10-Q 1 d86943e10-q.txt FORM 10-Q FOR QUARTER ENDED MARCH 31, 2001 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED March 31, 2001. -------------- OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO _______. Commission File Number 1-12793 ------- STARTEK, INC. -------------------------------------------------------------------------------- (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 84-1370538 ------------------------------- ------------------- (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 100 GARFIELD STREET DENVER, COLORADO 80206 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) (303) 361-6000 -------------------------------------------------------------------------------- (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) -------------------------------------------------------------------------------- (FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST REPORT) Indicate by check mark whether the Registrant (1) has filed all reports 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. Common Stock, $.01 Par Value - 14,035,101 shares as of May 1, 2001. 2 STARTEK, INC. FORM 10-Q INDEX
Page Number ------ PART I. FINANCIAL INFORMATION Item 1. Financial Statements (unaudited) Condensed Consolidated Balance Sheets - December 31, 2000 and March 31, 2001 3 Condensed Consolidated Income Statements - Three months ended March 31, 2000 and 2001 4 Condensed Consolidated Statements of Cash Flows - Three months ended March 31, 2000 and 2001 5 Notes to Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9 Item 3. Quantitative and Qualitative Disclosure About Market Risk 12 PART II. OTHER INFORMATION Item 2. Changes in Securities and Use of Proceeds 15 Item 6. Exhibits and Reports on Form 8-K 15 SIGNATURES 16
2 3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS (UNAUDITED) STARTEK, INC. AND SUBSIDIARIES Condensed Consolidated Balance Sheets (dollars in thousands)
DECEMBER 31 MARCH 31 2000 2001 ------------ ------------ (unaudited) ASSETS Current assets: Cash and cash equivalents $ 22,543 $ 16,295 Investments 32,413 37,962 Trade accounts receivable, less allowance for doubtful accounts of $672 and $659, respectively 20,399 13,756 Inventories 1,946 2,257 Deferred tax assets 1,902 2,073 Prepaid expenses and other assets 742 979 ------------ ------------ Total current assets 79,945 73,322 Property, plant and equipment, net 29,891 30,407 Investment in Gifts.com, Inc., at cost 2,606 2,606 Notes receivable from Gifts.com, Inc. 9,807 9,807 Other assets 34 34 ------------ ------------ Total assets $ 122,283 $ 116,176 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 8,375 $ 7,674 Accrued liabilities 5,962 5,997 Income taxes payable 3,108 1,961 Line of credit 4,000 -- Current portion of long-term debt 1,992 1,974 Other 362 331 ------------ ------------ Total current liabilities 23,799 17,937 Long-term debt, less current portion 5,505 4,839 Deferred income taxes 725 760 Other 290 143 Stockholders' equity: Common stock 140 140 Additional paid-in capital 47,095 47,121 Cumulative translation adjustment 8 (12) Unrealized loss on investments available for sale (495) (962) Retained earnings 45,216 46,210 ------------ ------------ Total stockholders' equity 91,964 92,497 ------------ ------------ Total liabilities and stockholders' equity $ 122,283 $ 116,176 ============ ============
See notes to condensed consolidated financial statements. 3 4 STARTEK, INC. AND SUBSIDIARIES Condensed Consolidated Income Statements (dollars in thousands, except per share data) (unaudited)
THREE MONTHS ENDED MARCH 31 --------------------------- 2000 2001 ------------ ------------ Revenues $ 49,668 $ 32,432 Cost of services 38,457 23,682 ------------ ------------ Gross profit 11,211 8,750 Selling, general and administrative expenses 5,185 5,802 ------------ ------------ Operating profit 6,026 2,948 Net interest income and other 716 1,665 Non-recurring loss on impaired investment -- (3,040) ------------ ------------ Income before income taxes 6,742 1,573 Income tax expense 2,501 580 ------------ ------------ Net income(A) $ 4,241 $ 993 ============ ============ Weighted average shares of common stock(B) 13,989,184 14,034,015 Dilutive effect of stock options 302,922 30,793 ------------ ------------ Common stock and common stock equivalents(C) 14,292,106 14,064,808 ============ ============ Earnings per share: Basic (A/B) $ 0.30 $ 0.07 Diluted (A/C) $ 0.30 $ 0.07
See notes to condensed consolidated financial statements. 4 5 STARTEK, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Cash Flows (dollars in thousands) (unaudited)
THREE MONTHS ENDED MARCH 31 ---------------------------- 2000 2001 ------------ ------------ OPERATING ACTIVITIES Net income $ 4,241 $ 993 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,132 1,454 Deferred income taxes 125 151 Changes in operating assets and liabilities: Purchases of trading securities, net (2,760) (1,047) Trade accounts receivable, net 2,618 6,643 Inventories (1,196) (311) Prepaid expenses and other assets 34 (237) Accounts payable (1,102) (701) Income taxes payable 1,583 (1,147) Accrued and other liabilities 1,131 (141) ------------ ------------ Net cash provided by operating activities 5,806 5,657 INVESTING ACTIVITIES Purchases of investments available for sale (9,878) (7,147) Proceeds from disposition of investments available for sale 5,629 1,903 Purchases of property, plant and equipment (1,019) (1,896) ------------ ------------ Net cash used in investing activities (5,268) (7,140) FINANCING ACTIVITIES Stock options exercised 289 26 Principal payments on borrowings, net (357) (4,685) Principal payments on capital lease obligations (9) -- ------------ ------------ Net cash used in financing activities (77) (4,659) Effect of exchange rate changes on cash 85 (106) ------------ ------------ Net increase (decrease) in cash and cash equivalents 546 (6,248) Cash and cash equivalents at beginning of period 11,943 22,543 ------------ ------------ Cash and cash equivalents at end of period $ 12,489 $ 16,295 ============ ============ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid for interest $ 86 $ 95 Income taxes paid $ 746 $ 1,531 (Increase) in unrealized loss on investments available for sale, net of tax $ (138) $ (467)
