governing the telecommunications industry in 1996, Tel-Save sought to position itself as a viable competitive enterprise in case the equal access rule was eliminated. The firm planned on using its offering proceeds to buy or lease switching and transmission equipment from AT&T to cut costs and offer steeper discounts under its One Better Network name.

Upon starting its own network, Tel-Save Holdings needed new subscribers for its long distance services, a prospect it found tougher than expected. As a result, in January 1997 the 36-year old Borislow approached top executives at America Online's headquarters in Dulles, Virginia, with an innovative marketing plan and a $50 million check. Borislow's approach proved to be impeccable timing for the ailing AOL, which was on the verge of ruin. The switch to flat-price billing weeks earlier resulted in constant busy signals for subscribers, generating class action suits, intense media criticism, and attempts by competitors to pick up disgruntled customers. AOL promised $350 million in network upgrades to keep its subscribers, but it was forced temporarily to reduce its marketing and advertising over concern it could not accommodate new customers. AOL needed cash and favorable press. Tel-Save could provide both, leading AOL executives to gamble on Borislow's offer. As a result, Borislow wrote a new check for $100 million to launch the new business in December 1997.

Borislow's plan included billing customers directly online via credit card, eliminating paper, postage, and check cashing costs. With its $100 million, Tel-Save received exclusive rights to sell long-distance phone service to AOL's 14-million customers and got top status among AOL's advertisers. Through its marketing alliance with AOL, Tel-Save attracted 500,000 new long-distance customers in less than four months. AOL saw advantages in the deal as a way of advertising the cheapest long distance service, conveniently billed, and serving as an impressive retention tool for millions of its customers. The simple billing idea that allowed AOL users to view and pay phone bills online stunned the entire industry with its cost efficiencies, leading AT&T, MCI, and others to offer similar services to their own Internet customers. The deal with AOL also attracted potential buyers looking to acquire Borislow's company. Although Wall Street estimated the company's worth at $1.2 billion, Borislow ran Tel-Save as a stripped down operation with only one assistant and shared a bullpen office with six of the company's 235 employees, including his president and chief financial officer.

Reorganization and Two More Name Changes

In July 1997, Tel-Save agreed to acquire Share Technologies Fairchild Inc., the largest U.S. provider of shared telecommunication services, for $511 million, or $11.25 per share. Tel-Share founder and chief executive officer Dan Borislow viewed the transaction as catapulting the company into the local exchange business with over 110,000 local access lines and creating a full-service, facilities-oriented telecommunications provider with local operations in 28 major markets nationwide. With the deal, Tel-Save also would get 475 buildings, 1,200 employees, and half a million customers. In November 1997, however, Intermedia Communications Inc. made a surprise bid of $366 million in cash and a $274 million assumption of debt for Shared Technologies, topping Tel-Save's friendly offer. Intermedia's bid broke up the Share Technologies' planned merger with Tel-Save two weeks away from closing. Tel-Save elected not to make a counteroffer, subsequently collecting $237.3 million in breakup fees from Intermedia. However, one month later, in December 1997, Tel-Save signed a definitive agreement to acquire Symetrics Industries, Inc., a diversified electronics company that served both the defense and telecommunications industries. The agreement provided that Tel-Save acquire all of the outstanding shares of Symetrics for $15 per share.

In 1998, the company changed its name to Tel-Save.com, Inc. and named Gabriel Battista as chairman, chief executive officer, and president. Prior to joining Tel-Save, Battista was chief executive officer of Network Solutions, Inc., an e-commerce company whose stock was one of the top performing Internet issues in 1998. Battista took over the company's reins at a time when its future appeared to be dimming. Borislow's innovative AOL deal that promised windfall profits proved to be only a limited success. Although Tel-Save attracted 1.8 million customers, recruiting them was expensive. The company's earnings also plunged, causing its stock to drop from $27 in February 1998 to $5 3/16 in October. Borislow's pronouncements about offering the company for sale, and then changing his mind, contributed to Tel-Save becoming one of Wall Street's most controversial telecom stocks. With its prospects waning, Tel-Save's board of directors recruited Gabriel Battista to give the company new direction.

