-----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, PjSaGJ288KPS4XJOVf9C+HIKIBCZd1hAR/1sk+GOzuZj70JvuF/4FY/deUILyifA PhWZ3YqwrQr7dqlvsYJzVg== 0000944209-96-000330.txt : 19960926 0000944209-96-000330.hdr.sgml : 19960926 ACCESSION NUMBER: 0000944209-96-000330 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 18 FILED AS OF DATE: 19960925 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: SMARTALK TELESERVICES INC CENTRAL INDEX KEY: 0001018730 STANDARD INDUSTRIAL CLASSIFICATION: COMMUNICATION SERVICES, NEC [4899] FILING VALUES: FORM TYPE: S-1/A SEC ACT: 1933 Act SEC FILE NUMBER: 333-10391 FILM NUMBER: 96634407 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/A 1 AMENDMENT NO. 1 TO FORM S-1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 25, 1996 REGISTRATION NO. 333-10391 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------- AMENDMENT NO. 1 TO 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 (I.R.S. EMPLOYER ID NO.) JURISDICTION OF STANDARD INDUSTRIAL INCORPORATION OR CLASSIFICATION CODE NO.) 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. [_] ---------------- 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 SEPTEMBER 25, 1996 PROSPECTUS 4,200,000 SHARES [LOGO OF SMARTALK 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. Omitted is a photograph of a business woman making a phone call from a public telephone. To the right of this woman the following text appears: "An Emerging Market. The Prepaid Phone Card Industry Is Expected to Reach A Billion Dollars In Sales In 1996.*" In smaller print at the bottom of the page the following text appears: "*Source: ATLANTIC-ATM Report. 1996 Calling and Prepaid Card Products: Trends and Opportunities." Superimposed over the page are six SMARTALK TELESERVICES CARDS. Omitted is a photograph of a woman holding a SMARTALK TELESERVICES CARD making a phone call from a public telephone. Along the left side of the page the following text appears: "Helping Marketers Build Brand Equity. Air Touch Cellular, Cellular One, Janna Systems, Kodak & Hallmark Cards with American Stores, Hello Direct, JVC, Smart & Final Iris, Software Publishing Company, The Stiffel Company, and more." Along the right side of the page the following text appears: "National Distribution through Leading Retailers. Acme, Best Buy, Bradlees, Builders Square, Dayton's, Fedco, Foley's, The Good Guys, Good Neighbor Pharmacies, Hills, Hudson's, Jewel/Osco Combo Stores, Marshall Field's, Office Depot, Office 1 Superstores, Osco Drug, Penn Daniels, Price/Costco, Robinsons-May, Sav-on Drug, Thrifty Oil, Venture Stores, and more." Omitted are two photographs: On the left side of the page is a photograph of a businessman making a phone call and holding up the SMARTALK TELESERVICES CARD. On the right side is a photograph of a young child making a call from a public telephone and holding up the SMARTALK TELESERVICES CARD. Down the center of the page the following text appears: "Strategic Alliances Enhance Distibution Channels. The Douglas Stewart Company, MCI, Pacific Bell Public Communications, West Interactive." 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 total U.S. calling card market, including prepaid and other phone cards, 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, Office 1 Superstores, Price/Costco, Acme, Best Buy, Dayton's, Fedco, The Good Guys, Hudson's, Penn Daniels, Pamida and Robinsons-May. 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, 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 3 payphones in California. The Company intends to pursue similar arrangements with other payphone operators nationwide. 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"). The acquisition of the VoiceChoice Platform provides the Company with the opportunity to reduce its 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. 4 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. 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 510,514 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)...... 9,335,348 9,335,348 9,335,348 9,335,348
JUNE 30, 1996 --------------------------- ACTUAL AS ADJUSTED(3) ----------- -------------- BALANCE SHEET DATA(1): Working capital................................... $(3,256,069) $44,313,929 Total assets...................................... 4,782,822 52,012,822 Deferred revenue(4)............................... 4,127,919 4,127,919 Total debt........................................ 3,825,000 200,000 Total shareholders' equity (deficit).............. (5,814,988) 45,040,012
FOR THE THREE MONTHS ENDED ----------------------------------------------- SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, 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) Adjusted to reflect $200,000 borrowed under a $1,000,000 line of credit established in September 1996 and 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 (the "Securities Act")). 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 7 telecommunications market and attempt to market telecommunications services similar to the Company's services which would result in greater competition. 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 to date has no registered servicemarks, trademarks, patents 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 on the ground that there is another company in the telecommunications industry using the name "Smartalk." The Company is presently appealing such determination. The Company's appeal is based on its belief that (i) the two companies are in different segments of the telecommunications industry and do not compete against each other and therefore consumer confusion is unlikely, and (ii) the other company will not suffer any indirect harm or loss of goodwill due to confusion regarding the source of products because customers of the other company are sophisticated about the source of their purchases. 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 8 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 loss of the use of the name SmarTalk would have a Material Adverse Effect. 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 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" and "Business -- Products and Telecommunications Services." 9 DEPENDENCE ON MAJOR 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, Office 1 Superstores, Price/Costco, Acme, Best Buy, Dayton's, Fedco, The Good Guys, Hudson's, Penn Daniels, Pamida and Robinsons-May. The Company's arrangements with retailers are 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 10 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." 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." The Company maintains, and is the sole beneficiary of, "key man" life insurance on Mr. Lorsch in the amount of $3,000,000. 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 within the periods specified in 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 11 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 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 12 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 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 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 transfers of control and corporate reorganizations, and assignments of certain regulatory authorizations. As a result, the Company has filed or will file certain notices and applications relating to 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 13 issuance and similar regulations, or that state and federal 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." 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 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 Operations -- 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 14 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 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. See "Description of Capital Stock -- Preferred Stock." The Company's Amended and Restated Articles of Incorporation (the "Articles") and Amended and Restated Bylaws (the "Bylaws") require that any action required or permitted to be taken by shareholders of the Company must be effected at a duly called annual or special meeting of shareholders of the Company and may not be effected by written consent. In addition, the Company's charter documents eliminate cumulative voting, which may make it more difficult for a third party to gain control of the Company's Board of Directors. Moreover, the Board of Directors has the authority, without action by, or consent of, the shareholders, to fix the rights and preferences of and issue shares of Preferred Stock. These and other charter provisions may deter a third party who would propose to acquire the Company or to engage in a similar transaction affecting control of the Company in which the shareholders might receive a premium for their shares over the then current market value. See "Management," "Principal and Selling Shareholders" and "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 15 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 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." BENEFITS OF OFFERING TO EXISTING SHAREHOLDERS The existing shareholders of the Company will receive certain benefits from the sale of the Common Stock offered hereby. The Offering will establish a public market for the Common Stock and provide increased liquidity to the existing shareholders for the shares of Common Stock they will own after the Offering, subject to certain limitations. See "Shares Eligible For Future Sale." SmarTalk Partners, an existing shareholder of the Company, will sell 200,000 shares of Common Stock in the Offering and, at an assumed public offering price of $14.00 per share, would receive approximately $2.5 million in net proceeds. If the Underwriters' over-allotment option is exercised in full, SmarTalk Partners and the other Selling Shareholders will sell 630,000 shares of Common Stock and, at an assumed public offering price of $14.00 per share, would receive approximately $10.5 million. See "Principal and Selling Shareholders." Of the net proceeds of the Offering to be received by the Company, approximately $2 million will be used to repay indebtedness to SmarTalk Partners, and approximately $2 million will be used to repay indebtedness to Lorsch Creative Network, Inc., of which Robert H. Lorsch, President and Chief Executive Officer of the Company, is the sole shareholder. See "Use of Proceeds" and "Certain Transactions." Additionally, immediately following the Offering existing shareholders, assuming a public offering price of $14.00 per share, would have an average unrealized gain of $13.96 per share over the original cost of the shares that will continue to be held by them. See "Dilution." 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 September 20, 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 September 20, 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. The aggregate amount of the net proceeds to the Company that will flow to affiliates is approximately $4 million. 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 a transaction 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 payment 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 with SmarTalk Partners. 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(1) AS ADJUSTED(1)(2) ----------- ----------------- Short-term debt................................. $ 989,998 $ 200,000 Long-term debt.................................. 3,285,002 0 ----------- ----------- Total debt...................................... 4,275,000 200,000 ----------- ----------- Shareholders' equity (deficit): Preferred stock, no par value; 10,000,000 shares authorized; no shares issued and outstanding(3)............................... -- -- 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(3)................... 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.......................... $(1,539,988) $45,240,012 =========== ===========
- -------- (1) Actual June 30, 1996 amounts have been adjusted to reflect a $250,000 loan from SmarTalk Partners obtained in August 1996, and $200,000 borrowed under a $1,000,000 line of credit established in September 1996. See "Use of Proceeds." (2) 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." (3) Excludes 510,514 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 510,514 shares of Common Stock at exercise prices ranging from $1.77 to $4.44 per share, with a weighted average exercise price of approximately $3.72 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 $3.52, representing an increase in pro forma net tangible book value of $3.94 per share and dilution to new investors of $10.48 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 510,514 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).......... 9,335,348 9,335,348 9,335,348 9,335,348 ========= =========== ========= =========== 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 30, DECEMBER 31, MARCH 31, JUNE 30, 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 $4,075,000 of the proceeds from the Offering were used to retire debt totaling $4,075,000. 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. Certain functions currently performed by the Company's employees were performed during 1994 and 1995 by employees of LCN for which the Company was subsequently billed by LCN. 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 or 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 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 21 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. Other sales and marketing expenses include a provision for bad debt expense. 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 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. Revenue 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 revenue reflects an increase in usage of SmarTalk services by users of the SmarTalk Card as well as Corporate Advantage customers, an increase in the number of retail storefronts in which the Company's product is distributed and greater brand awareness and consumer acceptance. Revenue generated from recharges comprised approximately 12% of total revenue for the six months ended June 30, 1996 and was insignificant for the comparable period in 1995. This increase in recharge revenue is due to a greater number of SmarTalk cards in the marketplace eligible for recharge. In addition, more than 10% of revenue was attributable to a distribution and processing agreement entered into on June 1, 1996 with West Interactive (see "Business -- Strategic Partners"). The agreement provides that the Company will provide prepaid phone card and certain related services for customers of West Interactive. The Company bills and recognizes revenue under this agreement based on minute usage. 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 in cost of revenue was primarily attributable to greater use of the Company's services, which increased the dollar amount of transport costs and card costs. 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 lower gross margin associated with the above-mentioned distribution and processing agreement. 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 in dollar amount was primarily due to commissions paid to sales representatives generally 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. The decrease as a percentage of revenue was due to increased revenue growth in 1996. For the six months ended June 30, 1995, LCN provided certain sales and marketing services for which the Company was subsequently billed by LCN. General and Administrative Expenses. General and administrative expenses increased to $1,521,293 (or 41.4% of revenue) for the six months ended June 30, 1996 from $124,823 (or 299.1% 22 of revenue) for the six months ended June 30, 1995. The increase in dollar amount was primarily due to the addition of personnel and costs associated with the growth in the Company's business. The decrease as a percentage of revenue was due to increased revenue growth in 1996. General and administrative costs for the six months ended June 30, 1996 included rent associated with the Company's move into a new office, 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 the Company was subsequently billed by LCN. There were no payroll expenses for the six months ended June 30, 1995 as the Company had no employees during the period. Certain functions performed during 1996 by the Company's employees were performed during 1995 by employees of LCN for which the Company paid fees to LCN aggregating less than $50,000. 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. Revenue increased to $453,916 for the year ended December 31, 1995 from $444 for the period ended December 31, 1994. The increase in revenue reflects an increase in usage of SmarTalk services in 1995, including 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 primarily engaged in establishing its corporate identity and 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 increase in cost of revenue was primarily attributable to greater use of the Company's services, which increased the dollar amount of transport costs and card costs. The gross profit percentage for the year ended December 31, 1995 was 31.2%. The gross profit percentage and the amount for the period ended December 31, 1994 were not meaningful as the Company had insignificant revenue 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, reflecting increased promotional activity and marketing support to retailers. The increase also reflects an increase in creative and consulting expenses as the Company developed its product advertising as well as its packaging concept. There were no significant promotional expenses or creative and consulting expenses during the period ended December 31, 1994. Certain of the expenses incurred by SmarTalk during the year ended December 31, 1995 and period ended December 31, 1994 were incurred by LCN and the Company was billed by LCN. The limited revenue during the period ended December 31, 1994 makes comparisons to the comparable period in 1995 not meaningful. 23 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.There were no payroll expenses in the period ended December 31, 1994. Certain of the expenses, including expenses related to functions performed by LCN employees, were incurred by LCN during the year ended December 31, 1995 and period ended December 31, 1994 and the Company was billed by LCN. 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
24 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 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 September 20, 1996, the Company's cash and cash equivalents were $223,856. 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 until July 31, 2000, when all amounts are due and payable. 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 a floating rate equal to the prime rate plus 2% and is payable monthly in arrears 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. 25 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 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. 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." In September 1996, the Company entered into a revolving line of credit with Southern California Bank (the "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 a first priority lien on substantially all of the Company's assets. Interest on the outstanding principal balance, calculated from the date of each advance to the repayment of each advance, is at the prime rate (as published in the Wall Street Journal) plus 2.375%. Interest payments are due monthly with the Company being required to make a minimum interest payment of $4,429 per month for one year. If the line of credit is paid off prior to one year, the remaining minimum monthly payments become due and payable. The SCB Line of Credit will become due and payable September 1, 1997. As of September 23, 1996, there was $200,000 outstanding pursuant to the SCB Line of Credit. 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. 26 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, Office 1 Superstores, Price/Costco, Acme, Best Buy, Dayton's, Fedco, The Good Guys, Hudson's, Penn Daniels, Pamida and Robinsons-May. Certain of those retailers have, from time to time, accounted for a significant percentage of the Company's revenue. 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, 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 27 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 and, in conjunction with Kodak and Hallmark Cards, American Stores. 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. The acquisition of the VoiceChoice Platform provides the Company with the opportunity to reduce its 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 total U.S. calling card market, including prepaid and other phone cards, 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 retail distribution channels. 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. 28 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 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 29 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 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 such as Office Depot, Office 1 Superstores and Hello Direct Catalog that market to commercial clients. 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 30 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. 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 button. 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, 31 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. 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 two buttons. 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 32 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. 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 more than 25 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, Office 1 Superstores, Price/Costco, Acme, Best Buy, Dayton's, Fedco, The Good Guys, Hudson's, Penn Daniels, Pamida and Robinsons-May. 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 33 and signage systems which make 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. 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, 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. 34 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. 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. SmarTalk has created promotional programs for JVC, Smart & Final Iris, Cellular One, AirTouch Cellular and, in conjunction with Kodak and Hallmark Cards, American Stores. 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. 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 such as Office Depot, Office 1 Superstores and Hello Direct Catalog that market to commercial clients. 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. 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 35 services. The information card alerts the customer that SmarTalk is a convenient and cost-effective alternative to the other long distance telephone calls 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, will purchase prepaid calling card services from SmarTalk for sale to West Interactive's clients. The agreement provides that prepaid cards sold by West Interactive to its clients and any related promotional literature distributed will 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. 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 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 36 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 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. 37 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 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 24 hours a day at the touch of a button. 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, 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, 38 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. 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 39 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/or 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. Certificates 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, for example, 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. 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 40 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. 41 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 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 42 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 43 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. On December 28, 1995, pursuant to a Loan and Investment Agreement among SmarTalk Partners, the Company and Robert H. Lorsch, SmarTalk Partners agreed to loan the Company $1,200,000, provide the Company with a $500,000 line of credit and purchase shares of Common Stock of the Company representing 30% of the outstanding shares for a purchase price of $300,000. The number of shares purchased was 2,647,449, as adjusted for subsequent stock splits, and the purchase price was determined on the basis of arms' length negotiations. This loan, evidenced by a promissory note and secured by substantially all of 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 and secured by substantially all of the assets of the Company, bears interest at a floating rate equal to prime rate plus 2%, payable monthly in arrears. 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 member 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 of the office furniture and equipment fixed assets 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, payable $35,000 a month beginning August 31, 1996, with all amounts due and payable in full on June 30, 2000. The transaction was determined by the board of directors of the Company to be (i) at a purchase price that was a fair value and (ii) favorable to the Company's shareholders. The shareholders of the Company unanimously consented to the transaction. The Company intends to repay the promissory note with the proceeds from the Offering. LCN is party to a subordination agreement with the Company and SmarTalk Partners pursuant to which LCN has agreed that no payments shall be made under the promissory note unless all amounts under the $250,000 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 promissory note. See "Use of Proceeds" and "Certain Transactions." 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. This 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. 44 Payments of principal and interest on the $1,200,000 loan, the line of credit, and the $2,000,000 term note are subordinated to, and may not be made prior to the repayment of, the $250,000 term loan. The Company intends to repay the $250,000 term loan with the proceeds from the Offering. See "Use of Proceeds," "Certain Transactions" and "Principal and Selling Shareholders. " 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 board 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 board 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 "-- 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. 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 certain amounts including consulting fees for Mr. Lorsch's services. See "-- 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. 45 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) 24 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. 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) 24 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. 46 STOCK OPTION PLANS 1996 NONQUALIFIED STOCK OPTION PLAN. In March 1996, the board of directors adopted the Company's 1996 Nonqualified Stock Option Plan (the "Nonqualified Plan"). The Nonqualified Plan provides for the granting of nonstatutory stock options to employees, officers, directors, consultants, advisors or agents of the Company. Pursuant to the Nonqualified 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 then 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 Nonqualified Plan. The board of directors may amend, suspend or terminate the Nonqualified Plan at any time. Upon completion of the Offering, however, any amendment which would materially (1) increase the benefits accruing to participants under the Nonqualified Plan, (2) increase the number of shares which may be issued under the Nonqualified Plan, or (3) modify the requirements for eligibility for participation in the Nonqualified Plan, must be approved by the Company's shareholders. The number of shares available for issuance under the Nonqualified 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 Nonqualified Plan. The Nonqualified Plan automatically terminates in March 2006 unless terminated earlier by the board of directors. It is anticipated that the Nonqualified Plan will be terminated upon consummation of the Offering. The Nonqualified Plan is administered by the Compensation Committee. Subject to the conditions of the Nonqualified Plan, the Compensation Committee, in its discretion, selects the recipient 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. Of such amount, since January 1, 1996, options to purchase an aggregate of 103,031 shares were granted under the Nonqualified Plan to officers and directors at exercise prices ranging from $1.77 per share to $4.44 per share.The Company anticipates that it will not issue any additional options under the Nonqualified 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 with the Nonqualified 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 the grant of stock options, including both incentive stock options and nonqualified 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. As of September 23, 1996, options to purchase 2,000 shares of Common Stock had been granted. The total 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 nonqualified 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 nonqualified 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 of 1986, as amended, to $100,000. The maximum term of stock options granted under 47 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 10 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 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. 48 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 then 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 Nonqualified 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 10 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, as amended (the "Exchange Act.") 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 nonqualified 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 nonqualified 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. 49 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 nonqualified 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. On December 28, 1995, pursuant to a Loan and Investment Agreement among SmarTalk Partners, the Company and Robert H. Lorsch, SmarTalk Partners agreed to loan the Company $1,200,000, provide the Company with a $500,000 line of credit and purchase shares of Common Stock of the Company representing 30% of the outstanding shares for a purchase price of $300,000. The number of shares purchased was 2,647,449, as adjusted for subsequent stock splits, and the purchase price was determined on the basis of arm's length negotiations. This loan, evidenced by a promissory note and secured by substantially all of 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 and secured by substantially all of the assets of the Company, bears interest at a floating rate equal to prime rate plus 2%, payable monthly in arrears. 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 member 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," "Management -- Compensation Committee Interlocks and Insider Participation" and "Use of Proceeds." SmarTalk purchased certain of the office furniture and equipment fixed assets of LCN pursuant to an agreement dated December 28, 1995 between SmarTalk and LCN. The purchase was 50 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, payable $35,000 a month, with all amounts due and payable in full on June 30, 2000. The transaction was determined by the then board of directors of the Company to be (i) at a purchase price that was a fair value and (ii) favorable to the Company's shareholders. The shareholders of the Company unanimously consented to the transaction. The Company intends to repay the promissory note with the proceeds from the Offering. LCN is party to a subordination agreement with the Company and SmarTalk Partners pursuant to which LCN has agreed that no payments shall be made under the promissory note unless all amounts under the $250,000 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 promissory note. 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. This 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. Payments of principal and interest on the $1,200,000 loan, the line of credit, and the $2,000,000 term note are subordinated to, and may not be made prior to the repayment of, the $250,000 term loan. The Company intends to repay the $250,000 term loan 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." 51 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)(6) 3 Civic Plaza, Suite 17D Newport Beach, CA 92660............................... 2,647,449 30.0% 380,000 2,267,449 17.7% Ahmed O. Alfi(6)......................................... -- -- -- -- -- Fred F. Fielding(7)...................................... -- -- -- -- -- Jeffrey I. Scheinrock(8)................................. -- -- -- -- -- Lloyd S. Zeiderman(9).................................... 477,632 5.4% 20,250 457,382 3.6% Bruce Bielinski(10)...................................... 308,870 3.5% 20,250 288,620 2.3% Richard M. Teich(10)..................................... 308,870 3.5% 20,250 288,620 2.3% Robert H. Thau(10)(11)................................... 123,548 1.4% 4,625 118,923 0.9% Bernard D. Walter(10)(12)................................ 123,548 1.4% 4,625 118,923 0.9% All directors and executive officers as a group (8 persons)(4)(6)(7)(8)(9)(10)(13)...................... 6,191,505 70.0% 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. Includes 168,762 shares held by the 1996 JBL Trust, the beneficiary of which is Mr. Lorsch's son. Mr. Lorsch disclaims beneficial ownership of the shares. (5) Amre Youness may be deemed the beneficial owner of the shares owned by SmarTalk Partners by virtue of his status as its sole manager. His business address is c/o SmarTalk Partners, 3 Civic Plaza, Suite 17D, Newport Beach, CA 92660. (6) Mr. Alfi, a director of the Company, is a member of SmarTalk Partners. Mr. Alfi disclaims beneficial ownership of the shares owned by SmarTalk Partners. (7) 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 Nonqualified Plan. Such options will not vest within 60 days of this Offering. See "Management -- Directors' Compensation." (8) 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 Nonqualified Plan. Such options will not vest within 60 days of this Offering. See "Management -- Directors' Compensation." (9) Includes 168,762 shares held by the 1996 JBL Trust, of which Mr. Zeiderman is trustee. Accordingly, Mr. Zeiderman may be deemed to beneficially own such shares. (10) 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. (11) 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. (12) 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. (13) 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 Nonqualified Plan. Such options will not vest within 60 days of this Offering. 52 DESCRIPTION OF CAPITAL STOCK GENERAL The authorized capital stock of the Company consists of 100,000,000 shares of Common Stock, no par value, and 10,000,000 shares of Preferred Stock, no par value. As of September 23, 1996, there were 8,824,834 shares of Common Stock issued and outstanding held by 11 shareholders of record and no shares of Preferred Stock issued and outstanding. As of September 23, 1996, there were 510,514 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 53 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 days prior to and for 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 the Company's Articles and Bylaws may have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire, control of the Company. Such provisions could limit the price that certain investors might be willing to pay in the future for shares of the Common Stock. Certain of these provisions allow the Company to issue Preferred Stock without any vote or further action by the shareholders, to eliminate the right of shareholders to act by written consent without a meeting and to eliminate cumulative voting in the election of directors. The authorization of undesignated Preferred Stock makes it possible for the board of directors to issue Preferred Stock with voting or other rights or preferences that could impede the success of any attempt to change control of the Company. These provisions may also make it more difficult for shareholders to take certain corporate actions. 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. 54 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 90 days after the effective date of this Offering in reliance upon Rule 144, but without the requirement to comply 55 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 Option Plans, as well as certain of the shares of Common Stock previously issued under its Stock Option 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. 56 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. 57 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. 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 Citicorp 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. 58 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.............. 9,335,348 9,335,348 9,335,348 9,335,348 ========= =========== ========= ===========
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 - ------------------------------------------------------------------------------- Other Current Assets Other current assets include the cost of cards which have been shipped to retailers but not yet sold to customers. These costs are reclassified from inventory at the time of shipment and are amortized into expense as the revenue to which they specifically relate is recognized. 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. F-8 SMARTALK TELESERVICES, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) FOR DECEMBER 31, 1994 AND 1995 AND UNAUDITED JUNE 30, 1996 - ------------------------------------------------------------------------------- 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. 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 ====== ======== ========
F-9 SMARTALK TELESERVICES, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) FOR DECEMBER 31, 1994 AND 1995 AND UNAUDITED JUNE 30, 1996 - ------------------------------------------------------------------------------- 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 ====== ======== ========
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. F-10 SMARTALK TELESERVICES, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) FOR DECEMBER 31, 1994 AND 1995 AND UNAUDITED JUNE 30, 1996 - ------------------------------------------------------------------------------- 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......................... $ -- $ -- ======== =========
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. F-11 SMARTALK TELESERVICES, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) FOR DECEMBER 31, 1994 AND 1995 AND UNAUDITED JUNE 30, 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 a manner similar to a capital distribution. 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. Amounts billed and services rendered by LCN are as follows:
1994 1995 ------- -------- Marketing and product development.......................... $25,000 $ 85,000 Software development....................................... 70,000 Management consulting...................................... 200,000 Other...................................................... 60,000 ------- -------- Total.................................................... $25,000 $415,000 ======= ========
All costs incurred by LCN on the Company's behalf have been appropriately reflected in the accompanying financial statements. 7. STOCK COMPENSATION PLANS The Company had two stock based compensation plans at June 30, 1996. The programs are described as follows: 1996 NONQUALIFIED STOCK OPTION PLAN: In March 1996, the board of directors adopted the Company's 1996 Nonqualified Stock Option Plan (the "Nonqualified 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 Nonqualified 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 F-12 SMARTALK TELESERVICES, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) FOR DECEMBER 31, 1994 AND 1995 AND UNAUDITED JUNE 30, 1996 - ------------------------------------------------------------------------------- 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 December 31, 1995....................... -- -- 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 Nonqualified Plan. Stock Options Nonqualified 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 nonqualified 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. 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 F-13 SMARTALK TELESERVICES, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) FOR DECEMBER 31, 1994 AND 1995 AND UNAUDITED JUNE 30, 1996 - ------------------------------------------------------------------------------- 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. 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. F-14 SMARTALK TELESERVICES, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) FOR DECEMBER 31, 1994 AND 1995 AND UNAUDITED JUNE 30, 1996 - ------------------------------------------------------------------------------- 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. 10. SUBSEQUENT EVENTS On August 13, 1996, the Company obtained a loan from SmarTalk Partners, LLC for $250,000. The note bears interest at a floating rate equal to the prime rate, which was 8.25% at September 20, 1996, and has a maturity date of January 31, 1997. On September 20, 1996, the Company obtained a $1,000,000 revolving line of credit from a financial institution. Borrowings under the line, which totaled $200,000 at September 20, 1996, bear interest monthly at a floating rate equal to the prime rate plus 2.375%, with minimum monthly interest charges of $4,429 for one year from date of the note. F-15 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.................................................................. 27 Plan of Operation......................................................... 41 Management................................................................ 42 Certain Transactions...................................................... 50 Principal and Selling Shareholders........................................ 52 Description of Capital Stock.............................................. 53 Shares Eligible for Future Sale........................................... 55 Underwriting.............................................................. 57 Legal Matters............................................................. 58 Experts................................................................... 58 Additional Information.................................................... 58 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 PARTICIPATING 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 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. From January 1, 1996 to June 24, 1996, Registrant granted stock options under the 1996 Nonqualified Stock Option Plan covering an aggregate of 508,514 shares of Registrant's Common Stock, at exercise prices ranging from $1.77 to $4.44 per share. None of such options have been exercised. On September 18, 1996, Registrant granted a stock option under the 1996 Stock Incentive Plan covering 2,000 shares of Registrant's Common Stock at an exercise price of $2.50 per share. Such option has not been exercised. 2. 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. 3. 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. 4. 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.(1) 3.1 Amended and Restated Articles of Incorporation. 3.2 Amended and Restated Bylaws. 4.1 Registration Rights Agreement.(1) 4.2 Specimen Stock Certificate.(1) 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.(1) 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.(1)
II-2 10.3 Security Agreement dated December 28, 1995 between SmarTalk TeleServices, Inc. and SmarTalk Partners, LLC.(1) 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.(1) 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.(1) 10.6 Subordination Agreement dated January 1, 1996 between SmarTalk TeleServices, Inc. and Lorsch Creative Network, Inc.(1) 10.7 Security Agreement dated August 9, 1996 between SmarTalk TeleServices, Inc. and Lorsch Creative Network, Inc.(1) 10.8A Employment Agreement between SmarTalk TeleServices, Inc. and Robert H. Lorsch. 10.8B Employment Agreement between SmarTalk TeleServices, Inc. and Richard M. Teich. 10.9 Form of Indemnification Agreement dated October 28, 1994 between SmarTalk TeleServices, Inc. and certain management personnel.(1) 10.10 1996 Nonqualified 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.(1) 10.13 Carrier Agreement dated November 9, 1995 between the Registrant and MCI Telecommunications Corporation.*(1) 10.14A First Amendment to Carrier Agreement dated March 2, 1996 between SmarTalk TeleServices, Inc. and MCI Telecommunications Corporation.*(1) 10.14B Second Amendment to Carrier Agreement dated September 9, 1996 between SmarTalk TeleServices, Inc. and MCI Telecommunications Corporation.* 10.15 Agreement dated October 4, 1995 between SmarTalk TeleServices, Inc. and West Interactive Corporation.*(1) 10.16 Security Agreement dated August 9, 1996 between SmarTalk TeleServices, Inc. and SmarTalk Partners, LLC.(1) 10.17 Subordination Agreement dated August 9, 1996 among Lorsch Creative Network, Inc., SmarTalk TeleServices, Inc. and SmarTalk Partners, LLC.(1) 10.18 Promissory Note in the amount of $250,000 dated August 9, 1996 between SmarTalk TeleServices, Inc. and SmarTalk Partners, LLC.(1) 10.19 Business Alliance Agreement between Pacific Bell and the SmarTalk TeleServices, Inc., dated May 24, 1996.* 10.20 Prepaid Carrier Referral Program Agreement between MCI Telecommunications Corporation and SmarTalk TeleServices, Inc., dated June 21, 1996.* 10.21 Wholesale Distribution Agreement between West Interactive Corporation and SmarTalk TeleServices, Inc., dated June 1, 1996.* 10.22 Loan Agreement dated September 18, 1996, between Southern California Bank and SmarTalk TeleServices, Inc. 10.23 Promissory Note in the amount of $1,000,000 dated September 18, 1996 between Southern California Bank and SmarTalk TeleServices, Inc.
II-3 10.24 Commercial Security Agreement in the amount of $1,000,000 dated September 18, 1996 between Southern California Bank and SmarTalk TeleServices, Inc. 21.1 Subsidiary of the Registrant.(1) 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.(1) 27.1 Financial Data Schedule.
- -------- * Confidential treatment has been requested. The copy filed as an exhibit omits information subject to the confidentiality request. (1) Previously filed. 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 Amendment No. 1 to the Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Los Angeles, State of California, on September 24, 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 Pursuant to the requirements of the Securities Act of 1933, this Amendment No. 1 to the 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 September 24, 1996 ____________________________________ Directors, President and Robert H. Lorsch Chief Executive Officer * Chief Financial Officer September 24, 1996 ____________________________________ and Vice President Glen Andrew Folck Finance/Operations * Director September 24, 1996 ____________________________________ Ahmed O. Alfi * Director September 24, 1996 ____________________________________ Fred F. Fielding * Director September 24, 1996 ____________________________________ Jeffrey I. Scheinrock * Director September 24, 1996 ____________________________________ Lloyd S. Zeiderman
*By /s/ Robert H. Lorsch ____________________________ Robert H. Lorsch Attorney-in-Fact 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.(1) 3.1 Amended and Restated Articles of Incorporation. 3.2 Amended and Restated Bylaws. 4.1 Registration Rights Agreement.(1) 4.2 Specimen Stock Certificate.(1) 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.(1) 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.(1) 10.3 Security Agreement dated December 28, 1995 between SmarTalk TeleServices, Inc. and SmarTalk Partners, LLC.(1) 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.(1) 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.(1) 10.6 Subordination Agreement dated January 1, 1996 between SmarTalk TeleServices, Inc. and Lorsch Creative Network, Inc.(1) 10.7 Security Agreement dated August 9, 1996 between SmarTalk TeleServices, Inc. and Lorsch Creative Network, Inc.(1) 10.8A Employment Agreement between SmarTalk TeleServices, Inc. and Robert H. Lorsch. 10.8B Employment Agreement between SmarTalk TeleServices, Inc. and Richard M. Teich. 10.9 Form of Indemnification Agreement dated October 28, 1994 between SmarTalk TeleServices, Inc. and certain management personnel.(1) 10.10 1996 Nonqualified 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.(1) 10.13 Carrier Agreement dated November 9, 1995 between the Registrant and MCI Telecommunications Corporation.*(1) 10.14A First Amendment to Carrier Agreement dated March 2, 1996 between SmarTalk TeleServices, Inc. and MCI Telecommunications Corporation.*(1) 10.14B Second Amendment to Carrier Agreement dated September 9, 1996 between SmarTalk TeleServices, Inc. and MCI Telecommunications Corporation.* 10.15 Agreement dated October 4, 1995 between SmarTalk TeleServices, Inc. and West Interactive Corporation.*(1)
EXHIBIT SEQUENTIALLY NUMBER DESCRIPTION NUMBERED PAGES ------- ----------- -------------- 10.16 Security Agreement dated August 9, 1996 between SmarTalk TeleServices, Inc. and SmarTalk Partners, LLC.(1) 10.17 Subordination Agreement dated August 9, 1996 among Lorsch Creative Network, Inc., SmarTalk TeleServices, Inc. and SmarTalk Partners, LLC.(1) 10.18 Promissory Note in the amount of $250,000 dated August 9, 1996 between SmarTalk TeleServices, Inc. and SmarTalk Partners, LLC.(1) 10.19 Business Alliance Agreement between Pacific Bell and the SmarTalk TeleServices, Inc., dated May 24, 1996.* 10.20 Prepaid Carrier Referral Program Agreement between MCI Telecommunications Corporation and SmarTalk TeleServices, Inc., dated June 21, 1996.* 10.21 Wholesale Distribution Agreement between West Interactive Corporation and SmarTalk TeleServices, Inc., dated June 1, 1996.* 10.22 Loan Agreement dated September 18, 1996, between Southern California Bank and SmarTalk TeleServices, Inc. 10.23 Promissory Note in the amount of $1,000,000 dated September 18, 1996 between Southern California Bank and SmarTalk TeleServices, Inc. 10.24 Commercial Security Agreement in the amount of $1,000,000 dated September 18, 1996 between Southern California Bank and SmarTalk TeleServices, Inc. 21.1 Subsidiary of the Registrant.(1) 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.(1) 27.1 Financial Data Schedule.
