-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, DXxpZw3a2UqZesXbQbFLiMKN1v3QrZv2bnwX7xy5NiXDRnUmczyNo0E8tN+P8Zgu DWybnRniOUF7BtGaoLBFVg== 0000891618-97-002390.txt : 19970520 0000891618-97-002390.hdr.sgml : 19970520 ACCESSION NUMBER: 0000891618-97-002390 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 9 FILED AS OF DATE: 19970519 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: STAR TELECOMMUNICATIONS INC CENTRAL INDEX KEY: 0001026486 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE COMMUNICATIONS (NO RADIO TELEPHONE) [4813] IRS NUMBER: 770362681 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1/A SEC ACT: 1933 Act SEC FILE NUMBER: 333-21325 FILM NUMBER: 97610988 BUSINESS ADDRESS: STREET 1: 223 EAST DE LA GUERRA STREET STREET 2: STE 202 CITY: SANTA BARBARA STATE: CA ZIP: 93101 BUSINESS PHONE: 8058991962 MAIL ADDRESS: STREET 1: 223 EAST DE LA GUERRA STREET CITY: SANTA BARBARA STATE: CA ZIP: 93101 S-1/A 1 AMENDMENT NO. 1 TO FORM S-1 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MAY 16, 1997. REGISTRATION NO. 333-21325 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ AMENDMENT NO. 1 TO FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------ STAR TELECOMMUNICATIONS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 4813 77-0362681 (STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
223 EAST DE LA GUERRA STREET SANTA BARBARA, CALIFORNIA 93101 (805) 899-1962 (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES) ------------------------ CHRISTOPHER E. EDGECOMB CHIEF EXECUTIVE OFFICER STAR TELECOMMUNICATIONS, INC. 223 EAST DE LA GUERRA STREET SANTA BARBARA, CALIFORNIA 93101 (805) 899-1962 (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) ------------------------ COPIES TO: CARLA S. NEWELL NEIL WOLFF CRAIG M. SCHMITZ ARMANDO CASTRO ANTHONY J. MCCUSKER JASON B. WACHA GUNDERSON DETTMER STOUGH VAHE H. SARRAFIAN VILLENEUVE FRANKLIN & HACHIGIAN, LLP WILSON SONSINI GOODRICH & ROSATI, PROFESSIONAL 155 CONSTITUTION DRIVE CORPORATION MENLO PARK, CALIFORNIA 94025 650 PAGE MILL ROAD (415) 321-2400 PALO ALTO, CALIFORNIA 94304-1050 (415) 493-9300
------------------------ APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after the effective date of this Registration Statement. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, as amended, check the following box. [ ] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ]__________ If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ]__________ If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [ ] ------------------------ THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT THAT SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING PURSUANT TO SUCH SECTION 8(a), MAY DETERMINE. ================================================================================ 2 INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. SUBJECT TO COMPLETION, DATED MAY 16, 1997 PROSPECTUS - ---------------- 4,000,000 SHARES LOGO COMMON STOCK Of the 4,000,000 shares of Common Stock offered hereby, 3,750,000 shares are being sold by the Company and 250,000 shares are being sold by the Selling Stockholders. The Company will not receive any of the proceeds from the sale of shares by the Selling Stockholders. See "Principal and Selling Stockholders." Prior to this offering, there has been no public market for the Common Stock of the Company. It is currently estimated that the initial public offering price will be between $10.00 and $12.00 per share. See "Underwriting" for a discussion of the factors to be considered in determining the initial public offering price. The Common Stock of the Company has been approved for quotation on the Nasdaq National Market under the symbol "STRX." ------------------ THE SHARES OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK. SEE "RISK FACTORS" COMMENCING ON PAGE 5. ------------------ THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. ======================================================================================================= PROCEEDS TO PRICE TO UNDERWRITING PROCEEDS TO SELLING PUBLIC DISCOUNT (1) COMPANY (2) STOCKHOLDERS - ------------------------------------------------------------------------------------------------------- Per Share.......................... $ $ $ $ - ------------------------------------------------------------------------------------------------------- Total(3)........................... $ $ $ $ =======================================================================================================
(1) See "Underwriting" for indemnification arrangements with the several Underwriters. (2) Before deducting expenses payable by the Company estimated at $1,325,000. (3) The Company and certain Selling Stockholders have granted to the Underwriters a 30-day option to purchase up to 600,000 additional shares of Common Stock solely to cover over-allotments, if any. If all such shares are purchased, the total Price to Public, Underwriting Discount, Proceeds to Company and Proceeds to Selling Stockholders will be $ , $ , $ and $ , respectively. See "Underwriting." ------------------ The shares of Common Stock are offered by the several Underwriters subject to prior sale, receipt and acceptance by them and subject to the right of the Underwriters to reject any order in whole or in part and certain other conditions. It is expected that certificates for such shares will be available for delivery on or about , 1997 at the office of the agent of Hambrecht & Quist LLC in New York, New York. HAMBRECHT & QUIST ALEX. BROWN & SONS INCORPORATED , 1997 3 CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK OF THE COMPANY, INCLUDING BY ENTERING STABILIZING BIDS, EFFECTING SYNDICATE COVERING TRANSACTIONS OR IMPOSING PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING." 2 4 PROSPECTUS SUMMARY The following summary is qualified in its entirety by the more detailed information and Consolidated Financial Statements and Notes thereto appearing elsewhere in this Prospectus. The Common Stock offered hereby involves a high degree of risk. See "Risk Factors." THE COMPANY STAR Telecommunications, Inc. ("STAR" or the "Company") is an international long distance provider offering highly reliable, low cost switched voice services on a wholesale basis, primarily to U.S.-based long distance carriers. STAR provides international long distance service to over 275 foreign countries through a flexible network of resale arrangements with long distance providers, various foreign termination relationships, international gateway switches, and leased and owned transmission facilities. The Company has grown its revenues rapidly by capitalizing on the deregulation of international telecommunications markets, by combining sophisticated information systems with flexible routing techniques and by leveraging management's industry expertise. STAR commenced operations as an international long distance provider in August 1995 and increased its revenues from $16.1 million in 1995 to $208.1 million in 1996. The Company serves the large and growing international long distance telecommunications market. According to industry sources, worldwide gross revenues in this market were approximately $57 billion in 1995 and the volume of international traffic on the public telephone network is expected to grow at a compound annual growth rate of 12% or more from 1995 through the year 2000. A segment of this market, the resale of international long distance capacity, has experienced particularly rapid growth. According to FCC data, total billed revenue of U.S. resellers of international switched services increased approximately 55% from 1994 to 1995, from approximately $1.1 billion to $1.7 billion. STAR markets to small and medium size long distance companies that do not have the critical mass to invest in their own international transmission facilities or to obtain volume discounts from the larger facilities-based carriers. STAR also markets to larger long distance companies seeking lower rates and overflow capacity. The Company had 88 customers during the first quarter of 1997. STAR operates international gateway switching facilities in New York and Los Angeles and holds ownership positions in eight digital undersea fiber optic cables. The Company has installed an international gateway switch in London, England, and plans to invest in additional undersea fiber optic cables. STAR's switching facilities are linked to a proprietary reporting system, which the Company believes provides it with a competitive advantage by permitting management on a real-time basis to determine the most cost-effective termination alternatives, monitor customer usage and manage gross margins by route. In 1995 and 1996, the Company rapidly built its wholesale customer base, traffic volume and revenue by offering favorable rates compared to other long distance providers. STAR now seeks to lower its cost of services and improve its gross margin by negotiating lower rates with domestic and foreign providers of transmission capacity and, when justified by traffic volume, invest in network facilities and enter into fixed cost arrangements, including long term leases. In addition, the Company intends to market its international long distance services directly to commercial customers overseas, with an initial focus on the U.K. and selected European cities. The Company was incorporated in Nevada in September 1993 as STAR Vending, Inc. and was reincorporated in Delaware as STAR Telecommunications, Inc. in April 1997. The Company's executive offices are located at 223 East De La Guerra Street, Santa Barbara, California 93101. Its telephone number at that location is (805) 899-1962. 3 5 THE OFFERING Common Stock offered by the Company............... 3,750,000 shares Common Stock offered by the Selling 250,000 shares Stockholders.................................... Common Stock to be outstanding after the 15,575,756 shares(1) offering........................................ Use of proceeds................................... Repayment of indebtedness, capital expenditures, working capital and general corporate purposes. See "Use of Proceeds." Proposed Nasdaq National Market symbol............ STRX
SUMMARY CONSOLIDATED FINANCIAL INFORMATION (in thousands, except per share and per minute data)
THREE MONTHS ENDED YEAR ENDED DECEMBER 31, MARCH 31, --------------------------------- --------------------------- 1994 1995 1996 1996 1997 ----- ------- ----------- ----------- ----------- (UNAUDITED) CONSOLIDATED STATEMENT OF OPERATIONS DATA: Revenues................................ $ 176 $16,125 $ 208,086 $ 35,667 $ 71,008 Gross profit............................ 176 1,768 19,656 3,381 7,270 Income (loss) from operations........... (114) (423) (5,504) 1,470 2,018 Net income (loss)....................... $(122) $ (568) $ (6,644) $ 848 $ 1,432 Pro forma net income (loss) per share(2).............................. $ (0.54) $ 0.08 $ 0.11 Pro forma number of shares used in per share computations(2)................. 12,198,000 11,281,000 12,825,000 OTHER CONSOLIDATED FINANCIAL AND OPERATING DATA: EBITDA(3)............................... $(121) $ (375) $ (4,531) 1,578 2,788 Cash provided by (used in) operating activities............................ (63) (1,526) (2,332) 60 2,208 Capital expenditures.................... 21 1,950 12,935 371 3,180 Billed minutes of use................... -- 38,106 479,681 85,375 172,455 Revenue per billed minute of use(4)..... $ -- $0.4102 $ 0.4288 $ 0.4149 $ 0.4064
MARCH 31, 1997 -------------------------- ACTUAL AS ADJUSTED(5) ------- -------------- (UNAUDITED) CONSOLIDATED BALANCE SHEET DATA: Working capital (deficit).................................................. $(8,363) $ 28,275 Total assets............................................................... 59,036 89,872 Long-term liabilities...................................................... 5,849 5,449 Retained deficit........................................................... (5,212) (5,212) Stockholders' equity....................................................... 8,339 45,377
- ------------------------------ (1) Based on the number of shares outstanding as of March 31, 1997. Excludes 1,605,852 shares subject to outstanding options as of March 31, 1997 at a weighted average exercise price of approximately $4.15 per share. Also excludes 1,214,148 shares reserved for issuance under the Company's stock plans. See "Management--1997 Omnibus Stock Incentive Plan," "--1996 Outside Director Nonstatutory Stock Option Plan" and Notes 8 and 10 of Notes to Consolidated Financial Statements. (2) See Note 2 of Notes to Consolidated Financial Statements for an explanation of the method used to determine the number of shares used in computing pro forma net income (loss) per share. (3) EBITDA represents earnings before interest income and expense, income taxes, depreciation and amortization expense; whereas, cash provided by (used in) operating activities represents income or loss from operations plus depreciation and amortization and also other adjustments for non-cash amounts such as charges to bad debts as well as changes in operating assets and liabilities. EBITDA does not represent cash flows as defined by generally accepted accounting principles and does not necessarily indicate that cash flows are sufficient to fund all the Company's cash needs. EBITDA should not be considered in isolation or as a substitute for net income, cash flows from operating activities or other measures of liquidity determined in accordance with generally accepted accounting principles. (4) Represents gross call usage revenue per billed minute. Amounts exclude other revenue-related items such as finance charges. (5) Adjusted to reflect the sale of 3,750,000 shares of Common Stock by the Company at an assumed public offering price of $11.00 per share and the application of the estimated net proceeds therefrom. See "Use of Proceeds" and "Capitalization." ------------------------------ Unless otherwise indicated, the information in this Prospectus (i) assumes no exercise of the Underwriters' overallotment option, (ii) reflects the reincorporation of the Company from Nevada to Delaware in April 1997, and the associated changes in the Company's charter documents, (iii) reflects a 3-for-2 reverse split of the Common Stock effected in May 1997, and (iv) except in the Consolidated Financial Statements, reflects the conversion of all outstanding shares of Preferred Stock into 911,360 shares of Common Stock upon completion of the offering. See "Description of Capital Stock" and "Underwriting." 4 6 RISK FACTORS The following risk factors should be considered carefully in addition to the other information contained in this Prospectus before purchasing the shares of Common Stock offered hereby. This Prospectus contains forward-looking statements that involve risks and uncertainties. The Company's actual results may differ materially from those projected in the forward-looking statements. Factors that may cause such a difference include, but are not limited to, those set forth below and elsewhere in this Prospectus. Risks Associated with Limited Operating History in the International Telecommunications Market. The Company was incorporated in September 1993, but did not commence its current business as an international long distance provider until the third quarter of 1995. As a result, the Company's business must be considered in light of the risks faced by early stage companies in the rapidly evolving international telecommunications market. Early stage companies must respond to external factors, such as competition and changing regulations, without the resources, infrastructure and broader business base of more established companies. Early stage companies also must respond to these risks while simultaneously developing systems, adding personnel and entering new markets. As a result, these risks can have a much greater effect on early stage companies. If the Company does not successfully address such risks, the Company's business, operating results and financial condition would be materially adversely affected. See "Selected Consolidated Financial Data" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." Operating Results Subject to Significant Fluctuations. The Company's quarterly operating results are difficult to forecast with any degree of accuracy because a number of factors subject these results to significant fluctuations. As a result, the Company believes that period-to-period comparisons of its operating results are not necessarily meaningful and should not be relied upon as indications of future performance. Factors Influencing Operating Results, Including Revenues, Costs and Margins. The Company's revenues, costs and expenses have fluctuated significantly in the past and are likely to continue to fluctuate significantly in the future as a result of numerous factors. The Company's revenues in any given period can vary due to factors such as call volume fluctuations, particularly in regions with relatively high per-minute rates; the addition or loss of major customers, whether through competition, merger, consolidation or otherwise; the loss of economically beneficial routing options for the termination of the Company's traffic; financial difficulties of major customers; pricing pressure resulting from increased competition; and technical difficulties with or failures of portions of the Company's network that impact the Company's ability to provide service to or bill its customers. The Company's cost of services and operating expenses in any given period can vary due to factors such as fluctuations in rates charged by carriers to terminate the Company's traffic; increases in bad debt expense and reserves; the timing of capital expenditures, and other costs associated with acquiring or obtaining other rights to switching and other transmission facilities; changes in the Company's sales incentive plans; and costs associated with changes in staffing levels of sales, marketing, technical support and administrative personnel. In addition, the Company's operating results can vary due to factors such as changes in routing due to variations in the quality of vendor transmission capability; loss of favorable routing options; the amount of, and the accounting policy for, return traffic under operating agreements; actions by domestic or foreign regulatory entities; the level, timing and pace of the Company's expansion in international and commercial markets; and general domestic and international economic and political conditions. Since the Company does not generally have long term arrangements for the purchase or resale of long distance services, and since rates fluctuate significantly over short periods of time, the Company's gross margins are subject to significant fluctuations over short periods of time. The Company's gross margins also may be negatively impacted in the longer term by competitive pricing pressures. 5 7 Recent Examples of Factors Affecting Operating Results. The Company has recently encountered significant difficulties in the collection of accounts receivable from certain of its major customers. In the fourth quarter of 1996, Hi-Rim Communications, Inc. ("Hi-Rim"), one of the Company's major customers, informed the Company that it was experiencing financial difficulties and would be unable to pay in full, on a timely basis, approximately $6.0 million in outstanding accounts receivable. The Company accepted a secured note in the amount of $3.4 million in lieu of a portion of past due payments and was able to offset a portion of the amounts due by sending traffic to Hi-Rim. The Company believes that it is unlikely to receive any additional payment from Hi-Rim under the note or otherwise. As a result, the full amount of the approximately $5.3 million owed to the Company by Hi-Rim as of December 31, 1996, which was not subsequently paid or offset, was written-off in the fourth quarter of 1996. In the first quarter of 1997, Cherry Communications, Inc. ("CCI"), the Company's largest customer in 1996, also informed the Company that it was unable to pay in full, on a timely basis, its accounts receivable balance. To account for the potential inability to collect on the accounts receivable and outstanding deposits which the Company had made to CCI, the Company increased its reserve against accounts receivable and reserve against deposits by $3.5 million and $2.0 million, respectively. In addition, the Company wrote off $820,000 of intangible assets relating to this customer. These reserves and write-off reflect the full amount of future benefits to have been received by the Company from assets related to CCI recorded on the Company's Balance Sheet at December 31, 1996. The Company continued to provide service to CCI through March 1997 and has received payment for services provided in the first quarter of 1997 through a combination of cash receipts from CCI and offsetting payables from the Company to CCI resulting from the Company's use of CCI as a vendor. While the Company no longer provides service to CCI, the Company is continuing to utilize CCI as a vendor and has entered into various other contractual arrangements with CCI in order to continue to offset outstanding accounts receivable. However, there can be no assurance that the Company will be able to collect or continue to offset any significant portion of the accounts receivable either through utilizing CCI as a vendor or otherwise. The Company's ability to collect or offset the CCI accounts receivable would be adversely affected to the extent that CCI's financial condition deteriorates or CCI becomes subject to voluntary or involuntary bankruptcy proceedings. In the event bankruptcy proceedings are commenced, CCI's creditors or a bankruptcy trustee would likely assert that any payments (including offsets) received by the Company in the 90 day period prior to the commencement of the bankruptcy proceeding are "preference payments" and should be returned to CCI for distribution among creditors. As a result, if bankruptcy proceedings were commenced with respect to CCI prior to September 1997, the Company could be required to repay amounts it received (including through accounts payable offsets) during the 90 day preference period. In such event, the Company's reserves may be inadequate and the Company may incur a higher than anticipated bad debt expense, which could have a material adverse effect on the Company's results of operations. The Company also took a $1.6 million write-off in the first quarter of 1997 due to the failure of one of its customers, NetSource, Inc., to pay its outstanding accounts receivable. The Company has commenced litigation against NetSource, Inc. for all outstanding amounts. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business -- Litigation." If the Company experiences similar difficulties in the collection of accounts receivable from its other major customers, the Company's financial condition and results of operations could be materially adversely affected. In addition, the Company's revenue growth slowed in the fourth quarter of 1996 and the first quarter of 1997 relative to the third quarter of 1996 primarily due to the Company significantly reducing the traffic it received from Hi-Rim and CCI due to financial difficulties of these Companies, an additional relatively smaller decrease in traffic from CCI due to pricing changes and transmission quality problems on several high volume routes, primarily as a result of call set-up delay and an ability to transmit facsimiles, that caused customers to choose alternate routes. If similar events occur in the future, such events could have a material adverse affect on the Company's business, operating results or financial condition. See "--Dependence on Other Long Distance Providers; Customer Concentra- 6 8 tion and Increased Bad Debt Exposure" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." No Assurance that Recent Growth Will Continue; Potential Impact on Net Income and Market Expectations. Although the Company's revenues have increased in each of the last seven quarters, such growth should not be considered indicative of future revenue growth or operating results. If revenue levels fall below expectations, net income is likely to be disproportionately adversely affected because a proportionately smaller amount of the Company's operating expenses varies with its revenues. This effect is likely to increase as a greater percentage of the Company's cost of services are associated with owned and leased facilities. There can be no assurance that the Company will be able to achieve or maintain profitability on a quarterly or annual basis in the future. Due to all of the foregoing factors, it is likely that in some future quarter the Company's operating results will be below the expectations of public market analysts and investors. In such event, the price of the Company's Common Stock would likely be materially adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Risks of International Telecommunications Business. The Company has to date generated substantially all of its revenues by providing international telecommunications services to its customers on a wholesale basis. The international nature of the Company's operations involves certain risks, such as changes in U.S. and foreign government regulations and telecommunications standards, dependence on foreign partners, tariffs, taxes and other trade barriers, the potential for nationalization and economic downturns and political instability in foreign countries. In addition, the Company's business could be adversely affected by a reversal in the current trend toward deregulation of telecommunications carriers. The Company will be increasingly subject to these risks to the extent that the Company proceeds with the planned expansion of its international operations. Risk of Dependence on Foreign Partners. The Company will increasingly rely on foreign partners to terminate its traffic in foreign countries and to assist in installing transmission facilities and network switches, complying with local regulations, obtaining required licenses, and assisting with customer and vendor relationships. The Company may have limited recourse if its foreign partners do not perform under their contractual arrangements with the Company. The Company's arrangements with foreign partners may expose the Company to significant legal, regulatory or economic risks. Risks Associated with Foreign Government Control and Highly Regulated Markets. Governments of many countries exercise substantial influence over various aspects of the telecommunications market. In some cases, the government owns or controls companies that are or may become competitors of the Company or companies (such as national telephone companies) upon which the Company and its foreign partners may depend for required interconnections to local telephone networks and other services. Accordingly, government actions in the future could have a material adverse effect on the Company's operations. In highly regulated countries in which the Company is not dealing directly with the dominant local exchange carrier, the dominant carrier may have the ability to terminate service to the Company or its foreign partner and, if this occurs, the Company may have limited or no recourse. In countries where competition is not yet fully established and the Company is dealing with an alternative carrier, foreign laws may prohibit or impede the entry of such new carriers in the market. Risks Associated with International Settlement Rates, International Traffic and Foreign Currency Fluctuations. The Company's revenues and cost of long distance services are sensitive to changes in international settlement rates, imbalances in the ratios between outgoing and incoming traffic and foreign currency fluctuations. International rates charged to customers are likely to decrease in the future for a variety of reasons, including increased competition between existing long distance providers, new entrants into the market and the consummation of joint ventures among large international long distance providers that facilitate targeted pricing and cost reductions. There can be no assurance that the Company will be able to increase its traffic volume or reduce its operating costs sufficiently to offset any resulting rate decreases. In addition, the Company expects that an increasing portion of the Company's 7 9 net revenue and expenses will be denominated in currencies other than U.S. dollars, and changes in exchange rates may have a significant effect on the Company's results of operations. As the Company continues to pursue a strategy of entering into operating agreements where it is economically advantageous to do so, the Company's results of operations will become increasingly subject to the risks of changes in international settlement rates and foreign currency fluctuations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Foreign Corrupt Practices Act. The Company is also subject to the Foreign Corrupt Practices Act ("FCPA"), which generally prohibits U.S. companies and their intermediaries from bribing foreign officials for the purpose of obtaining or keeping business. The Company may be exposed to liability under the FCPA as a result of past or future actions taken without the Company's knowledge by agents, strategic partners and other intermediaries. Such liability could have a material adverse effect on the Company's business, operating results and financial condition. Potential Adverse Affects of Government Regulation. The Company's business is subject to various U.S. federal laws, regulations, agency actions and court decisions. The Company's international facilities-based and resale services are subject to regulation by the Federal Communications Commission (the "FCC"). The FCC requires authorization prior to leasing capacity, acquiring international facilities, and/or initiating international service. Prior FCC approval is also required to transfer control of an authorized carrier. The Company is also subject to the FCC rules that regulate the manner in which international services may be provided, including, for instance, the circumstances under which carriers may provide international switched services by using private lines or route traffic through third countries. The FCC's Private Line Resale Policy. The FCC's private line resale policy prohibits a carrier from reselling international private leased circuits to provide switched services to a country unless the FCC has found that the country affords U.S. carriers equivalent opportunities to engage in similar activities in that country. Certain of the Company's arrangements with foreign carriers involve the transmission of switched services for termination in a country that has not been found by the FCC to offer equivalent resale opportunities. These arrangements are with foreign carriers that are not the dominant carriers in their respective foreign countries. There can be no assurance that the FCC, upon viewing these alternate carrier arrangements, would permit these arrangements under its private line resale policy. If the FCC finds that these arrangements conflict with its policy, among other measures, it may issue a cease and desist order or impose fines on the Company, which could have a material adverse effect on the Company's business, operating results and financial condition. It is also possible that the regulatory agency of the foreign government would find that foreign law does not permit the operation of alternate carriers or that the alternate carriers have not met foreign law requirements for such operations. Such a finding could have a material adverse effect on the Company's business, operating results and financial condition. FCC Policies on Transit and Refile. The FCC is currently considering whether to limit or prohibit the practice whereby a carrier routes, through its facilities in a third country, traffic originating from one country and destined for another country. The FCC has permitted third country calling where all countries involved consent to the routing arrangements (referred to as "transiting"). Under certain arrangements referred to as "refiling," the carrier in the destination country does not consent to receiving traffic from the originating country and does not realize the traffic it receives from the third country is actually originating from a different country. The FCC to date has made no pronouncement as to whether refile arrangements comport either with U.S. or International Telecommunications Union ("ITU") regulations. It is possible that the FCC will determine that refiling, as defined, violates U.S. and/or international law, which could have a material adverse effect on the Company's business, operating results and financial condition. The FCC's International Settlements Policy. The Company is also required to conduct its international business in compliance with the FCC's international settlements policy (the "ISP"). The ISP 8 10 establishes the permissible arrangements for U.S.-based carriers and their foreign counterparts to settle the cost of terminating each other's traffic over their respective networks. It is possible that the FCC would take the view that some of the Company's arrangements with alternative foreign carriers do not comply with the existing ISP rules. If the FCC, on its own motion or in response to a challenge filed by a third party, determines that the Company's foreign carrier arrangements do not comply with FCC rules, among other measures, it may issue a cease and desist order or impose fines on the Company. Such action could have a material adverse effect on the Company's business, operating results and financial condition. Recent and Potential FCC Actions. Regulatory action that has been and may be taken in the future by the FCC may enhance the intense competition faced by the Company. The FCC recently enacted certain changes in its rules designed to permit more flexibility in its ISP as a method of achieving lower cost-based accounting rates as more facilities-based competition is permitted in foreign markets. Specifically, the FCC has decided to allow U.S. carriers, subject to certain competitive safeguards, to propose methods to pay for international call termination that deviate from traditional bilateral accounting rates and the ISP. The FCC has also proposed to establish lower ceilings ("benchmarks") for the rates that U.S. carriers will pay foreign carriers for the termination of international services. In separate proceedings, the FCC is considering equivalency determinations for Australia, Chile, Denmark, Finland, Hong Kong and Mexico. While these rule changes may provide more flexibility to the Company to respond more rapidly to changes in the global telecommunications market, it will also provide similar flexibility to the Company's competitors. The FCC is also considering certain other international policy issues in several rulemaking proceedings and in response to specific applications and petitions filed by other telecommunications carriers, including mandating lower international accounting rates. The resolution of these proceedings could have an adverse effect on the Company's business. Foreign Regulations. The Company may also be subject to regulation in foreign countries in connection with certain of its business activities. For example, the Company's use of transit, international simple resale ("ISR") or other routing arrangements may be affected by laws or regulations in either the transited or terminating foreign jurisdiction. Foreign countries, either independently or jointly as members of the ITU, may have adopted or may adopt laws or regulatory requirements regarding such services for which compliance would be difficult or expensive, that could force the Company to choose less cost-effective routing alternatives and that could adversely affect the Company's business, operating results and financial condition. In the United Kingdom ("U.K."), the Company's services are subject to regulation by the Office of Telecommunications ("Oftel"). The regulatory regime currently being introduced by Oftel to facilitate competition has a direct and material effect on the ability of the Company to conduct its business in the U.K. The Company has been granted licenses to provide international facilities-based voice services from the U.K. ISR services over leased lines to all international points from the U.K. There can be no assurance that the Company will be granted the ISR license in the immediate future, or at all. Failure to obtain such authority would prevent the Company from providing certain resale services in the U.K. and would limit the Company's ability to expand its operations. Future changes in government regulation could have a material adverse effect on the Company's business, operating results or financial condition. To the extent that it seeks to provide telecommunications services in other non-U.S. markets, the Company is subject to the developing laws and regulations governing the competitive provision of telecommunications services in those markets. The Company currently plans to provide a limited range of services in Belgium, France, Germany and Mexico, as permitted by regulatory conditions in those markets, and to expand its operations as these markets implement scheduled liberalization to permit competition in the full range of telecommunications services in the next several years. The nature, extent and timing of the opportunity for the Company to compete in these markets will be determined, in part, by the actions taken by the governments in these countries to implement competition and the response of incumbent carriers to these efforts. There can be no assurance that 9 11 the regulatory regime in these countries will provide the Company with practical opportunities to compete in the near future, or at all, or that the Company will be able to take advantage of any such liberalization in a timely manner. See "Business--Government Regulation." Regulation of Customers. The Company's customers are also subject to actions taken by domestic or foreign regulatory authorities that may affect the ability of customers to deliver traffic to the Company. Regulatory sanctions have been imposed on certain of the Company's customers in the past. While such sanctions have not adversely impacted the volume of traffic received by the Company from such customers to date, future regulatory actions could materially adversely affect the volume of traffic received from a major customer, which could have a material adverse effect on the Company's business, financial condition and results of operations. Dependence on Availability of Transmission Capacity. During fiscal 1996, substantially all of the Company's revenue was derived from the sale of international long distance services terminated through resale arrangements with other long distance providers. The Company purchased capacity from 51 vendors in the quarter ended March 31, 1997, six of which accounted for a majority of the Company's capacity during the same period. There can be no assurance that such resale arrangements will continue to be available to the Company on a cost-effective basis or at all. Currently, most transmission capacity used by the Company is obtained on a variable, per minute basis, subjecting the Company to the possibility of unanticipated price increases and service cancellations. The Company also requires high voice quality transmission capacity, which may not always be available at cost-effective rates. If the Company is not able to continue to enter into cost-effective resale arrangements with its primary vendors, or is unable to locate suitable replacement vendors that offer sufficient, high quality alternative capacity, the Company's business, operating results and financial condition could be materially adversely affected. For instance, to the extent that the Company's variable costs increase, the Company may experience reduced or, in certain circumstances, negative margins for some services. As its traffic volume increases on particular routes, the Company expects to decrease its reliance on variable usage arrangements and enter into fixed monthly or longer-term leasing or ownership arrangements, subject to obtaining any requisite authorization. To the extent that the Company does so, and incorrectly projects traffic volume in a particular geographic area, the Company would experience higher fixed costs without a related increase in revenue. The Company has invested substantial resources and intends to continue to invest in developing its own global transmission and switching facilities, which is a capital intensive and time-consuming process. There can be no assurance that the Company will successfully complete development of its global network in a timely manner and within budget. See "Business--Network." Management of Changing Business. Increased Demands on Management and Need to Continue to Improve Systems. The Company has recently experienced significant revenue growth and has expanded the number of its employees and the geographic scope of its operations. These factors have resulted in increased responsibilities for management personnel and placed increased demands upon the Company's operating and financial systems. The Company expects that its expansion into foreign countries will lead to increased financial and administrative demands, such as increased operational complexity associated with expanded network facilities, administrative burdens associated with managing an increasing number of relationships with foreign partners and expanded treasury functions to manage foreign currency risks. The Company's accounting systems and policies have been developed as the Company has experienced significant growth, and the Company will require additional personnel, systems and policies to comply with the reporting requirements of a publicly held company. Although the Company has recently switched over to a new financial accounting system in 1997, there can be no assurance that the Company's personnel, systems, procedures and controls will be adequate to support the Company's future operations. Difficulties encountered in the Company's transition to a new accounting system or the failure to implement and improve the Company's operation, financial and management systems as 10 12 needed to accommodate any expansion of the Company's business could have a material adverse effect on the Company's business, operating results and financial condition. See "--Dependence on Key Personnel," "Business--Employees" and "Management." Risks of Expansion into Commercial Market. While the Company has focused to date solely on the wholesale market, the Company intends to expand into the commercial market and such expansion will increase the risk of bad debt exposure and lead to higher operating costs. The Company also may be required to update and improve its billing systems and procedures and/or hire new management personnel to handle the demands of the commercial market. There can be no assurance that the Company will be able to effectively manage the costs of and risks associated with expansion into the commercial market. Risks Associated with Complex Switching and Information Systems Hardware and Software. The Company's information systems and its Northern Telecom and Stromberg-Carlson switching equipment are expensive to purchase, complex to install and maintain, and subject to hardware defects and software bugs. The Company may experience technical difficulties with its hardware or software which could adversely affect the Company's ability to provide service to its customers, manage its network, collect billing information, or perform other vital functions. For example, in the fourth quarter of 1996 the Company experienced difficulties associated with the installation of a software upgrade to its switching equipment. If similar events occur in the future, such events could have a material adverse affect on the Company's business, operating results or financial condition. Dependence on Key Personnel. The Company's success depends to a significant degree upon the efforts of senior management personnel and a group of employees with longstanding industry relationships and technical knowledge of the Company's operations, in particular, Christopher E. Edgecomb, the Company's Chief Executive Officer. Mr. Edgecomb is bound by the terms of a Non-Compete Agreement, which restricts the Company's ability to offer domestic interexchange products and services until September 1997 and solicit certain customers for an 18 month period thereafter. Several of the Company's key management personnel joined the Company in the past six months, including the Company's Chief Financial Officer and Executive Vice President--Operations and Engineering. The Company maintains a key person life insurance policy in the amount of $10.0 million with respect to Mr. Edgecomb. The Company's management team has limited experience working together and there can be no assurance that they can successfully integrate as a management team. The Company believes that its future success will depend in large part upon its continuing ability to attract and retain highly skilled personnel. Competition for qualified, high-level telecommunications personnel is intense and there can be no assurance that the Company will be successful in attracting and retaining such personnel. The loss of the services of one or more of the Company's key individuals, or the failure to attract and retain other key personnel, could materially adversely affect the Company's business, operating results and financial condition. See "Management." Significant Competition. The international telecommunications industry is intensely competitive and subject to rapid change. The Company's competitors in the international wholesale switched long distance market include large, facilities-based multinational corporations and smaller facilities-based providers in the U.S. and overseas that have emerged as a result of deregulation (often referred to as Post, Telephone and Telegraphs or "PTTs"), switched-based resellers of international long distance services and international joint ventures and alliances among such companies. International wholesale switched long distance providers compete on the basis of price, customer service, transmission quality, breadth of service offerings and value-added services. The number of the Company's competitors is likely to increase as a result of the new competitive opportunities created by the WTO Agreement. Under the terms of the WTO Agreement, the United States and the other 67 countries participating in the 11 13 Agreement have committed to open their telecommunications markets to competition, foreign ownership and adopt measures to protect against anticompetitive behavior, effective starting on January 1, 1998. As a result, the Company believes that competition will continue to increase, placing downward pressure on prices. Such pressure could adversely affect the Company's gross margins if the Company is not able to reduce its costs commensurate with such price reductions. Competition from Domestic and International Companies and Alliances. The U.S.-based international telecommunications services market is dominated by American Telephone & Telegraph Co. ("AT&T"), MCI Communications Corp. ("MCI") and Sprint Communications Company L.P. ("Sprint"). The Company also competes with WorldCom, Inc., Pacific Gateway Exchange, Inc., TresCom International, Inc. and other U.S.-based and foreign long distance providers, many of which have considerably greater financial and other resources and more extensive domestic and international communications networks than the Company. The Company anticipates that it will encounter additional competition as a result of the formation of global alliances among large long distance telecommunications providers. For example, MCI and British Telecommunications recently announced a proposed merger that would create a global telecommunications company called Concert, and additionally have announced an alliance with Telefonica de Espana. The effect of the proposed merger and alliance could create significantly increased competition. Many of the Company's current competitors are also the Company's customers. The Company's business would be materially adversely affected to the extent that a significant number of such customers limit or cease doing business with the Company for competitive or other reasons. Consolidation in the telecommunications industry could not only create even larger competitors with greater financial and other resources, but could also adversely affect the Company by reducing the number of potential customers for the Company's services. Competition from New Technologies. The telecommunications industry is in a period of rapid technological evolution, marked by the introduction of new product and service offerings and increasing satellite and undersea cable transmission capacity for services similar to those provided by the Company. Such technologies include satellite-based systems, such as the proposed Iridium and GlobalStar systems, utilization of the Internet for international voice and data communications and digital wireless communication systems such as personal communications services ("PCS"). The Company is unable to predict which of many possible future product and service offerings will be important to maintain its competitive position or what expenditures will be required to develop and provide such products and services. Increased Competition as a Result of a Changing Regulatory Environment. The FCC recently granted AT&T's petitions to be classified as a non-dominant carrier in the domestic interstate and international markets, which has allowed AT&T to obtain relaxed pricing restrictions and relief from other regulatory constraints, including reduced tariff notice requirements. These reduced regulatory requirements could make it easier for AT&T to compete with the Company. In addition, the Telecommunications Act of 1996 (the "Telecommunications Act"), which substantially revises the Communications Act of 1934 (the "Communications Act"), permits and is designed to promote additional competition in the intrastate, interstate and international telecommunications markets by both U.S.-based and foreign companies, including the Regional Bell Operating Companies ("RBOCs"). RBOCs, as well as other existing or potential competitors of the Company, have significantly more resources than the Company. The Company also expects that competition from carriers will increase in the future along with increasing deregulation of telecommunications markets worldwide. As a result of these and other factors, there can be no assurance that the Company will continue to compete favorably in the future. See "--Potential Adverse Affects of Government Regulation," "Business--Competition" and "Business--Government Regulation." Dependence on Other Long Distance Providers; Customer Concentration and Increased Bad Debt Exposure. 12 14 The Company's primary business as a wholesale long distance provider makes it highly dependent upon traffic delivered to the Company by other long distance providers pursuant to arrangements that can generally be terminated by the provider on short notice. While the list of the Company's most significant customers varies from quarter to quarter, the Company's five largest customers accounted for approximately 43% of revenues in the year ended December 31, 1996 and 44% for the quarter ended March 31, 1997. During 1996, the Company's largest customer, CCI, accounted for approximately 21% of the Company's revenue. The Company ceased providing service to CCI in March 1997 due to its failure to pay outstanding accounts receivable. No other customer accounted for more than 10% of the Company's revenue in 1996. The Company could lose significant customer traffic for many reasons, including the entrance into the market of significant new competitors with lower rates than the Company, downward pressure on the overall costs of transmitting international calls, transmission quality problems, changes in U.S. or foreign regulations, or unexpected increases in the Company's cost structure as a result of expenses related to installing a global network or otherwise. Any significant loss of customer traffic would have a material adverse effect on the Company's business, operating results and financial condition. The Company's customer concentration also amplifies the risk of non-payment by customers. The Company's two largest customers in 1996 accounted for approximately 29% of the Company's gross accounts receivable as of December 31, 1996. The Company has recently encountered significant difficulties in the collection of accounts receivable from certain of its major customers. In the fourth quarter of 1996, Hi-Rim, one of the Company's major customers, informed the Company that it was experiencing financial difficulties and would be unable to pay in full, on a timely basis, approximately $6.0 million in outstanding accounts receivable. The Company accepted a secured note in the amount of $3.4 million in lieu of a portion of past due payments and was able to offset a portion of the amounts due by sending traffic to Hi-Rim. The Company believes that it is unlikely to receive any additional payment from Hi-Rim under the note or otherwise. As a result, the full amount of the approximately $5.3 million owed to the Company by Hi-Rim as of December 31, 1996, which was not subsequently collected or offset, was written-off in the fourth quarter of 1996. In the first quarter of 1997, CCI, the Company's largest customer in 1996, also informed the Company that it was unable to pay in full, on a timely basis, its accounts receivable balance. To account for the potential inability to collect on the accounts receivable and outstanding deposits which the Company had made to CCI, the Company increased its reserve against accounts receivable and reserve against deposits by $3.5 million and $2.0 million, respectively. In addition, the Company wrote-off $820,000 of intangible assets relating to this customer. These reserves and write-off reflect the full amount of future benefits to have been received by the Company from assets related to CCI recorded on the Company's Balance Sheet at December 31, 1996. The Company also took a $1.6 million write-off in the first quarter of 1997 due to the failure of one of its customers, NetSource, Inc., to pay its outstanding accounts receivable. The Company has commenced litigation against NetSource, Inc. for all outstanding amounts. See "-- Operating Results Subject to Significant Fluctuations," "Business -- Litigation" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." While the Company performs ongoing credit evaluations of its customers, it generally does not require collateral to support accounts receivable from its customers and there can be no assurance that reserves will be adequate in future periods. If the Company experiences similar difficulties in the collection of accounts receivable from its other major customers, the Company's financial condition and results of operations could be materially adversely affected. In addition, the identity of the Company's major customers can change significantly over short periods of time. For example, while Hi-Rim accounted for approximately 9% of the Company's business during 1996, Hi-Rim accounted for less than 1% of the Company's revenues during the fiscal quarter ended March 31, 1997, and Cable & Wireless, which accounted for approximately 5% of the Company's revenues during 1996, accounted for approximately 10% of the Company's revenues for the fiscal quarter ended March 31, 1997. In addition, CCI, which accounted for approximately 21% of the Company's revenues during 1996 ceased to be a customer in March 1997. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." 13 15 Capital Expenditures; Potential Need for Additional Financing. Expansion of the Company's network facilities will require a significant investment in equipment and facilities. While the Company believes that the proceeds of this offering, combined with other sources of liquidity, will be sufficient to fund its capital requirements for the next 12 months, the Company may be required to obtain additional financing depending on factors such as the rate and extent of the Company's international expansion, increased investment in ownership rights in fiber optic cable and increased sales and marketing expenses to support international wholesale and commercial operations. Issuance of additional equity securities would result in dilution to stockholders. There can be no assurance that additional financing will be available on terms acceptable to the Company, or at all. The Company's inability to fund its capital requirements would have a material adverse effect on the Company's business, operating results and financial condition. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Risks Related to STAR Trademark. The Company has been advised that trademark registration may not be available for the "STAR Telecommunications" mark because several companies in telecommunications-related industries hold registered trademarks that include the word "star." Such companies could allege that the Company's use of the STAR Telecommunications mark is confusingly similar to existing trademarks. Although the Company has not received any communication from a third party with respect to its use of its trademark, there can be no assurance that a third party utilizing a similar mark will not allege that the Company's use infringes its rights, that the Company would successfully defend any claim of infringement or that the Company would not be ordered to cease using the mark and/or pay any damages. The adoption of a new trademark or any related litigation could be costly, negatively affect customer relationships, result in confusion in the market and have a material adverse effect on the Company's business, operating results and financial condition. Effects of Natural Disasters and Other Catastrophic Events. The Company's business is susceptible to natural disasters such as earthquakes, as well as other catastrophic events such as fire, terrorism and war. Although the Company has taken a number of steps to prevent its network from being affected by natural disasters, fire and the like, such as building redundant systems for power supply to the switching equipment, there can be no assurance that any such systems will prevent the Company's switches from becoming disabled in the event of an earthquake, power outage or otherwise. The failure of the Company's network, or a significant decrease in telephone traffic resulting from effects of a natural or man-made disaster, could have a material adverse effect on the Company's relationship with its customers and the Company's business, operating results and financial condition. See "Business--Network." No Prior Trading Market for Common Stock. Prior to this offering, there has been no public market for the Company's Common Stock, and there can be no assurance that an active trading market will develop or be sustained after this offering. The initial public offering price will be determined through negotiations among the Company, the Selling Stockholders and the representatives of the Underwriters based on several factors and may not be indicative of the market price of the Common Stock after this offering. See "Underwriting." Potential Volatility of Stock Price. The market price of the shares of Common Stock is likely to be highly volatile and may be significantly affected by factors such as actual or anticipated fluctuations in the Company's operating results, changes in federal and international regulations, activities of the largest domestic providers, industry consolidation and mergers, conditions and trends in the international telecommunications market, adoption of new accounting standards affecting the telecommunications industry, changes in 14 16 recommendations and estimates by securities analysts, general market conditions and other factors. In addition, the stock market has from time to time experienced significant price and volume fluctuations that have particularly affected the market prices for the common stocks of emerging growth companies. These broad market fluctuations may adversely affect the market price of the Company's Common Stock. In the past, following periods of volatility in the market price of a particular company's securities, securities class action litigation has often been brought against the company. There can be no assurance that such litigation will not occur in the future with respect to the Company. Such litigation could result in substantial costs and a diversion of management's attention and resources, which could have a material adverse effect upon the Company's business, operating results and financial condition. See "Underwriting." Control of Company by Named Officers, Directors and Five Percent Stockholders. Upon the consummation of this offering, the Named Officers, directors, five percent stockholders and their affiliates in the aggregate will beneficially own approximately 55.3% of the outstanding shares of Common Stock and the Company's Chief Executive Officer will beneficially own approximately 46.7% of the outstanding shares. These stockholders will be able to exercise control over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. Such concentration of ownership may have the effect of delaying or preventing a change in control of the Company. See "Principal and Selling Stockholders." Benefits of the Offering to Current Stockholders. The offering will provide substantial benefits to existing stockholders of the Company, particularly the present directors, executive officers, five percent stockholders and their affiliates and related persons. Based upon an assumed public offering price of $11.00 per share, the Selling Stockholders will receive approximately $2.6 million in net proceeds, after deducting estimated underwriting discounts and commissions. In addition, all existing stockholders of the Company will benefit from the creation of a public market for the Common Stock held by them after the closing of the Offering. Upon the closing of the offering and after giving effect to the sale of Common Stock by the Selling Stockholders, the present directors, executive officers, five percent stockholders and their affiliates and related persons will beneficially own outstanding shares of Common Stock having an aggregate market value equal to approximately $96.4 million based on an assumed public offering price of $11.00 per share. See "Principal and Selling Stockholders." Effect of Certain Charter Provisions; Anti-takeover Effects of Certificate of Incorporation, Bylaws and Delaware Law. Upon completion of this offering, the Company's Board of Directors will have the authority to issue up to 5,000,000 shares of Preferred Stock and to determine the price, rights, preferences, privileges and restrictions, including voting and conversion rights of such shares, without any further vote or action by the Company's stockholders. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, the rights of the holders of any Preferred Stock that may be issued in the future. The issuance of Preferred Stock, while providing flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of the outstanding voting stock of the Company. The Company has no current plans to issue shares of Preferred Stock. The Company is also subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which will prohibit the Company from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. The application of Section 203 could have an effect of delaying or preventing a change in control of the Company. In addition, upon the closing of the offering the Company's Certificate of Incorporation will provide for a classified Board of Directors such that approximately only one-third of the members of the Board will be elected at each 15 17 annual meeting of stockholders. Classified Boards may have the effect of delaying, deferring or discouraging changes in control of the Company. Further, certain provisions of the Company's Certificate of Incorporation and Bylaws and of Delaware law could delay or make more difficult a merger, tender offer or proxy contest involving the Company. Additionally, certain Federal regulations require prior approval of certain transfers of control of telecommunications companies, which could also have the effect of delaying, deferring or preventing a change in control. See "Business-Government Regulation," "Description of Capital Stock--Preferred Stock" and "--Anti-takeover Effects of Provisions of the Certificate of Incorporation, Bylaws and Delaware Law." Shares Eligible for Future Sale. On the date of this Prospectus, only the 4,000,000 shares offered hereby (assuming no exercise of the Underwriters' over-allotment option) will be immediately eligible for sale in the public market. An additional approximately 11,502,756 shares of Common Stock will be eligible for sale beginning 181 days after the date of this Prospectus, unless earlier released, in whole or in part and with or without notice to the public, by Hambrecht & Quist LLC. At various times after 181 days after the date of this Prospectus, an additional approximately 73,000 shares will become eligible for sale in the public market upon expiration of their respective one-year holding periods, subject to certain volume and resale restrictions as set forth in Rule 144 under the Securities Act of 1933, as amended (the "Securities Act"). In addition, the Company intends to register, following the effective date of this offering, a total of approximately 2,830,000 shares of Common Stock subject to outstanding options or reserved for issuance under the Company's stock and option plans. Certain stockholders holding approximately 2,826,000 shares of Common Stock are entitled to registration rights with respect to their shares of Common Stock. If such stockholders, by exercising their demand registration rights, cause a large number of securities to be registered and sold in the public market, such sales could have an adverse effect on the market price of the Company's Common Stock. Sales of substantial amounts of such shares in the public market after this offering, or the prospect of such sales, could adversely affect the market price of the Common Stock. Such sales also might make it more difficult for the Company to sell equity securities or equity related securities in the future at a time and price that the Company deems appropriate. See "Description of Capital Stock," "Shares Eligible for Future Sale" and "Underwriting." Immediate and Substantial Dilution. The purchasers of Common Stock in this offering will experience immediate and substantial dilution. To the extent outstanding options to purchase the Company's Common Stock are exercised, there will be further dilution. See "Dilution." DESCRIPTION OF FORWARD-LOOKING STATEMENTS This Prospectus contains forward-looking statements, which may be deemed to include statements in "Management's Discussion and Analysis of Financial Condition and Results of Operations," regarding the Company's strategy to lower its cost of services and improve its gross margin, its expectation that return traffic under operating agreements will be immaterial through at least the first half of 1997, its intention to begin providing international long distance services to commercial customers in certain European countries in the second half of 1997, the Company's belief that this traffic has the potential to generate higher gross margins, its belief that price declines may be offset in part by increased calling volumes and decreased costs and its belief in the sufficiency of capital resources. Forward-looking statements in "Business" may be deemed to include projected growth in international telecommunications traffic; the Company's strategy of marketing its services to foreign-based long distance providers, expanding its U.S. and developing European switching capabilities, and expanding into foreign commercial markets and in the longer term into the U.S. commercial market; and the Company's expectations that its London switch will be operational in mid-1997 and that it will acquire ownership rights in additional cables. Actual results could differ from those projected in any forward-looking statements for the reasons detailed in the other sections of this "Risk Factors" portion of the Prospectus, or elsewhere in the Prospectus. 16 18 USE OF PROCEEDS The net proceeds to the Company from the sale of the shares of Common Stock to be sold by the Company in this offering are estimated to be $37,037,500 ($39,083,500 if the Underwriters' over-allotment option is exercised in full), after deducting underwriting discounts and commissions and estimated offering expenses payable by the Company. The Company will not receive any of the proceeds from the sale of shares of Common Stock by the Selling Stockholders. The Company intends to use approximately $6.4 million of the proceeds of the offering for the repayment of outstanding indebtedness under credit facilities, including (i) approximately $5.3 million outstanding under a revolving line of credit that bears interest at a rate of the bank's prime rate plus 1.0%, certain amounts of which are convertible at the time of funding into short-term obligations that bear interest either at LIBOR plus 3.5% or the bank's cost of funds rate plus 3.5%, and which expires on July 1, 1997, (ii) approximately $667,000 outstanding under a bank loan that bears interest at a rate of prime plus 1.5% and which expires on October 1, 1999, (iii) approximately $193,000 outstanding under bank loans at a variable interest rate equal to the Wall Street Journal Prime Rate, approximately $151,442 of which is due in July 1997 and $41,500 of which is due in June 1997, and (iv) approximately $279,000 in borrowings under lines of credit from Christopher Edgecomb, the Company's Chief Executive Officer, which amounts were drawn subsequent to March 31, 1997 at an interest rate of 9.0% expiring on March 30, 1998. The Company intends to use approximately $30 million of the proceeds of the offering for capital expenditures during 1997 to acquire digital fiber optic cable capacity and to acquire and install new switching equipment. The remainder of the proceeds are expected to be used for working capital, expansion of the Company's marketing and sales organization and general corporate purposes. Although the Company may use a portion of the net proceeds for possible acquisition of businesses that are complementary to those of the Company, there are no current plans in this regard. Pending such uses, the Company plans to invest the net proceeds in short-term, interest-bearing, investment grade securities. See "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business--Strategy" and "Certain Transactions." DIVIDEND POLICY The Company has never declared or paid any cash dividends on its Common Stock and does not expect to do so in the foreseeable future. The Company anticipates that all future earnings, if any, generated from operations will be retained by the Company to develop and expand its business. Any future determination with respect to the payment of dividends will be at the discretion of the Board of Directors and will depend upon, among other things, the Company's operating results, financial condition and capital requirements, the terms of then-existing indebtedness, general business conditions and such other factors as the Board of Directors deems relevant. In addition, the terms of the Company's revolving credit facility with Comerica Bank, which is collateralized by its accounts receivable, prohibits the payment of cash dividends without the lender's consent. 17 19 CAPITALIZATION The following table sets forth (i) the actual capitalization of the Company as of March 31, 1997 and (ii) the capitalization of the Company as adjusted to reflect changes in the Company's charter documents in connection with the Company's reincorporation into Delaware, a 3-for-2 reverse stock split of the Common Stock, the conversion of the preferred stock into 911,360 shares of common stock upon the closing of this offering, the sale of the shares of Common Stock offered hereby (assuming an offering price of $11.00 per share) and the application of the estimated net proceeds therefrom. See "Use of Proceeds."
MARCH 31, 1997 ----------------------- ACTUAL AS ADJUSTED ------- ----------- (IN THOUSANDS) Long-term liabilities, less current portion............................ $ 5,849 $ 5,449 ------- Stockholders' equity: Preferred stock: $0.001 par value, 1,367,050 shares authorized, 1,367,047 issued and outstanding on an actual basis; 5,000,000 authorized, no shares issued and outstanding as adjusted.......... 1 -- Common stock: $0.001 par value, 30,000,000 shares authorized, 10,914,396 shares issued and outstanding on an actual basis; 30,000,000 shares authorized, 15,575,756 shares outstanding as adjusted(1)....................................................... 11 16 Additional paid-in capital............................................. 13,637 50,671 Deferred compensation.................................................. (98) (98) Retained earnings...................................................... (5,212) (5,212) ------- ------- Stockholders' equity................................................. 8,339 45,377 ------- ------- Total capitalization................................................. $14,188 $50,826 ======= =======
- ------------------------------ (1) Excludes 1,605,852 shares subject to outstanding options as of March 31, 1997 at a weighted average exercise price of approximately $4.15 per share. Also excludes 1,214,148 shares reserved for issuance under the Company's stock plans. See "Management--1997 Omnibus Stock Incentive Plan," "--1996 Outside Directors Nonstatutory Stock Option Plan" and Notes 8 and 10 of Notes to Consolidated Financial Statements. 18 20 DILUTION The net tangible book value of the Company's Common Stock as of March 31, 1997, giving effect to the conversion of all outstanding shares of Preferred Stock into 911,360 shares of Common Stock upon the closing of this offering, was $8,339,000, or approximately $0.71 per share. "Net tangible book value" per share represents the amount of total tangible assets of the Company less total liabilities, divided by 11,825,756 shares of Common Stock outstanding. Net tangible book value dilution per share represents the difference between the amount per share paid by purchasers of shares of Common Stock in the offering made hereby and the pro forma net tangible book value per share of Common Stock immediately after completion of the offering. After giving effect to the sale of 3,750,000 shares of Common Stock in this offering at an assumed offering price of $11.00 per share and the application of the estimated net proceeds therefrom, the pro forma net tangible book value of the Company as of March 31, 1997 would have been $45,376,500, or $2.91 per share. This represents an immediate increase in net tangible book value of $2.20 per share to existing stockholders and an immediate dilution in net tangible book value of $8.09 per share to purchasers of Common Stock in the offering. Investors participating in this offering will incur immediate, substantial dilution. This is illustrated in the following table: Assumed initial public offering price per share..................... $11.00 Pro forma net tangible book value per share before the offering... $0.71 Increase per share attributable to new investors.................. 2.20 ----- Pro forma net tangible book value per share after the offering...... 2.91 ----- Net tangible book value dilution per share to new investors......... $ 8.09 =====
The following table summarizes, on a pro forma basis as of March 31, 1997, the difference between the existing stockholders and the purchasers of shares in the offering with respect to the number of shares purchased from the Company, the total consideration paid and the average price per share paid:
SHARES PURCHASED TOTAL CONSIDERATION ---------------------- ----------------------- AVERAGE PRICE NUMBER PERCENT AMOUNT PERCENT PER SHARE ---------- ------- ----------- ------- ------------- Existing stockholders.... 11,825,756 75.9% $13,649,000 24.9% $ 1.15 New stockholders(1)...... 3,750,000 24.1 41,250,000 75.1 $ 11.00 ---------- ----- ---------- ----- Totals......... 15,575,756 100.0% $54,899,000 100.0% ========== ===== ========== =====
- ------------------------------ (1) Sales by the Selling Stockholders in this offering will reduce the number of shares held by existing stockholders to 11,575,756, or 74.3% (11,175,756, or 70.8%, if the over-allotment option is exercised in full), and will increase the number of shares held by new stockholders to 4,000,000, or 25.7% (4,600,000, or 29.2%, if the over-allotment option is exercised in full), of the total number of shares of Common Stock outstanding after this offering. See "Principal and Selling Stockholders." As of March 31, 1997, there were 1,605,852 shares subject to outstanding options at a weighted average exercise price of approximately $4.15 per share, and 1,214,148 shares reserved for issuance under the Company's stock plans. To the extent outstanding options are exercised, there will be further dilution to new investors. See "Management--1997 Omnibus Stock Incentive Plan," "--1996 Outside Director Nonstatutory Stock Option Plan" and Notes 8 and 10 of Notes to Consolidated Financial Statements. 19 21 SELECTED CONSOLIDATED FINANCIAL DATA The following selected Consolidated financial data should be read in conjunction with the Consolidated Financial Statements and Notes thereto and with "Management's Discussion and Analysis of Financial Condition and Results of Operations," which are included elsewhere in this Prospectus. The statement of operations data for the years ended December 31, 1994, 1995 and 1996, and the balance sheet data at December 31, 1995 and 1996 are derived from audited financial statements included elsewhere in this Prospectus. The balance sheet data at December 31, 1994 are derived from audited financial statements not included in this Prospectus. Although incorporated in 1993, the Company did not commence business until 1994. The data presented for the three-month periods ended March 31, 1996 and 1997 are derived from unaudited financial statements and include, in the opinion of the Company's management, all adjustments necessary to present fairly the data for such periods. The results for an interim period are not necessarily indicative of the results to be expected for a full fiscal year.
