-----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, Ba1nnGc6+2ohxJcQe+5rJW1zWnCOx7Cfq4WE9cw86jTSaH56DUc3+4gcyw3VM9Tj +r+LwBe/V8Qwminf93SZHg== 0001047469-99-001435.txt : 19990120 0001047469-99-001435.hdr.sgml : 19990120 ACCESSION NUMBER: 0001047469-99-001435 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19990119 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: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q/A SEC ACT: SEC FILE NUMBER: 000-22581 FILM NUMBER: 99507835 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 10-Q/A 1 FORM 10-Q/A UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q/A AMENDMENT NO. 1 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED SEPTEMBER 30, 1998 COMMISSION FILE NUMBER 000-22581 STAR TELECOMMUNICATIONS, INC. (Exact name of registrant as specified in its charter) Delaware 77-0362681 (State or Other Jurisdiction (IRS Employer of Incorporation or Organization) Identification Number) 223 East De La Guerra, Santa Barbara, California, 93101 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code (805) 899-1962 ------------- None ---- (Former name, former address and former fiscal year if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] As of January 13, 1999, the number of the registrant's Common Shares of $.001 par value outstanding was 42,246,521. The undersigned Registrant hereby amends the following items of its Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, as set forth below: 2 ITEM 1. FINANCIAL STATEMENTS STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands, except for share data)
December 31, September 30, 1997 1998 ------------- ------------- (Unaudited) Current Assets: Cash and cash equivalents $ 1,903 $ 11,808 Short-term investments 18,631 92,390 Accounts and notes receivable, net 46,675 80,721 Receivable from related parties -- 330 Other current assets 10,696 27,580 ------------- ------------- Total current assets 77,905 212,829 ------------- ------------- Property and equipment, net 35,959 113,851 Other assets 6,452 7,340 ------------- ------------- Total assets $ 120,316 $ 334,020 ------------- ------------- ------------- ------------- Current Liabilities: Revolving lines of credit with stockholder $ 138 $ 5 Current portion of long-term obligations 3,259 7,595 Accounts payable and other accrued expenses 22,345 36,200 Accrued network cost 38,403 52,464 ------------- ------------- Total current liabilities 64,145 96,264 ------------- ------------- Long-Term Liabilities: Long-term obligations, net of current portion 12,107 31,053 Other long-term liabilities 863 1,638 ------------- ------------- Total long-term liabilities 12,970 32,691 ------------- ------------- Stockholders' Equity: Common Stock $.001 par value: Authorized - 100,000,000 shares 35 42 Additional paid-in capital 41,662 194,138 Deferred compensation (30) -- Accumulated other comprehensive income -- 219 Retained earnings 1,534 10,666 ------------- ------------- Total stockholders' equity 43,201 205,065 ------------- ------------- Total liabilities and stockholders' equity $ 120,316 $ 334,020 ------------- ------------- ------------- -------------
See accompanying notes to the condensed consolidated financial statements. 3 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data)
Three Months Ended Nine Months Ended September 30, September 30, -------------------------------- -------------------------------- 1997 1998 1997 1998 -------------------------------- -------------------------------- (Unaudited) (Unaudited) Revenue $ 103,297 $ 164,333 $ 283,374 $ 425,531 Operating expenses: Cost of services 90,100 139,324 246,712 363,794 Selling, general and administrative expenses 8,898 15,922 25,118 38,853 Depreciation and amortization 1,227 3,439 3,040 8,055 Merger expense -- -- -- 314 ------------ ------------ ------------ ---------- 100,225 158,685 274,870 411,016 ------------ ------------ ------------ ---------- Income from operations 3,072 5,648 8,504 14,515 ------------ ------------ ------------ ---------- Other income (expense): Interest income 293 1,839 367 3,511 Interest expense (453) (740) (1,289) (2,080) Other (794) 87 (1,499) (171) ------------ ------------ ------------ ---------- (954) 1,186 (2,421) 1,260 ------------ ------------ ------------ ---------- Income before provision for income taxes 2,118 6,834 6,083 15,775 Provision for income taxes 1,255 2,812 2,406 6,643 ------------ ------------ ------------ ---------- Net income $ 863 $ 4,022 $ 3,677 $ 9,132 ------------ ------------ ------------ ---------- ------------ ------------ ------------ ---------- Income before provision for income taxes 2,118 6,083 Pro forma income taxes 1,137 2,718 ------------ ------------ ------------ ------------ Pro forma net income $ 981 $ 3,365 ------------ ------------ ------------ ---------- ------------ ------------ ------------ ---------- Basic income per share $ 0.02 $ 0.10 $ 0.13 $ 0.23 ------------ ------------ ------------ ---------- ------------ ------------ ------------ ---------- Diluted income per share $ 0.02 $ 0.09 $ 0.12 $ 0.22 ------------ ------------ ------------ ---------- ------------ ------------ ------------ ---------- Pro forma basic income per share $ 0.03 $ 0.12 ------------ ------------ ------------ ------------ Pro forma diluted income per share $ 0.03 $ 0.11 ------------ ------------ ------------ ------------
