10-K405

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                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
 
                             WASHINGTON, D.C. 20549
                            ------------------------
 
                                   FORM 10-K
 
(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, 1998
                                       OR
 
  / /    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
         SECURITIES EXCHANGE ACT OF 1934
 
      FOR THE TRANSITION PERIOD FROM TO ______________ TO ______________.
 
                        COMMISSION FILE NUMBER 000-22581
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                         STAR TELECOMMUNICATIONS, INC.
 
             (Exact name of registrant as specified in its charter)
 
                  DELAWARE                             77-0362681
      (State or other jurisdiction of        (I.R.S. Employer Identification
       incorporation or organization)                     No.)
 
           223 EAST DE LA GUERRA                          93101
         SANTA BARBARA, CALIFORNIA                     (Zip Code)
  (Address of Principal Executive Offices)
 
                                 (805) 899-1962
              (Registrant's telephone number, including area code)
 
        Securities Registered Pursuant to Section 12(b) of the Act: NONE
 
     Name of each exchange on which registered: THE NASDAQ NATIONAL MARKET
 
          Securities Registered Pursuant to Section 12(g) of the Act:
                                  COMMON STOCK
                            ------------------------
 
    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 (Section 229.405 of this chapter) 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 /X/
 
    The aggregate market value of the Common Stock of the Registrant held by
non-affiliates of the Registrant on March 17, 1999, based on the average bid and
asked prices for the Common Stock as reported by Nasdaq was approximately
$361,205,316.
 
    As of March 17, 1999, the number of shares of the Registrant's Common Stock
outstanding was 57,369,000 shares.
 
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                                     PART I
 
    This Annual Report on Form 10-K for the year ended December 31, 1998 (the
"Form 10-K") contains certain "forward-looking statements" within the meaning of
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"). Forward-looking statements are statements other than historical
information or statements of current condition and relate to future events or
the future financial performance of the Company. Some forward-looking statements
may be identified by use of such terms as "expects," "anticipates," "intends,"
"estimates," "believes" and words of similar import. These forward-looking
statements relate to plans, objectives and expectations for future operations.
In light of the risks and uncertainties inherent in all such projected operation
matters, the inclusion of forward-looking statements in this Form 10-K should
not be regarded as a representation by the Company or any other person that the
objectives or plans of the Company will be achieved or that any of the Company's
operating expectations will be realized. Revenues and results of operations are
difficult to forecast and could differ materially from those projected in the
forward-looking statements contained in this Form 10-K for the reasons detailed
in the "Risk Factors" section of this Form 10-K, beginning on page 15, or
elsewhere in this Form 10-K.
 
ITEM 1. BUSINESS.
 
OVERVIEW
 
    STAR Telecommunications, Inc. ("STAR" or the "Company") is a multinational
telecommunications services company focused primarily on the international long
distance market. STAR 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 200 foreign
countries through a flexible network comprised of various foreign termination
relationships, international gateway switches, leased and owned transmission
facilities and resale arrangements with long distance providers. STAR has grown
its revenues rapidly by capitalizing on the deregulation of international
telecommunications markets, combining sophisticated information systems with
flexible routing and leveraging management's industry expertise. STAR has
increased its revenues and net income from $58.9 million and $3.7 million,
respectively, in 1995 to $595.5 million and $13.5 million, respectively, in
1998.
 
INDUSTRY BACKGROUND
 
    The international long distance telecommunications services industry
consists of all transmissions of voice and data that originate in one country
and terminate in another. This industry is undergoing a period of fundamental
change which has resulted in substantial growth in international
telecommunications traffic.
 
    From the standpoint of U.S.-based long distance providers, the industry can
be divided into two major segments: the U.S. international market, consisting of
all international calls billed in the U.S., and the overseas market, consisting
of all international calls billed in countries other than the U.S. The U.S.
international market has experienced substantial growth in recent years, with
gross revenues from international long distance services rising from
approximately $14.9 billion in 1996 to approximately $16.3 billion in 1997,
according to FCC data.
 
    STAR believes that a number of trends in the international
telecommunications market will continue to drive growth in international
traffic, including:
 
    - continuing deregulation and privatization of telecommunications markets;
 
    - pressure to reduce international outbound long distance rates paid by end
      users driven by increased competition in newly deregulated global markets;
 
                                       1

    - the dramatic increase in the availability of telephones and the number of
      access lines in service around the world;
 
    - the increasing globalization of commerce, trade and travel;
 
    - the proliferation of communications devices such as faxes, cellular
      telephones, pagers and data communications devices;
 
    - increasing demand for data transmission services, including the Internet;
      and
 
    - the increased utilization of high quality digital undersea cable and
      resulting expansion of bandwidth availability.
 
    THE DEVELOPMENT OF THE U.S. AND OVERSEAS MARKETS
 
    The 1984 deregulation of the U.S. telecommunications industry enabled the
emergence of a number of new long distance companies in the U.S. Today, there
are over 500 U.S. long distance companies, most of which are small or
medium-sized companies. In order to be successful, these small and medium-sized
companies need to offer their customers a full range of services, including
international long distance. However, most of these carriers do not have the
critical mass to receive volume discounts on international traffic from the
larger facilities-based carriers such as AT&T Corp. ("AT&T"), MCI WorldCom, Inc.
("MCI WorldCom") and Sprint Corporation ("Sprint") . In addition, these small
and medium sized companies generally have only limited capital resources to
invest in international facilities. New international carriers such as STAR
emerged to take advantage of this demand for less expensive international
bandwidth. These emerging multinational carriers acted as aggregators of
international traffic for smaller carriers, taking advantage of larger volumes
to obtain volume discounts on international routes (resale traffic), or
investing in facilities when volume on particular routes justify such
investments. Over time, as these emerging international carriers became
established and created a high quality networks, they began to carry overflow
traffic from the larger long distance providers seeking lower rates on certain
routes.
 
    Deregulation and privatization have also allowed new long distance providers
to emerge in foreign markets. By eroding the traditional monopolies held by
single national providers, many of which are wholly or partially government
owned, such as Post Telegraph & Telephone operators ("PTTs"), deregulation is
providing U.S.-based providers the opportunity to negotiate more favorable
agreements with PTTs and emerging foreign providers. In addition, deregulation
in certain foreign countries is enabling U.S.-based providers to establish local
switching and transmission facilities in order to terminate their own traffic
and begin to carry international long distance traffic originated in that
country. STAR believes that growth of traffic originated in markets outside of
the U.S. will be higher than the growth in traffic originated within the U.S.
due to recent deregulation in many foreign markets, relative economic growth
rates and increasing access to telecommunications facilities in emerging
markets.
 
    INTERNATIONAL SWITCHED LONG DISTANCE SERVICES
 
    International switched long distance services are provided through switching
and transmission facilities that automatically route calls to circuits based
upon a predetermined set of routing criteria. The call typically originates on a
local exchange carrier's network and is transported to the caller's domestic
long distance carrier. The domestic long distance provider then carries the call
to an international gateway switch. An international long distance provider
picks up the call at its gateway and sends it directly or through one or more
other long distance providers to a corresponding gateway switch operated in the
country of destination. Once the traffic reaches the country of destination, it
is then routed to the party being called though that country's domestic
telephone network.
 
    International long distance providers can generally be categorized by their
ownership and use of switches and transmission facilities. The largest U.S.
carriers, such as AT&T, MCI WorldCom and Sprint, primarily utilize owned
transmission facilities and generally use other long distance providers to carry
their
 
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overflow traffic. Since only very large carriers have transmission facilities
that cover the over 200 countries to which major long distance providers
generally offer service, a significantly larger group of long distance providers
own and operate their own switches but either rely solely on resale agreements
with other long distance carriers to terminate their traffic or use a
combination of resale agreements and owned facilities in order to terminate
their traffic as shown below:
 
                                 [LOGO]
 
    OPERATING AGREEMENTS.  Under traditional operating agreements, international
long distance traffic is exchanged under bilateral agreements between
international long distance providers in two countries. Operating agreements
provide for the termination of traffic in, and return traffic to, the
international long distance providers' respective countries at a standard
"accounting rate" with that international provider. Under a traditional
operating agreement, the international long distance provider that originates
more traffic compensates the long distance provider in the other country by
paying a net amount based on the difference between minutes sent and minutes
received and the settlement rate, which is generally one-half of the accounting
rate.
 
    Under a typical operating agreement both carriers jointly own the
transmission facilities between two countries. A carrier gains ownership rights
in a digital fiber optic cable by purchasing direct ownership in a particular
cable prior to the time the cable is placed in service, acquiring an
"Indefeasible Right of Use" ("IRU") in a previously installed cable, or by
leasing or obtaining capacity from another long distance provider that either
has direct ownership or IRUs in the cable. In situations where a long distance
provider has sufficiently high traffic volume, routing calls across directly
owned or IRU cable is generally more cost-effective on a per call basis than the
use of short-term variable capacity arrangements with other long distance
providers or leased cable. However, direct ownership and acquisition of IRUs
require a company to make an initial investment of its capital based on
anticipated usage.
 
    TRANSIT ARRANGEMENTS.  In addition to utilizing an operating agreement to
terminate traffic delivered from one country directly to another, an
international long distance provider may enter into transit arrangements
pursuant to which a long distance provider in an intermediate country carries
the traffic to a country of destination. Such transit arrangements involve
agreement among the providers in all the countries involved and are generally
used for overflow traffic or where a direct circuit is unavailable or not volume
justified.
 
    RESALE ARRANGEMENTS.  Resale arrangements typically involve the wholesale
purchase and sale of transmission and termination services between two long
distance providers on a variable, per minute basis. The resale of capacity,
which was first permitted in the U.S. market in the 1980s enabled the emergence
of new international long distance providers that rely at least in part on
capacity acquired on a wholesale basis from other long distance providers.
International long distance calls may be routed through a facilities-
 
                                       3

based carrier with excess capacity, or through multiple long distance resellers
between the originating long distance provider and the facilities-based carrier
that ultimately terminates the traffic. Resale arrangements set per minute
prices for different routes, which may be guaranteed for a set time period or
subject to fluctuation following notice. The resale market for international
capacity is constantly changing, as new long distance resellers emerge and
existing providers respond to fluctuating costs and competitive pressures. In
order to be able to effectively manage costs when utilizing resale arrangements,
long distance providers need timely access to changing market data and must
quickly react to changes in costs through pricing adjustments or routing
decisions.
 
    ALTERNATIVE TERMINATION ARRANGEMENTS.  As the international
telecommunications market has become deregulated, service providers have
developed alternative arrangements to reduce their termination costs by, for
example, routing traffic via third countries to obtain lower settlement rates or
using international private line facilities to bypass the settlement rates
applicable to traffic routed over the public switched telephone network
("PSTN"). These arrangements include international simple resale ("ISR"),
traffic refiling and the acquisition of transmission and switching facilities in
foreign countries so as to self-correspond. Refiling of traffic takes advantage
of disparities in settlement rates between different countries. An originating
operator typically refiles traffic by sending it first to a third country that
enjoys lower settlement rates with the destination country where upon it is
forwarded or refiled to the destination country thereby resulting in a lower
overall termination cost. The difference between transit and refiling is that,
with respect to transit, the operator in the destination country typically has a
direct relationship with the originating operator and is aware of the
arrangement, while with refiling, the operator in the destination country
typically is not aware that it is terminating refiled traffic originated in
another country. While the United States has taken no position with respect to
whether refile comports with international regulation, refile is illegal in many
countries. With ISR, a long distance provider completely bypasses the settlement
system by connecting an international private line ("IPL") to the PSTN on one or
both ends. While ISR currently is only sanctioned by U.S. and other regulatory
authorities on some routes, ISR services are increasing and are expected to
expand significantly as deregulation of the international telecommunications
market continues. In addition, new market access agreements, such as the WTO
Basic Telecommunications Agreement (the "WTO Agreement"), have made it possible
for many international service providers to establish their own transmission and
switching facilities in certain foreign countries, enabling them to
self-correspond and directly terminate traffic. See "--Government Regulation."
 
    The highly competitive and rapidly changing international telecommunications
market has created a significant opportunity for carriers that can offer high
quality, low cost international long distance service. Deregulation,
privatization, the expansion of the resale market and other trends influencing
the international telecommunications market are driving decreased termination
costs, a proliferation of routing options, and increased competition. Successful
companies among both the emerging and established international long distance
companies will need to aggregate enough traffic to lower costs of both
facilities-based or resale opportunities, maintain systems which enable analysis
of multiple routing options, invest in facilities and switches and remain
flexible enough to locate and route traffic through the most advantageous
routes.
 
THE STAR APPROACH
 
    STAR is a multinational telecommunications services company focused
primarily on the international long distance market. STAR 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 200 foreign countries through a flexible network
comprised of various foreign termination relationships, international gateway
switches, leased and owned transmission facilities and resale arrangements with
long distance providers. STAR has grown its revenues rapidly by capitalizing on
the deregulation of international telecommunications markets, combining
sophisticated information systems with flexible routing and leveraging
management's industry expertise.
 
                                       4

    STAR markets its services to large global carriers seeking lower rates, as
well as to small and medium-sized long distance companies that do not have the
critical mass to invest in their own international transmission facilities or to
obtain volume discounts from the larger facilities-based carriers. During the
fourth quarter of 1998, STAR provided switched international long distance
services to 151 customers and currently provides these services to fourteen of
the top forty global carriers. STAR has also recently focused on building a
customer base overseas, particularly in Europe, and has opened offices in
Dusseldorf, Frankfurt, Hamburg and Munich, Germany and London, England. In
addition, STAR has begun to market its international long distance services
directly to certain commercial customers in the U.S. and overseas.
 
STRATEGY
 
    STAR's objective is to be a leading provider of highly reliable, low-cost
switched international long distance services on a wholesale basis to U.S. and
foreign-based telecommunications companies, as well as on a retail basis to
commercial customers. Key elements of STAR's strategy include the following:
 
    EXPAND SWITCHING AND TRANSMISSION FACILITIES.  STAR is continuing to pursue
a flexible approach to expanding and enhancing its network facilities by
investing in both switching and transmission facilities where traffic volumes
justify such investments. STAR has expanded its international gateway switching
facilities through the addition of facilities in Dallas and Miami and
Dusseldorf, Frankfurt, Hamburg and Munich, Germany and plans to put into service
in 1999 switches in Atlanta; Paris, France; Geneva, Switzerland; Vienna,
Austria; and Tokyo, Japan. STAR's international gateway switch in London,
England went into service in April 1997 and four switches in Germany became
operational in the second quarter of 1998.
 
    CAPITALIZE ON PROJECTED INTERNATIONAL LONG DISTANCE GROWTH.  STAR believes
that the international long distance market provides attractive opportunities
due to its higher revenue and profit per minute, and greater projected growth
rate as compared to the domestic long distance market. STAR targets
international markets with high volumes of traffic, relatively high rates per
minute and prospects for deregulation and privatization. STAR believes that the
ongoing trend toward deregulation and privatization will create new
opportunities for STAR in international markets. Although STAR has focused to
date primarily on providing services for U.S. based long distance providers,
STAR also intends to expand the international long distance services it offers
to foreign-based long distance providers.
 
    LEVERAGE TRAFFIC VOLUME TO REDUCE COSTS.  STAR continues to focus on
building its volume of international long distance traffic. Higher traffic
volumes strengthen STAR's negotiating position with vendors, customers and
potential foreign partners, which allows STAR to lower its costs of service. In
addition, higher traffic volumes on particular routes allow STAR to lower its
cost of services on these routes by transitioning from acquiring capacity on a
variable cost per minute basis to fixed cost arrangements such as longer-term
capacity agreements with major carriers, long-term leases and ownership of
facilities.
 
    LEVERAGE INFORMATION SYSTEMS AND SWITCHING CAPABILITIES.  STAR leverages its
sophisticated information systems to analyze its routing alternatives, and
select the most cost-effective routing from among STAR owned facilities, network
of resale arrangements with other long distance providers, operating agreements
and alternative termination relationships. STAR has invested significant
resources in the development of software to track specific usage information by
customer and revenue and cost information on specific routes on a daily basis.
STAR's information systems are critical components in managing its customer and
vendor relationships, routing traffic to the most cost-effective alternative,
and targeting its marketing efforts.
 
    MAINTAIN HIGH QUALITY.  STAR believes that reliability, call completion
rates, voice quality, rapid set up time and a high level of customer and
technical support are key factors evaluated by U.S. and foreign-based
telecommunications companies and large corporate customers in selecting a
carrier for their
 
                                       5

international traffic. STAR's state-of-the-art switching equipment is fully
compliant with international C-7 and domestic SS-7 signaling standards. STAR
strives to provide a consistently high level of customer and technical support
and has technical support personnel at its switching facilities 24 hours per
day, seven days per week to assist its customers and to continually monitor
network operations.
 
    EXPAND INTO COMMERCIAL MARKET.  STAR plans to continue its expansion into
niche commercial markets in the U.S. and in other deregulating countries where
it believes it can leverage its international network and where the customer
base has a significant international calling pattern. To implement this
strategy, STAR is using its telemarketing sales force to target small commercial
customers in ethnic markets to increase traffic to Mexico and Latin America.
Additionally, STAR intends to use the network of independent sales agents of
United Digital Network, Inc. ("UDN") to target medium-sized commercial customers
with a demand for international calling services at competitive rates. Finally,
STAR targets larger commercial customers through its direct sales forces
concentrating at first on potential customers in Los Angeles and New York. With
respect to the offering of commercial services abroad, STAR has initially
focused on Germany and the U.K. and will expand its focus to selected European
cities where competition for commercial customers is less mature.
 
    GROWTH THROUGH ACQUISITIONS.  STAR actively pursues opportunities to enhance
its business through strategic and synergistic acquisitions. These acquisitions
may focus on entering new territories, enlarging STAR's presence in an existing
territory, adding capacity or expanding into new market segments, such as the
commercial market. In addition to expanding its revenue base, STAR plans to
realize operating efficiencies by integrating newly-acquired operations into
STAR's billing, tracking and other systems. STAR completed the acquisition of
UDN, a commercial long distance provider, on March 24, 1999. On November 30,
1997, STAR acquired LD Services, Inc., now known as CEO Telecommunications, Inc.
("CEO"), a long-distance provider focusing on small commercial customers
throughout the United States, for approximately 849,000 shares of Common Stock.
On March 10, 1998, STAR acquired T-One Corp. ("T-One"), an international
wholesale long distance provider, for 1,353,000 shares of Common Stock. Each of
these transactions has been accounted for as a pooling of interests. On August
20, 1998, STAR entered into an Amended and Restated Agreement and Plan of
Merger, which was amended on September 1, 1998 and on December 29, 1998 (as
amended, the "PT-1 Merger Agreement") to acquire PT-1 Communications, Inc.
("PT-1"). STAR consummated the merger of PT-1 with and into a wholly-owned
subsidiary of STAR (the "PT-1 Merger") and related transactions on February 4,
1999.
 
NETWORK
 
    STAR provides international long distance services to approximately 200
foreign countries through a flexible, switched-based network consisting of
resale arrangements with other long distance providers, various foreign
termination relationships, international gateway switches and leased and owned
transmission facilities. STAR's network employs state-of-the-art digital
switching and transmission technologies and is supported by comprehensive
monitoring and technical support personnel. STAR's switching facilities are
staffed 24 hours per day, seven days per week.
 
TERMINATION ARRANGEMENTS
 
    STAR seeks to retain flexibility and maximize its termination opportunities
by utilizing a continuously changing mix of routing alternatives, including
resale arrangements, operating agreements and other advantageous termination
arrangements. This diversified approach is intended to enable STAR to take
advantage of the rapidly evolving international telecommunications market in
order to provide low-cost international long distance service to its customers.
 
    STAR utilizes resale arrangements to provide it with multiple options for
routing traffic through its switches to each destination country. Traffic under
resale arrangements typically terminates pursuant to a third party's
correspondent relationships. STAR purchased capacity from 132 vendors in 1998. A
substantial portion of this capacity is obtained on a variable, per minute and
short-term basis, subjecting STAR to
 
                                       6

the possibility of unanticipated price increases and service cancellations.
STAR'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 STAR's
longer term arrangements requiring STAR to make minimum usage commitments in
order to achieve additional volume discounts. As a result of deregulation and
competition in the international telecommunications market, the pricing of
termination services varies by carrier depending on such factors as call traffic
and time of day. Since STAR does not typically enter into long-term contracts
with these providers, pricing can change significantly over short periods of
time. STAR's proprietary information systems enable STAR to track the pricing
variations in the international telecommunications market on a daily basis,
allowing STAR's management to locate and reroute traffic to the most cost-
effective alternatives. See "Risk Factors--Operating Results Subject to
Significant Fluctuations."
 
    STAR currently has operating agreements with carriers in a number of
countries and is in the process of negotiating additional operating agreements
for other countries. STAR has been and will continue to be selective in entering
into operating agreements. STAR also has agreements with international providers
of long distance services for termination of traffic that STAR routes over its
network to such countries. STAR currently has such termination arrangements with
several carriers in a number of countries, and STAR is in the process of
expanding its coverage of such countries and entering into similar arrangements
in additional countries. The FCC or foreign regulatory agencies may take the
view that certain of STAR's termination arrangements do not comply with current
rules and policies applicable to international settlements, such as current ISR
rules. To the extent that the revenue generated under such arrangements becomes
a significant portion of overall revenue, the loss of such arrangements, whether
as a result of regulatory actions or otherwise, could have a material adverse
effect on STAR's business, operating results and financial condition. In
addition, the FCC could impose sanctions on STAR, including forfeitures, if
certain of STAR's arrangements are found to be inconsistent with FCC rules. See
"--Government Regulation," "Risk Factors--Risks of International
Telecommunications Business," and "--Potential Adverse Effects of Government
Regulation."
 
SWITCHES AND TRANSMISSION FACILITIES
 
    International long distance traffic to and from the U.S. is generally
transmitted through an international gateway switching facility across undersea
digital fiber optic cable or via satellite to a termination point. International
gateway switches are digital computerized routing facilities that receive calls,
route calls through transmission lines to their destination and record
information about the source, destination and duration of calls. STAR's global
network facilities include both international gateway switches and undersea
digital fiber optic cable.
 
    STAR currently operates international gateway switches in New York, Los
Angeles, Dallas and Miami; London, England; and Dusseldorf, Frankfurt, Hamburg,
and Munich, Germany. In 1999, STAR plans to put into service international
gateway switches in Atlanta; Paris, France; and Tokyo, Japan. STAR considers any
of its switches to be international gateway switches if STAR can route
international calls across such switch.
 
    STAR's switching facilities are linked to a proprietary reporting system,
which STAR believes provides it with a competitive advantage by permitting
management on a real-time basis to determine the most cost-effective termination
alternatives, monitor customer usage and manage gross margins by route. STAR has
installed multiple redundancies into its switching facilities to decrease the
risk of a network failure. For example, STAR employs both battery and generator
power back-up and has installed hardware that automatically shifts the system to
auxiliary power during a power outage, rather than relying on manual override.
STAR is in the process of adding a network control center in its Los Angeles
facility, which is expected to be completed in 1999.
 
    STAR currently holds ownership positions in a number of digital undersea
fiber optic cables, including TPC-5, Gemini and AC-1 and has plans to acquire
transmission capacity on additional undersea fiber optic cable systems. STAR has
recently entered into a commitment to acquire transmission capacity on the
 
                                       7

Qwest domestic Macro Capacity (SM) Fiber Network, which is expected to serve
over 130 cities in the U.S. STAR plans to increase its investment in direct and
IRU ownership of cable in situations where STAR enters into operating agreements
and in other situations in which it determines that such an investment would
enhance operating efficiency or reduce transmission costs.
 
    Through its acquisitions of T-One and UDN, STAR has acquired additional
switching and transmission facilities. By acquiring T-One, STAR added a switch
located in the same building as STAR's New York international gateway switch and
has added a number of operating agreements to countries in Africa and the Middle
East, among other locations. In addition, T-One owns capacity on certain cable
and satellite systems. With the acquisition of UDN, STAR acquired a switch
located in the same building as STAR's Dallas switch. STAR plans to integrate
these facilities into its existing network.
 
SALES AND MARKETING
 
    STAR markets its services on a wholesale basis to other telecommunications
companies through its experienced direct sales force and marketing/account
management team who leverage the long-term industry relationships of STAR's
senior management. STAR reaches its customers primarily through domestic and
international trade shows and through relationships gained from years of
experience in the telecommunications industry. STAR had 68 direct sales and
marketing employees and approximately 180 telemarketing representatives as of
December 31, 1998.
 
    In the wholesale market, STAR's sales and marketing employees utilize the
extensive, customer specific usage reports and network utilization data
generated by STAR's sophisticated information systems to effectively negotiate
agreements with customers and prospective customers and to rapidly respond to
changing market conditions. STAR believes that it has been able to compete more
effectively as a result of the personalized service and ongoing senior
management-level attention that is given to each customer.
 
    In connection with its expansion into the commercial market, STAR targets
small commercial customers through CEO's existing telemarketing operation, and
plans to deliver services to medium-sized commercial customers through UDN's
network of independent sales agents and utilize a direct sales force to approach
larger commercial accounts. Establishment of a sales force capable of
effectively expanding STAR's services into the commercial market can be expected
to require substantial efforts and management and financial resources and will
increase STAR's operating costs. See "Risk Factors--Risks Associated with Growth
of Telecommunications Network and Customer Base."
 
INFORMATION AND BILLING SYSTEMS
 
    STAR's operations use advanced information systems including call data
collection and call data storage linked to a proprietary reporting system. STAR
also maintains redundant billing systems for rapid and accurate customer
billing. STAR's switching facilities are linked to a proprietary reporting
system, which STAR believes provides it with a competitive advantage by
permitting management on a real-time basis to determine the most cost-effective
termination alternatives, monitor customer usage and manage gross margins by
route. STAR's systems also enable it to ensure accurate and timely billing and
to reduce routing errors. As STAR's systems were designed for the wholesale
marketplace, STAR is currently in the process of modifying its systems in
anticipation of its entrance into the commercial marketplace.
 
    STAR's proprietary reporting software compiles call, price and cost data
into a variety of reports which STAR can use to re-program its routes on a
real-time basis. STAR's reporting software can generate the following reports as
needed:
 
    - customer usage, detailing usage by country and by time period within
      country, in order to track sales and rapidly respond to any loss of
      traffic from a particular customer;
 
    - country usage, subtotaled by vendor or customer, which assists STAR with
      route and network planning;
 
                                       8

    - vendor rates, through an audit report that allows management to determine
      at a glance which vendors have the lowest rates for a particular country
      in a particular time period;
 
    - vendor usage by minute, enabling STAR to verify and audit vendor bills;
 
    - dollarized vendor usage to calculate the monetary value of minutes passed
      to STAR's vendors, which assists with calculating operating margin when
      used in connection with the customer reports;
 
    - loss reports used to rapidly highlight routing alternatives that are
      operating at a loss as well as identifying routes experiencing substantial
      overflow; and
 
    - LATA (Domestic Call Area) reporting by originating and terminating LATA,
      allowing for accurate Local Exchange charge audits, and protecting from
      Local Exchange overcharging.
 
