-----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, LCSq1653dR8Ljar6MFGQqrxzuf5L8X46+JOJqtjZoIBOkw/QuGz6wTYiMeIx3zNR DAGpYR+V+YJ3466V2uuvQg== 0000898430-98-003864.txt : 19981109 0000898430-98-003864.hdr.sgml : 19981109 ACCESSION NUMBER: 0000898430-98-003864 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19981106 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SMARTALK TELESERVICES INC CENTRAL INDEX KEY: 0001018730 STANDARD INDUSTRIAL CLASSIFICATION: COMMUNICATION SERVICES, NEC [4899] IRS NUMBER: 954502740 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q/A SEC ACT: SEC FILE NUMBER: 000-21579 FILM NUMBER: 98738932 BUSINESS ADDRESS: STREET 1: 5080 TUTTLE CROSSING BLVD CITY: DUBLIN STATE: OH ZIP: 43017 BUSINESS PHONE: 6147642933 MAIL ADDRESS: STREET 1: 5080 TUTTLE CROSSING BLVD CITY: DUBLIN STATE: OH ZIP: 43017 10-Q/A 1 FORM 10-Q/A FOR THE PERIOD ENDED 06/30/1998 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 ---------------- FORM 10-Q/A QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED JUNE 30, 1998 COMMISSION FILE NO. 0-21579
SMARTALK TELESERVICES, INC. INCORPORATED UNDER THE LAWS IRS EMPLOYER IDENTIFICATION OF CALIFORNIA (1) NO. 95-4502740
5080 TUTTLE CROSSING BLVD. DUBLIN, OHIO 43016-3566 TELEPHONE: 614-789-8500 ---------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [_] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of August 14, 1998: Voting, No par value: 27,607,219 - -------- (1) A proposal to effect the reincorporation of SmarTalk TeleServices, Inc. (the "Company") from California to Delaware was approved by the shareholders of the Company on December 31, 1997. Accordingly, subject to receipt of requisite regulatory approval, the Company's state of incorporation will change from California to Delaware and the Company will be a Delaware corporation. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- RESTATEMENT OF FINANCIAL STATEMENTS AND CHANGES TO CERTAIN INFORMATION On August 10, 1998, SmarTalk TeleServices, Inc. ("SmarTalk" or the "Company") announced that the Company's management in conjunction with the Company's independent accountants, PricewaterhouseCoopers LLP ("PwC"), would investigate certain matters with regard to the Company's accounting treatment for deferred revenue recorded in conjunction with acquisitions that occurred during 1997, the restructuring reserve taken during the fourth quarter of 1997 as well as certain other items. The Company subsequently determined to review the charge for acquired research and development in-process taken during the fourth quarter of 1997. The Company's investigation into these issues ultimately resulted in the restatement of the Company's financial results for the year ended 1997 and for the first and second quarters of 1998 (See Note 9 to the Company's consolidated financial statements.) In addition, the Company has restructured its June 1997 acquisition of Worldwide Direct, Inc., a Framingham, Massachusetts based prepaid cellular communications company ("Worldwide"), to provide for the issuance of additional equity and/or debt securities based on the occurrence of certain conditions. As a result of this restructuring, the Company's financial results for the quarter ended June 30, 1998 include changes made to reflect the treatment of the acquisition of Worldwide using the purchase method of accounting. This Quarterly Report on Form 10-Q/A amends Items 1 and 2 of Part I and Item 1 of Part II of the Company's Quarterly Report on Form 10-Q previously filed for the quarter ended June 30, 1998. This Quarterly Report on Form 10-Q/A is filed in connection with the Company's restatement of its financial statements for the quarter ended June 30, 1998. Financial statement information and related disclosures included in this amended filing reflect where appropriate, changes as a result of the restatement. Except as otherwise noted, information contained in this Quarterly Report is as of June 30, 1998. This Quarterly Report on Form 10-Q/A contains statements that constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which generally can be identified by the use of forward-looking terminology such as "anticipate," "believe," "target," "estimate," "may," "will," "expect," "plan," "project" or "continue" or the negative thereof or other variations thereon or similar terminology. Such statements are based on information available to management as of the time of such statements and relate to, among other things, expectations of the business environment in which the Company operates, projections of future performance, perceived opportunities in the market and statements regarding the Company's mission and vision. Such statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions, including risks related to the highly competitive market in which the Company operates; the need to attract and retain qualified management personnel; uncertainty in consumer acceptance of the Company's products and services, including its prepaid cellular product; possible difficulty in obtaining acceptable financing for the Company's continued expansion; and difficulty in integrating the Company's operations acquired primarily through acquisitions. These and other risks, uncertainties and assumptions identified from time to time in the Company's filings with the Securities and Exchange Commission, including without limitation, its annual reports on Form 10-K and its quarterly reports on Form 10-Q, as amended, could cause the Company's future results to differ materially from those expressed in any forward-looking statements made by or on behalf of the Company. Many of such factors are beyond the Company's ability to control or predict. These forward-looking statements speak only as of the date for which they are made. The Company disclaims any intent or obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. PART I. FINANCIAL INFORMATION ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS SMARTALK TELESERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED)
JUNE 30, DECEMBER 31, 1998 1997 --------------- --------------- (AS RESTATED -- (AS RESTATED -- SEE NOTE 9) SEE NOTE 9) ASSETS Current assets: Cash and cash equivalents.................... $ 30,736,105 $ 62,900,673 Trade accounts receivable (less allowance for doubtful accounts of $(7,794,785) and $1,482,206, respectively)................... 24,598,273 28,012,237 Notes receivable............................. 4,383,017 -- Receivable from American Express Company..... -- 2,570,000 Inventories.................................. 5,165,136 4,301,487 Prepaid expenses............................. 1,979,386 1,377,844 Other current assets......................... 7,383,035 7,464,040 ------------ ------------ Total current assets........................ 74,244,952 106,626,281 Non-current assets: Property and equipment, net.................. 18,344,501 14,208,975 Intangibles, net............................. 288,118,106 235,506,706 Note receivable from ACMI, L.L.C., net....... -- 2,234,763 Other non-current assets..................... 10,143,176 9,724,352 ------------ ------------ Total assets................................ $390,850,735 $368,301,077 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable............................. $ 22,989,250 $ 15,081,532 Deferred revenue............................. 22,338,200 28,885,002 Accrued marketing costs...................... 1,121,698 1,811,817 Accrued interest payable..................... 2,735,232 2,615,480 Other accrued expenses....................... 14,409,917 5,571,728 Excise and sales tax payable................. 3,622,094 5,565,072 Reserve for discontinued operations.......... 1,035,000 -- Accrued litigation settlement................ -- 4,500,003 Current portion of long-term debt............ 5,089,217 7,285,401 ------------ ------------ Total current liabilities................... 73,340,608 71,316,035 Long-term debt less current portion............ 153,173,438 150,874,753 ------------ ------------ Total liabilities........................... 226,514,046 222,190,788 Shareholders' equity: Preferred stock, no par value; authorized 10,000,000 shares; no shares issued and outstanding................................. -- -- Common stock, no par value; authorized 100,000,000 shares; issued and outstanding 25,342,132 and 21,350,852 shares, respectively................................ 241,522,173 178,670,477 Accumulated deficit.......................... (77,267,694) (32,703,998) Cumulative translation adjustment............ 82,210 143,810 ------------ ------------ Total shareholders' equity.................. 164,336,689 146,110,289 ------------ ------------ Total liabilities and shareholders' equity.. $390,850,735 $368,301,077 ============ ============
