Washington, D.C. 20549

[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

[ ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

(Exact name of registrant as specified in its charter)

Delaware (State of incorporation)

23-2827736 (I.R.S. Employer Identification No.)

12020 Sunrise Valley Drive, Suite 250, Reston, Virginia (Address of principal executive offices)

20191 (Zip Code)

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes X No____ 

       Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

Yes X No____

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

26,978,275 shares of Common Stock, par value of $0.01 per share, were issued and outstanding as of November 2, 2004.

Talk America Holdings, Inc. is filing this Amendment No. 1 on Form 10-Q/A (“Amendment No. 1”) to our Quarterly Report on Form 10-Q originally filed with the Securities and Exchange Commission on November 9, 2004, for the purpose of restating our consolidated financial statements for the quarters ended September 30, 2004 and 2003 to reflect corrections of the following errors:

The quarterly results for the four quarters of 2003 and for the first three quarters of 2004 have been adjusted to reflect the restatement of our previously reported consolidated financial statements for those periods and for the year ended December 31, 2003 as detailed below.

We have revised our consolidated financial statements for these periods to correct for the following errors:

(a)  Due to a classification error in our general ledger, we incorrectly recorded certain customer fee revenues as sales, use and excise tax liability to the consolidated balance sheets for the four quarters of 2003, for the year ended December 31, 2003 and for the first three quarters of 2004. These customer fee revenues were $0.4 million for the third quarter of 2004, $0.2 million for the third quarter of 2003, $1.0 million for the nine months ended September 30, 2004, $0.7 million for the nine months ended September 30, 2003, and an aggregate of $1.0 million for the full year 2003. These customer fees have now been appropriately recorded to revenues in the consolidated statement of operations for the year ended December 31, 2003 and in the unaudited quarterly periods for the first three quarters 2004 and 2003;

(b) We determined that in our calculations of earnings per share since the third quarter of 2003 we had not incorporated the tax benefits associated with the assumed exercise of employee stock options. As a result, fully diluted shares outstanding were over-reported and income per fully diluted share was understated in the periods subsequent to third quarter 2003; and

(c) We identified errors in the computation of the deferred tax assets recognized in the third quarter of 2003 as follows: (i) failure to deduct state income tax expense from federal taxable income resulted in the deferred tax benefit as originally reported for the year ended December 31, 2003 and the unaudited third quarter 2003 being understated by $0.9 million and (ii) failure to complete the appropriately detailed analysis of our deferred tax assets relating to state net operating loss carryforwards resulted in the deferred tax benefit as originally reported for the year ended December 31, 2003 and the unaudited third quarter 2003 being understated by $1.7 million. In February 2005, we determined that we improperly corrected for the errors in the deferred tax computations through an adjustment to the effective tax rate for 2004 rather than through the restatement of our prior period financial statements. As a result, we have restated the first three quarters of 2004 and the third and fourth quarter of 2003 and year end December 31, 2003.

(d) In connection with the release of the valuation allowance in the third quarter 2003, $6.5 million of deferred tax assets associated with acquired net operating loss carryforwards were realizable and should have been recorded as a deferred tax asset. Originally, we believed this deferred tax asset was limited due to provisions of the Internal Revenue Code Section 382. This error resulted in deferred tax assets being understated and goodwill being overstated in each of the periods beginning in the third quarter 2003. As a result, we have restated the first three quarters of 2004 and the third and fourth quarter of 2003 and year end December 31, 2003.

The effect of these items are reflected in our consolidated financial statements contained in Item 1 of this Amendment, with corresponding changes reflected in Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 4, Controls and Procedures. The effect of these items on our consolidated statement of operations for the four quarters of 2003, the year ended December 31, 2003 and for the first three quarters of 2004 is summarized in the following table.

 

 

 

 

 

The consolidated balance sheets for the third quarters of 2004 and 2003 as originally reported have been restated as follows (in thousands):

*  Certain amounts reflected herein for 2003 have been reclassified to reflect the 2004 presentation.

Unless otherwise expressly stated, this Amendment No. 1 does not reflect events occurring after the filing on November 9, 2004 of our Quarterly Report on Form 10-Q for the period ended September 30, 2004, nor does it modify or update in any way disclosures contained in our Form 10-Q other than to reflect the restatement discussed above.

