-----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, Kspj6EqsWusiEVklWM1CCU5JceU20VoKXPW9FZoXvNDBRwOsp9eC6AL12V5v59fh nNtT3QFuU35OXh/YlTWEkA== 0000944209-98-001957.txt : 19981118 0000944209-98-001957.hdr.sgml : 19981118 ACCESSION NUMBER: 0000944209-98-001957 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981116 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SMARTALK TELESERVICES INC CENTRAL INDEX KEY: 0001018730 STANDARD INDUSTRIAL CLASSIFICATION: COMMUNICATION SERVICES, NEC [4899] IRS NUMBER: 954502740 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-21579 FILM NUMBER: 98752574 BUSINESS ADDRESS: STREET 1: 5080 TUTTLE CROSSING BLVD CITY: DUBLIN STATE: OH ZIP: 43017 BUSINESS PHONE: 6147642933 MAIL ADDRESS: STREET 1: 5080 TUTTLE CROSSING BLVD CITY: DUBLIN STATE: OH ZIP: 43017 10-Q 1 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 ---------------- FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter Ended September 30, 1998 Commission File No. 0-21579 SMARTALK TELESERVICES, INC. ------------------ Incorporated under the IRS Employer Identification laws of California(1) No. 95-4502740 5080 TUTTLE CROSSING BLVD. DUBLIN, OHIO 43016-3566 TELEPHONE: 614-789-8500 ---------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] Indicate the number of shares outstanding of each of the issuer's classes of common stock: Voting, No par value 27,607,379, as of November 9, 1998. - -------- (1) A proposal to effect the reincorporation of SmarTalk TeleServices, Inc. from California to Delaware was approved by the shareholders of the Company on December 31, 1997. Accordingly, subject to receipt of requisite regulatory approval, the Company's state of incorporation will change from California to Delaware and the Company will be a Delaware corporation. RESTATEMENT OF FINANCIAL STATEMENTS AND CHANGES TO CERTAIN INFORMATION On August 10, 1998, SmarTalk TeleServices, Inc. ("SmarTalk" or the "Company") announced that the Company's management in conjunction with the Company's independent accountants, PricewaterhouseCoopers LLP ("PwC"), would investigate certain matters with regard to the Company's accounting treatment for deferred revenue recorded in conjunction with acquisitions that occurred during 1997, the restructuring reserve taken during the fourth quarter of 1997, and certain other items, including the charge for acquired research and development in-process taken during the fourth quarter of 1997. The Company's investigation into these issues ultimately resulted in the restatement of the Company's financial results for the year ended 1997 and for the first and second quarters of 1998 (see Note 8 to the Company's consolidated financial statements included herein). The Company's interim period consolidated financial statements accompanying this Quarterly Report on Form 10-Q have been prepared in accordance with the accounting treatment changes made as a result of the restatement. In addition, the consolidated financial statements for the period ended September 30, 1997 contained herein have been adjusted (see Note 9 to the Company's consolidated financial statements). This Quarterly Report on Form 10-Q contains statements that constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which generally can be identified by the use of forward-looking terminology such as "anticipate," "believe," "target," "estimate," "may," "will," "expect," "plan," "project" or "continue" or the negative thereof or other variations thereon or similar terminology. Such statements are based on information available to management as of the time of such statements and relate to, among other things, expectations of the business environment in which the Company operates, projections of future performance, perceived opportunities in the market and statements regarding the Company's mission and vision. Such statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions, including risks related to the highly competitive market in which the Company operates; the need to attract and retain qualified management personnel; uncertainty in consumer acceptance of the Company's products and services, including its prepaid cellular product; possible difficulty in obtaining acceptable financing for the Company's continued expansion; and difficulty in integrating the Company's operations acquired primarily through acquisitions. These and other risks, uncertainties and assumptions identified from time to time in the Company's filings with the Securities and Exchange Commission, including without limitation, its annual reports on Forms 10-K and 10K/A and its quarterly reports on Forms 10-Q and 10Q/A could cause the Company's future results to differ materially from those expressed in any forward-looking statements made by or on behalf of the Company. Many of such factors are beyond the Company's ability to control or predict. These forward-looking statements speak only as of the date for which they are made. The Company disclaims any intent or obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SMARTALK TELESERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED)
SEPTEMBER 30, DECEMBER 31, 1998 1997 ------------- ------------- (AS RESTATED- SEE NOTE 8) ASSETS Current assets: Cash and cash equivalents....................... $ 18,516,643 $ 62,900,673 Trade accounts receivable (less allowance for doubtful accounts of $6,415,187 and $1,482,206, respectively).................................. 33,301,700 28,012,237 Notes receivable................................ 4,383,112 -- Receivable from American Express Company........ -- 2,570,000 Inventories..................................... 12,337,893 4,301,487 Prepaid expenses................................ 2,435,682 1,377,844 Other current assets............................ 5,840,074 7,464,040 ------------ ------------ Total current assets........................... 76,815,104 106,626,281 Non-current assets: Property and equipment, net..................... 20,569,512 14,208,975 Intangibles, net................................ 297,319,966 235,506,706 Note Receivable from ACMI, L.L.C., net.......... -- 2,234,763 Other non-current assets........................ 11,596,729 9,724,352 ------------ ------------ Total assets................................... $406,301,311 $368,301,077 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable................................ $ 26,392,035 $ 15,081,532 Deferred revenue................................ 20,604,410 28,885,002 Accrued marketing costs......................... 468,484 1,811,817 Accrued interest payable........................ 511,564 2,615,480 Other accrued expenses.......................... 16,107,875 5,571,728 Excise and sales tax payable.................... 2,224,704 5,565,072 Reserve for discontinued operations............. 1,035,000 -- Accrued litigation settlement................... -- 4,500,003 Current portion of long-term debt............... 5,915,058 7,285,401 ------------ ------------ Total current liabilities...................... 73,259,130 71,316,035 Long-term debt less current portion............... 153,622,089 150,874,753 ------------ ------------ Total liabilities.............................. 226,881,219 222,190,788 Shareholders' equity: Preferred stock, no par value; authorized 10,000,000 shares; no shares issued and outstanding.................................... -- Common stock, no par value; authorized 100,000,000 shares; issued and outstanding 27,607,379 and 21,350,852 shares, respectively................................... 279,155,873 178,670,477 Accumulated deficit............................. (99,802,511) (32,703,998) Cumulative translation adjustment............... 66,730 143,810 ------------ ------------ Total shareholders' equity..................... 179,420,092 146,110,289 ------------ ------------ Total liabilities and shareholders' equity... $406,301,311 $368,301,077 ============ ============
The accompanying notes are an integral part of these consolidated financial statements. 2 SMARTALK TELESERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ----------------------------------------- ----------------------------------------- 1997 1997 (AS 1997 (AS 1997 ADJUSTED-- (AS PREVIOUSLY ADJUSTED -- (AS PREVIOUSLY 1998 SEE NOTE 9) REPORTED) 1998 SEE NOTE 9) REPORTED) ------------ ----------- -------------- ------------ ----------- -------------- Revenue................. $59,829,325 $18,644,561 $20,565,622 $139,138,081 $37,358,084 $39,730,845 Cost of revenue......... 45,047,605 11,796,487 11,796,487 97,904,762 23,761,289 23,761,289 ------------ ----------- ----------- ------------ ----------- ----------- Gross profit.......... 14,781,720 6,848,074 8,769,135 41,233,319 13,596,795 15,969,556 Sales and marketing..... 9,711,141 4,672,415 4,672,415 42,803,858 10,213,879 10,213,879 General and administrative......... 15,679,984 2,326,765 2,489,913 32,764,736 5,169,012 5,169,012 Depreciation and amortization........... 10,306,197 2,202,694 1,177,887 25,174,316 3,168,041 2,019,163 ------------ ----------- ----------- ------------ ----------- ----------- Operating income (loss)............... (20,915,602) (2,353,800) 428,920 (59,509,591) (4,954,137) (1,432,498) Interest income......... 691,273 790,142 790,142 3,078,601 1,899,666 1,899,666 Interest expense........ (2,299,314) (740,425) (740,425) (7,196,244) (965,173) (965,173) Loss on disposal of asset.................. (11,174) -- -- (443,131) -- -- ------------ ----------- ----------- ------------ ----------- ----------- Income (loss) from continuing operations before income taxes.. (22,534,817) (2,304,083) 478,637 (64,070,365) (4,019,644) (498,005) Provision for income taxes.................. -- -- -- -- -- -- ------------ ----------- ----------- ------------ ----------- ----------- Income (loss) from continuing operations........... $(22,534,817) $(2,304,083) $ 478,637 $(64,070,365) $(4,019,644) $ (498,005) Discontinued operations; Loss from discontinued operations to the Resolution date...... -- -- -- (578,148) -- -- Income (loss) from the Resolution date to the date of disposal of discontinued operations........... -- -- -- (2,450,000) -- -- ============ =========== =========== ============ =========== =========== Net loss................ $(22,534,817) $(2,304,083) $ 478,637 $(67,098,513) $(4,019,644) $ (498,005) Per share loss-basic and diluted: Continuing operations... $ (0.82) $ (0.14) $ 0.03 $ (2.65) $ (0.28) $ (0.03) Discontinued operations............. -- -- -- $ (0.12) -- -- ------------ ----------- ----------- ------------ ----------- ----------- Total................... $ (0.82) $ (0.14) $ 0.03 $ (2.77) $ (0.28) $ (0.03) Weighted average number of shares.............. 27,370,763 16,846,271 16,846,271 24,190,916 14,396,661 14,396,661 ============ =========== =========== ============ =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. 3 SMARTALK TELESERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) (UNAUDITED)