The accompanying notes are an integral part of these consolidated financial statements. 2 SMARTALK TELESERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED JUNE 30 SIX MONTHS ENDED JUNE 30 ---------------------------- ---------------------------- 1998 1997 1998 1997 ------------ -------------- ------------ -------------- (AS (AS RESTATED-- (AS RESTATED-- RESTATED-- (AS RESTATED-- SEE NOTE 9) SEE NOTE 9) SEE NOTE 9) SEE NOTE 9) Revenue................. $ 42,927,385 $11,345,190 $ 79,308,756 $18,713,523 Cost of revenue......... 28,059,201 7,204,054 52,857,157 11,964,802 ------------ ----------- ------------ ----------- Gross profit.......... 14,868,184 4,141,136 26,451,599 6,748,721 Sales and marketing..... 25,755,318 2,996,050 33,092,717 5,541,464 General and administrative......... 16,900,296 2,906,363 31,952,871 3,807,594 ------------ ----------- ------------ ----------- Operating loss........ (27,787,430) (1,761,277) (38,593,989) (2,600,337) Interest income......... 1,245,017 580,761 2,387,328 1,109,524 Interest expense........ (2,492,887) (224,748) (4,896,930) (224,748) Loss on disposal of asset.................. (431,957) -- (431,957) -- ------------ ----------- ------------ ----------- Loss from continuing operations before income taxes........... (29,467,257) (1,405,264) (41,535,548) (1,715,561) Provision for income taxes.................. -- -- -- -- ------------ ----------- ------------ ----------- Loss from continuing operations............. (29,467,257) (1,405,264) (41,535,548) (1,715,561) ------------ ----------- ------------ ----------- Discontinued operations: Loss from discontinued operations to the Board Resolution Date................. -- -- (578,148) -- Income (Loss) from the Board Resolution Date to the date of disposal of discontinued operations........... 250,000 -- (2,450,000) -- ------------ ----------- ------------ ----------- Net loss................ $(29,217,257) $(1,405,264) $(44,563,696) $(1,715,561) ============ =========== ============ =========== Per share loss--basic and diluted: Continuing operations. $ (1.27) $ (.10) $ (1.84) $ (.13) Discontinued operations........... .01 -- (.13) -- ------------ ----------- ------------ ----------- Total ................ $ (1.26) $ (.10) $ (1.97) $ (.13) ============ =========== ============ =========== Weighted average number of shares.............. 23,240,455 13,940,285 22,574,640 13,421,860 ============ =========== ============ ===========
The accompanying notes are an integral part of these consolidated financial statements. 3 SMARTALK TELESERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) (UNAUDITED)
COMMON STOCK CUMULATIVE ----------------------- STOCK ACCUMULATED TRANSLATION SHARES AMOUNT SUBSCRIPTION DEFICIT ADJUSTMENT TOTAL ---------- ------------ ------------ ------------ ----------- ------------ December 31, 1995....... 8,824,834 $ 315,000 $(300,000) $ (1,394,774) $ -- $ (1,379,774) Issuance of subscribed shares............... -- -- 300,000 -- -- 300,000 Purchase of assets of related entity....... -- -- -- (2,464,028) -- (2,464,028) Compensation under stock options issued. -- 24,000 -- -- -- 24,000 Proceeds from sale of stock, net of costs.. 4,000,000 50,439,595 -- -- -- 50,439,595 Stock options exercised............ 4,625 8,186 -- -- -- 8,186 Net loss.............. -- -- -- (3,112,548) -- (3,112,548) ---------- ------------ --------- ------------ -------- ------------ December 31, 1996....... 12,829,459 50,786,781 -- (6,971,350) -- 43,815,431 Stock options exercised............ 227,398 851,485 -- -- -- 851,485 Distribution agreement............ 330,205 7,596,093 -- -- -- 7,596,093 Acquisitions: ConQuest Telecommunication Services Corp........ 4,488,935 71,917,228 -- -- -- 71,917,228 GTI Telecom, Inc...... 2,580,001 34,259,820 -- -- -- 34,259,820 SmarTel Communications, Inc.. 714,286 9,494,290 -- -- -- 9,494,290 Cardinal Voicecard Limited.............. 115,000 2,170,625 -- -- -- 2,170,625 Frontier Selected Assets............... 65,568 1,594,155 -- -- -- 1,594,155 Cumulative translation adjustment........... -- -- -- -- 143,810 143,810 Net loss.............. -- -- -- (25,732,648) -- (25,732,648) ---------- ------------ --------- ------------ -------- ------------ December 31, 1997 (As Restated--See Note 9).. 21,350,852 178,670,477 -- (32,703,998) 143,810 146,110,289 Licensing agreement... 100,000 3,056,300 -- -- -- 3,056,300 USA Telecommunication Services, Inc. acquisition.......... 81,302 2,500,037 -- -- -- 2,500,037 Litigation settlement. 215,569 4,500,003 -- -- -- 4,500,003 Stock options exercised............ 779,409 7,692,803 -- -- -- 7,692,803 SmarTel Communications release.............. 100,000 1,606,000 -- -- -- 1,606,000 Worldwide Direct, Inc. acquisition.......... 2,715,000 43,496,553 -- -- -- 43,496,553 Cumulative translation adjustment........... -- -- -- -- (61,600) (61,600) Net loss.............. -- -- -- (44,563,696) -- (44,563,696) ---------- ------------ --------- ------------ -------- ------------ June 30, 1998 (As Restated--See Note 9).. 25,342,132 $241,522,173 $ -- $(77,267,694) $ 82,210 $164,336,689 ========== ============ ========= ============ ======== ============
The accompanying notes are an integral part of these consolidated financial statements. 4 SMARTALK TELESERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
SIX MONTHS ENDED JUNE 30, ----------------------------- 1998 1997 -------------- -------------- (AS RESTATED-- (AS RESTATED-- SEE NOTE 9) SEE NOTE 9) Cash flows from operating activities: Net loss....................................... $(44,563,696) $ (1,715,561) Adjustments to reconcile net loss to net cash used by operating activities: Depreciation................................... 3,318,181 158,342 Amortization................................... 11,549,938 682,934 Discontinued operations........................ 1,035,000 -- Provision for obsolete inventory............... 2,065,556 -- MDF impairment write-off....................... 7,261,219 -- Provision for bad debts........................ 9,782,272 276 Loss on disposal of fixed assets............... 431,957 -- Sublease termination fee....................... -- (325,810) Changes in assets and liabilities, which increase (decrease) cash: Accounts receivable........................... (11,399,000) (2,140,172) Inventories................................... (2,281,328) (130,114) Receivable from related party................. 2,570,000 -- Prepaid expenses.............................. (408,214) (1,721,609) Other current assets.......................... 2,478,964 748,843 Other non-current assets...................... (3,775,083) (362,879) Accounts payable.............................. 4,411,228 (738,997) Deferred revenue.............................. (8,205,432) 502,940 Accrued marketing costs....................... (690,119) (136,931) Accrued interest.............................. 119,752 -- Other accrued expenses........................ 8,324,201 329,155 Excise and sales tax payable.................. (1,942,978) -- ------------ ------------ Net cash used by operating activities.......... (19,917,582) (4,849,583) ------------ ------------ Cash flows from investing activities: Cash paid for acquisitions, net of cash acquired...................................... (4,007,976) (1,623,342) Proceeds from sale of discontinued operations.. 1,000,000 -- Repayment of ACMI, L.L.C. note receivable...... 1,000,000 -- Capital expenditures........................... (6,905,228) (475,182) License fee.................................... (3,000,000) -- ------------ ------------ Net cash used by investing activities.......... (11,913,204) (2,098,524) ------------ ------------ Cash flows from financing activities: Stock options exercised........................ 7,692,803 594,093 Repayment of note payable to WorldCom.......... -- (6,383,691) Repayment of long-term debt.................... (652,874) -- Capital lease payments......................... (105,094) -- Repayment of Star Bank Line of Credit.......... (7,193,575) -- Payment on Century Bank Line of Credit......... (13,442) -- ------------ ------------ Net cash used by financing activities.......... (272,182) (5,789,598) ------------ ------------ Effect of currency exchange rate................ (61,600) -- ------------ ------------ Decrease in cash and cash equivalents........... (32,164,568) (12,737,705) Cash and cash equivalents at beginning of period......................................... 62,900,673 44,830,487 ------------ ------------ Cash and cash equivalents at end of period...... $ 30,736,105 $ 32,092,782 ============ ============ Supplemental disclosure of cash flow information: Cash paid for interest......................... $ 4,313,583 $ 3,915 ------------ ------------ Issuance of stock for acquisitions............. $ 47,602,590 $ 43,754,110 ============ ============ Issuance of debt for acquisitions.............. $ 5,500,000 $ 26,500,000 ============ ============ Debt assumed at acquisition.................... $ 2,567,486 $ 6,383,691 ============ ============ Issuance of stock for litigation settlement.... $ 4,500,003 $ -- ============ ============ Issuance of stock for licensing agreement...... $ 3,056,300 $ -- ============ ============
