-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PiJzrpa1WCFd+ZDXXsA0QlaVXi10qWHs9TQDUfW0UMbKmyUMo3nWGNoOescji6ey OOr7yaJMRMW06AU7KrKkXw== 0000898430-96-003945.txt : 19960820 0000898430-96-003945.hdr.sgml : 19960820 ACCESSION NUMBER: 0000898430-96-003945 CONFORMED SUBMISSION TYPE: S-1 PUBLIC DOCUMENT COUNT: 21 FILED AS OF DATE: 19960819 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: SMARTALK TELESERVICES INC CENTRAL INDEX KEY: 0001018730 STANDARD INDUSTRIAL CLASSIFICATION: [] FILING VALUES: FORM TYPE: S-1 SEC ACT: 1933 Act SEC FILE NUMBER: 333-10391 FILM NUMBER: 96617367 BUSINESS ADDRESS: STREET 1: 1640 S. SEPULVEDA BLVD STREET 2: SUITE 500 CITY: LOS ANGELES STATE: CA ZIP: 90025 BUSINESS PHONE: 3104448800X374 MAIL ADDRESS: STREET 1: 1640 S. SEPULVEDA BLVD STREET 2: SUITE 500 CITY: LOS ANGELES STATE: CA ZIP: 90025 S-1 1 FORM S-1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 19, 1996 REGISTRATION NO. 333- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------- FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ---------------- SMARTALK TELESERVICES, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) ---------------- CALIFORNIA 4899 95-4502740 (STATE OR OTHER (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER ID NO.) JURISDICTION OF CLASSIFICATION CODE NO.) INCORPORATION OR ORGANIZATION) 1640 SOUTH SEPULVEDA BOULEVARD, SUITE 500 LOS ANGELES, CALIFORNIA 90025 (310) 444-8800 (310) 444-8822 (FAX) (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES) ---------------- ROBERT H. LORSCH SMARTALK TELESERVICES, INC. 1640 SOUTH SEPULVEDA BOULEVARD, SUITE 500 LOS ANGELES, CALIFORNIA 90025 (310) 444-8800 (310) 479-3297 (FAX) (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) ---------------- COPIES TO: ROBERT M. SMITH ROBERT B. KNAUSS DEWEY BALLANTINE SANDRA A. SEVILLE-JONES 333 SOUTH HOPE STREET, SUITE 3000 MUNGER, TOLLES & OLSON LOS ANGELES, CALIFORNIA 90071 355 SOUTH GRAND AVENUE, 35TH FLOOR (213) 626-3399 LOS ANGELES, CALIFORNIA 90071 (213) 625-0562 (FAX) (213) 683-9100 (213) 687-3702 (FAX) APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after this Registration Statement becomes effective. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. [_] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [_] CALCULATION OF REGISTRATION FEE
- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- PROPOSED AMOUNT TO PROPOSED MAXIMUM TITLE OF EACH CLASS OF BE MAXIMUM AGGREGATE AMOUNT OF SECURITIES TO BE REGISTERED OFFERING PRICE OFFERING PRICE REGISTRATION REGISTERED (1) PER SHARE (2) (2) FEE - -------------------------------------------------------------------------------- Common Stock, no par value................. 4,830,000 $15.00 $72,450,000 $24,983 - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
(1) Includes 630,000 shares subject to the Underwriters' over-allotment option, if any. (2) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(a). ---------------- THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES EXCHANGE COMMISSION, ACTING PURSUANT TO SUCH SECTION 8(A), MAY DETERMINE. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ +INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A + +REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE + +SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY + +OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT + +BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR + +THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE + +SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE + +UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF + +ANY SUCH STATE. + ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ SUBJECT TO COMPLETION AUGUST 19, 1996 PROSPECTUS 4,200,000 SHARES [LOGO OF SMARTALK(SM) TELESERVICES, INC.] SMARTALK TELESERVICES, INC. COMMON STOCK (NO PAR VALUE) Of the 4,200,000 shares of Common Stock, no par value per share (the "Common Stock"), of SmarTalk TeleServices, Inc. ("SmarTalk" or the "Company") offered hereby, 4,000,000 shares are being sold by the Company and 200,000 shares are being sold by certain shareholders of the Company (the "Selling Shareholders"). See "Principal and Selling Shareholders." The Company will not receive any of the proceeds from the sale of the shares of Common Stock by the Selling Shareholders. Prior to this offering (the "Offering"), there has been no public market for the Common Stock. It is currently estimated that the initial public offering price will be between $13 and $15 per share. For a discussion relating to the factors to be considered in determining the initial public offering price, see "Underwriting." Application has been made for quotation of the Common Stock on the Nasdaq National Market under the proposed symbol "SMTK." SEE "RISK FACTORS" BEGINNING ON PAGE 7 FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE INVESTORS. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
- ------------------------------------------------------------------------------------------- PRICE TO UNDERWRITING PROCEEDS TO PROCEEDS TO PUBLIC DISCOUNT(1) COMPANY(2) SELLING SHAREHOLDERS Per Share........................... $ $ $ $ Total(3)............................ $ $ $ $ - -------------------------------------------------------------------------------------------
(1) See "Underwriting" for information concerning indemnification of the Underwriters and other matters. (2) Before deducting expenses of the Offering estimated at $1,225,000, all of which will be paid by the Company. (3) The Selling Shareholders have granted to the Underwriters a 30-day option to purchase up to 630,000 additional shares of Common Stock at the Price to Public, less Underwriting Discount, solely to cover over-allotments, if any. If the Underwriters exercise such option in full, the total Price to Public, Underwriting Discount and Proceeds to Selling Shareholders will be $ , $ and $ , respectively. See "Underwriting" and "Principal and Selling Shareholders." The shares are offered subject to receipt and acceptance by the Underwriters, to prior sale and to the Underwriters' right to reject any order in whole or in part and to withdraw, cancel or modify the offer without notice. It is expected that delivery of the shares will be made at the office of Salomon Brothers Inc, Seven World Trade Center, New York, New York or through the facilities of The Depository Trust Company, on or about , 1996. SALOMON BROTHERS INC CS FIRST BOSTON DONALDSON, LUFKIN & JENRETTE SECURITIES CORPORATION The date of this Prospectus is , 1996. [ARTWORK TO FOLLOW] IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK OF THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET, THE OVER-THE-COUNTER MARKET OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. DURING THIS OFFERING, CERTAIN PERSONS AFFILIATED WITH PERSONS PARTICIPATING IN THE DISTRIBUTION MAY ENGAGE IN TRANSACTIONS FOR THEIR OWN ACCOUNTS OR FOR THE ACCOUNTS OF OTHERS IN SHARES OF THE COMMON STOCK PURSUANT TO EXEMPTIONS FROM RULES 10B-6, 10B-7 AND 10B-8 UNDER THE SECURITIES EXCHANGE ACT OF 1934. 2 PROSPECTUS SUMMARY The following summary is qualified in its entirety by the more detailed information and Financial Statements, including the Notes thereto, appearing elsewhere in this Prospectus. Investors should also carefully consider the information set forth under the heading "Risk Factors" and are urged to read this Prospectus in its entirety. Unless otherwise indicated, all information in this Prospectus assumes no exercise of the Underwriters' over-allotment option. THE COMPANY SmarTalk provides convenient, easy to use, cost-effective telecommunications products and services to individuals and businesses primarily through its SmarTalk TeleServices Card (the "SmarTalk Card"). The SmarTalk Card provides customers with a single point of access to prepaid telecommunications services at a fixed rate charge per minute regardless of the time of day or, in the case of domestic calls, the distance of the call. The Company's services currently include domestic calling and outbound international long distance calling to more than 150 countries, as well as enhanced features such as sequential calling, speed dial and message delivery. The SmarTalk Card may also be recharged on-line with a major credit card, allowing the user to add minutes as needed. The Company expects to offer other enhanced services, including conference calling, voice mail, fax mail, content delivery and selected international calling services. The Company's long distance calls are carried primarily through MCI and AT&T. For the six months ended December 31, 1995 and June 30, 1996, the number of minutes decremented from SmarTalk cards or otherwise used by SmarTalk customers were approximately 2,576,000 and 15,901,000, respectively. The domestic prepaid phone card industry has grown significantly in recent years. Prepaid phone card revenues in the U.S. have grown from an estimated $20 million in 1990 to an estimated $1 billion in 1996, making prepaid phone services one of the fastest growing segments of the telecommunications industry. Industry sources project the U.S. market to exceed $5 billion in 2000. SmarTalk's primary marketing and distribution focus is to target individuals and small businesses through major national and regional retailers. Currently, the SmarTalk Card is sold at selected retail locations throughout the U.S., including locations operated by the following leading retailers: American Drug Stores (which includes Jewel/Osco Combo Stores, Osco Drug Stores and Sav-On Drug Stores), Office Depot, Thrifty Oil, Builders Square, Hills Department Stores, Bradlees, Bergen Brunswig Drug Company (Good Neighbor Pharmacy), Venture Stores, Foley's Department Stores, Marshall Field's, Fred W. Albrecht Grocery Company, Office1 Superstores and Price/Costco. The Company believes its success to date in rapidly expanding its retail network is attributable to management's ability to increase retailers' awareness of the profit potential of offering telecommunications services at retail, the minimal space involved in offering the SmarTalk Card at retail and the ability of the SmarTalk Card to generate ongoing residuals for retailers through participation in recharge revenues. SmarTalk also is exploring the opportunity of offering retailers a co-branded, pre-subscribed "1+" long distance service. This new product, if successfully introduced, would afford retailers the ability to offer residential and small business customers long distance services that are designed to generate ongoing revenue streams while requiring virtually no shelf space or inventory cost. SmarTalk also markets its services directly to customers through direct response sales which include recharge sales, payphone sales, and sales generated through print, direct mail, and, in the future, the Internet and television advertising. SmarTalk has recently entered into an agreement with Pacific Bell which permits the Company to place an information card, which displays details about SmarTalk services and provides an "800" number to call to purchase such services, on 30,000 payphones in California. The Company intends to pursue similar arrangements with other payphone operators nationwide. 3 The Company has developed additional marketing and distribution avenues, including the Company's Corporate Advantage Program and corporate promotional programs. Under the Corporate Advantage Program, employees who are away from their offices can utilize SmarTalk services, thereby enabling businesses to lower telecommunications costs and monitor call activity to better allocate long distance costs. Corporate promotional programs allow the Company's corporate customers to provide co-branded prepaid phone cards for use in corporate or product promotions. SmarTalk services are delivered through proprietary switching, application and database access software which run on two interactive call processing platforms (the "SmarTalk Platforms"), one of which was recently acquired from Pacific Bell Information Services (the "VoiceChoice Platform"). SmarTalk anticipates that ownership of the VoiceChoice Platform will reduce the Company's operating costs while providing the Company with the flexibility to customize and add features. The Company has also developed a proprietary in- house data reporting and tracking system (the "SmarTrac System"), which tracks inventory, controls fraud, monitors usage by card and retailer and allows the Company to provide certain customer and usage information to its retailers and business customers. The Company believes that its principal competitive advantages are its (i) well-established presence among major retailers, (ii) advanced telecommunications infrastructure, and (iii) management team, which has extensive marketing and merchandising expertise. The Company believes its competitive advantages will assist it in achieving its growth objective through implementation of the following strategies: Increase Penetration of Retailers. SmarTalk plans to increase penetration of retailers by expanding the number of stores in which the SmarTalk Card is sold and the points of sale at which a customer can purchase the SmarTalk Card within each store. The Company also intends to leverage its relationships with retailers to market additional telecommunications services such as "1+" long distance. Further Develop Direct Response Channels. SmarTalk plans to stimulate the growth of its existing direct response sales through, for example, volume discounts and on-line advertising. SmarTalk will market the recurring revenue arrangement established with Pacific Bell to other payphone companies. Broaden Corporate Advantage and Promotional Programs. SmarTalk intends to expand the Corporate Advantage Program and corporate promotional programs by (i) expanding its sales force to include representatives that focus on business customers, (ii) capitalizing on the Company's strategic relationships, and (iii) leveraging its existing relationships with retailers by promoting its corporate programs to retailers already familiar with SmarTalk services. Target the Business Customer. SmarTalk plans to introduce additional enhanced features in an effort to attract both small businesses at retail and corporations as subscribers to its Corporate Advantage Program. Such planned enhanced features include voice mail, fax mail, conference calling and selected international calling services. Leverage Existing Strategic Relationships. SmarTalk plans to leverage its existing network of strategic relationships to gain access to new business opportunities and a wider customer base. The Company has recently entered into strategic alliances, including those with Pacific Bell, MCI, West Interactive, and Douglas Stewart, which the Company believes will expand its distribution channels. The Company also plans to develop additional strategic relationships with partners whose customers are prospective users of SmarTalk services. Expand International Services. SmarTalk plans to expand its business to international markets in order to market prepaid phone cards to U.S. travelers and foreign customers who frequently call the U.S. SmarTalk believes that it can market to foreign customers who frequently call the U.S. by establishing a sales force abroad and by providing turnkey merchandising materials to retailers abroad which are customized for foreign markets. 4 SmarTalk TeleServices, Inc. was incorporated in California in October, 1994. As used in this Prospectus, the term "SmarTalk" or the "Company" refers to SmarTalk TeleServices, Inc. and its subsidiary, unless the context otherwise requires. All information in this Prospectus gives effect for all periods to a 3,500 for 1 stock split effected on February 13, 1996, a 2.51 for 1 stock split effected on May 23, 1996, and a 0.5625 for 1 reverse stock split effected on August 15, 1996. The Company's principal executive offices are located at 1640 South Sepulveda Boulevard, Suite 500, Los Angeles, California 90025, and its telephone number is (310) 444-8800. THE OFFERING Common Stock Offered By: The Company ............ 4,000,000 shares The Selling Shareholders........... 200,000 shares(1) --------- Total................. 4,200,000 shares(1) ========= Common Stock Outstanding after the Offering....... 12,824,834 shares(2) Use of Proceeds........... To repay indebtedness, to fund capital expenditures, marketing, new business development opportunities and the expansion of the Company's business internationally, and for additional working capital and general corporate purposes including possible acquisitions. Proposed Nasdaq National Market Symbol............ SMTK
- -------- (1) Excludes 630,000 shares of Common Stock that may be sold by the Selling Shareholders pursuant to the Underwriters' over-allotment option. (2) Excludes 508,514 shares of Common Stock reserved for issuance upon exercise of outstanding options granted by the Company. See "Dilution" and "Management -- Stock Option Plans." 5 SUMMARY FINANCIAL DATA
PERIOD FROM INCEPTION (OCTOBER 28, SIX MONTHS ENDED 1994) TO YEAR ENDED JUNE 30, DECEMBER 31, DECEMBER 31, ---------------------- 1994 1995 1995 1996 ------------ ------------ --------- ----------- STATEMENT OF OPERATIONS DATA(1): Revenue.................... $ 444 $ 453,916 $ 41,738 $ 3,678,020 Gross profit (loss)........ (272) 141,630 12,628 997,905 Operating expenses......... 65,200 1,472,944 298,065 3,164,719 --------- ----------- --------- ----------- Loss from operations....... (65,472) (1,331,314) (285,437) (2,166,814) Net loss................... $ (65,472) $(1,329,302) $(285,437) $(2,271,186) ========= =========== ========= =========== Net loss per share(2)...... $ (.01) $ (.14) $ (.03) $ (.24) ========= =========== ========= =========== Weighted average number of common shares and common equivalent shares(2)...... 9,333,348 9,333,348 9,333,348 9,333,348
JUNE 30, 1996 --------------------------- ACTUAL AS ADJUSTED(3) ----------- -------------- BALANCE SHEET DATA(1): Working capital................................... $(3,256,069) $44,313,929 Total assets...................................... 4,782,822 51,812,822 Deferred revenue(4)............................... 4,127,919 4,127,919 Total debt........................................ 3,825,000 0 Total shareholders' equity (deficit).............. (5,814,988) 45,040,012
FOR THE THREE MONTHS ENDED ---------------------------------------- SEPTEMBER DECEMBER MARCH JUNE 1995 1995 1996 1996 --------- --------- --------- ---------- SELECTED QUARTERLY OPERATING DATA: Number of PINs activated(5)......... 15,811 52,800 117,212 196,259 Number of minutes decremented(6).... 640,320 1,935,247 5,152,179 10,748,914 Number of recharge minutes purchased.......................... 154,974 312,390 666,030 1,112,130
- -------- (1) This data should be read in connection with the Financial Statements and Notes thereto included elsewhere in this Prospectus. (2) See Note 2 of Notes to Financial Statements for a discussion of net loss per share and shares used in computing net loss per share. (3) As adjusted to give effect to the application of the estimated net proceeds of the Offering based upon an assumed initial public offering price of $14 per share. See "Use of Proceeds." (4) Deferred revenue represents amounts for products shipped to retailers and recharged minutes that the Company has invoiced, which as of the date presented, have not been used by customers. Upon customer usage, the Company recognizes revenue and reduces the deferred revenue account. At the time the revenue is recognized, the costs to which that revenue specifically relates are also recognized. (5) "PINs" are personal identification numbers used by each customer to access the SmarTalk system. PINs are printed on the back of each SmarTalk Card or provided separately to customers. (6) "Minutes decremented" include minutes used by customers purchasing SmarTalk services and minutes used as a result of the distribution of free promotional goods. 6 CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS Certain statements contained under "Management's Discussion and Analysis of Financial Condition and Results of Operations," such as statements concerning the Company's ability to increase gross margins and decrease expenses, certain statements under "Business," such as statements concerning future services, proposed efforts to increase brand awareness, the future of the telecommunications industry and SmarTalk's plans to expand its retail distribution network and develop additional distribution channels and other statements contained herein regarding matters that are not historical facts, are forward-looking statements (as such term is defined in the Securities Act of 1933, as amended). Because such forward-looking statements include risks and uncertainties, actual results may differ materially from those expressed or implied by such forward-looking statements. Factors that could cause actual results to differ materially include, but are not limited to, those discussed under "Risk Factors." RISK FACTORS In addition to the other information in this Prospectus, the following factors should be considered carefully in evaluating an investment in the shares of Common Stock offered by this Prospectus. LIMITED OPERATING HISTORY; NET LOSSES; ACCUMULATED DEFICIT The Company was formed in October, 1994 and has had only a limited operating history upon which investors may base an evaluation of its performance. As a result of operating expenses and development expenditures, the Company has incurred significant operating and net losses to date. Net losses for the period ended December 31, 1994 and for the year ended December 31, 1995 and for the six months ended June 30, 1996 were approximately $65,000, $1.3 million, and $2.3 million, respectively. At June 30, 1996, the Company had an accumulated deficit of approximately $6.1 million. In addition, the Company plans to significantly increase its operating expenses in order to expand its sales and marketing efforts, fund a greater level of product development and marketing and otherwise support the growth of the Company. Given these planned expenditures, the Company anticipates that it will continue to incur losses for the foreseeable future and there can be no assurance that the Company will ever achieve or sustain profitability. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." INTENSE COMPETITION The telecommunications services industry is intensely competitive, rapidly evolving and subject to constant technological change. In 1994, there were approximately 75 companies marketing prepaid calling cards. Today there are more than 500 companies selling prepaid calling cards, and the Company expects competition to increase in the future. Other providers currently offer one or more of each of the services offered by the Company. As a service provider in the long distance telecommunications industry, the Company competes with three dominant providers, AT&T, MCI and Sprint, all of which are substantially larger and have: greater financial, technical, engineering, personnel and marketing resources; longer operating histories; greater name recognition; and larger customer bases than the Company. These advantages afford the Company's competitors pricing flexibility. Telecommunications services companies may compete for customers based on price, with the dominant providers conducting extensive advertising campaigns to capture market share. Competitors with greater financial resources may also be able to provide more attractive incentive packages to retailers to encourage them to carry products that compete with SmarTalk services. In addition, competitors with greater resources than the Company may be better situated to negotiate favorable contracts with retailers. The Company believes that existing competitors are likely to continue to expand their service offerings to appeal to retailers and their customers. Moreover, since there are few, if any, substantial barriers to entry, the Company expects that new competitors are likely to enter the telecommunications market and attempt to market telecommunications services similar to the Company's services which would result in greater competition. 7 The ability of the Company to compete effectively in the telecommunications services industry will depend upon the Company's continued ability to provide high quality SmarTalk services at prices generally competitive with, or lower than, those charged by its competitors. Certain of the Company's competitors dominate the telecommunications industry and have the financial resources to enable them to withstand substantial price competition, which is expected to increase significantly, and there can be no assurance that the Company will be able to compete successfully in the future. Moreover, there can be no assurance that certain of the Company's competitors will not be better situated to negotiate contracts with suppliers of telecommunications services which are more favorable than contracts negotiated by the Company. In addition, there can be no assurance that competition from existing or new competitors or a decrease in the rates charged for communications services by the major long distance carriers or other competitors would not have a material adverse effect on the Company's business, operating results or financial condition (a "Material Adverse Effect"). Recent changes in the regulation of the telecommunications industry may impact the Company's competitive position. The Telecommunications Act of 1996 (the "Telecommunications Act") was signed by President Clinton on February 8, 1996, effectively opening the long distance market to competition from the Regional Bell Operating Companies (the "RBOCs"). The entry of these well- capitalized and well-known entities into the long distance market will likely increase competition for long distance customers. The Telecommunications Act also grants the FCC the authority to deregulate other aspects of the telecommunications industry, which in the future may, if authorized by the FCC, facilitate the offering of telecommunications services by regulated entities, including the RBOCs, in competition with the Company. See "Business -- Competition." LIMITED PROTECTION OF PROPRIETARY RIGHTS; RISKS OF INFRINGEMENT The Company relies on a combination of copyright and trade secret laws and contractual confidentiality provisions to protect its proprietary rights. These laws and contractual provisions provide only limited protection of the Company's proprietary rights. The Company has patent and servicemark applications pending, but to date has no registered patents, servicemarks, trademarks or copyrights. The Company's application for the servicemark "SmarTalk" was initially denied by the Patent and Trademark Office of the U.S. Department of Commerce. The Company is presently appealing such determination. There can be no assurance that the Company will be successful in such appeal. While the Company believes that registering the servicemark is important to its business to further protect its existing common law right to use such servicemark, the Company does not believe that the failure thus far to register its servicemark is dispositive of whether the Company has the right to use such servicemark. Despite the Company's efforts to protect its proprietary rights, unauthorized parties may attempt to copy aspects of the Company's software or services or to obtain and use information that the Company regards as proprietary. There can be no assurance that the Company's efforts to protect its proprietary rights will be successful, or that the Company's competitors will not independently develop similar technology. In addition, the laws of some foreign countries do not protect the Company's proprietary rights to the extent of the laws of the U.S. See "Business -- The SmarTrac System" and "Business -- The SmarTalk Platforms." The Company is aware of other companies that use variations of the term "Smart" in their name or in describing their products or services, including telecommunications products and services. Three companies have written letters challenging the Company's use of the SmarTalk name. There can be no assurance that SmarTalk will achieve a satisfactory resolution of these disputes. If such claims are not satisfactorily resolved, the other parties may pursue additional avenues to address the dispute, including filing claims against the Company. The Company currently is incorporated or registered as a foreign corporation under the SmarTalk TeleServices, Inc. name in all fifty states and the District of Columbia. The Company does not believe that the use of "SmarTalk" as its name or with respect to SmarTalk services is improper, and no actions have been filed to date with respect to either patent, servicemark, trademark or copyright claims. However, no assurance can be given that actions or 8 claims alleging patent, servicemark, trademark or copyright infringement will not be brought against the Company with respect to its name or current or future SmarTalk services, or that, if such actions are brought, the Company will ultimately prevail. Any such claiming parties may have significantly greater resources than the Company to pursue litigation of such claims. Any such claims, whether with or without merit, could be time consuming, result in costly litigation, cause delays in introducing new or improved services, require the Company to enter into royalty or licensing agreements, or cause the Company to discontinue use of the challenged tradename, servicemark or technology, potentially giving rise to the significant expense associated with the marketing of a new name or the development or purchase of replacement technology, all of which could have a Material Adverse Effect. NEW INDUSTRY; UNCERTAINTY OF MARKET ACCEPTANCE The prepaid phone card industry segment is an emerging business characterized by an increasing and substantial number of new market entrants who have introduced or are developing an array of new products and services. Each of these entrants is seeking to market, advertise and position its products and services as the preferred method for accessing long distance telephone services, including providing enhanced service features. As is typically the case in an emerging industry, demand and market acceptance for newly introduced products and services are subject to a high level of uncertainty. There can be no assurance that substantial markets will continue to develop for prepaid phone cards or that the Company will be able to meet its current marketing objectives, succeed in positioning its cards and services as a preferred method for accessing long distance telephone services or achieve significant market acceptance for its products. See "Business -- Industry Overview." RAPID TECHNOLOGICAL CHANGE; DEPENDENCE ON NEW SERVICES The telecommunications services industry is characterized by rapid technological change, new product introduction and evolving industry standards. The Company's success will depend, in significant part, on its ability to make timely and cost-effective enhancements and additions to its technology and introduce new services that meet customer demands. The Company expects new products and services, and enhancements to existing products and services, to be developed and introduced to compete with SmarTalk services. The proliferation of new telecommunication technology, including personal communication services and voice communication over the Internet, may reduce demand for long distance services, including prepaid phone cards. There can be no assurance that the Company will be successful in developing and marketing new SmarTalk services or enhancements to SmarTalk services that respond to these or other technological changes or evolving industry standards. In addition, there can be no assurance that the Company will not experience difficulties that could delay or prevent the successful development, introduction and marketing of its existing SmarTalk services or that its new SmarTalk services or enhancements thereto, will adequately meet the requirements of the marketplace and achieve market acceptance. Delay in the introduction of new SmarTalk services or enhancements, the inability of the Company to develop such new SmarTalk services or enhancements or the failure of such SmarTalk services or enhancements to achieve market acceptance could have a Material Adverse Effect. See "Business -- Competition," "Business -- Products and Telecommunications Services." DEPENDENCE ON MAJOR RETAILER CUSTOMERS Currently, the SmarTalk Card is sold at selected retail locations throughout the U.S., including locations operated by the following leading retailers: American Drug Stores (which includes Jewel/Osco Combo Stores, Osco Drug Stores and Sav-On Drug Stores), Office Depot, Thrifty Oil, Builders Square, Hills Department Stores, Bradlees, Bergen Brunswig Drug Company (Good Neighbor Pharmacy), Venture Stores, Foley's Department Stores, Marshall Field's, Fred W. Albrecht Grocery Company, Office1 Superstores and Price/Costco. The Company's arrangements with retailers are 9 generally pursuant to short-term arrangements. If the Company is unsuccessful in providing competitive pricing, meeting the requirements of its retailers, developing new products that are attractive to such retailers, or complying with the terms of its arrangements with such retailers, such retailers may fail to market aggressively the Company's services or may terminate their relationship with the Company, either of which could have a Material Adverse Effect. Substantially all of the Company's revenue to date has been derived from the sale of the SmarTalk Card to retailers. Certain of those retailers have, from time to time, accounted for a significant percentage of the Company's revenue. The inability of any such retailer to pay the Company for SmarTalk cards shipped or the loss of any such retailer could have a Material Adverse Effect. SEASONALITY; FACTORS AFFECTING OPERATING RESULTS; POTENTIAL FLUCTUATIONS IN PERIOD-TO-PERIOD RESULTS The Company's sales have been, and the Company expects that its sales will continue to be, somewhat seasonal, due to holiday purchases of the SmarTalk Card. In addition, the Company's operating results have varied significantly in the past and may vary significantly in the future. Factors that may cause the Company's operating results to vary include (i) changes in operating expenses, (ii) the timing of the introduction of SmarTalk services, (iii) market acceptance of new and enhanced versions of SmarTalk services, (iv) potential acquisitions, (v) changes in legislation and regulation which affect the competitive environment for SmarTalk services, and (vi) general economic factors. Moreover, for many of the Company's retailers, SmarTalk services represent a new merchandising category, with the attendant concerns regarding shelf space positioning, sales force education and effective marketing and, with respect to arrangements with certain retailers requiring customized SmarTalk services, there may be significant leadtime to provide such SmarTalk services following receipt of the customers' orders. As a result of these factors, the Company believes that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as an indication of future performance. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." ABILITY TO MANAGE GROWTH AND IMPLEMENT NEW ACCOUNTING SYSTEM; NEED TO HIRE ADDITIONAL EMPLOYEES Although SmarTalk has experienced substantial growth in revenue in the last year and intends to continue to grow rapidly, there can be no assurance that the growth experienced by the Company will continue or that the Company will be able to achieve the growth contemplated by its business strategy. The Company's ability to continue to grow may be affected by various factors, many of which are not within the Company's control, including competition and federal and state regulation of the telecommunications industry. This growth has placed, and is expected to continue to place, significant demands on all aspects of the Company's business, including its administrative, technical and financial personnel and systems. The Company's future operating results will substantially depend on the ability of its officers and key employees to manage such anticipated growth, to attract and retain additional highly qualified management, technical and financial personnel, and to implement and/or improve its technical, administrative, financial control and reporting systems. The Company's financial controls and reporting systems will require enhancement and substantial investment in the future to accommodate the Company's anticipated growth. There can be no assurance that the Company will not encounter difficulties in expanding its financial controls and reporting systems to meet the Company's future needs. If the Company is unable to respond to and manage changing business conditions, then the quality of SmarTalk services, its ability to retain key personnel and its results of operations could be materially adversely affected. Difficulties in managing continued growth could have a Material Adverse Effect. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." 10 The Company recently revised its method of revenue recognition from the method originally utilized for internal financial reporting purposes. The financial information contained herein reflects this revised method, the principal effects of which are to decrease the level of current revenue recognition and to create a deferred revenue account. Under this method of revenue recognition, the Company recognizes revenue and reduces the deferred revenue account as the customer utilizes calling time and upon expiration of cards containing unused calling time. In response to these changes and in order to upgrade its management information systems, the Company is currently implementing a new accounting system with control and tracking applications not present in the previous system. In connection with the implementation of the new system, the Company will contract with outside consultants to review the controls and administrative protocols associated with the new system. Although the Company believes that the newly installed system will be adequate to keep pace with the growth in the Company's business and the revised method of revenue recognition, there can be no assurance that the newly installed system will function properly or that the Company will not experience financial control difficulties in future periods. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." DEPENDENCE ON KEY MANAGEMENT AND PERSONNEL SmarTalk's success is largely dependent upon its executive officers, the loss of one or more of whom could have a Material Adverse Effect. The Company believes that its continued success will depend to a significant extent upon the efforts and abilities of Robert H. Lorsch, Chairman of the Board, President and Chief Executive Officer and Richard Teich, Executive Vice President. Although the Company believes that it would be able to locate suitable replacements for these executives if their services were lost, there can be no assurance it would be able to do so. Accordingly, the loss of services of any of these individuals could have a Material Adverse Effect. See "Management." DEPENDENCE UPON TELECOMMUNICATIONS PROVIDERS; NO GUARANTEED SUPPLY The Company does not own a transmission network and, accordingly, depends primarily on AT&T (accessed through West Interactive) and MCI for transmission of its long distance calls. The Company obtains its MCI long distance telecommunications services pursuant to a Preferred Carrier Agreement with MCI which obligates the Company to utilize a specified number of minutes to receive favorable pricing. The Company's failure to utilize the required minutes by the end of the term of the agreement with MCI would require the Company to pay an underutilization charge to MCI. While the Company anticipates that it will fulfill its minimum usage requirements, any material failure to meet such minimum usage requirements could have a Material Adverse Effect. In the future, the Company may determine that it is desirable to enter into additional agreements containing minimum usage requirements. Further, the Company is dependent upon local exchange carriers for call origination and termination. The Company's ability to maintain and expand its business depends, in part, on its ability to continue to obtain telecommunications services on favorable terms from long distance carriers and other such suppliers, as well as the cooperation of both interexchange and local exchange carriers in originating and terminating service for its customers in a timely manner. The Company has not experienced significant losses in the past because of interruptions of service at any of its carriers, but no assurance can be made in this regard with respect to the future. In addition, no assurance can be given that the Company will be able to obtain long distance services in the future at favorable prices, and a material increase in the price at which the Company obtains long distance service could have a Material Adverse Effect. See "-- Intense Competition" and "Business -- Products and Telecommunications Services." POSSIBLE INABILITY TO RECOGNIZE A PORTION OF DEFERRED REVENUE The sale of long distance domestic and outbound international telephone service through prepaid phone cards may be subject to "escheat" laws in various states. These laws generally provide that 11 payments or deposits received in advance or in anticipation of the provision of utility (including telephone) services that remain unclaimed for a specific period of time after the termination of such services are deemed "abandoned property" and must be submitted to the state. Although the Company is not aware of any case in which such laws have been applied to the sale of prepaid phone cards, and does not believe that such laws are applicable, in the event that such laws are deemed applicable, the Company may be unable to recognize the portion of its deferred revenue remaining upon the expiration of SmarTalk cards with unused calling time. In such event, the Company may be required to deliver such amounts to certain states in accordance with these laws, which could have a Material Adverse Effect. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." UNCERTAINTY OF STRATEGIC RELATIONSHIPS A principal element of the Company's strategy is the creation and maintenance of relationships with wholesale distributors and other organizations with whom the Company has strategic alliances that will enable the Company to offer its services to a wider customer base than the Company could reach solely through direct marketing efforts. The Company has entered into strategic alliances, including those with Pacific Bell, MCI, West Interactive and Douglas Stewart, and the Company plans to aggressively develop additional strategic relationships. These relationships were formed recently and the Company is unable to predict the success or failure of these relationships due to limited operating experience with these organizations. The Company's success depends in part on the ultimate success of these relationships to effectively aid in the marketing and distribution of SmarTalk services. See "Business -- Strategic Partners." The ability of the Company's strategic partners to incorporate the Company's services into successful commercial ventures will require the Company, among other things, to continue to successfully enhance its existing SmarTalk services and develop new services. The Company's inability to meet the requirements of such strategic partners, or to comply with the terms of its arrangements with such parties, could result in such parties failing to market the Company's services, seeking alternative providers of telecommunications services or cancelling their contracts with the Company, any of which could have a Material Adverse Effect. See "Business -- The SmarTalk Strategy" and "Business -- Marketing and Distribution." DEPENDENCE ON FACILITIES AND PLATFORMS; DAMAGE, FAILURE AND DOWNTIME The Company currently owns the VoiceChoice Platform, a call processing platform site located in San Francisco, California, and utilizes additional call processing platform services at a facility located in San Antonio, Texas which is backed up by a facility in Omaha, Nebraska. The Company's network service operations are dependent upon its ability to protect the equipment and data at such facilities against damage that may be caused by fire, power loss, technical failures, unauthorized intrusion, natural disasters, sabotage and other similar events. Although the Company has taken precautions to protect itself and its customers from events that could interrupt delivery of SmarTalk services, there can be no assurance that a fire, act of sabotage, technical failure, human error, natural disaster or a similar event would not cause the failure of a significant technical component, thereby resulting in an outage. Such an outage could have a Material Adverse Effect. The Company believes that technical failures have not resulted in any material downtime of the SmarTalk Platforms since the Company's inception. Although the Company maintains business interruption insurance providing for aggregate coverage of approximately $1.0 million per occurrence, there can be no assurance that the Company will be able to maintain its business interruption insurance, that such insurance would continue to be available at reasonable prices, that such insurance would cover all such losses or that such insurance 12 would be sufficient to compensate the Company for losses it experiences due to the Company's inability to provide services to its customers. See "Business -- The SmarTalk Platforms." DEPENDENCE UPON SOFTWARE The Company has developed, and depends on, its own proprietary in-house data reporting and tracking system, the SmarTrac System, that provides a series of database query and report capabilities that are used to track inventory, control fraud and monitor system usage by card and retailer. The Company also depends on its software, as well as software developed by or on behalf of Pacific Bell Information Services, West Interactive and others, to provide services to its customers. While the Company is presently negotiating agreements to license certain software to operate the VoiceChoice Platform, there can be no assurance that such negotiations will be successfully completed. The software utilized by the Company in providing its services may contain undetected errors. Although the Company engages in extensive testing of its software prior to introducing the software onto its network, there can be no assurance that errors will not be found in software after commencement of use of such software. Any such error may result in partial or total failure of the Company's network, requiring the Company to commit additional and unanticipated funds for further product development, including the retention of additional programming personnel. In addition, such failure may result in a loss of customers and a corresponding decrease in revenue which would have a Material Adverse Effect. See "Business -- The SmarTrac System" and "Business -- The SmarTalk Platforms." REGULATION The Company is currently subject to federal and state government regulation of its long distance telephone services. The Company is regulated at the federal level by the FCC and is currently required to maintain both domestic and international tariffs for its services containing the currently effective rates, terms, and conditions of service. The FCC has proposed, however, to eliminate the tariffing requirement for domestic interstate non-dominant carriers. In addition, the Company is required to maintain a certificate, issued by the FCC, in connection with its outbound international services. The intrastate long distance telecommunications operations of the Company are also subject to various state laws and regulations, including prior certification, notification or registration requirements. The Company generally must obtain and maintain certificates of public convenience and necessity from regulatory authorities in most states in which it offers service. In most of these jurisdictions, the Company must file and obtain prior regulatory approval of tariffs for intrastate services. In addition, the Company must update or amend the tariffs and, in some cases, the certificates of public convenience and necessity when rates are adjusted or new products are added to the long distance services offered by the Company. The FCC and numerous state agencies also impose prior approval requirements on transfers of control, including pro forma transfers of control and corporate reorganizations, and assignments of regulatory authorizations. As a result, the Company has filed or will file certain notices and applications for the consummation of the Offering. While the Company expects to receive all such approvals that have been requested and believes that it is or shall soon be otherwise in compliance with the applicable state and federal regulations governing telecommunications service, there can be no assurance that the FCC or the regulatory authorities in one or more states will not raise material issues with regard to the Company's compliance with applicable regulations, including transfer, stock issuance and similar regulations, or that regulatory activities will not have a Material Adverse Effect. If the federal and state regulations requiring the local exchange carriers to provide equal access for the origination and termination of calls by long distance subscribers (such as the Company's customers) change or if the regulations governing the fees to be charged for such access services change, particularly if such regulations are changed to allow variable pricing of such access fees based upon volume, such changes could have a Material Adverse Effect. See "Business -- Industry Overview," "Business -- Competition" and "Business -- Government Regulation." 13 RISK OF LOSS FROM RETURNED TRANSACTIONS; FRAUD; BAD DEBT; THEFT OF SERVICES The Company utilizes national credit card clearance systems for electronic credit card settlement. The Company generally bears the same credit risks normally assumed by other users of these systems arising from returned transactions caused by closed accounts, frozen accounts, unauthorized use, disputes, theft or fraud. The Company's relationships with providers of merchant card services such as VISA and MasterCard could be adversely affected by excessive uncollectibles or chargebacks, which are generally higher in the telephone industry than in other industries, particularly with respect to recharges because the transaction typically is not on a face to face basis in which a cardholder signature is captured. Termination of the Company's ability to offer recharge through merchant card services would have a Material Adverse Effect. To minimize its financial exposure, the Company limits the amount that customers can recharge within specified timeframes and generally charges a higher rate for recharge services than for the initial purchase. From time to time, persons also have obtained services without rendering payment to the Company by unlawfully utilizing the Company's access numbers and PINs. Although to date the Company has not experienced material losses due to such unauthorized use of access numbers and customized PINs, no assurance can be given that future losses due to unauthorized use will not be material. The Company attempts to manage these credit, theft and fraud risks through its internal controls, monitoring and blocking systems. The Company also maintains reserves which it deems adequate for such risks. Past experience in estimating and establishing reserves and the Company's historical losses are not necessarily accurate indications of the Company's future losses or the adequacy of the reserves established by the Company in the future. Although the Company believes that its risk management and bad debt reserve practices are adequate, there can be no assurance that the Company's risk management practices or reserves will be sufficient to protect the Company from unauthorized or returned transactions or thefts of services which could have a Material Adverse Effect. See "Management's Discussion and Analysis of Financial Condition and Results of Operation -- Liquidity and Capital Resources" and "Business -- The SmarTrac System." SUBSTANTIAL DISCRETION OF MANAGEMENT CONCERNING USE OF PROCEEDS The Company has allocated approximately $39 million of the net proceeds of the Offering for specific identified purposes, with the remainder of approximately $12 million to be used for working capital and general corporate purposes, including possible acquisitions. Accordingly, management will have substantial discretion in spending a large percentage of the proceeds to be received by the Company. See "Use of Proceeds." The Company in the future may pursue acquisitions of complementary services, products, technologies or businesses, although the Company currently has no agreements or understandings with respect to any acquisition, and no portion of the net proceeds has been allocated to specific acquisitions. Future acquisitions may result in the potentially dilutive issuance of equity securities, the incurrence of additional debt, the writing off of software development costs, or the amortization of expenses related to goodwill and other intangible assets, any of which could have a Material Adverse Effect. Future acquisitions would involve numerous additional risks, including (i) difficulties in the assimilation of the operations, services, products and personnel of the acquired company, (ii) the diversion of management's attention from other business concerns, (iii) entry into markets in which the Company has limited or no prior experience, and (iv) the potential loss of key employees of the acquired company. CONTROL OF COMPANY Upon completion of the Offering and without giving effect to the Underwriters' over-allotment option, the present directors, executive officers and their respective affiliates will beneficially own 6,191,505 shares (approximately 48.2%) of the outstanding Common Stock, of which 5,868,515 shares (approximately 45.8%) will be beneficially owned by Mr. Lorsch. In addition to the shares included in 14 the calculation of beneficial ownership, the present directors, executive officers and their respective affiliates hold options to acquire an additional 81,851 shares of Common Stock not exercisable within 60 days of the date of this Prospectus, which together with shares currently beneficially owned would represent approximately 48.6% of the Common Stock outstanding after consummation of the Offering, after giving effect to the exercise of those options. As a result, these shareholders in general, and Mr. Lorsch in particular, will be able to exercise significant influence over all matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions. Such concentration of ownership may also have the effect of delaying or preventing a change in control of the Company. See "Principal and Selling Shareholders" and "Description of Capital Stock -- Certain Provisions of the Company's Articles and Bylaws." ANTI-TAKEOVER CONSIDERATIONS The board of directors has authority to issue up to 10,000,000 shares of preferred stock and to fix the rights, preferences, privileges and restrictions, including voting rights, of the preferred stock without further vote or action by the Company's shareholders. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. While the Company has no present intention to issue shares of preferred stock, such issuance could make it more difficult for a third party to acquire a majority of the outstanding voting stock of the Company. See "Description of Capital Stock -- Preferred Stock." The Company's Amended and Restated Articles of Incorporation (the "Articles"), Amended and Restated Bylaws (the "Bylaws") and the California Corporations Code contain certain provisions that could have the effect of making it more difficult for a party to acquire, or of discouraging a party from attempting to acquire, control of the Company without approval of the Company's board of directors. See "Description of Capital Stock -- Certain Provisions of the Company's Articles and Bylaws." ABSENCE OF PUBLIC MARKET AND POSSIBLE VOLATILITY OF STOCK PRICE Prior to the Offering, there has been no public market for the Common Stock and there can be no assurance that an active market will develop upon consummation of the Offering. The initial public offering price will be determined by negotiations among the Company, the Selling Shareholders and the Representatives of the Underwriters. See "Underwriting" for a description of the factors to be considered in determining the initial public offering price. There is no assurance that the market price of the Common Stock after the Offering will not decline below the initial public offering price. The market price of the Common Stock is likely to be volatile. The Company believes factors such as actual or anticipated quarterly fluctuations in financial results, changes in earnings estimates by securities analysts and announcements of material events by the Company, its retail customers or its competitors may cause the market price for the Common Stock to fluctuate, perhaps substantially. In addition, in recent years the stock market has experienced extreme price and volume fluctuations which have affected the market price for many companies in industries similar to the phone card industry and which have often been unrelated to the operating performance of these companies. These fluctuations, as well as general economic conditions, may have a material adverse effect on the price of the Common Stock. SHARES ELIGIBLE FOR FUTURE SALE Future sales of substantial shares of Common Stock by existing shareholders could adversely affect the market price of the Common Stock. The 4,200,000 shares offered hereby will be eligible for immediate sale in the public market without restriction. Of the remaining 8,624,834 shares of Common Stock which will be outstanding upon the completion of this Offering, 8,501,286 will be subject to 180-day lock-up agreements between the Company's current shareholders and the Underwriters. After the expiration of such agreements, pursuant to Rule 144 under the Securities Act, such shareholder(s) may sell such shares without registration, subject to certain holding requirements and volume 15 limitations. In addition, SmarTalk Partners, LLC ("SmarTalk Partners") is entitled to certain rights with respect to the registration of its shares of Common Stock under the Securities Act. A decision by any such shareholder(s) to publicly sell a significant number of shares of the Common Stock will have the potential to cause a material decrease in the trading price of the Common Stock and may impair the future ability of the Company to raise capital at prices or on terms favorable to the Company. See "Shares Eligible for Future Sale," "Description of Capital Stock -- Registration Rights" and "Underwriting." IMMEDIATE AND SUBSTANTIAL DILUTION TO NEW INVESTORS Purchasers of shares of Common Stock in the Offering will experience immediate and substantial dilution of the net tangible book value per share of Common Stock in the amount of $10.49 per share. To the extent options to purchase the Company's Common Stock are exercised in the future, there will be further dilution. See "Dilution." 16 USE OF PROCEEDS The net proceeds from the sale of the shares of Common Stock offered hereby by the Company at an assumed initial offering price of $14 per share are estimated to be approximately $50,855,000, after deducting the underwriting discount and estimated offering expenses payable by the Company. The Company intends to use the net proceeds of the Offering as follows: (i) approximately $1.2 million to repay term loan indebtedness to SmarTalk Partners (which bears interest at 7% per annum and has a maturity date of July 31, 2000), (ii) approximately $500,000 to repay existing borrowings under a revolving line of credit with SmarTalk Partners (which bears interest at a floating rate equal to the prime rate plus 2% per annum which equaled 10.25% at August 13, 1996 and has a maturity date of January 31, 1998), (iii) approximately $250,000 to repay term loan indebtedness to SmarTalk Partners (which bears interest at a floating rate equal to the prime rate which was 8.25% at August 13, 1996 and has a maturity date of January 31, 1997), (iv) approximately $2 million to repay term loan indebtedness to Lorsch Creative Network, Inc. ("LCN") (which bears interest at 7% per annum and has a maturity date of June 20, 2000), (v) approximately $10 million to fund certain capital expenditures, including upgrades to the SmarTalk Platforms, the possible acquisition of new platforms and purchases of point of sale equipment, (vi) approximately $20 million to fund marketing and new business development opportunities, (vii) approximately $5 million to fund the expansion of the Company's business internationally, and (viii) for additional working capital and general corporate purposes, including acquisitions, although the Company currently has no agreements or understandings with respect to any acquisition, and no portion of the net proceeds has been allocated to specific acquisitions. In addition, the Company is raising such monies at this time in order to create a market for the Company's Common Stock, to facilitate future access by the Company to the public equity markets and to enhance the Company's public image and credibility to support its marketing efforts, particularly with current or potential retailers and strategic partners. The Company has used proceeds from the indebtedness to SmarTalk Partners for working capital and general corporate purposes, including securing office space, expanding the Company's retail distribution network, and acquiring the VoiceChoice Platform. The indebtedness to LCN was incurred in connection with the acquisition of certain of its assets by the Company. See "Certain Transactions." The Company will not receive any of the proceeds from the sale of shares of Common Stock by the Selling Shareholders. Prior to the application of the net proceeds of the Offering as described above, such funds will be invested in short-term, interest bearing securities. DIVIDEND POLICY The Company has never paid cash dividends on its Common Stock, and the current policy of the Company's board of directors is to retain any available earnings for use in the operation and expansion of the Company's business. Therefore, the payments of cash dividends on the Common Stock is unlikely in the foreseeable future. Currently, the Company's line of credit prohibits the Company from paying cash dividends without the lender's prior approval. See the Financial Statements and Notes thereto included elsewhere in this Prospectus. However, the Company will use the proceeds from the Offering to pay off and terminate the line of credit. Any future determination to pay cash dividends will be at the discretion of the board of directors and will depend upon the Company's earnings, capital requirements, financial condition and any other factors deemed relevant by the board of directors. 17 CAPITALIZATION The following table sets forth the capitalization of the Company as of June 30, 1996, and as adjusted to reflect the sale of the 4,000,000 shares of Common Stock offered by the Company hereby at an assumed initial public offering price of $14 per share and the application of the estimated net proceeds therefrom as described in "Use of Proceeds." This table should be read in conjunction with the Financial Statements and the related Notes thereto included elsewhere in this Prospectus.
JUNE 30, 1996 -------------------------- ACTUAL AS ADJUSTED(1) ----------- ------------- Short-term debt.................................... $ 539,998 $ 0 Long-term debt..................................... 3,285,002 0 ----------- ----------- Total debt......................................... 3,825,000 0 ----------- ----------- Shareholders' equity (deficit): Preferred stock, no par value; 10,000,000 shares authorized; no shares issued and outstanding(2). -- -- Common stock, no par value; 100,000,000 shares authorized; 8,824,834 shares issued and outstanding; 12,824,834 shares issued and outstanding as adjusted(2)...................... 315,000 51,170,000 Retained earnings (accumulated deficit)............ (6,129,988) (6,129,988) ----------- ----------- Total shareholders' equity (deficit)............... (5,814,988) 45,040,012 ----------- ----------- Total capitalization............................. $(1,989,998) $45,040,012 =========== ===========
- -------- (1) Adjusted to reflect the application of the estimated net proceeds to the Company from the sale of Common Stock offered hereby. See "Use of Proceeds." (2) Excludes 508,514 shares of Common Stock reserved for issuance upon exercise of outstanding options granted by the Company. See "Management -- Stock Option Plans." 18 DILUTION The net tangible book value (deficit) of the Company's Common Stock as of June 30, 1996 was $(5.8) million or $(0.66) per share. "Net tangible book value (deficit)" per share represents the amount of total tangible net assets less total liabilities, divided by the number of shares of Common Stock outstanding. After giving effect to the sale of 4,000,000 shares of Common Stock offered by the Company hereby, and after deducting underwriting discounts and estimated offering expenses payable by the Company and receipt of the net proceeds by the Company in the Offering, the pro forma net tangible book value (deficit) of the Company as of June 30, 1996 would have been $45 million, or $3.51 per share, representing an immediate increase in net tangible book value of $4.17 per share to existing shareholders and an immediate dilution of $10.49 per share to new investors purchasing shares in the Offering. The following table illustrates the resulting per share dilution with respect to the shares of Common Stock to be sold by the Company in the Offering: Assumed initial public offering price per share............... $14.00 Net tangible book value (deficit) per share before the Offering................................................... $(0.66) Increase per share attributable to new investors............ 4.17 ------ Pro forma net tangible book value (deficit) per share after the Offering................................................. 3.51 ------ Dilution per share to new investors........................... $10.49 ======
The foregoing computations assume no exercise of stock options prior to completion of the Offering. Options to purchase an aggregate of 508,514 shares of Common Stock at exercise prices ranging from $1.77 to $4.44 per share, with a weighted average exercise price of approximately $3.96 per share, will be outstanding and unexercised upon completion of the Offering. If all of such stock options had been exercised at June 30, 1996, the pro forma net tangible book value per share after the Offering would be $3.53, representing an increase in pro forma net tangible book value of $3.94 per share and dilution to new investors of $10.47 per share. The following table summarizes the difference between existing shareholders and new investors with respect to the number of shares of Common Stock purchased from the Company, the total consideration paid to the Company before deduction of underwriting discounts and estimated offering expenses and the average price paid per share.
SHARES TOTAL PURCHASED CONSIDERATION AVERAGE --------------------- ---------------------- PRICE NUMBER PERCENTAGE AMOUNT PERCENTAGE PER SHARE ---------- ---------- ----------- ---------- --------- New Investors........... 4,000,000 31.2% $56,000,000 99.4% $14.00 Existing Shareholders(1)........ 8,824,834 68.8 315,000 0.6 0.04 ---------- ----- ----------- ----- Total................. 12,824,834 100.0% $56,315,000 100.0%
- -------- (1) Excludes 508,514 shares of Common Stock reserved for issuance upon exercise of outstanding options granted by the Company. See "Management -- Stock Option Plans." 19 SELECTED FINANCIAL DATA The following table sets forth selected financial data of the Company. The Statement of Operations Data for the period from inception (October 28, 1994) to December 31, 1994 and for the year ended December 31, 1995 and the Balance Sheet Data as of December 31, 1994 and 1995 have been derived from the Company's audited Financial Statements, which are included elsewhere in this Prospectus. The selected financial data for the six months ended June 30, 1995 and 1996 are derived from the unaudited Financial Statements of the Company, which are included elsewhere in this Prospectus. In the opinion of management, the unaudited Financial Statements have been prepared on the same basis as the audited Financial Statements and include all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of the financial position and results of operations for such periods. The results for the six months ended June 30, 1996 are not necessarily indicative of the results that may be expected for the year ending December 31, 1996 or any other future period. The selected financial data set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Financial Statements and Notes thereto included elsewhere in this Prospectus.
SIX MONTHS ENDED PERIOD FROM INCEPTION YEAR ENDED JUNE 30, (OCTOBER 28, 1994) TO DECEMBER 31, ---------------------- DECEMBER 31, 1994 1995 1995 1996 --------------------- ------------ --------- ----------- STATEMENT OF OPERATIONS DATA: Revenue............... $ 444 $ 453,916 $ 41,738 $ 3,678,020 Cost of revenue....... 716 312,286 29,110 2,680,115 --------- ----------- --------- ----------- Gross profit (loss). (272) 141,630 12,628 997,905 Operating expenses Sales and marketing. 1,980 842,306 173,242 1,643,426 General and administrative..... 63,220 630,638 124,823 1,521,293 --------- ----------- --------- ----------- Loss from operations.. (65,472) (1,331,314) (285,437) (2,166,814) Net interest expense (income)............. -- (2,012) -- 104,372 --------- ----------- --------- ----------- Loss from operations before income tax expense.............. (65,472) (1,329,302) (285,437) (2,271,186) Provision for income taxes................ -- -- -- -- --------- ----------- --------- ----------- Net loss............ $ (65,472) $(1,329,302) $(285,437) $(2,271,186) --------- ----------- --------- ----------- Net loss per share(1)........... $ (.01) $ (.14) $ (.03) $ (.24) ========= =========== ========= =========== Weighted average number of common shares and common equivalent shares(1).......... 9,333,348 9,333,348 9,333,348 9,333,348 ========= =========== ========= =========== Supplemental loss per common share(2)........... $ -- $ -- $ -- $ (.23) ========= =========== ========= ===========
DECEMBER 31, --------------------- JUNE 30, 1994 1995 1996 -------- ----------- ----------- BALANCE SHEET DATA: Working capital........................... $(60,472) $(1,400,360) $(3,256,069) Total assets.............................. 4,023 3,841,752 4,782,822 Deferred revenue(3)....................... 431 3,696,515 4,127,919 Total debt................................ -- -- 3,825,000 Total shareholders' equity (deficit)...... (60,472) (1,379,774) (5,814,988)
FOR THE THREE MONTHS ENDED ---------------------------------------- SEPTEMBER DECEMBER MARCH JUNE 1995 1995 1996 1996 --------- --------- --------- ---------- SELECTED QUARTERLY OPERATING DATA: Number of PINs activated(4)......... 15,811 52,800 117,212 196,259 Number of minutes decremented(5).... 640,320 1,935,247 5,152,179 10,748,914 Number of recharge minutes purchased.......................... 154,974 312,390 666,030 1,112,130
- ------- (1) See Note 2 of Notes to Financial Statements for a discussion of net loss per share and shares used in computing net loss per share. (2) Supplemental loss per share has been calculated as if $3,825,000 of the proceeds from the Offering were used to retire debt totaling $3,825,000. Only the incremental shares necessary to retire this debt, based upon assumed net proceeds of $12.71 per share, have been included in the calculation. See "Use of Proceeds." (3) Deferred revenue represents amounts for products shipped to retailers and recharged minutes that the Company has invoiced, which as of the date presented have not been used by customers. Upon customer usage, the Company recognizes revenue and reduces the deferred revenue account. At the time the revenue is recognized, the costs to which that revenue specifically relates are also recognized. (4) "PINs" are personal identification numbers used by each customer to access the SmarTalk system. PINs are printed on the back of each SmarTalk Card or provided separately to customers. (5) "Minutes decremented" include minutes used by customers purchasing SmarTalk services and minutes used as a result of the distribution of free promotional goods. 20 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the Company's Financial Statements and the related Notes thereto included elsewhere in this Prospectus. OVERVIEW SmarTalk provides convenient, easy to use, cost-effective long distance telecommunications products and services to customers primarily through the SmarTalk Card. The SmarTalk Card provides customers with a single point of access to telecommunications services at a favorable rate on a per minute prepaid basis. The SmarTalk Card may also be recharged on-line using a major credit card which allows the customer to add minutes as needed. The Company was formed in October, 1994 and had limited operations until June, 1995. From its date of inception until September, 1995, SmarTalk had no employees. SmarTalk contracted, on a project by project basis, with LCN and other independent contractors to perform substantially all operational activities, including sales management, marketing services, and general and administrative functions. See "Certain Transactions." Since the Company's inception, revenues have continued to increase. Over the period since July, 1995, when the Company began shipping its product to retailers, through June, 1996, total revenues were $4,090,198. The Company believes this amount is attributable to customers' acceptance of SmarTalk services and similar products, and management's unique marketing strategy of targeting the retail distribution channel. SmarTalk's revenue originates from (i) Company and co-branded phone card sales through retailers, (ii) recharges of existing phone cards, (iii) cards sold for promotional marketing campaigns, (iv) corporate sales to businesses (Corporate Advantage Program) and (v) certain services provided to one of the Company's strategic partners. Under sales agreements with the majority of retailers, the Company sells cards to the retailer at a set price with normal credit terms. The Company generally invoices the retailer upon shipment, recognizing deferred revenue. The Company recognizes revenue and reduces the deferred revenue account as the customer utilizes calling time and upon expiration of cards containing unused calling time. The Company also recognizes deferred revenue upon recharge of existing phone cards and recognizes the revenue upon the usage or expiration of the recharge minutes. The Company believes that its policy of recognizing revenue at the time its products and services are used by the customer or expire rather than upon sale to retailers or, in the case of recharges, at the time of the recharge, is a conservative method of revenue recognition. SmarTalk's cost of revenue consists primarily of the cost of providing the long distance service and related enhanced services as well as the cost of manufacturing and delivering the cards. The cost of providing long distance service represents obligations to carriers that provide minutes of long distance over their networks and the services associated with the Company's product. The Company expects its cost of revenue as a percentage of sales to decrease in the future due to the acquisition of the VoiceChoice Platform, economies of scale and volume discounts. Sales and marketing expenses consist primarily of commissions and advertising costs. The Company pays commissions to its sales representatives based on sales to retailers. The Company also pays a commission to its sales representatives and retailers based on the number of minutes recharged on SmartTalk cards sold by each retailer. These commissions are capitalized and amortized 21 into expense based on minutes used by the customer. Advertising consists primarily of co-op advertising and Manufacturers Development Funds ("MDF"). Under the typical co-op advertising program, the Company matches advertising expenditures by retailers to promote sales of SmarTalk services. The amount of funds the Company matches through its co-op advertising program is based on a percentage of sales of SmarTalk services by retailers. MDF consists of promotional and marketing programs to access shelf space. Advertising expense includes trade and consumer advertising, trade show expenses, promotional goods and the costs of providing to retailers the Company's turnkey merchandising supplies. The Company expects sales and marketing expenses to increase in the future, but expects that sales and marketing expenses as a percentage of revenue will decrease. General and administrative expenses consist primarily of salaries and other general expenses. Sales and excise taxes for the SmarTalk Platforms are incurred based on customer usage of long distance minutes which are processed through each of the individual platforms. Other general expenses include bad debt expense (accrued as a percentage of sales), rent, insurance, VISA and MasterCard processing fees and other operating expenses. The Company also includes in general and administrative expenses the costs related to the development of the Company's proprietary switching, application and database access software. The Company expects general and administrative expenses to increase in the future as it adds the personnel and infrastructure necessary to meet its planned growth in sales, but expects that general and administrative expenses as a percentage of revenue will decrease. SIX MONTHS ENDED JUNE 30, 1996 COMPARED WITH SIX MONTHS ENDED JUNE 30, 1995 Revenue. Sales increased to $3,678,020 for the six months ended June 30, 1996 from $41,738 for the six months ended June 30, 1995. The substantial increase in sales during the six months ended June 30, 1996 compared with the same period in the prior year reflects an increase in usage of SmarTalk products shipped, an increase in the number of retail storefronts in which the Company's product is distributed as well as usage by corporate customers which did not occur in the 1995 period. In addition, sales included approximately $460,000 relating to a distribution and processing agreement entered into on June 1, 1996 with one of the Company's strategic partners. The agreement provides that the Company will provide customer, marketing and processing services for a major prepaid phone card retail customer of one of its strategic partners. Other factors affecting the increase in revenue include broader product exposure and greater brand awareness and consumer acceptance. In addition, the Company experienced increased revenue from recharge minutes during the six months ended June 30, 1996 due to a greater number of SmarTalk cards in the marketplace. Cost of Revenue. Cost of revenue increased to $2,680,115 for the six months ended June 30, 1996 from $29,110 for the six months ended June 30, 1995. The increase is attributable to the increased usage of the Company services. The gross profit percentage for the six months ended June 30, 1996 was 27.1% as compared to 30.3% for the six months ended June 30, 1995. Gross margin decreased primarily due to the above-mentioned distribution and processing agreement. The Company is presently renegotiating this agreement and anticipates that if its efforts are successful, the impact on gross margin in the future will be lessened as it begins providing its products and services directly to the retailer. Sales and Marketing Expenses. Sales and marketing expenses increased to $1,643,426 (or 44.7% of revenue) for the six months ended June 30, 1996 from $173,242 (or 415.1% of revenue) for the six months ended June 30, 1995. The increase was primarily due to the increased commissions paid to sales representatives and to retailers on recharges, as well as the continued expansion of the Company's marketing activities, which include co-op advertising, MDF and free promotional goods. Certain of the expenses incurred by SmarTalk during the six months ended June 30, 1995 were incurred by LCN and LCN was subsequently reimbursed by the Company. 22 General and Administrative Expenses. General and administrative expense increased to $1,521,293 (or 41.4% of revenue) for the six months ended June 30, 1996 from $124,823 (or 299.1% of revenue) for the six months ended June 30, 1995. The increase was primarily due to the addition of personnel and costs associated with the growth in the Company's business. General and administrative costs for the six months ended June 30, 1996 included rent associated with the Company's move into a new office, higher VISA and MasterCard processing fees associated with the Company's on-line recharge feature, as well as increased general operating expenses. General and administrative costs for the six months ended June 30, 1995 primarily included expenses related to establishing regulatory compliance in all 50 states, the cost of developing the Company's product and packaging concept, and costs to file documentation related to the procurement of corporate servicemarks and patents. Certain of the expenses incurred by SmarTalk during the six months ended June 30, 1995 were incurred by LCN and LCN was subsequently reimbursed by the Company. Interest Expense. Interest expense, net of interest income, increased to $104,372 for the six months ended June 30, 1996. There was no interest expense or income for the six months ended June 30, 1995. Interest income for the six months ended June 30, 1996 was earned from returns on short-term cash investments. Interest expense for the six months ended June 30, 1996 was attributable to the Company's debt financing funded in January, 1996. See " -- Liquidity and Capital Resources". Income Taxes. The Company had losses for tax purposes for the six months ended June 30, 1996 and 1995. Accordingly, there was no provision for income taxes in these periods. Net Loss. As a result of the above items, the Company's net loss increased to $2,271,186 for the six months ended June 30, 1996 from $285,437 for the six months ended June 30, 1995. YEAR ENDED DECEMBER 31, 1995 COMPARED WITH THE PERIOD ENDED DECEMBER 31, 1994 Revenue. Sales increased to $453,916 for the year ended December 31, 1995 from $444 for the period ended December 31, 1994. The increase in sales reflects an increase in usage of SmarTalk products shipped in 1995 and usage by customers under the Corporate Advantage Program, as well as an increase in the number of retail storefronts in which the Company's products were distributed. During the period ended December 31, 1994, the Company was actively engaged in establishing its corporate identity and in the process of establishing regulatory compliance in all 50 states and had limited sales of its products. Cost of Revenue. Cost of revenue increased to $312,286 for the year ended December 31, 1995 from $716 for the period ended December 31, 1994. The gross profit percentage for the year ended December 31, 1995 was 31.2%. The gross profit percentage for the period ended December 31, 1994 was not meaningful as the Company had insignificant sales during this period. Sales and Marketing Expenses. Sales and marketing expenses increased to $842,306 for the year ended December 31, 1995 from $1,980 for the period ended December 31, 1994. This increase was primarily due to commissions which the Company was obligated to pay to retailers for recharges and to its sales representatives due to increased shipment volume, and continued expansion of the Company's marketing activities, which included co-op advertising. Certain of the expenses incurred by SmarTalk during each year were incurred by LCN and LCN was subsequently reimbursed by the Company. General and Administrative Expenses. General and administrative expenses increased to $630,638 for the year ended December 31, 1995 from $63,220 for the period ended December 31, 1994. This increase was primarily due to the addition of administrative personnel, the associated costs required to manage the growth in the Company's business and nonrecurring startup costs. Certain of the expenses incurred by SmarTalk during each year were incurred by LCN and LCN was subsequently reimbursed by the Company. 23 Interest Income. Net interest income, net of interest expense, for the year ended December 31, 1995 was $2,012. Interest income for the year ended December 31, 1995 was derived from returns on short-term cash investments. Interest expense for the year ended December 31, 1995 consisted of interest on intraperiod debt which the Company utilized during 1995. There was no interest expense or income for the period ended December 31, 1994. Income Taxes. The Company had losses for tax purposes for the year ended December 31, 1995 and the period ended December 31, 1994. Accordingly, there was no provision for income taxes in these periods. Net Income. As a result of the above items, net loss increased to $(1,329,302) for the year ended December 31, 1995 from $(65,472) for the period ended December 31, 1994. SELECTED QUARTERLY OPERATING RESULTS The following table sets forth certain unaudited quarterly financial data for each of the quarters since inception (October 28, 1994). In the opinion of management, the unaudited quarterly financial information has been prepared on the same basis as the audited Financial Statements and includes all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of the information for the periods presented. The unaudited quarterly information should be read in conjunction with the audited Financial Statements and Notes thereto included elsewhere in this Prospectus. The unaudited quarterly operating results are not necessarily indicative of results of operations for any future period.
