-----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, ObpXx5qodZyV+AVtRw2kdEG+wpU+f6NTEcG0Y81Oel90A4Em2f3UUprSvtL9Wrev DlK6FotN4MYZGvtz/LPzAA== 0000950150-97-001821.txt : 19971216 0000950150-97-001821.hdr.sgml : 19971216 ACCESSION NUMBER: 0000950150-97-001821 CONFORMED SUBMISSION TYPE: 8-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19971124 ITEM INFORMATION: ITEM INFORMATION: FILED AS OF DATE: 19971212 SROS: NONE 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: 8-K SEC ACT: SEC FILE NUMBER: 000-21579 FILM NUMBER: 97737582 BUSINESS ADDRESS: STREET 1: 1640 S. SEPULVEDA BLVD STREET 2: SUITE 500 CITY: LOS ANGELES STATE: CA ZIP: 90025 BUSINESS PHONE: 3104448800 MAIL ADDRESS: STREET 1: 1640 S. SEPULVEDA BLVD STREET 2: SUITE 500 CITY: LOS ANGELES STATE: CA ZIP: 90025 8-K 1 FORM 8-K 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 8-K ------------------------ CURRENT REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 ------------------------ DATE OF REPORT (DATE OF EARLIEST EVENT REPORTED): NOVEMBER 24, 1997 SMARTALK TELESERVICES, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) ------------------------ CALIFORNIA (STATE OR JURISDICTION OF INCORPORATION) 0-21579 95-4502740 (COMMISSION FILE NUMBER) (IRS EMPLOYER IDENTIFICATION NO.)
1640 SOUTH SEPULVEDA BOULEVARD, SUITE 500, LOS ANGELES, CA 90025 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (310) 444-8800 (REGISTRANT'S TELEPHONE NUMBER) ================================================================================ 2 ITEM 5. OTHER EVENTS The previously audited financial statements of SmarTel Communications, Inc. ("SmarTel") and GTI Telecom, Inc. ("GTI") have been restated and are included herein. SmarTalk is party to an Agreement and Plan of Reorganization and Merger by and among SmarTalk, SMTK Acquisition Corp. II and ConQuest Telecommunication Services Corp. ("ConQuest"), dated as of July 30, 1997. Included herein are the audited financial statements of ConQuest for the periods ending December 31, 1994, 1995, and 1996, and the unaudited financial statements of ConQuest for the periods ending September 30, 1996 and 1997. Also included herein are the Unaudited Pro Forma Combined Financial Statements of SmarTalk giving effect to (i) the ConQuest merger, (ii) the September 1997 issuance of $150,000,000 of convertible subordinated notes, (iii) the acquisitions of SmarTel and GTI and (iv) the September 1997 settlement of $25,970,000 in subordinated notes issued in connection with the GTI acquisition as if they occurred at the beginning of each period presented or on the dates indicated. ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS (a) FINANCIAL STATEMENTS OF BUSINESSES ACQUIRED SmarTel's audited and restated financial statements are filed as exhibit 99.1. GTI's audited and restated financial statements are filed as exhibit 99.2. ConQuest's audited and unaudited financial statements are filed as exhibit 99.3. (b) PRO FORMA FINANCIAL INFORMATION The Unaudited Pro Forma Financial Statements of SmarTalk are filed as exhibit 99.4. (c) EXHIBITS 23.1 Consent of Arthur Andersen LLP. 23.2 Consent of KPMG Peat Marwick LLP. 23.3 Consent of Price Waterhouse LLP. 23.4 Consent of Ernst & Young LLP. 99.1 Audited Financial Statements of SmarTel. 99.2 Audited Financial Statements of GTI. 99.3 Audited and Unaudited Financial Statements of ConQuest. 99.4 Unaudited Pro Forma Financial Statements. 3 SIGNATURE 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) By /s/ ERICH L. SPANGENBERG ------------------------------------ Erich L. Spangenberg Vice Chairman of the Board and Chief Operating Officer Date: December 12, 1997 4 EXHIBIT INDEX
NUMBER SUBJECT MATTER - ------ ------------------------------------------------------------------------------------ 23.1 Consent of Arthur Andersen LLP. 23.2 Consent of KPMG Peat Marwick LLP. 23.3 Consent of Price Waterhouse LLP. 23.4 Consent of Ernst & Young LLP. 99.1 Audited Financial Statements of SmarTel. 99.2 Audited Financial Statements of GTI. 99.3 Audited and Unaudited Financial Statements of ConQuest. 99.4 Unaudited Pro Forma Financial Statements.
EX-23.1 2 CONSENT OF ARTHUR ANDERSEN LLP 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the inclusion in this Form 8-K and to the incorporation by reference into the Registration Statement (Form S-8) of SmarTalk TeleServices, Inc. (Registration No. 333-36543) filed on September 26, 1997 of our report dated April 4, 1997 (except with respect to the matter discussed in Notes 1, 3(a), 4(d), 5 and 9, as to which the date is May 24, 1997 and to the matter discussed in Note 1(c), as to which the date is November 24, 1997) on the financial statements of SmarTel Communications, Inc. and subsidiaries (the Company) as of December 31, 1995 and 1996 and for the three years in the period ended December 31, 1996 and to all references to our Firm included in this registration statement. It should be noted that we have not audited any financial statements of the Company subsequent to December 31, 1996 or performed any audit procedures subsequent to the date of our report. /s/ ARTHUR ANDERSEN LLP Boston, Massachusetts December 10, 1997 EX-23.2 3 CONSENT OF KPMG PEAT MARWICK LLP 1 EXHIBIT 23.2 INDEPENDENT ACCOUNTANTS' CONSENT To the Board of Directors of GTI Telecom, Inc.: We consent to the use of our report dated April 4, 1997, except as to note 15 which is as of May 16, 1997 and note 2 which is as of November 24, 1997, with respect to the balance sheet of GTI Telecom, Inc. as of December 31, 1996 (as restated), and the related statements of operations, stockholders' deficit and cash flows for the year ended December 31, 1996 (as restated), included in Form 8-K filed on or about December 11, 1997 and to the incorporation by reference into the Registration Statement (Form S-8) of SmarTalk TeleServices, Inc. (registration No. 333-36543) filed on September 26, 1997. Our report contains an explanatory paragraph which states that the Company's financial statements have been restated. Our report also contains an explanatory paragraph that states that GTI Telecom, Inc. has suffered recurring losses from operations and has working capital and stockholder's deficits which raise substantial doubt about its ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of that uncertainty. /s/ KPMG Peat Marwick LLP Orlando, Florida December 11, 1997 EX-23.3 4 CONSENT OF PRICE WATERHOUSE LLP 1 EXHIBIT 23.3 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the use in this Form 8-K and incorporation by reference into the Registration Statement on Form S-8 of SmarTalk TeleServices, Inc. (Registration No. 333-36543) filed on September 26, 1997 of our report dated July 18, 1996, except as to Note 2 which is as of November 24, 1997, relating to the financial statements of GTI Telecom, Inc. which appears in this Form 8-K. /s/ Price Waterhouse LLP Century City, California December 11, 1997 EX-23.4 5 CONSENT OF ERNST & YOUNG LLP 1 EXHIBIT 23.4 CONSENT OF INDEPENDENT AUDITORS We consent to incorporation by reference in the Registration Statement (Form S-8 No. 333-36543) pertaining to the 1996 Nonqualified Stock Option Plan and the 1996 Stock Incentive Plan of SmarTalk TeleServices, Inc. of our report dated February 7, 1997 (except Note 11, as to which the date is February 19, 1997 and the last paragraph of Note 9 as to which the date is November 25, 1997) with respect to the consolidated financial statements of ConQuest Telecommunication Services Corp. included in this Current Report on Form 8-K of SmarTalk TeleServices, Inc. /s/ Ernst & Young LLP Columbus, Ohio December 11, 1997 EX-99.1 6 REPORT OF ARTHUR ANDERSEN LLP 1 EXHIBIT 99.1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS TO THE STOCKHOLDERS OF SMARTEL COMMUNICATIONS, INC. AND SUBSIDIARIES: We have audited the accompanying consolidated balance sheets of SmarTel Communications, Inc. (a Delaware corporation) and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, redeemable preferred stock and stockholders' equity (deficit) and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of SmarTel Communications, Inc. and subsidiaries as of December 31, 1996 and 1995, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. As explained in Note 1(c) to the financial statements, the Company has given retroactive effect to a change in its revenue recognition methodology relating to promotional cards. /s/ ARTHUR ANDERSEN LLP Boston, Massachusetts April 4, 1997 (except with respect to the matter discussed in Notes 1, 3(a), 4(d), 5 and 9, as to which the date is May 24, 1997 and to the matter discussed in Note 1(c), as to which the date is November 24, 1997) 1 2 SMARTEL COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS -- DECEMBER 31, 1996 AND 1995 ASSETS
1996 1995 (AS (AS RESTATED) RESTATED) Current Assets: Cash and cash equivalents....................................... $ 1,763,473 $ 1,869,656 Accounts receivable, net of allowance for doubtful accounts..... 785,146 565,576 Inventories..................................................... 26,798 30,238 Other current assets............................................ 439,213 499,015 ----------- ----------- Total current assets.................................... 3,014,630 2,964,485 ----------- ----------- Property and Equipment: Computer and office equipment................................... 189,523 159,926 Printing equipment.............................................. 29,788 23,717 Leasehold improvements.......................................... 63,153 63,153 Furniture and fixtures.......................................... 13,046 -- ----------- ----------- 295,510 246,796 Less -- Accumulated depreciation and amortization............... 101,511 42,244 ----------- ----------- 193,999 204,552 ----------- ----------- Other Assets: Note receivable from stockholder................................ 79,180 -- Intangible assets, net of accumulated amortization of $15,206 and $0 at December 31, 1996 and 1995, respectively........... 46,524 61,730 Organization costs, net of accumulated amortization of $29,015 and $14,911 at December 31, 1996 and 1995, respectively...... 40,162 54,267 Other assets.................................................... 50,677 50,639 ----------- ----------- $ 3,425,172 $ 3,335,673 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current Liabilities: Subordinated notes payable to stockholders, current portion..... $ 157,500 $ -- Capital lease obligation, current portion....................... 12,459 13,500 Equipment line of credit, current portion....................... 16,798 11,199 Unsecured note payable.......................................... -- 15,000 Accounts payable................................................ 1,764,543 435,255 Accrued expenses................................................ 282,068 139,806 Deferred revenue................................................ 3,742,622 2,530,993 ----------- ----------- Total current liabilities............................... 5,975,990 3,145,753 ----------- ----------- Equipment Line of Credit, net of current portion.................. 33,597 44,795 ----------- ----------- Subordinated Notes Payable to Stockholders........................ -- 157,500 ----------- ----------- Minority Interest -- Preferred Stock.............................. 30,000 30,000 ----------- ----------- Commitments and Contingencies (Notes 3, 4, 6 and 7) Redeemable Preferred Stock: Authorized -- 4,002 shares Issued and outstanding -- 3,909 shares (liquidation preference of $4,161,019 and $4,040,989 at December 31, 1996 and 1995, respectively)................................................ 3,796,190 2,718,686 Stockholders' Equity (Deficit): Common stock, $.001 par -- Authorized -- 10,000,000 shares Issued and outstanding -- 2,434,035 shares................... 2,434 2,434 Additional paid-in capital...................................... 1,507,004 1,507,004 Accumulated deficit............................................. (7,920,043) (4,270,499) ----------- ----------- Total stockholders' equity (deficit).................... (6,410,605) (2,761,061) ----------- ----------- $ 3,425,172 $ 3,335,673 =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. 2 3 SMARTEL COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1996 1995 1994 (AS (AS (AS RESTATED) RESTATED) RESTATED) Revenues............................................ $ 5,034,192 $ 1,377,035 $ 77,857 Cost of Revenues.................................... 4,100,955 1,201,163 113,680 ----------- ----------- --------- Gross profit.............................. 933,237 175,872 (35,823) Selling, General and Administrative Expenses........ 3,524,677 2,043,007 741,714 Loss on Discontinuance of Long Distance Service Businesses, net (Note 1).......................... -- 310,613 58,230 ----------- ----------- --------- Loss from operations...................... (2,591,440) (2,177,748) (835,767) Interest Income (Expense), net...................... 7,241 (211) -- Other Income, net................................... 12,159 -- -- ----------- ----------- --------- Net loss.................................. (2,572,040) (2,177,959) (835,767) Accretion of Redeemable Preferred Stock Dividends and Discount...................................... (1,074,744) (223,905) -- ----------- ----------- --------- Net Loss Attributable to Common Stockholders........ $(3,646,784) $(2,401,864) $ (835,767) =========== =========== ========= Net Loss per Common Share........................... $ (1.50) $ (1.27) $ (0.52) =========== =========== ========= Weighted Average Number of Common Shares Outstanding....................................... 2,434,035 1,895,495 1,612,511 =========== =========== =========
The accompanying notes are an integral part of these consolidated financial statements. 3 4 SMARTEL COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT) FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
STOCKHOLDERS' EQUITY (DEFICIT) REDEEMABLE ----------------------------------------------------------------------------- PREFERRED STOCK COMMON STOCK ------------------------ ----------------------- ADDITIONAL NUMBER REDEMPTION NUMBER $.001 PAID-IN TOTAL OF SHARES VALUE OF SHARES PAR VALUE CAPITAL ACCUMULATED STOCKHOLDERS' DEFICIT EQUITY (AS RESTATED) (DEFICIT) (AS RESTATED) Balance, December 31, 1993 (Unaudited)... -- $ -- 1,539,000 $ 1,539 -- $ 5,823 $ 7,362 Sale of common stock............ -- -- 130,183 130 199,831 -- 199,961 Net loss........... -- -- -- -- -- (835,767) (835,767) ----- --------- --------- ------ --------- ----------- ----------- Balance, December 31, 1994............... -- -- 1,669,183 1,669 199,831 829,944 (628,444) Issuance of redeemable preferred stock and warrants, net of issuance costs of $191,097...... 3,002 1,494,996 -- -- 1,507,004 (191,097) 1,315,907 Accretion of preferred stock dividends........ -- 33,989 -- -- -- (33,989) (33,989) Accretion of preferred stock discount......... -- 190,491 -- -- -- (190,491) (190,491) Preferred stock dividend on common stock..... 908 1,000,000 -- -- (199,831) (800,169) (1,000,000) Exercise of common stock warrants in exchange for redemption of preferred stock.. (1) (790) 789,888 790 -- -- 790 Repurchase and retirement of common stock..... -- -- (25,036) (25) -- (46,850) (46,875) Net loss........... -- -- -- -- -- (2,177,959) (2,177,959) ----- --------- --------- ------ --------- ----------- ----------- Balance, December 31, 1995............... 3,909 2,718,686 2,434,035 2,434 1,507,004 (4,270,499) (2,761,061) Accretion of preferred stock dividends........ -- 120,030 -- -- -- (120,030) (120,030) Accretion of preferred stock discount......... -- 957,474 -- -- -- (957,474) (957,474) Net loss........... -- -- -- -- -- (2,572,040) (2,572,040) ----- ---------- --------- ------ --------- ----------- ----------- Balance, December 31, 1996............... 3,909 $3,796,190 2,434,035 $ 2,434 $ 1,507,004 $(7,920,043) $(6,410,605) ===== ========== ========= ====== ========= =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. 4 5 SMARTEL COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1996 1995 1994 (AS RESTATED) (AS RESTATED) (AS RESTATED) Cash Flows from Operating Activities: Net loss.......................................................... $(2,572,040) $(2,177,959) $(835,767) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization................................... 88,576 50,161 6,993 Changes in assets and liabilities: Accounts receivable........................................... (219,570) (327,617) (191,940) Inventories................................................... 3,440 (21,688) (8,550) Other current assets.......................................... 59,802 (207,806) (281,108) Accounts payable.............................................. 1,329,288 329,895 65,218 Accrued expenses.............................................. 