    STAR has built multiple redundancies into its billing and call data
collections systems. Nine call collector computers receive call information in
real-time, immediately duplicating data, sending one copy to billing, while the
other copy is used for customer service internally and for traffic analysis.
STAR maintains two independent and redundant billing systems in order to both
verify billing internally and to ensure that bills are sent out on a timely
basis. All of the call data, and resulting billing data, are continuously backed
up on tape drives and redundant storage devices, and are regularly transported
to an off-site safe location.
 
COMPETITION
 
    The international telecommunications industry is intensely competitive and
subject to rapid change. STAR's competitors in the international wholesale
switched long distance market include large, facilities-based multinational
corporations and PTTs, smaller facilities-based providers in the U.S. and
overseas that have emerged as a result of deregulation, switched-based resellers
of international long distance services and international joint ventures and
alliances among such companies. International wholesale switched long distance
providers compete on the basis of price, customer service, transmission quality,
breadth of service offerings and value-added services. STAR also competes abroad
with a number of dominant telecommunications operators that previously held
various monopolies established by law over the telecommunications traffic in
their countries. See "Risk Factors-- Significant Competition." Additionally, the
telecommunications industry is in a period of rapid technological evolution,
marked by the introduction of competitive new product and service offerings,
such as the utilization of the Internet for international voice and data
communications. STAR is unable to predict which of many possible future product
and service offerings will be important to maintain its competitive position or
what expenditures will be required to develop and provide such products and
services. STAR believes that it competes favorably on the basis of price,
transmission quality and customer service. The number of STAR's competitors is
likely to increase as a result of the new competitive opportunities created by
the WTO Agreement. Further, under the terms of the WTO Agreement, the United
States and the other 68 countries participating in the Agreement have committed
to open their telecommunications markets to competition, and foreign ownership
and adopt measures to protect against anticompetitive behavior, effective
February 5, 1998. As a result, STAR believes that competition will continue to
increase, placing downward pressure on prices. Such pressure could adversely
affect STAR's gross margins if STAR is not able to reduce its costs commensurate
with such price reductions.
 
    COMPETITION FROM DOMESTIC AND INTERNATIONAL COMPANIES.  A majority of the
U.S.-based international telecommunications services revenue is currently
generated by AT&T, MCI WorldCom and Sprint. STAR also competes with Pacific
Gateway Exchange, Inc. and other U.S. based and foreign long distance providers,
including regional bell operating companies ("RBOCs"), which presently have FCC
authority to resell and terminate international telecommunication services. Many
of these companies have considerably greater financial and other resources and
more extensive domestic and international communications networks than STAR.
STAR's business would be materially adversely affected to the extent that a
significant number of such customers limit or cease doing business with STAR for
competitive or other
 
                                       9

reasons. Consolidation in the telecommunications industry could not only create
even larger competitors with greater financial and other resources, but could
also adversely affect STAR by reducing the number of potential customers for
STAR's services.
 
    EXPANSION INTO COMMERCIAL MARKET.  With the acquisition of CEO, STAR began
providing long distance service to the commercial market, a market that is
subject to intense competition from a number of well capitalized companies. The
commercial market is also characterized by the lack of customer loyalty, with
commercial customers regularly changing service providers. There can be no
assurance that STAR will be able to continue to compete successfully in the
commercial market.
 
GOVERNMENT REGULATION
 
    STAR's U.S. interstate and international telecommunications service
offerings generally are subject to the regulatory jurisdiction of the FCC.
Certain telecommunication services offered by STAR in the U.S. may also be
subject to the jurisdiction of state regulatory authorities, commonly known as
public utility commissions ("PUCs"). STAR's telecommunications service offerings
outside the U.S. are also generally subject to regulation by national regulatory
authorities. In addition, U.S. and foreign regulatory authorities may affect
STAR's international service offerings as a result of the termination or transit
arrangements associated therewith. U.S. or foreign regulatory authorities may
take actions or adopt regulatory requirements which could adversely affect STAR.
See "Risk Factors--Potential Adverse Effect of Government Regulation."
 
U.S. REGULATION
 
    STAR's business is subject to various U.S. and foreign laws, regulations,
agency actions and court decisions. STAR's U.S. international telecommunications
service offerings are subject to regulation by the FCC. The FCC requires
international carriers to obtain authorization under Section 214 of the
Communications Act of 1934, as amended (the "Communications Act"), prior to
acquiring international facilities by purchase or lease, or providing
international service to the public. Prior FCC approval is also required to
transfer control of a certificated carrier. STAR is also subject to FCC policies
and rules that regulate the manner in which international telecommunication
services may be provided, including, for instance, the circumstances under which
a carrier may provide international switched services using IPL facilities and
under which it may route traffic through third countries to or from its final
destination.
 
    The Communications Act and the FCC's rules and policies also impose certain
other obligations on carriers providing international telecommunication
services. These include the obligation to file at the FCC and to maintain
tariffs containing the rates, terms, and conditions applicable to their
services; to file certain reports regarding international traffic and
facilities; to file certain contracts with correspondent carriers; to disclose
affiliations with foreign carriers and significant foreign ownership interests;
to pay certain regulatory fees based, among other things, upon the carrier's
revenues and ownership of international transmission capacity.
 
    INTERNATIONAL SERVICES.  FCC rules require STAR to obtain prior FCC
authorization to acquire and operate international communication circuits in
satellites and undersea fiber optic cables; similar FCC authority is required
for STAR to resell such capacity. STAR holds both facilities-based and resale
international authorizations, including a "global" authorization that provides
broad authority to offer switched and private line international services. STAR
has filed tariffs for international services with the FCC.
 
    FCC INTERNATIONAL PRIVATE LINE RESALE POLICY.  The FCC's IPL resale policy
limits the conditions under which a carrier may connect IPLs to the PSTN at one
or both ends to provide switched services, commonly known as ISR. A carrier
generally may only offer ISR services to a foreign country if the FCC has found
(a) the country is a member of the WTO and at least 50% of the U.S. billed and
settled traffic to that country is settled at or below the benchmark settlement
rate adopted by the FCC in IB Docket No. 96-261;
 
                                       10

or (b) the country is not a WTO member, but it offers U.S. carriers equivalent
opportunities to engage in ISR and at least 50% of the U.S. billed and settled
traffic is settled at or below the applicable benchmark. Settled traffic refers
to traffic subject to an accounting rate agreement between U.S. and foreign
carriers. An accounting rate is a per minute wholesale charge negotiated by
international carriers for terminating traffic in either direction. Each carrier
is paid a settlement rate for terminating traffic on its own network which
ordinarily is one-half of the accounting rate. STAR's FCC authority currently
permits it to provide ISR service to Canada, the U.K., Sweden, New Zealand,
Australia, the Netherlands, Germany, France, Belgium, Denmark, Norway, Austria,
Switzerland, Luxembourg, Italy, Ireland, Hong Kong and Japan. The FCC is
currently reviewing U.S. carrier applications to provide ISR to Finland and
Mexico among other routes, and upon grant of any such ISR application to a given
country, the FCC's rules also would permit STAR to provide ISR service to that
country. If ISR is not permitted on a route, absent prior FCC consent, U.S.
facilities based international carriers must terminate switched telephone
traffic in accordance with the ISP which is primarily intended to deter foreign
carriers with market power from discriminating amongst competing U.S. carriers
by, for example, favoring the foreign carrier's U.S. affiliate. The ISP requires
that all U.S. carriers terminate traffic with a foreign carrier on the same
terms (i.e., that settlement rates be equivalent) and receive inbound traffic
only in proportion to the volume of U.S. outbound traffic which they generate.
 
    On a few routes, STAR may use IPLs to terminate international switched
telephone services where ISR has not been authorized. In such routes, therefore,
STAR's termination arrangements may not be consistent with the FCC's ISP. On any
such route, however, to STAR's knowledge the foreign correspondent lacks market
power, no U.S. inbound traffic is involved, and the effective settlement rate is
lower than the prevailing rate. Thus STAR believes its actions are not
inconsistent with the ISP's underlying purpose. If the FCC were to determine, by
its own actions or in response to the filing of a third party that any of STAR's
IPL arrangements violate its ISR policy or STAR's ISR authorization, the FCC
could order STAR to terminate any non-conforming arrangements. In addition, STAR
could be subject to a monetary forfeiture and to other penalties, including the
revocation of STAR's FCC authorizations to operate as an international carrier.
Any such FCC action could have a material adverse effect upon STAR's business,
operating results and financial condition.
 
    FCC INTERNATIONAL SETTLEMENTS POLICY.  The FCC's ISP places limits on the
arrangements which U.S. international carriers may enter into with foreign
carriers for exchanging public switched telecommunications traffic, which the
FCC terms International Message Telephone Service. The policy does not apply to
ISR services. The ISP is primarily intended to deter dominant foreign carriers
from discriminating amongst competing U.S. carriers by, for example, favoring
the foreign carrier's U.S. affiliate. Absent FCC consent, the ISP requires that
U.S. carriers receive an equal share of the accounting rate (i.e., that
settlement rates be equivalent) and receive inbound traffic in proportion to the
volume of U.S. outbound traffic which they generate. The ISP and other FCC
policies also prohibit a U.S. carrier from offering or accepting a "special
concession" from a foreign carrier where the foreign carrier possess sufficient
market power on the foreign end of the route to affect competition adversely in
the U.S. market. A "special concession" is defined by the FCC as an exclusive
arrangement involving services, facilities or functions on the foreign end of a
U.S. international route which are necessary for providing basic
telecommunications, and which are not offered to similarly situated U.S.
carriers authorized to serve that route. U.S. international carriers wishing to
establish settlement arrangements for IMTS which do not comply with the ISP must
obtain a waiver of the FCC's rules or a declaratory ruling from the FCC under
the FCC's "flexibility" policy that the non-standard arrangement is in the
public interest. FCC policy provides that a request by a U.S. international
carrier to establish a non-standard settlement arrangement with a foreign
carrier in a WTO member country is presumptively in the public interest, and
that said presumption generally may be overcome only by a demonstration that the
foreign carrier is not subject to competition in its home market from more than
one facilities-based international carrier. Notwithstanding the FCC's ISP waiver
and flexibility policies, it is possible that the FCC could find that certain of
STAR's arrangements with foreign operators were or are inconsistent with the ISP
and that STAR has not requested prior FCC authority therefore. If
 
                                       11

the FCC were to determine by its own actions or in response to the filing of a
third party that STAR has violated the ISP, the FCC could order STAR to
terminate any non-conforming arrangement. In addition, STAR could be subject to
a monetary forfeiture and to other penalties, including revocation of STAR's FCC
authorizations to operate as an international carrier. Any such FCC action could
have a material adverse effect upon STAR's business, operating results and
financial condition.
 
    The FCC's policies also require U.S. international carriers providing IMTS
to negotiate and adopt settlement rates with foreign correspondents for IMTS
which are at or below certain benchmark rates beginning January 1, 1999 for high
income countries. Pending reconsideration, the FCC has stayed a related policy
requiring U.S. international carriers to establish IMTS settlement rates at or
below the benchmark rate with any foreign affiliate beginning April 1, 1998.
STAR expects that any IMTS operating agreement which it has or may have with a
foreign affiliate will satisfy the foregoing benchmarks requirement when
applicable.
 
    STAR currently has IMTS operating agreements with certain foreign
correspondents which provide for settlement rates above the FCC's prescribed
benchmarks. STAR will negotiate in good faith to establish IMTS settlement rates
with its foreign correspondents which satisfy the FCC's benchmarks but there can
be no assurance that such negotiations will succeed. The FCC's order adopting
the foregoing settlement benchmarks and the timetable therefor was upheld by the
U.S. Court of Appeals, but is currently being reconsidered by the FCC. Subject
to FCC reconsideration, if STAR is unable to negotiate benchmark settlement
rates with certain foreign correspondents, the FCC may intervene on its own
action or in response to a filing by a third party. STAR is unable to predict
the form which such intervention may take but it could disrupt STAR's
arrangement for transmitting traffic to certain countries require STAR to
suspend direct service to certain countries or require STAR to make alternative
termination arrangements with certain countries all of which could have a
material adverse effect on STAR's business, operating results and financial
condition.
 
    FCC POLICIES ON TRANSIT AND REFILE.  International switched
telecommunication traffic is frequently routed indirectly via one or more third
countries to its final destination. When such arrangements are mutually agreed,
they are commonly based on a transit agreement under which settlement payments
are made to all parties. In other cases, traffic may be sent to a third country
and then forwarded or refiled for delivery to its final destination without the
knowledge or consent of the destination carrier. STAR uses both transit and
refile arrangements to terminate its international traffic. The FCC routinely
approves transit arrangements by U.S. international carriers. The FCC's rules
also permit carriers to use ISR facilities in many cases to route traffic via a
third country for refile through the public switched network. However, the
extent to which U.S. carriers may enter into refile arrangements consistent with
the ISP is currently under review by the FCC. In 1997, the FCC stated that
above-cost accounting rates had led an increasing amount of international
traffic to migrate to least cost routes through the use of practices such as
hubbing, refile and reorigination. The FCC stated that such practices are an
economically rational response to inflated settlement rates. Notwithstanding the
FCC's past rules, policies and statements regarding the scope of permissible
transit and refile arrangements, the FCC could find by its own actions or in
response to the filing of a third party, that certain of STAR's transit or
refile arrangements violate the ISP or other FCC policies. In that event, the
FCC could order STAR to terminate any non-conforming transit or refile
arrangements. In addition, STAR could be subject to a monetary forfeiture and to
other penalties, including revocation of STAR's FCC authorizations to operate as
an international carrier. Any such FCC action could have a material adverse
effect on STAR's business, operating results and financial condition.
 
                                       12

    REPORTING REQUIREMENTS.  International telecommunication carriers also are
required by the FCC's rules timely to file certain reports regarding
international traffic and revenues, the ownership and use of international
facilities; and their affiliates with foreign carriers. The FCC considers a U.S.
carrier to be affiliations a foreign carrier if it has a 25% interest in the
capital stock of the carrier or it controls the foreign carrier or is under
common ownership or control. The FCC requires these reports so that, among other
things, it may monitor the development of industry competition and the potential
for a dominant foreign carrier to discriminate amongst U.S. carriers. STAR
generally has filed said traffic, facilities and foreign affiliation reports.
The FCC's rules require international telecommunication carriers to file at the
FCC copies of their contracts with other carriers, including operating
agreements, within 30 days of execution. STAR has filed copies of its operating
agreements with the FCC. Competitive U.S. international carriers do not
routinely file other carrier-to-carrier contracts with the FCC and, consistent
with industry practice, STAR has not filed certain other carrier contracts.
Notwithstanding the foregoing FCC filings by STAR, the FCC by its own action or
in response to the filing of a third party could determine that STAR has failed
to meet certain of the foregoing filing and reporting requirements or that
certain Company filings are deficient. In that event, STAR could be directed to
remedy any asserted non-compliance; STAR could also be subject to a monetary
forfeiture and to other penalties, and, although STAR believes that it would be
largely unprecedented in such circumstances, and hence unlikely, the FCC could
revoke STAR's authorizations to operate as an international carrier. Any such
FCC action could have a material adverse effect on STAR's business, results and
financial condition.
 
    REGULATORY FEES.  The Communications Act, and FCC rules and policies, impose
certain fees upon carriers providing interstate and international
telecommunication services. These fees are levied, among other things, to defray
the FCC's operating expenses, to underwrite universal telecommunication service
(e.g., by subsidizing certain services used by schools and libraries), such as
Internet access, and by other telecommunications users in areas of the U.S.
where service costs are significantly above average), to fund the
Telecommunications Relay Service ("TRS"), which provides special options for
hearing-impaired users, and to support the administration of telephone numbering
plans.
 
    Carriers that provide domestic interstate services must pay an annual
regulatory fee based on their interstate revenues; the fee is currently 0.11% of
net revenue. Carriers that provide domestic interstate services to end users
must pay a universal telecommunications service fee each month based upon the
total estimated demand for U.S. universal service funding. If applicable, each
carrier's share is approximately 4% of the carrier's annual end user revenues.
STAR generally offers its services only to other carriers which in turn provide
services to end-users. Such carrier-to-carrier revenues are not subject to
universal service fees, and thus STAR generally is not liable to pay universal
service fees. Carriers that only offer international service (i.e., service
between the United States and a foreign country or service between two foreign
carriers) also are not subject to the universal service fee. However, if an
international carrier has an affiliate that provides domestic interstate
services, then the carrier's international revenues are subject to said fee.
Until its acquisition of CEO, STAR did not offer domestic interstate services.
As a result of the operations of CEO, any revenue STAR receives from end users
for international services may be subject to universal service fees. U.S.
interstate and international carriers must pay a percentage of their total
revenue each year to support the North American Numbering Plan Administrator.
For the 1998 filing year, the contribution rate is less than .003% of net
telecommunications revenue. U.S. carriers must pay a certain percentage of their
domestic interstate revenues to support the TRS Fund. For the 1998 filing year,
the contribution rate was less than .04% of gross domestic interstate revenue.
STAR has routinely paid the foregoing regulatory fees; however, approximately
$150,000 in additional fees may be owed by STAR to satisfy its TRS and annual
fee obligations for the 1996 and 1997 filing years. The foregoing regulatory
fees typically change annually. STAR cannot predict the future regulatory fees
for which it may be liable. Said fees could rise significantly for STAR and
amount to four percent or more of STAR's gross international and interstate
revenues if STAR is no longer exempt from paying universal service fees as a
result of an affiliate's provision of domestic interstate services, or because
STAR provides service directly to end users, or because amendments to the
Communications Act repeal the universal service fee exemption for
 
                                       13

revenues from connecting carriers. Because the international telecommunication
services business is highly competitive, an increase in the regulatory fees
which STAR must pay could impair its market position and have a material adverse
effect on STAR's business, operating results and financial condition.
 
    RECENT AND POTENTIAL FCC ACTIONS.  Recent FCC rulemaking orders and other
actions have lowered the entry barriers for new facilities-based and resale
international carriers by streamlining the processing of new applications and
granting non-dominant carriers greater flexibility in establishing non-standard
settlement arrangements with non-dominant foreign carriers, including the
non-dominant U.S. affiliates of such carriers. In addition, the FCC's rules
implementing the WTO Agreement presume that competition will be advanced by the
U.S. entry of facilities-based and resale carriers from WTO member countries,
thus further increasing the number of potential competitors in the U.S. market
and the number of carriers which may also offer end-to-end services. The FCC has
recently approved the mergers of AT&T and Teleport Communications Group and LCI
International, Inc. and Qwest Communications International Inc. FCC approval and
consummation of these mergers increases concentration in the international
telecommunications service industry and the potential market power of STAR's
competitors. The FCC also recently has sought to reduce the foreign termination
costs of U.S. international carriers by prescribing maximum or benchmark
settlement rates which foreign carriers may charge U.S. carriers for terminating
switched telecommunications traffic. This FCC action may reduce STAR's
settlement costs, although the costs of other U.S. international carriers also
may be reduced in a similar fashion. The FCC has not stated how it will enforce
the new settlement benchmarks if U.S. carriers are unsuccessful in negotiating
settlement rates at or below the prescribed benchmarks, but any future FCC
intervention could disrupt STAR's transmission arrangements to certain countries
or require STAR to modify its existing arrangements; other U.S. international
carriers might be similarly affected. The 1996 amendment to the Communications
Act permits the FCC to forbear enforcement of the tariff provisions in the Act,
which apply to all interstate and international carriers, and the U.S. Court of
Appeals is currently reviewing an FCC order directing all domestic interstate
carriers to detariff their offerings. Subject to the Court's decision, the FCC
may forbear its current tariff rules for U.S. international carriers, such as
STAR, or order such carriers to detariff their services. In that event, STAR
would have greater flexibility in pricing its service offerings and to compete,
although any such FCC action likely would grant other non-dominant international
carriers equivalent freedom. The FCC routinely reviews the contribution rate for
various levels of regulatory fees, including the rate for fees levied to support
universal service, which fees may be increased in the future for various
reasons, including the need to support the universal service programs mandated
by the Communications Act, the total costs for which are still under review by
the FCC. The FCC also is reviewing the extent to which international carriers
may refile traffic using international private line facilities or otherwise.
Future FCC actions regarding refile could affect STAR by, for example, requiring
it to discontinue certain termination arrangements which it now has or to
implement alternative routing arrangements for certain countries; on the other
hand, the FCC may further liberalize its existing rules and policies regarding
refile in which case STAR is likely to be well positioned to expand certain
refile operations even though new opportunities may become available to its
competitors. STAR can not predict the net effect of these or other possible
future FCC actions on its business, operating results and financial condition,
although the net effect could be material.
 
STATE REGULATION
 
    STATE.  The intrastate long distance telecommunications operations of STAR
and its subsidiaries are subject to various state laws and regulations,
including prior certification, notification, registration and/or tariff
requirements. In certain states, prior regulatory approval is required for
changes in control of telecommunications services. The vast majority of states
require STAR and its subsidiaries to apply for certification to provide
intrastate telecommunications services, or at a minimum to register or to be
found to be exempt from regulation, prior to commencing sale of intrastate
services. Additionally, the vast majority of states require STAR or its
subsidiaries to file and maintain detailed tariffs setting forth rates charged
by STAR to its end-users for intrastate services. Many states also impose
various reporting
 
                                       14

requirements and/or require prior approval for transfers of control of
certificated carriers and assignments of carrier assets, including customer
bases, carrier stock offerings, and incurrence by carriers of significant debt.
Certificates of authority can generally be conditioned, modified, canceled,
terminated or revoked by state regulatory authorities for failure to comply with
state laws and/or rules, regulations and policies of the state regulatory
authorities. Fines and other penalties, including, for example, the return of
all monies received for intrastate traffic from residents of a state in which a
violation has occurred may be imposed.
 
    STAR, along with its regulated subsidiaries, believes it has made the
filings and taken the actions it believes are necessary to provide the
intrastate services it currently provides to end users throughout the
U.S. STAR and/or its subsidiaries are qualified to do business as foreign
corporations, and have received certification to provide intrastate
telecommunications services in all states where certification is required, and
have received approval for changes of control where such approvals are
necessary. STAR and its subsidiaries are required to make periodic filings in
order to maintain certificated status and remain qualified as foreign
corporations.
 
    In early 1997, the FCC instituted significant changes to the current
incumbent local exchange carrier access charge structure. These changes were
meant, in part, to bring access charges closer to their actual costs. While
there has been a general trend towards access charge reductions, new primary
interexchange carrier charges (PICCs) were authorized by the FCC to be imposed
on interexchange carriers serving presubscribed access charges closer to their
actual costs. PICCs are a flat-rated, per presubscribed line, per month access
charge imposed upon all facilities-based carriers (although they may be passed
through to resellers). Facilities-based carriers were assessed interstate PICCs
effective January 1, 1998. Intrastate PICCs have also been adopted in the five
state Ameritech region (Michigan, Wisconsin, Illinois, Indiana, and Ohio), and
may be adopted elsewhere. At the same time, STAR may pursue underlying carriers
for pass throughs of any access charge reductions they may realize from
incumbent local exchange carriers.
 
    ACTIONS AGAINST CEO.  In 1997, prior to STAR's acquisition of CEO, it
settled disputes with the California PUC and with the District Attorney of
Monterey, California regarding CEO's alleged unauthorized switching of long
distance customers. As part of these settlements, CEO was subject to fines and
restrictions on its business operations in California. In addition, the FCC has
received numerous informal complaints against CEO regarding the alleged
unauthorized switching of long distance customers, which complaints currently
remain under review.
 
    Following STAR's acquisition of CEO and in order to comply with the
settlements described above, STAR has imposed strict restrictions on certain
former CEO employees, restricting these employees with respect to California
intrastate telecommunications operations. Additionally, STAR has taken a number
of steps to reduce the risk of a repeat occurrence regarding the alleged
unauthorized switching of commercial customers in California.
 
FOREIGN REGULATION
 
    UNITED KINGDOM.  In the U.K., telecommunications services offered by STAR
and through its affiliate, STAR Europe Ltd. ("STAR Europe"), are subject to
regulation by various U.K. regulatory agencies. The U.K. generally permits
competition in all sectors of the telecommunications market, subject to
licensing requirements and license conditions. STAR has been granted a license
to provide international services on a resale basis and STAR Europe has been
granted a license to provide international services over its own facilities,
which licenses are subject to a number of restrictions. Implementation of these
licenses have permitted STAR to engage in cost-effective routing of traffic
between the U.S. and the U.K. and beyond.
 
    GERMANY.  In Germany, telecommunications services offered by STAR through
its affiliate, STAR Telecommunications Deutschland GmbH ("STAR Germany"), are
subject to regulation by the Regulierungsbehorde fur Telekommunikation und Post
(which is under the jurisdiction of the Ministry of Economy). Germany permits
the competitive provision of international facilities-based and resale services.
STAR Germany was granted a license for the provision of voice telephony on the
basis of self-operated
 
                                       15

telecommunications networks in December 1997. Under this license, STAR Germany
has installed telecommunications switching facilities in Dusseldorf, Frankfurt,
Hamburg and Munich and is leasing connection transmission facilities between
these switches and additional facilities. The network of STAR Germany will be
used primarily for routing international telecommunications traffic between the
U.S., the U.K., Germany and beyond. There can be no assurance that future
changes in regulation of the services provided by STAR Germany will not have a
material adverse effect on STAR's business, operating results and financial
condition.
 
    OTHER COUNTRIES.  STAR plans to initiate a variety of services in certain
European countries including France and Belgium. These services will include
value-added services to closed user groups and other voice services as
regulatory liberalization in those countries permits. These and other countries
have announced plans or adopted laws to permit varying levels of competition in
the telecommunications market. Under the terms of the WTO Agreement, each of the
signatories has committed to opening its telecommunications market to
competition, foreign ownership and to adopt measures to protect against
anticompetitive behavior, effective starting on January 1, 1998. Although STAR
plans to obtain authority to provide service under current and future laws of
those countries, or, where permitted, provide service without government
authorization, there can be no assurance that foreign laws will be adopted and
implemented providing STAR with effective practical opportunities to compete in
these countries. Moreover, there can be no assurance of the nature and pace of
liberalization in any of these markets. STAR's inability to take advantage of
such liberalization could have a material adverse affect on STAR's ability to
expand its services as planned.
 
EMPLOYEES
 
    As of March 1, 1999, STAR employed 1,152 full-time employees. STAR is not
subject to any collective bargaining agreement and it believes that its
relationships with its employees are good.
 