FOR THE THREE MONTHS ENDED ------------------------------------------------------------------------------ DECEMBER JUNE SEPTEMBER DECEMBER MARCH JUNE 31, MARCH 31, 30, 30, 31, 31, 30, 1994 1995 1995 1995 1995 1996 1996 -------- --------- --------- --------- --------- ----------- ----------- STATEMENT OF OPERATIONS DATA: Revenue................ $ 444 $ 2,564 $ 39,174 $ 185,900 $ 226,278 $ 1,139,365 $ 2,538,655 Cost of revenue........ 716 1,744 27,366 127,446 155,730 794,277 1,885,838 -------- --------- --------- --------- --------- ----------- ----------- Gross profit (loss).. (272) 820 11,808 58,454 70,548 345,088 652,817 Operating expenses Sales and marketing.. 1,980 8,448 164,794 194,672 474,393 657,105 986,321 General and administrative...... 63,220 104,910 19,913 48,661 457,154 719,842 801,451 -------- --------- --------- --------- --------- ----------- ----------- Loss from operations... (65,472) (112,538) (172,899) (184,878) (860,999) (1,031,859) (1,134,955) Net interest expense (income).............. -- -- -- 1,531 (3,543) 44,813 59,559 -------- --------- --------- --------- --------- ----------- ----------- Loss from operations before income tax expense............... (65,472) (112,538) (172,899) (186,409) (857,456) (1,076,672) (1,194,514) Provision for income taxes................. -- -- -- -- -- -- -- -------- --------- --------- --------- --------- ----------- ----------- Net loss............. $(65,472) $(112,538) $(172,899) $(186,409) $(857,456) $(1,076,672) $(1,194,514) ======== ========= ========= ========= ========= =========== ===========
DECEMBER MARCH JUNE SEPTEMBER DECEMBER MARCH JUNE 31, 31, 30, 30, 31, 31, 30, 1994 1995 1995 1995 1995 1996 1996 -------- ------ ------- --------- ---------- ---------- ---------- SELECTED BALANCE SHEET DATA: Deferred revenue...... $431 $2,389 $89,505 $535,865 $3,696,515 $3,783,917 $4,127,919
The Company's sales have been, and the Company expects that its sales will continue to be, somewhat seasonal, due to holiday purchases of the SmarTalk Card. Factors that may cause the Company's operating results to vary include (i) changes in operating expenses, (ii) the timing of the introduction of SmarTalk services, (iii) market acceptance of new and enhanced versions of SmarTalk services, (iv) potential acquisitions, (v) changes in legislation and regulation which affect the competitive environment for SmarTalk services, and (vi) general economic factors. LIQUIDITY AND CAPITAL RESOURCES From inception through June 30, 1996, the Company has funded operations primarily from cash generated by operations and borrowings under its debt agreements. The Company's operating 24 activities used net cash of $2,395,916 in the six months ended June 30, 1996. The cash used by operating activities is primarily attributable to the Company's continued efforts to penetrate the retail distribution channel. As of June 30, 1996 the Company's cash and cash equivalents were $763,078. In December, 1995, the Company negotiated a financing package with SmarTalk Partners under which SmarTalk Partners agreed to loan $1,200,000 to the Company through a term loan and paid $300,000 to purchase a portion of the Company's Common Stock. The term loan is collateralized by substantially all assets of the Company and bears interest at 7% per annum. Interest accrues daily and is payable monthly beginning January 31, 1996 and ending December 31, 1996. Beginning January 31, 1997, monthly payments of principal and accrued interest are required through July, 2000. The funds from this transaction were received in January, 1996. See "Certain Transactions." In addition, the Company obtained a revolving loan facility from SmarTalk Partners, collateralized by substantially all assets of the Company. The facility provides for borrowings up to $500,000. Interest accrues daily at the prime rate plus 2% and is payable monthly beginning January 31, 1996. The principal portion of the loan is due and payable January 31, 1998. The Company may draw funds under the revolving loan at its discretion. At June 30, 1996, the Company had no funds available under this facility. See "Certain Transactions." In January, 1996, the Company entered into an agreement to purchase certain of the assets of LCN. Mr. Lorsch, LCN's sole shareholder, is the Company's majority shareholder and its President and Chief Executive Officer. The purchase was consummated in January, 1996 for $500,000 cash plus a $2,000,000 principal amount subordinated promissory note which bears interest at 7% per annum. Interest on the note is payable monthly through July 31, 1996. Beginning August 31, 1996, the Company is obligated to make a payment of $35,000 a month, with all amounts due and payable in full on June 30, 2000. Because the assets were purchased from a related party, the assets are reflected on the Company's balance sheet at LCN's cost less depreciation as of the date of acquisition. The excess of acquisition cost over the historical cost less depreciation of the assets acquired of approximately $2,464,028 was recorded as a charge to the Company's accumulated deficit. See "Certain Transactions." In June, 1996, the Company acquired the VoiceChoice Platform from Pacific Bell Information Services for total consideration of $325,000, plus other consideration including the release of certain of its contractual obligations to the Company. The purchase price was recorded at $325,000, comprised of $200,000 in cash and a $125,000 note. $100,000 of the $125,000 note is to be paid through six equal monthly installments, beginning July 1, 1996. A final payment due January 1, 1997 will include the remaining $25,000 principal amount of the note and an additional sum equal to the interest accrued on the declining balance paid in installments at 9% interest per annum calculated on a day-to-day basis. All amounts become due and payable upon completion of the Offering. In August, 1996 the Company entered into a loan agreement with SmarTalk Partners pursuant to which the Company obtained a loan of $250,000. This term loan is collateralized by substantially all assets of the Company and accrues interest at the prime rate. Interest on the loan is due the last day of each month, commencing August 31, 1996, with the loan maturing on January 31, 1997. All amounts become due and payable upon completion of the Offering. Payments of principal and interest on the $1,200,000 term loan, the $500,000 revolving loan facility, and the $2,000,000 term note (collectively, the "Original Indebtedness") are subordinated to, and may not be made prior to the repayment of, the $250,000 term loan. See "Certain Transactions." The proceeds of the Offering will be used, in part, to repay the Original Indebtedness, the indebtedness to Pacific Bell Information Services and the $250,000 term loan. See "Use of Proceeds." The Company believes that the proceeds from the Offering, together with the funds anticipated to be generated from operations, will be sufficient to finance the Company's operations for the next 18 months. 25 BUSINESS GENERAL SmarTalk provides convenient, easy to use, cost-effective telecommunications products and services to individuals and businesses primarily through its SmarTalk Card. The SmarTalk Card provides customers with a single point of access to prepaid telecommunications services at a fixed rate charge per minute regardless of the time of day or, in the case of domestic calls, the distance of the call. The Company's services currently include domestic calling and outbound international long distance calling to more than 150 countries, as well as enhanced features such as sequential calling, speed dial and message delivery. The SmarTalk Card may also be recharged on-line with a major credit card, allowing the user to add minutes as needed. The Company expects to offer other enhanced features, including conference calling, voice mail, fax mail, content delivery (including news, sports and weather information) and selected international calling services. The Company's long distance calls are carried primarily through MCI and AT&T. For the six months ended December 31, 1995 and June 30, 1996, the number of minutes decremented from SmarTalk cards or otherwise used by SmarTalk customers were approximately 2,576,000 and 15,901,000, respectively. SmarTalk's primary marketing and distribution focus is to target individuals and small businesses through major national and regional retailers. Currently, the SmarTalk Card is sold at selected retail locations throughout the U.S., including locations operated by the following leading retailers: American Drug Stores (which includes Jewel/Osco Combo Stores, Osco Drug Stores and Sav-On Drug Stores), Office Depot, Thrifty Oil, Builders Square, Hills Department Stores, Bradlees, Bergen Brunswig Drug Company (Good Neighbor Pharmacy), Venture Stores, Foley's Department Stores, Marshall Field's, Fred W. Albrecht Grocery Company, Office1 Superstores and Price/Costco. The Company believes its success to date in rapidly expanding its retail network is attributable to management's ability to increase retailers' awareness of the profit potential of offering telecommunications services at retail, the minimal space involved in offering the SmarTalk Card at retail and the ability of the SmarTalk Card to generate ongoing residuals for retailers through participation in recharge revenues. The Company is exploring the opportunity of offering retailers a co- branded, pre-subscribed "1+" long distance service. This new product, if successfully introduced, would afford retailers the ability to offer residential and small business customers long distance services that are designed to generate ongoing revenue streams while requiring virtually no shelf space or inventory cost. SmarTalk also markets its services directly to customers through direct response sales which include recharge sales, payphone sales, and sales generated through print, direct mail, and, in the future, the Internet and television advertising. SmarTalk has recently entered into an agreement with Pacific Bell which permits the Company to market SmarTalk services on 30,000 payphones in California and intends to pursue similar arrangements with other payphone operators nationwide. Information cards on payphones, which prominently display details about the advantages of SmarTalk services, attract customers to purchase SmarTalk services with a major credit card simply by calling an "800" number. Payphone companies are able to participate in ongoing revenues generated from the sale and recharge of SmarTalk services. The Company has developed additional marketing and distribution avenues, including the Company's Corporate Advantage Program and corporate promotional programs. Under the Corporate Advantage Program, employees who are away from their offices can utilize SmarTalk services, thereby enabling businesses to lower telecommunications costs and monitor call activity to better allocate long distance costs. Corporate promotional programs allow the Company's corporate customers to provide co-branded prepaid phone cards for use in corporate or product promotions, direct marketing programs, warranty registration, customer service programs and premium rewards for customers. SmarTalk has created promotional programs for JVC, Smart & Final Iris, Cellular One, AirTouch Cellular, FW Woolworth and, in conjunction with Kodak and Hallmark Cards, American Stores. 26 SmarTalk services are delivered through proprietary switching, application and database access software which run on two interactive call processing SmarTalk Platforms, one of which, the VoiceChoice Platform, was recently acquired from Pacific Bell Information Services. The SmarTalk Platforms and the Company's proprietary software allow users in the system to access SmarTalk services, and provide the Company with the flexibility to customize and add features to SmarTalk services on a platform-wide basis. SmarTalk anticipates that ownership of the VoiceChoice Platform will reduce the Company's operating costs. The Company has also developed a proprietary in- house data reporting and tracking system, the SmarTrac System, which tracks inventory, controls fraud, monitors usage by card and retailer and allows the Company to provide certain marketing information to its retailers and business customers. The Company believes that its principal competitive advantages are its (i) well-established presence among major retailers, (ii) advanced telecommunications infrastructure, and (iii) management team, which has extensive marketing and merchandising expertise. INDUSTRY OVERVIEW The $67.4 billion U.S. long distance industry is dominated by the nation's three largest long distance providers, AT&T, MCI and Sprint, which together generated approximately 82.7% of the aggregate revenues of all U.S. long distance interexchange carriers in 1994. While industry revenues have grown at a compound annual rate of 5.6% since 1984, the revenues of carriers other than AT&T, MCI and Sprint have grown at a compound annual rate of 27.8% during the same period. As a result, the aggregate market share of all interexchange carriers other than AT&T, MCI and Sprint has grown from 2.6% in 1984 to 17.3% in 1994. During the same period, the market share of AT&T declined from 90.1% to 55.2%. The changing market for telecommunications services created an opportunity for the growth of alternative long distance and telecommunications services providers, including prepaid phone card sales. The domestic prepaid phone card industry has grown significantly in recent years. Prepaid phone card revenues in the U.S. have grown from an estimated $20 million in 1990 to an estimated $1 billion in 1996, making prepaid phone services one of the fastest growing segments of the telecommunications industry. Industry sources project the U.S. market to exceed $5 billion in 2000. The Company believes that the affordable pricing, convenience and enhanced features of prepaid phone cards have attracted price sensitive customers, business travelers, international callers and other users of long distance services. Although prepaid phone cards are relatively new in the U.S., prepaid phone cards have been a widely used and accepted way of making telephone calls in Europe and Asia since the 1970s. Recently, the prepaid calling card industry has expanded substantially. According to industry sources, the number of companies marketing prepaid phone cards has grown from approximately 75 companies in 1994 to over 500 companies in 1996. In addition, companies have begun to couple long distance services with other enhanced features. In contrast to producers of prepaid phone cards that were established to serve the collectible or promotional market only or that provide long distance service only, the Company markets and distributes the SmarTalk Card and services with specific focus on the retail distribution channel. SmarTalk believes that it is well positioned to capitalize upon the expanding prepaid phone card market due to its focus on national retail distribution channels, as well as the other components of the SmarTalk strategy. THE SMARTALK STRATEGY SmarTalk's objective is to become a leading provider of quality, convenient, easy to use and cost-effective telecommunications products and services to individuals and businesses, primarily sold 27 through retailers. The Company's strategy for achieving that objective includes the following key elements: Increase Penetration of Retailers. SmarTalk markets and distributes the SmarTalk Card to individuals and small businesses through major national and regional retailers. The Company intends to continue to focus on the penetration of retailers by increasing the number of retailers at which the SmarTalk Card is sold, expanding the number of stores among retailers selling the SmarTalk Card and adding points of sale at which customers can purchase the SmarTalk Card within each store. In addition, SmarTalk plans to leverage its relationship with retailers to market additional telecommunications services such as "1+" long distance service. SmarTalk believes that it can continue to grow its network of major national and regional retailers by increasing awareness among retailers as to the profit potential of telecommunications services. This potential exists with regard to the SmarTalk Card because of the limited space utilized to offer the SmarTalk Card, as well as the ability to generate ongoing residuals through participation in recharge revenues. In addition, the SmarTrac System provides the retailer with certain marketing information about its customers. Moreover, the Company believes that it can increase the points of sale within a retail store by continuing to provide retailers with turnkey merchandising materials, which include customized retail packaging and complete display and signage systems, co-op advertising and MDF to access shelf space. SmarTalk also intends to capitalize upon its retail distribution network by offering new products and services and creating innovative marketing opportunities. For example, the Company is exploring the concept of selling a co-branded, pre-subscribed "1+" long distance service to customers through retailers at favorable rates. If successfully introduced, the program would allow patrons to purchase traditional long distance services directly from the retailer. Customers would receive a monthly statement itemizing the calls made and the amount due for that month. The monthly statement would afford retailers and the Company an additional direct advertising opportunity for their respective products and services. Further Develop Direct Response Channels. SmarTalk plans to stimulate the growth of its existing direct response sales. For example, the Company has developed on-line recharge of the SmarTalk Card which allows customers to increase the number of minutes available on the SmarTalk Card by using a major credit card. On-line recharge is designed to enable the Company to make direct sales to customers, to provide incentives to retailers to maintain SmarTalk as the exclusive supplier to the retailer and to create brand loyalty. With respect to recharge sales, the Company plans to (i) continue to offer volume discounts, whereby, for example, customers receive "free minutes" when recharging for the maximum time permitted and (ii) utilize on-line advertising, in which, for example, a customer is prompted to recharge his or her card. The Company also intends to pursue opportunities to market SmarTalk services on payphones. SmarTalk recently entered into an agreement with Pacific Bell to market and offer its products at 30,000 payphones in California, permitting the customer to purchase and then immediately begin using SmarTalk services. See "-- Strategic Partners." SmarTalk will market the recurring revenue arrangement established in its arrangement with Pacific Bell to other payphone companies. The Company will continue to utilize print, broadcast and other means of direct marketing, including direct response advertising in magazines and publications, such as in-flight magazines, that appeal to the business traveler. The Company plans to continue to develop new and innovative means of marketing its telecommunications products and services directly to customers to complement its 28 retail distribution network. Such means include television advertising, catalogue and other direct marketing methods. The Company is also developing a home page on the Internet through which it intends to provide the customer with information on the benefits of the SmarTalk Card, as well as to direct market SmarTalk services. Broaden Corporate Advantage and Promotional Programs. SmarTalk intends to expand the Corporate Advantage Program and corporate promotional programs which are directed towards business customers. Under the Corporate Advantage Program, employees who are away from their offices can utilize SmarTalk's services, thereby enabling businesses to lower telecommunications costs, monitor call activity and allocate long distance costs. Businesses enrolled in the Corporate Advantage Program may request detailed monthly reports generated by the SmarTalk System for use in controlling expenses and in recapturing costs from clients. SmarTalk also has established corporate promotional programs which allow the Company's business customers to provide co-branded prepaid phone cards for use in corporate or product promotions, direct marketing programs, warranty registration, customer service programs and premium rewards for customers. SmarTalk plans to broaden the Corporate Advantage Program and corporate promotional programs by (i) expanding its sales force to include representatives that focus on business customers, (ii) capitalizing on the Company's strategic relationships, and (iii) leveraging its existing relationships with retailers by promoting its corporate programs to retailers already familiar with SmarTalk services that market to commercial clients such as Office Depot, Office1 Superstores and Hello Direct Catalog. Target the Business Customer. SmarTalk plans to introduce additional enhanced features to the SmarTalk Card in an effort to attract both the small business customer at retail and corporations as subscribers to its Corporate Advantage Program. In response to the increasing demand, primarily by business users, for more bundled, single point of access telecommunications services, the Company plans to expand its telecommunications features to offer voice mail, fax mail, conference calling and selected international calling services. These services will be accessible from almost any touchtone phone, and will be provided on a prepaid and or a monthly recurring charge basis at a flat rate per minute without operator as- sistance, coins, collect or third party billed calls. See "-- Products and Telecommunications Services." Leverage Existing Strategic Relationships. SmarTalk plans to leverage its existing network of strategic relationships to gain access to new business opportunities and a wider customer base. The Company has recently entered into strategic alliances, including those with Pacific Bell, MCI, West Interactive, and Douglas Stewart, which the Company believes will expand its distribution channels. The Company also plans to develop additional strategic relationships with partners whose customers are prospective users of SmarTalk services. The Company believes that by developing additional strategic relationships, it will increase awareness of SmarTalk services. The Company anticipates that, as it continues to develop new and innovative products and services, it will attract additional strategic partners. Expand International Services. SmarTalk plans to expand its business to international markets in order to market prepaid phone cards to U.S. travelers and foreign customers who frequently call the U.S. The Company believes that by providing competitive rates for inbound international service and by advertising in travel locations such as airports and hotels, SmarTalk can attract U.S. customers traveling abroad. SmarTalk also believes that it can market to foreign customers who frequently call the U.S. by establishing a sales force abroad and by providing turnkey merchandising materials to retailers abroad which are customized for foreign markets. 29 PRODUCTS AND TELECOMMUNICATIONS SERVICES The SmarTalk Card provides customers with a single point of access to convenient, easy to use, cost-effective telecommunications products and services at a fixed rate charge per minute regardless of the time of day or, in the case of domestic calls, the distance of the call. The SmarTalk Card enables customers to place long distance and international calls from virtually any touchtone phone, without the need for coins, operator assistance, collect or other third party billed calls. Card users access these services by dialing a toll free "800" number and entering a PIN printed on the back of the card. The system explains the service on a user's first call and guides callers through all of the features. Prior to any call being processed, the system informs the caller of the time remaining on the card. The customer is also notified when there are five minutes and again when there are two minutes of calling time remaining on the SmarTalk Card. Time spent on a call or on the Company's enhanced features is automatically deducted from the remaining time on the card or billed to a pre-authorized corporate account. Unlike telephone or credit calling cards which usually impose surcharges on long distance services, SmarTalk's services are typically paid for in advance and are issued in specified time increments, typically 30, 60, and 120 minutes, at favorable per minute rates. A SmarTalk Card expires on the earlier to occur of six months after the date such SmarTalk Card is first activated or the expiration date printed on such SmarTalk Card. Customers' calls are carried primarily through AT&T (accessed through West Interactive) and MCI. The Company obtains long distance telecommunications services pursuant to supply agreements with MCI and West Interactive. The Company's Preferred Carrier Agreement with MCI obligates SmarTalk to utilize a specified number of minutes over a period of four years. If the Company utilizes a certain number of minutes, the price per minute paid by the Company for all long distance minutes decreases. The Company's agreement with West Interactive provides for the Company to be charged a flat rate per minute and includes no minimum commitment. Should users have questions about the use of their SmarTalk cards when inside the system, a customer service representative is available for assistance on-line at the touch of a key. This on-line customer service differentiates SmarTalk from most of its competitors whose cards generally require users to hang up and call a second number to reach customer service. The SmarTalk customer service representative has access to real time call records which allow the representative to trace the customer's system usage. See " -- SmarTalk Customer Service." Customers access the Company's services through one of the SmarTalk Platforms. The SmarTalk Platforms are designed in a manner which allows SmarTalk to customize or add features and services to the SmarTalk Card on a platform-wide basis. Generally, calls accessing enhanced telephonic features are charged for such access as disclosed by computerized voice prompts at the time such features are being accessed. SmarTalk attempts to design and develop enhanced teleservices in order to increase the marketability of the SmarTalk Card and satisfy customer requirements. The Company believes that offering enhanced services will attract additional customers to the SmarTalk services, promote brand loyalty and result in additional product usage. To date, these services have been utilized on a limited basis. See " -- The SmarTalk Platforms." Customers are currently provided with the option of accessing the following services: International Outbound Long Distance. Customers can use the SmarTalk Card to place international long distance calls from anywhere in the U.S. at rates that are generally lower than the standard card plan rates currently charged by AT&T, MCI and Sprint or the rate charged for a direct call from a payphone or hotel room. A connection through the SmarTalk Platforms costs less than a typical operator assisted connection, a collect call, and most major carrier calling card calls, including AT&T, MCI, and the RBOCs. 30 Speed Dial. Customers can create their own personal speed dial directory which can then be accessed each time the customer uses the PIN on which the directory has been created. This feature permits customers to place calls to any of nine frequently dialed numbers by pressing one key. Currently, the Company provides a first-time user of a particular PIN with a limited amount of free time to set up their personal speed dial directory. The personal speed dial directory created by the customer is inaccessible to the customer once all of the prepaid minutes on the SmarTalk Card associated with the directory have been utilized. The Company believes that the speed dial feature increases the likelihood that customers will recharge their SmarTalk cards in order to retain their personal speed dial directory. Message Delivery. Customers can record a message for the recipient of a call if the recipient does not answer or if the line is busy. The SmarTalk system will make multiple attempts to deliver the message over a period of six hours, and then notify the customer the next time that the customer accesses the SmarTalk system whether the message was delivered and, if so, the time at which it was delivered. Sequential Calling. Customers can make additional calls without the necessity of exiting the platform and entering it again. The Company believes that this feature encourages users to place multiple phone calls each time they use their SmarTalk cards. The Company is currently testing and anticipates offering the following additional features by the end of 1996: Conference Calling. Customers will be able to initiate conference calls from virtually any touchtone phone by adding a third party to the call. The conference calling feature will be automated and will not require operator assistance. Voice prompts will assist the customer through the procedure to establish the conference call. A customer using the conference calling feature will be deducted time on two outbound calls, therefore leveraging the cost to the Company of one inbound call. See " -- The SmarTalk Platforms." Content Delivery. Customers will be able to access financial news, headline news, sports updates, weather reports and other information updates, provided by SmarTalk through a digital feed from several selected on-line suppliers. These services will be frequently updated, and the information will be accessible by a series of menus presented to the user via voice prompts. Information will first be presented in a general format, with the consumer then being given the option to retrieve more detailed information on the topic selected. The following additional services are under development and are expected to be offered by SmarTalk in 1997: Voice Mail. SmarTalk plans to offer customers a secure, personalized voice mailbox which will allow them to receive, retrieve, save and delete voice mail messages from virtually any touchtone phone. Each time the customer accesses their voice mailbox, the customer will be notified if there are any new voice mail messages. The customer will also have the ability to elect to be notified of messages by instructing the system to send a message to their pagers or calling them at a designated number. 31 Fax Mail. SmarTalk plans to offer customers fax mail capability which will allow customers to receive, store and retrieve facsimile transmissions at any time by forwarding the faxed information to any fax machine or personal computer in the U.S. and certain parts of the world. The fax mailbox will provide customers with the convenience of controlling the time and location of receipt of facsimile transmissions, enhancing the customer's ability to receive confidential facsimiles and receive facsimiles at multiple or changing locations. Each time the customer accesses their fax mailbox, the customer will be notified if there are any new faxes. The customer will also have the ability to elect to be notified of waiting faxes. International Long Distance. The Company expects that customers will be able to utilize the SmarTalk Card to make international calls to the U.S. from up to fifteen foreign countries, with additional originating countries being added thereafter. The Company eventually expects to enable customers to place country to country international calls from most countries in the world to virtually any country in the world. MARKETING AND DISTRIBUTION The Company markets its services through multiple distribution channels which include (i) sales to retailers, (ii) direct response sales (which include recharge sales, sales generated by payphone marketing, and sales generated through print, mail, and in the near future, Internet and television advertising), and (iii) direct corporate programs and promotions. Retail Channel. SmarTalk's primary marketing and distribution focus is to target individuals and small businesses through major national and regional retailers. The Company currently derives most of its revenues from sales to retailers. The Company's retail distribution channel encompasses diverse categories of retailers ranging from convenience stores to food and drug stores, department stores, mass merchandisers, office superstores and consumer electronics retailers. SmarTalk markets and distributes the SmarTalk Card nationwide to retailers both through a direct sales force and through its national sales organization of independent manufacturers' representatives which utilizes its relationships with retailers to introduce the SmarTalk Card and its services. The Company believes that its broad retail distribution has resulted in SmarTalk becoming a leading brand at the retail level. Currently, the SmarTalk Card is sold at selected retail locations throughout the U.S., including locations operated by the following leading retailers: American Drug Stores (which includes Jewel/Osco Combo Stores, Osco Drug Stores and Sav-On Drug Stores), Office Depot, Thrifty Oil, Builders Square, Hills Department Stores, Bradlees, Bergen Brunswig Drug Company (Good Neighbor Pharmacy), Venture Stores, Foley's Department Stores, Marshall Field's, Fred W. Albrecht Grocery Company, Office1 Superstores and Price/Costco. The Company believes its success to date in rapidly expanding its retail network is attributable to management's ability to increase retailers' awareness of the profit potential of offering telecommunications services, the minimal space involved in offering the SmarTalk Card at retail and the ability of the SmarTalk Card to generate ongoing residuals for retailers through participation in recharge revenues. In furtherance of its strategy, the Company provides (i) turnkey merchandising materials which include the availability of customized cards and retail packaging and complete display and signage system which makes display of the SmarTalk Card easy, (ii) retail promotion programs in which SmarTalk and the retailer share the costs of the promotion, and (iii) access to marketing information from the SmarTrac System. 32 Unlike most products sold by retailers, the SmarTalk Card allows retailers to generate revenues beyond the initial sale of the SmarTalk Card by allowing an ongoing revenue stream based on the number of minutes recharged on any SmarTalk Card sold by that retailer, so long as the retailer continues to offer the SmarTalk Card. SmarTalk encourages the customer to utilize the recharge option by computerized voice prompts. The Company believes that this program increases retailer loyalty to SmarTalk and creates a barrier for the retailer to try other prepaid phone cards. The Company expects recharge revenues to increase as more SmarTalk Cards are sold and used and the Company introduces additional enhanced services. In addition, SmarTalk assists retailers in promoting the SmarTalk Card at retail points of sale at each retail location by providing turnkey merchandising materials to retailers. SmarTalk's turnkey merchandising and marketing program includes the availability of customized retail packaging and customized display and signage systems. The Company also provides promotional supplies to the retailer, to assist the retailer in making the SmarTalk Card immediately available at various retail locations. SmarTalk's retail promotional programs include various forms of co-op advertising programs and other incentive programs to access shelf space. The Company believes that these programs, together with the residual revenues from recharge and the Company's turnkey merchandising and marketing program, create ongoing retailer involvement in support of marketing the SmarTalk Card. Retailers also benefit from the SmarTrac System which enables the Company to provide certain demographic information to a retailer of its customers that utilize SmarTalk services. This information provides the retailer with information which it can use in formulating its marketing strategy. See "-- The SmarTrac System." In addition, the SmarTrac System provides the retailer with the ability to deliver custom audio information, such as store openings or store advertisements, to the retailer's customers when they access the SmarTalk system. Direct Response. The Company also markets its services directly to customers through direct response sales, which include recharge sales, payphone sales and sales generated through print, direct mail, and in the future, the Internet and television advertising. The Company offers on-line recharge which provides customers with the convenience of being able to add minutes to the SmarTalk Card with a major credit card while using the service. This allows the customer to purchase minutes without having to return to a retailer and allows the customer to continue using features already programmed into their SmarTalk card, currently the speed dial directory. See "-- Products and Telecommunications Services." In addition, SmarTalk intends to continue to market SmarTalk services on payphones, a point of sale where the Company believes customers are more likely to use SmarTalk services immediately. To this end, the Company recently signed an agreement with Pacific Bell to market SmarTalk services at 30,000 payphones in California. See "-- Strategic Partners." The Company is developing a home page on the Internet through which it intends to provide the customer with information as to the benefits of the SmarTalk Card. The Company believes that the Internet home page will give the SmarTalk Card exposure in the rapidly growing electronic commerce marketplace. The Company intends to use its Internet presence to provide the customer with information on the benefits of SmarTalk services, as well as to direct market the SmarTalk Card. Additionally, the Internet home page will provide the Company with a unique medium for providing interactive promotional programs to the Company's retailers and direct customers. 33 Direct Corporate Programs and Promotions. Corporate sales of SmarTalk services generate revenue primarily in two areas: (i) sales to corporations for employee use through the Corporate Advantage Program and (ii) sales to corporations for promotional distribution. SmarTalk markets SmarTalk services through the Corporate Advantage Program to businesses as a means to reduce long distance costs and better monitor long distance usage. Businesses enrolled in the Corporate Advantage Program have access to detailed monthly reports generated by the SmarTrac System for use in controlling expenses and allocating costs. The Corporate Advantage Program enables employees to access the SmarTalk system through a customized PIN and to track the cost of any service to a particular client or matter by dialing an additional two digit customized code. Businesses that enroll in the Corporate Advantage Program can be billed on either a prepaid or monthly basis. Use of SmarTalk services may result in substantial savings to business travelers by eliminating access and other surcharges that are typically added to calls made from a payphone or hotel room. In addition, the Company believes its enhanced services will be attractive to its corporate customers because they allow the caller to access long distance, speed dial, message delivery and future services. The Company also markets the SmarTalk Card and co-branded prepaid cards for use in promotional marketing, including sales for corporate or product promotional campaigns, direct marketing programs, warranty registration or customer service programs and premium rewards for consumers. For example, a corporate promotional customer can provide custom designed cards featuring its logo or customized advertisement to consumers and can use the SmarTalk Card to reward consumers for purchasing a product, using a service or providing information. In these ways, corporate clients can use the SmarTalk Card to reward consumers. In addition, the SmarTrac System allows corporate promotional customers to learn the habits of those same consumers for future marketing strategies. Similarly, corporate customers can utilize SmarTalk for warranty registration programs by inviting consumers to phone in their information to a dedicated "800" number rather than completing a warranty registration card. Information about the consumer can then be provided to the corporate customer from the SmarTrac System. SmarTalk has created promotional programs for JVC, Smart & Final Iris, Cellular One, AirTouch Cellular, FW Woolworth and, in conjunction with Kodak and Hallmark Cards, American Stores. In addition, SmarTalk is in the process of negotiating an agreement with Western International Media, a division of Interpublic Group, one of the largest media purchasing companies in the U.S., pursuant to which Western International Media will market SmarTalk services to its clients when developing marketing and promotional campaigns. The Company believes that this agreement will allow it to capitalize on Western International Media's extensive promotion oriented corporate customer base. See "-- Strategic Partners." The Company identifies potential corporate clients through its direct sales force, as well as its nationwide network of sales representatives and retailers. SmarTalk plans to capitalize upon its existing relationships by promoting its Corporate Advantage Program to retailers already familiar with the SmarTalk Card that market to commercial clients such as Office Depot, Office1 Superstores and Hello Direct Catalog. Following completion of the Offering, the Company intends to expand its sales force to significantly build upon its corporate programs and promotions distribution channel. STRATEGIC PARTNERS SmarTalk has recently entered into strategic alliances with several major telecommunications and other companies which the Company believes will further expand each of its distribution channels. 34 Pacific Bell. On May 24, 1996, the Company entered into an agreement with Pacific Bell which permits the Company to market SmarTalk services on 30,000 payphones designated by Pacific Bell in California. The information card placed on these phones will prominently display details about SmarTalk's services. The information card alerts the customer that SmarTalk is a convenient and cost- effective alternative to the 1-800-COLLECT or other long distance telephone call the customer may place. Payphone customers are able to call an "800" number dedicated to callers from Pacific Bell payphones and purchase SmarTalk services with a major credit card. The payphone customer is given a PIN by the operator and can immediately use the PIN to access the SmarTalk system. SmarTalk has agreed to pay Pacific Bell a fee for installing these new information cards and Pacific Bell is able to participate in ongoing revenues generated from the sale and recharge of SmarTalk services sold through the dedicated "800" number. The Company believes that this relationship provides a unique distribution channel. MCI. On June 21, 1996, the Company entered into a Prepaid Carrier Referral Program Agreement whereby MCI has agreed to refer potential clients to the Company. Currently, SmarTalk is one of three companies to which MCI refers certain potential clients. The Company has agreed to pay MCI a referral fee for any new clients that the Company develops as a result of such referrals from MCI. MCI has no obligation to refer any potential clients to SmarTalk. In addition, the Company has agreed to service these clients exclusively through inbound and outbound service provided by MCI. West Interactive. On June 1, 1996, the Company entered into a Wholesale Distribution Agreement with West Interactive whereby West Interactive, a national telemarketing corporation, has designated SmarTalk as the service provider for prepaid cards marketed and sold to West Interactive's clients, which include retailers. West Interactive will pay SmarTalk for each minute used by purchasers of such prepaid cards. Following an initial roll-out period, the prepaid cards sold by West Interactive clients and any promotional literature distributed by such clients, will, whenever reasonably possible, denote SmarTalk as the service provider. Douglas Stewart. The Company has an arrangement with Douglas Stewart, one of the nation's largest distributors to college bookstores, whereby Douglas Stewart distributes the SmarTalk Card to college bookstores across the nation. The Company believes that its relationship with Douglas Stewart provides it with the ability to target college students, whom the Company believes will be prime users of SmarTalk services. In addition, the Company believes that college students represent an opportunity to create brand loyalty among younger customers. Western International Media. The Company is in the process of negotiating an agreement with Western International Media, a division of Interpublic Group and one of the largest media buying companies in the U.S., pursuant to which Western International Media will present SmarTalk services to its clients when developing marketing and promotional campaigns. The Company believes that this agreement will allow it to expand its distribution to corporate customers by allowing it to capitalize on Western International Media's extensive promotion oriented corporate customer base. THE SMARTRAC SYSTEM The Company has developed the SmarTrac System, a proprietary in-house data reporting and tracking system that provides a series of database query and report capabilities that are used to track 35 inventory, control fraud and monitor usage by card and retailer. The Company markets the SmarTrac System's ability to provide customer and usage information to the Company's retailers and business customers. Data generated through the SmarTrac System also helps the Company to minimize unauthorized use of the SmarTalk Card. For example, SmarTalk personnel can determine whether multiple PINs are being used from any single telephone number, whether the same PIN is being used from many different parts of the country within a short period of time, or whether an unreasonable number of invalid PINs are being entered from any given telephone number. This data allows the Company to monitor activity in an effort to limit fraudulent use of the Company's services. The Company believes that by providing a marketing tool as well as a measure of fraud control, the SmarTrac System provides the Company with a competitive advantage. THE SMARTALK PLATFORMS Customers access the SmarTalk network through the SmarTalk Platforms. The SmarTalk Platforms are accessible from virtually any touchtone telephone in the U.S. and can communicate with telephones, PCs, facsimile machines and pagers. The SmarTalk Platforms feature multiple switches, thousands of inbound and outbound access ports for prepaid and corporate calling services, as well as voice response applications, high-speed database servers, voice recording capability and credit card verification software, among other capabilities. This structure provides SmarTalk customers with high capacity, reliable telecommunications products and services. The SmarTalk Platforms are controlled by proprietary database access software that was developed by the Company. The Company designed its proprietary software to be versatile and adaptable, and to work with the SmarTalk Platforms to provide users with efficient and reliable services. The SmarTalk proprietary software allows the SmarTalk Platforms to be easily expandable so that, as usage increases or new SmarTalk services are developed, the SmarTalk Platforms may evolve with the rest of the SmarTalk services. The Company believes that the SmarTalk Platforms will be capable of processing all of the Company's anticipated usage requirements. The modular and scalable design of the SmarTalk Platforms and the related software allows expansion of network capacity without requiring replacement of existing hardware or software or interrupting service. SmarTalk recently acquired the VoiceChoice Platform from Pacific Bell Information Services. Located in San Francisco, the VoiceChoice Platform was configured by Pacific Bell Information Services and supports the SmarTalk Card as well as other interactive voice response applications. The VoiceChoice Platform is an integrated call processing system, in which calls are carried on the VoiceChoice Platform by T1 circuits from MCI and are presented to either of two Summa Four switches. Traffic is split evenly between the Summa switches to provide redundancy. Incoming calls to the VoiceChoice Platform are answered by a Summa Four switch, which is connected to voice response units ("VRUs"). The VRUs, in turn, interact with an Oracle database server that stores all user information. Resident on the switch is the software and hardware necessary to allow the switch to interact with, and accept input from, customers. The VoiceChoice Platform software prompts customers for their PIN. The software validates this information by querying the database of active PINs, and verifying that only one customer is connected to the SmarTalk Platform using this PIN. Once the customer has been identified, the software instructs the switch to present the customer with various options, which the customer can access by responding to voice prompts. If the customer chooses to place an outbound telephone call, the software transmits the call over lines provided by the resident long distance provider. The voice response boxes are connected directly to the Company's outbound long distance services, again providing SmarTalk customers fast processing of their telephone calls. The system is monitored by on-site analysts 24 hours a day with numerous "heartbeat" programs in place to detect any potential problem. The acquisition of the VoiceChoice Platform provides the Company with the opportunity to reduce its costs while giving the Company a stronger technological infrastructure. This infrastructure enables 36 the Company to customize and add features, such as stand-alone interactive voice services which the Company can market to corporate clients. The San Antonio call processing platform and back-up Omaha call processing platform are owned and operated by West Interactive and are similarly configured for high-speed, high-capacity and high-reliability. West Interactive provides interstate and international long distance services to the Company through its agreement with AT&T. In addition, the Company has the ability to add access to MCI service to the platforms maintained by West Interactive. The Company's call processing centers are redundant within themselves and, in certain instances, with each other. Despite this fact, the Company intends to develop database portability between the different platforms, thus ensuring redundancy in the event of a major technical or network problem at any of the facilities. SMARTALK CUSTOMER SERVICE SmarTalk believes that effective and convenient customer service is essential to attracting and retaining customers. SmarTalk's customer service department is responsible for and assisting customers in using SmarTalk services, answering questions about usage, resolving billing related issues and resolving any technical problems. SmarTalk provides on-line customer support that is available twenty-four hours a day at the touch of a key. In addition, SmarTalk can identify calling activity by originating or destination phone number or other parameters. Customer service representatives can access detailed usage records through the SmarTrac System in order to efficiently answer customers questions or resolve customers concerns. SmarTalk also maintains a secondary corporate level customer service organization in the Company's offices to address unique customer service requests which are not handled while a caller is in the system. COMPETITION The telecommunications services industry is intensely competitive, rapidly evolving and subject to constant technological change. In 1994, there were approximately 75 companies marketing prepaid calling cards. Today there are more than 500 companies selling prepaid calling cards, and the Company expects competition to increase in the future. Other providers currently offer one or more of each of the services offered by the Company. As a service provider in the long distance telecommunications industry, the Company competes with three dominant providers, AT&T, MCI and Sprint, all of which are substantially larger and have: greater financial, technical, engineering, personnel and marketing resources; longer operating histories; greater name recognition; and larger customer bases than the Company. These advantages afford the Company's competitors pricing flexibility. Telecommunications services companies may compete for customers based on price, with the dominant providers conducting extensive advertising campaigns to capture market share. Competitors with greater financial resources may also be able to provide more attractive incentive packages to retailers to encourage them to carry products that compete with SmarTalk services. In addition, competitors with greater resources than the Company may be better situated to negotiate favorable contracts with retailers. The Company believes that existing competitors are likely to continue to expand their service offerings to appeal to retailers and their customers. Moreover, since there are few, if any, substantial barriers to entry, the Company expects that new competitors are likely to enter the telecommunications market and attempt to market telecommunications services similar to the Company's services which would result in greater competition for the Company. The ability of the Company to compete effectively in the telecommunications services industry will depend upon the Company's continued ability to provide high quality SmarTalk services at prices generally competitive with, or lower than, those charged by its competitors. Certain of the Company's competitors dominate the telecommunications industry and have the financial resources to enable them to withstand substantial price competition, which is expected to increase significantly, and there can be no assurance that the Company will be able to compete successfully in the future. Moreover, 37 there can be no assurance that certain of the Company's competitors will not be better situated to negotiate contracts with suppliers of telecommunications services which are more favorable than contracts negotiated by the Company. In addition, there can be no assurance that competition from existing or new competitors or a decrease in the rates charged for communications services by the major long distance carriers or other competitors would not have a Material Adverse Effect. The Company attempts to differentiate itself from its competitors by offering an integrated bundle of communications services through advanced telecommunications hardware and proprietary software and distributing these services primarily through retail channels, as well as a growing number of additional distribution channels. The Company believes that its principal competitive advantages are its (i) well-established presence among major national and regional retailers, (ii) advanced telecommunications infrastructure including the SmarTalk Platforms and proprietary SmarTrac System, and (iii) management team, which has extensive marketing and merchandising expertise. The Company believes that the principal competitive factors affecting the market for telecommunications services are price, quality of service, reliability of service, degree of service integration, ease of use, service features and name recognition. The Company believes that it competes effectively in these areas. Recent changes in the regulation of the telecommunications industry may impact the Company's competitive position. The Telecommunications Act has effectively opened the long distance market to competition from the RBOCs. The entry of these well-capitalized and well-known entities into the long distance market will likely increase competition for long distance customers. The Telecommunications Act also grants the FCC the authority to deregulate other aspects of the telecommunications industry, which in the future may, if authorized by the FCC, facilitate the offering of telecommunications services by regulated entities, including the RBOCs, in competition with the Company. GOVERNMENT REGULATION The terms and conditions under which the Company provides its services are subject to regulation by the state and federal governments of the U.S. Various international authorities may also seek to regulate the services provided or to be provided by the Company. Federal laws and FCC regulations apply to interstate telecommunications, while state regulatory authorities have jurisdiction over telecommunications that originate and terminate within the same state. Federal. On February 8, 1996, President Clinton signed into law the Telecommunications Act which will allow local exchange carriers, including the RBOCs, to provide inter-LATA long distance telephone service and which also grants the FCC the authority to deregulate other aspects of the telecommunications industry. The new legislation may result in increased competition in the industry, including from the RBOCs, in the future. See " -- Competition." The Company is classified by the FCC as a non-dominant carrier. The FCC has jurisdiction to act upon complaints against any common carrier for failure to comply with its statutory obligations. The FCC also has the authority to impose more stringent regulatory requirements on the Company and to change its regulatory classification. The Company has applied for and received all necessary authority from the FCC to provide domestic interstate and international telecommunications service. The Company has been granted authority by the FCC to provide international telecommunications services through the resale of switched services of U.S. facilities-based carriers. The FCC reserves the right to condition, modify or revoke such international authority for violations of the Federal Communications Act or its rules. 38 Both domestic and international non-dominant carriers currently must maintain tariffs on file with the FCC. Although the tariffs of non-dominant carriers, and the rates and charges they specify, are subject to FCC review, they are presumed to be lawful and are seldom contested. Prior to a recent court decision, domestic non-dominant carriers were permitted by the FCC to file tariffs with a "reasonable range of rates" instead of the detailed schedules of individual charges required of dominant carriers. In reliance on the FCC's past practice of allowing relaxed tariff filing requirements for non-dominant domestic carriers, the Company filed reasonable range of rates schedules in its FCC tariff. As an international non-dominant carrier, the Company will be required to include detailed rate schedules in its international tariffs. Resale carriers are also subject to a variety of miscellaneous regulations that, for instance, govern the documentation and verifications necessary to change a consumer's long distance carriers, limit the use of "800" numbers for pay-per-call services, require disclosure of operator services and restrict interlocking directors and management. On March 21, 1996, the FCC initiated a rulemaking proceeding in which it proposed to eliminate the requirement that non-dominant interstate carriers such as the Company maintain tariffs on file with the FCC for domestic interstate services. The FCC's proposed rules are pursuant to authority granted to the FCC in the Telecommunications Act to "forbear" from regulating any telecommunications service provider if the FCC determines that the public interest will be served. The FCC also requested public comment on whether any other regulations currently imposed on non-dominant carriers should be eliminated pursuant to the FCC's "forbearance" authority. It is not known when the FCC will take final action on this proposal. State. The intrastate long distance telecommunications operations of SmarTalk are subject to various state laws and regulations, including prior certification, notification and registration requirements. In certain states, prior regulatory approval may be required for changes in control of telecommunications operations. The Company is currently subject to varying levels of regulation in the states in which it provides card services (which are generally considered "1+" services by the states). The vast majority of states require SmarTalk to apply for certification to provide telecommunications services, or at least to register or to be found exempt from regulation, before commencing intrastate service. The vast majority of the states require SmarTalk to file and maintain detailed tariffs listing rates for intrastate service. Many states also impose various reporting requirements and/or require prior approval for transfers of control of certified carriers and assignments of carrier assets, including customer bases, carrier stock offerings and incurrence by carriers of significant debt obligations. Articles of authority can generally be conditioned, modified, canceled, terminated or revoked by state regulatory authorities for failure to comply with state law and/or the rules, regulations and policies of the state regulatory authorities. Fines and other penalties, including the return of all monies received for intrastate traffic from residents of a state, may be imposed for such violations. SmarTalk has made the filings and taken the actions it believes are necessary to become certified or tariffed to provide intrastate card services to customers throughout the U.S. The Company is certified to do business as a foreign corporation in the 49 states outside of its state of incorporation, and has received authorization to provide intrastate telecommunications services in all states where certification is required. There can be no assurance that the Company's provision of services in states where it is not licensed or tariffed to provide such services will not have a Material Adverse Effect. See "Risk Factors -- Regulation." EMPLOYEES As of August 1, 1996, the Company employed 33 persons on a full-time basis. None of the Company's employees are members of a labor union or are covered by a collective bargaining agreement. The Company believes that its relations with its employees are good. The Company believes that its future success will depend on its ability to attract and retain highly skilled and qualified employees to meet management and other requirements from time to time. 39 FACILITIES SmarTalk's principal executive offices are located in approximately 8,524 square feet of office space in Los Angeles, California under a lease expiring January 10, 2002. SmarTalk also subleases from Pacific Bell Information Services space to house the VoiceChoice Platform located in San Francisco. The Company is currently engaged in negotiations to have the lease assigned to it by Pacific Bell. In addition, the Company has commenced negotiations with the landlord of the space to enter into a lease to replace the Company's arrangements with Pacific Bell. The Company believes that other space is available at a comparable monthly rent if its negotiations are unsuccessful. The Company believes its facilities are suitable for the Company's current needs. LEGAL PROCEEDINGS The Company is not aware of any pending legal proceedings against the Company which, individually or in the aggregate, the Company expects to have a Material Adverse Effect. The Company is, from time to time, involved in regulatory proceedings before various public utilities commissions, as well as before the FCC. See also "Risk Factors -- Limited Protection of Proprietary Rights; Risk of Infringement." PLAN OF OPERATION SmarTalk intends to devote a majority of its efforts toward retail distribution, expanding the number of retailers at which the SmarTalk Card is sold, increasing the number of stores among retailers selling the SmarTalk Card and adding points of sale at which customers can purchase the SmarTalk Card within each store. In the next 12 months the Company expects to increase its staff by adding employees to help manage the planned growth of the Company. SmarTalk intends to develop an Internet home page, produce television advertising and continue to expand the payphone marketing program in an effort to pursue additional direct response opportunities. The Company plans to expand its sales force to include representatives to focus on businesses. As part of its efforts to attract businesses, SmarTalk plans to introduce voice mail, fax mail, conference calling and international calling services by the end of 1997. The Company anticipates that it will spend approximately $5 to $10 million to increase capacity of the SmarTalk Platforms required to handle anticipated usage volume and to provide enhanced features. 40 MANAGEMENT OFFICERS AND DIRECTORS The executive and certain other key officers and directors of the Company and their ages as of July 1, 1996 are as follows:
NAME AGE POSITION ---- --- -------- Robert H. Lorsch(1)........................ 46 Chairman of the Board of Directors, President and Chief Executive Officer Richard M. Teich........................... 42 Executive Vice President Glen Andrew Folck.......................... 32 Chief Financial Officer and Vice President, Finance/Operations William H. Mackall......................... 64 Vice President, Sales and Marketing Ahmed O. Alfi(2)........................... 39 Director Fred F. Fielding........................... 57 Director Jeffrey I. Scheinrock...................... 45 Director Lloyd S. Zeiderman(3)...................... 60 Director
- -------- (1) Mr. Lorsch serves as a director of the Company pursuant to his own designation under the Shareholders Agreement dated as of December 28, 1995 among the Company, Robert H. Lorsch and SmarTalk Partners (the "Shareholders Agreement"). The Shareholders Agreement shall terminate upon the consummation of the Offering. (2) Mr. Alfi serves as a director of the Company pursuant to SmarTalk Partners' designation under the Shareholders Agreement. The Shareholders Agreement shall terminate upon consummation of the Offering. (3) Mr. Zeiderman serves as a director of the Company pursuant to the designation of a voting trust set forth in the Shareholders Agreement. The Shareholders Agreement shall terminate upon consummation of the Offering. Robert H. Lorsch co-founded the Company and has served as Chairman of the Board of Directors, President and Chief Executive Officer of the Company since its inception in October, 1994. Prior to forming the Company, Mr. Lorsch served as President of LCN, a full service advertising and sales promotion agency formed by Mr. Lorsch in 1986 which specialized in merchandising, and interactive marketing on behalf of corporate clients. On December 28, 1995, the Company purchased certain of the assets of LCN. See "Certain Transactions." Richard M. Teich co-founded the Company and has served as the Company's Executive Vice President since January 1, 1996. From 1993 through 1995, Mr. Teich designed, developed and implemented various advertising and teleservices programs, including the implementation of interactive telephone sampling and promotion programs for consumer products companies, while serving as a consultant to LCN. From 1991 through 1992, Mr. Teich served as Vice President of LCN. Glen Andrew Folck has been the Company's Chief Financial Officer and Vice President, Finance/Operations since January 15, 1996. From December, 1993, until joining the Company, Mr. Folck served as Director of Strategic Planning for Harvard Industries, Inc., an automotive components manufacturer. From March, 1992 through December, 1993, he was Manager, Corporate Accounting and Financial Reporting, for Sonoco Products Company, a paper packaging manufacturer. He served as Manager, Branch Accounting, for Premark International, Inc., a diversified products manufacturer, from May, 1990 through March, 1992. William H. Mackall has served as the Company's Vice President, Sales and Marketing since June 1, 1996. Prior to joining the Company, from 1994 through May, 1996, Mr. Mackall was a private 41 marketing and sales promotion consultant. From 1991 through 1994, he co- founded and served as President of William Mackall & Associates, a full service sales promotion agency. Ahmed O. Alfi has been a director of the Company since 1996. Mr. Alfi has served as the Chairman of the Board of Directors and Chief Executive Officer of Alfigen, Inc., a prenatal diagnostic company, since January, 1992. He also co-manages Delphi Investments, Ltd., an investment management company which he founded in 1987. Mr. Alfi currently serves as a director of Creative Computers, Inc., a direct marketer of computer products. He is also a limited partner of SmarTalk Partners. See "Principal and Selling Shareholders." Fred F. Fielding has served as a director of the Company since 1996. Mr. Fielding has been a Senior Partner with Wiley, Rein & Fielding in Washington D.C. since 1986. From January, 1981 to April, 1986, Mr. Fielding was counsel to the President of the United States. Currently, Mr. Fielding serves as a director for USAir Shuttle, Inc. Jeffrey I. Scheinrock has served as a director of the Company since 1996. From March, 1989 until June, 1996, Mr. Scheinrock was the Vice Chairman of Finance and Strategic Planning for Packard Bell Electronics Inc. As of July, 1996, Mr. Scheinrock is the Vice Chairman of Kistler Aerospace. Lloyd S. Zeiderman has served as a director of the Company since 1995. Since 1991, Mr. Zeiderman has managed New Vest Capital Corporation, a mortgage portfolio firm, Nelson Equities, Inc., a real estate acquisitions and management firm, and HCS Specialized Training Centers, LLC, a computer training center. Additionally, he has managed three business management firms, Zeiderman Management Corporation, Zeiderman, Friedman & LaRosa, Inc., and ZFL Management, Inc. BOARD OF DIRECTORS AND COMMITTEES All directors hold office until the next annual meeting of the shareholders or until their successors have been elected, subject to a director's earlier death, resignation, retirement, disqualification or removal. There are no family relationships between any of the directors or the executive officers of the Company. The Company's board of directors has established Audit and Compensation Committees. The Audit Committee is responsible for reviewing and making recommendations regarding the appointment of the Company's independent auditors, the annual audit of the Company's financial statements and the Company's internal accounting practices and policies. The current members of the Audit Committee are Messrs. Alfi, Scheinrock and Zeiderman. The Compensation Committee is responsible for making recommendations to the board of directors regarding compensation arrangements for key employees and key consultants of the Company and for administering the Company's stock option plans. The current members of the Compensation Committee are Messrs. Fielding, Scheinrock and Zeiderman. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION Prior to July, 1996, there was no Compensation Committee, and the entire board of directors participated in deliberations regarding executive officer compensation. During the fiscal year ended December 31, 1995, Mr. Lorsch was an executive officer of the Company. During such period, no member of the board of directors served as a director or a member of the Compensation Committee of any other company of which any executive officer served as a member of the board of directors. Mr. Lorsch, the Company's Chairman of the Board, President and Chief Executive Officer, is the sole shareholder of LCN, which was a marketing and consulting firm. SmarTalk was formed in October, 1994 and had no employees until September, 1995. From October, 1994 through December, 1995 LCN provided the Company with consulting and operational assistance. All of the services of 42 Mr. Lorsch and certain of the services of Mr. Teich (the Company's present Executive Vice President) were provided to SmarTalk through LCN and SmarTalk was billed on an hourly basis for their services. In addition, LCN provided SmarTalk with assistance with product, platform, billing and software development. For a limited period through the end of 1995, SmarTalk employees were covered under LCN's benefit programs. The total amount paid by SmarTalk to LCN for all these services was approximately $25,000 in 1994 and $415,000 in 1995. In January, 1996 the Company assumed a lease from LCN of office space owned by Mr. Lorsch. Under this lease the Company paid rent to LCN totalling $11,226 in 1996. The Company no longer utilizes such space and the lease has been terminated. The Company has paid $5,000 of a $10,000 lease cancellation fee to LCN. From February 17, 1995 to November 30, 1995, Mr. Lorsch advanced funds, from time to time, to the Company. At no time during this period did the amount owed by the Company to Mr. Lorsch exceed $42,200. These loans were repaid in full by November 30, 1995. In addition, Mr. Lorsch was loaned $4,500 by the Company in October, 1995, which amount was repaid by the end of 1995. SmarTalk purchased certain assets and assumed certain liabilities of LCN pursuant to an agreement dated December 28, 1995 between SmarTalk and LCN. The purchase was consummated in January, 1996, for $500,000 cash plus a $2,000,000 principal amount subordinated promissory note which bears interest at 7% per annum (the "LCN Note"), payable $35,000 a month, with all amounts due and payable in full on June 30, 2000. The Company intends to repay the promissory note with the proceeds from the Offering. Mr. Lorsch is party to a subordination agreement with the Company and SmarTalk Partners pursuant to which he has agreed that no payments shall be made under the LCN Note unless all amounts under the New SmarTalk Partners Loan (referred to below) have been repaid in full. LCN received a security interest in substantially all assets of the Company for agreeing to subordinate its $2,000,000 term note. See "Use of Proceeds" and "Certain Transactions." The Company has agreed to pay certain expenses of the Selling Shareholders, including Mr. Lorsch and Mr. Zeiderman, a director of the Company, in connection with this Offering. See "Principal and Selling Shareholders" and "Underwriting." DIRECTORS' COMPENSATION All non-employee directors receive a directors fee of either $1,000 for each directors or committee meeting attended in person or $500 for each telephonic meeting thereof. Non-employee directors are reimbursed for reasonable out-of- pocket expenses incurred in connection with their attendance at directors and committee meetings. In addition, options to purchase 28,240 shares of Common Stock for $3.56 per share were granted to each of Fred F. Fielding and Jeffrey I. Scheinrock on June 11, 1996 pursuant to the Non-Qualified Plan (as defined below). See "Management -- Stock Option Plans." With respect to the options granted to each of Messrs. Fielding and Scheinrock, options to purchase 9,413 shares of Common Stock will vest on June 11, 1997, options to purchase 9,413 shares of Common Stock will vest on June 11, 1998 and options to purchase 9,414 shares of Common Stock will vest on June 11, 1999. For the year ended December 31, 1995, Mr. Lorsch received directors' fees aggregating $5,500 for attending eleven meetings of the board of directors. 43 EXECUTIVE COMPENSATION The following table sets forth certain information concerning compensation earned for services rendered in all capacities to the Company by the Company's Chairman of the Board, President and Chief Executive Officer (the "named executive officer"). No other officer of the Company had a total annual salary and bonus which exceeded $100,000 during the year ended December 31, 1995. SUMMARY COMPENSATION TABLE
NAME SALARY ---- ------- Robert H. Lorsch............................... $73,750
This amount represents compensation for the final three months of 1995, the payment of which was deferred until the first quarter of 1996. In addition, Mr. Lorsch's services were provided to SmarTalk by LCN from October, 1994 through September, 1995, and thereafter certain of Mr. Lorsch's services were provided by LCN through the end of the year. SmarTalk paid LCN an hourly consulting fee for Mr. Lorsch's services. See "Management -- Directors' Compensation" and "Certain Transactions." EMPLOYMENT AGREEMENTS The Company has entered into an employment agreement (the "Lorsch Employment Agreement") with Robert H. Lorsch to serve as the President and Chief Executive Officer. The Lorsch Employment Agreement provides for an initial term of three years commencing on the date of the closing of the Offering and contains a two year "evergreen" provision pursuant to which the employment period will automatically be extended for consecutive periods of two years unless the Company gives Mr. Lorsch written notice, no later than one year prior to the expiration of the then applicable employment period, that employment will terminate upon the expiration of that period. Under the Lorsch Employment Agreement, Mr. Lorsch is entitled to an annual base salary of $345,000 for each calendar year of the agreement and is to receive a bonus based on the Company's operating results in the discretion of the Compensation Committee. Pursuant to the Lorsch Employment Agreement, the Company will provide Mr. Lorsch with certain other benefits, including life and disability insurance, an automobile allowance and reimbursement for ordinary business expenses. Mr. Lorsch is entitled to participate in benefits available to employees and executive officers of the Company. Under the terms of the Lorsch Employment Agreement, Mr. Lorsch has agreed not to compete with the Company nor solicit SmarTalk employees on behalf of another person, firm or entity in competition with the Company, during the term of his employment and for one year after the effective date of termination. If Mr. Lorsch's employment is terminated by the Company following a "change in control" or "without cause" or by Mr. Lorsch for "good reason" (as such terms are defined in the Lorsch Employment Agreement), Mr. Lorsch is entitled to receive a payment equal to the then effective base salary for the longer of (a) the remainder of the term of the Lorsch Employment Agreement and (b) twenty-four months (the "Lorsch Severance Period"), and the Company shall continue to maintain Mr. Lorsch's benefits during the Lorsch Severance Period until comparable benefits are obtained from another employer. In addition, Mr. Lorsch's employment may be terminated by the Company "for cause" (as defined in the Lorsch Employment Agreement), in which case Mr. Lorsch would not be entitled to any further payments under the Lorsch Employment Agreement other than amounts already earned. The Company has entered into an employment agreement (the "Teich Employment Agreement") with Richard M. Teich to serve as the Executive Vice President. The Teich Employment Agreement provides for an initial term of two years commencing on the date of the closing of the Offering and contains a one year "evergreen" provision pursuant to which the employment period will be automatically extended for consecutive periods of one year unless the Company gives Mr. Teich written notice, no later than three months prior to the expiration of the then applicable employment period, that employment will terminate upon the expiration of that period. 44 Under the Teich Employment Agreement, Mr. Teich is entitled to an annual base salary of $185,000 for each calendar year of the agreement and is to receive a bonus based on the Company's operating results in the discretion of the Compensation Committee. Pursuant to the Teich Employment Agreement, the Company will provide Mr. Teich with certain other benefits, including life and disability insurance, an automobile allowance and reimbursement for ordinary business expenses. Mr. Teich is entitled to participate in benefits available to employees and executive officers of the Company. Under the terms of the Teich Employment Agreement, Mr. Teich has agreed not to compete with the Company nor solicit SmarTalk employees on behalf of another person, firm or entity in competition with the Company during the term of his employment and for one year after the effective date of termination. If Mr. Teich's employment is terminated by the Company following a "change in control" or "without cause" or by Mr. Teich for "good reason" (as such terms are defined in the Teich Employment Agreement), Mr. Teich is entitled to receive a payment equal to the then effective base salary for the longer of (a) the remainder of the term of the Teich Employment Agreement and (b) twelve months (the "Teich Severance Period"), and the Company shall continue to maintain Mr. Teich's benefits during the Teich Severance Period until comparable benefits are obtained from another employer. In addition, Mr. Teich's employment may be terminated by the Company "for cause" (as defined in the Teich Employment Agreement), in which case Mr. Teich would not be entitled to any further payments under the Teich Employment Agreement other than amounts already earned. STOCK OPTION PLANS 1996 NON-QUALIFIED STOCK OPTION PLAN. In March, 1996, the board of directors adopted the Company's 1996 Non-Qualified Stock Option Plan (the "Non-Qualified Plan"). The Non-Qualified Plan provides for the granting of nonstatutory stock options to employees, officers, directors, consultants, advisors or agents of the Company. Pursuant to the Non-Qualified Plan, an amount equal to (a) the lesser of (i) 7,087,991 shares of Common Stock and (ii) the number of shares of Common Stock equal to 9% of the total issued and outstanding shares of Common Stock minus (b) the number of shares of Common Stock issued or issuable pursuant to options exercised or outstanding under the 1996 Plan (referred to below) are reserved for issuance upon the exercise of options granted under the Non-Qualified Plan. The board of directors may amend, suspend or terminate the Non-Qualified Plan at any time. Upon completion of the Offering, however, any amendment which would materially (1) increase the benefits accruing to participants under the Non-Qualified Plan, (2) increase the number of shares which may be issued under the Non-Qualified Plan, or (3) modify the requirements for eligibility for participation in the Non-Qualified Plan, must be approved by the Company's shareholders. The number of shares available for issuance under the Non-Qualified Plan and the exercise price of options granted may be adjusted to reflect certain corporate reorganizations and recapitalizations in order to prevent an inequitable dilution or enlargement of the rights of the participants in the Non-Qualified Plan. The Non-Qualified Plan automatically terminates in March, 2006 unless terminated earlier by the board of directors. It is anticipated that the Non-Qualified Plan will be terminated upon consummation of the Offering. The Non-Qualified Plan is administered by the Compensation Committee. Subject to the conditions of the Non-Qualified Plan, the Compensation Committee, in its discretion, selects the recipients of each option grant and the number of shares of Common Stock each such option represents, as well as the terms and conditions of each grant, including the vesting schedule, the exercise price, the expiration or termination and the transferability of the options granted. As of June 30, 1996, options to purchase 508,514 shares of Common Stock had been granted. The Company anticipates that it will not issue any additional options under the Non-Qualified Plan. 1996 STOCK INCENTIVE PLAN. In August, 1996, the board of directors adopted and the shareholders of the Company approved the 1996 Stock Incentive Plan (the "1996 Plan" and together 45 with the Non-Qualified Plan, the "Stock Option Plans"). The 1996 Plan permits the Compensation Committee of the board of directors to make awards to directors, employees, advisors and consultants of the Company and its subsidiaries. The 1996 Plan provides for grant of stock options, including both incentive stock options and non-qualified options, as well as stock appreciation rights, restricted stock, performance shares and phantom stock, as described below. All awards under the 1996 Plan are nontransferable by the participant, except upon the participant's death in accordance with his will or applicable law. The number of shares of Common Stock or units or other rights that may be subject to options and other types of awards granted in the future under the 1996 Plan to officers, employees, advisors and consultants of the Company is not determinable at this time. Stock Options. The 1996 Plan authorizes the grant of non-qualified stock options to employees, consultants and advisors of the Company and its subsidiaries. Incentive stock options may only be granted to employees of the Company and its subsidiaries. The exercise price of a non-qualified stock option may be determined by the Compensation Committee in its discretion. The exercise price of an incentive stock option may not be less than the fair market value of the Common Stock on the date of grant. The value of Common Stock (determined at the time of grant) that may be subject to incentive stock options that become exercisable by any one employee in any one year is limited by the Internal Revenue Code to $100,000. The maximum term of stock options granted under the 1996 Plan is 10 years from the date of grant. The Compensation Committee shall determine the extent to which an option shall become and/or remain exercisable in the event of the termination of employment or service of a participant under certain circumstances, including retirement, death or disability, subject to certain limitations for incentive stock options. Under the 1996 Plan, the exercise price of an option is payable by the participant in cash or, in the discretion of the Compensation Committee, in Common Stock or a combination of cash and Common Stock. Stock Appreciation Rights. A stock appreciation right may be granted in connection with an option, either at the time of grant or at any time thereafter during the term of the option. A stock appreciation right granted in connection with an option entitles the holder, upon exercise, to surrender the related option and receive a payment based on the difference between the exercise price of the related option and the fair market value of the Company's Common Stock on the date of exercise. A stock appreciation right granted in connection with an option is exercisable only at such time or times as the related option is exercisable and expires no later than the related option expires. A stock appreciation right also may be granted without relationship to an option and will be exercisable as determined by the Compensation Committee, but in no event after ten years from the date of grant. A stock appreciation right granted without relationship to an option entitles the holder, upon exercise, to a payment based on the difference between the base price assigned to the stock appreciation right by the Compensation Committee on the date of grant and the fair market value of the Company's Common Stock on the date of exercise. Payment to the holder in connection with the exercise of a stock appreciation right may be in cash or shares of Common Stock or in a combination of cash and Common Stock. Restricted Stock Awards. The Compensation Committee may award shares of Common Stock to participants under the 1996 Plan, subject to such restrictions on transfer and conditions of forfeiture as it deems appropriate. Such conditions may include requirements as to the continued service of the participant with the Company, the attainment of specified performance goals or any other conditions determined by the Compensation Committee. Subject to the transfer restrictions and forfeiture restrictions relating to the restricted stock award, the participant will otherwise have the rights of a shareholder of the Company, including all voting and dividend rights, during the period of restriction. Performance Awards. The Compensation Committee may grant performance awards denominated in specified dollar units ("Performance Units") or in shares of Common Stock. Performance awards are payable upon the achievement of performance goals established by the Compensation Committee at the beginning of the performance period, which may not exceed ten years 46 from the date of grant. At the time of grant, the Compensation Committee establishes the number of units or shares, the duration of the performance period, the applicable performance goals and, in the case of Performance Units, the potential payment or range of payments for the performance awards. At the end of the performance period, the Compensation Committee determines the payment to be made based on the extent to which the performance goals have been achieved. The Compensation Committee may consider significant unforeseen events during the performance period when making the final award. Payments may be made in cash or shares of Common Stock or in a combination of cash and shares. Phantom Stock. An award of phantom stock gives the participant the right to receive cash at the end of a fixed vesting period based on the value of a share of Common Stock at that time. Phantom stock units are subject to such restrictions and conditions to payment as the Compensation Committee determines are appropriate. At the time of grant, the Compensation Committee determines, in its sole discretion, the number of units and the vesting period of the units, and it may also set a maximum value of a unit. If the participant remains employed by the Company throughout the applicable vesting period, he is entitled to receive payment of a cash amount for each phantom stock unit equal in value to the fair market value of one share of Common Stock on the last day of the vesting period, subject to any maximum value limitation. Administration. The 1996 Plan shall be administered by the Compensation Committee of the board of directors, or such other Compensation Committee as may be appointed by the board. Subject to the limitations set forth in the 1996 Plan, the Compensation Committee has the authority to determine the persons to whom awards will be granted, the time at which awards will be granted, the number of shares, units or other rights subject to each award, the exercise, base or purchase price of an award (if any), the time or times at which the award will become vested, exercisable or payable and the duration of the award. The Compensation Committee may provide for the acceleration of the vesting or exercise period of an award at any time prior to its termination or upon the occurrence of specified events. With the consent of the affected participant, the Compensation Committee has the authority to cancel and replace awards previously granted with new options for the same or a different number of shares and having a higher or lower exercise or base price, and may amend the terms of any outstanding awards to provide for an exercise or base price that is higher or lower than the current exercise or base price. Reservation of Shares. The Company has authorized and reserved a number of shares of Common Stock for issuance under the 1996 Plan equal to (a) the lesser of (i) 7,087,991 shares of Common Stock and (ii) the number of shares of Common Stock equal to 9% of the total issued and outstanding shares of Common Stock minus (b) the number of shares of Common Stock issued or issuable pursuant to options exercised or outstanding under the Non-Qualified Plan. If any shares of Common Stock that are the subject of an award are not issued or transferred and cease to be issuable or transferable for any reason, such shares will no longer be charged against such maximum share limitation and may again be made subject to awards under the 1996 Plan. In the event of certain corporate reorganizations, recapitalizations, or other specified corporate transactions affecting the Company or the Common Stock, proportionate adjustments may be made to the number of shares available for grant and to the number of shares and prices under outstanding awards made before the event. Term and Amendment. The 1996 Plan has a term of ten years, subject to earlier termination or amendment by the board of directors. All awards granted under the 1996 Plan prior to its termination remain outstanding until exercised, paid or terminated in accordance with their terms. The board of directors may amend the 1996 Plan at any time, except that shareholder approval is required for certain amendments to the extent necessary for purposes of Rule 16b-3 under the Securities Exchange Act of 1934. 47 Tax Consequences. The following is a general description of the current federal income tax consequences to participants and the Company relating to options and other awards that may be granted under the 1996 Plan. This discussion does not purport to cover all tax consequences relating to options or other awards. The grant of a stock option under the 1996 Plan will not generally result in taxable income for the participant, nor in a deductible compensation expense for the Company, at the time of grant. The participant will have no taxable income upon exercising an incentive stock option (except that the alternative minimum tax may apply), and the Company will receive no deduction when an incentive stock option is exercised. Upon exercising a non-qualified option, the participant will recognize ordinary income in the amount by which the fair market value of the Common Stock on the date of exercise exceeds the exercise price, and the Company will generally be entitled to a corresponding deduction. The treatment of a participant's disposition of shares of Common Stock acquired upon the exercise of an option is dependent upon the length of time the shares have been held and on whether such shares were acquired by exercising an incentive stock option or a non-qualified option. Generally, there will be no tax consequence to the Company in connection with the disposition of shares acquired under an option except that the Company may be entitled to a deduction in the case of a disposition of shares acquired upon exercise of an incentive stock option before the applicable incentive stock option holding period has been satisfied. The current federal income tax consequences of other awards authorized under the 1996 Plan generally follow certain basic patterns: stock appreciation rights are subjected to income tax upon exercise in substantially the same manner as non-qualified stock options; restricted stock subject to a substantial risk of forfeiture results in income recognition equal to the excess of the fair market value of the stock over the purchase price (if any) only at the time the restrictions lapse, unless the recipient elects to accelerate recognition as of the date of grant; performance awards and phantom stock generally are subject to tax at the time of payment. In each of the foregoing cases, the Company generally has a corresponding tax deduction at the time the participant recognizes taxable income. CERTAIN TRANSACTIONS Mr. Lorsch, the Company's Chairman of the Board, President and Chief Executive Officer, is the sole shareholder of LCN, which was a marketing and consulting firm. SmarTalk was formed in October, 1994 and had no employees until September, 1995. From October, 1994 through December, 1995 LCN provided the Company with consulting and operational assistance. All of the services of Mr. Lorsch and certain of the services of Mr. Teich (the Company's present Executive Vice President) were provided to SmarTalk through LCN and SmarTalk was billed on an hourly basis for their services. In addition, LCN provided SmarTalk with assistance with product, platform, billing and software development. For a limited period through the end of 1995, SmarTalk employees were covered under LCN's benefit programs. The total amount paid by SmarTalk to LCN for all these services was approximately $25,000 in 1994 and $415,000 in 1995. In January, 1996 the Company assumed a lease from LCN of office space owned by Mr. Lorsch. Under this lease the Company paid rent to LCN totalling $11,226 in 1996. The Company no longer utilizes such space and the lease has been terminated. The Company has paid $5,000 of a $10,000 lease cancellation fee to LCN. From February 17, 1995 to November 30, 1995, Mr. Lorsch advanced funds, from time to time, to the Company. At no time during this period did the amount owed by the Company to Mr. Lorsch exceed $42,200. These loans were repaid in full by November 30, 1995. In addition, Mr. Lorsch was loaned $4,500 by the Company in October, 1995, which amount was repaid by the end of 1995. 48 On December 28, 1995, pursuant to a Loan and Investment Agreement among SmarTalk Partners, the Company and Robert H. Lorsch, SmarTalk Partners entered into an agreement to loan the Company $1,200,000 (the "Loan"), provide the Company with a $500,000 line of credit (the "Line of Credit") and purchase shares of Common Stock of the Company representing 30% of the outstanding shares. The Loan, evidenced by a promissory note, secured by the assets of the Company, bears interest at 7% per annum. Interest only is payable on the last day of the month through December 31, 1996 and thereafter principal and interest shall be payable in equal fully amortizable monthly installments until July 31, 2000 when all amounts are due and payable. The Line of Credit, also evidenced by a promissory note, secured by the assets of the Company, bears interest at a floating rate equal to prime rate plus 2%, payable in arrears monthly. All amounts become due and payable in full on January 31, 1998. SmarTalk Partners is a significant shareholder of the Company. Mr. Alfi, a director of the Company, is a limited partner of SmarTalk Partners. The Company intends to repay the Loan and the Line of Credit with the proceeds from the Offering. See "Principal and Selling Shareholders" and "Use of Proceeds." SmarTalk purchased certain assets and assumed certain liabilities of LCN pursuant to an agreement dated December 28, 1995 between SmarTalk and LCN. SmarTalk paid $2,500,000 for the assets relating to SmarTalk's business, $500,000 of which was paid in cash, and $2,000,000 of which was paid by a subordinated promissory note which bears interest at 7% per annum and is payable in amounts of $35,000 a month, with all amounts due and payable in full on June 30, 2000. The Company intends to repay the promissory note with the proceeds from the Offering. See "Use of Proceeds" and "Management -- Compensation Committee Interlocks and Insider Participation." On August 9, 1996 the Company entered into a loan agreement with SmarTalk Partners pursuant to which the Company obtained a loan of $250,000 (the "New SmarTalk Partners Loan"). This term loan is collateralized by substantially all of the assets of the Company and accrues interest at the prime rate. Interest on the loan is due the last day of each month, commencing August 31, 1996, with the loan maturing on January 31, 1997. The Loan, the Line of Credit and the $2,000,000 term note are subordinated to the $250,000 term loan. LCN received a security interest in substantially all assets of the Company for subordinating its $2,000,000 term note. The Company intends to repay the $250,000 term note with the proceeds from the Offering. See "Use of Proceeds," "Management -- Compensation Committee Interlocks and Insider Participation" and "Principal and Selling Shareholders." The Company has agreed to pay certain expenses of the Selling Shareholders, including Mr. Lorsch, Mr. Zeiderman, Mr. Teich and SmarTalk Partners, in connection with this Offering. See "Principal and Selling Shareholders" and "Underwriting." 49 PRINCIPAL AND SELLING SHAREHOLDERS The following table sets forth certain information regarding the beneficial ownership of Common Stock as of August 1, 1996, the number of shares being offered hereby and the beneficial ownership of the Common Stock upon consummation of the Offering by: (i) the named executive officer, (ii) each person known to the Company to be the beneficial owner of more than 5% of the Common Stock, (iii) each director, (iv) all directors and executive officers of the Company as a group and (v) the Selling Shareholders. The following table assumes that the Underwriters' over-allotment option will be exercised in full.