THREE MONTHS ENDED YEAR ENDED DECEMBER 31, MARCH 31, ------------------------------- -------------------- 1994 1995 1996 1996 1997 ------ ------- -------- ------- -------- (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AND PER MINUTE DATA) CONSOLIDATED STATEMENT OF OPERATIONS DATA: Revenues.................................................... $ 176 $16,125 $208,086 $35,667 $ 71,008 Cost of services............................................ -- 14,357 188,430 32,286 63,738 ------- ------ ------- ------ -------- Gross profit......................................... 176 1,768 19,656 3,381 7,270 Operating expenses: Selling, general and administrative expenses.............. 290 2,063 24,087 1,803 4,530 Depreciation and amortization............................. -- 128 1,073 108 722 ------- ------ ------- ------ -------- Income (loss) from operations........................ (114) (423) (5,504) 1,470 2,018 Other income (expense): Interest income........................................... -- -- 83 -- 21 Interest expense.......................................... -- (64) (589) (78) (369) Other expense............................................. (7) (80) (100) -- 48 ------- ------ ------- ------ -------- Income (loss) before provision for income taxes........... (121) (567) (6,110) 1,392 1,718 Provision for income taxes.................................. 1 1 534 544 286 ------- ------ ------- ------ -------- Net income (loss).................................... $ (122) $ (568) $ (6,644) $ 848 $ 1,432 ======= ====== ======= ====== ======== Pro forma net income (loss) per share(1).................... $ (0.54) $ 0.08 $ 0.11 Pro forma number of shares used in per share computations(1)........................................... 12,198 11,281 12,825 OTHER CONSOLIDATED FINANCIAL AND OPERATING DATA: EBITDA(2)................................................... $ (121) $ (375) $ (4,531) $ 1,578 $ 2,788 Cash provided by (used in) operating activities............. (63) (1,526) (2,332) 60 2,208 Capital expenditures........................................ 21 1,950 12,935 371 3,180 Billed minutes of use....................................... -- 38,106 479,681 85,375 172,455 Revenue per billed minute of use(3)......................... $ -- $0.4102 $0.4288 $0.4149 $0.4064
DECEMBER 31, MARCH 31, ----------------------------- ----------- 1994 1995 1996 1997 ----- ------- ------- ----------- (IN THOUSANDS) (UNAUDITED) CONSOLIDATED BALANCE SHEET DATA: Working capital (deficit)............................................ $(236) $(1,400) $(7,551) (8,363) Total assets......................................................... 139 12,869 48,674 59,036 Long-term liabilities, net of current portion........................ -- 712 5,478 5,849 Retained deficit..................................................... (122) (690) (6,644) (5,212) Stockholders' equity (deficit)....................................... (112) 413 6,887 8,339
- ------------------------------ (1) See Note 2 of Notes to Consolidated Financial Statements for an explanation of the method used to determine the number of shares used in computing pro forma net income (loss) per share. (2) EBITDA represents earnings before interest income and expense, income taxes, depreciation and amortization expense; whereas cash provided by (used in) operating activities represents income or loss from operations plus depreciation and amortization and also other adjustments for non-cash amounts such as charges to bad debts as well as changes in operating assets and liabilities. EBITDA does not represent cash flows as defined by generally accepted accounting principles and does not necessarily indicate that cash flows are sufficient to fund all the Company's cash needs. EBITDA should not be considered in isolation or as a substitute for net income, cash flows from operating activities or other measures of liquidity determined in accordance with generally accepted accounting principles. (3) Represents gross call usage revenue per billed minute. Amounts exclude other revenue related items such as finance charges. 20 22 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the Consolidated Financial Statements and the Notes thereto included elsewhere in this Prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from those anticipated in the forward-looking statements as a result of certain factors, including, but not limited to those discussed in "Risk Factors" and elsewhere in this Prospectus. OVERVIEW The Company is an international long distance provider focused primarily on providing highly reliable, low cost switched voice long distance services to U.S. and foreign-based telecommunications companies. The Company currently offers U.S.-originated long distance service to over 200 countries worldwide through its flexible network of resale arrangements with other long distance providers, various foreign termination relationships, international gateway switches and leased and owned transmission facilities. Although the Company was incorporated in 1993, it did not commence its current business as a provider of long distance services until the second half of 1995. During 1994, the Company was primarily engaged in activities outside the international telecommunications industry. During the six months ended June 1995, the Company primarily acted as an agent for, and provided various consulting services to, companies in the telecommunications industry. Although the Company incurred expenses in the first half of 1995 related to the start-up of its service as a long distance provider, the Company did not install its first international gateway switch in Los Angeles until June 1995. The Company recognized initial revenue as an international long distance provider in August 1995. In June 1996, the Company began operation of its second switching facility in New York. From the third quarter of 1995 through the first quarter of 1997, the Company focused primarily on building international traffic volume. The Company's customer base grew from 32 customers at the end of 1995 to 88 customers at the end of March 1997. Minutes of use increased from 34.3 million in the fourth quarter of 1995 to 172.5 million in the first quarter of 1997. Revenue grew from $14.0 million in the fourth quarter of 1995 to $71.0 million in the first quarter of 1997. See "Risk Factors -- Operating Results Subject to Significant Fluctuations." Revenue. Currently, all of the Company's revenue is generated by the sale of international long distance services on a wholesale basis to other, primarily domestic, long distance providers. In the fourth quarter of 1996, the Company began to provide international long distance services to foreign-based telecommunications companies. The Company records revenues from the sale of long distance services at the time of customer usage. The Company's agreements with its wholesale customers are short term in duration and the rates charged to customers are subject to change from time to time, generally with five days notice to the customer. However, the Company is beginning to offer longer term, fixed price arrangements for certain countries. The Company's five largest customers, including CCI and Hi-Rim, accounted for approximately 43% of gross revenues in 1996. The Company's largest customer, CCI, accounted for approximately 21% of revenue in 1996 and 15% in the first quarter of 1997. The Company no longer provides service to CCI or Hi-Rim. The Company's five largest customers in the first quarter of 1997 accounted for 44% of revenue in such period. Any loss of, or decrease in usage by, the Company's major customers could have a material adverse effect on the Company's business operating results and financial condition. See "Risk Factors--Dependence on Other Long Distance Providers; Customer Concentration and Increased Bad Debt Exposure" and "--Operating Results Subject to Significant Fluctuations." Gross Margin. The Company has pursued a strategy of attracting customers and building calling volume and revenue by offering favorable rates compared to other long distance providers. This strategy adversely impacted the Company's gross margin, and will continue to impact gross margin to the extent that the Company continues to seek to build volume on selected routes. Having significantly 21 23 increased its call volume, the Company is now focusing on lowering its cost of services and improving its gross margin by (i) leveraging the Company's traffic volumes and information systems to negotiate lower variable usage based costs with domestic and foreign providers of transmission capacity, (ii) continuing to invest in the Company's owned network facilities and to enter into other fixed cost arrangements, such as long-term leases, when traffic volumes justify such investment and (iii) continuing to utilize the Company's sophisticated information systems to route calls over the most cost-effective routes. Cost of services includes those costs associated with the transmission and termination of international long distance services and has historically consisted largely of payments to other long distance providers and, to a lesser extent, line costs. Currently, most transmission capacity used by the Company is obtained on a variable, per minute basis. As a result, most of the Company's current cost of services is variable. The Company's contracts with its vendors provide that rates may fluctuate, with rate change notice periods varying from five days to one year, with certain of the Company's longer term arrangements requiring the Company to meet minimum usage commitments in order to avoid penalties. Such variability and the short-term nature of many of the contracts subject the Company to the possibility of unanticipated cost increases and the loss of cost-effective routing alternatives. Included in the Company's cost of services are accruals for rate and minute disputes and unreconciled billing differences between the Company and its vendors. Each quarter management reviews the cost of services accrual and adjusts the balance for resolved items. See "Risk Factors--Dependence on Availability of Transmission Capacity." The Company has initially obtained transmission capacity on a variable, per minute basis from other long distance providers, and is now in the process of acquiring capacity on a fixed-cost basis, either through leasing or the purchase of its own facilities, when traffic volume makes such a commitment cost-effective. As the Company increases the portion of traffic transmitted over owned or leased international facilities, cost of services will have an increasing proportion of fixed costs, reflecting lease, ownership and maintenance costs of the Company's owned network facilities. The Company currently has operating agreements with long distance providers in Norway, Denmark, Australia and Colombia, and is in the process of negotiating additional operating agreements for other countries. Operating agreements provide for the termination of traffic in, and return traffic to, the international long distance providers' respective countries at a negotiated "accounting rate." Under a traditional operating agreement, the international long distance provider that originates more traffic compensates the long distance provider in the other country by paying an additional "settlement payment." The Company currently expects that any return traffic that it will receive under such agreements will be immaterial through 1997. The Company intends to begin providing international long distance services to commercial customers in certain European countries in the second half of 1997. In the longer term, the Company also plans to expand into commercial markets in the U.S. and in other deregulating countries. The Company believes that traffic from commercial customers has the potential to generate higher gross margins than wholesale traffic. The Company also expects, however, that an expansion into this market will also increase the risk of bad debt exposure and lead to higher operating costs. See "Risk Factors--Management of Changing Business" and "--Dependence on Other Long Distance Providers; Customer Concentration and Increased Bad Debt Exposure." Prices in the international long distance market have declined in recent years and, as competition continues to increase, the Company believes that prices are likely to continue to decline. Additionally, the Company believes that the increasing trend of deregulation of international long distance telecommunications will result in greater competition, which could adversely affect the Company's revenue per minute and gross margin. The Company believes, however, that the effect of such decreases in prices may be offset in part by increased calling volumes and decreased costs. Operating Expenses. Selling, general and administrative costs consist primarily of personnel costs, tradeshow and travel expenses, commissions and consulting fees and professional fees, as well as an 22 24 accrual for bad debt expense. These expenses have been increasing over the past year, which is consistent with the Company's recent growth, accelerated expansion into Europe, and investment in systems and facilities. The Company expects this trend to continue and believes that additional selling, general and administrative expenses will be necessary to support the expansion of sales and marketing efforts, the expansion into commercial markets and operations. Selling, general and administrative expenses in the fourth quarter of fiscal 1996 include $11.6 million in bad debt expense in connection with accounts receivable, deposits and other assets related to two major customers who are no longer receiving services from the Company. See "Risk Factors -- Operating Results Subject to Significant Fluctuations." Foreign Exchange. Although the Company's functional currency is the U.S. dollar, the Company expects to derive an increasing percentage of its net revenue from international operations and changes in exchange rates may have a significant effect on the Company's results of operations. For example, the accounting rate under operating agreements is often defined in monetary units other than U.S. dollars, such as "special drawing rights" or "SDRs." To the extent that the dollar declines relative to units such as SDRs, the dollar equivalent accounting rate would increase. In addition, as the Company expands into the commercial market in foreign countries, its exposure to foreign currency rate fluctuations is expected to increase. The Company may choose to limit such exposure by the purchase of forward foreign exchange contracts or similar hedging strategies. There can be no assurance that any currency hedging strategy would be successful in avoiding exchange-related losses. See "Risk Factors--Risks of International Telecommunications Business." Factors Affecting Future Operating Results. The Company's quarterly operating results are difficult to forecast with any degree of accuracy because a number of factors subject these results to significant fluctuations. As a result, the Company believes that period-to-period comparisons of its operating results are not necessarily meaningful and should not be relied upon as indications of future performance. The Company's revenues, costs and expenses have fluctuated significantly in the past and are likely to continue to fluctuate significantly in the future as a result of numerous factors. The Company's revenues in any given period can vary due to factors such as call volume fluctuations, particularly in regions with relatively high per-minute rates; the addition or loss of major customers, whether through competition, merger, consolidation or otherwise; the loss of economically beneficial routing options for the termination of the Company's traffic; financial difficulties of major customers; pricing pressure resulting from increased competition; and technical difficulties with or failures of portions of the Company's network that impact the Company's ability to provide service to or bill its customers. The Company's cost of services and operating expenses in any given period can vary due to factors such as fluctuations in rates charged by carriers to terminate the Company's traffic; increases in bad debt expense and reserves; the timing of capital expenditures, and other costs associated with acquiring or obtaining other rights to switching and other transmission facilities; changes in the Company's sales incentive plans; and costs associated with changes in staffing levels of sales, marketing, technical support and administrative personnel. In addition, the Company's operating results can vary due to factors such as changes in routing due to variations in the quality of vendor transmission capability; the amount of, and the accounting policy for, return traffic under operating agreements; actions by domestic or foreign regulatory entities; the level, timing and pace of the Company's expansion in international and commercial markets; and general domestic and international economic and political conditions. Since the Company does not generally have long term arrangements for the purchase or resale of long distance services, and since rates fluctuate significantly over short periods of time, the Company's gross margins are subject to significant fluctuations over short periods of time. The Company's gross margins also may be negatively impacted in the longer term by competitive pricing pressures. Although the Company's revenues have increased in each of the last nine quarters, such growth should not be considered indicative of future revenue growth or operating results. If revenue levels fall below expectations, net income is likely to be disproportionately adversely affected because a 23 25 proportionately smaller amount of the Company's operating expenses varies with its revenues. This effect is likely to increase as a greater percentage of the Company's cost of services are associated with owned and leased facilities. There can be no assurance that the Company will be able to achieve or maintain profitability on a quarterly or annual basis in the future. See "Risk Factors--Risks Associated with Limited Operating History in the International Telecommunications Market" and "--Operating Results Subject to Significant Fluctuations." RESULTS OF OPERATIONS In 1994 the Company was primarily engaged in activities outside the international telecommunications industry. During the six months ended June 1995, the Company primarily acted as an agent for, and provided consulting services to, companies in the telecommunications industry. The Company discontinued this business in September 1995 and, as a result, the Company believes that a comparison of financial condition and results of operations between the years ended 1994 and 1995 is not meaningful. QUARTERS ENDED MARCH 31, 1997 AND 1996 Revenues. Revenues increased 98.9% to $71.0 million in the first quarter of 1997 from $35.7 million in the first quarter of 1996, with minutes of use increasing 102.0% to 172.5 million in the first quarter of 1997, as compared to 85.4 million minutes of use in the comparable quarter of the year prior. The increase in revenue resulted from an increase in new customers as well as increased usage by existing customers. Gross Margin. Gross profit increased to $7.3 million in the first quarter of 1997 from $3.4 million in the first quarter of 1996. Gross margin improved to 10.2% from 9.5%, reflecting the negotiation of lower rates on routes with significant traffic. Selling, General and Administrative. Selling, general and administrative expenses increased 150.0% to $4.5 million during the first quarter of 1997 from $1.8 million in the comparable quarter one year earlier, and increased as a percentage of revenue to 6.4% from 5.1% in the prior period. Selling, general and administrative expenses increased between periods as the Company continued to increase its employee base and incurred payroll, employee benefits, commission and related expenses. Marketing activities including tradeshows and travel also increased in support of the growing revenue and customer base. Selling, general and administrative expenses also increased as a percentage of revenues as a result of an increase in bad debt expense as a percentage of revenues. Depreciation. Depreciation increased to $722,000 in the first quarter of 1997 from $108,000 for the first quarter of 1996. Depreciation increased as a result of the Company's continued expansion of its transmission network, leasehold improvements associated with the Los Angeles and New York switching facilities and switch site buildout. Other Income (Expense). Other expense, net, increased to $300,000 in the first quarter of 1997 from $78,000 in the first quarter of 1996. This increase is primarily due to $369,000 in interest expense incurred under various bank and stockholder lines of credit. This increase was offset by $21,000 in interest income and $48,000 gain on the sale of short term investments and cash equivalents from funds raised in private placements of equity securities during 1996. Provision for Income Taxes. The Company's provision for income taxes decreased to $286,000 in the first quarter of 1997 from $544,000 in the first quarter of 1996 reflecting the write-off of a customer accounts receivable. YEARS ENDED DECEMBER 31, 1996 AND 1995 Revenues. Revenues increased to $208.1 million in 1996 from $16.1 million in 1995, with minutes of use increasing to 479.7 million in 1996, as compared to 38.1 million minutes of use in the prior year. The increase in revenue resulted from the Company's commencement of operations as an interna- 24 26 tional long distance carrier, an increase in the number of customers as compared to the prior year and an increase in minutes of traffic from new and existing customers. The increase in traffic is also attributable to an increase in the number of routes with favorable rates that the Company was able to offer to customers. The Company built its revenue and a customer base quickly by offering reliable, low cost wholesale switched long distance services utilizing capacity purchased from other long distance providers and by leveraging the industry relationships of its senior management. In addition, as a reseller the Company did not have to acquire rights to undersea cable or enter into operating or other termination agreements. Any loss of, or decrease in usage by, the Company's major customers could have a material adverse effect on the Company's business operating results and financial condition. The Company's two largest customers in 1996 accounted for 36% of revenue from late charges. See "Risk Factors--Operating Results Subject to Significant Fluctuations" and "--Dependence on Other Long Distance Providers; Customer Concentration and Increased Bad Debt Exposure." Gross Margin. Gross profit increased to $19.7 million in 1996 from $1.8 million for 1995. Gross margin decreased to 9.4% in 1996 from 11.0% in 1995, reflecting the change from the Company's prior consulting business to operating as an international long distance carrier. Gross margin was positively impacted during 1996 by the negotiation of lower rates on routes with significant traffic, and negatively impacted by increases in traffic on routes with lower margins. Selling, General and Administrative. Selling, general and administrative expenses increased to $24.1 million in 1996 from $2.1 million in 1995, and decreased as a percentage of revenue to 11.6% from 12.8% in the prior period. Selling, general and administrative expenses increased between periods as the Company increased its employee base and incurred payroll, employee benefits, commission and related expenses. The Company also established a reserve for doubtful accounts to reflect its significantly higher revenue levels and invested in sales and marketing activities including tradeshows and travel. In particular, in the fourth quarter of 1996, Hi-Rim, one of the Company's major customers, informed the Company that it was experiencing financial difficulties and would be unable to pay in full, on a timely basis, approximately $6.0 million in outstanding accounts receivable. The Company accepted a secured note in the amount of $3.4 million in lieu of a portion of past due payments and was able to offset a portion of the amounts due by sending traffic to Hi-Rim. The Company believes that it is unlikely to receive any additional payment from Hi-Rim under the note or otherwise. As a result, the full amount of the approximately $5.3 million owed to the Company by Hi-Rim as of December 31, 1996 which was not subsequently paid or offset was written off in the fourth quarter of 1996. In the first quarter of 1997, CCI, the Company's largest customer in 1996, also informed the Company that it was unable to pay in full, on a timely basis, its accounts receivable balance. To account for the potential inability to collect on the accounts receivable and outstanding deposits which the Company had made to CCI, the Company increased its reserve against accounts receivable and reserve against deposits by $3.5 million and $2.0 million, respectively. In addition, the Company wrote-off $820,000 of intangible assets relating to this customer. These reserves and write-off reflect the full amount of future benefits to have been received by the Company from assets related to CCI recorded on the Company's Balance Sheet at December 31, 1996. As a result, selling, general and administrative expenses increased by $11.6 million. See "Risk Factors--Dependence on Other Long Distance Providers; Customer Concentration and Increased Bad Debt Exposure." Depreciation. Depreciation increased to $1.1 million for 1996 from $128,000 for 1995, but decreased as a percentage of revenues to 0.5% from 0.8% in the prior period. Depreciation increased in absolute dollars as a result of the Company's acquisition of operating equipment and leasehold improvements associated with its Los Angeles and New York switching facilities and switch site buildouts. The Company expects depreciation expense to increase as the Company expands its ownership of switching and transmission facilities through purchase or use of capital leases. Other Income (Expense). Other expense, net, increased to $606,000 in 1996 from $144,000 in 1995. This increase is primarily due to a $100,000 legal settlement in the second quarter of 1996 as well as $589,000 in interest expense incurred under various bank and stockholder lines of credit. This increase 25 27 was offset by $83,000 in interest income on short term investments and cash equivalents from funds raised in private placements of equity securities during the first three quarters of 1996. Provision for Income Taxes. The Company had no provision for federal income taxes in 1995, since the Company incurred a loss for the year. In addition, the Company was an S corporation during 1995 and thus was only subject to 1.5% tax on taxable income for state purposes with a minimum of $800 per year. The pro forma provision for income taxes, assuming the Company was a C corporation for all periods presented, does not differ from the actual tax provision during 1995. During 1996 the provision for income taxes increased to $534,000 as a result of timing differences between the provision for income taxes and income taxes at statutory rates primarily relating to recognition of reserves for bad debt expense. 26 28 QUARTERLY RESULTS OF OPERATIONS The Company initiated its international telecommunications business in the third quarter of 1995. The following tables set forth certain unaudited statement of operations data for each of the seven quarters in the period ended March 31, 1997, as well as the percentage of the Company's revenues represented by each item. The unaudited financial statements have been prepared on the same basis as the audited financial statements contained herein and include all adjustments (consisting only of normal recurring adjustments) that the Company considers necessary for a fair presentation of such information when read in conjunction with the Company's Consolidated Financial Statements and Notes thereto appearing elsewhere in this Prospectus.
QUARTER ENDED ------------------------------------------------------------------------------- SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, 1995 1995 1996 1996 1996 1996 1997 --------- -------- -------- -------- --------- -------- -------- (IN THOUSANDS, EXCEPT PER SHARE AND PER MINUTE DATA) CONSOLIDATED STATEMENT OF OPERATIONS DATA: Revenues...................................... $ 1,622 $13,993 $35,667 $42,852 $61,169 $68,398 $ 71,008 Cost of services.............................. 1,420 12,926 32,286 38,754 56,527 60,863 63,738 ------- ------- ------- ------- ------- ------- Gross profit................................ 202 1,067 3,381 4,098 4,642 7,535 7,270 Operating expenses: Selling, general and administrative expenses.................................. 536 1,068 1,803 2,573 3,665 16,046 4,530 Depreciation and amortization............... 21 100 108 156 343 466 722 ------- ------- ------- ------- ------- ------- Total operating expenses............... 557 1,168 1,911 2,729 4,008 16,512 5,252 Income (loss) from operations................. (355) (101) 1,470 1,369 634 (8,977) 2,018 Other income (expense): Interest income............................. -- -- -- 28 42 13 21 Interest expense............................ -- (60) (78) (109) (173) (229) (369) Other expense............................... -- (80) -- (100) -- -- 48 ------- ------- ------- ------- ------- ------- Income (loss) before provision for income taxes.................................. (355) (241) 1,392 1,188 503 (9,193) 1,718 Provision (benefit) for income taxes.......... -- 1 544 485 217 (712) 286 ------- ------- ------- ------- ------- ------- Net income (loss)......................... $ (355) $ (242) $ 848 $ 703 $ 286 $(8,481) $ 1,432 ======= ======= ======= ======= ======= ======= AS A PERCENTAGE OF REVENUE --------------------------------------------------------------------- Revenues...................................... 100.0% 100.0 % 100.0 % 100.0 % 100.0% 100.0 % 100.0% Cost of services.............................. 87.5 92.4 90.5 90.4 92.4 89.0 89.8 ------- ------- ------- ------- ------- ------- Gross profit................................ 12.5 7.6 9.5 9.6 7.6 11.0 10.2 Operating expenses: Selling, general and administrative expenses.................................. 33.0 7.6 5.1 6.0 6.0 23.5 6.4 Depreciation and amortization............... 1.3 0.7 0.3 0.4 0.6 0.6 1.0 ------- ------- ------- ------- ------- ------- Total operating expenses............... 34.3 8.3 5.4 6.4 6.6 24.1 7.4 Income (loss) from operations................. (21.9) (0.7) 4.1 3.2 1.0 (13.1) 2.8 Other income (expense): Interest income............................. -- -- -- 0.1 0.1 -- -- Interest expense............................ -- (0.4) (0.2) (0.3) (0.3) (0.3) (0.5) Other expense............................... -- (0.6) -- (0.2) -- -- 0.1 ------- ------- ------- ------- ------- ------- Income (loss) before provision for income taxes.................................. (21.9) (1.7) 3.9 2.8 0.8 (13.4) 2.4 Provision for income taxes.................... -- -- 1.5 1.1 0.4 (1.0) 0.4 ------- ------- ------- ------- ------- ------- Net income (loss)......................... (21.9)% (1.7)% 2.4 % 1.6 % 0.5% (12.4)% 2.0% ======= ======= ======= ======= ======= ======= CONSOLIDATED OPERATING DATA: Billed minutes of use......................... 3,783 34,323 85,375 104,098 137,963 152,245 172,455 Revenue per billed minute of use(1)........... $0.3999 $0.4113 $0.4149 $0.4071 $0.4400 $0.4413 $0.4064
- ------------------------------ (1) Represents gross call usage revenue per billed minute. Amounts exclude other revenue related items such as finance charges. 27 29 Revenues. Revenues increased each quarter since the Company first recognized revenue as a long distance carrier in the quarter ended September 30, 1995. These increases reflected the increase in minutes of usage over the respective quarters as the Company increased its customer base and as usage increased among existing customers. The Company's revenue growth in the quarter ending June 30, 1996 was slower relative to the quarter ended March 31, 1996 because of limited port capacity at both the Los Angeles and the New York switch sites. The Company increased its port capacity by installing new switches at both the Los Angeles and the New York switch sites in June and July of 1996. As a result, the quarter ending September 30, 1996 reflects revenue growth attributable to the additional port capacity of the new switches in Los Angeles and New York. The Company's revenue growth slowed in the fourth quarter of 1996 relative to the prior quarter primarily due to the Company significantly reducing the traffic it received from a major customer experiencing financial difficulties, a relatively smaller decrease in traffic from another major customer due to pricing changes and transmission quality problems on several high volume routes, primarily as a result of call set-up delay and an ability to transmit facsimiles, that caused customers to choose alternative routes. The Company's revenue growth in the first quarter of 1997 reflects increased usage by the Company's existing customer base. Gross Margin. Gross margin fluctuated significantly from the quarter ended September 30, 1995 through the quarter ended December 31, 1996. Gross margin decreased to 7.6% in the quarter ended December 31, 1995 from 12.5% in the quarter ended September 30, 1995, reflecting the Company's continued transition from a higher margin consulting business as well as the Company's strategy of attracting customers and building traffic volume by offering favorable rates compared to other long distance providers. Gross margin for the quarters ended March 31, 1996 and June 30, 1996 improved to 9.5% and 9.6%, respectively as the Company gained traffic volume and customers for selected higher margin routes. As traffic volumes increased, the Company negotiated lower rates on these routes. Increased volume also distributed the fixed costs of the Los Angeles and New York switch sites over a larger number of minutes. Gross margin for the quarter ended September 30, 1996 declined because of price increases on three routes which had significant traffic. The Company elected to maintain customer traffic on these routes at the same prices while management sought alternative routing arrangements. New rates for these routes were negotiated and effective in the late third quarter of 1996. The Company's gross margins improved to 11.0% in the fourth quarter of 1996 due in part to lower costs on several major routes. The gross margin is also affected by the change in accrued line costs. The accrued line costs at December 31, 1996 increased to $19.5 million from $15.8 million at September 31, 1996. This increase is net of adjustments for the favorable settlement of disputes and the favorable reconciliation of vendor bills. However, the improvement in the Company's gross margin was offset by lower traffic minutes on higher margin routes due to quality problems, primarily unacceptably low call completion rates, with the most cost-effective routing option and by higher volume traffic to several lower margin countries. The Company's gross margin decreased to 10.2% in the first quarter of 1997 as a result of increased costs on selected routes and high usage by a customer on a short-term, low priced routing arrangement. Selling, General and Administrative Expenses. Selling, general and administrative expenses have increased in each quarter through December 31, 1996 since the Company commenced operation as an international long distance provider in July 1995. These increases in expenses are the result of increased payroll and related expenses as the Company has built its sales, marketing and administrative staffs, expansion of the Company's tradeshow and travel activities, increases in commissions and consulting fees related to higher revenue levels and the establishment of reserves for doubtful accounts. Selling, general and administrative expenses have fluctuated as a percentage of revenues. Selling, general and administrative expenses were higher in the quarter ended December 31, 1995 than in the prior period, due to the establishment of a reserve for doubtful accounts. These expenses for the quarter ended December 31, 1996 increased to 23.5% of revenues largely as a result of the Company's increase of its reserve against accounts receivable and reserve against deposit by $3.5 million and $2.0 million, respectively, the uncertainty of payment from CCI, who currently is experiencing financial difficulties, the write-off of $820,000 of intangible assets also relating to CCI and the 28 30 $5.3 million write-off of the Hi-Rim accounts receivables. These reserves and write-off reflect the full amount of future benefits to be received by the Company from assets related to CCI recorded on the Company's Balance Sheet at December 31, 1996. See "Risk Factors -- Operating Results Subject to Significant Fluctuations" and " -- Dependence on Other Long Distance Providers; Customer Concentration and Increased Bad Debt Exposure." Depreciation. Depreciation increased in the quarter ended December 31, 1995 as a result of the Company's acquisition of operating equipment and leasehold improvements for its Los Angeles switching facility. Depreciation also increased in the quarters ended September 30, 1996 and December 31, 1996 as a result of the addition of a third switch in Los Angeles and the increase in operating equipment and leasehold improvements related to the New York switching facility. LIQUIDITY AND CAPITAL RESOURCES To date, the Company has funded its business primarily through funds advanced from an officer of the Company, bank debt, the private sale of equity and, since the first quarter of 1996, cash generated from operations. The Company used net cash from operating activities of approximately $2.3 million in 1996, primarily comprised of a net loss plus an increase in accounts receivable and prepaid expenses and other assets and a decrease in accounts payable, offset in part by an increase in accrued line costs and the provision for doubtful accounts. The Company's investing activities used cash of approximately $14.9 million during 1996 primarily resulting from capital expenditures and an increase in deposits. The Company's financing activities provided cash of approximately $18.8 million during 1996 primarily from borrowings under various lines of credit, the sale of Preferred Stock and the sale of Common Stock, offset by repayments under various lines of credit. In the first quarter of 1997, net cash provided by operating activities was $2.2 million, consisting primarily of net income plus increases in accounts payable and the provision for doubtful accounts, offset in part by an increase in accounts receivable and a decrease in accrued line costs. Net cash used in investing activities in the first quarter of 1997 was $465,000, consisting primarily of capital expenditures, offset in part by purchase of investments. Net cash used in financing activities in the first quarter of 1997 was $2.7 million, consisting primarily of repayments under various lines of credit, offset in part by borrowings under such lines of credit. In the fourth quarter of 1996, the Company wrote off $5.3 million of the accounts receivable from Hi-Rim. The Company also increased its bad debt expense in the fourth quarter of 1996 by $6.3 million to provide for the potential inability to collect on accounts receivable, deposits and other assets from CCI. In addition, in the first quarter of 1997 the Company wrote off $1.6 million as a result of the failure of one of its customers to pay its outstanding accounts receivable balances. See "Risk Factors--Operating Results Subject to Significant Fluctuations" and "--Dependence on Other Long Distance Providers; Customer Concentration and Increased Bad Debt Exposure." As of December 31, 1995 and 1996, and March 31, 1997 the Company had cash and cash equivalents of approximately $164,000, $1.7 million, $766,000, respectively, and a working capital deficit of approximately $1.4 million, $7.6 million and $8.4 million, respectively. As of March 31, 1997 the Company had (i) approximately $5.3 million outstanding under a revolving line of credit that bears interest at a rate of the bank's prime rate plus 1.0%, certain amounts of which are convertible at the time of funding into short-term obligations that bear interest either at LIBOR plus 3.5% or the bank's cost of funds rate plus 3.5%, and which expires on July 1, 1997, (ii) $667,000 outstanding under an equipment lease line that bears interest at a rate of prime plus 1.5% and which expires on October 1, 1999, (iii) approximately $6.4 million outstanding under nine equipment leases relating to the Company's switching facilities, including approximately $3.0 million outstanding under a lease for the acquisition of the Company's switching equipment in New York, and (iii) approximately $193,000 outstanding under bank loans at a variable interest rate equal to the Wall Street Journal Prime Rate, approximately $151,442 of which is due in July 1997 and $41,500 of which is due in September 1997. The Company intends to use approximately $6.4 million of the proceeds from this offering for the 29 31 repayment of indebtedness under certain of these credit facilities. The Company anticipates making capital expenditures of approximately $30.0 million in 1997 to expand the Company's global network. See "Use of Proceeds." The Company currently is in discussions to obtain a new line of credit to provide it with additional funding to meet its capital requirements and will use capital lease financings as appropriate. There can be no assurance that the Company will be able to obtain a new line of credit or additional capital lease financing on commercially reasonable terms, if at all. The Company believes that the net proceeds from the offering, borrowing capacity under a new line of credit and available vendor financing, will be sufficient to fund the Company's net cash used in operating activities, capital expenditures and other cash needs for the next 12 months. Additional funding through the incurrence of debt or sale of additional equity may be required to meet the Company's growth plans beyond the first half of 1998, although there can be no assurance that such additional funds can be obtained on acceptable terms, if at all. If necessary funds are not available, the Company's business and results of operations and the future expansion of the business could be materially adversely affected. See "Risk Factors -- Capital Expenditures; Potential Need for Additional Financing." 30 32 BUSINESS OVERVIEW STAR Telecommunications is an international long distance provider offering highly reliable, low cost switched voice services on a wholesale basis, primarily to U.S.-based long distance carriers. STAR provides international long distance service to over 275 foreign countries through a flexible network of resale arrangements with long distance providers, various foreign termination relationships, international gateway switches, and leased and owned transmission facilities. The Company has grown its revenues rapidly by capitalizing on the deregulation of international telecommunications markets, by combining sophisticated information systems with flexible routing techniques and by leveraging management's industry expertise. STAR commenced operations as an international long distance provider in August 1995 and increased its revenues from $16.1 million in 1995 to $208.1 million in 1996. INDUSTRY BACKGROUND The international long distance telecommunications services industry consists of all transmissions of voice and data that originate in one country and terminate in another. This industry is undergoing a period of fundamental change which has resulted in substantial growth in international telecommunications traffic. According to industry sources, worldwide gross revenues for providers of international voice telephone service were approximately $57 billion in 1995 and the volume of international traffic on the public telephone network is expected to grow at a compound annual growth rate of 12% or more from 1995 through the year 2000. From the standpoint of U.S.-based long distance providers, the industry can be divided into two major segments: the U.S. international market, consisting of all international calls billed in the U.S. and the overseas market, consisting of all international calls billed in countries other than the U.S. The U.S. international market has experienced substantial growth in recent years with gross revenues from international long distance telephone services rising from approximately $8.0 billion in 1990 to approximately $14.9 billion in 1995, according to FCC data. The Company believes that a number of trends in the international telecommunications market will continue to drive growth in international traffic, including: - continuing deregulation and privatization of telecommunications markets; - pressure to reduce international outbound long distance rates paid by end users driven by increased competition among U.S. long distance carriers and among emerging foreign long distance carriers in deregulated countries; - the dramatic increase in the availability of telephones and the number of access lines in service around the world; - the increasing globalization of commerce, trade and travel; - the proliferation of communications devices such as faxes, cellular telephones, pagers and data communications devices; - increasing demand for data transmission services, including the Internet; and - the increased utilization of high quality digital undersea cable and resulting expansion of bandwidth availability. The Development of the U.S. and Overseas Markets The 1984 deregulation of the U.S. telecommunications industry enabled the emergence of new long distance companies in the U.S. Today, there are over 500 U.S. long distance companies, most of which are small or medium sized companies. In order to be successful, these small and medium size companies have to offer their customers a full range of services, including international long distance. 31 33 However, most of these carriers do not have the critical mass to receive volume discounts on international traffic from the larger facilities-based carriers such as AT&T, MCI and Sprint. In addition, these small and medium sized companies have only a limited ability to invest in international facilities. New international carriers such as STAR have emerged to take advantage of this demand for less expensive international bandwidth. These emerging international carriers act as aggregators of international traffic for smaller carriers, taking advantage of larger volumes to obtain volume discounts on international routes (resale traffic), or investing in facilities when volume on particular routes justify such investments. Over time, as these emerging international carriers have become established, they have also begun to carry overflow traffic from the larger long distance providers that own overseas transmission facilities. In an increasingly competitive market for international and domestic telecommunications, the resale market for telecommunications services has expanded rapidly. According to FCC data, total billed revenue of U.S. resellers of international switched services increased approximately 55% from 1994 to 1995, from approximately $1.1 billion to $1.7 billion. The expansion of the resale market has been facilitated by the significant increase in international fiber optic cable capacity, creating new routing options for providers of resale services as facilities-based carriers seek to fill that new capacity. Deregulation and privatization have also allowed new long distance providers to emerge in foreign markets. By eroding the traditional monopolies held by single national providers, many of which are wholly or partially government owned PTTs, deregulation is providing U.S.-based providers the opportunity to negotiate more favorable agreements with both the traditional PTTs and emerging foreign providers. In addition, deregulation in certain foreign countries is enabling U.S.-based providers to establish local switching and transmission facilities in order to terminate their own traffic and begin to carry international long distance traffic originated in that country. International Switched Long Distance Services International switched long distance services are provided through switching and transmission facilities that automatically route calls to circuits based upon a predetermined set of routing criteria. The call typically originates on a local exchange carrier's network and is transported to the caller's domestic long distance carrier. The domestic long distance provider then carries the call to an international gateway switch. An international long distance provider picks up the call at its gateway and sends it directly or through one or more other long distance providers to a corresponding gateway switch operated in the country of destination. Once the traffic reaches the country of destination, it is then routed to the party being called though that country's domestic telephone network. 32 34 International long distance providers can generally be categorized by their ownership and use of switches and transmission facilities. The largest U.S. carriers, such as AT&T, MCI and Sprint, primarily utilize owned transmission facilities and generally use other long distance providers to carry their overflow traffic. Since only very large carriers have transmission facilities that cover the over 200 countries to which major long distance providers generally offer service, a significantly larger group of long distance providers own and operate their own switches but either rely solely on resale agreements with other long distance carriers to terminate their traffic or use a combination of resale agreements and owned facilities in order to terminate their traffic as shown below: [STAR FACILITIES Illustration] Operating Agreements. Under traditional operating agreements, international long distance traffic is exchanged under bilateral agreements between international long distance providers in two countries. Operating agreements provide for the termination of traffic in, and return traffic to, the international long distance providers' respective countries at a negotiated "accounting rate." Under a traditional operating agreement, the international long distance provider that originates more traffic compensates the long distance provider in the other country by paying an additional "settlement payment." Under a typical operating agreement both carriers jointly own the transmission facilities between two countries. A carrier gains ownership rights in a digital fiber optic cable by purchasing direct ownership in a particular cable prior to the time the cable is placed in service, acquiring an "Indefeasible Right of Use" ("IRU") in a previously installed cable, or by leasing or obtaining capacity from another long distance provider that either has direct ownership or IRU rights in the cable. In situations where a long distance provider has sufficiently high traffic volume, routing calls across directly owned or IRU cable is generally more cost-effective on a per call basis than the use of short-term variable capacity arrangements with other long distance providers or leased cable. However, direct ownership and acquisition of IRU rights require a company to make an initial investment of its capital based on anticipated usage. Transit Arrangements. In addition to utilizing an operating agreement to terminate traffic delivered from one country directly to another, an international long distance provider may enter into transit arrangements pursuant to which a long distance provider in an intermediate country carries the traffic to a country of destination. Transit requires agreement among the carriers in all the countries involved and is generally used for overflow traffic or where a direct circuit is unavailable or not volume justified. Resale Arrangements. Resale arrangements typically involve the wholesale purchase and sale of transmission and termination services between two long distance providers on a variable, per minute basis. The resale of capacity, which was first permitted with the deregulation of the U.S. market, enabling the emergence of new international long distance providers that rely at least in part on capacity acquired on a wholesale basis from other long distance providers. International long distance 33 35 calls may be routed through a facilities-based carrier with excess capacity, or through multiple long distance resellers between the originating long distance provider and the facilities-based carrier that ultimately terminates the traffic. Resale arrangements set per minute prices for different routes, which may be guaranteed for a set time period or subject to fluctuation following notice. The resale market for international capacity is constantly changing, as new long distance resellers emerge and existing providers respond to fluctuating costs and competitive pressures. In order to be able to effectively manage costs when utilizing resale arrangements, long distance providers need timely access to changing market data and must quickly react to changes in costs through pricing adjustments or routing decisions. Alternative Termination Arrangements. As the international long distance market has become deregulated, long distance providers have developed alternative termination arrangements in an effort to decrease their costs of terminating international traffic. Some of the more significant of these arrangements include refiling, international simple resale ("ISR") and ownership of switching facilities in foreign countries. Refiling of traffic, which takes advantage of disparities in settlement rates between different countries, allows traffic to a destination country to be treated as if it originated in another country that enjoys lower settlement rates with the destination country, thereby resulting in a lower overall termination cost. The difference between transit and refiling is that, with respect to transit, the facilities-based long distance provider in the destination country has a direct relationship with the originating long distance provider and is aware of the arrangement, while with refiling, it is likely that the long distance provider in the destination country is not aware that the received traffic originated in another country and with another resale carrier. To date, the FCC has made no pronouncement as to whether refiling complies with either U.S. or International Telecommunications Union ("ITU") regulations. With ISR, a long distance provider completely bypasses the settlement system by connecting an international leased private line to the public switched telephone network ("PSTN") on one or both ends. While ISR currently is only sanctioned by applicable regulatory authorities on a limited number of routes, including U.S.-U.K., U.S.-Sweden, U.S.-New Zealand, U.K.-Worldwide and Canada-U.K., it is increasing in use and is expected to expand significantly as deregulation of the international telecommunications market continues. In addition, deregulation has made it possible for U.S.-based long distance providers to establish their own switching facilities in certain foreign countries, enabling them to directly terminate traffic. See "--Government Regulation." The highly competitive and rapidly changing international telecommunications market has created a significant opportunity for carriers that can offer high quality, low cost international long distance service. Deregulation, privatization, the expansion of the resale market and other trends influencing the international telecommunications market are driving decreased termination costs, a proliferation of routing options, and increased competition. Successful companies among both the emerging and established international long distance companies will need to aggregate enough traffic to lower costs of both facilities-based or resale opportunities, maintain systems which enable analysis of multiple routing options, to invest in facilities and switches and remain flexible enough to locate and route traffic through the most advantageous routes. THE STAR APPROACH STAR offers high quality, reliable switched international long distance services primarily to U.S.-based telecommunications companies that are seeking to utilize low cost routing alternatives to augment their own service and to address increased competition in their markets. The Company is also expanding to serve foreign-based international long distance providers. The Company provides international long distance service to over 275 foreign countries through a flexible network consisting of resale arrangements with other long distance providers, various foreign termination relationships, international gateway switches and leased and owned transmission facilities. STAR continuously monitors the market for long distance services, detecting trends in traffic flow, international network availability and pricing. The Company believes that this market knowledge enables it to react quickly to address market opportunities and to take advantage of changing market conditions. STAR utilizes its 34 36 flexible network structure and state-of-the-art digital switching technology to continuously reroute traffic to the most cost-effective transmission alternative for a particular country. STAR is further developing its network by establishing relationships with foreign PTTs and other foreign providers of long distance services and building network facilities, where existing and anticipated traffic volumes justify such investment. STRATEGY The Company's objective is to be a leading provider of highly reliable, low cost switched international long distance services on a wholesale basis to U.S. and foreign-based telecommunications companies, as well as on a retail basis to commercial customers. Key elements of the Company's strategy include the following: Capitalize on Projected International Long Distance Growth. The Company believes that the international long distance market provides attractive opportunities due to its higher revenue and profit per minute, and greater projected growth rate as compared to the domestic long distance market. The Company targets international markets with high volumes of traffic, relatively high rates per minute and prospects for deregulation and privatization. The Company believes that the ongoing trend toward deregulation and privatization will create new opportunities for the Company in international markets. Although the Company has focused to date primarily on providing services for U.S.-based long distance providers, the Company also intends in the future to expand the international long distance services it offers to foreign-based long distance providers to the extent allowed by U.S. and international governmental regulations. Leverage Traffic Volume to Reduce Costs. The Company has focused and is continuing to focus on building its volumes of international long distance traffic. Higher traffic volumes strengthen the Company's negotiating position with vendors, customers and potential foreign partners, which allows the Company to lower its costs of service. In addition, higher traffic volumes on particular routes allow the Company to lower its cost of services on these routes by transitioning from acquiring capacity on a variable cost per minute basis to fixed cost arrangements such as longer-term capacity agreements with major carriers, long-term leases and ownership of facilities. Expand Switching and Transmission Facilities. The Company is continuing to pursue a flexible approach to expanding and enhancing its network facilities by investing in both switching and transmission facilities where traffic volumes justify such investments. The Company intends to expand its U.S. switching facilities through the addition of switching facilities in Miami, Dallas and Atlanta. The Company is also in the process of developing switching capabilities in foreign countries with the addition of an international gateway switch in London, England, and is planning to install a network of switches in selected European cities. Leverage Information Systems and Switching Capabilities. The Company leverages its sophisticated information systems to analyze its routing alternatives, and select the most cost-effective routing from among the Company's network of resale arrangements with other long distance providers, operating agreements and other alternative termination relationships. The Company has invested significant resources in the development of software to track specific usage information by customer and cost and profit information on specific routes on a daily basis. The Company's information systems are critical components in managing its customer and vendor relationships, routing traffic to the most cost-effective alternative, and targeting marketing efforts. Maintain High Quality. The Company believes that reliability, call completion rates, voice quality, rapid set up time and a high level of customer and technical support are key factors evaluated by U.S. and foreign-based telecommunications companies in selecting a carrier for their international traffic. The Company has installed state-of-the-art Northern Telecom and Stromberg-Carlson switching equipment, is fully compliant with international C-7 and domestic SS-7 signaling standards, and strives to provide a consistently high level of customer and technical support. The Company has technical 35 37 support personnel at its facilities 24 hours per day, seven days per week to assist its customers and to continually monitor network operation. Expand Into Commercial Market. The Company intends to market its international long distance services directly to commercial customers in foreign countries, with an initial focus on the U.K. and selected European cities. The Company intends to initially provide services to closed user groups comprised of corporate customers. As regulatory restrictions ease in these foreign markets, the Company intends to aggregate long distance traffic from a broader range of commercial customers that will be routed over the Company's network back to the U.S. or to an alternate destination. In the longer term, the Company also plans to expand into commercial markets in the U.S. and in other deregulating countries. NETWORK The Company provides international long distance services to over 275 foreign countries through a flexible, switched-based network consisting of resale arrangements with other long distance providers, various foreign termination relationships, international gateway switches and leased and owned transmission facilities. The Company's network employs state-of-the-art digital switching and transmission technologies and is supported by comprehensive monitoring and technical support personnel who are at the Company's facilities 24 hours per day, seven days per week. Termination Arrangements International long distance traffic is ultimately terminated at the destination point pursuant to termination relationships between a provider of telecommunications services in the originating country and a provider in the terminating country. The Company seeks to retain flexibility and maximize its termination opportunities by utilizing a continuously changing mix of routing alternatives, including resale arrangements, operating agreements and other advantageous termination arrangements. This diversified approach is intended to enable the Company to take advantage of the rapidly evolving international telecommunications market in order to provide low cost international long distance service to its customers. The Company utilizes resale arrangements to provide it with multiple options for routing traffic through its switches to each destination country. Traffic under resale arrangements typically terminates pursuant to a third party's correspondent relationships. The Company purchased capacity from 51 vendors in the quarter ended March 31, 1997, six of which provided the majority of the Company's capacity during the same period. The majority of this capacity is obtained on a variable, per minute basis. The Company's contracts with its vendors provide that rates may fluctuate, with rate change notice periods varying from five days to one year, with certain of the Company's longer term arrangements requiring the Company to make minimum usage commitments in order to avoid penalties. As a result of deregulation and competition in the international telecommunications market, the pricing of termination services varies by carrier depending on such factors as call traffic and time of day. Since the Company does not typically enter into long term contracts with these providers, pricing can change significantly over short periods of time. These changes subject the Company to unanticipated price increases and service cancellations. The Company's proprietary information systems enable the Company to track the pricing variations in the international telecommunications market on a daily basis, allowing the Company's management to locate and reroute traffic to the most cost-effective alternatives. If the Company is not able to continue to enter into cost-effective resale arrangements with its primary vendors, or is unable to locate suitable replacement vendors the Company may not be able to obtain sufficient, high quality alternative capacity, in which case the Company's business, operating results and financial condition could be materially adversely affected. See "Risk Factors--Dependence on Availability of Transmission Capacity." The Company currently has operating agreements with carriers in Norway, Denmark, Australia and Colombia and is in the process of negotiating additional operating agreements for other countries. 36 38 The Company has been and will continue to be selective in entering into operating agreements. The Company also has agreements with two providers of long distance services in the Asia/Pacific Rim region for termination of U.S. originated traffic that the Company aggregates in the U.S. and routes over a leased network to such countries. The Company is exploring similar relationships with carriers in other countries. The FCC or foreign regulatory agencies may take the view that such arrangements are not in compliance with current regulatory policies relating to private line resale. The operations of alternative carriers like the Company's partners, who compete with the PTT, may not be permitted by foreign regulatory agencies. To the extent that the revenue generated under such arrangements becomes a significant portion of overall revenue, the loss of such arrangements, whether as a result of regulatory problems or otherwise, could have a material adverse effect on the Company's business, operating results and financial condition. In addition, the FCC could impose a range of sanctions on the Company, including fines or forfeitures, to the extent it determined any of the Company's arrangements to be non-compliant with FCC rules. See "Risk Factors--Risks of International Telecommunications Business," "-- Potential Adverse Affects of Government Regulation" and "Business - -- Government Regulation." Switches and Transmission Facilities International long distance traffic to and from the U.S. is generally transmitted through an international gateway switching facility across undersea digital fiber optic cable or via satellite to a termination point. International gateway switches are digital computerized routing facilities that receive calls, route calls through transmission lines to their destination and record information about the source, destination and duration of calls. The switches are linked to digital fiber optic cables, which are typically owned by consortia of international carriers. The Company's global network facilities include both international gateway switches and rights to use undersea digital fiber optic cable. The Company has international gateway switches, together with sophisticated switching software, installed in Los Angeles and New York City. Each gateway includes a Northern Telecom DMS 250/300 and two Stromberg-Carlson DCO switches. The software in the Company's switches provide continuous and detailed feedback about incoming and outgoing call traffic to the Company's proprietary reporting software and to its billing system. The reporting software provides detailed real-time vendor and customer usage reports, which allow the Company to seek the most cost-effective routing of calls and to target customers who might absorb increased levels of traffic. The Company has installed multiple redundancies into its switching facilities to decrease the risk of a network failure. For example, the Company employs both battery and generator power back-up and has installed hardware that automatically shifts the system to auxiliary power during a power outage, rather than relying on manual override. In addition, the Company has contracted with a third party to provide the Company with access to a mobile emergency power supply. The Company's Los Angeles-based switch generally routes the majority of the Company's Asian and Pacific Rim traffic and a portion of the Company's South American traffic, while the New York switch generally routes the majority of the Company's European and African traffic and the remainder of the South American traffic. The Company plans to add switching facilities in Dallas, Texas, Miami, Florida and Atlanta, Georgia to more efficiently address the South and Central American markets. The Company is also installing a gateway switch in London, England, which will serve as the focal point for the routing of calls through a network of switches to be located in selected European cities. The Company currently expects the London switch to be operational in mid-1997. There can be no assurance that these facilities will become operational within the time frame currently anticipated by the Company. The Company currently owns or has IRUs in three trans-Atlantic (Canus-1, Cantat-3 and TAT-12/13) and two interEuropean (Odin and Rioja) digital fiber optic cables serving the U.K., Norway and Denmark, two trans-Pacific cables (TPC-5 and APCN) serving Australia and the Philippines, one interEuropean cable (UK Netherlands 14) and is in the process of negotiating to acquire ownership rights or IRUs in other cables. The Company plans to increase its investment in 37 39 direct and IRU ownership of cable in situations where the Company enters into operating agreements and in other situations in which it determines that such an investment would enhance operating efficiency or reduce transmission costs. The cost for each unit of transmission capacity in jointly owned carrier undersea cables depends on the percentage of cable capacity that has been purchased. The total cost of the cable is fully allocated among the participants of the physical capacity of the cable. The per-unit cost of capacity declines as the percentage of cable capacity is fully purchased. SALES, MARKETING AND CUSTOMERS The Company markets its services on a wholesale basis to other telecommunications companies through its experienced direct sales force and marketing/account management team who leverage the long term industry relationships of the Company's senior management. The Company reaches its customers primarily through domestic and international trade shows and through relationships gained from years of experience in the telecommunications industry. As of March 31, 1997, the Company had 13 sales and marketing employees. The Company's sales and marketing employees utilize the extensive, customer specific usage reports and network utilization data generated by the Company's sophisticated information systems to negotiate agreements with customers and prospective customers more effectively and to rapidly respond to changing market conditions. The Company believes that it has been able to compete more effectively as a result of the personalized service and ongoing senior management-level attention that is given to each customer. In connection with the Company's proposed expansion into the commercial market, the Company expects to utilize a direct sales force. Establishment of a sales force capable of effectively expanding the Company's services into the retail market can be expected to require substantial efforts and management and financial resources. See "Risk Factors--Management of Changing Business." The Company's wholesale customers include both facilities-based carriers and switch-based long distance providers that purchase the Company's services for resale to their own customers. In the first quarter of 1997, the Company provided switched long distance services to 88 customers, including eight of the twelve largest U.S.-based long distance carriers. In 1996, the Company's largest customer, CCI, accounted for approximately 21% of the Company's revenue. No other customer accounted for more than 10% of the Company's revenue during such period. The Company no longer provides service to CCI. In 1995, CCI accounted for 36.5% of the Company's revenue. In 1994, during which time the Company was engaged in activities unrelated to its current business, the Company's largest customer, CareTel, accounted for 56% of the Company's revenue. Any loss or decrease in usage by the Company's major customers could have a material adverse effect on the Company's business, operating result or financial condition. See "Risk Factors--Dependence on Other Long Distance Providers; Customer Concentration and Increased Bad Debt Exposure." INFORMATION AND BILLING SYSTEMS The Company's operations use advanced information systems including call data collection and call data storage linked to a proprietary reporting system. The Company also maintains redundant billing systems for rapid and accurate customer billing. The Company's systems enable it, on a real-time basis to determine the most cost-effective termination alternatives, monitor customer usage and manage profit margins. The Company's systems also enable it to ensure accurate and timely billing and reduce routing errors. 38 40 The Company's proprietary reporting software compiles call, price and cost data into a variety of reports which the Company can use to re-program its routes on a real time basis. The Company's reporting software can generate the following reports as needed: - customer usage, detailing usage by country and by time period within country, in order to track sales and rapidly respond to any loss of traffic from a particular customer; - country usage, subtotaled by vendor or customer, which assists the Company with route and network planning; - vendor rates, through an audit report that allows management to determine at a glance which vendors have the lowest rates for a particular country in a particular time period; - vendor usage by minute, enabling the Company to verify and audit vendor bills; - dollarized vendor usage to calculate the monetary value of minutes passed to the Company's vendors, which assists with calculating operating margin when used in connection with the customer reports; and - loss reports used to rapidly highlight routing alternatives that are operating at a loss as well as identifying routes experiencing substantial overflow. The Company has built multiple redundancies into its billing and call data collection systems. Two call collector computers receive redundant call information simultaneously, one of which produces a file every 24 hours for billing purposes while the other immediately forwards the call data to corporate headquarters for use in customer service and traffic analysis. The Company maintains two independent and redundant billing systems in order to both verify billing internally and to ensure that bills are sent out on a timely basis. All of the call data, and resulting billing data, are continuously backed up on tape drives and redundant storage devices. COMPETITION The international telecommunications industry is intensely competitive and subject to rapid change. The Company's competitors in the international wholesale switched long distance market include large, facilities-based multinational corporations and PTTs, smaller facilities-based providers in the U.S. and overseas that have emerged as a result of deregulation, switched-based resellers of international long distance services and international joint ventures and alliances among such companies. International wholesale switched long distance providers compete on the basis of price, customer service, transmission quality, breadth of service offerings and value-added services. The Company believes that it competes favorably on the basis of price, transmission quality and customer service. The number of the Company's competitors is likely to increase as a result of the new competitive opportunities created by the WTO Agreement. Further, under the terms of the WTO Agreement, the United States and the other 67 countries participating in the Agreement have committed to open their telecommunications markets to competition, and foreign ownership and adopt measures to protect against anticompetitive behavior, effective starting on January 1, 1998. As a result, the Company believes that competition will continue to increase, placing downward pressure on prices. Such pressure could adversely affect the Company's gross margins if the Company is not able to reduce its costs commensurate with such price reductions. Competition from Domestic and International Companies and Alliances. The U.S.-based international telecommunications services market is dominated by AT&T, MCI and Sprint. The Company also competes with WorldCom, Inc., Pacific Gateway Exchange, Inc., TresCom International, Inc. and other U.S.-based and foreign long distance providers, many of which have considerably greater financial and other resources and more extensive domestic and international communications networks than the Company. The Company anticipates that it will encounter additional competition as a result of the formation of global alliances among large long distance telecommunications providers. For example, MCI and British Telecommunications recently announced a proposed merger that would create a 39 41 global telecommunications company called Concert, and additionally have announced an alliance with Telefonica de Espana. The effect of the proposed merger and alliance could create significantly increased competition. Many of the Company's current competitors are also the Company's customers. The Company's business would be materially adversely affected to the extent that a significant number of such customers limit or cease doing business with the Company for competitive or other reasons. Consolidation in the telecommunications industry could not only create even larger competitors with greater financial and other resources, but could also adversely affect the Company by reducing the number of potential customers for the Company's services. Competition from New Technologies. The telecommunications industry is in a period of rapid technological evolution, marked by the introduction of new product and service offerings and increasing satellite and undersea cable transmission capacity for services similar to those provided by the Company. Such technologies include satellite-based systems, such as the proposed Iridium and GlobalStar systems, utilization of the Internet for international voice and data communications and digital wireless communication systems such as PCS. The Company is unable to predict which of many possible future product and service offerings will be important to maintain its competitive position or what expenditures will be required to develop and provide such products and services. Increased Competition as a Result of a Changing Regulatory Environment. The FCC recently granted AT&T's petitions to be classified as a non-dominant carrier in the domestic interstate and international markets, which has allowed AT&T to obtain relaxed pricing restrictions and relief from other regulatory constraints, including reduced tariff notice requirements. These reduced regulatory requirements could make it easier for AT&T to compete with the Company. In addition, the Telecommunications Act, which substantially revises the Communications Act, permits and is designed to promote additional competition in the intrastate, interstate and international telecommunications markets by both U.S.