142,262 (65,003) 126,214 Deferred revenue.............................................. 1,211,629 1,676,424 854,569 ----------- ----------- --------- Net cash provided by (used in) operating activities........ 43,387 (743,593) (264,371) ----------- ----------- --------- Cash Flows from Investing Activities: Note receivable from stockholder.................................. (79,180) -- -- Purchases of property and equipment............................... (86,156) (184,996) (31,496) Proceeds from sale of property and equipment...................... 48,489 -- -- Increase in other assets.......................................... (38) (40,039) (10,600) Organization costs................................................ -- (53,032) (16,145) ----------- ----------- --------- Net cash used in investing activities...................... (116,885) (278,067) (58,241) ----------- ----------- --------- Cash Flows from Financing Activities: Proceeds from sale of common stock................................ -- -- 199,961 Proceeds from sale of minority interest -- preferred stock........ -- -- 30,000 Proceeds from sale of preferred stock and warrants, net of issuance costs.................................................. -- 2,810,903 -- Repurchase and retirement of common stock......................... -- (46,875) -- (Payments on) proceeds from subordinated notes payable to stockholders.................................................... -- (37,500) 195,000 (Payments on) proceeds from advances from stockholders............ -- (62,500) 2,000 Payments on unsecured note payable................................ (15,000) -- -- Payments on capital lease obligation.............................. (12,086) (8,532) (5,328) (Payments on) proceeds from borrowings on equipment line of credit.......................................................... (5,599) 55,994 -- ----------- ----------- --------- Net cash (used in) provided by financing activities........ (32,685) 2,711,490 421,633 ----------- ----------- --------- Net (Decrease) Increase in Cash and Cash Equivalents................ (106,183) 1,689,830 99,021 Cash and Cash Equivalents, beginning of year........................ 1,869,656 179,826 80,805 ----------- ----------- --------- Cash and Cash Equivalents, end of year.............................. $ 1,763,473 $ 1,869,656 $ 179,826 =========== =========== ========= Supplemental Disclosure of Noncash Information: Cash paid for interest............................................ $ 7,145 $ 20,685 $ 3,955 =========== =========== ========= Supplemental Disclosure of Noncash Investing and Financing Activities: Exercise of common stock warrants in exchange for redemption of preferred stock................................................. $ -- $ 790 $ -- =========== =========== ========= Accretion of preferred stock dividends............................ $ 117,270 $ 33,414 $ -- =========== =========== ========= Accretion of preferred stock discount............................. $ 957,474 $ 190,491 $ -- =========== =========== ========= Purchase of Global Media Networks -- Fair value of assets purchased.................................. $ -- $ 82,673 $ -- Issuance of note payable........................................ -- (15,000) -- Liabilities assumed............................................. -- (67,673) -- =========== =========== ========= $ -- $ -- $ -- =========== =========== ========= Equipment acquired under capital lease obligation................... $ 11,045 $ -- $ -- =========== =========== =========
The accompanying notes are an integral part of these consolidated financial statements. 5 6 SMARTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES SmarTel Communications, Inc. (the Company) (formerly Z-Axis Communications) is engaged in the business of providing marketing and telecommunications services through the sale of prepaid telephone cards. The Company was incorporated in 1985 as a Massachusetts corporation. On January 20, 1995, the Company reorganized in Delaware. In connection with this reorganization, the Delaware corporation issued 1,500 shares of common stock for each existing share of common stock in the Massachusetts corporation. All share amounts in the accompanying consolidated financial statements have been retroactively restated for this reorganization. Prior to 1994, the Company was also engaged in the business of selling long distance services principally to other businesses. The Company discontinued its operation in this business in June 1994 and, as a result, recorded a loss of approximately $58,000, net of $98,500 of revenue, in the accompanying consolidated statement of operations for the year ended December 31, 1994. In addition, during 1994, the Company began developing technology in an attempt to enter the international call arbitrage business. The Company abandoned this attempt in June 1995 and, as a result, recorded a loss of approximately $311,000 in the accompanying statement of operations for the year ended December 31, 1995. Through December 31, 1994, approximately $30,000 was charged to selling, general and administrative expenses relating to the development of this abandoned product line. On December 21, 1995, the Company acquired certain assets and liabilities of Global Media Network (see Note 8). The Company continues to be subject to certain risks common to companies in similar stages of development. Principal among these risks are dependence on key individuals; successful marketing of current products and services, combined with the need to successfully develop and introduce new products and services; dependence on independent commission agents whose compensation is based on the profitability of prepaid telephone card programs; the ability to raise additional capital to fund operations; and the ability to achieve profitable future operations. On May 24, 1997, the Company merged with SmarTalk Teleservices, Inc. (see Note 9). The accompanying consolidated financial statements reflect the application of the following significant accounting policies: (a) Principles of Consolidation The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries, SmarTel, Inc. (90%-owned), SmarTel Communications of Virginia, Inc. (100%-owned) and SmarTel International, Inc. (100%-owned). All significant intercompany transactions and balances have been eliminated in consolidation. (b) Management's Use of Estimates The preparation of these consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 6 7 SMARTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1996 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (c) Revenue Recognition The Company has restated its financial statements to give retroactive effect to a change in its revenue recognition relating to promotional cards. From inception, the Company's management has estimated, based on the usage patterns of customers, the portion of calling time which would not be used by the customer ("breakage") and recognized this as additional revenue for its promotional card programs. In November 1997 in consultation with the Securities and Exchange Commission staff, the Company modified its revenue recognition policy such that revenue is recognized as described herein. As a result, the Company has restated its financial statements and the impact on the Company's previously issued financial results for each of the three years ended December 31, 1996, 1995 and 1994 as summarized below:
1996 1995 1994 ------------------------- ------------------------- ------------------------- AS REPORTED AS RESTATED AS REPORTED AS RESTATED AS REPORTED AS RESTATED ----------- ----------- ----------- ----------- ----------- ----------- Revenues................... $ 5,496,640 $ 5,034,192 $ 2,546,246 $ 1,377,035 $ 861,270 $ 77,857 Net Loss................... (2,065,902) (2,572,040) (1,116,834) (2,177,959) (294,426) (835,767) Net Loss attributable to Common Stockholder....... (3,140,646) (3,646,784) (1,340,739) (2,401,864) (294,426) (835,767) Net Loss per Common Share... (1.29) (1.50) (.71) (1.27) (.18) (.52)
The Company sells its product into two distinct markets, retail and promotional. Retail card sales are ultimately funded by the end user, while promotional card sales are funded by third parties who have promotional information attached to the card. Promotional cards are then given to the end user to promote the buyer's product or service. The Company accounts for revenue from these sales as follows: - For retail markets, the Company records deferred retail revenue when it sells the card and recognizes revenues as the ultimate customer utilizes the calling time or as the card expires. Retail card revenue for the years ended December 31, 1996 and 1995 was approximately $512,000 and $142,000, respectively. The Company did not have any retail card revenue for the year ended December 31, 1994. - For promotional markets, the Company defers 100% of the revenue when it sells the card and recognizes the revenue as the ultimate customer utilizes the calling time or the card expires. - Revenue from third-party prepaid phone cards for which the Company acts solely as a reseller is recognized upon delivery. - The Company's primary costs of its prepaid telephone cards include the cost of design and manufacturing of the cards, long-distance carrier fees for processing the calls generated by use of the prepaid telephone cards and switch administration fees. For retail and promotional telephone cards, these costs are expensed as the associated revenues are earned. Substantially all prepaid telephone cards sold by the Company have expiration dates 12 months from the date of delivery to the customer and provide that payments for cards are nonrefundable. The Company utilizes several service bureaus to process calls and provide administrative support for calls generated by the use of prepaid telephone cards. These services are concentrated with one service provider. The Company could be adversely affected if this service bureau were unable or unwilling to 7 8 SMARTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1996 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) continue this relationship. Management believes that there are alternative service bureaus it could use to minimize any adverse impact on the loss of the existing service bureau. (d) Cash and Cash Equivalents The Company considers all highly liquid investments with original maturities of less than three months to be cash equivalents. These investments are reported at cost, which approximates market value. (e) Inventories Inventories are recorded at the lower of cost (first-in, first-out) or market. At December 31, 1996, inventories consisted primarily of printing materials and supplies used in the production of the telephone cards. (f) Depreciation and Amortization The Company provides for depreciation and amortization using the straight-line method by charges to operations in amounts that allocate the cost of the property and equipment over their estimated useful lives, as follows:
ESTIMATED ASSET CLASSIFICATION USEFUL LIFE Computer and office equipment.......... 4-7 years Printing equipment..................... 5 years Leasehold improvements................. Life of lease Furniture and fixtures................. 7 years
(g) Note Receivable from Stockholder On January 10, 1996, the Company entered into a $75,000 note receivable agreement (the Note) with a stockholder. The Note accrues interest at a rate of 5.73% compounded annually, totaling $4,180 at December 31, 1996. Principal and accrued interest, then outstanding, is due on January 10, 2005. The Note is secured by the stockholder's stock in the Company. (h) Organization Costs Organization costs include legal fees and costs associated with registering the Company as a public utility in jurisdictions where the Company provides telephone services. These costs are being amortized on a straight-line basis over five years. (i) Minority Interest The Company's 90%-owned subsidiary, SmarTel, Inc., has 50,000 authorized shares of preferred stock, of which 1,000 shares were issued at $30 per share in 1994 to a third party and were outstanding as of December 31, 1996. These 1,000 shares were convertible into a 10% interest in the subsidiary and had a $30,000 liquidation preference. Accordingly, this minority interest reflected its priority claim on the underlying equity in the subsidiary at December 31, 1996. This preferred stock was returned to the Company and retired on May 24, 1997 (see Note 5). 8 9 SMARTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1996 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (j) Postretirement Benefits The Company has no obligations for postretirement benefits. (k) Financial Instruments The estimated fair value of the Company's financial instruments, which include trade accounts receivable, note receivable from stockholder and long-term debt, approximates their carrying value. (l) Concentration of Credit Risk Statement of Financial Accounting Standards (SFAS) No.105, Disclosure of Information About Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit Risk, requires disclosure of any significant off-balance-sheet and credit risk concentrations. Financial instruments that subject the Company to credit risk consists primarily of trade accounts receivable. The Company had one customer who accounted for approximately 24% of consolidated revenue for the year ended December 31, 1996. The Company had no significant customers in the years ended December 31, 1995 and 1994. (m) Net Loss per Common and Common Equivalent Share Net loss per common share was computed based on the weighted average number of common shares outstanding. The Company's net loss was increased by $1,074,744 and $223,905 for the years ended December 31, 1996 and 1995, respectively, for accretion of dividends and discount on redeemable preferred stock to determine the loss applicable to common stock. Common equivalent shares are not included in the per share calculations as the effect of their inclusion would be antidilutive. On March 3, 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 128, Earnings per Share. SFAS No. 128 establishes standards for computing and presenting earnings per share and applies to entities with publicly held common stock or potential common stock. This statement is effective for fiscal years ending after December 15, 1997, and early adoption is not permitted. When adopted, the statement will require restatement of prior years' earnings per share. The Company believes that the adoption of SFAS No. 128 will not have a material effect on its financial statements. 2. INCOME TAXES The Company provides for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes. Under SFAS No. 109, deferred tax assets and liabilities are recognized based on temporary differences between the financial statement and tax bases of assets and liabilities using currently enacted statutory rates. The Company's gross deferred tax asset of $1,360,000 consists principally of the net operating loss carryforwards of approximately $3,200,000. Due to the uncertainty related to the realization of future tax return benefits of the gross deferred tax asset, a full valuation allowance has been provided. The United States Tax Reform Act of 1986 contains provisions that may limit the Company's net operating loss and credit carryforwards available to be used in any given year in the event of significant changes in the ownership interests of significant stockholders. The Company has completed several financings since its inception and may have incurred ownership changes, as defined in the Tax Reform Act of 1986. The Company believes that the ownership changes will not significantly impact its ability to utilize its net operating loss and credit carryforwards. 9 10 SMARTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1996 3. DEBT (a) Subordinated Notes Payable to Stockholders During 1994, the Company issued $195,000 of subordinated promissory notes payable to certain stockholders. The notes were issued in conjunction with the Company's 1994 private placement offering of its common stock and bear interest at 10% per year, payable semiannually. During 1995, the Company repurchased 25,036 shares of common stock and a $37,500 subordinated note payable held by a stockholder for $87,500, including accrued interest. These notes are unsecured and subordinate to all present and future senior debt issuances. The outstanding principal of $157,500 was due on February 28, 1997. These amounts and accrued interest of $184,721 were repaid on May 24, 1997, the closing date on sale of the Company (see Note 9). Accordingly, these amounts have been classified as a current liability as of December 31, 1996, in the accompanying consolidated financial statements. (b) Lines of Credit On September 8, 1995, the Company entered into a credit facility (the facility) with a bank, which provided for a $250,000 working capital line of credit. This line of credit expired on September 8, 1996. Advances under this line of credit bore interest at prime plus 1%. In addition, the facility provides for a $500,000 equipment line of credit. Advances under this line of credit bear interest at prime (8.25% at December 31, 1996) plus 2%. Principal payments are due in monthly installments on the first business day of each calendar month commencing August 5, 1996, with the final installment due on December 1, 1999. The Company was required to comply with certain operational and financial covenants under this credit facility. The financial covenants required certain minimum levels of profitability, tangible net worth and liquidity. At December 31, 1996, the Company was in default of certain of these covenants. On January 31, 1997, the facility was amended eliminating the existing financial covenants and providing for one liquidity covenant. This liquidity covenant provides that the Company shall maintain, as of the last calendar day of each month, at least $600,000 of cash or cash equivalents. The Company was in compliance with this covenant on January 31, 1997. 4. STOCKHOLDERS' EQUITY (DEFICIT) (a) Common Stock In connection with the Company's private placement offering of its common stock and subordinated notes payable, the Company had committed to certain levels of annual internal rate of return on each combined debt and equity unit within three years from the completion of the offering in December 1994. In connection with the September 15, 1995 preferred stock offering, the holders have terminated their rights with respect to the Company's commitment to achieving these levels. (b) Stock Option Plan In December 1994, the Board of Directors approved the SmarTel Communications, Inc. 1994 Stock Incentive Plan (the Plan) pursuant to which options to purchase up to 82,500 shares of common stock may be granted to directors, officers and other employees of the Company. Incentive stock options may be granted under the Plan at a price not less than the fair market value on the date of grant. Options vest over a two-year period and expire 10 years from the date of grant. In connection with the September 15, 1995 preferred stock offering, the Plan was amended to provide that no additional options be granted thereunder. 10 11 SMARTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1996 4. STOCKHOLDERS' EQUITY (DEFICIT) (CONTINUED) The following table summarizes option activity under the Plan:
WEIGHTED AVERAGE NUMBER OF EXERCISE PRICE EXERCISE OPTIONS PER SHARE PRICE Granted and Outstanding, December 31, 1994.......... 24,500 $0.50-$2.00 $ 1.69 Granted........................................... 5,000 2.00 2.00 Canceled.......................................... (1,000) 2.00 2.00 ------- ----------- ------ Outstanding, December 31, 1995...................... 28,500 0.50-2.00 1.73 Granted........................................... -- -- -- Canceled.......................................... (10,000) 0.50-2.00 1.25 ------- ----------- ------ Outstanding, December 31, 1996...................... 18,500 $ 2.00 $ 2.00 ======= =========== ====== Exercisable, December 31, 1996...................... 18,000 $ 2.00 $ 2.00 ======= =========== ======
The weighted average fair value of options granted during the year ended December 31, 1995 was $.51. There were no options granted during 1996. In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, Accounting for Stock-Based Compensation, which requires the measurement of the fair value of stock options or warrants to be included in the statement of operations or disclosed in the notes to the financial statements. The Company has determined that it will continue to account for stock-based compensation for employees under Accounting Principles Board Opinion No. 25 and elect the disclosure-only alternative under SFAS No. 123 for options granted in 1995 and 1996 using the Black-Scholes option pricing model prescribed by SFAS No. 123. The total value of options granted during the years ended December 31, 1996 and 1995 was not significant. (c) Common Stock Warrants In connection with the September 15, 1995 preferred stock offering, the Company granted warrants to purchase up to 1,507,968 shares of common stock to stockholders holding 3,002 shares of preferred stock. The warrants are exercisable at $.001 per share and expire on September 15, 2002. During 1995 warrants to purchase 789,888 shares of common stock were exercised. No warrants were exercised in 1996. Warrants to purchase up to 718,080 shares of common stock are outstanding at December 31, 1996. At any time on or after the date of the sale of the Company, liquidation of the Company or September 15, 2002, whichever occurs first, the warrant holders may put back the outstanding warrants and common shares to the Company at the then current fair market value of the common stock. However, if the Company redeems the warrant holder's preferred stock in cash prior to September 15, 2002 a portion of the warrants become unexercisable, as defined. The Company assigned the fair value, calculated using the Black-Scholes option pricing model, of $1,507,004 to the warrants as a component of additional paid-in capital in the accompanying financial statements. (d) Preferred Stock Dividend on Common Stock In conjunction with the issuance of redeemable preferred stock, the Company's Board of Directors authorized the issuance of up to 1,000 shares and declared a dividend on the Company's outstanding common stock for an aggregate of 1,000 shares of redeemable preferred stock, which were allocated to common stockholders based on each common stockholder's ownership percentage. In 1995, 908 of these shares were issued, and the 92 remaining shares were issued on May 24, 1997. 11 12 SMARTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1996 5. RELATED PARTY TRANSACTIONS During 1994, the Company received advances of $62,500 from parties related to corporate officers. These advances were repaid in 1995. The Company has a business relationship with an independent distributor who was also a stockholder in one of the Company's subsidiaries (see Note 1(i)). During the years ended December 31, 1996 and 1995, the Company entered into arrangements for promotional cards totaling approximately $903,000 and $1,542,000, respectively, with this distributor. In connection with these arrangements, the Company paid approximately $118,000 and $296,000 of commissions to this independent distributor. As of December 31, 1995 and 1996, the Company believes it has amounts due of $390,000 and $150,000, respectively, from this distributor. This relationship was terminated in June 1996 and the Company has commenced legal action against this distributor to collect these amounts. Therefore, the Company has provided a full reserve for these amounts in the accompanying financial statements as of December 31, 1995 and 1996, respectively. On May 24, 1997, the Company reached a settlement agreement with this distributor/stockholder. Under the terms of the settlement, the Company forgave its claim on all amounts due from the distributor/stockholder in exchange for the return of the distributor/stockholder's preferred stock to the Company. 6. REDEEMABLE PREFERRED STOCK During 1995, the Company authorized the issuance of up to 4,002 shares of redeemable preferred stock, $.001 par value, and issued 3,002 shares of preferred stock for $1,000 per share and issued 908 shares of preferred stock as a stock dividend to the common stockholders. At December 31 1996, 92 shares of preferred stock remain issuable. The rights and preferences of the redeemable preferred stock are as follows. (a) Voting Redeemable preferred stockholders are not entitled to vote, except for matters required by law, including, but not limited to, matters involving alterations of rights and preferences of capital stock; merger or sale of the Company; issuance of capital stock or rights to capital stock, which are senior to preferred stockholders; purchase or redemption of capital stock, other than certain preferred stock or capital stock, as defined; or alteration of the Company's bylaws or Certificate of Incorporation. (b) Dividends Preferred stockholders are entitled to receive cumulative annual dividends, when, as and if declared by the Board of Directors, at the annual rate of 3% of the base amount of each share of redeemable preferred stock. The base amount of preferred stock as of a particular date shall be an amount equal to the sum of $1,000 plus any unpaid dividends on such share added to the base amount of such share and not thereafter paid. The Company recorded $120,030 and $33,989 of dividend accretion on the outstanding shares of preferred stock for the years ended December 31, 1996 and 1995, respectively. (c) Liquidation Rights In certain events, including liquidation, dissolution or winding up of the Company, the holders of preferred stock shall be entitled, before any distribution or payment is made upon any shares of common stock, to be paid in cash an amount equal to the base amount of such share on such date, plus all unpaid dividends accrued on such share and not previously added to the base amount. If the assets of the Company shall be insufficient to permit payment in full to the holders of the preferred stock, then the entire assets of the Company that are available for distributions shall be distributed ratably among the preferred stockholders. 12 13 SMARTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1996 6. REDEEMABLE PREFERRED STOCK (CONTINUED) (d) Redemption The preferred stock is redeemable at the option of the Company, or at the option of the redeemable preferred stockholders, in three equal annual installments, beginning on August 31, 2000, unless redeemed earlier in connection with a liquidity event, as defined. The redemption price will equal $1,000 per share plus all accrued and unpaid dividends as of the redemption date. The proceeds from the issuance of the 3,002 shares of preferred stock for $1,000 per share have been allocated, based on the relative fair value, to the preferred stock and the warrants to purchase common stock issued to these preferred stockholders. The value attributable to the warrants issued to purchase common stock resulted in a $1,507,004 discount to the preferred stock. The Company has accreted this discount to the preferred stock over the redemption period (see Note 9). The Company recorded $957,474 and $190,491 of accretion on the discount of the 3,002 shares of preferred stock for the years ended December 31, 1996 and 1995, respectively. If for any reason the Company shall fail to redeem for cash all preferred shares requested to be redeemed by the holders thereof within 30 days of notice, each preferred stockholder shall have the right to require the Company to purchase some or all of the preferred shares at a price equal to the redemption price on such date. To the extent the Company does not have cash available or is not legally permitted to make such payments, the preferred stockholders will loan to the Company and its subsidiaries additional amounts necessary to fund the repurchase. The resulting preferred notes shall be secured by all assets of the Company and its subsidiaries and will bear interest at prime plus 2%. The notes will be repaid quarterly based on available cash. 7. COMMITMENTS (a) Lease Commitments The Company leases its facility and certain equipment under operating lease agreements expiring through fiscal 2000. Future minimum rental payments due under these agreements are approximately as follows:
YEAR AMOUNT 1997...................................... $142,000 1998...................................... 136,000 1999...................................... 110,000 2000...................................... 65,000 -------- $453,000 ========
Total rental expense included in the accompanying consolidated statements of operations amounted to approximately $125,000 and $31,000 for the years ended December 31, 1996 and 1995, respectively. During 1994, the Company leased its facilities and certain office equipment from an entity controlled by a related party to the officers and directors of the corporation. During 1994, the Company incurred approximately $75,000 in rental charges to this entity. (b) Litigation In the ordinary course of business, the Company is party to various types of litigation. The Company believes it has meritorious defense to all claims, and, in its opinion, all litigation currently pending or threatened will not have a material effect on the Company's financial position on results of operations. 13 14 SMARTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1996 8. ACQUISITION OF GLOBAL MEDIA NETWORK On December 21, 1995, the Company acquired certain assets of Global Media Network (GMN), previously its west coast distributor, in exchange for a $15,000 note payable and the assumption of certain GMN liabilities totaling $67,673. This transaction was accounted for as a purchase and, accordingly, the results of GMN since December 21, 1995 have been included in the accompanying consolidated financial statements. The aggregate purchase price has allocated based on the fair value of the tangible and intangible assets as follows: Current assets............................. $16,269 Property and equipment..................... 4,674 Purchased intangible assets................ 61,730 ------- $82,673 =======
Included in purchased intangible assets are amounts related to trade names and customer lists. These intangibles will be amortized on a straight-line basis over their estimated useful life of three years. The 1995 results of GMN operations were not material to the financial statements taken as a whole. During 1995, the Company entered into arrangements for promotional cards totaling approximately $479,000 with GMN prior to December 21, 1995. In connection with these arrangements, the Company paid approximately $142,000 in commissions to GMN. 9. SALE OF COMPANY TO SMARTALK TELESERVICES, INC. On May 24, 1997, the Company entered into a merger agreement (the "Merger") with SmarTalk TeleServices, Inc. (SmarTalk) in which SmarTalk acquired all outstanding common and preferred stock of the Company in a tax-free, stock-for-stock merger transaction. Under the terms of the Merger, SmarTel common and preferred stockholders received 714,286 shares of SmarTalk common stock, which, using a SmarTalk per share value of $14, had an approximate value of approximately $10,000,000. In addition, certain officers/stockholders of SmarTel received contingent value rights which would entitle them to receive additional shares of SmarTalk common stock based on SmarTel's future sales and profitability. 14 EX-99.2 7 REPORT OF KPMG PEAT MARWICK LLP 1 EXHIBIT 99.2 INDEPENDENT AUDITORS' REPORT To the Stockholder of GTI Telecom, Inc. We have audited the accompanying balance sheet of GTI Telecom, Inc. as of December 31, 1996 and the related statements of operations, changes in stockholder's deficit and cash flows for the year ended December 31, 1996 (all as restated, see note 2(a)). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of GTI Telecom, Inc. as of December 31, 1996, and the results of its operations and cash flows for the year then ended, in conformity with generally accepted accounting principles. The Company restated its 1996 financial statements as discussed in note 2(a). The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in note 3, the Company has suffered recurring losses from operations and has working capital and stockholder's deficits which raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in note 3. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ KPMG PEAT MARWICK LLP Orlando, Florida April 4, 1997, except as to note 15 which is as of May 16, 1997 and note 2(a) which is as of November 24, 1997 1 2 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Stockholders of GTI Telecom, Inc. In our opinion, the accompanying balance sheets and the related statements of operations, of changes in stockholder's deficit and of cash flows present fairly, in all material respects, the financial position of GTI Telecom, Inc. (the "Company") at December 31, 1995 and 1994, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. The Company restated its 1995 and 1994 financial statements as discussed in Note 2(a). The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 3, the Company has suffered recurring losses from operations and has a working capital deficit which raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 3. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ Price Waterhouse LLP Orlando, Florida July 18, 1996, except as to Note 2(a) which is as of November 24, 1997. 2 3 GTI TELECOM, INC. BALANCE SHEETS DECEMBER 31, 1996 AND 1995 ASSETS
