<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MAY 21, 1998
REGISTRATION NO. 333-
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------
STAR TELECOMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C> <C>
DELAWARE 4813 77-0362681
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification No.)
</TABLE>
223 EAST DE LA GUERRA STREET
SANTA BARBARA, CALIFORNIA 93101
(805) 899-1962
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
------------------------------
KELLY D. ENOS
CHIEF FINANCIAL OFFICER
STAR TELECOMMUNICATIONS, INC.
223 EAST DE LA GUERRA STREET
SANTA BARBARA, CALIFORNIA 93101
(805) 899-1962
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
------------------------------
COPIES TO:
TIMOTHY F. SYLVESTER, ESQ. MARTIN E. WEISBERG, ESQ.
RIORDAN & MCKINZIE PARKER CHAPIN FLATTAU & KLIMPL, LLP
300 SOUTH GRAND AVENUE, 29TH FLOOR 1211 AVENUE OF THE AMERICAS
LOS ANGELES, CALIFORNIA 90071 NEW YORK, NEW YORK 10036
(213) 629-4824 (212) 704-6000
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE OF THE SECURITIES TO THE
PUBLIC:
As soon as practicable after the Registration Statement becomes effective.
If the securities being registered on this Form are being offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, check the following box. / /
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. / /
If the form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AMOUNT TO OFFERING PRICE AGGREGATE
SECURITIES TO BE REGISTERED BE REGISTERED(1) PER UNIT OFFERING PRICE(2)
<S> <C> <C> <C>
Common Stock, par value $0.001 per share........... 707,016 shares Not Applicable $18,780,112.50
<CAPTION>
TITLE OF EACH CLASS OF AMOUNT OF
SECURITIES TO BE REGISTERED REGISTRATION FEE
<S> <C>
Common Stock, par value $0.001 per share........... $5,540.14
</TABLE>
(1) The number of shares of common stock, par value $0.001 per share (the "STAR
Common Stock"), of STAR Telecommunications, Inc. ("STAR") to be registered
has been determined based on the product of (a) the sum of, as of May 14,
1998, (i) 7,054,844 outstanding shares of common stock, par value $0.01 per
share (the "UDN Common Stock"), of United Digital Network, Inc. ("UDN"),
(ii) 275,000 shares of UDN Common Stock issuable upon conversion of a
convertible debenture issued by UDN and (iii) 771,634 shares of UDN Common
Stock subject to outstanding options and warrants and (b) an exchange ratio
of 0.08727 share of STAR Common Stock for each share of UDN Common Stock, as
provided in the Agreement and Plan of Merger, dated as of November 19, 1997,
as amended January 30, 1998 and April 6, 1998, by and among STAR, UDN and
IIWII Corp (the "Merger Agreement").
(2) Estimated solely for purposes of calculating the registration fee pursuant
to Rule 457(f)(1) of the Securities Act of 1933, as amended (the "Securities
Act"), based on the average of the high and low sales price of a share of
STAR Common Stock reported on the Nasdaq National Market on May 19, 1998.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE
SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
[LOGO]
May , 1998
Dear Stockholder:
You are cordially invited to attend a Special Meeting of Stockholders of
United Digital Network, Inc. ("UDN") at McCarthy Tetrault, Main Board Room, 13th
Floor, 777 Dunsmuir Street, Vancouver, B.C., Canada, on June 30, 1998 beginning
at 10:00 a.m. local time. The purpose of the Special Meeting is set forth below
and in the accompanying Notice of Special Meeting of Stockholders and is
described in detail in the accompanying Proxy Statement/Prospectus.
On November 19, 1997, UDN entered into an Agreement and Plan of Merger and
on January 30, 1998 and April 6, 1998, entered into amendments thereto (as
amended, the "Merger Agreement"), with STAR Telecommunications, Inc. ("STAR")
and IIWII Corp., a wholly-owned subsidiary of STAR ("Newco"), pursuant to which
Newco will be merged with and into UDN (the "Merger"), with UDN surviving as a
wholly-owned subsidiary of STAR. Subject to the terms and conditions of the
Merger Agreement, each share of common stock, par value $0.01 per share, of UDN
("UDN Common Stock"), outstanding immediately prior to the effective time of the
Merger (the "Effective Time") will be converted into the right to receive that
portion of a share (the "Exchange Ratio") of common stock, par value $0.001 per
share, of STAR ("STAR Common Stock") determined by dividing $2.05 by the average
closing price of STAR Common Stock on the Nasdaq National Market for the five
(5) trading days prior to the Effective Time (the "Average Price"), provided
that if the Average Price is equal to or greater than $27.50, the Exchange Ratio
shall be determined by using $27.50 as the Average Price, which would result in
an Exchange Ratio of 0.074545. As of May 15, 1998, based on a closing sales
price for STAR Common Stock of $26.50, the Exchange Ratio was 0.077358 share of
STAR Common Stock for each share of UDN Common Stock. Cash will be paid in lieu
of any fractional shares of STAR Common Stock. In order to accomplish the
Merger, stockholders of UDN are being asked to approve and adopt the Merger
Agreement and the transactions contemplated thereby.
AFTER CAREFUL CONSIDERATION, THE UDN BOARD OF DIRECTORS AND A SPECIAL
COMMITTEE OF THE BOARD HAS DETERMINED THAT THE MERGER IS FAIR AND IN THE BEST
INTERESTS OF UDN AND ITS STOCKHOLDERS. ACCORDINGLY, THE BOARD AND THE SPECIAL
COMMITTEE HAVE, BY UNANIMOUS VOTE OF ALL MEMBERS PRESENT, APPROVED THE MERGER
AGREEMENT AND RELATED TRANSACTIONS AND RECOMMEND THAT YOU VOTE "FOR" THE
APPROVAL AND ADOPTION OF THE MERGER AGREEMENT AND THE TRANSACTIONS CONTEMPLATED
THEREBY.
Madison Securities, Inc. has acted as financial advisor to UDN in connection
with the Merger and delivered a written opinion (the "Madison Opinion") to the
Board of Directors and the Special Committee that, as of May 7, 1998 and subject
to the assumptions and the limitations of the opinion, the Exchange Ratio is
fair to the holders of UDN Common Stock (other than STAR and its affiliates)
from a financial point of view. A copy of the Madison Opinion is included as
ANNEX B to the Proxy Statement/Prospectus and should be read in its entirety.
Consummation of the Merger is subject to certain conditions, including the
approval and adoption of the Merger Agreement and the other transactions
contemplated thereby by UDN's stockholders and the review by, or receipt of
certain approvals from, regulatory authorities.
You are urged to read the accompanying Proxy Statement/Prospectus, which
provides you with a description of the terms of the proposed transaction. A copy
of the Merger Agreement is included as ANNEX A to the Proxy
Statement/Prospectus.
<PAGE>
IT IS IMPORTANT THAT YOUR SHARES BE REPRESENTED AT THE SPECIAL MEETING.
WHETHER OR NOT YOU PLAN TO ATTEND THE SPECIAL MEETING IN PERSON, YOU ARE URGED
TO COMPLETE, DATE AND SIGN THE ENCLOSED PROXY CARD AND RETURN IT IN THE ENCLOSED
POSTAGE PAID ENVELOPE AS PROMPTLY AS POSSIBLE.
If you have any questions prior to the UDN Special Meeting or need further
assistance, please call D.F. King & Co., Inc., our proxy solicitor, at (800)
848-2998.
Thank you for your time and attention to the accompanying Notice of Special
Meeting and Proxy Statement/Prospectus.
Very truly yours,
John R. Snedegar
President
<PAGE>
[LOGO]
NOTICE OF
SPECIAL MEETING OF STOCKHOLDERS OF
UNITED DIGITAL NETWORK, INC.
TO BE HELD JUNE 30, 1998
------------------------
NOTICE IS HEREBY GIVEN that a Special Meeting of Stockholders (the "Special
Meeting") of United Digital Network, Inc., a Delaware corporation ("UDN"), will
be held at McCarthy Tetrault, Main Board Room, 13th Floor, 777 Dunsmuir Street,
Vancouver, B.C., Canada on June 30, 1998 beginning at 10:00 a.m., local time,
for the following purposes:
1. To consider and vote upon a proposal to approve and adopt the Agreement
and Plan of Merger, dated as of November 19, 1997, as amended January 30,
1998 and April 6, 1998 (as amended, the "Merger Agreement"), by and among
UDN, STAR Telecommunications, Inc., a Delaware corporation ("STAR"), and
IIWII Corp., a Delaware corporation and a wholly-owned subsidiary of STAR
("Newco"), and the transactions contemplated thereby, including, among
other things, the merger ("Merger") of Newco with and into UDN, pursuant
to which each share of common stock, par value $0.01 per share, of UDN
("UDN Common Stock") outstanding immediately prior to the effective time
of the Merger (the "Effective Time") will be converted into the right to
receive that portion of a share (the "Exchange Ratio") of common stock,
par value $0.001 per share, of STAR ("STAR Common Stock") determined by
dividing $2.05 by the average closing price of STAR Common Stock on the
Nasdaq National Market for the five (5) trading days prior to the
Effective Time (the "Average Price"), provided that if the Average Price
is equal to or greater than $27.50, the Exchange Ratio shall be
determined by using $27.50 as the Average Price, which would result in an
Exchange Ratio of 0.074545. Cash will be paid in lieu of any fractional
shares of STAR Common Stock. As of May 15, 1998, based on a closing price
for STAR Common Stock of $26.50, the Exchange Ratio was 0.077358 share of
STAR Common Stock for each share of UDN Common Stock. As a result of the
Merger, UDN will become a wholly-owned subsidiary of STAR. The Merger and
related matters are described in greater detail in, and a copy of the
Merger Agreement is attached as ANNEX A to the accompanying Proxy
Statement/Prospectus; and
2. To transact such other business as may properly come before the Special
Meeting or any adjournments or postponements thereof.
Only stockholders of record at the close of business on May 26, 1998, the
record date for the Special Meeting, will be entitled to vote at the Special
Meeting.
Approval of the proposal described in item 1 above requires the affirmative
vote of the holders of a majority of the outstanding shares of UDN Common Stock
entitled to be voted with respect to such proposal.
IT IS IMPORTANT THAT YOUR SHARES BE REPRESENTED AT THE SPECIAL MEETING,
WHETHER OR NOT YOU PLAN TO ATTEND THE SPECIAL MEETING IN PERSON, YOU ARE URGED
TO COMPLETE, DATE AND SIGN THE ENCLOSED PROXY CARD AND RETURN IT IN THE ENCLOSED
POSTAGE-PAID ENVELOPE AS PROMPTLY AS POSSIBLE. THE ENVELOPE REQUIRES NO POSTAGE
IF MAILED IN THE UNITED STATES. Any stockholder who signs and mails a proxy may
revoke such proxy by delivering written notice of such revocation to the
Secretary of UDN prior to the time voting is declared closed or by attending the
Special Meeting and voting in person.
<PAGE>
Please see the accompanying Proxy Statement/Prospectus for further details
regarding the treatment of proxies at the Special Meeting.
By Order of the Board of Directors
Janine Thomas
SECRETARY
Irvine, California
May , 1998
------------------------
PLEASE SIGN AND DATE THE ENCLOSED PROXY
AND RETURN IT IN THE ENCLOSED POSTAGE-PREPAID ENVELOPE
------------------------
PLEASE DO NOT MAIL ANY STOCK CERTIFICATES AT THIS TIME
<PAGE>
UNITED DIGITAL NETWORK, INC.
PROXY STATEMENT
---------------------
STAR TELECOMMUNICATIONS, INC.
PROSPECTUS
SHARES OF COMMON STOCK
---------------------
This Proxy Statement/Prospectus and the accompanying annexes (the "Proxy
Statement/Prospectus") are being furnished to the stockholders of United Digital
Network, Inc., a Delaware corporation ("UDN"), in connection with the
solicitation of proxies by the Board of Directors of UDN for use at a special
meeting of stockholders of UDN to be held on June 30, 1998, and any and all
adjournments and postponements thereof (the "Special Meeting").
At the Special Meeting, UDN's stockholders will be asked to consider a
proposal to approve and adopt the Agreement and Plan of Merger, dated as of
November 19, 1997, as amended January 30, 1998 and April 6, 1998 (as amended,
the "Merger Agreement"), by and among STAR Telecommunications, Inc., a Delaware
corporation ("STAR"), IIWII Corp., a Delaware corporation and wholly-owned
subsidiary of STAR ("Newco"), and UDN and the transactions contemplated thereby.
Pursuant to the Merger Agreement, Newco will merge with and into UDN (the
"Merger"), and UDN will become a wholly-owned subsidiary of STAR.
As a result of the Merger, each share of common stock, par value $0.01 per
share, of UDN ("UDN Common Stock") outstanding immediately prior to the
effective time (the "Effective Time") of the Merger (other than treasury shares,
which shares will be cancelled, and shares as to which dissenters' rights have
been perfected) will be converted into the right to receive that portion of a
share (the "Exchange Ratio") of common stock, par value $0.001 per share, of
STAR ("STAR Common Stock") determined by dividing $2.05 by the average closing
price of STAR Common Stock on the Nasdaq National Market for the five (5)
trading days prior to the Effective Time (the "Average Price"), provided that if
the Average Price is equal to or greater than $27.50, the Exchange Ratio shall
be determined by using $27.50 as the Average Price, which would result in an
Exchange Ratio of 0.074545. As of May 15, 1998, based on a closing price for
STAR Common Stock of $26.50, the Exchange Ratio was 0.077358 share of STAR
Common Stock for each share of UDN Common Stock. Cash will be paid in lieu of
any fractional shares of STAR Common Stock.
STAR has filed a Registration Statement on Form S-4 (the "Registration
Statement") with the Securities and Exchange Commission (the "Commission") under
the Securities Act of 1933, as amended (the "Securities Act"), with respect to
the shares of STAR Common Stock to be issued to the stockholders of UDN pursuant
to the Merger Agreement. This Proxy Statement/Prospectus constitutes the
prospectus of STAR filed as part of the Registration Statement. Completion of
the Merger is conditioned upon, among other things, the Registration Statement
being declared effective by the Commission and the shares of STAR Common Stock
to be issued in the Merger being authorized for listing on the Nasdaq National
Market.
On November 18, 1997, the last full day of trading prior to the announcement
of the execution of the Merger Agreement, the last reported sale prices of STAR
Common Stock and UDN Common Stock, as reported on the Nasdaq National Market and
Vancouver Stock Exchange, were $15.183 (adjusted to give effect to the Stock
Split (as defined herein)) and $2.15, respectively. On March 31, 1998, STAR
effected a 2.05-for-1 stock split in the form of a stock dividend to the holders
of all shares of STAR Common Stock outstanding as of February 20, 1998 with the
payment of 1.05 shares for each such outstanding share of STAR Common Stock. On
May , 1998, the last trading day prior to the date of this Proxy
Statement/Prospectus, the last reported sale prices of STAR Common Stock and UDN
Common Stock, as reported on the Nasdaq National Market and Vancouver Stock
Exchange, were $ and $ , respectively.
This Proxy Statement/Prospectus and the accompanying form of proxy are first
being mailed to stockholders of UDN on or about May 28, 1998.
------------------------
THE SHARES OF STAR COMMON STOCK TO BE ISSUED IN CONNECTION WITH THE MERGER
HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE
COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROXY STATEMENT/
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
------------------------
SEE "RISK FACTORS" BEGINNING ON PAGE 22 FOR A DISCUSSION OF CERTAIN MATTERS THAT
SHOULD BE CONSIDERED BY THE STOCKHOLDERS OF UDN WITH RESPECT TO THE MERGER.
------------------------
THE DATE OF THIS PROXY STATEMENT/PROSPECTUS IS MAY , 1998.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
AVAILABLE INFORMATION..................................................... 5
SUMMARY................................................................... 7
The Companies........................................................... 7
The Special Meeting..................................................... 8
The Merger.............................................................. 9
The Merger Agreement.................................................... 11
Other Considerations.................................................... 14
Risk Factors............................................................ 15
Selected Historical Financial Information (STAR)........................ 16
Selected Historical Financial Information (UDN)......................... 18
Comparative Per Share Data.............................................. 20
Summary Pro Forma Financial Information................................. 21
RISK FACTORS.............................................................. 22
Operating Results Subject to Significant Fluctuations................... 22
Ability to Continue and Manage Growth; Commercial Market................ 23
Risks Inherent in Acquisition Strategy.................................. 23
Risks Associated with Growth of Telecommunications Network and Customer
Base.................................................................. 24
Risks of International Telecommunications Business...................... 24
Potential Adverse Effects of Government Regulation...................... 25
Risks of Network Failure................................................ 27
Dependence on Key Personnel............................................. 28
Significant Competition................................................. 28
Customer Concentration.................................................. 29
Need for Additional Capital to Finance Growth and Capital
Requirements.......................................................... 29
Volatility of Stock Price............................................... 29
Control of Company by Named Officers, and Directors..................... 29
Effect of Certain Charter Provisions; Anti-Takeover Effects of
Certificate of Incorporation, Bylaws and Delaware Law................. 30
Shares Eligible for Future Sale......................................... 30
Year 2000 Computer Program Failure...................................... 31
No Assurance that STAR Will Realize Anticipated Benefits from the
Merger................................................................ 31
Interests of Certain Persons in the Merger.............................. 31
Maintenance of UDN's Customer Base...................................... 31
UDN's Dependence on Third Party Transmission Facilities................. 32
Dependence on Key Personnel of UDN...................................... 32
Dilution of Voting Power................................................ 32
Certain Federal Income Tax Consequences................................. 33
THE SPECIAL MEETING....................................................... 35
THE MERGER................................................................ 37
General Description..................................................... 37
Effective Time.......................................................... 37
Background of the Merger................................................ 37
UDN's Reasons for the Merger; Recommendations of the UDN Board and
Special Committee..................................................... 39
Opinion of Madison Securities, Financial Advisor to UDN................. 40
STAR's Reasons for the Merger........................................... 43
The Merger Agreement.................................................... 43
</TABLE>
2
<PAGE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Resale of Shares of STAR Common Stock Issued in the Merger;
Affiliates............................................................ 49
Accounting Treatment of the Merger...................................... 50
Interests of Certain Persons in the Merger.............................. 50
Regulatory Approvals.................................................... 50
Stock Exchange Listing.................................................. 51
Delisting and Deregistration of UDN Common Stock........................ 51
Comparative Stock Prices................................................ 51
APPRAISAL RIGHTS OF STOCKHOLDERS.......................................... 52
COMPARATIVE RIGHTS OF STOCKHOLDERS........................................ 55
Number of Directors..................................................... 55
Classification.......................................................... 55
Removal of Directors; Filling Vacancies on the Board of Directors....... 55
Limitation on Directors' Liability...................................... 56
Indemnification......................................................... 56
Restrictions on Business Combinations/Corporate Control Dividends....... 57
PRO FORMA FINANCIAL INFORMATION........................................... 59
NOTES TO PRO FORMA FINANCIAL INFORMATION.................................. 65
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS OF STAR...................................................... 67
BUSINESS OF STAR.......................................................... 75
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS OF UDN....................................................... 91
BUSINESS OF UDN........................................................... 95
MANAGEMENT OF STAR AND UDN................................................ 99
Officers and Directors of STAR.......................................... 99
STAR Board Composition.................................................. 100
STAR Director Compensation.............................................. 100
STAR Executive Compensation............................................. 101
STAR Compensation Committee Interlocks and Insider Participation........ 102
STAR 1997 Omnibus Stock Incentive Plan.................................. 102
STAR 1996 Outside Director Nonstatutory Stock Option Plan............... 103
STAR Employment Agreements and Change of Control Arrangements........... 104
Officers and Directors of UDN........................................... 105
UDN Director Compensation............................................... 106
UDN Executive Compensation.............................................. 106
UDN Employment Agreements............................................... 107
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............................ 109
PRINCIPAL STOCKHOLDERS OF STAR............................................ 111
PRINCIPAL STOCKHOLDERS OF UDN............................................. 113
DESCRIPTION OF STAR CAPITAL STOCK......................................... 115
Common Stock............................................................ 115
Preferred Stock......................................................... 115
Anti-Takeover Effects of Provisions of Certificate of Incorporation,
Bylaws and Delaware Law............................................... 115
Registration Rights..................................................... 116
Transfer Agent and Registrar............................................ 117
CERTAIN INCOME TAX CONSEQUENCES........................................... 117
Certain United States Federal Income Tax Considerations................. 117
Certain Canadian and Foreign Tax Consequences........................... 118
LEGAL MATTERS............................................................. 118
EXPERTS................................................................... 119
</TABLE>
3
<PAGE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
FUTURE STOCKHOLDER PROPOSALS.............................................. 119
INDEX TO FINANCIAL STATEMENTS............................................. F-1
ANNEXES
ANNEX A: AGREEMENT AND PLAN OF MERGER.................................... A-1
ANNEX B: MADISON SECURITIES OPINION...................................... B-1
ANNEX C: SECTION 262 OF THE GENERAL CORPORATION LAW OF THE STATE OF
DELAWARE........................................................ C-1
</TABLE>
4
<PAGE>
AVAILABLE INFORMATION
STAR is subject to the informational requirements of the Securities Exchange
Act of 1934, as amended (the "Exchange Act"), and, in accordance therewith,
files reports, proxy statements, registration statements and other information
with the Commission. The reports, proxy statements, registration statements and
other information filed by STAR with the Commission may be inspected and copied
at the public reference facilities maintained by the Commission at 450 Fifth
Street, N.W., Washington, D.C. 20549, and at the Commission's Regional Offices
at Seven World Trade Center, 13th Floor, New York, New York 10048 and Citicorp
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661-2511.
Copies of such material may be obtained by mail from the Public Reference
Section of the Commission at 450 West Fifth Street, N.W., Washington, D.C.
20549, at prescribed rates. The Commission also maintains a Web Site at
http://www.sec.gov which contains reports, proxy statements, registration
statements and other information regarding registrants that file electronically
with the Commission. STAR's Common Stock is listed on the Nasdaq National Market
under the symbol "STRX." UDN's Common Stock is listed on the Vancouver Stock
Exchange under the symbol "UDN.V." Reports, proxy statements and other
information filed by STAR may be inspected at the offices of the Nasdaq National
Market, Reports Section, 1735 K Street, Washington, D.C. 20006. Reports, proxy
statements and other information filed by UDN may be inspected at the offices of
the Vancouver Stock Exchange, 609 Granville Street, Vancouver, British Columbia,
Canada V7Y 1H1. After consummation of the Merger, UDN will no longer be required
to file reports, proxy statements or other information with the Vancouver Stock
Exchange.
STAR has filed with the Commission the Registration Statement with respect
to the STAR Common Stock to be issued pursuant to the Merger Agreement, of which
this Proxy Statement/Prospectus constitutes a part. The information contained
herein with respect to STAR and its affiliates has been provided by STAR, and
the information contained herein with respect to UDN and its affiliates has been
provided by UDN. This Proxy Statement/Prospectus does not contain all of the
information set forth in the Registration Statement and the exhibits thereto,
certain items of which were omitted in accordance with the rules and regulations
of the Commission. For further information, reference is hereby made to the
Registration Statement. Any statements contained herein concerning the contents
of any contract, agreement or other document referred to herein and filed as an
exhibit to the Registration Statement or otherwise filed with the Commission are
not necessarily complete. With respect to each such contract, agreement or other
document filed with the Commission as an exhibit, reference is made to the
exhibit for a more complete description of the matter involved, and each such
statement is qualified in its entirety by such reference.
NO PERSON IS AUTHORIZED BY STAR OR UDN TO GIVE ANY INFORMATION OR TO MAKE
ANY REPRESENTATION, OTHER THAN THOSE CONTAINED IN THIS PROXY
STATEMENT/PROSPECTUS, IN CONNECTION WITH THE SOLICITATION AND THE OFFERING MADE
BY THIS PROXY STATEMENT/PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR
REPRESENTATIONS SHOULD NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED. THIS PROXY
STATEMENT/PROSPECTUS DOES NOT CONSTITUTE THE SOLICITATION OF A PROXY OR AN OFFER
TO SELL, OR A SOLICITATION OF AN OFFER TO PURCHASE, ANY SECURITIES IN ANY
JURISDICTION IN WHICH SUCH SOLICITATION OR OFFERING MAY NOT LAWFULLY BE MADE.
NEITHER THE DELIVERY OF THIS PROXY STATEMENT/PROSPECTUS NOR ANY DISTRIBUTION
OF SECURITIES MADE HEREUNDER SHALL IMPLY THAT THERE HAS BEEN NO CHANGE IN THE
INFORMATION SET FORTH HEREIN OR IN THE AFFAIRS OF STAR OR UDN SINCE THE DATE
HEREOF.
------------------------
THIS PROXY STATEMENT/PROSPECTUS CONTAINS CERTAIN "FORWARD-LOOKING
STATEMENTS" WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933,
5
<PAGE>
AS AMENDED. FORWARD-LOOKING STATEMENTS ARE STATEMENTS OTHER THAN HISTORICAL
INFORMATION OR STATEMENTS OF CURRENT CONDITION. SOME FORWARD-LOOKING STATEMENTS
MAY BE IDENTIFIED BY USE OF SUCH TERMS AS "EXPECTS," "ANTICIPATES," "INTENDS,"
"ESTIMATES," "BELIEVES" AND WORDS OF SIMILAR IMPORT. THESE FORWARD-LOOKING
STATEMENTS RELATE TO PLANS, OBJECTIVES AND EXPECTATIONS FOR FUTURE OPERATIONS.
IN LIGHT OF THE RISKS AND UNCERTAINTIES INHERENT IN ALL SUCH PROJECTED OPERATION
MATTERS, THE INCLUSION OF FORWARD-LOOKING STATEMENTS IN THIS PROXY
STATEMENT/PROSPECTUS SHOULD NOT BE REGARDED AS A REPRESENTATION BY STAR, UDN OR
ANY OTHER PERSON THAT THE OBJECTIVES OR PLANS OF STAR OR UDN WILL BE ACHIEVED OR
THAT ANY OF STAR'S OR UDN'S OPERATING EXPECTATIONS WILL BE REALIZED. REVENUES
AND RESULTS OF OPERATIONS ARE DIFFICULT TO FORECAST AND COULD DIFFER MATERIALLY
FROM THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS CONTAINED IN THIS PROXY
STATEMENT/PROSPECTUS. FORWARD-LOOKING STATEMENTS MAY BE DEEMED TO INCLUDE THOSE
SET FORTH IN "SUMMARY," REGARDING STAR'S INTRODUCTION INTO SERVICE OF VARIOUS
INTERNATIONAL GATEWAY SWITCHES, COMMITMENTS TO ACQUIRE UNDERSEA CABLES AND
VARIOUS ASPECTS OF STAR'S STRATEGY. SUCH FORWARD-LOOKING STATEMENTS MAY BE
DEEMED TO INCLUDE STATEMENTS IN "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION OF STAR," REGARDING STAR'S STRATEGY
TO LOWER ITS COST OF SERVICES AND IMPROVE ITS GROSS MARGIN AND ITS BELIEF THAT
PRICE DECLINES MAY BE OFFSET IN PART BY INCREASED CALLING VOLUMES AND DECREASED
COSTS AND ITS BELIEF IN THE SUFFICIENCY OF CAPITAL RESOURCES. FORWARD-LOOKING
STATEMENTS IN "BUSINESS OF STAR" MAY BE DEEMED TO INCLUDE PROJECTED GROWTH IN
INTERNATIONAL TELECOMMUNICATIONS TRAFFIC, STAR'S STRATEGY OF MARKETING ITS
SERVICES TO FOREIGN-BASED LONG DISTANCE PROVIDERS, EXPANDING ITS U.S. AND
DEVELOPING EUROPEAN AND ASIAN SWITCHING CAPABILITIES, EXPANDING INTO COMMERCIAL
MARKETS AND PURSUING ACQUISITIONS. ACTUAL RESULTS COULD DIFFER FROM THOSE
PROJECTED IN ANY FORWARD-LOOKING STATEMENTS FOR THE REASONS DETAILED IN THE
"RISK FACTORS" SECTION OF THIS PROXY STATEMENT/ PROSPECTUS, BEGINNING ON PAGE
22, OR ELSEWHERE IN THIS PROXY STATEMENT/ PROSPECTUS. NEITHER STAR NOR UDN
UNDERTAKES ANY OBLIGATION TO RELEASE PUBLICLY THE RESULTS OF ANY FUTURE
REVISIONS IT MAY MAKE TO ANY OF ITS FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS
OR CIRCUMSTANCES AFTER THE DATE HEREOF, TO REFLECT THE OCCURRENCE OF
UNANTICIPATED EVENTS OR TO REFLECT ANY CHANGE IN STAR'S OPERATING STRATEGY.
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SUMMARY
THIS SUMMARY HIGHLIGHTS SELECTED INFORMATION FROM THIS PROXY
STATEMENT/PROSPECTUS AND MAY NOT CONTAIN ALL OF THE INFORMATION THAT IS
IMPORTANT TO YOU. TO UNDERSTAND THE MERGER FULLY AND FOR A MORE COMPLETE
DESCRIPTION OF THE LEGAL TERMS OF THE MERGER, STOCKHOLDERS SHOULD READ CAREFULLY
THIS ENTIRE DOCUMENT, INCLUDING THE ANNEXES. SEE "AVAILABLE INFORMATION." UDN'S
STOCKHOLDERS SHOULD ALSO CAREFULLY CONSIDER THE INFORMATION SET FORTH BELOW IN
"RISK FACTORS." UNLESS OTHERWISE INDICATED, THE INFORMATION IN THIS PROXY
STATEMENT/ PROSPECTUS GIVES EFFECT TO A 2.05-FOR-1 STOCK SPLIT PAID ON MARCH 31,
1998 IN THE FORM OF A STOCK DIVIDEND TO THE HOLDERS OF ALL SHARES OF STAR COMMON
STOCK OUTSTANDING ON FEBRUARY 20, 1998 WITH THE PAYMENT OF 1.05 SHARES FOR EACH
SUCH OUTSTANDING SHARE OF STAR COMMON STOCK (THE "STOCK SPLIT"). REFERENCES TO A
FISCAL YEAR REFER TO THE FISCAL YEAR BEGINNING IN THAT YEAR (E.G., THE FISCAL
YEAR BEGINNING MAY 1, 1996 AND ENDING APRIL 30, 1997 IS REFERRED TO HEREIN AS
"FISCAL 1996"). ALL REFERENCES TO DOLLAR AMOUNTS ARE SET FORTH IN U.S. DOLLARS,
UNLESS OTHERWISE NOTED.
THE COMPANIES
STAR AND NEWCO
STAR Telecommunications, Inc. ("STAR") is an emerging multinational carrier
focused primarily on the international long distance market. STAR offers highly
reliable, low cost switched voice services on a wholesale basis, primarily to
U.S.-based long distance carriers. STAR provides international long distance
service to approximately 220 foreign countries through a flexible network
comprised of various foreign termination relationships, international gateway
switches, leased and owned transmission facilities and resale arrangements with
long distance providers. STAR has grown its revenues rapidly by capitalizing on
the deregulation of international telecommunications markets, combining
sophisticated information systems with flexible routing and leveraging
management's industry expertise. STAR has increased its revenues from $46.3
million in 1995 to $376.2 million in 1997.
STAR serves the large and growing international long distance
telecommunications market. According to industry sources, worldwide gross
revenues in this market were over $60 billion in 1996 and the volume of
international traffic on the public telephone network is expected to grow at a
compound annual growth rate of approximately 13% from 1996 through the year
2000.
STAR markets its services to large global carriers seeking lower rates and
high quality overflow capacity, as well as to small and medium-sized long
distance companies that do not have the critical mass to invest in their own
international transmission facilities or to obtain volume discounts from the
larger facilities-based carriers. During the fourth quarter of 1997, STAR
provided switched international long distance services to 105 customers and
currently provides these services to nine of the top forty global carriers. STAR
has also recently focused on building a customer base overseas, particularly in
Europe, and has opened offices in Dusseldorf, Frankfurt, Hamburg and Munich,
Germany and London, England. In addition, STAR has begun to market its
international long distance services directly to certain commercial customers in
the U.S. and overseas.
STAR currently operates international gateway switching facilities in New
York, Los Angeles, Dallas and London, England. In 1998, STAR plans to put into
service switches in Atlanta, Chicago, Miami and Seattle; Dusseldorf, Frankfurt,
Hamburg and Munich, Germany; Paris, France; and Tokyo, Japan. STAR's switching
facilities are linked to a proprietary reporting system, which STAR believes
provides it with a competitive advantage by permitting management on a real-time
basis to determine the most cost-effective termination alternatives, monitor
customer usage and manage gross margins by route. STAR holds ownership positions
in a number of digital undersea fiber optic cables, has recently added capacity
on the TPC-5 undersea fiber optic cable system and has entered into commitments
to acquire transmission capacity on three additional undersea fiber optic cable
systems, Gemini, AC-1 and China-US.
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STAR was incorporated in Nevada in September 1993 as STAR Vending, Inc. and
was reincorporated in Delaware as STAR Telecommunications, Inc. in April 1997.
IIWII Corp. ("Newco"), which is a wholly-owned subsidiary of STAR, was
incorporated in Delaware on July 15, 1997 for the purpose of effecting the
Merger. Newco has no material assets and has not engaged in any activities
except in connection with such proposed Merger.
STAR's and Newco's executive offices are located at 223 East De La Guerra
Street, Santa Barbara, California 93101. Its telephone number at that location
is (805) 899-1962.
UDN
United Digital Network, Inc. ("UDN") is a provider of voice and data long
distance services, travelcard services, international long distance, prepaid
calling cards and various other telecommunication services to residential, small
to medium-sized commercial customers, switchless resellers, agents and wholesale
purchasers. The principal market for its long distance services is the central
and southwest United States. UDN operates primarily through its wholly-owned
subsidiaries, Advanced Management Services, Inc., CTN-Custom Telecommunications
Network of Arizona, Inc. and United Digital Network of Texas, Inc. UDN offers an
array of services designed to afford its customers an integrated
telecommunications solution to their telecommunications needs.
UDN was incorporated in Canada under the British Columbia Company Act on
June 2, 1980, reincorporated in 1995 as a Wyoming corporation and subsequently
merged into a wholly-owned Delaware subsidiary and accordingly now exists as a
Delaware corporation. Since its entry into the telecommunications business in
1992, UDN's long distance revenues have grown from $13,000 in 1992 to
approximately $24 million for the fiscal year ended April 30, 1997.
UDN's growth has resulted from a two-pronged growth strategy. First, a plan
of acquiring selected types of long distance companies has produced four major
acquisitions that have been integrated into UDN's operations. Second, a direct
sales force, complemented by a growing agent network, has produced significant
internal growth during the last two years. From fiscal year ended April 30, 1995
through December 31, 1997, UDN's customer base increased from approximately
2,000 to over 22,000 customers nationwide.
UDN has focused on retention of its customer base, exploration of
opportunities for expanding its product lines and continuing to search for
additional strategic acquisitions. UDN's executive offices are located at 18872
MacArthur Blvd., Suite 300, Irvine CA, 92612. Its telephone number at that
location is (714) 833-8050.
THE SPECIAL MEETING
PURPOSE
At the Special Meeting, UDN's stockholders will be asked to approve and
adopt the Merger Agreement and the transactions contemplated thereby and to
transact any other business that properly may come before the meeting or any
adjournments or postponements thereof.
TIME, PLACE AND DATE
The Special Meeting will be held at McCarthy Tetrault, Main Board Room, 13th
Floor, 777 Dunsmuir Street, Vancouver, B.C., Canada, on June 30, 1998, at 10:00
a.m. local time.
RECORD DATE; QUORUM; VOTES REQUIRED
Holders of shares of UDN Common Stock as of the close of business on May 26,
1998, which has been set as the "Record Date," will be entitled to vote at the
Special Meeting. As of the close of business on the
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Record Date, shares of UDN Common Stock were outstanding and entitled to
vote. The presence, in person or by proxy, of holders of record of a majority of
the issued and outstanding shares of UDN Common Stock is necessary to constitute
a quorum for the transaction of business at the Special Meeting. Approval of the
Merger Agreement and the transactions contemplated thereby will require the
affirmative vote of the holders of record of a majority of all outstanding
shares of UDN Common Stock. See "The Special Meeting."
VOTING OF PROXIES
The Proxy accompanying this Proxy Statement/Prospectus is solicited on
behalf of UDN's Board of Directors for use at the Special Meeting. UDN's
stockholders are requested to complete, date and sign the accompanying Proxy and
promptly return it in the enclosed envelope (which requires no postage if mailed
in the United States) to UDN's transfer agent. All properly executed Proxies
received by UDN's transfer agent prior to the vote at the Special Meeting that
are not revoked will be voted in accordance with the instructions indicated on
the Proxies or, if no direction is indicated, to approve and adopt the Merger
Agreement. A Proxy may be revoked at any time before its exercise by filing with
Janine Thomas, the Secretary of UDN, at 18872 MacArthur Blvd. #300, Irvine,
California 92612, an instrument of revocation or a duly executed proxy bearing a
later date, or by attendance at the Special Meeting and electing to vote in
person. Attendance at the Special Meeting will not in and of itself constitute
revocation of a Proxy. John Snedegar, President of UDN, has entered into a Proxy
Agreement with STAR pursuant to which Mr. Snedegar granted STAR a proxy to vote
his outstanding shares of UDN Common Stock in favor of the Merger. Mr. Snedegar
beneficially owns 11.8% of the outstanding shares of UDN Common Stock.
SOLICITATION OF PROXIES AND EXPENSES
UDN will bear the cost of the solicitation of Proxies from its stockholders.
D.F. King & Co., Inc. has been selected to act as the Proxy solicitor. In
addition to solicitation by mail, the directors, officers and employees of UDN
may solicit Proxies from UDN's stockholders by telephone, telegram, letter or in
person. UDN will request brokers, custodians, nominees and other record holders
to forward copies of this Proxy Statement/Prospectus, Proxies and other
soliciting materials to persons for whom they hold shares of UDN Common Stock
and to request authority for the exercise of Proxies. In such cases, UDN, upon
request of the record holders, will reimburse such holders for their reasonable
expenses.
THE MERGER
REASONS FOR THE MERGER
Each of the Board of Directors and the Special Committee (the "Special
Committee") of UDN and the Board of Directors of STAR have unanimously approved
the terms of the Merger for several reasons. By joining the operations of STAR
and UDN, the Merger will create for STAR a network of independent sales agents
targeted at residential and small to medium-sized commercial customers with a
demand for international calling services at competitive rates. The Merger
provides UDN with a large, well-capitalized parent with a developing,
switch-based network. No assurances can be made, however, that the Merger will
be successful for STAR or UDN.
In reaching a decision to recommend the Merger, each of the UDN and STAR
Boards of Directors and the UDN Special Committee considered a number of factors
in addition to those set forth above. See "The Merger--UDN's Reasons for the
Merger; Recommendations of the UDN Board and Special Committee" and "--STAR's
Reasons for the Merger."
RECOMMENDATIONS TO UDN STOCKHOLDERS
THE UDN BOARD OF DIRECTORS (THE "UDN BOARD") AND THE UDN SPECIAL COMMITTEE
BELIEVE THAT THE MERGER IS FAIR AND IN THE BEST INTERESTS OF UDN
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AND ITS STOCKHOLDERS AND UNANIMOUSLY RECOMMEND THAT UDN STOCKHOLDERS VOTE FOR
THE PROPOSAL TO APPROVE AND ADOPT THE MERGER AGREEMENT AND THE TRANSACTIONS
CONTEMPLATED THEREBY. SEE "THE MERGER--UDN'S REASONS FOR THE MERGER;
RECOMMENDATIONS OF THE UDN BOARD AND SPECIAL COMMITTEE."
OWNERSHIP OF STAR AFTER THE MERGER
Based on an Exchange Ratio of 0.077358, STAR anticipates issuing 567,022
shares of STAR Common Stock to UDN stockholders in the Merger, which will
constitute approximately 1.3% (on a fully diluted basis) of the outstanding STAR
Common Stock after the Merger. The actual amounts will be based on the numbers
of outstanding shares of both companies and the Exchange Ratio at the time of
the Merger. See "The Merger--The Merger Agreement."
MANAGEMENT AND OPERATIONS FOLLOWING THE MERGER
It is contemplated that after the Merger, UDN will continue to operate as a
separate entity. STAR does not presently intend to change the domicile, name or
material operations of UDN, other than to provide certain billing services to
UDN pursuant to a Management Services Agreement to be entered into between the
parties. STAR has advised UDN, however, that Christopher E. Edgecomb, Mary A.
Casey and Kelly D. Enos will be named as the Directors of UDN. STAR currently
intends that the existing officers of UDN will retain their offices after the
Effective Time, but may appoint additional officers of UDN from time to time.
See "Management of STAR and UDN--Officers and Directors of UDN."
OTHER INTERESTS OF OFFICERS AND DIRECTORS IN THE MERGER
In considering the UDN Board's recommendation that UDN stockholders vote in
favor of the Merger Agreement and the transactions contemplated thereby, UDN
stockholders should be aware that John Snedegar, President of UDN, and Dale
Christensen, Chief Operating Officer and Chief Financial Officer of UDN, have
employment agreements that provide them with bonuses and severance benefits
which would take effect if Mr. Snedegar or Mr. Christensen exercises his right
to terminate his employment agreement upon consummation of the Merger. See
"Management of STAR and UDN--UDN Employment Agreements." In addition,
Christopher E. Edgecomb, Chief Executive Officer of STAR, owns 136,000 shares of
UDN Common Stock, David Vaun Crumly, Executive Vice President--Sales and
Marketing of STAR, owns 2,500 shares of UDN Common Stock and holds options to
purchase 18,750 shares of UDN Common Stock and John Snedegar, President of UDN,
owns 30,750 shares of STAR Common Stock and options to acquire 10,250 shares of
STAR Common Stock. Mr. Snedegar is a Director of both STAR and UDN. See "The
Merger--Interests of Certain Persons in the Merger."
OPINIONS OF FINANCIAL ADVISOR
In deciding to approve the Merger, the UDN Board and UDN Special Committee
conditioned their approval on the receipt of the opinion of their financial
advisor, Madison Securities, Inc. ("Madison Securities"), as to the fairness of
the Exchange Ratio to the stockholders of UDN from a financial point of view.
This opinion is attached to this Proxy Statement/Prospectus as ANNEX B.
Stockholders of UDN are encouraged to read this opinion in its entirety as it
contains the assumptions made, the procedures followed, the other matters
considered and the limits of the review conducted by Madison Securities in
arriving at its opinion.
For purposes of delivering this opinion, Madison Securities performed a
variety of analyses, including comparing the historical stock prices and
financial multiples of UDN and STAR to each other and to those of other selected
public companies, comparing the financial terms of the Merger to those of other
publicly announced transactions and analyzing the relative values and
contributions of UDN and STAR based upon
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historical and projected future financial performance and anticipated benefits
of the Merger as provided by the management of UDN and STAR. See "The
Merger--Opinion of Madison Securities, Financial Advisor to UDN."
CERTAIN INCOME TAX CONSEQUENCES
The Merger has been structured so that, in general, none of UDN, STAR or
their respective stockholders will recognize any gain or loss for U.S. federal
incomes tax purposes in the Merger (except for any cash received by UDN
stockholders in lieu of fractional shares and stockholders exercising
dissenters' rights); provided STAR and UDN comply with certain representations
and warranties. Stockholders of UDN and dissenting stockholders of UDN who are
residents in or citizens of, Canada or another foreign jurisdiction may, as a
result of the Merger (or the exercise of appraisal rights in respect of the
Merger) realize or be required to realize a gain or loss on the exchange of
shares under the Merger (or upon the exercise of, or any payment being made in
connection with, appraisal rights) or experience other tax consequences. See
"Certain Income Tax Consequences."
ACCOUNTING TREATMENT
Consummation of the Merger is conditioned upon receipt of a letter from
UDN's independent public accountants stating that UDN will qualify as a poolable
entity and the receipt of a letter from STAR's independent public accountants
stating that the Merger will qualify as a pooling of interests, which means that
STAR will restate its historical consolidated financial statements to include
the assets, liabilities, stockholders' equity and results of operations of UDN.
See "The Merger--Accounting Treatment of the Merger."
APPRAISAL RIGHTS OF UDN STOCKHOLDERS
Under Delaware law, holders of UDN Common Stock who have not voted in favor
of the Merger Agreement and who have fully complied with the applicable
provisions of Delaware Law have the right to require UDN to purchase for cash
their shares at the fair market value thereof (as determined by agreement with
UDN or by a court) in lieu of shares of STAR Common Stock that they would
otherwise receive in the Merger. Such stockholders exercising such rights
("Dissenting Stockholders") must (i) abstain from voting or vote such shares
against the Merger Agreement, and (ii) deliver to UDN, prior to the taking of
the vote on the Merger Agreement, written notice of such Dissenting
Stockholders' intent to demand payment for such shares. Dissenting Stockholders
must also comply with the other requirements of Section 262 of the Delaware Law,
the full text of which is attached to this Proxy Statement/ Prospectus as ANNEX
C. Any deviation from or failure to comply with all such requirements may result
in the forfeiture of the appraisal rights of Dissenting Stockholders. See
"Appraisal Rights of Stockholders."
THE MERGER AGREEMENT
A COPY OF THE MERGER AGREEMENT IS ATTACHED AS ANNEX A TO THIS PROXY
STATEMENT/PROSPECTUS. UDN'S STOCKHOLDERS ARE STRONGLY ENCOURAGED TO READ THE
MERGER AGREEMENT AS IT IS THE LEGAL DOCUMENT THAT GOVERNS THE MERGER AND THE
TRANSACTIONS CONTEMPLATED THEREBY. THE DISCUSSION OF THE MERGER AGREEMENT IS
QUALIFIED IN ITS ENTIRETY BY THE FULL TEXT THEREOF, ATTACHED HERETO AS ANNEX A.
TERMS OF THE MERGER AGREEMENT
The Merger Agreement provides that, following the approval and adoption of
the Merger Agreement and the transactions contemplated thereby by the
stockholders of UDN and the satisfaction or waiver of certain other conditions,
Newco will be merged with and into UDN. As a result, UDN will become a
wholly-owned subsidiary of STAR after the Merger. The Merger will become
effective when a certificate of
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merger is accepted for filing by the Secretary of State of the State of
Delaware. See "The Merger--The Merger Agreement."
MERGER CONSIDERATION
As a result of the Merger, UDN's stockholders will receive for each share of
UDN Common Stock a portion of a share (the "Exchange Ratio") of STAR Common
Stock determined by dividing $2.05 by the average closing price of STAR Common
Stock on the Nasdaq National Market for the five (5) trading days prior to the
Effective Time (the "Average Price"), provided that if the Average Price is
equal to or greater than $27.50, the Exchange Ratio shall be determined by using
$27.50 as the Average Price, which will result in an Exchange Ratio of 0.074545.
As of May 15, 1998, the Exchange Ratio was 0.077358 share of STAR Common Stock
for each share of UDN Common Stock. No fractional shares will be issued.
Instead, UDN stockholders will receive cash in lieu of any fractional shares of
the STAR Common Stock. See "The Merger--The Merger Agreement" and "--The Merger
Agreement--Fractional Shares."
A VOTE TO APPROVE AND ADOPT THE MERGER AGREEMENT BY UDN'S STOCKHOLDERS WILL
BE DEEMED APPROVAL OF THE EXCHANGE RATIO. UDN STOCKHOLDERS SHOULD NOT SEND IN
THEIR STOCK CERTIFICATES UNTIL INSTRUCTED TO DO SO AFTER THE MERGER IS FINAL.
ASSUMPTION OF UDN STOCK OPTIONS AND WARRANTS
At or prior to the Effective Time, STAR and UDN shall take all action
necessary to cause the assumption by STAR as of the Effective Time of the
options and warrants to purchase UDN Common Stock outstanding as of the
Effective Time (the "UDN Options" and "UDN Warrants," respectively). Each of the
UDN Options and UDN Warrants shall be converted without any action on the part
of the holder thereof into an option or warrant to purchase a certain number of
shares of STAR Common Stock (based on the Exchange Ratio) on substantially
equivalent terms as of the Effective Time. As of the Record Date, 469,375 shares
of UDN Common Stock were subject to outstanding UDN Options and 302,259 shares
of UDN Common Stock were subject to outstanding UDN Warrants. In addition, UDN
carries $1,050,000 in convertible debentures, of which $550,000 will be
converted into 275,000 shares of UDN Common Stock upon consummation of the
Merger. See "The Merger--The Merger Agreement--Treatment of UDN Stock Options
and Warrants."
CONDITIONS TO THE MERGER
Completion of the Merger depends upon the satisfaction of a number of
conditions, including, but not limited to, the following:
(a) the Registration Statement shall have been declared effective by the
Commission;
(b) the approval and adoption of the Merger Agreement and the transactions
contemplated thereby by the requisite vote of the holders of the
outstanding shares of UDN Common Stock entitled to vote thereon at the
Special Meeting;
(c) the approval for listing on the Nasdaq National Market of the STAR
Common Stock issuable to the stockholders of UDN pursuant to the Merger
Agreement;
(d) the approval of governmental authorities, including the Federal
Communications Commission (the "FCC") and state public utility
commissions ("PUCs"), required for the transfer of ownership or control
of UDN;
(e) the receipt by UDN of the opinion of Madison Securities that the
Exchange Ratio contemplated by the Merger Agreement is fair, from a
financial point of view, to the UDN stockholders;
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(f) not more than 5% of the outstanding shares of UDN Common Stock
exercising appraisal rights; and
(g) the receipt by STAR of letters from Arthur Andersen LLP approving the
accounting treatment of the Merger as a "pooling of interests" and from
Price Waterhouse LLP that UDN is a poolable entity, and the SEC shall not
have objected to such accounting treatment.
Certain conditions to the Merger may be waived by the party entitled to
assert the condition. See "The Merger--The Merger Agreement--Conditions."
REGULATORY APPROVALS
The Merger is subject to the requirements of the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, as amended, and the rules and regulations promulgated
thereunder (the "HSR Act"). The HSR Act prohibits consummation of the Merger
until certain information has been furnished to the Antitrust Division of the
Department of Justice and to the Federal Trade Commission and a required waiting
period has expired. The Department of Justice or the Federal Trade Commission
may still challenge the Merger on antitrust grounds before or after the Merger
is final. Consummation of the Merger is contingent upon the receipt of approvals
from the FCC, various PUCs and various municipalities with respect to the
Merger. STAR and UDN have previously made the necessary filings with these
government agencies. See "The Merger--Regulatory Approvals."
NEGOTIATIONS
Pursuant to the Merger Agreement, and subject to certain conditions and
exceptions, UDN has agreed not to, directly and indirectly, solicit, initiate or
participate in discussions or negotiations with or the submission of any offer
or proposal by or provide any information to, any corporation, partnership,
person or other entity or group (other than STAR or Newco) concerning a proposal
to acquire (by means of a tender or exchange offer, merger, consolidation,
business combination or otherwise) all or a substantial portion of the
outstanding shares of UDN Common Stock or the assets of UDN and its
subsidiaries. UDN, however, may take certain actions with respect to the
above-described transactions where doing so is necessary for the UDN Board to
comply with its fiduciary responsibilities under applicable laws as advised by
counsel in writing. See "The Merger--Negotiations."
TERMINATION OF THE MERGER AGREEMENT
UDN and STAR may agree, by mutual written consent, to terminate the Merger
Agreement without completing the Merger. Moreover, either UDN or STAR may
terminate the Merger Agreement if, among other things, any of the following
occurs:
(a) the UDN Board of Directors fails to recommend, withdraws, modifies or
amends its approval or recommendation of the Merger and the transactions
contemplated by the Merger Agreement;
(b) the requisite approval of the UDN stockholders is not received;
(c) the other party breaches any of its representations and warranties or
fails to perform any of its covenants and agreements, which breaches and
failures are, in the aggregate, material in the context of the
transactions contemplated by the Merger Agreement; or
(d) the Merger is not completed on or before July 15, 1998; provided that if
such failure is the result of an injunction or order of a court or
governmental or regulatory body resulting from an action or proceeding
commenced by any party which is not a governmental authority, then at the
request of either party, the deadline date shall be extended for a
reasonable period of time, not in excess of 120 days, to permit the
parties to have such injunction vacated or order reversed.
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TERMINATION FEES
The Merger Agreement requires UDN to pay to STAR a termination fee of $2.0
million if the Merger Agreement terminates for certain reasons. See "The
Merger--The Merger Agreement--Termination Fee."
OTHER AGREEMENTS
In connection with the execution of the Merger Agreement on November 19,
1997 and the first amendment thereto on January 30, 1998, STAR loaned $2.5
million and $2.0 million to UDN, respectively. Pursuant to separate promissory
notes executed by UDN in favor of STAR, interest on the outstanding principal
amount of the notes will be repaid quarterly, plus interest at the "Prime Rate"
per annum (as reported in the WALL STREET JOURNAL) plus 1%, which rate shall be
reset quarterly. Upon execution of the Merger Agreement, John R. Snedegar,
President of UDN, executed a Proxy Agreement granting STAR an irrevocable proxy
to vote all shares of UDN Common Stock held, beneficially or of record, by Mr.
Snedegar in favor of the Merger and in opposition of any other proposal for any
merger, reorganization, recapitalization, sale of assets or stock of UDN or any
of its subsidiaries. As of May 18, 1998, Mr. Snedegar held 831,647 shares, or
approximately 11.8%, of the outstanding UDN Common Stock. STAR and UDN have
agreed to use their reasonable efforts to enter into a billing outsourcing
agreement (the "Management Services Agreement"), which will provide, among other
things, for the management by STAR of UDN's customer billings on terms at least
as favorable as the terms of UDN's present outsourcing agreement.
OTHER CONSIDERATIONS
COMPARATIVE RIGHTS OF STOCKHOLDERS OF UDN AND STAR
The rights of UDN stockholders are currently governed by Delaware law, UDN's
Certificate of Incorporation and UDN's Bylaws. After the Merger, UDN
stockholders will become STAR stockholders and their rights will be governed by
Delaware law, STAR's Certificate of Incorporation and STAR's Bylaws. There are
various differences between the existing rights of UDN stockholders and the
rights of STAR stockholders, including, among others, certain provisions of
STAR's Certificate of Incorporation that may have the effect of deterring or
making it more difficult for a third party to acquire control of STAR. See
"Comparative Rights of Stockholders."
STOCK EXCHANGE LISTING
STAR intends to apply to have the shares of STAR Common Stock to be issued
in the Merger listed on the Nasdaq National Market. The listing on the Nasdaq
National Market of the STAR Common Stock issuable in the Merger is a condition
to UDN's obligation to consummate the Merger. See "The Merger-- Stock Exchange
Listing."
COMPARATIVE STOCK PRICES
Shares of STAR Common Stock are listed on the Nasdaq National Market and
shares of UDN Common Stock are listed on the Vancouver Stock Exchange. On
November 18, 1997, the last full trading day prior to the public announcement of
the proposed Merger, UDN Common Stock closed at $2.15 per share, and STAR Common
Stock closed at $15.183 per share. On March 31, 1998, STAR effected a 2.05-for-1
stock split in the form of a stock dividend to the holders of all shares of STAR
Common Stock outstanding as of February 20, 1998 with the payment of 1.05 shares
for each such outstanding share of STAR Common Stock. On May , 1998, the last
full trading day prior to the date of this Proxy Statement/ Prospectus, UDN
Common Stock closed at $ per share, and STAR Common Stock closed at $
per share. STAR has never paid cash dividends on the STAR Common Stock and does
not intend to pay such dividends in the foreseeable future. In addition, STAR is
restricted by its revolving credit facility from
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paying cash dividends without the lender's consent. UDN has never paid dividends
on the UDN Common Stock and does not intend to pay dividends prior to
consummation of the Merger. See "The Merger-- Comparative Stock Prices."
RESALE RESTRICTIONS
At or prior to the Effective Time, the STAR Common Stock issuable in
connection with the Merger shall have been registered under the Securities Act.
Accordingly, all shares of STAR Common Stock received by UDN stockholders in the
Merger will be freely transferable in the U.S., except that the stockholders
deemed "affiliates" of UDN at the time the Merger becomes final are subject to
certain regulatory restrictions and restrictions relating to the publication of
the combined operating results of STAR and UDN under the Merger Agreement
regarding the resale of their shares of STAR Common Stock. For the UDN
stockholders resident in jurisdictions other than the U.S., the free
transferability of the STAR Common Stock may vary dependent on the laws of that
jurisdiction and, accordingly, each stockholder of UDN Common Stock so affected
should consult their legal or other advisors. See "The Merger--Resale of Shares
of STAR Common Stock Issued in the Merger; Affiliates."
RISK FACTORS
The information set forth under "Risk Factors" should be reviewed and
carefully considered by the stockholders of UDN in evaluating the Merger
Agreement.
15
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA OF
STAR TELECOMMUNICATIONS, INC.
The following selected consolidated financial data should be read in
conjunction with STAR's Consolidated Financial Statements and Notes thereto and
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations of STAR," each of which is included elsewhere in this Proxy
Statement/Prospectus. The consolidated statements of operations data for the
years ended December 31, 1995, 1996 and 1997, and the balance sheet data at
December 31, 1996 and 1997 are derived from audited financial statements
included elsewhere in this Proxy Statement/Prospectus. The consolidated
statement of operations data for the year ended December 31, 1994 and the
consolidated balance sheet data at December 31, 1994 are unaudited and are
derived from unaudited financial statements not included in this Proxy
Statement/Prospectus. The consolidated balance sheet data at December 31, 1995
is derived from audited financial statements not included in this Proxy
Statement/Prospectus. Although incorporated in 1993, STAR did not commence
business until 1994.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
----------------------------------------------------- ----------------------
1994 1995 1996 1997 1997 1998
----------- ------- -------- -------- -------- --------
(UNAUDITED)
(UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AND PER MINUTE DATA)
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENTS OF OPERATIONS
DATA(1):
Revenues.............................. $20,915 $46,283 $237,991 $376,198 $ 84,827 $129,269
Cost of services...................... 12,775 31,897 205,585 325,237 73,726 111,593
----------- ------- -------- -------- -------- --------
Gross profit........................ 8,140 14,386 32,406 50,961 11,101 17,676
Operating expenses:
Selling, general and
administrative.................... 4,782 10,086 34,331 35,381 7,720 11,561
Depreciation and amortization....... 30 186 1,151 4,245 820 1,879
Merger expense...................... -- -- -- 286 -- 314
----------- ------- -------- -------- -------- --------
Total operating expenses............ 4,812 10,272 35,482 39,912 8,540 13,754
----------- ------- -------- -------- -------- --------
Income (loss) from operations....... 3,328 4,114 (3,076) 11,049 2,561 3,922
Other income (expense):
Interest income..................... 3 22 110 492 21 283
Interest expense.................... -- (64) (601) (1,633) (398) (618)
Legal settlements and expenses...... -- -- (100) (1,653) -- --
Other............................... (7) (33) 39 208 51 (160)
----------- ------- -------- -------- -------- --------
Income (loss) before provision for
income taxes...................... 3,324 4,039 (3,628) 8,463 2,235 3,427
Provision for income taxes............ 1 66 592 2,895 341 1,534
----------- ------- -------- -------- -------- --------
Net income (loss)..................... $ 3,323 $ 3,973 $ (4,220) $ 5,568 $ 1,894 $ 1,893
----------- ------- -------- -------- -------- --------
----------- ------- -------- -------- -------- --------
Pro forma net income (loss)
(unaudited)(2)...................... $ 1,994 $ 2,407 $ (5,163) $ 5,373 $ 1,347
----------- ------- -------- -------- --------
----------- ------- -------- -------- --------
Diluted income per share.............. $ 0.05
--------
--------
Pro forma diluted income (loss) per
share (unaudited)(3)................ $ 0.12 $ 0.13 $ (0.24) $ 0.17 $ 0.05
----------- ------- -------- -------- --------
----------- ------- -------- -------- --------
Weighted average number of diluted
common shares outstanding(3)........ 16,865 18,020 21,939 31,625 28,494 37,714
</TABLE>
16
<PAGE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
----------------------------------------------------- ----------------------
1994 1995 1996 1997 1997 1998
----------- ------- -------- -------- -------- --------
(UNAUDITED)
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AND PER MINUTE DATA)
<S> <C> <C> <C> <C> <C> <C>
OTHER CONSOLIDATED FINANCIAL AND
OPERATING DATA(1):
EBITDA(4)............................. $ 3,351 $ 4,267 $ (1,986) $ 13,849 $ 3,432 $ 5,641
Capital expenditures(5)............... 57 2,175 13,018 24,732 3,237 33,734
Wholesale billed minutes of use....... -- 38,106 479,681 863,295 187,349 324,439
Wholesale revenue per billed minute of
use(6).............................. $-- $0.4102 $ 0.4288 $ 0.3997 $ 0.4036 $ 0.3701
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
--------------------------------------------- -----------
1994 1995 1996 1997 1998
----------- --------- --------- ---------- -----------
(UNAUDITED) (IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA(1):
Working capital (deficit)............................ $ 2,007 $ 1,222 $ (6,342) $ 15,846 $ 8,342
Total assets......................................... 5,105 18,316 54,000 113,553 144,312
Total long-term liabilities, net of current portion.. -- 904 5,870 12,271 26,280
Retained earnings (deficit).......................... 1,839 1,596 (5,968) (1,397) (607)
Stockholders' equity................................. 2,197 3,047 7,911 44,014 50,727
</TABLE>
- ------------------------
(1) Does not reflect the acquisition of UDN, which remains subject to the
approval of UDN's stockholders and to various regulatory approvals.
(2) The pro forma net income or loss per share assumes that both STAR and LD
Services, Inc. ("LDS"), which was acquired by STAR on November 30, 1997, had
been C-Corporations for all periods presented.
(3) See Note 2 of Notes to STAR Consolidated Financial Statements for an
explanation of the method used to determine the number of shares used in
computing pro forma net income (loss) per share.
(4) EBITDA represents earnings before interest income and expense, income taxes,
depreciation and amortization expense. EBITDA does not represent cash flows
as defined by generally accepted accounting principles and does not
necessarily indicate that cash flows are sufficient to fund all of STAR's
cash needs. EBITDA should not be considered in isolation or as a substitute
for net income, cash flows from operating activities or other measures of
STAR's liquidity determined in accordance with generally accepted accounting
principles.
(5) Includes assets financed with capital leases or notes. See Note 2 of Notes
to STAR Consolidated Financial Statements.
(6) Represents wholesale gross call usage revenue per billed minute. Amounts
exclude other revenue related items such as finance charges.
17
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA OF
UNITED DIGITAL NETWORK, INC.
The following selected consolidated financial data should be read in
conjunction with UDN's Consolidated Financial Statements and Notes thereto and
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations of UDN," which are included elsewhere in this Proxy
Statement/Prospectus. The statement of income data for the years ended April 30,
1995, 1996 and 1997, and the balance sheet data at April 30, 1996 and 1997 are
derived from audited financial statements included elsewhere in this Proxy
Statement/Prospectus. The statement of operations data for the years ended April
30, 1993 and 1994 and the balance sheet data at April 30, 1993, 1994 and 1995
are derived from audited financial statements not included in this Proxy
Statement/Prospectus. The data presented for the nine-month periods ended
January 31, 1997 and 1998 are derived from unaudited financial statements and
include, in the opinion of UDN's management, all adjustments necessary to
present fairly the data for such periods. The results for an interim period are
not necessarily indicative of the results to be expected for a full fiscal year.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED APRIL 30, JANUARY 31,
----------------------------------------------------- --------------------
1993 1994 1995 1996 1997 1997 1998
--------- --------- --------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT FOR PER SHARE AND PER MINUTE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF INCOME DATA:
Revenues................................. $ 2,495 $ 1,465 $ 2,338 $ 8,027 $ 24,012 $ 16,774 $ 23,941
Cost of revenues......................... 1,619 1,186 1,918 6,030 18,455 12,870 19,047
--------- --------- --------- --------- --------- --------- ---------
Gross profit............................. 876 279 420 1,997 5,557 3,904 4,894
Operating expenses:
Selling, general and administrative.... 962 1,278 1,941 2,675 5,155 3,458 6,344
Provision for doubtful accounts........ -- -- 75 229 693 245 3,055
Depreciation and amortization.......... 498 270 273 584 901 674 783
--------- --------- --------- --------- --------- --------- ---------
Total operating expenses................. 1,460 1,548 2,289 3,488 6,749 4,377 10,183
--------- --------- --------- --------- --------- --------- ---------
Loss from operations..................... (584) (1,269) (1,869) (1,491) (1,192) (473) (5,289)
Other income (expense):
Interest income........................ 1 1 2 43 28 20 26
Interest expense....................... (148) (110) (87) (150) (661) (447) (726)
Other.................................. (719) (119) (64) (485)
--------- --------- --------- --------- --------- --------- ---------
Loss before income tax benefit,
extraordinary gain and discontinued
operations............................. (1,450) (1,378) (2,073) (1,662) (1,825) (900) (6,474)
Income tax benefit, net of tax........... -- -- -- -- 50 23 --
Extraordinary gain on debt
restructuring.......................... -- -- -- -- 97 45 --
Loss from discontinued operations........ -- (128) -- -- -- -- --
Net loss................................. $ (1,450) $ (1,506) $ (2,073) $ (1,662) $ (1,678) $ (832) $ (6,474)
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Net loss per share (basic and diluted)... $ (1.41) $ (.96) $ (0.92) $ (0.45) $ (0.31) $ (0.16) $ (0.99)
Weighted average shares.................. 1,028 1,568 2,253 3,707 5,359 5,250 6,542
</TABLE>
18
<PAGE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED APRIL 30, JANUARY 31,
----------------------------------------------------- --------------------
1993 1994 1995 1996 1997 1997 1998
--------- --------- --------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT FOR PER SHARE AND PER MINUTE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
OTHER CONSOLIDATED FINANCIAL AND
OPERATING DATA:
EBITDA................................... $ (805) $ (1,126) $ (1,713) $ (928) $ (166) $ (266) $ (4,965)
Cash provided by (used in) operating
activities............................. (348) (1,149) (1,819) (1,345) 238 787 (1,248)
Cash used in investing activities........ (1,368) (31) (239) (658) (948) (875) (353)
Cash provided by (used in) financing
activities............................. 1,660 (1,528) 2,063 2,956 193 (722) 2,008
Capital expenditures..................... 408 189 194 186 674 577 412
</TABLE>
<TABLE>
<CAPTION>
APRIL 30,
------------------------------- JANUARY 31,
1995 1996 1997 1998
--------- --------- --------- -----------
(IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash................................................................ $ 121 $ 1,074 $ 556 $ 964
Working capital deficit............................................. (1,487) (2,041) (3,184) (10,297)
Total assets........................................................ 4,522 10,587 13,196 13,844
Total long-term liabilities, net of current portion................. 653 2,061 1,995 493
Retained deficit.................................................... (5,498) (7,161) (8,839) (15,313)
Total stockholders' equity (deficit)................................ 1,116 2,806 3,089 (2,627)
</TABLE>
19
<PAGE>
COMPARATIVE PER SHARE DATA
The following table presents certain historical, pro forma and pro forma
equivalent per share financial data for UDN Common Stock and STAR Common Stock.
The pro forma data does not purport to be indicative of the results of future
operations or the results that would have occurred had the Merger been
consummated at the beginning of the periods presented. The information presented
herein should be read in conjunction with the Unaudited Pro Forma Financial
Data, including the notes thereto, appearing elsewhere in this Proxy
Statement/Prospectus.
<TABLE>
<CAPTION>
STAR UDN PRO FORMA
HISTORICAL HISTORICAL COMBINED(1)
----------- ----------- -------------
<S> <C> <C> <C>
EARNING (LOSS) PER DILUTED COMMON SHARE FOR:
Year ended December 31, 1995................................................ $ 0.13 $ (0.92) $ 0.07
Year ended December 31, 1996................................................ $ (0.24) $ (0.45) $ (0.28)
Year ended December 31, 1997................................................ $ 0.17 $ (0.31) $ 0.02
Three months ended March 31, 1998........................................... $ 0.05 $ (0.08) $ 0.04
BOOK VALUE PER COMMON SHARE AT:
March 31, 1998.............................................................. $ 1.42 $ (0.39) $ 1.33
</TABLE>
- ------------------------
(1) The pro forma combined earnings per common share are based on the combined
weighted average number of common and common equivalent shares of UDN Common
Stock and STAR Common Stock outstanding for each period and on the Exchange
Ratio as of May 15, 1998. The pro forma combined book value per common share
is based on the pro forma number of common shares outstanding at the end of
the period.
20
<PAGE>
SUMMARY UNAUDITED PRO FORMA FINANCIAL DATA
The following table presents summary unaudited pro forma financial data that
was derived from the unaudited pro forma financial data included elsewhere in
this Proxy Statement/Prospectus and should be read in conjunction therewith and
with the related notes thereto. The following summary unaudited pro forma
financial data is presented assuming the Merger will be accounted for as a
pooling of interests, whereby STAR will restate its historical consolidated
financial statements to include the assets, liabilities, stockholders' equity
(deficit) and results of operations of UDN. The statement of operations data set
forth below reflects the combination of the historical operating results of STAR
for the years ended December 31, 1995, 1996 and 1997 and the three months ended
March 31, 1998 with the historical operating results of UDN for the 12 months
ended January 31, 1996, 1997 and 1998 and the three months ended March 31, 1998.
The balance sheet data set forth below reflects the combination of the
historical balance sheet data of STAR and of UDN as of March 31, 1998. STAR
reports its financial data on the basis of a December 31 fiscal year and UDN
reports its financial data on the basis of an April 30 fiscal year.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------- THREE MONTHS ENDED
1995 1996 1997 MARCH 31, 1998
--------- --------- --------- -------------------
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
REVENUES............................................ $ 51,951 $ 257,417 $ 406,224 $ 136,557
COST OF SERVICES.................................... 36,196 220,377 348,717 116,811
--------- --------- --------- --------
Gross profit...................................... 15,755 37,040 57,507 19,746
--------- --------- --------- --------
OPERATING EXPENSES:
Selling, general and administrative............... 12,580 38,894 47,211 13,974
Depreciation and amortization..................... 670 1,969 5,255 2,150
--------- --------- --------- --------
Total operating expenses:......................... 13,250 40,863 52,466 16,124
--------- --------- --------- --------
Income (loss) from operations..................... 2,505 (3,823) 5,041 3,622
--------- --------- --------- --------
OTHER INCOME (EXPENSE):
Interest income................................... 10 114 499 205
Interest expense.................................. (155) (1,049) (2,546) (789)
Legal settlement and expenses..................... -- (100) (1,653) --
Other income (expense)............................ (216) 56 (198) (160)
--------- --------- --------- --------
Total other income (expense):....................... (361) (979) (3,898) (744)
--------- --------- --------- --------
Income (loss) before provision for income taxes... 2,144 (4,802) 1,143 2,878
PROVISION FOR INCOME TAXES.......................... 858 1,485 417 1,534
--------- --------- --------- --------
NET INCOME (LOSS)................................... $ 1,286 $ (6,287) $ 726 $ 1,344
--------- --------- --------- --------
--------- --------- --------- --------
Earnings (loss) per common share:
Basic............................................. $ 0.07 $ (0.28) $ 0.02 $ 0.04
Diluted........................................... $ 0.07 $ (0.28) $ 0.02 $ 0.04
Weighted average number of common shares
outstanding:
Basic............................................. 18,278 22,329 29,358 36,159
Diluted........................................... 18,278 22,329 32,167 38,285
</TABLE>
<TABLE>
<CAPTION>
AS OF
MARCH 31, 1998
--------------
<S> <C>
BALANCE SHEET DATA:
Working capital deficit......................................................................... $ 1,665
Total assets.................................................................................... 152,990
Long term obligations (including current portion)............................................... 33,851
Stockholders equity............................................................................. $ 48,547
</TABLE>
21
<PAGE>
RISK FACTORS
THE FOLLOWING RISK FACTORS SHOULD BE CONSIDERED CAREFULLY IN ADDITION TO THE
OTHER INFORMATION CONTAINED IN THIS PROXY STATEMENT/PROSPECTUS IN CONSIDERING
WHETHER TO APPROVE AND ADOPT THE MERGER AGREEMENT AND THE TRANSACTIONS
CONTEMPLATED THEREBY. THIS PROXY STATEMENT/PROSPECTUS CONTAINS, IN ADDITION TO
HISTORICAL INFORMATION, "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF
SECTION 27A OF THE SECURITIES ACT THAT INVOLVE RISKS AND UNCERTAINTIES. STAR'S
ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE PROJECTED IN THE FORWARD-LOOKING
STATEMENTS. FACTORS THAT MAY CAUSE SUCH A DIFFERENCE INCLUDE, BUT ARE NOT
LIMITED TO, THOSE SET FORTH BELOW AND ELSEWHERE IN THIS PROXY
STATEMENT/PROSPECTUS. SEE "DESCRIPTION OF FORWARD-LOOKING STATEMENTS."
REFERENCES HEREIN TO STAR SHALL BE DEEMED TO INCLUDE STAR AND UDN AFTER THE
MERGER.
OPERATING RESULTS SUBJECT TO SIGNIFICANT FLUCTUATIONS
STAR's quarterly operating results are difficult to forecast with any degree
of accuracy because a number of factors subject these results to significant
fluctuations. As a result, STAR believes that period-to-period comparisons of
its operating results are not necessarily meaningful and should not be relied
upon as indications of future performance.
FACTORS INFLUENCING OPERATING RESULTS, INCLUDING REVENUES, COSTS AND
MARGINS. STAR's revenues, costs and expenses have fluctuated significantly in
the past and are likely to continue to fluctuate significantly in the future as
a result of numerous factors. STAR's revenues in any given period can vary due
to factors such as call volume fluctuations, particularly in regions with
relatively high per-minute rates; the addition or loss of major customers,
whether through competition, merger, consolidation or otherwise; the loss of
economically beneficial routing options for the termination of STAR's traffic;
financial difficulties of major customers; pricing pressure resulting from
increased competition; and technical difficulties with or failures of portions
of STAR's network that impact STAR's ability to provide service to or bill its
customers. STAR's cost of services and operating expenses in any given period
can vary due to factors such as fluctuations in rates charged by carriers to
terminate STAR's traffic; increases in bad debt expense and reserves; the timing
of capital expenditures, and other costs associated with acquiring or obtaining
other rights to switching and other transmission facilities; changes in STAR's
sales incentive plans; and costs associated with changes in staffing levels of
sales, marketing, technical support and administrative personnel. In addition,
STAR's operating results can vary due to factors such as changes in routing due
to variations in the quality of vendor transmission capability; loss of
favorable routing options; the amount of, and the accounting policy for, return
traffic under operating agreements; actions by domestic or foreign regulatory
entities; the level, timing and pace of STAR's expansion in international and
commercial markets; and general domestic and international economic and
political conditions. Further, a substantial portion of transmission capacity
used by STAR is obtained on a variable, per minute and short term basis,
subjecting STAR to the possibility of unanticipated price increases and service
cancellations. Since STAR does not generally have long term arrangements for the
purchase or resale of long distance services, and since rates fluctuate
significantly over short periods of time, STAR's gross margins are subject to
significant fluctuations over short periods of time. STAR's gross margins also
may be negatively impacted in the longer term by competitive pricing pressures.
EXAMPLES OF FACTORS AFFECTING OPERATING RESULTS. STAR has in the past
encountered significant difficulties in the collection of accounts receivable
from certain of its customers. For example, in the fourth quarter of 1996 and
the first quarter of 1997, Hi-Rim Communications, Inc. ("Hi-Rim"), formerly one
of STAR's major customers and Cherry Communications, Inc. ("CCI"), STAR's
largest customer in 1996, experienced financial difficulties and were unable to
pay in full, on a timely basis, outstanding accounts receivable. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations of STAR." In early 1997, STAR implemented more stringent credit
policies and monitoring systems. There can be no assurance, however, that if
STAR experiences similar difficulties in the collection of future accounts
receivable from its customers, STAR's financial condition and results of
operations would not be materially adversely affected.
22
<PAGE>
ABILITY TO CONTINUE AND MANAGE GROWTH; COMMERCIAL MARKET
STAR has increased revenues from $46.3 million in 1995 to $376.2 million in
1997, with revenues increasing in each of the last eleven quarters. Such growth
should not be considered indicative of future revenue growth or operating
results. If revenue levels fall below expectations, net income is likely to be
disproportionately adversely affected because a proportionately smaller amount
of STAR's operating expenses varies with its revenues. This effect is likely to
increase as a greater percentage of STAR's cost of services are associated with
owned and leased facilities. There can be no assurance that STAR will be able to
achieve or maintain profitability on a quarterly or annual basis in the future.
It is likely that in some future quarter STAR's operating results will be below
the expectations of public market analysts and investors. In such event, the
price of STAR Common Stock would likely be materially adversely affected. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations of STAR."
As part of STAR's significant revenue growth, it has expanded, and plans to
continue to expand, the number of its employees and the geographic scope of its
operations. Additionally, an important component of STAR's strategy is to grow
and expand through acquisition. These factors have resulted, and will continue
to result, in increased responsibilities for management personnel and have
placed, and will continue to place, increased demands upon STAR's operating and
financial systems, which may lead to unanticipated costs and divert management's
attention from day-to-day operations. STAR may also be required to attract,
train and retain additional highly qualified management, technical, sales and
marketing and customer support personnel. The process of locating such personnel
with the combination of skills and attributes required to implement STAR's
strategy is often lengthy. The inability to attract and retain additional
qualified personnel could materially and adversely affect STAR. STAR expects
that its expansion into foreign countries will lead to increased financial and
administrative demands, such as increased operational complexity associated with
expanded network facilities, administrative burdens associated with managing an
increasing number of foreign subsidiaries and relationships with foreign
partners and expanded treasury functions to manage foreign currency risks.
STAR's accounting systems and policies have been developed as STAR has
experienced significant growth. There can be no assurance that STAR's personnel,
systems, procedures and controls will be adequate to support STAR's future
operations. See "--Dependence on Key Personnel," "Business of STAR--Employees"
and "Management of STAR and UDN."
With the acquisition of LDS, STAR began providing service to the commercial
market, which is more labor intensive than the wholesale market, and as a result
has higher overhead costs. STAR also may be required to update and improve its
billing systems and procedures and/or hire new management personnel to handle
the demands of the commercial market. There can be no assurance that STAR will
be able to effectively manage the costs of and risks associated with its
expansion into the commercial market.