-based and foreign companies, including the RBOCs. RBOCs, as well as other existing or potential competitors of the Company, have significantly more resources than the Company. The Company also expects that competition from carriers will increase in the future along with increasing deregulation of telecommunications markets worldwide. As a result of these and other factors, there can be no assurance that the Company will continue to compete favorably in the future. See "Risk Factors--Potential Adverse Affects of Government Regulation" and "--Significant Competition." GOVERNMENT REGULATION The Company provides international facilities-based and resale services subject to the regulatory jurisdiction of the FCC. The Company also may be subject to regulation in foreign countries in connection with certain business activities. For example, the Company's use of transit agreements or arrangements, if any, may be affected by regulations in either the transited or terminating foreign jurisdiction. There can be no assurance that the FCC or foreign countries will not adopt regulatory requirements that could adversely affect the Company. See "Risk Factors--Potential Adverse Affects of Government Regulation." Federal Regulation General Requirements. The Company must comply with the requirements of common carriage under the Communications Act, including the offering of service on a non-discriminatory basis at just and reasonable rates, and obtaining FCC approval prior to any assignment of authorizations or any transfer de jure or de facto control of the Company. The FCC has authority to enforce the Communications Act and its rules as they may apply to carriers such as the Company either in proceedings initiated upon its own motion or in response to challenges by third parties. The FCC has established different levels of regulation for dominant and non-dominant carriers. The Company is classified as a non-dominant carrier for international service. The Communications Act and the FCC's rules require all international carriers, including the Company, to obtain authority 40 42 under Section 214 of the Communications Act prior to leasing or acquiring capacity, and/or initiating international telecommunications services. Carriers must also file at the FCC and maintain tariffs containing the rates, terms, and conditions applicable to their services, as well as comply with various FCC reporting and contract filing requirements. The trend at the FCC has been to reduce regulation and facilitate competition. To that end, the FCC recently declared AT&T to be a non-dominant international carrier. Nevertheless, an otherwise non-dominant U.S.-based carrier may be subject to dominant carrier regulation on a specific international route if it is affiliated with a foreign carrier operating at the foreign point. The Company has no affiliations that would subject it to dominant carrier treatment on any route. International Services. FCC rules require the Company to obtain facilities-based Section 214 authorization to operate its channels of communication via satellites and undersea fiber optic cables, and Section 214 resale authority to resell international services. The Company holds both facilities-based and resale international authorizations, including a "global" Section 214 authorization that provides broad authority to offer switched and private line international services. As required by FCC rules, the Company has filed an international tariff with the FCC. The FCC imposes few restrictions on the resale of international switched services. The FCC does, however, limit the resale of international private lines for the provision of switched telecommunications services interconnected to the public switched network at one end or at both ends, generally referred to as "private line resale." Private line resale is permitted only on those routes where the FCC has found that U.S. carriers have equivalent opportunities to offer similar services in the foreign country. The FCC permits private line resale to Canada, the U.K., Sweden and New Zealand and is considering applications for equivalency determinations in Australia, Denmark, Chile, Finland and Mexico. As a result of the recent signing of the WTO Agreement, the FCC may repeal or revise the "equivalency" test and apply the more inclusive WTO standards. The Company has entered into agreements with certain foreign carriers to provide switched services over leased lines. The Company has agreed to pay a termination charge to compensate the foreign carriers for terminating the services over their networks. It is possible that the FCC would adopt the view that these arrangements do not comply with the private line resale policy and filing requirements that pertain to certain carrier agreements. In that event, the FCC could, among other measures, impose a cease and desist order and/or impose fines on the Company. There can be no assurance that the FCC's action in this regard, if any, would not have a material adverse effect on the Company's business. The Company must also conduct its international business in compliance with the FCC's international settlements policy ("ISP"). The ISP establishes the permissible arrangements for U.S.-based carriers and the foreign correspondents to settle the cost of terminating each other's traffic over their respective networks. The precise terms of settlement are established on a correspondent agreement, also referred to as an operating agreement. Among other terms, the operating agreement establishes the types of service covered by the agreement, the division of revenues between the carrier that bills for the call and the carrier that terminates the call at the other end, the frequency of settlements (i.e., monthly or quarterly), the currency in which payments will be made, the formula for calculating traffic flows between countries, technical standards, procedures for the settlement of disputes, the effective date of the agreement and the term of the agreement. The ISP is designed to eliminate foreign carriers' incentives and opportunities to discriminate in their operating agreements among different U.S. carriers through "whipsawing." Whipsawing refers to the practice of a foreign carrier favoring one U.S.-based carrier over another in exchange for an accounting, settlement rate and/or other term that benefits the foreign carrier but may otherwise be inconsistent with the U.S. public interest. Under the ISP, U.S. carriers can only enter into operating agreements that contain the same accounting rate offered to all U.S. carriers. When a U.S. carrier negotiates an accounting rate with a foreign correspondent that is lower than the accounting rate offered to another U.S. carrier for the same service, the U.S. carrier with the lower rate must file a 41 43 waiver or a notification letter with the FCC. If a U.S. carrier varies the terms and conditions of its operating agreement in addition to lowering the accounting rate, then the U.S. carrier must request a waiver of the FCC's rule. Unless prior FCC approval is obtained, the amount of payment or "settlement rate" generally must be one half of the accounting rate. Carriers must obtain waivers of the FCC's rules if they wish to vary the settlement rate from one-half of the accounting rate. U.S. carriers are also subject to the principle of proportionate return to assure that competing U.S. carriers have roughly equitable opportunities to receive the return traffic from foreign correspondent that reduces the marginal cost of providing international service. Consistent with its procompetition policies, the FCC prohibits U.S. carriers from bargaining for any special concessions from foreign partners. The FCC is currently considering whether to limit or prohibit the practice whereby a carrier routes, through its facilities in a third country, traffic originating from one country and destined for another country. The FCC has permitted third country calling where all countries involved consent to the routing arrangements (referred to as "transiting"). Under certain arrangements referred to as "refiling," the carrier in the destination country does not consent to receiving traffic from the originating country and does not realize the traffic it receives from the third country is actually originating from a different country. The FCC to date has made no pronouncement as to whether refile arrangements comport either with U.S. or ITU regulations. It is possible that the FCC will determine that refiling, as defined, violates U.S. and/or international law. To the extent that the Company's traffic is routed through a third country to reach a destination country, such an FCC determination with respect to transiting and refiling could have a material adverse effect on the Company's business operating results and financial condition. The FCC is considering these and other international service issues in the context of several policy rulemaking proceedings and in response to specific petitions and applications filed by other international carriers. In one recent proceeding, the FCC reduced regulatory requirements of nondominant international telecommunications service providers such as the Company. The FCC also recently enacted certain changes in its rules designed to permit more flexibility in its ISP as a method of achieving lower cost-based accounting rates as more facilities-based competition is permitted in foreign markets. Specifically, the FCC has decided to allow U.S. carriers, subject to certain competitive safeguards, to propose methods to pay for international call termination that deviate from traditional bilateral accounting rates and the ISP. While this rule change may provide more flexibility to the Company to respond more rapidly to changes in the global telecommunications market, it will also provide similar flexibility to the Company's competitors. In addition, the FCC has also recently proposed revisions to its international settlement "benchmark" rates, which are the FCC's target ceilings for prices that U.S. carriers should pay to foreign carriers for terminating U.S. calls overseas. Partially in order to comply with WTO standards of "Most Favored Nation" and "National Treatment," the FCC has also proposed that private line resale be permitted to countries with accounting rates within the new benchmarks even if the FCC has not decided that such countries offer equivalent opportunities to U.S. carriers. The FCC's proposal is intended to move settlement rates closer to the costs that would be reflected in a competitive international telecommunications market. The FCC's continuing resolution of issues in such proceedings either may facilitate the Company's international business or adversely affect the Company's international business (by, for example, liberalizing requirements that predominately affect larger carriers). The Company is unable to predict how the FCC will resolve pending international policy issues or how such resolution will affect its international business. International telecommunications service providers are required to file copies of their contracts with other carriers, including operating agreements, at the FCC within 30 days of execution. The Company has filed both of its operating agreements with European carriers (including accounting rate terms) with the FCC. The FCC's rules also require the Company to periodically file a variety of reports regarding its international traffic flows and revenues and use of international facilities. The FCC is engaged in a rulemaking proceeding in which it has proposed to reduce certain reporting requirements 42 44 of common carriers. The Company is unable to predict the outcome of this proceeding or its effect on the Company. Foreign Ownership and Affiliations. The Communications Act limits the ownership of an entity holding a radio license by non-U.S. citizens, foreign corporations and foreign governments. The Company does not currently hold any radio licenses. Although these ownership restrictions currently do not apply to non-radio facilities, such as fiber optic cable, there can be no assurance that such restrictions will not be imposed on the operation of non-radio facilities used for the provision of international services. The FCC also regulates the extent to which U.S. international services carriers may become affiliated with foreign carriers. U.S. carriers must report to the FCC a 10% ownership affiliation with a foreign carrier and may be regulated as a dominant carrier on specific routes if it has a 25% or more affiliation with a foreign carrier. Foreign-affiliated carriers may also be subject to the FCC's "effective competitive opportunity" test, which examines, in determining whether the foreign carrier or its affiliate may provide services in the U.S. market, the extent to which U.S. carriers are afforded effective competitive opportunities to compete for like services in destination countries where the foreign carrier has market power. The Company does not currently have any foreign affiliations, but there can be no assurance that these rules will not prevent the Company from implementing its business plans in the future. As a result of the recent signing of the WTO Agreement, the FCC, after ratification of the Agreement by Congress, may repeal or revise the "effective competitive opportunity" test and apply the more inclusive WTO standards. Foreign Regulation United Kingdom. In the U.K., the Company's services are subject to regulation by the U.K. Office of Telecommunications. The U.K. generally permits competition in all sectors of the telecommunications market, subject to licensing requirements and license conditions. Individual licenses (with standard conditions) are required for the provision of facilities-based services and for the provision of ISR services over leased international lines. The Company has been granted licenses to provide ISR and international facilities-based voice services to all international points from the U.K. Implementation of these licenses would permit the Company to engage in cost-effective routing of traffic between the U.S. and the U.K. and beyond. However, the Company is subject to certain conditions that could limit its ability to provide the lowest cost service to certain countries than would otherwise be possible absent the conditions. In addition, there can be no assurance that future changes in regulation and government will not have a material adverse effect on the Company's business, operating results and financial condition. Other Countries. The Company plans to initiate a variety of services in certain European countries including Belgium, France and Germany. These services will include value-added services to closed user groups and other voice services as regulatory liberalization in those countries permits. These and other countries have announced plans or adopted laws to permit varying levels of competition in the telecommunications market. Under the terms of the WTO Agreement, each of the signatories has committed to opening its telecommunications market to competition, foreign ownership and to adopt measures to protect against anticompetitive behavior, effective starting on January 1, 1998. Although the Company plans to obtain authority to provide service under current and future laws of those countries, or, where permitted, provide service without government authorization, there can be no assurance that foreign laws will be adopted and implemented providing the Company with effective practical opportunities to compete in these countries. Moreover, there can be no assurance of the nature and pace of liberalization in any of these markets. The Company's inability to take advantage of such liberalization could have a material adverse affect on the Company's ability to expand its services as planned. EMPLOYEES As of March 31, 1997, the Company employed 116 full-time employees. The Company is not subject to any collective bargaining agreement and it believes that its relationships with its employees are good. 43 45 PROPERTIES The Company's principal offices are located in Santa Barbara, California in four facilities providing an aggregate of approximately 17,659 square feet of office space. Approximately 5,332 square feet of this office space is leased pursuant to two leases that both expire in July 1999. The remaining approximately 12,327 square feet of office space is located in two buildings and is rented by the Company pursuant to a lease that expires in June 2003. The Company also leases approximately 16,595 square feet of space for its switching facility in Los Angeles, California under a sublease and a lease expiring in April 2006, approximately 7,922 square feet of space for its switching facility in New York, New York under a lease expiring in April 2006, approximately 6,167 square feet of space for its switching facility in Dallas, Texas under a lease expiring in March 2007, and approximately 8,000 square feet of space for its switching facility in London, England under a lease expiring in July 2006. The aggregate facility lease payments made by the Company in 1996 were $561,822. The Company believes that all other terms of the leases are those commercially reasonable other terms that are typically found in commercial leases in each of the respective areas in which the Company leases space. The Company believes that its facilities are adequate to support its current needs and that additional facilities will be available as needed. LITIGATION In February 1996, the Company filed an action in Santa Barbara County Superior Court against Communication Telesystems International ("CTS") seeking $2.0 million in damages for an alleged breach of two contracts with CTS. The Company claims that CTS failed to pay amounts due to the Company and made certain demands that CTS was not entitled to make under the contract and that CTS then repudiated the contracts. CTS filed a separate action against the Company, seeking to recover liquidated damages of $6.0 million for the Company's alleged breach of one of the contracts. CTS claims that it is entitled to liquidated damages as a result of the Company's failure to deliver an increased cash deposit. The Company was granted summary judgment on CTS's First Amended Complaint claims on May 14, 1997. The Company intends to pursue its claim against CTS and to vigorously defend against any potential appeals by CTS. There can be no assurance, however, that the Company will prevail either in its collection of damages or in defending against any potential appeals by CTS. In addition, whether or not the Company is ever able to collect its damages or were to prevail in any potential appeals, such collection process and appeal could be time consuming and costly. In March 1997, the Company filed an action in Santa Barbara County Superior Court against NetSource, Inc. (formerly MTC Telemanagement Corporation) ("NetSource") seeking approximately $1.6 million in damages for an alleged breach of a contract with NetSource. The Company claims that NetSource failed to pay amounts due to the Company. There can be no assurance, however, that the Company will prevail in its collection of damages. In addition, whether or not the Company is ever able to collect its damages, such collection process could be time consuming and costly. 44 46 MANAGEMENT OFFICERS AND DIRECTORS The officers and directors of the Company, and their ages as of March 31, 1997, are as follows:
NAME AGE POSITION - ----------------------------------- --- ------------------------------------------- Christopher E. Edgecomb............ 38 Chief Executive Officer, Chairman of the Board and Director Mary A. Casey(1)................... 34 President, Secretary and Director David Vaun Crumly.................. 33 Executive Vice President--Sales and Marketing James E. Kolsrud................... 52 Executive Vice President--Operations and Engineering Kelly D. Enos...................... 38 Chief Financial Officer, Treasurer and Assistant Secretary Gordon Hutchins, Jr.(2)............ 47 Director John R. Snedegar(1)(2)............. 47 Director Roland A. Van der Meer(1)(2)....... 36 Director
- ------------------------------ (1) Member of Audit Committee (2) Member of Compensation Committee Christopher E. Edgecomb co-founded the Company in September 1993, served as President of the Company until January 1996 and has served as the Company's Chief Executive Officer and Chairman of the Board since January 1996. Mr. Edgecomb has been a Director of the Company since its inception. Prior to that time, Mr. Edgecomb was a founder and the Executive Vice President of West Coast Telecommunications ("WCT"), a nation-wide long distance carrier, from August 1989 to December 1994. Prior to founding WCT, Mr. Edgecomb was President of Telco Planning, a telecommunications consulting firm, from January 1986 to July 1989. Prior to that time, Mr. Edgecomb held senior level sales and marketing positions with TMC Communications, American Network and Bay Area Teleport. Mary A. Casey has been a Director and Secretary of the Company since co-founding the Company in September 1993 and has served as the Company's President since January 1996. Prior to that time, Ms. Casey was Director of Customer Service at WCT from December 1991 to June 1993, and served as Director of Operator Services at Call America, a long distance telecommunications company, from May 1988 to December 1991. David Vaun Crumly has served as the Company's Executive Vice President--Sales and Marketing since January 1996. Prior to that time, Mr. Crumly served as a consultant to the Company from November 1995 to January 1996, was Vice President of Carrier Sales of Digital Network, Inc. from June 1995 to November 1995 and was Director of Carrier Sales of WCT from June 1992 to June 1995. Prior to joining WCT, Mr. Crumly served in various sales and marketing capacities with Metromedia, a long-distance company, from September 1990 to June 1992 and with Claydesta, a long-distance company, from May 1987 to September 1989. James E. Kolsrud has served as the Company's Executive Vice President--Operations and Engineering since September 1996. Prior to joining the Company, Mr. Kolsrud was an international telecommunications consultant from March 1995 to September 1996. Prior to that time, he was a Vice President, Corporate Engineering and Administration of IDB Communications Group, Inc. ("IDB"), an international communications company, from October 1989 to March 1995, and prior to that time, he was President of the International Division of IDB. Kelly D. Enos has served as the Company's Chief Financial Officer since December 1996 and as Treasurer and Assistant Secretary since April 1997. Prior to that time, Ms. Enos was an independent consultant in the merchant banking field from February 1996 to November 1996 and a Vice President of Fortune Financial, a merchant banking firm, from April 1995 to January 1996. Ms. Enos served as a Vice President of Oppenheimer & Co., Inc., an investment bank, from July 1994 to March 1995 and a Vice President of Sutro & Co., an investment bank, from January 1991 to June 1994. 45 47 Gordon Hutchins, Jr. has served as a Director of the Company since January 23, 1996. Mr. Hutchins has been President of GH Associates, a management consulting company, since July 1989. Prior to founding GH Associates, Mr. Hutchins served as President and Chief Executive Officer of ICC Telecommunications, a competitive access provider, and held senior management positions with several other companies in the telecommunications industry. Mr. Hutchins serves as a director of United Digital Network, Inc., a long distance telecommunications company. John R. Snedegar has served as a Director of the Company since January 23, 1996. Mr. Snedegar has been the President of United Digital Network, Inc., a long distance telecommunications company, since June 1990. Mr. Snedegar serves as a director of StarBase Corporation, a software development company. Roland A. Van der Meer has served as a Director of the Company since July 8, 1996. Mr. Van der Meer has been a partner with Partech International, a venture capital firm, since April 1993. Prior to that time, Mr. Van der Meer was a partner with Communications Ventures from April 1987 to February 1993. BOARD COMPOSITION The Company currently has authorized seven directors, and five acting directors. In accordance with the terms of the Company's Certificate of Incorporation, upon the closing of the offering the terms of office of the Board of Directors will be divided into three classes; Class I, whose term will expire at the annual meeting of stockholders to be held in 1998; Class II, whose term will expire at the annual meeting of stockholders to be held in 1999; and Class III, whose term will expire at the annual meeting of stockholders to be held in 2000. The Class I directors are Gordon Hutchins, Jr. and John R. Snedegar, the Class II directors are Roland A. Van der Meer and Mary A. Casey, and the Class III director is Christopher E. Edgecomb. At each annual meeting of stockholders after the initial classification, the successors to directors whose term will then expire will be elected to serve from the time of election and qualification until the third annual meeting following election. This classification of the Board of Directors may have the effect of delaying or preventing changes in control or changes in management of the Company. Each officer is elected by and serves at the discretion of the Board of Directors. Each of the Company's officers and directors, other than nonemployee directors, devotes substantially full time to the affairs of the Company. The Company's nonemployee directors devote such time to the affairs of the Company as is necessary to discharge their duties. There are no family relationships among any of the directors, officers or key employees of the Company. DIRECTOR COMPENSATION The Company's non-employee directors receive $2,000 for each Board meeting attended and $1,000 for each telephonic Board meeting. In addition, each non-employee director is reimbursed for out-of-pocket expenses incurred in connection with attendance at meetings of the Board of Directors and its committees. In 1996, Messrs. Hutchins and Snedegar were each granted stock options to purchase 10,000 shares of the Company's Common Stock. In 1997, Messrs. Hutchins, Snedegar and Van der Meer were each granted stock options to purchase 5,000 shares of the Company's Common Stock. See "Certain Transactions--Transactions with Outside Directors." EXECUTIVE COMPENSATION The following Summary Compensation Table sets forth the compensation earned by the Company's Chief Executive Officer and four other executive officers who earned (or would have earned) salary and bonus in excess of $100,000 for services rendered in all capacities to the Company and its subsidiaries for the fiscal year ended December 31, 1996 (the "Named Officers"). 46 48 SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION ------------ AWARDS ANNUAL ------------ COMPENSATION SECURITIES ------------ UNDERLYING ALL OTHER NAME AND PRINCIPAL POSITION SALARY($) OPTIONS(#) COMPENSATION($) - ------------------------------------------------- ------------ ------------ --------------- Christopher E. Edgecomb.......................... $360,000 0 $ 9,223(1) Chief Executive Officer and Chairman of the Board Mary A. Casey.................................... 156,042(2) 0 15,028(3) President and Secretary John D. Marsch................................... 160,000(4) 400,000 4,000(5) Executive Vice President--STAR Europe David Vaun Crumly................................ 298,002 200,000 3,920(3) Executive Vice President--Sales and Marketing Kelly D. Enos.................................... 12,500(6) 75,000 0 Chief Financial Officer, Treasurer and Assistant Secretary
- ------------------------------ (1) Consists of life insurance and health insurance premiums paid by the Company. (2) Ms. Casey's annual salary is currently set at $195,000. (3) Consists of life insurance and health insurance premiums and a car allowance paid by the Company. (4) Mr. Marsch joined the Company in May 1996 and resigned as Executive Vice President STAR Europe effective January 30, 1997. (5) Consists of a car allowance paid by the Company. (6) Ms. Enos joined the Company in December 1996; her annual salary is currently set at $150,000. The following table contains information concerning the stock option grants made to each of the Named Officers named below for the year ended December 31, 1996. OPTION GRANTS IN LAST FISCAL YEAR
POTENTIAL INDIVIDUAL GRANTS REALIZABLE -------------------------------------------------------- VALUE AT ASSUMED NUMBER OF % OF TOTAL ANNUAL RATES OF SECURITIES OPTIONS STOCK UNDERLYING GRANTED TO PRICE APPRECIATION OPTIONS EMPLOYEES EXERCISE OR OPTION TERM(1) GRANTED IN BASE PRICE EXPIRATION ------------------- NAME (#) FISCAL YEAR ($/SH) DATE 5%($) 10%($) - ---------------------------- ---------- ----------- ----------- ---------- -------- -------- John D. Marsch.............. 200,000(2) 12.12% $2.00 02/28/06 $251,558 $637,497 200,000(3) 12.12 2.00 04/30/06 251,558 637,497 David Vaun Crumly........... 180,000(4) 10.91 1.50 01/21/06 169,802 430,310 20,000(5) 1.21 3.00 05/14/06 37,734 95,625 Kelly D. Enos............... 75,000(6) 4.55 8.20 12/09/06 386,770 980,152
- ------------------------------ (1) The 5% and 10% assumed annual rates of compounded stock price appreciation are mandated by rules of the Securities and Exchange Commission. There can be no assurance provided to any executive officer or any other holder of the Company's securities that the actual stock price appreciation over the 10-year option term will be at the assumed 5% and 10% levels or at any other defined level. Unless the market price of the Common Stock appreciates over the option term, no value will be realized from the option grants made to the executive officer. (2) Mr. Marsch became vested in 100,000 of the option shares on March 1, 1997, and, pursuant to Mr. Marsch's revised employment agreement with the Company, the remaining 100,000 option shares are forfeited. (3) The option is fully vested and exercisable. 47 49 (4) The option is vested and exercisable with respect to 60,000 of the option shares and becomes fully vested and exercisable with respect to the balance upon the closing of the offering. (5) The option is vested and exercisable with respect to 5,000 of the option shares and becomes exercisable with respect to the balance in three equal annual installments on December 31, 1997, 1998 and 1999, respectively. (6) The option becomes exercisable in four equal annual installments on December 2, 1997, 1998, 1999 and 2000, respectively. AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES No options were exercised by the Named Officers for the fiscal year ended December 31, 1996. No stock appreciation rights were exercised during such year or were outstanding at the end of that year. The following table sets forth certain information with respect to the value of stock options held by each of the Named Officers as of December 31, 1996. FISCAL YEAR-END OPTION VALUES
NUMBER OF SECURITIES VALUE OF UNEXERCISED UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS AT FY-END(#) OPTIONS AT FY-END($)(1) --------------------------- --------------------------- NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ---------------------------------------------- ----------- ------------- ----------- ------------- John D. Marsch................................ 200,000 200,000 $ 1,520,000 $ 1,520,000 David Vaun Crumly............................. 65,000 135,000 519,000 1,071,000 Kelly D. Enos................................. 0 75,000 0 105,000
- ------------------------------ (1) Based on the fair market value of the Company's Common Stock at year-end ($9.60 per share, as determined by the Company's Board of Directors) less the exercise price payable for such shares. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Compensation Committee of the Company's Board was formed in May 1996, and the members of the Compensation Committee are Gordon Hutchins, Jr., John R. Snedegar and Roland A. Van der Meer. None of these individuals was at any time during the year ended December 31, 1996, or at any other time, an officer or employee of the Company. No member of the Compensation Committee of the Company serves as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving as a member of the Company's Board or Compensation Committee. 1997 OMNIBUS STOCK INCENTIVE PLAN The Company's 1997 Omnibus Stock Incentive Plan (the "Omnibus Plan") was adopted by the Board of Directors on January 30, 1997, subject to stockholder approval, as the successor to the Company's 1996 Supplemental Option Plan (the "Supplemental Plan"). The Company has reserved 1,500,000 shares for issuance under the Omnibus Plan. This share reserve is comprised of (i) the 1,000,000 shares that were available for issuance under the Supplemental Plan, plus (ii) an increase of 500,000 shares. As of March 31, 1997, no shares had been issued under the Omnibus Plan, options for 466,827 shares were outstanding (from the Supplemental Plan) and 1,088,673 shares remained available for future grant. Shares of Common Stock subject to outstanding options, including options granted under the Supplemental Plan, which expire or terminate prior to exercise, will be available for future issuance under the Omnibus Plan. In addition, if stock appreciation rights ("SARs") and stock units are settled under the Omnibus Plan, then only the number of shares actually issued in settlement will reduce the number of shares available for future issuance under this plan. Under the Omnibus Plan, employees, outside directors and consultants may be awarded options to purchase shares of Common Stock, SARs, restricted shares and stock units. Options may be incentive 48 50 stock options designed to satisfy section 422 of the Internal Revenue Code or nonstatutory stock options not designed to meet such requirements. SARs may be awarded in combination with options, restricted shares or stock units, and such an award may provide that the SARs will not be exercisable unless the related options, restricted shares or stock units are forfeited. The Omnibus Plan will be administered by a committee designated by the board of directors of the Company and comprised of two or more directors (the "Committee"). The Committee has the complete discretion to determine which eligible individuals are to receive awards; determine the award type, number of shares subject to an award, vesting requirements and other features and conditions of such awards; interpret the Omnibus Plan; and make all other decisions relating to the operation of the Omnibus Plan. The exercise price for options granted under the Omnibus Plan may be paid in cash or in outstanding shares of Common Stock. Options may also be exercised on a cashless basis, by a pledge of shares to a broker or by promissory note. The payment for the award of newly issued restricted shares will be made in cash. If an award of SARs, stock units or restricted shares from the Company's treasury is granted, no cash consideration is required. The Committee has the authority to modify, extend or assume outstanding options and SARs or may accept the cancellation of outstanding options and SARs in return for the grant of new options or SARs for the same or a different number of shares and at the same or a different exercise price. The Board may determine that an outside director may elect to receive his or her annual retainer payments and meeting fees from the Company in the form of cash, options, restricted shares, stock units or a combination thereof. The Board will decide how to determine the number and terms of the options, restricted shares or stock units to be granted to outside directors in lieu of annual retainers and meeting fees. Upon a change in control, the Committee may determine that an option or SAR will become fully exercisable as to all shares subject to such option or SAR. A change in control includes a merger or consolidation of the Company, certain changes in the composition of the Board and acquisition of 50% or more of the combined voting power of the Company's outstanding stock. In the event of a merger or other reorganization, outstanding options, SARs, restricted shares and stock units will be subject to the agreement of merger or reorganization, which may provide for the assumption of outstanding awards by the surviving corporation or its parent, their continuation by the Company (if the Company is the surviving corporation), accelerated vesting and accelerated expiration, or settlement in cash. The Board may amend or terminate the Omnibus Plan at any time. Amendments may be subject to stockholder approval to the extent required by applicable laws. In any event, the Omnibus Plan will terminate on January 22, 2007, unless sooner terminated by the Board. 1996 OUTSIDE DIRECTOR NONSTATUTORY STOCK OPTION PLAN The Company's 1996 Outside Director Nonstatutory Stock Option Plan (the "Director Plan") was ratified and approved by the Board of Directors as of May 14, 1996. The Company has reserved 200,000 shares of Common Stock for issuance under the Director Plan. As of March 31, 1997, no shares have been issued under the Director Plan, options for 55,000 shares were outstanding and 145,000 shares remained available for future grant. If an outstanding option expires or terminates unexercised, then the shares subject to such option will again be available for issuance under the Director Plan. Under the Director Plan, outside directors of the Company may receive nonstatutory options to purchase shares of Common Stock. The Director Plan will be administered by the Board or the Compensation Committee (known as "Plan Administrator"). The Plan Administrator has the discretion to determine which eligible individuals will receive options, the number of shares subject to each option, vesting requirements and any other terms and conditions of such options. 49 51 The exercise price for options granted under the Director Plan will be at least 85% of the fair market value of the Common Stock on the option grant date, shall be 110% of the fair market value of the Common Stock on the option grant date if the option is granted to a holder of more than 10% of the Common Stock outstanding and may be paid in cash, check or shares of Common Stock. The exercise price may also be paid by cashless exercise or pledge of shares to a broker. The Plan Administrator may modify, extend or renew outstanding options or accept the surrender of such options in exchange for the grant of new options, subject to the consent of the affected optionee. Upon a change in control, the Board may accelerate the exercisability of outstanding options and provide an exercise period during which such accelerated options may be exercised. The Board also has the discretion to terminate any outstanding options that had been accelerated and had not been exercised during such exercise period. In the event of a merger of the Company into another corporation in which holders of Common Stock receive cash for their shares, the Board may settle the option with a cash payment equal to the difference between the exercise price and the amount paid to holders of Common Stock pursuant to the merger. The Board may amend or terminate the Director Plan at any time. In any event, the Director Plan will terminate on May 14, 2006, unless earlier terminated by the Board. EMPLOYMENT CONTRACTS AND CHANGE OF CONTROL ARRANGEMENTS The Company has an employment agreement with Mary A. Casey, pursuant to which Ms. Casey holds the position of President of the Company, is paid an annual salary of $16,250 per month, was entitled to purchase 818,182 shares of Common Stock, and is eligible to receive a bonus, as determined by the Chief Executive Officer and Board of Directors. The agreement also provides that Ms. Casey will receive a severance payment equal to $7,000 per month for the first six months after termination of employment, and an additional payment of $7,000 per month for the next six months, minus any amounts earned by her from other employment during such period. In addition, the agreement provides that if Ms. Casey's employment is terminated (other than for cause) within four months after a Sale Transaction (as defined below), she will continue to receive the compensation provided in this agreement until the expiration of the agreement on December 31, 1998, instead of the severance payments described above. A Sale Transaction is an acquisition of more than 75% of the voting securities of the Company, pursuant to a tender offer or exchange offer approved in advance by the Board of Directors. In January 1996, the Company entered into an employment agreement with David Vaun Crumly pursuant to which Mr. Crumly became Executive Vice President of the Company. The agreement provides for an annual salary of $10,000 per month with an annual increase, plus incentive bonuses tied to gross revenues of the Company. The agreement also provides for a commission on certain accounts of the Company and an option to purchase 180,000 shares of Common Stock at an exercise price of $1.50 per share. In addition, in the event of a Sale Transaction, Mr. Crumly will receive a bonus payment equal to the lesser of $1,500,000 or a percentage of the monthly gross sales of accounts relating to customers introduced to the Company by Mr. Crumly. If his employment is terminated in certain circumstances, without cause, within four months after a Sale Transaction, Mr. Crumly is entitled to receive the compensation provided in this agreement, minus any compensation earned by other employment, until the expiration of the agreement on December 31, 1998. In December 1996, the Company entered into an employment agreement with Kelly D. Enos, pursuant to which Ms. Enos became Chief Financial Officer of the Company. The agreement provides for an annual salary of $150,000 and an option to purchase 75,000 shares of Common Stock at an exercise price of $8.20 per share. The agreement also provides that Ms. Enos will receive a severance payment equal to the compensation which she would have received under the remaining term of this agreement if she terminates the agreement as a result of the Company's default of its material 50 52 obligations and duties under this agreement or if she is terminated by the Company without cause within four months after a Sale Transaction. In March 1997, the Company entered into an agreement with John Marsch, pursuant to which Mr. Marsch resigned as the Company's Executive Vice President--STAR Europe. From January 30, 1997 until February 28, 1998 (the "Effective Date"), Mr. Marsch will serve as a Director of Special Projects for the Company. Until the Effective Date, pursuant to the terms of a previously executed employment agreement with the Company, Mr. Marsch will continue to receive a monthly salary of $20,000 per month, an automobile allowance of $500 per month and any other fringe benefits which he received prior to the execution of the revised employment agreement. In consideration for the continuation of his employment until the Effective Date, Mr. Marsch waived his rights to vest in 100,000 of the option shares granted to him in May 1996, and such 100,000 shares have been forfeited. 51 53 CERTAIN TRANSACTIONS TRANSACTIONS WITH OUTSIDE DIRECTORS The Company provided services to Digital Network, Inc. ("DNI") in the amount of approximately $250,000 in 1996. DNI is a wholly owned subsidiary of United Digital Network, Inc. ("UDN"), and John R. Snedegar, a Director of the Company, is President of UDN. Gordon Hutchins, Jr., a Director of the Company, serves on UDN's Board of Directors. Gordon Hutchins, Jr. provides consulting services to the Company. In 1996, the Company made payments of approximately $154,000 to Mr. Hutchins for general business consulting services in the telecommunications industry and for the performance of other tasks requested of him by the Company's Chief Executive Officer, President or Board of Directors. In addition, in consideration for consulting services provided to the Company in his capacity as a member of the Board of Directors, the Company granted to Mr. Hutchins a nonstatutory option to purchase 100,000 shares of Common Stock at an exercise price of $3.00. On May 15, 1996, the Company granted to Messrs. Hutchins and Snedegar each a nonstatutory option to purchase 10,000 shares of Common Stock at an exercise price of $3.00 per share under the Company's 1996 Outside Director Nonstatutory Stock Option Plan. On January 30, 1997, the Company granted to Messrs. Hutchins, Snedegar and Van der Meer each a nonstatutory option to purchase 5,000 shares of Common Stock at an exercise price of $10.80 per share under the Company's 1996 Outside Director Nonstatutory Stock Option Plan. TRANSACTIONS WITH EXECUTIVE OFFICERS On October 4, 1996, the Company entered into a $12 million line of credit with Comerica Bank. The total amount outstanding under this line of credit as of March 31, 1997 was approximately $5.3 million. This line of credit is guaranteed by Christopher E. Edgecomb, the Company's Chief Executive Officer. Mr. Edgecomb does not receive any additional compensation in connection with such guarantee. The Company has entered into lines of credit with Mr. Edgecomb in the aggregate amount of $1,448,042 that expire on March 30, 1998. Borrowings under the lines of credit bear interest at a rate of 9.0% and there were no amounts outstanding under the lines of credit as of March 31, 1997. Mr. Edgecomb has two-thirds ownership of Star Aero Services, Inc. ("Star Aero"), which has ownership interests in five airplanes that the Company utilizes for business travel from time to time. For the years ended December 31, 1995 and 1996, the Company paid $144,000 and $68,000, respectively, in costs related to the use of Star Aero services. As of March 31, 1997, the Company had a receivable from Star Aero of approximately $128,000. David Vaun Crumly had controlling ownership of four companies that resold transmission capacity to the Company during 1996. As of March 31, 1997, the Company had made deposits on behalf of these companies of approximately $758,000 and had made payments of approximately $185,000 for such services. In addition, the Company has agreed to reimburse legal fees incurred by such companies in connection with a dispute with the provider of the capacity that was resold to STAR. To date, the fees paid or incurred total approximately $108,300. INDEMNIFICATION The Company's Certificate of Incorporation limits the liability of its directors for monetary damages arising from a breach of their fiduciary duty as directors, except to the extent otherwise required by the Delaware General Corporation Law. Such limitation of liability does not affect the availability of equitable remedies such as injunctive relief or rescission. The Company's Bylaws provide that the Company shall indemnify its directors and officers to the fullest extent permitted by Delaware law, including in circumstances in which indemnification is otherwise discretionary under Delaware law. The Company has also entered into indemnification 52 54 agreements with its officers and directors containing provisions that may require the Company, among other things, to indemnify such officers and directors against certain liabilities that may arise by reason of their status or service as directors or officers (other than liabilities arising from willful misconduct of a culpable nature), to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified, and to obtain directors' and officers' insurance if available on reasonable terms. The Company believes that all of the transactions set forth above were made on terms no less favorable to the Company than could have been obtained from unaffiliated third parties. All future transactions, including loans between the Company and its officers, directors, principal stockholders and their affiliates will be approved by a majority of the Board of Directors, including a majority of the independent and disinterested outside directors on the Board of Directors, and will continue to be on terms no less favorable to the Company than could be obtained from unaffiliated third parties. 53 55 PRINCIPAL AND SELLING STOCKHOLDERS The following table sets forth certain information known to the Company regarding beneficial ownership of its Common Stock as of May 1, 1997, and as adjusted to reflect the sale of shares offered hereby and the conversion of all outstanding shares by Preferred Stock into shares of Common Stock by (i) each person who is known by the Company to own beneficially more than five percent of the Company's Common Stock, (ii) each of the Company's directors, (iii) each of the Named Officers, (iv) all current officers and directors as a group, and (v) each other Selling Stockholder.
SHARES BENEFICIALLY SHARES BENEFICIALLY OWNED OWNED BEFORE THE OFFERING NUMBER OF AFTER THE OFFERING(2) ----------------------- SHARES BEING ----------------------- NAME AND ADDRESS OF BENEFICIAL OWNER(1) NUMBER PERCENT(3) OFFERED NUMBER PERCENT(3) - -------------------------------------------- --------- ---------- ------------ --------- ---------- Entities affiliated with the Hunt Family Trusts(4)................................. 1,072,993 9.1% -- 1,072,993 6.9% 3900 Thanksgiving Tower Dallas, Texas 75201 Gotel Investments, Ltd.(5).................. 914,406 7.7 -- 914,406 5.9 16, Rue de la Pelissiere 1204, Geneva Switzerland Gordon Hutchins, Jr.(6)..................... 77,000 * -- 77,000 * John R. Snedegar(7)......................... 10,000 * -- 10,000 * Roland A. Van der Meer(8)................... 275,840 2.3 -- 275,840 1.8 Christopher E. Edgecomb(9).................. 7,458,162 63.1 187,500 7,270,662 46.7 Mary A. Casey(10)........................... 878,226 7.4 50,000 828,226 5.3 David Vaun Crumly(11)....................... 285,000 2.4 -- 285,000 1.8 James E. Kolsrud............................ 10,000 * -- 10,000 * Kelly D. Enos............................... -- * -- -- * All directors and executive officers as a group (8 persons)(12)..................... 8,994,228 74.3% 237,500 8,756,728 55.3% OTHER SELLING STOCKHOLDERS Bancommerce Capital Corporation............. 50,000 * 12,500 37,500 *
- ------------------------------ * Represents beneficial ownership of less than 1% of the outstanding shares of Common Stock. (1) Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and includes voting or investment power with respect to securities. Unless otherwise indicated, the address for each listed stockholder is c/o STAR Telecommunications, Inc., 223 East De La Guerra Street, Santa Barbara, California 93101. To the Company's knowledge, except as indicated in the footnotes to this table and pursuant to applicable community property laws, the persons named in the table have sole voting and investment power with respect to all shares of Common Stock. (2) Assumes no exercise of the Underwriters' over-allotment option. See "Underwriting." (3) Percentage of beneficial ownership is based on 11,825,756 shares of Common Stock outstanding as of May 1, 1997, and 15,575,756 shares of Common Stock after the completion of this offering. The number of shares of Common Stock beneficially owned includes the shares issuable pursuant to stock options that are exercisable within 60 days of May 1, 1997 and, where indicated below, shares issuable pursuant to stock options that are exercisable upon the closing of the offering. Shares issuable pursuant to stock options are deemed outstanding for computing the percentage of the person holding such options but are not outstanding for computing the percentage of any other person. The number of shares of Common Stock outstanding after this offering includes 3,750,000 shares of Common Stock being offered for sale by the Company in this offering. (4) Consists of 357,665 shares held by Lyda Hunt--Herbert Trusts--David Shelton Hunt, 178,832 shares held by Lyda Hunt--Herbert Trusts--Bruce William Hunt, 178,832 shares held by Lyda Hunt--Herbert Trusts--Douglas Herbert Hunt, 178,832 shares held by Lyda Hunt--Herbert Trusts--Barbara Ann Hunt and 178,832 shares held by Lyda Hunt--Herbert Trusts--Lyda Bunker 54 56 Hunt. The co-trustees of each of the Hunt Family Trusts hold voting and investment power for all shares of the Company's Common Stock held by the respective trusts. Walter P. Roach and Gage A. Prichard are the co-trustees of each such trust. (5) The board of directors of Gotel Investments, Ltd. ("Gotel") holds voting and investment power for all shares of the Company's Common Stock held by Gotel. Gotel's board of directors is comprised of Barry Guterman, Walter Stresemann and Gregory Elias. (6) Consists of 77,000 shares issuable upon the exercise of stock options exercisable within sixty days of May 1, 1997. (7) Consists of 10,000 shares issuable upon the exercise of stock options exercisable within sixty days of May 1, 1997. (8) Consists of 91,136 shares held by Parvest U.S. Partners II C.V., 60,758 shares held by Partech U.S. Partners III C.V., 121,516 shares held by U.S. Growth Fund Partners C.V., and 2,430 shares held by Partech International Salary Deferral Plan U/A Dated 1/1/92 FBO: Roland A. Van der Meer. Mr. Van der Meer, a director of the Company, is a general partner of Parvest U.S. Partners II C.V., Partech U.S. Partners III C.V. and U.S. Growth Fund Partners C.V. (collectively, the "Partech Entities"). Mr. Van der Meer is the beneficiary of the Partech International Salary Deferral Plan U/A Dated 1/1/92 FBO: Roland A. Van der Meer. Mr. Van der Meer disclaims beneficial ownership of shares held by the Partech Entities, except for his proportional interest therein. (9) If the over-allotment option is exercised in full, the number of shares beneficially owned by Mr. Edgecomb after the offering will be reduced to 6,920,662 shares or 44.4% of shares outstanding. (10) If the over-allotment option is exercised in full, the number of shares beneficially owned by Ms. Casey after the offering will be reduced to 778,226 shares, or 5.0% of shares outstanding. (11) Consists of 100,000 shares of Common Stock, 180,000 shares of Common Stock issuable upon the exercise of stock options exercisable upon the closing of the offering and 5,000 shares of Common Stock issuable upon the exercise of stock options exercisable within sixty days of May 1, 1997. (12) Includes 272,000 shares issuable upon the exercise of stock options exercisable within sixty days of May 1, 1997, and where indicated above, shares issuable pursuant to stock options that are exercisable upon the closing of the offering. 55 57 DESCRIPTION OF CAPITAL STOCK Upon the closing of this offering, the authorized capital stock of the Company will consist of 30,000,000 shares of Common Stock, $0.001 par value, and 5,000,000 shares of Preferred Stock, $0.001 par value. COMMON STOCK As of March 31, 1997, there were 11,825,756 shares of Common Stock outstanding that were held of record by approximately 47 stockholders. There will be 15,575,756 shares of Common Stock outstanding (assuming no exercise of the Underwriters' over-allotment option and assuming no exercise after March 31, 1997, of outstanding options) after giving effect to the sale of the shares of Common Stock to the public offered hereby and the conversion of the Company's Preferred Stock into 911,360 shares of Common Stock. The holders of Common Stock are entitled to one vote per share on all matters to be voted upon by the stockholders. Subject to preferences that may be applicable to any outstanding Preferred Stock, the holders of Common Stock are entitled to receive ratably such dividends, if any, as may be declared from time to time by the Board of Directors out of funds legally available therefor. See "Dividend Policy." In the event of the liquidation, dissolution, or winding up of the Company, the holders of Common Stock are entitled to share ratably in all assets remaining after payment of liabilities, subject to prior distribution rights of Preferred Stock, if any, then outstanding. The Common Stock has no preemptive or conversion rights or other subscription rights. There are no redemption or sinking fund provisions applicable to the Common Stock. All outstanding shares of Common Stock are fully paid and nonassessable, and the shares of Common Stock to be issued upon completion of this offering will be fully paid and nonassessable. PREFERRED STOCK The Company's Amended and Restated Certificate of Incorporation authorizes 1,367,050 shares of Preferred Stock. The Board of Directors has the authority to issue the Preferred Stock in one or more series and to fix the rights, preferences, privileges and restrictions thereof, including dividend rights, dividend rates, conversion rights, voting rights, terms of redemption, redemption prices, liquidation preferences and the number of shares constituting any series or the designation of such series, without further vote or action by the stockholders. The issuance of Preferred Stock may have the effect of delaying, deferring or preventing a change in control of the Company without further action by the stockholders and may adversely affect the voting and other rights of the holders of Common Stock. The issuance of Preferred Stock with voting and conversion rights may adversely affect the voting power of the holders of Common Stock, including the loss of voting control to others. At present, the Company has no plans to issue any of the Preferred Stock. ANTI-TAKEOVER EFFECTS OF PROVISIONS OF THE CERTIFICATE OF INCORPORATION, BYLAWS AND DELAWARE LAW Certificate of Incorporation and Bylaws The Company's Amended and Restated Certificate of Incorporation provides that, upon the closing of this offering, the Board of Directors will be divided into three classes of directors, with each class serving a staggered three-year term. The classification system of electing directors may tend to discourage a third party from making a tender offer or otherwise attempting to obtain control of the Company and may maintain the incumbency of the Board of Directors, as the classification of the Board of Directors generally increases the difficulty of replacing a majority of the directors. The Certificate of Incorporation also provides that, effective upon the closing of this offering, all stockholder actions must be effected at a duly called meeting and not by a consent in writing. Further, provisions of the Bylaws and the Amended and Restated Certificate of Incorporation provide that the stockholders may amend the Bylaws or certain provisions of the Certificate of Incorporation only with the affirmative vote of 75% of the Company's capital stock. These provisions of the Certificate of 56 58 Incorporation and Bylaws could discourage potential acquisition proposals and could delay or prevent a change in control of the Company. These provisions are intended to enhance the likelihood of continuity and stability in the composition of the Board of Directors and in the policies formulated by the Board of Directors and to discourage certain types of transactions that may involve an actual or threatened change of control of the Company. These provisions are designed to reduce the vulnerability of the Company to an unsolicited acquisition proposal. The provisions also are intended to discourage certain tactics that may be used in proxy fights. However, such provisions could have the effect of discouraging others from making tender offers for the Company's shares and, as a consequence, they also may inhibit fluctuations in the market price of the Company's shares that could result from actual or rumored takeover attempts. Such provisions also may have the effect of preventing changes in the management of the Company. See "Risk Factors--Effect of Certain Charter Provisions; Anti-takeover Effects of Certificate of Incorporation, Bylaws, and Delaware Law." Delaware Takeover Statute The Company is subject to Section 203 of the Delaware General Corporation Law ("Section 203"), which, subject to certain exceptions, prohibits a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years following the date that such stockholder became an interested stockholder, unless: (i) prior to such date, the board of directors of the corporation approved either the business combination or the transaction that resulted in the stockholder becoming an interested stockholder; (ii) upon consummation of the transaction that resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced, excluding for purposes of determining the number of shares outstanding those shares owned (x) by persons who are directors and also officers and (y) by employee stock plans in which employee participants do not have the right to determine confidentially whether shares held subject to the plan will be tendered in a tender or exchange offer; or (iii) on or subsequent to such date, the business combination is approved by the board of directors and authorized at an annual or special meeting of stockholders, and not by written consent, by the affirmative vote of at least 66 2/3% of the outstanding voting stock that is not owned by the interested stockholder. Section 203 defines business combination to include: (i) any merger or consolidation involving the corporation and the interested stockholder; (ii) any sale, transfer, pledge or other disposition of 10% or more of the assets of the corporation involving the interested stockholder; (iii) subject to certain exceptions, any transaction that results in the issuance or transfer by the corporation of any stock of the corporation to the interested stockholder; (iv) any transaction involving the corporation that has the effect of increasing the proportionate share of the stock of any class or series of the corporation beneficially owned by the interested stockholder; or (v) the receipt by the interested stockholder of the benefit of any loans, advances, guarantees, pledges or other financial benefits provided by or through the corporation. In general, Section 203 defines an interested stockholder as any entity or person beneficially owning 15% or more of the outstanding voting stock of the corporation and any entity or person affiliated with or controlling or controlled by such entity or person. REGISTRATION RIGHTS After this offering, the holders of approximately 2,826,000 shares of Common Stock will be entitled to certain rights with respect to the registration of such shares under the Securities Act. Under the terms of the agreement between the Company and the holders of such registrable securities, if the Company proposes to register any of its securities under the Securities Act, either for its own account or for the account of other security holders exercising registration rights, such holders are entitled to notice of such registration and are entitled to include shares of such Common Stock therein. Additionally, certain holders are also entitled to demand registration rights pursuant to which they may require the Company to file a registration statement under the Securities Act at its expense with respect to their shares of Common Stock, and the Company is required to use its best efforts to effect 57 59 such registration. Further, holders may require the Company to file additional registration statements on Form S-3 at the Company's expense. All of these registration rights are subject to certain conditions and limitations, among them the right of the underwriters of an offering to limit the number of shares included in such registration and the right of the Company not to effect a requested registration within six months following an offering of the Company's securities, including the offering made hereby. TRANSFER AGENT AND REGISTRAR The Transfer Agent and Registrar for the Common Stock is U.S. Stock Transfer Corp., 1745 Gardena Avenue, Glendale, California 91204, and its telephone number is (818) 502-1404. 58 60 SHARES ELIGIBLE FOR FUTURE SALE Upon completion of this offering, the Company will have 15,575,756 shares of Common Stock outstanding. Of this amount, the 4,000,000 shares offered hereby will be available for immediate sale in the public market as of the date of this Prospectus. Approximately 11,502,756 additional shares will be available for sale in the public market immediately following the expiration of 180-day lockup agreements with the Representatives of the Underwriters or the Company, subject in some cases to compliance with the volume and other limitations of Rule 144.
DAYS AFTER DATE OF APPROXIMATE SHARES THIS PROSPECTUS ELIGIBLE FOR FUTURE SALE COMMENT - ------------------------- ------------------------ -------------------------------------------- Upon Effectiveness....... 4,000,000 Freely tradeable shares sold in offering and shares saleable under Rule 144(k) that are not subject to 180-day lockup. 180 days................. 11,502,756 Lockup released; shares saleable under Rule 144, 144(k) or 701. Thereafter............... 73,000 Restricted securities held for one year or less.
In general, under Rule 144 as currently in effect, a person (or persons whose shares are aggregated) who has beneficially owned shares for at least one year is entitled to sell within any three-month period commencing 90 days after the date of this Prospectus a number of shares that does not exceed the greater of (i) 1% of the then outstanding shares of Common Stock (approximately 155,758 shares immediately after the offering) or (ii) the average weekly trading volume during the four calendar weeks preceding such sale, subject to the filing of a Form 144 with respect to such sale. A person (or persons whose shares are aggregated) who is not deemed to have been an affiliate of the Company at any time during the 90 days immediately preceding the sale who has beneficially owned his or her shares for at least two years is entitled to sell such shares pursuant to Rule 144(k) without regard to the limitations described above. Persons deemed to be affiliates must always sell pursuant to Rule 144, even after the applicable holding periods have been satisfied. The Company is unable to estimate the number of shares that will be sold under Rule 144, since this will depend on the market price for the Common Stock of the Company, the personal circumstances of the sellers and other factors. Prior to this offering, there has been no public market for the Common Stock, and there can be no assurance that a significant public market for the Common Stock will develop or be sustained after the offering. Any future sale of substantial amounts of the Common Stock in the open market may adversely affect the market price of the Common Stock offered hereby. The Company, its directors, executive officers, stockholders with registration rights and certain other stockholders have agreed pursuant to the Underwriting Agreement and other agreements that they will not sell any Common Stock without the prior consent of Hambrecht & Quist LLC for a period of 180 days from the date of this Prospectus (the "180-day Lockup Period"), except that the Company may, without such consent, grant options and sell shares pursuant to the Stock Plan and the Purchase Plan and sell shares upon the exercise of an outstanding warrant. Any employee or consultant to the Company who purchased his or her shares pursuant to a written compensatory plan or contract is entitled to rely on the resale provisions of Rule 701, which permits nonaffiliates to sell their Rule 701 shares without having to comply with the public information, holding period, volume limitation or notice provisions of Rule 144 and permits affiliates to sell their Rule 701 shares without having to comply with the Rule 144 holding period restrictions, in each case commencing 90 days after the date of this Prospectus. As of the date of this Prospectus, the holders of options exercisable into approximately 936,475 shares of Common Stock will be eligible to sell their shares upon the expiration of the 180-day Lockup Period. The Company intends to file a registration statement on Form S-8 under the Securities Act to register options to purchase shares of Common Stock issued or reserved for issuance under the Company's stock plans or issued outside the Company's stock plans within 180 days after the date of this Prospectus, thus permitting the resale of such shares by nonaffiliates in the public market without 59 61 restriction under the Securities Act. The Company intends to register these options on Form S-8, along with options that have not been issued under the Company's stock plans as of the date of this Prospectus. In addition, after this offering, the holders of approximately 2,826,000 shares of Common Stock will be entitled to certain rights with respect to registration of such shares under the Securities Act. Registration of such shares under the Securities Act would result in such shares becoming freely tradeable without restriction under the Securities Act (except for shares purchased by affiliates of the Company) immediately upon the effectiveness of such registration. See "Description of Capital Stock--Registration Rights." 60 62 UNDERWRITING Subject to the terms and conditions of the Underwriting Agreement, a syndicate of Underwriters named below (the "Underwriters"), for whom Hambrecht & Quist LLC and Alex. Brown & Sons Incorporated are acting as representatives (the "Representatives"), have severally agreed to purchase from the Company and the Selling Stockholder an aggregate of 4,000,000 shares of Common Stock. The number of shares of Common Stock that each Underwriter has agreed to purchase is set forth opposite its name below:
NAME NUMBER OF SHARES --------------------------------------------------------------------- ---------------- Hambrecht & Quist LLC................................................ Alex. Brown & Sons Incorporated...................................... ------- Total...................................................... =======
The Underwriting Agreement provides that the obligations of the several Underwriters to purchase shares of Common Stock are subject to the approval of certain legal matters by counsel and to certain other conditions. If any of the shares of Common Stock are purchased by the Underwriters pursuant to the Underwriting Agreement, all such shares of Common Stock (other than the shares of Common Stock covered by the over-allotment option described below) must be so purchased. Prior to this offering, there has been no established trading market for the Common Stock. The initial price to the public for the Common Stock offered hereby will be determined by negotiation among the Company, the Representatives and the representatives of the Selling Stockholders. The factors considered in determining the initial price to the public will include the history of and the prospects for the industry in which the Company competes, the ability of the Company's management, the past and present operations of the Company, the historical results of operations of the Company, the prospects for future earnings of the Company, the general condition of the securities markets at the time of this offering and the recent market prices of securities of generally comparable companies. The Company and the Underwriters have agreed to indemnify each other against certain liabilities, including liabilities under the Securities Act, or to contribute to payments that the Underwriters may be required to make in respect thereof. The Company has been advised by the Representatives that the Underwriters propose to offer the Common Stock to the public initially at the price to the public set forth on the cover page of this Prospectus and to certain dealers (who may include the Underwriters) at such price less a concession not to exceed $ per share. The Underwriters may allow, and such dealers may reallow, discounts not in excess of $ per share to any other Underwriter and certain other dealers; and that after the initial public offering, the price to the public, the concession and the discount to dealers may be changed by the Representatives. The Company, the Selling Stockholder and one additional holder of the Company's Common Stock have granted to the Underwriters an option to purchase up to an aggregate of 600,000 additional shares of Common Stock at the initial public offering price less underwriting discounts and commissions solely to cover over-allotments. Such option may be exercised at any time until 30 days after the date of this Prospectus. To the extent that the Underwriters exercise such option, each of the Underwriters will be committed, subject to certain conditions, to purchase a number of option shares proportionate to such Underwriter's initial commitment as indicated in the preceding table. The Representatives have informed the Company that they do not expect to make sales to accounts over which they exercise discretionary authority in excess of 5% of the number of shares of Common Stock offered hereby. The Company, its officers, directors, stockholders with registration rights and certain other stockholders, have agreed not to offer, sell, contract to sell or otherwise dispose of any shares of Common Stock or any securities convertible into or exchangeable for Common Stock for the 180-day 61 63 Lockup Period without the prior written consent of Hambrecht & Quist LLC and provided that the Company may issue shares of Common Stock upon the exercise of an outstanding warrant, grant options and issue shares of Common Stock upon the exercise of options under its Stock Plan. See "Shares Eligible for Future Sale." Certain persons participating in this offering may overallot or affect transactions which stabilize, maintain or otherwise affect the market price of the Common Stock of the Company at levels above those which might otherwise prevail in the open market, including by entering stabilizing bids, effecting syndicate covering transactions or imposing penalty bids. A stabilizing bid means the placing of any bid or effecting of any purchase, for the purpose of pegging, fixing or maintaining the price of the Common Stock of the Company. A syndicate covering transaction means the placing of any bid on behalf of the underwriting syndicate or the effecting of any purchase to reduce a short position created in connection with the offering. A penalty bid means an arrangement that permits the Underwriters to reclaim a selling concession from a syndicate member in connection with the offering when the Common Stock of the Company sold by the syndicate member is purchased in syndicate covering transactions. Such transactions may be effected on the Nasdaq Stock Market, in the over-the-counter market, or otherwise. Such stabilizing, if commenced, may be discontinued at any time. In July 1996, H&Q Star Vending Investors, L.P. purchased 243,031 shares of the Company's Series A Preferred Stock for approximately $2.0 million, as part of a financing in which the Company sold an aggregate of 911,367 shares of Series A Preferred Stock to a group of 22 investors for an aggregate purchase price of approximately $7.5 million. Hambrecht & Quist Management Corporation and H&Q Star Vending Investment Management, L.L.C. are the general partners of H&Q Star Vending Investors, L.P. Hambrecht & Quist Management Corporation is a wholly owned subsidiary of Hambrecht & Quist California, which also owns 99% of Hambrecht & Quist LLC. The interests of H&Q Star Vending Investment Management, L.L.C. are beneficially owned by persons affiliated with Hambrecht & Quist LLC, including its President and Chief Executive Officer. LEGAL MATTERS The validity of the Common Stock offered hereby will be passed upon for the Company by Gunderson Dettmer Stough Villeneuve Franklin & Hachigian, LLP ("Gunderson Dettmer"), Menlo Park, California. Certain legal matters in connection with the offering will be passed upon for the Underwriters by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto, California. A partnership including partners of Gunderson Dettmer is a partner in H&Q Star Vending Investors, L.P., a stockholder in the Company, and as a result maintains an indirect beneficial interest in 2,736 shares of the Company's Common Stock. EXPERTS The Consolidated Financial Statements of STAR Telecommunications, Inc. as of December 31, 1995 and 1996 and for each of the years in the three year period ended December 31, 1996, included in this Prospectus and elsewhere in this Registration Statement have been audited by Arthur Andersen LLP, independent public accountants, as set forth in their reports with respect thereto, and are included herein in reliance upon the authority of said firm as experts in accounting and auditing in giving said reports. 62 64 ADDITIONAL INFORMATION The Company has filed with the Securities and Exchange Commission (the "Commission"), Washington, D.C. 20549, a Registration Statement on Form S-1 under the Securities Act with respect to the Common Stock offered hereby. This Prospectus does not contain all of the information set forth in the Registration Statement and the exhibits and schedules to the Registration Statement. For further information with respect to the Company and such Common Stock offered hereby, reference is made to the Registration Statement and the exhibits and schedules filed as a part of the Registration Statement. Statements contained in this Prospectus concerning the contents of any contract or any other document referred to are not necessarily complete; reference is made in each instance to the copy of such contract or document filed as an exhibit to the Registration Statement. Each such statement is qualified in all respects by such reference to such exhibit. The Registration Statement, including exhibits and schedules thereto, may be inspected without charge at the Commission's principal office in Washington, D.C., and copies of all or any part thereof may be obtained from such office after payment of fees prescribed by the Commission. The Commission maintains a Web site that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission at http://www.sec.gov. 63 65 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ----- Report of Independent Public Accountants.............................................. F-2 Consolidated Financial Statements: Consolidated Balance Sheets........................................................... F-3 Consolidated Statements of Operations................................................. F-5 Consolidated Statements of Stockholders' Equity....................................... F-6 Consolidated Statements of Cash Flows................................................. F-7 Notes to Consolidated Financial Statements............................................ F-8
F-1 66 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors and Stockholders of STAR Telecommunications, Inc.: We have audited the accompanying consolidated balance sheets of STAR Telecommunications, Inc. (a Delaware corporation) and subsidiary as of December 31, 1995 and 1996, and the related consolidated statements of operations, stockholders' 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 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 financial statements referred to above present fairly, in all material respects, the financial position of STAR Telecommunications, Inc. and subsidiary as of December 31, 1995 and 1996, and the 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. ARTHUR ANDERSEN LLP Los Angeles, California April 10, 1997 F-2 67 STAR TELECOMMUNICATIONS, INC. CONSOLIDATED BALANCE SHEETS ASSETS
PRO-FORMA (SEE NOTE 9) DECEMBER 31, MARCH 31, MARCH 31, --------------------------- ----------- -------------- 1995 1996 1997 1997 ----------- ----------- ----------- -------------- (UNAUDITED) Current Assets: Cash and cash equivalents.......... $ 164,000 $ 1,719,000 $ 766,000 $ 766,000 Short-term investments............. -- 1,630,000 -- -- Accounts receivable, net of allowance of $208,000 and $5,733,000 at December 31, 1995 and 1996, respectively and $4,862,000 at March 31, 1997.... 10,046,000 22,888,000 32,879,000 32,879,000 Receivable from related parties.... 50,000 115,000 129,000 129,000 Prepaid expenses and other assets.......................... 84,000 1,729,000 2,120,000 2,120,000 Prepaid taxes...................... -- 677,000 591,000 591,000 ----------- ----------- ----------- ----------- Total current assets....... 10,344,000 28,758,000 36,485,000 36,485,000 ----------- ----------- ----------- ----------- Property and Equipment: Operating equipment................ 1,353,000 8,653,000 11,448,000 11,448,000 Leasehold improvements............. 370,000 4,214,000 4,299,000 4,299,000 Computer equipment................. 187,000 1,604,000 1,690,000 1,690,000 Furniture and fixtures............. 61,000 435,000 650,000 650,000 ----------- ----------- ----------- ----------- 1,971,000 14,906,000 18,087,000 18,087,000 Less-accumulated depreciation and amortization.................... (128,000) (1,201,000) (1,924,000) (1,924,000) ----------- ----------- ----------- ----------- 1,843,000 13,705,000 16,163,000 16,163,000 ----------- ----------- ----------- ----------- Other Assets: Investments........................ -- 153,000 153,000 153,000 Deposits........................... 682,000 5,630,000 5,569,000 5,569,000 Other.............................. -- 428,000 666,000 666,000 ----------- ----------- ----------- ----------- 682,000 6,211,000 6,388,000 6,388,000 ----------- ----------- ----------- ----------- Total assets............... $12,869,000 $48,674,000 $59,036,000 $ 59,036,000 =========== =========== =========== ============
