-----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, A0MqelClOUALb6B0qle2QowFP6jBj4f2JddNCIFlxHkekkfD7lzVls6dESKEsPzL FIbRRpFEeV4Wunsrg9dyCA== 0001047469-99-001436.txt : 19990120 0001047469-99-001436.hdr.sgml : 19990120 ACCESSION NUMBER: 0001047469-99-001436 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19971231 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-K/A SEC ACT: SEC FILE NUMBER: 000-22581 FILM NUMBER: 99507843 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-K/A 1 10-K/A - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K/A (AMENDMENT NO. 2) (MARK ONE) /X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NUMBER 000-22581 ------------------------ STAR TELECOMMUNICATIONS, INC. (Exact name of registrant as specified in its charter) DELAWARE 77-0362681 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 223 EAST DE LA GUERRA STREET, 93101 SANTA BARBARA, CALIFORNIA (Zip code) (Address of principal executive offices)
(805) 899-1962 (Registrant's telephone no., including area code) Securities registered pursuant to Section 12(b) of the Act: Common Stock, par value $0.001 per share Name of each exchange on which registered: Nasdaq National Market Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the Registrant (1) has filed all reports required 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 ____ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. / / The aggregate market value of the Common Stock of the Registrant held by non-affiliates of the Registrant on January 13, 1999, based on the average bid and asked prices for the Common Stock as reported by Nasdaq was approximately $381,247,423. The number of shares of the Registrant's Common Stock outstanding as of January 13, 1999 was approximately 42,246,521 shares. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- The undersigned Registrant hereby amends the following items of its Annual Report on Form 10-K for the fiscal year ended December 31, 1997, as set forth below: PART II ITEM 6. SELECTED FINANCIAL DATA. The following selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and Notes thereto of STAR Telecommunications, Inc. ("STAR" or the "Company") and with "Management's Discussion and Analysis of Financial Condition and Results of Operations," filed as part of this Form 10-K. The consolidated statements of operations data for the years ended December 31, 1995, 1996 and 1997, and the balance sheet data at December 31, 1996 and 1997 are derived from the Company's audited financial statements. The consolidated statement of operations data for the year ended December 31, 1994 and the consolidated balance sheet data at December 31, 1994 are unaudited and are derived from unaudited financial statements not included in this Form 10-K. The consolidated balance sheet data at December 31, 1995 is derived from audited financial statements not included in this Form 10-K. Although incorporated in 1993, the Company did not commence business until 1994.
YEAR ENDED DECEMBER 31, ---------------------------------------------- 1994 1995 1996 1997 ----------- --------- ---------- ---------- (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA) CONSOLIDATED STATEMENTS OF OPERATIONS DATA:(1) Revenues........................................................... $ 20,915 $ 46,283 $ 237,991 $ 376,198 Operating expenses: Cost of services................................................. 12,775 31,897 205,585 325,237 Selling, general and administrative.............................. 4,782 10,086 34,331 35,381 Depreciation and amortization.................................... 30 186 1,151 4,245 Merger expense................................................... -- -- -- 286 ----------- --------- ---------- ---------- Total operating expenses......................................... 17,587 42,169 241,067 365,149 ----------- --------- ---------- ---------- Income (loss) from operations.................................... 3,328 4,114 (3,076) 11,049 Other income (expense): Interest income.................................................. 3 22 110 492 Interest expense................................................. -- (64) (601) (1,633) Legal settlements and expenses................................... -- -- (100) (1,653) Other............................................................ (7) (33) 39 208 ----------- --------- ---------- ---------- Income (loss) before provision for income taxes.................. 3,324 4,039 (3,628) 8,463 Provision for income taxes......................................... 1 66 592 2,895 ----------- --------- ---------- ---------- Net income (loss).................................................. $ 3,323 $ 3,973 $ (4,220) $ 5,568 ----------- --------- ---------- ---------- ----------- --------- ---------- ---------- Pro forma net income (loss) (unaudited)(2)......................... $ 1,994 $ 2,407 $ (5,163) $ 5,373 ----------- --------- ---------- ---------- ----------- --------- ---------- ---------- Income per share(3)................................................ $ 0.20 $ 0.22 $ (0.19) $ 0.19 ----------- --------- ---------- ---------- ----------- --------- ---------- ---------- Diluted income per share(3)........................................ $ 0.20 $ 0.22 $ (0.19) $ 0.18 ----------- --------- ---------- ---------- ----------- --------- ---------- ---------- Pro forma income (loss) per share (unaudited)(2)(3)................ $ 0.12 $ 0.13 $ (0.24) $ 0.19 ----------- --------- ---------- ---------- ----------- --------- ---------- ---------- Pro forma diluted income (loss) per share (unaudited)(2)(3)........ $ 0.12 $ 0.13 $ (0.24) $ 0.17 ----------- --------- ---------- ---------- ----------- --------- ---------- ---------- Weighted average number of common shares outstanding(3)............ 16,865 18,020 21,939 28,868 Weighted average number of diluted common shares outstanding(3).... 16,865 18,020 21,939 31,625
2
AS OF DECEMBER 31, -------------------------------------------- 1994 1995 1996 1997 ----------- --------- --------- --------- (UNAUDITED) (IN THOUSANDS) CONSOLIDATED BALANCE SHEET DATA: Working capital (deficit).......................... $ 2,007 $ 1,222 $ (6,342) $ 15,846 Total assets....................................... 5,105 18,316 54,000 113,553 Total long-term liabilities, net of current portion.......................................... -- 904 5,870 12,271 Retained earnings (deficit)........................ 1,839 1,596 (5,968) (1,397) Stockholders' equity............................... 2,197 3,047 7,911 44,014
YEAR ENDED DECEMBER 31, ----------------------------------------------- 1994 1995 1996 1997 ----------- ---------- ---------- ---------- (UNAUDITED) (IN THOUSANDS, EXCEPT PER MINUTE DATA) OTHER CONSOLIDATED FINANCIAL AND OPERATING DATA: Capital expenditures(4)........................................... $ 57 $ 2,175 $ 13,018 $ 24,732 Wholesale billed minutes of use................................... -- 38,106 479,681 863,295 Wholesale revenue per billed minute of use(5)..................... $ -- $ 0.4102 $ 0.4288 $ 0.3997
- ------------------------ (1) Does not reflect the acquisition of T-One Corp. ("T-One"), which was consummated on March 10, 1998, or the acquisition of United Digital Network ("UDN"), which remains subject to the approval of UDN's stockholders and to various regulatory approvals. If the Company's financial statements had been restated to include the combined operating results of the Company and T-One at the beginning of the audited periods presented, revenues would have been $58.9 million, $259.7 million and $404.6 million, income (loss) from operations would have been $3.8 million, $(3.7) million and $11.4 million and pro forma net income (loss) would have been $2.1 million, $(5.7) million and $5.6 million for the years ended December 31, 1995, 1996 and 1997, respectively. See Note 14 of Notes to Consolidated Financial Statements. (2) The pro forma net income or loss per share assumes that both STAR and L.D. Services, Inc. ("LDS") had been C-Corporations for all periods presented. (3) 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. (4) Includes assets financed with capital leases or notes. See Note 2 of Notes to Consolidated Financial Statements. (5) Represents wholesale gross call usage revenue per billed minute. Amounts exclude other revenue related items such as finance charges. 3 ITEM 7. 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 "SELECTED CONSOLIDATED FINANCIAL DATA" AND THE CONSOLIDATED FINANCIAL STATEMENTS AND THE NOTES THERETO CONTAINED ELSEWHERE IN THIS FORM 10-K. THIS DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS, AS DEFINED IN SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT") AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED (THE "EXCHANGE ACT"), THAT INVOLVE RISKS AND UNCERTAINTIES. STAR'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" IN THE COMPANY'S ANNUAL REPORT ON FORM 10-K. OVERVIEW The Company is an emerging multinational carrier focused primarily on the international long distance market. The Company offers 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 approximately 220 countries through its flexible network comprised of various foreign termination relationships, international gateway switches, leased and owned transmission facilities and resale arrangements with other long distance providers. The Company installed its first international gateway switch in Los Angeles in June 1995 and initially recognized wholesale revenues in August 1995. A significant portion of the Company's revenues in 1994 and 1995 were generated by the commercial operations of LDS. REVENUES. Most of the Company's revenues are generated by the sale of international long distance services on a wholesale basis to other, primarily domestic, long distance providers. 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. COSTS OF SERVICES (EXCLUSIVE OF DEPRECIATION AND AMORTIZATION). 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. The Company continues to lower its costs of services (exclusive of depreciation and amortization) by (i) expanding the Company's owned network facilities, (ii) continuing to utilize the Company's sophisticated information systems to route calls over the most cost-effective routes and (iii) leveraging the Company's traffic volumes and information systems to negotiate lower variable usage-based costs with domestic and foreign providers of transmission capacity. Costs of services (exclusive of depreciation and amortization) include those costs associated with the transmission and termination of international long distance services and does not include depreciation or amortization expense. Currently, a majority of transmission capacity used by the Company is obtained on a variable, per minute basis. As a result, some of the Company's current costs of services (exclusive of depreciation and amortization) 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. Each quarter management reviews the cost of services (exclusive of depreciation and amortization) accrual and adjusts the balance for resolved items. Cost of services (exclusive of depreciation and amortization) also include fixed costs associated with the leasing of network facilities. The Company intends to begin providing international long distance services to commercial customers in certain European countries in the second half of 1998. STAR began providing long distance service to commercial markets in the U.S. with its acquisition of LDS in November 1997. STAR believes that traffic 4 from commercial customers will be more profitable than wholesale traffic. STAR also expects, however, that an expansion into this market will also increase the risk of bad debt exposure and lead to higher overhead costs. Information related to wholesale and commercial revenues and operations will be reported in future Exchange Act filings made by STAR in accordance with Financial Accounting Standards Board Statement No. 131. Prices in the international long distance market have declined in recent years and, as competition continues to increase, STAR believes that prices are likely to continue to decline. Additionally, STAR believes that the increasing trend of deregulation of international long distance telecommunications will result in greater competition, which could adversely affect STAR's revenue per minute. STAR believes, however, that the effect of such decreases in prices will be offset by increased calling volumes and decreased costs. OPERATING EXPENSES. Selling, general and administrative expenses consist primarily of personnel costs, depreciation and amortization, tradeshow and travel expenses and commissions and consulting fees, as well as an accrual for bad debt expense. These expenses have been increasing over the past year, which is consistent with STAR's recent growth, accelerated expansion into Europe, and investment in systems and facilities. The Company expects this trend to continue, and to include, among other things, a significant increase in depreciation and amortization. Management believes that additional selling, general and administrative expenses will be necessary to support the expansion of the Company's network facilities, its sales and marketing efforts and STAR's expansion into commercial markets. FOREIGN EXCHANGE. The Company's revenues and cost of long distance services are sensitive to foreign currency fluctuations. The Company expects that an increasing portion of the Company's revenues 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. 