COMMON STOCK CUMULATIVE ---------------------- STOCK ACCUMULATED TRANSLATION SHARES AMOUNT SUBSCRIPTION DEFICIT ADJUSTMENT TOTAL ---------- ----------- ------------ ------------ ----------- ------------ December 31, 1995....... 8,824,834 $ 315,000 $(300,000) $ (1,394,774) $ -- $ (1,379,774) Issuance of subscribed shares............... -- -- 300,000 -- -- 300,000 Purchase of assets of related entity....... -- -- -- (2,464,028) -- (2,464,028) Compensation under stock options issued............... -- 24,000 -- -- -- 24,000 Proceeds from sale of stock, net of costs.. 4,000,000 50,439,595 -- -- -- 50,439,595 Stock options exercised............ 4,625 8,186 -- -- -- 8,186 Net loss.............. -- -- -- (3,112,548) -- (3,112,548) ---------- ----------- --------- ------------ -------- ------------ December 31, 1996....... 12,829,459 50,786,781 -- (6,971,350) -- 43,815,431 Stock options exercised............ 227,398 851,485 -- -- -- 851,485 Distribution agreement............ 330,205 7,596,093 -- -- -- 7,596,093 Acquisitions: ConQuest Telecommunication Services Corp........ 4,488,935 71,917,228 -- -- -- 71,917,228 GTI Telecom, Inc...... 2,580,001 34,259,820 -- -- -- 34,259,820 SmarTel Communications, Inc.................. 714,286 9,494,290 -- -- -- 9,494,290 Cardinal Voicecard Limited.............. 115,000 2,170,625 -- -- -- 2,170,625 Frontier Selected Assets............... 65,568 1,594,155 -- -- -- 1,594,155 Cumulative translation adjustment........... -- -- -- -- 143,810 143,810 Net loss.............. -- -- -- (25,732,648) -- (25,732,648) ---------- ----------- --------- ------------ -------- ------------ December 31, 1997 (As Restated--See Note 8).. 21,350,852 178,670,477 -- (32,703,998) 143,810 146,110,289 Licensing agreement... 100,000 3,056,300 -- -- -- 3,056,300 USA Telecommunications Services, Inc........ 81,302 2,500,037 -- -- -- 2,500,037 Litigation settlement........... 215,569 4,500,003 -- -- -- 4,500,003 Stock options exercised............ 925,614 7,818,455 -- -- -- 7,818,455 SmarTel Telecommunications, Inc. acquisition..... 100,000 1,606,000 -- -- -- 1,606,000 Worldwide Direct, Inc. acquisition.......... 2,715,000 43,496,553 -- -- -- 43,496,553 Private placement..... 1,751,824 29,999,986 -- -- -- 29,999,986 Distribution agreement............ 343,336 7,088,630 -- -- -- 7,088,630 Minority investment in subsidiary........... 23,882 419,432 -- -- -- 419,432 Cumulative translation adjustment........... -- -- -- -- (77,080) (77,080) Net (Loss)............ -- -- -- (67,098,513) -- (67,098,513) ---------- ----------- --------- ------------ -------- ------------ September 30, 1998...... 27,607,379 279,155,873 -- (99,802,511) 66,730 179,420,092 ========== =========== ========= ============ ======== ============
The accompanying notes are an integral part of these consolidated financial statements. 4 SMARTALK TELESERVICES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, ------------------------------------------ 1998 1997 1997 ------------ ------------ -------------- (AS RESATED (AS PREVIOUSLY SEE NOTE 9) REPORTED) Cash flows from operating activities: Net loss........................... $(67,098,513) $ (4,019,644) $ (498,005) Adjustments to reconcile net loss to net cash used by operating activities: Depreciation....................... 4,515,025 433,378 433,378 Amortization....................... 20,659,291 2,734,663 1,585,785 Discontinued Operations............ 1,035,000 -- -- Provision for obsolete inventory... 2,065,556 -- -- MDF impairment write-off........... 7,261,219 -- -- Provision for bad debts............ 9,782,272 276 276 Loss on disposal of fixed assets... 443,131 -- -- Sublease termination fee........... -- (325,810) (325,810) Changes in assets and liabilities which increase (decrease) cash: Accounts receivable............... (22,469,576) (2,667,337) (2,667,337) Inventories....................... (9,454,085) (227,061) (227,061) Receivable from related party..... 2,570,000 -- -- Prepaid expenses.................. (864,510) (3,277,229) (3,277,229) Other current assets.............. 4,021,925 1,202,037 1,202,037 Other non-current assets.......... (4,314,917) (726,039) (726,039) Accounts payable.................. 7,814,013 (3,903,643) (3,903,643) Deferred revenue.................. (10,072,073) 2,048,514 (324,247) Accrued marketing costs........... (1,343,333) (136,931) (136,931) Accrued interest.................. (2,103,916) -- -- Other accrued expenses............ 10,010,890 2,987,397 2,987,397 Deposit from customer............. -- (4,060,958) (4,060,958) Excise and sales tax payable...... (3,340,368) 711,116 711,116 ------------ ------------ ------------ Net cash used in operating activities........................ (50,882,969) (9,227,271) (9,227,271) ------------ ------------ ------------ Cash flows from investing activities: Cash paid for acquisitions, net of cash acquired..................... (6,083,697) (2,366,458) (2,366,458) Proceeds from sale of discontinued operations........................ 1,000,000 -- -- Repayment of ACMI, L.L.C. note receivable........................ 1,000,000 -- -- Capital expenditures............... (10,866,707) (1,429,976) (1,429,976) Minority investment in subsidiaries...................... (2,800,000) -- -- License fee........................ (3,000,000) -- -- ------------ ------------ ------------ Net cash used in investing activities........................ (20,750,404) (3,796,434) (3,796,434) ------------ ------------ ------------ Cash flows from financing activities: Stock issued in private placement.. 29,999,986 -- -- Stock options exercised............ 7,818,455 716,814 716,814 Repayment of note payable to WorldCom.......................... -- (6,383,691) (6,383,691) Repayment of long-term debt........ (3,129,405) -- -- Payment on debt issued for acquisition....................... -- (20,614,686) (20,614,686) Issuance of convertible debt, net of costs.......................... -- 145,335,023 145,335,023 Capital lease payments............. (155,596) (42,915) (42,915) Payments on lines of credit........ (7,207,017) -- -- ------------ ------------ ------------ Net cash provided by financing activities........................ 27,326,423 119,010,545 119,010,545 ------------ ------------ ------------ Effect of currency exchange rate... (77,080) -- -- ------------ ------------ ------------ Decrease in cash and cash equivalents........................ (44,384,030) 105,986,840 105,986,840 Cash and cash equivalents at beginning of period............... 62,900,673 44,830,487 44,830,487 ------------ ------------ ------------ Cash and cash equivalents at end of period............................ $ 18,516,643 $150,817,327 $150,817,327 ============ ============ ============ Supplemental disclosure of cash flow information: Cash paid for interest............. $ 9,353,217 $ 675,205 $ 675,205 ============ ============ ============ Issuance of stock for acquisitions...................... $ 55,110,652 $ 45,924,735 $ 46,375,629 ============ ============ ============ Issuance of debt for acquisitions.. $ 10,500,000 $ 20,614,686 $ 20,614,686 ============ ============ ============ Debt assumed at acquisition........ $ 2,567,486 $ -- $ -- ============ ============ ============ Issuance of stock for litigation settlement........................ $ 4,500,003 $ -- $ -- ============ ============ ============ Issuance of stock for licensing agreement......................... $ 3,056,300 $ -- $ -- ============ ============ ============ Issuance of stock for distribution agreement $ 7,088,630 $ -- $ -- ============ ============ ============ Issuance of stock in private placement $ 29,999,986 $ -- $ -- ============ ============ ============
The accompanying notes are an integral part of these consolidated financial statements. 5 SMARTALK TELESERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF INTERIM PRESENTATION The accompanying interim period consolidated financial statements have been prepared in accordance with the accounting treatment changes made as a result of the Company's restatement of its financial results for the year ended 1997 and for the first and second quarters of 1998 (see Note 8) and are unaudited, pursuant to certain rules and regulations of the Securities and Exchange Commission (the "Commission"), and include, in the opinion of management, all adjustments (consisting of only normal recurring adjustments) necessary for a fair presentation of the results for the periods indicated; which adjustments, however, are not necessarily indicative of results which may be expected for the full year. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The financial statements should be read in conjunction with the financial statements, as restated, and the notes thereto for the year ended December 31, 1997 and other information included in SmarTalk TeleServices, Inc.'s ("SmarTalk" or the "Company") Annual Report on Form 10- K/A and Current Reports on Form 8-K, as filed with the Commission. 2. DISCONTINUED OPERATIONS On February 28, 1998 (the "Board Resolution Date"), the Company's board of directors adopted a plan to sell the Company's call center business located in Butler, Pennsylvania. In the first quarter of 1998, the Company recorded a charge for the losses associated with operating this business up to the Board Resolution Date and an estimated charge for operating this business from the Board Resolution Date through the anticipated disposition date plus the transaction costs associated with the sale of the business. On June 12, 1998 (the "Sale Date"), the Company sold the assets of the call center business for $1,000,000 in cash and a note receivable (the "Call Center Note"), of $19,067,995. Interest on the Call Center Note is 12% per annum and is payable quarterly beginning September 12, 1998. The principal on the Call Center Note is due on June 12, 1999 (unless this date is extended to June 12, 2000 by the obligor) or upon completion of a financing transaction in excess of $50,000,000 by the obligor. The assets of the obligor secure the Call Center Note. Due to the thinly capitalized financial position of the obligor and the resulting risk of collection, a valuation allowance was recorded against the Call Center Note approximately equal to the difference between the sales price and net book value of the tangible assets sold, or $14,684,978. No gain or loss was recorded on the transaction. Operations for the business from January 1, 1998 to the Sale Date and transaction costs associated with the disposal have been recorded against the reserve for discontinued operations. Summarized financial information for the discontinued operations is as follows:
FOR THE PERIOD JANUARY 1, 1998 TO JUNE 12, 1998 ------------------- (AS RESTATED-- SEE NOTE 8) Revenues............................................. $10,065,127 Loss before income taxes............................. 3,028,148 Net loss............................................. 3,028,148
6
AS OF JUNE 12, 1998 -------------- (AS RESTATED-- SEE NOTE 8) Current assets............................................ $ 5,502,442 Total assets.............................................. 20,502,442 Current liabilities....................................... 434,447 Total liabilities......................................... 434,447 ----------- Net assets of discontinued operations..................... $20,067,995 ===========
SmarTalk did not own the call center business at September 30, 1997. 3. LICENSING AGREEMENT On March 30, 1998, the Company entered into a new licensing agreement with AudioFax IP LLC to license certain voice-fax mailbox technology. The Company paid a one-time fee to license the technology until the patents expire in 2008. The fee is being amortized over the remaining life of the patent. Prior to this agreement, the Company licensed this technology by paying a per-card fee for cards containing voice-fax mailbox services. 4. ACQUISITIONS On March 23, 1998, the Company acquired the outstanding shares of USA Telecommunications Services, Inc. (d.b.a. The Debit Cellular Network) ("DCN"), a North Carolina based prepaid cellular communications company. In consideration for the outstanding shares of DCN, the Company paid $1,500,000 in cash and issued 81,302 shares of Common Stock. This acquisition was accounted for using the purchase method of accounting. Accordingly, the operating results of the acquired business are included in the Company's consolidated financial results since the date of acquisition. On April 30, 1998, the Company acquired the outstanding shares of Canada Telecom Network, Inc., a Canadian prepaid calling card company ("CTN"). In consideration for the outstanding shares of CTN, the Company paid $3,000,000 in cash and $5,500,000 in a subordinated 7.5% per annum note which matures April 30, 2000. The note is payable in 24 monthly blended installments of principal and interest. This acquisition was accounted for using the purchase method of accounting. Accordingly, the results of the acquired business are included in the Company's consolidated financial results since the date of acquisition. On June 10, 1998, the Company acquired the outstanding shares of Worldwide Direct, Inc., a Framingham, Massachusetts based prepaid cellular communications company ("Worldwide"). In consideration for the outstanding shares of Worldwide, the Company issued 2,715,000 shares of Common Stock. The Company restructured this transaction to provide for the issuance of additional equity and/or debt securities based on the occurrence of certain conditions. As a result of this restructuring, the acquisition was accounted for using the purchase method of accounting. Accordingly, the results of the acquired business are included in the Company's consolidated financial results since the date of acquisition. The following unaudited pro forma summary presents the Company's combined financial results as if the 1998 acquisitions occurred at the beginning of the respective periods, after giving effect to certain adjustments including goodwill amortization, depreciation and interest expense. These pro forma results are not necessarily indicative of those that would have occurred had the acquisitions occurred at the beginning of the respective periods.
THREE MOS. ENDED NINE MOS. ENDED SEPTEMBER 30, SEPTEMBER 30, 1998 1998 ---------------- --------------- Revenue............................... $ 59,829,325 $144,094,546 ============ ============ Net loss from continuing operations... $(22,534,817) $(67,530,925) ============ ============ Net loss per share from continuing operations--basic and diluted........ $ (0.82) $ (2.79) ============ ============
7 The following unaudited pro forma summary presents the Company's combined results as if the 1997 acquisitions, as referenced in the Company's Annual Report on Form 10-K/A for the year ended December 31, 1997, occurred at the beginning of the respective periods, after giving effect to certain adjustments including goodwill amortization, depreciation and interest expense. These pro forma results are not necessarily indicative of those that would have occurred had the acquisitions occurred at the beginning of the respective periods.
THREE MOS. ENDED NINE MOS. ENDED SEPTEMBER 30, SEPTEMBER 30, 1997 1997 ---------------- --------------- (AS ADJUSTED-- (AS ADJUSTED-- SEE NOTE 9) SEE NOTE 9) Revenue................. $ 64,761,235 $ 75,824,550 ============ ============ Net loss................ $(10,715,747) $(17,902,981) ============ ============ Net loss per share-- basic and diluted...... $ (0.50) $ (0.84) ============ ============
5. REVENUE RECOGNITION The Company's revenue originates from: (i) Company and co-branded prepaid landline calling cards; (ii) sales of prepaid cellular phones, cellular calling cards, accessories and services; and (iii) sales of alternative products and services. The Company's products and services are distributed: (i) through retailers; (ii) directly to consumers; and (iii) through alternative methods of distribution. Under the majority of agreements with retailers for prepaid landline calling cards, the Company sells cards to the retailer at a fixed price with normal credit terms. When the retailer is invoiced, deferred revenue is recorded. The Company recognizes revenue and reduces the deferred revenue account as the end user utilizes calling time or upon expiration of cards containing unused calling time, as applicable. The Company also records deferred revenue upon recharge of existing phone cards and recognizes such revenue upon usage or expiration of the recharge minutes. With respect to deferred revenue on the books of an acquired entity, the obligation to provide future service relating to unused minutes is revalued as of the date of acquisition. The fair value of the future service obligation represents management's best estimate of the cost to service acquired unused minutes plus a normal profit margin for this service element (such margin intended to cover indirect costs and provide a reasonable return). Deferred revenue is not recorded for acquired unused minutes for which no future usage is anticipated. The acquired deferred revenue obligation is periodically remeasured to reflect actual used and unused minutes which may vary from original estimates. A reduction in acquired deferred revenue is recorded based on actual minutes used during the post-acquisition period. Substantially all prepaid landline calling cards sold by the Company have expiration dates and expire as of that date, if never activated, or six months after the initial activation unless recharged. For calling cards that have no printed expiration date, revenue for unused minutes is recognized when the calling cards have been dormant for greater than 12 months. The Company's prepaid cellular phones and cellular calling cards are sold to major national retailers and through direct-response broadcast advertising on cable television. In its retail sales, the Company invoices the retailer upon shipment of the prepaid cellular phones, accessories and services and, in general, prepaid cellular calling cards. In some cases, prepaid cellular calling cards are sold on consignment to retailers, and the Company is then paid for the prepaid cellular calling card upon sale of the card by the retailer to the consumer. With respect to sales of its prepaid cellular products and services directly to consumers, the Company is paid in advance of shipment. 8 6. NOTE RECEIVABLE FROM ACMI, L.L.C. On June 19, 1998, the Company received payment for the ACMI, L.L.C. note receivable. The note receivable had a net book value of $2,234,763 on such date and the repayment amount was $1,000,000 in cash. Because this note was acquired through the ConQuest acquisition, the devaluation of the note was recorded as a reduction of goodwill. Additionally, the Company was required to release 106,816 shares of Common Stock that was held in escrow and used as collateral to secure the note. The value of these shares has previously been recorded as an increase to goodwill. 7. DIVIDENDS There were no dividends declared or paid during the nine months ended September 30, 1998 or during the same period in 1997. 8. RESTATEMENT On August 10, 1998, SmarTalk announced that the Company's management in conjunction with the Company's independent accountants, PricewaterhouseCoopers LLP ("PwC"), would investigate certain matters with regard to the Company's accounting treatment for deferred revenue recorded in conjunction with acquisitions that occurred during 1997, the restructuring reserve taken during the fourth quarter of 1997 and certain other items including the charge for acquired research and development in-process taken during the fourth quarter of 1997. As a result of the Company's investigation into these issues, the accompanying consolidated financial statements for the year ended 1997 and for the first and second quarters of 1998 were restated. In addition, the Company restructured its June 1998 acquisition of Worldwide to provide for the issuance of additional equity and/or debt securities based on the occurrence of certain conditions. As a result of this restructuring, the Company's restatement of its financial results for the quarter ended June 30, 1998 included changes made to reflect the treatment of the acquisition of Worldwide using the purchase method of accounting. 