See notes to condensed consolidated financial statements. 5 6 STARTEK, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (dollars in thousands, except per share data) (unaudited) 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In management's opinion, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results during the three months ended March 31, 2001 are not necessarily indicative of operating results that may be expected during any other interim period of 2001. The condensed consolidated balance sheet as of December 31, 2000 was derived from audited financial statements, but does not include all information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. For further information, refer to consolidated financial statements and footnotes thereto included in StarTek, Inc.'s annual report on Form 10-K for the year ended December 31, 2000. 2. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 ("SFAS No. 133") "Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133 establishes accounting and reporting standards requiring derivative instruments (including certain derivative instruments embedded in other contracts) to be recorded as either assets or liabilities measured at fair value. SFAS No. 133 requires changes in a derivative's fair value to be recognized currently in income unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allow a derivative's gains and losses to offset related results on the hedged item in the income statement, and requires a company to formally document, designate, and assess effectiveness of transactions receiving hedge accounting treatment. SFAS No. 133 was effective for the Company on January 1, 2001. The adoption of SFAS No. 133 had no material impact on the Company. 3. EARNINGS PER SHARE Basic earnings per share is computed based on weighted average number of common shares outstanding. Diluted earnings per share is computed based on weighted average number of common shares outstanding plus effects of outstanding stock options using the "treasury stock" method. 4. NON-RECURRING LOSS ON IMPAIRED INVESTMENT In January 2001, the Company purchased an investment in Six Sigma, LLC ("Six Sigma"). Six Sigma provided its audited financial statements which included an unqualified independent auditors' opinion. The purpose of Six Sigma was to provide revolving platform financing to its customer, a national mortgage company ("Mortgage Company") and all advances were to be secured by first mortgages or deeds of trust on residential properties located in 47 different states. Six Sigma was to receive interest from the Lender and a portion of the loan origination fees. Subsequently, a federal court placed the Mortgage Company into receivership based on allegations by the Securities and Exchange Commission that the president of the Mortgage Company had misappropriated large amounts of funds. The concurrent default on the line of credit extended by Six Sigma to the Mortgage Company triggered a bankruptcy filing by Six Sigma. Based on the limited information available to the Company, the Company believes it is probable its investment in Six Sigma has been impaired, and as of March 31, 2001 has taken a charge for a non-recurring loss on the entire investment balance of $3,000 and accrued interest and fees of $40. The Company will continue to pursue recovery of this investment. 6 7 STARTEK, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (continued) (dollars in thousands, except per share data) (unaudited) 5. INVESTMENTS As of December 31, 2000, investments available for sale consisted of:
GROSS GROSS ESTIMATED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ---------- ---------- ---------- ---------- Corporate bonds $ 7,081 $ 139 -- $ 7,220 Foreign government bonds 1,438 178 -- 1,616 Equity securities 9,871 -- $ (1,107) 8,764 ---------- ---------- ---------- ---------- Total $ 18,390 $ 317 $ (1,107) $ 17,600 ========== ========== ========== ==========
As of March 31, 2001, investments available for sale consisted of:
GROSS GROSS ESTIMATED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ---------- ---------- ---------- ---------- Corporate bonds $ 8,609 $ 254 $ 8,863 Foreign government bonds 1,438 231 1,669 Equity securities 13,580 $ (2,011) 11,569 ---------- ---------- ---------- ---------- Total $ 23,627 $ 485 $ (2,011) $ 22,101 ========== ========== ========== ==========
As of March 31, 2001, amortized costs and estimated fair values of investments available for sale by contractual maturity were:
ESTIMATED COST FAIR VALUE ---------- ---------- Corporate bonds and foreign government bonds maturing within: One year $ 6,527 $ 6,794 Two to five years 2,082 2,069 Due after five years 1,438 1,669 ---------- ---------- 10,047 10,532 Equity securities 13,580 11,569 ---------- ---------- Total $ 23,627 $ 22,101 ========== ==========
Equity securities primarily consisted of publicly traded common stock of US based companies, equity mutual funds, and real estate investment trusts. As of December 31, 2000, the Company was invested in trading securities, which, in the aggregate, had an original cost and fair market value of $14,571 and $14,813, respectively. As of March 31, 2001, the Company was invested in trading securities, which, in the aggregate, had an original cost and fair market value of $15,560 and $15,860, respectively. Trading securities consisted primarily of US and international mutual funds and investments in limited partnerships. Certain investments include hedging and derivative securities. Trading securities were held to meet short-term investment objectives. As part of trading securities and as of March 31, 2001, the Company had sold call options for a total of 83,000 shares of US equity securities which, in the aggregate, had a basis and market value of $152 and $42, respectively, and sold put options for a total of 32,500 shares of US equity securities which, in the aggregate, had a basis and market value of $44 and $71, respectively. The foregoing call and put options were reported net as components of trading securities and expire April 21, 2001. Risk of loss to the Company regarding its current investments in the event of nonperformance by any party is not considered substantial. Because of potential limited liquidity of some of these instruments, recorded values of these transactions may be different from values that might be realized if the Company were to sell or close out the transactions. Such differences are not considered substantial to the Company's results of operations, financial condition, or liquidity. The foregoing call and put options may involve 7 8 STARTEK, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (continued) (dollars in thousands, except per share data) (unaudited) 5. INVESTMENTS (CONTINUED) elements of credit and market risks in excess of the amounts recognized in the Company's financial statements. A substantial decline and/or change in value of equity securities, equity prices in general, international equity mutual funds, investment limited partnerships, and/or call and put options could have a material adverse effect on the Company's portfolio of trading securities. Also, trading securities could be materially and adversely affected by increasing interest and/or inflation rates or market expectations thereon, poor management, shrinking product demand, and other risks that may affect single companies, as well as groups of companies. 