-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, INO0/cxT1iV5KkGHWnIey+722rrwbONUmEGfwSVpepHemJ0rBdYxEDN5StWKqpWX ABazsmeO4U25tIwZRRYEAw== 0000912057-02-026972.txt : 20020711 0000912057-02-026972.hdr.sgml : 20020711 20020711081152 ACCESSION NUMBER: 0000912057-02-026972 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20020331 FILED AS OF DATE: 20020711 FILER: COMPANY DATA: COMPANY CONFORMED NAME: STARMEDIA NETWORK INC CENTRAL INDEX KEY: 0001057334 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROCESSING & DATA PREPARATION [7374] IRS NUMBER: 061461770 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-31138 FILM NUMBER: 02700604 BUSINESS ADDRESS: STREET 1: 29 WEST 36TH STREET 5TH FL CITY: NEW YORK STATE: NY ZIP: 10018 BUSINESS PHONE: 2125489600 MAIL ADDRESS: STREET 1: 29 WEST 36TH STREET FIFTH FLOOR CITY: NEW YORK STATE: NY ZIP: 10018 10-Q 1 a2084090z10-q.txt 10-Q ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------- FORM 10-Q |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 1-15015 ----------- (COMMISSION FILE NUMBER) FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 ----------- STARMEDIA NETWORK, INC. (Exact Name of Registrant as Specified in its Charter) DELAWARE 06-1461770 (State or Other Jurisdiction of (I.R.S. Employer Identification Incorporation) Number) 999 BRICKELL AVE. SUITE #808 MIAMI, FL 33131 (305)-938-3000 (Address, including zip code, and telephone number, of registrant's principal executive offices) ----------- Indicate by check mark whether the Registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days: Yes |X| No |_| As of July 1, 2002, there were 79,970,177 shares of the Registrant's Common Stock, $0.001 par value per share, outstanding. ================================================================================ STARMEDIA NETWORK, INC. AND SUBSIDIARIES INDEX PAGE NO. -------- PART I. FINANCIAL INFORMATION Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Condensed Consolidated Balance Sheets at March 31, 2002 (unaudited) and December 31, 2001......................... 4 Unaudited Condensed Consolidated Statements of Operations for the three months ended March 31, 2002 and 2001................................... 5 Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2002 and 2001............................................. 6 Notes to Unaudited Condensed Consolidated Financial Statements...................................... 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............. 14 Item 3. Quantitative and Qualitative Disclosure About Market Risk............................................... 19 PART II. OTHER INFORMATION Item 1. Legal Proceedings......................................... 19 Item 2. Changes In Securities and Use of Proceeds................. 21 Item 3. Defaults upon Senior Securities........................... 21 Item 4. Submission of Matters to a Vote of Security Holders....... 22 Item 5. Other Information......................................... 22 Item 6. Exhibits and Reports on Form 8-K.......................... 22 Item 7. Signatures................................................ 22 -2- PART I FINANCIAL INFORMATION RECENT DEVELOPMENTS Since March 31, 2002, the Company has experienced the following developments: o Effective as of April 19, 2002, Enrique Narciso resigned as CEO, President and director of the Company. As disclosed in the Report on Form 8-K filed by the Company on April 19, 2002, in tendering his resignation Mr. Narciso informed the Company that he needed to focus on a personal matter that resulted in his pleading guilty to a tax violation involving his 1998 individual federal tax return. Mr. Narciso joined the Company in October 1999. Following Mr. Narciso's resignation, Jose Manuel Tost was appointed President of the Company and Jorge Rincon was appointed Chief Operating Officer of the Company. o Effective as of April 29, 2002, Ana Maria Lozano-Stickley was appointed as Chief Financial Officer of the Company. Prior to that time Ms. Lozano-Stickley had been Acting Vice President of Accounting and Administration of the Company since January 2002. o The Company has continued to undertake a realignment for the purposes of focusing its resources on its mobile solutions business. As part of this realignment, the Company reduced its number of full-time employees from 520 as of close of business on December 31, 2001 to 391 as of June 21, 2002. In addition, following the Company's change of its headquarters in late 2001 from New York to Miami, Florida, which was previously the headquarters of the Company's mobile solutions business, the Company has substantially reduced its presence in New York. As of June 21, 2002, the Company had 30 employees based in its New York City offices, as compared to 118 employees based in such office as of close of business on December 31, 2001. o In late 2001 and early 2002, eleven lawsuits were filed against the Company in the Southern District of New York in connection with the Company's announcement relating to the Restatement referred to in "Restatement Information" above. A lead plaintiff for the class and lead plaintiff's counsel were subsequently selected and a motion filed to consolidate the various claims. The Consolidated Amended Complaint was filed on May 31, 2002 in the Southern District of New York under the caption In re StarMedia Network, Inc. Securities Litigation 01 Civ. 10556 (S.D.N.Y.). In June 2002, the lead plaintiffs and all defendants executed a settlement agreement that resolves all claims in the consolidated action. The settlement amount will be paid by the Company's directors and officers liability insurance carrier. This settlement agreement is subject to review and ratification by the Honorable Denny Chin of the United States District Court for the Southern District of New York. See "Legal Proceedings". o On July 1, 2002, Fernando Espuelas notified the Company that effective as of that date he resigned as a director of the Company. o On July 3, 2002 the Company sold most of its assets associated with starmedia.com, its Spanish- and Portuguese-language portal, and LatinRed, its Spanish language online community, to eresMas Interactive S.A. ("EresMas"). Following the sale of starmedia.com and LatinRed to EresMas, the Company is principally engaged in the business of providing integrated Internet solutions to wireless telephone operators targeting Spanish- and Portuguese-speaking audiences, principally in Latin America, and the Company retains only the following Internet media services: o batepapo.com.br, a Brazilian chat service, which the Company is considering either selling or closing; o the local city guides such as nacidade.com,.br; guiasp.com.br; guiarj.com.br; paisas.com; openchile.cl; panoramas.cl and AdNet.com.mx, which the Company anticipates that it will continue to operate in support of its mobile solutions business. As part of the terms of the sale, the Company agreed to cease using the "StarMedia" brand commercially and, subject to shareholder approval, to amend its certificate of incorporation to change its name. Following the sale, the Company operates commercially under the name "CycleLogic." -3- ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS STARMEDIA NETWORK, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31, --------- ------------ 2002 2001 ---- ---- (UNAUDITED) (NOTE 1) ASSETS Current assets: Cash and cash equivalents ............................. $ 17,405,000 $ 21,635,000 Accounts receivable, net of allowance for bad debts of $4,095,000 (2002) and $4,453,000 (2001) ............. 2,940,000 2,963,000 Unbilled receivables .................................. 1,347,000 2,079,000 Receivable from sale of investment .................... -- 13,000,000 Other current assets .................................. 2,993,000 3,768,000 ------------- ------------- Total current assets .................................... 24,685,000 43,445,000 Fixed assets, net ....................................... 21,667,000 25,184,000 Intangible assets, net of accumulated amortization of $5,386,000 (2002) and $5,397,000 (2001) ............... 2,111,000 2,109,000 Goodwill, net of accumulated amortization of $1,111,000 (2002 and 2001) ....................................... 425,000 425,000 Other assets ............................................ 1,156,000 573,000 ------------- ------------- Total assets ............................................ $ 50,044,000 $ 71,736,000 ============= ============= LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY Current liabilities: Accounts payable ...................................... $ 3,129,000 $ 4,419,000 Accrued expenses ...................................... 11,873,000 15,112,000 Deferred revenues ..................................... 1,668,000 2,534,000 ------------- ------------- Total current liabilities ............................... 16,670,000 22,065,000 Preferred dividends payable ............................. 1,825,000 1,278,000 Series A Convertible Preferred Stock Series A Convertible Preferred Stock, $.001 par value, 1,960,784 shares authorized, 1,431,373 shares issued and outstanding at March 31, 2002 (liquidation preference of $37,778,000 (2001) and $38,325,000 at March 31, 2002) .................................. 35,277,000 35,204,000 Stockholders' equity: Preferred stock authorized 10,000,000 shares: Series 1999A junior-non-voting convertible preferred stock, $.001 par value 2,300,000 shares authorized, 58,140 shares issued and outstanding at March 31, 2002, and December 31, 2001, respectively Common stock, $.001 par value, 200,000,000 shares authorized, 80,320,089 shares issued (2002 and 2001) ..................................... 80,000 80,000 Common stock issuable ................................. 1,000,000 1,000,000 Treasury stock, cost of 350,859 shares (2002), 349,912 shares (2001) ....................................... (149,000) (143,000) Additional paid-in capital ............................ 542,115,000 542,144,000 Accumulated deficit ................................... (543,625,000) (527,116,000) Deferred compensation ................................. (43,000) (87,000) Accumulated comprehensive loss ........................ (3,106,000) (2,689,000) ------------- ------------- Total stockholders' (deficit) equity .................... (3,728,000) 13,189,000 ------------- ------------- Total liabilities and stockholders' equity .............. $ 50,044,000 $ 71,736,000 ============= =============
