TALK AMERICA HOLDINGS INC - 10-K Annual Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

_____________________

FORM 10-K

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

For the fiscal year ended December 31, 2004

Commission File No. 000-26728

TALK AMERICA HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

Delaware	23-2827736
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification Number)

12020 Sunrise Valley Drive, Suite 250	20191
Reston, Virginia	(zip code)
(Address of principal executive offices)

(703) 391-7500

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Name of each exchange on which registered
None	Not applicable

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, Par Value $.01 Per Share

Rights to Purchase Series A Junior Participating Preferred Stock

(Title of class)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K. [X]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [X] No [ ]

As of June 30, 2004, the aggregate market value of the voting stock held by non-affiliates of the registrant, based on the average of the high and low prices of the common stock on June 30, 2004 of $7.73 per share as reported on the Nasdaq National Market, was approximately $206,312,664 (calculated by excluding solely for purposes of this form outstanding shares owned by directors and executive officers).

As of March 11, 2005, the registrant had issued and outstanding 27,078,605 shares of common stock, par value $.01 per share.

DOCUMENTS INCORPORATED BY REFERENCE

None.

ITEMS OMITTED PURSUANT TO RULE 12b-25

Item 6, Item 7, Item 8, Item 9A, Item 15 - Financial Statement Schedules and Exhibits 23, 31 and 32.

TALK AMERICA HOLDINGS, INC. AND SUBSIDIARIES

INDEX TO FORM 10-K

FOR THE YEAR ENDED DECEMBER 31, 2004

ITEM NO.	PAGE NO.
PART I
1. Business	1
2. Properties	24
3. Legal Proceedings	25
4. Submission of Matters to a Vote of Security Holders	25

PART II
5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	26
7A. Quantitative and Qualitative Disclosure About Market Risk	27
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	28
9B. Other Information	28

PART III
10. Directors and Executive Officers of the Registrant	28
11. Executive Compensation	30
12. Security Ownership of Certain Beneficial Owners and Management	33
13. Certain Relationships and Related Transactions	34
14. Principal Accounting Fees and Services	34

PART IV
15. Exhibits	35

Unless the context otherwise requires, references to "us," "we," and "our" or to "Talk America" refer to Talk America Holdings, Inc. and its subsidiaries.

PART I

Cautionary Note Concerning Forward-Looking Statements

Certain of the statements contained in this Form 10-K Report may be considered "forward-looking statements" for purposes of the securities laws. From time to time, oral or written forward-looking statements may also be included in other materials released to the public. These forward-looking statements are intended to provide our management’s current expectations or plans for our future operating and financial performance, based on our current expectations and assumptions currently believed to be valid. For these statements, we claim protection of the safe harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995. These forward-looking statements can be identified by the use of forward-looking words or phrases, including, but not limited to, "believes," "estimates," "expects," "expected," "anticipates," "anticipated," "plans," "strategy," "target," "prospects" and other words of similar meaning in connection with a discussion of future operating or financial performance. Although we believe that the expectations reflected in such forward-looking statements are reasonable, there can be no assurance that such expectations will prove to have been correct.

All forward-looking statements involve risks and uncertainties that may cause our actual results to differ materially from those expressed or implied in the forward-looking statements. This Form 10-K Report includes important information as to risk factors in the "Business" section under the headings “Business Strategies,” "Business Operations," "Competition" and "Regulation" and in "Management’s Discussion and Analysis of Financial Condition and Results of Operations." In addition to those factors discussed in this Form 10-K Report, you should see our other reports on Forms 10-K, 10-Q and 8-K subsequently filed with the Securities and Exchange Commission from time to time for information identifying factors that may cause actual results to differ materially from those expressed or implied in the forward-looking statements.

ITEM 1. BUSINESS.