Under Battista's leadership, Tel-Save.com, Inc. changed its name to Talk.com in April 1999 to emphasize the company's new beginning as a hub for online and offline communications. Talk.com said it would continue to offer long-distance services on the Internet and provide such features as real-time call detail, various sorting capabilities, downloads, and interactive customer service. Battista also recruited a new senior management team to complete the company's turnaround as the leader in leveraging the power of the Internet to bill, service, and market telecom services. Its marketing agreement with AOL having broken new ground for Internet use, Talk.com worked to further its leadership position through marketing partnerships with other top Internet service providers, including Prodigy, Wired Digital, and Compuserve.

Entry into the Local Phone Market and Another Name Change

In October 1999, Talk.com said it would also begin providing local phone service to small and medium-sized businesses nationwide. With this aim in mind, in March 2000 Talk.com announced a merger agreement with Access One Communications, a privately held local telephone company that provided service in nine southeastern states, in a stock deal valued at $208 million. The company anticipated the merger to propel it into the new, emerging local services market and considerably expand its geographical reach. With the acquisition of Access One, which posted 1999 revenues of $50 million, Talk.com would get 55,000 local-service customers in Bell South territory, as well as have the capacity to offer local service to its already 300,000 long-distance customers in the region. The acquisition would provide little business overlap, since most of Access One's customers were small businesses, while Talk.com's customers were largely residential. With the conclusion of the acquisition in August 2000, Ken Baritz, former chief executive officer of Access One, became president of Talk.com. Gabriel Battista remained as chairman and chief executive officer. As a result of repositioning itself in the local telephone market, Talk.com began a more aggressive strategy of selling a bundled package of telecommunications services that included local, long-distance, and Internet services along with building more brand name awareness to acquire more customers.

Company Perspectives:

Talk America is a leading integrated communications service provider with programs designed to benefit the residential and small business markets. Talk America has a state-of-the-art telecommunications network, and real-time online billing platform and provides savings to its customer base.

Separately, Talk.com announced an agreement with Soros Private Equity to invest $80 million in the company for 80,000 shares of 7 percent convertible preferred Talk.com stock and warrants for 200,000 shares of the company's common stock at $17.91 per share. As part of the agreement, a partner of Soros Private Equity would join Talk.com's board of directors. Talk.com planned to use the investment proceeds for working capital and other corporate operations.

In April 2001, chairman and chief executive officer Gabriel Battista announced another name change for the local and long-distance service provider to Talk America Holdings, Inc. to better reflect its coast-to-coast reach. The company had recently expanded its network of bundled telecommunications services to California, establishing a presence in 13 states.

Legal and Financial Turbulence

Talk America's more aggressive marketing campaign, however, led regulators in ten states to begin making inquiries and launch legal proceedings against the company after receiving thousands of consumer complaints for "slamming," or switching phone service without consent, and overcharging for service. The complaints also prompted the Federal Communications Commission to initiate an investigation of Talk America's business practices and marketing activities. Despite denying the charges, one state had already fined Talk America, which lost $61.8 million in 2000 on revenue of $544.5 million. In Florida, regulators received 1,200 complaints, while consumers lodged 300 complaints in Tennessee, 554 in Georgia, 260 in North Carolina, 200 in Mississippi, 139 in Alabama, and 171 in Pennsylvania. In August 2001, the California Public Utilities Commission began its own investigation of the company for allegedly switching customers' phone service without their consent and billing them for services they never approved. Talk America also came under scrutiny for millions of promotional checks it sent to customers of other local and long-distance phone companies. When people cashed the checks, Talk America switched their service. Although the tactic was not illegal, regulators criticized the company for failing to make clear the terms of the promotional offer. As a result of the multi-state investigations and litigation, Talk America paid cash settlements in several states with the added requirement that it clean up its customer base.

