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FILES PURSUANT TO RULE 424(b)(4)
REGISTRATION STATEMENT NO. 333-10391
PROSPECTUS
4,200,000 SHARES
[LOGO OF SMARTALK TELESERVICES, INC.]
SMARTALK TELESERVICES, INC.
COMMON STOCK
(NO PAR VALUE)
Of the 4,200,000 shares of Common Stock, no par value per share (the "Common
Stock"), of SmarTalk TeleServices, Inc. ("SmarTalk" or the "Company") offered
hereby, 4,000,000 shares are being sold by the Company and 200,000 shares are
being sold by certain shareholders of the Company (the "Selling
Shareholders"). See "Principal and Selling Shareholders." The Company will not
receive any of the proceeds from the sale of the shares of Common Stock by the
Selling Shareholders.
Prior to this offering (the "Offering"), there has been no public market for
the Common Stock. For a discussion relating to the factors that were
considered in determining the initial public offering price, see
"Underwriting."
The Common Stock has been approved for listing on the Nasdaq National Market
under the symbol "SMTK."
SEE "RISK FACTORS" BEGINNING ON PAGE 7 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY PROSPECTIVE INVESTORS.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
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PRICE TO UNDERWRITING PROCEEDS TO PROCEEDS TO
PUBLIC DISCOUNT(1) COMPANY(2) SELLING SHAREHOLDERS
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Per Share........................... $14.50 $1.015 $13.485 $13.485
Total(3)............................ $60,900,000 $4,263,000 $53,940,000 $2,697,000
- ----------------------------------------------------------------------------------------------
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(1) See "Underwriting" for information concerning indemnification of the
Underwriters and other matters.
(2) Before deducting expenses of the Offering estimated at $1,225,000, all of
which will be paid by the Company.
(3) The Selling Shareholders have granted to the Underwriters a 30-day option
to purchase up to 630,000 additional shares of Common Stock at the Price
to Public, less Underwriting Discount, solely to cover over-allotments, if
any. If the Underwriters exercise such option in full, the total Price to
Public, Underwriting Discount and Proceeds to Selling Shareholders will be
$70,035,000, $4,902,450 and $11,192,550, respectively. See "Underwriting"
and "Principal and Selling Shareholders."
The shares are offered subject to receipt and acceptance by the Underwriters,
to prior sale and to the Underwriters' right to reject any order in whole or
in part and to withdraw, cancel or modify the offer without notice. It is
expected that delivery of the shares will be made at the office of Salomon
Brothers Inc, Seven World Trade Center, New York, New York or through the
facilities of The Depository Trust Company, on or about October 29, 1996.
SALOMON BROTHERS INC
CS FIRST BOSTON
DONALDSON, LUFKIN & JENRETTE
SECURITIES CORPORATION
The date of this Prospectus is October 23, 1996.
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Omitted is a photograph of a business woman making a phone call from a
public telephone. To the right of this woman the following text appears: "An
Emerging Market. The Prepaid Phone Card Industry is Expected to Reach A
Billion Dollars In Sales in 1996.*" In smaller print at the bottom of the page
the following text appears: "*Source: ATLANTIC-ACM Report, 1996 Calling and
Prepaid Card Products: Trends and Opportunities." Superimposed over the page
are six SMARTALK TELESERVICES CARDS.
Omitted is a photograph of a woman holding a SMARTALK TELESERVICES CARD
making a phone call from a public telephone. Along the left side of the page
the following text appears: "Helping Marketers Build Brand Equity. Air Touch
Cellular, Cellular One, Janna Systems, Kodak & Hallmark Cards with American
Stores, Hello Direct, JVC, Smart & Final Iris, Software Publishing Company,
The Stiffel Company, and more." Along the right side of the page the following
text appears: "National Distribution through Leading Retailers. Acme, Best
Buy, Bradlees, Builders Square, Dayton's, Fedco, Foley's, The Good Guys, Good
Neighbor Pharmacies, Hills, Hudson's, Jewel/Osco Combo Stores, Marshall
Field's, Office Depot, Office 1 Superstores, Osco Drug, Penn Daniels,
Price/Costco, Robinsons-May, Sav-on Drug, Thrifty Oil, Venture Stores and
more."
Omitted are two paragraphs: On the left side of the page is a photograph of
a businessman making a phone call and holding up the SMARTALK TELESERVICES
CARD. On the right side is a photograph of a young child making a call from a
public telephone and holding up the SMARTALK TELESERVICES CARD. Down the
center of the page the following text appears: "Strategic Alliances Enhance
Distribution Channels. The Douglas Stewart Company, MCI, West Interactive."
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK
OF THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET, THE
OVER-THE-COUNTER MARKET OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE
DISCONTINUED AT ANY TIME.
DURING THIS OFFERING, CERTAIN PERSONS AFFILIATED WITH PERSONS PARTICIPATING IN
THE DISTRIBUTION MAY ENGAGE IN TRANSACTIONS FOR THEIR OWN ACCOUNTS OR FOR THE
ACCOUNTS OF OTHERS IN SHARES OF THE COMMON STOCK PURSUANT TO EXEMPTIONS FROM
RULES 10B-6, 10B-7 AND 10B-8 UNDER THE SECURITIES EXCHANGE ACT OF 1934.
2
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PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and Financial Statements, including the Notes thereto, appearing
elsewhere in this Prospectus. Investors should also carefully consider the
information set forth under the heading "Risk Factors" and are urged to read
this Prospectus in its entirety. Unless otherwise indicated, all information in
this Prospectus assumes no exercise of the Underwriters' over-allotment option.
THE COMPANY
SmarTalk provides convenient, easy to use, cost-effective telecommunications
products and services to individuals and businesses primarily through its
SmarTalk TeleServices Card (the "SmarTalk Card"). The SmarTalk Card provides
customers with a single point of access to prepaid telecommunications services
at a fixed rate charge per minute regardless of the time of day or, in the case
of domestic calls, the distance of the call. The Company's services currently
include domestic calling and outbound international long distance calling to
more than 150 countries, as well as enhanced features such as sequential
calling, speed dial and message delivery. The SmarTalk Card may also be
recharged on-line with a major credit card, allowing the user to add minutes as
needed. The Company expects to offer other enhanced services, including
conference calling, voice mail, fax mail, content delivery and selected
international calling services. The Company's long distance calls are carried
primarily through MCI and AT&T. For the six months ended December 31, 1995 and
June 30, 1996, the number of minutes decremented from SmarTalk cards or
otherwise used by SmarTalk customers were approximately 2,576,000 and
15,901,000, respectively.
The domestic prepaid phone card industry has grown significantly in recent
years. Prepaid phone card revenues in the U.S. have grown from an estimated $20
million in 1990 to an estimated $1 billion in 1996, making prepaid phone
services one of the fastest growing segments of the telecommunications
industry. Industry sources project the total U.S. prepaid phone card market to
reach $2.5 billion in 2000.
SmarTalk's primary marketing and distribution focus is to target individuals
and small businesses through major national and regional retailers. Currently,
the SmarTalk Card is sold at selected retail locations throughout the U.S.,
including locations operated by the following leading retailers: American Drug
Stores (which includes Jewel/Osco Combo Stores, Osco Drug Stores and Sav-On
Drug Stores), Office Depot, Thrifty Oil, Builders Square, Hills Department
Stores, Bradlees, Bergen Brunswig Drug Company (Good Neighbor Pharmacy),
Venture Stores, Foley's Department Stores, Marshall Field's, Fred W. Albrecht
Grocery Company, Office 1 Superstores, Price/Costco, Acme, Best Buy, Dayton's,
Fedco, The Good Guys, Hudson's, Penn Daniels, Pamida and Robinsons-May. The
Company believes its success to date in rapidly expanding its retail network is
attributable to management's ability to increase retailers' awareness of the
profit potential of offering telecommunications services at retail, the minimal
space involved in offering the SmarTalk Card at retail and the ability of the
SmarTalk Card to generate ongoing residuals for retailers through participation
in recharge revenues. SmarTalk also is exploring the opportunity of offering
retailers a co-branded, pre-subscribed "1+" long distance service. This new
product, if successfully introduced, would afford retailers the ability to
offer residential and small business customers long distance services that are
designed to generate ongoing revenue streams while requiring virtually no shelf
space or inventory cost. SmarTalk also markets its services directly to
customers through direct response sales which include recharge sales, and sales
generated through print, direct mail, and, in the future, Internet and
television advertising.
The Company has developed additional marketing and distribution avenues,
including the Company's Corporate Advantage Program and corporate promotional
programs. Under the Corporate
3
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Advantage Program, employees who are away from their offices can utilize
SmarTalk services, thereby enabling businesses to lower telecommunications
costs and monitor call activity to better allocate long distance costs.
Corporate promotional programs allow the Company's corporate customers to
provide co-branded prepaid phone cards for use in corporate or product
promotions.
SmarTalk services are delivered through proprietary switching, application
and database access software which run on two interactive call processing
platforms (the "SmarTalk Platforms"), one of which was recently acquired from
Pacific Bell Information Services (the "VoiceChoice Platform"). The acquisition
of the VoiceChoice Platform provides the Company with the opportunity to reduce
its costs while providing the Company with the flexibility to customize and add
features. The Company has also developed a proprietary in-house data reporting
and tracking system (the "SmarTrac System"), which tracks inventory, controls
fraud, monitors usage by card and retailer and allows the Company to provide
certain customer and usage information to its retailers and business customers.
The Company believes that its principal competitive advantages are its (i)
well-established presence among major retailers, (ii) advanced
telecommunications infrastructure, and (iii) management team, which has
extensive marketing and merchandising expertise. The Company believes its
competitive advantages will assist it in achieving its growth objective through
implementation of the following strategies:
Increase Penetration of Retailers. SmarTalk plans to increase penetration of
retailers by expanding the number of stores in which the SmarTalk Card is sold
and the points of sale at which a customer can purchase the SmarTalk Card
within each store. The Company also intends to leverage its relationships with
retailers to market additional telecommunications services such as "1+" long
distance.
Further Develop Direct Response Channels. SmarTalk plans to stimulate the
growth of its existing direct response sales through, for example, volume
discounts and on-line advertising. The Company plans to continue to develop new
and innovative means of marketing its telecommunications products and services
directly to customers to complement its retail distribution network, including
television advertising, catalogue and other direct marketing methods.
Broaden Corporate Advantage and Promotional Programs. SmarTalk intends to
expand the Corporate Advantage Program and corporate promotional programs by
(i) expanding its sales force to include representatives that focus on business
customers, (ii) capitalizing on the Company's strategic relationships, and
(iii) leveraging its existing relationships with retailers by promoting its
corporate programs to retailers already familiar with SmarTalk services.
Target the Business Customer. SmarTalk plans to introduce additional enhanced
features in an effort to attract both small businesses at retail and
corporations as subscribers to its Corporate Advantage Program. Such planned
enhanced features include voice mail, fax mail, conference calling and selected
international calling services.
Leverage Existing Strategic Relationships. SmarTalk plans to leverage its
existing network of strategic relationships to gain access to new business
opportunities and a wider customer base. The Company has recently entered into
strategic alliances, including those with MCI, West Interactive, and Douglas
Stewart, which the Company believes will expand its distribution channels. The
Company also plans to develop additional strategic relationships with partners
whose customers are prospective users of SmarTalk services.
4
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Expand International Services. SmarTalk plans to expand its business to
international markets in order to market prepaid phone cards to U.S. travelers
and foreign customers who frequently call the U.S. SmarTalk believes that it
can market to foreign customers who frequently call the U.S. by establishing a
sales force abroad and by providing turnkey merchandising materials to
retailers abroad which are customized for foreign markets.
SmarTalk TeleServices, Inc. was incorporated in California in October 1994.
As used in this Prospectus, the term "SmarTalk" or the "Company" refers to
SmarTalk TeleServices, Inc. and its subsidiary, unless the context otherwise
requires. All information in this Prospectus gives effect for all periods to a
3,500 for 1 stock split effected on February 13, 1996, a 2.51 for 1 stock split
effected on May 23, 1996, and a 0.5625 for 1 reverse stock split effected on
August 15, 1996. The Company's principal executive offices are located at 1640
South Sepulveda Boulevard, Suite 500, Los Angeles, California 90025, and its
telephone number is (310) 444-8800.
THE OFFERING
Common Stock Offered By:
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<S> <C>
The Company ............ 4,000,000 shares
The Selling
Shareholders........... 200,000 shares(1)
Total................. 4,200,000 shares(1)
===================
Common Stock Outstanding
after the Offering....... 12,829,459 shares(2)
Use of Proceeds........... To repay indebtedness, to fund capital expenditures,
marketing, new business development opportunities
and the expansion of the Company's business
internationally, and for additional working capital
and general corporate purposes including possible
acquisitions.
Nasdaq National Market
Symbol................... SMTK
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(1) Excludes 630,000 shares of Common Stock that may be sold by the Selling
Shareholders pursuant to the Underwriters' over-allotment option.
(2) Excludes 505,889 shares of Common Stock reserved for issuance upon exercise
of outstanding options granted by the Company. See "Dilution" and
"Management -- Stock Option Plans."
5
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SUMMARY FINANCIAL DATA
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PERIOD FROM
INCEPTION
(OCTOBER 28, SIX MONTHS ENDED
1994) TO YEAR ENDED JUNE 30,
DECEMBER 31, DECEMBER 31, ----------------------
1994 1995 1995 1996
------------ ------------ --------- -----------
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STATEMENT OF OPERATIONS
DATA(1):
Revenue.................... $ 444 $ 453,916 $ 41,738 $ 3,678,020
Gross profit (loss)........ (272) 135,230 11,828 935,905
Operating expenses......... 65,200 1,466,544 297,265 3,102,719
--------- ----------- --------- -----------
Loss from operations....... (65,472) (1,331,314) (285,437) (2,166,814)
Net loss................... $ (65,472) $(1,329,302) $(285,437) $(2,271,186)
========= =========== ========= ===========
Net loss per share(2)...... $ (.01) $ (.14) $ (.03) $ (.24)
========= =========== ========= ===========
Weighted average number of
common shares and common
equivalent shares(2)...... 9,335,348 9,335,348 9,335,348 9,335,348
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JUNE 30, 1996
---------------------------
ACTUAL AS ADJUSTED(3)
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BALANCE SHEET DATA(1):
Working capital................................... $(3,256,069) $46,173,929
Total assets...................................... 4,782,822 54,182,822
Deferred revenue(4)............................... 4,127,919 4,127,919
Total debt........................................ 3,825,000 510,000
Total shareholders' equity (deficit).............. (5,814,988) 46,900,012
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FOR THE THREE MONTHS ENDED
-----------------------------------------------
SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30,
1995 1995 1996 1996
------------- ------------ --------- ----------
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SELECTED QUARTERLY OPERATING
DATA:
Number of PINs activated(5).. 15,811 52,800 117,212 196,259
Number of minutes
decremented(6).............. 640,320 1,935,247 5,152,179 10,748,914
Number of recharge minutes
purchased................... 154,974 312,390 666,030 1,112,130
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(1) This data should be read in connection with the Financial Statements and
Notes thereto included elsewhere in this Prospectus.
(2) See Note 2 of Notes to Financial Statements for a discussion of net loss
per share and shares used in computing net loss per share.
(3) Adjusted to reflect a $250,000 loan from SmarTalk Partners obtained in
August 1996 and $510,000 borrowed under a $1,000,000 line of credit
established in September 1996 and to give effect to the application of the
estimated net proceeds of the Offering. See "Use of Proceeds."
(4) Deferred revenue represents amounts for products shipped to retailers and
recharged minutes that the Company has invoiced, which, as of the date
presented, have not been used by customers. Upon customer usage, the
Company recognizes revenue and reduces the deferred revenue account. At the
time the revenue is recognized, the costs to which that revenue
specifically relates are also recognized.
(5) "PINs" are personal identification numbers used by each customer to access
the SmarTalk system. PINs are printed on the back of each SmarTalk Card or
provided separately to customers.
(6) "Minutes decremented" include minutes used by customers purchasing SmarTalk
services and minutes used as a result of the distribution of free
promotional goods.
6
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained under "Management's Discussion and Analysis of
Financial Condition and Results of Operations," such as statements concerning
the Company's ability to increase gross margins and decrease expenses, certain
statements under "Business," such as statements concerning future services,
proposed efforts to increase brand awareness, the future of the
telecommunications industry and SmarTalk's plans to expand its retail
distribution network and develop additional distribution channels and other
statements contained herein regarding matters that are not historical facts,
are forward-looking statements (as such term is defined in the Securities Act
of 1933, as amended (the "Securities Act")). Because such forward-looking
statements include risks and uncertainties, actual results may differ
materially from those expressed or implied by such forward-looking statements.
Factors that could cause actual results to differ materially include, but are
not limited to, those discussed under "Risk Factors."
RISK FACTORS
In addition to the other information in this Prospectus, the following
factors should be considered carefully in evaluating an investment in the
shares of Common Stock offered by this Prospectus.
LIMITED OPERATING HISTORY; NET LOSSES; ACCUMULATED DEFICIT
The Company was formed in October 1994 and has had only a limited operating
history upon which investors may base an evaluation of its performance. As a
result of operating expenses and development expenditures, the Company has
incurred significant operating and net losses to date. Net losses for the
period ended December 31, 1994 and for the year ended December 31, 1995 and
for the six months ended June 30, 1996 were approximately $65,000, $1.3
million, and $2.3 million, respectively. At June 30, 1996, the Company had an
accumulated deficit of approximately $6.1 million. In addition, the Company
plans to significantly increase its operating expenses in order to expand its
sales and marketing efforts, fund a greater level of product development and
marketing and otherwise support the growth of the Company. Given these planned
expenditures, the Company anticipates that it will continue to incur losses
for the foreseeable future and there can be no assurance that the Company will
ever achieve or sustain profitability. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
INTENSE COMPETITION
The telecommunications services industry is intensely competitive, rapidly
evolving and subject to constant technological change. In 1994, there were
approximately 75 companies marketing prepaid calling cards. Today there are
more than 500 companies selling prepaid calling cards, and the Company expects
competition to increase in the future. Other providers currently offer one or
more of each of the services offered by the Company. As a service provider in
the long distance telecommunications industry, the Company competes with three
dominant providers, AT&T, MCI and Sprint, all of which are substantially
larger and have: greater financial, technical, engineering, personnel and
marketing resources; longer operating histories; greater name recognition; and
larger customer bases than the Company. These advantages afford the Company's
competitors pricing flexibility. Telecommunications services companies may
compete for customers based on price, with the dominant providers conducting
extensive advertising campaigns to capture market share. Competitors with
greater financial resources may also be able to provide more attractive
incentive packages to retailers to encourage them to carry products that
compete with SmarTalk services. In addition, competitors with greater
resources than the Company may be better situated to negotiate favorable
contracts with retailers. The Company believes that existing competitors are
likely to continue to expand their service offerings to appeal to retailers
and their customers. Moreover, since there are few, if any, substantial
barriers to entry, the Company expects that new competitors are likely to
enter the
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telecommunications market and attempt to market telecommunications services
similar to the Company's services which would result in greater competition.
The ability of the Company to compete effectively in the telecommunications
services industry will depend upon the Company's continued ability to provide
high quality SmarTalk services at prices generally competitive with, or lower
than, those charged by its competitors. Certain of the Company's competitors
dominate the telecommunications industry and have the financial resources to
enable them to withstand substantial price competition, which is expected to
increase significantly, and there can be no assurance that the Company will be
able to compete successfully in the future. Moreover, there can be no
assurance that certain of the Company's competitors will not be better
situated to negotiate contracts with suppliers of telecommunications services
which are more favorable than contracts negotiated by the Company. In
addition, there can be no assurance that competition from existing or new
competitors or a decrease in the rates charged for communications services by
the major long distance carriers or other competitors would not have a
material adverse effect on the Company's business, operating results or
financial condition (a "Material Adverse Effect").
Recent changes in the regulation of the telecommunications industry may
impact the Company's competitive position. The Telecommunications Act of 1996
(the "Telecommunications Act") was signed by President Clinton on February 8,
1996, effectively opening the long distance market to competition from the
Regional Bell Operating Companies (the "RBOCs"). The entry of these well-
capitalized and well-known entities into the long distance market will likely
increase competition for long distance customers. The Telecommunications Act
also grants the FCC the authority to deregulate other aspects of the
telecommunications industry, which in the future may, if authorized by the
FCC, facilitate the offering of telecommunications services by regulated
entities, including the RBOCs, in competition with the Company. See
"Business -- Competition."
LIMITED PROTECTION OF PROPRIETARY RIGHTS; RISKS OF INFRINGEMENT
The Company relies on a combination of copyright and trade secret laws and
contractual confidentiality provisions to protect its proprietary rights.
These laws and contractual provisions provide only limited protection of the
Company's proprietary rights. The Company to date has no registered
servicemarks, trademarks, patents or copyrights. The Company's application for
the servicemark "SmarTalk" was initially denied by the Patent and Trademark
Office of the U.S. Department of Commerce on the ground that there is another
company in the telecommunications industry using the name "Smartalk." The
Company is represented by a shareholder of the Company and is presently
appealing such determination. The Company's appeal is based on its belief that
(i) the two companies are in different segments of the telecommunications
industry and do not compete against each other and therefore consumer
confusion is unlikely, and (ii) the other company will not suffer any indirect
harm or loss of goodwill due to confusion regarding the source of products
because customers of the other company are sophisticated about the source of
their purchases. There can be no assurance that the Company will be successful
in such appeal. While the Company believes that registering the servicemark is
important to its business to further protect its existing common law right to
use such servicemark, the Company does not believe that the failure thus far
to register its servicemark is dispositive of whether the Company has the
right to use such servicemark. Despite the Company's efforts to protect its
proprietary rights, unauthorized parties may attempt to copy aspects of the
Company's software or services or to obtain and use information that the
Company regards as proprietary. There can be no assurance that the Company's
efforts to protect its proprietary rights will be successful, or that the
Company's competitors will not independently develop similar technology. In
addition, the laws of some foreign countries do not protect the Company's
proprietary rights to the extent of the laws of the U.S. See "Business -- The
SmarTrac System" and "Business -- The SmarTalk Platforms."
The Company is aware of other companies that use variations of the term
"Smart" in their name or in describing their products or services, including
telecommunications products and services. Three
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companies have written letters challenging the Company's use of the SmarTalk
name. There can be no assurance that SmarTalk will achieve a satisfactory
resolution of these disputes. If such claims are not satisfactorily resolved,
the other parties may pursue additional avenues to address the dispute,
including filing claims against the Company. The loss of the use of the name
SmarTalk would have a Material Adverse Effect. The Company currently is
incorporated or registered as a foreign corporation under the SmarTalk
TeleServices, Inc. name in all fifty states and the District of Columbia. The
Company does not believe that the use of "SmarTalk" as its name or with
respect to SmarTalk services is improper, and no actions have been filed to
date with respect to either patent, servicemark, trademark or copyright
claims. However, no assurance can be given that actions or claims alleging
patent, servicemark, trademark or copyright infringement will not be brought
against the Company with respect to its name or current or future SmarTalk
services, or that, if such actions are brought, the Company will ultimately
prevail. Any such claiming parties may have significantly greater resources
than the Company to pursue litigation of such claims. Any such claims, whether
with or without merit, could be time consuming, result in costly litigation,
cause delays in introducing new or improved services, require the Company to
enter into royalty or licensing agreements, or cause the Company to
discontinue use of the challenged tradename, servicemark or technology,
potentially giving rise to the significant expense associated with the
marketing of a new name or the development or purchase of replacement
technology, all of which could have a Material Adverse Effect.
NEW INDUSTRY; UNCERTAINTY OF MARKET ACCEPTANCE
The prepaid phone card industry segment is an emerging business
characterized by an increasing and substantial number of new market entrants
who have introduced or are developing an array of new products and services.
Each of these entrants is seeking to market, advertise and position its
products and services as the preferred method for accessing long distance
telephone services, including providing enhanced service features. As is
typically the case in an emerging industry, demand and market acceptance for
newly introduced products and services are subject to a high level of
uncertainty. There can be no assurance that substantial markets will continue
to develop for prepaid phone cards or that the Company will be able to meet
its current marketing objectives, succeed in positioning its cards and
services as a preferred method for accessing long distance telephone services
or achieve significant market acceptance for its products. See "Business --
Industry Overview."
RAPID TECHNOLOGICAL CHANGE; DEPENDENCE ON NEW SERVICES
The telecommunications services industry is characterized by rapid
technological change, new product introduction and evolving industry
standards. The Company's success will depend, in significant part, on its
ability to make timely and cost-effective enhancements and additions to its
technology and introduce new services that meet customer demands. The Company
expects new products and services, and enhancements to existing products and
services, to be developed and introduced to compete with SmarTalk services.
The proliferation of new telecommunication technology, including personal
communication services and voice communication over the Internet, may reduce
demand for long distance services, including prepaid phone cards. There can be
no assurance that the Company will be successful in developing and marketing
new SmarTalk services or enhancements to SmarTalk services that respond to
these or other technological changes or evolving industry standards. In
addition, there can be no assurance that the Company will not experience
difficulties that could delay or prevent the successful development,
introduction and marketing of its existing SmarTalk services or that its new
SmarTalk services or enhancements thereto, will adequately meet the
requirements of the marketplace and achieve market acceptance. Delay in the
introduction of new SmarTalk services or enhancements, the inability of the
Company to develop such new SmarTalk services or enhancements or the failure
of such SmarTalk services or enhancements to achieve market acceptance could
have a Material Adverse Effect. See "Business -- Competition" and "Business --
Products and Telecommunications Services."
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DEPENDENCE ON MAJOR RETAILERS
Currently, the SmarTalk Card is sold at selected retail locations throughout
the U.S., including locations operated by the following leading retailers:
American Drug Stores (which includes Jewel/Osco Combo Stores, Osco Drug Stores
and Sav-On Drug Stores), Office Depot, Thrifty Oil, Builders Square, Hills
Department Stores, Bradlees, Bergen Brunswig Drug Company (Good Neighbor
Pharmacy), Venture Stores, Foley's Department Stores, Marshall Field's, Fred
W. Albrecht Grocery Company, Office 1 Superstores, Price/Costco, Acme, Best
Buy, Dayton's, Fedco, The Good Guys, Hudson's, Penn Daniels, Pamida and
Robinsons-May. The Company's arrangements with retailers are generally
pursuant to short-term arrangements. If the Company is unsuccessful in
providing competitive pricing, meeting the requirements of its retailers,
developing new products that are attractive to such retailers, or complying
with the terms of its arrangements with such retailers, such retailers may
fail to market aggressively the Company's services or may terminate their
relationship with the Company, either of which could have a Material Adverse
Effect. Substantially all of the Company's revenue to date has been derived
from the sale of the SmarTalk Card to retailers. Certain of those retailers
have, from time to time, accounted for a significant percentage of the
Company's revenue. See "Business -- General." The inability of any such
retailer to pay the Company for SmarTalk cards shipped or the loss of any such
retailer could have a Material Adverse Effect.