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, STAR 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 STAR's traffic; financial difficulties of major customers; pricing pressure resulting from increased competition; and technical difficulties with or failures of portions of STAR's network that impact STAR's ability to provide service to or bill its customers. STAR's operating expenses in any given period can vary due to factors such as fluctuations in rates charged by carriers to terminate STAR'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 STAR's sales incentive plans; and costs associated with changes in staffing levels of sales, marketing, technical support and administrative personnel. In addition, STAR'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 STAR's expansion in international and commercial markets; and general domestic and international economic and political conditions. Further, a substantial portion of transmission capacity used by the Company is obtained on a variable, per minute and short term basis, subjecting the Company to the possibility of unanticipated price increases and service cancellations. Since STAR 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, STAR's operating 5 results are subject to significant fluctuations over short periods of time. The Company's operating results also may be negatively impacted in the longer term by competitive pricing pressures. RECENT ACQUISITIONS AND DEVELOPMENTS The Company has recently acquired or entered into agreements to acquire the following companies and has taken the following actions: - L.D. SERVICES, INC. On November 30, 1997, the Company acquired LDS, certain non-operating entities and majority ownership in another entity for approximately 849,000 shares of Common Stock in a transaction accounted for as a pooling of interests. The Company's audited financial statements have been restated to include LDS' historical performance for all periods presented. The commercial business of LDS has historically had higher revenue per minute and higher selling, general and administrative expenses and operating costs than the Company's wholesale operations. As the Company integrates and expands the commercial accounts of LDS, such increase in operations may affect the Company's future operating margins. In 1997, LDS settled disputes with the California PUC and with the District Attorney of Monterey, California. The resulting payments and restrictions on LDS' activities adversely affected its 1997 operating results. - T-ONE CORP. On March 10, 1998, the Company acquired T-One for 1,353,000 shares of Common Stock in a transaction accounted for as a pooling of interests. The Company's audited financial statements included in this document have not been restated to include T-One's historical performance. For the fiscal year ended December 31, 1997, T-One had revenues of $30.4 million, gross profit of $1.8 million, selling, general and administrative expenses of $1.5 million and net income of $0.2 million. See Note 14 of Notes to Consolidated Financial Statements. - UNITED DIGITAL NETWORK, INC. On November 19, 1997, STAR entered into an agreement to acquire UDN for approximately 650,000 shares of STAR Common Stock. The acquisition of UDN is subject to the approval of UDN's stockholders and to various regulatory approvals, and STAR may not complete this acquisition. - On March 24, 1998, the Company filed a Registration Statement on Form S-1 (Registration No. 333-48559) registering 6,670,000 shares of Common Stock to be sold by the Company (the "Offering"). The Company also granted the Underwriters a 30-day option to purchase up to 1,050,000 additional shares of Common Stock solely to cover over-allotments, if any. The Company intends to use the proceeds from the Offering for capital expenditures, working capital and general corporate purposes. - STOCK SPLIT. On March 31, 1998, the Company will give effect to the Stock Split with payment to the holders of the shares of Common Stock outstanding on February 20, 1998 a stock dividend equal to 1.05 shares of Common Stock for each such outstanding share. 6 RESULTS OF OPERATIONS The following table sets forth certain selected items in the Company's statements of operations as a percentage of total revenues for the periods indicated:
YEARS ENDED DECEMBER 31, ---------------------------- 1995 1996 1997 ------ ------ ------ Revenues.......................................... 100.0% 100.0% 100.0% Operating Expenses: Cost of services................................ 68.9 86.4 86.5 Selling, general and administrative expenses.... 21.8 14.4 9.4 Depreciation and amortization................... 0.4 0.5 1.1 ------ ------ ------ Total operating expenses.................... 91.1 101.3 97.1 Income (loss) from operations..................... 8.9 (1.3) 2.9 ------ ------ ------ Income (loss) before provision for income taxes... 8.7 (1.5) 2.3 Provision for income taxes........................ 0.1 0.3 0.8 ------ ------ ------ Net income (loss)................................. 8.6% (1.8)% 1.5% ------ ------ ------ ------ ------ ------
YEARS ENDED DECEMBER 31, 1997 AND 1996 REVENUES: Revenues increased 58.1% to $376.2 million in 1997 from $238.0 million in 1996. Wholesale revenues increased to $348.7 million from $208.1 million, with wholesale minutes of use increasing to 863.3 million minutes in 1997, as compared to 479.7 million minutes of use in the prior year. This increase reflects an increase in the number of wholesale customers from 84 in 1996 to 105 at the end of 1997, as well as an increase in usage by existing customers, primarily resulting from STAR's expanding transmission capacity and improving transmission quality. The average rate per minute of usage for wholesale customers declined from $0.43 cents per minute in 1996 to $0.40 cents per minute in 1997, reflecting the change in country mix to include a larger proportion of lower rate per minute countries as well as lower prices on competitive routes. The decline in rates per wholesale minute partially offset the increase in wholesale minutes of use. The period to period decline in rates per minute was not a significant factor in the relative increase in minutes of use. Taking into account the acquisition of T-One, on a pro forma basis revenues in 1997 would have been $404.6 million, an increase of 55.8% from 259.7 million in 1996. Commercial revenues decreased to $27.5 million in 1997 from $29.9 million in 1996 reflecting the termination of the LDS customer base in California due to the 1997 settlement entered into by LDS with each of the California PUC and the District Attorney of Monterey, California. In 1997, commercial revenues generated in the State of California was $10.4 million, as compared to California-generated commercial revenues of $14.5 million in 1996. COST OF SERVICES (EXCLUSIVE OF DEPRECIATION AND AMORTIZATION): Cost of services (exclusive of depreciation and amortization) increased 58.2% to $325.2 million in 1997 from $205.6 million in 1996. Wholesale cost of services (exclusive of depreciation and amortization) increased to $308.9 million in 1997 from $188.4 million for 1996 and as a percentage of wholesale revenues decreased to 88.6% from 90.6%, respectively. Wholesale cost of services (exclusive of depreciation and amortization) declined during 1997 as traffic was increasingly routed over STAR's proprietary international network. Commercial cost of services (exclusive of depreciation and amortization) decreased 5.2% to $16.3 million in 1997 from $17.2 million in 1996 and as a percentage of commercial revenue increased to 59.3% from 57.4% over such periods, reflecting declining prices in the competitive long distance market. As STAR migrates the LDS commercial customer base onto STAR's network, LDS's cost of commercial long distance services (exclusive of depreciation and amortization) is expected to decline. 7 SELLING, GENERAL AND ADMINISTRATIVE: In 1997, selling, general and administrative expenses increased 3.1% to $35.4 million, from $34.3 million in 1996. Wholesale selling, general and administrative expenses increased to $26.0 million in 1997 from $24.1 million in 1996, but decreased as a percentage of wholesale revenues to 7.5% from 11.6% over the comparable periods. Total expenses increased year to year in absolute dollars as STAR expanded its proprietary international network and employee base. Included in the 1996 selling, general and administrative expense was $11.6 million in reserves and write-offs against deposits and accounts receivable related to bad debts from two customers. Commercial selling, general and administrative expenses decreased to $9.4 million in 1997 from $10.2 million in 1996 and remained flat as a percentage of commercial revenues at approximately 34.1%. STAR expects selling, general and administrative expenses to expand in absolute dollars and as a percentage of revenues in fiscal year 1998, as STAR expands its network and employee base and in connection with STAR's entry into the commercial market. DEPRECIATION AND AMORTIZATION: Depreciation increased to $4.2 million for 1997 from $1.2 million for 1996, and increased as a percentage of revenues to 1.1% from 0.5% in the prior period. Depreciation increased as a result of STAR's continuing expansion of its proprietary international network which includes purchases of switches, submarine cable and leasehold improvements associated with switch sites. STAR expects depreciation expense to increase as STAR continues to expand its global telecommunications network. OTHER INCOME (EXPENSE): Other expense, net, increased to $2.6 million in 1997 from $552,000 in 1996. This increase is primarily due to interest expense of $1.6 million incurred under various capital leases and bank lines of credit and a legal settlement and associated expenses of $1.7 million. The legal settlement relates to the dispute settled by LDS with the California PUC and the District Attorney of Monterey County. See "Business of STAR--Governmental Regulation--Actions Against LDS." Interest income earned on short-term investments increased to $492,000 in 1997 from $110,000 in 1996 due to interest earned on the proceeds of STAR's June 1997 initial public offering. PROVISION FOR INCOME TAXES: The historical provision for income taxes increased to $2.9 million in 1997 from $592,000 in 1996 primarily due to the increase in profitability of STAR. YEARS ENDED DECEMBER 31, 1996 AND 1995. REVENUES: Revenues increased 414.2% to $238.0 million in 1996 from $46.3 million 1995. Wholesale 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 wholesale revenue resulted from STAR's commencement of operations as an international long distance carrier, an increase in the number of customers as compared to the prior year and an increase in minutes of wholesale 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 STAR was able to offer to customers. Commercial revenues decreased to $29.9 million in 1996 from $30.2 million in 1995 due to a decrease in the rate per minute charged, which was partially offset by an increase in the number of minutes sold. In 1996, commercial revenue generated in the State of California