The accompanying notes are an integral part of these consolidated financial statements. 5 SMARTALK TELESERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF INTERIM PRESENTATION The accompanying interim period consolidated financial statements are unaudited, pursuant to certain rules and regulations of the Securities and Exchange Commission, and include, in the opinion of management, all adjustments (consisting of only normal recurring adjustments) necessary for a fair presentation of the results for the periods indicated; which, however, are not necessarily indicative of results which may be expected for the full year. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The financial statements should be read in conjunction with the financial statements, as restated, and the notes thereto for the year ended December 31, 1997 and other information included in SmarTalk TeleServices, Inc.'s (the "Company") Form 10-K, as amended, and Forms 8-K, as filed with the Securities and Exchange Commission. On August 10, 1998, the Company announced that the Company's management in conjunction with PricewaterhouseCoopers LLP ("PwC") would investigate certain matters with regard to the Company's accounting treatment for deferred revenue recorded in conjunction with acquisitions that occurred during 1997, the restructuring reserve taken during the fourth quarter of 1997 as well as certain other items. The Company subsequently determined to review the charge for acquired research and development in-process taken during the fourth quarter of 1997. As a result of the Company's investigation into these issues, the accompanying interim period consolidated financial statements as of June 30, 1998 and for the quarter then ended have been restated. (See Note 9 to the Company's consolidated financial statements.) In addition, the Company has restructured its June 1997 acquisition of Worldwide Direct, Inc., a Framingham, Massachusetts based prepaid cellular communications company ("Worldwide"), to provide for the issuance of additional equity and/or debt securities based on the occurrence of certain conditions. As a result of this restructuring, the Company's financial results for the quarter ended June 30, 1998 include changes made to reflect the treatment of the acquisition of Worldwide using the purchase method of accounting. 2. DISCONTINUED OPERATIONS On February 28, 1998 (the "Board Resolution Date"), the Board adopted a plan to sell the Company's call center business located in Butler, Pennsylvania. In the first quarter of 1998, the Company recorded a charge for the losses associated with operating this business up to the Board Resolution Date and an estimated charge for operating this business from the Board Resolution Date through the anticipated disposition date plus the transaction costs associated with the sale of the business. On June 12, 1998 (the "Sale Date"), the Company sold the assets of the call center business for $1,000,000 in cash and a note receivable (the "Call Center Note") of $19,067,995. Interest on the Call Center Note is 12% per annum and is payable quarterly beginning September 12, 1998. The principal on the Call Center Note is due on June 12, 1999 (unless this date is extended to June 12, 2000 by the obligor) or upon completion of a financing transaction in excess of $50,000,000 by the obligor. The assets of the obligor secure the Call Center Note. Due to the thinly capitalized financial position of the obligor and the resulting risk of collection, a valuation allowance was recorded against the Call Center Note approximately equal to the difference between the sales price and net book value of the tangible assets sold, or $14,684,978. No gain or loss was recorded on the transaction. Operations for the business from January 1, 1998 to the Sale Date and transaction costs associated with the disposal have been recorded against the reserve for discontinued operations. Revenue from the discontinued operations was $4,507,300 for the quarter ended June 30, 1998 and $0 for the quarter ended June 30, 1997. 6 Summarized financial information for the discontinued operations is as follows:
FOR THE PERIOD JANUARY 1, 1998 TO JUNE 12, 1998 ------------------- (AS RESTATED-- SEE NOTE 9) Revenues............................................. $10,065,127 Loss before income taxes............................. 3,028,148 Net loss............................................. 3,028,148 AS OF JUNE 12, 1998 ------------------- (AS RESTATED-- SEE NOTE 9) Current assets....................................... $ 5,502,442 Total assets......................................... 20,502,442 Current liabilities.................................. 434,447 Total liabilities.................................... 434,447 ----------- Net assets of discontinued operations................ $20,067,995 ===========
SmarTalk did not own the call center business at June 30, 1997. 3. LICENSING AGREEMENT On March 30, 1998, the Company entered into a new licensing agreement with AudioFax IP LLC to license certain voice-fax mailbox technology. The Company paid a one-time fee to license the technology until the patents expire in 2008. The fee is being amortized over the remaining life of the patent. Prior to this agreement, the Company licensed this technology by paying a per card fee for cards containing voice-fax mailbox services. 4. ACQUISITIONS On March 23, 1998, the Company acquired USA Telecommunications Services, Inc. (d.b.a. The Debit Cellular Network) ("DCN"), a North Carolina based prepaid cellular card company, for 81,302 shares of common stock and $1,500,000 in cash. This acquisition was accounted for using the purchase method of accounting. Accordingly, the operating results of the acquired business are included in the Company's consolidated results since the date of acquisition. On April 30, 1998, the Company acquired the outstanding shares of Canada Telecom Network, Inc., a Montreal, Quebec, Canada based prepaid calling card company, for $3,000,000 in cash and $5,500,000 in a subordinated, 7.5% per annum note which matures April 30, 2000. This acquisition was accounted for using the purchase method of accounting. Accordingly, the results of the acquired business are included in the Company's consolidated results since the date of acquisition. On June 10, 1998, the Company acquired the outstanding stock of Worldwide for 2,715,000 shares of Common Stock. The Company has restructured this transaction to provide for the issuance of additional equity and/or debt securities based on the occurrence of certain conditions. As a result of this restructuring, the acquisition required the use of the purchase method of accounting. Accordingly, the results of the acquired business are included in the Company's consolidated results since the date of acquisition. 7 The following unaudited pro forma summary presents the Company's combined results as if the 1998 acquisitions occurred at the beginning of the respective periods, after giving effect to certain adjustments including goodwill amortization, depreciation and interest expense. These pro forma results are not necessarily indicative of those that would have occurred had the acquisitions occurred at the beginning of the respective periods.
THREE MOS. ENDED SIX MOS. ENDED JUNE 30, 1998 JUNE 30, 1998 ---------------- -------------- (AS RESTATED-- (AS RESTATED-- SEE NOTE 9) SEE NOTE 9) Revenue................................. $ 49,440,886 $ 90,778,722 ============ ============ Net loss from continuing operations..... $(30,283,463) $(43,742,821) ============ ============ Net loss per share from continuing operations--basic and diluted.......... $ (1.19) $ (1.75) ============ ============
The following unaudited pro forma summary presents the Company's combined results as if the 1997 acquisitions, as referenced in the Company's Form 10- K/A for the year ended December 31, 1997, occurred at the beginning of the respective periods, after giving effect to certain adjustments including goodwill amortization, depreciation and interest expense. These pro forma results are not necessarily indicative of those that would have occurred had the acquisitions occurred at the beginning of the respective periods.
