SmarTalk Teleservices Inc. is experiencing some heavy static.
Just last year, the distributor of pre-paid phone cards was based in Westwood and topped the Business Journal’s list of L.A.’s fastest-growing companies, posting a blistering 3,208 percent rate of revenue growth.
Now, not only is SmarTalk no longer based in Los Angeles, but its finances are taking a beating.
On Aug. 10, the company announced that its independent auditor, PricewaterhouseCoopers LLP, was investigating the way it had accounted for a number of acquisitions it had made last year.
As a result of the audit, SmarTalk, which quietly moved to Columbus, Ohio in May, delayed the release of its second-quarter earnings. It simultaneously warned that it likely would have to revise its first-quarter 1998 and full-year 1997 financial results.
The market responded by pummeling SmarTalk stock, from about $16 before the announcement to just over $7 as of late last week.
That, in turn, has sparked at least seven shareholder lawsuits. The suits charge that SmarTalk issued a series of false and misleading statements regarding the firm’s financial condition and engaged in improper accounting practices, which served to inflate the stock. The suits also allege that certain SmarTalk insiders took advantage of the inflated price by selling personal holdings worth $52 million.
SmarTalk spokesman William Kahn declined to comment on the lawsuits, except to say that the charges are “baseless and without merit” and that the company “will vigorously defend itself against them.”
As for the accounting questions, Chief Executive Erich Spangenberg said in a statement that they stem “from issues relating to the accounting treatment of acquisitions completed in 1997 and the components of the restructuring charge taken in 1997.”
“Based on communications with (PricewaterhourseCoopers) it seems clear to the company that fraud is not the issue,” Spangenberg said in the statement. “These issues identified by PwC do not relate to SmarTalk’s operations or the company’s current cash position.”
Ironically, such accounting issues might never have come to light had SmarTalk not left Los Angeles.
PricewaterhouseCoopers has been analyzing the firm’s books since SmarTalk went public in 1996. But when the company landed in the Midwest, PricewaterhouseCoopers assigned a new team of auditors to the account, according to Kahn. The new auditors, he said, began taking a fresh look at the finances.
“The new audit team is questioning work that the old audit team already had signed off on,” Kahn said.
PricewaterhouseCoopers spokesman Steven Silber declined to comment, citing the firm’s policy not to discuss its clients’ affairs.
SmarTalk’s decision to pull up its L.A. stakes followed the acquisition of Conquest Telecommunications Services, a competitor based in Columbus. While all 35 L.A. employees were offered the chance to move, only about 15 accepted the offer, according to Kahn.
The move came after an 18-month acquisition spree, in which several hundred million dollars were spent purchasing 10 smaller telecommunications companies all in an effort to better compete with AT & T;, Sprint Corp. and WorldCom Inc. in the $1 billion market for pre-paid phone cards. That market is expected to expand to $2.6 billion over the next several years, according to the Yankee Group, a Boston-based consulting firm.
When it came time to consolidate those acquisitions and the nearly 800 new SmarTalk employees scattered across the country Columbus emerged as the best choice, said Robert H. Lorsch, SmarTalk’s founder and chairman.
The decision to leave L.A. was “painful,” Lorsch said, “but all of our decisions are driven by shareholder value. And what’s best for the employees and shareholder value dictated that Columbus was best for the company.”
Lorsch, who founded SmarTalk in 1994, opted to stay here. While he remains chairman and travels to Columbus on a regular basis, he handed over the reins in February to Spangenberg, the firm’s former president and COO.
Lorsch said he now divides his time between SmarTalk, various philanthropic activities (the pavilion at the new California Science Center bears his name) and launching a new venture, an incubator of Internet and e-commerce firms.
Lorsch declined to comment on SmarTalk’s recent financial problems or the spate of shareholder suits.
In November 1997, Lorsch sold 1.3 million shares of his SmarTalk stock, about one-fourth of his total holdings, for $23 a share, or almost $30 million. He remains the firm’s single largest shareholder.
The sale was driven by “estate- and tax-planning issues (Lorsch) had to deal with before year end,” according to Kahn.
But that sale, as well as divestitures by other SmarTalk insiders, raised the eyebrows of securities attorneys, especially after the firm announced that its financial results for the first quarter of 1998 and all of 1997 likely would need to be restated.
“It’s a very sophisticated financial fraud,” charged Darren Robbins, an attorney with Milberg Weiss Bershad Hynes & Lerach LLP, the San Diego-based law firm that filed the first of the shareholder suits against SmarTalk.
For the first quarter ended March 31, SmarTalk reported a net loss of $3.4 million (15 cents a share, fully diluted), compared with net income of $300,000 (3 cents a share) for the like period a year ago. Revenues were $39.6 million vs. $7.4 million.
Despite the turmoil, investment bank Credit Suisse First Boston Corp. upgraded its recommendation on SmarTalk from a “buy” to a “strong buy” in a recent report.
Questions raised by the auditors have little bearing on the firm’s fundamentals, wrote analyst Frank J. Governali, adding that the issues raised, in his opinion, do not indicate fraud, deception or incompetence by management.