- -------- * Confidential treatment has been requested. The copy filed as an exhibit omits information subject to the confidentiality request. (1) Previously filed. EX-1.1 2 UNDERWRITING AGREEMENT EXHIBIT 1.1 SMARTALK TELESERVICES, INC. __________ SHARES/1/ COMMON STOCK (NO PAR VALUE) UNDERWRITING AGREEMENT New York, New York _______ ___, 1996 Salomon Brothers Inc CS First Boston Donaldson Lufkin & Jenrette Securities Corporation As Representatives of the several Underwriters, c/o Salomon Brothers Inc Seven World Trade Center New York, New York 10048 Dear Sirs: SmarTalk Teleservices, Inc., a California corporation (the "Company"), proposes to sell to the underwriters named in Schedule I hereto (each an "Underwriter" and together, the "Underwriters"), for whom you (the "Representatives") are acting as representatives, ____________ shares of the Company's common stock, no par value per share ("Common Stock") [and the persons identified in Schedule II hereto propose to sell to the Underwriters the number of shares of Common Stock set forth opposite each person's name under the column "Number of Shares of Underwritten Securities" in Schedule II, or an aggregate of ___ shares of Common Stock] (said shares to be sold and issued by the Company [and the shares to be sold by Selling Shareholders collectively] being hereinafter called the "Underwritten Securities"). The shares of Common Stock to be sold by the Company and Selling Shareholders, excluding the Option Securities defined below, are collectively hereinafter called - --------------------- /1/ Plus an option to purchase from SmarTalk Teleservices, Inc. and the Selling Shareholders identified in Schedule III hereto up to _________ additional shares to cover over-allotments. -1- the "Underwritten Securities." The Company and the Selling Shareholders identified in Schedule III hereto also propose to grant to the Underwriters an option to purchase up to ___________ additional shares of Common Stock (the "Option Securities"; the Option Securities, together with the Underwritten Securities, being hereinafter called the "Securities"). The persons identified in Schedule II and Schedule III, excluding the Company, are hereby referred to as the "Selling Shareholders." 1. Representations and Warranties as to the Company. The Company ------------------------------------------------- represents and warrants to, and agrees with, each Underwriter as set forth below in this Section 1. Certain terms used in this Section 1 are defined in paragraph (t) hereof. (a) The Company has filed with the Securities and Exchange Commission (the "Commission") a registration statement (file number 333-_______) on Form S-1, including a related preliminary prospectus, for the registration under the Securities Act of 1933 (the "Act") of the offering and sale of the Securities. The Company may have filed one or more amendments thereto, including the related preliminary prospectus, each of which has previously been furnished to you. The Company will next file with the Commission either (A) prior to effectiveness of such registration statement, a further amendment to such registration statement, including the form of final prospectus or (B) after effectiveness of such registration statement, a final prospectus in accordance with Rules 430A and 424(b)(1) or (4). In the case of clause (B), the Company will include in such registration statement, as amended at the Effective Date, all information (other than Rule 430A Information) required by the Act and the rules thereunder to be included in the Prospectus with respect to the Securities and the offering thereof. As filed, such amendment and form of final prospectus, or such final prospectus, shall include all Rule 430A Information, together with all other such required information, with respect to the Securities and the offering thereof and, except to the extent the Representatives shall agree in writing to a modification, shall be in all substantive respects in the form furnished to you prior to the Execution Time or, to the extent not completed at the Execution Time, shall contain only such specific additional information and other changes (beyond that contained in the latest Preliminary Prospectus) as the Company has advised you, prior to the Execution Time, will be included or made therein. (b) On the Effective Date, the Registration Statement did or will, and when the Prospectus is first filed (if required) in accordance with Rule 424(b) and on the Closing Date, the Prospectus (and any supplements thereto) will, comply in all material respects with the applicable requirements of the Act and the rules thereunder; on the Effective Date, the Registration Statement did not or will not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein not misleading; and, on the Effective Date, the Prospectus, if not filed pursuant to Rule 424(b), did not or will not, -2- and on the date of any filing pursuant to Rule 424(b) and on the Closing Date, the Prospectus (together with any supplement thereto) will not, include any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. (c) Each of the Company and its subsidiaries has been duly incorporated and is validly existing as a corporation in good standing under the laws of the jurisdiction in which it is organized, with full corporate power and authority to own its properties and conduct its business as described in the Prospectus, and is duly qualified to do business as a foreign corporation and is in good standing under the laws of each jurisdiction which requires such qualification wherein it owns or leases properties or conducts business, and in which the failure to be so qualified would, in the aggregate in all such cases, have a material adverse effect on the business, condition (financial or otherwise), results of operation, operations or prospects of the Company and its subsidiaries on a consolidated basis (a "Material Adverse Effect"). (d) All the outstanding shares of capital stock of each subsidiary have been duly and validly authorized and issued and are fully paid and nonassessable, and, except as otherwise set forth in the Prospectus, all outstanding shares of capital stock of the subsidiaries are owned by the Company either directly or through wholly owned subsidiaries free and clear of any security interests, claims, liens or encumbrances. (e) The Company's authorized equity capitalization is as set forth in the Prospectus; the capital stock of the Company conforms to the description thereof contained in the Prospectus; the outstanding shares of Common Stock (including the Securities being sold hereunder by the Selling Shareholders) have been duly authorized and validly issued and are fully paid and nonassessable; the Securities being sold hereunder by the Company have been duly and validly authorized, and, when issued and delivered to and paid for by the Underwriters pursuant to this Agreement, will be fully paid and nonassessable and have been issued in full compliance with all federal and state securities laws; the Securities have been approved for quotation, subject to official notice of issuance, on the Nasdaq National Market System ("NMS"); the certificates for the Securities conform to the requirements of the California General Corporation Law and the NMS; the holders of outstanding shares of capital stock of the Company are not entitled to preemptive right, co-sale right, right of first refusal or other rights to subscribe for or purchase the Securities [other than those that will automatically expire upon the consummation of the transactions contemplated on the Closing Date]; and upon delivery of the Securities issued and sold by the Company pursuant to this Agreement and payment therefor as contemplated herein, the Underwriters will acquire good and marketable title to the Securities, free and clear of -3- any lien, claim, security interest or other encumbrance, restriction on transfer or other defect in title. (f) Except as described in the Prospectus, there are no outstanding options, warrants or other rights calling for the issuance of, and no commitments, plans or arrangements to issue, any shares of capital stock of the Company or any security convertible into or exchangeable or exercisable for capital stock of the Company; and except as described in the Prospectus, there is no holder of any securities of the Company or any other person who has the right, contractual or otherwise, to cause the Company to sell or otherwise issue to them, or to permit them to underwrite the sale of, any of the Securities or the right to have any Common Stock or other securities of the Company included in the Registration Statement or the right, as a result of the filing of the Registration Statement, to require registration under the Act of any shares of Common Stock or other securities of the Company. The description of the Company's stock option and other stock plans or arrangements, and the options or other rights granted and exercised thereunder, set forth in the Prospectus accurately and fairly presents the information required under the Act and the rules and regulations of the Commission thereunder (the "Regulations") to be shown with respect to such plans, arrangements, options and rights. (g) There is no pending or threatened action, suit or proceeding before any court or governmental agency, authority or body or any arbitrator involving the Company or any of its subsidiaries of a character required to be disclosed in the Prospectus which is not adequately disclosed in the Prospectus, and there is no franchise, contract, agreement or other document of a character required to be described in the Registration Statement or Prospectus, or to be filed as an exhibit to the Registration Statement, which is not in all material respects described or filed as required. The descriptions in the Registration Statement and the Prospectus of statutes, regulations, contracts, franchises, other documents, and pending or threatened actions, suits or proceedings before any court or arbitrator, or brought by any governmental agency, authority or body are accurate in all material respects and fairly summarize the matters therein described. (h) The consolidated financial statements of the Company and its consolidated subsidiaries, together with related schedules and notes, included in the Registration Statement and the Prospectus present fairly the consolidated financial position and the consolidated results of operations and cash flows of the Company and its consolidated subsidiaries for the periods or at the dates therein specified; such consolidated financial statements and related schedules and notes have been prepared in conformity with generally accepted accounting principles, consistently applied throughout the periods involved except as otherwise noted in such financial statements; and the other financial data concerning the Company and its subsidiaries set forth in the -4- Registration Statement and the Prospectus (and any amendment or supplement thereto) are accurately presented and were derived from such financial statements and the books and records of the Company. Price Waterhouse LLP, whose report is filed with the Commission as a part of the Registration Statement and the Prospectus, are independent public accountants as required by the Act and the Regulations. (i) Neither the Company nor any of its subsidiaries is in violation of its articles of incorporation or bylaws, or other organizational documents, or in violation in any material respect of any law, ordinance, administrative or governmental rule or regulation applicable to the Company or its subsidiaries, or in violation of any decree of any court or governmental agency or body having jurisdiction over the Company or its subsidiaries, or in default in any material respect in the performance of any obligation, agreement or condition contained in any bond, debenture, note or any other evidence of indebtedness or in any material agreement, indenture, lease or other instrument to which the Company or its subsidiaries are a party or by which it or any of their properties may be bound. (j) The Company and each of its subsidiaries has such permits, licenses, franchises and authorizations of governmental or regulatory authorities ("permits") as are necessary to own their properties and to conduct their business in the manner described in the Prospectus, except where the failure so to have would not, in all such cases in the aggregate, result in a Material Adverse Effect; the Company and each subsidiary has fulfilled and performed all of their material obligations with respect to such permits and no event has occurred which allows, or after notice or lapse of time would allow, revocation or termination thereof or results in any other material impairment of the rights of the holder of any such permit; and none of such permits contains any restriction that is materially burdensome to the Company or its subsidiaries in conducting its or their business as described in the Prospectus. (k) Subsequent to the respective dates as of which information is given in the Registration Statement and Prospectus, there has not been (1) any material adverse change in the condition (financial or otherwise), earnings, operations, business or business prospects of the Company, (2) any transaction that is material to the Company, except transactions entered into in the ordinary course of business, (3) any obligation, direct or contingent, that is material to the Company incurred by the Company, except obligations incurred in the ordinary course of business, (4) any change in the capital stock or outstanding indebtedness of the Company that is material to the Company, (5) any dividend or distribution of any kind declared, paid or made on the capital stock of the Company or (6) any loss or damage (whether or not insured) to the property of the Company which has been sustained or will have been sustained which has a Material Adverse Effect. -5- (l) Except as set forth in the Registration Statement and Prospectus, (1) the Company has good and marketable title to all properties and assets described in the Registration Statement and Prospectus as owned by it, free and clear of any pledge, lien, security interest, encumbrance, claim or equitable interest, other than such as would not have a Material Adverse Effect, (2) the agreements to which the Company is a party described in the Registration Statement and Prospectus are valid agreements, enforceable by the Company and its subsidiaries (as applicable), except as the enforcement thereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting creditors' rights generally or by general equitable principles or with respect to which any unenforceability would not have a Material Adverse Effect and, to the Company's knowledge, the other contracting party or parties thereto are not in material breach or material default under any of such agreements, and (3) the Company has valid and enforceable leases for all properties described in the Registration Statement and the Prospectus as leased by it, except as the enforcement thereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting creditors' rights generally or by general equitable principles or with respect to which any unenforceability would not have a Material Adverse Effect. Except as set forth in the Registration Statement and the Prospectus, the Company owns or leases all such properties as are necessary to its operations as now conducted or as proposed to be conducted. (m) The Company and its subsidiaries have filed all material federal, state, local, and foreign tax returns required to be filed, which returns are true and correct in all material respects, and the Company and its subsidiaries are not in default in the payment of any taxes which were payable pursuant to said returns or any assessments with respect thereto, except where either (i) the amount of such unpaid taxes is not in excess of the amount reserved therefor, or (ii) the Company is contesting such default in good faith through appropriate proceedings. (n) The Company maintains a system of internal accounting controls sufficient to provide reasonable assurance that: (i) transactions are executed in accordance with management's general or specific authorizations; (ii) transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles and to maintain accountability for assets; (ii) access to assets is permitted only in accordance with management's general or specific authorizations; and (iv) the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences. (o) The Company and its subsidiaries own or possess adequate licenses or other rights to use all patents, trademarks, trademark registrations, service marks, -6- service mark registrations, trade names, copyrights, licenses, inventions, trade secrets, and know-how or other similar rights ("Intellectual Property") described in the Prospectus as being owned or possessed by them, or necessary for the conduct of its business as described in the Prospectus, the Company has not infringed, is not now infringing, and its business as presently conducted and as proposed to be conducted will not cause it to infringe, any Intellectual Property belonging to any other person, which infringement or infringements, either individually or in the aggregate, could reasonably be expected to have a Material Adverse Effect; the Company has not received any claim or notice of infringement or potential infringement of any Intellectual Property of any other person which could reasonably be expected to have a Material Adverse Effect; and neither the Company nor any of its subsidiaries has any claim against a third party with respect to the infringement by such third party of Intellectual Property of the Company or any such subsidiary material to the business or prospects of the Company and its subsidiaries considered as a whole. To the Company's knowledge, the Company is not using any confidential information or trade secrets of any former employer of any past or present employees. (p) Neither the Company nor any of its subsidiaries is involved in any labor dispute with any union or group of employees nor, to the knowledge of the Company, is any dispute threatened; and the Company is not aware of any existing or imminent labor disturbance by the employees of any of its principal suppliers, manufacturers, distributors, licensees or contractors which might reasonably be expected to result in a Material Adverse Effect or any material adverse change in the condition, financial or otherwise, or in the earnings, business affairs or business prospects of the Company. (q) The Company and its subsidiaries maintain insurance of the types and in the amounts generally deemed adequate for their respective businesses, including, but not limited to, general liability insurance and insurance covering real and personal property owned or leased by the Company or any of its subsidiaries against theft, damage, destruction, acts of vandalism and all other risks customarily insured against, all of which insurance is in full force and effect. (r) This Agreement has been duly authorized, executed and delivered by the Company and is a valid and binding agreement enforceable against the Company in accordance with its terms, except to the extent that rights to indemnity and contribution hereunder may be limited by federal securities law or the public policy of a state with respect to such matters. (s) Neither the issuance and sale of the Securities, the execution, delivery or performance of this Agreement by the Company nor the consummation by the Company of the transactions contemplated hereby (i) requires any consent, approval, authorization or other order of or registration or filing with any court, regulatory body, administrative -7- agency or other governmental body, agency or official (except such as may have been obtained or such as may be required for the registration of the Securities under the Act and compliance with the securities or Blue Sky laws of various jurisdictions) or conflicts or will conflict with or constitutes or will constitute a breach of, or a default under, the articles of incorporation or bylaws of the Company or (ii) conflicts or will conflict with or constitutes or will constitute a breach of, or a default under, any agreement, indenture, lease or other instrument to which the Company is a party or by which it or any of its properties may be bound, or violates or will violate any statute, law, regulation or filing or judgment, injunction, order or decree applicable to the Company or any of its properties, or will result in the creation or imposition of any lien, charge or encumbrance upon any property or assets of the Company pursuant to the terms of any agreement or instrument to which it is a party or by which it may be bound or to which any of its property or assets is subject. (t) The terms which follow, when used in this Agreement, shall have the meanings indicated. The term "the Effective Date" shall mean each date that the Registration Statement and any post-effective amendment or amendments thereto became or become effective. "Execution Time" shall mean the date and time that this Agreement is executed and delivered by the parties hereto. "Preliminary Prospectus" shall mean any preliminary prospectus referred to in paragraph (a) above and any preliminary prospectus included in the Registration Statement at the Effective Date that omits Rule 430A Information. "Prospectus" shall mean the prospectus relating to the Securities that is first filed pursuant to Rule 424(b) after the Execution Time or, if no filing pursuant to Rule 424(b) is required, shall mean the form of final prospectus relating to the Securities included in the Registration Statement at the Effective Date. "Registration Statement" shall mean the registration statement referred to in paragraph (a) above, including exhibits and financial statements, as amended at the Execution Time (or, if not effective at the Execution Time, in the form in which it shall become effective) and, in the event any post- effective amendment thereto or a registration statement filed with respect to the Securities pursuant to Rule 462(b) (or post-effective amendment thereto), becomes effective prior to the Closing Date (as hereinafter defined), shall also mean such registration statement as so amended or registration statement (or amendment thereto) pursuant to Rule 462(b), respectively. Such term shall include any Rule 430A Information deemed to be included therein at the Effective Date as provided by Rule 430A or any Term Sheet filed pursuant to Rule 434. "Rule 424", "Rule 430A," "Rule 434" and "Rule 462" refer to such rules under the Act. "Rule 430A Information" means information with respect to the Securities and the offering thereof permitted to be omitted from the Registration Statement when it becomes effective pursuant to Rule 430A. 2. Representations and Warranties of the Selling Shareholders. Each ----------------------------------------------------------- Selling Shareholder represents and warrants to, and agrees with, each Underwriter that: -8- (a) Such Selling Shareholder is the lawful owner of the Securities to be sold by such Selling Shareholder hereunder, and upon sale and delivery of, and payment for, such Securities as provided herein, such Selling Shareholder will convey to the several Underwriters good and marketable title to such Securities, free and clear of all liens, encumbrances, equities and claims whatsoever. (b) Such Selling Shareholder, after due inquiry, has no reason to believe that the representations and warranties of the Company contained in Section 1 hereof are not true and correct in all material respects, is familiar with the Registration Statement and the Prospectus and has no knowledge of any material fact, condition or information not disclosed therein or in any amendment or supplement thereto which has adversely affected or may adversely affect the business of the Company, or any of its subsidiaries; and the sale of Securities by such Selling Shareholder pursuant hereto is not prompted by any material nonpublic information concerning the Company, or any of its subsidiaries which is not set forth in the Prospectus or any amendment or supplement thereto. (c) Such Selling Shareholder has not taken and will not take, directly or indirectly, any action designed to or which has constituted or which might reasonably be expected to cause or result in, under the Exchange Act or otherwise, stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Securities and has not effected any sales of shares of Common Stock which, if effected by the issuer, would be required to be disclosed in response to Item 701 of Regulation S-K. (d) Certificates in negotiable form for such Selling Shareholder's Securities have been placed in custody, for delivery pursuant to the terms of this Agreement, under a Power of Attorney and Custody Agreement executed and delivered by such Selling Shareholder, in the form heretofore furnished to you (the "Custody Agreement"), with _______________, as Custodian (the "Custodian"); the Securities represented by the certificates so held in custody for each Selling Shareholder are subject to the interests hereunder of the Underwriters, the Company, and the other Selling Shareholders; the arrangements for custody and delivery of such certificates, made by such Selling Shareholder hereunder and under the Custody Agreement, are not subject to termination by any acts of such Selling Shareholder, or by operation of law, whether by the death or incapacity of such Selling Shareholder or the occurrence of any other event; and if any such death, incapacity or any other such event shall occur before the delivery of such Securities hereunder, certificates for the Securities will be delivered by the Custodian in accordance with the terms and conditions of this Agreement and the Custody Agreement as if such death, incapacity or other event had not occurred, regardless of whether or not the Custodian shall have received notice of such death, incapacity or other event. -9- (e) No consent, approval, authorization or order of any court or governmental agency or body is required for the consummation by such Selling Shareholder of the transactions contemplated herein, except such as may have been obtained under the Act and such as may be required under the blue sky laws of any jurisdiction in connection with the purchase and distribution of the Securities by the Underwriters and such other approvals as have been obtained. (f) Neither the sale of the Securities being sold by such Selling Shareholder nor the consummation of any other of the transactions herein contemplated by such Selling Shareholder or the fulfillment of the terms hereof by such Selling Shareholder will conflict with, result in a breach or violation of, or constitute a default under, any law or the terms of any indenture or other agreement or instrument to which such Selling Shareholder is a party or bound, or any judgment, order or decree applicable to such Selling Shareholder of any court, regulatory body, administrative agency, governmental body or arbitrator having jurisdiction over such Selling Shareholder. In respect of any statements in or omissions from the Registration Statement or the Prospectus or any supplements thereto made in reliance upon and in conformity with information furnished in writing to the Company by the Selling Shareholder specifically for use in connection with the preparation thereof, the Selling Shareholder hereby makes the same representations and warranties to each Underwriter as the Company makes to such Underwriter under paragraph (1)(b). 3. Purchase and Sale. ------------------ (a) Subject to the terms and conditions and in reliance upon the representations and warranties herein set forth, the Company and the Selling Shareholders agree, severally and not jointly, to sell to each Underwriter, and each Underwriter agrees, severally and not jointly, to purchase from the Company and the Selling Shareholders, at a purchase price of $_____ per share, the amount of the Underwritten Securities set forth opposite such Underwriter's and Selling Shareholder's name in Schedule I and Schedule II hereto, respectively. (b) Subject to the terms and conditions and in reliance upon the representations and warranties herein set forth, the Company and the Selling Shareholders named in Schedule III hereto hereby grant an option to the several Underwriters to purchase, severally and not jointly, up to _________ shares of the Option Securities at the same purchase price per share as the Underwriters shall pay for the Underwritten Securities. Said option may be exercised only to cover over-allotments in the sale of the Underwritten Securities by the Underwriters. Said option may be exercised in whole or in part at any time (but not more than once) on or before the 30th day after the date of the Prospectus upon written notice by the Representatives -10- to the Company and the Selling Shareholders, setting forth the number of shares of the Option Securities as to which the several Underwriters are exercising the option and the settlement date. Delivery of certificates for the shares of Option Securities by the Company and the Selling Shareholders, and payment therefor to the Company and the Selling Shareholders, shall be made as provided in Section 4 hereof. The number of shares of the Option Securities to be purchased by each Underwriter shall be the same percentage of the total number of shares of the Option Securities to be purchased by the several Underwriters as such Underwriter is purchasing of the Underwritten Securities, subject to such adjustments as you in your absolute discretion shall make to eliminate any fractional shares. 4. Delivery and Payment. Delivery of and payment for the --------------------- Underwritten Securities and the Option Securities (if the option provided for in Section 3(b) hereof shall have been exercised on or before the third business day prior to the Closing Date) shall be made at 10:00 AM, New York City time, on ________ ___, 1996, or such later date (not later than _______, 1996) as the Representatives shall designate, which date and time may be postponed by agreement between the Representatives, the Company, and the Selling Shareholders or as provided in Section 10 hereof (such date and time of delivery and payment for the Securities being herein called the "Closing Date"). Delivery of the Securities shall be made to the Representatives for the respective accounts of the several Underwriters against payment by the several Underwriters through the Representatives of the respective aggregate purchase prices of the Securities being sold by the Company and the Selling Shareholders to or upon the order of the Company and the Selling Shareholders by certified or official bank check or checks drawn on or by a New York Clearing House bank and payable in next day funds. Delivery of the Securities shall be made at such location in New York, New York as the Representatives shall reasonably designate at least one business day in advance of the Closing Date and payment for the Securities shall be made at the offices of Munger, Tolles & Olson, 355 S. Grand Avenue, Los Angeles, California. Certificates for the Securities shall be registered in such names and in such denominations as the Representatives may request not less than three full business days in advance of the Closing Date. The Company and the Selling Shareholders agree to have the Securities available for inspection, checking and packaging by the Representatives in New York, New York, not later than 1:00 PM on the business day prior to the Closing Date. The Selling Shareholders will pay all applicable state transfer taxes, if any, involved in the transfer to the several Underwriters of the Underwritten Securities to be purchased by them from the Selling Shareholders and the respective Underwriters will pay any additional stock transfer taxes involved in further transfers. If the option provided for in Section 3(b) hereof is exercised after the second business day prior to the Closing Date, the Company will deliver (at the expense of the -11- Company) to the Representatives, at such location as the Representatives shall reasonably designate at least one business day in advance of the settlement date, on the date specified by the Representatives (which shall be within three business days after exercise of said option), certificates for the Option Securities in such names and denominations as the Representatives shall have requested not less than two full business days in advance of the settlement date against payment at the offices of Munger, Tolles & Olson of the purchase price thereof to or upon the order of the Company and the Selling Shareholders by certified or official bank check or checks drawn on or by a New York Clearing House bank and payable in next day funds. If settlement for the Option Securities occurs after the Closing Date, the Company will deliver to the Representatives on the settlement date for the Option Securities, and the obligation of the Underwriters to purchase the Option Securities shall be conditioned upon receipt of, supplemental opinions, certificates and letters confirming as of such date the opinions, certificates and letters delivered on the Closing Date pursuant to Section 7 hereof. 5. Offering by Underwriters. It is understood that the several ------------------------- Underwriters propose to offer the Securities for sale to the public as set forth in the Prospectus. 6. Agreements. ---------- (a) The Company agrees with the several Underwriters that: (i) The Company will use its best efforts to cause the Registration Statement, if not effective at the Execution Time, and any amendment thereof, to become effective. Prior to the termination of the offering of the Securities, the Company will not file any amendment of the Registration Statement or supplement to the Prospectus unless the Company has furnished you a copy for your review prior to filing and will not file any such proposed amendment or supplement to which you reasonably object. Subject to the foregoing sentence, if the Registration Statement has become or becomes effective pursuant to Rule 430A, or filing of the Prospectus is otherwise required under Rule 424(b), the Company will cause the Prospectus, properly completed, and any supplement thereto to be filed with the Commission pursuant to the applicable paragraph of Rule 424(b) within the time period prescribed and will provide evidence satisfactory to the Representatives of such timely filing. The Company will promptly advise the Representatives (A) when the Registration Statement, if not effective at the Execution Time, and any amendment thereto, shall have become effective, (B) when the Prospectus, and any supplement thereto, shall have been filed (if required) with the Commission pursuant to Rule 424(b), (C) when, prior to termination of the offering of the Securities, any amendment to the Registration Statement shall have been filed or become effective, (D) of any request by the Commission for any amendment of the Registration Statement or supplement to the Prospectus or for any additional information, (E) of the -12- issuance by the Commission of any stop order suspending the effectiveness of the Registration Statement or the institution or threatening of any proceeding for that purpose and (F) of the receipt by the Company of any notification with respect to the suspension of the qualification of the Securities for sale in any jurisdiction or the initiation or threatening of any proceeding for such purpose. The Company will use its best efforts to prevent the issuance of any such stop order and, if issued, to obtain as soon as possible the withdrawal thereof. (ii) If, at any time when a prospectus relating to the Securities is required to be delivered under the Act, any event occurs as a result of which the Prospectus as then supplemented would include any untrue statement of a material fact or omit to state any material fact necessary to make the statements therein in the light of the circumstances under which they were made not misleading, or if it shall be necessary to amend the Registration Statement or supplement the Prospectus to comply with the Act or the rules thereunder, the Company promptly will prepare and file with the Commission, subject to the second sentence of paragraph (i) of this Section 6(a), an amendment or supplement which will correct such statement or omission or effect such compliance. (iii) As soon as practicable, the Company will make generally available to its security holders and to the Representatives an earnings statement or statements of the Company and its subsidiaries which will satisfy the provisions of Section 11(a) of the Act and Rule 158 under the Act. (iv) The Company will furnish to the Representatives and counsel for the Underwriters, without charge, signed copies of the Registration Statement (including exhibits thereto) and to each other Underwriter a copy of the Registration Statement (without exhibits thereto) and, so long as delivery of a prospectus by an Underwriter or dealer may be required by the Act, as many copies of each Preliminary Prospectus and the Prospectus and any supplement thereto as the Representatives may reasonably request. The Company will furnish or cause to be furnished to the Representatives copies of all reports on Form SR required by Rule 463 under the Act. The Company will pay the expenses of printing or other production of all documents relating to the offering. (v) The Company will arrange for the qualification of the Securities for sale under the laws of such jurisdictions as the Representatives may designate, will maintain such qualifications in effect so long as required for the distribution of the Securities and will pay the fee of the National Association of Securities Dealers, Inc., in connection with its review of the offering. -13- (vi) The Company will not, for a period of 180 days following the Execution Time, without the prior written consent of Salomon Brothers Inc, 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; provided, however, that the Company may -------- ------- issue Common Stock issuable upon the exercise of options outstanding at the Execution Time. (vii) The Company will apply the net proceeds from the sale of its Securities substantially in accordance with the description set forth in the Prospectus and any Preliminary Prospectus under the heading "Use of Proceeds." (viii) The Company confirms as of the date hereof that it is in compliance with all provisions of Section 1 of Laws of Florida, Chapter 92-198, An Act Relating to Disclosure of Doing Business with ---------------------------------------------------- Cuba, and the Company further agrees that if it commences engaging in ---- business with the government of Cuba or with any person or affiliate located in Cuba after the date the Registration Statement becomes or has become effective with the Securities and Exchange Commission or with the Florida Department of Banking and Finance (the "Department"), whichever date is later, or if the information reported in the Prospectus, if any, concerning the Company's business with Cuba or with any person or affiliate located in Cuba changes in any material way, the Company will provide the Department notice of such business or change, as appropriate, in a form acceptable to the Department. (b) Each Selling Shareholder agrees with the several Underwriters that he will not during the time period of 180 days following the Execution Time, without the prior written consent of Salomon Brothers Inc, offer, sell or contract to sell, or otherwise dispose of, directly or indirectly, or announce the offering of, any other share of Common Stock beneficially owned by such person, or any securities convertible into, or exchangeable for, shares of Common Stock, other than shares of Common Stock disposed of as bona fide gifts. 7. Conditions to the Obligations of the Underwriters. The -------------------------------------------------- obligations of the Underwriters to purchase the Underwritten Securities and the Option Securities, as the case may be, shall be subject to the accuracy of the representations and warranties on the part of the Company and the Selling Shareholders contained herein as of the Execution Time and the Closing Date and any settlement date pursuant to Section 4 hereof, to the accuracy of the statements of the Company and the Selling Shareholders made in any certificates pursuant to the provisions hereof, to the performance by the Company and the Selling Shareholders of their respective obligations hereunder and to the following additional conditions: -14- (a) If the Registration Statement has not become effective prior to the Execution Time, unless the Representatives agree in writing to a later time, the Registration Statement will become effective not later than (i) 6:00 PM New York City time on the date of determination of the public offering price, if such determination occurred at or prior to 3:00 PM New York City time on such date or (ii) 12:00 Noon on the business day following the day on which the public offering price was determined, if such determination occurred after 3:00 PM New York City time on such date; if filing of the Prospectus, or any supplement thereto, is required pursuant to Rule 424(b), the Prospectus, and any such supplement, will be filed in the manner and within the time period required by Rule 424(b); and no stop order suspending the effectiveness of the Registration Statement shall have been issued and no proceedings for that purpose shall have been instituted or threatened. (b) The Company shall have furnished to the Representatives the opinions of Dewey Ballantine, counsel for the Company, dated the Closing Date, to the effect that: (i) each of the Company and its subsidiaries has been duly incorporated and is validly existing as a corporation in good standing under the laws of the jurisdiction in which it is chartered or organized, with full corporate power and authority to own and lease its properties and conduct its business as described in the Prospectus, and is duly qualified to do business as a foreign corporation and is in good standing under the laws of each jurisdiction which requires such qualification wherein the Prospectus states it owns or leases properties or conducts business, and in which the failure to be so qualified would, in the aggregate in all such cases, have a Material Adverse Effect; (ii) all the outstanding shares of capital stock of each subsidiary have been duly and validly authorized and issued and are fully paid and nonassessable, and, except as otherwise set forth in the Prospectus, all outstanding shares of capital stock of the subsidiary are owned by the Company free and clear of any perfected security interest and, to the knowledge of such counsel, after due inquiry, any other security interests, claims, liens or encumbrances; (iii) the Company's authorized equity capitalization is as set forth in the Prospectus; the authorized and outstanding capital stock of the Company is as set forth under the caption "Capitalization" in the Prospectus; the capital stock of the Company conforms to the description thereof contained in the Prospectus in all material respects; the outstanding shares of Common Stock, including the Securities being sold hereunder by the Selling Shareholders, have been duly and validly authorized and issued and are fully paid and non- assessable; the -15- Securities being sold hereunder by the Company have been duly and validly authorized, and, when issued and delivered to and paid for by the Underwriters pursuant to this Agreement, will be validly issued, fully paid and nonassessable; the Securities have been duly approved for quotation, subject to official notice of issuance, on NMS; the certificates for the Securities conform to the requirements of the California General Corporation Law and NMS; the holders of outstanding shares of capital stock of the Company are not entitled to preemptive or other rights to subscribe for the Securities; and upon delivery of the Securities being sold by the Company pursuant to this Agreement and payment therefor as contemplated herein, the several Underwriters will acquire the Securities free and clear of any "adverse claim" (as such term is used in Section 8-302 of the Uniform Commercial Code as in effect in the State of California), assuming the purchase of the Securities by the Underwriters in good faith and without notice of any such "adverse claim"; (iv) to the best knowledge of such counsel, there are no outstanding rights, warrants, or options to acquire, or instruments convertible into or exchangeable for any shares of capital stock or equity interest in the Subsidiaries; (v) to the best knowledge of such counsel, there is no pending or threatened action, suit or proceeding before any court or governmental agency, authority or body or any arbitrator involving the Company of a character required to be disclosed in the Registration Statement which is not adequately disclosed in the Prospectus, and there is no franchise, contract or other document of a character required to be described in the Registration Statement or Prospectus, or to be filed as an exhibit, which is not described or filed as required; the descriptions in the Registration Statement and the Prospectus of statutes, regulations, contracts, franchises, other documents, pending or threatened actions, suits or proceedings before any court or arbitrator, or brought by any governmental agency, authority or body fairly present the information required to be shown; (vi) the Registration Statement has become effective under the Act; any required filing of the Prospectus, and any supplements thereto, pursuant to Rule 424(b), have been filed in the manner and within the time period required by Rule 424(b); to the best knowledge of such counsel, no stop order suspending the effectiveness of the Registration Statement has been issued, no proceedings for that purpose have been instituted or threatened and the Registration Statement and the Prospectus (other than the financial statements, schedules and other financial information contained therein as to which such counsel need -16- express no opinion) comply as to form in all material respects with the applicable requirements of the Act and the rules thereunder; (vii) the Company has the corporate power and authority to enter into this Agreement and to issue, sell and deliver the Securities to be sold by it to the Underwriters as provided herein; this Agreement has been duly authorized, executed and delivered by the Company; (viii) no consent, approval, authorization or order of any court or governmental agency or body is required for the consummation of the transactions contemplated herein, except such as have been obtained under the Act and such as may be required under the blue sky laws of any jurisdiction in connection with the purchase and distribution of the Securities by the Underwriters; (ix) neither the issue and sale of the Securities, nor the consummation of any other of the transactions herein contemplated nor the fulfillment of the terms hereof will conflict with, result in a breach or violation of, or constitute a default under any law (except blue sky laws, as to which such counsel expresses no opinion) or the Articles of Incorporation or bylaws of the Company or the terms of any indenture or other agreement or instrument known to such counsel and to which the Company or any of its subsidiaries is a party or bound or any judgment, order or decree known to such counsel to be applicable to the Company or any of its subsidiaries of any court, regulatory body, administrative agency, governmental body or arbitrator having jurisdiction over the Company or any of its subsidiaries; and (x) to the best of such counsel's knowledge, except as described in the Prospectus, no holders of securities of the Company have rights to the registration of such securities under the Registration Statement. In addition, such counsel shall state that in the course of the preparation of the Registration Statement and the Prospectus, such counsel has participated in conferences with officers and representatives of the Company and with the Company's independent public accountants, at which conferences such counsel made inquiries of such officers, representatives and accountants and discussed the contents of the Registration Statement and the Prospectus and (without taking any further action to verify independently the statements made in the Registration Statement and the Prospectus and, except solely as expressly stated in the foregoing opinion, without assuming responsibility for the accuracy, completeness or fairness of such statements) nothing has come to such counsel's attention that causes such counsel to believe that the Registration Statement as of the Effective Date and as of the Closing Date or the Prospectus as of the date -17- thereof and as of the Closing Date contained or contains any untrue statement of a material fact or omitted or omits to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading (it being understood that such counsel need not express any statement with respect to the financial statements, schedules and other financial information included in the Registration Statement or the Prospectus). In rendering such opinion, such counsel may opine solely as to matters involving the application of the laws of the State of California and the federal law of the United States, and may rely as to matters of fact, to the extent they deem proper, on certificates of responsible officers of the Company and public officials. References to the Prospectus in this paragraph (b) include any supplements thereto at the Closing Date. (c) The Company shall have furnished to the Representatives the opinion of ___________, special counsel to the Company on regulatory matters, dated the Closing Date, to the effect that: (i) the statements in the Prospectus under the headings "Risk Factors - Intense Competition," "Risk Factors - Regulation," "Business-Competition," "Risk Factor - Limited Protection of Property Rights; Risk of Infringement" and "Business-Government Regulation" fairly and accurately summarize the laws, rules and regulations of the Federal Communications Commission ("FCC") and the comparable state regulatory agencies or bodies with direct regulatory jurisdiction over telecommunications matters in the states in which the Company and any of the Subsidiaries provide intrastate services (the "State Regulatory Agencies") and, to the best knowledge of such counsel, the statements in the Prospectus under the heading "Risk Factor - Limited Protection of Property Rights; Risk of Infringement" fairly and accurately summarize the right of the Company to use the SmarTalk name; (ii) The Company possesses all telecommunic material certificates, authorities or permits required by the FCC and State Regulatory Agencies for the provision of the telecommunications services currently provided by the Company, except where the failure to possess such certificate, authorities or permits could not reasonably be expected to have a material adverse effect on the Company and the Company is in compliance in all material respects with such certificates, authorities and permits; (iii) to the best knowledge of such counsel, the Company is not subject to any pending or threatened action, suit or proceeding before the FCC or any State Regulatory Agency or (with respect to federal or state -18- telecommunications laws) any court of a character required to be disclosed in the Registration Statement, which is not described as required; (iv) no consent, approval, authorization or order of the FCC or any State Regulatory Agency is required for the issuance and sale of the Securities or the consummation of the transactions contemplated thereby; and (v) neither the issuance and sale of the Securities nor the consummation of the transactions contemplated hereby will result in a breach or violation of any law, rule, regulation, judgment, order or decree of the FCC or any State Regulatory Agency applicable to the Company. In rendering such opinion, such counsel may rely as to matters of fact, to the extent they deem proper and reasonable, on certificates of public officials and responsible officers of the Company, including certificates that define the scope of the telecommunications services provided by the Company. References to the Prospectus in this paragraph (c) include any supplements thereto at the Closing Date. (d) The Selling Shareholders shall have furnished to the Representatives the opinion of __________, counsel for the Selling Shareholders, dated the Closing Date, to the effect that: (i) this Agreement, the Custody Agreement and the Power-of- Attorney have been duly authorized, executed and delivered by the Selling Shareholders, the Custody Agreement is valid and binding on the Selling Shareholders and each Selling Shareholder has full legal right and authority to sell, transfer and deliver in the manner provided in this Agreement and the Custody Agreement the Securities being sold by the Selling Shareholder hereunder; (ii) the delivery by each Selling Shareholder to the several Underwriters of certificates for the Securities being sold hereunder by the Selling Shareholders against payment therefor as provided herein, will pass good and marketable title to such Securities to the several Underwriters, free and clear of all liens, encumbrances, equities and claims whatsoever, and free and clear of any "adverse claim" (as such term is used in Section 8-302 of the Uniform Commercial Code as in effect in the State of California), assuming the purchase of the Securities by the Underwriters in good faith and without notice of any such "adverse claim"; (iii) no consent, approval, authorization or order of any court or governmental agency or body is required for the consummation by any Selling -19- Shareholder of the transactions contemplated herein, except such as may have been obtained under the Act and such as may be required under the blue sky laws of any jurisdiction in connection with the purchase and distribution of the Securities by the Underwriters and such other approvals (specified in such opinion) as have been obtained; and (iv) neither the sale of the Securities being sold by the Selling Shareholders nor the consummation of any other of the transactions herein contemplated by any Selling Shareholder or the fulfillment of the terms hereof by any Selling Shareholder will conflict with, result in a breach of, or constitute a default under the terms of any indenture or other agreement or instrument known to such counsel and to which the Selling Shareholder is a party or bound, or any order or regulation known to such counsel to be applicable to the Selling Shareholder of any court, regulatory body, administrative agency, governmental body or arbitrator having jurisdiction over the Selling Shareholder. In rendering such opinion, such counsel may rely (A) as to