RISKS INHERENT IN ACQUISITION STRATEGY
An important component to STAR's strategy is to grow and expand through
acquisitions. This growth strategy is dependent on the continued availability of
suitable acquisition candidates and subjects STAR to a number of risks. STAR has
recently completed two acquisitions, LDS on November 30, 1997, and T-One on
March 10, 1998. Additionally, on November 19, 1997, STAR entered into the Merger
Agreement to acquire UDN. The acquisition of UDN is subject to approval of UDN's
stockholders and to various regulatory approvals, and STAR may not complete this
acquisition. These acquisitions have placed significant demands on STAR's
financial and management resources, as the process for integrating acquired
operations presents a significant challenge to STAR's management and may lead to
unanticipated costs or a diversion of management's attention from day-to-day
operations. There can be no assurance that STAR will be able to successfully
integrate these acquisitions or any other acquisitions made by STAR in the
future into Company operations. Integrating acquisitions may require integration
of financial and call routing systems, network and other physical facilities and
personnel. Difficulties in integrating these and other acquisitions can cause
system degradation, added costs and loss of personnel or customers.
23
<PAGE>
Additionally, STAR may incur unknown liabilities despite management's efforts to
investigate the operations of the acquired business. The impact of these risks,
and other risks arising as a result of STAR's acquisition strategy, could
adversely affect STAR's operating results.
RISKS ASSOCIATED WITH GROWTH OF TELECOMMUNICATIONS NETWORK AND CUSTOMER BASE
Historically, STAR has relied primarily on leased transmission capacity for
the delivery of its telecommunications services. STAR's telecommunications
expenses have in the past primarily been variable, based upon minutes of use,
consisting largely of payments to other long distance carriers, customer/carrier
interconnect charges, leased fiber circuit charges and switch facility costs.
During 1997, however, STAR made considerable capital expenditures in order to
expand its network, and intends to continue to do so in the future. See
"Business of STAR--Network." Although STAR's strategy is to seek to establish
significant traffic volumes prior to investing in fixed-cost facilities, the
development of such facilities entails significant costs and prior planning,
which are based in part on STAR's expectations concerning future revenue growth
and market developments. As STAR expands its network and the volume of its
network traffic, its cost of revenues will increasingly consist of fixed costs
arising from the ownership and maintenance of its switches and undersea fiber
optic cables. While STAR believes that in the long-term these investments will
allow it to reduce its cost of service and to enhance its service offerings, in
the short-term, cost increases and a decrease in STAR's operating margins may
occur. If STAR's traffic volume were to decrease, or fail to increase to the
extent expected or necessary to make efficient use of its network, STAR's costs
as a percentage of revenues could increase significantly, which could have a
material adverse effect on STAR's business, financial condition or results of
operations.
In addition, STAR's business depends in part on its ability to obtain
transmission facilities on a cost-effective basis. Because undersea fiber optic
cables typically take several years to plan and construct, carriers generally
make investments well in advance, based on a forecast of anticipated traffic.
Therefore, STAR's operations are subject to the risk that it will not adequately
anticipate the amount of traffic over its network, and may not procure
sufficient cable capacity or network equipment in order to ensure the cost-
effective transmission of customer traffic. Although STAR participates in the
planning of undersea fiber optic transmission facilities, it does not control
the construction of such facilities and must seek access to such facilities
through partial ownership positions. If ownership positions are not available,
STAR must seek access to such facilities through lease arrangements on
negotiated terms that may vary with industry and market conditions. There can be
no assurance that STAR will be able to continue to obtain sufficient
transmission facilities or access to undersea fiber optic cable on economically
viable terms. The failure of STAR to obtain telecommunications facilities that
are sufficient to support its network traffic in a manner that ensures the
reliability and quality of its telecommunications services may have a material
adverse effect on its business, financial condition or results of operations.
RISKS OF INTERNATIONAL TELECOMMUNICATIONS BUSINESS
STAR has to date generated a substantial majority of its revenues by
providing international telecommunications services to its customers on a
wholesale basis. The international nature of STAR's operations involves certain
risks, such as changes in U.S. and foreign government regulations and
telecommunications standards, dependence on foreign partners, tariffs, taxes and
other trade barriers, the potential for nationalization and economic downturns
and political instability in foreign countries. In addition, STAR's business
could be adversely affected by a reversal in the current trend toward
deregulation of telecommunications carriers. STAR will be increasingly subject
to these risks to the extent that STAR proceeds with the planned expansion of
its international operations.
RISK OF DEPENDENCE ON FOREIGN PARTNERS. STAR will increasingly rely on
foreign partners to terminate its traffic in foreign countries and to assist in
installing transmission facilities and network switches, complying with local
regulations, obtaining required licenses, and assisting with customer and vendor
relationships. STAR may have limited recourse if its foreign partners do not
perform under their
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contractual arrangements with STAR. STAR's arrangements with foreign partners
may expose STAR to significant legal, regulatory or economic risks.
RISKS ASSOCIATED WITH FOREIGN GOVERNMENT CONTROL AND HIGHLY REGULATED
MARKETS. Governments of many countries exercise substantial influence over
various aspects of the telecommunications market. In some cases, the government
owns or controls companies that are or may become competitors of STAR or
companies (such as national telephone companies) upon which STAR and its foreign
partners may depend for required interconnections to local telephone networks
and other services. Accordingly, government actions in the future could have a
material adverse effect on STAR's operations. In highly regulated countries in
which STAR is not dealing directly with the dominant local exchange carrier, the
dominant carrier may have the ability to terminate service to STAR or its
foreign partner and, if this occurs, STAR may have limited or no recourse. In
countries where competition is not yet fully established and STAR is dealing
with an alternative operator, foreign laws may prohibit or impede new operators
from offering services in these markets.
RISKS ASSOCIATED WITH FOREIGN CURRENCY FLUCTUATIONS. STAR's revenues and
cost of long distance services are sensitive to foreign currency fluctuations.
STAR expects that an increasing portion of STAR's net revenue and expenses will
be denominated in currencies other than U.S. dollars, and changes in exchange
rates may have a significant effect on STAR's results of operations. Although
STAR utilizes hedging instruments to reduce the risk of foreign currency
fluctuations, STAR will not be fully protected from these risks and the
instruments themselves involve a degree of risk. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations of STAR."
FOREIGN CORRUPT PRACTICES ACT. STAR is also subject to the Foreign Corrupt
Practices Act ("FCPA"), which generally prohibits U.S. companies and their
intermediaries from bribing foreign officials for the purpose of obtaining or
keeping business. STAR may be exposed to liability under the FCPA as a result of
past or future actions taken without STAR's knowledge by agents, strategic
partners and other intermediaries. Such liability could have a material adverse
effect on STAR's business, operating results and financial condition.
POTENTIAL ADVERSE EFFECTS OF GOVERNMENT REGULATION
STAR's business is subject to various U.S. and foreign laws, regulations,
agency actions and court decisions. STAR's U.S. international telecommunications
service offerings are subject to regulation by the FCC. The FCC requires
international carriers to obtain authorizations under Section 214 of the
Communications Act of 1934, as amended, prior to acquiring international
facilities by purchase or lease, or providing international service to the
public. Prior FCC approval is also required to transfer control of a
certificated carrier. STAR must file reports and contracts with the FCC and must
pay regulatory fees, which are subject to change. STAR is also subject to the
FCC policies and rules discussed below. The FCC could determine, by its own
actions or in response to a third party's filing, that certain of STAR's
services, termination arrangements, agreements with foreign carriers, transit or
refile arrangements or reports do not or did not comply with FCC policies and
rules. If this occurred, the FCC could order STAR to terminate noncompliant
arrangements, fine STAR or revoke STAR's authorizations. Any of these actions
could have a material adverse effect on STAR's business, operating results and
financial condition.
FCC INTERNATIONAL PRIVATE LINE RESALE POLICY. The FCC's international
private line ("IPL") resale policy limits the conditions under which a carrier
may connect IPLs to the public switched telephone network ("PSTN") at one or
both ends to provide switched services, commonly known as International Simple
Resale ("ISR"). A carrier generally may only offer ISR services to a foreign
country if the FCC has found (a) the country is a member of the World Trade
Organization ("WTO") and at least 50% of the U.S. billed and settled traffic to
that country is settled at or below the FCC's benchmark settlement rate or (b)
the country is not a WTO member, but it offers U.S. carriers equivalent
opportunities to engage in ISR and at least 50% of the U.S. billed and settled
traffic is settled at or below the applicable benchmark. STAR's FCC authority
currently permits it to provide ISR service to Canada, the U.K., Sweden, New
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Zealand, Australia and the Netherlands. The FCC is currently reviewing U.S.
carrier applications to provide ISR to Belgium, Chile, Denmark, Finland, France,
Germany, Hong Kong, Norway and Luxembourg, among other routes. Upon grant of any
such ISR application to a given country, the FCC's rules also would permit STAR
to provide ISR service to that country. Certain of STAR's termination
arrangements with foreign operators may be inconsistent with the FCC's IPL
resale policy and STAR's existing ISR authorization.
FCC INTERNATIONAL SETTLEMENTS POLICY. The FCC's International Settlement
Policy ("ISP") limits the arrangements which U.S. international carriers may
enter into with foreign carriers for exchanging public switched
telecommunications traffic, which the FCC terms International Message Telephone
Service ("IMTS"). This policy does not apply to ISR services. The ISP requires
that U.S. carriers receive an equal share of the accounting rate and receive
inbound traffic in proportion to the volume of U.S. outbound traffic which they
generate. The ISP and other FCC policies also prohibit a U.S. carrier and a
foreign carrier which possesses sufficient market power on the foreign end of
the route to affect competition adversely in the U.S. market from entering into
exclusive arrangement involving services, facilities or functions on the foreign
end of a U.S. international route which are necessary for providing basic
telecommunications and which are not offered to similarly situated U.S.
carriers. It is possible that the FCC could find that certain of STAR's
arrangements with foreign operators are inconsistent with the ISP.
FCC POLICIES ON TRANSIT AND REFILE. STAR uses both transit and refile
arrangements to terminate its international traffic. The FCC routinely approves
transit arrangements by U.S. international carriers. The FCC's rules also permit
carriers in many cases to use ISR facilities to route traffic via a third
country for refile through the PSTN. The extent to which U.S. carriers may enter
into refile arrangements consistent with the ISP is currently under review by
the FCC. Certain of STAR's transit or refile arrangements may violate the ISP or
other FCC policies.
RECENT AND POTENTIAL FCC ACTIONS. Regulatory action that may be taken in
the future by the FCC may intensify the competition which STAR faces, impose
additional operating costs upon STAR, disrupt certain of STAR's transmission
arrangements or otherwise require STAR to modify its operations. Future FCC
action may also provide STAR additional competitive flexibility by, for example,
eliminating or substantially reducing the tariff requirements applicable to
STAR's interstate and international telecommunications services. The FCC is
encouraging new market entrants by implementing the WTO Basic Telecommunications
Agreement (the "WTO Agreement") and through other actions. The FCC may approve
pending mergers which could produce more effective competitors in STAR's
markets. The FCC may increase regulatory fees charged to STAR and its
competitors by eliminating the exemption for carriers which provide only
international services or through other actions, which could raise STAR's costs
of service without assurance that STAR and its competitors could pass fee
increases through to their customers. See "Business of STAR--Government
Regulation."
STATE. The intrastate long distance telecommunications operations of STAR
and its subsidiaries are subject to various state laws and regulations,
including prior certification, notification, registration and/or tariff
requirements. The vast majority of states require that STAR and its subsidiaries
apply for certification to provide intrastate telecommunications services.
Certificates of authority can generally be conditioned, modified or revoked by
state regulatory authorities for failure to comply with state laws and
regulations. Fines and other penalties, including revocation of a certificate of
authority, may be imposed.
In 1997, prior to STAR's acquisition of LDS, LDS settled disputes with the
California Public Utilities Commission (the "California PUC") and with the
District Attorney of Monterey, California regarding LDS' alleged unauthorized
switching of long distance customers (the "Settlements"). As part of the
Settlements, LDS was subject to fines and restrictions on its business
operations in California. In addition, the FCC has received numerous informal
complaints against LDS regarding the alleged unauthorized switching of long
distance customers, which complaints currently remain under review.
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Following STAR's acquisition of LDS and in order to comply with the
Settlements, STAR has imposed strict restrictions on certain former LDS
employees, restricting these employees with respect to California intrastate
telecommunications operations. Additionally, STAR has taken a number of steps to
reduce the risk of a repeat occurrence regarding the alleged unauthorized
switching of commercial customers in California. If STAR inadvertently fails to
comply with such guidelines or if such guidelines are determined to be
inadequate to comply with the Settlements, STAR may be subject to penalties or
revocation of its certificate of authority. See "Business of STAR--Government
Regulation--Actions Against LDS."
FOREIGN REGULATIONS. STAR is also subject to regulation in foreign
countries, such as the U.K. and Germany, in connection with certain of its
business activities. For example, STAR's use of transit, ISR or other routing
arrangements may be affected by laws or regulations in either the transited or
terminating foreign jurisdiction. Foreign countries, either independently or
jointly as members of the International Telecommunications Union ("ITU"), or
other supra-national organizations such as the European Union or the WTO, may
have adopted or may adopt laws or regulatory requirements regarding such
services for which compliance would be difficult or expensive, that could force
STAR to choose less cost-effective routing alternatives and that could adversely
affect STAR's business, operating results and financial condition.
To the extent that it seeks to provide telecommunications services in other
non-U.S. markets, STAR is subject to the developing laws and regulations
governing the competitive provision of telecommunications services in those
markets. STAR currently plans to provide a limited range of services in Mexico,
Belgium and France, as permitted by regulatory conditions in those markets, and
to expand its operations as these markets implement scheduled liberalization to
permit competition in the full range of telecommunications services in the next
several years. The nature, extent and timing of the opportunity for STAR to
compete in these markets will be determined, in part, by the actions taken by
the governments in these countries to implement competition and the response of
incumbent carriers to these efforts. There can be no assurance that the
regulatory regime in these countries will provide STAR with practical
opportunities to compete in the near future, or at all, or that STAR will be
able to take advantage of any such liberalization in a timely manner. See
"Business of STAR--Government Regulation."
REGULATION OF CUSTOMERS. STAR's customers are also subject to actions taken
by domestic or foreign regulatory authorities that may affect the ability of
customers to deliver traffic to STAR. Regulatory sanctions have been imposed on
certain of STAR's customers in the past. While such sanctions have not adversely
impacted the volume of traffic received by STAR from such customers to date,
future regulatory actions could materially adversely affect the volume of
traffic received from a major customer, which could have a material adverse
effect on STAR's business, financial condition and results of operations.
RISKS OF NETWORK FAILURE
Any system or network failure that causes interruptions in STAR's operations
could have a material adverse effect on its business, financial condition or
results of operations. STAR's operations are dependent on its ability to
successfully expand its network and integrate new and emerging technologies and
equipment into its network, which are likely to increase the risk of system
failure and to cause strain upon the network. STAR's operations also are
dependent on STAR's protection of its hardware and other equipment from damage
from natural disasters such as fires, floods, hurricanes and earthquakes, other
catastrophic events such as civil unrest, terrorism and war and other sources of
power loss and telecommunications failures. Although STAR has taken a number of
steps to prevent its network from being affected by natural disasters, fire and
the like, such as building redundant systems for power supply to the switching
equipment, there can be no assurance that any such systems will prevent STAR's
switches from becoming disabled in the event of an earthquake, power outage or
otherwise. The failure of STAR's network, or a significant decrease in telephone
traffic resulting from effects of a natural or man-made disaster, could have a
material adverse effect on STAR's relationship with its customers and STAR's
business, operating results and financial condition. See "Business of
STAR--Network."
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DEPENDENCE ON KEY PERSONNEL
STAR's success depends to a significant degree upon the efforts of senior
management personnel and a group of employees with longstanding industry
relationships and technical knowledge of STAR's operations, in particular,
Christopher E. Edgecomb, STAR's Chief Executive Officer. STAR maintains and is
the beneficiary under a key person life insurance policy in the amount of $10.0
million with respect to Mr. Edgecomb. STAR believes that its future success will
depend in large part upon its continuing ability to attract and retain highly
skilled personnel. Competition for qualified, high-level telecommunications
personnel is intense and there can be no assurance that STAR will be successful
in attracting and retaining such personnel. The loss of the services of one or
more of STAR's key individuals, or the failure to attract and retain other key
personnel, could materially adversely affect STAR's business, operating results
and financial condition. See "Management of STAR and UDN."
SIGNIFICANT COMPETITION
The international telecommunications industry is intensely competitive and
subject to rapid change. STAR's competitors in the international wholesale
switched long distance market include large, facilities-based multinational
corporations and smaller facilities-based providers in the U.S. and overseas
that have emerged as a result of deregulation, switch-based resellers of
international long distance services and international joint ventures and
alliances among such companies. STAR also competes abroad with a number of
dominant telecommunications operators that previously held various monopolies
established by law over the telecommunications traffic in their countries.
International wholesale switched service providers compete on the basis of
price, customer service, transmission quality, breadth of service offerings and
value-added services. Additionally, the telecommunications industry is in a
period of rapid technological evolution, marked by the introduction of
competitive product and service offerings, such as the utilization of the
Internet for international voice and data communications. STAR is unable to
predict which technological development will challenge its competitive position
or the amount of expenditures that will be required to respond to a rapidly
changing technological environment. Further, the number of STAR's competitors is
likely to increase as a result of the competitive opportunities created by a new
Basic Telecommunications Agreement concluded by members of the WTO in April
1997. Under the terms of the WTO Agreement, starting February 5, 1998, the
United States and over 65 countries have committed to open their
telecommunications markets to competition, foreign ownership and adopt measures
to protect against anticompetitive behavior. As a result, STAR believes that
competition will continue to increase, placing downward pressure on prices. Such
pressure could adversely affect STAR's gross margins if STAR is not able to
reduce its costs commensurate with such price reductions.
COMPETITION FROM DOMESTIC AND INTERNATIONAL COMPANIES. A majority of the
U.S.-based international telecommunications services revenue is currently
generated by AT&T Corp. ("AT&T"), MCI Communications Corp. ("MCI") and Sprint
Corporation ("Sprint"). STAR also competes with WorldCom, Inc. ("WorldCom"),
Pacific Gateway Exchange, Inc., and other U.S.-based and foreign long distance
providers, including the Regional Bell Operating Companies ("RBOCs"), which
presently have FCC authority to resell and terminate international
telecommunication services. Many of these competitors have considerably greater
financial and other resources and more extensive domestic and international
communications networks than STAR. STAR's business would be materially adversely
affected to the extent that a significant number of such customers limit or
cease doing business with STAR for competitive or other reasons. Consolidation
in the telecommunications industry could not only create even larger competitors
with greater financial and other resources, but could also adversely affect STAR
by reducing the number of potential customers for STAR's services.
EXPANSION INTO COMMERCIAL MARKET. With the acquisition of LDS, STAR began
providing long distance service to the commercial market, a market that is
subject to intense competition from a number of well capitalized companies. The
commercial market is also characterized by the lack of customer loyalty, with
commercial customers regularly changing service providers. There can be no
assurance that STAR will
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be able to compete successfully in the commercial market. See "Business of
STAR--Strategy--Expansion into Commercial Market."
CUSTOMER CONCENTRATION
While the list of STAR's most significant customers varies from quarter to
quarter, STAR's five largest customers accounted for approximately 30% of its
revenues in 1997. STAR could lose a significant customer for many reasons,
including the entrance into the market of significant new competitors with lower
rates than STAR, downward pressure on the overall costs of transmitting
international calls, transmission quality problems, changes in U.S. or foreign
regulations or unexpected increases in STAR's cost structure as a result of
expenses related to installing a global network or otherwise.
NEED FOR ADDITIONAL CAPITAL TO FINANCE GROWTH AND CAPITAL REQUIREMENTS
STAR believes that it must continue to enhance and expand its network and
build out its telecommunications network infrastructure in order to maintain its
competitive position and continue to meet the increasing demands for service
quality, capacity and competitive pricing. STAR's ability to grow depends, in
part, on its ability to expand its operations through the ownership and leasing
of network capacity, which requires significant capital expenditures, that are
often incurred prior to STAR's receipt of the related revenue.
STAR believes that, based upon its present business plan and its existing
cash resources and expected cash flow from operating activities, STAR will have
sufficient cash to meet its currently anticipated working capital and capital
expenditure requirements for at least twelve months. If STAR's growth exceeds
current expectations, if STAR obtains one or more attractive opportunities to
purchase the business or assets of another company, or if STAR's cash flow from
operations after the end of such period is insufficient to meet its working
capital and capital expenditure requirements, STAR will need to raise additional
capital from equity or debt sources. There can be no assurance that STAR will be
able to raise such capital on favorable terms or at all. If STAR is unable to
obtain such additional capital, STAR may be required to reduce the scope of its
anticipated expansion, which could have a material adverse effect on STAR's
business, financial condition or results of operations.
VOLATILITY OF STOCK PRICE
The market price of the shares of STAR Common Stock has risen since STAR's
initial public offering in June 1997 and is trading at a high multiple of STAR's
earnings. The market price for such shares has been highly volatile and may be
significantly affected by factors such as actual or anticipated fluctuations in
STAR's operating results, the announcement of potential acquisitions by STAR,
changes in federal and international regulations, activities of the largest
domestic providers, industry consolidation and mergers, conditions and trends in
the international telecommunications market, adoption of new accounting
standards affecting the telecommunications industry, changes in recommendations
and estimates by securities analysts, general market conditions and other
factors. In addition, the stock market has from time to time experienced
significant price and volume fluctuations that have particularly affected the
market prices for the shares of emerging growth companies like STAR. These broad
market fluctuations may adversely affect the market price of the STAR Common
Stock.
CONTROL OF COMPANY BY NAMED OFFICERS AND DIRECTORS
Upon the consummation of the Merger, STAR Named Officers (as defined below)
and directors in the aggregate will beneficially own approximately 37.4% of the
outstanding shares of STAR Common Stock and STAR's Chief Executive Officer will
beneficially own approximately 31.6% of the outstanding shares. These
stockholders may be able to exercise control over all matters requiring
stockholder approval, including the election of directors and approval of
significant corporate transactions. Such concentration of ownership may have the
effect of delaying or preventing a change in control of STAR. See "Principal
Stockholders of STAR."
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EFFECT OF CERTAIN CHARTER PROVISIONS; ANTI-TAKEOVER EFFECTS OF CERTIFICATE OF
INCORPORATION, BYLAWS AND DELAWARE LAW
STAR's Board of Directors has the authority to issue up to 5,000,000 shares
of Preferred Stock and to determine the price, rights, preferences, privileges
and restrictions, including voting and conversion rights of such shares, without
any further vote or action by STAR's stockholders. The rights of the holders of
STAR Common Stock will be subject to, and may be adversely affected by, the
rights of the holders of any Preferred Stock that may be issued in the future.
The issuance of Preferred Stock, while providing flexibility in connection with
possible acquisitions and other corporate purposes, could have the effect of
making it more difficult for a third party to acquire a majority of the
outstanding voting stock of STAR. STAR has no current plans to issue shares of
Preferred Stock. STAR is also subject to the anti-takeover provisions of Section
203 of the Delaware General Corporation Law, which will prohibit STAR from
engaging in a "business combination" with an "interested stockholder" for a
period of three years after the date of the transaction in which the person
became an interested stockholder, unless the business combination is approved in
a prescribed manner. The application of Section 203 could have an effect of
delaying or preventing a change in control of STAR. In addition, STAR's Amended
and Restated Certificate of Incorporation provides for a classified Board of
Directors such that approximately only one-third of the members of the Board
will be elected at each annual meeting of stockholders. Classified boards may
have the effect of delaying, deferring or discouraging changes in control of
STAR. Further, certain provisions of STAR's Amended and Restated Certificate of
Incorporation and Bylaws and of Delaware law could delay or make more difficult
a merger, tender offer or proxy contest involving STAR. Additionally, certain
federal regulations require prior approval of certain transfers of control of
telecommunications companies, which could also have the effect of delaying,
deferring or preventing a change in control. See "Business of STAR--Government
Regulation," "Description of STAR Capital Stock-- Preferred Stock" and
"--Anti-takeover Effects of Provisions of the Certificate of Incorporation,
Bylaws and Delaware Law."
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of the Merger, STAR will have approximately 42,322,616
shares of STAR Common Stock outstanding (assuming no exercise of any of the
options to purchase shares of STAR Common Stock outstanding and vested as of May
15, 1998) of which approximately 9,997,022 will be registered pursuant to the
Securities Act. Approximately 1,911,000 additional shares which are not
currently registered will be available for immediate unrestricted sale in the
public market on the date of this Proxy Statement/ Prospectus and approximately
1,601,000 additional shares will be available for immediate sale on the date of
this Proxy Statement/Prospectus, subject to the public information, volume
limitation and notice provisions of Rule 144 adopted under the Securities Act.
Approximately 410,000 shares will be available for sale within 45 days after the
date of this Proxy Statement/Prospectus, subject to the Rule 144 public
information, volume limitations and notice provisions. Approximately 1,875,000
shares will be available for sale in the public market on June 13, 1998 upon the
expiration of certain lock-up agreements, subject to the Rule 144 public
information, volume limitation and notice provisions described below. Upon the
expiration of certain additional lock-up agreements, on July 28, 1998, (i)
approximately 16,246,000 shares will be available for sale in the public market,
subject to the Rule 144 public information, volume limitation and notice
provisions and (ii) approximately 2,050,000 shares will be available for
unrestricted sale in the public market. Approximately 849,000 shares issued in
the LDS acquisition will be available for sale after November 30, 1998.
Certain stockholders holding approximately 7,153,000 shares of STAR Common
Stock are entitled to registration rights with respect to their shares of STAR
Common Stock. Sales of substantial amounts of such shares in the public market,
or the prospect of such sales, could adversely affect the market price of the
STAR Common Stock. Such sales also might make it more difficult for STAR to sell
equity securities or equity related securities in the future at a time and price
that STAR deems appropriate. See "Description of STAR Capital Stock."
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YEAR 2000 COMPUTER PROGRAM FAILURE
A significant percentage of the software that runs most of the computers in
the United States relies on two-digit date codes to perform computations and
decision-making functions. Commencing on January 1, 2000, these computer
programs may fail from an inability to interpret date codes properly,
misinterpreting "00" as the year 1900 rather than 2000. STAR believes that
STAR's billing, credit and call tracking systems are Year 2000 compliant and do
not use programs with the two-digit date code flaw. At the same time, a number
of the computers of STAR's customers and vendors that interface with STAR's
systems may run on programs that have Year 2000 problems and may disrupt STAR's
billing, credit and tracking systems. Failure of any of the computer programs
integral to STAR's key customers and vendors could adversely affect STAR's
business, operating results and financial condition. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations of
STAR."
NO ASSURANCE THAT STAR WILL REALIZE ANTICIPATED BENEFITS FROM THE MERGER
The Merger involves the combination of certain aspects of two companies that
have operated independently. Accordingly, there can be no assurance that UDN can
be successfully integrated into STAR or that STAR and its stockholders
(including persons who become stockholders as a result of the Merger) will
ultimately realize any of the anticipated benefits of the Merger.
In addition, the integration of the STAR and UDN operations and accounting,
personnel administrative and legal functions involves the risk that key
employees, who can not be easily replaced, in those operations and functions,
will leave even when offered continuing employment. The integration approach
adopted by STAR with respect to UDN requires the devotion of a significant
amount of time by senior executives, which may detract from business operations
and development of the combined companies.
In determining that the Merger is fair and in the best interests of its
stockholders, each of the UDN Board and the UDN Special Committee considered the
cost savings, operating efficiencies and other synergies expected to result
following the consummation thereof. See "The Merger--UDN's Reasons for the
Merger; Recommendations of the UDN Board and Special Committee" and "--STAR's
Reasons for the Merger." There can be no assurance that any of such cost
savings, operating efficiencies or other synergies will be accomplished as
rapidly as currently expected or at all or that such savings and synergies will
not be offset by increases in other expenses or operating losses, including
losses due to problems integrating the two companies.
INTERESTS OF CERTAIN PERSONS IN THE MERGER
In considering the recommendation of the Merger by the UDN Board and Special
Committee, the stockholders of UDN should be aware that John Snedegar, President
of UDN, and Dale Christensen, Chief Operating Officer and Chief Financial
Officer of UDN, have employment agreements that provide them with bonuses and
severance benefits which would take effect if Mr. Snedegar or Mr. Christensen
exercises his right to terminate his employment agreement upon consummation of
the Merger. See "Management of STAR and UDN--UDN Employment Agreements." In
addition, certain directors and officers of UDN or its subsidiaries may also be
directors and/or officers of other companies whose principal business is similar
to that of UDN. It is possible, therefore, that a conflict may arise between
their duties as directors or officers of UDN or its subsidiaries and their
duties as directors or officers of such other companies. Such interests,
together with other relevant factors, were considered by the UDN Board and
Special Committee in making their recommendation and approving the Merger
Agreement. See "The Merger--Interests of Certain Persons in the Merger."
MAINTENANCE OF UDN'S CUSTOMER BASE
Customers are not obligated to purchase any minimum usage amount and can
discontinue service, without penalty, at any time. There can be no assurance
that customers will continue to buy their long distance telephone service
through UDN. In the event that a significant portion of UDN's customers decide
to purchase long distance service directly from another long distance service
provider, there can be
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no assurance that UDN will be able to replace its customer base from other
sources. Loss of a significant portion of UDN's customers would have a material
adverse effect on its results of operations and financial condition.
A high level of customer attrition is inherent in the long distance
industry, and UDN's revenues are also affected by such attrition. Attrition
results from a variety of factors including termination of customers by UDN for
non-payment and the initiatives of existing and new competitors as they engage
in, among other things, national advertising campaigns, telemarketing programs
and the issuance of cash or other forms of incentives. Although UDN is aware of
the significance of attrition on its business, telecommunications providers
generally find it difficult to measure customer attrition in a consistently
meaningful manner due to, among other factors, the wide range of revenues
attributable to individual customers, the fact that service to an individual
customer may be provided by more than one underlying carrier and the variety of
reasons for changes in the volume of service provided to an individual customer.
UDN'S DEPENDENCE ON THIRD PARTY TRANSMISSION FACILITIES
UDN does not own all of the transmission facilities needed to complete long
distance telephone calls. Therefore, UDN's operator services, direct dial long
distance, "800" service, wholesale long distance service and prepaid calling
cards are largely dependent upon the contractual arrangements with facilities-
based carriers for the transmission of calls on a cost-effective basis. While
UDN believes it has ample access to transmission facilities at competitive rates
and expects to continue to have such access in the foreseeable future, due to
the possibility of unforeseen changes in industry conditions, the continued
availability of transmission facilities at historical rates cannot be assured.
In addition, UDN has entered into buying arrangements with other carriers
for the provision of originating and terminating long distance services,
primarily in those areas where UDN does not have its own network facilities.
Several of these contracts have monthly minimum usage requirements for the term
of the contract and contain penalties if these minimums are not met. UDN is
currently meeting the minimum usage requirements in its contracts, however,
there is no assurance that UDN will be able to continue meeting these minimum
usage requirements. If they are not met, the resulting penalties will severely
reduce UDN's gross margin and will negatively impact UDN's results of
operations.
DILUTION OF VOTING POWER
Consummation of the Merger will result in an approximate 1.4% increase in
the number of shares of STAR Common Stock outstanding. In exchange for 100% of
the outstanding UDN Common Stock, stockholders of UDN will receive approximately
1.3% of the outstanding voting stock of STAR upon the consummation of the
Merger. Thus, the stockholders of STAR will experience a very slight dilution of
their relative voting authority after the Merger.
CERTAIN INCOME TAX CONSEQUENCES
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
The following discussion addresses certain material United States federal
income tax consequences of the Merger to stockholders of UDN Common Stock who
hold their shares as capital assets (within the meaning of Section 1221 of the
Internal Revenue Code of 1986, as amended (the "Code")). The discussion is based
on the current provisions of the Code, applicable Treasury Regulations, judicial
authority and administrative rulings and practice. It does not address all
aspects of federal income taxation that may be relevant to particular UDN
stockholders in light of their specific circumstances, or to certain types of
stockholders subject to special treatment under the federal income tax laws,
including without limitation, insurance companies, tax-exempt organizations,
foreign persons, financial institutions or broker-dealers, and stockholders who
acquired their UDN Common Stock pursuant to the exercise of employee stock
options or in other compensatory transactions. This discussion also does not
address the state, local, foreign or other federal tax consequences of the
Merger. There can be no assurance that the Internal Revenue Service will not
take a contrary view to any expressed herein. No rulings have been or will be
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requested from the Internal Revenue Service with respect to the tax consequences
of the Merger. Moreover, legislative, judicial or administrative changes or
interpretations may be forthcoming that could alter or modify the statements and
conclusions set forth herein, possibly with retroactive effect.
ALL UDN STOCKHOLDERS ARE URGED TO CONSULT THEIR OWN TAX ADVISORS AS TO THE
SPECIFIC TAX CONSEQUENCES TO THEM OR THE MERGER, INCLUDING THE APPLICABILITY AND
EFFECT OF ANY FEDERAL, STATE, LOCAL AND FOREIGN TAX LAWS, AND POSSIBLE CHANGES
IN APPLICABLE TAX LAWS.
Based on the assumptions set forth below, the Merger should qualify as a
tax-free reorganization under Section 368(a)(1) of the Code. As a result, no
gain or loss will be recognized by a stockholder whose shares of UDN Common
Stock are converted into shares of STAR Common Stock, except to the extent of
any cash received in lieu of fractional shares of STAR Common Stock. Each
stockholder receiving cash in lieu of a fractional share of STAR Common Stock
will be treated as having received such fractional share interest and as having
sold it for the cash received, recognizing gain or loss equal to the difference
between the amount of cash received and the portion of that stockholder's basis
in the shares of UDN Common Stock allocable to the fractional share interest.
Such gain or loss will generally be treated as capital gain or loss (long-term
or short-term depending on the stockholder's holding period), unless the payment
transaction is essentially equivalent to a dividend within the meaning of
Section 302 of the Code (a "Dividend Transaction"). The tax basis of the STAR
Common Stock exchanged therefor (except for the basis attributable to any
fractional share interest in STAR Common Stock), and the holding period of the
STAR Common Stock will include the holding period of the UDN Common Stock
surrendered in the Merger.
A stockholder who exercises his appraisal rights with respect to a share of
UDN Common Stock and receives payment for such stock in cash will recognize
capital gain or loss (long-term or short-term depending on the the stockholder's
holding period) measured by the difference between the amount of cash received
and the stockholder's basis in such share, provided the appraisal transaction is
not a Dividend Transaction.
A transaction is not a Dividend Transaction with respect to a UDN
stockholder if, after taking into account shares owned actually and
constructively within the meaning of Section 318 of the Code, there is a
meaningful reduction in the stockholder's proportionate interest in the
corporation. Under this rule, the Internal Revenue Service has ruled that a
redemption of a fractional share for cash in the context of a reorganization
transaction (such as the Merger) is generally not a Dividend Transaction. In
addition, the Internal Revenue Service has ruled that any reduction in the
percentage interest of a small minority shareholder in a publicly held
corporation who exercises no control over corporate affairs should constitute a
meaningful reduction.
The tax discussion set forth herein is based on the accuracy of certain
representations made by STAR and UDN, including the following: (i) the Merger
will be consummated in accordance with the Merger Agreement; (ii) following the
Merger, UDN will hold substantially all (i.e., 90% of net asset value and 70% of
gross asset value) of its own properties and substantially all of Newco's
properties, and will continue its historic business or use a significant portion
of its historic business assets in a business; (iii) UDN has not redeemed, and
persons related to UDN have not acquired (other than in exchange for STAR or UDN
stock), an amount of UDN stock, and UDN has not made any extraordinary
distributions with respect to its stock, prior to and connection with the
Merger, that would in the aggregate, reduce the value of all outstanding UDN
stock immediately prior to the Merger (after giving effect to such redemptions,
acquisitions, and distributions) to a value of less than 50 percent of the value
of all of the outstanding stock of UDN stock immediately prior to the Merger
determined without regard to such redemptions, acquisitions and distributions;
and (iv) in connection with the Merger, neither STAR nor any person related to
STAR, will acquire any UDN Common Stock for consideration other than STAR Common
Stock (other cash paid for fractional share and dissenters' shares) or redeem
any of the STAR Common Stock issued in the Merger.
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If the Merger were not to constitute a reorganization under Section
368(a)(1) of the Code, each UDN stockholder would recognize gain or loss equal
to the difference between the fair market value of the STAR Common Stock
received and cash received in lieu of fractional share and such stockholder's
basis in the shares of UDN Common Stock exchanged therefor. Such gain or loss
would be long-term or short-term capital gain or loss, depending upon the
stockholder's holding period with respect to the UDN Stock.
Because the former UDN stockholders will own less than 50 percent of STAR
after the Merger, the Merger will be treated as an "ownership change" with
respect to UDN for purposes of Section 382 of the Code. As a result, the ability
of STAR to use any net operating losses of UDN from periods prior to the
Effective Time will generally be limited to an annual amount equal to the total
value (determined immediately prior to the Merger) of the stock of UDN
multiplied by a long-term tax-exempt interest rate factor (as published by the
Internal Revenue Service on a monthly basis).
CERTAIN CANADIAN AND FOREIGN TAX CONSEQUENCES
Stockholders of UDN and dissenting stockholders of UDN who are residents in,
or citizens of, Canada or another foreign jurisdiction should be aware that the
Merger (or the exercise of appraisal rights in respect of the Merger) may result
in the holder realizing or being required to record a gain or loss on the
exchange of shares under the Merger (or upon the exercise of, or any payment
being made in connection with, appraisal rights) or result in other tax
consequences to such holders. Such tax consequences, if any, are not described
herein. Such stockholders are urged to consult their own Canadian or foreign
tax, legal or other financial advisors, as applicable, as to the implications of
the Merger to them under such income tax laws.
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THE SPECIAL MEETING
This Proxy Statement/Prospectus is being furnished to holders of UDN Common
Stock in connection with the solicitation of proxies by the UDN Board for use at
the Special Meeting. This Proxy Statement/ Prospectus and accompanying form of
proxy are first being mailed to the stockholders of UDN on or about May 28,
1998.
THE SPECIAL MEETING
PURPOSE; TIME AND PLACE. At the Special Meeting, holders of UDN Common
Stock will be asked to vote upon a proposal (the "Proposal") to approve and
adopt the Merger Agreement and the transactions contemplated thereby and such
other matters as may properly come before the Special Meeting. The Special
Meeting will be held at McCarthy Tetrault, Main Board Room, 13th Floor, 777
Dunsmuir Street, Vancouver, B.C., Canada, June 30, 1998, starting at 10:00 a.m.,
local time.
The UDN Board and the Special Committee have determined that the Merger is
fair and in the best interests of UDN and its stockholders and have unanimously
approved the Merger Agreement. THE UDN BOARD AND THE SPECIAL COMMITTEE
UNANIMOUSLY RECOMMEND THAT THE STOCKHOLDERS OF UDN VOTE "FOR" THE APPROVAL AND
ADOPTION OF THE MERGER AGREEMENT AND THE TRANSACTIONS CONTEMPLATED THEREBY AT
THE SPECIAL MEETING. See "The Merger--UDN's Reasons for the Merger;
Recommendations of the UDN Board and Special Committee."
For a discussion of (i) the interests that certain directors and executive
officers of UDN have with respect to the Merger that are different from, or in
addition to, the interests of stockholders of UDN generally and (ii) information
regarding the treatment of options and warrants to purchase UDN Common Stock and
other rights of certain directors and executive officers of UDN, see "The
Merger--Interests of Certain Persons in the Merger." Such interests, together
with other relevant factors, were considered by the UDN Board and the Special
Committee in making their recommendation and approving the Merger Agreement.
VOTING RIGHTS; VOTES REQUIRED FOR APPROVAL. The UDN Board has fixed the
close of business on May 26, 1998, as the record date for voting at the Special
Meeting (the "Record Date"). Only holders of record of shares of UDN Common
Stock on the Record Date are entitled to notice of and to vote at the Special
Meeting. On the Record Date, there were shares of UDN Common Stock
outstanding and entitled to vote at the Special Meeting, held by approximately
stockholders of record. Each holder of record, as of the Record Date, of
UDN Common Stock is entitled to cast one vote per share. The presence, in person
or by proxy, of the holders of a majority of the outstanding shares of UDN
Common Stock entitled to vote is necessary to constitute a quorum at the Special
Meeting. The affirmative vote, in person or by proxy, of the holders of a
majority of the shares of UDN Common Stock outstanding on the Record Date is
required to approve and adopt the Proposal.
SHARE OWNERSHIP OF MANAGEMENT. At the close of business on May 15, 1998,
directors and executive officers of UDN, as a group, were the beneficial owners
of an aggregate of 1,713,464 shares (approximately 24.3%) of the UDN Common
Stock then outstanding. As of May 15, 1998, directors and executive officers of
STAR, as a group, were beneficial owners of an aggregate of approximately
15,930,974 shares (approximately 37.8%) of the STAR Common Stock then
outstanding. The vote of the STAR stockholders is not required to approve the
Merger.
PROXIES. All shares of UDN Common Stock represented by properly executed
proxies received prior to or at the Special Meeting and not revoked will be
voted in accordance with the instructions indicated in such proxies. IF NO
INSTRUCTIONS ARE INDICATED ON A PROPERLY EXECUTED RETURNED PROXY, HOWEVER, SUCH
PROXIES WILL BE VOTED FOR THE APPROVAL OF THE PROPOSAL. A properly executed
proxy marked "ABSTAIN", although counted for purposes of determining whether
there is a quorum and for purposes of determining the
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aggregate voting power and number of shares represented and entitled to vote at
the Special Meeting, will not be voted and will have the effect of a vote
against the Proposal.
The UDN Board is not currently aware of any business to be acted upon at the
Special Meeting other than the proposed Merger. If, however, other matters are
properly brought before the Special Meeting, or any adjournments or
postponements thereof, the persons appointed as proxies will have discretion to
vote or act thereon according to their judgment. Such adjournments may be for
the purpose of soliciting additional proxies. Shares represented by proxies
voting against the approval and adoption of the Proposal will be voted against a
proposal to adjourn the Special Meeting for the purpose of soliciting additional
proxies. UDN does not currently intend to seek an adjournment of its Special
Meeting.
The persons named in the accompanying instrument of proxy are directors or
officers of UDN. A stockholder has the right to appoint a person to attend and
act for him on his behalf at the Special Meeting other than the persons named in
the enclosed instrument of proxy. To exercise this right, a stockholder shall
strike out the names of the persons named in the instrument of proxy and insert
the name of his nominee in the blank space provided, or complete another
instrument of proxy. The completed instrument of proxy should be deposited at
UDN's transfer agent at Montreal Trust Company, 4th Floor--510 Burrard Street,
Vancouver, British Columbia, V6C 3B9 prior to the time of the Special Meeting.
The instrument of proxy must be signed by the stockholder or by his attorney
in writing, or, if the stockholder is a corporation, it must either be under its
common seal or signed by a duly authorized officer.
In addition to revocation in any other manner permitted by law, a
stockholder may revoke a proxy either by (a) signing a proxy bearing a later
date and depositing it at the place and within the time aforesaid, or (b)
signing and dating a written notice of revocation (in the same manner as the
instrument of proxy is required to be executed as set out in the notes to the
instrument of proxy) and either depositing it at the place and within the time
aforesaid or with the Chairman of the Special Meeting on the day of the Special
Meeting or on the day of any adjournment thereof, or (c) registering with Janine
Thomas, the Secretary of UDN, at the Special Meeting as a stockholder present in
person, whereupon such proxy shall be deemed to be have been revoked.
It is the policy of UDN to keep confidential proxy cards, ballots and voting
tabulations that identify individual stockholders, except where disclosure is
mandated by law and in other limited circumstances.
The cost of the solicitation of proxies will be paid by UDN for UDN proxies.
In addition to solicitation by mail, arrangements will be made with brokerage
houses and other custodians, nominees and fiduciaries to send proxy materials to
beneficial owners; and UDN will, upon request, reimburse them for their
reasonable expenses. UDN has retained D.F. King & Co., Inc. to aid in the
solicitation of proxies and to verify certain records related to the
solicitation at a fee of $5,000, plus expenses. To the extent necessary in order
to ensure sufficient representation at the Special Meeting, UDN may request by
telephone or facsimile transmission the return of proxy cards. The extent to
which this will be necessary depends entirely upon how promptly proxy cards are
returned. Stockholders are urged to send in their proxies without delay. UDN
will indemnify D.F. King & Co., Inc. against certain liabilities and expenses in
connection with the proxy solicitation, including liabilities under the federal
securities laws.
STOCKHOLDERS SHOULD NOT SEND IN ANY STOCK CERTIFICATES WITH THEIR PROXY
CARDS. A TRANSMITTAL FORM WITH INSTRUCTIONS FOR THE SURRENDER OF STOCK
CERTIFICATES FOR UDN COMMON STOCK WILL BE MAILED TO FORMER UDN STOCKHOLDERS AS
SOON AS PRACTICABLE AFTER THE CONSUMMATION OF THE MERGER.
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THE MERGER
GENERAL DESCRIPTION
The Merger Agreement provides for a business combination between STAR and
UDN in which Newco, a wholly-owned subsidiary of STAR, will be merged with and
into UDN and the holders of UDN Common Stock would receive shares of STAR Common
Stock in a transaction intended to qualify as a tax-free reorganization for
United States federal income tax purposes and as a pooling of interests for
accounting purposes. As a result of the Merger, UDN would become a wholly-owned
subsidiary of STAR.
EFFECTIVE TIME OF THE MERGER
The Merger will become effective upon the filing of a Certificate of Merger
(the "Certificate of Merger") with the Secretary of State of the State of
Delaware (the "Effective Time"). The Certificate of Merger will be filed as
promptly as practicable after the approval by UDN's stockholders has been
obtained and all other conditions to the Merger have been satisfied or waived.
It is presently expected that the Merger will be consummated on or about June
30, 1998 or as soon thereafter as such conditions are satisfied.
BACKGROUND OF THE MERGER
The terms of the Merger Agreement and the related agreements are the result
of arm's-length negotiations between representatives, legal advisors and
financial advisors of STAR and UDN. The following is a brief discussion of the
background of these negotiations, which resulted in the Merger Agreement and
related transactions.
STAR actively pursues opportunities to enhance its business through
strategic and synergistic acquisitions. These acquisitions may focus on entering
new territories, enlarging STAR's presence in an existing territory, adding
capacity or expanding into new market segments, such as the commercial market.
In furtherance of this objective, STAR acquired LDS, certain non-operating
entities and majority ownership in another entity on November 30, 1997 and
acquired T-One Corp. on March 10, 1998.
UDN has been evaluating a number of strategic options to provide it with the
necessary resources to fuel UDN's continued growth and to remain competitive in
an industry undergoing rapid consolidation and change. These options included
remaining independent but obtaining additional private equity to fund expansion
and further acquisitions; selling UDN to another company in the industry; or
selling an interest in UDN to a financial investor, with a plan of a subsequent
initial public offering of its shares in the United States or sale of UDN to a
strategic investor.
In July 1997, UDN engaged Madison Securities, Inc. to act as placement agent
in a private placement of equity to fund UDN's growth. Pursuant to the private
placement, UDN would have offered 30 units at a purchase price of $100,000 per
unit, with each unit consisting of 62,500 shares of UDN Common Stock and a
warrant to purchase 20,000 additional shares of UDN Common Stock. At a price of
$1.60 per share, the consummation of the private placement would have resulted
in a substantial dilutive effect on the stockholders of UDN.
On October 31, 1997, John Snedegar, the President of UDN and a member of the
Board of Directors of STAR, was attending a STAR board meeting in Santa Barbara,
California. After the board meeting, Mr. Snedegar advised Christopher Edgecomb,
Chief Executive Officer of STAR, that UDN was in the process of completing a
private placement financing, which, if completed, would be dilutive to UDN's
stockholders. Mr. Edgecomb expressed an interest, on behalf of STAR, for STAR to
acquire UDN but he added that STAR would not be interested in acquiring UDN
after the completion of the financing because an acquisition of UDN after the
financing would greatly increase the aggregate cost of UDN to STAR. Mr. Snedegar
and Mr. Edgecomb discussed a general price range of approximately $2.50 per
share. Mr. Edgecomb immediately arranged a meeting with STAR's management team
and Mr. Snedegar to
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discuss the possible merger of STAR and UDN. Mary Casey, President and Secretary
of STAR, David Vaun Crumly, Executive Vice President of STAR, and Kelly Enos,
Chief Financial Officer of STAR, together with Mr. Edgecomb, represented STAR at
the meeting. Mr. Snedegar presented UDN's business plan, which included
financial projections, at the meeting and agreed to deliver to Ms. Enos a copy
of the UDN private placement memorandum, as well as its historical financial
statements.
During the period from October 31 through November 17, 1997, the date of the
next STAR board meeting, which was held in Las Vegas, Nevada, Mr. Snedegar
delivered historical financial information to Ms. Enos, and STAR commenced its
initial due diligence investigation of UDN. In addition, during that period, Mr.
Snedegar informed the members of the UDN Board of the discussions with STAR, and
the UDN Board after analyzing the private placement and other alternatives
presently under consideration, advised Mr. Snedegar to pursue the merger
discussions with STAR. At the November 17 meeting of the STAR Board, Mr.
Edgecomb discussed the anticipated advantages of acquiring UDN. The reasons for
the Merger discussed by Mr. Edgecomb, as well as the other members of the STAR
Board, are discussed at length under the caption "STAR's Reasons for the
Merger." At the November 17 meeting, the STAR Board, with Mr. Snedegar
abstaining from voting on the proposed transaction, authorized Mr. Edgecomb to
pursue detailed discussions with UDN management to pursue a possible merger with
UDN.
On November 18, 1997, at the request of STAR a second meeting was held at
the offices of STAR in Santa Barbara, California. The meeting was attended by
Mr. Snedegar and Phil Pearce, an outside director of UDN, Dale Christensen,
Chief Operating Officer and Chief Financial Officer of UDN, on behalf of UDN,
and Mr. Edgecomb and Ms. Enos on behalf of STAR. The respective legal counsel of
STAR and UDN also attended. Periodically during the course of the meeting, Mr.
Sledge, the Chairman of the Board of UDN was added to the meeting
telephonically. At that meeting, the representatives of STAR and UDN actively
negotiated various terms of the Merger Agreement, including those related to the
exchange ratio, a loan of $2.5 million to be made by STAR to UDN before
consummation of the Merger, a break-up fee, representations and warranties,
conditions to closing, indemnification and the operation of UDN during the
pendency of the transaction. The negotiations were principally conducted by
Messrs. Sledge and Pearce on behalf of UDN, while consulting with Mr. Snedegar.
By November 18, 1997, negotiations of the principal terms of the Merger
Agreement were completed.
All of the members of the UDN Board participated in a special telephonic
meeting, held on November 18, 1997 at approximately 5:00 p.m. (California time).
Also participating in the meeting were Mr. Christensen, and Martin Eric
Weisberg, Esq., a partner of the law firm of Parker Chapin Flattau & Klimpl,
LLP, UDN's legal counsel. Mr. Snedegar reported to the Board generally about the
negotiations with STAR and the status of UDN's private placement with Madison
Securities. Prior to the meeting the members of UDN's Board had been furnished
with a term sheet which outlined the salient terms and conditions of the Merger
and the related proposed loan from STAR. Mr. Weisberg reviewed the terms set
forth on the term sheet with the Board and responded to numerous questions
regarding, among other things, the break-up fee, UDN's ability to engage in
merger discussions with other third parties, the terms for the repayment of the
loan if the Merger was not consummated, STAR's due diligence as a condition to
closing, and the requirement that UDN would have to obtain a "fairness opinion"
from an independent investment bank. Mr. Weisberg responded that UDN's
negotiating team had obtained various concessions from STAR in these and other
areas, but advised that STAR was not willing to further modify the terms. Mr.
Pearce added that, given the fact that Madison Securities had advised UDN that
it was about to commence the initial closing under the private placement, it was
imperative to decide at this meeting whether or not to proceed with the Merger.
Mr. Snedegar did not participate in the deliberations of UDN's Board. The UDN
Board, absent Mr. Snedegar, discussed the entire transaction in detail. At this
meeting, the Board debated and discussed the reasons for the Merger set forth
under the caption "UDN's Reasons for the Merger; Recommendations of the UDN
Board and Special Committee." The UDN Board also decided to retain an
independent investment bank to render an opinion as to the entire fairness of
the Merger and related loan transaction to UDN. The Board determined that
Madison Securities should be
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considered for this role since Madison Securities had done extensive due
diligence, including a valuation analysis, on UDN in connection with the private
placement. At that meeting the UDN Board unanimously approved the terms of the
proposed transaction and determined to engage Madison Securities to render the
fairness opinion. The Merger Agreement was signed on November 19, 1997.
During November and December 1997, STAR's due diligence investigation
continued and UDN finalized the schedules to the Merger Agreement. As a result
of STAR's investigation, and specifically the discovery of certain bad debt
exposure of UDN due to fraud by one of its former customers, in January 1998,
the Merger Agreement was amended to reduce the consideration to be received by
UDN stockholders and STAR agreed to loan UDN an additional $2.0 million on
substantially the same terms as the $2.5 million loaned in connection with the
execution of the Merger Agreement. At a special telephonic meeting of the UDN
Board on January 24, 1998, the UDN Board discussed and unanimously approved the
terms of a first amendment to the Merger Agreement, which was signed on January
30, 1998.
In March 1998, in light of the vast increase in the price of STAR Common
Stock, the Merger Agreement was further amended to provide for a minimum
Exchange Ratio to be received by UDN stockholders. In addition, based on the
advice of STAR regulatory counsel, they agreed to clarify the regulatory
approvals to be obtained prior to consummation of the Merger. The second
amendment to the Merger Agreement was signed on April 6, 1998.
UDN'S REASONS FOR THE MERGER; RECOMMENDATIONS OF THE UDN BOARD AND SPECIAL
COMMITTEE
The UDN Board and the Special Committee have carefully considered the terms
of the proposed Merger and believe that the Merger and the related transactions
are fair and in the best interests of UDN and its stockholders. In reaching this
determination, the UDN Board and the Special Committee consulted with their
financial and legal advisors and with senior management and considered a number
of factors, including, without limitation, the following:
(i) the consideration to be received by the UDN stockholders in the Merger
reflected an appropriate valuation of UDN;
(ii) the ability of the combined company to better compete in a rapidly
consolidating international long distance industry;
(iii) a review of the possible alternatives to a sale of UDN;
(iv) that the Merger consideration represented a premium for UDN Common
Stock on the last trading day prior to the public announcement of the
execution of the Merger Agreement;
(v) the financial presentation of UDN's financial advisor and the advisor's
opinion as of May 7, 1998 that the terms of the Merger are fair to the
stockholders of UDN from a financial point of view;
(vi) that STAR is a public company that has experienced substantial growth
in revenues and income and has a management team with a proven track
record;
(vii) the Merger consideration represents a substantial premium over the
$1.60 per share which would have been received by UDN in the Madison
Securities private placement and such private placement would have
resulted in substantial dilution to UDN existing stockholders;
(viii) that by providing UDN with the opportunity to combine with a company
having state-of-the-art switching equipment, a history of a high level
of customer and technical support and strong financial performance, the
Merger would support a major strategic objective of UDN to provide the
resources to allow the combined entity to rapidly expand into highly
fragmented international markets;
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(ix) the potential efficiencies, synergies and cost savings expected to be
realized as a result of the combination of the operations of STAR and
UDN, including the combination of billing systems and sales and
marketing service and utilization of switches and transmission
facilities;
(x) that the addition of STAR's facilities in complementary geographic
areas, as well as in new markets, would improve the combined entity's
ability to pursue its growth strategy;
(xi) information with respect to the financial condition, business,
operations and prospects of both STAR and UDN on a historical and
prospective basis, including certain information reflecting the two
companies on a pro forma combined basis, and treating the Merger as a
pooling of interests for accounting purposes;
(xii) the tax-free nature of the Merger;
(xiii) the Exchange Ratio and recent trading prices for UDN Common Stock and
STAR Common Stock; and
(xiv) the terms of the Merger Agreement.
The foregoing list of the information and factors considered by the UDN
Board is not intended to be exhaustive. In view of the variety of factors
considered in connection with its evaluation of the Merger, the UDN Board did
not find it practicable to and did not quantify or otherwise assign relative
weights to the specific factors considered in reaching its determination. In
addition, individual members of the UDN Board may have given different weights
to different factors.
THE UDN BOARD AND THE SPECIAL COMMITTEE UNANIMOUSLY RECOMMEND THAT THE
STOCKHOLDERS OF UDN VOTE "FOR" THE APPROVAL AND ADOPTION OF THE MERGER AGREEMENT
AND THE TRANSACTIONS CONTEMPLATED THEREBY.
OPINION OF MADISON SECURITIES, FINANCIAL ADVISOR TO UDN
On May 7, 1998, Madison Securities presented its fairness opinion to the UDN
Board, together with a written opinion dated May 7, 1998, that, as of such date,
the consideration to be received by UDN's stockholders pursuant to the Merger
Agreement was fair to such stockholders from a financial point of view. Madison
Securities has confirmed its written opinion as of the date of this Proxy
Statement/ Prospectus. Based on conditions then prevailing, Madison Securities
had rendered a similar opinion on April 13, 1998, as to the consideration
provided for in the Merger Agreement.
THE FULL TEXT OF THE OPINION OF MADISON SECURITIES DATED THE DATE OF THIS
PROXY STATEMENT/PROSPECTUS IS ATTACHED AS ANNEX B TO THIS PROXY
STATEMENT/PROSPECTUS. UDN'S STOCKHOLDERS ARE URGED TO READ THIS OPINION IN ITS
ENTIRETY. MADISON SECURITIES' OPINION IS DIRECTED ONLY TO THE FAIRNESS OF THE
CONSIDERATION TO BE PAID IN THE MERGER TO UDN'S STOCKHOLDERS FROM A FINANCIAL
POINT OF VIEW AND DOES NOT CONSTITUTE A RECOMMENDATION TO ANY OF UDN'S
STOCKHOLDERS AS TO HOW SUCH STOCKHOLDER SHOULD VOTE AT THE MEETING. THE SUMMARY
OF THE OPINION OF MADISON SECURITIES SET FORTH IN THIS PROXY
STATEMENT/PROSPECTUS IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE FULL TEXT
OF SUCH OPINION.
In rendering its opinion, Madison Securities (i) reviewed the Merger
Agreement; (ii) reviewed certain publicly available financial statements and
other information of STAR and UDN, respectively; (iii) reviewed certain internal
financial statements and other financial and operating data concerning UDN and
STAR prepared by the management of UDN and STAR, respectively; (iv) discussed
the past and current operations and financial condition and the prospects of
STAR, including information relating to certain strategic, financial and
operational benefits anticipated from the Merger, with senior executives of
STAR; (v) discussed the past and current operations and financial condition and
the prospects of UDN,
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including information relating to certain strategic, financial and operational
benefits anticipated from the Merger, with senior executives of UDN; (vi)
reviewed the pro forma impact of the Merger on the earnings per share and
consolidated capitalization of STAR and UDN, respectively; (vii) reviewed the
reported prices and trading activity for the STAR Common Stock; (viii) compared
the financial performance of UDN and STAR and the prices and trading activity of
the UND Common Stock and the STAR Common Stock with that of certain other
publicly-traded companies and their securities; (ix) reviewed the financial
terms, to the extent publicly available, of certain comparable acquisition
transactions; (x) reviewed and discussed with the senior managements of UDN and
STAR the strategic rationale for the Merger and certain alternatives to the
Merger; (xi) reviewed the Merger Agreement and the agreements to be entered in
connection therein; and (xii) considered such other factors as they deemed
appropriate.
In connection with its view, Madison Securities did not independently verify
any of the foregoing information and relied on such information as being
complete and accurate in all material respects. With respect to the financial
forecasts, Madison Securities assumed that they had been reasonably prepared
based on reflecting the best currently available estimates and judgments of the
managements of STAR and UDN as to the future financial performance of STAR and
UDN. In addition, Madison Securities did not make an independent evaluation or
appraisal of any of the assets of STAR and UDN.
In connection with rendering its opinion, Madison Securities considered a
variety of valuation methods. The material valuation methods used are summarized
below. These analyses taken together provided the basis for Madison Securities'
opinion. For purposes of its analysis, Madison Securities assumed a price for
The UDN Common Stock of $2.05 per share:
(1) Comparable Company Analysis. Using publicly available information,
Madison Securities compared selected historical operating financial, stock
data and financial ratios for UDN and certain other companies which, in
Madison Securities' judgment, were comparable to UDN for the purpose of this
analysis. Because there was no publicly-traded company directly comparable
to UDN, the comparable company analysis was comprised of eight companies
that Madison Securities deemed most similar to UDN. These companies are CCT
Communications Corporation, DCI Telecommunications, Equalnet Holdings
Corporation, Group Long Distance, l-Link Inc., Trescom International, USTel
Inc. and Worldport Communications, Inc. (the "Selected Companies"). The
financial information analyzed included earnings per share for the latest
twelve months ("LTM"), fiscal 1997 and estimates for fiscal 1998; book value
per share; price multiples for LTM earnings per share, fiscal 1997 earnings
per share and estimated 1998 earnings per share; market capitalization;
profitability; and a multiple of firm value to revenue, earnings before
interest and taxes ("EBIT"), and earnings before interest, taxes,
depreciation and amortization ("EBITDA"). This analysis showed that the
Selected Companies operate in businesses similar to UDN's and are similar in
size to UDN. Market capitalization ranged from $9.0 million to $230.0
million. The average market capitalization was $87.5 million compared to
UDN's $16 million. The Selected Companies reported annual earnings per share
ranging from -$10.07 to $0.42. The average annual EPS were -$1.91, compared
with UDN's -$0.31. The average estimated 1998 earnings per share were
-$0.28. Share prices ranged from $1.31 to $11.31. The average price was
$6.36. The average Price/Sales ratio was 10.82, compared to UDN's 0.46. The
average operating margins were -42.92%, compared to 7.6% for UDN. To
summarize, UDN has much higher profitability than the average Selected
Company, and at $2.05, its Price/Sales multiple is lower than the average
Selected Company.
(2) Selected Transaction Analysis. Madison Securities examined recent
IPOs of four telecommunications companies. Included in the analysis were
Global Telesystems, Nextlink Communications, Startec Global Communication
and USN Communications (The "IPO Companies"). This analysis showed that the
average offered price per share was $16.25, and the average number of shares
offered was 9.3 million. 1997 earnings of these companies ranged from
-$15.55 per share to $0.32 per share, averaging -$5.71 per share. The
average estimated 1998 earnings per share were -$3.15. Profitability
analysis showed that the average operating margin was -132.85% (range
-207.60% to 2.44%). Price/
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Sales ratios ranged from 1.79 to 35.28, averaging 15.34. Offered Price/Sales
ratios ranged from 0.86 to 15.22, averaging 7.81. The analysis of recent
telecommunications IPOs confirmed the findings of the analysis in the
preceeding paragraph of the Selected Companies. UDN has much higher
profitability than the average IPO Company, and at $2.05 per share, its
Price/Sales multiple is lower than the average IPO Company.
(3) Trading History of the Common Stock. Madison Securities analyzed the
price and trading volume history for the common stock of the Selected
Companies, UDN and STAR from December 16, 1997, through the date of the
fairness opinion. See "SUMMARY--Comparative Per Share Data (Unaudited)". The
trading history of the Selected Companies' common stock was reviewed to
examine trends in the industry and to examine industry factors affecting UDN
Common Stock. The trading history of the STAR Common Stock was examined to
evaluate the market price of the STAR Common Stock in light of historical
trading levels and volumes. It was noted that the price of the Company's
Common Stock had been trading in anticipation of the Merger and, since the
announcement of the Merger, the price of the UDN Common Stock has been tied
to the price of the STAR Common Stock.
In preparing its opinion to the UDN Board, Madison Securities performed a
variety of financial and comparative analyses, including those described above.
This summary of such analyses does not purport to be a complete description of
the analyses underlying Madison Securities' opinion. The preparation of a
fairness opinion is a complex analytical process involving various
determinations as to the most appropriate and relevant methods of financial
analyses and the application of those methods to the particular circumstances.
Therefore, such opinion is not readily susceptible to a summary description. In
arriving at its opinion Madison Securities did not attribute any particular
weight to any analysis or factor considered by it, but rather made qualitative
judgments as to the significance and relevance of each analysis and factor.
Madison Securities believes that its analyses must be considered as a whole and
that selecting portions of its analyses and other factors considered by it,
without considering all analyses and factors, could create a misleading view of
the processes underlying its opinion. Madison Securities made numerous
assumptions with respect to industry performance, general business and economic
conditions and other matters, many of which are beyond the control of the
company and Madison Securities. Any estimates contained in Madison Securities'
analyses are not necessarily indicative of actual values, which may be
significantly more or less favorable than as set forth therein. Estimates of the
financial value of companies do not purport to be appraisals or necessarily
reflect the prices at which companies actually may be sold. Because such
estimates are inherently subject to uncertainty, neither UDN, STAR, Madison
Securities nor any other person is responsible for their accuracy.
In rendering its opinion, Madison Securities expressed no view as to the
range of values at which the STAR Common Stock may trade following consummation
of the Merger, nor did Madison Securities make any recommendations to UDN's
stockholder with respect to how such holders should vote on the Merger or to the
advisability of disposing of or retaining STAR Common Stock following the
Merger.
The UDN Board selected Madison Securities as its financial advisor because
Madison Securities is a regionally recognized investment banking firm with
experience in transactions similar to the Merger. In addition, Madison
Securities has provided financial advisory and financial services for UDN and
has received fees for the rendering of such services. As a part of its
investment banking business Madison Securities is continually engaged in the
valuation of businesses and their securities.
Madison Securities will receive, upon completion of the Merger, total fees
of approximately $100,000 for acting as financial advisor for UDN and preparing
its fairness opinion. UDN has also agreed to reimburse Madison Securities for
its reasonable expenses, including attorney's fees, and to indemnify Madison
Securities against certain liabilities in connection with its engagement.
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STAR'S REASONS FOR THE MERGER
The STAR Board has unanimously approved the Merger, with Messrs. Edgecomb
and Snedegar abstaining. In reaching this determination, the STAR Board
consulted with STAR management, as well as its financial and legal advisors, and
considered a number of factors, including, without limitation, the following:
(i) that by providing STAR with the opportunity to acquire a company having
a significant sales force of independent agents with a number of
medium-sized commercial customers with a demand for international
calling services at competitive rates, the Merger would support a major
strategic objective of STAR to continue its expansion into the
commercial market;
(ii) the potential efficiencies and cost savings expected to be realized as
a result of the combination of the operations of STAR and UDN,
including the registration by UDN and its subsidiaries under the
respective public utility and common carrier rules and regulations of
more than 30 states;
(iii) that the addition of UDN's switch in Dallas and its other facilities in
complementary geographic areas, as well as in new markets, would
improve the combined entity's ability to pursue its growth strategy;
(iv) information with respect to the financial condition, business,
operations and prospects of both STAR and UDN on a historical and
prospective basis, including certain information reflecting the two
companies on a pro forma combined basis, and treating the Merger as a
pooling of interests for accounting purposes;
(v) the tax-free nature of the Merger;
(vi) the terms of the Merger Agreement; and
(vii) the opportunity to create a combined company with greater competitive
strengths and business opportunities than would be possible for STAR on
a stand-alone basis.
The foregoing list of the information and factors considered by the STAR
Board is not intended to be exhaustive. In view of the variety of factors
considered in connection with its evaluation of the Merger, the STAR Board did
not find it practicable to and did not quantify or otherwise assign relative
weights to the specific factors considered in reaching its determination. In
addition, individual members of the STAR Board may have given different weights
to different factors.
THE MERGER AGREEMENT
The following is a brief description of certain terms and provisions set
forth in the Merger Agreement. This description does not purport to be complete
and is qualified in its entirety by reference to the Merger Agreement, which is
attached hereto as ANNEX A and is incorporated herein by reference. Capitalized
terms used herein without definition shall have the respective meanings ascribed
thereto in the Merger Agreement. Holders of UDN Common Stock are strongly
encouraged to read the Merger Agreement in its entirety.
Pursuant to the terms of the Merger Agreement, at the Effective Time, (i)
Newco will be merged with and into UDN, (ii) each outstanding share of common
stock of Newco will be converted into approximately 7,564 shares of common stock
of the surviving corporation (the"Surviving Corporation"), and (iii) the
separate existence of Newco will cease and UDN will succeed to all the rights,
privileges, powers and franchises and be subject to all the restrictions,
disabilities and duties of the constituent corporations to the Merger (the
"Constituent Corporations") in accordance with the Delaware General Corporation
Law (the "DGCL"). UDN will remain as the Surviving Corporation in the Merger and
will continue to exist as a wholly-owned subsidiary of STAR.
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At the Effective Time, each share of UDN Common Stock then issued and
outstanding will be converted into the right to receive consideration per share
(the "Merger Consideration") consisting of that portion of a share (the
"Exchange Ratio") of STAR Common Stock determined by dividing $2.05 by the
average closing price of STAR's Common Stock on the Nasdaq National Market for
the five (5) trading days prior to the Effective Time (the "Average Price"),
provided that if the Average Price is equal to or greater than $27.50, the
Exchange Ratio shall be determined by using $27.50 as the Average Price. The
Exchange Ratio shall be adjusted as may be necessary and appropriate to reflect
any and all stock splits, reverse stock splits, reclassifications and similar
capital events that affect STAR Common Stock. Notwithstanding the foregoing, all
treasury shares will be cancelled pursuant to the Merger Agreement. All shares
of UDN Common Stock with respect to which appraisal rights have been demanded
and perfected in accordance with Section 262(d) of the DGCL (the "Dissenting
Stock") shall not be converted into the right to receive the Merger
Consideration at or after the Effective Time, and the holder thereof shall be
entitled only to such rights as are granted by the DGCL. See "Rights of
Dissenting Stockholders." No fractional shares of STAR Common Stock will be
issued in the Merger. Rather, holders of UDN Common Stock whose shares are
converted in the Merger will be entitled to a cash payment in lieu of fractional
shares, as described under "--Exchange of Certificates" and "--Fractional
Shares."
A description of certain material differences between the rights of holders
of STAR Common Stock and UDN Common Stock is set forth under "Comparative Rights
of Stockholders."
EFFECTIVE TIME. The "Effective Time" shall mean the day on which the Merger
will become effective upon the filing, in accordance with Section 251 of the
DGCL, of a duly executed certificate of merger with the Delaware Secretary of
State, which will occur upon satisfaction or waiver of all conditions set forth
in the Merger Agreement.
DIRECTORS AND OFFICERS OF THE SURVIVING CORPORATION. The Merger Agreement
provides that the directors of Newco at the Effective Time will be the initial
directors of the Surviving Corporation and the officers of UDN at the Effective
Time will be the initial officers of the Surviving Corporation. Each of these
directors will hold office from the Effective Time until their respective
successors have been duly elected and qualified in accordance with the
Certificate of Incorporation and Bylaws of the Surviving Corporation.
DIRECTORS AND OFFICERS OF STAR. The current directors of STAR, including
Mr. Snedegar, President and a Director of UDN, will remain as directors of STAR
following the Effective Time. The current officers of STAR will remain as
officers of STAR following the Effective Time. See "--Interests of Certain
Persons in the Merger--Directors and Officers of the Combined Company."
EXCHANGE OF CERTIFICATES. UDN STOCKHOLDERS SHOULD NOT SUBMIT THEIR STOCK
CERTIFICATES EVIDENCING SHARES OF UDN COMMON STOCK FOR EXCHANGE UNLESS AND UNTIL
THE TRANSMITTAL INSTRUCTIONS AND A FORM OF LETTER OF TRANSMITTAL ARE RECEIVED OR
OBTAINED FROM U.S. STOCK TRANSFER CORPORATION (THE "EXCHANGE AGENT").
As soon as practicable after the Effective Time, the Exchange Agent shall
send a notice and a letter of transmittal to each holder of record of UDN Common
Stock immediately prior to the Effective Time advising such holder of the
effectiveness of the Merger and the procedure for surrendering to the Exchange
Agent the certificate or certificates to be exchanged pursuant to the Merger.
Holders of UDN Common Stock, upon surrender of their certificates together with
a duly completed letter of transmittal, will receive the Merger Consideration
without interest thereon.
FRACTIONAL SHARES. No certificates or scrip representing a fractional share
interest in STAR Common Stock will be issued. In lieu of any such fractional
share interest, each holder of UDN Common Stock who otherwise would be entitled
to receive a fractional share interest in STAR Common Stock in the Merger will
be paid cash upon surrender of UDN Common Stock in an amount (rounded to the
nearest whole US $0.01) equal to the product of such fraction multiplied by the
Average Price.
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REPRESENTATIONS AND WARRANTIES. The Merger Agreement contains various
customary representations and warranties of UDN relating to, among other things:
(a) UDN's and its subsidiaries' organization and similar corporate matters; (b)
UDN's capital structure; (c) the authorization, execution, delivery and
enforceability of the Merger Agreement and related matters; (d) the absence of
(i) conflicts under charter documents or bylaws, (ii) the need (except as
specified) for governmental or other filings, permits, authorizations, consents
or approvals with respect to the Merger Agreement and the transactions
contemplated thereby, (iii) violations of, conflicts with, breaches of, or
defaults under any agreement, lien, instrument, order or decree and (iv)
violations of laws; (e) subject to certain exceptions, absence of certain
specified material changes or events; (f) litigation; (g) labor matters; (h)
employee benefit matters and matters relating to the Employee Retirement Income
Security Act of 1974, as amended; (i) owned and leased real property; (j)
environmental matters; (k) tax matters; (l) the accuracy of information to be
supplied in connection with the Registration Statement, the Joint Proxy
Statement/Prospectus and any other documents to be filed with the SEC, the
British Columbia Securities Commission, the Vancouver Stock Exchange or any
other regulatory agency; (m) financial statements and reports; (n) material
liabilities; (o) intellectual property; (p) material agreements; (q) insurance;
(r) certain accounting matters; (s) the hiring of brokers or finders; and (t)
transactions with affiliated parties.
The Merger Agreement also contains various customary representations and
warranties of STAR relating to, among other things: (a) STAR'S organization and
similar corporate matters; (b) STAR'S capital structure; (c) authorization,
execution, delivery and enforceability of the Merger Agreement and related
matters; (d) the absence of (i) conflicts under charter documents or bylaws,
(ii) the need (except as specified) for governmental filings, permits,
authorizations, consents or approvals with respect to the Merger Agreement and
in the transactions contemplated thereby, (iii) violations of, conflicts with,
breaches of, or defaults under any agreement, lien, instrument, order or decree
and (iv) violations of laws; (e) documents filed by STAR with the SEC and the
accuracy of the information contained therein; (f) litigation; (g) the accuracy
of information to be supplied in connection with the Registration Statement, the
Joint Proxy Statement/Prospectus and any other documents to be filed with the
SEC, the British Columbia Securities Commission, the Vancouver Stock Exchange or
any other regulatory agency; (h) the shares of STAR Common Stock to be issued in
the Merger; (i) financial statements and reports; and (j) the hiring of brokers
or finders.
BUSINESS OF UDN PENDING THE MERGER. UDN has agreed that, among other
things, prior to the Effective Time, unless STAR otherwise agrees in writing or
unless otherwise expressly provided by the Merger Agreement or the Disclosure
Schedules thereto: (a) the business of UDN and of its subsidiaries will be
conducted in the ordinary course and consistent with past practice; (b) neither
UDN nor its subsidiaries will (i) amend its Certificate of Incorporation or
Bylaws; (ii) declare, set aside or pay any dividend; (iii) make any redemption,
retirement or purchase of its capital stock; (iv) split, combine or reclassify
its capital stock; (v) issue, grant, sell or pledge any shares of its capital
stock, except upon exercise of outstanding stock options and warrants; (vi)
other than any promissory notes evidencing loans from STAR to UDN, incur any
material indebtedness for borrowed money, except material indebtedness for
borrowed money incurred under existing credit facilities; (vii) waive, release,
grant or transfer any rights of material value; (viii) transfer, lease, license,
sell, mortgage, pledge, dispose of or encumber any material assets; (ix) fail to
use their reasonable commercial efforts to preserve intact its business
organization, to keep available the services of its operating personnel and to
preserve the goodwill of those having business relationships with UDN and its
subsidiaries; (x) increase the compensation payable to any of its officers or
directors; (xi) adopt any new, or make any payment not required by any existing,
stock option, bonus, profit-sharing, pension, retirement, deferred compensation,
or other payment or employee compensation plan; (xii) grant any stock option or
stock appreciation rights or issue any warrants; (xiii) enter into or amend any
employment or severance agreement; (xiv) make any loan or advance to, or enter
into any written contract with any officer or director; (xv) assume, guarantee,
endorse or otherwise become responsible for the obligations of any other
individual, firm or corporation or make any loans or advances to any individual,
firm or corporation; (xvi) make any investment of a capital nature other than in
the
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ordinary course of business; (xvii) enter into, modify, amend or terminate any
material contract; (xviii) take any action, other than reasonable and usual
actions in the ordinary course of business and consistent with past practice,
with respect to accounting policies or procedures, except for changes required
by GAAP; (xix) settle or compromise any material federal, state, local or
foreign income tax proceeding or audit; or (xx) enter into an agreement to do
any of the things described above.