THREE MOS. ENDED SIX MOS. ENDED JUNE 30, 1997 JUNE 30, 1997 ---------------- -------------- (AS RESTATED-- (AS RESTATED-- SEE NOTE 9) SEE NOTE 9) Revenue.................................. $38,748,341 $ 75,824,550 =========== ============ Net loss................................. $(9,351,384) $(17,902,981) =========== ============ Net loss per share--basic and diluted.... $ (.44) $ (.84) =========== ============
5. REVENUE RECOGNITION The Company's revenue originates from: (i) Company and co-branded prepaid calling cards sold through retailers; (ii) recharges on existing calling cards; (iii) cards sold for promotional marketing campaigns; (iv) corporate sales to businesses; (v) prepaid calling card services provided to one of the Company's strategic partners, West Interactive Corporation ("WIC"); (vi) call processing; (vii) sales of prepaid cellular phones, accessories and services; and (viii) sales commissions from postpaid cellular activations. Under the majority of agreements with retailers, the Company sells cards to the retailer at a fixed price with normal credit terms. When the retailer is invoiced, deferred revenue is recorded. The Company recognizes revenue and reduces the deferred revenue account as the end user utilizes calling time or upon expiration of cards containing unused calling time, as applicable. The Company also records deferred revenue upon recharge of existing phone cards and recognizes such revenue upon usage or expiration of the recharge minutes. With respect to deferred revenue on the books of an acquired entity, the obligation to provide future service relating to unused minutes is revalued as of the date of acquisition. The fair value of the service obligation represents management's best estimate of the cost to service acquired unused minutes plus a normal profit margin for this service element (such margin intended to cover indirect costs and provide a reasonable return). Deferred revenue is not recorded for acquired unused minutes for which no future usage is anticipated. The acquired deferred revenue obligation is periodically remeasured to reflect actual used and unused minutes which may vary from original estimates. A reduction in acquired deferred revenue is recorded based on actual minutes used during the post-acquisition period. Substantially all prepaid phone cards sold by the Company have expiration dates and expire as of that date, if never activated, or six months after the initial activation unless recharged. For cards that have no printed 8 expiration date, revenue for unused minutes is recognized when cards have been dormant for greater than 12 months. Revenue for prepaid cellular phones, accessories, and services is recognized upon shipment. For postpaid cellular sales the Company recognizes a sales commission upon activation of individual customer accounts by the ultimate carrier. In a postpaid cellular sale, the Company remains liable to refund commissions paid by carriers for varying periods of time after activation in the event a customer discontinues service. The Company records a reserve for these returns at the time the related revenue is recognized. 6. NOTE RECEIVABLE FROM ACMI, L.L.C. On June 19, 1998, the Company received payment for the ACMI, L.L.C. note receivable. The note receivable had a net book value of $2,234,763 on such date and the repayment amount was $1,000,000 in cash. Since this note was acquired through the ConQuest acquisition, the devaluation of the note was recorded as a reduction of goodwill. Additionally, the Company was required to release 106,816 shares of its Common Stock that was held in escrow and used as collateral to secure the note. The value of these shares had previously been recorded as an increase to goodwill. 7. DIVIDENDS There were no dividends declared or paid during the six months ended June 30, 1998 or 1997. 8. SUBSEQUENT EVENTS As of July 1, 1998, the Company issued a promissory note in the amount of $5,000,000 and agreed to issue 1,000,000 shares of Common Stock to acquire a distribution arrangement with a former distributor of Worldwide and certain contractual relationships. The arrangement also provides for the issuance of additional equity and/or debt securities upon the occurrence of certain conditions. On July 9, 1998, the Company completed a private placement of 1,751,824 shares of its Common Stock, realizing proceeds before transaction costs of $29,999,986. On August 28, 1998, the terms of the private placement were restructured. In the event that the Company's Common Stock trades below the initial purchase price during specified periods, the Company will be obligated to issue up to $18,500,000 of additional Common Stock for no additional consideration. In addition, the Company granted an option exercisable for a period of two years commencing March 1, 1999 in connection with the private placement pursuant to which an additional $20,000,000 of the Company's Common Stock may be purchased. In the event the aggregate amount of Common Stock issued by the Company pursuant to the private placement would exceed 20% of the Company's total outstanding shares as of July 9, 1998 (the "20% Threshold"), as a result of either the exercise of the option or the initial purchase price adjustment, the Company would be required to obtain shareholder approval of the private placement or issue a note in a principal amount equal to the value of the Common Stock that otherwise would exceed the 20% Threshold. The Company expects to use the proceeds from this private placement to accelerate its entry into the prepaid cellular market and for general corporate purposes. Since July 23, 1998, 19 putative class actions have been filed against the Company and certain current and former members of its management and board of directors in state and Federal courts alleging violations of state and Federal securities laws with respect to certain alleged misrepresentations and/or omissions in regard to the Company's projected and actual revenues and earnings. These lawsuits seek unspecified damages on behalf of certain classes of persons who purchased the Company's securities during periods between May 1997 and August 1998. The complaints generally allege that the Company made material misrepresentations and omissions in regard to the Company's projected and actual revenues and earnings. Although the Company intends to defend against these lawsuits vigorously, it is not feasible to predict or determine the final outcome of these proceedings at this time. An unfavorable outcome with respect to such proceedings could have a material adverse effect on the Company's financial condition and results of operations. 9 9. RESTATEMENT On August 10, 1998, SmarTalk TeleServices, Inc. ("SmarTalk" or the "Company") announced that the Company's management in conjunction with the Company's independent accountants, PricewaterhouseCoopers LLP ("PwC"), would investigate certain matters with regard to the Company's accounting treatment for deferred revenue recorded in conjunction with acquisitions that occurred during 1997, the restructuring reserve taken during the fourth quarter of 1997 as well as certain other items. The Company subsequently determined to review the charge for acquired research and development in-process taken during the fourth quarter of 1997. As a result of the Company's investigation into these issues, the accompanying consolidated financial statements as of June 30, 1998 and for the quarter and six months then ended have been restated. In addition, the Company has restructured its June 1997 acquisition of Worldwide to provide for the issuance of additional equity and/or debt securities based on the occurrence of certain conditions. As a result of this restructuring, the Company's financial results for the quarter ended June 30, 1998 include changes made to reflect the treatment of the acquisition of Worldwide using the purchase method of accounting. 10 A summary of the significant effects of the restatement are as follows:
THREE MOS. ENDED THREE MOS. ENDED SIX MOS. ENDED SIX MOS. ENDED JUNE 30, 1998 JUNE 30, 1997 JUNE 30, 1998 JUNE 30, 1997 ------------------------- ------------------------ ------------------------- ------------------------ AS AS AS AS PREVIOUSLY AS PREVIOUSLY AS PREVIOUSLY AS PREVIOUSLY AS REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED ----------- ------------ ----------- ----------- ----------- ------------ ----------- ----------- Statement of Operations Data: Revenue.......... $51,830,277 $ 42,927,385 $11,796,890 $11,345,190 $94,235,441 $ 79,308,756 $19,165,223 $18,713,523 Cost of revenue.. 29,200,682 28,059,201 7,204,054 7,204,054 54,761,037 52,857,157 11,964,802 11,964,802 Gross profit..... 22,629,595 14,868,184 4,592,836 4,141,136 39,474,404 26,451,599 7,200,421 6,748,721 Operating expenses........ 18,244,063 42,655,614 5,615,194 5,902,413 36,925,209 65,045,588 9,061,839 9,349,058 Income (loss) from continuing operations...... 1,918,659 (29,467,257) (666,345) (1,405,264) (1,215,495) (41,535,548) (976,642) (1,715,561) Net income (loss).......... 2,168,659 (29,217,257) (666,345) (1,405,264) (4,243,643) (44,563,696) (976,642) (1,715,561) Statement of Cash Flows Data: Cash provided (used) by operating activities...... 3,838,700 1,938,557 (1,896,521) (1,896,521) (19,304,711) (19,917,582) (4,849,583) (4,849,583) Cash used by investing activities...... (15,687,974) (7,034,868) (2,002,101) (2,002,101) (14,754,906) (11,913,204) (2,098,524) (2,098,524) Cash (used) provided by financing activities...... (4,733,136) (7,689,477) (6,363,894) (6,363,894) 2,782,159 (272,182) (5,789,598) (5,789,598) JUNE 30, 1998 DECEMBER 31, 1997 ------------------------- ------------------------ AS AS PREVIOUSLY AS PREVIOUSLY REPORTED RESTATED REPORTED AS RESTATED ----------- ------------ ----------- ----------- Balance Sheet Data: Trade accounts receivable, net. $45,934,488 $ 24,598,273 $32,699,249 $28,012,237 Current assets... 114,921,082 74,244,952 111,487,102 106,626,281 Intangibles, net. 229,530,054 288,118,106 222,536,934 235,506,706 Total assets..... 381,721,252 390,850,735 360,502,826 368,301,077 Deferred revenue. 29,455,088 22,338,200 40,248,400 28,885,002 Restructuring reserve. 22,008,229 -- 23,943,070 -- Current liabilities..... 108,148,692 73,340,608 106,622,503 71,316,035 Total liabilities..... 259,274,511 226,514,046 257,497,256 222,190,788 Total shareholders' equity.......... 122,446,741 164,336,689 103,005,570 146,110,289