 

 

 

 

	Page
PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Statements of Operations - Three and Nine Months Ended September 30, 2004 (restated) and 2003 (restated) (unaudited)	2
Consolidated Balance Sheets - September 30, 2004 ( restated), December 31, 2003 (restated), and September 30, 2003 (restated) (unaudited)	3
Consolidated Statements of Stockholders' Equity - Nine Months Ended September 30, 2004 (restated) (unaudited)	4
Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2004 (restated) and 2003 (restated) (unaudited)	5
Notes to Consolidated Financial Statements (unaudited)	6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 4. Controls and Procedures	27
PART II - OTHER INFORMATION	29
Item 6. Exhibits

 

 

			Three Months Ended September, 30							Nine Months Ended September 30,
			2004 (restated)			2003 (restated)				2004 (restated)			2003 (restated)
Revenue		$	120,929		$	100,178			$	345,761		$	282,286
Costs and expenses:
Network and line costs, excluding depreciation and amortization (see below)			60,251			46,033				170,057			133,185
General and administrative expenses			15,934			14,236				46,987			39,664
Provision for doubtful accounts			5,728			3,444				14,054			8,561
Sales and marketing expenses			19,318			14,146				55,806			35,146
Depreciation and amortization			5,442			4,450				15,895			13,138
Total costs and expenses			106,673			82,309				302,799			229,694
Operating income			14,256			17,869				42,962			52,592
Other income (expense):
Interest income			61			42				204			337
Interest expense			561			(1,560)				(698)			(6,066)
Other income, net			--			4				--			2,469
Income before provision for income taxes			14,878			16,355				42,468			49,332
Provision (benefit) for income taxes			5,867			(37,747)				16,747			(24,884)
Net income		$	9,011		$	54,102			$	25,721		$	74,216
Income per share - Basic:
Net income per share		$	0.33		$	2.05			$	0.96		$	2.82
Weighted average common shares outstanding			26,974			26,367				26,799			26,325
Income per share - Diluted:		$	0.32		$	1.88			$	0.92		$	2.55
Net income per share
Weighted average common and common equivalent shares outstanding			27,737			28,877				27,854			29,337

 

See accompanying notes to consolidated financial statements.

			September 30, 2004 (restated)			December 31, 2003 (restated)			September 30, 2003 (restated)
Assets
Current assets:
Cash and cash equivalents		$	29,354		$	35,242		$	35,132
Accounts receivable, trade (net of allowance for uncollectible accounts of $14,304, $9,414, and $9,483 at September 30, 2004, December 31, 2003, and September 30, 2003, respectively)			48,876			40,321			36,777
Deferred income taxes			27,723			24,605			24,605
Prepaid expenses and other current assets			7,967			5,427			5,680
Total current assets			113,920			105,595			102,194
Property and equipment, net			66,643			68,069			65,860
Goodwill			13,013			13,013			13,013
Intangibles, net			2,533			4,666			5,245
Deferred income taxes			32,598			48,288			51,725
Other assets			8,499			7,547			7,488
		$	237,206		$	247,178		$	245,525
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable		$	43,678		$	35,296		$	35,707
Sales, use and excise taxes			12,544			13,521			13,037
Deferred revenue			15,588			10,873			9,797
Current portion of long-term debt			3,188			16,806			42
Accrued compensation			4,658			9,888			7,913
Other current liabilities			5,067			6,851			5,237
Total current liabilities			84,723			93,235			71,733
Long-term debt			2,352			31,791			59,485
Deferred income taxes			19,910			19,009			20,182
Commitments and contingencies
Stockholders' equity:
Preferred stock - $.01 par value, 5,000,000 shares authorized; no shares outstanding			--			--			--
Common stock - $.01 par value, 100,000,000 shares authorized; 26,976,075 and 26,662,952, and 26,406,864, issued and outstanding at September 30, 2004, December 31, 2003 and September 30, 2004, respectively			283			280			277
Additional paid-in capital			356,201			354,847			353,433
Accumulated deficit			(221,263	)		(246,984	)		(254,585	)
Treasury stock - $.01 par value, 1,315,789 shares at September 30, 2004 and December 31, 2003 and September 30, 2003, respectively			(5,000	)		(5,000	)		(5,000	)
Total stockholders' equity			130,221			103,143			94,125
		$	237,206		$	247,178		$	245,525

See accompanying notes to consolidated financial statements.

 

								Additional
		Common Stock						Paid-In			Accumulated			Treasury Stock
		Shares			Amount			Capital			Deficit			Shares			Amount			Total
Balances, December 31, 2003 (restated)			27,979		$	280		$	354,847		$	(246,984	)		1,316		$	(5,000	)	$	103,143
Net income (restated)			--			--			--			25,721			--			--			25,721
Income tax benefit related to exercise of common stock options			--			--			784			--			--			--			784
Change in terms of employee stock options			--			--			9			--			--			--			9
Exercise of common stock options			313			3			561			--			--			--			564
Balances, September 30, 2004 (restated)			28,292		$	283		$	356,201		$	(221,263	)		1,316		$	(5,000	)	$	130,221

See accompanying notes to consolidated financial statements.