SEASONALITY; FACTORS AFFECTING OPERATING RESULTS; POTENTIAL FLUCTUATIONS IN
PERIOD-TO-PERIOD RESULTS
The Company's sales have been, and the Company expects that its sales will
continue to be, somewhat seasonal, due to holiday purchases of the SmarTalk
Card. In addition, the Company's operating results have varied significantly
in the past and may vary significantly in the future. Factors that may cause
the Company's operating results to vary include (i) changes in operating
expenses, (ii) the timing of the introduction of SmarTalk services, (iii)
market acceptance of new and enhanced versions of SmarTalk services, (iv)
potential acquisitions, (v) changes in legislation and regulation which affect
the competitive environment for SmarTalk services, and (vi) general economic
factors. Moreover, for many of the Company's retailers, SmarTalk services
represent a new merchandising category, with the attendant concerns regarding
shelf space positioning, sales force education and effective marketing and,
with respect to arrangements with certain retailers requiring customized
SmarTalk services, there may be significant leadtime to provide such SmarTalk
services following receipt of the customers' orders. As a result of these
factors, the Company believes that period-to-period comparisons of its results
of operations are not necessarily meaningful and should not be relied upon as
an indication of future performance. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
ABILITY TO MANAGE GROWTH AND IMPLEMENT NEW ACCOUNTING SYSTEM; NEED TO HIRE
ADDITIONAL EMPLOYEES
Although SmarTalk has experienced substantial growth in revenue in the last
year and intends to continue to grow rapidly, there can be no assurance that
the growth experienced by the Company will continue or that the Company will
be able to achieve the growth contemplated by its business strategy. The
Company's ability to continue to grow may be affected by various factors, many
of which are not within the Company's control, including competition and
federal and state regulation of the telecommunications industry. This growth
has placed, and is expected to continue to place, significant demands on all
aspects of the Company's business, including its administrative, technical and
financial personnel and systems. The Company's future operating results will
substantially depend on the ability of its officers and key employees to
manage such anticipated growth, to attract and retain additional highly
qualified management, technical and financial personnel, and to implement
and/or improve its technical, administrative, financial control and reporting
systems. The Company's financial controls and reporting systems will require
enhancement and substantial investment in the future to accommodate
10
<PAGE>
the Company's anticipated growth. There can be no assurance that the Company
will not encounter difficulties in expanding its financial controls and
reporting systems to meet the Company's future needs. If the Company is unable
to respond to and manage changing business conditions, then the quality of
SmarTalk services, its ability to retain key personnel and its results of
operations could be materially adversely affected. Difficulties in managing
continued growth could have a Material Adverse Effect. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
The Company recently revised its method of revenue recognition from the
method originally utilized for internal financial reporting purposes. The
financial information contained herein reflects this revised method, the
principal effects of which are to decrease the level of current revenue
recognition and to create a deferred revenue account. Under this method of
revenue recognition, the Company recognizes revenue and reduces the deferred
revenue account as the customer utilizes calling time and upon expiration of
cards containing unused calling time. In response to these changes and in
order to upgrade its management information systems, the Company is currently
implementing a new accounting system with control and tracking applications
not present in the previous system. In connection with the implementation of
the new system, the Company will contract with outside consultants to review
the controls and administrative protocols associated with the new system.
Although the Company believes that the newly installed system will be adequate
to keep pace with the growth in the Company's business and the revised method
of revenue recognition, there can be no assurance that the newly installed
system will function properly or that the Company will not experience
financial control difficulties in future periods. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
DEPENDENCE ON KEY MANAGEMENT AND PERSONNEL
SmarTalk's success is largely dependent upon its executive officers, the
loss of one or more of whom could have a Material Adverse Effect. The Company
believes that its continued success will depend to a significant extent upon
the efforts and abilities of Robert H. Lorsch, Chairman of the Board,
President and Chief Executive Officer and Richard Teich, Executive Vice
President. Although the Company believes that it would be able to locate
suitable replacements for these executives if their services were lost, there
can be no assurance it would be able to do so. Accordingly, the loss of
services of any of these individuals could have a Material Adverse Effect. See
"Management." The Company maintains, and is the sole beneficiary of, "key man"
life insurance on Mr. Lorsch in the amount of $3,000,000.
DEPENDENCE UPON TELECOMMUNICATIONS PROVIDERS; NO GUARANTEED SUPPLY
The Company does not own a transmission network and, accordingly, depends
primarily on AT&T (accessed through West Interactive) and MCI for transmission
of its long distance calls. The Company obtains its MCI long distance
telecommunications services pursuant to a Preferred Carrier Agreement with MCI
which obligates the Company to utilize a specified number of minutes to
receive favorable pricing. The Company's failure to utilize the required
minutes within the periods specified in the agreement with MCI would require
the Company to pay an underutilization charge to MCI. While the Company
anticipates that it will fulfill its minimum usage requirements, any material
failure to meet such minimum usage requirements could have a Material Adverse
Effect. In the future, the Company may determine that it is desirable to enter
into additional agreements containing minimum usage requirements. Further, the
Company is dependent upon local exchange carriers for call origination and
termination. The Company's ability to maintain and expand its business
depends, in part, on its ability to continue to obtain telecommunications
services on favorable terms from long distance carriers and other such
suppliers, as well as the cooperation of both interexchange and local exchange
carriers in originating and terminating service for its customers in a timely
manner. The Company has not experienced significant losses in the past because
of interruptions of service at any of its carriers, but
11
<PAGE>
no assurance can be made in this regard with respect to the future. In
addition, no assurance can be given that the Company will be able to obtain
long distance services in the future at favorable prices, and a material
increase in the price at which the Company obtains long distance service could
have a Material Adverse Effect. See "-- Intense Competition" and "Business --
Products and Telecommunications Services."
POSSIBLE INABILITY TO RECOGNIZE A PORTION OF DEFERRED REVENUE
The sale of long distance domestic and outbound international telephone
service through prepaid phone cards may be subject to "escheat" laws in
various states. These laws generally provide that payments or deposits
received in advance or in anticipation of the provision of utility (including
telephone) services that remain unclaimed for a specific period of time after
the termination of such services are deemed "abandoned property" and must be
submitted to the state. Although the Company is not aware of any case in which
such laws have been applied to the sale of prepaid phone cards, and does not
believe that such laws are applicable, in the event that such laws are deemed
applicable, the Company may be unable to recognize the portion of its deferred
revenue remaining upon the expiration of SmarTalk cards with unused calling
time. In such event, the Company may be required to deliver such amounts to
certain states in accordance with these laws, which could have a Material
Adverse Effect. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
UNCERTAINTY OF STRATEGIC RELATIONSHIPS
A principal element of the Company's strategy is the creation and
maintenance of relationships with wholesale distributors and other
organizations with whom the Company has strategic alliances that will enable
the Company to offer its services to a wider customer base than the Company
could reach solely through direct marketing efforts. The Company has entered
into strategic alliances, including those with MCI, West Interactive and
Douglas Stewart, and the Company plans to aggressively develop additional
strategic relationships. These relationships were formed recently and the
Company is unable to predict the success or failure of these relationships due
to limited operating experience with these organizations. The Company's
success depends in part on the ultimate success of these relationships to
effectively aid in the marketing and distribution of SmarTalk services. See
"Business -- Strategic Partners."
The ability of the Company's strategic partners to incorporate the Company's
services into successful commercial ventures will require the Company, among
other things, to continue to successfully enhance its existing SmarTalk
services and develop new services. The Company's inability to meet the
requirements of such strategic partners, or to comply with the terms of its
arrangements with such parties, could result in such parties failing to market
the Company's services, seeking alternative providers of telecommunications
services or cancelling their contracts with the Company, any of which could
have a Material Adverse Effect. See "Business -- The SmarTalk Strategy" and
"Business -- Marketing and Distribution."
DEPENDENCE ON FACILITIES AND PLATFORMS; DAMAGE, FAILURE AND DOWNTIME
The Company currently owns the VoiceChoice Platform, a call processing
platform site located in San Francisco, California, and utilizes additional
call processing platform services at a facility located in San Antonio, Texas
which is backed up by a facility in Omaha, Nebraska. The Company's network
service operations are dependent upon its ability to protect the equipment and
data at such facilities against damage that may be caused by fire, power loss,
technical failures, unauthorized intrusion, natural disasters, sabotage and
other similar events. Although the Company has taken precautions to protect
itself and its customers from events that could interrupt delivery of SmarTalk
services, there can be no assurance that a fire, act of sabotage, technical
failure, human error, natural disaster or a
12
<PAGE>
similar event would not cause the failure of a significant technical
component, thereby resulting in an outage. Such an outage could have a
Material Adverse Effect. The Company believes that technical failures have not
resulted in any material downtime of the SmarTalk Platforms since the
Company's inception.
Although the Company maintains business interruption insurance providing for
aggregate coverage of approximately $1.0 million per occurrence, there can be
no assurance that the Company will be able to maintain its business
interruption insurance, that such insurance would continue to be available at
reasonable prices, that such insurance would cover all such losses or that
such insurance would be sufficient to compensate the Company for losses it
experiences due to the Company's inability to provide services to its
customers. See "Business -- The SmarTalk Platforms."
DEPENDENCE UPON SOFTWARE
The Company has developed, and depends on, its own proprietary in-house data
reporting and tracking system, the SmarTrac System, that provides a series of
database query and report capabilities that are used to track inventory,
control fraud and monitor system usage by card and retailer. The Company also
depends on its software, as well as software developed by or on behalf of
Pacific Bell Information Services, West Interactive and others, to provide
services to its customers. The software utilized by the Company in providing
its services may contain undetected errors. Although the Company engages in
extensive testing of its software prior to introducing the software onto its
network, there can be no assurance that errors will not be found in software
after commencement of use of such software. Any such error may result in
partial or total failure of the Company's network, requiring the Company to
commit additional and unanticipated funds for further product development,
including the retention of additional programming personnel. In addition, such
failure may result in a loss of customers and a corresponding decrease in
revenue which would have a Material Adverse Effect. See "Business -- The
SmarTrac System" and "Business -- The SmarTalk Platforms."
REGULATION
The Company is currently subject to federal and state government regulation
of its long distance telephone services. The Company is regulated at the
federal level by the FCC and is currently required to maintain both domestic
and international tariffs for its services containing the currently effective
rates, terms, and conditions of service. The FCC has proposed, however, to
eliminate the tariffing requirement for domestic interstate non-dominant
carriers. In addition, the Company is required to maintain a certificate,
issued by the FCC, in connection with its international services. The
intrastate long distance telecommunications operations of the Company are also
subject to various state laws and regulations, including prior certification,
notification or registration requirements. The Company generally must obtain
and maintain certificates of public convenience and necessity from regulatory
authorities in most states in which it offers service. In most of these
jurisdictions, the Company must file and obtain prior regulatory approval of
tariffs for intrastate services. In addition, the Company must update or amend
the tariffs and, in some cases, the certificates of public convenience and
necessity when rates are adjusted or new products are added to the long
distance services offered by the Company. The FCC and numerous state agencies
also impose prior approval requirements on transfers of control, including
transfers of control and corporate reorganizations, and assignments of certain
regulatory authorizations. As a result, the Company has filed or will file
certain notices and applications relating to the Offering. While the Company
expects to receive all such approvals that have been requested and believes
that it is or shall soon be otherwise in compliance with the applicable state
and federal regulations governing telecommunications service, there can be no
assurance that the FCC or the regulatory authorities in one or more states
will not raise material issues with regard to the Company's compliance with
applicable regulations, including transfer, stock issuance and similar
regulations, or that state and federal regulatory activities will not have a
Material Adverse Effect.
13
<PAGE>
If the federal and state regulations requiring the local exchange carriers
to provide equal access for the origination and termination of calls by long
distance subscribers (such as the Company's customers) change or if the
regulations governing the fees to be charged for such access services change,
particularly if such regulations are changed to allow variable pricing of such
access fees based upon volume, such changes could have a Material Adverse
Effect. See "Business -- Industry Overview," "Business -- Competition" and
"Business -- Government Regulation."
The FCC recently adopted a regulation which requires facilities-based
carriers such as AT&T and MCI to compensate payphone providers for each 800
number call placed. The regulation allows facilities-based carriers to seek to
recover these charges from their customers, including through future
contractual provisions with customers such as the Company. The Company is
unable to predict whether this regulation or other potential changes in the
regulatory environment could have a Material Adverse Effect.
RISK OF LOSS FROM RETURNED TRANSACTIONS; FRAUD; BAD DEBT; THEFT OF SERVICES
The Company utilizes national credit card clearance systems for electronic
credit card settlement. The Company generally bears the same credit risks
normally assumed by other users of these systems arising from returned
transactions caused by closed accounts, frozen accounts, unauthorized use,
disputes, theft or fraud. The Company's relationships with providers of
merchant card services such as VISA and MasterCard could be adversely affected
by excessive uncollectibles or chargebacks, which are generally higher in the
telephone industry than in other industries, particularly with respect to
recharges because the transaction typically is not on a face to face basis in
which a cardholder signature is captured. Termination of the Company's ability
to offer recharge through merchant card services would have a Material Adverse
Effect. To minimize its financial exposure, the Company limits the amount that
customers can recharge within specified timeframes and generally charges a
higher rate for recharge services than for the initial purchase. From time to
time, persons have obtained services without rendering payment to the Company
by unlawfully utilizing the Company's access numbers and PINs. Although to
date the Company has not experienced material losses due to such unauthorized
use of access numbers and customized PINs, no assurance can be given that
future losses due to unauthorized use will not be material. The Company
attempts to manage these credit, theft and fraud risks through its internal
controls, monitoring and blocking systems. The Company also maintains reserves
which it deems adequate for such risks. Past experience in estimating and
establishing reserves and the Company's historical losses are not necessarily
accurate indications of the Company's future losses or the adequacy of the
reserves established by the Company in the future. Although the Company
believes that its risk management and bad debt reserve practices are adequate,
there can be no assurance that the Company's risk management practices or
reserves will be sufficient to protect the Company from unauthorized or
returned transactions or thefts of services which could have a Material
Adverse Effect. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources" and
"Business -- The SmarTrac System."
SUBSTANTIAL DISCRETION OF MANAGEMENT CONCERNING USE OF PROCEEDS
The Company has allocated approximately $39 million of the net proceeds of
the Offering for specific identified purposes, with the remainder of
approximately $14 million to be used for working capital and general corporate
purposes, including possible acquisitions. Accordingly, management will have
substantial discretion in spending a large percentage of the proceeds to be
received by the Company. See "Use of Proceeds."
The Company in the future may pursue acquisitions of complementary services,
products, technologies or businesses, although the Company currently has no
agreements or understandings with respect to any acquisition, and no portion
of the net proceeds has been allocated to specific
14
<PAGE>
acquisitions. Future acquisitions may result in the potentially dilutive
issuance of equity securities, the incurrence of additional debt, the writing
off of software development costs, or the amortization of expenses related to
goodwill and other intangible assets, any of which could have a Material
Adverse Effect. Future acquisitions would involve numerous additional risks,
including (i) difficulties in the assimilation of the operations, services,
products and personnel of the acquired company, (ii) the diversion of
management's attention from other business concerns, (iii) entry into markets
in which the Company has limited or no prior experience, and (iv) the
potential loss of key employees of the acquired company.
CONTROL OF COMPANY
Upon completion of the Offering and without giving effect to the
Underwriters' over-allotment option, the present directors, executive officers
and their respective affiliates will beneficially own 6,191,505 shares
(approximately 48.2%) of the outstanding Common Stock, of which 5,868,515
shares (approximately 45.7%) will be beneficially owned by Mr. Lorsch. In
addition to the shares included in the calculation of beneficial ownership,
the present directors, executive officers and their respective affiliates hold
options to acquire an additional 81,851 shares of Common Stock not exercisable
within 60 days of the date of this Prospectus, which together with shares
currently beneficially owned would represent approximately 48.6% of the Common
Stock outstanding after consummation of the Offering, after giving effect to
the exercise of those options. As a result, these shareholders in general, and
Mr. Lorsch in particular, will be able to exercise significant influence over
all matters requiring shareholder approval, including the election of
directors and approval of significant corporate transactions. Such
concentration of ownership may also have the effect of delaying or preventing
a change in control of the Company. See "Principal and Selling Shareholders"
and "Description of Capital Stock -- Certain Provisions of the Company's
Articles and Bylaws."
ANTI-TAKEOVER CONSIDERATIONS
The board of directors has authority to issue up to 10,000,000 shares of
preferred stock and to fix the rights, preferences, privileges and
restrictions, including voting rights, of the preferred stock without further
vote or action by the Company's shareholders. The rights of the holders of
Common Stock will be subject to, and may be adversely affected by, the rights
of the holders of any preferred stock that may be issued in the future. See
"Description of Capital Stock -- Preferred Stock." The Company's Amended and
Restated Articles of Incorporation (the "Articles") and Amended and Restated
Bylaws (the "Bylaws") require that any action required or permitted to be
taken by shareholders of the Company must be effected at a duly called annual
or special meeting of shareholders of the Company and may not be effected by
written consent. In addition, the Company's charter documents eliminate
cumulative voting, which may make it more difficult for a third party to gain
control of the Company's Board of Directors. Moreover, the Board of Directors
has the authority, without action by, or consent of, the shareholders, to fix
the rights and preferences of and issue shares of Preferred Stock. These and
other charter provisions may deter a third party who would propose to acquire
the Company or to engage in a similar transaction affecting control of the
Company in which the shareholders might receive a premium for their shares
over the then current market value. See "Management," "Principal and Selling
Shareholders" and "Description of Capital Stock -- Certain Provisions of the
Company's Articles and Bylaws."
ABSENCE OF PUBLIC MARKET AND POSSIBLE VOLATILITY OF STOCK PRICE
Prior to the Offering, there has been no public market for the Common Stock
and there can be no assurance that an active market will develop upon
consummation of the Offering. The initial public offering price was determined
by negotiations among the Company, the Selling Shareholders and the
Representatives of the Underwriters. See "Underwriting" for a description of
the factors that were considered in determining the initial public offering
price. There is no assurance that the market price
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<PAGE>
of the Common Stock after the Offering will not decline below the initial
public offering price. The market price of the Common Stock is likely to be
volatile. The Company believes factors such as actual or anticipated quarterly
fluctuations in financial results, changes in earnings estimates by securities
analysts and announcements of material events by the Company, its retail
customers or its competitors may cause the market price for the Common Stock
to fluctuate, perhaps substantially. In addition, in recent years the stock
market has experienced extreme price and volume fluctuations which have
affected the market price for many companies in industries similar to the
phone card industry and which have often been unrelated to the operating
performance of these companies. These fluctuations, as well as general
economic conditions, may have a material adverse effect on the price of the
Common Stock.
SHARES ELIGIBLE FOR FUTURE SALE
Future sales of substantial shares of Common Stock by existing shareholders
could adversely affect the market price of the Common Stock. The 4,200,000
shares offered hereby will be eligible for immediate sale in the public market
without restriction. Of the remaining 8,629,459 shares of Common Stock which
will be outstanding upon the completion of this Offering, 8,444,137 will be
subject to 180-day lock-up agreements between the Company's current
shareholders and the Underwriters. After the expiration of such agreements,
pursuant to Rule 144 under the Securities Act, such shareholder(s) may sell
such shares without registration, subject to certain holding requirements and
volume limitations. In addition, SmarTalk Partners, LLC ("SmarTalk Partners")
is entitled to certain rights with respect to the registration of its shares
of Common Stock under the Securities Act. A decision by any such
shareholder(s) to publicly sell a significant number of shares of the Common
Stock will have the potential to cause a material decrease in the trading
price of the Common Stock and may impair the future ability of the Company to
raise capital at prices or on terms favorable to the Company. See "Shares
Eligible for Future Sale," "Description of Capital Stock -- Registration
Rights" and "Underwriting."
BENEFITS OF OFFERING TO EXISTING SHAREHOLDERS
The existing shareholders of the Company will receive certain benefits from
the sale of the Common Stock offered hereby. The Offering will establish a
public market for the Common Stock and provide increased liquidity to the
existing shareholders for the shares of Common Stock they will own after the
Offering, subject to certain limitations. See "Shares Eligible For Future
Sale." SmarTalk Partners, an existing shareholder of the Company, will sell
200,000 shares of Common Stock in the Offering and will receive approximately
$2.7 million in net proceeds. If the Underwriters' over-allotment option is
exercised in full, SmarTalk Partners and the other Selling Shareholders will
sell 630,000 shares of Common Stock and will receive approximately $11.2
million. See "Principal and Selling Shareholders." Of the net proceeds of the
Offering to be received by the Company, approximately $2 million will be used
to repay indebtedness to SmarTalk Partners, and approximately $2 million will
be used to repay indebtedness to Lorsch Creative Network, Inc., of which
Robert H. Lorsch, President and Chief Executive Officer of the Company, is the
sole shareholder. See "Use of Proceeds" and "Certain Transactions."
Additionally, immediately following the Offering existing shareholders will
have an average unrealized gain over the original cost of the shares that will
continue to be held by them of $14.46 per share or an aggregate unrealized
gain of approximately $124.8 million (approximately $115.7 million if the
Underwriters' over-allotment option is exercised in full). See "Dilution."
IMMEDIATE AND SUBSTANTIAL DILUTION TO NEW INVESTORS
Purchasers of shares of Common Stock in the Offering will experience
immediate and substantial dilution of the net tangible book value per share of
Common Stock in the amount of $10.84 per share. To the extent options to
purchase the Company's Common Stock are exercised in the future, there will be
further dilution. See "Dilution."
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USE OF PROCEEDS
The net proceeds from the sale of the shares of Common Stock offered hereby
by the Company are estimated to be approximately $52,715,000, after deducting
the underwriting discount and estimated offering expenses payable by the
Company. The Company intends to use the net proceeds of the Offering as
follows: (i) approximately $1.2 million to repay term loan indebtedness to
SmarTalk Partners (which bears interest at 7% per annum and has a maturity
date of July 31, 2000), (ii) approximately $500,000 to repay existing
borrowings under a revolving line of credit with SmarTalk Partners (which
bears interest at a floating rate equal to the prime rate plus 2% per annum
which equaled 10.25% at October 22, 1996 and has a maturity date of
January 31, 1998), (iii) approximately $250,000 to repay term loan
indebtedness to SmarTalk Partners (which bears interest at a floating rate
equal to the prime rate which was 8.25% at October 22, 1996 and has a maturity
date of January 31, 1997), (iv) approximately $2 million to repay term loan
indebtedness to Lorsch Creative Network, Inc. ("LCN") (which bears interest at
7% per annum and has a maturity date of June 20, 2000), (v) approximately $10
million to fund certain capital expenditures, including upgrades to the
SmarTalk Platforms, the possible acquisition of new platforms and purchases of
point of sale equipment, (vi) approximately $20 million to fund marketing and
new business development opportunities, (vii) approximately $5 million to fund
the expansion of the Company's business internationally, and (viii) for
additional working capital and general corporate purposes, including
acquisitions, although the Company currently has no agreements or
understandings with respect to any acquisition, and no portion of the net
proceeds has been allocated to specific acquisitions. The aggregate amount of
the net proceeds to the Company that will flow to affiliates is approximately
$4 million.
In addition, the Company is raising such monies at this time in order to
create a market for the Company's Common Stock, to facilitate future access by
the Company to the public equity markets and to enhance the Company's public
image and credibility to support its marketing efforts, particularly with
current or potential retailers and strategic partners. The Company has used
proceeds from the indebtedness to SmarTalk Partners for working capital and
general corporate purposes, including securing office space, expanding the
Company's retail distribution network, and acquiring the VoiceChoice Platform.
The indebtedness to LCN was incurred in connection with a transaction by the
Company. See "Certain Transactions." The Company will not receive any of the
proceeds from the sale of shares of Common Stock by the Selling Shareholders.
Prior to the application of the net proceeds of the Offering as described
above, such funds will be invested in short-term, interest bearing securities.
DIVIDEND POLICY
The Company has never paid cash dividends on its Common Stock, and the
current policy of the Company's board of directors is to retain any available
earnings for use in the operation and expansion of the Company's business.
Therefore, the payment of cash dividends on the Common Stock is unlikely in
the foreseeable future. Currently, the Company's line of credit prohibits the
Company from paying cash dividends without the lender's prior approval. See
the Financial Statements and Notes thereto included elsewhere in this
Prospectus. However, the Company will use the proceeds from the Offering to
pay off and terminate the line of credit with SmarTalk Partners. Any future
determination to pay cash dividends will be at the discretion of the board of
directors and will depend upon the Company's earnings, capital requirements,
financial condition and any other factors deemed relevant by the board of
directors.
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CAPITALIZATION
The following table sets forth the capitalization of the Company as of June
30, 1996, and as adjusted to reflect the sale of the 4,000,000 shares of
Common Stock offered by the Company hereby and the application of the
estimated net proceeds therefrom as described in "Use of Proceeds." This table
should be read in conjunction with the Financial Statements and the related
Notes thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
JUNE 30, 1996
------------------------------
ACTUAL(1) AS ADJUSTED(1)(2)
----------- -----------------
<S> <C> <C>
Short-term debt................................. $ 1,299,998 $ 510,000
Long-term debt.................................. 3,285,002 0
----------- -----------
Total debt...................................... 4,585,000 510,000
----------- -----------
Shareholders' equity (deficit):
Preferred stock, no par value; 10,000,000
shares authorized; no shares issued and
outstanding(3)............................... -- --
Common stock, no par value; 100,000,000 shares
authorized; 8,824,834 shares issued and
outstanding; 12,829,459 shares issued and
outstanding as adjusted(3)................... 315,000 53,030,000
Retained earnings (accumulated deficit)......... (6,129,988) (6,129,988)
----------- -----------
Total shareholders' equity (deficit)............ (5,814,988) 46,900,012
----------- -----------
Total capitalization.......................... $(1,229,988) $47,410,012
=========== ===========
</TABLE>
- --------
(1) Actual June 30, 1996 amounts have been adjusted to reflect a $250,000 loan
from SmarTalk Partners obtained in August 1996, and $510,000 borrowed
under a $1,000,000 line of credit established in September 1996. See "Use
of Proceeds."
(2) Adjusted to reflect the application of the estimated net proceeds to the
Company from the sale of Common Stock offered hereby. See "Use of
Proceeds."
(3) Excludes 505,889 shares of Common Stock reserved for issuance upon
exercise of outstanding options granted by the Company and, as adjusted,
includes 4,625 shares of Common Stock issued upon exercise of options
granted by the Company. See "Management -- Stock Option Plans."