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements. -4- STARMEDIA NETWORK, INC., AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2002 2001 ---- ---- (UNAUDITED) Revenues .................................................... $ 2,451,000 $ 8,871,000 Operating expenses: Product and technology development ........................ 7,546,000 14,542,000 Sales and marketing ....................................... 2,150,000 17,472,000 General and administrative ................................ 4,216,000 9,158,000 Restructuring and other charges ........................... 347,000 -- Depreciation and amortization ............................. 3,867,000 5,739,000 Stock-based compensation expense .......................... 14,000 715,000 Impairment of fixed assets ................................ -- 1,153,000 Loss on sale of fixed assets .............................. 104,000 -- ------------ ------------ Total operating expenses .................................... 18,244,000 48,779,000 ------------ ------------ Loss from operations ........................................ (15,793,000) (39,908,000) Other income (expense): Interest income ........................................... 123,000 1,375,000 Interest expense .......................................... -- (75,000) Other expenses ............................................ (219,000) (35,000) ------------ ------------ Loss before provision for income taxes ...................... (15,889,000) (38,643,000) Provision for income taxes .................................. -- -- ------------ ------------ Net loss .................................................... $(15,889,000) $(38,643,000) Preferred stock dividends and accretion ..................... (620,000) -- ------------ ------------ Net loss applicable to common stockholders .................. $(16,509,000) $(38,643,000) ============ ============ Basic and diluted net loss per common share ................. $ (0.21) $ (0.57) ============ ============ Number of shares used in computing basic and diluted net loss per share ................................................. 79,969,851 67,467,437 ============ ============
See accompanying See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.. -5- STARMEDIA NETWORK, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED -------------------------- MARCH 31, --------- 2002 2001 ---- ---- (UNAUDITED) OPERATING ACTIVITIES Net loss ...................................................... $(15,889,000) $(38,643,000) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization ............................... 3,867,000 5,739,000 Provision for bad debts ..................................... (7,000) 6,120,000 Loss on asset impairment .................................... -- 1,153,000 Loss on sale of fixed assets ................................ 104,000 -- Amortization of stock-based compensation .................... 14,000 715,000 Deferred rent expense ....................................... -- 335,000 Changes in operating assets and liabilities: Accounts receivable ...................................... (46,000) (11,000) Unbilled receivables ..................................... 732,000 143,000 Other assets ............................................. 387,000 421,000 Accounts payable and accrued expenses .................... (4,213,000) (195,000) Deferred revenues ........................................ (862,000) 297,000 ------------ ------------ Net cash used in operating activities ......................... (15,913,000) (23,926,000) INVESTING ACTIVITIES Purchase of fixed assets ...................................... (308,000) (7,186,000) Intangible assets ............................................. -- (104,000) Other assets .................................................. (587,000) 1,918,000 Officer loans ................................................. -- (2,478,000) ------------ ------------ Net cash used in investing activities ......................... (895,000) (7,850,000) FINANCING ACTIVITIES Issuance of common stock ...................................... -- 22,000 Purchase of treasury stock .................................... (6,000) -- Proceeds from the sale of investment .......................... 13,000,000 -- Repayment of long-term debt ................................... -- (731,000) ------------ ------------ Net cash used in financing activities ......................... 12,994,000 (709,000) Effect of exchange rate changes on cash and cash equivalents .. (416,000) 457,000 ------------ ------------ Net decrease in cash and cash equivalents ..................... (4,230,000) (32,028,000) Cash and cash equivalents, beginning of period ................ 21,635,000 93,408,000 ------------ ------------ Cash and cash equivalents, end of period ...................... $ 17,405,000 $ 61,380,000 ============ ============ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Interest paid ................................................. -- $ 184,000 Income taxes paid ............................................. -- $ 392,000 SUPPLEMENTAL DISCLOSURE OF NON CASH INVESTING AND FINANCING ACTIVITIES Accrued costs for acquisitions ................................ -- $ 5,576,000 Shares issued for acquisitions ................................ -- $ 4,639,000
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements. -6- STARMEDIA NETWORK, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR MARCH 31, 2002 1. BASIS OF PRESENTATION AND DESCRIPTION OF BUSINESS The accompanying condensed consolidated financial statements include the accounts of StarMedia Network, Inc. and its wholly-owned subsidiaries (collectively, the "Company"). All intercompany account balances and transactions have been eliminated in consolidation. StarMedia Network, Inc. was incorporated under Delaware law in March 1996. The Company, after a significant change in business strategy during the second half of 2001, is now principally engaged in providing mobile Internet software and application solutions to wireless telephone operators businesses targeting Spanish- and Portuguese-speaking audiences worldwide, described herein as the "mobile solutions business" or "mobile internet solutions". The Company's mobile Internet solutions allow users to access and receive Internet content, tools and applications through wireless devices, such as pagers, cellular phones, PCS handsets and personal digital assistants, or PDAs. The Company was originally established to develop Internet sites tailored specifically to the interests and needs of Spanish and Portuguese speakers, selling advertising to advertisers seeking to reach its user base, and historically derived a majority of its revenues from fees paid by advertisers on its sites, described herein as the "Internet media business" or "media solutions business". Although the Company continues to provide Internet media services, these services are no longer an integral part of the Company's business. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2002 are not necessarily indicative of the results that may be expected for the year ended December 31, 2002. The balance sheet at December 31, 2001 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2001. The Company has incurred recurring operating losses and may have insufficient capital to fund all of its obligations. These conditions raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty. While management believes that additional financing or proceeds from the sale of the Company's Internet media services business will be available, there can be no assurance that the Company will obtain such additional capital or that such additional financing will be sufficient for the Company's continued existence. Furthermore, there can be no assurances that the Company will be able to generate sufficient revenues from the operation of the mobile solutions business to meet the Company's obligations. 