                                       16

                                  RISK FACTORS
 
    IN EVALUATING THE COMPANY, ITS BUSINESS, OPERATIONS AND FINANCIAL POSITION,
THE FOLLOWING RISK FACTORS SHOULD BE CONSIDERED CAREFULLY IN ADDITION TO THE
OTHER INFORMATION CONTAINED IN THIS FORM 10-K. THIS FORM 10-K CONTAINS, IN
ADDITION TO HISTORICAL INFORMATION, "FORWARD-LOOKING STATEMENTS" WITHIN THE
MEANING OF SECTION 27A OF THE SECURITIES ACT AND SECTION 21E OF THE EXCHANGE ACT
THAT INVOLVE RISKS AND UNCERTAINTIES. STAR'S ACTUAL RESULTS MAY DIFFER
MATERIALLY FROM THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT
MAY CAUSE SUCH A DIFFERENCE INCLUDE, BUT ARE NOT LIMITED TO, THOSE SET FORTH
BELOW AND ELSEWHERE IN THIS FORM 10-K.
 
NO ASSURANCE THAT STAR WILL REALIZE ANTICIPATED BENEFITS FROM THE PT-1 MERGER
 
    STAR's acquisition of PT-1 is the most significant transaction in the
history of the Company. The PT-1 Merger involves the combination of certain
aspects of two companies that have operated independently. The process of
integrating the STAR and PT-1 businesses, operations and employees will present
a significant challenge to the Company's management and may lead to
unanticipated costs. Accordingly, there can be no assurance that PT-1 can be
successfully integrated into STAR or that STAR and its stockholders (including
persons who became stockholders as a result of the PT-1 Merger) will ultimately
realize any of the anticipated benefits of the PT-1 Merger.
 
    STAR's business has historically focused on providing switched voice
services on a wholesale basis, primarily to U.S.-based long distance carriers.
Alternatively, PT-1's operations are primarily focused on the marketing of
prepaid telephone calling cards ("Prepaid Cards") to the retail marketplace of
individual end-users. Thus, STAR and PT-1 operate in fundamentally different
business segments of the telecommunications market. These differences create
real challenges to the ability of STAR to integrate PT-1 operations and
personnel. Difficulties in the integration process may occur due to, among other
things, PT-1's emphasis on marketing of particular Prepaid Cards to specific
segments of the retail market, its need to maintain strong ties to a network of
independent distributors, PT-1's need for the continual introduction of new
products into the domestic market to achieve desired growth and the distance
between STAR's Santa Barbara headquarters and PT-1's New York-based operations.
There can be no assurance that STAR will be able to overcome these challenges to
integration.
 
    In addition, the integration of the STAR and PT-1 accounting and personnel
administrative functions involves the risk that key employees in those
operations, who can not be easily replaced, will leave even when offered
continuing employment. The integration approach adopted by STAR with respect to
PT-1 requires the devotion of a significant amount of time by senior executives,
which may detract from business operations and the development of the combined
companies.
 
    In considering the PT-1 Merger, the STAR Board considered, among other
things, the cost savings, operating efficiencies and other synergies expected to
result following the consummation thereof. There can be no assurance that any of
such cost savings, operating efficiencies or other synergies will be
accomplished as rapidly as currently expected or at all or that such savings and
synergies will not be offset by increases in other expenses or operating losses,
including losses due to problems arising from the integration of STAR and PT-1.
 
OPERATING RESULTS SUBJECT TO SIGNIFICANT FLUCTUATIONS
 
    STAR'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. STAR's revenues in any given period can vary due
to factors such as call volume fluctuations, particularly in regions with
relatively
 
                                       17

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 cost of services and operating expenses in any given period can vary due
to factors such as fluctuations in rates charged by carriers to terminate 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 STAR
is obtained on a variable, per minute and short term basis, subjecting STAR 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 gross margins are subject to significant
fluctuations over short periods of time. STAR's gross margins also may be
negatively impacted in the longer term by competitive pricing pressures.
 
ABILITY TO CONTINUE AND MANAGE GROWTH; COMMERCIAL MARKET
 
    STAR has increased revenues from $58.9 million in 1995 to $595.5 million in
1998, with revenues increasing in each of the last fourteen quarters. Such
growth should not be considered indicative of future revenue growth or operating
results. If revenue levels fall below expectations, net income is likely to be
disproportionately adversely affected because a proportionately smaller amount
of STAR's operating expenses varies with its revenues. This effect is likely to
increase as a greater percentage of STAR's cost of services are associated with
owned and leased facilities. There can be no assurance that STAR will be able to
achieve or maintain profitability on a quarterly or annual basis in the future.
It is likely that in some future quarter STAR's operating results will be below
the expectations of public market analysts and investors. In such event, the
price of the Company's Common Stock would likely be materially adversely
affected. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
 
    As part of STAR's significant revenue growth, it has expanded, and plans to
continue to expand, the number of its employees and the geographic scope of its
operations. Additionally, an important component of STAR's strategy is to grow
and expand through acquisition. These factors have resulted, and will continue
to result, in increased responsibilities for management personnel and have
placed, and will continue to place, increased demands upon STAR's operating and
financial systems, which may lead to unanticipated costs and divert management's
attention from day-to-day operations. STAR may also be required to attract,
train and retain additional highly qualified management, technical, sales and
marketing and customer support personnel. The process of locating such personnel
with the combination of skills and attributes required to implement STAR's
strategy is often lengthy. The inability to attract and retain additional
qualified personnel could materially and adversely affect STAR. STAR expects
that its expansion into foreign countries will lead to increased financial and
administrative demands, such as increased operational complexity associated with
expanded network facilities, administrative burdens associated with managing an
increasing number of foreign subsidiaries and relationships with foreign
partners and expanded treasury functions to manage foreign currency risks.
STAR's accounting systems and policies have been developed as STAR has
experienced significant growth. There can be no assurance that STAR's personnel,
systems, procedures and controls will be adequate to support STAR's future
operations. See "-- Dependence on Key Personnel," "Business--Employees" and
"Management."
 
                                       18

    With the acquisition of CEO, STAR began providing service to the commercial
market, which is more labor intensive than the wholesale market, and as a result
has higher overhead costs. STAR also may be required to update and improve its
billing systems and procedures and/or hire new management personnel to handle
the demands of the commercial market. There can be no assurance that STAR will
be able to effectively manage the costs of and risks associated with its
expansion into the commercial market.
 
RISKS INHERENT IN ACQUISITION STRATEGY
 
    An important component to STAR's strategy is to grow and expand through
acquisitions. This growth strategy is dependent on the continued availability of
suitable acquisition candidates and subjects the Company to a number of risks.
STAR has completed four acquisitions, CEO on November 30, 1997, T-One on March
10, 1998, PT-1 on February 4, 1999 and UDN on March 24, 1999. These acquisitions
have placed significant demands on STAR's financial and management resources, as
the process for integrating acquired operations presents a significant challenge
to STAR's management and may lead to unanticipated costs or a diversion of
management's attention from day-to-day operations. There can be no assurance
that the Company will be able to successfully integrate these acquisitions or
any other acquisitions made by STAR in the future into Company operations.
Integrating acquisitions may require integration of financial and call routing
systems, network and other physical facilities and personnel. Difficulties in
integrating these and other acquisitions can cause system degradation, added
costs and loss of personnel or customers. Additionally, STAR may incur unknown
liabilities despite management's efforts to investigate the operations of the
acquired business. The impact of these risks, and other risks arising as a
result of STAR's acquisition strategy, could adversely affect STAR's operating
results.
 
RISKS ASSOCIATED WITH GROWTH OF TELECOMMUNICATIONS NETWORK AND CUSTOMER BASE
 
    Historically, STAR has relied primarily on leased transmission capacity for
the delivery of its telecommunications services. STAR's telecommunications
expenses have in the past primarily been variable, based upon minutes of use,
consisting largely of payments to other long distance carriers, customer/carrier
interconnect charges, leased fiber circuit charges and switch facility costs.
During 1997 and 1998, however, the Company made considerable capital
expenditures in order to expand its network, and intends to continue to do so in
the future. See "Business--Network." Although STAR's strategy is to seek to
establish significant traffic volumes prior to investing in fixed-cost
facilities, the development of such facilities entails significant costs and
prior planning, which are based in part on STAR's expectations concerning future
revenue growth and market developments. As STAR expands its network and the
volume of its network traffic, its cost of revenues will increasingly consist of
fixed costs arising from the ownership and maintenance of its switches and
undersea fiber optic cables. While STAR believes that in the long-term these
investments will allow it to reduce its cost of service and to enhance its
service offerings, in the short-term, cost increases and a decrease in STAR's
operating margins may occur. If STAR's traffic volume were to decrease, or fail
to increase to the extent expected or necessary to make efficient use of its
network, STAR's costs as a percentage of revenues could increase significantly,
which could have a material adverse effect on STAR's business, financial
condition or results of operations.
 
    In addition, STAR's business depends in part on its ability to obtain
transmission facilities on a cost-effective basis. Because undersea fiber optic
cables typically take several years to plan and construct, carriers generally
make investments well in advance, based on a forecast of anticipated traffic.
Therefore, STAR's operations are subject to the risk that it will not adequately
anticipate the amount of traffic over its network, and may not procure
sufficient cable capacity or network equipment in order to ensure the cost-
effective transmission of customer traffic. Although STAR participates in the
planning of undersea fiber optic transmission facilities, it does not control
the construction of such facilities and must seek access to such facilities
through partial ownership positions. If ownership positions are not available,
STAR must seek access to such facilities through lease arrangements on
negotiated terms that may vary with industry and market conditions. There can be
no assurance that STAR will be able to continue to obtain sufficient
 
                                       19

transmission facilities or access to undersea fiber optic cable on economically
viable terms. The failure of STAR to obtain telecommunications facilities that
are sufficient to support its network traffic in a manner that ensures the
reliability and quality of its telecommunications services may have a material
adverse effect on its business, financial condition or results of operations.
 
RISKS OF INTERNATIONAL TELECOMMUNICATIONS BUSINESS
 
    STAR has to date generated a substantial majority of its revenues by
providing international telecommunications services to its customers on a
wholesale basis. STAR sends traffic to numerous countries throughout the world,
including India, Mexico and China. The international nature of STAR's operations
involves certain risks, such as changes in U.S. and foreign government
regulations and telecommunications standards, dependence on foreign partners,
tariffs, taxes and other trade barriers, the potential for nationalization and
economic downturns and political instability in foreign countries. In addition,
STAR's business could be adversely affected by a reversal in the current trend
toward deregulation of telecommunications carriers. The Company will be
increasingly subject to these risks to the extent that it proceeds with the
planned expansion of its international operations.
 
    RISK OF DEPENDENCE ON FOREIGN PARTNERS.  STAR will increasingly rely on
foreign partners to terminate its traffic in foreign countries and to assist in
installing transmission facilities and network switches, complying with local
regulations, obtaining required licenses, and assisting with customer and vendor
relationships. STAR may have limited recourse if its foreign partners do not
perform under their contractual arrangements with STAR. STAR's arrangements with
foreign partners may expose STAR to significant legal, regulatory or economic
risks.
 
    RISKS ASSOCIATED WITH FOREIGN GOVERNMENT CONTROL AND HIGHLY REGULATED
MARKETS.  Governments of many countries exercise substantial influence over
various aspects of the telecommunications market. In some cases, the government
owns or controls companies that are or may become competitors of STAR or
companies (such as national telephone companies) upon which STAR and its foreign
partners may depend for required interconnections to local telephone networks
and other services. Accordingly, government actions in the future could have a
material adverse effect on STAR's operations. In highly regulated countries in
which STAR is not dealing directly with the dominant local exchange carrier, the
dominant carrier may have the ability to terminate service to STAR or its
foreign partner and, if this occurs, STAR may have limited or no recourse. In
countries where competition is not yet fully established and STAR is dealing
with an alternative operator, foreign laws may prohibit or impede new operators
from offering services in these markets.
 
    RISKS ASSOCIATED WITH FOREIGN CURRENCY FLUCTUATIONS.  STAR's revenues and
cost of long distance services are sensitive to foreign currency fluctuations.
STAR expects that an increasing portion of STAR's net revenue and expenses will
be denominated in currencies other than U.S. dollars, and changes in exchange
rates may have a significant effect on STAR's results of operations. Although
STAR utilizes hedging instruments to reduce the risk of foreign currency
fluctuations, STAR will not be fully protected from these risks and the
instruments themselves involve a degree of risk. See "Quantitative and
Qualitative Disclosure About Market Risk."
 
    FOREIGN CORRUPT PRACTICES ACT.  STAR is also subject to the Foreign Corrupt
Practices Act ("FCPA"), which generally prohibits U.S. companies and their
intermediaries from bribing foreign officials for the purpose of obtaining or
keeping business. STAR may be exposed to liability under the FCPA as a result of
past or future actions taken without STAR's knowledge by agents, strategic
partners and other intermediaries. Such liability could have a material adverse
effect on STAR's business, operating results and financial condition.
 
                                       20

POTENTIAL ADVERSE EFFECTS OF GOVERNMENT REGULATION
 
    STAR's business is subject to various U.S. and foreign laws, regulations,
agency actions and court decisions. STAR's U.S. international telecommunications
service offerings are subject to regulation by the FCC. The FCC requires
international carriers to obtain authorizations under Section 214 of the
Communications Act, prior to acquiring international facilities by purchase or
lease, or providing international service to the public. Prior FCC approval is
also required to transfer control of a certificated carrier. STAR must file
reports and contracts with the FCC and must pay regulatory fees, which are
subject to change. STAR is also subject to the FCC policies and rules discussed
below. The FCC could determine, by its own actions or in response to a third
party's filing, that certain of STAR's services, termination arrangements,
agreements with foreign carriers, transit or refile arrangements or reports do
not or did not comply with FCC policies and rules. If this occurred, the FCC
could order STAR to terminate noncompliant arrangements, fine STAR or revoke
STAR's authorizations. Any of these actions could have a material adverse effect
on STAR's business, operating results and financial condition.
 
    FCC INTERNATIONAL PRIVATE LINE RESALE POLICY.  The FCC's IPL resale policy
limits the conditions under which a carrier may connect IPLs to the PSTN at one
or both ends to provide switched services, commonly known as ISR. A carrier
generally may only offer ISR services to a foreign country if the FCC has found
(a) the country is a member of the World Trade Organization ("WTO") and at least
50% of the U.S. billed and settled traffic to that country is settled at or
below the FCC's benchmark settlement rate or (b) the country is not a WTO
member, but it offers U.S. carriers equivalent opportunities to engage in ISR
and at least 50% of the U.S. billed and settled traffic is settled at or below
the applicable benchmark. STAR's FCC authority currently permits it to provide
ISR service to Canada, the U.K., Sweden, New Zealand, Australia, the
Netherlands, Germany, France, Belgium, Denmark, Norway, Austria, Switzerland,
Luxembourg, Italy, Hong Kong and Japan. The FCC is currently reviewing U.S.
carrier applications to provide ISR to Finland and Mexico, among other routes.
Upon grant of any such ISR application to a given country, the FCC's rules also
would permit STAR to provide ISR service to that country. If ISR is not
permitted on a route, absent prior FCC consent, U.S. facilities based
international carriers must terminate switched telephone traffic in accordance
with the FCC's International Settlement Policy ("ISP") which is primarily
intended to deter foreign carriers with market power from discriminating amongst
competing U.S. carriers by, for example, favoring the foreign carrier's U.S.
affiliate. The ISP requires that all U.S. carriers terminate traffic with a
foreign carrier on the same terms (i.e., that settlement rates be equivalent)
and receive inbound traffic only in proportion to the volume of U.S. outbound
traffic which they generate.
 
    On a few routes, STAR may use IPLs to terminate international switched
telephone services where ISR has not been authorized. On such routes, therefore,
STAR's termination arrangements may not be consistent with the FCC's ISP. On any
such route, however, to STAR's knowledge the foreign correspondent lacks market
power, no U.S. inbound traffic is involved, and the effective settlement rate is
lower than the prevailing rate. Thus, STAR believes its actions are not
inconsistent with the ISP's underlying purpose.
 
    FCC INTERNATIONAL SETTLEMENTS POLICY.  The ISP limits the arrangements which
U.S. international carriers may enter into with foreign carriers for exchanging
public switched telecommunications traffic, which the FCC terms International
Message Telephone Service ("IMTS"). This policy does not apply to ISR services.
The ISP requires that U.S. carriers receive an equal share of the accounting
rate and receive inbound traffic in proportion to the volume of U.S. outbound
traffic which they generate. The ISP and other FCC policies also prohibit a U.S.
carrier and a foreign carrier which possesses sufficient market power on the
foreign end of the route to affect competition adversely in the U.S. market from
entering into exclusive arrangement involving services, facilities or functions
on the foreign end of a U.S. international route which are necessary for
providing basic telecommunications and which are not offered to similarly
situated U.S. carriers. It is possible that the FCC could find that certain of
STAR's arrangements with foreign operators are inconsistent with the ISP.
 
                                       21

    FCC POLICIES ON TRANSIT AND REFILE.  STAR uses both transit and refile
arrangements to terminate its international traffic. The FCC routinely approves
transit arrangements by U.S. international carriers. The FCC's rules also permit
carriers in many cases to use ISR facilities to route traffic via a third
country for refile through the PSTN. The extent to which U.S. carriers may enter
into refile arrangements consistent with the ISP is currently under review by
the FCC. Certain of STAR's transit or refile arrangements may violate the ISP or
other FCC policies.
 
    RECENT AND POTENTIAL FCC ACTIONS.  Regulatory action that may be taken in
the future by the FCC may intensify the competition which STAR faces, impose
additional operating costs upon STAR, disrupt certain of STAR's transmission
arrangements or otherwise require either company to modify its operations.
Future FCC action may also provide STAR additional competitive flexibility by,
for example, eliminating or substantially reducing the tariff requirements
applicable to STAR's interstate and international telecommunications services.
The FCC is encouraging new market entrants by implementing the WTO Agreement and
through other actions. The FCC may approve pending mergers which could produce
more effective competitors in STAR's market. The FCC may increase regulatory
fees charged to STAR and its competitors by eliminating the exemption for
carrier revenues obtained from other carriers for certain fees or through other
actions, which could raise STAR's costs of service without assurance that STAR
could pass such fee increases through to its customers. See
"Business--Government Regulation." In addition, the FCC has received a number
informal complaints against CEO regarding the alleged unauthorized switching of
long distance customers and other matters, some of which currently remain under
review.
 
    STATE.  The intrastate long distance telecommunications operations of STAR
and its subsidiaries are subject to various state laws and regulations,
including prior certification, notification, registration and/or tariff
requirements. The vast majority of states require that STAR and its subsidiaries
apply for certification to provide intrastate telecommunications services. In
most jurisdictions, STAR also must file and obtain prior regulatory approval of
tariffs for intrastate services. Certificates of authority can generally be
conditioned, modified or revoked by state regulatory authorities for failure to
comply with state laws and regulations. Fines and other penalties, including
revocation of a certificate of authority, may be imposed.
 
    FOREIGN REGULATIONS.  STAR is also subject to regulation in foreign
countries, such as the U.K. and Germany, in connection with certain of its
business activities. For example, STAR's use of transit, ISR or other routing
arrangements may be affected by laws or regulations in either the transited or
terminating foreign jurisdiction. Foreign countries, either independently or
jointly as members of the International Telecommunications Union ("ITU"), or
other supra-national organizations such as the European Union or the WTO, may
have adopted or may adopt laws or regulatory requirements regarding such
services for which compliance would be difficult or expensive, that could force
STAR to choose less cost-effective routing alternatives and that could adversely
affect STAR's business, operating results and financial condition.
 
    To the extent that STAR seeks to provide telecommunications services in
other non-U.S. markets, STAR will be subject to the developing laws and
regulations governing the competitive provision of telecommunications services
in those markets. STAR currently plans to provide a limited range of services in
Mexico and Belgium, as permitted by regulatory conditions in those markets, and
to expand its operations as these markets implement scheduled liberalization to
permit competition in the full range of telecommunications services. The nature,
extent and timing of the opportunity for STAR to compete in these markets will
be determined, in part, by the actions taken by the governments in these
countries to implement competition and the response of incumbent carriers to
these efforts. There can be no assurance that the regulatory regime in these
countries will provide STAR with practical opportunities to compete in the near
future, or at all, or that STAR will be able to take advantage of any such
liberalization in a timely manner. See "Business--Government Regulation."
 
    REGULATION OF CUSTOMERS.  STAR's customers are also subject to actions taken
by domestic or foreign regulatory authorities that may affect the ability of
customers to deliver traffic to STAR. Regulatory
 
                                       22

sanctions have been imposed on certain of STAR's customers in the past. While
such sanctions have not adversely impacted the volume of traffic received by
STAR from such customers to date, future regulatory actions could materially
adversely affect the volume of traffic received from a major customer, which
could have a material adverse effect on STAR's business, financial condition and
results of operations.
 
RISKS OF NETWORK FAILURE; DEPENDENCE ON FACILITIES AND THIRD PARTIES
 
    Any system or network failure that causes interruptions in STAR's operations
could have a material adverse effect on its business, financial condition or
results of operations. STAR's operations are dependent on STAR's ability to
successfully expand its network and integrate new and emerging technologies and
equipment into its network, which are likely to increase the risk of system
failure and to cause strain upon the networks. STAR's operations also are
dependent on STAR's ability to protect its hardware and other equipment from
damage from natural disasters such as fires, floods, hurricanes and earthquakes,
other catastrophic events such as civil unrest, terrorism and war and other
sources of power loss and telecommunications failures. Although STAR has taken a
number of steps to prevent its network from being affected by natural disasters,
fire and the like, such as building redundant systems for power supply to the
switching equipment, there can be no assurance that any such systems will
prevent STAR's switches from becoming disabled in the event of an earthquake,
power outage or otherwise. The failure of STAR's network, or a significant
decrease in telephone traffic resulting from effects of a natural or man-made
disaster, could have a material adverse effect on STAR's relationships with its
customers and its business, operating results and financial condition. See
"Business--Network."
 
DEPENDENCE ON KEY PERSONNEL
 
    STAR's success depends to a significant degree upon the efforts of senior
management personnel and a group of employees with longstanding industry
relationships and technical knowledge of STAR's operations, in particular,
Christopher E. Edgecomb, STAR's Chief Executive Officer. STAR maintains and is
the beneficiary under a key person life insurance policy in the amount of $10.0
million with respect to Mr. Edgecomb. STAR believes that its future success will
depend in large part upon its continuing ability to attract and retain highly
skilled personnel. Competition for qualified, high-level telecommunications
personnel is intense and there can be no assurance that STAR will be successful
in attracting and retaining such personnel. The loss of the services of one or
more of STAR's key individuals, or the failure to attract and retain other key
personnel, could materially adversely affect STAR's business, operating results
and financial condition. See "Management."
 
SIGNIFICANT COMPETITION
 
    The international telecommunications industry is intensely competitive and
subject to rapid change. STAR's competitors in the international wholesale
switched long distance market include large, facilities-based multinational
corporations and smaller facilities-based providers in the U.S. and overseas
that have emerged as a result of deregulation, switch-based resellers of
international long distance services and international joint ventures and
alliances among such companies. STAR also competes abroad with a number of
dominant telecommunications operators that previously held various monopolies
established by law over the telecommunications traffic in their countries.
International wholesale switched service providers compete on the basis of
price, customer service, transmission quality, breadth of service offerings and
value-added services. Additionally, the telecommunications industry is in a
period of rapid technological evolution, marked by the introduction of
competitive product and service offerings, such as the utilization of the
Internet for international voice and data communications. STAR is unable to
predict which technological development will challenge its competitive position
or the amount of expenditures that will be required to respond to a rapidly
changing technological environment. Further, the number of competitors is likely
to increase as a result of the competitive opportunities created by a new Basic
Telecommunications Agreement concluded by members of the WTO in February 1997.
Under the terms of
 
                                       23

the WTO Agreement, starting February 5, 1998, the United States and over 68
countries have committed to open their telecommunications markets to competition
and foreign ownership and to adopt measures to protect against anticompetitive
behavior. As a result, STAR believes that competition will continue to increase,
placing downward pressure on prices. Such pressure could adversely affect STAR's
gross margins if STAR is not able to reduce their costs commensurate with such
price reductions.
 
    COMPETITION FROM DOMESTIC AND INTERNATIONAL COMPANIES.  A majority of the
U.S.-based international telecommunications services revenue is currently
generated by AT&T, MCI WorldCom and Sprint. STAR also competes with Pacific
Gateway Exchange, Inc., and other U.S.-based and foreign long distance
providers, including the Regional Bell Operating Companies ("RBOCs"), which
presently have FCC authority to resell and terminate international
telecommunication services. Many of these competitors have considerably greater
financial and other resources and more extensive domestic and international
communications networks than STAR. STAR's business would be materially adversely
affected to the extent that a significant number of such customers limit or
cease doing business with STAR for competitive or other reasons. Consolidation
in the telecommunications industry could not only create even larger competitors
with greater financial and other resources, but could also adversely affect STAR
by reducing the number of potential customers for STAR's services.
 
    EXPANSION INTO COMMERCIAL MARKET.  With the acquisition of CEO, STAR began
providing long distance service to the commercial market, a market that is
subject to intense competition from a number of well capitalized companies. The
commercial market is also characterized by the lack of customer loyalty, with
commercial customers regularly changing service providers. There can be no
assurance that STAR will be able to compete successfully in the commercial
market. See "Business--Strategy--Expansion into Commercial Market."
 
CUSTOMER CONCENTRATION
 
    While the list of STAR's most significant customers varies from quarter to
quarter, STAR's five largest customers accounted for approximately 33% of its
revenues in 1998, with one customer, PT-1, accounting for approximately 15% of
revenues in such period. STAR could lose a significant customer for many
reasons, including the entrance into the market of significant new competitors
with lower rates than STAR, downward pressure on the overall costs of
transmitting international calls, transmission quality problems, changes in U.S.
or foreign regulations or unexpected increases in STAR's cost structure as a
result of expenses related to installing a global network or otherwise.
 
NEED FOR ADDITIONAL CAPITAL TO FINANCE GROWTH AND CAPITAL REQUIREMENTS
 
    STAR believes that it must continue to enhance and expand its network and
build out its telecommunications network infrastructure in order to maintain its
competitive position and continue to meet the increasing demands for service
quality, capacity and competitive pricing. STAR's ability to grow depends, in
part, on its ability to expand its operations through the ownership and leasing
of network capacity, which requires significant capital expenditures, that are
often incurred prior to STAR's receipt of the related revenue. STAR believes
that, based upon its present business plan and its existing cash resources,
available financing and expected cash flow from operating activities, STAR will
have sufficient cash to meet its currently anticipated working capital and
capital expenditure requirements for at least twelve months. If STAR's growth
exceeds current expectations, if STAR obtains one or more attractive
opportunities to purchase the business or assets of another company, or if
STAR's cash flow from operations after the end of such period is insufficient to
meet its working capital and capital expenditure requirements, STAR will need to
raise additional capital from equity or debt sources. There can be no assurance
that STAR will be able to raise such capital on favorable terms or at all. If
STAR is unable to obtain such additional capital, STAR may be required to reduce
the scope of its anticipated expansion, which could have a material adverse
effect on STAR's business, financial condition or results of operations.
 