OVERVIEW

Talk America Holdings, Inc., through its subsidiaries, offers a bundle of local and long distance phone services and internet access services to residential and small business customers in the United States. We operate our own nationwide long distance network and our own local network in Michigan. We currently deliver local services primarily through the use of the unbundled network element platforms of the incumbent local exchange companies under wholesale operating agreements with these companies; but an increasing percentage of our customers will be served on our network in Michigan. We have developed integrated order processing, provisioning, leads management, billing, payment, collection, customer service and information systems that enable us to provide high-quality service to residential and small business customers. We provide our customers with savings through competitively priced services and products, simplicity through consolidated billing and award winning customer service. We operate our own sales and customer service centers.

BUSINESS STRATEGY

We have built a large, profitable base of bundled phone service customers by using the wholesale operating platforms of the incumbent local exchange companies. In 2005, we plan to migrate an additional 150,000 customers in Detroit and Grand Rapids, Michigan to our own networking platform. In 2003, we began developing our network in Michigan and by the end of 2004 had approximately 25,000 bundled lines on our network and by the end of 2005 we expect to have approximately 175,000 bundled lines on our network. We have automated the business processes required to migrate our customers off the incumbent local exchange company platform to our network. The migration to our network is transparent to the customer. The local networking platform enhances our operating flexibility and provides us with the opportunity to deliver digital subscriber line, or DSL, service to our customers at attractive margins. In addition, local networking is an alternative to the wholesale operating platforms of the incumbent local exchange companies, which are effectively not available to us for new customers after March 11, 2005 and for all customers after March 11, 2006, due to significant changes to the Federal Communications Commission rules that required the incumbent local exchange companies to provide us the unbundled network elements of their operating platforms on a wholesale basis. We are expanding our network by increasing the number of end offices of the incumbent local exchange company where we collocate our networking equipment. However, we have not previously developed, deployed or operated a local network of our own and of this scale and there can be no assurance that we shall be able successfully to do so and thereafter profitably provide local telephone services through such a network.

We are adding internet services to our existing phone service bundle for both our networked and non-networked customers. We believe these enhancements to our existing services will increase our revenues and profitability from those customers while also meeting their needs and demands and reducing our customer turnover. In 2004 we launched our dial-up Internet access service and ended the year with approximately 22,000 customers. In addition, we began offering digital subscriber line, or DSL, services to customers on our local network and expect to actively market the product in 2005 in those areas of Michigan where we have deployed our network facilities.

Serving the medium sized businesses in those areas where we plan to deploy network facilities is also a component of our future business strategy. Expansion into this business market will increase our addressable market in such an area and will permit us to leverage our investment in our network facilities due to the complementary telecommunication traffic or usage patterns of these business customers and our residential and small business customers. We will consider and pursue the acquisition of customers or networking assets to enter the business market, complement existing networking plans or to supplement customer density where there is a potential for deployment of network facilities, but there can be no assurances that we will be able to do so successfully.

SERVICES AND PRODUCTS

We provide various bundled phone service packages, stand-alone long distance service and internet access products to residential and small business customers. We focus on providing consumers value through competitively priced plans designed to fit their particular calling patterns, broad feature selections, consolidated billing and customer service.

Bundled Phone Services

We offer our customers the flexibility to create their own phone service package (our “bundled phone package”) using their current telephone number. Each bundled phone package includes complete basic phone service with unlimited local calling and free unlimited “member-to-member” calling anywhere our customers are located. Customers may also select additional features and services to add in their packages, including enhanced domestic and international calling plans, depending on their individual needs and budgets. We ended 2004 with approximately 671,000 billed bundled lines. However, due to the recent significant changes to the FCC rules and our plans to increase product pricing for our customers located outside of Michigan, we expect the number of bundled customers to drop significantly by the end of 2005 and to continue to decrease on an accelerated basis in 2006 outside of those areas where we have deployed network facilities.