SHARES BENEFICIALLY SHARES BENEFICIALLY OWNED PRIOR TO OWNED AFTER OFFERING(1)(2) NUMBER OFFERING ----------------------- OF SHARES ----------------------- NAME AND ADDRESS OF BENEFICIAL OWNER NUMBER PERCENT OFFERED(3) NUMBER PERCENT ------------------------------------ ------------ ---------- ---------- ------------ ---------- Robert H. Lorsch(4) 1640 South Sepulveda Boulevard, Suite 500 Los Angeles, CA 90025.................................. 5,868,515 66.5% 429,750 5,438,765 42.4% SmarTalk Partners, LLC(5) 3 Civic Plaza, Suite 17D Newport Beach, CA 92660................................ 2,647,449 30% 380,000 2,267,449 17.7% Ahmed O. Alfi(5)......................................... -- -- -- -- -- Fred F. Fielding(6)...................................... -- -- -- -- -- Jeffrey I. Scheinrock(7)................................. -- -- -- -- -- Lloyd S. Zeiderman....................................... 308,870 3.5% 20,250 288,620 2.3% Bruce Bielinski(8)....................................... 308,870 3.5% 20,250 288,620 2.3% Richard M. Teich(8)...................................... 308,870 3.5% 20,250 288,620 2.3% Robert H. Thau(8)(9)..................................... 123,548 1.4% 4,625 118,923 0.9% Bernard D. Walter(8)(10)................................. 123,548 1.4% 4,625 118,923 0.9% All directors and executive officers as a group (8 persons)(4)(5)(6)(7)(11)............................. 6,191,505 70% 450,000 5,741,505 44.7%
- ------- (1) In accordance with Rule 13d-3 under the Exchange Act, a person is deemed to be a "beneficial owner" of a security if he or she has or shares the power to vote or direct the voting of such security or the power to dispose or direct the disposition of such security. A person is also deemed to be a beneficial owner of any securities of which that person has the right to acquire beneficial ownership within 60 days. More than one person may be deemed to be a beneficial owner of the same securities. (2) This table is based upon information supplied by directors, executive officers and principal shareholders. Unless otherwise indicated in the footnotes to this table, each of the shareholders named in this table has sole voting and investment power with respect to the shares shown as beneficially owned. (3) The Selling Shareholders have granted the Underwriters an over-allotment option to purchase up to 630,000 shares of Common Stock. See "Underwriting." Of the 380,000 shares to be offered by SmarTalk Partners, 200,000 shares are to be offered as part of the Offering and up to an aggregate of 180,000 shares will be offered in the event the Underwriters' over-allotment option is exercised. If the Underwriters' over-allotment option is not exercised, then SmarTalk Partners would beneficially own 2,447,449 shares, representing 19.1% of the Common Stock after consummation of the Offering. (4) Includes 926,610 shares prior to the consummation of the Offering and 876,860 shares after the consummation of the Offering as to which Mr. Lorsch, pursuant to certain proxy agreements, has sole voting power, but not investment power. These proxy agreements expire on November 1, 1996. (5) Mr. Alfi, a director of the Company, is a limited partner of SmarTalk Partners. Mr. Alfi disclaims beneficial ownership of the shares owned by SmarTalk Partners. (6) Mr. Fielding was granted options to purchase 28,240 shares of Common Stock, at an exercise price of $3.56 per share, pursuant to the Non- Qualified Plan. Such options will not vest within 60 days of this Offering. See "Management -- Directors' Compensation." (7) Mr. Scheinrock was granted options to purchase 28,240 shares of Common Stock, at an exercise price of $3.56 per share, pursuant to the Non- Qualified Plan. Such options will not vest within 60 days of this Offering. See "Management -- Directors' Compensation." (8) Represents shares subject to proxy agreements which grant Mr. Lorsch sole voting power with respect to such shares. The proxy agreements expire November 1, 1996. (9) Includes 61,774 shares held by Rosenfeld, Meyer & Susman, LLP, of which Mr. Thau is a partner. Accordingly, Mr. Thau may be deemed to beneficially own such shares. (10) Includes 92,660 shares held by Walter and Associates, of which Mr. Walter is a principal. Accordingly, Mr. Walter may be deemed to beneficially own such shares. (11) Two of the Company's executive officers were granted options to purchase 11,251 and 14,120 shares of Common Stock, at exercise prices of $4.44 per share and $1.77 per share, respectively, pursuant to the Non-Qualified Plan. Such options will not vest within 60 days of this Offering. 50 DESCRIPTION OF CAPITAL STOCK GENERAL The authorized capital stock of the Company consists of 100,000,00 shares of Common Stock, no par value, and 10,000,000 shares of Preferred Stock, no par value. As of August 15, 1996, there were 8,824,834 shares of Common Stock issued and outstanding held by ten (10) shareholders of record and no shares of Preferred Stock issued and outstanding. As of August 15, 1996 there were 508,514 shares of Common Stock subject to stock options. The following statements are brief summaries of certain provisions with respect to the Company's capital stock contained in its Articles and Bylaws, copies of which have been filed as exhibits to the Registration Statement. The following is qualified in its entirety by reference thereto. COMMON STOCK The holders of Common Stock are entitled to one vote per share on all matters to be voted on by shareholders and have cumulative voting rights with respect to the election of directors. Subject to the prior rights of holders of Preferred Stock, if any, the holders of Common Stock are entitled to receive such dividends, if any, as may be declared from time to time by the board of directors in its discretion from funds legally available therefor. Upon liquidation or dissolution of the Company, the remainder of the assets of the Company will be distributed ratably among the holders of Common Stock after payment of liabilities and the liquidation preferences of any outstanding shares of Preferred Stock. The Common Stock has no preemptive or other subscription rights and there are no conversion rights or redemption or sinking fund provisions with respect to such shares. All of the outstanding shares of Common Stock are, and the shares to be sold in this Offering will be, fully paid and nonassessable. PREFERRED STOCK The Company is authorized to issue 10,000,000 shares of undesignated Preferred Stock. The board of directors has the authority to issue the Preferred Stock in one or more series and to fix the rights, preferences, privileges and restrictions thereof, including dividend rights, dividend rates, conversion rights, voting rights, preemption rights, terms of redemption, redemption prices, sinking fund provisions, liquidation preferences and the number of shares constituting a series or the designation of such series, without further vote or action by the shareholders. The issuance of Preferred Stock may have the effect of delaying, deferring or preventing a change in control of the Company without further action by the shareholders and may adversely effect the market price of, and the voting and other rights of, the holders of Common Stock. At present, the Company has no shares of Preferred Stock outstanding and has no plans to issue any shares of the Preferred Stock. REGISTRATION RIGHTS SmarTalk Partners, the holder of 2,447,449 shares of Common Stock following the Offering (the "Registrable Shares"), is entitled to certain rights with respect to the registration of such shares of Common Stock under the Securities Act. If the Company proposes to register any of its securities under the Securities Act for its own account, the Company must notify SmarTalk Partners of the Company's intent to register such Common Stock and allow SmarTalk Partners an opportunity to include the Registerable Shares in the Company's registration. SmarTalk Partners also has the right, from and after such time as the Company has closed an initial public offering of its Common Stock, to require the Company to prepare and file a registration statement under the Securities Act pertaining to the Registerable Shares. The Company is required to use its best efforts to effect such registration so long as such request relates to Registrable Shares constituting 5% or more of the Company's issued and outstanding Common Stock. The Company need only cause one such registration to become 51 effective during any one year period. These registration rights are subject to certain limitations and restrictions including the right of the underwriters of any offering of the Company's Common Stock to limit the number of Registerable Shares included in the registration. Generally, the Company is required to pay all registration expenses in connection with each registration of Registrable Shares pursuant to these registration rights. SmarTalk Partners has agreed that, in any registration in which it is participating effected pursuant to an underwritten public offering, it will not effect any public sale or distribution of any Registerable Shares or any other equity security of the Company within seven (7) days prior to and for one hundred twenty (120) days after the effective date of such registration. SmarTalk Partners has agreed to a limitation on its ability to sell or distribute shares of Common Stock and other securities for 180 days after the date of this Prospectus, without the prior written consent of Salomon Brothers Inc. See "Underwriting." CERTAIN PROVISIONS OF THE COMPANY'S ARTICLES AND BYLAWS Certain provisions of law and the Company's Articles and Bylaws could make the acquisition of the Company by means of a tender offer, proxy contest or otherwise and the removal of incumbent officers and directors more difficult. These provisions are expected to discourage certain types of coercive takeover practices and inadequate takeover bids and to encourage persons seeking to acquire control of the Company to first negotiate with the Company. The Company's Articles also provide that so long as the Company shall have a class of stock registered pursuant to the Securities Exchange Act of 1934, as amended (the "Exchange Act"), shareholder action can be taken only at an annual or special meeting of shareholders and may not be taken by written consent. LIMITATION ON LIABILITY AND INDEMNIFICATION The Company has adopted provisions in its Articles that eliminate, to the fullest extent permissible under California law, the liability of its directors to the Company for monetary damages. Such limitation of liability does not affect the availability of equitable remedies such as injunctive relief or rescission. The Company's Bylaws provide that the Company shall indemnify its directors and officers to the fullest extent permitted by California law, including in circumstances in which indemnification is otherwise discretionary under California law. The Company has entered into indemnification agreements with its officers and directors containing provisions which may require the Company, among other things, to indemnify the officers and directors against certain liabilities that may arise by reason of their status or service as directors or officers (other than liabilities arising from willful misconduct of a culpable nature), and to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified. TRANSFER AGENT The transfer agent and registrar for the Company's Common Stock is U. S. Stock Transfer Corporation. 52 SHARES ELIGIBLE FOR FUTURE SALE Upon completion of this Offering, the Company will have 12,824,834 shares of Common Stock outstanding. Of these shares, the 4,200,000 shares sold in this Offering will be freely tradeable without restriction or further registration under the Securities Act, except for shares purchased by "affiliates" of the Company, as that term is defined in Rule 144 under the Securities Act (which may generally be sold only in compliance with Rule 144). The remaining 8,624,834 shares are deemed "Restricted Shares" under Rule 144 in that they were originally issued and sold by the Company in private transactions in reliance upon exemptions from the registration provisions of the Securities Act. Upon the expiration of the 180-day lock-up agreements described below, none of the Restricted Shares will be eligible for sale pursuant to Rule 144 until the expiration of two years from the date such Restricted Shares were acquired. In addition to the Restricted Shares described in the preceding paragraph, the approximately 14,120 shares of Common Stock which may be acquired 180 days after the effective date of this Offering upon the exercise of currently outstanding stock options are subject to the 180-day lock-up agreements but may be eligible for resale following the expiration of the 180-day lock-up agreements (subject, in the case of affiliates, to certain limitations) pursuant to Rule 701 under the Securities Act. See "Management -- Stock Option Plans" and "Underwriting." Additional options will continue to vest and may be exercised and sold from time to time by option holders following the expiration of the 180-day lock-up agreements. The Company, its directors and officers and substantially all of the other shareholders of the Company, who upon completion of the Offering will own in the aggregate 8,624,834 shares of Common Stock, as well as the holder of, currently outstanding options to purchase 14,120 additional shares of Common Stock, have entered into "lock-up" agreements with the Underwriters, providing that they will not offer, sell, loan, pledge, grant any option to purchase or otherwise dispose of any of their shares of Common Stock, or any securities exercisable for or convertible into shares of Common Stock or request the registration to any of the foregoing, for a period of 180 days after the date of this Prospectus without the prior written consent of Salomon Brothers Inc, except that the Company may issue and may grant options to purchase and register shares of Common Stock under the Stock Option Plans. See "Underwriting." In general, under Rule 144 as currently in effect, a person (or persons whose shares are aggregated), including persons deemed to be affiliates, whose Restricted Shares have been fully paid for and held for at least two years from the date of issuance by the Company may sell such securities in brokers' transactions or directly to market makers, provided the number of shares sold in any three month period does not exceed the greater of (i) 1% of the then outstanding shares of the Common Stock (128,244 shares based on the number of shares to be outstanding after this Offering) or (ii) the average weekly trading volume in the public market during the four calendar weeks immediately preceding the filing of the seller's Form 144. Sales under Rule 144 are also subject to certain notice requirements and the availability of current public information concerning the Company. After three years have elapsed from the issuance of Restricted Shares by the Company, such shares generally may be sold without limitation by persons who have not been affiliates of the Company for at least three months. Rule 144 also provides that affiliates who are selling shares which are not Restricted Shares must nonetheless comply (with the exception of the holding period requirements) with the same restrictions applicable to Restricted Shares. In general, under Rule 701 as currently in effect, any employee, officer, director, consultant or advisor of the Company who purchased shares from the Company pursuant to a written compensatory benefit plan or written contract relating to compensation is eligible to resell such shares ninety days after the effective date of this Offering in reliance upon Rule 144, but without the requirement to comply 53 with certain restrictions contained in such rule. Shares obtained pursuant to Rule 701 may be sold by non-affiliates without regard to the holding period, volume limitations, or information or notice requirements of Rule 144, and by affiliates without regard to the holding period requirements. The Company intends to file Form S-8 Registration Statements under the Securities Act to register all shares of Common Stock issuable under its stock plan, as well as certain of the shares of Common Stock previously issued under its stock plans. These registration statements are expected to be filed as soon as practicable after the date of this Prospectus and are expected to become effective immediately upon filing. Shares covered by these registration statements will be eligible for sale in the public market after the effective date of such registration statements subject to Rule 144 limitations applicable to affiliates of the Company. See "Management -- Stock Option Plans." The Company has granted registration rights to certain of its shareholders. See "Description of Capital Stock -- Registration Rights." Prior to the Offering, there has been no public market for the Common Stock and it is impossible to predict with certainty the effect, if any, that market sales of shares or the availability of such shares for sale will have on the market price of the Common Stock. Nevertheless, sales of substantial amounts of Common Stock in the public market may have an adverse impact on such market price and could impair the Company's ability to raise capital through the sale of its equity securities. 54 UNDERWRITING Subject to the terms and the conditions set forth in the Underwriting Agreement, the Company has agreed to sell to each of the Underwriters named below (the "Underwriters"), for whom Salomon Brothers Inc ("Salomon"), CS First Boston Corporation and Donaldson, Lufkin & Jenrette Securities Corporation are acting as representatives (the "Representatives"), and each of the Underwriters, has severally agreed to purchase from the Company, the respective number of shares of Common Stock set forth opposite its name below:
NUMBER OF SHARES UNDERWRITERS TO BE PURCHASED ------------ ---------------- Salomon Brothers Inc..................................... CS First Boston Corporation.............................. Donaldson, Lufkin & Jenrette Securities Corporation...... ----------- Total.................................................... 4,200,000 ===========
In the Underwriting Agreement, the several Underwriters have agreed, subject to the terms and conditions set forth therein, to purchase all of the shares of Common Stock offered hereby (other than those subject to the over-allotment option described below) if any such shares are purchased. In the event of a default by any Underwriter, the Underwriting Agreement provides that, in certain circumstances, purchase commitments of the non-defaulting Underwriters may be increased or the Underwriting Agreement may be terminated. The Company has been advised by the Representatives that the several Underwriters propose initially to offer such stock to the public at the public offering price set forth on the cover page of this Prospectus, and to certain dealers at such price less a concession not in excess of $ per share. The Underwriters may allow and such dealers may reallow a concession not in excess of $ per share to other dealers. After the public offering, the public offering price and such concessions may be changed. The Selling Shareholders have granted to the Underwriters an option, exercisable within 30 days of the date of the Prospectus, to purchase up to 630,000 additional shares of Common Stock at the price to public less the underwriting discounts set forth on the cover page of this Prospectus to cover over-allotments, if any. To the extent that the Underwriters exercise such option, in whole or part, each of the Underwriters will be committed, subject to certain conditions, to purchase the same proportion of such additional shares of Common Stock as the number of shares of Common Stock to be purchased and offered by such Underwriter in the above table bears to the total number of shares of Common Stock initially offered by the Underwriters hereby. The Underwriting Agreement provides that the Company and the Selling Shareholders will indemnify the several Underwriters against certain liabilities, including liabilities under the Securities Act, or contribute to payments the Underwriters may be required to make in respect thereof. The Company, the Selling Shareholders and the Company's directors and executive officers have agreed not to offer, sell or contract to sell, or otherwise dispose of, directly or indirectly, or announce the offering of any other shares of Common Stock or any securities convertible into, or exchangeable for, shares of Common Stock for a period of 180 days after the date of this Prospectus, without the prior written consent of Salomon. The Representatives have informed the Company and the Selling Shareholders that they do not expect discretionary sales by the Underwriters to exceed 5% of the shares offered hereby. 55 Prior to the Offering, there has been no public market for the Common Stock. The initial public offering price for the Common Stock offered hereby will be determined by negotiation among the Company, the Selling Shareholders and the Representatives. Among the factors to be considered in determining the initial public offering price will be the earnings and certain other financial and operating information of the Company in recent periods, the future prospects of the Company and its industry in general, the general condition of the securities market at the time of the Offering and the market prices of securities and certain financial and operating information of companies engaged in activities similar to those of the Company. There can, however, be no assurance that the prices at which the Common Stock will sell in the public market after the Offering will not be lower than the price at which it is sold by the Underwriters. The Company has applied to list its Common Stock on the Nasdaq National Market System under the trading symbol "SMTK." LEGAL MATTERS The validity of the shares of Common Stock offered hereby will be passed upon for the Company by Dewey Ballantine, Los Angeles, California. Certain legal matters will be passed upon for the Underwriters by Munger, Tolles & Olson, Los Angeles, California. EXPERTS The financial statements as of December 31, 1994 and December 31, 1995 and for the period from inception and year ended, respectively, included in this Prospectus have been so included in reliance on the report of Price Waterhouse LLP, independent accountants, given on the authority of said firm as experts in auditing and accounting. ADDITIONAL INFORMATION The Company has filed with the Commission a Registration Statement on Form S-1 under the Securities Act with respect to the shares of Common Stock offered hereby. This Prospectus does not contain all of the information set forth in the Registration Statement and the exhibits and schedules thereto. Certain items are omitted in accordance with the rules and regulations of the Commission. For further information with respect to the Company and the Common Stock offered hereby, reference is made to the Registration Statement and to the exhibits and schedules filed as part thereof. Statements contained in this Prospectus as to the contents of any contract or other document referred to are not necessarily complete, and in each instance, reference is made to the copy of such contract or document filed as an exhibit to the Registration Statement, each such statement being qualified in all respects by such reference. As a result of the Offering, the Company will be subject to the informational requirements of the Exchange Act, and in accordance therewith, will file reports and other information with the Commission. A copy of the Registration Statement, including the exhibits and schedules thereto, and the reports and other information filed by the Company in accordance with the Exchange Act, may be inspected without charge at the principal office of the Commission in Washington, D.C. and copies may be obtained from the Public Reference Section at the Commission's principal office, 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549, and are also available for inspection and copying at the Commission's regional offices at Seven World Trade Center, 13th Floor, New York, New York 10048 and at Northwest Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661 upon payment of the fees prescribed by the Commission. Such material may also be accessed electronically by means of the Commission's home page on the Internet at http://www.sec.gov. 56 SMARTALK TELESERVICES, INC. INDEX TO FINANCIAL STATEMENTS
PAGE ---- Report of Price Waterhouse LLP, Independent Accountants.................. F-2 Balance Sheets as of December 31, 1994, December 31, 1995 and June 30, 1996.................................................................... F-3 Statements of Operations for the period ended December 31, 1994, the year ended December 31, 1995 and the six months ended June 30, 1995 and June 30, 1996................................................................ F-4 Statements of Shareholders' Equity (Deficit) for the period ended December 31, 1994, the year ended December 31, 1995 and the six months ended June 30, 1996..................................................... F-5 Statements of Cash Flows for the period ended December 31, 1994, the year ended December 31, 1995 and the six months ended June 30, 1995 and June 30, 1996................................................................ F-6 Notes to Financial Statements for December 31, 1994 and 1995 and Unaudited June 30, 1996................................................. F-7
F-1 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of SmarTalk TeleServices, Inc. In our opinion, the accompanying balance sheets and the related statements of operations, shareholders' equity (deficit) and of cash flows, present fairly, in all material respects, the financial position of SmarTalk TeleServices, Inc. at December 31, 1994 and 1995, and the results of its operations and its cash flows for the period from inception to December 31, 1994 and for the year ended December 31, 1995 in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP August 15, 1996 Century City, California F-2 SMARTALK TELESERVICES, INC. BALANCE SHEETS - --------------------------------------------------------------------------------
DECEMBER 31, --------------------- JUNE 30, 1994 1995 1996 -------- ----------- ----------- (UNAUDITED) ASSETS ------ Current assets: Cash and cash equivalents................ $ 391 $ 2,115,351 $ 763,078 Trade accounts receivable (less allowance for doubtful accounts of $35, $11,460, $89,724, respectively).................. 232 224,974 1,914,970 Inventories.............................. -- 718,045 629,900 Receivable from related party............ 3,400 -- -- Other current assets..................... -- 759,718 696,004 Prepaid expenses......................... -- 3,078 52,787 -------- ----------- ----------- Total current assets................... 4,023 3,821,166 4,056,739 Non-current assets: Deposits................................. -- 16,100 69,129 Other non-current assets................. -- -- 53,325 Net property and equipment............... -- 4,486 603,629 -------- ----------- ----------- Total assets........................... $ 4,023 $ 3,841,752 $ 4,782,822 ======== =========== =========== LIABILITIES AND SHAREHOLDERS' DEFICIT ------------------------------------- Current liabilities: Accounts payable......................... $ 27,002 $ 923,900 $ 1,981,444 Deferred revenue......................... 431 3,696,515 4,127,919 Accrued marketing costs.................. 37,062 381,429 164,897 Other accrued expenses................... -- 219,682 498,550 Note payable and current portion of long- term debt............................... -- -- 539,998 -------- ----------- ----------- Total current liabilities.............. 64,495 5,221,526 7,312,808 Long-term debt payable to related parties less current portion...................... -- -- 3,285,002 -------- ----------- ----------- Total liabilities...................... 64,495 5,221,526 10,597,810 Commitments (See Notes 6 and 8) Shareholders' deficit: Common stock, no par value; authorized 35,000,000 shares; issued and outstanding 4,941,904, 8,824,834, and 8,824,834 shares, respectively.......... 5,000 315,000 315,000 Common stock subscribed.................. -- (300,000) -- Accumulated deficit...................... (65,472) (1,394,774) (6,129,988) -------- ----------- ----------- Total shareholders' deficit............ (60,472) (1,379,774) (5,814,988) -------- ----------- ----------- Total liabilities and shareholders' deficit............................... $ 4,023 $ 3,841,752 $ 4,782,822 ======== =========== ===========
The accompanying notes are an integral part of these financial statements. F-3 SMARTALK TELESERVICES, INC. STATEMENTS OF OPERATIONS - --------------------------------------------------------------------------------
FROM INCEPTION (OCTOBER 28, 1994) SIX MONTHS ENDED THROUGH YEAR ENDED JUNE 30, DECEMBER 31, DECEMBER 31, ---------------------- 1994 1995 1995 1996 ------------------ ------------ --------- ----------- (UNAUDITED) Revenue................. $ 444 $ 453,916 $ 41,738 $ 3,678,020 Cost of revenue......... 716 312,286 29,110 2,680,115 --------- ----------- --------- ----------- Gross profit (loss)... (272) 141,630 12,628 997,905 Sales and marketing..... 1,980 842,306 173,242 1,643,426 General and administrative......... 63,220 630,638 124,823 1,521,293 --------- ----------- --------- ----------- Operating loss........ (65,472) (1,331,314) (285,437) (2,166,814) Interest income......... -- 5,290 -- 25,072 Interest expense........ -- 3,278 -- 129,444 --------- ----------- --------- ----------- Loss before income taxes................ (65,472) (1,329,302) (285,437) (2,271,186) Provision for income taxes.................. -- -- -- -- --------- ----------- --------- ----------- Net loss.............. $ (65,472) $(1,329,302) $(285,437) $(2,271,186) ========= =========== ========= =========== Net loss per share...... $ (.01) $ (.14) $ (.03) $ (.24) ========= =========== ========= =========== Weighted average number of shares.............. 9,333,348 9,333,348 9,333,348 9,333,348 ========= =========== ========= ===========
The accompanying notes are an integral part of these financial statements. F-4 SMARTALK TELESERVICES, INC. STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) - --------------------------------------------------------------------------------
COMMON STOCK ------------------ STOCK ACCUMULATED SHARES AMOUNT SUBSCRIPTION DEFICIT TOTAL --------- -------- ------------ ----------- ----------- Inception (October 28, 1994) Shares issued........... 4,941,904 $ 5,000 $ -- $ -- $ 5,000 Net loss................ -- -- -- (65,472) (65,472) --------- -------- -------- ----------- ----------- December 31, 1994....... 4,941,904 5,000 -- (65,472) (60,472) Shares issued........... 1,235,481 310,000 -- -- 310,000 Stock subscribed........ 2,647,449 -- (300,000) -- (300,000) Net loss................ -- -- -- (1,329,302) (1,329,302) --------- -------- -------- ----------- ----------- December 31, 1995....... 8,824,834 315,000 (300,000) (1,394,774) (1,379,774) --------- -------- -------- ----------- ----------- Funds received from stock subscription..... -- -- 300,000 -- 300,000 Purchase of assets of related entity (See Note 6)................ -- -- -- (2,464,028) (2,464,028) Net loss................ -- -- -- (2,271,186) (2,271,186) --------- -------- -------- ----------- ----------- June 30, 1996 (unaudited)............ 8,824,834 $315,000 $ -- $(6,129,988) $(5,814,988) ========= ======== ======== =========== ===========
The accompanying notes are an integral part of these financial statements. F-5 SMARTALK TELESERVICES, INC. STATEMENTS OF CASH FLOWS - --------------------------------------------------------------------------------
FROM INCEPTION SIX MONTHS ENDED (OCTOBER 28, 1994) YEAR ENDED JUNE 30, THROUGH DECEMBER 31, ---------------------- DECEMBER 31, 1994 1995 1995 1996 ------------------ ------------ --------- ----------- (UNAUDITED) Cash flows from operating activities: Net loss............. $(65,472) $(1,329,302) $(285,437) $(2,271,186) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation......... -- -- -- 18,186 Provision for bad debt................ 35 11,425 1,119 78,264 Changes in assets and liabilities which increase (decrease) cash: Accounts receivable........ (267) (236,167) (90,919) (1,768,260) Inventories........ -- (718,045) (161,228) 88,145 Receivable from related party..... (3,400) 3,400 3,400 -- Other current assets............ -- (759,718) (10,147) 63,714 Prepaid expenses... -- (3,078) (1,437) (49,709) Deposits........... -- (16,100) -- (53,029) Other non-current assets............ -- -- -- (53,325) Accounts payable... 27,002 896,898 197,058 1,057,544 Deferred revenue... 431 3,696,084 89,074 431,404 Accrued marketing costs............. 37,062 344,367 (37,062) (216,532) Other accrued expenses.......... -- 219,682 33,939 278,868 -------- ----------- --------- ----------- Net cash provided (used) by operating activities...... (4,609) 2,109,446 (261,640) (2,395,916) -------- ----------- --------- ----------- Cash flows from investing activities: Capital expenditures. -- (4,486) -- (456,357 ) -------- ----------- --------- ----------- Cash flows from financing activities: Common stock proceeds............ 5,000 10,000 -- 300,000 Note payable to related party....... -- -- 272,000 1,200,000 Revolving line of credit with related party............... -- -- -- 500,000 Payment to LCN....... -- -- -- (500,000) -------- ----------- --------- ----------- Net cash from financing activities...... 5,000 10,000 272,000 1,500,000 -------- ----------- --------- ----------- Increase (decrease) in cash and cash equivalents........... 391 2,114,960 10,360 (1,352,273) Cash and cash equivalents at beginning of period... -- 391 391 2,115,351 -------- ----------- --------- ----------- Cash and cash equivalents at end of period................ $ 391 $ 2,115,351 $ 10,751 $ 763,078 ======== =========== ========= =========== Supplemental disclosure of cash flow information: Cash paid for interest. $ -- $ 3,278 $ -- $ 129,444 ======== =========== ========= =========== Note payable issued for LCN purchase (see Note 6).................... $ -- $ -- $ -- $ 2,000,000 ======== =========== ========= =========== Purchase of VoiceChoice Platform through issuance of note payable (see Note 9).. $ -- $ -- $ -- $ 125,000 ======== =========== ========= ===========
The accompanying notes are an integral part of these financial statements. F-6 SMARTALK TELESERVICES, INC. NOTES TO FINANCIAL STATEMENTS FOR DECEMBER 31, 1994 AND 1995 AND UNAUDITED JUNE 30, 1996 - ------------------------------------------------------------------------------- 1. THE COMPANY SmarTalk TeleServices, Inc. (the "Company") is a provider of prepaid long distance services. The Company primarily sells its products to retailers who in turn sell to customers. The customer can add minutes to the SmarTalk Card by use of a major credit card. The Company has developed additional avenues to market and distribute its services, including through its Corporate Advantage Program and corporate promotional programs. The Company was incorporated in October, 1994. As shown in the accompanying financial statements, the Company has incurred net losses of $65,472 in 1994, $1,329,302 in 1995 and $2,271,186 through June 30, 1996. Management believes it has adequate capital resources available to fund operations through June 30, 1997. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Interim Results The accompanying balance sheet at June 30, 1996, the statements of operations and of cash flows for the six months ended June 30, 1995 and 1996, and the statement of shareholders' equity (deficit) for the six months ended June 30, 1996 are unaudited. In the opinion of management, these statements have been prepared on the same basis as the audited financial statements and include all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of the results of the interim periods. The Company's results of operations and cash flows for the interim period are not necessarily indicative of the results to be expected for any other interim period or the full year. The data disclosed in these notes to financial statements at such date and for such periods are also unaudited. Accounting 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 disclosures of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents Cash and cash equivalents are composed of highly liquid investments with an original maturity of three months or less. In accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities," the investments, which consist solely of money market funds, are stated at market value, which approximates cost. Property and Equipment Property and equipment is stated at cost. Depreciation is computed using principally the straight-line method over the estimated useful lives of the related assets. Depreciation expense and accumulated depreciation was $0 as of, and for the periods ended December 31, 1994 and 1995, respectively. For the six months ended June 30, 1996, depreciation expense and accumulated depreciation was $18,186. F-7 SMARTALK TELESERVICES, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) FOR DECEMBER 31, 1994 AND 1995 AND UNAUDITED JUNE 30, 1996 - ------------------------------------------------------------------------------- Accrued Marketing Costs Accrued marketing costs include printed and electronic advertising. These costs are accrued and expensed as incurred. Marketing expenses were $870, $251,676 and $991,409 for the periods ended December 31, 1994 and 1995 and June 30, 1996, respectively. The cost of co-op advertising undertaken in connection with co-op programs with retailers is expensed at the earlier of when the advertising takes place or the related revenue is recognized. Other Accrued Expenses Other accrued expenses include the cost of sales commissions and sales and use taxes. These obligations are accrued and capitalized upon shipment of SmarTalk cards to retailers and capitalized amounts are amortized into expense as the revenue to which they specifically relate is recognized. Fair Value of Financial Instruments Statement of Financial Accounting Standards No. 107, "Disclosures About Fair Value of Financial Instruments" requires the determination of fair value for certain of the Company's assets and liabilities. The Company estimates that the carrying value of its financial instruments approximates fair value at December 31, 1994 and 1995. Revenue Recognition and Deferred Revenue The Company's revenue is generated from: (i) sales of Company and co-branded phone cards to customers through retailers, (ii) recharges of existing phone cards, (iii) cards sold for promotional marketing campaigns, and (iv) corporate sales to businesses. Under the majority of agreements with retailers, the Company sells cards to the retailer at a fixed price with normal credit terms. The Company invoices the retailer upon shipment, recognizing deferred revenue. The Company recognizes revenue and reduces the deferred revenue account as the customer utilizes the calling time and upon expiration of cards containing unused calling time, subject to applicable escheat laws, if any. The Company also recognizes deferred revenue upon recharge of existing phone cards and recognizes revenue upon usage or expiration of the recharge minutes. Internally Developed Software The Company has incurred costs associated with developing and testing its proprietary software system. These costs, which are considered immaterial, consisted of amounts paid to consultants and salaries paid to employees, and have been expensed as incurred and are included in General and Administrative expense. Regulation The Company is subject to regulation by the Federal Communications Commission and by various state public service and public utility commissions. The Company's management and regulatory legal counsel believe the Company is in compliance with regulations in all states. Stock Split On February 15, 1996, the board of directors declared a 3,500 for 1 stock split distributable on February 13, 1996 to shareholders of record on February 13, 1996. Further, on May 23, 1996, the board of directors declared a 2.51 for 1 stock split distributable on May 23, 1996 to shareholders of record on that date. Further, on August 15, 1996, the Company effected a 0.5625 reverse stock split distributable on August 15, 1996 to shareholders of record on that date. In this report, per share amounts and numbers of shares have been restated to reflect the stock splits. F-8 SMARTALK TELESERVICES, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) FOR DECEMBER 31, 1994 AND 1995 AND UNAUDITED JUNE 30, 1996 - ------------------------------------------------------------------------------- Net Loss per Share Net loss per share is based on the weighted average number of common shares and common stock equivalents outstanding during each period, after retroactive adjustment for the stock splits (see above). Pursuant to requirements of the Staff of the Securities and Exchange Commission, shares related to stock sold and options issued subsequent to August 15, 1995 have been shown as outstanding for all periods presented. Long-Lived Assets In 1995, the Company adopted SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." SFAS No. 121 establishes accounting standards for the measurement and recognition of impairment of long-lived assets, certain identifiable intangibles, and goodwill related to those assets to be held and used and for long-lived assets and certain identifiable intangibles to be disposed of. The adoption of SFAS No. 121 had no effect on the Company's financial statements. 3. COMPOSITION OF CERTAIN BALANCE SHEET ACCOUNTS Inventories Inventories are valued at the lower of cost (using the first-in, first-out (FIFO) method) or market. Inventories consist of the following at:
DECEMBER 31, --------------- JUNE 30, 1994 1995 1996 ------ -------- ----------- (UNAUDITED) Phone cards................................... $ -- $582,110 $492,974 Displays...................................... -- 135,935 136,926 ------ -------- -------- Total..................................... $ -- $718,045 $629,900 ====== ======== ========
Other Current Assets
DECEMBER 31, --------------- JUNE 30, 1994 1995 1996 ------ -------- ----------- (UNAUDITED) Pre-paid sales commissions.................... $ -- $285,391 $337,533 Cards shipped................................. -- 243,557 147,695 Other......................................... -- 230,770 210,776 ------ -------- -------- Total other current assets................ $ -- $759,718 $696,004 ====== ======== ========
Property and Equipment
DECEMBER 31, --------------- JUNE 30, 1994 1995 1996 ------ -------- ----------- (UNAUDITED) Computers..................................... $ -- $ 3,661 $ 96,844 Telephone switching equipment................. -- -- 325,000 Office equipment and furniture................ -- 825 199,971 Less: Accumulated depreciation............ -- -- (18,186) ------ -------- -------- $ -- $ 4,486 $603,629 ====== ======== ========
F-9 SMARTALK TELESERVICES, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) FOR DECEMBER 31, 1994 AND 1995 AND UNAUDITED JUNE 30, 1996 - ------------------------------------------------------------------------------- 4. NOTE PAYABLE AND LONG-TERM DEBT PAYABLE TO RELATED PARTIES At June 30, 1996, note payable and long-term debt payable to related parties consisted of the following:
JUNE 30, 1996 ------------- (UNAUDITED) 9% Term loan payable, interest accrues daily on the outstanding balance and is payable January 1, 1997. Principal payable in six monthly installments of $16,667 beginning July, 1996 with $25,000 due January 1, 1997 (see Note 9)........................ $ 125,000 Revolving loan with SmarTalk Partners, LLC, interest at prime plus 2% payable monthly beginning January 31, 1996, principal due January 31, 1998 (see Note 6)............................... 500,000 7% Term loan, with SmarTalk Partners, LLC, interest only is payable monthly from January 31, 1996 through December 31, 1996. Interest plus principal totaling $31,634 is payable monthly beginning January 1, 1997 through July, 2000 (see Note 6)......................................................... 1,200,000 7% Subordinated Term loan, payable to LCN, principal and interest payable in monthly installments of $35,000 beginning August 31, 1996 with the balance due June 20, 2000 (see Note 6)...................................... 2,000,000 Less: Current maturities....................................... (539,998) ---------- Long-term debt, less current maturities.......................... $3,285,002 ==========
At June 30, 1996 future maturities of long-term debt are: 1997 -- $539,998, 1998 -- $1,125,279, 1999 -- $670,155, 2000 -- $1,460,674, 2001 -- $28,894. 5. INCOME TAXES The difference between the statutory federal income tax rate and the Company's effective income tax rate applied to loss before income taxes was as follows for the period ended December 31, 1994, and the year ended December 31, 1995:
DECEMBER 31, -------------------- 1994 1995 -------- --------- Statutory federal tax rate on loss........... (34)% (34)% State income tax provision, net of federal benefit .................................... (6)% (6)% Increase in valuation reserve against deferred tax asset.......................... 40 % 40 % -------- --------- Income taxes at the Company's effective rate. 0 % 0 % ======== ========= The major components of deferred tax assets arising from temporary differences at December 31, 1994 and 1995 are as follows: DECEMBER 31, -------------------- 1994 1995 -------- --------- Deferred revenue............................. $ -- $ 417,000 Net operating loss carryforwards............. 17,000 68,000 Other........................................ 14,000 115,000 -------- --------- Subtotal..................................... 31,000 600,000 Valuation allowance.......................... (31,000) (600,000) -------- --------- Total deferred taxes......................... $ -- $ -- ======== =========
F-10 SMARTALK TELESERVICES, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) FOR DECEMBER 31, 1994 AND 1995 AND UNAUDITED JUNE 30, 1996 - ------------------------------------------------------------------------------- The Company had net operating loss carryforwards of approximately $65,472 and $1,396,786 as of December 31, 1994 and 1995, respectively. To the extent not used, net operating loss carryforwards expire in varying amounts beginning in the year 2002. If substantial changes in the Company's ownership should occur, there will be an annual limitation on the amount of the carryforwards which can be utilized. Under SFAS No. 109, the Company has recorded valuation allowances against the realization of the deferred tax assets. Based on available evidence, including the Company's history of operating losses, the uncertainty of future profitability and the impact of tax laws which may limit the Company's ability to utilize such loss carryforwards, management has concluded that it is more likely than not that deferred tax assets will not be realized. 6. RELATED PARTIES Transactions With Related Entities At December 31, 1994 the Company had a receivable due from its majority shareholder in the amount of $3,400. On December 28, 1995 the Company entered into an agreement with SmarTalk Partners, LLC ("SP") under which SP agreed to loan $1,200,000 to the Company and to purchase 2,647,449 shares of the Company's Common Stock for $300,000. The term loan is collateralized by substantially all assets of the Company. Interest accrues daily and is payable monthly beginning January 31, 1996 and ending December 31, 1996. Beginning January 1, 1997 interest accrues daily and is payable monthly along with principal payments through July, 2000. The $1,500,000 was received in January, 1996. In addition, the Company obtained a revolving loan facility from SP, collateralized by substantially all assets of the Company. The facility provides for borrowings up to $500,000. The principal portion of the loan is due and payable January 31, 1998. The facility was fully drawn at June 30, 1996. Payment in Excess of Book Value of Assets Purchased From a Related Entity (Unaudited) In January, 1996 the Company entered into an agreement to purchase certain of the office furniture and equipment fixed assets of Lorsch Creative Network, Inc. ("LCN") that had historical net book value of $35,972. LCN's sole shareholder is the majority shareholder of the Company's Common Stock. Minority shareholders of the Company consented to the transaction. The purchase was consummated in January, 1996 for $500,000 cash plus a $2,000,000 subordinated term note which bears interest at 7% per annum (see Note 4). Because the assets were purchased from a related party, the assets are reflected on the Company's balance sheet at LCN's historical depreciated cost as of the date of the acquisition. The excess of acquisition cost over the historical cost less depreciation of the assets acquired of approximately $2,464,028 was recorded as a charge to the Company's accumulated deficit. In addition, prior to the purchase, LCN provided consulting and other services to the Company for which it billed approximately $25,000 and $415,000 in 1994 and 1995, respectively. Amounts were billed on an hourly basis for consulting and other services performed by LCN employees on behalf of SmarTalk. F-11 SMARTALK TELESERVICES, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) FOR DECEMBER 31, 1994 AND 1995 AND UNAUDITED JUNE 30, 1996 - ------------------------------------------------------------------------------- 7. STOCK COMPENSATION PLANS The Company had two stock based compensation plans at June 30, 1996. The programs are described as follows: 1996 NON QUALIFIED STOCK OPTION PLAN: In March, 1996, the board of directors adopted the Company's 1996 Non- Qualified Stock Option Plan (the "Non-Qualified Plan"), whereby nonstatutory stock options may be granted to employees, officers, directors, consultants, advisors, or agents of the Company. Options to purchase the Company's Common Stock are exercisable at a price not less than the fair market value of the stock at the date of grant and for a term not to exceed 10 years. Further, the options vest over a period ranging from grant date to 3 years from the anniversary of the grant. Pursuant to the Non-Qualified Plan, an amount equal to (a) the lesser of (i) 7,087,991 shares of Common Stock, and (ii) the number of shares of Common Stock equal to 9% of the total issued and outstanding shares of Common Stock minus (b) the number of shares of Common Stock issued or issuable pursuant to options exercised or outstanding under the 1996 Stock Incentive Plan are reserved for issuance under this plan. The Company accounts for the fair value of its grants under this plan in accordance with APB Opinion 25 Accounting for Stock Issued to Employees. Fair value of stock options granted was determined by the board of directors, who considered, among other factors, an independent valuation. The following table summarizes the activity in shares of Common Stock subject to options for the quarter ended June 30, 1996:
OPTION PRICE NUMBER OF PER SHARE SHARES ------------ --------- Balance at March 30, 1996.......................... -- -- Options granted.................................. $1.77-$4.44 508,514 Options exercised................................ -- -- Options canceled or expired...................... -- -- Balance at June 30, 1996........................... $1.77-$4.44 508,514
At June 30, 1996 no options had been exercised. 285,721 shares remain reserved for issuance under the plan. 1996 STOCK INCENTIVE PLAN: In August, 1996, the board of directors adopted and the shareholders of the Company approved the 1996 Stock Incentive Plan, whereby the Compensation Committee may make awards to directors, employees, advisors and consultants of the Company and its subsidiaries. Pursuant to the Stock Incentive Plan, the Company has authorized and reserved a number of shares of Common Stock for issuance equal to (a) the lesser of (i) 7,087,991 shares of Common Stock and (ii) a number of shares of Common Stock equal to 9% of the total issued and outstanding shares of Common Stock minus (b) the number of shares of Common Stock issued or issuable pursuant to options exercised or outstanding under the Non-Qualified Plan. Stock Options Non-qualified stock options may be granted to employees, consultants and advisors of the Company and its subsidiaries and incentive stock options may only be granted to employees of the Company and its subsidiaries. The exercise price of a non-qualified stock option may be determined by the Compensation Committee in its discretion. The exercise price of an incentive stock option may F-12 SMARTALK TELESERVICES, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) FOR DECEMBER 31, 1994 AND 1995 AND UNAUDITED JUNE 30, 1996 - ------------------------------------------------------------------------------- not be less than the fair market value of the Common Stock on the date of grant. The value of Common Stock (determined at the time of grant) that may be subject to incentive stock options that become exercisable by any one employee in any one year is limited by the Internal Revenue Code to $100,000. The maximum term of stock options granted under the 1996 Plan is 10 years from the date of grant. Stock Appreciation Rights A stock appreciation right may be granted in connection with an option, either at the time of grant or at any time thereafter during the term of the option. A stock appreciation right granted in connection with an option entitles the holder, upon exercise, to surrender the related option and receive a payment based on the difference between the exercise price of the related option and the fair market value of the Company's Common Stock on the date of exercise. A stock appreciation right granted in connection with an option is exercisable only at such time or times as the related option is exercisable and expires no later than when the related option expires. At June 30, 1996, no stock appreciation rights had been granted. Restricted Stock Awards The Compensation Committee may award shares of Common Stock to participants under this plan, subject to such restrictions on transfer and conditions of forfeiture as it deems appropriate. Such conditions may include requirements as to the continued service of the participant with the Company, the attainment of specified performance goals or any other conditions determined by the Compensation Committee. Subject to the transfer restrictions and forfeiture restrictions relating to the restricted stock award, the participant will otherwise have the rights of a shareholder of the Company, including all voting and dividend rights, during the period of restriction. At June 30, 1996, no restricted stock had been granted. Performance Awards The Compensation Committee may grant performance awards denominated in specified dollar units or in shares of Common Stock. Performance awards are payable upon the achievement of performance goals established by the Compensation Committee at the beginning of the performance period, which may not exceed ten years from the date of grant. Payments may be made in cash or shares of Common Stock or in a combination of cash and shares. At June 30, 1996, no performance awards had been granted. Phantom Stock An award of phantom stock gives the participant the right to receive cash at the end of a fixed vesting period based on the value of a share of Common Stock at that time. Phantom stock units are subject to such restrictions and conditions to payment as the Compensation Committee determines are appropriate. At June 30, 1996, no phantom stock had been awarded. 8. COMMITMENTS Telecommunications Service Agreements The Company has a minute volume commitment with one of its service providers which, if not met, could require the Company to make payments to such provider. If the Company fails to meet this commitment operating results could be adversely impacted. As of June 30, 1996, the Company anticipates that it will fulfill this commitment. F-13 SMARTALK TELESERVICES, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) FOR DECEMBER 31, 1994 AND 1995 AND UNAUDITED JUNE 30, 1996 - ------------------------------------------------------------------------------- Operating Leases The Company entered into a lease agreement on January 10, 1996 to lease office space. Lease payments commenced March 1, 1996 and end March 1, 2002. The future minimum annual rentals under this lease as of June 30, 1996 are as follows: 1996-$59,225, 1997-$164,684, 1998-$194,347, 1999-$194,347, 1999 and thereafter--$242,934. 9. PURCHASE OF VOICECHOICE PLATFORM In June, 1996 the Company acquired an interactive voice response platform facility known as the VoiceChoice Platform from Pacific Bell Information Services for total consideration of $325,000, plus other consideration including the release of certain contractual obligations of Pacific Bell Information Services to the Company. The purchase price was recorded at $325,000, comprised of $200,000 in cash and a $125,000 note. $100,000 of the $125,000 note is to be paid through six equal monthly installments beginning July 1, 1996 (see Note 4). A final payment due January 1, 1997 will include the remaining $25,000 principal amount of the note and an additional sum equal to the interest accrued on the declining balance paid in installments at 9% interest per annum calculated on a day-to-day basis. The Company was informed by Pacific Bell Information Services that the platform facility was constructed in 1994 at an original cost of approximately $1,648,000. The assets acquired include multiple switches, thousands of inbound and outbound access ports for prepaid and corporate calling services, voice response applications, high-speed database servers, voice recording capability and credit card verification software. The Company acquired the VoiceChoice Platform to enable it to provide additional services, such as stand-alone interactive voice services, and to reduce call handling costs. In conjunction with the purchase, the Company is negotiating a sublease from Pacific Bell Information Services for the building space housing the platform. At August 15, 1996 the sublease had not been finalized. Management believes its lease obligation under the sublease will approximate $5,000 per month for a period of three years. F-14 NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS IN CONNECTION WITH THE OFFER MADE BY THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY, THE SELLING SHAREHOLDERS OR ANY OF THE UNDERWRITERS. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATES AS OF WHICH INFORMATION IS GIVEN IN THIS PROSPECTUS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER OR SOLICITATION BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT QUALIFIED TO DO SO OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH SOLICITATION. --------------- TABLE OF CONTENTS
PAGE ---- Prospectus Summary........................................................ 3 Cautionary Statement Regarding Forward-Looking Statements................. 7 Risk Factors.............................................................. 7 Use of Proceeds........................................................... 17 Dividend Policy........................................................... 17 Capitalization............................................................ 18 Dilution.................................................................. 19 Selected Financial Data................................................... 20 Management's Discussion and Analysis of Financial Condition and Results of Operations............................................................... 21 Business.................................................................. 26 Plan of Operation......................................................... 40 Management................................................................ 41 Certain Transactions...................................................... 48 Principal and Selling Shareholders........................................ 50 Description of Capital Stock.............................................. 51 Shares Eligible for Future Sale........................................... 53 Underwriting.............................................................. 55 Legal Matters............................................................. 56 Experts................................................................... 56 Additional Information.................................................... 56 Index to Financial Statements............................................. F-1
--------------- UNTIL , 1996 (25 DAYS AFTER THE COMMENCEMENT OF THIS OFFERING), ALL DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPAT- ING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. 4,200,000 SHARES SMARTALK TELESERVICES, INC. COMMON STOCK (NO PAR VALUE) [LOGO OF SMARTALK(SM) TELESERVICES, INC.] SALOMON BROTHERS INC CS FIRST BOSTON DONALDSON, LUFKIN & JENRETTE SECURITIES CORPORATION Prospectus Dated , 1996 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. Set forth below is an estimate of the approximate amount of fees and expenses (other than underwriting discounts and commissions) payable by the Registrant in connection with the issuance and distribution of the securities registered hereby. No portion of such expenses will be borne by the Selling Shareholders. Securities and Exchange Commission registration fee........... $ 24,983 NASD filing fee............................................... 7,745 Nasdaq National Market listing fee............................ 32,500 Printing and engraving........................................ 125,000 Accountants' fees and expenses................................ 200,000 Blue sky fees and expenses.................................... 10,000 Counsel fees and expenses..................................... 720,000 Transfer Agent's fees......................................... 2,000 Miscellaneous................................................. 102,772 ---------- Total..................................................... $1,225,000 ==========
ITEM 14. INDEMNIFICATION OF OFFICERS AND DIRECTORS. Under California Law, a California corporation may eliminate or limit the personal liability of directors for monetary damages in an action brought by or in the right of a corporation for breach of a director's duty of care to the corporation and its shareholders. However, such a provision may not eliminate or limit a director's liability for (1) acts or omissions that involve intentional misconduct or a knowing and culpable violation of the law, (2) acts or omissions that a director believes to be contrary to the best interests of the corporation or its shareholders, or that involve the absence of good faith on the part of the director, (3) receipt of an improper personal benefit, (4) acts or omissions that show a reckless disregard for the director's duty to the corporation or its shareholders in circumstances in which the director was aware, or should have been aware, in the ordinary course of performing a director's duties, of a risk of serious injury to the corporation or its shareholders, (5) acts or omissions that constitute an unexcused pattern of inattention that amounts to an abdication of the director's duty to the corporation or its shareholders, (6) interested transactions between the corporation and a director or a corporation, firm or association in which the director has a material financial interest or (7) improper loans, distributions or guarantees. The Company has adopted provisions in its Articles that eliminate, to the fullest extent permissible under California law, the liability of its directors to the Company for monetary damages. Such limitation of liability does not affect the availability of equitable remedies such as injunctive relief or rescission. The Company's Bylaws provide that the Company shall indemnify its directors and officers to the fullest extent permitted by California law, including in circumstances in which indemnification is otherwise discretionary under California law. The Company has entered into indemnification agreements with its officers and directors containing provisions which may require the Company, among other things, to indemnify the officers and directors against certain liabilities that may arise by reason of their status or service as directors or officers (other than liabilities arising from willful misconduct of a culpable nature), and to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified. The Company maintains directors' and officers' liability insurance covering such persons in their official capacities with the Company and its subsidiaries. II-1 ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES. Since the Registrant's inception on October 28, 1994, the Registrant has issued and sold (without payment of any selling commission to any person) the following unregistered securities. The numbers of shares reflect (i) a 3,500 for 1 stock split of the Company's Common Stock effected on February 13, 1996, (ii) a 2.51 for 1 stock split of the Company's Common Stock effected on May 23, 1996 and (iii) a 0.5625 reverse stock split of the Company's Common Stock effected on August 15, 1996. 1. On December 1, 1994, the Registrant issued and sold 4,941,905 shares of Common Stock to the Company's founder for an aggregate purchase price of $5,000. 2. On December 1, 1995, the Registrant issued and sold 1,235,480 shares to seven investors for an aggregate purchase price of $10,000. Such shares were purchased upon the exercise of options granted to the investors by the Company. 3. On December 28, 1995, the Registrant issued and sold 2,647,449 shares of Common Stock to an investor for an aggregate purchase price of $300,000. The sales and issuance of securities described above were deemed to be exempt from registration under the Securities Act by virtue of Section 4(2) thereof, as transactions not involving a public offering, or, with respect to Common Stock issued to employees upon the exercise of stock options, in reliance upon the exemption from registration provided by Rule 701 of the Commission. The purchasers in such private offerings represented their intention to acquire the securities for investment only and not with a view to the distribution thereof, and appropriate legends were affixed to the stock certificates issued in such transactions. All purchasers had adequate access, through their employment or other relationships, to sufficient information about the Registrant to make an informed investment decision. No underwriter was employed with respect to any such sales. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. (a) Exhibits 1.1 Form of Underwriting Agreement.** 2.1 Agreement between SmarTalk TeleServices, Inc. and Lorsch Creative Network, Inc. dated December 28, 1995. 3.1 Amended and Restated Articles of Incorporation.** 3.2 Amended and Restated Bylaws.** 4.1 Registration Rights Agreement. 4.2 Specimen Stock Certificate. 5.1 Opinion of Dewey Ballantine, counsel to the Registrant, as to the legality of the shares being registered.** 10.1 Loan and Investment Agreement dated December 28, 1995 among SmarTalk TeleServices, Inc., SmarTalk Partners, LLC and Robert H. Lorsch. 10.2 Promissory Note in the amount of $1,200,000 dated December 28, 1995 made by SmarTalk TeleServices, Inc. in favor of SmarTalk Partners, LLC. 10.3 Security Agreement dated December 28, 1995 between SmarTalk TeleServices, Inc. and SmarTalk Partners, LLC. 10.4 Revolving Line of Credit Note in the amount of $500,000 dated December 28, 1995 made by SmarTalk TeleServices, Inc. in favor of SmarTalk Partners, LLC.
II-2 10.5 Subordinated Promissory Note in the amount of $2,000,000 dated January 1, 1996 by SmarTalk TeleServices, Inc. in favor of Lorsch Creative Network, Inc. 10.6 Subordination Agreement dated January 1, 1996 between SmarTalk TeleServices, Inc. and Lorsch Creative Network, Inc. 10.7 Security Agreement dated August 9, 1996 between SmarTalk TeleServices, Inc. and Lorsch Creative Network, Inc. 10.8 Employment Agreement between SmarTalk TeleServices, Inc. and Robert H. Lorsch.** 10.9 Form of Indemnification Agreement dated October 28, 1994 between SmarTalk Teleservices, Inc. and certain management personnel. 10.10 1996 Stock Option Plan.** 10.11 1996 Stock Incentive Plan.** 10.12 Standard Office Lease by and between LAOP IV, LLC and SmarTalk TeleServices, Inc., dated January 10, 1996, as amended on January 16, 1996, February 7, 1996 and April 19, 1996. 10.13 Carrier Agreement dated November 9, 1995 between the Registrant and MCI Telecommunications Corporation.* 10.14 First Amendment to Carrier Agreement dated March 2, 1996 between SmarTalk Teleservices, Inc. and MCI Telecommunications Corporation.* 10.15 Agreement dated October 4, 1995 between SmarTalk TeleServices, Inc. and West Interactive Corporation.* 10.16 Security Agreement dated August 9, 1996 between SmarTalk TeleServices, Inc. and SmarTalk Partners, LLC. 10.17 Subordination Agreement dated August 9, 1996 among Lorsch Creative Network, Inc., SmarTalk TeleServices, Inc. and SmarTalk Partners, LLC. 10.18 Promissory Note in the amount of $250,000 dated August 9, 1996 between SmarTalk Services, Inc. and SmarTalk Partners, LLC. 21.1 Subsidiary of the Registrant. 23.1 Consent of Price Waterhouse LLP. 23.2 Consent of Dewey Ballantine (included as part of Exhibit 5.1). 24.1 Power of Attorney (Included on Page II-5 hereto). 27.1 Financial Data Schedule.**
- -------- * Confidential treatment has been requested. The copy filed as an exhibit omits information subject to the confidentiality request. ** To be filed by Amendment. II-3 ITEM 17. UNDERTAKINGS. The undersigned Registrant hereby undertakes to provide to the underwriters at the closing specified in the underwriting agreement, certificates in such denominations and registered in such names as required by the underwriters to permit prompt delivery to each purchaser. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. The undersigned Registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this Registration Statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this Registration Statement as of the time it was declared effective. (2) For the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-4 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Los Angeles, State of California, on August 16, 1996. SmarTalk TeleServices, Inc. By /s/ Robert H. Lorsch ___________________________________ Name: Robert H. Lorsch Title: Chairman of the Board of Directors, President and Chief Executive Officer Each of the undersigned hereby constitutes and appoints Robert H. Lorsch such person's true and lawful attorney-in-fact and agent, in such person's name and on such person's behalf, in any and all capacities, to sign any and all amendments to this Registration Statement, including any post-effective amendments, and any subsequently filed registration statement, including any amendments thereto, for the same offering that is to be effective upon filing pursuant to Rule 462(b) under the Securities Act of 1933, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission. Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in the capacities and on the dates indicated.