                                       24

VOLATILITY OF STOCK PRICE
 
    The market price of the shares of the Company's Common Stock has risen since
STAR's initial public offering in June 1997 and is trading at a high multiple of
STAR's earnings. The market price for such shares has been highly volatile and
may be significantly affected by factors such as actual or anticipated
fluctuations in STAR's operating results, the announcement of potential
acquisitions by STAR, changes in federal and international regulations,
activities of the largest domestic providers, industry consolidation and
mergers, conditions and trends in the international telecommunications market,
adoption of new accounting standards affecting the telecommunications industry,
changes in recommendations and estimates by securities analysts, general market
conditions and other factors. In addition, the stock market has from time to
time experienced significant price and volume fluctuations that have
particularly affected the market prices for the shares of emerging growth
companies like STAR. These broad market fluctuations may adversely affect the
market price of the Company's Common Stock.
 
YEAR 2000 COMPUTER PROGRAM FAILURE
 
    A significant percentage of the software that runs most of the computers in
the United States relies on two-digit date codes to perform computations and
decision-making functions. Commencing on January 1, 2000, these computer
programs may fail from an inability to interpret date codes properly,
misinterpreting "00" as the year 1900 rather than 2000. STAR has implemented
Year 2000 compliance programs to ensure that its software, systems and equipment
are Year 2000 compliant and to ensure that the software and technology of its
third party vendors and customers are also Year 2000 compliant. 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 its compliance testing will not detect unanticipated Year 2000
compliance problems. While STAR intends to develop contingency plans to prepare
for a Year 2000 failure, there can be no assurance that such contingency plans
will be adequate. If STAR and/or third parties are not Year 2000 compliant as of
such date and if such contingency plans are inadequate or fail to address a
particular Year 2000 risk, STAR may be required to incur unanticipated costs,
change relationships with third parties, forego revenues or be subjected to
other material adverse effects. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
 
FORWARD-LOOKING STATEMENTS
 
    Certain statements contained in this Form 10-K, including without
limitation, statements containing the words "believes," "anticipates,"
"intends," "expects" and words of similar import, constitute "forward-looking
statements" within the meaning of Section 27A of the Securities Act and Section
21E of the Exchange Act. Such forward-looking statements involve known and
unknown risks, uncertainties and other factors that may cause the actual
results, performance or achievements of the Company to be materially different
from any future results, performance or achievements expressed or implied by
such forward-looking statements. Such factors include, among others, the
following: general economic and business conditions, both nationally and in the
regions in which the Company operates; industry capacity; existing government
regulations and changes in, or the failure to comply with, government
regulations; competition; changes in business strategy or development plans; the
ability of the Company to manage growth; the availability and terms of capital
to fund the expansion of the Company's business, including the acquisition of
additional businesses; and other factors referenced in this Form 10-K. GIVEN
THESE UNCERTAINTIES, THE STOCKHOLDERS OF THE COMPANY ARE CAUTIONED NOT TO PLACE
UNDUE RELIANCE ON SUCH FORWARD-LOOKING STATEMENTS.
 
                                       25

ITEM 2. PROPERTIES
 
    STAR's principal offices are located in Santa Barbara, California in five
facilities providing an aggregate of approximately 38,814 square feet of office
space expiring between June 1999 and October 2005. Additionally, STAR has office
and switching sites in the following locations:
 


                                                 APPROXIMATE
OFFICE SITES                                     SQUARE FEET           EXPIRATION DATE
- ----------------------------------------------  -------------  --------------------------------
                                                         
Fairfax, Virginia                                     3,909    May 2004
New York, New York                                    2,627    December 2001
Los Angeles, CA                                      17,500    June 2005
Houston, Texas                                          847    July 2003
London, England                                       5,414    December 2003

 


                                                 APPROXIMATE
SWITCH SITES                                     SQUARE FEET           EXPIRATION DATE
- ----------------------------------------------  -------------  --------------------------------
                                                         
Los Angeles, CA (multiple leases)                    39,175    April 2006 - December 2008
New York, New York (multiple leases)                 40,749    July 2003 - April 2008
Dallas, Texas                                         6,167    April 2007
Miami, Florida (multiple leases)                     20,571    June 2008 - August 2008
Atlanta, Georgia                                     17,300    April 2008
Seattle, Washington                                   7,020    June 2008
London, England                                       8,000    July 2006
Hamburg, Germany                                     20,342    December 2007
Dusseldorf, Germany                                  20,423    December 2007
Frankfurt, Germany                                   30,051    December 2007
Munich, Germany                                      12,408    December 2007

 
A number of the above-listed leases grant STAR the right to extend the lease
term beyond the stated expiration date. The aggregate facility lease payments
made by STAR in 1998 were approximately $5.0 million.
 
    On February 4, 1999, STAR completed its acquisition of PT-1, which has sales
offices in Houston, Texas, Columbus and Cleveland, Ohio, Seattle, Washington,
Jackson Heights, California, New York, Staten Island and Flushing, New York and
Toronto, Canada providing an aggregate of approximately 57,497 square feet of
office space expiring between June 1999 and December 2008. PT-1 also leases
approximately 5,565 square feet of space for its switching facilities in Jersey
City, New Jersey under a lease expiring December 2008, and approximately 10,353
square feet for its switching facility in Miami, Florida under a lease expiring
April 2008.
 
    STAR believes that all other material terms of its leases are commercially
reasonable terms that are typically found in commercial leases in each of the
respective areas in which STAR leases space. STAR believes that its facilities
are adequate to support its current needs and that additional facilities will be
available at competitive rates as needed.
 
ITEM 3. LEGAL PROCEEDINGS
 
    STAR is not presently a party to any material pending litigation. From time
to time, however, STAR is party to various legal proceedings, including billing
disputes and collection matters, that arise in the ordinary course of business.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS.
 
    None.
 
                                       26

                                    PART II
 
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
 
    The Company's Common Stock has been traded on the Nasdaq National Market
under the symbol "STRX" since June 12, 1997. The following table sets forth, for
the fiscal periods indicated, the quarterly high and low sales prices for the
Common Stock, as reported by Nasdaq and as adjusted to reflect the Stock Split
that occurred on March 31, 1998.
 


                                           HIGH          LOW
                                         ---------    ---------
                                                
FISCAL YEAR ENDED DECEMBER 31, 1997
Second Quarter (from June 12, 1997).....   7 3/8        4 41/64
Third Quarter...........................  11 53/64      6 7/32
Fourth Quarter..........................  17 11/16      9 33/64
 
FISCAL YEAR ENDED DECEMBER 31, 1998
First Quarter...........................  28 3/64      13 29/32
Second Quarter..........................  37 3/8       19 3/8
Third Quarter...........................  23            9 11/16
Fourth Quarter..........................  18            7 1/8

 
    The last reported sale price of the Common Stock on the Nasdaq National
Market on March 17, 1999 was $10 13/16 per share. As of March 17, 1999, there
were 177 holders of record of the Company's Common Stock.
 
    The Company has never paid cash dividends on its Common Stock and has no
intention of paying cash dividends in the foreseeable future. The Company
anticipates that all future earnings, if any, generated from operations will be
retained by the Company to develop and expand its business. Any future
determination with respect to the payment of dividends will be at the discretion
of the Board of Directors and will depend upon, among other things, the
Company's operating results, financial condition and capital requirements, the
terms of then-existing indebtedness, general business conditions and such other
factors as the Board of Directors deems relevant. In addition, the Company's
existing revolving credit facility prohibits the payment of cash dividends
without the lender's consent.
 
    The Company issued and sold the following unregistered securities during
1998, which amounts have been adjusted to reflect the Stock Split:
 
    1.  On March 10, 1998, the Registrant issued 1,353,000 shares of its Common
Stock in exchange for all of the outstanding capital stock of T-One Corp. in a
transaction valued at $25,080,000.
 
    2.  During the year ended December 31, 1998, the Registrant granted to
employees and directors options to purchase an aggregate of approximately
1,026,925 shares of Common Stock pursuant to stock option agreements and the
Registrant's stock option plans.
 
    The sales and issuances described above were deemed to be exempt from
registration under the Securities Act in reliance upon Section 4(2) thereof, as
transactions by an issuer not involving any public offering, Regulation S of the
Securities Act, or in reliance upon the exemption from registration provided by
Rule 701 promulgated under the Securities Act. In addition, the recipients of
securities in each such transaction represented their intentions to acquire the
securities for investment only and not with a view to or for sale in connection
with any distribution thereof and appropriate legends were affixed to the share
certificates issued in such transactions. All recipients had adequate access,
through their relationships with the Registrant, to information about the
Registrant.
 
                                       27

ITEM 6. SELECTED FINANCIAL DATA.
 
    The following selected consolidated financial data should be read in
conjunction with the Company's Consolidated Financial Statements and Notes
thereto and with "Management's Discussion and Analysis of Financial Condition
and Results of Operations," each of which is included elsewhere in this Form
10-K. The consolidated statements of operations data for the years ended
December 31, 1996, 1997, and 1998 and the balance sheet data at December 31,
1997 and 1998 are derived from audited financial statements included elsewhere
in this Form 10-K. 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 statement of operations data for
the year ended December 31, 1995 and the balance sheet data at December 31, 1995
and 1996 are derived from audited financial statements not included in this Form
10-K.
 


                                                                        YEAR ENDED DECEMBER 31,
                                                       ----------------------------------------------------------
                                                                      1995        1996        1997        1998
                                                                    ---------  ----------  ----------  ----------
                                                          1994
                                                       -----------
                                                       (UNAUDITED)
                                                                 (IN THOUSANDS, EXCEPT PER SHARE DATA)
                                                                                        
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Revenues.............................................   $  24,512   $  58,937  $  259,697  $  404,605  $  595,540
Operating expenses:
  Cost of services...................................      16,042      44,270     225,957     351,821     504,281
  Selling, general and administrative................       5,066      10,452      35,956      36,496      56,121
  Depreciation and amortization......................         106         368       1,442       4,637      13,112
  Merger expense.....................................          --          --          --         286         361
                                                       -----------  ---------  ----------  ----------  ----------
  Total operating expenses...........................      21,214      55,090     263,355     393,240     573,875
                                                       -----------  ---------  ----------  ----------  ----------
  Income (loss) from operations......................       3,298       3,847      (3,658)     11,365      21,665
Other income (expenses):
  Interest income....................................           3          22         110         492       4,849
  Interest expense...................................          --         (64)       (609)     (1,738)     (2,828)
  Legal settlements and expenses.....................          --          --        (100)     (1,653)         --
  Other..............................................          (7)        (33)         39         208        (304)
                                                       -----------  ---------  ----------  ----------  ----------
  Income (loss) before provision for income taxes....       3,294       3,772      (4,218)      8,674      23,382
Provision for income taxes...........................          22          66         577       2,905       9,923
                                                       -----------  ---------  ----------  ----------  ----------
Net income (loss)....................................   $   3,272   $   3,706  $   (4,795) $    5,769  $   13,459
                                                       -----------  ---------  ----------  ----------  ----------
                                                       -----------  ---------  ----------  ----------  ----------
Pro forma net income (loss) (unaudited)(1)...........   $   1,943   $   2,140  $   (5,738) $    5,574
                                                       -----------  ---------  ----------  ----------
                                                       -----------  ---------  ----------  ----------
Basic income (loss) per common share(2)..............   $    0.18   $    0.19  $    (0.21) $     0.19  $     0.34
                                                       -----------  ---------  ----------  ----------  ----------
                                                       -----------  ---------  ----------  ----------  ----------
Diluted income (loss) per common share(2)............   $    0.18   $    0.19  $    (0.21) $     0.17  $     0.32
                                                       -----------  ---------  ----------  ----------  ----------
                                                       -----------  ---------  ----------  ----------  ----------
Pro forma basic income (loss) per common share
  (unaudited)(2).....................................   $    0.11   $    0.11  $    (0.25) $     0.18
                                                       -----------  ---------  ----------  ----------
                                                       -----------  ---------  ----------  ----------
Pro forma diluted income (loss) per common share
  (unaudited)(2).....................................   $    0.11   $    0.11  $    (0.25) $     0.17
                                                       -----------  ---------  ----------  ----------
                                                       -----------  ---------  ----------  ----------
Weighted average number of common shares
  outstanding--basic(2)..............................      18,218      19,373      23,292      30,221      39,924
Weighted average number of diluted common shares
  outstanding--diluted(2)............................      18,218      19,373      23,292      32,978      41,525

 
                                       28

 


                                                                           AS OF DECEMBER 31,
                                                       ----------------------------------------------------------
                                                                      1995        1996        1997        1998
                                                                    ---------  ----------  ----------  ----------
                                                          1994
                                                       -----------
                                                       (UNAUDITED)           (IN THOUSANDS)
                                                                                        
CONSOLIDATED BALANCE SHEET DATA:
Working capital (deficit)............................   $   2,135   $     976  $   (7,729) $   14,546  $   64,377
Total assets.........................................       9,081      26,582      63,054     121,102     372,134
Total long-term liabilities, net of current
  portion............................................          21         919       6,839      13,756      32,908
Retained earnings (deficit)..........................       1,377         867      (3,238)      1,534      14,993
Stockholders' equity.................................       2,956       3,808       6,897      43,201     209,612

 


                                                                      YEAR ENDED DECEMBER 31,
                                                   --------------------------------------------------------------
                                                                  1995        1996         1997          1998
                                                                ---------  ----------  ------------  ------------
                                                      1994
                                                   -----------
                                                   (UNAUDITED)   (IN THOUSANDS, EXCEPT MINUTE DATA)
                                                                                      
OTHER CONSOLIDATED FINANCIAL AND OPERATING DATA:
Capital expenditures(3)..........................   $     515   $   2,716  $   13,646  $     25,422  $    146,849
North American wholesale billed minutes of
  use(4).........................................          --      38,106     479,681     1,034,187     1,657,523
North American wholesale revenue per billed
  minute of use(5)...............................   $      --   $  0.4102  $   0.4288  $     0.3612  $     0.3145

 
- ------------------------
 
(1) The pro forma net income or loss per share assumes that both STAR and CEO,
    which was acquired by STAR in a pooling of interests transaction on November
    30, 1997, were C-corporations for all periods presented.
 
(2) See Note 2 of Notes to Consolidated Financial Statements for an explanation
    of the method used to determine the number of shares used in computing basic
    and diluted income (loss) per common share and pro forma basic and diluted
    income (loss) per common share.
 
(3) Includes assets financed with capital leases or notes. See Note 2 of Notes
    to Consolidated Financial Statements.
 
(4) Does not include wholesale billed minutes of use from T-One prior to the
    year ended December 31, 1997.
 
(5) Represents wholesale gross call usage revenue per billed minute. Amounts
    exclude other revenue related items such as finance charges. This data does
    not include wholesale billed minutes of use from T-One prior to the year
    ended December 31, 1997.
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS 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, EACH OF WHICH IS INCLUDED ELSEWHERE IN THIS FORM 10-K. THIS
DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS, AS DEFINED IN SECTION 27A OF THE
SECURITIES ACT AND SECTION 21E OF 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" AND ELSEWHERE IN
THIS FORM 10-K.
 
                                       29

OVERVIEW
 
    STAR is a multinational telecommunications services company focused
primarily on the international long distance market. STAR 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 200 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.
 
    STAR installed its first international gateway switch in Los Angeles in June
1995 and initially recognized wholesale revenues through this switch in August
1995. A significant portion of STAR's revenues in 1994 and 1995 were generated
by the commercial operations of CEO.
 
    REVENUES.  Most of STAR's revenues are generated by the sale of
international long distance services on a wholesale basis to other, primarily
domestic, long distance providers. STAR records revenues from the sale of long
distance services at the time of customer usage. STAR'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.
 
    Historically, STAR has increased revenues from quarter to quarter, often
times by a significant percentage. STAR's North American wholesale minutes of
use have also greatly increased from quarter to quarter, generally by amounts
that exceed the relative increases in revenues. For example, in the year ended
December 31, 1998, North American wholesale revenues increased by 42.0% over
revenues for 1997. Over the same period to period comparison, North American
minutes of wholesale use increased by 60.3%. There are a variety of reasons for
the growth in STAR's call volume, including growth of STAR's North American
customer base, which increased by 43.8% from 1997 to 1998, increased usage by
existing North American customers, and increased capacity over STAR's
telecommunications network, with the addition of a number of switches and growth
in available fiber optic lines.
 
    The growth in North American wholesale minutes has been accompanied by a
corresponding decline in North American rates per minute. For example, for the
year ended December 31, 1998, such rates declined by 12.9% from wholesale rates
per minute in 1997. The decline in wholesale rates can be attributed to a number
of factors, including a changing country mix that includes a growing number of
minutes routed by STAR to lower rates per minute countries such as Mexico,
Germany and the United Kingdom and, as the wholesale international long distance
market continues to mature and evolve, a general downward trend in rates on
competitive routes. STAR's pricing for wholesale minutes varies materially from
customer to customer and is generally based on the time of day, the day of the
week and the destination of the call. While STAR continues to route traffic to
certain destinations at attractive rates, market conditions have forced STAR to
reduce its overall wholesale rates per minute.
 
    Accordingly, STAR believes that the growth in its revenues has been fueled
almost entirely by STAR's ability to increase the volume of North American
wholesale minutes of use, for the reasons noted above. At the same time, the
general erosion in the rates per minute for such wholesale traffic has partially
offset the contribution to the increase of revenues made by such increased
volume of minutes.
 
    STAR completed its acquisition of T-One in March 1998. Revenues from T-One's
operations for the periods set forth below were not material to the overall
result of operations of STAR during such periods.
 
    COSTS OF SERVICES (EXCLUSIVE OF DEPRECIATION AND AMORTIZATION).  STAR has
pursued a strategy of attracting customers and building calling volume and
revenue by offering favorable rates compared to other long distance providers.
STAR continues to lower its cost of services (exclusive of depreciation and
amortization) by (i) expanding STAR's owned network facilities, (ii) continuing
to utilize STAR's sophisticated information systems to route calls over the most
cost-effective routes and (iii) leveraging STAR's traffic volumes and
information systems to negotiate lower variable usage-based costs with domestic
and foreign providers of transmission capacity.
 
                                       30

    Costs of services (exclusive of depreciation and amortization) include those
costs associated with the transmission and termination of international long
distance services. Currently, a majority of transmission capacity used by STAR
is obtained on a variable, per minute basis. As a result, some of STAR's current
costs of services (exclusive of depreciation and amortization) are variable.
STAR'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 STAR's
longer term arrangements requiring STAR to meet minimum usage commitments in
order to avoid penalties. Such variability and the short-term nature of many of
the contracts subject STAR 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. Costs of services (exclusive
of depreciation and amortization) also include fixed costs associated with the
leasing of network facilities.
 
    STAR recently began to provide international long distance services to
commercial customers in certain European countries, including Germany. STAR
began providing long distance service to commercial markets in the U.S. with its
acquisition of CEO in November 1997. STAR believes that traffic from commercial
customers will be more profitable than wholesale traffic. STAR expects that an
expansion into this market will increase the risk of bad debt exposure and lead
to higher overhead costs.
 
    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.
 
    OTHER OPERATING EXPENSES.  Selling, general and administrative expenses
consist primarily of personnel costs, tradeshow and travel expenses, commissions
and consulting fees, as well as 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.
STAR 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 STAR's network facilities, its sales and marketing
efforts and STAR's expansion into commercial markets.
 
    FOREIGN EXCHANGE.  STAR's revenues and cost of long distance services are
sensitive to foreign currency fluctuations. STAR expects that an increasing
portion of STAR'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 STAR's results of operations. See "Quantitative and Qualitative Disclosures
About Market Risk."
 
    FACTORS AFFECTING FUTURE OPERATING RESULTS.  STAR'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.
 
    STAR'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. STAR'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
 
                                       31

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 STAR
is obtained on a variable, per minute and short-term basis, subjecting STAR 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 results are subject to significant
fluctuations over short periods of time. STAR's operating results also may be
negatively impacted in the longer term by competitive pricing pressures.
 
RECENT ACQUISITIONS AND DEVELOPMENTS
 
    STAR has recently acquired the following companies and has taken the
following actions:
 
    - T-ONE CORP. On March 10, 1998, STAR acquired T-One for 1,353,000 shares of
      Common Stock in a transaction accounted for as a pooling of interests. All
      financial data presented has been restated to include the results of
      operations, financial position and cash flows of T-One.
 
    - STOCK SPLIT. On March 31, 1998, STAR effected a 2.05-for-1 stock split
      with payment to the holders of the shares of Common Stock outstanding on
      February 20, 1998 of a stock dividend equal to 1.05 shares of Common Stock
      for each such outstanding share.
 
    - PUBLIC OFFERING. On May 4, 1998, STAR consummated a firmly underwritten
      public offering of 6,000,000 shares of Common Stock, of which 5,685,000
      shares were sold by STAR and 315,000 shares were sold by a certain
      stockholder of STAR. On June 4, 1998, an additional 30,900 shares of
      Common Stock were sold by a certain stockholder of STAR to cover an
      over-allotment option for the offering.
 
    - PT-1 COMMUNICATIONS, INC. On August 20, 1998, the Company entered into the
      PT-1 Merger Agreement. Per the agreement, the Company issued 15,050,000
      shares of Common Stock and $19,500,000 in short term promissory notes for
      all outstanding shares, options and warrants of PT-1, plus an additional
      250,000 shares of Common Stock to certain independent distributors of
      PT-1. The PT-1 Merger was consummated on February 4, 1999 and will be
      accounted for as a purchase.
 
    - UNITED DIGITAL NETWORK, INC. On March 24, 1999, STAR completed the
      acquisition of UDN for approximately 1 million shares of Common Stock in a
      transaction to be accounted for as a pooling of interests.
 
                                       32

RESULTS OF OPERATIONS
 
    The following table sets forth certain selected items in STAR's statements
of operations as a percentage of total revenues for the periods indicated:
 


                                                                                    YEAR ENDED DECEMBER 31,
                                                                               ---------------------------------
                                                                                  1996        1997       1998
                                                                               -----------  ---------  ---------
                                                                                              
Revenues.....................................................................      100.0%       100.0%     100.0%
Operating Expenses:
  Cost of services...........................................................       87.0         87.0       84.7
  Selling, general and administrative expenses...............................       13.8          9.1        9.5
  Depreciation and amortization..............................................        0.6          1.1        2.2
                                                                                   -----    ---------  ---------
    Total operating expenses.................................................      101.4         97.2       96.4
Income (loss) from operations................................................       (1.4)         2.8        3.6
                                                                                   -----    ---------  ---------
Income (loss) before provision for income taxes..............................       (1.6)         2.1        3.9
Provision for income taxes...................................................        0.2          0.7        1.7
                                                                                   -----    ---------  ---------
Net income (loss)............................................................       (1.8)%        1.4%       2.3%
                                                                                   -----    ---------  ---------
                                                                                   -----    ---------  ---------
Pro forma net income (loss)..................................................       (2.2)%        1.4%
                                                                                   -----    ---------
                                                                                   -----    ---------

 
YEARS ENDED DECEMBER 31, 1998 AND 1997
 
    REVENUES:  Total revenues increased 47.2% to $595.5 million in 1998 from
$404.6 million in 1997 primarily as a result of the continued growth in North
America wholesale operations, as described below.
 
    Revenues from North American wholesale customers increased 42.0% to $535.3
million in 1998 from $377.1 million in 1997. Minutes of use generated by North
American wholesale customers increased 60.3% to 1.7 billion minutes of use in
1998, as compared to 1 billion minutes of use in 1997. The increase in revenues
and minutes of use reflects the growth in the number of North American wholesale
customers from 105 in 1997 to 151 at the end of 1998, as well as an increase in
usage by existing customers, primarily resulting from the Company's expanding
transmission capacity. The increase in revenues was partially offset by a
decline in rates per minute, as average North American wholesale rate per minute
of use declined from $0.36 cents per minute in 1997 to $0.31 cents per minute in
1998, reflecting continued lower prices on competitive routes. The decline in
rates per minute is also attributable to the change in country mix to include a
larger proportion of lower rate per minute countries such as Mexico, Germany and
the United Kingdom. The period to period decline in rates per minute was not a
significant factor in the relative increase in minutes of use.
 
    North American commercial revenues increased 13.1% to $31.1 million in 1998
from $27.5 million in 1997 reflecting the continued success of new international
rate plans that target ethnic markets for Latin America and the Pacific Rim. The
average North American commercial rate per minute of use increased from $0.26
cents per minute in 1997 to $0.34 cents per minute in 1998, reflecting the
continued success at targeting markets with higher rates in the international
market.
 
    In 1998 revenues generated from the European operations totaled $29.2
million. Management believes that the prospects for growth in Germany remain
strong as Star Telecommunications Deutschland GmbH is fully utilizing its
interconnect with Deutsche Telekom, AG as well as other European PTTs, to lower
the Company's cost of services and to grow its European commercial customer
base.
 
    COST OF SERVICES (EXCLUSIVE OF DEPRECIATION AND AMORTIZATION):  Total cost
of services (exclusive of depreciation and amortization) increased 43.3% to
$504.3 million in 1998 from $351.8 million in 1997 and decreased as a percentage
of total revenues for the same periods to 84.7% from 87.0%.
 
    Cost of services (exclusive of depreciation and amortization) from North
American wholesale vendors increased 35.1% to $453.2 million in 1998 from $335.5
million in 1997 and decreased as a percentage of
 
                                       33

North American wholesale revenues for the same periods to 84.7% from 89.0%.
North American commercial cost of services (exclusive of depreciation and
amortization) increased 11.0% to $18.1 million in 1998 from $16.3 million in
1997 and decreased as a percentage of North American commercial revenues for the
same periods to 58.2% from 59.3%. The year ended 1998 also includes cost of
services (exclusive of depreciation and amortization) of $33.0 million generated
from the European operations. The growth in cost of services (exclusive of
depreciation and amortization) reflects the increase in minutes of use as well
as an increase in leased private line cost offset by an overall declining
average cost per minute. The average cost per minute declined as a result of
changes in country mix to include a larger proportion of lower cost per minute
countries, competitive pricing pressures as well as an increasing proportion on
traffic routed over the Company's proprietary network. The Company currently
routes to 51 countries on its global network up from 24 countries in 1997.
Management believes that countries will continue to be added to the Company's
global network thereby contributing to an overall decline in cost per minute.
 
    SELLING, GENERAL AND ADMINISTRATIVE:  In 1998, total selling, general and
administrative expenses, exclusive of merger expenses, increased 53.8% to $56.1
million from $36.5 million in 1997 and increased as a percentage of revenues to
9.4% from 9.0% over the comparable periods, due primarily to an increased sales
force, as described below. North American wholesale selling, general and
administrative expenses increased 26.8% to $32.6 million in 1998 from $25.7
million in 1997 and decreased as a percentage of North American wholesale
revenue to 6.1% from 6.8%, respectively.
 