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DILUTION
The net tangible book value (deficit) of the Company's Common Stock as of
June 30, 1996 was $(5.8) million or $(0.66) per share. "Net tangible book
value (deficit)" per share represents the amount of total tangible net assets
less total liabilities, divided by the number of shares of Common Stock
outstanding. After giving effect to the sale of 4,000,000 shares of Common
Stock offered by the Company hereby, and after deducting underwriting
discounts and estimated offering expenses payable by the Company and receipt
of the net proceeds by the Company in the Offering, the pro forma net tangible
book value (deficit) of the Company as of June 30, 1996 would have been
$47 million, or $3.66 per share, representing an immediate increase in net
tangible book value of $4.32 per share to existing shareholders and an
immediate dilution of $10.84 per share to new investors purchasing shares in
the Offering. The following table illustrates the resulting per share dilution
with respect to the shares of Common Stock to be sold by the Company in the
Offering:
<TABLE>
<S> <C> <C>
Initial public offering price per share....................... $14.50
Net tangible book value (deficit) per share before the
Offering................................................... $(0.66)
Increase per share attributable to new investors............ 4.32
------
Pro forma net tangible book value (deficit) per share after
the Offering................................................. 3.66
------
Dilution per share to new investors........................... $10.84
======
</TABLE>
The foregoing computations assume no exercise of stock options prior to
completion of the Offering. Options to purchase an aggregate of 505,889 shares
of Common Stock at exercise prices ranging from $1.77 to $4.44 per share, with
a weighted average exercise price of approximately $3.72 per share, will be
outstanding and unexercised upon completion of the Offering. If all of such
stock options had been exercised at June 30, 1996, the pro forma net tangible
book value per share after the Offering would be $3.66, representing an
increase in pro forma net tangible book value of $4.08 per share and dilution
to new investors of $10.84 per share.
The following table summarizes the difference between existing shareholders
and new investors with respect to the number of shares of Common Stock
purchased from the Company, the total consideration paid to the Company before
deduction of underwriting discounts and estimated offering expenses and the
average price paid per share.
<TABLE>
<CAPTION>
SHARES TOTAL
PURCHASED CONSIDERATION AVERAGE
--------------------- ---------------------- PRICE
NUMBER PERCENTAGE AMOUNT PERCENTAGE PER SHARE
---------- ---------- ----------- ---------- ---------
<S> <C> <C> <C> <C> <C>
New Investors........... 4,000,000 31.2% $58,000,000 99.5% $14.50
Existing
Shareholders(1)........ 8,829,459 68.8 323,186 0.5 0.04
---------- ----- ----------- -----
Total................. 12,829,459 100.0% $58,323,186 100.0%
</TABLE>
- --------
(1) Excludes 505,889 shares of Common Stock reserved for issuance upon
exercise of outstanding options granted by the Company. See "Management --
Stock Option Plans."
19
<PAGE>
SELECTED FINANCIAL DATA
The following table sets forth selected financial data of the Company. The
Statement of Operations Data for the period from inception (October 28, 1994)
to December 31, 1994 and for the year ended December 31, 1995 and the Balance
Sheet Data as of December 31, 1994 and 1995 have been derived from the
Company's audited Financial Statements, which are included elsewhere in this
Prospectus. The selected financial data for the six months ended June 30, 1995
and 1996 are derived from the unaudited Financial Statements of the Company,
which are included elsewhere in this Prospectus. In the opinion of management,
the unaudited Financial Statements have been prepared on the same basis as the
audited Financial Statements and include all adjustments, consisting only of
normal recurring adjustments, necessary for the fair presentation of the
financial position and results of operations for such periods. The results for
the six months ended June 30, 1996 are not necessarily indicative of the
results that may be expected for the year ending December 31, 1996 or any
other future period. The selected financial data set forth below should be
read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the Financial Statements and Notes
thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
PERIOD FROM INCEPTION YEAR ENDED JUNE 30,
(OCTOBER 28, 1994) TO DECEMBER 31, ----------------------
DECEMBER 31, 1994 1995 1995 1996
--------------------- ------------ --------- -----------
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenue............... $ 444 $ 453,916 $ 41,738 $ 3,678,020
Cost of revenue....... 716 318,686 29,910 2,742,115
--------- ----------- --------- -----------
Gross profit (loss). (272) 135,230 11,828 935,905
Operating expenses
Sales and marketing. 1,980 842,306 173,242 1,643,426
General and
administrative..... 63,220 624,238 124,023 1,459,293
--------- ----------- --------- -----------
Loss from operations.. (65,472) (1,331,314) (285,437) (2,166,814)
Net interest expense
(income)............. -- (2,012) -- 104,372
--------- ----------- --------- -----------
Loss from operations
before income tax
expense.............. (65,472) (1,329,302) (285,437) (2,271,186)
Provision for income
taxes................ -- -- -- --
--------- ----------- --------- -----------
Net loss............ $ (65,472) $(1,329,302) $(285,437) $(2,271,186)
--------- ----------- --------- -----------
Net loss per
share(1)........... $ (.01) $ (.14) $ (.03) $ (.24)
========= =========== ========= ===========
Weighted average
number of common
shares and common
equivalent
shares(1).......... 9,335,348 9,335,348 9,335,348 9,335,348
========= =========== ========= ===========
Supplemental loss
per common
share(2)........... $ (.23)
===========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------- JUNE 30,
1994 1995 1996
-------- ----------- -----------
<S> <C> <C> <C>
BALANCE SHEET DATA:
Working capital........................... $(60,472) $(1,400,360) $(3,256,069)
Total assets.............................. 4,023 3,841,752 4,782,822
Deferred revenue(3)....................... 431 3,696,515 4,127,919
Total debt................................ -- -- 3,825,000
Total shareholders' equity (deficit)...... (60,472) (1,379,774) (5,814,988)
</TABLE>
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
-----------------------------------------------
SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30,
1995 1995 1996 1996
------------- ------------ --------- ----------
<S> <C> <C> <C> <C>
SELECTED QUARTERLY OPERATING
DATA:
Number of PINs activated(4).. 15,811 52,800 117,212 196,259
Number of minutes
decremented(5).............. 640,320 1,935,247 5,152,179 10,748,914
Number of recharge minutes
purchased................... 154,974 312,390 666,030 1,112,130
</TABLE>
- -------
(1) See Note 2 of Notes to Financial Statements for a discussion of net loss
per share and shares used in computing net loss per share.
(2) Supplemental loss per share has been calculated as if $4,075,000 of the
proceeds from the Offering were used to retire debt totaling $4,075,000.
Only the incremental shares necessary to retire this debt, based upon
assumed net proceeds of $13.18 per share, have been included in the
calculation. See "Use of Proceeds."
(3) Deferred revenue represents amounts for products shipped to retailers and
recharged minutes that the Company has invoiced, which as of the date
presented have not been used by customers. Upon customer usage, the
Company recognizes revenue and reduces the deferred revenue account. At
the time the revenue is recognized, the costs to which that revenue
specifically relates are also recognized.
(4) "PINs" are personal identification numbers used by each customer to access
the SmarTalk system. PINs are printed on the back of each SmarTalk Card or
provided separately to customers.
(5) "Minutes decremented" include minutes used by customers purchasing
SmarTalk services and minutes used as a result of the distribution of free
promotional goods.
20
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Company's
Financial Statements and the related Notes thereto included elsewhere in this
Prospectus.
OVERVIEW
SmarTalk provides convenient, easy to use, cost-effective long distance
telecommunications products and services to customers primarily through the
SmarTalk Card. The SmarTalk Card provides customers with a single point of
access to telecommunications services at a favorable rate on a per minute
prepaid basis. The SmarTalk Card may also be recharged on-line using a major
credit card which allows the customer to add minutes as needed.
The Company was formed in October 1994 and had limited operations until June
1995. From its date of inception until September 1995, SmarTalk had no
employees. Certain functions currently performed by the Company's employees
were performed during 1994 and 1995 by employees of LCN for which the Company
was subsequently billed by LCN. SmarTalk contracted, on a project by project
basis, with LCN and other independent contractors to perform substantially all
operational activities, including sales management, marketing services, and
general and administrative functions. See "Certain Transactions."
Since the Company's inception, revenues have continued to increase. Over the
period since July 1995, when the Company began shipping its product to
retailers, through June 1996, total revenues were $4,090,198. The Company
believes this amount is attributable to customers' acceptance of SmarTalk
services and similar products, and management's unique marketing strategy of
targeting the retail distribution channel.
SmarTalk's revenue originates from (i) Company and co-branded phone card
sales through retailers, (ii) recharges of existing phone cards, (iii) cards
sold for promotional marketing campaigns, (iv) corporate sales to businesses
(Corporate Advantage Program) and (v) certain services provided to one of the
Company's strategic partners.
Under sales agreements with the majority of retailers, the Company sells
cards to the retailer at a set price with normal credit terms. The Company
generally invoices the retailer upon shipment, recognizing deferred revenue.
The Company recognizes revenue and reduces the deferred revenue account as the
customer utilizes calling time or upon expiration of cards containing unused
calling time. The Company also recognizes deferred revenue upon recharge of
existing phone cards and recognizes the revenue upon the usage or expiration
of the recharge minutes. Revenue recognized upon expiration of calling cards
containing unused calling time and upon expiration of recharge minutes was
insignificant for the year ended December 31, 1994 and the six months ended
June 30, 1995 and less than 7.9% and 5.7%, respectively, of total revenues for
the year ended December 31, 1995 and the six months ended June 30, 1996. The
Company believes that its policy of recognizing revenue at the time its
products and services are used by the customer or expire rather than upon sale
to retailers or, in the case of recharges, at the time of the recharge, is a
conservative method of revenue recognition.
SmarTalk's cost of revenue consists primarily of the cost of providing the
long distance service and related enhanced services as well as the cost of
manufacturing and delivering the cards. The cost of providing long distance
service represents obligations to carriers that provide minutes of long
distance over their networks and the services associated with the Company's
product. The Company expects its cost of revenue as a percentage of sales to
decrease in the future due to the acquisition of the VoiceChoice Platform,
economies of scale and volume discounts.
21
<PAGE>
Sales and marketing expenses consist primarily of commissions and
advertising costs. The Company pays commissions to its sales representatives
based on sales to retailers. The Company also pays a commission to its sales
representatives and retailers based on the number of minutes recharged on
SmartTalk cards sold by each retailer. These commissions are capitalized and
amortized into expense based on minutes used by the customer. Advertising
consists primarily of co-op advertising and Manufacturers Development Funds
("MDF"). Under the typical co-op advertising program, the Company matches
advertising expenditures by retailers to promote sales of SmarTalk services.
The amount of funds the Company matches through its co-op advertising program
is based on a percentage of sales of SmarTalk services by retailers. MDF
consists of promotional and marketing programs to access shelf space.
Advertising expense includes trade and consumer advertising, trade show
expenses, promotional goods and the costs of providing to retailers the
Company's turnkey merchandising supplies. The Company expects sales and
marketing expenses to increase in the future, but expects that sales and
marketing expenses as a percentage of revenue will decrease. Other sales and
marketing expenses include a provision for bad debt expense.
General and administrative expenses consist primarily of salaries and other
general expenses. Sales taxes for the SmarTalk Platforms are incurred based on
customer usage of long distance minutes which are processed through each of
the individual platforms. Other general expenses include rent, insurance, VISA
and MasterCard processing fees and other operating expenses. The Company also
includes in general and administrative expenses the costs related to the
development of the Company's proprietary switching, application and database
access software. The Company expects general and administrative expenses to
increase in the future as it adds the personnel and infrastructure necessary
to meet its planned growth in sales, but expects that general and
administrative expenses as a percentage of revenue will decrease.
SIX MONTHS ENDED JUNE 30, 1996 COMPARED WITH SIX MONTHS ENDED JUNE 30, 1995
Revenue. Revenue increased to $3,678,020 for the six months ended June 30,
1996 from $41,738 for the six months ended June 30, 1995. The substantial
increase in revenue reflects an increase in usage of SmarTalk services by
users of the SmarTalk Card as well as Corporate Advantage customers, an
increase in the number of retail storefronts in which the Company's product is
distributed and greater brand awareness and consumer acceptance. Revenue
generated from recharges comprised approximately 14% of total revenue for the
six months ended June 30, 1996 and was insignificant for the comparable period
in 1995. This increase in recharge revenue is due to a greater number of
SmarTalk cards eligible for recharge in the marketplace. In addition,
$460,000, or approximately 13% of revenue for the six months ended June 30,
1996, was attributable to a distribution and processing agreement entered into
on June 1, 1996 with West Interactive (see "Business -- Strategic Partners").
The agreement provides that the Company will provide prepaid phone card and
certain related services for customers of West Interactive. The Company
recognizes revenue under this agreement based on minute usage, which is
consistent with the manner in which the Company recognizes revenue on cards
sold to retailers.
Cost of Revenue. Cost of revenue increased to $2,742,115 for the six months
ended June 30, 1996 from $29,910 for the six months ended June 30, 1995. The
increase was primarily attributable to greater use of the Company's services,
which increased transport costs and card costs. The gross profit percentage
for the six months ended June 30, 1996 was 25.5% as compared to 28.3% for the
six months ended June 30, 1995. Gross margin decreased primarily due to the
lower gross margin associated with the above-mentioned distribution and
processing agreement. Transport costs comprised approximately 82% of cost of
revenue for the six months ended June 30, 1996 compared to approximately 69%
for the six months ended June 30, 1995. The remainder of cost of revenue was
distributed between card costs and cost of fulfillment. Transport costs
constituted a greater percentage of cost of revenue in the 1996 period as cost
of fulfillment was essentially constant.
22
<PAGE>
Sales and Marketing Expenses. Sales and marketing expenses increased to
$1,643,426 (or 44.7% of revenue) for the six months ended June 30, 1996 from
$173,242 (or 415.1% of revenue) for the six months ended June 30, 1995. The
increase in dollar amount was primarily due to commissions paid to sales
representatives generally and to retailers on recharges, as well as the
continued expansion of the Company's marketing activities, which include co-op
advertising, MDF and free promotional goods. The decrease as a percentage of
revenue was due to increased revenue growth in 1996. For the six months ended
June 30, 1995, LCN provided certain sales and marketing services for which the
Company was subsequently billed by LCN. Such expenses billed by LCN are
reflected in total sales and marketing expenses.
Commissions paid to the Company's sales representatives and retailers
increased to 16.5% of sales and marketing expenses for the six months ended
June 30, 1996 from 1.8% for the six months ended June 30, 1995 and bad debt
expense increased to 10.4% of sales and marketing expenses for the six months
ended June 30, 1996 from 0.6% for the six months ended June 30, 1995. These
increases reflect the greater sales volume experienced during the six months
ended June 30, 1996. Expenses for promotional activities, including co-op
advertising, MDF and free promotional goods, were 56% of sales and marketing
expenses for the six months ended June 30, 1996 as compared to 24% for the six
months ended June 30, 1995. The increase in expenses related to promotional
activities reflects the Company's emphasis on generating revenue during the
six months ended June 30, 1996 as compared to the emphasis during the six
months ended June 30, 1995 on design and development of marketing and
advertising materials in the early stage of its growth. There were no creative
and consulting expenses during the six months ended June 30, 1996 as compared
to the same period in 1995 during which creative and consulting expenses,
primarily incurred by LCN and subsequently billed to the Company, represented
65% of sales and marketing expenses.
General and Administrative Expenses. General and administrative expenses
increased to $1,459,293 (or 39.7% of revenue) for the six months ended June
30, 1996 from $124,023 (or 297.1% of revenue) for the six months ended
June 30, 1995. The increase in dollar amount was primarily due to the addition
of personnel and costs associated with the growth in the Company's business.
The decrease as a percentage of revenue was due to increased revenue growth in
1996. General and administrative costs for the six months ended June 30, 1996
included rent associated with the Company's move into a new office, VISA and
MasterCard processing fees associated with the Company's on-line recharge
feature, as well as increased general operating expenses. General and
administrative costs for the six months ended June 30, 1995 primarily included
expenses related to establishing regulatory compliance in all 50 states, the
cost of developing the Company's product and packaging concept, and costs to
file documentation related to the procurement of corporate servicemarks and
patents. Certain of these general and administrative expenses incurred by
SmarTalk during the six months ended June 30, 1995 were incurred by LCN and
the Company was subsequently billed by LCN. There were no payroll expenses for
the six months ended June 30, 1995 as the Company had no employees during the
period. Certain functions performed during 1996 by the Company's employees
were performed during 1995 by employees of LCN for which the Company paid fees
to LCN aggregating less than $50,000, which fees are included as general and
administrative expenses.
Payroll costs were 41.0% of total general and administrative expenses for
the six months ended June 30, 1996. There was no payroll expense for the six
months ended June 30, 1995 as the Company had no employees during the period.
Sales taxes increased to 10.6% of total general and administrative expenses
for the six months ended June 30, 1996 from 1.2% for the comparable period in
1995. This increase is due to the increased usage of the Company's product by
consumers. Legal, accounting and consulting costs as a percentage of total
general and administrative expenses decreased to 19.6% for the six months
ended June 30, 1996 from 74% for the 1995 period reflecting the Company's
transition in 1996 to selling its services from its activities in 1995 when it
was in its early stage of growth.
23
<PAGE>
Interest Expense. Interest expense, net of interest income, increased to
$104,372 for the six months ended June 30, 1996. There was no interest expense
or income for the six months ended June 30, 1995. Interest income for the six
months ended June 30, 1996 was earned from returns on short-term cash
investments. Interest expense for the six months ended June 30, 1996 was
attributable to the Company's debt financing funded in January, 1996. See " --
Liquidity and Capital Resources".
Income Taxes. The Company had losses for tax purposes for the six months
ended June 30, 1996 and 1995. Accordingly, there was no provision for income
taxes in these periods.
Net Loss. As a result of the above items, the Company's net loss increased
to $2,271,186 for the six months ended June 30, 1996 from $285,437 for the six
months ended June 30, 1995.
YEAR ENDED DECEMBER 31, 1995 COMPARED WITH THE PERIOD ENDED DECEMBER 31, 1994
Revenue. Revenue increased to $453,916 for the year ended December 31, 1995
from $444 for the period ended December 31, 1994. The increase in revenue
reflects an increase in usage of SmarTalk services in 1995, including usage by
customers under the Corporate Advantage Program, as well as an increase in the
number of retail storefronts in which the Company's products were distributed.
During the period ended December 31, 1994, the Company was primarily engaged
in establishing its corporate identity and regulatory compliance in all 50
states and had limited sales of its products.
Cost of Revenue. Cost of revenue increased to $318,686 for the year ended
December 31, 1995 from $716 for the period ended December 31, 1994. The
increase in cost of revenue was primarily attributable to greater use of the
Company's services, which increased transport costs and card costs. The gross
profit percentage for the year ended December 31, 1995 was 29.8%. The gross
profit percentage and the amount for the period ended December 31, 1994 were
not meaningful as the Company had insignificant revenue during this period.
Sales and Marketing Expenses. Sales and marketing expenses increased to
$842,306 for the year ended December 31, 1995 from $1,980 for the period ended
December 31, 1994, reflecting increased promotional activity and marketing
support to retailers. The increase also reflects an increase in creative and
consulting expenses as the Company developed its product advertising as well
as its packaging concept. There were no significant promotional expenses or
creative and consulting expenses during the period ended December 31, 1994.
Certain of these sales and marketing expenses incurred by SmarTalk during the
year ended December 31, 1995 and period ended December 31, 1994 were incurred
by LCN and the Company was billed by LCN. The limited revenue during the
period ended December 31, 1994 makes comparisons to the comparable period in
1995 not meaningful.
Expenses for promotional activities, including co-op advertising and point
of sale displays, were 32.7% of total sales and marketing expense for the year
ended December 31, 1995. During the year ended December 31, 1995, creative and
consulting expenses were 42.1% of total sales and marketing expenses, due to
the Company's efforts to develop its product advertising as well as its
packaging concept. Commissions paid to the Company's sales representatives and
bad debt expenses were not material components of sales and marketing expenses
for either period.
General and Administrative Expenses. General and administrative expenses
increased to $624,238 for the year ended December 31, 1995 from $63,220 for
the period ended December 31, 1994. This increase was primarily due to the
addition of administrative personnel, the associated costs required to manage
the growth in the Company's business and nonrecurring startup costs. There
were no payroll expenses in the period ended December 31, 1994. Certain of
these general and administrative expenses, including expenses related to
functions performed by LCN employees, were
24
<PAGE>
incurred by LCN during the year ended December 31, 1995 and period ended
December 31, 1994 and the Company was billed by LCN.
Payroll costs were 27.4% of total general and administrative expenses for
the year ended December 31, 1995. Sales taxes were 3.3% of total general and
administrative expenses for the year ended December 31, 1995 and immaterial
for the comparable period in 1994. Legal and accounting expenses decreased to
34.0% of total general and administrative expenses for the year ended December
31, 1995 from 54.5% for the comparable period in 1994 when the Company was in
its initial stage of development.
Interest Income. Net interest income, net of interest expense, for the year
ended December 31, 1995 was $2,012. Interest income for the year ended
December 31, 1995 was derived from returns on short-term cash investments.
Interest expense for the year ended December 31, 1995 consisted of interest on
intraperiod debt which the Company utilized during 1995. There was no interest
expense or income for the period ended December 31, 1994.
Income Taxes. The Company had losses for tax purposes for the year ended
December 31, 1995 and the period ended December 31, 1994. Accordingly, there
was no provision for income taxes in these periods.
Net Income. As a result of the above items, net loss increased to
$(1,329,302) for the year ended December 31, 1995 from $(65,472) for the
period ended December 31, 1994.
SELECTED QUARTERLY OPERATING RESULTS
The following table sets forth certain unaudited quarterly financial data
for each of the quarters since inception (October 28, 1994). In the opinion of
management, the unaudited quarterly financial information has been prepared on
the same basis as the audited Financial Statements and includes all
adjustments, consisting only of normal recurring adjustments, necessary for
the fair presentation of the information for the periods presented. The
unaudited quarterly information should be read in conjunction with the audited
Financial Statements and Notes thereto included elsewhere in this Prospectus.
The unaudited quarterly operating results are not necessarily indicative of
results of operations for any future period.
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
------------------------------------------------------------------------------
DECEMBER JUNE SEPTEMBER DECEMBER MARCH JUNE
31, MARCH 31, 30, 30, 31, 31, 30,
1994 1995 1995 1995 1995 1996 1996
-------- --------- --------- --------- --------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenue................ $ 444 $ 2,564 $ 39,174 $ 185,900 $ 226,278 $ 1,139,365 $ 2,538,655
Cost of revenue........ 716 1,793 28,118 129,858 158,917 812,877 1,929,238
-------- --------- --------- --------- --------- ----------- -----------
Gross profit (loss).. (272) 771 11,056 56,042 67,361 326,488 609,417
Operating expenses
Sales and marketing.. 1,980 8,448 164,794 194,671 474,393 657,105 986,321
General and
administrative...... 63,220 104,861 19,161 46,249 453,967 701,242 758,051
-------- --------- --------- --------- --------- ----------- -----------
Loss from operations... (65,472) (112,538) (172,899) (184,878) (860,999) (1,031,859) (1,134,955)
Net interest expense
(income).............. -- -- -- 1,531 (3,543) 44,813 59,559
-------- --------- --------- --------- --------- ----------- -----------
Loss from operations
before income tax
expense............... (65,472) (112,538) (172,899) (186,409) (857,456) (1,076,672) (1,194,514)
Provision for income
taxes................. -- -- -- -- -- -- --
-------- --------- --------- --------- --------- ----------- -----------
Net loss............. $(65,472) $(112,538) $(172,899) $(186,409) $(857,456) $(1,076,672) $(1,194,514)
======== ========= ========= ========= ========= =========== ===========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER MARCH JUNE SEPTEMBER DECEMBER MARCH JUNE
31, 31, 30, 30, 31, 31, 30,
1994 1995 1995 1995 1995 1996 1996
-------- ------ ------- --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
SELECTED BALANCE SHEET
DATA:
Deferred revenue...... $431 $2,389 $89,505 $535,865 $3,696,515 $3,783,917 $4,127,919
</TABLE>
25
<PAGE>
The Company's sales have been, and the Company expects that its sales will
continue to be, somewhat seasonal, due to holiday purchases of the SmarTalk
Card. Factors that may cause the Company's operating results to vary include
(i) changes in operating expenses, (ii) the timing of the introduction of
SmarTalk services, (iii) market acceptance of new and enhanced versions of
SmarTalk services, (iv) potential acquisitions, (v) changes in legislation and
regulation which affect the competitive environment for SmarTalk services, and
(vi) general economic factors.
LIQUIDITY AND CAPITAL RESOURCES
From inception through June 30, 1996, the Company has funded operations
primarily from cash generated by operations and borrowings under its debt
agreements. The Company's operating activities used net cash of $2,395,916 in
the six months ended June 30, 1996. The cash used by operating activities is
primarily attributable to the Company's continued efforts to penetrate the
retail distribution channel. As of October 23, 1996, the Company's cash and
cash equivalents were approximately $310,000.
In December 1995, the Company negotiated a financing package with SmarTalk
Partners under which SmarTalk Partners agreed to loan $1,200,000 to the
Company through a term loan and paid $300,000 to purchase a portion of the
Company's Common Stock. The term loan is collateralized by substantially all
assets of the Company and bears interest at 7% per annum. Interest accrues
daily and is payable monthly beginning January 31, 1996 and ending December
31, 1996. Beginning January 31, 1997, monthly payments of principal and
accrued interest are required until July 31, 2000, when all amounts are due
and payable. The funds from this transaction were received in January 1996.
See "Certain Transactions."
In addition, the Company obtained a revolving loan facility from SmarTalk
Partners, collateralized by substantially all assets of the Company. The
facility provides for borrowings up to $500,000. Interest accrues daily at a
floating rate equal to the prime rate plus 2% and is payable monthly in
arrears beginning January 31, 1996. The principal portion of the loan is due
and payable January 31, 1998. The Company may draw funds under the revolving
loan at its discretion. At June 30, 1996, the Company had no funds available
under this facility. See "Certain Transactions."
In January 1996, the Company entered into an agreement to purchase certain
of the assets of LCN. Mr. Lorsch, LCN's sole shareholder, is the Company's
majority shareholder and its President and Chief Executive Officer. The
purchase was consummated in January 1996 for $500,000 cash plus a $2,000,000
principal amount subordinated promissory note which bears interest at 7% per
annum. Interest on the note is payable monthly through July 31, 1996.
Beginning August 31, 1996, the Company is obligated to make a payment of
$35,000 a month, with all amounts due and payable in full on June 30, 2000.
Because the assets were purchased from a related party, the assets are
reflected on the Company's balance sheet at LCN's cost less depreciation as of
the date of acquisition. The excess of acquisition cost over the historical
cost less depreciation of the assets acquired of approximately $2,464,028 was
recorded as a charge to the Company's accumulated deficit. See "Certain
Transactions."
In June 1996, the Company acquired the VoiceChoice Platform from Pacific
Bell Information Services for total consideration of $325,000, plus other
consideration including the release of certain of its contractual obligations
to the Company. The purchase price was recorded at $325,000, comprised of
$200,000 in cash and a $125,000 note. $100,000 of the $125,000 note is to be
paid through six equal monthly installments, beginning July 1, 1996. A final
payment due January 1, 1997 will include the remaining $25,000 principal
amount of the note and an additional sum equal to the interest accrued on the
declining balance paid in installments at 9% interest per annum calculated on
a day-to-day basis. All amounts become due and payable upon completion of the
Offering.