SIGNATURES TITLE DATE ---------- ----- ---- /s/ Robert H. Lorsch Chairman of the Board of August 16, 1996 ____________________________________ Directors, President and Robert H. Lorsch Chief Executive Officer /s/ Glen Andrew Folck Chief Financial Officer and August 16, 1996 ____________________________________ Vice President Glen Andrew Folck Finance/Operations /s/ Ahmed O. Alfi Director August 16, 1996 ____________________________________ Ahmed O. Alfi /s/ Fred F. Fielding Director August 16, 1996 ____________________________________ Fred F. Fielding /s/ Jeffrey I. Scheinrock Director August 16, 1996 ____________________________________ Jeffrey I. Scheinrock /s/ Lloyd S. Zeiderman Director August 16, 1996 ____________________________________ Lloyd S. Zeiderman
II-5 EXHIBIT INDEX
EXHIBIT SEQUENTIALLY NUMBER DESCRIPTION NUMBERED PAGES ------- ----------- -------------- 1.1 Form of Underwriting Agreement.** 2.1 Agreement between SmarTalk TeleServices, Inc. and Lorsch Creative Network, Inc. dated December 28, 1995. 3.1 Amended and Restated Articles of Incorporation.** 3.2 Amended and Restated Bylaws.** 4.1 Registration Rights Agreement. 4.2 Specimen Stock Certificate. 5.1 Opinion of Dewey Ballantine, counsel to the Registrant, as to the legality of the shares being registered.** 10.1 Loan and Investment Agreement dated December 28, 1995 among SmarTalk TeleServices, Inc., SmarTalk Partners, LLC and Robert H. Lorsch. 10.2 Promissory Note in the amount of $1,200,000 dated December 28, 1995 made by SmarTalk TeleServices, Inc. in favor of SmarTalk Partners, LLC. 10.3 Security Agreement dated December 28, 1995 between SmarTalk TeleServices, Inc. and SmarTalk Partners, LLC. 10.4 Revolving Line of Credit Note in the amount of $500,000 dated December 28, 1995 made by SmarTalk TeleServices, Inc. in favor of SmarTalk Partners, LLC. 10.5 Subordinated Promissory Note in the amount of $2,000,000 dated January 1, 1996 by SmarTalk TeleServices, Inc. in favor of Lorsch Creative Network, Inc. 10.6 Subordination Agreement dated January 1, 1996 between SmarTalk TeleServices, Inc. and Lorsch Creative Network, Inc. 10.7 Security Agreement dated August 9, 1996 between SmarTalk TeleServices, Inc. and Lorsch Creative Network, Inc. 10.8 Employment Agreement between SmarTalk TeleServices, Inc. and Robert H. Lorsch.** 10.9 Form of Indemnification Agreement dated October 28, 1994 between SmarTalk Teleservices, Inc. and certain management personnel. 10.10 1996 Stock Option Plan.** 10.11 1996 Stock Incentive Plan.** 10.12 Standard Office Lease by and between LAOP IV, LLC and SmarTalk TeleServices, Inc., dated January 10, 1996, as amended on January 16, 1996, February 7, 1996 and April 19, 1996. 10.13 Carrier Agreement dated November 9, 1995 between the Registrant and MCI Telecommunications Corporation.* 10.14 First Amendment to Carrier Agreement dated March 2, 1996 between SmarTalk Teleservices, Inc. and MCI Telecommunications Corporation.* 10.15 Agreement dated October 4, 1995 between SmarTalk TeleServices, Inc. and West Interactive Corporation.*
EXHIBIT SEQUENTIALLY NUMBER DESCRIPTION NUMBERED PAGES ------- ----------- -------------- 10.16 Security Agreement dated August 9, 1996 between SmarTalk TeleServices, Inc. and SmarTalk Partners, LLC. 10.17 Subordination Agreement dated August 9, 1996 among Lorsch Creative Network, Inc., SmarTalk TeleServices, Inc. and SmarTalk Partners, LLC. 10.18 Promissory Note in the amount of $250,000 dated August 9, 1996 between SmarTalk TeleServices, Inc. and SmarTalk Partners, LLC. 21.1 Subsidiary of the Registrant. 23.1 Consent of Price Waterhouse LLP. 23.2 Consent of Dewey Ballantine (included as part of Exhibit 5.1). 24.1 Power of Attorney (Included on Page II-5 hereto). 27.1 Financial Data Schedule.**
- -------- * Confidential treatment has been requested. The copy filed as an exhibit omits information subject to the confidentiality request. ** To be filed by Amendment. EX-2.1 2 AGREEMENT OF SMARTALK AND LORSCH CREATIVE NETWORK EXHIBIT 2.1 AGREEMENT --------- 1. Identification. -------------- This agreement (the "Agreement") is dated December 28, 1995 and is between SmarTalk Teleservices, Inc., a California corporation ("Buyer") and Lorsch Creative Network, Inc., a California corporation ("Seller"). 2. Recitals. -------- 2.1 Seller owns and operates an advertising agency business in Los Angeles, California (the "Business"). 2.2 Buyer and Seller desire to enter into this Agreement to provide for the transfer of all of the assets of Seller pertaining to the Business to Buyer, and the assumption of certain liabilities by Buyer. 3. Transfer of Certain Assets of the Business. ------------------------------------------ 3.1 Subject to and conditioned upon all of the terms and provisions set forth in this Agreement, and except as provided in Section 3.2, Buyer hereby purchases from Seller and Seller hereby sells, transfers and assigns to Buyer all of the assets of the Business including, without limitation, those assets which are listed on the attached schedule attached hereto as Exhibit "A" and incorporated herein by this reference (the "Assets"). 3.2 The assets on Exhibit "B" shall be excluded from the Assets transferred hereunder. 4. Purchase Price; Assumption of Liabilities. ----------------------------------------- 4.1 The purchase price for the Assets shall be Two Million Five Hundred Thousand Dollars ($2,500,000) payable by delivery to Seller at Closing (as hereinafter defined) of: (a) Five Hundred Thousand Dollars ($500,000) by wire transfer in accordance with Seller's written instructions or by any other mutually acceptable manner of payment. (b) Buyer's subordinated promissory note dated as of the Closing Date (as hereinafter defined) in the principal amount of Two Million Dollars ($2,000,000), which shall be substantially in the form of Exhibit "C" attached hereto and incorporated herein by this reference. 4.2 Buyer shall assume and hereby agrees to pay, perform and discharge all of the liabilities of Seller identified on Exhibit "D" attached hereto and incorporated herein by this reference. Except as provided in this Section 4.2, it is expressly understood and agreed that Buyer is not assuming any of the debts or payables of Seller and shall not be liable for any of the obligations or liabilities of Seller of any kind and nature. 4.3 Seller and Buyer shall report this transaction for federal tax purposes in accordance with the allocation of the purchase price set forth on Exhibit "E" attached hereto and incorporated herein by this reference. 4.4 Seller and Buyer shall pay an equal share of all sales and use taxes arising out of the transfer of the Assets. Seller shall pay its portion, pro rated as of the Closing Date, of state and local real and personal property taxes of the Business. Buyer shall not be responsible for any business, occupation, withholding or similar tax or taxes of any kind related to any period before the Closing Date. 5. Representations and Warranties of Seller. ---------------------------------------- Except as set forth on the Disclosure Schedule attached hereto as Exhibit "F", Seller hereby represents and warrants to Buyer as follows: 5.1 Organization, Standing. Seller is a corporation duly organized ---------------------- and validly existing under the laws of the State of California, and has all requisite power, corporate or otherwise to execute, deliver and perform all of its obligations under this Agreement. Neither the ownership of its properties nor the nature of its business requires Seller to be qualified in any jurisdiction other than its state of incorporation. 5.2 Corporate Authority. The execution and delivery of this ------------------- Agreement by Seller and the performance of all obligations by Seller hereunder has been duly authorized by all necessary corporate action. 5.3 Enforceability. This Agreement, when executed and delivered, will -------------- constitute a legal, valid and binding obligation of Seller enforceable against it, in accordance with its terms. 5.4 Title to Shares. Robert Lorsch ("Lorsch") is the owner, --------------- beneficially and of record, of all of the issued and outstanding shares of Seller, and these shares are free and clear of all liens, encumbrances, security agreements, equities, options, claims, charges and restrictions. 3 5.5 Consents Required. Seller has the requisite power, authority, ----------------- capacity and legal right to execute, deliver and perform this Agreement without obtaining the consent or approval of any other person, entity or governmental authority. 5.6 Financial Statements. Exhibit "G" to this Agreement sets forth -------------------- the balance sheet of Seller as of October 31, 1995 and the related statement of income and retained earnings and cash flow statement for the period ending on such date. The financial statements in Exhibit "G" are referred to as the Financial Statements. The Financial Statements are unaudited, internally prepared compilations based on Seller's historical accounting practices consistently applied and fairly present the financing condition of Seller as of the date of such Financial Statements, and the results of its operations for the period indicated. 5.7 Absence of Specified Changes. Since October 31, 1995 there has ---------------------------- not been any: (a) Transaction by Seller except in the ordinary course of business as conducted on that date; (b) Material adverse change in the financial condition, finances, income, debts, liabilities, assets, business, or prospects of Seller; (c) Destruction, damage to, or loss of any asset of Seller (whether or not covered by insurance) that materially and adversely affects the financial condition, business, or prospects of Seller; (d) Change in accounting methods or practices by Seller; 4 (e) Revaluation by Seller of any of its assets; (f) Sale or transfer including, without limitation, any mortgage, pledge or other encumbrance, of any asset of Seller, except in the ordinary course of business; (g) Amendment or termination of any material contract, agreement, or license to which Seller is a party, except in the ordinary course of business that materially and adversely affects the financial condition or projects of Seller; (h) Waiver or release of any material right or claim of Seller, except in the ordinary course of business; (i) Commencement or notice or threat of commencement of any civil litigation or any governmental proceeding against or investigation of Seller or its affairs; (j) Labor trouble or claim of wrongful discharge or other unlawful labor practice or action; (k) Agreement by Seller to do any of the things described in the preceding clauses (a) through (j); or (l) Other event or condition of any character that has or that is reasonably expected by Seller to have a material and adverse effect on the financial condition, business, assets, liabilities, or prospects of Seller. 5.8 Marketable Title. Seller has good and marketable title to the ---------------- Assets. All of the Assets are free and clear of restrictions on or conditions to transfer or assignment, and free and clear of all mortgages, liens, pledges, encumbrances, equities, claims, charges and restrictions. All of the material 5 tangible Assets are in good operating condition suitable for use in the conduct of the Business, ordinary wear and tear excepted. 5.9 Accounts Receivable. Exhibit "H" to this Agreement is a complete ------------------- and accurate schedule of the accounts receivable of Seller as of November 30, 1995, as reflected in the balance sheet as of that date, which is included in the Financial Statements, together with an accurate aging of these accounts. These accounts receivable, and all accounts receivable of Seller created after that date, arose from valid sales in the ordinary course of business. 5.10 Liabilities. Exhibit "I" to this Agreement contains a true and ----------- complete schedule of all liabilities and obligations of Seller. To the best knowledge of Seller after diligent inquiry, Seller does not have any material debts, liabilities, or obligations of any nature, whether accrued, absolute, contingent, or otherwise and whether due or to become due, that are not set forth on Exhibit "I". Except for those liabilities that Buyer is assuming pursuant to Section 4.2, Seller shall pay, perform, discharge or otherwise adequately provide for such debts, liabilities or obligations especially with those creditors who provide goods or services to the Business and who will have an ongoing relationship with Buyer after the Closing. 5.11 Tax Returns. Within the times and in the manner prescribed by ----------- law, Seller has filed all federal, state and local tax returns required by law and has paid all taxes, assessments and penalties due and payable. 6 5.12 Employment Contracts and Benefits. Seller is not a party to any --------------------------------- employment contracts, collective bargaining agreements, pension, bonus, profit sharing, stock option or other agreements or arrangements providing for employee remuneration or benefits. There is no pending or to Seller's knowledge, threatened, labor dispute, strike or work stoppage affecting Seller's Business. Seller has not entered into any severance or similar arrangement with respect to any present or former employee that will result in any obligation, absolute or contingent, of Buyer or Seller to make any payment to any present or former employee following termination of employment. 5.13 Insurance Policies. Seller has maintained and now maintains (i) ------------------ insurance on all of the Assets of a type customarily insured, covering property damage and loss of income by fire or other casualty and (ii) adequate insurance protection against other liabilities, claims and risks against which it is customary to insure. Seller is not in default with respect to payment of premiums on any such policy. No claim is pending under any such policy. 5.14 Other Contracts. Seller is not a party to nor is the property of --------------- Seller bound by any agreement not entered into in the ordinary course of business, any indenture, mortgage, deed of trust or lease, or any agreement that is unusual in nature, duration, or amount (i.e. which requires the performance by Seller of any obligation for a period of time extending beyond the Closing or calls for consideration of more than Ten Thousand Dollars ($10,000)), except for the agreements listed in 7 Exhibit "J", copies of which have been furnished or made available to Buyer. There is no default or event that with notice or lapse of time or both would constitute a default by any party to any of these agreements. Seller has not received notice that any party to any of these agreements intends to cancel or terminate any of these agreements or to exercise or not exercise any options under any of these agreements. Seller is not a party to nor is the property of Seller bound by any agreement that is materially adverse to the Business, properties or financial conditions of Seller. 5.15 Compliance With Law. To the best knowledge of Seller, Seller has ------------------- materially complied with, and is not in material violation of any applicable federal, state or local statutes, laws or regulations affecting the Assets or the Business. 5.16 Litigation. There is no suit, action, arbitration or legal, ---------- administrative, or other proceeding or governmental investigation pending, threatened against or affecting the Business or the Assets. Seller is not in default with respect to any order, writ, injunction or decree of any federal, state, local or foreign court, department, agency, or instrumentality which affects the Assets or the Business. 5.17 Creation of Liens. Neither the execution and delivery of this ----------------- Agreement, nor the consummation of the transaction contemplated hereby will, with or without notice and/or lapse of time, result in the imposition or creation of any liens, charges, encumbrances, equities, claims or security interests in or on the Assets. 8 5.18 Limitation on Representations and Warranties. Except as -------------------------------------------- expressly set forth herein, the Assets are being acquired as is, where is, and with all faults. No representation or warranty is made except as expressly set forth herein, including any implied warranty of any nature whatsoever. 6. Representations and Warranties of Buyer. --------------------------------------- Buyer represents and warrants that: 6.1 Organization; Standing. Buyer is a corporation duly organized, ---------------------- validly existing and in good standing under the laws of the State of California. Buyer has all requisite power, corporate or otherwise, to conduct its business, to own its properties, and to execute, deliver and perform all of its obligations under this Agreement. 6.2 Corporate Authority. The execution and delivery of this ------------------- Agreement and the performance of all obligations of Buyer hereunder and thereunder has been duly authorized by all necessary corporate action. 6.3 Enforceability. This Agreement, when executed and delivered, will -------------- constitute legal, valid and binding obligations of Buyer enforceable against it, in accordance with its terms. 6.4 Consents Required. Buyer has the requisite power, authority, ----------------- capacity and legal right to execute, deliver and perform this Agreement without obtaining the consent or approval of any other person, entity or governmental authority. 6.5 Litigation. There is no suit, action, arbitration or legal, ---------- administrative, or other proceeding or governmental 9 investigation pending, threatened against or affecting Buyer. Buyer is not in default with respect to any order, writ, injunction or decree of any federal, state, local or foreign court, department, agency, or instrumentality which affects Buyer. 7. Transfer of the Assets. ---------------------- The transfer of legal title to the Assets from Seller and to Buyer (the "Closing") shall occur upon January 1, 1996 (the "Closing Date"), and upon Closing Seller shall put Buyer in possession of the Assets. 8. Costs; Brokerage. ---------------- 8.1 Seller shall be responsible for all broker or finder fees in connection with this transaction and Seller hereby indemnifies, defends and holds harmless Buyer from and against any claims, damages, liabilities, costs or expenses arising out of any and all claims by any broker or finder in connection with this transaction. 8.2 Except as otherwise specifically provided, each of the parties shall pay all costs and expenses incurred or to be incurred by it in negotiating and preparing this Agreement and in closing and carrying out the transaction contemplated by this Agreement. 10 9. Prorations. ---------- 9.1 Items of proration with respect to the Business including utilities and all other operational costs and expenses for which billings or invoices include periods of ownership by both Buyer and Seller shall be determined as of the Closing. Such proration shall be accomplished between the parties as soon as possible after such items are determined. If Seller fails to pay its obligations in respect of the prorated items, Buyer shall be entitled to offset the amount of such proration against the Promissory Note. 10. Indemnification. --------------- 10.1 Except for obligations expressly assumed hereunder Buyer shall have no liability for any debts, contracts, agreements, taxes, claims, obligations, liabilities, or deficiencies of Seller ("Retained Seller Liabilities"). Seller shall indemnify, defend, and hold harmless Buyer from and against and in respect of any and all claims, demands, losses, costs, expenses, obligations, liabilities, damages, recoveries, and deficiencies, including interest, penalties, and reasonable attorneys' fees and costs, that Buyer may incur or suffer, which arise out of, result from, or relate to (i) any breach of, or failure by Seller to perform any of its representations, warranties, covenants, or agreements contained in this Agreement; or (ii) any Retained Seller Liabilities. 10.2 Buyer agrees to indemnify and hold harmless Seller from and against and in respect of any and all claims, demands, 11 losses, costs, expenses, obligations, liabilities, damages, recoveries, and deficiencies, including interest, penalties and reasonable attorneys' fees and costs, that Seller may incur or suffer which arise out of, result from, or relate to (i) any breach of, or failure by Buyer to perform any of its representations, warranties, covenants, or agreements contained in this Agreement, (ii) or its failure to perform any obligation, duty or liability assumed by Buyer pursuant to this Agreement, but only to the extent to which Buyer has expressly assumed said obligations, duties and liabilities under this Agreement or (iii) any Liabilities of the Business or relating to the Assets from and after the Closing Date. 10.3 Any party claiming indemnification pursuant to this Agreement shall give notice in accordance with Section 11.10 to the indemnifying party as soon as is reasonably practicable together with the relevant information pertaining to the indemnifiable event. 10.4 No claim for indemnification pursuant to Section 10.1(i) hereof shall be made until the amount of such claims exceed $50,000 and then only for amounts in excess thereof. In no event shall Seller's maximum liability for all claims for indemnification pursuant to Section 10.1(i) exceed an amount equal to $300,000 plus the amount of the outstanding liability of the Buyer to SmarTalk Partners, LLC pursuant to that certain Promissory Note secured by Personal Property in the original principal amount of $1,200,000 and that certain Revolving Line of Credit note in the original principal amount of $500,000. 12 11. Miscellaneous. ------------- 11.1 The subject headings of the Articles and Sections of this Agreement are included for purposes of convenience only, and shall not affect the construction or interpretation of any of its provisions. 11.2 This Agreement and the documents and agreements referred to herein constitute the entire agreement between the parties pertaining to the subject matter contained herein and supersedes all prior and contemporaneous agreements, representations, and understandings of the parties. No supplement, modification, or amendment of this Agreement shall be binding unless executed in writing by the parties. No waiver of any of the provisions of this Agreement shall be deemed, or shall constitute, a waiver of any other provisions, whether or not similar, nor shall any waiver constitute a continuing waiver. No waiver shall be binding unless executed in writing by the party making the waiver. 11.3 This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 11.4 Nothing in this Agreement, whether express or implied, is intended to confer any rights or remedies under or by reason of this Agreement on any persons other than the parties to it and their respective successors and assigns, nor is anything in this Agreement intended to relieve or discharge the obligation or liability of any third persons to any party to this Agreement, 13 nor shall any provision give any third persons any right of subrogation or action over against any party to this Agreement. 11.5 This Agreement shall be binding on, and shall inure to the benefit of, the parties hereto and their respective heirs, legal representatives, successors, and assigns. 11.6 If any action or proceeding is brought by any party with respect to this Agreement, the transaction referred to herein, or with respect to the interpretation, enforcement or breach hereof, the prevailing party in such action shall be entitled to an award of all reasonable costs of litigation including, without limitation, attorneys' fees, to be paid by the losing party, in such amount as may be determined by the court having jurisdiction of the action. This attorneys' fees clause shall include all post-judgment attorneys' fees and costs and shall not be merged into, but rather shall survive, the judgment. 11.7 This Agreement shall be construed in accordance with, and governed by, the laws of the State of California. Nothing in this Agreement shall be construed to require the commission of any act contrary to law, and wherever there is any conflict between any provision in this Agreement and any present or future statute, law, ordinance or regulation contrary to which the parties have no legal right to contract, the latter shall prevail, but in such event the provision of this Agreement so affected shall be curtailed and limited only to the extent necessary to bring it within the requirement of the law. In the event that any term or provision of this Agreement is determined by a court competent jurisdiction to be illegal, invalid, or 14 unenforceable for any reason whatsoever, such illegality, invalidity, or unenforceability shall not affect the remainder of the terms and provisions of this Agreement, which remaining terms and provisions shall remain in full force and effect. 11.8 All representations, warranties, covenants and agreements of the parties contained in this Agreement or in any document delivered pursuant hereto shall survive the transfer of the Assets for approximately eighteen (18) months through and including July 31, 1997. 11.9 The parties hereto shall use their best efforts and shall cooperate fully in regard to transferring the Assets, notifying other parties to the agreements, contracts and leases being assigned hereby and maintaining continuing relationships with those parties previously associated with the Business. The parties hereto shall execute such other documents and take such other actions as are reasonably necessary to carry out the purposes of this Agreement. 11.10 All notices, requests, demands and other communications hereunder shall be in writing and shall be deemed to have been duly given on the date of service, if served personally on the party to whom notice is to be given, or on the third (3rd day after mailing, if mailed to the party to whom notice is to be given by first class, registered or certified mail, return receipt requested, postage prepaid, or on the date of confirmation of receipt if sent by facsimile transmission properly addressed as follows: 15 To Seller: 3188 Kings Court Los Angeles, CA 90077 Facsimile: (310) 471-9659 To Buyer: 3188 Kings Court Los Angeles, CA 90077 Facsimile: (310) 471-9659 With a Copy to: Jones, Day, Reavis & Pogue Suite 4600 555 West Fifth Street Los Angeles, CA 90013-1025 Attn: Erich L. Spangenberg Facsimile: (213) 243-2539 Any party may change its address for purposes of this Section by serving the other parties with notice of the new address in the manner set forth above. IN WITNESS WHEREOF, the parties to this Agreement have duly executed it effective this December 28, 1995. "BUYER" SMARTALK TELESERVICES, INC., a California corporation By: /s/ Robert Lorsch ------------------------------- Its: President -------------------------- "SELLER" LORSCH CREATIVE NETWORK, INC. By: /s/ Robert Lorsch ------------------------------- Robert Lorsch, President 16 EXHIBIT A --------- LORSCH CREATIVE NETWORK, INC. FIXED ASSETS TO BE SOLD AS OF DECEMBER 28, 1995 Fax machine - Panasonic Fax machine - Panasonic Fax machine - Sharp plain paper* Copier- Canon* Dictaphone Electric typewriters - 2 Cassette player Letter opener - LA, S/N 57396 Computers (6) - excludes Eddie's Pentium, property of SmarTalk - keep one computer at Kings Court Printer - Panasonic KX-P1191 Printer - HP Laserjet II Printer - HP Laserjet III Sony Trinitron Monitor with VCR Amplifier Television stand Conference table Conference chairs VMX Dial system Fireproof file cabinet - 4 drawer Furniture and fixtures currently located at Kings Court office suite above the garage and west of the copier machine only, including desks and chairs for: Judy Aufderbeck, Doug Elmer, Michelle des Lauriers, Rich Teich, Juliet Rozsa, Ingrid Goldstein and Eddie Joffe*, excluding all artwork which is personal property of RHL *Items to be sold and requested to remain at 3188 Kings Court Items to be moved to SmarTalk's new offices, but are the personal property of - ----------------------------------------------------------------------------- Robert H. Lorsch and will be excluded from the assets sold, include, but are not - -------------------------------------------------------------------------------- limited to: - ---------- Burlwood console, desk and credenza, leather chair and floor pad All artwork and furnishings to be located in Robert H. Lorsch's SmarTalk office, with the exception of any items that may be purchased by SmarTalk after the sale of LCN to SmarTalk. EXHIBIT B --------- LORSCH CREATIVE NETWORK, INC. Assets to be Excluded from Sale as of December 28, 1995 The Company shall furnish a copy of this Schedule to the Commission upon request EXHIBIT C --------- $2,000,000.00 SUBORDINATED PROMISSORY NOTE DATED JANUARY 1, 1996 The Company shall furnish a copy of this Schedule to the Commission upon request EXHIBIT D --------- LORSCH CREATIVE NETWORK, INC. Liabilities as of December 28, 1995 The Company shall furnish a copy of this Schedule to the Commission upon request EXHIBIT E --------- PURCHASE PRICE ALLOCATION ------------------------- The Company shall furnish a copy of this Schedule to the Commission upon request EXHIBIT G --------- Lorsch Creative Network, Inc. BALANCE SHEET-ACCRUAL BASIS As of October 31, 1995 The Company shall furnish a copy of this Schedule to the Commission upon request EXHIBIT G --------- Lorsch Creative Network, Inc. INCOME STATEMENT-ACCRUAL BASIS October 1995 The Company shall furnish a copy of this Schedule to the Commission upon request EXHIBIT G --------- Lorsch Creative Network, Inc. STATEMENT OF CASH FLOWS for the 10 Months ended October 31, 1995 The Company shall furnish a copy of this Schedule to the Commission upon request EXHIBIT H --------- Lorsch Creative Network, Inc. A/R AGING SUMMARY As of November 30, 1995 The Company shall furnish a copy of this Schedule to the Commission upon request EXHIBIT I --------- Lorsch Creative Network, Inc. A/P AGING SUMMARY As of December 28, 1995 The Company shall furnish a copy of this Schedule to the Commission upon request EXHIBIT J --------- LORSCH CREATIVE NETWORK, INC. OTHER CONTRACTS AS OF DECEMBER 28, 1995 Office Space Lease The Company shall furnish a copy of this Schedule to the Commission upon request EX-4.1 3 REGISTRATION RIGHTS AGREEMENT EXHIBIT 4.1 Company: SMARTALK TELESERVICES, INC. REGISTRATION RIGHTS ------------------- Section 1. Definitions. As used in this Addendum, the following ----------- capitalized terms shall have the following respective meanings: 1(a) Exchange Act. The Securities Exchange Act of 1934, as amended, ------------ or any similar federal statute then in effect, and a reference to a particular section thereof shall be deemed to include a reference to the comparable section, if any, of any such similar federal statute. 1(b) Holder. SmarTalk Partners, LLC. ------ 1(c) Person. An individual, partnership, joint venture, corporation, ------ trust, unincorporated organization or government or any department or agency thereof. 1(d) Registrable Securities. Any shares of Common Stock which are ---------------------- owned by Holder. As to any particular Registrable Securities, such securities shall cease to be Registrable Securities when (i) a registration statement with respect to the sale of such securities shall have become effective under the Securities Act and such securities shall have been disposed or in accordance with such registration statement, (ii) they shall have been distributed to the public pursuant to Rule 144 (or any successor provision) under the Securities Act, (iii) they shall have been otherwise transferred, new certificates for them not bearing a legend restricting further transfer shall have been delivered by the Company and subsequent disposition of them shall not require registration or qualification of them under the Securities Act or any similar state law then in force, or (iv) they shall have ceased to be outstanding. 1(e) Registration Expenses. Any and all expenses incident to --------------------- performance of or compliance with this Addendum, including without limitation, (i) all SEC and stock exchange or National Association of Securities Dealers registration and filing fees, (ii) all fees and expenses of complying with securities or blue sky laws (including reasonable fees and disbursements of counsel for the underwriters in connection with blue sky qualifications of the Registrable Securities), (iii) all printing, messenger and delivery expenses, (iv) the fees and disbursements of counsel for the Company and of its independent public accountants, including the expenses of any special audits and/or "cold comfort" letters required by or incident to such performance and compliance, (v) the reasonable fees and disbursements of one counsel retained in connection with each such registration by the Holder of Registrable Securities being registered, (vi) any fees and disbursements of underwriters customarily paid by issuers or sellers of securities, including liability insurance if the Company so desires or if the underwriters so require, and the reasonable fees and expenses of any special experts retained in connection with the requested registration, but excluding underwriting discounts and commissions and transfer taxes, if any. 1(f) Securities Act. The Securities Act of 1933, as amended, or any -------------- similar federal statute then in effect, and a reference to a particular section thereof shall be deemed to include a reference to the comparable section, if any, of any such similar federal statute. 1(g) SEC. The Securities and Exchange Commission or any other --- federal agency at the time administering the Securities Act or the Exchange Act. Section 2. Incidental Registration. ----------------------- 2(a) Right to Include Registrable Securities. If the Company at any --------------------------------------- time proposes to register any class of security on any form for the general registration of securities under the Securities Act (other than a registration form relating to (i) a registration of a stock option, stock purchase or compensation or incentive plan or of stock issued or issuable pursuant to any such plan, or a dividend investment plan, (ii) a registration of stock proposed to be issued in exchange for securities or assets of, or in connection with a merger or consolidation with, another corporation, or (iii) a registration of stock proposed to be issued in exchange for other securities of the Company, then the Company will at such time give prompt written notice to the Holder of Registrable Securities of its intention to do so and of such Holder's rights under this Section 2. Upon the written request of any such Holder made within twenty (20) days after the receipt of any such notice (which request shall specify the Registrable Securities intended to be disposed of by the Holder and the intended method of disposition thereof), the Company will use its best efforts to cause the Registrable Securities which the Company has been so requested to register by the Holder to be registered under the Securities Act; provided, that (i) if, at any time after giving written notice of its intention to register any securities but prior to the effective date of the registration statement filed in connection with such registration, the Company shall determine for any reason not to register such securities, the Company may at its election, give written notice of such determination to the Holder and, thereupon, shall be relieved of its obligation to register any Registrable Securities in connection with such registration, and (ii) if such registration involves an underwritten offering, the 2 Holder requesting to be included in such registration must sell its Registrable Securities to the underwriters of such offering on the same terms and conditions as apply to the Company or the Holder for whose account securities are to be sold, as the case may be. If a registration requested pursuant to this Section 2(a) involves an underwritten public offering, the Holder requesting to be incLuded in such registration may elect in writing, not later than three (3) days prior to the effectiveness of the registration statement filed in connection with such registration, not to register such securities in connection with such registration. The Company will pay all Registration Expenses in connection with each registration of Registrable Securities requested pursuant to this Section 2. 2(b) Priority in Incidental Registrations. In connection with any ------------------------------------ registration pursuant to this Section 2 involving an underwritten offering, (i) if the managing underwriter or underwriters advise the Company in writing that, in its or their opinion, the number of securities requested to be included in such registration would have a material adverse effect on such offering (including, without limitation, a significant decrease in the price at which such securities can be sold), then the amount of Registrable Securities to be offered for the account of the Holder shall be reduced pro rata as to all other persons (other than the Company) holding registration rights on the basis of the relative number of shares of Registrable Securities Holder has requested to be included in such registration and the number of shares requested to be included by any other person holding registration rights, or such Registrable Securities shall be excluded from such registration, to the extent necessary to reduce the total amount of securities to be included in such offering to the amount recommended by such managing underwriter or underwriters provided, however, that if securities are being registered for the account of person or entities other than the Company, such reduction shall not represent a greater fraction of the number of Registrable Securities intended to be offered by Holder than the fraction of similar reductions imposed on such other persons or entities (but not the Company) with respect to the amount or securities they intended to offer; and (ii) if such underwritten offering involves only debt securities and the managing underwriter or underwriters advise the Company in writing that, in its or their opinion, the inclusion of any Registrable Securities in such offering would have a material adverse effect on such offering (including, without limitation, a significant decrease in the price at which such securities can be sold), then no Registrable Securities shall be offered for the account of Holder. Section 3. Demand Registration. ------------------- 3(a) Request for Registration. From and after such time as the ------------------------ Company has closed an initial public offering of its 3 Common Stock then the Holder may thereafter and from time to time make on or more written requests for the registration under the Securities Act of all or part of its Registrable Securities (a "Demand Registration") and the Company shall use its best efforts to effect such Demand Registration, so long as such request relates to Registrable Securities constituting 5% or more of Company's issued and outstanding common stock; provided, however, that the Company need only cause one Demand Registration to become effective curing any one year period. Any request for a Demand Registration shall specify the aggregate number of the Registrable Securities proposed to be sold and shall also specify the intended method of disposition thereof. Unless the Holder requesting the Demand Registration shall give written consent, no other party, including the Company, shall be permitted to offer securities under any such Demand Registration. In any registration initiated as a Demand Registration, the Company will pay all Registration Expenses in connection therewith. 3(b) Priority of Demand Registrations. If the Holder so elects, the -------------------------------- offering of Registrable Securities pursuant to such Demand Registration shall be in the form of an underwritten offering. In such an event, if the managing underwriter or underwriters of such offering advise the Company in writing that in their opinion the number of Registrable Securities requested to be included in such offering is sufficiently large to materially and adversely affect the success of such offering (including by a significant decrease in the proposed offering price), the Company will include in such registration a number of Registrable Securities equal to the total number which in the opinion of such managing underwriter or underwriters will not have such material adverse effect. 3(c) Selection of Underwriters. If any Demand Registration is in the ------------------------- form of an underwritten offering, the Holder will select and obtain the investment banker or investment bankers and manager or managers that will administer the offering; provided, however, that such selection will be subject to the Company's consent, which shall not be unreasonably withheld. Section 4. Registration Procedures. If whenever the Company is required ----------------------- to use its best efforts to effect or cause the registration of any Registrable Securities under the Securities Act as provided in this Addendum, the Company will, as expeditiously as possible: 4(a) prepare and, in any event within ninety (90) days after the end of the period within which requests for registration may be given to the Company (but subject to the provision of the second sentence of Section 2(a) hereof), file with the SEC a registration statement with respect to such Registrable Securities and use its best efforts to cause such 4 registration statement to become effective, provided, however, the Company may delay such filing and effectiveness for a period of ninety (90) days (but not more than ninety (90) days in any 730-day period) if in the opinion of the Company such filing or effectiveness would impair the Company's ability to execute its business plan, provided further, however, that the Company may discontinue any registration of its securities which is being effected pursuant to Section 2 herein at any time prior to the effective date of the registration statement relating thereto. The Company will promptly notify the Holder of such Registrable Securities and confirm such advise in writing (i) when such registration statement becomes effective, (ii) when any posteffective amendment to such registration statement becomes effective and (iii) of any request by the SEC for any amendment or supplement to such registration statement or any prospectus relating thereto or for additional information: 4(b) prepare and file with the SEC such amendments and supplements to such registration statement and the prospectus issued in connection therewith as may be necessary to keep such registration statement effective for a period of not less than nine (9) months and to comply with the provisions of the Securities Act with respect to the disposition of all securities covered by such registration statement during such period in accordance with the intended methods of disposition by the seller or sellers of Registrable Securities set forth in such registration statement. If at any time the SEC should institute or threaten to institute any proceedings for the purpose of issuing a stop order suspending the effectiveness of any such registration statement, the Company will promptly notify the Holder of such Registrable Securities and will use all reasonable efforts to prevent the issuance of any such stop order or to obtain the withdrawal thereof as soon as possible; 4(c) furnish to the Holder of such Registrable Securities such number of copies of such registration statement and of each such amendment and supplement thereto (in each case including all exhibits), such number of copies of the prospectus included in such registration statement (including each preliminary prospectus and summary prospectus), in conformity with the requirements of the Securities Act, and such other documents as the Holder may reasonably request in order to facilitate the disposition of the Registrable Securities by the Holder; 4(d) use its best efforts to register or qualify such Registrable Securities covered by such registration statement under such securities or blue sky laws of any State of the United States as the Holder or managing underwriter, if any, shall reasonably request, and do any and all other acts and things which may be reasonably necessary or advisable to enable the Holder and underwriter, if any, to consummate the disposition in 5 such jurisdictions of the Registrable Securities owned by the Holder, except that the Company shall not for any such purpose be required to qualify generally to do business as a foreign corporation in any jurisdiction where, but for the requirements of this clause 4(d), it would not be obligated to be so qualified, to subject itself to taxation in any such jurisdiction, or to consent to general service of process in any such jurisdiction; 4(e) use its best efforts to cause such Registrable Securities covered by such registration statement to be registered with or approved by such other governmental agencies or authorities of the United States or any State thereof as may be necessary to enable the Holder to consummate the disposition of such Registrable Securities; 4(f) promptly notify the Holder of any such Registrable Securities covered by such registration statement, at any time when a prospectus relating thereto is required to be delivered under the Securities Act within the appropriate period mentioned in clause (b) of this Section 4 of the Company becoming aware that the prospectus included in such registration statement, as then in effect, includes an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances then existing; and at the request of any the Holder promptly prepare and furnish to the Holder a reasonable number of copies of an amended or supplemental prospectus as may be necessary so that, as thereafter delivered to the purchasers of such Registrable Securities, such prospectus shall not include an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances then existing; 4(g) otherwise use its best efforts to comply with all applicable rules and regulations of the SEC, and make available to its security holders, as soon as reasonable practicable, an earnings statement which need not be audited covering the period of at least twelve (12) months, beginning with the first month after the effective date of the registration statement, which earnings statement shall satisfy the provisions of Section 11(a) of the Securities Act; 4(h) use its best efforts to list such Registrable Securities on any securities exchange on which the Company's Common Stock is then listed, if such Registrable Securities are not already so listed and if such listing is then permitted under the rules of such exchange, and to provide a transfer agent and registrar for such Registrable Securities covered by such registration statement not later than the effective date of such registration statement; 6 4(i) use all reasonable efforts to obtain a "cold comfort" letter or letters from the Company's independent public accountants in customary form and covering matters of the type customarily covered by "cold comfort" letters as the underwriters or the Holder shall reasonably request; and 4(j) make available for inspection by the Holder of such Registrable Securities covered by such registration statement, by any underwriter participating in any disposition to be effected pursuant to such registration statement and by any attorney, accountant or other agent retained by the Holder or any such underwriter, all pertinent financial and other records, pertinent corporate documents and properties of the Company, and cause all of the Company's officers, directors and employees to supply all information reasonably requested by the Holder, underwriter, attorney, accountant or agent in connection with such registration statement. 4(k) The Company may require the Holder of Registrable Securities as to which any registration is being effected to furnish the Company in writing such information and documents regarding the Holder and the distribution of such securities as may be required to be disclosed in the registration statement in question by the rules and regulations under the Securities Act or under any other applicable securities or blue sky laws of the jurisdictions referred to in clause (d) of this Section 4. 4(l) The Holder of Registrable Securities agree, by acquisition of such Registrable Securities that, upon receipt of any notice from the Company of the happening of any event of the kind described in clause (f) of this Section 4, the Holder will forthwith discontinue disposition of Registrable Securities until the Holder's receipt of the copies of the supplemented or amended prospectus contemplated by clause (f) of this Section 4, and, if so directed by the Company, the Holder will deliver to the Company (at the Company's expense) all copies, other than permanent file copies then in the Holder's possession, of the prospectus covering such Registrable Securities current at the time of receipt of such notice. In the event the Company shall give any such notice, the period mentioned in clause (b) of this Section 4 shall be extended by the number of days during the period from and including the date of the giving of such notice pursuant to clause (f) of this Section 4 to and including the date when the Holder of Registrable Securities covered by such registration statement shall have received the copies of the supplemented or amended prospectus contemplated by clause (f) of this Section 4. Section 5. Indemnification. --------------- 2(a) Indemnification by the Company. In the event of any ------------------------------ registration of any Common Stock of the Company under the 7 Securities Act pursuant to this Addendum, the Company shall, and it hereby does, indemnify and hold harmless, to the extent permitted by law, the Holder of any Registrable Securities covered by such registration statement, its directors and officers or general and limited partners or managers and members, (and directors and officers thereof), each other Person who participates as an underwriter in the offering or sale of such securities and each other Person, if any, who controls the Holder or any such underwriter within the meaning of the Securities Act, against any and all losses, claims, damages or liabilities, joint or several, and expenses (including any amounts paid in any settlement effected with the Company's consent) to which the Holder, any such director or officer or general or limited partner, or manager or member, or any such underwriter or controlling Person may become subject under the Securities Act, common law or otherwise, insofar as such losses, claims, damages or liabilities (or actions or proceedings in respect thereof) arise out of or are based upon (i) any untrue statement or alleged untrue statement of any material fact contained in any registration statement under which such securities were registered under the Securities Act, any preliminary, final or summary prospectus contained therein, or any amendment or supplement thereto, or (ii) any omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, and the Company will reimburse the Holder and each such director, officer, general or limited partner, manager or member, underwriter and controlling Person for any legal or any other expenses reasonably incurred by them in connection with investigating or defending any such loss, claim, liability, action or proceeding; provided that the Company shall not be liable in any such case to the extent that any such loss, claim, damage, liability (or action or proceeding in respect thereof) or expense arises out of or is based upon any untrue statement or alleged untrue statement or omission or alleged omission made in such preliminary, final or summary prospectus or amendment or supplement thereto, or a document incorporated by reference into any of the foregoing, in reliance upon and in conformity with information furnished to the Company by or on behalf of the Holder or underwriter for use in the preparation thereof; and provided, further, that the Company will not be liable to any Person who participates as an underwriter in the offering or sale or Registrable Securities, or to any other Person who controls such underwriter, within the meaning of the Securities Act, under the indemnity agreement in this Section 5(a) with respect to any preliminary prospectus or the final prospectus, or the final prospectus as amended or supplemented, as the case may be, to the extent that any such loss, claim, damage or liability or such underwriter or controlling Person results from the fact that such underwriter sold Registrable Securities to a person to whom there was not sent or given, at or prior to the written confirmation of such sale, a copy of the final prospectus (including any 8 document; incorporated by reference therein) or of the final prospectus as then amended or supplemented (including any documents incorporated by reference therein), whichever is most recent, if the Company has previously furnished copies thereof to such underwriter and such final prospectus, as then amended or supplemented, has corrected any such misstatement or omission. Such indemnity shall remain in full force and effect regardless of any investigation made by or on behalf of the Holder or any such director, officer, general or limited partner, manager or member, underwriter or controlling Person and shall survive the transfer of such securities by such seller. 5(b) Indemnification by the Holder. The Company may require, as a ----------------------------- condition to including any Registrable Securities in any registration statement filed in accordance with this Addendum, that the Company shall have achieved an undertaking reasonably satisfactory to it from the Holder of such Registrable Securities to indemnify and hold harmless (in the same manner and to the same extent as set forth in subdivision (a) of this Section 5) the Company, each director of the Company, each officer of the Company who shall sign the registration statement and its controlling Person, if any, and all other prospective sellers and their respective directors, officers and controlling Persons with respect to any statement or alleged statement in or omission or alleged omission from such registration statement, any preliminary, final or summary prospectus contained therein, or any amendment or supplement, if such statement or alleged statement or omission or alleged omission was made in reliance upon and in conformity with information furnished to the Company by or on behalf of such seller or underwriter for use in the preparation of such registration statement, preliminary, final or summary prospectus or amendment or supplement, or a document incorporated by reference into any of the foregoing. Such indemnity shall remain in full force and effect regardless of any investigation made by or on behalf of the Company or any of the prospective sellers or any of their respective directors, officers or controlling Persons and shall survive the transfer of such securities by the Holder. 5(c) Notices of Claims Etc. Promptly after receipt by an indemnified ---------------------- party hereunder of written notice of the commencement of any action or proceeding with respect to which a claim for indemnification may be made pursuant to this Section 5, such indemnified party will, if a claim in respect thereof is to be made against an indemnifying party, give written notice to the latter of the commencement of such action; provided, that the failure of any indemnified party to give notice as provided herein shall not relieve the indemnifying party of its obligations under the preceding subdivisions of this Section 5, except to the extent that the indemnifying party is actually prejudiced by such failure to give notice. In case any such action is brought against an indemnified party, unless in such 9 indemnified party's reasonable judgment a conflict of interest between such indemnified parties may exist in respect of such claim, the indemnifying party will be entitled to participate in and to assume the defense thereof, jointly with any other indemnifying party similarly notified to the extent that it may wish, with counsel reasonably satisfactory to such indemnified party, and after notice from the indemnifying party to such indemnified party of its election so as to assume the defense thereof, the indemnifying party will not be liable to such indemnified party for any legal or other expenses subsequently incurred by the latter in connection with the defense thereof. No indemnifying party will consent to entry of any judgment or enter into any settlement which does not include as an unconditional term thereof the giving by the claimant or plaintiff to such indemnified party of a release from all liability in respect to such claim or litigation. 5(d) Other Indemnification. Indemnification similar to that --------------------- specified in the preceding subdivisions of this Section 5 (with appropriate modifications) shall be given by the Company to the Holder and any underwriter of Registrable Securities with respect to any required registration or other qualification of securities under any federal or state law or regulation other than the Securities Act. 5(e) Contribution. If the indemnification provided for in Section ------------ 5(a), 5(b) or 5(d) is unavailable to a party that would have been an indemnified party under any such section in respect of any and all losses, claims, damages or liabilities, joint or several (or actions in respect thereof), referred to therein, then each party that would have been an indemnifying party thereunder shall, in lieu of indemnifying such indemnified party, contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages or liabilities (or actions in respect thereof) in such proportion as is appropriate to reflect the relative fault of the indemnifying party on the one hand and such indemnified party on the other in connection with the statements or omissions which result in such losses, claims, damages or liabilities, joint or several (or actions in respect thereof). The relative fault shall be determined by reference to, among other things, whether the untrue or alleged untrue statements of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the indemnifying party or such indemnified party and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Company agrees that it would not be just and equitable if contribution pursuant to this Section 5(e) were determined by pro rata allocation or by any -------- other method of allocation which does not take account of the equitable considerations referred to above in this Section 5(e). The amount paid or payable by an indemnified party as a result of the 10 losses, claims, damages or liabilities (or actions in respect thereof) referred to above in this Section 5(e) shall include any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any such action or claim (which shall be limited as provided in Section 5(c) hereof if the indemnifying party has assumed the defense of any such action in accordance with the provisions thereof). No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. Section 6. Rule 144. If the Company shall have filed a registration -------- statement relating to the Company's Common Stock pursuant to the requirements of Section 12 of the Exchange Act or a registration statement relating to the Company's Common Stock pursuant to the requirements of the Securities Act, the Company covenants that it will file the reports required to be filed by it under the Securities Act and the Exchange Act and the rules and regulations adopted by the SEC thereunder to the extent required from time to time to enable the Holder to sell shares of Registrable Securities without registration under the Securities Act within the limitation of the exemptions provided by (i) Rule 144 under the Securities Act, as such rule may be amended from time to time, or (ii) any similar rule or regulation hereafter adopted by the SEC. Upon the request of the Holder of Registrable Securities, the Company will deliver to the Holder a written statement as to whether it has complied with such requirements. Notwithstanding anything contained in this Section 6, the Company may register its Common Stock under Section 12 of the Exchange Act if it then is permitted to do so pursuant to the Exchange Act and the rules and regulations thereunder. Section 7. Mergers, Etc. In addition to any other restrictions on ------------- mergers, consolidations or reorganizations contained or incorporated by reference herein or contained in the Articles of Incorporation of the Company, if any, the Company shall not, directly or indirectly, enter into any merger, consolidation or reorganization in which the Company shall not be the surviving corporation unless the surviving corporation shall, prior to such merger, consolidation or reorganization, agree in writing to assume the obligations of the Company under this Addendum, and for that purposes references hereunder to "Registrable Securities" shall be deemed to include the securities which the Holder would be entitled to receive in exchange for the Company's Common Stock under any such merger, consolidation or reorganization; provided, that to the extent such securities to be received are convertible into shares of common stock of the issuer thereof, then any such shares of common stock as are issued upon conversion of said convertible securities shall be included within the definition of 11 "Registrable Securities," and said convertible securities shall not be included within said definition. Section 8. Miscellaneous. ------------- 8(a) Holdback Agreement. If any registration in which the Holder is ------------------ participating shall be in connection with an underwritten public offering, the Holder of Registrable Securities agrees not to effect any public sale or distribution, including any sale pursuant to Rule 144 under the Securities Act, of any Registrable Securities, and to use the Holder's best efforts not to effect any such public sale or distribution of any other equity security of the Company or of any equity security, of the Company (in each case, other than as part of such underwritten public offering) within seven (7) days before or one hundred twenty (120) days after the effective date of such registration, and the Company hereby also so agrees and agrees to cause other holders of any equity security, or of any security convertible into or exchangeable or exercisable for any equity security, of the Company purchased from the Company (at any time other than in a public offering) to so agree. 8(b) Amendments and Waivers. This Addendum may be amended and the ---------------------- Company may take any action herein prohibited, or omit to perform any act herein required to be performed by it, only if the Company shall have obtained the written consent to such amendment, action or omission to act, of the Holder. 12 EX-4.2 4 SPECIMEN STOCK CERTIFICATE EXHIBIT 4.2 COMMON STOCK COMMON STOCK [LOGO OF SMARTALK TELESERVICES, INC.] INCORPORATED UNDER THE LAWS SEE REVERSE FOR CERTAIN OF THE STATE OF CALIFORNIA DEFINITIONS AND A STATEMENT AS TO RIGHTS, PREFERENCES, PRIVILEGES AND RESTRICTIONS, ON SHARES THIS CERTIFIES THAT CUSIP 83169A 10 0 is the owner of FULLY PAID AND NONASSESSABLE SHARES OF THE COMMON STOCK, NO PAR VALUE, OF SMARTALK TELESERVICES, INC. transferable on the books of the Corporation by the holder hereof in person or by duly authorized attorney upon surrender of this certificate properly endorsed. This certificate is not valid until countersigned and registered by the Transfer Agent and Registrar. WITNESS the facsimile seal of the Corporation and the facsimile signatures of its duly authorized officers. Dated: /s/ Andrew Folck [SEAL] /s/ Robert H. Lorsch CHIEF FINANCIAL OFFICER PRESIDENT AND CHIEF EXECUTIVE OFFICER COUNTERSIGNED AND REGISTERED: U.S. STOCK TRANSFER CORPORATION TRANSFER AGENT AND REGISTRAR BY AUTHORIZED SIGNATURE The Corporation is authorized to issue two classes of stock, Common Stock and Preferred Stock. The Board of Directors of the Corporation has authority to fix the number of shares and the designation of any series of Preferred Stock and to determine or alter the rights, preferences, privileges and restrictions granted to or imposed upon any unissued series of Preferred Stock. A statement of the rights, preferences, privileges and restrictions granted to or imposed upon the respective classes or series of shares of stock of the Corporation, and upon the holders thereof as established, from time to time, by the Articles of Incorporation and by any certificate of determination of Preferences, and the number of shares constituting each series and class and the designations thereof, may be obtained by the holder hereof upon request and without charge from the Public Relations Officer of the Corporation at its corporate headquarters in Los Angeles, California. The following abbreviations, when used in the inscription on the face of this certificate, shall be construed as though they were written out in full according to applicable laws or regulations: TEN COM -- as tenants in common UNIF GIFT MIN ACT -- ............. Custodian ............. TEN ENT -- as tenants by the entireties (Cust) (Minor) JT TEN -- as joint tenants with right of under Uniform Gifts to Minors survivorship and not as tenants in Act ................................. common (State) UNIF TRF MIN ACT -- ........ Custodian (until age ......) (Cust) ............. under Uniform Transfers (Minor) to Minors Act ....................... (State)
Additional abbreviations may also be used though not in the above list. FOR VALUE RECEIVED, _________________ hereby sell, assign and transfer unto PLEASE INSERT SOCIAL SECURITY OR OTHER IDENTIFYING NUMBER OF ASSIGNEE - -------------------------------------- ________________________________________________________________________________ (PLEASE PRINT OR TYPEWRITE NAME AND ADDRESS, INCLUDING ZIP CODE, OF ASSIGNEE) ________________________________________________________________________________ ________________________________________________________________________________ __________________________________________________________________________Shares of the capital stock represented by the within Certificate, and do hereby irrevocably constitute and appoint ________________________________________________________________________Attorney to transfer the said stock on the books of the within named Corporation with full power of substitution in the premises. Dated _______________________ X ________________________________________________ X ________________________________________________ NOTICE: THE SIGNATURE(S) TO THIS ASSIGNMENT MUST CORRESPOND WITH THE NAME(S) AS WRITTEN UPON THE FACE OF THE CERTIFICATE IN EVERY PARTICULAR, WITHOUT ALTERATION OR ENLARGEMENT OR ANY CHANGE WHATSOEVER. Signature(s) Guaranteed By____________________________________ THE SIGNATURE(S) SHOULD BE GUARANTEED BY AN ELIGIBLE GUARANTOR INSTITUTION (BANKS, STOCKBROKERS, SAVINGS AND LOAN ASSOCIATIONS AND CREDIT UNIONS WITH MEMBERSHIP IN AN APPROVED SIGNATURE GUARANTEE MEDALLION PROGRAM), PURSUANT TO S.E.C. RULE 17Ad-15. EX-10.1 5 LOAN AND INVESTMENT AGREEMENT 12-28-95 EXHIBIT 10.1 LOAN AND INVESTMENT AGREEMENT The parties to this Loan and Investment Agreement (the "Agreement") are: LENDER SmarTalk Partners, LLC 3 Civic Plaza Suite 170 Newport Beach, CA 92660 BORROWER SmarTalk TeleServices, Inc., a California Corporation 3188 Kings Court Los Angeles, CA 90077 SHAREHOLDER Robert H. Lorsch Recitals -------- A. Shareholder owns a majority of the capital stock of Borrower. B. Lender has agreed to loan to Borrower (i) $1,200,000 (the "Term Loan"), which shall be due and payable in full on July 31, 2000 and shall be evidenced by a promissory note in the form attached hereto as Exhibit "A" (the "Term Note"), and (ii) $500,000 (the "Line of Credit"), which shall be due and payable in full on January 31, 1998 and shall be evidenced by a promissory note in the form attached hereto as Exhibit "B" (the "Credit Note"). (The Term Loan and Line of Credit are collectively referred to herein as the "Loans", and the Term Note and the Credit Note are collectively referred to herein as the "Notes"). C. Borrower is willing to execute a Security Agreement (the "Security Agreement") in the form attached hereto as Exhibit "C" in favor of Lender granting Lender a security interest in Borrower's assets to induce Lender to make the Loans. 1 D. In consideration of the payment of $300,000 (the "Purchase Price") by Lender to Borrower, Borrower is willing to issue to Lender that number of shares of Common Stock, no par value ("Common Stock"), of Borrower which as of the date hereof represents on a fully diluted basis 30% of the Common Stock of Borrower (the "Shares"). E. Lender is willing to make the Loans to Borrower and to purchase the Shares from Borrower based on (i) the representations, warranties and covenants of Borrower and Shareholder contained in this Agreement, and (ii) the personal property security interest granted by Borrower pursuant to the Security Agreement. ARTICLE 1 DEFINED TERMS/PRINCIPLES OF CONSTRUCTION SECTION 1.1. DEFINITIONS As used in this Agreement, the following terms will have the following meanings: AFFILIATE shall mean, with respect to any Person, any other Person (i) directly or indirectly controlling (including, but not limited to, all directors, officers, partners and members of such Person), controlled by, or under direct or indirect common control with, such Person, (ii) that directly or indirectly owns more than 5% of the voting securities of such Person; or (iii) who is related to such person by blood, marriage or adoption (a "Family Member"). A Person shall be deemed to control a corporation, partnership, limited liability company or other legal entity if such Person possesses, directly or indirectly, the power to direct or cause the direction of the management and policies of such corporation, partnership, or other legal entity whether through the ownership of voting securities, partnership interests, membership interests, by contract or otherwise. COLLATERAL is defined in the Security Agreement. CREDIT NOTE is defined in Recital A. DISCLOSURE SCHEDULE is defined in Article 3. 2 EVENTS OF DEFAULT is defined in Article 7. FINANCIAL STATEMENTS means the financial statements of Borrower, as may be required by Lender from time to time, including operating statements, income statements, balance sheets, cash flow statements, statements of changes in financial condition and any other financial reports and information that Lender may require. FUNDING DATE is defined in Section 2.2. LCN shall mean Lorsch Creative Network, Inc., a California corporation. LINE OF CREDIT is defined in Recital A. LOANS is defined in Recital A. LOAN MATURITY DATE means July 31, 2000 for the Term Loan and January 31, 1998 for the Line of Credit. LOAN PROCEEDS means funds disbursed by Lender pursuant to the Term Loan and Line of Credit in accordance with this Agreement. NOTES is defined in Recital A. PERMITTED LIENS is defined in Section 6.1. PERSON shall mean any individual, partnership, joint venture, limited liability company, firm, corporation, association, trust or other enterprise or any government or political subdivision or any agency, department or instrumentality thereof. PURCHASE PRICE is defined in Recital D. SECURITY AGREEMENT is defined in Recital C. SECURITY DOCUMENTS mean the Security Agreement and UCC-1 Financing Statements SHARES is defined in Recital D. 3 TERM LOAN is defined in Recital A. TERM NOTE is defined in Recital A. TRANSACTION DOCUMENTS means the Notes, this Agreement and the Security Documents. ARTICLE 2 MAKING OF LOANS AND PURCHASE OF SHARES SECTION 2.1. LOANS. Lender agrees to lend to Borrower, and Borrower agrees to borrow from Lender, $1,200,000 pursuant to the Term Loan and $500,000 as a Line of Credit, subject to the terms, conditions, representations, warranties, and covenants in this Agreement. SECTION 2.2. DISBURSEMENTS. Lender agrees to disburse the Loan Proceeds at such time as all conditions precedent specified in Section 2.4 ("Conditions Precedent") have been satisfied or waived, provided, however, that such conditions precedent must be satisfied no later than December 31, 1995 or this Agreement shall terminate without liability to any party hereto. Funding of the Term Loan shall be scheduled by Lender within one (1) business day following satisfaction of all Conditions Precedent (the "Funding Date"). Funding of the Line of Credit shall occur as provided in the Credit Note. Interest will accrue on disbursed Loan Proceeds at 7% per annum under the Term Loan, and at the "Prime Rate" (as defined in the Credit Note) plus 2% per annum under the Line of Credit. All Loan Proceeds will be evidenced by the Term Note and Credit Note as applicable and will be secured by the Security Documents. SECTION 2.3. SHARE PURCHASE. 2.3.(a) Shares Purchase. On the Funding Date, Borrower shall issue --------------- to Lender, and Lender shall purchase from Borrower, the Shares. The Purchase Price for the Shares shall be paid in cash, by bank cashier's check or by wire transfer on the Funding Date. Borrower shall agree to register the Shares as 4 required by the Registration Rights Addendum attached hereto as Exhibit "D" and incorporated herein by this reference. 2.3.(b) Investment Representations. Lender is acquiring the Shares -------------------------- for its own account and not with a view to, or for the sale in connection with, any distribution thereof in violation of the Securities Act of 1933, as amended (the "Securities Act"). Lender understands that the Shares will not be registered under the Securities Act or qualified with any state securities agency for the reason that the sale provided for in this Agreement is exempt pursuant to Section 4 of the Securities Act and similar provisions of applicable state law, and that the reliance of Borrower on such exemptions is predicated in part on Lender's representations set forth herein. Lender further represents that (i) it is an "Accredited Investor" in the meaning of Rules 501-506 under the Securities Act and is an "Excluded Purchaser" within the meaning of Regulation 260.102.13 under the California General Corporation Law, or (ii) by reason of its financial experience or the financial experience of those persons that Lender has retained to advise it (none of whom are Affiliated with or compensated by Borrower), Lender, together with such advisors has such knowledge, sophistication and experience in business and financial matters that it is capable of evaluating the merits and risks of an investment in the Shares, that it is able to bear the economic risk of such investment, and that it is able to afford a complete loss of such investment. SECTION 2.4. CONDITIONS PRECEDENT. The obligation of Lender to make the Loans and purchase the Shares is subject to the satisfaction of the following conditions: 2.4.(a) Execution of Notes. On the Funding Date, Borrower shall ------------------ deliver the Notes to Lender in the form attached hereto. 2.4.(b) No Default; Representations and Warranties. On the ------------------------------------------ Funding Date (i) there shall exist no Event of Default and (ii) all representations and warranties contained in the Transaction Documents shall be true and correct in all material 5 respects with the same effect as though such representations and warranties had been made on and as of the Funding Date. 2.4.(c) Opinions of Counsel. On the Funding Date, the Lender shall ------------------- have received from Jones, Day, Reavis and Pogue, McGill, Gotsdiner, Workman & Lepp, P.C., and Bernard Walter, Esq., counsel to Borrower and Shareholder, opinions addressed to Lender covering the matters set forth in Exhibits "E-1" and "E-2", and "E-3" respectively, and in form and substance satisfactory to Lender. 2.4.(d) Corporate Documents; Proceedings. -------------------------------- 2.4.(d)(i) On the Funding Date, Lender shall have received a Certificate, dated the Funding Date, signed by the President of Borrower, and attested to by the Secretary of Borrower, authorizing the issuance of the Shares, the execution and delivery of the Transaction Documents, and the amendment to the Articles of Incorporation and Bylaws of Borrower required pursuant to Section 5.9, together with copies of the Articles of Incorporation, as amended, and By-Laws, as amended, of Borrower and the resolutions of the Borrower referred to in such certificate. 2.4.(d)(ii) All corporate and legal proceedings and all instruments and agreements in connection with the transactions contemplated in this Agreement shall be satisfactory in form and substance to the Lender, and the Lender shall have received all information and copies of all documents and papers, including records of corporate proceedings and governmental approvals, if any, which Lender reasonably may have requested in connection therewith, such documents and papers where appropriate to be certified by proper corporate or governmental authorities. 2.4.(e) Security Agreement. Borrower shall have duly authorized, ------------------ executed and delivered the Security Agreement, covering all of Borrower's present and future Collateral, together with: 2.4.(e)(i) acknowledgment copies of proper Financing Statements (Form UCC-1) duly filed under the UCC of each jurisdiction as may be necessary or, in the opinion of 6 Lender, desirable to perfect the security interests purported to be created by such Security Agreement; 2.4.(e)(ii) evidence of the completion of all other recordings and filings of, or with respect to, such Security Agreement as may be necessary or, in the opinion of the Lender, desirable to perfect the security interests intended to be created by such Security Agreement; and 2.4.(e)(iii) evidence that all other actions necessary or, in the opinion of the Lender, desirable to perfect and protect the security interests purported to be created by such Security Agreement have been taken. 2.4.(f) LCN Acquisition. Concurrently with the funding of the Loans --------------- on the Funding Date, Borrower and Shareholder shall have executed and delivered that certain purchase and sale agreement providing for the acquisition of CM attached hereto as Exhibit "F" and incorporated herein by this reference. 2.4.(g) Employment Agreement. Shareholder shall have executed and -------------------- delivered to Borrower an Employment Agreement in the form attached hereto as Exhibit "G". ARTICLE 3 REPRESENTATIONS AND WARRANTIES OF BORROWER Except as disclosed on the Schedule annexed hereto as Exhibit "H" and incorporated herein by this reference (the "Disclosure Schedule"), as a material inducement to Lender to enter into this Agreement, to make the Loans to Borrower, and to purchase the Shares from Borrower, Borrower and Shareholder jointly and severally, unconditionally represent and warrant to Lender as of the date hereof and the Funding Date as follows: SECTION 3.1. FORMATION. Borrower is duly organized, validly existing and in corporate good standing under the laws of California, is duly qualified to do business in California and in each other jurisdiction (and is in corporate good standing in each such 7 jurisdiction) where it is required to be qualified to transact business as a foreign corporation, and has full power and authority to consummate the transactions contemplated by this Agreement. SECTION 3.2. CAPITALIZATION. On the Funding Date, the authorized capital stock of Borrower consists of (i) 10,000 shares of Common Stock of which 1,250 shares are issued and outstanding. All such outstanding shares of Common Stock have been duly and validly issued, are fully paid and nonassessable. The Shares when issued will be duly and validly issued, fully paid and nonassessable. Except as set forth on the Disclosure Schedule, Borrower does not have outstanding any securities convertible into or exchangeable for its capital stock or outstanding any rights to subscribe for or to purchase, or any options for the purchase of, or any agreements providing for the issuance (contingent or otherwise) of, or any calls, commitments or claims of any character relating to, its capital stock. SECTION 3.3. SHAREHOLDER IS SOLE OWNER. Shareholder is the owner, beneficially and of record, of 1,000 issued and outstanding shares of Common Stock of Borrower free and clear of all liens, encumbrances, security agreements, equities, options, claims and charges. SECTION 3.4. NO SUBSIDIARIES. Borrower does not own, directly or indirectly, any interest or investment (whether equity or debt) in any corporation, partnership, limited liability company, business, trust or other entity. SECTION 3.5. BORROWER'S POWERS. Borrower has full authority to execute this Agreement, the Notes and the Security Documents, to undertake and consummate the contemplated transactions, and to pay, perform, and observe all of the conditions, covenants, agreements, and obligations contained in the Transaction Documents, and has taken all necessary corporate actions to authorize the foregoing. 8 SECTION 3.6. BINDING OBLIGATION. This Agreement, the Notes and the Security Documents have been duly executed and delivered by Borrower and Shareholder and constitute a legal and binding obligation of, and is valid and enforceable against, each party hereto and thereto other than Lender, in accordance with the terms of each. SECTION 3.7. LITIGATION. Except as set forth on the Disclosure Schedule, there are no actions, suits, or proceedings pending or, to the best knowledge of Borrower and Shareholder, threatened against or affecting Borrower, the Collateral, or involving the validity or enforceability of the Transaction Documents, or the priority of the security interest granted pursuant to the Security Agreement, at law or in equity, or before or by any governmental authority. Borrower is in material compliance or good-faith compliance with all applicable statutes, regulations and orders of, and all applicable restrictions imposed by, all governmental bodies, domestic or foreign, in respect of the conduct of its business and the ownership of its property (including applicable statutes, regulations, orders and restrictions relating to environmental standards and controls), except for such noncompliances as would not, in the aggregate, have a Material Adverse Effect on the business, operations, property, assets, condition (financial or otherwise) or prospects of Borrower (a "Material Adverse Effect"). Borrower is not in default with respect to any order, writ, injunction, decree, or demand of any court or other Governmental Authority. SECTION 3.8. NO VIOLATION. Except as set forth on the Disclosure Schedule, the consummation of the transactions covered by this Agreement and the payment and performance of all of the obligations in the Transaction Documents, will not (i) contravene any provision of any law, statute, rule, regulation or order, writ, injunction or decree of any court or governmental instrumentality, except for such of the foregoing as would not have a Material Adverse Effect, (ii) result in any breach of, or constitute a default under, any material mortgage, deed of trust, lease, contract, loan or credit agreement, corporate charter, bylaws, partnership 9 agreement, trust agreement, or other instrument to which the Borrower or Shareholder is a party or by which it or they or the Collateral may be bound or affected except for such of the foregoing as would not have a Material Adverse Effect, or (iii) violate Borrower's Articles of Incorporation or Bylaws. SECTION 3.9. NO DEFAULT. There is no Event of Default on the part of Borrower under this Agreement or the other Transaction Documents, and no event has occurred and is continuing which with notice or the passage of time or both would constitute a default or an Event of Default thereunder. SECTION 3.10. TITLE TO COLLATERAL. Borrower is the sole legal and beneficial owner of the Collateral, which is free of all claims, liens, encumbrances and security interests other than the Permitted Liens, and the security interest of Lender in the Collateral is a first priority perfected security interest. SECTION 3.11. GOVERNMENTAL APPROVALS. Except as set forth on the Disclosure Schedule, no material order, consent, approval, license, authorization or validation of, or filing, recording or registration with (except as have been obtained or made), or exemption by, any governmental or public body or authority, or any subdivision thereof, is required to authorize, or is required in connection with, (i) the execution, delivery and performance of any Transaction Document or (ii) the legality, validity, binding effect or enforceability of any such Transaction Document. SECTION 3.12. SECURITY DOCUMENTS. The Security Documents create, as security for the obligations purported to be secured thereby, a valid and enforceable perfected security interest in and lien on all of the Collateral in favor of the Lender, superior to and prior to the rights of all third Persons and subject to no other Liens (except that the security interest in the Collateral may be subject to the security interests evidenced by the Permitted Liens). Except 10 as fully reflected in the Financial Statements (delivered pursuant to Section 3.17, and except as set forth on the Disclosure Schedule, there are no material liabilities or obligations (excluding current obligations incurred in the ordinary course of business) with respect to Borrower of any nature whatsoever (whether absolute, accrued, contingent or otherwise and whether or not due) which, either individually or in aggregate, would be material to Borrower, and neither Borrower nor Shareholder knows of any reasonable basis for the assertion against Borrower of any such liability or obligation. SECTION 3.13. LABOR RELATIONS. 3.13.(a) Borrower is not a party to any employment contract not terminable at will, collective bargaining agreement, or pension, bonus, profit sharing, stock option or other agreement providing for employee remuneration or benefits. 3.13.(b) Borrower is not engaged in any unfair labor practice that could have a Material Adverse Effect on Borrower. There is (i) no significant unfair labor practice complaint pending against Borrower or, to Borrower and Shareholder's best knowledge, threatened against Borrower, before the National Labor Relations Board, and no significant grievance or significant arbitration proceeding arising out of or under any collective bargaining agreement is so pending against Borrower or, to Borrower and Shareholder's best knowledge, threatened against Borrower (ii) no significant strike, labor dispute, slowdown or stoppage pending against Borrower or, to Borrower and Shareholder's best knowledge, threatened against Borrower, and (iii) to Borrower and Shareholder's best knowledge, no union representation question existing with respect to the employees of Borrower and, to their best knowledge, no union organizing activities are taking place, except (with respect to any matter specified in clause (i), (ii) or (iii) above, either individually or in the aggregate) such as could not have a Material Adverse Effect. SECTION 3.14. TRADEMARKS, LICENSES AND FRANCHISES. Except as set forth on the Delivery Schedule, Borrower owns or has the right to use all of the material trademarks, permits, service marks, trade names, copyrights, licenses, franchises, or 11 rights with respect to the foregoing, utilized in the operation of its business, without any known conflict with the rights of others which, or the failure to obtain which, as the case may be, would result in a Material Adverse Effect. SECTION 3.15. NO USURY. The Loans are not usurious under California or Federal law. SECTION 3.16. TAXES. Borrower has filed all required Federal, State, County, and City tax returns and has paid all taxes due and required to be paid. Borrower knows of no reasonable basis for additional assessments with respect to any material taxes. Borrower has paid, or has provided adequate reserves (in the good faith judgment of the management of Borrower) for the payment of, all federal and state income taxes applicable for all prior fiscal years and for the current fiscal year to the date hereof. SECTION 3.17. FINANCIAL STATEMENTS. The Financial Statements of Borrower at October 31, 1995 (the "Financial Statement Date") including the balance sheet and the related statements of income and retained earnings and cash flow statement for the ten (10)-month period ended on such date and heretofore furnished to Lender are unaudited internally prepared compilations, based on Borrower's historical accounting practices consistently applied, which present fairly the financial condition of Borrower at the date of such Financial Statements and the results of the operations of Borrower for such ten (10)-month period. SECTION 3.18. ABSENCE OF SPECIFIED CHANGES. Since the Financial Statement Date, there has not been any: 3.18.