6. INVENTORIES The Company purchases components of its clients' products as an integral part of its supply chain management services. At the close of an accounting period, packaged and assembled products (together with other associated costs) are reflected as finished goods inventories pending shipment. The Company generally has the right to be reimbursed from its clients for unused inventories. Client-owned inventories are not valued in the Company's balance sheet. Inventories consisted of:
DECEMBER 31 MARCH 31 2000 2001 ------------ ------------ Purchased components and fabricated assemblies $ 1,524 $ 1,682 Finished goods 422 575 ------------ ------------ $ 1,946 $ 2,257 ============ ============
7. GIFTS.COM, INC. Through its wholly-owned subsidiary Domain.com, Inc., the Company has a 19.9% investment in and notes receivable from Gifts.com, Inc. of $12,413 in the aggregate. The Company's investment in Gifts.com, Inc. is carried at cost. During the three months ended March 31, 2000, the Company recognized $605 of revenues related to services performed for Gifts.com, Inc. and $158 of interest income. During the three months ended March 31, 2001, the Company recognized $175 of interest income. As of March 31, 2001, regular quarterly interest of $175 was due and current from Gifts.com, Inc. Management believes the Company's investment in and notes receivable from Gifts.com, Inc. are recoverable and no impairment loss provision is necessary. Gifts.com, Inc. is currently experiencing operating losses, negative cash flows, and a deficiency in working capital. The Company could lose its entire investment in and notes receivable from Gifts.com, Inc. An impairment of the Company's investment in and notes receivable from Gifts.com, Inc. could have an adverse effect on the Company's result of operations and financial condition. The Company does not exercise significant influence over financial or operating policies of Gifts.com, Inc. 8. PRINCIPAL CLIENTS Three clients accounted for 41.7%, 36.6%, and 11.6% of the Company's revenues during the three months ended March 31, 2001. Two clients accounted for approximately 70.1% and 10.1% of revenues during the three months ended March 31, 2000. The loss of a principal client and/or changes in timing or termination of a principal client's product launch or service offering would have a material adverse effect on the Company's business, revenues, operating results, and financial condition. To limit the Company's credit risk, management performs ongoing credit evaluations of its clients. Although the Company is directly impacted by economic conditions in which its clients operate, management does not believe substantial credit risk existed as of March 31, 2001. 9. COMPREHENSIVE INCOME Financial Accounting Standards Board Statement No. 130, "Reporting Comprehensive Income", establishes standards for reporting and display of comprehensive income. Comprehensive income is defined essentially as all changes in stockholders' equity, exclusive of transactions with owners. Comprehensive income was $4,143 and $507 for the three months ended March 31, 2000 and 2001, respectively. 8 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS All statements contained in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" or elsewhere in this Form 10-Q which are not statements of historical facts are forward-looking statements that involve substantial risks and uncertainties. Forward-looking statements are preceded by terms such as "may", "will", "should", "anticipates", "expects", "believes", "plans", "future", "estimate", "continue", and similar expressions. The following are important factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements; these include, but are not limited to, inflation and general economic conditions in the Company's and its clients' markets, risks associated with the Company's reliance on principal clients, loss or delayed implementation of a large project or service offering for a principal client, which could cause substantial quarterly variation in the Company's revenues and earnings, difficulties in managing rapid growth, risks associated with rapidly changing technology, dependence on labor force, risks associated with international operations and expansion, control by principal stockholders, dependence on key personnel, dependence on key industries and trends toward outsourcing, risks associated with the Company's contracts, highly competitive markets, risks of business interruptions, volatility of the Company's stock price, risks related to the Company's investment in and note receivable from Gifts.com, Inc., risks related to the Company's Internet web site operations, risks related to the Company's portfolio of Internet domain names, and risks related to changes in valuation of the Company's investments. These factors include risks and uncertainties beyond the Company's ability to control; and, in many cases, the Company and its management cannot predict the risks and uncertainties that could cause actual results to differ materially from those indicated by use of forward-looking statements. Similarly, it is impossible for management to foresee or identify all such factors. As such, investors should not consider the foregoing list to be an exhaustive statement of all risks, uncertainties, or potentially inaccurate assumptions. All forward-looking statements herein are made as of the date hereof, and the Company undertakes no obligation to update any such forward-looking statements. All forward-looking statements herein are qualified in their entirety by information set forth in "Management's Discussion and Analysis of Financial Condition and Results of Operations"--"Factors That May Affect Future Results" section of the Company's annual report on Form 10-K for the year ended December 31, 2000. The following table sets forth certain unaudited condensed consolidated income statement data expressed as a percentage of revenues:
THREE MONTHS ENDED MARCH 31 ---------------------------- 2000 2001 ------------ ------------ Revenues 100.0% 100.0% Cost of services 77.4 73.0 ------------ ------------ Gross profit 22.6 27.0 Selling, general and administrative expenses 10.4 17.9 ------------ ------------ Operating profit 12.2 9.1 Net interest income and other 1.4 5.1 Non-recurring loss on impaired investment -- (9.3) ------------ ------------ Income before income taxes 13.6 4.9 Income tax expense 5.0 1.8 ------------ ------------ Net income 8.6% 3.1% ============ ============
THREE MONTHS ENDED MARCH 31, 2001 COMPARED TO THREE MONTHS ENDED MARCH 31, 2000 Revenues. Revenues decreased $17.3 million, or 34.7%, from $49.7 million to $32.4 million during the three months ended March 31, 2000 and 2001, respectively. This decrease was largely due to reduced revenue from the Company's largest client which provided 70.1% and 41.7% of revenues in the three months ended March 31, 2000 and 2001, respectively, partially offset by increased services provided to certain other clients, one of which provided 36.6% of revenues in the three months ended March 31, 2001. The Company believes its share of business from its largest client has not declined. Cost of Services. Cost of services decreased $14.8 million, or 38.4%, from $38.5 million to $23.7 million during the three months ended March 31, 2000 and 2001, respectively. As a percentage of revenues, cost of services was 77.4% and 73.0% during the three months ended March 31, 2000 and 2001, respectively. This percentage amount declined mainly as a result of improved processes, better operating efficiency, and changes in the mix of services provided. Gross Profit. Due to the foregoing factors, gross profit decreased $2.4 million, or 22.0%, from $11.2 million to $8.8 million during the three months ended March 31, 2000 and 2001, respectively. As a percentage of revenues, gross profit was 22.6% and 27.0% during the three months ended March 31, 2000 and 2001, respectively. Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $0.6 million, or 11.9%, from $5.2 million to $5.8 million during the three months ended March 31, 2000 and 2001, respectively. As a percentage of revenues, selling, general and administrative expenses were 10.4% and 17.9% during the three months ended March 31, 2000 and 2001, respectively. The increase in selling, general and administrative expenses as a percentage of revenue was primarily due to the spreading of relatively fixed costs over a smaller revenue base together with increased costs of developing systems and infrastructure. 9 10 Operating Profit. As a result of the foregoing factors, operating profit decreased from $6.0 million to $2.9 million during the three months ended March 31, 2000 and 2001, respectively. As a percentage of revenues, operating profit was 12.2% and 9.1% during the three months ended March 31, 2000 and 2001, respectively. Net Interest Income and Other. Net interest income and other was approximately $0.7 million and $1.7 million during the three months ended March 31, 2000 and 2001, respectively. Substantially all net interest income and other continues to be derived from cash equivalents and investment balances, partially offset by interest expense incurred as a result of the Company's various debt and lease arrangements. Non-Recurring Loss on Impaired Investment. The Company believes it is probable that its $3.0 million investment plus accrued interest and fees in Six Sigma, LLC has been impaired and has taken a charge for a non-recurring loss on the entire investment balance as of March 31, 2001. See Note 4 to the Financial Statements. Income Before Income Taxes. As a result of the foregoing factors, income before income taxes decreased $5.1 million, or 76.7%, from $6.7 million to $1.6 million during the three months ended March 31, 2000 and 2001, respectively. As a percentage of revenues, income before income taxes decreased from 13.6% to 4.9% during the three months ended March 31, 2000 and 2001, respectively. Income Tax Expense. Income tax expense during the three months ended March 31, 2000 and 2001 reflects a provision for federal, state, and foreign income taxes at an effective rate of 37.1% and 36.9%, respectively. Net Income. Based on the factors discussed above, net income decreased $3.2 million, or 76.6%, from $4.2 million to $1.0 million during the three months ended March 31, 2000 and 2001, respectively. LIQUIDITY AND CAPITAL RESOURCES Since its initial public offering, the Company has primarily financed its operations, liquidity requirements, capital expenditures, and capacity expansion through cash flows from operations, and to a lesser degree, through various forms of debt and leasing arrangements. The Company had a $5.0 million line of credit with Wells Fargo Bank West, N.A. (the "Bank") that matured on April 30, 2001. The Company has renewed this line of credit on an unsecured basis. Borrowings under the new line of credit bear interest at the Bank's prime rate minus 1% (7.00% as of March 31, 2001). Under this new line of credit, the Company is required to maintain minimum tangible net worth of $65.0 million and operate at a profit (excluding any adjustments of carrying value pertaining to Gifts.com, Inc). The Company may not pay dividends in an amount which would cause a failure to meet these financial covenants. As of March 31, 2001 and the date of this Form 10-Q the Company was in compliance with the financial covenants pertaining to the unsecured line of credit. Effective September 15, 1999, the Company entered into a contribution agreement (the "Contribution Agreement") and stockholders agreement with The Reader's Digest Association, Inc. ("Reader's Digest") and Gifts.com. Inc. (formerly known as Good Catalog Company), previously a wholly-owned subsidiary of Reader's Digest. On November 8, 1999, pursuant to the Contribution Agreement, Domain.com purchased 19.9% of the outstanding common stock of Gifts.com, Inc. for approximately $2.6 million in cash. Reader's Digest owns the remaining 80.1% of the outstanding common stock of Gifts.com, Inc. The Contribution Agreement provides for an assignment from Domain.com to Gifts.com, Inc. of Domain.com's right, title, and interest in and to the URL www.gifts.com. Domain.com has the right to designate at least one member of Gifts.com, Inc.'s board of directors, which consists of at least five directors. Effective November 1, 1999, Domain.com and Reader's Digest entered into a loan agreement pursuant to