ACQUISITION PROPOSALS. UDN has agreed that neither UDN nor any of its
subsidiaries, nor the directors, officers, attorneys, financial advisors, or
other authorized persons of any of them, shall, directly or indirectly, solicit,
initiate or participate in discussions or negotiations with or the submission of
any offer or proposal by or provide any information to, any corporation,
partnership, person, or other entity or group (other than Newco or STAR or any
officer or other authorized representative of Newco or STAR) concerning the
acquisition (by means of a tender or exchange offer, merger, consolidation,
business combination or otherwise) of all or a substantial portion of the
outstanding shares of UDN Common Stock or of the assets of UDN and its
subsidiaries (all such transactions being referred to herein as "Third Party
Transactions"), or, except as may be consistent with fiduciary responsibilities
under applicable law as advised in writing by outside counsel, participate in
any negotiation regarding any Third Party Transaction or otherwise cooperate in
any way with any effort or attempt by any other person to effectuate a Third
Party Transaction. However, the UDN Board may furnish such information to or
enter into discussions and/or negotiations with any corporation, partnership,
person or other entity or group that makes an unsolicited offer to engage in a
Third Party Transaction with UDN that the UDN Board in good faith determines,
with the assistance of its financial advisor, may represent a transaction more
favorable to UDN's stockholders when compared to the Merger and the Merger
Consideration if, and only to the extent that, the UDN Board determines after
consultation with outside legal counsel that the failure to take such action
would be inconsistent with the compliance by the UDN Board with its fiduciary
duties to the UDN stockholders under applicable law, provided that such party
shall enter into a confidentiality agreement on substantially the terms
contained in the Merger Agreement, UDN shall notify STAR as to the contents of
information being provided and UDN shall diligently enforce its rights under
such confidentiality agreement. UDN will promptly communicate to STAR the
identity of any potential third party purchaser making any such proposal or
contact and, prior to the execution of any agreement relating to any such Third
Party Transaction, shall also communicate the proposed terms and conditions
thereof. UDN agrees not to release any third party from, or waive any provision
of, any confidentiality or standstill agreement to which UDN is a party.
TREATMENT OF UDN STOCK OPTIONS AND WARRANTS. On the Effective Time, STAR
shall assume the duties and obligations of UDN, and STAR shall be vested with
the powers, rights and privileges of UDN, under (a) the warrants of UDN that
remain outstanding at the Effective Time and (b) the options of UDN that remain
outstanding at the Effective Time. As of the Effective Time, STAR shall have
reserved for issuance and continue to maintain sufficient shares of registered
STAR Common Stock to issue the required shares of STAR Common Stock pursuant to
the exercise of such warrants and options after the Effective Time, subject to
appropriate adjustment in the exercise price thereof, based on the Exchange
Ratio.
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INDEMNIFICATION. Under the Merger Agreement, for a period of six years from
the Effective Time, STAR has agreed to ensure and guarantee that all provisions
with respect to indemnification as set forth in UDN's certificate of
incorporation, bylaws or indemnification agreements in each case, as in effect
on the date of the Merger Agreement in favor of persons who served as directors,
officers, employees or agents of UDN and certain subsidiaries on or before the
Effective Time shall not be amended, repealed or modified.
CONFIDENTIALITY. Subject to applicable law and to subpoena, STAR, Newco and
UDN and its subsidiaries have agreed to hold, and to cause each of their
affiliates, employees, officers, directors and other representatives to hold, in
strict confidence, and to not use to the detriment of the other party, any
information or data furnished to them in connection with the transactions
contemplated by the Merger Agreement, except for information or data generally
known or available to the public. If the transactions contemplated by the Merger
Agreement are not consummated, such confidence shall be maintained and all such
information and data as requested shall be returned.
EXPENSES AND FEES. If the Merger is consummated, all reasonable fees and
expenses incurred in connection with the Merger and the transactions
contemplated thereby will be paid by the Surviving Corporation. If the Merger is
not consummated, each party shall bear its own fees and expenses. In addition,
in certain circumstances, UDN shall pay to Newco a termination fee. See
"--Termination Fee."
CONDITIONS. The respective obligations of STAR and UDN to effect the Merger
are subject to the satisfaction of the following conditions at or prior to the
Effective Time: (a) the effectiveness of the Registration Statement, of which
this Proxy Statement/Prospectus is a part, and the absence of a stop order or
proceedings seeking a stop order; (b) the approval and adoption of the Merger
Agreement and the transactions contemplated thereby by the requisite vote of UDN
stockholders; (c) the absence of any statute, rule, regulation, preliminary or
permanent injunction or other order by any United States, Canadian or state
governmental authority, agency, commission or court of competent jurisdiction
prohibiting consummation of the Merger; (d) the expiration or termination of any
waiting period applicable to the consummation of the Merger under the HSR Act;
(e) the receipt by or on behalf of STAR of all necessary regulatory approvals
from the FCC and all PUCs required for the transfer of ownership or control over
UDN (which condition may be waived by STAR); (f) the authorization for listing
of the shares of STAR Common Stock to be issued in connection with the Merger on
the Nasdaq National Market upon official notice of issuance; and (g) the absence
of any action or proceeding by or before any court or governmental authority or
other regulatory or administrative agency or commission of competent
jurisdiction which would require either party to take any action which would
result in a material adverse effect to their respective businesses.
In addition, the obligations of UDN to effect the Merger are subject to the
satisfaction at or prior to the Effective Time of the following additional
conditions: (a) each of STAR and Newco shall have performed in all material
respects its obligations under the Merger Agreement required to be performed by
it on or prior to the Effective Time; (b) the representations and warranties of
STAR and Newco contained in the Merger Agreement shall be true and correct in
all material respects as if such representations and warranties were made as of
the Effective Time, except as contemplated by the Merger Agreement; (c) there
shall not have been any material adverse change in the financial condition,
results of operations, properties or business of STAR and its subsidiaries; (d)
UDN shall have received a certificate of the President or Vice President of STAR
with respect to clauses (a), (b) and (c); (e) UDN shall have received an opinion
of counsel in form reasonably agreed to by the parties; and (f) UDN shall have
received the opinion of its financial advisors that the Merger and the other
transactions contemplated by the Merger Agreement are fair, from a financial
point of view, to the UDN stockholders.
The obligations of STAR and Newco to effect the Merger are subject to the
satisfaction at or prior to the Effective Time of the following additional
conditions: (a) Each of UDN and its subsidiaries shall have performed in all
material respects its obligations under the Merger Agreement required to be
performed by it on or prior to the Effective Time; (b) the representations and
warranties of UDN contained in the Merger Agreement shall be true and correct in
all material respects as if such representations and
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warranties were made as of the Effective Time, except as contemplated by the
Merger Agreement; (c) there shall not have been any material adverse change in
the financial condition, results of operations, properties or business of UDN;
(d) STAR and Newco shall have received a certificate of the President or Vice
President of UDN with respect to clauses (a), (b) and (c); (e) Newco shall have
received letters of resignation from the members of UDN's Board of Directors;
(f) STAR shall have received an opinion of counsel from counsel to UDN in form
reasonably agreed to by the parties; (g) holders of no more than 5% of the
outstanding shares of UDN Common Stock shall have validly exercised their
appraisal rights; (h) each affiliate of UDN shall have executed and delivered an
Affiliate Agreement; and (i) STAR shall have received letters (i) from Arthur
Andersen LLP approving the accounting treatment of the Merger as a "pooling of
interests" and (ii) from Price Waterhouse LLP that UDN has taken no action in
the past two years that would prevent the application of a "pooling of
interests" accounting treatment to the Merger, and the SEC shall not have
objected to such accounting treatment.
TERMINATION. The Merger Agreement may be terminated at any time prior to
the Effective Time and before approval by the UDN stockholders in a number of
circumstances which include, among others: (a) by mutual consent of Newco and
UDN; (b) by Newco or UDN, if (i) the Board of Directors of UDN shall have failed
to recommend, or withdrawn, modified or amended in any respect its approval or
recommendation of the Merger and of the transactions contemplated by the Merger
Agreement or the Board of Directors of UDN shall have resolved to do any of the
foregoing or (ii) the stockholders of UDN shall have failed to vote in favor of
the Merger Agreement and the Merger and, in the case of UDN seeking termination
pursuant to (b)(i) above, UDN having paid to Newco the Termination Fee, as
defined below; (c) by Newco if (i) there has occurred a material adverse change
in the financial condition, operations, or business of UDN and its subsidiaries
taken as a whole, or (ii) there is a material breach of any of the
representations and warranties of UDN, or if UDN fails to comply in any material
respect with any of its covenants or agreements, which breaches or failures are,
in the aggregate, material in the context of the transactions contemplated by
the Merger Agreement; (d) by UDN (i) if there has occurred a material adverse
change in the financial condition, operations, or business of STAR or (ii) there
is a material breach of any of the representations and warranties of STAR or
Newco, or if STAR or Newco fails to comply in any material respect with any of
its covenants or agreements, which breaches or failures are, in the aggregate,
material in the context of the transactions contemplated by the Merger
Agreement; (e) by either Newco or UDN, if on or before July 15, 1998 the Merger
shall not have been consummated; provided that such failure has not been caused
by that party's material breach of the Merger Agreement; provided further that
if any condition to the Merger Agreement shall fail to be satisfied by reason of
the existence of an injunction or order of any court or governmental or
regulatory body resulting from an action or proceeding commenced by any party
which is not a government or governmental authority, then at the request of
either party the deadline date referred to above shall be extended for a
reasonable period of time, not in excess of 120 days, to permit the parties to
have such injunction vacated or order reversed; and (f) by UDN, if it has not
received the opinion of its financial advisors that the Merger and the other
transactions contemplated by the Merger Agreement are fair, from a fiscal point
of view, to the stockholders of UDN.
In the event of such termination and abandonment, no party hereto (or any of
its directors or officers) shall have any liability or further obligation to any
other party to the Merger Agreement, except for the Termination Fee, if
required, and except that nothing herein will relieve any party from liability
for any wilful breach of the Merger Agreement prior to such termination or
abandonment.
TERMINATION FEE. If the Merger Agreement is terminated by either Newco or
UDN, pursuant to clause (b)(i) above (a) after receipt of a bona fide
Third-Party Transaction proposal or (b) prior to receipt of the fairness opinion
described in clause (f) above, then UDN shall, simultaneously with such
termination, pay to Newco by wire transfer of immediately available funds, $2.0
million (the "Termination Fee").
AMENDMENT AND WAIVER. Subject to applicable law, the Merger Agreement may
be amended by STAR and UDN solely by action of their respective Boards of
Directors. Any such amendment must be in
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writing and signed by both of the parties. At any time prior to the Effective
Time, the parties may (i) extend the time for the performance of any of the
obligations or other acts of the other parties to the Merger Agreement, (ii)
waive any inaccuracies in the representations and warranties of the other party,
and (iii) waive compliance by the other party with any of the agreements or
conditions to the Merger Agreement. Any agreement on the part of such a party to
any such extension or waiver shall be valid only if set forth in an instrument
in writing signed on behalf of such party.
PROMISSORY NOTES. Upon execution of the Merger Agreement and the first
amendment thereto and in connection with the Merger, UDN issued promissory notes
to STAR in the principal amount of $2.5 million and $2.0 million, respectively
(the "Promissory Notes"). The Promissory Notes provide for, among other things:
(a) interest equal to the "Prime Rate" (as reported in the WALL STREET JOURNAL
on the date of each Promissory Note and as reset on each Reset Date (defined as
each date that interest is payable under each Promissory Note until the
principal amount of each Promissory Note is paid in full)) per annum plus one
percent (1%); (b) interest shall be paid quarterly in arrears commencing on
February 18, 1998 and April 1, 1998, respectively; (c) the outstanding principal
amount of the Promissory Note shall become automatically due and payable in full
(i) upon the closing of a Third Party Transaction, (ii) in nine months from the
issuance date of the Promissory Note, if UDN terminates the Merger Agreement
because it has not received the opinion of its financial advisor that the Merger
and the other transactions contemplated by the Merger Agreement are fair, from a
financial point of view, to the stockholders of UDN, or the stockholders of UDN
shall have failed to vote in favor of the Merger Agreement and the Merger, or
(iii) in six months from the date of termination, if the Merger Agreement is
terminated by either STAR or UDN for any reason whatsoever pursuant to the
Merger Agreement (other than as specified in the preceding clause); and (d) the
interest rate shall be 15% commencing on the date which is six months from the
date of termination if termination is terminated by STAR pursuant to Section
8.1(b)(ii) of the Merger Agreement.
MANAGEMENT SERVICES AGREEMENT. STAR and UDN have agreed to use their
reasonable efforts to enter into a billing outsourcing agreement (the
"Management Services Agreement") which will provide, among other things, for the
management by STAR of UDN's customer billings on terms at least as favorable as
the terms of UDN's present outsourcing agreement.
PROXY AGREEMENT. Upon execution of the Merger Agreement, John R. Snedegar,
President of UDN, executed a Proxy Agreement granting STAR an irrevocable proxy
to vote all shares of UDN Common Stock held, beneficially or of record, by Mr.
Snedegar, and to express consent, in favor of the Merger pursuant to the Merger
Agreement and any transaction that is reasonably necessary or appropriate to
implement the Merger and in opposition of any proposal for the amendment of
UDN's certificate of incorporation or bylaws. The obligations of Mr. Snedegar
under the Proxy Agreement shall terminate on the earlier of the Effective Time
or termination of the Merger Agreement for any reason. As of May 18, 1998, Mr.
Snedegar held 831,647 shares, or approximately 11.8%, of outstanding UDN Common
Stock.
RESALE OF SHARES OF STAR COMMON STOCK ISSUED IN THE MERGER; AFFILIATES
The shares of STAR Common Stock to be issued in the Merger will be freely
transferable in the U.S., except that shares issued to any UDN stockholder who
may be deemed to be an "affiliate" (as defined under the Securities Act, and
generally including, without limitation, directors, certain executive officers
and beneficial owners of 10% or more of a class of capital stock) of UDN for
purposes of Rule 145 under the Securities Act may be resold by them only in
transactions permitted by the resale provisions of Rule 145 or as otherwise
permitted under the Securities Act and only after publication by STAR of at
least 30 days of combined operating results of STAR and UDN. The Merger
Agreement provides that UDN shall cause such affiliate to deliver to STAR at or
prior to the Effective Time, a letter agreement from each of them to the effect
that such affiliate will not offer or sell or otherwise dispose of any shares of
STAR Common Stock issued to such affiliate in or pursuant to the Merger in
violation of the Securities Act or the rules and regulations promulgated
thereunder. This Proxy Statement/Prospectus does not cover resales of
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shares of STAR Common Stock received by any person who may be deemed to be an
affiliate of UDN. For the UDN stockholders resident in jurisdictions other than
the U.S., the free transferability of the STAR Common Stock may vary dependent
on the laws of that jurisdiction and, accordingly, each stockholder so affected
should consult their legal or other advisors.
ACCOUNTING TREATMENT OF THE MERGER
The Merger is expected to be accounted for by the pooling of interests
method in accordance with generally accepted accounting principles, which means
that STAR will restate its historical consolidated financial statements to
include the historical assets, liabilities, stockholders' equity and results of
operations of UDN.
INTERESTS OF CERTAIN PERSONS IN THE MERGER
In reviewing the actions of the UDN Board with respect to the Merger
Agreement and the transactions contemplated thereby, UDN stockholders should be
aware that certain members of UDN's management and the UDN Board have interests
in the Merger that are in addition to the interests of UDN stockholders
generally.
DIRECTORS OF STAR. Mr. Snedegar, President and a director of UDN, also
serves as a director of STAR. Mr. Snedegar owns 30,750 shares of STAR Common
Stock and options to acquire 10,250 shares of STAR Common Stock, which
represents beneficial ownership of less than 1% of the outstanding STAR Common
Stock.
SEVERANCE PAYMENTS, NONCOMPETITION PAYMENTS AND BONUSES. Each of Messrs.
Snedegar and Christensen is a party to an employment agreement with UDN which
provides that in the event that there is a change in control of UDN, each may
elect to terminate the agreement and upon such termination, each will be
entitled to a severance payment equal to his monthly salary times the number of
months remaining in the term of the employee agreement which expires on May 31,
2000, in the case of John Snedegar, and six (6) months, in the case of Dale
Christensen. See "Certain Relationships and Related Transactions-- UDN
Employment Agreements".
STOCK OPTION PLANS. At the close of business on the UDN Record Date, the
senior management of UDN held outstanding options to purchase an aggregate of
75,000 shares of UDN Common Stock, at exercise prices ranging from $1.64 to
$2.04 per share, all of which are currently vested. On the Effective Time, STAR
shall assume the duties and obligations of UDN, and STAR shall be vested with
the powers, rights and privileges of UDN under the options to purchase UDN
Common Stock outstanding at the Effective Time.
REGULATORY APPROVALS
Under the HSR Act, and the rules promulgated thereunder by the Federal Trade
Commission (the "FTC"), the Merger may not be consummated until notification and
certain information has been furnished to the FTC and the Antitrust Division of
the Department of Justice (the "Antitrust Division") and specified waiting
period requirements have been satisfied.
STAR and UDN each intend to file notification and report forms with respect
to the Merger under the HSR Act with the FTC and the Antitrust Division. The
required waiting period with respect to the Merger will expire within thirty
days of such filings, unless early termination is granted or a request for
additional information is issued. At any time before or after consummation of
the Merger, the Antitrust Division or the FTC could take such action under the
antitrust laws as it deems necessary or desirable in the public interest,
including seeking to enjoin the consummation of the Merger or seeking
divestiture of substantial assets of STAR or UDN or any of their respective
subsidiaries. At any time before or after the Effective Time, and
notwithstanding that the HSR Act waiting period has expired, any state could
take such action under its antitrust laws as it deems necessary or desirable.
Such action could include seeking to enjoin the consummation of the Merger or
seeking divestiture of substantial assets of STAR or UDN or
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the Surviving Corporation. Private parties also may seek to take legal action
under the antitrust laws under certain circumstances.
Prior to the change in ownership or management of UDN or the transfer of
control over UDN's certificate of public convenience and necessity and daily
operations, STAR must obtain all necessary regulatory approvals from the FCC and
all PUCs required for the transfer of ownership or control over UDN. STAR is
currently in the process of obtaining all such necessary regulatory approvals.
STOCK EXCHANGE LISTING
It is a condition to the consummation of the Merger that the shares of STAR
Common Stock issuable to the stockholders of UDN pursuant to the terms of the
Merger Agreement be authorized for listing on the Nasdaq National Market.
DELISTING AND DEREGISTRATION OF UDN COMMON STOCK
If the Merger is consummated, UDN Common Stock will be delisted from the
Vancouver Stock Exchange.
COMPARATIVE STOCK PRICES
STAR Common Stock has been traded on the Nasdaq National Market under the
symbol "STRX" since June 12, 1997. UDN Common Stock has been traded on the
Vancouver Stock Exchange under the symbol "UDN.V" since August 9, 1996.
The following table sets forth, for the calendar periods indicated, the high
and low trading prices per share of STAR Common Stock on the Nasdaq National
Market, adjusted to reflect the Stock Split, and the UDN Common Stock on the
Vancouver Stock Exchange.
<TABLE>
<CAPTION>
STAR UDN
COMMON STOCK COMMON STOCK(1)
----------------------- -----------------------
HIGH LOW HIGH LOW
---------- --------- ---------- ---------
<S> <C> <C> <C> <C>
1996
First Quarter........................... -- -- 2 5/8 1 7/8
Second Quarter.......................... -- -- 2 1/4 1 3/8
Third Quarter........................... -- -- 2 1/8 1 3/8
Fourth Quarter.......................... -- -- 2 1 5/8
1997
First Quarter........................... -- -- 2 1 1/2
Second Quarter (from June 12, 1997 for
STAR Common Stock).................... 7 3/8 4 41/64 2 3/8 1 3/8
Third Quarter........................... 11 53/64 6 7/32 3 1 5/8
Fourth Quarter.......................... 17 11/16 9 33/64 2 1/4 1 3/4
1998
First Quarter........................... 28 3/64 14 33/64 2 1/8 1 3/8
Second Quarter (through May 19, 1998)... 37 3/8 26 3/8 1 7/8 1 3/4
</TABLE>
- ------------------------
(1) All amounts set forth in U.S. dollars, based on the exchange rate of US
dollars for each Canadian dollar on the date the UDN Common Stock reached
the high and low noted above.
STAR has never paid cash dividends on STAR Common Stock and has no intention
of paying cash dividends in the foreseeable future. STAR's existing revolving
credit facility prohibits the payment of cash dividends without the lender's
consent. UDN has never paid cash dividends on UDN Common Stock and has no
intention of paying dividends in the foreseeable future.
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On March 31, 1998, STAR paid a 2.05-for-1 stock split in the form of a stock
dividend to the holders of all shares of STAR Common Stock outstanding as of
February 20, 1998 with the payment of 1.05 shares for each such outstanding
share of STAR Common Stock. The reported closing sale price of STAR Common Stock
on the Nasdaq National Market on November 18, 1997, the last full day of trading
for STAR Common Stock prior to the announcement by STAR and UDN of the execution
of the Merger Agreement, was $15.183 per share (adjusted to reflect the Stock
Split). The closing sale price of UDN Common Stock on the Vancouver Stock
Exchange on such date was $2.15 per share.
On May , 1998, the last trading day prior to the date of this Proxy
Statement/Prospectus, the last reported sale price of STAR Common Stock on the
Nasdaq National Market was $ per share, and the last reported price of UDN
Common Stock on the Vancouver Stock Exchange was $ per share.
Following the Merger, STAR Common Stock will continue to be traded on the
Nasdaq National Market. At such time, UDN Common Stock will cease to be quoted
on the Vancouver Stock Exchange, and, since UDN will be a wholly-owned
subsidiary of STAR, there will be no further market for such stock. See
"--Delisting and Deregistration of UDN Common Stock."
APPRAISAL RIGHTS OF STOCKHOLDERS
GENERAL
Since UDN's state of incorporation is Delaware, dissenting stockholders who
comply with the applicable provision of the Delaware Law will be eligible for
appraisal rights in the Merger. If the Merger is consummated, any stockholder
who votes against or abstains from voting for the Merger has the right, upon
compliance with the provisions set forth in Section 262 of the Delaware Law,
more particularly described below, to have his or her shares of UDN Common Stock
appraised and to receive payment in cash for the fair value of such stock
exclusive of any element of value arising from the accomplishment or expectation
of the Merger.
The following summary does not purport to be a complete statement of the law
in Delaware relating to dissenters' appraisal rights, and the following summary
is qualified in its entirety by the statutory provisions of the Delaware Law
which are attached to this Proxy Statement/Prospectus as ANNEX C. THE FOLLOWING
SUMMARY AND ANNEX C SHOULD BE REVIEWED CAREFULLY BY ANY STOCKHOLDER WHO WISHES
TO EXERCISE APPRAISAL RIGHTS, OR WISHES TO PRESERVE THE ABILITY TO DO SO. A
STOCKHOLDER MAY WISH TO CONSULT COUNSEL, SINCE FAILURE TO COMPLY WITH THE
PROCEDURES SET FORTH BELOW COULD RESULT IN THE LOSS OF SUCH RIGHTS.
Payments to Dissenting Stockholders, if any, made in connection with the
exercise of appraisal rights will be taxable transactions for federal income tax
purposes.
DELAWARE LAW
When the Merger is effected, stockholders of UDN who comply with the
procedures prescribed in Section 262 of the Delaware Law ("Section 262") will be
entitled to a judicial determination of the "fair value" of their shares
(exclusive of any element of value arising from the accomplishment or
expectation of the Merger) and to receive from UDN payment of such fair value in
cash. Shares of UDN Common Stock which are outstanding immediately prior to the
Effective Time and with respect to which appraisal shall have been properly
demanded in accordance with Section 262 shall not be converted into the right to
receive the Merger Consideration at or after the Effective Time unless and until
the holder of such shares withdraws his or her demand for such appraisal or
becomes ineligible for such appraisal.
The following is a brief summary of the statutory procedures to be followed
by a stockholder of UDN in order to dissent from the Merger and perfect
appraisal rights under the Delaware Law. THIS SUMMARY IS NOT INTENDED TO BE
COMPLETE AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SECTION 262, THE TEXT
OF WHICH IS INCLUDED AS ANNEX C OF THIS PROXY STATEMENT/PROSPECTUS. ANY
STOCKHOLDER CONSIDERING DEMANDING APPRAISAL IS ADVISED TO CONSULT LEGAL COUNSEL.
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A written demand for appraisal of shares of UDN Common Stock must be
delivered to UDN by a stockholder seeking appraisal before the taking of the
vote on the Merger Agreement. This written demand must be separate from any
proxy or vote abstaining from or voting against approval of the Merger
Agreement. Voting against approval of the Merger Agreement, abstaining from
voting or failing to vote with respect to approval of the Merger Agreement will
not constitute a demand for appraisal within the meaning of Section 262.
STOCKHOLDERS ELECTING TO EXERCISE THEIR APPRAISAL RIGHTS UNDER SECTION 262
MUST NOT VOTE FOR APPROVAL OF THE MERGER AGREEMENT. A VOTE BY A STOCKHOLDER
AGAINST APPROVAL OF THE MERGER AGREEMENT IS NOT REQUIRED IN ORDER FOR THAT
STOCKHOLDER TO EXERCISE APPRAISAL RIGHTS. HOWEVER, IF A STOCKHOLDER RETURNS A
SIGNED PROXY BUT DOES NOT SPECIFY A VOTE AGAINST APPROVAL OF THE MERGER
AGREEMENT OR A DIRECTION TO ABSTAIN, THE PROXY, IF NOT REVOKED, WILL BE VOTED
FOR APPROVAL OF THE MERGER AGREEMENT, WHICH WILL HAVE THE EFFECT OF WAIVING THAT
STOCKHOLDER'S APPRAISAL RIGHTS.
A written demand for appraisal must reasonably inform UDN of the identity of
the stockholder of record and that such stockholder intends thereby to demand
appraisal. Accordingly, a demand for appraisal should be executed by or for the
stockholder of record, fully and correctly, as such stockholder's name appears
on the stock certificates. If UDN Common Stock is owned of record in a fiduciary
capacity, such as by a trustee, guardian or custodian, such demand must be
executed by the fiduciary. If, for example, a stockholder holds shares of UDN
Common Stock through a broker, who in turn holds shares through a central
securities depository nominee, such as Cede & Co., a demand for appraisal of
such shares must be made by or on behalf of such depository nominee. If UDN
Common Stock is owned of record by more than one person, as in a joint tenancy
or tenancy in common, such demand must be executed by or for all joint owners.
An authorized agent, including an agent for two or more joint owners, may
execute the demand for appraisal for a stockholder of record; however, the agent
must identify the record owner and expressly disclose the fact that, in
exercising the demand, he is acting as agent for the record owner.
A record owner, such as a broker, who holds UDN Common Stock as a nominee
for others, may exercise appraisal rights with respect to the UDN Common Stock
held for all or less than all beneficial owners of UDN Common Stock as to which
the holder is the record owner. In such case, the written demand must set forth
the number of shares of UDN Common Stock covered by such demand. Where the
number of shares of UDN Common Stock is not expressly stated, the demand will be
presumed to cover all shares of UDN Common Stock outstanding in the name of such
record owner. Beneficial owners who are not record owners and who intend to
exercise appraisal rights should instruct the record owner to comply strictly
with the statutory requirements with respect to the delivery of written demand
prior to the taking of the vote on the Merger.
A UDN stockholder who elects to exercise appraisal rights must mail or
deliver the written demands for appraisal to: Secretary, United Digital Network,
Inc., 18872 MacArthur Boulevard, Suite 300, Irvine, California 92612; or should
deliver such demand to UDN in person at the Special Meeting. The written demand
for appraisal should specify the stockholder's name and mailing address and the
number of shares of UDN Common Stock covered by the demand, and should state
that the stockholder is thereby demanding appraisal in accordance with Section
262.
Within ten days after the Effective Time, UDN must provide notice as to the
date of effectiveness of the Merger to all stockholders who have duly and timely
delivered demands for appraisal and who have not voted for approval of the
Merger Agreement.
Within 120 days after the Effective Time, any Dissenting Stockholder is
entitled, upon written request, to receive from UDN a statement setting forth
the aggregate number of shares not voted in favor of approval of the Merger
Agreement and with respect to which demands for appraisal have been received by
UDN and the number of holders of such shares. Such statement must be mailed
within 10 days after the written request therefor has been received by UDN.
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Within 120 days after the Effective Time, either UDN or any Dissenting
Stockholder may file a petition in the Delaware Court of Chancery demanding a
determination of the fair value of shares of UDN Common Stock of all dissenting
stockholders. If a petition for an appraisal is timely filed, after a hearing on
such petition, the Delaware Court of Chancery will determine which of the UDN
stockholders are entitled to appraisal rights and thereafter will appraise the
shares of UDN Common Stock owned by such stockholders, determining the fair
value of such shares, exclusive of any element of value arising from the
accomplishment or expectation of the Merger, together with the fair rate of
interest to be paid, if any, upon the amount determined to be fair value. In
determining fair value, the Delaware Court of Chancery is to take into account
all relevant factors. In WEINBERGER V. UOP, INC., ET AL., the Delaware Supreme
Court discussed the factors that could be considered in determining fair value
in an appraisal proceeding, stating that "proof of value by any techniques or
methods which are generally considered acceptable in the financial community and
otherwise admissible in court" should be considered and the "[f]air price
obviously requires consideration of all relevant factors involving the value of
a company." The Delaware Supreme Court stated that in making this determination
of fair value the court and the appraiser may consider "all factors and elements
which reasonably might enter into the fixing of value," including "market value,
asset value, dividends, earnings prospects, the nature of the enterprise and any
other facts which were known or which could be ascertained as of the date of the
merger and which throw any light on future prospects of the merged corporation."
The Delaware Supreme Court has construed Section 262 to mean that "elements of
future value, including the nature of the enterprise, which are known or
susceptible of proof as of the date of the merger and not the product of
speculation, may be considered." However, such court noted that Section 262
provides that fair value is to be determined "exclusive of any element of value
arising from the accomplishment or expectation of the merger."
Upon the filing of any such petition by a dissenting stockholder, service of
a copy thereof shall be made upon STAR, which shall within 20 days of such
service file in the office of the Register in Chancery in which the petition was
filed a duly verified list containing the names and addresses of all
stockholders who have demanded payment for their shares and with whom agreements
as to the value of their shares have not been reached by STAR. If such petition
is filed by STAR, the petition shall be accompanied by such duly verified list.
Stockholders considering whether to seek appraisal should bear in mind that
the fair value of their UDN Common Stock determined under Section 262 could be
more than, the same as, or less than the value of the Merger Consideration to be
exchanged in the Merger, and that opinions of investment banking firms as to
fairness from a financial point of view are not necessarily opinions as to fair
value under Section 262. Moreover, the Surviving Corporation reserves the right
to assert in any appraisal proceeding that, for purposes thereof, the "fair
value" of the UDN Common Stock is less than the value of the Merger
Consideration.
The cost of the appraisal proceeding may be determined by the Delaware Court
of Chancery and taxed upon the parties as the court deems equitable in the
circumstances. Upon application of a dissenting stockholder, the court may order
that all or a portion of the expenses incurred by any dissenting stockholder in
connection with the appraisal proceeding, including, without limitation,
reasonable attorneys' fees, and the fees and expenses of experts, be charged pro
rata against the value of all shares entitled to appraisal. In the absence of
such a determination or assessment, each party bears its own expenses.
A dissenting stockholder who has duly demanded appraisal in compliance with
Section 262 will not, after the Effective Time, be entitled to vote for any
purpose the UDN Common Stock subject to such demand or to receive payment of
dividends or other distributions on such UDN Common Stock, except for dividends
or other distributions payable to stockholders of record at a date prior to the
Effective Time.
At any time within 60 days after the Effective Time, any dissenting
stockholder will have the right to withdraw his or her demand for appraisal and
to accept the Merger Consideration. After this period, a dissenting stockholder
may withdraw his or her demand for appraisal only with the consent of UDN. If no
petition for appraisal is filed with the Delaware Court of Chancery within 120
days after the Effective
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Time, dissenting stockholders' rights to appraisal shall cease and they shall be
entitled only to receive the Merger Consideration. Inasmuch as UDN has no
obligation to file such a petition, any stockholder who desires such a petition
to be filed is advised to file it on a timely basis. However, no petition timely
filed in the Delaware Court of Chancery demanding appraisal shall be dismissed
as to any stockholder without the approval of the Delaware Court of Chancery,
and such approval may be conditioned upon such terms as the Delaware Court of
Chancery deems just.
A vote for the Merger will constitute a waiver of appraisal rights. A
failure to vote against the Merger will not, under Delaware law, constitute a
waiver of appraisal rights. If a stockholder returns a proxy which does not
contain instructions as to how it should be voted, such proxy will be voted in
favor of the Merger and, accordingly, appraisal rights will be waived. As
described above, a vote against the Merger is not sufficient to perfect
appraisal rights. A stockholder's failure to make the written demand prior to
the Special Meeting as described above will constitute a waiver of appraisal
rights. FAILURE TO TAKE ANY REQUIRED STEP IN CONNECTION WITH THE EXERCISE OF
APPRAISAL RIGHTS MAY RESULT IN THE TERMINATION OR WAIVER OF SUCH RIGHTS.
COMPARATIVE RIGHTS OF STOCKHOLDERS
Upon consummation of the Merger, the stockholders of UDN will become
stockholders of STAR, a Delaware corporation, and their rights will be governed
by STAR's Amended and Restated Certificate of Incorporation (the "STAR Charter")
and Bylaws (the "STAR Bylaws"), which differ in certain material respects from
UDN's Restated Certificate of Incorporation (the "UDN Charter") and Amended
Bylaws (the "UDN Bylaws"). As stockholders of STAR, the rights of the former
stockholders of UDN will continue to be governed by the DGCL.
The following comparison of the STAR Charter and the STAR Bylaws, on the one
hand, and the UDN Charter and the UDN Bylaws, on the other, is not intended to
be complete and is qualified in its entirety by reference to the STAR Charter,
the STAR Bylaws, the UDN Charter and the UDN Bylaws. Copies of STAR's Charter
and the STAR Bylaws are available for inspection at the principal executive
office of STAR, and copies will be sent to the holders of UDN Common Stock upon
request. Copies of the UDN Charter and the UDN Bylaws are available for
inspection at the principal executive office of UDN, and copies will be sent to
holders of UDN Common Stock upon request.
NUMBER OF DIRECTORS
The DGCL provides that a corporation's board of directors shall consist of
at least one member and that the authorized number of directors may be fixed in
the corporation's certificate of incorporation or in the bylaws. The STAR Bylaws
provide that the authorized number of directors constituting the STAR Board
shall be established by the STAR Board pursuant to a resolution adopted by a
majority of the total number of authorized directors and is currently set at
six. The UDN Bylaws provide that the authorized number of directors constituting
the UDN Board shall be six until such Bylaws are amended by resolution duly
adopted by the UDN Board or the stockholders of UDN. The UDN Board currently
consists of five members.
CLASSIFICATION
The STAR Bylaws provide that the STAR Board will be divided into three
classes, and each class generally serves for a term of three years. The term of
only one class of directors expires annually, so it is only possible to elect
one class of the Board of Directors (or approximately one-third) in any one
year. The UDN Board is not classified.
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REMOVAL OF DIRECTORS; FILLING VACANCIES ON THE BOARD OF DIRECTORS
Under the DGCL, any director or the entire board of directors generally may
be removed, with or without cause, by the holders of a majority of the shares
entitled to vote at an election of directors, provided, however, that directors
serving on a classified board may be removed only for cause unless the
corporation's charter provides otherwise. The STAR Bylaws provide that any
director may be removed only for cause by a majority of the outstanding shares
of stock entitled to vote at an election of directors. As the UDN Charter
contains no provision concerning removal of directors, under the DGCL, UDN
stockholders representing a majority of the outstanding shares of stock entitled
to vote at an election of directors may remove a UDN director only for cause.
The DGCL generally provides that all vacancies on the board of directors,
including vacancies caused by an increase in the number of authorized directors,
may be filled by a majority of the remaining directors even if they constitute
less than a quorum. Both the STAR Bylaws and the UDN Bylaws provide that
vacancies and newly created directorships resulting from an increase in the
authorized number of directors may be filled by a majority of the directors then
in office, even if less than a quorum, or by a sole remaining director.
LIMITATION ON DIRECTORS' LIABILITY
The DGCL permits a corporation to include in its certificate of
incorporation a provision limiting or eliminating the liability of its directors
to such corporation or its stockholders for monetary damages arising from a
breach of fiduciary duty, except for: (i) a breach of the duty of loyalty to the
corporation, (ii) acts or omissions not in good faith or which involve
intentional misconduct or a knowing violation of law, (iii) a declaration of a
dividend or the authorization of the repurchase or redemption of stock in
violation of the DGCL or (iv) any transaction from which the director derived an
improper personal benefit. Both the STAR Charter and the UDN Charter eliminate
director liability to the maximum extent permitted by the DGCL.
INDEMNIFICATION
The DGCL provides in general that a corporation may indemnify any person,
including its directors, officers, employees and agents, who was or is a party
or is threatened to be made a party to any threatened, pending or completed
action, suit or proceeding, whether civil, criminal, administrative or
investigative (other than actions by or in the right of the corporation) by
reason of the fact that he or she is or was a representative of or serving at
the request of the corporation, against expenses (including attorneys' fees),
judgments, fines and amounts paid in settlement actually and reasonably incurred
by him or her in connection with the action, suit or proceeding if he or she
acted in good faith and in a manner he or she reasonably believed to be in, or
not opposed to, the best interests of the corporation and, with respect to any
criminal proceeding, had no reasonable cause to believe his or her conduct was
unlawful. The DGCL permits similar indemnification in the case of actions by or
in the right of the corporation, provided that indemnification is not permitted
for (i) breach of duty of loyalty to the company, (ii) acts or omissions not in
good faith or constituting intentional misconduct or knowing violation of the
law, (iii) declaration of an improper dividend, stock purchase or redemption of
shares or (iv) any transaction from which the director derived an improper
personal benefit. In general, no indemnification for expenses in derivative
actions is permitted under the DGCL where the person has been adjudged liable to
the corporation, unless a court finds him or her entitled to such
indemnification. However, to the extent that a present or former director or
officer of a corporation has been successful on the merits or otherwise in
defense of any action, suit or proceeding, or in defense of any claim, issue or
matter, he or she shall be indemnified against expenses (including attorneys'
fees) actually and reasonably incurred by him or her in connection therewith.
The DGCL also provides that the indemnification permitted or required by the
DGCL is not exclusive of any other rights to which a person seeking
indemnification may be entitled.
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The UDN Charter provides that UDN shall indemnify any person acting as
director or officer of UDN and any person serving at the request of UDN as a
director or officer of another corporation, joint venture, partnership, trust or
other enterprise, to the fullest extent permitted by the DGCL and provides that
UDN may enter into indemnification agreements with each of its directors and
officers providing a contractual right of indemnification to the maximum extent
permitted by law. The language in the STAR Bylaws provides for indemnification
of directors to the full extent permitted by the DGCL and provides that the STAR
Board in its discretion may indemnify any person, other than a director, made a
party to any action, suit or proceeding by reason of the fact that such person,
their testator or intestate, is or was an officer or employee of the
corporation.
RESTRICTIONS ON BUSINESS COMBINATIONS/CORPORATE CONTROL
Section 203 of the DGCL applies to a broad range of business combinations
(as defined in the DGCL) between a Delaware corporation and an interested
stockholder (as defined). The DGCL definition of "business combination" includes
mergers, sales of assets, issuance of voting stock and certain other
transactions. An "interested stockholder" is defined as any person who owns,
directly or indirectly, 15.0% or more of the outstanding voting stock of a
corporation. The DGCL prohibits a corporation from engaging in a business
combination with an interested stockholder for a period of three years following
the date on which the stockholder became an interested stockholder, unless (i)
the board of directors approved the business combination before the stockholder
became an interested stockholder, or the board of directors approved the
transaction that resulted in the stockholder becoming an interested stockholder,
(ii) upon consummation of the transaction which resulted in the stockholder
becoming an interested stockholder, such stockholder owned at least 85.0% of the
voting stock outstanding when the transaction began other than shares held by
directors who are also officers and by certain employee stock plans, or (iii)
the board of directors approved the business combination after the stockholder
became an interested stockholder and the business combination was approved at a
meeting by at least two-thirds of the outstanding voting stock not owned by such
stockholder. Both STAR and UDN are subject to the provisions of Section 203 of
the DGCL.
STOCKHOLDER ACTION BY WRITTEN CONSENT; SPECIAL MEETINGS. The DGCL provides
that, unless otherwise provided in the certificate of incorporation, any action
that may be taken or is required to be taken at any annual or special meeting of
stockholders may be taken without a meeting, without prior notice and without a
vote, if a consent in writing, setting forth the action so taken, is signed by
the holders of outstanding stock having not less than the minimum number of
votes that would be necessary to authorize or take such action at a meeting at
which all shares entitled to vote thereon were present and voted. The UDN
Charter currently permits such action without a meeting. The STAR Charter
provides that any action required or permitted to be taken by the stockholders
of STAR may be taken without an annual or special meeting only by the unanimous
written consent of all stockholders entitled to vote on such action.
Under the DGCL, a special meeting of the stockholders may be called by the
board of directors or such other person as may be authorized the certificate of
incorporation or bylaws. The STAR Bylaws provide that special meetings of
stockholders may be called by the President and shall be called by the President
or Secretary at the request in writing of a majority of the STAR Board. The UDN
Bylaws provide that special meetings of the stockholders of UDN may be called
only by the UDN Board, the Chairman of the Board or the holders of shares
entitled to cast not less than 10% of the votes at such meeting.
AMENDMENT OR REPEAL OF THE CHARTER AND BYLAWS. Under the DGCL, a
corporation may amend its certificate of incorporation, from time to time, in
any and as many respects as may be desired, so long as its certificate of
incorporation as amended would contain only such provisions as it would be
lawful and proper to insert in an original certificate of incorporation. The
DGCL also provides that a certificate of incorporation may confer on the board
of directors the power to amend the bylaws. Additionally, under the DGCL, a
corporation's bylaws may be amended by the stockholders entitled to vote, which
power may not
57
<PAGE>
be divested or limited where the board also has such power. The STAR Bylaws
provide that such Bylaws may be altered, amended or repealed or new bylaws may
be adopted by the STAR Board or by stockholders holding at least seventy-five
percent (75%) of the STAR outstanding capital stock. The UDN Bylaws provide that
such Bylaws may be amended or repealed or new bylaws may be adopted by the UDN
Board and by the affirmative vote of the holders of a majority of the
outstanding shares of stock entitled to vote generally in the election of
directors.
CUMULATIVE VOTING. Under the DGCL, cumulative voting of stock applies only
when so provided in the certificate of incorporation of a corporation. Neither
the STAR Charter nor the UDN Charter provides for cumulative voting.
STOCKHOLDER VOTE FOR MERGER. Except with respect to certain mergers between
parent and subsidiary corporations, the DGCL generally requires the affirmative
vote of a majority of the outstanding shares of the constituent corporations in
a merger; provided, that where a corporation's certificate of incorporation
provides for more or less than one vote per share on any matter, the required
vote is a majority of the combined voting power of the corporation's stock.
Under the DGCL, holders of stock which is not by its terms entitled to vote on
such a transaction are entitled to notice of the meeting at which the proposed
transaction is considered. The DGCL does not require, unless provided for in a
corporation's charter (and neither the STAR Charter nor the UDN Charter so
provides), a stockholder vote of the surviving corporation in a merger, however,
if (a) the merger agreement does not amend the existing certificate of
incorporation, (b) each outstanding or treasury share of the surviving
corporation before the merger is unchanged after the merger, (c) the number of
shares to be issued by the surviving corporation in a merger does not exceed
20.0% of the shares outstanding immediately prior to such issuance; and (d)
certain other conditions are satisfied. Neither STAR's Charter, the UDN Charter,
the STAR Bylaws nor the UDN Bylaws provide for any additional notice or voting
requirement with respect to a merger other than those required by the DGCL.
DIVIDENDS. The DGCL permits a corporation to pay dividends out of surplus
(defined as the excess, if any, of net assets over capital) or, if no surplus
exists, out of its net profits for the fiscal year in which such dividends are
declared and/or for its preceding fiscal year, provided, that dividends may not
be paid out of net profits if the capital of such corporation is less than the
aggregate amount of capital represented by the outstanding stock of all classes
having a preference upon the distribution of assets. The STAR Bylaws provide
that dividends upon the capital stock of the corporation may be declared by the
STAR Board at any regular or special meeting, pursuant to law. STAR has not
declared or paid cash dividends on the STAR Common Stock since its initial
public offering and does not intend to pay such dividends in the foreseeable
future. Additionally, STAR's existing credit facility restricts the payment of
cash dividends. According to the UDN Bylaws, subject to limitations contained in
the DGCL and the UDN Charter, holders of shares of UDN Common Stock are entitled
to receive such dividends as may be declared by the UDN Board. UDN has never
declared or paid dividends on the UDN Common Stock and does not intend to pay
dividends prior to the consummation of the Merger.
58
<PAGE>
UNAUDITED PRO FORMA FINANCIAL DATA
The following unaudited pro forma financial data is presented assuming the
Merger will be accounted for as a pooling of interests, whereby STAR will
restate its historical consolidated financial statements to include the assets,
liabilities, stockholders' equity (deficit) and results of operations of UDN.
The statement of operations data included in the unaudited pro forma
financial data reflects the combination of the historical operating results of
STAR for the years ended December 31, 1995, 1996 and 1997 and the three months
ended March 31, 1998 with the historical operating results of UDN for the twelve
month periods ended January 31, 1996, 1997 and 1998 and the three months ended
March 31, 1998. The balance sheet data included in the unaudited pro forma
financial data reflects the combination of the historical balance sheet data of
STAR and of UDN as of March 31, 1998.
The unaudited pro forma financial data does not purport to present the
financial position or results of operations of STAR had the transactions and
events assumed therein occurred on the dates specified, nor are they necessarily
indicative of the results of operations that may be achieved in the future.
The unaudited pro forma financial data does not give effect to certain cost
savings that STAR management believes may be realized as a result of the Merger.
There can be no assurances that such cost savings, if any, will be achieved. See
"Forward-Looking Statements." The unaudited pro forma condensed combined
statements of operations do not reflect certain non-recurring costs expected to
be incurred in connection with the Merger. These costs are expected to include
investment advisory fees and legal, accounting and other professional fees and
certain charges associated with the combination of STAR and UDN.
The unaudited pro forma financial data is based on certain assumptions and
adjustments described in the Notes to the unaudited pro forma financial data
included in this Proxy Statement/Prospectus and should be read in conjunction
therewith and with "Management's Discussion and Analysis of Financial Condition
and Results of Operations of STAR," "Management's Discussion and Analysis of
Financial Condition and Results of Operations of UDN" and the consolidated
financial statements of STAR and UDN and the related notes thereto, included
elsewhere in this Proxy Statement/Prospectus.
59
<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
AT MARCH 31, 1998
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
STAR UDN
MARCH 31, MARCH 31, MERGER PRO FORMA
1998 1998 ADJUSTMENTS COMBINED
---------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
ASSETS:
Cash and cash equivalents....................................... $ 5,285 $ 1,113 $ -- $ 6,398
Short-term investments.......................................... 2,978 -- -- 2,978
Trade and notes receivable...................................... 51,024 4,859 (5,808) 50,075
Receivable from related parties................................. 303 -- -- 303
Other current assets............................................ 16,057 257 -- 16,314
---------- ----------- ----------- -----------
Total current assets........................................ 75,647 6,229 (5,808) 76,068
Property and equipment, net..................................... 67,814 2,122 -- 69,936
Intangible assets, net.......................................... -- 5,893 -- 5,893
Other long-term assets.......................................... 851 242 -- 1,093
---------- ----------- ----------- -----------
$ 144,312 $ 14,486 $ (5,808) $ 152,990
---------- ----------- ----------- -----------
---------- ----------- ----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT):
Payable to stockholders......................................... $ 82 $ 1,025 $ (550) $ 557
Current portion of long-term obligations........................ 6,314 1,205 -- 7,519
Note payable.................................................... -- 4,500 (4,500) --
Accounts payable and accrued expenses........................... 23,242 10,056 (1,308) 31,990
Accrued network cost............................................ 37,667 -- -- 37,667
---------- ----------- ----------- -----------
Total current liabilities................................... 67,305 16,786 (6,358) 77,733
---------- ----------- ----------- -----------
Long-term obligations........................................... 25,902 430 -- 26,332
Other long-term liabilities..................................... 378 -- -- 378
---------- ----------- ----------- -----------
Total long-term liabilities................................. 26,280 430 -- 26,710
---------- ----------- ----------- -----------
STOCKHOLDERS' EQUITY (DEFICIT)..................................
Common Stock of STAR (50,000,000 shares authorized, 35,798,210
actual shares and 36,365,232 pro forma shares issued and
outstanding)................................................ 36 -- -- 36
Common Stock of UDN (100,000 shares authorized, 6,993,817
actual shares and no pro forma shares)...................... -- 69 (69) --
Additional paid-in capital.................................... 51,308 12,890 69 64,817
550
Deferred compensation......................................... (10) -- -- (10)
Retained earnings (deficit)................................... (607) (15,689) -- (16,296)
---------- ----------- ----------- -----------
Total stockholders' equity (deficit).......................... 50,727 (2,730) 550 48,547
---------- ----------- ----------- -----------
Total liabilities and stockholders' equity (deficit)........ $ 144,312 $ 14,486 $ (5,808) $ 152,990
---------- ----------- ----------- -----------
---------- ----------- ----------- -----------
</TABLE>
60
<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
FOR THE YEAR ENDED DECEMBER 31, 1995
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
UDN
STAR YEAR ENDED
YEAR ENDED JANUARY 31, MERGER PRO FORMA
DECEMBER 31, 1995 1996 ADJUSTMENTS COMBINED
----------------- --------------- ----------- ----------------
<S> <C> <C> <C> <C>
REVENUES..................................... $ 46,283 $ 5,711 $ (43) $ 51,951
COST OF SERVICES............................. 31,897 4,342 (43) 36,196
-------- ------- ----------- -------
Gross profit............................... 14,386 1,369 -- 15,755
-------- ------- ----------- -------
OPERATING EXPENSES:
Selling, general and administrative........ 10,086 2,494 -- 12,580
Depreciation and amortization.............. 186 484 -- 670
-------- ------- ----------- -------
Total operating expenses..................... 10,272 2,978 -- 13,250
-------- ------- ----------- -------
Income (loss) from operations.............. 4,114 (1,609) -- 2,505
-------- ------- ----------- -------
OTHER INCOME (EXPENSE):
Interest income............................ 22 (12) -- 10
Interest expense........................... (64) (91) -- (155)
Other expense.............................. (33) (183) -- (216)
-------- ------- ----------- -------
Total other income (expense)................. (75) (286) -- (361)
-------- ------- ----------- -------
Income (loss) before provision for income
taxes.................................... 4,039 (1,895) -- 2,144
PRO FORMA PROVISION FOR INCOME TAXES......... 1,632 -- (774) 858
-------- ------- ----------- -------
Pro forma Net Income (Loss).................. $ 2,407 $ (1,895) $ 774 $ 1,286
-------- ------- ----------- -------
-------- ------- ----------- -------
Pro forma Net Income (Loss) per common share:
Basic...................................... $ 0.13 $ 0.07
Diluted.................................... $ 0.13 $ 0.07
Weighted average number of common shares
outstanding:
Basic...................................... 18,020 258 18,278
Diluted.................................... 18,020 258 18,278
</TABLE>
61
<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
FOR THE YEAR ENDED DECEMBER 31, 1996
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
UDN
STAR YEAR ENDED
YEAR ENDED JANUARY 31, MERGER PRO FORMA
DECEMBER 31, 1996 1997 ADJUSTMENTS COMBINED
----------------- --------------- -------------- ----------------
<S> <C> <C> <C> <C>
REVENUES.................................. $ 237,991 $ 19,685 $ (259) $ 257,417
COST OF SERVICES.......................... 205,585 15,051 (259) 220,377
----------------- ------- -------------- ----------------
Gross profit............................ 32,406 4,634 -- 37,040
----------------- ------- -------------- ----------------
OPERATING EXPENSES:
Selling, general and administrative..... 34,331 4,563 -- 38,894
Depreciation and amortization........... 1,151 818 -- 1,969
----------------- ------- -------------- ----------------
Total operating expenses.................. 35,482 5,381 -- 40,863
----------------- ------- -------------- ----------------
Loss from operations.................... (3,076) (747) -- (3,823)
----------------- ------- -------------- ----------------
OTHER INCOME (EXPENSE):
Interest income......................... 110 4 -- 114
Interest expense........................ (601) (448) -- (1,049)
Legal settlement and expenses........... (100) -- -- (100)
Other income............................ 39 17 -- 56
----------------- ------- -------------- ----------------
Total other income (expense).............. (552) (427) -- (979)
----------------- ------- -------------- ----------------
Loss before provision for income
taxes................................. (3,628) (1,174) -- (4,802)
PRO FORMA PROVISION (BENEFIT) FOR INCOME
TAXES................................... 1,535 (50) -- 1,485
----------------- ------- -------------- ----------------
Pro Forma Net Loss........................ $ (5,163) $ (1,124) $ -- $ (6,287)
----------------- ------- -------------- ----------------
----------------- ------- -------------- ----------------
Pro forma loss per common share:
Basic................................... $ (0.24) $ (0.28)
Diluted................................. $ (0.24) $ (0.28)
Weighted average number of common shares
outstanding:
Basic................................... 21,939 390 22,329
Diluted................................. 21,939 390 22,329
</TABLE>
62
<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
FOR THE YEAR ENDED DECEMBER 31, 1997
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
UDN
STAR YEAR ENDED
YEAR ENDED JANUARY 31, MERGER PROFORMA
DECEMBER 31, 1997 1998 ADJUSTMENTS COMBINED
----------------- --------------- ----------- ----------------
<S> <C> <C> <C> <C>
REVENUES..................................... $ 376,198 $ 31,179 $ (1,153) $ 406,224
COST OF SERVICES............................. 325,237 24,633 (1,153) 348,717
----------------- ------- ----------- ----------------
Gross profit............................... 50,961 6,546 -- 57,507
----------------- ------- ----------- ----------------
OPERATING EXPENSES:
Selling, general and administrative........ 35,667 11,544 -- 47,211
Depreciation and amortization.............. 4,245 1,010 -- 5,255
----------------- ------- ----------- ----------------
Total operating expenses..................... 39,912 12,554 -- 52,466
----------------- ------- ----------- ----------------
Income from operations..................... 11,049 (6,008) -- 5,041
----------------- ------- ----------- ----------------
OTHER INCOME (EXPENSE):
Interest income............................ 492 35 (28) 499
Interest expense........................... (1,633) (941) 28 (2,546)
Legal settlement and expenses.............. (1,653) -- -- (1,653)
Other income (expense)..................... 208 (406) -- (198)
----------------- ------- ----------- ----------------
Total other income (expense)................. (2,586) (1,312) -- (3,898)
----------------- ------- ----------- ----------------
Income (loss) before provision for income
taxes.................................... 8,463 (7,320) -- 1,143
PRO FORMA PROVISION FOR INCOME TAXES......... 3,090 -- (2,673) 417
----------------- ------- ----------- ----------------
Pro Forma Net Income (Loss).................. $ 5,373 $ (7,320) $ 2,673 $ 726
----------------- ------- ----------- ----------------
----------------- ------- ----------- ----------------
Pro forma earnings per common share:
Basic...................................... $ 0.19 $ 0.02
Diluted.................................... $ 0.17 $ 0.02
Weighted average number of common shares
outstanding:
Basic...................................... 28,868 490 29,358
Diluted.................................... 31,625 542 32,167
</TABLE>
63
<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
FOR THE THREE MONTHS ENDED MARCH 31, 1998
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
STAR UDN
THREE MONTHS THREE MONTHS
ENDED ENDED MERGER PRO FORMA
MARCH 31, 1998 MARCH 31, 1998 ADJUSTMENTS COMBINED
-------------- -------------- ----------- -----------
<S> <C> <C> <C> <C>
REVENUES............................................... $ 129,269 $ 8,673 $ (1,385) $ 136,557
COST OF SERVICES....................................... 111,593 6,603 (1,385) 116,811
-------------- ------- ----------- -----------
Gross profit......................................... 17,676 2,070 -- 19,746
-------------- ------- ----------- -----------
OPERATING EXPENSES:
Selling, general and administrative.................. 11,875 2,099 -- 13,974
Depreciation and amortization........................ 1,879 271 -- 2,150
-------------- ------- ----------- -----------
Total operating expenses............................... 13,754 2,370 -- 16,124
-------------- ------- ----------- -----------
Income (loss) from operations........................ 3,922 (300) -- 3,622
OTHER INCOME (EXPENSE):
Interest income...................................... 283 14 (92) 205
Interest expense..................................... (618) (263) 92 (789)
Other expense........................................ (160) -- -- (160)
-------------- ------- ----------- -----------
Total other income (expense)........................... (495) (249) -- (744)
-------------- ------- ----------- -----------
Income (loss) before provision for income taxes...... 3,427 (549) -- 2,878
PROVISION FOR INCOME TAXES............................. 1,534 -- -- 1,534
-------------- ------- ----------- -----------
Net Income (Loss)...................................... $ 1,893 (549) -- 1,344
-------------- ------- ----------- -----------
-------------- ------- ----------- -----------
Net Income per common share:
Basic................................................ $ 0.05 $ 0.04
Diluted.............................................. $ 0.05 $ 0.04
Weighted average number of common shares outstanding:
Basic................................................ 35,629 530 36,159
Diluted.............................................. 37,714 571 38,285
</TABLE>
64
<PAGE>
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL DATA
1. PERIODS COMBINED
The Star Telecommunications Inc. (STAR) consolidated balance sheet as of
March 31, 1998 has been combined with the United Digital Network Inc. (UDN)
consolidated balance sheet as of March 31, 1998. The Star consolidated
statements of operations for the years ended December 31, 1995, 1996 and 1997
have been combined with the UDN consolidated statements of operations for the
years ended January 31, 1996, 1997 and 1998, respectively. The Star consolidated
statement of operations for the three month period ended March 31, 1998 has been
combined with the UDN consolidated statement of operations for the three month
period ended March 31, 1998. The unaudited pro forma condensed statements of
operations for the years ended December 31, 1995, 1996 and 1997 do not include
the results of operations of T-One, which merged with STAR on March 10, 1998,
since it is immaterial to the consolidated results of operations of STAR.
2. MERGER COSTS
STAR and UDN estimate that they will incur direct transaction costs of
approximately $800,000 associated with the Merger, consisting of fees for
investment banking, legal, accounting, financial printing and other related
charges. Fees incurred by STAR will be charged to operations in the fiscal
quarter in which the Merger is consummated. No significant merger related costs
were incurred by STAR through December 31, 1997. UDN expensed $160,000 of merger
related costs in the year ended January 31, 1998.
Merger expenses for the three months ended March 31, 1998 for STAR and UDN
amounted to $378,000 and $14,000, respectively.
3. INTERCOMPANY BALANCES
At March 31, 1998, STAR had amounts due from UDN as follows (amounts in
thousands):
<TABLE>
<S> <C>
Note receivable............................................. $ 4,500
Trade receivables........................................... 1,188
Interest receivable......................................... 120
---------
Total....................................................... $ 5,808
---------
---------
</TABLE>
4. INTERCOMPANY TRANSACTIONS
For the years ended December 31, 1995, 1996 and 1997, intercompany sales and
related costs of sales amounted to $43,000, $259,000 and $1,153,000,
respectively. Intercompany sales for the three months ended March 31, 1998
amounted to $1,385,000. Intercompany interest for the year ended December 31,
1997 and for the three month period ended March 31, 1998 related to the note and
amounted to $28,000 and $92,000, respectively.
5. PRO FORMA INCOME TAXES
The pro forma provision for income taxes, pro forma net income (loss) and
pro forma net income (loss) per common share of STAR for the years ended
December 31, 1995, 1996 and 1997 reflect a pro forma tax adjustment, which
assumes that both STAR as well as LDS, which was acquired by STAR in a pooling
of interest transaction on November 30, 1997, were C-Corporations for all
periods presented (see Note 9 of Notes to STAR Telecommunications, Inc.
Consolidated Financial Statements).
65
<PAGE>
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL DATA
5. PRO FORMA INCOME TAXES (CONTINUED)
The Merger adjustment in the provision for income taxes for the years ended
December 31, 1995, 1996 and 1997 as well as for the three months ended March 31,
1998 are an adjustment to reflect STAR's effective tax rate in the statements of
income for the combined entity.
6. EXCHANGE OF STOCK
Eliminates UDN's common stock balance less the par value of 567,022 shares
to be issued in the Merger.
7. CONVERTIBLE DEBENTURE
To record the conversion of a debenture in the amount of $550,000 at March
31, 1998 which is convertible into 275,000 shares of UDN Common Stock which in
turn will be converted into an equivalent number of STAR Common Stock based on
the Exchange Ratio.
8. PRO FORMA EARNINGS PER SHARE
The unaudited pro forma combined basic earnings per share and diluted
earnings per share are based on the weighted average number of common and
dilutive equivalent shares, for each period at the Exchange Ratio of 0.077358
shares of STAR Common Stock for each share of UDN Common Stock outstanding
during the period.
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<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF STAR
THE FOLLOWING DISCUSSION OF THE FINANCIAL CONDITION AND RESULTS OF
OPERATIONS OF STAR SHOULD BE READ IN CONJUNCTION WITH "SELECTED CONSOLIDATED
FINANCIAL DATA OF STAR" AND THE STAR CONSOLIDATED FINANCIAL STATEMENTS AND THE
NOTES THERETO, EACH OF WHICH IS INCLUDED ELSEWHERE IN THIS PROXY
STATEMENT/PROSPECTUS. THIS DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS, AS
DEFINED IN SECTION 27A OF THE SECURITIES ACT, THAT INVOLVE RISKS AND
UNCERTAINTIES. STAR'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE
ANTICIPATED IN THE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS,
INCLUDING, BUT NOT LIMITED TO THOSE DISCUSSED IN "RISK FACTORS" AND ELSEWHERE IN
THIS PROXY STATEMENT/PROSPECTUS. SEE "DESCRIPTION OF FORWARD-LOOKING
STATEMENTS."
OVERVIEW
STAR is an emerging multinational carrier focused primarily on the
international long distance market. STAR offers highly reliable, low-cost
switched voice services on a wholesale basis, primarily to U.S.-based long
distance carriers. STAR provides international long distance service to
approximately 220 countries through its flexible network comprised of various
foreign termination relationships, international gateway switches, leased and
owned transmission facilities and resale arrangements with other long distance
providers.
STAR installed its first international gateway switch in Los Angeles in June
1995 and initially recognized wholesale revenues in August 1995. A significant
portion of STAR's revenues in 1994 and 1995 were generated by the commercial
operations of LDS.
REVENUES. Most of STAR's revenues are generated by the sale of
international long distance services on a wholesale basis to other, primarily
domestic, long distance providers. STAR records revenues from the sale of long
distance services at the time of customer usage. STAR's agreements with its
wholesale customers are short-term in duration and the rates charged to
customers are subject to change from time to time, generally with five days
notice to the customer.
COSTS OF SERVICES. STAR has pursued a strategy of attracting customers and
building calling volume and revenue by offering favorable rates compared to
other long distance providers. STAR continues to lower its cost of services by
(i) expanding STAR's owned network facilities, (ii) continuing to utilize STAR's
sophisticated information systems to route calls over the most cost-effective
routes and (iii) leveraging STAR's traffic volumes and information systems to
negotiate lower variable usage-based costs with domestic and foreign providers
of transmission capacity.
Costs of services include those costs associated with the transmission and
termination of international long distance services. Currently, a majority of
transmission capacity used by STAR is obtained on a variable, per minute basis.
As a result, some of STAR's current costs of services is variable. STAR's
contracts with its vendors provide that rates may fluctuate, with rate change
notice periods varying from five days to one year, with certain of STAR's longer
term arrangements requiring STAR to meet minimum usage commitments in order to
avoid penalties. Such variability and the short-term nature of many of the
contracts subject STAR to the possibility of unanticipated cost increases and
the loss of cost-effective routing alternatives. Included in STAR's costs of
services are accruals for rate and minute disputes and unreconciled billing
differences between STAR and its vendors. Each quarter management reviews the
cost of services accrual and adjusts the balance for resolved items. Costs of
services also include fixed costs associated with the leasing of network
facilities.
STAR intends to begin providing international long distance services to
commercial customers in certain European countries in the second half of 1998.
STAR began providing long distance service to commercial markets in the U.S.
with its acquisition of LDS in November 1997. STAR believes that traffic from
commercial customers has the potential to generate higher gross margins than
wholesale traffic. STAR also expects, however, that an expansion into this
market will also increase the risk of bad debt
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<PAGE>
exposure and lead to higher overhead costs. Information related to wholesale and
commercial revenues and operations will be reported in future Exchange Act
filings made by STAR in accordance with Financial Accounting Standards Board
Statement No. 131.
Prices in the international long distance market have declined in recent
years and, as competition continues to increase, STAR believes that prices are
likely to continue to decline. Additionally, STAR believes that the increasing
trend of deregulation of international long distance telecommunications will
result in greater competition, which could adversely affect STAR's revenue per
minute and gross margin. STAR believes, however, that the effect of such
decreases in prices will be offset by increased calling volumes and decreased
costs.
OPERATING EXPENSES. Selling, general and administrative expenses consist
primarily of personnel costs, depreciation and amortization, tradeshow and
travel expenses and commissions and consulting fees, as well as an accrual for
bad debt expense. These expenses have been increasing over the past year, which
is consistent with STAR's recent growth, accelerated expansion into Europe, and
investment in systems and facilities. STAR expects this trend to continue, and
to include, among other things, a significant increase in depreciation and
amortization. Management believes that additional selling, general and
administrative expenses will be necessary to support the expansion of STAR's
network facilities, its sales and marketing efforts and STAR's expansion into
commercial markets.
FOREIGN EXCHANGE. STAR's revenues and cost of long distance services are
sensitive to foreign currency fluctuations. STAR expects that an increasing
portion of STAR's revenues and expenses will be denominated in currencies other
than U.S. dollars, and changes in exchange rates may have a significant effect
on STAR's results of operations.
FACTORS AFFECTING FUTURE OPERATING RESULTS. STAR's quarterly operating
results are difficult to forecast with any degree of accuracy because a number
of factors subject these results to significant fluctuations. As a result, STAR
believes that period-to-period comparisons of its operating results are not
necessarily meaningful and should not be relied upon as indications of future
performance.
STAR's revenues, costs and expenses have fluctuated significantly in the
past and are likely to continue to fluctuate significantly in the future as a
result of numerous factors. STAR's revenues in any given period can vary due to
factors such as call volume fluctuations, particularly in regions with
relatively high per-minute rates; the addition or loss of major customers,
whether through competition, merger, consolidation or otherwise; the loss of
economically beneficial routing options for the termination of STAR's traffic;
financial difficulties of major customers; pricing pressure resulting from
increased competition; and technical difficulties with or failures of portions
of STAR's network that impact STAR's ability to provide service to or bill its
customers. STAR's cost of services and operating expenses in any given period
can vary due to factors such as fluctuations in rates charged by carriers to
terminate STAR's traffic; increases in bad debt expense and reserves; the timing
of capital expenditures, and other costs associated with acquiring or obtaining
other rights to switching and other transmission facilities; changes in STAR's
sales incentive plans; and costs associated with changes in staffing levels of
sales, marketing, technical support and administrative personnel. In addition,
STAR's operating results can vary due to factors such as changes in routing due
to variations in the quality of vendor transmission capability; loss of
favorable routing options; the amount of, and the accounting policy for, return
traffic under operating agreements; actions by domestic or foreign regulatory
entities; the level, timing and pace of STAR's expansion in international and
commercial markets; and general domestic and international economic and
political conditions. Further, a substantial portion of transmission capacity
used by STAR is obtained on a variable, per minute and short-term basis,
subjecting STAR to the possibility of unanticipated price increases and service
cancellations. Since STAR does not generally have long term arrangements for the
purchase or resale of long distance services, and since rates fluctuate
significantly over short periods of time, STAR's gross margins are subject to
significant fluctuations over short periods of time. STAR's gross margins also
may be negatively impacted in the longer term by competitive pricing pressures.
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RECENT ACQUISITIONS AND DEVELOPMENTS
STAR has recently acquired or entered into agreements to acquire the
following companies and has taken the following actions:
- L.D. SERVICES, INC. On November 30, 1997, STAR acquired LDS, certain
non-operating entities and majority ownership in another entity for
approximately 849,000 shares of Common Stock in a transaction accounted
for as a pooling of interests. STAR's audited financial statements have
been restated to include LDS' historical performance for all relevant
periods. The commercial business of LDS has historically had higher gross
margins and higher selling, general and administrative expenses and
operating costs than STAR's wholesale operations. As STAR integrates and
expands the commercial accounts of LDS, such increase in operations may
affect STAR's future operating margins. In 1997, LDS settled disputes with
the California PUC and with the District Attorney of Monterey, California.
The resulting payments and restrictions on LDS' activities adversely
affected its 1997 operating results. See "Business of STAR--Government
Regulation--Actions Against LDS."
- T-ONE CORP. On March 10, 1998, STAR acquired T-One for 1,353,000 shares of
Common Stock in a transaction accounted for as a pooling of interests. For
the fiscal year ended December 31, 1997, T-One had revenues of $30.4
million, gross profit of $1.8 million, selling, general and administrative
expenses of $1.5 million and net income of $0.2 million. See Note 14 of
Notes to STAR Consolidated Financial Statements.
- STOCK SPLIT. On March 31, 1998, STAR effected the Stock Split with payment
to the holders of the shares of Common Stock outstanding on February 20,
1998 of a stock dividend equal to 1.05 shares of Common Stock for each
such outstanding share.
- PUBLIC OFFERING. On May 4, 1998, STAR consummated a firmly underwritten
public offering of 6,000,000 shares of STAR Common Stock, of which
5,685,000 shares were sold by STAR and 315,000 shares were sold by a
certain stockholder of STAR. STAR and certain STAR stockholders have
granted the underwriters a 30-day option to purchase up to 900,000
additional shares of STAR Common Stock solely to cover over-allotments, if
any.
RESULTS OF OPERATIONS
The following table sets forth certain selected items in STAR's statements
of operations as a percentage of total revenues for the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS
YEARS ENDED DECEMBER 31, ENDED MARCH 31,
----------------------------- -----------------
1995 1996 1997 1997 1998
------ ------- ------ ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues................................ 100.0% 100.0% 100.0% 100.0% 100.0%
Costs of services....................... 68.9 86.4 86.5 86.9 86.3
------ ------- ------ ------ ------
Gross profit............................ 31.1 13.6 13.5 13.1 13.7
Operating Expenses:
Selling, general and administrative
expenses............................ 21.8 14.4 9.4 9.1 9.1
Depreciation and amortization......... 0.4 0.5 1.1 1.0 1.5
------ ------- ------ ------ ------
Total operating expenses.............. 22.2 14.9 10.6 10.1 10.6
Income (loss) from operations........... 8.9 (1.3) 2.9 3.0 3.0
------ ------- ------ ------ ------
Income (loss) before provision for
income taxes.......................... 8.7 (1.5) 2.3 2.6 2.7
Provision for income taxes.............. 0.1 0.3 0.8 0.4 1.2
------ ------- ------ ------ ------
Net income (loss)....................... 8.6% (1.8)% 1.5% 2.2% 1.5%
------ ------- ------ ------ ------
------ ------- ------ ------ ------
</TABLE>
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THREE MONTHS ENDED MARCH 31, 1998 COMPARED TO THREE MONTHS ENDED MARCH 31,
1997 (UNAUDITED)
REVENUES. Revenues increased 52.4% to $129.3 million in the first quarter
of 1998 from $84.8 million in the first quarter of 1997. Wholesale revenues
increased to $121.2 million (including $11.4 million of revenue from T-One) from
$76.5 million (including $5.4 million of revenue from T-One). Wholesale minutes
of use increased 73.2% to 324.4 million in the first quarter of 1998, as
compared to 187.3 million minutes of use in the comparable quarter of the year
prior. This increase reflects growth in the number of wholesale customers from
100 in March of 1997 to 131 at the end of March 1998, as well as an increase in
usage by existing customers. The average rate per minute of use declined to
$0.37 for the current quarter as compared to $0.40 for the quarter ended March
31, 1997 reflecting the change in country mix to include a larger proportion of
lower rate per minute countries as well as lower prices on competitive routes.
Commercial revenues decreased to $8.1 million in the first quarter of 1998
from $8.4 million in the first quarter of 1997 reflecting the termination of the
LDS customer base in California due to the 1997 settlement entered into by LDS
with each of the California PUC and the District Attorney of Monterey,
California.
GROSS PROFIT. On a consolidated basis gross profit increased 59.2% to $17.7
million in the first quarter of 1998 from $11.1 million in the first quarter of
1997. Wholesale gross profit increased to $14.3 million in 1998 from $7.6
million for 1997 and wholesale gross margin increased to 11.8% from 9.9%,
respectively. Wholesale gross profit expanded during the first quarter of 1998
as traffic was increasingly routed over the Company's proprietary international
network. Without the inclusion of T-One in the Company's wholesale results the
gross margin would have been 12.5% and 10.2% for the quarters ending March 31,
1998 and 1997, respectively.
SELLING, GENERAL AND ADMINISTRATIVE. For the first quarter of 1998,
selling, general and administrative expenses increased 49.8% to $11.6 million,
from $7.7 million in the first quarter of 1997. Wholesale selling, general and
administrative expenses increased to $8.1 million in the first quarter of 1998
from $4.7 million in the first quarter of 1997, and increased as a percentage of
wholesale revenues to 6.7% from 6.1% over the comparable periods. Total expenses
increased year to year in absolute dollars as STAR expended its proprietary
international network and employee base. Commercial selling, general and
administrative expenses increased to $3.5 million in the first quarter of 1998
from $3.0 million in the first quarter of 1997 and increased as a percentage of
commercial revenues to 42.4% from 36.3%, respectively, as LD Services increased
its telemarketing sales force to focus on new ethnic marketing programs. The
Company expects selling, general and administrative expenses to expand in
absolute dollars and as a percentage of revenues throughout fiscal year 1998, as
the Company expands its network and employee base and in connection with the
Company's development of the commercial market.
DEPRECIATION. Depreciation increased to $1.9 million for the first quarter
of 1998 from $820,000 for the first quarter of 1997, and increased as a
percentage of revenues to 1.5% from 1.0% in the prior period. Depreciation
increased as a result of STAR's continuing expansion of its proprietary
international network which includes purchases of switches, undersea cable and
leasehold improvements associated with switch sites. STAR expects depreciation
expense to increase as the Company continues to expand its global
telecommunications network.
OTHER INCOME (EXPENSE). Other expense, net, increased to $495,000 in the
first quarter of 1998 from $326,000 in the first quarter of 1997. This increase
is primarily due to interest expense of $618,000 incurred under various capital
leases and bank lines of credit. Interest income earned on short-term
investments increased to $283,000 in the first quarter of 1998 from $21,000 in
the first quarter of 1997 reflecting interest earned on cash generated by
operations. Also included in other expense is $171,000 in foreign currency
losses related to the intercompany account between STAR and its German
subsidiary.
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PROVISION FOR INCOME TAXES. The provision for income taxes increased to
$1.5 million in the first quarter of 1998 from $341,000 in the first quarter of
1997 ($888,000 pro forma), primarily due to the increase in profitability of the
Company.
YEARS ENDED DECEMBER 31, 1997 AND 1996
REVENUES. Revenues increased 58.1% to $376.2 million in 1997 from $238.0
million in 1996. Wholesale revenues increased to $348.7 million from $208.1
million, with minutes of use increasing to 863.3 million minutes in 1997, as
compared to 479.7 million minutes of use in the prior year. This increase
reflects an increase in the number of wholesale customers from 84 in 1996 to 105
at the end of 1997, as well as an increase in usage by existing customers. The
average rate per minute of usage for wholesale customers declined from $0.43
cents per minute in 1996 to $0.40 cents per minute in 1997, reflecting the
change in country mix to include a larger proportion of lower rate per minute
countries as well as lower prices on competitive routes. Taking into account the
acquisition of T-One, on a pro forma basis, revenues in 1997 would have been
$406.6 million, an increase of 56.1% from $260.4 million in 1996.
Commercial revenues decreased to $27.5 million in 1997 from $29.9 million in
1996 reflecting the termination of the LDS customer base in California due to
the 1997 settlement entered into by LDS with each of the California PUC and the
District Attorney of Monterey, California. See "Business of STAR-- Governmental
Regulation--Actions Against LDS."
GROSS PROFIT. Gross profit increased 57.3% to $51.0 million in 1997 from
$32.4 million in 1996. Wholesale gross profit increased to $39.8 million in 1997
from $19.7 million for 1996 and wholesale gross margin increased to 11.4% from
9.4%, respectively. Wholesale gross profit expanded during 1997 as traffic was
increasingly routed over STAR's proprietary international network. Commercial
gross profit decreased 11.8% to $11.2 million in 1997 from $12.7 million in 1996
and commercial gross margin declined to 40.7% from 42.6% over such periods,
reflecting declining prices in the competitive long distance market. As STAR
migrates the LDS commercial customer base onto STAR's network, LDS's cost of
commercial long distance services is expected to decline. Taking into account
the acquisition of T-One, on a pro forma basis, gross profit in 1997 would have
been $52.8 million, an increase of 56.4% over gross profit of $33.7 million in
1996.
SELLING, GENERAL AND ADMINISTRATIVE. In 1997, selling, general and
administrative expenses increased 3.1% to $35.4 million, from $34.3 million in
1996. Wholesale selling, general and administrative expenses increased to $26.0
million in 1997 from $24.1 million in 1996, but decreased as a percentage of
wholesale revenues to 7.5% from 11.6% over the comparable periods. Total
expenses increased year to year in absolute dollars as STAR expanded its
proprietary international network and employee base. Included in the 1996
selling, general and administrative expense was $11.6 million in reserves and
write-offs against deposits and accounts receivable related to bad debts from
two customers. Commercial selling, general and administrative expenses decreased
to $9.4 million in 1997 from $10.2 million in 1996 and remained flat as a
percentage of commercial revenues at approximately 34.1%. STAR expects selling,
general and administrative expenses to expand in absolute dollars and as a
percentage of revenues in fiscal year 1998, as STAR expands its network and
employee base and in connection with STAR's entry into the commercial market.
DEPRECIATION. Depreciation increased to $4.2 million for 1997 from $1.2
million for 1996, and increased as a percentage of revenues to 1.1% from 0.5% in
the prior period. Depreciation increased as a result of STAR's continuing
expansion of its proprietary international network which includes purchases of
switches, submarine cable and leasehold improvements associated with switch
sites. STAR expects depreciation expense to increase as STAR continues to expand
its global telecommunications network.