26
<PAGE>
In August 1996, the Company entered into a loan agreement with SmarTalk
Partners pursuant to which the Company obtained a loan of $250,000. This term
loan is collateralized by substantially all of the assets of the Company and
accrues interest at the prime rate. Interest on the loan is due the last day
of each month, commencing August 31, 1996, with the loan maturing on January
31, 1997. All amounts become due and payable upon completion of the Offering.
Payments of principal and interest on the $1,200,000 term loan, the $500,000
revolving loan facility, and the $2,000,000 term note (collectively, the
"Original Indebtedness") are subordinated to, and may not be made prior to the
repayment of, the $250,000 term loan. See "Certain Transactions."
In September 1996, the Company entered into a revolving line of credit with
Southern California Bank (the "SCB Line of Credit"). Pursuant to the terms of
the SCB Line of Credit, the Company can borrow up to $1,000,000 secured by a
first priority lien on substantially all of the Company's assets. Interest on
the outstanding principal balance, calculated from the date of each advance to
the repayment of each advance, is at the prime rate (as published in the Wall
Street Journal) plus 2.375%. Interest payments are due monthly with the
Company being required to make a minimum interest payment of $4,429 per month
for one year. If the line of credit is paid off prior to one year, the
remaining minimum monthly payments become due and payable. The SCB Line of
Credit will become due and payable September 1, 1997. As of October 23, 1996,
there was $510,000 outstanding pursuant to the SCB Line of Credit.
The proceeds of the Offering will be used, in part, to repay the Original
Indebtedness, the indebtedness to Pacific Bell Information Services and the
$250,000 term loan. See "Use of Proceeds."
The Company believes that the proceeds from the Offering, together with the
funds anticipated to be generated from operations, will be sufficient to
finance the Company's operations for the next 18 months.
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BUSINESS
GENERAL
SmarTalk provides convenient, easy to use, cost-effective telecommunications
products and services to individuals and businesses primarily through its
SmarTalk Card. The SmarTalk Card provides customers with a single point of
access to prepaid telecommunications services at a fixed rate charge per
minute regardless of the time of day or, in the case of domestic calls, the
distance of the call. The Company's services currently include domestic
calling and outbound international long distance calling to more than 150
countries, as well as enhanced features such as sequential calling, speed dial
and message delivery. The SmarTalk Card may also be recharged on-line with a
major credit card, allowing the user to add minutes as needed. The Company
expects to offer other enhanced features, including conference calling, voice
mail, fax mail, content delivery (including news, sports and weather
information) and selected international calling services. The Company's long
distance calls are carried primarily through MCI and AT&T. For the six months
ended December 31, 1995 and June 30, 1996, the number of minutes decremented
from SmarTalk cards or otherwise used by SmarTalk customers were approximately
2,576,000 and 15,901,000, respectively.
SmarTalk's primary marketing and distribution focus is to target individuals
and small businesses through major national and regional retailers. Currently,
the SmarTalk Card is sold at selected retail locations throughout the U.S.,
including locations operated by the following leading retailers: American Drug
Stores (which includes Jewel/Osco Combo Stores, Osco Drug Stores and Sav-On
Drug Stores), Office Depot, Thrifty Oil, Builders Square, Hills Department
Stores, Bradlees, Bergen Brunswig Drug Company (Good Neighbor Pharmacy),
Venture Stores, Foley's Department Stores, Marshall Field's, Fred W. Albrecht
Grocery Company, Office 1 Superstores, Price/Costco, Acme, Best Buy, Dayton's,
Fedco, The Good Guys, Hudson's, Penn Daniels, Pamida and Robinsons-May.
Certain of those retailers have, from time to time, accounted for a
significant percentage of the Company's revenue. Based upon the value of
shipments of SmarTalk cards to retailers ("Retailer Shipment Value"), American
Drug Stores accounted for approximately 78% and 11%, respectively, and Office
Depot accounted for 0% and approximately 21%, respectively, of the total
Retailer Shipment Value for the year ended December 31, 1995 and the six
months ended June 30, 1996. No other retailer accounted for more than 10% of
Retailer Shipment Value in more than one quarter during either such period.
The Company believes its success to date in rapidly expanding its retail
network is attributable to management's ability to increase retailers'
awareness of the profit potential of offering telecommunications services at
retail, the minimal space involved in offering the SmarTalk Card at retail and
the ability of the SmarTalk Card to generate ongoing residuals for retailers
through participation in recharge revenues. The Company is exploring the
opportunity of offering retailers a co-branded, pre-subscribed "1+" long
distance service. This new product, if successfully introduced, would afford
retailers the ability to offer residential and small business customers long
distance services that are designed to generate ongoing revenue streams while
requiring virtually no shelf space or inventory cost. SmarTalk also markets
its services directly to customers through direct response sales which include
recharge sales, and sales generated through print, direct mail, and, in the
future, Internet and television advertising.
The Company has developed additional marketing and distribution avenues,
including the Company's Corporate Advantage Program and corporate promotional
programs. Under the Corporate Advantage Program, employees who are away from
their offices can utilize SmarTalk services, thereby enabling businesses to
lower telecommunications costs and monitor call activity to better allocate
long distance costs. Corporate promotional programs allow the Company's
corporate customers to provide co-branded prepaid phone cards for use in
corporate or product promotions, direct marketing programs, warranty
registration, customer service programs and premium rewards for customers.
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SmarTalk has created promotional programs for JVC, Smart & Final Iris,
Cellular One, AirTouch Cellular and, in conjunction with Kodak and Hallmark
Cards, American Stores.
SmarTalk services are delivered through proprietary switching, application
and database access software which run on two interactive call processing
SmarTalk Platforms, one of which, the VoiceChoice Platform, was recently
acquired from Pacific Bell Information Services. The SmarTalk Platforms and
the Company's proprietary software allow users in the system to access
SmarTalk services, and provide the Company with the flexibility to customize
and add features to SmarTalk services on a platform-wide basis. The
acquisition of the VoiceChoice Platform provides the Company with the
opportunity to reduce its costs. The Company has also developed a proprietary
in-house data reporting and tracking system, the SmarTrac System, which tracks
inventory, controls fraud, monitors usage by card and retailer and allows the
Company to provide certain marketing information to its retailers and business
customers.
The Company believes that its principal competitive advantages are its (i)
well-established presence among major retailers, (ii) advanced
telecommunications infrastructure, and (iii) management team, which has
extensive marketing and merchandising expertise.
INDUSTRY OVERVIEW
The $67.4 billion U.S. long distance industry is dominated by the nation's
three largest long distance providers, AT&T, MCI and Sprint, which together
generated approximately 82.7% of the aggregate revenues of all U.S. long
distance interexchange carriers in 1994. While industry revenues have grown at
a compound annual rate of 5.6% since 1984, the revenues of carriers other than
AT&T, MCI and Sprint have grown at a compound annual rate of 27.8% during the
same period. As a result, the aggregate market share of all interexchange
carriers other than AT&T, MCI and Sprint has grown from 2.6% in 1984 to 17.3%
in 1994. During the same period, the market share of AT&T declined from 90.1%
to 55.2%.
The changing market for telecommunications services created an opportunity
for the growth of alternative long distance and telecommunications services
providers, including prepaid phone card sales. The domestic prepaid phone card
industry has grown significantly in recent years. Prepaid phone card revenues
in the U.S. have grown from an estimated $20 million in 1990 to an estimated
$1 billion in 1996, making prepaid phone services one of the fastest growing
segments of the telecommunications industry. Industry sources project the
total U.S. prepaid phone card market to reach $2.5 billion in 2000. The
Company believes that the affordable pricing, convenience and enhanced
features of prepaid phone cards have attracted price sensitive customers,
business travelers, international callers and other users of long distance
services. Although prepaid phone cards are relatively new in the U.S., prepaid
phone cards have been a widely used and accepted way of making telephone calls
in Europe and Asia since the 1970s.
Recently, the prepaid calling card industry has expanded substantially.
According to industry sources, the number of companies marketing prepaid phone
cards has grown from approximately 75 companies in 1994 to over 500 companies
in 1996. In addition, companies have begun to couple long distance services
with other enhanced features. In contrast to producers of prepaid phone cards
that were established to serve the collectible or promotional market only or
that provide long distance service only, the Company markets and distributes
the SmarTalk Card and services with specific focus on retail distribution
channels. SmarTalk believes that it is well positioned to capitalize upon the
expanding prepaid phone card market due to its focus on national retail
distribution channels, as well as the other components of the SmarTalk
strategy.
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THE SMARTALK STRATEGY
SmarTalk's objective is to become a leading provider of quality, convenient,
easy to use and cost-effective telecommunications products and services to
individuals and businesses, primarily sold through retailers. The Company's
strategy for achieving that objective includes the following key elements:
Increase Penetration of Retailers.
SmarTalk markets and distributes the SmarTalk Card to individuals and small
businesses through major national and regional retailers. The SmartTalk Card
generally is sold in 30, 60 and 120 minute denominations at a price to
retailers averaging approximately $0.22 per minute. The Company intends to
continue to focus on the penetration of retailers by increasing the number of
retailers at which the SmarTalk Card is sold, expanding the number of stores
among retailers selling the SmarTalk Card and adding points of sale at which
customers can purchase the SmarTalk Card within each store. In addition,
SmarTalk plans to leverage its relationship with retailers to market
additional telecommunications services such as "1+" long distance service.
SmarTalk believes that it can continue to grow its network of major national
and regional retailers by increasing awareness among retailers as to the
profit potential of telecommunications services. This potential exists with
regard to the SmarTalk Card because of the limited space utilized to offer the
SmarTalk Card, as well as the ability to generate ongoing residuals through
participation in recharge revenues. In addition, the SmarTrac System provides
the retailer with certain marketing information about its customers. Moreover,
the Company believes that it can increase the points of sale within a retail
store by continuing to provide retailers with turnkey merchandising materials,
which include customized retail packaging and complete display and signage
systems, co-op advertising and MDF to access shelf space.
SmarTalk also intends to capitalize upon its retail distribution network by
offering new products and services and creating innovative marketing
opportunities. For example, the Company is exploring the concept of selling a
co-branded, pre-subscribed "1+" long distance service to customers through
retailers at favorable rates. If successfully introduced, the program would
allow patrons to purchase traditional long distance services directly from the
retailer. Customers would receive a monthly statement itemizing the calls made
and the amount due for that month. The monthly statement would afford
retailers and the Company an additional direct advertising opportunity for
their respective products and services.
Further Develop Direct Response Channels.
SmarTalk plans to stimulate the growth of its existing direct response
sales. For example, the Company has developed on-line recharge of the SmarTalk
Card which allows customers to increase the number of minutes available on the
SmarTalk Card without purchasing a new SmarTalk Card by using a major credit
card, generally at a rate of $0.35 per minute. On-line recharge is designed to
enable the Company to make direct sales to customers, to provide incentives to
retailers to maintain SmarTalk as the exclusive supplier to the retailer and
to create brand loyalty. With respect to recharge sales, the Company plans to
(i) continue to offer volume discounts, whereby, for example, customers from
time to time receive "free minutes" when recharging for the maximum time
permitted and (ii) utilize on-line advertising, in which, for example, a
customer is prompted to recharge his or her card.
The Company will continue to utilize print, broadcast and other means of
direct marketing, including direct response advertising in magazines and
publications, such as in-flight magazines, that appeal to the business
traveler. The Company plans to continue to develop new and innovative means of
marketing its telecommunications products and services directly to customers
to complement its retail distribution network. Such means include television
advertising, catalogue and other direct
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marketing methods. The Company is also developing a home page on the Internet
through which it intends to provide the customer with information on the
benefits of the SmarTalk Card, as well as to direct market SmarTalk services.
Broaden Corporate Advantage and Promotional Programs.
SmarTalk intends to expand the Corporate Advantage Program and corporate
promotional programs which are directed towards business customers. Under the
Corporate Advantage Program, employees who are away from their offices can
utilize SmarTalk's services, thereby enabling businesses to lower
telecommunications costs, monitor call activity and allocate long distance
costs. Businesses enrolled in the Corporate Advantage Program may request
detailed monthly reports generated by the SmarTalk System for use in
controlling expenses and in recapturing costs from clients. SmarTalk also has
established corporate promotional programs which allow the Company's business
customers to provide co-branded prepaid phone cards for use in corporate or
product promotions, direct marketing programs, warranty registration, customer
service programs and premium rewards for customers. SmarTalk plans to broaden
the Corporate Advantage Program and corporate promotional programs by (i)
expanding its sales force to include representatives that focus on business
customers, (ii) capitalizing on the Company's strategic relationships, and
(iii) leveraging its existing relationships with retailers by promoting its
corporate programs to retailers already familiar with SmarTalk services such
as Office Depot, Office 1 Superstores and Hello Direct Catalog that market to
commercial clients.
Target the Business Customer.
SmarTalk plans to introduce additional enhanced features to the SmarTalk
Card in an effort to attract both the small business customer at retail and
corporations as subscribers to its Corporate Advantage Program. In response to
the increasing demand, primarily by business users, for more bundled, single
point of access telecommunications services, the Company plans to expand its
telecommunications features to offer voice mail, fax mail, conference calling
and selected international calling services. These services will be accessible
from almost any touchtone phone, and will be provided on a prepaid and/or a
monthly recurring charge basis at a flat rate per minute without operator as-
sistance, coins, collect or third party billed calls. See "-- Products and
Telecommunications Services."
Leverage Existing Strategic Relationships.
SmarTalk plans to leverage its existing network of strategic relationships
to gain access to new business opportunities and a wider customer base. The
Company has recently entered into strategic alliances, including those with
MCI, West Interactive, and Douglas Stewart, which the Company believes will
expand its distribution channels. The Company also plans to develop additional
strategic relationships with partners whose customers are prospective users of
SmarTalk services. The Company believes that by developing additional
strategic relationships, it will increase awareness of SmarTalk services. The
Company anticipates that, as it continues to develop new and innovative
products and services, it will attract additional strategic partners.
Expand International Services.
SmarTalk plans to expand its business to international markets in order to
market prepaid phone cards to U.S. travelers and foreign customers who
frequently call the U.S. The Company believes that by providing competitive
rates for inbound international service and by advertising in travel locations
such as airports and hotels, SmarTalk can attract U.S. customers traveling
abroad. SmarTalk also believes that it can market to foreign customers who
frequently call the U.S. by establishing a sales force abroad and by providing
turnkey merchandising materials to retailers abroad which are customized for
foreign markets.
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PRODUCTS AND TELECOMMUNICATIONS SERVICES
The SmarTalk Card provides customers with a single point of access to
convenient, easy to use, cost-effective telecommunications products and
services at a fixed rate charge per minute regardless of the time of day or,
in the case of domestic calls, the distance of the call. The SmarTalk Card
enables customers to place long distance and international calls from
virtually any touchtone phone, without the need for coins, operator
assistance, collect or other third party billed calls. Card users access these
services by dialing a toll free "800" number and entering a PIN printed on the
back of the card. The system explains the service on a user's first call and
guides callers through all of the features. Prior to any call being processed,
the system informs the caller of the time remaining on the card. The customer
is also notified when there are five minutes and again when there are two
minutes of calling time remaining on the SmarTalk Card. Time spent on a call
or on the Company's enhanced features is automatically deducted from the
remaining time on the card or billed to a pre-authorized corporate account.
Unlike telephone or credit calling cards which usually impose surcharges on
long distance services, SmarTalk's services are typically paid for in advance
and are issued in specified time increments, typically 30, 60, and
120 minutes, at favorable per minute rates. A SmarTalk Card expires on the
earlier to occur of six months after the date such SmarTalk Card is first
activated or the expiration date printed on such SmarTalk Card.
Customers' calls are carried primarily through AT&T (accessed through West
Interactive) and MCI. The Company obtains long distance telecommunications
services pursuant to supply agreements with MCI and West Interactive. The
Company's Preferred Carrier Agreement with MCI obligates SmarTalk to utilize a
specified number of minutes over a period of four years. If the Company
utilizes a certain number of minutes, the price per minute paid by the Company
for all long distance minutes decreases. The Company's agreement with West
Interactive provides for the Company to be charged a flat rate per minute and
includes no minimum commitment.
Should users have questions about the use of their SmarTalk cards when
inside the system, a customer service representative is available for
assistance on-line at the touch of a button. This on-line customer service
differentiates SmarTalk from most of its competitors whose cards generally
require users to hang up and call a second number to reach customer service.
The SmarTalk customer service representative has access to real time call
records which allow the representative to trace the customer's system usage.
See " -- SmarTalk Customer Service."
Customers access the Company's services through one of the SmarTalk
Platforms. The SmarTalk Platforms are designed in a manner which allows
SmarTalk to customize or add features and services to the SmarTalk Card on a
platform-wide basis. Generally, calls accessing enhanced telephonic features
are charged for such access as disclosed by computerized voice prompts at the
time such features are being accessed. SmarTalk attempts to design and develop
enhanced teleservices in order to increase the marketability of the SmarTalk
Card and satisfy customer requirements. The Company believes that offering
enhanced services will attract additional customers to the SmarTalk services,
promote brand loyalty and result in additional product usage. To date, these
services have been utilized on a limited basis. See " -- The SmarTalk
Platforms."
Customers are currently provided with the option of accessing the following
services:
International Outbound Long Distance.
Customers can use the SmarTalk Card to place international long distance
calls from anywhere in the U.S. at rates that are generally lower than the
standard card plan rates currently charged by AT&T, MCI and Sprint or the rate
charged for a direct call from a payphone or hotel room. A connection through
the SmarTalk Platforms costs less than a typical operator assisted connection,
a collect call, and most major carrier calling card calls, including AT&T,
MCI, and the RBOCs.
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Speed Dial.
Customers can create their own personal speed dial directory which can then
be accessed each time the customer uses the PIN on which the directory has
been created. This feature permits customers to place calls to any of nine
frequently dialed numbers by pressing two buttons. Currently, the Company
provides a first-time user of a particular PIN with a limited amount of free
time to set up their personal speed dial directory. The personal speed dial
directory created by the customer is inaccessible to the customer once all of
the prepaid minutes on the SmarTalk Card associated with the directory have
been utilized. The Company believes that the speed dial feature increases the
likelihood that customers will recharge their SmarTalk cards in order to
retain their personal speed dial directory.
Message Delivery.
Customers can record a message for the recipient of a call if the recipient
does not answer or if the line is busy. The SmarTalk system will make multiple
attempts to deliver the message over a period of six hours, and then notify
the customer the next time that the customer accesses the SmarTalk system
whether the message was delivered and, if so, the time at which it was
delivered.
Sequential Calling.
Customers can make additional calls without the necessity of exiting the
platform and entering it again. The Company believes that this feature
encourages users to place multiple phone calls each time they use their
SmarTalk cards.
The Company is currently testing and anticipates offering the following
additional features by the end of 1996:
Conference Calling.
Customers will be able to initiate conference calls from virtually any
touchtone phone by adding a third party to the call. The conference calling
feature will be automated and will not require operator assistance. Voice
prompts will assist the customer through the procedure to establish the
conference call. A customer using the conference calling feature will be
deducted time on two outbound calls, therefore leveraging the cost to the
Company of one inbound call. See " -- The SmarTalk Platforms."
Content Delivery.
Customers will be able to access financial news, headline news, sports
updates, weather reports and other information updates, provided by SmarTalk
through a digital feed from several selected on-line suppliers. These services
will be frequently updated, and the information will be accessible by a series
of menus presented to the user via voice prompts. Information will first be
presented in a general format, with the consumer then being given the option
to retrieve more detailed information on the topic selected.
The following additional services are under development and are expected to be
offered by SmarTalk in 1997:
Voice Mail.
SmarTalk plans to offer customers a secure, personalized voice mailbox which
will allow them to receive, retrieve, save and delete voice mail messages from
virtually any touchtone phone. Each time the customer accesses their voice
mailbox, the customer will be notified if there are any new voice mail
messages. The customer will also have the ability to elect to be notified of
messages by instructing the system to send a message to their pagers or
calling them at a designated number.
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Fax Mail.
SmarTalk plans to offer customers fax mail capability which will allow
customers to receive, store and retrieve facsimile transmissions at any time
by forwarding the faxed information to any fax machine or personal computer in
the U.S. and certain parts of the world. The fax mailbox will provide
customers with the convenience of controlling the time and location of receipt
of facsimile transmissions, enhancing the customer's ability to receive
confidential facsimiles and receive facsimiles at multiple or changing
locations. Each time the customer accesses their fax mailbox, the customer
will be notified if there are any new faxes. The customer will also have the
ability to elect to be notified of waiting faxes.
International Long Distance.
The Company expects that customers will be able to utilize the SmarTalk Card
to make international calls to the U.S. from more than 25 foreign countries,
with additional originating countries being added thereafter. The Company
eventually expects to enable customers to place country to country
international calls from most countries in the world to virtually any country
in the world.
MARKETING AND DISTRIBUTION
The Company markets its services through multiple distribution channels
which include (i) sales to retailers, (ii) direct response sales (which
include recharge sales, sales generated by payphone marketing and sales
generated through print, mail, and in the near future, Internet and television
advertising), and (iii) direct corporate programs and promotions.
Retail Channel.
SmarTalk's primary marketing and distribution focus is to target individuals
and small businesses through major national and regional retailers. The
Company currently derives most of its revenues from sales to retailers. The
Company's retail distribution channel encompasses diverse categories of
retailers ranging from convenience stores to food and drug stores, department
stores, mass merchandisers, office superstores and consumer electronics
retailers. SmarTalk markets and distributes the SmarTalk Card nationwide to
retailers both through a direct sales force and through its national sales
organization of independent manufacturers' representatives which utilizes its
relationships with retailers to introduce the SmarTalk Card and its services.
The Company believes that its broad retail distribution has resulted in
SmarTalk becoming a leading brand at the retail level.
Currently, the SmarTalk Card is sold at selected retail locations throughout
the U.S., including locations operated by the following leading retailers:
American Drug Stores (which includes Jewel/Osco Combo Stores, Osco Drug Stores
and Sav-On Drug Stores), Office Depot, Thrifty Oil, Builders Square, Hills
Department Stores, Bradlees, Bergen Brunswig Drug Company (Good Neighbor
Pharmacy), Venture Stores, Foley's Department Stores, Marshall Field's, Fred
W. Albrecht Grocery Company, Office 1 Superstores, Price/Costco, Acme, Best
Buy, Dayton's, Fedco, The Good Guys, Hudson's, Penn Daniels, Pamida and
Robinsons-May.
The Company believes its success to date in rapidly expanding its retail
network is attributable to management's ability to increase retailers'
awareness of the profit potential of offering telecommunications services, the
minimal space involved in offering the SmarTalk Card at retail and the ability
of the SmarTalk Card to generate ongoing residuals for retailers through
participation in recharge revenues. In furtherance of its strategy, the
Company provides (i) turnkey merchandising materials which include the
availability of customized cards and retail packaging and complete display and
signage systems which make display of the SmarTalk Card easy, (ii) retail
promotion programs in which SmarTalk and the retailer share the costs of the
promotion, and (iii) access to marketing information from the SmarTrac System.
Unlike most products sold by retailers, the SmarTalk Card allows retailers
to generate revenues beyond the initial sale of the SmarTalk Card by allowing
an ongoing revenue stream based on the
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number of minutes recharged on any SmarTalk Card sold by that retailer, so
long as the retailer continues to offer the SmarTalk Card. SmarTalk encourages
the customer to utilize the recharge option by computerized voice prompts. The
Company believes that this program increases retailer loyalty to SmarTalk and
creates a barrier for the retailer to try other prepaid phone cards. The
Company expects recharge revenues to increase as more SmarTalk Cards are sold
and used and the Company introduces additional enhanced services.
In addition, SmarTalk assists retailers in promoting the SmarTalk Card at
retail points of sale at each retail location by providing turnkey
merchandising materials to retailers. SmarTalk's turnkey merchandising and
marketing program includes the availability of customized retail packaging and
customized display and signage systems. The Company also provides promotional
supplies to the retailer, to assist the retailer in making the SmarTalk Card
immediately available at various retail locations.
SmarTalk's retail promotional programs include various forms of co-op
advertising programs and other incentive programs to access shelf space. The
Company believes that these programs, together with the residual revenues from
recharge and the Company's turnkey merchandising and marketing program, create
ongoing retailer involvement in support of marketing the SmarTalk Card.
Retailers also benefit from the SmarTrac System which enables the Company to
provide certain demographic information to a retailer of its customers that
utilize SmarTalk services. This information provides the retailer with
information which it can use in formulating its marketing strategy. See "--
The SmarTrac System." In addition, the SmarTrac System provides the retailer
with the ability to deliver custom audio information, such as store openings
or store advertisements, to the retailer's customers when they access the
SmarTalk system.
Direct Response.
The Company also markets its services directly to customers through direct
response sales, which include recharge sales, and sales generated through
print, direct mail, and in the future, Internet and television advertising,
generally at a rate of $0.35 per minute and without requiring the issuance of
a new SmarTalk Card.
The Company offers on-line recharge, generally at a rate of $0.35 per
minute, which provides customers with the convenience of being able to add
minutes to an existing SmarTalk Card with a major credit card while using the
service. This allows the customer to purchase minutes without having to return
to a retailer and allows the customer to continue using features already
programmed into their SmarTalk Card, currently the speed dial directory. See
"-- Products and Telecommunications Services." The Company generally pays
credit card providers a service fee of 3% on recharge sales and other direct
response sales. See "Risk Factors -- Risk of Loss from Returned Transactions;
Fraud; Bad Debt; Theft of Services."
The Company is developing a home page on the Internet through which it
intends to provide the customer with information as to the benefits of the
SmarTalk Card. The Company believes that the Internet home page will give the
SmarTalk Card exposure in the rapidly growing electronic commerce marketplace.
The Company intends to use its Internet presence to provide the customer with
information on the benefits of SmarTalk services, as well as to direct market
the SmarTalk Card. Additionally, the Internet home page will provide the
Company with a unique medium for providing interactive promotional programs to
the Company's retailers and direct customers.
Direct Corporate Programs and Promotions.
Corporate sales of SmarTalk services generate revenue primarily in two
areas: (i) sales to corporations for employee use through the Corporate
Advantage Program and (ii) sales to corporations for promotional distribution.
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SmarTalk markets SmarTalk services through the Corporate Advantage Program
to businesses as a means to reduce long distance costs and better monitor long
distance usage. Businesses enrolled in the Corporate Advantage Program have
access to detailed monthly reports generated by the SmarTrac System for use in
controlling expenses and allocating costs. The Corporate Advantage Program
enables employees to access the SmarTalk system through a customized PIN and
to track the cost of any service to a particular client or matter by dialing
an additional two digit customized code. Businesses that enroll in the
Corporate Advantage Program can be billed on either a prepaid or monthly
basis. Use of SmarTalk services may result in substantial savings to business
travelers by eliminating access and other surcharges that are typically added
to calls made from a payphone or hotel room. In addition, the Company believes
its enhanced services will be attractive to its corporate customers because
they allow the caller to access long distance, speed dial, message delivery
and future services.