With the steep telecommunications downturn, and under mandated requirements to clean up its customer base, in August 2001 Talk America reported a second-quarter loss 62 times greater than its first-quarter deficit. The company lost $62.7 million compared to $891,000 for the same quarter in 2000. The company's marketing agreement with AOL was also terminated. By August 2002, however, Talk America was turning a surprise profit at a time when other telecommunications firms were going bankrupt. The company managed to repair its finances by twice restructuring its debt. The debt restructuring plan came after the company's share price collapsed from a high of $30 in February 1998 to $0.33 a share in the fourth quarter of 2001 as investors fled over concerns of the company's high debt load and troubles with its local telephone service. By pushing out 95 percent of its immediate debt obligations to the year 2007 and negotiating a restructuring deal with MCG Finance Corp. and its largest shareholder and creditor, AOL Time Warner Inc., Talk America managed to show a profit amidst the greater telecommunications collapse. As a result, Talk America's stock rose an extraordinary 500 percent.

Part of the company's success stemmed from selling local phone service by leasing lines from the Baby Bells at very attractive prices, putting it at a competitive advantage to take local market share. Like AT&T and WorldCom Inc.'s MCI Group, Talk America and others also were expanding their use of leased land lines to compete with the Bells in various states. With the Bells mandated to provide all the connection services, competing carriers needed to invest little capital to add lines beyond state-required leasing charges. In this way, Talk America and other carriers could add thousands of new lines each month at minimal expense. The company already had 244,000 lines by the end of the second quarter of 2002 with plans to have eventually two to four million in service. With each line earning between $40 and $60 in monthly revenue, Talk America had the potential to make billions in annual sales. Nonetheless, the company had plenty of skeptics who believed Talk America was too dependent on the FCC and noted that the Baby Bells were responding to competition by offering bundled services similar to Talk America's with fewer subscribers leaving. Nevertheless, the company was succeeding in a difficult environment amidst the telecom downturn, posting five consecutive quarters of sales growth and seven quarters of profits by July 2003.

Key Dates:

1989:: Tel-Save, Inc. is founded.
1995:: The company goes public and changes its name to Tel-Save Holdings, Inc.
1997:: The company launches a major marketing agreement with America Online.
1998:: The company changes its name to Tel-Save.com, Inc.
1998:: Founder Daniel Borislow leaves the company and is replaced by Gabriel Battista.
2000:: The company acquires Access One Communications.
2001:: The company changes its name to Talk America Holdings, Inc.
2002:: Talk America restructures its debt.
2003:: Talk America signs a deal with Kingdom Ventures, Inc., a rapidly growing church development company, to market telecommunications services to faith-based organizations and their members.

Surviving in a New Telecom Environment

In July 2003, Talk America and Kingdom Ventures, Inc., a rapidly growing church development company, signed a deal enabling Kingdom Ventures to market telecommunications services to faith-based organizations and their members. With continued growth in its bundled customer base, Talk America reported second quarter 2004 revenue of $114.9 million, up 23 percent over second quarter revenue in 2003. Second quarter highlights also included the launch of dial-up Internet service to existing customers, plans to offer broadband service, a cash balance that exceeded total debt by $9.9 million, and the addition of 49,000 bundled service customers, which spurred strong revenue growth. However, the company was dealt a heavy blow when new FCC regulations resulted in its losing access to the Baby Bells' local networks at attractive prices, causing some investors to jettison its stock. Investor concerns over this reversal evaporated after the company posted solid third quarter results, reporting a 21 percent increase in revenue to $120.5 million. With the close of 2004, Talk America had weathered the worst of the telecom downturn, offering new bundled services to an expanding customer base nationwide. As a result, Talk America could look forward to further positioning itself to take advantage of a recovering telecommunications market.