OTHER INCOME (EXPENSE). Other expense, net, increased to $2.6 million in
1997 from $552,000 in 1996. This increase is primarily due to interest expense
of $1.6 million incurred under various capital leases and bank lines of credit
and a legal settlement and associated expenses of $1.7 million. The legal
settlement
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relates to the dispute settled by LDS with the California PUC and the District
Attorney of Monterey County. See "Business of STAR--Governmental
Regulation--Actions Against LDS." Interest income earned on short-term
investments increased to $492,000 in 1997 from $110,000 in 1996 due to interest
earned on the proceeds of STAR's June 1997 initial public offering.
PROVISION FOR INCOME TAXES. The historical provision for income taxes
increased to $2.9 million in 1997 from $592,000 in 1996 primarily due to the
increase in profitability of STAR.
YEARS ENDED DECEMBER 31, 1996 AND 1995
REVENUES. Revenues increased 414.2% to $238.0 million in 1996 from $46.3
million 1995. Wholesale revenues increased to $208.1 million in 1996 from $16.1
million in 1995, with minutes of use increasing to 479.7 million in 1996, as
compared to 38.1 million minutes of use in the prior year. The increase in
wholesale revenue resulted from STAR's commencement of operations as an
international long distance carrier, an increase in the number of customers as
compared to the prior year and an increase in minutes of wholesale traffic from
new and existing customers. The increase in traffic is also attributable to an
increase in the number of routes with favorable rates that STAR was able to
offer to customers. Commercial revenues decreased to $29.9 million in 1996 from
$30.2 million in 1995 due to a decrease in the rate per minute charged, which
was partially offset by an increase in the number of minutes sold. Taking into
account the acquisition of T-One, on a pro forma basis revenues would have been
$260.4 million in 1996, an increase of 341.9% from $58.9 million in 1995.
GROSS PROFIT. Gross profit increased 125.3% to $32.4 million for 1996 from
$14.4 million in 1995. Wholesale gross profit increased to $19.7 million in 1996
from $1.8 million for 1995. Wholesale gross margin decreased to 9.4% in 1996
from 11.0% in 1995, reflecting the change from STAR's prior consulting business
to operating as an international long distance carrier. Gross profit was
positively impacted during 1996 by the negotiation of lower rates on routes with
significant traffic, and negatively impacted by increases in traffic on routes
with lower margins. Commercial gross profit increased to $12.7 million in 1996
from $12.6 million in 1995 with gross margin increasing to 42.6% from 41.8%,
respectively. The gross profit from commercial services expanded as costs
associated with the local exchange carriers declined. Taking into account the
acquisition of T-One, on a pro forma basis, gross profit in 1996 would have been
$33.7 million, an increase of 130.0% from $14.7 million in 1995.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses increased 240.4% to $34.3 million in 1996 from $10.1 million in 1995.
Wholesale selling, general and administrative expenses increased to $24.1
million in 1996 from $2.1 million in 1995, and decreased as a percentage of
revenues to 11.6% from 12.8% in the prior period. Selling, general and
administrative expenses increased between periods as STAR increased its employee
base and incurred payroll, employee benefits, commission and related expenses.
STAR also established a reserve for doubtful accounts to reflect its
significantly higher revenue levels and invested in sales and marketing
activities, including tradeshows and travel. Hi-Rim and CCI, two of STAR's major
customers in 1996, informed STAR that they were experiencing financial
difficulties and would be unable to pay in full outstanding accounts receivable.
As a result, the full amount of the approximately $10.8 million owed to STAR by
Hi-Rim and CCI as of December 31, 1996 which was not subsequently collected or
for which no offsetting value was received, was written off or reserved in 1996.
In addition, STAR wrote-off $820,000 of intangible assets relating to CCI.
Commercial selling, general and administrative expenses increased to $10.2
million in 1996 from $8.0 million in 1995 reflecting higher operating costs.
DEPRECIATION. Depreciation increased to $1.2 million for 1996 from $186,000
for 1995, an increase as a percentage of revenues to 0.5% from 0.4% in the prior
period. Depreciation increased as a result of STAR's purchase of switches and of
the operating equipment and leasehold improvements associated with its Los
Angeles and New York switching facilities. Depreciation expense will increase as
STAR expands its ownership of switching and transmission facilities through
purchase or use of capital leases.
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OTHER INCOME (EXPENSE). Other expense, net, increased to $552,000 in 1996
from $75,000 in 1995. This increase is primarily due to a $100,000 legal
settlement in the second quarter of 1996 as well as $601,000 in interest expense
incurred under various bank and stockholder lines of credit. This increase was
offset by $110,000 in interest income on short-term investments and cash
equivalents primarily from funds raised in private placements of equity
securities during the first three quarters of 1996.
PROVISION FOR INCOME TAXES. Through December 31, 1995 STAR had elected to
be taxed as an
S-Corporation for both federal and state income tax purposes and thus was only
subject to 1.5% tax on taxable income for state purposes. LDS was an
S-Corporation through the date of the merger on November 30, 1997. The pro forma
provision for income taxes, assumes that both STAR and LDS were C-Corporations
for all periods presented. During 1996, the historical provision for income
taxes increased to $592,000 as a result of the reserve of $2.9 million of the
net deferred tax asset.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 1998, STAR had cash and cash equivalents of approximately
$5.3 million, short-term investments of $3.0 million, and a working capital
surplus of $8.3 million. In June 1997, STAR completed an initial public offering
of 9.4 million shares of Common Stock of which approximately 8.1 million shares
were sold by STAR and approximately 1.3 million shares were sold by certain
selling stockholders. The net proceeds to STAR (after deducting, underwriting,
discounts and offering expenses) from the sale of such shares of Common Stock
were approximately $30.9 million. As of December 31, 1997, STAR had used the
proceeds from the offering to repay indebtedness of $14.2 million, to purchase
switching and transmission related equipment and to finance STAR's operations in
the U.K.
On May 4, 1998, STAR completed a secondary offering of 6,000,000 shares of
Common Stock of which 5,685,000 shares were sold by STAR and 315,000 shares were
sold by a selling stockholder. The net proceeds to STAR (after deducting
underwriting discounts and offering expenses) from the sale of such shares of
Common Stock were aproximately $145.0 million.
As of March 31, 1998, STAR had no funds outstanding on its $25 million
revolving line of credit, which bears interest at the bank's cost of funds plus
175 basis points and expires on July 1, 1999. However, the line of credit is
reduced by outstanding letters of credit in the amount of $4.7 million.
STAR generated net cash from operating activities of $10.1 million in 1997,
primarily from net income plus depreciation and amortization, while using $3.4
million in 1996. STAR's investing activities used cash of approximately $29.6
million during 1997 primarily resulting from capital expenditures and the
investment of the proceeds from the initial public offering in marketable
securities, while using $9.8 million in 1996. STAR's financing activities
provided cash of approximately $19.3 million during 1997 primarily from the sale
of Common Stock and borrowings under lines of credit, offset by repayments under
various lines of credit, while providing $14.7 million in 1996.
STAR generated net cash from operating activities of $3.7 million in the
first quarter of 1998. The Company's investing activities provided cash of
approximately $17,000 during the first quarter of 1998 primarily from the sale
of marketable securities offset by investments made in additional undersea
cables and switching equipment. STAR's financing activities used cash of
approximately $335,000 during the first quarter of 1998 primarily from
repayments under capital lease agreements offset by the exercise of employee
stock options.
At March 31, 1998, STAR had capital lease obligations of $30.1 million, and
$2.1 million in term loans, relating to its switching facilities and operating
equipment. STAR anticipates making capital expenditures of approximately $80.0
million during 1998 to expand its global network. STAR believes that the
proceeds from the offering and cash generated from operations, as well as
funding under its bank line of credit, will satisfy STAR's current liquidity
needs. Nevertheless, as STAR continues to expand its network facilities and
pursues its strategy of growth through acquisition, STAR's liquidity needs may
increase, perhaps
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significantly, which could require STAR to seek such additional financing or the
expansion of its borrowing capacity under current or new lines of credit. As
appropriate, STAR will use capital lease financing or raise additional debt or
equity capital to finance new projects or acquisitions. STAR had foreign
currency contracts outstanding at December 31, 1997 in the notional amount of
$6.3 million. STAR had no foreign currency contracts outstanding at March 31,
1998.
YEAR 2000 COMPLIANCE. STAR has made a concerted effort to ensure that the
software components of its information and billing systems are Year 2000
compliant. As such, management believes that, after January 1, 2000, STAR will
be able to continue to accurately track and bill calls. At the same time, it is
likely that the operations of a number of STAR's customers and vendors rely on
software that is not Year 2000 compliant.
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BUSINESS OF STAR
OVERVIEW
STAR is an emerging multinational carrier focused primarily on the
international long distance market. STAR offers highly reliable, low-cost
switched voice services on a wholesale basis, primarily to U.S.-based long
distance carriers. STAR provides international long distance service to
approximately 220 foreign countries through a flexible network comprised of
various foreign termination relationships, international gateway switches,
leased and owned transmission facilities and resale arrangements with long
distance providers. STAR has grown its revenues rapidly by capitalizing on the
deregulation of international telecommunications markets, combining
sophisticated information systems with flexible routing and leveraging
management's industry expertise. STAR has increased its revenues from $46.3
million in 1995 to $376.2 million in 1997.
INDUSTRY BACKGROUND
The international long distance telecommunications services industry
consists of all transmissions of voice and data that originate in one country
and terminate in another. This industry is undergoing a period of fundamental
change which has resulted in substantial growth in international
telecommunications traffic. According to industry sources, worldwide gross
revenues for providers of international telephone service were over $60 billion
in 1996 and the volume of international traffic on the public telephone network
is expected to grow at a compound annual growth rate of approximately 13% from
1996 through the year 2000.
From the standpoint of U.S.-based long distance providers, the industry can
be divided into two major segments: the U.S. international market, consisting of
all international calls billed in the U.S., and the overseas market, consisting
of all international calls billed in countries other than the U.S. The U.S.
international market has experienced substantial growth in recent years, with
gross revenues from international long distance services rising from
approximately $8.5 billion in 1990 to approximately $14.9 billion in 1996,
according to FCC data.
STAR believes that a number of trends in the international
telecommunications market will continue to drive growth in international
traffic, including:
- continuing deregulation and privatization of telecommunications markets;
- pressure to reduce international outbound long distance rates paid by end
users driven by increased competition in newly deregulated global markets;
- the dramatic increase in the availability of telephones and the number of
access lines in service around the world;
- the increasing globalization of commerce, trade and travel;
- the proliferation of communications devices such as faxes, cellular
telephones, pagers and data communications devices;
- increasing demand for data transmission services, including the Internet;
and
- the increased utilization of high quality digital undersea cable and
resulting expansion of bandwidth availability.
THE DEVELOPMENT OF THE U.S. AND OVERSEAS MARKETS
The 1984 deregulation of the U.S. telecommunications industry enabled the
emergence of a number of new long distance companies in the U.S. Today, there
are over 500 U.S. long distance companies, most of which are small or
medium-sized companies. In order to be successful, these small and medium-sized
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companies need to offer their customers a full range of services, including
international long distance. However, most of these carriers do not have the
critical mass to receive volume discounts on international traffic from the
larger facilities-based carriers such as AT&T, MCI and Sprint. In addition,
these small and medium sized companies generally have only limited capital
resources to invest in international facilities. New international carriers such
as STAR emerged to take advantage of this demand for less expensive
international bandwidth. These emerging multinational carriers acted as
aggregators of international traffic for smaller carriers, taking advantage of
larger volumes to obtain volume discounts on international routes (resale
traffic), or investing in facilities when volume on particular routes justify
such investments. Over time, as these emerging international carriers became
established and created a high quality networks, they began to carry overflow
traffic from the larger long distance providers seeking lower rates on certain
routes.
Deregulation and privatization have also allowed new long distance providers
to emerge in foreign markets. By eroding the traditional monopolies held by
single national providers, many of which are wholly or partially government
owned, such as Post Telegraph & Telephone operators ("PTTs"), deregulation is
providing U.S.-based providers the opportunity to negotiate more favorable
agreements with PTTs and emerging foreign providers. In addition, deregulation
in certain foreign countries is enabling U.S.-based providers to establish local
switching and transmission facilities in order to terminate their own traffic
and begin to carry international long distance traffic originated in that
country. STAR believes that growth of traffic originated in markets outside of
the U.S. will be higher than the growth in traffic originated within the U.S.
due to recent deregulation in many foreign markets, relative economic growth
rates and increasing access to telecommunications facilities in emerging
markets.
INTERNATIONAL SWITCHED LONG DISTANCE SERVICES
International switched long distance services are provided through switching
and transmission facilities that automatically route calls to circuits based
upon a predetermined set of routing criteria. The call typically originates on a
local exchange carrier's network and is transported to the caller's domestic
long distance carrier. The domestic long distance provider then carries the call
to an international gateway switch. An international long distance provider
picks up the call at its gateway and sends it directly or through one or more
other long distance providers to a corresponding gateway switch operated in the
country of destination. Once the traffic reaches the country of destination, it
is then routed to the party being called though that country's domestic
telephone network.
International long distance providers can generally be categorized by their
ownership and use of switches and transmission facilities. The largest U.S.
carriers, such as AT&T, MCI and Sprint, primarily utilize owned transmission
facilities and generally use other long distance providers to carry their
overflow traffic. Since only very large carriers have transmission facilities
that cover the over 200 countries to which major long distance providers
generally offer service, a significantly larger group of long distance providers
own and operate their own switches but either rely solely on resale agreements
with other long distance
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carriers to terminate their traffic or use a combination of resale agreements
and owned facilities in order to terminate their traffic as shown below:
[GRAPH]
OPERATING AGREEMENTS. Under traditional operating agreements, international
long distance traffic is exchanged under bilateral agreements between
international long distance providers in two countries. Operating agreements
provide for the termination of traffic in, and return traffic to, the
international long distance providers' respective countries at a standard
"accounting rate" with that international provider. Under a traditional
operating agreement, the international long distance provider that originates
more traffic compensates the long distance provider in the other country by
paying a net amount based on the difference between minutes sent and minutes
received and the settlement rate, which is generally one-half of the accounting
rate.
Under a typical operating agreement both carriers jointly own the
transmission facilities between two countries. A carrier gains ownership rights
in a digital fiber optic cable by purchasing direct ownership in a particular
cable prior to the time the cable is placed in service, acquiring an
"Indefeasible Right of Use" ("IRU") in a previously installed cable, or by
leasing or obtaining capacity from another long distance provider that either
has direct ownership or IRUs in the cable. In situations where a long distance
provider has sufficiently high traffic volume, routing calls across directly
owned or IRU cable is generally more cost-effective on a per call basis than the
use of short-term variable capacity arrangements with other long distance
providers or leased cable. However, direct ownership and acquisition of IRUs
require a company to make an initial investment of its capital based on
anticipated usage.
TRANSIT ARRANGEMENTS. In addition to utilizing an operating agreement to
terminate traffic delivered from one country directly to another, an
international long distance provider may enter into transit arrangements
pursuant to which a long distance provider in an intermediate country carries
the traffic to a country of destination. Such transit arrangements involve
agreement among the providers in all the countries involved and are generally
used for overflow traffic or where a direct circuit is unavailable or not volume
justified.
RESALE ARRANGEMENTS. Resale arrangements typically involve the wholesale
purchase and sale of transmission and termination services between two long
distance providers on a variable, per minute basis. The resale of capacity,
which was first permitted in the U.S. market in the 1980s enabled the emergence
of new international long distance providers that rely at least in part on
capacity acquired on a wholesale basis from other long distance providers.
International long distance calls may be routed through a facilities-based
carrier with excess capacity, or through multiple long distance resellers
between the originating long
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distance provider and the facilities-based carrier that ultimately terminates
the traffic. Resale arrangements set per minute prices for different routes,
which may be guaranteed for a set time period or subject to fluctuation
following notice. The resale market for international capacity is constantly
changing, as new long distance resellers emerge and existing providers respond
to fluctuating costs and competitive pressures. In order to be able to
effectively manage costs when utilizing resale arrangements, long distance
providers need timely access to changing market data and must quickly react to
changes in costs through pricing adjustments or routing decisions.
ALTERNATIVE TERMINATION ARRANGEMENTS. As the international
telecommunications market has become deregulated, service providers have
developed alternative arrangements to reduce their termination costs by, for
example, routing traffic via third countries to obtain lower settlement rates or
using international private line facilities to bypass the settlement rates
applicable to traffic routed over the PSTN. These arrangements include ISR,
traffic refiling and the acquisition of transmission and switching facilities in
foreign countries so as to self-correspond. Refiling of traffic takes advantage
of disparities in settlement rates between different countries. An originating
operator typically refiles traffic by sending it first to a third country that
enjoys lower settlement rates with the destination country where upon it is
forwarded or refiled to the destination country thereby resulting in a lower
overall termination cost. The difference between transit and refiling is that,
with respect to transit, the operator in the destination country typically has a
direct relationship with the originating operator and is aware of the
arrangement, while with refiling, the operator in the destination country
typically is not aware that it is terminating refiled traffic originated in
another country. While the United States has taken no position with respect to
whether refile comports with international regulation, refile is illegal in many
countries. With ISR, a long distance provider completely bypasses the settlement
system by connecting an IPL to the PSTN on one or both ends. While ISR currently
is only sanctioned by U.S. and other regulatory authorities on some routes, ISR
services are increasing and are expected to expand significantly as deregulation
of the international telecommunications market continues. In addition, new
market access agreements, such as the WTO Agreement, have made it possible for
many international service providers to establish their own transmission and
switching facilities in certain foreign countries, enabling them to
self-correspond and directly terminate traffic. See "--Government Regulation."
The highly competitive and rapidly changing international telecommunications
market has created a significant opportunity for carriers that can offer high
quality, low cost international long distance service. Deregulation,
privatization, the expansion of the resale market and other trends influencing
the international telecommunications market are driving decreased termination
costs, a proliferation of routing options, and increased competition. Successful
companies among both the emerging and established international long distance
companies will need to aggregate enough traffic to lower costs of both
facilities-based or resale opportunities, maintain systems which enable analysis
of multiple routing options, invest in facilities and switches and remain
flexible enough to locate and route traffic through the most advantageous
routes.
THE STAR APPROACH
STAR is an emerging multinational carrier focused primarily on the
international long distance market. STAR offers highly reliable, low-cost
switched voice services on a wholesale basis, primarily to U.S.-based long
distance carriers. STAR provides international long distance service to
approximately 220 foreign countries through a flexible network comprised of
various foreign termination relationships, international gateway switches,
leased and owned transmission facilities and resale arrangements with long
distance providers. STAR has grown its revenues rapidly by capitalizing on the
deregulation of international telecommunications markets, combining
sophisticated information systems with flexible routing and leveraging
management's industry expertise.
STAR markets its services to large global carriers seeking lower rates and
high quality overflow capacity, as well as to small and medium-sized long
distance companies that do not have the critical mass to invest in their own
international transmission facilities or to obtain volume discounts from the
larger
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facilities-based carriers. During the fourth quarter of 1997, STAR provided
switched international long distance services to 105 customers and currently
provides these services to nine of the top forty global carriers. STAR has also
recently focused on building a customer base overseas, particularly in Europe,
and has opened offices in Dusseldorf, Frankfurt, Hamburg and Munich, Germany and
London, England. In addition, STAR has begun to market its international long
distance services directly to certain commercial customers in the U.S. and
overseas.
STRATEGY
STAR's objective is to be a leading provider of highly reliable, low-cost
switched international long distance services on a wholesale basis to U.S. and
foreign-based telecommunications companies, as well as on a retail basis to
commercial customers. Key elements of STAR's strategy include the following:
EXPAND SWITCHING AND TRANSMISSION FACILITIES. STAR is continuing to pursue a
flexible approach to expanding and enhancing its network facilities by investing
in both switching and transmission facilities where traffic volumes justify such
investments. STAR has expanded its international gateway switching facilities
through the addition of a facility in Dallas and plans to put into service in
1998 switches in Atlanta, Chicago, Miami and Seattle; Dusseldorf, Frankfurt,
Hamburg and Munich, Germany; Paris, France; and Tokyo, Japan. STAR's
international gateway switch in London, England went into service in April 1997
and four switches in Germany are expected to be operational in the second
quarter of 1998. In addition, STAR is planning to install a network of switches
in selected other European and Asian cities.
CAPITALIZE ON PROJECTED INTERNATIONAL LONG DISTANCE GROWTH. STAR believes
that the international long distance market provides attractive opportunities
due to its higher revenue and profit per minute, and greater projected growth
rate as compared to the domestic long distance market. STAR targets
international markets with high volumes of traffic, relatively high rates per
minute and prospects for deregulation and privatization. STAR believes that the
ongoing trend toward deregulation and privatization will create new
opportunities for STAR in international markets. Although STAR has focused to
date primarily on providing services for U.S.-based long distance providers,
STAR also intends to expand the international long distance services it offers
to foreign-based long distance providers.
LEVERAGE TRAFFIC VOLUME TO REDUCE COSTS. STAR continues to focus on building
its volume of international long distance traffic. Higher traffic volumes
strengthen STAR's negotiating position with vendors, customers and potential
foreign partners, which allows STAR to lower its costs of service. In addition,
higher traffic volumes on particular routes allow STAR to lower its cost of
services on these routes by transitioning from acquiring capacity on a variable
cost per minute basis to fixed cost arrangements such as longer-term capacity
agreements with major carriers, long-term leases and ownership of facilities.
LEVERAGE INFORMATION SYSTEMS AND SWITCHING CAPABILITIES. STAR leverages its
sophisticated information systems to analyze its routing alternatives, and
select the most cost-effective routing from among STAR owned facilities, network
of resale arrangements with other long distance providers, operating agreements
and alternative termination relationships. STAR has invested significant
resources in the development of software to track specific usage information by
customer and revenue and cost information on specific routes on a daily basis.
STAR's information systems are critical components in managing its customer and
vendor relationships, routing traffic to the most cost-effective alternative,
and targeting its marketing efforts.
MAINTAIN HIGH QUALITY. STAR believes that reliability, call completion
rates, voice quality, rapid set up time and a high level of customer and
technical support are key factors evaluated by U.S. and foreign-based
telecommunications companies and large corporate customers in selecting a
carrier for their international traffic. STAR's state-of-the-art switching
equipment is fully compliant with international C-7 and domestic SS-7 signaling
standards. STAR strives to provide a consistently high level of customer and
technical support and has technical support personnel at its switching
facilities 24 hours per day, seven days per week to assist its customers and to
continually monitor network operations.
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EXPAND INTO COMMERCIAL MARKET. STAR plans to expand into niche commercial
markets in the U.S. and in other deregulating countries where it believes it can
leverage its international network and where the customer base has a significant
international calling pattern. As an example of this strategy, STAR is using the
LDS telemarketing sales force to target small commercial customers in ethnic
markets to increase traffic to Mexico and Latin America. Additionally, STAR
intends to use UDN's network of independent sales agents to target medium-sized
commercial customers with a demand for international calling services at
competitive rates. Finally, STAR plans to use its direct sales forces to target
larger commercial customers, concentrating at first on potential customers in
Los Angeles and New York. With respect to the offering of commercial services
abroad, STAR initially intends to focus on Germany, the U.K. and selected
European cities where competition for commercial customers is less mature.
GROWTH THROUGH ACQUISITIONS. STAR actively pursues opportunities to enhance
its business through strategic and synergistic acquisitions. These acquisitions
may focus on entering new territories, enlarging STAR's presence in an existing
territory, adding capacity or expanding into new market segments, such as the
commercial market. In addition to expanding its revenue base, STAR plans to
realize operating efficiencies by integrating newly-acquired operations into
STAR's billing, tracking and other systems. On November 30, 1997, STAR acquired
LDS, a long-distance provider focusing on small commercial customers throughout
the United States, for approximately 849,000 shares of Common Stock. On March
10, 1998, STAR acquired T-One, an international wholesale long distance
provider, for 1,353,000 shares of Common Stock. On November 19, 1997, STAR
entered into an agreement to acquire UDN, a commercial long distance provider.
The acquisition of UDN is subject to approval by UDN's stockholders and to
various regulatory approvals. Assuming the receipt of all necessary approvals,
STAR expects to consummate the UDN acquisition in the second quarter of 1998 for
approximately 800,000 shares of Common Stock. Each of these transactions has
been, or will be, accounted for as a pooling of interests.
NETWORK
STAR provides international long distance services to approximately 220
foreign countries through a flexible, switched-based network consisting of
resale arrangements with other long distance providers, various foreign
termination relationships, international gateway switches and leased and owned
transmission facilities. STAR's network employs state-of-the-art digital
switching and transmission technologies and is supported by comprehensive
monitoring and technical support personnel. STAR's switching facilities are
staffed 24 hours per day, seven days per week.
TERMINATION ARRANGEMENTS
STAR seeks to retain flexibility and maximize its termination opportunities
by utilizing a continuously changing mix of routing alternatives, including
resale arrangements, operating agreements and other advantageous termination
arrangements. This diversified approach is intended to enable STAR to take
advantage of the rapidly evolving international telecommunications market in
order to provide low-cost international long distance service to its customers.
STAR utilizes resale arrangements to provide it with multiple options for
routing traffic through its switches to each destination country. Traffic under
resale arrangements typically terminates pursuant to a third party's
correspondent relationships. STAR purchased capacity from 57 vendors in 1997. A
substantial portion of this capacity is obtained on a variable, per minute and
short-term basis, subjecting STAR to the possibility of unanticipated price
increases and service cancellations. STAR's contracts with its vendors provide
that rates may fluctuate, with rate change notice periods varying from five days
to one year, with certain of STAR's longer term arrangements requiring STAR to
make minimum usage commitments in order to achieve additional volume discounts.
As a result of deregulation and competition in the international
telecommunications market, the pricing of termination services varies by carrier
depending on such factors as call traffic and time of day. Since STAR does not
typically enter into long-term contracts with these providers, pricing can
change significantly over short periods of time. STAR's proprietary
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information systems enable STAR to track the pricing variations in the
international telecommunications market on a daily basis, allowing STAR's
management to locate and reroute traffic to the most cost-effective
alternatives. See "Risk Factors--Operating Results Subject to Significant
Fluctuations."
STAR currently has operating agreements with carriers in a number of
countries and is in the process of negotiating additional operating agreements
for other countries. STAR has been and will continue to be selective in entering
into operating agreements. STAR also has agreements with international providers
of long distance services for termination of traffic that STAR routes over a its
network to such countries. STAR currently has such termination arrangements with
several carriers in a number of countries, and STAR is in the process of
expanding its coverage of such countries and entering into similar arrangements
in additional countries. The FCC or foreign regulatory agencies may take the
view that certain of STAR's termination arrangements do not comply with current
rules and policies applicable to international settlements, such as current ISR
rules. To the extent that the revenue generated under such arrangements becomes
a significant portion of overall revenue, the loss of such arrangements, whether
as a result of regulatory actions or otherwise, could have a material adverse
effect on STAR's business, operating results and financial condition. In
addition, the FCC could impose sanctions on STAR, including forfeitures, if
certain of STAR's arrangements are found to be inconsistent with FCC rules. See
"--Government Regulation," "Risk Factors--Risks of International
Telecommunications Business," and "--Potential Adverse Effects of Government
Regulation."
SWITCHES AND TRANSMISSION FACILITIES
International long distance traffic to and from the U.S. is generally
transmitted through an international gateway switching facility across undersea
digital fiber optic cable or via satellite to a termination point. International
gateway switches are digital computerized routing facilities that receive calls,
route calls through transmission lines to their destination and record
information about the source, destination and duration of calls. STAR's global
network facilities include both international gateway switches and undersea
digital fiber optic cable.
STAR currently operates international gateway switches in New York, Los
Angeles, Dallas and London, England. In 1998, STAR plans to put into service
international gateway switches in Atlanta, Chicago, Miami and Seattle;
Dusseldorf, Frankfurt, Hamburg, and Munich, Germany; Paris, France; and Tokyo,
Japan. STAR considers any of its switches to be international gateway switches
if STAR can route international calls across such switch.
STAR's switching facilities are linked to a proprietary reporting system,
which STAR believes provides it with a competitive advantage by permitting
management on a real-time basis to determine the most cost-effective termination
alternatives, monitor customer usage and manage gross margins by route. STAR has
installed multiple redundancies into its switching facilities to decrease the
risk of a network failure. For example, STAR employs both battery and generator
power back-up and has installed hardware that automatically shifts the system to
auxiliary power during a power outage, rather than relying on manual override.
STAR is in the process of adding a network control center in its Los Angeles
facility, which is expected to be completed in 1998.
STAR currently holds ownership positions in a number of digital undersea
fiber optic cables, and has recently added capacity on the TPC-5 undersea fiber
optic cable system and has entered into commitments to acquire transmission
capacity on three additional undersea fiber optic cable systems, Gemini, AC-1
and China-U.S. STAR plans to increase its investment in direct and IRU ownership
of cable in situations where STAR enters into operating agreements and in other
situations in which it determines that such an investment would enhance
operating efficiency or reduce transmission costs.
Through its acquisitions of T-One and UDN, STAR has acquired, or will
acquire, additional switching and transmission facilities. By acquiring T-One,
STAR has added a switch located in the same building as STAR's New York
international gateway switch and has added a number of operating agreements to
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countries in Africa and the Middle East, among other locations. In addition,
T-One owns capacity on certain cable and satellite systems. Upon consummation of
the acquisition of UDN, STAR will acquire a switch located in the same building
as STAR's Dallas switch. STAR plans to integrate these facilities into its
existing network.
SALES AND MARKETING
STAR markets its services on a wholesale basis to other telecommunications
companies through its experienced direct sales force and marketing/account
management team who leverage the long-term industry relationships of STAR's
senior management. STAR reaches its customers primarily through domestic and
international trade shows and through relationships gained from years of
experience in the telecommunications industry. STAR had 20 direct sales and
marketing employees and over 145 telemarketing representatives as of March 1,
1998.
In the wholesale market, STAR's sales and marketing employees utilize the
extensive, customer specific usage reports and network utilization data
generated by STAR's sophisticated information systems to effectively negotiate
agreements with customers and prospective customers and to rapidly respond to
changing market conditions. STAR believes that it has been able to compete more
effectively as a result of the personalized service and ongoing senior
management-level attention that is given to each customer.
In connection with STAR's expansion into the commercial market, STAR expects
to target small commercial customers through LDS' existing telemarketing
operation, deliver services to medium-sized commercial customers through UDN's
network of independent sales agents and utilize a direct sales force to approach
larger commercial accounts. Establishment of a sales force capable of
effectively expanding STAR's services into the commercial market can be expected
to require substantial efforts and management and financial resources and may
increase STAR's operating costs. See "Risk Factors--Risks Associated with Growth
of Telecommunications Network and Customer Base."
INFORMATION AND BILLING SYSTEMS
STAR's operations use advanced information systems including call data
collection and call data storage linked to a proprietary reporting system. STAR
also maintains redundant billing systems for rapid and accurate customer
billing. STAR's switching facilities are linked to a proprietary reporting
system, which STAR believes provides it with a competitive advantage by
permitting management on a real-time basis to determine the most cost-effective
termination alternatives, monitor customer usage and manage gross margins by
route. STAR's systems also enable it to ensure accurate and timely billing and
to reduce routing errors. As STAR's systems were designed for the wholesale
marketplace, STAR is currently in the process of modifying its systems in
anticipation of its entrance into the commercial marketplace.
STAR's proprietary reporting software compiles call, price and cost data
into a variety of reports which STAR can use to re-program its routes on a
real-time basis. STAR's reporting software can generate the following reports as
needed:
- customer usage, detailing usage by country and by time period within
country, in order to track sales and rapidly respond to any loss of
traffic from a particular customer;
- country usage, subtotaled by vendor or customer, which assists STAR with
route and network planning;
- vendor rates, through an audit report that allows management to determine
at a glance which vendors have the lowest rates for a particular country
in a particular time period;
- vendor usage by minute, enabling STAR to verify and audit vendor bills;
- dollarized vendor usage to calculate the monetary value of minutes passed
to STAR's vendors, which assists with calculating operating margin when
used in connection with the customer reports;
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- loss reports used to rapidly highlight routing alternatives that are
operating at a loss as well as identifying routes experiencing substantial
overflow; and
- LATA (Domestic Call Area) reporting by originating and terminating LATA,
allowing for accurate Local Exchange charge audits, and protecting from
Local Exchange overcharging.
STAR has built multiple redundancies into its billing and call data
collections systems. Nine call collector computers receive call information in
real-time, immediately duplicating data, sending one copy to billing, while the
other copy is used for customer service internally and for traffic analysis.
STAR maintains two independent and redundant billing systems in order to both
verify billing internally and to ensure that bills are sent out on a timely
basis. All of the call data, and resulting billing data, are continuously backed
up on tape drives and redundant storage devices, and are regularly transported
to an off-site safe location.
COMPETITION
The international telecommunications industry is intensely competitive and
subject to rapid change. STAR's competitors in the international wholesale
switched long distance market include large, facilities-based multinational
corporations and PTTs, smaller facilities-based providers in the U.S. and
overseas that have emerged as a result of deregulation, switched-based resellers
of international long distance services and international joint ventures and
alliances among such companies. International wholesale switched long distance
providers compete on the basis of price, customer service, transmission quality,
breadth of service offerings and value-added services. STAR also competes abroad
with a number of dominant telecommunications operators that previously held
various monopolies established by law over the telecommunications traffic in
their countries. See "Risk Factors--Significant Competition." Additionally, the
telecommunications industry is in a period of rapid technological evolution,
marked by the introduction of competitive new product and service offerings,
such as the utilization of the Internet for international voice and data
communications. STAR is unable to predict which of many possible future product
and service offerings will be important to maintain its competitive position or
what expenditures will be required to develop and provide such products and
services. STAR believes that it competes favorably on the basis of price,
transmission quality and customer service. The number of STAR's competitors is
likely to increase as a result of the new competitive opportunities created by
the WTO Agreement. Further, under the terms of the WTO Agreement, the United
States and the other 68 countries participating in the Agreement have committed
to open their telecommunications markets to competition, and foreign ownership
and adopt measures to protect against anticompetitive behavior, effective
starting on February 5, 1998. As a result, STAR believes that competition will
continue to increase, placing downward pressure on prices. Such pressure could
adversely affect STAR's gross margins if STAR is not able to reduce its costs
commensurate with such price reductions.
COMPETITION FROM DOMESTIC AND INTERNATIONAL COMPANIES AND ALLIANCES. A
majority of the U.S.-based international telecommunications services revenue is
currently generated by AT&T, MCI and Sprint. STAR also competes with WorldCom,
Pacific Gateway Exchange, Inc. and other U.S.-based and foreign long distance
providers, including the RBOCs, which presently have FCC authority to resell and
terminate international telecommunication services. Many of these companies have
considerably greater financial and other resources and more extensive domestic
and international communications networks than STAR. STAR's business would be
materially adversely affected to the extent that a significant number of such
customers limit or cease doing business with STAR for competitive or other
reasons. Consolidation in the telecommunications industry could not only create
even larger competitors with greater financial and other resources, but could
also adversely affect STAR by reducing the number of potential customers for
STAR's services.
EXPANSION INTO COMMERCIAL MARKET. With the acquisition of LDS, STAR began
providing long distance service to the commercial market, a market that is
subject to intense competition from a number
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of well capitalized companies. The commercial market is also characterized by
the lack of customer loyalty, with commercial customers regularly changing
service providers. There can be no assurance that STAR will be able to compete
successfully in the commercial market.
GOVERNMENT REGULATION
STAR's U.S. interstate and international telecommunications service
offerings generally are subject to the regulatory jurisdiction of the FCC.
Certain telecommunication services offered by STAR in the U.S. may also be
subject to the jurisdiction of state regulatory authorities, commonly known as
public utility commissions ("PUCs"). STAR's telecommunications service offerings
outside the U.S. are also generally subject to regulation by national regulatory
authorities. In addition, U.S. and foreign regulatory authorities may affect
STAR's international service offerings as a result of the termination or transit
arrangements associated therewith. U.S. or foreign regulatory authorities may
take actions or adopt regulatory requirements which could adversely affect STAR.
See "Risk Factors--Potential Adverse Effect of Government Regulation."
U.S. REGULATION
STAR's business is subject to various U.S. and foreign laws, regulations,
agency actions and court decisions. STAR's U.S. international telecommunications
service offerings are subject to regulation by the FCC. The FCC requires
international carriers to obtain authorization under Section 214 of the
Communications Act prior to acquiring international facilities by purchase or
lease, or providing international service to the public. Prior FCC approval is
also required to transfer control of a certificated carrier. STAR is also
subject to FCC policies and rules that regulate the manner in which
international telecommunication services may be provided, including, for
instance, the circumstances under which a carrier may provide international
switched services using IPL facilities and under which it may route traffic
through third countries to or from its final destination.
The Communications Act and the FCC's rules and policies also impose certain
other obligations on carriers providing international telecommunication
services. These include the obligation to file at the FCC and to maintain
tariffs containing the rates, terms, and conditions applicable to their
services; to file certain reports regarding international traffic and
facilities; to file certain contracts with correspondent carriers; to disclose
affiliations with foreign carriers and significant foreign ownership interests;
to pay certain regulatory fees based, among other things, upon the carrier's
revenues and ownership of international transmission capacity.
INTERNATIONAL SERVICES. FCC rules require STAR to obtain prior FCC
authorization to acquire and operate international communication circuits in
satellites and undersea fiber optic cables; similar FCC authority is required
for STAR to resell such capacity. STAR holds both facilities-based and resale
international authorizations, including a "global" authorization that provides
broad authority to offer switched and private line international services. STAR
has filed tariffs for international services with the FCC.
FCC INTERNATIONAL PRIVATE LINE RESALE POLICY. The FCC's IPL resale policy
limits the conditions under which a carrier may connect IPLs to the PSTN at one
or both ends to provide switched services, commonly known as ISR. A carrier
generally may only offer ISR services to a foreign country if the FCC has found
(a) the country is a member of the WTO and at least 50% of the U.S. billed and
settled traffic to that country is settled at or below the benchmark settlement
rate adopted by the FCC in IB Docket No. 96-261; or (b) the country is not a WTO
member, but it offers U.S. carriers equivalent opportunities to engage in ISR
and at least 50% of the U.S. billed and settled traffic is settled at or below
the applicable benchmark. Settled traffic refers to traffic subject to an
accounting rate agreement between U.S. and foreign carriers. An accounting rate
is a per minute wholesale charge negotiated by international carriers for
terminating traffic in either direction. Each carrier is paid a settlement rate
for terminating traffic on its own network
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which ordinarily is one-half of the accounting rate. STAR's FCC authority
currently permit it to provide ISR service to Canada, the U.K., Sweden, New
Zealand, Australia and the Netherlands. The FCC is currently reviewing U.S.
carrier applications to provide ISR to Belgium, Chile, Denmark, Finland, France,
Germany, Hong Kong, Norway and Luxembourg, among other routes, and upon grant of
any such ISR application to a given country, the FCC's rules also would permit
STAR to provide ISR service to that country. Certain of STAR's termination
arrangements with foreign operators involve IPL arrangements which may be
inconsistent with the foregoing FCC IPL resale policy and STAR's existing ISR
authorization. If the FCC were to determine, by its own actions or in response
to the filing of a third party that any of STAR's IPL arrangements violate its
ISR policy or STAR's ISR authorization, the FCC could order STAR to terminate
any non-conforming arrangements. In addition, STAR could be subject to a
monetary forfeiture and to other penalties, including the revocation of STAR's
FCC authorizations to operate as an international carrier. Any such FCC action
could have a material adverse effect upon STAR's business, operating results and
financial condition.
FCC INTERNATIONAL SETTLEMENTS POLICY. The FCC's ISP places limits on the
arrangements which U.S. international carriers may enter into with foreign
carriers for exchanging public switched telecommunications traffic, which the
FCC terms International Message Telephone Service. The policy does not apply to
ISR services. The ISP is primarily intended to deter dominant foreign carriers
from discriminating amongst competing U.S. carriers by, for example, favoring
the foreign carrier's U.S. affiliate. Absent FCC consent, the ISP requires that
U.S. carriers receive an equal share of the accounting rate (i.e., that
settlement rates be equivalent) and receive inbound traffic in proportion to the
volume of U.S. outbound traffic which they generate. The ISP and other FCC
policies also prohibit a U.S. carrier from offering or accepting a "special
concession" from a foreign carrier where the foreign carrier possess sufficient
market power on the foreign end of the route to affect competition adversely in
the U.S. market." A "special concession" is defined by the FCC as an exclusive
arrangement involving services, facilities or functions on the foreign end of a
U.S. international route which are necessary for providing basic
telecommunications, and which are not offered to similarly situated U.S.
carriers authorized to serve that route. U.S. international carriers wishing to
establish settlement arrangements for IMTS which do not comply with the ISP must
obtain a waiver of the FCC's rules or a declaratory ruling from the FCC under
the FCC's "flexibility" policy that the non-standard arrangement is in the
public interest. FCC policy provides that a request by a U.S. international
carrier to establish a non-standard settlement arrangement with a foreign
carrier in a WTO member country is presumptively in the public interest, and
that said presumption generally may be overcome only by a demonstration that the
foreign carrier is not subject to competition in its home market from more than
one facilities-based international carrier. Notwithstanding the FCC's ISP waiver
and flexibility policies, it is possible that the FCC could find that certain of
STAR's arrangements with foreign operators were or are inconsistent with the ISP
and that STAR has not requested prior FCC authority therefore. If the FCC were
to determine by its own actions or in response to the filing of a third party
that STAR has violated the ISP, the FCC could order STAR to terminate any
non-conforming arrangement. In addition, STAR could be subject to a monetary
forfeiture and to other penalties, including revocation of STAR's FCC
authorizations to operate as an international carrier. Any such FCC action could
have a material adverse effect upon STAR's business, operating results and
financial condition.
The FCC's policies also require U.S. international carriers providing IMTS
to negotiate and adopt settlement rates with foreign correspondents for IMTS
which are at or below certain benchmark rates beginning January 1, 1999 for high
income countries. U.S. international carriers must establish IMTS settlement
rates at or below the benchmark rate with any foreign affiliate beginning April
1, 1998. STAR expects that any IMTS operating agreement which it has or may have
with a foreign affiliate will satisfy the foregoing benchmarks requirement.
STAR currently has IMTS operating agreements with certain foreign
correspondents which provide for settlement rates above the FCC's prescribed
benchmarks. STAR will negotiate in good faith to establish IMTS settlement rates
with its foreign correspondents which satisfy the FCC's benchmarks but
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there can be no assurance that such negotiations will succeed. The FCC's order
adopting the foregoing settlement benchmarks and the timetable therefor is
currently being reconsidered by the FCC. Several foreign telecommunications
carriers also have petitioned the U.S. Court of Appeals to vacate the FCC's
benchmarks order arguing that, among other things, the FCC lacks the
jurisdiction to prescribe the settlement rates which foreign carriers may
collect from U.S. carriers. However, subject to FCC reconsideration and action
by the Court of Appeals, if STAR is unable to negotiate benchmark settlement
rates with certain foreign correspondents, the FCC may intervene on its own
action or in response to a filing by a third party. STAR is unable to predict
the form which such intervention may take but it could disrupt STAR's
arrangement for transmitting traffic to certain countries require STAR to
suspend direct service to certain countries or require STAR to make alternative
termination arrangements with certain countries all of which could have a
material adverse effect on STAR's business, operating results and financial
condition.
FCC POLICIES ON TRANSIT AND REFILE. International switched
telecommunication traffic is frequently routed indirectly via one or more third
countries to its final destination. When such arrangements are mutually agreed,
they are commonly based on a transit agreement under which settlement payments
are made to all parties. In other cases, traffic may be sent to a third country
and then forwarded or refiled for delivery to its final destination without the
knowledge or consent of the destination carrier. STAR uses both transit and
refile arrangements to terminate its international traffic. The FCC routinely
approves transit arrangements by U.S. international carriers. The FCC's rules
also permit carriers to use ISR facilities in many cases to route traffic via a
third country for refile through the public switched network. However, the
extent to which U.S. carriers may enter into refile arrangements consistent with
the ISP is currently under review by the FCC. In 1997, the FCC stated that
above-cost accounting rates had led an increasing amount of international
traffic to migrate to least cost routes through the use of practices such as
hubbing, refile and reorigination. The FCC stated that such practices are an
economically rational response to inflated settlement rates. Notwithstanding the
FCC's past rules, policies and statements regarding the scope of permissible
transit and refile arrangements, the FCC could find by its own actions or in
response to the filing of a third party, that certain of STAR's transit or
refile arrangements violate the ISP or other FCC policies. In that event, the
FCC could order STAR to terminate any non-conforming transit or refile
arrangements. In addition, STAR could be subject to a monetary forfeiture and to
other penalties, including revocation of STAR's FCC authorizations to operate as
an international carrier. Any such FCC action could have a material adverse
effect on STAR's business, operating results and financial condition.
REPORTING REQUIREMENTS. International telecommunication carriers also are
required by the FCC's rules timely to file certain reports regarding
international traffic and revenues, the ownership and use of international
facilities; and their affiliates with foreign carriers. The FCC considers a U.S.
carrier to be affiliated with a foreign carrier if it has a 25% interest in the
capital stock of the carrier or it controls the foreign carrier or is under
common ownership or control. The FCC requires these reports so that, among other
things, it may monitor the development of industry competition and the potential
for a dominant foreign carrier to discriminate amongst U.S. carriers. STAR
generally has filed said traffic, facilities and foreign affiliation reports.
The FCC's rules require international telecommunication carriers to file at the
FCC copies of their contracts with other carriers, including operating
agreements, within 30 days of execution. STAR has filed copies of its operating
agreements with the FCC. Competitive U.S. international carriers do not
routinely file other carrier-to-carrier contracts with the FCC and, consistent
with industry practice, STAR has not filed certain other carrier contracts.
Notwithstanding, the foregoing FCC filings by STAR, the FCC by its own action or
in response to the filing of a third party could determine that STAR has failed
to meet certain of the foregoing filing and reporting requirements or that
certain Company filings are deficient. In that event, STAR could be directed to
remedy any asserted non-compliance; STAR could also be subject to a monetary
forfeiture and to other penalties, and, although STAR believes that it would be
largely unprecedented in such circumstances, and hence unlikely, the FCC could
revoke STAR's
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authorizations to operate as an international carrier. Any such FCC action could
have a material adverse affect on STAR's business, results and financial
condition.
REGULATORY FEES. The Communications Act, and FCC rules and policies, impose
certain fees upon carriers providing interstate and international
telecommunication services. These fees are levied, among other things, to defray
the FCC's operating expenses, to underwrite universal telecommunication service
(e.g., by subsidizing certain services used by schools and libraries), such as
Internet access, and by other telecommunications users in areas of the U.S.
where service costs are significantly above average), to fund the
Telecommunications Relay Service ("TRS"), which provides special options for
hearing-impaired users, and to support the administration of telephone numbering
plans.
Carriers that provide domestic interstate services must pay an annual
regulatory fee based on their interstate revenues; the fee is currently 0.12% of
revenue. The bulk of STAR's revenue, which is derived from international
services, is not subject to this fee. Carriers that provide domestic interstate
services to end users must pay a universal telecommunications service fee each
month based upon the total estimated demand for U.S. universal service funding.
If applicable, each carrier's share is approximately four percent of the
carrier's annual end user revenues. STAR generally offers its services only to
other carriers which in turn provide services to end-users. Such
carrier-to-carrier revenues are not subject to universal service fees, and thus
STAR generally is not liable to pay universal service fees. Carriers that only
offer international service (i.e., service between the United States and a
foreign country or service between two foreign carriers) also are not subject to
the universal service fee. However, if an international carrier has an affiliate
that provides domestic interstate services, then the carrier's international
revenues are subject to said fee. Until its acquisition of LDS, STAR did not
offer domestic interstate services. As a result of the operations of LDS, any
revenue STAR receives from end users for international services may be subject
to universal service fees. U.S. interstate and international carriers must pay a
percentage of their total revenue each year to support the North American
Numbering Plan Administrator. For the 1998 filing year, the contribution rate is
less than .003 percent of net telecommunications revenue. U.S. carriers must pay
a certain percentage of their domestic interstate revenues to support the TRS
Fund. For the 1998 filing year, the contribution rate is less than .04 percent
of gross domestic interstate revenue. STAR has routinely paid the foregoing
regulatory fees and, with regard to the annual regulatory fees owed by
interstate carriers, STAR is currently owed approximately $20,000 by the FCC due
to the inadvertent overpayment of said fee for a prior year. The foregoing
regulatory fees typically change annually. STAR cannot predict the future
regulatory fees for which it may be liable. Said fees could rise significantly
for STAR and amount to four percent or more of STAR's gross international and
interstate revenues if STAR is no longer exempt from paying universal service
fees as a result of an affiliate's provision of domestic interstate services, or
because STAR provides service directly to end users, or because amendments to
the Communications Act repeal the universal service fee exemption for carriers
which only offer international service or services provided to connecting
carriers. Because the international telecommunication services business is
highly competitive, an increase in the regulatory fees which STAR must pay could
impair its market position and have a material adverse effect on STAR's
business, operating results and financial condition.
RECENT AND POTENTIAL FCC ACTIONS. Recent FCC rulemaking orders and other
actions have lowered the entry barriers for new facilities-based and resale
international carriers by streamlining the processing of new applications and
granting non-dominant carriers greater flexibility in establishing non-standard
settlement arrangements with non-dominant foreign carriers, including the
non-dominant U.S. affiliates of such carriers. In addition, the FCC's rules
implementing the WTO Agreement presume that competition will be advanced by the
U.S. entry of facilities-based and resale carriers from WTO member countries,
thus further increasing the number of potential competitors in the U.S. market
and the number of carriers which may also offer end-to-end services. The FCC is
reviewing the proposed merger of WorldCom and MCI, and is expected soon to
review the proposed merger of LCI International, Inc. and Qwest Communications
International Inc. FCC approval and consummation of these mergers would increase
concentration in the international telecommunications service industry and the
potential market power of
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STAR's competitors. The FCC also recently has sought to reduce the foreign
termination costs of U.S. international carriers by prescribing maximum or
benchmark settlement rates which foreign carriers may charge U.S. carriers for
terminating switched telecommunications traffic and, if the FCC's benchmarks
order survives judicial review, the FCC's action may reduce STAR's settlement
costs, although the costs of other U.S. international carriers also may be
reduced in a similar fashion. The FCC has not stated how it will enforce the new
settlement benchmarks if U.S. carriers are unsuccessful in negotiating
settlement rates at or below the prescribed benchmarks, but any future FCC
intervention could disrupt STAR's transmission arrangements to certain countries
or require STAR to modify its existing arrangements; other U.S. international
carriers might be similarly affected. The 1996 amendment to the Communications
Act permits the FCC to forbear enforcement of the tariff provisions in the Act,
which apply to all interstate and international carriers, and the U.S. Court of
Appeals is currently reviewing an FCC order directing all domestic interstate
carriers to detariff their offerings. Subject to the Court's decision, the FCC
may forbear its current tariff rules for U.S. international carriers, such as
STAR, or order such carriers to detariff their services. In that event, STAR
would have greater flexibility in pricing its service offerings and to compete,
although any such FCC action likely would grant other non-dominant international
carriers equivalent freedom. The FCC routinely reviews the contribution rate for
various levels of regulatory fees, including the rate for fees levied to support
universal service, which fees may be increased in the future for various
reasons, including the need to support the universal service programs mandated
by the Communications Act, the total costs for which are still under review by
the FCC. The FCC also is reviewing the extent to which international carriers
may refile traffic using international private line facilities or otherwise.
Future FCC actions regarding refile could affect STAR by, for example, requiring
it to discontinue certain termination arrangements which it now has or to
implement alternative routing arrangements for certain countries; on the other
hand, the FCC may further liberalize its existing rules and policies regarding
refile in which case STAR is likely to be well positioned to expand certain
refile operations even though new opportunities may become available to its
competitors. STAR can not predict the net effect of these or other possible
future FCC actions on its business, operating results and financial condition,
although the net effect could be material.
STATE REGULATION
STATE. The intrastate long distance telecommunications operations of STAR
and its subsidiaries are subject to various state laws and regulations,
including prior certification, notification, registration and/or tariff
requirements. In certain states, prior regulatory approval is required for
changes in control of telecommunications services. The vast majority of states
require STAR and its subsidiaries to apply for certification to provide
intrastate telecommunications services, or at a minimum to register or to be
found to be exempt from regulation, prior to commencing sale of intrastate
services. Additionally, the vast majority of states require STAR or its
subsidiaries to file and maintain detailed tariffs setting forth rates charged
by STAR to its end-users for intrastate services. Many states also impose
various reporting requirements and/or require prior approval for transfers of
control of certificated carriers and assignments of carrier assets, including
customer bases, carrier stock offerings, and incurrence by carriers of
significant debt. Certificates of authority can generally be conditioned,
modified, canceled, terminated or revoked by state regulatory authorities for
failure to comply with state laws and/or rules, regulations and policies of the
state regulatory authorities. Fines and other penalties, including, for example,
the return of all monies received for intrastate traffic from residents of a
state in which a violation has occurred may be imposed.
STAR, along with its regulated subsidiaries, believes it has made the
filings and taken the actions it believes are necessary to provide the
intrastate services it currently provides to end users throughout the U.S. STAR
and/or its subsidiaries are qualified to do business as foreign corporations,
and have received certification to provide intrastate telecommunications
services in all states where certification is required, and have received
approval for changes of control where such approvals are necessary. STAR and its
subsidiaries are required to make periodic filings in order to maintain
certificated status and remain qualified as foreign corporations.
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In early 1997, the FCC instituted significant changes to the current
incumbent local exchange carrier access charge structure. These changes were
meant, in part, to bring access charges closer to their actual costs. While
there has been a general trend towards access charge reductions, new primary
interexchange carrier charges (PICCs) were authorized by the FCC to be imposed
on interexchange carriers serving presubscribed access charges closer to their
actual costs. PICCs are a flat-rated, per presubscribed line, per month access
charge imposed upon all facilities-based carriers (although they may be passed
through to resellers). Facilities-based carriers were assessed interstate PICCs
effective January 1, 1998. Intrastate PICCs have also been adopted in the five
state Ameritech region (Michigan, Wisconsin, Illinois, Indiana, and Ohio), and
may be adopted elsewhere. At the same time, STAR may pursue underlying carriers
for pass throughs of any access charge reductions they may realize from
incumbent local exchange carriers.
ACTIONS AGAINST LDS. In 1997, prior to STAR's acquisition of LDS, LDS
settled disputes with the California PUC and with the District Attorney of
Monterey, California regarding LDS' alleged unauthorized switching of long
distance customers. As part of the Settlements, LDS was subject to fines and
restrictions on its business operations in California. In addition, the FCC has
received numerous informal complaints against LDS regarding the alleged
unauthorized switching of long distance customers, which complaints currently
remain under review.
Following STAR's acquisition of LDS and in order to comply with the
Settlements, STAR has imposed strict restrictions on certain former LDS
employees, restricting these employees with respect to California intrastate
telecommunications operations. Additionally, STAR has taken a number of steps to
reduce the risk of a repeat occurrence regarding the alleged unauthorized
switching of commercial customers in California. There can, however, be no
assurance that LDS or STAR will not be subject to further regulatory review by
the California PUC or the FCC.
FOREIGN REGULATION
UNITED KINGDOM. In the U.K., telecommunications services offered by STAR
and through its affiliate, STAR Europe Ltd. ("STAR Europe"), are subject to
regulation by various U.K. regulatory agencies. The U.K. generally permits
competition in all sectors of the telecommunications market, subject to
licensing requirements and license conditions. STAR has been granted a license
to provide international services on a resale basis and STAR Europe has been
granted a license to provide international services over its own facilities,
which licenses are subject to a number of restrictions. Implementation of these
licenses have permitted STAR to engage in cost-effective routing of traffic
between the U.S. and the U.K. and beyond.
GERMANY. In Germany, telecommunications services offered by STAR through
its affiliate, STAR Telecommunications Deutschland GmbH ("STAR Germany"), are
subject to regulation by the Regulierungsbehorde fur Telekommunikation und Post
(which is under the jurisdiction of the Ministry of Economy). Germany permits
the competitive provision of international facilities-based and resale services.
STAR Germany was granted a license for the provision of voice telephony on the
basis of self-operated telecommunications networks on December 4, 1997. Under
this license, STAR Germany is presently installing telecommunications switching
facilities in Dusseldorf, Frankfurt, Hamburg and Munich and is leasing
connection transmission facilities between these switches and additional
facilities. The network of STAR Germany will be used primarily for routing
international telecommunications traffic between the U.S., the U.K., Germany and
beyond. There can be no assurance that future changes in regulation of the
services provided by STAR Germany will not have a material adverse effect on
STAR's business, operating results and financial condition.
OTHER COUNTRIES. STAR plans to initiate a variety of services in certain
European countries including France and Belgium. These services will include
value-added services to closed user groups and other voice services as
regulatory liberalization in those countries permits. These and other countries
have announced plans or adopted laws to permit varying levels of competition in
the telecommunications market. Under
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the terms of the WTO Agreement, each of the signatories has committed to opening
its telecommunications market to competition, foreign ownership and to adopt
measures to protect against anticompetitive behavior, effective starting on
January 1, 1998. Although STAR plans to obtain authority to provide service
under current and future laws of those countries, or, where permitted, provide
service without government authorization, there can be no assurance that foreign
laws will be adopted and implemented providing STAR with effective practical
opportunities to compete in these countries. Moreover, there can be no assurance
of the nature and pace of liberalization in any of these markets. STAR's
inability to take advantage of such liberalization could have a material adverse
affect on STAR's ability to expand its services as planned.
EMPLOYEES
As of April 30, 1998, STAR employed 507 full-time employees. STAR is not
subject to any collective bargaining agreement and it believes that its
relationships with its employees are good.
PROPERTIES
STAR's principal offices are located in Santa Barbara, California in four
facilities providing an aggregate of approximately 24,972 square feet of office
space. Approximately 5,332 square feet of this office space is leased pursuant
to two leases that both expire in July 1999. The remaining approximately 12,327
square feet of office space is located in two buildings and is rented by STAR
pursuant to a lease that expires in June 2003. STAR also leases approximately
16,595 square feet of space for its switching facility in Los Angeles,
California under a sublease and a lease expiring in April 2006, an aggregate of
approximately 33,445 square feet of space for its switching facilities in New
York, New York under three leases which expire in December 31, 2001, July 31,
2003 and April 2008, respectively, approximately 6,167 square feet of space for
its switching facility in Dallas, Texas under a lease expiring in April 2007,
and approximately 8,000 square feet of space for its switching facility in
London, England under a lease expiring in July 2006. STAR leases approximately
14,628 square feet in Dusseldorf, approximately 27,835 square feet in Frankfurt,
approximately 12,002 square feet in Hamburg and approximately 12,408 square feet
in Munich, Germany under four leases expiring on or about January 1, 2008. The
aggregate facility lease payments made by STAR in 1997 were approximately $2.2
million. STAR believes that all other material terms of its leases are
commercially reasonable terms that are typically found in commercial leases in
each of the respective areas in which STAR leases space. STAR believes that its
facilities are adequate to support its current needs and that additional
facilities will be available at competitive rates as needed.
LITIGATION
STAR is not presently a party to any material pending litigation. From time
to time, however, STAR is party to various legal proceedings, including billing
disputes and collection matters, that arise in the ordinary course of business.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF UDN
RESULTS OF OPERATIONS
The following table sets forth certain selected items in UDN's statements of
operations as a percentage of total revenues for the periods indicated:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED APRIL 30, JANUARY 31,
------------------------------- -------------------
1995 1996 1997 1997 1998
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Revenues................................ 100.0% 100.0% 100.0% 100.0% 100.0%
Costs of services....................... 82.0 75.1 76.9 76.7 79.6
------- ------- ------- ------- -------
Gross profit............................ 18.0 24.9 23.1 23.3 20.4
Operating Expenses:
Selling, general and administrative
expenses............................ 83.0 33.3 21.5 20.6 26.5
Provision for doubtful accounts....... 3.2 2.9 2.8 1.5 12.7
Depreciation and amortization
expense............................. 11.7 7.3 3.8 4.0 3.3
------- ------- ------- ------- -------
Total Operating Expenses.............. 97.9 43.5 28.1 26.1 42.5
------- ------- ------- ------- -------
Loss from operations.................... (79.9) (18.6) (5.0) (2.8) (22.1)
Other income (expense):
Other gains and losses................ (5.1) (0.8) 0.4 0.3 (2.0)
------- ------- ------- ------- -------
Interest expense, net................. (3.6) (1.3) (2.6) (2.6) (2.9)
------- ------- ------- ------- -------
Total other income (expense).......... (8.7) (2.1) (2.2) (2.3) (4.9)
Income tax benefit...................... 0.2 0.2
------- ------- ------- ------- -------
Net loss................................ (88.6)% (20.7)% (7.0)% (4.9)% (27.0)%
------- ------- ------- ------- -------
------- ------- ------- ------- -------
</TABLE>
NINE MONTHS ENDED JANUARY 31, 1998 AND 1997
REVENUES. UDN's revenues increased 42.7% to $23.9 million for the nine
months ended January 31, 1998 as compared to $16.8 million for the nine months
ended January 31, 1997. The acquisition of CTN on January 1, 1997 contributed
$2.8 million of this increase. Growth in agent/affinity revenue accounted for an
additional $1.8 million of new revenue, while a new international calling
program that began in October 1997 produced $0.9 million in increased revenue.
GROSS PROFIT. In the nine month periods ended January 31, 1998 and January
31, 1997, gross profits were $4.9 million (20.4% of revenue) and $3.9 million
(23.3% of revenue), respectively. The decline in gross profit in the nine months
ended January 31, 1998 was caused by a number of factors. The start-up of UDN's
California network and switching operations resulted in significant network
underutilization and unbillable call records. UDN's Arizona switch also
experienced operating problems that caused increased costs in certain types of
calls. UDN believes that these were one-time factors that have been rectified,
although network inefficiencies may continue to impact gross profits as UDN's
California network continues to grow at a rapid pace. Another factor affecting
gross profit is the increase during the nine months ended January 31, 1998 in
international and wholesale revenues as a percentage of UDN's total revenue mix.
International and wholesale products have lower gross margins than UDN's other
products.
SELLING, GENERAL AND ADMINISTRATIVE. For the nine months ended January 31,
1998 and January 31, 1997, UDN's selling, general and administrative ("SG&A")
expenses were $6.3 million (26.5% of revenue) and $3.5 million (20.6% of
revenue), respectively. The most recent nine month period was negatively
impacted by several factors. First, UDN is incurring costs related to
transitioning to new billing and order-entry systems. UDN has outgrown its
existing systems, has temporarily added significant new staff in order
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to manually process the order entry flow, and is expending resources in order to
consolidate the separate billing processes. Additionally, UDN expanded its sales
and marketing efforts through increases in personnel and through agent
commission and incentive plans. Significant growth in UDN's agent/affinity
revenue has caused a corresponding increase in monthly commission expenses. The
combination of the above factors has caused the most recent nine month SG&A
expenses to increase substantially as a percentage of revenues. As a part of the
Merger Agreement, UDN is in the process of converting to STAR's billing and
order-entry systems. The completion of the conversion by mid-1998 should cause a
major reduction in billing and order-entry expenses. This will, in the view of
UDN management, cause SG&A expenses to decrease and to compare more favorably as
a percentage of revenue.
PROVISION FOR DOUBTFUL ACCOUNTS. UDN's provision for doubtful accounts
increased from $245,000 (1.5% of revenue) in the nine months ended January 31,
1997 to $3.1 million (12.7% of revenue) in the nine months ended January 31,
1998. The most recent nine month period was negatively impacted by the
bankruptcies of two major wholesale customers and an approximate $1.3 million
write-off due to a fraud situation that arose in December 1997.
DEPRECIATION. UDN's depreciation and amortization expenses for the nine
months ended January 31, 1998 increased to $0.8 million from $0.7 million in the
nine months ended January 31, 1997. The increase in the most recent nine month
period results from amortization of the goodwill and customer base costs
associated with the January 1997 CTN acquisition.
INTEREST EXPENSE. UDN's interest expense in the nine month period ended
January 31, 1998 increased to $0.7 million from $0.4 million in the nine month
period ended January 31, 1997. Three factors contributed to this increase.
First, UDN has accrued interest of $48,000 on the $2.5 million promissory note
dated November 19, 1997 with STAR. Second, $1.0 million of the purchase price
related to the January 1, 1997 CTN acquisition was financed through the issuance
of notes payable to the sellers. UDN had interest expense from the CTN notes of
$48,000 in the nine month period ended January 31, 1998 and only $6,000 in the
comparable nine month period ended January 31, 1997. Third, borrowings under
UDN's accounts receivable financing arrangement began for DNI in July 1996 and
in September 1996 for AMS. UDN was financing its accounts receivable for the
full nine month period ended January 31, 1998, but for only a portion of the
nine months ended January 31, 1997. Interest expense under the accounts
receivable financing was $0.3 million and $0.1 million in the nine months ended
January 31, 1998 and 1997, respectively.
OTHER INCOME (EXPENSE). Other expenses of $0.4 million were recorded by UDN
in the nine months ended January 31, 1998. These expenses result from the
November 19, 1997 Merger Agreement. As a result of this agreement, UDN incurred
a $0.1 million penalty for terminating an underwriting agreement with Madison
Securities, Inc., expensed legal and other costs related to that offering and
UDN's Form 10-SB filing with the Securities and Exchange Commission, and
additionally expended $0.1 million for a fairness opinion with respect to the
Merger Agreement. Finally, certain costs incurred for the development of and
conversion to a new billing system were expensed since UDN is now proceeding
with moving to the STAR billing system. In the nine months ended January 31,
1997, an extraordinary gain of $45,000, net of tax, was recognized on the
settlement of amounts owed under a switching equipment lease.
YEARS ENDED APRIL 30, 1997, 1996 AND 1995
REVENUES. UDN's revenues increased 199% to $24.0 million in the year ended
April 30, 1997 from $8.0 million in the 1996 period, and 1996 revenues were up
243% from $2.3 million in the 1995 period. This increase resulted from a growth
strategy combining significant internal growth with three acquisitions. On April
27, 1995, UDN acquired DNI. On March 26, 1996, UDN acquired AMS. On January 1,
1997, UDN acquired CTN. Internal growth in the period ended April 30, 1997 was
primarily through UDN's agent/affinity programs and through a recently initiated
international calling program, while the 1996
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comparable period revenue growth was through agent/affinity programs and prepaid
calling card programs. The 1995 revenues were derived through direct sales
efforts primarily in the Dallas/Ft. Worth metropolitan area.
GROSS PROFIT. In the year ended April 30, 1997, UDN's gross profit was $5.6
million (23.1%). This compares to a gross profit of $2.0 million (24.9%) in the
year ended April 30, 1996 and to a gross profit of $0.4 million (18.0%) in the
year ended April 30, 1995. The 1995 gross profit percentage was smaller than in
1996 and 1997 due to initial over-capacity in UDN's newly expanded network. The
acquisition of DNI in April 1995 caused a significant increase in the 1996 gross
profit and in the gross profit percentage. This resulted from consolidation of
UDN's network into the DNI network, consolidation of switching platforms and
more efficient usage of the network as a result of the significant growth in
revenue. Gross profit in 1997 ($5.6 million) increased by 178% as compared to
1996 gross profit ($2.0 million), which resulted from a 199% growth in revenue.
Gross profit as a percentage of revenue declined in 1997 to 23.1% as compared to
24.9% in 1996. The acquisition of AMS in March 1996 contributed to the 1997
decline. AMS is a switchless reseller with significantly lower margins than
UDN's switched customer base. Gross profit as a percentage of revenue in UDN's
switched base actually increased in 1997 to 31.3%, as compared to 24.9% in 1996,
but UDN's total gross profit percentage was reduced by the addition of the AMS
switchless base which had a gross profit percentage of 14.1% in 1997.
SELLING, GENERAL AND ADMINISTRATIVE. UDN's selling, general and
administrative expenses were $5.2 million in the year ended April 30, 1997, a
86% increase over SG&A expenses of $2.8 million in the year ended April 30,
1996, which in turn was up 47% over SG&A expenses of $1.9 million in the year
ended April 30, 1995. SG&A expenses as a percentage of revenue declined
significantly as UDN grew during the last three years. SG&A expenses were 21.5%
of revenue in the year ended April 30, 1997, while they were 33.3% in 1996 and
83.0% in 1995. This improvement was the result of the economies realized as the
operations of the DNI, AMS and CTN acquisitions were consolidated and as revenue
growth in the year ended April 30, 1997 increased rapidly.
PROVISION FOR DOUBTFUL ACCOUNTS. In the year ended April 30, 1995, UDN's
provision for doubtful accounts was $75,000 (3.2% of revenue), while in the year
ended April 30, 1996 the provision for doubtful accounts was $229,000 (2.9% of
revenue) and in the year ended April 30, 1997 was $693,000 (2.8% of revenue).
While the total provision for doubtful accounts has increased each year, its
percentage as compared to total revenue has declined in each of the last two
years, indicating an improvement in the quality of the Company's customer base
and in its management of the accounts receivable.
DEPRECIATION. UDN's depreciation and amortization expense grew to $0.9
million in the year ended April 30, 1997 from $0.6 million in the year ended
April 30, 1996, which was an increase from $0.3 million in the year ended April
30, 1995. Amortization of the customer base and goodwill associated with the
acquisition of DNI comprise the majority of the increase for the year ended
April 30, 1996. Amortization of the AMS and CTN acquisitions caused the increase
in the year ended April 30, 1997.
INTEREST EXPENSE. UDN's interest expense in the year ended April 30, 1995
was $85,000 which was primarily related to the financing of switching, computer
and other equipment. In the year ended April 30, 1996, interest expense
increased to $0.1 million due to interest on the notes issued as part of the DNI
acquisition price and also to interest expense on the acquired DNI switch. In
the year ended April 30, 1997, interest expense increased to $0.6 million as a
result of the notes and convertible debentures issued as part of the AMS and CTN
acquisitions. In addition, in July 1996, UDN began incurring interest expense
under an accounts receivable financing arrangement on the DNI receivables, which
was expanded in September 1996 to include financing on the AMS receivables.
Interest expense of $200,000 was realized from the financing of receivables
during the year ended April 30, 1997.
OTHER INCOME (EXPENSE). In the year ended April 30, 1997, UDN realized an
extraordinary gain of $97,000, net of income taxes, which was related to the
settlement of amounts owed under a switching
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equipment lease. In the year ended April 30, 1996, a loss on impairment of
assets was recorded to reflect the write down of certain excess switching
equipment to reflect fair market value. In the year ended April 30, 1995, UDN
recorded a $0.1 million loss on the sale of assets, which resulted from the
March 1995 sale of UDN's answering service business.
LIQUIDITY, CAPITAL RESOURCES AND OTHER
At January 31, 1998, UDN had $1.0 million cash on hand and a working capital
deficit of $10.3 million, which compares to working capital deficits $3.2
million at April 30, 1997 and $2.0 million at April 30, 1996. The $7.1 million
decrease in working capital during the most recent nine month period related
primarily to UDN's net loss of $6.5 million and also to an increase in the
current portion of notes and debentures payable.
UDN has historically operated with small cash balances and negative working
capital. Funds have been raised, as needed, generally through private placements
of UDN Common Stock. In their audit report on the April 30, 1997 financial
statements, UDN's independent accountants raise substantial doubt about UDN's
ability to continue as a going concern due to UDN's significant working capital
deficiency and current cash flows that are not sufficient to repay debts on the
scheduled due dates. At the time that the Merger Agreement was executed in
November 1997, UDN was in the process of raising $3.0 million in a private
placement through Madison Securities, Inc.
In the nine months ended January 31, 1998, $0.8 million had been raised
through the issuance of UDN Common Stock. In the previous fiscal year ended
April 30, 1997, $1.4 million was raised through the issuance of UDN Common
Stock. As a part of the Merger Agreement, UDN terminated the $3.0 million
Madison private placement and received from STAR a loan in the amount of $2.5
million. In December 1997, UDN discovered the extent of a fraud situation and
certain other uncollectible amounts out of its Phoenix location. On January 30,
1998, the original Merger Agreement was amended and on February 2, 1998 UDN
received a second loan in the amount of $2.0 million. UDN believes it has
sufficient funds on hand to be able to meet its obligations as they become due
through the closing date of the Merger.
In September 1997, UDN began expending funds to expand its operations by
installing a California statewide network utilizing a new switch lease
agreement. Also, in the latter months of 1997, UDN began expending significant
funds on the development of a new billing system. This effort was terminated
upon the signing of the Merger Agreement and UDN is now proceeding with
integrating its three different billing systems into the STAR billing platform.
These efforts combined with the unexpected losses realized in the fraud
situation, the other bad debt write-offs, debt repayments, the cost of manually
processing high numbers of new orders and the cost of the sales and marketing
and incentive plans have caused UDN to experience a severe lack of liquidity.
The STAR loans have temporarily cured that situation. However, should the Merger
terminate without completion, UDN will be in the position of finding another
billing alternative and of raising sufficient capital to repay the STAR loans
and to meet its other obligations. There can be no assurance that UDN would be
successful in raising such funds in that eventuality or that UDN will have
sufficient liquidity to continue operations as a going concern.
The company is reviewing its computer programs and systems to ensure that
the programs and systems will function properly and be Year 2000 compliant. In
this process, the Company expects to replace some existing systems and upgrade
others. The Company presently believes that, with modifications to existing
software and conversions to new software, the year 2000 problem will not pose
significant operational problems for the Company's computer systems. The
estimated cost of these efforts are not expected to be material to the Company's
financial position or any year's results of operations.
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BUSINESS OF UDN
UDN is a provider of voice and data long distance services, travelcard
services, international long distance, prepaid calling cards and various other
telecommunication services to residential, small to medium-sized commercial
customers, switchless resellers, agents and wholesale purchasers. The principal
market for its long distance services is the central and southwest United
States. UDN has customers in over 40 states. UDN operates primarily through its
wholly-owned subsidiaries, Advanced Management Services, Inc. ("AMS"),
CTN-Custom Telecommunications Network of Arizona, Inc. ("CTN") and United
Digital Network of Texas, Inc. ("DNI"). UDN offers an array of services designed
to afford its customers an integrated telecommunications solution to their
telecommunication needs.
UDN was incorporated in Canada under the British Columbia Company Act on
June 2, 1980 under the name Stag Explorations Ltd. and, on November 30, 1990,
UDN changed its name to Stag Holdings Ltd. and, on February 8, 1993, UDN changed
its name to Unidex Communications Corp. On April 25, 1995, UDN reincorporated in
the United States by filing Articles of Continuance with the Secretary of State
of Wyoming, which allowed UDN to continue its existence as a Wyoming
corporation. Subsequently, UDN merged into its wholly-owned subsidiary, a
Delaware corporation, and continued its existence as Unidex Communications Corp,
a Delaware corporation.
Effective August 9, 1996, UDN changed its name from Unidex Communications
Corp. to United Digital Network, Inc., consolidated its share capital on the
basis of four old shares for one new share, and increased its authorized capital
to 100 million shares of common stock, par value, $0.01 per share.
UDN's growth has resulted from a two-pronged growth strategy. First, a plan
of acquiring selected types of long distance companies has produced four major
acquisitions that have been successfully integrated into UDN's operations.
Second, a direct sales force, complemented by a small but rapidly growing agent
network, has produced significant internal growth during the last two years.
ACQUISITIONS
In March 1993, for a purchase price of $747,000, UDN acquired ANI, a Texas
based company. ANI was a small start-up long distance company in Texas that also
provided various "live-operator" functions such as answering services and third
party customer service to business customers.
In April 1995, for a purchase price of $827,665, UDN acquired DNI, a Dallas,
Texas based company which provides telecommunications services to small and
medium sized commercial customers in Texas and Oklahoma. DNI's operations were
integrated into UDN's existing Dallas base of business. This acquisition brought
to UDN a more sophisticated switching platform, a more efficient and flexible
customer-billing system and its own leased network facilities in the south
central United States.
In March 1996, for a purchase price of $5.0 million UDN, subject to
adjustment based on various revenue performance criteria, acquired AMS, a
Phoenix, Arizona based long distance switchless reseller which has in the past
specialized in marketing long distance services to the motor freight industry.
The $5.0 million purchase price consisted of $1.0 million in cash and $4.0
million in convertible debentures and promissory notes; as a result of discounts
applied to the convertible debentures and promissory notes under generally
accepted accounting principles, the purchase price has been recorded by UDN at
$3.5 million for financial reporting purposes. The acquisition of AMS gave UDN
an expanded agent program, a nationwide retail customer base and a long distance
provider in the trucking industry market. AMS provides services to customers in
Arizona and over 40 other states. Prior to the AMS acquisition, most of UDN's
revenue came from Texas and Oklahoma.
In January 1997, UDN entered into a capital lease agreement with RealSource,
Inc. to lease, with the option to purchase for a nominal amount, the WorldDial
Prepaid Calling Platform, the WorldDial Point-
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of-Sale Activation Platform and all equipment necessary for the operation
thereof ("WorldDial Platforms"). UDN has commenced providing services to certain
prepaid card marketers and anticipates that this activity will provide
increasing revenues during the next 12 months.
In January 1997, for a purchase price of $1.4 million, UDN acquired CTN, a
switch-based reseller located in Phoenix, Arizona. CTN has a commercial customer
base and a complete originating and terminating network in Arizona and New
Mexico. With the acquisition of CTN, UDN's network extends through Arizona,
California, New Mexico, Oklahoma and Texas.
INTERNAL GROWTH
From fiscal year ending April 30, 1995 through December 31, 1997, UDN's
customer base increased from approximately 2,000 customers to over 22,000
customers nationwide. As a part of UDN's two-pronged growth strategy, besides
acquisitions, UDN's internal growth contributed significantly to this increase
in customers and total revenue. During the fiscal year ended April 30, 1997,
internal growth contributed nearly $750,000 in new monthly revenues.
Approximately one-fourth of this growth came from UDN's pre-paid calling card
product line, with the remainder coming from revenue increases in agent,
affinity group and direct sales customers.