9. ADJUSTMENT As a result of the investigation described in Note 8, the Company in conjunction with PwC determined that certain amounts for the periods ended September 30, 1997 should be adjusted. As a result, the consolidated financial statements for the periods ended September 30, 1997 contained herein were adjusted. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION GENERAL SmarTalk TeleServices, Inc. ("SmarTalk" or the "Company") is a leading provider of prepaid telecommunications and prepaid wireless products and services. SmarTalk was formed in October 1994 and had limited operations until June 1995. On October 23, 1996, the Company completed the sale of 4,000,000 shares of its stock in a public offering. The Company's common stock, no par value (the "Common Stock"), is listed on the NASDAQ National Market. SmarTalk provides convenient, easy-to-use and cost-effective telecommunications products and services to individuals and businesses primarily through the SmarTalk prepaid phone card (the "SmarTalk Card"). The SmarTalk Card provides customers with a single point of access to prepaid telecommunications services at a fixed rate charge per minute regardless of the time of day or, in the case of domestic calls, the distance of the call. The Company's landline services currently include domestic calling, inbound and outbound international long distance calling, as well as enhanced features such as sequential calling, content delivery, speed dial and message delivery and on selected cards, voice and fax mail services. The SmarTalk Card may be recharged with a major credit card by calling SmarTalk's customer service department or, in select retail locations, at point of sale, allowing the user to add minutes as needed. SmarTalk also provides prepaid wireless products and services, including prepaid cellular phones and cellular calling cards. SmarTalk's current prepaid cellular product provides consumers a convenient cellular option with no contracts, no monthly fees, no credit checks and no security deposits. SmarTalk's prepaid cellular phones and cellular calling cards are marketed through television advertisements on national cable stations and sold at retail with "as seen on TV" packaging. SmarTalk's services are delivered through proprietary switching, application and database access software which run on interactive call processing platforms. The SmarTalk platforms and the Company's proprietary software allow users in the system to access SmarTalk services, and provide the Company with the flexibility to customize and add features to SmarTalk services on a platform-wide basis. SmarTalk's revenue originates from: (i) SmarTalk and co-branded prepaid landline calling cards; (ii) sales of prepaid cellular phones, cellular calling cards, accessories and services; and (iii) sales of alternative products and services. SmarTalk's products and services are distributed through: (i) retailers; (ii) directly to consumers; and (iii) alternative methods of distribution. The Company operates in a highly competitive market. Future revenues and earnings may be impacted by, among other factors, the Company's ability to address competition, its ability to sign new accounts, its ability to introduce new products, such as its prepaid cellular product offering, and its ability to integrate its operations successfully. In light of these and other factors discussed herein, the Company has engaged financial advisors to assist in evaluating its strategic alternatives. Under sales agreements with the majority of its retailers, the Company sells prepaid landline calling cards to the retailer at a set price. The Company generally invoices the retailer upon shipment of the prepaid landline calling cards. The Company also offers pay-on-sale and pay-on-activation programs to certain retailers whereby the retailers are invoiced upon sale to or activation by a retailer's customer, respectively. The Company anticipates that its pay-on-sale and pay-on-activation programs will be increasingly utilized by its retail customers. Deferred revenue is recorded when the retailer is invoiced. The Company recognizes revenue and reduces deferred revenue as the customer utilizes calling time or upon expiration of cards containing unused calling time ("breakage"). The Company also records deferred revenue upon recharge of existing prepaid calling cards and recognizes such revenue upon the usage or expiration of the recharge minutes. Call processing revenues are recognized as these services are rendered. The Company's prepaid cellular phones and cellular calling cards are sold to major national retailers and through direct-response broadcast advertising on cable television. In its retail sales, the Company invoices the retailer upon shipment of the prepaid cellular phones, accessories and services and, in general, prepaid cellular calling cards. In some cases, prepaid cellular calling cards are sold on consignment to retailers, and the Company 10 is then paid for the prepaid cellular calling card upon sale of the card by the retailer to the consumer. With respect to sales of its prepaid cellular products and services directly to consumers, the Company is paid in advance of shipment. SmarTalk's cost of revenue consists primarily of the cost of providing long distance services and related enhanced services, as well as the cost of manufacturing and delivering the cards, excise taxes, Universal Service Fund fees and the costs of cellular phones and accessories. The cost of providing long distance services represents obligations to carriers that provide minutes of long distance over their networks in order to facilitate use of SmarTalk's product. SmarTalk seeks to leverage its competitive advantages in implementing the key elements of its growth strategy, which include: (i) increasing penetration of retailers; (ii) increasing the productivity of individual retail accounts; (iii) developing new products and services; and (iv) pursuing selected acquisitions. Sales and marketing expenses consist primarily of commissions and advertising costs. The Company pays commissions to its sales representatives based on sales to retailers. The Company also pays commissions to its sales representatives and retailers based on the number of minutes recharged on the SmarTalk Cards sold by each retailer. These commissions are capitalized and amortized based on customer usage. Advertising consists primarily of trade, consumer and cooperative ("co-op") advertising. Under the typical co-op advertising program, the Company provides advertising funds to retailers to promote sales of SmarTalk products and services. The amount of funds the Company provides in co-op advertising is based on a percentage of sales of SmarTalk products to retailers. Corporate advertising expense includes trade and consumer advertising, trade show expenses, promotional goods and the costs of providing to retailers the Company's turnkey merchandising materials and services. General and administrative expenses consist primarily of salaries and related benefits, sales and use taxes, rent, insurance, bank card processing fees and other general expenses. Sales and use taxes for the SmarTalk platforms are incurred based on customer usage of long distance minutes which are processed through the Company's platforms. Depreciation expense relates to purchased assets recorded at their fair values at the date of acquisition. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets, ranging from three to ten years. Expenditures for new property and equipment are recorded at cost and capitalized while expenditures for maintenance and repairs are charged against earnings as incurred. Amortization expense relates to costs in excess of the fair value of net assets acquired and is expensed on a straight-line basis over a period of two to twenty years. The Company completed the following acquisitions from January 1, 1997 to September 30, 1998 (the "Acquisitions"): Worldwide Direct, Inc. On June 10, 1998, SmarTalk acquired the outstanding shares of Worldwide. In consideration for the outstanding shares of Worldwide, SmarTalk issued 2,715,000 shares of Common Stock. The Company restructured this transaction to provide for the issuance of additional equity and/or debt securities based on the occurrence of certain conditions. As a result of this restructuring, the acquisition has been accounted for using the purchase method of accounting and the results of the acquired business have been included in the Company's consolidated results of operations from the date of acquisition. Canada Telecom Networks Inc. On April 30, 1998, SmarTalk acquired the outstanding shares of Canada Telecom Network, Inc. ("CTN"), a Canadian prepaid calling card company based in Montreal, Quebec. In consideration for the outstanding shares of CTN, SmarTalk paid $3,000,000 in cash and $5,500,000 in a subordinated 7.5% per annum note which matures April 30, 2000. The note is payable in 24 monthly blended installments of principal and interest. This acquisition was accounted for using the purchase method of accounting. Accordingly, the results of the acquired business are included in the Company's consolidated financial results since the date of acquisition. USA Telecommunications Services, Inc. On March 23, 1998, the Company acquired the outstanding shares of USA Telecommunications Services, Inc. (d.b.a. The Debit Cellular Network) ("DCN"), a North Carolina 11 based prepaid cellular communications company. In consideration for the outstanding shares of DCN, the Company paid $1,500,000 in cash and issued 81,302 shares of Common Stock. This acquisition was accounted for using the purchase method of accounting. Accordingly, the results of the acquired business are included in the Company's consolidated financial results since the date of acquisition. American Express Telecom, Inc. On December 31, 1997, SmarTalk acquired the outstanding shares of American Express Telecom, Inc. ("Amex Telecom"), a provider of prepaid calling products, including the FirstClass Phonecard(TM) sold through the U.S. Postal Service and the PhoneFunds(TM) card