2. RESTATEMENT OF FINANCIAL STATEMENTS The Company, in consultation with its independent accountants, determined to restate its unaudited consolidated financial statements for the fiscal quarters ended March 31, June 30, September 30, and December 31, 2000, as well as quarters ended March 31 and June 30, 2001, and its audited consolidated financial statements for the fiscal year ended December 31, 2000. The Company initially announced its intention to restate these consolidated financial statements on November 19, 2001. That announcement related to the preliminary conclusion of a Special Committee of the Board of Directors that approximately $10,000,0000 in revenues was improperly recognized by two of the Company's Mexican subsidiaries during the period October 1, 2000 through June 30, 2001. Subsequent to that announcement, the Special Committee authorized the Company's management to undertake an additional investigation in order to confirm whether any additional accounting irregularities occurred during the periods in question. -7- The Company's unaudited restated consolidated financial statements for quarters ended March 31, June 30, September 30, and December 31, 2000, as well as quarters ended March 31 and June 30, 2001, and for the audited fiscal year ended December 31, 2000 contain adjustments that fall into five categories. The first category of adjustments arises from the independent investigation conducted by a Special Committee of the Board of Directors and referred to in the Company's November 19, 2001 announcement. The findings of the Special Committee's investigation indicate that the Company improperly recognized certain revenues and pre-paid expenses. The majority of these revenues and pre-paid expenses were recognized by its Mexican subsidiary, SMN de Mexico (d/b/a StarMedia Mexico). The remainder was recognized by its other Mexican subsidiary, AdNet, S.A. de C.V. ("AdNet"). The other categories of adjustments arise from management's additional investigation to confirm the accuracy of the consolidated financial statements to be restated based on the Special Committee's investigation. The findings of management's investigation indicate that, in addition to the accounting irregularities identified by the Special Committee, the Company improperly (A) recognized certain revenues and related expenses that should have been classified as barter transactions in accordance with US GAAP; (B) recognized revenues from a number of sales that provided for future contingencies, were not appropriately authorized by the customer, or for some other reason should not have been recognized; (C) failed to write down the value of certain assets at Mach 31, 2001 upon shutting down of a subsidiary; and (D) recognized certain other transactions that management identified in the course of its review of the Company's financial statements. As a result of the restatement, the consolidated financial statements of the Company have been restated as summarized below (in thousand except per share amounts):
For the period ended March 31, 2001 -------------------- As previously Reported As restated -------- ----------- Consolidated Statement of Operations: Revenues $ 16,039 $ 8,871 Sales and marketing 19,664 17,472 General and administrative 7,674 9,158 Loss from impairment of fixed assets -- 1,153 Total operating expenses 48,334 48,779 Loss from operations (32,295) (39,908) Interest expense (184) (75) Loss before provision for income taxes (31,139) (38,643) Provision for income taxes (87) -- Net Loss (31,226) (38,643) Basic and diluted net loss per Common Share $ (0.46) $ (0.57)
For additional information concerning the Company's consolidated financial results, as restated, see the Company's selected restated consolidated financial information data and Management's Discussion and Analysis of Financial Condition and Results of Operations. Management believes that it has made all the adjustments considered necessary as a result of the special committee's investigation and management's own investigation into prior periods financial statements. Management further believes that the Company's consolidated financial statements for the fiscal quarters ended March 31, June 30, September 30, and December 31, 2000; March 31 and June 30, 2001 and for the fiscal year ended December 31, 2000, as restated, include all adjustments necessary for a fair presentation of the Company's financial position and results of operations for such periods. -8- 3. BARTER TRANSACTIONS A portion of the Company's revenues are derived from barter transactions (agreements whereby the Company trades advertising on its Network or services in exchange for advertising from unrelated parties). Barter advertising revenues and expenses are recognized in accordance with Emerging Issues Task Force Issue No. 99-17, "Accounting for Barter Advertising". Barter service revenues and expenses are recognized in accordance with Accounting Principals Board Opinion No. 29, "Accounting for Non-monetary Transactions". Revenues from barter transactions are recognized during the period in which the advertisements are displayed on the Company's network or the services are rendered. Barter expense is recognized when the Company's advertisements are run by the unrelated party, which is typically the same period when the barter revenues are recognized. For the three months ended March 31, 2002 and 2001, revenue derived from advertising barter transactions were approximately $319,000 and $3.1 million, respectively. 4. FOREIGN CURRENCY AND INTERNATIONAL OPERATIONS The functional currency of the Company's active subsidiaries in Argentina, Brazil, Chile, Mexico, Spain and Colombia is the local currency. The financial statements of these subsidiaries are translated to U.S. dollars using period-end exchange rates for assets and liabilities, and average rates for the period for revenues and expenses. Translation gains and losses are deferred and accumulated as a component of stockholders' (deficit) equity. The functional currency of the Company's Venezuelan subsidiary which in a highly inflationary is the U.S. dollar. Accordingly, the U.S. dollar is the functional currency, and monetary assets and liabilities are translated using the current exchange rate in effect at the period-end date, while nonmonetary assets and liabilities are translated at historical rates. Operations are generally translated at the weighted average exchange rate in effect during the period. The resulting foreign exchange gains and losses are recorded in the consolidated statement of operations. 5. STOCKHOLDERS' (DEFICIT) EQUITY In May 2001, the Company issued 1,431,373 shares of its Series A Convertible Preferred Stock at a price per share of $25.50 to Bell South Enterprises, Inc. ("BellSouth") and certain other investors resulting in total proceeds of approximately $35.1 million to the Company, net of issuance costs of approximately $1,400,000 (the "BellSouth Investment"). These shares are convertible into 14,313,730 shares of the Company's common stock at any time at the option of the holder. After 60 months from the date of issuance, the Company shall redeem the Series A Preferred Stock for cash or shares of the Company's common stock, in an amount equal to $36.5 million, plus accrued dividends thereon. The carrying value of the Series A Convertible Preferred Stock is being accreted up to its redemption value over 60 months using the effective interest method. Such accretion was $73,000 during the quarter ended March 31, 2002. Dividends accrue at 6% per annum and totaled approximately $547,000 during the quarter ended March 31, 2002. During the quarter ended March 31, 2002, the Company repurchased 947 shares of its common stock in connection with the termination agreement of a certain employee. 6. STOCK OPTIONS In connection with the granting of stock options in 1998 and the exchange of non-qualified options to incentive stock options, the Company recorded deferred compensation of approximately $19,500,000. In connection with the granting of stock options in 1999, the Company recorded additional deferred compensation of approximately $6,400,000. Deferred compensation is adjusted quarterly for exercises, cancellations and terminations and is being amortized for financial reporting purposes over the vesting period of the options. The amounts recognized as expense during the three-month period ended March 31, 2002 and March 31, 2001 were approximately $14,000 and $715,000, respectively. Diluted net loss per share does not include the effect of options and warrants to 15,822,528 and 23,399,256 shares of common stock at March 31, 2002 and 2001, respectively. Diluted net loss per share for the three-months ended March 31, 2002 also does not include the effect of 14,313,730 shares of common stock issuable upon the conversion of preferred stock on a "as if converted" basis, respectively, as the effect of their inclusion is antidilutive. -9- 7. RESTRUCTURING AND OTHER CHARGES In May 2001, the Company announced a restructuring, the purpose of which was to realign the Company's business operations and reduce its operational overhead. In connection with such restructuring, the Company recorded during the three months ended March 31, 2002 aggregate charges of approximately $347,000, which includes severance payments to employees of the Company. Substantially all restructuring and other charges previously accrued were paid during the quarter ended March 31, 2002. 