PRODUCT OFFERINGS
UDN provides long-distance voice and data services primarily in the
south-central and southwestern United States. UDN offers a broad array of
services designed to afford small and medium-sized commercial clients, and on a
limited basis residential customers, integrated telecommunications solutions to
their telecommunication needs. UDN operates in Texas, Oklahoma and California
under the name DNI in Arizona and in over 40 other states under the name AMS,
and also in Arizona and New Mexico under the name CTN. UDN's direct sales force
targets businesses with monthly telecommunication expenses within a range of
$250 to $10,000. UDN provides these clients with basic inbound and outbound long
distance service as well as travelcard, prepaid calling cards and international
long distance services. To complement these offerings and to be viewed by its
clients as a provider of "bundled" products, UDN also provides on a limited
basis the following services: Conference Calling, Fax Mail-Box, FAX Broadcast,
FAX-on-Demand, voice mail and Dedicated and Switched Data Services.
UDN's strategy is to provide a broad product line so that its clients will
view UDN as a one-stop provider of telecommunication services. UDN believes that
the more services a client obtains from UDN, the less susceptible a client will
be to switch to one of UDN's competitors. One of UDN's strengths is its ability
to customize products to fit a customer's needs.
Like many other resellers, UDN buys bulk long distance services from various
wholesale carriers. Unlike many resellers, however, UDN also originates and
terminates a majority of its traffic on its own network throughout Texas,
Oklahoma, Arizona and New Mexico. With significant volumes, this constitutes a
lower cost method of routing long distance traffic. With the CTN acquisition,
UDN obtained an Arizona and New Mexico network and a switch-sharing lease
arrangement on a switch located in Phoenix, Arizona. UDN's network is built
around its DEX-400 switch located in Dallas. During 1997, UDN entered into a
switch-sharing arrangement with STAR for the use of a switch in southern
California. A statewide California network is being implemented.
UDN's business plan contemplates continuing growth by marketing its services
through four separate channels:
1. DIRECT SALES. UDN currently employs direct-sales representatives in
both the Dallas and Phoenix offices. These representatives each carry a
monthly quota for generating new business, and focus on selling to small and
medium-sized commercial accounts.
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2. AGENT SALES. UDN uses a nationwide force of over 75 independent
agents to sell UDN's services to both residential and commercial accounts.
The independent agents are paid on the basis of a percentage of revenue that
is billed by the clients that they have brought to UDN. In addition to the
existing agent development group, a director of third party marketing was
hired in May 1996 who is focusing on developing agents primarily through
affinity marketing.
3. WHOLESALE SERVICES--SWITCHLESS RESELLERS AND CARRIER SALES. A
switchless reseller is a non-facilities based long distance company for whom
UDN acts as a wholesale provider of long distance services. The switchless
reseller's clients are connected directly to UDN's network. Call detail
records are sent to the reseller at the end of each month, which allows the
reseller to utilize his own billing system in order to bill his clients.
Alternatively, UDN may provide billing services to the switchless reseller
and, for a fee, will bill the switchless reseller's customers for him.
"Carrier sales" are those minutes other long distance carriers send to UDN
to be terminated by UDN on its own network which presently covers Texas,
Oklahoma, Arizona, New Mexico and portions of southern California. Although
carrier sales constitute lower margin revenue, UDN's strategy is to have a
base of wholesale clients for expanding its network geographically, which in
turn should provide additional markets for higher margin direct sales and
may ultimately increase margins in the agent base.
4. PREPAID CALLING CARDS. The agreement with RealSource, Inc. with
respect to the WorldDial Platforms has made prepaid calling cards a recent
addition to UDN's product line. Prepaid calling cards constitute a rapidly
growing market.
In addition to continuing to expand the above channels to market, UDN
intends to focus on several other key areas to ensure the future growth of UDN.
First, UDN must retain its customer base. The replacement of lost clients is a
major expense to UDN and results in lost revenues.
Second, UDN will continue to explore opportunities for expanding its product
line. Just as the acquisition of the WorldDial Platforms has expanded UDN's
product lines, UDN intends to continue to acquire, develop and market products
and services that meet the expanding needs of its clients. These products may
include, among others, local service, cellular service, paging and personal
communications services.
UDN currently serves over 22,000 customers nationwide, primarily located in
Texas, Oklahoma, Arizona and California. Current monthly long distance revenue
is approximately $3.0 million, which has grown as follows from UDN's entrance
into the market in 1992:
<TABLE>
<CAPTION>
LONG DISTANCE
REVENUES
-------------
<S> <C>
Fiscal Year Ended April 30, 1993............................................... $ 13,000
Fiscal Year Ended April 30, 1994............................................... $ 152,000
Fiscal Year Ended April 30, 1995............................................... $ 1,378,000
Fiscal Year Ended April 30, 1996............................................... $ 8,027,000
Fiscal Year Ended April 30, 1997............................................... $24,012,000
For the Nine Months Ended January 31, 1998..................................... $23,942,000
</TABLE>
EMPLOYEES
UDN has 67 employees, of which 7 are full-time direct-sales representatives.
DESCRIPTION OF PROPERTY
UDN and its subsidiaries lease each of their principal executive offices.
UDN does not own all of the transmission facilities needed to complete long
distance telephone calls. Other than the switching facility in Dallas, UDN
leases ports on switching facilities in Los Angeles and Phoenix. Therefore,
UDN's operator services, direct dial long distance, "800" service, wholesale
long distance service and international business
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are largely dependent upon the contractual arrangement with facilities-based
carriers for the transmission of calls on a cost-effective basis. UDN has
contractual arrangements with a carrier for the use of its switch and
transmission facilities in Los Angeles and Phoenix. These contracts are on a
month-to-month basis.
LEGAL PROCEEDINGS
Except as set forth below, UDN is not engaged in any material litigation,
and the officers and directors presently know of no threatened or pending
material litigation in which it is contemplated that UDN will be made a party,
except for proceedings involving AMS with respect to AMS operating in certain
states without certification.
In January 1998, AMS filed an action in Maricopa County Court of the State
of Arizona against The Software Group, LLC, d/b/a Global Software Group, LLC
("Global") seeking $1.3 million in damages for an alleged breach of service
contracts with AMS. AMS claims that Global failed to pay amounts due to AMS for
services provided to Global under the service contracts. Global has filed a
counterclaim against UDN and Messrs. Snedegar and Christensen. AMS intends to
vigorously pursue its claim against Global. There can be no assurance, however,
that AMS will prevail in its collection of damages. In addition, whether or not
AMS is ever able to collect its damages, such collection process could be time
consuming and costly.
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MANAGEMENT OF STAR AND UDN
OFFICERS AND DIRECTORS OF STAR
The officers and directors of STAR and their ages as of May 18, 1998, are as
follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---------------------------------------- --- ------------------------------------------------------------------
<S> <C> <C>
Christopher E. Edgecomb(1).............. 39 Chief Executive Officer, Chairman of the Board and Director
Mary A. Casey(1)(2)..................... 35 President, Secretary and Director
David Vaun Crumly....................... 34 Executive Vice President--Sales and Marketing
James E. Kolsrud........................ 53 Executive Vice President--Operations and Engineering
Kelly D. Enos........................... 39 Chief Financial Officer, Treasurer and Assistant Secretary
Mark Gershien........................... 46 Director
Gordon Hutchins, Jr.(3)................. 49 Director
John R. Snedegar(2)(3).................. 49 Director
Arunas A. Chesonis...................... 36 Director
</TABLE>
- ------------------------
(1) Member of Non-Executive Stock Option Committee
(2) Member of Audit Committee
(3) Member of Compensation Committee
CHRISTOPHER E. EDGECOMB co-founded STAR in September 1993, served as
President of STAR until January 1996 and has served as STAR's Chief Executive
Officer and Chairman of the Board since January 1996. Mr. Edgecomb has been a
Director of STAR since its inception. Prior to that time, Mr. Edgecomb was a
founder and the Executive Vice President of West Coast Telecommunications
("WCT"), a nation-wide long distance carrier, from August 1989 to December 1994.
Prior to founding WCT, Mr. Edgecomb was President of Telco Planning, a
telecommunications consulting firm, from January 1986 to July 1989. Prior to
that time, Mr. Edgecomb held senior level sales and marketing positions with TMC
Communications, American Network and Bay Area Teleport.
MARY A. CASEY has been a Director and Secretary of STAR since co-founding
STAR in September 1993, and has served as STAR's President since January 1996.
Prior to that time, Ms. Casey was Director of Customer Service at WCT from
December 1991 to June 1993, and served as Director of Operator Services at Call
America, a long distance telecommunications company, from May 1988 to December
1991.
DAVID VAUN CRUMLY has served as STAR's Executive Vice President--Sales and
Marketing since January 1996. Prior to that time, Mr. Crumly served as a
consultant to the Company from November 1995 to January 1996, was Vice President
of Carrier Sales of Digital Network, Inc. from June 1995 to November 1995 and
was Director of Carrier Sales of WCT from June 1992 to June 1995. Prior to
joining WCT, Mr. Crumly served in various sales and marketing capacities with
Metromedia, a long-distance company, from September 1990 to June 1992 and with
Claydesta, a long-distance company, from May 1987 to September 1989.
JAMES E. KOLSRUD has served as STAR's Executive Vice President--Operations
and Engineering since September 1996. Prior to joining STAR, Mr. Kolsrud was an
international telecommunications consultant from March 1995 to September 1996.
Prior to that time, he was a Vice President, Corporate Engineering and
Administration of IDB Communications Group, Inc. ("IDB"), an international
communications company, from October 1989 to March 1995, and prior to that time,
he was President of the International Division of IDB.
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KELLY D. ENOS has served as STAR's Chief Financial Officer since December
1996 and as Treasurer and Assistant Secretary since April 1997. Prior to that
time, Ms. Enos was an independent consultant in the merchant banking field from
February 1996 to November 1996 and a Vice President of Fortune Financial, a
merchant banking firm, from April 1995 to January 1996. Ms. Enos served as a
Vice President of Oppenheimer & Co., Inc., an investment bank, from July 1994 to
March 1995 and a Vice President of Sutro & Co., an investment bank, from January
1991 to June 1994.
MARK GERSHIEN has served as a Director of STAR since March 1998. Mr.
Gershien has been the Senior Vice President of Sales and Marketing for Level 3
Communications, a telecommunications and information services company, since
January 1998. Prior to that time, Mr. Gershien was the Senior Vice President of
National Accounts for WorldCom, Inc., an international telecommunications
company, and President and Chief Executive Officer of MFS Telecom, a division of
MFS Communications, Inc. prior to its merger with WorldCom, Inc.
GORDON HUTCHINS, JR. has served as a Director of STAR since January 1996.
Mr. Hutchins has been President of GH Associates, a telecommunications
consulting firm, since July 1989. Prior to founding GH Associates, Mr. Hutchins
served as President and Chief Executive Officer of ICC Telecommunications, a
competitive access provider, and held senior management positions with several
other companies in the telecommunications industry.
JOHN R. SNEDEGAR has served as a Director of STAR since January 1996. Mr.
Snedegar has been the President of UDN since June 1990. See "--Officers and
Directors of UDN."
ARUNAS A. CHESONIS has served as a Director of STAR since May 1998. From May
1987 to April 1998, Mr. Chesonis served in various executive positions with ACC
Corp. and its subsidiaries, including most recently President of ACC Corp. and
President and Chief Operating Officer of ACC Global Corp.
STAR BOARD COMPOSITION
In accordance with the terms of STAR's Certificate of Incorporation, the
terms of office of the Board of Directors are divided into three classes: Class
I, whose term will expire at the annual meeting of stockholders to be held in
1998; Class II, whose term will expire at the annual meeting of stockholders to
be held in 1999; and Class III, whose term will expire at the annual meeting of
stockholders to be held in 2000. The Class I directors are Gordon Hutchins, Jr.
and John R. Snedegar, the Class II directors are Mark Gershien and Mary A.
Casey, and the Class III directors are Christopher E. Edgecomb and Arunas A.
Chesonis. At each annual meeting of stockholders after the initial
classification, the successors to directors whose term will then expire will be
elected to serve from the time of election and qualification until the third
annual meeting following election. This classification of the Board of Directors
may have the effect of delaying or preventing changes in control or changes in
management of STAR. See "Risk Factors--Anti-takeover Effects of Certificate of
Incorporation, Bylaws and Delaware Law" and "Description of STAR Capital
Stock--Anti-takeover Effects of Provisions of the Certificate of Incorporation,
Bylaws and Delaware Law."
Each officer is elected by and serves at the discretion of the STAR Board.
Each of STAR's officers and directors, other than nonemployee directors, devotes
substantially full time to the affairs of STAR. STAR's nonemployee directors
devote such time to the affairs of STAR as is necessary to discharge their
duties. There are no family relationships among any of the directors, officers
or key employees of STAR.
STAR DIRECTOR COMPENSATION
STAR's non-employee directors receive $2,000 for each Board meeting attended
and $1,000 for each telephonic Board meeting. In addition, each non-employee
director is reimbursed for out-of-pocket expenses incurred in connection with
attendance at meetings of the Board of Directors and its committees. In 1996,
Messrs. Hutchins and Snedegar were each granted stock options to purchase 20,500
shares of
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STAR's Common Stock. In 1997, Messrs. Hutchins and Snedegar and Roland Van der
Meer, a former director, were each granted stock options to purchase 10,250
shares of STAR's Common Stock. In 1998, Messrs. Hutchins, Snedegar and Gershien
were each granted stock options to purchase 10,250 shares of STAR Common Stock,
and Mr. Chesonis was granted stock options to purchase 10,000 shares of STAR
Common Stock. See "Certain Transactions--Transactions with STAR Outside
Directors."
STAR EXECUTIVE COMPENSATION
The following Summary Compensation Table sets forth the compensation earned
by STAR's Chief Executive Officer and four other executive officers who earned
(or would have earned) salary and bonus in excess of $100,000 for services
rendered in all capacities to STAR and its subsidiaries (the "STAR Named
Officers") for each of the fiscal years in the two year period ended December
31, 1997.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
-------------
SECURITIES
UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION FISCAL YEAR SALARY ($) BONUS ($) OPTIONS (#) COMPENSATION ($)
- ------------------------------------------------- ----------- ----------- ----------- ------------- -----------------
<S> <C> <C> <C> <C> <C>
Christopher E. Edgecomb ......................... 1997 360,000 -- -- 3,202(1)
Chief Executive Officer and Chairman of the 1996 360,000 -- -- 9,223(1)
Board
Mary A. Casey ................................... 1997 217,500 -- -- 13,615(2)
President and Secretary 1996 156,042 -- -- 15,028(2)
David Vaun Crumly ............................... 1997 380,779 1,014 -- 6,202(2)
Executive Vice President--Sales and Marketing 1996 298,002 -- 410,000 3,202(2)
James E. Kolsrud ................................ 1997 177,083 1,014 -- 5,528(3)
Executive Vice President--Operations and 1996 25,000 -- 205,000 --
Engineering
Kelly D. Enos(4) ................................ 1997 150,000 1,014 20,500 25,924(5)
Chief Financial Officer and Treasurer 1996 12,500 -- 153,750 --
</TABLE>
- ------------------------
(1) Consists of life and health insurance premiums paid by STAR.
(2) Consists of life and health insurance premiums and a car allowance paid by
STAR.
(3) Consists of health insurance premiums paid by STAR.
(4) Ms. Enos joined STAR in December 1996.
(5) Consists of a moving allowance of $22,721 and life and health insurance
premiums paid by STAR.
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The following table contains information concerning the stock option grants
made to each of the STAR Named Officers named below for the year ended December
31, 1997.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE OF ASSUMED
NUMBER OF ANNUAL RATES OF STOCK
SECURITIES PERCENT OF TOTAL PRICE APPRECIATION
UNDERLYING OPTIONS GRANTED EXERCISE FOR OPTION TERM(1)
OPTIONS TO EMPLOYEES IN PRICE PER EXPIRATION ---------------------
NAME GRANTED (#) FISCAL YEAR SHARE ($/SH) DATE 5% ($) 10% ($)
- ------------------------------------ ----------- ----------------- ------------- ----------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Kelly D. Enos....................... 20,500(2) 2.3% $ 6.83 06/27/07 $ 88,045 $ 223,124
</TABLE>
- ------------------------
(1) The 5% and 10% assumed annual rates of compounded stock price appreciation
are mandated by rules of the Securities and Exchange Commission. There can
be no assurance provided to any executive officer or any other holder of
STAR's securities that the actual stock price appreciation over the 10-year
option term will be at the assumed 5% and 10% levels or at any other defined
level. Unless the market price of the STAR Common Stock appreciates over the
option term, no value will be realized from the option grants made to the
executive officer.
(2) The option becomes exercisable in four equal annual installments on June 26,
1998, 1999, 2000 and 2001, respectively.
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
No options were exercised by the STAR Named Officers for the fiscal year
ended December 31, 1997. No stock appreciation rights were exercised during such
year or were outstanding at the end of that year.
STAR COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee of STAR's Board (the "Compensation Committee")
was formed in May 1996, and, in 1997, the members of the Compensation Committee
were Gordon Hutchins, Jr., John R. Snedegar and Roland A. Van der Meer. None of
these individuals was at any time during the year ended December 31, 1997, or at
any other time, an officer or employee of STAR. Mr. Van der Meer resigned from
the Board and the Compensation Committee, effective as of February 1, 1998. The
Non-Executive Compensation Committee of STAR's Board (the "Non-Executive
Compensation Committee") was formed in 1997, and the members are Christopher E.
Edgecomb and Mary A. Casey. No member of the Compensation Committee or the
Non-Executive Compensation Committee served at any time during the year ended
December 31, 1997 as a member of the board of directors or compensation
committee of any entity that has one or more executive officers serving as a
member of STAR's Board, Compensation Committee or Non-Executive Compensation
Committee, except that Mr. Hutchins was a director of UDN for a portion of 1997.
The Compensation Committee and the Non-Executive Compensation Committee shall
collectively be referred to hereafter as the "Compensation Committees."
STAR 1997 OMNIBUS STOCK INCENTIVE PLAN
STAR's 1997 Omnibus Stock Incentive Plan (the "Omnibus Plan") was adopted by
the Board of Directors on January 30, 1997 as the successor to STAR's 1996
Supplemental Option Plan (the "Supplemental Plan"). STAR has reserved 3,075,000
shares for issuance under the Omnibus Plan. This share reserve is comprised of
(i) the 2,050,000 shares that were available for issuance under the Supplemental
Plan, plus (ii) an increase of 1,025,000 shares. As of May 15, 1998, 32,060
shares had been issued under the Supplemental and Omnibus Plans, options for
approximately 2,142,314 shares were outstanding (873,686 of which were granted
under the Supplemental Plan) and approximately 915,330 shares remained available
for future grant. Shares of STAR Common Stock subject to outstanding options,
including options granted
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under the Supplemental Plan, which expire or terminate prior to exercise, will
be available for future issuance under the Omnibus Plan. In addition, if stock
appreciation rights ("SARs") and stock units are settled under the Omnibus Plan,
then only the number of shares actually issued in settlement will reduce the
number of shares available for future issuance under this plan.
Under the Omnibus Plan, employees, outside directors and consultants may be
awarded options to purchase shares of STAR Common Stock, SARs, restricted shares
and stock units. Options may be incentive stock options designed to satisfy
Section 422 of the Internal Revenue Code or nonstatutory stock options not
designed to meet such requirements. SARs may be awarded in combination with
options, restricted shares or stock units, and such an award may provide that
the SARs will not be exercisable unless the related options, restricted shares
or stock units are forfeited.
The Omnibus Plan is administered by the Board or the Compensation Committees
(the "Administrator"). The Administrator has the complete discretion to
determine which eligible individuals are to receive awards; determine the award
type, number of shares subject to an award, vesting requirements and other
features and conditions of such awards; interpret the Omnibus Plan; and make all
other decisions relating to the operation of the Omnibus Plan.
The exercise price for options granted under the Omnibus Plan may be paid in
cash or in outstanding shares of STAR Common Stock. Options may also be
exercised on a cashless basis, by a pledge of shares to a broker or by
promissory note. The payment for the award of newly issued restricted shares
will be made in cash. If an award of SARs, stock units or restricted shares from
STAR's treasury is granted, no cash consideration is required.
The Administrator has the authority to modify, extend or assume outstanding
options and SARs or may accept the cancellation of outstanding options and SARs
in return for the grant of new options or SARs for the same or a different
number of shares and at the same or a different exercise price.
The Board may determine that an outside director may elect to receive his or
her annual retainer payments and meeting fees from STAR in the form of cash,
options, restricted shares, stock units or a combination thereof. The Board will
decide how to determine the number and terms of the options, restricted shares
or stock units to be granted to outside directors in lieu of annual retainers
and meeting fees.
Upon a change in control, the Administrator may determine that an option or
SAR will become fully exercisable as to all shares subject to such option or
SAR. A change in control includes a merger or consolidation of STAR, certain
changes in the composition of the Board and acquisition of 50% or more of the
combined voting power of STAR's outstanding stock. In the event of a merger or
other reorganization, outstanding options, SARs, restricted shares and stock
units will be subject to the agreement of merger or reorganization, which may
provide for the assumption of outstanding awards by the surviving corporation or
its parent, their continuation by STAR (if STAR is the surviving corporation),
accelerated vesting and accelerated expiration, or settlement in cash.
The Board may amend or terminate the Omnibus Plan at any time. Amendments
may be subject to stockholder approval to the extent required by applicable
laws. In any event, the Omnibus Plan will terminate on January 22, 2007, unless
sooner terminated by the Board.
STAR 1996 OUTSIDE DIRECTOR NONSTATUTORY STOCK OPTION PLAN
STAR's 1996 Outside Director Nonstatutory Stock Option Plan (the "Director
Plan") was ratified and approved by the Board of Directors as of May 14, 1996.
STAR has reserved 410,000 shares of STAR Common Stock for issuance under the
Director Plan. As of May 15, 1998, 71,750 shares had been issued under the
Director Plan, options for 81,750 shares were outstanding and 256,500 shares
remained available for future grant. If an outstanding option expires or
terminates unexercised, then the shares subject to such option will again be
available for issuance under the Director Plan.
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<PAGE>
Under the Director Plan, outside directors of STAR may receive nonstatutory
options to purchase shares of STAR Common Stock. The Director Plan is
administered by the Board or the Compensation Committee (the "Administrator").
The Administrator has the discretion to determine which eligible individuals
will receive options, the number of shares subject to each option, vesting
requirements and any other terms and conditions of such options.
The exercise price for options granted under the Director Plan will be at
least 85% of the fair market value of the STAR Common Stock on the option grant
date, shall be 110% of the fair market value of the STAR Common Stock on the
option grant date if the option is granted to a holder of more than 10% of the
STAR Common Stock outstanding and may be paid in cash, check or shares of STAR
Common Stock. The exercise price may also be paid by cashless exercise or pledge
of shares to a broker.
The Administrator may modify, extend or renew outstanding options or accept
the surrender of such options in exchange for the grant of new options, subject
to the consent of the affected optionee.
Upon a change in control, the Board may accelerate the exercisability of
outstanding options and provide an exercise period during which such accelerated
options may be exercised. The Board also has the discretion to terminate any
outstanding options that had been accelerated and had not been exercised during
such exercise period. In the event of a merger of STAR into another corporation
in which holders of STAR Common Stock receive cash for their shares, the Board
may settle the option with a cash payment equal to the difference between the
exercise price and the amount paid to holders of STAR Common Stock pursuant to
the merger.
The Board may amend or terminate the Director Plan at any time. In any
event, the Director Plan will terminate on May 14, 2006, unless sooner
terminated by the Board.
STAR EMPLOYMENT AGREEMENTS AND CHANGE OF CONTROL ARRANGEMENTS
STAR has an employment agreement with Mary A. Casey, pursuant to which Ms.
Casey holds the position of President of STAR, is paid an annual salary of
$20,000 per month, subject to adjustment to reflect increases in the Consumer
Price Index, was entitled to purchase 1,677,273 shares of STAR Common Stock, and
is eligible to receive a bonus, as determined by the Chief Executive Officer and
Board of Directors. The agreement also provides that Ms. Casey will receive a
severance payment equal to $7,000 per month for the first six months after
termination of employment, and an additional payment of $7,000 per month for the
next six months, minus any amounts earned by her from other employment during
such period. In addition, the agreement provides that if Ms. Casey's employment
is terminated (other than for cause) within four months after a Sale Transaction
(as defined below), she will continue to receive the compensation provided in
the agreement until the expiration of the agreement on December 31, 2000,
instead of the severance payments described above. A Sale Transaction is an
acquisition of more than 75% of the voting securities of STAR, pursuant to a
tender offer or exchange offer approved in advance by the Board of Directors.
In January 1996, STAR entered into an employment agreement with David Vaun
Crumly pursuant to which Mr. Crumly became Executive Vice President of STAR. The
agreement provides for an annual salary of $10,000 per month with an annual
increase, plus incentive bonuses tied to gross revenues of STAR. The agreement
also provides for a commission on certain accounts of STAR and an option to
purchase 369,000 shares of STAR Common Stock at an exercise price of $0.73 per
share. In addition, in the event of a Sale Transaction, Mr. Crumly will receive
a bonus payment equal to the lesser of $1,500,000 or a percentage of the monthly
gross sales of accounts relating to customers introduced to STAR by Mr. Crumly.
If his employment is terminated in certain circumstances, without cause, within
four months after a Sale Transaction, Mr. Crumly is entitled to receive the
compensation provided in this agreement, minus any compensation earned by other
employment, until the expiration of the agreement on December 31, 2000.
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<PAGE>
In December 1996, STAR entered into an employment agreement with Kelly D.
Enos, pursuant to which Ms. Enos became Chief Financial Officer of STAR. The
agreement provides for an annual salary of $150,000 (which has been increased to
$160,000) and an option to purchase 153,750 shares of STAR Common Stock at an
exercise price of $4.00 per share. The agreement also provides that Ms. Enos
will receive a severance payment equal to the compensation which she would have
received under the remaining term of the agreement if she terminates the
agreement as a result of STAR's default of its material obligations and duties
under the agreement or if she is terminated by STAR without cause within four
months after a Sale Transaction.
In September 1996, STAR entered into an employment agreement with James E.
Kolsrud, pursuant to which Mr. Kolsrud became Executive Vice
President--Operations and Engineering of STAR. The agreement provides for a
monthly salary of $16,667, an option to purchase 205,000 shares of STAR Common
Stock pursuant to STAR's 1996 Supplemental Stock Option Plan at a price of $4.00
per share, reimbursement of reasonable out-of-pocket expenses incurred in
connection with Company business, and fringe benefits accorded to executives of
STAR as determined by the Board of Directors. In the event of termination
pursuant to the agreement, Mr. Kolsrud shall be entitled to receive compensation
accrued and payable to him as of the date of his termination or death, and all
other amounts payable to him under the agreement shall thereupon cease. If his
employment is terminated in certain circumstances within four months after a
Sale Transaction, then Mr. Kolsrud shall continue to receive the compensation
provided in the agreement until the expiration of the agreement on December 31,
2000.
OFFICERS AND DIRECTORS OF UDN
After the Merger, the officers and directors of UDN are expected to be and
their ages as of December 31, 1997 are, as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ----------------------------------- --- ---------------------------------------------------
<S> <C> <C>
John R. Snedegar .................. 49 President
Laguna Hills, CA 92653
Dale W. Christensen ............... 45 Chief Operating Officer and Chief Financial Officer
Carrollton, TX 75007
Christopher E. Edgecomb ........... 38 Director
Santa Barbara, CA 93101
Mary A. Casey ..................... 34 Director
Santa Barbara, CA 93101
Kelly D. Enos ..................... 38 Director
Santa Barbara, CA 93101
</TABLE>
JOHN R. SNEDEGAR has been the President and a Director of UDN since June
1990. From June 1980 to February 1992, Mr. Snedegar was the President and CEO of
AmeriTel Management, Inc., a provider of long distance telecommunications and
management services. Mr. Snedegar is also a director for StarBase Corporation, a
software development company, and of STAR. Mr. Snedegar also serves as President
of Kendall Venture Funding, Ltd., a reporting company in Alberta, Canada.
DALE W. CHRISTENSEN co-founded ANI Communications in February 1992, and
joined UDN as Chief Operating Officer and Chief Financial Officer upon UDN's
acquisition of ANI later that same year. From 1989 to 1992, Mr. Christensen was
the Controller of International Telecharge, Inc. ("ITI"), a telecommunications
company that provided alternative operator services primarily to the pay phone
and hospitality markets.
For biographies of Mr. Edgecomb, Ms. Casey and Ms. Enos, see "--Officers and
Directors of STAR."
All directors hold office until the next annual meeting of stockholders or
until their successors have been duly elected or qualified or until his earlier
death, resignation or removal. Executive officers of UDN are appointed by and
serve at the discretion of the UDN Board.
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<PAGE>
UDN DIRECTOR COMPENSATION
The members of the UDN Board of Directors are not compensated in such
capacity. However, the UDN Board of Directors may, by resolution, reimburse
directors for out-of-pocket expenses incurred in their capacity as directors of
UDN.
UDN EXECUTIVE COMPENSATION
The following Summary Compensation Table sets forth the compensation earned
by UDN's President and one other executive officer who earned (or would have
earned) salary and bonus in excess of $100,000 for services rendered in all
capacities to UDN and its subsidiaries (the "UDN Named Officers") for each of
the fiscal years in the three year period ended April 30, 1998.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
------------
SECURITIES
FISCAL UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY ($) BONUS OPTIONS (#) COMPENSATION
- ----------------------------------- ------ -------------- -------- ------------ ------------
<S> <C> <C> <C> <C> <C>
John R. Snedegar, ................. 1998 $ 125,587 $ 50,000 -- $7,200
President/Chief Executive Officer 1997 118,019 25,000 -- 6,000
1996 -- -- -- --
Dale W. Christensen, .............. 1998 $ 101,443 $ 23,750 37,500 $2,400
Chief Operating Officer and Vice 1997 104,877 20,000 -- --
President Finance 1996 90,930 6,500 37,500 --
</TABLE>
The following table contains information concerning the stock option grants
made to each of the UDN Named Officers named below for the year ended April 30,
1998.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
MARKET VALUE OF
NUMBER OF PERCENT OF SECURITIES
SECURITIES TOTAL OPTIONS EXERCISE UNDERLYING
UNDERLYING GRANTED TO PRICE PER OPTIONS ON THE
OPTIONS GRANTED EMPLOYEES IN SHARE DATE OF GRANT EXPIRATION
NAME (#)(1) FISCAL YEAR (CDN $/SH) (CDN $/SECURITY) DATE
- ---------------------------------------- --------------- --------------- ------------- ----------------- -----------
<S> <C> <C> <C> <C> <C>
Dale W. Christensen..................... 37,500 49.0% $ 2.28 $ 2.28 6/11/02
</TABLE>
- ------------------------
(1) These options are fully vested.
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
No options were exercised by the UDN Named Officers for the fiscal year
ended April 30, 1998. No stock appreciation rights were exercised during such
year or were outstanding at the end of that year.
<TABLE>
<CAPTION>
UNEXERCISED OPTIONS @ APRIL VALUE OF UNEXERCISED
30, IN-THE-MONEY
1997 OPTIONS AT APRIL 30, 1997
NAME EXERCISABLE/UNEXERCISABLE (#) EXERCISABLE/UNEXERCISABLE ($$)
- ------------------------------------------------- ------------------------------ -------------------------------
<S> <C> <C>
Dale Christensen................................. 37,500/0 nil
</TABLE>
106
<PAGE>
OUTSTANDING STOCK OPTIONS
<TABLE>
<CAPTION>
NUMBER OF UDN EXERCISE PRICE EXPIRY DATE OF
CLASS OF OPTIONEE SHARES UNDER OPTION PER SHARE OPTION
- ------------------------------------------------ ------------------- -------------------- --------------------
<S> <C> <C> <C>
Executive Officers, as a group (1 person)....... 37,500 US$ 1.64/CD$2.80 May 2, 2000
37,500 US$ 2.04/CD$2.28 June 11, 2002
Directors who are not executive officers, as a 25,000 US$ 2.16/CD$2.92 May 11, 2000
group (3 persons)............................. 75,000 US$ 2.14/CD$2.92 January 15, 2001
50,000 US$ 1.97/CD$2.68 March 26, 2001
Other employees of UDN, or its subsidiaries, as 16,250 US$ 1.64/CD$2.80 May 2, 2000
a group (21 persons).......................... 39,375 US$ 1.77/CD$2.40 August 21, 2000
98,750 US$ 2.02/CD$2.76 June 6, 2001
40,000 US$ 1.84/CD$2.50 October 4, 2001
36,250 US$ 1.59/CD$2.22 April 4, 2002
13,750 US$ 2.04/CD$2.28 June 11, 2002
</TABLE>
UDN EMPLOYMENT AGREEMENTS
EMPLOYMENT CONTRACT WITH MR. SNEDEGAR. UDN entered into an Employment
Agreement, dated June 1, 1996, with its President, John R. Snedegar, pursuant to
which Mr. Snedegar is employed for a four-year term from June 1, 1996, at a base
salary of $125,000 per annum. The agreement also provides for typical
perquisites such as reimbursement of expenses, paid vacation, automobile
allowance and medical, disability and life insurance. Mr. Snedegar can earn a
bonus of up to $50,000 per fiscal year at the discretion of the Board of
Directors or based on revenue and profitability targets to be established by the
Board (the "Bonus").
Mr. Snedegar may terminate the agreement for any reason upon ninety days'
prior written notice. In the event that Mr. Snedegar's employment is terminated
without cause, Mr. Snedegar will be entitled to a severance payment equal to his
monthly base salary times the number of months remaining in the term of the
agreement up to a maximum of 24 months, in addition to two times the amount of
the Bonus earned during the fiscal year prior to termination.
In the event that there is a change in control of UDN, Mr. Snedegar may
elect to terminate the agreement. In that event, Mr. Snedegar will be entitled
to a severance payment equal to his monthly base salary times the number of
months remaining in the term of the contract, up to a maximum of 24 months, in
addition to two times the amount of the Bonus earned during the fiscal year
prior to termination and will continue to receive life insurance, health
insurance and disability insurance benefits for a period of two years from the
date of termination.
In the event that the agreement is otherwise terminated, Mr. Snedegar will
be entitled to receive an amount equivalent to the Bonus for the fiscal year in
which termination occurs multiplied by a fraction, the numerator of which is the
number of days in that year prior to termination and the denominator is 365.
EMPLOYMENT CONTRACT WITH MR. CHRISTENSEN. UDN entered into an Employment
Agreement dated May 1, 1997, with its Chief Financial Officer and Chief
Operating Officer, Dale W. Christensen, pursuant to which Mr. Christensen is
employed for a two-year term from May 1, 1997, at a base salary of $100,000 per
annum. The agreement also provides for typical perquisites such as reimbursement
of expenses, paid vacation, automobile allowance and medical and disability
insurance. Mr. Christensen can earn a bonus of up to $25,000 per fiscal year
based on revenue and profitability targets to be agreed upon between UDN's
President and Mr. Christensen (the "Bonus").
Mr. Christensen may terminate the agreement for any reason upon thirty days'
prior written notice. In the event that Mr. Christensen's employment is
terminated by UDN without cause, Mr. Christensen will be
107
<PAGE>
entitled to a severance payment equal to his monthly base salary times the
number of months remaining in the term of the agreement up to a maximum of six
months, in addition to the amount of the Bonus which would have been earned in
the fiscal year of termination, multiplied by a fraction of which the numerator
is the number of days in that year prior to termination and the denominator is
365.
In the event that there is a change in control of UDN, Mr. Christensen may
elect to terminate the agreement. In that event, Mr. Christensen will be
entitled to a severance payment equal to his monthly base salary times the
number of months remaining in the term of the contract, up to a maximum of six
months and will continue to receive medical and disability insurance benefits
for a period of six (6) months from the date of termination.
108
<PAGE>
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
TRANSACTIONS WITH STAR OUTSIDE DIRECTORS
STAR provides services to Digital Network, Inc. ("DNI"), a wholly owned
subsidiary of UDN. John R. Snedegar, a Director of STAR, is President of UDN.
For the year ended December 31, 1997 and the four months ended April 30, 1998,
DNI made payments to STAR in the amount of approximately $1,141,000 and
$1,877,000, respectively for such services.
On November 19, 1997, STAR entered into an agreement to acquire UDN. Messrs.
Snedegar and Edgecomb beneficially own 11.4% and 2%, respectively, of the
outstanding common stock of UDN. In the context of the potential acquisition of
UDN, STAR has loaned $4.5 million to UDN at market rates of interest. Assuming
the receipt of all necessary stockholder and regulatory approvals, management
expects to consummate the UDN acquisition at the end of the second quarter of
1998 for approximately 600,000 shares of STAR Common Stock. UDN's Common Stock
is traded on the Vancouver Stock Exchange under the symbol UDN.V.
GH Associates, an affiliate of Gordon Hutchins, Jr., a Director of STAR,
provides consulting services to STAR. For the years ended December 31, 1995,
1996 and 1997 and for the four months ended April 30, 1998, STAR made payments
of approximately $60,000, $154,000, $72,000 and $31,000, respectively, to GH
Associates for general business consulting services relating to the
telecommunications industry and for the performance of other tasks requested by
STAR's Chief Executive Officer, President and Board of Directors. In addition,
in connection with these services, STAR granted to Mr. Hutchins a nonstatutory
option to purchase 205,000 shares of STAR Common Stock at an exercise price of
$1.46 per share.
STAR's Outside Directors have been granted nonstatutory stock options under
the Director Plan. See "Management of STAR and UDN--STAR Director Compensation."
TRANSACTIONS WITH STAR EXECUTIVE OFFICERS
Each of Kelly D. Enos, David Vaun Crumly and James E. Kolsrud received
incentive stock options to purchase 4,100 shares of STAR Common Stock at an
exercise price of $16.31 in January 1998, and incentive stock options to
purchase 100 shares of STAR Common Stock at an exercise price of $27.00 in May
1998.
On October 4, 1996, STAR entered into a $12.0 million line of credit with
Comerica Bank. This line of credit was guaranteed by Christopher E. Edgecomb,
STAR's Chief Executive Officer. STAR has entered into a new revolving credit
facility since that time and Mr. Edgecomb's guarantee of the Comerica Bank line
has been terminated. Mr. Edgecomb did not receive any additional compensation in
connection with such guarantee. STAR has entered into lines of credit with Mr.
Edgecomb in the aggregate amount of $1,448,000. Borrowings under the lines of
credit bear interest at a rate of 9.0% and there was $82,000 outstanding under
these lines of credit as of March 31, 1998. In addition, on November 27, 1997
STAR provided a short-term loan to Mr. Edgecomb for $8.0 million. The loan
carried interest of 7% per annum and was repaid in seven days.
Mr. Edgecomb owns Star Aero Services, Inc. ("Star Aero"), which has
ownership interests in five airplanes that STAR utilizes for business travel
from time to time. For the years ended December 31, 1995, 1996 and 1997 and the
four months ended April 30, 1998, STAR paid $144,000, $68,000, $171,000 and
$10,000, respectively, in costs related to the use of Star Aero services.
Mr. Crumly had controlling ownership of three companies that resold
transmission capacity to STAR during 1996 for a total of approximately $240,000.
No fees were paid to Mr. Crumly during 1997 with respect to such transmission
capacity. In addition, STAR reimbursed approximately $131,000 in legal fees
incurred by such companies in connection with a dispute with the provider of the
capacity that was resold to STAR.
109
<PAGE>
Mr. Kolsrud has a 12.5% interest in Interpacket Group, Inc. ("Interpacket")
which has direct termination arrangements with STAR for certain countries in
Central and South America. For the years ended December 31, 1996 and 1997 and
the four months ended April 30, 1998, STAR paid $37,000, $256,000 and
$1,146,000, respectively, for services rendered by Interpacket. In addition,
STAR purchased satellite transmission equipment and services from Interpacket
during 1997 in the amount of $1,114,000.
INDEMNIFICATION OF STAR DIRECTORS AND OFFICERS
STAR's Amended and Restated Certificate of Incorporation limits the
liability of its directors for monetary damages arising from a breach of their
fiduciary duty as directors, except to the extent otherwise required by the
Delaware General Corporation Law. Such limitation of liability does not affect
the availability of equitable remedies such as injunctive relief or rescission.
STAR's Bylaws provide that STAR shall indemnify its directors and officers
to the fullest extent permitted by Delaware law, including in circumstances in
which indemnification is otherwise discretionary under Delaware law. STAR's has
also entered into or will enter into indemnification agreements with its
officers and directors containing provisions that may require STAR, among other
things, to indemnify such officers and directors against certain liabilities
that may arise by reason of their status or service as directors or officers
(other than liabilities arising from willful misconduct of a culpable nature),
to advance their expenses incurred as a result of any proceeding against them as
to which they could be indemnified, and to obtain directors' and officers'
insurance if available on reasonable terms.
STAR believes that all of the transactions set forth above were made on
terms no less favorable to STAR than could have been obtained from unaffiliated
third parties. All future transactions, including loans between STAR and its
officers, directors, principal stockholders and their affiliates will be
approved by a majority of the Board of Directors, including a majority of the
independent and disinterested outside directors on the Board of Directors, and
will continue to be on terms no less favorable to STAR than could be obtained
from unaffiliated third parties.
TRANSACTIONS WITH UDN DIRECTORS AND OFFICERS
Donald Sledge is covered by UDN's health and dental insurance plan, and UDN
reimburses the annual costs of his life insurance policy.
In March 1996, UDN acquired all of the outstanding common stock of AMS for
consideration totaling $5.0 million, consisting of $1.0 million in cash, $3.0
million in convertible debentures and $1.0 million in notes payable.
Ninety-three percent of the outstanding shares of AMS were owned by Ennis
Rushton and Cindy Rushton, his wife. Immediately following this transaction, Mr.
Rushton became a director of UDN.
Under the AMS acquisition agreement, UDN was entitled to reduce the
outstanding amount of the convertible debentures and notes payable issued in the
transaction by the amounts by which (a) the net worth of AMS at closing was less
than an agreed upon amount and (b) revenue in several specified post-closing
periods was less than an agreed upon amount. Pursuant to these provisions, UDN
reduced the outstanding debentures by approximately $1.1 million as a result of
the closing-date equity level of AMS, and by approximately $368,000 as a result
of the post-closing revenue of AMS. Ennis and Cindy Rushton disputed the amount
of the reduction relating to post-closing revenue. In addition, subsequent to
the AMS acquisition, $500,000 of the convertible debentures were converted by
the holders into 250,000 shares of UDN Common Stock. In March 1998, UDN settled
the dispute with Ennis and Cindy Rushton by a reduction of $200,000 in the
amount outstanding under the Convertible Debenture. All amounts due under the
notes payable to the AMS sellers have been paid and the net amount outstanding
under the Convertible Debenture is $550,000.
In each of fiscal 1998 and fiscal 1996, Dale Christensen was granted options
to acquire 37,500 shares of UDN Common Stock.
110
<PAGE>
PRINCIPAL STOCKHOLDERS OF STAR
The following table sets forth certain information known to STAR regarding
beneficial ownership of STAR Common Stock as of May 15, 1998, as adjusted to
reflect the issuance of shares in the Merger by (i) each person who is known by
STAR to own beneficially more than five percent of STAR's Common Stock, (ii)
each of STAR's directors, (iii) each of the Named Officers, and (iv) all current
officers and directors as a group.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED SHARES BENEFICIALLY OWNED
BEFORE THE MERGER(1) AFTER THE MERGER(1)
--------------------------- ---------------------------
NAME AND ADDRESS OF BENEFICIAL OWNER NUMBER PERCENT(2) NUMBER PERCENT(2)
- ------------------------------------------------------------ ------------ ------------- ------------ -------------
<S> <C> <C> <C> <C>
Entities affiliated with the Hunt Family Trusts(3) ......... 2,099,182 5.0% 2,099,182 5.0%
3900 Thanksgiving Tower
Dallas, Texas 75201
Gordon Hutchins, Jr.(4) .................................... 178,350 * 178,350 *
John R. Snedegar(5) ........................................ 30,750 * 95,084 *
Mark Gershien .............................................. -- * -- *
Arunas A. Chesonis ......................................... -- * -- *
Christopher E. Edgecomb .................................... 13,353,707 32.0 13,364,227 31.6
Mary A. Casey .............................................. 1,646,613 3.9 1,646,613 3.9
David Vaun Crumly(6) ....................................... 594,500 1.4 596,143 1.4
James E. Kolsrud(7) ........................................ 71,747 * 71,747 *
Kelly D. Enos(8) ........................................... 55,307 * 55,307 *
All directors and executive officers as a group (9
persons)(9) .............................................. 15,930,974 37.8 16,007,471 37.4
</TABLE>
- ------------------------
* Represents beneficial ownership of less than 1% of the outstanding shares of
Common Stock.
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and includes voting or investment power
with respect to securities. The address for each listed director and officer
is c/o STAR Telecommunications, Inc., 223 East De La Guerra Street, Santa
Barbara, California 93101. To STAR's knowledge, except as indicated in the
footnotes to this table and pursuant to applicable community property laws,
the persons named in the table have sole voting and investment power with
respect to all shares of STAR Common Stock.
(2) Percentage of beneficial ownership is based on 41,755,594 shares of STAR
Common Stock outstanding as of May 15, 1998 and 42,322,616 shares of STAR
Common Stock after the completion of the Merger. The number of shares of
STAR Common Stock beneficially owned includes the shares issuable pursuant
to stock options and warrants that are exercisable within sixty days of May
15, 1998. Shares issuable pursuant to stock options are deemed outstanding
for computing the percentage of the person holding such options but are not
outstanding for computing the percentage of any other person.
(3) Consists of 692,895 shares held by Lyda Hunt--Herbert Trusts--David Shelton
Hunt, 346,447 shares held by Lyda Hunt--Herbert Trusts--Bruce William Hunt,
346,447 shares held by Lyda Hunt-- Herbert Trusts--Douglas Herbert Hunt,
346,447 shares held by Lyda Hunt--Herbert Trusts--Barbara Ann Hunt, 346,447
shares held by Lyda Hunt--Herbert Trusts--Lyda Bunker Hunt and 20,500 shares
held by David Shelton Hunt. The co-trustees of each of the Hunt Family
Trusts hold voting and investment power for all shares of STAR's Common
Stock held by the respective trusts. Walter P. Roach and Gage A. Prichard
are the co-trustees of each such trust.
(4) Consists of 178,350 shares issuable upon the exercise of stock options
exercisable within sixty days of May 15, 1998.
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<PAGE>
(5) Prior to the Merger, consists of 20,500 shares of Common Stock, and 10,250
shares issuable upon the exercise of stock options exercisable within sixty
days of May 15, 1998. After completion of the Merger, consists of 2,804
shares of STAR Common Stock owned by a trust for the benefit of Mr.
Snedegar's children, under which Mr. Snedegar is a potential beneficiary and
the sole trustee. In addition, Mr. Snedegar is a potential beneficiary and
the sole trustee under the Snedegar Revocable Living Trust ("SRLT"). SRLT,
in turn, owns 100% of the issued shares of Norexco Petroleum Company
("Norexco"), which in turn owns 100% of the issued shares of Avalon
Management Corp. ("Avalon"). Avalon is the general partner of and owns 25%
of a limited partnership, Access Financial, L.P. ("Access"), which owns
21,555 shares of STAR Common Stock. The post-merger number also includes
2,296 shares of STAR Common Stock subject to share purchase warrants owned
by Access and exercisable within sixty days of May 15, 1998, and 10,250
shares issuable upon the exercise of stock options exercisable within sixty
days of May 15, 1998
(6) Prior to the Merger, consists of 451,000 shares of Common Stock, and 143,500
shares of Common Stock issuable upon the exercise of stock options
exercisable within sixty days of May 15, 1998, and after the completion of
the Merger, consists of 451,193 shares of Common Stock and 144,950 shares of
Common Stock issuable upon the exercise of stock options exercisable within
sixty days of May 15, 1998.
(7) Consists of 20,497 shares of Common Stock held in joint tenancy and 51,250
shares of Common Stock issuable upon the exercise of stock options
exercisable within sixty days of May 15, 1998.
(8) Consists of 16,870 shares of Common Stock and 39,718 shares of Common Stock
issuable upon the exercise of stock options exercisable within sixty days of
May 15, 1998.
(9) Prior to the Merger, consists of 421,787 shares of Common Stock issuable
upon the exercise of stock options exercisable within sixty days of May 15,
1998, and after completion of the Merger, includes 425,533 shares of STAR
Common Stock issuable upon the exercise of stock options and warrants
exercisable within sixty days of May 15, 1998.
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<PAGE>
PRINCIPAL STOCKHOLDERS OF UDN
The following table sets forth the number of and percentage of outstanding
shares of Common Stock owned by officers, directors and principal stockholders
of UDN as of May 15, 1998.
<TABLE>
<CAPTION>
SHARES OF COMMON STOCK
BENEFICIALLY OWNED(1)
-------------------------
NAMES AND ADDRESS OF BENEFICIAL OWNER NUMBER PERCENT(2)
- ---------------------------------------- ------------- ------
<S> <C> <C>
John R. Snedegar ....................... 831,647(3) 11.8%
18872 MacArthur Boulevard, Suite 300
Irvine, California 92612
Dale W. Christensen .................... 236,817(4) 3.3%
1431 Greenway Drive, Suite 640
Irving, Texas 75038
Ennis Rushton .......................... 507,500(5) 7.2%
660 Bird Lane
Litchfield, Arizona
Donald Sledge .......................... 112,500(6) 1.6%
27 Cherry Hill Court
Alamo, California 94507
Janine Thomas .......................... 25,000(7) 0.4%
109 Stevens Drive
W. Vancouver, BC V751C2
All Directors and Executive Officers as
a Group (5 persons) .................. 1,713,464 24.3%
</TABLE>
- ------------------------
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and includes voting or investment power
with respect to securities. To UDN's knowledge, except as indicated in the
footnotes to this table and pursuant to applicable community property laws,
the persons named in the table have sole voting and investment power with
respect to all shares of UDN Common Stock.
(2) Percentage of beneficial ownership is based on 7,054,844 shares of UDN
Common Stock outstanding as of May 15, 1998.
(3) Includes 36,250 shares of UDN Common Stock owned by a trust for the benefit
of Mr. Snedegar's children, under which Mr. Snedegar is a potential
beneficiary and the sole trustee. In addition, Mr. Snedegar is a potential
beneficiary and the sole trustee under SRLT. SRLT, in turn, owns 100% of the
issued shares of Norexco which in turn owns 100% of the issued shares of
Avalon. Avalon is the general partner of and owns 25% of Access which owns
278,650 shares of UDN. Includes share purchase warrants to purchase 29,688
shares of UDN Common Stock owned by Access, which warrants are currently
exercisable and expire on February 10, 1999. Includes 62,500 shares of UDN
Common Stock held pursuant to an Escrow Agreement dated October 21, 1993
among Montreal Trust Company of Canada, UDN and the shareholders named
therein.
(4) Includes 37,500 shares of UDN Common Stock held pursuant to an Escrow
Agreement dated October 21, 1993 among Montreal Trust Company of Canada, UDN
and the stockholders named therein. Includes 7,500 shares of UDN Common
Stock issuable upon exercise of share purchase warrants, which warrants are
currently exercisable and expire of February 10, 1999. Also includes 75,000
shares of UDN Common Stock issuable upon exercise of stock options
exercisable within sixty days of May 15, 1998.
(5) Consists of the shares issued to Ennis Rushton, a director of UDN, and Cindy
Rushton, his wife, upon conversion of $500,000 in principal amount of UDN's
convertible debentures and 275,000 shares of UDN Common Stock issuable upon
conversion of the remaining $550,000 of convertible debentures
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<PAGE>
held by Mr. and Mrs. Rushton. See "Business of UDN--Acquisitions" and
"Certain Relationships and Related Transactions."
(6) Includes 75,000 shares of UDN Common Stock issuable upon the exercise of
stock options exercisable within sixty days of May 15, 1998.
(7) Includes 25,000 shares of UDN Common Stock issuable upon the exercise of
stock options exercisable within sixty days of May 15, 1998.
SHARES HELD IN ESCROW ON BEHALF OF CERTAIN STOCKHOLDERS. Pursuant to an
escrow agreement dated October 21, 1993, among Montreal Trust Company of Canada,
UDN and certain stockholders of UDN, including John Snedegar, Dale Christensen
and three non-related parties, 187,500 shares of UDN Common Stock were placed in
escrow in accordance with the Securities Act of British Columbia. These shares
may be released from escrow if UDN achieves certain cumulative cash flow levels.
If the terms for the release of the shares are not achieved by December 13,
1998, the shares will be canceled. By agreement between STAR and UDN, such
escrow shares will be released from escrow concurrently with the consummation of
the Merger, and may be exchanged pursuant to the Merger Agreement.
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<PAGE>
DESCRIPTION OF STAR CAPITAL STOCK
The authorized capital stock of STAR consists of 50,000,000 shares of Common
Stock, $0.001 par value, and 5,000,000 shares of Preferred Stock, $0.001 par
value.
COMMON STOCK
As of May 15, 1998, there were approximately 41,755,594 shares of STAR
Common Stock outstanding that were held of record by approximately 170
stockholders. There will be approximately 42,322,616 shares of Common Stock
outstanding (assuming no exercise after May 15, 1998 of outstanding options)
after giving effect to the issuance of shares of STAR Common Stock in the
Merger.
The holders of STAR Common Stock are entitled to one vote per share on all
matters to be voted upon by the stockholders. Subject to preferences that may be
applicable to any outstanding Preferred Stock, the holders of STAR Common Stock
are entitled to receive ratably such dividends, if any, as may be declared from
time to time by STAR's Board of Directors out of funds legally available
therefor. In the event of the liquidation, dissolution, or winding up of STAR,
the holders of STAR Common Stock are entitled to share ratably in all assets
remaining after payment of liabilities, subject to prior distribution rights of
Preferred Stock, if any, then outstanding. The STAR Common Stock has no
preemptive or conversion rights or other subscription rights. There are no
redemption or sinking fund provisions applicable to the STAR Common Stock. All
outstanding shares of STAR Common Stock are fully paid and nonassessable, and
the shares of STAR Common Stock to be issued upon completion of this offering
will be fully paid and nonassessable.
PREFERRED STOCK
Pursuant to STAR's Amended and Restated Certificate of Incorporation, the
Board of Directors has the authority to issue up to 5,000,000 shares of
Preferred Stock in one or more series and to fix the rights, preferences,
privileges and restrictions thereof, including dividend rights, dividend rates,
conversion rights, voting rights, terms of redemption, redemption prices,
liquidation preferences and the number of shares constituting any series or the
designation of such series, without further vote or action by the stockholders.
The issuance of Preferred Stock may have the effect of delaying, deferring or
preventing a change in control of STAR without further action by the
stockholders and may adversely affect the voting and other rights of the holders
of STAR Common Stock. The issuance of Preferred Stock with voting and conversion
rights may adversely affect the voting power of the holders of STAR Common
Stock, including the loss of voting control to others. At present, STAR has no
plans to issue any of the Preferred Stock.
ANTI-TAKEOVER EFFECTS OF PROVISIONS OF THE CERTIFICATE OF INCORPORATION, BYLAWS
AND DELAWARE LAW
CERTIFICATE OF INCORPORATION AND BYLAWS. STAR's Amended and Restated
Certificate of Incorporation provides that the Board of Directors be divided
into three classes of directors, with each class serving a staggered three-year
term. The classification system of electing directors may tend to discourage a
third party from making a tender offer or otherwise attempting to obtain control
of STAR and may maintain the incumbency of the Board of Directors, as the
classification of the Board of Directors generally increases the difficulty of
replacing a majority of the directors. The Amended and Restated Certificate of
Incorporation also provides that all stockholder actions must be effected at a
duly called meeting and not by a consent in writing. Further, provisions of the
Bylaws and the Amended and Restated Certificate of Incorporation provide that
the stockholders may amend the Bylaws or certain provisions of the Amended and
Restated Certificate of Incorporation only with the affirmative vote of 75% of
STAR's capital stock. These provisions of the Amended and Restated Certificate
of Incorporation and Bylaws could discourage potential acquisition proposals and
could delay or prevent a change in control of STAR. These provisions are
intended to enhance the likelihood of continuity and stability in the
composition of the Board of Directors and in the policies formulated by the
Board of Directors and to discourage certain types of
115
<PAGE>
transactions that may involve an actual or threatened change of control of STAR.
These provisions are designed to reduce the vulnerability of STAR to an
unsolicited acquisition proposal. The provisions also are intended to discourage
certain tactics that may be used in proxy fights. However, such provisions could
have the effect of discouraging others from making tender offers for STAR's
shares and, as a consequence, they also may inhibit fluctuations in the market
price of STAR's shares that could result from actual or rumored takeover
attempts. Such provisions also may have the effect of preventing changes in the
management of STAR. See "Risk Factors--Effect of Certain Charter Provisions;
Anti-takeover Effects of Certificate of Incorporation, Bylaws and Delaware Law."
DELAWARE TAKEOVER STATUTE. STAR is subject to Section 203 of the Delaware
General Corporation Law ("Section 203"), which, subject to certain exceptions,
prohibits a Delaware corporation from engaging in any business combination with
any interested stockholder for a period of three years following the date that
such stockholder became an interested stockholder, unless: (i) prior to such
date, the board of directors of the corporation approved either the business
combination or the transaction that resulted in the stockholder becoming an
interested stockholder; (ii) upon consummation of the transaction that resulted
in the stockholder becoming an interested stockholder, the interested
stockholder owned at least 85% of the voting stock of the corporation
outstanding at the time the transaction commenced, excluding for purposes of
determining the number of shares outstanding those shares owned (x) by persons
who are directors and also officers and (y) by employee stock plans in which
employee participants do not have the right to determine confidentially whether
shares held subject to the plan will be tendered in a tender or exchange offer;
or (iii) on or subsequent to such date, the business combination is approved by
the board of directors and authorized at an annual or special meeting of
stockholders, and not by written consent, by the affirmative vote of at least
66 2/3% of the outstanding voting stock that is not owned by the interested
stockholder.
Section 203 defines business combination to include: (i) any merger or
consolidation involving the corporation and the interested stockholder; (ii) any
sale, transfer, pledge or other disposition of 10% or more of the assets of the
corporation involving the interested stockholder; (iii) subject to certain
exceptions, any transaction that results in the issuance or transfer by the
corporation of any stock of the corporation to the interested stockholder; (iv)
any transaction involving the corporation that has the effect of increasing the
proportionate share of the stock of any class or series of the corporation
beneficially owned by the interested stockholder; or (v) the receipt by the
interested stockholder of the benefit of any loans, advances, guarantees,
pledges or other financial benefits provided by or through the corporation. In
general, Section 203 defines an interested stockholder as any entity or person
beneficially owning 15% or more of the outstanding voting stock of the
corporation and any entity or person affiliated with or controlling or
controlled by such entity or person.
REGISTRATION RIGHTS
Holders of approximately 7,153,000 shares of STAR Common Stock are entitled
to certain rights with respect to the registration of such shares under the
Securities Act. Under the terms of the agreement between STAR and the holders of
such registrable securities, if STAR proposes to register any of its securities
under the Securities Act, either for its own account or for the account of other
security holders exercising registration rights, such holders are entitled to
notice of such registration and are entitled to include shares of such Common
Stock therein. Additionally, certain holders are also entitled to demand
registration rights pursuant to which they may require STAR to file a
registration statement under the Securities Act at its expense with respect to
their shares of Common Stock, and STAR is required to use its best efforts to
effect such registration. Further, holders may require STAR to file additional
registration statements on Form S-3 at STAR's expense. All of these registration
rights are subject to certain conditions and limitations, among them the right
of the underwriters of an offering to limit the number of shares included in
such registration and the right of STAR not to effect a requested registration
within six months following an offering of STAR's securities, including the
offering made hereby.
116
<PAGE>
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the STAR Common Stock is U.S. Stock
Transfer Corporation, 1745 Gardena Avenue, Glendale, California 91204, and its
telephone number is (818) 502-1404.
CERTAIN INCOME TAX CONSEQUENCES
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
The following discussion addresses certain material federal income tax
consequences of the Merger to stockholders of UDN Common Stock who hold their
shares as capital assets (within the meaning of Section 1221 of the Internal
Revenue Code of 1986, as amended (the "Code")). The discussion is based on the
current provisions of the Code, applicable Treasury Regulations, judicial
authority and administrative rulings and practice. It does not address all
aspects of federal income taxation that may be relevant to particular UDN
stockholders in light of their specific circumstances, or to certain types of
stockholders subject to special treatment under the federal income tax laws,
including without limitation, insurance companies, tax-exempt organizations,
foreign persons, financial institutions or broker-dealers, and stockholders who
acquired their UDN Common Stock pursuant to the exercise of employee stock
options or in other compensatory transactions. This discussion also does not
address the state, local, foreign or other federal tax consequences of the
Merger. There can be no assurance that the Internal Revenue Service will not
take a contrary view to any expressed herein. No rulings have been or will be
requested from the Internal Revenue Service with respect to the tax consequences
of the Merger. Moreover, legislative, judicial or administrative changes or
interpretations may be forthcoming that could alter or modify the statements and
conclusions set forth herein, possibly with retroactive effect.
ALL UDN STOCKHOLDERS ARE URGED TO CONSULT THEIR OWN TAX ADVISORS AS TO THE
SPECIFIC TAX CONSEQUENCES TO THEM OR THE MERGER, INCLUDING THE APPLICABILITY AND
EFFECT OF ANY FEDERAL, STATE, LOCAL AND FOREIGN TAX LAWS, AND POSSIBLE CHANGES
IN APPLICABLE TAX LAWS.
Based on the assumptions set forth below, the Merger should qualify as a
tax-free reorganization under Section 368(a)(1) of the Code. As a result, no
gain or loss will be recognized by a stockholder whose shares of UDN Common
Stock are converted into shares of STAR Common Stock, except to the extent of
any cash received in lieu of fractional shares of STAR Common Stock. Each
stockholder receiving cash in lieu of a fractional share of STAR Common Stock
will be treated as having received such fractional share interest and as having
sold it for the cash received, recognizing gain or loss equal to the difference
between the amount of cash received and the portion of that stockholder's basis
in the shares of UDN Common Stock allocable to the fractional share interest.
Such gain or loss will generally be treated as capital gain or loss (long-term
or short-term depending on the stockholder's holding period), unless the payment
transaction is essentially equivalent to a dividend within the meaning of
Section 302 of the Code (a "Dividend Transaction"). The tax basis of the STAR
Common Stock exchanged therefor (except for the basis attributable to any
fractional share interest in STAR Common Stock), and the holding period of the
STAR Common Stock will include the holding period of the UDN Common Stock
surrendered in the Merger.
A stockholder who exercises his appraisal rights with respect to a share of
UDN Common Stock and receives payment for such stock in cash will recognize
capital gain or loss (long-term or short-term depending on the the stockholder's
holding period) measured by the difference between the amount of cash received
and the stockholder's basis in such share, provided the appraisal transaction is
not a Dividend Transaction.
A transaction is not a Dividend Transaction with respect to a UDN
stockholder if, after taking into account shares owned actually and
constructively within the meaning of Section 318 of the Code, there is a
meaningful reduction in the stockholder's proportionate interest in the
corporation. Under this rule, the
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<PAGE>
Internal Revenue Service has ruled that a redemption of a fractional share for
cash in the context of a reorganization transaction (such as the Merger) is
generally not a Dividend Transaction. In addition, the Internal Revenue Service
has ruled that any reduction in the percentage interest of a small minority
shareholder in a publicly held corporation who exercises no control over
corporate affairs should constitute a meaningful reduction.
The tax discussion set forth herein is based on the accuracy of certain
representations made by STAR and UDN, including the following: (i) the Merger
will be consummated in accordance with the Merger Agreement; (ii) following the
Merger, UDN will hold substantially all (i.e., 90% of net asset value and 70% of
gross asset value) of its own properties and substantially all of Newco's
properties, and will continue its historic business or use a significant portion
of its historic business assets in a business; (iii) UDN has not redeemed, and
persons related to UDN have not acquired (other than in exchange for STAR or UDN
stock), an amount of UDN stock, and UDN has not made any extraordinary
distributions with respect to its stock, prior to and connection with the
Merger, that would in the aggregate, reduce the value of all outstanding UDN
stock immediately prior to the Merger (after giving effect to such redemptions,
acquisitions, and distributions) to a value of less than 50 percent of the value
of all of the outstanding stock of UDN stock immediately prior to the Merger
determined without regard to such redemptions, acquisitions and distributions;
and (iv) in connection with the Merger, neither STAR nor any person related to
STAR, will acquire any UDN Common Stock for consideration other than STAR Common
Stock (other cash paid for fractional share and dissenters' shares) or redeem
any of the STAR Common Stock issued in the Merger.
If the Merger were not to constitute a reorganization under Section
368(a)(1) of the Code, each UDN stockholder would recognize gain or loss equal
to the difference between the fair market value of the STAR Common Stock
received and cash received in lieu of fractional share and such stockholder's
basis in the shares of UDN Common Stock exchanged therefor. Such gain or loss
would be long-term or short-term capital gain or loss, depending upon the
stockholder's holding period with respect to the UDN Stock.
Because the former UDN stockholders will own less than 50 percent of STAR
after the Merger, the Merger will be treated as an "ownership change" with
respect to UDN for purposes of Section 382 of the Code. As a result, the ability
of STAR to use any net operating losses of UDN from periods prior to the
Effective Time will generally be limited to an annual amount equal to the total
value (determined immediately prior to the Merger) of the stock of UDN
multiplied by a long-term tax-exempt interest rate factor (as published by the
Internal Revenue Service on a monthly basis).
CERTAIN CANADIAN AND FOREIGN TAX CONSEQUENCES
Stockholders of UDN and dissenting stockholders of UDN who are residents in,
or citizens of, Canada or another foreign jurisdiction should be aware that the
Merger (or the exercise of appraisal rights in respect of the Merger) may result
in the holder realizing or being required to record a gain or loss on the
exchange of shares under the Merger (or upon the exercise of, or any payment
being made in connection with, appraisal rights) or result in other tax
consequences to such holders. Such tax consequences, if any, are not described
herein. Such stockholders are urged to consult their own Canadian or foreign
tax, legal or other financial advisors, as applicable, as to the implications of
the Merger to them under such income tax laws.
LEGAL MATTERS
The validity of the STAR Common Stock offered hereby will be passed upon for
STAR by Riordan & McKinzie, a Professional Corporation, Los Angeles, California.
Certain legal matters will be passed on for UDN by Parker Chapin Flattau &
Klimpl, LLP, New York, New York.
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<PAGE>
EXPERTS
The Consolidated Financial Statements of STAR Telecommunications, Inc. as of
December 31, 1996 and 1997 and for each of the years in the three year period
ended December 31, 1997, included in this Proxy Statement/Prospectus and
elsewhere in this Registration Statement have been audited by Arthur Andersen
LLP, independent public accountants, as set forth in their reports with respect
thereto, and are included herein in reliance upon the authority of said firm as
experts in accounting and auditing in giving said reports.
The Consolidated Financial Statements of United Digital Network, Inc. as of
April 30, 1996 and 1997 and for each of the years in the two year period ended
April 30, 1997, included in this Proxy Statement/ Prospectus and elsewhere in
this Registration Statement have been audited by Price Waterhouse LLP,
independent accountants, as set forth in their reports with respect thereto, and
are included herein in reliance upon the authority of said firm as experts in
accounting and auditing in giving said reports.
The Consolidated Financial Statements of United Digital Network, Inc. as of
April 30, 1995 and for the one-year period ended April 30, 1995, included in
this Proxy Statement/Prospectus and elsewhere in this Registration Statement
have been audited by Weaver & Tidwell, L.L.P., independent accountants, as set
forth in their report with respect thereto, and are included herein in reliance
upon the authority of said firm as experts in accounting and auditing in giving
said reports.
FUTURE STOCKHOLDER PROPOSALS
UDN expects to hold an annual meeting of stockholders in 1998 unless the
Merger is completed prior thereto. Any UDN stockholder who intends to submit a
proposal for inclusion in the proxy materials for the 1998 annual meeting of UDN
must submit such proposal to the Secretary of UDN by September 21, 1998.
119
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Report of Independent Public Accountants................................................................... F-2
Consolidated Balance Sheets as of December 31, 1996 and 1997............................................... F-3
Consolidated Statements of Operations for the years ended December 31, 1995, 1996 and 1997................. F-4
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1996 and 1997....... F-5
Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1996 and 1997................. F-6
Notes to Consolidated Financial Statements................................................................. F-8
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders
of STAR Telecommunications, Inc. and Subsidiaries:
We have audited the accompanying consolidated balance sheets of STAR
TELECOMMUNICATIONS, INC. (a Delaware corporation) AND SUBSIDIARIES, as of
December 31, 1996 and 1997, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of STAR Telecommunications,
Inc. and Subsidiaries as of December 31, 1996 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997 in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Los Angeles, California
February 12, 1998
(except with respect
to the stock split discussed
in Note 14 as to which the
date is March 31, 1998)
F-2
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------
1996 1997
------------- --------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents............. $ 1,726,000 $ 1,458,000
Short-term investments................ 1,630,000 18,579,000
Accounts receivable, net of allowance
of $6,202,000 and $7,745,000 at
December 31,
1996 and 1997, respectively......... 27,660,000 42,407,000
Receivable from related parties....... 115,000 --
Other receivables..................... 284,000 2,198,000
Prepaid expenses...................... 960,000 4,712,000
Prepaid taxes......................... 677,000 --
Deferred income taxes................. -- 3,699,000
Other current assets.................. 825,000 61,000
------------- --------------
Total current assets................ 33,877,000 73,114,000
------------- --------------
PROPERTY AND EQUIPMENT:
Operating equipment................... 8,653,000 29,142,000
Leasehold improvements................ 4,248,000 6,289,000
Furniture, fixtures and equipment..... 2,418,000 4,564,000
------------- --------------
15,319,000 39,995,000
Less-Accumulated depreciation and
amortization........................ (1,407,000) (5,638,000)
------------- --------------
13,912,000 34,357,000
------------- --------------
OTHER ASSETS:
Investments........................... 153,000 27,000
Deposits.............................. 5,630,000 6,055,000
Other................................. 428,000 --
------------- --------------
6,211,000 6,082,000
------------- --------------
Total assets........................ $ 54,000,000 $ 113,553,000
------------- --------------
------------- --------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Revolving lines of credit............. $ 7,814,000 $ --
Revolving lines of credit with
stockholder......................... 26,000 138,000
Current portion of long-term debt..... 267,000 480,000
Current portion of obligations under
capital leases...................... 872,000 2,495,000
Accounts payable...................... 9,391,000 7,987,000
Taxes payable......................... -- 2,156,000
Related party payable................. 269,000 --
Accrued line costs.................... 19,494,000 38,403,000
Accrued expenses...................... 2,086,000 5,609,000
------------- --------------
Total current liabilities........... 40,219,000 57,268,000
------------- --------------
LONG-TERM LIABILITIES:
Long-term debt, net of current
portion............................. 466,000 348,000
Capital lease obligations, net of
current portion..................... 4,936,000 11,139,000
Deferred compensation................. 116,000 57,000
Deposits.............................. -- 164,000
Other long-term liabilities........... 352,000 563,000
------------- --------------
Total long-term liabilities......... 5,870,000 12,271,000
------------- --------------
STOCKHOLDERS' EQUITY:
Series A Preferred Stock, $.001 par
value, authorized-- 5,000,000 shares
Issued and outstanding-- 2,802,446
at December 31, 1996 and none at
December 31, 1997................... 3,000 --
Common Stock, $.001 par value,
authorized - 50,000,000 shares
Issued and outstanding-- 23,223,810
and 33,678,519 at December 31, 1996
and 1997, respectively.............. 23,000 34,000
Additional paid-in capital............ 13,971,000 45,407,000
Deferred compensation................. (118,000) (30,000)
Retained earnings (deficit)........... (5,968,000) (1,397,000)
------------- --------------
Stockholders' equity................ 7,911,000 44,014,000
------------- --------------
Total liabilities and
stockholders' equity............. $ 54,000,000 $ 113,553,000
------------- --------------
------------- --------------
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
F-3
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------
1995 1996 1997
------------- -------------- --------------
<S> <C> <C> <C>
REVENUES......................................................... $ 46,283,000 $ 237,991,000 $ 376,198,000
COSTS OF SERVICES................................................ 31,897,000 205,585,000 325,237,000
------------- -------------- --------------
Gross Profit................................................... 14,386,000 32,406,000 50,961,000
------------- -------------- --------------
OPERATING EXPENSES:
Selling, general and administrative expenses................... 10,086,000 34,331,000 35,381,000
Depreciation and amortization.................................. 186,000 1,151,000 4,245,000
Merger expense................................................. -- -- 286,000
------------- -------------- --------------
10,272,000 35,482,000 39,912,000
------------- -------------- --------------
Income (loss) from operations................................ 4,114,000 (3,076,000) 11,049,000
------------- -------------- --------------
OTHER INCOME (EXPENSES):
Interest income................................................ 22,000 110,000 492,000
Interest expense............................................... (64,000) (601,000) (1,633,000)
Legal settlement and expenses.................................. -- (100,000) (1,653,000)
Other income (expense)......................................... (33,000) 39,000 208,000
------------- -------------- --------------
(75,000) (552,000) (2,586,000)
------------- -------------- --------------
Income (loss) before provision for income taxes.............. 4,039,000 (3,628,000) 8,463,000
PROVISION FOR INCOME TAXES....................................... 66,000 592,000 2,895,000
------------- -------------- --------------
NET INCOME (LOSS)................................................ $ 3,973,000 $ (4,220,000) $ 5,568,000
------------- -------------- --------------
------------- -------------- --------------
Income (loss) before provision for income taxes.............. 4,039,000 (3,628,000) 8,463,000
PRO FORMA INCOME TAXES (UNAUDITED)............................... 1,632,000 1,535,000 3,090,000
------------- -------------- --------------
PRO FORMA NET INCOME (LOSS) (UNAUDITED).......................... $ 2,407,000 $ (5,163,000) $ 5,373,000
------------- -------------- --------------
------------- -------------- --------------
Pro forma basic income (loss) per common share (unaudited)....... $ 0.13 $ (0.24) $ 0.19
------------- -------------- --------------
------------- -------------- --------------
Pro forma diluted income (loss) per common share (unaudited)..... $ 0.13 $ (0.24) $ 0.17
------------- -------------- --------------
------------- -------------- --------------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-4
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK ADDITIONAL
---------------------- ---------------------- PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
----------- -------- ----------- -------- ------------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1994................... -- $ -- 17,455,959 $17,000 $ 341,000
Issuance of common stock..................... -- -- 1,843,339 2,000 101,000
Conversion of debt to equity................. -- -- -- -- 990,000
Net income................................... -- -- -- -- --
Cash distributions to stockholders........... -- -- -- -- --
----------- -------- ----------- -------- ------------
Balance, December 31, 1995................... -- -- 19,299,298 19,000 1,432,000
Effect of terminating the S-corporation
election................................... -- -- -- -- (690,000)
Compensation expense relating to stock
options.................................... -- -- -- -- 168,000
Issuance of common stock..................... -- -- 3,924,512 4,000 5,564,000
Issuance of preferred stock.................. 2,802,446 3,000 -- -- 7,497,000
Net loss..................................... -- -- -- -- --
Cash distributions to stockholders........... -- -- -- -- --
----------- -------- ----------- -------- ------------
Balance, December 31, 1996................... 2,802,446 3,000 23,223,810 23,000 13,971,000
Effect of L.D. Services terminating the
S-corporation election..................... -- -- -- -- (61,000)
Conversion of redeemable preferred stock to
common stock............................... (2,802,446) (3,000) 1,868,284 3,000 --
Initial public offering of common stock...... -- -- 8,097,500 8,000 30,936,000
Exercise of stock options.................... -- -- 488,925 -- 447,000
Compensation expense relating to stock
options.................................... -- -- -- -- --
Tax benefit from non-qualified stock
options.................................... -- -- -- -- 114,000
Cash distributions to stockholders........... -- -- -- -- --
Net income................................... -- -- -- -- --
----------- -------- ----------- -------- ------------
Balance, December 31, 1997................... -- $ -- 33,678,519 $34,000 $ 45,407,000
----------- -------- ----------- -------- ------------
----------- -------- ----------- -------- ------------
<CAPTION>
RETAINED
DEFERRED EARNINGS
COMPENSATION (DEFICIT) TOTAL
------------ ------------ ------------
<S> <C> <C> <C>
Balance, December 31, 1994................... $ -- $ 1,839,000 $ 2,197,000
Issuance of common stock..................... -- -- 103,000
Conversion of debt to equity................. -- -- 990,000
Net income................................... -- 3,973,000 3,973,000
Cash distributions to stockholders........... -- (4,216,000) (4,216,000)
------------ ------------ ------------
Balance, December 31, 1995................... -- 1,596,000 3,047,000
Effect of terminating the S-corporation
election................................... -- 690,000 --
Compensation expense relating to stock
options.................................... (118,000) -- 50,000
Issuance of common stock..................... -- -- 5,568,000
Issuance of preferred stock.................. -- -- 7,500,000
Net loss..................................... -- (4,220,000) (4,220,000)
Cash distributions to stockholders........... -- (4,034,000) (4,034,000)
------------ ------------ ------------
Balance, December 31, 1996................... (118,000) (5,968,000) 7,911,000
Effect of L.D. Services terminating the
S-corporation election..................... -- 61,000 --
Conversion of redeemable preferred stock to
common stock............................... -- -- --
Initial public offering of common stock...... -- -- 30,944,000
Exercise of stock options.................... -- -- 447,000
Compensation expense relating to stock
options.................................... 88,000 -- 88,000
Tax benefit from non-qualified stock
options.................................... -- -- 114,000
Cash distributions to stockholders........... -- (1,058,000) (1,058,000)
Net income................................... -- 5,568,000 5,568,000
------------ ------------ ------------
Balance, December 31, 1997................... $ (30,000) $ (1,397,000) $ 44,014,000
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-5
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------
1995 1996 1997
-------------- ------------- -------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)................................................ $ 3,973,000 $ (4,220,000) $ 5,568,000
Adjustments to reconcile net income (loss) to net cash provided
by (used in) operating activities:
Depreciation and amortization.................................. 186,000 1,151,000 4,245,000
Loss on investment............................................. 80,000 -- --
Loss on disposal of equipment.................................. -- -- 42,000
Compensation expense relating to stock options................. -- 50,000 88,000
Provision for doubtful accounts................................ 217,000 15,753,000 7,695,000
Deferred income taxes.......................................... -- -- (3,699,000)
Deferred compensation.......................................... -- 116,000 (59,000)
Decrease (increase) in assets:
Accounts receivable.............................................. (10,522,000) (28,476,000) (22,442,000)
Receivable from related parties.................................. 129,000 (65,000) 115,000
Other receivables................................................ (268,000) -- (1,914,000)
Prepaid expenses................................................. (114,000) (830,000) (3,752,000)
Deposits......................................................... (630,000) (4,948,000) (425,000)
Prepaid taxes.................................................... -- (677,000) 677,000
Other current assets............................................. -- (825,000) 764,000
Increase (decrease) in liabilities:
Accounts payable................................................. 8,035,000 (1,269,000) (1,404,000)
Taxes payable.................................................... -- -- 2,270,000
Related party payables........................................... 320,000 (51,000) (269,000)
Accrued line costs............................................... 476,000 19,018,000 18,909,000
Accrued expenses................................................. 194,000 1,865,000 3,523,000
Deposits......................................................... -- -- 164,000
-------------- ------------- -------------
Net cash provided by (used in) operating activities........ 2,076,000 (3,408,000) 10,096,000
-------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures............................................. (1,123,000) (7,852,000) (13,436,000)
Investments...................................................... -- (153,000) 126,000
Short-term investments........................................... -- (1,630,000) (16,949,000)
Other............................................................ -- (139,000) 639,000
-------------- ------------- -------------
Net cash used in investing activities...................... (1,123,000) (9,774,000) (29,620,000)
-------------- ------------- -------------
</TABLE>
F-6
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------
1995 1996 1997
------------- ------------- --------------
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Stockholders' distributions...................................... $ (4,216,000) $ (4,034,000) $ (1,058,000)
Borrowings under lines of credit................................. 1,460,000 14,746,000 34,211,000
Repayments under lines of credit................................. (130,000) (8,262,000) (42,025,000)
Borrowings under lines of credit with stockholder................ 3,418,000 701,000 583,000
Repayments under lines of credit with stockholder................ (1,319,000) (1,873,000) (471,000)
Borrowings under long-term debt.................................. -- 800,000 193,000
Payments under long-term debt.................................... -- (67,000) (1,622,000)
Payments under capital lease obligations......................... (52,000) (358,000) (1,946,000)
Issuance of common stock......................................... -- 5,568,000 30,944,000
Stock options exercised.......................................... -- -- 447,000
Issuance of preferred stock...................................... -- 7,500,000 --
------------- ------------- --------------
Net cash (used in) provided by financing activities.......... (839,000) 14,721,000 19,256,000
------------- ------------- --------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS................... 114,000 1,539,000 (268,000)
CASH AND CASH EQUIVALENTS, beginning of year....................... 73,000 187,000 1,726,000
------------- ------------- --------------
CASH AND CASH EQUIVALENTS, end of year............................. $ 187,000 $ 1,726,000 $ 1,458,000
------------- ------------- --------------
------------- ------------- --------------
</TABLE>
The accompanying notes are an integral part of these consolidated statements
F-7
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
1. NATURE OF BUSINESS
STAR Telecommunications, Inc., a Delaware corporation, and Subsidiaries (the
"Company" or "STAR"), is an emerging multinational carrier focused primarily on
the international long distance market. The Company offers highly reliable,
low-cost switched voice services on a wholesale basis primarily to U.S.-based
long distance carriers. STAR provides international long distance service
through a flexible network comprised of foreign termination relationships,
international gateway switches, leased and owned transmission facilities and
resale arrangements with other long distance providers. While the Company was
incorporated in 1993, it did not commence its current business as a provider of
long distance services until the second half of 1995. During the six months
ended June 1995, the Company primarily acted as an agent for, and provided
various consulting services to, companies in the telecommunications industry.