was $14.5 million, as compared to California-generated commercial revenues of $15.4 million in 1995. Taking into account the acquisition of T-One, on a pro forma basis revenues would have been $259.7 million in 1996, an increase of 340.6% from $58.9 million in 1995. COST OF SERVICES (EXCLUSIVE OF DEPRECIATION AND AMORTIZATION): Cost of services (exclusive of depreciation and amortization) increased 544.5% to $205.6 million for 1996 from $31.9 million in 1995. Wholesale cost of services (exclusive of depreciation and amortization) increased to $188.4 million in 1996 from $14.3 million for 1995. Wholesale cost of services (exclusive of depreciation and amortization) as a percentage of wholesale revenues decreased to 90.6% in 1996 from 89.0% in 1995, reflecting the change from STAR's prior consulting business to operating as an international long distance carrier. Cost of 8 services (exclusive of depreciation and amortization) 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. Commercial cost of services (exclusive of depreciation and amortization) decreased to $17.2 million in 1996 from $17.6 million in 1995 representing 57.4% and 58.2% of commercial revenues, respectively. Cost of services (exclusive of depreciation and amortization) from commercial services declined as costs associated with the local exchange carriers declined. SELLING, GENERAL AND ADMINISTRATIVE: Selling, general and administrative expenses increased 240.4% to $34.3 million in 1996 from $10.1 million in 1995. Wholesale selling, general and administrative expenses increased to $24.1 million in 1996 from $2.1 million in 1995, and increased as a percentage of revenues to 11.6% from 12.8% in the prior period. Selling, general and administrative expenses increased between periods as STAR increased its employee base and incurred payroll, employee benefits, commission and related expenses. STAR 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. Hi-Rim and CCI, two of STAR's major customers in 1996, informed STAR that they were experiencing financial difficulties and would be unable to pay in full outstanding accounts receivable. As a result, the full amount of the approximately $10.8 million owed to STAR by Hi-Rim and CCI as of December 31, 1996 which was not subsequently collected or for which no offsetting value was received, was written off or reserved in 1996. In addition, STAR wrote-off $820,000 of intangible assets relating to CCI. Commercial selling, general and administrative expenses increased to $10.2 million in 1996 from $8.0 million in 1995 reflecting higher operating costs. DEPRECIATION: Depreciation increased to $1.2 million for 1996 from $186,000 for 1995, an increase as a percentage of revenues to 0.5% from 0.4% in the prior period. Depreciation increased as a result of STAR's purchase of switches and of the operating equipment and leasehold improvements associated with its Los Angeles and New York switching facilities. Depreciation expense will increase as STAR expands its ownership of switching and transmission facilities through purchase or use of capital leases. OTHER INCOME (EXPENSE): Other expense, net, increased to $552,000 in 1996 from $75,000 in 1995. This increase is primarily due to a $100,000 legal settlement in the second quarter of 1996 as well as $601,000 in interest expense incurred under various bank and stockholder lines of credit. This increase was offset by $110,000 in interest income on short-term investments and cash equivalents primarily from funds raised in private placements of equity securities during the first three quarters of 1996. PROVISION FOR INCOME TAXES: Through December 31, 1995, STAR had elected to be taxed as an S-Corporation for both federal and state income tax purposes and thus was only subject to 1.5% tax on taxable income for state purposes. LDS was an S-Corporation through the date of the merger on November 30, 1997. The pro forma provision for income taxes, assumes that both STAR and LDS were C-Corporations for all periods presented. During 1996, the historical provision for income taxes increased to $592,000 as a result of the reserve of $2.9 million of the net deferred tax asset. LIQUIDITY AND CAPITAL RESOURCES As of December 31, 1997, STAR had cash and cash equivalents of approximately $1.5 million, short-term investments of $18.6 million and a working capital surplus of $15.8 million. In June 1997, the Company completed an initial public offering of 9.4 million shares of Common Stock of which approximately 8.1 million shares were sold by the Company and approximately 1.3 million shares were sold by certain selling stockholders. The net proceeds to the Company (after deducting underwriting discounts and offering expenses) from the sale of such shares of Common Stock were approximately $30.9 million. As of December 31, 1997, the Company had used the proceeds from the offering to repay indebtedness of $14.2 9 million, to purchase switching and transmission related equipment and to finance the Company's operations in the U.K. As of December 31, 1997, 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 175 basis points and expires on July 1, 1999. However, the line of credit is reduced by outstanding letters of credit in the amount of $4.9 million. STAR generated net cash from operating activities of $10.1 million in 1997, primarily from net income plus depreciation and amortization, while using $3.4 million in 1996. The Company's investing activities used cash of approximately $29.6 million during 1997 primarily resulting from capital expenditures and the investment of the proceeds from the initial public offering in marketable securities, while using $9.8 million in 1996. The Company's financing activities provided cash of approximately $19.3 million during 1997 primarily from the sale of Common Stock and borrowings under lines of credit, offset by repayments under various lines of credit, while providing $14.7 million in 1996. STAR had capital lease obligations of $13.6 million, and $0.8 million in term loans, relating to its switching facilities and operating equipment. STAR anticipates making capital expenditures of approximately $80.0 million over the next 12 months to expand its global network. STAR believes that the proceeds from the 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 the Company continues to expand its network facilities and pursues its strategy of growth through acquisition, the Company's liquidity needs may increase, perhaps significantly, which could require the Company to seek such additional financing or the expansion of its borrowing capacity under current or new lines of credit. As appropriate, STAR will use capital lease financing or raise additional debt or equity capital to finance new projects or acquisitions. The Company had foreign currency contracts outstanding at December 31, 1997 in the notional amount of $6.3 million. See Note 2 of Notes to Consolidated Financial Statements. 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, its 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 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 systems interface 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 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. 10 Historically, STAR has not incurred any costs to date 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 1998 and 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 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 will be its inability to route telephone traffic at current rates to desired locations for an indeterminable period of time. Such worst case scenario could have a material adverse affect 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. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. See the Index included at "Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K." 11 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) Documents filed as part of this Report: (1) Index to Financial Statements:
PAGE ----- Report of Independent Public Accountants F-1 Consolidated Balance Sheets as of December 31, 1996 and 1997 F-2 Consolidated Statements of Operations for the years ended December 31, 1995, 1996 and 1997 F-3 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1996 and 1997 F-4 Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1996 and 1997 F-5 Notes to Consolidated Financial Statements F-7
(2) Index to Financial Statement Schedules: Report of Independent Public Accountants S-1 Schedule II--Valuation and Qualifying Accounts S-2
(3)(a) Exhibits: 2.1* Amended and Restated Stock Acquisition Agreement and Plan of Merger dated as of November 30, 1997 by and among the Registrant, Big Dave's Acquisition Corp., LCCR, Inc., and the shareholders listed on the signature page thereto. 2.2** Agreement and Plan of Merger dated as of November 19, 1997 by and among the Registrant, IIWII Corp. and United Digital Network, Inc. (the "UDN Merger Agreement"). 2.3** First Amendment to the UDN Merger Agreement dated as of January 30, 1998. 2.4** Stock Purchase Agreement dated as of January 26, 1998 by and among the Registrant, T-One Corp. and Taha Mikati, as amended. 3.1** Amended and Restated Certificate of Incorporation of the Registrant. 3.2** Bylaws of the Registrant. 4.1+++ Specimen Common Stock certificate. 4.2+ Registration Rights Agreement, dated September 24, 1996, between the Registrant and the investors named therein. 4.3+ Registration Rights Agreement, dated July 12, 1996, between the Registrant and the investor named therein. 4.4+ Investor Rights Agreement dated July 25, 1996, between the Registrant and the investors named therein. 4.5* Registration Rights Agreement dated as of November 30, 1997 by and among the Company and the shareholders listed on the signature page thereto. 4.6** Registration Rights Agreement dated as of March 10, 1998 between the Registrant and Taha Mikati. 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.
12 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** Credit Agreement dated as of September 30, 1997 among the Registrant, the financial institutions party thereto and Sanwa Bank California, as amended. 10.26** Office Lease between the Registrant, Hudson Telegraph Associates and American Communications Corp., as amended. 10.27** Amendment Number Three to Employment Agreement between the Registrant and Mary A. Casey dated as of July 1, 1997. 10.28** Amendment Number One to Employment Agreement between the Registrant and Kelly D. Enos dated as of November 12, 1997. 10.29** Amendment Number One to First Restatement of Employment Agreement between the Registrant and James Kolsrud dated as of June 16, 1997. 10.30** Amendment Number One to Employment Agreement between the Registrant and David Vaun Crumly dated as of November 11, 1997. 10.31** First Amendment to Amended and Restated 1996 Stock Incentive Plan. 10.32*** Agreement dated as of December 1, 1997 between the Registrant and Nortel Dasa Network Systems GmbH & Co. KG. 10.33** Leasing Agreement between the Registrant and Nortel Dasa Network Systems GmbH & Co. KG.
13 10.34** Guarantee Agreement between the Registrant and Nortel Dasa Network Systems GmbH & Co. KG. 10.35** Note and Security Agreement dated as of December 18, 1997 between the Registrant and NationsBanc Leasing Corporation. 10.36** Amendment of Lease dated as of September 30, 1997 between the Registrant and Hudson Telegraph (reference is hereby made to Exhibit 10.14). 10.37 Intentionally omitted. 10.38** Lease Agreement dated July 29, 1996 between the Registrant and Telecommunications Finance Group. 10.39** Promissory Note issued by Christopher E. Edgecomb in favor of the Registrant dated November 26, 1997. 10.40** Stock Pledge Agreement dated November 26, 1997 between the Registrant and Christopher E. Edgecomb. 10.41** Commercial Lease dated October 31, 1997 between the Registrant and Prinzenpark GbR. 10.42** Commercial Lease dated October 9, 1997 between the Registrant and WSL Weststadt Liegenschafts GmbH. 10.43** Office Lease between the Registrant and Airport-Center KGHP Gewerbeban GmbH & Cie. 10.44** Lease dated November 19, 1997 between the Registrant and DIFA Deutsche Immobilien Fonds Aktiengesellschaft. 21.1*** Subsidiaries of the Registrant. 23.1 Consent of Arthur Andersen LLP, Independent Accountants. 24.1*** Power of Attorney. 27.1 Financial Data Schedule.