The accompanying notes are an integral part of these consolidated balance sheets. F-3 68 STAR TELECOMMUNICATIONS, INC. CONSOLIDATED BALANCE SHEETS LIABILITIES AND STOCKHOLDERS' EQUITY
PRO-FORMA (SEE NOTE 9) DECEMBER 31, MARCH 31, MARCH 31, ------------------------- ----------- ----------- 1995 1996 1997 1997 ----------- ----------- ----------- ----------- (UNAUDITED) Current Liabilities: Revolving lines of credit................. $ 1,330,000 $ 7,814,000 $ 5,342,000 $ 5,342,000 Revolving lines of credit with stockholder............................ 1,198,000 26,000 -- -- Current portion of long-term debt......... -- 267,000 460,000 460,000 Current portion of capital lease obligations............................ 143,000 827,000 1,246,000 1,246,000 Accounts payable.......................... 8,515,000 6,260,000 20,255,000 20,255,000 Accrued line costs........................ 476,000 19,494,000 15,895,000 15,895,000 Accrued expenses.......................... 82,000 1,621,000 1,650,000 1,650,000 ----------- ----------- ----------- ----------- Total current liabilities......... 11,744,000 36,309,000 44,848,000 44,848,000 ----------- ----------- ----------- ----------- Long-Term Liabilities: Long-term debt, net of current portion.... -- 466,000 400,000 400,000 Capital lease obligations, net of current portion................................ 712,000 4,808,000 5,117,000 5,117,000 Deferred compensation..................... -- 116,000 35,000 35,000 Deposits.................................. -- -- 63,000 63,000 Other..................................... -- 88,000 234,000 234,000 ----------- ----------- ----------- ----------- 712,000 5,478,000 5,849,000 5,849,000 ----------- ----------- ----------- ----------- Commitments and Contingencies (Note 5) Stockholders' Equity: Preferred Stock $.001 par value: Authorized -- 1,367,050 shares Issued and outstanding -- 1,367,047 shares at December 31, 1996 and March 31, 1997 and none in Pro-Forma 1997....................... -- 1,000 1,000 -- Common Stock $.001 par value: Authorized -- 30,000,000 shares Issued and outstanding -- 9,000,000 shares at December 31, 1995 and 10,914,396 shares at December 31, 1996 and March 31, 1997 and 11,825,756 in Pro Forma 1997......... 9,000 11,000 11,000 12,000 Additional paid-in capital................ 1,094,000 13,637,000 13,637,000 13,637,000 Deferred compensation..................... -- (118,000) (98,000) (98,000) Retained deficit.......................... (690,000) (6,644,000) (5,212,000) (5,212,000) ----------- ----------- ----------- ----------- Stockholders' equity................... 413,000 6,887,000 8,339,000 8,339,000 ----------- ----------- ----------- ----------- Total liabilities and stockholders' equity............ $12,869,000 $48,674,000 $59,036,000 $59,036,000 =========== =========== =========== ===========
The accompanying notes are an integral part of these consolidated balance sheets. F-4 69 STAR TELECOMMUNICATIONS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED YEARS ENDED DECEMBER 31, MARCH 31, -------------------------------------- ------------------------- 1994 1995 1996 1996 1997 --------- ----------- ------------ ----------- ----------- (UNAUDITED) Revenues........................ $ 176,000 $16,125,000 $208,086,000 $35,667,000 $71,008,000 Cost of services................ -- 14,357,000 188,430,000 32,286,000 63,738,000 --------- ------------ ------------ ----------- ----------- Gross profit............... 176,000 1,768,000 19,656,000 3,381,000 7,270,000 Operating expenses: Selling, general and administrative expenses.... 290,000 2,063,000 24,087,000 1,803,000 4,530,000 Depreciation and amortization............... -- 128,000 1,073,000 108,000 722,000 --------- ------------ ------------ ----------- ----------- 290,000 2,191,000 25,160,000 1,911,000 5,252,000 --------- ------------ ------------ ----------- ----------- Income (loss) from operations............... (114,000) (423,000) (5,504,000) 1,470,000 2,018,000 --------- ------------ ------------ ----------- ----------- Other income (expense): Interest income............... -- -- 83,000 -- 21,000 Interest expense.............. -- (64,000) (589,000) (78,000) (369,000) Loss on investment............ (7,000) (80,000) -- -- -- Legal settlement.............. -- -- (100,000) -- -- Other......................... -- -- -- -- 48,000 --------- ------------ ------------ ----------- ----------- (7,000) (144,000) (606,000) (78,000) (300,000) --------- ------------ ------------ ----------- ----------- Income (loss) before provision for income taxes.................... (121,000) (567,000) (6,110,000) 1,392,000 1,718,000 Provision for income taxes (Note 7)............................ 1,000 1,000 534,000 544,000 286,000 --------- ------------ ------------ ----------- ----------- Net income (loss)............... $(122,000) $ (568,000) $ (6,644,000) $ 848,000 $ 1,432,000 ========= ============ ============ =========== =========== Pro forma net income (loss) per common share.................. $ (0.54) $ 0.08 $ 0.11 ============ =========== =========== Weighted average number of common shares used to compute Pro forma earnings per share......................... 12,198,000 11,281,000 12,825,000 ============ =========== ===========
The accompanying notes are an integral part of these consolidated statements. F-5 70 STAR TELECOMMUNICATIONS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996 AND FOR THE THREE MONTH PERIOD ENDED MARCH 31, 1997
PREFERRED STOCK COMMON STOCK ADDITIONAL RETAINED ------------------ -------------------- PAID-IN DEFERRED EARNINGS SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION (DEFICIT) TOTAL ---------- ------ ----------- ------- ----------- ------------ ----------- ----------- Balance, December 31, 1993... -- $ -- -- $ -- $ -- $ -- $ -- $ -- Issuance of common stock..... -- -- 8,100,810 8,000 2,000 -- -- 10,000 Net loss..................... -- -- -- -- -- -- (122,000) (122,000) --------- ------ ---------- ------- ----------- --------- ----------- ----------- Balance, December 31, 1994... -- -- 8,100,810 8,000 2,000 -- (122,000) (112,000) Issuance of common stock..... -- -- 899,190 1,000 102,000 -- -- 103,000 Conversion of debt to equity..................... -- -- -- -- 990,000 -- -- 990,000 Net loss..................... -- -- -- -- -- -- (568,000) (568,000) --------- ------ ---------- ------- ----------- --------- ----------- ----------- Balance, December 31, 1995... -- -- 9,000,000 9,000 1,094,000 -- (690,000) 413,000 Effect of termination of the S-Corporation election..... -- -- -- -- (690,000) -- 690,000 -- Compensation expense relating to stock options........... -- -- -- -- 168,000 (118,000) -- 50,000 Issuance of common stock..... -- -- 1,914,396 2,000 5,566,000 -- -- 5,568,000 Issuance of preferred stock...................... 1,367,047 1,000 -- -- 7,499,000 -- -- 7,500,000 Net income................... -- -- -- -- -- -- (6,644,000) (6,644,000) --------- ------ ---------- ------- ----------- --------- ----------- ----------- Balance, December 31, 1996... 1,367,047 1,000 10,914,396 11,000 13,637,000 (118,000) (6,644,000) 6,887,000 Compensation expense relating to stock options........... -- -- -- -- -- 20,000 -- 20,000 Net income................... -- -- -- -- -- -- 1,432,000 1,432,000 --------- ------ ---------- ------- ----------- --------- ----------- ----------- Balance, March 31, 1997 (unaudited)................ 1,367,047 $1,000 10,914,396 $11,000 $13,637,000 $ (98,000) $(5,212,000) $ 8,339,000 ========= ====== ========== ======= =========== ========= =========== ===========
The accompanying notes are an integral part of these consolidated statements. F-6 71 STAR TELECOMMUNICATIONS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS YEARS ENDED DECEMBER 31, ENDED MARCH 31, ---------------------------------------- --------------------------- 1994 1995 1996 1996 1997 --------- ----------- ------------ ----------- ------------ (UNAUDITED) Cash Flows From Operating Activities: Net income (loss)................... $(122,000) $ (568,000) $ (6,644,000) $ 848,000 $ 1,432,000 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization..... -- 128,000 1,073,000 108,000 722,000 Loss on investment................ 7,000 80,000 -- -- -- Compensation expense relating to stock options................... -- -- 50,000 -- 20,000 Provision for doubtful accounts... -- 208,000 15,561,000 416,000 1,611,000 Deferred income taxes............. -- -- -- (203,000) -- Deferred compensation............. -- -- 116,000 12,000 (81,000) Decrease (increase) in assets: Accounts receivable............... -- (10,254,000) (28,403,000) (8,612,000) (11,602,000) Receivable from related parties... -- (50,000) (65,000) 50,000 (14,000) Prepaid expenses and other assets.......................... -- (84,000) (1,645,000) (676,000) (391,000) Prepaid taxes..................... -- -- (677,000) -- 86,000 Increase (decrease) in liabilities: Accounts payable.................. 32,000 8,476,000 (2,255,000) 7,591,000 13,995,000 Accrued line costs................ -- 476,000 19,018,000 (464,000) (3,599,000) Accrued expenses.................. 20,000 62,000 1,539,000 243,000 29,000 Taxes payable..................... -- -- -- 747,000 -- --------- ------------ ------------ ----------- ----------- Net cash provided by (used in) operating activities... (63,000) (1,526,000) (2,332,000) 60,000 2,208,000 --------- ------------ ------------ ----------- ----------- Cash Flows From Investing Activities: Capital expenditures................ (21,000) (1,062,000) (7,838,000) (371,000) (2,127,000) Purchases of investments, net....... (80,000) -- (1,783,000) -- 1,630,000 Increase in deposits................ (23,000) (659,000) (4,948,000) (349,000) 61,000 Increase in other long-term assets............................ -- -- (428,000) -- (175,000) Increase in other long-term liabilities....................... -- -- 88,000 176,000 146,000 --------- ------------ ------------ ----------- ----------- Net cash used in investing activities................. (124,000) (1,721,000) (14,909,000) (544,000) (465,000) --------- ------------ ------------ ----------- ----------- Cash Flows From Financing Activities: Borrowings under lines of credit.... -- 1,460,000 14,474,000 100,000 21,345,000 Repayments under lines of credit.... -- (130,000) (7,990,000) (100,000) (23,817,000) Borrowings under lines of credit with stockholder.................. 192,000 3,418,000 701,000 17,000 -- Repayments under lines of credit with stockholder.................. -- (1,319,000) (1,873,000) (16,000) (26,000) Borrowings under long-term debt..... -- -- 800,000 -- 193,000 Repayments under long-term debt..... -- -- (67,000) -- (66,000) Payments under capital lease obligations....................... -- (33,000) (317,000) (33,000) (325,000) Issuance of common stock............ 10,000 -- 5,568,000 1,500,000 -- Issuance of preferred stock......... -- -- 7,500,000 -- -- --------- ------------ ------------ ----------- ----------- Net cash provided by (used in) financing activities... 202,000 3,396,000 18,796,000 1,468,000 (2,696,000) --------- ------------ ------------ ----------- ----------- Increase (decrease) in cash and cash equivalents......................... 15,000 149,000 1,555,000 984,000 (953,000) Cash and cash equivalents, beginning of period........................... -- 15,000 164,000 164,000 1,719,000 --------- ------------ ------------ ----------- ----------- Cash and cash equivalents, end of period.............................. $ 15,000 $ 164,000 $ 1,719,000 $ 1,148,000 $ 766,000 ========= ============ ============ =========== ============
The accompanying notes are an integral part of these consolidated statements. F-7 72 STAR TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 1. NATURE OF BUSINESS STAR Telecommunications, Inc. and subsidiary (the Company or STAR), a Delaware corporation, is an international long distance provider focused primarily on providing low cost switched voice long distance services to U.S. and foreign-based telecommunications companies. The Company currently offers U.S.-originated long distance service through its network of resale arrangements with other long distance providers, foreign termination relationships, international gateway switches and leased and owned transmission facilities. While the Company was incorporated in 1993, it did not commence its current business as a provider of long distance services until the second half of 1995. During 1994, the Company was primarily engaged in activities outside the international telecommunications industry. During the six months ended June 1995, the Company primarily acted as an agent for, and provided various consulting services to, companies in the telecommunications industry. In November 1996, the Company established a wholly owned subsidiary (STAR Europe Limited) in London, England. The Company is subject to various risks in connection with the operation of its business. These risks include, but are not limited to, regulations (See Note 5f), dependence on transmission facilities-based carriers and suppliers, price competition and competition from larger industry participants. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES a. Principles of Consolidation The accompanying consolidated financial statements include the accounts of STAR Telecommunications, Inc. and its wholly owned subsidiary STAR Europe Limited, after elimination of all significant intercompany accounts and transactions which were not material during 1996. b. Revenue Recognition The Company records revenues for long distance telecommunications sales at the time of customer usage. Finance charges for customer late payments are included in revenues and amount to $32,000 and $1,467,000 for the years ended December 31, 1995 and 1996, respectively. The Company had no revenue from finance charges during 1994. The Company charges its customers 1.5 percent of the outstanding balance if the customer is late in making its payment. Two customers, Cherry Communications and Hi-Rim Communications, Inc., represented the two largest balances for the year ended December 31, 1996, representing 20 percent and 16 percent of revenue from late charges, respectively. These two customers also were the two largest customers overall, representing 21 percent and 9 percent of overall revenue for the year. The two next largest balances for the year ended December 31, 1996 represented 8 and 7 percent of revenue from late charges for the year. c. Cost of Services Cost of services represents direct charges from vendors that the Company incurs to deliver service to its customers. These include leasing costs for the dedicated phone lines which form the Company's network and rate-per-minute charges from other carriers that terminate international traffic on behalf of the Company. d. Accounting for International Long Distance Traffic At the end of 1996, the Company entered into operating agreements with telecommunication carriers in foreign countries under which international long distance traffic is both originated and F-8 73 STAR TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) terminated on the Company's network. The Company records international settlement revenues and related costs as the traffic is recorded in the switch. For the year ended December 31, 1996, $178,000 in revenue has been recorded from foreign customers. e. Property and Equipment Property and equipment are carried at cost. Depreciation and amortization of property and equipment is computed using the straight-line method over the following estimated useful lives: Operating equipment...................................... 5-25 years Leasehold improvements................................... Life of lease Computer equipment....................................... 3 years Furniture and fixtures................................... 5 years
Operating equipment includes assets financed under capital lease obligations of $888,000 at December 31, 1995 and $5,985,000 at December 31, 1996. Operating equipment at December 31, 1996 also includes two Indefeasible Rights of Use (IRU) in cable systems amounting to $110,000 and one interest in an international cable amounting to $148,000. These assets are amortized over the life of the agreements of 14 to 25 years. Replacements and betterments, renewals and extraordinary repairs that extend the life of the asset are capitalized; other repairs and maintenance are expensed. The cost and accumulated depreciation applicable to assets sold or retired are removed from the accounts and the gain or loss on disposition is recognized in other income or expense. f. Fair Value of Financial Instruments The carrying amounts of cash and cash equivalents, receivables, other assets, revolving lines of credit, notes payable, capital lease obligations, accounts payable, and accrued liabilities approximate their fair value. g. Statements of Cash Flows During the years ended December 31, 1995 and 1996, cash paid for interest was $43,000 and $530,000, respectively. For the same periods, cash paid for income taxes amounted to $1,000 and $1,211,000 respectively. The Company paid no cash for interest or income taxes during 1994. Non-cash investing and financing activities are as follows:
YEARS ENDED DECEMBER 31, --------------------------------- 1994 1995 1996 ------- ---------- ---------- Equipment purchased through capital leases........... $ -- $ 888,000 $5,097,000 Debt converted to equity............................. -- 1,093,000 --
These non-cash transactions are excluded from the statements of cash flows. Cash equivalents consist primarily of money market accounts. The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. h. Stock Split On January 23, 1996, the Board of Directors authorized an increase to the authorized number of common shares from 10,000 to 100,000,000 and effected a 8,100.8109-for-1 stock split of the Company's F-9 74 STAR TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) issued and outstanding shares. All common shares have been retroactively restated to reflect the effect of the stock split. On July 22, 1996, the Company changed the par value of its common stock from $0.01 per share to $0.001 per share. All common shares have been retroactively restated to reflect the effect of this change (also see Note 10f for post year-end restructuring and stock split). i. Concentrations of Risk The Company's two largest customers account for approximately 44 percent and 29 percent of gross accounts receivable at December 31, 1995 and 1996, respectively. The Company's largest customer in 1995 and 1996 was Cherry Communications, Inc. The Company's second largest customer in 1995 was Cable & Wireless and the Company's second largest customer in 1996 was Hi-Rim Communications, Inc. Each of these customers represents more than 10 percent of gross accounts receivable at December 31, 1995 but only one customer represents more than 10 percent of accounts receivable in 1996. These customers represent approximately 47 percent of revenues during the year ended December 31, 1995 and 30 percent of revenues for the year ended December 31, 1996. Each of these customers represents more than 10 percent of sales in 1995 while only one represents more than 10 percent of sales in 1996. The Company performs ongoing credit evaluations of its customers. The Company analyzes daily traffic patterns and concludes whether or not the customer's credit status justifies the traffic volume. If the customer is deemed to carry too large a volume in relation to its credit history, the traffic received by the Company's switch is reduced to prevent further build up of the receivable from this customer. The Company's allowance for doubtful accounts is based on current market conditions. Purchases from the three largest vendors for the year ended December 31, 1995 amounted to 49 percent of total purchases. Purchases from the four largest vendors for the year ended December 31, 1996 amounted to 51 percent of total purchases. Included in the Company's balance sheet at December 31, 1995 and 1996, are the net assets of the Company's international telecommunication switching equipment which is located in Los Angeles at a cost of $1,288,000 at December 31, 1995 and in Los Angeles and New York at a cost of $8,205,000 at December 31, 1996. In addition, approximately $179,000 of equipment is located in foreign countries at December 31, 1996. j. Deposits and Other Assets Deposits represent payments made to long distance providers to secure lower rates. These deposits are refunded or applied against future service and are net of a $2 million reserve at December 31, 1996. Other assets represents initial public offering expenses. k. Net Loss Per Common Share Pro forma net loss per common share for the year ended December 31, 1996 is based on the weighted average number of common shares outstanding giving effect of the conversion of the preferred stock (see Note 9. Per share information was computed pursuant to the rules of the Securities and Exchange Commission (SEC), which require that common shares issued by the Company during the twelve months immediately preceding the Company's initial public offering plus the number of common shares issuable pursuant to the grant of options issued during the same period, be included in the calculation of the shares outstanding using the treasury stock method from the beginning of all periods presented. Historical earnings per share are not presented for all periods, since such amounts are not meaningful in light of the conversion of the preferred stock. F-10 75 STAR TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The following schedule summarizes the information used to compute pro forma net loss per common share for the year ended December 31, 1996: Net loss.......................................................... $(6,644,000) ----------- Weighted average common shares outstanding........................ 10,575,000 Effect of stock options pursuant to SEC rules..................... 1,095,000 Conversion of preferred stock..................................... 528,000 ----------- Weighted average number of common shares used to compute net income per share................................................ 12,198,000 ----------- Pro forma net loss per common share............................... $ (0.54) ===========
Pro forma net loss per common share reflects the conversion of 1,367,047 shares of preferred stock into common stock upon the effectiveness of the initial public offering at a rate of three preferred shares to two common shares. l. 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 reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. m. Recently Issued Accounting Standards In March 1995, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," which requires impairment losses to be recorded on long-lived assets used in operations when indications of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amounts. The Company adopted SFAS 121 during 1995 which had no impact on the Company's financial position or results of operations. In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS 123 encourages, but does not require, a fair value based method of accounting for employee stock options or similar equity instruments. It also allows an entity to elect to continue to measure compensation cost under Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," but requires pro forma disclosure of net income and earnings per share as if the fair value based method had been applied. The Company adopted this standard in 1996, electing to measure compensation cost under APB 25 and complying with the pro forma disclosure requirements. Therefore, the adoption of SFAS 123 had little impact on the Company's financial position or results of operations. 3. LINES OF CREDIT a. Bank Lines of Credit On November 13, 1995, the Company entered into an agreement for a one-year $1 million revolving credit facility. On October 4, 1996 the bank increased the revolving credit facility to $12 million, including draws on the line and outstanding letters of credit, and extended it to May 1, 1997. Any borrowings under this facility are limited by the balance in eligible accounts receivable, as defined, and bear interest at the prime rate plus 1 percent (9.25 percent at December 31, 1996). The F-11 76 STAR TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) agreement allows the Company to convert certain amounts into short-term obligations that bear interest at the bank's LIBOR rate plus 3.5 percent (9.1 percent at December 31, 1996) or the bank's cost of fund's rate plus 3.5 percent at the time of funding. Upon maturity of these short-term obligations, the interest rate on these borrowings converts back to prime plus 1 percent. This facility is collateralized by virtually all assets of the Company. Performance under the revolving credit facility has been guaranteed up to $10 million by the majority shareholder and officer of the Company. The agreement contains certain financial and non-financial covenants which include, among other restrictions, maintenance of minimum levels of net income, tangible effective net worth and working capital. At December 31, 1996, there were no unused amounts available to be borrowed against this line of credit. In addition, the bank issued a waiver to cure non-compliance under the tangible effective net worth, current ratio, ratio of total liabilities to tangible effective net worth, net income after taxes for the fourth quarter of 1996 and the stockholder subordination covenants for the period ended December 31, 1996 and continuing through March 30, 1997, when new covenants come into effect. The Company entered into a one-year $100,000 revolving line of credit on July 19, 1995. This facility's interest rate was the prime rate plus 1 percent and it was paid off and terminated on July 19, 1996. The weighted average interest rate on the above facilities during the year ended December 31, 1995 and 1996 was 10.21 percent and 9.68 percent, respectively. b. Lines of Credit with Stockholder At December 31, 1996, the Company's revolving lines of credit with the majority stockholder and chief executive officer of the Company totaled $1,448,000 and mature on March 30, 1998. Interest is payable at maturity at a rate of 9 percent. There was $1,422,000 available to be borrowed against these lines of credit at December 31, 1996. The Company recognized interest expense relating to this debt of $0, $11,000 and $34,000 for the years ended December 31, 1994, 1995 and 1996, respectively. 4. LONG-TERM DEBT a. Note Payable On October 4, 1996, the Company entered into an $800,000 variable rate installment note with a bank. The agreement calls for monthly payments of $22,222 plus interest at the prime rate plus 1.5 percent (9.75 percent at December 31, 1996). The note is due in full by October 1, 1999 and is collateralized by related equipment of the Company with a cost of $787,000. F-12 77 STAR TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) b. Capital Lease Obligation The Company leases various telecommunications equipment under capital lease arrangements. Minimum future lease payments under these capital leases at December 31, 1996 are as follows:
YEAR ENDING DECEMBER 31, ----------------------------------------------------------------- 1997............................................................. $1,490,000 1998............................................................. 1,490,000 1999............................................................. 1,490,000 2000............................................................. 1,408,000 2001............................................................. 981,000 Thereafter....................................................... 748,000 ---------- 7,607,000 Less: Amount representing interest............................... 1,972,000 ---------- 5,635,000 Less: Current portion............................................ 827,000 ---------- $4,808,000 ==========
Accumulated amortization related to assets financed under capital leases was $59,000 and $324,000 at December 31, 1995 and 1996, respectively. The Company had no assets financed under capital leases during 1994. 5. COMMITMENTS AND CONTINGENCIES a. Operating Leases The Company leases office space, dedicated private telephone lines, equipment and other items under various agreements expiring through 2006. At December 31, 1996, the minimum aggregate payments under non-cancelable operating leases are summarized as follows:
OFFICE FACILITIES TELECOMMUNICATIONS YEAR ENDING DECEMBER 31, AND EQUIPMENT FACILITIES AND EQUIPMENT TOTAL -------------------------------- ----------------- ------------------------ ----------- 1997............................ $ 393,000 $ 1,293,000 $ 1,686,000 1998............................ 364,000 1,591,000 1,955,000 1999............................ 309,000 1,710,000 2,019,000 2000............................ 241,000 1,710,000 1,951,000 2001............................ 214,000 1,441,000 1,655,000 Thereafter...................... 281,000 3,616,000 3,897,000 ---------- ----------- ----------- $ 1,802,000 $ 11,361,000 $13,163,000 ========== =========== ===========
Office facility and equipment rent expense for the years ended December 31, 1994, 1995 and 1996 was approximately $7,000, $125,000 and $681,000, respectively. Telecommunications facility and equipment rent expense was approximately $604,000 in 1995 and $7,260,000 in 1996 and is included in cost of services in the accompanying statements of operations. b. Employment Agreements During 1996, the Company entered into employment agreements with several employees and amended the employment agreement of the Company president. Some of these agreements provide for a continuation of salaries in the event of a termination, with or without cause, following a change in F-13 78 STAR TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) control of the Company. One agreement provides for a guaranteed salary continuation of at least six months after termination and another, under certain conditions, for a payment of at least $1,500,000 in the event of a change in control of the Company. The Company entered into a consulting agreement on February 29, 1996 which was converted to an employment agreement on May 1, 1996. The employment agreement is with an officer of the Company. It is for a two year period and provides for continuation of salary and certain benefits for up to 12 months after termination. The Company also entered into two separate stock option agreements with this officer (see Note 8). During 1996, the Company expensed $116,000 of deferred compensation relating to these agreements. c. Purchase Commitments The Company is obligated under various service agreements with long distance carriers to pay minimum usage charges of approximately $51,995,000, $11,685,000 and $900,000 for the twelve months ending December 31, 1997, 1998 and 1999, respectively. The Company anticipates exceeding the minimum usage volume with these vendors. d. Letters of Credit At December 31, 1996, the Company has eight standby letters of credit outstanding, which expire between January 2, 1997 and November 25, 1997. These letters of credit total $4,751,000, of which $2,501,000 are secured by the bank line of credit and $2,250,000 are secured by short-term investments. e. Legal Matters The Company is subject to litigation from time to time in the ordinary course of business. In February 1996, the Company filed an action in Santa Barbara County Superior Court against Communication Telesystems International ("CTS") seeking $2.0 million in damages for an alleged breach of two contracts with CTS. The Company claims that CTS failed to pay moneys due to the Company and made certain demands that CTS was not entitled to make under the contract and that CTS then repudiated the contracts. CTS filed a separate action against the Company, seeking to recover liquidated damages of $6.0 million for the Company's alleged breach of one of the contracts. CTS claims that it is entitled to liquidated damages as a result of the Company's failure to deliver an increased cash deposit. The Company was granted summary judgment on CTS's First Amended Complaint claims on May 14, 1997. The Company intends to pursue its claim against CTS and to vigorously defend against any potential appeals by CTS. There can be no assurance, however, that the Company will prevail either in its collection of damages or in defending against any potential appeals by CTS. In addition, whether or not the Company is able to collect its damages or were to prevail in any potential appeals, such collection process and appeal could be time consuming and costly. Since CTS's counterclaim is based on liquidating damages, where CTS will either prevail or not prevail, a range of loss cannot be determined. During 1996, the Company settled a disagreement with a former consultant to the Company for a payment of $100,000. F-14 79 STAR TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) f. Telecommunications Legislation Revisions In the United States, the Federal Communications Commission and relevant state Public Service Commissions have the authority to regulate interstate and intrastate rates, respectively, ownership of transmission facilities, and the terms and conditions under which the Company's services are provided. Legislation that substantially revised the U.S. Communications Act of 1934 was signed into law on February 8, 1996. The legislation has specific guidelines under which the regional operating companies (RBOCs) can provide long distance services, which will permit the RBOCs to compete with the Company in providing domestic and international long distance services. Further, the legislation, among other things, opens local service markets to competition from any entity (including long distance carriers, such as AT&T, cable television companies and utilities). Because the legislation opens the Company's markets to additional competition, particularly from the RBOCs, the Company's ability to compete may be affected. Moreover, as a result of and to implement the legislation, certain federal and other governmental regulations will be amended or modified, and any such amendment or modification could have an effect on the Company's business, results of operations and financial condition. 6. RELATED PARTY TRANSACTIONS The majority stockholder and chief executive officer of the Company owns two-thirds of Star Aero Services, Inc. (Star Aero). Star Aero's principal assets represent airplanes which it provides to the Company for business travel on an as needed basis. In return, the Company pays for costs related to the airplanes. Star Aero reimburses the Company for certain costs relating to the maintenance of the planes. For the years ended December 31, 1994, 1995 and 1996, the Company paid $0, $144,000 and $68,000, respectively, in costs related to the use of Star Aero services. As of December 31, 1995 and 1996, the Company has a receivable from Star Aero of $50,000 and $115,000, respectively. During 1995, the Company invested $128,000 in a company related to an employee of STAR and purchased services from that company in the amount of $167,000. During 1995 and 1996, the Company purchased consulting services from a company owned by a board member in the amount of $60,000 and $154,000, respectively. During the year ended December 31, 1995 and 1996, the Company also provided long distance telephone service to a company controlled by another board member in the amount of $43,000 and $250,000 respectively. During 1996, the Company purchased telecommunication services from three companies controlled by a Company executive for $240,000 and made up front payments in the amount of $758,000, which are included in deposits in the accompanying financial statements at December 31, 1996. 7. INCOME TAXES Through December 31, 1995, the Company had elected to be taxed as an S-Corporation for both federal and state income tax purposes. While the election was in effect, all taxable income, deductions, losses and credits of the Company were included in the tax returns of the shareholders. Accordingly, for federal income tax purposes, no tax benefit, liability or provision has been reflected in the accompanying financial statements at December 31, 1994 and 1995 and for the years then ended. For state tax purposes, an S-Corporation is subject to a 1.5 percent tax on taxable income, with a minimum tax of approximately $1,000 annually. Effective January 1, 1996, the Company terminated its S-Corporation election and is now taxable as a C-Corporation. The Company accounts for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes," under which deferred assets and liabilities are provided on differences between financial reporting and taxable income using enacted tax rates. Deferred income tax expenses or credits are based on the changes in deferred income tax assets or liabilities from period to period. F-15 80 STAR TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Under SFAS No. 109, deferred tax assets may be recognized for temporary differences that will result in deductible amounts in future periods. A valuation allowance is recognized if on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized. There is no assurance that the Company will continue to be profitable in future periods, therefore, a valuation allowance has been recognized for the full amount of the deferred asset for each period presented. The components of the net deferred tax assets at December 31, 1995 and 1996 are as follows:
1995 1995 HISTORICAL PRO FORMA 1996 ---------- --------- ---------- Deferred tax asset: Allowance for bad debts............................. $ 3,000 $83,000 $3,104,000 Accrued line cost................................... -- -- 201,000 Vacation accrual.................................... -- -- 24,000 Deferred compensation............................... -- -- 47,000 Accrued bonus....................................... -- -- 25,000 Accrued interest.................................... -- 6,000 -- State income taxes.................................. -- -- 48,000 ------- -------- ---------- 3,000 89,000 3,449,000 Deferred tax liability: Depreciation........................................ (1,000) (59,000) (565,000) ------- -------- ---------- Subtotal.............................................. 2,000 30,000 2,884,000 Valuation reserve..................................... (2,000) (30,000) (2,884,000) ------- -------- ---------- Net deferred tax asset................................ $ -- $ -- $ -- ======= ======== ==========
The provision for income taxes for the years ended December 31, 1994, 1995 and 1996 are as follows:
1994 1995 1996 ------ ------ -------- Current - Federal taxes.................................... $ -- $ -- $393,000 - State taxes...................................... 1,000 1,000 141,000 ------ ------ 1,000 1,000 534,000 ------ ------ Deferred - Federal taxes.................................... -- -- -- - State taxes...................................... -- -- -- ------ ------ -- -- -- ------ ------ Provision for income taxes................................... $1,000 $1,000 $534,000 ====== ======
There is no difference between historical and pro forma provision for income taxes for the years ended December 31, 1994 and 1995 because the amount of provision is the minimum state taxes payable. F-16 81 STAR TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Differences between the provision for income taxes and income taxes at the statutory federal income tax rate for the years ended December 31, 1994, 1995 and 1996 are as follows:
HISTORICAL PRO FORMA 1996 --------------- -------------------- --------------------- 1994 1995 1994 1995 AMOUNT PERCENT ------ ------ -------- --------- ----------- ------- Income taxes at the statutory federal rate...................... $ -- $ -- $(41,000) $(193,000) $(2,077,000) (34.0)% State income taxes, net of federal income tax effect................. 1,000 1,000 1,000 1,000 (375,000) (6.1)% Change in valuation reserve......... -- -- -- -- 2,882,000 47.1% Tax benefits not recognized......... -- -- 41,000 193,000 -- -- Meals and gifts..................... -- -- -- -- 104,000 1.7% ------ ------ -------- --------- -------- ----- $1,000 $1,000 $ 1,000 $ 1,000 $ 534,000 8.7% ====== ====== ======== ========= ======== =====
8. STOCK OPTIONS On January 22, 1996, the Company adopted the 1996 Stock Incentive Plan (the "Plan"). The Plan, which was amended on March 31, 1996, provides for the granting of stock options to purchase up to 720,000 shares of common stock and terminates January 22, 2006. Options granted become exercisable at a rate of not less than 20 percent per year for five years. Subsequent to the adoption of the Plan, the Company granted two employees options to purchase a total of 360,000 shares of the Company's common stock exercisable at the fair market value of $1.50 per share as determined by the Board of Directors. One-third of the options are exercisable immediately. The remaining options are exercisable equally on January 2, 1997 and 1998. In May 1996, the Company issued an additional 337,100 stock options to certain employees and consultants under the Plan, of which 10,600 were subsequently canceled. The options are exercisable at fair market value of $3.00 per share at the date of issuance, and vest through August 2000. In connection with the consulting agreement and subsequent employment agreement with an officer of the Company, the Company entered into two separate stock option agreements. The first agreement, dated March 1, 1996, provides for 200,000 non-incentive stock options exercisable immediately. The options are exercisable at fair market value at the date of issuance, which was $2.00 per share, and expire in 10 years. The second stock option agreement was entered into on May 1, 1996 for an additional 200,000 shares to also be issued at $2.00 per share. These options vest half on March 1, 1997 and half on March 1, 1998. These options, which expire in 10 years, may be subject to accelerated vesting if a change in control occurs, as defined. On May 15, 1996, the Company granted 100,000 options, valued at $3.00 per share at the date of issuance to a director. Of these options 34 percent are exercisable immediately. The remaining options are exercisable equally on May 15, 1997 and 1998. On May 14, 1996, the Company adopted the 1996 Outside Director Nonstatutory Stock Option Plan. The number of shares which may be issued under this plan upon exercise of options may not exceed 200,000 shares. The exercise price of an option is determined by the Board of Directors and may not be less than 85 percent of the fair market value of the common stock at the time of grant and has to be 110 percent of the fair market value of the common stock at the time of grant if the option is granted to a holder of more than 10 percent of the common stock outstanding. At the discretion of the administrator, the options vest at a rate of not less than 20 percent per year, which may accelerate upon a change in control, as defined. The plan expires on May 14, 2006. On May 15, 1996, the Company issued 40,000 options under this plan at $3.00 per share, which vest immediately and expire 10 years from the grant date. F-17 82 STAR TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) On September 23, 1996, the Company adopted the 1996 Supplemental Stock Option Plan. This plan which expires on August 31, 2006, replaces the Plan and has essentially the same features. The Company can issue options or other rights to purchase up to 1,000,000 shares of stock which expire up to 10 years after the date of grant, except for incentive options issued to a holder of more than 10 percent of the common stock outstanding, which expire five years after the date of grant. On September 23, 1996, the Company granted 126,500 options under this plan at $8.20 per share, which vest through September 2000 of which 2,500 shares were subsequently canceled. In October 1996, the Company issued 254,500 options at $8.20 per share, as determined by the Board of Directors, and in December 1996, an additional 85,000 options were issued at $8.20 per share. The Board of Directors determined the market value of the December options to be $9.60 per share. The Company is recognizing the difference between the market value at the date of grant and the exercise price as compensation expense over the vesting period. Stock Option information with respect to the Company's stock option plans is as follows:
COMMON AVAILABLE OPTION AGGREGATE SHARES FOR PRICE OPTION RESERVED GRANT OPTIONS PER SHARE PRICE --------- --------- --------- ---------- ---------- Balance at December 31, 1995............ -- -- -- $ -- $ -- Adoption of 1996 Stock Incentive Plan... 720,000 720,000 -- -- -- Options granted under 1996 Stock Incentive Plan........................ -- (697,100) 697,100 1.50-3.00 1,551,000 Canceled Options........................ -- 10,600 (10,600) 3.00 (32,000) Options granted outside a plan.......... 500,000 -- 500,000 2.00-3.00 1,100,000 Adoption of 1996 Outside Director Non Statutory Stock Option Plan........... 200,000 200,000 -- -- -- Granted under 1996 Outside Director Non Statutory Stock Option Plan........... -- (40,000) 40,000 3.00 120,000 Adoption of 1996 Supplemental Stock Option Plan........................... 1,000,000 1,000,000 -- -- -- Options granted under 1996 Supplemental Stock Option Plan..................... -- (466,000) 466,000 8.20 3,821,000 Canceled Options........................ -- 2,500 (2,500) 8.20 (20,000) --------- ---------- --------- ---------- ---------- Balance at December 31, 1996............ 2,420,000 730,000 1,690,000 $1.50-8.20 $6,540,000 ========= ========== ========= ========== ==========
The Company has elected to adopt FASB No. 123 for disclosure purposes only and applies Accounting Principle Board (APB) Opinion No. 25 and related interpretations in accounting for its employee stock options. Approximately $50,000 in compensation cost was recognized relating to consultant options for the year ended December 31, 1996. Had compensation cost for stock options awarded under these plans been determined based on the fair value at the dates of grant consistent with the methodology of FASB No. 123, the Company's net loss and loss per share for the year ended December 31, 1996 would have reflected the following pro-forma amounts:
NET LOSS LOSS PER SHARE ---------- ------------------ As reported.............................................. $ (6,644) $(0.54) Pro-Forma................................................ $ (7,227) $(0.59)
The fair value of each option grant is estimated on the date of grant using the minimum value method of option pricing with the following assumptions used for the grants; weighted average risk-free interest rate of 6.4%; expected dividend yields of 0.00 percent; and an expected life of 10 years. F-18 83 STAR TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Because the Company did not have a stock option program prior to 1996, the resulting pro-forma compensation cost may not be representative of that to be expected in future years. A summary of the status of the Company's stock options at December 31, 1996 and activity during 1996 is presented in the table below:
DECEMBER 31, 1996 ----------------------------- WEIGHTED AVERAGE SHARES EXERCISE PRICE --------- ---------------- Outstanding at December 31, 1995........................ -- $ -- Granted................................................. 1,703,100 $ 3.87 Exercised............................................... -- $ -- Forfeited............................................... 13,100 $ 3.99 Expired................................................. -- $ -- Outstanding at December 31, 1996........................ 1,690,000 $ 3.87 Exercisable at end of year.............................. 448,500 $ 2.25 Weighted average fair value of options granted.......... $1.94
1,226,500 of the options outstanding at December 31, 1996 have an exercise price between $1.50 and $3.00, a weighted average exercise price of $2.24 with a weighted average remaining contractual life of 9.5 years and 448,333 of these options are exercisable. 463,500 of the options outstanding have an exercise price of $8.20 and a weighted average remaining contractual life of 9.9 years, none of which are exercisable. 9. CAPITAL STOCK During 1994, the Company issued 8,100,810 shares of stock to the Company's founder for $10,000. During 1995, this stockholder converted $990,000 of debt into capital for no additional shares. During 1995, the Company also issued 899,190 shares to another executive of the Company on conversion of a loan. On February 23, 1996, the Company sold 1,000,000 shares of common stock to various investors for $1,500,000. These stockholders entered into an agreement containing a non-dilution covenant. The covenant allows the investors to purchase sufficient shares of common stock to maintain their current interest in the Company in the event of future stock sales. The stock purchase agreement gives the investors the same rights of first refusal, registration or other rights as the Company may grant to other stockholders. On July 12, 1996, the Company sold 914,396 shares of common stock to an investor for $4,068,000. Concurrent with this stock sale, the Company entered into a registration rights agreement with the investor. According to this agreement, the Company has to use its best efforts to effect registration of these shares. The stock purchase agreement also provides for non dilution rights and rights of first refusal which terminate upon an underwritten public offering of common stock over $5,000,000 and certain merger transactions. On July 25, 1996, the Company sold 1,367,047 shares of Series A preferred stock to a group of investors for $7,500,000. The holders of preferred shares have voting rights and are entitled to receive annual noncumulative dividends of $0.33 per share, payable only if and when declared by the Board of Directors. Additional distributions or dividends are to be distributed to common and preferred shareholders proportionately. These preferred shares also have liquidation preference in the amount of $5.4863 per share plus declared but unpaid dividends, and may be converted to common stock at a ratio of 3-for-2 at the option of the holder. In the event of a public offering, as defined, each three such preferred shares automatically converts to two shares of common stock. See Note 2 for pro forma F-19 84 STAR TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) earnings per share computation assuming the preferred stock had been converted into common stock at the beginning of the year. In connection with this transaction, the Company and buyers of the preferred shares entered into an investors rights agreement which obligates the Company to file up to two registration statements to register such shares. These stockholders also may require the company to file additional registration statements on Form S-3, subject to certain conditions and limitations. Holders of approximately 1,914,000 shares of common stock are also entitled to certain registration rights. 10. UNAUDITED FIRST QUARTER INFORMATION The unaudited financial statements for the three-month periods ended March 31, 1996 and 1997 reflect, in the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to fairly present the financial position, results of operations and changes in cash flows as of and for the periods presented. These unaudited financial statements should be read in conjunction with the audited financial statements and related notes thereto. The results for the interim periods presented are not necessarily indicative of results to be expected for the full year. a. Net Income Per Common Share Net income per common share for the three months ended March 31, 1996 and 1997 are based on the weighted average number of common shares outstanding and the dilutive effect of stock options outstanding. Net income per share for each of the three months ended March 31, 1996 and 1997 have been computed on a pro-forma basis giving effect to the conversion of preferred stock. Historical earnings per share are not presented, since such amounts are not meaningful in light of the conversion of the preferred stock (see Note 9). The following schedule summarizes the information used to compute pro forma net income per common share:
THREE MONTHS ENDED MARCH 31, ---------------------------- 1996 1997 ----------- ----------- Net income....................................................... $ 848,000 $ 1,432,000 -------- ----------- Weighted average common shares outstanding....................... 9,956,000 10,914,000 Conversion of preferred stock.................................... 230,000 911,000 Dilutive effect of stock options pursuant to SEC Rules........... 1,095,000 1,000,000 -------- ----------- Weighted average common shares used to compute net income per share.......................................................... 11,281,000 12,825,000 -------- ----------- Pro forma net income per common share............................ $ 0.08 $ 0.11 ======== ===========
b. Provision for Income Taxes The provision for income taxes for the three months ended March 31, 1996 is based on the estimated annualized tax rate for the year. The provision for income taxes at March 31, 1997 is based on taxable income for the three months then ended, because the net deferred tax asset has been fully reserved. c. Leases Rent expense for the three months ended March 31, 1996 and 1997 was approximately $54,000 and $307,000, respectively. F-20 85 STAR TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) d. Supplemental Cash Flow Information For the three month period ended March 31, 1997, the Company paid taxes of approximately $200,000. No taxes were paid by the Company in the three month period ended March 31, 1996. The Company paid interest in the amount of $58,000 and $326,000 in the first three months of 1996 and 1997, respectively. In the first quarter of 1997, $1,053,000 in equipment was purchased under capital leases. These purchases were excluded from the statement of cash flows as a non-cash transaction. No equipment was purchased under capital leases in the first quarter of 1996. e. Debt During the three months ended March 31, 1997, the Company entered into two term loans totaling $193,000. Both loans bear interest at the prime rate and have interest only payments until the due dates in June and July 1997. On April 28, 1997, the Company extended its line of credit through July 1, 1997. At March 31, 1997, the Company had outstanding letters of credit in the amount of $2 million. At March 31, 1997, the Company was in default of certain covenants, relating to tangible effective net worth, total liabilities to tangible effective net worth, ratio of cash flow to fixed charges and quarterly expenditures. The bank issued a waiver to cure non-compliance through June 29, 1997. f. Reincorporation On January 30, 1997, the Board of Directors approved the merger of STAR Vending, Inc., a Nevada corporation (d.b.a. STAR Telecommunications, Inc.) with STAR Telecommunications, Inc., a Delaware corporation. All shares of STAR Vending, Inc. were converted into STAR Telecommunications, Inc. shares at the ratio of 2-for-3 shares. On March 11, 1997, the Board of Directors approved an amendment to the certificate of incorporation increasing the number of shares authorised to 50 million common shares and 5 million preferred shares upon the consumation of the initial public offering. On May 15, 1997, in connection with the initial public offering, the Company reversed the stock split by converting all outstanding common shares at the ratio of 3-for-2 shares. The accompanying financial statements have been retroactively restated to reflect the effect of the related stock splits. g. Stock Options On January 30, 1997, the Board of Directors approved the 1997 Omnibus Stock Incentive Plan to replace the existing 1996 supplemental plan upon the effective date of the initial public offering (IPO). The plan provides for awards to employees, outside directors and consultants in the form of restricted shares, stock units, stock options and stock appreciation rights. The maximum number of shares available for issuance under this plan may not exceed 500,000 shares plus the number of shares still unissued under the supplemental option plan. Options granted to any one optionee may not exceed more than 500,000 common shares per year subject to certain adjustments. Incentive stock options may not have a term of more than 10 years from the date of grant. On January 30, 1997, the Board of Directors granted 56,327 incentive stock options to vest over four years and 15,000 options under the Outside Director's plan. The options were granted at the then current market value of $10.80 per share, as determined by the Board of Directors. The board also approved accelerated vesting of options in certain instances following a change in control, as defined. F-21 86 STAR TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Stock option information with respect to the Company's stock option plans is as follows:
COMMON OPTION AGGREGATE SHARES AVAILABLE PRICE OPTION RESERVED FOR GRANT OPTIONS PER SHARE PRICE --------- --------- --------- ----------- ---------- Balance at December 31, 1996........... 2,420,000 730,000 1,690,000 $ 1.50-8.20 $6,540,000 Options Granted........................ -- (71,327) 71,327 10.80 770,000 Options Canceled....................... (100,000) 55,475 (155,475) 2.00-8.20 (642,000) --------- --------- --------- ----------- ---------- Balance at March 31, 1997.............. 2,320,000 714,148 1,605,852 $1.50-10.80 $6,668,000 ========= ========= ========= =========== ==========
During the three month period ended March 31, 1997, the Company expensed $20,000 in connection with consultant options. The weighted average fair value of options outstanding at March 31, 1997 is $4.15 and 697,775 options are vested at that date. h. Purchase Commitments In January 1997, the Company entered into an agreement to purchase switching equipment with a cost of $3.8 million to be installed in London, England. On May 6, 1997, the Company entered into a capital lease to finance approximately $3.3 million of the purchase price. The Company also entered into a 10 year facility lease in Dallas, Texas at a cost of approximately $123,000 per year. On March 6, 1997, the Company entered into two separate agreements to purchase IRUs on north transatlantic cable for approximately $1.2 million. Both agreements are effective April 1, 1997 and continue in effect for the initial term up to the expected useful life of the cables, through September 2019 and 2020, respectively. The cost of the first IRU is $1,024,000 to be paid in quarterly payments through September 1999 with an initial payment of $183,000 due on April 30, 1997. The second IRU has a cost of $128,000 due in quarterly payments plus interest through September 30, 1999 with an initial payment of $34,340 due on April 30, 1997. Both agreements also require the Company to make quarterly payments for operating and maintenance charges as well as for certain restoration costs. At March 31, 1997, the Company is obligated under various service agreements with long distance carriers to pay minimum charges of approximately $84,956,000 over the next three years. The Company anticipates exceeding the minimum usage volume with these vendors. i. Foreign Sales Foreign sales accounted for approximately one percent of revenues in the three month period ended March 31, 1997. j. Employment Agreement In February 1997, the Company revised the employment agreement of a Company executive, to terminate effective February 28, 1998 and to eliminate the post employment compensation provision. k. Significant Customers The two largest customers represent 32 percent of the gross accounts receivable at March 31, 1997. Only one of these customers represents more than 10 percent of accounts receivable at that date. These same two customers represent 21 percent of revenue for the quarter ended March 31, 1997, only one of them over 10 percent. The five largest customers represent 44 percent of revenue for the same period. F-22 87 STAR TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 11. NEW AUTHORITATIVE PRONOUNCEMENTS In March 1997 the Financial Accounting Standards Board introduced SFAS No. 128 "Earnings per Share" and SFAS No. 129 "Disclosure of Information About Capital Structure". SFAS No. 128 revises and simplifies the computation of earnings per share and requires certain additional disclosures. SFAS No. 129 requires additional disclosure about the Company's capital structure. Both standards will be adopted in the fourth quarter of fiscal 1997. Management does not expect the adoption of these standards to have a material effect on the Company's financial position or results of operations. F-23 88 APPENDIX - DESCRIPTION OF GRAPHICS PAGE 29 [STAR FACILITIES Illustration]: Diagram depicting route of international telephone call from the originating telephone, through the local exchange carrier, long distance provider, STAR's international gateway switch and then to the terminating country either through the Company's owned, IRU or leased facilities or through resale arrangements with third parties. 89 ====================================================== NO DEALER, SALESPERSON, OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY, THE SELLING STOCKHOLDERS OR THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY TO ANY PERSON IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION WOULD BE UNLAWFUL OR TO ANY PERSON TO WHOM IT IS UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY OFFER OR SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY OR THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF. ------------------ TABLE OF CONTENTS
PAGE ----- Prospectus Summary...................... 3 Risk Factors............................ 5 Use of Proceeds......................... 17 Dividend Policy......................... 17 Capitalization.......................... 18 Dilution................................ 19 Selected Consolidated Financial Data.... 20 Management's Discussion and Analysis of Financial Condition and Results of Operations............................ 21 Business................................ 31 Management.............................. 45 Certain Transactions.................... 52 Principal and Selling Stockholders...... 54 Description of Capital Stock............ 56 Shares Eligible for Future Sale......... 59 Underwriting............................ 61 Legal Matters........................... 62 Experts................................. 62 Additional Information.................. 63 Index to Consolidated Financial Statements.............................. F-1
------------------ UNTIL , 1997 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. ====================================================== ====================================================== 4,000,000 SHARES LOGO COMMON STOCK ----------------------- PROSPECTUS ----------------------- HAMBRECHT & QUIST ALEX. BROWN & SONS INCORPORATED , 1997 ============================================================ 90 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION The following table sets forth the costs and expenses, other than underwriting discounts and commissions, payable by the Company in connection with the sale of Common Stock being registered. All amounts are estimates except the SEC registration fee and the NASD filing fees. SEC Registration fee.................................................. $ 22,652.00 NASD fee.............................................................. 7,975.00 Nasdaq National Market listing fee.................................... 37,187.50 Printing and engraving expenses....................................... 135,000.00 Legal fees and expenses............................................... 550,000.00 Accounting fees and expenses.......................................... 492,000.00 Blue sky fees and expenses............................................ 10,000.00 Transfer agent fees................................................... 5,000.00 Miscellaneous fees and expenses....................................... 65,185.50 ------------- Total....................................................... $1,325,000.00 =============
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS Section 145 of the Delaware General Corporation Law authorizes a court to award or a corporation's Board of Directors to grant indemnification to directors and officers in terms sufficiently broad to permit such indemnification under certain circumstances for liabilities (including reimbursement for expenses incurred) arising under the Securities Act of 1933, as amended (the "Securities Act"). Article VII, Section 6, of the Registrant's Bylaws provides for mandatory indemnification of its directors and officers and permissible indemnification of employees and other agents to the maximum extent permitted by the Delaware General Corporation Law. The Registrant's Amended and Restated Certificate of Incorporation provides that, pursuant to Delaware law, its directors shall not be liable for monetary damages for breach of the directors' fiduciary duty as directors to the Company and its stockholders. This provision in the Amended and Restated Certificate of Incorporation does not eliminate the directors' fiduciary duty, and in appropriate circumstances equitable remedies such as injunctive or other forms of non-monetary relief will remain available under Delaware law. In addition, each director will continue to be subject to liability for breach of the director's duty of loyalty to the Company for acts or omissions not in good faith or involving intentional misconduct, for knowing violations of law, for actions leading to improper personal benefit to the director, and for payment of dividends or approval of stock repurchases or redemptions that are unlawful under Delaware law. The provision also does not affect a director's responsibilities under any other law, such as the federal securities laws or state or federal environmental laws. The Registrant has entered into Indemnification Agreements with its officers and directors, a form of which is attached as Exhibit 10.1 hereto and incorporated herein by reference. The Indemnification Agreements provide the Registrant's officers and directors with further indemnification to the maximum extent permitted by the Delaware General Corporation Law. Reference is made to Section 7 of the Underwriting Agreement contained in Exhibit 1.1 hereto, indemnifying officers and directors of the Registrant against certain liabilities. II-1 91 ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES Since inception, the Company has issued and sold the following securities: 1. As of March 31, 1997, the Registrant had issued 9,000,000 shares of its Common Stock pursuant to direct issuances to employees in consideration for services provided by such employees for an aggregate purchase price of approximately $1,115,960.45. 2. On February 23, 1996, the Registrant issued and sold 1,000,000 shares of its Common Stock to a group of six investors for an aggregate purchase price of $1,500,000.00. 3. On July 12, 1996, the Registrant issued and sold 914,406 shares of its Common Stock to Gotel Investments Ltd. for an aggregate purchase price of $4,068,651.00. 4. On July 25, 1996, the Registrant issued and sold 1,367,047 (911,360 shares after giving effect to the reverse stock split effective upon the closing of this offering) shares of its Series A Preferred Stock to a group of twenty-two investors for an aggregate purchase price of $7,500,003.51. The issuances described in Item 15(1) were deemed exempt from registration under the Securities Act in reliance upon Rule 701 promulgated under the Securities Act or Section 4(2) of the Securities Act. The issuances of the securities described in Item 15(2), Item 15(3) and Item 15(4) were deemed to be exempt from registration under the Securities Act in reliance on Section 4(2) of such Act as transactions by an issuer not involving any public offering. In addition, the recipients of securities in each such transaction represented their intentions to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof and appropriate legends were affixed to the share certificates issued in such transactions. All recipients had adequate access, through their relationships with the Registrant, to information about the Registrant. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (A) EXHIBITS.
EXHIBIT NO. DESCRIPTION - ------- ------------------------------------------------------------------------------------ 1.1+ Form of Underwriting Agreement (preliminary form). 3.1 Certificate of Incorporation of the Registrant, as amended to date. 3.3* Form of Restated Certificate of Incorporation of the Registrant to be filed upon the closing of the offering made hereby. 3.4+ Bylaws of the Registrant. 3.5* Form of Bylaws of the Registrant to be filed upon the closing of the offering made hereby. 4.1+ Reference is made to Exhibits 3.1, 3.3, 3.4, and 3.5. 4.2* Specimen Common Stock certificate. 4.3+ Registration Rights Agreement, dated September 24, 1996, between the Registrant and the investors named therein. 4.4+ Registration Rights Agreement, dated July 12, 1996, between the Registrant and the investor named therein. 4.5+ Investor Rights Agreement dated July 25, 1996, between the Registrant and the investors named therein. 5.1* Opinion of Gunderson Dettmer Stough Villeneuve Franklin & Hachigian, LLP. 10.1+ Form of Indemnification Agreement. 10.2+ 1996 Amended and Restated Stock Incentive Plan. 10.3+ 1996 Outside Director Nonstatutory Stock Option Plan. 10.4 1997 Omnibus Stock Incentive Plan.
II-2 92
EXHIBIT NO. DESCRIPTION - ------- ------------------------------------------------------------------------------------ 10.5+ Employment Agreement between the Registrant and Mary Casey dated July 14, 1995, as amended. 10.6+ Employment Agreement between the Registrant and Kelly Enos dated December 2, 1996. 10.7+ Employment Agreement between the Registrant and David Vaun Crumly dated January 1, 1996. 10.8+ Employment Agreement between the Registrant and James Kolsrud dated December 18, 1996. 10.9+ Consulting Agreement between the Registrant and Gordon Hutchins, Jr. dated May 1, 1996. 10.10+ Nonstatutory Stock Option Agreement between the Registrant and Gordon Hutchins, Jr. dated May 15, 1996. 10.11+ Free Standing Commercial Building Lease between the Registrant and Thomas M. Spear, as receiver for De La Guerra Court Investments, dated for reference purposes as of March 1, 1996. 10.12+ Standard Office Lease--Gross between the Registrant and De La Guerra Partners, L.P. dated for reference purposes as of July 9, 1996. 10.13+ Office Lease between the Registrant and WHUB Real Estate Limited Partnership dated June 28, 1996, as amended. 10.14+ Standard Form of Office Lease between the Registrant and Hudson Telegraph Associates dated February 28, 1996. 10.15+ Agreement for Lease between the Registrant and Telehouse International Corporation of Europe Limited dated July 16, 1996. 10.16+ Sublease between the Registrant and Borton, Petrini & Conron dated March 20, 1994, as amended. 10.17+ Office Lease between the Registrant and One Wilshire Arcade Imperial, Ltd. dated June 28, 1996. 10.18+ Lease Agreement between the Registrant and Telecommunications Finance Group dated April 6, 1995. 10.19+ Lease Agreement between the Registrant and Telecommunications Finance Group dated January 3, 1996, as amended. 10.20 Master Lease Agreement between the Registrant and NTFC Capital Corporation dated December 20, 1996. 10.21+ Variable Rate Installment Note between the Registrant and Metrobank dated October 4, 1996. 10.22+ Assignment of Purchase Order and Security Interest between the Registrant and DSC Finance Corporation dated January 1, 1996. 10.23 Line of Credit Promissory Note between the Registrant and Christopher E. Edgecomb dated November 7, 1996, as amended. 10.24 Office Lease Agreement between the Registrant and Beverly Hills Center LLC effective as of April 1, 1997. 10.25 Agreement between the Registrant and John Marsch dated March 1, 1997. 11.1+ Computation of Loss Per Share.
II-3 93
EXHIBIT NO. DESCRIPTION - ------- ------------------------------------------------------------------------------------ 21.1+ Subsidiary of the Registrant. 23.1 Consent of Arthur Andersen LLP, Independent Accountants. 23.2* Consent of Counsel. Reference is made to Exhibit 5.1. 24.1+ Power of Attorney (see page II-5). 27.1+ Financial Data Schedule.
- ------------------------------ * To be filed by amendment. + Previously filed. (B) FINANCIAL STATEMENT SCHEDULES Schedule II -- Valuation and Qualifying Accounts. Schedules not listed above have been omitted because the information required to be set forth therein is not applicable or is shown in the financial statements or notes thereto. ITEM 17. UNDERTAKINGS The Registrant hereby undertakes to provide to the Underwriters at the closing specified in the Underwriting Agreement, certificates in such denominations and registered in such names as required by the Underwriters to permit prompt delivery to each purchaser. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Registrant pursuant to the Delaware General Corporation Law, the Certificate of Incorporation or the Bylaws of the Registrant, the Underwriting Agreement, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act, and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer, or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered hereunder, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question of whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. The Registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act, the information omitted from the form of Prospectus filed as part of this Registration Statement in reliance upon Rule 430A and contained in a form of Prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this Registration Statement as of the time it was declared effective. (2) For the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of Prospectus shall be deemed to be a new Registration Statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-4 94 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, as amended, the registrant has duly caused this amendment to registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Santa Barbara, State of California, on this 16th day of May, 1997. STAR TELECOMMUNICATIONS, INC. By: /s/ MARY A. CASEY -------------------------------------- Mary A. Casey President PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, AS AMENDED, THIS AMENDMENT TO REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE CAPACITIES AND ON THE DATES INDICATED: /s/ CHRISTOPHER E. EDGECOMB* Chief Executive Officer and Director May 16, 1997 - ---------------------------------------- (Principal Executive Officer) Christopher E. Edgecomb /s/ KELLY D. ENOS* Chief Financial Officer (Principal May 16, 1997 Financial and Accounting Officer) - ---------------------------------------- Kelly D. Enos /s/ MARY A. CASEY President and Director May 16, 1997 - ---------------------------------------- Mary A. Casey /s/ GORDON HUTCHINS, JR.* Director May 16, 1997 - ---------------------------------------- Gordon Hutchins, Jr. /s/ JOHN R. SNEDEGAR* Director May 16, 1997 - ---------------------------------------- John R. Snedegar /s/ ROLAND A. VAN DER MEER* Director May 16, 1997 - ---------------------------------------- Roland A. Van der Meer *By: /s/ MARY A. CASEY - ---------------------------------------- Mary A. Casey Attorney-in-Fact
II-5 95 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors and Stockholders of STAR Telecommunications, Inc.: We have audited in accordance with generally accepted auditing standards the consolidated financial statements of STAR Telecommunications, Inc., included in this registration statement and have issued our report thereon dated April 10, 1997. Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedule of valuation and qualifying accounts is the responsibility of the Company's management and is presented for the purpose of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and, in our opinion, fairly states, in all material respects, the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole. ARTHUR ANDERSEN LLP Los Angeles, California April 10, 1997 S-1 96 SCHEDULE II STAR TELECOMMUNICATIONS, INC. SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
BALANCE AT BALANCE AT BEGINNING OF END OF PERIOD PROVISION WRITE-OFF PERIOD ------------ --------- --------- ---------- (IN THOUSANDS) Allowance for doubtful accounts 1994......................................... $ -- $ -- $ -- $ -- 1995......................................... $ -- $ 208 $ -- $ 208 1996......................................... $208 $15,561 $ (10,036) $5,733 Deferred tax asset valuation allowance 1994......................................... $ -- $ -- $ -- $ -- 1995......................................... $ -- $ 30 $ -- $ 30 1996......................................... $ 30 $ 2,854 $ -- $2,884
S-2 97 INDEX TO EXHIBITS
SEQUENTIALLY EXHIBIT NUMBERED NO. EXHIBIT PAGE NUMBER - ------- ----------------------------------------------------------------------- 1.1+ Form of Underwriting Agreement (preliminary form). 3.1 Certificate of Incorporation of the Registrant, as amended to date. 3.3* Form of Restated Certificate of Incorporation of the Registrant to be filed upon the closing of the offering made hereby. 3.4+ Bylaws of the Registrant. 3.5* Form of Bylaws of the Registrant to be filed upon the closing of the offering made hereby. 4.1+ Reference is made to Exhibits 3.1, 3.3, 3.4, and 3.5. 4.2* Specimen Common Stock certificate. 4.3+ Registration Rights Agreement, dated September 24, 1996, between the Registrant and the investors named therein. 4.4+ Registration Rights Agreement, dated July 12, 1996, between the Registrant and the investor named therein. 4.5+ Investor Rights Agreement dated July 25, 1996, between the Registrant and the investors named therein. 5.1* Opinion of Gunderson Dettmer Stough Villeneuve Franklin & Hachigian, LLP. 10.1+ Form of Indemnification Agreement. 10.2+ 1996 Amended and Restated Stock Incentive Plan. 10.3+ 1996 Outside Director Nonstatutory Stock Option Plan. 10.4 1997 Omnibus Stock Incentive Plan. 10.5+ Employment Agreement between the Registrant and Mary Casey dated July 14, 1995, as amended. 10.6+ Employment Agreement between the Registrant and Kelly Enos dated December 2, 1996. 10.7+ Employment Agreement between the Registrant and David Vaun Crumly dated January 1, 1996. 10.8+ Employment Agreement between the Registrant and James Kolsrud dated December 18, 1996. 10.9+ Consulting Agreement between the Registrant and Gordon Hutchins, Jr. dated May 1, 1996. 10.10+ Nonstatutory Stock Option Agreement between the Registrant and Gordon Hutchins, Jr. dated May 15, 1996. 10.11+ Free Standing Commercial Building Lease between the Registrant and Thomas M. Spear, as receiver for De La Guerra Court Investments, dated for reference purposes as of March 1, 1996. 10.12+ Standard Office Lease--Gross between the Registrant and De La Guerra Partners, L.P. dated for reference purposes as of July 9, 1996. 10.13+ Office Lease between the Registrant and WHUB Real Estate Limited Partnership dated June 28, 1996, as amended. 10.14+ Standard Form of Office Lease between the Registrant and Hudson Telegraph Associates dated February 28, 1996. 10.15+ Agreement for Lease between the Registrant and Telehouse International Corporation of Europe Limited dated July 16, 1996. 10.16+ Sublease between the Registrant and Borton, Petrini & Conron dated March 20, 1994, as amended. 10.17+ Office Lease between the Registrant and One Wilshire Arcade Imperial, Ltd. dated June 28, 1996. 10.18+ Lease Agreement between the Registrant and Telecommunications Finance Group dated April 6, 1995.
98
SEQUENTIALLY EXHIBIT NUMBERED NO. EXHIBIT PAGE NUMBER - ------- ----------------------------------------------------------------------- 10.19+ Lease Agreement between the Registrant and Telecommunications Finance Group dated January 3, 1996, as amended. 10.20 Master Lease Agreement between the Registrant and NTFC Capital Corporation dated December 20, 1996. 10.21+ Variable Rate Installment Note between the Registrant and Metrobank dated October 4, 1996. 10.22+ Assignment of Purchase Order and Security Interest between the Registrant and DSC Finance Corporation dated January 1, 1996. 10.23 Line of Credit Promissory Note between the Registrant and Christopher E. Edgecomb dated November 7, 1996, as amended. 10.24 Office Lease Agreement between the Registrant and Beverly Hills Center LLC effective as of April 1, 1997. 10.25 Agreement between the Registrant and John Marsch dated March 1, 1997. 11.1 Computation of Loss Per Share. 21.1+ Subsidiary of the Registrant. 23.1 Consent of Arthur Andersen LLP, Independent Accountants. 23.2* Consent of Counsel. Reference is made to Exhibit 5.1. 24.1+ Power of Attorney (see page II-5). 27.1+ Financial Data Schedule.