The Company also markets the SmarTalk Card and co-branded prepaid cards for
use in promotional marketing, including sales for corporate or product
promotional campaigns, direct marketing programs, warranty registration or
customer service programs and premium rewards for consumers. For example, a
corporate promotional customer can provide custom designed cards featuring its
logo or customized advertisement to consumers and can use the SmarTalk Card to
reward consumers for purchasing a product, using a service or providing
information. In these ways, corporate clients can use the SmarTalk Card to
reward consumers. In addition, the SmarTrac System allows corporate
promotional customers to learn the habits of those same consumers for future
marketing strategies. SmarTalk has created promotional programs for JVC, Smart
& Final Iris, Cellular One, AirTouch Cellular and, in conjunction with Kodak
and Hallmark Cards, American Stores. Similarly, corporate customers can
utilize SmarTalk for warranty registration programs by inviting consumers to
phone in their information to a dedicated "800" number rather than completing
a warranty registration card. Information about the consumer can then be
provided to the corporate customer from the SmarTrac System.
The Company identifies potential corporate clients through its direct sales
force, as well as its nationwide network of sales representatives and
retailers. SmarTalk plans to capitalize upon its existing relationships by
promoting its Corporate Advantage Program to retailers already familiar with
the SmarTalk Card such as Office Depot, Office 1 Superstores and Hello Direct
Catalog that market to commercial clients. Following completion of the
Offering, the Company intends to expand its sales force to significantly build
upon its corporate programs and promotions distribution channel.
STRATEGIC PARTNERS
SmarTalk has recently entered into strategic alliances with several major
telecommunications and other companies which the Company believes will further
expand each of its distribution channels.
MCI.
On July 10, 1996, the Company entered into a Prepaid Carrier Referral
Program Agreement whereby MCI has agreed to refer potential clients to the
Company. Currently, SmarTalk is one of three companies to which MCI refers
certain potential clients. The Company has agreed to pay MCI a referral fee
for any new clients that the Company develops as a result of such referrals
from MCI. MCI has no obligation to refer any potential clients to SmarTalk. In
addition, the Company has agreed to service these clients exclusively through
inbound and outbound service provided by MCI.
West Interactive.
On June 1, 1996, the Company entered into a Wholesale Distribution Agreement
with West Interactive whereby West Interactive, a national telemarketing
corporation, will purchase prepaid
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calling card services from SmarTalk for sale to West Interactive's clients.
The agreement provides that prepaid cards sold by West Interactive to its
clients and any related promotional literature distributed will denote
SmarTalk as the service provider.
Douglas Stewart.
The Company has an arrangement with Douglas Stewart, one of the nation's
largest distributors to college bookstores, whereby Douglas Stewart
distributes the SmarTalk Card to college bookstores across the nation. The
Company believes that its relationship with Douglas Stewart provides it with
the ability to target college students, whom the Company believes will be
prime users of SmarTalk services. In addition, the Company believes that
college students represent an opportunity to create brand loyalty among
younger customers.
THE SMARTRAC SYSTEM
The Company has developed the SmarTrac System, a proprietary in-house data
reporting and tracking system that provides a series of database query and
report capabilities that are used to track inventory, control fraud and
monitor usage by card and retailer. The Company markets the SmarTrac System's
ability to provide customer and usage information to the Company's retailers
and business customers. Data generated through the SmarTrac System also helps
the Company to minimize unauthorized use of the SmarTalk Card. For example,
SmarTalk personnel can determine whether multiple PINs are being used from any
single telephone number, whether the same PIN is being used from many
different parts of the country within a short period of time, or whether an
unreasonable number of invalid PINs are being entered from any given telephone
number. This data allows the Company to monitor activity in an effort to limit
fraudulent use of the Company's services. The Company believes that by
providing a marketing tool as well as a measure of fraud control, the SmarTrac
System provides the Company with a competitive advantage.
THE SMARTALK PLATFORMS
Customers access the SmarTalk network through the SmarTalk Platforms. The
SmarTalk Platforms are accessible from virtually any touchtone telephone in
the U.S. and can communicate with telephones, PCs, facsimile machines and
pagers. The SmarTalk Platforms feature multiple switches, thousands of inbound
and outbound access ports for prepaid and corporate calling services, as well
as voice response applications, high-speed database servers, voice recording
capability and credit card verification software, among other capabilities.
This structure provides SmarTalk customers with high capacity, reliable
telecommunications products and services.
The SmarTalk Platforms are controlled by proprietary database access
software that was developed by the Company. The Company designed its
proprietary software to be versatile and adaptable, and to work with the
SmarTalk Platforms to provide users with efficient and reliable services. The
SmarTalk proprietary software allows the SmarTalk Platforms to be easily
expandable so that, as usage increases or new SmarTalk services are developed,
the SmarTalk Platforms may evolve with the rest of the SmarTalk services. The
Company believes that the SmarTalk Platforms will be capable of processing all
of the Company's anticipated usage requirements. The modular and scalable
design of the SmarTalk Platforms and the related software allows expansion of
network capacity without requiring replacement of existing hardware or
software or interrupting service.
SmarTalk recently acquired the VoiceChoice Platform from Pacific Bell
Information Services. Located in San Francisco, the VoiceChoice Platform was
configured by Pacific Bell Information Services and supports the SmarTalk Card
as well as other interactive voice response applications. The VoiceChoice
Platform is an integrated call processing system, in which calls are carried
on the VoiceChoice Platform by T1 circuits from MCI and are presented to
either of two Summa Four switches. Traffic is split evenly between the Summa
switches to provide redundancy. Incoming calls to
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the VoiceChoice Platform are answered by a Summa Four switch, which is
connected to voice response units ("VRUs"). The VRUs, in turn, interact with
an Oracle database server that stores all user information. Resident on the
switch is the software and hardware necessary to allow the switch to interact
with, and accept input from, customers. The VoiceChoice Platform software
prompts customers for their PIN. The software validates this information by
querying the database of active PINs, and verifying that only one customer is
connected to the SmarTalk Platform using this PIN. Once the customer has been
identified, the software instructs the switch to present the customer with
various options, which the customer can access by responding to voice prompts.
If the customer chooses to place an outbound telephone call, the software
transmits the call over lines provided by the resident long distance provider.
The voice response boxes are connected directly to the Company's outbound long
distance services, again providing SmarTalk customers fast processing of their
telephone calls. The system is monitored by on-site analysts 24 hours a day
with numerous "heartbeat" programs in place to detect any potential problem.
The acquisition of the VoiceChoice Platform provides the Company with the
opportunity to reduce its costs while giving the Company a stronger
technological infrastructure. This infrastructure enables the Company to
customize and add features, such as stand-alone interactive voice services
which the Company can market to corporate clients.
The San Antonio call processing platform and back-up Omaha call processing
platform are owned and operated by West Interactive and are similarly
configured for high-speed, high-capacity and high-reliability. West
Interactive provides interstate and international long distance services to
the Company through its agreement with AT&T. In addition, the Company has the
ability to add access to MCI service to the platforms maintained by West
Interactive. The Company's call processing centers are redundant within
themselves and, in certain instances, with each other. Despite this fact, the
Company intends to develop database portability between the different
platforms, thus ensuring redundancy in the event of a major technical or
network problem at any of the facilities.
SMARTALK CUSTOMER SERVICE
SmarTalk believes that effective and convenient customer service is
essential to attracting and retaining customers. SmarTalk's customer service
department is responsible for assisting customers in using SmarTalk services,
answering questions about usage, resolving billing related issues and
resolving any technical problems. SmarTalk provides on-line customer support
that is available 24 hours a day at the touch of a button. In addition,
SmarTalk can identify calling activity by originating or destination phone
number or other parameters. Customer service representatives can access
detailed usage records through the SmarTrac System in order to efficiently
answer customers' questions or resolve customers' concerns. SmarTalk also
maintains a secondary corporate level customer service organization in the
Company's offices to address unique customer service requests which are not
handled while a caller is in the system.
COMPETITION
The telecommunications services industry is intensely competitive, rapidly
evolving and subject to constant technological change. In 1994, there were
approximately 75 companies marketing prepaid calling cards. Today there are
more than 500 companies selling prepaid calling cards, and the Company expects
competition to increase in the future. Other providers currently offer one or
more of each of the services offered by the Company. As a service provider in
the long distance telecommunications industry, the Company competes with three
dominant providers, AT&T, MCI and Sprint, all of which are substantially
larger and have: greater financial, technical, engineering, personnel and
marketing resources; longer operating histories; greater name recognition; and
larger customer bases than the Company. These advantages afford the Company's
competitors pricing flexibility. Telecommunications services companies may
compete for customers based on price, with
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the dominant providers conducting extensive advertising campaigns to capture
market share. Competitors with greater financial resources may also be able to
provide more attractive incentive packages to retailers to encourage them to
carry products that compete with SmarTalk services. In addition, competitors
with greater resources than the Company may be better situated to negotiate
favorable contracts with retailers. The Company believes that existing
competitors are likely to continue to expand their service offerings to appeal
to retailers and their customers. Moreover, since there are few, if any,
substantial barriers to entry, the Company expects that new competitors are
likely to enter the telecommunications market and attempt to market
telecommunications services similar to the Company's services which would
result in greater competition for the Company.
The ability of the Company to compete effectively in the telecommunications
services industry will depend upon the Company's continued ability to provide
high quality SmarTalk services at prices generally competitive with, or lower
than, those charged by its competitors. Certain of the Company's competitors
dominate the telecommunications industry and have the financial resources to
enable them to withstand substantial price competition, which is expected to
increase significantly, and there can be no assurance that the Company will be
able to compete successfully in the future. Moreover, there can be no
assurance that certain of the Company's competitors will not be better
situated to negotiate contracts with suppliers of telecommunications services
which are more favorable than contracts negotiated by the Company. In
addition, there can be no assurance that competition from existing or new
competitors or a decrease in the rates charged for communications services by
the major long distance carriers or other competitors would not have a
Material Adverse Effect.
The Company attempts to differentiate itself from its competitors by
offering an integrated bundle of communications services through advanced
telecommunications hardware and proprietary software and distributing these
services primarily through retail channels, as well as a growing number of
additional distribution channels. The Company believes that its principal
competitive advantages are its (i) well-established presence among major
national and regional retailers, (ii) advanced telecommunications
infrastructure including the SmarTalk Platforms and proprietary SmarTrac
System, and (iii) management team, which has extensive marketing and
merchandising expertise. The Company believes that the principal competitive
factors affecting the market for telecommunications services are price,
quality of service, reliability of service, degree of service integration,
ease of use, service features and name recognition. The Company believes that
it competes effectively in these areas.
Recent changes in the regulation of the telecommunications industry may
impact the Company's competitive position. The Telecommunications Act has
effectively opened the long distance market to competition from the RBOCs. The
entry of these well-capitalized and well-known entities into the long distance
market will likely increase competition for long distance customers. The
Telecommunications Act also grants the FCC the authority to deregulate other
aspects of the telecommunications industry, which in the future may, if
authorized by the FCC, facilitate the offering of telecommunications services
by regulated entities, including the RBOCs, in competition with the Company.
GOVERNMENT REGULATION
The terms and conditions under which the Company provides its services are
subject to regulation by the state and federal governments of the U.S. Various
international authorities may also seek to regulate the services provided or
to be provided by the Company. Federal laws and FCC regulations apply to
interstate telecommunications, while state regulatory authorities have
jurisdiction over telecommunications that originate and terminate within the
same state.
Federal. On February 8, 1996, President Clinton signed into law the
Telecommunications Act which will allow local exchange carriers, including the
RBOCs, to provide inter-LATA long distance telephone service and which also
grants the FCC the authority to deregulate other aspects of the
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telecommunications industry. The new legislation may result in increased
competition in the industry, including from the RBOCs, in the future. See "'--
Competition." The Company is classified by the FCC as a non-dominant carrier.
The FCC has jurisdiction to act upon complaints against any common carrier for
failure to comply with its statutory obligations. The FCC also has the
authority to impose more stringent regulatory requirements on the Company and
to change its regulatory classification. The Company has applied for and
received all necessary authority from the FCC to provide domestic interstate
and international telecommunications service. The Company has been granted
authority by the FCC to provide international telecommunications services
through the resale of switched services of U.S. facilities-based carriers. The
FCC reserves the right to condition, modify or revoke such international
authority for violations of the Federal Communications Act or its rules.
Both domestic and international non-dominant carriers currently must
maintain tariffs on file with the FCC. Although the tariffs of non-dominant
carriers, and the rates and charges they specify, are subject to FCC review,
they are presumed to be lawful and are seldom contested. Prior to a recent
court decision, domestic non-dominant carriers were permitted by the FCC to
file tariffs with a "reasonable range of rates" instead of the detailed
schedules of individual charges required of dominant carriers. In reliance on
the FCC's past practice of allowing relaxed tariff filing requirements for
non-dominant domestic carriers, the Company filed reasonable range of rates
schedules in its FCC tariff. As an international non-dominant carrier, the
Company will be required to include detailed rate schedules in its
international tariffs. Resale carriers are also subject to a variety of
miscellaneous regulations that, for instance, govern the documentation and
verifications necessary to change a consumer's long distance carriers, limit
the use of "800" numbers for pay-per-call services, require disclosure of
operator services and restrict interlocking directors and management.
On March 21, 1996, the FCC initiated a rulemaking proceeding in which it
proposed to eliminate the requirement that non-dominant interstate carriers
such as the Company maintain tariffs on file with the FCC for domestic
interstate services. The FCC's proposed rules are pursuant to authority
granted to the FCC in the Telecommunications Act to "forbear" from regulating
any telecommunications service provider if the FCC determines that the public
interest will be served. The FCC also requested public comment on whether any
other regulations currently imposed on non-dominant carriers should be
eliminated pursuant to the FCC's "forbearance" authority. It is not known when
the FCC will take final action on this proposal.
The FCC recently adopted a regulation which requires facilities-based
carriers such as AT&T and MCI to compensate payphone providers for each 800
number call placed. The regulation allows facilities-based carriers to seek to
recover these charges from their customers, including through future
contractual provisions with customers such as the Company.
State. The intrastate long distance telecommunications operations of
SmarTalk are subject to various state laws and regulations, including prior
certification, notification and/or registration requirements. In certain
states, prior regulatory approval may be required for changes in control of
telecommunications operations. The Company is currently subject to varying
levels of regulation in the states in which it provides card services (which
are generally considered "1+" services by the states). The vast majority of
states require SmarTalk to apply for certification to provide
telecommunications services, or at least to register or to be found exempt
from regulation, before commencing intrastate service. The vast majority of
the states require SmarTalk to file and maintain detailed tariffs listing
rates for intrastate service. Many states also impose various reporting
requirements and/or require prior approval for transfers of control of
certified carriers and assignments of carrier assets, including customer
bases, carrier stock offerings and incurrence by carriers of significant debt
obligations. Certificates of authority can generally be conditioned, modified,
canceled, terminated or revoked by state regulatory authorities for failure to
comply with state law and/or the rules, regulations and policies of the state
regulatory authorities. Fines and other penalties, including, for example, the
return of all monies received for intrastate traffic from residents of a
state, may be imposed for such violations.
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SmarTalk has made the filings and taken the actions it believes are
necessary to become certified or tariffed to provide intrastate card services
to customers throughout the U.S. The Company is certified to do business as a
foreign corporation in the 49 states outside of its state of incorporation,
and has received authorization to provide intrastate telecommunications
services in all states where certification is required. There can be no
assurance that the Company's provision of services in states where it is not
licensed or tariffed to provide such services will not have a Material Adverse
Effect. See "Risk Factors -- Regulation."
EMPLOYEES
As of October 1, 1996, the Company employed 39 persons on a full-time basis.
None of the Company's employees are members of a labor union or are covered by
a collective bargaining agreement. The Company believes that its relations
with its employees are good. The Company believes that its future success will
depend on its ability to attract and retain highly skilled and qualified
employees to meet management and other requirements from time to time.
FACILITIES
SmarTalk's principal executive offices are located in approximately 8,524
square feet of office space in Los Angeles, California under a lease expiring
January 10, 2002. SmarTalk also subleases from Pacific Bell Information
Services space to house the VoiceChoice Platform located in San Francisco. The
Company is currently engaged in negotiations to have the lease assigned to it
by Pacific Bell. In addition, the Company has commenced negotiations with the
landlord of the space to enter into a lease to replace the Company's
arrangements with Pacific Bell. The Company believes that other space is
available at a comparable monthly rent if its negotiations are unsuccessful.
The Company believes its facilities are suitable for the Company's current
needs.
LEGAL PROCEEDINGS
The Company is not aware of any pending legal proceedings against the
Company which, individually or in the aggregate, the Company expects to have a
Material Adverse Effect. The Company is, from time to time, involved in
regulatory proceedings before various public utilities commissions, as well as
before the FCC. See also "Risk Factors -- Limited Protection of Proprietary
Rights; Risk of Infringement."
PLAN OF OPERATION
SmarTalk intends to devote a majority of its efforts toward retail
distribution, expanding the number of retailers at which the SmarTalk Card is
sold, increasing the number of stores among retailers selling the SmarTalk
Card and adding points of sale at which customers can purchase the SmarTalk
Card within each store. In the next 12 months the Company expects to increase
its staff by adding employees to help manage the planned growth of the
Company. SmarTalk intends to develop an Internet home page and produce
television advertising in an effort to pursue additional direct response
opportunities. The Company plans to expand its sales force to include
representatives to focus on businesses. As part of its efforts to attract
businesses, SmarTalk plans to introduce voice mail, fax mail, conference
calling and international calling services by the end of 1997. The Company
anticipates that it will spend approximately $5 to $10 million to increase
capacity of the SmarTalk Platforms required to handle anticipated usage volume
and to provide enhanced features.
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MANAGEMENT
OFFICERS AND DIRECTORS
The executive and certain other key officers and directors of the Company
and their ages as of October 1, 1996 are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<C> <C> <S>
Robert H. Lorsch(1)........................ 46 Chairman of the Board of
Directors, President and
Chief Executive Officer
Richard M. Teich........................... 43 Executive Vice President
Glen Andrew Folck.......................... 32 Chief Financial Officer and
Vice President,
Finance/Operations
William H. Mackall......................... 64 Vice President, Sales and
Marketing
Ahmed O. Alfi(2)........................... 40 Director
Fred F. Fielding........................... 57 Director
Jeffrey I. Scheinrock...................... 45 Director
Lloyd S. Zeiderman(3)...................... 60 Director
</TABLE>
- --------
(1) Mr. Lorsch serves as a director of the Company pursuant to his own
designation under the Shareholders Agreement dated as of December 28, 1995
among the Company, Robert H. Lorsch and SmarTalk Partners (the
"Shareholders Agreement"). The Shareholders Agreement shall terminate upon
the consummation of the Offering.
(2) Mr. Alfi serves as a director of the Company pursuant to SmarTalk
Partners' designation under the Shareholders Agreement. The Shareholders
Agreement shall terminate upon consummation of the Offering.
(3) Mr. Zeiderman serves as a director of the Company pursuant to the
designation of a voting trust set forth in the Shareholders Agreement. The
Shareholders Agreement shall terminate upon consummation of the Offering.
Robert H. Lorsch co-founded the Company and has served as Chairman of the
Board of Directors, President and Chief Executive Officer of the Company since
its inception in October 1994. Prior to forming the Company, Mr. Lorsch served
as President of LCN, a full service advertising and sales promotion agency
formed by Mr. Lorsch in 1986 which specialized in interactive marketing on
behalf of corporate clients. On December 28, 1995, the Company purchased
certain of the assets of LCN. See "Certain Transactions."
Richard M. Teich co-founded the Company and has served as the Company's
Executive Vice President since January 1, 1996. From 1993 through 1995, Mr.
Teich designed, developed and implemented various advertising and teleservices
programs, including the implementation of interactive telephone sampling and
promotion programs for consumer products companies, while serving as a
consultant to LCN. From 1991 through 1992, Mr. Teich served as Vice President
of LCN.
Glen Andrew Folck has been the Company's Chief Financial Officer and Vice
President, Finance/Operations since January 15, 1996. From December 1993,
until joining the Company, Mr. Folck served as Director of Strategic Planning
for Harvard Industries, Inc., an automotive components manufacturer. From
March 1992 through December 1993, he was Manager, Corporate Accounting and
Financial Reporting, for Sonoco Products Company, a paper packaging
manufacturer. He served as Manager, Branch Accounting, for Premark
International, Inc., a diversified products manufacturer, from May 1990
through March 1992.
William H. Mackall has served as the Company's Vice President, Sales and
Marketing since June 1, 1996. Prior to joining the Company, from 1994 through
May 1996, Mr. Mackall was a private
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marketing and sales promotion consultant. From 1991 through 1994, he co-
founded and served as President of William Mackall & Associates, a full
service sales promotion agency.
Ahmed O. Alfi has been a director of the Company since 1996. Mr. Alfi has
served as the Chairman of the Board of Directors and Chief Executive Officer
of Alfigen, Inc., a prenatal diagnostic company, since January 1992. He also
co-manages Delphi Investments, Ltd., an investment management company which he
founded in 1987. Mr. Alfi currently serves as a director of Creative
Computers, Inc., a direct marketer of computer products. He is a member of
SmarTalk Partners. See "Principal and Selling Shareholders."
Fred F. Fielding has served as a director of the Company since 1996. Mr.
Fielding has been a Senior Partner with Wiley, Rein & Fielding in Washington
D.C. since 1986. From January 1981 to April 1986, Mr. Fielding was counsel to
the President of the United States. Currently, Mr. Fielding serves as a
director for USAir Shuttle, Inc.
Jeffrey I. Scheinrock has served as a director of the Company since 1996.
From March 1989 until June 1996, Mr. Scheinrock was the Vice Chairman of
Finance and Strategic Planning for Packard Bell Electronics Inc. As of July
1996, Mr. Scheinrock is the Vice Chairman of Kistler Aerospace.
Lloyd S. Zeiderman has served as a director of the Company since 1995. Since
1991, Mr. Zeiderman has managed New Vest Capital Corporation, a mortgage
portfolio firm, Nelson Equities, Inc., a real estate acquisitions and
management firm, and HCS Specialized Training Centers, LLC, a computer
training center. Additionally, he has managed three business management firms,
Zeiderman Management Corporation, Zeiderman, Friedman & LaRosa, Inc., and ZFL
Management, Inc.
BOARD OF DIRECTORS AND COMMITTEES
All directors hold office until the next annual meeting of the shareholders
or until their successors have been elected, subject to a director's earlier
death, resignation, retirement, disqualification or removal. There are no
family relationships between any of the directors or the executive officers of
the Company.
The Company's board of directors has established Audit and Compensation
Committees. The Audit Committee is responsible for reviewing and making
recommendations regarding the appointment of the Company's independent
auditors, the annual audit of the Company's financial statements and the
Company's internal accounting practices and policies. The current members of
the Audit Committee are Messrs. Alfi, Scheinrock and Zeiderman. The
Compensation Committee is responsible for making recommendations to the board
of directors regarding compensation arrangements for key employees and key
consultants of the Company and for administering the Company's stock option
plans. The current members of the Compensation Committee are Messrs. Fielding,
Scheinrock and Zeiderman.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Prior to July 1996, there was no Compensation Committee, and the entire
board of directors participated in deliberations regarding executive officer
compensation. During the fiscal year ended December 31, 1995, Mr. Lorsch was
an executive officer of the Company. During such period, no member of the
board of directors served as a director or a member of the Compensation
Committee of any other company of which any executive officer served as a
member of the board of directors.
Mr. Lorsch, the Company's Chairman of the Board, President and Chief
Executive Officer, is the sole shareholder of LCN, which was a marketing and
consulting firm. SmarTalk was formed in October 1994 and had no employees
until September 1995. From October 1994 through December 1995 LCN
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provided the Company with consulting and operational assistance. All of the
services of Mr. Lorsch and certain of the services of Mr. Teich (the Company's
present Executive Vice President) were provided to SmarTalk through LCN and
SmarTalk was billed on an hourly basis for their services. In addition, LCN
provided SmarTalk with assistance with product, platform, billing and software
development. For a limited period through the end of 1995, SmarTalk employees
were covered under LCN's benefit programs. The total amount paid by SmarTalk
to LCN for all these services was approximately $25,000 in 1994 and $415,000
in 1995.
In January 1996 the Company assumed a lease from LCN of office space owned
by Mr. Lorsch. Under this lease the Company paid rent to LCN totalling $11,226
in 1996. The Company no longer utilizes such space and the lease has been
terminated. The Company has paid $5,000 of a $10,000 lease cancellation fee to
LCN.
From February 17, 1995 to November 30, 1995, Mr. Lorsch advanced funds, from
time to time, to the Company. At no time during this period did the amount
owed by the Company to Mr. Lorsch exceed $42,200. These loans were repaid in
full by November 30, 1995. In addition, Mr. Lorsch was loaned $4,500 by the
Company in October 1994, which amount was repaid by the end of 1994.
On December 28, 1995, pursuant to a Loan and Investment Agreement among
SmarTalk Partners, the Company and Robert H. Lorsch, SmarTalk Partners agreed
to loan the Company $1,200,000, provide the Company with a $500,000 line of
credit and purchase shares of Common Stock of the Company representing 30% of
the outstanding shares for a purchase price of $300,000. The number of shares
purchased was 2,647,449, as adjusted for subsequent stock splits, and the
purchase price was determined on the basis of arms' length negotiations. This
loan, evidenced by a promissory note and secured by substantially all of the
assets of the Company, bears interest at 7% per annum. Interest only is
payable on the last day of the month through December 31, 1996 and thereafter
principal and interest shall be payable in equal fully amortizable monthly
installments until July 31, 2000, when all amounts are due and payable. The
line of credit, also evidenced by a promissory note and secured by
substantially all of the assets of the Company, bears interest at a floating
rate equal to prime rate plus 2%, payable monthly in arrears. All amounts
become due and payable in full on January 31, 1998. SmarTalk Partners is a
significant shareholder of the Company. Mr. Alfi, a director of the Company,
is a member of SmarTalk Partners. The Company intends to repay the loan and
the line of credit with the proceeds from the Offering. See "Principal and
Selling Shareholders" and "Use of Proceeds."
SmarTalk purchased certain of the office furniture and equipment fixed
assets of LCN (the "LCN Assets") pursuant to an agreement dated December 28,
1995 between SmarTalk and LCN. The purchase was consummated in January 1996
for $500,000 cash plus a $2,000,000 principal amount subordinated promissory
note which bears interest at 7% per annum, payable $35,000 a month beginning
August 31, 1996, with all amounts due and payable in full on June 30, 2000.
