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