sold through the National Park Foundation, American Express Travel Service Offices ("AmEx TSOs"), and certain foreign exchange offices. In consideration for the outstanding shares of Amex Telecom, SmarTalk paid $44 million in cash, which was provided from SmarTalk's working capital, with a portion thereof held in escrow pending regulatory approval to Amex Telecom's sole stockholder, American Express Travel Related Services Company, Inc. ("Amex TRS"). Additionally, SmarTalk purchased a profit and cost sharing agreement between Amex Telecom and the United States Postal Service ("USPS"). The Amex Telecom acquisition secured for SmarTalk distribution rights to certain AmEx TSOs, distribution through the USPS and the National Park Foundation and an agreement with Amex TRS to be the exclusive provider of a co-branded prepaid calling card for Amex TRS. In addition, SmarTalk was granted exclusive access to the Amex TRS point-of-sale system for activation and recharge of prepaid phone cards. Under the purchase agreement, Amex TRS agreed to reimburse SmarTalk for the estimated unused minutes as of December 31, 1997. ConQuest Telecommunication Services Corp. On December 3, 1997, SmarTalk entered into an interim operating agreement with ConQuest Telecommunication Services Corp. ("ConQuest"), which transferred all risks and rewards from ConQuest to SmarTalk. SmarTalk assumed responsibility for operating the ConQuest business and the employees of ConQuest became employees of SmarTalk on this date. On December 31, 1997, SmarTalk acquired the outstanding shares of ConQuest. In consideration for the outstanding shares of ConQuest, SmarTalk issued approximately 4,500,000 shares of Common Stock. SmarTalk also assumed $6,139,679 of ConQuest's debt. Additionally, in connection with this acquisition SmarTalk paid $350,000 in cash in 1997 and issued 215,569 shares of Common Stock in January 1998 to obtain an agreement and mutual release from a group of individuals that had brought a lawsuit against ConQuest prior to the acquisition. ConQuest was a developer and marketer of prepaid calling cards and other enhanced telecommunication services and technology, including domestic and international calling services for the tour and travel industry. The acquisition of ConQuest added significantly to SmarTalk's technological infrastructure, customer base, platform operations and management infrastructure. Selected Assets of Frontier Corporation. On December 9, 1997, SmarTalk acquired selected assets (the "Frontier Selected Assets"), of the retail prepaid phone card business of Frontier Corporation, a New York corporation ("Frontier"). In consideration for the Frontier Selected Assets, SmarTalk paid $35 million in cash and issued 65,568 shares of Common Stock. The acquisition of the Frontier Selected Assets added to SmarTalk's size, scale and scope, and helped establish SmarTalk's presence on the East Coast. Cardinal Voicecard Limited. On August 13, 1997, SmarTalk issued 115,000 shares of Common Stock to purchase this Toronto, Ontario based company. This acquisition provided the Company with access to the Canadian marketplace and added to the Company's international distribution. GTI Telecom, Inc. On May 31, 1997, SmarTalk acquired the outstanding shares of GTI Telecom, Inc., a Florida corporation ("GTI"). In consideration for the outstanding shares of GTI, SmarTalk issued 2,580,001 shares of Common Stock and $26,500,000 in subordinated 10% per annum term notes which mature June 1, 2001 (the "GTI Notes"). $25,970,000 of the GTI Notes were repaid in September 1997 at $20,614,686. The difference of $5,355,314 was recorded as a reduction to goodwill. This acquisition expanded the Company's distribution and added human resource, technical and manufacturing infrastructure. SmarTel Communications, Inc. On May 28, 1997, SmarTalk acquired SmarTel Communications, Inc., a Boston, Massachusetts based prepaid promotions phone card corporation ("SmarTel"). In consideration for its acquisition of SmarTel, SmarTalk issued 714,286 shares of Common Stock. The Acquisitions have been accounted for using the purchase method of accounting. Accordingly, the operating results of the Acquisitions have been included in the Company's consolidated financial results since the date of acquisition. 12 RESULTS OF OPERATIONS QUARTER ENDED SEPTEMBER 30, 1998 COMPARED WITH QUARTER ENDED SEPTEMBER 30, 1997 (AS ADJUSTED) Revenue. Revenue increased to $59,829,325 for the quarter ended September 30, 1998 from $18,644,561 for the same period in 1997. The substantial increase in revenue reflects primarily the effect of the Acquisitions and an increase in usage of SmarTalk services by users of the SmarTalk Card, an increase in the number of retail storefronts in which the Company's product is distributed, greater brand awareness and consumer acceptance and sales of the Company's pre-paid cellular products. Revenue attributable to the distribution and processing agreement was $4,541,849 for the quarter ended September 30, 1998 and $5,147,196 for the same period in 1997. In addition, 1.0% of total revenue for the quarter ended September 30, 1998 consisted of revenue recognized on the unused portion of expired cards (breakage revenue) as compared to .5% for the same period in 1997. Recharge revenue was $3,011,155 for the quarter ended September 30, 1998 as compared to $1,607,639 for the same period in 1997. Cost of Revenue. Cost of revenue increased to $45,047,605 for the quarter ended September 30, 1998 from $11,796,487 for the same period in 1997. The substantial increase was primarily attributable to the effect of the Acquisitions, greater use of the Company's services, and the addition of Universal Service fund charges. The gross profit percentage for the quarter ended September 30, 1998 was 24.7% as compared to 36.7% for the same period in 1997. The gross profit margin percentage decreased primarily due to the introduction of the Company's prepaid cellular products and the addition of Universal Service fund charges. Gross profit margins relating to the Company's prepaid cellular business are lower than the gross profit margins relating to the Company's traditional prepaid landline products. Sales and Marketing Expenses. Sales and marketing expenses increased to $9,711,141 (16.2% of revenue) for the quarter ended September 30, 1998 from $4,672,415 (25.1% of revenue) for the same period in 1997. The increase in dollar amount and percentage of revenue was primarily due to the effect of the Acquisitions as well as the continued expansion of the Company's marketing activities, which include co-op advertising, consumer advertising, manufacturer's development funds and promotional goods. General and Administrative Expenses. General and administrative expenses increased to $15,679,984 (26.2% of revenue) for the quarter ended September 30, 1998 from $2,326,765 (12.5% of revenue) for the same period in 1997. The increase in dollar amount and percentage of revenue was primarily due to the effect of the Acquisitions as well as the addition of personnel and costs associated with the growth in the Company's business. Depreciation and Amortization Expenses. Depreciation and amortization expenses increased to $10,306,197 (17.2% of revenue) for the quarter ended September 30, 1998 from $2,202,694 (11.8% of revenue) for the quarter ended September 30, 1997. The increase in dollar amount and percentage amount reflects the Company's Acquisitions during 1998 and 1997, as well as additional capital spending to support the overall growth of the business. Interest Income and Expense. Net interest expense for the quarter ended September 30, 1998 was $1,608,041 as compared to net interest income of $49,717 for the same period in 1997. This was primarily due to interest expense on the Company's subordinated debt that was issued September 17, 1997. Interest expense for the quarter ended September 30, 1998 and the same period in 1997 included $216,231 and $0, respectively, of debt issue costs and amortization. Income Tax. The Company had losses for the quarter ended September 30, 1998 and the same period in 1997. Accordingly, there was no provision for income taxes. Decremented Minutes and PIN Activations. Decremented minutes, which represent actual call traffic over the SmarTalk platforms, were estimated at 270,098,328 for the quarter ended September 30, 1998 as compared to 91,207,466 for the same period in 1997. PIN activations were estimated at 5,070,132 and 1,770,574 for the quarter ended September 30, 1998 and the same period in 1997, respectively. These increases were due to increased usage of the Company's services and the effect of the Acquisitions. 13 Discontinued Operations. On February 28, 1998 (the "Board Resolution Date"), the Company's board of directors adopted a plan to sell the Company's call center business located in Butler, Pennsylvania. The call center operations up to the Board Resolution Date have been classified as a loss from discontinued operations. The estimated loss from operations after the Board Resolution Date until the date of sale have been recorded as a loss on disposal of discontinued operations. This estimate was decreased by $250,000 in the quarter ended June 30, 1998. Net Loss. As a result of the above items, net loss increased to $22,534,817 ($.82 per share) for the quarter ended September 30, 1998 from $2,304,083 ($.14 per share) for the same period in 1997. NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED WITH NINE MONTHS ENDED SEPTEMBER 30, 1997 (AS ADJUSTED) Revenue. Revenue increased to $139,138,081 for the nine months ended June 30, 1998 from $37,358,084 for the same period in 1997. The substantial increase in revenue reflects primarily the effect of the Acquisitions, an increase in usage of SmarTalk services by users of the SmarTalk Card, an increase in the number of retail storefronts in which the Company's product is distributed, greater brand awareness and consumer acceptance and sales of the Company's pre-paid cellular products. Revenue attributable to the distribution and processing agreement with WIC was $13,493,335 and $13,766,587 for the nine months ended September 30, 1998 and the same period in 1997, respectively. In addition, 2.7% of total revenue for the nine months ended September 30, 1998 consisted of breakage revenue as