matters involving the application of laws of any jurisdiction other than the State of California or the United States, to the extent they deem proper and specified in such opinion, upon the opinion of other counsel of good standing whom they believe to be reliable and who are satisfactory to counsel for the Underwriters, and (B) as to matters of fact, to the extent they deem proper, on certificates of responsible officers of the Selling Shareholders and public officials. References to the Prospectus in this paragraph (d) include any supplements thereto at the Closing Date. (e) The Representatives shall have received from Munger, Tolles & Olson, counsel for the Underwriters, such opinion or opinions, dated the Closing Date, with respect to the issuance and sale of the Securities, the Registration Statement, the Prospectus (together with any supplement thereto) and other related matters as the Representatives may reasonably require, and the Company and the Selling Shareholders shall have furnished to such counsel such documents as they reasonably request for the purpose of enabling them to pass upon such matters. (f) The Company shall have furnished to the Representatives a certificate of the Company, signed on behalf of the Company by the Chief Executive Officer and the principal financial or accounting officer of the Company, dated the Closing Date, to the effect that the signers of such certificate have carefully examined the Registration Statement, the Prospectus, any supplement to the Prospectus and this Agreement and that: (i) the representations and warranties of the Company in this Agreement are true and correct in all material respects on and as of the Closing -20- Date with the same effect as if made on the Closing Date and the Company has complied with all the agreements and satisfied all the conditions on its part to be performed or satisfied at or prior to the Closing Date; (ii) to the Company's knowledge, no stop order suspending the effectiveness of the Registration Statement has been issued and no proceedings for that purpose have been instituted or threatened; and (iii) since the date of the most recent financial statements included in the Prospectus (exclusive of any supplement thereto), there has been no material adverse change in the condition (financial or other), earnings, business or properties of the Company, whether or not arising from transactions in the ordinary course of business, except as set forth in or contemplated in the Prospectus (exclusive of any supplement thereto). (g) Each Selling Shareholder shall have furnished to the Representatives a certificate, signed by the Selling Shareholder, dated the Closing Date, to the effect that the signer of such certificate has carefully examined the Registration Statement, the Prospectus, any supplement to the Prospectus and this Agreement and that the representations and warranties of such Selling Shareholder in this Agreement are true and correct in all material respects on and as of the Closing Date to the same effect as if made on the Closing Date. (h) At the Execution Time and at the Closing Date, Price Waterhouse LLP shall have furnished to the Representatives a letter or letters, dated respectively as of the Execution Time and as of the Closing Date, in form and substance satisfactory to the Representatives, confirming that they are independent accountants within the meaning of the Act and the Exchange Act and the respective applicable published rules and regulations thereunder and stating in effect that: (i) in their opinion the audited financial statements and financial statement schedules included or incorporated in the Registration Statement and the Prospectus and reported on by them comply in form in all material respects with the applicable accounting requirements of the Act and the Regulations; (ii) on the basis of procedures (but not an examination in accordance with generally accepted auditing standards) consisting of the following: (1) a reading of the minutes of the meetings of the stockholders, directors and the Audit and Compensation Committees of the Company and, where applicable, the Company's subsidiaries; -21- (2) performing the procedures specified by the American Institute of Certified Public Accountants for a review of interim financial information as described in SAS No. 71, Interim Financial Information, on the unaudited interim financial statements of the Company and its consolidated subsidiaries included in the Registration Statement and reading the unaudited interim financial data for the period from the date of the latest audited balance sheet included in the Registration Statement to the date of the latest available interim financial data; and (3) inquiries of certain officials of the Company who have responsibility for financial and accounting matters of the Company regarding its subsidiaries as to transactions and events subsequent to the December 31, 1995 audited financial statements incorporated in the Prospectus, nothing came to their attention which caused them to believe that: (1) the unaudited financial statements included in the Registration Statement and the Prospectus do not comply in form in all material respects with the applicable accounting requirements of the Act and the related published rules and regulations; (2) any material modifications should be made to the unaudited financial statements for them to be in conformity with generally accepted accounting principles; or (3) with respect to the period subsequent to June 30, 1995, there were any changes, at a specified date not more than five business days prior to the date of the letter, in the Long-Term Debt or Capital Stock of the Company and its consolidated subsidiaries or decreases in Working Capital or the Shareholders' Equity of the Company as compared with the amounts shown on the June 30, 1995 consolidated balance sheet included in the Registration Statement and the Prospectus, or for the period from July 1, 1995 to such specified date there were any decreases, as compared with the corresponding period in the preceding year, in Sales, or in total or per share amounts of Net Income (Loss) of the Company and its consolidated subsidiaries, except in all instances for changes or decreases set forth in such letter, in which case the letter shall be accompanied by an explanation by the Company as to the significance thereof unless said explanation is not deemed necessary by the Representatives; and -22- (iii) they have performed certain other specified procedures as a result of which they determined that certain information of an accounting, financial or statistical nature (which is limited to accounting, financial or statistical information derived from the general accounting records of the Company and its subsidiaries) set forth in the Registration Statement and the Prospectus, including the information set forth under the captions "Summary Consolidated Financial Data," "Risk Factors", "Capitalization," "Dilution," "Selected Consolidated Financial Information," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business" in the Prospectus, agrees with the accounting records of the Company and its subsidiaries, excluding any questions of legal interpretation. References to the Prospectus in this paragraph (h) include any supplement thereto at the Closing Date. (i) Subsequent to the Execution Time or, if earlier, the dates as of which information is given in the Registration Statement (exclusive of any amendment thereof) and the Prospectus (exclusive of any supplement thereto), there shall not have been (i) any change or decrease specified in the letter or letters referred to in paragraph (h) of this Section 7 or (ii) any change, or any development involving a prospective change, in or affecting the business or properties of the Company and its subsidiaries the effect of which, in any case referred to in clause (i) or (ii) above, is, in the reasonable judgment of the Representatives, so material and adverse as to make it impractical or inadvisable to proceed with the offering or delivery of the Securities as contemplated by the Registration Statement (exclusive of any amendment thereof) and the Prospectus (exclusive of any supplement thereto). (j) At the Execution Time, the Company shall have furnished to the Representatives a letter substantially in the form of Exhibit A hereto from each executive officer and director of the Company addressed to the Representatives, in which each such person agrees to certain restrictions, on the terms provided therein, on the disposition of any shares of Common Stock beneficially owned by such person or any securities convertible into, or exchangeable for, shares of Common Stock. (k) Prior to the Closing Date, the Company shall have furnished to the Representatives such further information, certificates and documents as the Representatives may reasonably request. If any of the conditions specified in this Section 7 shall not have been fulfilled in all material respects when and as provided in this Agreement, or if any of the opinions and certificates mentioned above or elsewhere in this Agreement shall not be in all material respects reasonably satisfactory in form and substance to the Representatives and counsel for -23- the Underwriters, this Agreement and all obligations of the Underwriters hereunder may be cancelled at, or at any time prior to, the Closing Date by the Representatives. Notice of such cancellation shall be given to the Company in writing or by telephone or telegraph confirmed in writing. 8. Reimbursement of Underwriters' Expenses. If the sale of the ---------------------------------------- Securities provided for herein is not consummated because any condition to the obligations of the Underwriters set forth in Section 7 hereof is not satisfied, because of any termination pursuant to Section 11 hereof or because of any refusal, inability or failure on the part of the Company or any Selling Shareholder to perform any agreement herein or comply with any provision hereof other than by reason of a default by the Underwriters, the Company will reimburse the Underwriters severally upon demand for all out-of-pocket expenses (including fees and disbursements of counsel) that shall have been reasonably incurred by them in connection with the proposed purchase and sale of the Securities. If the Company is required to make any payments to the Underwriters under this Section 8 because of any Selling Shareholder's refusal, inability or failure to satisfy any condition to the obligations of the Underwriters set forth in Section 7, the Selling Shareholders pro rata in proportion to the percentage of Securities to be sold by each shall reimburse the Company on demand for all amounts so paid. 9. Indemnification and Contribution. --------------------------------- (a) The Company and the Selling Shareholders, jointly and severally, agree to indemnify and hold harmless each Underwriter, the directors, officers, employees and agents of each Underwriter and each person who controls any Underwriter within the meaning of the Act against any and all losses, claims, damages or liabilities, joint or several, to which they or any of them may become subject under the Act or other federal or state statutory law or regulation, at common law or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of a material fact contained in the registration statement for the registration of the Securities as originally filed or in any amendment thereof, or in any Preliminary Prospectus or the Prospectus, or in any amendment thereof or supplement thereto, or arise out of or are based upon the 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 agrees to reimburse each such indemnified party, as incurred, for any legal or other expenses reasonably incurred by them in connection with investigating or defending any such loss, claim, damage, liability or action; provided, however, that the Company and the Selling -------- ------- Shareholders will not be liable in any such case to the extent that any such loss, claim, damage or liability arises out of or is based upon any such untrue statement or alleged untrue statement or omission or alleged omission made therein in reliance upon and in conformity with written information furnished to the Company by or on behalf of an Underwriter through the Representatives specifically for use in connection with -24- the preparation thereof; provided further, that the indemnification -------- ------- contained in this paragraph 9(a) with respect to any Preliminary Prospectus shall not inure to the benefit of any Underwriter (or any person controlling such Underwriter) on account of any such loss, claim, damage or liability arising from the sale of the Securities by such Underwriter to any person if a copy of the Prospectus was not delivered or sent to such person within the time required by the Act and the Regulations, and it has been finally decided by a court of law that such Prospectus was not so delivered or sent, and if the Prospectus would have cured the defect giving rise to such loss, claim, damage or liability, provided that the Company has delivered such Prospectus in requisite quantity on a timely basis to permit such delivery or sending. This indemnity agreement will be in addition to any liability which the Company or the Selling Shareholders may otherwise have. (b) Each Underwriter severally agrees to indemnify and hold harmless the Company, each of its directors, each of its officers who signs the Registration Statement, each person who controls the Company within the meaning of either the Act or the Exchange Act, and each Selling Shareholder to the same extent as the foregoing indemnity from the Company to each Underwriter, but only with reference to written information relating to such Underwriter furnished to the Company by or on behalf of such Underwriter through the Representatives specifically for inclusion in the documents referred to in the foregoing indemnity. This indemnity agreement will be in addition to any liability which any Underwriter may otherwise have. The Company and each Selling Shareholder acknowledges that the statements set forth in the last paragraph on the cover page, in the stabilization legend on the inside cover page, and under the heading "Underwriting" in any Preliminary Prospectus and the Prospectus constitute the only information furnished in writing by or on behalf of the several Underwriters for inclusion in any Preliminary Prospectus or the Prospectus, and you, as the Representatives, confirm that such statements are correct. (c) Promptly after receipt by an indemnified party under this Section 9 of notice of the commencement of any action, such indemnified party will, if a claim in respect thereof is to be made against the indemnifying party under this Section 9, notify the indemnifying party in writing of the commencement thereof; but the failure so to notify the indemnifying party (i) will not relieve it from liability under paragraph (a) or (b) above unless and to the extent it did not otherwise learn of such action and such failure results in the forfeiture by the indemnifying party of substantial rights and defenses and (ii) will not, in any event, relieve the indemnifying party from any obligations to any indemnified party other than the indemnification obligation provided in paragraph (a) or (b) above. The indemnifying party shall be entitled to appoint counsel of the indemnifying party's choice at the indemnifying party's expense to represent the indemnified party in any action for which indemnification is sought (in which case the indemnifying party shall not thereafter be responsible for the fees and -25- expenses of any separate counsel retained by the indemnified party or parties except as set forth below); provided, however, that such counsel -------- ------- shall be reasonably satisfactory to the indemnified party. Notwithstanding the indemnifying party's election to appoint counsel to represent the indemnified party in an action, the indemnified party shall have the right to employ separate counsel (including local counsel), and the indemnifying party shall bear the reasonable fees, costs and expenses of such separate counsel if (i) the use of counsel chosen by the indemnifying party to represent the indemnified party would present such counsel with a conflict of interest, (ii) the actual or potential defendants in, or targets of, any such action include both the indemnified party and the indemnifying party and the indemnified party shall have reasonably concluded that there may be legal defenses available to it and/or other indemnified parties which are different from or additional to those available to the indemnifying party, (iii) the indemnifying party shall not have employed counsel reasonably satisfactory to the indemnified party to represent the indemnified party within a reasonable time after notice of the institution of such action or (iv) the indemnifying party shall authorize in writing the indemnified party to employ separate counsel at the expense of the indemnifying party. An indemnifying party will not, without the prior written consent of the indemnified parties, settle or compromise or consent to the entry of any judgment with respect to any pending or threatened claim, action, suit or proceeding in respect of which indemnification or contribution may be sought hereunder (whether or not the indemnified parties are actual or potential parties to such claim or action) unless such settlement, compromise or consent includes an unconditional release of each indemnified party from all liability arising out of such claim, action, suit or proceeding. (d) In the event that the indemnity provided in paragraph (a) or (b) of this Section 9 is unavailable to or insufficient to hold harmless an indemnified party for any reason, the Company, the Selling Shareholders, and the Underwriters agree to contribute to the aggregate losses, claims, damages and liabilities (including legal or other expenses reasonably incurred in connection with investigating or defending same) (collectively "Losses") to which the Company, the Selling Shareholders, or one or more of the Underwriters may be subject in such proportion as is appropriate to reflect the relative benefits received by the Company, by the Selling Shareholders, and by the Underwriters from the offering of the Securities; provided, however, that in no case shall any Underwriter (except as may be -------- ------- provided in any agreement among underwriters relating to the offering of the Securities) be responsible for any amount in excess of the underwriting discount or commission applicable to the Securities purchased by such Underwriter hereunder. If the allocation provided by the immediately preceding sentence is unavailable for any reason, the Company, the Selling Shareholders, and the Underwriters shall contribute in such proportion as is appropriate to reflect not only such relative benefits but also the relative fault of the Company, the Selling Shareholders, and of the Underwriters in connection with the statements or omissions which resulted in such Losses as well as any other relevant equitable considerations. -26- Benefits received by the Company and the Selling Shareholders shall be deemed to be equal to their respective net proceeds from the offering (before deducting expenses), and benefits received by the Underwriters shall be deemed to be equal to the total underwriting discounts and commissions, in each case as set forth on the cover page of the Prospectus. Relative fault shall be determined by reference to whether any alleged untrue statement or omission relates to information provided by the Company, the Selling Shareholders, or the Underwriters. The Company, the Selling Shareholders, and the Underwriters agree that it would not be just and equitable if contribution were determined by pro rata allocation or any other method of allocation which does not take account of the equitable considerations referred to above. Notwithstanding the provisions of this paragraph (d), no person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. For purposes of this Section 9, each person who controls an Underwriter within the meaning of either the Act or the Exchange Act and each director, officer, employee and agent of an Underwriter shall have the same rights to contribution as such Underwriter, and each person who controls the Company within the meaning of either the Act or the Exchange Act, each officer of the Company who shall have signed the Registration Statement and each director of the Company shall have the same rights to contribution as the Company, subject in each case to the applicable terms and conditions of this paragraph (d). 10. Default by an Underwriter. If any one or more Underwriters shall -------------------------- fail to purchase and pay for any of the Securities agreed to be purchased by such Underwriter or Underwriters hereunder and such failure to purchase shall constitute a default in the performance of its or their obligations under this Agreement, the remaining Underwriters shall be obligated severally to take up and pay for (in the respective proportions which the amount of Securities set forth opposite their names in Schedule I hereto bears to the aggregate amount of Securities set forth opposite the names of all the remaining Underwriters) the Securities which the defaulting Underwriter or Underwriters agreed but failed to purchase; provided, however, that in the event that the aggregate amount of -------- ------- Securities which the defaulting Underwriter or Underwriters agreed but failed to purchase shall exceed 10% of the aggregate amount of Securities set forth in Schedule I hereto, the remaining Underwriters shall have the right to purchase all, but shall not be under any obligation to purchase any, of the Securities, and if such nondefaulting Underwriters do not purchase all the Securities, this Agreement will terminate without liability to any nondefaulting Underwriter, Selling Shareholder, or the Company. In the event of a default by any Underwriter as set forth in this Section 10, the Closing Date shall be postponed for such period, not exceeding seven days, as the Representatives shall determine in order that the required changes in the Registration Statement and the Prospectus or in any other documents or arrangements may be effected. Nothing contained in this Agreement shall relieve any defaulting Underwriter of its liability, if any, to -27- the Company, the Selling Shareholders, and any nondefaulting Underwriter for damages occasioned by its default hereunder. 11. Termination. This Agreement shall be subject to termination in ------------ the absolute discretion of the Representatives, by notice given to the Company prior to delivery of and payment for the Securities, if prior to such time (i) trading in the Company's Common Stock shall have been suspended by the Commission or on NMS or trading in securities generally on NMS shall have been suspended or limited or minimum prices shall have been established on NMS, (ii) a banking moratorium shall have been declared either by federal or New York state authorities or (iii) there shall have occurred any outbreak or escalation of hostilities, declaration by the United States of a national emergency or war or other calamity or crisis the effect of which on financial markets is such as to make it, in the judgment of the Representatives, impracticable to market the Securities. 12. Representations and Indemnities to Survive. The respective ------------------------------------------- agreements, representations, warranties, indemnities and other statements of the Company or its officers and of the Underwriters set forth in or made pursuant to this Agreement will remain in full force and effect, regardless of any investigation made by or on behalf of any Underwriter, any Selling Shareholder, or the Company or any of the officers, directors or controlling persons referred to in Section 9 hereof, and will survive delivery of and payment for the Securities. The provisions of Sections 8 and 9 hereof shall survive the termination or cancellation of this Agreement. 13. Notices. All communications hereunder will be in writing and -------- effective only on receipt, and, if sent to the Representatives, will be mailed, delivered or telegraphed and confirmed to them, care of Salomon Brothers Inc, at Seven World Trade Center, New York, New York 10048; or, if sent to the Company, will be mailed, delivered or telegraphed and confirmed to it at 1640 South Sepulveda Boulevard, Suite 500, Los Angeles, California 90025, Attention: Chief Executive Officer; or if sent to the Selling Shareholders, will be mailed, delivered or telegraphed and confirmed to them at ________________. 14. Successors. This Agreement will inure to the benefit of and be ----------- binding upon the parties hereto and their respective successors and the officers and directors and controlling persons referred to in Section 9 hereof, and no other person will have any right or obligation hereunder. 15. Applicable Law. This Agreement will be governed by and construed --------------- in accordance with the laws of the State of New York. -28- If the foregoing is in accordance with your understanding of our agreement, please sign and return to us the enclosed duplicate hereof, whereupon this letter and your acceptance shall represent a binding agreement among the Company and the several Underwriters. Very truly yours, SMARTALK TELESERVICES, INC. By: ----------------------------------- Chief Executive Officer The foregoing Agreement is hereby confirmed and accepted as of the date first above written. SALOMON BROTHERS INC CS FIRST BOSTON DONALDSON LUFKIN & JENRETTE SECURITIES CORPORATION By: Salomon Brothers Inc By: ------------------------------- Its: ------------------------------- For themselves and the other several Underwriters named in Schedule I to the foregoing Agreement -29- EXHIBIT A [Letterhead of executive officer or director of SmarTalk Teleservices, Inc.] SmarTalk Teleservices, Inc. Public Offering of Common Stock ------------------------------- _________ ____, 1996 Salomon Brothers Inc CS First Boston Donaldson Lufkin & Jenrette Securities Corporation As Representatives of the several Underwriters, c/o Salomon Brothers Inc Seven World Trade Center New York, New York 10048 Dear Sirs: This letter is being delivered to you in connection with the proposed Underwriting Agreement (the "Underwriting Agreement"), between SmarTalk Teleservices, Inc., a California corporation (the "Company"), and each of you as representatives of a group of Underwriters named therein, relating to an underwritten public offering of Common Stock, no par value (the "Common Stock"), of the Company. In order to induce you and the other Underwriters to enter into the Underwriting Agreement, the undersigned agrees not to offer, sell or contract to sell, or otherwise dispose of, directly or indirectly, or announce an offering of, any shares of Common Stock beneficially owned by the undersigned or any securities convertible into, or exchangeable for, shares of Common Stock for a period of 180 days following the day on which the Underwriting Agreement is executed without the prior written consent of Salomon Brothers Inc; provided, however, that the undersigned may exercise any outstanding stock options without such consent. -30- If for any reason the Underwriting Agreement shall be terminated prior to the Closing Date (as defined in the Underwriting Agreement), the agreement set forth above shall likewise be terminated. Yours very truly, [Signature of executive officer or director] [Name and address of executive officer or director] -31- EX-3.1 3 ARTICLES OF INCORPORATION EXHIBIT 3.1 AMENDED AND RESTATED ARTICLES OF INCORPORATION OF SMARTALK TELESERVICES, INC. The undersigned certify that: 1. They are the president and the assistant secretary, respectively, of SmarTalk TeleServices, Inc., a California corporation. 2. The Articles of Incorporation of this corporation are hereby amended and restated to read in full as follows: I The name of this corporation is SmarTalk TeleServices, Inc. II The purpose of this corporation is to engage in any lawful act or activity for which a corporation may be organized under the California Corporations Code (the "Corporations Code") other than the banking business, the trust company business or the practice of a profession permitted to be incorporated by the Corporations Code. III The corporation is authorized to issue a total of 100,000,000 shares of common stock with no par value; and 10,000,000 shares of preferred stock with no par value and with such rights, preferences, privileges and restrictions as shall be approved by the board of directors. Immediately upon the filing of this Amended and Restated Articles of Incorporation, each one (1) outstanding share of the corporation's common stock, no par value, will be reverse split, automatically, without further action, into .5625 shares of common stock. The shares of preferred stock may be issued from time to time in one or more series. The board of directors is authorized, subject to limitations prescribed by law and the provisions of this Article III, to provide for the issuance of the shares of preferred stock in series and, by filing a certificate pursuant to the applicable law of the State of California, to establish from time to time the number of shares to be included in each such series, and to fix the designation, powers, preferences and rights of the shares of each such series and the qualifications, limitations or restrictions thereof. IV The liability of the directors of the corporation for monetary damages shall be eliminated to the fullest extent permissible under California law. V The corporation is authorized to provide indemnification of its agents (as defined in Section 317 of the Corporations Code) for breach of duty to the corporation and its shareholders through bylaw provisions or through agreements with the agents, or both, in excess of the indemnification otherwise permitted by Section 317 of the Corporations Code, subject to the limits on such excess indemnification set forth in Section 204 of the Corporations Code. VI Immediately upon the closing of an underwritten initial public offering of the corporation's common stock, the power of the shareholders to take any action by written consent without a meeting shall be eliminated and any further action taken by the shareholders shall only be taken at a duly convened meeting of the shareholders, notwithstanding that applicable law would otherwise permit such shareholder action to be taken by written consent without a meeting. VII Notwithstanding Section 708 of the California Corporations Code, shareholders may not cumulate their votes in any election of directors. This Article VII shall become effective only when the corporation becomes a listed corporation within the meaning of Section 301.5 of the California Corporations Code. 3. The foregoing amendment and restatement of Articles of Incorporation has been duly approved by the board of directors. 4. The foregoing amendment and restatement of Articles of Incorporation has been duly approved by the required vote of shareholders in accordance with Section 902 of the Corporations Code. The total number of outstanding shares of the corporation is 15,687,500. The number of shares voting in favor of the amendment and restatement equaled or exceeded the vote required. The percentage vote required was more than 50%. 2 We further declare under penalty of perjury under the laws of the State of California that the matters set forth in this certificate are true and correct of our own knowledge. DATE: August 15, 1996 /s/ Robert H. Lorsch --------------------------- Robert H. Lorsch President /s/ Glen Andrew Folck --------------------------- Glen Andrew Folck Assistant Secretary 3 EX-3.2 4 AMENDED AND RESTATED BYLAWS EXHIBIT 3.2 AMENDED AND RESTATED BYLAWS OF SMARTALK TELESERVICES, INC. A CALIFORNIA CORPORATION ARTICLE I. OFFICES SECTION 1. Principal Executive Office. The principal executive office of -------------------------- the corporation is hereby fixed and located at 1640 S. Sepulveda Boulevard, Suite 500, Los Angeles, California 90025. The Board of Directors (herein called the "Board") is hereby granted full power and authority to change said principal executive office from one location to another. Any such change shall be noted on these Amended and Restated Bylaws (the "Bylaws") opposite this Section, or this Section may be amended to state the new location. SECTION 2. Other Offices. Branch or subordinate offices may at any time ------------- be established by the Board at any place or places. ARTICLE II. SHAREHOLDERS SECTION 1. Place of Meetings. Regular or special meetings of the ----------------- shareholders shall be held at any place within or without the State of California which has been designated in the notice of meeting or, if not stated in the notice or there is no notice, designated by resolution of the Board. In the absence of such designation regular meetings shall be held at the principal executive office of the corporation. SECTION 2. Annual Meetings. The annual meetings of shareholders shall be --------------- held on May 15th of each year, at 10:00 a.m., local time, or such other date or such other time as may be fixed by the Board; provided, however, that should said day fall upon a Saturday, Sunday, or legal holiday observed by the corporation at its principal executive office, then any such annual meeting of shareholders shall be held at the same time and place on the next day thereafter ensuing which is a full business day. At such meetings directors shall be elected and any other proper business may be transacted. SECTION 3. Special Meetings. Special meetings of the shareholders may be ---------------- called at any time by the Board, the Chairman of the Board, the President, or by the holders of shares entitled to cast not less than 10 percent of the votes at such meeting. Upon request in writing to the Chairman of the Board, the President, any Vice President or the Secretary by any person (other than the Board) entitled to call a special meeting of the shareholders, the officer forthwith shall cause notice to be given to the shareholders entitled to vote that a meeting will be held at a time requested by the person or persons calling the meeting, not less than 35 nor more than 60 days after the receipt or request. If the notice is not given within 20 days after receipt of the request, the persons entitled to call the meeting may give the notice. SECTION 4. Notice of Annual or Special Meeting. Written notice of each ----------------------------------- annual or special meeting of shareholders shall be given not less than 10 nor more than 60 days before the date of the meeting to each shareholder entitled to vote thereat. Such notice shall state the place, date, and hour of the meeting and (i) in the case of a special meeting the general nature of the business to be transacted, and no other business may be transacted, or (ii) in the case of the annual meeting, those matters which the Board, at the time of the mailing of the notice, intends to present for action by the shareholders, but, subject to the provisions of applicable law, any proper matter may be presented at the meeting for such action. The notice of any meeting at which directors are to be elected shall include the names of nominees intended at the time of the notice to be presented by management for election. Notice of a shareholders meeting shall be given either personally or by mail or by other means of written communication, addressed to the shareholder at the address of such shareholder appearing on the books of the corporation or given by the shareholder to the corporation for the purpose of notice; or, if no such address appears or is given, at the place where the principal executive office of the corporation is located or by publication at least once in a newspaper of general circulation in the county in which the principal executive office is located. Notice by mail shall be deemed to have been given at the time a written notice is deposited in the United States mails, postage prepaid. Any other written notice shall be deemed to have been given at the time it is personally delivered to the recipient or is delivered to a common carrier for transmission, or actually transmitted by the person giving the notice by electronic means, to the recipient. SECTION 5. Quorum. A majority of the shares entitled to vote, represented ------ in person or by proxy, shall constitute a quorum at any meeting of shareholders. The shareholders present at a duly called or held meeting at which a quorum is present may continue to do business until adjournment, notwithstanding the withdrawal of enough shareholders to leave less than a quorum, if any action 2 taken (other than adjournment) is approved by at least a majority of the shares required to constitute a quorum. SECTION 6. Adjourned Meeting and Notice Thereof. Any shareholders ------------------------------------ meeting, whether or not a quorum is present, may be adjourned from time to time by the vote of a majority of the shares, the holders of which are either present in person or represented by proxy thereat, but in the absence of a quorum (except as provided in Section 5 of this Article) no other business may be transacted at such meeting. It shall not be necessary to give any notice of the time and place of the adjourned meeting or of the business to be transacted thereat, other than by announcement at the meeting at which such adjournment is taken; provided, however, when any shareholders meeting is adjourned for more than 45 days or, if after adjournment a new record date is fixed for the adjourned meeting, notice of the adjourned meeting shall be given as in the case of an original meeting. SECTION 7. Voting. The shareholders entitled to notice of any meeting or ------ to vote at any such meeting shall be only persons in whose name shares stand on the stock records of the corporation on the record date determined in accordance with Section 9 of this Article. Unless the corporation shall have consummated an initial public offering of its common stock, any and all actions for which shareholder approval is required by California law or by these Bylaws or otherwise, shall require the prior approval (by vote or written consent) of the shareholders entitled to exercise not less than seventy-five percent (75%) of the voting power of this corporation, notwithstanding that applicable law would otherwise permit such actions with the approval of a lesser percentage. Voting shall in all cases be subject to the provisions of Chapter 7 of the California Corporations Code and to the following provisions: (a) Subject to clause (g), shares held by an administrator, executor, guardian, conservator or custodian may be voted by such holder either in person or by proxy, without a transfer of such shares into the holder's name; and shares standing in the name of a trustee may be voted by the trustee, either in person or by proxy, but no trustee shall be entitled to vote shares held by such trustee without a transfer of such shares into the trustee's name. (b) Shares standing in the name of a receiver may be voted by such receiver; and shares held by or under the control of a receiver may be voted by such receiver without the transfer thereof into the receiver's name if authority to do so is contained in the order of the court by which such receiver was appointed. 3 (c) Subject to the provisions of Section 705 of the California Corporations Code, and except where otherwise agreed in writing between the parties, a shareholder whose shares are pledged shall be entitled to vote such shares until the shares have been transferred into the name of the pledgee, and thereafter the pledgee shall be entitled to vote the shares so transferred. (d) Shares standing in the name of a minor may be voted and the corporation may treat all rights incident thereto as exercisable by the minor, in person or by proxy, whether or not the corporation has notice, actual or constructive, of the nonage, unless a guardian of the minor's property has been appointed and written notice of such appointment given to the corporation. (e) Shares standing in the name of another corporation, domestic or foreign, may be voted by such officer, agent or proxy holder as the bylaws of such other corporation may prescribe, or in the absence of such provision, as the Board of Directors of such other corporation may determine or, in the absence of such determination, by the chairman of the board, president or any vice president of such other corporation, or by any other person authorized to do so by the board, president or any vice president of such other corporation. Shares which are purported to be voted or any proxy purported to be executed in the name of a corporation (whether or not any title of the person signing is indicated) shall be presumed to be voted or the proxy executed in accordance with the provisions of this subdivision, unless the contrary is shown. (f) Shares of the corporation owned by any subsidiary shall not be entitled to vote on any matter. (g) Shares held by the corporation in a fiduciary capacity, and shares of the corporation held in a fiduciary capacity by any subsidiary, shall not be entitled to vote on any matter, except to the extent that the settlor or beneficial owner possesses and exercises a right to vote or to give the corporation binding instructions as to how to vote such shares. (h) If shares stand of record in the names of two or more persons, whether fiduciaries, members of a partnership, joint tenants, tenants in common, husband and wife as community property, tenants by the entirety, voting trustees, persons entitled to vote under a shareholder voting agreement or otherwise, or if two or more persons (including proxy-holders) have the same fiduciary relationship respecting the same shares, unless the secretary of the corporation is given written notice to the contrary and is furnished with a copy of the instrument or order appointing them or creating the relationship wherein 4 it is so provided, their acts with respect to voting shall have the following effect: (i) If only one votes, such act binds all; (ii) If more than one vote, the act of the majority so voting binds all; (iii) If more than one vote, but the vote is evenly split on any particular matter, each faction may vote the securities in question proportionately. If the instrument so filed or the registration of the shares shows that any such tenancy is held in unequal interests, a majority or even split for the purpose of this section shall be a majority or even split in interest. Elections need not be by ballot; provided, however, that all elections for directors must be by ballot upon demand made by a shareholder at the meeting and before the voting begins. In any election of directors, the candidates receiving the highest number of votes of the shares entitled to be voted for them up to the number of directors to be elected by such shares are elected. SECTION 8. Cumulative Voting. Notwithstanding Section 708 of the ----------------- California Corporations Code, shareholders may not cumulate their votes in any election of directors. This provision shall become effective only when the corporation becomes a listed corporation within the meaning of Section 301.5 of the California Corporations Code. SECTION 9. Record Date. The Board may fix, in advance, a, record date for ----------- the determination of the shareholders entitled to notice of any meeting or to vote or entitled to receive payment of any dividend or other distribution, or any allotment of rights, or to exercise rights in respect of any other lawful action. The record date so fixed shall be not more than 60 nor less than 10 days prior to the date of the meeting nor more than 60 days prior to any other action. When a record date is so fixed, only shareholders of record on that date are entitled to notice of and to vote at the meeting or to receive the dividend, distribution, or allotment of rights, or to exercise of the rights, as the case may be, notwithstanding any transfer of shares on the books of the corporation after the record date. A determination of shareholders of record entitled to notice of or to vote at a meeting of shareholders shall apply to any adjournment of the meeting unless the Board fixes a new record date for the adjourned 5 meeting. The Board shall fix a new record date if the meeting is adjourned for more than 45 days. If no record date is fixed by the Board, the record date for determining shareholders entitled to notice of or to vote at a meeting of shareholders shall be at the close of business on the business day next preceding the day on which notice is given or, if notice is waived, at the close of business on the business day next preceding the day on which the meeting is held. The record date for determining shareholders for any purpose other than set forth in this Section 9 or Section 10 of this Article shall be at the close of business on the day on which the Board adopts the resolution relating thereto, or the sixtieth day prior to the date of such other action, whichever is later. SECTION 10. Proxies. Every person entitled to vote shares has the right ------- to do so either in person or by one or more persons authorized by a written proxy executed by such shareholder and filed with the Secretary. Any proxy duly executed is not revoked and continues in full force and effect until revoked by the person executing it prior to the vote pursuant thereto by a writing delivered to the corporation stating that the proxy is revoked or by a subsequent proxy executed by, or by attendance at the meeting and voting in person by, the person executing the proxy; provider however, that no proxy shall be valid after the expiration of 11 months from the date of its execution unless otherwise provided in the proxy. SECTION 11. Inspectors of Election. In advance of any meeting of ---------------------- shareholders, the Board may appoint any persons other than nominees for office as inspectors of election to act at such meeting and any adjournment thereof. If inspectors of election be not so appointed, or if any persons so appointed fail to appear or refuse to act, the chairman of any such meeting may, and on the request of any shareholder or shareholder's proxy shall, make such appointment at the meeting. The number of inspectors shall be either one or three. If appointed at a meeting on the request of one or more shareholders or proxies, the majority of shares present shall determine whether one or three inspectors are to be appointed. The duties of such inspectors shall be as prescribed by Section 707(b) of the California Corporations Code and shall include: determining the number of shares outstanding and the voting power of each; the shares represented at the meeting, the existence of a quorum; the authenticity, validity, and effect of proxies; receiving votes, ballots, or consents; hearing and determining all challenges and questions in any way arising in connection with the right to vote; counting and tabulating al:L votes or consents, determining when the polls shall close; determining the result; and doing such acts as may be proper to conduct the 6 election or vote with fairness to all shareholders. If there are three inspectors of election, the decision, act, or certificate of a majority is effective in all respects as the decision, act, or certificate of all. ARTICLE III. DIRECTORS SECTION 1. Powers. Subject to the limitations of the Articles of ------ Incorporation (the "Articles"), of these Bylaws, and of the California Corporations Code relating to action required to be approved by the shareholders or by the outstanding shares, the business and affairs of the corporation shall be managed and all corporate powers shall be exercised by or under the direction of the Board. The Board may delegate the management of the day-to-day operation of the business of the corporation to a management company or other person provided that the business and affairs of the corporation shall be managed and all corporate powers shall be exercised under the ultimate direction of the Board. Without prejudice to such general power" but subject to the same limitations, it is hereby expressly declared that the Board shall have the following powers in addition to the other powers enumerated in these Bylaws: (a) To select and remove all the other officers, agents, and employees of the corporation, prescribe the powers and duties for them as may not be inconsistent with law, or with the Articles or these Bylaws, fix their compensation, and require from them security for faithful service. (b) To conduct, manage, and control the affairs and business of the corporation and to make such rules and regulations therefor not inconsistent with law, or with the Articles or these Bylaws, as they may deem best. (c) To adopt, make, and use a corporate seal, and to prescribe the forms of certificates of stock, and to alter the form of such seal and of such certificates from time to time as in their judgment they may deem best. (d) To authorize the issuance of shares of stock of he corporation from time to time, upon such terms and for such consideration as may be lawful. (e) To borrow money and incur indebtedness for the purposes of the corporation, and to cause to be executed and delivered therefor, in the corporate name, promissory notes, bonds, debentures, deeds of trust, mortgages, pledges, hypothecations, or other evidences of debt and securities therefor. SECTION 2. Number and Qualification of Directors. The authorized number ------------------------------------- of directors shall be not less than 7 five (5) nor more than nine (9) until changed by amendment of the Articles or by a Bylaw duly adopted by the shareholders amending this Section 2. SECTION 3. Election and Term of Office. The directors shall be elected at --------------------------- each annual meeting of shareholders but if any such annual meeting is not held or the directors are not elected thereat, the directors may be elected at any special meeting of shareholders held for that purpose. Each director shall hold office until the next annual meeting and until a successor has been elected and qualified. SECTION 4. Vacancies. Any director may resign effective upon giving --------- written notice to the Chairman of the Board, the President, Secretary, or the Board, unless the notice specifies a later time for the effectiveness of such resignation. If the resignation is effective at a future time, a successor may be elected to take office when the resignation becomes effective. Vacancies in the Board, including those existing as a result of a removal of a director, may be filled by a majority of the remaining directors, though less than a quorum, or by a sole remaining director, and each director so elected shall hold office until the next annual meeting and until such director's successor has been elected and qualified. A vacancy or vacancies in the Board shall be deemed to exist in case of the death, resignation, or removal of any director, or if the authorized number of directors be increased, or if the shareholders fail, at any annual or special meeting of shareholders at which any director or directors are elected, to elect the full authorized number of directors to be voted for at that meeting. The Board may declare vacant the office of a director who has been declared of unsound mind by an order of court or convicted of a felony. The shareholders may elect a director or directors at any time to fill any vacancy or vacancies not filled by the directors. Any such election by written consent requires the consent of a majority of the outstanding shares entitled to vote. If the Board accepts the resignation of a director tendered to take effect at a future time, the Board or the shareholders shall have power to elect a successor to take office when the resignation is to become effective. No reduction of the authorized number of directors shall have the effect of removing any director prior to the expiration of :he director's term of office. 8 SECTION 5. Place of Meeting. Regular or special meetings of the Board ---------------- shall be held at any place within or without the State of California which has been designated from time to time by the Board. In the absence of such designation regular meetings shall be held at the principal executive office of the corporation. SECTION 6. Regular Meetings. Immediately following each annual meeting of ---------------- shareholders the Board shall hold a regular meeting for the purpose of organization, election of officers, and the transaction of other business. SECTION 7. Special Meetings. Special meetings of the Board for any ---------------- purpose or purposes may be called at any time by the Chairman of the Board, the President, or the Secretary or by any two directors. Special meetings of the Board shall be held upon four days' written notice or 48 hours' notice given personally or by telephone, telegraph, telex, or other similar means of communication. Any such notice shall be addressed or delivered to each director at such director's address as it is shown upon the records of the corporation or as may have been given to the corporation by the director for purposes of notice or, if such address is not shown on such records or is not readily ascertainable, at the place in which the meetings of the directors are regularly held. Notice by mail shall be deemed to have been given at the time a written notice is deposited in the United States mails, postage prepaid. Any other written notice shall be deemed to have been given at the time it is personally delivered to the recipient or is delivered to a common carrier for transmission, or actually transmitted by the person giving the notice by electronic means, to the recipient. Oral notice shall be deemed to have been given at the time it is communicated, in person or by telephone or wireless to the recipient or to a person at the office of the recipient who the person giving the notice has reason to believe will promptly communicate it to the recipient. SECTION 8. Quorum. A majority of the authorized number of directors ------ constitutes a quorum of the Board for the transaction of business, except to adjourn as hereinafter provided. Every act or decision done or made by a majority of the directors present at a meeting duly held at which a quorum is present shall be regarded as the act of the Board, unless a greater number be required by law or by the Articles. A meeting at which a quorum is initially present may continue to transact business notwithstanding the withdrawal of directors, if any action taken is approved by at least a majority of the required quorum for such meeting. 