Features

Our customers have the option of selecting from many different features, which they can purchase either individually or as part of a package. We generally offer the following features depending on the customer’s location:

Call Waiting	Call Return Block	Distinctive Ring I
Caller ID	Speed Dialing 30	Distinctive Ring II
Caller ID with Name	Speed Dialing 8	Ringmaster I
Call Waiting with ID and Name	Repeat Dialing	Ringmaster II
Internet Call Waiting	Anonymous Call Rejection	Custom Toll Restriction
Remote Call Forwarding	Call Trace	Voicemail
Ring no answer Call Forward	Call Block	3-way Calling
Busy Call Forward	900/976 Block	3-way Calling with Call Transfer
Call Forward Remote Access	Privacy Director/Mgr	Call Return
Wire Maintenance	Non-Published Numbers	Additional Listings

Domestic Long Distance Services

Domestic long distance service is automatically included in each package, allowing the customer to place long distance calls and to be billed based on their usage. Additionally, customers have the option of adding either a statewide long distance plan or a nationwide long distance plan as part of their telephone service package. The statewide plan includes unlimited long distance calling within the customer’s state, and, in some places, Canada. The nationwide long distance plan includes unlimited long distance calling inside the United States and to Canada and Puerto Rico.

International Long Distance Services

We also automatically include an international calling plan in each of our packages that allows the customer to place international calls and to be billed based on their usage. For customers that frequently make international calls, they may choose one of our international calling plans that feature discounted billing options.

Long Distance Services

We provide 1+ long distance telecommunication services on a stand-alone basis as well as bundled with our package plans as described above. Our long distance service includes intrastate, interstate and international calling services as well as calling cards. We ended 2004 with 128,000 stand-alone long distance subscribers.

Internet Access Products

Dial-up Internet Services

We offer standard and accelerated dial-up Internet access to our residential telephone customers throughout the United States. The "accelerated" dial-up services utilize compression, caching and other technologies that reduce the time for certain web pages to download to users' computers when compared to standard dial-up access services. As of December 31, 2004, we had approximately 22,000 dial-up Internet access customers.

DSL Internet Services

We offer digital subscriber line, or DSL, internet speeds of up to 4.0 megabytes per second download speed and 384 kilobytes per second upload speed in the Detroit, Michigan region where we have deployed our own local networking assets. Generally, we make DSL available to customers who are within 16,500 feet of one of our collocation facilities.

DSL technology reduces the bottleneck in the transport of information, particularly for data services, by increasing the data carrying capacity of copper telephone lines. We believe that, for many residential customers within the geographic areas that can be served by DSL technology, existing copper connections using DSL technology from customer homes to our network offers a lower cost alternative for high-quality broadband services than cable or broadband wireless connections. As we increase the number of collocation facilities in our network in 2005, we expect to increase our addressable market for DSL.

BUSINESS OPERATIONS

Local Phone Services

Overview

We offer local services through both our own network and the unbundled network element platform of the incumbent local exchange companies, or ILECS, including the Regional Bell Operating Companies such as SBC, Verizon and BellSouth. The unbundled network element platform of the incumbent local exchange companies offer to us, in an individual or combined form, a series of unbundled network elements that comprise the most important facilities, features, functions and capabilities of an incumbent local exchange company's network. When offered in the combination known as the unbundled network element platform, these components include the loop and switching elements needed to provide local telephone service to a customer. However, as a result of the FCC’s final rules, beginning on March 11, 2005, the unbundled network element platform became unavailable to us for adding new customers. Further, as of March 11, 2005 there is a $1 increase per line, per month in the cost for us to continue providing service to our existing customers that are on the unbundled network element platform and as of March 11, 2006, we will no longer be able to use the unbundled network element platform and thus will be forced to transition our customers from the unbundled network element platform to our own network facilities or to service them through total resale service agreements or with elements purchased through commercial agreements that we may enter into with the incumbent local exchange companies.

Beginning in 2003, we deployed networking assets in Michigan and, as of December 31, 2004, we had approximately 25,000 bundled lines on our network. We are continuing the expansion of our network by collocating our networking equipment in the incumbent local exchange companies’ end offices to provide service over our own network to a larger portion of our existing customer base. By December 31, 2005 we expect to have 175,000 bundled lines on our network, and we are actively exploring network opportunities in areas outside of Michigan, although there can be no assurances that we will be able to economically deploy networking assets in such areas.