compared to 3.1% for the same period in 1997. Recharge revenue was $5,067,084 for the nine months ended September 30, 1998 as compared to $2,790,361 for the same period in 1997. Cost of Revenue. Cost of revenue increased to $97,904,762 for the nine months ended September 30, 1998 from $23,761,289 for the same period in 1997. The increase was primarily attributable to the effect of the Acquisitions, greater use of the Company's services, and the addition of Universal Service fund charges. The gross profit percentage for the nine months ended September 30, 1998 was 29.6% as compared to 36.4% for the same period in 1997. The gross profit margin percentage decreased primarily due to the introduction of the Company's prepaid cellular products, the addition of the Universal Service fund charges, the decrease in breakage revenue which has minimal cost of revenue associated with it. Gross profit margins relating to the Company's prepaid cellular business are lower than the gross profit margins relating to the Company's traditional prepaid landline products. Sales and Marketing Expenses. Sales and marketing expenses increased to $42,803,858 (30.8% of revenue) for the nine months ended September 30, 1998 from $10,213,879 (27.3% of revenue) for the same period in 1997. The increase in dollar amount and percentage of revenue was primarily due to the effect of the Acquisitions as well as the continued expansion of the Company's marketing activities, which include co-op, consumer advertising, manufacturer's development funds and promotional goods. The Company also paid a major retailer $2.5 million for entering into a long term agreement. This amount was expensed during the quarter ended March 31, 1998. In addition, the Company, in connection with the restatement of its financial statements for the period ended June 30, 1998, reassessed the collectibility of certain accounts receivable as of June 30, 1998. In connection with such reassessment, the Company revised its evaluation relating to the allowance for uncollectible accounts receivable and increased this allowance as well as wrote off accounts receivable in the aggregate amount of $10.9 million at June 30, 1998. General and Administrative Expenses. General and administrative expenses increased to $32,764,736 (23.5% of revenue) for the nine months ended September 30, 1998 from $5,169,012 (13.8% of revenue) for the same period in 1997. The increase in dollar amount and percentage of revenue was primarily due to the effect of the Acquisitions, as well as the addition of personnel and costs associated with the growth of the Company's business. 14 Depreciation and Amortization Expenses. Depreciation and amortization expenses increased to $25,174,316 (18.1%) of revenue for the nine months ended September 30, 1998 from $3,168,041 (8.5%) from the nine months ended September 30, 1997. The increase in dollar amount and percentage amount reflects the Company's Acquisitions during 1998 and 1997, as well as additional capital spending to support the overall growth of the business. Interest Income and Expense. Net interest expense for the nine months ended September 30, 1998 was $4,117,643 as compared to net interest income of $934,493 for the same period in 1997. This was primarily due to interest expense on the Company's subordinated debt that was issued September 17, 1997. Interest expense for the nine months ended September 30, 1998 and the same period in 1997 included $669,665 and $0, respectively, of debt issue costs and amortization. Income Tax. The Company had losses for the nine months ended September 30, 1998 and the same period in 1997. Accordingly, there was no provision for income taxes. Decremented Minutes and PIN Activations. Decremented minutes, which represent actual call traffic over the SmarTalk platforms, were 649,107,470 for the nine months ended September 30, 1998 as compared to 181,253,093 for the same period in 1997. PIN activations were 12,945,032 for the nine months ended September 30, 1998 as compared to 2,901,076 for the same period in 1997. These increases are due to increased usage of the Company's services and the effect of the Acquisitions. Discontinued Operations. On the Board Resolution Date, SmarTalk's board of directors adopted a plan to sell the Company's call center business located in Butler, Pennsylvania. The call center operations up to the Board Resolution Date have been classified as a loss from discontinued operations. The estimated loss from operations after the Board Resolution Date until the date of sale has been recorded as a loss on disposal of discontinued operations. Net Loss. As a result of the above items, net loss increased to 67,098,513 ($2.77 per share) for the nine months ended September 30, 1998 as compared to $4,019,644 ($.28 per share) for the same period in 1997. LIQUIDITY AND CAPITAL RESOURCES On July 9, 1998, the Company completed a private placement of 1,751,824 shares of its Common Stock, realizing proceeds before transaction costs of $29,999,986. On August 28, 1998, the terms of the private placement were restructured. In the event that the Company's Common Stock trades below the initial purchase price during specified periods, the Company will be obligated to issue up to $18,500,000 of additional Common Stock for no additional consideration. In addition, the Company granted an option exercisable for a period of two years commencing March 1, 1999 in connection with the private placement pursuant to which an additional $20,000,000 of the Company's Common Stock may be purchased. In the event the aggregate amount of Common Stock issued by the Company pursuant to the private placement would exceed 20% of the Company's total outstanding shares as of July 9, 1998 (the "20% Threshold"), as a result of either the exercise of the option or the initial purchase price adjustment, the Company would be required to obtain shareholder approval of the private placement or issue a note in a principal amount equal to the value of the Common Stock that otherwise would exceed the 20% Threshold. The Company has used and expects to continue to use the proceeds from this private placement to accelerate its entry into the prepaid cellular market and for general corporate purposes. As of July 1, 1998, the Company issued a promissory note in the amount of $5,000,000 and agreed to issue 1,000,000 shares of Common Stock to acquire a distribution arrangement with a former distributor of Worldwide and certain contractual relationships. The arrangement also provides for the issuance of additional equity and/or debt securities upon the occurrence of certain conditions. On June 10, 1998, the Company issued 2,715,000 shares of Common Stock to purchase Worldwide. On April 30, 1998, the Company paid $3,000,000 in cash and $5,500,000, in a subordinated 7.5% per annum note which matures April 30, 2000, to purchase CTN. The principle and interest due on this note is secured by a stand-by letter of credit. 15 On March 23, 1998, the Company paid $1,500,000 in cash and issued 81,302 shares of Common Stock to purchase DCN. On December 31, 1997, the Company issued 4,488,935 shares of Common Stock to purchase ConQuest. On December 31, 1997, the Company paid $44,000,000 in cash to purchase Amex Telecom. On December 9, 1997, the Company paid $35,000,000 in cash and issued 65,568 shares of Common Stock to purchase selected retail assets of Frontier's prepaid phone card business. In November, 1997, the Company paid $1,000,000 in cash and issued 326,531 shares of Common Stock to acquire a certain distribution agreement. In December, 1997, the Company issued an additional 3,674 shares of Common Stock for a referral associated with the distribution agreement. On September 17, 1997, the Company issued 5 3/4% per annum convertible subordinated notes due September, 2004, in an aggregate principal amount of $150,000,000 (the "Notes"). The net proceeds to the Company from the Notes offering (after deducting the underwriting discounts and other expenses) was $144,946,319. Interest on the Notes is payable semi-annually on March 15 and September 15 of each year commencing March 15, 1998. On August 6, 1997, ConQuest entered into a revolving credit facility with Star Bank, N.A. ("Star Line of Credit"). Pursuant to the terms of the Star Line of Credit, ConQuest could borrow up to $9,500,000 as secured by various accounts receivable. Interest is based on the ninety-day LIBOR plus one percent. This credit facility was assumed by the Company upon the acquisition of ConQuest and had an outstanding balance of $7,193,575 at April 27, 1998. This credit facility was paid in full and terminated on April 27, 1998. In December 1996, the Company entered into a revolving credit facility with Southern California Bank ("SCB Line of Credit"). Pursuant to the terms of the SCB Line of Credit, the Company can borrow up to $1,000,000 secured by an assignment of a deposit account with Southern California Bank. Interest on the outstanding principal balance, calculated from the date of each advance to the repayment of each advance is at a fixed rate of 7.12%. This credit facility was undrawn at September 30, 1998. Throughout 1997 to September 30, 1998, the Company has paid approximately $99,000,000 in cash, assumed approximately $31,644,686 for acquisition indebtedness and has issued approximately 13,600,000 shares of Common Stock for the Acquisitions, investments, distribution and licensing agreements. From inception through September 30, 1998, the Company has funded operations primarily from borrowings under its debt agreements and the sale of Common Stock. The Company's operating activities used net cash of $50,882,969 for the nine months ended September 30, 1998. The cash used by operating activities is primarily attributable to the Company's continued efforts to increase its penetration of the retail and alternate distribution channels. Short-term and long-term funding needs for SmarTalk relate principally to acquisitions, additional market penetration, liquidity, operations and capital expenditures. These requirements principally have been met through the proceeds of the initial public offering in October 1996, the Notes offering in September 1997 and the private placement in July 1998. The following table sets forth selected financial data from the consolidated statements of cash flows.