9 SECTION 9. Participation in Meetings by Conference Telephone. Members of ------------------------------------------------- the Board may participate in a meeting through use of conference telephone or similar communications equipment, so long as all members participating in such meeting can hear one another. SECTION 10. Waiver of Notice. The transactions of any meeting of the ---------------- Board, however called and noticed or wherever held, are as valid as though had at a meeting duly held after regular call and notice if a quorum be present and if, either before or after the meeting, each of the directors not present signs a written waiver of notice, a consent to holding such meeting or an approval of the minutes thereof. All such waivers, consents, or approvals shall be filed with the corporate records or made a part of the minutes of the meeting. SECTION 11. Adjournment. A majority of the directors present, whether or ----------- not a quorum is present, may adjourn any directors' meeting to another time and place. Notice of the time and place of holding an adjourned meeting need not be given to absent directors if the time and place be fixed at the meeting adjourned. If the meeting is adjourned for more than 24 hours, notice of any adjournment to another time or place shall be given prior to the time of the adjourned meeting to the directors who were not present at the time of the adjournment. SECTION 12. Fees and Compensation. Directors and members of committees --------------------- may receive such compensation, if any, for their services, and such reimbursement for expenses, as may be fixed or determined by the Board. SECTION 13. Action Without Meeting. Any action required or permitted to ---------------------- be taken by the Board may be taken without a meeting if all members of the Board shall individually or collectiveLy consent in writing to such action. Such consent or consents shaLl have the same effect as a unanimous vote of the Board and shall be filed with the minutes of the proceedings of the Board. SECTION 14. Rights of Inspection. Every director shall have the absolute -------------------- right at any reasonable time to inspect and copy all books, records, and documents of every kind and to inspect he physical properties of the corporation and also of its subsidiary corporations, domestic or foreign. Such inspection by a director may be made in person or by agent or attorney and includes the right to copy and obtain extracts. SECTION 15. Committees. The Board may appoint one or more committees, ---------- each consisting of two or more directors, and delegate to such committees any of the authority of the Board except with respect to: 10 (a) The approval of any action for which the California Corporations Code also requires shareholders' approval or approval of the outstanding shares; (b) The filling of vacancies on the Board or on any committee; (c) The fixing of compensation of the directors for serving on the Board or on any committee; (d) The amendment or repeal of Bylaws or the adoption of new Bylaws; (e) The amendment or repeal of any resolution of the Board which by its express terms is not so amendable or repealable; (f) A distribution to the shareholders of the corporation except at a rate or in a periodic amount or within a price range determined by the Board; (g) The appointment of other committees of the Board or the members thereof. Any such committee must be appointed by resolution adopted by a majority of the authorized number of directors and may be designated an Executive Committee or by such other name as the Board shall specify. The Board shall have the power to prescribe the manner in which proceedings of any such committee shall be conducted. In the absence of any such prescription, such committee shall have the power to prescribe the manner in which its proceedings shall be conducted. Unless the Board or such committee shall otherwise provide, the regular and special meetings and other actions of any such committee shall be governed by the provisions of this Article applicable to meetings and actions of the Board. Minutes shall be kept of each meeting of each committee. ARTICLE IV. OFFICERS SECTION 1. Officers. The officers of the corporation shall be a --------- president, a secretary, and a chief financial officer. The corporation may also have, at the discretion of the Board, a chairman of the board, a treasurer, one or more vice-presidents, one or more assistant secretaries, one or more assistant treasurers, and such other officers as may be elected or appointed in accordance with the provisions of Section 3 of this Article. SECTION 2. Election. The officers of the corporation, except such -------- officers as may be elected or appointed in accordance with the provisions of Section 3 or Section 5 of this Article, shall be chosen annually by, and 11 shall serve at the pleasure of, the Board, and shall hold their respective offices until their resignation, removal, or other disqualification from service, or until their respective successors shall be elected. SECTION 3. Subordinate Officers. The Board may elect, and may empower the -------------------- President to appoint, such other officers as the business of the corporation may require, each of whom shall hold office for such period, have such authority, and perform such duties as are provided in these Bylaws or as the Board may from time to time determine. SECTION 4. Removal and Resignation. Any officer may be removed, either ----------------------- with or without cause, by the Board of Directors at any time, or, except in the case of an officer chosen by the Board, by any officer upon whom such power of removal may be conferred by the Board. Any such removal shall be without prejudice to the rights, if any, of the officer under any contract of employment of the officer. Any officer may resign at any time by giving written notice to the corporation, but without prejudice to the rights, if any, of the corporation under any contract to which the officer is a party. Any such resignation shall take effect at the date of the receipt of such notice or at any later time specified therein; and, unless otherwise specified therein, the acceptance of such resignation shall not be necessary to make it effective. SECTION 5. Vacancies. A vacancy in any office because of death, --------- resignation, removal, disqualification, or any other cause shall be filled in the manner prescribed in these Bylaws for regular election or appointment to such office. SECTION 6. Chairman of the Board. The Chairman of the Board, if there --------------------- shall be such an officer, shall, if present, preside at all meetings of the Board and exercise and perform such other powers and duties as may be from time to time assigned by the Board. SECTION 7. President. Subject to such powers, if any, as may be given by --------- the Board to the Chairman of the Board, if there be such an officer, the President is the general manager and chief executive officer of the corporation and has, subject to the control of the Board, general supervision, direction, and control of the business and officers of the corporation. The President shall preside at all meetings of the shareholders and, in the absence of the Chairman of the Board, or if there be none, at all meetings of the Board. The President has the general powers and duties of management usually vested in the office of president and general manager of a corporation and such other powers and duties as may be prescribed by the Board. 12 SECTION 8. Vice President. In the absence or disability of the -------------- President, the Vice Presidents in order of their rank as filed by the Board or, if not ranked, the Vice President designated by the Board, shall perform all the duties of the President, and when so acting shall have all the powers of, and be subject to all the restrictions upon, the President. The Vice Presidents shall have such other powers and perform such other duties as from time to time may be prescribed for them respectively by the Board. SECTION 9. Secretary. The Secretary shall keep or cause to be kept, at --------- the principal executive office and such other place as the Board may order, a book of minutes of all meetings of shareholders, the Board, and its committees, with the time and place of holding, whether regular or special, and, if special, how authorized, the notice thereof given, the names of those present at Board and committee meetings, the number of shares present or represented at shareholders' meetings, and the proceedings thereof. The Secretary shall keep, or cause to be kept, a copy of the Bylaws of the corporation at the principal executive office or business office in accordance with Section 213 of the California Corporations Code. The Secretary shall keep, or cause to be kept, at the Principal executive office or at the office of the corporation's transfer agent or registrar, if one be appointed, a share register, or a duplicate share register, showing the names of the shareholders and their addresses, the number and classes of shares held by each, the number and date of certificates issued for the same, and the number and date of cancellation of every certificate surrendered for cancellation. The Secretary shall give, or cause to be given, notice of all the meetings of the shareholders and of the Board and of any committees thereof required by these Bylaws or by law to be given, shall keep the seal of the corporation in safe custody, and shall have such other powers and perform such other duties as may be prescribed by the Board. SECTION 10. The Chief Financial Officer. The Chief Financial Officer --------------------------- shall keep and maintain, or cause to be kept and maintained, adequate and correct accounts of the properties and business transactions of the corporation, and shall send or cause to be sent to the shareholders of the corporation such financial statements and reports as are by law or these Bylaws required to be sent to them. The books of account shall at all times be open to inspection by any director. The Chief Financial Officer shall cause all moneys and other valuables to be deposited in the name and to the credit of the corporation with such depositaries as may be 13 designated by the Board. The Chief Financial Officer shall disburse the funds of the corporation as may be ordered by the Board, shall render to the President and directors, whenever they request it, an account of all transactions as Chief Financial Officer and of the financial condition of the corporation, and shall have such other powers and perform such other duties as may be prescribed by the Board. ARTICLE V. OTHER PROVISIONS SECTION 1. Inspection of Corporate Records. ------------------------------- (a) A shareholder or shareholders holding at least five percent in the aggregate of the outstanding voting shares of the corporation or who hold at least one percent of such voting shares and have filed a Schedule 14B with the United States Securities and Exchange Commission relating to the election of directors of the corporation shall have an absolute right to do either or both of the following: (i) Inspect and copy the record of shareholders' names and addresses and shareholdings during usual business hours upon five business days' prior written demand upon the corporation; or (ii) Obtain from the transfer agent, if any, for the corporation, upon five business days' prior written demand and upon the tender of its usual charges for such a list (the amount of which charges shall be stated to the shareholder by the transfer agent upon request), a list of the shareholders' names and addresses who are entitled to vote for the election of directors and their shareholdings, as of the most recent record date for which it has been compiled or as of a date specified by the shareholder subsequent to the date of demand. (b) The record of shareholders shall also be open to inspection and copying by any shareholder or holder of a voting trust certificate at any time during usual business hours upon written demand on the corporation, for a purpose reasonably related to such holder's interest as a shareholder or holder of a voting trust certificate. 14 (c) The accounting books and records and minutes of proceedings of the shareholders and the Board and committees of the Board shall be open to inspection upon written demand on the corporation of any shareholder or holder of a voting trust certificate at any reasonable time during usual business hours, for a purpose reasonably related to such holders' interests as a shareholder or as a holder of such voting trust certificate. (d) Any inspection and copying under this Article may be made in person or by agent or attorney. SECTION 2. Inspection of Bylaws. The corporation shall keep in its -------------------- principal executive office the original or a copy of these Bylaws as amended to date which shall be open to inspection by shareholders at all reasonable times during office hours. If the principal executive of the corporation is outside the State of California and the corporation has no principal business office in such state it shall upon the written notice of any shareholder send to such shareholder a copy of these Bylaws as amended to date. SECTION 3. Endorsement of Documents; Contracts. Subject to the ----------------------------------- provisions of applicable law, any note, mortgage, evidence of indebtedness, contract, share certificate, conveyance, or other instrument in writing and any assignment or endorsement thereof executed or entered into between this corporation and any other person, when signed by the Chairman of the Board, the President or any Vice President, and the Secretary, any Assistant Secretary, the Chief Financial Officer, the Treasurer or any Assistant Treasurer of this corporation shall be valid and binding on this corporation in the absence of actual knowledge on the part of the other person that the signing officers had no authority to execute the same. Any such instruments may be signed by any other person or persons and in such manner as from time to time shall be determined by the Board and, unless so authorized by the Board, no officer, agent, or employee shall have any power or authority to bind the corporation by any contract or engagement or to pledge its credit or to render it liable for any purpose or amount. SECTION 4. Certificates of Stock. Every holder of shares of the --------------------- corporation shall be entitled to have a certificate signed in the name of the corporation by the Chairman of the Board, the President or a Vice President and by the Chief Financial Officer or the treasurer or an Assistant Treasurer or the Secretary or an Assistant Secretary, certifying the number of shares and the class or series of shares owned by the shareholder. Any or all of the signatures on the certificate may be facsimile. If any officer, transfer agent, or registrar who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer, transfer agent, or registrar before such certificate is issued, it 15 may be issued by the corporation with the same effect as if such person were an officer, transfer agent, or registrar at the date of issue. Certificates for shares may be issued prior to full payment under such restrictions and for such purposes as the Board may provide; provided, however, that on any certificate issued to represent any partly paid shares, the total amount of the consideration to be paid therefor and the amount paid thereon shall be stated. Except as provided in this Section, no new certificate for shares shall be issued in lieu of an old one unless the latter is surrendered and canceled at the same time. The Board may, however, in case any certificate for shares is alleged to have been lost, stolen, or destroyed, authorize the issuance of a new certificate in lieu thereof, and the corporation may require that the corporation be given a bond or other adequate security sufficient to indemnify it against any claim that may be made against it (including expense or liability) on account of the alleged loss, theft, or destruction of such certificate or the issuance of such new certificate. SECTION 5. Representation of Shares of other Corporations. The President ---------------------------------------------- or any other officer or officers authorized by the Board or the President are each authorized to vote, represent, and exercise on behalf of the corporation all rights incident to any and all shares of any other corporation or corporations standing in the name of the corporation. The authority herein granted may be exercised either by any such officer in person or by any other person authorized so to do by proxy or power of attorney duly executed by said officer. SECTION 6. Stock Purchase Plans. The corporation may adopt and carry out -------------------- a stock purchase plan or agreement or stock option plan or agreement providing for the issue and sale for such consideration as may be fixed of its unissued shares, or of issued shares acquired or to be acquired, to one or more of the employees or directors of the corporation or of a subsidiary or to a trustee on their behalf and for the payment for such shares in installments or at one time, and may provide for aiding any such persons in paying for such shares by compensation for services rendered, promissory notes, or otherwise. Any such stock purchase plan or agreement or stock option p an or agreement may include, among other features, the fixing of eligibility for participation therein, the class and price of shares to be issued or sold under the plan or agreement, the number of shares which may be subscribed for, the method of payment therefor, the reservation of title until full payment therefor, the effect of the termination of employment and option or 16 obligation on the part of the corporation to repurchase the shares upon termination of employment, restrictions upon transfer of the shares, the time limits of the termination of the plan, and any other matters, not in violation of applicable law, as may be included in the plan as approved or authorized by the Board or any committee of the Board. SECTION 7. Annual Report to Shareholders. The annual report to ----------------------------- shareholders referred to in Section 1501 of the California Corporations Code is expressly waived, but nothing herein shall be interpreted as prohibiting the Board from issuing annual or other periodic reports to shareholders. SECTION 8. Construction and Definitions. Unless the context otherwise ---------------------------- requires, the general provisions, rules of construction, and definitions contained in the California Corporations Code shall govern the construction of these Bylaws. ARTICLE VI. INDEMNIFICATION SECTION 1. Indemnification. --------------- (a) The corporation shall have the power to indemnify its "agents" (as defined in Section 317 of the California Corporations Code), to the full extent permitted by said Section and applicable law. (b) The corporation shall indemnify its officers and directors who were or are parties, or threatened to be made parties, to any "proceeding" (as defined in Section 317 of the California Corporations Code), from and against any and all claims, expenses (including attorney's fees and court costs) judgments, fines, amounts paid in settlement, and other costs and amounts actually and reasonably incurred in connection with such "proceeding" to the broadest and maximum extent permitted by California Law if such person acted in the course and scope of his position with the corporation, acted in good faith, and acted in a manner such person reasonably believed to be in the best interests of the corporation and its shareholders (and in the case of a criminal proceeding had no reasonable cause to believe that the conduct of such person was unlawful); provided, however, that the determination whether the officer or director has met the applicable standard of conduct and indemnification therefor is proper shall be determined in each specific case in accordance with Section 317 of the California Corporations Code; and provided, further that this indemnification shall not apply to any acts, omissions or transactions for which indemnification is expressly prohibited by Sections 204 or 317 of the California Corporations Code. 17 (c) Expenses reasonably and actually incurred by an officer or director in any "proceeding" shall be advanced by the corporation as and when incurred prior to final disposition of the "proceeding" on receipt of an undertaking, which need not be secured, by or on behalf of the officer or director to repay such amount if it is ultimately determined that the officer or director is not entitled to indemnification. (d) The Board of Directors is authorized to enter into contracts with any "agent" of this corporation, or any person serving at the request of this corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, including employee benefit plans, providing for indemnification rights to the maximum extent permitted by California Law. SECTION 2. Insurance. The corporation shall have power to purchase and --------- maintain insurance on behalf of any agent of the corporation against any liability asserted against or incurred by the agent in such capacity or arising out of the agent's status as such whether or not the corporation would have the power to indemnify the agent against such liability under the provisions of this Article. SECTION 3. Nonapplicability to Fiduciaries of Employee Benefit Plans. --------------------------------------------------------- This Article does not apply to any proceeding against any trustee, investment manager, or other fiduciary of an employee benefit plan in such person's capacity as such, even though such person may also be an agent of the corporation as defined in Section l. Nothing contained in this Article shall limit any right to indemnification to which such a trustee, investment manager, or other fiduciary may be entitled by contract or otherwise which shall be enforceable to the extent permitted by applicable law other than Section 317 of the California Corporations Code. ARTICLE VII. EMERGENCY BYLAWS During any emergency resulting from an attack on the United States or on a locality in which the corporation conducts its business or customarily holds meetings of its Board or its shareholders, or during any nuclear or atomic disaster, or during the existence of any catastrophe, or other similar emergency condition, as a result of which a quorum of the Board or of the executive committee, if any, cannot readily be convened for action, a meeting of the Board or of said committee may be called by any officer or director. Such notice may be given only to such of he directors or members of the committee, as the case may be, as it may be feasible to reach at the time and by such means as may be feasible at the time. 18 The director or directors in attendance at the meeting of the Board, and the member or members of the executive committee, if any, in attendance at the meeting of the committee shall constitute a quorum. If none is in attendance at the meeting, the officers or other persons designated on a list approved by the Board before 1:he emergency, all in such order of priority and subject to such conditions and for such period of time (not longer than reasonably necessary after the termination of the emergency) as may be provided in the resolution approving the list, shall, to the extent required to provide a quorum at any meeting of the Board or of the executive committee, be deemed directors or members of the committee, as the case may be, for such meeting. The Board, either before or during any such emergency, may provide, and from time to time modify, lines of succession in the event that during such emergency any or all officers or agents of the corporation shall for any reason be rendered incapable of discharging their duties. The Board, either before or during any such emergency, may, effective in the emergency, change the principal executive office or designate several alternative offices or authorize the officers so to do. ARTICLE VIII. AMENDMENTS These Bylaws may be amended or repealed either by approval of the outstanding shares or by the approval of the Board; provided, however, that after the issuance of shares, a Bylaw specifying or changing a fixed number of directors or the maximum or minimum number or changing from a fixed to a variable Board or vice versa may only be adopted by approval of the outstanding shares. * * * * * 19 EX-5.1 5 OPINION OF DEWEY BALLANTINE EXHIBIT 5.1 September 24, 1996 SmarTalk TeleServices, Inc. 1640 South Sepulveda Boulevard Suite 500 Los Angeles, California 90025 Gentlemen: We have acted as counsel to SmarTalk TeleServices, Inc., a California corporation (the "Company"), in connection with the proposed initial public offering (the "Offering") of up to 4,200,000 shares (the "Firm Shares") of the Company's common stock, no par value (the "Common Stock"), and up to an additional 630,000 shares (the "Option Shares") of the Common Stock, which may be sold pursuant to an over-allotment option granted to the several underwriters of the Offering. Of the Firm Shares, 4,000,000 shares will be sold by the Company and 200,000 shares will be sold by certain shareholders (the "Selling Shareholders"). All of the Option Shares will be sold by the Selling Shareholders to the extent the underwriters exercise their over-allotment option. The Company has filed a Registration Statement on Form S-1 (the "Registration Statement"), which the Company initially filed with the Securities and Exchange Commission on August 19, 1996 (File No. 33-10391), pursuant to the Securities Act of 1933, as amended, with respect to the Offering. As such counsel, we have been requested to render this opinion. We have examined and reviewed such documents, records and matters of law as we have deemed necessary for purposes of this opinion. With respect to the foregoing, we have assumed, without investigation, the genuineness of all signatures, the authenticity of all documents submitted to us as originals and the conformity to originals of all documents submitted to us as certified or reproduced copies. We also have obtained from the officers of the Company such advice as to such factual matters as we consider necessary for the purpose of this opinion, and insofar as this opinion is based on such matters of fact, we have relied on such advice. SmarTalk TeleServices, Inc. September 24, 1996 Page 2 Based on the foregoing and solely in reliance thereon, we are of the opinion that: A. The Firm Shares to be sold by the Company have been duly authorized and, when issued and paid for as contemplated by the Registration Statement, will be validly issued, fully paid and nonassessable. B. The Firm Shares and the Option Shares to be sold by the Selling Shareholders have been duly authorized and validly issued and are fully paid and nonassessable. We hereby disclaim any obligation to notify any person or entity after the date hereof if any change in fact or law should change our opinion with respect to any matter set forth in this letter. This opinion letter may not be relied upon by any other person or entity and may not be circulated, quoted, or cited in whole or in part, without our express prior written consent. We hereby consent to the filing of this opinion as Exhibit 5.1 to the Registration Statement and to the reference to us under the caption "Legal Matters" in the prospectus which is part of the Registration Statement. Very truly yours, /s/ Dewey Ballantine EX-10.8A 6 EMPLOYMENT AGREEMENT SMARTALK/LORSCH EXHIBIT 10.8A EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT (the "Agreement") is made this sixteenth day of July, 1996 between SMARTALK TELESERVICES, INC., a California corporation (the "Company") and ROBERT H. LORSCH (the "Executive"); and WHEREAS, the parties hereto wish to enter into an employment agreement to employ the Executive as President, Chief Executive Officer and Chairman of the Board of the Company and to set forth certain additional agreements between the Executive and the Company. NOW, THEREFORE, in consideration of the mutual covenants and representations contained herein, the parties hereto agree as follows: 1. Term. ---- The Company will employ the Executive, and the Executive will serve the Company, under the terms of this Agreement for an initial term of three years, commencing on the closing of an initial public offering. The Executive shall retain any accrued benefits under his previous employment agreement with the Company. Effective as of the expiration of such initial three-year term and as of each two-year anniversary date thereof, the term of this Agreement shall be extended for an additional two-year period unless, not later than twelve months prior to each such respective date, either party hereto shall have given notice to the other that the term shall not be so extended. Notwithstanding the foregoing, the Executive's employment hereunder may be earlier terminated, as provided in Section 4 hereof. The term of this Agreement, as in effect from time to time in accordance with the foregoing, shall be referred to herein as the "Term". The period of time between the commencement and the termination of the Executive's employment hereunder shall be referred to herein as the "Employment Period." 2. Employment. ---------- (a) Positions and Reporting. The Company hereby employs the ----------------------- Executive for the Employment Period as its President, Chief Executive Officer and Chairman of the Board on the terms and conditions set forth in this Agreement. During the Employment Period, the Executive shall report directly to the Board of Directors of the Company (the "Board"). (b) Authority and Duties. The Executive shall exercise such -------------------- authority, perform such executive duties and functions and discharge such responsibilities as are reasonably associated with the Executive's positions, commensurate with the authority vested in the Executive pursuant to this Agreement and consistent with the By-Laws of the Company. During the Employment Period, the Executive shall devote full business time, skill and efforts to the business of the Company. Notwithstanding the foregoing, the Executive may (i) make and manage personal business investments of his choice and serve in any capacity with any civic, educational or charitable organization, or any trade association, without seeking or obtaining approval by the Board, provided such activities and service do not materially interfere or conflict with the performance of his duties hereunder and (ii) with the approval of the Board, serve on the boards of directors of other corporations. 3. Compensation and Benefits. ------------------------- (a) Salary. During the Employment Period, the Company shall pay to ------ the Executive, as compensation for the performance of his duties and obligations under this Agreement, a base salary at the rate of $345,000 per annum, payable in arrears not less frequently than monthly in accordance with the normal payroll practices of the Company (the "Base Salary"). Such Base Salary shall be subject to review each year for possible increase by the Board in its sole discretion, but shall in no event be decreased from its then-existing level during the Employment Period. (b) Annual Bonus. The Executive shall earn bonus amounts, based upon ------------ the satisfaction of performance criteria that will be established by a committee of the Board (the "Compensation Committee") in its discretion and upon consultation with the Executive at the beginning of each year, but in no case after January 31, subject to the approval of the Board. Such performance criteria will include corporate performance goals consistent with the Company's business plan for the year, as well as individual objectives for the Executive's performance that are separate from, but are consistent with, the Company's business plan. The final determinations as to the actual corporate and individual performance against the pre-established goals and objectives, and the amounts of any additional bonus payout in relationship to such performance, shall be made by the Compensation Committee in its sole discretion. (c) Car Allowance. Employer shall pay to Executive as an automobile ------------- allowance the sum of $2,400 per month during the Employment Period in lieu of any other provision for an automobile, insurance, maintenance, gasoline and expenses. 2 (d) Insurance Policies. The Company shall purchase for up to an ------------------ annual premium amount of $20,000 and maintain in force during the Employment Period, life and disability insurance on the Executive, the beneficiary of which shall be designated by the Executive (the "Executive Policies"). In the event that the Company cancels the Executive Policies, the Executive shall have the option to continue them in force at his own expense. The Executive Policies shall be assigned to the Executive upon the termination of this Agreement. The Company may also purchase "key-person" life insurance policies on the Executive's life in such amounts and of such types as is determined by the Board. The Executive shall cooperate fully with the Company in obtaining such insurance and shall submit to such physical examinations and provide such information as is reasonably required to obtain and maintain such policies. Neither the Executive nor his successor-in-interest or estate shall have any interest in any such key-person policies so obtained. (e) Other Benefits. During the Employment Period, the Executive -------------- shall receive such other life insurance, pension, disability insurance, health insurance, holiday, vacation and sick pay benefits and other benefits which the Company extends, as a matter of policy, to its executive employees and, except as otherwise provided herein, shall be entitled to participate in all deferred compensation and other incentive plans of the Company on the same basis as other like employees or the Company. Without limiting the generality of the foregoing, the Executive shall be entitled to four (4) weeks vacation during each year of the Employment Period, which shall be scheduled in the Executive's discretion, subject to and taking into account the business exigencies of the Company. Unused vacation may be accrued up to a maximum of six (6) weeks of unused vacation, and thereafter the Executive shall cease to accrue vacation thereafter until used. (f) Business Expenses. During the Employment Period, the Company ----------------- shall promptly reimburse the Executive for all documented reasonable business expenses incurred by the Executive in the performance of his duties under this Agreement, in accordance with the Company's policies and standards of similar or comparable companies. 4. Termination of Employment. ------------------------- (a) Termination for Cause. The Company may terminate the Executive's --------------------- employment hereunder for cause. For purposes of this Agreement and subject to the Executive's opportunity to cure as provided in Section 4(c) hereof, the Company shall have "cause" to terminate the Executive's employment hereunder if: 3 (i) The Executive has materially breached a provision of this Agreement, and, if such breach is curable, it has not been cured or reasonably commenced being cured within ninety (90) days after written notice from the Company; (ii) The Executive is convicted of or pleads guilty to a felony involving financial misconduct or moral turpitude. (b) Termination for Good Reason. The Executive shall have the right --------------------------- at any time to terminate his employment with the Company at any time and for any reason. For purposes of this Agreement and subject to the Company's opportunity to cure as provided in Section 4(c) hereof, the Executive shall have "good reason" to terminate his employment hereunder if such termination shall be the result of: (i) a material diminution during the Employment Period in the Executive's duties or responsibilities as set forth in Section 2 hereof; (ii) a breach by the Company of the compensation and benefits provisions set forth in Section 3 hereof; (iii) notice of non-renewal of the Agreement by the Company in accordance with Section 1 hereof; (iv) notice of termination by the Executive under Section 4(c) hereof within 12 months following the occurrence of a Change in Control (as defined in Section 4(e) hereof); or (v) a material breach by the Company of any material terms of this Agreement. (c) Notice and Opportunity to Cure. Notwithstanding the foregoing, it ------------------------------ shall be a condition precedent to the Company's right to terminate the Executive's employment for "cause" and the Executive's right to terminate his employment for "good reason" that (1) the party seeking the termination shall first have given the other party written notice stating with specificity the reason for the termination ("breach") and (2) if such breach is susceptible of cure or remedy, a period of 30 days from and after the giving of such notice shall have elapsed without the breaching party having effectively cured or remedied such breach during such 30-day period, unless such breach cannot be cured or remedied within 30 days, in which case the period for remedy or cure shall be extended for a reasonable time (not to exceed 30 days) provided the breaching party has made and continues to make a diligent effort to effect such remedy or cure. (d) Termination Upon Death or Permanent and Total Disability. The -------------------------------------------------------- Employment Period shall be terminated by the 4 death of the Executive. The Employment Period may be terminated by the Company if the Executive shall be rendered incapable of performing his duties to the Company by reason of any medically determined physical or mental impairment that can be expected to result in death or that can be expected to last for a period of six or more consecutive months from the first date of the disability ("Disability"). If the Employment Period is terminated by reason of Disability of the Executive, the Company shall give 30-days' advance written notice to that effect to the Executive. (e) Definition of Change in Control. A "Change in Control" shall ------------------------------- be deemed to have taken place if: (i) there shall be consummated any consolidation or merger of the Company in which the Company is not the continuing or surviving corporation or pursuant to which shares of the Company's capital stock are converted into cash, securities or other property, other than a consolidation or merger of the Company in which the holders of the Company's voting stock immediately prior to the consolidation or merger shall, upon consummation of the consolidation or merger, own at least 50% of the voting stock, or any sale, lease, exchange or other transfer (in one transaction or a series of transactions contemplated or arranged by any party as a single plan) of all or substantially all of the assets of the Company; or (ii) any person (as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) shall, after the date hereof, become the beneficial owner (as defined in Rules 13d-3 and 13d-5 under the Exchange Act), directly or indirectly, of securities of the Company representing 35% or more of the voting power of all of the then outstanding securities of the Company having the right under ordinary circumstances to vote in an election of the Board (including, without limitation, any securities of the Company that any such person has the right to acquire pursuant to any agreement, or upon exercise of conversion rights, warrants or options, or otherwise, shall be deemed beneficially owned by such person); or (iii) individuals who as of the date hereof constitute the entire Board and any new directors whose election by the Company's shareholders, or whose nomination for election by the Company's board, shall have been approved by a vote of at least a majority of the directors then in office who either were directors at the date hereof or whose election or nomination for election shall have been so approved (the "Continuing Directors") shall cease for any reason to constitute a majority of the members of the Board. 5 5. Consequences of Termination. --------------------------- (a) Termination Without Cause or for Good Reason. In the event of -------------------------------------------- termination of the Executive's employment hereunder by the Company without "cause" (other than upon death or Disability) or by the Executive for "good reason" (each as defined in Section 4 hereof), the Executive shall be entitled to the following severance pay and benefits: (i) Severance Pay - severance payments in the form of ------------- continuation of payments of the Executive's Base Salary as in effect immediately prior to such termination over the longer of (A) the then remainder of the Term (as if a timely non-renewal notice has been given) and (B) 24 months (the "Severance Period"). (ii) Benefits Continuation - continuation for the Severance --------------------- Period of coverage under the group medical care, disability and life insurance benefit plans or arrangements in which the Executive is participating at the time of termination; provided, however, that the -------- ------- Company's obligation to provide such coverages shall be terminated if the Executive obtains comparable substitute coverage from another employer at any time during the Severance Period. The Executive shall be entitled, at the expiration of the Severance Period, to elect continued medical coverage in accordance with Section 4980B of the Internal Revenue Code of 1986, as amended (or any successor provision thereto). (b) Termination Upon Disability. In the event of termination of the --------------------------- Executive's employment hereunder by the Company on account of Disability, the Executive shall be entitled to the following severance pay and benefits: (i) Severance Pay - severance payments in the form of ------------- continuation of the Executive's Base Salary as in effect immediately prior to such termination for a period of the longer of 12 months following the first date of Disability and the then remainder of the Term (as if a timely non-renewal notice has been given); (ii) Benefits Continuation - the same benefits as provided in --------------------- Section 5(a)(ii) above, to be provided during the Employment Period while the Executive is suffering from Disability and for a period of 12 months following the effective date of termination of employment by reason of Disability. In addition to the foregoing, the Company shall remit to the Executive any benefits received by the Company, as beneficiary, pursuant to any additional disability insurance 6 policy which was maintained by the Executive prior to his employment with the Company. (c) Termination Upon Death. In the event of termination of the ---------------------- Executive's employment hereunder on account of the Executive's death, the Executive's heirs, estate or personal representatives under law, as applicable, shall be entitled to the payment of the Executive's Base Salary as in effect immediately prior to death for a period of not less than two calendar months and not more than the earlier of six calendar months or the payment of benefits pursuant to the Executive's life insurance policy, as provided for in Section 3(d) above. The Executive's beneficiary or estate shall not be required to remit to the Company any payments received pursuant to any life insurance policy purchased pursuant to Section 3(d) above. (d) Other Terminations. In the event of termination of the ------------------ Executive's employment hereunder for any reason other than those specified in subsection (a) through (c) of this Section 5, the Executive shall not be entitled to any severance pay or benefits continuation contemplated by the foregoing, except as may otherwise be provided under the applicable benefit plans or award agreements relating to the Executive. (e) Accrued Rights. Notwithstanding the foregoing provisions of this -------------- Section 5, in the event of termination of the Executive's employment hereunder for any reason, the Executive shall be entitled to payment of any unpaid portion of his Base Salary through the effective date of termination, and payment of any accrued but unpaid rights solely in accordance with the terms of any incentive bonus or employee benefit plan or program of the Company. (f) Conditions to Severance Benefits. (i) The Company shall have the -------------------------------- right to seek repayment of the severance payments and benefits provided by this Section 5 in the event that the Executive fails to honor in accordance with their terms the provisions of Sections 6, 7 and 8 hereof. (ii) For purposes only of this Section, Employee shall be treated as having failed to honor the provisions of Sections 6, 7 or 8 hereof only upon the vote of two-thirds of the Board following notice of the alleged failure by the Company to the Executive, an opportunity for the Executive to cure the alleged failure for a period of 30 days from the date of such notice and the Executive's opportunity to be heard on the issue by the Board. 6. Confidentiality. The Executive agrees that he will not at any --------------- time during the Employment Period or at any time thereafter for any reason, in any fashion, form or manner, either directly or indirectly, divulge, disclose or communicate to any 7 person, firm, corporation or other business entity, in any manner whatsoever, any confidential information or trade secrets concerning the business of the Company, including, without limiting the generality of the foregoing, the techniques, methods or systems of its operation or management, any information regarding its financial matters, or any other material information concerning the business of the Company (including customer lists), its manner of operation, its plans or other material data (the "Business"). The provisions of this Section 6 shall not apply to (i) information disclosed in the performance of the Executive's duties to the Company based on his good faith belief that such a disclosure is in the best interests of Company; (ii) information that is, at the time of the disclosure, public knowledge; (iii) information disseminated by the Company to third parties in the ordinary course of business; (iv) information lawfully received by the Executive from a third party who, based upon inquiry by the Executive, is not bound by a confidential relationship to the Company; or (v) information disclosed under a requirement of law or as directed by applicable legal authority having jurisdiction over the Executive. 7. Inventions. The Executive is hereby retained in a capacity such ---------- that the Executive's responsibilities may include the making of technical and managerial contributions of value to Company. The Executive hereby assigns to Company all rights, title and interest in such contributions and inventions made or conceived by the Executive alone or jointly with others during the Employment Period which relate to the Business. This assignment shall include (a) the right to file and prosecute patent applications on such inventions in any and all countries, (b) the patent applications filed and patents issuing thereon, and (c) the right to obtain copyright, trademark or trade name protection for any such work product. The Executive shall promptly and fully disclose all such contributions and inventions to Company and assist Company in obtaining and protecting the rights therein (including patents thereon), in any and all countries; provided, however, that said contributions and inventions will be the -------- ------- property of Company, whether or not patented or registered for copyright, trademark or trade name protection, as the case may be. Inventions conceived by the Executive which are not related to the Business, will remain the property of the Executive. 8. Non-Competition. (i) The Executive agrees that he shall not --------------- during the Employment Period and for a period of one (1) year thereafter, without the approval of the Board, directly or indirectly, alone or as partner, joint venturer, officer, director, employee, consultant, agent, independent contractor or stockholder (other than as provided below) of any company or business, engage in any "Competitive Business" within the United 8 States. For purposes of the foregoing, the term "Competitive Business" shall mean any business directly involved in prepaid telecommunications services industry. Notwithstanding the foregoing, the Executive shall not be prohibited during the noncompetition period applicable above from acting as a passive investor where he owns not more than five percent (5%) of the issued and outstanding capital stock of any publicly-held company. During the period that the above noncompetition restriction applies, the Executive shall not, without the written consent of the Company, solicit any employee who is under contract with the Company or any current or future subsidiary or affiliate thereof to terminate his or her employment; nor shall the Executive solicit employees for any enterprise that competes with Company; but shall have the right to solicit employees not under contract with the Company for an enterprise that does not compete with the Company. 9. Breach of Restrictive Covenants. The parties agree that a breach ------------------------------- or violation of Sections 6, 7 or 8 hereof will result in immediate and irreparable injury and harm to the innocent party, and that such innocent party shall have, in addition to any and all remedies of law and other consequences under this Agreement, the right to seek an injunction, specific performance or other equitable relief to prevent the violation of the obligations hereunder. 10. Notice. For the purposes of this Agreement, notices, demands ------ and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when delivered or (unless otherwise specified) mailed by United States certified or registered mail, return receipt requested, postage prepaid, addressed as follows: (a) If to the Company, to: Attn: President SmarTalk TeleServices, Inc. 1640 South Sepulveda Blvd., Suite 500 Los Angeles, CA 90025 with a copy to: Robert M. Smith Dewey Ballantine 333 South Hope Street, Suite 3000 Los Angeles, CA 90071-1406 9 (b) If to the Executive, to: Robert H. Lorsch 3188 Kings Court Los Angeles, CA 90077 or to such other respective addresses as the parties hereto shall designate to the other by like notice, provided that notice of a change of address shall be effective only upon receipt thereof. 11. Excise Tax Limit. Notwithstanding anything in this Agreement to ---------------- the contrary, in the event it shall be determined that any payment or distribution by the Company or any other person or entity to or for the benefit of the Executive is a "parachute payment" (within the meaning of Section 280G of the Code, whether paid or payable or distributed or distributable pursuant to the terms of this Agreement or otherwise (a "Payment") in connection with, or arising out of, his employment with the Company or a change in ownership or effective control of the Company (within the meaning of Section 280G of the Code, and would be subject to the excise tax imposed by Section 4999 of the Code) (the "Excise Tax"), the Payments shall be reduced to the extent necessary so that such remaining Payment would not be subject to the excise tax imposed by Section 4999 of the Code. 12. Arbitration; Legal Fees. Except as provided in Section 9 hereof, ----------------------- any dispute or controversy arising under or in connection with this Agreement shall be settled exclusively by arbitration in Los Angeles County, California in accordance with the rules of the American Arbitration Association then in effect. Judgment may be entered on the arbitrator's award in any court having jurisdiction. The Company shall reimburse Executive for all reasonable legal fees and costs and other fees and expenses which Executive may incur in respect of any dispute or controversy arising under or in connection with this Agreement; provided, however, that the Company shall not reimburse any such fees -------- ------- costs and expenses if the fact finder determines that the action brought by the Executive was frivolous. 13. Waiver of Breach. Any waiver of any breach of this Agreement ---------------- shall not be construed to be a continuing waiver or consent to any subsequent breach on the part either of the Executive or of the Company. 14. Non-Assignment; Successors. Neither party hereto may assign his -------------------------- or its rights or delegate his or its duties under this Agreement without the prior written consent of the other party; provided, however, that: (i) this -------- ------- Agreement shall inure to 10 the benefit of and be binding upon the successors and assigns of the Company upon any sale of all or substantially all of the Company's assets, or upon any merger, consolidation or reorganization of the Company with or into any other corporation, all as though such successors and assigns of the Company and their respective successors and assigns were the Company; and (ii) this Agreement shall inure to the benefit of and be binding upon the heirs, assigns or designees of the Executive to the extent of any payments due to them hereunder. As used in this Agreement, the term "Company" shall be deemed to refer to any such successor or assign of the Company referred to in the preceding sentence. 15. Withholding of Taxes. All payments required to be made by the -------------------- Company to the Executive under this Agreement shall be subject to the withholding of such amounts, if any, relating to tax, and other payroll deductions as the Company may reasonably determine it should withhold pursuant to any applicable law or regulation. 16. Severability. To the extent any provision of this Agreement or ------------ portion thereof shall be invalid or unenforceable, it shall be considered deleted therefrom and the remainder of such provision and of this Agreement shall be unaffected and shall continue in full force and effect. 17. Director and Officer Insurance. The Company shall use its best ------------------------------ efforts to obtain and maintain director's and officer's insurance for the Executive (in such amounts as are appropriate for executives of businesses comparable to that of the Company) pursuant to Board of Directors indemnity agreements then in force and shall give timely notice to the Executive of termination of any such insurance policy. 18. Counterparts. This Agreement may be executed in one or more ------------ counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument. 19. Governing Law. This Agreement shall be construed, interpreted ------------- and enforced in accordance with the laws of the State of California, without giving effect to the choice of law principles thereof. 