In addition to providing us with alternatives to our reliance on the unbundled network element operating platforms of the incumbent local exchange companies, our own local networking should provide us with certain strategic benefits such as increased operating flexibility with respect to capability to enhance and expand our service and product offerings for our customers and the opportunity to increase our operating margins. In order to viably support our local network, we must maintain a sufficient number of customers on the network.

As we continue to pursue the development and deployment of our own networking platform, we expect that our capital expenditures will increase from what they were in 2004. In 2005, we expect capital expenditures, including capitalized software development, to be approximately $43 to $47 million, primarily in connection with the deployment of our facilities in Michigan.

Local Network

Our local network is comprised of equipment and facilities that are either owned or leased by us and certain telecommunication services for which we contract with a variety of other carriers. We maintain certain pieces of equipment in collocation sites owned or leased by SBC, the incumbent local exchange company in Michigan. The incumbent local exchange companies are currently required to provide us with access to these collocation sites, however, such access can be conditioned upon our paying charges for upgrading the power supply or physical layout of the collocation site. Failure of the incumbent local exchange company to provide us with access to the collocation site or access in a timely manner will affect our ability to continue building our local network. The following diagram outlines the basic method by which we provide our customers with local phone service.

In order to provide a customer with phone service on our local network, we must first submit an order with the incumbent local exchange company to move, or “hot cut,” the customer’s existing unbundled network element loop. The loop is the copper telephone line that connects the customer’s premise to the incumbent local exchange company’s switch. For our existing unbundled network element platform, we hot cut transfer the customer’s loop from the incumbent local exchange company’s switch to our loop carrier equipment in the collocation site at the incumbent local exchange company’s end office, assigned to that customer. There are limitations on the number of phone lines the incumbent local exchange company is required to hot cut over to our network per day at a particular end office.

Upon confirmation that the customer line has been switched to either our digital loop carrier and digital subscriber line access multiplexer equipment or our broadband loop carrier equipment, we update numerous external databases, including E911 databases, which, as the customer’s local phone provider, we are required to timely and accurately update.

The customer lines in each collocation site are aggregated and connected to our Lucent 5ESS-2000 switch located in Southfield, Michigan, using DS3 or higher capacity transmission equipment that we lease primarily from SBC, the incumbent local exchange company, supplemented by leases with competitive access providers. This transmission is referred to as transport. As we expand our local switching capacity during 2005, these dedicated transport facilities, dark fiber (otherwise unused fiber optic cable that is leased by us for transport), and entrance facilities under the FCC’s rules may be unavailable to us on an unbundled basis at cost-based rates along certain routes. This may adversely impact us where our own switching facilities have been deployed and could substantially impede our plans to deploy additional network facilities. We could be forced to use other means to effect this deployment, including the use of facilities purchased from the incumbent local exchange carrier at higher tariffed special access rates or transport services purchased from other competitive access providers. In either event, our cost of service could rise dramatically and our plans for a service roll-out using our own network facilities could be delayed substantially or derailed entirely.

Our Lucent 5ESS-2000 switch is generally considered extremely reliable and features the Digital Networking Unit-SONET technology. The Digital Networking Unit is a switching interface that is designed to increase the reliability of the 5ESS-2000 and to provide much greater capacity in a significantly smaller footprint. Our switch is connected to other carriers in the public switched telephone network through circuit trunking equipment. We lease the circuit trunking equipment primarily from incumbent local exchange companies. If the incumbent local exchange companies are no longer required to provide this circuit trunking equipment or to provide it at Total Element Long Run Incremental Cost, or TELRIC, based rates, we will be forced to acquire this trunking equipment at higher rates from either a competitive access provider, if available, or, if they are willing to lease the trunking equipment to us, from the incumbent local exchange company. The equipment that comprises this physical layer of our network can support both voice and data communications technologies.