The LCN Assets were originally purchased by LCN for approximately $106,000 and
had a net book value of approximately $36,000 at the time of their purchase by
the Company. The substantial excess in the cost to the Company over the net
book value to LCN of the LCN Assets (which excess was approximately $2.46
million) was recorded as a charge to the Company's accumulated deficit in a
manner similar to a capital distribution. See Note 6 to the Notes to Financial
Statements. At the time of the purchase of the LCN Assets, Mr. Lorsch was the
sole shareholder of LCN and the Chairman of the Board, President and Chief
Executive Officer and majority shareholder of the Company. The Company did not
seek nor obtain a fairness opinion from an independent financial advisor with
respect to its purchase of the LCN Assets, but rather agreed upon the purchase
price thereof following negotiations with SmarTalk Partners, which was then
contemplating an investment in the Company. In addition, the shareholders of
the Company unanimously consented to the transaction. The Company intends to
repay the promissory note with the proceeds from the Offering. LCN is party to
a
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subordination agreement with the Company and SmarTalk Partners pursuant to
which LCN has agreed that no payments shall be made under the promissory note
unless all amounts under the $250,000 SmarTalk Partners loan (referred to
below) have been repaid in full. LCN received a security interest in
substantially all assets of the Company for agreeing to subordinate its
promissory note. See "Use of Proceeds" and "Certain Transactions."
On August 9, 1996, the Company entered into a loan agreement with SmarTalk
Partners pursuant to which the Company obtained a loan of $250,000. This loan
is collateralized by substantially all of the assets of the Company and
accrues interest at the prime rate. Interest on the loan is due the last day
of each month, commencing August 31, 1996, with the loan maturing on January
31, 1997. Payments of principal and interest on the $1,200,000 loan, the line
of credit, and the $2,000,000 term note are subordinated to, and may not be
made prior to the repayment of, the $250,000 term loan. The Company intends to
repay the $250,000 term loan with the proceeds from the Offering. See "Use of
Proceeds," "Certain Transactions" and "Principal and Selling Shareholders."
The Company has agreed to pay certain expenses of the Selling Shareholders,
including Mr. Lorsch and Mr. Zeiderman, a director of the Company, in
connection with this Offering. See "Principal and Selling Shareholders" and
"Underwriting."
DIRECTORS' COMPENSATION
All non-employee directors receive a directors fee of either $1,000 for each
board or committee meeting attended in person or $500 for each telephonic
meeting thereof. Non-employee directors are reimbursed for reasonable out-of-
pocket expenses incurred in connection with their attendance at board and
committee meetings. In addition, options to purchase 28,240 shares of Common
Stock for $3.56 per share were granted to each of Fred F. Fielding and Jeffrey
I. Scheinrock on June 11, 1996 pursuant to the Non-Qualified Plan (as defined
below). See "-- Stock Option Plans." With respect to the options granted to
each of Messrs. Fielding and Scheinrock, options to purchase 9,413 shares of
Common Stock will vest on June 11, 1997, options to purchase 9,413 shares of
Common Stock will vest on June 11, 1998 and options to purchase 9,414 shares
of Common Stock will vest on June 11, 1999. For the year ended December 31,
1995, Mr. Lorsch received directors' fees aggregating $5,500 for attending
eleven meetings of the board of directors.
EXECUTIVE COMPENSATION
The following table sets forth certain information concerning compensation
earned for services rendered in all capacities to the Company by the Company's
Chairman of the Board, President and Chief Executive Officer (the "named
executive officer"). No other officer of the Company had a total annual salary
and bonus which exceeded $100,000 during the year ended December 31, 1995.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
NAME SALARY
---- -------
<S> <C>
Robert H. Lorsch............................... $73,750
</TABLE>
This amount represents compensation for the final three months of 1995, the
payment of which was deferred until the first quarter of 1996. In addition,
Mr. Lorsch's services were provided to SmarTalk by LCN from October 1994
through September 1995, and thereafter certain of Mr. Lorsch's services were
provided by LCN through the end of the year. SmarTalk paid LCN certain amounts
including consulting fees for Mr. Lorsch's services. See "-- Directors'
Compensation" and "Certain Transactions."
EMPLOYMENT AGREEMENTS
The Company has entered into an employment agreement (the "Lorsch Employment
Agreement") with Robert H. Lorsch to serve as the President and Chief
Executive Officer. The Lorsch Employment Agreement provides for an initial
term of three years commencing on the date of the closing of the
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<PAGE>
Offering and contains a two year "evergreen" provision pursuant to which the
employment period will automatically be extended for consecutive periods of
two years unless the Company gives Mr. Lorsch written notice, no later than
one year prior to the expiration of the then applicable employment period,
that employment will terminate upon the expiration of that period.
Under the Lorsch Employment Agreement, Mr. Lorsch is entitled to an annual
base salary of $345,000 for each calendar year of the agreement and is to
receive a bonus based on the Company's operating results in the discretion of
the Compensation Committee. Pursuant to the Lorsch Employment Agreement, the
Company will provide Mr. Lorsch with certain other benefits, including life
and disability insurance, an automobile allowance and reimbursement for
ordinary business expenses. Mr. Lorsch is entitled to participate in benefits
available to employees and executive officers of the Company. Under the terms
of the Lorsch Employment Agreement, Mr. Lorsch has agreed not to compete with
the Company nor solicit SmarTalk employees on behalf of another person, firm
or entity in competition with the Company, during the term of his employment
and for one year after the effective date of termination.
If Mr. Lorsch's employment is terminated by the Company following a "change
in control" or "without cause" or by Mr. Lorsch for "good reason" (as such
terms are defined in the Lorsch Employment Agreement), Mr. Lorsch is entitled
to receive a payment equal to the then effective base salary for the longer of
(a) the remainder of the term of the Lorsch Employment Agreement and (b) 24
months (the "Lorsch Severance Period"), and the Company shall continue to
maintain Mr. Lorsch's benefits during the Lorsch Severance Period until
comparable benefits are obtained from another employer. In addition, Mr.
Lorsch's employment may be terminated by the Company "for cause" (as defined
in the Lorsch Employment Agreement), in which case Mr. Lorsch would not be
entitled to any further payments under the Lorsch Employment Agreement other
than amounts already earned.
The Company has entered into an employment agreement (the "Teich Employment
Agreement") with Richard M. Teich to serve as the Executive Vice President.
The Teich Employment Agreement provides for an initial term of two years
commencing on the date of the closing of the Offering and contains a one year
"evergreen" provision pursuant to which the employment period will be
automatically extended for consecutive periods of one year unless the Company
gives Mr. Teich written notice, no later than three months prior to the
expiration of the then applicable employment period, that employment will
terminate upon the expiration of that period.
Under the Teich Employment Agreement, Mr. Teich is entitled to an annual
base salary of $185,000 for each calendar year of the agreement and is to
receive a bonus based on the Company's operating results in the discretion of
the Compensation Committee. Pursuant to the Teich Employment Agreement, the
Company will provide Mr. Teich with certain other benefits, including life and
disability insurance, an automobile allowance and reimbursement for ordinary
business expenses. Mr. Teich is entitled to participate in benefits available
to employees and executive officers of the Company. Under the terms of the
Teich Employment Agreement, Mr. Teich has agreed not to compete with the
Company nor solicit SmarTalk employees on behalf of another person, firm or
entity in competition with the Company during the term of his employment and
for one year after the effective date of termination.
If Mr. Teich's employment is terminated by the Company following a "change
in control" or "without cause" or by Mr. Teich for "good reason" (as such
terms are defined in the Teich Employment Agreement), Mr. Teich is entitled to
receive a payment equal to the then effective base salary for the longer of
(a) the remainder of the term of the Teich Employment Agreement and (b) 24
months (the "Teich Severance Period"), and the Company shall continue to
maintain Mr. Teich's benefits during the Teich Severance Period until
comparable benefits are obtained from another employer. In addition,
46
<PAGE>
Mr. Teich's employment may be terminated by the Company "for cause" (as
defined in the Teich Employment Agreement), in which case Mr. Teich would not
be entitled to any further payments under the Teich Employment Agreement other
than amounts already earned.
STOCK OPTION PLANS
1996 NONQUALIFIED STOCK OPTION PLAN. In March 1996, the board of directors
adopted the Company's 1996 Nonqualified Stock Option Plan (the "Nonqualified
Plan"). The Nonqualified Plan provides for the granting of nonstatutory stock
options to employees, officers, directors, consultants, advisors or agents of
the Company. Pursuant to the Nonqualified Plan, an amount equal to (a) the
lesser of (i) 7,087,991 shares of Common Stock and (ii) the number of shares
of Common Stock equal to 9% of the then total issued and outstanding shares of
Common Stock minus (b) the number of shares of Common Stock issued or issuable
pursuant to options exercised or outstanding under the 1996 Plan (referred to
below) are reserved for issuance upon the exercise of options granted under
the Nonqualified Plan. The board of directors may amend, suspend or terminate
the Nonqualified Plan at any time. Upon completion of the Offering, however,
any amendment which would materially (1) increase the benefits accruing to
participants under the Nonqualified Plan, (2) increase the number of shares
which may be issued under the Nonqualified Plan, or (3) modify the
requirements for eligibility for participation in the Nonqualified Plan, must
be approved by the Company's shareholders. The number of shares available for
issuance under the Nonqualified Plan and the exercise price of options granted
may be adjusted to reflect certain corporate reorganizations and
recapitalizations in order to prevent an inequitable dilution or enlargement
of the rights of the participants in the Nonqualified Plan. The Nonqualified
Plan automatically terminates in March 2006 unless terminated earlier by the
board of directors. It is anticipated that the Nonqualified Plan will be
terminated upon consummation of the Offering.
The Nonqualified Plan is administered by the Compensation Committee. Subject
to the conditions of the Nonqualified Plan, the Compensation Committee, in its
discretion, selects the recipient of each option grant and the number of
shares of Common Stock each such option represents, as well as the terms and
conditions of each grant, including the vesting schedule, the exercise price,
the expiration or termination and the transferability of the options granted.
As of October 23, 1996, options to purchase 508,514 shares of Common Stock had
been granted. Of such amount, since January 1, 1996, options to purchase an
aggregate of 103,031 shares were granted under the Nonqualified Plan to
officers and directors at exercise prices ranging from $1.77 per share to
$4.44 per share. The Company anticipates that it will not issue any additional
options under the Nonqualified Plan.
1996 STOCK INCENTIVE PLAN. In August 1996, the board of directors adopted
and the shareholders of the Company approved the 1996 Stock Incentive Plan
(the "1996 Plan" and together with the Nonqualified Plan, the "Stock Option
Plans"). The 1996 Plan permits the Compensation Committee of the board of
directors to make awards to directors, employees, advisors and consultants of
the Company and its subsidiaries. The 1996 Plan provides for the grant of
stock options, including both incentive stock options and nonqualified
options, as well as stock appreciation rights, restricted stock, performance
shares and phantom stock, as described below. All awards under the 1996 Plan
are nontransferable by the participant, except upon the participant's death in
accordance with his will or applicable law. As of October 23, 1996, options to
purchase 2,000 shares of Common Stock had been granted. The total number of
shares of Common Stock or units or other rights that may be subject to options
and other types of awards granted in the future under the 1996 Plan to
officers, employees, advisors and consultants of the Company is not
determinable at this time.
Stock Options. The 1996 Plan authorizes the grant of nonqualified stock
options to employees, consultants and advisors of the Company and its
subsidiaries. Incentive stock options may only be granted to employees of the
Company and its subsidiaries. The exercise price of a nonqualified stock
option may be determined by the Compensation Committee in its discretion. The
exercise price of an
47
<PAGE>
incentive stock option may not be less than the fair market value of the
Common Stock on the date of grant. The value of Common Stock (determined at
the time of grant) that may be subject to incentive stock options that become
exercisable by any one employee in any one year is limited by the Internal
Revenue Code of 1986, as amended, to $100,000. The maximum term of stock
options granted under the 1996 Plan is 10 years from the date of grant. The
Compensation Committee shall determine the extent to which an option shall
become and/or remain exercisable in the event of the termination of employment
or service of a participant under certain circumstances, including retirement,
death or disability, subject to certain limitations for incentive stock
options. Under the 1996 Plan, the exercise price of an option is payable by
the participant in cash or, in the discretion of the Compensation Committee,
in Common Stock or a combination of cash and Common Stock.
Stock Appreciation Rights. A stock appreciation right may be granted in
connection with an option, either at the time of grant or at any time
thereafter during the term of the option. A stock appreciation right granted
in connection with an option entitles the holder, upon exercise, to surrender
the related option and receive a payment based on the difference between the
exercise price of the related option and the fair market value of the
Company's Common Stock on the date of exercise. A stock appreciation right
granted in connection with an option is exercisable only at such time or times
as the related option is exercisable and expires no later than the related
option expires. A stock appreciation right also may be granted without
relationship to an option and will be exercisable as determined by the
Compensation Committee, but in no event after 10 years from the date of grant.
A stock appreciation right granted without relationship to an option entitles
the holder, upon exercise, to a payment based on the difference between the
base price assigned to the stock appreciation right by the Compensation
Committee on the date of grant and the fair market value of the Company's
Common Stock on the date of exercise. Payment to the holder in connection with
the exercise of a stock appreciation right may be in cash or shares of Common
Stock or in a combination of cash and Common Stock.
Restricted Stock Awards. The Compensation Committee may award shares of
Common Stock to participants under the 1996 Plan, subject to such restrictions
on transfer and conditions of forfeiture as it deems appropriate. Such
conditions may include requirements as to the continued service of the
participant with the Company, the attainment of specified performance goals or
any other conditions determined by the Compensation Committee. Subject to the
transfer restrictions and forfeiture restrictions relating to the restricted
stock award, the participant will otherwise have the rights of a shareholder
of the Company, including all voting and dividend rights, during the period of
restriction.
Performance Awards. The Compensation Committee may grant performance awards
denominated in specified dollar units ("Performance Units") or in shares of
Common Stock. Performance awards are payable upon the achievement of
performance goals established by the Compensation Committee at the beginning
of the performance period, which may not exceed ten years from the date of
grant. At the time of grant, the Compensation Committee establishes the number
of units or shares, the duration of the performance period, the applicable
performance goals and, in the case of Performance Units, the potential payment
or range of payments for the performance awards. At the end of the performance
period, the Compensation Committee determines the payment to be made based on
the extent to which the performance goals have been achieved. The Compensation
Committee may consider significant unforeseen events during the performance
period when making the final award. Payments may be made in cash or shares of
Common Stock or in a combination of cash and shares.
Phantom Stock. An award of phantom stock gives the participant the right to
receive cash at the end of a fixed vesting period based on the value of a
share of Common Stock at that time. Phantom stock units are subject to such
restrictions and conditions to payment as the Compensation Committee
determines are appropriate. At the time of grant, the Compensation Committee
determines, in its sole discretion, the number of units and the vesting period
of the units, and it may also set a maximum
48
<PAGE>
value of a unit. If the participant remains employed by the Company throughout
the applicable vesting period, he is entitled to receive payment of a cash
amount for each phantom stock unit equal in value to the fair market value of
one share of Common Stock on the last day of the vesting period, subject to
any maximum value limitation.
Administration. The 1996 Plan shall be administered by the Compensation
Committee of the board of directors, or such other Compensation Committee as
may be appointed by the board. Subject to the limitations set forth in the
1996 Plan, the Compensation Committee has the authority to determine the
persons to whom awards will be granted, the time at which awards will be
granted, the number of shares, units or other rights subject to each award,
the exercise, base or purchase price of an award (if any), the time or times
at which the award will become vested, exercisable or payable and the duration
of the award. The Compensation Committee may provide for the acceleration of
the vesting or exercise period of an award at any time prior to its
termination or upon the occurrence of specified events. With the consent of
the affected participant, the Compensation Committee has the authority to
cancel and replace awards previously granted with new options for the same or
a different number of shares and having a higher or lower exercise or base
price, and may amend the terms of any outstanding awards to provide for an
exercise or base price that is higher or lower than the current exercise or
base price.
Reservation of Shares. The Company has authorized and reserved a number of
shares of Common Stock for issuance under the 1996 Plan equal to (a) the
lesser of (i) 7,087,991 shares of Common Stock and (ii) the number of shares
of Common Stock equal to 9% of the then total issued and outstanding shares of
Common Stock minus (b) the number of shares of Common Stock issued or issuable
pursuant to options exercised or outstanding under the Nonqualified Plan. If
any shares of Common Stock that are the subject of an award are not issued or
transferred and cease to be issuable or transferable for any reason, such
shares will no longer be charged against such maximum share limitation and may
again be made subject to awards under the 1996 Plan. In the event of certain
corporate reorganizations, recapitalizations, or other specified corporate
transactions affecting the Company or the Common Stock, proportionate
adjustments may be made to the number of shares available for grant and to the
number of shares and prices under outstanding awards made before the event.
Term and Amendment. The 1996 Plan has a term of 10 years, subject to earlier
termination or amendment by the board of directors. All awards granted under
the 1996 Plan prior to its termination remain outstanding until exercised,
paid or terminated in accordance with their terms. The board of directors may
amend the 1996 Plan at any time, except that shareholder approval is required
for certain amendments to the extent necessary for purposes of Rule 16b-3
under the Securities Exchange Act of 1934, as amended (the "Exchange Act.")
Tax Consequences. The following is a general description of the current
federal income tax consequences to participants and the Company relating to
options and other awards that may be granted under the 1996 Plan. This
discussion does not purport to cover all tax consequences relating to options
or other awards.
The grant of a stock option under the 1996 Plan will not generally result in
taxable income for the participant, nor in a deductible compensation expense
for the Company, at the time of grant. The participant will have no taxable
income upon exercising an incentive stock option (except that the alternative
minimum tax may apply), and the Company will receive no deduction when an
incentive stock option is exercised. Upon exercising a nonqualified option,
the participant will recognize ordinary income in the amount by which the fair
market value of the Common Stock on the date of exercise exceeds the exercise
price, and the Company will generally be entitled to a corresponding
deduction. The treatment of a participant's disposition of shares of Common
Stock acquired upon the exercise of an option is dependent upon the length of
time the shares have been held and on whether such shares
49
<PAGE>
were acquired by exercising an incentive stock option or a nonqualified
option. Generally, there will be no tax consequence to the Company in
connection with the disposition of shares acquired under an option except that
the Company may be entitled to a deduction in the case of a disposition of
shares acquired upon exercise of an incentive stock option before the
applicable incentive stock option holding period has been satisfied.
The current federal income tax consequences of other awards authorized under
the 1996 Plan generally follow certain basic patterns: stock appreciation
rights are subjected to income tax upon exercise in substantially the same
manner as nonqualified stock options; restricted stock subject to a
substantial risk of forfeiture results in income recognition equal to the
excess of the fair market value of the stock over the purchase price (if any)
only at the time the restrictions lapse, unless the recipient elects to
accelerate recognition as of the date of grant; performance awards and phantom
stock generally are subject to tax at the time of payment. In each of the
foregoing cases, the Company generally has a corresponding tax deduction at
the time the participant recognizes taxable income.
CERTAIN TRANSACTIONS
Mr. Lorsch, the Company's Chairman of the Board, President and Chief
Executive Officer, is the sole shareholder of LCN, which was a marketing and
consulting firm. SmarTalk was formed in October 1994 and had no employees
until September 1995. From October 1994 through December 1995 LCN provided the
Company with consulting and operational assistance. All of the services of
Mr. Lorsch and certain of the services of Mr. Teich (the Company's present
Executive Vice President) were provided to SmarTalk through LCN and SmarTalk
was billed on an hourly basis for their services. In addition, LCN provided
SmarTalk with assistance with product, platform, billing and software
development. For a limited period through the end of 1995, SmarTalk employees
were covered under LCN's benefit programs. The total amount paid by SmarTalk
to LCN for all these services was approximately $25,000 in 1994 and $415,000
in 1995.
In January 1996, the Company assumed a lease from LCN of office space owned
by Mr. Lorsch. Under this lease the Company paid rent to LCN totalling $11,226
in 1996. The Company no longer utilizes such space and the lease has been
terminated. The Company has paid $5,000 of a $10,000 lease cancellation fee to
LCN.
From February 17, 1995 to November 30, 1995, Mr. Lorsch advanced funds, from
time to time, to the Company. At no time during this period did the amount
owed by the Company to Mr. Lorsch exceed $42,200. These loans were repaid in
full by November 30, 1995. In addition, Mr. Lorsch was loaned $4,500 by the
Company in October 1994, which amount was repaid by the end of 1994.
On December 28, 1995, pursuant to a Loan and Investment Agreement among
SmarTalk Partners, the Company and Robert H. Lorsch, SmarTalk Partners agreed
to loan the Company $1,200,000, provide the Company with a $500,000 line of
credit and purchase shares of Common Stock of the Company representing 30% of
the outstanding shares for a purchase price of $300,000. The number of shares
purchased was 2,647,449, as adjusted for subsequent stock splits, and the
purchase price was determined on the basis of arm's length negotiations. This
loan, evidenced by a promissory note and secured by substantially all of the
assets of the Company, bears interest at 7% per annum. Interest only is
payable on the last day of the month through December 31, 1996 and thereafter
principal and interest shall be payable in equal fully amortizable monthly
installments until July 31, 2000, when all amounts are due and payable. The
line of credit, also evidenced by a promissory note and secured by
substantially all of the assets of the Company, bears interest at a floating
rate equal to prime rate plus 2%, payable monthly in arrears. All amounts
become due and payable in full on January 31, 1998. SmarTalk Partners is a
significant shareholder of the Company. Mr. Alfi, a director of the Company,
is a member of SmarTalk Partners. The Company intends to repay
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<PAGE>
the loan and the line of credit with the proceeds from the Offering. See
"Principal and Selling Shareholders," "Management -- Compensation Committee
Interlocks and Insider Participation" and "Use of Proceeds."
SmarTalk purchased the LCN Assets pursuant to an agreement dated December 28,
1995 between SmarTalk and LCN. The purchase was consummated in January 1996,
for $500,000 cash plus a $2,000,000 principal amount subordinated promissory
note which bears interest at 7% per annum, payable $35,000 a month, with all
amounts due and payable in full on June 30, 2000. The LCN Assets were
originally purchased by LCN for approximately $106,000 and had a net book value
of approximately $36,000 at the time of their purchase by the Company. The
substantial excess in the cost to the Company over the net book value to LCN of
the LCN Assets (which excess was approximately $2.46 million) was recorded as a
charge to the Company's accumulated deficit in a manner similar to a capital
distribution. See Note 6 to the Notes to Financial Statements. At the time of
the purchase of the LCN Assets, Mr. Lorsch was the sole shareholder of LCN and
the Chairman of the Board, President and Chief Executive Officer and majority
shareholder of the Company. The Company did not seek nor obtain a fairness
opinion from an independent financial advisor with respect to its purchase of
the LCN Assets, but rather agreed upon the purchase price thereof following
negotiations with SmarTalk Partners, which was then contemplating an investment
in the Company. In addition, the shareholders of the Company unanimously
consented to the transaction. The Company intends to repay the promissory note
with the proceeds from the Offering. LCN is party to a subordination agreement
with the Company and SmarTalk Partners pursuant to which LCN has agreed that no
payments shall be made under the promissory note unless all amounts under the
$250,000 SmarTalk Partners loan (referred to below) have been repaid in full.
LCN received a security interest in substantially all assets of the Company for
agreeing to subordinate its promissory note. See "Use of Proceeds" and
"Management -- Compensation Committee Interlocks and Insider Participation."
On August 9, 1996, the Company entered into a loan agreement with SmarTalk
Partners pursuant to which the Company obtained a loan of $250,000. This loan
is collateralized by substantially all of the assets of the Company and accrues
interest at the prime rate. Interest on the loan is due the last day of each
month, commencing August 31, 1996, with the loan maturing on January 31, 1997.
Payments of principal and interest on the $1,200,000 loan, the line of credit,
and the $2,000,000 term note are subordinated to, and may not be made prior to
the repayment of, the $250,000 term loan. The Company intends to repay the
$250,000 term note with the proceeds from the Offering. See "Use of Proceeds,"
"Management -- Compensation Committee Interlocks and Insider Participation" and
"Principal and Selling Shareholders."
The Company has agreed to pay certain expenses of the Selling Shareholders,
including Mr. Lorsch, Mr. Zeiderman, Mr. Folck, Mr. Teich and SmarTalk
Partners, in connection with this Offering. See "Principal and Selling
Shareholders" and "Underwriting."
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<PAGE>
PRINCIPAL AND SELLING SHAREHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of Common Stock as of October 1, 1996, the number of shares being
offered hereby and the beneficial ownership of the Common Stock upon
consummation of the Offering by: (i) the named executive officer, (ii) each
person known to the Company to be the beneficial owner of more than 5% of the
Common Stock, (iii) each director, (iv) all directors and executive officers
of the Company as a group and (v) the Selling Shareholders. The following
table assumes that the Underwriters' over-allotment option will be exercised
in full.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED PRIOR TO OWNED AFTER
OFFERING(1)(2) NUMBER OFFERING
----------------------- OF SHARES -----------------------
NAME AND ADDRESS OF BENEFICIAL OWNER NUMBER PERCENT OFFERED(3) NUMBER PERCENT
------------------------------------ ------------ ---------- ---------- ------------ ----------
<S> <C> <C> <C> <C> <C>
Robert H. Lorsch(4)
1640 South Sepulveda Boulevard, Suite 500
Los Angeles, CA 90025................................. 5,868,515 66.5% 425,125 5,443,390 42.4%
SmarTalk Partners, LLC(5)(6)
3 Civic Plaza, Suite 17D
Newport Beach, CA 92660............................... 2,647,449 30.0% 380,000 2,267,449 17.7%
Ahmed O. Alfi(6)......................................... -- -- -- -- --
Fred F. Fielding(7)...................................... -- -- -- -- --
Jeffrey I. Scheinrock(8)................................. -- -- -- -- --
Lloyd S. Zeiderman(9).................................... 477,632 5.4% 20,250 457,382 3.6%
Bruce Bielinski(10)...................................... 308,870 3.5% 20,250 288,620 2.2%
Glen Andrew Folck(11).................................... 14,120 * 4,625 9,495 *
Richard M. Teich(10)..................................... 308,870 3.5% 20,250 288,620 2.2%
Bernard D. Walter(10)(12)................................ 123,548 1.4% 4,625 118,923 *
All directors and executive officers as a group
(8 persons)(4)(6)(7)(8)(9)(10)(11)(13).................. 6,191,505 70.0% 450,000 5,741,505 44.7%
</TABLE>
- -------
* Less than one percent
(1) In accordance with Rule 13d-3 under the Exchange Act, a person is deemed
to be a "beneficial owner" of a security if he or she has or shares the
power to vote or direct the voting of such security or the power to
dispose or direct the disposition of such security. A person is also
deemed to be a beneficial owner of any securities of which that person
has the right to acquire beneficial ownership within 60 days. More than
one person may be deemed to be a beneficial owner of the same securities.
(2) This table is based upon information supplied by directors, executive
officers and principal shareholders. Unless otherwise indicated in the
footnotes to this table, each of the shareholders named in this table has
sole voting and investment power with respect to the shares shown as
beneficially owned.