20. Entire Agreement. This Agreement constitutes the entire ---------------- agreement by the Company and the Executive with respect to 11 the subject matter hereof and supersedes any and all prior agreements or understandings between the Executive and the Company with respect to the subject matter hereof, whether written or oral. This Agreement may be amended or modified only by a written instrument executed by the Executive and the Company. IN WITNESS WHEREOF, the parties have executed this Agreement as of July 16, 1996. THE COMPANY By: /s/ Smartalk TeleServices, Inc. ----------------------------------- Smartalk TeleServices, Inc. THE EXECUTIVE /s/ Robert H. Lorsch ----------------------------------- Robert H. Lorsch 12 EX-10.8B 7 EMPLOYMENT AGREEMENT SMARTALK/TEICH EXHIBIT 10.8B EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT (the "Agreement") is made this sixteenth day of July, 1996 between SMARTALK TELESERVICES, INC., a California corporation (the "Company") and RICHARD M. TEICH (the "Executive"); and WHEREAS, the parties hereto wish to enter into an employment agreement to employ the Executive as Executive Vice President of the Company and to set forth certain additional agreements between the Executive and the Company. NOW, THEREFORE, in consideration of the mutual covenants and representations contained herein, the parties hereto agree as follows: 1. Term. ---- The Company will employ the Executive, and the Executive will serve the Company, under the terms of this Agreement for an initial term of two years, commencing on the closing of an initial public offering. The Executive shall retain any accrued benefits under his previous employment agreement with the Company. Effective as of the expiration of such initial two-year term and as of each anniversary date thereof, the term of this Agreement shall be extended for an additional one-year period unless, not later than three months prior to each such respective date, either party hereto shall have given notice to the other that the term shall not be so extended. Notwithstanding the foregoing, the Executive's employment hereunder may be earlier terminated, as provided in Section 4 hereof. The term of this Agreement, as in effect from time to time in accordance with the foregoing, shall be referred to herein as the "Term". The period of time between the commencement and the termination of the Executive's employment hereunder shall be referred to herein as the "Employment Period." 2. Employment. ---------- (a) Positions and Reporting. The Company hereby employs the ----------------------- Executive for the Employment Period as its Executive Vice President on the terms and conditions set forth in this Agreement. During the Employment Period, the Executive shall report directly to the President of the Company. (b) Authority and Duties. The Executive shall exercise such -------------------- authority, perform such executive duties and functions and discharge such responsibilities as are reasonably associated with the Executive's positions, commensurate with the authority vested in the Executive pursuant to this Agreement and consistent with the By-Laws of the Company. During the Employment Period, the Executive shall devote full business time, skill and efforts to the business of the Company. Notwithstanding the foregoing, the Executive may (i) make and manage personal business investments of his choice and serve in any capacity with any civic, educational or charitable organization, or any trade association, without seeking or obtaining approval by the Board, provided such activities and service do not materially interfere or conflict with the performance of his duties hereunder and (ii) with the approval of the Board of Directors of the Company (the "Board"), serve on the boards of directors of other corporations. 3. Compensation and Benefits. ------------------------- (a) Salary. During the Employment Period, the Company shall pay to ------ the Executive, as compensation for the performance of his duties and obligations under this Agreement, a base salary at the rate of $185,000 per annum, payable in arrears not less frequently than monthly in accordance with the normal payroll practices of the Company (the "Base Salary"). Such Base Salary shall be subject to review each year for possible increase by the Board in its sole discretion, but shall in no event be decreased from its then-existing level during the Employment Period. (b) Annual Bonus. The Executive shall earn bonus amounts, based upon ------------ the satisfaction of performance criteria that will be established by a committee of the Board (the "Compensation Committee") in its discretion and upon consultation with the Executive at the beginning of each year, but in no case after January 31, subject to the approval of the Board. Such performance criteria will include corporate performance goals consistent with the Company's business plan for the year, as well as individual objectives for the Executive's performance that are separate from, but are consistent with, the Company's business plan. The final determinations as to the actual corporate and individual performance against the pre-established goals and objectives, and the amounts of any additional bonus payout in relationship to such performance, shall be made by the Compensation Committee in its sole discretion. (c) Car Allowance. Employer shall pay to Executive as an automobile ------------- allowance the sum of $600 per month during the Employment Period in lieu of any other provision for an automobile, insurance, maintenance, gasoline and expenses. 2 (d) Insurance Policies. The Company shall purchase for up to an ------------------ annual premium amount of $5,000 and maintain in force during the Employment Period, life and disability insurance on the Executive, the beneficiary of which shall be designated by the Executive (the "Executive Policies"). In the event that the Company cancels the Executive Policies, the Executive shall have the option to continue them in force at his own expense. The Executive Policies shall be assigned to the Executive upon the termination of this Agreement. The Company may also purchase "key-person" life insurance policies on the Executive's life in such amounts and of such types as is determined by the Board. The Executive shall cooperate fully with the Company in obtaining such insurance and shall submit to such physical examinations and provide such information as is reasonably required to obtain and maintain such policies. Neither the Executive nor his successor-in-interest or estate shall have any interest in any such key-person policies so obtained. (e) Other Benefits. During the Employment Period, the Executive -------------- shall receive such other life insurance, pension, disability insurance, health insurance, holiday, vacation and sick pay benefits and other benefits which the Company extends, as a matter of policy, to its executive employees and, except as otherwise provided herein, shall be entitled to participate in all deferred compensation and other incentive plans of the Company on the same basis as other like employees or the Company. Without limiting the generality of the foregoing, the Executive shall be entitled to four (4) weeks vacation during each year of the Employment Period, which shall be scheduled in the Executive's discretion, subject to and taking into account the business exigencies of the Company. Unused vacation may be accrued up to a maximum of six (6) weeks of unused vacation, and thereafter the Executive shall cease to accrue vacation thereafter until used. (f) Business Expenses. During the Employment Period, the Company ----------------- shall promptly reimburse the Executive for all documented reasonable business expenses incurred by the Executive in the performance of his duties under this Agreement, in accordance with the Company's policies and standards of similar or comparable companies. 4. Termination of Employment. ------------------------- (a) Termination for Cause. The Company may terminate the Executive's --------------------- employment hereunder for cause. For purposes of this Agreement and subject to the Executive's opportunity to cure as provided in Section 4(c) hereof, the Company shall have "cause" to terminate the Executive's employment hereunder if: 3 (i) The Executive has materially breached a provision of this Agreement, and, if such breach is curable, it has not been cured or reasonably commenced being cured within ninety (90) days after written notice from the Company; (ii) The Executive is convicted of or pleads guilty to a felony involving financial misconduct or moral turpitude. (b) Termination for Good Reason. The Executive shall have the right --------------------------- at any time to terminate his employment with the Company at any time and for any reason. For purposes of this Agreement and subject to the Company's opportunity to cure as provided in Section 4(c) hereof, the Executive shall have "good reason" to terminate his employment hereunder if such termination shall be the result of: (i) a material diminution during the Employment Period in the Executive's duties or responsibilities as set forth in Section 2 hereof; (ii) a breach by the Company of the compensation and benefits provisions set forth in Section 3 hereof; (iii) notice of non-renewal of the Agreement by the Company in accordance with Section 1 hereof; (iv) notice of termination by the Executive under Section 4(c) hereof within 12 months following the occurrence of a Change in Control (as defined in Section 4(e) hereof); or (v) a material breach by the Company of any material terms of this Agreement. (c) Notice and Opportunity to Cure. Notwithstanding the foregoing, it ------------------------------ shall be a condition precedent to the Company's right to terminate the Executive's employment for "cause" and the Executive's right to terminate his employment for "good reason" that (1) the party seeking the termination shall first have given the other party written notice stating with specificity the reason for the termination ("breach") and (2) if such breach is susceptible of cure or remedy, a period of 30 days from and after the giving of such notice shall have elapsed without the breaching party having effectively cured or remedied such breach during such 30-day period, unless such breach cannot be cured or remedied within 30 days, in which case the period for remedy or cure shall be extended for a reasonable time (not to exceed 30 days) provided the breaching party has made and continues to make a diligent effort to effect such remedy or cure. (d) Termination Upon Death or Permanent and Total Disability. The -------------------------------------------------------- Employment Period shall be terminated by the 4 death of the Executive. The Employment Period may be terminated by the Company if the Executive shall be rendered incapable of performing his duties to the Company by reason of any medically determined physical or mental impairment that can be expected to result in death or that can be expected to last for a period of six or more consecutive months from the first date of the disability ("Disability"). If the Employment Period is terminated by reason of Disability of the Executive, the Company shall give 30-days' advance written notice to that effect to the Executive. (e) Definition of Change in Control. A "Change in Control" shall ------------------------------- be deemed to have taken place if: (i) there shall be consummated any consolidation or merger of the Company in which the Company is not the continuing or surviving corporation or pursuant to which shares of the Company's capital stock are converted into cash, securities or other property, other than a consolidation or merger of the Company in which the holders of the Company's voting stock immediately prior to the consolidation or merger shall, upon consummation of the consolidation or merger, own at least 50% of the voting stock, or any sale, lease, exchange or other transfer (in one transaction or a series of transactions contemplated or arranged by any party as a single plan) of all or substantially all of the assets of the Company; or (ii) any person (as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) shall, after the date hereof, become the beneficial owner (as defined in Rules 13d-3 and 13d-5 under the Exchange Act), directly or indirectly, of securities of the Company representing 35% or more of the voting power of all of the then outstanding securities of the Company having the right under ordinary circumstances to vote in an election of the Board (including, without limitation, any securities of the Company that any such person has the right to acquire pursuant to any agreement, or upon exercise of conversion rights, warrants or options, or otherwise, shall be deemed beneficially owned by such person); or (iii) individuals who as of the date hereof constitute the entire Board and any new directors whose election by the Company's shareholders, or whose nomination for election by the Company's board, shall have been approved by a vote of at least a majority of the directors then in office who either were directors at the date hereof or whose election or nomination for election shall have been so approved (the "Continuing Directors") shall cease for any reason to constitute a majority of the members of the Board. 5 5. Consequences of Termination. --------------------------- (a) Termination Without Cause or for Good Reason. In the event of -------------------------------------------- termination of the Executive's employment hereunder by the Company without "cause" (other than upon death or Disability) or by the Executive for "good reason" (each as defined in Section 4 hereof), the Executive shall be entitled to the following severance pay and benefits: (i) Severance Pay - severance payments in the form of ------------- continuation of payments of the Executive's Base Salary as in effect immediately prior to such termination over the longer of (A) the then remainder of the Term (as if a timely non-renewal notice has been given) and (B) 24 months (the "Severance Period"). (ii) Benefits Continuation - continuation for the Severance --------------------- Period of coverage under the group medical care, disability and life insurance benefit plans or arrangements in which the Executive is participating at the time of termination; provided, however, that the -------- ------- Company's obligation to provide such coverages shall be terminated if the Executive obtains comparable substitute coverage from another employer at any time during the Severance Period. The Executive shall be entitled, at the expiration of the Severance Period, to elect continued medical coverage in accordance with Section 4980B of the Internal Revenue Code of 1986, as amended (or any successor provision thereto). (b) Termination Upon Disability. In the event of termination of the --------------------------- Executive's employment hereunder by the Company on account of Disability, the Executive shall be entitled to the following severance pay and benefits: (i) Severance Pay - severance payments in the form of ------------- continuation of the Executive's Base Salary as in effect immediately prior to such termination for a period of the longer of 12 months following the first date of Disability and the then remainder of the Term (as if a timely non-renewal notice has been given); (ii) Benefits Continuation - the same benefits as provided in --------------------- Section 5(a)(ii) above, to be provided during the Employment Period while the Executive is suffering from Disability and for a period of 12 months following the effective date of termination of employment by reason of Disability. In addition to the foregoing, the Company shall remit to the Executive any benefits received by the Company, as beneficiary, pursuant to any additional disability insurance 6 policy which was maintained by the Executive prior to his employment with the Company. (c) Termination Upon Death. In the event of termination of the ---------------------- Executive's employment hereunder on account of the Executive's death, the Executive's heirs, estate or personal representatives under law, as applicable, shall be entitled to the payment of the Executive's Base Salary as in effect immediately prior to death for a period of not less than two calendar months and not more than the earlier of six calendar months or the payment of benefits pursuant to the Executive's life insurance policy, as provided for in Section 3(d) above. The Executive's beneficiary or estate shall not be required to remit to the Company any payments received pursuant to any life insurance policy purchased pursuant to Section 3(d) above. (d) Other Terminations. In the event of termination of the ------------------ Executive's employment hereunder for any reason other than those specified in subsection (a) through (c) of this Section 5, the Executive shall not be entitled to any severance pay or benefits continuation contemplated by the foregoing, except as may otherwise be provided under the applicable benefit plans or award agreements relating to the Executive. (e) Accrued Rights. Notwithstanding the foregoing provisions of this -------------- Section 5, in the event of termination of the Executive's employment hereunder for any reason, the Executive shall be entitled to payment of any unpaid portion of his Base Salary through the effective date of termination, and payment of any accrued but unpaid rights solely in accordance with the terms of any incentive bonus or employee benefit plan or program of the Company. (f) Conditions to Severance Benefits. (i) The Company shall have the -------------------------------- right to seek repayment of the severance payments and benefits provided by this Section 5 in the event that the Executive fails to honor in accordance with their terms the provisions of Sections 6, 7 and 8 hereof. (ii) For purposes only of this Section, Employee shall be treated as having failed to honor the provisions of Sections 6, 7 or 8 hereof only upon the vote of two-thirds of the Board following notice of the alleged failure by the Company to the Executive, an opportunity for the Executive to cure the alleged failure for a period of 30 days from the date of such notice and the Executive's opportunity to be heard on the issue by the Board. 6. Confidentiality. The Executive agrees that he will not at any --------------- time during the Employment Period or at any time thereafter for any reason, in any fashion, form or manner, either directly or indirectly, divulge, disclose or communicate to any 7 person, firm, corporation or other business entity, in any manner whatsoever, any confidential information or trade secrets concerning the business of the Company, including, without limiting the generality of the foregoing, the techniques, methods or systems of its operation or management, any information regarding its financial matters, or any other material information concerning the business of the Company (including customer lists), its manner of operation, its plans or other material data (the "Business"). The provisions of this Section 6 shall not apply to (i) information disclosed in the performance of the Executive's duties to the Company based on his good faith belief that such a disclosure is in the best interests of Company; (ii) information that is, at the time of the disclosure, public knowledge; (iii) information disseminated by the Company to third parties in the ordinary course of business; (iv) information lawfully received by the Executive from a third party who, based upon inquiry by the Executive, is not bound by a confidential relationship to the Company; or (v) information disclosed under a requirement of law or as directed by applicable legal authority having jurisdiction over the Executive. 7. Inventions. The Executive is hereby retained in a capacity such ---------- that the Executive's responsibilities may include the making of technical and managerial contributions of value to Company. The Executive hereby assigns to Company all rights, title and interest in such contributions and inventions made or conceived by the Executive alone or jointly with others during the Employment Period which relate to the Business. This assignment shall include (a) the right to file and prosecute patent applications on such inventions in any and all countries, (b) the patent applications filed and patents issuing thereon, and (c) the right to obtain copyright, trademark or trade name protection for any such work product. The Executive shall promptly and fully disclose all such contributions and inventions to Company and assist Company in obtaining and protecting the rights therein (including patents thereon), in any and all countries; provided, however, that said contributions and inventions will be the -------- ------- property of Company, whether or not patented or registered for copyright, trademark or trade name protection, as the case may be. Inventions conceived by the Executive which are not related to the Business, will remain the property of the Executive. 8. Non-Competition. (i) The Executive agrees that he shall not --------------- during the Employment Period and for a period of one (1) year thereafter, without the approval of the Board, directly or indirectly, alone or as partner, joint venturer, officer, director, employee, consultant, agent, independent contractor or stockholder (other than as provided below) of any company or business, engage in any "Competitive Business" within the United 8 States. For purposes of the foregoing, the term "Competitive Business" shall mean any business directly involved in prepaid telecommunications services industry. Notwithstanding the foregoing, the Executive shall not be prohibited during the noncompetition period applicable above from acting as a passive investor where he owns not more than five percent (5%) of the issued and outstanding capital stock of any publicly-held company. During the period that the above noncompetition restriction applies, the Executive shall not, without the written consent of the Company, solicit any employee who is under contract with the Company or any current or future subsidiary or affiliate thereof to terminate his or her employment; nor shall the Executive solicit employees for any enterprise that competes with Company; but shall have the right to solicit employees not under contract with the Company for an enterprise that does not compete with the Company. 9. Breach of Restrictive Covenants. The parties agree that a breach ------------------------------- or violation of Sections 6, 7 or 8 hereof will result in immediate and irreparable injury and harm to the innocent party, and that such innocent party shall have, in addition to any and all remedies of law and other consequences under this Agreement, the right to seek an injunction, specific performance or other equitable relief to prevent the violation of the obligations hereunder. 10. Notice. For the purposes of this Agreement, notices, demands ------ and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when delivered or (unless otherwise specified) mailed by United States certified or registered mail, return receipt requested, postage prepaid, addressed as follows: (a) If to the Company, to: Attn: President SmarTalk TeleServices, Inc. 1640 South Sepulveda Blvd., Suite 500 Los Angeles, CA 90025 with a copy to: Robert M. Smith Dewey Ballantine 333 South Hope Street, Suite 3000 Los Angeles, CA 90071-1406 9 (b) If to the Executive, to: Richard M. Teich 3770 Casados Street Los Angeles, CA 90065 or to such other respective addresses as the parties hereto shall designate to the other by like notice, provided that notice of a change of address shall be effective only upon receipt thereof. 11. Excise Tax Limit. Notwithstanding anything in this Agreement to ---------------- the contrary, in the event it shall be determined that any payment or distribution by the Company or any other person or entity to or for the benefit of the Executive is a "parachute payment" (within the meaning of Section 280G of the Code, whether paid or payable or distributed or distributable pursuant to the terms of this Agreement or otherwise (a "Payment") in connection with, or arising out of, his employment with the Company or a change in ownership or effective control of the Company (within the meaning of Section 280G of the Code, and would be subject to the excise tax imposed by Section 4999 of the Code) (the "Excise Tax"), the Payments shall be reduced to the extent necessary so that such remaining Payment would not be subject to the excise tax imposed by Section 4999 of the Code. 12. Arbitration; Legal Fees. Except as provided in Section 9 hereof, ----------------------- any dispute or controversy arising under or in connection with this Agreement shall be settled exclusively by arbitration in Los Angeles County, California in accordance with the rules of the American Arbitration Association then in effect. Judgment may be entered on the arbitrator's award in any court having jurisdiction. The Company shall reimburse Executive for all reasonable legal fees and costs and other fees and expenses which Executive may incur in respect of any dispute or controversy arising under or in connection with this Agreement; provided, however, that the Company shall not reimburse any such fees -------- ------- costs and expenses if the fact finder determines that the action brought by the Executive was frivolous. 13. Waiver of Breach. Any waiver of any breach of this Agreement ---------------- shall not be construed to be a continuing waiver or consent to any subsequent breach on the part either of the Executive or of the Company. 14. Non-Assignment; Successors. Neither party hereto may assign his -------------------------- or its rights or delegate his or its duties under this Agreement without the prior written consent of the other party; provided, however, that: (i) this -------- ------- Agreement shall inure to the benefit of and be binding upon the successors and assigns of 10 the Company upon any sale of all or substantially all of the Company's assets, or upon any merger, consolidation or reorganization of the Company with or into any other corporation, all as though such successors and assigns of the Company and their respective successors and assigns were the Company; and (ii) this Agreement shall inure to the benefit of and be binding upon the heirs, assigns or designees of the Executive to the extent of any payments due to them hereunder. As used in this Agreement, the term "Company" shall be deemed to refer to any such successor or assign of the Company referred to in the preceding sentence. 15. Withholding of Taxes. All payments required to be made by the -------------------- Company to the Executive under this Agreement shall be subject to the withholding of such amounts, if any, relating to tax, and other payroll deductions as the Company may reasonably determine it should withhold pursuant to any applicable law or regulation. 16. Severability. To the extent any provision of this Agreement or ------------ portion thereof shall be invalid or unenforceable, it shall be considered deleted therefrom and the remainder of such provision and of this Agreement shall be unaffected and shall continue in full force and effect. 17. Director and Officer Insurance. The Company shall use its best ------------------------------ efforts to obtain and maintain director's and officer's insurance for the Executive (in such amounts as are appropriate for executives of businesses comparable to that of the Company) pursuant to Board of Directors indemnity agreements then in force and shall give timely notice to the Executive of termination of any such insurance policy. 18. Counterparts. This Agreement may be executed in one or more ------------ counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument. 19. Governing Law. This Agreement shall be construed, interpreted ------------- and enforced in accordance with the laws of the State of California, without giving effect to the choice of law principles thereof. 20. Entire Agreement. This Agreement constitutes the entire ---------------- agreement by the Company and the Executive with respect to the subject matter hereof and supersedes any and all prior 11 agreements or understandings between the Executive and the Company with respect to the subject matter hereof, whether written or oral. This Agreement may be amended or modified only by a written instrument executed by the Executive and the Company. [THIS SPACE INTENTIONALLY LEFT BLANK.] 12 IN WITNESS WHEREOF, the parties have executed this Agreement as of July 16, 1996. THE COMPANY By: /s/ Smartalk TeleServices, Inc. ----------------------------------- Smartalk TeleServices, Inc. THE EXECUTIVE /s/ Richard M. Teich ----------------------------------- Richard M. Teich 13 EX-10.10 8 STOCK OPTION PLAN EXHIBIT 10.10 AMENDED AND RESTATED 1996 NONQUALIFIED STOCK OPTION PLAN OF SMARTALK TELESERVICES, INC. -------------------------------------- ARTICLE 1. ESTABLISHMENT AND PURPOSE This Amended and Restated 1996 Nonqualified Stock Option Plan (the "Plan") is intended to promote the interests of SmarTalk TeleServices, Inc., a California corporation (the "Company"), by providing a method whereby eligible persons may be offered incentives and rewards which will encourage them to acquire a proprietary interest, or otherwise increase their proprietary interest, in the Company and continue to render services which benefit the Company. ARTICLE 2. DEFINITIONS 2.1 Board of Directors. "Board of Directors" shall mean the Board of ------------------ Directors of the Company, as constituted from time to time. 2.2 Code. "Code" shall mean the Internal Revenue Code of 1986, as ---- amended. 2.3 Change of Control. "Change of Control" shall mean a merger of the ----------------- Company with or into another corporation, or the sale of substantially all of the assets of the Company. 2.4 Committee. "Committee" shall mean a committee of the members of the --------- Board of Directors, as described in Section 3.1, or, if no such Committee has been so designated, the Board of Directors. 2.5 Date of Grant. "Date of Grant" shall mean the date on which the ------------- Committee makes a grant of an Option pursuant to this Plan. 2.6 Eligible Participant. "Eligible Participant" shall mean any person -------------------- that is an employee, officer, director, consultant, advisor or agent of the Company as permitted under the Exchange Act, the Securities Act and the Code. 2.7 Exchange Act. "Exchange Act" shall mean the Securities Exchange Act ------------ of 1934, as amended. 1 2.8 Exercisability Date. "Exercisability Date" shall have the meaning set ------------------- forth in Section 6.5(a). 2.9 Exercise Price. "Exercise Price" shall mean the aggregate amount for -------------- which the Shares may be purchased upon exercise of an Option, as specified by the Committee in the applicable Stock Option Agreement. 2.10 Exercise Term. "Exercise Term" shall have the meaning set forth in ------------- Section 6.5(b). 2.11 Expiration Date. "Expiration Date" shall have the meaning set forth --------------- in Section 6.5(b). 2.12 Fair Market Value. "Fair Market Value" shall mean ----------------- (a) If the Common Stock is listed on any established stock exchange or a national market system including, without limitation, the National Market System of the National Association of Securities Dealers, Inc. Automated Quotation ("NASDAQ") System, the Fair Market Value of a share of Common Stock shall be the closing sales price for such stock (or the closing bid, if no sales were reported) as quoted on such system or exchange (or the exchange with the greatest volume of trading in Common Stock) on the last market trading day prior to the day of determination, as reported in The Wall Street Journal or such other source as the Committee deems reliable; (b) If the Common Stock is quoted on the NASDAQ System (but not on the National Market System thereof) or is regularly quoted by a recognized securities dealer but selling prices are not reported, the Fair Market Value of a share of Common Stock shall be the mean between the high bid and low asked prices for the Common Stock on the last market trading day prior to the day of determination, as reported in The Wall Street Journal or such other source as the Committee deems reliable; (c) In the absence of an established market for the Common Stock, the Fair Market Value shall be determined in good faith by the Committee. 2.13 Full-Time Employment. "Full-Time Employment" shall mean employed to -------------------- work a weekly schedule of not less than forty (40) hours or such other schedule as the Board of Directors may establish with an Optionee pursuant to a Stock Option Agreement. 2.14 Option. "Option" shall mean a nonqualified stock option granted ------ under the Plan and entitling the Optionee to purchase any Shares. 2 2.15 Optionee. "Optionee" shall mean a person who holds an Option. -------- 2.16 Permanent Disability. "Permanent Disability" shall mean that the -------------------- Optionee is unable to substantially perform the Optionee's duties to the Company by reason of any medically determinable physical or mental impairment that can be expected to result in death or which has lasted, or can be expected to last, for a continuous period of not less than twelve (12) months. 2.17 Rule 16b-3. "Rule 16b-3" shall mean Rule 16b-3(b) (or its successor) ---------- under Section 16 of the Exchange Act. 2.18 Securities Act. "Securities Act" shall mean the Securities Act of -------------- 1933, as amended. 2.19 Share. "Share" shall mean one (1) share of Stock, as adjusted in ----- accordance with Article 8 (if applicable). 2.20 Shareholder Approval. "Shareholder Approval" shall mean the approval -------------------- of the Plan by the Company's shareholders, in compliance with Rule 16b-3. 2.21 Stock. "Stock" shall mean the voting common stock of the Company. ----- 2.22 Stock Option Agreement. "Stock Option Agreement" shall mean the ---------------------- agreement between the Company and the Optionee which contains the terms, conditions and restrictions pertaining to his or her Option. ARTICLE 3. ADMINISTRATION 3.1 Committee Membership. -------------------- (a) The Plan shall be administered by a Committee duly designated from time to time by the Board of Directors, which shall consist of two (2) or more members of the Board of Directors. If at any time the Plan should become subject to Rule 16b-3, from such time forward, and to the extent required by the provisions of Rule 16b-3, the Committee shall consist only of disinterested directors. A member of the Board of Directors is "disinterested" only if he or she satisfies such requirements as the Securities and Exchange Commission (the "Commission") may establish for disinterested administrators acting under plans intended to qualify for exemption under Rule 16b-3. The members of the Committee shall be appointed by the Board of Directors. 3 The Committee shall have such powers as specified by the Board of Directors. (b) If, at any time the Committee consists of only two (2) members and the Committee is unable to agree on the proper administration of the Plan, either, or both, of such members shall so advise the Board of Directors and the Board of Directors shall immediately appoint one of its members to serve on the Committee in accordance with Section 3.1(a) hereof. If no member of the Board of Directors is able, or willing, to serve as a member of the Committee, then the Board of Directors shall appoint a qualified individual (such qualification to be at the Board of Directors' sole determination and discretion) to serve as a consultant (the "Consultant") to the Committee and to recommend to the Board of Directors the appropriate actions to be taken in administering the Plan. The Consultant shall be appointed until such time as the Board of Directors shall appoint one of its members to serve on the Committee, at which time the Consultant's appointment shall expire. In no event shall the Consultant serve for a period in excess of sixty (60) days. 3.2 Ineligibility. No member of the Committee shall be eligible to ------------- participate in this Plan. 3.3 Committee Procedures. The Board of Directors shall designate one of -------------------- the members of the Committee as chairperson. The Committee may hold meetings at such times and places as it shall determine. The Committee shall act at a meeting by vote of a majority of the Committee members present at a meeting at which a quorum exists. The Committee may act without a meeting if all of the Committee members approve such act in writing. 3.4 Committee Responsibilities. Subject to the other provisions of this -------------------------- Plan, the Committee shall have full authority and discretion to take the following actions: (a) To interpret the Plan and to apply its provisions; (b) To adopt, amend or rescind rules, procedures and forms relating to the Plan; (c) To authorize any person to execute, on behalf of the Company, any instrument required to carry out the purposes of the Plan; (d) To determine when Options are to be granted under the Plan; 4 (e) To select the Optionees; (f) To determine the number of Shares to be made subject to each Option; (g) To prescribe the terms and conditions of each Option, including (without limitation) the vesting schedule and the Exercise Price per Share (which shall be not less than the greater of Fair Market Value on the Date of Grant or the par value of the Shares), and to specify the provisions of the Stock Option Agreement relating to such Option; (h) To amend any outstanding Stock Option Agreement, subject to applicable legal restrictions and, if the effect of such amendment(s) would be to directly, materially and adversely effect any right of an Optionee under an existing Option, subject to the consent of such Optionee; and (i) To take any other actions deemed necessary or advisable for the administration of the Plan. All decisions, interpretations and other actions of the Committee shall be final and binding on all Optionees and all persons deriving their rights from an Optionee. No member of the Committee shall be liable for any action that he or she has taken or has failed to take in good faith with respect to the Plan or any Option. 3.5 Financial Reports. Not less often than annually, the Company shall ----------------- furnish to Optionees reports of its financial condition, unless such Optionees have access to equivalent information through their employment or through public records. Such reports need not be audited. ARTICLE 4. ELIGIBILITY 4.1 Each Eligible Participant shall be eligible for designation as an Optionee by the Committee. ARTICLE 5. STOCK SUBJECT TO PLAN 5.1 Basic Limitation. The aggregate number of Shares that the Company may ---------------- issue under the Plan upon exercise of Options shall be (i) the lesser of (a) 7,087,991 Shares and (b) the number of Shares equal to 9% of the then outstanding shares of the Company's Common Stock (or securities exercisable or otherwise convertible into shares of Common Stock) minus (ii) the number of shares of Common Stock issued or issuable pursuant to options exercised or outstanding under any other stock 5 option plan of the Company, subject to adjustment pursuant to Article 8 hereof. The Shares may be authorized, but unissued, or reacquired Common Stock. The number of Shares that are subject to Options outstanding at any time under the Plan shall not exceed the number of Shares which then remain available for issuance under the Plan. The Company, during the term of the Plan, shall at all times reserve and keep available sufficient Shares to satisfy the requirements of the Plan. 5.2 Additional Shares. If any outstanding Option for any reason expires ----------------- or is canceled or otherwise terminated, the Shares allocable to the unexercised portion of such Option shall again be available for the purposes of the Plan. If the Company reacquires any Shares issued under the Plan pursuant to a forfeiture provision, a right of repurchase or a right of first refusal, such Shares shall again be available for the purposes of the Plan. ARTICLE 6. TERMS AND CONDITIONS OF OPTIONS The Committee may from time to time authorize grants of Options to Eligible Participants upon such terms and conditions as the Committee may determine in accordance with the following provisions, unless alternate provisions are agreed upon by the Committee: 6.1 Stock Option Agreement. The Company and each Optionee shall enter ---------------------- into a Stock Option Agreement that provides the terms of each grant of an Option under this Plan. The Stock Option Agreement shall be consistent with the terms and conditions of the Plan and may contain any other terms and conditions which are not inconsistent with the Plan or applicable law and which the Committee deems appropriate for inclusion in a Stock Option Agreement, and may be amended by the Committee, provided such amendments are not inconsistent with the Plan; provided, however, that if the effect of any such amendment(s) would be - -------- ------- directly, materially and adversely effect any right of an Optionee under an existing Option, the consent of such Optionee shall be required for such amendment. The provisions of the various Stock Option Agreements entered into under the Plan need not be identical. 6.2 Number of Shares. Each Stock Option Agreement shall specify the ---------------- number of Shares that are subject to the Option and shall provide for the adjustment of such number in accordance with Article 8 hereof. 6.3 Exercise Price. Each Stock Option Agreement shall specify the -------------- Exercise Price per Share. 6 6.4 Vesting. (a) Each Stock Option Agreement shall specify the time or ------- times when the Options will vest and become exercisable. A Stock Option Agreement may, in the sole discretion of the Committee, provide for accelerated exercisability (after the Exercisability Date) or vesting in the event of the Optionee's death, Permanent Disability, termination of employment without cause or retirement, or such other events as the Committee deems appropriate under the circumstances. To the extent exercisable, each Option shall be exercisable in whole or in part from time to time. (b) In the event of a Change of Control, each outstanding Option shall be assumed or an equivalent option shall be substituted by the successor corporation or a parent or subsidiary of the successor corporation. In the event that the successor corporation does not agree to assume the Option or to substitute an equivalent option, each outstanding Option shall become fully vested and exercisable, including as to Shares as to which it would not otherwise be exercisable. If an Option becomes fully vested and exercisable in the event of a Change of Control, the Board shall notify the Optionee that the Option shall be fully exercisable for a period of thirty (30) days from the date of such notice, and the Option will terminate upon the expiration of such period. 6.5 Exercise Term; Expiration Date. ------------------------------ (a) Each Stock Option Agreement shall specify the times when the Option is to become exercisable; provided, however, that no portion of the Option shall -------- ------- become exercisable within such time as (i) either (A) there has been sold or distributed to the public in one or more underwritten public offerings pursuant to one or more registration statements filed with, and declared effective by, the Commission under the Securities Act, an aggregate number of shares of the common stock of the Company representing not less than 15% of the outstanding common stock of the Company on the date of any such public offering, or (B) the Committee has resolved to waive (subject to such terms and conditions as the Committee may specify) the requirement contained in clause (A), above, and (ii) either (X) there exists on file with the Commission an effective registration statement under the Securities Act on Form S-8 or other applicable form with respect to the issuance of Shares pursuant to such Option(s), or (Y) an exemption from registration is available under the Securities Act with respect to the issuance of Shares pursuant to such Option(s) (with the date upon which items (i) and (ii) are both satisfied referred to herein as the "Exercisability Date"). At such 7 time as the Company becomes eligible for Form S-8, the Company shall use its best efforts to cause a registration statement on Form S-8 with respect to the Shares to be filed and declared effective. (b) Subject to Sections 6.7 and 6.9, below, the Committee, at its sole discretion, shall determine the date on which the period of exercisability of the vested portion of the Option (the "Exercise Term") shall expire (the "Expiration Date"). Notwithstanding anything in this Plan to the contrary, no Option granted under this Plan may be exercised more than 10 years from the Date of Grant. 6.6 Nontransferability. The Optionee shall not transfer the Option by any ------------------ means whatsoever. An Option may be exercised during the lifetime of the Optionee only by the Optionee. The term "transfer" shall include any attempt by the Optionee or any other person to assign the Option or any right or interest therein, claim any right or interest (except as otherwise set forth in Section 6.9 hereof) in the Option as a successor in interest, dispose, pledge or hypothecate the Option or any right or interest therein whether by operation of law or otherwise, or make the Option or any right or interest therein subject to sale under execution, attachment or similar process. Any attempt to transfer the Option or any right or interest therein shall be void and of no effect whatsoever. 6.7 Termination of Employment (Except by Death). If an Optionee is an ------------------------------------------- employee of the Company on the Date of Grant and the Optionee's Full-Time Employment with the Company terminates for any reason other than his or her death or Permanent Disability, then his or her vested Option(s) shall expire within ninety (90) days of such occurrence. Such an Optionee may exercise all or part of the vested portion of his or her Option(s) at any time after the Exercisability Date and before the expiration of such Option(s) under the preceding sentence, but only to the extent that such Option(s) had become exercisable before such Optionee's Full-Time Employment terminated. The unvested balance of such Option(s) shall lapse when such Optionee's Full-Time Employment terminates. 6.8 Leaves of Absence. For purposes of Section 6.7, above, for an ----------------- Optionee who is an employee of the Company, Full-Time Employment shall be deemed to continue while such Optionee is on military leave, sick leave or other bona fide leave of absence (as determined by the Committee, in its sole discretion). 6.9 Death or Permanent Disability of Optionee. If an Optionee who is an ----------------------------------------- employee of the Company dies or 8 becomes Permanently Disabled subsequent to the vesting of an Option and prior to such Option's Expiration Date, then the vested portion of his or her Option(s) shall expire on the date six (6) calendar months after his or her death or the date six (6) calendar months after such Optionee becomes Permanently Disabled. In the case of an Optionee who is not an employee of the Company and who dies or becomes Permanently Disabled subsequent to the vesting of an Option and prior to such Option's Expiration Date, the vested portion of his or her Option(s) shall expire on the date six (6) calendar months after his or her death or the date six (6) calendar months after such Optionee becomes Permanently Disabled. Notwithstanding Section 6.6 hereof, all or part of the vested portion of the Optionee's Option(s) may be exercised at any time after the Exercisability Date and before the Expiration Date of such vested portion of the Option(s) pursuant to the preceding sentence by the executors or administrators of his or her estate or by any person who has acquired such vested portion of the Option(s) directly from him or her by bequest, beneficiary designation or inheritance, but only to the extent that such vested portion of the Option(s) had become exercisable before his or her death or became exercisable as a result of her or her death. The unvested balance of such Option(s) shall lapse when the Optionee dies. 6.10 No Rights as a Stockholder. An Optionee, or a transferee of an -------------------------- Optionee, shall have no rights as a stockholder with respect to any Shares covered by his or her Option until the date of the issuance of a stock certificate for such Shares. No adjustments shall be made, except as provided in Article 8 hereof. 6.11 Modification, Extension and Assumption of Options. Within the ------------------------------------------------- limitations of the Plan, the Committee may modify, extend or assume outstanding Options or may accept the cancellation of outstanding Options (whether granted by the Company or another issuer) in return for the grant of new Options for the same or a different number of Shares and at the same or a different price. 6.12 Restrictions on Transfer of Shares. Any Shares issued upon exercise ---------------------------------- of an Option shall be subject to such special forfeiture conditions, rights of repurchase, rights of first refusal and other transfer restrictions as the Committee may determine. Such restrictions shall be set forth in the applicable Stock Option Agreement and shall apply, in addition to any general restrictions that may apply, to all holders of Shares. 9 6.13 Nonqualified Options. All Options granted pursuant to this Plan -------------------- shall be options that are not intended to be qualified incentive stock options under Section 422 of the Code. ARTICLE 7. PAYMENT FOR SHARES 7.1 General Rule. The entire Exercise Price of Shares issued under the ------------ Plan shall be payable in lawful money of the United States or by check acceptable to the Company. However, the Committee, in its sole discretion, may accept payment in the form described in Section 7.2, below. 7.2 Surrender of Stock. To the extent that applicable law permits, an ------------------ Optionee may pay for Shares with Shares owned by the Optionee for more than six months having a value at the time of exercise equal to the total Exercise Price. The Optionee must surrender the Shares to the Company in good form for transfer. Such Shares will be valued at their Fair Market Value on the date when the new Shares are purchased under the Plan. Upon the full or partial payment of the Exercise Price by the transfer to the Company of Shares or upon satisfaction of tax withholding provisions in connection with any such exercise or any other payment made or benefit realized under this Plan by the transfer or relinquishment of Shares, there shall be deemed to have been issued or transferred under this plan only the net number of Shares actually issued or transferred by the Company less the number of Shares so transferred or relinquished. ARTICLE 8. ADJUSTMENT OF SHARES 8.1 Adjustment. The Committee may make or provide for such adjustments in ---------- the (a) number of Shares covered by outstanding Options granted hereunder, and (b) Exercise Price per Share applicable to such Options (provided that the Exercise Price per Share as adjusted pursuant to this Section 8 shall not be less than the greater of Fair Market Value on the Date of Grant or the par value of the Shares), as the Committee in its sole discretion may in good faith and in its sole discretion determine to be equitably required in order to prevent dilution or enlargement of the rights of Eligible Participants that otherwise would result from (x) any stock dividend, stock split, combination of shares, recapitalization or other change in the capital structure of the Company, (y) any merger, consolidation, reorganization, partial or complete liquidation or other distribution of assets, issuance of rights or warrants to purchase securities or (z) any other corporate transaction 10 or event having an effect similar to any of the foregoing. In the event of any such transaction or event, the Committee may provide in substitution for any or all outstanding awards under this Plan such alternative consideration as it may in good faith determine to be equitable under the circumstances and may require in connection therewith the surrender of all awards so replaced. The Committee may also make or provide for such adjustments in the number of Shares available for future grants under Article 5 of the Plan as the Committee in its sole discretion may in good faith determine to be appropriate in order to reflect any transaction or event described in this Section 8. ARTICLE 9. SECURITIES LAW MATTERS 9.1 Shares shall not be issued under the Plan unless the issuance and delivery of such Shares complies with (or is exempt from) all applicable requirements of law, including (without limitation) the Securities Act, the rules and regulations promulgated thereunder, state securities laws and regulations, and the regulations of any stock exchange on which the Company's securities may then be listed. Without limiting the foregoing, the Company may require any Optionee, as a condition of receiving an Option, to give written assurances in substance and form satisfactory to the Company and its counsel to the effect that such person is acquiring the Shares subject to the Options for his own account for investment and not with any current intention of selling or otherwise distributing the same, and to such other effects as the Company deems necessary or appropriate in order to comply with federal and applicable state securities laws. Certificates representing Shares issued upon the exercise of any Option shall bear such legends as the Committee, in its sole discretion, deems appropriate to reflect any restrictions on the transfer of the Shares under any applicable federal or state securities laws. 9.2 If at any time the Plan should become subject to Rule 16b-3, from such time forward, and to the extent required by Rule 16b-3, the provisions of this Plan are intended to qualify for exemption under Rule 16b-3, and any provision of this Plan shall be construed consistent with the applicability, interpretation and scope of Rule 16b-3. ARTICLE 10. TAX MATTERS 10.1 Withholding Taxes. To the extent that the Company is required ----------------- to withhold federal, state, local or foreign taxes in connection with any payment made or 11 benefit realized by an Eligible Participant or other person under this Plan, and the amounts available to the Company for such withholding are insufficient, it shall be a condition to the receipt of such payment or the realization of such benefit that the Eligible Participant or such other person make arrangements satisfactory to the Company for payment of the balance of such taxes required to be withheld. At the discretion of the Committee, such arrangements may include relinquishment of a portion of such benefit. The Company and any Eligible Participant or such other person may also make similar arrangements with respect to the payment of any taxes with respect to which withholding is not required. ARTICLE 11. EMPLOYMENT RIGHTS 11.1 No Employment Right. No provision of the Plan, nor any Option ------------------- granted under the Plan, shall be construed to give any person currently in the employ of the Company any right to continue in such employ. Subject to any written employment agreement between the Company and any Optionee who is an employee of the Company providing to the contrary, the Company reserves the right to terminate any such person's employment at any time and for any reason. ARTICLE 12. DURATION AND AMENDMENTS 12.1 Term of the Plan. The Plan shall become effective on the date ---------------- of its adoption by the Board of Directors. The Plan shall terminate automatically ten years after its adoption by the Board of Directors and may be terminated on any earlier date pursuant to Section 12.2 below. 