    North American commercial selling, general and administrative expense
increased 31.9% to $12.4 million in 1998 from $9.4 million in 1997 and increased
as a percentage of North American commercial revenues to 39.9% during the period
from 34.2% in 1997, reflecting the expansion of the telemarketing sales force to
focus on new ethnic markets. The Company expects North American commercial
selling, general and administrative costs to continue to increase as a
percentage of revenues as additions to the sales force are hired to expand
STAR's North American commercial customer base.
 
    Selling, general and administrative expenses related to the European
operations amounted to $11.1 million in 1998 and $1.4 million in 1997 reflecting
the start up of new business efforts in Europe. The Company expects overall
selling, general and administrative expenses to continue to grow as a percentage
of revenues as the Company adds personnel to staff its German operations and to
initiate carrier operations in additional European countries.
 
    DEPRECIATION AND AMORTIZATION:  In 1998, depreciation expense attributable
to North American assets amounted to $9.1 million and European operations
realized total depreciation of $4.0 million. In 1998, total depreciation
increased as a percentage of revenues to 2.2% from 1.1% for 1997. Depreciation
expense 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 continue to increase as a percentage of revenues as it continues to
expand its global telecommunications network. As of July 1, 1998, STAR revised
the remaining lives of certain operating equipment from five to ten years. This
charge reduced depreciation expenses and increased income before income taxes by
approximately $2.0 million.
 
    INCOME FROM OPERATIONS:  Income from operations increased 90.6% to $21.7
million during 1998 from $11.4 million in 1997. Operating margin increased to
3.6% from 2.8%, respectively. Operating margin is expected to expand as STAR
continues to diversify its revenue base and as traffic is migrated from leased
facilities onto STAR's owned network. Offsetting the declining cost of services
on a per minute basis were the startup costs of launching operations in Europe
and the expansion of the North American based commercial operations.
 
    OTHER INCOME (EXPENSE):  Other income (expense), net, increased to $1.7
million in 1998 from a net expense of $2.7 million in 1997. Interest income grew
to $4.8 million in 1998 from $492,000 in 1997 as a result of interest earned on
investing proceeds from the Company's secondary equity offering in May 1998.
 
                                       34

Interest expense increased to $2.8 million in 1998 from $1.7 in 1997 in response
to the additional capital leases for the financing of new switches.
 
    PROVISION FOR INCOME TAXES:  The provision for income taxes increased to
$9.9 million in 1998 from $2.9 million in 1997 primarily due to the increase in
profitability of STAR.
 
YEARS ENDED DECEMBER 31, 1997 AND 1996.
 
    REVENUES:  Revenues increased 55.8% to $404.6 million in 1997 from $259.7
million in 1996. Wholesale revenues increased to $377.1 million from $229.8
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 minute of
use. Wholesale minutes or average rate per minute computations do not include
the revenue or minutes of T-One in 1996 and 1997; in 1997 T-One wholesale
minutes and average rate per minute were 170.9 million and $0.17, respectively.
 
    Commercial revenues decreased to $27.5 million in 1997 from $29.9 million in
1996 reflecting the termination of the CEO customer base in California due to
the 1997 settlement entered into by CEO 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. See "Business
of STAR--Governmental Regulation-- Actions Against CEO."
 
    COST OF SERVICES (EXCLUSIVE OF DEPRECIATION AND AMORTIZATION):  Cost of
services (exclusive of depreciation and amortization) increased 55.7% to $351.8
million in 1997 from $226.0 million in 1996. Wholesale cost of services
(exclusive of depreciation and amortization) increased to $335.5 million in 1997
from $208.8 million for 1996 and as a percentage of wholesale revenues decreased
to 89.0% from 90.9%, 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 CEO
commercial customer base onto STAR's network, CEO's cost of commercial long
distance services (exclusive of depreciation and amortization) is expected to
decline.
 
    SELLING, GENERAL AND ADMINISTRATIVE:  In 1997, selling, general and
administrative expenses (exclusive of merger related costs of $286,000)
increased 1.5% to $36.5 million, from $36.0 million in 1996. Wholesale selling,
general and administrative expenses increased to $27.1 million in 1997 from
$25.4 million in 1996, but decreased as a percentage of wholesale revenues to
7.2% from 11.1% 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.
 
                                       35

    DEPRECIATION AND AMORTIZATION:  Depreciation increased to $4.6 million for
1997 from $1.4 million for 1996, and increased as a percentage of revenues to
1.1% from 0.6% 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 $2.7 million in
1997 from $560,000 in 1996. This increase is primarily due to interest expense
of $1.7 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 CEO with the California PUC and the
District Attorney of Monterey County. See "Business--Governmental
Regulation--Actions Against CEO." 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 $577,000 in 1996 primarily due to the
increase in profitability of STAR.
 
LIQUIDITY AND CAPITAL RESOURCES.
 
    As of December 31, 1998, STAR had cash and cash equivalents of approximately
$46.7 million, short-term investments of $0.8 million (as a result of STAR's
secondary stock offering), and a working capital surplus of $64.4 million.
 
    On May 4, 1998, STAR completed a secondary offering of 6,000,000 shares of
Common Stock of which 5,685,000 shares were sold by STAR and 315,000 shares were
sold by a selling stockholder. The net proceeds to STAR (after deducting
underwriting discounts and offering expenses) from the sale of such shares of
Common Stock were approximately $145.0 million.
 
    As of December 31, 1998, STAR had $19.3 million outstanding on its $25
million revolving line of credit, which bears interest at the bank's cost of
funds plus 175.0 basis points and expires on July 1, 1999. Available borrowing
under the line of credit is further reduced by outstanding letters of credit in
the amount of $5.5 million.
 
    At December 31, 1998, STAR had capital lease obligations of $37.5 million,
and $0.5 million in term loans, relating to its switching facilities and
operating equipment.
 
    STAR used net cash from operating activities of $13.8 million for the twelve
months ended December 31, 1998, primarily from net income exclusive of
depreciation and amortization, as well as increases in accounts payable and
accrued expenses offset by increases in accounts and other receivables. The
increase in accounts and other receivables were due to general increases in
volume and extended payment terms for certain customers. The Company's investing
activities used cash of $100.7 million during the twelve months ended December
31, 1998, primarily from capital expenditures, offset by the sales of short-term
investments. The Company's financing activities generated cash of approximately
$159.0 million primarily from $144.7 million net proceeds raised in the
secondary stock offering as well as stock options exercised and borrowings under
lines of credit, offset by payments under capital lease obligations.
 
    On February 19, 1999, STAR announced that it had received a fully
underwritten commitment for $275 million in senior secured credit facilities.
The completion of the financing is subject to the execution of definitive loan
documents and customary conditions for financings of this type.
 
    The Company also entered into a 20 year, $85 million agreement to purchase
capacity on the Qwest nationwide Macro Capacity (SM) Fiber network. Remaining
commitments under this agreement at March 31, 1999 equaled $85.0 million.
 
                                       36

    STAR believes that the cash generated from operations, as well as funding
under its bank line of credit and the senior secured credit facility, will
satisfy STAR's current liquidity needs. Nevertheless, as STAR continues to
expand its network facilities and pursues its strategy of growth through
acquisitions, STAR's liquidity needs may increase, perhaps significantly, which
could require STAR to seek such additional financing or the expansion of its
borrowing capacity under current or new lines of credit.
 
    As appropriate, STAR will use capital lease financing or raise additional
debt or equity capital to finance new projects or acquisitions. STAR had foreign
currency contracts outstanding at December 31, 1997 and 1998 in the notional
amount of $6.3 million and $35 million, respectively.
 
    While the termination of the CEO customer base in California resulted in a
loss of commercial revenues from that state during 1998, management does not
believe that the loss of such revenues will have a material impact on STAR's
liquidity in the future.
 
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 July 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 July 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 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.
 
    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 the remainder of 1998 and throughout 1999. STAR estimates the
costs of such efforts will be between $70,000 and $150,000 over the life of the
project; though such expenditures may increase materially following testing of
non-information technology systems and the evaluation of the Year 2000
compliance status of integral third party vendors and customers. Costs incurred
to date in connection with STAR's Year 2000 compliance efforts have been
immaterial and will be expensed as incurred.
 
                                       37

    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 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
 
    FOREIGN CURRENCY RISK.  As a global enterprise, the Company faces exposure
to adverse movements in foreign currency exchange rates. The Company's foreign
currency exposures may change over time as the level of activity in foreign
markets grows and could have a material adverse impact upon the Company's
financial results.
 
    Certain of the Company's assets, including certain bank accounts and
accounts receivable, exist in nondollar-denominated currencies, which are
sensitive to foreign currency exchange rate fluctuations. The
nondollar-denominated currencies are principally German Deutschmarks and British
Pounds Sterling. Additionally, certain of the Company's current and long-term
liabilities are denominated principally in German Deutschmarks and British
Pounds Sterling currencies, which are also sensitive to foreign currency
exchange rate fluctuations.
 
    The Company employs hedges in order to mitigate foreign currency exposures
and intends to do so in the future, in the appropriate circumstances. The
success of this activity depends upon the estimation of international cash flow
and intercompany balances denominated in various currencies, primarily the
German Deutschmark. To the extent that these forecasts are over- or understated
during periods of currency volatility, the Company could experience
unanticipated currency gains or losses.
 
    In December 1998, the Company entered into a currency rate swap agreement
(the "Swap") with a bank in the amount of $35,000,000 denominated in German
Deutschmarks. The Swap committed the Company to buy and sell currencies at the
same rate of exchange and was established in order to eliminate the possibility
of gains or losses due to currency fluctuations during its duration. The term of
the Swap was for seven days over the fiscal year-end, culminating on January 4,
1999.
 
    INTEREST RATE RISK.  As of December 31, 1998 the Company had borrowings
under its line of credit facility amounting to $19.3 million. The interest rate
on the line of credit is equal to the London Interbank Offered Rate (LIBOR) plus
1.75%. At any time, a sharp rise in interest rates could have a material adverse
impact upon the Company's cost of working capital and the interest expense. The
Company does not currently hedge this interest rate exposure.
 
    In addition, the Company had borrowings under long-term debt for capital
equipment amounting to $471,000 at December 31, 1998. The interest rate on this
long-term debt is equal to LIBOR plus 6.0%. At any time, a sharp rise in
interest rates could have a material adverse impact upon the Company's cost of
working capital and interest expense. The Company does not currently hedge this
interest rate exposure.
 
    The following table presents the hypothetical impact on the Company's
financial results for changes in interest rates for variable rate obligations
held by the Company at December 31, 1998. The modeling
 
                                       38

technique used measures the change in the Company's results arising from
selected potential changes in interest rates. Market rate changes reflect
immediate hypothetical parallel shifts in the yield curve of plus or minus 50
basis points ("BPS"), 100 BPS, and 150 BPS over a twelve month time horizon.
 
                        INTEREST RATE EXPOSURE ANALYSIS
  INCREASE OR (DECREASE) IN ANNUAL INTEREST EXPENSE DUE TO CHANGES IN INTEREST
                                     RATES
                             (DOLLARS IN THOUSANDS)
 


DESCRIPTION                                          50 BPS       100 BPS      150 BPS     (50) BPS     (100) BPS    (150) BPS
- -------------------------------------------------  -----------  -----------  -----------  -----------  -----------  -----------
                                                                                                  
Line of Credit(1)................................   $      97    $     193    $     290    $     (97)   $    (193)   $    (290)
Long-Term Debt...................................   $       2    $       5    $       7    $      (2)   $      (5)   $      (7)

 
- ------------------------
 
(1) Actual rate reflects the bank's cost of funds plus 1.75%. Historically the
    banks' cost of funds approximates LIBOR.
 
ITEM 8. FINANCIAL STATEMENTS.
 
    See the Index included at "Item 14. Exhibits, Financial Statement Schedules
and Reports on Form 10-K.
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
  FINANCIAL DISCLOSURE.
 
    None.
 
                                       39

                                    PART III
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
 
    The officers and directors of the Company and their ages as of March 26,
1999 are as follows:
 


NAME                               AGE                               POSITION
- ---------------------------------  ---   -----------------------------------------------------------------
                                   
Christopher E. Edgecomb(1).......  40    Chief Executive Officer, Chairman of the Board and Director
 
Mary A. Casey(1)(2)..............  36    President, Secretary and Director
 
David Vaun Crumly................  35    Executive Vice President--Sales and Marketing
 
James E. Kolsrud.................  54    Executive Vice President--Operations and Engineering
 
Kelly D. Enos....................  40    Chief Financial Officer, Treasurer and Assistant Secretary
 
Mark Gershien....................  47    Director
 
Gordon Hutchins, Jr.(3)..........  49    Director
 
John R. Snedegar(2)(3)...........  49    Director
 
Arunas A. Chesonis...............  36    Director
 
Samer Tawfik.....................  33    Director

 
- ------------------------
 
(1) Member of Non-Executive Stock Option Committee
 
(2) Member of Audit Committee
 
(3) Member of Compensation Committee
 
    CHRISTOPHER E. EDGECOMB co-founded the Company in September 1993, served as
President of STAR until January 1996 and has served as STAR's Chief Executive
Officer and Chairman of the Board since January 1996. Mr. Edgecomb has been a
Director of STAR since its inception. Prior to that time, Mr. Edgecomb was a
founder and the Executive Vice President of West Coast Telecommunications
("WCT"), a nation-wide long distance carrier, from August 1989 to December 1994.
Prior to founding WCT, Mr. Edgecomb was President of Telco Planning, a
telecommunications consulting firm, from January 1986 to July 1989. Prior to
that time, Mr. Edgecomb held senior level sales and marketing positions with TMC
Communications, American Network and Bay Area Teleport.
 
    MARY A. CASEY has been a Director and Secretary of STAR since co-founding
STAR in September 1993, and has served as STAR's President since January 1996.
Prior to that time, Ms. Casey was Director of Customer Service at WCT from
December 1991 to June 1993, and served as Director of Operator Services at Call
America, a long distance telecommunications company, from May 1988 to December
1991.
 
    DAVID VAUN CRUMLY has served as STAR's Executive Vice President--Sales and
Marketing since January 1996. Prior to that time, Mr. Crumly served as a
consultant to the Company from November 1995 to January 1996, was Vice President
of Carrier Sales of Digital Network, Inc. from June 1995 to November 1995 and
was Director of Carrier Sales of WCT from June 1992 to June 1995. Prior to
joining WCT, Mr. Crumly served in various sales and marketing capacities with
Metromedia, a long-distance company, from September 1990 to June 1992 and with
Claydesta, a long-distance company, from May 1987 to September 1989.
 
    JAMES E. KOLSRUD has served as the Company's Executive Vice
President--Operations and Engineering since September 1996. Prior to joining
STAR, Mr. Kolsrud was an international telecommunications consultant from March
1995 to September 1996. Prior to that time, he was a Vice President, Corporate
 
                                       40

Engineering and Administration of IDB Communications Group, Inc. ("IDB"), an
international communications company, from October 1989 to March 1995, and prior
to that time, he was President of the International Division of IDB.
 
    KELLY D. ENOS has served as the Company's Chief Financial Officer since
December 1996 and as Treasurer and Assistant Secretary since April 1997. Prior
to that time, Ms. Enos was an independent consultant in the merchant banking
field from February 1996 to November 1996 and a Vice President of Fortune
Financial, a merchant banking firm, from April 1995 to January 1996. Ms. Enos
served as a Vice President of Oppenheimer & Co., Inc., an investment bank, from
July 1994 to March 1995 and a Vice President of Sutro & Co., an investment bank,
from January 1991 to June 1994.
 
    MARK GERSHIEN has served as a Director of STAR since March 1998. Mr.
Gershien has been the Senior Vice President of Sales and Marketing for Level 3
Communications, a telecommunications and information services company, since
January 1998. Prior to that time, Mr. Gershien was the Senior Vice President of
National Accounts for WorldCom, Inc., an international telecommunications
company, and President and Chief Executive Officer of MFS Telecom, a division of
MFS Communications, Inc. prior to its merger with WorldCom, Inc.
 
    GORDON HUTCHINS, JR. has served as a Director of STAR since January 1996.
Mr. Hutchins has been President of GH Associates, a telecommunications
consulting firm, since July 1989. Prior to founding GH Associates, Mr. Hutchins
served as President and Chief Executive Officer of ICC Telecommunications, a
competitive access provider, and held senior management positions with several
other companies in the telecommunications industry.
 
    JOHN R. SNEDEGAR has served as a Director of the Company since January 1996.
Mr. Snedegar has been the President of UDN since June 1990. From June 1980 to
February 1992, Mr. Snedegar was the President and CEO of AmeriTel Management,
Inc., a provider of long distance telecommunications and management services.
Mr. Snedegar is also a director for StarBase Corporation, a software development
company, Micro General Corporation, a full service communications service
provider, TeleHub Communications Corporation, a long-distance technology company
and Techwave Inc., an electronic commerce software company. Mr. Snedegar also
serves as President of Kendall Venture Funding, Ltd., a reporting company in
Alberta, Canada.
 
    ARUNAS A. CHESONIS has served as a Director of STAR since May 1998. Mr.
Chesonis is presently the Chairman and Chief Executive Officer of PaeTec
Communications, Inc., a local exchange carrier located in Fairfield, New York.
From May 1987 to April 1998, Mr. Chesonis served in various executive positions
with ACC Corp. and its subsidiaries, including most recently President of ACC
Corp. and President and Chief Operating Officer of ACC Global Corp.
 
    SAMER TAWFIK has served as a Director of STAR since February 1999. Mr.
Tawfik founded PT-1 in April 1995 and has served as Chief Executive Officer of
PT-1 since that time. From 1984 to 1994, Mr. Tawfik was principal owner and
manager of three amusement companies.
 
BOARD COMPOSITION
 
    In accordance with the terms of the Company's Certificate of Incorporation,
the terms of office of the Board of Directors are divided into three classes:
Class I, whose term will expire at the annual meeting of stockholders to be held
in 2001; Class II, whose term will expire at the annual meeting of stockholders
to be held in 1999; and Class III, whose term will expire at the annual meeting
of stockholders to be held in 2000. The Class I directors are Gordon Hutchins,
Jr. and John R. Snedegar, the Class II directors are Mark Gershien, Mary A.
Casey and Samer Tawfik, and the Class III directors are Christopher E. Edgecomb
and Arunas A. Chesonis. At each annual meeting of stockholders after the initial
classification, the successors to directors whose term will then expire will be
elected to serve from the time of election and qualification
 
                                       41

until the third annual meeting following election. This classification of the
Board of Directors may have the effect of delaying or preventing changes in
control or changes in management of STAR.
 
    Each officer is elected by and serves at the discretion of the Board of
Directors of the Company. Each of STAR's officers and directors, other than
nonemployee directors, devotes substantially full time to the affairs of the
Company. STAR's nonemployee directors devote such time to the affairs of the
Company as is necessary to discharge their duties. There are no family
relationships among any of the directors and officers of STAR.
 
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
 
    Section 16(a) of the Exchange Act ("Section 16") requires the Company's
executive officers, directors and beneficial owners of more than 10% of the
Company's Common Stock (collectively, "Insiders") to file reports of ownership
and changes in ownership of Common Stock of the Company with the Securities and
Exchange Commission and to furnish the Company with copies of all Section 16
forms they file. The Company became subject to Section 16 in conjunction with
the registration of its Common Stock under the Exchange Act effective June 12,
1997. Based solely on its review of the copies of such forms received by it, or
written representations from certain reporting persons that no reports on Form 5
were required for those persons, the Company believes that its Insiders complied
with all applicable Section 16 filing requirements during 1998.
 
ITEM 11. EXECUTIVE COMPENSATION
 
EXECUTIVE COMPENSATION
 
    The following Summary Compensation Table sets forth the compensation earned
by STAR's Chief Executive Officer and four other executive officers who earned
(or would have earned) salary and bonus in excess of $100,000 for services
rendered in all capacities to STAR and its subsidiaries (the "STAR Named
Officers") for each of the fiscal years in the three-year period ended December
31, 1998.
 
                           SUMMARY COMPENSATION TABLE
 


                                                                     LONG-TERM
                                                                    COMPENSATION
                                                                    ------------
                                                                     SECURITIES
                                   FISCAL                            UNDERLYING         ALL OTHER
NAME AND PRINCIPAL POSITION        YEAR  SALARY ($)     BONUS ($)    OPTIONS(#)      COMPENSATION($)
- ---------------------------------  ----  ----------     ---------   ------------   -------------------
                                                                    
Christopher E. Edgecomb .........  1998     360,000           --          --                  --
  Chief Executive Officer and      1997     360,000           --          --               3,202(1)
  Chairman of the Board            1996     360,000           --          --               9,223(1)
 
                                   1998     240,000           --          --              10,413(2)
                                   1997     217,500           --          --              13,615(2)
                                   1996     156,042           --          --              15,028(3)
Mary A. Casey ...................
  President and Secretary
 
David Vaun Crumly ...............  1998     351,005           --       4,200               7,000(2)
  Executive Vice President--Sales  1997     380,779          253          --               6,202(3)
  and Marketing                    1996     298,002        1,014     410,000               3,202(3)
 
James E. Kolsrud ................  1998     200,833          354       4,200               9,600(2)
  Executive Vice President--       1997     177,083        1,014          --               5,528(5)
  Operations and Engineering       1996      25,000           --     205,000                  --
 
                                   1998     160,833          259       4,200                  --
                                   1997     150,000        1,014      20,500              25,924(7)
                                   1996      12,500           --     153,750                  --
Kelly D. Enos(6) ................
  Chief Financial Officer and
  Treasurer

 
- ------------------------
 
(1) Consists of life and health insurance premiums paid by STAR.
 
                                       42

(2) Consists of a car allowance paid by STAR.
 
(3) Consists of life and health insurance premiums and a car allowance paid by
    STAR.
 
(4) Includes $231,005 of sales commissions.
 
(5) Consists of health insurance premiums paid by STAR.
 
(6) Ms. Enos joined STAR in December 1996.
 
(7) Consists of a moving allowance of $22,721 and life and health insurance
    premiums paid by STAR.
 
    The following table contains information concerning the stock option grants
made to each of the Company's Named Officers named below during the year ended
December 31, 1998.
 
                       OPTION GRANTS IN LAST FISCAL YEAR
 


                                                                                        POTENTIAL
                                                                                       REALIZABLE
                                                                                        VALUE OF
                                                                                     ASSUMED ANNUAL
                                           PERCENT OF                                     RATES
                                              TOTAL                                  OF STOCK PRICE
                              NUMBER OF      OPTIONS                                  APPRECIATION
                             SECURITIES    GRANTED TO      EXERCISE                    FOR OPTION
                             UNDERLYING     EMPLOYEES     PRICE PER                      TERM(1)
                               OPTIONS      IN FISCAL       SHARE       EXPIRATION   ---------------
NAME                         GRANTED (#)      YEAR          ($/SH)         DATE      5% ($)  10% ($)
- ---------------------------  -----------   -----------   ------------   ----------   ------  -------
 
                                                                           
David Vaun Crumly..........     4,100(2)        0.4%        $16.31       2/1/08      $42,054 $106,575
 
                                  100(4)       0.01%        $27.00       5/1/08      $1,698  $ 4,303
 
James E. Kolsrud...........     4,100(2)        0.4%        $16.31       2/1/08      $42,054 $106,575
 
                                  100(4)       0.01%        $27.00       5/1/08      $1,698  $ 4,303
 
Kelly D. Enos..............     4,100(3)        0.4%        $16.31      2/18/08      $42,054 $106,575
 
                                  100(4)       0.01%        $27.00       5/1/08      $1,698  $ 4,303

 
- ------------------------
 
(1) The 5% and 10% assumed annual rates of compounded stock price appreciation
    are mandated by rules of the Securities and Exchange Commission. There can
    be no assurance provided to any executive officer or any other holder of the
    Company's securities that the actual stock price appreciation over the
    10-year option term will be at the assumed 5% and 10% levels or at any other
    defined level. Unless the market price of the Company's Common Stock
    appreciates over the option term, no value will be realized from the option
    grants made to the executive officer.
 
(2) The option becomes exercisable in four equal annual installments on February
    1, 1999, 2000, 2001 and 2002, respectively.
 
(3) The option becomes exercisable in four equal annual installments on February
    18, 1999, 2000, 2001 and 2002.
 
(4) The option becomes exercisable in four equal annual installments on May 1,
    1999, 2000, 2001 and 2002.
 
                                       43

AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
 


                                                              NUMBER OF
                                                             UNEXERCISED      VALUE OF UNEXERCISED
                                SHARES                        OPTIONS AT      IN-THE-MONEY OPTIONS
                             ACQUIRED ON     (#) VALUE        FY-END (#)         AT FY-END ($)
NAME                           EXERCISE     REALIZED ($)   EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
- ---------------------------  ------------   ------------   ----------------   --------------------
                                                                  
 
David Vaun Crumly..........  136,666        3,580$,239.64   17,084/14,450     $183,268.61/$109,956.89
 
James E. Kolsrud...........   51,250          717$,500.00   51,250/106,700    $419,609.38/$839,218.75
 
Kelly D. Enos..............       --                  --    82,001/96,449     $656,879.44/$711,777.44

 
    No stock appreciation rights were exercised during 1998 nor were any
outstanding at the end of that year.
 
DIRECTOR COMPENSATION
 
    STAR's non-employee directors receive $2,000 for each Board meeting attended
and $1,000 for each telephonic Board meeting. In addition, each non-employee
director is reimbursed for out-of-pocket expenses incurred in connection with
attendance at meetings of the Board of Directors and its committees. In 1998,
Messrs. Hutchins, Snedegar and Gershien were each granted stock options to
purchase 20,250 shares of Common Stock, and Mr. Chesonis was granted stock
options to purchase 20,000 shares of Common Stock. See "Certain Relationships
and Related Transactions--Transactions with Outside Directors."
 
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
 
    The Compensation Committee of the Board of Directors (the "Compensation
Committee") was formed in May 1996, and, in 1998, the members of the
Compensation Committee were Gordon Hutchins, Jr. and John R. Snedegar. Neither
of these individuals was at any time during the year ended December 31, 1998, or
at any other time, an officer or employee of STAR. The Non-Executive
Compensation Committee of the Board of Directors (the "Non-Executive
Compensation Committee") was formed in 1997, and the members are Christopher E.
Edgecomb and Mary A. Casey. No member of the Compensation Committee or the
Non-Executive Compensation Committee served at any time during the year ended
December 31, 1998 as a member of the board of directors or compensation
committee of any entity that has one or more executive officers serving as a
member of the Company's Board of Directors, Compensation Committee or
Non-Executive Compensation Committee. The Compensation Committee and the
Non-Executive Compensation Committee shall collectively be referred to hereafter
as the "Compensation Committees." See "Certain Relationships and Related
Transactions" for information regarding the interests of Messrs. Snedegar and
Hutchins in certain transactions and arrangements involving the Company.
 