which Domain.com advanced an unsecured loan of $7.8 million and Reader's Digest also advanced an unsecured loan to Gifts.com, Inc. ( the "Loans"). The Loans mature November 1, 2002, bear interest at a rate equal to a three month LIBO rate plus 2.0% per annum, and interest is payable quarterly. Gifts.com, Inc. provides two Internet web sites that sell gifts on-line and operates a gifts catalog business. The Company advanced two additional $0.99 million loans to Gifts.com, Inc.: the first loan was made August 2, 2000 and the second loan was made December 5, 2000. Both loans are governed by the same terms and conditions as those set forth in the $7.8 million loan agreement effective November 1, 1999. In conjunction with the loans made by Domain.com, Inc., and in order to maintain proportionate ownership interest, Reader's Digest Association, Inc., owning 80.1% of Gifts.com, Inc. made corresponding loans in the amount of $4.0 million each to Gifts.com, Inc. thereby maintaining an 80.1% ownership interest in Gifts.com, Inc. Gifts.com, Inc. is currently experiencing operating losses, negative cash flows and a deficiency in working capital. The Company could lose its entire investment in and notes receivable from Gifts.com, Inc. An impairment of the Company's investment and notes receivable from Gifts.com, Inc. could have an adverse effect on the Company's results of operations and financial condition. As of March 31, 2001, the Company had cash, cash equivalents, and investment balances of $54.3 million, working capital of $55.4 million, and stockholders' equity of $92.5 million. Cash and cash equivalents are not restricted. See "Quantitative and Qualitative Disclosure About Market Risk" set forth herein for further discussions regarding the Company's cash, cash equivalents, investments available for sale, and trading securities. 10 11 The Company has committed to spend approximately $1.6 million in the remainder of 2001 related to property, plant, and equipment. Net cash provided by operating activities was $5.8 million and $5.7 million for the three months ended March 31, 2000 and 2001, respectively. This decrease was primarily a result of a decrease in net income and income taxes payable, partially offset by increases in accounts receivable and a decrease in net purchases of trading securities. Without the effect of net purchases of trading securities, and the non-recurring loss on impaired investment, operating cash flows were $8.6 million and $9.7 million for 2000 and 2001, respectively. Net cash used in investing activities was $5.3 million and $7.1 million for the three months ended March 31, 2000 and 2001, respectively. This increase was primarily due to a net increase in investments available for sale together with an increase in purchases of property, plant, and equipment. Net cash used in financing activities was $ 0.1 million and $4.7 million for the three months ended March 31, 2000 and 2001, respectively. Financing activities, during both periods, consisted of principal payments on borrowings and capital lease obligations, offset by proceeds from exercises of employee stock options. The effect of currency exchange rate changes on translation of the Company's United Kingdom and Singapore operations was not substantial during the three months ended March 31, 2001. Terms of the Company's agreements with clients and subcontractors are typically in US dollars except for certain agreements related to its United Kingdom and Singapore operations. If the international portion of the Company's business continues to grow, more revenues and expenses will be denominated in foreign currencies, which increases the Company's exposure to fluctuations in currency exchange rates. See "Quantitative and Qualitative Disclosure About Market Risk" set forth herein for a further discussion of the Company's exposure to foreign currency exchange risks in connection with its investments. Management believes the Company's cash, cash equivalents, investments, anticipated cash flows from future operations, and $10.0 million line of credit will be sufficient to support its operations, capital expenditures, and various repayment obligations under its debt and lease agreements for the foreseeable future. Liquidity and capital requirements depend on many factors, including, but not limited to, the Company's ability to retain or successfully and timely replace its principal clients and the rate at which the Company expands its business, whether internally or through acquisitions and strategic alliances. To the extent funds generated from sources described above are insufficient to support the Company's activities in the short or long-term, the Company will be required to raise additional funds through public or private financing. No assurance can be given that additional financing will be available, or if available, it will be available on terms favorable to the Company. INFLATION AND GENERAL ECONOMIC CONDITIONS Although management cannot accurately anticipate effects of domestic and foreign inflation on the Company's operations, management does not believe inflation has had, or is likely in the foreseeable future to have, a material adverse effect on the Company's results of operations or financial condition. RELIANCE ON PRINCIPAL CLIENT RELATIONSHIPS Microsoft Corporation ("Microsoft") accounted for 70.1% and 41.7% of the Company's revenues during the three months ended March 31, 2000 and 2001, respectively. The Company believes its share of business from Microsoft has not declined. AT&T Corporation accounted for less than 10.0% of the Company's revenues during the three months ended March 31, 2000 and 36.6% of the Company's revenues during the three months ended March 31, 2001. America Online accounted for 10.1% and 11.6% of the Company's revenues during the three months ended March 31, 2000 and 2001, respectively. Loss of a principal client(s) and/or changes in timing or termination of a principal client's product launch or service offering would have a material adverse affect on the Company's business, revenues, operating results, and financial condition. The Company provides various outsourced services to various divisions of Microsoft, which began its outsourcing relationship with the Company in April 1996. There can be no assurance the Company will be able to retain its principal client(s) or, if it were to lose its principal client(s), would be able to timely replace such clients with clients that generate a comparable amount of revenues. Additionally, the amount and