12.2 Right to Amend or Terminate the Plan. The Board of Directors ------------------------------------ may amend, suspend or terminate the Plan at any time and for any reason. However, if at any time the Plan should become subject to Rule 16b-3, from such time forward, and to the extent required by the provisions of Rule 16b-3, any amendment which would materially (1) increase the benefits accruing to participants under the Plan, (2) increase the number of shares which may be issued under the Plan, or (3) modify the requirements as to eligibility for participation in the Plan, must be approved by the Company's shareholders pursuant to the requirements the Commission may establish for plans intended to qualify for exemption under Rule 16b-3, and no such amendment shall cause Rule 16b-3 to cease to be applicable to this Plan. 12.3 Effect of Amendment or Termination. No Shares shall be issued ---------------------------------- under the Plan after the termination 12 thereof, except upon exercise of an Option granted prior to such termination. The termination of the Plan, or any amendment thereof, shall not affect any Share previously issued or any Option previously granted under the Plan. 12.4 Conflict. If there is any conflict between the terms of an -------- Option Agreement and the terms of the Plan, the terms of the Plan shall control. ARTICLE 13. MISCELLANEOUS 13.1 Governing Law. The Plan shall be governed by and construed in ------------- accordance with the laws, including conflicts of laws, of the State of California. 13 EX-10.11 9 STOCK INCENTIVE PLAN EXHIBIT 10.11 SMARTALK TELESERVICES, INC. 1996 STOCK INCENTIVE PLAN 1. PURPOSE OF THE PLAN The purpose of the SmarTalk TeleServices Inc. 1996 Stock Incentive Plan is to promote the interests of the Company and its shareholders by strengthening the Company's ability to attract, motivate and retain employees, advisors, directors and consultants of the Company, and to provide a means to encourage stock ownership and a proprietary interest in the Company by employees, advisors, directors and consultants to the Company upon whose judgment, initiative, and efforts the financial success and growth of the business of the Company largely depend. 2. DEFINITIONS (a) "Award" means an award of an Option, Restricted Stock, Stock Appreciation Right, Performance Award or Phantom Stock granted under the Plan. (b) "Award Agreement" means an agreement entered into between the Company and a Participant setting forth the terms and conditions of an Award granted to a Participant. (c) "Board" means the Board of Directors of the Company. (d) "Change of Control" shall be deemed to occur upon a merger of the Company with or into another corporation, or the sale of substantially all of the assets of the Company. (e) "Code" means the Internal Revenue Code of 1986, as amended. (f) "Committee" means the Compensation Committee of the Board, unless the Board appoints another committee to administer the Plan under Section 4 hereof. (g) "Common Stock" means the no par value common stock of the Company. (h) "Company" means SmarTalk TeleServices, Inc., a California corporation. (i) "Date of Grant" means the date on which an Award under the Plan is made by the Committee, or such later date as the Committee may specify that the Award becomes effective. (j) "Eligible Person" means an Employee, advisor, director and consultant of the Company or any of its Subsidiaries. (k) "Employee" means any person who is an employee of the Company or of any of its Subsidiaries. (l) "Exchange Act" means the Securities Exchange Act of 1934, as amended. (m) "Fair Market Value" means (i) If the Common Stock is listed on any established stock exchange or a national market system including, without limitation, the National Market System of the National Association of Securities Dealers, Inc. Automated Quotation ("NASDAQ") System, the Fair Market Value of a share of Common Stock shall be the closing sales price for such stock (or the closing bid, if no sales were reported) as quoted on such system or exchange (or the exchange with the greatest volume of trading in Common Stock) on the last market trading day prior to the day of determination, as reported in The Wall Street Journal or such other source as the Committee deems reliable; (ii) If the Common Stock is quoted on the NASDAQ System (but not on the National Market System thereof) or is regularly quoted by a recognized securities dealer but selling prices are not reported, the Fair Market Value of a share of Common Stock shall be the mean between the high bid and low asked prices for the Common Stock on the last market trading day prior to the day of determination, as reported in The Wall Street Journal or such other source as the Committee deems reliable; (iii) In the absence of an established market for the Common Stock, the Fair Market Value shall be determined in good faith by the Committee. (n) "Incentive Stock Option" means an option to purchase Common Stock that is intended to qualify under section 422 of the Code and the Treasury Regulations thereunder. (o) "Nonqualified Stock Option" means an option to purchase Common Stock that is not an Incentive Stock Option. 2 (p) "Option" means an Incentive Stock Option or a Nonqualified Stock Option granted under Section 6 hereof. (q) "Participant" means any Eligible Person who has received an Award under the Plan. (r) "Permanent Disability" shall mean that the Participant is unable to substantially perform the Participant's duties to the Company by reason of any medically determinable physical or mental impairment that can be expected to result in death or which has lasted, or can be expected to last, for a continuous period of not less than twelve (12) months. (s) "Phantom Stock" means an Award under Section 10 hereof entitling a Participant to a payment at the end of a vesting period of a unit value based on the Fair Market Value of a share of Common Stock. (t) "Plan" means the 1996 Stock Incentive Plan as set forth herein, as it may be amended from time to time. (u) "Performance Award" means an Award made under Section 9 hereof entitling a Participant to a payment based on the value of Common Stock (a "Performance Share") or based on specified dollar units (a "Performance Unit") at the end of a performance period if certain conditions as may be established by the Committee are satisfied. (v) "Restricted Stock" means an Award under Section 8 hereof entitling a Participant to shares of Common Stock that are nontransferable and subject to forfeiture until specific conditions established by the Committee are satisfied. (w) "Stock Appreciation Right" or "SAR" means an Award under Section 7 hereof entitling a Participant to receive an amount, representing the difference between the base price per share of the right and the Fair Market Value of a share of Common Stock on the date of exercise. (x) "Subsidiary" means a subsidiary corporation of the Company, within the meaning of section 424(f) of the Code. 3. SHARES OF COMMON STOCK SUBJECT TO THE PLAN 3.1 Number of Shares. Subject to the following provisions of this Section ---------------- 3, the aggregate number of shares of Common Stock that may be issued or transferred or exercised pursuant to Awards under the Plan is (i) the lesser of (a) 7,087,991 shares of Common Stock and (b) the 3 number of shares equal to 9% of the then outstanding shares of Common Stock minus (ii) the number of shares of Common Stock issued or issuable pursuant to options exercised or outstanding under the Company's 1996 Nonqualified Stock Option Plan. The shares of Common Stock to be delivered under the Plan will be made available, at the discretion of the Board or the Committee, either from authorized but unissued shares of Common Stock or from shares of Common Stock held in the Company's treasury. If any share of Common Stock that is the subject of an Award is not issued or transferred and ceases to be issuable or transferable for any reason, such share of Common Stock will no longer be charged against such maximum share limitation and may again be made subject to Awards under the Plan. 3.2 Adjustments. If there shall occur any recapitalization, ----------- reclassification, stock dividend, stock split, reverse stock split or other distribution with respect to the shares of Common Stock, or any similar corporate transaction or event in respect of the Common Stock, then the Committee shall, in the manner and to the extent that it deems appropriate and equitable to the Participants and consistent with the terms of this Plan, cause a proportionate adjustment to be made in (i) the maximum number and kind of shares provided in Section 3.1 hereof, (ii) the number and kind of shares, units, or other securities subject to the then outstanding Awards, (iii) the price for each share or unit or other right subject to then outstanding Awards without change in the aggregate purchase price or value as to which such Awards remain exercisable or subject to restrictions, (iv) the performance targets or goals appropriate to any other outstanding Performance Awards, or (v) any other terms that are affected by the event. 4. ADMINISTRATION OF THE PLAN 4.1 Committee Members. The Plan will be administered by the Committee, ----------------- which will consist of two or more persons who satisfy the requirements for a "non-employee director" under Rule 16b-3 promulgated under section 16 of the Exchange Act. The Committee has and may exercise such powers and authority of the Board as may be necessary or appropriate for the Committee to carry out its functions as described in the Plan. No member of the Board nor the Committee will be liable for any action or determination made in good faith by the Board or the Committee with respect to the Plan or any Award under it. 4.2 Discretionary Authority. Subject to the express limitation of the ----------------------- Plan, the Committee has authority in its discretion to determine the Eligible Persons to whom, and 4 the time or times at which, Awards may 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 an Award will become vested, exercisable or payable and the duration of the Award. The Committee also has discretionary authority to interpret the Plan, to make all factual determinations under the Plan, and to determine the terms and provisions of the respective Award Agreements and to make all other determinations necessary or advisable for Plan administration. The Committee has authority to prescribe, amend, and rescind rules and regulations relating to the Plan. All interpretations, determinations, and actions by the Committee will be final, conclusive, and binding upon all parties. 4.3 Changes to Awards. The Committee shall have the authority to effect, ----------------- at any time and from time to time, with the consent of the affected Participants, (i) the cancellation of any or all outstanding Awards and the grant in substitution therefor of new Awards covering the same or different numbers of shares of Common Stock and having an exercise or base price which may be the same as or different than the exercise or base price of the cancelled Awards or (ii) the amendment of the terms of any and all outstanding Awards. The Committee may in its discretion accelerate the vesting or exercisability of an Award at any time. 4.4 Financial Reports. Not less often than annually, the Company ----------------- shall furnish to Participants reports of its financial condition, unless such Participants have access to equivalent information through their employment or through public records. Such reports need not be audited. 5. ELIGIBILITY AND AWARDS All Eligible Persons are eligible to be designated by the Committee to receive an Award under the Plan. The Committee has authority, in its sole discretion, to determine and designate from time to time those Eligible Persons who are to be granted Awards, and the type and amount of Award to be granted. Each Award will be evidenced by an Award Agreement as described in Section 11 hereof between the Company and the Participant that may include any terms and conditions consistent with the Plan as the Committee may determine. 5 6. STOCK OPTIONS 6.1 Grant of Option; Exercise Price. An Option may be granted to any ------------------------------- Eligible Person selected by the Committee; provided, however, that only -------- ------- Employees meeting the requirements of Treasury Regulation (S) 1.421-7(h) shall be eligible for Awards of Incentive Stock Options. Each Option shall be designated, at the discretion of the Committee, as an Incentive Stock Option or a Nonqualified Stock Option. The exercise price of the Option shall be determined by the Committee; provided, however, that the exercise price of an -------- ------- Incentive Stock Option shall not be less than 100 percent of the Fair Market Value of the Common Stock subject to the Option on the Date of Grant. 6.2 Vesting; Term of Option. The Committee, in its sole discretion, shall ----------------------- prescribe in the Award Agreement for a Participant the time or times at which an Option or portion thereof shall become vested and exercisable, and may accelerate the exercisability of any Option at any time. Notwithstanding the foregoing, all such Options shall vest at a rate of at least 20 percent per year over five years from the Date of Grant. An Option may become vested and exercisable upon a Participant's retirement, death disability or other event to the extent provided in an Award Agreement. The period during which a vested Option may be exercised shall be ten years from the Date of Grant, unless a shorter exercise period is specified by the Committee in an Award Agreement. 6.3 Vesting; Change of Control. In the event of a Change of Control, each -------------------------- outstanding Option shall be assumed or an equivalent option shall be substituted by the successor corporation or a parent or subsidiary of the successor corporation. In the event that the successor corporation does not agree to assume the Option or to substitute an equivalent option, each outstanding Option shall become fully vested and exercisable, including as to Shares as to which it would not otherwise be exercisable. If an Option becomes fully vested and exercisable in the event of a Change of Control, the Board shall notify the Optionee that the Option shall be fully exercisable for a period of thirty (30) days from the date of such notice, and the Option will terminate upon the expiration of such period. 6.4 Option Exercise; Withholding. An Option may be exercised in whole or ---------------------------- in part at any time, with respect to whole shares only, within the period permitted for the exercise thereof, and shall be exercised by written notice of intent to exercise the Option with respect to a specified number of shares delivered to the Company at its 6 principal office, and payment in full to the Company at said office of the amount of the exercise price for the number of shares of the Common Stock with respect to which the Option is then being exercised. Payment of the exercise price shall be made (i) in cash or by cash equivalent, (ii) at the discretion of the Committee, in Common Stock (not subject to limitations on transfer) valued at the Fair Market Value of such shares on the trading date immediately preceding the date of exercise or (iii) at the discretion of the Committee, by a combination of such cash and such Common Stock. In addition to and at the time of payment of the exercise price, the Participant shall pay to the Company in cash or, at the discretion of the Committee, in Common Stock the full amount of all federal and state withholding and other employment taxes applicable to the taxable income of such Participant resulting from such exercise. 6.5 Effect of Termination of Employment. ----------------------------------- (a) Except by Death or Disability. If a Participant is an Employee of the ----------------------------- Company on the Date of Grant and the Participant's full-time employment with the Company terminates for any reason other than his or her death or Permanent Disability, then his or her vested Option(s) shall expire within ninety (90) days of such occurrence. Such a Participant may exercise all or part of the vested portion of his or her Option(s) at any time after the date on which such Option(s) may be exercised and before the expiration of such Option(s) under the preceding sentence, but only to the extent that such Option(s) had become exercisable before such Participant's full-time employment terminated. The unvested balance of such Option(s) shall lapse when such Participant's full-time employment terminates. (b) Death or Permanent Disability. If a Participant who is an Employee of ----------------------------- the Company dies or becomes Permanently Disabled subsequent to the vesting of an Option and prior to the expiration date of such Option, then the vested portion of his or her Option(s) shall expire on the date six (6) calendar months after his or her death or the date six (6) calendar months after such Participant becomes Permanently Disabled. In the case of a Participant who is not an Employee of the Company and who dies or becomes Permanently Disabled subsequent to the vesting of an Option and prior to the expiration date of such Option, the vested portion of his or her Option(s) shall expire on the date six (6) calendar months after his or her death or the date six (6) calendar months after such Participant becomes Permanently Disabled. 7 Notwithstanding the provisions of Section 13.1, below, all or part of the vested portion of the Participant's Option(s) may be exercised at any time after the Option(s) become exercisable and before the expiration date of such vested portion of the Option(s) pursuant to the preceding sentence by the executors or administrators of his or her estate or by any person who has acquired such vested portion of the Option(s) directly from him or her by bequest, beneficiary designation or inheritance, but only to the extent that such vested portion of the Option(s) had become exercisable before his or her death or became exercisable as a result of her or her death. The unvested balance of such Option(s) shall lapse when the Participant dies. 6.6 Additional Rules for Incentive Stock Options. -------------------------------------------- (a) Annual Limits. No Incentive Stock Option shall be granted to a ------------- Participant as a result of which the aggregate fair market value (determined as of the Date of Grant) of the stock with respect to which incentive stock options are exercisable for the first time in any calendar year under the Plan, and any other stock option plans of the Company, any Subsidiary or any parent corporation, would exceed $100,000, determined in accordance with section 422(d) of the Code. This limitation shall be applied by taking options into account in the order in which granted. (b) Termination of Employment. Any Incentive Stock Option granted under ------------------------- the Plan shall be subject to such limitations on the period of exercise following termination of employment, including such special rules relating to death and disability, as shall be determined by the Committee to be consistent with section 422 of the Code and Treasury Regulations thereunder and set forth in the applicable Award Agreement. (c) Ten-Percent Owners. Notwithstanding any other provisions of this Plan ------------------ to the contrary, in the case of an Incentive Stock Option granted to an Employee who, at the time an Incentive Stock Option is granted, owns stock possessing more than ten percent of the total combined voting power of all classes of stock of the Company, its parent, if any, or any Subsidiary, as determined under sections 422(b)(6) and 424(d) of the Code, (i) the period during which any such Incentive Stock Option may be exercised shall not be greater than five years from the Date of Grant and (ii) the exercise price of such Incentive Stock Option shall not be less than 110 percent of the Fair Market Value of a share of Common Stock on the Date of Grant. 8 (d) Disqualifying Dispositions. If shares of Common Stock acquired by -------------------------- exercise of an Incentive Stock Option are disposed of within two years following the Date of Grant or one year following the transfer of such shares to the Participant upon exercise, the Participant shall, promptly following such disposition, notify the Company in writing of the date and terms of such disposition and provide such other information regarding the disposition as the Committee may reasonably require. 7. STOCK APPRECIATION RIGHTS 7.1 Grant of SARs. A Stock Appreciation Right granted to a Participant is ------------- an Award in the form of a right to receive, upon surrender of the right, but without other payment, an amount based on appreciation in the value of the Common Stock over a base price established for the Award, payable in cash, Common Stock or such other form or combination of forms of payout, exercisable at such time or times and upon conditions as may be approved by the Committee. 7.2 Tandem SARs. 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. An SAR granted in connection with an Option will entitle the holder, upon exercise, to surrender such Option or any portion thereof to the extent unexercised, with respect to the number of shares as to which such SAR is exercised, and to receive payment of an amount computed as described below. Such Option will, to the extent and when surrendered, cease to be exercisable. An SAR granted in connection with an Option hereunder will be exercisable at such time or times, and only to the extent, that a related Option is exercisable, and will expire no later than the related Option expires. Upon the exercise of an SAR granted in connection with an Option, the holder will be entitled to receive payment of an amount determined by multiplying: (i) the difference between the exercise price of a share of Common Stock specified in the related Option and the Fair Market Value of a share of Common Stock on the date of exercise of such SAR, by (ii) the number of shares as to which such SAR will have been exercised. 7.3 Freestanding SARs. A Stock Appreciation Right may be granted without ----------------- relationship to an Option and, in such case, will be exercisable as determined by the Committee, but in no event after 10 years from the Date of Grant. The base price of an SAR granted without relationship to an Option shall be determined by the Committee in its sole discretion. An SAR granted without relationship to an Option will entitle the holder, upon 9 exercise of the SAR, to receive payment of an amount determined by multiplying: (i) the difference between the base price of the SAR and the Fair Market Value of a share of Common Stock on the date of exercise of such SAR, by (ii) the number of shares as to which such SAR will have been exercised. 7.4 Payment of SARs. Payment of the amount determined under Section 7.2 --------------- or 7.3 hereof may be made, in the discretion of the Committee, in cash, in shares of Common Stock valued at their Fair Market Value on the date of exercise or in a combination of cash and shares of Common Stock. 8. RESTRICTED STOCK 8.1 Grants of Restricted Stock. An award of Restricted Stock to a -------------------------- Participant represents shares of Common Stock that are issued subject to restrictions on transfer and such other restrictions on incidents of ownership and forfeiture conditions as the Committee may determine. The restrictions imposed upon Restricted Stock will lapse in accordance with a schedule or other conditions as determined by the Committee. The Committee may, in connection with an award of Restricted Stock, require the payment of a specified purchase price. 8.2 Restrictions. Shares of Restricted Stock may not be transferred, ------------ assigned or subject to any encumbrance, pledge or charge until all applicable restrictions are removed or expire or unless otherwise allowed by the Committee. The Committee may require the Participant to enter into an escrow agreement providing that the certificates representing Restricted Stock granted or sold pursuant to the Plan will remain in the physical custody of an escrow holder until all restrictions are removed or expire. Each certificate representing Restricted Stock granted pursuant to the Plan will bear a legend making appropriate reference to the restrictions imposed. The Committee may impose such conditions on any shares of Restricted Stock as it may deem advisable, including, without limitation, restrictions under the Securities Act of 1933, as amended, under the requirements of any stock exchange upon which such shares of the same class are then listed, and under any blue sky or other securities laws applicable to such shares. 8.3 Rights as Stockholder. Subject to the foregoing provisions of this --------------------- Section 8 and the applicable Award Agreement, Section 8.1 hereof, the holder will have all rights of a shareholder with respect to shares of Restricted Stock granted to him or her, including the right 10 to vote the shares and receive all dividends and other distributions paid or made with respect thereto, unless the Committee determines otherwise at the time the Restricted Stock is granted. 8.4 Section 83(b) Election. If a Participant makes an election pursuant ---------------------- to section 83(b) of the Code, the Participant shall be required to promptly file a copy of such election with the Company. 9. PERFORMANCE AWARDS 9.1 Grant of Performance Awards. The Committee may grant Performance --------------------------- Awards, which shall be denominated on the Date of Grant either in shares of Common Stock (Performance Shares) or in specified dollar units (Performance Units). At the time of a Performance Award grant, the Committee shall determine, in its sole discretion, one or more performance periods and performance goals to be achieved during the applicable performance periods, as well as such other restrictions and conditions as the Committee deems appropriate. In the case of Performance Units, the Committee shall also determine a target unit value or a range of unit values for each Award. No performance period shall exceed ten years from the date of the grant. The performance goals applicable to a Performance Award grant may be subject to such later revisions as the Committee shall deem appropriate to reflect significant unforeseen events such as changes in law, accounting practices or unusual or nonrecurring items or occurrences. 9.2 Payment of Performance Awards. At the end of the performance period, ----------------------------- the Committee shall determine the extent to which performance goals have been attained or a degree of achievement between maximum and minimum levels in order to establish the level of payment to be made, if any, and shall determine if payment is to be made in the form of cash or Common Stock (valued at its Fair Market Value at the time of payment) or a combination of cash and Common Stock. In the case of Performance Shares, the Committee may provide that during a performance period a Participant shall be paid with respect to each Performance Share a cash amount in the same amount and at the same time as a dividend is paid on a share of Common Stock. 10. PHANTOM STOCK 10.1 Grant of Phantom Stock. Phantom Stock is an Award to a Participant of ---------------------- a number of hypothetical share units with respect to shares of Common Stock, with an initial value based on the Fair Market Value of the Common Stock on the Date of Grant. Phantom Stock shall be subject 11 to such restrictions and conditions as the Committee shall determine. On the Date of Grant, the Committee shall determine, in its sole discretion, the vesting period of the Phantom Stock and the maximum value of the Phantom Stock, if any. No vesting period shall exceed 10 years from the date of the grant. 10.2 Payment of Phantom Stock. At the end of the vesting period applicable ------------------------ to Phantom Stock granted to a Participant, a cash amount equivalent 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 determined by the Committee at the time of grant, shall be paid with respect to each such Phantom Stock unit to the Participant. The Committee may provide that during the vesting period a Participant shall be paid with respect to each Phantom Stock unit, cash amounts in the same amount and at the same time as a dividend on a share of Common Stock. 11. AWARD AGREEMENTS 11.1 Form of Agreement. Each Award under this Plan shall be evidenced by ----------------- an Award Agreement in a form approved by the Committee setting forth the number of shares of Common Stock, units or other rights (as applicable) subject to the Award, the exercise, base or purchase price (if any) of the Award, the time or times at which an Award will become vested, exercisable or payable, the duration of the Award and, in the case of Performance Awards, the applicable performance goals. The Award Agreement shall also set forth other material terms and conditions applicable to the Award as determined by the Committee consistent with the limitations of this Plan. 11.2 Termination of Employment. The Award Agreements may include ------------------------- provisions describing the treatment of an Award in the event of the retirement, disability, death or other termination of a Participant's employment with or other services to the Company, including any provisions relating to the vesting, exercisability, acceleration, forfeiture or cancellation of the Award in these circumstances, including such provisions as required for Incentive Stock Options pursuant to Section 6.4(b) thereof. 11.3 Contract Rights. Any obligation of the Company to any Participant ---------------- with respect to an Award shall be based solely upon contractual obligations created by this Plan and an Award Agreement. No Award shall be enforceable until the Award Agreement or a receipt has been signed by the Participant and on behalf of the Company by its authorized representative. By executing the Award 12 Agreement or receipt, a Participant shall be deemed to have accepted and consented to the terms of this Plan and any action taken in good faith under this Plan by and within the discretion of the Committee, the Board of Directors or their delegates. 12. EFFECTIVE DATE, TERMINATION AND AMENDMENT 12.1 Effective Date. The Plan shall become effective on the date of its -------------- adoption by the Board; provided, however, that no Incentive Stock Option shall -------- ------- be exercisable by a Participant unless and until the Plan shall have been approved by the stockholders of the Company, which approval shall be obtained within 12 months before or after the adoption of the Plan by the Board. 12.2 Termination. The Plan shall terminate on the date immediately ----------- preceding the tenth anniversary of the earlier of the date the Plan is adopted by the Board or the date the Plan is approved by the Company's stockholders. The Board may, in its sole discretion and at any earlier date, terminate the Plan. Notwithstanding the foregoing, no termination of the Plan shall in any manner affect any Award theretofore granted without the consent of the Participant or the permitted transferee of the Award. 12.3 Amendment. The Board may at any time and from time to time and in any --------- respect, amend or modify the Plan. Notwithstanding the foregoing, no amendment or modification of the Plan shall in any manner affect any Award theretofore granted without the consent of the Participant or the permitted transferee of the Award. 13. GENERAL PROVISIONS 13.1 Non-assignability. Awards under the Plan shall not be assignable nor ----------------- transferable, except by will or by the laws of descent and distribution, and during the lifetime of a Participant the Award shall be exercised only by such Participant or by his or her guardian or legal representative. 13.2 Rights as Stockholder. A Participant shall have no rights as a holder --------------------- of Common Stock with respect to any unissued securities covered by an Award until the date the Participant becomes the holder of record of these securities. Except as provided in Section 3.2 hereof, no adjustment or other provision shall be made for dividends or other stockholder rights, except to the extent that the Award Agreement provides for dividend payments or similar economic benefits. 13 13.3 Employment. Nothing in the Plan, in the grant of any Award or in any ---------- Award Agreement shall confer upon any Eligible Person the right to continue in the capacity in which he is employed by or otherwise serves the Company or any Subsidiary. 13.4 Securities Laws. No shares of Common Stock will be issued or --------------- transferred pursuant to an Award unless and until all then applicable requirements imposed by federal and state securities and other laws, rules and regulations and by any regulatory agencies having jurisdiction, and by any stock exchanges upon which the Common Stock may be listed, have been fully met. As a condition precedent to the issuance of shares pursuant to the grant or exercise of an Award, the Company may require the Participant to take any reasonable action to meet such requirements. 13.5 Tax Withholding. The Participant shall be responsible for payment of --------------- any taxes or similar charges required by law to be withheld from an Award or an amount paid in satisfaction of an Award and these obligations shall be paid by the Participant on or prior to the payment of the Award. The Award Agreement shall specify the manner in which the withholding obligation shall be satisfied with respect to the particular type of Award. 13.6 Other Compensation and Benefit Plans. The adoption of the Plan shall ------------------------------------ not affect any other stock incentive or other compensation plans in effect for the Company or any Subsidiary, nor shall the Plan preclude the Company from establishing any other forms of stock incentive or other compensation for employees of the Company or any Subsidiary. The amount of any compensation deemed to be received by Participant pursuant to an Award shall not constitute compensation with respect to which any other employee benefits of such Participant are determined, including, without limitation, benefits under any bonus, pension, profit sharing, life insurance or salary continuation plan, except as otherwise specifically provided by the terms of such plan. 13.7 Plan Binding on Successors. The Plan shall be binding upon the -------------------------- Company, its successors and assigns, and the Participant, his or her executor, administrator and permitted transferees. 13.8 Construction and Interpretation. Whenever used herein, nouns in the ------------------------------- singular shall include the plural, and the masculine pronoun shall include the feminine gender. Headings of Articles and Sections hereof are inserted for convenience and reference and constitute no part of the Plan. 14 13.9 Severability. If any provision of the Plan or any Award Agreement ------------ shall be determined to be illegal or unenforceable by any court of law in any jurisdiction, the remaining provisions hereof and thereof shall be severable and enforceable in accordance with their terms, and all provisions shall remain enforceable in any other jurisdiction. 13.10 Governing Law. The validity and construction of this Plan and of ------------- the Award Agreements shall be governed by the laws of the State of California. ------------------ 15 This SmarTalk TeleServices, Inc. 1996 Stock Incentive Plan was duly adopted and approved by the Board of Directors of this SmarTalk TeleServices, Inc. on the 15th day of August, 1996. /s/ Glen Andrew Folck - ---------------------------------------------------- [Assistant Secretary] of SmarTalk TeleServices, Inc. This SmarTalk TeleServices, Inc. 1996 Stock Incentive Plan was duly approved by the stockholders of this SmarTalk TeleServices, Inc. on the 15th day of August, 1996. /s/ Glen Andrew Folck - ---------------------------------------------------- [Assistant Secretary] of SmarTalk TeleServices, Inc. 16 EX-10.14B 10 SECOND AGREEMENT TO CARRIER AGREEMENT EXHIBIT 10.14B Second Amendment to Carrier Agreement dated September 9, 1996 between SmarTalk TeleServices, Inc. and MCI Telecommunications Corporation.* - ------------------------------ * Confidential treatment has been requested. The copy filed as an exhibit omits information subject to the confidentiality request. EX-10.19 11 BUSINESS ALLIANCE AGREEMENT EXHIBIT 10.19 Business Alliance Agreement between Pacific Bell and the Company, dated May 24, 1996.* - ------------------------------ * Confidential treatment has been requested. The copy filed as an exhibit omits information subject to the confidentiality request. EX-10.20 12 CARRIER REFERRAL PROGRAM AGREEMENT EXHIBIT 10.20 Prepaid Carrier Referral Program Agreement between MCI Telecommunications Corporation and the Company, dated June 21, 1996.* - ------------------------------ * Confidential treatment has been requested. The copy filed as an exhibit omits information subject to the confidentiality request. EX-10.21 13 WHOLESALE DISTRIBUTION AGREEMENT EXHIBIT 10.21 Wholesale Distribution Agreement between Western Interactive Corporation and the Company, dated June 1, 1996.* - ------------------------------ * Confidential treatment has been requested. The copy filed as an exhibit omits information subject to the confidentiality request. EX-10.22 14 LOAN AGREEMENT EXHIBIT 10.22 [LOGO OF SOUTHERN CALIFORNA BANK APPEAR HERE] LOAN AGREEMENT BORROWER: SMARTALK TELESERVICES, INC. (TIN: 95--4502740) LENDER: SOUTHERN CALIFORNIA BANK 1640 S. SEPULVEDA BLVD., STE. 500 HEAD OFFICE - DOWNEY MAIN LOS ANGLES, CA 90025 10990 DOWNEY AVENUE DOWNEY, CA 90240-2296 ====================================================================================================================================
THIS LOAN AGREEMENT BETWEEN SMARTALK TELESERVICES, INC. ("BORROWER") AND SOUTHERN CALIFORNIA BANK ("LENDER") IS MADE AND EXECUTED ON THE FOLLOWING TERMS AND CONDITIONS. BORROWER HAS RECEIVED PRIOR COMMERCIAL LOANS FROM LENDER OR HAS APPLIED TO LENDER FOR A COMMERCIAL LOAN OR LOANS AND OTHER FINANCIAL ACCOMMODATIONS, INCLUDING THOSE WHICH MAY BE DESCRIBED ON ANY EXHIBIT OR SCHEDULE ATTACHED TO THIS AGREEMENT. ALL SUCH LOANS AND FINANCIAL ACCOMMODATIONS, TOGETHER WITH ALL FUTURE LOANS AND FINANCIAL ACCOMMODATIONS FROM LENDER TO BORROWER, ARE REFERRED TO IN THIS AGREEMENT INDIVIDUALLY AS THE "LOAN" AND COLLECTIVELY AS THE "LOANS." BORROWER UNDERSTANDS AND AGREES THAT: (A) IN GRANTING, RENEWING, OR EXTENDING ANY LOAN, LENDER IS RELYING UPON BORROWER'S REPRESENTATIONS, WARRANTIES, AND AGREEMENTS, AS SET FORTH IN THIS AGREEMENT; (B) THE GRANTING, RENEWING, OR EXTENDING OF ANY LOAN BY LENDER AT ALL TIMES SHALL BE SUBJECT TO LENDER'S SOLE JUDGMENT AND DISCRETION; AND (C) ALL SUCH LOANS SHALL BE AND ALL SHALL REMAIN SUBJECT TO THE FOLLOWING TERMS AND CONDITIONS OF THIS AGREEMENT. TERM. This Agreement shall be effective as of SEPTEMBER 18, 1996 and shall continue thereafter until all indebtedness of Borrower to Lender has been performed in full and the parties terminate this Agreement in writing. DEFINITIONS. The following words shall have the following meanings when used in this Agreement. Terms not otherwise defined in this Agreement shall have the meanings attributed to such terms in the Uniform Commercial Code. All references to dollar amounts shall mean amounts in lawful money of the United States of America. AGREEMENT. The word "Agreement" means this Loan Agreement, as this Loan Agreement may be amended or modified from time to time, together with all exhibits and schedules attached to this Loan Agreement from time to time. ACCOUNT. The word "Account" means a trade account, account receivable, or other right to payment for goods sold or services rendered owing to Borrower (or to a third party grantor acceptable to Lender). ACCOUNT DEBTOR. The words "Account Debtor" mean the person or entity obligated upon an Account. ADVANCE. The word "Advance" means a disbursement of Loan funds under this Agreement. BORROWER. The word "Borrower" means SmarTalk TeleServices, Inc.. The word "Borrower" also includes, as applicable, all subsidiaries and affiliates of Borrower as provided below in the paragraph titled "Subsidiaries and "Affiliates." BORROWING BASE. The words "Borrowing Base" mean as determined by Lender from time to time, the lesser of (a) $1,000,000.00; or (b) 70.00% of the aggregate amount of Eligible Accounts. BUSINESS DAY. The words "Business Day" mean a day on which commercial banks are open for business in the State of California. CERCLA. The word "CERCLA" means the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended. CASH FLOW. The words "Cash Flow" mean net income after taxes, and exclusive of extraordinary gains and income, plus depreciation and amortization. COLLATERAL. The word "Collateral" means and includes without limitation all property and assets granted as collateral security for a Loan, whether real or personal property, whether granted directly or indirectly, whether granted now or in the future, and whether granted in the form of a security interest, mortgage, deed of trust, assignment, pledge, chattel mortgage, chattel trust, factor's lien, equipment trust, conditional sale, trust receipt, lien, charge, lien or title retention contract, lease or consignment intended as a security device, or any other security or lien interest whatsoever, whether created by law, contract, or otherwise. The word "Collateral" includes without limitation all collateral described below in the section titled "COLLATERAL." DEBT. The word "Debt" means all of Borrower's liabilities excluding Subordinated Debt. ELIGIBLE ACCOUNTS. The words "Eligible Accounts" mean, at any time, all of Borrower's Accounts which contain selling terms and conditions acceptable to Lender. The net amount of any Eligible Account against which Borrower may borrow shall exclude all returns, discounts, credits, and offsets of any nature. Unless otherwise agreed to by Lender in writing, Eligible Accounts do not include: (a) Accounts with respect to which the Account Debtor is an officer, an employee or agent of Borrower. (b) Accounts with respect to which the Account Debtor is a subsidiary of, or affiliated with or related to Borrower or its shareholders, officers, or directors. (c) Accounts with respect to which goods are placed on consignment, guaranteed sale, or other terms by reason of which the payment by the Account Debtor may be conditional. (d) Accounts with respect to which the Account Debtor is not a resident of the United States, except to the extent such Accounts are supported by insurance, bonds or other assurances satisfactory to Lender. (e) Accounts with respect to which Borrower is or may become liable to the Account Debtor for goods sold or services rendered by the Account Debtor to Borrower. (f) Accounts which are subject to dispute, counterclaim, or setoff. (g) Accounts with respect to which the goods have not been shipped or delivered, or the services have not been rendered, to the Accounts Debtor. (h) Accounts with respect to which Lender, in its sole discretion, deems the creditworthiness or financial condition of the Account Debtor to be unsatisfactory. (i) Accounts of any Account Debtor who has filed or has had filed against it a petition in bankruptcy or an application for relief under any provision of any state or federal bankruptcy, insolvency, or debtor-in-relief acts; or who has had appointed a trustee, custodian, or receiver for the assets of such Account Debtor; or who has made an assignment for the benefit of creditors or has become insolvent or fails generally to pay its debts (including its payrolls) as such debts become due. (j) Accounts with respect to which the Account Debtor is the United States government or any department or agency of the United States. (k) Accounts which have not been paid in full within 90 DAYS from the invoice date. The entire balance of any Account of any single Account debtor will be ineligible whenever the portion of the Account which has not been paid within 90 DAYS from the invoice date is in excess of 25.000% of the total amount outstanding on the Account. (l) That portion of the Accounts of any single Account Debtor which exceeds 15.000% of all of Borrower's Accounts. (m) Accounts with respect to which the Account Debtor is obligated to Borrower under a Note. ELIGIBLE INVENTORY. The words "Eligible Inventory" mean, at any time, all of Borrower's inventory as defined below except: (a) Inventory which is not owned by Borrower free and clear of all security interests, liens, encumbrances, and claims of third parties. (b) Inventory which Lender, in its sole discretion, deems to be obsolete, unsalable, damaged, defective, or unfit for further processing. ERISA. The word "ERISA" means the Employee Retirement Income Security Act of 1974, as amended. EVENT OF DEFAULT. The words "Event of Default" mean and include without limitation any of the Events of Default set forth below in the section titled "EVENTS OF DEFAULT." EXPIRATION DATE. The words "Expiration Date" mean the date of termination of Lender's commitment to lend under this Agreement. GRANTOR. The word "Grantor" means and includes without limitation each and all of the persons or entities granting a Security interest in any Collateral for the Indebtedness, including without limitation all Borrowers granting such a Security Interest. 09-18-1996 LOAN AGREEMENT PAGE 2 LOAN NO 404569048 (CONTINUED) =============================================================================== connection with any Indebtedness. INDEBTEDNESS. The word "Indebtedness" means and includes without limitation all Loans, together with all other obligations, debts and liabilities of Borrower to Lender, or any one or more of them, as well as all claims by Lender against Borrower, or any one more of them; whether now or hereafter existing, voluntary or involuntary, due or not due, absolute or contingent, liquidated or unliquidated; whether Borrower may be liable individually or jointly with others; whether Borrower may be obligated as a guarantor, surety, or otherwise; whether recovery upon such Indebtedness may be or hereafter may become barred by any statute of limitations; and whether such Indebtedness may be or hereafter may become otherwise unenforceable. INVENTORY. The word "Inventory" means all of Borrower's raw materials, work in process, finished goods, merchandise, parts and supplies, of every kind and description, and goods held for sale or lease or furnished under contracts of service in which Borrower now has or hereafter acquires any right, whether held by Borrower or others, and all documents of title, warehouse receipts, bills of lading, and all other documents of every type covering all or any part of the foregoing. Inventory includes inventory temporarily out of Borrower's custody or possession and all returns on Accounts. LENDER. The word "Lender" means SOUTHERN CALIFORNIA BANK, its successors and assigns. LINE OF CREDIT. The words "Line of Credit" mean the credit facility described in the Section titled "LINE OF CREDIT" below. LIQUID ASSETS. The words "Liquid Assets" means Borrower's cash on hand plus Borrower's readily marketable securities. LOAN. The word "Loan" or "Loans" means and includes without limitation any and all commercial loans and financial accommodations from Lender to Borrower, whether now or hereafter existing, and however evidenced, including without limitation those loans and financial accommodations described herein or described on any exhibit or schedule attached to this Agreement from time to time NOTE. The word "Note" means and includes without limitation Borrower's promissory note or notes, if any, evidencing Borrower's Loan obligations in favor of Lender, as well as any substitute, replacement or refinancing note or notes therefor. PERMITTED LIENS. The words "Permitted Liens" mean: (a) liens and security interests securing indebtedness owed by Borrower to Lender; (b) liens for taxes, assessments, or similar charges either not yet due or being contested in good faith; (c) liens of materialmen, mechanics, warehousemen, or carriers, or other like liens arising in the ordinary course of business and securing obligations which are not yet delinquent; (d) purchase money liens or purchase money security interests upon or in any property acquired or held by Borrower in the ordinary course of business to secure indebtedness outstanding on the date of this Agreement or permitted to be incurred under the paragraph of this Agreement titled "Indebtedness and Liens"; (e) liens and security interests which, as of the date of this Agreement, have been disclosed to and approved by the Lender in writing; and (f) those liens and security interests which in the aggregate constitute an immaterial and insignificant monetary amount with respect to the net value of Borrower's assets. RELATED DOCUMENTS. The words "Related Documents" mean and include without limitation all promissory notes, credit agreements, loan agreements, environmental agreements, guaranties, security agreements, mortgages, deeds of trust, and all other instruments, agreements and documents, whether now or hereafter existing, executed in connection with the Indebtedness. SECURITY AGREEMENT. The words "Security Agreement" mean and include without limitation any agreements, promises, covenants, arrangements, understandings or other agreements, whether created by law, contract, or otherwise, evidencing, governing, representing, or creating a Security Interest. SECURITY INTEREST. The words "Security Interest" mean and include without limitation any type of collateral security, whether in the form of a lien, charge, mortgage, deed of trust, assignment, pledge, chattel mortgage, chattel trust, factor's lien, equipment trust, conditional sale, trust receipt, lien or title retention contract, lease or consignment intended as a security device, or any other security or lien interest whatsoever, whether created by law, contract, or otherwise. SARA. The word "SARA" means the Superfund Amendments and Reauthorization Act of 1986 as now or hereafter amended. SUBORDINATED DEBT. The words "Subordinated Debt" mean indebtedness and liabilities of Borrower which have been subordinated by written agreement to indebtedness owed by Borrower to Lender in form and substance acceptable to Lender. TANGIBLE NET WORTH. The words "Tangible Net Worth" mean "Borrower's total assets excluding all intangible assets (i.e., goodwill, trademarks, patents, copyrights, organizational expenses, and similar intangible items, but including leaseholds and leasehold improvements) less total Debt. WORKING CAPITAL. The words "Working Capital" mean Borrower's current assets, excluding prepaid expenses, less Borrower's current liabilities. LINE OF CREDIT. Lender agrees to make Advances to Borrower from time to time from the date of this Agreement to the Expiration Date, provided the aggregate amount of such Advances outstanding at any time does not exceed the Borrowing Base. Within the foregoing limits, Borrower may borrow, partially or wholly prepay, and reborrow under this Agreement as follows. CONDITIONS PRECEDENT TO EACH ADVANCE. Lender's obligation to make any Advance to or for the account of Borrower under this Agreement is subject to the following conditions precedent, with all documents, instruments, opinions, reports, all other items required under this Agreement to be in form and substance satisfactory to Lender: (a) Lender shall have received evidence that this Agreement and all Related Documents have been duly authorized, executed, and delivered by Borrower to Lender. (b) Lender shall have received such opinions of counsel, supplemental opinions, and documents as Lender may request. (c) The security interests in the Collateral shall have been duly authorized, created, and perfected with first lien priority and shall be in full force and effect. (d) All guaranties required by Lender for the Line of Credit shall have been executed by each Guarantor, delivered to Lender, and be in full force and effect. (e) Lender, at its option and for its sole benefit, shall have conducted an audit of Borrower's Accounts, inventory, books, records, and operations, and Lender shall be satisfied as to their condition. (f) Borrower shall have paid to Lender all fees, costs, and expenses specified in this Agreement and the Related Documents as are then due and payable. (g) There shall not exist at the time of any Advance a condition which would constitute an Event of Default under this Agreement, and Borrower shall have delivered to Lender the compliance certificate called for in the paragraph below titled "Compliance Certificate." MAKING LOAN ADVANCES. Advances under the Line of Credit may be requested orally by authorized persons. Lender may, but need not, require that all oral requests be confirmed in writing. Each Advance shall be conclusively deemed to have been made at the request of and for the benefit of Borrower (a) when credited to any deposit account of Borrower maintained with Lender or (b) when advanced in accordance with the instructions of an authorized person. Lender, at its option, may set a cutoff time, after which all requests for Advances will be treated as having been requested on the next succeeding Business Day. Under no circumstances shall Lender be required to make any Advance in an amount less than $1,000.00. MANDATORY LOAN REPAYMENTS. If at any time the aggregate principal amount of the outstanding Advances shall exceed the applicable Borrowing Base, Borrower, immediately upon written or oral notice from Lender, shall pay to Lender an amount equal to the difference between the outstanding principal balance of the Advances and the Borrowing Base. On the Expiration Date, Borrower shall pay to Lender in full the aggregate unpaid principal amount of all Advances then outstanding and all accrued unpaid interest, together with all other applicable fees, costs and charges, if any, not yet paid. FACILITY CHARGE. Borrower recognizes that Lender has incurred and will continue to incur certain costs and expenses in connection with establishing, maintaining, servicing, and administering the credit facility. To ensure that Lender is able to recover such costs and expenses, Borrower agrees that, notwithstanding any other provision of this Agreement, the promissory note for the Line of Credit, or the Related Documents, Lender shall be entitled to collect the following facility charge, which Borrower hereby promises and agrees to pay: [(a) THE BORROWER AGREES TO IMMEDIATELY REPAY THE lENDER FOR EXPENSES THAT INCLUDE, BUT ARE NOT LIMITED TO, FILING, RECORDING, SEARCH FEES, APPRAISAL FEES, TITLE REPORT FEES AND DOCUMENTATION FEES. (b) THE BORROWER AGREES TO REIMBURSE THE LENDER FOR THE COST OF PERIODIC AUDITS AND APPRAISAL OF PERSONAL PROPERTY COLLATERAL SECURING THIS AGREEMENT, AT SUCH INTERVALS AS THE LENDER MAY REASONALBLY REQUIRE. THE AUDITS AND APPRAISALS MAY BE PERFORMED BY EMPLOYEES OF THE lENDER OR BY INDEPENDENT APPRAISERS, AND MINIMUM MONTHLY INTEREST CHARGE OF $4,429.00 WHICH THE BORROWER HEREBY PROMISES AND AGREES TO PAY FOR A PERIOD OF ONE YEAR FROM THE DATE OF THIS AGREEMENT.] LOAN ACCOUNT. Lender shall maintain on its books a record of account in which Lender shall make entries for each Advance and such other debits and credits as shall be appropriate in connection with the credit facility. Lender shall provide Borrower with periodic statements of Borrower's account, which statements shall be considered to be correct and conclusively binding on Borrower unless Borrower notifies Lender to the contrary within thirty (30) days after Borrower's receipt of any such statement which Borrower deems to be incorrect. 