During 1996 and 1997, the Company established several wholly-owned foreign
subsidiaries to further expand its international network. The Company made
substantial investments to install switch facilities in two of these
subsidiaries, Star Europe Limited (SEL) which is located in London, England, and
Star Telecommunications Deutschland (GmbH) which is located in Frankfurt,
Germany. The Company plans to use these switch facilities to decrease
international traffic termination costs and to initiate outbound calls from
these local markets.
In December 1997, the Company entered into the domestic commercial
long-distance market through the acquisition of L.D. Services, Inc., also known
as LCCR Inc. ("LDS"). LDS is a retail long-distance service provider throughout
the United States. The merger constituted a tax-free reorganization and has been
accounted for as a pooling of interests under Accounting Principles Board
Opinion No. 16. Accordingly, all prior period consolidated financial statements
presented have been restated to include the results of operations, financial
position and cash flows of LDS as though it had always been a part of STAR (see
Note 8). The pro forma results of operations and pro forma income or loss per
common share for 1995, 1996 and 1997 assumes that both STAR and LDS had been
C-Corporations for all periods presented.
The Company is subject to various risks in connection with the operation of
its business. These risks include, but are not limited to, regulations (both
domestic and foreign), dependence on transmission facilities-based carriers and
suppliers, price competition and competition from larger industry participants.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
STAR Telecommunications, Inc. and its wholly-owned subsidiaries. All significant
intercompany balances and transactions have been eliminated.
REVENUE RECOGNITION
The Company records revenues for telecommunications sales at the time of
customer usage. Finance charges for customer late payments are included in
revenues and amount to $32,000, $1,467,000 and $2,747,000 for the years ended
December 31, 1995, 1996 and 1997, respectively.
F-8
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
COST OF SERVICES
Cost of services for wholesale long distance services represents direct
charges from vendors that the Company incurs to deliver service to its
customers. These include leasing costs for the dedicated phone lines, which form
the Company's network, and rate-per-minute charges from other carriers that
terminate traffic on behalf of the Company. In addition, retail long distance
service cost includes billing and collection service fees from local exchange
carriers and call rating services.
ACCOUNTING FOR INTERNATIONAL LONG DISTANCE TRAFFIC
The Company has carrier service agreements with telecommunication carriers
in foreign countries under which international long distance traffic is both
originated and terminated on the Company's network. The Company records revenues
and related costs as the traffic is recorded in the switch. Revenue from foreign
customers equaled $178,000 and $6,577,000 for the years ended December 31, 1996
and 1997, respectively. The Company had no revenues from foreign customers
during 1995.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of demand deposits and money market funds,
which are highly liquid short-term instruments with original maturities of three
months or less from the date of purchase. Cash and cash equivalents are stated
at cost, which approximates market.
FINANCIAL INSTRUMENTS
The carrying amounts of notes payable and capital lease obligations
approximate their fair value because interest rates approximate market rates for
similar instruments.
Off balance sheet derivative financial instruments at December 31, 1997
consist of foreign currency exchange agreements.
The Company enters into foreign currency exchange contracts to manage
foreign currency exposures. The principle objective of such contracts is to
minimize the risks and/or costs associated with financial and global operating
activities. The Company does not utilize financial instruments for trading or
other speculative purposes. The counterparty to these contractual arrangements
is a multinational financial institution with which the Company also has other
financial relationships.
The Company enters into forward currency exchange contracts in the normal
course of business to manage its exposure against foreign currency fluctuations
on payable positions resulting from fixed asset purchases and other contractual
expenditures denominated in foreign currencies. At December 31, 1997, gains and
losses on foreign exchange contracts are not material to the consolidated
financial statements.
The fair values of foreign currency contracts are estimated by obtaining
quotes from brokers. At December 31, 1997, the Company has foreign currency
contracts outstanding with the notional value of $6,305,000 which had an
estimated fair value to receive $6,218,000 worth of German marks and British
pounds, the difference of which has been recognized in operations.
F-9
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following table summarizes outstanding commitments to purchase foreign
currency at December 31, 1997:
<TABLE>
<CAPTION>
MATURITY NOTIONAL
DATE AMOUNT FAIR VALUE DIFFERENCE
-------------------------- ------------ ------------ ----------
<S> <C> <C> <C> <C>
British Pounds..................... 1/29/98 through 3/27/98 $ 364,000 $ 373,000 $ 9,000
Deutsche Mark...................... 1/05/98 through 1/26/98 5,941,000 5,845,000 (96,000)
------------ ------------ ----------
$ 6,305,000 $ 6,218,000 $ (87,000)
------------ ------------ ----------
------------ ------------ ----------
</TABLE>
MARKETABLE SECURITIES
Marketable securities consists of interest bearing securities with original
maturities in excess of three months. At December 31, 1997, the fair market
value of temporary investments, classified as "available for sale securities",
approximated cost, thus no unrealized holding gains or losses were reported in
the accompanying balance sheets. During fiscal year 1997, the Company realized
gains from the sale of securities of approximately $48,000.
PROPERTY AND EQUIPMENT
Property and equipment are carried at cost. Depreciation and amortization of
property and equipment are computed using the straight-line method over the
following estimated useful lives:
<TABLE>
<S> <C>
Operating equipment....................................... 5-25 years
Leasehold improvements.................................... Life of lease
Computer equipment........................................ 3-7 years
Furniture and fixtures.................................... 5-7 years
</TABLE>
Operating equipment includes assets financed under capital lease obligations
of $6,218,000 and $15,921,000 at December 31, 1996 and 1997, respectively.
Accumulated amortization related to assets financed under capital leases was
$391,000 and $2,123,000 at December 31, 1996 and 1997, respectively.
In addition, operating equipment includes seven Indefeasible Rights of Use
(IRU) in cable systems amounting to $110,000 and $2,303,000 and four ownership
interests in an international cable amounting to $148,000 and $1,534,000 at
December 31, 1996 and 1997, respectively. These assets are amortized over the
life of the agreements of 14 to 25 years (see Note 5).
Replacements and betterments, renewals and extraordinary repairs that extend
the life of the asset are capitalized; other repairs and maintenance are
expensed. The cost and accumulated depreciation applicable to assets sold or
retired are removed from the accounts and the gain or loss on disposition is
recognized in other income or expense.
DEPOSITS AND OTHER ASSETS
Deposits represent payments made to long distance providers to secure lower
rates. These deposits are refunded or applied against future services. Other
assets at December 31, 1996 represent initial public offering expenses, which
were subsequently charged to additional paid in capital during 1997 at the time
of the initial public offering.
F-10
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CONSOLIDATED STATEMENTS OF CASH FLOWS
During the years ended December 31, 1995, 1996 and 1997 cash paid for
interest was $45,000, $534,000 and $1,359,000, respectively. For the same
periods, cash paid for income taxes amounted to $51,000, $1,262,000 and
$3,761,000, respectively.
Non-cash investing and financing activities are as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------
1995 1996 1997
------------- ------------- -------------
<S> <C> <C> <C>
Equipment purchased through capital leases.......................... $ 1,052,000 $ 5,166,000 $ 9,772,000
Notes issued for asset purchases.................................... -- -- 1,524,000
Debt converted to equity............................................ 1,093,000 -- --
Tax benefits related to stock options............................... -- -- 114,000
</TABLE>
These non-cash transactions are excluded from the consolidated statements of
cash flows.
NET INCOME (LOSS) PER COMMON SHARE
The following schedule summarizes the information used to compute pro forma
net income or loss per common share for the years ended December 31, 1995, 1996
and 1997:
<TABLE>
<CAPTION>
1995 1996 1997
------------- ------------- -------------
<S> <C> <C> <C>
Pro forma net income (loss)......................................... $ 2,407,000 $ (5,163,000) $ 5,373,000
------------- ------------- -------------
------------- ------------- -------------
Weighted average number of common shares used to compute basic
earnings (loss) per share.......................................... 18,020,000 21,939,000 28,868,000
Weighted average common share equivalents........................... -- -- 2,757,000
------------- ------------- -------------
Weighted average number of common shares and common share
equivalents used to compute diluted net income (loss) per common
share.............................................................. 18,020,000 21,939,000 31,625,000
------------- ------------- -------------
------------- ------------- -------------
Basic pro forma net income (loss) per common share (unaudited)...... $ 0.13 $ (0.24) $ 0.19
Diluted pro forma net income (loss) per common share (unaudited).... $ 0.13 $ (0.24) $ 0.17
</TABLE>
CONCENTRATIONS OF RISK
The Company's two largest customers account for approximately 25 percent and
7 percent of gross accounts receivable at December 31, 1996 and 1997,
respectively. The Company's largest customer and second largest customer in 1997
represent 3 percent and 4 percent of accounts receivable as of December 31,
1997, respectively. The Company's largest customer in 1996 was Cherry
Communications, Inc. The second largest customer in 1996 was Hi-Rim
Communications, Inc. Only one customer, Cherry Communications had a receivable
balance exceeding 10 percent of gross accounts receivable at December 31, 1996
and no individual customer has an account receivable balance greater than 10
percent of gross accounts receivable at December 31, 1997.
F-11
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The two largest customers represent approximately 16 percent, 26 percent and
17 percent of revenues during the years ended December 31, 1995, 1996 and 1997,
respectively. During 1995 and 1996, only sales to Cherry Communications exceeded
10 percent of total sales. For the year ended December 31, 1997, only one
customer equaled 10 percent of consolidated sales.
The Company performs ongoing credit evaluations of its customers. The
Company analyzes daily traffic patterns and concludes whether or not the
customer's credit status justifies the traffic volume. If the customer is deemed
to carry too large a volume in relation to its credit history, the traffic
received by the Company's switch is reduced to prevent further build up of the
receivable from this customer. The Company's allowance for doubtful accounts is
based on current market conditions.
Purchases from the four largest vendors for the years ended December 31,
1995 and 1996 amounted to 57 percent and 45 percent of total purchases,
respectively. Purchases from the four largest vendors for the year ended
December 31, 1997 amounted to 36 percent of total purchases.
Included in the Company's balance sheets at December 31, 1996 and 1997 are
approximately $179,000 and $6,367,000 of equipment which is located in foreign
countries.
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
RECENTLY ISSUED ACCOUNTING STANDARDS
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share". The statement replaces primary EPS with basic EPS, which is computed by
dividing reported earnings available to common stockholders by weighted average
shares outstanding. The provision requires the calculation of diluted EPS. The
Company adopted this statement in 1997 and all prior year earnings per share
amounts have been recalculated based on the provisions of SFAS No. 128.
F-12
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
TRANSLATION OF FOREIGN CURRENCY
Management determined that the functional currency of its foreign
subsidiaries is still the U.S. dollar. Thus all foreign translation gains or
losses are reflected in the results of operations in other income (expense).
The foreign subsidiary balance sheets are translated into U.S. dollars using
the year-end exchange rates except for prepayments, property, other long-term
assets, and stockholders' equity accounts, which are translated at rates in
effect when these balances were originally recorded. Revenues and expenses are
translated at average rates during the year except for depreciation and
amortization, which are translated at historical rates.
3. ACCRUED EXPENSES
Accrued expenses at December 31, 1996 and 1997 consist of the following:
<TABLE>
<CAPTION>
1996 1997
------------ ------------
<S> <C> <C>
Payroll and related......................................................... $ 783,000 $ 943,000
Management bonuses.......................................................... 25,000 152,000
Professional services....................................................... 640,000 384,000
Sales and other taxes....................................................... 10,000 295,000
Line and billing cost....................................................... 324,000 2,592,000
Other....................................................................... 304,000 1,243,000
------------ ------------
$ 2,086,000 $ 5,609,000
------------ ------------
------------ ------------
</TABLE>
4. LINES OF CREDIT
BANK LINE OF CREDIT
Effective as of September 30, 1997, the Company executed an agreement with
Sanwa Bank, California for a $25 million line of credit, which expires on July
1, 1999. The facility has certain financial and non-financial covenants that
include, among other restrictions, the maintenance of minimum levels of tangible
net worth. Borrowings on the facility are limited to 75 percent of eligible
accounts receivable and are secured by substantially all of the assets of the
Company. The credit facility provides for borrowings at an interest rate based
upon the bank's cost of funds plus 1.75 percent (7.47 percent at December 31,
1997). The Company plans to use the credit facility to support letters of credit
and for working capital or other general corporate purposes. At December 31,
1997, no amounts were outstanding, however the Company's availability under this
credit facility was reduced to $20.1 million due to $4.9 million in letters of
credit which were outstanding at December 31, 1997.
The weighted average interest rate on short term debt during the years ended
December 31, 1995, 1996 and 1997 was 10.21 percent, 9.68 percent and 9.12
percent, respectively.
LINES OF CREDIT WITH STOCKHOLDER
At December 31, 1996 and 1997, the Company's revolving lines of credit with
the founder and chief executive officer of the Company totaled $1,448,000. The
debt matures on March 30, 1998 with interest
F-13
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
4. LINES OF CREDIT (CONTINUED)
payable at maturity at a rate of 9 percent. There was $1,422,000 and $1,310,000
available to be borrowed against these lines of credit at December 31, 1996 and
1997, respectively. The Company recognized interest expense related to this debt
of $11,000, $34,000 and $9,000 for the years ended December 31, 1995, 1996 and
1997, respectively.
5. LONG-TERM DEBT
The Company finances some of its telecommunication equipment under capital
lease arrangements or through notes payable as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1996 1997
------------ -------------
<S> <C> <C>
Bank debt at prime plus 1.5 percent........................................ $ 733,000 $ --
Notes payable for Indefeasible Rights of Use on submarine cable, payable in
quarterly installments of principal plus interest at LIBOR plus 6 percent
(11.72 percent at December 31, 1997) through September 1999............... -- 762,000
Note payable for Indefeasible Right of Use, payable in quarterly
installments of $9,000 plus interest at LIBOR plus 6 percent through
September 1999............................................................ -- 66,000
Obligations under capital leases........................................... 5,808,000 13,634,000
------------ -------------
$ 6,541,000 $ 14,462,000
------------ -------------
------------ -------------
</TABLE>
Minimum future lease payments under capital leases at December 31, 1997 are
as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
- -----------------------------------------------------------------------------------------
<S> <C>
1998................................................................................. $ 3,944,000
1999................................................................................. 3,943,000
2000................................................................................. 3,614,000
2001................................................................................. 2,927,000
2002................................................................................. 2,505,000
Thereafter........................................................................... 814,000
-------------
17,747,000
Less: Amount representing interest....................................................... (4,113,000)
-------------
13,634,000
Less: Current portion.................................................................... (2,495,000)
-------------
$ 11,139,000
-------------
-------------
</TABLE>
F-14
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
6. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
The Company leases office space, dedicated private telephone lines,
equipment and other items under various agreements expiring through 2006. At
December 31, 1997, the minimum aggregate payments under non-cancelable operating
leases are summarized as follows:
<TABLE>
<CAPTION>
FACILITIES AND DEDICATED
YEAR ENDING DECEMBER 31, EQUIPMENT PRIVATE LINES TOTAL
- --------------------------------------------------------- -------------- ------------- -------------
<S> <C> <C> <C>
1998................................................. $ 3,375,000 $ 4,969,000 $ 8,344,000
1999................................................. 3,318,000 1,906,000 5,224,000
2000................................................. 3,283,000 372,000 3,655,000
2001................................................. 2,946,000 -- 2,946,000
2002................................................. 2,739,000 -- 2,739,000
Thereafter........................................... 8,423,000 -- 8,423,000
-------------- ------------- -------------
$ 24,084,000 $ 7,247,000 $ 31,331,000
-------------- ------------- -------------
-------------- ------------- -------------
</TABLE>
Facility and equipment rent expense for the years ended December 31, 1995,
1996 and 1997 was approximately $195,000, $1,076,000 and $3,199,000,
respectively. Dedicated private line expense was approximately $604,000,
$7,045,000 and $9,414,000, for those same periods and is included in cost of
services in the accompanying consolidated statements of operations.
EMPLOYMENT AGREEMENTS
The Company has employment agreements through December 31, 2000 with several
employees and executives. Some of these agreements provide for a continuation of
salaries in the event of a termination, with or without cause, following a
change in control of the Company. One agreement provides for a payment of at
least $1,500,000 in the event of a change in control of the Company.
The Company expensed $116,000 and $64,000 of deferred compensation relating
to these agreements for the years ended December 31, 1996 and 1997,
respectively.
PURCHASE COMMITMENTS
The Company is obligated under various service agreements with long distance
carriers to pay minimum usage charges. The Company anticipates exceeding the
minimum usage volume with these vendors. Minimum future usage charges at
December 31, 1997 are as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
- -----------------------------------------------------------------------------------------
<S> <C>
1998..................................................................................... $ 44,053,000
1999..................................................................................... 8,356,000
2000..................................................................................... 2,949,000
2001..................................................................................... 65,000
2002..................................................................................... 65,000
Thereafter............................................................................... 774,000
-------------
$ 56,262,000
-------------
-------------
</TABLE>
F-15
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
6. COMMITMENTS AND CONTINGENCIES (CONTINUED)
The Company has entered into six fixed asset purchase agreements. These
commitments are to purchase IRU's, switches, and leasehold improvements for
switch sites. The total commitment approximates $63 million. The Company plans
to finance the majority of these costs through capital lease arrangements.
LEGAL MATTERS
The Company is subject to litigation from time to time in the normal course
of business. Although it is not possible to predict the outcome of such
litigation, based on the facts known to the Company and after consultation with
counsel, management believes that such litigation will not have a material
adverse effect on its financial position or results of operations.
On September 4, 1997, prior to the merger between LDS and the Company, LDS
entered into a settlement agreement with the Consumer Services Division of the
California Public Utilities Commission (PUC). The agreement settles the alleged
unauthorized switching of long-distance customers to LDS between the years 1995
and 1996. It includes a payment of $760,000 to the PUC for restitution to
affected customers as defined in the agreement. Additionally, LDS agreed to a
voluntary revocation of its operating authority in the State of California.
Under the agreement, service to all California customers has to be terminated
within 120 days after approval of the agreement by the PUC. On November 19,
1997, the PUC approved the agreement along with a transfer of control to STAR.
On November 15, 1997, LDS settled a civil suit with the District Attorney of
Monterey, California for a monetary payment of $700,000 and various non-monetary
concessions as defined in the agreement. This suit was of the same nature as the
above action of the PUC and covers complaints from the years 1994 through 1997.
LETTERS OF CREDIT
At December 31, 1997, the Company has nine standby letters of credit
outstanding, which expire between January 20, 1998 and December 19, 1998. These
letters of credit, all of which are secured by the bank line of credit, total
$4,900,000.
7. RELATED PARTY TRANSACTIONS
The founder and chief executive officer of the Company owns Star Aero
Services, Inc. (Star Aero). Star Aero's principal assets represent airplanes
which it provides to the Company for business travel on an as needed basis. In
return, the Company pays for costs related to the airplanes. Star Aero
reimburses the Company for certain costs relating to the maintenance of the
planes. For the years ended December 31, 1995, 1996 and 1997, the Company paid
$144,000, $68,000 and $171,000, respectively, in costs related to the use of
Star Aero services. As of December 31, 1995 and 1996, the Company had
receivables from Star Aero of $50,000 and $115,000, respectively. The Company
had no receivables from Star Aero at December 31, 1997.
During 1997, the Company provided a short-term loan to the chief executive
officer for $8,000,000. The loan carried interest of 7 percent per annum, was
secured by $30,000,000 of the stockholder's stock in the Company, and was repaid
in seven days.
F-16
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
7. RELATED PARTY TRANSACTIONS (CONTINUED)
During 1995, the Company invested $128,000 in a company related to an
employee of STAR. During 1996 and 1997, the Company provided services to this
company in the amounts of $167,000 and $926,000. As of December 31, 1996 and
1997, accounts receivable from this related party amounted to $57,000 and
$41,000, respectively.
During 1995, 1996 and 1997, the Company purchased consulting services from a
company owned by a board member in the amount of $60,000, $154,000 and $72,000,
respectively.
During 1996 and 1997, the Company purchased consulting services from a
company owned in part by an employee and a significant stockholder for $37,000
and $256,000, respectively. In addition, the Company purchased equipment and
services from this company in the amount of $1,114,000 in 1997. This significant
stockholder is also a 30 percent investor in a company, whose subsidiary
provided consulting services to the Company in the amount of $12,000 in 1996 and
$213,000 in 1997. In addition, the Company purchased telecommunication services
from three related companies for $240,000 during 1996 and paid legal fees on
behalf of these companies in the amount of $131,000.
During the years ended December 31, 1995, 1996 and 1997, the Company also
provided long distance telephone service to a company controlled by another
board member in the amount of $43,000, $250,000 and $1,141,000, respectively.
Accounts receivable for these services total $721,000 as of December 31, 1997.
In addition, the Company loaned $2,500,000 to this related party. The Company
has announced its intention to merge the two companies (see Note 14).
8. BUSINESS COMBINATIONS
In November 1997, the Company acquired LDS, a domestic commercial long
distance telecommunications provider, in a transaction that was accounted for as
a pooling of interests. The Company issued 849,298 shares of its common stock to
LDS' shareholders in exchange for all outstanding LDS shares plus shares of
certain non-operating entities owned by LDS' shareholders and majority ownership
in an affiliated telephone retailer controlled by LDS. The accompanying
consolidated financial statements have been restated to include the financial
position and results of operations of LDS for all periods presented.
Net sales and historical net income (loss) of the combining companies for
the last three years are as follows:
<TABLE>
<CAPTION>
1995 1996 1997
------------- -------------- --------------
<S> <C> <C> <C>
Net Sales:
STAR................................................. $ 16,125,000 $ 208,086,000 $ 348,738,000
LDS.................................................. 30,158,000 29,905,000 27,460,000
------------- -------------- --------------
Total................................................ $ 46,283,000 $ 237,991,000 $ 376,198,000
------------- -------------- --------------
------------- -------------- --------------
Net Income (Loss):
STAR................................................. $ (568,000) $ (6,644,000) $ 5,605,000
LDS.................................................. 4,541,000 2,424,000 (37,000)
------------- -------------- --------------
Total................................................ $ 3,973,000 $ (4,220,000) $ 5,568,000
------------- -------------- --------------
------------- -------------- --------------
</TABLE>
F-17
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
9. INCOME TAXES
Through December 31, 1995, the Company had elected to be taxed as an
S-Corporation for both federal and state income tax purposes. While the election
was in effect, all taxable income, deductions, losses and credits of the Company
were included in the tax returns of the shareholders. Accordingly, for federal
income tax purposes, no tax benefit, liability or provision has been reflected
in the accompanying historical consolidated financial statements for the year
ended December 31, 1995. For state tax purposes, an S-Corporation is subject to
a 1.5 percent tax on taxable income, with a minimum tax of approximately $1,000
annually. Effective January 1, 1996, the Company terminated its S-Corporation
election and is now taxable as a C-Corporation.
In addition, the results of operations and provision for income taxes for
LDS through November 30, 1997 reflects LDS' status as an S-Corporation. The
unaudited pro forma income taxes, pro forma net income (loss), and pro forma
earnings per share information reflected in the consolidated statements of
operations assumes that both STAR and LDS were taxed as C-Corporations for all
periods presented.
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes," under which deferred assets and liabilities are
provided on differences between financial reporting and taxable income using
enacted tax rates. Deferred income tax expenses or credits are based on the
changes in deferred income tax assets or liabilities from period to period.
Under SFAS No. 109, deferred tax assets may be recognized for temporary
differences that will result in deductible amounts in future periods. A
valuation allowance is recognized if, on the weight of available evidence, it is
more likely than not that some portion or all of the deferred tax asset will not
be realized.
The Company has recorded a net deferred tax asset of $3,699,000 at December
31, 1997. Realization is dependent on generating sufficient taxable income in
the future. Although realization is not assured, management believes it is more
likely than not that the net deferred tax asset recorded will be realized.
The components of the net deferred tax assets at December 31, 1996 and 1997
are as follows:
<TABLE>
<CAPTION>
1996 1997
------------- -------------
<S> <C> <C>
Deferred tax asset:
Reserve for accounts and note receivable................................ $ 3,104,000 $ 4,169,000
Accrued line cost....................................................... 201,000 798,000
Vacation accrual........................................................ 24,000 138,000
Deferred compensation................................................... 47,000 38,000
Accrued bonuses......................................................... 25,000 --
Accrued services........................................................ -- 183,000
Foreign net operating losses............................................ -- 468,000
State income taxes...................................................... 48,000 392,000
------------- -------------
3,449,000 6,186,000
Deferred tax liability:
Depreciation............................................................ (565,000) (804,000)
------------- -------------
Subtotal.................................................................. 2,884,000 5,382,000
Valuation reserve......................................................... (2,884,000) (1,683,000)
------------- -------------
Net deferred tax asset.................................................... $ -- $ 3,699,000
------------- -------------
------------- -------------
</TABLE>
F-18
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
9. INCOME TAXES (CONTINUED)
The provision for income taxes for the years ended December 31, 1995, 1996
and 1997 are as follows:
<TABLE>
<CAPTION>
PRO FORMA
HISTORICAL (UNAUDITED)
-------------------------------- ----------------------------------
1995 1996 1997 1995 1996 1997
--------- --------- ---------- --------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Current
Federal taxes............................. $ -- $ 393,000 $4,899,000 $1,365,000 $1,231,000 $5,281,000
State taxes............................... 66,000 199,000 1,138,000 416,000 394,000 1,261,000
--------- --------- ---------- --------- ----------- ----------
66,000 592,000 6,037,000 1,781,000 1,625,000 6,542,000
--------- --------- ---------- --------- ----------- ----------
Deferred
Federal taxes............................. -- -- (2,273,000) (121,000) (70,000) (2,512,000)
State taxes............................... -- -- (869,000) (28,000) (20,000) (940,000)
--------- --------- ---------- --------- ----------- ----------
-- -- (3,142,000) (149,000) (90,000) (3,452,000)
--------- --------- ---------- --------- ----------- ----------
Provision for income taxes.................. $ 66,000 $ 592,000 $2,895,000 $1,632,000 $1,535,000 $3,090,000
--------- --------- ---------- --------- ----------- ----------
--------- --------- ---------- --------- ----------- ----------
</TABLE>
Differences between the provision for income taxes and income taxes at the
statutory federal income tax rate for the years ended December 31, 1995, 1996
and 1997 are as follows:
<TABLE>
<CAPTION>
PRO FORMA
HISTORICAL (UNAUDITED)
---------------------------------- ----------------------------------
1995 1996 1997 1995 1996 1997
---------- ---------- ---------- --------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Income taxes at the statutory federal
rate................................ $1,373,000 $(1,234,000) $2,962,000 $1,373,000 ($1,234,000) $2,962,000
State income taxes, net of federal
income tax effect................... 246,000 (221,000) 486,000 246,000 (221,000) 486,000
Foreign taxes at rates different than
U.S. taxes.......................... -- -- 187,000 -- -- 187,000
Change in valuation reserve........... -- 2,884,000 (1,201,000) -- 2,884,000 (1,201,000)
Permanent differences................. -- 104,000 33,000 13,000 108,000 307,000
Effect of STAR S-Corp status until
December 31, 1995................... 223,000 -- -- -- -- --
Effects of LDS S-Corp status until
November 30, 1997................... (1,808,000) (958,000) 152,000 -- -- --
Other................................. 32,000 17,000 276,000 -- (2,000) 349,000
---------- ---------- ---------- --------- ----------- ----------
$ 66,000 $ 592,000 $2,895,000 $1,632,000 $1,535,000 $3,090,000
---------- ---------- ---------- --------- ----------- ----------
---------- ---------- ---------- --------- ----------- ----------
</TABLE>
10. STOCK OPTIONS
On January 22, 1996, the Company adopted the 1996 Stock Incentive Plan (the
"Plan"). The Plan, which was amended on March 31, 1996, provides for the
granting of stock options to purchase up to 1,476,000 shares of common stock and
terminates January 22, 2006. Options granted become exercisable at a rate of not
less than 20 percent per year for five years.
During 1996, the Company entered into three separate stock option agreements
outside the Plan. The first agreement, dated March 1, 1996, provided for 410,000
non-incentive stock options exercisable immediately. The options were
exercisable at fair market value at the date of issuance, which was $0.98 per
share, to expire in 10 years. The second stock option agreement was entered into
on May 1, 1996 for an
F-19
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
10. STOCK OPTIONS (CONTINUED)
additional 410,000 shares to also be issued at $0.98 per share. Of these options
half vested on March 1, 1997 and half expired. On May 15, 1996, the Company
granted 205,000 options, valued at $1.46 per share at the date of issuance to a
director. Of these options 34 percent were exercisable immediately. The
remaining options are exercisable equally on May 15, 1997 and 1998.
At December 31, 1996 and 1997, 1,025,000 and 820,000 options, respectively,
issued outside a plan were outstanding.
On September 23, 1996, the Company adopted the 1996 Supplemental Stock
Option Plan. This plan which expires on August 31, 2006, replaces the Plan and
has essentially the same features. The Company can issue options or other rights
to purchase up to 2,050,000 shares of stock which expire up to 10 years after
the date of grant, except for incentive options issued to a holder of more than
10 percent of the common stock outstanding, which expire five years after the
date of grant.
In December 1996, the Company issued 174,000 options at $4.00 per share. The
Board of Directors determined the market value of the December options to be
$4.68 per share. The Company is recognizing the difference between the market
value at the date of grant and the exercise price as compensation expense over
the vesting period.
At December 31, 1996 and 1997, 2,358,000 and 1,873,000 options,
respectively, were outstanding under the aggregate of the 1996 Stock Incentive
Plan and the Supplemental Stock Option Plan.
On May 14, 1996, the Company adopted the 1996 Outside Director Nonstatutory
Stock Option Plan (the "Director Plan"). The number of shares which may be
issued under this plan upon exercise of options may not exceed 410,000 shares.
The exercise price of an option is determined by the Board of Directors and may
not be less than 85 percent of the fair market value of the common stock at the
time of grant and has to be 110 percent of the fair market value of the common
stock at the time of grant if the option is granted to a holder of more than 10
percent of the common stock outstanding. At the discretion of the administrator,
the options vest at a rate of not less than 20 percent per year, which may
accelerate upon a change in control, as defined. The plan expires on May 14,
2006. At December 31, 1996 and 1997, 82,000 and 41,000 options, respectively,
were outstanding under the Director Plan.
On January 30, 1997, the Board of Directors approved the 1997 Omnibus Stock
Incentive Plan (the "Omnibus Plan") to replace the existing 1996 supplemental
plan upon the effective date of the initial public offering. The plan provides
for awards to employees, outside directors and consultants in the form of
restricted shares, stock units, stock options and stock appreciation rights and
terminates on January 22, 2007. The maximum number of shares available for
issuance under this plan may not exceed 1,025,000 shares plus the number of
shares still unissued under the supplemental option plan. Options granted to any
one optionee may not exceed more than 1,025,000 common shares per year subject
to certain adjustments. Incentive stock options may not have a term of more than
10 years from the date of grant. At December 31, 1997, 763,000 options, were
outstanding under the Omnibus Plan.
F-20
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
10. STOCK OPTIONS (CONTINUED)
Information regarding the Company's stock option plans and nonqualified
stock options as of December 31, 1995, 1996 and 1997, and changes during the
years ended on those dates is summarized as follows:
<TABLE>
<CAPTION>
WEIGHTED-AVERAGE
SHARES EXERCISE PRICE
--------------- -----------------
<S> <C> <C>
December 31, 1995.......................................... -- $ --
Granted.................................................... 3,491,355 1.89
Exercised.................................................. -- --
Forfeited.................................................. (26,855) 1.95
--------------- ------
December 31, 1996.......................................... 3,464,500 1.89
--------------- ------
Granted.................................................... 914,296 7.91
Exercised.................................................. (488,925) 0.89
Forfeited.................................................. (392,774) 2.40
--------------- ------
December 31, 1997.......................................... 3,497,097 $ 3.54
--------------- ------
--------------- ------
</TABLE>
At December 31, 1996, 912,425 options were exercisable at a weighted average
exercise price of $1.10 per share. At December 31, 1997, 1,275,645 options were
exercisable at a weighted average exercise price of $1.51 per share. The options
outstanding at December 31, 1997 expire in various years through 2007.
Information about stock options outstanding at December 31, 1997 is
summarized as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
-------------------------------------------------------------------
WEIGHTED-
AVERAGE WEIGHTED- WEIGHTED-
NUMBER REMAINING AVERAGE NUMBER AVERAGE
OUTSTANDING CONTRACTED EXERCISE EXERCISABLE EXERCISE
RANGE OF EXERCISE PRICES AT 12/31/97 LIFE PRICE AT 12/31/97 PRICE
- ---------------------------------------------------- ----------- ------------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C>
$0.73 to $1.46...................................... 1,807,126 8.28 $ 1.17 1,113,695 $ 1.14
$4.00 to $6.83...................................... 1,146,721 8.96 $ 4.68 161,950 $ 4.07
$8.11 to $11.10..................................... 543,250 9.66 $ 9.06 -- $ --
----------- ----- ----------- ----------- -----
3,497,097 8.72 $ 3.54 1,275,645 $ 1.51
----------- ----- ----------- ----------- -----
----------- ----- ----------- ----------- -----
</TABLE>
The Company has elected to adopt FASB No. 123 for disclosure purposes only
and applies Accounting Principle Board (APB) Opinion No. 25 and related
interpretations in accounting for its employee stock options. Approximately
$50,000 and $88,000 in compensation cost was recognized relating to consultant
options for the years ended December 31, 1996 and 1997, respectively. Had
compensation cost for stock options awarded under these plans been determined
based on the fair value at the dates of grant consistent with the methodology of
FASB No. 123, the Company's net income or loss and basic and diluted income or
loss per share for the years ended December 31, 1996 and 1997 would have
reflected the following pro forma amounts:
F-21
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
10. STOCK OPTIONS (CONTINUED)
Pro forma Net Income (Loss) Per Share
<TABLE>
<CAPTION>
1996 1997
------------- ------------
<S> <C> <C>
Pro forma Net Income (Loss)...................................... $ (5,536,000) $ 4,756,000
Pro forma Basic Net Income (Loss) per share...................... $ (0.25) $ 0.16
Pro forma Diluted Net Income (Loss) per share.................... $ (0.25) $ 0.15
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the minimum value method of option pricing with the following assumptions used
for the grants; weighted average risk-free interest rate of 6.4 and 6.2 percent
and an expected life of ten years and six years for the years ended December 31,
1996 and 1997, respectively. Expected volatility for 1997 was 31.05 percent and
it is assumed that no dividends would be issued during the option term. Because
the Company did not have a stock option program prior to 1996, the resulting pro
forma compensation cost may not be representative of that to be expected in
future years.
11. CAPITAL STOCK
During 1994, the Company issued 16,606,661 shares of stock to the Company's
founder for $10,000. During 1995, this stockholder converted $990,000 of debt
into capital for no additional shares. During 1995, the Company also issued
1,843,339 shares to another executive of the Company on conversion of a loan.
On February 23, 1996, the Company sold 2,049,980 shares of common stock to
various investors for $1,500,000. On July 12, 1996, the Company sold 1,874,532
shares of common stock to an investor for $4,068,000.
On July 25, 1996, the Company sold 2,802,446 shares of Series A preferred
stock to a group of investors for $7,500,000. In connection with this
transaction, the Company and buyers of the preferred shares entered into an
investor's rights agreement which obligated the Company to file up to two
registration statements to register such shares. These preferred shares
converted to common stock at a ratio of 3-for-2 as a result of the public
offering in accordance with the investors rights agreement.
In June 1997, the Company completed its Initial Public Offering ("IPO") of
9,430,000 shares of common stock of which 8,097,500 shares were sold by the
Company and 1,332,500 shares were sold by certain selling shareholders. The net
proceeds to the Company (after deducting underwriting discounts and offering
expenses of approximately $4.6 million) from the sale of shares was
approximately $30.9 million.
On November 30, 1997, the Company completed the acquisition of LDS pursuant
to the terms of the agreement and 849,298 shares were issued for all of the
outstanding shares to LDS.
12. BUSINESS SEGMENTS
At December 31, 1997, Star has two business segments, wholesale long
distance and commercial long distance telecommunications. The wholesale segment
provides long distance services to U.S. and foreign based telecommunications
companies and the commercial segment, obtained by acquisition of LDS, provides
commercial long distance services to small retailers throughout the United
States.
F-22
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
12. BUSINESS SEGMENTS (CONTINUED)
The accounting policies of the segments are the same as those described in
the significant accounting policies, however, the Company evaluates performance
based on profit or loss from operations before income taxes and non-recurring
gains or losses. There are no intercompany sales among the wholesale and
commercial segments and both segments are managed separately.
Reportable segment information for the years ended December 31, 1995, 1996
and 1997 are as follows:
<TABLE>
<CAPTION>
WHOLESALE COMMERCIAL ALL OTHER TOTAL
-------------- ------------- ---------- --------------
<S> <C> <C> <C> <C>
1995
Revenues from external customers..................... $ 16,125,000 $ 30,158,000 $ -- $ 46,283,000
Interest income...................................... -- 22,000 -- 22,000
Interest expense..................................... (64,000) -- -- (64,000)
Depreciation and amortization........................ (128,000) (58,000) -- (186,000)
Segment profit (loss)................................ (568,000) 4,541,000 -- 3,973,000
Other significant non-cash items:
Capital lease additions............................ 888,000 164,000 -- 1,052,000
Property additions financed by notes payable....... -- -- -- --
Debt converted to equity........................... 1,093,000 -- -- 1,093,000
Segment assets....................................... 12,869,000 5,447,000 -- 18,316,000
Expenditures for segment assets...................... 1,062,000 61,000 -- 1,123,000
1996
Revenues from external customers..................... $ 208,086,000 $ 29,905,000 $ -- $ 237,991,000
Interest income...................................... 83,000 27,000 -- 110,000
Interest expense..................................... (589,000) (12,000) -- (601,000)
Depreciation and amortization........................ (1,073,000) (78,000) -- (1,151,000)
Segment profit (loss)................................ (6,644,000) 2,424,000 -- (4,220,000)
Other significant non-cash items:
Capital lease additions............................ 5,097,000 69,000 -- 5,166,000
Property additions financed by notes payable....... -- -- -- --
Segment assets....................................... 48,674,000 5,326,000 -- 54,000,000
Expenditures for segment assets...................... 7,838,000 14,000 -- 7,852,000
1997
Revenues from external customers..................... $ 348,738,000 $ 27,460,000 $ -- $ 376,198,000
Interest income...................................... 519,000 -- (27,000) 492,000
Interest expense..................................... (1,633,000) (27,000) 27,000 (1,633,000)
Depreciation and amortization........................ (4,189,000) (56,000) -- (4,245,000)
Segment profit (loss)................................ 5,605,000 (37,000) -- 5,568,000
Other significant non-cash items:
Capital lease additions............................ 9,772,000 -- -- 9,772,000
Property additions financed by notes payable....... 1,524,000 -- -- 1,524,000
Segment assets....................................... 106,709,000 6,844,000 -- 113,553,000
Expenditures for segment assets...................... 13,419,000 17,000 -- 13,436,000
</TABLE>
F-23
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
12. BUSINESS SEGMENTS (CONTINUED)
The Company had no customers, collectively, representing more than 10
percent of consolidated revenue in any foreign country.
13. QUARTERLY CONSOLIDATED INFORMATION (UNAUDITED)
The following table presents unaudited quarterly operating results,
including the results of LDS, for each of the Company's eight quarters in the
two-year period ended December 31, 1997 (amounts in thousands):
<TABLE>
<CAPTION>
QUARTER ENDED
---------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31,
----------- --------- --------- ----------
<S> <C> <C> <C> <C>
1996
Net sales............................................... $ 42,926 $ 50,064 $ 68,433 $ 76,568
Gross profit............................................ 6,689 7,206 7,714 10,797
Operating income (loss)................................. 2,100 1,961 1,219 (8,356)
Net income (loss)....................................... 1,477 1,294 870 (7,861)
1997
Net sales............................................... $ 79,382 $ 89,167 $ 94,867 $ 112,782
Gross profit............................................ 10,789 11,730 12,913 15,529
Operating income........................................ 2,495 2,633 3,100 2,821
Net income.............................................. 1,907 656 1,014 1,991
</TABLE>
14. SUBSEQUENT EVENTS
ACQUISITIONS
In November 1997, the Company signed a merger agreement with United Digital
Network, Inc. ("UDN"). The Company intends to account for the transaction as a
pooling of interests. At December 31, 1997, the Company has accounts receivable
from UDN in the amount of $721,000 and a note receivable of $2.5 million plus
accrued interest of $28,000. Both the accounts receivable and the note have been
fully reserved at December 31, 1997. Subsequent to year end, the Company loaned
an additional $2 million to UDN.
On March 10, 1998, the Company consummated a merger with T-One Corp.
("T-One") to be accounted for as a pooling of interests. In connection with this
merger, the Company issued 1,353,000 shares of its common stock for all
outstanding shares of T-One. The following unaudited pro forma data
F-24
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
14. SUBSEQUENT EVENTS (CONTINUED)
summarizes the combined operating results of the Company and T-One as if the
merger had occurred at the beginning of the periods presented.
<TABLE>
<CAPTION>
1995 1996 1997
------------- -------------- --------------
<S> <C> <C> <C>
Revenue.......................................................... $ 58,937,000 $ 260,423,000 $ 406,636,000
Gross profit..................................................... 14,667,000 33,739,000 52,784,000
Income (loss) from operations.................................... 3,847,000 (3,658,000) 11,365,000
Net income (loss) (1)............................................ 2,140,000 (5,738,000) 5,574,000
Diluted income (loss) per common share (2)....................... $ 0.11 $ (0.25) $ 0.17
</TABLE>
- ------------------------
(1) Includes pro forma income (loss) of STAR plus net income (loss) of T-One
assuming STAR and LDS C-Corporation status.
(2) The diluted pro forma income (loss) per common share is based on the sum of
the historical average common shares outstanding, as reported by STAR, and
the historical average common shares outstanding for T-One (adjusted to
reflect non-dilutive common stock equivalents) converted to STAR shares at
the exchange ratio of 13,530 STAR shares per T-One share.
EQUITY TRANSACTIONS
On February 3, 1998 the Company announced a 2.05 for 1 stock split in the
nature of a stock dividend. The stock split is effective March 31, 1998 and has
been retroactively reflected in the accompanying consolidated financial
statements for all periods presented.
Subsequent to year end, the Company granted 219,350 additional stock options
to employees and directors.
LINE OF CREDIT
On March 18, 1998, the Company amended the line of credit agreement with
Sanwa Bank by adjusting the borrowing base to 55% of aggregate eligible accounts
receivable, revising certain covenants and releasing all pledged collateral.
F-25
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Condensed Consolidated Balance Sheets As Of December 31, 1997 And March 31, 1998........................... F-27
Condensed Consolidated Statements Of Income For the Three Month Periods Ended
March 31, 1997 and 1998.................................................................................. F-28
Condensed Consolidated Statements of Cash Flows For The Three Month Periods Ended March 31, 1997 And
1998..................................................................................................... F-29
Notes To Condensed Consolidated Financial Statements....................................................... F-30
</TABLE>
F-26
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
1997
------------ MARCH 31,
1998
-----------
(UNAUDITED)
<S> <C> <C>
Current Assets:
Cash and cash equivalents......................................................... $ 1,903 $ 5,285
Short-term investments............................................................ 18,631 2,978
Accounts receivable, net.......................................................... 46,675 51,024
Receivable from related parties................................................... -- 303
Other current assets.............................................................. 10,695 16,057
------------ -----------
Total current assets............................................................ 77,904 75,647
------------ -----------
Property and equipment, net........................................................... 35,959 67,814
Other assets.......................................................................... 6,453 851
------------ -----------
Total assets.................................................................... $ 120,316 $ 144,312
------------ -----------
------------ -----------
Current Liabilities:
Revolving lines of credit with stockholder........................................ $ 138 $ 82
Current portion of long-term obligations.......................................... 2,975 6,314
Accounts payable and other accrued expenses....................................... 22,344 23,242
Accrued network cost.............................................................. 38,403 37,667
------------ -----------
Total current liabilities....................................................... 63,860 67,305
------------ -----------
Long-Term Liabilities:
Long-term obligations, net of current portion..................................... 12,391 25,902
Other long-term liabilities....................................................... 863 378
------------ -----------
Total long-term liabilities..................................................... 13,254 26,280
------------ -----------
Stockholders' Equity:
Common Stock $.001 par value:
Authorized--50,000,000 shares................................................... 35 36
Additional paid-in capital........................................................ 45,697 51,308
Deferred compensation............................................................. (30) (10)
Retained deficit.................................................................. (2,500) (607)
------------ -----------
Total stockholders' equity...................................................... 43,202 50,727
------------ -----------
Total liabilities and stockholders' equity...................................... $ 120,316 $ 144,312
------------ -----------
------------ -----------
</TABLE>
See accompanying notes to the condensed consolidated financial statements.
F-27
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------
1997 1998
--------- -----------
(UNAUDITED)
<S> <C> <C>
Revenue................................................................................... $ 84,827 $ 129,269
Cost of services.......................................................................... 73,726 111,593
--------- -----------
Gross profit.......................................................................... 11,101 17,676
Operating expenses
Selling, general and administrative expenses.......................................... 7,720 11,561
Depreciation and amortization......................................................... 820 1,879
Merger expense........................................................................ -- 314
--------- -----------
8,540 13,754
--------- -----------
Income from operations.................................................................. 2,561 3,922
--------- -----------
Other income (expense):
Interest income....................................................................... 21 283
Interest expense...................................................................... (398) (618)
Other................................................................................. 51 (160)
--------- -----------
(326) (495)
--------- -----------
Income before provision for income taxes.............................................. 2,235 3,427
Provision for income taxes................................................................ 341 1,534
--------- -----------
Net income................................................................................ $ 1,894 $ 1,893
--------- -----------
--------- -----------
Income before provision for income taxes.............................................. 2,235
Pro forma income taxes.................................................................... 888
---------
Pro forma net income...................................................................... $ 1,347
---------
---------
Basic income per share.................................................................... $ 0.05
-----------
-----------
Diluted income per share.................................................................. $ 0.05
-----------
-----------
Pro forma basic income per share.......................................................... $ 0.05
---------
---------
Pro forma diluted income per share........................................................ $ 0.05
---------
---------
</TABLE>
See accompanying notes to the condensed consolidated financial statements.
F-28
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
---------------------
1997 1998
--------- ----------
(UNAUDITED)
<S> <C> <C>
Cash Flows From Operating Activities:
Net income.............................................................................. $ 1,894 $ 1,893
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization....................................................... 820 1,879
Loss on disposal of equipment....................................................... 42 --
Compensation expense relating to stock options...................................... 20 20
Provision for doubtful accounts..................................................... 1,128 1,017
Deferred income taxes............................................................... -- (1,411)
Deferred compensation............................................................... (81) 50
Decrease (increase) in assets:
Accounts receivable............................................................. (6,315) (5,366)
Receivable from related parties................................................. (14) (303)
Other assets.................................................................... (207) 6,294
Increase (decrease) in liabilities:
Accounts payable and accrued expenses........................................... 9,169 898
Accrued network cost............................................................ (3,599) (736)
Other liabilities............................................................... 287 (535)
--------- ----------
Net cash provided by operating activities................................... 3,144 3,700
--------- ----------
Cash Flows From Investing Activities:
Capital expenditures.................................................................... (2,324) (15,636)
Investments............................................................................. (93) --
Short-term investments, net............................................................. 1,656 15,653
Proceeds from the sale of assets........................................................ 18 --
--------- ----------
Net cash provided (used) by investing activities............................ (743) 17
--------- ----------
</TABLE>
<TABLE>
<S> <C> <C>
Cash Flows From Financing Activities:
Repayments under lines of credit..................................... (2,472) --
Repayments under lines of credit with stockholder.................... (26) (56)
Payments under long-term debt........................................ (101) (187)
Payments under capital lease obligations............................. (67) (1,061)
Other financing activities........................................... (467) --
Stock options exercised.............................................. -- 969
--------- ---------
Net cash used in financing activities (3,133) (335)
--------- ---------
Increase (decrease) in cash and cash equivalents......................... (732) 3,382
Cash and cash equivalents, beginning of period........................... 1,844 1,903
--------- ---------
Cash and cash equivalents, end of period................................. $ 1,112 $ 5,285
--------- ---------
--------- ---------
</TABLE>
See accompanying notes to the condensed consolidated financial statements.
F-29
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) GENERAL
The financial statements included herein are unaudited and have been
prepared in accordance with generally accepted accounting principles for interim
financial reporting and Securities Exchange Commission ("SEC") regulations.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to such rules and regulations. In
management's opinion, the financial statements reflect all adjustments (of a
normal and recurring nature) which are necessary to present fairly the financial
position, results of operations, stockholders' equity and cash flows for the
interim periods. These financial statements should be read in conjunction with
the audited financial statements for the year ended December 31, 1997, as set
forth in the Registration Statement on Form S-1 of STAR Telecommunications, Inc.
("STAR" or the "Company") Registration No. 333-48559, as amended, which was
filed with the SEC on March 24, 1998. The results for the three month period
ended March 31, 1998, are not necessarily indicative of the results that may be
expected for the year ending December 31, 1998.
In March 1998, the company consummated a merger with T-One Corp. ("T-One").
The merger constituted a tax-free reorganization and has been accounted for as
pooling of interests under Accounting Principles Board Opinion No. 16.
Accordingly, all prior period consolidated financial statements presented have
been restated to include the results of operations, financial position, and cash
flows of T-One.
On March 31, 1998, the Company effected a 2.05 for 1 stock split in the
nature of a stock dividend with payment to the holders of the shares of common
stock outstanding on February 20, 1998. The stock split has been retroactively
reflected in the condensed consolidated financial statements for all periods
presented.
(2) BUSINESS AND PURPOSE
Star is an international long distance service provider offering low cost
switched voice services on a wholesale basis primarily to U. S.-based long
distance carriers. In addition, STAR provides domestic commercial long-distance
services through its subsidiary, LD Services, Inc. ("LDS").
(3) NET INCOME PER COMMON SHARE
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share". The statement replaces primary EPS with basic EPS, which is computed by
dividing reported earnings available to common stockholders by weighted average
shares outstanding. The provision requires the calculation of diluted EPS. The
Company adopted this statement in 1997.
F-30
<PAGE>
The following schedule summarizes the information used to compute net income
per common share for the three months ended March 31, 1997 and 1998 (in
thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------
1997 1998
--------- ---------
<S> <C> <C>
Weighted number of common shares used to compute basic earnings per share...................... 24,577 35,629
Weighted common share equivalents.............................................................. 3,917 2,085
--------- ---------
Weighted number of common share and share equivalents used to compute diluted earnings per
share......................................................................................... 28,494 37,714
--------- ---------
--------- ---------
</TABLE>
(4) PRO FORMA INCOME TAXES
The results of operations and provision for income taxes for the three
months ended March 31, 1997 reflects LDS status as an S-Corporation prior to the
merger with STAR. The pro forma income taxes, pro forma net income, and pro
forma earnings per share information reflected in the condensed consolidated
statements of income assumes that both STAR and LDS were taxed as C-Corporations
for all periods presented.
(5) COMPREHENSIVE INCOME
On January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income". For year end financial statements SFAS 130 requires that
comprehensive income, which is the total of net income and all other non-owner
changes in equity, be displayed in a financial statement with the same
prominence as other consolidated financial statements. In addition, the standard
encourages companies to display the components of other comprehensive income
below the total for net income. During the quarters ended March 31, 1997 and
1998, comprehensive income equaled net income.
(6) SIGNIFICANT EVENTS
In March 1998, the Company acquired T-One, an international wholesale long
distance telecommunications provider based in New York, in a transaction that
was accounted for as a pooling of interests. The Company issued 1,353,000 shares
of its common stock to T-One's shareholders in exchange for all outstanding
T-One shares. The accompanying consolidated financial statements are restated to
include the financial position and result of operations of T-One for all periods
presented. Net sales and historical net income (loss) of the combining companies
for the three months ended March 31, 1997 and 1998, are as follows (in
thousands):
F-31
<PAGE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
---------------------
1997 1998
--------- ----------
<S> <C> <C>
Net Sales:
STAR............................................................... $ 79,382 $ 117,899
T-One.............................................................. 5,528 11,788
Elimination........................................................ (83) (418)
--------- ----------
Total.............................................................. $ 84,827 $ 129,269
--------- ----------
--------- ----------
Net Income (Loss):
STAR............................................................... $ 1,907 $ 1,981
T-One.............................................................. (13) (88)
--------- ----------
Total.................................................................. $ 1,894 $ 1,893
--------- ----------
--------- ----------
</TABLE>
In November 1997, the Company signed a merger agreement with United Digital
Network, Inc. ("UDN"). The Company intends to account for the transaction as a
pooling of interests.
On February 3, 1998, the Company announced a 2.05 for 1 stock split in the
nature of a stock dividend. The Company effected the stock split on March 31,
1998, which has been retroactively reflected in the accompanying consolidated
financial statements for all periods presented.
(7) STATEMENTS OF CASH FLOWS
During the three month periods ended March 31, 1997 and 1998, cash paid for
interest was $357,000 and $585,000 respectively. For the same periods, cash paid
for income taxes amounted to $212,000 and $1,575,000, respectively.
Non-cash investing and financing activities are as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------
1997 1998
--------- ---------
<S> <C> <C>
Equipment purchased through notes and capital leases....................... $ 913 $ 18,098
Tax benefits related to stock options...................................... - 4,643
--------- ---------
$ 913 $ 22,741
--------- ---------
--------- ---------
</TABLE>
(8) SUBSEQUENT EVENTS
On May 4, 1998, the Company completed a public offering of 6,000,000 shares
of Common Stock of which 5,685,000 shares were sold by the Company and 315,000
shares were sold by a selling stockholder. The net proceeds to the Company
(after deducting underwriting discounts and offering expenses) from the sale of
such shares of Common Stock were approximately $145 million.
(9) SEGMENT INFORMATION
At March 31, 1998, Star has two business segments, wholesale long distance
and commercial long distance telecommunications. The wholesale segment provides
long distance services to U.S. and foreign based telecommunications companies
and the commercial segment provides commercial long distance services to small
retailers throughout the United States.
F-32
<PAGE>
Both segments are accounted for in accordance with Generally Accepted
Accounting Principles or "GAAP". Reportable segment information for the periods
ended March 31, 1997 and 1998 are as follows:
<TABLE>
<CAPTION>
MARCH 31, 1997 WHOLESALE COMMERCIAL TOTAL
<S> <C> <C> <C>
Revenue from external customers............................................. $ 76,454 $ 8,373 $ 84,827
Interest income............................................................. 21 -- 21
Interest expense............................................................ 397 1 398
Depreciation and amortization............................................... 814 6 820
Segment profit.............................................................. 1,419 475 1,894
Segment assets.............................................................. 63,546 5,181 68,727
</TABLE>
<TABLE>
<CAPTION>
MARCH 31, 1998 WHOLESALE COMMERCIAL TOTAL
<S> <C> <C> <C>
Revenue from external customers............................................. $ 121,193 $ 8,076 $ 129,269
Interest income............................................................. 281 2 283
Interest expense............................................................ 618 -- 618
Depreciation and amortization............................................... 1,876 3 1,879
Segment profit (loss)....................................................... 1,978 (85) 1,893
Segment assets.............................................................. 137,678 6,634 144,312
</TABLE>
F-33
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Report of Independent Accountants for the years ended April 30, 1996 and 1997.............................. F-36
Report of Independent Accountants for the year ended April 30, 1995........................................
Consolidated Financial Statements:
Consolidated Balance Sheets as of April 30, 1996 and 1997................................................ F-38
Consolidated Statements of Operations for the years ended April 30, 1995, 1996 and 1997.................. F-39
Consolidated Statements of Shareholders' Equity for the years ended April 30, 1995,
1996 and 1997.......................................................................................... F-40
Consolidated Statements of Cash Flows for the years ended April 30, 1995, 1996 and 1997.................. F-41
Notes to Consolidated Financial Statements................................................................. F-42
</TABLE>
F-34
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
September 5, 1997,
except as to Notes 2, 9 and 15,
which are as of May 18, 1998
To the Board of Directors and Shareholders
of United Digital Network, Inc. and Subsidiaries
(formerly Unidex Communications Corp.)
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, shareholders' equity and of cash flows
present fairly, in all material respects, the financial position of United
Digital Network, Inc. and its subsidiaries (formerly Unidex Communications
Corp.) at April 30, 1996 and 1997, and the results of their operations and their
cash flows for the years then ended, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
financial statements in accordance with generally accepted auditing standards
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As described in Note
14 to the consolidated financial statements, the Company has a significant
working capital deficiency and its current cash flow from operations is not
sufficient to permit the Company to repay debts on the scheduled due dates.
These conditions raise substantial doubt about the Company's ability to continue
as a going concern. Management's plans in regard to this matter are also
described in Note 14. The financial statements do not include any adjustment
that might result from the outcome of this uncertainty.
/s/ PRICE WATERHOUSE LLP
F-35
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Shareholders
UNIDEX COMMUNICATIONS CORP.
We have audited the consolidated statements of operations, shareholders'
equity and cash flows of Unidex Communications Corp. and Subsidiaries for the
year ended April 30, 1995. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our previously issued report dated July 21, 1995, we expressed an opinion
that the 1995 consolidated financial statements presented fairly the results of
operation, changes in shareholders' equity and cash flows of Unidex
Communications Corp. and Subsidiaries for the year ended April 30, 1995 in
conformity with generally accepted accounting principles, except for the
omission of the disclosure of proforma results of operations relating to a
business acquisition. The Company has included the omitted proforma information
in Note 3. Accordingly, our present opinion on the 1995 financial statements is
different from that presented in our previous report.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the results of operations, changes in
shareholders' equity and cash flows of the Unidex Communications Corp. for the
year ended April 30, 1995 in accordance with generally accepted accounting
principles.
WEAVER AND TIDWELL, L.L.P.
Dallas, Texas
July 21, 1995, except for the proforma
information relating to the business
acquisition, as to which the date is
May 20, 1997.
F-36
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
AS OF APRIL 30,
----------------------------
1996 1997
------------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................................................ $ 1,073,649 $ 556,366
Accounts and notes receivable, net (Note 5)...................................... 2,452,336 3,918,905
Receivable from employee......................................................... 12,010 --
Prepaid expenses and other....................................................... 140,991 453,247
------------- -------------
Total current assets........................................................... 3,678,986 4,928,518
Property and equipment, net (Note 6)............................................... 1,369,576 1,947,234
Intangible assets, net (Note 7).................................................... 5,367,809 6,158,354
Other assets....................................................................... 170,791 162,067
------------- -------------
Total assets................................................................... $ 10,587,162 $ 13,196,173
------------- -------------
------------- -------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Trade accounts payable........................................................... $ 3,407,351 $ 5,628,664
Other accrued liabilities........................................................ 220,834 330,640
Notes and accounts payable to shareholders, net (Note 12)........................ 1,143,650 896,470
Current maturities of long-term obligations (Note 8)............................. 559,596 689,712
Accrued taxes, other than income taxes........................................... 388,881 567,352
------------- -------------
Total current liabilities...................................................... 5,720,312 8,112,838
------------- -------------
Long-term obligations (Note 8)..................................................... 436,700 1,309,792
Long-term obligations to shareholders, net (Note 12)............................... 1,624,586 684,990
Commitments and contingencies (Note 13)
Shareholders' equity:
Common stock, $.01 par value 100,000,000 shares authorized;
5,250,340 and 6,378,442 issued at April 30, 1996 and 1997,
respectively (Notes 2 and 9)................................................... 52,503 63,784
Additional paid-in capital....................................................... 9,913,694 11,863,723
Retained deficit................................................................. (7,160,633) (8,838,954)
------------- -------------
Total shareholders' equity..................................................... 2,805,564 3,088,553
------------- -------------
Total liabilities and shareholders' equity................................... $ 10,587,162 $ 13,196,173
------------- -------------
------------- -------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-37
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED APRIL 30,
-------------------------------------------
1995 1996 1997
------------- ------------- -------------
<S> <C> <C> <C>
Telecommunications revenues.......................................... $ 2,338,467 $ 8,026,587 $ 24,012,368
Cost of revenues..................................................... 1,917,734 6,029,796 18,455,095
------------- ------------- -------------
Gross profit..................................................... 420,733 1,996,791 5,557,273
------------- ------------- -------------
Operating expenses:
Selling, general and administrative................................ 1,941,624 2,675,265 5,154,901
Provision for doubtful accounts.................................... 74,662 228,827 693,164
Depreciation and amortization...................................... 273,053 583,530 900,545
------------- ------------- -------------
Total operating expenses......................................... 2,289,339 3,487,622 6,748,610
------------- ------------- -------------
Loss from operations before other expenses........................... (1,868,606) (1,490,831) (1,191,337)
Other expenses:
Interest expense, net.............................................. (85,431) (107,474) (634,103)
Loss on sale of assets............................................. (118,680) -- --
Loss on impairment of assets....................................... -- (63,997) --
------------- ------------- -------------
Total other expenses............................................. (204,111) (171,471) (634,103)
------------- ------------- -------------
Loss before income tax benefit and extraordinary gain................ (2,072,717) (1,662,302) (1,825,440)
------------- ------------- -------------
Income tax benefit (Note 10)......................................... -- -- 50,000
------------- ------------- -------------
Loss before extraordinary gain....................................... (2,072,717) (1,662,302) (1,775,440)
------------- ------------- -------------
Extraordinary gain on debt restructuring (net of
income taxes of $50,000)........................................... -- -- 97,119
------------- ------------- -------------
Net loss............................................................. $ (2,072,717) $ (1,662,302) $ (1,678,321)
------------- ------------- -------------
------------- ------------- -------------
Loss per weighted average common shares outstanding (basic and
diluted):
Loss before extraordinary gain on debt restructuring............... $ (0.92) $ (0.45) $ (0.33)
Extraordinary gain................................................. -- -- 0.02
------------- ------------- -------------
Net loss per share................................................. $ (0.92) $ (0.45) $ (0.31)
Weighted average number of common shares outstanding (basic and
diluted)......................................................... 2,252,953 3,706,993 5,359,156
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-38
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
FOR THE YEARS ENDED APRIL 30, 1995, 1996 AND 1997
------------------------------------------------------------------
COMMON STOCK ADDITIONAL
--------------------- PAID-IN RETAINED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
---------- --------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Balance at April 30, 1994................... 1,854,002 $ -- $ 4,074,620 $ (3,425,614) $ 649,006
Net loss.................................... -- -- -- (2,072,717) (2,072,717)
Issuance of common stock for:
Private placements........................ 1,205,625 -- 2,015,722 -- 2,015,722
Exercise of warrants...................... 43,405 -- 167,113 -- 167,113
Acquisition of DNI........................ 250,000 -- 407,006 -- 407,006
Consideration for finder's fees........... 1,984 -- --
Issuance costs.............................. -- -- (49,915) -- (49,915)
---------- --------- ------------- ------------- -------------
Balance at April 30, 1995................... 3,355,016 -- 6,614,546 (5,498,331) 1,116,215
---------- --------- ------------- ------------- -------------
Net loss.................................... -- -- -- (1,662,302) (1,662,302)
Increase in par value to $.01/share......... -- 33,550 (33,550) -- --
Issuance of common stock for:
Private placements........................ 1,444,432 14,444 2,674,593 -- 2,689,037
Exercise of warrants...................... 450,892 4,509 714,644 -- 719,153
Compensation expense........................ -- -- 47,000 -- 47,000
Issuance costs.............................. -- -- (103,539) -- (103,539)
---------- --------- ------------- ------------- -------------
Balance at April 30, 1996................... 5,250,340 $ 52,503 $ 9,913,694 $ (7,160,633) $ 2,805,564
---------- --------- ------------- ------------- -------------
---------- --------- ------------- ------------- -------------
Net loss.................................... -- -- -- (1,678,321) (1,678,321)
Issuance of common stock for:
Private placements........................ 722,250 7,222 1,143,272 -- 1,150,494
Exercise of warrants...................... 155,852 1,559 264,259 -- 265,818
Conversion of 11% debentures.............. 250,000 2,500 497,498 -- 499,998
Compensation expense........................ -- -- 45,000 -- 45,000
---------- --------- ------------- ------------- -------------
Balance at April 30, 1997................... 6,378,442 $ 63,784 $ 11,863,723 $ (8,838,954) $ 3,088,553
---------- --------- ------------- ------------- -------------
---------- --------- ------------- ------------- -------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-39
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED APRIL 30,
-------------------------------------------
1995 1996 1997
------------- ------------- -------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss........................................................... $ (2,072,717) $ (1,662,302) $ (1,678,321)
Adjustments to reconcile net loss to net cash used by operating
activities:
Depreciation and amortization.................................... 276,026 583,530 900,545
Gain on debt restructure......................................... -- -- (147,119)
Loss on disposal of assets....................................... 118,680 -- --
Loss on impairment............................................... -- 63,997 --
Compensation recognized for stock options........................ -- 47,000 45,000
Interest amortization of notes discount.......................... -- -- 263,307
Other............................................................ (14,914) (3,494) 7,990
(Increase) decrease, net of effect of acquisition:
Unfactored accounts and notes receivable....................... (203,307) 179,016 (3,750,778)
Prepaid expenses and other assets.............................. 47,751 152,385 (631,734)
Increase (decrease), net of effect of acquisition:
Accounts and notes payable and accrued expenses................ 29,143 (705,416) 1,666,637
------------- ------------- -------------
Net cash provided by (used in) operating activities.......... (1,819,338) (1,345,284) (3,324,473)
------------- ------------- -------------
Cash flows from investing activities:
Additions to property and equipment................................ (193,745) (186,439) (673,714)
Purchase of CTN, net of cash acquired.............................. -- -- (350,000)
Purchase of AMS, net of cash acquired.............................. -- (542,980) --
Purchase of DNI, net of cash acquired.............................. (200,000) -- --
Sale of assets..................................................... 150,000 -- --
Receipts on notes.................................................. 5,128 71,375 75,752
------------- ------------- -------------
Net cash used in investing activities........................ (238,617) (658,044) (947,962)
------------- ------------- -------------
Cash flows from financing activities:
Proceeds from issuance of common stock............................. 2,132,920 3,236,725 1,350,309
Proceeds from factoring of trade receivables, net.................. -- -- 3,562,230
Principal payments on obligations.................................. (303,080) (280,825) (1,157,387)
Advances from shareholders......................................... 233,329 -- --
------------- ------------- -------------
Net cash provided by financing activities.................... 2,063,169 2,955,900 3,755,152
------------- ------------- -------------
Increase (decrease) in cash.......................................... 5,214 952,572 (517,283)
Cash at beginning of year............................................ 115,863 121,077 1,073,649
------------- ------------- -------------
Cash at end of year.................................................. $ 121,077 $ 1,073,649 $ 556,366
------------- ------------- -------------
------------- ------------- -------------
Supplemental disclosure of cash flow information:
Interest paid...................................................... $ 93,105 $ 113,815 $ 719,758
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-40
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
United Digital Network, Inc. (the "Company"), formerly Unidex Communications
Corp. was incorporated in 1980 under the British Columbia Company Act in British
Columbia, Canada, and its shares are publicly traded on the Vancouver Stock
Exchange. In April 1995, the Company's continuance was authorized to the
jurisdiction of Wyoming under the Wyoming Business Corporation Act from the
Registrar of Companies for the Province of British Colombia. The Company then
merged with a wholly-owned subsidiary domiciled in the state of Delaware,
thereafter becoming a Delaware Corporation. The Company operates through its
principal subsidiaries, Answer-Net, Inc. (ANI), Digital Network, Inc. (DNI),
Advanced Management Services, Inc. (AMS) and CTN-Custom Telecommunications
Network of Arizona, Inc. (CTN). The Company's principal business activity is
providing basic long distance services, travelcard services, prepaid calling
card services, and various other telecommunication services to residential and
small to medium sized commercial customers. The majority of the Company's
customers are located in the states of Texas, Oklahoma, Arizona, New Mexico and
California, as well as customers located nationwide in the motor freight
industry.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries ANI, DNI, AMS and CTN. The financial
statements and related footnotes are presented in U.S. dollars, unless otherwise
indicated, and all significant intercompany accounts and transactions are
eliminated in consolidation. Certain previously reported amounts have been
reclassified to conform to the current year presentation.
FINANCIAL INSTRUMENTS
The fair market value of financial instruments is determined by reference to
various market data and other valuation techniques as appropriate. The Company
believes that the fair values of financial instruments approximate their
recorded values.
BUSINESS AND CREDIT CONCENTRATIONS
In the normal course of business, the Company extends unsecured credit to
its customers. Management has provided an allowance for doubtful accounts to
provide for amounts which may eventually become uncollectible and to provide for
any disputed charges.
Sales to one customer for the period ended April 30, 1997 represents
approximately 12% of telecommunications revenues.
REVENUE RECOGNITION
The Company recognizes revenue from its direct dial long distance and
operator services as such services are performed.
F-41
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation for financial
statement purposes, which includes amortization of assets under capital leases,
is provided utilizing the straight-line method over the estimated useful lives
of the depreciable assets or the lease terms.
Expenditures for major renewals and betterments, which significantly extend
the useful lives of existing property and equipment, are capitalized and
depreciated. Upon retirement or disposition of property and equipment, the cost
and related accumulated depreciation are removed from the accounts and any
resulting gain or loss is recognized in income. Expenditures for repair and
maintenance are charged to expense as incurred.
In March 1995, the FASB issued Statement of Financial Accounting Standards
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of" ("SFAS 121"), which requires that an entity review
long-lived assets for impairment, and any impairment loss for assets to be held
and used shall be reported as a component of income from continuing operations
before income taxes. The impairment loss recognized shall be measured as the
amount by which the carrying amount of the asset exceeds the fair value of the
asset.
In November 1995, the Company adopted SFAS 121. The application of SFAS 121
resulted in a charge to income for the 1996 fiscal year and a decrease in the
value of two long-lived assets.
FOREIGN CURRENCY TRANSACTIONS
Foreign currency transaction gains and losses are included in determining
net income and are not significant.
INTANGIBLE ASSETS
Intangible assets consist of the acquired cost of goodwill and customer
lists. These intangibles are amortized utilizing the straight-line method over
their estimated useful lives. The realizability of goodwill and customer lists
is evaluated periodically as events or circumstances indicate a possible
inability to recover their carrying amount. Such evaluation is based on various
analyses, including cash flow and profitability projections that incorporate, as
applicable, the impact on existing company businesses. The analyses necessarily
involve significant management judgment to evaluate the capacity of an acquired
business to perform within projections. Historically, the Company has generated
sufficient returns from acquired businesses to recover the cost of their
intangible assets.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires the Company to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent liabilities at the date of the financial statements and
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
F-42
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SHAREHOLDERS' EQUITY
Loss per share is computed by dividing the net loss by the weighted average
number of shares of common stock outstanding during the periods. The effect of
outstanding options and warrants on the computation of net loss per share is
antidilutive and, therefore, is not included in the computation for the years
ended April 30, 1995, 1996 and 1997.
On June 5, 1996, the Company's board of directors declared a four-for-one
reverse common stock split. As a result, effective August 9, 1996, all of the
Company's 50,000,000 shares of common stock, both issued and unissued, were
consolidated into 12,500,000 shares. The Company's par value of $.01 per share
remained unchanged. All share and per share amounts appearing in the
consolidated financial statements and notes thereto have been retroactively
adjusted for the stock split.
On June 5, 1996, the Company's board of directors also approved an increase
in the authorized shares of the Company from 12,500,000 to 100,000,000 shares
effective August 9, 1996. Concurrent with this change, the Company's name was
changed to United Digital Network, Inc.
FEDERAL INCOME TAXES
During fiscal 1994, the Company adopted Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). Deferred income
taxes are calculated utilizing an asset and liability approach, whereby deferred
taxes are provided for tax effects of basis differences for assets and
liabilities arising from differing treatments for financial and income tax
reporting purposes. Valuation allowances against deferred tax assets are
provided where appropriate. There was no impact on the consolidated financial
statements upon adoption of SFAS 109.
NEW ACCOUNTING STANDARDS
In February 1997, the FASB issued Financial Statement of Accounting
Standards No. 128, "Earnings per Share" ("SFAS 128"). SFAS 128 specifies the
computation, presentation and disclosure requirements for earnings per share
("EPS") for entities with publicly held common stock or potential common stock.
The Company adopted SFAS 128 in the third quarter of fiscal 1998 and has
restated all prior period EPS amounts pursuant to SFAS 128. SFAS 128 simplifies
the standards for computing EPS previously found in Accounting Principles Board
Opinion No. 15, "Earnings per Share" and makes them comparable to international
EPS standards. It replaces the presentation of primary EPS with a presentation
of basic EPS. It also requires dual presentation of basic and diluted EPS on the
face of the statement of operations for all entities with complex capital
structures and requires a reconciliation of the numerator and denominator of the
basic EPS computation to the numerator and denominator of the diluted EPS
computation.
Basic EPS excludes the effect of potentially dilutive securities while
diluted EPS reflects the potential dilution that would occur if securities or
other contracts to issue common stock were exercised, converted into or resulted
in the issuance of common stock. Common stock equivalents consist of common
stock issuable under the assumed exercise of stock options and warrants,
computed based on the treasury stock method and the assumed conversion of the
Company's issued and outstanding preferred stock. Common stock equivalents are
not included in diluted EPS calculations to the extent their inclusion would
have an anti-dilutive effect.
F-43
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In June 1997, the FASB issued SFAS 130 "Reporting Comprehensive Income."
This statement establishes standards for reporting and display of comprehensive
income and its components (revenues, expenses, gains and losses) in a full set
of general-purpose financial statements.
This statement is effective for fiscal years beginning after December 15,
1997. The Company believes that the adoption of this standard will not have a
material effect on the Company's consolidated results of operations or financial
position.
3. ACQUISITIONS
DIGITAL NETWORK, INC.
Effective April 27, 1995, the Company acquired all of the outstanding shares
of Digital Network, Inc. (DNI). DNI provides telecommunication services to
customers in Texas and southern Oklahoma.
The acquisition was accounted for using the purchase method of accounting,
and accordingly, the purchase price was allocated to the assets purchased and
the liabilities assumed based upon fair values at the date of acquisition. The
excess of the purchase price over the fair values of the net assets acquired was
$679,241, and was reflected as goodwill.