- ------------------------------ * To be filed by amendment. + Previously filed. EX-3.1 2 CERTIFICATE OF INCORPORARTION 1 EXHIBIT 3.1 AMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF STAR TELECOMMUNICATIONS, INC., A DELAWARE CORPORATION STAR Telecommunications, Inc., a corporation organized and existing under the General Corporation Law of the State of Delaware (the "General Corporation Law") DOES HEREBY CERTIFY: FIRST: That this corporation was originally incorporated on September 13, 1996, pursuant to the General Corporation Law. SECOND: That the Board of Directors duly adopted resolutions proposing to amend and restate the Certificate of Incorporation of this corporation, declaring said amendment and restatement to be advisable and in the best interests of this corporation and its stockholders, and authorizing the appropriate officers of this corporation to solicit the consent of the stockholders therefor, which resolution setting forth the proposed amendment and restatement is as follows: "RESOLVED, that the Certificate of Incorporation of this corporation be amended and restated in its entirety as follows: ARTICLE I The name of this corporation is STAR Telecommunications, Inc. (the "Corporation"). ARTICLE II The address of the registered office of this corporation in the State of Delaware is 1209 Orange Street, in the City of Wilmington, County of New Castle. The name of its registered agent at such address is The Corporation Trust Company. ARTICLE III A. Classes of Stock. This Corporation is authorized to issue two classes of stock to be designated, respectively, "Common Stock" and "Preferred Stock." The total number of shares which this Corporation is authorized to issue is fifty-one million three hundred sixty-seven thousand fifty (51,367,050) shares. Fifty million (50,000,000) shares shall be Common Stock, par value of $0.001 per share, and one million three hundred sixty-seven thousand fifty (1,367,050) shares shall be Series A Preferred Stock, par value of $0.001 per share. B. Rights, Preferences and Restrictions of Preferred Stock. The rights, preferences, privileges, and restrictions granted to and imposed on the Series A Preferred Stock (the "Series A Preferred Stock") are as follows: 2 1. Distributions. The holders of shares of Series A Preferred Stock shall be entitled to receive dividends, out of any assets legally available therefor, prior and in preference to any declaration or payment of any distribution (but excluding any dividends payable in Common Stock or other securities and rights convertible into or entitling the holder thereof to receive, directly or indirectly, additional shares of Common Stock of this Corporation) on the Common Stock of this Corporation, at the rate of $0.3267 per share per annum, payable only when and if declared by the Board of Directors. Such dividends shall not be cumulative and no right shall accrue to the holders of Series A Preferred Stock by reason of the fact that dividends on such shares are not declared in any year, nor shall any undeclared dividends bear or accrue interest. After payment of any such dividends, any additional dividends or distributions shall be distributed among all holders of Common Stock and all holders of Series A Preferred Stock in proportion to the number of shares of Common Stock which would be held by each such holder if all shares of Series A Preferred Stock were converted to Common Stock at the then effective conversion rate. 2. Liquidation Preference. (a) In the event of any liquidation, dissolution, or winding up of this Corporation, either voluntary of involuntary, the holders of Series A Preferred Stock shall be entitled to receive, prior and in preference to any distribution of any of the assets of this Corporation to the holders of Common Stock by reason of their ownership thereof, an amount per share equal to $5.4863 for each outstanding share of Series A Preferred Stock (the "Original Series A Issue Price"), plus any declared but unpaid dividends on such share (such amount of declared but unpaid dividends being referred to herein as the "Premium"). If upon the occurrence of such event, the assets and funds thus distributed among the holders of the Series A Preferred Stock shall be insufficient to permit the payment to such holders of the full aforesaid preferential amounts, then the entire assets and funds of this Corporation legally available for distribution shall be distributed ratably among the holders of the Series A Preferred Stock in proportion to the amount of such stock owned by each such holder. (b) Upon the completion of the distribution required by subparagraph (a) of this Section 2, the remaining assets of this Corporation available for distribution to stockholders shall be distributed among the holders of Common Stock pro rata based on the number of shares of Common Stock held by each. (c) A consolidation or merger of this Corporation (a "Merger") with or into any other corporations (other than a wholly owned subsidiary corporation) wherein the stockholders of the Company immediately before such merger or consolidation do not retain in substantially the same proportions as their ownership of shares of the Company's voting stock immediately before such event, directly or indirectly (including, without limitation, through their ownership of shares of the voting stock of a corporation which, as a result of such merger or consolidation, owns this Corporation either directly or through one or more subsidiaries), at least a majority of the beneficial interest in the voting stock of this Corporation immediately after such 3 merger or consolidation; or a sale, conveyance, or other disposition of all or substantially all of this Corporation's property or business, shall be deemed to be a liquidation, dissolution, or winding up within the meaning of this Section 2. In any of such events, if the consideration received by this Corporation is other than in cash or indebtedness, its value will be deemed to be its fair market value. In the case of publicly traded securities, fair market value shall mean the average closing market price for such securities for the thirty (30) consecutive trading days ending three (3) business days prior to such consolidation, merger, or sale is consummated. If such considerations is in a form other than publicly traded securities, its fair market value shall be determined in good faith by the Board of Directors of this Corporation. 3. Redemption. The Series A Preferred Stock is not redeemable. 4. Conversion. The holders of the Series A Preferred Stock shall have conversion rights as follows (the "Conversion Rights"): (a) Right to Convert. Subject to subsections 4(d), 4(e) and 4(f) hereof: each share of Series A Preferred Stock shall be convertible, at the option of the holder thereof, at any time after the date of issuance of such share, at the office of this Corporation or any transfer agent for such stock, into one share of Common Stock, such share being fully paid and nonassessable. (b) Automatic Conversion. Subject to subsections 4(d), 4(e) and 4(f) hereof: each share of Series A Preferred Stock shall automatically be converted into one share of Common Stock immediately upon the earlier of (i) the Corporation's sale of its Common Stock in a firm commitment underwritten public offering pursuant to a registration statement on Form S-1 under the Securities Act of 1933, as amended, the public per share offering price of which would value the Company's total pre-offering capitalization (on a fully-diluted basis) at $150,000,000 or more, and where aggregate proceeds to the Company are at least $10,000,000 (a "Public Offering"), or (ii) the date specified by written consent or agreement of the holders of a majority of the then outstanding shares of Series A Preferred Stock. (c) Mechanics of Conversion. Before any holder of Series A Preferred Stock shall be entitled to convert the same into shares of Common Stock, it shall surrender the certificate or certificates therefor, duly endorsed, at the office of this Corporation or of any transfer agent for the Series A Preferred Stock, and shall give written notice to this Corporation at its principal corporate office, of the election to convert the same and shall state therein the name or names in which the certificate or certificates for shares of Common Stock are to be issued. This Corporation shall, as soon as practicable thereafter, issue and deliver at such office to such holder of Series A Preferred Stock, or the nominee or nominees of such holder, a certificate or certificates for the number of shares of Common Stock to which such holder shall be entitled as aforesaid. Such conversion shall be deemed to have been made immediately prior to the close of business on the date of such surrender of the shares Series A Preferred Stock to be converted, and the person or persons entitled to receive the shares of Common Stock issuable upon such conversion shall be treated for all purposes as the record holder or holders of such shares of Common Stock as of such date. If the conversion is in connection with a Merger or an underwritten offering of securities registered pursuant to the Securities Act of 1933, the conversion may, at the option of any holder tendering Series A Preferred Stock for conversion, be 4 conditioned upon the closing of the Merger or with the underwriters of the sale of securities pursuant to such offering, in which event the person(s) entitled to receive the Common Stock upon conversion of the Series A Preferred Stock shall not be deemed to have converted such Series A Preferred Stock until immediately prior to the closing of such sale of securities. (d) Adjustment for Combinations or Subdivisions of Common Stock. In the event this Corporation at any time or from time to time effects a subdivision or combination of its outstanding Common Stock into a greater or lesser number of shares, then and in each such event the respective conversion rate for the Series A Preferred Stock shall be increased or decreased proportionately. (e) Other Distributions. In the event this Corporation shall declare a distribution payable in securities of other persons, evidences of indebtedness issued by this Corporation or other persons, assets (excluding cash dividends), then, in each case for the purpose of this subsection 4(e), the holders of the Series A Preferred Stock shall be entitled to a proportionate share of any such distribution as though they were the holders of the number of shares of Common Stock of this Corporation into which their shares of Series A Preferred Stock are convertible as of the record date fixed for the determination of the holders of Common Stock of this Corporation entitled to receive such distribution. (f) Recapitalizations. If at any time or from time to time there shall be a recapitalization of the Common Stock (other than a subdivision, combination or merger or sale of assets transaction provided for elsewhere in this Section 4 or Section 2) provision shall be made so that the holders of the Series A Preferred Stock shall thereafter be entitled to receive upon conversion of the Series A Preferred Stock the number of shares of stock or other securities or property of this Corporation or otherwise, to which a holder of the number of shares of Common Stock deliverable upon conversion of such shares of Preferred Stock would have been entitled on such recapitalization. In any such case, appropriate adjustment shall be made in the application of the provisions of this Section 4 with respect to the rights of the holders of the Series A Preferred Stock after the recapitalization to the end that the provisions of this Section 4 shall be applicable after that event as nearly equivalent as may be practicable. (g) No Impairment. This Corporation will not, by amendment of its Articles of Incorporation or through any reorganization, recapitalization, transfer of assets, consolidation, merger, dissolution, issue or sale of securities or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms to be observed or performed hereunder by this Corporation, but will at all times in good faith assist in the carrying out of all the provisions of this Section 4 and in the taking of all such actions as may be necessary or appropriate in order to protect the Conversion Rights of the holders of the Series A Preferred Stock against impairment. (h) No Fractional Shares and Certificate as to Adjustments. (i) No fractional shares shall be issued upon the conversion of any share or shares of the Series A Preferred Stock, and the number of shares of Common Stock to be issued shall be rounded to the nearest whole share. Whether or not fractional shares are issuable 5 upon such conversion shall be determined on the basis of the total number of shares of Series A Preferred Stock the holder is at the time converting into Common Stock and the number of shares of Common Stock issuable upon such aggregate conversion. (ii) Upon the occurrence of each adjustment or readjustment of the Conversion Price of Series A Preferred Stock pursuant to this Section 4, this Corporation, at its expense, shall promptly compute such adjustment or readjustment in accordance with the terms hereof and prepare and furnish to each holder of Series A Preferred Stock a certificate setting forth such adjustment or readjustment and showing in detail the facts upon which such adjustment or readjustment is based. This Corporation shall, upon the written request at any time of any holder of Series A Preferred Stock, furnish or cause to be furnished to such holder a like certificate setting forth (a) such adjustment and readjustment, (b) the conversion rate then in effect, and (c) the number of shares of Common Stock and the amount, if any, of other property which at the time would be received upon the conversion of a share of Series A Preferred Stock. (i) Notice of Record Date. In the event of any taking by this Corporation of a record of the holders of any class of securities for the purposes of determining the holders thereof who are entitled to receive any dividend (other than a cash dividend) or other distribution, any right to subscriber for, purchase or otherwise acquire any shares of stock of any class or any other securities or property, or to receive any other right, this Corporation shall mail to each holder of Series A Preferred Stock, at least 20 days prior to the date specified therein, a notice specifying the date on which any such record is to be taken for the purpose of such dividend, distribution or right, and the amount and character of such dividend, distribution or right. (j) Reservation of Stock Issuable Upon Conversion. This Corporation shall at all times reserve and keep available out of its authorized but unissued shares of Common Stock, solely for the purpose of effecting the conversion of the shares of Series A Preferred Stock, such number of its shares of Common Stock as shall from time to time be sufficient to effect the conversion of all outstanding shares of the Series A Preferred Stock; and if any at any time the number of authorized but unissued shares of Common Stock shall not be sufficient to effect the conversion of all then outstanding shares of the Series A Preferred Stock, in addition to such other remedies as shall be available to the holder of such Preferred Stock, this Corporation will take such corporate action as may, in the opinion of its counsel, be necessary to increase its authorized but unissued shares of Common Stock to such number of shares as shall be sufficient for such purposes, including, without limitation, engaging in best efforts to obtain the requisite shareholder approval of any necessary amendment to these articles. (k) Notices. Any notice required by the provisions of this Section 4 to be given to the holders of shares of Series A Preferred Stock shall be deemed given three (3) days after deposited in the United States mail, postage prepaid, and addressed to each holder or record at his address appearing on the books of this Corporation. 5. Voting Rights. (a) The holder of each share of Series A Preferred Stock shall have the right to one vote for each share of Common Stock into which such Series A Preferred Stock could then 6 be converted (with any fractional share determined on an aggregate conversion basis being rounded to the nearest whole share), and with respect to such vote, such holder shall have full voting rights and powers equal to the voting rights and powers of the holders of Common Stock, and shall be entitled, notwithstanding any provision hereof, to notice of any stockholders' meeting in accordance with the Bylaws of this Corporation, and shall be entitled to vote, together with holders of Common Stock, with respect to any question upon which holders of Common Stock have the right to vote. (b) At each annual or other election of Directors, the holders a majority of the then outstanding shares of Series A Preferred Stock, voting together as a single class, shall be entitled to elect one (1) director of this Corporation. Such director may be removed only with the written consent of the holders of a majority of the then outstanding shares of Series A Preferred Stock, voting together as a single class. Any vacancy occurring because of the death, resignation, or removal of a director elected by the holders of Series A Preferred Stock shall be filled by the vote or written consent of the holders of a majority of the then outstanding shares of Series A Preferred Stock. 6. Protective Provisions. So long as at least 683,525 shares of Series A Preferred Stock are outstanding (subject to stock splits, combinations or recapitalizations), this Corporation shall not without first obtaining the approval (by vote or written consent, as provided by law) of the holders of at least a majority of the then outstanding shares of Series A Preferred Stock, voting as a separate class: (a) sell, convey, or otherwise dispose of or encumber all or substantially all of its property or business ("Sale of Assets") or effect or consummate a Merger; provided however, that no such prior approval shall be required if the consideration received in such Sale of Assets or Merger reflects a total valuation exceeding $150,000,000; or (b) alter or change the rights, preferences, or privileges of the Series A Preferred Stock or increase the authorized number of shares thereof; or (c) create any new class or series of stock or any other securities convertible into equity securities of this Corporation senior to the Series A Preferred Stock with respect to conversion, redemption, distributions, voting rights, or liquidation; or (d) voluntarily dissolve or liquidate this Corporation; or (e) apply any of its assets to the assumption, retirement, purchase or acquisition, directly or indirectly, of any shares of any class or series of this Corporation's stock, except from employees and directors upon termination of employment or services pursuant to repurchase rights set forth in repurchase agreements. 7. Status of Converted Stock. In the event any shares of Series A Preferred Stock shall be converted pursuant to Section 4 hereof, the shares so converted shall be canceled, and shall not be issuable by this Corporation. The Certificate of Incorporation of this Corporation shall be appropriately amended to effect the corresponding reduction in this Corporation's 7 authorized capital stock. C. Common Stock. 1. Dividend Rights. Subject to the prior rights of holders of all classes of stock at the time outstanding having prior rights as to dividends, the holders of the Common Stock shall be entitled to receive, when and as declared by the Board of Directors, out of any assets of this Corporation legally available therefor, such dividends as may be declared from time to time by the Board of Directors. 2. Liquidation Rights. Upon the liquidation, dissolution, or winding up of this Corporation, the assets of this Corporation shall be distributed as provided in subsection 2(b) of this Article III hereof. 3. Redemption. The Common Stock is not redeemable. 4. Voting Rights. The holder of each share of Common Stock shall have the right to one vote, and shall be entitled to notice of any stockholders' meeting in accordance with the Bylaws of this Corporation, and shall be entitled to vote upon such matters and in such manner as may be provided by law. ARTICLE IV Except as otherwise provided in this Amended and Restated Certificate of Incorporation, in furtherance and not in limitation of the powers conferred by statute, the Board of Directors is expressly authorized to make, repeal, alter, amend and rescind any or all of the Bylaws of this corporation. Any adoption, amendment or repeal of Bylaws of the Corporation by the Board of Directors shall require the approval of a majority of the total number of authorized directors (whether or not there exist any vacancies in previously authorized directorships at the time any resolution providing for adoption, amendment or repeal is presented to the Board). The stockholders shall also have power to adopt, amend or repeal the Bylaws of the Corporation. Any adoption, amendment or repeal of Bylaws of the Corporation by the stockholders shall require, in addition to any vote of the holders of any class or series of stock of this Corporation required by law or by this Certificate of Incorporation, the affirmative vote of the holders of at least a majority of the voting power of all of the then outstanding shares of the capital stock of the Corporation entitled to vote generally in the election of directors, voting together as a single class; provided, however, that following the closing of the Corporation's initial public offering pursuant to an effective registration statement under the Securities Act of 1933, as amended (the "1933 Act"), covering the offer and sale of Common Stock of the Corporation (the "Initial Public Offering"), any such adoption, amendment or repeal of Bylaws of the Corporation by the stockholders shall require, in addition to any vote of the holders of any class or series of stock of this Corporation required by law or by this Certificate of Incorporation, the affirmative vote of the holders of at least seventy-five percent (75%) of the voting power of all of the then outstanding shares of the capital stock of the Corporation entitled to vote generally in the election of directors, voting together as a single class. 8 ARTICLE V The number of directors of the corporation shall be fixed from time to time by a Bylaw or amendment thereof duly adopted by the Board of Directors. Except as provided by applicable law and the Protective Provisions, the Board of Directors shall have the exclusive power and authority to fill any vacancies or an newly created directorships on the Board of Directors and the stockholders shall have no right to fill such vacancies. A director appointed by the Board of Directors to fill a vacancy shall serve for the remainder of the term of the vacated directorship he is filling. Following the closing of the Corporation's initial public offering pursuant to an effective registration statement under the Securities Act of 1933, as amended (the "1933 Act"), covering the offer and sale of Common Stock of the corporation (the "Initial Public Offering"), the directors shall be divided into three classes, as nearly equal in number as reasonably possible, with the term of office of the first class to expire at the 1998 annual meeting of stockholders, the term of office of the second class to expire at the 1999 annual meeting of stockholders and the term of office of the third class to expire at the 2000 annual meeting of stockholders. At each annual meeting of stockholders following such initial classification and election, directors elected to succeed those directors whose terms expire shall be elected for a term of office to expire at the third succeeding annual meeting of stockholders after their election. The foregoing notwithstanding, each director shall serve until his successor shall have been duly elected and qualified, unless he shall resign, become disqualified, disabled or shall otherwise be removed. At each annual election, directors chosen to succeed those whose terms then expire shall be of the same class as the directors they succeed, unless by reason of any intervening changes in the authorized number of directors, the Board shall designate one or more directorships whose term then expires as directorships of another class in order more nearly to achieve equality of number of directors among the classes. Notwithstanding the rule that the three classes shall be as nearly equal in number of directors as possible, in the event of any change in the authorized number of directors each director then continuing to serve as such shall nevertheless continue as a director of the class of which he is a member until the expiration of his current term, or his prior death, resignation or removal. If any newly created directorship may, consistently with the rule that the three classes shall be as nearly equal in number of directors as possible, be allocated to either class, the Board shall allocate it to that of the available class whose term of office is due to expire at the earliest date following such allocation. ARTICLE VI Elections of directors need not be by written ballot unless the Bylaws of this corporation shall so provide. ARTICLE VII Following the closing of the Corporation's Initial Public Offering, and except as 9 otherwise provided in this Certificate of Incorporation, any action required or permitted to be taken by the stockholders of the Corporation must be effected at an annual or special meeting of the stockholders of the Corporation, and no action required to be taken or that may be taken at any annual or special meeting of the stockholders of the Corporation may be taken without a meeting except by the unanimous written consent of all stockholders entitled to vote on such action, and the power of stockholders to consent in writing to the taking of any action by less than unanimous consent of all such stockholders is specifically denied. ARTICLE VIII A director of this corporation shall not be personally liable to this corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, except for liability (i) for any breach of the director's duty of loyalty to this corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the General Corporation Law, or (iv) for any transaction from which the director derived any improper personal benefit. If the General Corporation Law is amended after approval by the stockholders of this Article to authorize corporation action further eliminating or limiting the personal liability of directors, then the liability of a director of this corporation shall be eliminated or limited to the fullest extent permitted by the General Corporation Law, as so amended. Any repeal or modification of the foregoing paragraph by the stockholders of this corporation shall not adversely affect any right or protection of a director of this corporation existing at the time of such repeal or modification. ARTICLE IX In addition to any vote of the holders of any class or series of the stock of this Corporation required by law or by this Certificate of Incorporation, the affirmative vote of the holders of a majority of the voting power of all of the then outstanding shares of capital stock of the Corporation entitled to vote generally in the election of directors, voting together as a single class, shall be required to amend or repeal the provisions of ARTICLE I, ARTICLE II, and ARTICLE III of this Certificate of Incorporation. Notwithstanding any other provision of this Certificate of Incorporation or any provision of law which might otherwise permit a lesser vote or no vote, but in addition to any vote of the holders of any class or series of the stock of this Corporation required by law or by this Certificate of Incorporation, following the closing of the Corporation's Initial Public Offering, the affirmative vote of the holders of at least seventy-five percent (75%) of the voting power of all of the then outstanding shares of the capital stock of the Corporation entitled to vote generally in the election of directors, voting together as a single class, shall be required to amend or repeal any provision of this Certificate of Incorporation not specified in the preceding sentence. ARTICLE X The nature of the business and, the objects and purposes proposed to be 10 transacted, promoted and carried on, are to do any or all the things herein mentioned, as fully and to the same extent as natural persons might or could do, and in any part of the world, viz: The purpose of the corporation is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of Delaware. * * * THIRD: That thereafter said amendment and restatement was duly adopted in accordance with the provisions of Section 242 and Section 245 of the General Corporation Law by obtaining a majority vote of each of the Common Stock and Preferred Stock, in favor of said amendment and restatement. 11 IN WITNESS WHEREOF, the undersigned has signed this Certificate this 20th day of February, 1997. Christopher E. Edgecomb Chief Executive Officer 12 CERTIFICATE OF AMENDMENT OF THE AMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF STAR TELECOMMUNICATIONS, INC. STAR Telecommunications, Inc., a corporation organized and existing under and by virtue of the General Corporation Law of the State of Delaware (the "Corporation"), DOES HEREBY CERTIFY: FIRST: The name of the Corporation is STAR Telecommunications, Inc. SECOND: The date on which the Certificate of Incorporation of the Corporation was originally filed with the Secretary of State of the State of Delaware is September 13, 1996, under the name of STAR Telecommunications, Inc. THIRD: That by written consent of the Board of Directors of the Corporation, resolutions setting forth proposed amendments to the Amended and Restated Certificate of Incorporation of the Corporation were duly adopted, declaring said amendments to be advisable and in the best interests of the Corporation, and authorizing the appropriate officers of the Corporation to solicit the consent of the stockholders of the Corporation therefor, which resolutions setting forth the proposed amendments are as follows: RESOLVED, that Article III, Paragraph A of the Amended and Restated Certificate of Incorporation of the Corporation be amended to read in full as follows: "ARTICLE III A. Classes of Stock. This Corporation is authorized to issue two classes of stock to be designated, respectively, "Common Stock" and "Preferred Stock." The total number of shares which this Corporation is authorized to issue is thirty-one million three hundred sixty-seven thousand fifty (31,367,050) shares. Thirty million (30,000,000) shares shall be Common Stock, par value of $0.001 per share, and one million three hundred sixty-seven thousand fifty (1,367,050) shares shall be Series A Preferred Stock, par value of $0.001 per share. Upon the filing of this Certificate of Amendment of the Amended and Restated Certificate of Incorporation, each issued and outstanding share of Common Stock shall be automatically combined and reconstituted as two-thirds (2/3) of a share of Common Stock. No fractional shares shall be issued. In lieu thereof, the holder of any fractional shares resulting from the stock split (after aggregating all fractional shares to which any one stockholder shall be entitled) shall be entitled to an amount of cash equal to the product of such fraction multiplied by the Common Stock's fair market value (as determined by the Corporation's Board of Directors) 13 on the date of conversion." RESOLVED FURTHER, that Article III, Paragraph B(4)(h)(i) of the Corporation's Amended and Restated Certificate of Incorporation of the Corporation be amended to read in full as follows: "(h) No Fractional Shares and Certificate as to Adjustments. (i) No fractional shares shall be issued upon the conversion of any share or shares of the Series A Preferred Stock. All shares of Common Stock (including fractions thereof) issuable upon conversion of shares of Series A Preferred Stock by a stockholder thereof shall be aggregated with all other fractional shares to which such stockholder is entitled for purposes of determining whether the conversion would result in the issuance of any fractional shares. If after the aforementioned aggregation, the conversion would result in the issuance of any fractional shares, this Corporation shall, in lieu of issuing any fractional shares, pay cash for such fractional share equal to the product of such fraction multiplied by the Common Stock's fair market value (as determined by the Corporation's Board of Directors) on the date of conversion." FOURTH: That thereafter said amendment was duly adopted in accordance with the provisions of Section 242 of the General Corporation Law by the written consent of the Corporation's Board of Directors. FIFTH: The foregoing amendment was approved by the holders of the requisite number of shares of the Corporation in accordance with Section 228 of the General Corporation Law. 14 IN WITNESS WHEREOF, STAR Telecommunications, Inc., has caused this Certificate of Amendment of the Amended and Restated Certificate of Incorporation to be signed by its Chief Executive Officer and attested to by its Secretary this ________ day of May, 1997. STAR TELECOMMUNICATIONS, INC. Christopher E. Edgecomb Chief Executive Officer Mary A. Casey Secretary EX-10.4 3 1997 OMNIBUS STOCK INCENTIVE PLAN 1 EXHIBIT 10.4 1997 OMNIBUS STOCK INCENTIVE PLAN OF STAR TELECOMMUNICATIONS, INC. (ADOPTED _____________, 1997) 2 1997 OMNIBUS STOCK INCENTIVE PLAN OF STAR TELECOMMUNICATIONS, INC. 1. ARTICLE 1. INTRODUCTION The Plan was adopted by the Board on __________, 1997, subject to approval by the Company's stockholders. The Plan is effective as of the date of the Company's initial public offering. The purpose of the Plan is to promote the long-term success of the Company and the creation of stockholder value by (a) encouraging Employees, Outside Directors and Consultants to focus on critical long-range objectives, (b) encouraging the attraction and retention of Employees, Outside Directors and Consultants with exceptional qualifications and (c) linking Employees, Outside Directors and Consultants directly to stockholder interests through increased stock ownership. The Plan seeks to achieve this purpose by providing for Awards in the form of Restricted Shares, Stock Units, Options (which may constitute incentive stock options or nonstatutory stock options) or stock appreciation rights. The Plan shall be governed by, and construed in accordance with, the laws of the State of Delaware (except their choice-of-law provisions). 2. ARTICLE 2. ADMINISTRATION 2.1. Committee Composition. The Plan shall be administered by the Committee. The Committee shall consist exclusively of two or more directors of the Company, who shall be appointed by the Board. In addition, the composition of the Committee shall satisfy: (a) Such requirements as the Securities and Exchange Commission may establish for administrators acting under plans intended to qualify for exemption under Rule 16b-3 (or its successor) under the Exchange Act; and (b) Such requirements as the Internal Revenue Service may establish for outside directors acting under plans intended to qualify for exemption under section 162(m)(4)(C) of the Code. The Board may also appoint one or more separate committees of the Board, each composed of one or more directors of the Company who need not satisfy the foregoing requirements, who may administer the Plan with respect to Employees and Consultants who are not considered officers or directors of the Company under section 16 of the Exchange Act, may grant Awards under the Plan to such Employees and Consultants and may determine all terms of such Awards. 2.2. Committee Responsibilities. The Committee shall (a) select the Employees, Outside Directors and Consultants who are to receive Awards under the Plan, 3 (b) determine the type, number, vesting requirements and other features and conditions of such Awards, (c) interpret the Plan and (d) make all other decisions relating to the operation of the Plan. The Committee may adopt such rules or guidelines as it deems appropriate to implement the Plan. The Committee's determinations under the Plan shall be final and binding on all persons. ARTICLE 3. SHARES AVAILABLE FOR GRANTS 3.1. Basic Limitation. Common Shares issued pursuant to the Plan may be authorized but unissued shares or treasury shares. The aggregate number of Restricted Shares, Stock Units, Options and SARs awarded under the Plan shall not exceed the sum of (i) 750,000 shares, plus (ii) that number of shares available for issuance under the Supplemental Option Plan from time to time, less those shares actually issued or reserved for issuance upon the exercise of options awarded under the Supplemental Option Plan. The limitation of this Section 3.1 shall be subject to adjustment pursuant to Article 10. 3.2. Additional Shares. If Stock Units, Options or SARs are forfeited or if Options or SARs terminate for any other reason before being exercised, then the corresponding Common Shares shall again become available for Awards under the Plan. If Stock Units are settled, then only the number of Common Shares (if any) actually issued in settlement of such Stock Units shall reduce the number available under Section 3.1 and the balance shall again become available for Awards under the Plan. If SARs are exercised, then only the number of Common Shares (if any) actually issued in settlement of such SARs shall reduce the number available under Section 3.1 and the balance shall again become available for Awards under the Plan. If Restricted Shares are forfeited, then such Shares shall not become available for subsequent Awards under the Plan. 3.3. Dividend Equivalents. Any dividend equivalents distributed under the Plan shall not be applied against the number of Restricted Shares, Stock Units, Options or SARs available for Awards, whether or not such dividend equivalents are converted into Stock Units. ARTICLE 4. ELIGIBILITY 4.1. General Rules. Only Employees, Outside Directors and Consultants shall be eligible for designation as Participants by the Committee. 4.2. Incentive Stock Options. Only Employees shall be eligible for the grant of ISOs. In addition, an Employee who owns more than 10% of the total combined voting power of all classes of outstanding stock of the Company or any of its Parents or Subsidiaries shall not be eligible for the grant of an ISO unless the requirements set forth in section 422(c)(6) of the Code are satisfied. ARTICLE 5. OPTIONS 5.1. Stock Option Agreement. Each grant of an Option under the Plan shall be evidenced by a Stock Option Agreement between the Optionee and the Company. Such 2 4 Option shall be subject to all applicable terms of the Plan and may be subject to any other terms that are not inconsistent with the Plan. The Stock Option Agreement shall specify whether the Option is an ISO or an NSO. The provisions of the various Stock Option Agreements entered into under the Plan need not be identical. Options may be granted in consideration of a cash payment or in consideration of a reduction in the Optionee's other compensation. A Stock Option Agreement may provide that a new Option will be granted automatically to the Optionee when he or she exercises a prior Option and pays the Exercise Price in the form described in Section 6.2. 5.2. Number of Shares. Each Stock Option Agreement shall specify the number of Common Shares subject to the Option and shall provide for the adjustment of such number in accordance with Article 10. Options granted to any Optionee in a single calendar year shall in no event cover more than 750,000 Common Shares, subject to adjustment in accordance with Article 10. 5.3. Exercise Price. Each Stock Option Agreement shall specify the Exercise Price; provided that the Exercise Price under an ISO shall in no event be less than 100% of the Fair Market Value of a Common Share on the date of grant and the Exercise Price under an NSO shall in no event be less than the par value of the Common Shares subject to such NSO. In the case of an NSO, a Stock Option Agreement may specify an Exercise Price that varies in accordance with a predetermined formula while the NSO is outstanding. 5.4. Exercisability and Term. Each Stock Option Agreement shall specify the date when all or any installment of the Option is to become exercisable. The Stock Option Agreement shall also specify the term of the Option; provided that the term of an ISO shall in no event exceed 10 years from the date of grant. A Stock Option Agreement may provide for accelerated exercisability in the event of the Optionee's death, disability or retirement or other events and may provide for expiration prior to the end of its term in the event of the termination of the Optionee's service. Options may be awarded in combination with SARs, and such an Award may provide that the Options will not be exercisable unless the related SARs are forfeited. NSOs may also be awarded in combination with Restricted Shares or Stock Units, and such an Award may provide that the NSOs will not be exercisable unless the related Restricted Shares or Stock Units are forfeited. 5.5. Effect of Change in Control. The Committee may determine, at the time of granting an Option or thereafter, that such Option shall become fully exercisable as to all Common Shares subject to such Option in the event that a Change in Control occurs with respect to the Company. 5.6. Modification or Assumption of Options. Within the limitations of the Plan, the Committee may modify, extend or assume outstanding options or may accept the cancellation of outstanding options (whether granted by the Company or by another issuer) in return for the grant of new options for the same or a different number of shares and at the same or a different exercise price. The foregoing notwithstanding, no modification of an Option shall, 3 5 without the consent of the Optionee, alter or impair his or her rights or obligations under such Option. ARTICLE 6. PAYMENT FOR OPTION SHARES 6.1. General Rule. The entire Exercise Price of Common Shares issued upon exercise of Options shall be payable in cash at the time when such Common Shares are purchased, except as follows: (a) In the case of an ISO granted under the Plan, payment shall be made only pursuant to the express provisions of the applicable Stock Option Agreement. The Stock Option Agreement may specify that payment may be made in any form(s) described in this Article 6. (b) In the case of an NSO, the Committee may at any time accept payment in any form(s) described in this Article 6. 6.2. Surrender of Stock. To the extent that this Section 6.2 is applicable, payment for all or any part of the Exercise Price may be made with Common Shares which are already owned by the Optionee. Such Common Shares shall be valued at their Fair Market Value on the date when the new Common Shares are purchased under the Plan. The Optionee shall not surrender Common Shares in payment of the Exercise Price if such surrender would cause the Company to recognize compensation expense with respect to the Option for financial reporting purposes. 6.3. Exercise/Sale. To the extent that this Section 6.3 is applicable, payment may be made by the delivery (on a form prescribed by the Company) of an irrevocable direction to a securities broker approved by the Company to sell Common Shares and to deliver all or part of the sales proceeds to the Company in payment of all or part of the Exercise Price and any withholding taxes. 6.4. Exercise/Pledge. To the extent that this Section 6.4 is applicable, payment may be made by the delivery (on a form prescribed by the Company) of an irrevocable direction to pledge Common Shares to a securities broker or lender approved by the Company, as security for a loan, and to deliver all or part of the loan proceeds to the Company in payment of all or part of the Exercise Price and any withholding taxes. 6.5. Promissory Note. To the extent that this Section 6.5 is applicable, payment may be made with a full-recourse promissory note; provided that the par value of the Common Shares shall be paid in cash. 6 .6. Other Forms of Payment. To the extent that this Section 6.6 is applicable, payment may be made in any other form that is consistent with applicable laws, regulations and rules. 4 6 ARTICLE 7. STOCK APPRECIATION RIGHTS 7.1. SAR Agreement. Each grant of an SAR under the Plan shall be evidenced by an SAR Agreement between the Optionee and the Company. Such SAR shall be subject to all applicable terms of the Plan and may be subject to any other terms that are not inconsistent with the Plan. The provisions of the various SAR Agreements entered into under the Plan need not be identical. SARs may be granted in consideration of a reduction in the Optionee's other compensation. 7.2. Number of Shares. Each SAR Agreement shall specify the number of Common Shares to which the SAR pertains and shall provide for the adjustment of such number in accordance with Article 10. SARs granted to any Optionee in a single calendar year shall in no event pertain to more than 750,000 Common Shares, subject to adjustment in accordance with Article 10. 7.3. Exercise Price. Each SAR Agreement shall specify the Exercise Price. An SAR Agreement may specify an Exercise Price that varies in accordance with a predetermined formula while the SAR is outstanding. 7.4. Exercisability and Term. Each SAR Agreement shall specify the date when all or any installment of the SAR is to become exercisable. The SAR Agreement shall also specify the term of the SAR. An SAR Agreement may provide for accelerated exercisability in the event of the Optionee's death, disability or retirement or other events and may provide for expiration prior to the end of its term in the event of the termination of the Optionee's service. SARs may also be awarded in combination with Options, Restricted Shares or Stock Units, and such an Award may provide that the SARs will not be exercisable unless the related Options, Restricted Shares or Stock Units are forfeited. An SAR may be included in an ISO only at the time of grant but may be included in an NSO at the time of grant or thereafter. An SAR granted under the Plan may provide that it will be exercisable only in the event of a Change in Control. 7.5. Effect of Change in Control. The Committee may determine, at the time of granting an SAR or thereafter, that such SAR shall become fully exercisable as to all Common Shares subject to such SAR in the event that a Change in Control occurs with respect to the Company. 7.6. Exercise of SARs. If, on the date when an SAR expires, the Exercise Price under such SAR is less than the Fair Market Value on such date but any portion of such SAR has not been exercised or surrendered, then such SAR shall automatically be deemed to be exercised as of such date with respect to such portion. Upon exercise of an SAR, the Optionee (or any person having the right to exercise the SAR after his or her death) shall receive from the Company (a) Common Shares, (b) cash or (c) a combination of Common Shares and cash, as the Committee shall determine. The amount of cash and/or the Fair Market Value of Common Shares received upon exercise of SARs shall, in the aggregate, be equal to the amount by which the Fair Market Value (on the date of surrender) of the Common Shares subject to the SARs exceeds the Exercise Price. 5 7 7.7. Modification or Assumption of SARs. Within the limitations of the Plan, the Committee may modify, extend or assume outstanding SARs or may accept the cancellation of outstanding SARs (whether granted by the Company or by another issuer) in return for the grant of new SARs for the same or a different number of shares and at the same or a different exercise price. The foregoing notwithstanding, no modification of an SAR shall, without the consent of the Optionee, alter or impair his or her rights or obligations under such SAR. ARTICLE 8. RESTRICTED SHARES AND STOCK UNITS 8.1. Time, Amount and Form of Awards. Awards under the Plan may be granted in the form of Restricted Shares, in the form of Stock Units, or in any combination of both. Restricted Shares or Stock Units may also be awarded in combination with NSOs or SARs, and such an Award may provide that the Restricted Shares or Stock Units will be forfeited in the event that the related NSOs or SARs are exercised. 8.2. Payment for Awards. To the extent that an Award is granted in the form of newly issued Restricted Shares, the Award recipient, as a condition to the grant of such Award, shall be required to pay the Company in cash an amount equal to the par value of such Restricted Shares. To the extent that an Award is granted in the form of Restricted Shares from the Company's treasury or in the form of Stock Units, no cash consideration shall be required of the Award recipients. 8.3. Vesting Conditions. Each Award of Restricted Shares or Stock Units shall become vested, in full or in installments, upon satisfaction of the conditions specified in the Stock Award Agreement. A Stock Award Agreement may provide for accelerated vesting in the event of the Participant's death, disability or retirement or other events. The Committee may determine, at the time of making an Award or thereafter, that such Award shall become fully vested in the event that a Change in Control occurs with respect to the Company. 8.4. Form and Time of Settlement of Stock Units. Settlement of vested Stock Units may be made in the form of (a) cash, (b) Common Shares or (c) any combination of both, as determined by the Committee. The actual number of Stock Units eligible for settlement may be larger or smaller than the number included in the original Award, based on predetermined performance factors. Methods of converting Stock Units into cash may include (without limitation) a method based on the average Fair Market Value of Common Shares over a series of trading days. Vested Stock Units may be settled in a lump sum or in installments. The distribution may occur or commence when all vesting conditions applicable to the Stock Units have been satisfied or have lapsed, or it may be deferred to any later date. The amount of a deferred distribution may be increased by an interest factor or by dividend equivalents. Until an Award of Stock Units is settled, the number of such Stock Units shall be subject to adjustment pursuant to Article 10. 8.5. Death of Recipient. Any Stock Units Award that becomes payable after the recipient's death shall be distributed to the recipient's beneficiary or beneficiaries. Each recipient of a Stock Units Award under the Plan shall designate one or more beneficiaries for this purpose by filing the prescribed form with the Company. A beneficiary designation may be 6 8 changed by filing the prescribed form with the Company at any time before the Award recipient's death. If no beneficiary was designated or if no designated beneficiary survives the Award recipient, then any Stock Units Award that becomes payable after the recipient's death shall be distributed to the recipient's estate. 8.6 Creditors' Rights. A holder of Stock Units shall have no rights other than those of a general creditor of the Company. Stock Units represent an unfunded and unsecured obligation of the Company, subject to the terms and conditions of the applicable Stock Award Agreement. ARTICLE 9. VOTING AND DIVIDEND RIGHTS 9.1. Restricted Shares. The holders of Restricted Shares awarded under the Plan shall have the same voting, dividend and other rights as the Company's other stockholders. A Stock Award Agreement, however, may require that the holders of Restricted Shares invest any cash dividends received in additional Restricted Shares. Such additional Restricted Shares shall be subject to the same conditions and restrictions as the Award with respect to which the dividends were paid. Such additional Restricted Shares shall not reduce the number of Common Shares available under Article 3. 9.2. Stock Units. The holders of Stock Units shall have no voting rights. Prior to settlement or forfeiture, any Stock Unit awarded under the Plan may, at the Committee's discretion, carry with it a right to dividend equivalents. Such right entitles the holder to be credited with an amount equal to all cash dividends paid on one Common Share while the Stock Unit is outstanding. Dividend equivalents may be converted into additional Stock Units. Settlement of dividend equivalents may be made in the form of cash, in the form of Common Shares, or in a combination of both. Prior to distribution, any dividend equivalents which are not paid shall be subject to the same conditions and restrictions as the Stock Units to which they attach. ARTICLE 10. PROTECTION AGAINST DILUTION 10.1. Adjustments. In the event of a subdivision of the outstanding Common Shares, a declaration of a dividend payable in Common Shares, a declaration of a dividend payable in a form other than Common Shares in an amount that has a material effect on the price of Common Shares, a combination or consolidation of the outstanding Common Shares (by reclassification or otherwise) into a lesser number of Common Shares, a recapitalization, a spin-off or a similar occurrence, the Committee shall make such adjustments as it, in its sole discretion, deems appropriate in one or more of (a) the number of Options, SARs, Restricted Shares and Stock Units available for future Awards under Article 3, (b) the limitations set forth in Sections 5.2 and 7.2, (c) the number of Stock Units included in any prior Award which has not yet been settled, (d) the number of Common Shares covered by each outstanding Option and SAR or (e) the Exercise Price under each outstanding Option and SAR. Except as provided in this Article 10, a Participant shall have no rights by reason of any issue by the Company of stock of any class or securities convertible into stock of any class, any subdivision or consolidation of 7 9 shares of stock of any class, the payment of any stock dividend or any other increase or decrease in the number of shares of stock of any class. 10.2. Reorganizations. In the event that the Company is a party to a merger or other reorganization, outstanding Options, SARs, Restricted Shares and Stock Units shall be subject to the agreement of merger or reorganization. Such agreement may provide, without limitation, for the assumption of outstanding Awards by the surviving corporation or its parent, for their continuation by the Company (if the Company is a surviving corporation), for accelerated vesting and accelerated expiration, or for settlement in cash. ARTICLE 11. AWARDS UNDER OTHER PLANS The Company may grant awards under other plans or programs. Such awards may be settled in the form of Common Shares issued under this Plan. Such Common Shares shall be treated for all purposes under the Plan like Common Shares issued in settlement of Stock Units and shall, when issued, reduce the number of Common Shares available under Article 3. ARTICLE 12. PAYMENT OF DIRECTOR'S FEES IN SECURITIES 12.1. Effective Date. No provision of this Article 12 shall be effective unless and until the Board has determined to implement such provision. 12.2. Elections to Receive NSOs, Restricted Shares or Stock Units. An Outside Director may elect to receive his or her annual retainer payments and meeting fees from the Company in the form of cash, NSOs, Restricted Shares, Stock Units, or a combination thereof, as determined by the Board. Such NSOs, Restricted Shares and Stock Units shall be issued under the Plan. An election under this Article 12 shall be filed with the Company on the prescribed form. 12 .3. Number and Terms of NSOs, Restricted Shares or Stock Units. The number of NSOs, Restricted Shares or Stock Units to be granted to Outside Directors in lieu of annual retainers and meeting fees that would otherwise be paid in cash shall be calculated in a manner determined by the Board. The terms of such NSOs, Restricted Shares or Stock Units shall also be determined by the Board. ARTICLE 13. LIMITATION ON RIGHTS 13.1. Retention Rights. Neither the Plan nor any Award granted under the Plan shall be deemed to give any individual a right to remain an Employee, Outside Director or Consultant of the Company, a Parent or a Subsidiary. The Company and its Parents and Subsidiaries reserve the right to terminate the service of any Employee, Outside Director or Consultant at any time, with or without cause, subject to applicable laws, the Company's certificate of incorporation and by-laws and a written employment agreement (if any). 13.2. Stockholders' Rights. A Participant shall have no dividend rights, voting rights or other rights as a stockholder with respect to any Common Shares covered by his or her 8 10 Award prior to the time when a stock certificate for such Common Shares is issued or, in the case of an Option, the time when he or she becomes entitled to receive such Common Shares by filing a notice of exercise and paying the Exercise Price. No adjustment shall be made for cash dividends or other rights for which the record date is prior to such time, except as expressly provided in Articles 8, 9 and 10. 13.3 Regulatory Requirements. Any other provision of the Plan notwithstanding, the obligation of the Company to issue Common Shares under the Plan shall be subject to all applicable laws, rules and regulations and such approval by any regulatory body as may be required. The Company reserves the right to restrict, in whole or in part, the delivery of Common Shares pursuant to any Award prior to the satisfaction of all legal requirements relating to the issuance of such Common Shares, to their registration, qualification or listing or to an exemption from registration, qualification or listing. ARTICLE 14. LIMITATION ON PAYMENTS 14.1. Basic Rule. Any provision of the Plan to the contrary notwithstanding, in the event that the independent auditors most recently selected by the Board (the "Auditors") determine that any payment or transfer by the Company under the Plan to or for the benefit of a Participant (a "Payment") would be nondeductible by the Company for federal income tax purposes because of the provisions concerning "excess parachute payments" in section 280G of the Code, then the aggregate present value of all Payments shall be reduced (but not below zero) to the Reduced Amount; provided that the Committee, at the time of making an Award under this Plan or at any time thereafter, may specify in writing that such Award shall not be so reduced and shall not be subject to this Article 14. For purposes of this Article 14, the "Reduced Amount" shall be the amount, expressed as a present value, which maximizes the aggregate present value of the Payments without causing any Payment to be nondeductible by the Company because of section 280G of the Code. 14.2. Reduction of Payments. If the Auditors determine that any Payment would be nondeductible by the Company because of section 280G of the Code, then the Company shall promptly give the Participant notice to that effect and a copy of the detailed calculation thereof and of the Reduced Amount, and the Participant may then elect, in his or her sole discretion, which and how much of the Payments shall be eliminated or reduced (as long as after such election the aggregate present value of the Payments equals the Reduced Amount) and shall advise the Company in writing of his or her election within 10 days of receipt of notice. If no such election is made by the Participant within such 10-day period, then the Company may elect which and how much of the Payments shall be eliminated or reduced (as long as after such election the aggregate present value of the Payments equals the Reduced Amount) and shall notify the Participant promptly of such election. For purposes of this Article 14, present value shall be determined in accordance with section 280G(d)(4) of the Code. All determinations made by the Auditors under this Article 14 shall be binding upon the Company and the Participant and shall be made within 60 days of the date when a Payment becomes payable or transferable. As promptly as practicable following such determination and the elections hereunder, the Company shall pay or transfer to or for the benefit of the Participant such amounts 9 11 as are then due to him or her under the Plan and shall promptly pay or transfer to or for the benefit of the Participant in the future such amounts as become due to him or her under the Plan. 14.3. Overpayments and Underpayments. As a result of uncertainty in the application of section 280G of the Code at the time of an initial determination by the Auditors hereunder, it is possible that Payments will have been made by the Company which should not have been made (an "Overpayment") or that additional Payments which will not have been made by the Company could have been made (an "Underpayment"), consistent in each case with the calculation of the Reduced Amount hereunder. In the event that the Auditors, based upon the assertion of a deficiency by the Internal Revenue Service against the Company or the Participant which the Auditors believe has a high probability of success, determine that an Overpayment has been made, such Overpayment shall be treated for all purposes as a loan to the Participant which he or she shall repay to the Company, together with interest at the applicable federal rate provided in section 7872(f)(2) of the Code; provided, however, that no amount shall be payable by the Participant to the Company if and to the extent that such payment would not reduce the amount which is subject to taxation under section 4999 of the Code. In the event that the Auditors determine that an Underpayment has occurred, such Underpayment shall promptly be paid or transferred by the Company to or for the benefit of the Participant, together with interest at the applicable federal rate provided in section 7872(f)(2) of the Code. 14.4. Related Corporations. For purposes of this Article 14, the term "Company" shall include affiliated corporations to the extent determined by the Auditors in accordance with section 280G(d)(5) of the Code. ARTICLE 15. WITHHOLDING TAXES 15.1. General. To the extent required by applicable federal, state, local or foreign law, a Participant or his or her successor shall make arrangements satisfactory to the Company for the satisfaction of any withholding tax obligations that arise in connection with the Plan. The Company shall not be required to issue any Common Shares or make any cash payment under the Plan until such obligations are satisfied. 15.2. Share Withholding. The Committee may permit a Participant to satisfy all or part of his or her withholding or income tax obligations by having the Company withhold all or a portion of any Common Shares that otherwise would be issued to him or her or by surrendering all or a portion of any Common Shares that he or she previously acquired. Such Common Shares shall be valued at their Fair Market Value on the date when taxes otherwise would be withheld in cash. ARTICLE 16. FUTURE OF THE PLAN 16.1. Term of the Plan. The Plan, as set forth herein, was adopted on _________, 1997, and shall become effective on the date of the Company's initial public offering. The Plan shall remain in effect until it is terminated under Section 16.2, except that no ISOs shall be granted after ____________, 2007. 10 12 16.2. Amendment or Termination. The Board may, at any time and for any reason, amend or terminate the Plan. An amendment of the Plan shall be subject to the approval of the Company's stockholders only to the extent required by applicable laws, regulations or rules. No Awards shall be granted under the Plan after the termination thereof. The termination of the Plan, or any amendment thereof, shall not affect any Award previously granted under the Plan. ARTICLE 17. DEFINITIONS 17.1. "Award" means any award of an Option, an SAR, a Restricted Share or a Stock Unit under the Plan. 17.2. "Board" means the Company's Board of Directors, as constituted from time to time. 17.3. "Change in Control" shall mean the occurrence of any of the following events: (a) The consummation of a merger or consolidation of the Company with or into another entity or any other corporate reorganization, if more than 50% of the combined voting power of the continuing or surviving entity's securities outstanding immediately after such merger, consolidation or other reorganization is owned by persons who were not stockholders of the Company immediately prior to such merger, consolidation or other reorganization; (b) A change in the composition of the Board, as a result of which fewer than one-half of the incumbent directors are directors who either: (A) Had been directors of the Company 24 months prior to such change; or (B) Were elected, or nominated for election, to the Board with the affirmative votes of at least a majority of the directors who had been directors of the Company 24 months prior to such change and who were still in office at the time of the election or nomination; or (c) Any "person" (as such term is used in sections 13(d) and 14(d) of the Exchange Act) by the acquisition or aggregation of securities is or becomes the beneficial owner, directly or indirectly, of securities of the Company representing 50% or more of the combined voting power of the Company's then outstanding securities ordinarily (and apart from rights accruing under special circumstances) having the right to vote at elections of directors (the "Base Capital Stock"); except that any change in the relative beneficial ownership of the Company's securities by any person resulting solely from a reduction in the aggregate number of outstanding shares of Base Capital Stock, and any decrease thereafter in such person's ownership of securities, shall be disregarded until such person increases in any manner, directly or indirectly, such person's beneficial ownership of any securities of the Company. 11 13 The term "Change in Control" shall not include a transaction, the sole purpose of which is to change the state of the Company's incorporation. 17.4. "Code" means the Internal Revenue Code of 1986, as amended. 17.5. "Committee" means a committee of the Board, as described in Article 2. 17.6."Common Share" means one share of the common stock of the Company. 17.7. "Company" means Star Telecommunications, Inc., a Delaware corporation. 17.8. "Consultant" means a consultant or adviser who provides bona fide services to the Company, a Parent or a Subsidiary as an independent contractor. Service as a Consultant shall be considered employment for all purposes of the Plan, except as provided in Section 4.2. 17.9. "Employee" means a common-law employee of the Company, a Parent or a Subsidiary. 17.10. "Exchange Act" means the Securities Exchange Act of 1934, as amended. 17.11. "Exercise Price," in the case of an Option, means the amount for which one Common Share may be purchased upon exercise of such Option, as specified in the applicable Stock Option Agreement. "Exercise Price," in the case of an SAR, means an amount, as specified in the applicable SAR Agreement, which is subtracted from the Fair Market Value of one Common Share in determining the amount payable upon exercise of such SAR. 17.12. "Fair Market Value" means the market price of Common Shares, determined by the Committee as follows: (a) If the Common Shares were traded over-the-counter on the date in question but was not traded on the Nasdaq system or the Nasdaq National Market System, then the Fair Market Value shall be equal to the mean between the last reported representative bid and asked prices quoted for such date by the principal automated inter-dealer quotation system on which the Common Shares are quoted or, if the Common Shares are not quoted on any such system, by the "Pink Sheets" published by the National Quotation Bureau, Inc.; (b) If the Common Shares were traded over-the-counter on the date in question and were traded on the Nasdaq system or the Nasdaq National Market System, then the Fair Market Value shall be equal to the last-transaction price quoted for such date by the Nasdaq system or the Nasdaq National Market System; (c) If the Common Shares were traded on a stock exchange on the date in question, then the Fair Market Value shall be equal to the closing price reported by the applicable composite transactions report for such date; and 12 14 (d) If none of the foregoing provisions is applicable, then the Fair Market Value shall be determined by the Committee in good faith on such basis as it deems appropriate. Whenever possible, the determination of Fair Market Value by the Committee shall be based on the prices reported in the Western Edition of The Wall Street Journal. Such determination shall be conclusive and binding on all persons. 17.13 "ISO" means an incentive stock option described in section 422(b) of the Code. 17.14. "NSO" means a stock option not described in sections 422 or 423 of the Code. 17.15. "Option" means an ISO or NSO granted under the Plan and entitling the holder to purchase one Common Share. 17.16. "Optionee" means an individual or estate who holds an Option or SAR. 17.17. "Outside Director" shall mean a member of the Board who is not an Employee. Service as an Outside Director shall be considered employment for all purposes of the Plan, except as provided in Section 4.2. 17.18. "Parent" means any corporation (other than the Company) in an unbroken chain of corporations ending with the Company, if each of the corporations other than the Company owns stock possessing 50% or more of the total combined voting power of all classes of stock in one of the other corporations in such chain. A corporation that attains the status of a Parent on a date after the adoption of the Plan shall be considered a Parent commencing as of such date. 17.19. "Participant" means an individual or estate who holds an Award. 17.20. "Plan" means this 1997 Omnibus Stock Incentive Plan of the Company, as amended from time to time. 17.21. "Restricted Share" means a Common Share awarded under the Plan. 17.22. "SAR" means a stock appreciation right granted under the Plan. 17.23. "SAR Agreement" means the agreement between the Company and an Optionee which contains the terms, conditions and restrictions pertaining to his or her SAR. 17.24. "Stock Award Agreement" means the agreement between the Company and the recipient of a Restricted Share or Stock Unit which contains the terms, conditions and restrictions pertaining to such Restricted Share or Stock Unit. 13 15 17.25. "Stock Option Agreement" means the agreement between the Company and an Optionee which contains the terms, conditions and restrictions pertaining to his or her Option. 17.26. "Stock Unit" means a bookkeeping entry representing the equivalent of one Common Share, as awarded under the Plan. 17.27. "Subsidiary" means any corporation (other than the Company) in an unbroken chain of corporations beginning with the Company, if each of the corporations other than the last corporation in the unbroken chain owns stock possessing 50% or more of the total combined voting power of all classes of stock in one of the other corporations in such chain. A corporation that attains the status of a Subsidiary on a date after the adoption of the Plan shall be considered a Subsidiary commencing as of such date. 17.28. "Supplemental Option Plan" means the Company's 1996 Supplemental Stock Option Plan as in effect on the date of the adoption of this Plan by the Company's Board of Directors. ARTICLE 18. EXECUTION To record the adoption of the Plan by the Board, the Company has caused its duly authorized officer to affix the corporate name and seal hereto. STAR TELECOMMUNICATIONS, INC. By:__________________________ Name: Title: 14 EX-10.20 4 MASTER LEASE AGREEMENT DATED DECEMBER 20, 1996 1 EXHIBIT 10.20 Lessor NTFC CAPITAL CORPORATION Master Lease Agreement Lessee STAR VENDING, INC. Person to Contact/Title D/B/A STAR TELECOMMUNICATIONS, INC. MARY CASEY, PRESIDENT Address 740 STATE STREET Telephone Number Facsimile Number SUITE 202 (805) 899-1962 ( ) - /X/ Corporation / / Proprietorship / / Partnership / / _________ City County State Zip Code Master Lease Agreement No. SANTA BARBARA SANTA BARBARA CA 93101 54273 TERMS AND CONDITIONS (The Reverse side contains Terms and Conditions which are also a part of this Agreement) 1. LEASE: Lessor shall purchase and lease to Lessee the equipment and associated items ("Equipment") described in any Equipment Schedule ("Schedule") executed from time to time by Lessor and Lessee that makes reference to this Master Lease Agreement ("Agreement"). This Agreement shall be incorporated into each Schedule. When computer programs and related documentation are furnished with the Equipment, and a non-exclusive license and/or sublicense (collectively, "Software") is granted to Lessee in an agreement ("Supplier Agreement") with the suppliers (collectively, "Supplier") identified on the Schedule. Lessor, to the extent permitted, grants Lessee a similar non-exclusive sublicense to use the Software only in conjunction with the Equipment for so long as the Equipment is leased hereunder. The Equipment and Software include, but are not limited to, all additions, attachments and accessions thereto and replacements therefore (collectively, "System"). Any reference to "Lease" shall mean with respect to each System, this Agreement, a Schedule, a Consent of Supplier, an Acceptance Certificate, any riders, amendments and addenda thereto, and any other documents as may from time to time be made a part thereof. As conditions precedent to Lessor's obligation to purchase any Equipment and obtain any Software, not later than the Commitment Date set forth on the applicable Schedule, (a) Lessee and Lessor shall execute this Agreement, a Schedule, an Acceptance Certificate and other documentation contemplated herein, and (b) there shall have been no material adverse change in Lessee's financial condition. Upon Lessor's execution of a Schedule, Lessee assigns to Lessor its rights to receive title to the Equipment and any non-exclusive sublicense to use the Software described in the Supplier Agreement as of the day the System is delivered to the installation Site set forth in the applicable Schedule but no other right or any warranty thereunder. In consideration of such an assignment and subject to the terms and conditions herein, Lessor agrees to pay to the Supplier the Price (as defined in Section 3 below) for the System pursuant to the Supplier Agreement, but not to perform any other obligation thereunder. Unless Lessee exercises its Purchase Option as set forth in the applicable Schedule, Lessee hereby assigns to Lessor all of Lessee's then-remaining rights pursuant to the applicable Supplier Agreement effective upon the termination or expiration of the Term (as set forth in the applicable Schedule) for any reason. 2. TERM, RENEWAL AND EXTENSIONS: If all other conditions precedent to a Lease have been met, the Lease Term for the System described on each Schedule shall commence on the date of Lessee's execution of an Acceptance Certificate ("Commencement Date"), and continue for the number of whole months, or other periods set forth in such Schedule ("Initial Term"), the first such full month commencing on the first day of the month following the Commencement Date (or commencing on the Commencement Date if such date is the first day of the month). If Lessee selects Purchase Option B or C in the applicable Schedule, on the expiration date of the Initial Term, the Lease shall be automatically renewed for a six-month period ("Renewal Term") unless, by giving written notice to Lessor six (6) months prior to the expiration date, the Lessee elects to terminate the Lease. After the Renewal Term, at Lessor's option, the Lease shall be automatically extended on a month-to-month basis until either party gives the other not less than thirty (30) days prior written notice of its intention to terminate the Lease. Any renewals and extensions shall be on the same terms and conditions as during the Initial Term. "Term" shall mean the applicable Initial Term, the Renewal Term, if any, and any extension thereof as provided herein. 3. RENT AND PAYMENT: Lessee shall pay to Lessor all the rental payments as shown in the applicable Schedule ("Rent') during the Term of the Lease, except as such Rent may be adjusted pursuant to this Section and Sections 2 and 8 of a Schedule, plus such additional amounts as are due Lessor under the Lease. Rent shall be paid as designated in the applicable Schedule in advance on the first day of each Payment Period ("Rent Payment Date"). If the Commencement Date is not the first day of a calendar month (or other Payment Period), Lessee shall pay to Lessor, on demand, interim Rent prorated daily based on a 360-day year for each day from and including the Commencement Date to and including the last day of such month or other Payment Period. The Rent is based upon the Price of the System and the acceptance of the System by Lessee on or before the Commitment Date set forth in the applicable Schedule. The "Price" of the System shall be as set forth in the Schedule, and shall exclude all other costs, including sales or other taxes included in the Supplier Agreement as part of the purchase price. If the Price is increased or decreased as a result of a job change order ("JCO"), the Lessee authorizes Lessor to adjust the Rent. If the Commencement Date occurs after the Commitment Date, and Lessor waives the condition precedent that the Commencement Date occurs on or before the Commitment Date, Lessor's then-current Lease Rate Factor for similar transactions shall apply and the Lessee authorizes Lessor to adjust the Rent, accordingly. Whenever any payment of Rent or other amount is not made within ten (10) days after the date when due, Lessee agrees to pay on demand (as a fee to offset Lessor's collection and administrative expenses), the greater of twenty-five dollars ($25.00) or ten (10%) of each such overdue amount, but not exceeding the lawful maximum, if any. All payments shall be payable to Lessor in U.S. dollars at Lessor's address set forth in Section 18 or such other place as Lessor directs in writing. If Lessee requests changes or amendments to any Lease, Lessor may charge Lessee Lessor's reasonable costs and expenses of negotiation and documentation, including fees of legal staff or outside counsel. 4. DELIVERY: All transportation, delivery and installation costs (unless included in the Price) are the sole responsibility of Lessee. Lessee assumes all risk of loss and damage if the Supplier fails to deliver or delays in the delivery of any System, or if any System is unsatisfactory for any reason. 5. NET LEASE: Lessee's obligations under each Lease are absolute, unconditional and non-cancelable and shall not be subject to any delay, reduction, setoff, defense, counterclaim or recoupment for any reason including any failure of any System, or any misrepresentations of any supplier, manufacturer, installer, vendor or distributor. Lessor is not responsible for the delivery, installation, maintenance or operation of any System. 6. WARRANTIES: Lessor agrees that third-party warranties, if any, inure to the benefit of Lessee during the Term and on exercise of the Purchase Option. Lessee agrees to pursue any warranty claim directly against such third party and shall not pursue any such claim against Lessor. Lessee shall continue to pay Lessor all amounts payable under any Lease under any and all circumstances. 7. QUIET ENJOYMENT: Lessor shall not interfere with Lessee's quiet enjoyment and use of the System during the Term if no Event of Default has occurred and is continuing. 8. TAXES AND FEES: Lessee shall promptly reimburse Lessor, upon demand, as additional Rent, or shall pay directly, if so requested by Lessor, all license and registration fees, sales, use, personal property taxes and all other taxes and charges imposed by any federal, state, or local government or taxing authority, relating to the purchase, ownership, leasing, or use of the System or the Rent excluding, however, all taxes computed upon the net income of Lessor. 9. DISCLAIMER OF WARRANTIES AND DAMAGE: LESSEE ACKNOWLEDGES THAT (a) THE SIZE, DESIGN, CAPACITY OF EACH SYSTEM AND THE MANUFACTURER AND SUPPLIER HAVE BEEN SELECTED BY LESSEE; (b) LESSOR IS NOT A MANUFACTURER, SUPPLIER, DEALER, DISTRIBUTOR OR INSTALLER OF ANY SYSTEM; (c) NO MANUFACTURER OR SUPPLIER OR ANY OF THEIR REPRESENTATIVES IS AN AGENT OF LESSOR OR AUTHORIZED TO WAIVE OR ALTER ANY TERM OR CONDITION OF ANY LEASE; AND (d) EXCEPT FOR LESSORS' WARRANTY OF QUIET ENJOYMENT SET FORTH IN SECTION 7, LESSOR HAS NOT MADE, AND DOES NOT HEREBY MAKE, ANY REPRESENTATION, WARRANTY OR COVENANT, WRITTEN OR ORAL, STATUTORY, EXPRESS OR IMPLIED, AS TO ANY MATTER WHATSOEVER INCLUDING, WITHOUT LIMITATION, THE DESIGN, QUALITY, CAPACITY, MATERIAL, WORKMANSHIP, OPERATION, CONDITION, MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE, HIDDEN OR LATENT DEFECTS, OR AS TO ANY PATENT, COPYRIGHT OR TRADEMARK INFRINGEMENT. LESSEE LEASES EACH SYSTEM "AS IS, WHERE IS." LESSOR SHALL HAVE NO LIABILITY TO LESSEE OR ANY THIRD PARTY FOR ANY SPECIAL DIRECT, INDIRECT, INCIDENTAL OR CONSEQUENTIAL DAMAGES - ------------------------------------------------------------------------------- Except as otherwise provided in Section 3 of this Agreement and Sections 2, 3 and 8 of a Schedule, any modifications, amendments or waivers to a Lease shall be effecvtive only if mutually agreed upon in a writing, duly executed by authorized representatives of the parties. - ------------------------------------------------------------------------------- NTFC CAPITAL CORPORATION STAR VENDING INC. D/B/A STAR TELECOMMUNICATIONS, INC. By /s/ L.W. Middleton By /s/ Mary Casey --------------------------------- -------------------------------- Authorized Representative Authorized Representative PRINT NAME /s/ L.W. Middleton PRINT NAME /s/ Mary Casey ------------------------- ------------------------ TITLE Secretary DATE 12/17/96 TITLE President DATE 11/5/96 ------------ ----------- ------------ ---------- 2 OF ANY SORT INCLUDING, WITHOUT LIMITATION, DAMAGES FOR PERSONAL INJURY, LOSS OF PROFITS OR SAVINGS, LOSSES OF USE, OR ANY OTHER DAMAGES, WHETHER BASED ON STRICT LIABILITY OR NEGLIGENCE, WHETHER RESULTING FROM USE OF A SYSTEM OR BREACH OF A LEASE OR OTHERWISE, EXCEPT FOR DIRECT, SPECIFIC DAMAGES FOR PERSONAL INJURY OR PROPERTY DAMAGE TO THE EXTENT CAUSED BY LESSOR'S ACTIVE GROSS NEGLIGENCE OR WILLFUL MISCONDUCT. IF LESSEE HAS ELECTED PURCHASE OPTION B OR C, ARTICLE 2A OF THE UCC MAY APPLY TO THE LEASE AND LESSEE MAY HAVE CERTAIN RIGHTS THEREUNDER. IF SO, LESSEE ACKNOWLEDGES THAT SUCH A LEASE IS A FINANCE LEASE AS DEFINED IN UCC SECTION 2A-103. TO THE EXTENT PERMITTED BY LAW, LESSEE HEREBY WAIVES ANY RIGHTS OR REMEDIES LESSEE MAY HAVE UNDER UCC SECTIONS 2A-608-822 INCLUDING, WITHOUT LIMITATION, RIGHTS OF REJECTION, REVOCATION, CANCELLATION, GRANTING OF SECURITY INTERESTS, AND RECOVERY FOR BREACH OF WARRANTY. 10. INSURANCE: At its expense, Lessee shall keep each System insured against all risks of loss and damage for an amount equal to the installed replacement cost of such System with Lessor named as a loss payee. Lessee shall also maintain comprehensive general liability insurance, with Lessor named as an additional insured. All insurance policies shall be with an insurer having a "Best Policy Holders" rating of "A-X" or better, and be in such form, amount and deductibles as are satisfactory to Lessor. Each such policy must state by endorsement that insurer shall give Lessor not less than thirty (30) days prior written notice of any amendment, renewal or cancellation. Lessee shall, upon request, furnish to Lessor satisfactory evidence that such insurance coverage is in effect. Lessee may self insure for such coverages only with Lessors prior written consent. 