As of March 14, 2005, we have customers on our local network in 14 collocation sites around the Detroit, Michigan and one switch in Southfield, Michigan. We expect to have customers in 81 collocation sites in Michigan as of March 11, 2006. In Michigan, SBC is currently only required to hot cut over to our network 20 lines related to new customers per end office per day. Migration of existing customers or acquired customers is on a negotiated basis. In addition to the difficulties and uncertainties of operating a service that we have not previously operated, operating our own local switches will, as it does with our long distance switches, subject us to the risk of significant interruption. Fires or natural disasters, for example, could cause damage to our switching equipment or to transmission facilities connecting our switches. Any interruption in our services over our network caused by such damage could have a material adverse impact on our financial condition and results of operations. In such circumstances, we could attempt to minimize the interruption of our service by carrying traffic through one of our other local switches or obtaining a portable disaster recovery switch from Lucent (discussed below). However, we have not previously developed, deployed or operated a local network of our own or of this scale and there can be no assurance that we shall be able successfully to do so and thereafter profitably provide local telephone services through such a network. In addition, we are dependent upon a variety of vendors for the provision of equipment necessary for the construction, deployment and migration of customers to our local network, and failure of these vendors to deliver the equipment in a timely manner may result in delays in the deployment, and ultimately, the migration of customers to our network.

Our network described above, like most networks today, carries local voice traffic via circuit switch-based networks. Circuit switch-based systems establish a dedicated channel for each telecommunication signal (such as a telephone call for voice or fax), maintain the channel for the duration of the call, and disconnect the channel at the conclusion of the call. In contrast, packet switch-based telecommunications systems are a newer technology, under which the information to be transmitted is formatted into a series of shorter digital messages called “packets.” In addition to supporting data, packet switch-based systems have been used for long haul voice traffic and is now starting to be deployed to support local phone service. Each packet consists of a portion of the complete message plus the addressing information to identify the destination and return address. A key feature that distinguishes Internet architecture from the public telephone network is that on the packet-switched Internet, a single dedicated channel between telecommunication points is not required. Packet switch-based systems may offer several advantages over circuit switch-based systems, particularly the ability to commingle packets from several telecommunications sources together simultaneously onto a single channel. For most telecommunications, particularly those with bursts of information followed by periods of “silence,” the ability to commingle packets provides for superior network utilization and efficiency, resulting in more information being transmitted through a given telecommunication channel. We believe that in the longer term most new networks will be based on packet switching to take advantage of transport efficiencies, more open standards for interoperability, lower capital costs and easier deployment and maintenance.

In Grand Rapids, Michigan, we have deployed a newly developed soft-switch technology. The soft-switch is a distributed computer system that performs the same functions as a circuit switch. It can support both circuit and packet-switched communications. We are currently testing the soft-switch technology and, if successful, plan to use this technology to complement and relieve traffic from our Lucent 5ESS-2000 circuit switch. Soft-switch technology is currently being used by very few residential phone providers and has not been used on this scale. There can be no assurances that the technology will be able to be successfully and economically deployed in the residential market or that we will be successful in developing, deploying and managing the technology. We expect however, that, if successful, the soft-switched technology will enable us to enter into more markets due to the lower cost of the soft-switch technology than that of a traditional circuit switch technology.

We also continue to actively explore other next generation networking opportunities with a variety of vendors in order to decrease our cost of delivering service, reduce our reliance upon the incumbent local exchange companies and provide local telephone services through new, innovative methods of delivery.

Long Distance Phone Services

Overview

We generally use our own nationwide long distance network to provide long distance phone services directly to our customers. We operate our own switches and are thus subject to the risk of significant interruption, as discussed with respect to our operation of our own local switches, above. In such circumstances, we could attempt to minimize the interruption of our long distance service by carrying traffic through our resale arrangements with other carriers.