A summary of the DNI excess of cost over the net assets acquired is as
follows:
<TABLE>
<S> <C>
Assets, including identified intangible assets of $360,000.............. $1,331,363
Property and equipment.................................................. 1,261,674
Current liabilities..................................................... (1,906,894)
Long-term debt, net..................................................... (537,719)
----------
Net liabilities acquired................................................ 148,424
Goodwill................................................................ 679,241
----------
Purchase price.......................................................... $ 827,665
----------
----------
</TABLE>
The following unaudited pro forma combined results of operations for the
Company assume that the acquisition of CTN was completed at May 1, 1995, the
acquisition of AMS was completed at May 1, 1994 and the acquisition of DNI was
completed at May 1, 1993. These pro forma amounts represent the historical
operating results of DNI combined with those of the Company with appropriate
adjustments which give effect to interest expense and amortization. These pro
forma amounts are not necessarily indicative of consolidated operating results
which would have occurred had AMS and DNI been included in the operations of the
Company during the periods presented, or which may result in the future, because
these amounts do not reflect full transmission and switched service cost
optimization, and the synergistic effect on operating, selling, and general and
administrative expenses.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
APRIL 30,
-------------------------------------------
<S> <C> <C> <C>
1995 1996 1997
------------- ------------- -------------
Revenues.................................................. $ 17,429,712 $ 21,647,023 $ 26,966,853
Net loss.................................................. (3,190,433) (2,722,749) (2,104,696)
Net loss per share outstanding (basic and diluted)........ (1.42) (.73) (.39)
</TABLE>
F-44
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. ACQUISITIONS (CONTINUED)
ADVANCED MANAGEMENT SERVICES, INC.
Effective March 26, 1996, the Company acquired all of the outstanding common
stock of AMS, a long distance carrier based in Phoenix, Arizona. The acquisition
was accomplished through the payment of $1,100,000 in cash and the issuance of a
series of convertible debentures and a note payable totaling $2,381,947, net of
discount. The Company has recorded adjustments to the purchase price and
reductions to the notes and debentures payable to the sellers based on
management's best estimate of allowable adjustments defined in the stock
purchase agreement.
The present value of the notes and debentures was imputed using an interest
rate of 11%. Future payments are contingent upon, and may be reduced, if various
revenue and equity targets through March 1998 as outlined in the purchase
agreement are not met.
The acquisition was accounted for using the purchase method of accounting,
and accordingly, the purchase price was allocated to the assets purchased and
the liabilities assumed based upon fair values at the date of acquisition. The
excess of the purchase price over the fair values of the net liabilities
acquired was $3,541,050 and was reflected as goodwill.
A summary of the AMS excess of cost over net liabilities acquired is as
follows:
<TABLE>
<S> <C>
Assets, including identified intangible assets of $820,000.............. $2,994,730
Property and equipment.................................................. 24,295
Liabilities............................................................. (3,078,128)
----------
Net liabilities acquired................................................ (59,103)
Goodwill................................................................ 3,541,050
----------
Purchase price.......................................................... $3,481,947
----------
----------
</TABLE>
The Company's consolidated statement of operations includes the results of
operations of AMS since March 26, 1996. The Company will also include AMS in its
1996 consolidated federal income tax return for the period it was owned in 1996.
CTN-CUSTOM TELECOMMUNICATIONS NETWORK OF ARIZONA, INC.
Effective January 1, 1997, the Company acquired all of the outstanding
common stock of CTN, a long distance carrier based in Phoenix, Arizona. The
acquisition was accomplished through the payment of $350,000 in cash and the
issuance of a convertible debenture and a note payable totaling $1,050,000,
accumulating interest at 7% per annum.
Future payments are contingent upon, and may be reduced, if various revenue
targets through November 1997, as outlined in the purchase agreement, are not
met.
The acquisition was accounted for using the purchase method of accounting,
and accordingly, the purchase price was allocated to the assets purchased and
the liabilities assumed based upon fair values at the date of acquisition. The
excess of the purchase price over the fair values of the net assets acquired was
F-45
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. ACQUISITIONS (CONTINUED)
$975,956 and was reflected as goodwill. A summary of the CTN excess of cost over
net assets acquired is as follows:
<TABLE>
<S> <C>
Assets, including identified intangible
assets of $290,000.................... $ 1,298,495
Property and equipment.................. 18,369
Liabilities............................. (842,950)
-------------
Net assets acquired..................... 473,914
Goodwill................................ 975,956
-------------
Purchase price.......................... $ 1,449,870
-------------
-------------
</TABLE>
The Company's consolidated statement of operations includes the results of
operations of CTN since January 1, 1997. The Company will also include CTN in
its 1997 consolidated federal income tax return for the period it was owned in
1997.
4. NONCASH INVESTING AND FINANCING ACTIVITIES
During the year ended April 30, 1996, the Company purchased all of the
capital stock of AMS for $1,100,000 in cash and the issuance of a series of
convertible debentures and a note payable totaling $2,381,947. During the year
ended April 30, 1995, the Company purchased all of the capital stock of DNI for
$200,000 in cash and the issuance of a $200,000 note payable and the issuance of
250,000 shares of common stock at $1.628 a share. Additionally, during fiscal
1995, the Company sold net assets with a carrying value of $578,876 in exchange
for $150,000 cash and a $295,000 note receivable.
The Company recorded capital lease obligations of $87,465, $19,949 and
$489,802 during the years ended April 30, 1995, 1996 and 1997, respectively.
During the year ended April 30, 1996, accounts payable to shareholders of
$17,926 and notes payable of $50,000 were relieved through the exercise of
warrants.
During the year ended April 30, 1997, an accrued liability of $66,000 was
relieved through the issuance of common stock.
During the year ended April 30, 1997 the Company purchased all of the
capital stock of CTN for $350,000 in cash and the issuance of a convertible
debenture and a note payable totaling $1,050,000.
F-46
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. ACCOUNTS AND NOTES RECEIVABLE
Accounts and notes receivable consist of the following:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
APRIL 30,
---------------------------
<S> <C> <C>
1996 1997
------------- ------------
Trade receivables:......................................................... $ 1,262,617 $ 3,420,941
Billed................................................................... 1,337,640 3,213,712
Unbilled.................................................................
Receivable from Freshstart Communications.................................. -- 614,858
Credit reserve due from factor............................................. -- 330,695
Other...................................................................... 74,790 332,468
------------- ------------
Total notes and unfactored accounts receivable............................. 2,675,047 7,912,674
Total receivables assigned to factor....................................... -- (3,562,230)
------------- ------------
Total notes and accounts receivables....................................... 2,675,047 4,350,444
Allowance for doubtful accounts............................................ (222,711) (431,539)
------------- ------------
Total accounts and notes receivable, net................................... $ 2,452,336 $ 3,918,905
------------- ------------
------------- ------------
</TABLE>
The Company's monthly billing cycle is such that certain services performed
in the last month of one fiscal year will not be billed until the first month of
the subsequent fiscal year. These services are recognized as revenue and
recorded as unbilled receivables when earned.
In May 1996, the Company entered into a receivables purchase facility with
Receivables Funding Corporation (RFC). Under this facility, the Company
transfers receivables with recourse to RFC subject to the conditions of the
facility. The transfers are recorded in the period in which they occur. DNI and
AMS began transferring approximately 90% of eligible receivables to RFC
beginning in July and September, respectively.
In June 1996, the FASB issued Statement of Financial Accounting Standards
No. 125, "Accounting for Transfer and Servicing of Financial Assets and
Extinguishment of Liabilities" ("SFAS 125"). SFAS 125 requires that a transfer
of financial assets be accounted for as either a sale of these assets or as a
secured borrowing with a pledge of collateral. There are certain criteria which
must be met to classify the transfer as a sale. The Company adopted SFAS 125 for
the 1997 fiscal year. Under the provisions of SFAS 125, the Company's transfers
of receivables to RFC meet the criteria for classification as sales.
In 1997, the Company received $14,307,392 in proceeds from the factoring of
trade receivables.
F-47
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. PROPERTY AND EQUIPMENT
Property and equipment consist of:
<TABLE>
<CAPTION>
APRIL 30,
----------------------------
<S> <C> <C> <C>
1996 1997 LIFE
------------- ------------- ----------
Communications equipment..................................... $ 3,281,643 $ 4,153,300 2-8 years
Office equipment............................................. 321,250 569,705 5 years
Leasehold improvements....................................... 20,053 43,894 5 years
------------- -------------
3,622,946 4,766,899
Accumulated depreciation..................................... (2,253,370) (2,819,665)
------------- -------------
Total property and equipment, net............................ $ 1,369,576 $ 1,947,234
------------- -------------
------------- -------------
</TABLE>
Total depreciation expense, including amortization of equipment under
capital leases, charged to operations for the years ended April 30, 1995, 1996
and 1997 was $245,768, $436,688 and $498,701, respectively.
7. INTANGIBLE ASSETS
Intangible assets consist of:
<TABLE>
<CAPTION>
APRIL 30,
--------------------------
<S> <C> <C> <C>
1996 1997 LIFE
------------ ------------ ----------
Goodwill....................................................... $ 4,193,143 $ 5,094,387 25 years
Customer lists................................................. 1,316,832 1,606,832 7 years
------------ ------------
5,509,975 6,701,219
Accumulated amortization....................................... (142,166) (542,865)
------------ ------------
Total intangible assets, net................................... $ 5,367,809 $ 6,158,354
------------ ------------
------------ ------------
</TABLE>
Additions to goodwill and customer lists were recorded during fiscal years
1995, 1996 and 1997 as a result of the Company's acquisitions (Note 3).
8. LONG-TERM OBLIGATIONS
Long-term obligations consist of:
<TABLE>
<CAPTION>
APRIL 30,
---------------------------
<S> <C> <C>
1996 1997
------------- ------------
Convertible debenture with interest of 7% per annum due January 1999.
Amounts contingent on certain factors discussed in Note 3................ $ -- $ 500,000
Notes payable
Repayable in monthly installment amounts of $24,625 including interest at
7% per annum, commencing in February 1997, due January 1999............ -- 463,581
</TABLE>
F-48
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. LONG-TERM OBLIGATIONS (CONTINUED)
<TABLE>
<CAPTION>
APRIL 30,
---------------------------
1996 1997
------------- ------------
<S> <C> <C>
Repayable in monthly installments of $7,395 including interest at 16.9%
per annum. Final payment due November 1998............................. -- 116,828
Repayable to a bank in monthly installments of $2,042 including interest
at the WALL STREET JOURNAL prime rate plus 2% per annum, fully
retired................................................................ 50,117 --
Repayable in monthly installment amounts of $3,678 plus interest at 8%,
final payment due June 1995. This note is currently in default......... 41,098 41,098
Repayable to a bank in monthly installments of $1,825 including interest
at the WALL STREET JOURNAL prime rate plus 2% per annum, fully
retired................................................................ 63,743 --
Repayable in monthly installments of $4,894 including interest at 8%,
fully retired.......................................................... 36,800 --
Capital lease obligations................................................ 804,538 877,997
------------- ------------
Total long-term obligations................................................ 996,296 1,999,504
Less current maturities:
Long-term debt........................................................... 191,758 387,322
Capital lease obligations................................................ 367,838 302,390
------------- ------------
Long-term portion.......................................................... $ 436,700 $ 1,309,792
------------- ------------
------------- ------------
</TABLE>
Principal repayments of long-term debt are due approximately as follows:
<TABLE>
<CAPTION>
YEARS ENDING
APRIL 30,
------------
<S> <C>
1998...................................................................................... $ 689,712
1999...................................................................................... 1,059,059
2000...................................................................................... 234,244
2001...................................................................................... 16,489
2002...................................................................................... --
------------
Total long-term debt...................................................................... $1,999,504
------------
------------
</TABLE>
In September 1996, the Company recorded an extraordinary gain of $68,258
from the restructuring of a capital lease to a note payable.
In February 1997, the Company recorded an extraordinary gain of $78,861 from
the full settlement of two notes payable.
F-49
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. STOCK OPTIONS, WARRANTS, AND OTHER
ACCOUNTING FOR STOCK-BASED COMPENSATION
In October 1995, Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-based Compensation" ("SFAS No. 123"), was issued by the
Financial Accounting Standards Board. The statement requires the fair value of
stock options and other stock-based compensation issued to employees to either
be included as compensation expense in the income statements of companies or the
pro forma effect on net income and earnings per share of such compensation
expense to be disclosed in the footnotes to the Company's financial statements
beginning in 1996. The Company has elected to adopt SFAS No. 123 on a disclosure
basis only. Had compensation cost for the Company's stock option plan been
determined based on the fair market value at the grant dates for awards
consistent with the method provided by SFAS No. 123, the Company's net loss and
net loss per share would have been reflected by the following pro forma amounts
for the years ended April 30, 1995, 1996, and 1997.
<TABLE>
<CAPTION>
YEARS ENDED APRIL 30,
----------------------------------------
1995 1996 1997
------------ ------------ ------------
<S> <C> <C> <C> <C>
Net loss As reported........................ $ 2,072,717 $ 1,662,302 $ 1,678,321
Pro forma.......................... $ 2,097,861 $ 1,969,630 $ 1,878,190
Primary net loss per share (basic As reported........................ $ .92 $ .45 $ .31
and diluted)
Pro forma.......................... $ .93 $ .53 $ .35
</TABLE>
The fair value of each grant is estimated on the date of grant using the
Black-Scholes Option Pricing Model with the following weighted-average
assumptions used for grants during the years ended April 30, 1995, 1996 and
1997.
<TABLE>
<CAPTION>
YEARS ENDED APRIL 30,
-------------------------------
1995 1996 1997
--------- --------- ---------
<S> <C> <C> <C>
Dividend yield............................................................ -- -- --
Expected volatility....................................................... 60.31% 57.65% 56.23%
Risk free interest rate................................................... 7.60% 7.23% 6.16%
Option term............................................................... 3 years 5 years 5 years
</TABLE>
The Company granted stock options entitling the holders to purchase 61,250,
386,250 and 296,250 common shares during the fiscal years ended April 30, 1995,
1996 and 1997, respectively. Outstanding stock options to certain directors,
officers, employees, and others entitle the holders to purchase totals of
143,250, 411,250 and 605,625 common shares at prices ranging from $2.40 to
$6.40, $2.40 to $2.92, and $2.22 to $2.92 (Canadian) per share as of April 30,
1995, 1996 and 1997, respectively. These options are exercisable subject to
vesting schedules, and in the case of options granted to others, the achievement
of certain performance targets. The options expire on various dates between
January 1998 and April 2002.
During the years ended April 30, 1996 and 1997, respectively, the Company
recorded compensation expense and an increase in additional paid-in-capital in
the amount of $47,000 and $45,000, respectively, for options granted to
outsiders.
F-50
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. STOCK OPTIONS, WARRANTS, AND OTHER (CONTINUED)
Additional information regarding options granted and outstanding is
summarized below:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER OF OPTION PRICE
OPTIONS (CANADIAN)
----------- ---------------
<S> <C> <C>
Outstanding at April 30, 1994................................................. 153,250 $ 4.49
Granted..................................................................... 61,250 $ 2.73
Canceled/Expired............................................................ (71,250) $ 3.68
-----------
Outstanding at April 30, 1995................................................. 143,250 $ 4.14
Granted..................................................................... 386,250 $ 2.74
Canceled/Expired............................................................ (118,250) $ 4.34
-----------
Outstanding at April 30, 1996................................................. 411,250 $ 2.77
Granted..................................................................... 296,250 $ 2.49
Canceled/Expired............................................................ (101,875) $ 2.75
-----------
Outstanding at April 30, 1997................................................. 605,625 $ 2.64
-----------
Exercisable at April 30, 1997................................................. 438,125 $ 2.65
-----------
</TABLE>
The following table summarizes information about the fixed-price stock
options outstanding at April 30, 1997.
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------- --------------------------
WEIGHTED- WEIGHTED- WEIGHTED-
RANGE OF AVERAGE AVERAGE SHARES AVERAGE
EXERCISE SHARES REMAINING EXERCISE EXERCISABLE EXERCISE
PRICES OUTSTANDING CONTRACTUAL PRICE AT PRICE
(CANADIAN) AT 4/30/97 LIFE (CANADIAN) 4/30/97 (CANADIAN)
- ------------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C>
$2.22 36,250 4.9 years $ 2.22 10,000 $ 2.22
$2.24 75,000 4.6 years $ 2.24 75,000 $ 2.24
$2.40 37,500 3.3 years $ 2.40 37,500 $ 2.40
$2.50 77,500 4.4 years $ 2.50 25,000 $ 2.50
$2.68 50,000 3.9 years $ 2.68 50,000 $ 2.68
$2.76 98,750 4.1 years $ 2.76 10,000 $ 2.76
$2.80 130,625 2.1 years $ 2.80 130,625 $ 2.80
$2.92 100,000 3.6 years $ 2.92 100,000 $ 2.92
----------- -----------
$2.22-$2.92 605,625 3.7 years $ 2.64 438,125 $ 2.65
----------- -----------
</TABLE>
WARRANTS
The Company issued warrants attached to certain shares issued for cash
entitling the holders to purchase an additional 1,205,625, 797,216 and 361,125
common shares during the years ended April 30, 1995, 1996 and 1997,
respectively. Total outstanding warrants entitle the holders to purchase up to
1,475,792, 1,551,949 and 1,757,222 shares as of April 30, 1995, 1996 and 1997,
respectively, at prices
F-51
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. STOCK OPTIONS, WARRANTS, AND OTHER (CONTINUED)
ranging from $2.00 to $6.00, $2.00 to $4.40, and $2.22 to $4.00 (Canadian) per
share for 1995, 1996 and 1997, respectively, exercisable at any time and
expiring on various dates through March 1999.
Pursuant to an agreement, the Company issued additional warrants to certain
warrant holders entitling them to purchase an additional 647,216 common shares
as the Company did not file with various securities regulatory authorities as
defined in the agreement by December 22, 1996. The additional warrants issued
expire in March 1998.
ESCROW SHARES
The Company issued 187,500 common shares to certain shareholders subject to
an escrow agreement dated May 19, 1988 and amended October 21, 1993, concurrent
with its initial public offering on the Vancouver Stock Exchange.
Under the terms of the escrow agreement, shares are to be released from
escrow on the basis of one share for each $1.52 (Canadian) of cumulative cash
flow, as defined by the agreement. Any shares released from escrow and issued to
employees will be treated as compensation. No shares had been released as of
April 30, 1997. In December 1998, any shares not released from escrow will be
canceled.
10. FEDERAL INCOME TAXES
The components of the net deferred tax asset were as follows:
<TABLE>
<CAPTION>
APRIL 30,
----------------------------
1996 1997
------------- -------------
<S> <C> <C>
Deferred tax assets:
Allowance for doubtful accounts........................................... $ 76,000 $ 158,057
Depreciation.............................................................. 23,000 92,943
Net operating loss carryforwards.......................................... 1,669,000 1,813,844
------------- -------------
Gross deferred tax asset................................................ 1,768,000 2,064,844
Deferred tax liability:
Basis difference arising from purchase accounting......................... 279,000 416,433
------------- -------------
Gross deferred tax liability.............................................. 279,000 416,433
------------- -------------
Valuation allowance......................................................... (1,489,000) (1,648,411)
------------- -------------
Net deferred tax asset...................................................... $ -- $ --
------------- -------------
------------- -------------
</TABLE>
F-52
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. FEDERAL INCOME TAXES (CONTINUED)
The following is a reconciliation of the provision for income taxes at the
U.S. federal income tax rate to the income taxes reflected in the consolidated
statements of operations:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED APRIL 30,
-------------------------------------
1995 1996 1997
----------- ----------- -----------
<S> <C> <C> <C>
Income tax benefit at federal statutory rate............................... $ (705,000) $ (565,000) $ (450,920)
Operating losses not benefited............................................. 750,000 407,000 144,610
Nondeductible amortization arising from purchase accounting................ -- 57,000 70,693
Change in valuation reserve and other...................................... (45,000) 101,000 235,617
----------- ----------- -----------
Income tax benefit provided................................................ $ -- $ -- $ --
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The net deferred tax asset is fully reserved because of management's
uncertainty regarding the Company's ability to recognize the benefit of the
asset in future years. A portion of the deferred tax asset at April 30, 1997,
has been recognized as a tax benefit, the result of an extraordinary gain from
debt restructuring. At April 30, 1996 and 1997, the Company had net operating
loss carryforwards of approximately $4,909,511 and $5,334,835, respectively.
Utilization of the net operating loss carryforwards may be limited by the
separate return loss year rules and by ownership changes which have occurred or
could occur in the future.
11. LEASES
The Company leases certain office facilities and equipment under capital
leases and noncancellable operating leases expiring through January 2001. At the
end of the capital lease terms, the Company has the option to purchase the
leased equipment. Minimum annual rentals under these leases are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
YEARS ENDING APRIL 30, LEASES LEASES
- -------------------------------------------------------------------------------- ------------ ----------
<S> <C> <C>
1998............................................................................ $ 374,427 $ 258,884
1999............................................................................ 367,026 251,499
2000............................................................................ 246,305 191,170
2001............................................................................ 17,537 68,700
2002............................................................................ -- --
------------ ----------
Total minimum lease payments.................................................... 1,005,295 $ 770,253
----------
Amounts representing interest................................................... (127,298)
------------
Present value of net minimum lease payments..................................... 877,997
Current portion................................................................. (302,390)
------------
Long-term capitalized lease obligations......................................... $ 575,607
------------
------------
</TABLE>
F-53
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. LEASES (CONTINUED)
Assets recorded under capital leases are included in property and equipment
as follows:
<TABLE>
<CAPTION>
APRIL 30,
-------------------------
1996 1997
----------- ------------
<S> <C> <C>
Communications equipment....................................................... $ 948,733 $ 1,322,695
Office equipment............................................................... 64,106 53,432
----------- ------------
1,012,839 1,376,127
Accumulated amortization....................................................... (202,852) (497,816)
----------- ------------
$ 809,987 $ 878,311
----------- ------------
----------- ------------
</TABLE>
The total rent expense incurred during the years ended April 30, 1995, 1996
and 1997 was $126,660, $186,470 and $300,662, respectively. In addition to
minimum rentals, one lease provides for the Company to pay contingent rentals
based on usage. Contingent rentals under this lease were not significant in
fiscal 1997.
The Company was in default on certain lease obligations totaling $211,110 at
April 30, 1996 due to nonpayment. The Company successfully restructured the
lease agreement and recorded an extraordinary gain during fiscal 1997.
12. RELATED PARTY TRANSACTIONS
The Company has the following obligations to shareholders:
<TABLE>
<CAPTION>
APRIL 30,
--------------------------
1996 1997
------------ ------------
<S> <C> <C>
Convertible debenture with interest imputed at 11% per annum
(Amounts contingent on certain factors discussed in Note 3)
Due February 1997................................................................. $ 838,056 $ --
Due December 1997................................................................. 250,000 250,000
Due July 1998..................................................................... 750,000 750,000
Notes payable
Repayable in four quarterly installments of $250,000 from June 1997 to June 1998,
with interest imputed at 11%. (Amount contingent on certain factors discussed in
Note 3)........................................................................... 1,000,000 725,341
Notes repayable in monthly installment amounts of $9,202 each including interest at 6%
per annum, refinanced in July 1996, due June 1997.................................... 200,000 36,532
Notes repayable in monthly installment amounts of $3,144 each including interest at
12% per annum, refinanced in July 1996, due June 1997................................ 150,000 12,388
Other................................................................................. 36,289 --
------------ ------------
3,224,345 1,774,261
Less: Discount on convertible debentures and note payable
imputed at 11%.................................................................... (456,109) (192,801)
------------ ------------
Total long-term notes payable to shareholders....................................... 2,768,236 1,581,460
Less current maturities:
Long-term debt, net of discount on convertible debenture
imputed at 11% of $80,695 and $51,144, respectively............................. 1,143,650 896,470
------------ ------------
$ 1,624,586 $ 684,990
------------ ------------
------------ ------------
</TABLE>
F-54
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. RELATED PARTY TRANSACTIONS (CONTINUED)
In March 1996, in order to finance the acquisition of AMS, the Company
issued a series of convertible debentures with scheduled maturities through July
1998. The debentures are convertible at the option of the holder into a maximum
of 875,000 shares of the Company's common stock at a conversion rate of .5
shares for each $1 of outstanding debentures.
In February 1997, the holder of the convertible debentures converted
$500,000 of the outstanding debentures into 250,000 shares of the Company's
common stock.
In January 1997, as part of the financing of the acquisition of CTN, the
Company issued a convertible debenture with scheduled maturity in January 1999.
This debenture is convertible at the option of the holder into a maximum of
150,000 shares of the Company's common stock at a conversion rate of 3 shares
for each $10 of the outstanding debenture.
The Company is provided executive office space by another company of which a
Company executive is a director.
Interest of $1,587 and $12,706 was paid to directors of the Company for the
years ended April 30, 1996 and 1997, respectively. No interest was paid to
related parties during 1995.
13. COMMITMENTS AND CONTINGENCIES
The Company has entered into various long-term commitments for the purchase
of network usage. Total payments under these agreements were $1,613,863 and
$8,801,941 for the years ended April 30, 1996 and 1997. The aggregate amount of
minimum purchases of network usage under these various agreements are
$12,450,000 and $12,100,000, for 1998 and 1999, none thereafter, respectively.
The Company is involved in various claims and legal actions arising in the
ordinary course of business. Management believes it is unlikely that the final
outcome of any of the claims or proceedings to which the Company is a party
would have a materially adverse effect on the Company's financial position or
results of operations.
On February 8, 1996, the federal government signed legislation that will,
without limitation, permit the Regional Bell Operating Companies ("RBOC") to
provide domestic and international long distance services upon a finding by the
FCC that the petitioning RBOC has satisfied certain criteria for opening up its
local exchange network to competition and that its provision of long distance
services would further the public interest; removes existing barriers to entry
into local service markets; significantly changes the manner in which
carrier-to-carrier arrangements are regulated at the federal and state level;
establishes procedures to revise universal service standards; and, establishes
penalties for unauthorized switching of customers. The Company cannot predict
the effect such legislation will have on the Company or the industry. However,
the Company believes that it is positioned to take advantage of business
opportunities in the rapidly changing telecommunications market.
14. FINANCING OF OPERATIONS
At April 30, 1997, the Company's current liabilities exceeded its current
assets by $3,184,320 and the Company was experiencing losses from operations.
The financial stability of the Company depends on its ability to raise
additional capital until operations reach a profitable level. The Company's
plans are to
F-55
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. FINANCING OF OPERATIONS (CONTINUED)
continue funding the growth of the Company through additional private
placements, as it has done in the past, and by discounting receivables.
The Company has entered into an agreement with a brokerage firm whereby the
brokerage firm has committed to raise $2-3 million through an equity offering of
the Company's shares on a best efforts basis. Also, on September 3, 1997, the
Company received proceeds of $540,015 in a private placement of the Company's
common stock, which is subject to the approval of the Vancouver Stock Exchange
before the shares can be issued.
15. SUBSEQUENT EVENT
On November 19, 1997, the Company entered into an Agreement and Plan of
Merger (the "Merger") whereby IIWII Corp., a wholly-owned subsidiary of STAR
Telecommunications, Inc. ("STAR"), will be merged with and into the Company.
Under the terms of amendments to the Merger dated January 30, 1998 and April 6,
1998 (the "Amendments"), UDN's stockholders will receive for each share of UDN
Common Stock a portion of a share (the "Exchange Ratio") of STAR Common Stock
determined by dividing $2.05 by the average closing price of STAR Common Stock
on the Nasdaq National Market for the five trading days prior to the Effective
Time (the "Average Price"), provided that if the Average Price is equal to or
greater than $27.50, the Exchange Ratio shall be determined by using $27.50 as
the Average Price. STAR will also assume all outstanding options, warrants, and
other rights to acquire the Company's stock. The Merger is subject to approval
by the stockholders of both companies and certain other conditions, including
the receipt of an opinion that the Merger may be accounted for as a pooling of
interests.
The Amendments to the Merger contain provisions whereby STAR and the Company
executed promissory notes totaling $4.5 million as a financial accommodation to
fund the Company's working capital needs.
F-56
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Consolidated Financial Statements:
Consolidated Balance Sheets as of January 31, 1997 and January 31, 1998.................................. F-58
Consolidated Statements of Operations for the nine months ended January 31, 1997 and January 31, 1998 ... F-59
Consolidated Statements of Shareholders' Equity as of January 31, 1997 and
January 31, 1998....................................................................................... F-60
Consolidated Statements of Cash Flows for the nine months ended January 31, 1997 and January 31, 1998.... F-61
Notes to Consolidated Financial Statements................................................................. F-62
</TABLE>
F-57
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JANUARY 31,
----------------------------
1997 1998
------------- -------------
<S> <C> <C>
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents........................................................ $ 263,178 $ 964,077
Accounts and notes receivable, net of allowance of $375,406 and $2,451,877,
respectively................................................................... 3,584,353 4,381,550
Receivable from employee......................................................... 12,010 --
Prepaid expenses and other....................................................... 433,176 335,655
------------- -------------
Total current assets........................................................... 4,292,717 5,681,282
------------- -------------
Property and equipment, net of accumulated depreciation of $2,705,910 and
$3,211,500, respectively.......................................................... 1,974,026 2,042,779
Intangible assets, net of accumulated amortization of $429,945 and $875,314,
respectively...................................................................... 6,484,063 5,920,447
Other assets....................................................................... 132,201 199,976
------------- -------------
Total assets................................................................... $ 12,883,007 $ 13,844,484
------------- -------------
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Trade accounts payable........................................................... $ 5,054,441 $ 10,224,885
Other accrued liabilities........................................................ 345,724 412,109
Notes and accounts payable to shareholders, net.................................. 1,700,864 957,978
Note payable to STAR Telecommunications, Inc..................................... -- 2,500,000
Current maturities of long-term obligations...................................... 784,057 1,254,615
Accrued taxes, other than income taxes........................................... 640,926 628,945
------------- -------------
Total current liabilities...................................................... 8,526,012 15,978,532
------------- -------------
Long-term obligations.............................................................. 1,424,391 493,325
Long-term obligations to shareholders, net......................................... 913,604 --
Shareholders' equity (deficit):
Common stock $.01 par value, 100,000,000 shares and authorized; 5,250,340 and
6,808,594 issued at January 31, 1997 and 1998, respectively.................... 52,503 68,086
Additional paid-in capital....................................................... 9,958,694 12,617,072
Retained deficit................................................................. (7,992,197) (15,312,531)
------------- -------------
Total shareholders' equity (deficit)........................................... 2,019,000 (2,627,373)
------------- -------------
------------- -------------
Total liabilities and shareholders' equity (deficit)......................... $ 12,883,007 $ 13,844,484
------------- -------------
------------- -------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-58
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED
JANUARY 31,
----------------------------
1997 1998
------------- -------------
(UNAUDITED)
<S> <C> <C>
Telecommunications revenues........................................................ $ 16,774,044 $ 23,941,796
Cost of revenues................................................................. 12,869,586 19,047,419
------------- -------------
Gross profit................................................................... 3,904,458 4,894,377
------------- -------------
Operating expenses:
Selling, general and administrative.............................................. 3,458,440 6,344,242
Provision for doubtful accounts.................................................. 245,055 3,055,433
Depreciation and amortization.................................................... 674,023 783,186
------------- -------------
Total operating expenses....................................................... 4,377,518 10,182,861
------------- -------------
Loss from operations before other expenses......................................... (473,060) (5,288,484)
Other expenses:
Interest expense, net............................................................ (426,762) (699,907)
Other............................................................................ -- (485,186)
------------- -------------
Total other expenses........................................................... (426,762) (1,185,093)
------------- -------------
Loss before income tax benefit and extraordinary gain.............................. (899,822) (6,473,577)
Income tax benefit................................................................. 23,208 --
------------- -------------
Loss before extraordinary gain................................................... (876,614) (6,473,577)
------------- -------------
Extraordinary gain on debt restructuring (net of income taxes of $23,208).......... 45,050 --
------------- -------------
Net loss......................................................................... $ (831,564) $ (6,473,577)
------------- -------------
------------- -------------
Loss per weighted average common shares outstanding (basic and diluted):
Loss before extraordinary gain on debt restructuring............................. $ (.17) $ (.99)
Extraordinary gain............................................................... .01 --
------------- -------------
Net loss per share............................................................... (.16) (0.99)
------------- -------------
------------- -------------
Weighted average number of common shares outstanding (basic and diluted)......... 5,250,340 6,541,734
------------- -------------
------------- -------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-59
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
(UNAUDITED)
--------------------------------------------------------------------
ADDITIONAL
PAID-IN RETAINED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
---------- ---------- ------------- -------------- -------------
<S> <C> <C> <C> <C> <C>
Balance at April 30, 1996................. 5,250,340 $ 52,503 $ 9,913,694 $ (7,160,633) $ 2,805,564
Net loss.................................. -- -- -- (831,564) (831,564)
Compensation expenses..................... -- -- 45,000 -- 45,000
---------- ---------- ------------- -------------- -------------
Balance at January 31, 1997............... 5,250,340 $ 52,503 $ 9,958,694 $ (7,992,197) $ 2,019,000
---------- ---------- ------------- -------------- -------------
---------- ---------- ------------- -------------- -------------
</TABLE>
<TABLE>
<CAPTION>
(UNAUDITED)
--------------------------------------------------------------------
ADDITIONAL
PAID-IN RETAINED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
---------- ---------- ------------- -------------- -------------
<S> <C> <C> <C> <C> <C>
Balance at April 30, 1997................. 6,378,442 $ 63,784 $ 11,863,723 $ (8,838,954) $ 3,088,553
Net loss.................................. -- -- -- (6,473,577) (6,473,577)
Issuance of common stock for:
Private placements...................... 337,152 3,372 586,644 -- 590,016
Exercise of warrants.................... 93,000 930 166,705 -- 167,635
---------- ---------- ------------- -------------- -------------
Balance at January 31, 1998............... 6,808,594 $ 68,086 $ 12,617,072 $ (15,312,531) $ (2,627,373)
---------- ---------- ------------- -------------- -------------
---------- ---------- ------------- -------------- -------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-60
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE NINE MONTHS
ENDED JANAURY 31,
---------------------------
1997 1998
------------ -------------
(UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net loss........................................................................... $ (831,564) $ (6,473,577)
Adjustments to reconcile net loss to net cash used by operating activities:
Depreciation and amortization.................................................... 674,023 783,096
Extraordinary gain on debt restructuring......................................... (68,258) --
Interest amortization of note discounts.......................................... 137,118 148,680
Compensation recognized for stock options........................................ 45,000 --
Other, net....................................................................... 78,795 (3,409)
(Increase) decrease, net of effects of acquisitions:
Accounts and notes receivable.................................................... (47,915) (457,259)
Prepaid expenses and other assets................................................ (381,622) 15,016
Increase (decrease), net of effects of acquisitions:
Accounts and notes payable and accrued expenses.................................. 1,181,076 4,739,294
------------ -------------
Net cash provided by (used in) operating activities.......................... 786,653 (1,248,159)
------------ -------------
Cash flows from investing activities:
Additions to property and equipment................................................ (577,329) (411,787)
Purchase of CTN.................................................................... (350,000) --
Proceeds from notes................................................................ 52,419 59,280
------------ -------------
Net cash used in investing activities........................................ (874,910) (352,507)
Cash flows from financing activities:
Proceeds from issuance of common stock............................................. -- 757,652
Proceeds from issuance of short-term debt.......................................... -- 2,500,000
Principal payments on obligations.................................................. (722,214) (1,249,275)
------------ -------------
Net cash used in provided by financing activities............................ (722,214) 2,008,377
------------ -------------
Increase (Decrease) in cash.......................................................... (810,471) 407,711
Cash at beginning of period.......................................................... 1,073,649 556,366
------------ -------------
Cash at end of period................................................................ $ 263,178 $ 964,077
------------ -------------
------------ -------------
Supplemental disclosure of cash flow information:
Interest paid...................................................................... $ 494,360 $ 669,129
------------ -------------
------------ -------------
</TABLE>
The accompanying notes are integral part of these consolidated financial
statements.
F-61
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
United Digital Network (the "Company"), formerly Unidex Communications
Corp., operates through its principal subsidiaries, United Digital Network of
Texas, Inc. ("DNI"), Advanced Management Services, Inc. (AMS) and Custom Telecom
Network (CTN). In September 1997, the Company formed DNI with the merger of two
wholly-owned subsidiaries, Answer-Net, Inc. and Digital Network, Inc.
The Company's principal business activity is providing basic long distance
services, travelcard service, international long-distance, and various other
telecommunication services to residential and small to medium sized commercial
customers. The principal markets for its long distance services are the central
and southwest United States as well as customers located nationwide in the motor
freight industry.
The Company has suffered recurring losses from operations that raise
substantial doubt about its ability to continue as a going concern. At January
31, 1998, the Company's current liabilities exceeded its current assets by
$10,297,250. The Company is actively pursuing opportunities for a business
combination in order to achieve financial stability. On November 19, 1997, the
Company entered into a merger agreement with STAR Telecommunications, Inc. See
further discussion in Note 4.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries DNI, AMS and CTN. The financial statements and
related footnotes are presented in U.S. dollars, unless otherwise indicated, and
all significant intercompany accounts and transactions are eliminated in
consolidation. The interim financial data as of January 31, 1997 and 1998 and
for the nine month periods then ended is unaudited; however, in the opinion of
the Company, the interim data includes all adjustments, consisting only of
normal recurring adjustments, necessary to present fairly the financial
position, results of operations and cash flows for the interim periods. The
interim consolidated financial statements and the notes thereto should be read
in conjunction with the consolidated financial statements and notes included in
the Company's consolidated financial statements for the year ended April 30,
1997.
LOSS PER SHARE
Loss per share is computed by dividing the net loss by the weighted average
number of shares of common stock outstanding during the periods. The effect of
outstanding options and warrants on the computation of net loss per share is
antidilutive and, therefore, is not included in the computation of loss per
share amounts for the nine month periods ended January 31, 1997 and 1998.
NEW ACCOUNTING STANDARDS
In February 1997, the FASB issued Financial Statement of Accounting
Standards No. 128, "Earnings per Share" ("SFAS 128"). SFAS 128 specifies the
computation, presentation, and disclosure requirements for earnings per share
("EPS") for entities with publicly held common stock or potential common stock.
The Company adopted SFAS 128 in the third quarter of fiscal 1998 and has
restated all prior period EPS amounts pursuant to SFAS 128. SFAS 128 simplifies
the standards for computing EPS previously found in Accounting Principles Board
Opinion No. 15, "Earnings per Share" and makes them comparable to international
EPS standards. It replaces the presentation of primary EPS with a presentation
of basic EPS. It also requires dual presentation of basic and diluted EPS on the
face of the statement of operations for
F-62
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
all entities with complex capital structures and requires a reconciliation of
the numerator and denominator of the basic EPS computation to the numerator and
denominator of the diluted EPS computation.
Basic EPS excludes the effect of potentially dilutive securities while
diluted EPS reflects the potential dilution that would occur if securities or
other contracts to issue common stock were exercised, converted into or resulted
in the issuance of common stock. Common stock equivalents consist of common
stock issuable under the assumed exercise of stock options and warrants,
computed based on the treasury stock method and the assumed conversion of the
Company's issued and outstanding preferred stock. Common stock equivalents are
not included in diluted EPS calculations to the extent their inclusion would
have an anti-dilutive effect.
3. ACCOUNTS RECEIVABLE
During the nine months ended January 31, 1998, bad debt expense of $3.1
million was recorded by the Company. Included in this amount was the write-off
of receivables from two major wholesale customers as a result of the customer's
bankruptcy, and the write-off of $1.3 million receivable resulting from customer
fraud.
4. SUBSEQUENT EVENTS
On November 19, 1997, the Company entered into an Agreement and Plan of
Merger (the "Merger") whereby IIWII Corp., a wholly-owned subsidiary of STAR
Telecommunications, Inc. ("STAR"), will be merged with and into the Company.
Under the terms of amendments to the Merger dated January 30, 1998 and April 6,
1998 (the "Amendments"), UDN's stockholders will receive for each share of UDN
Common Stock a portion of a share (the "Exchange Ratio") of STAR Common Stock
determined by dividing $2.05 by the average closing price of STAR Common Stock
on the Nasdaq National Market for the five trading days prior to the Effective
Time (the "Average Price"), provided that if the Average Price is equal to or
greater than $27.50, the Exchange Ratio shall be determined by using $27.50 as
the Average Price. STAR will also assume all outstanding options, warrants, and
other rights to acquire the Company's stock. The Merger is subject to approval
by the stockholders of both companies and certain other conditions, including
the receipt of an opinion that the Merger may be accounted for as a pooling of
interests.
The Amendments to the Merger contain provisions whereby STAR and the Company
executed promissory notes totaling $4.5 million as a financial accommodation to
fund the Company's working capital needs.
In the third quarter of fiscal 1998, the Company entered into an Agreement
of Compromise, Settlement and Release (the "Agreement") related to disputes
arising under the AMS stock purchase agreement dated March 5, 1996. Under the
Agreement, the convertible debenture in the amount of $750,000 due in July 1998
was reduced to $550,000 as a result of allowable adjustments defined in the
stock purchase agreement.
F-63
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
ANNEX A
AGREEMENT AND PLAN OF MERGER
BY AND AMONG
STAR TELECOMMUNICATIONS, INC.,
IIWII CORP.
AND
UNITED DIGITAL NETWORK, INC.
Dated as of November 19, 1997
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C> <C>
ARTICLE I THE MERGER....................................................................................... A-1
1.1 The Merger...................................................................................... A-1
1.2 Filing.......................................................................................... A-1
1.3 Effective Time of the Merger.................................................................... A-1
1.4 Certificate of Incorporation and By-Laws........................................................ A-1
1.5 Directors and Officers.......................................................................... A-1
1.6 Warrants and Options............................................................................ A-2
ARTICLE II CONVERSION OF AND SURRENDER AND A-2
PAYMENT FOR COMMON STOCK.......................................................................
2.1 Conversion...................................................................................... A-2
2.2 Closing of Transfer Books....................................................................... A-3
2.3 Surrender of Certificates....................................................................... A-3
ARTICLE III CERTAIN EFFECTS OF MERGER...................................................................... A-3
3.1 Effect of Merger................................................................................ A-3
3.2 Further Assurances.............................................................................. A-4
ARTICLE IV REPRESENTATIONS AND WARRANTIES OF THE A-4
ACQUIROR AND NEWCO............................................................................
4.1 Organization.................................................................................... A-4
4.2 Capital Stock................................................................................... A-4
4.3 Authority Relative to Agreement................................................................. A-4
4.4 Acquiror Common Stock........................................................................... A-4
4.5 No Violations or Consents....................................................................... A-4
4.6 Litigation...................................................................................... A-5
4.7 Financial Statements and Reports................................................................ A-5
4.8 Registration Statement; Blue Sky Filings; Proxy Statement; Other Information.................... A-5
4.9 Brokers......................................................................................... A-6
ARTICLE V REPRESENTATIONS AND WARRANTIES OF THE COMPANY.................................................... A-6
5.1 Corporate Organization.......................................................................... A-6
5.2 Capital Stock................................................................................... A-6
5.3 Options, Warrants or Other Rights............................................................... A-6
5.4 Authority Relative to Agreement................................................................. A-6
5.5 No Violations or Consents....................................................................... A-7
5.6 Governmental Authorizations and Regulations..................................................... A-7
5.7 Litigation...................................................................................... A-8
5.8 Financial Statements and Reports; Material Liabilities.......................................... A-8
5.9 Absence of Certain Changes or Events............................................................ A-8
5.10 Benefit Plans................................................................................... A-8
5.11 ERISA........................................................................................... A-9
5.12 Environmental Matters........................................................................... A-10
5.13 Real Estate Leases.............................................................................. A-10
5.14 Title to Properties; Absence of Liens and Encumbrances.......................................... A-10
5.15 Tax Matters..................................................................................... A-11
5.16 Intellectual Property........................................................................... A-12
5.17 Labor Matters................................................................................... A-12
5.18 Insurance....................................................................................... A-12
</TABLE>
i
<PAGE>
<TABLE>
<CAPTION>
PAGE
---------
<S> <C> <C>
5.19 Contracts....................................................................................... A-12
5.20 Registration Statement; Blue Sky Filings; Proxy Statement; Other Information.................... A-13
5.21 Brokers......................................................................................... A-13
5.22 Continuity of Interest.......................................................................... A-13
5.23 Transactions with Affiliated Parties............................................................ A-13
ARTICLE VI COVENANTS AND AGREEMENTS........................................................................ A-13
6.1 Registration Statement; Proxy Statement; Stockholder Meeting; Vancouver Exchange................ A-13
6.2 Conduct of the Business of the Company Prior to the Effective Time.............................. A-14
6.3 Access to Properties and Record; Acquiror Notice................................................ A-16
6.4 Negotiations.................................................................................... A-16
6.5 Indemnification................................................................................. A-16
6.6 Confidentiality................................................................................. A-17
6.7 Reasonable Best Efforts......................................................................... A-17
6.8 Certification of Stockholder Vote............................................................... A-17
6.9 Loan to Company................................................................................. A-17
6.10 Outsourcing Agreement........................................................................... A-18
6.11 Affiliate Agreements............................................................................ A-18
6.12 Proxy Agreement................................................................................. A-18
6.13 Disclosure Schedules............................................................................ A-18
ARTICLE VII CONDITIONS PRECEDENT........................................................................... A-18
7.1 Conditions to Each Party's Obligation to Effect the Merger...................................... A-18
7.2 Conditions to the Obligation of the Company to Effect the Merger................................ A-19
7.3 Conditions to Obligations of the Acquiror and Newco to Effect the Merger........................ A-19
7.4 Closing Conditions Deemed Satisfied............................................................. A-20
ARTICLE VIII TERMINATION, AMENDMENT AND WAIVER............................................................. A-20
8.1 Termination..................................................................................... A-20
8.2 Fees and Expenses............................................................................... A-21
8.3 Amendment....................................................................................... A-21
8.4 Waiver.......................................................................................... A-21
ARTICLE IX MISCELLANEOUS................................................................................... A-22
9.1 Survival........................................................................................ A-22
9.2 Expenses and Fees............................................................................... A-22
9.3 Notices......................................................................................... A-22
9.4 Headings........................................................................................ A-23
9.5 Publicity....................................................................................... A-23
9.6 Entire Agreement; Knowledge..................................................................... A-23
9.7 Assignment...................................................................................... A-23
9.8 Counterparts.................................................................................... A-23
9.9 Invalidity, Etc................................................................................. A-23
9.10 Specific Performance............................................................................ A-23
9.11 Governing Law................................................................................... A-23
</TABLE>
ii
<PAGE>
EXHIBITS
<TABLE>
<CAPTION>
<S> <C>
Exhibit A Certificate of Merger
Exhibit B Promissory Note
Exhibit C Affiliate Agreements
Exhibit D Proxy Agreement
</TABLE>
iii
<PAGE>
ANNEX A
AGREEMENT AND PLAN OF MERGER
AGREEMENT AND PLAN OF MERGER dated as of November 19, 1997 (this
"Agreement"), by and among STAR Telecommunications, Inc., a Delaware corporation
(the "Acquiror"), IIWII Corp., a Delaware corporation and wholly-owned
subsidiary of the Acquiror ("Newco"), and United Digital Network, Inc., a
Delaware corporation (the "Company").
R E C I T A L S:
A. The Boards of Directors of Newco, the Acquiror and the Company deem it
advisable and in the best interests of their respective stockholders to merge
Newco with and into the Company (the "Merger") upon the terms and conditions set
forth herein and in accordance with the General Corporation Law of the State of
Delaware (the "General Corporation Law") (the Company and Newco being
hereinafter sometimes referred to as the "Constituent Corporations" and the
Company, following the effectiveness of the Merger, being hereinafter sometimes
referred to as the "Surviving Corporation"); and
B. The Boards of Directors of the Acquiror, Newco and the Company have
approved the Merger upon the terms and subject to the conditions set forth
herein and, in the case of the Company, on the receipt of a "fairness opinion"
from its financial advisor in form, substance, and scope that is satisfactory to
the Board of Directors of the Company.
A G R E E M E N T
NOW, THEREFORE, in consideration of the mutual representations, warranties,
covenants, agreements and conditions contained herein, and in order to set forth
the terms and conditions of the Merger and the mode of carrying the same into
effect, the parties hereby agree as follows:
ARTICLE I
THE MERGER
1.1 THE MERGER. Upon the terms and conditions hereinafter set forth and in
accordance with the General Corporation Law, at the Effective Time, as defined
below, Newco shall be merged with and into the Company and thereupon the
separate existence of Newco shall cease, and the Company, as the Surviving
Corporation, shall continue to exist under and be governed by the General
Corporation Law.
1.2 FILING. Upon the satisfaction or waiver of the conditions set forth in
Section 7 hereof (other than the condition set forth in Section 7.1(b) which may
not be waived), Newco and the Company will cause a Certificate of Merger, in
substantially the form of EXHIBIT A attached hereto (the "Certificate of
Merger"), to be executed and filed with the Secretary of State of the State of
Delaware as provided in Section 251 of the General Corporation Law.
1.3 EFFECTIVE TIME OF THE MERGER. The Merger shall become effective
immediately upon the filing, in accordance with Section 251 of the General
Corporation Law, of the Certificate of Merger with the Secretary of State of the
State of Delaware in accordance with Section 251. The date and time of such
filing is herein sometimes referred to as the "Effective Time."
1.4 CERTIFICATE OF INCORPORATION AND BY-LAWS. Upon the effectiveness of
the Merger, the Certificate of Incorporation of Newco shall be the certificate
of incorporation of the Surviving Corporation and the By-Laws of Newco as in
effect on the date hereof shall be the By-Laws of the Surviving Corporation.
1.5 DIRECTORS AND OFFICERS. The persons who are directors of Newco
immediately prior to the Effective Time and the officers of the Company shall,
after the Effective Time and in accordance with the
A-1
<PAGE>
Certificate of Merger, serve as the directors and officers, respectively, of the
Surviving Corporation, in each case such directors and officers to serve until
their successors have been duly elected and qualified in accordance with the
Certificate of Incorporation and By-Laws of the Surviving Corporation.
1.6 WARRANTS AND OPTIONS. On the Effective Time, the Acquiror shall assume
the duties and obligations of the Company, and the Acquiror shall be vested with
the powers, rights and privileges of the Company, under (a) the warrants of the
Company that remain outstanding at the Effective Time (the "Warrants") and (b)
the options of the Company that remain outstanding at the Effective Time (the
"Options"), as such warrants and options are listed on Schedule 5.3. As of the
Effective Time, the Acquiror shall have reserved for issuance and continue to
maintain sufficient shares of Acquiror Common Stock, as defined below, to issue
the required shares of Acquiror Common Stock pursuant to the exercise of
Warrants and Options after the Effective Time, subject to appropriate adjustment
in the exercise price thereof, based on the Exchange Ratio, as defined below.
ARTICLE II
CONVERSION OF AND SURRENDER AND PAYMENT FOR COMMON STOCK
2.1 CONVERSION. At the Effective Time, by virtue of the Merger and without
any action on the part of the holders thereof:
(a) Each of the issued and outstanding shares of the Common Stock, $.01
par value, of the Company ("Common Stock"), other than (i) Dissenting Stock,
as defined below, or (ii) shares of Common Stock held in the treasury of the
Company, shall be automatically converted into the right to receive
consideration per share (the "Merger Consideration") consisting of that
portion of a share (the "Exchange Ratio") of the Acquiror's common stock,
$0.001 per share ("Acquiror Common Stock"), determined by dividing $2.75 by
the average closing price of Acquiror's Common Stock on the Nasdaq National
Market for the five (5) trading days prior to the Effective Time (the
"Average Price"), provided that, if the Average Price is equal to or greater
than $32.73, then the Exchange Ratio shall be determined by dividing $3.00
by the Average Price, provided, further, that, if the Average Price is less
than or equal to $26.78, then the Exchange Ratio shall be determined by
dividing $2.50 by the Average Price. The Exchange Ratio shall be adjusted as
may be necessary and appropriate to reflect any and all stock splits,
reverse stock splits, reclassifications and similar capital events that
affect Acquiror Common Stock.
(b) Each issued and outstanding share of the Common Stock of Newco shall
be converted into approximately Seven Thousand Five Hundred Sixty-Four
(7,564) validly issued, fully paid and non-assessable shares of common
stock, $.01 par value (the "New Common Stock"), of the Surviving
Corporation.
(c) All shares of Common Stock which are held by the Company as treasury
shares shall be canceled and retired and cease to exist, without any
conversion thereof or payment with respect thereto.
(d) No fraction of a share of Acquiror Common Stock will be issued in
the Merger, but, in lieu thereof, each holder of Common Stock who would
otherwise be entitled to a fraction of a share of Acquiror Common Stock
(after aggregating all fractional shares of Acquiror Common Stock to be
received by such holder) will be entitled to receive from the Acquiror an
amount of cash (rounded to the nearest whole US $0.01) equal to the product
of (i) such fraction of a share multiplied by (ii) the Average Price.
Notwithstanding any provision of this Agreement to the contrary, shares of
the Common Stock with respect to which appraisal rights have been demanded and
perfected in accordance with Section 262(d) of the General Corporation Law (the
"Dissenting Stock") shall not be converted into the right to receive the Merger
Consideration at or after the Effective Time, and the holder thereof shall be
entitled only to such
A-2
<PAGE>
rights as are granted by the General Corporation Law. Notwithstanding the
preceding sentence, if any holder of shares of Common Stock who demands
appraisal of such shares under the General Corporation Law shall effectively
withdraw his demand for such appraisal (in accordance with Section 262(k) of the
General Corporation Law) or becomes ineligible for such appraisal (through
failure to perfect or otherwise) then, as of the Effective Time or the
occurrence of such event, whichever is the last to occur, such holder's
Dissenting Stock shall cease to be Dissenting Stock and shall be converted into
and represent the right to receive the Merger Consideration, without interest
thereon, as provided in this Section 2.1. The Company shall give Acquiror (i)
prompt notice of any written demands for appraisal, withdrawals of demands for
appraisal and any other instrument served pursuant to Section 262 of the General
Corporation Law received by the Company and (ii) the opportunity to participate
in all negotiations and proceedings with respect to demands for appraisal under
such Section.
2.2 CLOSING OF TRANSFER BOOKS. At the Effective Time, the stock transfer
books of the Company shall be closed, and no transfer of shares of Common Stock
of the Company shall thereafter be made. If, after the Effective Time,
certificates previously representing shares of Common Stock are presented to the
Surviving Corporation or the Exchange Agent, as defined below, such certificates
shall be canceled and exchanged for the Merger Consideration as provided in
Section 2.1, subject to applicable law in the case of Dissenting Stock.
2.3 SURRENDER OF CERTIFICATES. At least five days prior to the mailing of
the Proxy Statement, as defined below, Newco shall, subject to the reasonable
approval of the Company, designate an exchange agent (the "Exchange Agent") to
effect the exchange for Acquiror Common Stock of certificates that, prior to the
Effective Time, represented shares of Common Stock entitled to the Merger
Consideration. As soon as practicable after the Effective Time, the Exchange
Agent shall send a notice and transmittal form to each holder of record of
Common Stock immediately prior to the Effective Time advising such holder of the
effectiveness of the Merger and the procedure for surrendering to the Exchange
Agent (who may appoint forwarding agents with the approval of Newco) the
certificate or certificates to be exchanged pursuant to the Merger. Upon the
surrender for exchange of such a certificate, together with such letter of
transmittal duly completed and properly executed in accordance with instructions
thereto and such other documents as may be required pursuant to such
instructions, the holder shall receive the Merger Consideration. After the
Effective Time, until so surrendered and exchanged, each certificate which
immediately prior to the Effective Time represented outstanding shares of the
Common Stock (other than Dissenting Stock) shall represent solely the right to
receive the Merger Consideration.
ARTICLE III
CERTAIN EFFECTS OF MERGER
3.1 EFFECT OF MERGER. On and after the Effective Time, the Surviving
Corporation shall possess all the rights, privileges, powers and franchises, and
be subject to all the restrictions, disabilities and duties of each of the
Constituent Corporations; and all and singular rights, privileges, powers and
franchises of each of the Constituent Corporations, and all property, real,
personal and mixed, and all debts due to either of the Constituent Corporations
on whatever account, as well for stock subscriptions as all other things in
action or belonging to each of the Constituent Corporations, shall be vested in
the Surviving Corporation; and all property, rights, privileges, powers and
franchises, and all and every other interest shall be thereafter the property of
the Surviving Corporation as they were of the Constituent Corporations, and the
title to any real estate vested by deed or otherwise, in either of the
Constituent Corporations shall not revert or be in any way impaired; but all
rights of creditors and all liens upon any property of either of the Constituent
Corporations shall be preserved unimpaired, and all debts, liabilities and
duties of the Constituent Corporations shall thenceforth attach to and be the
sole responsibility of the Surviving Corporation and may be enforced against the
Surviving Corporation to the same extent as if said debts, liabilities and
duties had been incurred or contracted by it.
A-3
<PAGE>
3.2 FURTHER ASSURANCES. If at any time after the Effective Time the
Surviving Corporation shall consider or be advised that any further deeds,
assignments or assurances in law or any other acts are necessary, desirable or
proper to vest, perfect or confirm, of record or otherwise, in the Surviving
Corporation, the title to any property or right of the Constituent Corporations
acquired or to be acquired by reason of, or as a result of, the Merger, the
Constituent Corporations agree that the Surviving Corporation and its proper
officers and directors shall and will execute and deliver all such deeds,
assignments and assurances in law and do all acts necessary, desirable or proper
to vest, perfect or confirm title to such property or right in the Surviving
Corporation and otherwise to carry out the purposes of this Agreement, and that
the proper officers and directors of the Constituent Corporations and the proper
officers and directors of the Surviving Corporation are fully authorized in the
name of the Constituent Corporations or otherwise to take any and all such
action.
ARTICLE IV
REPRESENTATIONS AND WARRANTIES OF THE ACQUIROR AND NEWCO
The Acquiror and Newco jointly and severally represent and warrant to the
Company as follows:
4.1 ORGANIZATION. Each of Acquiror and Newco is a corporation duly
organized, validly existing and in good standing under the laws of the State of
Delaware, and each has the requisite corporate power and authority to own, lease
and operate its assets and to conduct its business in the manner in which it is
presently conducted.
4.2 CAPITAL STOCK. The authorized capital stock of the Acquiror consists
in its entirety of 50,000,000 shares of Common Stock, $0.001 par value, of
which, as of September 30, 1997, 15,798,254 are issued and outstanding, and
5,000,000 shares of Preferred Stock, $0.001 par value per share, none of which
is issued and outstanding. The authorized capital stock of Newco consists in its
entirety of 1,000 shares of common stock, $.01 par value, all of which are
issued and outstanding. All of the outstanding shares of Newco common stock are
owned beneficially and of record by the Acquiror.
4.3 AUTHORITY RELATIVE TO AGREEMENT. Each of the Acquiror and Newco has
full corporate power and authority to execute and deliver this Agreement and to
consummate the Merger and the other transactions contemplated on its part
hereby. The execution, delivery and performance by each of the Acquiror and
Newco of this Agreement and the consummation of the transactions contemplated
hereby have been duly authorized by all necessary corporate action on the part
of the Acquiror and Newco. This Agreement has been duly executed and delivered
by each of the Acquiror and Newco, and is a legal, valid and binding obligation
of each of the Acquiror and Newco, enforceable against each of the Acquiror and
Newco in accordance with its terms, except to the extent that its enforceability
may be limited by applicable bankruptcy, insolvency, reorganization or other
laws affecting the enforcement of creditors' rights generally or by general
equitable principles.
4.4 ACQUIROR COMMON STOCK. The shares of Acquiror Common Stock to be
issued in connection with the Merger have been duly authorized and, when issued
as contemplated hereby at the Effective Time, will be validly issued, fully paid
and non-assessable, and not subject to any preemptive rights or other rights or
interests of third parties.
4.5 NO VIOLATIONS OR CONSENTS. The execution, delivery and performance of
this Agreement by each of the Acquiror and Newco and the consummation by each of
them of the transactions contemplated hereby, will not (i) violate or conflict
with any provision of any charter or by-laws of the Acquiror or Newco, (ii)
require the consent, waiver, approval, license or authorization of or any filing
by the Acquiror or Newco with any public authority, other than (a) the filing of
a pre-merger notification report under The Hart-Scott-Rodino Antitrust
Improvements Act of 1976, as amended, and the rules and regulations promulgated
thereunder (the "HSR Act"), (b) in connection with or in compliance with the
provisions of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), the Securities Act of 1933, as amended (the "Securities Act"), the
Communications Act of 1934, as amended (the "Communications
A-4
<PAGE>
Act"), the General Corporation Law or the "takeover" or "blue sky" laws of
various states and (c) any other filings and approvals expressly contemplated by
this Agreement, (iii) violate, conflict with or result in a breach of or the
acceleration of any obligation under, or constitute a default (or an event which
with notice or the lapse of time or both would become a default) under, or give
to others any right of termination, amendment, acceleration or cancellation of,
or result in the creation of a lien or other encumbrance on any property or
asset of the Acquiror or Newco pursuant to any provision of any indenture,
mortgage, lien, lease, agreement, instrument, order, judgment or decree to which
the Acquiror or Newco is subject or by which the Acquiror or Newco or any of
their property or assets is bound, or (iv) violate or conflict with any law,
rule, regulation, permit, ordinance or decree applicable to the Acquiror or
Newco or by which any property or asset of either of them is bound or affected
except, in each of the instances set forth in items (i) through (iv) above,
where failure to give such notice, make such filings, or obtain such
authorizations, consents or approvals, or where such violations, conflicts,
breaches or defaults, in the aggregate, would not have an Acquiror Material
Adverse Effect, as defined below.
4.6 LITIGATION. Except as may be disclosed in the Acquiror SEC Filings, as
defined below, there are no suits, arbitrations, actions or proceedings pending
or, to the best of the Acquiror's knowledge, threatened or, to the best of the
Acquiror's knowledge, investigations pending or threatened against the Acquiror
or with respect to any property or asset of it before any court, arbitrator,
administrator or governmental or regulatory authority or body which, in the
aggregate, are likely to have a material adverse effect on the business,
operations or financial condition of the Acquiror (an "Acquiror Material Adverse
Effect").
4.7 FINANCIAL STATEMENTS AND REPORTS. The Acquiror heretofore has
delivered to the Company true and complete copies of (a) its Registration
Statement on Form S-1 dated June 12, 1997, Registration No. 333-21325, and (b)
its Quarterly Reports on Form 10-Q for the quarters ended June 30, 1997 and
September 30, 1997 (collectively,"Acquiror SEC Filings"). As of the respective
times such documents were filed or, as applicable, became effective, the
Acquiror SEC Filings complied as to form and content, in all material respects,
with the requirements of the Securities Act and the Exchange Act, as the case
may be, and the rules and regulations promulgated thereunder, and did not
contain any untrue statement of a material fact or omit to state any material
fact required to be stated therein or necessary to make the statements therein,
in light of the circumstances under which they were made, not misleading. The
financial statements of the Acquiror included in the Acquiror SEC Filings were
prepared in accordance with generally accepted accounting principles ("GAAP")
applied on a consistent basis and (except as may be indicated therein or in the
notes thereto) present fairly the consolidated financial position, results of
operations and cash flows of the Acquiror and its consolidated subsidiaries as
of the dates and for the periods indicated subject, in the case of unaudited
interim consolidated financial statements, to normal recurring year-end
adjustments.
4.8 REGISTRATION STATEMENT; BLUE SKY FILINGS; PROXY STATEMENT; OTHER
INFORMATION. The Registration Statement, as defined below, and the information
supplied or to be supplied in writing by either the Acquiror or Newco for
inclusion in the Proxy Statement, as defined below, and any other documents to
be filed with the Securities and Exchange Commission (the "SEC"), including,
without limitation, the British Columbia Securities Commission ("BCSC"), the
Vancouver Stock Exchange (the "VSE") or any regulatory agency in connection with
the transactions contemplated hereby, will not be, at the respective times such
documents are filed or declared effective by the SEC and on the Effective Time,
and, with respect to the Proxy Statement, when first published, sent or given to
stockholders of the Company, false or misleading with respect to any material
fact, or omit to state any material fact necessary in order to make the
statements therein not misleading or, in the case of the Proxy Statement or any
amendment thereof or supplement thereto, at the time of the special meeting of
the Company's stockholders provided for in Section 6.1, be false or misleading
with respect to any material fact, or omit to state any material fact necessary
to correct any statement in any earlier communication with respect to the
solicitation of any proxy for such meeting. All documents which the Acquiror or
Newco files or is responsible for filing with
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the SEC and any regulatory agency in connection with the Merger (including,
without limitation, the Registration Statement) will comply as to form and
content in all material respects with the provisions of applicable law and
regulations. Notwithstanding the foregoing, the Acquiror and Newco make no
representations or warranties with respect to any information that has been
supplied in writing by the Company or its auditors, attorneys or financial
advisors specifically for use in the Registration Statement or in any other
documents to be filed by the Acquiror with the SEC or any other regulatory
agency in connection with the transactions contemplated hereby.
4.9 BROKERS. Neither the Acquiror nor Newco has paid or become obligated
to pay any fee or commission to any broker, finder, investment banker or other
intermediary in connection with this Agreement, except that the Acquiror has
retained Lehman Brothers as its financial advisor in connection with the
transactions contemplated by this Agreement.
ARTICLE V
REPRESENTATIONS AND WARRANTIES OF THE COMPANY
Except as set forth in the disclosure schedules to be delivered to the
Acquiror by the Company (the "Disclosure Schedules") pursuant to Section 6.13,
the Company represents and warrants to the Acquiror and Newco as follows:
5.1 CORPORATE ORGANIZATION. Each of the Company and each of its
subsidiaries Advanced Management Services, Inc. CTN-- Custom Telecommunications
Network of Arizona, Inc. and United Digital Network of Texas, Inc. (formerly
known as AnswerNet, Inc., which includes, pursuant to a merger, Digital Network,
Inc.) (each a "Subsidiary" and collectively, the "Subsidiaries"), is a
corporation duly organized, validly existing and in good standing under the laws
of its state of incorporation with all requisite corporate power and authority
to own, operate and lease its properties and to carry on its business as it is
now being conducted, and is qualified or licensed to do business and is in good
standing in each jurisdiction in which the failure to be so qualified or
licensed, in the aggregate, would have a material adverse effect on the
financial condition, operations or business of the Company and the Subsidiaries
taken as a whole (a "Company Material Adverse Effect"). The Certificates of
Incorporation and By-Laws of the Company and the Subsidiaries are in full force
and effect. The Company is not in violation of or in default under any provision
of its Certificate of Incorporation or By-Laws. The Subsidiaries are the only
subsidiaries, direct or indirect, of the Company.
5.2 CAPITAL STOCK. The authorized capital stock of the Company consists in
its entirety of 100,000,000 shares of Common Stock, $.01 par value, of which, as
of the date hereof, 7,564,103 are issued and outstanding and none are held in
the Company's treasury. Except as set forth on SCHEDULE 5.2, all of the
outstanding shares of capital stock of each of the Subsidiaries are owned
beneficially and of record by the Company free and clear of all liens, charges,
encumbrances, options, rights of first refusal or limitations or agreements
regarding voting rights of any nature, other than the Proxy Agreement, as
defined below. All of the outstanding shares of capital stock of the Company and
the Subsidiaries have been duly authorized, validly issued and are fully paid
and nonassessable.
5.3 OPTIONS, WARRANTS OR OTHER RIGHTS. Except as set forth on SCHEDULE 5.3
or as contemplated by this Agreement, there is no outstanding right,
subscription, warrant, call, unsatisfied preemptive right, option or other
agreement or arrangement of any kind to purchase or otherwise to receive from
the Company or any Subsidiary any of the outstanding, authorized but unissued,
unauthorized or treasury shares of the capital stock or any other equity
security of the Company or any Subsidiary and there is no outstanding security
of any kind convertible into or exchangeable for such capital stock.
5.4 AUTHORITY RELATIVE TO AGREEMENT. The Company has full corporate power
and authority to execute and deliver this Agreement and to consummate the Merger
and the other transactions contemplated on its part hereby. The execution and
delivery by the Company of this Agreement and the consummation of the
transactions contemplated on its part hereby have been duly authorized by its
Board
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of Directors, and (other than the approval and adoption of this Agreement by the
holders of a majority of the then outstanding shares of Common Stock, as
provided in Section 6.1 hereof, the filing and recordation of appropriate merger
documents as required by the General Corporation Law and the receipt of a
satisfactory fairness opinion from its financial advisor) no other corporate
proceedings on the part of the Company or its stockholders are necessary to
authorize the execution and delivery of this Agreement by the Company or the
consummation of the transactions contemplated on its part hereby. In that
regard, the Company hereby represents that its Board of Directors has (i)
determined that the Merger is fair to and in the best interests of the Company's
stockholders, (ii) approved the Merger and (iii) resolved to recommend in the
Proxy Statement adoption of this Agreement and authorization of the Merger by
the stockholders of the Company, such matters to be subject to the fiduciary
duties of such directors and to the receipt of a satisfactory fairness opinion
from its financial advisor. This Agreement has been duly executed and delivered
by the Company, and constitutes a legal, valid and binding obligation of the
Company, enforceable against the Company in accordance with its terms, except to
the extent that its enforceability may be limited by applicable bankruptcy,
insolvency, reorganization or other laws affecting the enforcement of creditors'
rights generally or by general equitable principles.
5.5 NO VIOLATIONS OR CONSENTS. Except as set forth on SCHEDULE 5.5, the
execution, delivery and performance of this Agreement by the Company and the
consummation by it of the transactions contemplated hereby will not (i) violate
or conflict with any provision of any charter or by-laws of the Company or any
Subsidiary, (ii) require the consent, waiver, approval, license or authorization
of or any filing by the Company or any Subsidiary with any third party or public
authority (other than (a) the filing of a premerger notification report under
the HSR Act, (b) in connection with or in compliance with the provisions of the
Exchange Act, the Securities Act, the General Corporation Law, the
Communications Act or the "takeover" or "blue sky" or "public utility" laws of
various states, and (c) and any other filings and approvals expressly
contemplated by this Agreement, including, without limitation, those with the
BCSC and the VSE), (iii) violate, conflict with or result in a breach of or the
acceleration of any obligation under, or constitute a default (or an event which
with notice or the lapse of time or both would become a default) under, or give
to others any right of termination, amendment, acceleration or cancellation of,
or result in the creation of a lien or other encumbrance on any property or
asset of the Company or any Subsidiary pursuant to any provision of any
indenture, mortgage, lien, lease, agreement, instrument, order, judgment or
decree to which the Company or any Subsidiary is subject or by which the Company
or any Subsidiary or any of their property or assets is bound, or (iv) violate
or conflict with any law, rule, regulation, permit, ordinance, regulation or
decree applicable to the Company or any Subsidiary or by which any property or
asset of either of them is bound or affected except, in each of the instances
set forth in items (i) through (iv) above, where failure to give such notice,
make such filings, or obtain such authorizations, consents or approvals, or
where such violations, conflicts, breaches or defaults, in the aggregate, would
not have a Company Material Adverse Effect.
5.6 GOVERNMENTAL AUTHORIZATIONS AND REGULATIONS. SCHEDULE 5.6 is a true
and complete list of all material governmental licenses, franchises, permits and
other authorizations ("Permits") held by the Company and/or the Subsidiaries.
Such Permits are all governmental licenses, franchises, permits and other
authorizations necessary to the conduct of the business of the Company and the
Subsidiaries, except where the failure to hold such Permits, in the aggregate,
would not have a Company Material Adverse Effect. Such Permits are valid and in
full force and effect and the Company knows of no threatened suspension,
cancellation or invalidation of any such Permit except where any such action
would not result in a Company Material Adverse Effect. Neither the Company nor
any Subsidiary is in conflict with, or is in default or violation of, any law,
rule, regulation, order, judgment, Permit, ordinance, regulation or decree
applicable to the Company or any Subsidiary or by which any property or asset of
either of them is bound or affected, except where such conflicts, defaults or
violations, in the aggregate, would not have a Company Material Adverse Effect.
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5.7 LITIGATION. Except as may be disclosed in the PPM, as defined below,
or on SCHEDULE 5.7, there are no suits, arbitrations, actions or proceedings,
pending or, to the best of the Company's or any Subsidiary's knowledge,
threatened or, to the best of the Company's or any Subsidiary's knowledge,
investigations pending or threatened against the Company or any Subsidiary or
with respect to any property or asset of any of them before any court,
arbitrator, administrator or governmental or regulatory authority or body which,
in the aggregate, are likely to have a Company Material Adverse Effect.
5.8 FINANCIAL STATEMENTS AND REPORTS; MATERIAL LIABILITIES.
(a) The Company has delivered to the Acquiror true and complete copies
of its Confidential Private Placement Memorandum dated October 28, 1997 (the
"PPM") As of the date thereof, the PPM did not contain any untrue statement
of a material fact or omit to state any material fact required to be stated
therein or necessary to make the statements therein, in light of the
circumstances under which they were made, not misleading. The financial
statements in the PPM were prepared in accordance with GAAP applied on a
consistent basis and (except as may be indicated therein or in the notes
thereto) present fairly the consolidated financial position, results of
operations and cash flows of the Company and its consolidated subsidiaries
as of the dates and for the periods indicated subject, in the case of
un-audited interim consolidated financial statements, to normal recurring
year-end adjustments and subject to the "going concern" opinion of the
Company's independent accountants. (The audited consolidated balance sheet
of the Company and the Subsidiaries as of April 30, 1997 included in the PPM
is hereinafter called the "Company Balance Sheet," and April 30, 1997 is
hereinafter called the "Company Balance Sheet Date," and the Company's
balance sheet for the three month period ended July 31, 1997 included in the
PPM is hereafter called the "Interim Balance Sheet").
(b) Except as set forth on SCHEDULE 5.8(b), the Company and its
Subsidiaries, considered as a whole, have no material liabilities or
obligations (whether fixed, accrued, contingent or otherwise) that are not
fully reflected or provided for on, or disclosed in the notes to, the
Company Balance Sheet or the Company Interim Balance Sheet, except for (i)
liabilities in the ordinary course of business that could not be reasonably
expected to have a Company Material Adverse Effect or (ii) liabilities
incurred in the ordinary course of business that are not required by GAAP to
be reflected thereon and which are not material.
5.9 ABSENCE OF CERTAIN CHANGES OR EVENTS. Since the Company Balance Sheet
Date and except as disclosed on SCHEDULE 5.9, the business of the Company and
the Subsidiaries have been conducted in the ordinary course consistent with past
practice, and (i) there has not been any material adverse change in the
financial condition, results of operations, properties, or business of the
Company or any Subsidiary, nor, to the Company's knowledge, has there occurred
any event or development that could be reasonably foreseen to result in a
Company Material Adverse Effect.
5.10 BENEFIT PLANS. Except as disclosed on SCHEDULE 5.10, neither the
Company nor any Subsidiary has outstanding any employment agreement with any
officer or employee of the Company or any Subsidiary or any bonus, incentive
compensation, deferred compensation, profit sharing, stock option, stock bonus,
stock purchase, savings, severance, salary continuation, consulting, retirement
(including health and life insurance benefits provided after retirement) or
pension plan (including Company Employee Benefit Plans as defined in Section
5.11 hereof) or arrangement with or for the benefit of any officer, employee or
other person, or for the benefit of any group of officers, employees or other
persons that provides for payment of more than $100,000 in annual benefits.
Neither the Company nor any Subsidiary has made, or entered into any agreement
to make, any payment that becomes payable as a result of the consummation of
this transaction which would be treated as an "excess parachute payment" as
defined in Section 280G of the Internal Revenue Code of 1986, as amended (the
"IRC"). There are no such agreements, plans or other arrangements entered into
with or provided for any independent contractors with whom the Company or any
Subsidiary has a business relationship.
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5.11 ERISA. Set forth on SCHEDULE 5.10 are all of the employee benefit
plans, as defined in Section 3(3) of the Employee Retirement Income Security Act
of 1974, as amended ("ERISA"), but without regard to whether any such plan is in
fact subject to ERISA, that is sponsored, or is being maintained or contributed
to, by the Company or any Subsidiary that provides for payment of more than
$25,000 in annual benefits (the "Company Employee Benefit Plans"). None of the
Company Employee Benefit Plans are "multiemployer plans" as defined in Section
3(37) of ERISA. The Company has furnished or made available or will promptly
after the date hereof make available to Newco and the Acquiror (a) a true and
complete copy of the plan document and summary plan description for each Company
Employee Benefit Plan, (b) a true and complete copy of the most recently filed
Form 5500 (including the related schedules) with respect to each Company
Employee Benefit Plan for which such form is required to be filed, (c) a true
and complete copy of any trust agreement, insurance contract or other agreement
or arrangement serving as source of funding any benefits payable under any
Company Employee Benefit Plan, and (d) the most recently issued financial
statement and actuarial report, if any, for each Company Employee Benefit Plan.
No "prohibited transactions" (as such term is defined in Section 4975 of the
IRC, or in Part 4 of Subtitle B of Title I of ERISA) have occurred with respect
to any Company Employee Benefit Plan that could result in the imposition of
taxes or penalties that, in the aggregate, could have a Company Material Adverse
Effect. With respect to each of the Company Employee Benefit Plans that is
intended to qualify for favorable income tax treatment under Section 401(a) of
the IRC, (i) the Internal Revenue Service ("IRS") has issued a favorable
determination letter with respect to such plan; (ii) except as set forth on
SCHEDULE 5.10, the Company has furnished Newco and Acquiror with a copy of the
determination letter most recently issued by the IRS with respect to such plan
and the application filed with the IRS for such determination letter; and (iii)
to the best knowledge of the Company, no event has occurred from the date of
each such favorable determination letter that would adversely affect the
tax-qualified status of the plan in question. Each Company Employee Benefit Plan
has been administered in compliance with the applicable requirements of ERISA
and the IRC, and in compliance with all other applicable provisions of law,
except for such noncompliance, if any, that, in the aggregate, would not have a
Company Material Adverse Effect. With respect to each Company Employee Benefit
Plan, neither the Company nor any Subsidiary has incurred liabilities which, in
the aggregate, could have a Company Material Adverse Effect as a result of the
violation of or the failure to comply with any applicable provision of ERISA,
the IRC, any other applicable provision of law, or any provision of such plan.