1997 OMNIBUS STOCK INCENTIVE PLAN
 
    The Company's 1997 Omnibus Stock Incentive Plan (as amended, the "Omnibus
Plan") was adopted by the Board of Directors on January 30, 1997 as the
successor to STAR's 1996 Supplemental Option Plan (the "Supplemental Plan").
STAR has issued and reserved for issuance an aggregate of 4,075,000 shares under
the Omnibus Plan, comprised of (i) the 2,050,000 shares that were available for
issuance under the Supplemental Plan, plus (ii) an increase of 2,025,000 shares.
As of December 31, 1998, 221,414 shares had been issued under the Supplemental
and Omnibus Plans, options for approximately 2,348,157 shares were outstanding
(696,274 of which were granted under the Supplemental Plan) and approximately
1,505,429 shares remained available for future grant. Shares of Common Stock
subject to outstanding options, including options granted under the Supplemental
Plan, which expire or terminate prior to exercise, will be available for future
issuance under the Omnibus Plan. In addition, if stock appreciation rights
("SARs")
 
                                       44

and stock units are settled under the Omnibus Plan, then only the number of
shares actually issued in settlement will reduce the number of shares available
for future issuance under this plan.
 
    Under the Omnibus Plan, employees, outside directors and consultants may be
awarded options to purchase shares of STAR Common Stock, SARs, restricted shares
and stock units. Options may be incentive stock options designed to satisfy
Section 422 of the Internal Revenue Code or nonstatutory stock options not
designed to meet such requirements. SARs may be awarded in combination with
options, restricted shares or stock units, and such an award may provide that
the SARs will not be exercisable unless the related options, restricted shares
or stock units are forfeited.
 
    The Omnibus Plan is administered by the Board or the Compensation Committees
(the "Administrator"). The Administrator has the complete discretion to
determine which eligible individuals are to receive awards; determine the award
type, number of shares subject to an award, vesting requirements and other
features and conditions of such awards; interpret the Omnibus Plan; and make all
other decisions relating to the operation of the Omnibus Plan.
 
    The exercise price for options granted under the Omnibus Plan may be paid in
cash or in outstanding shares of Common Stock. Options may also be exercised on
a cashless basis, by a pledge of shares to a broker or by promissory note. The
payment for the award of newly issued restricted shares will be made in cash. If
an award of SARs, stock units or restricted shares from STAR's treasury is
granted, no cash consideration is required.
 
    The Administrator has the authority to modify, extend or assume outstanding
options and SARs or may accept the cancellation of outstanding options and SARs
in return for the grant of new options or SARs for the same or a different
number of shares and at the same or a different exercise price.
 
    The Board may determine that an outside director may elect to receive his or
her annual retainer payments and meeting fees from STAR in the form of cash,
options, restricted shares, stock units or a combination thereof. The Board will
decide how to determine the number and terms of the options, restricted shares
or stock units to be granted to outside directors in lieu of annual retainers
and meeting fees.
 
    Upon a change in control, the Administrator may determine that an option or
SAR will become fully exercisable as to all shares subject to such option or
SAR. A change in control includes a merger or consolidation of STAR, certain
changes in the composition of the Board and acquisition of 50% or more of the
combined voting power of STAR's outstanding stock. In the event of a merger or
other reorganization, outstanding options, SARs, restricted shares and stock
units will be subject to the agreement of merger or reorganization, which may
provide for the assumption of outstanding awards by the surviving corporation or
its parent, their continuation by STAR (if STAR is the surviving corporation),
accelerated vesting and accelerated expiration, or settlement in cash.
 
    The Board may amend or terminate the Omnibus Plan at any time. Amendments
may be subject to stockholder approval to the extent required by applicable
laws. In any event, the Omnibus Plan will terminate on January 22, 2007, unless
sooner terminated by the Board.
 
1996 OUTSIDE DIRECTOR NONSTATUTORY STOCK OPTION PLAN
 
    The Company's 1996 Outside Director Nonstatutory Stock Option Plan (the
"Director Plan") was ratified and approved by the Board of Directors as of May
14, 1996. STAR has issued and reserved for issuance an aggregate of 410,000
shares of Common Stock under the Director Plan. As of December 31, 1998, 82,000
shares had been issued under the Director Plan, options for 71,500 shares were
outstanding and 256,500 shares remained available for future grant. If an
outstanding option expires or terminates unexercised, then the shares subject to
such option will again be available for issuance under the Director Plan.
 
                                       45

    Under the Director Plan, outside directors of the Company may receive
nonstatutory options to purchase shares of Common Stock. The Director Plan is
administered by the Board or the Compensation Committee (the "Administrator").
The Administrator has the discretion to determine which eligible individuals
will receive options, the number of shares subject to each option, vesting
requirements and any other terms and conditions of such options.
 
    The exercise price for options granted under the Director Plan will be at
least 85% of the fair market value of the Common Stock on the option grant date,
shall be 110% of the fair market value of the Common Stock on the option grant
date if the option is granted to a holder of more than 10% of the Common Stock
outstanding and may be paid in cash, check or shares of Common Stock. The
exercise price may also be paid by cashless exercise or pledge of shares to a
broker.
 
    The Administrator may modify, extend or renew outstanding options or accept
the surrender of such options in exchange for the grant of new options, subject
to the consent of the affected optionee.
 
    Upon a change in control, the Board may accelerate the exercisability of
outstanding options and provide an exercise period during which such accelerated
options may be exercised. The Board also has the discretion to terminate any
outstanding options that had been accelerated and had not been exercised during
such exercise period. In the event of a merger of STAR into another corporation
in which holders of Common Stock receive cash for their shares, the Board may
settle the option with a cash payment equal to the difference between the
exercise price and the amount paid to holders of Common Stock pursuant to the
merger.
 
    The Board may amend or terminate the Director Plan at any time. In any
event, the Director Plan will terminate on May 14, 2006, unless sooner
terminated by the Board.
 
EMPLOYMENT AGREEMENTS AND CHANGE OF CONTROL ARRANGEMENTS
 
    The Company has an employment agreement with Mary A. Casey, pursuant to
which Ms. Casey holds the position of President, is paid an annual salary of
$20,000 per month, subject to adjustment to reflect increases in the Consumer
Price Index, was entitled to purchase 1,677,273 shares of Common Stock, and is
eligible to receive a bonus, as determined by the Chief Executive Officer and
the Board of Directors. The agreement also provides that Ms. Casey will receive
a severance payment equal to $7,000 per month for the first six months after
termination of employment, and an additional payment of $7,000 per month for the
next six months, minus any amounts earned by her from other employment during
such period. In addition, the agreement provides that if Ms. Casey's employment
is terminated (other than for cause) within four months after a Sale Transaction
(as defined below), she will continue to receive the compensation provided in
the agreement until the expiration of the agreement on December 31, 2000,
instead of the severance payments described above. A Sale Transaction is an
acquisition of more than 75% of the voting securities of STAR, pursuant to a
tender offer or exchange offer approved in advance by the Board of Directors.
 
    In January 1996, STAR entered into an employment agreement with David Vaun
Crumly pursuant to which Mr. Crumly became Executive Vice President. The
agreement provides for an annual salary of $10,000 per month with an annual
increase, plus incentive bonuses tied to gross revenues of STAR. The agreement
also provides for a commission on certain of the Company's accounts and an
option to purchase 369,000 shares of Common Stock at an exercise price of $0.73
per share. In addition, in the event of a Sale Transaction, Mr. Crumly will
receive a bonus payment equal to the lesser of $1,500,000 or a percentage of the
monthly gross sales of accounts relating to customers introduced to the Company
by Mr. Crumly. If his employment is terminated in certain circumstances, without
cause, within four months after a Sale Transaction, Mr. Crumly is entitled to
receive the compensation provided in this agreement, minus any compensation
earned by other employment, until the expiration of the agreement on December
31, 2000.
 
    In December 1996, STAR entered into an employment agreement with Kelly D.
Enos, pursuant to which Ms. Enos became Chief Financial Officer. The agreement
provides for an annual salary of $150,000
 
                                       46

(which has been increased to $160,000) and an option to purchase 153,750 shares
of Common Stock at an exercise price of $4.00 per share. The agreement also
provides that Ms. Enos will receive a severance payment equal to the
compensation which she would have received under the remaining term of the
agreement if she terminates the agreement as a result of STAR's default of its
material obligations and duties under the agreement or if she is terminated by
STAR without cause within four months after a Sale Transaction.
 
    In September 1996, STAR entered into an employment agreement with James E.
Kolsrud, pursuant to which Mr. Kolsrud became Executive Vice
President--Operations and Engineering. The agreement provides for a monthly
salary of $16,667, an option to purchase 205,000 shares of Common Stock pursuant
to the 1996 Supplemental Stock Option Plan at a price of $4.00 per share,
reimbursement of reasonable out-of-pocket expenses incurred in connection with
Company business, and fringe benefits accorded to executives of STAR as
determined by the Board of Directors. In the event of termination pursuant to
the agreement, Mr. Kolsrud shall be entitled to receive compensation accrued and
payable to him as of the date of his termination or death, and all other amounts
payable to him under the agreement shall thereupon cease. If his employment is
terminated in certain circumstances within four months after a Sale Transaction,
then Mr. Kolsrud shall continue to receive the compensation provided in the
agreement until the expiration of the agreement on December 31, 2000.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
    The following table sets forth certain information known to the Company
regarding beneficial ownership of the Company's Common Stock as of March 17,
1999 by (i) each person who is known by STAR to own beneficially more than five
percent of the Company's Common Stock, (ii) each of the Company's directors,
(iii) each of the Named Officers, and (iv) all current officers and directors as
a group.
 


                                                                          SHARES BENEFICIALLY
                                                                               OWNED(1)
                                                                      ---------------------------
NAME AND ADDRESS OF BENEFICIAL OWNER                                     NUMBER      PERCENT(2)
- --------------------------------------------------------------------  ------------  -------------
                                                                              
West Highland Capital(3)............................................     7,737,660         13.5%
Gordon Hutchins, Jr.(4).............................................       188,600            *
John R. Snedegar(4).................................................        10,250            *
Mark Gershien(4)....................................................        10,250            *
Arunas A. Chesonis..................................................            --           --
Christopher E. Edgecomb(5)..........................................    12,676,907         22.1%
Mary A. Casey.......................................................     1,596,613          2.8%
David Vaun Crumly(6)................................................       891,416          1.6%
James E. Kolsrud(7).................................................       174,022            *
Kelly D. Enos(8)....................................................       214,337            *
Samer Tawfik........................................................     9,138,711         15.9%
All directors and executive officers as a group (10 persons)(9).....    24,901,106         43.4%

 
- ------------------------
 
  * Represents beneficial ownership of less than 1% of the outstanding shares of
    Common Stock.
 
 (1) Beneficial ownership is determined in accordance with the rules of the
     Securities and Exchange Commission and includes voting or investment power
     with respect to securities. The address for each listed director and
     officer is c/o STAR Telecommunications, Inc., 223 East De La Guerra Street,
     Santa Barbara, California 93101. To the Company's knowledge, except as
     indicated in the footnotes to this table and pursuant to applicable
     community property laws, the persons named in the table have sole voting
     and investment power with respect to all shares of Common Stock.
 
                                       47

 (2) Percentage of beneficial ownership is based on 57,369,000 shares of Common
     Stock outstanding as of March 17, 1999. The number of shares of Common
     Stock beneficially owned includes the shares issuable pursuant to stock
     options and warrants that are exercisable within sixty days of March 17,
     1999.
 
 (3) Represents 2,079,500 shares of Common Stock held by West Highland Capital,
     Inc., 1,789,330 shares of Common Stock held by Estero Partners, LLC,
     2,079,500 shares of Common Stock held by Lang H. Gerhard, 1,539,790 shares
     of Common Stock held by West Highland Partners, L.P., and 249,540 shares of
     Common Stock held by Buttonwood Partners, L.P., as reported by West
     Highland Capital, Inc. in its Schedule 13G filed with the Securities and
     Exchange Commission on February 11, 1999.
 
 (4) Consists entirely of shares of Common Stock issuable upon the exercise of
     stock options exercisable within sixty days of March 17, 1999.
 
 (5) Mr. Edgecomb disclaims beneficial ownership with respect to 4,100 shares of
     Common Stock.
 
 (6) Consists of 737,666 shares of Common Stock, and 153,750 shares of Common
     Stock issuable upon the exercise of stock options exercisable within sixty
     days of March 17, 1999.
 
 (7) Consists of 101,250 shares of Common Stock, 20,497 shares of Common Stock
     held in joint tenancy and 52,275 shares of Common Stock issuable upon the
     exercise of stock options exercisable within sixty days of March 17, 1999.
 
 (8) Consists of 96,720 shares of Common Stock and 117,617 shares of Common
     Stock issuable upon the exercise of stock options exercisable within sixty
     days of March 17, 1999.
 
 (9) Consists of 532,742 shares of Common Stock issuable upon the exercise of
     stock options exercisable within sixty days of March 17, 1999.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
 
TRANSACTIONS WITH OUTSIDE DIRECTORS
 
    Prior to its acquisition of UDN STAR provided services to Digital Network,
Inc. ("DNI"), a wholly owned subsidiary of UDN. John R. Snedegar, a Director,
was a director and President of UDN. For the year ended December 31, 1998,
services provided by STAR to DNI equaled approximately $5.5 million.
 
    On November 19, 1997, STAR entered into an agreement to acquire UDN. At that
time, Messrs. Snedegar and Edgecomb beneficially owned 11.2% and 2%,
respectively, of the outstanding common stock of UDN. In connection with its
acquisition of UDN, STAR loaned $4.5 million to UDN at market rates of interest.
 
    GH Associates, an affiliate of Gordon Hutchins, Jr., a Director, provides
consulting services to STAR. For the year ended December 31, 1998, STAR paid
approximately $71,000 to GH Associates for general business consulting services
relating to the telecommunications industry and for the performance of other
tasks requested by the Company's Chief Executive Officer, President and Board of
Directors.
 
    During 1998, STAR invested $5.1 million in the common stock of PaeTec
Communications, Inc. ("PaeTec"), a competitive local exchange carrier, STAR's
investment represents approximately 19% of PaeTec's outstanding equity
outstanding at December 31, 1998. Arunas Chesonis, a Director, is a majority
shareholder and the Chief Executive Officer of PaeTec.
 
    During 1998, STAR's non-employee Directors were granted nonstatutory stock
options under the Director Plan. See "Management--Director Compensation."
 
                                       48

TRANSACTIONS WITH EXECUTIVE OFFICERS
 
    Each of Kelly D. Enos, David Vaun Crumly and James E. Kolsrud received
incentive stock options to purchase 4,100 shares of Common Stock at an exercise
price of $16.31 in February 1998, and incentive stock options to purchase 100
shares of Common Stock at an exercise price of $27.00 in May 1998.
 
    Mr. Kolsrud has a 21.6% interest in Interpacket Group, Inc. ("Interpacket")
which has direct termination arrangements with STAR for certain countries in
Central and South America. During 1998, STAR purchased satellite transmission
equipment and services from Interpacket during 1998 for approximately $10.0
million.
 
INDEMNIFICATION OF DIRECTORS AND OFFICERS
 
    STAR's Amended and Restated Certificate of Incorporation limits the
liability of its directors for monetary damages arising from a breach of their
fiduciary duty as directors, except to the extent otherwise required by the
Delaware General Corporation Law. Such limitation of liability does not affect
the availability of equitable remedies such as injunctive relief or rescission.
 
    STAR's Bylaws provide that STAR shall indemnify its directors and officers
to the fullest extent permitted by Delaware law, including in circumstances in
which indemnification is otherwise discretionary under Delaware law. STAR's has
also entered into or will enter into indemnification agreements with its
officers and directors containing provisions that may require STAR, among other
things, to indemnify such officers and directors against certain liabilities
that may arise by reason of their status or service as directors or officers
(other than liabilities arising from willful misconduct of a culpable nature),
to advance their expenses incurred as a result of any proceeding against them as
to which they could be indemnified, and to obtain directors' and officers'
insurance if available on reasonable terms.
 
    STAR believes that all of the transactions set forth above were made on
terms no less favorable to STAR than could have been obtained from unaffiliated
third parties. All future transactions, including loans between STAR and its
officers, directors, principal stockholders and their affiliates will be
approved by a majority of the Board of Directors, including a majority of the
independent and disinterested outside directors on the Board of Directors, and
will continue to be on terms no less favorable to STAR than could be obtained
from unaffiliated third parties.
 
                                       49

                                   SIGNATURE
 
    Pursuant to the requirements of the Section 15(d) of the Securities Act of
1934, the Registrant has duly caused this Report on Form 10-K to be signed on
its behalf by the undersigned, thereunto duly authorized, in Santa Barbara,
California on March 29, 1999.
 
                               
                                By:              /s/ KELLY D. ENOS
                                     -----------------------------------------
                                                   Kelly D. Enos
                                              CHIEF FINANCIAL OFFICER


 
                               POWER OF ATTORNEY
 
    KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Christopher E. Edgecomb, Mary A. Casey and Kelly
D. Enos, and each of them, his true and lawful attorney-in-fact with full power
of substitution and resubstitution, for him or her and in his or her name, place
and stead, in and any all capacities, to sign any and all amendments to this
Report on Form 10-K and to file same, with all exhibits thereto, and other
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorney-in-fact and agents, and each of them, full power and
authority to do and perform each and every act and thing requisite and necessary
to be done in and about the premises, as fully to all intents and purposes as he
or she might or could do in person, hereby ratifying and confirming all that
said attorney-in-fact and agent, or his or her substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.
 
    Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report on Form 10-K has been signed by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.
 


          SIGNATURE                       TITLE                    DATE
- ------------------------------  --------------------------  -------------------
 
                                                      
 /s/ CHRISTOPHER E. EDGECOMB    Chief Executive Officer
- ------------------------------    and Director (Principal     March 26, 1999
   Christopher E. Edgecomb        Executive Officer)
 
      /s/ MARY A. CASEY
- ------------------------------  President and Director        March 29, 1999
        Mary A. Casey
 
                                Chief Financial Officer
      /s/ KELLY D. ENOS           (Principal Financial
- ------------------------------    Officer and Accounting      March 29, 1999
        Kelly D. Enos             Officer)
 
   /s/ GORDON HUTCHINS, JR.
- ------------------------------  Director                      March 29, 1999
     Gordon Hutchins, Jr.
 
     /s/ JOHN R. SNEDEGAR
- ------------------------------  Director                      March 29, 1999
       John R. Snedegar

 
                                       50



          SIGNATURE                       TITLE                    DATE
- ------------------------------  --------------------------  -------------------
 
                                                      
      /s/ MARK GERSHIEN
- ------------------------------  Director                      March 26, 1999
        Mark Gershien
 
     /s/ ARUNAS CHESONIS
- ------------------------------  Director                      March 29, 1999
       Arunas Chesonis
 
       /s/ SAMER TAWFIK
- ------------------------------  Director                      March 29, 1999
         Samer Tawfik

 
                                       51

                                    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:
 
                      Report of Independent Public Accountants.................................        F-1
 
                      Consolidated Balance Sheets as of December 31, 1997 and 1998.............        F-2
 
                      Consolidated Statements of Operations for the years ended December 31,
                        1996, 1997 and 1998....................................................        F-3
 
                      Consolidated Statements of Stockholders' Equity for the years ended
                        December 31, 1996, 1997 and 1998.......................................        F-4
 
                      Consolidated Statements of Cash Flows for the years ended December 31,
                        1996, 1997 and 1998....................................................        F-5
 
                      Notes to Consolidated Financial Statements...............................        F-7
 
           (2)        Index to Financial Statement Schedules:
 
                      Report of Independent Public Accountants on Supplemental Schedules.......        S-1
 
                      Schedule II--Valuation and Qualifying Accounts...........................        S-2
 
           (3)        Exhibits:


 


  EXHIBIT
  NUMBER                                                  DESCRIPTION
- -----------  -----------------------------------------------------------------------------------------------------
          
    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.
 
    2.3**    Stock Purchase Agreement dated as of January 26, 1998 by and among the Registrant, T-One Corp. and
               Taha Mikati, as amended.
 
    2.4-     Amended and Restated Agreement and Plan of Merger dated as of August 20, 1998 by and among the
               Registrant, Sierra Acquisition Co., Inc., PT-1 Communications, Inc. and the Stockholders listed on
               the signature page thereto, (the "PT-1 Merger Agreement").
 
    2.5++    First Amendment to the PT-1 Merger Agreement dated September 1, 1998.
 
    2.6++    Second Amendment to the PT-1 Merger Agreement dated December 29, 1998.
 
    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.

 
                                       52



  EXHIBIT
  NUMBER                                                  DESCRIPTION
- -----------  -----------------------------------------------------------------------------------------------------
          
    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.l+     Form of Indemnification Agreement.
 
   10.2+     1996 Amended and Restated Stock Incentive Plan.
 
   10.3+     1996 Outside Director Nonstatutory Stock Option Plan.
 
   10.4+     1997 Omnibus Stock Incentive Plan.
 
   10.5+     Employment Agreement between the Registrant and Mary Casey dated July 14, 1995, as amended.
 
   10.6+     Employment Agreement between the Registrant and Kelly Enos dated December 2, 1996.
 
   10.7+     Employment Agreement between the Registrant and David Vaun Crumly dated January 1, 1996.
 
   10.8+     Intentionally omitted.
 
   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.

 
                                       53



  EXHIBIT
  NUMBER                                                  DESCRIPTION
- -----------  -----------------------------------------------------------------------------------------------------
          
   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.
 
   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.
 
   10.45-    Second Restatement of Employment Agreement between the Company and James Kolsrud dated as of July 9,
               1998.

 
                                       54



  EXHIBIT
  NUMBER                                                  DESCRIPTION
- -----------  -----------------------------------------------------------------------------------------------------
          
   10.46-    First Amendment to 1997 Omnibus Stock Incentive Plan.
 
   21.1      Subsidiaries of the Registrant.
 
   23.1      Consent of Arthur Andersen LLP, Independent Public Accountants.
 
   24.1      Power of Attorney (included on page 50).
 
   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 the Company's Registration Statement on Form S-4
    (Registration No. 333-53335) and incorporated by reference herein.
 
  * Filed on December 15, 1997 as an exhibit to the Company's Current Report on
    Form 8-K (File No. 000-22581) 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 incoroporated by
    reference herein.
 
 ***Filed as an exhibit to the Company's Annual Report on Form 10-K (File No.
    000-22581) on March 31, 1998 and incorporated by reference herein.
 
  - Filed as an exhibit to the Company's Quarterly Report on Form 10-Q (File No.
    000-22581) on November 11, 1998 and incorporated by reference herein.
 
                        
           (4)        Reports on Form 8-K.
 
                      (a)        Current Report on Form 8-K dated March 25, 1998 related to the acquisition
                                   of T-One Corp.


 
                                       55

                    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, 1997 and 1998, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1998. 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, 1997 and 1998, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.
 
                                          ARTHUR ANDERSEN LLP
 
Los Angeles, California
February 25, 1999
 
                                      F-1

                 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
 
                          CONSOLIDATED BALANCE SHEETS
 
                 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
 
                                     ASSETS
 


                                                                                                   DECEMBER 31,
                                                                                               --------------------
                                                                                                 1997       1998
                                                                                               ---------  ---------
                                                                                                    
CURRENT ASSETS:
  Cash and cash equivalents..................................................................  $   1,903  $  46,662
  Short-term investments.....................................................................     18,631        835
  Accounts receivable, net of allowance of $7,234 and $11,220 at December 31, 1997 and 1998,
    respectively.............................................................................     46,634     96,610
  Receivables from related parties, net......................................................         41      6,845
  Other receivables..........................................................................      2,198     22,626
  Prepaid expenses...........................................................................      4,799     14,144
  Deferred income taxes......................................................................      4,485      6,269
                                                                                               ---------  ---------
      Total current assets...................................................................     78,691    193,991
                                                                                               ---------  ---------
PROPERTY AND EQUIPMENT:
  Operating equipment........................................................................     31,340    156,848
  Leasehold improvements.....................................................................      6,477     14,796
  Furniture, fixtures and equipment..........................................................      4,711     17,733
                                                                                               ---------  ---------
                                                                                                  42,528    189,377
  Less--Accumulated depreciation and amortization............................................     (6,569)   (19,681)
                                                                                               ---------  ---------
                                                                                                  35,959    169,696
                                                                                               ---------  ---------
OTHER ASSETS:
  Investments................................................................................         27      5,110
  Deposits...................................................................................      6,055      2,208
  Other......................................................................................        370      1,129
                                                                                               ---------  ---------
                                                                                                   6,452      8,447
                                                                                               ---------  ---------
      Total assets...........................................................................  $ 121,102  $ 372,134
                                                                                               ---------  ---------
                                                                                               ---------  ---------
                                       LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
  Revolving lines of credit..................................................................  $      --  $  19,330
  Revolving lines of credit with stockholder.................................................        138         --
  Current portion of long-term debt..........................................................        764        471
  Current portion of capital lease obligations...............................................      2,495      8,188
  Accounts payable...........................................................................     14,009     33,942
  Taxes payable..............................................................................      2,156      1,640
  Related party payable......................................................................         --      1,267
  Accrued network costs......................................................................     39,565     51,262
  Accrued expenses...........................................................................      5,018     13,514
                                                                                               ---------  ---------
      Total current liabilities..............................................................     64,145    129,614
                                                                                               ---------  ---------
LONG-TERM LIABILITIES:
  Long-term debt, net of current portion.....................................................        968         --
  Capital lease obligations, net of current portion..........................................     11,139     29,267
  Deferred income taxes......................................................................        786      2,991
  Other long-term liabilities................................................................        863        650
                                                                                               ---------  ---------
      Total long-term liabilities............................................................     13,756     32,908
                                                                                               ---------  ---------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
  Series A Preferred Stock, $.001 par value, authorized--5,000 shares; issued and
    outstanding--none........................................................................         --         --
  Common stock, $.001 par value, authorized--100,000 shares; issued and outstanding--35,031
    and 42,239 at December 31, 1997 and 1998, respectively...................................         35         42
  Additional paid-in capital.................................................................     41,662    194,389
  Deferred compensation......................................................................        (30)        --
  Accumulated other comprehensive income.....................................................         --        188
  Retained earnings..........................................................................      1,534     14,993
                                                                                               ---------  ---------
    Stockholders' equity.....................................................................     43,201    209,612
                                                                                               ---------  ---------
      Total liabilities and stockholders' equity.............................................  $ 121,102  $ 372,134
                                                                                               ---------  ---------
                                                                                               ---------  ---------

 
   The accompanying notes are an integral part of these consolidated balance
                                    sheets.
 