See accompanying notes to the condensed consolidated financial statements. 4 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
Nine Months Ended September 30, -------------------------------- 1997 1998 -------------------------------- (Unaudited) Cash Flows From Operating Activities: Net income $ 3,677 $ 9,132 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 3,040 8,055 Loss on disposal of equipment 42 -- Compensation expense relating to stock options 60 30 Provision for doubtful accounts 4,068 3,952 Deferred income taxes -- (511) Deferred compensation (66) 62 Increase in assets: Accounts and notes receivable (8,214) (37,998) Receivable from related parties (174) (330) Other assets (1,495) (6,038) Increase (decrease) in liabilities: Accounts payable and other accrued expenses (1,470) 13,855 Accrued network cost 13,042 14,061 Other liabilities 63 48 ------------ ------------ Net cash provided by operating activities 12,573 4,318 ------------ ------------ Cash Flows From Investing Activities: Capital expenditures (6,649) (57,847) Short-term investments (19,206) (73,759) Other long term assets 385 (5,084) ------------ ------------ Net cash used in investing activities (25,470) (136,690) ------------ ------------
See accompanying notes to the condensed consolidated financial statements. 5 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
Nine Months Ended September 30, -------------------------------- 1997 1998 -------------------------------- (Unaudited) Cash Flows From Financing Activities: Borrowing under lines of credit 34,211 -- Repayments under lines of credit (42,025) -- Borrowing under lines of credit with stockholders 583 -- Repayments under lines of credit with stockholder (423) (133) Payments under long-term debt and capital lease obligations (3,061) (4,818) Stockholder distributions for LDS (794) -- Issuance of common stock 30,914 144,711 Other financing activities -- (12) Stock options exercised 67 2,310 ------------ ------------ Net cash provided by financing activities 19,472 142,058 ------------ ------------ Effects Of Foreign Currency Translation -- 219 Increase in cash and cash equivalents 6,575 9,905 Cash and cash equivalents, beginning of period 1,845 1,903 ------------ ------------ Cash and cash equivalents, end of period $ 8,420 $ 11,808 ------------ ------------ ------------ ------------
See accompanying notes to the condensed consolidated financial statements. 6 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (1) GENERAL The financial statements included herein are unaudited and have been prepared in accordance with generally accepted accounting principles for interim financial reporting and Securities Exchange Commission ("SEC") regulations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In management's opinion, the financial statements reflect all adjustments (of a normal and recurring nature) which are necessary to present fairly the financial position, results of operations, stockholders' equity and cash flows for the interim periods. These financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 1997, as set forth in the STAR Telecommunications, Inc. ("STAR" or the "Company") Annual Report on Form 10-K. The results for the three and nine month periods ended September 30, 1998, are not necessarily indicative of the results that may be expected for the year ending December 31, 1998. In March 1998, the Company consummated a merger with T-One Corp. ("T-One"). The merger constituted a tax-free reorganization and has been accounted for as a pooling of interests under Accounting Principles Board Opinion No. 16. Accordingly, all prior period consolidated financial statements presented have been restated to include the results of operations, financial position, and cash flows of T-One. (2) BUSINESS AND PURPOSE STAR is an emerging multinational carrier focused primarily on the international long-distance market. The Company offers highly reliable, low-cost switched voice services through a flexible network comprised of foreign termination relationships, international gateway switches, leased and owned transmission facilities, and resale arrangements with other long-distance providers. During 1996 and 1997, the Company established several wholly-owned foreign subsidiaries to further expand its international network. The Company made substantial investments to install switch facilities in two of these subsidiaries, Star Europe Limited (SEL) which is located in London, England, and Star Telecommunications Deutschland (GmbH) which is located in Frankfurt, Germany. The Company plans to use these switch facilities to decrease international traffic termination cost and to initiate outbound calls from these local markets. In December 1997, the Company entered into the domestic long-distance market through the acquisition of L.D. Services, Inc. ("LDS"). In addition, the Company established a domestic long-distance provider Arvilla Telecommunication, Inc. ("Arvilla"). Effective September 25, 1998, LDS and Arvilla were merged into a wholly-owned subsidiary, CEO Telecommunications, Inc. ("CEO"). (3) NET INCOME PER COMMON SHARE In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share". The statement replaces primary EPS with basic EPS, which is computed by dividing reported earnings available to common stockholders by weighted average shares outstanding. The provision requires the calculation of diluted EPS. The Company adopted this statement in 1997 and prior year earnings per share information has been restated to be consistent with SFAS No. 128. 7 The following schedule summarizes the information used to compute net income per common share for the three and nine months ended September 30, 1997 and 1998 (in thousands):