- ------------------------ + Filed as an exhibit to the Company's Registration Statement on Form S-1 (Registration No. 333-21325) on February 7, 1997 and incorporated by reference herein. ++ Filed as an exhibit to Amendment No. 1 to the Company's Registration Statement on Form S-1 (Registration No. 333-21325) on May 16, 1997 and incorporated by reference herein. +++ Filed as an exhibit to Amendment No. 2 to the Company's Registration Statement on Form S-1 (Registration No. 333-21325) on May 29, 1997 and incorporated by reference herein. * Filed as an exhibit to the Company's Current Report on Form 8-K (File No. 000-22581) on December 15, 1997 and incorporated by reference herein. ** Filed as an exhibit to the Company's Registration Statement on Form S-1 (Registration No. 333-48559) on March 24, 1998 and incorporated by reference herein. *** Filed as an exhibit to the Company's Annual Report on Form 10-K on March 31, 1998 and incorporated by reference herein. (b) Reports on Form 8-K: Current Report on Form 8-K, dated November 30, 1997, reporting under Item 2: (i) the acquisition by STAR of all of the outstanding shares of the capital stock of LCCR, Inc. ("LCCR"); (ii) the Audited Financial Statements of LCCR; (iii) Pro Forma Combined Balance Sheet of STAR and LCCR as of September 30, 1997; (iv) Pro Forma Combined Statements of Operations of STAR and LCCR for the year ended December 31, 1996 and for the nine-month period ended September 30, 1997; and (v) Notes to Pro Forma Combined Statements of STAR and LCCR. 14 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ----- Report of Independent Public Accountants................................................................................ F-2 Consolidated Balance Sheets as of December 31, 1996 and 1997............................................................ F-3 Consolidated Statements of Operations for the years ended December 31, 1995, 1996 and 1997.............................. F-4 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1996 and 1997.................... F-5 Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1996 and 1997.............................. F-6 Notes to Consolidated Financial Statements.............................................................................. F-8
F-1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors and Stockholders of STAR Telecommunications, Inc. and Subsidiaries: We have audited the accompanying consolidated balance sheets of STAR TELECOMMUNICATIONS, INC. (a Delaware corporation) AND SUBSIDIARIES, as of December 31, 1996 and 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. 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 Subsidiaries as of December 31, 1996 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Los Angeles, California February 12, 1998 (except with respect to the stock split discussed in Note 14 as to which the date is March 31, 1998) F-2 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS
DECEMBER 31, ----------------------- 1996 1997 ---------- ----------- CURRENT ASSETS: Cash and cash equivalents............................................................ $1,726,000 $ 1,458,000 Short-term investments............................................................... 1,630,000 18,579,000 Accounts receivable, net of allowance of $6,202,000 and $7,745,000 at December 31, 1996 and 1997, respectively........................................................ 27,660,000 42,407,000 Receivable from related parties...................................................... 115,000 -- Other receivables.................................................................... 284,000 2,198,000 Prepaid expenses..................................................................... 960,000 4,712,000 Prepaid taxes........................................................................ 677,000 -- Deferred income taxes................................................................ -- 3,699,000 Other current assets................................................................. 825,000 61,000 ---------- ----------- Total current assets............................................................... 33,877,000 73,114,000 ---------- ----------- PROPERTY AND EQUIPMENT: Operating equipment.................................................................. 8,653,000 29,142,000 Leasehold improvements............................................................... 4,248,000 6,289,000 Furniture, fixtures and equipment.................................................... 2,418,000 4,564,000 ---------- ----------- 15,319,000 39,995,000 Less-Accumulated depreciation and amortization....................................... (1,407,000) (5,638,000) ---------- ----------- 13,912,000 34,357,000 ---------- ----------- OTHER ASSETS: Investments.......................................................................... 153,000 27,000 Deposits............................................................................. 5,630,000 6,055,000 Other................................................................................ 428,000 -- ---------- ----------- 6,211,000 6,082,000 ---------- ----------- Total assets....................................................................... $54,000,000 $113,553,000 ---------- ----------- ---------- ----------- LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Revolving lines of credit............................................................ $7,814,000 $ -- Revolving lines of credit with stockholder........................................... 26,000 138,000 Current portion of long-term debt.................................................... 267,000 480,000 Current portion of obligations under capital leases.................................. 872,000 2,495,000 Accounts payable..................................................................... 9,391,000 7,987,000 Taxes payable........................................................................ -- 2,156,000 Related party payable................................................................ 269,000 -- Accrued line costs................................................................... 19,494,000 38,403,000 Accrued expenses..................................................................... 2,086,000 5,609,000 ---------- ----------- Total current liabilities.......................................................... 40,219,000 57,268,000 ---------- ----------- LONG-TERM LIABILITIES: Long-term debt, net of current portion............................................... 466,000 348,000 Capital lease obligations, net of current portion.................................... 4,936,000 11,139,000 Deferred compensation................................................................ 116,000 57,000 Deposits............................................................................. -- 164,000 Other long-term liabilities.......................................................... 352,000 563,000 ---------- ----------- Total long-term liabilities........................................................ 5,870,000 12,271,000 ---------- ----------- STOCKHOLDERS' EQUITY: Series A Preferred Stock, $.001 par value, authorized-- 5,000,000 shares Issued and outstanding-- 2,802,446 at December 31, 1996 and none at December 31, 1997............................................................................... 3,000 -- Common Stock, $.001 par value, authorized - 50,000,000 shares Issued and outstanding-- 23,223,810 and 33,678,519 at December 31, 1996 and 1997, respectively....................................................................... 23,000 34,000 Additional paid-in capital........................................................... 9,937,000 41,373,000 Deferred compensation................................................................ (118,000) (30,000) Retained earnings (deficit).......................................................... (1,934,000) (2,637,000) ---------- ----------- Stockholders' equity............................................................... 7,911,000 44,014,000 ---------- ----------- Total liabilities and stockholders' equity....................................... $54,000,000 $113,553,000 ---------- ----------- ---------- -----------
The accompanying notes are an integral part of these consolidated balance sheets. F-3 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, --------------------------------------------- 1995 1996 1997 ------------- -------------- -------------- REVENUES......................................................... $ 46,283,000 $ 237,991,000 $ 376,198,000 ------------- -------------- -------------- OPERATING EXPENSES: Cost of services............................................... 31,897,000 205,585,000 325,237,000 Selling, general and administrative expenses................... 10,086,000 34,331,000 35,381,000 Depreciation and amortization.................................. 186,000 1,151,000 4,245,000 Merger expense................................................. -- -- 286,000 ------------- -------------- -------------- 42,169,000 241,067,000 365,149,000 ------------- -------------- -------------- Income (loss) from operations................................ 4,114,000 (3,076,000) 11,049,000 ------------- -------------- -------------- OTHER INCOME (EXPENSES): Interest income................................................ 22,000 110,000 492,000 Interest expense............................................... (64,000) (601,000) (1,633,000) Legal settlement and expenses.................................. -- (100,000) (1,653,000) Other income (expense)......................................... (33,000) 39,000 208,000 ------------- -------------- -------------- (75,000) (552,000) (2,586,000) ------------- -------------- -------------- Income (loss) before provision for income taxes.............. 4,039,000 (3,628,000) 8,463,000 PROVISION FOR INCOME TAXES....................................... 66,000 592,000 2,895,000 ------------- -------------- -------------- NET INCOME (LOSS)................................................ $ 3,973,000 $ (4,220,000) $ 5,568,000 ------------- -------------- -------------- ------------- -------------- -------------- Income (loss) before provision for income taxes.............. 4,039,000 (3,628,000) 8,463,000 PRO FORMA INCOME TAXES (UNAUDITED)............................... 1,632,000 1,535,000 3,090,000 ------------- -------------- -------------- PRO FORMA NET INCOME (LOSS) (UNAUDITED).......................... $ 2,407,000 $ (5,163,000) $ 5,373,000 ------------- -------------- -------------- ------------- -------------- -------------- Income (loss) per common share................................... $ 0.22 $ (0.19) $ 0.19 ------------- -------------- -------------- ------------- -------------- -------------- Diluted income (loss) per common share........................... $ 0.22 $ (0.19) $ 0.18 ------------- -------------- -------------- ------------- -------------- -------------- Pro forma basic income (loss) per common share (unaudited)....... $ 0.13 $ (0.24) $ 0.19 ------------- -------------- -------------- ------------- -------------- -------------- Pro forma diluted income (loss) per common share (unaudited)..... $ 0.13 $ (0.24) $ 0.17 ------------- -------------- -------------- ------------- -------------- --------------
The accompanying notes are an integral part of these consolidated statements. F-4 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
PREFERRED STOCK COMMON STOCK ADDITIONAL ---------------------- ---------------------- PAID-IN DEFERRED SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION --------- ----------- --------- ----------- ---------- ------------- Balance, December 31, 1994.............................. -- $ -- 17,455,959 $ 17,000 $ 341,000 $ -- Issuance of common stock................................ -- -- 1,843,339 2,000 101,000 -- Conversion of debt to equity............................ -- -- -- -- 990,000 -- Net income.............................................. -- -- -- -- -- -- Cash distributions to stockholders...................... -- -- -- -- -- -- --------- ----------- --------- ----------- ---------- ------------- Balance, December 31, 1995.............................. -- -- 19,299,298 19,000 1,432,000 -- Effect of terminating the S-corporation election........ -- -- -- -- (690,000) -- Compensation expense relating to stock options.......... -- -- -- -- 168,000 (118,000) Issuance of common stock................................ -- -- 3,924,512 4,000 5,564,000 -- Issuance of preferred stock............................. 2,802,446 3,000 -- -- 7,497,000 -- Net loss................................................ -- -- -- -- -- -- Cash distributions to stockholders...................... -- -- -- -- (4,034,000) -- --------- ----------- --------- ----------- ---------- ------------- Balance, December 31, 1996.............................. 2,802,446 3,000 23,223,810 23,000 9,937,000 (118,000) Effect of L.D. Services terminating the S-corporation election.............................................. -- -- -- -- (61,000) -- Conversion of redeemable preferred stock to common stock................................................. (2,802,446) (3,000) 1,868,284 3,000 -- -- Initial public offering of common stock................. -- -- 8,097,500 8,000 30,936,000 -- Exercise of stock options............................... -- -- 488,925 -- 447,000 -- Compensation expense relating to stock options.......... -- -- -- -- -- 88,000 Tax benefit from non-qualified stock options............ -- -- -- -- 114,000 -- Cash distributions to stockholders...................... -- -- -- -- -- -- Net income.............................................. -- -- -- -- -- -- --------- ----------- --------- ----------- ---------- ------------- Balance, December 31, 1997.............................. -- $ -- 33,678,519 $ 34,000 $41,373,000 $ (30,000) --------- ----------- --------- ----------- ---------- ------------- --------- ----------- --------- ----------- ---------- ------------- RETAINED EARNINGS (DEFICIT) TOTAL ---------- ---------- Balance, December 31, 1994.............................. $1,839,000 $2,197,000 Issuance of common stock................................ -- 103,000 Conversion of debt to equity............................ -- 990,000 Net income.............................................. 3,973,000 3,973,000 Cash distributions to stockholders...................... (4,216,000) (4,216,000) ---------- ---------- Balance, December 31, 1995.............................. 1,596,000 3,047,000 Effect of terminating the S-corporation election........ 690,000 -- Compensation expense relating to stock options.......... -- 50,000 Issuance of common stock................................ -- 5,568,000 Issuance of preferred stock............................. -- 7,500,000 Net loss................................................ (4,220,000) (4,220,000) Cash distributions to stockholders...................... -- (4,034,000) ---------- ---------- Balance, December 31, 1996.............................. (1,934,000) 7,911,000 Effect of L.D. Services terminating the S-corporation election.............................................. 61,000 -- Conversion of redeemable preferred stock to common stock................................................. -- -- Initial public offering of common stock................. -- 30,944,000 Exercise of stock options............................... -- 447,000 Compensation expense relating to stock options.......... -- 88,000 Tax benefit from non-qualified stock options............ -- 114,000 Cash distributions to stockholders...................... (1,058,000) (1,058,000) Net income.............................................. 5,568,000 5,568,000 ---------- ---------- Balance, December 31, 1997.............................. $2,637,000 $44,014,000 ---------- ---------- ---------- ----------