11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION RESTATEMENT On August 10, 1998, the Company announced that the Company's management in conjunction with PwC would investigate certain matters with regard to the Company's accounting treatment for deferred revenue recorded in conjunction with acquisitions that occurred during 1997, the restructuring reserve taken during the fourth quarter of 1997 as well as certain other items. The Company subsequently determined to review the charge for acquired research and development in-process taken during the fourth quarter of 1997. The Company's investigation into these issues ultimately resulted in the restatement of the Company's financial results for the year ended 1997 and the first and second quarters of 1998. The financial information contained herein has been restated to incorporate all relevant information obtained from the aforementioned investigations. (See Note 9 to the Company's condensed consolidated financial statements.) In addition, the Company has restructured its acquisition of Worldwide Direct, Inc. ("Worldwide") to provide for the issuance of additional equity and/or debt securities based on the occurrence of certain conditions. As a result of this restructuring, the Company's financial results for the quarter ended June 30, 1998 include changes made to reflect the treatment of the acquisition of Worldwide using the purchase method of accounting. GENERAL The Company was formed in October 1994 and had limited operations until June 1995. On October 23, 1996, the Company completed the sale of 4,000,000 shares of its stock in a public offering. The Company's common stock, no par value (the "Common Stock"), is listed on the NASDAQ National Market. SmarTalk provides convenient, easy-to-use and cost-effective telecommunications products and services to individuals and businesses primarily through the SmarTalk prepaid phone 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, inbound and outbound international long distance calling, as well as enhanced features such as sequential calling, content delivery, speed dial and message delivery and on selected cards, voice and fax mail services. The SmarTalk Card may be recharged with a major credit card by calling SmarTalk's customer service department or, in select retail locations, at point of sale, allowing the user to add minutes as needed. SmarTalk services are delivered through proprietary switching, application and database access software which run on interactive call processing platforms. 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's revenue originates from: (i) SmarTalk and co-branded prepaid calling cards sold through retailers; (ii) recharges on existing calling cards; (iii) cards sold for promotional marketing campaigns; (iv) corporate sales to businesses; (v) prepaid calling card services provided to one of the Company's strategic partners, West Interactive Corporation ("WIC"); (vi) call processing; (vii) sales of prepaid cellular phones, accessories and services; and (viii) sales commissions from postpaid cellular activations. The Company operates in a highly competitive market. Future revenues and earnings may be impacted by, among other factors, the Company's ability to address competition, its ability to sign new accounts, its ability to introduce new products, such as its prepaid cellular product offering and its ability to integrate its operations successfully. Under sales agreements with the majority of its retailers, the Company sells cards to the retailer at a set price. The Company generally invoices the retailer upon shipment of the cards. The Company also offers pay-on-sale and pay-on-activation programs to certain retailers whereby the retailers are invoiced upon sale to or activation by a retailer's customer, respectively. The Company anticipates that its pay-on-sale and pay-on-activation programs will be increasingly utilized by its retail customers. Deferred revenue is recorded when the retailer is invoiced. The Company recognizes revenue and reduces deferred revenue as the customer utilizes 12 calling time or upon expiration of cards containing unused calling time ("breakage"). The Company also records deferred revenue upon recharge of existing prepaid calling cards and recognizes such revenue upon the usage or expiration of the recharge minutes. Call processing revenues are recognized as these services are rendered. SmarTalk's cost of revenue consists primarily of the cost of providing long distance services and related enhanced services, as well as the cost of manufacturing and delivering the cards, excise taxes, Universal Service Fund fees and the costs of cellular phones and accessories. The cost of providing long distance services represents obligations to carriers that provide minutes of long distance over their networks in order to facilitate use of SmarTalk's product. SmarTalk seeks to leverage its competitive advantages in implementing the key elements of its growth strategy, which include: (i) increasing penetration of retailers; (ii) developing new products and services; and (iii) continuing to pursue selected acquisitions. 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 commissions to its sales representatives and retailers based on the number of minutes recharged on the SmarTalk Cards sold by each retailer. Advertising consists primarily of trade, consumer, cooperative advertising ("co-op"). Under the typical co-op advertising program, the Company provides advertising funds to retailers to promote sales of SmarTalk products and services. The amount of funds the Company provides in co-op advertising is based on a percentage of sales of SmarTalk products to retailers. Corporate advertising expense includes trade and consumer advertising, trade show expenses, promotional goods and the costs of providing to retailers the Company's turnkey merchandising materials and services. General and administrative expenses consist primarily of salaries and related benefits, sales and use taxes, rent, insurance, bank card processing fees and other general expenses including depreciation and amortization. Sales and use taxes for the SmarTalk platforms are incurred based on customer usage of long distance minutes which are processed through the Company's platforms. The Company completed the following acquisitions from January 1, 1997 to June 30, 1998 (the "Acquisitions"): Worldwide Direct, Inc. On June 10, 1998, SmarTalk acquired the outstanding stock of Worldwide for 2,715,000 shares of Common Stock. The Company has restructured this transaction to provide for the issuance of additional equity and/or debt securities based on the occurrence of certain conditions. As a result of this restructuring, the acquisition required the use of the purchase method of accounting and the results of the acquired business are included in the Company's consolidated results of operations from the date of acquisition. Canada Telecom Networks Inc. On April 30, 1998, SmarTalk acquired the outstanding shares of Canada Telecom Network Inc. ("CTN") for $3,000,000 in cash and $5,500,000 in a subordinated 7.5% note which matures April 30, 2000. The note is payable in 24 monthly blended installments of principal and interest. USA Telecommunications Services, Inc. On March 23, 1998, SmarTalk acquired USA Telecommunications Services, Inc. (d.b.a. The Debit Cellular Network) ("DCN"), a North Carolina-based prepaid cellular card company for $1,500,000 in cash and 81,302 shares of Common Stock. American Express Telecom, Inc. On December 31, 1997, SmarTalk acquired American Express Telecom, Inc. ("Amex Telecom") a provider of prepaid calling products, including the FirstClass Phonecard(TM) sold through the U.S. Postal Service and the PhoneFunds(TM) card sold through the National Park Foundation, American Express Travel Service Offices ("AmEx TSOs"), and certain foreign exchange offices. In consideration for the outstanding shares of Amex Telecom, SmarTalk paid $44 million in cash, which was provided from SmarTalk's 13 working capital, with a portion thereof held in escrow pending