THREE MONTHS NINE MONTHS ENDED ENDED SEPTEMBER 30, SEPTEMBER 30, --------------------------------------------------------- 1997 1998 1997 1998 ------------ ------------ ------------ ------------ Weighted number of common shares used to compute basic earnings per share 34,589 42,087 28,650 39,147 Weighted average common share equivalents 2,114 1,245 2,930 1,774 ------ ------ ------ ------ Weighted average number of common share and share equivalents used to compute diluted earnings per share 36,703 43,332 31,580 40,921 ------ ------ ------ ------ ------ ------ ------ ------
(4) PRO FORMA INCOME TAXES The results of operations and provision for income taxes for the three and nine months ended September 30, 1997, reflect LDS' status as an S-Corporation prior to the merger with STAR. The pro-forma income taxes, pro-forma net income, and pro-forma earnings per share information reflected in the condensed consolidated statements of income assumes that both STAR and LDS were taxed as C-Corporations for all periods presented. (5) COMPREHENSIVE INCOME On January 1, 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive Income". For year end financial statements, SFAS 130 requires that comprehensive income, which is the total of net income and all other non-owner changes in equity, be displayed in a financial statement with the same prominence as other consolidated financial statements. Under SFAS No. 130, the Company's foreign currency translation adjustments are considered to be components of other comprehensive income. During the three and nine month periods ended September 30, 1997, comprehensive income equaled net income. During the three and nine month periods ended September 30, 1998, comprehensive income equaled approximately $4,241,000 and $9,351,000, respectively. (6) CHANGE IN ACCOUNTING ESTIMATE As of July 1, 1998, the Company prospectively revised the remaining lives of certain operating equipment from five to ten years. The increase in the estimated life of these assets was based on the knowledge gained by the Company in making the transition from a reseller of telephone services to a facility based provider, as well as to the fact that the Company is purchasing more sophisticated telephone switches and has transitioned from a Stromberg platform to a Nortel based telecommunications platform. All such assets will be amortized over their respective useful lives. This change increased income before provision for income taxes for the three and nine-month periods ended September 30, 1998 by approximately one million dollars. The difference between depreciating all switch equipment over a 5 year life versus a 10 year life since acquisition would represent approximately $945,000 for the 3 month period and $1,770,000 for the 9 month period, or 1 cent or 3 cent per diluted share for the 3 and 9 month periods, respectively. (7) SIGNIFICANT EVENTS In November 1997, the Company signed a merger agreement with United Digital Network, Inc. ("UDN"). The Company intends to account for the transaction as a pooling of interests. In August 1998, the Company signed an amended and restated agreement to acquire PT-1 Communications, Inc. ("PT-1") which will be accounted for as a purchase. The Company anticipates closing these transactions in the fourth quarter. According to SFAS 52, "Foreign Currency Translation," the functional currency of a foreign subsidiary of a U.S. company ordinarily will be the currency of the country in which the entity is located or the U.S. dollar. The determination of the functional currency is basically a matter of fact. On July 1, 1998, due to changes in facts and circumstances, the Company changed the functional currency of it's German subsidiary from the U.S. dollar to the German mark. 8 (8) STATEMENTS OF CASH FLOWS During the nine month periods ended September 30, 1997 and 1998, cash paid for interest was approximately $1,175,000 and $2,342,000, respectively. For the same periods, cash paid for income taxes amounted to approximately $2,693,000 and $2,545,000, respectively. Non-cash investing and financing activities are as follows (in thousands):
NINE MONTHS ENDED SEPTEMBER 30, ----------------------------- 1997 1998 ------------ ------------ Equipment purchased through notes and capital leases $ 10,230 $ 28,100 Tax benefits related to stock options -- 5,474 ------------ ------------ $ 10,230 $ 33,574 ------------ ------------ ------------ ------------
(9) SEGMENT INFORMATION At September 30, 1998, STAR has two business segments, North American and European long distance telecommunications.