11. CASUALTY: If any System, in whole or in part, is lost, stolen, damaged or destroyed, or is taken in any condemnation or similar proceeding (an "Event of Loss"), Lessee shall immediately notify Lessor. Lessee shall, at its option (a) immediately place the affected Equipment and Software in good condition and working order, (b) replace the affected item with like equipment or software in good condition and transfer clear title and any sublicense to Lessor, or (c) pay to Lessor, within thirty (30) days of the Event of Loss, an amount equal to the Stipulated Loss Value ("SLV") as defined below, for such affected Equipment or Software plus any other unpaid amounts then due under the Lease. If an Event of Loss occurs as to part of a System for which the SLV is paid, a prorata amount of Rent shall abate from the date the SLV payment is received by Lessor. Upon payment of the SLV, title to the applicable Equipment and the sublicense to the applicable Software, shall pass to Lessee with no warranties, subject to the rights, if any, of the insurer. The SLV shall be an amount equal to all future Rent from the last Rent Payment Date for which Rent has been paid to the end of the Term with each such payment discounted to present value at a simple interest rate of five percent (5%) per annum or the Lease Rate, as applicable, or, if such rate is not permitted by law, then at the lowest permitted rate, plus (a) if Lessee selects Purchase Option B, twenty percent of the product obtained by multiplying the total number of Rent payments shown on the Schedule for the applicable Term by the then periodic Rent, or (b) if Lessee selects Purchase Option C, the percent set forth in the Purchase Option C election in the Schedule times the Price as it may have been adjusted ("Percent Option Amount"). If Lessor receives any insurance proceeds, Lessor shall apply such proceeds to Lessee's outstanding obligations with any remaining sums to be delivered to Lessee. 12. INDEMNITY: Lessee shall indemnify Lessor against, and hold Lessor harmless from, and covenants to defend Lessor against, any and all losses, claims, liens, encumbrances, suits, damages, and liabilities (and all costs and expenses including, without limitation, reasonable attorney's fees) related to the Lease including, without limitation, the selection, purchase, delivery, ownership, condition, use, operation of a System, or violation of a Software Sublicense, or arising by operation of law (excluding any of the foregoing to the extent caused by the active gross negligence or willful misconduct of Lessor). Lessee shall assume full responsibility for or, at Lessor's sole option, reimburse Lessor for the defense thereof. This Section shall survive the termination of the Lease but not longer than the applicable statute of limitations. 13. TAX INDEMNITY: If Lessee selects Purchase Option B, the Lease is entered into based upon the assumptions ("Assumptions") that for federal, state, and local income tax purposes, Lessor shall be entitled to deduct, at the highest marginal rate of tax imposed on corporations, the maximum depreciation or cost recovery allowances provided in the Internal Revenue Code of 1986, as amended, and under state and local law in effect on the date Lessee executes the applicable Schedule. If, in its reasonable opinion, Lessor determines that its net after-tax economic yield or after-tax cash flow ("Net Economic Return") has been adversely affected as a result of a change in the Assumptions (a "Loss"), Lessee agrees to pay to Lessor, on demand, an amount which will cause Lessors' then Net Economic Return to equal the Net Economic Return that Lessor would have received had such Loss not occurred. Lessee shall have no right to inspect the tax returns of Lessor. 14. DEFAULT: Any of the following shall constitute an Event of Default: (a) Lessee fails to pay when due any Rent or other amount payable under a Lease that is not paid within ten (10) days of Lessee's receipt of written notice of nonpayment; (b) Lessee fails to perform any other material term in any Lease or other agreement given in connection with any Lease that continues uncured for twenty (20) days after Lessee's receipt of written notice thereof; (c) the inaccuracy of any material representation or warranty made by Lessee or any guarantor in connection with any Lease and the continuation thereof for thirty (30) days or more; (d) Lessee attempts to make a Transfer (as defined in Section 10) without Lessor's prior written consent; (e) Lessee dissolves or ceases to do business as a going concern; (f) Lessee sells all or substantially all of its assets, merges or consolidates with or into, or reorganizes with any entity; (g) Lessee becomes insolvent, makes an assignment for the benefit of creditors, files a voluntary petition or has an involuntary petition filed or action commenced against it under the United States Bankruptcy Code or any similar federal or state law; (h) Lessee fails to perform its obligations under any other Lessee or agreement with Lessor; or (i) Any partner of Lessee or any guarantor takes any actions described in subsections (e), (f), or (g) above. 15. REMEDIES: If an Event of Default has occurred, Lessor shall have the right to exercise one or more of the following remedies set forth below. Lessor may (a) terminate and/or declare an Event of Default under any Lease or other agreement with Lessee; (b) recover from Lessee all Rent and any and all amounts then due and unpaid, and (c) recover from Lessee all Rent and other amounts to become due, by acceleration or otherwise (plus, if the System is not returned in accordance with Section 9 of the applicable Schedule, an amount equal to (i) Lessor's reasonable estimate of the fair market value of the System at the end of the applicable Term if Lessee selects Purchase Option B in the Schedule, or (ii) if Lessee selects Purchase Option C in the Schedule, Percent Option Amount. The amounts described in subsection (c) shall be present valued using a five percent (5%) simple interest rate per annum or the Lease Rate, as applicable, or, if such rate is not permitted by law, then at the lowest permitted rate. The amounts set forth in subsections (b) and (c) above shall be the agreed upon damages ("Lessor's Loss"). Lessor may also charge Lessee interest on the Lessor's Loss from the date of the Event of Default until paid at the rate of one and one-half percent (1-1/2%) per month, but in no event more than the maximum rate permitted by law; demand the Lessee return any System to Lessor in the manner provided in Section 9 of the Schedule, and take possession of, render unusable, or disable any System wherever located, with or without demand or notice or any court order or any process by law. Upon repossession or return of a System, Lessor shall have the right to sell, lease or otherwise dispose of the System, with or without notice and by public or private bid, and shall apply the net proceeds thereof, if any, toward Lessor's Loss but only after deducting from such proceeds (a) in the case of any reletting of the System, the rent due for any period beyond the scheduled expiration of the Lease; (b) in the case of sale, (i) if Lessee has elected Purchase Option B, the estimated fair market value of the System as of the scheduled expiration of the Term of the Lease, or (ii) if Lessee has elected Purchase Option C, an amount equal to the Percent Option Amount; and (c) all expenses including, without limitation, reasonable attorney's fees incurred in enforcement of any remedy. Lessee shall be liable for any deficiency if the net proceeds available after the permitted deductions are less than Lessor's Loss. No right or remedy is exclusive of any other provided herein or permitted by law or equity. All rights and remedies shall be cumulative and may be enforced concurrently or individually from time to time. 16. ASSIGNMENT: Lessor may, without notice to or the consent of Lessee, sell, assign, grant a security interest in, or pledge its interest in all or a portion of a System and/or a Lease and any amounts payable hereunder to any third party ("Assignee"). Lessee shall, if directed, pay all Rent and other amounts due to Assignee free from any claim or counterclaim, defense or other right which Lessee may have against Lessor. Lessor shall be relieved of its future obligations under the Lease as a result of such assignment if Lessor assigns to Assignee its interest in the System and Assignee assumes Lessor's future obligations. WITHOUT LESSOR'S PRIOR WRITTEN CONSENT, LESSEE SHALL NOT ASSIGN, SUBLEASE, TRANSFER, PLEDGE, MORTGAGE OR OTHERWISE ENCUMBER ("TRANSFER") ANY SYSTEM OR ANY LEASE OR ANY OF ITS RIGHTS THEREIN OR PERMIT ANY LEVY, LIEN OR ENCUMBRANCE THEREON. Any attempted non-consensual Transfer by Lessee shall be void ab inibo. No Transfer shall relieve Lessee of any of its obligations under a Lease. 17. ORGANIZATION AND AUTHORITY: Lessee is duly organized, validly existing and in good standing under the laws of its State of formation and in any jurisdiction where a System is located. Lessee has the power and authority to execute, delivery and perform each Lease. The person executing this Agreement and any Schedules on behalf of Lessee has been given authority to bind the Lessee and each Lease constitutes or will constitute a legally binding and enforceable obligation of the Lessee. The execution, delivery and performance of each Lease is not and will not be in contravention of, or will not result in a breach of, any of the terms of Lessee's organizational documents, and any agreements, contracts or instruments to which Lessee is a party or under which it is bound. 18. NOTICES: Notices, demands and other communications shall be in writing and shall be sent by hand delivery, certified mail (return receipt requested), or overnight courier service, or facsimile transmission (effective upon transmission) with a copy sent by one of the foregoing methods, to Lessee at the address or facsimile number stated above and to Lessor at 220 Athens Way, Nashville, Tennessee 37228-1314. Attention: V.P. Finance, or facsimile no. (615) 734-6110. Notices shall be effective upon the earlier of actual receipt or four days after the mailing date. Either party may substitute another address by such written notice. 19. JURISDICTION AND GOVERNING LAW: EACH LEASE SHALL BE GOVERNED BY THE LAWS OF THE STATE OF TENNESSEE AND THE LESSEE CONSENTS AND AGREES THAT, AT LESSOR'S OPTION, PERSONAL JURISDICTION, SUBJECT MATTER JURISDICTION AND VENUE SHALL BE WITH THE COURTS OF THE STATE OF TENNESSEE, OR THE FEDERAL COURT FOR THE MIDDLE DISTRICT OF TENNESSEE. 20. MISCELLANEOUS: (a) Any failure of Lessor to require strict performance by Lessee, or any waiver by Lessor of any provision of a Lease, shall not be construed as a consent to or waiver of any other breach of the same or of any other provision. (b) If there is more than one Lessee, the obligations of each Lessee are joint and several. (c) Lessee agrees to execute and deliver, upon demand, any documents necessary, in Lessor's reasonable opinion, to evidence the intent of a Lease, and/or to protect Lessor's interest in a System. Lessee appoints Lessor as its attorney-in-fact for the sole purpose of executing and delivering any UCC financing statements. Lessee agrees to pay Lessor's out-of-pocket costs of filing and recording such documentation. (d) Lessee shall deliver to Lessor such additional financial information as Lessor may reasonably request. (e) If any provision shall be held to be invalid or unenforceable, the validity and enforceability of the remaining provisions shall not in any way be affected or impaired. (f) In the event Lessee fails to pay or perform any obligations under a Lease, Lessor may, at its option, pay or perform such obligation, and any payment made or expense incurred by Lessor in connection therewith shall be due and payable by Lessee upon Lessor's demand with interest thereon accruing at the maximum rate permitted by law until paid. (g) Time is of the essence in each Lease. (h) Lessee shall pay Lessor, on demand, all costs and expenses, including reasonable attorneys' and collection fees, incurred by Lessor in enforcing the terms and conditions of a Lease or in protecting Lessor's rights and interests in a Lease or a System. (i) LESSOR INTENDS TO COMPLY WITH ALL APPLICABLE LAWS, INCLUDING THOSE CONCERNING THE REGULATION OF INTEREST. Therefore, no lease charge, late charge, fee or interest, if applicable, is intended to exceed the maximum amount permitted to be charged or collected by applicable law. If one or more of such charges exceed such maximum, then such charges will be reduced to the legally permitted maximum charge and any excess charge will be used to reduce the future Rent and/or the Price of the System or refunded. (j) Each Lease may be executed by one or more of the parties on any number of separate counterparts (which may be originals or copies sent by facsimile transmission), each of which counterparts shall be an original. (k) Each Lease constitutes the entire agreement between Lessor and Lessee with respect to the subject matter thereof and supersedes all previous writing and understandings of any nature whatsoever. (l) No agent, employee, or representative of Lessor has any authority to bind Lessor to any representation or warranty concerning any System and, unless such representation or warranty is specifically included in a Lease, it shall not be enforceable by Lessee against Lessor. 3 Lessor NTFC Capital Corporation Agreement Addendum Lessee Star Vending, Inc. Agreement No. d/b/a Star Telecommunications, Inc. 54273 Contemporaneously with entering into the Agreement referenced above, Lessee and Lessor agree to the following amendments to the Agreement: 1. SECTION 1. LEASE. The words "since the later of January 30, 1996 or the date financial information was last delivered by Lessee to Lessor," are added at the end of the first sentence of the second paragraph of Section 1. The following is added as an additional conditions precedent in paragraph 2 of Section 1 of the Lease. (c) Lessee shall have obtained a release from Metrobank releasing any and all right, title and interest it may have in any Lease or the Systems subject thereto. (d) No Event of Default, or no event which, with the giving of notice or passage of time or both, would constitute an Event of Default, has occurred and is continuing. The following is added as the third paragraph of Section 1. The Price of all Systems subject to all Leases entered into pursuant to this Agreement, including any Purchase Price Payment adjustments, CSO Equipment (as defined in the Schedule) and Equipment and Software added as a result of JCO's (as defined in Section 3 thereof) shall not exceed $3,200,000 in the aggregate. All Leases entered into pursuant to this Agreement must commence on or before December 31, 1996. 2. SECTION 2. TERM, RENEWAL AND EXTENSIONS. The second, third and fourth sentences of Section 2 are deleted and the following substituted in lieu thereof: If Lessee selects Purchase Option B or C in the Schedule, Lessee must give Lessor not less than four (4) months written notice of its intent to (a) renew the Lease ("Option Renewal Term") with such renewal to be on the same terms and conditions as the Lease for the Initial Term, except that the Optional Renewal Term shall be for a six month period commencing on the first day after the expiration date of the Initial Term, and the Rent for the System during the Optional Renewal Term shall be equal to the then fair market rental value for the System; (b) exercise its purchase option set forth in Section 10 in the Schedule, or (c) return the System in accordance with Section 9 of the Schedule. In the event the Lessee does not notify Lessor in writing of its election, the Lease shall be automatically renewed for a six-month period ("Automatic Renew Term"). Such renewal shall be on the same terms and conditions as the Lease for the Initial Term including the Rent for the Automatic Renewal Term which shall be equal to the Rent during the Initial Term. The "Renewal Term" shall mean the Optional Renewal Term or the Automatic Renewal Term, as applicable. After the end of the Renewal Term, if any, the Term of the Lease shall be automatically extended until terminated by either party as provided herein. Such extension shall be on the same terms and conditions as during the applicable Renewal term. Lessor and Lessee may terminate such Lease effective as of the first day of any calendar month after the end of the Renewal Term, by giving to the other not less than thirty (30) days prior written notice of such termination. 3. SECTION 3. RENT AND PAYMENT. The words "approved in writing by Lessee as evidenced by Lessee's initials on the Supplier invoice relative thereto" are added after "(JCO")" in the third sentence of the second paragraph of Section 3. The fourth sentence of the second paragraph of Section 3 of the Agreement is deleted and the following substituted in lieu thereof: The following Lease Rate Factors shall be increased or decreased based upon changes from April 15, 1996 until the Commencement Date of a Lease in three (3) year Treasury Constant Maturities' ("Yield") as reported by the Federal Reserve Statistical Release (H.15 Report). For each five (5) basis points of increase or decrease (rounded downward to the nearest whole five (5) basis point increment or decrement) in the Yield, the Lease Rate Factors shall be increased or decreased, respectively by the applicable Adjustment Factors set forth below. This adjusted Lease Rate Factors shall be the Lease Rate Factors used to determine the Rent relative to the Schedule. NTFC CAPITAL CORPORATION STAR VENDING, INC D/B/A/ STAR TELECOMMUNICATIONS, INC BY /s/ L.W. Middleton BY /s/ Mary Casey ----------------------------------- ------------------------------------ Authorized Representative Authorized Representative PRINT NAME L.W. Middleton PRINT NAME Mary Casey --------------------------- ---------------------------- TITLE Secretary DATE 12/17/96 TITLE President DATE 10-31-96 --------------- ----------- --------------- ------------- 4
Lease payment Nos. Lease Rate Factors Adjustment Factors 1-12 .013173 .0000180 13-24 .015808 .0000216 25-72 .018443 .0000251
The words "legal staff of" are deleted from the last sentence of the third paragraph of Section 3. 4. SECTION 4. DELIVERY. The word "engineering," is added after the word "All" in the first sentence of Section 4. 5. SECTION 9. DISCLAIMER OF WARRANTIES AND DAMAGES. The words "ACTIVE GROSS" are deleted from the last line of the first paragraph of Section 9. 6. SECTION 10. INSURANCE. The word "reasonably" is added prior to the word "satisfactory" in the third sentence of Section 10. 7. SECTION 12. INDEMNITY. The words "active gross" are deleted from the second parenthetical in Section 12. 8. SECTION 13. TAX INDEMNITY. The text of Section 13 is deleted in its entirety and the following is substituted in lieu thereof: The Lease is entered into based on the assumptions ("Assumptions") that for federal, state, and local income tax purposes, Lessor: (a) shall be the owner of the System and (b) shall be entitled to deduct, at the highest marginal rate of tax imposed on corporations in effect on the date Lessee executes the Lease ("Execution Date") (i) interest expense incurred to finance the Price of the System, (ii) the maximum depreciation or cost recovery allowances provided in the Internal Revenue Code of 1986 in effect on the Execution Date, based on the Price, and (iii) any similar allowances provided for by state and local income tax codes in effect on the Execution Date, based on the Price. If, in its reasonable option, Lessor determines that its net after-tax economic yield or after-tax cash flow ("Net Economic Return") has been adversely affected as a result of a change in the Assumptions caused in whole or in part, directly or indirectly, by (x) any act or failure to act of Lessee, (y) the breach of or inaccuracy of any of Lessee's representations and warranties set forth in any Lease, or (z) any use of any System by Lessee which would prevent deductions for depreciation or cost recovery allowances as set forth above (a "Loss"), Lessee agrees to pay to Lessor, on demand, and amount which will cause Lessor's then Net Economic Return to equal the Net Economic Return that Lessor would have received had such Loss not occurred. For purposes of this paragraph, the term "Lessor" shall include any affiliated group of which Lessor is a member for purposes of filing consolidated tax return. Lessee agrees that it shall have no right to inspect the tax returns of Lessor. 9. SECTION 14 DEFAULT. The words "without Lessor's prior written consent" are added at the end of subsection (f) of Section 14 prior to the semicolon. The following is added as the second paragraph of Section 14. With respect to Section 14 (f) above, Lessor consents to the Reorganization defined and described as follows subject to the terms and conditions setforth below. Lessee is currently a corporation incorporated under the laws of the State of Nevada. On or before December 31, 1996, (a) Lessee will incorporate a wholly owned subsidiary under the laws of the State of Delaware under a name yet to be determined, and (b) merge the Nevada corporation into the Delaware corporation. The Nevada corporation will be merged out of existence with the Delaware corporation being the surviving corporation. As a result of the merger, all assets and liabilities of the Nevada corporation will be assets and liabilities of the Delaware corporation and all of the outstanding capital stock of the Nevada corporation will be exchanged by the shareholders for the common stock of the Delaware corporation. The foregoing is collectively called "Reorganization." Lessor's consent to this Reorganization is conditioned upon Lessee providing Lessor within five days of the date of Reorganization, the following: (a) a certified copy of the Articles of incorporation showing the name of the reorganized entity, (b) appropriate UCC financing statements, and (c) a document evidencing the assumption by the reorganized entity of all obligations of Lessee under this Lease, all of which shall be in a form and substance satisfactory to Lessor. 10. SECTION 17. ORGANIZATION AND AUTHORITY. The text of Section 17 is deleted in its entirety and the following substituted in lieu thereof: Lessee is duly organized, validly existing, and in good standing under the laws of the state of its formation and in any jurisdiction where a System is located. Lessee has the corporate power and authority to execute, deliver, and perform each Lease. The person executing this Agreement and any Schedules on behalf of Leases has been given authority to bind the Lessee, and each Lease constitutes or will constitute a legally binding and enforceable obligation of the Lessee, except as such enforcement may be limited by provision of applicable bankruptcy, insolvency, moratorium, or similar laws affecting the rights of creditors generally. The execution, deliver, and performance of each Lease is not and will not be in contravention of, or will not result in a breach of, any of the terms of Lessee's organizational documents, and any agreements, contracts, or instruments to which Lessee is a party or under which it is bound; provided, however, that Lessee shall not be deemed to have violated this representation as a result of any failure to comply that would not have a Material Advance Effect. 11. SECTION 19. JURISDICTION AND GOVERNING LAW. The text of Section 19 is deleted and the following substituted in lieu thereof EACH LEASE SHALL BE GOVERNED BY THE LAWS OF THE STATE OF CALIFORNIA. 12. SECTION 20. MISCELLANEOUS. The text of subsection (d) is deleted. The following new sections are added to the Agreement. Page 2 of 5 5 21. AFFIRMATIVE COVENANTS. In addition to other covenants set forth herein, Lessee hereby agrees that as long as this Agreement remains in effect or any amount is owing to Lessor or under any Lease, Lessee shall keep and perform fully each and all of the following covenants. Lessee shall: (a) Maintain it corporate existence, good standing and rights in full force and effect in its jurisdiction of incorporation. Lessee shall qualify and remain qualified and in good standing as a foreign corporation in each jurisdiction in which failure to receive or retain such qualification would have a Material Advance Effect on the business, operations or financial condition of Lessee as a whole. (b) Comply with all laws applicable to Lessee or its properties (including, without limitation, any employee benefit law, and tax law, securities law, product safety law, occupational safety or health law, communications and utilities law, environmental protection or pollution control law, and hazardous waste or toxic substances management, handling or disposal law) in all respect, provided that Lessee shall not be deemed to be in violation of this Section as a result of any failures to comply which would not results in fines, penalties, injunctive relief or other civil or criminal liabilities which, in the aggregate, would have a Material Advance Effect. (c) Lessee shall at all times obtain and maintain in force all authorizations, permits, consents, approvals, licenses, franchises, exemptions and other action by, and all registrations, qualifications, designations, declarations and other filings with, any governmental authority necessary in connection with execution and delivery of this Agreement, consummation of the transactions herein or therein contemplated, performance of or compliance with the terms and condition hereof or thereof or to ensure the legality, validity and enforceability hereof or thereof provided that Lessee shall not be deemed to be in violation of this Section as a result of any failure to comply which would not have a Material Advance Effect. (d) Pay its taxes and discharge its liabilities as and when due, except if contested in good faith by appropriate proceedings; (e) Comply in all respects with all material agreements or instruments to which it is a party or by which it or any of its properties are bound; and (f) Notify Lessor at least sixty (60) days prior to the date of Mr. Christopher Edgecomb ceases to be an employee. In the event of Mr. Christopher Edgecomb to be an employee of Lessee, and Lessor finds in its reasonable opinion that such cessation of employment will have a Material Advance Effect on Lessee, Lessee shall, within thirty (30) days of a receipt of a demand therefore, pay to Lessor (a) all Rent and any and all amounts then due and unpaid and (b) all Rent and other amounts to become due, by acceleration or otherwise discounted to present value using a five percent (5%) simple interest rate per annum, or if such rate is not permitted by law, then at the lowest permitted rate. Lessee shall either immediately return the System to Lessor or purchase the System for its then fair market value. Notwithstanding the foregoing, the preceding requirement shall be eliminated upon the occurrence of one of the following (a) NTFC receives satisfactory evidence that the Lessee has successfully completed an initial public offering of its stock in an amount not less than fifteen million dollars: or (b) NTFC determines that the Lessee has maintained a Debt Service Coverage Ratio in excess of 2.5:1 for two consecutive fiscal years. 22. FINANCIAL COVENANTS. In addition to other covenants set forth herein, Lessee hereby agrees that as long as this Agreement remains in effect or any amount is owing to Lessor or under any Lease, Lessee will comply with the following ratios and covenants on a consolidated and non-consolidated basis as such covenants may be adjusted in accordance with this Section; (a) A ratio of Current Assets to Current Liabilities of greater than 1.10:1. (b) Tangible Effective Net Worth in an amount not less than $17,500,000 as of 12/31/96, increasing to $22,500,000 by 6/30/97. (c) A ratio of Total Liabilities (less Subordinated Debt) to Tangible Effective Net Worth of less than 2.5:1.00 at 12/31/96, 3.0:1.00 at 3/31/97 and 2.75:1 at 6/30/97. (d) Net Income after taxes not less than $500,000 at 12/3196, $750,000 at 3/31/97 and $1,000,000 at 6/30/97. (e) A ratio, calculated in arrears on a rolling four quarter basis, of Cash Flow to Debt Service plus capital expenditures of not less than 1.75:1 at 12/31/96, 1.50:1 at 3/31/97 and 1.75:1 at 6/30/97 In the event the covenants contained in the Revolving Credit Loan and Security Agreement dated October 4, 1996 between Lessee and Metrobank ("Metrobank Loan") are amended, without further action on the part of Lessor and Lessee, the covenants contained in this Section shall be automatically amended to the extent necessary to be identical to the respective covenants in the Metrobank Loan, as amended. 23. REPORTING REQUIREMENTS. Lessee shall furnish to Lessor each of the following items: (a) As soon as practicable, and in any event within ninety (90) days after the close of each fiscal year of Lessee, Lessee shall furnish or cause to be furnished to Lessor consolidated statement of income, cash flow and retained earnings of Lessee for such fiscal year and the consolidated balance sheet of Lessee as of the close of such fiscal year, and notes to each, all in reasonable detail, and, beginning with Lessee's second full fiscal year, setting forth in comparative form the corresponding figures for the preceding fiscal year, with such consolidated statements and balance sheet to be certified (without qualification) by independent certified public accountants of recognized national standing selected by Lessee and reasonably satisfactory to Lessor. In addition, Lessee shall furnish consolidating work papers for the statements of income and balance sheet of Lessee an unaudited statement of all consolidating eliminations. (b) Within thirty (30) days after the last Business Day of each month (other than the last month of each fiscal year), Lessee shall furnish to Page 3 of 5 6 Lessor (i) unaudited consolidated statements of income, cash flow and retained earnings for Lessee for such month and for the period from the beginning of Lessee's then current fiscal year to the end of such month, and an unaudited consolidated balance sheet of Lessee as of the end of such month, all in reasonable detail and certified by a responsible officer of Lessee as presenting fairly the financial position of Lessee as of the end of such month and the results of their operations and the changes in their financial position for such month, in conformity with GAAP applied in a manner consistent with that of the most recent audited financial statements furnished to Lessor, subject to year end audit adjustments, and (ii) an aging of accounts payable and accounts receivable. (c) As soon as practical, and in any event within twenty (20) days of a receipt of a request therefore, Lessee shall provide Lessor with such other information concerning its business, records or financial conditions as Lessor may reasonably request including annual updates of five year projections. 24. Definitions. In addition to other words and terms defined elsewhere in a Lease, the following words and terms shall have the following meanings unless the context otherwise clearly requires. "Business Day" means a day other than a Saturday, Sunday or other day on which commercial banks in Nashville, Tennessee or California are authorized law to close. "Cash Flow" means during any fiscal period of Lessee, the sum of (i) net income (or loss) (which may be a positive or negative number) for such period plus (ii) all non-cash items deducted in determining such net income (or loss), minus (iii) all non-cash items added in determining such net income (or loss) during such period, less (iv) any equity payments or payments on Subordinated Debt made during such period. "Current Assets" means, as of any applicable date of determination, all cash, non-affiliated customer receivables, United States government securities, claims against the United States government, and inventories. "Current Liabilities" means, as of any applicable date of determination, (i) all liabilities of a Person that should be classified as current in accordance with GAAP, including without limitation any portion of the principal of the indebtedness classified as current, plus (ii) to the extent not otherwise included, all liabilities of the Lessee to any of its affiliates whether or not classified as current in accordance with GAAP. "Debt service" means for any fiscal period of Lessee, the sum of all principal and interest payments that Lessee is required to make during such period on account of all of its indebtedness including, without limitation, (a) amounts due during such period on account of capitalized leases, (b) the then current portion of any long-term indebtedness, (c) amounts due on short-term indebtedness, and (d) amounts due under this Agreement or any lease. "Debt Service Coverage Ratio" means at the end of any fiscal period, the ratio of Lessee's Cash Flow for such fiscal period to Lessee's Debt Service for such fiscal period. "GAAP" means as of any applicable period, generally accepted accounting principles in effect during such period. "Material Adverse Effect" means a material adverse effect on, or material adverse change in, all cases whether attributable to a single event or an aggregation of circumstances or events (i) the business operations or financial condition of Lessee, (ii) the ability of Lessees to perform obligations under any Lease, or (iii) Lessor's ability to enforce the rights and remedies granted under any Lease. "Net Income" means the net income (or loss) of a person for any period determined in accordance with GAAP but excluding in any event: (a) any gains or losses on the sale or other disposition, not in the ordinary course of business, of investments fixed or capital assets, and any taxes on the excluded gains and any tax deductions or credits on account on any excluded losses; and (b) in the case of the Lessee, net earning of any Person in which Lessee has an ownership interest, unless such net earning shall have actually been received by Lessee in the form of cash distributions. "Person" or "person" means and includes any individual, corporation, partnership, joint venture, association, trust, incorporated association, joint stock company, government, municipality, political subdivision or agency, or other entity. "Subordinated Debt" means indebtedness of the Lessee to third parties which has been subordinated to Lessee's obligations to Lessor pursuant to a subordination agreement in form and content satisfactory to Lessor. "Tangible Effective Net Worth" means net worth as determined in accordance with GAAP consistently applied, increased by Subordinated Debt, if any, and decreased by the following: patents, licenses, goodwill, subscription lists, organization expenses, trade receivable converted to notes, money due from affiliates (including officers, directors, subsidiaries and commonly held companies). "Total Liabilities" means the total of all items of indebtedness, obligations or liability which, in accordance with GAAP consistently applied, would be included in determining the total liabilities of the Lessee as of the date Total Liabilities is to be determined, including without limitation (a) all obligations secured by any mortgage, pledge, security interest or other lien on property owned or acquired, whether or not the obligations secured thereby shall have been assumed; (b) all obligations which are capitalized lease obligations; and (c) all guaranties, endorsements or other contingent or surety obligations with respect to the indebtedness of others, whether or not reflected on the balance sheets of the Lessee, including any obligation to furnish funds, directly or indirectly through the purchase of goods, suppliers, services or by the way of stock, capital 7 contribution, advance or loan or any obligation to enter into a contract for any of the foregoing. All financial covenants shall be computed in accordance with GAAP consistently applied except as otherwise specifically set forth in this Agreement. All monies due from affiliates (including officers, directors and shareholders) shall be excluded from Lessee's assets for all purposes hereunder. 8 Lessor NTFC Capital Corporation Agreement Addendum Lessee Star Vending, Inc. Agreement No. d/b/a Star Telecommunications, Inc. 54273 Contemporaneously with entering into the Agreement addendum dated October 31, 1996 relative to the Agreement referenced above, Lessee and Lessor agree to the following amendment to Agreement Addendum: 1. SECTION 3. RENT AND PAYMENT. The table contained in Section 3 of the Agreement Addendum is deleted and the following substituted in lieu thereof: "For Leases with Purchase Option B (FMV):
Lease Payment Nos. Lease Rate Factors Adjustment Factors - ------------------ ------------------ ------------------ 1-12 .013173 .0000180 13-14 .015808 .0000216 25-72 .018443 .0000251
For Lease with Purchase Option A ($1.00):
Lease Payment Nos. Lease Rate Factor Adjustment Factor - ------------------ ------------------ ------------------ 1-72 .019489 .000025
NTFC CAPITAL CORPORATION STAR VENDING, INC d/b/a STAR TELECOMMUNICATIONS, INC BY /s/ L.W. Middleton BY /s/ Mary Casey -------------------------------------- ----------------------------------- PRINT NAME L.W. Middleton PRINT NAME Mary Casey ----------------------------- -------------------------- TITLE Secretary DATE 12/31/96 TITLE President DATE 12/23/96 ------------- -------------- --------------- ---------- 9 Lessor Equipment Schedule NTFC CAPITAL CORPORATION Lessee STAR VENDING, INC. D/B/A STAR TELECOMMUNICATIONS, INC. Billing Address Attention 740 STATE STREET MARY CASEY, PRESIDENT SUITE 202 City State Zip Code SANTA BARBARA CA 93101 Installation Site City County State Zip Code 624 SOUTH GRAND AVENUE LOS ANGELES LOS ANGELES CA 90017 Supplier Name NW-CARRIER NETWORKS Agreement No./Schedule No. Price 54273 / 54273 $3,200,000.00 Date of Schedule Initial Term (months) 10/17/1996 072 Commitment Date Payment Period 10/10/96 /X/ Monthly / / Other________
Payment Nos. Lease Rate Factor Rent 1 - 12 0.0131730 $42,153.60 13 - 24 0.0158080 $50,585.60 25 - 72 0.0184430 $59,017.60
Purchase Option / / (A) $1.00 /X/ (B) FMV / / (C) ______________% Advance Payment $42,153.60 The Advance Payment shall be applied to the first 1 and last 0 Rent payment(s). TERMS AND CONDITIONS (The reverse side contains Terms and Conditions which are also a part of this Schedule) The terms and conditions of the Master Lease Agreement between Lessor and Lessee referenced above are made a part of this Schedule. Lessor and Lessee hereby agree to the terms defined above and further agree as set forth herein. 1. ADVANCE PAYMENT: Lessee shall pay to Lessor, upon the execution and delivery of this Schedule, the advance payment set forth above ("Advance Payment") in consideration of the Lessor holding funds available to purchase the Equipment and obtain the Software and as compensation for Lessor's review of Lessee's credit and document preparation. Upon Lessor's acceptance of the Lease, the Advance Payment shall be applied to the payment of Rent as set forth above. Any Advance Payment shall be non-refundable if Lessee fails to timely provide all documentation or satisfy all conditions required by this Lease. 2. PURCHASE PRICE PAYMENTS: Lessee acknowledges that it has signed and received a copy of the Supplier Agreement. If Lessee is required to make payments to Supplier under the Supplier Agreement prior to the Commencement Date ("Purchase Price Payments"), Lessee requests Lessor to pay such payments subject to the following terms and conditions. The Price will be increased by adding a price adjustment for each Purchase Price Payment. Each such price adjustment shall be computed by multiplying the Purchase Price Payment paid by Lessor to Supplier by a rate equal to the "Base Lending Rate" from time to time designated by Citibank N.A., NY, NY in effect on the date Lessor makes the first Purchase Price Payment plus two and one-half percent, divided by 360, and multiplied by the actual number of days elapsed from the date of the Purchase Price Payment to the Commencement Date or, if the Lease does not commence, to the date Lessee refunds the Purchase Price Payments to Lessor in accordance with Section 3. In no event will all or any price adjustment(s) exceed any limits imposed by applicable law. The periodic Rent shall be increased as a result of adding to the Price of the System an amount equal to the total price adjustment(s). 3. ACCEPTANCE: Lessee agrees to accept the System for purposes of this Lease by signing the Acceptance Certificate within ten (10) days after the System has met the acceptance criteria specified in the Supplier Agreement. If Lessee fails or refuses to sign the Acceptance Certificate within such (10) ten day period, Lessor may declare Lessee's assignments and Lessor's agreement to pay the Price set forth in Section 1 of the Agreement and Section 2 of this Schedule to be null and void ab initio and thereupon the Lease shall terminate. Lessor shall then have no obligations under the Lease and Lessee shall, within ten (10) days of a demand therefore, immediately pay to Lessor all Purchase Price Payments and all price adjustment(s) under Section 2 herein as well as Lessor's out-of-pocket expenses. 4. MAINTENANCE, USE, AND OPERATION: At all times during the Term, at its sole cost and expense, Lessee shall maintain the System in good repair, condition and working order, ordinary wear and tear excepted. Lessee shall use the System and all parts thereof for its designated purpose and in compliance with all applicable laws, shall keep the System in its possession and control and shall not permit the System to be moved from the Installation Site set forth above without Lessor's prior written consent. 5. PERSONAL PROPERTY: The System is, and shall at all times remain, personal property even if the Equipment is affixed or attached to real property or any improvements thereon. At Lessor's request, Lessee shall, at no charge, promptly affix to the System any tags, decals, or plates furnished by Lessor indicating Lessor's interest in the System and Lessee shall not permit their removal or concealment. At Lessee's expense, Lessee shall (a) at all times keep the System free and clear of all liens and encumbrances, except those described in Section 6 and those arising through the actions of Lessor, and (b) otherwise cooperate to defend lessor's interest in the System and to maintain the status of the System and all parts thereof as personal property. If requested by Lessor, Lessee will, at Lessee's expense, furnish a waiver of any interest in the System from any party having an A complete description of the System is set forth on the Equipment and Software Listing attached hereto and made a part hereof. NTFC CAPITAL CORPORATION BY /s/ L. W. MIDDLETON --------------------------------------- Authorized Representative PRINT NAME L. W. Middleton ------------------------------- TITLE Secretary DATE 12/17/96 ------------------- ---------- STAR VENDING, INC. D/B/A STAR TELECOMMUNICATIONS, INC. BY /s/ MARY CASEY --------------------------------------- Authorized Representative PRINT NAME Mary Casey ------------------------------- TITLE President DATE 11-5-96 ------------------- ---------- 10 interest in the real estate or building in which the System is located. Lessor may inspect the System and any related maintenance records at any time during Lessee's normal business hours. 6. TRUE LEASE AND SECURITY INTEREST: If Lessee has selected Purchase Option B, (a) Lessor holds title to the Equipment and the right to use the Software and Lessor shall be entitled to all tax benefits resulting therefrom, (b) Lessee shall have no right, title or interest therein, other than possession and use as a lessee and non-exclusive sublicensee, and (c) Lessee and Lessor intend the Lease to create a true lease and not a security interest, and the provisions of this Section or the filing of any financing statements with respect to the Lease shall not be deemed evidence of any contrary intent but of an attempt to protect Lessor's rights and title. Regardless of the purchase option selected, and without limiting or negating the foregoing sentence, to secure the performance of Lessee's obligations under this Lease including, without limitation, the repayment of any Purchase Price Payments, price adjustments and out-of-pocket expenses under Section 3 above, Lessee hereby grants to Lessor a first priority security interest in Lessee's existing and future right, title and interest in, to and under (i) the System including all additions, attachments, accessions, and leased Modifications and Additions (as defined in Section 7 below) thereto, and replacements therefor, (ii) the applicable Supplier Agreement, and (iii) all products and proceeds of the foregoing including, without limitation, insurance proceeds, rents and all sums due or to become due to Lessee without respect to any of the foregoing, and all monies received in respect thereof. 7. MODIFICATIONS, ADDITIONS AND ALTERATIONS: After the Commencement Date of this Lease and without notice to Lessor, Lessee may, at Lessee's expense, alter or modify any item of Equipment with an upgrade, accessory or any other equipment that meets the specifications of the System's manufacturer for use on or in connection with the System ("Modification") or with Software or other associated items or materials that meet the specifications of such manufacturer and are to be use on or in connection with such System ("Addition"). Any other modification or addition ("Alteration") shall be permitted only upon written notice to Lessor and at Lessee's expense and risk, and any such Alteration shall be removed and the System restored to its normal, unaltered condition at Lessee's expense prior to its return to Lessor. If not removed upon return of the System, any Modification or Addition shall become, without charge, the property of Lessor free and clear of all encumbrances. Restoration will include replacement of any parts removed in connection with the installation of an Alteration, Modification or Addition. Any Equipment or Software installed in connection with warranty or maintenance service or manufacturer's upgrades provided at no charge to Lessee shall be the property of Lessor. 8. LEASES FOR MODIFICATIONS AND ADDITIONS: During the Term of this Lease, at Lessee's request, Lessor may elect to lease to Lessee Modifications and Additions ("CSO Equipment") subject to the terms of this Lease. While the CSO Equipment shall be added to and become a part of this Lease as of the CSO Commencement Date (as defined below), the CSO Lease Addendum shall be assigned a separate Schedule number. The lease for CSO Equipment shall expire at the same time as this Lease. The applicable Lease Rate Factor shall be Lessor's then-current Lease Rate Factor for similar transactions based upon the remaining length of the Term. The rent for CSO Equipment shall be determined by Lessor who shall adjust the then-current Rent and notify Lessee in writing of such adjustment(s), which shall be effective as of the first day of the month following the date of the notice (or the date of the notice if it is the first day of the month) ("CSO Commencement Date"). Any adjustment notice shall be added to and become a part of this Lease. CSO Equipment must be ordered by Lessee from the Supplier. On the date any CSO Equipment is delivered to Lessee, Supplier shall pass title to such CSO Equipment (other than any Software which shall be licensed and/or sublicensed) directly to Lessor. Such title shall be good and marketable and free and clear of any and all liens and encumbrances of any nature whatsoever. Lessor shall promptly pay to Supplier the appropriate price of the CSO Equipment after the later of (a) the date the CSO Equipment is installed and functioning, or (b) Lessor's receipt of a full and complete listing of the CSO Equipment and the Supplier's invoice. No interest shall be payable by Lessor to Supplier with respect to such payment. Lessor's agreement to lease any CSO Equipment is subject to the condition that the Price payable to Supplier with respect thereto shall not exceed $100,000.00 or be less than $1,000.00, and is subject to satisfactory credit review by Lessor of Lessee's credit at the time of the CSO. 9. RETURN OF SYSTEM: (a) Upon any termination of this Lease pursuant to the term hereof prior to the end of the Term, (b) at Lessor's request upon the occurrence of an Event of Default, or (c) if Lessee has not exercised its Purchase Option set forth herein at the end of the applicable Term, Lessee shall, at its own risk and sole expense, immediately return the System to Lessor by properly removing, disassembling and packing it for shipment, loading it on board a carrier acceptable to Lessor, and shipping the same to a destination in the continental United States specified by Lessor, freight and insurance prepaid. The returned System shall be in the same condition and operating order as existed when received, ordinary wear and tear excepted. If the Lessee does not immediately return the System to Lessor as required, Lessee shall pay to Lessor, on demand, an amount equal to the then-current Rent prorated on a daily basis for each day from and including the termination or expiration date of the Lease through and including the day Lessee ships the System to Lessor in accordance with this Section . Lessee shall pay to Lessor, upon written demand, any amount necessary to place the System in good repair, condition and working order, ordinary wear and tear excepted. 10. PURCHASE OPTION: At the expiration of the initial Term or any Term, if Lessee has performed all terms and conditions of the Lease, except the return of the System pursuant ot Section 9 herein, Lessee shall have the right to purchase all, but not less than all, of the Equipment and all leased Modifications and to receive an assignment of all, but not less than all, non-exclusive sublicenses to use the Software and Additions, if any, for the purchase price described below subject to the following terms and conditions: If Lessee has elected Purchase Option B or C above, Lessee shall provide written notice to Lessor at least six (6) months prior to such purchase that Lessee has elected to exercise its Purchase Option. In any event, upon exercise of its purchase option, Lessee shall purchase the Equipment and all leased Modifications and obtain a non-exclusive sublicense to use the associated Software and Additions, AS-IS, WHERE-IS, WITH ALL FAULTS AND SUBJECT TO THE SAME DISCLAIMERS OF WARRANTIES AND DAMAGES AS SET FORTH IN SECTION 9 OF THE AGREEMENT. Lessee also shall be responsible for the payment of any sales tax or other fees in connection with Lessee's exercise of this Purchase Option. The purchase price shall be due and payable to Lessor by Lessee at the expiration of the applicable Term. Upon satisfaction by Lessee of the purchase conditions, Lessor's sole and exclusive obligations under this Purchase Option shall be to deliver to Lessee good title to such Equipment and leased Modifications such as Lessor received from the Supplier, to assign to Lessee a non-exclusive sublicense, as described in the Supplier Agreement, to use the associated Software and Additions, free and clear of all liens, encumbrances and rights of others arising solely out of or created by Lessor's actions. Lessor's assignment of the sublicense is limited to such sublicense as Lessor can assign without incurring further cost and is subject to all applicable terms and conditions of the license and/or sublicense set forth in the Supplier Agreement. The purchase price shall be as follows: (a) Purchase Option A. If Lessee has selected Purchase Option A above, the purchase price shall be $1.00. (b) Purchase Option B. If Lessee has selected Purchase Option B above, the purchase price shall be the installed fair market value thereof assuming the System is in good repair, condition and working order, ordinary wear and tear excepted ("FMV"). The FMV shall be determined by Lessor and Lessee. If Lessor and Lessee are unable to agree, the FMV shall be determined by an independent appraiser selected by Lessor and approved by Lessee which approval shall not be unreasonably withheld or delayed. Lessee shall bear the fees of the appraiser. (c) Purchase Option C. If Lessor has selected Purchase Option C, the purchase price shall be the product obtained by multiplying the Price, as it may have been adjusted, by the percent set forth in Option C above. 11. LEASE RATE: By signing a Lease with a Purchase Option A or Purchase Option C, Lessee agrees to pay Rent (consisting of a principal payment for Equipment and, if applicable, Software, Maintenance, and/or other costs) based on the Price of such items and a Lease charge derived from an implied interest rate ("Lease Rate"). The Lease Rate, as used to calculate the portion of each monthly Rent payment that constitutes a lease charge, may be determined by applying to the Price, the rate that will amortize such Price (adjusting for any Advance Rent) down to the amount of the Purchase Option at a constant rate over the Initial Term by payment of the monthly Rent. The Lease Rate is the constant rate referred to in the preceding sentence. The Lease Rate can also be calculated using the Price as the present value, the Purchase Option as the future value, the Rent as the payment and the stated Term. 11 Lessor Equipment and Software Listing NTFC CAPITAL CORPORATION Lessee STAR VENDING, INC. Agreement No./Schedule No. D/B/A STAR TELECOMMUNICATIONS, INC. 54273 / 54273 Lessor and Lessee agree that the following described Equipment and Software are subject to the Master Lease Agreement and Schedule referenced above. 1 DMS 250/300 SWITCH 12 Lessor Schedule Addendum NTFC CAPITAL CORPORATION Lessee Star Vending, Inc. Agreement No./Schedule No. d/b/a Star Technologies, Inc. 54273 / 54273 Contemporaneously with entering into the Schedule to the Agreement referenced above, Lessee and Lessor agree to the following amendments to the Schedule. 1. SECTION 1. ADVANCE PAYMENT. The word "Any" is deleted as the first word of the last sentence of Section 1 and the words "An amount equal to fifty percent (50%) of any" substituted in lieu thereof. 2. SECTION 4. MAINTENANCE, USE AND OPERATION. The words "to the extent such release may be obtained from or through Supplier" are added at the end of the second sentence of Section 4. 3. SECTION 5. PERSONAL PROPERTY. The words "upon not less than forty-eight (48) hours prior written notice by Lessor to Lessee" are added as the final words of the last sentence of Section 5. NTFC CAPITAL CORPORATION BY /s/ L. W. MIDDLETON ------------------------------------ Authorized Representative PRINT NAME L. W. Middleton ---------------------------- TITLE Secretary DATE 12/17/96 ---------------- ----------- STAR VENDING, INC. d/b/a STAR TELECOMMUNICATIONS, INC. BY /s/ MARY CASEY ------------------------------------ Authorized Representative PRINT NAME Mary Casey ---------------------------- TITLE President DATE 11-5-96 ---------------- ----------- 13 Lessor Acceptance Certificate NTFC CAPITAL CORPORATION Lessee STAR VENDING, INC. Agreement No./Schedule No. D/B/A STAR TELECOMMUNICATIONS, INC. 54273 / 54273 This Acceptance Certificate is made with respect to that Master Lease Agreement and Schedule referenced above. Capitalized terms used herein shall have the same meanings assigned to them in the Agreement and the Schedule. On behalf of Lessee, I hereby certify that all of the System described in the Schedule to the Agreement has been delivered to and received by the Lessee. The System has been examined by the Lessee and is in good operating order and condition and is satisfactory to the Lessee. Therefore, the System is irrevocably accepted by the Lessee for all purposes under the Lease as of the following date: 11-5-96 - ----------------------------------------- (Insert Date of Acceptance) By /s/ MARY CASEY -------------------------------------- Authorized Representative Print Name Mary Casey ------------------------------ Title President Date 11-5-96 --------------- ------------- 14 Lessor Equipment Schedule NTFC CAPITAL CORPORATION Lessee STAR VENDING, INC. D/B/A STAR TELECOMMUNICATIONS, INC. Billing Address Attention 740 STATE STREET MARY CASEY, PRESIDENT SUITE 202 City State Zip Code SANTA BARBARA CA 93101 Installation Site City County State Zip Code 60 HUDSON STREET SUITE 1215 NEW YORK, NEW YORK, NY 10013 Supplier Name NORTEL COMMUNICATIONS SYSTEMS, INC. Agreement No./Schedule No. Price 54273/3002296-002 $3,200,000.00 Date of Schedule Initial Term (months) 12/18/96 072 Commitment Date Payment Period 12-20-96 /X/ Monthly / / Other_________
Payment Nos. Lease Rate Factor Rent 1 - 72 .019489 $62,364.80
Purchase Option /X/ (A) $1.00 / / (B) FMV / / (C) ______________% Advance Payment $62,364.80 -------------------- The Advance Payment shall be applied to the first 1 and last 0 Rent payment(s). TERMS AND CONDITIONS (The reverse side contains Terms and Conditions which are also a part of this Schedule) The terms and conditions of the Master Lease Agreement between Lessor and Lessee referenced above are made a part of this Schedule. Lessor and Lessee hereby agree to the terms defined above and further agree as set forth herein. 1. ADVANCE PAYMENT: Lessee shall pay to Lessor, upon the execution and delivery of this Schedule, the advance payment set forth above ("Advance Payment") in consideration of the Lessor holding funds available to purchase the Equipment and obtain the Software and as compensation for Lessor's review of Lessee's credit and document preparation. Upon Lessor's acceptance of the Lease, the Advance Payment shall be applied to the payment of Rent as set forth above. Any Advance Payment shall be non-refundable if Lessee fails to timely provide all documentation or satisfy all conditions required by this Lease. 2. PURCHASE PRICE PAYMENTS: Lessee acknowledges that it has signed and received a copy of the Supplier Agreement. If Lessee is required to make payments to Supplier under the Supplier Agreement prior to the Commencement Date ("Purchase Price Payments"), Lessee requests Lessor to pay such payments subject to the following terms and conditions. The Price will be increased by adding a price adjustment for each Purchase Price Payment. Each such price adjustment shall be computed by multiplying the Purchase Price Payment paid by Lessor to Supplier by a rate equal to the "Base Lending Rate" from time to time designated by Citibank N.A., NY, NY in effect on the date Lessor makes the first Purchase Price Payment plus two and one-half percent, divided by 360, and multiplied by the actual number of days elapsed from the date of the Purchase Price Payment to the Commencement Date or, if the Lease does not commence, to the date Lessee refunds the Purchase Price Payments to Lessor in accordance with Section 3. In no event will all or any price adjustment(s) exceed any limits imposed by applicable law. The periodic Rent shall be increased as a result of adding to the Price of the System an amount equal to the total price adjustment(s). 3. ACCEPTANCE: Lessee agrees to accept the System for purposes of this Lease by signing the Acceptance Certificate within ten (10) days after the System has met the acceptance criteria specified in the Supplier Agreement. If Lessee fails or refuses to sign the Acceptance Certificate within such (10) ten day period, Lessor may declare Lessee's assignments and Lessor's agreement to pay the Price set forth in Section 1 of the Agreement and Section 2 of this Schedule to be null and void ab initio and thereupon the Lease shall terminate. Lessor shall then have no obligations under the Lease and Lessee shall, within ten (10) days of a demand therefore, immediately pay to Lessor all Purchase Price Payments and all price adjustment(s) under Section 2 herein as well as Lessor's out-of-pocket expenses. 4. MAINTENANCE, USE, AND OPERATION: At all times during the Term, at its sole cost and expense, Lessee shall maintain the System in good repair, condition and working order, ordinary wear and tear excepted. Lessee shall use the System and all parts thereof for its designated purpose and in compliance with all applicable laws, shall keep the System in its possession and control and shall not permit the System to be moved from the Installation Site set forth above without Lessor's prior written consent. 5. PERSONAL PROPERTY: The System is, and shall at all times remain, personal property even if the Equipment is affixed or attached to real property or any improvements thereon. At Lessor's request, Lessee shall, at no charge, promptly affix to the System any tags, decals, or plates furnished by Lessor indicating Lessor's interest in the System and Lessee shall not permit their removal or concealment. At Lessee's expense, Lessee shall (a) at all times keep the System free and clear of all liens and encumbrances, except those described in Section 6 and those arising through the actions of Lessor, and (b) otherwise cooperate to defend Lessor's interest in the System and to maintain the status of the System and all parts thereof as personal property. If requested by Lessor, Lessee will, at Lessee's expense, furnish a waiver of any interest in the System from any party having an A complete description of the System is set forth on the Equipment and Software Listing attached hereto and made a part hereof. NTFC CAPITAL CORPORATION BY /s/ L. W. MIDDLETON ----------------------------------------- Authorized Representative PRINT NAME L. W. Middleton --------------------------------- TITLE Secretary DATE 12/31/96 ----------------- ------------- STAR VENDING, INC. D/B/A STAR TELECOMMUNICATIONS, INC. BY /s/ MARY CASEY ----------------------------------------- Authorized Representative PRINT NAME Mary Casey --------------------------------- TITLE President DATE 12-23-96 ----------------- ------------- 15 Lessor Schedule Addendum NTFC CAPITAL CORPORATION Lessee Star Vending, Inc. Agreement No./Schedule No. d/b/a Star Telecommunications, Inc. 54273 / 3002296-002 Contemporaneously with entering into the Schedule to the Agreement referenced above, Lessee and Lessor agree to the following amendments to the Schedule. 1. SECTION 1. ADVANCE PAYMENT. The word "Any" is deleted as the first word of the last sentence of Section 1 and the words "An amount equal to fifty percent (50%) of any" substituted in lieu thereof. 2. SECTION 4. MAINTENANCE, USE AND OPERATION. The words "to the extent such release may be obtained from or through Supplier" are added at the end of the second sentence of Section 4. 3. SECTION 5. PERSONAL PROPERTY. The words "upon not less than forty-eight (48) hours prior written notice by Lessor to Lessee" are added as the final words of the last sentence of Section 5. NTFC CAPITAL CORPORATION BY /s/ L. W. MIDDLETON --------------------------------------- Authorized Representative PRINT NAME L. W. Middleton ------------------------------- TITLE Secretary DATE 12/31/96 ---------------- ----------- STAR VENDING, INC. d/b/a STAR TELECOMMUNICATIONS, INC. BY /s/ MARY CASEY --------------------------------------- Authorized Representative PRINT NAME Mary Casey ------------------------------- TITLE President DATE 12-23-96 ---------------- ----------- 16 Lessor Equipment and Software Listing NTFC CAPITAL CORPORATION Lessee STAR VENDING, INC. Agreement No./Schedule No. D/B/A STAR TELECOMMUNICATIONS, INC. 54273/3002296-002 Lessor and Lessee agree that the following described Equipment and Software are subject to the Master Lease Agreement and Schedule referenced above. DMS 250/300 SWITCH 17 STAR VENDING, INC. d/b/a/ STAR TELECOMMUNICATIONS, INC. ACCOUNT SCHEDULE #3002296-002 Legal Description of Property: BEGINNING, at the corner formed by the intersection of the northerly side of Thomas Street and the westerly side of West Broadway, running thence northerly along the westerly side of West Broadway 180 feet, more or less, to the southerly side of Worth Street; thence westerly along the southerly side of Worth Street 329 feet, more or less, to the northeasterly side of Hudson Street, thence southeasterly along the northeasterly side of Hudson Street 193 feet 5 inches to the northerly side of Thomas Street, thence easterly along the northerly side of Thomas Street 254 feet, more or less, to the westerly side of West Broadway and the point or place of beginning. 18 Lessor Acceptance Certificate NTFC CAPITAL CORPORATION Lessee STAR VENDING, INC. Agreement No./Schedule No. D/B/A STAR TELECOMMUNICATIONS, INC. 54273/3002296-002 This Acceptance Certificate is made with respect to that Master Lease Agreement and Schedule referenced above. Capitalized terms used herein shall have the same meanings assigned to them in the Agreement and the Schedule. On behalf of Lessee, I hereby certify that all of the System described in the Schedule to the Agreement has been delivered to and received by the Lessee. The System has been examined by the Lessee and is in good operating order and condition and is satisfactory to the Lessee. Therefore, the System is irrevocably accepted by the Lessee for all purposes under the Lease as of the following date: December 17, 1996 - -------------------------------------- (Insert Date of Acceptance) By /s/ MARY CASEY ----------------------------------- Authorized Representative Print Name Mary Casey --------------------------- Title President Date 12-23-96 --------------- ----------- EX-10.23 5 LINE OF CREDIT PROMISSORY NOTE DATED 11/7/96 1 EXHIBIT 10.23 LINE OF CREDIT PROMISSORY NOTE 1. FUNDAMENTAL PROVISIONS The following terms will be used as defined terms in this Note: Date of this Note: NOVEMBER 7, 1995 Borrower: STAR VENDING, INC. Lender: CHRISTOPHER E. EDGECOMB Principal Amount: $248,042.49 Interest Rate: 5.90 PERCENT PER ANNUM Maturity Date: NOVEMBER 6, 1996 Prepayment Charge: NONE Default Rate: THE MAXIMUM RATE PERMITTED BY CALIFORNIA LAW, NOT TO EXCEED FIFTEEN PERCENT (15%) 2. PROMISE TO PAY For good and valuable consideration, Borrower promises to pay to Lender, or order, the Principal Amount, or so much thereof as is advanced (pursuant to the terms of this Note) and outstanding, with interest at the Interest Rate from the dates of the respective advances by Lender, or at the Default Rate as hereinafter provided, until paid, in accordance with the terms contained herein. The unpaid balance of this obligation at any time shall be the total amounts advanced hereunder less the amount of payments made hereon by or for Maker, which balance may be endorsed from time to time by Holder at Exhibit A hereto. Interest shall be computed on the basis of a 360-day year and the actual number of days elapsed. Should any interest not be paid when due, it shall thereafter accrue interest as principal. 3. LIMITATIONS ON ADVANCES The total advances hereunder may not exceed $248,042.49. Advances of the amounts described in this Note may be made by Lender to Borrower at the oral or written request of Mr. Christopher E. Edgecomb, President. 4. PAYMENTS - 1 - 2 The Principal Amount (as advanced hereunder from time to time) and all accrued and unpaid interest shall be due and payable on the Maturity Date. All payments prior to the Maturity Date, if any, shall be applied first to accrued interest, and then to the principal balance. 5. PLACE AND MANNER OF PAYMENT All payments shall be made to Lender at 4167 Creciente Drive, Santa Barbara, California or at such other place as the holder of this Note may from time to time designate. All payments shall be made in lawful money of the United States. Checks will constitute payment only when collected. 6. LATE CHARGES If Maker fails to pay any installment of interest on this Note within ten (10) days when due, then (in addition to any other remedies available to Holder) Maker shall be subject to and shall pay a late charge of ten percent (10%) of the amount of the installment due. 7. DEFAULT INTEREST RATE Commencing on the first to occur of (a) the Maturity Date, or (b) the occurrence of an Event of Default followed by the acceleration of this Note and the lapse of such time (if any) as may then be required by law during which lender must allow Borrower to reinstate the obligation evidenced hereby as if no acceleration had occurred, and continuing thereafter until this Note has been paid in full, all amounts due and owing under this Note shall bear interest at the Default Rate. The provisions of this Paragraph shall not limit the Lender's right to compel prompt performance hereunder. 8. PREPAYMENTS All amounts due under this Note may be prepaid without penalty. 9. EVENT OF DEFAULT At the option of Lender, it shall be an "Event of Default" hereunder if (a) Borrower fails to pay when due any sum payable under this Note, (b) Borrower fails to perform any obligation or commits a breach of any agreement set forth in this Note, or (c) if Borrower makes an assignment for the benefit of creditors, or if a petition is filed by or against Borrower under the provisions of the Bankruptcy Code. 10. ACCELERATION - 2 - 3 Upon the occurrence of an Event of Default, then, at the option of Lender, the entire sum of principal, interest, and all other charges due under this Note shall become immediately due and payable. 11. ATTORNEYS' FEES If Lender refers this Note to an attorney to enforce, construe or defend any provision hereof, or as a consequence of any Event of Default hereunder, with or without the filing of any legal action or proceeding, Borrower shall pay to Lender upon demand the amount of all attorneys' fees, costs and other expenses incurred by Lender in connection therewith, together with interest thereon from the date of demand at the rate applicable to the principal balance of this Note. The reference to "attorneys' fees" in this Paragraph shall include without limitation such amounts as may then be charged by Lender for legal services furnished by attorneys in the employ of Lender, at rates not exceeding those that would be charged by outside attorneys for comparable services. 12. WAIVER No delay or omission of Lender in exercising any right or power arising in connection with any Event of Default shall be construed as a waiver or as an acquiescence therein, nor shall any single or partial exercise thereof preclude any further exercise thereof. Lender may, at his option, waive any of the conditions herein and no such waiver shall be deemed to be a waiver of Lender's rights hereunder, but rather shall be deemed to have been made in pursuance of this Note and not in modification thereof. No waiver of any Event of Default shall be construed to be a waiver of or acquiescence in or consent to any preceding or subsequent Event of Default. 13. WAIVER OF NOTICES Borrower, and all endorsers, all guarantors and all persons liable or to become liable on this Note waive presentment, protest, demand, notice of protest, dishonor or non-payment of this Note, and any and all other notices or matters of a like nature, consent to any and all renewals and extensions of the time of payment hereto, and agree further that at any time and from time to time without notice, the terms of payment hereof may be modified, or the security described in any of the Loan Documents at any time securing this Note may be released in whole or in part, or increased, changed or exchanged by agreement between the holder hereof and any owner of the Collateral or other collateral affected thereby, without in any way affecting the liability of any party to this Note, any endorser, any guarantor, or any person liable or to become liable with respect - 3 - 4 to any indebtedness evidenced hereby. 14. MISCELLANEOUS PROVISIONS No provision of this Note may be amended, modified, supplemented, changed, waived, discharged or terminated unless Lender consents thereto in writing. In case any one or more of the provisions contained in this Note should be held to be invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions contained herein shall not in any way be affected or impaired thereby. This Note shall be binding upon and inure to the benefit of Borrower, Lender and their respective successors and assigns. This Note is not assumable. The Note Holder shall have the right to sell, assign or otherwise transfer, either in part or in its entirety, this Note or the Loan Documents, without Borrower's consent, with any such transferee being entitled to be treated in all favorable respects as a holder or holders in due course. Time is of the essence of this Note and the performance of each of the covenants and agreements contained herein. This Note shall be governed by and construed in accordance with the laws of the State of California. If Borrower consists of more than one person or entity, the obligations of Borrower shall be the joint and several obligations of all such persons or entities, and any married person who executes this Note agrees that recourse may be had against his or her separate property for satisfaction of his or her obligations hereunder. IN WITNESS WHEREOF, Borrower has executed this Note on the Date of this Note. BORROWER: STAR VENDING, INC., a Nevada corporation By -------------------------------------- Christopher E. Edgecomb, President By -------------------------------------- Mary Casey, Secretary - 4 - 5 EXHIBIT A Outstanding balances, as enclosed by holder - 5 - 6 MODIFICATION OF LINE OF CREDIT PROMISSORY NOTE THIS MODIFICATION OF LINE OF CREDIT PROMISSORY NOTE (the "Modification") is executed between STAR VENDING, INC., a Nevada corporation (the "Borrower") and CHRISTOPHER E. EDGECOMB (the "Lender"). Borrower previously executed that certain Line of Credit Promissory Note dated November 7, 1995 (the "Note") (see copy attached as Exhibit A), under which Borrower promised to pay certain amounts to Lender under the terms and conditions set forth in such Note. The full amount of the principal and accrued and unpaid interest of the Note became due and payable on November 6, 1996. Borrower failed to pay the full amount owed at the Maturity Date, as set forth in the Note, which failure constitutes an Event of Default, as defined in the Note. Lender has waived his right to take any actions allowed under the Note resulting from Borrower's default, and has agreed with Borrower to modify the terms of the Note as follows: 1. MODIFICATION DATE. The date of this modification of the Note is December 31, 1996 (the "Modification Date"). 2. PRINCIPAL AMOUNT. The total remaining amount owed under the Note as December 31, 1996 is $248,042.49 (the "Principal Amount"). 3. INTEREST RATE. The interest rate of the Note from the Modification Date through Maturity Date shall be nine percent (9%) per annum. 4. MATURITY DATE. The Maturity Date for the Note shall be March 30, 1998. 5. NO OTHER MODIFICATIONS. In all other respects, the terms and conditions of the Note shall remain unchanged. IN WITNESS WHEREOF, the parties have executed this Modification effective as of the Modification Date. BORROWER: LENDER: STAR VENDING, INC. By: ------------------------------------- ------------------------------------- Mary Casey, President Christopher E. Edgecomb - 1 - 7 EXHIBIT A ORIGINAL PROMISSORY NOTE EX-10.24 6 OFFICE LEASE AGREEMENT DATED APRIL 1, 1997 1 EXHIBIT 10.24 - ------------------------------------------------------------------------------- ALLIANZ FINANCIAL CENTRE - ------------------------------------------------------------------------------- OFFICE LEASE AGREEMENT Between BEVERLY HILLS CENTER LLC as Landlord and STAR VENDING, INC. as Tenant Dated January 29, 1997 2 TABLE OF CONTENTS
Page 1. DEFINITIONS AND BASIC PROVISIONS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 2. GRANTING CLAUSE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 3. EARLY OCCUPANCY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 4. RENTAL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 5. USE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 6. SERVICES TO BE PROVIDED BY LANDLORD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 7. REPAIR AND MAINTENANCE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 8. FIRE AND OTHER CASUALTY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 9. COMPLIANCE WITH LAWS AND USAGE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 10. LIABILITY AND INDEMNITY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 11. ADDITIONS AND FIXTURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 12. ASSIGNMENT AND SUBLETTING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 13. SUBORDINATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 14. OPERATING EXPENSES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 15. EMINENT DOMAIN . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 16. ACCESS BY LANDLORD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 17. LANDLORD'S LIEN . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 18. DEFAULTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 19. NONWAIVER . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 20. HOLDING OVER . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 21. COMMON AREA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 22. RULES AND REGULATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 23. TAXES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 24. INSURANCE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 25. PARKING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
i 3 26. PERSONAL LIABILITY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 27. NOTICE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 28. LANDLORD'S MORTGAGEE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 29. BROKERAGE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 30. PREPAID RENTAL AND SECURITY DEPOSIT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 31. SPRINKLERS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 32. ROOFTOP RIGHTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 33. INTERCONNECTION RIGHTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 36. REMOVAL OF ABOVE-CEILING ALTERATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 37. DELIVERY OF LEASED PREMISES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 38. RENEWAL OPTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 39. MISCELLANEOUS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 40. ENTIRE AGREEMENT AND BINDING EFFECT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