		Nine Months Ended September 30,
			2004 (restated)			2003 (restated)
Cash flows from operating activities:
Net income		$	25,721		$	74,216
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for doubtful accounts			14,054			8,561
Depreciation and amortization			15,895			13,138
Loss on sale and retirement of assets			--			16
Non-cash compensation			9			--
Non-cash interest and amortization of accrued interest liabilities			(956	)		(195	)
Gain from extinguishment of debt			--			(2,476	)
Deferred income taxes			14,257			(26,665	)
Changes in assets and liabilities:
Accounts receivable, trade			(22,609	)		(17,495	)
Prepaid expenses and other current assets			(1,979	)		(1,786	)
Other assets			(17	)		1,404
Accounts payable			8,382			3,555
Sales, use and excise taxes			(977	)		1,598
Deferred revenue			4,715			3,317
Accrued compensation			(5,230	)		2,304
Other current liabilities			(1,784	)		(3,776	)
Net cash provided by operating activities			49,481			55,716
Cash flows from investing activities:
Capital expenditures			(8,053	)		(9,166	)
Capitalized software development costs			(2,673	)		(2,038	)
Net cash used in investing activities			(10,726	)		(11,204	)
Cash flows from financing activities:
Payments of borrowings			(44,258	)		(38,672	)
Payments of capital lease obligations			(949	)		(46	)
Proceeds from exercise of options			564			750
Purchase of treasury stock			--			(5,000	)
Net cash used in financing activities			(44,643	)		(42,968	)
Net increase (decrease) in cash and cash equivalents			(5,888	)		1,544
Cash and cash equivalents, beginning of period			35,242			33,588
Cash and cash equivalents, end of period		$	29,354		$	35,132

See accompanying notes to consolidated financial statements.

The consolidated financial statements include the accounts of Talk America Holdings, Inc. and its wholly-owned subsidiaries (collectively, "Talk America," "we," "our" and "us"). All intercompany balances and transactions have been eliminated.

The consolidated financial statements and related notes thereto as of September 30, 2004 and for the three and nine months ended September 30, 2004 and September 30, 2003 are presented as unaudited, but in the opinion of management include all adjustments necessary to present fairly the information set forth therein. The consolidated balance sheet information for December 31, 2003 was derived from the audited financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2003, filed March 12, 2004, as amended by our Form 10-K/A filed May 7, 2004, as restated by our Form 10-K/A Amendment No. 2 filed March 28, 20005. These interim financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2003, as amended by our Form 10-K/A, as restated by our Form 10-K/A Amendment No. 2. The interim results are not necessarily indicative of the results for any future periods. Certain prior year amounts have been reclassified for comparative purposes.

Future results of operations involve a number of risks and uncertainties. Factors that would likely negatively affect future operating results and cash flows and cause actual results to vary materially from historical results include, but are not limited to:

• Dependence on the availability and functionality of the networks of the incumbent local telephone carriers as they relate to the unbundled network element platform.
• Outcomes unfavorable to us of the FCC’s rule-making process and of pending litigation with regard to the availability and pricing of various network elements and bundles thereof.
• Additional changes in government policy, regulation and enforcement or adverse judicial or administrative interpretations and rulings or legislative action relating to regulations, enforcement and pricing.
• Increased price competition in telecommunication services, including bundled services of local and long distance
• Unanticipated delays, costs and technical difficulties in developing, deploying and operating our own local networking capability, including our potential inability to acquire and successfully utilize certain of those technologies that will permit us to reduce our reliance on the incumbent local telephone companies and profitably provide local telephone services through new methods of delivery.

Further negative developments in these areas would likely have a material adverse effect on our business prospects, financial condition and results of operations.

 

 

 

 

The following is a summary of our debt and capital lease obligations (in thousands):

			September 30, 2004			December 31, 2003			September 30, 2003
8% Secured Convertible Notes Due 2006		$	--		$	--		$	12,452
12% Senior Subordinated Notes Due 2007			--			40,730			42,520
8% Convertible Senior Subordinated Notes Due 2007 (1)			--			3,778			3,843
5% Convertible Subordinated Notes Due 2004			670			670			670
Other, primarily vendor-financed computer software			2,401			--			--
Capital lease obligations			2,469			3,419			42
Total long-term debt and capital lease obligations			5,540			48,597			59,527
Less: current maturities			3,188			16,806			42
Total long-term debt and capital lease obligations, excluding current maturities		$	2,352		$	31,791		$	59,485

(1) Includes future accrued interest of $1.0 million as of December 31, 2003.