NORTH THREE MONTHS ENDED, SEPTEMBER 30, 1997 AMERICA EUROPE TOTAL - -------------------------------------- -------------- ------------- -------------- Revenue $ 103,297 $ -- $ 103,297 Interest income 293 -- 293 Interest expense 356 97 453 Depreciation and amortization 1,084 143 1,227 Segment profit (loss) 1,451 (588) 863 Segment assets $ 102,097 $ 5,965 $ 108,062
NORTH THREE MONTHS ENDED, SEPTEMBER 30, 1998 AMERICA EUROPE TOTAL - -------------------------------------- -------------- ------------- -------------- Revenue $ 157,584 $ 6,749 $ 164,333 Interest income 1,814 25 1,839 Interest expense 356 384 740 Depreciation and amortization 2,384 1,055 3,439 Segment profit (loss) 9,733 (5,711) 4,022 Segment assets $ 285,381 $ 48,639 $ 334,020
9
NORTH NINE MONTHS ENDED, SEPTEMBER 30, 1997 AMERICA EUROPE TOTAL - -------------------------------------- -------------- ------------- -------------- Revenue $ 283,374 $ -- $ 283,374 Interest income 367 -- 367 Interest expense 1,153 136 1,289 Depreciation and amortization 2,824 216 3,040 Segment profit (loss) 4,895 (1,218) 3,677 Segment assets $ 102,097 $ 5,965 $ 108,062
NORTH NINE MONTHS ENDED, SEPTEMBER 30, 1998 AMERICA EUROPE TOTAL - -------------------------------------- -------------- ------------- -------------- Revenue $ 418,588 $ 6,943 $ 425,531 Interest income 3,486 25 3,511 Interest expense 1,116 964 2,080 Depreciation and amortization 6,033 2,022 8,055 Segment profit (loss) 19,944 (10,812) 9,132 Segment assets $ 285,381 $ 48,639 $ 334,020
The Company provides wholesale and commercial long distance telephone service. The commercial segment represents less than 10% of revenue, net income or assets of the Company for the periods presented. (10) NEW PRONOUNCEMENTS In June 1998, the AICPA issued statement of Financial Accounting Standards No. 133 "Accounting For Derivative Instruments and Hedging Activities." The Company has not yet analyzed the impact of this new standard. The Company will adopt the standard in January of 2000. (11) SUBSEQUENT EVENTS In November 1998, the Company signed a twenty year, $31 million dollar indefeasible right of use (IRU) agreement with IXC Communication, Inc. ("IXC") to purchase capacity on IXC's U.S. based digital fiber network. 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Quarterly Report on Form 10-Q contains certain "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are statements other than historical information or statements of current condition. Some forward looking statements may be identified by use of such terms as "believes", "anticipates", "intends", or "expects". These forward-looking statements relate to the plans, objectives and expectations of the Company for future operations. In light of the risks and uncertainties inherent in all such projected operation matters, the inclusion of forward-looking statements in this report should not be regarded as a representation by the Company or any other person that the objectives or plans of the Company will be achieved or that any of the Company's operating expectations will be realized. The Company's revenues and results of operations are difficult to forecast and could differ materially from those projected in the forward-looking statements contained in this report as a result of numerous factors including among others, the following: (i) changes in customer rates per minute; (ii) foreign currency fluctuations; (iii) termination of certain service agreements or inability to enter into additional service agreements; (iv) inaccuracies in the Company's forecast of traffic growth; (v) changes in or developments under domestic or foreign laws, regulations, licensing requirements or telecommunications standards; (vi) foreign political or economic instability; (vii) changes in the availability of transmission facilities; (viii) loss of the services of key officers; (ix) loss of a customer which provides significant revenues to the Company; (x) highly competitive market conditions in the industry; and (xi) concentration of credit risk. The foregoing review of the important factors should not be considered as exhaustive; the Company undertakes no obligation to release publicly the results of any future revisions it may make to forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. The following table sets forth income statement data as a percentage of revenues for the periods indicated.
THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ------------------------------ -------------------------- 1997 1998 1997 1998 ------------ ------------ ------------ ------------ Revenues 100% 100% 100% 100% Operating expenses: Cost of services 87.2 84.8 87.1 85.5 Selling, general and administrative 8.6 9.7 8.9 9.1 Depreciation and amortization 1.2 2.1 1.1 1.9 Merger expense -- -- -- 0.1 ----- ----- ----- ----- 97.0 96.6 97.0 96.6 ----- ----- ----- ----- Income from operations 3.0 3.4 3.0 3.4 ----- ----- ----- ----- Other income (expense): Interest income 0.3 1.1 0.1 0.8 Interest expense (0.4) (0.5) (0.5) (0.5) Other (0.8) 0.1 (0.5) (0.0) ----- ----- ----- ----- (0.9) 0.7 (0.9) 0.3 Income before provision for income taxes 2.1 4.2 2.1 3.7 ----- ----- ----- ----- Provision for income taxes 1.2 1.7 0.8 1.6 ----- ----- ----- ----- Net income 0.8% 2.4% 1.3% 2.1% ----- ----- ----- ----- ----- ----- ----- -----
11 THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 1997 Revenues: Total revenues increased 59.1% to $164.3 million in the third quarter of 1998 from $103.3 million in the third quarter of 1997. Total revenues for the third quarter of 1998 increased 24.6% from $131.9 million in the second quarter ended June 30, 1998. Revenues from North American wholesale customers increased 54.2% to $149.4 million from $96.9 million in the prior year quarter. Minutes of use generated by North American wholesale customers increased 97.2% to 475.1 million minutes of use in the third quarter of 1998, as compared to 240.9 million minutes of use in the comparable quarter of the year prior. This increase in revenues and minutes reflects growth in the number of North American wholesale customers to 175 at September 30, 1998, up from 137 customers at September 30, 1997, as well as an increase in usage by existing customers, primarily resulting from the Company's expanding transmission capacity. The increase in revenues was partially offset by a decline in rates per minute, as the average North American wholesale rate per minute of use declined to $0.30 for the current quarter as compared to $0.40 for the quarter ended September 30, 1997, as well as the quarter ended June 30, 1998 of $0.34, reflecting continued lower prices on competitive routes. The decline in rates per minute is also attributable to the change in country mix to include a larger proportion of lower rate per minute countries such as Mexico, Germany and the United Kingdom. The period to period decline in rates per minute was not a significant factor in the relative increase in minutes of use. North American commercial revenues increased 28.1% to $8.2 million in the third quarter of 1998 from $6.4 million in the third quarter of 1997 reflecting the continued success of new international rate plans that target ethnic markets for Latin America and the Pacific Rim. Traditionally, the telemarketing operation experiences declining minutes of use during the third quarter summer months due to the usage trends of its international users. On a quarter to quarter basis, the growth in North American commercial minutes and the average North American commercial rate per minute at $0.24 remained flat due to these trends. The third quarter also includes revenues of $6.7 million dollars generated from the European operations, representing the initial realization of benefits from the Company's investment in the German telecommunications marketplace. Management believes that the prospects for growth in Germany remain strong as Star Telecommunications Deutschland GmbH is fully utilizing its interconnect with Deutsche Telekom, AG to lower the Company's cost of services and to grow its European commercial customer base. Cost of Services (exclusive of depreciation and amortization): Cost of services (exclusive of depreciation and amortization) increased 54.6% to $139.3 million in the third quarter of 1998 from $90.1 million in the third quarter of 1997 and decreased as a percentage of revenues for the same periods to 84.8% from 87.2%. The growth in cost of services (exclusive of depreciation and amortization) reflects the increase in minutes of use offset by an overall declining average cost per minute as well as an increase in leased private line cost. The average cost per minute declined as a result of changes in country mix to include a larger proportion of lower cost per minute countries, competitive pricing pressures as well as an increasing proportion on traffic routed over the Company's proprietary network. The Company currently routes to 43 countries on its global network up from 40 countries in the quarter ended June 30, 1998. Management believes that countries will continue to be added to the Company's global network thereby contributing to an overall decline in cost per minute. Selling, General and Administrative: For the third quarter of 1998, selling, general and administrative expenses increased 78.9% to $15.9 million from $8.9 million in the third quarter of 1997 and increased as a percentage of revenues to 9.7% from 8.6% over the comparable periods. North American wholesale selling, general and administrative expenses increased to $10.1 million in the third quarter of 1998 from $6.4 million in the comparable period of 1997 and increased as a percentage of North American wholesale revenue from 6.6% to 6.8%, respectively. North American commercial selling, general and administrative expenses increased to $3.0 million during the period from $2.2 million in the third quarter of 1997. North American commercial selling, general and administrative expenses increased as a percentage of North American commercial revenues to 36.6% during the period from 34.4% in the third quarter of 1997, reflecting the expansion of the telemarketing sales force to focus on new ethnic markets. 