09-18-1996 LOAN AGREEMENT PAGE 3 LOAN NO 404569048 (CONTINUED) ================================================================================ Borrower (and others, if required) shall grant to Lender Security Interests in such property and assets as Lender may require (the "Collateral"), including without limitation Borrower's present and future Accounts, general intangibles, and Inventory. Lender's Security Interests in the Collateral shall be continuing liens and shall include the proceeds and products of the Collateral, including without limitation the proceeds of any insurance. With respect to the Collateral, Borrower agrees and represents and warrants to Lender: PERFECTION OF SECURITY INTERESTS. Borrower agrees to execute such financing statements and to take whatever other actions are requested by Lender to perfect and continue Lender's Security Interests in the Collateral. Upon request of Lender, Borrower will deliver to Lender any and all of the documents evidencing or constituting the Collateral, and Borrower will note Lender's interest upon any and all chattel paper if not delivered to Lender for possession by Lender. Contemporaneous with the execution of this Agreement, Borrower will execute one or more UCC financing statements and any similar statements as may be required by applicable law, and will file such financing statements and all such similar statements in the appropriate location or locations. Borrower hereby appoints Lender as its irrevocable attorney-in-fact for the purpose of executing any documents necessary to perfect or to continue any Security Interest. Lender may at any time, and without further authorization from Borrower, file a carbon, photograph, facsimile, or other reproduction of any financing statement for use as a financing statement. Borrower will reimburse Lender for all expenses for the perfection, termination, and the continuation of the perfection of Lender's security interest in the Collateral. Borrower promptly will notify Lender of any change in Borrower's Social Security Number or Employer Identification Number. Borrower further agrees to notify Lender in writing prior to any change in address or location of Borrower's principal governance office or should Borrower merge or consolidate with any other entity. COLLATERAL RECORDS. Borrower does now, and at all times hereafter shall, keep correct and accurate records of the Collateral, all of which records shall be available to Lender or Lender's representative upon demand for inspection and copying at any reasonable time. With respect to the Accounts, Borrower agrees to keep and maintain such records as Lender may require, including without limitation information concerning Eligible Accounts and Account Balances and agings. With respect to the Inventory, Borrower agrees to keep and maintain such records as Lender may require, including without limitation information concerning Eligible Inventory and records itemizing and describing the kind, type, quality, and quantity of Inventory, Borrower's Inventory costs and selling prices, and the daily withdrawals and additions to Inventory. The following is an accurate and complete list of all locations at which Borrower keeps or maintains business records concerning Borrower's Accounts and Inventory: 1640 S. SEPULVEDA #500, LOS ANGELES, CA 90025. COLLATERAL SCHEDULES. Concurrently with the execution and delivery of this Agreement, Borrower shall execute and deliver to Lender schedules of Accounts and Inventory and Eligible Accounts and Eligible Inventory, in form and substance satisfactory to the Lender. Thereafter and at such frequency as Lender shall require, Borrower shall execute and deliver to Lender such supplemental schedules of Eligible Accounts and Eligible Inventory and such other matters and information relating to the Accounts and Inventory as Lender may request. REPRESENTATIONS AND WARRANTIES CONCERNING ACCOUNTS. With respect to the Accounts, Borrower represents and warrants to Lender: (a) Each Account represented by Borrower to be an Eligible Account for purposes of this Agreement conforms to the requirements of the definition of an Eligible Account; (b) All Account information listed on schedules delivered to Lender will be true and correct, subject to immaterial variance; and (c) Lender, its assigns, or agents shall have the right at any time and at Borrower's expense to inspect, examine, and audit Borrower's records and to confirm with Account Debtors the accuracy of such Accounts. REPRESENTATIONS AND WARRANTIES CONCERNING INVENTORY. With respect to the Inventory, Borrower represents and warrants to Lender: (a) All Inventory represented by Borrower to be Eligible Inventory for purposes of this Agreement conforms to the requirements of the definition of Eligible Inventory; (b) All Inventory values listed on schedules delivered to Lender will be true and correct, subject to immaterial variance; (c) The value of the Inventory will be determined on a consistent accounting basis; (d) Except as agreed to the contrary by Lender in writing, all Eligible Inventory is now and at all times hereafter will be in Borrower's physical possession and shall not be held by others on consignment, sale on approval, or sale or return; (e) Except as reflected in the Inventory schedules delivered to Lender, all Eligible Inventory is now and at all times hereafter will be of good and merchantable quality, free from defects; (f) Eligible Inventory is not now and will not at any time hereafter be stored with a bailee, warehouseman, or similar party without Lender's prior written consent, and, in such event, Borrower will concurrently at the time of bailment cause any such bailee, warehouseman, or similar party to issue and deliver to Lender, in form acceptable to Lender, warehouse receipts in Lender's name evidencing the storage of Inventory; and (g) Lender, its assigns, or agents shall have the right at any time and at Borrower's expense to inspect and examine the Inventory and to check and test the same as to quality, quantity, value, and condition. REMITTANCE ACCOUNT. Borrower agrees that Lender may at any time require Borrower to institute procedures whereby the payments and other proceeds of the Accounts shall be paid by the Account Debtors under a remittance account or lock box arrangement with Lender, or Lender's agent, or with one or more financial institutions designated by Lender. Borrower further agrees that, if no Event of Default exists under this Agreement, any and all of such funds received under such a remittance account or lock box arrangement shall, at Lender's sole election and discretion, either be (a) paid or turned over to Borrower; (b) deposited into one or more accounts for the benefit of Borrower (which deposit accounts shall be subject to a security assignment in favor of Lender); (c) deposited into one or more accounts for the joint benefit of Borrower and Lender (which deposit accounts shall likewise be subject to a security assignment in favor of Lender); (d) paid or turned over to Lender to be applied to the Indebtedness in such order and priority as Lender may determine within its sole discretion; or (e) any combination of the foregoing as Lender shall determine from time to time. Borrower further agrees that, should one or more Events of Default exist, any and all funds received under such a remittance account or lock box arrangement shall be paid or turned over to Lender to be applied to the Indebtedness, again in such order and priority as Lender may determine within its sole discretion. REPRESENTATIONS AND WARRANTIES. Borrower represents and warrants to Lender, as of the date of this Agreement, as of the date of each disbursement of Loan proceeds, as of the date of any renewal, extension or modification of any Loan, and at all times any Indebtedness exists: ORGANIZATION. Borrower is a corporation which is duly organized, validly existing, and in good standing under the laws of the State of California and is validly existing and in good standing in all states in which Borrower is doing business. Borrower has the full power and authority to own its properties and to transact the businesses in which it is presently engaged or presently proposes to engage. Borrower also is duly qualified as a foreign corporation and is in good standing in all states in which the failure to so qualify would have a material adverse effect on its businesses or financial condition. AUTHORIZATION. The execution, delivery, and performance of this Agreement and all Related Documents by Borrower, to the extent to be executed, delivered or performed by Borrower, have been duly authorized by all necessary action by Borrower; do not require the consent or approval of any other person, regulatory authority or governmental body; and do not conflict with, result in a violation of, or constitute a default under (a) any provision of its articles of incorporation or organization, or bylaws, or any agreement or other instrument binding upon Borrower of (b) any law, governmental regulation, court decree, or order applicable to Borrower. FINANCIAL INFORMATION. Each financial statement of Borrower supplied to Lender truly and completely disclosed Borrower's financial condition as of the date of the statement, and there has been no material adverse change in Borrower's financial condition subsequent to the date of the most recent financial statement supplied to Lender. Borrower has no material contingent obligations except as disclosed in such financial statements. LEGAL EFFECT. This Agreement constitutes, and any instrument or agreement required hereunder to be given by Borrower when delivered will constitute, legal, valid and binding obligations of Borrower enforceable against Borrower in accordance with their respective terms. PROPERTIES. Except for Permitted Liens, Borrower owns and has good title to all of Borrower's properties free and clear of all Security Interests, and has not executed any security documents or financing statements relating to such properties. All of Borrower's properties are titled in Borrower's legal name, and Borrower has not used, or filed a financing statement under, any other name for at least the last five (5) years. HAZARDOUS SUBSTANCES. The terms "hazardous waste," "hazardous substance," "disposal," "release," and "threatened release," as used in this Agreement, shall have the same meanings as set forth in the "CERCLA," "SARA," the Hazardous Materials Transportation Act, 49 U.S.C. Section 1801, et seq., the Resource Conservation and Recovery Act, 42 U.S.C. Section 6901, et seq., Chapters 6.5 through 7.7 of Division 20 of the California Health and Safety Code, Section 25100, et seq., or other applicable state or Federal laws, rules, or regulations adopted pursuant to any of the foregoing. Except as disclosed to and acknowledged by Lender in writing, Borrower represents and warrants that: (a) During the period of Borrower's ownership of the properties, there has been no use, generation, manufacture, storage, treatment, disposal, release or threatened release of any hazardous waste or substance by any person on, under, about or from any of the properties. (b) Borrower has no knowledge of, or reason to believe that there has been (i) any use, generation, manufacture, storage, treatment, disposal, release, or threatened release of any hazardous waste or substance on, under, about or from the properties by any prior owners or occupants of any of the properties, or (ii) any actual or threatened litigation or claims of any kind by any person relating to such matters. (c) Neither Borrower nor any tenant, contractor, agent or other authorized user of any of the properties shall use, generate, manufacture, store, treat, dispose of, or release any hazardous waste or substance on, under, about or from any of the properties; and any such activity shall be conducted in compliance with all applicable federal, state, and local laws, regulations, and ordinances, including without limitation those laws, regulations and ordinances described above. Borrower authorizes Lender and its agents to enter upon the properties to make such inspections and tests as Lender may deem appropriate to determine compliance of the properties with this section of the Agreement. Any inspections or tests made by Lender shall be at Borrower's expense and for Lender's purposes only and shall not be construed to create any responsibility or liability on the part of Lender to Borrower or to any other person. The representations and warranties contained herein are based on Borrower's due diligence in investigating the properties for hazardous waste and hazardous substances. Borrower hereby (a) releases and waives any future claims against Lender for indemnity or contribution in the event Borrower becomes liable for cleanup or other costs under any such laws, and (b) agrees to indemnify and hold harmless Lender against any and 09-18-1996 LOAN AGREEMENT PAGE 4 LOAN NO 404569048 (CONTINUED) ================================================================================ this section of the Agreement or as a consequence of any use, generation, manufacture, storage, disposal, release or threatened release occurring prior to Borrower's ownership or interest in the properties, whether or not the same was or should have been known to Borrower. The provisions of this section of the Agreement, including the obligation to indemnify, shall survive the payment of the Indebtedness and the termination or expiration of this Agreement and shall not be affected by Lender's acquisition of any interest in any of the properties, whether by foreclosure or otherwise. LITIGATION AND CLAIMS. No litigation, claim, investigation, administrative proceeding or similar action (including those for unpaid taxes) against Borrower is pending or threatened, and no other event has occurred which may materially adversely affect Borrower's financial condition or properties, other than litigation, claims, or other events, if any, that have been disclosed to and acknowledged by Lender in writing. TAXES. To the best of Borrower's knowledge, all tax returns and reports of Borrower that are or were required to be filed, have been filed, and all taxes, assessments and other governmental charges have been paid in full, except those presently being or to be contested by Borrower in good faith in the ordinary course of business and for which adequate reserves have been provided. LIEN PRIORITY. Unless otherwise previously disclosed to Lender in writing, Borrower has not entered into or granted any Security Agreements or permitted the filing or attachment of any Security interests on or affecting any of the Collateral directly or indirectly securing repayment of Borrower's Loan and Note, that would be prior or that may in any way be superior to Lenders Security Interests and rights in and to such Collateral. BINDING EFFECT. This Agreement, the Note, all Security Agreements directly or indirectly securing repayment of Borrower's Loan and Note and all of the Related Documents are binding upon Borrower as well as upon Borrower's successors, representatives and assigns, and are legally enforceable in accordance with their respective terms. COMMERCIAL PURPOSES. Borrower intends to use the Loan proceeds solely for business or commercial related purposes. EMPLOYEE BENEFIT PLANS. Each employee benefit plan as to which Borrower may have any liability complies in all material respects with all applicable requirements of law and regulations, and (i) no Reportable Event nor Prohibited Transaction (as defined in ERISA) has occurred with respect to any such plan, (ii) Borrower has not withdrawn from any such plan or initiated steps to do so, (iii) no steps have been taken to terminate any such plan, and (iv) there are no unfunded liabilities other than those previously disclosed to Lender in writing. INVESTMENT COMPANY ACT. Borrower is not an "investment company" or a company "controlled" by an "investment company", within the meaning of the Investment Company Act of 1940, as amended. PUBLIC UTILITY HOLDING COMPANY ACT. Borrower is not a "holding company", or a "subsidiary company" of a "holding company", or an "affiliate" of a "holding company" or of a "subsidiary company" of a "holding company", within the meaning of the Public Utility Holding Company Act of 1935, as amended. REGULATIONS G, T AND U. Borrower is not engaged principally, or as one of its important activities, in the business of extending credit for the purpose of purchasing or carrying margin stock (within the meaning of Regulations G,T and U of the Board of Governors of the Federal Reserve System). LOCATION OF BORROWER'S OFFICES AND RECORDS. Borrower's place of business, or Borrower's Chief executive office, if Borrower has more than one place of business, is located at 1640 S. Sepulveda Blvd., Ste. 500, Los Angeles, CA 90025. Unless Borrower has designated otherwise in writing this location is also the office or offices where Borrower keeps its records concerning the collateral. INFORMATION. All information heretofore or contemporaneously herewith furnished by Borrower to Lender for the purposes of or in connection with this Agreement or any transaction contemplated hereby is, and all information hereafter furnished by or on behalf of Borrower to Lender will be, true and accurate in every material respect on the date as of which such information is dated or certified; and none of such information is or will be incomplete by omitting to state any material fact necessary to make such information not misleading. CLAIMS AND DEFENSES. There are no defenses or counterclaims, offsets or other adverse claims demands or actions of any kind, personal or otherwise, that Borrower, Grantor, or any Guarantor could assert with respect to the Note, Loan, Indebtedness, this Agreement, or the Related Documents. SURVIVAL OF REPRESENTATIONS AND WARRANTIES. Borrower understands and agrees that Lender, without independent investigation, is relying upon the above representations and warranties in extending Loan Advances to Borrower. Borrower further agrees that the foregoing representations and warranties shall be continuing in nature and shall remain in full force and effect until such time as Borrower's Indebtedness shall be paid in full, or until this Agreement shall be terminated in the manner provided above, whichever is the last to occur. AFFIRMATIVE COVENANTS. Borrower covenants and agrees with Lender that, while this Agreement is in effect, Borrower will: LITIGATION. Promptly inform Lender in writing of (a) all material adverse changes in Borrower's financial condition, and (b) all existing and all threatened litigation, claims, investigations, administrative proceedings or similar actions affecting Borrower or any Guarantor which could materially affect the financial condition of Borrower or the financial condition of any Guarantor. FINANCIAL RECORDS. Maintain its books and records in accordance with generally accepted accounting principles, applied on a consistent basis, and permit Lender to examine and audit Borrower's books and records at all reasonable times. FINANCIAL STATEMENTS. Furnish Lender with, as soon as available, but in no event later than one hundred twenty (120) days after the end of each fiscal year, Borrower's balance sheet and income statement for the year ended, audited by a certified public accountant satisfactory to Lender, and, as soon as available, but in no event no later than thirty (30) days after the end of each month, Borrower's balance sheet and profit and loss statement for the period ended, prepared and certified as correct to the best knowledge and belief by Borrower's chief financial officer or other officer or person acceptable to Lender. All financial reports required to be provided under this Agreement shall be prepared in accordance with generally accepted accounting principles, applied on a consistent basis, and certified by Borrower as being true and correct. ADDITIONAL INFORMATION. Furnish such additional information and statements, lists of assets and liabilities, agings of receivables and payables, inventory schedules, budgets, forecasts, tax returns, and other reports with respect to Borrower's financial condition and business operations as Lender may request from time to time. FINANCIAL COVENANTS AND RATIOS. Comply with the following covenants and ratios: TANGIBLE NET WORTH. Maintain a minimum Tangible Net Worth of not less than $55,000,000.00. The following provisions shall apply for purposes of determining compliance with the foregoing financial covenants and ratios: QUARTERLY. Except as provided above, all computations made to determine compliance with the requirements contained in this paragraph shall be made in accordance with generally accepted accounting principles, applied on a consistent basis, and certified by Borrower as being true and correct. INSURANCE. Maintain fire and any other risk insurance, public liability insurance, and such other insurance as Lender may require with respect to Borrower's properties and operations, in form, amounts, coverages and with insurance companies reasonably acceptable to Lender. Borrower, upon request of Lender, will deliver to Lender from time to time the policies or certificates of insurance in form satisfactory to Lender, including stipulations that coverages will not be cancelled or diminished without at least thirty (30) days' prior written notice to Lender. Each insurance policy also shall include an endorsement providing that coverage in favor of Lender will not be impaired in any way by any act, omission or default of Borrower or any other person. In connection with all policies covering assets in which Lender holds or is offered a security interest for the Loans, Borrower will provide Lender with such loss payable or other endorsements as Lender may require. INSURANCE REPORTS. Furnish to Lender, upon request of Lender, reports on each existing insurance policy showing such information as Lender may reasonably request, including without limitation the following: (a) the name of the insurer; (b) the risks insured; (c) the amount of the policy; (d) the properties insured; (e) the then current property values on the basis of which insurance has been obtained, and the manner of determining those values; and (f) the expiration date of the policy. In addition, upon request of Lender (however not more often than annually), Borrower will have an independent appraiser satisfactory to Lender determine, as applicable, the actual cash value or replacement cost of any Collateral. The cost of such appraisal shall be paid by Borrower. OTHER AGREEMENTS. Comply with all terms and conditions of all other agreements, whether now or hereafter existing, between Borrower and any other party and notify Lender immediately in writing of any default in connection with any other such agreements. LOAN FEES AND CHARGES. In addition to all other agreed upon fees and charges, pay the following: $10,000.00 LOAN FEE. LOAN PROCEEDS. Use all Loan proceeds solely for Borrower's business operations, unless specifically consented to the contrary by Lender in writing. TAXES, CHARGES AND LIENS. Pay and discharge when due all of its indebtedness and obligations, including without limitation all assessments, taxes, governmental charges, levies and liens, of every kind and nature, imposed upon Borrower or its properties, income, or profits, prior to the date on which penalties would attach, and all lawful claims that, if unpaid, might become a lien or charge upon any of Borrower's properties, income, or profits. Provided however, Borrower will not be required to pay and discharge any such assessment, tax, charge, levy, lien or claim so 09-18-1996 LOAN AGREEMENT PAGE 5 LOAN NO 404569048 (CONTINUED) ================================================================================ accounting practices. Borrower, upon demand of Lender, will furnish to Lender evidence of payment of the assessments, taxes, charges, levies, liens and claims and will authorize the appropriate governmental official to deliver to Lender at any time a written statement of any assessments, taxes, charges, levies, liens and claims against Borrower's properties, income, or profits. PERFORMANCE. Perform and comply with all terms, conditions, and provisions set forth in this Agreement and in the Related Documents in a timely manner, and promptly notify Lender if Borrower learns of the occurrence of any event which constitutes an Event of Default under this Agreement or under any of the Related Documents. OPERATIONS. Maintain executive and management personnel with substantially the same qaualifications and experience as the present executive and management personnel; provide written notice to Lender of any change in executive and management personnel; conducts its business affairs in a reasonable and prudent manner and in compliance with all applicable federal, state and municipal laws, ordiances, rules and regulations respecting its properties, charters, businesses and operations, including without limitation, compliance with the Americans With Disabilities Act and with all minimum funding standards and other requirements of ERISA and other laws applicable to Borrower's employee benefits plans. INSPECTION. Permit employees or agents of Lender at any reasonable time to inspect any and all Collateral for the Loan or Loans and Borrower's other properties and to examine or audit Borrower's books, accounts, and records and to make copies and memoranda of Borrower's books, accounts, and records. If Borrower now or at any time hereafter maintains any records (including without limitation computer generated records and computer software programs for the generation of such records) in the possession of a third party, Borrower, upon request of Lender, shall notify such party to permit Lender free access to such records at all reasonable times and to provide Lender with copies of any records it may request, all at Borrower's expense. COMPLIANCE CERTIFICATE. Unless waived in writing by Lender, provide Lender at least annually and at the time of each disbursement of Loan proceeds with a certificate executed by Borrower's chief financial officer, or other officer or person acceptable to Lender, certifying that the representations and warranties set forth in this Agreement are true and correct as of the date of the certificate and further certifying that, as of the date of the certificate, no Event of Default exists under this Agreement. ENVIRONMENT COMPLIANCE AND REPORTS. Borrower shall comply in all environmental, protection federal, state and local laws, statutes, regulations and ordinances; not cause or permit to exist, as a result of a intentional or unintentional action or omission on its part or on the part of any third party, on property owned and/or occupied by Borrower, any environmental activity where damage may result to the environment, unless such environmental activity is pursuant to and in complicance with the conditions of a permit issued by the appropriate federal, state or local governmental authorities; shall furnish to Lender promptly and in any event within thirty (30) days after receipt thereof a copy of any notice, summons, lien, citation, directive, letter or other communication from any governmental agency or instrumentality concerning any intentional or unintentional action or omission on Borrower's part in connection with any environmental activity whether or not there is damage to the environment and/or other natural resources. ADDITIONAL ASSURANCES. Make, execute and deliver to Lender such promissory notes, mortgages, deeds of trust, security agreements, financing statements, instruments, documents and other agreements as Lender or its attorneys may reasonably request to evidence and secure the Loans and to perfect all Security Interests. RECOVERY OF ADDITIONAL COSTS. If the imposition of or any change in any law, rule, regulation or guideline, or the interpretation or application of any thereof by any court or administrative or governmental authority (including any request or policy not having the force of law) shall impose, modify of make applicable any taxes (except U.S. federal, state or local income or franchise taxes imposed on Lender), reserve requirements, capital adequacy requirements or other obligations which would (a) increase the cost to Lender for extending or maintaining the credit facilities to which this Agreement relates, (b) reduce the amounts payable to Lender under this Agreement or the Related Documents, or (c) reduce the rate of return on Lender's capital as a consequence of Lender's obligations with respect to the credit facilities to which this Agreement relates, then Borrower agrees to pay Lender such additional amounts as will compensate Lender therefor, within five (5) days after Lender's written demand for such payment, which demand shall be accompanied by an explanation of such imposition or charge and a calculation in reasonable detail of the additional amounts payable by Borrower, which explanation and calculations shall be conclusive in the absence of manifest error. NEGATIVE COVENANTS. Borrower covenants and agrees with Lender that while this Agreement is in effect, Borrower shall not, without the prior written consent of Lender: INDEBTEDNESS AND LIENS. (a) Except for trade debt incurred in the normal course of business and indebtedness to Lender contemplated by this Agreement, create, incur or assume indebtedness for borrowed money, including capital leases, (b) except as allowed as a Permitted Lien, sell, transfer, mortgage, assign, pledge, lease, grant a security interest in, or encumber any of Borrower's assets, or (c) sell with recourse any of Borrower's accounts, except to Lender. CONTINUITY OF OPERATIONS. (a) Engage in any business activities substantially different that those in which Borrower is presently engaged, (b) cease operations, liquidate, merge, transfer, acquire or consolidate with any other entity, change ownership, change its name, dissolve or transfer or sell Collateral out of the ordinary course of business, (c) pay any dividends on Borrower's stock (other than dividends payable in its stock), provided, however that notwithstanding the foregoing, but only so long as no Event of Default has occurred and is continuing or would result from the payment of dividends, if Borrower is a "Subchapter S Corporation" (as defined in the Internal Revenue Code of 1986, as amended). Borrower may pay cash dividends on its stock to its shareholders from time to time in amounts necessary to enable the shareholders to pay income taxes and make estimated income tax payments to satisfy their liabilities under federal and state law which arise solely from their status as Shareholders of a Subchapter S Corporation because of their ownership of shares of stock of Borrower, or (d) purchase or retire any of Borrower's outstanding shares or alter or amend Borrower's capital structure. LOANS, ACQUISITIONS AND GUARANTIES. (a) Loan, invest in or advance money or assets, (b) purchase, create or acquire any interest in any other enterprise or entity, or (c) incur any obligation as surety or guarantor other than in the ordinary course of business. CESSATION OF ADVANCES. If Lender has made any commitment to make any Loan to Borrower, whether under this Agreement or under any other agreement, Lender shall have no obligation to make Loan Advances or to disburse Loan proceeds if: (a) Borrower or any Guarantor is in default under the terms of this Agreement or any of the Related Documents or any other agreement that Borrower or any Guarantor has with Lender; (b) Borrower or any Guarantor becomes insolvent, files a petition in bankruptcy or similar proceedings, or is adjudged a bankrupt; (c) there occurs a material adverse change in Borrower's financial condition, in the financial condition of any Guarantor, or in the value of any Collateral securing any Loan; (d) any Guarantor seeks, claims or otherwise attempts to limit, modify or revoke such Guarantor's guaranty of the Loan or any other loan with Lender; or (e) Lender in good faith deems itself insecure, even though no Event of Default shall have occurred. ADDITIONAL TERMS, CONDITIONS AND COVENANTS. An exhibit, titled "ADDITIONAL TERMS, CONDITIONS AND COVENANTS, " is attached to this Agreement by this reference is made a part of this Agreement just as if all the provisions, terms and conditions of the Exhibit had been fully set forth in this Agreement. RIGHT OF SETOFF. Borrower grants to Lender a contractual possessory security interest in, and hereby assigns, conveys, delivers, pledges, and transfers to Lender all Borrower's right, title and interest in and to, Borrower's accounts with Lender (whether checking, saving, or some other account), including without limitation all accounts held jointly with someone else and all accounts Borrower may open in the future, excluding however all IRA and Keogh accounts, and all trust accounts for which the grant of a security interest would be prohibited by law. Borrower authorizes Lender, to the extent permitted by applicable law, to charge or setoff all sums owing on the Indebtedness against any and all such accounts. EVENTS OF DEFAULT. Each of the following shall constitute an Event of Default under this Agreement: DEFAULT ON INDEBTEDNESS. Failure of Borrower to make any payment when due on the Loans. OTHER DEFAULTS. Failure of Borrower or any Grantor to comply with or to perform when due any other term, obligation, covenant or condition contained in this Agreement or in any of the Related Documents, or failure of Borrower to comply with or to perform any other term, obligation, covenant or condition contained in any other agreement between Lender and Borrower. DEFAULT IN FAVOR OF THIRD PARTIES. Should Borrower or any Grantor default under any loan, extension of credit, security agreement, purchase or sales agreement, or any other agreement, in favor of any other creditor or person that may materially affect any of Borrower's property or Borrower's or any Grantor's ability to repay the Loans or perform their respective obligations under this Agreement or any of the Related Documents. FALSE STATEMENTS. Any warranty, representation or statement made or furnished to Lender by or on behalf of Borrower or any Grantor under this Agreement or the Related Documents is false or misleading in any material respect at the time made or furnished, or becomes false or misleading at any time thereafter. DEFECTIVE COLLATERALIZATION. This Agreement or any or the Related Documents ceases to be in full force and effect (including failure of any Security Agreement to create a valid and perfected Security Interest) at any time and for any reason. INSOLVENCY. The dissolution or termination of Borrower's existence as a going business, the insolvency of Borrower, the appointment of a receiver for any part of Borrower's property, any assignment for the benefit of creditors, any type of creditor workout, or the commencement of any proceeding under any bankruptcy or insolvency laws by or against Borrower. 09-18-1996 LOAN AGREEMENT PAGE 6 LOAN NO 404569048 (CONTINUED) ================================================================================ any governmental agency. This includes a garnishment, attachment, or levy on or of any of Borrower's deposit accounts with Lender. EVENTS AFFECTING GUARANTOR. Any of the preceding events occurs with respect to any Guarantor of any of the Indebtedness or any Guarantor dies or becomes incompetent, or revokes or disputes the validity of, or liability under, any Guaranty of the Indebtedness. CHANGE IN OWNERSHIP. Any change in ownership other than an underwritten initial public stock offering of twenty-five percent (25%) or more of the common stock of Borrower. ADVERSE CHANGE. A material adverse change occurs in Borrower's financial condition, or Lender believes the prospect of payment or performance of the Indebtedness impaired. INSECURITY. Lender, in good faith, deems itself insecure. EFFECT OF AN EVENT OF DEFAULT. If any Event of Default shall occur, except where otherwise provided in this Agreement or the Related Documents, all commitments and obligations of Lender under this Agreement or the Related Documents or any other agreement immediately will terminate (including any obligation to make Loan Advances or disbursements), and, at Lender's option, all Indebtedness immediately will become due and payable, all without notice of any kind to Borrower, except that in the case of an Event of Default of the type described in the "Insolvency" subsection above, such acceleration shall be automatic and not optional. In addition, Lender shall have all the rights and remedies provided in the Related Documents or available at law, in equity, or otherwise. Except as may be prohibited by applicable law, all of Lender's rights and remedies shall be cumulative and may be exercised singularly or concurrently. Election by Lender to pursue any remedy shall not exclude pursuit of any other remedy, and an election to make expenditures or to take action to perform an obligation of Borrower or of any Grantor shall not affect Lender's rights to declare a default and to exercise its rights and remedies. MISCELLANEOUS PROVISIONS. The following miscellaneous provisions are a part of this Agreement: AMENDMENTS. This Agreement, together with any Related Document, constitutes the entire understanding and agreement of the parties as to the matters set forth in this Agreement. No alteration of or amendment to this Agreement shall be effective unless given in writing and signed by the party or parties sought to be charged or bound by the alteration or amendment. APPLICABLE LAW. THIS AGREEMENT HAS BEEN DELIVERED TO LENDER AND ACCEPTED BY LENDER IN THE STATE OF CALIFORNIA. IF THERE IS A LAWSUIT, BORROWER AGREES UPON LENDER'S REQUEST TO SUBMIT TO THE JURISDICTION OF THE COURTS OF LOS ANGELES COUNTY, THE STATE OF CALIFORNIA. SUBJECT TO THE PROVISIONS ON ARBITRATION, THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF CALIFORNIA. ARBITRATION. LENDER AND BORROWER AGREE THAT ALL DISPUTES, CLAIMS AND CONTROVERSIES BETWEEN THEM, WHETHER INDIVIDUAL, JOINT, OR CLASS IN NATURE, ARISING FROM THIS AGREEMENT OR OTHERWISE, INCLUDING WITHOUT LIMITATION CONTRACT AND TORT DISPUTES, SHALL BE ARBITRATED PURSUANT TO THE RULES OF THE AMERICAN ARBITRATION ASSOCIATION, UPON REQUEST OF EITHER PARTY. No act to take or dispose of any Collateral shall constitute a waiver of this arbitration agreement or be prohibited by this arbitration agreement. This includes, without limitation, obtaining injunctive relief or a temporary restraining order; invoking a power of sale under any deed of trust or mortgage; obtaining a writ of attachment or imposition of a receiver; or exercising any rights relating to personal property, including taking or disposing of such property with or without judicial process pursuant to Article 9 of the Uniform Commercial Code. Any disputes, claims, or controversies concerning the lawfulness or reasonableness of any act, or exercise of any right, concerning any Collateral, including any claim to rescind, reform, or otherwise modify any agreement relating to the Collateral, shall also be arbitrated, provided however that no arbitrator shall have the right or the power to enjoin or restrain any act of any party. Lender and Borrower agree that in the event of an action for judicial foreclosure pursuant to California Code of Civil Procedure Section 726, or any similar provision in any other state, the commencement of such an action will not constitute a waiver of the right to arbitrate and the court shall refer to arbitration as much of such action, including counterclaims, as lawfully may be refered to arbitration. Judgment upon any award rendered by any arbitrator may be entered in any court having jurisdiction. Nothing in this Agreement shall preclude any party from seeking equitable relief from a court of competent jurisdiction. The statute of limitations, estoppel, waiver, laches, and similar doctrines which would otherwise be applicable in an action brought by a party shall be applicable in any arbitration proceeding, and the commencement of an arbitration proceeding shall be deemed the commencement of an action for these purposes. The Federal Arbitration Act shall apply to the construction, interpretation, and enforcement of this arbitration provision. CAPTION HEADINGS. Caption headings in this Agreement are for convenience purposes only and are not to be used to interpret or define the provisions of this Agreement. MULTIPLE PARTIES; CORPORATE AUTHORITY. All obligations of Borrower under this Agreement shall be joint and several, and all references to Borrower shall mean each and every Borrower. This means that each of the Borrowers signing below is responsible for ALL obligations in this Agreement. CONSENT TO LOAN PARTICIPATION. Borrower agrees and consents to Lender's sale or transfer, whether now or later, of one or more participation interests in the Loans to one or more purchasers, whether related or unrelated to Lender. Lender may provide, without any limitation whatsoever, to any one or more purchases, or potential purchasers, any information or knowledge Lender may have about Borrower or about any other matter relating to the Loan, and Borrower hereby waives any rights to privacy it may have with respect to such matters. Borrower additionally waives any and all notices of sale of participation interests, as well as all notices of any repurchase of such participation interests. Borrower also agrees that the purchasers of any such participation interests will be considered as the absolute owners of such interests in the Loans and will have all the rights granted under the participation agreement or agreements governing the sale of such participation interests. Borrower further waives all rights to offset or counterclaim that it may now or later against Lender or against any purchaser of a participation interest and unconditionally agrees that either Lender or such purchaser may enforce Borrower's obligation under the Loans irrespective of the failure or insolvency of any holder of any interest in the Loans. Borrower further agrees that purchaser of any such participation interests may enforce its interests irrespective of any personal claims or defenses that Borrower may have against Lender. BORROWER INFORMATION. Borrower consents to the release of information on or about Borrower by Lender in accordance with any court order, law or regulation and in response to credit inquiries concerning Borrower. NON-LIABILITY OF LENDER. The relationship between Borrower and Lender ia a debtor and creditor relationship and not fiduciary in nature, nor is the relationship to be construed as creating any partnership or joint venture between Lender and Borrower. Borrower is exercising its own judgment with respect to Borrower's business. All information supplied to Lender is for Lender's protection only and no other party is entitled to rely on such information. There is no duty for Lender to review, inspect, supervise, or inform Borrower of any matter with respect to Borrower's business. Lender and Borrower intend that Lender may reasonably rely on all information supplied by Borrower to Lender, together with all representations and warranties given by Borrower to Lender, without investigation or confirmation by Lender and that any investigation or failure to investigate will not diminish Lender's right to so rely. NOTICE OF LENDER'S BREACH. Borrower must notify Lender in writing of any breach of this Agreement or the Related Documents by Lender and any other claim, cause of action or offset against Lender within thirty (30) days after the occurrence of such breach or after the accrual of such claim, cause of action or offset. Borrower waives any claim, cause of action or offset for which notice is not given in accordance with this paragraph. Lender is entitled to rely on any failure to give such notice. BORROWER INDEMNIFICATION. Borrower shall indemnify and hold Lender harmless from and against all claims, costs, expenses, losses, damages, and liabilities of any kind, including but not limited to attorneys' fees and expenses, arising out of any matter relating directly or indirectly to the Indebtedness, whether resulting from internal disputes of the Borrower, disputes between Borrower and any Guarantor, or whether involving any third parties, or out of any other matter whatsoever related to this Agreement or the Related Documents, but excluding any claim or liability which arises as a direct result of Lender's gross negligence of willful misconduct. This indemnity shall survive full repayment and satisfaction of the indebtedness and termination of this Agreement. COUNTERPARTS. This Agreement may be executed in multiple counterparts, each of which, when so executed, shall be deemed an original, but all such counterparts, taken together, shall constitute one and the same Agreement. COSTS AND EXPENSES. Borrower agrees to pay upon demand all of Lender's expenses, including without limitation attorneys' fees, incurred in connection with the preparation, execution, enforcement, modification and collection of this Agreement or in connection with the Loans made pursuant to this Agreement. Lender may pay someone else to help collect the Loans and to enforce this Agreement, and Borrower will pay that amount. This includes, subject to any limits under applicable law, Lender's attorneys' fees and Lender's legal expenses, whether or not there is a lawsuit, including attorneys' fees for bankruptcy proceedings (including efforts to modify or vacate any automatic stay or injunction), appeals, and any anticipated post-judgment collection services. Borrower also will pay any court costs, in addition to all other sums provided by law. NOTICES. All notices required to be given under this Agreement shall be given in writing, may be sent by telefacsimilie, and shall be effective when actually delivered or when deposited with a nationally recognized overnight courier or deposited in the United States mail, first class, postage prepaid, addressed to the party to whom the notice is to be given at the address shown above. Any party may change its address for notices under this Agreement by giving formal written notice to the other parties, specifying that the purpose of the notice is to change the party's address. To the extent permitted by applicable law, if there is more than one Borrower, notice to any Borrower will constitute notice to all Borrowers. For notice purposes, Borrower will keep Lender informed at all times of Borrower's current address(es). SEVERABILITY. If a court of competent jurisdiction finds any provision of this Agreement to be invalid or unenforceable as to any person or circumstance such finding shall not render that provision invalid or unenforceable as to any other persons or circumstances. If feasible, any such 09-18-1996 LOAN AGREEMENT PAGE 7 LOAN NO 404569048 (CONTINUED) ================================================================================ SUBSIDIARIES AND AFFILIATES OF BORROWER. To the extent the context of any provisions of this Agreement makes it appropriate, including without limitation any representation, warranty or covenant, the word "Borrower" as used herein shall include all subsidiaries and affiliates of Borrower. Notwithstanding the foregoing however, under no circumstances shall this Agreement be construed to require Lender to make any Loan or other financial accommodation to any subsidiary or affiliate of Borrower. SUCCESSORS AND ASSIGNS. All covenants and agreements contained by or on behalf of Borrower shall bind its successors and assigns and shall inure to the benefit of Lender, its successors and assigns. Borrower shall not, however, have the right to assign its rights under this Agreement or any interest therein, without the prior written consent of Lender. SURVIVAL. All warranties, representations, and covenants made by Borrower in this Agreement or in any certificate or other instrument delivered by Borrower to Lender under this Agreement shall be considered to have been relied upon by Lender and will survive the making of the Loan and delivery to Lender of the Related Documents, regardless of any investigation made by Lender or on any Lender's behalf. TIME IS OF THE ESSENCE. Time is of the essence in the performance of this Agreement. WAIVER. Lender shall not be deemed to have waived any rights under this Agreement unless such waiver is given in writing and signed by Lender. No delay or omission on the part Lender in exercising any right shall operate as a waiver of such right or any other right. A waiver by Lender of a provision of this Agreement shall not prejudice or constitute a waiver of Lender's right otherwise to demand strict compliance with that provision or any other provision of this Agreement. No prior waiver by Lender, nor any course of dealing between Lender and Borrower, or between Lender and any Grantor, shall constitute a waiver of any of Lender's rights or of any obligations of Borrower or of any Grantor as to any future transactions. Whenever the consent of Lender is required under this Agreement, the granting of such consent by Lender in any instance shall not constitute continuing consent in subsequent instances where such consent is required, and in all cases such consent may be granted or withheld in the sole discretion of Lender. BORROWER ACKNOWLEDGES HAVING READ ALL THE PROVISIONS OF THIS LOAN AGREEMENT, AND BORROWER AGREES TO ITS TERMS. THIS AGREEMENT IS DATED AS OF SEPTEMBER 18, 1996. BORROWER: SMARTALK TELESERVICES, INC. BY: /s/ Robert H. Lorsch BY: /s/ Glen Andrew Folck ------------------------------- -------------------------------------- ROBERT H. LORSCH, PRESIDENT GLEN ANDREW FOLCK, ASSISTANT SECRETARY LENDER: SOUTHERN CALIFORNIA BANK BY: /s/ Authorized Officer ------------------------------ AUTHORIZED OFFICER ================================================================================ ADDITIONAL TERMS, CONDITIONS AND COVENANTS BORROWER: SMARTALK TELESERVICES, INC. (TIN: 95--4502740) LENDER: SOUTHERN CALIFORNIA BANK 1640 S. SEPULVEDA BLVD., STE. 500 HEAD OFFICE - DOWNEY MAIN LOS ANGELES, CA 90025 10990 DOWNEY AVENUE DOWNEY, CA 90240-2296 ====================================================================================================================================
THIS ADDITIONAL TERMS, CONDITIONS AND COVENANTS IS ATTACHED TO AND BY THIS REFERENCE IS MADE A PART OF EACH BUSINESS LOAN AGREEMENT OR NEGATIVE PLEDGE AGREEMENT, DATED SEPTEMBER 18, 1996, AND EXECUTED IN CONNECTION WITH A LOAN OR OTHER FINANCIAL ACCOMMODATIONS BETWEEN SOUTHERN CALIFORNIA BANK AND SMARTALK TELESERVICES, INC.. AFFIRMATIVE COVENANTS--OTHERS: Borrower covenants and agrees with Lender that, while this Agreement is in effect, Borrower will provide the following financial information and statements and such additional information as requested by the Lender from time to time: (a) Borrower's quarterly financial statements reviewed by a C.P.A. to the Lender within 60 days of quarter end. (b) Borrower may be subject to collateral audits on a periodic basis as determined by Lender. (c) A Collateral Schedule and Borrowing Base Certificate setting forth the respective amounts of Eligible Accounts and Eligible Inventory within 5 days after the end of each week with corresponding Sales and Collection Reports. (d) Statements showing an aging and reconciliation of the Borrower's receivables within 15 days after the end of each month. (e) A statement showing an aging of accounts payable within 15 days after the end of each month. (f) A listing of names and addresses of all debtors obligated upon the Borrower's accounts receivable within 15 days after the end of each quarter. (g) Copies of the Borrower's future Federal Income Tax Returns, and any amendments thereto, within 15 days of filing thereof with the Internal Revenue Service. Borrower further agrees to promptly deliver to the Lender copies of all receipts issued to Borrower for the payments of federal withholding taxes required of it. (h) Promptly upon the Lender's request, such other statements, lists, budgets, forecasts, projections, or reports as the Borrower and as to each guarantor of the Borrower's obligations to the Lender as the Lender may request. ADDITIONAL COVENANTS AND RATIOS. Borrower agrees to comply with the following covenants and ratios: (1) Lender to review loan covenants for adjustment based upon results of pending equity offering. Covenants will be first measured as of 12/31/96 and quarterly thereafter. (2) Borrower deposit relationship to be established at Southern California Bank. (3) Borrower to maintain a ratio of Total Liabilities to Tangible Net Worth of not more than 0.50 to 1.00. ADDITIONAL DEFINITIONS. For the purpose of calculating tangible net worth and debt to tangible net worth, intangible assets shall include amounts due from Officers, Stockholders and Affiliates. THIS ADDITIONAL TERMS, CONDITIONS AND COVENANTS IS EXECUTED ON SEPTEMBER 18, 1996. BORROWER: SMARTALK TELESERVICES, INC. BY: /s/ Robert H. Lorsch BY: /s/ Glen Andrew Folck --------------------------- -------------------------------------- ROBERT H. LORSCH, PRESIDENT GLEN ANDREW FOLCK, ASSISTANT SECRETARY LENDER: SOUTHERN CALIFORNIA BANK BY: /s/ -------------------------- AUTHORIZED OFFICER ================================================================================ EX-10.23 15 PROMISSORY NOTE EXHIBIT 10.23 [LOGO OF SOUTHERN CALIFORNIA BANK APPEARS HERE] PROMISSORY NOTE BORROWER: SMARTALK TELESERVICES,INC. (TIN: 95-4502740) LENDER: SOUTHERN CALIFORNIA BANK 1640 S. SEPUIVEDA BLVD., STE. 500 HEAD OFFICE - DOWNEY MAIN LOS ANGELES, CA 90025 10990 DOWNEY AVENUE DOWNEY, CA 90240-2296 ====================================================================================================================================