1996 1995 (RESTATED) (RESTATED) Current assets: Cash........................................................ $ 600,614 $ 1,814,568 Accounts receivable, net (note 4)........................... 1,602,180 851,959 Inventories (note 5)........................................ 733,838 690,648 Note receivable from stockholder (note 12).................. 1,279,483 209,991 Other current assets (notes 2 and 6)........................ 1,773,928 1,587,922 Prepaid expenses............................................ 16,033 -- ------------ ----------- Total current assets..................................... 6,006,076 5,155,088 Property and equipment, net (note 7).......................... 1,829,159 1,533,203 Intangible assets (net of accumulated amortization of $318,000 and $147,000 for 1996 and 1995, respectively)............... 202,423 203,981 Deposits...................................................... 27,360 14,181 ------------ ----------- $ 8,065,018 $ 6,906,453 ============ =========== LIABILITIES AND STOCKHOLDER'S DEFICIT Current liabilities: Accounts payable............................................ 6,323,882 1,518,626 Accrued expenses............................................ 1,678,267 1,380,737 Customer deposits........................................... 2,180,075 1,140,535 Excise and sales taxes payable (note 8)..................... 2,302,226 837,993 Current portion of treasury stock repurchase debt and notes payable (note 9)......................................... 1,319,688 1,291,719 Current portion of capital leases payable (note 10)......... 187,481 65,443 Deferred revenue -- telecards (note 2)...................... 7,151,141 8,122,931 ------------ ----------- Total current liabilities................................ 21,142,760 14,357,984 Treasury stock repurchase debt and notes payable (note 9)... 244,203 1,114,895 Capital leases payable (note 10)............................ 417,866 368,477 ------------ ----------- Total liabilities........................................ 21,804,829 15,841,356 ------------ ----------- Stockholder's deficit: Preferred stock, $.001 par value, 5,000,000 shares authorized, no shares issued and outstanding (note 14)... -- -- Common stock, $.001 par value, 10,000,000 shares authorized, 1,000 issued............................................. 1 1 Additional paid-in capital.................................. 83,707 83,707 Accumulated deficit (note 2)................................ (11,213,207) (6,408,299) Treasury stock -- 500 common shares in treasury, at cost.... (2,610,312) (2,610,312) ------------ ----------- Total stockholder's deficit.............................. (13,739,811) (8,934,903) Commitments, contingencies and subsequent events (notes 8, 13, 14 and 15).................................................. -- -- ------------ ----------- $ 8,065,018 $ 6,906,453 ============ ===========
See accompanying notes to financial statements. 3 4 GTI TELECOM, INC. STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1996 1995 1994 (RESTATED) (RESTATED) (RESTATED) Net revenues...................................... $21,264,323 $ 8,064,864 $ 1,988,974 ----------- ----------- ---------- Operating expenses: Cost of revenues................................ 18,294,789 6,218,159 2,115,181 Selling, general and administrative expenses.... 6,575,261 4,904,562 2,090,322 Depreciation and amortization expense........... 773,727 278,735 72,874 ----------- ----------- ---------- Total operating expenses..................... 25,643,777 11,401,456 4,278,377 ----------- ----------- ---------- Loss from operations......................... (4,379,454) (3,336,592) (2,289,403) ----------- ----------- ---------- Other income (expenses): Other income.................................... 133,908 1,870 -- Interest expense, net........................... (559,362) (143,057) (34,031) ----------- ----------- ---------- (425,454) (141,187) (34,031) ----------- ----------- ---------- Net loss before income taxes................. (4,804,908) (3,477,779) (2,323,434) Income taxes...................................... -- -- -- ----------- ----------- ---------- Net loss..................................... $(4,804,908) $(3,477,779) $(2,323,434) =========== =========== ========== Net Loss per common share (unaudited)............. $ (9,609.82) $ (3,847.10) $ (2,323.43) =========== =========== ========== Weighted average number of shares outstanding (unaudited)..................................... 500 904 1,000 =========== =========== ==========
See accompanying notes to financial statements. 4 5 GTI TELECOM, INC. STATEMENTS OF STOCKHOLDER'S DEFICIT YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 (ALL AS RESTATED, NOTE 2)
SERIES A PREFERRED TOTAL STOCK (NOTE 14) ADDITIONAL ACCUMULATED STOCKHOLDER'S --------------- COMMON PAID-IN DEFICIT TREASURY DEFICIT SHARES AMOUNT STOCK CAPITAL (RESTATED) STOCK (RESTATED) Balance at December 31, 1993...... -- $ -- $ 10 $83,698 $ (607,086) $ -- $ (523,378) Adjustment of par value of common stock from $.01 to $.001........ -- -- (9) 9 -- -- -- Net loss.......................... -- -- -- -- (2,323,434) -- (2,323,434) --- ---- ---- ------- ----------- ----------- ------------ Balance at December 31, 1994...... -- -- 1 83,707 (2,930,520) -- (2,846,812) Purchase of treasury stock........ -- -- -- -- -- (2,610,312) (2,610,312) Net loss.......................... -- -- -- -- (3,477,779) -- (3,477,779) --- ---- ---- ------- ----------- ----------- ------------ Balance at December 31, 1995...... -- -- 1 83,707 (6,408,299) (2,610,312) (8,934,903) Net loss.......................... -- -- -- -- (4,804,908) -- (4,804,908) --- ---- ---- ------- ----------- ----------- ------------ Balance at December 31, 1996...... -- $ -- $ 1 $83,707 $(11,213,207) $(2,610,312) $(13,739,811) === ==== ==== ======= =========== =========== ============
See accompanying notes to financial statements. 5 6 GTI TELECOM, INC. STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1996 1995 1994 (RESTATED) (RESTATED) (RESTATED) Cash flows from operating activities: Net loss (note 2), as restated.............................. $(4,804,908) $(3,477,779) $(2,323,434) Adjustments to reconcile net loss to cash provided by operating activities: Depreciation and amortization............................... 773,727 278,735 72,874 Increase (decrease) in cash caused by changes in operating assets and liabilities: Accounts receivable....................................... (750,221) (508,047) (202,775) Inventories............................................... (43,190) (342,862) (303,588) Other current assets (note 2), as restated................ (186,006) (1,322,144) (223,398) Prepaid expenses.......................................... (16,033) 26,199 (23,272) Intangible assets......................................... (169,298) (100,387) (103,594) Deposits.................................................. (13,179) 9,176 (23,357) Accounts payable.......................................... 4,805,256 892,682 426,786 Accrued expenses.......................................... 297,530 760,321 573,318 Customer deposits......................................... 1,039,540 1,110,342 30,193 Excise and sales taxes payable............................ 1,464,233 607,390 213,536 Deferred distribution agreement........................... -- -- (200,000) Deferred revenue -- telecards (note 2), as restated....... (971,790) 5,124,474 2,599,328 ----------- ----------- ---------- Cash provided by operating activities................... 1,425,661 3,058,100 512,617 ----------- ----------- ---------- Cash flows used in investing activities: Acquisition of property and equipment....................... (595,682) (1,371,406) (256,152) Proceeds from equipment sale leaseback...................... -- 414,744 -- ----------- ----------- ---------- Cash used in investing activities......................... (595,682) (956,662) (256,152) ----------- ----------- ---------- Cash used in financing activities: Principal payments for treasury stock repurchase debt....... (831,342) (403,698) -- Principal payments on notes payable......................... (28,381) -- -- Proceeds from notes payable................................. -- 50,000 50,000 Collection of stockholder notes receivable.................. 220,000 20,000 -- Advances to stockholder under notes receivable.............. (1,289,492) (202,949) (64,396) Principal payments for capital leases....................... (114,718) (8,166) -- ----------- ----------- ---------- Cash used in financing activities......................... (2,043,933) (544,813) (14,396) ----------- ----------- ---------- (Decrease) increase in cash............................... (1,213,954) 1,556,625 242,069 Cash at beginning of year..................................... 1,814,568 257,943 15,874 ----------- ----------- ---------- Cash at end of year........................................... $ 600,614 $ 1,814,568 $ 257,943 =========== =========== ========== Supplemental disclosure of cash flow information: Cash paid during the period for interest.................... $ 287,756 $ 143,100 $ 32,500 =========== =========== ==========
Supplemental disclosures of noncash financing activities: Capital lease obligations of $286,145 were incurred when the Company entered into leases for computer equipment during the year ended December 31, 1996. A note payable of $17,000 was incurred when the Company entered into a financing arrangement for an automobile during the year ended December 31, 1996. See accompanying notes to financial statements. 6 7 GTI TELECOM, INC. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1996, 1995 AND 1994 1. NATURE OF BUSINESS GTI Telecom, Inc. ("GTI" or the "Company") was incorporated on February 15, 1993 in the state of Florida. GTI is a fully integrated telecommunications company that develops, implements and supports specialized communication applications for business and individual use. GTI provides domestic and switch service for intrastate, interstate and international telephone calls and is an international carrier licensed by the Federal Communications Commission ("F.C.C."). The primary product line of GTI is telecards; which are prepaid calling cards that can be used for either domestic or international telephone calls. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) ACCOUNTS RECEIVABLE, REVENUE RECOGNITION AND RESTATEMENT The Company sells its product in two distinct markets, retail and promotional. Retail telecard sales are ultimately sold to the end user, while promotional telecards are given to the end user to promote the buyer's product or service. Accounts receivable relate to the sale of telecards to retail and promotional customers. Deferred revenues are established at the time the telecards are sold. Revenue is then recognized upon the utilization of minutes by the end user or upon expiration. For telecards which had no printed expiration date, revenue for unused minutes is recognized when telecards have been in circulation for greater than twelve months. From inception, the Company's management estimated the portion of calling time which would not be used by the customer ("breakage") and recognized this breakage as revenue for both retail (in 1995 and 1994) and promotional programs (in 1996, 1995 and 1994). In November 1997, in consultation with the Securities and Exchange Commission staff, the Company modified its revenue recognition policy such that revenue is recognized as described in the preceding paragraph. As a result, the Company has restated its financial statements and the impact on the Company's previously issued financial results for each of the years ended December 31, 1996, 1995 and 1994 is summarized below:
1996 1996 1995 1995 1994 1994 AS REPORTED AS RESTATED AS REPORTED AS RESTATED AS REPORTED AS RESTATED ----------- ----------- ----------- ----------- ----------- ----------- Net revenues........... $21,168,508 21,264,323 8,771,398 8,064,864 2,627,107 1,988,974 Cost of revenues....... 18,226,855 18,294,789 6,320,806 6,218,159 2,148,781 2,115,181 Loss from operations... (4,407,269) (4,379,454) (2,732,705) (3,336,592) (1,684,870) (2,289,403) Net loss............... (4,832,723) (4,804,908) (2,873,892) (3,477,779) (1,718,901) (2,323,434) Net loss per common share (unaudited).... (9,665.45) (9,609.82) (3,179.08) (3,847.10) (1,718.90) (2,323.43)
The accumulated deficit as of December 31, 1993 was increased by $144,474 to reflect this change in accounting policy. (b) INVENTORIES Inventories consist of telecards and supplies held primarily for sale and are stated at the lower of cost or market on a first-in, first-out basis. Cost has been determined using the average cost method. (c) OTHER CURRENT ASSETS Other current assets consist primarily of prepaid telecard and commission expense and prepaid royalties. 7 8 GTI TELECOM, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1996, 1995 AND 1994 GTI defers the recognition of production costs of telecards and commission expense for telecards sold and recognizes the expense as the related revenue is recognized. Royalty costs relate to agreements entered into by GTI to reproduce images on GTI telecards for a one, two or three year period. The costs are deferred and recognized as expense in conjunction with the recognition of revenues. (d) PROPERTY AND EQUIPMENT Property and equipment are stated at cost. Additions, improvements and expenditures that significantly extend the useful life of an asset are capitalized. Expenditures for repair and maintenance are charged to operations as incurred. The Company provides for depreciation and amortization of property, equipment and leasehold improvements over their estimated useful lives as follows:
DESCRIPTION USEFUL LIVES Communications and distribution equipment.............. 5 years Office equipment....................................... 5 years Furniture and fixtures................................. 1-5 years Automobiles............................................ 5 years
Leasehold improvements expenses are amortized over the shorter of the useful life of the asset on the term of the lease. (e) INTANGIBLE ASSETS GTI capitalizes expenditures for state licenses and registrations, trademarks and telecard design artwork. The costs are amortized over the estimated useful lives of the assets which range from one to five years for the state licenses, registrations and trademarks. Telecard design artwork is amortized over two years which approximates the telecard production and distribution period. (f) INCOME TAXES GTI follows Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," which requires an asset and liability approach for financial accounting and reporting on income taxes. The asset and liability approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities. Recognition of a deferred tax asset is allowed if future realization is more likely than not. As discussed more fully in note 6, GTI has established a full valuation allowance against its deferred tax asset associated with its tax carryforward benefits. (g) ADVERTISING The Company expenses costs of advertising as incurred. Advertising costs for the years ended December 31, 1996, 1995 and 1994 amounted to approximately $1,190,000, $61,000 and $95,000, respectively. (h) USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the 8 9 GTI TELECOM, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1996, 1995 AND 1994 reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company's financial statements reflect the Company earning certain volume discounts with their sole supplier of long distance phone service due to their level of purchases. However, as further described in note 14, the Company has financed these purchases with the supplier and in the event that the Company does not meet its payment commitments under the terms of the financing agreement, the supplier can retroactively revoke the volume discount. Management believes it can meet its commitments under the financing agreement. (i) FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amount of cash, accounts and notes receivable, accounts and notes payable approximates fair value because of the short maturity of those instruments. (j) RECLASSIFICATIONS Certain amounts in the 1995 and 1994 financial statements and notes have been reclassified to conform with the 1996 presentation. 3. OPERATING PLANS GTI has incurred significant operating losses since inception resulting in working capital and stockholder's deficits as of December 31, 1996, 1995 and 1994, which raise substantial doubt about its ability to continue as a going concern. The financial statements do not include any adjustments that may result from the outcome of this uncertainty. Management believes that expansion of the distribution of telecards and the introduction of new products will result in increased revenues, both domestic and international, which, when coupled with the Company seeking and obtaining additional financing will provide sufficient liquidity for GTI to continue as a going concern. 4. ACCOUNTS RECEIVABLE AND CONCENTRATION OF RISK Receivables at December 31, 1996 and 1995 consisted of the following:
1996 1995 Trade............................................... $1,227,098 $ 833,208 Other............................................... 465,082 162,751 Allowance for doubtful accounts..................... (90,000) (144,000) ---------- --------- $1,602,180 $ 851,959 ========== =========
The Company grants credit for sales to customers located throughout the United States. Two retail companies have been extended credit at December 31, 1996 amounting to 81% of total trade receivables. These two retail companies accounted for approximately 46% of the Company's sales during the year ended December 31, 1996. Two retail companies and one automobile rental company had been extended credit at December 31, 1995 amounting to 69% of total trade receivables. These two retail companies and one automobile rental company accounted for approximately 33% of the Company's sales during the year ended December 31, 1995. Currently the Company utilizes one supplier of long distance telephone service. While the Company believes that there are alternate suppliers, there is no guarantee that the Company will be able to secure the same rates as currently contracted in the event the relationship with the supplier is terminated. Recorded amounts due to this supplier totaled approximately $7,481,000 at December 31, 1996. The Company has 9 10 GTI TELECOM, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1996, 1995 AND 1994 granted this supplier a security interest in all assets of the Company. As further described in note 14, the Company financed certain amounts due to this supplier subsequent to December 31, 1996. 5. INVENTORIES Inventories consist of the following components as of December 31:
1996 1995 Raw materials....................................... $ 194,465 $ 14,040 Work-in-process..................................... 344,732 390,684 Finished goods...................................... 194,641 285,924 ---------- ---------- Total inventories......................... $ 733,838 $ 690,648 ========== ==========
6. OTHER CURRENT ASSETS Other current assets consist of the following at December 31:
1995 1996 (RESTATED) (RESTATED) Telecards distributed............................... $1,014,777 $ 816,280 Sales commissions................................... 610,638 592,660 Royalties........................................... 148,513 178,982 ---------- ---------- $1,773,928 $1,587,922 ========== ==========
7. PROPERTY AND EQUIPMENT, NET Property and equipment, net consists of the following at December 31:
1996 1995 Communications and distribution equipment........... $1,414,134 $ 969,548 Office equipment.................................... 819,441 578,748 Furniture and fixtures.............................. 287,799 155,005 Leasehold improvements.............................. 117,102 102,306 Automobile.......................................... 65,958 -- ---------- ---------- 2,704,434 1,805,607 Less: accumulated depreciation...................... (875,275) (272,404) ---------- ---------- $1,829,159 $1,533,203 ========== ==========
8. EXCISE AND SALES TAXES PAYABLE GTI has recorded excise and sales taxes payable and accrued interest totaling $2,302,226 and $837,993 as of December 31, 1996 and 1995, respectively, for state, local and federal excise taxes. State and local jurisdictions in which GTI operates have not been contacted to determine amounts owed based on GTI's calculations for those jurisdictions. Federal excise taxes were first remitted in February 1997 as part of a voluntary disclosure. The Company has not yet been advised as to whether penalties and additional interest, if any, will be assessed relating to these taxes. Management is in the process of reviewing GTI's tax collection, remittance and compliance policies and procedures. Depending on the ultimate resolution of these matters, it is reasonably possible that the amount of this reserve could require adjustment in the near term. 10 11 GTI TELECOM, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1996, 1995 AND 1994 9. LONG-TERM DEBT Long-term debt consists of the following at December 31:
1996 1995 Promissory note for treasury stock repurchase, including imputed interest of 10.75%............ $ 1,375,272 $ 2,206,614 Promissory note payable; interest at 13.5% per annum, payable quarterly, commencing March 31, 1996; principal balance due March 31, 1997...... 175,000 200,000 Promissory note payable; interest rate of 9.25%, payable in monthly installments of $542 including principal and interest, maturing in April 1999; collateralized by a vehicle......... 13,619 -- ---------- ---------- 1,563,891 2,406,614 Less current portion.............................. (1,319,688) (1,291,719) ---------- ---------- $ 244,203 $ 1,114,895 ========== ==========
In October 1995, an agreement was entered into between GTI and a stockholder of GTI to repurchase all of the stockholder's stock for $3 million. GTI paid $250,000 upon the execution of the agreement and issued a noninterest bearing note payable for $2,750,000. Interest has been imputed at 10.75%. The note payments are payable in the following installments commencing in December 1995: $250,000 quarterly through June 30, 1996; $500,000 semi-annually from September 30, 1996 through June 30, 1997; and $500,000 on December 31, 1997. The note is secured by the redeemed shares of stock. In 1995 and 1994, this former stockholder served as a GTI officer and received compensation totaling approximately $135,000 and $68,000, respectively. The compensation expense is included in selling, general and administrative expenses. GTI obtained a $100,000 loan for working capital in 1993 and an additional $50,000 in 1995 and 1994. The loans bear interest at 13.5%, requires quarterly interest payments and the principal balance is due on March 31, 1997. The working capital loans were obtained from an individual who was a stockholder in a related entity which was dissolved. Aggregate future annual principal payments on long-term debt for years ending subsequent to December 31, 1996 are summarized as follows:
YEAR ENDING DECEMBER 31, 1997............................. $1,319,688 1998............................. 242,065 1999............................. 2,138 ---------- $1,563,891 ==========
10. LEASES The Company is obligated under various capital leases for certain communications, computer and office equipment which expire over the next four years. At December 31, 1996, the gross amount of property and equipment and related accumulated amortization recorded under capital leases was $701,915 and $135,384, respectively. During 1995, GTI entered into an agreement for the sale and leaseback of certain communications and distribution equipment under a capital lease. The book value and accumulated depreciation of approximately $430,000 and $54,000 were removed from the accounts and the equipment was recorded at the sale price of 11 12 GTI TELECOM, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1996, 1995 AND 1994 approximately $404,000. The deferred gain approximating $28,000 is netted against capital leases payable and will be recognized over the lease term as other income. Payments under the lease approximate $155,000 annually, commencing January 1996. The Company also has several noncancelable operating leases, primarily for office and warehouse space that expire over the next two years. Rental expense for operating leases during 1996, 1995 and 1994 was approximately $405,000, $163,000 and $94,000, respectively. Future minimum lease payments under noncancelable operating leases (with initial or remaining lease terms in excess of one year) and future minimum capital lease payments as of December 31, 1996 are:
YEAR ENDING CAPITAL OPERATING DECEMBER 31, LEASES LEASES ---------------------------------------------------- 1997........................................... $252,952 $293,340 1998........................................... 240,807 52,873 1999........................................... 216,975 -- 2000........................................... 23,621 -- -------- -------- Total minimum lease payments................. 734,355 $346,213 ======== Less amount representing interest.............. 129,008 -------- Present value of net minimum capital lease payments.................................. 605,347 Less current installments of obligations under capital leases............................... 187,481 -------- Obligations under capital leases, excluding current installments...................... $417,866 ========
11. INCOME TAXES As of December 31, 1996, GTI had a net operating loss carryforward available to reduce future income of approximately $8,000,000. The tax net operating loss carryforwards begin expiring in the year 2008. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and amounts used for income tax purposes. Significant components of the Company's deferred income tax assets and liability are as follows:
DECEMBER 31, --------------------------- 1996 1995 (RESTATED) (RESTATED) Gross deferred tax assets: Net operating loss carryforward................. $ 3,253,541 $ 1,925,514 Excise and sales tax provision.................. 885,143 315,337 Bad debt provision.............................. 33,867 54,311 Other........................................... 23,304 33,897 ---------- ----------- 4,195,855 2,329,059 ---------- ----------- Gross deferred tax liability: Depreciation.................................... (77,495) (81,303) ---------- ----------- Net deferred tax assets before valuation allowance.................................. 4,118,860 2,247,256 Valuation allowance............................. (4,118,860) (2,247,756) ---------- ----------- Net deferred tax asset....................... $ -- $ -- ========== ===========
12 13 GTI TELECOM, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1996, 1995 AND 1994 As of December 31, 1996 and 1995, a valuation allowance was recorded to fully offset the net deferred tax asset. The valuation allowance for deferred tax assets was increased $1,871,104 during the year ended December 31, 1996, relating primarily to the generation of the 1996 net operating loss carryforward. The difference between the "expected" tax benefit (computed by applying the federal corporate income tax rate of 34% to the net loss before income taxes) and the actual tax benefit is due to limitations on the benefit for the net operating losses recognized and the effect of the valuation allowance. 12. RELATED PARTY TRANSACTIONS During 1996 and 1995, GTI entered into note receivable agreements with the remaining stockholder of GTI. At December 31, 1996 and 1995, the notes receivable balances were $1,279,483 and $209,991, respectively. The 1996 note is due upon demand and the 1995 note was repaid during 1996. The notes earn interest at 7% per annum for 1996 and 1995, respectively. The balances are recorded as notes receivable from stockholder in the accompanying balance sheets. In January 1996, the remaining stockholder formed Tuscany, Inc., a Delaware Corporation. Tuscany, Inc. owns and operates charter aircraft. At December 31, 1996 and 1995, GTI advanced approximately $259,000 and $50,000, respectively to Tuscany, Inc. These advances are recorded as accounts receivable. During 1996, Tuscany, Inc. provided the Company with approximately $159,900 of charter aircraft services. In January 1996, the remaining stockholder purchased Wicks Printing. As of December 31, 1996, the Company advanced approximately $8,200 to Wicks Printing. During 1996, Wicks Printing provided printing services of approximately $703,000 for the production of prepaid telecards for the Company. 13. COMMITMENTS AND CONTINGENCIES Commission Agreements GTI entered into several agreements to produce telecards with selected designs or logos. GTI provides the company, which owns the design and logo rights, a commission based on the quantity of telecards sold. Certain agreements include commitments to provide a guaranteed minimum commission or cooperative advertising costs. In accordance with the contract terms, GTI records the greater of the liability for cards sold or the guaranteed minimum. As of December 31, 1996, commitments through December 31, 1998 total approximately $220,000. Distribution Agreement On October 22, 1993, the Company entered into a three-year exclusive agreement for the distribution of telecards in Brazil. The Company sold telecards to the distributor at suggested retail prices less a stated discount percentage. The agreement terminated in 1994 and in conjunction with settlement of the agreement, the Company recognized revenue of $200,000. Litigation GTI is involved in litigation for which counsel has been retained. In the opinion of management, the pending matters will not result in a material adverse effect upon the financial condition or results of operations of GTI. 13 14 GTI TELECOM, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1996, 1995 AND 1994 14. SUBSEQUENT EVENTS Series A Convertible Exchangeable Preferred Stock In February 1997, the Company issued 3,500 shares of Series A convertible preferred stock for $3.5 million. The preferred stock is convertible into common stock based upon a conversion price, as defined (initial conversion price is $43,000 per share), and has a liquidation preference of $1,000 per share and certain voting rights. On or after July 20, 1997 and before August 20, 1997, the holder of the preferred stock may exchange all preferred stock for telecard inventory having an aggregate card value equal to the liquidation preference plus an amount equal to any accrued interest and unpaid dividends, if any. Worldcom Financing Agreement On January 30, 1997, the Company entered into an agreement with its sole long distance supplier, Worldcom Network Services, Inc. ("Worldcom"), to finance a portion of its indebtedness to Worldcom totaling approximately $6.0 million which is included in accounts payable and accrued expenses in the accompanying December 31, 1996 balance sheet. As part of the agreement, the Company agreed to pay monthly installments of $500,000 commencing February 25, 1997 with the final balance due on January 25, 1998. The note bears interest at 16% per annum and includes certain restrictive debt covenants as well as a lock box arrangement for cash collections of the Company. As of the date of this report, the Company was in violation of certain debt covenants. The agreement also reinstates certain volume discounts and forgives related finance charges related to these amounts contingent upon the Company's payment of all amounts due in accordance with the note agreement. Sales Commitment Subsequent to December 31, 1996, the Company entered into an agreement to be the exclusive supplier of prepaid phone cards to a major retailer. As part of the supply agreement, the Company is required to support the retailer's marketing and promotion expense with payments totaling approximately 16% of the retailer's phone card purchase commitment over the two year term of the contract. 15. MERGER NEGOTIATIONS As of May 16, 1997, the Company was in the process of negotiating an agreement to merge into another entity. 16. SALE OF COMPANY TO SMARTALK TELESERVICES, INC. (UNAUDITED) On May 31, 1997, the Company entered into a merger agreement (the "Merger") with SmarTalk Teleservices, Inc. (SmarTalk) in which SmarTalk acquired all outstanding common stock of the Company in a tax-free, stock-for-stock merger transaction. Under the terms of the Merger, the GTI Telecom common stockholder received 2,580,000 shares of SmarTalk common stock, which had an approximate value of $35,000,000. 14 EX-99.3 8 REPORT OF ERNST & YOUNG LLP 1 EXHIBIT 99.3 REPORT OF INDEPENDENT AUDITORS The Board of Directors ConQuest Telecommunication Services Corp. We have audited the accompanying consolidated balance sheets of ConQuest Telecommunication Services Corp. and subsidiaries as of December 31, 1995 and 1996, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of ConQuest Telecommunication Services Corp. and subsidiaries at December 31, 1995 and 1996 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. /s/ ERNST & YOUNG LLP Columbus, Ohio February 7, 1997, except for Note 11 as to which the date is February 19, 1997 and the last paragraph of Note 9 as to which the date is November 25, 1997 1 2 CONQUEST TELECOMMUNICATION SERVICES CORP. CONSOLIDATED BALANCE SHEETS ASSETS