12 Selling, general and administrative expenses related to the European operations amounted to $2.8 million in the third quarter of 1998, an increase from $348,000 in the third quarter of 1997 reflecting the start up of new business efforts in Europe. The Company expects overall selling, general and administrative expenses to continue to grow as a percentage of revenues as the Company adds personnel to become a carrier in additional European countries and continues to hire a sales force to expand its North American commercial customer base. Depreciation and Amortization: Depreciation expense increased to $3.4 million for the third quarter of 1998 from $1.2 million for the third quarter of 1997, and increased as a percentage of revenues to 2.1% from 1.2% over the comparable period in the prior year. Depreciation expense increased with the operation of new switch sites, the purchase of additional fiber capacity to connect the Company's expanding network and leasehold improvements. Depreciation attributable to North American assets amounted to $2.4 million. European operations realized total depreciation of $1.1 million. STAR expects depreciation expense to continue to increase as a percentage of revenues as it continues to expand its global telecommunications network. As of July 1, 1998, STAR revised the remaining lives of certain operating equipment from five to ten years. This change increased income before income taxes by approximately $1.0 million. Income from Operations: Income from operations increased to $5.6 million during the third quarter of 1998 from $3.1 million in the third quarter of 1997 and operating margin increased to 3.4% from 3.0%, respectively. Operating margin is expanding overall as the Company continues to increasingly route traffic over its proprietary network. Offsetting the declining cost of services on a per minute basis were the startup costs of launching operations in new European countries and the expansion of the North American based commercial operations. Other Income (Expense): The Company reported other income of $1.2 million in the third quarter of 1998 as compared to other expense of approximately $1.0 million for the third quarter of 1997. Interest income earned on short-term investments increased to $1.8 million in the third quarter of 1998 from $293,000 in the third quarter of 1997 as a result of interest earned on investing the proceeds from the Company's secondary equity offering in May 1998. Interest expense increased to $740,000 during the quarter from $453,000 in the third quarter of 1997 in response to the additional capital leases for the financing of new switches. Included in other expense for the third quarter ended September 30, 1997 is approximately $700,000 for a legal settlement which relates to the dispute settled by L.D. Services, Inc. with the District Attorney of Monterey County. Provision for Income Taxes: The Company's provision for income taxes increased to $2.8 million in the third quarter of 1998 from $1.3 million in the third quarter of 1997. The effective tax rate decreased to 41.1% in the third quarter of 1998 from 59.3% in the third quarter of 1997. The effective tax rate in the third quarter of 1997 includes the impact of the valuation reserve on the deferred tax asset created by foreign operating losses and other book/tax timing differences. NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 1997 Revenues: Historically, STAR has increased revenues from quarter to quarter, often times by a significant percentage. STAR's North American wholesale minutes of use have also greatly increased from quarter to quarter, generally by amounts that exceed the relative increases in revenues. In the nine months ended September 30, 1998, revenues increased by 50.2% over revenues for the nine months ended September 30, 1997. Over the same period to period comparison, North American minutes of wholesale use increased by 73.0%. There are a variety of reasons for the growth in STAR's call volume, including the growth of STAR's North American customer base, which increased by 27.7% from the nine months ended September 30, 1997 compared to the same period in 1998, an increased usage by existing North American customers, and increased capacity over STAR's telecommunications network, with the addition of a number of switches and growth in available fiber optic lines. The growth in North American wholesale minutes has been accompanied by a corresponding decline in North American rates per minute. For example, for the nine months ended September 30, 1998, such rates declined by 24.3% from wholesale rates per minute in the corresponding period in 1997. The decline in wholesale rates can be attributed to a number of factors, including a changing country mix that includes a growing number of minutes routed by STAR to lower rates per minute countries such as Mexico, Germany and the United Kingdom and, as the wholesale international long distance market continues to mature and evolve, a general downward trend in rates on competitive routes. STAR's pricing for wholesale minutes varies materially from customer to customer and is generally based on the time of day, the day of the week and the destination of the call. While STAR continues to route traffic to certain destinations at attractive rates, market conditions have forced STAR to reduce its overall wholesale rates per minute. Accordingly, the Company believes that the growth in its revenues has been fueled almost entirely by its ability to increase the volume of North American wholesale minutes of use, for the reasons noted above. At the same time, the general erosion in the rates per minute for such wholesale traffic has partially offset the contribution to the increase of revenues made by such increased volume of minutes. STAR completed its acquisition of T-One in March 1998. Revenues from T-One's operations for the periods set forth below were not material to the overall result of operations of STAR during such periods. North American wholesale minutes of use increased to 1.1 billion with an average rate per minute of $0.33 for the period ended September 30, 1998 as compared to minutes of use of 635.9 million