The accompanying notes are an integral part of these consolidated statements. F-5 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, -------------------------------------------- 1995 1996 1997 -------------- ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss)................................................ $ 3,973,000 $ (4,220,000) $ 5,568,000 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization.................................. 186,000 1,151,000 4,245,000 Loss on investment............................................. 80,000 -- -- Loss on disposal of equipment.................................. -- -- 42,000 Compensation expense relating to stock options................. -- 50,000 88,000 Provision for doubtful accounts................................ 217,000 15,753,000 7,695,000 Deferred income taxes.......................................... -- -- (3,699,000) Deferred compensation.......................................... -- 116,000 (59,000) Decrease (increase) in assets: Accounts receivable.............................................. (10,522,000) (28,476,000) (22,442,000) Receivable from related parties.................................. 129,000 (65,000) 115,000 Other receivables................................................ (268,000) -- (1,914,000) Prepaid expenses................................................. (114,000) (830,000) (3,752,000) Deposits......................................................... (630,000) (4,948,000) (425,000) Prepaid taxes.................................................... -- (677,000) 677,000 Other current assets............................................. -- (825,000) 764,000 Increase (decrease) in liabilities: Accounts payable................................................. 8,035,000 (1,269,000) (1,404,000) Taxes payable.................................................... -- -- 2,270,000 Related party payables........................................... 320,000 (51,000) (269,000) Accrued line costs............................................... 476,000 19,018,000 18,909,000 Accrued expenses................................................. 194,000 1,865,000 3,523,000 Deposits......................................................... -- -- 164,000 -------------- ------------- ------------- Net cash provided by (used in) operating activities........ 2,076,000 (3,408,000) 10,096,000 -------------- ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures............................................. (1,123,000) (7,852,000) (13,436,000) Investments...................................................... -- (153,000) 126,000 Short-term investments........................................... -- (1,630,000) (16,949,000) Other............................................................ -- (139,000) 639,000 -------------- ------------- ------------- Net cash used in investing activities...................... (1,123,000) (9,774,000) (29,620,000) -------------- ------------- -------------
F-6 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED DECEMBER 31, -------------------------------------------- 1995 1996 1997 ------------- ------------- -------------- CASH FLOWS FROM FINANCING ACTIVITIES: Stockholders' distributions...................................... $ (4,216,000) $ (4,034,000) $ (1,058,000) Borrowings under lines of credit................................. 1,460,000 14,746,000 34,211,000 Repayments under lines of credit................................. (130,000) (8,262,000) (42,025,000) Borrowings under lines of credit with stockholder................ 3,418,000 701,000 583,000 Repayments under lines of credit with stockholder................ (1,319,000) (1,873,000) (471,000) Borrowings under long-term debt.................................. -- 800,000 193,000 Payments under long-term debt.................................... -- (67,000) (1,622,000) Payments under capital lease obligations......................... (52,000) (358,000) (1,946,000) Issuance of common stock......................................... -- 5,568,000 30,944,000 Stock options exercised.......................................... -- -- 447,000 Issuance of preferred stock...................................... -- 7,500,000 -- ------------- ------------- -------------- Net cash (used in) provided by financing activities.......... (839,000) 14,721,000 19,256,000 ------------- ------------- -------------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS................... 114,000 1,539,000 (268,000) CASH AND CASH EQUIVALENTS, beginning of year....................... 73,000 187,000 1,726,000 ------------- ------------- -------------- CASH AND CASH EQUIVALENTS, end of year............................. $ 187,000 $ 1,726,000 $ 1,458,000 ------------- ------------- -------------- ------------- ------------- --------------
The accompanying notes are an integral part of these consolidated statements F-7 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 1. NATURE OF BUSINESS STAR Telecommunications, Inc., a Delaware corporation, and Subsidiaries (the "Company" or "STAR"), is an emerging multinational carrier focused primarily on the international long distance market. The Company offers 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 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. 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 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. 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 costs and to initiate outbound calls from these local markets. In December 1997, the Company entered into the domestic commercial long-distance market through the acquisition of L.D. Services, Inc., also known as LCCR Inc. ("LDS"). LDS is a retail long-distance service provider throughout the United States. 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 LDS as though it had always been a part of STAR (see Note 8). The pro forma results of operations and pro forma income or loss per common share for 1995, 1996 and 1997 assumes that both STAR and LDS had been C-Corporations for all periods presented. The Company is subject to various risks in connection with the operation of its business. These risks include, but are not limited to, regulations (both domestic and foreign), dependence on transmission facilities-based carriers and suppliers, price competition and competition from larger industry participants. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements include the accounts of STAR Telecommunications, Inc. and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated. REVENUE RECOGNITION The Company records revenues for telecommunications sales at the time of customer usage. Finance charges for customer late payments are included in revenues and amount to $32,000, $1,467,000 and $2,747,000 for the years ended December 31, 1995, 1996 and 1997, respectively. F-8 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) COST OF SERVICES Cost of services for wholesale long distance 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 traffic on behalf of the Company. In addition, retail long distance service cost includes billing and collection service fees from local exchange carriers and call rating services. ACCOUNTING FOR INTERNATIONAL LONG DISTANCE TRAFFIC The Company has carrier service agreements with telecommunication carriers in foreign countries under which international long distance traffic is both originated and terminated on the Company's network. The Company records revenues and related costs as the traffic is recorded in the switch. Revenue from foreign customers equaled $178,000 and $6,577,000 for the years ended December 31, 1996 and 1997, respectively. The Company recognized settlement costs relating to foreign carrier agreements of $152,000 in 1996 and $12,314,000 in 1997, which are included in cost of services in the consolidated statements of operations. The Company had no revenues or costs relating to foreign customers during 1995. CASH AND CASH EQUIVALENTS Cash and cash equivalents consist of demand deposits and money market funds, which are highly liquid short-term instruments with original maturities of three months or less from the date of purchase. Cash and cash equivalents are stated at cost, which approximates market. FINANCIAL INSTRUMENTS The carrying amounts of notes payable and capital lease obligations approximate their fair value because interest rates approximate market rates for similar instruments. Off balance sheet derivative financial instruments at December 31, 1997 consist of foreign currency exchange agreements. The Company enters into foreign currency exchange contracts to manage foreign currency exposures. The principle objective of such contracts is to minimize the risks and/or costs associated with financial and global operating activities. The Company does not utilize financial instruments for trading or other speculative purposes. The counterparty to these contractual arrangements is a multi-national financial institution with which the Company also has other financial relationships. The Company enters into forward currency exchange contracts in the normal course of business to manage its exposure against foreign currency fluctuations on payable positions resulting from fixed asset purchases and other contractual expenditures denominated in foreign currencies. At December 31, 1997, gains and losses on foreign exchange contracts are not material to the consolidated financial statements. The fair values of foreign currency contracts are estimated by obtaining quotes from brokers. At December 31, 1997, the Company has foreign currency contracts outstanding with the notional value of $6,305,000 which had an estimated fair value to receive $6,218,000 worth of German marks and British pounds, the difference of which has been recognized in operations. F-9 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) The following table summarizes outstanding commitments to purchase foreign currency at December 31, 1997:
MATURITY NOTIONAL DATE AMOUNT FAIR VALUE DIFFERENCE -------------------------- ------------ ------------ ---------- British Pounds..................... 1/29/98 through 3/27/98 $ 364,000 $ 373,000 $ 9,000 Deutsche Mark...................... 1/05/98 through 1/26/98 5,941,000 5,845,000 (96,000) ------------ ------------ ---------- $ 6,305,000 $ 6,218,000 $ (87,000) ------------ ------------ ---------- ------------ ------------ ----------
MARKETABLE SECURITIES Marketable securities consists of interest bearing securities with original maturities in excess of three months. At December 31, 1997, the fair market value of temporary investments, classified as "available for sale securities", approximated cost, thus no unrealized holding gains or losses were reported in the accompanying balance sheets. During fiscal year 1997, the Company realized gains from the sale of securities of approximately $48,000. PROPERTY AND EQUIPMENT Property and equipment are carried at cost. Depreciation and amortization of property and equipment are computed using the straight-line method over the following estimated useful lives: Operating equipment....................................... 5-25 years Leasehold improvements.................................... Life of lease Computer equipment........................................ 3-7 years Furniture and fixtures.................................... 5-7 years