Long Distance Network

Our long distance network is comprised of equipment and facilities that are either owned or leased by us. We contract for certain telecommunication services with a variety of other carriers. We own, operate and maintain five Lucent 5ESS-2000 switches in our long distance network, which feature the Digital Networking Unit-SONET technology. The switches are connected to each other by connection lines and digital cross-connect equipment that we own or lease. We also have installed lines to connect our long distance switches to switches owned by various local telecommunication service carriers. We are responsible for maintaining these lines and have entered into a contract with a third party vendor with respect to the monitoring, servicing and maintenance of this equipment. In 2005, we expect to decommission two of our switches.

With respect to connections to local carriers, international and operator assisted services, in December 2003, we entered into a 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. Our AT&T agreement establishes pricing and provides for annual minimum commitments based upon usage as follows: 2005 - $32 million, 2006 - $32 million and 2007 - $32 million and obligates us to pay 65 percent of the revenue shortfall, if any. Despite the expected reduction in our local bundled customer base due to the reduction in our addressable market, we anticipate that we will not be required to make any shortfall payments under this contract as a result of the restructuring of the obligations or the addition of network minutes as a result of acquisitions, 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.

Internet Access Services

We offer DSL internet access to customers who are located within 16,500 feet of a collocation site in our local network. DSL service is provided through either broadband loop carrier equipment or digital loop carrier equipment and digital subscriber line access multiplexer equipment. We are dependent upon a small number of vendors to provide us with this equipment and failure to attain the equipment in a timely manner will affect our ability to offer DSL services. In addition, a portion of those customers located within 16,500 feet of a collocation site in our local network will not be able to receive DSL service due to line conditions, the presence of a fiber-optic cable connection to the home and other limitations of the incumbent local exchange company’s line facilities. We utilize a third party vendor to supply modems to our DSL customers to enable them to establish a DSL connection at their premise.

We also offer dial-up internet access service to bundled phone customers, whether or not such customer is on our local network. The service is provided through a third party vendor, who also hosts the email service for both our dial-up and DSL services. We are dependent upon this vendor for the content of and support for our internet access portal.

INTEGRATED INFORMATION SYSTEMS

We have integrated leads management, order processing, provisioning, billing, payment, collection, customer service and information systems that enable us to offer and deliver high-quality, competitively priced telecommunication services to our customers and process millions of call records each day. These operational support systems were developed by our employees and customized for our business and operational requirements and, due to the system's component-based architecture, provide an extensible framework for the introduction of new products and services. We use "state-of-the-art" software and hardware applications and products to support our systems and development efforts. We are currently migrating our database systems from an Informix to an Oracle architecture and expect the migration to be completed in 2005, although there can be no assurances that we will be able to do so successfully. Through dedicated electronic connections with our local and long distance networks and the incumbent local exchange companies, we have designed our systems to process information on a "real time" basis. We have automated the business processes required to deploy and support our local circuit switch-based network, and continue to automate the business processes required to provide DSL service. Should we expand our network or customer base through the acquisition of another company or the acquisition of another company’s customers or assets, we would need to integrate such company systems or customers into our information systems, particularly our provisioning and billing systems, and there can be no assurances that we would be able to do so successfully. Further, if we are successful in implementing our business strategy to enter the medium-sized business market, we will need to either redesign our integrated information systems to support new business products and billing needs of these customers or purchase the necessary information systems from a third party, which may prove costly and cause delays, and then integrate these information systems into our reporting and decision support systems. There can be no guarantee that we will be successful in integrating these customers into or be able to redesign these systems on a timely basis.

Our core operational support systems include the following:

Our leads database system is utilized in the marketing of our telecommunication services. The leads database system enables us to alter telemarketing campaigns to track areas where mass advertisements are airing, manage the bundled sales price by customer, zone and state, maintain customer credit information, and comply with various regulatory requirements.

Our proprietary automated order processing system enables us to shorten the customer provisioning time cycle and reduce associated costs. Prior to submitting an order to provision a customer to our service, our system processes the customer's credit history, and, once the customer's credit is approved, the customer's service record detailing the customer's existing phone service is immediately verified. In addition, our system has enabled us to significantly increase our customer provisioning rate for qualified and verified orders while reducing the number of orders that are rejected by the incumbent local exchange company, reducing manual work requirements.