at an average rate per minute of $0.41 in the comparable period of 1997. The volume growth was driven by an increase in sales to existing North American wholesale customers taking advantage of the Company's expanding transmission capacity and an increase in the number of North American wholesale carrier customers, which growth was partially offset by a decline in rates per minute from period to period. The relative decline in rates per minute was not a significant factor in the period to period increase in minutes of use. Cost of Services (exclusive of depreciation and amortization): Cost of Services (exclusive of depreciation and amortization) increased 47.5% to $363.8 million during the nine months ended September 30, 1998, up from $246.7 million for the comparable period of 1997, but decreased as a percentage of revenues to 85.5% from 87.1%, respectively. The decrease in cost of services (exclusive of depreciation and amortization) relative to revenues reflects the increasing amount of traffic terminated over the Company's owned network. Management believes that countries will continue to be added to STAR's global network thereby contributing to an overall decline in cost per minute. 13 Selling, General and Administrative: Selling, general and administrative expenses increased 54.7% to $38.9 million during the first nine months of 1998 from $25.1 million in the comparable period of 1997 and increased as a percentage of revenues to 9.1% from 8.9%, respectively. The increase in these expenses both in absolute terms and as a percentage of revenues reflects the continued expansion of the STAR network in its North American and European operations. Depreciation and Amortization: Depreciation expense increased to $8.1 million for the nine months ended September 30, 1998 from $3.0 million for the comparable period of 1997. Depreciation expense increased as a result of the Company's continued expansion of its global transmission network which involved the expansion and start-up of new switch sites, the purchase of fiber capacity and the build out of direct termination arrangements around the world. As of July 1, 1998, STAR revised the remaining lives of certain operating equipment from five to ten years. This change increased income before income taxes by approximately $1.0 million. Income from Operations: Income from operations increased 70.7% to $14.5 million during the nine months ended September 30, 1998 from $8.5 million during the same period of 1997. Operating margin increased to 3.4% from 3.0%, respectively. Operating margin will continue to expand as STAR continues to diversify its revenue base and as traffic is migrated from leased facilities onto STAR's owned network. Other Income (Expense): Other income, net increased to $1.3 million in the nine months ended September 30, 1998 from a net expense of $2.4 million in the comparable period of 1997. This increase can be attributed to interest income of $3.5 million earned on the proceeds from the secondary offering offset by interest expense of $2.1 million incurred on capital leases for the nine months ended September 30, 1998. Other expense for the nine months ended September 30, 1997 included $1.6 million in legal settlements which relate to the disputes settled by L.D. Services, Inc. with the California PUC and the District Attorney of Monterey County. Provision for Income Taxes: The Company's provision for income taxes increased to $6.6 million for the nine months ended September 30, 1998 from $2.4 million for the comparable period in 1997. The effective tax rate increased to 42.1% during the nine months ended September 30, 1998 from 39.6% during the comparable period in 1997. The lower effective tax rate for the period ended September 30, 1997 includes the write-off of a customer accounts receivable in the first quarter of 1997. YEAR 2000 COMPLIANCE A significant percentage of the software that runs most of the computers in the United States relies on two-digit date codes to perform a number of computation and decision making functions. Commencing on January 1, 2000 these computer programs may fail from an inability to interpret date codes properly, misreading "00" for the year 1900 instead of the year 2000. STAR has initiated a comprehensive program to identify, evaluate and address issues associated with the ability of its information technology and non-information technology systems to properly recognize the Year 2000 in order to avoid interruption of the operation of these systems and a material adverse effect on STAR's operations as a result of the century change. Each of the information technology software programs that STAR currently uses has either been certified by its respective vendor as Year 2000 compliant or will be replaced with software that is so certified prior to January 1, 1999. STAR intends to conduct comprehensive tests of all of its software programs for Year 2000 compliance as part of its Year 2000 readiness program. An integral part of STAR's non-information technology systems, the telecommunications switches, is not currently Year 2000 compliant. The respective vendors of STAR's twelve switches are in the process of upgrading the switches and have informed STAR that the switches will be Year 2000 compliant on or before February 28, 1999. STAR does not believe that its other non-information technology systems will be affected by the Year 2000, but will not know definitively until STAR tests and evaluates such equipment during January 1999. STAR's computer system interfaces with the computers and technology of many different telecommunications companies, including those of foreign companies, on a daily basis. STAR considers the Year 2000 readiness of its foreign customers and vendors of particular importance given the general concern that the computer systems abroad may not be as prepared as those in domestic operations to handle the century change. As part of its Year 2000 compliance program, STAR intends to contact its significant 