Operating equipment includes assets financed under capital lease obligations of $6,218,000 and $15,921,000 at December 31, 1996 and 1997, respectively. Accumulated amortization related to assets financed under capital leases was $391,000 and $2,123,000 at December 31, 1996 and 1997, respectively. In addition, operating equipment includes seven Indefeasible Rights of Use (IRU) in cable systems amounting to $110,000 and $2,303,000 and four ownership interests in an international cable amounting to $148,000 and $1,534,000 at December 31, 1996 and 1997, respectively. These assets are amortized over the life of the agreements of 14 to 25 years (see Note 5). 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. DEPOSITS AND OTHER ASSETS Deposits represent payments made to long distance providers to secure lower rates. These deposits are refunded or applied against future services. Other assets at December 31, 1996 represent initial public offering expenses, which were subsequently charged to additional paid in capital during 1997 at the time of the initial public offering. F-10 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) ACCRUED LINE COSTS Accrued line costs represent accruals for services to transmit and terminate long distance telephone traffic, which has been provided to the Company but not yet billed. It also includes differences between billings received by the Company and the liability computed by the Company's own systems which are being resolved by the Company and its vendors. Such disputed amounts have not been material to the results of operations for each statement of operations period presented. CONSOLIDATED STATEMENTS OF CASH FLOWS During the years ended December 31, 1995, 1996 and 1997 cash paid for interest was $45,000, $534,000 and $1,359,000, respectively. For the same periods, cash paid for income taxes amounted to $51,000, $1,262,000 and $3,761,000, respectively. Non-cash investing and financing activities are as follows:
YEARS ENDED DECEMBER 31, ------------------------------------------- 1995 1996 1997 ------------- ------------- ------------- Equipment purchased through capital leases.......................... $ 1,052,000 $ 5,166,000 $ 9,772,000 Notes issued for asset purchases.................................... -- -- 1,524,000 Debt converted to equity............................................ 1,093,000 -- -- Tax benefits related to stock options............................... -- -- 114,000
These non-cash transactions are excluded from the consolidated statements of cash flows. NET INCOME (LOSS) PER COMMON SHARE The following schedule summarizes the information used to compute pro forma net income or loss per common share for the years ended December 31, 1995, 1996 and 1997:
1995 1996 1997 ------------- ------------- ------------- Pro forma net income (loss)......................................... $ 2,407,000 $ (5,163,000) $ 5,373,000 ------------- ------------- ------------- ------------- ------------- ------------- Weighted average number of common shares used to compute basic earnings (loss) per share.......................................... 18,020,000 21,939,000 28,868,000 Weighted average common share equivalents........................... -- -- 2,757,000 ------------- ------------- ------------- Weighted average number of common shares and common share equivalents used to compute diluted net income (loss) per common share.............................................................. 18,020,000 21,939,000 31,625,000 ------------- ------------- ------------- ------------- ------------- ------------- Basic pro forma net income (loss) per common share (unaudited)...... $ 0.13 $ (0.24) $ 0.19 Diluted pro forma net income (loss) per common share (unaudited).... $ 0.13 $ (0.24) $ 0.17
F-11 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) CONCENTRATIONS OF RISK The Company's two largest customers account for approximately 25 percent and 7 percent of gross accounts receivable at December 31, 1996 and 1997, respectively. The Company's largest customer and second largest customer in 1997 represent 3 percent and 4 percent of accounts receivable as of December 31, 1997, respectively. The Company's largest customer in 1996 was Cherry Communications, Inc. The second largest customer in 1996 was Hi-Rim Communications, Inc. Only one customer, Cherry Communications had a receivable balance exceeding 10 percent of gross accounts receivable at December 31, 1996 and no individual customer has an account receivable balance greater than 10 percent of gross accounts receivable at December 31, 1997. The two largest customers represent approximately 16 percent, 26 percent and 17 percent of revenues during the years ended December 31, 1995, 1996 and 1997, respectively. During 1995 and 1996, only sales to Cherry Communications exceeded 10 percent of total sales. For the year ended December 31, 1997, only one customer exceeded 10 percent of revenues. 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 four largest vendors for the years ended December 31, 1995 and 1996 amounted to 57 percent and 45 percent of total purchases, respectively. Purchases from the four largest vendors for the year ended December 31, 1997 amounted to 36 percent of total purchases. Included in the Company's balance sheets at December 31, 1996 and 1997 are approximately $179,000 and $6,367,000 of equipment which is located in foreign countries. USE OF ESTIMATES The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. RECENTLY ISSUED ACCOUNTING STANDARDS 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 all prior year earnings per share amounts have been recalculated based on the provisions of SFAS No. 128. F-12 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) TRANSLATION OF FOREIGN CURRENCY Management determined that the functional currency of its foreign subsidiaries is still the U.S. dollar. Thus all foreign translation gains or losses are reflected in the results of operations in other income (expense). The foreign subsidiary balance sheets are translated into U.S. dollars using the year-end exchange rates except for prepayments, property, other long-term assets, and stockholders' equity accounts, which are translated at rates in effect when these balances were originally recorded. Revenues and expenses are translated at average rates during the year except for depreciation and amortization, which are translated at historical rates. 3. ACCRUED EXPENSES Accrued expenses at December 31, 1996 and 1997 consist of the following:
1996 1997 ------------ ------------ Payroll and related......................................................... $ 783,000 $ 943,000 Management bonuses.......................................................... 25,000 152,000 Professional services....................................................... 640,000 384,000 Sales and other taxes....................................................... 10,000 295,000 Line and billing cost....................................................... 324,000 2,592,000 Other....................................................................... 304,000 1,243,000 ------------ ------------ $ 2,086,000 $ 5,609,000 ------------ ------------ ------------ ------------
4. LINES OF CREDIT BANK LINE OF CREDIT Effective as of September 30, 1997, the Company executed an agreement with Sanwa Bank, California for a $25 million line of credit, which expires on July 1, 1999. The facility has certain financial and non-financial covenants that include, among other restrictions, the maintenance of minimum levels of tangible net worth. Borrowings on the facility are limited to 75 percent of eligible accounts receivable and are secured by substantially all of the assets of the Company. The credit facility provides for borrowings at an interest rate based upon the bank's cost of funds plus 1.75 percent (7.47 percent at December 31, 1997). The Company plans to use the credit facility to support letters of credit and for working capital or other general corporate purposes. At December 31, 1997, no amounts were outstanding, however the Company's availability under this credit facility was reduced to $20.1 million due to $4.9 million in letters of credit which were outstanding at December 31, 1997. The weighted average interest rate on short term debt during the years ended December 31, 1995, 1996 and 1997 was 10.21 percent, 9.68 percent and 9.12 percent, respectively. F-13 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 4. LINES OF CREDIT (CONTINUED) LINES OF CREDIT WITH STOCKHOLDER At December 31, 1996 and 1997, the Company's revolving lines of credit with the founder and chief executive officer of the Company totaled $1,448,000. The debt matures on March 30, 1998 with interest payable at maturity at a rate of 9 percent. There was $1,422,000 and $1,310,000 available to be borrowed against these lines of credit at December 31, 1996 and 1997, respectively. The Company recognized interest expense related to this debt of $11,000, $34,000 and $9,000 for the years ended December 31, 1995, 1996 and 1997, respectively. 5. LONG-TERM DEBT The Company finances some of its telecommunication equipment under capital lease arrangements or through notes payable as follows:
DECEMBER 31, --------------------------- 1996 1997 ------------ ------------- Bank debt at prime plus 1.5 percent........................................ $ 733,000 $ -- Notes payable for Indefeasible Rights of Use on submarine cable, payable in quarterly installments of principal plus interest at LIBOR plus 6 percent (11.72 percent at December 31, 1997) through September 1999............... -- 762,000 Note payable for Indefeasible Right of Use, payable in quarterly installments of $9,000 plus interest at LIBOR plus 6 percent through September 1999............................................................ -- 66,000 Obligations under capital leases........................................... 5,808,000 13,634,000 ------------ ------------- $ 6,541,000 $ 14,462,000 ------------ ------------- ------------ -------------
Minimum future lease payments under capital leases at December 31, 1997 are as follows:
YEAR ENDING DECEMBER 31, - ----------------------------------------------------------------------------------------- 1998................................................................................. $ 3,944,000 1999................................................................................. 3,943,000 2000................................................................................. 3,614,000 2001................................................................................. 2,927,000 2002................................................................................. 2,505,000 Thereafter........................................................................... 814,000 ------------- 17,747,000 Less: Amount representing interest....................................................... (4,113,000) ------------- 13,634,000 Less: Current portion.................................................................... (2,495,000) ------------- $ 11,139,000 ------------- -------------
F-14 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 6. COMMITMENTS AND CONTINGENCIES OPERATING LEASES The Company leases office space, dedicated private telephone lines, equipment and other items under various agreements expiring through 2006. At December 31, 1997, the minimum aggregate payments under non-cancelable operating leases are summarized as follows:
FACILITIES AND DEDICATED YEAR ENDING DECEMBER 31, EQUIPMENT PRIVATE LINES TOTAL - --------------------------------------------------------- -------------- ------------- ------------- 1998................................................. $ 3,375,000 $ 4,969,000 $ 8,344,000 1999................................................. 3,318,000 1,906,000 5,224,000 2000................................................. 3,283,000 372,000 3,655,000 2001................................................. 2,946,000 -- 2,946,000 2002................................................. 2,739,000 -- 2,739,000 Thereafter........................................... 8,423,000 -- 8,423,000 -------------- ------------- ------------- $ 24,084,000 $ 7,247,000 $ 31,331,000 -------------- ------------- ------------- -------------- ------------- -------------
Facility and equipment rent expense for the years ended December 31, 1995, 1996 and 1997 was approximately $195,000, $1,076,000 and $3,199,000, respectively. Dedicated private line expense was approximately $604,000, $7,045,000 and $9,414,000, for those same periods and is included in cost of services in the accompanying consolidated statements of operations. EMPLOYMENT AGREEMENTS The Company has employment agreements through December 31, 2000 with several employees and executives. Some of these agreements provide for a continuation of salaries in the event of a termination, with or without cause, following a change in control of the Company. One agreement provides for a payment of at least $1,500,000 in the event of a change in control of the Company. The Company expensed $116,000 and $64,000 of deferred compensation relating to these agreements for the years ended December 31, 1996 and 1997, respectively. PURCHASE COMMITMENTS The Company is obligated under various service agreements with long distance carriers to pay minimum usage charges. The Company anticipates exceeding the minimum usage volume with these vendors. Minimum future usage charges at December 31, 1997 are as follows:
YEAR ENDING DECEMBER 31, - ----------------------------------------------------------------------------------------- 1998..................................................................................... $ 44,053,000 1999..................................................................................... 8,356,000 2000..................................................................................... 2,949,000 2001..................................................................................... 65,000 2002..................................................................................... 65,000 Thereafter............................................................................... 774,000 ------------- $ 56,262,000 ------------- -------------