(a) Transaction by Borrower, other than this transaction, except in the ordinary course of business as conducted on that date; 12 3.18.(b) Material adverse change in Borrower's financial condition, finances, income, debts, liabilities, assets or prospects; 3.18.(c) Destruction, damage to, or loss of any asset of Borrower (whether or not covered by insurance) that materially and adversely affects the financial condition or prospects of Borrower; 3.18.(d) Change in accounting methods or practices of Borrower; 3.18.(e) Re-evaluation by Borrower of any of its assets; 3.18.(f) Sale or transfer, including without limitation, any mortgage, pledge or other encumbrance, of any of Borrower's assets, except in the ordinary course of business; 3.18.(g) Waiver or release of any material right or a claim of Borrower in connection with its business, except in the ordinary course of business; 3.18.(h) Amendment or termination of any material contract, agreement or license, except in the ordinary course of business that materially and adversely affects the financial condition or prospects of Borrower; 3.18.(i) Other events or condition of any character, that is or might reasonably have a material and adverse affect on the financial condition, assets or prospects of Borrower; or 3.18.(j) Agreement by Borrower to do any of the things described in this Section 3.18. SECTION 3.19. BUSINESS USE OF LOAN PROCEEDS. Borrower shall use the Loan Proceeds solely for the ongoing and legitimate business needs of Borrower in its ordinary course of business. No portion of the Loan Proceeds will be disbursed to the Shareholder or the Affiliates of Borrower or the Shareholder, directly or indirectly, or loaned to Shareholder or 13 to any Affiliates of Borrower or the Shareholder, except pursuant to the terms of the LCN Acquisition Agreement, LCN Note and accounts and notes payable reflected on the Financial Statements to Affiliates or Shareholder. Borrower shall not use the Loan Proceeds to pay or fund dividends to the shareholders of Borrower, or to redeem or repurchase shares of Borrower. Borrower shall not repay loans to the Shareholder, except pursuant to the terms of the LCN Acquisition Agreement, CM Note and accounts and notes payable reflects on the Financial Statements to Affiliates or Shareholder or Affiliates of Borrower or the Shareholder or salaries to the Shareholder or Affiliates of Borrower or Shareholder (other than pursuant to the Employment Agreement) out of the Loan Proceeds, unless Lender expressly consents to the contrary. SECTION 3.20. CORPORATE RECORDS. All of the corporate records of Borrower are contained in a minute book and stock book and are true, correct and complete and accurately reflect all actions taken by Borrower. SECTION 3.21. TRANSPORT AGREEMENTS. Borrower has entered into a Service Agreement with West Interactive pursuant to which West Interactive provides services of AT&T and a Transport Agreement with MCI, true and complete copies of which have been provided by Borrower to Lender. The West Interactive Service Agreement and MCI Transport Agreements are in full force and effect, and there is not any default or event that with notice or lapse of time or both, would constitute a default under either of these agreements. Borrower has not received notice that any party to these agreements intends to cancel or terminate any of these agreements. SECTION 3.22. OTHER CONTRACTS. The Disclosure Schedule contains a true and complete list of all agreements of which Borrower is a party which are material to Borrower or its business, copies of which have been furnished to or made available to Lender. There is no default or event that, with notice or lapse of time or both, would constitute a default by any party to any of these agreements. Borrower has not received notice that any party to any of these agreements intends 14 to cancel or terminate any of these agreements or to exercise or not exercise any options under any of these agreements. Borrower is a not a party to, nor is its property bound by, any agreement not entered into in the ordinary course of business, any agreement that is unusual in nature, duration, or amount, or any agreement that is materially adverse to the business, properties or financial condition of Borrower. SECTION 3.23. NATURE OF REPRESENTATIONS AND WARRANTIES. Borrower and Shareholder jointly and severally certify to Lender that as of the date hereof and on the Funding Date, all representations and warranties made in this Agreement and all other Transaction Documents are true and correct in all material respects and do not contain any untrue statement of a material fact or omit any material fact necessary to make the representations and warranties not misleading. The representations and warranties will survive so long as any of the Loans or any part of them remains outstanding. Each representation and warranty made in this Agreement and in any other Transaction Document, and in any other document delivered to Lender by Borrower, will be deemed to have been relied on by Lender, regardless of any investigation, inspection, or inquiry made by Lender. The representations and warranties that are made to the best knowledge of Borrower and Shareholder have been made after diligent inquiry calculated to ascertain the truth and accuracy of the subject matter of each representation and warranty. SECTION 3.24. LIMITATIONS. 3.24.(a) No representation or warranty is made by Borrower or Shareholder except as expressly set forth herein. 3.24.(b) Shareholder shall have no liability for any breach of the representations and warranties set forth in Sections 3.8, 3.11 and 3.16, except to the extent that Shareholder made such representations and warranties with knowledge of their falsehood with the intent to induce Lender to enter into this Agreement. 15 3.24.(c) The maximum amount of Borrower's and Shareholder's liability for breach of the representations and warranties set forth in this Agreement will not exceed $2,000,000. In no event will Borrower or Shareholder have any liability in excess of actual damages incurred and resulting from any such breach. Lender hereby waives all claims for consequential expectancy or similar loss or damages. ARTICLE 4 REPRESENTATIONS AND WARRANTIES OF LENDER Lender hereby represents and warrants to Borrower as follows: SECTION 4.1. FORMATION Lender is duly organized and validly existing under the laws of California, is duly qualified to do business in California which is the only jurisdiction in which such qualification is required, and has full power and authority to consummate the transactions contemplated by this Agreement. SECTION 4.2. LENDER'S POWERS Lender has full authority to execute this Agreement, to undertake and consummate the contemplated transactions and to pay, perform and observe all the conditions, covenants, agreements and obligations applicable to it contained in the Transaction Documents, and has taken all necessary action to authorize the foregoing. SECTION 4.3. BINDING OBLIGATION This Agreement and the other documents to which Lender is a party have been duly executed and delivered by Lender and constitute legal and binding obligation of, and are valid and enforceable against Lender in accordance with the terms of each such document. SECTION 4.4. LITIGATION There are no actions, suits or proceedings pending, or to the best knowledge of Lender, threatened against or affecting 16 Lender or involving the validity or enforceability of the Transaction Documents, at law or in equity, or for or by any governmental authority. Lender is in material compliance or good-faith compliance with all applicable statutes, regulations and orders of, and all applicable restrictions imposed by all governmental bodies, domestic or foreign, in respect of the conduct of its business and the ownership of its property (including applicable statutes, regulations, orders and restrictions relating to environmental standards and controls), except for such noncompliance and would not have a Material Adverse Effect. Lender is not in default with respect to any order, writ, injunction, decree or demand of any court or other governmental authority. SECTION 4.5. CONTROL OF LENDER Lender hereby represents that Amre Youness is the sole manager of Lender. ARTICLE 5 AFFIRMATIVE COVENANTS Borrower covenants and agrees that (and Shareholder covenants and agrees that he will use his best efforts to cause Borrower to perform the covenants contained in this Article 5): SECTION 5.1. INFORMATION COVENANTS Borrower will furnish to Lender: 5.1.(a) Monthly Operating Statements. Within 20 days after the end of ---------------------------- each month, a monthly written report of the operating results and material events occurring in such month which report shall also contain such other information as is reasonably requested by Lender and shall be in a form reasonably satisfactory to Lender. 5.1.(b) Quarterly Financial Statements. Within 45 days (or 90 days ------------------------------ in the case of the fourth fiscal quarter) after the close of each quarterly accounting period in each fiscal year, the balance sheet of Borrower as at the end of such quarterly period and the related statements of income and 17 retained earnings and cash flow statement for such quarterly period, and for the elapsed portion of the fiscal year ended with the last day of such quarterly period all prepared in accordance with generally accepted accounting principles applied on a consistent basis, in each case setting forth comparative figures for the related periods in the prior fiscal year, all of which shall be certified by Borrower's chief financial officer, subject to normal year-end audit adjustments. 5.1.(c) Annual Financial Statements. Within 90 days after the close --------------------------- of each fiscal year, the balance sheet of Borrower and as at the end of such fiscal year and the related statements of income and retained earnings and cash flow statement for such fiscal year all prepared in accordance with generally accepted accounting principles applied on a consistent basis, in each case setting forth comparative figures for the preceding fiscal year and certified by independent certified public accountants of recognized national standing satisfactory to Lender (Lender hereby pre-approves Price Waterhouse and Deloitte & Touche), in each case together with a report of such accounting firm stating that in the course of its regular audit of Borrower's financial statements, which audit was conducted in accordance with generally accepted auditing standards, except as noted in such report, such accounting firm obtained no knowledge of any litigation, breach or default of Borrower to third Persons or Event of Default which has occurred and is continuing or, if in the opinion of such accounting firm such has occurred and is continuing, a statement as to the nature thereof. 5.1.(d) Management Letters. Promptly after Borrower's receipt ------------------ thereof, a copy of any "management letter" received by Borrower from its certified public accountants. 5.1.(e) Budgets. Within 60 days after the first day of each fiscal ------- year of Borrower, a budget in form reasonably satisfactory to the Lender (including budgeted statements of income and sources and uses of cash and a balance sheet) prepared by Borrower for each of the four fiscal quarters immediately following the last day of such fiscal year accompanied by the statement of the chief financial officer of Borrower to the effect that, to the best of his knowledge, the budget is as of the date of its preparation, a reasonable estimate for the period covered thereby. 18 5.1.(f) Officer's Certificates. At the time of the delivery of the ---------------------- monthly operating report and Financial Statements provided for in Sections 4.1(a), (b) and (c), a certificate of the chief financial officer of Borrower to the effect that, to the best of his knowledge, no default or breach of any material agreement with a third Person or Event of Default has occurred and is continuing or, if such has occurred and is continuing, specifying the nature and extent thereof. 5.1.(g) Notice of Default or Litigation. Promptly, and in any event ------------------------------- within 3 business days after an officer of Borrower obtains knowledge thereof, notice of (i) the occurrence of any event which constitutes a default or breach of any material agreement with a third Person or Event of Default, (ii) any litigation or governmental proceeding pending (x) against Borrower which could materially and adversely affect the business, operations, property, assets, condition (financial or otherwise) or prospects of Borrower or (y) with respect to any Transaction Document and (iii) any other event which is likely to materially and adversely affect the business, operations, property, assets, condition (financial or otherwise) or prospects of Borrower. 5.1.(h) Other Information. From time to time, such other information ----------------- or documents (financial or otherwise) as Lender may reasonably request. 5.1.(i) Termination of Reporting Obligation. The provisions of ----------------------------------- Sections 5.1.(a) through (h) shall terminate upon the consummation of an initial public offering by Borrower, and thereafter, to the extent all or any portion of the Loans remain outstanding Lender shall receive copies of all documents filed by Borrower with the Securities and Exchange Commission. SECTION 5.2. BOOKS, RECORDS AND INSPECTIONS. Borrower will keep proper books of record and account in which full, true and correct entries in conformity with generally accepted accounting principles (commencing not later than February 1, 1996 re GAAP accounting practices) and all requirements of law shall be made of all dealings and transactions in relation to its business and activities. Borrower will permit designated representatives of Lender subject 19 to reasonable confidentiality arrangements to visit and inspect, under guidance of officers of Borrower, any of the properties of Borrower, and to examine the books of account of Borrower and discuss the affairs, finances and accounts of Borrower with, and be advised as to the same by, its officers, all at such reasonable times and intervals and to such reasonable extent as Lender may request. SECTION 5.3. MAINTENANCE OF PROPERTY, INSURANCE. Borrower shall, in accordance with prudent industry practices, (i) keep all property useful and necessary in its business in good working order and condition, (ii) maintain with financially sound and reputable insurance companies insurance which is reasonable and customary in nature and amounts for businesses such as Borrower's, and (iii) furnish to Lender, upon written request, full information as to the insurance carried. The provisions of this Section 5.3 shall be deemed to be supplemental to, but not duplicative of, the provisions of any of the Security Documents that require the maintenance of insurance. SECTION 5.4. CORPORATE FRANCHISES. Borrower will, in accordance with prudent industry practices, do, or cause to be done, all things reasonably necessary to preserve and keep in full force and effect its existence and its material rights, franchises, licenses and leases. SECTION 5.5. COMPLIANCE WITH STATUTES, ETC. Borrower will, in accordance with prudent industry practices, comply with all applicable statutes, regulations and orders of, and all applicable restrictions imposed by, all governmental bodies, domestic or foreign, in respect of the conduct of its business and the ownership of its property (including applicable statutes, regulations, orders and restrictions relating to environmental standards and controls), except such noncompliances as could not, in the aggregate, have a Material Adverse Effect. 20 SECTION 5.6. PERFORMANCE OF OBLIGATIONS. Borrower will perform all of its obligations under the terms of each mortgage, indenture, security agreement and other debt instrument by which it is bound, except such non-performances as could not in the, aggregate, have a Material Adverse Effect. SECTION 5.7. RECONSTRUCTED FINANCIAL STATEMENTS. Borrower shall have prepared reconstructed, audited Financial Statements for the fiscal years of Borrower ended December 31, 1994 and December 31, 1995 by December 31, 1996. SECTION 5.8. KEY MAN INSURANCE. Borrower shall obtain and maintain in full force and effect a policy of key man life insurance on the life of Shareholder in the amount of $3,000,000 or such insurance as can be obtained for an annual premium not in excess of $15,000. SECTION 5.9. SHAREHOLDERS AGREEMENT; AMENDMENT OF ARTICLES OF INCORPORATION AND BYLAWS. Shareholder shall enter into that certain Shareholders Agreement with Lender which is attached hereto as Exhibit "I". Borrower shall amend the Articles of Incorporation and Bylaws of Borrower to provide for all matters required by the Shareholders Agreement to be reflected in the Articles and Bylaws of Borrower. SECTION 5.10. CHIEF FINANCIAL OFFICER. Within 90 days after the Funding Date, Borrower shall employ a qualified chief financial officer who shall be approved by Lender. ARTICLE 6 NEGATIVE COVENANTS Except to the extent the Lender otherwise consents in writing, which consent, so long as no Event of Default exists and is continuing, will not be unreasonably withheld, Borrower covenants and agrees that (and Shareholder covenants and agrees that he will 21 use his best efforts to cause Borrower to comply with the Covenants contained in this Article 6): SECTION 6.1. LIENS. Borrower will not create, incur, assume or suffer to exist any lien or security interest upon or with respect to any property or assets (real or personal, tangible or intangible) of Borrower, whether now owned or hereafter acquired, or sell any such property or assets subject to an understanding or agreement, contingent or otherwise, to repurchase such property or assets (including sales of accounts receivable with recourse to Borrower, or assign any right to receive income or permit the filing of any financing statement under the UCC or any other similar notice of lien or security under any similar recording or notice statute; provided that the provisions of this Section 6.1 shall not prevent the creation, incurrence, assumption or existence of the following (collectively, the "Permitted Liens"): 6.1.(a) liens for taxes, governmental assessments or claims not yet due or delinquent, or that are being contested in good faith and by appropriate proceedings for which adequate reserves have been established; 6.1.(b) liens in respect of property or assets of Borrower imposed by law, which were incurred in the ordinary course of business, such as carriers', warehousemen's and mechanics' liens and other similar liens arising in the ordinary course of business, and (x) which do not in the aggregate materially detract from the value of such property or assets or materially impair the use thereof in the operation of the business of Borrower or (y) which are being contested in good faith by appropriate proceedings, which proceedings have the effect of preventing the forfeiture or sale of the property or assets subject to any such lien; 6.1.(c) liens which are listed, and the property subject thereto described in the Disclosure Schedule; 6.1.(d) liens created pursuant to the Security Documents; 22 6.1.(e) utility deposits and pledges or deposits in connection with worker's compensation, unemployment insurance and other social security legislation. 6.1.(f) liens in respect of Permitted Indebtedness or any extension, renewal, refunding or refinancing of any Permitted Indebtedness; 6.1.(g) liens to secure the performance of statutory obligations, surety or appeal bonds in the ordinary course of business; 6.1.(h) liens on property of a Person existing at the time such Person is merged into, acquired or consolidated with Borrower; and 6.1.(i) liens incurred in the ordinary course of business with respect to obligations that do not exceed $500,000 at any time outstanding, including liens to secure Permitted Indebtedness. SECTION 6.2. CONSOLIDATION, MERGER, SALE OF ASSETS, ETC. Borrower will not (a) wind up, liquidate or dissolve its affairs or enter into any transaction of merger or consolidation, (b) convey, sell, lease or otherwise dispose of (or agree to do any of the foregoing at any future time) all or any part of its property or assets, or (c) purchase or otherwise acquire (in one or a series of related transactions) any part of the property or assets (other than purchases or other acquisitions of inventory, materials and equipment in the ordinary course of business) of any Person, except that (i) Borrower may sell and lease inventory, materials and equipment in the ordinary course of business, (ii) investments may be acquired to the extent expressly permitted by Section 5.6 and (iv) capital expenditures shall be permitted to the extent not in violation of Section 6.8. Notwithstanding the foregoing to the contrary, Borrower may enter into a transaction of merger or consolidation in which it is the surviving corporation and consummate purchase transactions as described in clause (c), provided that Borrower's financial condition will not be impaired as reasonably determined by Lender and provided, further, that the total consideration for such transactions in cash, stock value, and 23 debt assumed does not exceed Two Hundred Fifty Dollars ($250,000) in the aggregate in any fiscal year. SECTION 6.3. DIVIDENDS. Borrower will not declare or pay any dividends, or return any capital to, its shareholders or authorize (or make any other distribution, payment or delivery of property or cash to its shareholders as such), or redeem, retire, purchase or otherwise acquire, directly or indirectly, for a consideration, any shares of any class of its capital stock now or hereafter outstanding (or any options or warrants issued by Borrower with respect to its capital stock), or set aside any funds for any of the foregoing purposes. SECTION 6.4. LEASES. Borrower will not permit the aggregate payments (including, without limitation, any property taxes paid as additional rent or lease payments) by Borrower under agreements to rent or lease any real or personal property (excluding capitalized lease obligations, office base rent, and Telecommunications Agreements) to exceed $500,000, in any fiscal year. SECTION 6.5. INDEBTEDNESS. Borrower will not contract, create, incur, assume or suffer to exist any indebtedness, except (i) indebtedness incurred under this Agreement, (ii) indebtedness listed on the Disclosure Schedule, including any renewal or refinancing thereof ("Existing Indebtedness"), (iii) accrued expenses and trade accounts payable incurred and satisfied in the ordinary course of business, and obligations under trade letters of credit incurred by Borrower in the ordinary course of business, which are to be repaid in full not more than 18 months after the date on which such indebtedness is originally incurred to finance the purchase of goods by Borrower, (iv) obligations under letters of credit incurred by Borrower in the ordinary course of business in support of amounts owing to utilities from time to time and/or obligations incurred in connection with worker's compensation, unemployment insurance and other social security legislation, (v) indebtedness to any Person (other than Affiliate) providing credit to Borrower pursuant to the terms of a credit facility, including any guarantee thereof, (vi) indebtedness to finance purchases of equipment or to make capital 24 expenditures not in excess of One Hundred Thousand Dollars ($100,000) at any time outstanding, and (vii) indebtedness not otherwise permitted hereunder not in excess of Five Hundred Thousand Dollars ($500,000) at any time outstanding, reduced by the amount of any Existing Indebtedness and indebtedness pursuant to clause (vi) above (collectively, "Permitted Indebtedness"). SECTION 6.6. ADVANCES, INVESTMENTS AND LOANS. Borrower will not lend money or credit or make advances to any Person (excluding loans to employees not in excess of $5,000), or purchase or acquire any stock, obligations or securities of, or any other interest in, or make any capital contribution to, any other Person, except that the following shall be permitted: 6.6.(a) Borrower may acquire and hold receivables owing to it, if created or acquired in the ordinary course of business and payable or dischargeable in accordance with customary trade terms; 6.6.(b) Other than (i) amounts held in Transport Reserves, and (ii) the Loan proceeds disbursed in the first six (6) months after funding, Borrower may acquire and hold cash equivalents, so long as the aggregate amount thereof at no time exceeds $500,000; and 6.6.(c) Borrower may make such purchases and acquisitions as is permitted by Section 6.2. SECTION 6.7. TRANSACTIONS WITH AFFILIATES. Borrower will not enter into any transaction or series of related transactions, whether or not in the ordinary course of business, with any Affiliate of Borrower or Shareholder, other than on terms and conditions substantially as favorable to Borrower as would be obtainable by Borrower at the time in a comparable arm's length transaction with a Person other than an Affiliate; provided, however, notwithstanding the foregoing, Borrower shall not, without Lender's consent: (i) increase Shareholder's or any Affiliates' salary or employment benefit from the amounts or type being paid at November 30, 1995, except pursuant to the Employment Agreement, (ii) increase the lease obligations to any Affiliate from those existing at November 30, 1995, and (iii) employ any Family Member. 25 SECTION 6.8. CAPITAL EXPENDITURES. Borrower will not make any expenditure for fixed or capital assets (including, without limitation, expenditures for maintenance and repairs which should be capitalized in accordance with generally accepted accounting principles and including capitalized lease obligations) during any fiscal year (taken as one accounting period) which exceeds $250,000. SECTION 6.9. MODIFICATIONS OF ARTICLES OF INCORPORATION, AND BY-LAWS Borrower will not amend or modify, or permit the amendment or modification of, its Articles of Incorporation or Bylaws, without Lender's consent. SECTION 6.10. LIMITATION ON ISSUANCES OF CAPITAL STOCK. Except as set forth on the Disclosure Schedule, Borrower shall not issue any capital stock or any options or warrants to purchase, or securities convertible into, capital stock, except for transfers and replacements of then outstanding shares of capital stock. SECTION 6.11. BUSINESS. The Borrowers will not engage (directly or indirectly) in any business other than the business in which it is engaged on the Funding Date (including reasonable extensions and business incidental thereto), and the Shareholder will not engage in such business except through Borrower. SECTION 6.12. RETENTION OF PROFESSIONALS. Lender shall have the right to approve any investment banker or underwriter engaged by Borrower to represent Borrower in an initial public offering, merger, acquisition or other significant corporate transaction and any accountant engaged by Borrower. ARTICLE 7 EVENTS OF DEFAULT 26 At the option of Lender, the incurrence and continuation of any of the following events will unless and until cured within any applicable cure period or waived, constitute a default (each an "Event of Default"): (a) Payments. Borrower shall default in the payment when due of any -------- principal of the Loans or shall default for a period of more than five (5) days from the date due in the payment of interest on the Loans; or (b) Representations, etc. Any representation or warranty made by --------------------- Borrower or Shareholder in Article 3 of this Agreement or in any other Transaction Document or in any certificate delivered pursuant hereto or thereto shall prove to be untrue in any material respect on the date as of which made and such representation or warranty shall remain untrue from and after a period of 30 days after notice from Lender to Borrower; provided, no Event of Default shall be deemed to have occurred if such breach is susceptible of being cured, during such period Borrower diligently and in good faith commences curing any such breach, such breach is cured within said thirty (30)-day period and during such cure period the financial condition of Borrower is not materially impaired thereby; or (c) Covenants. Borrower shall default in the due performance or --------- observance by it of any term, covenant or agreement contained in this Agreement (other than those referenced to in Sections 7(a) and (b), and such default shall continue unremedied for a period of thirty (30) days after written notice to the Borrower by Lender; provided, however, no Event of Default shall be deemed to have occurred if such breach is susceptible of being cured, during such period Borrower diligently and in good faith commences curing any such default, such default is cured within said thirty (30)-day period, and during such cure period the financial condition of Borrower is not materially impaired thereby; or (d) Default Under Other Agreements. Borrower shall (i) default in ------------------------------ any payment of any indebtedness for borrowed money in excess of $100,000 (other than the Notes) beyond the period of grace if any, provided in the instrument or agreement under which such indebtedness for borrowed money in excess of $100,000 was created, (ii) default in the observance or performance of any 27 agreement or condition relating to any indebtedness for borrowed money in excess of $100,000 (other than the Notes) or contained in any instrument or agreement evidencing, securing or relating thereto, or any other event shall occur or condition exist, the effect of which default or other event or condition is to cause, or to permit the holder or holders of such indebtedness for borrowed money in excess of $100,000 (or a trustee or agent on behalf of such holder or holders) to cause (determined without regard to whether any notice is required), any such indebtedness for borrowed money in excess of $100,000 to become due prior to its stated maturity or (iii) any indebtedness for borrowed money in excess of $100,000 of Borrower shall be declared to be due and payable, or required to be prepaid other than by a regularly scheduled required prepayment, prior to the stated maturity thereof; or (e) Bankruptcy, etc. Borrower shall commence a voluntary case --------------- concerning itself under Title 11 of the United States Code entitled "Bankruptcy," as now or hereafter in effect, or any successor thereto (the "Bankruptcy Code"); or an involuntary case is commenced against Borrower, and the petition is not controverted within 20 days, or is not dismissed within 60 days, after commencement of the case; or a custodian (as defined in the Bankruptcy Code) is appointed for, or takes charge of, all or substantially all of the property of Borrower, or Borrower commences any other proceeding under any reorganization, arrangement, adjustment of debt, relief of debtors, dissolution, insolvency or liquidation or similar law of any jurisdiction whether now or hereafter in effect relating to Borrower, or there is commenced against Borrower any such proceeding which remains undismissed for a period of 60 days, or Borrower is adjudicated insolvent or bankrupt; or any order of relief or other order approving any such case or proceeding is entered; or Borrower suffers any appointment of any custodian or the like for it or any substantial part of its property to continue undischarged or unstayed for a period of 60 days; or Borrower makes a general assignment for the benefit of creditors; or any corporate action is taken by Borrower for the purpose of effecting any of the foregoing; or (f) Security Documents. The Security Documents shall cease to be in ------------------ full force and effect, or shall cease to give the Lender the liens, rights, powers and privileges purported to be 28 created thereby (including, without limitation, a perfected security interest in, and lien on, all the Collateral under the Security Agreement, in favor of Lender, superior to and prior to the rights and liens of all third Persons (except that the security interests created by the Security Agreement may be junior to the Permitted Liens) and subject to no junior liens, or the Borrower shall default in the due performance or observance of any term, covenant or agreement on its part to be performed or observed pursuant to any of the Security Documents and with respect to Borrower's breach of a term, covenant or condition contained in Article 3 of the Security Agreement, such default continues unremedied for a period of thirty (30) days after written notice from Lender to Borrower; provided, however, that no Event of Default shall be deemed to have occurred if such breach is susceptible of being cured, during such period Borrower diligently and in good faith commences curing such default, such default is cured within said thirty (30)-day period and during such cure period the financial condition of Borrower is not materially impaired thereby; or (g) Judgments. One or more judgments or decrees shall be entered --------- against Borrower involving in the aggregate a liability (not paid and to the extent not covered by insurance) of $100,000 or more, and all such judgments or decrees shall not have been vacated, discharged or stayed or bonded pending appeal within 60 days from the entry thereof; or (h) Attachment. The attachment, levy, execution, or other judicial ---------- seizure of any portion of the Collateral or any substantial portion of the other assets of Borrower, that is not released, expunged, bonded, discharged, or dismissed within 30 days after the attachment, levy, execution, or seizure; or (i) Cross-default. Any Event of Default under any Transaction ------------- Document shall constitute an Event of Default under all Transaction Documents. 29 ARTICLE 8 REMEDIES SECTION 8.1. OPTION TO ACT. On the occurrence of any Event of Default, in addition to its other rights in this Agreement or in any of the other Transaction Documents, at law, or in equity, Lender may, without prior demand, exercise any one or more of the following rights and remedies: 8.1.(a) Acceleration. Declare the Notes and all other sums owing to ------------ Lender with respect to the other Transaction Documents immediately due and payable without presentment, demand, protest or other notice, any and all of which are hereby waived by Borrower and Shareholder. 8.1.(b) Legal and Equitable Remedies. Proceed as authorized at law ---------------------------- or in equity with respect to the Event of Default, and in connection therewith, remain entitled to exercise all other rights and remedies described in this Agreement or the other Transaction Documents. SECTION 8.2. REPAYMENT OF FUNDS ADVANCED. If Lender spends its funds in exercising or enforcing any of its rights or remedies under any of the Transaction Documents, the amount of funds spent will be payable to Lender on demand, together with interest at the Prime Rate (as defined in the Credit Note) plus 4% (the "Default Rate") from the date the funds were spent until repaid. These amounts will be deemed secured by the Security Documents. SECTION 8.3. RIGHTS CUMULATIVE, NO WAIVER. All of Lender's rights and remedies provided in this Agreement or in any of the other Transaction Documents are cumulative and may be exercised by Lender at any time and in any order. Lender's exercise of any right or remedy will not constitute a cure of any Event of Default unless all sums then due to Lender under the Transaction Documents are repaid and Borrower has cured all other Events of Default. No waiver will be implied from Lender's failure to take, or delay in taking, any 30 action concerning any Event of Default or from any previous waiver of any similar or unrelated Event of Default. Any waiver under any of the Transaction Documents must be in writing and will be limited to its specific terms. SECTION 8.4. DISCLAIMER. Whether Lender elects to employ any of the remedies available to it in connection with an Event of Default, Lender will not be liable for the performance or nonperformance of any other obligation of Borrower. ARTICLE 9 MISCELLANEOUS SECTION 9.1. NO WAIVER. No failure or delay on the part of Lender in exercising any right or remedy under the Transaction Documents will operate as a waiver nor will Lender be estopped to exercise any right or remedy at any future time because of any failure or delay. No express waiver will affect any matter other than the matter expressly waived and that waiver will be operative only for the time and to the extent stated. Waivers of any covenant, term, or condition in this Agreement will not be construed to waive any subsequent breach of the same covenant, term, or condition. SECTION 9.2. NO THIRD PARTIES BENEFITED. This Agreement is made and entered into for the sole protection and benefit of the parties and their permitted successors and assigns. SECTION 9.3. NOTICES. Notice shall be given as follows: 31 IF TO LENDER: SmarTalk Partners, LLC 3 Civic Plaza Suite 170 Newport Beach, CA 92660 By fax to (714) 721-8102 IF TO BORROWER OR SHAREHOLDER: 3188 Kings Court Los Angeles, California 90077 Attn. Robert H. Lorsch By fax to (310) 471-5019 WITH A COPY TO: Jones, Day, Reavis & Pogue Suite 4600 555 West Fifth Street Los Angeles, CA 90013-1025 Attn. Erich L. Spangenberg, Esq. By fax to (213) 243-2539 Service shall be effected either: (1) by fax when the fax transmission is completed, provided a hard copy is deposited in the U.S. Mail within 24 hours of fax notice; or (2) by personal service when a copy is personally delivered to the person being served. If for any reason a party cannot readily serve the other either by fax or by personal delivery, service shall be proper if mailed to the party to be served at the address set forth above, certified mail, return receipt requested, in which event, service shall be deemed effective on the third business day after deposit in the mails. A party's failure or refusal to sign a return receipt shall not invalidate the notice. Any party may change his or its address by notifying the other party in writing and supplying a new fax number. SECTION 9.4. ASSIGNMENT. The terms of this Agreement will be binding on and inure to the benefit of the successors and assigns of the parties. 32 Neither Borrower nor Lender will assign this Agreement, any other Transaction Document or any interest therein or rights thereunder without the prior written consent of the other party; provided, however, that upon the occurrence and continuance of an Event of Default Lender may enter into such assignments without Borrower's consent. Lender may at any time assign the Transaction Documents to any Affiliate of Lender. In that case, the provisions of this Agreement will continue to apply to the Loans, and the assignee will be substituted in the place and stead of Lender, with all rights, obligations, and remedies of Lender, including, without limitation, the right to further assign the Transaction Documents and its interest in the Loans. SECTION 9.5. TIME. Time is of the essence. SECTION 9.6. BORROWER'S RESPONSIBILITIES. Borrower shall, at Borrower's expense, defend, indemnify, save, and hold Lender harmless against all claims, demands, losses, expenses, liabilities, damages (general, punitive, or otherwise), judgments, costs, reasonable attorneys' fees and causes of action (whether legal or equitable) ("Liabilities") asserted by any Person which Lender may incur (a) as a direct or indirect consequence of (i) the making of the Loans, (ii) Borrower's failure to perform any obligations as and when required by this Agreement or any of the other Transaction Documents, (iii) the failure at any time of any of Borrower's representations or warranties to be true and correct; or (b) which (i) are related to the Transaction Documents, (ii) arise out of the transactions contemplated hereby, or (iii) arise out of the use of the Loan Proceeds, except to the extent that any such Liabilities arising from or relate to the negligence or willful misconduct of Lender. Borrower shall pay Lender on demand all amounts owing under this indemnity together with interest at the Default Rate from the date Lender makes a payment of a Liability. The provisions of this Section 11.6 will survive the termination of this Agreement and the repayment of the Loans. 33 SECTION 9.7. NONLIABILITY FOR NEGLIGENCE, LOSS, OR DAMAGE. Borrower and Shareholder acknowledge, understand, and agree that the relationship between Borrower and Lender is, and will at all times remain, solely that of borrower and lender, and there is no other relationship between the parties except as is expressly set forth in a written agreement signed by the party to be charged. SECTION 9.8. CONTROLLING LAW; APPROVALS. 9.8.(a) The Transaction Documents will be governed by and construed in accordance with California law. 9.8.(b) All consents and approvals by Lender required or permitted by any provision of this Agreement must be in writing, Lender's consent to or approval of any act by Borrower requiring further consent or approval will not be deemed to waive or render unnecessary the consent or approval to or of any subsequent similar act. SECTION 9.9. SURVIVAL OF WARRANTIES AND COVENANTS. The warranties, representations, conditions, covenants, and agreements in this Agreement and in the other Transaction Documents will survive the making of the Loans and the execution and delivery of the Notes and will continue in full force until the Loans have been paid in full; provided, however, that the provisions of Sections 5.1(a) through 5.1(f) and Section 6.7 shall survive for so long as Lender owns not less than 10% of the outstanding common stock of Borrower and Borrower is not a public company. Nothing in this Section 11.9 is intended to limit any other provision of the Transaction Documents that by their stated terms survive the repayment of the Loans or the termination of any Transaction Document. SECTION 9.10. NO REPRESENTATIONS BY LENDER. By accepting or approving anything required to be observed, performed, or fulfilled, or to be given to Lender pursuant to this Agreement or pursuant to the Transaction Documents, including, but not limited to, any officer's certificate, Financial Statement, survey, appraisal, or insurance policy, 34 Lender will not be deemed to have warranted or represented the sufficiency, legality, effectiveness, or legal effect of it or of any particular term, provision, or condition of it, and any acceptance or approval will not be or constitute any warranty or representation by Lender. SECTION 9.11. AMENDMENT. The Transaction Documents and the terms of each of them may not be modified, waived, discharged, or terminated except by a written instrument signed by the party against whom enforcement of the modification, waiver, discharge, or termination is asserted. SECTION 9.12. COUNTERPARTS. The Transaction Documents may be executed in any number of counterparts and by different parties in separate counterparts, each of which when executed and delivered will be deemed an original and all of which counterparts taken together will constitute one and the same instrument. They may be executed by facsimile. SECTION 9.13. SEVERABILITY. If any terms, provision, covenant, or condition or any application is held by a court of competent jurisdiction to be invalid, void, or unenforceable, all terms, provisions, covenants, and conditions and all applications not held invalid, void, or unenforceable will continue in full force and will in no way be affected, impaired, or invalidated. SECTION 9.14. CAPTIONS. All Article and Section headings in this Agreement are inserted for convenience of reference only and do not constitute a part of this Agreement for any other purpose. SECTION 9.15. COSTS Each party shall bear its own costs and attorney fees related to the preparation and filing of the documents for the Loans. 35 SECTION 9.16. FURTHER ASSURANCES. At Lender's request and at Borrower's expense, Borrower will execute, acknowledge, and deliver all other instruments and perform all other acts necessary, desirable, or proper to carry out the purposes of the Transaction Documents or to perfect and preserve any liens created by the Transaction Documents. SECTION 9.17. INTEGRATION AND INTERPRETATION. The Transaction Documents contain or expressly incorporate by reference the entire agreement between Lender, Borrower and Shareholder with respect to the covered matters and supersede all prior negotiations. Any reference to the Transaction Documents themselves in any of the Transaction Documents will include all amendments, renewals, or extensions approved by Lender. There are no oral agreements or promises of any kind, and the only understandings of the parties are those set forth in the written agreements signed by the parties. No modification or obligation of any kind shall be binding or enforceable unless in writing and signed by the party to be charged. 36 SECTION 9.18. NUMBER. When the context and construction so require, all words used in the singular will be deemed to have been used in the plural and vice versa. ARTICLE 10 SUBORDINATION The indebtedness evidenced by this Loan and Investment Agreement and the Notes is hereby expressly subordinated, to the extent and in the manner hereinafter set forth, in right of payment to the prior payment in full of all the Borrower's Senior Indebtedness, as hereinafter defined. SECTION 10.1. SENIOR INDEBTEDNESS. As used in this Loan and Investment Agreement, the term "Senior Indebtedness" shall mean the principal of and unpaid accrued interest on: (i) all indebtedness of the Borrower to banks, insurance companies or other financial institutions regularly engaged in the business of lending money, which is for money borrowed by the Borrower (whether or not secured), (ii) all indebtedness of the Borrower to unaffiliated lenders which is for money borrowed by the Borrower and secured by the Borrower's accounts receivable, and (iii) any such indebtedness or any debentures, notes or other evidence of indebtedness issued in exchange for Senior Indebtedness. SECTION 10.2. DEFAULT ON SENIOR INDEBTEDNESS. Unless and until a bankruptcy proceeding is filed, if any Senior Indebtedness shall be declared due and payable prior to its stated maturity upon the occurrence of an event of default thereunder, then no amount shall be paid by the Borrower in respect of the principal of or interest on the Notes at the time outstanding unless and until the principal of and interest on the Senior Indebtedness then outstanding shall be paid in full or such event of default shall have been cured or waived. SECTION 10.3. EFFECT OF SUBORDINATION. 37 Subject to the rights, if any, of the holders of Senior Indebtedness under this Article 10 to receive cash, securities or other properties otherwise payable or deliverable to the Lender, nothing contained in this Article 10 shall impair, as between the Borrower and the Lender, the obligation of the Borrower, subject to the terms and conditions hereof, to pay to the Lender the principal of and interest on the Notes as and when the same become due and payable, or shall prevent the Lender, upon default under the Notes, from exercising all rights, powers and remedies otherwise provided herein, therein or by applicable law. SECTION 10.4. SECURITY INTERESTS. Lender agrees that the security interest securing the Notes shall be subordinate in priority to the security interests, if any, of holders of Senior Indebtedness. SECTION 10.5. SUBROGATION. Subject to the payment in full of all Senior Indebtedness and until the Notes shall be paid in full, the Lender shall be subrogated to the rights of the holders of Senior Indebtedness (to the extent of payments or distributions previously made to such holders of Senior Indebtedness pursuant to the provisions of Section 10.2 above) to receive payments or distributions of assets of the Borrower applicable to the Senior Indebtedness; shall, as between the Borrower and its creditors, other than the holders of Senior Indebtedness and the Lender, be deemed to be a payment by the Borrower to or on account of the Notes; and for the purposes of such subrogation, no payments or distributions to the holders of Senior Indebtedness to which the Lender would be entitled except for the provisions of this Article 10 shall, as between the Borrower and its creditors, other than the holders of Senior Indebtedness and the Lender, be deemed to be a payment by the Borrower to or on account of the Senior Indebtedness. SECTION 10.6. UNDERTAKING. By its acceptance of the Notes, the Lender agrees to execute and deliver such documents as may be reasonably requested from time to time by the Borrower or the lender of any Senior Indebtedness in order to implement the foregoing provisions of this Article 10. 38 LENDER Dated: December 28, 1995 SmarTalk Partners, LLC -- By:/s/ Amre Youness ----------------------------- Amre Youness, Manager Dated: December 28, 1995 BORROWER -- SmarTalk TeleServices, Inc. By:/s/ Robert H. Lorsch ----------------------------- Robert H. Lorsch SHAREHOLDER Dated: December 28, 1995 /s/ Robert H. Lorsch -- -------------------------------- Robert H. Lorsch 39 EX-10.2 6 PROMISSORY NOTE $1,200,000 EXHIBIT 10.2 PROMISSORY NOTE SECURED BY PERSONAL PROPERTY $1,200,000.00 Los Angeles, California December 28, 1995 FOR VALUE RECEIVED, the undersigned, SmarTalk TeleServices, Inc. ("SmarTalk"), hereby unconditionally promises to pay to the order of SmarTalk Partners, LLC ("Partners"), or order, at 3 Civic Plaza, Suite 170, Newport Beach, California 92660, or at such other place as Partners may designate in writing, the principal sum of One Million Two Hundred Thousand Dollars ($1,200,000), in lawful money of the United States of America, together with interest on the unpaid principal balance from time to time outstanding from the date hereof at the rate of 7% per annum. Interest only shall be due and payable in arrears on the last day of each calendar month, commencing January 31, 1996 until and including December 31, 1996. Thereafter, principal and interest shall be payable in equal fully amortizable monthly installments. The first combined installment payment of principal and interest shall commence on January 31, 1997 and subsequent monthly installments shall be paid on the last day of each month thereafter until July 31, 2000 (the "Maturity Date") upon which date the entire unpaid principal balance hereunder, together with any accrued but unpaid interest thereon, shall be due and payable in full. This Note has been executed and delivered pursuant to that certain Loan and Investment Agreement between SmarTalk and Partners of even date herewith (the "Loan Agreement"), and is secured by the collateral identified in a security agreement between the parties of even date herewith (the "Security Agreement"). Until such time as there occurs and is continuing as Event of Default, this Note (and any interest therein) shall not be transferred or assigned, except to an Affiliate of Partners. SmarTalk may, at any time or from time to time, prepay principal on this Note, in whole or in part, without penalty or bonus. Each payment shall be credited first to late charges, fees or other sums to be paid by SmarTalk to Partners; second to accrued and unpaid interest; and third, to principal. Interest shall cease on principal so credited. Upon the occurrence of an Event of Default as defined in the Loan Agreement, Partners shall have the right, without further notice or demand, to declare the entire balance of this Note, including interest, immediately due and payable. No waiver by Partners of any of its rights or remedies under this Note or under any other document evidencing this Note or otherwise shall be a waiver of any other right or remedy of Partners; no delay or omission in the exercise or enforcement by Partners of any right or remedy shall be construed as a waiver of any right or remedy of Partners; and no exercise or enforcement of any such right or remedy shall be held to exhaust any right or remedy of Partners. SmarTalk and any endorsers, guarantors or sureties of this Note each waive presentment for payment, demand, notice of non-payment and protest; and any endorsers, guarantors or sureties of this Note agree that the time for payment may be extended without notice to or consent by them. This Note is being executed and delivered, and is intended to be performed, in the State of California. Any controversy or claim arising out of or relating to this Note, or the making, performance, breach or interpretation of it, including tort claims, shall be adjudicated in the courts located in Los Angeles County, California, which shall be the exclusive venue and jurisdiction for all claims arising out of or related to this Note. If any suit or other proceeding is brought to enforce this Note, or to collect all or any portion of it, including interest, or because of an alleged dispute, breach, default or misrepresentation in connection with any of the provisions of this Note, or if the holder of this Note sues to protect, preserve or enforce its rights or position, the prevailing party shall recover reasonable attorneys' fees and other costs incurred in that action or proceeding, in addition to any other relief to which it may be entitled. "SMARTALK" SMARTALK TELESERVICES, INC., a California corporation By: /s/ Robert Lorsch ----------------------------- Robert Lorsch, President 2 EX-10.3 7 SECURITY AGREEMENT 12-28-95 EXHIBIT 10.3 SECURITY AGREEMENT ------------------ This Security Agreement (the "Agreement"), dated as of December 28, 1995, is executed by SmarTalk TeleServices, Inc., a California corporation, for the benefit of SmarTalk Partners, LLC. 1. Definitions. ----------- a. "Collateral" includes all personal property of Debtor, whether tangible or intangible, wherever located or situated, whether now owned or hereafter acquired by Debtor, including without limitation: (i) existing and future accounts receivable, including accounts, instruments, documents, chattel paper, and general intangibles in which Debtor has or later acquires rights; (ii) contract rights; (iii) rights as lessee under any lease of office space, including all furnishings, fixtures and improvements, and personal property; (iv) equipment; (v) inventory, including raw materials, work-in-process, and finished goods; (vi) accounts, deposits and certificates; (vii) general intangibles; and (viii) all proceeds, products, additions, replacements and substitutes of any and all of the above. b. "Debtor" means SmarTalk TeleServices, Inc. c. "Event of Default" is as defined in the Loan Agreement. d. "Indebtedness" means all of Debtor's obligations to Secured Party arising under the Loan Agreement and Promissory Notes and for all current and future loans, advances, and debt obligations, attorneys' fees and out-of-pocket costs, interest on those fees and costs at the rate specified in the Promissory Notes from the date incurred arising thereunder. "Indebtedness" shall include, without limitation, all past, current and future attorneys' fees and out-of- pocket costs, and interest on those fees and costs at annual rate as specified in the Promissory Note from the date billed, concerning or relating to advances or loans by 1 Secured Party to or on behalf of Debtor pursuant to the Loan Agreement and Promissory Notes. e. "Loan Agreement" means that certain Loan and Investment Agreement of even date between Debtor and Secured Party. f. "Obligations" means existing and future Indebtedness, including any non-monetary liabilities of Debtor to Secured Party, and obligations under the Loan Agreement, Promissory Note and this Agreement, including attorneys' fees and costs incurred in enforcing this Agreement or collecting payment under it. g. "Promissory Notes" means those certain promissory note of even date executed by Debtor for the benefit of Secured Party in the principal amount of One Million Two Hundred Thousand Dollars ($1,200,000.00) (the "Term Note"), and Five Hundred Thousand Dollars ($500,000) (the "Credit Note"), respectively. h. "Secured Party" means SmarTalk Partners, LLC. i. Terms defined in the California Commercial Code (the "Code") not otherwise defined in this Agreement are used in this Agreement as defined in the Code on the date of this Agreement. Capitalized terms used herein and not defined herein shall have the meanings ascribed to them in the Loan Agreement. 2. Security Interest. As consideration for Secured Party's loan to ----------------- Debtor of $1,700,000 in the aggregate Debtor grants Secured Party a security interest in the Collateral to secure payment of the Obligations. The security interest is subject to the following: a. Debtor represents that, with the exception of rights granted to Secured Party hereunder and the "Permitted Liens" (as defined in the Loan Agreement), Debtor is the sole legal and equitable owner of 100% of the Collateral and has not previously transferred, assigned, pledged, or hypothecated any interest in any of the Collateral. b. Debtor will not transfer, assign, pledge or hypothecate any interest in the Collateral until it satisfies the Obligations in full owed to Secured Party, except as permitted by the Loan Agreement. c. Secured Party's security interest shall be extinguished on full indefeasible payment of the Indebtedness. 3. Covenants by Debtor. Debtor promises: ------------------- a. To comply, in accordance with their terms, with each of the covenants contained in the Loan Agreement. b. To pay all expenses, including attorneys' fees, incurred by Secured Party in the perfection, preservation, 2 realization, enforcement, and exercise of its rights under this Agreement. c. To indemnify Secured Party against loss of any kind, including reasonable attorneys' fees, caused to Secured Party by reason of its interest in the Collateral. d. Not to permit liens on the Collateral, except the "Permitted Liens" (as defined in the Loan Agreement). e. To execute and deliver to Secured Party all financing statements and other documents that Secured Party requests, in order to maintain a perfected first priority security interest in the Collateral (except for the Permitted Liens). f. To maintain and to continue to maintain at Debtor's address listed in Paragraph 12 complete and accurate books and records comprising a standard modern accounting system in accordance with generally accepted accounting principles, consistently applied, that accurately and correctly record and reflect Debtor's income, expenses, liabilities, operations, accounts and ownership and location of the Collateral. Such books and records shall include all accounts, all payments received or credited granted thereon, and other dealings therewith. All such books and records and all documents relating to any of the Collateral are and shall continue to be genuine and will contain such information as may be reasonably requested by Secured Party. g. To promptly notify Secured Party in writing of any change of the address in its principal executive office and/or the location of any of the Collateral. 4. Appointment of Attorney in Fact. Upon the occurrence of, and during ------------------------------- the continuance of, an Event of Default, Debtor appoints Secured Party as Debtor's attorney in fact, with the following powers: a. To perform any of Debtor's obligations hereunder and/or under the Loan Agreement and Promissory Notes in Debtor's name or otherwise. b. To give notice of Debtor's right to payment, to enforce that right, and to make extension agreements with respect to it. c. To prepare and file financing statements, continuation statements, statements of assignment, termination statements, and the like, as necessary to perfect, protect, preserve, or release Secured Party's interest in the Collateral. d. To endorse Debtor's name on instruments, documents, or other forms of payment or security that come into Secured Party's possession. e. To accept cash in payment of the Obligations. 3 5. Termination; Release of Collateral. ---------------------------------- 5.1 Release of Collateral. This Agreement will terminate when (a) --------------------- Debtor satisfies the Indebtedness in full and completes performance of all Obligations to Secured Party; and (b) Secured Party has no commitment that could give rise to an Obligation. 5.2 Release of Collateral. Debtor has advised Secured Party that --------------------- under various state laws or regulations applicable to Debtor's business, Debtor may incur certain liability for the failure to satisfy transport, call processing and tax liability pertaining to sold calling cards. Therefore, Secured Party agrees that its security interest in the Collateral will not include monies maintained in the Debtor's segregated Transport Reserve Accounts which amounts are based on projected liability with respect to call processing, transport and taxes associated with issued and outstanding phone cards as determined from time to time by the Debtor's independent public accountants. 6. Documents to Perfect. Debtor shall execute all required documents, -------------------- including UCC-1 financing statements, requested by Secured Party to effectuate and perfect the security interest granted hereunder. 7. Default. Debtor will be in default under this Agreement if any Event ------- of Default occurs pursuant to the Loan Agreement and is not cured, remedied or waived as provided therein. 8. Remedies. -------- a. Secured Party shall have all rights of a secured party under the California Commercial Code or the Uniform Commercial Code of any other jurisdiction, where necessary to enforce this Agreement. All such rights, powers and remedies shall be cumulative and may be exercised successively or concurrently in Secured Party's sole discretion without impairing its security interest, rights or available remedies. Secured Party's forbearance, failure or delay in exercising any right, power or remedy shall not preclude further exercise of that right, power or remedy which shall continue in effect unless and until it specifically waives it in writing. b. If Secured Party conducts a private sale of any Collateral by soliciting bids from 10 or more dealers or distributors in that type of Collateral, any such sale of Collateral in bulk or in parcels, to the bidder submitting the highest cash bid, within 120 days of (i) Secured Party taking possession and control of the Collateral or (ii) when Secured Party is otherwise authorized to sell the Collateral (whichever occurs last), is a commercially reasonable sale of the Collateral. Commercially reasonable notice of any public or private sale is given to Debtor if Secured Party sends Debtor a notice of the sale at least 7 days before the date of any public sale (or 7 days before the time after which a private sale will be made). The 4 purchase of any Collateral by a supplier, as provided in any agreement between Secured Party and the supplier, is a commercially reasonable disposition or sale of the Collateral. If Secured Party disposes of any Collateral other than as set forth in this subparagraph, the commercial reasonableness of the disposition will be determined in accordance with the laws of the State of California. Debtor will (i) pay Secured Party even if any Collateral is defective or fails to conform to any warranties extended by any third party, (ii) not assert against Secured Party any claim or defense it has against any third party and (iii) indemnify and hold Secured Party harmless against any claims or defense asserted by any buyer of the Collateral relating to the condition of, or representations made about, any Collateral. Debtor waives all rights of offset against Secured Party. 9. Further Acts; Cooperation. The parties will execute all further ------------------------- documents reasonable, convenient, necessary or desirable to carry out this Agreement. The parties shall cooperate to effectuate the intent of this Agreement and the mutual benefits intended to be conferred under it. 10. Successors and Assigns. This Agreement shall be binding upon the ---------------------- parties and their respective heirs, successors and assigns. 11. Jurisdiction and Venue for Disputes. Any action relating to any ----------------------------------- dispute under this Agreement shall be litigated solely in the courts located in Los Angeles County, California. All parties consent to the jurisdiction in the State of California over all disputes and consent that venue is proper in Los Angeles County, California. 12. Notices. Any notice or other communication relating to this Agreement ------- shall be deemed effective when served as follows: IF TO SECURED PARTY: SmarTalk Partners, LLC 3 Civic Plaza Suite 170 Newport Beach, CA 92660 Fax: (714) 721-8102 IF TO DEBTOR: SmarTalk TeleServices, Inc. 3188 Kings Court Los Angeles, CA 90077 Attention: Mr. Robert Lorsch Fax: (310) 471-5019 WITH A COPY TO: Jones Day Reavis & Pogue 555 West Fifth Street 5 Los Angeles, CA 90013 Attention: Erich Spangenberg Fax: (213) 243-2708 Service shall be effected either: (1) by fax when the fax transmission is completed, provided a hard copy is deposited in the U.S. Mail within 24 hours of fax notice; or (2) by personal service when a copy is personally delivered to the person being served. If for any reason a party cannot readily serve the other either by fax or by personal delivery, service shall be proper if mailed to the party to be served at the address set forth above, certified mail, return receipt requested, with a copy to the party's respective attorney by first class mail, in which event, service shall be deemed effective on the third business day after deposit in the mail. A party's failure or refusal to sign a return receipt shall not invalidate the notice. Any party may change his or his address by notifying the other party in writing and supplying a new fax number. 13. Headings. Headings in this Agreement are for convenience only and -------- shall not be deemed a part of this Agreement. 14. Governing Law. This Agreement shall be interpreted and enforced in ------------- accordance with the laws of California. 15. Construction. All parties have cooperated in the drafting and ------------ preparation of this Agreement. Accordingly, no provision of this Agreement shall be construed for or against either party by virtue of its having drafted a specific provision. 16. Attorneys' Fees. If any dispute occurs relating to this Agreement, --------------- its alleged breach, its interpretation, the circumstances under which it was executed, or any other dispute pertaining to it, whether such dispute is based on contract, tort or equitable theories, the prevailing party shall recover his reasonable attorneys' fees and costs from the losing party. 17. Post-Judgment Fees. In addition to the attorneys' fees and costs ------------------ provided for in Paragraph 16 above, the parties agree that if any dispute between the parties results in a judgment in favor of either party, such party will be entitled to recover from the other all attorneys' fees and costs incurred by it in enforcing such judgment. This provision is intended to be severable from any other provision of this Agreement, and is not to be deemed merged in the judgment. 18. No Waiver. No waiver by Secured Party of any breach or default will --------- be a waiver of any breach or default occurring later. A waiver will be valid only if it is in writing and signed by Secured Party. 19. Integration. This Agreement (and the agreements referred to herein) ----------- is the entire agreement, and supersedes any prior agreement or understandings, between Secured Party and Debtor relating to its subject matter. There are no oral agreements 6 pertaining to the subject matter of this Agreement, and this Agreement shall supersede all oral representations and statements by the parties. This Agreement may only be modified by a writing signed by the party to be charged. SMARTALK TELESERVICES, INC., a California corporation By: /s/ Robert Lorsch ------------------------------- Robert Lorsch, President SMARTALK PARTNERS, LLC By: /s/ Amre Youness ------------------------------- Amre Youness, Manager 7 EX-10.4 8 REVOLVING LINE OF CREDIT 12-28-95 EXHIBIT 10.4 SMARTALK PARTNERS, LLC 3 Civic Plaza Suite 170 Newport Beach, CA 92660 REVOLVING LINE OF CREDIT NOTE $500,000 December 28, 1995 1. Loan Obligation. --------------- 1.1 Loan. FOR VALUE RECEIVED, the undersigned, SMARTALK TELESERVICES, ---- INC., a California corporation (the "Borrower"), promises to pay to the order of SMARTALK PARTNERS, LLC, (the "Lender"), at its principal office at 3 Civic Plaza, Suite 170, Newport Beach, CA 92660 ("Principal Office"), or at such other place as Lender may from time to time designate in writing, the aggregate principal amount outstanding on the date this Note becomes due and payable in full, with interest thereon and any fees and expenses as provided herein; provided, however, that at no time shall the outstanding principal amount borrowed hereunder exceed FIVE HUNDRED THOUSAND DOLLARS ($500,000). Principal and interest shall be payable as follows: Interest only, due and payable in arrears on the last day of each month commencing January 31, 1996 until January 31, 1998 (the "Maturity Date") upon which date the entire unpaid balance of principal, and all unaccrued, but unpaid interest and any unpaid fees and expenses shall be paid in full. 1.2 Revolving Borrowings. Borrower may from time to time during the term -------------------- of this Note borrow (so long as no Event of Default exists), partially or wholly repay outstanding borrowings, and reborrow (so long as no Event of Default exists), subject to all of the limitations in connection with this Note, provided that the outstanding principal balance of this Note shall at no time exceed the principal amount stated above. No borrowing shall be permitted after December 31, 1997. The unpaid principal balance of this obligation at any time shall be the total amounts advanced hereunder by Lender less the amount of principal payments made hereon by or for Borrower. 1.3 Requests. Advances hereunder, up to the total amount of the principal -------- sum stated above, shall be made by Lender (so long as no Event of Default exists) at the oral or written request of Borrower or any individual person designated by Borrower in writing as authorized to request advances (until written notice of the revocation of such authority is received by Lender at its Principal Office) such advances to be wired to an account designated by Borrower not later than three (3) business days after such request. Any such advances shall be conclusively presumed to have been made to or for the benefit of Borrower when Lender believes in good faith that such requests and directions have been made by authorized persons. 1.4 Governing Loan Agreement. This Note is being issued pursuant to the ------------------------ terms of that certain Loan and Investment Agreement (the "Loan Agreement") of even date herewith between Lender and Borrower, and is subject to the terms thereof. The payment of this Note and all other amounts due from Borrower to Lender, whether direct or indirect, absolute or contingent, due or to become due, now existing or hereafter arising (the "Liabilities"), are secured by the property (the "Collateral") described in a Security Agreement which has been, shall be or shall be caused to be, delivered to the Lender by Borrower as more particularly detailed in the Loan Agreement. 2. Interest Rate. ------------- 2.1 Interest Rate Determination. Subject to Section 2.4 herein, interest --------------------------- shall accrue on the outstanding principal balance (as it exists from the date of disbursement of any borrowing hereunder until paid in full) at a floating rate of interest (the "Interest Rate") equal to two percent (2%) per annum in excess of the Prime Rate, in effect from time to time, as reported in the Wall Street ----------- Journal (Western Edition) in its general guide to money rates as the base rate - ------- on corporate loans at large U.S. money center commercial banks (the "Prime Rate"). If this rate is reported as a range of rates, the Prime Rate shall be the highest rate reported in such range. The Interest Rate shall change each time the Prime Rate changes effective on the date the change in the Prime Rate is reported in the Wall Street Journal (Western Edition). ------------------- 2 2.2 Unavailability of Index. If the interest rate index stated above ----------------------- ceases to be available, Lender may substitute any similar index, whether reported in The Wall Street Journal or any other newspaper, and Lender's ----------------------- selection shall be conclusive and binding on Borrower. In such event, and until Lender selects a substitute index, interest shall accrue at the rate in effect at the time the index was determined to be unavailable. 2.3 Interest Calculation. Interest will be calculated on the basis of -------------------- actual days elapsed in a 360-day year and will be payable in arrears. Interest shall begin to accrue on the day any proceeds of this Note are disbursed, and shall continue to, but excluding the day of payment. Except as provided in Section 2.4 herein, interest will continue to accrue at the Interest Rate described above on the outstanding principal balance until all principal amounts have been paid in full. 2.4 Interest on Overdue Amounts; Alternate Rate of Interest. If Borrower ------------------------------------------------------- shall default in the payment of principal or interest when due hereunder, by acceleration, demand or otherwise, Borrower shall, to the extent permitted by law, pay interest on the defaulted amount from the date that any such payment first becomes due, up to the date of actual payment (after as well as before judgment) at a rate equal to the Prime Rate, as it varies from time to time, plus 4%. 2.5 Usury Limitation. Notwithstanding any provision herein to the ---------------- contrary, the total liability of Borrower for payments in the nature of interest shall not exceed the applicable limits imposed by applicable state and federal laws. Any such payments in excess of such limits shall be deemed payments on account of principal. 3. Payments. -------- 3.1 Application. All payments hereunder received by Lender shall be ----------- applied first to fees and other charges due, including collection costs and attorneys' fees, second to unpaid and accrued interest, and the balance if any to principal. 3.2 Monthly Interest Payments. Lender will provide Borrower with at least ------------------------- one (1) business day advance notice of the interest 3 amount payable hereunder. The first interest payment will be due on the last day of the month immediately following any advance hereunder. Borrower shall make subsequent payments to Lender of interest accrued during the month on the last day of each month thereafter. 3.3 Prepayment Privilege. The Line of Credit evidenced by this Note may -------------------- be prepaid in full at any time, without penalty or premium. Each such payment must also include all interest accrued and unpaid on such amount to the date of payment and any other fees charges due. 3.4 Evidence of Amounts Due. The entries on the records of Lender ----------------------- (including any appearing on this Note) shall be prima facie evidence of the aggregate principal amount outstanding under this Note and interest accrued on such principal; provided, however, that the failure of Lender to make such a -------- ------- notation or any error in such a notation shall not in any manner affect the obligation of Borrower to make payments of principal and interest in accordance with the terms of this Note. 3.5 Legal Tender; Principal Office. All payments due under this Note ------------------------------ shall be made in United States Dollars in immediately available funds at the Lender's Principal Office, or at such other address as designated by written notice from Lender to Borrower. 4. Events of Default. ----------------- Any Event of Default specified in Article 6 of the Loan Agreement shall constitute an Event of Default hereunder. 5. General Remedies Upon Event of Default. -------------------------------------- 5.1 Upon the occurrence of, and during the continuance of, any Event of Default hereunder, Lender shall be entitled, at its option and without notice, to declare this Note immediately due and payable whereupon the principal of this Note, together with accrued interest and fees thereon and other Liabilities and obligations of the Borrower accrued hereunder, shall become immediately due and payable, without presentment, demand, protest, notice of dishonor, 4 or any other notice of any kind, all of which are expressly waived by Borrower, anything contained herein notwithstanding; and 5.2 To exercise all other remedies available hereunder or under the Loan Agreement or any security documents executed in connection therewith, or otherwise available under California (or other applicable) law including, without limitation, the appointment of a receiver or the institution of a suit in equity. 5.3 Unless the Lender's obligation to Borrower to make further advances hereunder has already terminated pursuant to Paragraph 1.1 of this Note, then the Lender's obligation to make further advances shall cease upon the Lender's exercise of its right under Section 6.1 of this Note to declare this Note immediately due and payable. 5.4 All rights, powers and remedies may be exercised at any time by Lender after the occurrence of any such Event of Default while said Event of Default continues. 5.5 All rights, powers and remedies of Lender hereunder are cumulative and not exclusive and shall be in addition to any other rights, powers or remedies provided by law or equity. 6. Miscellaneous. ------------- 6.1 Borrower's Waiver. Except as otherwise expressly provided herein, ----------------- Borrower hereby waives diligence, presentment, demand, notice, protest and all other demands and notices in connection with the delivery, acceptance, performance, default, or enforcement of this Note, and assents to any one or more extensions or postponements of the time of payment or any other indulgences, to any additions or substitutions, exchanges or releases of Collateral and/or to the addition, substitution or release of any one or more parties or persons primarily or secondarily liable hereunder. 6.2 Attorneys' Fees; Collection Costs. Borrower shall pay on demand all --------------------------------- costs and expenses, including reasonable attorneys' fees incurred or paid by Lender in enforcing this Note, whether or not litigation is commenced; or incurred or paid by Lender in protecting the value of the Collateral as hereinabove provided and 5 in exercising any of its rights with respect to the Collateral, including, without limitation, those costs and expenses incurred in selling or otherwise disposing of all or any part of any Collateral pledged to secure this Note. All such costs and expenses shall be secured by such Collateral. 6.3 Lender's Representations; Modification. Borrower agrees and -------------------------------------- acknowledges that Lender has not made any representations concerning Lender's willingness not to exercise, or to delay exercising, its rights to enforce this Note or to demand payment hereof. No delay or omission by Lender in exercising in whole or in part any right or remedy hereunder shall operate as a waiver thereof or of any other right or remedy. A waiver of any right or remedy, in whole or in part, on any one occasion shall not be construed as a bar to enforcing or as a waiver of that or any other right or remedy on any future occasion. No waiver by Lender of any right or remedy shall be effective unless in writing and signed by Lender. No modification or amendment of this Note shall be effective unless the modification is in writing and is signed by Lender. 6.4 Successors and Assigns. This Note inures to the benefit of Lender and ---------------------- to the benefit of its successors and assigns. This Note is binding on Borrower and on any executor, administrator or legal representative of Borrower. Until such time as there occurs and is continuing an Event of Default, this Note (and any interest thereon) shall not be transferred or assigned, except to an Affiliate of Lender. Subject to the foregoing, Borrower agrees that the rights granted to Lender pursuant to this Note shall accrue to any permitted endorsee of this Note who is lawfully in possession of this Note. 6.5 Entire Agreement. The terms and conditions of this Note, the Loan ---------------- Agreement and those of any other agreement or instrument referred to in this Note or the Loan Agreement are deemed to be incorporated herein by reference, constitute the entire agreement of the parties, and supersede all prior agreements and understandings, both written and oral, of the parties hereto with respect to the subject matter of this Note, the Loan Agreement or of any such agreement or instrument referred to therein. 6 6.6 Address Change. Borrower shall notify Lender, in writing, of any -------------- change in the Borrower's address of record stated below. 6.7 Applicable Law; Jurisdiction. This Note shall be governed by, and ---------------------------- construed in accordance with, the laws of the State of California, except to the extent Lender has greater rights or remedies under Federal law, in which case such choice of California law shall not be deemed to deprive Lender of any such rights and remedies as may be available under Federal law. Borrower agrees that Lender shall have all rights and remedies available to a creditor under the laws of the State of California. The Line of Credit Loan evidenced hereby is deemed to have been made by Lender upon its acceptance of this Note and the payment from time to time of the proceeds of the Line of Credit Loan in Newport Beach, California. 6.8 Severability. If any provision of this Note is deemed to be in ------------ conflict with applicable law, it will be considered to be modified to comply with the law or, if not able to be so modified, such provision will be deemed to be deleted from this Note. Notwithstanding any such modification or deletion, the remaining provisions will remain valid and enforceable. Executed as of the date first above written. Address of Record "BORROWER" 3188 Kings Court SMARTALK TELESERVICES, INC., a Los Angeles, CA 90077 California corporation By: /s/ Robert Lorsch ------------------------------ Robert Lorsch, President Accepted for SMARTALK PARTNERS, LLC By: /s/ Amre Youness ------------------------ Amre Youness, Manager Dated: --------------------- 7 EX-10.5 9 SUBORDINATED PROMISSORY NOTE $2,000,000 EXHIBIT 10.5 PAYMENT OF THE PRINCIPAL AND INTEREST OF THIS NOTE IS SUBJECT TO A SUBORDINATION AGREEMENT IN FAVOR OF SMARTALK PARTNERS, LLC SUBORDINATED PROMISSORY NOTE $2,000,000.00 Los Angeles, California January 1, 1996 FOR VALUE RECEIVED, the undersigned, SmarTalk Teleservices, Inc. ("SmarTalk"), hereby unconditionally promises to pay to Lorsch Creative Network, Inc. ("LCN"), or order, at 3188 Kings Court, Los Angeles, California 90007, or at such other place as LCN may designate in writing, the principal sum of Two Million Dollars ($2,000,000), in lawful money of the United States of America, together with interest on the unpaid principal balance from time to time outstanding from the date hereof at the rate of 7% per annum. Interest only shall be due and payable in arrears on the last day of each calendar month, commencing January 31, 1996 until and including July 31, 1996. Commencing August 31, 1996 SmarTalk shall make a payment of $35,000 on the last day of each month until all principal and accrued interest is paid in full, provided, however, that on or before June 30, 2000 (the "Maturity Date") the entire unpaid principal balance hereunder, together with any accrued but unpaid interest thereon, shall be due and payable in full. All payments shall be credited first to accrued interest and the balance to reduce principal. This Note has been executed and delivered pursuant to that certain Agreement between SmarTalk and LCN dated December 28, 1995 (the "Purchase Agreement"). SmarTalk may, at any time or from time to time, prepay principal on this Note, in whole or in part, without penalty or bonus. Each payment shall be credited first to late charges, fees or other sums to be paid by SmarTalk to LCN; second to accrued and unpaid interest; and third, to principal. Interest shall cease on principal so credited. If SmarTalk fails to pay any installment of interest or principal on this Note when due, LCN shall have the right, without further notice or demand, to declare the entire balance of this Note, including interest, immediately due and payable. No waiver by LCN of any of its rights or remedies under this Note or under any other document evidencing this Note or otherwise shall be a waiver of any other right or remedy of LCN; no delay or omission in the exercise or enforcement by LCN of any right or remedy shall be construed as a waiver of any right or remedy of LCN; and no exercise or enforcement of any such right or remedy shall be held to exhaust any right or remedy of LCN. SmarTalk waives presentment for payment, demand, notice of non-payment and protest. This Note is being executed and delivered, and is intended to be performed, in the State of California. Any controversy or claim arising out of or relating to this Note, or the making, performance, breach or interpretation of it, including tort claims, shall be adjudicated in the courts located in Los Angeles County, California, which shall be the exclusive venue and jurisdiction for all claims arising out of or related to this Note. If any suit or other proceeding is brought to enforce this Note, or to collect all or any portion of it, including interest, or because of an alleged dispute, breach, default or misrepresentation in connection with any of the provisions of this Note, or if the holder of this Note sues to protect, preserve or enforce its rights or position, the prevailing party shall recover reasonable attorneys' fees and other costs incurred in that action or proceeding, in addition to any other relief to which it may be entitled. Maker shall have no right of set-off with respect to this Note. "SMARTALK" SMARTALK TELESERVICES, INC., a California corporation By:/s/ Robert Lorsch --------------------------- Robert Lorsch, President 2 EX-10.6 10 SUBORDINATION AGREEMENT 1-1-96 EXHIBIT 10.6 SUBORDINATION AGREEMENT ----------------------- FOR VALUE RECEIVED, the undersigned (the "Subordinated Holder") agrees with SmarTalk Teleservices, Inc. (the "Maker") for the express, intended benefit of SmarTalk Partners, LLC (the "Investor") that the indebtedness represented by the Subordinated Promissory Note, dated January 1, 1996 in the principal amount of $2,000,000 (the "Note") is subordinated in right of payment to the prior payment in full of all indebtedness outstanding pursuant to the Promissory Note Secured by Personal Property, dated December 28, 1995, in the principal amount of $1,200,000 (the "Term Note") and the Revolving Line of Credit Note, dated December 28, 1995, in the principal amount of $500,000 (the "Line of Credit Note") (collectively the "Investor Debt") owed by the Maker of the Note to the Investor, all on the following terms and conditions: 1. Until the date on which all Investor Debt shall be paid in full, without the written consent of the Investor, no payment on account of all or any portion of the principal represented by the Note (the "Subordinated Debt") other than those provided for in the Note shall be made either directly or indirectly by the Maker or any subsidiary or affiliate of the Maker, and the Maker shall not cancel, forgive or offset Subordinated Debt against any indebtedness owed by the Subordinated Holder to the Maker. 