8. RELATED PARTY TRANSACTIONS BELLSOUTH In May 2001, the Company entered into an agreement with BellSouth to create multi-access portals in Latin America (the "BellSouth Strategic Agreement"). Under the terms of the five-year agreement, the Company will design and service the multi-access portals and mobile applications and provide content, software application integration and support to BellSouth's operating companies in Latin America. BellSouth will supply wireless communications, marketing of services and billing capabilities. The two companies will share revenues generated by the new multi-access portals. All revenues associated with design and maintenance activities and the technology licenses are being recognized ratably over the life of the agreement, while the user fees and transaction revenues are being recognized when the services are rendered. In addition, in connection with the BellSouth Strategic Agreement (see Note 5), the Company agreed to issue warrants to BellSouth to purchase up to 4,500,000 shares of the Company's common stock, with exercise prices ranging from $4.55 to $8.55 per share that vest in May 2002 and expire during the period from May 2005 through May 2007. These warrants were valued, by an independent appraiser, at approximately $2.2 million and are being amortized over 60 months. During August 2001, the Company issued 251,172 shares of the Company's common stock valued at $500,000 to its placement agent "JP Morgan Ventures Corporation" in connection with the aforementioned financing. Under the terms of the agreement with "JP Morgan Ventures Corporation," if the Company does not have in place an effective registration statement covering these shares by November 30, 2001, "JP Morgan Ventures Corporation" will have the right to cause the Company to repurchase such shares for $500,000. The value of these shares has not been included in stockholders' deficit due to the fact that the Company has not yet filed such registration statement. For the period ended March 31, 2002, the Company recognized $200,000 in revenue, net of amortization for the warrants, in connection with the BellSouth Strategic Agreement. 9. COMPREHENSIVE LOSS Total comprehensive loss was approximately $16.3 million and $38.8 million for the three months ended March 31, 2002, and three months ended March 31, 2001, respectively. 10. NEW ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards (SFAS) No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. SFAS No. 41 also includes guidance on the initial recognition and measurement of goodwill and other intangible assets arising from business combinations completed after June 30, 2001. SFAS No. 142 prohibits the amortization of goodwill and intangible assets with indefinite useful lives. The impact of adopting Statement 142 was to decrease the net loss and net loss per share by $291,000 and $.004, respectively, for the three months ended March 31, 2002. SFAS No. 142 requires that these assets be reviewed for impairment at least annually. Intangible assets with finite lives will continue to be amortized over their estimated useful lives. Additionally, SFAS No. 142 requires that goodwill included in the carrying value of equity method investments no longer be amortized. The adoption of this statement had no material effect on the Company's financial position and results of operations. -10- In August 2001, the FASB issued Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of, and the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations for a Disposal of a Segment of a Business. The adoption of this statement had no material effect on the Company's financial position and results of operations. 11. LEGAL PROCEEDINGS In August 2001, the Company, three of its executive officers and each of the underwriters who participated in the Company's May 25, 1999 initial public offering were named as defendants in three class action complaints filed in the United States District Court for the Southern District of New York: Earl Arneson v. StarMedia Network, Inc, et al; John R. Longman v. StarMedia Network, Inc., et al; and BH Holdings LLC v. StarMedia Network, Inc., et al. The complaints, which are substantially identical, each seek unspecified damages for alleged violations of Sections 11, 12 and 15 of the Securities Act of 1933, Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder in connection with the Company's initial public offering. The complaints allege that the underwriters charged the Company excessive commissions and inflated transaction fees not disclosed in the registration statement and allocated shares of the Company's initial public offering to favored customers in exchange for purported promises by such customers to purchase additional shares in the aftermarket, thereby allegedly inflating the market price for the Company's common stock. These actions have been consolidated with hundreds of other securities class actions commenced against more than 300 companies and approximately 40 investment banks in which plaintiffs make substantially similar allegations as those made against the Company with respect to the initial public offerings at issue in those cases. All of these actions have been consolidated under the caption In re: Initial Public Offering Securities Litigation, 21 MC 92 (SAS). The judge in the consolidated action has adjourned without date the time for all defendants to respond to the complaints. On November 19, 2001, the Company announced to the public that it had commenced an investigation into the facts and circumstances related to certain accounting irregularities related to Mexican subsidiaries and that a restatement (the "Restatement") of its audited financial statements for the year ended December 31, 2000 and its unaudited financial statements for the quarters ended March 31, 2001 and June 30, 2001 would likely be necessary. The Company informed the SEC of this matter concurrently with its public announcement. Subsequently, the SEC has informed the Company that it has opened an investigation into this matter. The SEC investigation is on-going. In late 2001 and early 2002, eleven lawsuits were filed against the Company in the Southern District of New York in connection with the Company's announcement relating to the restatement referred to above. A lead plaintiff for the class and lead plaintiff's counsel were subsequently selected and a motion filed to consolidate the various claims. The Consolidated Amended Complaint was filed on May 31, 2002 in the Southern District of New York under the caption In re StarMedia Network, Inc. Securities Litigation 01 Civ. 10556 (S.D.N.Y.). The lead plaintiffs and all defendants have executed a settlement agreement that resolves all claims in the consolidated action. The settlement amount will be paid by the Company's directors and officers' liability insurance carrier. This settlement agreement is subject to review and ratification by the Honorable Denny Chin of the United States District Court for the Southern District of New York. A list of the eleven lawsuits before consolidation follows:
----------------------------------------------------------------------------- CASE NAME DATE FILED ----------------------------------------------------------------------------- Kramon v. StarMedia Network, et al. November 20, 2001 Stourbridge Ltd., et al. v. StarMedia Network, et al. November 20, 2001 Rennel Trading Corp. v. StarMedia Network, et al. November 21, 2001 Ehrenreich v. StarMedia Network, et al. November 27, 2001 Howe v. StarMedia Network, et al. November 27, 2001 Mayper v. StarMedia Network, et al. November 28, 2001 Dorn v. StarMedia Network, et al. December 3, 2001 Hindo v. StarMedia Network, et al. December 12, 2001 Mather v. StarMedia Network, et al. December 19, 2001 Nulf v. StarMedia Network, et al. December 19, 2001 Vasko v. StarMedia Network, et al. January 7, 2002
-11- In April 2002, AT&T Corp filed a claim in the United States District Court for the Southern District of New York seeking payment from the Company for telecommunications services rendered to the Company in the amount of approximately $337,000, and in June 2002 AT&T amended that complaint to increase the amounts claimed to approximately $1,400,000. In addition, for over a year the Company has engaged in periodic discussions with AT&T regarding the Company's alleged commitments to purchase a variety of services from AT&T, and in April 2002 had received correspondence from AT&T alleging that approximately a total of $1,100,000 was payable by the Company. The Company denies that it owes most of the amounts alleged to be payable by AT&T. The parties have commenced settlement discussions. In October 2001, Fausto Zapata, formerly President of SMN de Mexico, S de RL, filed a notice in the applicable Labor Courts in Mexico City alleging that the Company failed to make payments due to him under an employment agreement following his termination by the Company. The amounts claimed by Mr. Zapata exceed 8.5 million Pesos, or approximately $900,000. The Company maintains that it owes Mr. Zapata solely the minimum amounts required to be paid following termination of his at-will employment, which the Company calculates to be approximately 600,000 Mexico Pesos, or approximately $65,000. In January 2002 Mr. Carlos Ponce filed a claim in the U.S. District Court in the Southern District Court of Florida in connection with allegations by Mr. Ponce that the Company exceeded the scope of a license to use his image in connection with an advertising campaign. Mr. Ponce claims violations of common law and statutory rights of publicity under Florida law, unfair business practices, misappropriation, and also asserts claims under the Lanham Act. Mr. Ponce seeks damages allegedly in excess of $1,000,000, treble damages, punitive damages, and injunctive and other equitable relief. The Company filed an answer to the complaint in February 2002. In June 2002 the judge in this case issued an order to show cause directing the plaintiff to show cause why the case should not be dismissed. Mr. Ponce has responded and delivered to the Company a request to produce documents. The Company denies Mr. Ponce's claims and believes that even if such claims were proven, the damages sought are grossly