14 vendors and customers to ascertain whether the systems used by such third parties are Year 2000 compliant. STAR plans to have all Year 2000 compliance initial testing and any necessary conversions completed by July 1999. Historically, STAR has not incurred any costs to reprogram, replace and test its information and non-information technology systems for Year 2000 compliance. The costs associated with STAR's Year 2000 compliance efforts will be incurred during the remainder of 1998 and throughout 1999. STAR estimates the costs of the efforts will be between $70,000 and $150,000 over the life of the project; though such expenditures may increase materially following testing of non-information technology systems and the evaluation of the Year 2000 compliance status of integral third party vendors and customers. Costs incurred in connection with STAR's Year 2000 compliance efforts will be expensed as incurred. STAR currently anticipates that its information technology and non-information technology systems will be Year 2000 compliant before January 1, 2000, though no assurances can be given that STAR's compliance testing will not detect unanticipated Year 2000 compliance problems. Furthermore, STAR does not yet know the Year 2000 compliance status of integral third parties and is therefore currently unable to assess the likelihood or the risk to STAR of third party system failures. However, a system failure by any of STAR's significant customers or vendors could have a material adverse effect on STAR's operations. The Company believes that the most reasonably likely worst case scenario resulting from the century change could be the inability to route telephone traffic at current rates to desired locations for an indeterminable period of time, which could have a material adverse effect on STAR's results of operations and liquidity. STAR intends to develop contingency plans to handle a Year 2000 system failure experienced by its information and non-information technology systems and to handle any necessary interactions with the computers and technology of any integral non-complying third party. LIQUIDITY AND CAPITAL RESOURCES As of September 30, 1998, STAR had cash and cash equivalents of $11.8 million, short-term investments of $92.4 million and a working capital surplus of $116.6 million. As of September 30, 1998, STAR had no funds outstanding on its $25 million revolving line of credit, which bears interest at a rate of the bank's cost of funds plus 137.5 basis points and expires on July 1, 1999. However, available borrowing under the line of credit are reduced by outstanding letters of credit in the amount of $4.9 million. The Company has signed a merger agreement with United Digital Network, Inc. ("UDN") and plans to account for this merger as a poolings of interests. The Company also signed a definitive agreement to acquire PT-1 Communications, Inc. ("PT-1") in a transaction to be accounted for as a purchase. The Company will issue 15.05 million shares of STAR common stock and $19.5 million cash for all of PT-1 common stock plus 250,000 shares to certain PT-1 distributors. The Company expects to consummate these transactions by the end of 1998. The Company also entered into a 20 year commitment to purchase IRUs from IXC Communications, Inc. for approximately $31 million and a 20 year, $70 million agreement to purchase capacity on the Quest nationwide Macro Capacity (SM) Fiber network. As appropriate, STAR will use capital lease financing or raise additional debt or equity capital to finance new projects. STAR generated net cash from operating activities of $4.3 million for the nine months ended September 30, 1998, primarily from net income plus depreciation and amortization, as well as increases in accounts payable and accrued expenses offset by increases in accounts and notes receivable. The increase in accounts and notes receivable was due to general increases in volume and extended payment terms for certain customers. The Company's investing activities used cash of $136.7 million during the nine months ended September 30, 1998, primarily from capital expenditures and the purchase of short-term investments. Cash generated from financing activities of $142.0 million can be attributed to STAR's secondary offering of common stock, which generated net cash proceeds of $144.7 million. At September 30, 1998, STAR had capital lease obligations of $37.7 million, and $0.9 million in term loans, relating to its switching facilities and operating equipment. STAR believes that the proceeds from its secondary stock offering and cash generated from operations, as well as funding under its bank line of credit, will satisfy STAR's current liquidity needs. Nevertheless, as STAR continues to expand its network facilities and pursues its strategy of growth through acquisition, STAR's liquidity needs may increase, perhaps significantly, which could require STAR to seek such additional financing or the expansion of its borrowing capacity under current or new lines of credit. While the termination of the LDS customer base in California will result in a loss of commercial revenues from that state during 1998, management does not believe that the loss of such revenues will have a material impact on STAR's liquidity in the future. 15 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. STAR TELECOMMUNICATIONS, INC. Dated: January 15, 1999 By: /s/ Kelly D. Enos ---------------------------- Kelly D. Enos Chief Financial Officer (Principal Financial & Accounting Officer) EX-27 2 EXHIBIT 27
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM STAR TELECOMMUNICATIONS, INC. FORM 10-Q/A AMENDMENT NO 1 FOR THE QTR ENDED SEPTEMBER 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 9-MOS DEC-31-1998 JAN-01-1998 SEP-30-1998 11,808 92,390 80,721 0 0 212,829 113,851 0 334,020 96,264 38,648 0 0 42 205,033 334,020 0 425,531 0 411,016 171 0 2,080 15,775 6,643 0 0 0 0 9,132 0.23 0.22
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