2. If any Subordinated Debt becomes due and payable before its stated maturity date or upon any payment or distribution of assets of the Maker of any kind or character, whether in cash, properties or securities or by way of cancellation, forgiveness or offset of Subordinated Debt against any indebtedness owed by the Subordinated Debt to the Maker, whether upon any dissolution, winding up, liquidation or reorganization of the Maker, either voluntary or involuntary, or in bankruptcy, insolvency, receivership, reorganization, arrangement or other proceedings, or otherwise, then, in such event, all Investor Debt shall be paid in full before the holders of the Subordinated Debt shall be entitled to retain any assets so paid or distributed in respect of the Subordinated Debt. Any payment or distribution of assets of the Maker of any kind or character, whether in cash, property or securities or by way of cancellation, forgiveness or offset of Subordinated Debt against any indebtedness owed by the Subordination Holder or any subsequent holder of the Subordinated Debt to the Maker (other than Permitted Securities) which would be payable on account of the Subordinated Debt, except for these provisions, shall be paid by the Maker or by any receiver, trustee in bankruptcy, liquidating trustee, agent or other person making such payment or distribution, or by the holder of the Subordinated Debt directly to the Investor to the extent necessary to pay all Investor Debt in full before any payment or distribution is made on account of the Subordinated Debt. 3. Anything herein to the contrary notwithstanding, the provisions of this Subordination Agreement shall not be construed to preclude or in any way limit the payment to the Subordinated Holder, or to its successors or assigns, of the full amount of interest of the Note so long as at the time of payment no Event of Default on the Investor Debt has been declared and has not been cured, remedied or waived in accordance with the Term Note and Line of Credit Note. 4. Subject to the payment in full of all Investor Debt, the holders of the Subordinated Debt shall be subrogated to the rights of the holders of Investor Debt to receive payments or distributions of cash, property or securities of the Maker applicable to the Investor Debt until all amounts owing on the Subordinated Debt shall be paid in full, and, as between the Maker, its creditors other than holders of Investor Debt, and the holders of the Subordinated Debt, no such payment or distribution made to the holders of Investor Debt by virtue of this Subordination Agreement which otherwise would have been made to the holders of the Subordinated Debt shall be deemed to be a payment by the Maker on account of the Subordinated Debt, it being understood that the provisions of this Subordination Agreement are intended solely for the purpose of defining the relative rights of the holder of the Subordinated Debt, on the one hand, and the holder of the Investor Debt, on the other hand. 5. Nothing contained in this Subordination Agreement is intended to or shall impair, as between the Maker, its creditors other than the holders of Investor Debt, and the holders of the Subordinated Debt, the obligation of the Maker, which is absolute and unconditional, to pay to the holders of the Subordinated Debt the Subordinated Debt as and when the same shall become due and payable in accordance with its terms, or affect the relative rights 2 of the holders of the Subordinated Debt and creditors of the Maker other than the holders of Investor Debt, nor shall anything herein prevent the holder of any Subordinated Debt from exercising all remedies otherwise permitted by applicable law upon default under any instrument defining the rights of holders of Subordinated Debt, subject to the rights, if any, under this Subordination Agreement of the holders of Investor Debt in respect of cash, property or securities of the Maker received upon the exercise of any such remedy. 6. Nothing contained herein, express or implied, shall give to any person, other than the holders of Investor Debt and the holders of Subordinated Debt, any benefit or any legal or equitable right, remedy or claim hereunder. 7. The term "indebtedness" as used herein is used in its most comprehensive sense and includes any and all advances, debts, obligations and liabilities of the Maker heretofore, now or hereafter made, incurred or created, whether voluntary or involuntary and however arising, whether due or not due, absolute or contingent, liquidated or unliquidated, determined or undetermined, and whether the Maker may be liable individually or jointly with others, as principal or as surety or guarantor. IN WITNESS WHEREOF, the undersigned has executed this Subordination Agreement on January 1, 1996. LORSCH CREATIVE NETWORK, INC. By: /s/ Robert Lorsch ------------------------- Robert Lorsch, President SMARTALK TELESERVICES, INC. By: /s/ Robert Lorsch ------------------------- Robert Lorsch, President 3 EX-10.7 11 SECURITY AGREEMENT 8-9-96 EXHIBIT 10.7 SECURITY AGREEMENT ------------------ This Security Agreement (this "Agreement"), dated as of August 9, 1996, is executed by SmarTalk TeleServices, Inc., a California corporation ("Debtor"), for the benefit of Lorsch Creative Network, Inc., a California corporation ("Secured Party"), with reference to the following facts: A. Secured Party is the holder of that certain Subordinated Promissory Note dated January 1, 1996 in the original principal amount of Two Million Dollars (the "Note"). The Note was issued by Debtor to Secured Party pursuant to that certain agreement dated December 28, 1995 between Debtor and Secured Party, providing for Debtor's purchase of Secured Party's advertising agency business in Los Angeles, California. B. Pursuant to that certain Subordination Agreement dated January 1, 1996 between Debtor and Secured Party, the indebtedness represented by the Note is subordinated in right of payment to the prior payment of certain indebtedness of Debtor to SmarTalk Partners, LLC. C. Debtor is entering into an interim financing agreement with SmarTalk Partners, LLC ("Lender"), substantially contemporaneously with the execution hereof. As a condition to providing such financing, Lender requires that Secured Party agree that the indebtedness represented by the Note shall be subordinated in right of payment to the prior payment of Debtor's indebtedness to Lender. To induce Secured Party to enter into a subordination agreement with Lender and as consideration for such subordination agreement, Debtor has agreed to execute this Agreement in favor of Secured Party. NOW, THEREFORE, it is agreed as follows: 1. Definitions. ----------- As used in this Agreement, the following terms shall have the meanings set forth below: a. "Affiliate" shall have meaning set forth in Section 1.1 of the Loan Agreement. b. "Collateral" shall mean all personal property of Debtor, whether tangible or intangible, wherever located or situated, whether now owned or hereafter acquired by Debtor, including without limitation: i. existing and future accounts receivable, including accounts, instruments, documents, chattel paper and general intangibles in which Debtor has or later acquires rights; ii. contract rights; iii. rights as lessee under any lease of office space, including all furnishings, fixtures and improvements, and personal property; iv. equipment; v. inventory, including raw materials, work-in-process, and finished goods; vi. accounts, deposits and certificates; vii. general intangibles; and viii. all proceeds, products, additions, replacements and substitutes of any and all of the above. c. "Commercial Lender" shall mean SmarTalk Partners LLC. d. "Debtor" shall mean SmarTalk TeleServices, Inc. e. "Event of Default" shall mean any failure by Debtor to pay any installment of interest or principal on the Note when due. f. "First Amendment" shall mean that certain Amendment to Subordinated Promissory Note dated June 11, 1996 between Debtor and Secured Party. g. "Indebtedness" shall mean all of Debtor's obligations to Secured Party arising under the Note. h. "Loan Agreement" shall mean that certain Loan and Investment Agreement dated December 28, 1995 among SmarTalk Partners LLC, as lender, Debtor, as borrower, and Robert H. Lorsch, a shareholder of Debtor. i. "Note" shall mean that certain promissory note dated January 1, 1996 in the original principal amount of Two Million Dollars, issued by Debtor to Secured Party. j. "Obligations" shall mean existing and future Indebtedness and all other obligations of Debtor under the Note and under this Agreement, including attorneys' fees and costs incurred in enforcing this Agreement or collecting payment under it. k. "Permitted Liens" shall mean liens which are permitted pursuant to Section 6.1 of the Loan Agreement. l. "Secured Party" shall mean Lorsch Creative Network, Inc. 2 m. Terms defined in the California Commercial Code not otherwise defined in this Agreement are used in this Agreement as defined in the California Commercial Code on the date of this Agreement. 2. Security Interest. As consideration for Secured Party's agreement to ----------------- enter into a subordination agreement in favor of Commercial Lender providing for subordination of payment of the Indebtedness, Debtor hereby grants Secured Party a security interest in the Collateral to secure payment of the Obligations. The security interest is subject to the following: a. Debtor represents that, with the exception of rights granted to Secured Party hereunder and the Permitted Liens, Debtor is the sole legal and equitable owner of 100% of the Collateral and has not previously transferred, assigned, pledged or hypothecated any interest in any of the Collateral. b. Debtor will not transfer, assign, pledge or hypothecate any interest in the Collateral until it satisfies the Obligations in full owed to Secured Party, except as permitted by the Loan Agreement. c. Secured Party's security interest shall be extinguished on full indefeasible payment of the Indebtedness. 3. Covenants by Debtor. Debtor promises: ------------------- a. To comply, in accordance with their terms, with each of the covenants contained in the Loan Agreement. b. To pay all expenses, including attorneys' fees, incurred by Secured Party in the perfection, preservation, realization, enforcement and exercise of its rights under this Agreement. c. To indemnify Secured Party against loss of any kind, including reasonable attorneys' fees, caused to Secured Party by reason of its interest in the Collateral. d. Not to permit liens on the Collateral, except the Permitted Liens and liens granted to Lender. e. To execute and deliver to Secured Party all financing statements and other documents that Secured Party requests, in order to maintain a perfected security interest in the Collateral. f. To maintain and to continue to maintain at Debtor's address listed in Paragraph 12 complete and accurate books and records comprising a standard modern accounting system in accordance with generally accepted accounting principles, consistently applied, that accurately and correctly record and reflect Debtor's income, expenses, liabilities, operations, accounts and ownership and location of the Collateral. Such books and records shall include all accounts, all payments received or credits granted thereon, and other dealings therewith. All such books and records and all documents relating to any of the Collateral are and shall continue 3 to be genuine and will contain such information as may be reasonably requested by Secured Party. g. To promptly notify Secured Party in writing of any change of the address in its principal executive office and/or the location of any of the Collateral. 4. Appointment of Attorney in Fact. Upon the occurrence of, and during ------------------------------- the continuance of, an Event of Default, Debtor appoints Secured Party as Debtor's attorney in fact, with the following powers: a. To perform any of Debtor's obligations hereunder and/or under the Note in Debtor's name or otherwise. b. To give notice of Debtor's right to payment, to enforce that right, and to make extension agreements with respect to it. c. To prepare and file financing statements, continuation statements, statements of assignment, termination statements, and the like, as necessary to perfect, protect, preserve or release Secured Party's interest in the Collateral. d. To endorse Debtor's name on instruments, documents or other forms of payment or security that come into Secured Party's possession. e. To accept cash in payment of the Obligations. 5. Termination; Release of Collateral. ---------------------------------- a. This Agreement will terminate when Debtor satisfies the Indebtedness in full and completes performance of all Obligations to Secured Party. b. Debtor has advised Secured Party that under various state laws or regulations applicable to Debtor's business, Debtor may incur certain liability for the failure to satisfy transport, call processing and tax liability pertaining to sold calling cards. Therefore, Secured Party agrees that its security interest in the Collateral will not include monies maintained in Debtor's segregated Transport Reserve Accounts which amounts are based on projected liability with respect to call processing, transport and taxes associated with issued and outstanding phone cards as determined from time to time by the Debtor's independent public accountants. 6. Documents to Perfect. Debtor shall execute all required documents, -------------------- including UCC-1 financing statements, requested by Secured Party to effectuate and perfect the security interest granted hereunder. 7. Default. Debtor will be in default under this Agreement if any Event ------- of Default occurs. 8. Remedies. -------- 4 a. Secured Party shall have all rights of a secured party under the California Commercial Code or the Uniform Commercial Code of any other jurisdiction, where necessary to enforce this Agreement. All such rights, powers and remedies shall be cumulative and may be exercised successively or concurrently in Secured Party's sole discretion without impairing its security interest, rights or available remedies. Secured Party's forbearance, failure or delay in exercising any right, power or remedy shall not preclude further exercise of that right, power or remedy which shall continue in effect unless and until Secured Party specifically waives it in writing. b. If Secured Party conducts a private sale of any Collateral by soliciting bids from 10 or more dealers or distributors in that type of Collateral, any such sale of Collateral in bulk or in parcels, to the bidder submitting the highest cash bid, within 120 days of (i) Secured Party taking possession and control of the Collateral or (ii) when Secured Party is otherwise authorized to sell the Collateral (whichever occurs last), is a commercially reasonable sale of the Collateral. Commercially reasonable notice of any public or private sale is given to Debtor if Secured Party sends Debtor a notice of the sale at least 7 days before the date of any public sale (or 7 days before the time after which a private sale will be made). The purchase of any Collateral by a supplier, as provided in any agreement between Secured Party and the supplier, is a commercially reasonable disposition or sale of the Collateral. If Secured Party disposes of any Collateral other than as set forth in this subparagraph, the commercial reasonableness of the disposition will be determined in accordance with the laws of the State of California. Debtor will (i) pay Secured Party even if any Collateral is defective or fails to conform to any warranties extended by any third party, (ii) not assert against Secured Party any claim or defense it has against any third party and (iii) indemnify and hold Secured Party harmless against any claims or defenses asserted by any buyer of the Collateral relating to the condition of, or representations made about, any Collateral. Debtor waives all rights of offset against Secured Party. 9. Further Acts; Cooperation. The parties will execute all further ------------------------- documents reasonable, convenient, necessary or desirable to carry out this Agreement. The parties shall cooperate to effectuate the intent of this Agreement and the mutual benefits intended to be conferred under it. 10. Successors and Assigns. This Agreement shall be binding upon the ---------------------- parties and their respective heirs, successors and assigns. 11. Jurisdiction and Venue for Disputes. Any action relating to any ----------------------------------- dispute under this Agreement shall be litigated solely in the courts located in Los Angeles County, California. All parties consent to the jurisdiction in the State of California over all disputes and consent that venue is proper in Los Angeles County, California. 12 Notices. Any notice or other communication relating to this Agreement ------- shall be deemed effective when served as follows: IF TO SECURED PARTY: Lorsch Creative Network, Inc. 5 3188 Kings Court Los Angeles, California 90077 Attention: Mr. Robert H. Lorsch Fax: (310) 471-9659 IF TO DEBTOR: SmarTalk TeleServices, Inc. 1640 South Sepulveda Boulevard, Suite 500 Los Angeles, California 90025 Attention: Mr. Andrew Folck Fax: (310) 444-8800 WITH A COPY TO: Dewey Ballantine 333 South Hope Street, Suite 3000 Los Angeles, California 90071 Attention: Robert M. Smith Fax: (213) 625-0562 Service shall be effected either: (1) by fax when the fax transmission is completed, provided a hard copy is deposited in the U.S. Mail within 24 hours of fax notice; or (2) by personal service when a copy is personally delivered to the person being served. If for any reason a party cannot readily serve the other either by fax or by personal delivery, service shall be proper if mailed to the party to be served at the address set forth above, certified mail, return receipt requested, with a copy to the party's respective attorney by first class mail, in which event, service shall be deemed effective on the third business day after deposit in the mail. A party's failure or refusal to sign a return receipt shall not invalidate the notice. Any party may change his address by notifying the other party in writing and supplying a new fax number. 13. Headings. Headings in this Agreement are for convenience only and -------- shall not be deemed a part of this Agreement. 14. Governing Law. This Agreement shall be interpreted and enforced in ------------- accordance with the laws of California. 15. Construction. All parties have cooperated in the drafting and ------------ preparation of this Agreement. Accordingly, no provision of this Agreement shall be construed for or against either party by virtue of its having drafted a specific provision. 16. Attorneys' Fees. If any dispute occurs relating to this Agreement, --------------- its alleged breach, its interpretation, the circumstances under which it was executed, or any other dispute pertaining to it, whether such dispute is based on contract, tort or equitable theories, the prevailing party shall recover its reasonable attorneys' fees and costs from the losing party. 6 17. Post-Judgment Fees. In addition to the attorneys' fees and costs ------------------ provided for in Paragraph 16 above, the parties agree that if any dispute between the parties results in a judgment in favor of either party, such party will be entitled to recover from the other all attorneys' fees and costs incurred by it in enforcing such judgment. This provision is intended to be severable from any other provision of this Agreement, and is not to be deemed merged in the judgment. 18. No Waiver. No waiver by Secured Party of any breach or default will --------- be a waiver of any breach or default occurring later. A waiver will be valid only if it is in writing and signed by Secured Party. 19. Other Matters. The parties agree that, effective as of the date of ------------- this Agreement, the First Amendment shall be terminated and of no further force and effect. 20. Integration. This Agreement (and the agreements referred to herein) ----------- is the entire agreement, and supersedes any prior agreement or understandings, between Secured Party and Debtor relating to its subject matter. There are no oral agreements pertaining to the subject matter of this Agreement, and this Agreement shall supersede all oral representations and statements by the parties. This Agreement may only be modified by a writing signed by the party to be charged. DEBTOR SMARTALK TELESERVICES, INC., a California corporation By: /s/ Andrew Folck _______________________________ Andrew Folck Chief Financial Officer SECURED PARTY LORSCH CREATIVE NETWORK, INC., a California corporation By: /s/ Robert H. Lorsch _______________________________ Robert H. Lorsch President 7 EX-10.9 12 INDEMNIFICATION AGREEMENT EXHIBIT 10.9 INDEMNIFICATION AGREEMENT ------------------------- THIS AGREEMENT is established effective with the date of incorporation of SMARTALK TELESERVICES, INC. a California corporation ("the Company") between the Company and its undersigned management personnel (collectively herein "Indemnitee"). RECITALS -------- A. The Company believes that it is essential to its best interests to attract and retain highly capable persons to serve as directors and/or officers of the Company. B. Indemnitee is or has been selected to be a director and/or officer of the Company. C. The Company and Indemnitee recognize the increased risk of litigation and other claims being asserted against directors and officers of corporations. D. In recognition of Indemnitee's need for substantial protection against personal liability, in order to enhance Indemnitee's service to the Company, and in order to induce Indemnitee to continue to provide services to the Company as a director and/or officer, the Company wishes to provide in this Agreement for the indemnification of and the advancing of expenses to Indemnitee to the fullest extent permitted by law and as set forth in this Agreement and, to the extent applicable insurance is maintained, for the coverage of Indemnitee under the Company's policies of directors' and officers' liability insurance. IN CONSIDERATION of the foregoing and of Indemnitee's continuing to provide services to the Company directly or, at its request, with another enterprise, the parties agree as follows: Section 1. DEFINITIONS. ---------------------- a. Board. The board of directors of the Company. b. Expenses. (i) any expense, liability, or loss, including attorney fees, judgments, fines, ERISA excise taxes and penalties, and amounts paid or to be paid in settlement; (ii) any interest, assessments, or other charges imposed on any of the items in part (i) of this subsection (c); and (iii) any federal, state, local, or foreign taxes imposed as a result of the actual or deemed receipt of any payments under this Agreement paid or incurred in connection with investigating, defending, being a witness in, participating in (including on appeal), or preparing for any of the foregoing in any proceeding relating to any indemnifiable event. 1 c. Indemnifiable Event. Any event or occurrence that takes place either before or after the execution of this Agreement and that is related to: (i) the fact that Indemnitee is or was a director or an officer of the Company, or while a director or officer is or was serving at the request of the Company as a director, officer, employee, trustee, agent, or fiduciary of another foreign or domestic corporation, partnership, joint venture, employee benefit plan, trust, or other enterprise, or was a director, officer, employee, or agent of a foreign or domestic corporation that was a predecessor corporation of the Company or another enterprise at the request of such predecessor corporation; or (ii) anything done or not done by Indemnitee in any such capacity, whether or not the basis of the proceeding is an alleged action in an official capacity as a director and/or officer, or in any other capacity while serving as a director and/or officer, of the Company, as described in this subsection (d). d. Independent Counsel. The person or body appointed in connection with Section 3. e. Person. "Person" (as that term is used in sections 13(d) and 14(d) of the Exchange Act), other than a trustee or other fiduciary holding securities under an employee benefit plan of the Company acting in such capacity, or a corporation owned directly or indirectly by the shareholders of the Company in substantially the same proportions as their ownership of shares of the Company at the date of this Agreement. f. Participant. A person who is a party to, or a witness or a participant (including on appeal) in, a proceeding. g. Potential Change in Control. A state of affairs that shall be deemed to exist if: (i) the Company enters into an agreement or arrangement, the consummation of which would result in the occurrence of a change in control; (ii) any person (including the Company) announces publicly an intention to take or to consider taking actions that, if consummated, would constitute a change in control; (iii) any person who is or becomes the beneficial owner, directly or indirectly, of securities of the Company representing 10 percent or more of the combined voting power of the Company's then-outstanding voting securities, increases his or her beneficial ownership of such securities by 5 percent or more over the percentage owned by such person on the date of this Agreement; or (iv) the board adopts a resolution to the effect that, for purposes of this Agreement, a potential change in control has occurred. 2 h. Proceeding. Any threatened, pending, or completed action, suit, or proceeding, or any inquiry, hearing, or investigation, whether conducted by the Company or any other party, that Indemnitee in good faith believes might lead to the institution of any such action, suit, or proceeding, whether civil, criminal, administrative, investigative, or other. i. Reviewing Party. The person or body appointed in accordance with Section 3. j. Voting Securities. Any securities of the Company that have the right to vote generally in the election of directors. Section 2. AGREEMENT TO INDEMNIFY. --------------------------------- a. General Agreement. In the event Indemnitee was, is, or becomes a participant in, or is threatened to be made a participant in, a proceeding by reason of (or arising in part out of) an indemnifiable event, the Company shall indemnify Indemnitee from and against any and all expenses to the fullest extent permitted by law, as the same exists or may hereafter be amended or interpreted (but in the case of any such amendment or interpretation, only to the extent that such amendment or interpretation permits the Company to provide broader indemnification rights than were permitted prior thereto). The parties hereto intend that this Agreement shall provide for indemnification in excess of that expressly permitted by statute, including, without limitation, any indemnification provided by the Company's articles of incorporation, its bylaws, a vote of its shareholders or disinterested directors, or applicable law. b. Initiation of Proceeding. Notwithstanding anything in this Agreement to the contrary, Indemnitee shall not be entitled to indemnification under this Agreement in connection with any proceeding initiated by Indemnitee against the Company or any director and/or officer of the Company unless: (i) the Company has joined in or the Board has consented to the initiation of such proceeding; (ii) the proceeding is one to enforce indemnification rights under Section 5; or (iii) the proceeding is instituted after a change in control and independent counsel has approved its initiation. c. Expense Advances. If so requested by Indemnitee, the Company shall, within 10 business days after such request, advance __________________________. Notwithstanding the foregoing, to the extent that the reviewing party determines that Indemnitee would not be permitted to be so indemnified under applicable law, the Company shall be entitled to be reimbursed by Indemnitee for all such amounts, and Indemnitee hereby agrees to reimburse the Company promptly for the same. If Indemnitee has commenced legal proceedings in a court of competent jurisdiction to secure a determination that 3 Indemnitee should be indemnified under applicable law, as provided in Section 4, any determination made by the reviewing party that Indemnitee would not be permitted to be indemnified under applicable law shall not be binding, and Indemnitee shall not be required to reimburse the Company for any expense advance until a final judicial determination is made with respect thereto and all rights of appeal therefrom have been exhausted or have lapsed. Indemnitee's obligation to reimburse the Company for expense advances shall be unsecured, and no interest shall be charged thereon. d. Mandatory Indemnification. Notwithstanding any other provision of this Agreement, to the extent that Indemnitee has been successful on the merits in defense of any proceeding relating in whole or in part to an indemnifiable event or in defense of any issue or matter in such proceeding, Indemnitee shall be indemnified against all expenses incurred in connection therewith. e. Partial Indemnification. If Indemnitee is entitled under any provision of this Agreement to indemnification by the Company for a portion of expenses, but not for the total amount of expenses, the Company shall indemnify Indemnitee for the portion to which Indemnitee is entitled. f. Prohibited Indemnification. No indemnification under this Agreement shall be paid by the Company on account of any proceeding in which judgment is rendered against Indemnitee for an accounting of profits made from the purchase or sale by Indemnitee of securities of the Company under section 16(b) of the Exchange Act, or similar provisions of any federal, state, or local laws. Section 3. REVIEWING PARTY. -------------------------- Before any change in control occurs, the reviewing party shall be any appropriate person or body consisting of a member or members of the board or any other person or body appointed by the board who is not a party to the proceeding for which Indemnitee is seeking indemnification; after a change in control, the reviewing party shall be the independent counsel. On all matters arising after a change in control (other than a change in control approved by a majority of the directors of the board who were directors immediately before such change in control) concerning the rights of Indemnitee to indemnity payments and expense advances under this Agreement, any other agreement, applicable law, or the Company's articles of incorporation or bylaws now or hereafter in effect relating to indemnification for indemnifiable events, the Company shall seek legal advice only from independent counsel selected by Indemnitee and approved by the Company (which approval shall not be unreasonably withheld), and who has not otherwise performed services for the Company or Indemnitee (other than in connection with indemnification matters) within the last five years. The independent counsel shall not include any person who, under the applicable standards of professional conduct then prevailing, would have a conflict of interest in representing either the Company or Indemnitee in an action to determine Indemnitee's rights under this Agreement. Such counsel, among other things, shall render a written opinion to the Company and Indemnitee on whether and to what extent Indemnitee should be permitted to be indemnified under applicable law. The Company agrees to pay the 4 reasonable fees of the independent counsel and to indemnify fully such counsel against any and all expenses, including attorney fees, claims, liabilities, loss, and damages arising out of or relating to this Agreement or the engagement of independent counsel under this Agreement. Section 4. INDEMNIFICATION PROCESS AND APPEAL. --------------------------------------------- a. Indemnification Payment. Indemnitee shall receive indemnification of expenses from the Company in accordance with this Agreement as soon as practicable after Indemnitee has made written demand on the Company for indemnification, unless the reviewing party has given a written opinion to the Company that Indemnitee is not entitled to indemnification under this Agreement or applicable law. b. Suit To Enforce Rights. Regardless of any action by the reviewing party, if Indemnitee has not received full indemnification within 30 days after making a demand in accordance with Section 4(a), Indemnitee shall have the right to enforce its indemnification rights under this Agreement by commencing binding arbitration with the Judicial Arbitration and Mediation Services in Los Angeles seeking an initial determination by the court or challenging any determination by the reviewing party or any aspect thereof. The Company hereby consents to service of process and to appear in any such proceeding. Any determination by the reviewing party not challenged by Indemnitee shall be binding on the Company and Indemnitee. The remedy provided for in this Section 4 shall be in addition to any other remedies available to Indemnitee in law or equity. The prevailing party shall be awarded reasonably attorneys' fees and costs sufficient to compensate that party for the arbitration. c. Defense to Indemnification, Burden of Proof, and Presumptions. It shall be a defense to any action brought by Indemnitee against the Company to enforce this Agreement (other than an action brought to enforce a claim for expenses incurred in defending a proceeding in advance of its final disposition when the required undertaking has been tendered to the Company) that it is not permissible, under this Agreement or applicable law, for the Company to indemnify Indemnitee for the amount claimed. In connection with any such action or any determination by the reviewing party or otherwise on whether Indemnitee is entitled to be indemnified under this Agreement, the burden of proving such a defense or determination shall be on the Company. Neither the failure of the reviewing party or the Company (including its board, independent legal counsel, or its shareholders) to have made a determination before the commencement of such action by Indemnitee that indemnification is proper under the circumstances because Indemnitee has met the standard of conduct set forth in applicable law, nor an actual determination by the reviewing party or the Company (including its board, independent legal counsel, or its shareholders) that Indemnitee had not met such applicable standard of conduct, shall be a defense to the action or create a presumption that Indemnitee has not met the applicable standard of conduct. For purposes of this Agreement, the termination of any claim, action, suit, or proceeding, by judgment, order, settlement (whether with or without court approval), conviction or on a plea of nolo contendere, or its equivalent, shall not create a presumption that Indemnitee did not meet any 5 particular standard of conduct or have any particular belief or that a court has determined that indemnification is not permitted by applicable law. Section 5. INDEMNIFICATION FOR EXPENSES INCURRED IN ENFORCING RIGHTS. -------------------------------------------------------------------- The Company shall indemnify Indemnitee against any and all expenses. If requested by Indemnitee, the Company shall, within 10 business days after such request, advance to Indemnitee such expenses as are incurred by Indemnitee in connection with any claim asserted against or action brought by Indemnitee for: (a) indemnification of expenses or advances of expenses by the Company under this Agreement, or any other agreement, or under applicable law, or the Company's articles of incorporation or bylaws now or hereafter in effect relating to indemnification for indemnifiable events, and/or (b) recovery under directors' and officers' liability insurance policies maintained by the Company, for amounts paid in settlement if the independent counsel has approved the settlement. The Company shall not settle any proceeding in any manner that would impose any penalty or limitation on Indemnitee without Indemnitee's written consent. Neither the Company nor Indemnitee will unreasonably withhold its consent to any proposed settlement. The Company shall not be liable to indemnify the Indemnitee under this Agreement with regard to any judicial award if the Company was not given a reasonable and timely opportunity, at its expense, to participate in the defense of such action; however, the Company's liability under this Agreement shall not be excused if participation in the proceeding by the Company was barred by this Agreement. Section 6. NONEXCLUSIVITY. ------------------------- The rights of Indemnitee under this Agreement shall be in addition to any other rights Indemnitee may have under the Company's articles of incorporation, bylaws, applicable law, or otherwise. To the extent that a change in applicable law (whether by statute or judicial decision) permits greater indemnification by agreement than would be afforded currently under the Company's articles of incorporation, bylaws, applicable law, or this Agreement, it is the intent of the parties that Indemnitee enjoy by this Agreement the greater benefits afforded by such change. Section 7. LIABILITY INSURANCE. ------------------------------ To the extent the Company maintains an insurance policy or policies providing directors' and officers' liability insurance, Indemnitee shall be covered by such policy or policies, in accordance with its or their terms, to the maximum extent of the coverage available for any Company director or officer. 6 Section 8. PERIOD OF LIMITATIONS. -------------------------------- No legal action shall be brought, and no cause of action shall be asserted, by or on behalf of the Company or any affiliate of the Company against Indemnitee, Indemnitee's spouse, heirs, executors, or personal or legal representatives after the expiration of two years from the date of accrual of such cause of action, or such longer period as may be required by state law under the circumstances. Any claim or cause of action of the Company or its affiliate shall be extinguished and deemed released unless asserted by the timely filing of a legal action within such period; provided, however, that if any shorter period of limitations is otherwise applicable to any such cause of action, the shorter period shall govern. Section 9. AMENDMENT OF THIS AGREEMENT. -------------------------------------- No supplement, modification, or amendment of this Agreement shall be binding unless executed in writing by both of the parties hereto. No waiver of any of the provisions of this Agreement shall operate as a waiver of any other provisions hereof (whether or not similar), nor shall such waiver constitute a continuing waiver. Except as specifically provided herein no failure to exercise or any delay in exercising any right or remedy hereunder shall constitute a waiver thereof. Section 10. SUBROGATION. ----------------------- In the event of payment under this Agreement, the Company shall be subrogated to the extent of such payment to all rights of recovery of Indemnitee, who shall execute all papers required and shall do everything that may be necessary to secure such rights, including the execution of such documents necessary to enable the Company effectively to bring suit to enforce such rights. Section 11. NO DUPLICATION OF PAYMENTS. -------------------------------------- The Company shall not be liable under this Agreement to make any payment in connection with any claim made against Indemnitee to the extent Indemnitee has otherwise received payment (under any insurance policy, bylaw, or otherwise) of the amounts otherwise indemnifiable under this Agreement Section 12. BINDING EFFECT. -------------------------- This Agreement shall be binding on and inure to the benefit of and be enforceable by the parties hereto and their respective successors (including any direct or indirect successor by purchase, merger, consolidation, or otherwise to all or substantially all of the business and/or assets of the Company), assigns, spouses, heirs, and personal and legal representatives. The Company shall require and cause any successor (whether direct or indirect, by purchase, merger, consolidation, or otherwise) to all, substantially all, or a substantial part of the business and/or assets of the Company, by written agreement in form and substance satisfactory to Indemnitee, expressly to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required 7 to perform if no such succession had taken place. The indemnification provided under this Agreement shall continue for Indemnitee for any action taken or not taken while serving in an indemnified capacity pertaining to an indemnifiable event even though Indemnitee may have ceased to serve in such capacity at the time of any proceeding. Section 13. SEVERABILITY. ------------------------ If any portion of this Agreement shall be held by a court of competent jurisdiction to be invalid, void, or otherwise unenforceable, the remaining provisions shall remain enforceable to the fullest extent permitted by law. Furthermore, to the fullest extent possible, the provisions of this Agreement (including, without limitation, each portion of this Agreement containing any provision held to be invalid, void, or otherwise unenforceable, that is not itself invalid, void, or unenforceable) shall be construed so as to give effect to the intent manifested by the provision held invalid, void, or unenforceable. Section 14. GOVERNING LAW. ------------------------- This Agreement shall be governed by and construed and enforced in accordance with the laws of the State of California applicable to contracts made and to be performed in such State without giving effect to the principles of conflicts of laws. Section 15. NOTICES. ------------------- All notices, demands, and other communications required or permitted hereunder shall be made in writing and shall be deemed to have been duly given if delivered by hand, against receipt, or mailed, postage prepaid, certified or registered mail, return receipt requested, and addressed to the Company at its principal place of business and to Indemnitee at such address as the Company shall have for its officers and directors. Notice of change of address shall be effective only when given in accordance with this section. All notices complying with this section shall be deemed to have been received on the date of delivery or on the third business day after mailing. 8 IN WITNESS WHEREOF, the parties hereto have duly executed and delivered this Agreement as of the day specified above. Dated: January 6, 1995 SMARTALK TELESERVICES, INC. --------------- /s/ Robert H. Lorsch -------------------------------------- By: Robert H. Lorsch, President INDEMNITEES /s/ Robert H. Lorsch - ---------------------------------- Robert H. Lorsch /s/ Bruce W. Bielinski, M.D. - ---------------------------------- Bruce W. Bielinski, M.D. - ---------------------------------- - ---------------------------------- - ---------------------------------- - ---------------------------------- - ---------------------------------- - ---------------------------------- 9 EX-10.12 13 STANDARD OFFICE LEASE EXHIBIT 10.12 STANDARD OFFICE LEASE BY AND BETWEEN LAOP IV, LLC AS LANDLORD, AND SMARTALK TELESERVICES, INC. AS TENANT Table of Contents -----------------
Page ---- ARTICLE 1 - Basic Lease Provisions......................................... 1 ARTICLE 2 - Term........................................................... 3 ARTICLE 3 - Rental......................................................... 3 (a) Basic Rental................................................... 3 (b) Increase in Direct Costs....................................... 4 (c) Definitions.................................................... 4 (d) Determination of Payment....................................... 8 ARTICLE 4 - Security Deposit............................................... 10 ARTICLE 5 - Holding Over................................................... 10 ARTICLE 6 - Personal Property Taxes........................................ 10 ARTICLE 7 - Use............................................................ 11 ARTICLE 8 - Condition of Premises.......................................... 11 ARTICLE 9 - Repairs and Alterations........................................ 12 ARTICLE 10 - Liens.......................................................... 14 ARTICLE 11 - Project Services............................................... 14 ARTICLE 13 - Indemnity; Exemption of Landlord from Liability................ 17 (a) Indemnity...................................................... 17 (b) Exemption of Landlord from Liability........................... 17 ARTICLE 14 - Insurance...................................................... 17 (a) Tenant's Insurance............................................. 17 (b) Form of Policies............................................... 18 (c) Landlord's Insurance........................................... 18 (d) Waiver of Subrogation.......................................... 18 (e) Compliance with Law............................................ 19 ARTICLE 15 - Assignment and Subletting...................................... 19
i ARTICLE 16 - Damage Or Destruction.......................................... 22 ARTICLE 17 - Subordination.................................................. 23 ARTICLE 18 - Eminent Domain................................................. 24 ARTICLE 19 - Default........................................................ 24 ARTICLE 20 - Remedies....................................................... 25 ARTICLE 21 - Transfer of Landlord's Interest................................ 27 ARTICLE 22 - Broker......................................................... 27 ARTICLE 23 - Parking........................................................ 27 ARTICLE 24 - Waiver......................................................... 28 ARTICLE 25 - Estoppel Certificate........................................... 28 ARTICLE 26 - Liability Of Landlord.......................................... 28 ARTICLE 27 - Inability To Perform........................................... 29 ARTICLE 28 - Hazardous Waste................................................ 29 ARTICLE 29 - Surrender of Premises; Removal of Property..................... 31 ARTICLE 30 - Miscellaneous.................................................. 32 (a) Severability; Entire Agreement................................. 32 (b) Attorneys' Fees................................................ 32 (c) Time of Essence................................................ 32 (d) Headings....................................................... 33 (e) Reserved Area.................................................. 33 (f) No Option...................................................... 33 (g) Use of Project Name; Improvements.............................. 33 (h) Rules and Regulations.......................................... 33 (i) Quiet Possession............................................... 33 (j) Rent........................................................... 33 (k) Successors and Assigns......................................... 34 (l) Notices........................................................ 34 (m) Persistent Delinquencies....................................... 34 (n) Right of Landlord to Perform................................... 34 (o) Access, Changes in Project, Facilities, Name................... 34 (p) Corporate Authority............................................ 35 (q) Identification of Tenant....................................... 35
ii (r) Substitute Premises............................................ 35 (s) Building Codes................................................. 36 (t) Exhibits and Addendum.......................................... 36 ARTICLE 31 - Option to Renew................................................ 36 (a) Option Right................................................... 36 (b) Option Rent.................................................... 36 (c) Exercise of Options............................................ 36 (d) Determination of Market Rent................................... 37 ARTICLE 32 - Right of First Offer/Right of First Refusal.................... 37 (a) Right of First Offer........................................... 37 (b) Right of First Refusal......................................... 38 ARTICLE 33 - Storage Space.................................................. 40 ARTICLE 34 - Signage/Directory.............................................. 40 ARTICLE 35 - Option to Cancel............................................... 40 ARTICLE 36 - Building Antenna(s) or Satellite Dish(es)...................... 41 ARTICLE 37 - Limited Arbitration/Dispute Resolution Procedure............... 42
Addendum [] Yes [X] No Exhibit "A" Premises Exhibit "B" Rules and Regulations Exhibit "C" Notice of Lease Term Dates and Tenant's Percentage iii STANDARD OFFICE LEASE This Standard Office Lease ("Lease") is made and entered into as of this 10th day of January, 1996, between LAOP IV, LLC, a Nevada limited liability - ---- company ("Landlord"), and SMARTALK TELESERVICES, INC., a California corporation ("Tenant"). Landlord hereby leases to Tenant and Tenant hereby leases from Landlord the premises described as Suite No. 500, as designated on the plan attached hereto and incorporated herein as Exhibit "A" ("Premises"), of the project ("Project") now known as Westwood Terrace, whose address is 1640 Sepulveda Boulevard, Los Angeles, California 90025, for the term and upon the terms and conditions hereinafter set forth, and Landlord and Tenant hereby agree as follows: ARTICLE 1 - Basic Lease Provisions: - ---------------------------------- A. Term: Commencement Date: On the later of (i) February 1, 1996, or (ii) up to five (5) business days after substantial completion of the tenant improvement work defined in Article 9 below to install Tenant's main "T- Switch"; provided, however, Tenant shall use its best efforts to install such switch prior to the expiration of said five (5) day period, and if Tenant does install said switch prior to the expiration of such five (5) day period the Lease shall commence on such earlier date. Substantial completion shall mean completion of "the Tenant Improvements" (defined in Article 9), punch-list items excluded, in accordance with the approved plans, and the final inspection by the City of Los Angeles has occurred. Upon Tenant's occupancy of the Premises, Landlord and Tenant agree to execute and deliver a Commencement Letter in a form substantially similar to that attached hereto as Exhibit "C." Tenant shall be allowed access to the Premises prior to the commencement of the Lease term (without a charge for rent), to ensure the Premises are properly furnished and special leasehold improvements, equipment, furniture, telephone and computer/data cabling is properly installed and operational; provided, Tenant shall not unreasonably interfere with any tenant improvement work to be done. If Tenant interferes with the tenant improvement work because of such early occupancy, the Commencement Date shall not be delayed but shall be started as of the date which would have occurred but for such Tenant interference. 1 Expiration Date: Seventy-two (72) months from the Commencement Date. B. Square Footage: Approximately 6,795 rentable square feet. C. Basic Rental:
Months Monthly Basic Rental Annual Basic Rent ------ -------------------- ----------------- 1 through 6 $12,502.80 $150,033.60 7 through 9 Free -0- 10 through 15 $ 8,561.70 $102,740.40 16 through 72 $12,502.80 $150,033.60
D. Base Year: 1996 E. Tenant's Proportionate Share: 4.99045% F. Security Deposit A security deposit of $46,613.70, shall be due and payable by Tenant to Landlord upon Tenant's execution of this Lease. Landlord agrees to return to Tenant a portion of the security deposit equal to $34,960.28 at the start of the of the thirty-seventh (37th) month after the Commencement Date, provided: (1) Tenant is not then in material default, and (2) Tenant has not had more than three (3) material financial defaults under this Lease prior to such thirty- seventh (37th) month. G. Permitted Use: General office use not inconsistent with the use in the Project or other first- class office projects in the area of the Project. H. Broker: First Property Realty Corporation; Prentiss Properties, Limited, Inc. I. Parking Passes: Tenant shall have the use of three (3) unreserved parking spaces for each 1,000 square feet contained in the Premises, which equals twenty (20) spaces. Four (4) of the twenty (20) spaces may be reserved spaces. Parking charges for such spaces shall be as set forth in Article 1.J., immediately below. J. Parking Charges: All parking provided in Article 1.1. above shall be at the prevailing monthly rate in effect at the beginning of each month during the term of this Lease, and any extensions or renewals thereof; provided, however, such charge during the initial Lease term shall not exceed Ninety-Nine Dollars 2 ($99.00) a space each month (including all applicable taxes) for each unreserved space or One Hundred Thirty-Two Dollars ($132.00) a space each month (including all applicable taxes) for each reserved space. K. First Month's Rent: The first month's rent of $12,502.80 shall be due and payable by Tenant to Landlord upon Tenant's execution of this Lease. L. Consent: Whenever the consent of either Landlord or Tenant is required hereunder, the party giving such consent shall not unreasonably withhold or delay the giving of such consent. ARTICLE 2 - Term - ---------------- The term of this Lease shall commence on the Commencement Date (the "Commencement Date") as set forth in Article 1.A. of the Basic Lease Provisions, and shall end on the expiration date set forth in Article 1.A. of the Basic Lease Provisions. If Landlord is unable to deliver possession of the Premises to Tenant on or before the Commencement Date, Landlord shall not be subject to any liability for its failure to do so, and such failure shall not affect the validity of this Lease nor the obligations of Tenant hereunder, but the term hereof shall commence on the earlier of (a) the day that Landlord gives Tenant written notice that the Premises are ready for occupancy or (b) on the day that Tenant first occupies the Premises, and the expiration of the term hereof shall be extended accordingly. In the event that the Substantial Completion of the Premises has not occurred by the "Outside Date", which shall be July 1, 1996, and as such the July 1, 1996 date may be extended by the number of days of tenant delays (as defined below), then the sole remedy of Tenant shall be the right to deliver a notice to Landlord ("Termination Notice") electing to terminate this Lease effective upon receipt of the Termination Notice by Landlord ("Effective Date"). The Termination Notice must be delivered by Tenant to Landlord, if at all, not earlier than the Outside Date and not later than five (5) business days after the Outside Date. ARTICLE 3 - Rental - ------------------ (a) BASIC RENTAL. Tenant agrees to pay to Landlord during the term hereof, at Landlord's office or to such other person or at such other place as directed from time to time by written notice to Tenant from Landlord, the initial monthly and annual sums as set forth in Article 1.C of the Basic Lease Provisions, payable in advance on the first day of each calendar month, without demand, setoff or deduction, and in the event this Lease commences or the date of expiration of this Lease occurs other than on the first day or last day of a calendar month, the rent of such month shall be prorated. Notwithstanding the foregoing, the first month's rent shall be paid to Landlord in accordance with Article 1.K. of the Basic Lease provisions. Basic Rental shall be subject to increase from time to time pursuant to the subsequent provisions of this Article 3, or other articles of this Lease and any Addendum (if applicable) incorporated herein. 3 (b) INCREASE IN DIRECT COSTS. The term "Base Year" means the calendar year set forth in Article 1.D. of the Basic Lease Provisions. If, in any calendar year during the term of this Lease, the "direct costs" (as hereinafter defined) paid or incurred by Landlord shall be higher than the direct costs for the Base Year, Tenant shall pay an additional sum for such and each subsequent calendar year equal to the product of the amount set forth in Article 1.E. of the Basic Lease Provisions multiplied by such increased amount of "direct costs." In the event either the Premises and/or the Project is expanded or reduced, then Tenant's proportionate share shall be appropriately adjusted, and as to the calendar year in which such change occurs, Tenant's proportionate share for such year shall be determined on the basis of the number of days during that particular calendar year that such Tenant's proportionate share was in effect. In the event this Lease shall terminate on any date other than the last day of a calendar year, the additional sum payable hereunder by Tenant during the calendar year in which this Lease terminates shall be prorated on the basis of the relationship which the number of days which have elapsed from the commencement of said calendar year to and including said date on which this Lease terminates bears to three hundred sixty (360). Any and all amounts due and payable by Tenant pursuant to Article 3(b), (c) and (d) hereof shall be deemed "Additional Rent" and Landlord shall be entitled to exercise the same rights and remedies upon default in these payments as Landlord is entitled to exercise with respect to defaults in monthly Basic Rental payments. (c) DEFINITIONS. As used herein the term "direct costs" shall mean the sum of the following: (i) "Tax Costs," which shall mean any and all real estate taxes and other similar charges on real property or improvements, assessments, water and sewer charges, and all other charges assessed, reassessed or levied upon the Project and appurtenances thereto and the parking or other facilities thereof, or the real property (the "Property") thereunder (collectively the "Real Property") or attributable thereto or on the rents, issues, profits or income received or derived therefrom which are assessed, reassessed or levied by the United States, the State of California or any local government authority or agency or any political subdivision thereof, and shall include Landlord's reasonable legal fees, costs and disbursements incurred in connection with proceedings for reduction of Tax Costs or any part thereof (but only to the extent Landlord reasonably expects to receive a reduction of Tax Costs); provided, however, if at any time after the date of this Lease the methods of taxation now prevailing shall be altered so that in lieu of or as a supplement to or a substitute for the whole or any part of any Tax Costs, there shall be assessed, reassessed or levied (a) a tax, assessment, reassessment, levy, imposition or charge wholly or partially as a net income, capital or franchise levy or otherwise on the rents, issues, profits or income derived therefrom, or (b) a tax, assessment, reassessment, levy (including but not limited to any municipal, state or federal levy), imposition or charge measured by or based in whole or in part upon the Real Property and imposed upon Landlord, or (c) a license fee measured by the rent payable under this Lease, then all such taxes, assessments, reassessments or levies or the part thereof so measured or based, shall be deemed to be included in the term "direct costs." Notwithstanding the foregoing, Tax Costs shall not include excess profits, franchise taxes, gift taxes, capital stock taxes, inheritance and succession taxes, estate taxes and federal and state income taxes. Any increase in Tax Costs as a result of the sale of the Project in 1995 which is paid, assessed or which accrues during the Base Year shall be included in Tax Costs for the Base Year. Notwithstanding anything to the contrary set forth in this Article 3(c)(i), any Tax Cost increase resulting from the sale or transfer of the Project after the execution of this Lease 4 which results in a reassessment of the Project for tax purposes shall not be included in computations for payment of increases of direct costs during the first three (3) years of the initial Lease term. (ii) "Operating Costs," which shall mean all costs and expenses incurred by Landlord in connection with the maintenance, operation, replacement, ownership (as set forth herein) and repair of the Project, the equipment, the intrabuilding network cable, adjacent walks, malls and landscaped and common areas and the parking structure, areas and facilities of the Project, including, but not limited to, salaries, wages, medical, surgical and general welfare benefits and pension payments, payroll taxes, fringe benefits, employment taxes, workers' compensation, uniforms and dry cleaning thereof for all persons who perform duties connected with the operation, maintenance and repair of the Project, its equipment the intrabuilding network cable and the adjacent walks and landscaped areas, including janitorial, gardening, security, parking, operating engineer, elevator, painting, plumbing, electrical, carpentry, heating, ventilation, air conditioning, window washing, hired services, a reasonable allowance for depreciation of the cost of acquiring or the rental expense of personal property used in the maintenance, operation and repair of the Project, accountant's fees incurred in the preparation of rent adjustment statements, legal fees, real estate tax consulting fees, personal property taxes on property used in the maintenance and operation of the Project, gross receipts tax imposed by the City of Los Angeles, capital expenditures incurred to effect economies of operation (but only to the extent Landlord reasonably expects to receive a savings effect from such capital expenditures) and capital expenditures required by government regulations, laws, or ordinances, and the cost of all charges for electricity, gas, water and other utilities furnished to the Project, including any taxes thereon; the cost of all charges for fire and extended coverage, liability and all other insurance for the Project carried by Landlord (provided, however, if Landlord acquires additional insurance, then Landlord shall recalculate the Base Year to take into account the cost of such additional insurance as if the same had been an Operating Cost in existence at the time the Base Year was determined); the cost of all building and cleaning supplies and materials; the cost of all charges for cleaning, maintenance and service contracts and other services with independent contractors (including property management fees); and license, permit and inspection fees relating to the Project. In the event, during any calendar year, the Project is less than ninety-five percent (95%) occupied at all times, the Operating Costs shall be adjusted to reflect the operating costs of the Project as though ninety-five percent (95%) were occupied at all times, and the increase or decrease in the sums owed hereunder shall be based upon such operating costs as so adjusted. Operating Costs shall also include all management fees (provided, however, the Base Year Management fees shall be determined based on the percentage described in Subsection (c)(ii)(k) immediately below) and administrative fees. Notwithstanding the foregoing, for purposes of this Lease, Operating Costs and Tax Costs shall not, however, include: (a) Costs, including marketing costs, legal fees, space planner's fees, advertising and promotional expenses, and brokerage fees incurred in connection with the original construction or development, or leasing of the Project, and costs, including permit, license and inspection costs, incurred with respect to the installation of tenant improvements made for new tenants in the Project or incurred in renovating or otherwise improving, decorating, painting or redecorating vacant space for tenants or other occupants of the Project (excluding, however, such costs relating to any common areas of the Project or parking facilities); 5 (b) Depreciation, interest and principal payments on mortgage and other debt costs, if any, penalties and interest, costs of all capital items (except as set forth in (c)(ii) above with respect to economies of operation and governmental compliance), including without limitation, repairs, replacements and alterations, and costs of capital improvements and equipment; (c) Costs for which Landlord is reimbursed by any tenant or occupant of the Project or by insurance by its carrier or any tenant's carrier, and electric power costs for which any tenant directly contracts with the local public service company; (d) Costs associated with the operation of the business of the partnership or entity which constitutes the Landlord, as the same are distinguished from the costs of operation of the Project; (e) The wages and benefits of any employee who does not devote substantially all of his or her employed time to the Project unless such wages and benefits are prorated to reflect time spent on maintaining, operating or managing the Project vis-a-vis time spent on matters unrelated to maintaining, operating or managing the Project; provided, that in no event shall Operating Costs for purposes of this Lease include wages and/or benefits attributable to personnel above the level of Project Manager or Project Engineer (and allocated costs of Landlord's Asset Supervisor); (f) Amount as ground rental for the Project by the Landlord; (g) Except for a Project management fee to the extent allowed pursuant to Subparagraph (c)(ii)(k) below, overhead and profit increment paid to the Landlord or to subsidiaries or affiliates of the Landlord for services in the Project to the extent the same exceeds the costs of such services rendered by unaffiliated third parties on a competitive basis; (h) Any compensation, including wages, benefits and bonuses paid to clerks, attendants or other persons in commercial concessions (except parking) operated by the Landlord; (i) Rentals and other related expenses incurred in leasing air conditioning systems, elevators or other equipment which if purchased the cost of which would be excluded from Operating Costs as a capital cost, except equipment not affixed to the Project which is used in providing janitorial or similar services and, further excepting from this exclusion such equipment rented or leased to remedy or ameliorate an emergency condition in the Project; (j) Costs, other than those incurred in ordinary maintenance and repair, for sculpture, painting, fountains or other objects or art; (k) Fees payable by landlord for management of the Project in excess of five percent (5%) of Landlord's gross rental revenues, adjusted and grossed up to reflect a one hundred percent (100%) occupancy of the Project with all tenants paying 6 rent, including base rent, pass-throughs and parking fees (but excluding the cost of after-hours services or utilities) from the Project for any calendar year or portion thereof; (l) Any costs expressly excluded from Operating Costs elsewhere un this Lease; (m) Rent for any space occupied by Project management personnel to the extent the size or rental rate of such office space exceeds the size or fair market rental value of office space occupied by management personnel of the comparable buildings in the vicinity of the Project, with adjustment where appropriate for the size of the applicable project; (n) Costs arising from Landlord's charitable or political contributions; (o) Costs arising from the gross negligence or wilful misconduct of Landlord or its agents, employees, vendors, contractors, or providers of materials or services, and costs arising from legal proceedings against other tenants or occupants of the Project, or prospective occupants of the Project; (p) Costs of advertising and promotion; (q) Except as set forth in Article 28 below, costs incurred to comply with laws relating to the removal of hazardous material (as defined under applicable law) and asbestos or asbestos containing material (collectively, "Hazardous Material") which was in existence in or on the Project prior to the Lease Commencement Date, and was of such a nature that a federal, state or municipal governmental authority, if it had then had knowledge of the presence of such Hazardous Material, in the state, and under the conditions that then existed in or on the Project, would have then required the removal of such Hazardous Material or other remedial or containment action with respect thereto; and costs incurred to remove, remedy, contain or treat Hazardous Material, which Hazardous Material is brought into or onto the Project after the date hereof by Landlord and is of such a nature, at that time, that a federal, state or municipal governmental authority, if it had then had knowledge of the presence of such Hazardous Material in the state and under the conditions that then exists in the building or on the Project, would have then required the removal of such Hazardous Material or other remedial or containment action with respect thereto; (r) Any bad debt loss, rent loss, or reserves; (s) Costs of seismic inspection and testing required pursuant to statutes, codes or ordinances in effect and as enacted prior to the Lease Commencement Date; and (t) Costs for capital improvements to comply with the requirements of the Americans with Disabilities Act as enacted as of the execution of this Lease. 7 (d) DETERMINATION OF PAYMENT. (i) At any time following the end of calendar year 1996, but not more often than once (excepting therefrom adjusted billings) during each calendar year, commencing with the present calendar year, Landlord shall furnish to Tenant a written statement showing in reasonable detail Landlord's direct costs for the Base Year and for the calendar year preceding the year in which such statement is furnished, and showing the amount, if any, of any increase or decrease in the sums due from Tenant for such calendar year. The failure of Landlord to so furnish said statement shall not constitute a default by Landlord hereunder or a waiver of Landlord's right to any adjustment provided for hereunder. (ii) On the monthly rental payment date which next occurs thirty (30) days after Tenant's receipt of such statement Tenant shall pay to Landlord an amount equal to the sum of (a) the amount shown in said statement as being due from Tenant (less any amounts paid by Tenant on account therefrom during such previous calendar year) and (b) one twelfth (1/12th) of said amount multiplied by the number of rental payment dates having elapsed during the current calendar year, to be applied on account of Tenant's proportionate share of the increase in direct costs for the then present calendar year. The monthly rental payment then due and subsequent monthly rental payments during the then current calendar year shall be increased by one-twelfth (1/12th) of Tenant's Proportionate Share of the increase in direct costs for the preceding calendar year over the Base Year direct costs. In the case of the decrease in direct costs, any overpayment by Tenant shall be credited against the next rent payment falling due. (iii) In the event Tenant disputes Landlord's calculation of any Additional Rent due hereunder for a given Lease year, Tenant shall, only once for each lease year, have the right within one hundred eighty (180) days of receipt of the yearly reconciliation provided to Tenant from Landlord, after reasonable notice and at reasonable times, to inspect Landlord's accounting records at Landlord's accounting office and if, after such inspection, Tenant still disputes such Additional Rent, a certification as to the proper amount shall be made by a nationally recognized accounting firm (who is paid on an hourly or flat-fee basis and not a contingency or commission basis) selected by Tenant and approved by Landlord. Tenant agrees to pay the cost of such certification unless it is subsequently determined that Landlord's original statement was in error to Tenant's disadvantage by more than five percent (5%) of the direct costs. As a condition precedent to its exercise of its rights of dispute aforesaid, Tenant shall timely pay to Landlord all amounts set forth in the statement which Tenant wishes to dispute. No audit may be conducted by Tenant if any other tenant of the Project has notified Landlord of its intention to perform an audit and timely performs the same. If Tenant requests an audit and another tenant of the Project has previously notified Landlord of its intention to audit, then Landlord agrees to furnish to Tenant a copy of the results of such other audit. No audit shall be conducted if Tenant is in default under any provision of this Lease, including, but not limited to, timely payment of any amount due pursuant to the actual statement. Tenant shall deliver to Landlord a copy of the results of an audit within fifteen (15) days of its receipt by Tenant. If an audit indicates an over-billing, Tenant may submit a claim for the over-billed amount to Landlord, detailing the nature of the over-billing, and Landlord shall have sixty (60) 8 days to pay such amount or contest the claim by giving notice thereof to Tenant, detailing the nature of Landlord's contest of Tenant's claims. If Landlord contests the claim, either Landlord or Tenant may submit the claim to arbitration in accordance with the dispute resolution procedures set forth by the American Arbitration Association (or similar successor entity) for such matters. If the arbitration discloses that the actual statement is more than five percent (5%) overstated, Landlord shall, within thirty (30) days of the date of decision by the Arbitrator, pay to Tenant the amount of any over- billing. If the Arbitrator determines that the actual statement is understated, Tenant shall, within thirty (30) days of the date of the Arbitrator's decision pay to Landlord the amount of the underbilling so determined. Except as provided in this Article 3, Tenant shall keep all information gained in connection with any audit confidential. Tenant shall not disclose any information gained in connection with any audit to third parties except to those who must receive the information in order to carry out the purpose of this Article 3, and agree in writing to keep the information confidential. Failure to observe the provision of this confidentiality requirement shall be deemed a material default under the Lease. (iv) Landlord shall have the right, prior to the commencement of each calendar year during the term hereof during which Tenant's obligations may be adjusted under this Article 3, to furnish to Tenant a written estimate showing in reasonable detail Landlord's estimated direct costs for the next following calendar year and the amount of Tenant's proportionate share of increase in direct costs over the Base Year direct costs appropriately prorated on a monthly basis. Thereafter, the monthly rent adjustment payments becoming due hereunder shall be in the amounts set forth in said written estimate. Neither Landlord's failure to deliver nor the late delivery of such estimate shall constitute a default by Landlord hereunder or a waiver of Landlord's right to any rent or other adjustment provided for herein. Within one hundred twenty (120) calendar days following the close of each calendar year during the term hereof, Landlord will furnish to Tenant a written statement (the "Reconciliation") showing in reasonable detail Landlord's actual direct costs for the relevant calendar year, together with a full statement of any adjustments necessary to reconcile any sums paid (or credited) hereunder as an estimated amount of Tenant's Proportionate Share of direct costs during such calendar year with those sums actually payable and due hereunder for such calendar year as set forth in the Reconciliation. If the Reconciliation shows that additional sums are due from Tenant hereunder, Tenant shall pay such sums to Landlord within thirty (30) days of receipt of the Reconciliation. If the Reconciliation shows that a credit is due Tenant, such credit shall be credited against the next sums becoming due from Tenant hereunder. Notwithstanding that the term of this Lease has expired and Tenant has vacated the Premises, Tenant shall pay to Landlord any additional sums due Landlord and Landlord shall rebate to Tenant the amount of any credit due Tenant, as set forth in the Reconciliation for the year in which the Lease term expired. Even though the term of this Lease has expired and Tenant has vacated the Premises, when the final determination is made of Tenant's share of Tax Costs and Operating Costs for the year in which this Lease terminated, Tenant shall pay any increase due over the estimated amounts paid. The terms of this Article 3(d)(iv) shall survive the expiration or earlier termination of the Lease Term (including any and all option periods, if applicable). 