F-15 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 6. COMMITMENTS AND CONTINGENCIES (CONTINUED) The Company has entered into six fixed asset purchase agreements. These commitments are to purchase IRU's, switches, and leasehold improvements for switch sites. The total commitment approximates $63 million. The Company plans to finance the majority of these costs through capital lease arrangements. LEGAL MATTERS The Company is subject to litigation from time to time in the normal course of business. Although it is not possible to predict the outcome of such litigation, based on the facts known to the Company and after consultation with counsel, management believes that such litigation will not have a material adverse effect on its financial position or results of operations. On September 4, 1997, prior to the merger between LDS and the Company, LDS entered into a settlement agreement with the Consumer Services Division of the California Public Utilities Commission (PUC). The agreement settles the alleged unauthorized switching of long-distance customers to LDS between the years 1995 and 1996. It includes a payment of $760,000 to the PUC for restitution to affected customers as defined in the agreement. Additionally, LDS agreed to a voluntary revocation of its operating authority in the State of California. Under the agreement, service to all California customers has to be terminated within 120 days after approval of the agreement by the PUC. On November 19, 1997, the PUC approved the agreement along with a transfer of control to STAR. On November 15, 1997, LDS settled a civil suit with the District Attorney of Monterey, California for a monetary payment of $700,000 and various non-monetary concessions as defined in the agreement. This suit was of the same nature as the above action of the PUC and covers complaints from the years 1994 through 1997. LETTERS OF CREDIT At December 31, 1997, the Company has nine standby letters of credit outstanding, which expire between January 20, 1998 and December 19, 1998. These letters of credit, all of which are secured by the bank line of credit, total $4,900,000. 7. RELATED PARTY TRANSACTIONS The founder and chief executive officer of the Company owns 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, 1995, 1996 and 1997, the Company paid $144,000, $68,000 and $171,000, respectively, in costs related to the use of Star Aero services. As of December 31, 1995 and 1996, the Company had receivables from Star Aero of $50,000 and $115,000, respectively. The Company had no receivables from Star Aero at December 31, 1997. During 1997, the Company provided a short-term loan to the chief executive officer for $8,000,000. The loan carried interest of 7 percent per annum, was secured by $30,000,000 of the stockholder's stock in the Company, and was repaid in seven days. F-16 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 7. RELATED PARTY TRANSACTIONS (CONTINUED) During 1995, the Company invested $128,000 in a company related to an employee of STAR. During 1996 and 1997, the Company provided services to this company in the amounts of $167,000 and $926,000. As of December 31, 1996 and 1997, accounts receivable from this related party amounted to $57,000 and $41,000, respectively. During 1995, 1996 and 1997, the Company purchased consulting services from a company owned by a board member in the amount of $60,000, $154,000 and $72,000, respectively. During 1996 and 1997, the Company purchased consulting services from a company owned in part by an employee and a significant stockholder for $37,000 and $256,000, respectively. In addition, the Company purchased equipment and services from this company in the amount of $1,114,000 in 1997. This significant stockholder is also a 30 percent investor in a company, whose subsidiary provided consulting services to the Company in the amount of $12,000 in 1996 and $213,000 in 1997. In addition, the Company purchased telecommunication services from three related companies for $240,000 during 1996 and paid legal fees on behalf of these companies in the amount of $131,000. During the years ended December 31, 1995, 1996 and 1997, the Company also provided long distance telephone service to a company controlled by another board member in the amount of $43,000, $250,000 and $1,141,000, respectively. Accounts receivable for these services total $721,000 as of December 31, 1997. In addition, the Company loaned $2,500,000 to this related party. The Company has announced its intention to merge the two companies (see Note 14). 8. BUSINESS COMBINATIONS In November 1997, the Company acquired LDS, a domestic commercial long distance telecommunications provider, in a transaction that was accounted for as a pooling of interests. The Company issued 849,298 shares of its common stock to LDS' shareholders in exchange for all outstanding LDS shares plus shares of certain non-operating entities owned by LDS' shareholders and majority ownership in an affiliated telephone retailer controlled by LDS. The accompanying consolidated financial statements have been restated to include the financial position and results of operations of LDS for all periods presented. Net sales and historical net income (loss) of the combining companies for the last three years are as follows:
1995 1996 1997 ------------- -------------- -------------- Net Sales: STAR................................................. $ 16,125,000 $ 208,086,000 $ 348,738,000 LDS.................................................. 30,158,000 29,905,000 27,460,000 ------------- -------------- -------------- Total................................................ $ 46,283,000 $ 237,991,000 $ 376,198,000 ------------- -------------- -------------- ------------- -------------- -------------- Net Income (Loss): STAR................................................. $ (568,000) $ (6,644,000) $ 5,605,000 LDS.................................................. 4,541,000 2,424,000 (37,000) ------------- -------------- -------------- Total................................................ $ 3,973,000 $ (4,220,000) $ 5,568,000 ------------- -------------- -------------- ------------- -------------- --------------
F-17 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 9. 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 historical consolidated financial statements for the year ended December 31, 1995. 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. In addition, the results of operations and provision for income taxes for LDS through November 30, 1997 reflects LDS' status as an S-Corporation. The unaudited pro-forma income taxes, pro-forma net income (loss), and pro-forma earnings per share information reflected in the consolidated statements of operations assumes that both STAR and LDS were taxed as C-Corporations for all periods presented. 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. 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. The Company has recorded a net deferred tax asset of $3,699,000 at December 31, 1997. Realization is dependent on generating sufficient taxable income in the future. Although realization is not assured, management believes it is more likely than not that the net deferred tax asset recorded will be realized. The components of the net deferred tax assets at December 31, 1996 and 1997 are as follows:
1996 1997 ------------- ------------- Deferred tax asset: Reserve for accounts and note receivable................................ $ 3,104,000 $ 4,169,000 Accrued line cost....................................................... 201,000 798,000 Vacation accrual........................................................ 24,000 138,000 Deferred compensation................................................... 47,000 38,000 Accrued bonuses......................................................... 25,000 -- Accrued services........................................................ -- 183,000 Foreign net operating losses............................................ -- 468,000 State income taxes...................................................... 48,000 392,000 ------------- ------------- 3,449,000 6,186,000 Deferred tax liability: Depreciation............................................................ (565,000) (804,000) ------------- ------------- Subtotal.................................................................. 2,884,000 5,382,000 Valuation reserve......................................................... (2,884,000) (1,683,000) ------------- ------------- Net deferred tax asset.................................................... $ -- $ 3,699,000 ------------- ------------- ------------- -------------
F-18 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 9. INCOME TAXES (CONTINUED) The provision for income taxes for the years ended December 31, 1995, 1996 and 1997 are as follows:
PRO FORMA HISTORICAL (UNAUDITED) -------------------------------- ---------------------------------- 1995 1996 1997 1995 1996 1997 --------- --------- ---------- --------- ----------- ---------- Current Federal taxes............................. $ -- $ 393,000 $4,899,000 $1,365,000 $1,231,000 $5,281,000 State taxes............................... 66,000 199,000 1,138,000 416,000 394,000 1,261,000 --------- --------- ---------- --------- ----------- ---------- 66,000 592,000 6,037,000 1,781,000 1,625,000 6,542,000 --------- --------- ---------- --------- ----------- ---------- Deferred Federal taxes............................. -- -- (2,273,000) (121,000) (70,000) (2,512,000) State taxes............................... -- -- (869,000) (28,000) (20,000) (940,000) --------- --------- ---------- --------- ----------- ---------- -- -- (3,142,000) (149,000) (90,000) (3,452,000) --------- --------- ---------- --------- ----------- ---------- Provision for income taxes.................. $ 66,000 $ 592,000 $2,895,000 $1,632,000 $1,535,000 $3,090,000 --------- --------- ---------- --------- ----------- ---------- --------- --------- ---------- --------- ----------- ----------
Differences between the provision for income taxes and income taxes at the statutory federal income tax rate for the years ended December 31, 1995, 1996 and 1997 are as follows:
PRO FORMA HISTORICAL (UNAUDITED) ---------------------------------- ---------------------------------- 1995 1996 1997 1995 1996 1997 ---------- ---------- ---------- --------- ----------- ---------- Income taxes at the statutory federal rate................................ $1,373,000 $(1,234,000) $2,962,000 $1,373,000 ($1,234,000) $2,962,000 State income taxes, net of federal income tax effect................... 246,000 (221,000) 486,000 246,000 (221,000) 486,000 Foreign taxes at rates different than U.S. taxes.......................... -- -- 187,000 -- -- 187,000 Change in valuation reserve........... -- 2,884,000 (1,201,000) -- 2,884,000 (1,201,000) Permanent differences................. -- 104,000 33,000 13,000 108,000 307,000 Effect of STAR S-Corp status until December 31, 1995................... 223,000 -- -- -- -- -- Effects of LDS S-Corp status until November 30, 1997................... (1,808,000) (958,000) 152,000 -- -- -- Other................................. 32,000 17,000 276,000 -- (2,000) 349,000 ---------- ---------- ---------- --------- ----------- ---------- $ 66,000 $ 592,000 $2,895,000 $1,632,000 $1,535,000 $3,090,000 ---------- ---------- ---------- --------- ----------- ---------- ---------- ---------- ---------- --------- ----------- ----------
10. 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 1,476,000 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. During 1996, the Company entered into three separate stock option agreements outside the Plan. The first agreement, dated March 1, 1996, provided for 410,000 non-incentive stock options exercisable immediately. The options were exercisable at fair market value at the date of issuance, which was $0.98 per share, to expire in 10 years. The second stock option agreement was entered into on May 1, 1996 for an additional 410,000 shares to also be issued at $0.98 per share. Of these options half vested on March 1, F-19 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 10. STOCK OPTIONS (CONTINUED) 1997 and half expired. On May 15, 1996, the Company granted 205,000 options, valued at $1.46 per share at the date of issuance to a director. Of these options 34 percent were exercisable immediately. The remaining options are exercisable equally on May 15, 1997 and 1998. At December 31, 1996 and 1997, 1,025,000 and 820,000 options, respectively, issued outside a plan were outstanding. 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 2,050,000 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. In December 1996, the Company issued 174,000 options at $4.00 per share. The Board of Directors determined the market value of the December options to be $4.68 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. At December 31, 1996 and 1997, 2,358,000 and 1,873,000 options, respectively, were outstanding under the aggregate of the 1996 Stock Incentive Plan and the Supplemental Stock Option Plan. On May 14, 1996, the Company adopted the 1996 Outside Director Nonstatutory Stock Option Plan (the "Director Plan"). The number of shares which may be issued under this plan upon exercise of options may not exceed 410,000 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. At December 31, 1996 and 1997, 82,000 and 41,000 options, respectively, were outstanding under the Director Plan. On January 30, 1997, the Board of Directors approved the 1997 Omnibus Stock Incentive Plan (the "Omnibus Plan") to replace the existing 1996 supplemental plan upon the effective date of the initial public offering. 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 and terminates on January 22, 2007. The maximum number of shares available for issuance under this plan may not exceed 1,025,000 shares plus the number of shares still unissued under the supplemental option plan. Options granted to any one optionee may not exceed more than 1,025,000 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. At December 31, 1997, 763,000 options, were outstanding under the Omnibus Plan. F-20 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 10. STOCK OPTIONS (CONTINUED) Information regarding the Company's stock option plans and nonqualified stock options as of December 31, 1995, 1996 and 1997, and changes during the years ended on those dates is summarized as follows:
WEIGHTED-AVERAGE SHARES EXERCISE PRICE --------------- ----------------- December 31, 1995.......................................... -- $ -- Granted.................................................... 3,491,355 1.89 Exercised.................................................. -- -- Forfeited.................................................. (26,855) 1.95 --------------- ------ December 31, 1996.......................................... 3,464,500 1.89 --------------- ------ Granted.................................................... 914,296 7.91 Exercised.................................................. (488,925) 0.89 Forfeited.................................................. (392,774) 2.40 --------------- ------ December 31, 1997.......................................... 3,497,097 $ 3.54 --------------- ------ --------------- ------
At December 31, 1996, 912,425 options were exercisable at a weighted average exercise price of $1.10 per share. At December 31, 1997, 1,275,645 options were exercisable at a weighted average exercise price of $1.51 per share. The options outstanding at December 31, 1997 expire in various years through 2007. Information about stock options outstanding at December 31, 1997 is summarized as follows:
OPTIONS OUTSTANDING ------------------------------------------------------------------- WEIGHTED- AVERAGE WEIGHTED- WEIGHTED- NUMBER REMAINING AVERAGE NUMBER AVERAGE OUTSTANDING CONTRACTED EXERCISE EXERCISABLE EXERCISE RANGE OF EXERCISE PRICES AT 12/31/97 LIFE PRICE AT 12/31/97 PRICE - ---------------------------------------------------- ----------- ------------- ----------- ----------- ------------- $0.73 to $1.46...................................... 1,807,126 8.28 $ 1.17 1,113,695 $ 1.14 $4.00 to $6.83...................................... 1,146,721 8.96 $ 4.68 161,950 $ 4.07 $8.11 to $11.10..................................... 543,250 9.66 $ 9.06 -- $ -- ----------- ----- ----------- ----------- ----- 3,497,097 8.72 $ 3.54 1,275,645 $ 1.51 ----------- ----- ----------- ----------- ----- ----------- ----- ----------- ----------- -----
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 and $88,000 in compensation cost was recognized relating to consultant options for the years ended December 31, 1996 and 1997, respectively. 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 income or loss and basic and diluted income or loss per share for the years ended December 31, 1996 and 1997 would have reflected the following pro-forma amounts: F-21 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 10. STOCK OPTIONS (CONTINUED) Pro-forma Net Income (Loss) Per Share
1996 1997 ------------- ------------ Pro-Forma Net Income (Loss)...................................... $ (5,536,000) $ 4,756,000 Pro-Forma Basic Net Income (Loss) per share...................... $ (0.25) $ 0.16 Pro Forma Diluted Net Income (Loss) per share.................... $ (0.25) $ 0.15
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 and 6.2 percent and an expected life of ten years and six years for the years ended December 31, 1996 and 1997, respectively. Expected volatility for 1997 was 31.05 percent and it is assumed that no dividends would be issued during the option term. 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. 11. CAPITAL STOCK During 1994, the Company issued 16,606,661 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 1,843,339 shares to another executive of the Company on conversion of a loan. On February 23, 1996, the Company sold 2,049,980 shares of common stock to various investors for $1,500,000. On July 12, 1996, the Company sold 1,874,532 shares of common stock to an investor for $4,068,000. On July 25, 1996, the Company sold 2,802,446 shares of Series A preferred stock to a group of investors for $7,500,000. In connection with this transaction, the Company and buyers of the preferred shares entered into an investor's rights agreement which obligated the Company to file up to two registration statements to register such shares. These preferred shares converted to common stock at a ratio of 3-for-2 as a result of the public offering in accordance with the investors rights agreement. In June 1997, the Company completed its Initial Public Offering ("IPO") of 9,430,000 shares of common stock of which 8,097,500 shares were sold by the Company and 1,332,500 shares were sold by certain selling shareholders. The net proceeds to the Company (after deducting underwriting discounts and offering expenses of approximately $4.6 million) from the sale of shares was approximately $30.9 million. On November 30, 1997, the Company completed the acquisition of LDS pursuant to the terms of the agreement and 849,298 shares were issued for all of the outstanding shares to LDS. 12. BUSINESS SEGMENTS At December 31, 1997, Star has two business segments, wholesale long distance and commercial long distance telecommunications. The wholesale segment provides long distance services to U.S. and foreign based telecommunications companies and the commercial segment, obtained by acquisition of LDS, provides commercial long distance services to small retailers throughout the United States. F-22 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 12. BUSINESS SEGMENTS (CONTINUED) The accounting policies of the segments are the same as those described in the significant accounting policies, however, the Company evaluates performance based on profit or loss from operations before income taxes and non-recurring gains or losses. There are no intercompany sales among the wholesale and commercial segments and both segments are managed separately. Reportable segment information for the years ended December 31, 1995, 1996 and 1997 are as follows:
WHOLESALE COMMERCIAL ALL OTHER TOTAL -------------- ------------- ---------- -------------- 1995 Revenues from external customers..................... $ 16,125,000 $ 30,158,000 $ -- $ 46,283,000 Interest income...................................... -- 22,000 -- 22,000 Interest expense..................................... (64,000) -- -- (64,000) Depreciation and amortization........................ (128,000) (58,000) -- (186,000) Segment profit (loss)................................ (568,000) 4,541,000 -- 3,973,000 Other significant non-cash items: Capital lease additions............................ 888,000 164,000 -- 1,052,000 Property additions financed by notes payable....... -- -- -- -- Debt converted to equity........................... 1,093,000 -- -- 1,093,000 Segment assets....................................... 12,869,000 5,447,000 -- 18,316,000 Expenditures for segment assets...................... 1,062,000 61,000 -- 1,123,000 1996 Revenues from external customers..................... $ 208,086,000 $ 29,905,000 $ -- $ 237,991,000 Interest income...................................... 83,000 27,000 -- 110,000 Interest expense..................................... (589,000) (12,000) -- (601,000) Depreciation and amortization........................ (1,073,000) (78,000) -- (1,151,000) Segment profit (loss)................................ (6,644,000) 2,424,000 -- (4,220,000) Other significant non-cash items: Capital lease additions............................ 5,097,000 69,000 -- 5,166,000 Property additions financed by notes payable....... -- -- -- -- Segment assets....................................... 48,674,000 5,326,000 -- 54,000,000 Expenditures for segment assets...................... 7,838,000 14,000 -- 7,852,000 1997 Revenues from external customers..................... $ 348,738,000 $ 27,460,000 $ -- $ 376,198,000 Interest income...................................... 519,000 -- (27,000) 492,000 Interest expense..................................... (1,633,000) (27,000) 27,000 (1,633,000) Depreciation and amortization........................ (4,189,000) (56,000) -- (4,245,000) Segment profit (loss)................................ 5,605,000 (37,000) -- 5,568,000 Other significant non-cash items: Capital lease additions............................ 9,772,000 -- -- 9,772,000 Property additions financed by notes payable....... 1,524,000 -- -- 1,524,000 Segment assets....................................... 106,709,000 6,844,000 -- 113,553,000 Expenditures for segment assets...................... 13,419,000 17,000 -- 13,436,000
F-23 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 12. BUSINESS SEGMENTS (CONTINUED) The Company had no customers, collectively, representing more than 10 percent of consolidated revenue in any foreign country. 13. QUARTERLY CONSOLIDATED INFORMATION (UNAUDITED) The following table presents unaudited quarterly operating results, including the results of LDS, for each of the Company's eight quarters in the two-year period ended December 31, 1997 (amounts in thousands):
QUARTER ENDED --------------------------------------------- MARCH 31, JUNE 30, SEPT. 30, DEC. 31, ----------- --------- --------- ---------- 1996 Net sales............................................... $ 42,926 $ 50,064 $ 68,433 $ 76,568 Operating income (loss)................................. 2,100 1,961 1,219 (8,356) Pro forma net income (loss)............................. 1,477 1,294 870 (7,861) 1997 Net sales............................................... $ 79,382 $ 89,167 $ 94,867 $ 112,782 Operating income........................................ 2,495 2,633 3,100 2,821 Pro forma net income.................................... 1,907 656 1,014 1,991
14. SUBSEQUENT EVENTS ACQUISITIONS 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. At December 31, 1997, the Company has accounts receivable from UDN in the amount of $721,000 and a note receivable of $2.5 million plus accrued interest of $28,000. Both the accounts receivable and the note have been fully reserved at December 31, 1997. Subsequent to year end, the Company loaned an additional $2 million to UDN which has also been fully reserved since the time of issuance. F-24 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 14. SUBSEQUENT EVENTS (CONTINUED) On March 10, 1998, the Company consummated a merger with T-One Corp. ("T-One") to be accounted for as a pooling of interests. In connection with this merger, the Company issued 1,353,000 shares of its common stock for all outstanding shares of T-One. The following unaudited pro forma data summarizes the combined operating results of the Company and T-One as if the merger had occurred at the beginning of the periods presented.
1995 1996 1997 ------------- -------------- -------------- Revenue.......................................................... $ 58,937,000 $ 259,697,000 $ 404,605,000 Income (loss) from operations.................................... 3,847,000 (3,658,000) 11,365,000 Net income (loss) (1)............................................ 2,140,000 (5,738,000) 5,574,000 Diluted income (loss) per common share (2)....................... $ 0.11 $ (0.25) $ 0.17
- ------------------------ (1) Includes pro forma income (loss) of STAR plus net income (loss) of T-One assuming STAR and LDS C-Corporation status. (2) The diluted pro forma income (loss) per common share is based on the sum of the historical average common shares outstanding, as reported by STAR, and the historical average common shares outstanding for T-One (adjusted to reflect non-dilutive common stock equivalents) converted to STAR shares at the exchange ratio of 13,530 STAR shares per T-One share. EQUITY TRANSACTIONS On February 3, 1998 the Company announced a 2.05 for 1 stock split in the nature of a stock dividend. The stock split is effective March 31, 1998 and has been retroactively reflected in the accompanying consolidated financial statements for all periods presented. Subsequent to year end, the Company granted 219,350 additional stock options to employees and directors. LINE OF CREDIT On March 18, 1998, the Company amended the line of credit agreement with Sanwa Bank by adjusting the borrowing base to 55% of aggregate eligible accounts receivable, revising certain covenants and releasing all pledged collateral. F-25 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To STAR Telecommunications, Inc. and Subsidiaries: We have audited in accordance with generally accepted auditing standards the consolidated financial statements of STAR Telecommunications, Inc. and subsidiaries, included in this Form 10-K and have issued our report thereon dated February 12, 1998. 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 February 12, 1998 S-1 SCHEDULE II STAR TELECOMMUNICATIONS, INC. SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
BALANCE AT BALANCE AT BEGINNING END OF OF PERIOD PROVISION WRITE-OFF PERIOD ----------- ----------- ---------- ----------- (IN THOUSANDS) Allowance for doubtful accounts 1995........................................................... $ 81 $ 217 $ -- $ 298 1996........................................................... $ 298 $ 15,753 $ (9,849) $ 6,202 1997........................................................... $ 6,202 $ 7,695 $ (6,152) $ 7,745 Deferred tax asset valuation allowance 1995........................................................... $ -- $ 30 $ -- $ 30 1996........................................................... $ 30 $ 2,854 $ -- $ 2,884 1997........................................................... $ 2,884 $ (1,201) $ -- $ 1,683 Note Receivable 1997........................................................... $ -- $ 2,500 $ -- $ 2,500
S-2 Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report on Form 10-K/A to be signed on its behalf by the undersigned, thereunto duly authorized in the City of Santa Barbara, State of California, on the 15th day of January, 1999. STAR TELECOMMUNICATIONS, INC. By: /s/ KELLY D. ENOS ----------------------------------------- Kelly D. Enos Chief Financial Officer
II-1 EX-27 2 EXHIBIT 27
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM STAR TELECOMMUNICATIONS, INC. FORM 10-K/A AMENDMENT NO. 2 FOR THE YEAR ENDED DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 1,458 18,579 56,354 13,947 0 73,114 39,995 5,638 113,553 57,268 14,462 0 0 34 43,980 113,553 0 376,198 0 365,149 0 0 1,633 8,463 2,895 0 0 0 0 5,568 0.19 0.18
-----END PRIVACY-ENHANCED MESSAGE-----