·	Our automated service provisioning system enhances our ability to add customer lines to our telecommunication service and to change the features associated with that particular customer's service, reducing manual work requirements.

·	Our billing system enables us to preview and run a bill cycle each day of the month for the many different, tailored service packages, increasing customer satisfaction while minimizing revenue leakage in the provision of local telecommunication service.

Our proprietary automated payment and collections management system is integrated with our billing and customer relationship management system. This system increases the efficiency of our collection process, accelerates the recovery of accounts receivable and assists in the retention of valuable customers.

·	Our new customer relationship manager system, enables our customer service representatives to access data in a real-time, organized manner, while the representative is speaking with the customer, thereby reducing the length of customer service calls and improving the customer experience.

In addition, we maintain our own web site at www.talkamerica.com and www.talk.com to provide for customer sign-up and to provide customers and potential customers with information about our products and services as well as billing information and customer service. We provide these services and features using our web-enabled technologies that allow us to offer our customers:

·	Detailed rate schedules and product and service related information.

·	Online sign-up for our telecommunication and data services.

·	Credit card billing.

·	Real-time and 24 x 7 billing services and online information, providing customers with up to the hour billing information.

The information functions of our systems are designed to provide easy access to all information about a customer, including volumes and patterns of use. This information can be used to identify emerging customer trends and to respond with services to meet customers' changing needs. This information also allows us to identify unusual usage by an individual customer, which may indicate fraud. FCC rules, however, may limit our use of customer proprietary network information. See "Regulation."

SALES AND MARKETING

We use diverse sales and marketing channels to reach the residential and small business markets with our service offerings. Our sales and marketing efforts focus on marketing a bundle of local and long distance phone services directly to customers exclusively under our own brand. As a result of the FCC’s final rules regarding access to the incumbent local exchange companies’ networks, beginning on March 11, 2005, we are only marketing our services in those markets where we can provision customers directly to our own network facilities. In anticipation of this reduction, in November 2004, upon expiration of our lease, we closed our Fort Meyers telemarketing center and we expect to continue evaluating further reductions and consolidations in our telemarketing centers. Due to the reduction in our addressable market and the number of leads for residential and small businesses, we expect to focus most of our sales and marketing activity in Detroit and later this year in Grand Rapids, Michigan and expect a significant reduction in the number of new customers that we add in the periods after March 11, 2005 compared to prior periods and for sales and marketing expense to decline in 2005. In order to maintain economic efficiencies with our local network, we must maintain a high number of customers in each collocation site and thus must continue to penetrate these particular markets in which we have been marketing for over three years in order to counter reductions in such levels due to customer turnover.

We employ a targeted approach to customer acquisition and use database-marketing tools to identify and prioritize target customers. We offer our customers the ability to build their own telecommunications package beginning with an extended local calling area, a diverse selection of intrastate and interstate calling plans, discounted feature packages and ala carte feature selection, and several options for Internet access. Customers can switch to us online, through a telesales representative, or through an authorized agent, each of which uses consultative sales tools to assist the customer’s creation of the right plan for their telecommunications needs. At the point of sale, we provide each customer with an estimate of their first month’s invoice, including all fees and taxes. Customers are able to keep their same phone lines and number, can easily add features, and, generally within days of the sale, are switched to our service and receive a personalized welcome kit explaining their service.

We market our bundled services within our targeted markets through the following channels:

Telemarketing - We operate our own call centers and purchase residential and small business lead databases utilized for targeted, professional and courteous outbound telesales campaigns. Telemarketing is an important sales channel for us. Any changes in the federal or state "do not call" regulations could adversely affect us. See "Regulation."

·	Direct Mail - We purchase small business and residential lead databases utilized for demographically targeted direct mail campaigns designed to direct inbound calls to our telemarketing centers.

·	Referrals - We solicit, through the use of referral promotions and our member-to-member free long distance product, the names of potential customers or referrals from our existing customers.

·	Online Marketing - We have developed a productive online marketing presence, through traditional online media and business relationships.