DECEMBER 31, --------------------------- 1995 1996 Current assets: Cash............................................................ $ -- $ 300,557 Accounts receivable, less allowance for doubtful accounts (1995 -- $123,000; 1996 -- $232,000)............................... 5,513,437 6,796,262 Refundable income taxes......................................... -- 278,431 Agent loans..................................................... 254,783 373,837 Inventory....................................................... 818,904 781,876 Deferred income taxes........................................... 352,000 799,000 Prepaid expenses................................................ 290,153 256,001 ----------- ----------- Total current assets......................................... 7,229,277 9,585,964 Property and equipment: Telecommunications equipment.................................... 5,374,700 7,168,549 Office equipment, furniture and fixtures........................ 551,364 529,799 ----------- ----------- 5,926,064 7,698,348 Less accumulated depreciation................................... 2,409,145 3,528,917 ----------- ----------- 3,516,919 4,169,431 Deferred income taxes............................................. -- 31,000 Other assets: Agent bonuses, net of accumulated amortization.................. 217,503 297,472 Agent loans -- noncurrent....................................... 6,950 -- Goodwill, net of accumulated amortization....................... 1,549,975 2,734,312 Other intangibles, net of accumulated amortization.............. 664,840 544,707 Other........................................................... 66,850 94,983 ----------- ----------- 2,506,118 3,671,474 ----------- ----------- Total assets............................................ $13,252,314 $17,457,869 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable................................................ $ 1,962,493 $ 3,064,861 Deferred revenue................................................ 2,147,156 4,534,319 Borrowings under credit agreements.............................. 58,283 1,033,411 Accrued liabilities............................................. 1,156,662 1,664,017 Income taxes payable............................................ 381,565 -- Current portion of long-term debt and capital lease obligations.................................................. 531,911 603,343 ----------- ----------- Total current liabilities.................................... 6,238,070 10,899,951 Long-term debt.................................................... 1,124,340 2,400,000 Capital lease obligations......................................... 251,147 -- Deferred income taxes............................................. 268,000 -- Contingent liabilities (Note 10).................................. -- -- Shareholders' equity (Note 11): Preferred stock, $.001 par value: Authorized shares -- 750 Issued and outstanding -- none............................... -- -- Common stock, $.001 par value: Authorized shares -- 4,000,000 Issued and outstanding 546,293 and 559,730 shares at December 31, 1995 and 1996........................................... 547 560 Additional paid-in capital...................................... 4,351,014 4,538,036 Retained earnings (deficit)..................................... 1,049,996 (349,878) ----------- ----------- 5,401,557 4,188,718 Less treasury stock -- at cost.................................. 30,800 30,800 ----------- ----------- 5,370,757 4,157,918 ----------- ----------- Total liabilities and shareholders' equity.............. $13,252,314 $17,457,869 =========== ===========
See accompanying notes. 2 3 CONQUEST TELECOMMUNICATION SERVICES CORP. CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, ------------------------------------------- 1994 1995 1996 Revenues: Call center services.............................. $31,625,716 $28,843,172 $28,020,986 Prepaid calling card.............................. 14,590 761,724 8,592,316 International services............................ 180,514 1,091,508 1,207,759 ----------- ----------- ----------- 31,820,820 30,696,404 37,821,061 Expenses: Cost of services.................................. 24,880,174 23,600,604 28,926,051 Sales and marketing expenses...................... 1,596,112 1,387,938 2,856,212 General and administrative expenses............... 3,998,602 4,450,435 6,883,849 Write-down of assets.............................. -- -- 918,445 ----------- ----------- ----------- Operating income (loss)............................. 1,345,932 1,257,427 (1,763,496) Interest expense.................................... 315,339 244,810 402,378 ----------- ----------- ----------- Income (loss) before income taxes................... 1,030,593 1,012,617 (2,165,874) Provision (benefit) for income taxes: Current........................................... 315,000 529,000 (20,000) Deferred.......................................... 92,000 (138,000) (746,000) ----------- ----------- ----------- Net income (loss)................................... $ 623,593 $ 621,617 $(1,399,874) =========== =========== ===========
See accompanying notes. 3 4 CONQUEST TELECOMMUNICATION SERVICES CORP. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
COMMON STOCK ADDITIONAL RETAINED TREASURY ---------------- PAID-IN EARNINGS STOCK SHARES AMOUNT CAPITAL (DEFICIT) TOTAL TOTAL Balances at January 1, 1994............ 449,796 $450 $2,646,621 $ (195,214) $ -- $2,451,857 Net income........................... -- -- -- 623,593 -- 623,593 Exercise of B warrants............... 39,719 39 591,491 -- -- 591,530 Shares issued under employment agreement......................... 520 1 599 -- -- 600 ------- ---- ---------- ---------- -------- ---------- Balances at December 31, 1994.......... 490,035 490 3,238,711 428,379 -- 3,667,580 Net income........................... -- -- -- 621,617 -- 621,617 Issuance of stock for acquisition.... 55,298 55 1,105,905 -- -- 1,105,960 Repurchase treasury shares........... (1,400) -- -- -- (30,800) (30,800) Stock Options Exercised.............. 2,360 2 6,398 -- -- 6,400 ------- ---- ---------- ---------- -------- ---------- Balances at December 31, 1995.......... 546,293 547 4,351,014 1,049,996 (30,800) 5,370,757 Net loss............................. -- -- -- (1,399,874) -- (1,399,874) Issuance of stock for acquisition.... 13,437 13 187,022 -- -- 187,035 ------- ---- ---------- ---------- -------- ---------- Balances at December 31, 1996.......... 559,730 $560 $4,538,036 $ (349,878) $(30,800) $4,157,918 ======= ==== ========== ========== ======== ==========
See accompanying notes. 4 5 CONQUEST TELECOMMUNICATION SERVICES CORP. CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, --------------------------------------- 1994 1995 1996 OPERATING ACTIVITIES Net income (loss)....................................... $ 623,593 $ 621,617 $(1,399,874) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation.......................................... 730,036 827,156 1,182,997 Amortization.......................................... 292,422 332,470 550,216 Provision (benefit) for deferred taxes................ 92,000 (138,000) (746,000) Loss on sale of assets................................ -- 120 155 Write-down of assets.................................. -- -- 918,445 Changes in operating assets and liabilities: Accounts receivable................................ (739,526) (1,018,290) (1,283,004) Refundable income taxes............................ -- -- (278,431) Inventory.......................................... (47,103) (224,801) (356,316) Prepaid expenses and agent loans................... (209,960) 117,059 (208,665) Other assets....................................... (391,745) (246,376) (327,649) Accounts payable................................... 116,653 1,259,020 1,102,368 Deferred revenue................................... 263,316 1,883,840 2,387,163 Accrued liabilities................................ 191,171 416,603 (162,454) Income taxes payable............................... 230,838 94,091 (381,565) ----------- ----------- ----------- Net cash provided by operating activities............... 1,151,695 3,924,509 997,386 INVESTING ACTIVITIES Acquisition of ACMI..................................... -- (1,820,775) (64,846) Acquisition of CPC...................................... -- -- (709,360) Capital expenditures, net of disposals.................. (1,497,533) (1,271,772) (1,993,696) ----------- ----------- ----------- Net cash used in investing activities................... (1,497,533) (3,092,547) (2,767,902) FINANCING ACTIVITIES Proceeds from credit agreements and long-term obligations........................................... 8,082,000 9,538,283 3,975,128 Payments on credit agreements and long-term obligations........................................... (8,792,037) (10,509,108) (1,904,055) Proceeds from issuance of common stock.................. 592,130 6,400 -- Repurchase of treasury stock............................ -- (30,800) -- ----------- ----------- ----------- Net cash provided by (used in) financing activities..... (117,907) (995,225) 2,071,073 ----------- ----------- ----------- Net increase (decrease) in cash......................... (463,745) (163,263) 300,557 Cash, beginning of year................................. 627,008 163,263 -- ----------- ----------- ----------- Cash, end of year....................................... $ 163,263 $ -- $ 300,557 =========== =========== ===========
See accompanying notes. 5 6 CONQUEST TELECOMMUNICATION SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF BUSINESS ConQuest Telecommunication Services Corp. (ConQuest), through its wholly-owned subsidiaries, provides call center services, prepaid calling card services and international telecommunications services to its customers. The Company's principal call center services include operator assisted long distance services and inbound call handling and fulfillment services. Call center services are provided to consumers mainly through aggregators such as hotels/motels, hospitals, universities, and public and private pay stations located primarily in the United States. Prepaid calling card services are primarily provided to consumers through national and regional convenience and grocery store chains. International services includes a range of telecommunication services offered to its customers abroad including call center services, prepaid calling cards and resale of long distance. ConQuest has contracted with OAN Services, Inc. (OAN), a clearing house, to bill and collect a significant portion of its call center services revenues. Under this arrangement, 46% of ConQuest's accounts receivable are due from OAN. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of ConQuest and its wholly-owned subsidiaries, collectively referred to herein as the Company. Significant intercompany accounts and transactions have been eliminated in consolidation. USE OF ESTIMATES The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. REVENUE RECOGNITION POLICIES The Company recognizes revenue from its call center services as such services are performed. Prepaid calling card revenue is recognized based on actual usage and the unused portion upon 1) expiration of the cards or 2) twelve months from the date of issuance for promotional and collector cards with no expiration date. ADVERTISING COSTS The Company expenses advertising costs as incurred. Advertising expense was $138,000, $154,000 and $185,000 for each of the three years ended December 31, 1994, 1995 and 1996, respectively. INVENTORY The Company accounts for inventory at cost based upon the specific identification method. The cost of prepaid calling cards sold is amortized to cost of services based on actual usage or upon the expiration of the cards. PROPERTY AND EQUIPMENT Property and equipment is carried at cost. Depreciation and amortization, which includes the amortization of assets recorded under capital leases, are computed principally by the straight-line method over the estimated lives of assets or, if applicable, the life of lease. Expenditures for maintenance and repairs are charged to operations as incurred. 6 7 CONQUEST TELECOMMUNICATION SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1996 AGENT LOANS AND BONUSES The Company uses independent agents to obtain new call center services customers. The Company extends interest-bearing loans to agents typically for financing the acquisition of telephone equipment. The loans, which are personally guaranteed by the agents, have repayment terms of one to two years. Agents also receive one time bonuses for customers who have contracted with the Company as a result of the agent's efforts. The Company has contractual rights to recover bonuses from agents for customers who do not meet their predetermined minimum period of service. These bonuses are deferred and amortized over the life of the respective agreement. Accumulated amortization totaled $440,000 and $381,000 at December 31, 1995 and 1996, respectively. GOODWILL Goodwill represents the excess of cost over fair value of assets acquired in acquisitions. Goodwill is amortized on a straight line basis over 10 years. Accumulated amortization totaled $13,000 and $243,000 at December 31, 1995 and 1996, respectively. INTANGIBLE ASSETS Intangible assets are primarily licensing and financing costs, and installation costs charged by local telephone companies. Licensing costs and financing costs are amortized using the straight-line method over three years. Installation costs are being amortized over a maximum of five years. Accumulated amortization totaled $413,000 and $529,000 at December 31, 1995 and 1996, respectively. STOCK COMPENSATION In 1996, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation." This Statement encourages, but does not require companies to record compensation cost for stock-based employee compensation at fair value. In accordance with the provisions of SFAS No. 123, the Company has elected to continue to account for stock-based compensation using the intrinsic value method prescribed in APB Opinion 25, Accounting for Stock Issued to Employees, and related Interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the market price of the Company's stock at the date of the grant over the amount an employee must pay to acquire the stock. FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of the Company's agent loans, borrowings under credit agreements and long term debt approximated the carrying values at December 31, 1995 and 1996. RECLASSIFICATIONS Certain reclassifications have been made to the 1994 and 1995 financial statements to conform to the 1996 presentation. 2. ACQUISITIONS On April 19, 1996, the Company acquired substantially all of the assets of Convenience Products Corporation (CPC), a marketer of prepaid calling cards. The purchase price was $709,360 in cash (including $209,360 in acquisition expenses) and 13,437 shares of common stock of the Company (total purchase price of $896,400). The Company's consolidated financial statements include the results of operations of CPC since acquisition. As part of the purchase, additional shares of the Company's common stock may become issuable to CPC during 1997 if certain financial criteria are met. At December 31, 1996, the Company determined that these 7 8 CONQUEST TELECOMMUNICATION SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1996 criteria will be met. Accordingly, the Company has accrued $403,000 of additional consideration as additional purchase price at December 31, 1996. The CPC acquisition has been accounted for under the purchase method, and accordingly, the acquired assets and assumed liabilities, including goodwill of $1,205,000, have been recorded at their estimated fair values at acquisition. On November 30, 1995, the Company acquired Anderton Communications Marketing, Inc. (ACMI) in exchange for $1,885,621 (including $285,621 in acquisition expenses) and 55,298 shares of common stock of the Company (total purchase price of $2,991,582). ACMI is a marketer of telecommunication services including prepaid calling cards. The Company's consolidated financial statements include the results of operations of ACMI since acquisition. In February, 1997, the Company paid an additional $125,000 and issued an additional 1,547 shares of common stock in settlement of certain provisions of the purchase agreement. This final payout has been accrued in the consolidated financial statements at December 31, 1996. The ACMI acquisition has been accounted for under the purchase method, and accordingly, the acquired assets and assumed liabilities, including goodwill of $1,770,427, have been recorded at their estimated fair values at acquisition. The following pro forma data summarizes the results of operations of the Company for each of the three years in the period ended December 31, 1996 assuming ACMI was acquired as of January 1, 1994 and CPC was acquired as of January 1, 1995. In preparing the pro forma data, adjustments have been made to reflect purchase accounting adjustments, interest expense and amortization.