regulatory approval to Amex Telecom's sole stockholder, American Express Travel Related Services Company, Inc. ("Amex TRS"). Additionally, SmarTalk purchased a profit and cost sharing agreement between Amex Telecom and the U.S. Postal Service. The Amex Telecom acquisition secured for SmarTalk distribution rights to certain AmEx TSOs, distribution through the U.S. Postal Service and the National Park Foundation and an agreement with American Express to be the exclusive provider of a co-branded prepaid calling card for American Express. In addition, SmarTalk was granted exclusive access to the American Express point-of-sale system for activation and recharge of prepaid phone cards. Under the purchase agreement Amex TRS agreed to reimburse SmarTalk for the estimated unused minutes as of December 31, 1997. ConQuest Telecommunication Services Corp. On December 3, 1997, SmarTalk entered into an interim operating agreement with ConQuest Telecommunication Services Corp. ("ConQuest") which transferred all risks and rewards from ConQuest to SmarTalk. SmarTalk assumed responsibility for operating the ConQuest business and the employees of ConQuest became employees of SmarTalk on this date. On December 31, 1997, SmarTalk acquired 100% of ConQuest's outstanding common stock. In consideration for each outstanding share of ConQuest common stock, ConQuest stockholders received 7.63 shares of Common Stock (approximately 4.5 million shares of Common Stock in total). SmarTalk also assumed $6,139,679 of ConQuest's debt. Additionally, in connection with this acquisition SmarTalk paid $350,000 in cash in 1997 and issued 215,569 shares of Common Stock in January 1998 to obtain an agreement and mutual release from a group of individuals that had brought a lawsuit against ConQuest prior to the acquisition. ConQuest was a developer and marketer of prepaid calling cards and other enhanced telecommunication services and technology, including domestic and international calling services for the tour and travel industry. The acquisition of ConQuest added significantly to SmarTalk's technological infrastructure, customer base, platform operations and management infrastructure. Selected Assets of Frontier Corporation. On December 9, 1997, SmarTalk acquired selected assets (the "Frontier Selected Assets") of the retail prepaid phone card business of Frontier Corporation, a New York corporation ("Frontier"). In consideration for the Frontier Selected Assets, SmarTalk paid $35 million in cash and 65,568 shares of Common Stock. The acquisition of the Frontier Selected Assets added to SmarTalk's size, scale and scope, and helped establish SmarTalk's presence on the East Coast. Cardinal Voicecard Limited. On August 13, 1997, SmarTalk issued 115,000 shares of Common Stock to purchase this Toronto, Ontario based company. This acquisition provided the Company with access to the Canadian marketplace and added to the Company's international distribution. GTI Telecom, Inc. On May 31, 1997, SmarTalk issued 2,580,001 shares of Common Stock and $26,500,000 in subordinated 10% per annum term notes which mature June 1, 2001 (the "GTI Notes"), to purchase GTI Telecom, Inc. ("GTI"). $25,970,000 of the GTI Notes were repaid in September 1997 at $20,614,686. The difference of $5,355,314 was recorded as a reduction to goodwill. This acquisition expanded the Company's distribution and added human resource, technical and manufacturing infrastructure. SmarTel Communications, Inc. On May 28, 1997, the Company acquired SmarTel Communications, Inc. ("SmarTel"), a Boston-based prepaid promotions phone card company, for 714,286 shares of Common Stock. The Acquisitions have been accounted for using the purchase method of accounting. Accordingly, the operating results of the Acquisitions have been included in the Company's consolidated financial results since the date of acquisition. 14 RESULTS OF OPERATIONS QUARTER ENDED JUNE 30, 1998 (AS RESTATED) COMPARED WITH QUARTER ENDED JUNE 30, 1997 Revenue. Revenue increased to $42,927,385 for the quarter ended June 30, 1998 from $11,345,190 for the same period in 1997. The substantial increase in revenue reflects an increase in usage of SmarTalk services by users of the SmarTalk Card, the effect of the Acquisitions, an increase in the number of retail storefronts in which the Company's product is distributed, greater brand awareness and consumer acceptance and revenue attributable to a distribution and processing agreement entered into on June 1, 1996 with WIC. Revenue attributable to the distribution and processing agreement was $4,390,939 for the quarter ended June 30, 1998 and $4,769,342 for the same period in 1997. In addition, 2.3% of total revenue for the quarter ended June 30, 1998 consisted of revenue recognized on the unused portion of expired cards (breakage revenue) as compared to 5.2% for the same period in 1997. Recharge revenue for the quarters ended June 30, 1998 and 1997 was $2,198,338 and $745,667, respectively. Cost of Revenue. Cost of revenue increased to $28,059,201 for the quarter ended June 30, 1998 from $7,204,054 for the same period in 1997. The substantial increase was primarily attributable to greater use of the Company's services, the effect of the Acquisitions and an increase in taxes. The gross profit percentage for the quarter ended June 30, 1998 was 34.6% as compared to 36.5% for the same period in 1997. The gross margin percentage decreased primarily due to the decrease in breakage revenue which has minimal cost of revenues associated with it and the effect of the additional taxes. Sales and Marketing Expenses. Sales and marketing expenses increased to $25,755,318 (60.0% of revenue) for the quarter ended June 30, 1998 from $2,996,050 (26.4% of revenue) for the same period in 1997. The increase in dollar amount and percentage of revenue was due to the effect of the Acquisitions and the continued expansion of the Company's marketing activities, which include co-op advertising, consumer advertising, manufacturer's development funds and promotional goods. In addition, the Company revised its evaluation relating to the allowance for uncollectible accounts receivable and increased this allowance as well as wrote off accounts receivable in the aggregate amount of $10.9 million at June 30, 1998. For the quarter ended June 30, 1998, the Company recorded a charge of $7.3 million relating to certain manufacturer's development funds that had become permanently impaired in accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed of." General and Administrative Expenses. General and administrative expenses increased to $16,900,296 (39.4% of revenue) for the quarter ended June 30, 1998 from $2,906,363 (25.6% of revenue) for the same period in 1997. The increase in dollar amount and percentage of revenue was primarily due to the effect of the Acquisitions, which included intangible assets and goodwill amortization, depreciation expense and the addition of personnel and costs associated with the growth in the Company's business. Interest Income and Expense. Net interest expense for the quarter ended June 30, 1998, was $1,247,870 as compared to net interest income of $356,013 for the same period in 1997. This was primarily due to interest expense on the Company's subordinated debt that was issued September 17, 1997. Interest expense for the quarter ended June 30, 1998 and the same period in 1997 included $228,650 and $0, respectively, of debt issue costs and amortization. 15 Income Tax. The Company had losses for the quarter ended June 30, 1998 and the same period in 1997. Accordingly, there was no provision for income taxes. Decremented Minutes and PIN Activations. Decremented minutes, which represent actual call traffic over the SmarTalk platforms, were estimated at 205,365,484 for the quarter ended June 30, 1998 as compared to 54,824,541 for the quarter ended June 30, 1997. PIN activations were estimated at 4,391,777 and 693,447 for the quarters ended June 30, 1998 and 1997, respectively. These increases were due to increased usage of the Company's services and the effect of the Acquisitions. Discontinued Operations. On February 28, 1998 (the "Board Resolution Date"), the Company's board of directors adopted a plan to sell the Company's call center business located in Butler, Pennsylvania. The call center operations up to the Board Resolution Date have been classified as a loss from discontinued operations. The estimated loss from operations after the Board Resolution Date until the date of sale have been recorded as a loss on disposal of discontinued operations. This estimate was decreased by $250,000 in the quarter ended June 30, 1998. Net Loss. As a result of the above items, net loss increased to $29,217,257 ($1.26 per share) for the quarter ended June 30, 1998 from $1,405,264 ($.10 per share) for the same period in 1997. SIX MONTHS ENDED JUNE 30, 1998 (AS RESTATED) COMPARED WITH SIX MONTHS ENDED JUNE 30, 1997 Revenue. Revenue increased to $79,308,756 for the six months ended June 30, 1998 from $18,713,523 for the same period in 1997. The substantial increase in revenue reflects an increase in usage of SmarTalk services by users of the SmarTalk Card, the effect of the Acquisitions, an increase in the number of retail storefronts in which the Company's