growth rate of revenues derived from its principal clients in the past is not necessarily indicative of revenues that may be expected from such clients in the future. VARIABILITY OF QUARTERLY OPERATING RESULTS The Company's business is seasonal and is at times conducted in support of product launches for new and existing clients. Historically, the Company's revenues have been substantially lower in the quarters preceding the fourth quarter due to timing of its clients' marketing programs and product launches, which are typically geared toward the holiday 11 12 buying season. However, the Company's revenues and operating results for the three months ended March 31, 2001 are not necessarily indicative of revenues or operating results that may be experienced in future periods. Additionally, the Company has experienced and expects to continue to experience, quarterly variations in revenues and operating results as a result of a variety of factors, many of which are outside the Company's control, including: (i) timing of existing and future client product launches or service offerings; (ii) expiration or termination of client projects; (iii) timing and amount of costs incurred to expand capacity in order to provide for further revenue growth from existing and future clients; (iv) seasonal nature of certain clients' businesses; (v) cyclical nature of certain high technology clients' businesses; and (vi) changes in the amount and growth rate of revenues generated from the Company's principal clients. RISKS RELATED TO THE COMPANY'S INVESTMENT IN AND NOTES RECEIVABLE FROM GIFTS.COM, INC. Through its wholly-owned subsidiary Domain.com, Inc., the Company's investment in and note receivable from Gifts.com, Inc. of approximately $12.4 million, in the aggregate, involves a high degree of risk. Gifts.com, Inc. is currently experiencing operating losses and negative cash flows and has a deficiency in working capital. Accordingly, an investor in the Company's common stock must consider the challenges, risks, and uncertainties frequently encountered by early stage companies using new and unproven business models in new and rapidly evolving markets. These challenges influencing Gifts.com, Inc.'s ability to substantially increase its revenues and thereby achieve profitability, include Gifts.com, Inc.'s ability to: (i) execute on its business model; (ii) increase brand recognition; (iii) manage growth in its operations; (iv) cost-effectively attract and retain a high volume of catalog and online customers and build a critical mass of repeat customers at a reasonable cost; (v) effectively manage, control, and account for inventory; (vi) upgrade and enhance its web sites, transaction-processing systems, order fulfillment capabilities, and inventory management systems; (vii) increase awareness of its online stores; (viii) establish pricing to meet customer expectations; (ix) compete effectively in its market; (x) adapt to rapid regulatory and technological changes related to catalog operations, E-commerce and the Internet; and (xi) protect its trademarks, service marks, and copyrights. These and other uncertainties generally attributable to businesses engaging in catalog operations, E-commerce and the Internet must be considered when evaluating the Company's investment in and notes receivable from Gifts.com, Inc., and the Company's participation in the business of Gifts.com, Inc. An impairment of the Company's investment in and notes receivable from Gifts.com, Inc. could have an adverse effect on the Company's results of operations and financial condition. The Company could lose its entire investment in and notes receivable from Gifts.com, Inc. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The following discusses the Company's exposure to market risks related to changes in interest rates and other general market risks, equity market prices and other general market risks, and foreign currency exchange rates as of March 31, 2001. All of the Company's investment decisions are supervised or managed by its Chairman of the Board. The Company's investment portfolio policy, approved by the Board of Directors during 1999, provides for investment objectives and portfolio allocation guidelines. This discussion contains forward-looking statements subject to risks and uncertainties. Actual results could vary materially as a result of a number of factors, including but not limited to, changes in interest and inflation rates or market expectations thereon, equity market prices, foreign currency exchange rates, and those set forth in the "Management's Discussion and Analysis of Financial Condition and Results of Operations"--"Factors That May Affect Future Results" section of the Company's annual report on Form 10-K for the year ended December 31, 2000. Interest Rate Sensitivity and Other General Market Risks Cash and Cash Equivalents. The Company had $16.3 million in cash and cash equivalents, which consisted of: (i) $15.7 million invested in various money market funds, overnight investments, and various commercial paper securities at a combined weighted average interest rate of approximately 5.85%; and (ii) $0.6 million in various non-interest bearing accounts. Cash and cash equivalents are not restricted. Management considers cash equivalents to be short-term, highly liquid investments readily convertible to known amounts of cash, and so near their maturity they present insignificant risk of changes in value because of changes in interest rates. The Company does not expect any substantial loss with respect to its cash and cash equivalents as a result of interest rate changes, and estimated fair value of its cash and cash equivalents approximates original cost. Investments Available for Sale. The Company had investments available for sale, which, in the aggregate, had an original cost and fair market value of $23.6 million and $22.1 million, respectively. Investments available for sale generally consisted of corporate bonds, foreign government bonds denominated in US dollars, bond mutual funds, and various forms of equity securities. The Company's investment portfolio is subject to interest and inflation rate risks and will fall in value if interest and/or inflation rates or market expectations thereon increase. 