CASH (USED IN) PROVIDED BY: ---------------------------------------- NINE MONTHS ENDED SEPTEMBER 30, OPERATIONS INVESTING FINANCING ------------------------------- ------------ ------------ ------------ 1998.............................. $(50,882,969) $(20,750,404) $ 27,326,423 1997(As Adjusted(1)).............. $ (9,227,271) $ (3,796,434) $119,010,545
16 Working capital, current assets and current liabilities are illustrated in the table below:
CURRENT CURRENT WORKING ASSETS LIABILITIES CAPITAL ------------ ------------ ------------ September 30, 1998................... $ 76,815,104 $ 73,259,130 $ 3,555,974 December 31, 1997(As Restated(2)).... $106,626,281 $ 71,316,035 $ 35,310,246
- -------- (1) See Note 9 to the Company's consolidated financial statements. (2) See Note 8 to the Company's consolidated financial statements. The ability of the Company to satisfy its cash requirements is dependent in part on the Company's ability to timely collects its accounts receivable. In addition, as indicated above, the Company has been required to rely on external financing sources for its operations and investment activities. The Company requires additional external financing to fund its continuing operations and any expansion activities. The Company currently is in discussions with various potential financing sources. There can be no assurances that the Company will be able to obtain such financing or that, if obtained, such financing would be on favorable terms. The inability to obtain required financing on acceptable terms could have a material adverse effect on the Company's business, financial condition and results of operations. The Company has engaged financial advisors to assist it in evaluating its strategic alternatives. IMPACT OF INFLATION SmarTalk does not consider inflation to have had a material impact on the results of operations for the nine months ended September 30, 1998 and the same period in 1997. YEAR 2000 The Company is aware of and is addressing the issues associated with the programming code in existing computer systems as the year 2000 approaches (the "Year 2000 Issue"). The Year 2000 Issue is pervasive and complex, as many computer systems will be affected in some way by the rollover of the two-digit year value to 00. Systems that do not properly recognize such information could generate erroneous data or cause a system to fail. The Company utilizes some software and related computer hardware technologies in its operations that may be affected by the Year 2000 Issue. While the Company believes that most of its proprietary software and platforms will be unaffected by the Year 2000 Issue, the Company is currently attempting to evaluate the impact of the Year 2000 Issue on the systems of its vendors, suppliers and key customers. The Company is currently reviewing what actions will be necessary to make its computer systems and those of its vendors, suppliers and key customers year 2000 compliant. The impact of these actions has yet to be fully determined, but could materially affect the Company's business. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not Applicable. 17 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On April 20, 1998, Intrine Communications ("Intrine"), filed a complaint against the Company and DCN in the Superior Court of California in Los Angeles County. In the complaint, Intrine alleges that, by virtue of the Company's acquisition of DCN, the Company and DCN breached written and oral agreements not to circumvent and appropriate for themselves the benefits of a purported deal by Intrine to acquire DCN. The lawsuit seeks damages and injunctive relief. Management of the Company believes that the claims against the Company and DCN are without merit and does not at present expect this lawsuit to have a material adverse effect on the Company's financial position, liquidity, cash flow or results of operations. Since July 23, 1998, 20 class actions have been filed against the Company and certain current and former members of its management and board of directors in state and Federal courts alleging violations of state and Federal securities laws with respect to certain alleged misrepresentations and/or omissions in regard to the Company's projected and actual revenues and earnings. These lawsuits seek unspecified damages on behalf of certain classes of persons who purchased the Company's securities during periods between May, 1997 and August, 1998. The complaints generally allege that the Company made material misrepresentations and omissions in regard to the Company's projected and actual revenues and earnings. Although the Company intends to defend against these lawsuits vigorously, it is not feasible to predict or determine the final outcome of these proceedings at this time. An unfavorable outcome with respect to any one or all of these proceedings could have a material adverse effect on the Company's financial condition and results of operations. In addition to the pending class action complaints discussed above, on November 5, 1998, the Company was also named as a nominal defendant in a derivative action purportedly brought on its behalf by a shareholder of the Company. Certain current and former officers and directors of the Company were named individually as defendants in this action. The allegations against the individual defendants include intentional and negligent breaches of fiduciary duty, waste of corporate assets, constructive fraud, gross mismanagement and breach of contract. Plaintiff seeks no recovery from the Company. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS In June, 1998, the Company issued 106,816 shares of Common Stock pursuant to an agreement reached in conjunction with a previous acquisition. The shares were issued in reliance upon the exemption from registration provided for under Section 4(2) of the Securities Act of 1933, as amended (the "Act"). In July, 1998, the Company issued 1,751,824 shares of Common Stock in a private placement. The shares were issued in reliance upon the exemption from registration provided for under Section 4(2) of the Act. In July, 1998, the Company granted an option to purchase shares of Common Stock having an aggregate purchase price of up to $20 million. The Company issued these unregistered securities in reliance upon Section 4(2) of the Act. In July, 1998, the Company issued 343,336 shares of Common Stock pursuant to the acquisition of a certain distribution agreement. The Company issued these unregistered securities in reliance upon Section 4(2) of the Act. In July, 1998, the Company issued 23,882 shares of Common Stock pursuant to an investment. The Company issued these unregistered securities in reliance upon Section 4(2) of the Act. In July, August and September of 1998, the Company granted 182,500 options to purchase Common Stock to certain officers and employees of the Company and certain other persons in consideration for their services. These unregistered securities were issued by the Company in reliance upon Section 4(2) of the Act. 18 ITEM 3. DEFAULT UPON SENIOR SECURITIES Not Applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not Applicable. ITEM 5. OTHER INFORMATION Not Applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits required by Item 601 of Regulation S-K. 10.1 Employment Agreement with Victor Grillo, Jr. 10.2 Employment Agreement with Wayne Wooddell. 27.1 Financial Data Schedule. (b) Current Reports on Form 8-K. SmarTalk filed a Current Report on Form 8-K on August 13, 1998 pertaining to its press release dated August 10, 1998, containing item 5 and item 7(c) exhibit 99.1. SmarTalk filed a Current Report on Form 8-K on September 11, 1998 pertaining to its agreement to amend the subscription agreement between SmarTalk and Fletcher International, Inc., containing item 5 and item 7(c) exhibit 99.1. SmarTalk filed a Current Report on Form 8-K on October 23, 1998 pertaining to its press release dated October 22, 1998, containing item 5 and item 7(c) exhibit 99.1. SmarTalk filed a Current Report on Form 8-K on November 6, 1998 pertaining to its press release dated November 6, 1998, containing item 5 and exhibit 99.1. 19 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Smartalk Teleservices, Inc. (Registrant) /s/ Wayne Wooddell ------------------------------------- Wayne Wooddell Vice President and Chief Financial Officer Date: November 16, 1998 20 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.1 Employment Agreement with Victor Grillo, Jr. 10.2 Employment Agreement with Wayne Wooddell. 27.1 Financial Data Schedule.
21 EX-10.1 2 EMPLOYMENT AGREEMENT WITH VICTOR GRILLO, JR. EXHIBIT 10.1 EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT (the "Agreement") is made this 10th day of June, --------- 1998 between SMARTALK TELESERVICES, INC., a California corporation (the "Company") and VICTOR GRILLO, JR. (the "Executive"); and ------- --------- WHEREAS, the parties hereto wish to enter into an employment agreement to employ the Executive as the President - Direct to Consumer division 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 (3) years (the "Initial Term"), commencing on the date hereof (the "Effective ------------ --------- Date"). Effective as of the expiration of the Initial 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 Effective Date 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 - Direct to Consumer division, which may include, among other things, responsibility for prepaid cellular products, new product development, direct response distribution and media purchases and marketing. During the Employment Period, the Executive shall report directly to the Chief Executive Officer (the "CEO") or the CEO's designee. --- (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 bylaws 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 of Directors of the Company (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 $200,000 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 the levels set forth above during the Initial Term, or from its then-existing level during the Employment Period. (b) Annual Bonus. The Executive shall earn bonus amounts in the form of ------------ cash and stock awards 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, subject to the approval of the Board. Performance criteria will be based upon the achievement of corporate performance goals for the Company's Direct to Consumer division as established by the CEO pursuant to the Company's business plan. The final determinations as to the achievement of the pre-established goals and the amounts of any bonus payout in relationship to such performance, shall be made by the Compensation Committee in its sole discretion. Executive's bonus shall be paid to Executive at such time as other executive bonuses are paid. (c) Other Benefits. During the Employment Period, the Executive shall -------------- receive such life insurance, pension, 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 of the Company. Without limiting the generality of the foregoing, the Executive shall be entitled to three (3) 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 four (4) weeks of unused vacation, and thereafter the Executive shall cease to accrue vacation thereafter until used. (d) 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. (e) Car Allowance. The Company 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 June 8, 1998 (f) Stock Options. Concurrently with the execution of this Agreement, the ------------- Company and Executive will enter into a Stock Option Agreement, attached hereto as Exhibit A, pursuant to which the Company shall grant to the Employee an option to purchase up to 100,000 shares of common stock of the Company on the terms and conditions set forth therein. 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 Executive shall commit any of the following: (i) any act or omission which shall represent a material breach in any material respect of any of the terms of this Agreement. (ii) gross misconduct that, in the reasonable good faith opinion of the Company that is or is likely to be significantly injurious to the Company; (iii) gross negligence or wanton and reckless acts or omissions in the performance of Executive's duties, in any such case which are to the material detriment of the Company; (iv) bad faith in the performance of Executive's duties, consisting of willful acts or omissions, to the material detriment of the Company; (v) addiction to illegal drugs or chronic alcoholism; or (vi) any conviction or pleading of guilty to a crime that constitutes a felony under the laws of the United States or any political subdivision thereof. (b) Termination for Good Reason. The Executive shall have the right at --------------------------- any time to terminate his employment with the Company 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 diminution during the Employment Period in the Executive's title, 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; or (iii) a material breach by the Company of any material terms of this Agreement. 