product is distributed, greater brand awareness and consumer acceptance and revenue attributable to a distribution and processing agreement entered into on June 1, 1996 with WIC. Revenue attributable to the distribution and processing agreement was $8,951,486 and $8,619,391 for the six months ended June 30, 1998 and the same period in 1997, respectively. In addition, 4.0% of total revenue for the six months ended June 30, 1998 consisted of breakage revenue as compared to 5.0% for the same period in 1997. Recharge revenue was $2,055,929 and $1,182,722 for the six months ended June 30, 1998 and the same period in 1997, respectively. Cost of Revenue. Cost of revenue increased to $52,857,157 for the six months ended June 30, 1998 from $11,964,802 for the same period in 1997. The increase was primarily attributable to greater use of the Company's services, the effect of the Acquisitions, and an increase in taxes. The gross profit percentage for the six months ended June 30, 1998 was 33.4% as compared to 36.1% for the same period in 1997. The gross margin percentage decreased primarily due to the decrease in breakage revenue which has minimal cost of revenue associated with it and the effect of the additional taxes. Sales and Marketing Expenses. Sales and marketing expenses increased to $33,092,717 (41.7% of revenue) for the six months ended June 30, 1998 from $5,541,464 (29.6% of revenue) for the same period in 1997. The increase in dollar amount and percentage of revenue was primarily due to the effect of the Acquisitions and the continued expansion of the Company's marketing activities, which include co-op, consumer advertising, manufacturer's development funds and promotional goods. [The Company also paid a major retailer $2.5 million for entering into a long term agreement. This amount was expensed during the quarter ended March 31, 1998.] In addition, the Company, in connection with the restatement of its financial statements for the period ended June 30, 1998, reassessed the collectibility of certain accounts receivable as of June 30, 1998. In connection with such reassessment, the Company revised its evaluation relating to the allowance for uncollectible accounts receivable and increased this allowance as well as wrote off accounts receivable in the aggregate amount of $10.9 million at June 30, 1998. General and Administrative Expenses. General and administrative expenses increased to $31,952,871 (40.3% of revenue) for the six months ended June 30, 1998 from $3,807,594 (20.3% of revenue) for the same 16 period in 1997. The increase in dollar amount and percentage of revenue was primarily due to the effect of the Acquisitions, which includes intangible assets and goodwill amortization, depreciation expense, and the addition of personnel and costs associated with the growth of the Company's business. Interest Income and Expense. Net interest expense for the six months ended June 30, 1998 was $2,509,602 as compared to net interest income of $884,776 for the same period in 1997. This was primarily due to interest expense on the Company's subordinated debt that was issued September 17, 1997. Interest expense for the quarter ended June 30, 1998 and the same period in 1997 included $453,434 and $0, respectively, of debt issue costs and amortization. Income Tax. The Company had losses for the six months ended June 30, 1998 and the same period in 1997. Accordingly, there was no provision for income taxes. Decremented Minutes and Pin Activations. Decremented minutes, which represent actual call traffic over the SmarTalk platforms, were 378,509,142 for the six months ended June 30, 1998 as compared to 90,045,627 for the six months ended June 30, 1997. PIN activations were 7,874,900 for the six months ended June 30, 1998 as compared to 1,130,502 for the six months ended June 30, 1997. These increases are due to increased usage of the Company's services and the effect of the Acquisitions. Discontinued Operations. On the Board Resolution Date, SmarTalk's board of directors adopted a plan to sell the Company's call center business located in Butler, Pennsylvania. The call center operations up to the Board Resolution Date have been classified as a loss from discontinued operations. The estimated loss from operations after the Board Resolution Date until the date of sale has been recorded as a loss on disposal of discontinued operations. This estimate was decreased by $250,000 in the quarter ended June 30, 1998. Net Loss. As a result of the above items, net loss increased to $44,563,696 ($1.97 per share) for the six months ended June 30, 1998 as compared to $1,715,561 ($.13 per share) for the same period in 1997. LIQUIDITY AND CAPITAL RESOURCES On July 9, 1998, the Company completed a private placement of 1,751,824 shares of its Common Stock, realizing proceeds before transaction costs of $29,999,986. On August 28, 1998, the terms of the private placement were restructured. In the event that the Company's Common Stock trades below the initial purchase price during specified periods, the Company will be obligated to issue up to $18,500,000 of additional Common Stock for no additional consideration. In addition, the Company granted an option exercisable for a period of two years commencing March 1, 1999 in connection with the private placement pursuant to which an additional $20,000,000 of the Company's Common Stock may be purchased. In the event the aggregate amount of Common Stock issued by the Company pursuant to the private placement would exceed 20% of the Company's total outstanding shares as of July 9, 1998 (the "20% Threshold"), as a result of either the exercise of the option or the initial purchase price adjustment, the Company would be required to obtain shareholder approval of the private placement or issue a note in a principal amount equal to the value of the Common Stock that otherwise would exceed the 20% Threshold. The Company expects to use the proceeds from this private placement to accelerate its entry into the prepaid cellular market and for general corporate purposes. On December 31, 1997, the Company issued 4,488,935 shares of Common Stock to purchase ConQuest. On December 31, 1997, the Company purchased Amex Telecom for $44,000,000 in cash. On December 9, 1997, the Company purchased selected retail assets of Frontier's prepaid phone card business for $35,000,000 in cash and 65,568 shares of Common Stock. In November 1997, the Company acquired a distribution agreement for $1,000,000 in cash and 326,531 shares of Common Stock. In December 1997, an additional 3,674 shares of Common Stock were issued for a referral associated with the distribution agreement. 17 On September 17, 1997, SmarTalk issued 5 3/4% per annum convertible subordinated notes due September, 2004, in an aggregate principal amount of $150,000,000 (the "Notes"). The net proceeds to SmarTalk from the Notes offering (after deducting the underwriting discounts and other expenses) was $144,946,319. Interest on the Notes is payable semi-annually on March 15 and September 15 of each year commencing March 15, 1998. On August 6, 1997, ConQuest entered into a revolving credit facility with Star Bank, N.A. ("Star Line of Credit"). Pursuant to the terms of the Star Line of Credit, ConQuest could borrow up to $9,500,000 as secured by various accounts receivable. Interest is based on the ninety-day LIBOR plus one percent. This credit facility was assumed by SmarTalk upon the acquisition of ConQuest and had an outstanding balance of $7,193,575 at April 27, 1998. This credit facility was paid in full and terminated on April 27, 1998. In December 1996, the Company entered into a revolving credit facility with Southern California Bank ("SCB Line of Credit"). Pursuant to the terms of the SCB Line of Credit, the Company can borrow up to $1,000,000 secured by an assignment of a deposit account with Southern California Bank. Interest on the outstanding principal balance, calculated from the date of each advance to the repayment of each advance is at a fixed rate of 7.12%. This credit facility was undrawn at June 30, 1998. Throughout 1997 to June 30, 1998, the Company has paid approximately $96,000,000 in cash, paid $26,644,686 for acquisition indebtedness and has issued approximately 12,500,000 shares of Common Stock for the Acquisitions, distribution and licensing agreements. From inception through June 30, 1998, the Company has funded operations primarily from borrowings under its debt agreements and the sale of Common Stock. The Company's operating activities used net cash of $19,917,582 for the six months ended June 30, 1998. The cash used by operating activities is primarily attributable to the Company's continued efforts to increase its penetration of the retail and alternate distribution channels. Short-term and long-term funding needs for SmarTalk relate principally to acquisitions, additional market penetration, liquidity, operations and capital expenditures. These requirements principally have been met through the proceeds of the initial public offering in October 1996 and the Notes offering in September 1997. The following table sets forth selected financial data from the consolidated statements of cash flows. (As Restated--See Note 9 to the Company's consolidated financial statements.)