9 ARTICLE 4 - Security Deposit - ---------------------------- Tenant has deposited with Landlord the sum set forth in Article 1.F. of the Basic Lease Provisions as security for the full and faithful performance of every provision of this Lease to be performed by Tenant. If Tenant breaches any provision of this Lease, including but not limited to the payment of rent, Landlord may, following the expiration of any grace or notice period, use all or any part of this security deposit for the payment of any rent or any other sums in default, or to compensate Landlord for any other loss or damage which Landlord may suffer by reason of Tenant's default. If any portion of said deposit is so used or applied, Tenant shall, within five (5) days after written demand therefor, deposit cash with Landlord in an amount sufficient to restore the security deposit to amount then required in Article l.F. of the Basic Lease Provisions. Tenant agrees that Landlord shall not be required to keep this security deposit in trust, segregate it or keep it separate from Landlord's general funds but Landlord may commingle the security deposit with its general funds and Tenant shall not be entitled to interest on such deposit. At the expiration of the Lease term, and provided there exists no default, following the expiration of any grace or notice period, by Tenant hereunder, the security deposit or any balance thereof shall be returned to Tenant (or, at Landlord's option, to Tenant's assignee), provided that subsequent to the expiration of this Lease, Landlord may retain from said security deposit (a) any and all amounts permitted by California Civil Code (S)1950.7 or any successor or replacement statute; but not limited to this section. ARTICLE 5 - Holding Over - ------------------------ Should Tenant, without Landlord's written consent, hold over after termination of this Lease, Tenant shall become a tenant from month to month, only upon each and all of the terms herein provided as may be applicable to a month-to-month tenancy, and any such holding over shall not constitute an extension of this Lease. During the first three (3) months of such holding over, Tenant shall pay on the first of each month, Monthly Basic Rental, all direct costs, and all other and additional rent due hereunder at the rate of one hundred twenty-five percent (125%) for such amounts in effect for the last month of the Lease term. After the first three (3) months of such holding-over period, Tenant shall pay Monthly Basic Rental at the rate of one hundred fifty percent (150%) of the Monthly Basic Rental in effect for the last month of the term of this Lease, in addition to, and not in lieu of, all other payments required to be made by Tenant hereunder, including but not limited to, Tenant's Proportionate Share of any increase in direct costs. If Tenant fails to surrender the Premises upon the expiration or termination of this Lease, Tenant hereby indemnifies and agrees to hold Landlord and any real estate broker and agent harmless from all costs, loss, expense or liability, including without limitation, costs, real estate brokers claims and attorney's fees. ARTICLE 6 - Personal Property Taxes - ----------------------------------- Tenant shall pay, prior to delinquency, all taxes assessed against or levied upon fixtures, furnishings, equipment and all other personal property of Tenant located in the Premises. In the event any or all of Tenant's fixtures, furnishings, equipment and other personal property shall be assessed and taxed with property of Landlord, Tenant shall pay to Landlord its share of such taxes within ten (10) days after delivery to Tenant by Landlord of a statement in writing setting forth the amount of such taxes applicable to Tenant's property. Tenant shall pay directly to the 10 party or entity entitled thereto all business license fees, gross receipts taxes and similar taxes and impositions which may from time to time be assessed against or levied upon Tenant, as and when the same become due and before delinquency. Notwithstanding anything to the contrary contained herein, any sums payable by Tenant under this Article 6 shall not be included in the computation of "Tax Costs." ARTICLE 7 - Use - --------------- Tenant shall use and occupy the Premises only for the use set forth in Article 1.G. of the Basic Lease Provisions and shall not use or occupy the Premises or permit the same to be used or occupied for any other purpose without the prior written consent of Landlord, which Landlord consent may be given or withheld in its sole and absolute discretion, and Tenant agrees that it will use the Premises in such a manner so as not to unreasonably interfere with or infringe the rights of other tenants in the Project. Tenant shall, at its sole cost and expense, promptly comply with all laws, statutes, ordinances and governmental regulations or requirements now in force or which may hereafter be in force relating to or affecting (i) the manner of use or occupancy of the Premises or the Project, and (ii) improvements installed or constructed in the Premises by or for the benefit of Tenant. Tenant shall not do or permit to be done anything which would invalidate or increase the cost of any fire and extended coverage insurance policy covering the Project and/or the property located therein and Tenant shall comply with all rules, orders, regulations and requirements of any organization which sets out standards, requirements or recommendations commonly referred to by major fire insurance underwriters. Tenant shall promptly upon demand reimburse Landlord for any additional premium charges for any such insurance policy assessed or increased by reason of Tenant's failure to comply with the provisions of this Article. ARTICLE 8 - Condition of Premises - --------------------------------- Tenant hereby agrees that the Premises shall be taken "as is", and Tenant hereby agrees and warrants that it has inspected the condition of the visible portion of the Premises and the suitability of same for Tenant's purposes, and Tenant does hereby waive and disclaim any objection to, cause of action based upon, or claim that its obligations hereunder should be reduced or limited because of the condition of the visible portions of the Premises or the Project or the suitability of same for Tenant's purposes. The foregoing sentence notwithstanding, Landlord agrees to bear the cost for any latent structural defects in the Premises which are discovered by Tenant (and written notice is given to Landlord) during the first year of the Lease term only. Except to the extent set forth in this Lease, Tenant acknowledges that neither Landlord nor any agent nor any employee of Landlord has made any representations or warranty with respect to the Premises or the Project or with respect to the suitability of either for the conduct of Tenant's business. The taking of possession of the Premises by Tenant shall conclusively establish that the Premises and the Project were at such time in satisfactory condition, subject to punch list items if applicable. Tenant hereby waives Sections 1941 and 1942 of the Civil Code of California or any successor provision of law. Landlord reserves the right from time to time: (i) to install, use, maintain, repair, replace and relocate for service to the Premises and/or other parts of the Project pipes, ducts, conduits, wires, appurtenant fixtures, and mechanical systems, wherever located in the Premises or the 11 Project, (ii) to alter, close or relocate any facility in the Premises or the Common Areas or otherwise conduct any of the above activities for the purpose of complying with a general plan for fire/life safety for the Project or otherwise and (iii) to comply with any federal, state or local law, rule or order with respect thereto or the regulation thereof not currently in effect. Landlord shall attempt to perform any such work with the least inconvenience to Tenant as possible (including the performance of same during after hours), but in no event shall Tenant be permitted to withhold or reduce Basic Rent or other charges due hereunder as a result of same or otherwise make claim against Landlord for interruption or interference with Tenant's business and/or operations or for any other reason whatsoever unless the work materially interferes with the operation of Tenant's business. Landlord agrees, at its sole cost and expense, to thoroughly clean the Premises immediately prior to Tenant's occupancy and immediately after Tenant has moved in and "set-up" the Premises. ARTICLE 9 - Repairs and Alterations - ----------------------------------- Tenant shall keep the Premises in good condition and repair, except for damage caused by ordinary wear and tear, or caused by Landlord, its agents, representatives, employees or contractors or otherwise beyond the reasonable control of Tenant (provided, however, such exclusion shall not exclude damage caused by Tenant or Tenant's employees, invitees, agents and the like). All damage or injury to the Premises or the Project caused by the act or negligence of Tenant, its employees, agents or visitors, guests, invitees or licensees or by the use of the Premises shall be promptly repaired by Tenant, at its sole cost and expense (except to the extent Landlord has responsibility for same under this Lease), to the satisfaction of Landlord; provided, however, that for damage to the Project, Landlord shall have the right (but not the obligation) to select the contractor and oversee all such repairs. Landlord may make any repairs which are not promptly made by Tenant after Tenant's receipt of written notice and the reasonable opportunity of Tenant to make said repair within five (5) business days from receipt of said written notice, and charge Tenant for the cost thereof, which cost shall be paid by Tenant within five (5) days from invoice from Landlord. Tenant shall be responsible for the design and function of all nonstandard improvements of the Premises, whether or not installed by Landlord at Tenant's request. Tenant waives all rights to make repairs at the expense of Landlord, or to deduct the cost thereof from the rent. Tenant shall make no alterations, changes or additions in or to the Premises without Landlord's prior written consent, and then only by contractors or mechanics approved by Landlord in writing and upon the approval by Landlord in writing of fully detailed and dimensioned plans and specifications pertaining to the work in question, to be prepared and submitted by Tenant at its sole cost and expense. Tenant shall at its sole cost and expense obtain all necessary approvals and permits pertaining to any work approved by Landlord. If Landlord, in approving any work, specifies a reasonable commencement date therefor, Tenant shall not commence any work prior to such date. Tenant hereby indemnifies and agrees to hold Landlord free and harmless from all liens and claims of lien, and all other liability, claims and demands arising out of any work done or material supplied to the Premises by or at the request of Tenant. If permitted alterations, changes, or additions are made, they shall be made at Tenant's sole cost and expense and shall be and become the property of Landlord, except that Landlord may, by written notice to Tenant given at the time of approval of such work, require Tenant at Tenant's expense to remove all partitions, counters, railings and the like installed by 12 Tenant (excluding the Tenant Improvements as defined below), and to repair any damages to the Premises caused by such removal. With regard to repairs, alterations or any other work (excluding the Tenant Improvements) arising from or related to this Article 9 which Tenant requests Landlord to complete, Landlord shall be entitled to receive an administrative/supervision fee of fifteen percent (15%) of the total cost of all (i) work performed; (ii) materials, plans and drawings furnished; and (iii) all other costs and expenses related to such repairs, alterations or other work. On a one-time only basis in accordance with that certain space plan dated December 13, 1995, prepared by Pace Compumetrics and agreed to by Landlord and Tenant, Landlord shall construct the tenant improvements to the Premises set forth on such plan ("Tenant Improvements"). Landlord shall provide on behalf of, or to the account of, Tenant a tenant improvement allowance of Ten Dollars and Fifty Cents ($10.50) for each useable square foot of space in the Premises ("Tenant Improvement Allowance"), for a total of $62,055.00. The Tenant Improvement Allowance shall be used for the construction of the Tenant Improvements, including space planning (but excluding preliminary space planning which shall be at Landlord's cost and expense), working drawings, mechanical, electrical and plumbing drawings, architect fees, contractors, permits, construction supervision fees, and "soft construction costs", including built-in furniture, a telephone and data cabling system, and moving costs for professional movers. Landlord shall receive a five percent (5%) construction supervision fee in connection with the construction of the Tenant Improvements, which fee shall be a part of the Tenant Improvement Allowance. Except as otherwise provided herein, in no event shall Landlord be obligated to make disbursements or the Tenant Improvements in a total amount which exceeds the Tenant Improvement Allowance ("Excess Costs"), provided, however, that Landlord shall pay up to Three Dollars ($3.00) for each usable square foot of space in the Premises towards the Excess Costs and Tenant agrees to pay an additional amount above Landlord's agreed upon limit of Three Dollars ($3.00) a usable square foot needed to complete the Tenant Improvements prior to Landlord beginning construction of the Tenant Improvements; provided, further, however, that if, at Tenant's option, Landlord shall initially pay for up to Three Dollars ($3.00) a usable square foot of such Excess Costs, then Tenant shall pay as Additional Rent due under this Lease an amount equal to Two Cents ($.02) a month for each rentable square foot of space in the Premises for each One Dollar ($1.00) of Excess Costs paid by Landlord on Tenant's behalf. Landlord's payment of any Excess Costs shall be referred to herein as the "Loan". Tenant shall have the right to have the cost of the Tenant Improvements competitively bid by one (1) contractor of Tenant's choosing who is also reasonably acceptable by Landlord and approved, or approvable, to do work in the Project. Landlord shall oversee the competitive bid process and shall be the party to reconcile any such competitive bid. After reconciliation, Landlord and Tenant shall accept the most reasonable lowest bid. In the event Tenant does not use the entire Tenant Improvement Allowance for the initial Tenant Improvements, said remaining amount shall be credited to Tenant only for future tenant improvements agreed to by Landlord and Tenant during the Lease term. As part of, or in addition to, the Tenant Improvements to be constructed by Landlord, Tenant shall have the right (but not the obligation) to install at Tenant's sole cost and expense, subject to the Tenant Improvement Allowance up to two and one-half (2-1/2) tons of plenummounted twenty-four (24) hour HVAC unit(s) within the Premises. Notwithstanding Article 11 13 below, Tenant shall also pay for any required metering system for such unit(s) and shall pay for any and all utility charges to operate the unit(s). Notwithstanding anything to the contrary contained in this Lease, the contractor(s) and subcontractors constructing the Tenant Improvements shall receive free on-site parking during construction of the Tenant Improvements, and Tenant shall not be charged for the use of freight elevators, loading docks, utilities or temporary HVAC during the construction of the Tenant Improvements. ARTICLE 10 - Liens - ------------------ Tenant shall keep the Premises and the Project free from any mechanics' liens, vendors liens or any other liens arising out of any work performed, materials furnished or obligations incurred by Tenant, and agrees to defend, indemnify and hold harmless Landlord from and against any such lien or claim or action thereon, together with costs of suit and reasonable attorneys' fees incurred by Landlord in connection with any such claim or action. Before commencing any work of alteration, addition or improvement (other than the Tenant Improvements) to the Premises, Tenant shall give Landlord at least ten (10) business days' written notice of the proposed commencement of such work (to afford Landlord an opportunity to post appropriate notices of non- responsibility). In the event that there shall be recorded against the Premises or the Project or the property of which the Premises is a part any claim or lien arising out of any such work performed, materials furnished or obligations incurred by Tenant and such claim or lien shall not be removed or discharged within ten (10) days of filing, Landlord shall have the right but not the obligation to pay and discharge said lien without regard to whether such lien shall be lawful or correct or to require that Tenant deposit with Landlord in cash, lawful money of the United States, one hundred fifty percent (150%) of the amount of such claim, which sum may be retained by Landlord until such claim shall have been removed of record or until judgment shall have been rendered on such claim and such judgment shall have become final, at which time Landlord shall have the right to apply such deposit in discharge of the judgment on said claim and any costs, including attorneys' fees incurred by Landlord, and shall remit the balance thereof to Tenant. ARTICLE 11 - Project Services - ----------------------------- (a) Landlord agrees to furnish to the Premises, at a cost to be included in Operating Costs, from 8:00 a.m. to 6:00 p.m. Mondays through Fridays and 9:00 a.m. to 1:00 p.m. on Saturdays, excepting local and national holidays, air conditioning and heat, electric current for normal lighting and fractional horsepower for office machines, elevator service and water on the same floor as the Premises, for lavatory and drinking purposes, all in such reasonable quantities as in the judgment of Landlord is reasonably necessary for the comfortable occupancy of the Premises and otherwise consistent with the amounts furnished by landlords of similar office buildings in West Los Angeles. Janitorial and maintenance services shall be furnished five (5) days a week, excepting local and national holidays. Tenant shall comply with all non-discriminatory rules and regulations which Landlord may reasonably establish for the proper functioning and protection of the common area air conditioning, heating, elevator, electrical intrabuilding network cable and plumbing systems. Landlord shall enforce said rules and regulations on a non-discriminatory basis. Landlord shall not be liable for, and there shall be no 14 rent abatement as a result of, any stoppage, reduction or interruption of any such services caused by governmental rules, regulations or ordinances, riot, strike, labor disputes, breakdowns, accidents, necessary repairs or other cause. Except as specifically provided in this Article 11, Tenant agrees to pay for all utilities and other services utilized by Tenant for all overtime or additional building services furnished to Tenant not uniformly furnished to all tenants of the Project at Landlord's actual expense. (b) Tenant will not, without the prior written consent of Landlord, use any apparatus or device in the Premises, including without limitation electronic data processing machines, computer or video equipment or other machines or equipment, using current in excess of 110 volts, which will in any way increase the amount of electricity or water usually furnished or supplied for use of the Premises as general office space; nor connect any apparatus, machine or device with water pipes or electric current (except through existing electrical outlets in the Premises), for the purpose of using electric current or water. Nothing contained in this subsection (b) is intended to restrict Tenant from using equipment and other machines which are deemed to be standard in first-class office buildings in West Los Angeles. (c) If Tenant shall require electric current in excess of that which Landlord is obligated to furnish under Article 11(a) and (b) above, Tenant shall first obtain the written consent of Landlord, which Landlord may refuse in its reasonable discretion, to the use thereof and Landlord may cause an electric current meter to be installed in the Premises to measure the amount of electric current consumed for any such other use. The cost of any such meter and of installation, maintenance and repair thereof shall be paid for by Tenant so long as such consumption by Tenant is in excess of that uniformly furnished to all tenants at Landlord's expense, and Tenant agrees to pay to Landlord, promptly upon demand therefor by Landlord, for all such excess electric current consumed by any such use as shown by said meter at the rates charged for such service by the City in which the Project is located or the local Public Utility, as the case may be, furnishing the same, plus any additional expense incurred by Landlord in keeping account of the electric current so consumed. (d) If any lights, machines or equipment (including but not limited to computers) are used by Tenant in the Premises in amounts beyond the standard found in first-class office buildings in West Los Angeles and which materially affect the temperature otherwise maintained by the air conditioning system, or generate substantially more heat in the Premises than would be generated by the building standard lights and usual fractional horsepower office equipment, Landlord shall have the right to install any machinery and equipment which Landlord reasonably deems necessary to restore temperature balance, including but not limited to modifications to the standard air conditioning equipment, and the cost thereof, including the cost of installation and any additional cost of operation and maintenance occasioned thereby, shall be paid by Tenant to Landlord upon demand by Landlord. Landlord shall not be liable under any circumstances for loss of or injury to properly, however occurring, through or in connection with or incidental to failure to furnish any of the foregoing, [unless such failure was within Landlord's actual control to prevent.] (e) If Tenant requires heating, ventilation and/or air conditioning during times other than the times provided in Article 11(a) above, Tenant shall give Landlord such advance notice as Landlord shall reasonably require and shall pay Landlord's actual cost for the use of such 15 equipment with a two (2) hour minimum, provided, however, the cost for the use of such equipment shall not exceed, during the Lease tenn, Sixty-Five Dollars ($65.00) for each hour. (f) Landlord, at its sole cost and expense, shall hire a security service company for the Project, which company shall also provide after-hours escort service to the Project's parking structure for Tenant's employees and visitors. Landlord makes no representations as to the type and level of security or quality of the company's employees. Tenant specifically agrees that the security is for the Project and is not a full-time service to guard the parking structure or the Premises. (g) In the event that Tenant is prevented from using the Premises or any portion thereof as a result of any failure of Landlord to provide utilities, services or access to the Premises or the Project, or there exists a hazardous material in the Premises (not brought into the Premises by Tenant or any party under Tenant's control, including employees, invitees, customers and the like) which by law prevents Tenant from using the Premises, then Tenant shall promptly give Landlord notice thereof ("Tenant's Notice"). Notwithstanding anything to the contrary contained in this Lease, in the event that Tenant is prevented from using the Premises or any portion thereof as a result of such a failure for a period of five (5) consecutive business days following the date Landlord receives Tenant's Notice ("Notice Date"), all of Tenant's rents (and escalations thereto) shall be abated or reduced, as the case may be, in the proportion that the rentable area of the portion of the Premises that the Tenant is prevented from using bears to the total rentable area of the Premises, during the period after the Notice Date that Tenant is prevented from conducting its business from the Premises or portion of the Premises. However, in the event that Tenant is prevented from conducting its business in any portion of the Premises and the remaining portion of the Premises is not sufficient to allow Tenant to efficiently conduct its business therein, and if Tenant does not conduct its business from such remaining portion, then all of the rents for the entire Premises shall be abated during said period. Provided, however, that if Tenant is prevented from using the Premises and Tenant reoccupies and conducts its business from any portion of the Premises during such period, the rents allocable to such reoccupied portion, based upon the proportion which the rentable area of such reoccupied portion of the Premises bears to the total rentable area of the Premises, shall be payable by Tenant from the date such business operation commences. ARTICLE 12 - Rights of Landlord - ------------------------------- Landlord and its agents shall have the right to enter the Premises at all reasonable times for the purpose of cleaning the Premises, examining or inspecting the same, serving or posting and keeping posted thereon notices as provided by law, or which Landlord deems necessary for the protection of Landlord or the Property, showing the same to prospective tenants or purchasers of the Project, in the case of an emergency, and for making such alterations, repairs, improvements or additions to the Premises or to the Project as Landlord may deem necessary or desirable. If Tenant shall not be personally present to open and permit an entry into the Premises at any time when such an entry by Landlord is necessary or permitted hereunder, Landlord may enter by means of a master key or may enter forcibly, only in the case of an emergency, without liability to Tenant except for any failure to exercise due care for Tenant's property, and without affecting this Lease. Any such entry by Landlord shall be conducted at such times as is 16 reasonably necessary under the circumstances to cause the least amount of disruption to Tenant's business. ARTICLE 13 - Indemnity; Exemption of Landlord from Liability - ------------------------------------------------------------ (a) INDEMNITY. Tenant shall indemnify, defend and hold Landlord harmless from any and all claims arising from Tenant's use of the Premises or the Project (including Tenant's Signage rights set forth in Article 34) or from the conduct of its business or from any activity, work or thing which may be permitted or suffered by Tenant in or about the Premises or the Project and shall further indemnify, defend and hold Landlord harmless from and against any and all claims arising from any breach or default in the performance of any obligation on Tenant's part to be performed under this Lease or arising from any negligence of Tenant or any of its agents, contractors, employees or invitees, patrons or customers in or about the Project and from any and all costs, attorneys' fees, expenses and liabilities incurred in the defense of any claim or any action or proceeding brought thereon, including negotiations in connection therewith. Tenant hereby assumes all risk of damage to property or injury to persons in or about the Premises from any cause, and Tenant hereby waives all claims in respect thereof against Landlord, excepting where the damage is caused by the gross negligence or willful misconduct of Landlord and is not covered by Tenant's insurance. (b) EXEMPTION OF LANDLORD FROM LIABILITY. Landlord shall not be liable for injury to Tenant's business, or loss of income therefrom, or for damage that may be sustained by the person, goods, wares, merchandise or property of Tenant, its employees, invitees, customers, agents, or contractors, or any other person in, on or about the Premises directly or indirectly caused by or resulting from fire, steam, electricity, gas, water, or rain which may leak or flow from or into any part of the Premises, or from the breakage, leakage, obstruction or other defects of the pipes, sprinklers, wires, appliances,. plumbing, air conditioning, light fixtures, or mechanical or electrical systems or from intrabuilding network cable, whether such damage or injury results from conditions arising upon the Premises or upon other portions of the Project or from other sources or places and regardless of whether the cause of such damage or injury or the means or repairing the same is inaccessible to Tenant, except in connection with damage or injury resulting from the gross negligence or willful misconduct of Landlord, or its authorized agents. Landlord shall not be liable to Tenant for any damages arising from any act or neglect of any other tenant of the building. ARTICLE 14 - Insurance - ---------------------- (a) TENANT'S INSURANCE. Tenant, shall at all times during the term of this Lease, and at its own cost and expense, procure and continue in force the following insurance coverage: (i) Commercial General Liability Insurance with a combined single limit for bodily injury and property damages of not less than One Million Dollars ($1,000,000) per occurrence and Two Million Dollars ($2,000,000) in the annual aggregate, including products liability coverage if applicable, covering the insuring provisions of this Lease and the performance of Tenant of the indemnity and exemption of Landlord from liability agreements set forth in Article 13 hereof; (ii) a policy of standard fire, extended coverage and special extended coverage insurance (all risks), including a vandalism and malicious mischief endorsement, sprinkler leakage coverage and earthquake sprinkler leakage where sprinklers are provided in an amount equal to the full 17 replacement value new without deduction for depreciation of all equipment, fixtures and furniture installed by or at the expense of Tenant; and (iii) insurance for all telecommunications equipment and intrabuilding network for which Tenant is responsible. Tenant shall carry and maintain during the entire Lease term (including any option periods, if applicable), at Tenant's sole cost and expense, increased amounts of the insurance required to be carried by Tenant pursuant to this Article 14 and such other reasonable types of insurance coverage and in such reasonable amounts covering the Premises and Tenant's operations therein, as may be reasonably required by Landlord, so long as such requirement is consistent with the requirements of other landlords of first-class office buildings in West Los Angeles, or required by Landlord's lender. (b) FORM OF POLICIES. The aforementioned minimum limits of policies and Tenant's procurement and maintenance thereof shall in no event limit the liability of Tenant hereunder. Such insurance shall name Landlord and such other persons or firms with insurable interests, as Landlord specifies from time to time, as additional insureds' with an appropriate endorsement to the policy(s) and shall be with companies having a rating of not less than A-VIII in Best's Insurance Guide. Tenant shall furnish to Landlord, from the insurance companies, or cause the insurance companies to furnish, certificates of coverage. No such policy shall be cancelable or subject to reduction of coverage or other modification or cancellation except after thirty (30) days prior written notice to Landlord by the insurer. All such policies shall be endorsed to agree that Tenant's policy is primary and that any insurance covered by Landlord is excess and not contributing with any Tenant insurance requirement hereunder. Tenant shall, at least twenty (20) days prior to the expiration of such policies, furnish Landlord with renewals or binders. Tenant agrees that if Tenant does not take out and maintain such insurance or furnish Landlord with renewals or binders, Landlord may (but shall not be required to) procure said insurance on Tenant's behalf and charge Tenant the cost thereof, which amount shall be payable by Tenant upon demand with interest from the date such sums are extended. Tenant shall have the right to provide such insurance coverage, pursuant to blanket policies obtained by Tenant, provided such blanket policies expressly afford coverage to the Premises and to Tenant as required by this Lease. (c) LANDLORD'S INSURANCE. Landlord shall, as a cost to be included in Operating Costs, procure and maintain at all times during the term of this Lease, a policy or policies of insurance covering loss or damage to the Project (including the Tenant Improvements, but excluding Tenant's personal property, equipment, fixtures, and the like) in the amount of the full replacement costs without deduction for depreciation thereof (exclusive of Tenant's trade fixtures, inventory, personal property and equipment); providing protection against all perils included within the classification of fire and extended coverage, vandalism coverage and malicious mischief, sprinkler leakage, water damage, and special extended coverage on building. Additionally, Landlord may (but shall not be required to) carry: (i) Bodily Injury and Property Damage Liability Insurance and/or Excess Liability Coverage Insurance; and (ii) Earthquake and/or Flood Damage Insurance; and (iii) Rental Income Insurance at its election or if required by its lender from time to time during the term hereof, in such amounts and with such limits as Landlord or its lender may deem appropriate. The costs of such insurance shall be included in Operating Costs. (d) WAIVER OF SUBROGATION. Tenant releases Landlord (and its respective authorized representatives) and Landlord releases Tenant (and its respective authorized representatives) from 18 any claims for damage to any person or the Premises, and to the fixtures, personal property, improvements, and alterations of either Landlord or Tenant, in or on the Premises, and the Project, that are caused by or result from risks insured against under any insurance policies carried by either Tenant or Landlord and in force at the time of any such damage. (e) COMPLIANCE WITH LAW. Tenant agrees that it will not, at any time, during the term of this Lease, carry any stock of goods or do anything in or about the Premises that will in any way tend to increase the insurance rates upon the Project. Tenant agrees to pay Landlord forthwith upon demand the amount of any increase in premiums for insurance against loss by fire that may be charged during the term of this Lease on the amount of insurance to be carried by Landlord on the Project resulting from the foregoing, or from Tenant doing any act in or about said Premises that does so increase the insurance rates, whether or not Landlord shall have consented to such act on the part of Tenant. If Tenant installs upon the Premises any electrical equipment which constitutes an overload of electrical lines of the Premises, Tenant shall at its own cost and expense in accordance with all other Lease provisions, and subject to the provisions of Article 9, 10 and 11, hereof, make whatever changes are necessary to comply with requirements of the insurance underwriters and any governmental authority having jurisdiction thereover, but nothing herein contained shall be deemed to constitute Landlord's consent to such overloading. Tenant shall, at its own expense, comply with all requirements of the insurance authority having jurisdiction over the Project necessary for the maintenance of reasonable fire and extended coverage insurance for the Premises, including without limitation thereto, the installation of fire extinguishers or an automatic dry chemical extinguishing system. ARTICLE 15 - Assignment and Subletting - -------------------------------------- Tenant shall have no power to, either voluntarily, involuntarily, by operation of law or otherwise, sell, assign, transfer or hypothecate this Lease, or sublet the Premises or any part thereof, or permit the Premises or any part thereof to be used or occupied by anyone other than Tenant or Tenant's employees without the prior written consent of Landlord which consent shall not be unreasonably withheld. If Tenant is a corporation, unincorporated association or partnership, the sale, assignment, transfer or hypothecation of any class of stock or other ownership interest in such corporation, association or partnership in excess of twenty-five percent (25%) in the aggregate ("Internal Transfer") shall meet the transfer provisions of Subsection (g) below, but Tenant shall not be required to pay any of the review, processing or attorney's fees set forth below. The foregoing notwithstanding, Landlord shall have no right of consent or approval, of any kind, in connection with the issuance, sale, transfer, assignment, or hypothecation of securities and/or assets by Tenant for which filings are required to be made with federal or state agencies, including by way of illustration, but not limitation, the Securities and Exchange Commission or the California Commissioner of Corporations. Subject to the foregoing, Tenant may transfer its interest pursuant to this Lease only upon the following express conditions: (a) That the proposed transferee shall be subject to the prior written consent of Landlord, which consent will not be unreasonably withheld (it being agreed that if Landlord does not respond within ten (10) business days from a written request for sublease or assignment, such refusal to respond shall be deemed an approval by Landlord to such assignment or sublease) but, without limiting the generality of the foregoing, it shall be reasonable for Landlord to deny such consent if: 19 (i) The use to be made of the Premises by the proposed transferee is (a) not generally consistent with the character and nature of all other tenancies in the Project, or (b) a use which conflicts with any so-called "exclusive" then in favor of, or for any use which is the same as that stated in any percentage Lease to, another tenant of the Project or any of Landlord's then buildings which are in the same complex as the Project, or (c) a use which would be prohibited by any other portion of this Lease (including but not limited to any Rules and Regulations then in effect); or (ii) The financial responsibility of the proposed transferee is not reasonably satisfactory to Landlord or in any event not at least equal to those which were possessed by Tenant as of the date of execution of this Lease; (b) That Tenant shall pay to Landlord Landlord's then standard processing fee, review fee and attorneys' fees up to the sum of One Thousand Dollars ($1,000.00); (c) That the proposed transferee shall execute an agreement pursuant to which it shall agree to perform faithfully and be bound by all of the terms, covenants, conditions, provisions and agreements of this Lease (provided, however, this Subparagraph (c) shall not be deemed to apply to the economic business terms of the transfer between Tenant and such transferee); (d) That an executed duplicate original of said assignment and assumption agreement or other transfer on Landlord's then standard form, shall be delivered to Landlord within five days after the execution thereof, and that such transfer shall not be binding upon Landlord until the delivery thereof to Landlord and the execution and delivery of Landlord's consent thereto. It shall be a condition to Landlord's consent to any subleasing, assignment or other transfer of part or all of Tenant's interest in the Premises (hereinafter referred to as a "Transfer") that (i) upon Landlord's consent to any Transfer, Tenant shall pay and continue to pay one-half (1/2) of any "Transfer Premium" (defined below), received by Tenant from the transferee; provided, however, Tenant shall have the right to sublease up to twenty percent (20%) of the Premises to individual users without sharing of the Transfer Premium; (ii) any sublessee of part or all of Tenant's interest in the Premises shall agree that in the event Landlord gives such sublessee notice that Tenant is in default under this Lease following the expiration of any grace or cure period, such sublessee shall thereafter make all sublease or other payments directly to Landlord, which will be received by Landlord without any liability whether to honor the sublease or otherwise (except to credit such payments against sums due under this Lease), and any sublessee shall agree to attorn to Landlord or its successors and assigns at their request should this Lease be terminated for any reason, except that in no event shall Landlord or its successors or assigns be obligated to accept such attornment; (iii) any such Transfer and consent shall be effected on reasonable forms, supplied or approved by Landlord and/or its legal counsel; and (iv) Landlord may require that Tenant not then be in default following the expiration of any grace or cure period hereunder in any respect. "Transfer Premium" shall mean all rent, additional rent or other consideration payable by a transferee in connection with a Transfer in excess of the rent and Additional Rent payable by Tenant under this Lease during the term of the Transfer and if such Transfer is less than all of the Premises, the Transfer Premium shall be calculated on a rentable square foot basis. The Transfer Premium shall be calculated after deducting the reasonable expenses incurred by Tenant for any reasonable Tenant improvements (reasonably approved by Landlord), legal fees, rent concessions and brokerage commissions in connection with the 20 Transfer. "Transfer Premium" shall also include, but not be limited to, key money, bonus money or other cash consideration paid by a transferee to Tenant in connection with such Transfer, and any payment in excess of fair market value for services rendered by Tenant to transferee or for assets, fixtures, inventory, equipment, or furniture transferred by Tenant to transferee in connection with such Transfer. If Landlord consents to a requested assignment or sublease, Tenant hereby agrees that (i) it shall thereupon be deemed, automatically and irrevocably to have assigned to Landlord as additional security for the performance and observance of Tenant's obligations and covenants under this Lease, all rent or other sums received or to be received by Tenant in connection therewith and (ii) Landlord as assignee and as attorney-in- fact of Tenant, or a receiver for Tenant whether or not appointed on Landlord's application, may collect such rent or other sums and apply the same toward Tenant's obligations under this Lease. Notwithstanding the foregoing, Tenant shall have the right to collect such rent and other sums unless and until Tenant commits any act of default hereunder following the expiration of any grace or cure period. Tenant hereby agrees and acknowledges that the above conditions imposed upon the granting of Landlord's consent to any proposed Transfer by Tenant are reasonable. Any sale assignment, hypothecation, transfer or subletting of this Lease which is not in compliance with the provisions of this Article 15 shall be void. In no event shall the consent by Landlord to an assignment or subletting be construed as relieving Tenant, any assignee, or sublessee from obtaining the express written consent of Landlord to any further assignment or subletting, or as releasing Tenant from any liability or obligation hereunder whether or not then accrued and Tenant shall continue to be fully liable therefor. No collection or acceptance of rent by Landlord from any person other than Tenant shall be deemed a waiver of any provision of this Article 15 on the acceptance of any assignee or subtenant hereunder, or a release of Tenant (or of any successor of Tenant or any subtenant holding theretofore or thereafter accruing). Notwithstanding anything to the contrary in this Lease, if Tenant or any proposed transferee claims that Landlord has unreasonably withheld or delayed its consent under this Article 15 or otherwise has breached or acted unreasonably under this Article 15, their sole remedies shall be a declaratory judgment and an injunction for the relief sought without any monetary damages, and Tenant hereby waives all other remedies, including, without limitation, any right at law or equity to terminate this Lease, on its own behalf and, to the extent permitted under all applicable laws, on behalf of the proposed transferee; (e) Tenant shall not enter into any sublease or assignment in which any of the following is applicable: (i) The determination of the amount of rent is expressed in whole or in part as a percentage of the income or profits derived by the tenant or subtenant or assignee from the space Leased (other than an amount based on a fixed percentage or percentages of gross receipts or gross sales); (f) In any sublease or assignment in which the amount of rent is determined in whole or in part by reference to the gross sales or receipts of the subtenant or assignee such sublease or assignment shall contain a provision which prohibits subleasing or assigning or if subleasing or assigning is permitted it shall prohibit the tenant or any successor in interest from subleasing all or any portion of its Leasehold interest for an amount of rent determined in whole or in part from the income or profits derived by any person from such interest (other than an amount based in a fixed percentage or percentages of receipts or sales); provided, however, Tenant shall have 21 the right to sublease up to twenty percent (20%) of the Premises to individual users without sharing of the Transfer Premium. (g) Notwithstanding anything to the contrary contained in this Article 15, (i) an Internal Transfer, (ii) an assignment or subletting of all or a portion of the Premises to an affiliate of Tenant (an entity which is controlled by, controls, or is under common control with, Tenant) ("Permitted Transferees"), or a subletting or assignment of all of the premises to a purchaser of all or substantially all of the assets of Tenant or a Permitted Transferee, or (iii) a transfer, by law or otherwise, in connection with the merger, consolidation or other corporate reorganization of Tenant or a Permitted Transferee, shall not be deemed a Transfer requiring payment of a Transfer Premium under this Article 15, but Tenant shall still be required to obtain Landlord's written consent and approval of such transfer; provided, however, Landlord shall only be able to disapprove of such transfer under 15(a)(i) above, or if the transfer would result in either Tenant or the Permitted Transferee having a net worth less than that of Tenant on the date this Lease is executed (or in Landlord's reasonable business discretion the Permitted Transferee does not have the financial ability to meet the economic terms and conditions of the Lease); and further provided that such assignment or sublease is not a subterfuge by Tenant to avoid its obligations under this Lease. "Control" as used in this Section 15(g) shall mean the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person or entity, or ownership of any sort, whether through the ownership of voting securities, by contract or otherwise. ARTICLE 16 - Damage Or Destruction - ---------------------------------- If the Project is damaged by fire or other insured casualty and the insurance proceeds have been made available therefor by the holder or holders of any mortgages or deeds of trust covering the Premises or the Project, the damage shall be repaired by and at the expense of the Landlord to the extent such insurance proceeds are available therefor and provided such repairs can, in Landlord's sole opinion, be completed within one hundred eighty (180) days after the occurrence of such damage becomes known to Landlord without the payment of overtime or other premiums, and until such repairs are completed rent shall be abated in proportion to the part of the Premises which is unusable by Tenant in the conduct of its business, provided that if the damaged portion renders the entire Premises unusable by Tenant, then rent shall be abated for the entire Premises (but there shall be no abatement of rent by reason of any portion of the Premises being unusable for a period equal to one (1) day or less). If the damage is due to the fault or neglect of Tenant, its employees, guests, invitees and the like, there shall be no abatement of rent, and Tenant agrees to make a claim, in an expeditious manner, under its insurance policies for the cost of such damage or destruction, and to assign any such insurance proceeds from its insurance policies to Landlord. If repairs cannot, in Landlord's opinion, be completed within one hundred eighty (180) days, Landlord may, at its option, make them in a reasonable time and in such event this Lease shall continue in effect and the rent shall be abated, if at all, in the manner provided in this Article 16; provided, however, that if repairs cannot be completed within one hundred eighty (180) days from commencement of construction, Tenant shall have the right after the expiration of such one hundred eighty (180) days to terminate this Lease upon thirty (30) days' written notice to Landlord. Tenant's failure to so notify Landlord within such thirty (30) day period shall be deemed to constitute Tenant's waiver of its right to terminate this Lease. In addition, Landlord may elect not to rebuild and/or restore the Project, and instead terminate this Lease, by 22 notifying Tenant in writing of such termination within thirty (30) days after Landlord receives notice of the date of damage, such notice to include a termination date giving Tenant sixty (60) days to vacate the Premises, but Landlord may so elect only if the Project shall be damaged by fire or other casualty or cause, whether or not the Premises are affected, and the damage is not fully covered, except for deductible amounts, by Landlord's insurance policies. A total destruction of the Project shall automatically terminate this Lease. Except as provided in this Article, there shall be no abatement of rent and no liability of Landlord by reason of any injury to or interference with Tenant's business or property arising from such damage or destruction or the making of any repairs, alterations or improvements in or to any portion of the Project or the Premises or in or to fixtures, appurtenances and equipment therein. Tenant understands that Landlord will not carry insurance of any kind to Tenant's furniture, furnishings, fixtures or equipment, and that Landlord shall not be obligated to repair any damage thereto or replace the same. With respect to any damage which Landlord is obligated to repair or elects to repair, Tenant, as a material inducement to Landlord entering into this Lease, irrevocably waives and releases its rights under the provisions of Sections 1932 and 1933 of the California Civil Code. ARTICLE 17 - Subordination - -------------------------- This Lease is subject and subordinate to all ground or underlying Leases, mortgages and deeds of trust which affect the property or the Project, including all renewals, modifications, consolidations, replacements and extensions thereof; provided, however, if the lessor under any such lease or the holder or holders of any such mortgage or deed of trust shall advise Landlord that they desire or require this Lease to be prior and superior thereto, upon written request of Landlord to Tenant, Tenant agrees to promptly execute, acknowledge and deliver any and all documents or instruments which Landlord or such lessor, holder or holders deem necessary or desirable for purposes thereof. Landlord shall have the right to cause this Lease to be and become and remain subject and subordinate to any and all ground or underlying leases, mortgages or deeds of trust which may hereafter be executed covering the Premises, the Project or the property or any renewals, modifications, consolidations, replacements or extensions thereof, for the full amount of all advances made or to be made thereunder and without regard to the time or character of such advances, together with interest thereon and subject to all the terms and provisions thereof, provided, however, that Landlord obtains from the lender or other party in question a written undertaking in favor of Tenant to the effect that such lender or other party will not disturb Tenant's right of possession under this Lease if Tenant is not then or thereafter in breach following the expiration of any grace or cure period of any covenant or provision of this Lease; and Tenant agrees, within fifteen (15) days after Landlord's written request therefor, to execute, acknowledge and deliver upon request any and all documents or instruments requested by Landlord or necessary or proper to assure the subordination of this Lease to any such mortgages, deed of trust, or leasehold estates. Tenant agrees not to assert against Landlord and hereby expressly waives any claims for interference with, or disturbance of Tenant's right of possession and/or breach of the covenant of quiet enjoyment by reason of the enforcement of any and all ground or underlying leases, mortgages and deeds of trust affecting the Project or the Premises and all renewals, modifications, consolidations, replacements and extensions thereof, whether or not the Lease is subordinate thereto. The foregoing notwithstanding, Landlord shall use its best efforts to obtain a Non-Disturbance and Attornment Agreement from any lienholders or mortgagees of the Project, whether currently existing or in the future. The Non-Disturbance 23 and Attornment Agreement shall be in a form reasonably acceptable to Tenant and any lienholders or mortgagees. ARTICLE 18 - Eminent Domain - --------------------------- If the whole of the Premises or the Project or so much thereof as to render the balance unusable by Tenant shall be taken under power of eminent domain, or is sold, transferred or conveyed in lieu thereof, this Lease shall automatically terminate as of the date of such condemnation, or as of the date possession is taken by the condemning authority, at Landlord's option. No award for any partial or entire taking shall be apportioned, and Tenant hereby assigns to Landlord any award which may be made in such taking or condemnation, together with any and all rights of Tenant now or hereafter arising in or to the same or any part thereof; provided, however, that nothing contained herein shall be deemed to give Landlord any interest in or to require Tenant to assign to Landlord any award made to Tenant for the taking of personal property and fixtures and one-half (1/2) of any leasehold bonus as it relates to the Premises belonging to Tenant and removable by Tenant at the expiration of the term hereof as provided hereunder or for the interruption of, or damage to, Tenant's business. In the event of a partial taking described in this Article 18, or a sale, transfer or conveyance in lieu thereof, which does not result in a termination of this Lease, the rent shall be apportioned according to the ratio that the part of the Premises remaining useable by Tenant bears to the total area of the Premises. Tenant hereby waives any and all rights it might otherwise have pursuant to Section 1265.130 of the California Code of Civil Procedure. ARTICLE 19 - Default - -------------------- Each of the following acts or omissions of Tenant or of any guarantor of Tenant's performance hereunder, or occurrences, shall constitute an "Event of Default": (a) Failure or refusal to pay Monthly Basic Rental, Additional Rent or any other amount to be paid by Tenant to Landlord hereunder within five (5) calendar days after notice that the same was not paid when due or payable hereunder; said five (5) day period shall be in lieu of, and not in addition to, the notice requirements pertaining to the unlawful detainer statutes; (b) Except as set forth in item (g) below, failure to perform or observe any other covenant or condition of this Lease to be performed or observed within thirty (30) days following written notice to Tenant of such failure; provided that if the nature of such default cannot reasonably be cured within thirty (30) days, Tenant shall not be in default if it commences such cure within such period and diligently proceeds with such cure and does cure within ninety (90) days. Such thirty (30) day notice shall also constitute any notice required under Section 1161 of the California Code of Civil Procedure; (c) Abandonment or vacating or failure to accept tender of possession of the Premises or any significant portion thereof, unless Tenant continues to pay Monthly Basic Rental and all other sums due hereunder. (d) The taking in execution or by similar process or law (other than by eminent domain) of the estate hereby created; 24 (e) The filing by Tenant or any guarantor hereunder in any court pursuant to any statute of a petition in bankruptcy or insolvency or for reorganization or arrangement for the appointment of a receiver of all or a portion of Tenant's property; the filing against Tenant or any guarantor hereunder of any such petition, or the commencement of a proceeding for the appointment of a trustee, receiver or liquidator for Tenant, or for any guarantor hereunder, or of any of the property of either, or a proceeding by any governmental authority for the dissolution or liquidation of Tenant or any guarantor hereunder, if such proceeding shall not be dismissed or trusteeship discontinued within thirty (30) days after commencement of such proceeding or the appointment of such trustee or receiver; or the making by Tenant or any guarantor hereunder of an assignment for the benefit of creditors. Tenant hereby stipulates to the lifting of the automatic stay in effect and relief from such stay for Landlord in the event Tenant files a petition under the United States Bankruptcy laws, for the purpose of Landlord pursuing its rights and remedies against Tenant and/or a guarantor of this Lease; (f) Tenant's failure to cause to be released any mechanics liens filed against the Premises or the Project within twenty (20) days after the date the same shall have been filed or recorded; or (g) Tenant's failure to observe or perform according to the provisions of Articles 17 or 25 within fifteen (15) business days after notice from Landlord. All defaults following the expiration of any applicable notice or grace period by Tenant of any covenant or condition of this Lease shall be deemed by the parties hereto to be material. ARTICLE 20 - Remedies - --------------------- (a) In the event of a breach of or default under this Lease as provided in Article 19 hereof, Landlord may exercise all of its remedies as may be permitted by law, including but not limited to the remedy provided by Section 1951.4 of the California Civil Code, and including without limitation, terminating this Lease, reentering the Premises and removing all persons and property therefrom, which property may be stored by Landlord at a warehouse or elsewhere at the risk, expense and for the account of Tenant. If Landlord elects to terminate this Lease, Landlord shall be entitled to recover from Tenant the aggregate of all amounts permitted by law, including but not limited to (i) the worth at the time of any unpaid rent which has been earned at the time of such termination; plus (ii) the worth at the time of award of the amount by which the unpaid rent which would have been earned after termination until the time of award exceeds the amount of such rental loss that Tenant proves could have been reasonably avoided; plus (iii) the worth at the time of award of the amount by which the unpaid rent for the balance of the Lease Term after the time of award exceeds the amount of such rental loss that Tenant proves could have been reasonably avoided; plus (iv) any other amount necessary to compensate Landlord for all the detriment proximately caused by Tenant's failure to perform its obligations under this Lease or which in the ordinary course of things would be likely to result therefrom, specifically including but not limited to, brokerage commissions and advertising expenses incurred, expenses of remodeling the Premises or any portion thereof for a new tenant, whether for the same or a different use, and any special concessions made to obtain a new tenant; and (v) at Landlord's election, such other amounts in addition to or in lieu of the foregoing as may be permitted from time to time by applicable law. The term "rent" as used in this Article 20(a) 25 shall be deemed to be and to mean all sums of every nature required to be paid by Tenant pursuant to the terms of this Lease, whether to Landlord or to others. As used in items (i) and (ii), above, the "worth at the time of award" shall be computed by allowing interest at the rate set forth in item (e), below, but in no case greater than the maximum amount of such interest permitted by law. As used in item (iii), above, the "worth at the time of award" shall be computed by discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award plus one percent (1%). If Landlord terminates this Lease or Tenant's right to possession, Landlord shall use reasonable efforts to mitigate Landlord's damages, and Tenant shall be entitled to submit proof of such failure to mitigate as a defense to Landlord's claims hereunder, if mitigation of damages by Landlord is required by applicable law. Further, Tenant shall be liable for all unamortized leasing commissions paid by or owing by Landlord arising from this Lease and extensions thereof. (b) Nothing in this Article 20 shall be deemed to affect Landlord's right to indemnification for liability or liabilities arising prior to the termination of this Lease for personal injuries or property damage under the indemnification clause or clauses contained in this Lease. (c) Notwithstanding anything to the contrary set forth herein, Landlord's re-entry to perform acts of maintenance or preservation of or in connection with efforts to relet the Premises or any portion thereof, or the appointment of a receiver upon Landlord's initiative to protect Landlord's interest under this Lease shall not terminate Tenant's right to possession of the Premises or any portion thereof and, until Landlord does elect to terminate this Lease, this Lease shall continue in full force and effect and Landlord shall enforce all of Landlord's rights and remedies hereunder including, without limitation, the remedy described in California Civil Code Section 1951.4 (lessor may continue lease in effect after lessee's breach and abandonment and recover rent as it becomes due, if Lessee has the right to sublet or assign, subject only to reasonable limitations). Accordingly, if Landlord does not elect to terminate this Lease on account of any default by Tenant, Landlord may, from time to time, without terminating this Lease, enforce all of its rights and remedies under this Lease, including the right to recover all rent as it becomes due. (d) All rights, powers and remedies of Landlord hereunder and under any other agreement now or hereafter in force between Landlord and Tenant shall be cumulative and not alternative and shall be in addition to all rights, powers and remedies given to Landlord by law, and the exercise of one or more rights or remedies shall not impair Landlord's right to exercise any other right or remedy. (e) Any amount due from Tenant to Landlord hereunder which is not paid within five (5) days after Tenant's receipt of written notice that the same is due shall bear interest at the lower of 18% per annum or the maximum lawful rate of interest from the due date until paid, unless otherwise specifically provided herein, but the payment of such interest shall not excuse or cure any default by Tenant under this Lease. In addition to such interest: (a) if Basic Rental is not paid within ten (10) days after the same is due, a late charge equal to ten percent (10%) of the amount overdue or $100, whichever is greater, shall be assessed and shall accrue for each calendar month or part thereof until such rental, including the late charge, is paid in full, which late charge Tenant hereby agrees is a reasonable estimate of the damages Landlord shall suffer as a result of Tenant's late payment and (b) an additional charge of $25 shall be assessed for any 26 check given to Landlord by or on behalf of Tenant which is not honored by the drawee thereof; which damages include Landlord's additional administrative and other costs associated with such late payment and unsatisfied checks and the parties agree that it would be impracticable or extremely difficult to fix Landlord's actual damage in such event. Such charges for interest and late payments and unsatisfied checks are separate and cumulative and are in addition to and shall not diminish or represent a substitute for any or all of Landlord's rights or remedies under any other provision of this Lease. (f) Tenant shall be liable for any other amount necessary to compensate Landlord for all the detriment proximately caused by Tenant's default following the expiration of any applicable cure or notice period under this Lease, or which in the ordinary cause of things would be likely to result therefrom. ARTICLE 21 - Transfer of Landlord's Interest - -------------------------------------------- In the event of any transfer or termination of Landlord's interest in the Premises or the Project by sell, assignments, transfer, foreclosure, deed-in- lieu of foreclosure or otherwise whether voluntary or involuntary, Landlord shall be automatically relieved of any and all obligations and liabilities on the part of Landlord which accrue from and after the date of such transfer or termination, including furthermore without limitation the obligation of Landlord under Article 4 and California Civil Code 1950.7 above to return the security deposit, provided said security deposit is transferred to said assignee. Tenant expressly waives and releases its rights with regard to its security deposit pursuant to the provision of California Civil Code 1950.7 or any substitute or successor statute to the extent the same could be asserted by Tenant against Landlord. ARTICLE 22 - Broker - ------------------- In connection with this Lease, Landlord and Tenant each warrant and represent that it has had dealings only with firm(s) set forth in Article 1.H. of the Basic Lease Provisions and that it knows of no other person or entity who is or might be entitled to a commission, finder's fee or other like payment in connection herewith and each does hereby indemnify and agree to hold the other, its agents, partners, representatives, officers, affiliates, shareholders, employees, successors and assigns harmless from and against any and all loss, liability and expenses that such party may incur should such warranty and representation prove incorrect, inaccurate or false. ARTICLE 23 - Parking - -------------------- Tenant shall have the right but not the obligation to rent up to the number of parking passes set forth in Article 1.I. of Basic Lease Provisions. The initial parking rates are set forth in Article 1.J. of the Basic Lease Provisions. Such parking shall be available upon terms and conditions to be established from time to time by Landlord or Landlord's operator of such parking facilities, but Landlord does not warrant or represent that the parking will continue to be available if Tenant does not rent the same continuously from the commencement of the term of this Lease. Tenant agrees that it shall be liable for and pay for any and all parking taxes imposed in connection with such parking. 27 ARTICLE 24 - Waiver - ------------------- No waiver by Landlord of any provision of this Lease shall be deemed to be a waiver of any other provision hereof or of any subsequent breach by Tenant of the same or any other provision. No provision of this Lease may be waived by Landlord, except by an instrument in writing executed by Landlord. Landlord's consent to or approval of any act by Tenant requiring Landlord's consent or approval shall not be deemed to render unnecessary the obtaining of Landlord's consent to or approval of any subsequent act of Tenant, whether or not similar to the act so consented to or approved. No act or thing done by Landlord or Landlord's agents during the term of this Lease shall be deemed an acceptance of a surrender of the Premises, and no agreement to accept such surrender shall be valid unless in writing and signed by Landlord. Any payment by Tenant or receipt by Landlord of an amount less than the total amount then due hereunder shall be deemed to be in partial payment only thereof and not a waiver of the balance due or an accord and satisfaction, notwithstanding any statement or endorsement to the contrary on any check or any other instrument delivered concurrently therewith or in reference thereto. Accordingly, Landlord may accept any such amount and negotiate any such check without prejudice to Landlord's right to recover all balances due and owing and to pursue its other rights against Tenant under this Lease, regardless of whether Landlord makes any notation on such instrument of payment or otherwise notifies Tenant that such acceptance or negotiation is without prejudice to Landlord's rights. ARTICLE 25 - Estoppel Certificate - --------------------------------- Tenant shall, at any time and from time to time, upon not less than fifteen (15) days' prior written notice from Landlord, execute, acknowledge and deliver to Landlord a statement in writing certifying the following information, (but not limited to the following information in the event further information is requested by Landlord): (i) that this Lease is unmodified and in full force and effect (or, if modified, stating the nature of such modification and certifying that this Lease, as modified, is in full force and effect); (ii) the dates to which the rental and other charges are paid in advance, if any; (iii) the amount of Tenant's security deposit, if any; and (iv) acknowledging that there are not, to Tenant's knowledge, any uncured defaults on the part of Landlord hereunder, and no events or conditions then in existence which, with the passage of time or notice or both, would constitute a default on the part of Landlord hereunder, or specifying such defaults, events or conditions, if any are claimed. It is expressly understood and agreed that any such statement may be relied upon by any prospective purchaser or encumbrancer of all or any portion of the Real Property. Tenant's failure upon Landlord's reasonable request to deliver such statement within such time shall, at the option of Landlord, constitute a default under this Lease. Furthermore, Tenant's failure to deliver such statement within such time shall constitute an admission by Tenant that all statements contained therein are true and correct. Tenant agrees to execute all documents required in accordance with this Article 25 within fifteen (15) days after delivery of said documents. ARTICLE 26 - Liability Of Landlord - ---------------------------------- Tenant agrees to look solely to Landlord's interest in the Project and the Premises, if any, for the satisfaction of any remedy of Tenant for the collection of a judgment (or other judicial process) requiring the payment of money by Landlord in the event of any default by Landlord 28 hereunder or any claim cause of action, obligation, contractual statutory or otherwise by Tenant against Landlord concerning, arising out of or relating to any matter relating to this Lease and all of the covenants and condition or any obligations, contractual, statutory, or otherwise set forth herein, and no other property or assets of Landlord, or any officer, director, shareholder, partner, trustee, agent, servant or employee of Landlord (the "Representative") shall be subject to levy, execution or other enforcement procedure for the satisfaction of Tenant's remedies under or with respect to this Lease, Landlord's obligations to Tenant, whether contractual, statutory or otherwise, the relationship of Landlord and Tenant hereunder, or Tenant's use or occupancy of the Premises. Tenant further understands that any liability, duty or obligation of Landlord to Tenant, shall no longer accrue as of the date that Landlord or any of the Representatives no longer have any right, title or interest in or to the Project, and shall automatically cease if another entity has agreed to assume such liabilities through a written assignment and assumption agreement. ARTICLE 27 - Inability To Perform - --------------------------------- This Lease and the obligations of Tenant hereunder shall not be affected or impaired because Landlord is unable to fulfill any of its obligations hereunder or is delayed in doing so, if such inability or delay is caused by reason of any stoppage due to strikes, lockouts, acts of God, or any other cause previously, or at such time, beyond the reasonable control or anticipation of Landlord (collectively, a "Force Majeure") and Landlord's obligations under this Lease shall be forgiven and suspended by any such Force Majeure, excepting, however, Landlord's obligations under the last sentence of Article 2 and Article 11(g). ARTICLE 28 - Hazardous Waste - ---------------------------- (a) Tenant shall not cause or permit any Hazardous Material (as defined in Article 28(d) below) to be brought, kept or used in or about the Project by Tenant, its agents, employees, contractors, or invitees, excluding, however, customary office supplies, and equipment. Tenant indemnitees Landlord from and against any breach by Tenant of the obligations stated in the preceding sentence, and agrees to defend and hold Landlord harmless from and against any and all claims, judgments, damages, penalties, fines, costs, liabilities, or losses (including, without limitation, diminution in value of the Project, damages for the loss or restriction or use of rentable or usable space or of any amenity of the Project, damages arising from any adverse impact or marketing of space in the Project, and sums paid in settlement of claims, attorneys' fees, consultant fees, and expert fees) which arise during or after the term of this Lease as a result of such breach. This indemnification of Landlord by Tenant includes, without limitation, costs incurred in connection with any investigation of site conditions or any cleanup, remedial, removal, or restoration work required by any federal, state, or local governmental agency or political subdivision because of Hazardous Material present in the soil or ground water on or under the Project. Without limiting the foregoing, if the presence of any Hazardous Material on the Project caused or permitted by Tenant results in any contamination of the Project and subject to the provisions of Articles 9, 10 and 11, hereof, Tenant shall promptly take all actions at its sole expense as are necessary to return the Project to the condition existing prior to the introduction of any such Hazardous Material and the contractors to be used by Tenant must be approved by the Landlord, which approval shall not be unreasonably withheld so long as such actions would not potentially have any material adverse long-term or short-term effect on the 29 Project and so long as such actions do not materially interfere with the use and enjoyment of the Project by the other tenants thereof. (b) Landlord and Tenant acknowledge that Landlord may become legally liable for the costs of complying with Laws (as defined in Article 28(e) below) relating to Hazardous Material which are not the responsibility of Landlord or the responsibility of Tenant, including the following: (i) Hazardous Material present in the soil or ground water on the project of which Landlord has no knowledge as of the effective date of this Lease: (ii) a change in Laws which relate to Hazardous Material which make that Hazardous Material which is present on the Property as of the effective date of his Lease, whether known or unknown to Landlord, a violation of such new Laws: (iii) Hazardous Material that migrates, flows, percolates, diffuses, or in any way moves on to, or under the Project after the effective date of this Lease; or Hazardous Material present on or under the Project as a result of any discharge, dumping or spilling (whether accidental or otherwise) on the Product by other lessees of the Project or their agents, employees, contractors, or invitees, or by others. Accordingly, Landlord and Tenant agree that the cost of complying with Laws relating to Hazardous Material on the Project for which Landlord is legally liable and which are paid or incurred by Landlord shall not be an Operating Cost. (c) it shall not be unreasonable for Landlord to withhold its consent to any proposed Transfer if (i) the proposed transferee's anticipated use of the Premises involves the generation, storage, use, treatment, or disposal of Hazardous Material; (ii) the proposed Transferee has been required by any prior landlord, lender, or governmental authority to take remedial action in connection with Hazardous Material contaminating a property if the contamination resulted from such Transferee's actions or use of the property in question; or (iii) the proposed Transferee is subject to an enforcement order issued by any governmental authority in connection with the use, disposal, or storage of a Hazardous Material. (d) As used herein, the term "Hazardous Material" means any hazardous or toxic substance, material, or waste which is or becomes regulated by any local governmental authority, the State of California or the United States Government. The term Hazardous Material" includes, without limitation, any material or substance which is (i) defined as "Hazardous Waste," "Extremely Hazardous Waste," or "Restricted Hazardous Waste" under Sections 25115, 25117 or 25122.7, or listed pursuant to Section 25140, of the California Health and Safety Code, Division 20, Chapter 6.5 (Hazardous Waste Control Law), (ii) defined as a "Hazardous Substance" under Section 25316 of the California Health and Safety Code, Division 20, Chapter 6.8 (Carpenter-Presley-Tanner Hazardous Substance Account Act), (iii) defined as a "Hazardous Material," "Hazardous Substance," or "Hazardous Waste" under Section 25501 of the California Health and Safety Code, Division 20, Chapter 6.95 (Hazardous Materials Release Response Plans and Inventory), (iv) defined as a "Hazardous Substance" under Section 25281 of the California Health and Safety Code, Division 20, Chapter 6.7 (Underground Storage of Hazardous Substances), (v) petroleum, (vi) asbestos, (vii) listed under Article 9 or defined as Hazardous or extremely hazardous pursuant to Article 11 of Title 22 of the California Administrative Code, Division 4, Chapter 20, (viii) designated as a Hazardous Substance" pursuant to Section 311 of the Federal Water Pollution Control Act (33 U.S.C. & 1317), (ix) defined as a "Hazardous Waste" pursuant to Section 1004 of the Federal Resource Conservation and Recovery Act, 42 U.S.C. & 6901 et seq. (42 U.S.C. & 6903), or (x) defined as a "Hazardous Substance" pursuant 30 to Section 101 of the Comprehensive Environmental Response, Compensation and Liability Act, 42 U.S.C. & 9601 et seq. (42 U.S.C. & 9601). (e) As used herein, the term "Laws" mean any applicable federal, state or local laws, ordinances, or regulations relating to any Hazardous Material affecting the Project, including, without limitation, the laws, ordinances, and regulations referred to in Article 28 (d) above. ARTICLE 29 - Surrender of Premises; Removal of Property - ------------------------------------------------------- (a) The voluntary or other surrender of this Lease by Tenant to Landlord, or a mutual termination hereof, shall not work a merger, and shall at the option of Landlord, operate as an assignment to it of any or all subleases or subtenancies affecting the Premises. (b) Upon the expiration of the term of this Lease, or upon any earlier termination of this Lease, Tenant shall quit and surrender possession of the Premises to Landlord in as good order and condition as the same are now and hereafter may be improved by Landlord or Tenant, reasonable wear and tear and repairs which are Landlord's obligation excepted, and shall, without expense to Landlord, remove or cause to be removed from the Premises all debris and rubbish, all furniture, equipment, business and trade fixtures, free-standing cabinet work, moveable partitioning and other articles of personal property owned by Tenant or installed or placed by Tenant at its own expense in the Premises, and all similar articles of any other persons claiming under Tenant unless Landlord exercises its option to have any subleases or subtenancies assigned to it, and Tenant shall repair all damage to the Premises resulting from the installation and removal of such items to be removed. (c) Whenever Landlord shall reenter the Premises as provided in Article 20 hereof, or as otherwise provided in this Lease, any property of Tenant not removed by Tenant upon the expiration of the term of this Lease (or within forty-eight (48) hours after a termination by reason of Tenant's default), as provided in this Lease, shall be considered abandoned and Landlord may remove any or all of such items and dispose of the same in any manner or store the same in a public warehouse or elsewhere for the account and at the expense and risk of Tenant, and if Tenant shall fail to pay the cost of storing any such property after it has been stored for a period of ninety (90) days or more, Landlord may sell any or all of such property at public or private sale, in such manner and at such times and places as Landlord, in its sole discretion, may deem proper, without notice or to demand upon Tenant, for the payment of all or any part of such charges or the removal of any such property, and shall apply the proceeds of such sale: first, to the cost and expense of such sale, including reasonable attorneys' fees for services rendered; second, to the payment of the cost of or charges for storing any such property; third, to the payment of any other sums of money which may then or thereafter be due to Landlord from Tenant under any of the terms hereof; and fourth, the balance, if any, to Tenant. (d) All fixtures, equipment, alterations, additions, improvements and/or appurtenances attached to or built into the Premises prior to or during the Term, whether by Landlord or Tenant and whether at the expense of Landlord or Tenant, or of both, shall be and remain part of the Premises and shall not be removed by Tenant at the end of the term unless otherwise expressly provided for in this Lease or unless such removal is required by Landlord pursuant to the provisions of Article 9, above. Such fixtures, equipment, Tenant Improvements, alterations, 31 additions, improvements and/or appurtenances shall include but not be limited to: all floor coverings, drapes, paneling, built-in cabinetry, molding, doors, vaults (including vault doors), plumbing systems, electrical systems, lighting systems, silencing equipment, communication systems, all fixtures and outlets for the systems mentioned above and for all telephone, radio, telegraph and television purposes, and any special flooring or ceiling installations. Notwithstanding the foregoing, Tenant shall have the right to remove any non- permanently affixed alterations or free-standing improvements made and paid by Tenant, so long as Tenant repairs any damage to the Premises caused by such removal. ARTICLE 30 - Miscellaneous - -------------------------- (a) SEVERABILITY; ENTIRE AGREEMENT. Any provision of this Lease which shall prove to be invalid, void, or illegal shall in no way affect, impair or invalidate any other provision hereof any such other provisions shall remain in full force and effect. This Lease and the Exhibits and any Addendum attached hereto constitute the entire agreement between the parties hereto with respect to the subject matter hereof, and no prior agreement or understanding pertaining to any such matter shall be effective for any purpose. No provision of this Lease may be amended or supplemented except by an agreement in writing signed by the parties hereto or their successor in interest. This Lease shall be governed by and construed in accordance with the laws of the State of California. (b) ATTORNEYS' FEES. (i) In any action to enforce the terms of this Lease, including any suit by Landlord for the recovery of rent or possession of the Premises, the losing party shall pay the successful party a reasonable sum for attorneys' fees in such suit and such attorneys' fees shall be deemed to have accrued prior to the commencement of such action and shall be paid whether or not such action is prosecuted to judgment. (ii) Should Landlord, without fault on Landlord's part, be made a party to any litigation instituted by Tenant or by any third party against Tenant, or by or against any person holding under or using the Premises by license of Tenant, or for the foreclosure of any lien for labor or material furnished to or for Tenant or any such other person or otherwise arising out of or resulting from any act or transaction of Tenant or of any such other person, Tenant covenants to save and hold Landlord harmless from any judgment rendered against Landlord or the Premises or any part thereof and from all costs and expenses, including reasonable attorneys' fees incurred by Landlord in collection with such litigation. (iii) When legal services are rendered by an attorney at law who is an employee of a party, shall be determined as to amount, including overhead, by consideration of the same factors, including but not limited by, the importance of the matter, time applied, difficulty and results, as are considered when an attorney not in the employ of a party is engaged to render such service. (c) TIME OF ESSENCE. Each of Tenant's covenants herein is a condition and time is of the essence with respect to the performance of every provision of this Lease. 