                                      F-2

                 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
 
                 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
 


                                                                                    YEARS ENDED DECEMBER 31,
                                                                               ----------------------------------
                                                                                  1996        1997        1998
                                                                               ----------  ----------  ----------
                                                                                              
REVENUES.....................................................................  $  259,697  $  404,605  $  595,540
OPERATING EXPENSES:
  Cost of services...........................................................     225,957     351,821     504,281
  Selling, general and administrative expenses...............................      35,956      36,496      56,121
  Depreciation and amortization..............................................       1,442       4,637      13,112
  Merger expense.............................................................          --         286         361
                                                                               ----------  ----------  ----------
                                                                                  263,355     393,240     573,875
                                                                               ----------  ----------  ----------
    Income (loss) from operations............................................      (3,658)     11,365      21,665
                                                                               ----------  ----------  ----------
OTHER INCOME (EXPENSES):
  Interest income............................................................         110         492       4,849
  Interest expense...........................................................        (609)     (1,738)     (2,828)
  Legal settlement and expenses..............................................        (100)     (1,653)         --
  Other income (expense).....................................................          39         208        (304)
                                                                               ----------  ----------  ----------
                                                                                     (560)     (2,691)      1,717
                                                                               ----------  ----------  ----------
    Income (loss) before provision for income taxes..........................      (4,218)      8,674      23,382
PROVISION FOR INCOME TAXES...................................................         577       2,905       9,923
                                                                               ----------  ----------  ----------
NET INCOME (LOSS)............................................................  $   (4,795) $    5,769  $   13,459
                                                                               ----------  ----------  ----------
                                                                               ----------  ----------  ----------
    Income (loss) before provision for income taxes..........................  $   (4,218) $    8,674
PRO FORMA INCOME TAXES (UNAUDITED)...........................................       1,520       3,100
                                                                               ----------  ----------
PRO FORMA NET INCOME (LOSS) (UNAUDITED)......................................  $   (5,738) $    5,574
                                                                               ----------  ----------
                                                                               ----------  ----------
Income (loss) per common share:
  Basic......................................................................  $    (0.21) $     0.19  $     0.34
                                                                               ----------  ----------  ----------
  Diluted....................................................................  $    (0.21) $     0.17  $     0.32
                                                                               ----------  ----------  ----------
Pro forma income (loss) per common share (unaudited):
  Basic......................................................................  $    (0.25) $     0.18
                                                                               ----------  ----------
  Diluted....................................................................  $    (0.25) $     0.17
                                                                               ----------  ----------

 
 The accompanying notes are an integral part of these consolidated statements.
 
                                      F-3

                 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
 
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
               FOR THE YEARS ENDED DECEMBER, 1996, 1997 AND 1998
                             (AMOUNTS IN THOUSANDS)


                                                                         PREFERRED STOCK           COMMON STOCK       ADDITIONAL
                                                                      ----------------------  ----------------------    PAID-IN
                                                                       SHARES      AMOUNT      SHARES      AMOUNT       CAPITAL
                                                                      ---------  -----------  ---------  -----------  -----------
                                                                                                       
Balance, December 31, 1995..........................................         --   $      --      20,652   $      21    $   2,920
    Net loss........................................................         --          --          --          --           --
    Effect of terminating the S-Corporation election................         --          --          --          --         (690)
    Conversion of capital to debt...................................         --          --          --          --       (1,200)
    Compensation expense relating to stock options..................         --          --          --          --          168
    Issuance of common stock........................................         --          --       3,925           4        5,564
    Issuance of preferred stock.....................................      2,802           3          --          --        7,497
    Cash distributions to stockholders..............................         --          --          --          --       (4,034)
                                                                      ---------       -----   ---------         ---   -----------
Balance, December 31, 1996..........................................      2,802           3      24,577          25       10,225
    Net income......................................................         --          --          --          --           --
    Effect of CEO Telecommunications, Inc. terminating the
      S-corporation election........................................         --          --          --          --          (61)
    Conversion of redeemable preferred stock to common stock........     (2,802)         (3)      1,868           2            1
    Initial public offering of common stock.........................         --          --       8,097           8       30,936
    Exercise of stock options.......................................         --          --         489          --          447
    Compensation expense relating to stock options..................         --          --          --          --           --
    Tax benefit from non-qualified stock options....................                     --          --          --          114
    Cash distributions to stockholders..............................         --          --          --          --           --
                                                                      ---------       -----   ---------         ---   -----------
Balance, December 31, 1997..........................................         --          --      35,031          35       41,662
    Comprehensive income:
      Net income....................................................         --          --          --          --           --
      Foreign currency translation adjustment, net of taxes of
        $136........................................................         --          --          --          --           --
    Comprehensive income............................................         --          --          --          --           --
    Secondary public offering of common stock.......................         --          --       5,685           6      144,705
    Exercise of stock options.......................................         --          --       1,523           1        2,387
    Compensation expense relating to stock option...................         --          --          --          --           --
    Tax benefit from non-qualified stock options....................         --          --          --          --        5,635
                                                                      ---------       -----   ---------         ---   -----------
Balance, December 31, 1998..........................................         --   $      --      42,239   $      42    $ 194,389
                                                                      ---------       -----   ---------         ---   -----------
                                                                      ---------       -----   ---------         ---   -----------
 

                                                                                       ACCUMULATED OTHER   RETAINED
                                                                         DEFERRED        COMPREHENSIVE     EARNINGS
                                                                       COMPENSATION         INCOME         (DEFICIT)     TOTAL
 
                                                                      ---------------  -----------------  -----------  ---------
 
                                                                                                           
Balance, December 31, 1995..........................................     $      --         $      --       $     867   $   3,808
 
    Net loss........................................................            --                --          (4,795)     (4,795)
 
    Effect of terminating the S-Corporation election................            --                --             690          --
 
    Conversion of capital to debt...................................            --                --              --      (1,200)
 
    Compensation expense relating to stock options..................          (118)               --              --          50
 
    Issuance of common stock........................................            --                --              --       5,568
 
    Issuance of preferred stock.....................................            --                --              --       7,500
 
    Cash distributions to stockholders..............................            --                --              --      (4,034)
 
                                                                             -----             -----      -----------  ---------
 
Balance, December 31, 1996..........................................          (118)               --          (3,238)      6,897
 
    Net income......................................................            --                --           5,769       5,769
 
    Effect of CEO Telecommunications, Inc. terminating the
      S-corporation election........................................            --                --              61          --
 
    Conversion of redeemable preferred stock to common stock........            --                --              --          --
 
    Initial public offering of common stock.........................            --                --              --      30,944
 
    Exercise of stock options.......................................            --                --              --         447
 
    Compensation expense relating to stock options..................            88                --              --          88
 
    Tax benefit from non-qualified stock options....................            --                --              --         114
 
    Cash distributions to stockholders..............................            --                --          (1,058)     (1,058)
 
                                                                             -----             -----      -----------  ---------
 
Balance, December 31, 1997..........................................           (30)               --           1,534      43,201
 
    Comprehensive income:
      Net income....................................................            --                --          13,459      13,459
 
      Foreign currency translation adjustment, net of taxes of
        $136........................................................            --               188              --         188
 
                                                                                                                       ---------
 
    Comprehensive income............................................            --                --              --      13,647
 
    Secondary public offering of common stock.......................            --                --              --     144,711
 
    Exercise of stock options.......................................            --                --              --       2,388
 
    Compensation expense relating to stock option...................            30                --              --          30
 
    Tax benefit from non-qualified stock options....................            --                --              --       5,635
 
                                                                             -----             -----      -----------  ---------
 
Balance, December 31, 1998..........................................     $      --         $     188       $  14,993   $ 209,612
 
                                                                             -----             -----      -----------  ---------
 
                                                                             -----             -----      -----------  ---------
 

 
 The accompanying notes are an integral part of these consolidated statements.
 
                                      F-4

                 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 
                             (AMOUNTS IN THOUSANDS)
 


                                                                                         YEARS ENDED DECEMBER 31,
                                                                                      -------------------------------
                                                                                        1996       1997       1998
                                                                                      ---------  ---------  ---------
                                                                                                   
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income (loss).................................................................  $  (4,795) $   5,769  $  13,459
  Adjustments to reconcile net income (loss) to net cash provided by (used in)
    operating activities:
  Depreciation and amortization.....................................................      1,442      4,637     13,112
  Loss on disposal of equipment.....................................................         --         42         --
  Compensation expense relating to stock options....................................         50         88         30
  Provision for doubtful accounts...................................................     16,284      7,791      5,490
  Deferred income taxes.............................................................        (15)    (3,699)       421
  Deferred compensation.............................................................        116        (59)        52
Decrease (increase) in assets:
  Accounts receivable...............................................................    (29,548)   (19,272)   (55,466)
  Receivables from related parties, net.............................................         (8)        99     (6,804)
  Other receivables.................................................................         --     (1,914)   (20,428)
  Prepaid expenses..................................................................     (2,366)    (2,271)    (9,345)
  Deposits..........................................................................     (4,948)      (425)      (558)
Increase (decrease) in liabilities:
  Accounts payable..................................................................        109     (3,921)    19,933
  Taxes payable.....................................................................         --      2,270      5,119
  Related party payable.............................................................        (51)      (269)     1,267
  Accrued network costs.............................................................     19,342     19,747     11,697
  Accrued expenses..................................................................      1,541      2,356      8,496
  Other long-term liabilities.......................................................         --        164       (265)
                                                                                      ---------  ---------  ---------
    Net cash provided by (used in) operating activities.............................     (2,847)    11,133    (13,790)
                                                                                      ---------  ---------  ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Capital expenditures..............................................................     (8,480)   (13,760)  (112,633)
  Investments.......................................................................       (153)       126     (5,083)
  Short-term investments............................................................     (1,631)   (16,975)    17,796
  Other.............................................................................       (139)       639       (759)
                                                                                      ---------  ---------  ---------
    Net cash used in investing activities...........................................    (10,403)   (29,970)  (100,679)
                                                                                      ---------  ---------  ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
  Stockholders' distributions.......................................................     (4,034)    (1,058)        --
  Borrowings under lines of credit..................................................     14,746     34,211     19,330
  Repayments under lines of credit..................................................     (8,262)   (42,025)        --
  Borrowings under lines of credit with stockholder.................................        701        583         --
  Repayments under lines of credit with stockholder.................................     (3,073)      (471)      (138)
  Borrowings under long-term debt...................................................      2,000        193         --
  Payments under long-term debt.....................................................        (67)    (1,983)    (1,261)
  Payments under capital lease obligations..........................................       (358)    (1,946)    (5,990)
  Issuance of common stock..........................................................      5,568     30,944    144,711
  Stock options exercised...........................................................         --        447      2,388
  Issuance of preferred stock.......................................................      7,500         --         --
                                                                                      ---------  ---------  ---------
    Net cash provided by financing activities.......................................     14,721     18,895    159,040
                                                                                      ---------  ---------  ---------
EFFECTS OF FOREIGN CURRENCY TRANSLATION.............................................         --         --        188
 
INCREASE IN CASH AND CASH EQUIVALENTS...............................................      1,471         58     44,759
CASH AND CASH EQUIVALENTS:
  Beginning of year.................................................................        374      1,845      1,903
                                                                                      ---------  ---------  ---------
  End of year.......................................................................  $   1,845  $   1,903  $  46,662
                                                                                      ---------  ---------  ---------
                                                                                      ---------  ---------  ---------

 
 The accompanying notes are an integral part of these consolidated statements.
 
                                      F-5

                 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
                               DECEMBER 31, 1998
 
1. NATURE OF BUSINESS
 
    STAR Telecommunications, Inc., a Delaware Corporation, and Subsidiaries (the
"Company" or "STAR"), is a multinational telecommunications services company
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
services through a flexible network comprised of foreign termination
relationships, international gateway switches, leased and owned transmission
facilities and resale arrangements with other long distance providers.
 
    During 1996, 1997 and 1998, 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 uses these switching facilities to decrease international
traffic termination costs and to initiate outbound calls from these local
markets.
 
    In November 1997, the Company entered into the domestic commercial
long-distance market through the acquisition of L.D. Services Inc., now known as
CEO Telecommunications, Inc. ("CEO"). CEO is a commercial long-distance service
provider throughout the United States. In March 1998, the Company consummated a
merger with T-One Corp. ("T-One"), an international wholesale long-distance
telecommunications provider. The mergers constituted tax-free reorganizations
and have been accounted for as poolings of interests. Accordingly, all prior
period consolidated financial data has been restated to include the results of
operations, financial position and cash flows of CEO and T-One (see Note 7). The
pro forma results of operations and pro forma income or loss per common share
for 1996 and 1997 assumes that both STAR and CEO 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.
 
    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 and
rate-per-minute charges from other carriers that terminate traffic on behalf of
the Company. In addition, commercial long distance service costs include billing
and collection service fees, call rating services, and per minute charges from
other carriers that terminate traffic on behalf of the Company.
 
                                      F-6

                 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
                               DECEMBER 31, 1998
 
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
    REVENUES FROM FOREIGN CUSTOMERS
 
    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. Revenues from
foreign customers amounted to $178,000, $6,577,000 and $83,998,000 for the years
ended December 31, 1996, 1997 and 1998, respectively.
 
    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. Cash and cash equivalents are stated at cost, which approximates
market.
 
    FINANCIAL INSTRUMENTS
 
    The carrying amounts of long-term debt and capital lease obligations
approximate their fair value as interest rates approximate market rates for
similar instruments.
 
    Off balance sheet derivative financial instruments at December 31, 1997 and
1998 consist of foreign currency exchange agreements. The Company enters into
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. 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 fair value of foreign currency contracts are estimated by obtaining
quotes from brokers. At December 31, 1997 and 1998, the Company has foreign
currency contracts outstanding with the notional value of $6,305,000 and
$35,000,000. The estimated fair value of these contracts was $6,218,000 and
$35,000,000, respectively, the difference of which has been recognized in
operations. The Company had contracts in British Pounds and German Marks at
December 31, 1997 and only in German Marks at December 31, 1998.
 
    At December 31, 1997 and 1998, gains and losses on foreign exchange
contracts are not material to the consolidated financial statements.
 
    SHORT-TERM INVESTMENTS
 
    Short-term investments consist of interest bearing securities with original
maturities in excess of three months. At December 31, 1997 and 1998, 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.
During 1996 and 1998, the Company did not realize any gains or losses from sale
of securities.
 
                                      F-7

                 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
                               DECEMBER 31, 1998
 
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
    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
                                                                    Life of
Leasehold improvements........................................        lease
Furniture, fixtures and equipment.............................    3-7 years


 
    Operating equipment includes assets financed under capital lease obligations
of $15,921,000 and $50,137,000 at December 31, 1997 and 1998, respectively.
Accumulated amortization related to assets financed under capital leases was
$2,123,000 and $6,976,000 at December 31, 1997 and 1998, respectively.
 
    In addition, operating equipment includes twelve Indefeasible Rights of Use
("IRU") in cable systems amounting to $2,669,000 and $25,060,000 and seven
ownership interests in an international cable amounting to $1,534,000 and
$6,200,000 at December 31, 1997 and 1998, respectively. These assets are
amortized over the life of the agreements of 14 to 25 years (see Note 4).
 
    As of July 1, 1998, the Company prospectively revised the remaining useful
lives of certain operating equipment from five to ten years. The increase in the
estimated life of these assets was based on the knowledge gained by the Company
in making the transition from a reseller of telephone services to a facility
based provider, as well as to the fact that the Company is purchasing more
sophisticated telephone switches and has transitioned from smaller Stromberg
switches to larger capacity more feature rich Nortel switches. This change
reduced depreciation expense and increased income before provision for income
taxes for the year ended December 31, 1998 by approximately $2 million. The
difference between depreciating all switch equipment over a 5-year life verses a
10-year life since acquisition would represent approximately $2.9 million for
the year ended December 31, 1998, or 4 cents per diluted share for the year then
ended.
 
    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 operations.
 
    OTHER ASSETS
 
    During 1998, the Company made a $5.1 million investment in a competitive
local exchange carrier ("CLEC") for 2.9 million common shares, representing
18.97 percent of the CLEC's common shares outstanding at December 31, 1998. This
ownership interest is in the form of Class A common stock which has voting
rights significantly less than the respective ownership interest. A stockholder
of the Company is also an investor and board member of this company. The CLEC,
which is still in the start-up phase, is controlled by one of the Company's
board members. STAR accounts for this investment under the cost method.
 
    Deposits represent payments made to long distance providers to secure lower
rates. These deposits are refunded or applied against future services.
 
                                      F-8

                 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
                               DECEMBER 31, 1998
 
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
    ACCRUED NETWORK COSTS
 
    Accrued network 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.
 
    CONSOLIDATED STATEMENTS OF CASH FLOWS
 
    During the years ended December 31, 1996, 1997 and 1998, cash paid for
interest was $541,000, $1,462,000 and $3,897,000, respectively. For the same
periods, cash paid for income taxes amounted to $1,262,000, $3,761,000 and
$4,146,000, respectively.
 
    Non-cash investing and financing activities, which are excluded from the
consolidated statements of cash flows, are as follows (amounts in thousands):
 


                                                                     YEARS ENDED DECEMBER 31,
                                                                  -------------------------------
                                                                    1996       1997       1998
                                                                  ---------  ---------  ---------
                                                                               
Equipment purchased through capital leases......................  $   5,166  $   9,772  $  34,216
Deposit applied against capital leases..........................         --         --      4,405
Notes issued for asset purchases................................         --      1,890         --
Operating agreement acquired through issuance of note...........         --        350         --
Equity converted to debt........................................      1,200         --         --
Tax benefits related to stock options...........................         --        114      5,635

 
    NET INCOME (LOSS) PER COMMON SHARE
 
    The following schedule summarizes the information used to compute actual and
pro forma basic and diluted net income or loss per common share for the years
ended December 31, 1996, 1997 and 1998 (in thousands):
 


                                                                     1996       1997       1998
                                                                   ---------  ---------  ---------
                                                                                
Weighted average number of common shares used to compute basic
  net income (loss) per common share.............................     23,292     30,221     39,924
Weighted average common share equivalents........................         --      2,757      1,601
                                                                   ---------  ---------  ---------
Weighted average number of common shares and common share
  equivalents used to compute diluted net income (loss) per
  common share...................................................     23,292     32,978     41,525
                                                                   ---------  ---------  ---------
                                                                   ---------  ---------  ---------

 
    Options to purchase 238,400 shares of common stock at prices ranging from
$18.48 to $27.00 were outstanding at December 31, 1998, but were not included in
the computation of diluted earnings per share, as the exercise prices of these
options were greater than the average market price of the Company's common
stock.
 
                                      F-9

                 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
                               DECEMBER 31, 1998
 
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
    There were no options to purchase shares of common stock outstanding at
prices greater than the average market price at December 31, 1996 and 1997.
 
    CONCENTRATIONS OF RISK
 
    At December 31, 1997 and 1998, no individual customer had an account
receivable balance greater than 10 percent of gross accounts receivable other
than PT-1 Communications, Inc. ("PT-1"), which was acquired on February 4, 1999
(see Note 13).
 
    The two largest customers represent approximately 26 percent, 16 percent and
11 percent of revenues during the years ended December 31, 1996, 1997 and 1998,
respectively. During 1996, sales to one customer exceeded 10 percent of
revenues. During 1997, no customer exceeded 10 percent of revenues. During 1998,
no customer other than PT-1 exceeded 10 percent of revenues (see Note 13).
 
    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 facilities 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,
1996, 1997 and 1998 amounted to 44 percent, 34 percent and 30 percent of total
purchases, respectively.
 
    Included in the Company's balance sheets at December 31, 1997 and 1998 are
approximately $7,028,000 and $85,207,000, respectively, 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
 
    On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 130, "Reporting Comprehensive Income." For the year-end
financial statements, SFAS 130 requires that comprehensive income, which is the
total of net income and all other non-owner changes in equity, be displayed in a
financial statement that is displayed with the same prominence as other
consolidated financial statements. The Company displays the components of other
comprehensive income in the consolidated statements of stockholders' equity.
 
    In June 1998, the AICPA issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The Company will adopt the standard in
January 2000 and is currently analyzing the statement to determine the impact,
if any, on the Company's financial position or results of operations.
 
                                      F-10

                 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
                               DECEMBER 31, 1998
 
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
    TRANSLATION OF FOREIGN CURRENCY
 
    Management determined that the functional currency of its foreign
subsidiaries, excluding its German subsidiary, is the U.S. dollar. Thus, all
foreign translation gains or losses, which were immaterial for the years ended
December 31, 1996, 1997 and 1998, are reflected in the results of operations as
a component of other income (expense). On July 1, 1998, due to the fact that
GmbH became self sufficient as an operating entity, the Company changed the
functional currency from the U.S. dollar to the German mark. As a result,
translation effects of this subsidiary after July 1, 1998 are reflected as other
comprehensive income in the consolidated statements of stockholders' equity.
 
    The foreign subsidiaries' balance sheets, excluding the German subsidiary,
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. The German subsidiary's balance sheet at December 31, 1998
is translated into U.S. dollars using the year-end exchange rate except for
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.
 
    RECLASSIFICATIONS
 
    Certain prior year balances have been reclassified to conform to the current
year presentation.
 
3. LINES OF CREDIT
 
    REVOLVING LINES OF CREDIT
 
    Effective 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. The Company was in compliance with these covenants at December 31,
1998. 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 (7.75 percent at December 31, 1998). 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, 1998, $19.3
million was outstanding. The Company's availability under this credit facility
was further reduced by $5.5 million in letters of credit, which were outstanding
at December 31, 1998 (see Note 5).
 
    The Company also has a $1.1 million line of credit at its German subsidiary.
The credit facility has an interest rate of 9.00 percent and may be called
without notice. No amount was outstanding under this line of credit at December
31, 1998.
 
    The weighted average interest rate on short-term debt during the years ended
December 31, 1996, 1997 and 1998, was 9.68 percent, 9.12 percent and 7.75
percent, respectively.
 
                                      F-11

                 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
                               DECEMBER 31, 1998
 
3. LINES OF CREDIT (CONTINUED)
    REVOLVING LINES OF CREDIT WITH STOCKHOLDER
 
    The Company had revolving lines of credit with its founder and chief
executive officer. The debt matured on March 30, 1998 with interest payable at a
rate of 9 percent. The Company recognized interest expense related to this debt
of $34,000, $9,000 and $4,000 for the years ended December 31, 1996, 1997 and
1998, respectively.
 
4. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
 
    The Company finances some of its telecommunication equipment under capital
lease arrangements or through notes payable as follows (dollars in thousands):
 


                                                                                   DECEMBER 31,
                                                                               --------------------
                                                                                 1997       1998
                                                                               ---------  ---------
                                                                                    
Bank promissory note.........................................................  $     904  $      --
Notes payable for Indefeasible Rights of Use, payable in quarterly
  installments of principal plus interest at LIBOR plus 6 percent (11.1
  percent at December 31, 1998) through September 1999.......................        762        424
Note payable for Indefeasible Right of Use, payable in quarterly installments
  of principal plus interest at LIBOR plus 6 percent (11.1 percent at
  December 31, 1998) through September 1999..................................         66         47
                                                                               ---------  ---------
                                                                                   1,732        471
  Less--Current portion......................................................       (764)      (471)
                                                                               ---------  ---------
                                                                               $     968  $      --
                                                                               ---------  ---------
                                                                               ---------  ---------

 
    Minimum future payments under capital lease obligations at December 31, 1998
are as follows:
 


                                                                                      CAPITAL
YEAR ENDING DECEMBER 31,                                                              LEASES
- -----------------------------------------------------------------------------------  ---------
                                                                                  
    1999...........................................................................  $  10,787
    2000...........................................................................     10,561
    2001...........................................................................      9,468
    2002...........................................................................     11,046
    2003...........................................................................      2,389
                                                                                     ---------
                                                                                        44,251
Less--Amount representing interest.................................................     (6,796)
                                                                                     ---------
                                                                                        37,455
Less--Current portion..............................................................     (8,188)
                                                                                     ---------
                                                                                     $  29,267
                                                                                     ---------
                                                                                     ---------

 
                                      F-12

                 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
                               DECEMBER 31, 1998
 
5. COMMITMENTS AND CONTINGENCIES
 
    OPERATING LEASES
 
    The Company leases office space, dedicated private telephone lines,
equipment and other items under various agreements expiring through 2008. At
December 31, 1998, the minimum aggregate payments under non-cancelable operating
leases are summarized as follows (in thousands):
 


                                                                       DEDICATED
                                                      FACILITIES AND    PRIVATE
YEAR ENDING DECEMBER 31,                                EQUIPMENT        LINES        TOTAL
- ----------------------------------------------------  --------------  ------------  ---------
                                                                           
    1999............................................    $    7,887     $   20,270   $  28,157
    2000............................................         7,786            604       8,390
    2001............................................         7,534            159       7,693
    2002............................................         7,320             --       7,320
    2003............................................         6,501             --       6,501
    Thereafter......................................        22,600             --      22,600
                                                           -------    ------------  ---------
                                                        $   59,628     $   21,033   $  80,661
                                                           -------    ------------  ---------
                                                           -------    ------------  ---------

 
    Office facility and equipment rent expense for the years ended December 31,
1996, 1997 and 1998 was approximately $1,137,000, $3,333,000 and $5,386,000,
respectively. Dedicated private line expense was approximately $7,045,000,
$9,414,000 and $24,306,000, respectively, 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, $64,000 and $52,000 of deferred compensation
relating to these agreements for the years ended December 31, 1996, 1997 and
1998, 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, 1998 are as follows (in thousands):
 


YEAR ENDING DECEMBER 31,
- ------------------------------------------------------------------------------
                                                                             
    1999......................................................................    $   37,296
    2000......................................................................        19,776
    2001......................................................................            58
                                                                                     -------
                                                                                  $   57,130
                                                                                     -------
                                                                                     -------

 
                                      F-13

                 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
                               DECEMBER 31, 1998
 
5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
    The Company signed a $85 million agreement with Qwest Communications
International, Inc. ("Qwest") to purchase the long-term rights to use capacity
over Qwest's domestic network over a twenty-year period. In addition, in
November 1998, the Company signed an IRU agreement with IXC Communication, Inc.
("IXC") and has a commitment to purchase $20 million of capacity on IXC's U.S.
based digital fiber network. These commitments are not included in the above
table.
 
    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 CEO and the Company, CEO
entered into a settlement agreement with the Consumer Services Division of the
California Public Utilities Commission ("PUC"). The agreement settled the
alleged unauthorized switching of long-distance customers to CEO between the
years 1995 and 1996. It included payment of $760,000 to the PUC for restitution
to affected customers as defined in the agreement. Additionally, CEO agreed to a
voluntary revocation of its operating authority in the State of California.
Under the agreement, service to all California customers had 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, CEO 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, 1998, the Company had 18 stand by letters of credit
outstanding, which expire beginning January 6, 1999. These letters of credit,
which are partially secured by the bank lines of credit, totaled approximately
$6.7 million.
 
6. 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, 1996, 1997 and 1998, the Company paid
$68,000, $171,000 and $0, respectively, in costs related to the use of Star Aero
services.
 
                                      F-14

                 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
                               DECEMBER 31, 1998
 
6. RELATED PARTY TRANSACTIONS (CONTINUED)
 
    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. During 1998, the Company paid for certain expenses for this
individual, which are to be reimbursed to the Company resulting in a receivable
due to the Company of $164,000, at December 31, 1998.
 