overstated, and that the Lanham Act claim may be legally deficient. In May 2002 the Company was notified that Digital Impact has presented a demand for arbitration seeking payment of approximately $594,000 allegedly owed to Digital Impact by the Company in connection with the Company's termination of an agreement between Digital Impact and the Company. In June 2001, the Company commenced an action entitled StarMedia Network, Inc. v. Patagon.com International, Inc. in the Commercial Division of the Supreme Court of the State of New York, New York County against Patagon.com International, Inc. ("Patagon"). The complaint seeks to recover compensatory and consequential damages in an amount not less than $4,250,000 for Patagon's breach of a Web Content Agreement pursuant to which the Company and Patagon hosted a co-branded website linked to the Company's internet property StarMedia.com through its "Money Channel." The complaint alleges that Patagon breached the Web Content Agreement by wrongfully and prematurely terminating the agreement. In August 2001, Patagon filed an Answer and Counterclaim (the "Counterclaim") to the complaint in which Patagon seeks to recover unspecified damages on claims for breach of contract and breach of the duty of good faith and fair dealing premised upon the Company's alleged breach of the Web Content Agreement. Also in August 2001, the Company served its Answer and Affirmative Defenses to the Counterclaim in which it denied all of the material allegations of the Counterclaim and asserted affirmative defenses to the claims asserted therein. Discovery is pending in this case. In September 2001, Justin K. Macedonia, the then General Counsel of the Company, filed a notice of intention to arbitrate against the Company, asserting that the Company was obligated to make tax indemnity payments to him in the amount of $1,700,000. The Company denied any obligation to make such payment and asserted counterclaims against Mr. Macedonia. Mr. Macedonia's employment with the Company terminated in November 2001. The arbitration hearing was concluded in March 2002. In May 2002 the arbitrator issued a final judgment denying Mr. Macedonia's claims, as well as the Company's counterclaims. In December 2000, a consulting company filed suit against the Company in the New York Supreme Court claiming unpaid fees of approximately $2,300,000. In October 2001, pursuant to a Settlement Agreement, the Company and the -12- consulting company agreed to settle the lawsuit. The Company agreed to pay the consulting company an amount within the range that the Company had previously reserved for such lawsuit in its financial statements. The suit was settled for an amount not material to the Company. The Company has paid such amount and such lawsuit has been dismissed with prejudice. The Company is subject to legal proceedings and claims in the ordinary course of business from time to time, including claims of alleged infringement of trademarks, copyrights and other intellectual property rights, and a variety of claims arising in connection with our e-mail, message boards and other communications and community features, such as claims alleging defamation and invasion of privacy. The Company intends to vigorously defend the aforementioned claims that are threatened or pending against it but believes that an adverse outcome with respect to one or more of these matters could have a material adverse effect on the financial condition of the Company. 12. SUBSEQUENT EVENT On July 3, 2002 the Company sold substantially all of the assets associated with starmedia.com, the Company's Spanish- and Portuguese-language portal, and LatinRed, the Company's Spanish language online community, to eresMas Interactive S.A. ("EresMas") for $8,000,000 in cash. -13- In addition, in order to facilitate the transfer of these assets, the Company agreed to provide transitional services to EresMas under a Transition Licensing Agreement. The Company will recognize a loss of approximately $500,000 from the aforementioned sale. The assets sold comprised substantially of fixed assets and intangible assets. As part of the terms of the sale to Eresmas, the Company has agreed to cease using the "StarMedia" brand commercially and, subject to shareholder approval, to amend its certificate of incorporation to change its name. Henceforth, the Company will operate commercially under the name "CycleLogic." ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR FINANCIAL STATEMENTS AND THE NOTES TO THOSE STATEMENTS AND OTHER FINANCIAL INFORMATION APPEARING ELSEWHERE IN THIS REPORT. THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS RELATING TO FUTURE EVENTS AND FUTURE PERFORMANCE OF THE COMPANY WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, INCLUDING, WITHOUT LIMITATION, STATEMENTS REGARDING THE COMPANY'S EXPECTATIONS, BELIEFS, INTENTIONS OR FUTURE STRATEGIES THAT ARE SIGNIFIED BY THE WORDS "EXPECTS," "ANTICIPATES," "INTENDS," "BELIEVES" OR SIMILAR LANGUAGE. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN SUCH FORWARD-LOOKING STATEMENTS. ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS DOCUMENT ARE BASED ON INFORMATION AVAILABLE TO THE COMPANY ON THE DATE HEREOF, AND THE COMPANY ASSUMES NO OBLIGATION TO UPDATE ANY FORWARD LOOKING STATEMENTS. THE COMPANY CAUTIONS INVESTORS THAT ITS BUSINESS AND FINANCIAL PERFORMANCE ARE SUBJECT TO SUBSTANTIAL RISKS AND UNCERTAINTIES. IN EVALUATING THE COMPANY'S BUSINESS, PROSPECTIVE INVESTORS SHOULD CAREFULLY CONSIDER THE INFORMATION SET FORTH IN OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2001 UNDER THE CAPTION "RISK FACTORS" IN ADDITION TO THE OTHER INFORMATION SET FORTH HEREIN. OVERVIEW StarMedia Network, Inc. (d/b/a CycleLogic) was incorporated in Delaware in March 1996. We commenced operations in September 1996 and launched the StarMedia network of websites targeted at Spanish and Portuguese-speaking Internet users in December 1996. In May 1999, we completed the initial public offering of our common stock and in October 1999 we completed a follow-on public offering of our common stock. Our principal executive offices are located at 999 Brickell Ave. Suite 808, Miami, Florida, 33131 and our telephone number is (305) 938-3000. Previously, our principal offices were located at 75 Varick Street, New York, New York, 10013. The Company was established as an Internet media Company. The Company was among the first companies to develop Internet sites tailored specifically to the interests and needs of Spanish and Portuguese speakers. In so doing, we were also among the first to attract a broad user base among Spanish- and Portuguese-speaking Internet users. Much like operators of traditional media companies (print, television, radio, etc.), the Company sold advertising to advertisers seeking to reach its user base, and historically derived a majority of its revenues from fees paid to us by advertisers on our sites. The Company subsequently acquired Internet properties and businesses that were deemed to be complementary to this business. One such acquisition was the September 1999 purchase of PageCell International Holdings (PageCell), which formed the basis of our mobile Internet solutions business. These solutions consist of a unique mix of technology and content that allows operators and their end users to take full advantage of the Internet across multiple platforms. Since the acquisition of PageCell the Company has, in addition to its media business, engaged in the business of providing Internet solutions to wireless telephone operators in Latin America. In May 2001, the Company signed a strategic agreement with Bell South International under which the Company would design and implement "multi-access portals" for Bell South's subsidiaries in Latin America. At the same time, Bell South and several other investors invested $35.1 million in the Company. -14- Since the summer of 2001, the Company has undertaken a realignment for the general purpose of reducing the costs of operating our Internet media services business and focusing our resources on the development of our mobile solutions business. Management believes this realignment was necessary in order to preserve the Company's prospects of becoming profitable. The rationale for this realignment was that since the StarMedia network was established, the Company's media business has continued to incur significant operating losses as the costs of providing content, tools and applications necessary to attract and maintain a broad user base continued to significantly exceed the revenues derived from basic advertisers' fees. Also underlying this realignment was the expectation of management and the board of directors that the deterioration of the Internet advertising market in Latin America and the U.S. during 2001 would continue and was unlikely to increase to levels that would support the established levels of operating costs of the Company's media business. In early 2002, the Company's management and board of directors determined that, notwithstanding the realignment undertaken as of that time, the continued operation of the Company's media assets would undermine the Company's prospects for profitability. Accordingly, the Company undertook efforts to sell its remaining media assets, including the starmedia.com portal and its LatinRed community products. On July 3, 2002, the Company sold most of the intellectual property, hardware and other assets associated with the operation of starmedia.com and LatinRed to EresMas, and agreed that it would