12 13 Fair market value of and estimated cash flows from the Company's investments in corporate bonds are substantially dependent upon credit worthiness of certain corporations expected to repay their debts to the Company. If such corporations' financial condition and liquidity adversely changes, the Company's investments in their debts can be expected to be materially and adversely affected. The Company's investments in foreign government bonds denominated in US dollars entail special risks of global investing. These risks include, but are not limited to: (i) currency exchange fluctuations which could adversely affect the ability of foreign governments to repay their debts in US dollars; (ii) foreign government regulations; and (iii) potential for political and economic instability. Fair market value of investments in foreign government bonds (denominated in US dollars) can be expected to be more volatile than that of US government bonds. These risks are intensified for the Company's investments in debt of foreign governments located in countries generally considered to be emerging markets. The table below provides information about maturity dates and corresponding weighted average interest rates related to certain of the Company's investments available for sale:
WEIGHTED EXPECTED MATURITY DATE AVERAGE -COST- INTEREST RATES (DOLLARS IN THOUSANDS) --------------------------------------------------------------------------------------------------- 1 year 2 years 3 years 4 years 5 years Thereafter Total FAIR VALUE ------ ------- ------- ------- ------- ---------- ------- ---------- Corporate bonds 8.30% $6,527 $ -- $ -- $ -- $ 6,527 $ 6,794 Corporate bonds 8.73% $ 2,082 2,082 2,069 Foreign government bonds 9.26% $ 1,438 1,438 1,669 ------ ------- ------- ------- ------- ---------- ------- ---------- Total $6,527 $ 2,082 $ -- $ -- $ -- $ 1,438 $10,047 $ 10,532 ====== ======= ======= ======= ======= ========== ======= ==========
Management believes the Company has the ability to hold the foregoing investments until maturity, and therefore, if held to maturity, the Company would not expect the future proceeds from these investments to be affected, to any significant degree, by the effect of a sudden change in market interest rates. Declines in interest rates over time will, however, reduce the Company's interest income derived from future investments. As part of its investments available for sale portfolio, the Company was invested in equity securities which, in aggregate, had an original cost and fair market value of $13.6 million and $11.6 million, respectively. Outstanding Debt of the Company. The Company had outstanding debt of $6.8 million, $1.6 million of which bears interest at an annual fixed rate of 7.0%, and $1.6 million of which bears no interest as long as the Company complies with the terms of this debt arrangement. On October 22, 1999, the Company completed an equipment loan, $1.4 million outstanding, whereby the Company is expected to repay its debt at a variable rate of interest (6.9%) over a forty-eight month period. Management believes a hypothetical 10.0% increase in interest rates would not have a material adverse effect on the Company. Increases in interest rates would, however, increase interest expense associated with the Company's existing variable rate equipment loan and future borrowings by the Company, if any. For example, the Company may from time to time effect borrowings under its $10.0 million line of credit for general corporate purposes, including working capital requirements, capital expenditures, and other purposes related to expansion of the Company's capacity. Borrowings under the $10.0 million line of credit bear interest at the lender's prime rate less 1% (7.0%). The Company had no outstanding line of credit obligations. In the past, the Company has not hedged against interest rate changes. Equity Price Risks, General Market Risks, and Other Risks Equity Securities. The Company held in its investments available for sale portfolio certain equity securities with original cost and fair market value, in the aggregate, of $13.6 million and $11.6 million, respectively. Equity securities primarily consisted of publicly traded common stock of US based companies, equity mutual funds, and real estate investment trusts. A substantial decline in values of equity securities and equity prices in general would have a material adverse affect on the Company's equity investments. Also, prices of common stocks held by the Company would be materially and adversely affected by increasing inflation and/or interest rates or market expectations thereon, poor management, shrinking product demand, and other risks that may affect single companies, as well as groups of companies. The Company has partially hedged against some equity price changes. Trading Securities. The Company was invested in trading securities, which, in the aggregate, had an original cost and fair market value of $15.6 million and $15.9 million, respectively. Trading securities consisted primarily of US and international mutual funds, investments in limited partnerships, and US equity securities. Trading securities were held to meet short-term investment objectives. As part of trading securities and as of March 31, 2001, the Company had sold call options for a total of 83,000 shares of US equity securities which, in the aggregate, had a basis and market value of $0.2 million and $0.0 million, and sold put options for a total of 32,500 shares of US equity securities which, in the aggregate, had a basis and market value of $0.0 million and $0.1 million. The foregoing call and put options were reported net as components of trading securities and expire April 21, 2001. 13 14 Non-Recurring Loss on Impaired Investment. In January 2001, the Company purchased an investment in Six Sigma, LLC ("Six Sigma"). Six Sigma provided its audited financial statements which included an unqualified independent auditors' opinion. The purpose of Six Sigma was to provide revolving platform financing to its customer, a national mortgage company ("Mortgage Company") and all advances were to be secured by first mortgages or deeds of trust on residential properties located in 47 different states. Six Sigma was to receive interest from the Lender and a portion of the loan origination fees. Subsequently, a federal court placed the Mortgage Company into receivership based on allegations by the Securities and Exchange Commission that the president of the Mortgage Company had misappropriated large amounts of funds. The concurrent default on the line of credit extended by Six Sigma to the Mortgage Company triggered a bankruptcy filing by Six Sigma. Based on the limited information available to the Company, the Company believes it is probable its investment in Six Sigma