    During 1995, the Company invested $128,000 in a company related to an
employee of STAR. During 1996, 1997 and 1998, the Company provided services to
this company in the amounts of $167,000, $926,000 and $289,000, respectively. As
of December 31, 1997 and 1998, the account receivable from this related party
amounted to $41,000 and $11,000, respectively.
 
    During 1996, 1997 and 1998, the Company purchased consulting services from a
company owned by a board member in the amount of $154,000, $72,000 and $71,000,
respectively. The Company has a payable to this company of $6,000 at December
31, 1998.
 
    The Company purchased equipment and services from a company owned in part by
an employee of STAR in the amount of $1,114,000 and $10,013,000 in 1997 and
1998, respectively. At December 31, 1998, the Company has a payable due to this
related party of $1,261,000.
 
    During the years ended December 31, 1996, 1997 and 1998, the Company also
provided long distance telephone service to United Digital Network, Inc.
("UDN"), a company controlled by another board member, in the amount of
$250,000, $1,141,000 and $5,486,000, respectively. The Company also extended two
loans to this company at an interest rate of prime plus one percent. At December
31, 1997, $2,500,000 plus accrued interest of $28,000 was outstanding under the
loan agreement as well as $721,000 of receivables arising from long distance
services provided. These amounts were fully reserved. At December 31, 1998,
$4,500,000 plus accrued interest of $454,000 was outstanding under the loan
agreement plus $1,129,000 of receivables arising from long distance services
provided. None of these receivables were reserved at December 31, 1998, as the
Company consummated the merger with this company on March 24, 1999 (see Note
14).
 
    During 1998, the Company provided long distance telephone service to a
company in which the founder and chief executive officer of STAR and other STAR
employees and board members are investors. During 1998, services provided to
this company amounted to $4,931,000. At December 31, 1998, the Company has
$541,000 in receivables from this company.
 
    At December 31, 1998, the Company has various receivables due from other
related parties in the amount of $46,000.
 
    STAR believes that all of the transactions set forth above were made on
terms no less favorable to STAR than could have been obtained from unaffiliated
third parties.
 
7. BUSINESS COMBINATIONS
 
    In November 1997, the Company acquired CEO, 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
CEO shareholders in exchange for all outstanding CEO shares plus shares of
certain non-operating entities owned by CEO shareholders and majority ownership
in an affiliated telephone retailer controlled by CEO.
 
                                      F-15

                 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
                               DECEMBER 31, 1998
 
7. BUSINESS COMBINATIONS (CONTINUED)
    On March 10, 1998, the Company acquired T-One, an international wholesale
long distance telecommunications provider, in a transaction accounted for as a
pooling of interests. The Company issued 1,353,000 shares of its common stock to
the T-One shareholder in exchange for all outstanding T-One shares.
 
    The accompanying consolidated financial statements have been restated to
include the financial position and results of operations of CEO and T-One for
all periods presented.
 
    Revenues and historical net income (loss) of STAR, CEO and T-One through the
dates of acquisitions are as follows (in thousands):
 


                                                              1996        1997        1998
                                                           ----------  ----------  ----------
                                                                          
Revenues:
  STAR...................................................  $  208,086  $  348,738  $  584,170
  CEO....................................................      29,905      27,460          --
  T-ONE..................................................      22,432      30,438      11,788
  Eliminations...........................................        (726)     (2,031)       (418)
                                                           ----------  ----------  ----------
    Total................................................  $  259,697  $  404,605  $  595,540
                                                           ----------  ----------  ----------
                                                           ----------  ----------  ----------
Net income (loss):
  STAR...................................................      (6,644) $    5,605  $   13,547
  CEO....................................................       2,424         (37)         --
  T-ONE..................................................        (575)        201         (88)
                                                           ----------  ----------  ----------
    Total................................................  $   (4,795) $    5,769  $   13,459
                                                           ----------  ----------  ----------
                                                           ----------  ----------  ----------

 
    Revenues and net income (loss) subsequent to the dates of acquisitions are
included in the STAR balances above.
 
    On February 4, 1999, the Company completed its acquisition of PT-1 and on
March 24, 1999, the Company consummated the merger with UDN (see Notes 13 and
14). In connection with these acquisitions, the Company has capitalized
approximately $4,800,000 of merger related costs which are included in prepaid
expenses in the accompanying consolidated balance sheet at December 31, 1998.
 
8. INCOME TAXES
 
    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 $3,278,000 at December
31, 1998. Realization is dependent on generating sufficient taxable income in
the future. Although realization is not assured, management believes it is
likely that the net deferred tax asset will be realized.
 
                                      F-16

                 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
                               DECEMBER 31, 1998
 
8. INCOME TAXES (CONTINUED)
    The components of the net deferred tax asset at December 31, 1997 and 1998
are as follows (in thousands):
 


                                                                             1997       1998
                                                                           ---------  ---------
                                                                                
Deferred taxes short-term:
  Reserve for accounts and other receivables.............................  $   4,215  $   4,054
  Accrued network costs..................................................        798      1,707
  Vacation accrual.......................................................        138        157
  Deferred compensation..................................................         38         --
  Accrued services.......................................................        276         52
  Other accrued liabilities..............................................         --        151
  State income taxes.....................................................        392        270
  Change in tax method...................................................         60         41
  Merger costs...........................................................         --       (163)
                                                                           ---------  ---------
                                                                               5,917      6,269
  Valuation reserve......................................................     (1,432)        --
                                                                           ---------  ---------
                                                                           $   4,485  $   6,269
                                                                           ---------  ---------
                                                                           ---------  ---------
Deferred taxes long-term:
  Net operating loss.....................................................  $     684  $   2,538
  Deferred rent..........................................................         --        313
  Depreciation and amortization..........................................       (786)    (3,304)
                                                                           ---------  ---------
                                                                                (102)      (453)
  Valuation reserve......................................................       (684)    (2,538)
                                                                           ---------  ---------
                                                                           $    (786) $  (2,991)
                                                                           ---------  ---------
                                                                           ---------  ---------

 
    In prior years, T-One generated net operating losses ("NOL's") for financial
statement and income tax purposes which may be available for carryforwards
against future income. As of December 31, 1998, T-One has deductions available
for carryforward in the amount of approximately $500,000. These NOL's will
expire through 2010. The Company also has foreign NOL's of approximately
$5,200,000.
 
    The results of operations and provision for income taxes for CEO through
November 30, 1997 reflects CEO's 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 CEO were taxed as C-Corporations for all periods presented.
 
                                      F-17

                 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
                               DECEMBER 31, 1998
 
8. INCOME TAXES (CONTINUED)
    The provision for income taxes for the years ended December 31, 1996, 1997
and 1998 are as follows (in thousands):
 


                                                                            HISTORICAL                  PRO FORMA
                                                                  -------------------------------  --------------------
                                                                    1996       1997       1998       1996       1997
                                                                  ---------  ---------  ---------  ---------  ---------
                                                                                                       (UNAUDITED)
                                                                                               
Current taxes:
  Federal.......................................................  $     280  $   4,900  $   7,146  $   1,118  $   5,282
  State.........................................................        164      1,147      1,909        359      1,270
  Foreign.......................................................         --         --        447         --         --
                                                                  ---------  ---------  ---------  ---------  ---------
                                                                        444      6,047      9,502      1,477      6,552
                                                                  ---------  ---------  ---------  ---------  ---------
Deferred taxes:
  Federal.......................................................        133     (2,273)       278         63     (2,512)
  State.........................................................         --       (869)       143        (20)      (940)
                                                                  ---------  ---------  ---------  ---------  ---------
                                                                        133     (3,142)       421         43     (3,452)
                                                                  ---------  ---------  ---------  ---------  ---------
Provision for income taxes......................................  $     577  $   2,905  $   9,923  $   1,520  $   3,100
                                                                  ---------  ---------  ---------  ---------  ---------
                                                                  ---------  ---------  ---------  ---------  ---------

 
    Differences between the provision for income taxes and income taxes at the
statutory federal income tax rate for the years ended December 31, 1996, 1997
and 1998 are as follows (in thousands):
 


                                                                        HISTORICAL                  PRO FORMA
                                                              -------------------------------  --------------------
                                                                1996       1997       1998       1996       1997
                                                              ---------  ---------  ---------  ---------  ---------
                                                                                                   (UNAUDITED)
                                                                                           
Income taxes at the statutory federal rate..................  $  (1,434) $   3,036  $   8,184  $  (1,434) $   3,036
State income taxes, net of federal income tax effect........       (257)       498      1,344       (257)       498
Foreign taxes at rates different than U.S. taxes............         --        187       (359)        --        187
Changes in valuation reserve................................      3,124     (1,268)       422      3,124     (1,268)
Permanent differences.......................................        104         35        235        108        309
Effects of CEO S-Corp status until November 30, 1997........       (958)       152         --         --         --
Other.......................................................         (2)       265         97        (21)       338
                                                              ---------  ---------  ---------  ---------  ---------
                                                              $     577  $   2,905  $   9,923  $   1,520  $   3,100
                                                              ---------  ---------  ---------  ---------  ---------
                                                              ---------  ---------  ---------  ---------  ---------

 
9. 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 to issue 1,025,000 option shares at fair market value. At
December 31, 1997 and 1998, 820,000 and 147,600 options, respectively, issued
under these agreements were outstanding.
 
                                      F-18

                 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
                               DECEMBER 31, 1998
 
9. STOCK OPTIONS (CONTINUED)
    On September 23, 1996, the Company adopted the 1996 Supplemental Stock
Option Plan. This plan, which expires on August 31, 2006, replaces the Plan and
has essentially the same features. The Company can issue options or other rights
to purchase up to 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, 1997 and 1998, 2,358,000, 1,873,000 and 1,025,403
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, 1997 and 1998, 82,000, 41,000 and 71,500 options,
respectively, were outstanding under the Director Plan.
 
    On January 30, 1997, the Board of Directors approved the 1997 Omnibus Stock
Option Incentive Plan (the "Omnibus Plan") to replace the existing 1996
Supplemental Stock Option 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 4,075,000
shares, comprised of the 2,050,000 shares that were available for issuance under
the Supplemental Stock Option Plan, plus an increase of 2,025,000 shares. Under
this 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 and 1998, 763,000 and 1,651,883 options, respectively, were
outstanding under the Omnibus Plan.
 
                                      F-19

                 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
                               DECEMBER 31, 1998
 
9. STOCK OPTIONS (CONTINUED)
    Information regarding the Company's stock option plans and nonqualified
stock options as of December 31, 1996, 1997 and 1998, 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
                                                                -----------         ------
  Granted.....................................................    1,026,925          15.37
  Exercised...................................................   (1,522,649)          1.57
  Forfeited...................................................     (104,987)         10.79
                                                                -----------         ------
December 31, 1998.............................................    2,896,386      $    8.62
                                                                -----------         ------
                                                                -----------         ------

 
    At December 31, 1998, 765,317 options were exercisable at a weighted average
exercise price of $4.28 per share. The options outstanding at December 31, 1998
expire in various years through 2008.
 
    Information about stock options outstanding at December 31, 1998 is
summarized as follows:
 


                      NUMBER      WEIGHTED AVERAGE                         NUMBER
RANGE OF EXERCISE   OUTSTANDING       REMAINING       WEIGHTED AVERAGE   EXERCISABLE  WEIGHTED AVERAGE
      PRICES        AT 12/31/98    CONTRACTED LIFE     EXERCISE PRICE    AT 12/31/98   EXERCISE PRICE
- ------------------  -----------  -------------------  -----------------  -----------  -----------------
                                                                       
$1.46                  497,229             7.37           $    1.46         248,615       $    1.46
$4.00 to $6.83         883,132             7.98           $    4.69         378,952       $    4.40
$8.11 to $11.94        788,000             9.02           $    9.55         137,750       $    9.05
$12.81 to $20.94       686,925             9.29           $   16.66              --       $      --
$27.00 to $34.38        41,100             9.33           $   27.72              --       $      --
                    -----------             ---              ------      -----------          -----
                     2,896,386             8.49           $    8.62         765,317       $    4.28
                    -----------             ---              ------      -----------          -----
                    -----------             ---              ------      -----------          -----

 
                                      F-20

                 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
                               DECEMBER 31, 1998
 
9. STOCK OPTIONS (CONTINUED)
    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 for
the grants:
 


                                                                        1996        1997       1998
                                                                        -----     ---------  ---------
                                                                                    
Expected life (years)..............................................          10           6          6
Interest rate......................................................         6.4%        6.2%       5.2%
Volatility.........................................................          --       31.05%     75.49%
Dividend yield.....................................................          --          --         --

 
    The Company has elected to adopt FASB No. 123 for disclosure purposes only
and applies APB Opinion No. 25 and related interpretations in accounting for its
employee stock options. Approximately $50,000, $88,000 and $30,000 in
compensation cost was recognized relating to consultant options for the years
ended December 31, 1996, 1997 and 1998, 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, 1997 and 1998 would have reflected the
following pro forma amounts:
 


                                                        1996           1997          1998
                                                    -------------  ------------  -------------
                                                                        
Pro forma Net Income (Loss).......................     (6,111,000) $  4,957,000  $  11,893,000
Pro forma Basic Net Income (Loss) Per Common
  Share...........................................  $       (0.26) $       0.16  $        0.30
Pro forma Diluted Net Income (Loss) Per Common
  Share...........................................  $       (0.26) $       0.15  $        0.29

 
    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.
 
10. CAPITAL STOCK
 
    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
investors 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 stockholders. 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.
 
                                      F-21

                 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
                               DECEMBER 31, 1998
 
10. CAPITAL STOCK (CONTINUED)
 
    On November 30, 1997, the Company completed the acquisition of CEO pursuant
to the terms of the agreement and 849,298 shares were issued for all of the
outstanding shares of CEO.
 
    On March 10, 1998, the Company completed the acquisition of T-One, and
1,353,000 shares were issued for all of the outstanding shares of T-One.
 
    On March 31, 1998, the Company effected a 2.05 for 1 stock split in the
nature of a stock dividend. The stock split has been reflected in the
consolidated financial statements for all periods presented.
 
    On May 4, 1998, the Company completed a secondary public offering of
6,000,000 shares of common stock of which 5,685,000 were sold by the Company and
315,000 shares were sold by a selling stockholder. On June 4, 1998, an
additional 30,900 shares of common stock were sold by a selling stockholder of
STAR. The net proceeds to the Company (after deducting underwriting discounts
and offering expenses) from the sale of such shares of common stock were
approximately $145 million.
 
    On July 1, 1998, the Company's stockholders voted to amend and restate the
certificate of incorporation to increase the number of shares of the Company's
authorized common stock from 50 million shares to 100 million shares.
 
11. BUSINESS SEGMENTS
 
    At December 31, 1998, Star has two separately managed business segments,
North American and European long distance telecommunications.
 
    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.
 
    For the year ended December 31, 1997, STAR evaluated performance based on
profit or loss from wholesale and commercial operations, however, the commercial
segment represents less than 10 percent of revenue, net income and assets of the
Company for the periods presented. Due to the growth of its international
operations, senior management began analyzing operations by its North American
and European segments.
 
                                      F-22

                 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
                               DECEMBER 31, 1998
 
11. BUSINESS SEGMENTS (CONTINUED)
    Reportable segment information for the years ended December 31, 1996, 1997
and 1998 are as follows (in thousands):
 


                                                                                 NORTH
                                                                                AMERICAN    EUROPEAN     TOTAL
                                                                               ----------  ----------  ----------
                                                                                              
1996
  Revenues from external customers...........................................  $  259,697  $       --  $  259,697
  Interest income............................................................         110          --         110
  Interest expense...........................................................         609          --         609
  Depreciation and amortization..............................................       1,442          --       1,442
  Segment net loss before provision for income taxes.........................      (4,218)         --      (4,218)
  Other significant non-cash items:
    Capital lease additions..................................................       5,166          --       5,166
    Debt converted to equity.................................................       1,200          --       1,200
  Segment assets.............................................................      63,054          --      63,054
Expenditures for segment assets..............................................       8,480          --       8,480
 
1997
  Revenues from external customers...........................................  $  404,605  $       --  $  404,605
  Revenue between segments...................................................          --         321         321
  Interest income............................................................         492          --         492
  Interest expense...........................................................       1,509         229       1,738
  Depreciation and amortization..............................................       4,208         429       4,637
  Segment net income (loss) before provision for income taxes................      10,595      (1,921)      8,674
  Other significant non-cash items:
    Capital lease additions..................................................       6,507       3,265       9,772
    Property financed by notes payable.......................................       1,890          --       1,890
    Operating agreement acquired through issuance of a note..................         350          --         350
  Segment assets.............................................................     109,170      11,932     121,102
  Expenditures for segment assets............................................      10,961       2,799      13,760
 
1998
  Revenues from external customers...........................................  $  566,369  $   29,171  $  595,540
  Revenue between segments...................................................      16,061      34,018      50,079
  Interest income............................................................       4,806          43       4,849
  Interest expense...........................................................       1,525       1,303       2,828
  Depreciation and amortization..............................................       9,075       4,037      13,112
  Segment net income (loss) before provision for income taxes................      25,172      (1,790)     23,382
  Other significant non-cash items
    Capital lease additions..................................................      11,080      23,136      34,216
    Deposit applied against capital leases...................................          --       4,405       4,405
    Tax benefit related to stock options.....................................       5,635          --       5,635
  Segment assets.............................................................     222,223     149,911     372,134
  Expenditures for segment assets............................................      59,738      52,895     112,633

 
                                      F-23

                 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
                               DECEMBER 31, 1998
 
11. BUSINESS SEGMENTS (CONTINUED)
    Segment information for North America represents primarily activity in the
United States. In 1998, approximately 97 percent of European revenue from
external customers was generated in Germany.
 
12. QUARTERLY CONSOLIDATED INFORMATION (UNAUDITED)
 
    The following table presents unaudited quarterly operating results,
including the results of CEO and T-One for each of the Company's eight quarters
in the two-year period ended December 31, 1998 (amounts in thousands):
 


                                                                                   QUARTER ENDED
                                                                   ----------------------------------------------
                                                                   MARCH 31,    JUNE 30,   SEPT. 30,    DEC. 31,
                                                                   ----------  ----------  ----------  ----------
                                                                                           
1997
  Net sales......................................................  $   84,827  $   95,250  $  103,297  $  121,231
  Operating income...............................................       2,561       2,871       3,072       2,861
  Pro forma net income...........................................       1,347       1,037         981       2,209
 
1998
  Net sales......................................................  $  129,269  $  131,929  $  164,333  $  170,009
  Operating income...............................................       3,922       4,944       5,648       7,151
  Net income.....................................................       1,893       3,218       4,022       4,326

 
13. SUBSEQUENT EVENTS
 
    Effective February 4, 1999, the Company completed its acquisition of PT-1.
PT-1 is a provider of international and domestic long distance and local
telecommunications services primarily through the marketing of prepaid phone
cards. STAR issued 15.05 million shares of STAR common stock and $19.5 million
in short-term promissory notes for all outstanding shares, options and warrants
of PT-1 plus an additional 250,000 shares to certain PT-1 distributors. This
transaction was accounted for as a purchase. The value assigned to the common
shares issued was approximately $156 million, based upon the average of the high
and low market price from August 31, 1998 through September 2, 1998, the dates
surrounding the first amendment to the Merger Agreement.
 
    The Company recorded approximately $181 million of goodwill representing the
excess of fair market value over the net assets acquired, which will be
amortized over a 20-year period. For the year ended December 31, 1998, PT-1 had
revenues and operating income of $505.4 million (unaudited) and $2.7 million
(unaudited), respectively. At December 31, 1998, PT-1 had total assets of $124.7
million (unaudited.)
 
    During 1996, 1997 and 1998, the Company provided long distance service to
PT-1. Revenue from these services amounted to approximately $8 million, $36
million and $89 million, respectively. The Company also made a $10 million loan
to PT-1 and a $3 million loan to its founder and majority stockholder. Accounts
and other receivables outstanding at December 31, 1997 and 1998 from PT-1 and
its founder amounted to approximately $1 million and $40 million, respectively.
 
                                      F-24

                 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
                               DECEMBER 31, 1998
 
14. EVENTS SUBSEQUENT TO THE DATE OF THE AUDITORS' REPORT (UNAUDITED)
 
    In February 1999, the Company announced a transaction with WorldPort
Communications Inc. that calls for the firms to exchange as much as $55 million
worth of fiber-optic network capacity over the next three years. WorldPort will
exchange capacity on its pan-European fiber network with a capacity on STAR
Telecom Deutschland's Project Apollo network in Germany. The Company purchased
$8 million of pan-European STM-1 fiber capacity from WorldPort as part of the
agreement. The Company anticipates this capacity will be activated in April
1999.
 
    In February 1999, the Company received a fully underwritten commitment for
$275 million in senior secured credit facilities from Goldman Sachs Credit
Partners L.P. ING Barings and Deutsche Bank have also committed to the
facilities and will act as the Administrative Agent and Documentation Agent,
respectively. The completion of the financing is subject to the execution of
definitive loan documents and customary conditions for financing of this type.
 
    In February 1999, the Company's subsidiary PT-1 signed a $170 million,
3-year exclusive distribution agreement with Harold Levinson Associates, Inc., a
distributor of tobacco, grocery and confectionary products with annual sales
exceeding $500 million, to distribute its New York Millionaire Phonecard.
 
    On March 24, 1999, the Company acquired UDN, a telephone service provider
focused on switched and dedicated local, and long-distance, toll free and
calling card services to multinational corporations, in a transaction that was
accounted for as a pooling of interests. The Company issued 1 million shares of
its common stock in exchange for all of the shares of UDN. Upon the completion
of the merger, the Company changed the name UDN to Allstar Telecom.
 
                                      F-25

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
To the Board of Directors and Stockholders
  of 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 25, 1999. 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 25, 1999
 
                                      S-1

                                                                     SCHEDULE II
 
                 STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
                 SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
 


                                                                   BALANCE AT
                                                                    BEGINNING                            BALANCE AT
                                                                       OF                                  END OF
                                                                     PERIOD      PROVISION   WRITE-OFF     PERIOD
                                                                   -----------  -----------  ----------  -----------
                                                                                    (IN THOUSANDS)
                                                                                             
Allowance for doubtful accounts
  Year ended December 31, 1996...................................   $     298    $  16,284   $  (10,320)  $   6,262
  Year ended December 31, 1997...................................   $   6,262    $   7,220   $   (6,248)  $   7,234
  Year ended December 31, 1998...................................   $   7,234    $   8,711   $   (4,725)  $  11,220
 
Deferred tax valuation allowance
  Year ended December 31, 1996...................................   $      30    $   3,354   $       --   $   3,384
  Year ended December 31, 1997...................................   $   3,384    $  (1,268)  $       --   $   2,116
  Year ended December 31, 1998...................................   $   2,116    $     422   $       --   $   2,538
 
Receivable from related party
  Year ended December 31, 1997...................................   $      --    $   3,221   $       --   $   3,221
  Year ended December 31, 1998...................................   $   3,221    $  (3,221)  $       --   $      --

 
                                      S-2

EX-21.1

                                                                    EXHIBIT 21.1
 
                         SUBSIDIARIES OF THE REGISTRANT
 


NAME OF SUBSIDIARY                                                        JURISDICTION OF INCORPORATION
- ------------------------------------------------------------------------  ---------------------------------------
                                                                       
CEO Telecommunications, Inc.                                              California
 
CEO California Telecommunications, Inc.                                   California
 
Helvey Com, Inc.                                                          California
 
T-One Corp.                                                               Delaware
 
Lucius Enterprises, Inc.                                                  California
 
STAR Telecommunications Australia PTY. Ltd.                               Australia
 
Romborg Holding, B.V.                                                     Netherlands
 
STAR Europe Ltd.                                                          United Kingdom
 
STAR Telecommunications Deutschland, GmbH                                 Germany
 
STAR Telecommunications Holding, GmbH                                     Germany
 
STAR Telecommunications France Holding                                    France
 
STAR Telecommunications France                                            France
 
STAR Telecommunications Switzerland, S.a.r.l.                             Switzerland
 
Grupo Industrial Arvilla S.A. de C.V.                                     Mexico
 
Servicios Sumosierra S.A. de C.V.                                         Mexico
 
Grupo Bunden, S.A. de C.V.                                                Mexico
 
Grupo Palafox-Toledo, S.A. de C.V.                                        Mexico
 
PT-1 Communications, Inc.                                                 New York
 
STAR Network, GmbH                                                        Germany
 
Morningside, S.A. de C.V.                                                 Mexico
 
Milhouse, S.A. de C.V.                                                    Mexico
 
United Digital Network of Texas, Inc.                                     Texas
 
Advanced Management Services, Inc.                                        Arizona
 
CTN--Custom Telecommunications Network of Arizona, Inc.                   Arizona
 
STAR Japan, Inc.                                                          Japan (51%)
 
Asian Datanet, Inc.                                                       Japan (50%)
 
United Digital Network, Inc.                                              Delaware
 
Phonetime Technologies, Inc.                                              Delaware
 
PT-1 Long Distance, Inc.                                                  Delaware
 
PT-1 Holdings I, Inc.                                                     Delaware
 
PT-1 Holdings II, Inc.                                                    Delaware
 
Nationwide Distributors, Inc.                                             Delaware
 
PT-1 Phonecard, L.P.                                                      Texas
 
Platform Services, L.P.                                                   Delaware
 
PT-1 Communications Puerto Rico, Inc.                                     Delaware
 
PT-1 Communications Canada, Inc.                                          Canada
 
Investment Services, Inc.                                                 Delaware
 
Bayonne, S.A. de C.V.                                                     Mexico

EX-23.1

                                                                    EXHIBIT 23.1
 
                   CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
    As independent public accountants, we hereby consent to the incorporation by
reference of our reports dated February 25, 1999 included in this Form 10-K,
into the Company's previously filed Registration Statements File No. 333-29681
and 333-32083 pertaining to STAR Telecommunications, Inc. 1997 Omnibus Stock
Incentive Plan, 1996 Stock Incentive Plan, 1996 Outside Director Non Statutory
Stock Option and Employment/Consulting Agreements. It should be noted that we
have not audited any financial statements of the Company subsequent to December
31, 1998 or performed any audit procedures subsequent to the date of our report.
 
                                          ARTHUR ANDERSEN LLP
 
Los Angeles, California
March 30, 1999

EX-27.1

 


<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S CONSOLIDATED BALANCE SHEETS, CONSOLIDATED STATEMENTS OF OPERATIONS,
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND CONSOLIDATED STATEMENTS OF
CASH FLOWS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH SCHEDULE.

<MULTIPLIER> 1,000
       
                             
<PERIOD-TYPE>                   YEAR
<FISCAL-YEAR-END>                          DEC-31-1998
<PERIOD-START>                             JAN-01-1998
<PERIOD-END>                               DEC-31-1998
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<SECURITIES>                                       835
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<INVENTORY>                                          0
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<PP&E>                                         189,377
<DEPRECIATION>                                  19,681
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<EPS-PRIMARY>                                     0.34
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