cease to conduct business under the StarMedia name. Effective as of July 3, 2002, the Company operates under the name "CycleLogic." This change of name has been approved by management and the board of directors, who expect to propose at the next meeting of the Company's shareholders that the Company formally change its name to "CycleLogic, Inc." Any such change of name is subject to the approval by the Company's shareholders. The Company is now principally engaged in providing integrated Internet solutions to wireless telephone operators in Latin America targeting Spanish- and Portuguese-speaking end-users. In addition, we continue to operate several Spanish- and Portuguese- language websites and to design and operate portals for third parties. Substantially all of our revenues are currently being generated from our mobile solutions business. Our customers are in Latin America and most of our revenues come from Venezuela, Brazil, Colombia, Argentina, and Chile. MOBILE INTERNET SOLUTIONS. We are one of the leading providers of mobile Internet software and application solutions to wireless telephone operators in Spanish- and Portuguese-speaking markets. We offer comprehensive end-to-end solutions that are comprised of an integrated and customized suite of technology platforms, content and applications. Our mobile Internet solutions enable wireless carriers and enterprises to provide end-users with access to personalized Internet content, email, messaging, secure mobile banking and other mCommerce opportunities through a variety of technologies, including SMS (Short Message Services), WAP (Wireless Application Protocol) and voice telephony. Through our solutions, end users can access this content through a variety of devices, including personal computers, cellular phones, pagers, PDAs and PCs and GSM handsets. By providing their end-users the services enabled by our mobile Internet solutions, wireless operators hope to increase user airtime and subscription fees (thereby increasing their average revenue per user or "ARPU") and reduce their customer turnover rates (referred to in the industry as "churn rates"). Our scalable, proprietary technology is comprised of our Wireless Internet Server (WIS) and "Gen3" wireless portal technology. o WIS TECHNOLOGY. The WIS software is a carrier-class technology that permits mobile operators to deliver short-message services (SMS) and other content from the Internet to their customers in a manner that is fully integrated with the wireless operator's provisioning systems (the systems that determine which customers have elected to receive specific services), billing systems, gateway infrastructure systems, and other back-end systems. Two components of our WIS technology are: -- TRANSACTIONAL-BILLING. This feature of the WIS technology allows wireless operators to apply different business rules to permit flexible billing (for post-paid and pre-paid) based on the type of mobile Internet service accessed by an end-user, the end-user's subscription plan and other variables identified by the operator. -15- -- WIRELESS MARKETPLACE. This feature of the WIS technology allows wireless operators to efficiently and cost-effectively distribute third parties' content and applications (in addition to the Company's own) through the WIS and to integrate such services within their overall mobile Internet service offerings. The WIS software is designed to operate on dedicated servers placed in the wireless operators' premises. o GEN3 WIRELESS PORTAL TECHNOLOGY. Our Gen3 wireless portal technology allows wireless operators to provide to their customers personalized Internet websites that can be viewed through different browser types and devices, including their personal computers and wireless devices (such as WAP-enabled phones and PDAs). Using this technology, the content and services offered on end-users' portals, as well as the branding of the portal, vary based on the user's profile and subscription of services. Although our competitors have been able to develop technologies that are similar to our WIS technology and Gen3 wireless portal technology, the Company believes that its proprietary technologies' ability to interface with wireless operators' back end systems via our Transactional Billing system and Wireless Marketplace gives it a competitive advantage over other solutions providers. This technology allows our customers to better target their end-users by being able to track and identify the services or plans being accessed through the different platforms (personal computer, mobile telephones and PDAs) used by the end-user. We use third party content and technology to further enhance the services and tools that wireless operators can deliver through our WIS and Gen3 wireless portal technology. In addition, we have integrated third-party voice recognition, text-to-speech and telephony technologies (also known as voice portal technologies), along with our proprietary technologies, to create an integrated access platform, allowing end-users to have seamless interactive access via voice, web, WAP and SMS to a variety of content and applications. This integrated access platform is the basis of the Multiple Access Portal (MAP) services we provide to subsidiaries of BellSouth International in Latin America. The Company derives revenues from its mobile Internet solutions through set up and installation fees, technology licenses fees and usage-based fees. We currently have agreements for the use of our WIS technology with more than 20 wireless operators throughout the region, including subsidiaries of BellSouth International, Verizon, Telefonica and Americas Telecom. INTERNET MEDIA SERVICES. Historically, the Company has also provided extensive services to consumers, including community features such as o free email, promotional email newsletters, user surveys, chats, instant messaging, and home pages; o tools and applications, such as games, multimedia players, comprehensive city guide content, and sophisticated search capabilities; o local and global editorial content; and o online shopping in Spanish and Portuguese. The Company has derived revenues from its Internet media services principally through sales of advertising and promotions on these services, including banners, buttons and sponsorships. For the three months ended March 31, 2002, one advertiser accounted for more than 10% of total revenues and our top five customers accounted for 45% of our total revenues. In addition, the Company has used the information derived about users of its services, particularly from user surveys and email usage patterns, to sell targeted direct marketing emails to advertisers seeking to target specific user profiles. As explained above, these revenues are no longer an integral part of the Company's business model. Currently, the Company continues to operate the following media services: o batepapo.com.br, a Brazilian chat services, which the Company may either sell or shut down in the near future; and o local Internet city guides such as nacidade.com.br; guiasp.com.br; guiarj.com.br; paisas.com; yoinvito.com; panoramas.cl and openchile.cl, which the Company expects to continue to operate in connection with its mobile solutions business. -16- PORTAL SOLUTIONS. The Company provides portal development services to enable companies to leverage the power of the Internet to reach their business objectives. We use our content, technology and know-how to create branded, content-rich websites (commonly referred to as "portals") for consumer-oriented businesses that desire to attract and serve customers through the Internet. Through the Company's portal development services enterprises can establish a powerful presence on the World Wide Web, which enables them to improve customer service, conduct further transactions, and increase their service/product offerings, ultimately resulting in increased revenues. In the past we were able to draw on the existing content, tools and applications from our Internet media services and include them as part of our portal solutions. Following the sale or liquidation of our Internet media services business, the Company will continue to develop and access third party content, tools and applications in order to continue to provide portal solutions to businesses, although we do not expect this to be our principal business and we may not generate significant revenues from this business The Company derives revenues from its portal solutions principally through development fees and maintenance fees it charges its portal solutions customers. Historically, it has also generated revenues from on-line promotions and advertising it undertakes with respect to the portals it develops. The Company does not anticipate that this will be a significant source of revenues for its portal solutions business in the future. RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2002 AND MARCH 31, 2001 REVENUES Total revenues decreased to $2.5 million for the three months ended March 31, 2002 from $8.9 million, for the three months ended March 31, 2001. This decrease is mainly attributed to a decline in the volume of revenue-producing advertising impressions and sponsorships. Barter revenue for the three months ended March 31, 2002 and 2001 were 13% and 35%, respectively. For the three months ended March 31, 2002, one advertiser accounted for more than 10% of total revenues. For the three months ended March 31, 2001, two advertisers, individually, accounted for more than 10% of our total