PRINCIPAL AMOUNT: $1,000,000.00 INITIAL RATE: 10.625% DATE OF NOTE: September 18, 1996 PROMISE TO PAY. SMARTALK TELESERVICES, INC. ("BORROWER") PROMISES TO PAY TO SOUTHERN CALIFORNIA BANK ("LENDER"), OR ORDER, IN LAWFUL MONEY OF THE UNITED STATES OF AMERICA, THE PRINCIPAL AMOUNT OF ONE MILLION & 00/100 DOLLARS ($1,000,000.00) OR SO MUCH AS MAY BE OUTSTANDING, TOGETHER WITH INTEREST ON THE UNPAID OUTSTANDING PRINCIPAL BALANCE OF EACH ADVANCE. INTEREST SHALL BE CALCULATED FROM THE DATE OF EACH ADVANCE UNTIL REPAYMENT OF EACH ADVANCE. PAYMENT. BORROWER WILL PAY THIS LOAN ON DEMAND, OR IF NO DEMAND IS MADE, IN ONE PAYMENT OF ALL OUTSTANDING PRINCIPAL PLUS ALL ACCRUED UNPAID INTEREST ON SEPTEMBER 1, 1997. IN ADDITION, BORROWER WILL PAY REGULAR MONTHLY PAYMENTS OF ACCRUED UNPAID INTEREST BEGINNING NOVEMBER 1, 1996, AND ALL SUBSEQUENT INTEREST PAYMEMNTS ARE DUE ON THE SAME DAY OF EACH MONTH AFTER THAT. Interest on this Note is computed on a 365/360 simple interest basis; that is, by applying the ratio of the annual interest rate over a year of 360 days, multiplied by the outstanding principal balance, multiplied by the actual number of days the principal balance is outstanding. Borrower will pay Lender at Lender's address shown above or at such other place as Lender may designate in writing. Unless otherwise agreed or required by applicable law, payments will be applied first to accrued unpaid interest, then to principal, and any remaining amount to any unpaid collection costs and late charges. VARIABLE INTEREST RATE. The interest rate on this Note is subject to change from time to time based on changes in an independent index which is the WALL STREET JOURNAL PRIME RATE (the "Index"). The Index is not necessarily the lowest rate charged by Lender on its loans. If the Index becomes unavailable during the term of this loan, Lender may designate a substitute index after notice to Borrower. Lender will tell Borrower the current Index rate upon Borrower's request. Borrower understands that Lender may make loans based on other rates as well. The interest rate change will not occur more often than each DAY. THE INDEX CURRENTLY IS 8.250% PER ANNUM. THE INTEREST RATE TO BE APPLIED TO THE UNPAID PRINCIPAL BALANCE OF THIS NOTE WILL BE AT A RATE OF 2.375 PERCENTAGE POINTS OVER THE INDEX, RESULTING IN AN INITIAL RATE OF 10.625% PER ANNUM. NOTICE: Under no circumstances will the interest rate on this Note be more than the maximum rate allowed by applicable law. PREPAYMENT; MINIMUM INTEREST CHARGE. Borrower agrees that all loan fees and other prepaid finance charges are earned fully as of the date of the loan and will not be subject to refund upon early payment (whether voluntary or as a result of default), except as otherwise required by law. Other than Borrower's obligation to pay any minimum interest charge, Borrower may pay without penalty all or a portion of the amount owed earlier than it is due. Early payments will not, unless agreed to by Lender in writing, relieve Borrower of Borrower's obligation to continue to make payments of accrued unpaid interest. Rather, they will reduce the principal balance due. LATE CHARGE. If a payment is 10 DAYS OR MORE LATE, Borrower will be charged 5.000% OF THE REGULARLY SCHEDULED PAYMENT OR $5.00, WHICHEVER IS GREATER. DEFAULT. Borrower will be in default if any of the following happens: (a) Borrower fails to make any payment when due. (b) Borrower breaks any promise Borrower has made to Lender, or Borrower fails to comply with or to perform when due any other term, obligation, covenant, or condition contained in this Note or any agreement related to this Note, or in any other agreement or loan Borrower has with Lender. (c) Borrower defaults under any loan, extension of credit, security agreement, purchase or sales agreement, or any other agreement, in favor of any other creditor or person that may materially affect any of Borrower's property or Borrower's ability to repay this Note or perform Borrower's obligations under this Note or any of the Related Documents. (d) Any representation or statement made or furnished to Lender by Borrower or on Borrower's behalf is false or misleading in any of the material respect either now or at the time made or furnished. (e) Borrower becomes insolvent, a receiver is appointed for any part of Borrower's property, Borrower makes an assignment for the benefit of creditors, or any proceeding is commenced either by Borrower or against Borrower under any bankruptcy or insolvency laws. (f) Any creditor tries to take any of Borrower's property on or in which Lender has a lien or security interest. This includes a garnishment of any of Borrower's accounts with Lender. (g) Any guarantor dies or any of the other events described in this default section occurs with respect to any guarantor of this Note. (h) A material adverse change occurs in Borrower's financial condition, or Lender believes the prospect of payment or performance of the Indebtedness is impaired. (i) Lender in good faith deems itself insecure. LENDER'S RIGHTS. Upon default, Lender may declare the entire unpaid principal balance on this Note and all accrued unpaid interest immediately due, without notice, and then Borrower will pay that amount. Upon Borrower's failure to pay all amounts declared due pursuant to this section, including failure to pay upon final maturity, Lender, at its option, may also, if permitted under applicable law, increase the variable interest rate on this Note to 7.375 percentage points over the Index. Lender may hire or pay someone else to help collect this Note if Borrower does not pay. Borrower also will pay Lender that amount. This includes, subject to any limits under applicable law, Lender's attorneys' fees and Lender's legal expenses whether or not there is a lawsuit, including attorneys' fees and legal expenses for bankruptcy proceedings (including efforts to modify or vacate any automatic stay or injunction), appeals, and any anticipated post-judgment collection services. Borrower also will pay any court costs, in addition to all other sums provided by law. THIS NOTE HAS BEEN DELIVERED TO LENDER AND ACCEPTED BY LENDER IN THE STATE OF CALIFORNIA. IF THERE IS A LAWSUIT, BORROWER AGREES UPON LENDER'S REQUEST TO SUBMIT TO THE JURISDICTION OF THE COURTS OF LOS ANGELES COUNTY, THE STATE OF CALIFORNIA SUBJECT TO THE PROVISIONS ON ARBITRATION, THIS NOTE SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF CALIFORNIA. DISHONORED ITEM FEE. Borrower will pay a fee to lender of $16.00 if Borrower makes a payment on Borrower's loan and the check or preauthorized charge with which Borrower pays is later dishonored. RIGHT OF SETOFF. Borrower grants to Lender a contractual possessory security interest in, and hereby assigns, conveys, delivers, pledges, and transfers to Lender all Borrower's right, title and interest in and to, Borrower's accounts with Lender (whether checking, savings, or some other account), including without limitation all accounts held jointly with someone else and all accounts Borrower may open in the future, excluding however all IRA and Keogh accounts, and all trust accounts for which the grant of a security interest would be prohibited by law. Borrower authorizes Lender, to the extent permitted by applicable law, to charge or setoff all sums owing on this Note against any and all such accounts. LINE OF CREDIT. This Note evidences a revolving line of credit. Advances under this Note may be requested orally by Borrower or by an authorized person. Lender may, but need not, require that all oral requests be confirmed in writing. All communications, instructions, or directions by telephone or otherwise to Lender are to be directed to Lender's office shown above. The following party or parties are authorized to request advances under the line of credit until Lender receives from Borrower at Lender's address shown above written notice of revocation of their authority: ROBERT H. LORSCH, PRESIDENT; AND GLEN ANDREW FOLCK, ASSISTANT SECRETARY. Borrower agrees to be liable for all sums either: (a) advanced in accordance with the instructions of an authorized person or (b) credited to any of Borrower's accounts with Lender. The unpaid principal balance owing on this Note at any time may be evidenced by endorsements on this Note or by Lender's internal records, including daily computer print-outs. Lender will have no obligation to advance funds under this Note if: (a) Borrower or any guarantor is in default under the terms of this Note or any agreement that Borrower or any guarantor has with Lender, including any agreement made in connection with the signing of this Note; (b) Borrower or any guarantor ceases doing business or is insolvent; (c) any guarantor seeks, claims or otherwise attempts to limit, modify or revoke such guarantor's guarantee of this Note or any other loan with Lender; (d) Borrower has applied funds provided pursuant to this Note for purposes other than those authorized by Lender; or (e) Lender in good faith deems itself insecure under this Note or any other agreement Lender and Borrower. ARBITRATION. LENDER AND BORROWER AGREE THAT ALL DISPUTES, CLAIMS AND CONTROVERSIES BETWEEN THEM, WHETHER INDIVIDUAL, JOINT, OR CLASS IN NATURE, ARISING FROM THIS NOTE OR OTHERWISE, INCLUDING WITHOUT LIMITATION CONTRACT AND TORT DISPUTES, SHALL BE ARBITRATED PURSUANT TO THE RULES OF THE AMERICAN ARBITRATION ASSOCIATION, UPON REQUEST OF EITHER PARTY. No act to take or dispose of any collateral securing this Note shall constitute a waiver of this arbitration agreement or be prohibited by this arbitration agreement. This includes, without limitation, obtaining injunctive relief or a temporary restraining order; invoking a power of sale under any deed of trust or mortgage; obtaining a writ of attachment or imposition of a receiver; or exercising any rights relating to personal property, including taking or disposing of such property with or without judicial process pursuant to Article 9 of the Uniform Commercial Code. Any disputes, claims, or controversies concerning the lawfulness or reasonableness of any act, or exercise of any right, concerning any collateral securing this Note, including any claim to rescind, reform, or otherwise modify any agreement relating to the collateral securing this Note, shall also be arbitrated, provided however that no arbitrator shall have the right or the power to enjoin or restrain any act of any party. Lender and Borrower agree that in the event of an action for judicial foreclosure pursuant to California Code of Civil Procedure Section 726, or any similar provision in any other state, the commencement of such an action will not constitute a waiver of the right to arbitrate and the court shall refer to arbitration as much of such action, including counterclaims, as lawfully may be referred to arbitration. Judgment upon any award rendered by any arbitrator may be entered in any court having jurisdiction. Nothing in this Note shall preclude any party from seeking equitable relief from a court of 09-18-1996 PROMISSORY NOTE PAGE 2 LOAN NO 404569048 (CONTINUED) ================================================================================ brought by a party shall be applicable in any arbitration proceeding, and the commencement of an arbitration proceeding shall be deemed the commencement of an action for these purposes. The Federal Arbitration Act shall apply to the construction, interpretation, and enforcement of this arbitration provision. GENERAL PROVISIONS. This Note is payable on demand. The inclusion of specific default provisions or rights of Lender shall not preclude Lender's right to declare payment of this Note on its demand. Lender may delay or forgo enforcing any of its rights or remedies under this Note without losing them. Borrower and any other person who signs, guarantees or endorses this Note, to the extent allowed by law, waive any applicable statute of limitations, presentment, demand for payment, protest and notice of dishonor. Upon any change in the terms of this Note, and unless otherwise expressly stated in writing, no party who signs this Note, whether as maker, guarantor, accommodation maker or endorser, shall be released from liability. All such parties agree that Lender may renew or extend (repeatedly and for any length of time) this loan, or release any party or guarantor or collateral; or impair, fail to realize upon or perfect Lender's security interest in the collateral; and take any other action deemed necessary by Lender without the consent of or notice to anyone. All such parties also agree that Lender may modify this loan without the consent of or notice to anyone other than the party with whom the modification is made. PRIOR TO SIGNING THIS NOTE, BORROWER READ AND UNDERSTOOD ALL THE PROVISIONS OF THIS NOTE, INCLUDING THE VARIABLE INTEREST RATE PROVISIONS. BORROWER AGREES TO THE TERMS OF THE NOTE AND ACKNOWLEDGES RECEIPT OF A COMPLETED COPY OF THE NOTE. BORROWER: SMARTALK TELESERVICES, INC. BY: /s/ Robert H. Lorsch BY: /s/ Glen Andrew Folck --------------------------- -------------------------------------- ROBERT H. LORSCH, PRESIDENT GLEN ANDREW FOLCK, ASSISTANT SECRETARY LENDER: SOUTHERN CALIFORNIA BANK BY: /s/ --------------------------- AUTHORIZED OFFICER ================================================================================ EX-10.24 16 COMMERCIAL SECURITY AGREEMENT EXHIBIT 10.24 [LOGO OF SOUTHERN CALIFORNIA APPEARS HERE] COMMERCIAL SECURITY AGREEMENT BORROWER: SMARTALK TELESERVICES, INC. (TIN: 95-4502740) LENDER: SOUTHERN CALIFORNIA BANK 1640 S. SEPULVEDA BLVD., STE.500 HEAD OFFICE - DOWNEY MAIN LOS ANGELES, CA 90025 10990 DOWNEY AVENUE DOWNEY, CA 90240-2296 ==========================================================================================================================
THIS COMMERCIAL SECURITY AGREEMENT IS ENTERED INTO BETWEEN SMARTALK TELESERVICES, INC. (REFERRED TO BELOW AS "GRANTOR"); AND SOUTHERN CALIFORNIA BANK (REFERRED TO BELOW AS "LENDER"). FOR VALUABLE CONSIDERATION, GRANTOR GRANTS TO LENDER A SECURITY INTEREST IN THE COLLATERAL TO SECURE THE INDEBTEDNESS AND AGREES THAT LENDER SHALL HAVE THE RIGHTS STATED IN THIS AGREEMENT WITH RESPECT TO THE COLLATERAL, IN ADDITION TO ALL OTHER RIGHTS WHICH LENDER MAY HAVE BY LAW. DEFINITIONS. The following words shall have the following meanings when used in this Agreement. Terms not otherwise defined in this Agreement shall have the meanings attributed to such terms in the Uniform Commercial Code. All references to dollar amounts shall mean amounts in lawful money of the United States of America. AGREEMENT. The word "Agreement" means this Commercial Security Agreement, as this Commercial Security Agreement may be amended or modified from time to time, together with all exhibits and schedules attached to this Commercial Security Agreement from time to time. COLLATERAL. The word "Collateral" means the following described property of Grantor, whether now owned or hereafter acquired, whether now existing or hereafter arising, and wherever located: ALL INVENTORY, CHATTEL PAPER, ACCOUNTS, EQUIPMENT AND GENERAL INTANGIBLES In addition, the word "Collateral" includes all the following, whether now owned or hereafter acquired, whether now existing or hereafter arising, and wherever located: (a) All attachments, accessions, accessories, tools, parts, supplies, increases, and additions to and all replacements of and substitutions for any property described above. (b) All products and produce of any of the property described in this Collateral section. (c) All accounts, general intangibles, instruments, rents, monies, payments, and all other rights, arising out of a sale, lease, or other disposition of any of the property described in this Collateral section. (d) All proceeds (including insurance proceeds) from the sale, destruction, loss, or other disposition of any of the property described in this Collateral section. (e) All records and data relating to any of the property described in this Collateral section, whether in the form of a writing; photograph, microfilm, microfiche, or electronic media, together with all of Grantor's right, title, and interest in and to all computer software required to utilize, create, maintain, and process any such records or data on electronic media. EVENT OF DEFAULT. The words "Event of Default" mean and include without limitation any of the Events of Default set forth below in the section titled "Events of Default." GRANTOR. The word "Grantor" means SmarTalk TeleServices, Inc., its successors and assigns. GUARANTOR. The word "Guarantor" means and includes without limitation each and all of the guarantors, sureties, and accommodation parties in connection with the indebtedness. INDEBTEDNESS. The word "Indebtedness" means the Indebtedness evidenced by the Note, including all principal and interest, together with all other indebtedness and costs and expenses for which Grantor is responsible under this Agreement or under any of the Related Documents. In addition, the word "Indebtedness" includes all other obligations, debts and liabilities, plus interest thereon, of Grantor, or any one or more of them, to Lender, as well as all claims by Lender against Grantor, or any one or more of them, whether existing now or later; whether they are voluntary or involuntary, due or not due, direct or indirect, absolute or contingent, liquidated or unliquidated; whether Grantor may be liable individually or jointly with others; whether Guarantor may be obligated as guarantor, surety, accommodation party or otherwise; whether recovery upon such indebtedness may be or hereafter may become barred by any statute of limitations; and whether such indebtedness may be or hereafter may become otherwise unenforceable. LENDER. The word "Lender" means SOUTHERN CALIFORNIA BANK, its successors and assigns. NOTE. The word "Note" means the note or credit agreement dated September 18, 1996, in the principal amount of $1,000,000.00 from SmarTalk TeleServices, Inc. to Lender, together with all renewals of, extensions of, modifications of, refinancings of, consolidations of and substitutions for the note or credit agreement. RELATED DOCUMENTS. The words "Related Documents" mean and include without limitation all promissory notes, credit agreements, loan agreements, environments, environmental agreements, guaranties, security agreements, mortgages, deeds of trust, and all other instruments, agreements and documents, whether now or hereafter existing, executed in connection with the Indebtedness. RIGHT OF SETOFF. Grantor hereby grants Lender a contractual possessory security interest in and hereby assigns, conveys, delivers, pledges, and transfers all of Grantor's right, title and interest in and to Grantor's accounts with Lender (whether checking, savings, or some other account), including all accounts held jointly with someone else and all accounts Grantor may open in the future, excluding, however, all IRA and Keogh accounts, and all trust accounts for which the grant of a security interest would be prohibited by law. Grantor authorizes Lender, to the extent permitted by applicable law, to charge or setoff all Indebtedness against any and all such accounts. OBLIGATIONS OF GRANTOR. Grantor warrants and covenants to Lender as follows: PERFECTION OF SECURITY INTEREST. Grantor agrees to exclude such financing statements and to take whatever other actions are requested by Lender to perfect and continue Lender's security interest in the Collateral. Upon request of Lender, Grantor will deliver to Lender any and all of the documents evidencing or constituting the Collateral, and Grantor will note Lender's interest upon any and all chattel paper if not delivered to Lender for possession by Lender. Grantor hereby appoints Lender as its irrevocable attorney-in-fact for the purpose of executing any documents necessary to perfect or to continue the security interest granted in this Agreement. Lender may at any time, and without further authorization from Grantor, file a carbon, photographic or other reproduction of any financing statement or of this Agreement for use as a financing statement. Grantor will reimburse Lender for all expenses for the perfection and the continuation of the perfection of Lender's security interest in the Collateral. Grantor promptly will notify Lender before any change in Grantor's name including any change to the assumed business names of Guarantor. THIS IS A CONTINUING SECURITY AGREEMENT AND WILL CONTINUE IN EFFECT EVEN THOUGH ALL OR ANY PART OF THE INDEBTEDNESS IS PAID IN FULL AND EVEN THOUGH FOR A PERIOD OF TIME GRANTOR MAY NOT BE INDEBTED TO LENDER. NO VIOLATION. The execution and delivery of this Agreement will not violate any law or agreement governing Grantor or to which Grantor is a party, and its certificate or articles of incorporation and bylaws do not prohibit any term or condition of this Agreement. ENFORCEABILITY OF COLLATERAL. To the extent the Collateral consists of accounts, chattel paper, or general intangibles, the Collateral is enforceable in accordance with its terms, is genuine, and complies with applicable laws concerning form, content and manner of preparation and execution, and all persons appearing to be obligated on the Collateral have authority and capacity to contract and are in fact obligated as they appear to be on the Collateral. At the time any account becomes subject to a security interest in favor of Lender, the account shall be a good and valid account representing an undisputed, bona fide indebtedness incurred by the account debtor, for merchandise held subject to delivery instructions or theretofore shipped or delivered pursuant to a contract of sale, or for services theretofore performed by Grantor with or for the account debtor; there shall be no setoffs or counterclaims against any such account; and no agreement under which any deductions or discounts may be claimed shall have been made with the account debtor those disclosed to Lender in writing. LOCATION OF THE COLLATERAL. Grantor, upon request of Lender, will deliver to Lender in form satisfactory to Lender a schedule of real properties and Collateral locations relating to Grantor's operations, including without limitation the following: (a) all real property owned or being purchased by Grantor; (b) all real property being rented or leased by Grantor; (c) all storage facilities owned, rented, leased, or being used by Grantor; and (d) all other properties where Collateral is or may be located. Except in the ordinary course of its business, Grantor shall not remove the 09-18-1996 COMMERCIAL SECURITY AGREEMENT PAGE 2 LOAN NO 404569048 (CONTINUED) ================================================================================ REMOVAL OF COLLATERAL. Grantor shall keep the Collateral (or to the extent the Collateral consists of intangible property such as accounts, the records concerning the Collateral) at Grantor's address shown above, or at such other locations as are acceptable to Lender. Except in the ordinary course of its business, including the sales of inventory, Grantor shall not remove the Collateral from its existing locations without the prior written consent of Lender. To the extent that the Collateral consists of vehicles, or other titled property, Grantor shall not take or permit any action which would require application for certificate of title for the vehicles outside the State of California, without the prior written consent of Lender. TRANSACTIONS INVOLVING COLLATERAL. Except for inventory sold or accounts collected in the ordinary course of Grantor's business, Grantor shall not sell, offer to sell, or otherwise transfer or dispose of the Collateral. While Grantor is not in default under this Agreement, Grantor may sell inventory, but only in the ordinary course of its business and only to buyers who qualify as a buyer in the ordinary course of business. A sale in the ordinary course of Grantor's business does not include a transfer in partial or total satisfaction of a debt or any bulk sale. Grantor shall not pledge, mortgage, encumber or otherwise permit the Collateral to be subject to any lien, security interest, encumbrance, or charge, other than the security interest provided for in this Agreement, without the prior written consent of Lender. This includes security interests even if junior in right to the security interests granted under this Agreement. Unless waived by Lender, all proceeds from any disposition of the Collateral (for whatever reason) shall be held in trust for Lender and shall not be commingled with any other funds; provided however, this requirement shall not constitute consent by Lender to any sale or other disposition. Upon receipt, Grantor shall immediately deliver any such proceeds to Lender. TITLE. Grantor represents and warrants to Lender that it holds good and marketable title to the Collateral, free and clear of all liens and encumbrances except for the lien of this Agreement. No financing statement covering any of the Collateral is on file in any public office other than those which reflect the security interest created by this Agreement or to which Lender has specially consented. Grantor shall defend Lender's rights in the Collateral against the claims and demands of all other persons. COLLATERAL SCHEDULES AND LOCATIONS. As often as Lender shall require, and insofar as the Collateral consists of accounts and general intangibles, Grantor shall deliver to Lender schedules of such Collateral, including such information as Lender may require, including without limitation names and addresses of account debtors and agings of accounts and general intangibles. Insofar as the Collateral consists of inventory and equipment, Grantor shall deliver to Lender, as often as Lender shall require, such lists, descriptions, and designations of such Collateral as Lender may require to identify the nature, extent, and location of such Collateral. Such information shall be submitted for Grantor and each of its subsidiaries or related companies. MAINTENANCE AND INSPECTION OF COLLATERAL. Grantor shall maintain all tangible Collateral in good condition and repair. Grantor will not commit or permit damage to or destruction of the Collateral or any part of the Collateral. Lender and its designated representatives and agents shall have the right at all reasonable times to examine, inspect, and audit the Collateral wherever located. Grantor shall immediately notify Lender of all cases involving the return, rejection, repossession, loss or damage of or to any Collateral; of any request for credit or adjustment or of any other dispute arising with respect to the Collateral; and generally of all happenings and events affecting the Collateral or the value or the amount of the Collateral. TAXES, ASSESSMENTS AND LIENS. Grantor will pay when due all taxes, assessments and liens upon the Collateral, its use or operation, upon this Agreement, upon any promissory note or notes evidencing the Indebtedness, or upon any of the other Related Documents. Grantor may withhold any such payment or may elect to contest any lien if Grantor is in good faith conducting an appropriate proceeding to contest the obligation to pay and so long as Lender's interest in the Collateral is not jeopardized in Lender's sole opinion. If the Collateral is subjected to a lien which is not discharged within fifteen (15) days, Grantor shall deposit with Lender cash, a sufficient corporate surety bond or other security satisfactory to Lender in an amount adequate to provide for the discharge of the lien plus any interest, costs, attorneys' fees or other charges that could accrue as a result of foreclosure or sale of the Collateral. In any contest Grantor shall defend itself and Lender and shall satisfy any final adverse judgment before enforcement against the Collateral. Grantor shall name Lender as an additional obligee under any surety bond furnished in the contest proceedings. COMPLIANCE WITH GOVERNMENT REQUIREMENTS. Grantor shall comply promptly with laws, ordinances, rules and regulations of all governmental authorities, now or hereafter in effect, applicable to the ownership, production, disposition, or use of the Collateral. Grantor may contest in good faith any such law, ordinance or regulation and withhold compliance during any proceeding, including appropriate appeals, so long as Lender's interest in the Collateral, in Lender's opinion, is not jeopardized. HAZARDOUS SUBSTANCES. Grantor represents and warrants that the Collateral never has been, and never will be so long as this Agreement remains a lien on the Collateral, used for the generation, manufacture, storage, transportation, treatment, disposal, release or threatened release of any hazardous waste or substance, as those terms are defined in the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended, 42 U.S.C. Section 9601, et seq. ("CERCLA"), the Superfund Amendments and Reauthorization Act of 1986, Pub. L. No. 99-499 ("SARA"), the Hazardous Material Transportation Act, 49 U.S.C. Section 1801, et seq., the Resource Conversation and Recovery Act, 42 U.S.C. Section 6901, et seq., Chapters 6.5 through 7.7 of Division 20 of the California Health and Safety Code, Section 25100, et seq., or other applicable state or Federal laws, rules, or regulations adopted pursuant to any of the foregoing. The terms "hazardous waste" and "hazardous substance" shall also include, without limitation, petroleum and petroleum by-products or any fraction thereof and asbestos. The representations and warranties contained herein are based on Grantor's due diligence in investigating the Collateral for hazardous wastes and substances. Grantor hereby (a) release and waives any future claims against Lender for indemnity or contribution in the event Grantor becomes liable for cleanup or other costs under any such laws, and (b) agrees to indemnify and hold harmless Lender against any and all claims and losses resulting from a breach of this provision of this Agreement. This obligation to indemnify shall survive the payment of the Indebtedness and the satisfaction of this Agreement. MAINTENANCE OF CASUALTY INSURANCE. Grantor shall procure and maintain all risks insurance, including without limitation fire, theft and liability coverage together with such other insurance as Lender may require with respect to the Collateral, in form, amounts, coverages and basis reasonably acceptable to Lender and issued by a company or companies reasonably acceptable to Lender. Grantor, upon request of Lender, will deliver to Lender from time to time the policies or certificates of insurance in form satisfactory to Lender, including stipulations that coverages will not be cancelled or diminished without at least thirty (30) days' prior written notice to Lender and not including any disclaimer of the insurer's liability for failure to give such a notice. Each insurance policy also shall include an endorsement providing that coverage in favor of Lender will not be impaired in any way by any act, omission or default or Grantor or any other person. In connection with all policies covering assets in which Lender holds or is offered a security interest, Grantor will provide Lender with such loss payable or other endorsements as Lender may require. If Grantor at any time fails to obtain or maintain any insurance as required under this Agreement, Lender may (but shall not be obligated to) obtain such insurance as Lender deems appropriate, including if it so chooses "single interest insurance," which will cover only Lender's interest in the Collateral. APPLICATION OF INSURANCE PROCEEDS. Grantor shall promptly notify Lender of any loss or damage to the Collateral. Lender may make proof of loss if Grantor fails to do so within fifteen (15) days of the casualty. All proceeds of any insurance on the Collateral, including accrued proceeds thereon, shall be held by Lender as part of the Collateral. If Lender consents to repair or replacement of the damaged or destroyed Collateral, Lender shall, upon satisfactory proof of expenditure, pay or reimburse Grantor from the proceeds for the reasonable cost of repair or restoration. If Lender does not consent to repair or replacement of the Collateral, Lender shall retain a sufficient amount of the proceeds to pay all of the indebtedness, and shall pay the balance to Grantor. Any proceeds which have not been disbursed within six (6) months after their receipt and which Grantor has not committed to the repair or restoration of the Collateral shall be used to prepay the Indebtedness. INSURANCE RESERVES. Lender may require Grantor to maintain with Lender reserves for payment of insurance premiums, which reserves shall be created by monthly payments from Grantor of a sum estimated by Lender to be sufficient to produce, at least fifteen (15) days before the premium due date, amounts at least equal to the insurance premiums to be paid. If fifteen (15) days before payment is due, the reserve funds are insufficient, Grantor shall upon demand pay any deficiency to Lender. The reserve funds shall be held by Lender as a general deposit and shall constitute a non-interest-bearing account which Lender may satisfy by payment of the insurance premiums required to be paid by Grantor as they become due. Lender does not hold the reverse funds in trust for Grantor, and Lender is not the agent of Grantor for payment of the insurance premiums required to be paid by Grantor. The responsibility for the payment of premiums shall remain Grantor's sole responsibility. INSURANCE REPORTS. Grantor, upon request of Lender, shall furnish Lender reports on each existing policy of insurance showing such information as lender may reasonably request including the following: (a) the name of the insurer; (b) the risks insured; (c) the amount of the policy; (d) the property insured; (e) the then current value on the basis of which insurance has been obtained and the manner of determining that value; and (f) the expiration date of the policy. In addition, Grantor shall upon request by Lender (however not more often than annually) have an independent appraiser satisfactory to Lender determine, as applicable, the cash value or replacement cost of the Collateral. GRANTOR'S RIGHT TO POSSESSION AND TO COLLECT ACCOUNTS. Until default and except as otherwise provided below with respect to accounts, Grantor may have possession of the tangible personal property and beneficial use of all the Collateral and may use it in any lawful manner not inconsistent with this Agreement or the Related Documents, provided that Grantor's right to possession and beneficial use shall not apply to any Collateral where possession of the Collateral by Lender is required by law to perfect Lender's security interest in such Collateral. Until otherwise notified by Lender, Grantor may collect any of the Collateral consisting of accounts. At any time and even though no Event of Default exists, Lender may exercise its rights to collect the accounts and to notify account debtors to make payments directly to Lender for application to the Indebtedness. If Lender at any time has possession of any Collateral, whether before or after an Event of Default, Lender shall be deemed to have exercised reasonable care in the custody and preservation of the Collateral if Lender takes such action for that purpose as Grantor shall request or as Lender, in 09-18-1996 COMMERCIAL SECURITY AGREEMENT PAGE 3 LOAN NO 404569048 (CONTINUED) ================================================================================ parties, nor to protect, preserve or maintain any security interest given to secure the Indebtedness. EXPENDITURES BY LENDER. If not discharged or paid when due, Lender may (but shall not be obligated to) discharge or pay any amounts required to be discharged or paid by Grantor under this Agreement, including without limitation all taxes, liens, security interests, encumbrances, and other claims, at any time levied or placed on the Collateral. Lender also may (but shall not be obligated to) pay all costs for insuring, maintaining and preserving the Collateral. All such expenditures incurred or paid by Lender for such purposes will then bear interest at the rate charged under the Note from the date incurred or paid by Lender to the date of repayment by Grantor. All such expenses shall become a part of the Indebtedness and, at Lender's option, will (a) be payable on demand, (b) be added to the balance of the Note and be apportioned among and be payable with any installment payments to become due during either (i) the term of any applicable insurance policy or (ii) the remaining term of the Note, or (c) be treated as a balloon payment which will be due and payable at the Note's maturity. This Agreement also will secure payment of these amounts. Such right shall be in addition to all other rights and remedies to which Lender may be entitled upon the occurrence of an Event of Default. EVENTS OF DEFAULT. Each of the following shall constitute an Event of Default under this Agreement: DEFAULT ON INDEBTEDNESS. Failure of Grantor to make any payment when due on the Indebtedness. OTHER DEFAULTS. Failure of Grantor to comply with or to perform any other term, obligation, covenant or condition contained in this Agreement or in any of the Related Documents or in any other agreement between Lender and Grantor. DEFAULT IN FAVOR OF THIRD PARTIES. Should Borrower or any Grantor default under any loan, extension of credit, security agreement, purchase or sales agreement, or any other agreement, in favor of any other creditor or person that may materially affect any of Borrower's property or Borrower's or any Grantor's ability to repay the Loans or perform their respective obligations under this Agreement or any of the Related Documents. FALSE STATEMENTS. Any warranty, representation or statement made or furnished to Lender by or on behalf of Grantor under this Agreement, the Note or the Related Documents is false or misleading in any material respect, either now or at the time made or furnished. DEFECTIVE COLLATERALIZATION. This Agreement or any of the Related Documents ceases to be in full force and effect (including failure of any collateral documents to create a valid and perfected security interest or lien) at any time and for any reason. INSOLVENCY. The dissolution or termination of Grantor's existence as a going business, the insolvency of Grantor, the appointment of a receiver for any part of Grantor's property, any assignment for the benefit of creditors, any type of creditor workout, or the commencement of any proceeding under any bankruptcy or insolvency laws by or against Grantor. CREDITOR OR FORFEITURE PROCEEDINGS. Commencement of foreclosure or forfeiture proceedings, whether by judicial proceeding, self-help, repossession or any other method, by any creditor of Grantor or by any governmental agency against the Collateral or any other collateral securing the Indebtedness. This includes a garnishment of any Grantor's deposit accounts with Lender. EVENTS AFFECTING GUARANTOR. Any of the preceding events occurs with respect to any Guarantor of any of the Indebtedness or such Guarantor dies or becomes incompetent. ADVERSE CHANGE. A material adverse change occurs in Grantor's financial condition, or Lender believes the prospect of payment or performance of the indebtedness is impaired. INSECURITY. Lender, in good faith, deems itself insecure. RIGHTS AND REMEDIES ON DEFAULT. If an Event of Default occurs under this Agreement, at any time thereafter, Lender shall have all the rights of a secured party under the California Uniform Commercial Code. In addition and without limitation, Lender may exercise any one or more of the following rights and remedies: ACCELERATE INDEBTEDNESS. Lender may declare the entire Indebtedness, including any prepayment penalty which Grantor would be required to pay, immediately due any payable, without notice. ASSEMBLE COLLATERAL. Lender may require Grantor to deliver to Lender all or any portion of the Collateral and any and all certificates of title and other documents relating to the Collateral. Lender may require Grantor to assemble the Collateral and make it available to Lender at a place to be designated by Lender. Lender also shall have full power to enter upon the property of Grantor to take possession of and remove the Collateral. If the Collateral contains other goods not covered by this Agreement at the time of repossession, Grantor agrees Lender may take such other goods, provided that Lender makes reasonable efforts to return them to Grantor after repossession. SELL THE COLLATERAL. Lender shall have full power to sell, lease, transfer, or otherwise deal with the Collateral or proceeds thereof in its own name or that of Grantor. Lender may sell the Collateral at public auction or private sale. Unless the Collateral threatens to decline speedily in value or is of a type customarily sold on a recognized market, Lender will give Grantor reasonable notice of the time after which any private sale or any other intended disposition of the Collateral is to be made. The requirements of reasonable notice shall be met if such notice is given at least ten (10) days, or such lesser time as required by state law, before the time of the sale or disposition. All expenses relating to the disposition of the Collateral, including without limitation the expense of retaking, holding, insuring, preparing for sale and selling the Collateral, shall become a part of the Indebtedness secured by this Agreement and shall be payable on demand, with interest at the Note rate from date of expenditure until repaid. APPOINT RECEIVER. To the extent permitted by applicable law, Lender shall have the following rights and remedies regarding the appointment of a receiver: (a) Lender may have a receiver appointed as a matter of right, (b) the receiver may be an employee of Lender and may serve without bond, and (c) all fees of the receiver and his or her attorney shall become part of the Indebtedness secured by this Agreement and shall be payable on demand, with interest at the Note rate from date of expenditure until repaid. COLLECT REVENUES, APPLY ACCOUNTS. Lender, either itself or through a receiver, may collect the payments, rents, income, and revenues from the Collateral. Lender may at any time in its discretion transfer any Collateral into its own name or that of its nominee and receive the payments, rents, income, and revenues therefrom and hold the same as security for the Indebtedness or apply it to payment of the Indebtedness in such order of preference as Lender may determine. Insofar as the Collateral consists of accounts, general intangibles, insurance policies, instruments, chattel paper, choses in action, or similar property, Lender may demand, collect, receipt for, settle, compromise, adjust, sue for, foreclose, or realize on the Collateral as Lender may determine, whether or not Indebtedness or Collateral is then due. For these purposes, Lender may, on behalf of and in the name of Grantor, receive, open and dispose of mail addressed to Grantor; change any address to which mail and payments are to be sent; and endorse notes, checks, drafts, money orders, documents of title, instruments and items pertaining to payment, shipment, or storage of any Collateral. To facilitate collection, Lender may notify account debtors and obligors on any Collateral to make payments directly to Lender. OBTAIN DEFICIENCY. If Lender chooses to sell any or all of the Collateral, Lender may obtain a judgment against Grantor for any deficiency remaining on the Indebtedness due to Lender after application of all amounts received from the exercise of the rights provided in this Agreement. Grantor shall be liable for a deficiency even in the transaction described in this subsection is a sale of accounts or chattel paper. OTHER RIGHTS AND REMEDIES. Lender shall have all the rights and remedies of a secured creditor under the provisions of the Uniform Commercial Code, as may be amended from time to time. In addition, Lender shall have and may exercise any or all other rights and remedies it may have available at law, in equity, or otherwise. CUMULATIVE REMEDIES. All of Lender's rights and remedies, whether evidenced by this Agreement or the Related Documents or by any other writing, shall be cumulative and may be exercised singularly or concurrently. Election by Lender to pursue any remedy shall not exclude pursuit of any other remedy, and an election to make expenditures or to take action to perform an obligation of Grantor under this Agreement, after Grantor's failure to perform, shall not affect Lender's right to declare a default and to exercise its remedies. MISCELLANEOUS PROVISIONS. The following miscellaneous provisions are a part of this Agreement; AMENDMENTS. This Agreement, together with any Related Documents, constitutes the entire understanding and agreement of the parties as to the matters set forth in this Agreement. No alteration of or amendment to this Agreement shall be effective unless given in writing and signed by the party or parties sought to be charged or bound by the alteration or amendment. APPLICABLE LAW. This Agreement has been delivered to Lender accepted by Lender in the State of California. If there is a lawsuit, Grantor agrees upon Lender's request to submit to the jurisdiction of the courts of the State of California. Subject to the provisions on arbitration, this Agreement shall be governed by and construed in accordance with the laws of the State of California. ARBITRATION. LENDER AND GRANTOR AGREE THAT ALL DISPUTES, CLAIMS AND CONTROVERSIES BETWEEN THEM, WHETHER INDIVIDUAL, JOINT, OR CLASS IN NATURE, ARISING FROM THIS AGREEMENT OR OTHERWISE, INCLUDING WITHOUT LIMITATION CONTRACT AND TORT DISPUTES, SHALL BE ARBITRATED PURSUANT TO THE RULES OF THE AMERICAN ARBITRATION ASSOCIATION, UPON REQUEST OF EITHER PARTY. No act to take or dispose of any Collateral shall constitute a waiver of this arbitration agreement or be prohibited by this arbitration agreement. This includes, without limitation, obtaining injunctive relief or a temporary restraining order; invoking a power of sale under any deed of trust or mortgage; obtaining a writ of attachment or imposition of a receiver; or exercising any rights relating to personal property, including taking or disposing of such property with or without judicial process pursuant to Article 9 of the Uniform Commercial Code. Any disputes, claims, or controversies concerning the lawfulness or reasonableness of 09-18-1996 COMMERCIAL SECURITY AGREEMENT PAGE 4 LOAN NO 404569048 (CONTINUED) ================================================================================ the Collateral, shall also be arbitrated, provided however that no arbitrator shall have the right or the power to enjoin or restrain any act of any party. Lender and Grantor agree that in the event of an action for judicial foreclosure pursuant to California Code of Civil Procedure Section 726, or any similar provision in any other state, the commencement of such an action will not constitute a waiver of the right to arbitrate and the court shall refer to arbitration as much of such action, including counterclaims, as lawfully may be referred to arbitration. Judgment upon any award rendered by any arbitrator may be entered in any court having jurisdiction. Nothing in this Agreement shall preclude any party from seeking equitable relief from a court of competent jurisdiction. The statute of limitations, estoppel, waiver, laches, and similar doctrines which would otherwise be applicable in an action brought by a party shall be applicable in any arbitration proceeding, and the commencement of an arbitration proceeding shall be deemed the commencement of an action for these purposes. The Federal Arbitration Act shall apply to the construction, interpretation, and enforcement of this arbitration provision. ATTORNEY'S FEES; EXPENSES. Grantor agrees to pay upon demand all of Lender's costs and expenses, including attorneys' fees and Lender's legal expenses, incurred in connection with the enforcement of this Agreement. Lender may pay someone else to help enforce this Agreement, and Grantor shall pay the costs and expenses of such enforcement. Costs and expenses include Lender's attorneys' fees and legal expenses whether or not there is a lawsuit, including attorneys' fees and legal expenses for bankruptcy proceedings (and including efforts to modify or vacate any automatic stay or injunction), appeals, and any anticipated post-judgment collection services. Grantor also shall pay all courts costs and such additional fees as may be directed by the court. CAPTION HEADINGS. Caption headings in this Agreement are for convenience purposes only and are not to be used to interpret or define the provisions of this Agreement. MULTIPLE PARTIES; CORPORATE AUTHORITY. All obligations of Grantor under this Agreement shall be joint and several, and all reference to Grantor shall mean each and every Grantor. This means that each of the Borrowers signing below is responsible for ALL obligations in this Agreement. NOTICES. All notices required to be given under this Agreement shall be given in writing, may be sent by telefacsimille, and shall be effective when actually delivered or when deposited with a nationally recognized overnight courier or deposited in the United States mail, first class, postage prepaid, addressed to the party to whom the notice is given at the address shown above. Any party may change its address for notices under this Agreement by giving formal written notice to the parties, specifying that the purpose of the notice is to change the party's address. To the extent permitted by applicable law, if there is more than one Grantor, notice to any Grantor will constitute notice to all Grantors. For notice purposes, Grantor will keep Lender informed at all times of Grantor's current address(es). POWER OF ATTORNEY. Grantor hereby appoints Lender as it true and lawful attorney-in-fact, irrevocably, with full power of substitution to do the following: (a) to demand, collect, receive, receipt for, sue and recover all sums of money or other property which may now or hereafter become due, owing or payable from the Collateral; (b) to execute, sign and endorse any and all claims, instruments, receipts, checks, drafts or warrants issued in payment for the Collateral; (c) to settle or compromise any and all claims arising under the Collateral, and, in the place and stead of Grantor, to execute and deliver its release and settlement for the claim; and (d) to file any claim or claims or to take any action or institute or take part in any proceedings, either in its own name or in the name of Grantor, or otherwise, which in the discretion of Lender may seem to be necessary or advisable. This power is given as security for the Indebtedness, and the authority hereby conferred is and shall be irrevocable and shall remain in full force and effect until renounced by Lender. PREFERENCE PAYMENTS. Any monies Lender pays because of an asserted preference claim in Borrower's bankruptcy will become a part of the Indebtedness and, at Lender's option, shall be payable by Borrower as provided above in the "EXPENDITURES BY LENDER" paragraph. SEVERABILITY. If a court of competent jurisdiction finds any provision of this Agreement to be invalid or unenforceable as to any person or circumstance, such finding shall not render that provision invalid or unenforceable as to any other persons or circumstances. If feasible, any such offending provision shall be deemed to be modified to be within the limits of enforceability or validity; however, if the offering provision cannot be so modified, it shall be stricken and all other provisions of this Agreement in all other respects shall remain valid and enforceable. SUCCESSOR INTERESTS. Subject to the limitations set forth above on transfer of the Collateral, this Agreement shall be binding upon and inure to the benefit of the parties, their successors and assigns. WAIVER. Lender shall not be deemed to have waived any rights under this Agreement unless such waiver is given in writing and signed by Lender. No delay or omission on the part of Lender in exercising any right shall operate as a waiver of such right or any other right. A waiver by Lender of provision of this Agreement shall not prejudice or constitute a waiver of Lender's right otherwise to demand strict compliance with that provision or any other provision of this Agreement. No prior waiver by Lender, nor any course of dealing between Lender and Grantor, shall constitute a waiver of any of Lender's rights or of any Grantor's obligations as to any future transactions. Whenever the consent of Lender is required under this Agreement, the granting of such consent by Lender in any instance shall not constitute continuing consent to subsequent instances where such consent is required and in all cases such consent may be granted or withheld in the sole discretion of Lender. WAIVER OF CO-OBLIGOR'S RIGHTS. If more than one person is obligated for the Indebtedness, Borrower irrevocably waives, disclaims and relinquishs all claims against such other person which Borrower has or would otherwise have by virtue of payment of the Indebtedness or any part thereof, specifically including but not limited to all rights of indemnity, contribution or exoneration. GRANTOR ACKNOWLEDGES HAVING READ ALL THE PROVISIONS OF THIS COMMERCIAL SECURITY AGREEMENT, AND GRANTOR AGREES TO ITS TERMS. THIS AGREEMENT IS DATED SEPTEMBER 18, 1996. GRANTOR: SMARTALK TELESERVICES, INC. BY: /s/ Robert H. Lorsch BY: /s/ Glen Andrew Folck --------------------------- ---------------------------- ROBERT H. LORSCH, PRESIDENT GLEN ANDREW FOLCK, ASSISTANT SECRETARY ================================================================================ EX-23.1 17 CONSENT OF PRICE WATERHOUSE LLP 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 September 25, 1996 EX-27.1 18 ARTICLE 5 FINANCIAL DATA SCHEDULE
5 OTHER YEAR DEC-31-1994 DEC-31-1995 OCT-28-1994 JAN-01-1995 DEC-31-1994 DEC-31-1995 391 2,115,351 0 0 267 236,434 35 11,460 0 718,045 4,023 3,821,166 0 4,486 0 0 4,023 3,841,752 64,495 5,221,526 0 0 0 0 0 0 5,000 315,000 0 (300,000) 4,023 3,841,752 444 453,916 444 453,916 716 312,286 716 312,286 65,200 1,472,944 0 0 0 2,012 (65,472) (1,329,302) 0 0 (65,472) (1,329,302) 0 0 0 0 0 0 (65,472) (1,329,302) (.01) (.14) (.01) (.14) PERIOD OF 2.5 MONTHS
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