(3) The Selling Shareholders have granted the Underwriters an over-allotment
option to purchase up to 630,000 shares of Common Stock. See
"Underwriting." Of the 380,000 shares to be offered by SmarTalk Partners,
200,000 shares are to be offered as part of the Offering and up to an
aggregate of 180,000 shares will be offered in the event the
Underwriters' over-allotment option is exercised. If the Underwriters'
over-allotment option is not exercised, then SmarTalk Partners would
beneficially own 2,447,449 shares, representing 19.1% of the Common Stock
after consummation of the Offering.
(4) Includes 926,610 shares prior to the consummation of the Offering and
881,485 shares after the consummation of the Offering as to which
Mr. Lorsch, pursuant to certain proxy agreements, has sole voting power,
but not investment power. These proxy agreements expire on November 1,
1996. Includes 168,762 shares held by the 1996 JBL Trust, the beneficiary
of which is Mr. Lorsch's son. Mr. Lorsch disclaims beneficial ownership
of the shares.
(5) Amre Youness may be deemed the beneficial owner of the shares owned by
SmarTalk Partners by virtue of his status as its sole manager. His
business address is c/o SmarTalk Partners, 3 Civic Plaza, Suite 17D,
Newport Beach, CA 92660.
(6) Mr. Alfi, a director of the Company, is a member of SmarTalk Partners.
Mr. Alfi disclaims beneficial ownership of the shares owned by SmarTalk
Partners.
(7) Mr. Fielding was granted options to purchase 28,240 shares of Common
Stock, at an exercise price of $3.56 per share, pursuant to the
Nonqualified Plan. Such options will not vest within 60 days of this
Offering. See "Management -- Directors' Compensation."
(8) Mr. Scheinrock was granted options to purchase 28,240 shares of Common
Stock, at an exercise price of $3.56 per share, pursuant to the
Nonqualified Plan. Such options will not vest within 60 days of this
Offering. See "Management -- Directors' Compensation."
(9) Includes 168,762 shares held by the 1996 JBL Trust, of which Mr.
Zeiderman is trustee. Accordingly, Mr. Zeiderman may be deemed to
beneficially own such shares.
(10) Represents shares subject to proxy agreements which grant Mr. Lorsch sole
voting power with respect to such shares. The proxy agreements expire
November 1, 1996.
(11) Includes 9,495 shares of Common Stock that Mr. Folck has the right to
purchase within 60 days of this Offering pursuant to options.
(12) Includes 92,660 shares held by Walter and Associates, of which Mr. Walter
is a principal. Accordingly, Mr. Walter may be deemed to beneficially own
such shares.
(13) Two of the Company's executive officers were granted options to purchase
11,251 and 14,120 shares of Common Stock, at exercise prices of $4.44 per
share and $1.77 per share, respectively, pursuant to the Nonqualified
Plan. Such options will not vest within 60 days of this Offering.
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<PAGE>
DESCRIPTION OF CAPITAL STOCK
GENERAL
The authorized capital stock of the Company consists of 100,000,000 shares
of Common Stock, no par value, and 10,000,000 shares of Preferred Stock, no
par value. As of October 23, 1996, there were 8,829,459 shares of Common Stock
issued and outstanding held by 12 shareholders of record and no shares of
Preferred Stock issued and outstanding. As of October 23, 1996, there were
505,889 shares of Common Stock subject to stock options.
The following statements are brief summaries of certain provisions with
respect to the Company's capital stock contained in its Articles and Bylaws,
copies of which have been filed as exhibits to the Registration Statement. The
following is qualified in its entirety by reference thereto.
COMMON STOCK
The holders of Common Stock are entitled to one vote per share on all
matters to be voted on by shareholders and have cumulative voting rights with
respect to the election of directors. Subject to the prior rights of holders
of Preferred Stock, if any, the holders of Common Stock are entitled to
receive such dividends, if any, as may be declared from time to time by the
board of directors in its discretion from funds legally available therefor.
Upon liquidation or dissolution of the Company, the remainder of the assets of
the Company will be distributed ratably among the holders of Common Stock
after payment of liabilities and the liquidation preferences of any
outstanding shares of Preferred Stock. The Common Stock has no preemptive or
other subscription rights and there are no conversion rights or redemption or
sinking fund provisions with respect to such shares. All of the outstanding
shares of Common Stock are, and the shares to be sold in this Offering will
be, fully paid and nonassessable.
PREFERRED STOCK
The Company is authorized to issue 10,000,000 shares of undesignated
Preferred Stock. The board of directors has the authority to issue the
Preferred Stock in one or more series and to fix the rights, preferences,
privileges and restrictions thereof, including dividend rights, dividend
rates, conversion rights, voting rights, preemption rights, terms of
redemption, redemption prices, sinking fund provisions, liquidation
preferences and the number of shares constituting a series or the designation
of such series, without further vote or action by the shareholders. The
issuance of Preferred Stock may have the effect of delaying, deferring or
preventing a change in control of the Company without further action by the
shareholders and may adversely effect the market price of, and the voting and
other rights of, the holders of Common Stock. At present, the Company has no
shares of Preferred Stock outstanding and has no plans to issue any shares of
the Preferred Stock.
REGISTRATION RIGHTS
SmarTalk Partners, the holder of 2,447,449 shares of Common Stock following
the Offering (the "Registrable Shares"), is entitled to certain rights with
respect to the registration of such shares of Common Stock under the
Securities Act. If the Company proposes to register any of its securities
under the Securities Act for its own account, the Company must notify SmarTalk
Partners of the Company's intent to register such Common Stock and allow
SmarTalk Partners an opportunity to include the Registerable Shares in the
Company's registration. SmarTalk Partners also has the right, from and after
such time as the Company has closed an initial public offering of its Common
Stock, to require the Company to prepare and file a registration statement
under the Securities Act pertaining to the Registerable Shares. The Company is
required to use its best efforts to effect such registration so long as such
request relates to Registrable Shares constituting 5% or more of the Company's
issued and outstanding Common Stock. The Company need only cause one such
registration to become
53
<PAGE>
effective during any one year period. These registration rights are subject to
certain limitations and restrictions including the right of the underwriters
of any offering of the Company's Common Stock to limit the number of
Registerable Shares included in the registration. Generally, the Company is
required to pay all registration expenses in connection with each registration
of Registrable Shares pursuant to these registration rights. SmarTalk Partners
has agreed that, in any registration in which it is participating effected
pursuant to an underwritten public offering, it will not effect any public
sale or distribution of any Registerable Shares or any other equity security
of the Company within seven days prior to and for 120 days after the effective
date of such registration. SmarTalk Partners has agreed to a limitation on its
ability to sell or distribute shares of Common Stock and other securities for
180 days after the date of this Prospectus, without the prior written consent
of Salomon Brothers Inc. See "Underwriting."
CERTAIN PROVISIONS OF THE COMPANY'S ARTICLES AND BYLAWS
Certain provisions of the Company's Articles and Bylaws may have the effect
of making it more difficult for a third party to acquire, or of discouraging a
third party from attempting to acquire, control of the Company. Such
provisions could limit the price that certain investors might be willing to
pay in the future for shares of the Common Stock. Certain of these provisions
allow the Company to issue Preferred Stock without any vote or further action
by the shareholders, to eliminate the right of shareholders to act by written
consent without a meeting and to eliminate cumulative voting in the election
of directors. The authorization of undesignated Preferred Stock makes it
possible for the board of directors to issue Preferred Stock with voting or
other rights or preferences that could impede the success of any attempt to
change control of the Company. These provisions may also make it more
difficult for shareholders to take certain corporate actions.
LIMITATION ON LIABILITY AND INDEMNIFICATION
The Company has adopted provisions in its Articles that eliminate, to the
fullest extent permissible under California law, the liability of its
directors to the Company for monetary damages. Such limitation of liability
does not affect the availability of equitable remedies such as injunctive
relief or rescission. The Company's Bylaws provide that the Company shall
indemnify its directors and officers to the fullest extent permitted by
California law, including in circumstances in which indemnification is
otherwise discretionary under California law. The Company has entered into
indemnification agreements with its officers and directors containing
provisions which may require the Company, among other things, to indemnify the
officers and directors against certain liabilities that may arise by reason of
their status or service as directors or officers (other than liabilities
arising from willful misconduct of a culpable nature), and to advance their
expenses incurred as a result of any proceeding against them as to which they
could be indemnified.
TRANSFER AGENT
The transfer agent and registrar for the Company's Common Stock is U. S.
Stock Transfer Corporation.
54
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this Offering, the Company will have 12,829,459 shares of
Common Stock outstanding. Of these shares, the 4,200,000 shares sold in this
Offering will be freely tradeable without restriction or further registration
under the Securities Act, except for shares purchased by "affiliates" of the
Company, as that term is defined in Rule 144 under the Securities Act (which
may generally be sold only in compliance with Rule 144).
The remaining 8,629,459 shares are deemed "Restricted Shares" under Rule 144
in that they were originally issued and sold by the Company in private
transactions in reliance upon exemptions from the registration provisions of
the Securities Act. Upon the expiration of the 180-day lock-up agreements
described below, none of the Restricted Shares will be eligible for sale
pursuant to Rule 144 until the expiration of two years from the date such
Restricted Shares were acquired.
In addition to the Restricted Shares described in the preceding paragraph,
the approximately 9,495 shares of Common Stock which may be acquired 180 days
after the effective date of this Offering upon the exercise of currently
outstanding stock options are subject to the 180-day lock-up agreements but
may be eligible for resale following the expiration of the 180-day lock-up
agreements (subject, in the case of affiliates, to certain limitations)
pursuant to Rule 701 under the Securities Act. See "Management -- Stock Option
Plans" and "Underwriting." Additional options will continue to vest and may be
exercised and sold from time to time by option holders following the
expiration of the 180-day lock-up agreements.
The Company, its directors and officers and substantially all of the other
shareholders of the Company, who upon completion of the Offering will own in
the aggregate 8,629,459 shares of Common Stock, as well as the holder of
currently outstanding options to purchase 9,495 additional shares of Common
Stock, have entered into "lock-up" agreements with the Underwriters, providing
that they will not offer, sell, loan, pledge, grant any option to purchase or
otherwise dispose of any of their shares of Common Stock, or any securities
exercisable for or convertible into shares of Common Stock or request the
registration to any of the foregoing, for a period of 180 days after the date
of this Prospectus without the prior written consent of Salomon Brothers Inc,
except that the Company may issue and may grant options to purchase and
register shares of Common Stock under the Stock Option Plans. See
"Underwriting."
In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated), including persons deemed to be affiliates, whose
Restricted Shares have been fully paid for and held for at least two years
from the date of issuance by the Company may sell such securities in brokers'
transactions or directly to market makers, provided the number of shares sold
in any three month period does not exceed the greater of (i) 1% of the then
outstanding shares of the Common Stock (128,295 shares based on the number of
shares to be outstanding after this Offering) or (ii) the average weekly
trading volume in the public market during the four calendar weeks immediately
preceding the filing of the seller's Form 144. Sales under Rule 144 are also
subject to certain notice requirements and the availability of current public
information concerning the Company. After three years have elapsed from the
issuance of Restricted Shares by the Company, such shares generally may be
sold without limitation by persons who have not been affiliates of the Company
for at least three months. Rule 144 also provides that affiliates who are
selling shares which are not Restricted Shares must nonetheless comply (with
the exception of the holding period requirements) with the same restrictions
applicable to Restricted Shares.
In general, under Rule 701 as currently in effect, any employee, officer,
director, consultant or advisor of the Company who purchased shares from the
Company pursuant to a written compensatory benefit plan or written contract
relating to compensation is eligible to resell such shares 90 days after the
effective date of this Offering in reliance upon Rule 144, but without the
requirement to comply
55
<PAGE>
with certain restrictions contained in such rule. Shares obtained pursuant to
Rule 701 may be sold by non-affiliates without regard to the holding period,
volume limitations, or information or notice requirements of Rule 144, and by
affiliates without regard to the holding period requirements.
The Company intends to file Form S-8 registration statements under the
Securities Act to register all shares of Common Stock issuable under its Stock
Option Plans, as well as certain of the shares of Common Stock previously
issued under its Stock Option Plans. These registration statements are
expected to be filed as soon as practicable after the date of this Prospectus
and are expected to become effective immediately upon filing. Shares covered
by these registration statements will be eligible for sale in the public
market after the effective date of such registration statements subject to
Rule 144 limitations applicable to affiliates of the Company. See
"Management -- Stock Option Plans."
The Company has granted registration rights to certain of its shareholders.
See "Description of Capital Stock -- Registration Rights."
Prior to the Offering, there has been no public market for the Common Stock
and it is impossible to predict with certainty the effect, if any, that market
sales of shares or the availability of such shares for sale will have on the
market price of the Common Stock. Nevertheless, sales of substantial amounts
of Common Stock in the public market may have an adverse impact on such market
price and could impair the Company's ability to raise capital through the sale
of its equity securities.
56
<PAGE>
UNDERWRITING
Subject to the terms and the conditions set forth in the Underwriting
Agreement, the Company has agreed to sell to each of the Underwriters named
below (the "Underwriters"), for whom Salomon Brothers Inc ("Salomon"), CS
First Boston Corporation and Donaldson, Lufkin & Jenrette Securities
Corporation are acting as representatives (the "Representatives"), and each of
the Underwriters has severally agreed to purchase from the Company, the
respective number of shares of Common Stock set forth opposite its name below:
<TABLE>
<CAPTION>
NUMBER OF SHARES
UNDERWRITERS TO BE PURCHASED
------------ ----------------
<S> <C>
Salomon Brothers Inc..................................... 790,000
CS First Boston Corporation.............................. 790,000
Donaldson, Lufkin & Jenrette Securities Corporation...... 790,000
Bear, Stearns & Co. Inc. ................................ 90,000
Alex. Brown & Sons Incorporated.......................... 90,000
Dean Witter Reynolds Inc. ............................... 90,000
Dillon, Read & Co. Inc. ................................. 90,000
A.G. Edwards & Sons, Inc................................. 90,000
Lehman Brothers Inc...................................... 90,000
Merrill Lynch, Pierce, Fenner & Smith Incorporated....... 90,000
Montgomery Securities.................................... 90,000
Oppenheimer & Co., Inc................................... 90,000
PaineWebber Incorporated................................. 90,000
Robertson, Stephens & Company............................ 90,000
J.C. Bradford & Co. ..................................... 65,000
EVEREN Securities, Inc................................... 65,000
Fahnestock & Co. Inc..................................... 65,000
Jefferies & Company, Inc................................. 65,000
McDonald & Company Securities, Inc. ..................... 65,000
Raymond James & Associates, Inc. ........................ 65,000
The Robinson-Humphrey Company, Inc. ..................... 65,000
Sutro & Co. Incorporated................................. 65,000
Advest, Inc. ............................................ 40,000
Crowell, Weedon & Co..................................... 40,000
First Albany Corporation................................. 40,000
Gerard Klauer Mattison & Co., LLC........................ 40,000
Hanifen, Imhoff Inc. .................................... 40,000
Pennsylvania Merchant Group Ltd.......................... 40,000
Ragen Mackenzie Incorporated............................. 40,000
The Seidler Companies Incorporated....................... 40,000
---------
Total.................................................... 4,200,000
=========
</TABLE>
In the Underwriting Agreement, the several Underwriters have agreed, subject
to the terms and conditions set forth therein, to purchase all of the shares
of Common Stock offered hereby (other than those subject to the over-allotment
option described below) if any such shares are purchased. In the event of a
default by any Underwriter, the Underwriting Agreement provides that, in
certain circumstances, purchase commitments of the non-defaulting Underwriters
may be increased or the Underwriting Agreement may be terminated.
57
<PAGE>
The Company has been advised by the Representatives that the several
Underwriters propose initially to offer such stock to the public at the public
offering price set forth on the cover page of this Prospectus, and to certain
dealers at such price less a concession not in excess of $0.61 per share. The
Underwriters may allow and such dealers may reallow a concession not in excess
of $0.10 per share to other dealers. After the public offering, the public
offering price and such concessions may be changed.
The Selling Shareholders have granted to the Underwriters an option,
exercisable within 30 days of the date of the Prospectus, to purchase up to
630,000 additional shares of Common Stock at the price to public less the
underwriting discounts set forth on the cover page of this Prospectus to cover
over-allotments, if any. To the extent that the Underwriters exercise such
option, in whole or part, each of the Underwriters will be committed, subject
to certain conditions, to purchase the same proportion of such additional
shares of Common Stock as the number of shares of Common Stock to be purchased
and offered by such Underwriter in the above table bears to the total number
of shares of Common Stock initially offered by the Underwriters hereby.
The Underwriting Agreement provides that the Company and the Selling
Shareholders will indemnify the several Underwriters against certain
liabilities, including liabilities under the Securities Act, or contribute to
payments the Underwriters may be required to make in respect thereof.
The Company, the Selling Shareholders and the Company's directors and
executive officers have agreed not to offer, sell or contract to sell, or
otherwise dispose of, directly or indirectly, or announce the offering of any
other shares of Common Stock or any securities convertible into, or
exchangeable for, shares of Common Stock for a period of 180 days after the
date of this Prospectus, without the prior written consent of Salomon.
The Representatives have informed the Company and the Selling Shareholders
that they do not expect discretionary sales by the Underwriters to exceed 5%
of the shares offered hereby.
At the request of the Company, the Underwriters have reserved up to 210,000
shares of Common Stock for sale at the initial public offering price to
directors, officers, employees and persons with business relationships with
the Company, as well as others associated with such persons. The number of
shares of Common Stock available for sale to the general public will be
reduced to the extent such persons purchase the reserved shares. Any reserved
shares not so purchased will be offered by the Underwriters on the same basis
as all other shares offered hereby.
Prior to the Offering, there has been no public market for the Common Stock.
The initial public offering price for the Common Stock offered hereby was
determined by negotiation among the Company, the Selling Shareholders and the
Representatives. Among the factors that were considered in determining the
initial public offering price were the earnings and certain other financial
and operating information of the Company in recent periods, the future
prospects of the Company and its industry in general, the general condition of
the securities market at the time of the Offering and the market prices of
securities and certain financial and operating information of companies
engaged in activities similar to those of the Company. There can, however, be
no assurance that the prices at which the Common Stock will sell in the public
market after the Offering will not be lower than the price at which it is sold
by the Underwriters.
The Common Stock has been approved for listing on the Nasdaq National Market
System under the trading symbol "SMTK."
LEGAL MATTERS
The validity of the shares of Common Stock offered hereby will be passed
upon for the Company by Dewey Ballantine, Los Angeles, California. Certain
legal matters will be passed upon for the Underwriters by Munger, Tolles &
Olson, Los Angeles, California.
58
<PAGE>
EXPERTS
The financial statements as of December 31, 1994 and December 31, 1995 and
for the period from inception and year ended, respectively, included in this
Prospectus have been so included in reliance on the report of Price Waterhouse
LLP, independent accountants, given on the authority of said firm as experts
in auditing and accounting.
ADDITIONAL INFORMATION
The Company has filed with the Commission a Registration Statement on Form
S-1 under the Securities Act with respect to the shares of Common Stock
offered hereby. This Prospectus does not contain all of the information set
forth in the Registration Statement and the exhibits and schedules thereto.
Certain items are omitted in accordance with the rules and regulations of the
Commission. For further information with respect to the Company and the Common
Stock offered hereby, reference is made to the Registration Statement and to
the exhibits and schedules filed as part thereof. Statements contained in this
Prospectus as to the contents of any contract or other document referred to
are not necessarily complete, and in each instance, reference is made to the
copy of such contract or document filed as an exhibit to the Registration
Statement, each such statement being qualified in all respects by such
reference.
As a result of the Offering, the Company will be subject to the
informational requirements of the Exchange Act, and in accordance therewith,
will file reports and other information with the Commission. A copy of the
Registration Statement, including the exhibits and schedules thereto, and the
reports and other information filed by the Company in accordance with the
Exchange Act, may be inspected without charge at the principal office of the
Commission in Washington, D.C. and copies may be obtained from the Public
Reference Section at the Commission's principal office, 450 Fifth Street,
N.W., Room 1024, Washington, D.C. 20549, and are also available for inspection
and copying at the Commission's regional offices at Seven World Trade Center,
13th Floor, New York, New York 10048 and at Citicorp Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661 upon payment of the fees
prescribed by the Commission. Such material may also be accessed
electronically by means of the Commission's home page on the Internet at
http://www.sec.gov.
59
<PAGE>
SMARTALK TELESERVICES, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Price Waterhouse LLP, Independent Accountants.................. F-2
Balance Sheets as of December 31, 1994, December 31, 1995 and June 30,
1996.................................................................... F-3
Statements of Operations for the period ended December 31, 1994, the year
ended December 31, 1995 and the six months ended June 30, 1995 and June
30, 1996................................................................ F-4
Statements of Shareholders' Equity (Deficit) for the period ended
December 31, 1994, the year ended December 31, 1995 and the six months
ended June 30, 1996..................................................... F-5
Statements of Cash Flows for the period ended December 31, 1994, the year
ended December 31, 1995 and the six months ended June 30, 1995 and June
30, 1996................................................................ F-6
Notes to Financial Statements for December 31, 1994 and 1995 and
Unaudited June 30, 1996................................................. F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
of SmarTalk TeleServices, Inc.
In our opinion, the accompanying balance sheets and the related statements
of operations, shareholders' equity (deficit) and of cash flows, present
fairly, in all material respects, the financial position of SmarTalk
TeleServices, Inc. at December 31, 1994 and 1995, and the results of its
operations and its cash flows for the period from inception to December 31,
1994 and for the year ended December 31, 1995 in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express
an opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
August 15, 1996
Century City, California
F-2
<PAGE>
SMARTALK TELESERVICES, INC.
BALANCE SHEETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------- JUNE 30,
1994 1995 1996
-------- ----------- -----------
(UNAUDITED)
ASSETS
------
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents................ $ 391 $ 2,115,351 $ 763,078
Trade accounts receivable (less allowance
for doubtful accounts of $35, $11,460,
$89,724, respectively).................. 232 224,974 1,914,970
Inventories.............................. -- 718,045 629,900
Receivable from related party............ 3,400 -- --
Other current assets..................... -- 759,718 696,004
Prepaid expenses......................... -- 3,078 52,787
-------- ----------- -----------
Total current assets................... 4,023 3,821,166 4,056,739
Non-current assets:
Deposits................................. -- 16,100 69,129
Other non-current assets................. -- -- 53,325
Net property and equipment............... -- 4,486 603,629
-------- ----------- -----------
Total assets........................... $ 4,023 $ 3,841,752 $ 4,782,822
======== =========== ===========
<CAPTION>
LIABILITIES AND SHAREHOLDERS' DEFICIT
-------------------------------------
<S> <C> <C> <C>
Current liabilities:
Accounts payable......................... $ 27,002 $ 923,900 $ 1,981,444
Deferred revenue......................... 431 3,696,515 4,127,919
Accrued marketing costs.................. 37,062 381,429 164,897
Other accrued expenses................... -- 219,682 498,550
Note payable and current portion of long-
term debt............................... -- -- 539,998
-------- ----------- -----------
Total current liabilities.............. 64,495 5,221,526 7,312,808
Long-term debt payable to related parties
less current portion...................... -- -- 3,285,002
-------- ----------- -----------
Total liabilities...................... 64,495 5,221,526 10,597,810
Commitments (See Notes 6 and 8)
Shareholders' deficit:
Common stock, no par value; authorized
35,000,000 shares; issued and
outstanding 4,941,904, 8,824,834, and
8,824,834 shares, respectively.......... 5,000 315,000 315,000
Common stock subscribed.................. -- (300,000) --
Accumulated deficit...................... (65,472) (1,394,774) (6,129,988)
-------- ----------- -----------
Total shareholders' deficit............ (60,472) (1,379,774) (5,814,988)
-------- ----------- -----------
Total liabilities and shareholders'
deficit............................... $ 4,023 $ 3,841,752 $ 4,782,822
======== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
SMARTALK TELESERVICES, INC.
STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FROM INCEPTION
(OCTOBER 28, 1994) SIX MONTHS ENDED
THROUGH YEAR ENDED JUNE 30,
DECEMBER 31, DECEMBER 31, ----------------------
1994 1995 1995 1996
------------------ ------------ --------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C>
Revenue................. $ 444 $ 453,916 $ 41,738 $ 3,678,020
Cost of revenue......... 716 318,686 29,910 2,742,115
--------- ----------- --------- -----------
Gross profit (loss)... (272) 135,230 11,828 935,905
Sales and marketing..... 1,980 842,306 173,242 1,643,426
General and
administrative......... 63,220 624,238 124,023 1,459,293
--------- ----------- --------- -----------
Operating loss........ (65,472) (1,331,314) (285,437) (2,166,814)
Interest income......... -- 5,290 -- 25,072
Interest expense........ -- 3,278 -- 129,444
--------- ----------- --------- -----------
Loss before income
taxes................ (65,472) (1,329,302) (285,437) (2,271,186)
Provision for income
taxes.................. -- -- -- --
--------- ----------- --------- -----------
Net loss.............. $ (65,472) $(1,329,302) $(285,437) $(2,271,186)
========= =========== ========= ===========
Net loss per share...... $ (.01) $ (.14) $ (.03) $ (.24)
========= =========== ========= ===========
Weighted average number
of shares.............. 9,335,348 9,335,348 9,335,348 9,335,348
========= =========== ========= ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
SMARTALK TELESERVICES, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
COMMON STOCK
------------------ STOCK ACCUMULATED
SHARES AMOUNT SUBSCRIPTION DEFICIT TOTAL
--------- -------- ------------ ----------- -----------
<S> <C> <C> <C> <C> <C>
Inception (October 28,
1994)
Shares issued........... 4,941,904 $ 5,000 $ -- $ -- $ 5,000
Net loss................ -- -- -- (65,472) (65,472)
--------- -------- -------- ----------- -----------
December 31, 1994....... 4,941,904 5,000 -- (65,472) (60,472)
Shares issued........... 1,235,481 310,000 -- -- 310,000
Stock subscribed........ 2,647,449 -- (300,000) -- (300,000)
Net loss................ -- -- -- (1,329,302) (1,329,302)
--------- -------- -------- ----------- -----------
December 31, 1995....... 8,824,834 315,000 (300,000) (1,394,774) (1,379,774)
--------- -------- -------- ----------- -----------
Funds received from
stock subscription..... -- -- 300,000 -- 300,000
Purchase of assets of
related entity (See
Note 6)................ -- -- -- (2,464,028) (2,464,028)
Net loss................ -- -- -- (2,271,186) (2,271,186)
--------- -------- -------- ----------- -----------
June 30, 1996
(unaudited)............ 8,824,834 $315,000 $ -- $(6,129,988) $(5,814,988)
========= ======== ======== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
SMARTALK TELESERVICES, INC.
STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FROM INCEPTION SIX MONTHS ENDED
(OCTOBER 28, 1994) YEAR ENDED JUNE 30,
THROUGH DECEMBER 31, ----------------------
DECEMBER 31, 1994 1995 1995 1996
------------------ ------------ --------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C>
Cash flows from
operating activities:
Net loss............. $(65,472) $(1,329,302) $(285,437) $(2,271,186)
Adjustments to
reconcile net loss to
net cash provided by
(used in) operating
activities:
Depreciation......... -- -- -- 18,186
Provision for bad
debt................ 35 11,425 1,119 78,264
Changes in assets and
liabilities which
increase (decrease)
cash:
Accounts
receivable........ (267) (236,167) (90,919) (1,768,260)
Inventories........ -- (718,045) (161,228) 88,145
Receivable from
related party..... (3,400) 3,400 3,400 --
Other current
assets............ -- (759,718) (10,147) 63,714
Prepaid expenses... -- (3,078) (1,437) (49,709)
Deposits........... -- (16,100) -- (53,029)
Other non-current
assets............ -- -- -- (53,325)
Accounts payable... 27,002 896,898 197,058 1,057,544
Deferred revenue... 431 3,696,084 89,074 431,404
Accrued marketing
costs............. 37,062 344,367 (37,062) (216,532)
Other accrued
expenses.......... -- 219,682 33,939 278,868
-------- ----------- --------- -----------
Net cash provided
(used) by
operating
activities...... (4,609) 2,109,446 (261,640) (2,395,916)
-------- ----------- --------- -----------
Cash flows from
investing activities:
Capital expenditures. -- (4,486) -- (456,357 )
-------- ----------- --------- -----------
Cash flows from
financing activities:
Common stock
proceeds............ 5,000 10,000 -- 300,000
Note payable to
related party....... -- -- 272,000 1,200,000
Revolving line of
credit with related
party............... -- -- -- 500,000
Payment to LCN....... -- -- -- (500,000)
-------- ----------- --------- -----------
Net cash from
financing
activities...... 5,000 10,000 272,000 1,500,000
-------- ----------- --------- -----------
Increase (decrease) in
cash and cash
equivalents........... 391 2,114,960 10,360 (1,352,273)
Cash and cash
equivalents at
beginning of period... -- 391 391 2,115,351
-------- ----------- --------- -----------
Cash and cash
equivalents at end of
period................ $ 391 $ 2,115,351 $ 10,751 $ 763,078
======== =========== ========= ===========
Supplemental disclosure
of cash flow
information:
Cash paid for interest. $ -- $ 3,278 $ -- $ 129,444
======== =========== ========= ===========
Note payable issued for
LCN purchase (see Note
6).................... $ -- $ -- $ -- $ 2,000,000
======== =========== ========= ===========
Purchase of VoiceChoice
Platform through
issuance of note
payable (see Note 9).. $ -- $ -- $ -- $ 125,000
======== =========== ========= ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
SMARTALK TELESERVICES, INC.
NOTES TO FINANCIAL STATEMENTS
FOR DECEMBER 31, 1994 AND 1995 AND UNAUDITED JUNE 30, 1996
- -------------------------------------------------------------------------------
1. THE COMPANY
SmarTalk TeleServices, Inc. (the "Company") is a provider of prepaid long
distance services. The Company primarily sells its products to retailers who
in turn sell to customers. The customer can add minutes to the SmarTalk Card
by use of a major credit card. The Company has developed additional avenues to
market and distribute its services, including through its Corporate Advantage
Program and corporate promotional programs. The Company was incorporated in
October 1994. As shown in the accompanying financial statements, the Company
has incurred net losses of $65,472 in 1994, $1,329,302 in 1995 and $2,271,186
through June 30, 1996. Management believes it has adequate capital resources
available to fund operations through June 30, 1997.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Interim Results
The accompanying balance sheet at June 30, 1996, the statements of
operations and of cash flows for the six months ended June 30, 1995 and 1996,
and the statement of shareholders' equity (deficit) for the six months ended
June 30, 1996 are unaudited. In the opinion of management, these statements
have been prepared on the same basis as the audited financial statements and
include all adjustments, consisting only of normal recurring adjustments,
necessary for the fair presentation of the results of the interim periods. The
Company's results of operations and cash flows for the interim period are not
necessarily indicative of the results to be expected for any other interim
period or the full year. The data disclosed in these notes to financial
statements at such date and for such periods are also unaudited.
Accounting Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents are composed of highly liquid investments with an
original maturity of three months or less. In accordance with Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities," the investments, which consist solely of money
market funds, are stated at market value, which approximates cost.
Property and Equipment
Property and equipment is stated at cost. Depreciation is computed using
principally the straight-line method over the estimated useful lives of the
related assets. Depreciation expense and accumulated depreciation was $0 as
of, and for the periods ended December 31, 1994 and 1995, respectively. For
the six months ended June 30, 1996, depreciation expense and accumulated
depreciation was $18,186.
F-7
<PAGE>
SMARTALK TELESERVICES, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR DECEMBER 31, 1994 AND 1995 AND UNAUDITED JUNE 30, 1996
- -------------------------------------------------------------------------------
Other Current Assets
Other current assets include the cost of cards which have been shipped to
retailers but not yet sold to customers. These costs are reclassified from
inventory at the time of shipment and are amortized into expense as the
revenue to which they specifically relate is recognized.
Accrued Marketing Costs
Accrued marketing costs include printed and electronic advertising. These
costs are accrued and expensed as incurred. Marketing expenses were $870,
$251,676 and $991,409 for the periods ended December 31, 1994 and 1995 and
June 30, 1996, respectively. The cost of co-op advertising undertaken in
connection with co-op programs with retailers is expensed at the earlier of
when the advertising takes place or the related revenue is recognized.
Other Accrued Expenses
Other accrued expenses include the cost of sales commissions and sales and
use taxes. These obligations are accrued and capitalized upon shipment of
SmarTalk cards to retailers and capitalized amounts are amortized into expense
as the revenue to which they specifically relate is recognized.
Fair Value of Financial Instruments
Statement of Financial Accounting Standards No. 107, "Disclosures About Fair
Value of Financial Instruments" requires the determination of fair value for
certain of the Company's assets and liabilities. The Company estimates that
the carrying value of its financial instruments approximates fair value at
December 31, 1994 and 1995.
Revenue Recognition and Deferred Revenue
The Company's revenue is generated from: (i) sales of Company and co-branded
phone cards to customers through retailers, (ii) recharges of existing phone
cards, (iii) cards sold for promotional marketing campaigns, and
(iv) corporate sales to businesses. Under the majority of agreements with
retailers, the Company sells cards to the retailer at a fixed price with
normal credit terms. The Company invoices the retailer upon shipment,
recognizing deferred revenue. The Company recognizes revenue and reduces the
deferred revenue account as the customer utilizes the calling time and upon
expiration of cards containing unused calling time, subject to applicable
escheat laws, if any. The Company also recognizes deferred revenue upon
recharge of existing phone cards and recognizes revenue upon usage or
expiration of the recharge minutes. Revenue recognized upon expiration of
calling cards containing unused calling time and upon expiration of recharge
minutes was insignificant for the year ended December 31, 1994 and the six
months ended June 30, 1995 and less than $36,000 and $209,000, respectively,
for the year ended December 31, 1995 and the six months ended June 30, 1996.
Internally Developed Software
The Company has incurred costs associated with developing and testing its
proprietary software system. These costs, which are considered immaterial,
consisted of amounts paid to consultants and salaries paid to employees, and
have been expensed as incurred and are included in General and Administrative
expense.
F-8
<PAGE>
SMARTALK TELESERVICES, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR DECEMBER 31, 1994 AND 1995 AND UNAUDITED JUNE 30, 1996
- -------------------------------------------------------------------------------
Regulation
The Company is subject to regulation by the Federal Communications
Commission and by various state public service and public utility commissions.
The Company's management and regulatory legal counsel believe the Company is
in compliance with regulations in all states.
Stock Split
On February 15, 1996, the board of directors declared a 3,500 for 1 stock
split distributable on February 13, 1996 to shareholders of record on February
13, 1996. Further, on May 23, 1996, the board of directors declared a 2.51 for
1 stock split distributable on May 23, 1996 to shareholders of record on that
date. Further, on August 15, 1996, the Company effected a 0.5625 reverse stock
split distributable on August 15, 1996 to shareholders of record on that date.
In this report, per share amounts and numbers of shares have been restated to
reflect the stock splits.
Net Loss per Share
Net loss per share is based on the weighted average number of common shares
and common stock equivalents outstanding during each period, after retroactive
adjustment for the stock splits (see above). Pursuant to requirements of the
Staff of the Securities and Exchange Commission, shares related to stock sold
and options issued subsequent to August 15, 1995 have been shown as
outstanding for all periods presented.
Long-Lived Assets
In 1995, the Company adopted SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." SFAS No. 121
establishes accounting standards for the measurement and recognition of
impairment of long-lived assets, certain identifiable intangibles, and
goodwill related to those assets to be held and used and for long-lived assets
and certain identifiable intangibles to be disposed of. The adoption of SFAS
No. 121 had no effect on the Company's financial statements.
3. COMPOSITION OF CERTAIN BALANCE SHEET ACCOUNTS
Inventories
Inventories are valued at the lower of cost (using the first-in, first-out
(FIFO) method) or market. Inventories consist of the following at:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------- JUNE 30,
1994 1995 1996
------ -------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Phone cards................................... $ -- $582,110 $492,974
Displays...................................... -- 135,935 136,926
------ -------- --------
Total..................................... $ -- $718,045 $629,900
====== ======== ========
</TABLE>
F-9
<PAGE>
SMARTALK TELESERVICES, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR DECEMBER 31, 1994 AND 1995 AND UNAUDITED JUNE 30, 1996
- -------------------------------------------------------------------------------
Other Current Assets
<TABLE>
<CAPTION>
DECEMBER 31,
---------------
JUNE 30,
1994 1995 1996
------ -------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Pre-paid sales commissions.................... $ -- $285,391 $337,533
Cards shipped................................. -- 243,557 147,695
Other......................................... -- 230,770 210,776
------ -------- --------
Total other current assets................ $ -- $759,718 $696,004
====== ======== ========
</TABLE>
Property and Equipment
<TABLE>
<CAPTION>
DECEMBER 31,
---------------
JUNE 30,
1994 1995 1996
------ -------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Computers..................................... $ -- $ 3,661 $ 96,844
Telephone switching equipment................. -- -- 325,000
Office equipment and furniture................ -- 825 199,971
Less: Accumulated depreciation............ -- -- (18,186)
------ -------- --------
$ -- $ 4,486 $603,629
====== ======== ========
</TABLE>
4. NOTE PAYABLE AND LONG-TERM DEBT PAYABLE TO RELATED PARTIES
At June 30, 1996, note payable and long-term debt payable to related parties
consisted of the following:
<TABLE>
<CAPTION>
JUNE 30, 1996
-------------
(UNAUDITED)
<S> <C>
9% Term loan payable, interest accrues daily on the outstanding
balance and is payable January 1, 1997. Principal payable in six
monthly installments of $16,667 beginning July, 1996 with
$25,000 due January 1, 1997 (see Note 9)........................ $ 125,000
Revolving loan with SmarTalk Partners, LLC, interest at prime
plus 2% payable monthly beginning January 31, 1996, principal
due January 31, 1998 (see Note 6)............................... 500,000
7% Term loan, with SmarTalk Partners, LLC, interest only is
payable monthly from January 31, 1996 through December 31, 1996.
Interest plus principal totaling $31,634 is payable monthly
beginning January 1, 1997 through July, 2000 (see
Note 6)......................................................... 1,200,000
7% Subordinated Term loan, payable to LCN, principal and interest
payable in monthly installments of $35,000 beginning August 31,
1996 with the balance due
June 20, 2000 (see Note 6)...................................... 2,000,000
Less: Current maturities....................................... (539,998)
----------
Long-term debt, less current maturities.......................... $3,285,002
==========
</TABLE>
At June 30, 1996 future maturities of long-term debt are: 1997 -- $539,998,
1998 -- $1,125,279, 1999 -- $670,155, 2000 -- $1,460,674, 2001 -- $28,894.
F-10
<PAGE>
SMARTALK TELESERVICES, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR DECEMBER 31, 1994 AND 1995 AND UNAUDITED JUNE 30, 1996
- -------------------------------------------------------------------------------
5. INCOME TAXES
The difference between the statutory federal income tax rate and the
Company's effective income tax rate applied to loss before income taxes was as
follows for the period ended December 31, 1994, and the year ended December
31, 1995:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1994 1995
-------- --------- --- ---
<S> <C> <C> <C> <C>
Statutory federal tax rate on loss........... (34)% (34)%
State income tax provision, net of federal
benefit .................................... (6)% (6)%
Increase in valuation reserve against
deferred tax asset.......................... 40 % 40 %
-------- --------- ---
Income taxes at the Company's effective rate. 0 % 0 %
======== ========= ===
The major components of deferred tax assets arising from temporary
differences at December 31, 1994 and 1995 are as follows:
<CAPTION>
DECEMBER 31,
--------------------
1994 1995
-------- ---------
<S> <C> <C> <C> <C>
Deferred revenue............................. $ -- $ 417,000
Net operating loss carryforwards............. 17,000 68,000
Other........................................ 14,000 115,000
-------- ---------
Subtotal..................................... 31,000 600,000
Valuation allowance.......................... (31,000) (600,000)
-------- ---------
Total deferred taxes......................... $ -- $ --
======== =========
</TABLE>
The Company had net operating loss carryforwards of approximately $65,472
and $1,396,786 as of December 31, 1994 and 1995, respectively. To the extent
not used, net operating loss carryforwards expire in varying amounts beginning
in the year 2002. If substantial changes in the Company's ownership should
occur, there will be an annual limitation on the amount of the carryforwards
which can be utilized.
Under SFAS No. 109, the Company has recorded valuation allowances against
the realization of the deferred tax assets. Based on available evidence,
including the Company's history of operating losses, the uncertainty of future
profitability and the impact of tax laws which may limit the Company's ability
to utilize such loss carryforwards, management has concluded that it is more
likely than not that deferred tax assets will not be realized.
6. RELATED PARTIES
Transactions With Related Entities
At December 31, 1994 the Company had a receivable due from its majority
shareholder in the amount of $3,400. On December 28, 1995 the Company entered
into an agreement with SmarTalk Partners, LLC ("SP") under which SP agreed to
loan $1,200,000 to the Company and to purchase 2,647,449 shares of the
Company's Common Stock for $300,000. The term loan is collateralized by
substantially all assets of the Company. Interest accrues daily and is payable
monthly beginning January 31, 1996 and ending December 31, 1996. Beginning
January 1, 1997 interest accrues daily and is payable monthly along with
principal payments through July 2000. The $1,500,000 was received in January
1996.
F-11
<PAGE>
SMARTALK TELESERVICES, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR DECEMBER 31, 1994 AND 1995 AND UNAUDITED JUNE 30, 1996
- -------------------------------------------------------------------------------
In addition, the Company obtained a revolving loan facility from SP,
collateralized by substantially all assets of the Company. The facility
provides for borrowings up to $500,000. The principal portion of the loan is
due and payable January 31, 1998. The facility was fully drawn at June 30,
1996.
Payment in Excess of Book Value of Assets Purchased From a Related Entity
(Unaudited)
In January 1996, the Company entered into an agreement to purchase certain
of the office furniture and equipment fixed assets of Lorsch Creative Network,
Inc. ("LCN") that had historical net book value of $35,972. LCN's sole
shareholder is the majority shareholder of the Company's Common Stock.
Minority shareholders of the Company consented to the transaction. The
purchase was consummated in January 1996 for $500,000 cash plus a $2,000,000
subordinated term note which bears interest at 7% per annum (see Note 4).
Because the assets were purchased from a related party, the assets are
reflected on the Company's balance sheet at LCN's historical depreciated cost
as of the date of the acquisition. The excess of acquisition cost over the
historical cost less depreciation of the assets acquired of approximately
$2,464,028 was recorded as a charge to the Company's accumulated deficit in a
manner similar to a capital distribution. In addition, prior to the purchase,
LCN provided consulting and other services to the Company for which it billed
approximately $25,000 and $415,000 in 1994 and 1995, respectively. Amounts
were billed on an hourly basis for consulting and other services performed by
LCN employees on behalf of SmarTalk.
Amounts billed and services rendered by LCN are as follows:
<TABLE>
<CAPTION>
1994 1995
------- --------
<S> <C> <C>
Marketing and product development.......................... $25,000 $ 85,000
Software development....................................... 70,000
Management consulting...................................... 200,000
Other...................................................... 60,000
------- --------
Total.................................................... $25,000 $415,000
======= ========
</TABLE>
All costs incurred by LCN on the Company's behalf have been appropriately
reflected in the accompanying financial statements.
7. STOCK COMPENSATION PLANS
The Company had two stock based compensation plans at June 30, 1996. The
programs are described as follows:
1996 NONQUALIFIED STOCK OPTION PLAN:
In March 1996, the board of directors adopted the Company's 1996
Nonqualified Stock Option Plan (the "Nonqualified Plan"), whereby nonstatutory
stock options may be granted to employees, officers, directors, consultants,
advisors, or agents of the Company. Options to purchase the Company's Common
Stock are exercisable at a price not less than the fair market value of the
stock at the date of grant and for a term not to exceed 10 years. Further, the
options vest over a period ranging from grant date to 3 years from the
anniversary of the grant. Pursuant to the Nonqualified Plan, an amount equal
to (a) the lesser of (i) 7,087,991 shares of Common Stock, and (ii) the number
of shares of Common Stock equal to 9% of the total issued and outstanding
shares of Common Stock minus (b) the number of shares of Common Stock issued
or issuable pursuant to options exercised or
F-12
<PAGE>
SMARTALK TELESERVICES, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR DECEMBER 31, 1994 AND 1995 AND UNAUDITED JUNE 30, 1996
- -------------------------------------------------------------------------------
outstanding under the 1996 Stock Incentive Plan are reserved for issuance
under this plan. The Company accounts for the fair value of its grants under
this plan in accordance with APB Opinion 25 Accounting for Stock Issued to
Employees. Fair value of stock options granted was determined by the board of
directors, who considered, among other factors, an independent valuation. The
following table summarizes the activity in shares of Common Stock subject to
options for the quarter ended June 30, 1996:
<TABLE>
<CAPTION>
OPTION PRICE NUMBER OF
PER SHARE SHARES
------------ ---------
<S> <C> <C>
Balance at December 31, 1995....................... -- --
Options granted.................................. $1.77-$4.44 508,514
Options exercised................................ -- --
Options canceled or expired...................... -- --
Balance at June 30, 1996........................... $1.77-$4.44 508,514
</TABLE>
At June 30, 1996 no options had been exercised. 285,730 shares remain
reserved for issuance under the plan.
1996 STOCK INCENTIVE PLAN:
In August 1996, the board of directors adopted and the shareholders of the
Company approved the 1996 Stock Incentive Plan, whereby the Compensation
Committee may make awards to directors, employees, advisors and consultants of
the Company and its subsidiaries. Pursuant to the Stock Incentive Plan, the
Company has authorized and reserved a number of shares of Common Stock for
issuance equal to (a) the lesser of (i) 7,087,991 shares of Common Stock and
(ii) a number of shares of Common Stock equal to 9% of the total issued and
outstanding shares of Common Stock minus (b) the number of shares of Common
Stock issued or issuable pursuant to options exercised or outstanding under
the Nonqualified Plan.
Stock Options
Nonqualified stock options may be granted to employees, consultants and
advisors of the Company and its subsidiaries and incentive stock options may
only be granted to employees of the Company and its subsidiaries. The exercise
price of a nonqualified stock option may be determined by the Compensation
Committee in its discretion. The exercise price of an incentive stock option
may not be less than the fair market value of the Common Stock on the date of
grant. The value of Common Stock (determined at the time of grant) that may be
subject to incentive stock options that become exercisable by any one employee
in any one year is limited by the Internal Revenue Code to $100,000. The
maximum term of stock options granted under the 1996 Plan is 10 years from the
date of grant. In September 1996, the Company granted an option to acquire
2,000 shares at an exercise price of $2.50 per share in settlement of an
employment dispute.
Stock Appreciation Rights
A stock appreciation right may be granted in connection with an option,
either at the time of grant or at any time thereafter during the term of the
option. A stock appreciation right granted in connection with an option
entitles the holder, upon exercise, to surrender the related option and
receive a payment based on the difference between the exercise price of the
related option and the fair market value of the Company's Common Stock on the
date of exercise. A stock appreciation right granted in
F-13
<PAGE>
SMARTALK TELESERVICES, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR DECEMBER 31, 1994 AND 1995 AND UNAUDITED JUNE 30, 1996
- -------------------------------------------------------------------------------
connection with an option is exercisable only at such time or times as the
related option is exercisable and expires no later than when the related
option expires. At June 30, 1996, no stock appreciation rights had been
granted.
Restricted Stock Awards
The Compensation Committee may award shares of Common Stock to participants
under this plan, subject to such restrictions on transfer and conditions of
forfeiture as it deems appropriate. Such conditions may include requirements
as to the continued service of the participant with the Company, the
attainment of specified performance goals or any other conditions determined
by the Compensation Committee. Subject to the transfer restrictions and
forfeiture restrictions relating to the restricted stock award, the
participant will otherwise have the rights of a shareholder of the Company,
including all voting and dividend rights, during the period of restriction. At
June 30, 1996, no restricted stock had been granted.
Performance Awards
The Compensation Committee may grant performance awards denominated in
specified dollar units or in shares of Common Stock. Performance awards are
payable upon the achievement of performance goals established by the
Compensation Committee at the beginning of the performance period, which may
not exceed ten years from the date of grant. Payments may be made in cash or
shares of Common Stock or in a combination of cash and shares. At June 30,
1996, no performance awards had been granted.
Phantom Stock
An award of phantom stock gives the participant the right to receive cash at
the end of a fixed vesting period based on the value of a share of Common
Stock at that time. Phantom stock units are subject to such restrictions and
conditions to payment as the Compensation Committee determines are
appropriate. At June 30, 1996, no phantom stock had been awarded.
8. COMMITMENTS
Telecommunications Service Agreements
The Company has a minute volume commitment with one of its service providers
which, if not met, could require the Company to make payments to such
provider. If the Company fails to meet this commitment operating results could
be adversely impacted. As of June 30, 1996, the Company anticipates that it
will fulfill this commitment.
Operating Leases
The Company entered into a lease agreement on January 10, 1996 to lease
office space. Lease payments commenced March 1, 1996 and end March 1, 2002.
The future minimum annual rentals under this lease as of June 30, 1996 are
as follows: 1996-$59,225, 1997-$164,684, 1998-$194,347, 1999-$194,347, 1999
and thereafter--$242,934.
F-14
<PAGE>
SMARTALK TELESERVICES, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR DECEMBER 31, 1994 AND 1995 AND UNAUDITED JUNE 30, 1996
- -------------------------------------------------------------------------------
9. PURCHASE OF VOICECHOICE PLATFORM
In June 1996, the Company acquired an interactive voice response platform
facility known as the VoiceChoice Platform from Pacific Bell Information
Services for total consideration of $325,000, plus other consideration
including the release of certain contractual obligations of Pacific Bell
Information Services to the Company. The purchase price was recorded at
$325,000, comprised of $200,000 in cash and a $125,000 note. $100,000 of the
$125,000 note is to be paid through six equal monthly installments beginning
July 1, 1996 (see Note 4). A final payment due January 1, 1997 will include
the remaining $25,000 principal amount of the note and an additional sum equal
to the interest accrued on the declining balance paid in installments at 9%
interest per annum calculated on a day-to-day basis. The Company was informed
by Pacific Bell Information Services that the platform facility was
constructed in 1994 at an original cost of approximately $1,648,000. The
assets acquired include multiple switches, thousands of inbound and outbound
access ports for prepaid and corporate calling services, voice response
applications, high-speed database servers, voice recording capability and
credit card verification software. The Company acquired the VoiceChoice
Platform to enable it to provide additional services, such as stand-alone
interactive voice services, and to reduce call handling costs.
In conjunction with the purchase, the Company is negotiating a sublease from
Pacific Bell Information Services for the building space housing the platform.
At August 15, 1996 the sublease had not been finalized. Management believes
its lease obligation under the sublease will approximate $5,000 per month for
a period of three years.
10. SUBSEQUENT EVENTS
On August 13, 1996, the Company obtained a loan from SmarTalk Partners, LLC
for $250,000. The note bears interest at a floating rate equal to the prime
rate, which was 8.25% at September 20, 1996, and has a maturity date of
January 31, 1997.
On September 20, 1996, the Company obtained a $1,000,000 revolving line of
credit from a financial institution. Borrowings under the line, which totaled
$510,000 at October 8, 1996, bear interest monthly at a floating rate equal to
the prime rate plus 2.375%, with minimum monthly interest charges of $4,429
for one year from date of the note.
F-15
<PAGE>
NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE OFFER MADE BY THIS PROSPECTUS AND, IF GIVEN
OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED BY THE COMPANY, THE SELLING SHAREHOLDERS OR ANY OF THE
UNDERWRITERS. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE
HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATES AS OF WHICH
INFORMATION IS GIVEN IN THIS PROSPECTUS. THIS PROSPECTUS DOES NOT CONSTITUTE
AN OFFER OR SOLICITATION BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR
SOLICITATION IS NOT AUTHORIZED OR IN WHICH THE PERSON MAKING SUCH OFFER OR
SOLICITATION IS NOT QUALIFIED TO DO SO OR TO ANY PERSON TO WHOM IT IS UNLAWFUL
TO MAKE SUCH SOLICITATION.
---------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary........................................................ 3
Cautionary Statement Regarding Forward-Looking Statements................. 7
Risk Factors.............................................................. 7
Use of Proceeds........................................................... 17
Dividend Policy........................................................... 17
Capitalization............................................................ 18
Dilution.................................................................. 19
Selected Financial Data................................................... 20
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 21
Business.................................................................. 28
Plan of Operation......................................................... 41
Management................................................................ 42
Certain Transactions...................................................... 50
Principal and Selling Shareholders........................................ 52
Description of Capital Stock.............................................. 53
Shares Eligible for Future Sale........................................... 55
Underwriting.............................................................. 57
Legal Matters............................................................. 58
Experts................................................................... 59
Additional Information.................................................... 59
Index to Financial Statements............................................. F-1
</TABLE>
---------------
UNTIL NOVEMBER 17, 1996 (25 DAYS AFTER THE COMMENCEMENT OF THIS OFFERING), ALL
DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPAT-
ING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN
ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS
UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
4,200,000 SHARES
SMARTALK TELESERVICES, INC.
COMMON STOCK
(NO PAR VALUE)
[LOGO OF SMARTALK TELESERVICES, INC.(SM)]
SALOMON BROTHERS INC
CS FIRST BOSTON
DONALDSON, LUFKIN & JENRETTE
SECURITIES CORPORATION
PROSPECTUS
DATED OCTOBER 23, 1996