revenues. For the three months ended March 31, 2002, our top five customers accounted for 45% of our total revenues. For the three months ended March 31, 2001, our top five customers accounted for 49% of our total revenues. OPERATING EXPENSES PRODUCT AND TECHNOLOGY Product and technology expenses decreased to $7.5 million, or 308% of total revenues, for the three months ended March 31, 2002, from $14.5 million, or 164% of total revenues, for the three months ended March 31, 2001. This decrease was primarily due to a decrease of approximately $3.7 million for compensation-related expense, $1.4 million for consulting and contract fees, and $1.2 million in hosting and content acquisition related expense. SALES AND MARKETING Sales and marketing expenses decreased to $2.2 million, or 88% of total revenues for the three months ended March 31, 2002 from $17.5 million, or 197% of total revenues for the three months ended March 31, 2001. This decrease was primarily due to decreases of approximately $2.8 million in compensation-related expense, $5.1 million in advertising expense, and $6.1 million for bad debt reserve. We believe the Company has ample coverage for bad debt and will continue to review the collectibility of our receivables. -17- GENERAL AND ADMINISTRATIVE General and administrative expenses decreased to $4.2 million, or 172% of total revenues, for the three months ended March 31, 2002, from $9.2 million, or 103% of total revenues, for the three months ended March 31, 2001. The decrease in general and administrative expenses was primarily attributed to decreases in approximately $2.0 million in compensation-related expenses, approximately $1.5 million in office rent and utilities due to a significant reduction in our operating lease arrangements for the quarter ended March 31, 2001, and approximately $1.0 million in miscellaneous expenses recorded for the quarter ended March 31, 2001 in connection with the restatement. DEPRECIATION AND AMORTIZATION Depreciation and amortization expenses decreased to $3.9 million, or 158% of total revenues, for the three months ended March 31, 2002, from $5.7 million or 65% of total revenues, for the three months ended March 31, 2001. This decrease is attributed to decreases in depreciation expense due to a reduction in capital purchases, fixed asset impairment in year 2001, and the adoption of FASB Statement 142, which states that goodwill and indefinite lived intangible assets are no longer amortized but are reviewed annually, or more frequently if impairment indicators arise, for impairment. Goodwill and intangibles were impaired in 2001. For the period ended March 31, 2002, the Company reviewed and assessed that there were no impairment for goodwill and intangibles. STOCK-BASED COMPENSATION EXPENSE Of the cumulative deferred compensation amount, $14,000 was recorded as an expense for the three months ended March 31, 2002 compared with $715,000 recorded as expense for the three months ended March 31, 2001. The decrease relates to the reduction in employees. The unamortized balance is being amortized over the vesting period for the individual options, which is typically three years for options issued prior to February 1999 and four years for options issued thereafter. INTEREST Interest income includes income from our cash and investments. Interest income decreased to $123,000 for the three months ended March 31, 2002 from $1.4 million for the three months ended March 31, 2001. Interest income decreased as a result of a decrease in the average invested cash balance for the above periods. For the quarter ended March 31, 2002, the Company had no debts outstanding, therefore, there was no interest expense recorded. For the quarter ended March 31, 2001, $75,000 in interest expense was recorded. LIQUIDITY AND CAPITAL RESOURCES To date, we have financed our operations primarily through the sale of our equity securities. At March 31, 2002, we had $17.4 million in cash and cash equivalents, a decrease of $4.2 million from December 31, 2001. We used $15.9 million in operating activities for the three months ended March 31, 2002, a decrease from $23.9 million for the three months ended March 31, 2001 due to our efforts to reduce cost. Cash used in operating activities substantially related to our loss of $15.9 million and $38.6 million during the periods ended March 31, 2002 and March 31, 2001, respectively. For the three months ended March 31, 2002, non-cash activities included $3.9 million in depreciation and amortization. For the three months ended March 31, 2001, non-cash activities were $5.7 million for depreciation and amortization, $6.1 million in loss on asset impairment, and $1.2 million in loss on sale of fixed assets. For the three months ended March 31, 2002, we used $895,000 in investing activities, including $308,000 for purchase of fixed assets and $587,000 in purchase of other assets. For the three months ended March 31, 2001, we used $7.9 million in investing activities, including $7.2 million in purchase of fixed assets, $2.5 million in advances to officers, offset by $1.9 million in cash provided by release of letters of credit. Net cash provided by (used in) financing activities was $13.0 million and ($709,000) for the three months ended March 31, 2002 and 2001, respectively. Net cash provided by financing activities during the three months ended March 31, -18- 2002 consisted of cash from sale of investment in KD Sistemas. Net cash used by financing activities during the three months ended March 31, 2001 consisted primarily of repayment of long-term debt. Our principal commitments consist of obligations outstanding under operating leases. We have experienced a substantial decrease in our capital expenditures this past year and operating lease arrangements have been reduced significantly. While we have reduced operating expenses significantly, through a reduction of our work force and other operating costs, our current cash and cash equivalents may not be sufficient to meet our anticipated cash needs for working capital and capital expenditures for the next 12 months. If working capital is insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or debt securities or establish an additional credit facility. The sale of additional equity or convertible debt securities could result in additional dilution to our stockholders. The incurrence of additional indebtedness would result in increased fixed obligations and could result in operating covenants that would restrict our operations. We cannot assure you that financing will be available in amounts or on terms acceptable to us, if at all. While management believes that additional financing or proceeds from the sale of the Company's Internet media services business will be available, there can be no assurance that the Company will obtain such additional capital or that such additional financing will be sufficient for the Company's continued existence. Furthermore, there can be no assurances that the Company will be able to generate sufficient revenues from the operation of the mobile solutions business to meet the Company's obligations. These conditions raise substantial doubt about the Company's ability to continue as a going concern. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK COLLECTION RISK Our accounts receivable are subject, in the normal course of business, to collection risks. We regularly assess these risks and have established policies and business practices to protect against the adverse effects of collection risks. INTEREST RATE RISK Our investments are classified as cash and cash equivalents with original maturities of three months or less. Therefore, changes in the market's interest rates do not affect the value of the investments as recorded by us. FOREIGN CURRENCY EXCHANGE RISK We do not hedge our exposure to foreign currency exchange risk. We are subject to exchange rate fluctuations, which may be a significant risk, because of our operations in Latin America. PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In August 2001, the Company, three of its executive officers and each of the underwriters who participated in the Company's May 25, 1999 initial public offering were named as defendants in three class action complaints filed in the United States District Court for the Southern District of New York: Earl Arneson v. StarMedia Network, Inc, et al; John R. Longman v. StarMedia Network, Inc., et al; and BH Holdings LLC v. StarMedia Network, Inc., et al. The complaints, which are substantially identical, each seek unspecified damages for alleged violations of Sections 11, 12 and 15 of the Securities Act of 1933, Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder in connection with the Company's initial public offering. The complaints allege that the underwriters charged the Company excessive commissions and inflated transaction fees not disclosed in the registration statement and allocated shares of the Company's initial public offering to favored customers in exchange for purported promises by such customers to purchase additional shares in the aftermarket, thereby allegedly inflating the market price for the Company's common stock. These -19- actions have been consolidated with hundreds of other securities class actions commenced against more than 300 companies and approximately 40 investment banks in which plaintiffs make substantially similar allegations as those made against the Company with respect to the initial public offerings at issue in those cases. All of these