has been impaired, and as of March 31, 2001 has taken a charge for a non-recurring loss on the entire investment balance of $3,000 and accrued interest and fees of $40. The Company will continue to pursue recovery of this investment. Risk of loss regarding its current investments to the Company in the event of nonperformance by any party is not considered substantial. Because of potential limited liquidity of some of these instruments, recorded values of these transactions may be different from values that might be realized if the Company were to sell or close out the transactions. Such differences are not considered substantial to the Company's results of operations, financial condition, or liquidity. The foregoing call and put options, may involve elements of credit and market risks in excess of the amounts recognized in the Company's financial statements. A substantial decline and/or change in value of equity securities, equity prices in general, international equity mutual funds, investments in limited partnerships, and/or call and put options could have a material adverse effect on the Company's portfolio of trading securities. Also, trading securities could be materially and adversely affected by increasing interest and/or inflation rates or market expectations thereon, poor management, shrinking product demand, and other risks that may affect single companies, as well as groups of companies. Foreign Currency Exchange Risks Of the Company's revenues for the three months ended March 31, 2001, 19.1% were derived from arrangements whereby the Company received payments from clients in currencies other than US dollars. Terms of the Company's agreements with clients and subcontractors are typically in US dollars except for certain agreements related to its United Kingdom and Singapore operations. If an arrangement provides for the Company to receive payments in a foreign currency, revenues realized from such an arrangement may be less if the value of such foreign currency declines. Similarly, if an arrangement provides for the Company to make payments in a foreign currency, cost of services and operating expenses for such an arrangement may be more if the value of such foreign currency increases. For example, a 10% change in the relative value of such foreign currency could cause a related 10% change in the Company's previously expected revenues, cost of services, and operating expenses. If the international portion of the Company's business continues to grow, more revenues and expenses will be denominated in foreign currencies, which increases the Company's exposure to fluctuations in currency exchange rates. In the past, the Company has not hedged against foreign currency exchange rate changes related to its United Kingdom and Singapore operations. Certain of the Company's investments classified as bond mutual funds (discussed in further detail above as part of "Interest Rate Sensitivity and Other General Market Risks") include investments in various forms of currency risk hedging instruments which are intended to reduce fair market value fluctuations of such mutual funds. 14 15 PART II. OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS (c) Sales of Unregistered Securities The Company did not issue or sell unregistered securities during the three months ended March 31, 2001 except as follows: On January 2, 2001, the Company granted options to purchase 21,600 shares of common stock, in the aggregate, to 216 employees pursuant to the Company's employee stock option plan. These options vest at a rate of 20% per year beginning January 2, 2002, expire January 2, 2011, and are exercisable at price of $14.94 per share, which was the market value of the Company's common stock on the date the options were granted. On January 8, 2001, the Company granted options to purchase 100,000 shares of common stock, in the aggregate, to the Company's Chief Executive Officer pursuant to the Company's employee stock option plan. These options vest at a rate of 20% per year beginning January 8, 2002, expire January 8, 2011, and are exercisable at price of $14.94 per share, which was the market value of the Company's common stock on the date the options were granted. On March 9, 2001, the Company granted options to purchase 51,600 shares of common stock, in the aggregate, to 16 employees pursuant to the Company's employee stock option plan. These options vest at a rate of 20% per year beginning March 9, 2002, expire March 9, 2011, and are exercisable at price of $14.50 per share, which was the market value of the Company's common stock on the date the options were granted. The foregoing stock option grants were made in reliance upon exemptions from registration provided by Sections 4(2) and 3(b) of the Securities Act of 1933, as amended, and regulations promulgated thereunder. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10.31 Amendment dated April 23, 2001 to the Startek, Pacific, Inc. Manufacturing agreement dated January 1, 1998 between StarTek Pacific, Ltd. and Mentor Media Ltd. 10.32 Assignment and Amendment dated January 1, 2001 to the Microsoft Corporation Manufacturing Agreement dated January 1, 1998 between Microsoft Corporation and StarTek, Inc. 10.33 Credit Agreement and $10,000,000 Revolving Line of Credit Note dated April 30, 2001 between StarTek, Inc. and Wells Fargo Bank West, National Association. (b) Reports on Form 8-K No reports on Form 8-K were filed by the Company during the three months ended March 31, 2001. 15 16 SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. STARTEK, INC. ----------------------------------------- (Registrant) Date: May 14, 2001 /s/ A. EMMET STEPHENSON, JR. ----------------------------- ----------------------------------------- A. Emmet Stephenson, Jr. Chairman of the Board Date: May 14, 2001 /s/ DENNIS M. SWENSON ----------------------------- ----------------------------------------- Dennis M. Swenson Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) 16 17 INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.31 Amendment dated April 23, 2001 to the Startek, Pacific, Inc. Manufacturing agreement dated January 1, 1998 between StarTek Pacific, Ltd. and Mentor Media Ltd. 10.32 Assignment and Amendment dated January 1, 2001 to the Microsoft Corporation Manufacturing Agreement dated January 1, 1998 between Microsoft Corporation and StarTek, Inc. 10.33 Credit Agreement and $10,000,000 Revolving Line of Credit Note dated April 30, 2001 between StarTek, Inc. and Wells Fargo Bank West, National Association.