1994 1995 1996 (Unaudited) Net sales......................... $35,358,846 $33,806,137 $38,011,143 Net income (loss)................. 578,786 473,047 (1,597,694)
The pro forma information does not purport to be indicative of the results of operations which would have actually been obtained if the acquisitions had occurred on the dates indicated or the results of operations which will be reported in the future. 3. CREDIT ARRANGEMENTS Long-term debt consists of the following:
DECEMBER 31, ------------------------- 1995 1996 Term loan payable to bank........................... $ -- $3,000,000 Term loan payable to bank........................... 966,666 -- Term loan agreement to vendor....................... 500,819 -- Other notes payable................................. 9,104 3,343 ---------- ---------- 1,476,589 3,003,343 Less current portion................................ (352,249) (603,343) ---------- ---------- $1,124,340 $2,400,000 ========== ==========
In November 1996, the Company refinanced the amounts outstanding under its existing term loans payable to a bank and a vendor and its capital lease obligations. The new term loan provided borrowings of $3,000,000 payable in twenty quarterly principal installments of $150,000 beginning January 31, 1997. Interest is payable monthly and accrues at a fixed rate of 9.125% per annum for the first $800,000 and at 7.625% per annum for the remaining $2,200,000. On November 1, 1997 until maturity, the Company has an option to 8 9 CONQUEST TELECOMMUNICATION SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1996 select an interest rate based on the three year treasury rate, one year treasury rate, or the prime rate plus an additional margin. In addition to its long term debt, the Company has a $5,000,000 revolving credit agreement (the Agreement) with a bank which expires May 31, 1997. Under the terms of the Agreement, interest rates are determined at the time of borrowing at prime plus 1% at December 31, 1995 and at prime plus 1/2% at December 31, 1996 (9.500% and 8.750 at December 31, 1995 and 1996, respectively). Borrowings are restricted based on percentages of eligible accounts receivable. The Company is required to pay a fee of 1/4% per annum on the unused portion of the Agreement during the revolving period. At December 31, 1995 and 1996, borrowings outstanding under the Agreement totaled $58,283 and $1,033,411, respectively. Available borrowings under this Agreement were approximately $3,821,000 and $3,967,000 at December 31, 1995 and 1996, respectively. The Company also has a standby letter of credit facility with the same bank. This facility provides for the issuance of standby letters of credit in an aggregate amount not to exceed $500,000. Interest on amounts disbursed under the standby letter of credit agreement accrues at a rate of prime plus 4.500%. At December 31, 1995 and 1996, no amounts were borrowed under this facility. Borrowings under the revolving credit agreement, term loan and standby letter of credit agreement are secured by substantially all of the Company's assets. The credit arrangements discussed above contain various restrictions and financial ratio maintenance requirements. One of these restrictions limits payments of dividends to 10% of the Company's net income after taxes. Interest paid during 1994, 1995 and 1996 was $352,000, $281,000 and $411,000, respectively. Maturities of long-term debt for the years subsequent to December 31, 1996 are as follows: 1997................................... $ 603,343 1998................................... 600,000 1999................................... 600,000 2000................................... 600,000 2001................................... 600,000 Thereafter............................. -- ---------- $3,003,343 ==========
4. LEASES The Company leases office space under noncancelable operating leases that expire in various years through 1999. Future minimum lease payments under noncancelable operating leases consist of the following at December 31, 1996: 1997................................... $ 438,552 1998................................... 436,148 1999................................... 271,620 2000................................... 131,140 2001................................... 44,148 ---------- Total minimum lease payments........... $1,321,608 ==========
Rent expense for operating leases was approximately $268,000, $336,000 and $522,000 for 1994, 1995, and 1996, respectively. 9 10 CONQUEST TELECOMMUNICATION SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1996 5. STOCK OPTIONS AND WARRANTS The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related interpretations in accounting for its employee stock options because, the alternative fair value accounting provided under Statement of Financial Accounting Standards No. 123 (FASB No. 123), "Accounting for Stock Based Compensation," requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. The Company's 1992 Non Qualified Employee Stock Option Plan (the Plan) has authorized the grant of options to management personnel for up to 20,000 shares of the Company's common stock. The options granted have 10 year terms and become exercisable in 20% increments over five years beginning November 6, 1993 and will be fully vested on November 6, 1998. Options have also been granted under two executive employment agreements. Under the first employment agreement, nonqualified stock options were granted to purchase 3,000 shares of the Company's common stock. The grant was made on November 6, 1992 and expires on November 6, 2002. At December 31, 1996 all options under this agreement are fully vested and exercisable. Under the second employment agreement, nonqualified stock options were granted to purchase 2,500 shares of the Company's common stock. The grant was made on August 26, 1996 and expires on August 26, 2006. The options under this agreement vest as follows: 1,000 on August 26, 1998 and 500 each of the three years thereafter. Pro forma information required by FASB No. 123 regarding net income has not been presented as no significant grants have been made subsequent to December 31, 1994. A summary of the Company's stock option activity, and related information for the years ended December 31 follows:
1994 1995 1996 ----------------------- ----------------------- ----------------------- WEIGHTED- WEIGHTED- WEIGHTED- AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE Outstanding -- beginning of year............................ 21,145 $ 2.50 20,270 $ 2.50 14,325 $ 2.50 Granted........................... -- -- -- -- 2,500 14.45 Exercised......................... (240) 2.50 (2,360) 2.50 -- -- Forfeited......................... (635) 2.50 (3,585) 2.50 (25) 2.50 ------ ----- ------ ----- ------ ------ Outstanding -- end of year........ 20,270 14,325 16,800 ====== ====== ====== Exercisable at end of year........ 8,740 9,675 11,980 ====== ====== ====== Weighted average fair value of options granted during year..... $ -- $ -- $14.45 ====== ====== ======
Exercise prices for options outstanding as of December 31, 1996 ranged from $2.50 to $14.45. The weighted-average remaining contractual life of those options is 6.5 years. In November, 1995, the Company entered into an agreement with a customer which granted 25,000 common stock warrants to the customer which become exercisable based upon purchase volume of the Company's products and services. Each warrant gives the holder the right to purchase one share of common stock. The warrants expire 48 months from their issue date and are exercisable at prices ranging from $42 to $50 per share based upon their exercise date. The excess of fair market value over exercise price, if any, will be reflected as sales discount as the warrants become exercisable. Total warrants exercisable under this 10 11 CONQUEST TELECOMMUNICATION SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1996 agreement were 2,588 and 14,026 at December 31, 1995 and 1996. As of December 31, 1996, no sales discounts have been recorded since the fair market value of the warrants was less than the exercise price. 6. INCOME TAXES The Company accounts for income taxes under the provisions of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." Under Statement No. 109, the liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Significant components of the Company's deferred tax assets and liabilities are as follows:
DECEMBER 31, ----------------------- 1995 1996 Deferred tax assets: Deferred revenue -- promotional and collector cards........................................... $ -- $ 460,000 Write down of assets............................... -- 252,000 Net operating loss and AMT carryforward............ 5,000 156,000 Accrued expenses................................... 296,000 92,000 Bad debt allowance................................. 51,000 90,000 Intangible assets.................................. -- 25,000 --------- --------- Total deferred tax assets............................ 352,000 1,075,000 Deferred tax liabilities: Tax over book depreciation and amortization........ (175,000) (245,000) Deferred charges................................... (93,000) -- --------- --------- Deferred tax liabilities............................. (268,000) (245,000) --------- --------- Net deferred tax assets.............................. $ 84,000 $ 830,000 ========= ========= Components of net deferred tax assets (liabilities): Current............................................ $ 352,000 $ 799,000 Long-term.......................................... (268,000) 31,000 --------- --------- $ 84,000 $ 830,000 ========= =========
At December 31, 1996, the Company has alternative minimum tax credit carryforwards of $156,000. Significant components of the provision (benefit) for income taxes are as follows:
YEAR ENDED DECEMBER 31, ------------------------------------ 1994 1995 1996 Current: Federal................................ $251,000 $ 444,000 $ (20,000) State and local........................ 64,000 85,000 -- -------- --------- --------- 315,000 529,000 (20,000) Deferred................................. 92,000 (138,000) (746,000) -------- --------- --------- $407,000 $ 391,000 $(766,000) ======== ========= =========
11 12 CONQUEST TELECOMMUNICATION SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1996 The Company's provision for income taxes differs from the amounts computed by applying the federal statutory rate due to the following:
YEAR ENDED DECEMBER 31, ----------------------------------- 1994 1995 1996 Expected tax (benefit) at federal statutory rates......................... $350,000 $344,000 $(736,000) State and local taxes, net of federal tax benefit............................. 35,000 47,000 (100,000) Surtax exemption.......................... -- -- 62,000 Other..................................... 22,000 -- 8,000 -------- -------- --------- $407,000 $391,000 $(766,000) ======== ======== =========
Taxes paid during 1994, 1995 and 1996 were $83,000, $486,000, and $613,000 respectively. 7. SAVINGS PLAN Effective January 1, 1995, the Company adopted a 401(k) savings plan which covers substantially all employees of the Company. Contributions are at the discretion of the Company at a percentage of voluntary employee contributions not to exceed 4% of total compensation determined prior to the beginning of each plan year. Employees may make contributions up to 15% of their compensation and are limited to the amount deductible for federal income tax purposes. Total expense under the plan was approximately $6,000 and $27,000 for the years ended December 31, 1995 and 1996, respectively. 8. WRITE-DOWN OF ASSETS During 1996, the Company decided to exit the collector prepaid calling card business. Accordingly, the Company evaluated the recoverability of certain tangible and intangible assets related to its collector prepaid calling card operations, and based on the technological obsolescence and non-marketability of these assets, deemed them to have no fair market value. Accordingly, the Company wrote off these assets in accordance with Statement of Financial Accounting Standards No. 121. These assets include certain computer equipment, licensing agreements and a proportional share of the excess of cost over the fair value of assets acquired in the ACMI acquisition. The impairment loss of $918,445 is reflected in the statement of operations as "write-down of assets." 9. ACCOUNTING CHANGES In anticipation of registering its common stock for public distribution, the Company has restated its financial statements for the years ended December 31, 1993, 1994 and 1995 to conform the revenue recognition method to that in use during 1996. During 1996, the Company adopted a more refined method of recognizing revenue on its prepaid calling cards. The new method provides for recognition based upon actual decremented minutes of usage. Previously, prepaid calling card revenue was recognized based upon estimated usage and the passage of time. The Company also changed its method of accruing for compensated absences to conform with the provisions of Statement of Financial Accounting Standards No. 43. The effect of these changes on net income and beginning of the year shareholders' equity is as follows: .
1993 1994 1995 ----------------------- ----------------------- ----------------------- AS AS AS AS AS AS REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED Net income................. $1,026,339 $1,026,339 $ 746,397 $ 623,593 $ 822,507 $ 621,617 Beginning of year shareholders' equity..... 1,493,613 1,426,613 2,518,857 2,451,857 3,857,384 3,667,580
In November 1997, in consultation with the Securities and Exchange Commission staff and in conjunction with the use of the Company's financial statements in a registration statement on Form S-4 by SmarTalk Teleservices, Inc., the Company adopted a new method of recognizing revenue on promotional and 12 13 CONQUEST TELECOMMUNICATION SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1996 collector prepaid calling cards. The new method provides for recognition of revenue on these cards based upon actual usage or the expiration date of the card. For cards with no expiration date, revenue from unused minutes is recognized after 12 months from the date of issuance. Previously, revenue for promotional and collector cards was recognized at the date of issuance based upon expected usage which is less than 10%. This change increased the previously reported net loss for 1996 by $718,966. The adoption of this method had no effect on the 1994 and 1995 financial statements since sales of promotional and collector cards were negligible in those years. 10. CONTINGENT LIABILITIES The Company and certain directors are named defendants among a group of defendants in a lawsuit brought by a former officer and former directors of the Company who are also shareholders of the Company. The lawsuit alleges, among other things, a breach of duties owed to the plaintiffs as shareholders through unspecified acts of mismanagement, wrongful removal of plaintiffs from their previous positions as officer and directors of the Company, and tortuous interference with the plaintiffs alleged right to purchase shares of common stock of the Company which certain shareholders might desire to sell, and that the Company failed to comply with its charter documents in the removal of defendants as directors of the company and in the election of their successors. The Board of Directors of the Company passed a resolution to indemnify the named directors for all expenses and liabilities arising from the aforementioned lawsuit. Management of the Company, after consulting with legal counsel, believes that meritorious defenses exist with respect to this lawsuit and is vigorously defending the lawsuit and disputing all claims relating thereto. Management further believes that any losses to the Company resulting from resolution of this matter will not be material to the Company's results of operations or financial position. However, the ultimate outcome cannot presently be determined. Accordingly, no accrual for any potential liability that may result has been made in the financial statements. The Company has determined that its method of processing prepaid calling cards may be alleged to infringe a certain U.S. patent held by an unaffiliated third party. However, there are currently no claims of infringement outstanding against the Company by the patent holder. The validity of this patent, which expires November 13, 2005, is at issue in litigation now pending in federal district court; the Company is not a party to this litigation. The Company has initiated discussions with the patent holder for a license under the patent and expects that the terms of the licensing agreement would require the Company to pay licensing fees to the patent holder until the expiration or invalidation of the patent. These license fees would be applicable to prepaid calling card revenues generated subsequent to the date of the license agreement. Although the validity of the patent has not been determined and license payments under the potential agreement with the patent holder are based on future use, the ultimate outcome of the Company's negotiations with the patent holder cannot presently be determined. Accordingly, no accrual for any potential liability that may result has been made in the financial statements. 11. SUBSEQUENT EVENTS On February 19, 1997, the Company restated its certificate of incorporation increasing the number of shares of all classes of capital stock to 54,000,000 shares which are divided into two classes: 4,000,000 shares of preferred stock with a par value of $.001 per share and 50,000,000 shares of common stock with a par value of $.001 per share. The Company adopted an Incentive Stock Option Plan on February 19, 1997 (Incentive Stock Plan) contingent upon completion of an initial public offering of the Company's common stock. The purpose of the Incentive Stock Plan is to attract and retain key personnel, including consultants, advisors and directors of the Company, and to enhance their interest in the Company's continued success. The maximum number of shares available to be issued under the Incentive Stock Plan will be 67,500, subject to adjustment for stock splits and other similar corporate events. The maximum number of shares of common stock for which an individual may receive awards is limited to 2,000 shares per year. 13 14 CONQUEST TELECOMMUNICATION SERVICES CORP. CONDENSED CONSOLIDATED BALANCE SHEETS ASSETS
SEPTEMBER DECEMBER 30, 31, 1997 1996 ----------- ----------- (UNAUDITED) Current assets: Cash.......................................................... $ -- $ 300,557 Trade accounts receivable, net................................ 9,974,958 6,796,262 Inventories................................................... 349,262 782,210 Prepaid expenses.............................................. 399,076 629,838 Other current assets.......................................... 541,136 1,099,840 ----------- ----------- Total current assets....................................... 11,264,432 9,608,707 Non-current assets: Property and equipment, net................................... 4,886,111 4,178,490 Other non-current assets...................................... 3,807,388 937,360 Goodwill...................................................... 1,046,055 2,733,312 ----------- ----------- Total assets.......................................... $21,003,986 $17,457,869 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Accounts payable.............................................. $ 3,002,385 $ 3,064,861 Deferred revenue.............................................. 5,008,920 4,534,319 Other accrued expenses........................................ 1,239,707 1,664,017 Line of Credit................................................ 1,901,452 1,033,411 Current portion of long-term debt and capital lease obligations................................................ -- 603,343 ----------- ----------- Total current liabilities.................................. 11,152,464 10,899,951 Long-term debt................................................ 5,144,025 2,400,000 ----------- ----------- Total liabilities.......................................... 16,296,489 13,299,951 ----------- ----------- Shareholders' Equity: Preferred stock............................................... -- -- Common stock and additional paid-in capital................... 4,941,188 4,538,596 Accumulated deficit........................................... (202,891) (349,878) Treasury stock, at cost....................................... (30,800) (30,800) ----------- ----------- Total shareholders' equity................................. 4,707,497 4,157,918 ----------- ----------- Total liabilities and shareholders' equity............ $21,003,986 $17,457,869 =========== ===========