actions have been consolidated under the caption In re: Initial Public Offering Securities Litigation, 21 MC 92 (SAS). The judge in the consolidated action has adjourned without date the time for all defendants to respond to the complaints. On November 19, 2001, the Company announced to the public that it had commenced an investigation into the facts and circumstances related to certain accounting irregularities related to Mexican subsidiaries and that a restatement of its audited financial statements for the year ended December 31, 2000 and its unaudited financial statements for the quarters ended March 31, 2001 and June 30, 2001 would likely be necessary. The Company informed the SEC of this matter concurrently with its public announcement. Subsequently, the SEC has informed the Company that it has opened an investigation into this matter. The SEC investigation is on-going. In late 2001 and early 2002, eleven lawsuits were filed against the Company in the Southern District of New York in connection with the Company's announcement relating to the restatement referred to above. A lead plaintiff for the class and lead plaintiff's counsel were subsequently selected and a motion filed to consolidate the various claims. The Consolidated Amended Complaint was filed on May 31, 2002 in the Southern District of New York under the caption In re StarMedia Network, Inc. Securities Litigation 01 Civ. 10556 (S.D.N.Y.). The lead plaintiffs and all defendants have executed a settlement agreement that resolves all claims in the consolidated action. The settlement amount will be paid by the Company's directors and officers' liability insurance carrier. This settlement agreement is subject to review and ratification by the Honorable Denny Chin of the United States District Court for the Southern District of New York. A list of the eleven lawsuits before consolidation follows:
----------------------------------------------------------------------------- CASE NAME DATE FILED ----------------------------------------------------------------------------- Kramon v. StarMedia Network, et al. November 20, 2001 Stourbridge Ltd., et al. v. StarMedia Network, et al. November 20, 2001 Rennel Trading Corp. v. StarMedia Network, et al. November 21, 2001 Ehrenreich v. StarMedia Network, et al. November 27, 2001 Howe v. StarMedia Network, et al. November 27, 2001 Mayper v. StarMedia Network, et al. November 28, 2001 Dorn v. StarMedia Network, et al. December 3, 2001 Hindo v. StarMedia Network, et al. December 12, 2001 Mather v. StarMedia Network, et al. December 19, 2001 Nulf v. StarMedia Network, et al. December 19, 2001 Vasko v. StarMedia Network, et al. January 7, 2002
In April 2002, AT&T Corp filed a claim in the United States District Court for the Southern District of New York seeking payment from the Company for telecommunications services rendered to The Company in the amount of approximately $337,000, and in June 2002 AT&T amended that complaint to increase the amounts claimed to approximately $1,400,000. In addition, for over a year the Company has engaged in periodic discussions with AT&T regarding the Company's alleged commitments to purchase a variety of services from AT&T, and in April 2002 had received correspondence from AT&T alleging that approximately a total of $1,100,000 was payable by the Company. The Company denies that it owes most of the amounts alleged to be payable by AT&T. The parties have commenced settlement discussions. In October 2001, Fausto Zapata, formerly President of SMN de Mexico, S de RL, filed a notice in the applicable Labor Courts in Mexico City alleging that the Company failed to make payments due to him under an employment agreement following his termination by the Company. The amounts claimed by Mr. Zapata exceed 8.5 million Pesos, or approximately $900,000. The Company maintains that it owes Mr. Zapata solely the minimum amounts required to be paid following termination of his at-will employment, which the Company calculates to be approximately 600,000 Mexico Pesos, or approximately $65,000. In January 2002 Mr. Carlos Ponce filed a claim in the U.S. District Court in the Southern District Court of Florida in connection with allegations by Mr. Ponce that the Company exceeded the scope of a license to use his image in connection with an advertising campaign. Mr. Ponce claims violations of common law and statutory rights of publicity -20- under Florida law, unfair business practices, misappropriation, and also asserts claims under the Lanham Act. Mr. Ponce seeks damages allegedly in excess of $1,000,000, treble damages, punitive damages, and injunctive and other equitable relief. The Company filed an answer to the complaint in February 2002. In June 2002 the judge in this case issued an order to show cause directing the plaintiff to show cause why the case should not be dismissed. Mr. Ponce has responded and delivered to the Company a request to produce documents. The Company denies Mr. Ponce's claims and believes that even if such claims were proven, the damages sought are grossly overstated, and that the Lanham Act claim may be legally deficient. In May 2002 the Company was notified that Digital Impact has presented a demand for arbitration seeking payment of approximately $594,000 allegedly owned to Digital Impact by the Company in connection with the Company's termination of an agreement with Digital Impact and the Company. In June 2001, the Company commenced an action entitled StarMedia Network, Inc. v. Patagon.com International, Inc. in the Commercial Division of the Supreme Court of the State of New York, New York County against Patagon.com International, Inc. ("Patagon"). The complaint seeks to recover compensatory and consequential damages in an amount not less than $4,250,000 for Patagon's breach of a Web Content Agreement pursuant to which the Company and Patagon hosted a co-branded website linked to the Company's internet property StarMedia.com through its "Money Channel." The complaint alleges that Patagon breached the Web Content Agreement by wrongfully and prematurely terminating the agreement. In August 2001, Patagon filed an Answer and Counterclaim (the "Counterclaim") to the complaint in which Patagon seeks to recover unspecified damages on claims for breach of contract and breach of the duty of good faith and fair dealing premised upon the Company's alleged breach of the Web Content Agreement. Also in August 2001, the Company served its Answer and Affirmative Defenses to the Counterclaim in which it denied all of the material allegations of the Counterclaim and asserted affirmative defenses to the claims asserted therein. Discovery is pending in this case. In September 2001, Justin K. Macedonia, the then General Counsel of the Company, filed a notice of intention to arbitrate against the Company, asserting that the Company was obligated to make tax indemnity payments to him in the amount of $1,700,000. The Company denied any obligation to make such payment and asserted counterclaims against Mr. Macedonia. Mr. Macedonia's employment with the Company terminated in November 2001. The arbitration hearing was concluded in March 2002. In May 2002 the arbitrator issued a final judgment denying Mr. Macedonia's claims, as well as the Company's counterclaims. In December 2000, a consulting company filed suit against the Company in the New York Supreme Court claiming unpaid fees of approximately $2,300,000. In October 2001, pursuant to a Settlement Agreement, the Company and the consulting company agreed to settle the lawsuit. The Company agreed to pay the consulting company an amount within the range that the Company had previously reserved for such lawsuit in its financial statements. The suit was settled for an amount not material to the Company. The Company has paid such amount and such lawsuit has been dismissed with prejudice. The Company intends to vigorously defend the aforementioned claims that are threatened or pending against it but believes that an adverse outcome with respect to one or more of these matters could have a material adverse effect on the financial condition of the Company. The Company is subject to legal proceedings and claims in the ordinary course of business from time to time, including claims of alleged infringement of trademarks, copyrights and other intellectual property rights, and a variety of claims arising in connection with our e-mail, message boards and other communications and community features, such as claims alleging defamation and invasion of privacy. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. -21- ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) None. (b) Reports on Form 8-K: A Form 8-K was filed on January 8, 2002, reporting sale Cade?, a popular Brazilian search engine and web directory acquired in 1999, to Yahoo! Brasil, a property of Yahoo! Inc. (Nasdaq:YHOO), a global Internet communications, commerce and media company. The financial terms of the transaction were not disclosed. A Form 8-K was filed on January 25, 2002, reporting the status of the investigation by the Company's Special Committee and delisting by The Nasdaq National Market. No financial statements were filed with this Current Report. ITEM 7. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: July 10, 2002 STARMEDIA NETWORK, INC. /s/ Ana M. Lozano-Stickley ------------------------------------------------ By: Ana M. Lozano-Stickley CHIEF FINANCIAL OFFICER (DULY AUTHORIZED OFFICER AND PRINCIPAL FINANCIAL OFFICER) -22- -----END PRIVACY-ENHANCED MESSAGE-----