EXHIBIT A LEASED PREMISES EXHIBIT B LAND EXHIBIT C RULES AND REGULATIONS EXHIBIT D EMERGENCY GENERATOR AND HVAC LOCATIONS EXHIBIT E NON-DISTURBANCE AND ATTORNMENT AGREEMENT EXHIBIT F APPROVED CONTRACTORS ii 4 OFFICE LEASE AGREEMENT 1. DEFINITIONS AND BASIC PROVISIONS. A. Date of Lease: January 29, 1996. B. "Landlord": Beverly Hills Center LLC C. Address of Landlord: 2323 Bryan Street, Suite 2020 Lock Box 120 Dallas, Texas 75201 D. "Tenant": Star Vending, Inc. E. Address of Tenant: 223 E. De La Guerra Street Santa Barbara, CA 93101 F. "Building": The structure commonly known as the Allianz Financial Centre and which is located on the 0.8437 acre tract of land (the "Land") described by metes and bounds on Exhibit B attached hereto and made a part hereof for all purposes. G. "Leased Premises": Approximately 6,167 square feet of rentable area on the third (3rd) floor of the Building, as outlined and hatched on the floor plan attached hereto as Exhibit A and made a part hereof for all purposes. Tenant acknowledges that Tenant has had the opportunity to measure the Leased Premises and that there has been applied to the usable square footage of the Leased Premises a common area factor to arrive at the rentable square footage of the Leased Premises. Therefore, Landlord and Tenant hereby stipulate that notwithstanding anything herein to the contrary, the Leased Premises shall be deemed to consist of 6,167 rentable square feet, and that no shortage or overage in the rentable square feet of the Leased Premises purported by either party shall be the basis for changing the number of rentable square feet herein stipulated. H. "Project": The Building, the parking facilities, parking garage, the Skybridge and other structures, improvements, landscaping, fixtures, appurtenances and other common areas now or hereafter, constructed or erected on the Land. I. "Rentable area in the Building" shall be 464,542 square feet of rentable area, unless modified as provided herein. J. "Commencement Date": Sixty (60) days after Landlord delivers the Leased Premises to Tenant. The estimated Commencement Date is April 1, 1997. Upon request of either party hereto, Landlord and Tenant agree to execute and deliver a written declaration in recordable form expressing the Commencement Date hereof. 1 5 K. "Term": Commencing on the Commencement Date and ending ten (10) years after the Commencement Date, plus any partial calendar month following the Commencement Date, unless sooner terminated as provided herein. L. "Base Rental": $123,340.00 per year for the first ten (10) years of the Term of this Lease, payable in equal monthly installments of $10,278.33 each; each such monthly installment shall be due and payable on the first day of each calendar month, monthly in advance without demand and without setoff or deduction whatsoever. Tenant's rental obligations with respect to the first eight (8) diameter inches of conduits or equivalent cable runs (the "Initial Conduits") shall be abated during the Term and any extensions thereof. In the event at Tenant's request Landlord permits Tenant to install additional conduits on equivalent cable runs in excess of Initial Conduits, Tenant shall pay a riser fee ("Riser Fee") with respect to such additional installations in an amount equal to the then prevailing market riser fee rate; provided, however, that during the first ten (10) years of the Term, the Riser Fee shall be $250.00 per month per one inch diameter of conduit or equivalent cable run. The foregoing shall apply to all conduits and equivalent cable runs installed by or on behalf of Tenant, including, without limitation, conduits and equivalent cable runs related to Paragraph 33, the Emergency Power Installation and the HVAC Installation (as defined in Paragraphs 34 and 35, respectively) which exceed the Initial Conduits. M. "Prepaid Rental": $10,278.33, to be applied to the first accruing monthly installments of rental. N. "Security Deposit": $10,278.33. O. "Permitted Use": The Leased Premises shall be used only for office purposes and for a telecommunications facility. P. "Common Area": That part of the Project designated by Landlord from time to time for the common use of all tenants, including among other facilities, the Skybridge, sidewalks, service corridors, curbs, truckways, loading areas, private streets and alleys, lighting facilities, mechanical and electrical rooms, janitors' closets, halls, lobbies, delivery passages, elevators, drinking fountains, meeting rooms, public toilets, parking areas and garages, decks and other parking facilities, landscaping and other common rooms and common facilities. Q. "Prime Rate": The rate announced as such from time to time by Chase Manhattan Bank, N.A., or its successors, at its principal office. R. "Broker": Cushman & Wakefield of Texas The MTA Company S. "Parking": Three (3) parking spaces for three (3) vehicles or the placement of equipment, subject, however, to the payment of prevailing market rental established from time to time for similar parking spaces and further subject to the other terms, covenants and conditions specified in Paragraph 25 hereof. Notwithstanding the foregoing or anything in Paragraph 25 to the contrary, during the first ten (10) years of the Term, Tenant's rental obligations with respect to such three (3) parking spaces shall be $120.00 (plus applicable taxes) 2 6 per month per parking space utilized for a vehicle and $250.00 (plus applicable taxes) per month per parking space utilized for equipment. T. "Base Operating Expenses Rate": The Actual Operating Expenses Rate for the 1997 calendar year. U. "Skybridge": The aerial walkway connecting the Building with the Plaza of the Americas, together with any alterations, improvements and/or replacements thereof. Each of the foregoing definitions and basic provisions shall be construed in conjunction with the references thereto contained in the other provisions of this Lease and shall be limited by such other provisions. Each reference in this Lease to any of the foregoing definitions and basic provisions shall be construed to incorporate each term set forth above under such definition or provision. 2. GRANTING CLAUSE. Landlord, in consideration of the covenants and agreements to be performed by Tenant, and upon the terms and conditions hereinafter stated, does hereby lease, demise and let unto Tenant, and Tenant does hereby lease from Landlord, the Leased Premises specified in Paragraph 1.G. hereof to have and to hold for the Term of this Lease, as specified in Paragraph 1.K. hereof. 3. EARLY OCCUPANCY. Any occupancy of the Leased Premises by Tenant prior to the Commencement Date shall be subject to all of the terms and provisions of this Lease excepting only those requiring the payment of rental and other charges. If this Lease is executed before the Leased Premises becomes vacant, or if any present tenant or occupant of the Leased Premises holds over and Landlord cannot acquire possession thereof prior to the Commencement Date, then Landlord shall not be deemed in default hereunder, and Tenant agrees to accept possession of the Leased Premises at such time as Landlord is able to tender the same and, in such event, the date of such tender by Landlord shall be deemed to be the Commencement Date, and Landlord hereby waives the payment of rental and other charges covering any period prior to the date of such tender. If Landlord does not deliver possession of the Leased Premises to Tenant on or before May 1, 1997, Tenant shall have the option, as Tenant's sole and exclusive right and remedy, to terminate this Lease by delivering written notice to Landlord of such termination prior to Landlord's delivery of possession. In the event of such termination, Landlord and Tenant shall be automatically discharged of any obligations hereunder. 4. RENTAL. As rental for the lease and use of the Leased Premises, Tenant will pay Landlord or Landlord's assigns, at the address of Landlord specified in Paragraph 1.C. hereof, without demand and without deduction, abatement or setoff (except as otherwise expressly provided for herein in Paragraph 8 hereof and Paragraph 15 hereof), the Base Rental in the manner specified in Paragraph 1.L. hereof, in lawful money of the United States. However, Tenant reserves the right to make payment under protest if any of the charges are in dispute. If the Term of this Lease does not commence on the first day of a calendar month, Tenant shall pay to Landlord in advance a pro rata part of such sum as rental for such first partial month. Tenant shall not pay any installment of rental more than one (1) month in advance. All past due 3 7 installments of rental or other payment specified herein shall bear interest at the lower per annum rate of (i) four percent (4%) in excess of Prime Rate (as defined in Paragraph 1.Q. hereof), or (ii) the highest lawful rate, from the date due until paid. If Tenant fails to timely pay three (3) consecutive installments of Base Rental, or other payment specified herein, or any combination thereof, Landlord may require Tenant to pay (in addition to any interest) Base Rental and other payments specified herein (as estimated by Landlord, if necessary) quarterly in advance, and, in such event, all future payments shall be made on or before the due date in cash or by cashier's check or money order, and the delivery of Tenant's personal or corporate check shall no longer constitute payment thereof. Any acceptance of Tenant's personal or corporate check thereafter by Landlord shall not be construed as a waiver of the requirement that such payments be made in cash or by cashier's check or money order. Any amount so estimated by Landlord and paid by Tenant shall be adjusted promptly after actual figures become available and paid or credited to Landlord or Tenant, as the case may be. 5. USE. Tenant shall use the Leased Premises solely for the Permitted Use specified in Paragraph 1.0 hereof and for no other business or purpose without the prior written consent of Landlord. 6. SERVICES TO BE PROVIDED BY LANDLORD. A. Subject to the rules and regulations hereinafter referred to, Landlord shall furnish Tenant, at Landlord's expense, while Tenant is occupying the Leased Premises, the following services during the Term of this Lease: (1) Air conditioning and heating in season, during Building Hours at such temperatures and in such amounts as are reasonably considered by Landlord to be standard, but such service at times other than Building Hours to be furnished only upon the request of Tenant, who shall bear the cost thereof. As used herein, the term "Building Hours" shall mean 7:00 a.m. to 6:00 p.m. Monday through Friday and Saturday 8:00 a.m. to 1:00 p.m., except legal holidays. Tenant acknowledges that such service and temperature may be subject to change by local, county, state or federal regulation. Whenever machines or equipment that generate abnormal heat are used in the Leased Premises which affect the temperature otherwise maintained by the air conditioning system, Landlord shall have the right to install supplemental air conditioning in the Leased Premises, and the cost thereof, including the cost of installation, operation, use and maintenance, shall be paid by Tenant to Landlord as additional rental upon demand. (2) Water at those points of supply provided for general use. (3) Janitor service in and about the Building, and the Leased Premises, as may in the judgment of Landlord be reasonably required; however, Tenant shall pay the additional costs attributable to the cleaning of improvements within the Leased Premises other than building standard improvements. (4) Elevators for ingress to and egress from the Building as may in the judgment of Landlord be reasonably required. Landlord may reasonably limit the number 4 8 of elevators in operation after usual and customary business hours and on Saturday afternoons, Sundays and legal holidays. (5) Replacement of fluorescent lamps in the building standard ceiling mounted fixtures installed by Landlord and incandescent bulb replacement in all public areas. B. Landlord shall provide or cause to be provided to the Leased Premises all electrical current required by Tenant in the normal use and occupancy of the Leased Premises. Without Landlord's prior written consent, which consent shall not be unreasonably withheld, delayed or conditioned, Tenant shall not install any equipment which would result in Tenant's connected load exceeding 3.0 watts per square foot of rentable area within the Leased Premises or which would generate sufficient heat to affect the temperature otherwise maintained in the Leased Premises by the normal operation of the Building air conditioning equipment serving the Leased Premises. The obligation of Landlord to provide or cause to be provided electrical service shall be subject to the rules and regulations of the supplier of such electricity and of any municipal or other governmental authority regulating the business of providing electrical utility service. Landlord shall not be liable or responsible to Tenant for any loss, damage or expense which Tenant may sustain or incur if either the quantity or character of the electric service is changed or is no longer available or no longer suitable for Tenant's requirements. At any time when Landlord is furnishing electric current to the Leased Premises pursuant to this Paragraph 6.B., Landlord may, at its option, upon not less than sixty (60) days prior written notice to Tenant, discontinue the furnishing of such electric current. If Landlord gives such notice of discontinuance, Landlord shall make all reasonably necessary arrangements with the public utilities supplying the electric current to the Project with respect to connecting electric current to the Leased Premises, but Tenant shall contract directly with such public utility with respect to supplying such service. Landlord shall have the right to measure electrical usage in the Leased Premises (1) by installing a submeter, (2) by periodic determinations by Landlord's engineers or other competent consultants selected by Landlord, or (3) by any combination of such methods. The cost of purchase and installation of a submeter in the Leased Premises shall be borne by Tenant. C. Tenant shall be obligated to pay to Landlord, as additional rental, (1) Tenant's proportionate share of all electrical service to the Common Area (collectively, "Common Area Electrical Service") and (2) the cost of electrical service to the Leased Premises. Tenant's proportionate share of the cost of Common Area Electrical Service shall be equal to the cost of such service times a fraction in which the numerator is the rentable area of the Leased Premises and the denominator is the rentable area of the Building. In the event the electrical service to the Leased Premises is submetered or otherwise measured in accordance with the provisions of Paragraph 6.B., Tenant shall pay to Landlord the cost of such electrical service based upon rates determined by Landlord from time to time (which shall not exceed the amount Tenant would have been charged for such service by the local utility company furnishing such service). In the event electrical service to the Leased Premises is not measured by a submeter or periodic determination by Landlord's engineers or other competent consultants selected by Landlord (or a combination of such methods), then, Tenant shall pay to Landlord Tenant's proportionate share of the cost of all electrical service to tenants in the Building which does not exceed Building standard consumption as established from time to time by Landlord. Such 5 9 proportionate share shall be based upon the statements therefor received by Landlord from the electrical utility company providing such service, adjusted as Landlord reasonably determines appropriate to eliminate over-standard consumption, and shall be determined by multiplying the cost of such service times a fraction (the "Leased Premises Electrical Expense Percentage") the numerator of which is the rentable area of the Leased Premises and the denominator of which is the rentable area of the Building. In the event that other tenants of the Building pay directly either to Landlord or third parties for electricity supplied to their respective premises (e.g. separately metered electricity), then Landlord may, at its sole option, adjust the Leased Premises Electrical Expenses Percentage by excluding from the denominator thereof the rentable area of all tenants making such payments. The cost of electrical service shall include without limitation all fuel adjustment charges, demand charges and taxes. If, during any period of time, the Building is not fully leased, then, for purposes of this Paragraph 6.C., the area of the Building shall be deemed to mean and include that portion of the Building which is occupied (calculated on the basis of rentable area). D. Prior to the Commencement Date, Landlord shall deliver to Tenant a statement which sets forth the Estimated Monthly Charge (as hereinafter defined) due and payable by Tenant under the terms of Paragraph 6.C. hereof for electrical service each month during the Term. Tenant shall pay to Landlord on the first day of each calendar month during the Term, commencing with the Commencement Date, as additional rental, the Estimated Monthly Charge. In the event the Commencement Date occurs on a day other than the first day of a calendar month, the Estimated Monthly Charge payable in respect of the month in which the Commencement Date falls shall be prorated and the Estimated Monthly Charge, as so prorated, shall be due and payable on or before the Commencement Date. Thereafter, as the actual amounts owed by Tenant for Tenant's proportionate share of Common Area Electrical Service and electrical service to the Leased Premises are determined, Landlord shall deliver to Tenant a statement setting forth the electrical service utilized during the period in question and the actual amount owed by Tenant under the terms of Paragraph 6.C. hereof in respect of such electrical service. If the Estimated Monthly Charge previously paid by Tenant is less than the amount owed by Tenant based upon Landlord's actual utility bills (for the period covered in such bills), Tenant shall pay to Landlord the amount of the deficiency for such period within ten (10) days after receipt of Landlord's statement. In the event the Estimated Monthly Charge exceeds Tenant's proportionate share of such costs, the excess payment shall be credited against subsequent amounts next due from Tenant for electrical service. From time to time Landlord shall review the Estimated Monthly Charge and make such adjustments as may appear to be appropriate in the reasonable discretion of Landlord. Landlord shall have the right to revise the Estimated Monthly Charge at any time and from time to time in the exercise of Landlord's reasonable judgment upon at least ten (10) days prior written notice to Tenant. All payments due under this paragraph 6.D. after the expiration of such ten (10) day period shall be increased or decreased as may be required to make such payments consistent with such revised Estimated Monthly Charge. As used in this Paragraph 6.D., the term "Estimated Monthly Charge" shall mean Landlord's estimate of the amount due and payable by Tenant each month during the Term with respect to Tenant's proportionate share of Common Area Electrical Service and electrical service to be provided to the Leased Premises. E. If Tenant's connected load for electrical design exceeds 3.0 watts per square foot, Tenant shall pay as a surcharge a proportionate part of all electrical service costs 6 10 which are attributable to the aggregate over-standard electrical consumption by all tenants in the Building. Such proportion shall be equal to the product of the aggregate cost of all over-standard electrical consumption in the Building (as determined by Landlord) times a fraction in which the numerator is Tenant's electrical design load in excess of 3.0 watts per square foot and the denominator is the aggregate of the total electrical design load of all tenants in the Building in excess of 3.0 watts per square foot. Tenant's proportionate share of such sums shall be due within ten (10) days after the date of receipt of a statement therefor from Landlord setting forth the amount of the charges involved and calculating Tenant's proportionate share thereof. F. No interruption or malfunction of any of such services shall constitute an eviction or disturbance of Tenant's use and possession of the Leased Premises or the Building or a breach by Landlord of any of Landlord's obligations hereunder or render Landlord liable for damages or entitle Tenant to be relieved from any of Tenant's obligations hereunder (including the obligation to pay rental) or grant Tenant any right of setoff or recoupment. In the event of any such interruption, however, Landlord shall use reasonable diligence to restore such service or cause same to be restored in any circumstances in which such restoration is within the reasonable control of Landlord and the interruption was not caused in whole or in part by Tenant's fault. Notwithstanding the foregoing, in the event that an interruption of any of those services to be provided by Landlord under this Paragraph 6 shall render the Leased Premises untenantable, such interruption was not caused by any act or omission of Tenant or Tenant's employees, agents or contractors and such interruption shall continue for a period in excess of ten (10) consecutive days, then Tenant's Base Rental obligations under the Lease shall abate for such period which exceeds ten (10) consecutive days; provided, however, that such rental abatement shall be on a pro rata basis to reflect only that portion of the Leased Premises affected by the interruption of services. The abatement of rent provided for in this paragraph shall not be applicable in the case of any interruption or malfunction resulting from a reduction or elimination of electrical service to the Building from the electrical utility company or governmental agency providing such electrical service or change in quality of such service, nor shall such abatement be applicable in the event of any interruption or malfunction of services due to regulations of any government or governmental authority or any utility company providing electrical service provided such interruption or malfunction is not due to the failure of Landlord to make payment for such service or the failure to comply or perform its contractual obligations or Landlord's failure to comply with existing applicable rules or regulations. G. Should Tenant desire any additional services beyond those described in this Paragraph 6 hereof or rendition of any of such services outside the normal times of Landlord for providing such service, Landlord may (at Landlord's option), upon reasonable advance notice from Tenant to Landlord, furnish such services, and Tenant agrees to pay Landlord such charges as may be agreed on between Landlord and Tenant, but in no event at a charge less than Landlord's actual cost plus overhead for the additional services provided. 7. REPAIR AND MAINTENANCE. A. Landlord shall, at Landlord's own cost and expense, except as may be provided elsewhere herein, make necessary repairs of damage to the Building corridors, lobby, structural members of the Building and equipment used to provide the services referred to in Paragraph 6 hereof, unless any such damage is caused in whole or in part by acts or omission of 7 11 Tenant, or Tenant's agents, employees or invitees, in which event Tenant shall bear the cost of such repairs. Tenant shall promptly give Landlord notice of any damage in the Leased Premises requiring repair by Landlord, as aforesaid. B. Tenant shall not in any manner deface or injure the Leased Premises or the Building but shall maintain the Leased Premises, including, without limitation, all fixtures installed by Tenant and all plate glass, walls, carpeting and other floor covering placed or found therein, in a clean, attractive, first-class condition and in good repair, except as to damage required to be repaired by Landlord, as provided in Paragraph 7.A. hereof. Upon the expiration of the Term of this Lease, Tenant shall surrender and deliver up the Leased Premises with all improvements located thereon (except as provided in Paragraph 11.B. hereof) to Landlord broom-clean and in the same condition in which they existed at the commencement of the Lease, excepting only ordinary wear and tear and damage arising from any cause not required to be repaired by Tenant, failing which Landlord may restore the Leased Premises to such condition, and Tenant shall pay the reasonable cost thereof. C. This Paragraph 7 shall not apply in the case of damage or destruction by fire or other casualty which is covered by insurance maintained by Landlord on the Building (as to which Paragraph 8 hereof shall apply), or damage resulting from an eminent domain taking (as to which Paragraph 15 hereof shall apply). 8. FIRE AND OTHER CASUALTY. A. If at any time during the Term of this Lease, the Leased Premises or any portion of the Building shall be damaged or destroyed by fire or other casualty, then Landlord shall have the election to terminate this Lease or to repair and reconstruct the Leased Premises and the Building to substantially the same condition in which they existed immediately prior to such damage or destruction, except that Landlord shall not be required to rebuild, repair or replace any part of the partitions, fixtures and other improvements which may have been installed by Tenant or other tenants within the Building. In the event that the Leased Premises are damaged or destroyed by fire or other casualty, or a portion of the Building is damaged or destroyed by fire or other casualty so as to materially impair the use and occupancy by Tenant of the Leased Premises, then Landlord shall be obligated to provide written notice (the "Restoration Notice") to Tenant within sixty (60) days of such event of casualty stating a good faith estimate, certified by an independent architect of the period of time (the "Stated Restoration Period") which shall be required for the repair and restoration of the Leased Premises and/or the Building. Tenant shall have the right, at its election, to terminate the Lease if either (i) the Stated Restoration Period shall be in excess of one hundred eighty (180) days following the event of casualty and Tenant terminates this Lease with written notice thereof to Landlord within ten (10) days following delivery of the Restoration Notice, or (ii) Landlord shall fail to substantially complete the repair and restoration of the Leased Premises or the Building within the Stated Restoration Period and Tenant delivers written notice of such termination to Landlord within ten (10) days following the expiration of the restoration deadline. B. In any of the aforesaid circumstances, rental shall abate proportionately during the period and to the extent that the Leased Premises are unfit for use by Tenant in the ordinary conduct of Tenant's business. If this Lease continues, such repairs shall be made within 8 12 a reasonable time thereafter, subject to delays arising from shortages of labor or material, acts of God, war or other conditions beyond Landlord's reasonable control. In the event that this Lease is terminated as herein permitted, Landlord shall refund to Tenant the prepaid rental (unaccrued as of the date of damage or destruction) less any sum then owing Landlord by Tenant. If this Lease continues, then the Term of this Lease shall be extended by a period of time equal to the period of such repair and reconstruction. Any insurance which may be carried by Landlord or Tenant against loss or damage to the Building or to the Leased Premises shall be for the sole benefit of the party carrying such insurance under its control, and it is understood that Landlord shall in no event be obligated to carry insurance on Tenant's contents. 9. COMPLIANCE WITH LAWS AND USAGE. Tenant, at Tenant's own expense, (a) shall comply with all federal, state, municipal, fire underwriting and other laws, ordinances, orders, rules and regulations applicable to Tenant's particular use of the Leased Premises and the business conducted therein by Tenant, (b) shall not engage in any activity which would cause Landlord's fire and extended coverage insurance to be cancelled or the rate therefor to be increased (or, at Landlord's option, Tenant shall pay any such increase to Landlord immediately upon demand as additional rental in the event of such rate increase by reason of such activity), (c) shall not commit, and shall cause Tenant's agents, employees and invitees not to commit, any act which is a nuisance or annoyance to Landlord or to other tenants, or which might, in the exclusive judgment of Landlord, damage Landlord's goodwill or reputation, or tend to injure or depreciate the Building, (d) shall not commit or permit waste in the Leased Premises or the Building, (e) shall comply with reasonable rules and regulations from time to time promulgated by Landlord applicable to the Leased Premises and/or the Building applied to all tenants of the Building on a uniform basis, (f) shall not paint, erect or display any sign, advertisement, placard or lettering which is visible in the corridors or lobby of the Building or from the exterior of the Building without Landlord's prior written approval, and (g) shall not occupy or use, or permit any portion of the Leased Premises to be occupied or used, for any business or purpose other than the Permitted Use specified in Paragraph 1.0. hereof. If a controversy arises concerning Tenant's compliance with any federal, state, municipal or other laws, ordinances, orders, rules or regulations applicable to the Leased Premises and the business conducted therein by Tenant, Landlord may retain consultants of recognized standing to investigate Tenant's compliance. If it is determined that Tenant has not complied as required, Tenant shall reimburse Landlord on demand for all reasonable consulting and other reasonable costs incurred by Landlord in such investigation. Landlord and Tenant acknowledge that, in accordance with the provisions of the Americans with Disabilities Act of 1990 and the Texas Elimination of Architectural Barriers Act, each as amended from time to time, and all regulations and guidelines issued by authorized agencies with respect thereto (collectively, the "ADA" and the "EAB", respectively), responsibility for compliance with the terms and conditions of Title III of the ADA and the EAB may be allocated as between Landlord and Tenant. Notwithstanding anything to the contrary contained in the Lease, Landlord and Tenant agree that the responsibility for compliance with the ADA and the EAB shall be allocated as follows: (i) Tenant shall be responsible for compliance with the provisions of Title III of the ADA and with the provisions of the EAB with respect to the Leased Premises, including restrooms within the Leased Premises, and (ii) Landlord shall be responsible for compliance with the provisions of Title III of the ADA and with the provisions of the EAB with respect to the exterior of the Building, parking areas, sidewalks and walkways, and any and all areas appurtenant thereto, together with all common areas of the Building not included within the Leased Premises. The allocation of responsibility for ADA and EAB 9 13 compliance between Landlord and Tenant, and the obligations of Landlord and Tenant established by such allocations, shall supersede any other provisions of the Lease that may contradict or otherwise differ from the requirements of this paragraph. 10. LIABILITY AND INDEMNITY. A. Tenant agrees to indemnify and save Landlord harmless from all claims (including costs and expenses of defending against such claims) arising or alleged to arise from any act or omission of Tenant or Tenant's agents, employees, invitees or contractors, or arising from any injury to any person or damage to the property of any person occurring during the Term of this Lease in or about the Leased Premises, except to the extent attributable to Landlord's negligence or willful misconduct. Tenant agrees to use and occupy the Leased Premises and other facilities of the Building at Tenant's own risk and hereby releases Landlord, Landlord's agents or employees, from all claims for any damage or injury to the full extent permitted by law. B. Tenant waives any and all rights of recovery, claim, action, or cause of action, against Landlord, its agents, officers, or employees, for any loss or damage that may occur to the Leased Premises, or any improvements thereto, or the Project, or any improvements thereto, or any personal property of such party therein, by reason of fire, the elements, or any other cause which could be insured against under the terms of standard fire and extended coverage insurance policies, regardless of cause or origin, including negligence of Landlord, its agents, officers or employees, and Tenant covenants that no insurer shall hold any right of subrogation against Landlord and all such insurance policies shall be amended or endorsed to reflect such waiver of subrogation. C. Tenant, to the extent permitted by law, waives all claims Tenant may have against Landlord, and against Landlord's agents and employees for injury to person or damage to or loss of property sustained by Tenant or by any occupant of the Leased Premises, or by any other person, resulting from any part of the Building or any equipment or appurtenances becoming out of repair or resulting from any accident in or about the Building or resulting directly or indirectly from any act or neglect of any tenant or occupant of any part of the Building or of any other person unless such damage is a result of the negligence of Landlord, or Landlord's agents or employees. If any damage results from any act or neglect of Tenant, Landlord may, at Landlord's option, repair such damage, and Tenant shall thereupon pay to Landlord the total cost of such repair to the extent not reimbursed by Landlord's insurance. All personal property belonging to Tenant or any occupant of the Leased Premises that is in or on any part of the Building shall be there at the risk of Tenant or of such other person only, and Landlord, Landlord's agents and employees shall not be liable for any damage thereto or for the theft or misappropriation thereof unless such damage, theft or misappropriation is a result of the gross negligence of Landlord or Landlord's agents or employees. Tenant agrees to indemnify and hold Landlord harmless from and against any and all loss, cost, claim and liability (including reasonable attorneys' fees) for injuries to all persons and for damage to or loss of property occurring in or about the Building, due to any act or negligence or default under this Lease by Tenant, Tenant's contractors, agents or employees. 11. ADDITIONS AND FIXTURES. 10 14 A. Tenant will make no alteration, change, improvement, repair, replacement or physical addition in or to the Leased Premises without the prior written consent of Landlord. Notwithstanding anything in the Lease to the contrary, Landlord shall not unreasonably withhold or delay its consent in the event Tenant requests Landlord's permission to make non-structural alterations, additions or improvements to the Leased Premises which do not affect the electrical mechanical, or heating, ventilating and air conditioning systems of the Leased Premises on the Building. Notwithstanding anything in Paragraph 11.B. of the Lease to the contrary, in the event Landlord approves such request, Landlord shall advise Tenant, contemporaneously with delivery of Landlord's consent, whether Landlord will require Tenant to remove such additions or alterations prior to the termination of the Lease. If such prior written consent of Landlord is granted, the work in such connection shall be at Tenant's expense but by workmen of Landlord or by workmen and contractors reasonably approved in advance in writing by Landlord and in a manner and upon terms and conditions and at times satisfactory to and approved in advance in writing by Landlord. In any instance where Landlord grants such consent, Landlord may grant such consent contingent and conditioned upon Tenant's contractors, laborers, materialmen and others furnishing labor or materials for Tenant's job working in harmony and not interfering with any labor utilized by Landlord, Landlord's contractors or mechanics or by any other tenant or such other tenants contractors or mechanics; and if at any time such entry by one (1) or more persons furnishing labor or materials for Tenant's work shall cause disharmony or interference for any reason whatsoever without regard to fault, the consent granted by Landlord to Tenant may be withdrawn at any time upon written notice to Tenant. B. Tenant, if Tenant so elects, may remove Tenant's trade fixtures, office supplies and movable office furniture and equipment not attached to the Building provided (i) such removal is made prior to the expiration of the Term of this Lease, (ii) Tenant is not in default of any obligation or covenant under this Lease at the time of such removal, and (iii) Tenant promptly repairs all damage caused by such removal. All other property at the Leased Premises and any alteration or addition to the Leased Premises (including wall-to-wall carpeting, paneling or other wall covering) and any other article attached or affixed to the floor, wall or ceiling of the Leased Premises shall become the property of Landlord shall be in good condition, normal wear and tear excepted, and shall remain upon and be surrendered with the Leased Premises as part thereof at the expiration of the Term of this Lease, Tenant hereby waiving all rights to any payment or compensation therefor. If, however, Landlord so requests in writing, Tenant will, prior to the termination of this Lease, remove in a good and workmanlike manner any and all alterations, additions, fixtures, equipment and property placed or installed by Tenant in the Leased Premises and will repair any damage occasioned by such removal. 12. ASSIGNMENT AND SUBLETTING. A. Except as provided in subparagraph E, neither Tenant nor Tenant's legal representatives or successors in interest by operation of law or otherwise shall assign this Lease or sublease the Leased Premises or any part thereof or mortgage, pledge or hypothecate its leasehold interest or grant any concession or license within the Leased Premises without the prior express written permission of Landlord, and any attempt to do any of the foregoing without the prior express written permission of Landlord shall be void and of no effect. Except with respect to a Permitted Assignee (as defined in subparagraph E below), in the event Tenant requests Landlord's prior express permission as to any such assignment or a sublease of substantially all 11 15 of the Leased Premises, Landlord shall have the right and option, as of the requested effective date of such assignment or sublease (but no obligation), to cancel and terminate this Lease as to the portion of the Leased Premises with respect to which Landlord has been requested to permit such assignment or sublease, and if Landlord elects to cancel and terminate this Lease as to the aforesaid portion of the Leased Premises, then the rental and other charges payable hereunder shall thereafter be proportionately reduced. In the event of any such attempted assignment or attempted sublease, or should Tenant, in any other nature of transaction, permit or attempt to permit anyone to occupy the Leased Premises (or any portion thereof) without the prior express written permission of Landlord, Landlord shall thereupon have the right and option to cancel and terminate this Lease effective upon ten (10) days' notice to Tenant given by Landlord at any time thereafter either as to the entire Leased Premises or as to only the portion thereof which Tenant shall have attempted to assign or sublease or otherwise permitted some other party's occupancy without Landlord's prior express written permission, and if Landlord elects to cancel and terminate this Lease as to the aforesaid portion of the Leased Premises, then the rental and other charges payable hereunder shall thereafter be proportionately reduced. This prohibition against assignment or subletting shall be construed to include a prohibition against any assignment or subletting by operation of law. B. Notwithstanding that the prior express written permission of Landlord to any of the aforesaid transactions may have been obtained, the following shall apply: (1) In the event of an assignment, contemporaneously with the granting of Landlord's aforesaid consent, Tenant shall cause the assignee to expressly assume in writing and agree to perform all of the covenants, duties and obligations of Tenant hereunder, and such assignee shall be jointly and severally liable therefor along with Tenant; Tenant shall further cause such assignee to grant Landlord an express first and prior contract lien and security interest in the manner hereinafter stated as applicable to Tenant; (2) A signed counterpart of all instruments relative thereto (executed by all parties to such transactions with the exception of Landlord) shall be submitted by Tenant to Landlord prior to or contemporaneously with the request for Landlord's prior express written permission thereto (it being understood that no such instrument shall be effective without the prior express written permission of Landlord); (3) Tenant shall subordinate to Landlord's statutory lien and Landlord's aforesaid contract lien and security interest any liens or other rights which Tenant may claim with respect to any fixtures, equipment, goods, wares, merchandise or other property owned by or leased to the proposed assignee or sublessee or other party intending to occupy the Leased Premises; (4) No usage of the Leased Premises different from the usage herein provided to be made by Tenant shall be permitted, and all other terms and provisions of this Lease shall continue to apply after any such transaction; (5) In any case where Landlord consents to an assignment, sublease, grant of a concession or license or mortgage, pledge or hypothecation of the leasehold, the 12 16 undersigned Tenant will nevertheless remain directly and primarily liable for the performance of all of the covenants, duties and obligations of Tenant hereunder (including, without limitation, the obligation to pay all rental and other sums herein provided to be paid), and Landlord shall be permitted to enforce the provisions of this Lease against the undersigned Tenant and/or any assignee, sublessee, concessionaire, licensee or other transferee without demand upon or proceeding in any way against any other person; and (6) If the rental due and payable by a sublessee under any such permitted sublease (or a combination of the rental payable under such sublease plus any bonus or other consideration therefor or incident thereto) exceeds the hereinabove provided rental payable under this Lease, or if with respect to a permitted assignment, permitted license or other transfer by Tenant permitted by Landlord, the consideration payable to Tenant by the assignee, licensee or other transferee exceeds the rental payable under this Lease, then Tenant shall be bound and obligated to pay Landlord all such excess rental and other excess consideration within ten (10) days following receipt thereof by Tenant from such sublessee, assignee, licensee or other transferee, as the case might be. C. If Tenant is a corporation, then any transfer of this Lease from Tenant by merger, consolidation or dissolution or any change in ownership or power to vote a majority of the voting stock in Tenant outstanding at the time of execution of this Lease shall constitute an assignment for the purpose of this Lease; provided, however, that acquisition of all stock of a corporate tenant by any corporation, the stock of which is registered pursuant to the Securities Act of 1933 or the merger of a corporate tenant into such a corporation, the stock of which is so registered, shall not itself be deemed to be a violation of Paragraph 12.A. For purposes of this Paragraph 12.C., the term "voting stock" shall refer to shares of stock regularly entitled to vote for the election of directors of the corporation involved. If Tenant is a general partnership having one (1) or more corporations as partners or if Tenant is a limited partnership having one (1) or more corporations as general partners, the provisions of the preceding paragraph of this Paragraph 12.C. shall apply to each of such corporations as if such corporation alone had been the Tenant hereunder. If Tenant is a general partnership (whether or not having any corporations as partners) or if Tenant is a limited partnership (whether or not having any corporations as general partners), the transfer of the partnership interest or interests constituting a majority shall constitute an assignment for the purposes of this Lease. D. Consent by Landlord to a particular assignment or sublease or other transaction shall not be deemed a consent to any other or subsequent transaction. If this Lease is assigned, or if the Leased Premises are subleased (whether in whole or in part), or in the event of the mortgage, pledge or hypothecation of the leasehold interest or grant of any concession or license within the Leased Premises without the prior express written permission of Landlord, or if the Leased Premises are occupied in whole or in part by anyone other than Tenant without the prior express written permission of Landlord, then Landlord may nevertheless collect rental and other charges from the assignee, sublessee, mortgagee, pledgee, party to whom the leasehold interest was hypothecated, concessionaire or licensee or other occupant and apply the net amount 13 17 collected to the rental and other charges payable hereunder, but no such transaction or collection of rental and other charges or application thereof by Landlord shall be deemed a waiver of these provisions or a release of Tenant from the further performance by Tenant of Tenant's covenants, duties and obligations hereunder. E. Notwithstanding any provision in this Lease to the contrary, the undersigned Tenant may, without Landlord's prior written consent, assign its rights hereunder or sublease the Leased Premises to any parent, subsidiary or entity under the common control of the owner of the controlling interest of the undersigned Tenant's voting common stock, to a bona fide purchaser of substantially all of the undersigned Tenant's assets or all of the corporate stock of the undersigned Tenant, or to an entity with which the undersigned Tenant enters into a bona fide merger or consolidation or in connection with Tenant's reincorporation in the State of Delaware (collectively, a "Permitted Assignee"); provided, however, that (i) the undersigned Tenant shall remain liable for the performance of all covenants, duties and obligations under the Lease, irrespective of any such assignment or sublease, (ii) the use of the Leased Premises by the Permitted Assignee may not violate any other agreements affecting the Leased Premises, the Building, Landlord or other tenants, and (iii) use of the Leased Premises by the Permitted Assignee shall conform with the uses permitted by this Lease. Tenant shall notify Landlord, in writing, of any such assignment or sublease within thirty (30) days of its occurrence and shall provide Landlord with all such reasonable information as Landlord may request regarding the identity and status of such assignee or sublessee. F. Landlord acknowledges that the business to be conducted by the undersigned Tenant in the Leased Premises requires the installation of certain communications equipment owned by customers and co-locators of the undersigned Tenant ("Permitted Licensees") in (but not outside of) the Leased Premises, in order for the Permitted Licensees to interconnect with Tenant's facilities. To expedite the Permitted Licensees' access to the Leased Premises, Landlord expressly agrees that Tenant may license the use of portions of the Leased Premises to, or enter into other co-location agreements (collectively, "Permitted Agreements") with, the Permitted Licensees without Landlord's further consent. Landlord expressly waives its right to prior review of such Permitted Agreements; provided, however, that Tenant shall promptly provide Landlord with copies of all such Permitted Agreements and shall accede to Landlord's reasonable requests, if any, as to floor plans and space layout. In addition, Landlord expressly waives any right it may have to terminate this Lease or any portion hereof as set forth in Paragraph 12.A. above with respect to such Permitted Agreements. Paragraph 12.B.(6), 12.C. and 12.D. above shall not apply with respect to Tenant's Permitted Agreements with Permitted Licensees. Notwithstanding anything herein to the contrary, Tenant's Permitted Agreements with the Permitted Licensees may not affect the Building's riser facilities or the Common Area of the Building. 13. SUBORDINATION. Tenant accepts this Lease subject and subordinate to any ground lease, mortgage, deed of trust or other lien presently existing or hereafter placed upon the Leased Premises or upon the Building or any part thereof, and to any renewals, modifications, extensions and refinancings thereof, which might now or hereafter constitute a lien upon the Building or any part thereof, and to zoning ordinances and other building and fire ordinances and governmental regulations relating to the use of the Leased Premises, but Tenant agrees that any such ground lessor, mortgagee and/or beneficiary of any deed of trust or other lien ("Landlord's 14 18 Mortgagee") and/or Landlord shall have the right at any time to subordinate such ground lease, mortgage, deed of trust or other lien to this Lease on such terms and subject to such conditions as such Landlord's Mortgagee may deem appropriate in its discretion. Upon demand Tenant agrees to execute such further commercially reasonable instruments subordinating this Lease, as Landlord may reasonably request, and such nondisturbance and attornment agreements, as any such Landlord's Mortgagee shall request, in form reasonably satisfactory to Landlord's Mortgagee. In the event that Tenant shall fail to execute any such instrument within ten (10) days after requested, Tenant hereby irrevocably constitutes Landlord as Tenant's attorney-in-fact to execute such instrument Tenant's name, place and stead, it being stipulated by Landlord and Tenant that such agency is coupled with an interest in Landlord and is, accordingly, irrevocable. Upon foreclosure of the Building or upon acceptance of a deed in lieu of such foreclosure, Tenant hereby agrees to attorn to the new owner of such property after such foreclosure or acceptance of a deed in lieu of foreclosure, if so requested by such new owner of the Building. Landlord shall use reasonable efforts to obtain from Landlord's current Mortgagee a non-disturbance and attornment agreement in the form attached hereto as Exhibit E and made a part hereof for all purposes. In addition, notwithstanding any contrary provision contained herein, the subordination of this Lease to any mortgage, deed of trust or other lien hereafter placed upon the Leased Premises or the Building or any part thereof and Tenant's agreement to attorn to the holder of such mortgage, deed of trust or other lien as provided in this Paragraph 13 shall be conditioned upon such holder's entering into a non-disturbance and attornment agreement providing Tenant with substantially the same protection as to Tenant's use and enjoyment of Tenant's leasehold estate, use, possession, tenancy and other rights hereunder as is afforded Tenant under the form instrument attached hereto as Exhibit E. 14. OPERATING EXPENSES. A. For purposes of this Paragraph 14, the following definitions and calculations shall apply: (1) The term "Operating Expenses" shall mean all expenses, costs and disbursements of every kind and nature which Landlord shall pay or become obligated to pay because of or in connection with the ownership, operation, maintenance, repair, replacement, protection and security of the Project, determined on an accrual basis in accordance with generally accepted accounting principles, including, without limitation, the following: (i) Salaries and wages of all employees engaged in the operation, maintenance and security of the Project, including taxes, insurance and benefits (including pension, retirement and fringe benefits) relating thereto; (ii) Cost of all supplies and materials used in the operation, maintenance and security of the Project; (iii) Cost of all water and sewage service supplied to the Project; (iv) Cost of all maintenance and service agreements for the Project and the equipment therein, including, without limitation, alarm service, parking 15 19 facilities, security (both on-site and off-site), janitorial service, landscaping, fire protection, sprinklers, window cleaning and elevator maintenance; (v) Cost of all insurance relating to the Project, including the cost of casualty, rental and liability insurance applicable to the Project and Landlord's personal property used in connection therewith; (vi) All taxes, assessments and governmental charges (foreseen or unforeseen, general or special, ordinary or extraordinary) whether federal, state, county or municipal and whether levied by taxing districts or authorities presently taxing the Project or by others subsequently created or otherwise, and any other taxes and assessments attributable to the Project or its operation, and all taxes of whatsoever nature that are imposed in substitution for or in lieu of any of the taxes, assessments or other charges herein defined; provided, however, Operating Expenses shall not include taxes paid by tenants of the Project as a separate charge on the value of their leasehold improvements, death taxes, excess profits taxes, franchise taxes and state and federal income taxes; (vii) Cost of repairs and general maintenance, including, without limitation, reasonable depreciation charges applicable to all equipment used in repairing and maintaining the Project, but specifically excluding repairs and general maintenance paid by proceeds of insurance or by Tenant or by other third parties; (viii) Cost of capital improvement items, including installation thereof, which are acquired primarily for the purpose of reducing Operating Expenses; and (ix) Reasonable management fees paid by Landlord to third parties or to management companies owned by, or management divisions of, Landlord, not to exceed the then prevailing market rate for the management of high quality class A office buildings comparable to the Project. To the extent that any Operating Expenses are attributable to the Project and other projects of Landlord, a fair and reasonable allocation of such Operating Expenses shall be made between the Project and such other projects. (2) The term "Operating Expenses" shall exclude the cost of electrical energy supplied to the Project and to tenants of the Building. (3) The term "Base Operating Expenses Rate" is stipulated to be the rate specified in Paragraph 1.T. hereof per square foot of rentable area in the Leased Premises. (4) The term "Actual Operating Expenses" shall mean, with respect to each calendar year during the Term of this Lease, the actual Operating Expenses for such year. The term "Actual Operating Expenses Rate" shall mean, with respect to each calendar year during the Term of this Lease, the Actual Operating Expenses attributable to each square foot of rentable area in the Building, and shall be calculated by dividing the Actual Operating Expenses by the total number of square feet of rentable area in the Building, as 16 20 specified in Paragraph 1.I. hereof. The term "Tenant's Proportionate Share of Actual Operating Expenses" shall mean, with respect to each calendar year during the Term of this Lease, an amount equal to the product of (i) the positive difference (if any) obtained by subtracting the Base Operating Expenses Rate from the Actual Operating Expenses Rate, multiplied by (ii) the weighted average number of square feet of rentable area in the Leased Premises in such year; provided, however, if the Actual Operating Expenses Rate is determined on the basis of a partial calendar year, then in making the foregoing calculation, the Base Operating Expenses Rate shall be multiplied by a fraction, the numerator of which is the number of days in such partial calendar year and the denominator of which is 365, and the foregoing weighted average shall be calculated only on the basis of the portion of such calendar year covered by the Term of this Lease. For example, if the Actual Operating Expenses Rate for a calendar year is $3.20 and the Base Operating Expenses Rate is $3.00, and the Leased Premises contains 19,000 square feet of rentable area during the entire calendar year, Tenant's Proportionate Share of Actual Operating Expenses is $3,800.00, calculated as follows: ($3.20 - $3.00) x 19,000 = $3,800.00. B. If the Actual Operating Expenses Rate during any calendar year is greater than the Base Operating Expenses Rate, Tenant shall be obligated to pay to Landlord as additional rental an amount equal to Tenant's Proportionate Share of Actual Operating Expenses. To implement the foregoing, Landlord shall provide to Tenant within ninety (90) days (or as soon thereafter as reasonably possible) after the end of the calendar year in which the Commencement Date occurs, a statement of the Actual Operating Expenses for such calendar year, the Actual Operating Expenses Rate for such calendar year, and Tenant's Proportionate Share of Actual Operating Expenses. If the Actual Operating Expenses Rate for such calendar year exceeds the Base Operating Expenses Rate, Tenant shall pay to Landlord, within thirty (30) days after Tenant's receipt of such statement, an amount equal to Tenant's Proportionate Share of Actual Operating Expenses for such calendar year. C. Beginning with January 1, 1998 (or as soon thereafter as reasonably possible), Landlord shall provide to Tenant a statement of the projected annual Operating Expenses per square foot of rentable area in the Project (the "Projected Operating Expenses Rate"). Tenant shall pay to Landlord on the first day of each month an amount (the "Projected Operating Expenses Installment") equal to one-twelfth (1/12) of the product of (i) the positive difference (if any) obtained by subtracting the Base Operating Expenses Rate from the Projected Operating Expenses Rate for such calendar year, multiplied by (ii) the number of square feet of rentable area in the Leased Premises on the first day of the prior month. Until Tenant has received the statement of the Projected Operating Expenses Rate from Landlord, Tenant shall continue to pay Projected Operating Expenses Installments to Landlord in the same amount (if any) as required for the last month of the prior calendar year. Upon Tenant's receipt of such statement of the Projected Operating Expenses Rate, Tenant shall pay to Landlord, or Landlord shall pay to Tenant (whichever is appropriate), the difference between the amount paid by Tenant prior to receiving such statement and the amount payable by Tenant as set forth in such statement. Landlord shall provide Tenant a statement within ninety (90) days (or as soon thereafter as reasonably possible) after the end of each calendar year, showing the Actual Operating Expenses Rate as compared to the Projected Operating Expenses Rate for such 17 21 calendar year. If Tenant's Proportionate Share of Actual Operating Expenses for such calendar year exceeds the aggregate of the Projected Operating Expenses Installments collected by Landlord from Tenant, Tenant shall pay to Landlord, within thirty (30) days following Tenant's receipt of such statement, the amount of such excess. If Tenant's Proportionate Share of Actual Operating Expenses for such calendar year is less than the aggregate of the Projected Operating Expenses Installments collected by Landlord from Tenant, Landlord shall pay to Tenant, within thirty (30) days following Tenant's receipt of such statement, the amount of such excess. Landlord shall have the right from time to time during each calendar year to revise the Projected Operating Expenses Rate and provide Tenant with a revised statement thereof, and thereafter Tenant shall pay Projected Operating Expenses Installments on the basis of the revised statement. If the Commencement Date of this Lease is not the first day of a calendar year, or the expiration or termination date of this Lease is not the last day of a calendar year, then Tenant's Proportionate Share of Actual Operating Expenses shall be prorated. The foregoing adjustment provisions shall survive the expiration or termination of the Term of this Lease. D. Notwithstanding any other provision herein to the contrary, it is agreed that if the Project is not fully occupied during any calendar year an adjustment shall be made in computing the Actual Operating Expenses for such year so that the Actual Operating Expenses are computed as though the Project had been fully occupied during such year. E. Landlord agrees to keep books and records reflecting the Operating Expenses of the Project in accordance with generally accepted accounting principles. Tenant, at its expense, shall have the right, within six (6) months after receiving Landlord's statement of Actual Operating Expenses for a particular year, to audit Landlord's books and records relating to the Operating Expenses for such year if the Actual Operating Expenses Rate exceeds the Base Operating Expenses Rate. If conducted by Tenant, such audit shall be conducted only during regular business hours at Landlord's office and only after Tenant gives Landlord fourteen (14) days written notice. Tenant shall deliver to Landlord a copy of the results of such audit within fifteen (15) days of its receipt by Tenant. No such audit shall be conducted if any other tenant not affiliated with Landlord has conducted an audit for the time period Tenant intends to audit and Landlord furnishes to Tenant a copy of the results of such audit. No audit shall be conducted at any time that Tenant is in default of any of terms of the lease. No subtenant shall have any right to conduct an audit and no assignee shall conduct an audit for any period during which such assignee was not in possession of the Leased Premises. Such audit must be conducted by an independent nationally recognized accounting firm that is not being compensated by Tenant on a contingency fee basis. All information obtained through the Tenant's audit with respect to financial matters (including, without limitation, costs, expenses, income) and any other matters pertaining to the Landlord and/or the Project as well as any compromise, settlement, or adjustment reached between Landlord and Tenant relative to the results of the audit shall be held in strict confidence by the Tenant and its officers, agents, and employees; and Tenant shall cause its auditor and any of its officers, agents, and employees to be similarly bound. As a condition precedent to Tenant's exercise of its right to audit, Tenant must deliver to Landlord a signed covenant from the auditor in a form reasonably satisfactory to Landlord acknowledging that all of the results of such audit as well as any compromise, settlement, or adjustment reached between Landlord and Tenant shall be held in strict confidence and shall not be revealed in any manner to any person except upon the prior written consent of Landlord, which consent may be withheld in Landlord's sole discretion, or if required pursuant to any litigation between Landlord 18 22 and Tenant materially related to the facts disclosed by such audit, or if required by law. Tenant understands and agrees that this provision is of material importance to Landlord and that any violation of the terms of this provision shall result in immediate and irreparable harm to Landlord. Landlord shall have all rights allowed by law or equity if Tenant, its officers, agents, or employees and/or the auditor violate the terms of this provision, including, without limitation, the right to terminate this Lease or the right to terminate Tenant's right to audit in the future pursuant to this paragraph. Tenant shall indemnify, defend upon request, and hold Landlord harmless from and against all costs, damages, claims, liabilities, expenses, losses, court costs, and attorneys' fees suffered by or claimed against Landlord, based in whole or in part upon the breach of this paragraph by Tenant and/or its auditor, and shall cause its auditor to be similarly bound. If within such six (6) month period Tenant does not give Landlord written notice stating in reasonable detail any objection to the statement of Actual Operating Expenses, Tenant shall be deemed to have approved such statement in all respects. F. Notwithstanding any provision of the Lease to the contrary, for the purpose of calculating Tenant's Proportionate Share of Actual Operating Expenses each year during the first ten (10) years of the Term of the Lease, the items of Actual Operating Expenses which are reasonably subject to the control of Landlord ("Controllable Expenses") shall be deemed not to increase more than ten percent (10%) per calendar year (determined on a cumulative compounding basis throughout the Term of the Lease) for each calendar year from and after January 1, 1998; provided, however, that no item of Actual Operating Expenses other than Controllable Expenses shall be subject to the foregoing limitation. Controllable Expenses shall not include, without limitation, (i) insurance, (ii) taxes, assessments and governmental charges, as specified in Paragraph 14.A.(1)(vi) above, and (iii) utilities. 15. EMINENT DOMAIN. If there shall be taken by exercise of the power of eminent domain during the Term of this Lease any part of the Leased Premises or the Building, Landlord may elect to terminate this Lease or to continue same in effect. If Landlord elects to continue this Lease, the rental shall be reduced in proportion to the area of the Leased Premises so taken, and Landlord shall repair any damage to the Leased Premises or the Building resulting from such taking. All sums awarded or agreed upon between Landlord and the condemning authority for the taking of the interest of Landlord or Tenant, whether as damages or as compensation, will be the property of Landlord without prejudice, however, to claims of Tenant against the condemning authority on account of the unamortized cost of leasehold improvements paid for by Tenant taken by the condemning authority. If this Lease should be terminated under any provision of this Paragraph 15, rental shall be payable up to the date that possession is taken by the condemning authority, and Landlord will refund to Tenant any prepaid unaccrued rental less any sum then owing by Tenant to Landlord. 16. ACCESS BY LANDLORD. Landlord, Landlord's agents and employees shall have access to and the right to enter upon any and all parts of the Leased Premises at any reasonable time after reasonable prior notice, oral or written (except in cases of emergency, defined to be any situation in which Landlord perceives imminent danger of injury to person and/or damage to or loss of property, in which case Landlord may enter upon any and all parts of the Leased Premises at any time) to examine the condition thereof, to clean, to make any repairs, alterations or additions required to be made by Landlord hereunder, to show the Leased Premises to prospective purchasers or mortgage lenders (prospective or current) and for any other purpose 19 23 deemed reasonable by Landlord, and to show the Leased Premises to prospective tenants during the last nine (9) months of the Term of the Lease, and Tenant shall not be entitled to any abatement or reduction of rental by reason thereof. Tenant may elect to have a representative present at such entries, but the failure of Tenant's representative to be present at the time set forth in Landlord's notice shall not prevent Landlord from exercising its rights hereunder. 17. LANDLORD'S LIEN. In addition to the statutory landlord's lien, Landlord shall have at all times a valid security interest to secure payment of all rentals and other sums of money becoming due hereunder from Tenant, and to secure payment of any damages or loss which Landlord may suffer by reason of the breach by Tenant of any covenant, agreement or condition contained herein, upon all goods, wares, equipment, fixtures, furniture, improvements and other personal property of Tenant presently, or which may hereafter be, situated in the Leased Premises, and all proceeds therefrom, and such property shall not be removed therefrom without the consent of Landlord until all arrearages in rental as well as any and all other sums of money then due to Landlord hereunder shall first have been paid and discharged and all the covenants, agreements and conditions hereof have been fully complied with and performed by Tenant. Upon the occurrence of an Event of Default as set forth in Paragraph 18 hereof by Tenant, Landlord may, to the extent permitted by law and in addition to any other remedies provided herein, enter upon the Leased Premises and take possession of any and all goods, wares, equipment, fixtures, furniture, improvements and other personal property of Tenant situated in the Leased Premises, without liability for trespass or conversion, and sell the same at public or private sale, with or without having such property at the sale, after giving Tenant reasonable notice of the time and place of any public sale or of the time after which any private sale is to be made, at which sale Landlord or Landlord's assigns may purchase unless otherwise prohibited by law. Unless otherwise provided by law, and without intending to exclude any other manner of giving Tenant reasonable notice, the requirement of reasonable notice shall be met if such notice is given in the manner prescribed in this Lease at least ten (10) days before the time of sale. Any sale made pursuant to the provisions of this Paragraph 17 shall be deemed to have been a public sale conducted in a commercially reasonable manner if held in the Leased Premises or where the property is located after the time, place and method of sale and a general description of the types of property to be sold have been advertised in a daily newspaper published in the county in which the Building is located, for five (5) consecutive days before the date of the sale. The proceeds from any such disposition, less any and all expenses connected with the taking of possession, holding and selling of the property (including reasonable attorneys' fees) shall be applied as a credit against the indebtedness secured by the security interest granted in this Paragraph 17. Any surplus shall be paid to Tenant or as otherwise required by law; Tenant shall pay any deficiencies forthwith. Upon request of Landlord, Tenant agrees to execute Uniform Commercial Code financing statements relating to the aforesaid security interest. 18. DEFAULTS. A. Each of the following acts or omissions of Tenant or occurrences shall constitute an "Event of Default": (1) Failure or refusal by Tenant to pay rental or other payments hereunder upon the expiration of a period of ten (10) days following written notice to Tenant of such failure; provided, however, that Landlord shall not be required to send such written notice 20 24 to Tenant more than twice in any one calendar year and after such two (2) written notices, Landlord shall have no obligation to give Tenant written notice of any subsequent default during the remainder of such calendar year and Tenant's failure or refusal to timely pay rental or other payments hereunder when due during the remainder of such calendar year shall constitute an Event of Default. (2) Failure to perform or observe any covenant or condition of this Lease by Tenant to be performed or observed upon the expiration of a period of ten (10) days following written notice to Tenant of such failure; provided, however, that in the event Tenant's failure to perform a covenant or condition of this Lease cannot reasonably be cured within ten (10) days following written notice to Tenant, Tenant shall not be in default if Tenant commences to cure same within the ten (10) day period and thereafter diligently prosecutes the curing thereof, but in no event shall Tenant's cure period exceed thirty (30) days following written notice to Tenant. (3) Abandonment or vacating of the Leased Premises or any significant portion thereof. (4) The filing or execution or occurrence of any one of the following: (i) a petition in bankruptcy or other insolvency proceeding by or against Tenant, (ii) petition or answer seeking relief under any provision of the Bankruptcy Act, (iii) an assignment for the benefit of creditors, or composition, (iv) a petition or other proceeding by or against Tenant for the appointment of a trustee, receiver or liquidator of Tenant or any of Tenant's property, or (v) a proceeding by any governmental authority for the dissolution or liquidation of Tenant. (5) Tenant shall default under that certain agreement by and between Landlord and Tenant with respect to rooftop rights referenced in Paragraph 32 of this Lease upon the expiration of any cure period set forth therein. B. This Lease and the Term and estate hereby granted and the demise hereby made are subject to the limitation that if and whenever any Event of Default shall occur, Landlord may, at Landlord's option, in addition to all other rights and remedies given hereunder or by law or equity, do any one (1) or more of the following: (1) Terminate this Lease, in which event Tenant shall immediately surrender possession of the Leased Premises to Landlord. (2) Enter upon and take possession of the Leased Premises and expel or remove Tenant and any other occupant therefrom, with or without having terminated the Lease. (3) Alter locks and other security devices at the Leased Premises. C. Exercise by Landlord of any one (1) or more remedies hereunder granted or otherwise available shall not be deemed to be an acceptance of surrender of the Leased Premises by Tenant, whether by agreement or by operation of law, it being understood that such surrender can be effected only by the written agreement of Landlord and Tenant. No such 21 25 alteration of security devices and no removal or other exercise of dominion by Landlord over the property of Tenant or others at the Leased Premises shall be deemed unauthorized or constitute a conversion, Tenant hereby consenting, after any Event of Default, to the aforesaid exercise of dominion over Tenant's property within the Building. All claims for damages by reason of such re-entry and/or possession and/or alteration of locks or other security devices are hereby waived, as are all claims for damages by reason of any distress warrant, forcible detainer proceedings, sequestration proceedings or other legal process. Tenant agrees that any re-entry by Landlord may be pursuant to judgment obtained in forcible detainer proceedings or other legal proceedings or without the necessity for any legal proceedings, as Landlord may elect, and Landlord shall not be liable in trespass or otherwise. D. In the event that Landlord elects to terminate this Lease by reason of an Event of Default, then, notwithstanding such termination, Tenant shall be liable for and shall pay to Landlord, at the address specified in Paragraph 1.C. hereof, the sum of all rental and other indebtedness accrued to the date of such termination, plus, as damages, an amount equal to the then present value of the rental reserved hereunder for the remaining portion of the Term of this Lease (had such Term not been terminated by Landlord prior to the expiration of the Term of this Lease) less the then present value of the fair rental value of the Leased Premises for such period, the undersigned parties hereby stipulating that such fair rental value shall in no event be deemed to exceed sixty percent (60%) of the then present value of the rental reserved for such period. In the event that Landlord elects to terminate the Lease by reason of an Event of Default, in lieu of exercising the rights of Landlord under the preceding paragraph of this Paragraph 18.D., Landlord may instead hold Tenant liable for all rental and other indebtedness accrued to the date of such termination, plus such rental and other indebtedness as would otherwise have been required to be paid by Tenant to Landlord during the period following termination of the Term of this Lease measured from the date of such termination by Landlord until the expiration of the Term of this Lease (had Landlord not elected to terminate the Lease on account of such Event of Default) diminished by any net sums thereafter received by Landlord through reletting the Leased Premises during said period (after deducting expenses incurred by Landlord as provided in Paragraph 18.F. hereof). Actions to collect amounts due by Tenant provided for in this paragraph of this Paragraph 18.D. may be brought from time to time by Landlord during the aforesaid period, on one (1) or more occasions, without the necessity of Landlord's waiting until the expiration of such period, and in no event shall Tenant be entitled to any excess of rental (or rental plus other sums) obtained by reletting over and above the rental provided for in this Lease. E. In the event that Landlord elects to repossess the Leased Premises without terminating this Lease, then Tenant shall be liable for and shall pay to Landlord, at the address specified in Paragraph 1.C. hereof, all rental and other indebtedness accrued to the date of such repossession, plus rental required to be paid by Tenant to Landlord during the remainder of the Term of this Lease until the expiration of the Term of this Lease, diminished by any net sums thereafter received by Landlord through reletting the Leased Premises during said period (after deducting expenses incurred by Landlord as provided in Paragraph 18.F. hereof). In no event shall Tenant be entitled to any excess of any rental obtained by reletting over and above the rental herein reserved. Actions to collect amounts due by Tenant as provided in this 22 26 Paragraph 18.E. may be brought from time to time, on one (1) or more occasions, without the necessity of Landlord's waiting until the expiration of the Term of this Lease. F. In case of an Event of Default, Tenant shall also be liable for and shall pay to Landlord, at the address specified in Paragraph 1.C. hereof, in addition to any sum provided to be paid above: (i) broker's fees incurred by Landlord in connection with reletting the whole or any part of the Leased Premises, (ii) the cost of removing and storing Tenant's or other occupant's property, (iii) the cost of repairing, altering, remodeling or otherwise putting the Leased Premises into condition acceptable to a new tenant or tenants and (iv) all reasonable expenses incurred by Landlord in enforcing Landlord's remedies, including reasonable attorneys' fees. Past due rental and other past due payments shall bear interest from maturity at the lesser per annum rate of (i) four percent (4%) in excess of Prime Rate (as defined in Paragraph 1.Q. hereof), or (ii) the highest lawful rate, until paid. G. In the event of termination or repossession of the Leased Premises for an Event of Default, Landlord shall not have any obligation to relet or attempt to relet the Leased Premises, or any portion thereof, or to collect rental after reletting; but Landlord shall have the option to relet or attempt to relet; and in the event of reletting, Landlord may relet the whole or any portion of the Leased Premises for any period to any tenant and for any use and purpose. H. If Tenant should fail to make any payment or cure any default hereunder within the time herein permitted, Landlord; without being under any obligation to do so and without thereby waiving such default, may make such payment and/or remedy such other default for the account of Tenant (and enter the Leased Premises for such purpose), and thereupon Tenant shall be obligated to, and hereby agrees to, pay Landlord, upon demand, all costs, expenses and disbursements (including reasonable attorneys' fees) incurred by Landlord in taking such remedial action. I. In the event of any default by Landlord, Tenant's exclusive remedy shall be an action for damages (Tenant hereby waiving the benefit of any laws granting Tenant a lien upon the property of Landlord and/or upon rental due Landlord), but prior to any such action Tenant will give Landlord written notice specifying such default with particularity, and Landlord shall thereupon have thirty (30) days (plus such additional reasonable period as may be required in the exercise by Landlord of due diligence) in which to cure any such default. Unless and until Landlord fails to so cure any default after such notice, Tenant shall not have any remedy or cause of action by reason thereof. All obligations of Landlord hereunder will be construed as covenants, not conditions; and all such obligations will be binding upon Landlord only during the period of Landlord's possession of the Building and not thereafter. The term "Landlord" shall mean only the owner, for the time being, of the Building, and in the event of the transfer by such owner of its interest in the Building, such owner shall thereupon be released and discharged from all covenants and obligations of the Landlord thereafter accruing, but such covenants and obligations shall be binding during the Term of this Lease upon each new owner for the duration of such owner's ownership. 19. NONWAIVER. Neither acceptance of rental or other payments by Landlord nor failure by Landlord to complain of any action, nonaction or default of Tenant shall constitute a 23 27 waiver of any of Landlord's rights hereunder. Waiver by Landlord of any right for any default of Tenant shall not constitute a waiver of any right for either a subsequent default of the same obligation or any other default. Receipt by Landlord of Tenant's keys to the Leased Premises shall not constitute an acceptance of surrender of the Leased Premises. 20. HOLDING OVER. If Tenant should remain in possession of the Leased Premises after the expiration of the Term of this Lease, without the execution by Landlord and Tenant of a new lease or an extension of this Lease, then Tenant shall be deemed to be occupying the Leased Premises as a tenant-at-sufferance, subject to all the covenants and obligations of this Lease and at a daily rental of one hundred fifty percent (150%) of the per day rental provided for the last month of the Term of this Lease, computed on the basis of a thirty (30) day month. The inclusion of the preceding sentence shall not be construed as Landlord's consent for Tenant to hold over. If any property not belonging to Landlord remains at the Leased Premises after the expiration of the Term of this Lease, Tenant hereby authorizes Landlord to make such disposition of such property as Landlord may desire without liability for compensation or damages to Tenant in the event that such property is the property of Tenant; and in the event that such property is the property of someone other than Tenant, Tenant agrees to indemnify and hold Landlord harmless from all suits, actions, liability, loss, damages and expenses in connection with or incident to any removal, exercise or dominion over and/or disposition of such property by Landlord. 21. COMMON AREA. The Common Area, as defined in Paragraph 1.P. hereof, shall be subject to Landlord's sole management and control and shall be operated and maintained in such manner as Landlord in Landlord's discretion shall determine. Landlord reserves the right to change from time to time the dimensions and location of the Common Area, to construct additional stories on the Building and to place, construct or erect new structures or other improvements on any part of the Land without the consent of Tenant. Such changes shall not materially interfere with Tenant's use of the Leased Premises. Tenant, and Tenant's employees and invitees shall have the nonexclusive right to use the Common Area as constituted from time to time, such use to be in common with Landlord, other tenants of the Building and other persons entitled to use the same, and subject to such reasonable rules and regulations governing use as Landlord may from time to time prescribe. Tenant shall not solicit business or display merchandise within the Common Area, or distribute handbills therein, or take any action which would interfere with the rights of other persons to use the Common Area. Landlord may temporarily close any part of the Common Area for such periods of time as may be necessary to prevent the public from obtaining prescriptive rights or to make repairs or alterations. 22. RULES AND REGULATIONS. Tenant, and Tenant's agents, employees and invitees shall comply fully with all requirements of the rules and regulations of the Building which are attached hereto as Exhibit C and made a part hereof. Landlord shall at all times have the right to change such rules and regulations or to amend or supplement them in such manner as may be deemed advisable for the safety, care and cleanliness of the Leased Premises and the Building and for preservation of good order therein, all of which rules and regulations, changes and amendments shall be forwarded to Tenant and shall be carried out and observed by Tenant from and after ten (10) days following delivery of notice thereof to Tenant. Such rules and regulations may not require Tenant to pay additional rental and shall not be applied retroactively. 24 28 Tenant shall further be responsible for the compliance with such rules and regulations by the employees, agents and invitees of Tenant. 23. TAXES. Tenant shall be liable for the timely payment of all taxes levied or assessed against personal property, furniture or fixtures or equipment placed by Tenant in the Leased Premises. If any such taxes for which Tenant is liable are levied or assessed against Landlord or Landlord's property and if Landlord elects to pay the same, or if the assessed value of Landlord's property is increased by inclusion of personal property, furniture or fixtures or equipment placed by Tenant in the Leased Premises, and Landlord elects to pay the taxes based on such increase Tenant shall pay to Landlord upon demand that part of such taxes for which Tenant is liable hereunder. 24. INSURANCE. Tenant shall, at Tenant's expense, procure and maintain throughout the Term of this Lease a policy or policies of comprehensive public liability insurance, contractual liability insurance and property damage insurance, issued by insurers of recognized responsibility, authorized to do business in the State in which the Building is located, insuring Tenant and Landlord against any and all liability for injury to or death of a person or persons, occasioned by or arising out of or in connection with the use or occupancy of the Leased Premises, the limits of such policy or policies to be in an amount of not less than $2,000,000 combined single limit with respect to any one (1) occurrence, and shall furnish evidence satisfactory to Landlord of the maintenance of such insurance. Tenant shall obtain a written obligation on the part of each insurer to notify Landlord at least fifteen (15) days prior to modification or cancellation of such insurance. In the event Tenant shall not have delivered to Landlord a policy or certificate evidencing such insurance at least fifteen (15) days prior to the Commencement Date and at least fifteen (15) days prior to the expiration dates of each expiring policy, Landlord may obtain such insurance as Landlord may reasonably require to protect Landlord's interest. The cost for such policies shall be paid by Tenant to Landlord as additional rental upon demand plus an administrative charge as determined by Landlord. 25. PARKING. Landlord hereby leases to Tenant and Tenant hereby leases from Landlord the number of parking spaces specified in Paragraph 1.S. hereof in the parking facility from time to time associated with the Building at the prevailing market rental established by Landlord from time to time for similar parking spaces in such parking facility. Tenant shall pay to Landlord the prevailing market rental from time to time established by Landlord for such number of parking spaces as additional rental monthly together with and in addition to Base Rental, whether or not such number of parking spaces are in use. Tenant may not increase or decrease such number of parking spaces without the prior written consent of Landlord. Tenant agrees to comply with such reasonable rules and regulations as may be promulgated from time to time for the use of such parking facility, including, without limitation, rules and regulations requiring the parking of vehicles in designated spaces or areas to the exclusion of other spaces or areas. Such rules may not require Tenant to pay additional rental and shall not be applied retroactively. Parking spaces will be unassigned, provided that Landlord may at any time assign parking spaces. Tenant shall, if requested by Landlord, furnish to Landlord a complete list of the license plate numbers of all vehicles operated by Tenant, Tenant's employees and agents. Landlord shall not be liable for any damage of any nature whatsoever to, or any theft of, vehicles, or contents therein, in or about such parking facility. During temporary periods of construction or repair, Landlord shall use Landlord's best efforts to provide suitable substitute parking 25 29 facilities in reasonable proximity to the Building; provided, however, if for any reason Landlord fails or is unable to provide suitable substitute parking facilities in reasonable proximity to the Building, Landlord shall not be deemed to be in default hereunder, but Tenant's obligation to pay the prevailing market rental for any such parking spaces shall cease for so long as Tenant does not have the use of such parking spaces and such abatement shall constitute full settlement of all claims that Tenant might otherwise have against Landlord by reason of such failure or inability to provide such parking spaces. 26. PERSONAL LIABILITY. The liability of Landlord to Tenant for any default by Landlord under the terms of this Lease shall be limited to the proceeds of sale on execution of the interest of Landlord in the Building and in the Land, and neither Landlord, nor any party comprising Landlord, shall be personally liable for any deficiency. This clause shall not be deemed to limit or deny any remedies which Tenant may have in the event of default by Landlord hereunder which do not involve the personal liability of Landlord. 27. NOTICE. Any notice which may or shall be given under the terms of this Lease shall be in writing and shall be either delivered by hand (including commercially recognized messenger and express mail service) or sent by United States Mail, registered or certified, return receipt requested, postage prepaid, if for Landlord, to the Building office and at the address specified in Paragraph 1.C. hereof, or if for Tenant, to the Leased Premises or, if prior to the Commencement Date, at the address specified in Paragraph 1.E. hereof, or at such other addresses as either party may have theretofore specified by written notice delivered in accordance herewith. Such address may be changed from time to time by either party by giving notice as provided herein. Notice shall be deemed given when delivered (if delivered by hand) or, whether actually received or not, when postmarked (if sent by mail). If the term "Tenant" as used in this Lease refers to more than one (1) person and/or entity, and notice given as aforesaid to any one of such persons and/or entities shall be deemed to have been duly given to Tenant. 