The accompanying notes are an integral part of these condensed consolidated financial statements. 14 15 CONQUEST TELECOMMUNICATION SERVICES CORP. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, ------------------------------- 1997 1996 ----------- ----------- Revenue........................................................... $36,384,544 $28,856,296 Cost of revenue................................................... 26,054,289 22,167,283 ----------- ----------- Gross profit.................................................... 10,330,255 6,689,013 Sales and marketing............................................... 3,941,940 2,874,679 General and administrative........................................ 5,959,815 3,948,751 ----------- ----------- Operating income (loss)......................................... 428,500 (134,417) Interest expense, net............................................. 187,541 290,149 ----------- ----------- Income (loss) before taxes...................................... 240,959 (424,566) Provision for income taxes........................................ 93,974 (170,675) ----------- ----------- Net (loss) income............................................... $ 146,985 $ (253,891) =========== =========== Net (loss) income per share....................................... $ 0.26 $ (0.46) =========== =========== Weighted Average number of shares................................. 565,765 547,693 =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. 15 16 CONQUEST TELECOMMUNICATION SERVICES CORP. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, --------------------------- 1997 1996 ----------- ----------- OPERATING ACTIVITIES: Net income (loss)................................................. $ 146,985 $ (253,891) Adjustments to reconcile net income (loss) to net cash used in operating activities: Depreciation and amortization................................... 1,070,728 839,026 Goodwill amortization........................................... 350,052 390,388 Changes in operating assets and liabilities: Accounts receivable.......................................... (3,171,584) (2,551,499) Inventory.................................................... 178,699 (657,596) Prepaid and agent loans...................................... 221,887 446,660 Other current assets......................................... 558,704 (329,821) Other non-current assets..................................... (1,131,040) (1,131,956) Accounts payable............................................. (62,307) 1,917,974 Deferred revenue............................................. 474,600 421,131 Other accrued expenses....................................... (18,972) (904,432) ----------- ----------- Net cash used in operating activities............................. (1,382,248) (1,814,016) INVESTING ACTIVITIES: Capital expenditures, net of disposals............................ (1,929,694) (1,690,662) ----------- ----------- Net cash used in investing activities............................. (1,929,694) (1,690,662) FINANCING ACTIVITIES: Proceeds from credit agreements and long-term obligations......... 3,884,002 4,111,463 Payments on credit agreements and long-term obligations........... (872,617) (606,785) ----------- ----------- Net cash provided by financing activities......................... 3,011,385 3,504,678 ----------- ----------- Net (decrease) in cash............................................ (300,557) -- Cash, beginning of period......................................... 300,557 -- ----------- ----------- Cash, end of period............................................... $ -- $ -- =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. 16 17 CONQUEST TELECOMMUNICATION SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF INTERIM PRESENTATION. The accompanying interim period financial statements are unaudited, pursuant to certain rules and regulations of the Securities and Exchange Commission, and include, in the opinion of management, all adjustments (consisting of only normal recurring accruals) necessary for a fair statement of the results for the periods indicated; which, however, are not necessarily indicative of results which may be expected for the full year. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The financial statements should be read in conjunction with the financial statements and the notes thereto for the year ended December 31, 1996. 2. Effective April 1, 1997, the Company sold substantially all of the assets of its ACMI division, with a net book value of $2,225,000, in exchange for a promissory note receivable. No gain or loss was recorded on the transaction. As the disposition of the ACMI Division is a non-cash transaction, the effects of this transaction have been excluded from the statement of cash flows. 3. As the settlement of CPC's contingent stock earnout in the amount of approximately $403,000 is a non-cash transaction, the affects of this transaction have been excluded from the statement of cash flows. 4. Certain amounts in the 1996 financial statements have been reclassified to conform to the 1997 presentation. 17 EX-99.4 9 UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS 1 EXHIBIT 99.4 UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS The following unaudited pro forma combined financial statements are based on the historical financial statements of SmarTalk TeleServices, Inc. ("SmarTalk"), SmarTel Communications, Inc. ("SmarTel"), GTI Telecom, Inc. ("GTI") and ConQuest Telecommunication Services Corp. ("ConQuest") adjusted to give effect to certain transactions and events. The unaudited pro forma combined statements of operations for the year ended December 31, 1996 and the nine month period ended September 30, 1997 give effect to (i) the merger of ConQuest and SmarTalk (the "Merger"), (ii) the September 1997 issuance by SmarTalk of $150,000,000 of Convertible Subordinated Notes, (iii) the acquisitions of GTI and SmarTel and (iv) the September 1997 settlement of $25,970,000 in subordinated notes issued by SmarTalk in connection with the GTI Acquisition as if they occurred on January 1, 1996. The unaudited pro forma combined balance sheet as of September 30, 1997 gives effect to the Merger. References in this document to data presented on a "pro forma basis" as of any date or for any period shall have the meaning set forth above with respect to such date or period. The unaudited pro forma combined financial statements give effect to the Merger in a transaction to be accounted under the purchase method of accounting and are based upon a preliminary allocation of the purchase price and upon the assumptions and adjustments described in the accompanying notes. The unaudited pro forma combined financial statements should be read in conjunction with the Financial Statements of SmarTalk and ConQuest. The unaudited pro forma combined financial statements are presented for information purposes only and are not necessarily indicative of the results that would have been reported or the financial position of SmarTalk had such events actually occurred on the dates specified, nor is it indicative of SmarTalk's future results or financial position. The results of operations for interim periods are not necessarily indicative of the results for the full year. 1 2 UNAUDITED PRO FORMA COMBINED BALANCE SHEET SEPTEMBER 30, 1997 ASSETS
PRO FORMA ADJUSTMENTS AS ADJUSTED FOR THE PRO FORMA HISTORICAL HISTORICAL MERGER (NOTE WITH THE SMARTALK CONQUEST 1) MERGER Current assets: Cash and cash equivalents...... $150,817,327 $ -- $ -- $150,817,327 Trade accounts receivable, net......................... 11,664,768 9,974,958 -- 21,639,726 Inventories.................... 1,487,296 349,262 -- 1,838,558 Prepaid expenses............... 2,023,768 399,076 -- 2,422,844 Other current assets........... 4,270,655 541,136 -- 4,811,791 ------------ ----------- ----------- ------------ Total current assets........ 170,263,814 11,264,432 -- 181,528,246 ------------ ----------- ----------- ------------ Non-current assets: Property and equipment, net.... 4,338,795 4,886,111 -- 9,224,906 Note receivable................ -- -- -- -- Debt issuance cost............. 4,664,997 -- -- 4,664,997 Other non-current assets....... 881,025 3,807,388 -- 4,688,413 Goodwill, net.................. 93,012,218 1,046,055 67,040,803(b) 161,099,076 ------------ ----------- ----------- ------------ Total assets........... $273,160,829 $21,003,986 $ 67,040,803 $361,205,618 ============ =========== =========== ============ LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) Current liabilities: Accounts payable............... $ 6,287,733 $ 3,002,385 $ -- $ 9,290,118 Deferred revenue............... 18,060,812 5,008,920 -- 23,069,732 Customer deposits.............. -- 24,530 -- 24,530 Excise, sales and use taxes payable...................... 3,638,229 440,438 -- 4,078,667 Accrued marketing costs........ -- 223,369 -- 223,369 Other accrued expenses......... 3,752,826 551,370 3,350,000(b) 7,654,196 Line of credit................. -- 1,901,452 -- 1,901,452 Current portion of long-term debt......................... -- -- -- -- Current portion of capital lease obligations............ 60,249 -- -- 60,249 ------------ ----------- ----------- ------------ Total current liabilities.... 31,799,849 11,152,464 3,350,000 46,302,313 ------------ ----------- ----------- ------------ Long-term debt, less current portion........................ 150,951,111 5,144,025 -- 156,095,136 ------------ ----------- ----------- ------------ Total liabilities............ 182,750,960 16,296,489 3,350,000 202,394,449 ------------ ----------- ----------- ------------ Shareholders' equity: Preferred stock................ -- -- -- -- Common stock................... 97,879,224 4,941,188 (4,941,188)(a) 68,398,300(b) 166,277,524 Retained earnings (accumulated deficit)..................... (7,469,355) (202,891) 202,891(a) (7,469,355) Treasury stock, at cost........ -- (30,800) 30,800(a) -- ------------ ----------- ----------- ------------ Total shareholders' equity... 90,409,869 4,707,497 63,690,803 158,808,169 ------------ ----------- ----------- ------------ Total liabilities and shareholders' equity....... $273,160,829 $21,003,986 $ 67,040,803 $361,205,618 ============ =========== =========== ============
2 3 UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997
CONVERTIBLE PRO FORMA SUBORDINATED AS ADJUSTED ADJUSTMENTS NOTES PRO FORMA FOR COMPLETED OFFERING COMBINED FOR HISTORICAL HISTORICAL ACQUISITIONS ADJUSTMENTS COMPLETED SMARTALK SMARTEL HISTORICAL GTI (NOTE 1) (NOTE 1) ACQUISITIONS Revenue.......................... $39,730,845 $1,946,606 $ 9,175,357 $ -- $ -- $ 50,852,808 Cost of revenue.................. 23,761,289 935,860 7,434,075 -- -- 32,131,224 ----------- ----------- ----------- ----------- ----------- ------------ Gross profit................... 15,969,556 1,010,746 1,741,282 -- -- 18,721,584 Sales and marketing.............. 10,213,879 861,917 1,000,630 -- -- 12,076,426 General and administrative....... 7,188,175 867,013 3,427,372 1,830,561(a) -- 13,313,121 ----------- ----------- ----------- ----------- ----------- ------------ Operating (loss) income........ (1,432,498) (718,184) (2,686,720) 1,830,561 -- (6,667,963) Interest income.................. 1,899,666 1,461 -- -- -- 1,901,127 Interest expense................. (965,173) -- (405,181) 220,833(b) (9,024,990) (c)(d) (10,174,511) ----------- ----------- ----------- ----------- ----------- ------------ (Loss)/Income before income taxes........................ (498,005) (716,723) (3,091,901) (1,609,728) (9,024,990) (14,941,347) Provision for income taxes....... -- -- -- -- -- -- ----------- ----------- ----------- ----------- ----------- ------------ Net/(loss) income.............. $ (498,005) $ (716,723) $ (3,091,901) $(1,609,728) $(9,024,990) $(14,941,347) =========== =========== =========== =========== =========== ============ Net loss per share............... $ (0.92) ============ Weighted average number of common shares outstanding............. 16,253,644 ============ PRO FORMA AS ADJUSTED ADJUSTMENTS PRO FORMA FOR THE COMBINED HISTORICAL MERGER WITH THE CONQUEST (NOTE 1) MERGER Revenue.......................... $36,384,544 $ -- $ 87,237,352 Cost of revenue.................. 26,054,289 -- 58,185,513 ----------- ----------- ------------ Gross profit................... 10,330,255 -- 29,051,839 Sales and marketing.............. 3,941,940 -- 16,018,366 General and administrative....... 5,959,815 2,514,030 (e) 21,786,966 ----------- ----------- ------------ Operating (loss) income........ 428,500 (2,514,030) (8,753,493) Interest income.................. 83,267 -- 1,984,394 Interest expense................. (270,808) -- (10,445,319) ----------- ----------- ------------ (Loss)/Income before income taxes........................ 240,959 (2,514,030) (17,214,418) Provision for income taxes....... (93,974) 93,974 (f) -- ----------- ----------- ------------ Net/(loss) income.............. $ 146,985 $(2,420,056) $(17,214,418) =========== =========== ============ Net loss per share............... $ (0.83) ============ Weighted average number of common shares outstanding............. 20,741,244 ============
3 4 UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1996
CONVERTIBLE PRO FORMA SUBORDINATED AS ADJUSTED ADJUSTMENTS NOTES PRO FORMA FOR COMPLETED OFFERING COMBINED FOR HISTORICAL HISTORICAL HISTORICAL ACQUISITIONS ADJUSTMENTS COMPLETED SMARTALK SMARTEL GTI (NOTE 1) (NOTE 1) ACQUISITIONS Revenue.................... $15,021,060 $ 5,034,192 $ 21,264,323 $ $ -- $ 41,319,575 Cost of revenue............ 10,198,971 4,100,955 18,294,789 -- 32,594,715 ----------- ----------- ----------- ----------- ----------- ------------ Gross profit........... 4,822,089 (933,237) 2,969,534 -- -- 8,724,860 Sales and marketing........ 4,511,291 1,306,635 6,575,261 -- -- 12,393,187 General and administrative........... 3,615,070 2,205,883 639,819 4,555,128(a) -- 11,015,900 Write-down of assets....... -- -- -- -- -- -- ----------- ----------- ----------- ----------- ----------- ------------ Operating loss......... (3,304,272) (2,579,281) (4,245,546) (4,555,128) -- (14,684,227) Interest income............ 443,352 7,241 -- -- -- 450,593 Interest expense........... (251,628) -- (559,362) (9,317,857)(c)(d) (10,128,847) ----------- ----------- ----------- ----------- ----------- ------------ Loss before income taxes................ (3,112,548) (2,572,040) (4,804,908) (4,555,128) (9,317,857) (24,362,481) Provision for income taxes.................... -- -- -- -- ----------- ----------- ----------- ----------- ----------- ------------ Net loss............... $(3,112,548) $(2,572,040) $ (4,804,908) $(4,555,128) $(9,317,857) $(24,362,481) =========== =========== =========== =========== =========== ============ Net loss per share......... $ (1.82) ============ Weighted average number of common shares outstanding.............. 13,394,662 ============ AS ADJUSTED PRO FORMA PRO FORMA ADJUSTMENTS COMBINED HISTORICAL FOR THE MERGER WITH THE CONQUEST (NOTE 1) MERGER Revenue.................... $ 37,821,061 -- $ 79,140,636 Cost of revenue............ 28,926,051 -- 61,520,766 ----------- ----------- ------------ Gross profit........... 8,895,010 17,619,870 Sales and marketing........ 2,856,212 -- 15,249,399 General and administrative........... 6,883,849 3,352,040(e) 21,251,789 Write-down of assets....... 918,445 -- 918,445 ----------- ----------- ------------ Operating loss......... (1,763,496) (3,352,040) (19,799,763) Interest income............ -- -- 450,593 Interest expense........... (402,378) (10,531,225) ----------- ----------- ------------ Loss before income taxes................ (2,165,874) (3,352,040) (29,880,395) Provision for income taxes.................... 766,000 (766,000)(f) -- ----------- ----------- ------------ Net loss............... (1,399,874) $ (4,118,040) $(29,880,395) =========== =========== ============ Net loss per share......... $ (1.67) ============ Weighted average number of common shares outstanding.............. 17,882,262 ============
4 5 NOTES TO UNAUDITED PRO FORMA COMBINED BALANCE SHEET NOTE 1 The Unaudited Pro Forma Combined Balance Sheet has been prepared to reflect the effect of the Merger as if it occurred on September 30, 1997 for an aggregate purchase price of $63,948,300 and estimated transaction costs of approximately $7,800,000. Pro forma adjustments are made to reflect: (a) The elimination of the equity of ConQuest on acquisition. (b) The adjustment to allocate the excess purchase price over the fair value of ConQuest's net assets at September 30, 1997 to goodwill.
SEPTEMBER 30, 1997 ------------------ Purchase price (4,487,600(1) shares at $14.25 per share)............................................. $ 63,948,300 Estimated transaction costs to be settled in SmarTalk Common Stock....................................... 4,450,000 Estimated cash transaction costs..................... 3,350,000 ----------- Total purchase price (including transaction costs)... 71,748,300 Less: Net assets acquired............................ 4,707,497 ----------- Goodwill............................................. $ 67,040,803 ===========
-------------------- (1) Shares calculated as follows: ConQuest common shares outstanding............................ 588,152 Conversion rate............................................... 7.63 --------- Total SmarTalk common stock to be issued...................... 4,487,600 =========
Management has not yet allocated any of the excess purchase price to identifiable intangible assets such as intellectual property, in-process research and development, customer relationships or specific contracts as valuations of any potential intangible assets are not currently available. Should management identify such assets in the future, the useful life of any individual asset may differ from the goodwill amortization period of 20 years currently reflected in the Pro Forma Combined Statements of Operations. 5 6 NOTES TO UNAUDITED PRO FORMA COMBINED STATEMENTS OF OPERATIONS NOTE 1 The Unaudited Pro Forma Combined Statements of Operations give effect to the following pro forma adjustments necessary to reflect (i) the pending Merger; (ii) the Convertible Subordinated Notes Offering; (iii) the acquisitions of GTI and SmarTel; and (iv) settlement of $25,970,000 in subordinated notes issued in connection with the GTI Acquisition as if all of the transactions occurred on January 1, 1996: (a) To record amortization of goodwill on the SmarTel and GTI acquisitions on a straight line basis over 20 years. (b) To exclude substantially all interest expense recorded on the subordinated notes issued on acquisition of GTI. (c) To record interest expense on the $150,000,000 principal amount of the Convertible Subordinated Notes. (d) Amortization of debt issuance costs over the life of the Convertible Subordinated Notes. (e) Amortization of goodwill on the Merger on a straight line basis over 20 years. (f) To adjust the tax benefit/(expense) for ConQuest given the continuing operating losses of SmarTalk. 6 -----END PRIVACY-ENHANCED MESSAGE-----