·	Direct Sales - Utilizing independent agents, we solicit new customers in targeted geographic areas.

·	Broadcast Media - We solicit inbound subscriber calls through advertising on television, radio and in print.

While we do not actively market our stand-alone long distance telecommunications service, we offer the long distance telecommunications service when contacted by persons located in those regions where local service is unavailable. We also add long distance customers when the customer requests its local service provider to provide the customer with our long distance telecommunications service.

We focus on targeting, acquiring and retaining profitable customers that we can directly provision to our own network platform by providing savings, simplicity and service. We continue to seek new marketing partners and arrangements to expand both our opportunities to attract other customers to our services and the products and services that we offer to our customer base.

COMPETITION

The telecommunication industry is highly competitive. Major participants in the industry regularly introduce new services and marketing activities. Competition in the telecommunication industry is based upon the ability to offer services at competitive prices, customer service, billing service and perceived quality. We expect the number of competitors in the telecommunication industry to shrink significantly in 2005 as a result of announcements of intentions to exit the consumer market and the FCC’s final rules regarding access to the incumbent local exchange companies’ networks issued on February 4, 2005. In Michigan, we expect our competitor to be SBC, which is the incumbent local exchange company, and Comcast, which is the largest provider of cable television and broadband internet access in Michigan. SBC offers the same services as we do plus other services, such as television programming, and is substantially larger and has greater financial, technical and marketing resources. Further, SBC and AT&T have recently announced SBC’s proposed acquisition of AT&T and both Verizon and Qwest have recently announced bids for the acquisition of MCI, which we expect to further reduce our ability to compete. In addition, Comcast offers television programming, broadband internet access and, in Michigan, has begun offering voice over internet protocol phone service in certain areas at a cost that appears to be below that of traditional circuit-switched service, and is also substantially larger and has greater financial, technical and marketing resources. Our success will depend upon our continued ability to provide high quality, high value services at prices generally competitive with, or lower than, those charged by our competitors.

The incumbent local exchange companies and the major carriers, including SBC, Verizon, BellSouth, AT&T, Sprint Corporation and MCI/Worldcom, Inc., have targeted price plans at residential customers - our primary target market - with significantly simplified rate structures and with bundles of local services with long distance, which may lower overall local and long distance prices. Competition is also fierce for the small businesses that we also serve. In addition, both cable providers and wireless carriers have marketed their services as an alternative to traditional long distance and local services, further increasing competition. Reductions in prices charged by competitors may have a material adverse effect on us.

The incumbent local exchange companies are well-capitalized, well-known companies that have the capacity to "bundle" other services, such as local and wireless telephone services and high speed Internet access, with long distance telephone services. The incumbent local exchange companies' name recognition in their existing markets, the established relationships that they have with their existing local service customers, their ability to take advantage of those relationships, and the possibility that interpretations of the Telecommunications Act and the FCC’s final rules regarding the unbundled network element platform may be favorable to the incumbent local exchange companies, also make it more difficult for us to compete with them.

As a result of the FCC’s final rules, which made the unbundled network element effectively unavailable to us after March 11, 2005 for new customers, we will cease marketing in those markets where we do not have our own networking facilities. Based on previous announcements as discussed above, we expect other competitive local exchange carriers to likewise decide to cease marketing in these markets, resulting in very limited competition for the incumbent local exchange company. While we plan to continue serving our existing customer base in these markets, due to the regulatory actions and our plans to increase product pricing for our customers located outside of Michigan, we expect the number of bundled customers to drop significantly by the end of 2005 and to continue to decrease on an accelerated basis outside of those areas where we plan to deploy network facilities in 2006. These price increases will result in customers seeking other providers for their telecommunications needs, further bolstering the incumbent local exchange companies’ dominance of the market.

The internet access market is also highly competitive. Residential broadband internet access in Michigan is currently dominated by Comcast, through use of its hybrid fiber-coaxial cable networks, and SBC through the use of digital subscriber line technology. Both Comcast and SBC have an established brand name and reputation for