28. LANDLORD'S MORTGAGEE. If the Building and/or Leased Premises are at any time subject to a ground lease, mortgage, deed of trust or other lien, then in any instance in which Tenant gives notice to Landlord alleging default by Landlord hereunder, Tenant will also simultaneously give a copy of such notice to each Landlord's Mortgagee (provided Landlord or Landlord's Mortgagee shall have advised Tenant of the name and address of Landlord's Mortgagee) and each Landlord's Mortgagee shall have the right (but no obligation) to cure or remedy such default during the period that is permitted to Landlord hereunder, plus an additional period of thirty (30) days, and Tenant will accept such curative or remedial action (if any) taken by Landlord's Mortgagee with the same effect as if such action had been taken by Landlord. 29. BROKERAGE. Landlord and Tenant each represents and warrants that it has dealt with no broker, agent or other person in connection with this transaction and that no broker, agent or other person brought about this transaction, other than Broker specified in Paragraph 1.R. hereof, and Landlord and Tenant each agrees to indemnify and hold the other harmless from and against any claims by any other broker, agent or other person claiming a commission or other form of compensation by virtue of having dealt with the indemnifying party with regard to this leasing transaction. The provisions of this Paragraph 29 shall survive the termination of this Lease. 26 30 30. PREPAID RENTAL AND SECURITY DEPOSIT. Landlord hereby acknowledges receipt from Tenant of the sum stated in Paragraph 1.M. hereof to be applied to the first accruing monthly installments of rental. Landlord further acknowledges receipt from Tenant of a Security Deposit in the amount stated in Paragraph 1.N. hereof to be held by Landlord as security for the performance by Tenant of Tenant's covenants and obligations under this Lease, it being expressly understood that such deposit shall not be considered an advance payment of rental or a measure of Landlord's damages in case of default by Tenant. The Security Deposit shall be held by Landlord without liability to Tenant for interest, and Landlord may commingle such deposit with any other funds held by Landlord. If Tenant should be late in the making of any payment of rental or other sum due under this Lease, Tenant agrees that, upon request of Landlord, Tenant will increase forthwith the amount of the Security Deposit to a sum double the existing amount thereof. Upon the occurrence of any Event of Default, Landlord may, from time to time, without prejudice to any other remedy, use such fund to the extent necessary to make good any arrears of rental and any other damage, injury, expense or liability caused to Landlord by such Event of Default. Following any such application of the Security Deposit, Tenant shall pay to Landlord on demand the amount so applied in order to restore the Security Deposit to the amount thereof immediately prior to such application. If Tenant is not then in default hereunder, any remaining balance of such deposit shall be returned by Landlord to Tenant upon termination of this Lease; provided, however, Landlord shall have the right to retain and expend such remaining balance for cleaning and repairing the Leased Premises if Tenant shall fail to deliver up the same at the expiration or earlier termination of this Lease in the condition required by the provisions of this Lease. If Landlord transfers Landlord's interest in the Leased Premises during the Term of this Lease (including any renewal thereof), Landlord may assign the Security Deposit to the transferee and thereafter shall have no further liability for the return of the Security Deposit. 31. SPRINKLERS. If there now is or shall be installed in the Building a sprinkler system and such system, or any of its components shall be damaged or injured or not in proper working order by reason of any act or omission of Tenant, Tenant's agents servants, employees, licensees or visitors, then Tenant shall forthwith restore the same to good working condition at Tenant's own expense; and if the Board of Fire Underwriters or any bureau, department or official of the state or local government require or recommend that any changes, modifications, alterations or additional sprinkler heads or other equipment be made or supplied by reason of Tenant's business, or the location of partitions, trade fixtures or other contents of the Leased Premises, or for any other reason, or if any such changes, modifications alterations, additional sprinkler heads or other equipment become necessary to prevent the imposition of a penalty or charge against the full allowance for a sprinkler system in the fire insurance rate as fixed by the Board of Fire Underwriters, or by any fire insurance company, Tenant shall, at Tenant's expense, promptly make and supply such changes, modifications, alterations, additional sprinkler heads or other equipment. Subject to Landlord's approval of the plans and specifications therefor and the contractors who will perform such work, Tenant may install a FM 200 fire suppression system in the Leased Premises. Upon the expiration or earlier termination of the Term of this Lease, Tenant shall remove such fire suppression system and return the sprinkler system in the Leased Premises to the condition in which it existed on the date Landlord delivered the Leased Premises to Tenant. 32. ROOFTOP RIGHTS. 27 31 Landlord and Tenant contemplate entering into a separate agreement to be negotiated with Tenant by Landlord or Landlord's roof consultant addressing Tenant's rights with respect to the Building's rooftop. 33. INTERCONNECTION RIGHTS. A. Landlord acknowledges that the nature of Tenant's business may require it to interconnect with other telecommunications companies which may also be located in the Building. Landlord agrees that Tenant may, subject to the payment of a Riser Fee as set forth in Paragraph 1.L and Landlord's prior written approval, which approval, subject to the following provisions, shall not be unreasonably withheld, delayed or conditioned: i. install, maintain and use cable, conduits, wires, cable ducts, telephone closets and ladder racks for the conduct of its business between the Leased Premises and other parts of the Building; and ii. directly connect to, interface with, or otherwise attach to, the lines and facilities of the public utilities supplying electrical or telephone services to the Building, for additional electric energy and telephone connections to the Leased Premises. B. In the event that Tenant desires to make any of the foregoing modifications or improvements, Tenant shall provide written notice to Landlord describing the type, size, location and manner of such desired modification or improvement. Landlord shall advise Tenant in writing within five (5) business days of Landlord's receipt of such notice of Landlord's approval or disapproval of such requested modification or improvement, or of the requirement that Tenant submit detailed drawings and specifications of such modification or improvement. If Landlord notifies Tenant of the requirement that Tenant submit detailed drawings and specifications, Tenant may then elect to withdraw its request or submit detailed drawings and specifications, at Tenant's sole cost and expense, regarding such modification or improvement. Tenant agrees that Landlord's disapproval of any of the foregoing modifications and improvements shall be reasonable if any such modifications or improvements have a material negative impact on any Building electrical, mechanical, plumbing or other system or the structual or aesthetic integrity of the Building or if space is not available for such installation after taking into consideration the needs of Landlord and of other tenants in the Building. Subject to Landlord's prior written approval, Tenant shall have access to and use of all common areas, lines, chase ways and ways of passage in the Building and the Leased Premises necessary to effectuate the rights set forth in this paragraph, provided said access and use does not interfere with the operation of the Building, the existing equipment of other tenants or Landlord's obligations to other tenants in the Building. Any installation carried out by Tenant pursuant to this paragraph shall be at Tenant's sole cost and expense, shall be performed in accordance with the other provisions of this Lease, and shall comply with all applicable federal, state and local laws and ordinances. Tenant agrees to indemnify and hold Landlord harmless from and against any and all loss, cost, claim and liability (including all attorneys' fees) for injuries to all persons and for damage to or loss of all property arising or alleged to arise from any act or omission of Tenant or Tenant's agents, employees, or contractors relating to the installation, maintenance, operation and removal of such improvements, installations and modifications. 28 32 C. Upon the expiration or earlier termination of the Term of this Lease, Tenant shall remove any and all of the improvements described in this Paragraph 33 in a good and workmanlike manner, and Tenant will repair any damage occasioned by such removal. If Tenant fails to remove such improvements within thirty (30) days after the expiration or earlier termination of the Term of this Lease, Landlord shall have the right, but not the obligation, to elect either (i) to remove such improvements at Tenant's cost and expense, and Landlord shall have no liability for the return of, or damage to, such improvements, or (ii) to treat such improvements as abandoned by Tenant. 34. EMERGENCY POWER. A. Tenant shall have the right, subject to Landlord's weight stress, load bearing and ventilation requirements and at Tenant's sole cost and expense, to install and maintain a 400 kilowatt emergency diesel generator and associated skid fuel tank at the location set forth on Exhibit D attached hereto and made a part hereof for all purposes. Tenant shall maintain, at Tenant's sole cost and expense, a fence around such emergency generator. Additionally, subject to Landlord's prior written approval of plans and specifications relating thereto, Tenant shall have the right to install such wire, conduits, cables and other materials as necessary to connect such emergency generator to the Leased Premises (the emergency generator and connecting material, being collectively referred to as the "Generator Installation"). Tenant shall be responsible for all costs and expenses arising from and relating to the Generator Installation. The Generator Installation shall be in compliance with all applicable federal, state and local laws and ordinances and Tenant shall indemnify and hold Landlord harmless from and against any and all loss, cost, claim and liability arising from Tenant's failure to satisfy such requirement. Landlord agrees that Tenant and representatives designated by Tenant and approved by Landlord shall have reasonable access to the Generator Installation in order to install, operate, maintain inspect and remove as required, the Generator Installation, except when reasonable safety and security requirements of Landlord preclude such access. Landlord shall not unreasonably interfere with or impair Tenant's use, operation, maintenance or repair of the Generator Installation. Subject to Landlord's obligation not to unreasonably interfere with or impair Tenant's use, operation, maintenance or repair of the Generator Installation, Landlord reserves the right to lease space in the Project to other tenants, as Landlord may desire, for any purpose, including the installation and operation of a separate emergency generator. Notwithstanding any contrary provision contained herein, Landlord shall have the right to relocate, at Landlord's sole, expense the Generator Installation to another location in the Project, as Landlord shall elect; provided, however, that no such relocation may result in any additional cost or expense to Tenant or have any detrimental effect on Tenant's use and operation of the Generator Installation. B. Subject to the availability of a location in the Project acceptable to Landlord and Tenant and subject to Landlord's approval of the plans and specifications therefor and the contractors who will perform such work, Tenant may, at Tenant's sole cost and expense install a generator plug (the "Plug Installation") for the purpose of connecting the Leased Premises to a portable generator. C. Subject to Landlord's approval of the location thereof, the plans and specifications therefor and the contractors who will perform such work, Tenant may, at Tenant's 29 33 sole cost and expense, install an electrical grounding system (the "Electrical Grounding Installation") utilizing grounding rods, which system shall connect to the Building's main telecommunications electrical grounding system. D. The Generator Installation, the Plug Installation and the Electrical Grounding Installation are collectively referred to herein as the "Emergency Power Installation." E. Tenant agrees to indemnify and hold Landlord harmless from and against any and all loss, cost, claim and liability (including all attorneys' fees) for injuries to all persons and for damage to or loss of all property arising or alleged to arise from any act or omission of Tenant or Tenant's agents, employees, or contractors relating to the installation, maintenance, operation or removal of the Emergency Power Installation. F. Upon the expiration or earlier termination of the Term of this Lease, Tenant shall remove the Emergency Power Installation and related improvements in a good and workmanlike manner, and Tenant will repair any damage occasioned by such removal. If Tenant fails to remove the Emergency Power Installation within thirty (30) days after the expiration or earlier termination of the Term of this Lease, Landlord shall have the right, but not the obligation, to elect either (i) to remove the Emergency Power Installation at Tenant's cost and expense, and Landlord shall have no liability for the return of, or damage to, the Emergency Power Installation, or (ii) to treat the Emergency Power Installation as abandoned by Tenant. 35. SUPPLEMENTAL HVAC. A. Tenant shall have the right to install and maintain, at Tenant's sole cost and expense, at least forty (40) tons of supplemental air-conditioning equipment at the location set forth on Exhibit D attached hereto. Tenant shall maintain, at Tenant's sole cost and expense, a fence around such supplemental air conditioning equipment. Additionally, subject to Landlord's prior written approval of plans and specifications relating thereto, Tenant shall have the right to install such wire, conduits, cables and other materials as necessary to connect such supplemental air conditioning equipment to the Leased Premises (the supplemental air conditioning equipment and connecting material being collectively referred to as the "HVAC Installation"). Landlord agrees not to unreasonably withhold or delay its approval regarding matters involving the HVAC Installation on which Landlord's approval is required. Tenant shall be responsible for all costs and expenses arising from and relating to the HVAC Installation. The HVAC Installation shall be in compliance with all applicable federal, state and local laws and ordinances and Tenant shall indemnify and hold Landlord harmless from and against any and all loss, cost, claim and liability arising from Tenant's failure to satisfy such requirement. B. Tenant agrees to indemnify and hold Landlord harmless from and against any and all loss, cost, claim and liability (including all attorneys' fees) for injuries to all persons and for damage to or loss of all property arising or alleged to arise from any act or omission of Tenant or Tenant's agents, employees, or contractors relating to the installation, maintenance, operation or removal of the Installation, except to the extent such injury, damage or loss of property is caused by Landlord's negligence or willful misconduct. 30 34 C. Landlord agrees that Tenant and representatives designated by Tenant and approved by Landlord shall have reasonable access to the HVAC Installation in order to install, operate, maintain, inspect and remove as required, the HVAC Installation, except when reasonable safety and security requirements of Landlord preclude such access. Landlord shall not unreasonably interfere with or impair Tenant's use, operation, maintenance or repair of the HVAC Installation. D. Subject to Landlord's obligation not to unreasonably interfere with or impair Tenant's use, operation, maintenance or repair of the HVAC Installation, Landlord reserves the right to lease space in the Project to other tenants, as Landlord may desire, for any purpose, including the installation and operation of supplemental air conditioning equipment. E. Notwithstanding any contrary provision contained herein, Landlord shall have the right to relocate, at Landlord's sole expense, the HVAC Installation to another location in the Project, as Landlord shall elect; provided, however, that no such relocation may result in any additional cost or expense to Tenant or have any detrimental effect on Tenant's use and operation of the HVAC Installation. F. Upon the expiration or earlier termination of the Term of this Lease, Tenant shall remove the HVAC Installation and related improvements in a good and workmanlike manner, and Tenant will repair any damage occasioned by such removal. If Tenant fails to remove the HVAC Installation within thirty (30) days after the expiration or earlier termination of the Term of this Lease, Landlord shall have the right, but not the obligation, to elect either (i) to remove the HVAC Installation at Tenant's cost and expense, and Landlord shall have no liability for the return of, or damage to, the HVAC Installation, or (ii) to treat the HVAC Installation as abandoned by Tenant. 36. REMOVAL OF ABOVE-CEILING ALTERATIONS. At the termination of this Lease, Tenant shall, at Tenant's sole cost and expense, remove all above-ceiling alterations made by or on behalf of Tenant to the Leased Premises, including, without limitation, the initial alterations made to the Leased Premises, and repair all damage caused thereby. In addition, Tenant shall, at Tenant's sole cost and expense, replace all above-ceiling improvements removed by Tenant or on behalf of Tenant from the Leased Premises so that Tenant shall return the above-ceiling portion of the Leased Premises to Landlord in the same condition as it exists on the date of this Lease. Such work shall be done in a good and workmanlike manner and in accordance with the terms and conditions of Paragraph 11 of this Lease. 37. DELIVERY OF LEASED PREMISES. A. Prior to the execution of this Lease, Tenant has inspected the Leased Premises and conducted such tests as Tenant, in Tenant's sole discretion, deems appropriate. Tenant hereby leases the Leased Premises on an "as is," "where is" basis without representation or warranty, express or implied. Landlord shall have no obligation to construct or install leasehold improvements in the Leased Premises. B. Tenant shall construct or have constructed in a first class and workmanlike manner the tenant finish improvements (the "Tenant Finish Work") to be constructed and 31 35 installed in the Leased Premises. The Tenant Finish Work shall be constructed in accordance with plans and specifications prepared or caused to be prepared by Tenant, at Tenant's sole cost and expense, and approved in advance, in writing, by Landlord, such approval not to be unreasonably withheld or delayed; provided, however, that Landlord shall be deemed to have reasonably withheld its consent if Landlord withholds its consent because any proposed tenant finish improvements negatively impacts any system of the Building including, without limitation, the Building's floor load bearing requirements or its mechanical, electrical, plumbing or HVAC systems. The Tenant Finish Work shall be constructed in accordance with all applicable building laws and ordinances and all covenants, conditions and restrictions affecting the Project. Tenant shall obtain Landlord's written approval of Tenant's bid package prior to delivering the bid package to prospective contractors, such approval not to be unreasonably withheld or delayed. Tenant shall not commence the construction of any portion of the Tenant Finish Work until Landlord has approved, in writing, the contractors who shall perform the Tenant Finish Work, including, without limitation, the mechanical, electrical, and plumbing contractors, such approval not to be unreasonably withheld or delayed. Attached as Exhibit F is a list of Landlord's approved general, electrical and mechanical contractors. Tenant shall have the right to competitively bid the Tenant Finish Work. Tenant shall pay Landlord's designated construction manager a construction management fee of five percent (5%) of the cost of the Tenant Finish Work. C. Landlord shall permit Tenant and Tenant's agents to enter the Leased Premises after Landlord tenders possession of the Leased Premises to Tenant and prior to the Commencement Date in order that Tenant may perform the Tenant Finish Work through Tenant's own contractors. The foregoing license to enter prior to the Commencement Date is conditioned upon Tenant's workmen and mechanics working in harmony and not materially interfering with the labor employed by Landlord, Landlord's mechanics or contractors or with any other tenant or their contractors. Such license is further conditioned upon workers' compensation and public liability insurance and property damage insurance, all in amounts and with companies and on forms reasonably satisfactory to Landlord, being provided and at all times maintained by Tenant's contractors engaged in the performance of the Tenant Finish Work, and certificates of such insurance being furnished to Landlord prior to proceeding with the work and upon Tenant's workmen and mechanics complying with the rules and regulations promulgated from time to time by Landlord for the construction of tenant improvements. If at any time such entry shall cause material disharmony or interference to other tenants, contractors or labor for any reason whatsoever including, without limitation, strikes or other work stoppages and if Tenant has not caused such disharmony or interference to promptly cease following notice thereof to Tenant, then this license may be revoked by Landlord until such disharmony or interference ceases. Such entry shall be deemed to be under all of the terms, covenants, provisions and conditions of the Lease. Landlord shall not be liable in any way for any injury, loss or damage which may occur to any of the Tenant Finish Work prior to or after the Commencement Date, the same being solely at Tenant's risk. D. Tenant shall indemnify and hold Landlord harmless from and against any and all demands liability, liens, claims, losses, costs and expenses (including reasonable attorneys' fees) relating to or arising from the design, construction and installation of the Tenant Finish Work. Notwithstanding the fact that Landlord may, from time to time, review all applicable plans and specifications and monitor the progress of the Tenant Finish Work, 32 36 Landlord shall have no obligation or liability to Tenant relating to or arising from the workmanship or materials employed in the construction and preparation of the Tenant Finish Work and the related space planning and architectural services. 38. RENEWAL OPTIONS. A. If there is no uncured Event of Default hereunder, Tenant shall have the right to renew the term of this Lease for two (2) additional periods of five (5) years each upon the same terms, conditions and provisions applicable to the primary term of this Lease (unless otherwise expressly provided herein), except that the Base Rental for each additional term of five (5) years shall be the product of (i) the number of rentable square feet then contained in the Leased Premises multiplied by (ii) an amount equal to the then prevailing market base rental rate per rentable square foot per annum (taking into consideration use, location and floor level, size of space, definition of rentable area, quality, age and location of the applicable building, Tenant's financial status, rental concessions, tenant improvements and refurbishment allowances, expense stop, moving allowances, architectural allowances, parking rental concessions, brokerage commissions, other inducements, the time the particular rate under consideration becomes effective and all other relevant factors) plus the then prevailing market riser fee (collectively, the Market Rental") charged for comparable office space and riser facilities in comparable buildings in the central business district of Dallas, Texas. B. Tenant shall evidence its intent to exercise its right of renewal separately with respect to each renewer term by delivering to Landlord written notice ("Tenant's Notice") of Tenant's desire to renew the Term of this Lease as aforesaid at least nine (9) months (but not more than twelve (12) months) prior to the expiration of the then current Term of this Lease. Within thirty (30) days following delivery of Tenant's Notice, Landlord shall deliver to Tenant a written notice ("Landlord's Notice") specifying the Market Rental for the additional term of five (5) years in question. Tenant shall have sixty (60) days following delivery of Landlord's Notice in which to notify Landlord of Tenant's exercise of its rights to renew the Term hereof. Failure to notify Landlord within such period or to timely deliver Tenant's Notice shall automatically extinguish Tenant's rights to renew. Tenant shall have no right to renew the Term of this Lease following the expiration of the second renewal term of five (5) years detailed herein. 39. MISCELLANEOUS. A. Provided Tenant complies with Tenant's covenants, duties and obligations hereunder, Tenant shall quietly have, hold and enjoy the Leased Premises subject to the terms and provisions of this Lease without hinderance from Landlord or any person or entity claiming by, through or under Landlord. B. In any circumstance where Landlord is permitted to enter upon the Leased Premises during the Term of this Lease, whether for the purpose of curing any default of Tenant, repairing damage resulting from fire or other casualty or an eminent domain taking or is otherwise permitted hereunder or by law to go upon the Leased Premises, no such entry shall constitute an eviction or disturbance of Tenant's use and possession of the Leased Premises or a breach by Landlord of any of Landlord's obligations hereunder or render Landlord liable for 33 37 damages for loss of business or otherwise or entitle Tenant to be relieved from any of Tenant's obligations hereunder or grant Tenant any right of setoff or recoupment or other remedy; and in connection with any such entry incident to performance of repairs, replacements, maintenance or construction, all of the aforesaid provisions shall be applicable notwithstanding that Landlord may elect to take building materials in, to or upon the Leased Premises that may be required or utilized in connection with such entry by Landlord. C. [Intentionally Deleted.] D. Landlord may restrain or enjoin any breach or threatened breach of any covenant, duty or obligation of Tenant herein contained without the necessity of proving the inadequacy of any legal remedy or irreparable harm. The remedies of Landlord hereunder shall be deemed cumulative, and no remedy of Landlord, whether exercised by Landlord or not, shall be deemed to be in exclusion of any other. Except as may be otherwise herein expressly provided, in all circumstances under this Lease where prior consent or permission of one (1) party ("first party") is required before the other party ("second party") is authorized to take any particular type of action, the matter of whether to grant such consent or permission shall be within the sole and exclusive judgment and discretion of the first party; and it shall not constitute any nature of breach by the first party hereunder or any defense to the performance of any covenant, duty or obligation of the second party hereunder that the first party delayed or withheld the granting of such consent or permission, whether or not the delay or withholding of such consent or permission was prudent or reasonable or based on good cause. E. In all instances where either party is required to pay any sum or do any act at a particular indicated time or within an indicated period, it is understood that time is of the essence. F. The obligation of Tenant to pay all rental and other sums hereunder provided to be paid by Tenant and the obligation of Tenant to perform Tenant's other covenants and duties hereunder constitute independent, unconditional obligations to be performed at all times provided for hereunder, save and except only when an abatement thereof or reduction therein is hereinabove expressly provided for and not otherwise. Tenant waives and relinquishes all rights which Tenant might have to claim any nature of lien against or withhold, or deduct from or offset against any rental and other sums provided hereunder to be paid Landlord by Tenant. Tenant waives and relinquishes any right to assert, either as a claim or as a defense, that Landlord is bound to perform or is liable for the nonperformance of any implied covenant or implied duty of Landlord not expressly herein set forth. G. Under no circumstances whatsoever shall Landlord ever be liable hereunder for consequential damages or special damages. H. Landlord retains the exclusive right to create any additional improvements to structural and/or mechanical systems, interior and exterior walls and/or glass, which Landlord deems necessary without the prior consent of Tenant. I. All monetary obligations of Landlord and Tenant (including, without limitation, any monetary obligation of Landlord or Tenant for damages for any breach of the 34 38 respective convenants, duties or obligations of Landlord or Tenant hereunder) are performable exclusively in the county in which the Building is located. J. The laws of the State in which the Building is located shall govern the interpretation, validity, performance and enforcement of this Lease. K. If any clause or provision of this Lease is or becomes illegal, invalid, or unenforceable because of present or future laws or any rule or regulation of any governmental body or entity, effective during the Term of this Lease, the intention of the parties hereto is that the remaining parts of this Lease shall not be affected thereby. L. Tenant waives the benefits of all existing and future rental control legislation and statutes and similar governmental rules and regulations, whether in time of war of not, to the extent permitted by law. In the event that any law, decision, rule or regulation of any governmental body having jurisdiction shall have the effect of limiting for any period of time the amount of rental or other charges payable by Tenant to any amount less than that otherwise provided pursuant to this Lease, the following amounts shall nevertheless be payable to Tenant: (i) throughout such period of limitation, Tenant shall remain liable for the maximum amount of rental and other charges which are legally payable (without regard to any limitation to the amount thereof expressed in this Lease except that all amounts payable by reason of this paragraph shall not in the aggregate exceed the total of all amounts which would otherwise be payable by Tenant pursuant to the terms of this Lease for the period of limitation), (ii) at the termination of such period of limitation, Tenant shall pay to Landlord, on demand but only to the extent legally collectible by Landlord, any amounts which would have been due from Tenant during the period of limitation but which were not paid because of such limiting law, decision, rule or regulation, and (iii) for the remainder of the Term of this Lease following the period of limitation, Tenant shall pay to Landlord all amounts due for such portion of the Term of this Lease in accordance with the terms hereof calculated as though there had been no intervening period of limitation. M. It is mutually agreed by and between Landlord and Tenant that the respective parties hereto shall and they hereby do waive trial by jury in any action, proceeding or counterclaim brought by either of the parties hereto against the other on any matters whatsoever arising out of or in any way connected with this Lease, the relationship of landlord and tenant, Tenant's use or occupancy of the Leased Premises, and any emergency statutory or, any other statutory remedy. N. [Intentionally Deleted.] O. No receipt of money by Landlord from Tenant after the expiration of the Term of this Lease, or after the service of any notice, or after the commencement of any suit, or after final judgment for possession of the Leased Premises, shall reinstate, continue or extend the Term of this Lease or affect any such notice, demand or suit or imply consent for any action for which Landlord's consent is required. P. In the event of variation or discrepancy, Landlord's original copy of the Lease shall control. 35 39 Q. Words of any gender used in this Lease shall be held and construed to include any other gender, and words in the singular number shall be held to include the plural, unless the context otherwise requires. The headings of the Paragraphs of this Lease have been inserted for convenience only and are not to be considered in any way in the construction or interpretation of this Lease. R. Tenant agrees that Tenant shall from time to time upon request by Landlord and/or Landlord's Mortgagee execute and deliver to Landlord a statement in recordable form certifying (i) that the Lease is unmodified and in full force and effect (or, if there have been modifications that the same is in full force and effect as so modified), (ii) the dates to which rental and other charges payable under this Lease have been paid, and (iii) that Landlord is not in default hereunder (or, if Landlord is in default, specifying the nature of such default). Tenant further agrees that Tenant shall from time to time upon request by Landlord execute and deliver to Landlord an instrument in recordable form acknowledging Tenant's receipt of any notice of assignment of this Lease by Landlord. S. In no event shall Tenant have the right to create or permit there to be established any lien or encumbrance of any nature against the Leased Premises or the Building for any improvement or improvements by Tenant, and Tenant shall fully pay the cost of any improvement or improvements made or contracted for by Tenant. Any mechanic's lien filed against the Leased Premises or the Building for work claimed to have been done, or materials claimed to have been furnished to Tenant, shall be duly discharged by Tenant within ten (10) days after the filing of the lien. T. Whenever a period of time is herein prescribed for action to be taken by a party (other than the payment of rental), such party shall not be liable or responsible for, and there shall be excluded from the computation for any such period of time, any delays due to strikes, riots, acts of God, shortages of labor or materials, war, governmental laws, regulations or restrictions, or any other causes of any kind whatsoever which are beyond the reasonable control of the party required to take such action. U. This Lease shall not be recorded by either party without the consent of the other. V. Nothing herein contained shall be deemed or construed by the parties hereto, nor by any third party, as creating the relationship of principal and agent, or of partnership or of joint venture between the parties hereto, it being understood and agreed that neither the method of the computation of rental, nor any other provision contained herein, nor any acts of the parties hereto, shall be deemed to create any relationship between the parties hereto other than the relationship of landlord and tenant. W. Whenever it is provided herein that a monetary sum shall be due to Landlord together with interest at the highest lawful rate, if at such time there shall be no highest rate prescribed by applicable law, interest shall be due at the rate of two percent (2%) in excess of Prime Rate as defined in Paragraph l.Q. hereof. 36 40 X. Tenant acknowledges that Landlord's agents and employees have made no representations or promises with respect to the Leased Premises or the Building except as herein expressly set forth, and Tenant further acknowledges that no rights, easements or licenses are acquired by Tenant by implication or otherwise, except as herein expressly set forth. Y. Tenant warrants that Tenant is, and shall remain throughout the Term of this Lease, authorized to do business and in good standing in the State in which the Building is located if such authorization is required by applicable law. Tenant agrees, upon request by Landlord, to furnish Landlord satisfactory evidence of Tenant's authority for entering into this Lease. Z. In case it should be necessary or proper for Landlord to bring any action under this Lease (including specifically, without limitation, for the review of instruments evidencing a proposed assignment, subletting or other transfer by Tenant submitted to Landlord for consent) or the enforcement of any of Landlord's rights hereunder, Tenant agrees to pay to Landlord reasonable attorneys' fees whether suit be brought or not. AA. In the event Tenant requests from Landlord the written consent of Landlord to any proposed action for which this Lease requires such consent, Landlord may require (in addition to the payment of reasonable attorney's fees) the payment by Tenant of a reasonable fee representing the administrative cost incurred by Landlord in processing such request, regardless of whether such consent is granted. Such fee shall be payable by Tenant at the time such request is made by Tenant. BB. Submission of this Lease for examination does not constitute an offer, right of first refusal, reservation of, or option for, the Leased Premises or any other premises in the Building. This Lease shall become effective only upon execution and delivery by both Landlord and Tenant. CC. If Tenant is composed of more than one (1) person or entity, each person and/or entity comprising Tenant shall be jointly and severally liable for the performance of the obligations of Tenant under this Lease, including specifically, without limitation, the payment of rental and all other sums payable hereunder. DD. Landlord shall have the right at any time to change the name or street address of the Building and to install and maintain a sign or signs on the interior or exterior of the Building. EE. Any charges against Tenant by Landlord for services or for work done on the Leased Premises by order of Tenant, or otherwise accruing under this Lease, shall be considered as rental due and shall be included in any lien for rental. FF. If at any time during the Term of this Lease a tax or excise on rental, a sales tax or other tax however described (except any inheritance, estate, gift, income or excess profit tax imposed upon Landlord) is levied or assessed against Landlord by any taxing authority having jurisdiction on account of Landlord's interest in this Lease, or the rentals or other charges payable hereunder, as a substitute in whole or in part for, or in addition to, the taxes described elsewhere in this paragraph. Tenant shall pay to Landlord as additional rental upon demand the 37 41 amount of such tax or excise. In the event that any such tax or excise is levied or assessed directly against Tenant, Tenant shall pay the same at such times and in such manner as such taxing authority shall require. GG. Tenant has no right to protest the real estate tax rate assessed against the Project and/or the appraised value of the Project determined by any appraisal review board or other taxing entity with authority to determine tax rates and/or appraised values (each a "Taxing Authority"). Tenant hereby knowingly, voluntarily and intentionally waives and releases any right, whether created by law or otherwise, to (a) file or otherwise protest before any Taxing Authority any such rate or value determination even though Landlord may elect not to file any such protest; (b) receive, or otherwise require Landlord to deliver, a copy of any reappraisal notice received by Landlord from any Taxing Authority; and (c) appeal any order of a Taxing Authority which determines any such protest. The foregoing waiver and release covers and includes any and all rights, remedies and recourse of Tenant, now or at any time hereafter, under Section 41.413 and Section 42.015 of the Texas Tax Code (as currently enacted or hereafter modified) together with any other or further laws, rules or regulations covering the subject matter thereof. Tenant acknowledges and agrees that the foregoing waiver and release was bargained for by Landlord and Landlord would not have agreed to enter into this Lease in the absence of this waiver and release. If, notwithstanding any such waiver and release, Tenant files or otherwise appeals any such protest, then Tenant will be in default under this Lease and, in addition to Landlord's other rights and remedies, Tenant must pay or otherwise reimburse Landlord for all costs, charges and expenses incurred by, or otherwise asserted against, Landlord as a result of any tax protest or appeal by Tenant, including, appraisal costs, tax consultant charges and attorneys' fees (collectively, the "Tax Protest Costs"). If, as a result of Tenant's tax protest or appeal, the appraised value for the Project is increased above that previously determined by the Taxing Authority (such increase, the "Value Increase") for the year covered by such tax protest or appeal such year, the "Protest Year"), then Tenant must pay Landlord, in addition to all Tax Protest Costs, an amount (the "Additional Taxes") equal to the sum of the following: (i) the product of the Value Increase multiplied by the tax rate in effect for the Protest Year; plus (ii) the amount of additional taxes payable during the five (5) year period following the Protest Year, such amount to be calculated based upon the Value Increase multiplied by the tax rate estimated to be in effect for each year during such five (5) year period. Tenant must pay all Additional Taxes -- even those in excess of Tenant's proportionate share and which may relate to years beyond the term of this Lease. The Additional Taxes will be conclusively determined by a tax consultant selected by Landlord, without regard to whether and to what extent Landlord may be able in years following the Protest Year to reduce or otherwise eliminate any Value Increase. All Tax Protest Costs and Additional Taxes must be paid by Tenant within five (5) days following written demand by Landlord. 40. ENTIRE AGREEMENT AND BINDING EFFECT. This Lease and any contemporaneous workletter, addenda or exhibits signed by the parties constitute the entire agreement between Landlord and Tenant; no prior written or prior contemporaneous oral promises or representations shall be binding. This Lease shall not be amended, changed or extended except by written instrument signed by both parties hereto. The provisions of this Lease shall be binding upon and inure to the benefit of the heirs, personal representatives, successors and assigns of the parties, but this provision shall in no way alter the restriction herein in connection with assignment, subletting and other transfer by Tenant. 38 42 EXECUTED in multiple counterparts, each of which shall have the force and effect of an original, on the date specified in Paragraph 1.A. hereof. LANDLORD: BEVERLY HILLS CENTER LLC, a California limited liability company By: ___________________________________ Name: _________________________________ Title: ________________________________ TENANT STAR VENDING, INC., a Nevada corporation By: ___________________________________ Name: _________________________________ Title: ________________________________ 39 43 Exhibit A (Diagram of Leased Premises) [GRAPHIC] Exhibit A - Page 1 of 1 44 Exhibit B Being a tract of land situated in the City of Dallas, Dallas County, Texas; and being all of Lot 1 and part of Lot 2 in Block 263 of Burks Addition, as recorded in Volume W, Page 800 of the Deed Records of Dallas County, Texas; and also being that tract of land conveyed to Louis Cerf, as recorded in Volume 2044, Page 577 of the Deed Records of Dallas County, Texas; and being all of former Federal Street between Crockett Street and Leonard Street abandoned by City of Dallas Ordinance No. 17025 and being part of Block 316, as conveyed to Provident Investment Company by deed dated June 14, 1977, and recorded in Volume 77177, Page 204 of the Deed Records of Dallas County, Texas; and being more particularly described as follows: BEGINNING at the intersection of the northeasterly line of Crockett Street (variable width) and the north cut-off line between the northwesterly line of Bryan Street and said northeasterly line of Crockett Street; THENCE North 47[degree]10'35" West along said northeasterly line of Crockett Street a distance of 134.10 feet to an angle point; said point being the most westerly corner of Block 263; THENCE North 39[degree]05'39" West a distance of 21.41 feet to an angle point; said point being the most southerly corner of Block 316; THENCE North 45[degree]06'53" West a distance of 70.95 feet to a point for corner; THENCE North 44[degree]49'25" East along the northwesterly line of said Provident Investment Company tract and the southeasterly line of a tract of land conveyed to the Dallas Independent School District by deed dated May 3, 1977, a distance of 155.75 feet to a point for corner in the southwesterly line of Leonard Street (variable width); THENCE South 45[degree]07'10" East along said southwesterly line of Leonard Street a distance of 234.43 feet to a point for corner; said point being the intersection of said southwesterly line of Leonard Street and the west cut-off line between said northwesterly line of Bryan Street and said southwesterly line of Leonard Street; THENCE South 20[degree]16'36" West along said west cut-off line a distance of 5.50 feet to a point for corner; said point being the intersection of said west cut-off line and said northwesterly line of Bryan Street; THENCE South 45[degree]00'00" West along said northwesterly line of Bryan Street a distance of 137.84 feet to a point for corner; said point being the intersection of said northwesterly line of Bryan Street and said north cut-off line between said northwesterly line of Bryan Street and said northeasterly line of Crockett Street; THENCE South 88[degree]54'43" West along said north cut-off line a distance of 14.41 feet to the POINT OF BEGINNING and containing 36,753 square feet, or 0.8437 acres, more or less. Exhibit B - Page 1 of 1 45 Exhibit C RULES AND REGULATIONS 1. Landlord shall provide Tenant with fifteen (15) keys. Thereafter, Tenant shall pay a reasonable amount fixed by Landlord from time to time for each additional key issued by Landlord to Tenant for Tenant's offices, and upon termination of this Lease, Tenant agrees to return all keys to Landlord. 2. Landlord shall provide and maintain in a conspicuous place in the Building an alphabetical directory board of the tenants. No other directories shall be permitted, unless previously consented to by Landlord in writing. 3. Tenant shall refer all contractors, contractor's representatives and installation technicians rendering any service to Tenant, to Landlord for Landlord's supervision, approval and control before performance of any contractual service. This provision shall apply to all work performed in the Building, including, without limitation, installation of telephones, telegraph equipment, electrical devices and attachments and installations of any nature affecting floors, walls, woodwork, trim, windows, ceilings, equipment or any other physical portion of the Building. 4. Movement in and out of the Building of furniture, office equipment or other bulky materials, or movement through Building entrances or lobby, or dispatch or receipt by Tenant of any merchandise or materials which requires use of elevators or stairways shall be restricted to hours designated by Landlord. All such movement shall be under supervision of Landlord and in the manner agreed between Tenant and Landlord by prearrangement before performance of any such movement. Such prearrangements initiated by Tenant shall include determination by Landlord, and subject to Landlord's decision and control, of the time, method and routing of movement, and limitations imposed by safety or other concerns which may prohibit any article, equipment or any other item from being brought into the Building. Tenant shall assume all risk as to damage to articles moved and injury to persons or public engaged or not engaged in such movement, including equipment, property and personnel of Landlord if damaged or injured as a result of acts in connection with carrying out this service for Tenant from the time of entering property to completion of work; and Landlord shall not be liable for acts of any person engaged in, or any damage or loss to any of said property or persons resulting from any act in connection with such service performed for Tenant, and Tenant hereby agrees to indemnify and hold Landlord harmless from and against any and all such damage, injury or loss, including attorney's fees. 5. No signs, advertisements or notices shall be allowed in any form on windows or doors inside or outside the Leased Premises or any other part of the Building, and no signs except in uniform location and uniform styles fixed by Landlord shall be permitted on exterior identification pylons, if any, in the public corridors or on corridor doors or entrances to the Leased Premises. All signs shall be contracted for by Landlord for Tenant at the rate fixed by Landlord from time to time, and Tenant shall be billed and pay for such service accordingly upon Exhibit C - Page 1 of 3 46 demand. No nails, hooks or screws shall be driven or inserted in any part of the Building, except by the maintenance personnel of the Building, nor shall any part be defaced by tenants. 6. No draperies, shutters, or other window covering shall be installed on exterior windows or walls or windows and doors facing public corridors without Landlord's written approval. Landlord shall have the right to require installation and continued use of uniform window covering for such windows. 7. No portion of the Leased Premises or any other part of the Building shall at any time be used or occupied as sleeping or lodging quarters. 8. Tenant shall not place, install or operate in the Leased Premises or in any other part of the Building any engine, stove or machinery, or conduct mechanical operations or cook thereon or therein, or place or use in or about the Leased Premises any explosives, gasoline, kerosene, oil, acids, caustics or any other inflammable, explosive or hazardous materials, fluid or substance without the prior written consent of Landlord. 9. Landlord shall not be responsible for lost or stolen personal property, equipment, money or jewelry from the Leased Premises or public rooms regardless of whether such loss occurs when any such area is locked against entry or not. 10. No birds or animals shall be brought into or kept in or about the Leased Premises or any other part of the Building. 11. Employees of Landlord shall not receive or carry messages for or to any tenant or other person, nor contract with or render free or paid services to any tenant or tenant's agents, employees or invitees. In the event any of Landlord's employees perform any such services, such employee shall be deemed to be the agent of any such tenant regardless of whether or how payment is arranged for services, and Landlord is expressly relieved from and all liability in connection with any such services and any associated injury or damage to person or property. 12. Landlord shall not permit entrance to Tenant's offices by use of pass keys controlled by Landlord to any person at any time without written permission of Tenant, except employees contractors or service personnel directly supervised by Landlord and employees of the United States Postal Service. 13. None of the entries, sidewalks, vestibules, elevator shafts, passages, doorways or hallways and similar areas shall be blocked or obstructed, or any rubbish, litter, trash or material of any nature placed, emptied or thrown into such areas, or such areas be used at any time for any purpose except for ingress or egress by Tenant, Tenant's agents, employees or invitees to and from the Leased Premises and for going from one to another part of the Building. 14. Tenant and Tenant's employees, agents and invitees shall observe and comply with the driving and parking signs and markers on the premises or parking facilities surrounding the Building. 15. Landlord shall have the right to prescribe the weight and position of safes, computers and other heavy equipment which shall, in all cases, in order to distribute their weight, Exhibit C - Page 2 of 3 47 stand on supporting devices approved by Landlord. All damage done to the Leased Premises or to the Building by placing in or taking out any property of Tenant, or done by Tenant's property while in the Leased Premises or the Building, shall be repaired immediately at the sole expense of Tenant. 16. To insure orderly operation of the Building, no ice, minerals or other water, towels, newspapers, etc, shall be delivered to the Leased Premises except by persons approved by Landlord in advance in writing. 17. Should Tenant require telegraphic, telephonic, annunciator or other communication services, Landlord shall direct all service personnel where and how wires are to be introduced and placed, and none shall be introduced or placed except as Landlord shall direct. Electric current shall not be used for power or heating without the prior written consent of Landlord. 18. Plumbing fixtures and appliances shall be used only for purposes for which constructed, and no sweeping, rubbish, rags or other unsuitable material shall be thrown or placed therein. Damage resulting to any such fixtures or appliances from misuse by Tenant, or Tenant's agents or employees shall be paid by Tenant, and Landlord shall not in any case be responsible therefor. 19. Tenants shall not make or permit any improper noises in the Building, or otherwise interfere in any way with other tenants, or persons having business with them. 20. Landlord specifically reserves the right to refuse admittance to the Building from 7 p.m. to 7 a.m. daily, or on Sundays or on legal holidays, to any person or persons who cannot furnish satisfactory identification, or to any person or persons who, for any other reason in Landlord's reasonable judgment, should be denied access to the premises. Landlord, for the protection of the tenants and their effects, may prescribe hours and intervals during the night, on Sundays and holidays, when all person entering and departing the Building shall be required to enter their names, the offices to which they are going or from which they are leaving, and the time of entrance or departure in a register provided for that purpose by Landlord. 21. Landlord reserves the right to rescind any of these rules and make such other and further reasonable rules and regulations as in Landlord's judgment shall from time to time be needful for the safety, protection, care and cleanliness of the Building, the operation thereof, the preservation of good order therein, and the protection and comfort of its tenants, their agents, employees and invitees, which rules when made and notice thereof given to a tenant shall be binding upon such tenant in like manner as if originally prescribed. Exhibit C - Page 3 of 3 48 EXHIBIT D [Emergency Generator and HVAC Locations] Exhibit D - Page 1 of 1 49 Exhibit E NON-DISTURBANCE AND ATTORNMENT AGREEMENT THIS NON-DISTURBANCE AND ATTORNMENT AGREEMENT (this "Agreement"), made and entered into as of this ___ day of _______________, 199 _, by and between ______________ ("Mortgagee"), and _________________, ("Tenant"). W I T N E S S E T H: WHEREAS, Tenant entered into a certain _____________ dated _____________, with _____________ ("Landlord"), a _____________ corporation (the "Lease Agreement"), covering certain premises more particularly described therein (the "Demised Premises"); WHEREAS, Mortgagee is the holder of a lien and security interest (collectively, the "Lien") upon the Demised Premises. WHEREAS, Tenant has requested Mortgagee to agree not to disturb Tenant's rights in the Demised Premises in the event that Mortgagee should elect to foreclose upon the lien created under and by virtue of the Lien for any reason, provided that Tenant is not in default under the Lease Agreement and, provided further, that Tenant attorns to Mortgagee in any such event; and WHEREAS, Mortgagee is willing to so agree on the terms and conditions hereinafter set forth. NOW, THEREFORE, for and in consideration of the recitals set forth above, and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged and confessed, the parties hereto agree as follows: 1. That the Lease Agreement and all rights of Tenant thereunder are subject and subordinate to the Lien, and to any and all advances made on the security thereof, and to any and all increases, renewals, modifications, consolidations, replacements and extensions of the Lien. This provision is hereby declared to be self-operative and no further instruments shall be required to effect such subordination. Tenant shall, however, upon demand at any time or times, execute acknowledge and deliver to Mortgagee any and all instruments and certificates that in the judgment of Mortgagee may be necessary or proper to confirm or evidence such subordination. 2. That, provided Tenant complies with this Agreement and is not in default under the terms of the Lease Agreement or in the payment of sums due thereunder or in the performance of any of the terms, covenants or provisions on its part to be performed under the Lease Agreement, as of the date Mortgagee commences a foreclosure action, or at any time thereafter, no default under the Lien, and no proceedings to foreclose the same shall disturb or interfere with Tenant's rights under the Lease Agreement, and the Lease Agreement shall not be terminated, nor shall Tenant's use, possession or enjoyment of the Demised Premises be interfered with, and notwithstanding any such foreclosure or other acquisition of the Demised Premises by Mortgagee or any other party acquiring the Demised Premises upon foreclosure sale, or upon sale in lieu thereof, the Lease Agreement shall be recognized as a direct agreement from Exhibit E - Page 1 of 4 50 Mortgagee or any other party acquiring the Demised Premises upon foreclosure sale, or upon sale in lieu thereof, except that Mortgagee, or any subsequent owner, and their respective heirs, personal representatives, successors and assigns, shall not be (a) liable for any act or omission of Landlord under the Lease Agreement (b) subject to any offsets or defenses which Tenant might have against Landlord under the Lease Agreement, (c) be liable for the return of any security deposit or prepaid rental delivered by Tenant to Landlord under the Lease Agreement, except to the extent same has been actually delivered to Mortgagee, or (d) bound by any previous modification of the Lease Agreement or by any previous payment of any sums due to Landlord thereunder for a period greater than one (1) month in advance, unless such modification or prepayment shall have been expressly approved in writing by Mortgagee, provided that Mortgagee or any other party acquiring the Demised Premises upon foreclosure sale, or upon sale in lieu thereof, shall assume the obligations of Landlord under the Lease Agreement, provided that upon a subsequent sale or other transfer of the Demised Premises, such parties so assuming the obligation of Landlord shall be released and relieved of the obligations so assumed under the Lease Agreement accruing from and after the date of such subsequent sale or other transfer of the Demised Premises. 3. That if the interest of Landlord under the Lease Agreement shall be transferred by reason of foreclosure or other proceedings for enforcement of the Lien, Tenant shall be bound to Mortgagee or any purchaser at a foreclosure sale, or upon sale in lieu thereof, under all of the terms, covenants and conditions of the Lease Agreement for the balance of the term therefor with the same force and effect as if the purchaser were Landlord under the Lease Agreement, and Tenant does hereby attorn to such purchaser, as Landlord, under the Lease Agreement, said attornment to be effective and self-operative without the execution of any further instruments upon such purchaser succeeding to the interest of Landlord under the Lease Agreement, provided that from and after the date of such succession, such purchaser shall assume the obligations of Landlord under the Lease Agreement and, provided further, that upon the subsequent sale or other transfer of the Demised Premises, such purchaser shall be released and relieved of the obligations of Landlord under the Lease Agreement accruing from and after the date of such subsequent sale or other transfer of the Demised Premises. 4. That Tenant shall from and after the date hereof furnish to Mortgagee any notice request, demand or document of any nature whatsoever which Tenant is obligated to furnish to Landlord under the terms of the Lease Agreement at the same time any such notice, request, demand or document is furnished to Landlord. 5. That Tenant hereby agrees that from and after the date hereof in the event of any act or omission by Landlord under the Lease Agreement which would give Tenant the right, either immediately or after the lapse of a period of time to terminate the Lease Agreement, Tenant shall not exercise any such right (a) until it shall have given written notice of such act or omission to Mortgagee, and (b) (i) for monetary defaults, until thirty (30) days shall have elapsed following such giving of notice, or (ii) for non-monetary defaults, until a reasonable period for remedying such act or omission shall have elapsed following such giving of notice and following the time when Mortgagee, at its option, shall, following the giving of any such notice, have elected to remedy such act or omission, or to cause the same to be remedied, and shall thereafter commence to remedy such act or omission, or to cause the same to be remedied and pursue the same with reasonable diligence to completion. Exhibit E - Page 2 of 4 51 6. In the event of the termination of the Lease Agreement, or of any succeeding lease agreement made pursuant to the provisions of this paragraph, prior to its stated expiration date, Tenant will enter into a new lease agreement with Mortgagee or its designee for the remainder of the term, effective as of the date of such termination, on the same terms, covenants and provisions, provided that Mortgagee makes written request upon Tenant for such new lease agreement within sixty (60) days from the date of such termination. Notwithstanding the foregoing, to the extent Tenant exercises its right to terminate the Lease pursuant to the express terms of the Lease, Tenant shall not be obligated to enter into a new lease agreement with Mortgagee or its designee. 7. That Tenant shall not modify, amend, cancel or terminate the Lease Agreement without the prior written consent of Mortgagee, which consent shall not be unreasonably withheld or delayed and any attempt to do so shall be void; provided, however, Tenant may cancel or terminate the Lease Agreement for cause in accordance with the provisions of the Lease Agreement, and subject to the provisions of this Agreement, without the prior written consent of Mortgagee. 8. That any notice which may or is required to be given hereunder shall be in writing and shall be deemed given (i) when delivered (if delivered by hand), or (ii) whether actually received or not, if orderly delivery of mail has not been disrupted or threatened, when deposited, postage prepaid, certified or registered mail, return receipt requested, in the United States mail, or (iii) when delivered to the courier (if sent by recognized overnight courier), addressed to Mortgagee or Tenant, as the case may be, at the addresses set forth after their respective names below, or at such different addresses as they shall have theretofore advised the other in writing in accordance herewith. If intended for Mortgagee: _______________________________ _______________________________ _______________________________ If intended for Tenant: _______________________________ _______________________________ _______________________________ 9. That no modification, amendment, waiver or release of any provision of this Agreement or any right, obligation, claim or cause of action arising hereunder shall be valid or binding for any purposes whatsoever unless in writing and duly executed by the party against whom the same is sought to be asserted. 10. That this Agreement shall inure to the benefit of the parties hereto, and their respective successors and assigns; provided, however, the right of assignment of Tenant and its successors and assigns shall be limited by the terms of the Lease Agreement. Exhibit E - Page 3 of 4 52 11. That Tenant agrees that this Agreement satisfies any condition or requirement in the Lease Agreement relating to the granting of a non-disturbance agreement. 12. This Agreement may be executed in any number of counterparts, each of which shall be deemed to be an original and all of which shall constitute one and the same agreement. IN WITNESS WHEREOF, the parties have caused this Agreement to be executed as of the day and year first above written. MORTGAGEE: _______________________________ By_____________________________ Name:__________________________ Title:_________________________ TENANT: ________________________________ By _____________________________ Name: __________________________ Title: _________________________ Landlord agrees for itself, its successors and assigns, that this Agreement does not (a) constitute a waiver by Mortgagee of any of its rights under the Lien, and (b) in any way release Landlord as grantor under the Lien from its obligations to comply with the terms, covenants and provisions thereof, and of the Lease Agreement, and that the provisions thereof and of the Lease Agreement remain in full force and effect and must be complied with by Landlord. LANDLORD: ________________________________ By _____________________________ Name: __________________________ Title: _________________________ Exhibit E - Page 4 of 4 EX-10.25 7 AGREEMENT BETWEEN REGISTRANT & JOHN MARSCH 1 EXHIBIT 10.25 AGREEMENT THIS AGREEMENT is made and entered into effective as of March 1, 1997, by and between STAR VENDING, INC., a Nevada corporation dba STAR Telecommunications, Inc. ("STAR"), and JOHN MARSCH ("Employee"), with respect to the following recitals of fact: A. Commencing March 1, 1996, Employee was engaged as a consultant to STAR with the status of an independent contractor. B. Effective May 1, 1996, STAR and Employee entered into a written Employment Agreement, a full, true and correct copy of which is attached hereto as Exhibit "A" and incorporated herein by this reference as though fully set forth. C. STAR has advised Employee of the termination of his employment pursuant to paragraph 7(d) of the Employment Agreement effective February 28, 1998. D. STAR and Employee desire to enter into this Agreement to conclude all matters as between them relating to the employment of Employee by STAR. NOW, THEREFORE, in consideration of the premises and mutual covenants, terms and conditions set forth herein, the parties hereto agree as follows: 1. Employee's employment by STAR is terminated pursuant to paragraph 7(d) of the Employment Agreement effective February 28, 1998 (the "Effective Date"). Effective January 30, 1997, Employee's title at STAR is Director of Special Projects. 2. On or about March 1, 1996, STAR and Employee entered into a STAR Vending, Inc. Non-Statutory Stock Option Agreement (the "March Option Agreement") pursuant to which Employee was granted an option to purchase shares of STAR's common stock on the terms and conditions set forth therein. A full, true and correct copy of the March Option Agreement is attached hereto as Exhibit "B" and incorporated herein by this reference as though fully set forth. Pursuant to the March Option Agreement. 2 Employee's option to purchase 200,000 shares of STAR's common stock vested immediately upon execution of the March Option Agreement. Pursuant to a stock split, Employee now has the option to purchase 300,000 shares for $1.33 per share pursuant to the March Option Agreement. Employee shall have the right to exercise such option for a period of 90 days after the Effective Date in accordance with the terms of the March Option Agreement. 3. On or about May 1, 1996, Employee entered into a STAR Vending, Inc. Non-Statutory Stock Option Agreement (the "May Option Agreement") pursuant to which Employee was granted an option to purchase shares of STAR's common stock on the terms and conditions set forth therein. A full, true and correct copy of the May Option Agreement is attached hereto as Exhibit "C" and incorporated herein by this reference as though fully set forth. Pursuant to the May Option Agreement, Employee's option to purchase 100,000 shares of common stock vested effective March 1, 1997. Pursuant to a stock split, Employee now has the option to purchase 150,000 shares for $1.33 per share pursuant to the May Option Agreement. Employee shall have the right to exercise such option for a period of 90 days after the Effective Date in accordance with the terms of the May Option Agreement. 4. Pursuant to the terms of the May Option Agreement, Employee would have an option to purchase an additional 100,000 (150,000 after stock-split) shares of common stock vesting at the earlier of the closing of an initial public offering by STAR or on March 1, 1998, if Employee were still employed by STAR as of that date. In consideration for STAR's forebearing from terminating Employee effective immediately, Employee hereby knowingly and voluntarily waives and relinquishes his option, which is presently unvested and which may never vest, to purchase the additional 100,000 (150,000 shares after stock-split) shares of STAR common stock pursuant to the May Option Agreement. The parties expressly agree and acknowledge that the total number of shares which Employee has an option to purchase pursuant to the March Option Agreement, the May Option Agreement, and this Agreement, is 300,000 shares (450,000 shares after stock-split). STAR agrees, if STAR in the future goes effective with an underwritten initial public offering of its securities, that, within six months after the effective date of such offering, the shares for such 450,000 (post-split) options shall be registered by STAR at STAR's expense under a Form S-8. 5. In consideration for STAR's forebearing from exercising -2- 3 its right to terminate Employee effective immediately, Employee hereby knowingly and voluntarily waives his right under paragraph 7 of the Employment Agreement to receive the compensation provided in paragraph 3(a) of the Employment Agreement and the fringe benefits provided in paragraph 3(c) for one year after the date of his termination. The Employment Agreement is therefore hereby amended to provide that immediately upon the Effective Date, Employee's right to compensation and fringe benefits of any kind shall cease and terminate. Until the Effective Date, however, Employee shall continue to receive the compensation from STAR described at paragraphs 3(a), 3(c) and 3(d) of the Employment Agreement. The Employment Agreement is also hereby amended to provide that the final sentence of paragraph 7 of the Employment Agreement, which provides that any amounts earned by Employee by virtue of other employment (other than through his personal investment activities) during the period in which he is receiving any compensation required under paragraph 7 shall be deducted from such compensation, shall not apply to any amount earned by Employee by virtue of his employment by or consulting for LCR, a startup retail telecommunications company based in London, England ("LCR"). 6. If Employee makes such an election by giving STAR at least 30 days advance written notice, Employee's termination date as described in this Agreement may be at any time after August 31, 1997, and up to and including February 28, 1998 (the "Advanced Termination Date"). If Employee makes such a timely written election, then the "Effective Date" as used in this Agreement shall refer to such Advanced Termination Date, instead of to "February 28, 1998." This means without limitation: (1) no compensation of any kind, including, but not limited to, Employment Agreement paragraph 3(a) compensation and paragraphs 3(c) and 3(d) benefits, shall be paid to Employee for any period after such Advanced Termination Date; and (2) the Employment Agreement solely in the event of such election is amended to provide that the first and second sentences of paragraph 5 shall not survive after the Advanced Termination Date. In all respects, however, the provisions of that certain Confidentiality, Non-Circumvention and Invention Assignment Agreement dated February 29, 1996 shall remain in full force and effect. A full, true and correct copy of the Confidentiality Agreement is attached hereto as Exhibit "D" and incorporated herein by this reference as though fully set forth herein. -3- 4 7. The provisions of paragraph 4, paragraph 5 and paragraph 8 of the Employment Agreement shall survive after the Effective Date. Notwithstanding the foregoing sentence: (1) the first and second sentences of paragraph 5 shall not survive after the Effective Date; and (2) after March 1, 1997 the second sentence of paragraph 5 shall not prohibit Employee from being employed by LCR. 8. STAR agrees to reimburse Employee for his legal fees to Arter & Hadden for assisting him with the preparation and review of this Agreement, with a maximum reimbursement of $5,000. STAR further agrees to reimburse Employee for his ordinary and necessary business expenses in accordance with its company-wide policies; provided, however, that Employee acknowledges that there have been and shall be no further such expenses after Thursday, February 13, 1997. Until the Effective Date, Employee's title shall be "Director of Special Projects." 9. To the extent, if any, that this Agreement is inconsistent with the Employment Agreement, the March Option Agreement and/or the May Option Agreement, the terms of this Agreement shall prevail and the Employment Agreement, the March Option Agreement and the May Option Agreement are deemed amended by this Agreement. 10. Except as provided in this Agreement, all obligations of Employee and STAR pursuant to the Employment Agreement, the March Option Agreement, and the May Option Agreement are terminated as of the Effective Date; provided, further, that the provisions of paragraph 7 of the Employment Agreement are terminated as of March 1, 1997. 11. It is expressly acknowledged and agreed that the releases given pursuant to this Agreement are not made on account of any claim or right on account of wages due, or to become due, or made as an advance on wages to be earned, and that all wages due, or to become due, to Employee from STAR have been or shall be paid as and when due. The releases given pursuant to this Agreement are given in consideration of the mutual covenants, agreements and promises of the parties hereto. 12. Subject to the rights and obligations expressly set forth in or reserved by this Agreement, STAR and Employee, for themselves and for their successors, assigns, heirs and -4- 5 representatives, hereby release each other, and their respective representatives, successors, assigns, shareholders, officers, directors, affiliates, attorneys, partners and related entities, from any and all sums of money, accounts, claims, damages and causes of action of whatever kind or nature, whether known or unknown, or suspected or unsuspected, which they now own, hold, have, claim to have, or claim to be entitled to with respect to, related to or arising out of the Employment Agreement, the March Option Agreement, the May Option Agreement, their employment relationship, their independent contractor relationship, and all other documents and transactions between them related thereto, including all other employment, independent contractor or consultant agreements and all other stock option agreements, if any, and all matters and transactions between them through March 1, 1997, including, without limitation, any and all claims whether based in tort or in contract, and whether based on any federal, state or local law, statute or regulation, including, but not limited to, the Age Discrimination and Employment Act, as Amended, Title 7 of the Civil Rights Act of 1964, the California Labor Code, the California Fair Employment and Housing Act, the Fair Labor Standards Act, the Equal Pay Act, the Americans with Disabilities Act, and the Employee Retirement Security Act of 1973. 13. The parties hereto acknowledge that after entering into this Agreement, they may discover different or additional facts from the claims being released hereby, but this release will remain effective in all respects. The parties expressly waive all rights and benefits under section 1542 of the California Civil Code which reads: "A general release does not extend to claims which the creditor does not know or suspect to exist in his favor at the time of executing the release, which, if known by him, must have materially affected his settlement with the debtor." In this connection, the parties acknowledge that the parties may hereafter discover facts different from or in addition to the facts the parties now know or believe to be true with regard to the claims which are the subject matter of this Agreement, and the parties hereto further agree that this Agreement shall remain effective in all respects notwithstanding -5- 6 such discovery of such new or different facts. 14. In the event that any party hereto brings any action, suit or proceeding against any other party hereto arising out of or in any way connected to this Agreement or any actual or asserted right or obligation released or claimed to be released under the terms hereof, the prevailing party in any such action, suit or proceeding shall, in addition to any such relief as may be awarded, recover its reasonable attorneys' fees incurred in connection therewith, including attorneys' fees incurred in connection with any appeal from any judgment or award. 15. The parties acknowledge that no representation, promise or inducement has been made other than as set forth in this Agreement, and that the parties do not enter into this Agreement in reliance upon any representation, promise, or inducement not set forth herein. This Agreement supersedes all prior negotiations and understandings of any kind with respect to the subject matter hereof and contains all of the terms and provisions of the agreement between the parties hereto with respect to the subject matter hereof. Any representation, promise or condition, whether written or oral, not specifically incorporated herein, shall be of no binding effect upon the parties. 16. Each party hereby represents and warrants that he, she or it has not heretofore assigned or transferred or purported to assign or transfer to any person, association or entity any claim which is subject to this Agreement, and each party hereby agrees to indemnify and hold harmless the other parties against, without any limitation, any and all rights, claims, warranties, demands, debts, obligations, liabilities, costs, expenses, causes of action and judgments based on, arising out of or connected with any such transfer or assignment or purported transfer or assignment. 17. The provisions of this Agreement shall be in all respects governed by and construed and enforced in accordance with the laws of the State of California, including all matters of construction, validity and performance, without regard to choice of law rules which would otherwise require reference to the laws of some other jurisdiction. Both parties hereby consent to the jurisdiction of the Superior Court and the Municipal Court of the State of California for the County of Santa Barbara and -6- 7 agree that such courts shall have exclusive jurisdiction over any suit, claim or cause of action arising out of or related to this Agreement and any of the matters or transactions which are the subject of this Agreement. This Agreement is entered into in Santa Barbara, California and is to be performed in Santa Barbara, California. Any action to enforce or interpret the terms of this Agreement shall be instituted and maintained in the Municipal or Superior Court of the County of Santa Barbara, State of California, in accordance with the respective subject matter jurisdiction of those courts. 18. This Agreement may be executed in counterparts, each of which is deemed to be an original, but such counterparts together shall constitute one and the same instrument. 19. This Agreement may not be modified or terminated orally and no modification, termination, or waiver shall be valid unless the same be in writing and signed by all of the parties hereto. 20. This Agreement shall be binding on, and inure to the benefit of, the parties and their respective successors, assigns, transferees, legal representatives, and all other persons or entities succeeding to the rights or obligations of the parties, and each of them. 21. The undersigned each acknowledges and represents that he or it has read this Agreement and had the opportunity to consult with his or its attorney regarding its contents and consequences, that this Agreement is being executed solely in reliance on his or its judgment, belief and knowledge of the matters set forth herein and on the advice of his or its attorney, that the terms and conditions of this Agreement are contractual and not mere recitals, between the settling parties, and that the undersigned has taken all actions and obtained all authorizations, consents and approvals as are conditions precedent to his or its authority to execute this Agreement. 22. In the event any provision of this Agreement shall be held invalid, illegal, or unenforceable, the validity, legality and enforceability of the remaining provisions shall not in any way be affected or impaired thereby. -7- 8 DATED: ________________________. --------------------------------- JOHN MARSCH DATED: _______________________. STAR VENDING, INC. By: ------------------------------- Christopher E. Edgecomb Chief Executive Officer -8- EX-11.1 8 COMPUTATION OF LOSS PER SHARE 1 EXHIBIT 11.1 STATEMENT REGARDING COMPUTATION OF LOSS PER SHARE
YEAR ENDED DECEMBER 31, ---------------------- 1996 ---------------------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Net loss............................................................... $ (6,644) ======== Weighted average common shares outstanding............................. 10,575 Effect of stock options pursuant to SEC rules.......................... 1,095 Conversion of preferred stock.......................................... 528 -------- Weighted average number of common shares used to compute pro forma loss per share............................................................ 12,198 ======== Pro forma loss per common share........................................ $ (0.54) ========
EX-23.1 9 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the use of our reports (and to all references to our Firm) included in or made a part of this Registration Statement on Form S-1 (File No. 333-21325). ARTHUR ANDERSEN LLP Los Angeles, California May 16, 1997 -----END PRIVACY-ENHANCED MESSAGE-----