3 June 8, 1998 (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 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 reasonably can be expected to result in death or that can be expected to last for a period of six (6) or more consecutive months from the first date of the disability ("Disability"). In the event of a dispute as to whether the Executive is ---------- impaired within the meaning of this Section 4(d), or as to the likely duration of any incapacity of the Executive either party may request a medical examination of the Executive by a doctor appointed by the Chief of Staff of a hospital selected by mutual agreement of the parties, or as the parties may otherwise agree, and the written medical opinion of such doctor shall be borne by the Company. 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. 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 - a lump sum amount equal to the Executive's ------------- annual Base Salary; and (ii) Benefits Continuation - continuation for six (6) months (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 with the Company continuing to pay its share of premiums and associated costs as if Executive continued in the employ of the Company; 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 4 June 8, 1998 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 6 months following the first date of Disability; and (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 6 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 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(c) 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(c) 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 though 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 5 June 8, 1998 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, Executive 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 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. Concurrently with the execution of this --------------- Agreement, the Company and Executive will enter into a Non-Competition Agreement, attached hereto as 6 June 8, 1998 Exhibit A, pursuant to which the Executive agrees that he shall not engage in any Proscribed Business (as defined in the Non-Competition Agreement) for a period of five (5) years. 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: Thaddeus Bereday General Counsel SmarTalk TeleServices, Inc. 5080 Tuttle Crossing Blvd. Dublin, Ohio 43017 If to the Executive, to: Victor Grillo, Jr. 14 Doeskin Drive Framingham, MA 01701 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. Arbitration. 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 Columbus, Ohio 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. 12. 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. 13. 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 7 June 8, 1998 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. 14. 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. 15. 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. 16. Payment. All amounts payable by the Company to the Executive under ------- this Agreement shall be paid promptly on the dates required for such payment in this Agreement without notice or demand. Any salary, benefits or other amounts paid or to be paid to Executive or provided to or in respect of the Executive pursuant to this Agreement shall not be reduced by amounts owing from Executive to the Company. 17. Authority. Each of the parties hereto hereby represents that each has --------- taken all actions necessary in order to execute and deliver this Agreement. 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 Ohio, 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 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. * * * 8 June 8, 1998 IN WITNESS WHEREOF, the parties have executed this Agreement as of June 9, 1998. SMARTALK TELESERVICES, INC. /s/ Erich L. Spangenberg ------------------------------ By: Erich L. Spangenberg Its: Chief Executive Officer /s/ Victor Grillo, Jr. ------------------------------ Victor Grillo, Jr. 9 June 8, 1998 EX-10.2 3 EMPLOYMENT AGREEMENT WITH WAYNE WOODDELL EXHIBIT 10.2 EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT (the "Agreement") is made this ______ day of September, 1998 between SMARTALK TELESERVICES, INC., a California corporation (the "Company"), and WAYNE WOODDELL (the "Executive"). WHEREAS, the Executive was previously a party to that certain Employment Agreement, dated July 30, 1997 (the "1997 Employment Agreement"), pursuant to which, among other things, Executive was employed as the Vice President - Integration of ConQuest Telecommunication Services Corp., a subsidiary of the Company; WHEREAS, the parties hereto wish to enter into an employment agreement to employ the Executive as the Chief Financial Officer, Vice President of Finance, and Assistant Secretary 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, effective as of September 21, 1998 (the "Effective Date"). Effective as of the expiration of such initial two-year term and 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 Effective Date 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 Chief Financial Officer, Vice President of Finance, and Assistant Secretary on the terms and conditions set forth in this Agreement. During the Employment Period, the Executive shall report directly to the Chief Executive Officer of the Company or his designee. (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 of Directors of the Company (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 $150,000 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 in the form of ------------ cash and stock awards, to be paid to the Executive within sixty (60) days following the year-end audit, 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 preestablished 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. The cash and stock components of the Executive's bonus awards shall be in the same average proportion as the awards granted to the other senior management of the Company. For purposes of this Agreement, senior management of the Company shall be the chief executive officer, the president, the chief operating officer, the executive vice president, and the general counsel. (c) Car Allowance. The Company, at its election, shall either (i) pay to ------------- Executive as an automobile allowance the sum of $400 per month during the Employment Period in lieu of any other provision for an automobile, insurance, maintenance, gasoline and expenses or (ii) permit Executive to continue the use of a Company-provided automobile during the Employment Period. (d) 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 of the Company. Without limiting the generality of the foregoing, the Executive shall be entitled to three (3) 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. (e) 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 Executive shall commit any of the following: (i) any act or omission which shall represent a material breach in any material respect of any of the terms of this Agreement; (ii) gross misconduct that, in the reasonable good faith opinion of the Company that is or is likely to be significantly injurious to the Company; (iii) gross negligence or wanton and reckless acts or omissions in the performance of Executive's duties, in any such case which are to the material detriment of the Company; (iv) bad faith in the performance of Executive's duties, consisting of willful acts or omissions, to the material detriment of the Company; (v) addiction to illegal drugs or chronic alcoholism; or (vi) any conviction or pleading of guilty to a crime that constitutes a felony under the laws of the United States or any political subdivision thereof. (b) Termination for Good Reason. The Executive shall have the right at --------------------------- any time to terminate his employment with the Company 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 title, duties or responsibilities with the Company as set forth in Section 2 hereof; (ii) a material breach by the Company of the compensation and benefits provisions set forth in Section 3 hereof; (iii) termination by the Executive for any reason within 12 months following the occurrence of a Change in Control (as defined in Section 4(e) hereof); or (iv) 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" (other than pursuant to Section 4(b)(iii) hereof) 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 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 (6) 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. 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: (1) Severance Pay - a lump sum amount equal to three (3) times the ------------- Executive's Base Salary as in effect immediately prior to such termination and the highest bonus paid (including the fair value, as of the date of grant, of any bonus paid in the form of stock based awards) to the Executive during the Employment Period. (ii) Benefits Continuation - continuation for 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") 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 (x) 12 months following the first date of Disability and (y) 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 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) Condition 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 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 the 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 the 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. 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 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: Chief Executive Officer SmarTalk TeleServices, Inc. 1640 South Sepulveda Blvd., Suite 500 Los Angeles, CA 90025 with a copy to: Robert M. Smith, Esq. Dewey Ballantine 333 South Hope Street, Suite 3000 Los Angeles, CA 90071-1406 (b) If to the Executive, to: Wayne Wooddell 423 North Street Utica, OH 43080 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 Franklin County, Ohio 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 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 there from 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. Payments; Mitigation. All amounts payable by the Company to the -------------------- Executive under this Agreement shall be paid promptly on the dates required for such payment in this Agreement without notice or demand. There shall be no right of set-off or counterclaim in respect of any claim, debt or obligation against any payment to the Executive, his dependents, beneficiaries or estate provided for in this Agreement. Any salary, benefits or other amounts paid or to be paid to Executive or provided to or in respect of the Executive pursuant to this Agreement shall not be reduced by amounts owing from Executive to the Company. Executive shall not be obligated to seek other employment in mitigation of the amounts payable or the arrangements made under any provision of this Agreement. 19. 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. 20. 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. 21. 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 agreements or understandings between the Executive and the Company with respect to the subject matter hereof, whether written or oral, including without limitation the 1997 Employment Agreement; provided, however, that all stock option agreements between the Company and the Executive shall remain in full force and effect and provided, further, that Executive shall be entitled to all amounts payable or reimbursable under the 1997 Employment Agreement for periods ending on or prior to the date hereof. 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 September , 1998. -- SMARTALK TELESERVICES, INC. /s/ Erich L. Spangenberg ------------------------ By: Erich L. Spangenberg Its: Chief Executive Officer /s/ Wayne Wooddell ------------------ Wayne Wooddell EX-27.1 4 FINANCIAL DATA SCHEDULE
5 9-MOS 9-MOS DEC-31-1998 DEC-31-1997 JAN-01-1998 JAN-01-1997 SEP-30-1998 SEP-30-1997 18,516,643 62,900,673 0 0 39,716,887 29,494,443 6,415,187 1,482,206 12,337,893 4,301,487 76,815,104 106,626,281 27,405,499 15,403,784 6,835,987 1,194,809 406,301,311 368,301,077 73,259,130 71,316,035 0 0 0 0 0 0 279,155,873 178,670,477 66,730 143,810 406,301,311 368,301,077 139,138,081 37,358,084 139,138,081 37,358,084 97,904,762 23,761,289 97,904,762 23,761,289 101,186,041 18,550,932 0 0 7,196,244 965,173 (64,070,365) (4,019,644) 0 0 (64,070,365) (4,019,644) 3,028,148 0 0 0 0 0 (67,098,513) (4,019,644) (2.77) (.28) (2.77) (.28)
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