32 (d) HEADINGS. The article headings contained in this Lease are for convenience only and do not in any way limit or amplify any term or provision hereof. The terms "Landlord" and "Tenant" as used herein shall include the plural as well as the singular, the neuter shall include the masculine and feminine genders and the obligations herein imposed upon Tenant shall be joint and several as to each of the persons, firms or corporations of which Tenant may be composed. (e) RESERVED AREA. Tenant hereby acknowledges and agrees that the exterior walls of the Premises and the area between the finished ceiling of the Premises and the slab of the floor of the project thereabove have not been demised hereby and the use thereof together with the right to install, maintain, use, repair and replace pipes, ducts, conduits and wires leading through, under or above the Premises in locations which will not materially interfere with Tenant's use of the Premises and serving other parts of the Project are hereby excepted and reserved unto Landlord. (f) NO OPTION. The submission of this Lease by Landlord, its agent or representative for examination or execution by Tenant does not constitute an option or offer to Lease the Premises upon the terms and conditions contained herein or a reservation of the Premises in favor of Tenant, it being intended hereby that this Lease shall only become effective upon the execution hereof by Landlord and delivery of a fully executed counterpart hereof to Tenant. (g) USE OF PROJECT NAME; IMPROVEMENTS. Tenant shall not be allowed to use the name, picture or representation of the Project, or words to that effect, in connection with any business carried on in the Premises or otherwise (except as Tenant's address) without the prior written consent of Landlord. In the event that Landlord undertakes any additional improvements on the real property including but not limited to new construction or renovation or additions to the existing improvements, Landlord shall not be liable to Tenant for any noise, dust, vibration or interference with access to the Premises or disruption in Tenant's business caused thereby and rental hereunder shall only be abated to the extent that such interference materially interferes with Tenant's business. (h) RULES AND REGULATIONS. Tenant shall observe faithfully and comply strictly with the Rules and Regulations attached to this Lease and made a part hereof, and such other Rules and Regulations as Landlord may from time to time reasonably adopt for the safety, care and cleanliness of the Project, the facilities thereof, or the preservation of good order therein. Landlord shall not be liable to Tenant for violation of any such Rules and Regulations, or for the breach of any covenant or condition in any Lease by any other tenant in the Project. A waiver by Landlord of any Rule or Regulation for any other tenant shall not constitute nor be deemed a waiver of the Rule or Regulation for this Tenant. (i) QUIET POSSESSION. Upon Tenant's paying the Basic Rent, Additional Rent and other sums provided hereunder and observing and performing all of the covenants, conditions and provisions on Tenant's part to be observed and performed hereunder, Tenant shall have quiet possession of the Premises for the entire term hereof, subject to all of the provisions of this Lease. (j) RENT. All payments required to be made hereunder shall be deemed to be rent, whether or not described as such. 33 (k) SUCCESSORS AND ASSIGNS. Subject to the provisions of Article 15 hereof, all of the covenants, conditions and provisions of this Lease shall be binding upon and shall inure to the benefit of the parties hereto and their respective heirs, personal representatives, successors and assigns. (l) NOTICES. Any notice required or permitted to be given hereunder shall be in writing and may be given by facsimile, personal service, first-class mail, or registered or certified mail, return receipt requested, addressed to Tenant at the Premises with a copy via U.S. Mail, to Robert Thau, Esq., Rosenfeld, Meyer & Susman at 9601 Wilshire Boulevard, 5th Floor, Beverly Hills, California 90210 (provided, however, a notice shall not be ineffective because a copy was not sent to Robert Thau, Esq., or any other designated copy recipient), or to Landlord at the address of the place from time to time established for the payment of rent and which shall be effective upon proof of delivery. Either party may by notice to the other specify a different address for notice purposes except that, upon Tenant's taking possession of the Premises, the Premises shall constitute Tenant's address for notice purposes. A copy of all notices to be given to Landlord hereunder shall be concurrently transmitted by Tenant to such party hereafter designated by notice from Landlord to Tenant. Any notices sent by Landlord regarding or relating to eviction procedures, including without limitation Three Day Notices, may be sent by regular mail. (m) PERSISTENT DELINQUENCIES. In the event that Tenant shall be delinquent by more than fifteen (15) days in the payment of rent on three (3) separate occasions in any twelve (12) month period, Landlord shall have the right to require Tenant to deposit (and maintain) three (3) months' rent in advance to be used as security for future rental payments due hereunder and may be applied by Landlord for the payment of Monthly Basic Rental and other sums as the same become due hereunder. (n) RIGHT OF LANDLORD TO PERFORM. All covenants and agreements to be performed by Tenant under any of the terms of this Lease shall be performed by Tenant at Tenant's sole cost and expense and without any abatement of rent, except as otherwise provided in this Lease. If Tenant shall fail to pay any sum of money, other than rent, required to be paid by it hereunder or shall fail to perform any other act on its part to be performed hereunder, and such failure shall continue beyond any applicable period of notice set forth in this Lease, Landlord may, but shall not be obligated so to do, and without waiving or releasing Tenant from any obligations of Tenant, make any such payment or perform any such other act on Tenant's part to be made or performed as is in this Lease provided. All sums so paid by Landlord and all reasonable incidental costs, together with interest thereon at the rate of ten percent (10%) per annum from the date of such payment by Landlord, shall be payable to Landlord on demand and Tenant covenants to pay any such sums, and Landlord shall have (in addition to any other right or remedy of Landlord) the same rights and remedies in the event of the nonpayment thereof by Tenant as in the case of default by Tenant in the payment of the rent. (o) ACCESS, CHANGES IN PROJECT, FACILITIES, NAME. (i) Every part of the Project except the inside surfaces of all walls, windows and doors bounding the Premises (including exterior building walls, core corridor walls and doors and any core corridor entrance), and any space in or adjacent to the Premises used for shafts, 34 stacks, pipes, conduits, fan rooms, ducts, electric or other utilities, sinks or other building facilities, and the use thereof, as well as access thereto through the Premises for the purposes of operation, maintenance, decoration and repair, are reserved to Landlord. (ii) Tenant shall permit Landlord to install, use and maintain pipes, ducts and conduits within the walls, bearing columns and ceilings of the Premises. (iii) Landlord reserves the right, without incurring any liability to Tenant therefor, to make such reasonable changes in or to the Building and the fixtures and equipment thereof, as well as in or to the street entrances, halls, passages, elevators, stairways and other improvements thereof, as it may deemed necessary or desirable. (iv) Landlord may adopt any name for the Project and Landlord reserves the right to change the name or address of the Building at any time. (p) CORPORATE AUTHORITY. If Tenant is a corporation, each individual executing this Lease on behalf of said corporation represents and warrants that he is duly authorized to execute and deliver this Lease on behalf of said corporation in accordance with a duly adopted resolution of the Board of Directors of said corporation or in accordance with the By-laws of said corporation, and that this Lease is binding upon said corporation in accordance with its terms. If Tenant is a corporation, said corporation and each individual executing this Lease on behalf of said corporation covenants that Tenant shall provide to Landlord a copy of such resolution of the Board of Directors authorizing the execution of this Lease on behalf of such corporation, which copy of resolution shall be duly certified by the secretary or an assistant secretary of the corporation to be a true copy of a resolution duly adopted by the Board of Directors of said corporation. (q) IDENTIFICATION OF TENANT. (a) If more than one person executes this Lease as Tenant, (i) each of them shall be jointly and severally liable for the keeping, observing and performing of all of the terms, covenants, conditions and provisions of this Lease to be kept, observed and performed by Tenant, (ii) the term "Tenant" as used in this Lease shall mean and include each of them jointly and severally, and (iii) the act of or notice from, or notice or refund to, or the signature of, any one or more of them, with respect to the tenancy of this Lease, including, but not limited to, any renewal, extension, expiration, termination or modification of this Lease, shall be binding upon each and all of the persons executing this Lease as Tenant with the same force and effect as if each and all of them had so acted or so given or received such notice or refund or so signed. (r) SUBSTITUTE PREMISES. Provided Landlord shall have a full floor tenant for the fifth (5th) floor of the Project, then Landlord shall have the right at any time during the term hereof, upon giving Tenant not less than one hundred twenty (120) days prior notice, to provide and furnish Tenant with space elsewhere in the Project of the same size or greater and reasonably similar tenant improvements as the Premises, and remove and place Tenant in such space. Landlord shall pay all verified costs and expenses incurred as a result of such removal and relocation of Tenant, including without limitation the cost of replacing Tenant's existing supply of stationary and business cards and relocation of all of Tenant's telephone and communications 35 equipment. Should Tenant refuse to permit Landlord to move Tenant to such new space at the end of said one hundred twenty (120) day period, Landlord or Tenant shall have the right to cancel and terminate this Lease, subject to the cancellation provisions set forth in Article 35, below, and Tenant's prospective obligations hereunder effective ninety (90) days after the date of Landlord's original notification to Tenant of its intent to relocate Tenant. If Landlord moves Tenant to such new space, this Lease and each and all of its terms, covenants and conditions shall remain in full force and effect and shall be deemed applicable to such new space and such new space shall thereafter be deemed to be the "Premises" as though Landlord and Tenant had entered into an express written amendment of this lease with respect thereto. (s) BUILDING CODES. After the Tenant Improvements have been completed, any and all costs attributable to or related to the applicable building codes of the city in which the Project is located (or any other authority having jurisdiction over the Project) arising from Tenants plans, specifications, improvements, alterations or otherwise (other than the Tenant Improvements) shall be paid by Tenant at its sole cost and expense. (t) EXHIBITS AND ADDENDUM. The Exhibits and Addendum, if applicable, attached hereto are incorporated herein by this reference as if fully set forth herein. ARTICLE 31 - Option to Renew - ---------------------------- (a) OPTION RIGHT. Landlord hereby grants the Tenant named in this Lease and any Permitted Transferees (the "Original Tenant") one (1) option to extend the Lease term for a period of five (5) years an ("Option Term"), which option shall be exercisable only by written notice delivered by Tenant to Landlord set forth below. The rights contained in this Article 31 shall be personal to the Original Tenant and may only be exercised by the Original Tenant and any Permitted Transferees (and not any assignee, sublessee or other transferee of the Original Tenant's interest in this Lease, excepting a Permitted Transferee) if the Original Tenant occupies at least fifty-one percent (51%) of the entire Premises. (b) OPTION RENT. The rent payable by Tenant during the Option Term ("Option Rent") shall be equal to one hundred percent (100%) of the "Market Rent" (defined below). "Market Rent" shall mean the applicable monthly basic rent, including all escalations, direct costs, additional rent and other charges, including rent concessions and tenant improvement allowances at which tenants, as of the commencement of the Option term, are leasing non-sublease, nonencumbered, non-equity, space comparable in size, location and quality to the Premises for a term of five (5) years which comparable space is located in office buildings comparable to the Project in the West Los Angeles area of Los Angeles, California. (c) EXERCISE OF OPTIONS. The Option shall be exercised by Tenant only in the following manner: (i) Tenant shall not be in default following the expiration of any applicable notice or cure period on the delivery date of the notice to exercise the Option; (ii) Tenant shall deliver written notice to Landlord not more than ten (10) months nor less than nine (9) months prior to the expiration of the Lease term, stating that Tenant is interested in exercising the Option, (iii) within five (5) business days of Landlord's receipt of Tenant's written notice, Landlord shall deliver notice ("Option Rent Notice") to Tenant setting forth the Option Rent; and (iv) if Tenant 36 desires to exercise such Option, Tenant shall provide Landlord written notice within thirty (30) calendar days after receipt of the Option Rent Notice ("Tenant's Acceptance"). (d) DETERMINATION OF MARKET RENT. If Tenant timely and appropriately objects to the Market Rent in Tenant's Acceptance, Landlord and Tenant shall attempt to agree upon the Market Rent using their best good-faith efforts. If Landlord and Tenant fail to reach agreement within ten (10) calendar days following Tenant's Acceptance ("Outside Agreement Date"), then each party shall make a separate determination of the Market Rent which shall be submitted to arbitration in accordance with the following items (i) through (vii): (i) Landlord and Tenant shall each appoint one arbitrator who shall by profession be a current real estate broker or appraiser of commercial high- rise properties in the immediate vicinity of the Project, and who has been active in such field over the last five (5) years. The determination of the arbitrators shall be limited solely to the issue of whether Landlord's or Tenant's submitted Market Rent is the closest to the actual Market Rent as determined by the arbitrators, taking into account the requirements of item (b), above. (ii) The two arbitrators so appointed shall within five (5) business days of the date of the appointment of the last appointed arbitrator agree upon and appoint a third arbitrator who shall be qualified under the same criteria set forth hereinabove for qualification of the initial two arbitrators. (iii) The three arbitrators shall within fifteen (15) days of the appointment of the third arbitrator reach a decision as to whether the parties shall use Landlord's or Tenant's submitted Market Rent, and shall notify Landlord and Tenant thereof. (iv) The decision of the majority of the three arbitrators shall be binding upon Landlord and Tenant. (v) If either Landlord or Tenant fails to appoint an arbitrator within fifteen (15) days after the applicable Outside Agreement Date, the arbitrator appointed by one of them shall reach a decision, notify Landlord and Tenant thereof, and such arbitrator's decision shall be binding upon Landlord and Tenant. (vi) If the two arbitrators fail to agree upon and appoint a third arbitrator, or both parties fail to appoint an arbitrator, then the appointment of the third arbitrator or any arbitrator shall be dismissed and the matter to be decided shall be forthwith submitted to arbitration under the provisions of the American Arbitration Association, but subject to the instruction set forth in this item (d). (vii) The cost of arbitration shall be paid by Landlord and Tenant equally. ARTICLE 32 - Right of First Offer/Right of First Refusal - -------------------------------------------------------- (a) RIGHT OF FIRST OFFER. From and after the sixteenth (16th) month of the Commencement Date, and provided Tenant is not, in default following the expiration of any applicable notice or cure period under this Lease, then Landlord grants to the Original Tenant 37 (and any Permitted Transferees) a right of first offer on any space which becomes available for lease and which is contiguous to the Premises ("First Offer Space"), subject to any rights of renewal or expansion of existing Tenants in the Project executing leases with Landlord prior to the date of this Lease. Tenant's right of first offer shall be on the terms and conditions set forth in this Article. (i) Procedure for Offer. Landlord shall from time to time during the initial Lease term, notify Tenant in writing of the availability to lease space contiguous to the Premises which notice shall set forth the rental rate therefore in accordance with Article 32(a)(iii) below ("First Offer Rent"). Within five (5) business days following such notice, Tenant shall notify Landlord in writing of its desire to lease such available space ("Notice"). (ii) Procedure for Acceptance. In the event Tenant disputes the First Offer Rent applicable to the First Offer Space, Tenant shall concurrently notify Landlord of such dispute, along with the Notice, in which event the First Offer Rent shall be determined in accordance with the terms of Article 31(b) and (d) above, of this Lease. If Tenant does not so notify Landlord within the five (5) business day period, then Landlord shall be free to lease the space to anyone to whom Landlord desires on any terms Landlord desires, provided the amount is not less than five percent (5%) of the First Offer Rent. (iii) First Offer Rent. The rent payable by Tenant for the First Offer Space (the "First Offer Rent") shall be equal to one hundred percent (100%) of the then Market Rent. (iv) Construction in First Offer Space. Landlord and Tenant shall attempt to mutually agree on a tenant improvement allowance for such First Offer Space at the time the First Offer Space becomes available and Tenant receives the Notice in Article 32(a)(i) above. (v) Amendment to Lease. If Tenant timely exercises Tenant's right to lease the First Offer Space as set forth herein, Landlord and Tenant shall within thirty (30) days thereafter execute an amendment to this Lease for the First Offer Space upon the terms and conditions as set forth in the First Offer Notice and this Article 32. Tenant shall commence payment of rent for the First Offer Space and the term of the First Offer Space shall commence upon the date mutually agreed to by Landlord and Tenant ("First Offer Commencement Date") and shall terminate on the Expiration Date of this Lease. (vi) Termination of right of First Offer. The rights contained in this Article 32 shall be personal to the Original Tenant or any Permitted Transferee, and may only be exercised by the Original Tenant or any Permitted Transferee (and not any other assignee, sublessee or other transferee of the Original Tenant's interest in this Lease) if the Original Tenant or any Permitted Transferee has not subleased fifty percent (50%) or more of the original Premises. Tenant shall not have the right to lease First Offer Space, as provided in this Article 32, or if, as of the date of the attempted exercise of any right of first offer by Tenant, or as of the scheduled date of delivery of the First Offer Space to Tenant, Tenant is in default following any applicable notice or cure period under this Lease. (b) RIGHT OF FIRST REFUSAL. During the first fifteen (15) months after the Commencement Date, and provided Tenant has not subleased fifty percent (50%) or more of the 38 Premises, Landlord hereby grants to the Original Tenant and any Permitted Transferee a right of first refusal with respect to all the available space on the fifth (5th) floor located in the Project other than the Premises ("First Refusal Space"). Tenant's right of first refusal shall be on the terms and conditions set forth in this Article 32(b). (i) Procedure for Offer. During the first fifteen (15) months after the Commencement Date, Landlord shall notify Tenant in writing, from time to time, of third party interest in available space on the fifth (5th) floor of the Project, along with the third party offer acceptable to Landlord ("First Refusal Notice"). (ii) Procedure for Acceptance. If Tenant desires to exercise Tenant's right of first refusal with respect to all or a portion (but not less than 1,500 rentable square feet) of the space described in the First Refusal Notice, then within five (5) business days of delivery of the First Refusal Notice, Tenant shall deliver notice to Landlord of Tenant's intention to exercise its right of first refusal with respect to any portion of the available First Refusal Space on the same terms and conditions of this Lease (including the effective rental rate of $1.71 a rentable square foot and Subparagraph (iii) immediately below); provided, however, that if Tenant desires to take less than all of the First Refusal Space, the remaining space must be in a "commercially leasable configuration" or Tenant cannot exercise its right of first offer hereunder. Landlord shall have the right in its sole and absolute discretion to determine what constitutes a "commercially leasable configuration". If Tenant does not exercise its right of first refusal within such five (5) business day period, then Landlord may lease the First Refusal Space to such third party upon terms and conditions substantially similar to those set forth in the First Refusal Notice. (iii) Construction in First Refusal Space. Landlord and Tenant shall agree in Tenant's acceptance of the First Refusal Space as to the construction, if any, of the First Refusal Space. The amount of tenant improvements shall be proportionately adjusted based on the term remaining on this Lease in comparison to the original Lease term. (iv) Amendment to Lease. If Tenant timely and in writing exercises Tenant's right to lease the First Refusal Space as set forth herein, Landlord and Tenant shall within thirty (30) days thereafter execute an amendment to this Lease for the First Refusal Space upon the terms and conditions as set forth in the First Refusal Notice. Tenant shall commence payment of rent for the First Refusal Space, and the term of the First Refusal Space shall commence upon the date of delivery of the First Refusal Space to Tenant, including the substantial completion of tenant improvements and shall terminate on the Expiration Date of this Lease. (v) Termination of Right of First Refusal. The rights contained in this Article 32(b) shall be personal to the Original Tenant, and may only be exercised by the Original Tenant and any Permitted Transferee (and not any other assignee, sublessee or other transferee of the Original Tenant's interest in this Lease, except an affiliate of Tenant) if the Original Tenant and any Permitted Transferee occupies at least fifty percent (50%) of the entire Premises and Tenant may not exercise its right of first refusal, if, as of the date of the attempted exercise of such right of first refusal or as of the scheduled date of delivery of the First Refusal Space to Tenant, Tenant is in material default following the expiration of any applicable notice or cure period under this Lease. 39 ARTICLE 33 - Storage Space - -------------------------- If available, Tenant shall have the right, on a month-to-month basis, to lease up to 500 square feet of available storage space ("Storage Space") in a location designated by Landlord, in Landlord's reasonable discretion. The Storage Space shall be leased at a monthly gross rental rate of $0.90 a usable square foot during the Lease term. Tenant shall have the right, on a monthly basis, to cease leasing or to commence leasing all or a portion of the Storage Space at Tenant's sole election; provided, however, Tenant shall give Landlord fifteen (15) days' prior written notice of its intent to either cease leasing or to commence leasing such Storage Space. Tenant's right to lease Storage Space following Tenant's election not to lease all or a portion of the Storage Space shall be on an "as-available" basis. All Storage Space leased by Tenant shall be leased in its then existing "as-is" condition, and Tenant shall be fully responsible for repairing any damage to the Storage Space resulting from or relating to Tenant's use thereof. Tenant shall comply with such reasonable rules and regulations as promulgated by Landlord from time to time pertaining to the use of such Storage Space. Tenant shall indemnify, defend and hold Landlord from and against any and all loss, liability, claims, expenses, damages or costs arising out of or in connection with Tenant's use of the Storage Space. ARTICLE 34 - Signage/Directory - ------------------------------ Provided Tenant is not in default hereunder, Tenant shall have the right to the following signage/directory rights: (a) At Landlord's sole cost and expense, the right to fourteen (14) lines in the Project's lobby directory; and (b) Tenant, at Tenant's sole cost and expense, shall have the right to install custom suite identification (including logo and business name) on all entrances to the Premises, subject to Landlord's reasonable approval, which shall not be unreasonably withheld or delayed. ARTICLE 35 - Option to Cancel - ----------------------------- Tenant shall have a one-time right to cancel the Lease effective as of the end of the thirty-sixth (36th) month of the initial Lease term only ("Termination Date"). In order for the termination right set forth herein to be valid and effective, Tenant must give Landlord written notice of its intention to cancel the Lease not later than six (6) months prior to the Termination Date. In the event Tenant timely and in writing exercises its option to cancel, Tenant shall, at the time of providing such written notice, pay to Landlord a cancellation fee equal to the sum of (a) the outstanding balance of the Loan (defined in Article 9), (b) the unamortized portion of (i) Tenant Improvements in the amount of Sixty-Two Thousand Fifty-Five Dollars ($62,055.00), (ii) brokerage commissions in the amount of Forty-Five Thousand Eight Hundred Forty- One Dollars and Seventy-Nine Cents ($45,841.79), and (iii) Sixty-One Thousand One Hundred Fifty-Five Dollars ($61,155.00) in rent concessions paid by and given by Landlord in connection with the Lease, and (c) the sum of Forty-Six Thousand Six Hundred Thirteen Dollars and Seventy Cents ($46,613.70) which equals four (4) months' Monthly Basic Rental (calculated at the effective rate). 40 ARTICLE 36 - Building Antenna(s) or Satellite Dish(es) - ------------------------------------------------------ Subject to all governmental laws, rules and regulations, Tenant and Tenant's contractors (which shall first be reasonably approved by Landlord) shall have the right and access to install, repair, replace, remove, operate and maintain one (1) so-called "satellite dish" or other similar device, such as antennae (collectively, "Communication Equipment") no greater than one (1) meter in diameter, together with all cable, writing, conduits and related equipment, for the purpose of receiving and sending radio, television, computer, telephone or other communication signals at a location on the roof of the Project designated by Landlord. Landlord shall have the right to require Tenant to relocate the Communication Equipment (at Landlord's cost) at any time to another location on the roof of the Project reasonably approved by Tenant. Tenant shall retain Landlord's roofing contractor to make any necessary penetrations and associated repairs to the roof in order to preserve Landlord's roof warranty. Tenant's installation and operation of the Communication Equipment shall be governed by the following terms and conditions: (a) Tenant's right to install, replace, repair, remove, operate and maintain the Communication Equipment shall be subject to all governmental laws, rules and regulations, and Landlord makes no representation that such laws, rules and regulations permit such installation and operation. (b) All plans and specifications for the Communication Equipment shall be subject to Landlord's reasonable approval. (c) All costs of installation, operation, maintenance and removal (and restoration of the Project due to such removal) of the Communication Equipment and any necessary related equipment (including, without limitation, costs of obtaining any necessary permits and connections to the Project's electrical system) shall be borne by Tenant. (d) It is expressly understood that Landlord retains the right to use the roof of the Project for any purpose whatsoever provided that Landlord shall not unduly interfere with Tenant's use of the Communication Equipment. (e) Tenant shall use the Communication Equipment so as not to cause any interference to other tenants in the Project or with any other tenant's Communication Equipment (installed prior to Tenant's installation), and not to damage the Project or interfere with the normal operation of the Project. (f) Landlord shall not have any obligations with respect to the Communication Equipment. Landlord makes no representation that the Communication Equipment will be able to receive or transmit communication signals without interference or disturbance (whether or not by reason of the installation or use of similar equipment by others on the roof of the Project) and Tenant agrees that Landlord shall not be liable to Tenant therefor. (g) Tenant shall (i) be solely responsible for any damage caused as a result of the Communication Equipment; (ii) promptly pay any tax, license or permit fees charged pursuant to any laws or regulations in connection with the installation, maintenance or use of the Communication Equipment and comply with all precautions and safeguards recommended by all 41 governmental authorities; and (iii) pay for all necessary repairs, replacements to or maintenance of the Communication Equipment. (h) The Communication Equipment shall remain the sole property of Tenant. Tenant shall remove the Communication Equipment and related equipment at Tenant's sole cost and expense upon the expiration or sooner termination of this Lease or upon the imposition of any governmental law or regulation which may require removal, and shall repair the Project upon such removal to the extent required by such work of removal. If Tenant fails to remove the Communication Equipment and repair the Project within fifteen (15) days after the expiration or earlier termination of this Lease, Landlord may do so at Tenant's expense. The provisions of this Article 36 shall survive the expiration or earlier termination of this Lease. (i) The Communication Equipment shall be deemed to constitute a portion of the Premises for purposes of the Basic Lease Provisions of this Lease (j) Tenant shall be solely responsible for the cost of removal of the Communication Equipment from the Project, and for the cost of repairing and restoring the Project to its condition immediately prior to the communication equipment being installed. ARTICLE 37 - Limited Arbitration/Dispute Resolution Procedure - ------------------------------------------------------------- The submittal of all matters to arbitration in accordance with the terms of this Article 37 shall be the sole and exclusive method, means and procedure to resolve any and all claims, disputes or disagreements of Fifty Thousand Dollars ($50,000.00) or less arising under this Lease, except for (a) determination of First Offer Rent and Fair Market Rental Rate, which shall be determined in accordance with the applicable Articles above, (b) all claims by either party which (i) seek anything other than enforcement of rights under this Lease, or (ii) are primarily founded upon matters of fraud, wilful misconduct, bad faith or any other allegations of tortious action, and seek the award of punitive or exemplary damages, and (c) claims relating to Landlord's exercise of any unlawful detainer rights pursuant to California law or rights or remedies used by Landlord to gain possession of the Premises or terminate Tenant's right of possession to the Premises. Should there be a dispute under the Lease for amounts less than Fifty Thousand Dollars ($50,000.00), and accepted pursuant to (a), (b) or (c) above, then such procedure shall be that Landlord and Tenant shall select an arbitrator, which arbitrator shall be selected and qualified pursuant to the rules of the Judicial Arbitration and Mediation Service (such arbitrator to be selected by a process by which each party either agrees upon a third party arbitrator or selects an independent third party, each of which independent third party shall meet and agree upon such arbitrator, and, failing to agree within fifteen (15) days after the commencement of such process, such arbitrator shall be selected by the rules of the Judicial Arbitration Mediation Service without regard to input by Landlord and Tenant) and whose costs shall be paid for by the losing party unless it is not clear that there is a "losing" party, in which event the costs of arbitration shall be shared equally. The purpose of the use of an arbitrator to resolve such dispute is to avoid the delays incident to the court calendar system of the jurisdiction within which the Premises are located. Therefore, the parties agree that if the issue in dispute between Landlord and Tenant under this Article may be expected to be resolved under the then current calendar of the court of appropriate jurisdiction within a period not exceeding six (6) months from the date the issue 42 is in dispute arises, then the arbitration process described hereinabove shall not be utilized, and the matter shall proceed through the judicial process in the court of appropriate jurisdiction. IN WITNESS WHEREOF, the parties have executed this Lease, consisting of the foregoing provisions and Articles, including all exhibits and other attachments referenced therein, as of the date first above written. "TENANT" "LANDLORD" SmarTalk Teleservices, Inc., LAOP, IV, LLC, a Nevada limited a California corporation liability company, By: Metropolitan Falls Partners, a California general partnership By: /s/ Robert H. Lorsch Its: Managing Member ---------------------------------- Robert H. Lorsch, Chairman, CEO By: /s/ Richard S. Ziman ------------------------- By: /s/ Bruce W. Bielinski Richard S. Ziman, ---------------------------------- Managing General Partner Bruce W. Bielinski, M.D. Secretary By: /s/ Victor J. Coleman ------------------------- Victor J. Coleman, Executive Officer 43 EXHIBIT "B" ----------- RULES AND REGULATIONS 1. No sign, advertisement or notice shall be displayed, printed or affixed on or to the Premises or to the outside or inside of the Building or so as to be visible from outside the Premises or Building without Landlord's prior written consent. Landlord shall have the right to remove any non-approved sign, advertisement or notice, without notice to and at the expense of Tenant, and Landlord shall not be liable in damages for such removal. All approved signs or lettering on doors and walls shall be printed, painted, affixed or inscribed at the expense of Tenant by Landlord or by a person selected by Landlord and in a manner and style acceptable to Landlord. 2. Tenant shall not obtain for use on the Premises ice, drilling water, waxing, cleaning, interior glass polishing, rubbish removal, towel or other similar services, or accept barbering or bootblackening, or coffee cart services, milk, soft drinks or other like services on the Premises, except from persons authorized by Landlord and at the hours and under regulations fixed by Landlord. No vending machines or machines of any description shall be installed, maintained or operated upon the Premises without Landlord's prior written consent. 3. The sidewalks, hall, passages, exits, entrances, elevators and stairways shall not be obstructed by Tenant or used for any purpose other than for ingress and egress from Tenant's Premises. 4. Toilet rooms, toilets, urinals, wash bowls and other apparatus shall not be used for any purpose other than for which they were constructed and no foreign substance of any kind whatsoever shall be thrown therein. 5. Tenant shall not overload the floor of the Premises or mark, drive nails, screw or drill into the partitions, ceilings or floor or in any way deface the Premises. 6. In no event shall Tenant place a load upon any floor of the Premises or portion of any such flooring exceeding the floor load per square foot of area for which such floor is designed to carry and which is allowed by law, or any machinery or equipment which shall cause excessive vibration to the Premises or noticeable vibration to any other part of the Building. Prior to bringing any heavy safes, vaults, large computers or similarly heavy equipment into the Building, Tenant shall inform Landlord in writing of the dimensions and weights thereof and shall obtain Landlord's consent thereto, which consent Landlord shall have the right to deny. Such consent shall not constitute a representation or warranty by Landlord that the safe, vault or other equipment complies, with regard to distribution of weight and/or vibration, with the provisions of this Rule 6 nor relieve Tenant from responsibility for the consequences of such noncompliance, and any such safe, vault or other equipment which Landlord determines to constitute a danger of damage to the Building or a nuisance to other Tenants, either alone or in combination with other heavy and/or vibrating objects and equipment, shall be promptly removed by Tenant upon Landlord's written notice of such determination and demand for removal thereof. 1 7. Tenant shall not use or keep in the Premises or Project any kerosene, gasoline or inflammable, explosive or combustible fluid or material, or use any method of heating or air-conditioning other than that supplied by Landlord. 8. Tenant shall not lay linoleum, tile, carpet or other similar floor covering so that the same shall be affixed to the floor of the Premises in any manner except as approved by Landlord. 9. Tenant shall not install or use any blinds, shades, awnings or screens in connection with any window or door of the Premises and shall not use any drape or window covering facing any exterior glass surface other than the standard drapes, blinds or other window covering. 2 EXHIBIT "C" NOTICE OF LEASE TERM DATES AND TENANT'S PERCENTAGE TO: _______________________________ DATE: _____________________________ _______________________________ _______________________________ RE: Lease dated __________________, 19___, between __________________________ ________________________ ("Landlord"), and ___________________________________ ("Tenant"), concerning Suite ________, located at ____________________________. Gentlemen: In accordance with the Lease, Landlord wishes to advise and/or conform the following: 1. That the Premises have been accepted herewith by the Tenant as being substantially complete in accordance with the Lease and that there is no deficiency in construction. 2. That the Tenant has taken possession of the Premises and acknowledges that under the provisions of the Lease the term of said Lease shall commence as of ___________________________ for a term of ________________ ending on _________________________________. 3. That in accordance with the Lease, Basic Rental commenced to accrue on ___________________. 4. If the Commencement Date of the Lease is other than the first day of the month, the first billing will contain a pro rata adjustment. Each billing thereafter shall be for the full amount of the monthly installment as provided for in said Lease. 5. Rent is due and payable in advance on the first day of each and every month during the term of said Lease. Your rent checks should be made payable to _____________________ at ___________________________ ___________________________________________________________. 6. The exact number of rentable square feet within the Premises is ________ square feet. 1 7. Tenant's Percentage, as adjusted based upon the exact number of rentable square feet within the Premises is _______%. AGREED AND ACCEPTED: TENANT: ______________________________________ By:___________________________________ Its:__________________________________ 2 AMENDMENT NO. 1 TO LEASE AGREEMENT ---------------------------------- THIS AMENDMENT NO. 1 TO LEASE ("Agreement") dated as of this 16th day of January, 1996 by and between LAOP IV, LLC, a Nevada limited liability company ("Landlord") and SMARTALK TELESERVICES, INC., a California corporation ("Tenant"), with reference to the following recitals: A. Landlord and Tenant entered into that certain Lease dated January 10, 1996 ("Lease") for Suite 500, consisting of approximately 6,795 rentable square feet ("Premises"), located in the building at 1640 Sepulveda Boulevard, Los Angeles, California 90025, known as Westwood Terrace ("Project"). B. Pursuant to Article 32 of the Lease, Landlord has provided Tenant with notice of the availability of approximately 1,729 rentable square feet of contiguous space ("First Refusal Space") to the Premises and Tenant has provided Landlord with written notification of its intent to exercise its right of first refusal to lease the First Refusal Space. C. Landlord and Tenant desire to amend the Lease to include the First Refusal Space as part of the Premises on the terms and conditions hereinafter set forth. NOW, THEREFORE, in consideration of the terms, covenants and conditions as set forth in the Lease and in this Agreement, the sufficiency and adequacy of which is hereby acknowledged, Landlord and Tenant hereby agree to amend the Lease as follows: 1. PREMISES: Article 1.B of the Lease shall be amended to delete the --------- number "6,795" as the definition of rentable square feet of the Premises and to replace it with the number "8,524" thereby reflecting that the Premises shall be defined as for all purposes under the Lease approximately 8,524 rentable square feet as designated on the plan attached hereto and incorporated in the Lease as Exhibit "A." 2. BASIC RENTAL: Article 1.C of the Lease shall be amended to reflect ------------- that Tenant shall pay to Landlord as Monthly Base Rental during the Lease term, the following amounts:
Months Monthly Basic Rental Annual Basic Rent ------ -------------------- ----------------- 1 through 6 $15,684.16 $188,209.92 7 through 9 Free -0- 10 through 15 $10,740.24 $128,882.88 16 through 72 $15,684.16 $188,209.92
1 3. TENANT'S PROPORTIONATE SHARE: Article 1.E of the Lease shall be ----------------------------- amended by deleting the number "4.99045%" as the definition of Tenant's Proportionate Share under the Lease and replacing it with the number "6.26039%" reflecting that Tenant's Proportionate Share shall be defined as for all purposes under the Lease as 6.26039%. 4. SECURITY DEPOSIT: Article 1.F of the Lease shall be amended to ----------------- reflect that Tenant's security deposit shall be increased to $58,474.64. Landlord and Tenant acknowledge that Tenant has previously paid Landlord $46,613.70 towards the security deposit and that upon execution of this Agreement, Tenant shall pay Landlord the balance of the security deposit in the amount of $11,860.94. Landlord agrees to return to Tenant a portion of the security deposit equal to $43,855.98 at the start of the thirty-seventh (37th) month after the Commencement Date, provided: (1) Tenant is not then in material default under the Lease, and (2) Tenant has not had more than three (3) material financial defaults under the Lease prior to such thirty- seventh (37th) month. 5. PARKING PASSES: Article 1.1 of the Lease shall be amended to reflect --------------- that Tenant shall be entitled to twenty-six (26) unreserved parking spaces. Five (5) of the twenty-six (26) parking spaces located in the Project's parking structure may be reserved parking spaces. The charges for all parking spaces shall be as set forth in the Lease. 6. FIRST MONTH'S RENT: Article 1.K of the Lease shall be amended to ------------------- reflect that the first month's rent for the Premises is $15,684.16. Landlord and Tenant acknowledge that Tenant has previously paid Landlord $12,502.80 towards the first month's rent and that upon execution of this Agreement Tenant shall pay Landlord the balance of the first month's rent in the amount of $3,181.36. 7. REPAIRS AND ALTERATIONS: Article 9 of the Lease shall be amended to ------------------------ reflect that the Tenant Improvement Allowance shall be Ten Dollars and Fifty Cents ($10.50) for each usable square foot of space in the Premises, for a total of $77,826.00. 8. OPTION TO CANCEL: Article 35 of the Lease shall be amended to ----------------- reflect that the cancellation fee shall be equal to the sum of (a) the outstanding balance of the Loan (defined in Article 9 of the Lease), (b) the unamortized portion of (i) the Tenant Improvements in the amount of Seventy Seven Thousand Eight Hundred and Twenty-Six Dollars ($77,826.00), (ii) brokerage commissions in the amount of Fifty Seven Thousand Five Hundred Six Dollars and thirty-Two Cents ($57,506.32), and (iii) Seventy-Six Thousand Seven Hundred Sixteen Dollars ($76,716.00) in rent concessions paid and given by Landlord in connection with the Lease and this Agreement, and (c) Fifty-Eight Thousand Four Hundred Seventy-Four Dollars and Sixty-Four Cents ($58,474.64) which equals four (4) months' rental (calculated at the effective rate). 2 9. CAPITALIZED TERMS: Except as otherwise expressly provided herein to ------------------ the contrary, all capitalized terms used in this First Amendment to Lease shall have the same meanings given such terms in the Lease. 10. APPLICABILITY OF LEASE: All terms, covenants and conditions of the ----------------------- Lease, except as expressly amended herein are hereby ratified and shall continue in full force and effect throughout the term of the Lease, including any extension or renewal thereof. The terms, covenants and conditions expressly amended herein shall become effective upon the execution of this First Amendment to Lease Agreement by both Landlord and Tenant and the full and complete satisfaction of each and every one of the conditions set forth in Paragraphs 4 and 6 above. 11. AUTHORIZATION: Each individual and entity executing this First -------------- Amendment to Lease Agreement hereby represents and warrants that it has the capacity set forth on the signature page hereof with full power and authority to bind the party on whose behalf it is executing this First Amendment to Lease Agreement, to the terms hereof. IN WITNESS WHEREOF, the parties have executed this Agreement on the day and date first written above. "LANDLORD" "TENANT" LAOP IV, LLC, a Nevada limited SMARTALK TELESERVICES, INC., a liability company California corporation By: Metropolitan Falls Partners, a By: /s/ Robert H. Lorsch California general partnership -------------------------------- Its: Managing Member Robert H. Lorsch, Chairman, CEO By: /s/ Bruce W. Bielinski By: /s/ Richard S. Ziman ------------------------------- -------------------------------- Bruce W. Bielinski, M.D., Richard S. Ziman, Managing Secretary General Partner By: /s/ Victor J. Coleman ------------------------------------- Victor J. Coleman, Executive Officer 3 AMENDMENT NO. 2 TO LEASE AGREEMENT ---------------------------------- THIS AMENDMENT NO. 2 TO LEASE ("Agreement") dated as of this 7th day of February, 1996 by and between LAOP IV, LLC, a Nevada limited liability company ("Landlord") and SMARTALK TELESERVICES, INC., a California corporation ("Tenant"), with reference to the following recitals: A. Landlord and Tenant entered into that certain Lease dated January 10, 1996 ("Lease") for Suite 500, consisting of approximately 6,795 rentable square feet ("Premises"), located in the building at 1640 Sepulveda Boulevard, Los Angeles, California 90025, known as Westwood Terrace ("Project"). The Lease was subsequently amended in or about February, 1996, to include approximately 1,729 rental square feet of additional contiguous space. The Lease and the Amendment are collectively referred to herein as the "Lease" and the term "Premises" includes the original Premises and the additional space added pursuant to the Amendment. B. Landlord and Tenant desire to amend the Lease to, among other matters, change the Commencement Date set forth in the Lease on the terms and conditions hereinafter set forth. NOW, THEREFORE, in consideration of the terms, covenants and conditions as set forth in the Lease and in this Agreement, the sufficiency and adequacy of which is hereby acknowledged, Landlord and Tenant hereby agree to amend the Lease as follows: 1. COMMENCEMENT DATE: Article 1.A of the Lease shall be amended by ------------------ deleting the following language: "On the later of (i) February 1, 1996," and replacing it with the following language: "The earlier of (i) March 25, 1996," 2. CAPITALIZED TERMS: Except as otherwise expressly provided herein to ------------------ the contrary, all capitalized terms used in this Agreement shall have the same meanings given such terms in the Lease. 3. APPLICABILITY OF LEASE: All terms, covenants and conditions of the ----------------------- Lease, except as expressly amended herein are hereby ratified and shall continue in full force and effect throughout the term of the Lease, including any extension or renewal thereof. The terms, covenants and conditions expressly amended herein shall become effective upon the execution of this Agreement by both Landlord and Tenant. 4. AUTHORIZATION: Each individual and entity executing this Agreement -------------- hereby represents and warrants that it has the capacity set forth on the signature page 1 hereof with full power and authority to bind the party on whose behalf it is executing this Agreement. "LANDLORD" "TENANT" LAOP IV, LLC, a Nevada limited SMARTALK TELESERVICES, INC., a liability company California corporation By: Metropolitan Falls Partners, a By: /s/ Robert H. Lorsch California general partnership --------------------------- Its: Managing Member Robert H. Lorsch, Chairman CEO By: /s/ Richard S. Ziman By: /s/ Bruce W. Bielinski --------------------------- ------------------------- Richard S. Ziman, Managing Bruce W. Bielinski, M.D., General Partner Secretary By: /s/ Victor J. Coleman ------------------------------------- Victor J. Coleman, Executive Officer 2 AMENDMENT NO. 3 TO LEASE AGREEMENT ---------------------------------- THIS AMENDMENT NO.3 TO LEASE ("Agreement") dated as of this 19th day of April, 1996 by and between LAOP IV, LLC, a Nevada limited liability company ("Landlord") and SMARTALK TELESERVICES, INC., a California corporation ("Tenant"), with reference to the following recitals: A. Landlord and Tenant entered into that certain Lease dated January 10, 1996 ("Lease") for Suite 500, consisting of approximately 6,795 rentable square feet ("Premises"), located in the building at 1640 Sepulveda Boulevard, Los Angeles, California 90025, known as Westwood Terrace ("Project"). The Lease was subsequently amended ("Amendment No. 1") in or about January or February, 1996, to, among other things, include approximately 1,729 rental square feet of additional contiguous space, and further amended on February 7, 1996, ("Amendment No. 2") to, among other things, recalculate the Commencement Date under the Lease. The Lease and the amendments are collectively referred to herein as the "Lease," and the term "Premises" includes the original Premises and the additional space added pursuant to Amendment No. 1. B. Landlord and Tenant desire to amend the Lease to, among other matters, document the Loan to Tenant for construction of the Tenant Improvements and the increase in Monthly Basic Rental for the repayment of the Loan, as more specifically set forth in the Lease, on the terms and conditions hereinafter set forth. C. Except as otherwise stated herein, all capitalized and defined terms have the same meaning as set forth in the Lease. NOW, THEREFORE, in consideration of the terms, covenants and conditions as set forth in the Lease and in this Agreement, the sufficiency and adequacy of which is hereby acknowledged, Landlord and Tenant hereby agree to amend the Lease as follows: 1. LOAN: Upon the presentation of invoices, approved by Tenant, Landlord ----- hereby agrees to pay to Tenant's contractor an amount up to the sum of Twenty-two Thousand Two Hundred Thirty-Six Dollars ($22,236.00) representing the Loan for the Excess Costs as defined in Article 9 of the Lease. The total obligation of Landlord with respect to disbursements for the Tenant Improvements (i.e., the Loan and the Tenant Improvement Allowance) is confirmed to be One Hundred Thousand Sixty-two Dollars ($100,062.00). Tenant agrees hereby to repay the Loan by amortizing the Loan over the initial Lease term and increasing Monthly Basic Rental by .06 cents per rentable square foot each month as set forth in paragraph 2 below. 1 2. BASIC RENTAL: Article I.C. of the Lease and Paragraph 2 of Amendment ------------- No. 1 shall be amended to reflect that Tenant shall pay to Landlord as Monthly Basic Rental during the Lease term, the following amounts (which includes the repayment of the Loan with interest):
Months Monthly Basic Rental Annual Basic ------ -------------------- Rent ------------ 1 through 6 $16,195.60 $194,347.20 7 through 9 $ 511.44 $ 6,137.28 10 through 15 $11,251.68 $135,020.16 16 through 72 $16,195.60 $194,347.20
3. RENTAL ADJUSTMENT: Pursuant to the provisions of Paragraph 6 of ------------------ Amendment No. 1, Tenant has prepaid a monthly installment of Monthly Basic Rental attributable to the initial Monthly Basic Rental due under the Lease. However, as a result of the adjustment of the Monthly Basic Rental set forth in Paragraph 2 above, Tenant has underpaid the monthly installments of Monthly Basic Rental, since the Commencement Date. Therefore, concurrent with Tenant's execution of this Agreement, Tenant shall pay to Landlord an amount equal to $511.44. 4. APPLICABILITY OF LEASE: All terms, covenants and conditions of the ----------------------- Lease, except as expressly amended herein are hereby ratified and shall continue in full force and effect throughout the term of the Lease, including any extension or renewal thereof. The terms, covenants and conditions expressly amended herein shall become effective upon the earlier of (i) disbursement of the Loan to Tenant, or (ii) execution of this Agreement by both Landlord and Tenant. 5. AUTHORIZATION: Each individual and entity executing this Agreement -------------- hereby represents and warrants that it has the capacity set forth on the signature page hereof with full power and authority to bind the party on whose behalf it is executing this Agreement. 6. DEFAULTS: As of the date of this Agreement, Tenant hereby represents --------- and warrants to Landlord that Tenant is in full compliance with all terms, covenants and conditions of the Lease and that there are no breaches or defaults under the Lease by Landlord or Tenant, and Tenant knows of no events or circumstances which given the passage of time would constitute a default under the Lease by either Landlord or Tenant. 2 IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and date first written above. "LANDLORD" "TENANT" LAOP IV, LLC, a Nevada limited SMARTALK TELESERVICES, INC., a liability company California corporation By: Metropolitan Falls Partners, a California general partnership Its: Managing Member By: /s/ Robert H. Lorsch ------------------------------ Robert H. Lorsch, Chairman, CEO By: /s/ Richard S. Ziman ---------------------- Richard S. Ziman, Managing By: /s/ Bruce W. Bielinski General Partner ------------------------------ Bruce W. Bielinski, M.D., Secretary By: /s/ Vicor J. Coleman ---------------------- Victor J. Coleman, Executive Officer 3 NOTICE OF LEASE TERM DATES AND TENANT'S PERCENTAGE -------------------------------------------------- TO: Robert H. Lorsch, Chairman, CEO DATE: April 25, 1996 Bruce W. Bielinski, M.D., Secretary SMARTALK TELESERVICES, INC. 1640 S. Sepulveda Blvd., Suite 500 Los Angeles, CA 90025 RE: Lease dated January 10, 1996, Amendment No. 1 dated January 30, 1996, Amendment No. 2 dated February 7, 1996 and Amendment No. 3 dated April 19, 1996, between LAOP IV, LLC, a Nevada limited liability company ("Landlord") and SMARTALK TELESERVICES, INC., a California corporation ("Tenant"), concerning Suite 500, located at 1640 S. Sepulveda Boulevard, Los Angeles, California. Gentlemen: In accordance with the Lease, Landlord wishes to advise and/or confirm the following: 1. That the Premises have been accepted herewith by the Tenant as being substantially complete in accordance with the Lease and that there is no deficiency in construction. 2. That the Tenant has taken possession of the Premises and acknowledges that under the provisions of the Lease term of said Lease shall commence as of March 11, 1996 for a term of seventy-two months ending on March 31, 2002. 3. That in accordance with the Lease Basic Rental commenced to accrue on March 11, 1996. 4. If the Commencement Date of the Lease is other than the first day of the month, the first billing will contain a pro rata adjustment. Each billing thereafter shall be for the full amount of the monthly installment as provided for in said Lease. 5. Rent is due and payable on the first day of each and every month during the term of said Lease. Your rent checks should be made payable to Hanford/Healy Agent for LBHI at P.O. Box 54177, Los Angeles, California 90051- 4177. 6. The exact number of rentable square feet within the Premises is 8,524 square feet. 1 7. Tenant's Percentage, as adjusted based upon the exact number of rentable square feet within the Premises is 6.26039%. AGREED AND ACCEPTED: TENANT: SMARTALK TELESERVICES, INC. - --------------------------- By: /s/ Robert H. Lorsch ------------------------ Robert H. Lorsch Its: Chairman, CEO By: /s/ Bruce W. Bielinski ------------------------ Bruce W. Bielinski, M.D. Its: Secretary 2 RENT SCHEDULE ------------- Tenant: SmartTalk Teleservices, Inc.
Commencement Termination Rental $ Month 03/11/96 03/31/96 10,971.21 04/01/96 04/30/96 16,195.60 1 05/01/96 05/31/96 16,195.60 2 06/01/96 06/30/96 16,195.60 3 07/01/96 07/31/96 16,195.60 4 08/01/96 08/31/96 16,195.60 5 09/01/96 09/30/96 16,195.60 6 - ---------------------------------------------------- 10/01/96 10/31/96 511.44 7 11/01/96 11/30/96 511.44 8 12/01/96 12/31/96 511.44 9 - ---------------------------------------------------- 01/01/97 01/31/97 11,251.68 10 02/01/97 02/28/97 11,251.68 11 03/01/97 03/31/97 11,251.68 12 04/01/97 04/30/97 11,251.68 13 05/01/97 05/31/97 11,251.68 14 06/01/97 06/30/97 11,251.68 15 - ---------------------------------------------------- 07/01/97 07/31/97 16,195.60 16 08/01/97 08/31/97 16,195.60 17 09/01/97 09/30/97 16,195.60 18 10/01/97 10/31/97 16,195.60 19 11/01/97 11/30/97 16,195.60 20 12/01/97 12/31/97 16,195.60 21 01/01/98 01/31/98 16,195.60 22 02/01/98 02/28/98 16,195.60 23 03/01/98 03/31/98 16,195.60 24 04/01/98 04/30/98 16,195.60 25 05/01/98 05/31/98 16,195.60 26 06/01/98 06/30/98 16,195.60 27 07/01/98 07/31/98 16,195.60 28 08/01/98 08/31/98 16,195.60 29 09/01/98 09/30/98 16,195.60 30 10/01/98 10/31/98 16,195.60 31 - -------------------------------------------------
1
Commencement Termination Rental $ Month 11/01/98 11/30/98 16,195.60 32 12/01/98 12/31/98 16,195.60 33 01/01/99 01/31/99 16,195.60 34 02/01/99 02/28/99 16,195.60 35 03/01/99 03/31/99 16,195.60 36 - ---------------------------------------------------- Security 04/01/99 04/30/99 16,195.60 37 Deposit - ---------------------------------------------------- Refund 05/01/99 05/31/99 16,195.60 38 06/01/99 06/30/99 16,195.60 39 07/01/99 07/31/99 16,195.60 40 08/01/99 08/31/99 16,195.60 41 09/01/99 09/30/99 16,195.60 42 10/01/99 10/31/99 16,195.60 43 11/01/99 11/30/99 16,195.60 44 12/01/99 12/31/99 16,195.60 45 01/01/00 01/31/97 16,195.60 46 02/01/00 02/29/00 16,195.60 47 03/01/00 03/31/00 16,195.60 48 04/01/00 04/30/00 16,195.60 49 05/01/00 05/31/00 16,195.60 50 06/01/00 06/30/00 16,195.60 51 07/01/00 07/31/00 16,195.60 52 08/01/00 08/31/00 16,195.60 53 09/01/00 09/30/00 16,195.60 54 10/01/00 10/31/00 16,195.60 55 11/01/00 11/30/00 16,195.60 56 12/01/00 12/31/00 16,195.60 57 01/01/01 01/31/01 16,195.60 58 02/01/01 02/28/01 16,195.60 59 03/01/01 03/31/01 16,195.60 60 04/01/01 04/30/01 16,195.60 61 05/01/01 05/31/01 16,195.60 62 06/01/01 06/30/01 16,195.60 63 07/01/01 07/31/01 16,195.60 64 - ----------------------------------------------------
2
Commencement Termination Rental $ Month 08/01/01 08/31/01 16,195.60 65 09/01/01 09/30/01 16,195.60 66 10/01/01 10/31/01 16,195.60 67 11/01/01 11/30/01 16,195.60 68 12/01/01 12/31/01 16,195.60 69 01/01/02 01/31/02 16,195.60 70 02/01/02 02/28/02 16,195.60 71 03/01/02 03/31/02 16,195.60 72 - ---------------------------------------------------- 1,100,338.41 ===============
3 EX-10.13 14 CARRIER AGREEMENT EXHIBIT 10.13 Carrier Agreement dated November 9, 1995 between Registrant and MCI Telecommunications Corporation.* - ------------------------ * Confidential treatment has been requested. The copy filed as an exhibit omits information subject to the confidentiality request. EX-10.14 15 1ST AMENDMENT TO CARRIER AGREEMENT EXHIBIT 10.14 First Amendment to Carrier Agreement dated March 2, 1996 between Registrant and MCI Telecommunications Corporation.* - --------------------------- * Confidential treatment has been requested. The copy filed as an exhibit omits information subject to the confidentiality request. EX-10.15 16 AGREEMENT OF SMARTALK AND WEST INTERACTIVE EXHIBIT 10.15 Agreement dated October 4, 1995 between Registrant and West Interactive Corporation.* - -------------------------- * Confidential treatment has been requested. The copy filed as an exhibit omits information subject to the confidentiality request. EX-10.16 17 SECURITY AGREEMENT 8-9-96 EXHIBIT 10.16 SECURITY AGREEMENT ------------------ This Security Agreement (the "Agreement"), dated as of August 9, 1996, is executed by SmarTalk TeleServices, Inc., a California corporation, for the benefit of SmarTalk Partners, LLC. 1. Definitions ----------- a. "Collateral" includes all personal property of Debtor, whether tangible or intangible, wherever located or situated, whether now owned or hereafter acquired by Debtor, including without limitation: (i) existing and future accounts receivable, including accounts, instruments, documents, chattel paper, and general intangibles in which Debtor has or later acquires rights; (ii) contract rights; (iii) rights as lessee under any lease of office space, including all furnishings, fixtures and improvements, and personal property; (iv) equipment; (v) inventory, including raw materials, work-in-process, and finished goods; (vi) accounts, deposits and certificates; (vii) general intangibles; and (viii) all proceeds, products, additions, replacements and substitutes of any and all of the above. b. "Debtor" means SmarTalk TeleServices, Inc. c. "Event of Default" is as defined in the Promissory Note. d. "Indebtedness" means all of Debtor's obligations to Secured Party arising under the Promissory Note and for all current and future loans, advances, and debt obligations, attorneys' fees and out-of-pocket costs, interest on those fees and costs at the rate specified in the Promissory Note from the date incurred arising thereunder. "Indebtedness" shall include, without limitation, all past, current and future attorneys' fees and out-of- pocket costs, and interest on those fees and costs at annual rate as specified in the Promissory Note from the date billed, concerning or relating to advances or loans by Secured Party to or on behalf of Debtor pursuant to the Promissory Note. e. "Obligations" means existing and future Indebtedness, including any non-monetary liabilities of Debtor to Secured Party, and obligations under the Promissory Note and this Agreement, including attorneys' fees and costs incurred in enforcing this Agreement or collecting payment under it. f. "Promissory Note" means that certain promissory note of even date executed by Debtor for the benefit of Secured Party in the principal amount of Two Hundred Fifty Thousand Dollars ($250,000). g. "Secured Party" means SmarTalk Partners, LLC. h. Terms defined in the California Commercial Code (the "Code") not otherwise defined in this Agreement are used in this Agreement as defined in the Code on the date of this Agreement. Capitalized terms used herein and not defined herein shall have the meanings ascribed to them in the Loan Agreement. 2. Security Interest. As consideration for Secured Party's loan to ----------------- Debtor of $250,000 Debtor grants Secured Party a security interest in the Collateral to secure payment of the Obligations. The security interest is subject to the following: a. Debtor represents that, with the exception of rights granted to Secured Party, Debtor is the sole legal and equitable owner of 100% of the Collateral and has not previously transferred, assigned, pledged, or hypothecated any interest in any of the Collateral, except with respect to (i) liens granted in favor of SmarTalk Partners LLC with respect to the Term Note and the Line of Credit Note (as such terms are defined in that certain Subordination Agreement, dated August 9, 1996, among SmarTalk Partners, LLC, Lorsch Creative Network, Inc. and SmarTalk Teleservices, Inc. (the "Subordination Agreement")), and (ii) liens granted in favor of LCN with respect to the LCN Note (as such terms are defined in the Subordination Agreement); provided, however, that Debtor agrees that the proceeds of any indebtedness incurred by Debtor (other than accounts receivable financing and equipment leases to the extent permitted in Section 2.b.) and any proceeds of any equity financing by Debtor shall be utilized to prepay the Indebtedness secured hereby. b. Debtor will not transfer, assign, pledge or hypothecate any interest in the Collateral until it satisfies the Obligations in full owed to Secured Party, except with respect to (i) liens granted in favor of SmarTalk Partners LLC with respect to the Term Note and the Line of Credit Note, (ii) liens granted in favor of LCN with respect to the LCN Note and (iii) liens to secure accounts receivable financing and equipment leases not to exceed 2 $500,000 in the aggregate; provided, however, that Debtor agrees that the proceeds of any indebtedness incurred by Debtor (other than such accounts receivable and equipment lease indebtedness) and any proceeds of any equity financing by Debtor shall be utilized to prepay the Indebtedness secured hereby. c. Secured Party's security interest shall be extinguished on full indefeasible payment of the Indebtedness. 3. Covenants by Debtor. Debtor promises: ------------------- a. In accordance with prudent industry practices to preserve, maintain, protect and insure the Collateral. b. To pay all expenses, including attorneys' fees, incurred by Secured Party in the perfection, preservation, realization, enforcement, and exercise of its rights under this Agreement. c. To indemnify Secured Party against loss of any kind, including reasonable attorneys' fees, caused to Secured Party by reason of its interest in the Collateral. d. Not to permit liens on the Collateral except to Secured Party, or except as contemplated by Sections 2.1. and 2.b. hereof. e. To execute and deliver to Secured Party all financing statements and other documents that Secured Party requests, in order to maintain a perfected first priority security interest in the Collateral. f. To maintain and to continue to maintain at Debtor's address listed in Paragraph 12 complete and accurate books and records comprising a standard modern accounting system in accordance with generally accepted accounting principles, consistently applied, that accurately and correctly record and reflect Debtor's income, expenses, liabilities, operations, accounts and ownership and location of the Collateral. Such books and records shall include all accounts, all payments received or credits granted thereon, and other dealings therewith. All such books and records and all documents relating to any of the Collateral are and shall continue to be genuine and will contain such information as may be reasonably requested by Secured Party. g. To promptly notify Secured Party in writing of any change of the address in its principal executive office and/or the location of any of the Collateral. 4. Appointment of Attorney in Fact. Upon the occurrence of, and during ------------------------------- the continuance of, an Event of Default, Debtor appoints 3 Secured Party as Debtor's attorney in fact, with the following powers: a. To perform any of Debtor's obligations hereunder and/or under the Promissory Note in Debtor's name or otherwise. b. To give notice of Debtor's right to payment, to enforce that right, and to make extension agreements with respect to it. c. To prepare and file financing statements, continuation statements, statements of assignment, termination statements, and the like, as necessary to perfect, protect, preserve, or release Secured Party's interest in the Collateral. d. To endorse Debtor's name on instruments, documents, or other forms of payment or security that come into Secured Party's possession. e. To accept cash in payment of the Obligations. 5. Termination; Release of Collateral. This Agreement will terminate when ---------------------------------- (a) Debtor satisfies the Indebtedness in full and completes performance of all Obligations to Secured Party; and (b) Secured Party has no commitment that could give rise to an Obligation. 6. Documents to Perfect. Debtor shall execute all required documents, -------------------- including UCC-1 financing statements, requested by Secured Party to effectuate and perfect the security interest granted hereunder. 7. Default. Debtor will be in default under this Agreement if any Event ------- of Default occurs pursuant to the Promissory Note. 8. Remedies. -------- a. Secured Party shall have all rights of a secured party under the California Commercial Code or the Uniform Commercial Code of any other jurisdiction, where necessary to enforce this Agreement. All such rights, powers and remedies shall be cumulative and may be exercised successively or concurrently in Secured Party's sole discretion without impairing its security interest, rights or available remedies. Secured Party's forbearance, failure or delay in exercising any right, power or remedy shall not preclude further exercise of that right, power or remedy which shall continue in effect unless and until it specifically waives it in writing. b. If Secured Party conducts a private sale of any Collateral by soliciting bids from 10 or more dealers or distributors in that type of Collateral, any such sale of 4 Collateral in bulk or in parcels, to the bidder submitting the highest cash bid, within 120 days of (i) Secured Party taking possession and control of the Collateral or (ii) when Secured Party is otherwise authorized to sell the Collateral (whichever occurs last), is a commercially reasonable sale of the Collateral. Commercially reasonable notice of any public or private sale is given to Debtor if Secured Party sends Debtor a notice of the sale at least 7 days before the date of any public sale (or 7 days before the time after which a private sale will be made). The purchase of any Collateral by a supplier, as provided in any agreement between Secured Party and the supplier, is a commercially reasonable disposition or sale of the Collateral. If Secured Party disposes of any Collateral other than as set forth in this subparagraph, the commercial reasonableness of the disposition will be determined in accordance with the laws of the State of California. Debtor will (i) pay Secured Party even if any Collateral is defective or fails to conform to any warranties extended by any third party, (ii) not assert against Secured Party any claim or defense it has against any third party and (iii) indemnify and hold Secured Party harmless against any claims or defenses asserted by any buyer of the Collateral relating to the condition of, or representations made about, any Collateral. Debtor waives all rights of offset against Secured Party. 9. Further Acts; Cooperation. The parties will execute all further ------------------------- documents reasonable, convenient, necessary or desirable to carry out this Agreement. The parties shall cooperate to effectuate the intent of this Agreement and the mutual benefits intended to be conferred under it. 10. Successors and Assigns. This Agreement shall be binding upon the ---------------------- parties and their respective heirs, successors and assigns. 11. Jurisdiction and Venue for Disputes. Any action relating to any ----------------------------------- dispute under this Agreement shall be litigated solely in the courts located in Los Angeles County, California. All parties consent to the jurisdiction in the State of California over all disputes and consent that venue is proper in Los Angeles County, California. 12. Notices. Any notice or other communication relating to this Agreement ------- shall be deemed effective when served as follows: IF TO SECURED PARTY: SmarTalk Partners, LLC 3 Civic Plaza Suite 170 Newport Beach, CA 92660 FAX: (714) 721-8102 5 IF TO DEBTOR: SmarTalk TeleServices, Inc. 1640 South Sepulveda Boulevard, Suite 500 Los Angeles, CA 90025 Attention: Mr. Robert H. Lorsch FAX: (310) 444-8822 Service shall be effected either: (1) by fax when the fax transmission is completed, provided a hard copy is deposited in the U.S. Mail within 24 hours of fax notice; or (2) by personal service when a copy is personally delivered to the person being served. If for any reason a party cannot readily serve the other either by fax or by personal delivery, service shall be proper if mailed to the party to be served at the address set forth above, certified mail, return receipt requested, with a copy to the party's respective attorney by first class mail, in which event, service shall be deemed effective on the third business day after deposit in the mails. A party's failure or refusal to sign a return receipt shall not invalidate the notice. Any party may change his or his address by notifying the other party in writing and supplying a new fax number. 13. Headings. Headings in this Agreement are for convenience only and -------- shall not be deemed a part of this Agreement. 14. Governing Law. This Agreement shall be interpreted and enforced in ------------- accordance with the laws of California. 15. Construction. All parties have cooperated in the drafting and ------------ preparation of this Agreement. Accordingly, no provision of this Agreement shall be construed for or against either party by virtue of its having drafted a specific provision. 16. Attorneys' Fees. If any dispute occurs relating to this Agreement, --------------- its alleged breach, its interpretation, the circumstances under which it was executed, or any other dispute pertaining to it, whether such dispute is based on contract, tort or equitable theories, the prevailing party shall recover his reasonable attorneys' fees and costs from the losing party. 17. Post-Judgment Fees. In addition to the attorneys' fees and costs ------------------ provided for in Paragraph 16 above, the parties agree that if any dispute between the parties results in a judgment in favor of either party, such party will be entitled to recover from the other all attorneys' fees and costs incurred by it in enforcing such judgment. This provision is intended to be severable from any other provision of this Agreement, and is not to be deemed merged in the judgment. 6 18. No Waiver. No waiver by Secured Party of any breach or default will --------- be a waiver of any breach or default occurring later. A waiver will be valid only if it is in writing and signed by Secured Party. 20. Integration. This Agreement (and the agreements referred to herein) ----------- is the entire agreement, and supersedes any prior agreement or understandings, between Secured Party and Debtor relating to its subject matter. There are no oral agreements pertaining to the subject matter of this Agreement, and this Agreement shall supersede all oral representations and statements by the parties. This Agreement may only be modified by a writing signed by the party to be charged. SMARTALK TELESERVICES, INC., a California corporation By: /s/ Robert H. Lorsch --------------------------- Robert H. Lorsch, President SMARTALK PARTNERS, LLC By: -------------------------- Amre Youness, Manager 7 EX-10.17 18 SUBORDINATION AGREEMENT 8-9-96 EXHIBIT 10.17 SUBORDINATION AGREEMENT ----------------------- FOR VALUE RECEIVED, the undersigned SmarTalk Partners, LLC (the "Investor") and Lorsch Creative Network, Inc. ("LCN") (the "Subordinated Holders") agree with SmarTalk Teleservices, Inc. (the "Maker") for the express, intended benefit of Investor that the indebtedness to LCN represented by the Subordinated Promissory Note, dated January 1, 1996 in the principal amount of $2,000,000 (the "LCN Note"), and the indebtedness to Investor represented by the Promissory Note Secured by Personal Property, dated December 28, 1995, in the principal amount of $1,200,000 (the "Term Note") and the Revolving Line of Credit Note, dated December 28, 1995, in the principal amount of $500,000 (the "Line of Credit Note") is subordinated in right of payment and priority to the prior payment in full of all indebtedness outstanding pursuant to the Promissory Note dated August 9, 1996 in the original principal amount of $250,000 (the "Investor Debt") owed by the Maker to the Investor, all on the following terms and conditions: 1. Until the date on which all Investor Debt shall be paid in full, without the written agreement of the Investor and each of the Subordinated Holders, no payment on account of all or any portion of the principal represented by the LCN Note, Term Note, or Line of Credit Note (the "Subordinated Debt") or any interest thereon shall be made either directly or indirectly by the Maker or any subsidiary or affiliate of the Maker, and the Maker shall not cancel, forgive or offset Subordinated Debt against any indebtedness owed by the Subordinated Holders to the Maker. Upon such date as all Investor Debt shall have been repaid in full, the provisions of this Section 1 shall be of no further force and effect. 2. If any Subordinated Debt becomes due and payable before its stated maturity date or upon any payment or distribution of assets of the Maker of any kind or character, whether in cash, properties or securities or by way of cancellation, forgiveness or offset of Subordinated Debt against any indebtedness owed by the Subordinated Holders to the Maker, whether upon any dissolution, winding up, liquidation or reorganization of the Maker, either voluntary or involuntary, or in bankruptcy, insolvency, receivership, reorganization, arrangement or other proceedings, or otherwise, then, in such event, all Investor Debt shall be paid in full before the holders of the Subordinated Debt shall be entitled to retain any assets so paid or distributed in respect of the Subordinated Debt. Any payment or distribution of assets of the Maker of any kind or character, whether in cash, property or securities or by way of cancellation, forgiveness or offset of Subordinated Debt against any indebtedness owed by the Subordinated Holders or any subsequent holder of the Subordinated Debt to the Maker which would be payable on account of the Subordinated Debt, except for these provisions, shall be paid by the Maker or by any receiver, trustee in bankruptcy, liquidating trustee, agent or other person making such payment or distribution, or by the holder of the Subordinated Debt directly to the Investor to the extent necessary to pay all Investor Debt in full before any payment or distribution is made on account of the Subordinated Debt. 3. Subject to the payment in full of all Investor Debt, the holders of the Subordinated Debt shall be subrogated to the rights of the holders of Investor Debt to receive payments or distributions of cash, property or securities of the Maker applicable to the Investor Debt until all amounts owing on the Subordinated Debt shall be paid in full, and, as between the Maker, its creditors other than holders of Investor Debt, and the holders of the Subordinated Debt, no such payment or distribution made to the holders of Investor Debt by virtue of this Subordination Agreement which otherwise would have been made to the holders of the Subordinated Debt shall be deemed to be a payment by the Maker on account of the Subordinated Debt, it being understood that the provisions of this Subordination Agreement are intended solely for the purpose of defining the relative rights of the holders of the Subordinated Debt, on the one hand, and the holder of the Investor Debt, on the other hand. 4. Nothing contained in this Subordination Agreement is intended to or shall impair, as between the Maker, its creditors other than the holders of Investor Debt, and the holders of the Subordinated Debt, the obligation of the Maker, which is absolute and unconditional, to pay to the holders of the Subordinated Debt the Subordinated Debt as and when the same shall become due and payable in accordance with its terms, or affect the relative rights of the holders of the Subordinated Debt and creditors of the Maker other than the holders of Investor Debt, nor shall anything herein prevent the holder of any Subordinated Debt from exercising all remedies otherwise permitted by applicable law upon default under any instrument defining the rights of holders of Subordinated Debt, subject to the rights, if any, under this Subordination Agreement of the holders of Investor Debt in respect of cash, property or securities of the Maker received upon the exercise of any such remedy. 5. Nothing contained herein, express or implied, shall give to any person, other than the holders of Investor Debt and the holders of Subordinated Debt, any benefit or any legal or equitable right, remedy or claim hereunder. 6. The term "indebtedness" as used herein is used in its most comprehensive sense and includes any and all advances, debts, obligations and liabilities of the Maker heretofore, now or hereafter made, incurred or created, whether voluntary or involuntary and however arising, whether due or not due, absolute 2 or contingent, liquidated or unliquidated, determined or undetermined, and whether the Maker may be liable individually or jointly with others, as principal or as surety or guarantor. 7. Notwithstanding anything to the contrary herein, Investor is entering into this Subordination Agreement solely for the purpose of establishing the priority of payment of the Investor Debt vis-a-vis the Term Note, the Line of Credit Note and the LCN Note. This Subordination Agreement shall not in any way affect the validity of that certain Subordination Agreement dated January 1, 1996 made by LCN and Maker for the benefit of Investor (the "Existing Subordination Agreement"). This Subordination Agreement shall not under any circumstances cause the subordination of the Term Note and Line of Credit Note to any obligation of Maker which may be held to be superior in right of payment or priority to the Investor Debt, but not to the Line of Credit Note or the Term Note; and in such case this Subordination Agreement shall terminate as to the Term Note and Revolving Line of Credit Note. 8. In consideration of LCN entering into the arrangements contemplated hereby, Maker hereby grants to LCN, and Investor hereby consents to the granting to LCN by Maker of, a perfected security interest in the Collateral (excluding the Transport Reserve Accounts as described in Section 5.2 of that certain Security Agreement dated December 28, 1995 between Maker and Investor); provided, however, that the security interests of Investor with respect to the Promissory Note, the Term Note and the Line of Credit Note shall at all times be prior and superior to the security interest hereby granted to LCN; the security interest granted to LCN pursuant to this Section 8 shall be subject to and governed by the Existing Subordination Agreement, so that LCN's security interest is subordinate in priority to the security interests of Investor and the obligation secured by LCN's security interest shall be subordinate in payment to Maker's obligations to Investor; and LCN shall execute such further documents and instruments which Investor shall request to evidence such prior and perfected security interests of Investor. 3 IN WITNESS WHEREOF, the undersigned has executed this Subordination Agreement on August 9, 1996. LORSCH CREATIVE NETWORK, INC. By: /s/ Robert H. Lorsch _____________________________ Robert H. Lorsch, President SMARTALK TELESERVICES, INC. By: /s/ Robert H. Lorsch _____________________________ Robert H. Lorsch, President SMARTALK PARTNERS, LLC By: _____________________________ Amre Youness, Manager 4 EX-10.18 19 PROMISSORY NOTE $250,000 EXHIBIT 10.18 SMARTALK PARTNERS, LLC 3 Civic Plaza Suite 170 Newport Beach, CA 92660 PROMISSORY NOTE $250,000 August 9, 1996 1. Loan Obligation. --------------- FOR VALUE RECEIVED, the undersigned, SMARTALK TELESERVICES, INC., a California corporation (the "Borrower"), promises to pay to the order of SMARTALK PARTNERS, LLC, (the "Lender"), at its principal office at 3 Civic Plaza, Suite 170, Newport Beach, CA 92660 ("Principal Office"), or at such other place as Lender may from time to time designate in writing, the principal sum of Two Hundred Fifty Thousand Dollars ($250,000), with interest thereon and any fees and expenses as provided herein. Principal and interest shall be payable as follows: Interest only, due and payable in arrears on the last day of each month commencing August 31, 1996 and continuing until January 31, 1997 (the "Maturity Date") upon which date the entire unpaid balance of principal, and all accrued, but unpaid interest and any unpaid fees and expenses shall be paid in full. 2. Interest Rate. ------------- 2.1 Interest Rate Determination. Subject to Section 2.4 herein, --------------------------- interest shall accrue on the outstanding principal balance at a floating rate of interest (the "Interest Rate") equal to the Prime Rate, in effect from time to time, as reported in the Wall Street Journal (Western Edition) in its general ------------------- guide to money rates as the base rate on corporate loans at large U.S. money center commercial banks (the "Prime Rate"). If this rate is reported as a range of rates, the Prime Rate shall be the highest rate reported in such range. The Interest Rate shall change each time the Prime Rate changes effective on the date the change in the Prime Rate is reported in the Wall Street Journal ------------------- (Western Edition). 2.2 Unavailability of Index. If the interest rate index stated above ----------------------- ceases to be available, Lender may substitute any similar index, whether reported in The Wall Street Journal or any other newspaper, and Lender's ----------------------- selection shall be conclusive and binding on Borrower. In such event, and until Lender selects a substitute index, interest shall accrue at the rate in effect at the time the index was determined to be unavailable. 2.3 Interest Calculation. Interest will be calculated on the basis -------------------- of actual days elapsed in a 360-day year and will be payable in arrears. Interest shall begin to accrue on the day the proceeds of this Note are disbursed, and shall continue to, but excluding the day of payment. Except as provided in Section 2.4 herein, interest will continue to accrue at the Interest Rate described above on the outstanding principal balance until all principal amounts have been paid in full. 2.4 Interest on Overdue Amounts; Alternate Rate of Interest. If ------------------------------------------------------- Borrower shall default in the payment of principal or interest when due hereunder, by acceleration, demand or otherwise, Borrower shall, to the extent permitted by law, pay interest on the defaulted amount from the date that any such payment first becomes due, up to the date of actual payment (after as well as before judgment) at a rate equal to the Prime Rate, as it varies from time to time, plus 4%. 2.5 Usury Limitation. Notwithstanding any provision herein to the ---------------- contrary, the total liability of Borrower for payments in the nature of interest shall not exceed the applicable limits imposed by applicable state and federal laws. Any such payments in excess of such limits shall be deemed payments on account of principal. 3. Payments. -------- 3.1 Application. All payments hereunder received by Lender shall be ----------- applied first to fees and other charges due, including collection costs and attorneys' fees, second to unpaid and accrued interest, and the balance if any to principal. 3.2 Notice of Monthly Interest Payments. Lender will provide ----------------------------------- Borrower with at least one (1) business day advance notice of the interest amount payable hereunder. This Note shall be prepaid with the proceeds of the first debt or equity financing received by Borrower, including the proceeds of the proposed initial public offering of Borrower currently contemplated (and any subsequent financing, if those proceeds are insufficient to fully pay the Note); provided, however, that Borrower shall not be obligated to prepay this Note with the proceeds of any accounts receivable financing or equipment leasing program. 3.3 Prepayment. This Note may be prepaid in full at any time, ---------- without penalty or premium. Each such payment must also include all interest accrued and unpaid on such amount to the date of payment and any other fees charges due. 3.4 Evidence of Amounts Due. The entries on the records of Lender ----------------------- (including any appearing on this Note) shall be prima facie evidence of the aggregate principal amount outstanding under this Note and interest accrued on such principal; provided, however, -------- ------- 2 that the failure of Lender to make such a notation or any error in such a notation shall not in any manner affect the obligation of Borrower to make payments of principal and interest in accordance with the terms of this Note. 3.5 Legal Tender; Principal Office. All payments due under this Note ------------------------------ shall be made in United States Dollars in immediately available funds at the Lender's Principal Office, or at such other address as designated by written notice from Lender to Borrower. 3.6 Subordination. All of Borrower's existing obligations, including ------------- those to Lender pursuant to that certain Promissory Note Secured By Personal Property dated December 28, 1995 in the original principal amount of $1,200,000 and that certain Revolving Line of Credit Note dated December 28, 1995 in the original principal amount of $500,000; and Borrower's obligation to Lorsch Creative Network, Inc. ("LCN") pursuant to that certain Subordinated Promissory Note dated January 1, 1996 in the original principal amount of $2,000,000 shall be subordinated in priority and payment to this Note; and LCN and Lender and any other creditor shall agree to a moratorium on payments of principal and interest on such obligations until this Note has been paid in full. Borrower shall secure subordination agreements from all creditors to reflect the foregoing. 4. Events of Default. ----------------- Any failure by Borrower to pay any installment of (i) interest on this Note within seven (7) days after such amount is due or (ii) principal on this Note within 30 days after such amount is due shall constitute an Event of Default hereunder. 5. General Remedies Upon Event of Default. -------------------------------------- 5.1 Upon the occurrence of, and during the continuance of, any Event of Default hereunder, Lender shall be entitled, at its option and without notice, to declare this Note immediately due and payable whereupon the principal of this Note, together with accrued interest and fees thereon and other Liabilities and obligations of the Borrower accrued hereunder, shall become immediately due and payable, without presentment, demand, protest, notice of dishonor, or any other notice of any kind, all of which are expressly waived by Borrower, anything contained herein notwithstanding; and 5.2 To exercise all other remedies available hereunder or under the Security Agreement of even date executed in connection herewith, or otherwise available under California (or other applicable) law including, without limitation, the appointment of a receiver or the institution of a suit in equity. 3 5.3 All rights, powers and remedies may be exercised at any time by Lender after the occurrence of any such Event of Default while said Event of Default continues. 5.4 All rights, powers and remedies of Lender hereunder are cumulative and not exclusive and shall be in addition to any other rights, powers or remedies provided by law or equity. 6. Miscellaneous. ------------- 6.1 Borrower's Waiver. Except as otherwise expressly provided ----------------- herein, Borrower hereby waives diligence, presentment, demand, notice, protest and all other demands and notices in connection with the delivery, acceptance, performance, default, or enforcement of this Note, and assents to any one or more extensions or postponements of the time of payment or any other indulgences, to any additions or substitutions, exchanges or releases of Collateral and/or to the addition, substitution or release of any one or more parties or persons primarily or secondarily liable hereunder. 6.2 Attorneys' Fees; Collection Costs. Borrower shall pay on demand --------------------------------- all costs and expenses, including reasonable attorneys' fees incurred or paid by Lender in enforcing this Note, whether or not litigation is commenced; or incurred or paid by Lender in protecting the value of the Collateral as hereinabove provided and in exercising any of its rights with respect to the Collateral, including, without limitation, those costs and expenses incurred in selling or otherwise disposing of all or any part of any Collateral pledged to secure this Note. All such costs and expenses shall be secured by such Collateral. 6.3 Lender's Representations; Modification. Borrower agrees and -------------------------------------- acknowledges that Lender has not made any representations concerning Lender's willingness not to exercise, or to delay exercising, its rights to enforce this Note or to demand payment hereof. No delay or omission by Lender in exercising in whole or in part any right or remedy hereunder shall operate as a waiver thereof or of any other right or remedy. A waiver of any right or remedy, in whole or in part, on any one occasion shall not be construed as a bar to enforcing or as a waiver of that or any other right or remedy on any future occasion. No waiver by Lender of any right or remedy shall be effective unless in writing and signed by Lender. No modification or amendment of this Note shall be effective unless the modification is in writing and is signed by Lender. 6.4 Successors and Assigns. This Note inures to the benefit of ---------------------- Lender and to the benefit of its successors and assigns. This Note is binding on Borrower and on any executor, administrator or legal representative of Borrower. Until such time as there occurs and is continuing an Event of Default, this Note (and any interest 4 thereon) shall not be transferred or assigned, except to an Affiliate of Lender. Subject to the foregoing, Borrower agrees that the rights granted to Lender pursuant to this Note shall accrue to any permitted endorsee of this Note who is lawfully in possession of this Note. 6.5 Entire Agreement. The terms and conditions of this Note, the ---------------- Security Agreement and those of any other agreement or instrument referred to in this Note, constitute the entire agreement of the parties, and supersede all prior agreements and understandings, both written and oral, of the parties hereto with respect to the subject matter of this Note, the Security Agreement or of any such agreement or instrument referred to therein. 6.6 Address Change. Borrower shall notify Lender, in writing, of any -------------- change in the Borrower's address of record stated below. 6.7 Applicable Law; Jurisdiction. This Note shall be governed by, ---------------------------- and construed in accordance with, the laws of the State of California, except to the extent Lender has greater rights or remedies under Federal law, in which case such choice of California law shall not be deemed to deprive Lender of any such rights and remedies as may be available under Federal law. Borrower agrees that Lender shall have all rights and remedies available to a creditor under the laws of the State of California. 6.8 Severability. If any provision of this Note is deemed to be in ------------ conflict with applicable law, it will be considered to be modified to comply with the law or, if not able to be so modified, such provision will be deemed to be deleted from this Note. Notwithstanding any such modification or deletion, the remaining provisions will remain valid and enforceable. Executed as of the date first above written. Address of Record "BORROWER" 1640 South Sepulveda Blvd. SMARTALK TELESERVICES, INC., a Suite 500 California corporation Los Angeles, CA 90025 By: /s/ Robert H. Lorsch ------------------------------ Robert H. Lorsch, President Accepted for SMARTALK PARTNERS, LLC By: ----------------------- Amre Youness, Manager Dated: -------------------- 5 EX-21.1 20 SUBSIDIARIES OF THE REGISTRANT EXHIBIT 21.1 Company: SMARTALK TELESERVICES, INC. SUBSIDIARY ---------- 1. As of August 16, 1996, the sole subsidiary of SmarTalk TeleServices, Inc. is Creative Network Marketing, Inc., a Delaware corporation. EX-23.1 21 CONSENT OF INDEPENDENT ACCOUNTANTS EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the use in the Prospectus constituting part of this Registration Statement on Form S-1 of our report dated August 15, 1996, relating to the financial statements of SmarTalk TeleServices, Inc., which appears in such Prospectus. We also consent to the references to us under the heading "Experts" in such Prospectus. PRICE WATERHOUSE LLP Century City, California August 19, 1996 -----END PRIVACY-ENHANCED MESSAGE-----