CASH (USED IN) PROVIDED BY: --------------------------------------- SIX MONTHS ENDED JUNE 30, OPERATIONS INVESTING FINANCING ------------------------- ------------ ------------ ----------- 1998............................... $(19,917,582) $(11,913,204) $ (272,182) 1997............................... $ (4,849,583) $ (2,098,524) $(5,789,598) Working capital, current assets and current liabilities are illustrated in the table below: CURRENT CURRENT WORKING ASSETS LIABILITIES CAPITAL ------------ ------------ ----------- June 30, 1998...................... $ 74,244,952 $ 73,340,608 $ 904,344 December 31, 1997.................. $106,626,281 $ 71,316,035 $35,310,246
As of June 30, 1998, the Company believed that the net proceeds from the Notes offering, together with existing sources of liquidity, would be sufficient to fund its capital expenditures, working capital, selected acquisitions, and other requirements through the next twelve months. As described in Note 9 to the Company's consolidated financial statements, the consolidated financial statements of the Company have been restated to reflect, among other things, a revaluation of the Company's accounts receivable. The ability of the Company to satisfy its cash requirements is dependent in part on the Company's ability to timely collect its accounts receivable. In the event that the Company is unable to collect such receivables in a timely fashion, the Company may be required to consider other financing sources, including 18 the borrowing of additional funds or the issuance of additional debt or equity securities of the Company. There can be no assurance that the Company would be able to obtain such financing or that such financing would be on favorable terms. IMPACT OF INFLATION SmarTalk does not consider inflation to have had a material impact on the results of operations for the six months ended June 30, 1998 and 1997. YEAR 2000 The Company is aware of and is addressing the issues associated with the programming code in existing computer systems as the year 2000 approaches (the "Year 2000 Issue"). The Year 2000 Issue is pervasive and complex, as many computer systems will be affected in some way by the rollover of the two-digit year value to 00. Systems that do not properly recognize such information could generate erroneous data or cause a system to fail. The Company utilizes some software and related computer hardware technologies in its operations that may be affected by the Year 2000 Issue. While the Company believes that most of its proprietary software and platforms will be unaffected by the Year 2000 Issue, the Company is currently attempting to evaluate the impact of the Year 2000 Issue on the systems of its vendors, suppliers and key customers. The Company is currently reviewing what actions will be necessary to make its computer systems and those of its vendors, suppliers and key customers year 2000 compliant. The impact of these actions has yet to be fully determined, but could materially affect the Company's business. 19 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. The description of the Company's Legal Proceedings has changed substantially since the end of the period to which this Quarterly Report on Form 10-Q/A relates. The following is a description as of November 5, 1998. On April 20, 1998, Intrine Communications ("Intrine"), filed a complaint against the Company and DCN in the Superior Court of California in Los Angeles County. In the complaint, Intrine alleges that, by virtue of the Company's acquisition of DCN, the Company and DCN breached written and oral agreements not to circumvent and appropriate for themselves the benefits of a purported deal by Intrine to acquire DCN. The lawsuit seeks damages and injunctive relief. Management of the Company believes that the claims against the Company and DCN are without merit and does not at present expect this lawsuit to have a material adverse effect on the Company's financial position, liquidity, cash flow or results of operations. Since July 23, 1998, 19 putative class actions have been filed against the Company and certain current and former members of its management and board of directors in state and Federal courts alleging violations of state and Federal securities laws with respect to certain alleged misrepresentations and/or omissions in regard to the Company's projected and actual revenues and earnings. These lawsuits seek unspecified damages on behalf of certain classes of persons who purchased the Company's securities during periods between May, 1997 and August, 1998. The complaints generally allege that the Company made material misrepresentations and omissions in regard to the Company's projected and actual revenues and earnings. Although the Company intends to defend against these lawsuits vigorously, it is not feasible to predict or determine the final outcome of these proceedings at this time. An unfavorable outcome with respect to such proceedings could have a material adverse effect on the Company's financial condition and results of operations. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits required by Item 601 of Regulation S-K. 27.1 Financial Data Schedule (b) Reports on Form 8-K. SmarTalk filed a Form 8-K on June 10, 1998 pertaining to the consummation of the acquisition of Worldwide Direct, Inc. containing item 2 and item 7(c) exhibits 2.1 and 99.1. SmarTalk filed a Form 8-K on July 8, 1998 pertaining to the consummation of a subscription agreement between SmarTalk and Fletcher International Limited, containing item 5 and item 7(c) exhibits 99.1 and 99.2. SmarTalk filed a Form 8-K on August 13, 1998 pertaining to its press release dated August 10, 1998, containing item 5 and item 7(c) exhibit 99.1. 20 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Smartalk Teleservices, Inc. (Registrant) /s/ Wayne Wooddell ------------------------------------- Wayne Wooddell Vice President and Chief Financial Officer Date: November 6, 1998 21 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION ------- ----------- 27.1 Financial Data Schedule
22 EX-27.1 2 FINANCIAL DATA SCHEDULE
5 6-MOS 6-MOS DEC-31-1998 DEC-31-1997 JAN-01-1998 JAN-01-1997 JUN-30-1998 JUN-30-1997 30,736,105 62,900,673 0 0 32,393,058 29,494,443 7,794,758 1,482,206 5,165,136 4,301,487 74,244,952 106,626,281 22,847,491 15,403,784 4,502,990 1,194,809 390,850,735 368,301,077 73,340,608 71,316,035 0 0 0 0 0 0 241,522,173 178,670,477 82,210 143,810 390,850,735 368,301,077 79,308,756 18,713,523 79,308,756 18,713,523 52,857,157 11,964,802 52,857,157 11,964,802 65,045,588 9,349,058 0 0 4,896,930 224,748 (41,535,548) (1,715,561) 0 0 (41,535,548) (1,715,561) (3,028,148) 0 0 0 0 0 (44,563,696) (1,715,561) (1.97) (.13) (1.97) (.13)
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