(a)  12% Senior Subordinated Notes Due 2007 and 8% Convertible Senior Subordinated Notes Due 2007

On August 23, 2004, we redeemed the remaining principal amounts of our 12% Senior Subordinated Notes and our 8% Convertible Senior Subordinated Notes. The redemption of the 8% Convertible Senior Subordinated Notes prior to maturity resulted in recording $0.8 million of future accrued interest benefit as an offset to interest expense.

(b)  5% Convertible Subordinated Notes Due 2004

 

As of September 30, 2004, we had $0.7 million principal amount outstanding of our 5% Convertible Subordinated Notes that mature on December 15, 2004. The notes are convertible, at the option of the holder, at a conversion price of $76.14 per share. The 5% Convertible Subordinated Notes are redeemable, in whole or in part at our option, at 100.71% of par.

(c)  Other

In 2004, we entered into a vendor-financed computer software purchase agreement for upgrades to our database management systems. Approximately $2.4 million was outstanding under this agreement at September 30, 2004. Total assets under this purchase agreement are approximately $2.9 million as of September 30, 2004, consisting of a perpetual software license agreement of approximately $2.5 million and a one-year vendor maintenance agreement of approximately $0.4 million. The agreement is repayable in 12 quarterly installments through March 2007, which includes interest based on an annual percentage rate of approximately 3% and annual maintenance agreement renewals.

(d)  Capital Leases

During 2003, we entered into a non-cancelable capital lease agreement for upgrades to our customer data storage equipment. Total debt of approximately $2.5 million and $3.4 million was outstanding under this agreement at September 30, 2004 and December 31, 2003, respectively. Total assets, net of accumulated depreciation, under this lease agreement are approximately $2.8 million and $3.4 million as of September 30, 2004 and December 31, 2003, respectively. The lease is repayable in monthly installments through December 2006, which includes interest based on an annual percentage rate of approximately 2%.

 

 

We are party to a number of legal actions and proceedings arising from our provision and marketing of telecommunications services (including matters involving do not call regulations), as well as certain legal actions and regulatory matters arising in the ordinary course of business. During the first quarter of 2003, we were made aware that AOL agreed to settle a class action case for approximately $10 million; the claims in the case allegedly relate to marketing activities conducted pursuant to the former telecommunications marketing agreement, between us and AOL. At the time of the settlement agreement, AOL asserted that we are required to indemnify AOL in this matter under the terms of the marketing agreement and advised that it will seek such indemnification from us. We believe that we do not have an obligation to indemnify AOL in this matter and that any claim by AOL for this indemnification would be without merit. We have received no further information regarding this matter and it is our intention, if AOL initiates a claim for indemnification under the marketing agreement, to defend against the claim vigorously. We believe that the ultimate outcome of the foregoing actions will not result in a liability that would have a material adverse effect on our financial condition or results of operations.

In December 2003, we entered into a new four-year master carrier agreement with AT&T. The agreement provides us with a variety of services, including transmission facilities to connect our network switches as well as services for international calls, local traffic, international calling cards, overflow traffic and operator assisted calls. The agreement also provides that, subject to certain terms and conditions, we will purchase these services exclusively from AT&T during the term of the agreement, provided, however, that we are not obligated to purchase exclusively in certain cases, including if such purchases would result in a breach of any contract with another carrier that was in place when we entered into the AT&T agreement, or if vendor diversity is required. Certain of our network service agreements, including the AT&T agreement, contain certain minimum usage commitments. Our contract with AT&T establishes pricing and provides for annual minimum commitments based upon usage as follows: 2004 - $25 million, 2005 - $32 million, 2006 - $32 million and 2007 - $32 million and obligates us to pay 65 percent of the revenue shortfall, if any. A separate contract with a different vendor establishes pricing and provides for annual minimum payments for 2004 of $3.0 million. While we anticipate that we will not be required to make any shortfall payments under these contracts as a result of the restructuring of these obligations, there can be no assurances that we will be successful in our efforts. To the extent that we are unable to meet these minimum commitments, our costs of purchasing the services under the agreement will correspondingly increase.

 

We account for our stock option awards under the intrinsic value based method of accounting prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations, including FASB Interpretation No. 44 "Accounting for Certain Transactions Including Stock Compensation," an interpretation of APB Opinion No. 25. Under the intrinsic value based method, compensation cost is the excess, if any, of the quoted market price of the stock at grant date or other measurement date over the amount an employee must pay to acquire the stock. We make pro forma disclosures of net income and earnings per share as if the fair value based method of accounting had been applied as required by SFAS No. 123, "Accounting for Stock-Based Compensation" and SFAS 148, “Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of SFAS 123.” The following disclosure complies with the adoption of this statement and includes pro forma net income as if the fair value based method of accounting had been applied (in thousands except for per share data):