None of the Company Employee Benefit Plans which is an "employee pension benefit
plan", as that term is defined in Section 3(2) of ERISA (a "Company Employee
Pension Benefit Plan"), has incurred an "accumulated funding deficiency," within
the meaning of Section 302 of ERISA or Section 412 of the IRC which, in the
aggregate, could have a Company Material Adverse Effect. Neither the Company nor
any Subsidiary has failed to make any contribution to, or to make any payment
under, any Company Employee Benefit Plan that it was required to make pursuant
to the terms of the plan or pursuant to applicable law in any amount which, in
the aggregate, could have a Company Material Adverse Effect. To the best
knowledge of the Company, no "reportable events," with respect to which a notice
must be filed with the Pension Benefit Guaranty Corporation ("PBGC"), has
occurred with respect to any Company Employee Pension Benefit Plan subject to
Title IV of the ERISA which events, in the aggregate, could have a Company
Material Adverse Effect. No proceedings by the PBGC to terminate any Company
Employee Pension Benefit Plan pursuant to Subtitle C of Title IV of ERISA have
to the best of the Company's knowledge, been instituted or threatened which, in
the aggregate, could have a Company Material Adverse Effect. Except for any
liabilities in an amount which, in the aggregate, would not have a Company
Material Adverse Effect, neither the Company nor any Subsidiary (1) has incurred
any liability to the PBGC in connection with any Company Employee Pension
Benefit Plan, including any liability under Section 4069 of ERISA and any
penalty imposed under Section 4071 of ERISA, (2) has terminated any Company
Employee Pension Benefit Plan, or ceased operations at any facility or withdrawn
from any Company Employee Pension Benefit Plan, in a manner that could subject
it to liability or any liens under Section 4062, 4063, 4064 or 4068 of ERISA or
(3) has any knowledge as to the existence of any state of facts, or as to the
occurrence of any transactions, that might reasonably be anticipated to result
in any
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liability of the Company or any Subsidiary to the PBGC under any other provision
of Title IV of ERISA. There is no pending or, to the best knowledge of the
Company, threatened legal action, proceeding or investigation against or
involving any Company Employee Benefit Plan which could result in liabilities to
the Plan, the Company or any Subsidiary that, in the aggregate, could have a
Company Material Adverse Effect. Except as disclosed on SCHEDULE 5.10, the
present value of accrued benefits of each Company Employee Benefit Plan that is
a defined benefit plan as defined in Section 3(35) of ERISA does not exceed the
value of the assets of such plan available to pay such benefits by an amount
that, in the aggregate for all such plans, could have a Company Material Adverse
Effect. All representations made by the Company in this Section 5.11 are
likewise true with respect to each Subsidiary.
5.12 ENVIRONMENTAL MATTERS. "Company Real Properties" shall mean all real
property now or previously owned, operated or leased by the Company, any
Subsidiary or any predecessor-in-interest. Except as set forth on SCHEDULE 5.12:
(i) the Company, each of the Subsidiaries, and to the best of the Company's
knowledge, each of the Company Real Properties is in compliance with, and has no
liability under any or all applicable Environmental Laws, except where the
failure to comply or such liability would not have a Company Material Adverse
Effect; (ii) none of the Company, any Subsidiary or any of the Company Real
Properties has been alleged in writing by any governmental agency or third party
to be in violation of, to be liable under, or to be subject to any
administrative or judicial proceeding pursuant to, any Environmental Law, the
violation of which would have a Company Material Adverse Effect; and (iii) to
the best knowledge of the Company and each Subsidiary, there are no facts or
circumstances which could reasonably form the basis for the assertion of any
claims against the Company or any Subsidiary relating to environmental matters
which, in the aggregate, would have a Company Material Adverse Effect. As used
herein, Environmental Law means any federal, state, or local law, statute, rule
or regulation, or the common law governing or relating to the environment or to
occupational health and safety.
5.13 REAL ESTATE LEASES. SCHEDULE 5.13 sets forth a complete and accurate
list, a copy of which has been delivered to the Acquiror of (i) all leases and
subleases under which the Company or any Subsidiary is lessor or lessee of any
real property, together with all amendments, supplements, nondisturbance
agreements and other agreements pertaining thereto; (ii) all material options
held by the Company or any Subsidiary or contractual obligations on the part of
the Company or any Subsidiary to purchase or acquire any interest in real
property; and (iii) all options granted by the Company or any Subsidiary or
contractual obligations on the part of the Company or any Subsidiary to sell or
dispose of any material interest in real property (except for sale-leaseback
transactions) in each such instance in items (i) through (iii) above, which
provides for a payment of more than $25,000. Such leases, subleases and other
agreements are in full force and constitute binding obligations of the Company
and, to the best of its knowledge, the other parties thereto, and (i) there are
no defaults thereunder by the Company or any Subsidiary or, to the best of
Company's knowledge, by any other party thereto; and (ii) no event has occurred
which (with notice, lapse of time or both or occurrence of any other event)
would constitute a default by the Company or any Subsidiary or, to the best of
the Company's knowledge, by any other party thereto, other than defaults or
events which, in the aggregate, would not have a Company Material Adverse
Effect. The Company or a Subsidiary has good, valid and insurable leasehold
title to all such leased property, free and clear of all encumbrances, liens,
charges or other restrictions of any kind or character, except for Permitted
Liens, as defined below.
5.14 TITLE TO PROPERTIES; ABSENCE OF LIENS AND ENCUMBRANCES. SCHEDULE 5.14
lists all real property owned by the Company or any Subsidiary as of the date of
this Agreement. The Company and/or a Subsidiary has good, valid and insurable
title in fee simple to all of the real property listed on SCHEDULE 5.14, free
and clear of all encumbrances, liens, charges or other restrictions of any
character whatsoever, except for (i) statutory liens for current taxes or
assessments not due or delinquent or the validity of which is being contested in
good faith, (ii) mechanics, workers, repairmen's and other similar liens arising
or incurred in the ordinary course of business, (iii) such other liens,
imperfections in title,
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charges, easements, restrictions and other encumbrances, if any, which in the
aggregate do not have a Company Material Adverse Effect, and (iv) except as set
forth on SCHEDULE 5.14 (collectively "Permitted Liens"). Except for leased
assets, the Company and the Subsidiaries have good and insurable title to all of
their material tangible personal property used in their businesses, including,
without limitation, those reflected in the Company Balance Sheet (other than
assets disposed of in the ordinary course of business since the Company Balance
Sheet Date), free and clear of all liens, charges, pledges, security interests
or other encumbrances, except liens for taxes not yet due and payable and such
liens or other imperfections of title of the type and nature described as
"Permitted Liens" above to the extent applicable, if any, as would not, in the
aggregate, have a Company Material Adverse Effect on the operation of the
business of the Company or any Subsidiary, and except as reflected or disclosed
in the Company Balance Sheet, or on SCHEDULE 5.14.
5.15 TAX MATTERS. Except as set forth on SCHEDULE 5.15, the Company has
paid, or the Company Balance Sheet contains adequate provision for, all federal,
state, local, foreign or other governmental income, franchise, payroll,
F.I.C.A., unemployment, withholding, real property, personal property, sales,
payroll, disability and all other taxes imposed on the Company or any Subsidiary
or with respect to any of their respective properties, or otherwise payable by
them, including interest and penalties, if any, in respect thereof
(collectively, "Company Taxes"), for the Company taxable period ended on the
date of the Company Balance Sheet and all fiscal periods of the Company prior
thereto, except such nonpayment, or failure to make adequate provision, which,
in the aggregate, would not have a Company Material Adverse Effect. Company
Taxes paid and/or incurred from the date of the Company Balance Sheet until the
Effective Time include only Company Taxes incurred in the ordinary course of
business determined in the same manner as in the taxable period ending on the
date of the Company Balance Sheet. Except as disclosed on SCHEDULE 5.15, the
Company and its Subsidiary have timely filed all income tax, excise tax, sales
tax, use tax, gross receipts tax, franchise tax, employment and payroll related
tax, property tax, and all other tax returns which the Company and/or each
Subsidiary (as the case may be) are required to file ("Tax Returns"), and have
paid or provided for all the amounts shown to be due thereon, except where such
failure to make such timely filings, in the aggregate, would not have a Company
Material Adverse Effect, and except for the nonpayment of such amounts which, in
the aggregate, would not have a Company Material Adverse Effect. Except as set
forth on SCHEDULE 5.15, (i) neither the Company nor any Subsidiary has filed or
entered into, or is otherwise bound by, any election, consent or extension
agreement that extends any applicable statute of limitations with respect to
taxable periods of the Company, (ii) the Company is not a party to any
contractual obligation requiring the indemnification or reimbursement of any
person with respect to the payment of any Tax, (iii) no claim has ever been made
or threatened by an authority in a jurisdiction where the Company or any
Subsidiary do not file Tax Returns that they are or may be subject to Taxes by
that jurisdiction, except for any such claims as, in the aggregate, would not
have a Company Material Adverse Effect, (iv) no issues have been raised by the
relevant taxing authorities on audit that are of a recurring nature and that
would have an effect upon the Taxes of the Company or any Subsidiary, except for
any issue which, in the aggregate, would not have a Company Material Adverse
Effect. Except as set forth on SCHEDULE 5.15, to the best of the Company's and
each Subsidiary's knowledge, no action or proceeding is pending or threatened by
any governmental authority for any audit, examination, deficiency, assessment or
collection from the Company or any Subsidiary of any Company Taxes, no
unresolved claim for any deficiency, assessment or collection of any Company
Taxes has been asserted against the Company or any Subsidiary, and all resolved
assessments of Company Taxes have been paid or are reflected in the Company
Balance Sheet, except for any of the foregoing which, in the aggregate, would
not have a Company Material Adverse Effect.
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5.16 INTELLECTUAL PROPERTY. SCHEDULE 5.16 lists all the registered
patents, trademarks, service marks, copyrights, trade names and applications for
any of the foregoing owned by the Company or any Subsidiary as of the date of
this Agreement (the "Registered Intellectual Property"). The Company and/or the
Subsidiaries have good title to the Registered Intellectual Property and have
good title to, or valid licenses or rights to use, all patents, copyrights,
trademarks, trade names, brand names, proprietary and other technical
information, technology and software (collectively "Intellectual Property")
which are used in the operation of their businesses as presently conducted,
except for such title, license or use imperfections as, in the aggregate, would
not have a Company Material Adverse Effect. There are no claims or proceedings
pending or, to the Company's and each Subsidiary's knowledge, threatened against
the Company or any Subsidiary asserting that the Company or any Subsidiary is
infringing or engaging in the unauthorized use of any Intellectual Property of
any other person or entity, except such claims or proceedings which, in the
aggregate, would not have a Company Material Adverse Effect.
5.17 LABOR MATTERS. Neither the Company nor any Subsidiary is a party to
any collective bargaining agreement with respect to any of their employees. None
of the employees of the Company or any Subsidiary are represented by any labor
union and, as of the date hereof, neither the Company nor any Subsidiary has any
knowledge of any union organizational efforts involving the Company's employees
during the past five years. Except as set forth on SCHEDULE 5.17, neither the
Company nor any Subsidiary has received written notice of any claim, or has
knowledge of any facts which are likely to give rise to any claim, that they
have not complied in any respect with any laws relating to the employment of
labor, including, without limitation, any provisions thereof relating to wages,
hours, collective bargaining, the payment of social security and similar taxes,
equal employment opportunity, employment discrimination or employment safety,
except such claims which, in the aggregate, would not have a Company Material
Adverse Effect.
5.18 INSURANCE. SCHEDULE 5.18 lists, as of the date of this Agreement, all
material policies of fire, products liability, general liability, vehicle,
worker's compensation, directors' and officers' liability, title and other
insurance owned or held by or covering the Company or any Subsidiary or any of
their property or assets which are material to the business of the Company and
any Subsidiary, taken as a whole. As of the date hereof, all of such policies
are in full force and effect, except as to matters or defaults which, in the
aggregate, would not have a Company Material Adverse Effect, and no written
notice of cancellation or termination has been received with respect to any such
policy which has not been replaced or cannot be replaced on substantially
similar terms prior to the date of such cancellation or termination.
5.19 CONTRACTS. SCHEDULE 5.19 contains a complete and correct list of all
material agreements, contracts and commitments (collectively, the "Contracts"),
(a) to which the Company is a party or by which it is bound, or (b) by which any
of the assets, properties or the business is bound, and in either case, which
constitute (i) mortgages, indentures, security agreements, and other agreements
and instruments relating to the borrowing of money by or from, or any extension
or credit to or from, the Company; (ii) sales agency or marketing agreements;
(iii) agreements or commitments for capital expenditures; (iv) brokerage or
finder's agreements; (v) partnership, joint venture or other arrangements or
agreements involving a sharing of profits or expenses; (vi) contracts or
commitments to sell, lease or otherwise dispose of any assets, properties or
business other than in the ordinary course of business; (vii) contracts or
commitments limiting the freedom of the Company to compete in any line of
business or in any geographic area or with any person, and any nondisclosure or
nonsolicitation agreements which limit the Company; (viii) any other agreements,
contracts and commitments material to the business, operations or financial
condition of the Company in each instance under items (i) through (viii) above
which Contract relates to an aggregate amount of more than $75,000. All of the
Contracts are valid and in full force and effect and the Company has performed
all of its obligations under each Contract and no default, violation or breach
by the Company or, to the Company's knowledge, any other party, under any
Contract has occurred which affects the enforceability of such Contract or any
party's rights thereunder, except for such defaults, violations and breaches
which would not, in the aggregate, have a Company Material Adverse Effect.
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5.20 REGISTRATION STATEMENT; BLUE SKY FILINGS; PROXY STATEMENT; OTHER
INFORMATION. The Proxy Statement and the information supplied or to be supplied
in writing by the Company for inclusion in the Registration Statement and any
other documents to be filed with the SEC, the BCSC, the VSE or any other
regulatory agency in connection with the transactions contemplated hereby will,
at the respective times such documents are filed, or, as applicable, declared
effective, and on the Effective Time, and, with respect to the Proxy Statement,
when first published, sent or given to stockholders of the Company, be false or
misleading with respect to any material fact, or omit to state any material fact
necessary in order to make the statements therein not misleading or, in the case
of the Proxy Statement or any amendment thereof or supplement thereto, at the
time of the special meeting of the Company's stockholders provided for in
Section 6.1, be false or misleading with respect to any material fact, or omit
to state any material fact necessary to correct any statement in any earlier
communication with respect to the solicitation of any proxy for such meeting.
If, at any time prior to the Effective Time, any event relating to the Company
or any of its affiliates, officers or directors is discovered by the Company
that should be set forth in an amendment to the Registration Statement or a
supplement to the Proxy Statement, the Company will promptly inform the
Acquiror, and such amendment or supplement will be promptly filed with the VSE
and disseminated to the stockholders of the Company, to the extent required by
applicable securities laws. All documents which the Company files or is
responsible for filing with the VSE and any other regulatory agency in
connection with the Merger (including, without limitation, the Proxy Statement)
will comply as to form and content in all material respects with the provisions
of applicable law. Notwithstanding the foregoing, neither the Company nor the
Subsidiary make any representations or warranties with respect to any
information that has been supplied in writing by the Acquiror or Newco, or their
auditors, attorneys, financial advisors, specifically for use in the Proxy
Statement, or in any other documents to be filed with the VSE or any other
regulatory agency in connection with the transactions contemplated hereby.
5.21 BROKERS. Except as set forth in Schedule 5.21, neither the Company
nor any Subsidiary has paid or become obligated to pay any fee or commission to
any broker, finder, investment banker or other intermediary in connection with
this Agreement.
5.22 CONTINUITY OF INTEREST. The Company has caused each person who is an
affiliate, as defined in Rule 12b-2 under the Exchange Act (an "Affiliate"), to
deliver to the Acquiror and each Affiliate has, concurrently with the signing of
this Agreement, signed an affiliate agreement in the form attached hereto as
EXHIBIT C (an "Affiliate Agreement") providing, among other things, that such
person has no plan or intention and will not sell, pledge, transfer or otherwise
dispose of shares of Acquiror Common Stock or in any way reduce their risk
relative to any such shares, until such time as financial results covering at
least 30 days of combined operations of the Acquiror and the Company have been
published within the meaning of Section 201.01 of the Codification of Financial
Reporting Policies of the SEC and except in compliance with the applicable
provisions of the Securities Act, and the rules and regulations thereunder.
5.23 TRANSACTIONS WITH AFFILIATED PARTIES. SCHEDULE 5.23 sets forth a true
and complete list and description of all transactions engaged in between the
Company and any director, officer, employee, stockholder, partner or agent of
the Company, or any of their respective spouses or children, any trust of which
any such person is the grantor, trustee or beneficiary, any corporation of which
any such person or party is a stockholder, employee, officer or director, or any
partnership or other person in which any such person or party owns an interest
(all such persons, trusts, corporations and partnerships being herein referred
to collectively as "Affiliated Parties" and individually as an "Affiliated
Party"). No Affiliated Party is a party to any agreement, contract or commitment
with the Company except as set forth in SCHEDULE 5.24.
ARTICLE VI
COVENANTS AND AGREEMENTS
6.1 REGISTRATION STATEMENT; PROXY STATEMENT; STOCKHOLDER MEETING; VANCOUVER
EXCHANGE.
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(a) As promptly as practicable after the execution of this Agreement,
the Acquiror and Newco will file with the SEC a registration statement on
Form S-4 (as amended or supplemented, the "Registration Statement") relating
to the registration under the Securities Act of the Acquiror Common Stock to
be received in the Merger, and file with state securities administrators
such registration statements or other documents as may be required under
applicable blue sky laws to qualify or register such Acquiror Common Stock
in such states as are designated by the Company (the "Blue Sky Filings").
The Acquiror and Newco will use their reasonable best efforts to cause the
Registration Statement to become effective as soon as practicable. In the
process of its preparation of the Registration Statement, the Acquiror will
provide the Company and its advisors drafts of the Registration Statement
and will provide the Company and its advisors a reasonable opportunity to
participate in such drafting process. The Acquiror will notify the Company
promptly of the receipt of any comments from the SEC or its staff or from
any state securities administrators and of any request by the SEC or its
staff or by any state securities administrators for amendments or
supplements to the Registration Statement or any Blue Sky Filings or for
additional information, and will supply the Company and its legal counsel
with copies of all correspondence between the Acquiror or any of its
representatives, on the one hand, and the SEC, its staff or any state
securities administrators, on the other hand, with respect to the
Registration Statement.
(b) As promptly as practicable following the execution of this
Agreement, and after receipt by the Company of a fairness opinion from its
financial advisor, the Company agrees that this Agreement shall be submitted
at a meeting (the "Meeting") of its stockholders duly called and held
pursuant to Section 251(c) of the General Corporation Law. As soon as
practicable after the date of this Agreement, the Company shall take all
action, to the extent necessary in accordance with applicable law, its
Certificate of Incorporation and By-Laws, to convene a meeting of its
stockholders promptly to consider and vote upon the approval of the Merger,
and the Company shall prepare and file with the VSE, subject to the prior
approval of the Acquiror, which approval the Acquiror shall not unreasonably
withhold, such information as may be necessary to allow the VSE to approve
the merger (the "VSE Approval"), preliminary and final versions of a proxy
statement and proxy and other filings relating to the Meeting as required by
the VSE and the applicable regulations thereof. The term "Proxy Statement"
shall mean such proxy statement at the time it initially is mailed to
stockholders and all duly filed amendments or revisions made thereto, if
any, similarly mailed. Notice of the Meeting shall be mailed to the
Company's stockholders of the Company along with the Proxy Statement. The
Company will notify the Acquiror promptly of the receipt of any comments
from the VSE with respect to the Proxy Statement and will supply the
Acquiror and its legal counsel with copies of all correspondence from or to
the VSE and any other applicable regulatory authority. The Company, after
consultation with the Acquiror and its legal counsel, shall respond promptly
to any comments made by the VSE with respect to the VSE Approval and the
Proxy Statement and cause the Proxy Statement and proxy to be mailed to its
stockholders at the earliest practicable time following the execution
hereof.
6.2 CONDUCT OF THE BUSINESS OF THE COMPANY PRIOR TO THE EFFECTIVE
TIME. Except as set forth on SCHEDULE 6.2, the Company agrees that prior to the
Effective Time, except as otherwise consented to or approved in writing by the
Acquiror or expressly permitted by this Agreement:
(a) the business of the Company and the Subsidiaries shall be conducted
only in the ordinary course and consistent with past practice;
(b) each of the Company and each Subsidiary shall not (i) amend its
Certificate of Incorporation or By-Laws, (ii) change the number of
authorized, issued or outstanding shares of its capital stock, except upon
the exercise of stock options or warrants outstanding on the date hereof,
(iii) declare, set aside or pay any dividend or other distribution or
payment in cash, stock or property in respect of shares of its capital
stock, (iv) make any direct or indirect redemption, retirement, purchase or
other acquisition of any of its capital stock (except for repurchases of
Common Stock from employees
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pursuant to existing stock subscription agreements between the Company and
certain of its employees) or (v) split, combine or reclassify its
outstanding shares of capital stock;
(c) neither the Company nor any Subsidiary shall, directly or
indirectly, (i) issue, grant, sell or pledge or agree or propose to issue,
grant, sell or pledge any shares of, or rights of any kind to acquire any
shares of the capital stock of the Company or any Subsidiary, except that
the Company may issue shares of Common Stock upon the exercise of stock
options or warrants outstanding on the date hereof, (ii) other than in the
ordinary course of business and consistent with past practice and other than
with respect to the Promissory Note, incur any material indebtedness for
borrowed money, except material indebtedness for borrowed money incurred
under credit facilities existing as of the date hereof, (iii) waive,
release, grant or transfer any rights of material value, except in the
ordinary course of business consistent with past practices or (iv) transfer,
lease, license, sell, mortgage, pledge, dispose of or encumber any material
assets of the Company or any Subsidiary other than in the ordinary course of
business and consistent with past practice;
(d) the Company and the Subsidiaries shall use their reasonable
commercial efforts to preserve intact the business organization of the
Company and the Subsidiaries, to keep available the services of its
operating personnel and to preserve the goodwill of those having business
relationships with each of them, including, without limitation, suppliers
and customers;
(e) neither the Company nor any Subsidiary will, directly or indirectly,
(i) increase the compensation payable or to become payable by it to any of
its employees, officers or directors, except in accordance with employment
agreements, welfare and benefit plans set forth on SCHEDULE 5.10, and
except, with respect to employees who are not directors or officers, for
increases in the ordinary course of business, consistent with past practice,
(ii) adopt additional, or make any payment or provision, other than as
required by existing plans or agreements, including provisions and actions
under existing stock option plans in connection with the Merger, in the
ordinary course of business and consistent with prior practice, with respect
to any stock option, bonus, profit sharing, pension, retirement, deferred
compensation, employment or other payment or employee compensation plan,
agreement or arrangement for the benefit of employees of the Company or any
Subsidiary, (iii) grant any stock options or stock appreciation rights or
issue any warrants, (iv) enter into or amend any employment or severance
agreement or arrangement or (v) make any loan or advance to, or enter into
any written contract, lease or commitment with, any officer or director of
the Company or its Subsidiary;
(f) neither the Company nor any Subsidiary shall, directly or
indirectly, assume, guarantee, endorse or otherwise become responsible for
the obligations of any other individual, firm or corporation other than a
Subsidiary or make any loans or advances to any individual, firm or
corporation except in the ordinary course of its business and consistent
with past practices;
(g) neither the Company nor any Subsidiary shall make any investment of
a capital nature either by purchase of stock or securities, contributions to
capital, property transfers, acquisition or financing of equipment or
otherwise, or other than in the ordinary course of business, by the purchase
of any property or assets of any other individual, firm or corporation;
(h) neither the Company nor any Subsidiary shall enter into modify or
amend in any material respect or take any action to terminate their
respective material contracts, except in the ordinary course of business;
(i) neither the Company nor any Subsidiary shall take any action, other
than reasonable and usual actions in the ordinary course of business and
consistent with past practice, with respect to accounting policies or
procedures, except for changes required by GAAP;
(j) neither the Company nor any Subsidiary shall, without the consent of
the Acquiror, settle or compromise any material federal, state, local or
foreign income tax proceeding or audit;
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(k) the Company and the Subsidiaries will promptly advise the Acquiror
in writing of any Company Material Adverse Effect or any breach of the
Company's representations or warranties, or any material breach of a
covenant contained herein of which the Company or any Subsidiary has
knowledge; and
(l) neither the Company nor any Subsidiary shall enter into an agreement
to do any of the things described in clauses (a) through (k).
6.3 ACCESS TO PROPERTIES AND RECORD; ACQUIROR NOTICE. The Company and the
Subsidiaries shall afford to the Acquiror and Newco and their respective
accountants, counsel and representatives, reasonable access during normal
business hours throughout the period prior to the Effective Time to all of their
properties, books, contracts, commitments and written records (including, but
not limited to, tax returns for the preceding six years), and shall make
reasonably available their officers and employees to answer fully and promptly
questions put to them thereby; provided that no investigation pursuant to this
Section 6.3 shall alter any representation or warranties of any party hereto or
conditions to the obligation of the parties hereto; provided, further, that such
access shall not unreasonably interfere with the normal business operations of
any of the parties hereto. In connection with the preparation of its fairness
opinion, the Company's financial advisor shall be provided with the reasonable
level of access to the Acquiror and its books and records that may be necessary
with respect thereto. The Acquiror will provide the Company written notice of
any Acquiror Material Adverse Effect.
6.4 NEGOTIATIONS. Following the execution of this Agreement by the
Company, neither the Company nor any Subsidiary, nor the directors, officers,
attorneys, financial advisors, or other authorized persons of any of them,
shall, directly or indirectly, solicit, initiate or participate in discussions
or negotiations with or the submission of any offer or proposal by or provide
any information to, any corporation, partnership, person, or other entity or
group (other than Newco or the Acquiror or any officer or other authorized
representative of Newco or the Acquiror) concerning any Third Party Transaction,
as defined below, or, except as provided in Section 8.1(b) or as may be
consistent with fiduciary responsibilities under applicable law as advised in
writing by outside counsel, participate in any negotiation regarding any Third
Party Transaction or otherwise cooperate in any way with any effort or attempt
by any other person to effectuate a Third Party Transaction. Notwithstanding the
foregoing, the Board of Directors of the Company may furnish such information to
or enter into discussions and/or negotiations with any corporation, partnership,
person or other entity or group that makes an unsolicited offer to engage in a
Third Party Transaction with the Company that the Board of Directors of the
Company in good faith determines, with the assistance of its financial advisor,
may represent a transaction more favorable to the Company's stockholders when
compared to the Merger and the Merger Consideration if, and only to the extent
that, the Board determines after consultation with outside legal counsel that
the failure to take such action would be inconsistent with the compliance by the
Board of Directors with its fiduciary duties to the stockholders of the Company
under applicable law, provided that such party shall enter into a
confidentiality agreement on substantially the terms contained in Section 6.6 of
this Agreement, the Company shall notify the Acquiror as to the contents of
information being provided and the Company shall diligently enforce its rights
under such confidentiality agreement. The Company represents and warrants that
the Company is not currently involved in discussions or negotiations with any
third party with respect to a Third Party Transaction. The Company will promptly
communicate to the Acquiror the identity of any potential third party purchaser
making any such proposal or contact and, prior to the execution of any agreement
relating to any such Third Party Transaction, shall also communicate the
proposed terms and conditions thereof. The Company agrees not to release any
third party from, or waive any provision of, any confidentiality or standstill
agreement to which the Company is a party.
6.5 INDEMNIFICATION. The Acquiror agrees that all provisions with respect
to indemnification by the Company and the Subsidiaries or with respect to
liability to the Company or any Subsidiary now existing in favor of any present
or former director, officer, employee or agent (and their respective heirs and
assigns) of the Company or any Subsidiary, respectively (the "Indemnified
Parties"), as set forth in their respective
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Certificates of Incorporation, as amended, or By-Laws or pursuant to other
agreements in effect on the date hereof, shall survive the Merger, shall not be
amended, repealed or modified and shall continue in full force and effect for a
period of at least six years from the Effective Time.
6.6 CONFIDENTIALITY.
(a) Subject to applicable law and to subpoena, the Acquiror and Newco
will hold, and will cause each of their affiliates, employees, officers,
directors and other representatives to hold, in strict confidence, and to
not use to the detriment of the Company or the Subsidiaries, any information
or data concerning the Company or the Subsidiaries furnished to them in
connection with the transactions contemplated by this Agreement, except for
information or data generally known or available to the public; and if the
transactions contemplated by this Agreement are not consummated, such
confidence shall be maintained and the Acquiror and Newco will return to the
Company or the Subsidiaries all such information and data as the Company or
the Subsidiaries may request.
(b) Subject to applicable law and to subpoena, each of the Company and
the Subsidiaries will hold, and will cause each of the Company's and each
Subsidiary's employees, officers, directors and other representatives to
hold, in strict confidence, and to not use to the detriment of the Acquiror
or Newco, any information or data concerning the Acquiror or Newco furnished
to them in connection with the transactions contemplated by this Agreement,
except for information or data generally known or available to the public;
and if the transactions contemplated by this Agreement are not consummated,
such confidence shall be maintained and the Company and the Subsidiaries
will return to the Acquiror or Newco all such information and data as the
Acquiror or Newco may request.
6.7 REASONABLE BEST EFFORTS. Subject to the terms and conditions hereof
and the fiduciary obligations of the directors of the Company, each of the
parties hereto agrees to use their reasonable best efforts to take, or cause to
be taken, all action and to do, or cause to be done, all things necessary to
satisfy the conditions set forth herein as soon as practicable, including,
without limitation, reasonable best efforts necessary to list on the Nasdaq
National Market the shares of the Acquiror Common Stock issuable pursuant to the
Merger or thereafter, reasonable best efforts necessary to have removed or
rescinded any temporary, preliminary or permanent injunction, including the
injunctions or other orders described in Section 7.1(c), and reasonable best
efforts necessary to defend against any and all litigation, including the
proceedings described in Section 7.1(f) brought against either of the parties
hereto. The Acquiror and the Company each agree to take, or cause to be taken,
all action, and to do, or cause to be done, all things necessary or required by
the United States Federal Trade Commission or the United States Department of
Justice in connection with the expiration or termination of the waiting period
under the HSR Act; provided that neither party will be required to take any
action or to do anything in connection with the foregoing which would materially
impair the Acquiror's or the Surviving Corporation's ownership or operation of
all or a material portion of the business and assets of the Company and its
Subsidiary taken as a whole, or compel the Acquiror to dispose of all or a
material portion of the business or assets of the Acquiror and its subsidiaries,
taken as a whole. No party hereto will take any action for the purpose of
delaying, impairing or impeding the receipt of any required consent,
authorization, order or approval or the making of any required filing or
registration.
6.8 CERTIFICATION OF STOCKHOLDER VOTE. At or prior to the closing of the
transactions contemplated by this Agreement, the Company shall deliver to
Acquiror a certificate of the Company's Secretary setting forth (i) the number
of shares of Common Stock voted in favor of adoption of this Agreement and
consummation of the Merger and the number of shares of Common Stock voted
against adoption of this Agreement and consummation of the Merger; and (ii) the
number of shares of Dissenting Stock.
6.9 LOAN TO COMPANY. On the execution of this Agreement, the Acquiror
shall loan to the Company $2.5 million pursuant to the terms and conditions set
forth in that certain promissory note attached hereto as Exhibit B (the
"Promissory Note").
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6.10 OUTSOURCING AGREEMENT. The Company and the Acquiror shall use
reasonable efforts to negotiate the terms and conditions of and enter into a
billing outsourcing agreement, which shall provide, among other things, for the
management by Acquiror of the Company's customer billings and which shall be on
terms at least as favorable as the terms of the Company's present outsourcing
agreement.
6.11 AFFILIATE AGREEMENTS. To ensure that the Merger is accounted for as a
"pooling of interests," the Company will deliver to Newco from such affiliates
of the Company as deemed necessary by the Acquiror's independent auditors a
written agreement in the form attached hereto as Exhibit C (the "Affiliate
Agreements") relating to the disposition of the shares of the Acquiror's Common
Stock received thereby in the Merger.
6.12 PROXY AGREEMENT. On the execution of this Agreement, John R. Snedegar
shall deliver to the Acquiror a proxy agreement substantially in the form
attached hereto as Exhibit D (the "Proxy Agreement").
6.13 DISCLOSURE SCHEDULES. The Company shall use its reasonable best
efforts to deliver the Disclosure Schedules to the Acquiror promptly following
the execution of this Agreement.
ARTICLE VII
CONDITIONS PRECEDENT
7.1 CONDITIONS TO EACH PARTY'S OBLIGATION TO EFFECT THE MERGER. The
respective obligations of each party to effect the Merger shall be subject to
the fulfillment at or prior to the Effective Time of the following conditions:
(a) The Registration Statement shall have been declared effective, and
no stop order suspending the effectiveness of the Registration Statement
shall have been issued by the SEC or shall be continuing to be in effect,
and no proceedings for that purpose shall have been initiated or threatened
by the SEC.
(b) This Agreement and the Merger contemplated hereby shall have been
approved and adopted by the requisite vote of the holders of the outstanding
shares of Common Stock of the Company entitled to vote thereon at the
Meeting.
(c) No United States, Canadian or state governmental authority or other
agency or commission or United States, Canadian or state court of competent
jurisdiction shall have enacted, issued, promulgated, enforced or entered
any statute, rule, regulation, injunction or other order (whether temporary,
preliminary or permanent) which is in effect and has the effect of making
the acquisition of Common Stock by Newco illegal or otherwise prohibiting
consummation of the transactions contemplated by this Agreement.
(d) Any waiting period applicable to the Merger under the HSR Act shall
have expired or been terminated.
(e) All filings with the FCC required under the Communications Act and
with state agencies under state public utility statutes, if necessary, shall
have been made.
(f) The shares of Acquiror Common Stock issuable in the Merger or
thereafter shall have been authorized for listing on the Nasdaq National
Market, upon official notice of issuance.
(g) There shall not have been instituted or pending any action or
proceeding by or before any court or governmental authority or other
regulatory or administrative agency or commission, domestic or foreign, by
any government or governmental authority, nor shall there be any
determination by any government, governmental authority, regulatory or
administrative agency or commission which, in either case, would require
either party to take any action or do anything in connection with the
foregoing which would result in a material adverse effect to their
respective businesses or materially impair Acquiror's or the Surviving
Corporation's ownership or operation of all or a material portion of the
business or assets of the Company and the Subsidiary, taken as a whole, or
compel Acquiror to
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dispose of all or a material portion of the business or assets of Acquiror
and the Subsidiaries, taken as a whole.
7.2 CONDITIONS TO THE OBLIGATION OF THE COMPANY TO EFFECT THE MERGER. The
obligation of the Company to effect the Merger shall be subject to the
fulfillment at or prior to the Effective Time of the following additional
conditions:
(a) Each of the Acquiror and Newco shall have performed in all material
respects its obligations under this Agreement required to be performed by it
on or prior to the Effective Time pursuant to the terms hereof.
(b) All representations or warranties of the Acquiror and Newco in this
Agreement which are qualified with respect to an Acquiror Material Adverse
Effect or materiality shall be true and correct, and all such
representations or warranties that are not so qualified shall be true and
correct in all material respects, in each case as if such representation or
warranty was made as of the Effective Time, except to the extent that any
such representation or warranty is made as of a specified date, in which
case such representation or warranty shall have been true and correct as of
such specified date.
(c) Since the date of this Agreement, there shall not have been any
material adverse change in the financial condition, results of operations,
properties or business of the Acquiror and its Subsidiaries, taken as a
whole, excluding any such change caused by a general change in the economy
or in the telecommunications industry served by the Acquiror and its
Subsidiaries.
(d) Each of the Acquiror and Newco shall have delivered a certificate of
its President or Vice President to the effect set forth in paragraphs (a),
(b) and (c) of this Section 7.2.
(e) The Company shall have received from Riordan & McKinzie, counsel to
the Acquiror and Newco, an opinion dated the Effective Time in the form
reasonably agreed to by the parties hereto.
(f) The Company shall have received the opinion of its financial
advisors that the Merger and other transactions contemplated by this
Agreement are fair, from a financial point of view, to the stockholders of
the Company.
7.3 CONDITIONS TO OBLIGATIONS OF THE ACQUIROR AND NEWCO TO EFFECT THE
MERGER. The obligations of Acquiror and Newco to effect the Merger shall be
subject to the fulfillment at or prior to the Effective Time of the following
additional conditions:
(a) Each of the Company and its Subsidiaries shall have performed in all
material respects each of its obligations under this Agreement required to
be performed by it on or prior to the Effective Time pursuant to the terms
hereof.
(b) All representations or warranties of the Company in this Agreement
which are qualified with respect to a Company Material Adverse Effect or
materiality shall be true and correct, and all such representations or
warranties that are not so qualified shall be true and correct in all
material respects, in each case as if such representation or warranty were
made as of the Effective Time except to the extent that any such
representation or warranty is made as of a specified date, in which case
such representation or warranty shall have been true and correct as of such
specified date.
(c) Since the date of this Agreement, there shall not have been any
material adverse change in the financial condition, results of operations,
properties or business of the Company and its Subsidiaries, taken as a
whole, excluding any such change caused by a general change in the economy
or in the telecommunications industry served by the Company and its
Subsidiaries and other than any such change approved by the Acquiror.
(d) The Company shall have delivered a certificate of its President or
Vice President to the effect set forth in paragraphs (a), (b) and (c) to
this Section 7.3.
(e) Newco shall have received letters of resignation addressed to the
Company from those members of the Company's board of directors as listed on
SCHEDULE 7.3(e), which resignations shall be effective as of the Effective
Time.
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(f) The Acquiror shall have received from Parker Chapin Flattau &
Klimpl, LLP, counsel to the Company, an opinion dated the Effective Time in
the form reasonably agreed to by the parties hereto.
(g) Holders of no more than 5% of the outstanding shares of Common Stock
shall not have caused such shares to become Dissenting Stock.
(h) Newco shall have received executed Affiliate Agreements from
designated Company affiliates.
(i) The Acquiror shall have received letters (i) from Arthur Andersen
LLP approving the accounting treatment of the Merger as a "pooling of
interests" and (ii) from Price Waterhouse LLP that the Company has taken no
action in the past two years that would prevent the application of a
"pooling of interests" accounting treatment to the Merger, and the SEC shall
not have objected to such accounting treatment.
7.4 CLOSING CONDITIONS DEEMED SATISFIED. If the Meeting has been completed
and has resulted in a vote sufficient to approve the Merger in accordance with
applicable law, and if all other conditions precedent to the consummation of the
Merger contained in this Article VII (other than the conditions set forth in
Sections 7.1(c) and (d)) have been satisfied or have otherwise been waived as of
the date of such Meeting, such conditions precedent to the consummation of the
Merger (except as provided in the next succeeding sentence) shall terminate, and
the parties to this Agreement agree to consummate the Merger as soon as
practicable thereafter; provided, however, that in no event shall any party be
required to consummate the Merger or any other transactions contemplated by this
Agreement to the extent that such consummation would violate any applicable laws
or regulations. In such event, the Acquiror, on the one hand, and the Company,
on the other hand, shall cooperate to deliver, as soon as practicable after the
satisfaction or waiver of such conditions precedent, the officer's certificates
and opinions required of the Acquiror by Section 7.2(d) and 7.2(f), and required
of the Company by Section 7.3(d) and 7.3(f), respectively, and, upon the
Effective Time, the Acquiror shall deliver the certificate required of the
Exchange Agent by Section 7.2(e) and the Company will deliver to Newco the
letters of resignation required by Section 7.3(e).
ARTICLE VIII
TERMINATION, AMENDMENT AND WAIVER
8.1 TERMINATION. This Agreement may be terminated and the Merger
contemplated herein may be abandoned at any time prior to the Effective Time and
before approval by the stockholders of the Company:
(a) by the mutual consent of Newco and the Company;
(b) by Newco or the Company, if (i) the Board of Directors of the
Company shall have failed to recommend, or withdrawn, modified or amended in
any respect its approval or recommendation of the Merger and of the
transactions contemplated hereby or the Board of Directors of the Company
shall have resolved to do any of the foregoing or (ii) the stockholders
shall have failed to vote in favor of this Agreement and the Merger and, in
the case of the Company seeking termination pursuant to Section 8.1(b)(i),
the Company having paid to Newco the Termination Fee, as defined below, in
accordance with the terms of Section 8.2.
(c) by Newco if (i) there has occurred a material adverse change in the
financial condition, operations, or business of the Company and its
Subsidiaries taken as a whole, or (ii) there is a breach of any of the
representations and warranties of the Company which are qualified with
respect to a Company Material Adverse Effect or materiality or if the
Company shall have breached in any material respect any of such
representations or warranties which are not so qualified, or if the Company
fails to comply in any material respect with any of its covenants or
agreements contained herein, which breaches or failures, as the case may be,
are, in the aggregate, material in the context of the transactions
contemplated by this Agreement;
A-20
<PAGE>
(d) by the Company (i) if there has occurred a material adverse change
in the financial condition, operations, or business of the Acquiror or (ii)
there is a breach of any of the representations and warranties of the
Acquiror or Newco which are qualified with respect to an Acquiror Material
Adverse Effect or materiality or if the Acquiror or Newco shall have
breached in any material respect any of such representations or warranties
which are not so qualified, or if the Acquiror or Newco fails to comply in
any material respect with any of its covenants or agreements contained
herein, which breaches or failures, as the case may be, are, in the
aggregate, material in the context of the transactions contemplated by this
Agreement; and
(e) by either Newco or the Company, if on or before May 1, 1998 the
Merger shall not have been consummated; provided that neither party may
terminate under this Section 8.1(e) if such failure has been caused by that
party's material breach of this Agreement; provided further that if any
condition to this Agreement shall fail to be satisfied by reason of the
existence of an injunction or order of any court or governmental or
regulatory body resulting from an action or proceeding commenced by any
party which is not a government or governmental authority, then at the
request of either party the deadline date referred to above shall be
extended for a reasonable period of time, not in excess of 120 days, to
permit the parties to have such injunction vacated or order reversed.
(f) by the Acquiror by the later to occur of December 3, 1997, or the
date that is three business days after delivery by the Company of the final
version of the Disclosure Schedules.
(g) by the Company if it has not satisfied the condition set forth in
Section 7.2 (f).
In the event of such termination and abandonment, no party hereto (or any of
its directors or officers) shall have any liability or further obligation to any
other party to this Agreement except as provided in Section 8.2, and except that
nothing herein will relieve any party from liability for any wilful breach of
this Agreement prior to such termination or abandonment.
8.2 FEES AND EXPENSES. If this Agreement is terminated by Newco or the
Company pursuant to Section 8.1(b)(i), (a) after receipt of a bona fide proposal
to acquire (by means of a tender or exchange offer, merger, consolidation,
business combination or otherwise) all or a substantial portion of the
outstanding shares of Common Stock or of the assets of the Company and the
Subsidiaries (all such transactions being referred to herein as "Third Party
Transactions"), or (b) prior to the satisfaction of the condition set forth in
Section 7.2(f), then the Company shall, simultaneously with such termination,
pay to Newco by wire transfer of immediately available funds, $2,000,000.00 (the
"Termination Fee").
8.3 AMENDMENT. Subject to the applicable provisions of the General
Corporation Law, this Agreement may be amended by the parties hereto solely by
action taken by their respective Boards of Directors. This Agreement may not be
amended except by an instrument in writing signed on behalf of each of the
parties hereto.
8.4 WAIVER. At any time prior to the Effective Time, the parties hereto,
by action taken by their respective Boards of Directors, may (i) extend the time
for the performance of any of the obligations or other acts of the other parties
hereto, (ii) waive any inaccuracies in the representations and warranties of the
other party contained herein or in any documents delivered pursuant hereto, and
(iii) waive compliance by the other party with any of the agreements or
conditions herein. Any agreement on the part of a party hereto to any such
extension or waiver shall be valid only if set forth in an instrument in writing
signed on behalf of such party.
A-21
<PAGE>
ARTICLE IX
MISCELLANEOUS
9.1 SURVIVAL. All representations, warranties and agreements contained in
this Agreement or in any instrument delivered pursuant to this Agreement shall
terminate and be extinguished at the Effective Time or the earlier date of
termination of this Agreement pursuant to Section 8.1, as the case may be,
except that the agreements set forth in Article I and in Sections 6.5, 6.6, 6.7,
6.9, 6.10 and 9.5 will survive the Effective Time indefinitely and those set
forth in Sections 8.2 and 9.5 will survive the termination of this Agreement
indefinitely, and other than any covenant the breach of which has resulted in
the termination of this Agreement.
9.2 EXPENSES AND FEES. If the Merger is consummated, all reasonable fees
and expenses incurred in connection with the Merger and the transactions
contemplated thereby will be paid by the Surviving Corporation. If the Merger is
not consummated, each party hereto shall, subject to the provision of Section
8.2 above, bear their respective fees and expenses.
9.3 NOTICES. All notices and other communications given or made pursuant
hereto shall be in writing and shall be deemed to have been given or made if in
writing and delivered personally or sent by registered or certified mail
(postage prepaid, return receipt requested) or by telecopier to the parties at
the following addresses and facsimile numbers:
(a) if to Newco or the Acquiror to:
STAR Telecommunications, Inc.
223 E. De La Guerra St.
Santa Barbara, CA 93101
Attention: Chris Edgecomb
Fax: (805) 884-1137
with copies to:
Riordan & McKinzie
300 South Grand Avenue, Ste. 2900
Los Angeles, CA 90071
Attention: Timothy F. Sylvester, Esq.
Fax: (213) 229-8550
(b) if to the Company, to:
United Digital Network, Inc.
18872 MacArthur Blvd., Suite 300
Irvine, CA 92612
Attention: John R. Snedegar
Fax: (714) 833-8679
with copies to:
Parker Chapin Flattau & Klimpl, LLP
1211 Avenue of the Americas
New York, NY 10036
Attention: Martin E. Weisberg, Esq.
Fax: (212) 704-6288
or at such other addresses as shall be furnished by the parties by like notice,
and such notice or communication shall be deemed to have been given or made as
of the date so delivered or mailed or confirmation of transmission.
A-22
<PAGE>
9.4 HEADINGS. The headings contained in this Agreement are inserted for
convenience only and do not constitute a part of this Agreement.
9.5 PUBLICITY. The parties hereto shall not, and shall cause their
affiliates not to, issue or cause the publication of any press release or other
announcement with respect to the Merger or this Agreement without consulting
with all other parties and their respective counsel and without delivering a
draft of any such press release to such parties.
9.6 ENTIRE AGREEMENT; KNOWLEDGE. This Agreement constitutes the entire
agreement among the parties and supersedes all other prior agreements and
understandings, both written and oral, among the parties, or any of them, with
respect to the subject matter hereof. For purposes of this Agreement,
"knowledge" of any party shall mean the knowledge of the executive officers of
that party after such officers shall have made all reasonable inquiries.
9.7 ASSIGNMENT. This Agreement and all of the provisions hereof shall be
binding upon and inure to the benefits of the parties hereto and their
respective successors and permitted assigns. Neither this Agreement nor any of
the rights, interests or obligations shall be assigned by any of the parties
hereto without the prior written consent of the other parties, provided that
Newco's rights and duties hereunder may be assigned to a wholly owned subsidiary
of the Acquiror, which assumes all of Newco's duties and obligations. This
Agreement is not intended to confer upon any other person any rights or remedies
hereunder.
9.8 COUNTERPARTS. This Agreement may be executed in one or more
counterparts, all of which shall be considered one and the same agreement and
each of which shall be deemed an original.
9.9 INVALIDITY, ETC. In the event that any provision of this Agreement
shall be deemed contrary to law or invalid or unenforceable in any respect by a
court of competent jurisdiction, the remaining provisions shall remain in full
force and effect to the extent that such provisions can still reasonably be
given effect in accordance with the intentions of the parties, and the invalid
and unenforceable provisions shall be deemed, without further action on the part
of the parties, modified, amended and limited solely to the extent necessary to
render the same valid and enforceable.
9.10 SPECIFIC PERFORMANCE. Each of the parties hereto acknowledges and
agrees that the other parties hereto would be irreparably damaged in the event
any of the provisions of this Agreement were not performed in accordance with
their specific terms or were otherwise breached. Accordingly, each of the
parties hereto agrees that they each shall be entitled to an injunction or
injunctions to prevent breaches of the provisions of this Agreement and to
enforce specifically this Agreement and the terms and conditions hereof in any
action instituted in any court of the United States or any state having
competent jurisdiction, in addition to any other remedy to which such party may
be entitled, at law or in equity.
9.11 GOVERNING LAW. The validity and interpretation of this Agreement
shall be governed by the laws of the State of Delaware, without reference to the
conflict of laws principles thereof.
[THE REMAINDER OF THIS PAGE IS INTENTIONALLY LEFT BLANK]
A-23
<PAGE>
IN WITNESS WHEREOF, the Acquiror, Newco and the Company have caused this
Agreement to be signed by their respective officers thereunto duly authorized,
all as of the date first written above.
<TABLE>
<S> <C> <C>
ACQUIROR: STAR TELECOMMUNICATIONS, INC.
By: /s/ CHRIS EDGECOMB
-----------------------------------------
Chris Edgecomb
CHIEF EXECUTIVE OFFICER
</TABLE>
<TABLE>
<S> <C> <C>
NEWCO: IIWII CORP.
By: /s/ KELLY ENOS
-----------------------------------------
Kelly Enos
CHIEF FINANCIAL OFFICER
</TABLE>
<TABLE>
<S> <C> <C>
COMPANY: UNITED DIGITAL NETWORK, INC.
By: /s/ JOHN R. SNEDEGAR
-----------------------------------------
John R. Snedegar
CHIEF EXECUTIVE OFFICER
</TABLE>
A-24
<PAGE>
FIRST AMENDMENT TO AGREEMENT AND PLAN OF MERGER
FIRST AMENDMENT TO AGREEMENT AND PLAN OF MERGER dated as of January 30, 1998
(this "Amendment"), by and among STAR Telecommunications, Inc., a Delaware
corporation (the "Acquiror"), IIWII Corp., a Delaware corporation and
wholly-owned subsidiary of the Acquiror ("Newco"), and United Digital Network,
Inc., a Delaware corporation (the "Company").
R E C I T A L S:
A. The parties to this Amendment entered into that certain Agreement and
Plan of Merger dated as of November 19, 1997 (the "Merger Agreement"), which set
forth the terms and conditions pursuant to which the Merger would be
consummated.
B. The parties to this Amendment hereby wish to amend the Merger Agreement
on the terms set forth below.
C. Capitalized terms not otherwise defined herein shall have the meanings
therefor in the Merger Agreement.
A G R E E M E N T
NOW, THEREFORE, in consideration of the mutual representations, warranties,
covenants, agreements and conditions contained herein, and in order to set forth
the terms and conditions of the Merger and the mode of carrying the same into
effect, the parties hereby agree as follows:
ARTICLE I
THE MERGER
1. CONVERSION. Section 2.1(a) of the Agreement shall be deleted in its
entirety and replaced with the following:
(a) Each of the issued and outstanding shares of the Common Stock, $.01
par value, of the Company ("Common Stock"), other than (i) Dissenting Stock,
as defined below, or (ii) shares of Common Stock held in the treasury of the
Company, shall be automatically converted into the right to receive
consideration per share (the "Merger Consideration") consisting of that
portion of a share (the "Exchange Ratio") of the Acquiror's common stock,
$0.001 per share ("Acquiror Common Stock"), determined by dividing US$2.05
by the average closing price of Acquiror's Common Stock on the Nasdaq
National Market for the five (5) trading days prior to the Effective Time
(the "Average Price").
2. SECOND LOAN TO COMPANY. Promptly following the execution of this
Amendment, the Acquiror shall loan to the Company $2 million pursuant to the
terms and conditions set forth in that certain promissory note attached hereto
as Exhibit B-1. Following the receipt of such funds, the Company shall
immediately apply at least $700,000 to balances due by the Company to the
Acquiror.
3. WAIVER OF SECTION 8.1(F). STAR hereby waives Section 8.1(f) of the
Merger Agreement. In that regard, the Acquiror acknowledges that, subject to
Sections 6.2(k) and 7.3(b) of the Merger Agreement, it has completed its due
diligence investigation of the Company.
4. NO FURTHER AMENDMENT. Except as otherwise set forth in this Amendment,
the Merger Agreement shall remain in full force and effect without further
amendment, modification or alteration.
A-25
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be
signed by their respective officers thereunto duly authorized, all as of the
date first written above.
<TABLE>
<S> <C> <C>
ACQUIROR: STAR TELECOMMUNICATIONS, INC.
By: /s/ KELLY ENOS
-----------------------------------------
Kelly Enos
CHIEF EXECUTIVE OFFICER
</TABLE>
<TABLE>
<S> <C> <C>
NEWCO: IIWII CORP.
By: /s/ KELLY ENOS
-----------------------------------------
Kelly Enos
CHIEF FINANCIAL OFFICER
</TABLE>
<TABLE>
<S> <C> <C>
COMPANY: UNITED DIGITAL NETWORK, INC.
By: /s/ JOHN R. SNEDEGAR
-----------------------------------------
John R. Snedegar
CHIEF EXECUTIVE OFFICER
</TABLE>
A-26
<PAGE>
SECOND AMENDMENT TO AGREEMENT AND PLAN OF MERGER
SECOND AMENDMENT TO AGREEMENT AND PLAN OF MERGER dated as of April 6, 1998
(this "Second Amendment"), by and among STAR Telecommunications, Inc., a
Delaware corporation (the "Acquiror"), IIWII Corp., a Delaware corporation and
wholly-owned subsidiary of the Acquiror ("Newco"), and United Digital Network,
Inc., a Delaware corporation (the "Company").
R E C I T A L S:
A. The parties to this Second Amendment entered into that certain Agreement
and Plan of Merger dated as of November 19, 1997, as amended to date (the
"Merger Agreement"), which set forth the terms and conditions pursuant to which
the Merger would be consummated.
B. The parties to this Second Amendment hereby wish to amend the Merger
Agreement on the terms set forth below.
C. Capitalized terms not otherwise defined herein shall have the meanings
therefor in the Merger Agreement.
A G R E E M E N T
NOW, THEREFORE, in consideration of the mutual representations, warranties,
covenants, agreements and conditions contained herein, and in order to set forth
the terms and conditions of the Merger and the mode of carrying the same into
effect, the parties hereby agree as follows:
1. CONVERSION. Section 2.1(a) of the Agreement shall be deleted in its
entirety and replaced with the following:
"(a) Each of the issued and outstanding shares of the Common Stock,
$.01 par value, of the Company ("Common Stock"), other than (i) Dissenting
Stock, as defined below, or (ii) shares of Common Stock held in the treasury
of the Company, shall be automatically converted into the right to receive
consideration per share (the "Merger Consideration") consisting of that
portion of a share (the "Exchange Ratio") of the Acquiror's Common Stock,
$0.001 par value per share ("Acquiror Common Stock"), determined by dividing
US$2.05 by the average closing price of Acquiror's Common Stock on the
Nasdaq National Market for the five (5) trading days prior to the Effective
Time (the "Average Price"), provided that, if the Average Price is equal to
or greater than $27.50, the Exchange Ratio shall be determined by using
$27.50 as the Average Price."
2. COVENANTS AND AGREEMENTS. The following Section should be added to
"Article VI Covenants and Agreements," as follows:
"6.14 REGULATORY APPROVALS.
(a) The Company agrees to utilize all reasonable efforts and to
cooperate with Acquiror in every way as may be necessary, reasonable or
advisable to consummate and make effective the transactions contemplated by
this Agreement and will use all reasonable efforts to assist Acquiror in
obtaining all Regulatory Approvals, waivers, permits, consents, other
approvals, authorizations and clearances and to effect all registrations,
filings and notices with or to third parties or governmental, regulatory or
public bodies or authorities which are, in the reasonable opinion of
Acquiror, necessary or desirable in connection with the transactions
contemplated by this Agreement. Until such time as the Regulatory Approvals
have been obtained, there shall be no change in the ownership or management
of the Company and no transfer of control whatsoever over the Company's
certificates of public convenience and necessity and daily operations.
Pending receipt of the Regulatory Approvals, the Company, its current
shareholders, officers, directors and employees shall remain directly and
solely responsible for the operation of the Company's telecommunications
services and for compliance with all applicable provisions of federal
telecommunications law, state public service commission laws and all
applicable
A-27
<PAGE>
regulations and policies thereunder. Further, pending receipt of the
Regulatory Approvals, the Company, its current shareholders, officers,
directors and employees shall manage and operate the Company's
telecommunications services in a manner that is fully consistent with the
terms and conditions of the Company's certificates of public convenience and
necessity, the public interest and the best interest of the Company's
shareholders. As used herein, "Regulatory Approvals" shall mean all
necessary regulatory approvals from the FCC and from any and all state
public service commissions required for the transfer of ownership or control
over the Company.
(b) Acquiror agrees to use its reasonable efforts to take, as promptly
as possible, or cause to be taken, all action and do, or cause to be done,
all things necessary, proper or advisable to consummate and make effective
the transactions contemplated by this Agreement, and Acquiror specifically
agrees to use all reasonable efforts to obtain all Regulatory Approvals,
waivers, permits, consents, other approvals, authorizations and clearances
and to effect all registrations, filings and notices with or to third
parties or governmental, regulatory or public bodies or authorities which
are, in the reasonable opinion of Acquiror, necessary or desirable in
connection with the transactions contemplated by this Agreement. Until such
time as the Regulatory Approvals have been obtained, there shall be no
change in the ownership or management of the Company and no transfer of
control whatsoever over the Company's certificates of public convenience and
necessity and daily operations. Pending receipt of the Regulatory Approvals,
the Company, its current shareholders, officers, directors and employees
shall remain directly and solely responsible for the operation of the
Company's telecommunications services and for compliance with all applicable
provisions of federal telecommunications law, state public service
commission laws and all applicable regulations and policies thereunder.
Further, pending receipt of the Regulatory Approvals, the Company, its
current shareholders, officers, directors and employees shall manage and
operate the Company's telecommunications services in a manner that is fully
consistent with the terms and conditions of the Company's certificates of
public convenience and necessity, the public interest and the best interest
of the Company's shareholders."
3. CONDITIONS PRECEDENT.
(a) Section 7.1(e) of the Agreement is hereby amended by adding the
following sentence:
"The Regulatory Approvals, all licenses, permits, authorizations, consents
and other approvals of and filing with any governmental or regulatory agency
required to be obtained or made in connection with the consummation of the
transactions contemplated by this Agreement shall have been duly obtained or
made by or on behalf of Acquiror."
(b) The introductory language of Section 7.2 shall be modified by adding
the following clause after the word "conditions":
"each of which may be waived by the Company, in its sole discretion:"
(c) The introductory language of Section 7.3 shall be modified by adding
the following clause after the word "conditions":
"each of which may be waived by the Acquiror and Newco, in their sole
discretion:"
4. TERMINATION, AMENDMENT AND WAIVER. Section 8.1(e) of the Agreement is
hereby amended by deleting the date "May 1, 1998" in the first line and
replacing such date with "July 15, 1998".
5. NO FURTHER AMENDMENT. Except as otherwise set forth in this Amendment,
the Merger Agreement shall remain in full force and effect without further
amendment, modification or alteration.
A-28
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Second Amendment to
be signed by their respective officers thereunto duly authorized, all as of the
date first written above.
<TABLE>
<S> <C> <C>
ACQUIROR: STAR TELECOMMUNICATIONS, INC.
By: /s/ KELLY ENOS
-----------------------------------------
Kelly Enos
CHIEF EXECUTIVE OFFICER
</TABLE>
<TABLE>
<S> <C> <C>
NEWCO: IIWII CORP.
By: /s/ KELLY ENOS
-----------------------------------------
Kelly Enos
CHIEF FINANCIAL OFFICER
</TABLE>
<TABLE>
<S> <C> <C>
COMPANY: UNITED DIGITAL NETWORK, INC.
By: /s/ JOHN R. SNEDEGAR
-----------------------------------------
John R. Snedegar
CHIEF EXECUTIVE OFFICER
</TABLE>
A-29
<PAGE>
ANNEX B
May 7, 1998
Board of Directors
United Digital
18872 Macarthur Blvd.
Suite 300
Irvine, CA 92612
Members of the Board:
We understand that Star Telecommunications, Inc. ("Star"), United Digital
Network, Inc. ("United Digital") and IIWII Corp. ("Merger Sub"), a wholly-owned
subsidiary of Star, have entered into an Agreement and Plan of Merger, dated as
of November 19, 1997 (the "Merger Agreement"), which provides, among other
things, for the merger (the "Merger") of Merger Sub with and into United
Digital. Pursuant to the Merger, United Digital will become a wholly-owned
subsidiary of Star and each issued and outstanding share of common stock, par
value $0.01 per share, of United Digital (the "United Digital Common Stock"),
other than shares held in treasury or held by United Digital or any subsidiary
of United Digital, shall be converted into the right to receive a fraction of a
share of common stock, par value $0.001 per share, of Star (the "Star Common
Stock"). This conversion is subject to terms and conditions which are more fully
set forth in the Merger Agreement. Capitalized terms used herein without
definition shall have the same meanings herein as are ascribed to those terms in
the Merger Agreement.
You have asked for our opinion as to whether the Exchange Ratio pursuant to
the Merger Agreement is fair from a financial point of view to the holders of
shares of United Digital Common Stock.
For purposes of the opinion set forth herein, we have:
(i) reviewed certain publicly available financial statements and other
information of Star and United Digital, respectively;
(ii) reviewed certain internal financial statements and other financial and
operating data concerning United Digital and Star prepared by the
management of United Digital and Star, respectively;
(iii) discussed the past and current operations and financial condition and
the prospects of Star, including information relating to certain
strategic, financial and operational benefits anticipated from the
Merger, with senior executives of Star;
(iv) discussed the past and current operations and financial condition and
the prospects of United Digital, including information relating to
certain strategic, financial and operational benefits anticipated from
the Merger, with senior executives of United Digital;
(v) reviewed the pro forma impact of the Merger on the earnings per share
and consolidated capitalization of Star and United Digital,
respectively;
(vi) reviewed the reported prices and trading activity for the Star Common
Stock;
(vii) compared the financial performance of United Digital and Star and the
prices and trading activity of the United Digital Common Stock and the
Star Common Stock with that of certain other publicly-traded companies
and their securities;
(viii) reviewed the financial terms, to the extent publicly available, of
certain comparable acquisition transactions;
(ix) reviewed and discussed with the senior managements of United Digital
and Star the strategic rationale for the Merger and certain
alternatives to the Merger;
B-1
<PAGE>
(x) reviewed the Merger Agreement and the agreements to be entered in
connection therein; and
(xi) considered such other factors as we have deemed appropriate.
We have assumed and relied upon, without independent verification, the
accuracy and completeness of the information furnished to us by United Digital,
Star and other publicly available sources and reviewed by us for the purposes of
this opinion. With respect to the internal financial statements and other
financial and operating data including estimates of the strategic, financial and
operational benefits anticipated from the Merger provided by United Digital and
Star, we have assumed that they have been reasonably prepared on a basis
reflecting the best currently available estimates and judgments of the prospects
of Star and United Digital, respectively. We have relied upon the assessment by
the managements of Star and United Digital of their ability to retain key
employees of both Star and United Digital. We have also relied upon, without
independent verification, the assessment by managements of United Digital and
Star of the strategic and other benefits expected to result from the Merger. We
have also relied upon, without independent verification, the assessment by
mangements of United Digital and Star of the timing and risks associated with
the integration of United Digital with Star. We have not made any independent
valuation or appraisal of the assets, liabilities or technology of Star or
United Digital, respectively, nor have we been furnished with any such
appraisals. We have assumed that the Merger will be accounted for as a
"pooling-of-interests" business combination in accordance with U.S. Generally
Accepted Accounting Principles and the Merger will be treated as a tax-free
reorganization and/or exchange pursuant to the Internal Revenue Code of 1986 and
will be consummated in accordance with the terms set forth in the Merger
Agreement. Our opinion is necessarily based on economic, market and other
conditions as in effect on, and the information made available to us as of, the
date hereof. In arriving at our opinion, we were not authorized to solicit, and
did not solicit, interest from any third party with respect to an acquisition,
business combination or other extraordinary transaction involving United
Digital, nor did we discuss the acquisition with any parties other than Star.
We have acted as financial advisor to the Board of Directors of United
Digital in connection with this transaction and will receive a fee for our
services. In the past, Madison Securities, Inc. has provided financial advisory
and financing services for United Digital and have received fees for the
rendering of these services. In addition, in the ordinary course of our business
we may actively trade the securities of Star for our own account and for the
accounts of our customers and, accordingly, may at any time hold a long or short
position in such securities.
It is understood that this letter is for the information of the Board of
Directors of United Digital and may not be used for any other purpose without
our prior written consent, except that this opinion may be included in its
entirety in any filing made by Star and/or United Digital with the Securities
and Exchange Commission with respect to the transactions contemplated by the
Merger Agreement. In addition, this opinion does not in any manner address the
prices at which the Star Common Stock will actually trade at any time and we
express no recommendation or opinion as to how the holders of United Digital
Common Stock should vote at the shareholders' meeting held in connection with
the Merger.
Based upon and subject to the foregoing, we are of the opinion on the date
hereof that the Exchange Ratio pursuant to the Merger Agreement is fair from a
financial point of view to the holders of shares of United Digital Common Stock.
Very truly yours,
/s/Madison Securities, Inc.
----------------------------------------------------------------------
MADISON SECURITIES, INC.
B-2
<PAGE>
ANNEX C
SECTION 262 OF THE GENERAL
CORPORATION LAW OF THE STATE OF DELAWARE
Section 262 APPRAISAL RIGHTS. (a) Any stockholder of a corporation of this
State who holds shares of stock on the date of the making of a demand pursuant
to subsection (d) of this section with respect to such shares, who continuously
holds such shares through the effective date of the merger or consolidation, who
has otherwise complied with subsection (d) of this section and who has neither
voted in favor of the merger or consolidation nor consented thereto in writing
pursuant to Section 228 of this title shall be entitled to an appraisal by the
Court of Chancery of the fair value of his shares of stock under the
circumstances described in subsections (b) and (c) of this section. As used in
this section, the word "stockholder" means a holder of record of stock in a
stock corporation and also a member of record of a nonstock corporation; the
words "stock" and "share" mean and include what is ordinarily meant by those
words and also membership or membership interest of a member of a nonstock
corporation; and the words "depository receipt" mean a receipt or other
instrument issued by a depository representing an interest in one or more
shares, or fractions thereof, solely of stock of a corporation, which stock is
deposited with the depository.
(b) Appraisal rights shall be available for the shares of any class or
series of stock of a constituent corporation in a merger or consolidation to be
effected pursuant to Section Section 251, 252, 254, 257, 258, 263 or 264 of this
title:
(1) Provided, however, that no appraisal rights under this section shall
be available for the shares of any class or series of stock, which stock, or
depository receipts in respect thereof at the record date fixed to determine
the stockholders entitled to receive notice of and to vote at the meeting of
stockholders to act upon the agreement of merger or consolidation, were
either (i) listed on a national securities exchange or designated as a
national market system security on an interdealer quotation system by the
National Association of Securities Dealers, Inc. or (ii) held of record by
more than 2,000 holders; and further provided that no appraisal rights shall
be available for any shares of stock of the constituent corporation
surviving a merger if the merger did not require for its approval the vote
of the stockholders of the surviving corporation as provided in subsection
(f) of Section 251 of this title.
(2) Notwithstanding paragraph (1) of this subsection, appraisal rights
under this section shall be available for the shares of any class or series
of stock of a constituent corporation if the holders thereof are required by
the terms of an agreement of merger or consolidation pursuant to Section
Section 251, 252, 254, 257, 258, 263 and 264 of this title to accept for
such stock anything except:
a. Shares of stock of the corporation surviving or resulting from
such merger or consolidation, or depository receipts in respect thereof;
b. Shares of stock of any other corporation, or depository receipts
in respect thereof, which shares of stock or depository receipts at the
effective date of the merger or consolidation will be either listed on a
national securities exchange or designated as a national market system
security on an interdealer quotation system by the National Association
of Securities Dealers, Inc. or held of record by more than 2,000 holders;
c. Cash in lieu of fractional shares or fractional depository
receipts described in the foregoing subparagraphs a. and b. of this
paragraph; or
d. Any combination of the shares of stock and cash in lieu of
fractional shares or fractional depository receipts described in the
foregoing subparagraphs a., b. and c. of this paragraph.
C-1
<PAGE>
(3) In the event all of the stock of a subsidiary Delaware corporation
party to a merger effected under Section 253 of this title is not owned by
the parent corporation immediately prior to the merger, appraisal rights
shall be available for the shares of the subsidiary Delaware corporation.
(c) Any corporation may provide in its certificate of incorporation that
appraisal rights under this section shall be available for the shares of any
class or series of its stock as a result of an amendment to its certificate of
incorporation, any merger or consolidation in which the corporation is a
constituent corporation or the sale of all or substantially all of the assets of
the corporation. If the certificate of incorporation contains such a provision,
the procedures of this section, including those set forth in subsections (d) and
(e) of this section, shall apply as nearly as is practicable.
(d) Appraisal rights shall be perfected as follows:
(1) If a proposed merger or consolidation for which appraisal rights are
provided under this section is to be submitted for approval at a meeting of
stockholders, the corporation, not less than 20 days prior to the meeting,
shall notify each of its stockholders who was such on the record date for
such meeting with respect to shares for which appraisal rights are available
pursuant to subsections (b) or (c) hereof that appraisal rights are
available for any or all of the shares of the constituent corporations, and
shall include in such notice a copy of this section. Each stockholder
electing to demand the appraisal of his shares shall deliver to the
corporation, before the taking of the vote on the merger or consolidation, a
written demand for appraisal of his shares. Such demand will be sufficient
if it reasonably informs the corporation of the identity of the stockholder
and that the stockholder intends thereby to demand the appraisal of his
shares. A proxy or vote against the merger or consolidation shall not
constitute such a demand. A stockholder electing to take such action must do
so by a separate written demand as herein provided. Within 10 days after the
effective date of such merger or consolidation, the surviving or resulting
corporation shall notify each stockholder of each constituent corporation
who has complied with this subsection and has not voted in favor of or
consented to the merger or consolidation of the date that the merger or
consolidation has become effective; or
(2) If the merger or consolidation was approved pursuant to Section
Section 228 or 253 of this title, the surviving or resulting corporation,
either before the effective date of the merger or consolidation or within 10
days thereafter, shall notify each of the stockholders entitled to appraisal
rights of the effective date of the merger or consolidation and that
appraisal rights are available for any or all of the shares of the
constituent corporation, and shall include in such notice a copy of this
section. The notice shall be sent by certified or registered mail, return
receipt requested, addressed to the stockholder at his address as it appears
on the records of the corporation. Any stockholder entitled to appraisal
rights may, within 20 days after the date of mailing of the notice, demand
in writing from the surviving or resulting corporation the appraisal of his
shares. Such demand will be sufficient if it reasonably informs the
corporation of the identity of the stockholder and that the stockholder
intends thereby to demand the appraisal of his shares.
(e) Within 120 days after the effective date of the merger or consolidation,
the surviving or resulting corporation or any stockholder who has complied with
subsections (a) and (d) hereof and who is otherwise entitled to appraisal
rights, may file a petition in the Court of Chancery demanding a determination
of the value of the stock of all such stockholders. Notwithstanding the
foregoing, at any time within 60 days after the effective date of the merger or
consolidation, any stockholder shall have the right to withdraw his demand for
appraisal and to accept the terms offered upon the merger or consolidation.
Within 120 days after the effective date of the merger or consolidation, any
stockholder who has complied with the requirements of subsections (a) and (d)
hereof, upon written request, shall be entitled to receive from the corporation
surviving the merger or resulting from the consolidation a statement setting
forth the aggregate number of shares not voted in favor of the merger or
consolidation and with respect to which demands for appraisal have been received
and the aggregate number of holders of such shares. Such
C-2
<PAGE>
written statement shall be mailed to the stockholder within 10 days after his
written request for such a statement is received by the surviving or resulting
corporation or within 10 days after expiration of the period for delivery of
demands for appraisal under subsection (d) hereof, whichever is later.
(f) Upon the filing of any such petition by a stockholder, service of a copy
thereof shall be made upon the surviving or resulting corporation, which shall
within 20 days after such service file in the office of the Register in Chancery
in which the petition was filed a duly verified list containing the names and
addresses of all stockholders who have demanded payment for their shares and
with whom agreements as to the value of their shares have not been reached by
the surviving or resulting corporation. If the petition shall be filed by the
surviving or resulting corporation, the petition shall be accompanied by such a
duly verified list. The Register in Chancery, if so ordered by the Court, shall
give notice of the time and place fixed for the hearing of such petition by
registered or certified mail to the surviving or resulting corporation and to
the stockholders shown on the list at the addresses therein stated. Such notice
shall also be given by one or more publications at least one week before the day
of the hearing, in a newspaper of general circulation published in the City of
Wilmington, Delaware or such publication as the Court deems advisable. The forms
of the notices by mail and by publication shall be approved by the Court, and
the costs thereof shall be borne by the surviving or resulting corporation.
(g) At the hearing on such petition, the Court shall determine the
stockholders who have complied with this section and who have become entitled to
appraisal rights. The Court may require the stockholders who have demanded an
appraisal for their shares and who hold stock represented by certificates to
submit their certificates of stock to the Register in Chancery for notation
thereon of the pendency of the appraisal proceedings; and if any stockholder
fails to comply with such direction, the Court may dismiss the proceedings as to
such stockholder.
(h) After determining the stockholders entitled to an appraisal, the Court
shall appraise the shares, determining their fair value exclusive of any element
of value arising from the accomplishment or expectation of the merger or
consolidation, together with a fair rate of interest, if any, to be paid upon
the amount determined to be the fair value. In determining such fair value, the
Court shall take into account all relevant factors. In determining the fair rate
of interest, the Court may consider all relevant factors, including the rate of
interest which the surviving or resulting corporation would have had to pay to
borrow money during the pendency of the proceeding. Upon application by the
surviving or resulting corporation or by any stockholder entitled to participate
in the appraisal proceeding, the Court may, in its discretion, permit discovery
or other pretrial proceedings and may proceed to trial upon the appraisal prior
to the final determination of the stockholder entitled to an appraisal. Any
stockholder whose name appears on the list filed by the surviving or resulting
corporation pursuant to subsection (f) of this section and who has submitted his
certificates of stock to the Register in Chancery, if such is required, may
participate fully in all proceedings until it is finally determined that he is
not entitled to appraisal rights under this section.
(i) The Court shall direct the payment of the fair value of the shares,
together with interest, if any, by the surviving or resulting corporation to the
stockholders entitled thereto. Interest may be simple or compound, as the Court
may direct. Payment shall be so made to each such stockholder, in the case of
holders of uncertificated stock forthwith, and the case of holders of shares
represented by certificates upon the surrender to the corporation of the
certificates representing such stock. The Court's decree may be enforced as
other decrees in the Court of Chancery may be enforced, whether such surviving
or resulting corporation be a corporation of this State or of any state.
(j) The costs of the proceeding may be determined by the Court and taxed
upon the parties as the Court deems equitable in the circumstances. Upon
application of a stockholder, the Court may order all or a portion of the
expenses incurred by any stockholder in connection with the appraisal
proceeding, including, without limitation, reasonable attorney's fees and the
fees and expenses of experts, to be charged pro rata against the value of all
the shares entitled to an appraisal.
C-3
<PAGE>
(k) From and after the effective date of the merger or consolidation, no
stockholder who has demanded his appraisal rights as provided in subsection (d)
of this section shall be entitled to vote such stock for any purpose or to
receive payment of dividends or other distributions on the stock (except
dividends or other distributions payable to stockholders of record at a date
which is prior to the effective date of the merger or consolidation); provided,
however, that if no petition for an appraisal shall be filed within the time
provided in subsection (e) of this section, or if such stockholder shall deliver
to the surviving or resulting corporation a written withdrawal of his demand for
an appraisal and an acceptance of the merger or consolidation, either within 60
days after the effective date of the merger or consolidation as provided in
subsection (e) of this section or thereafter with the written approval of the
corporation, then the right of such stockholder to an appraisal shall cease.
Notwithstanding the foregoing, no appraisal proceeding in the Court of Chancery
shall be dismissed as to any stockholder without the approval of the Court, and
such approval may be conditioned upon such terms as the Court deems just.
(l) The shares of the surviving or resulting corporation to which the shares
of such objecting stockholders would have been converted had they assented to
the merger or consolidation shall have the status of authorized and unissued
shares of the surviving or resulting corporation.
C-4
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporation Law authorizes a court to
award or a corporation's Board of Directors to grant indemnification to
directors and officers in terms sufficiently broad to permit such
indemnification under certain circumstances for liabilities (including
reimbursement for expenses incurred) arising under the Securities Act of 1933,
as amended (the "Securities Act"). Article VII, Section 6, of the Registrant's
Bylaws provides for mandatory indemnification of its directors and officers and
permissible indemnification of employees and other agents to the maximum extent
permitted by the Delaware General Corporation Law. The Registrant's Amended and
Restated Certificate of Incorporation provides that, pursuant to Delaware law,
its directors shall not be liable for monetary damages for breach of the
directors' fiduciary duty as directors to the Company and its stockholders. This
provision in the Amended and Restated Certificate of Incorporation does not
eliminate the directors' fiduciary duty, and in appropriate circumstances
equitable remedies such as injunctive or other forms of non-monetary relief will
remain available under Delaware law. In addition, each director will continue to
be subject to liability for breach of the director's duty of loyalty to the
Company for acts or omissions not in good faith or involving intentional
misconduct, for knowing violations of law, for actions leading to improper
personal benefit to the director, and for payment of dividends or approval of
stock repurchases or redemptions that are unlawful under Delaware law. The
provision also does not affect a director's responsibilities under any other
law, such as the federal securities laws or state or federal environmental laws.
The Registrant has entered or will enter into Indemnification Agreements with
its officers and directors that provide the Registrant's officers and directors
with further indemnification to the maximum extent permitted by the Delaware
General Corporation Law.
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(A) EXHIBITS.
The following Exhibits are attached hereto and incorporated herein by
reference.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
2.1* Amended and Restated Stock Acquisition Agreement and Plan of Merger dated as of November 30, 1997 by
and among the Registrant, Big Dave's Acquisition Corp., LCCR, Inc., and the shareholders listed on
the signature page thereto.
2.2 Agreement and Plan of Merger dated as of November 19, 1997 by and among the Registrant, IIWII Corp.
and United Digital Network, Inc. (the "UDN Merger Agreement"), as amended (incorporated by reference
from ANNEX A to the Proxy Statement/Prospectus constituting Part I of this Registration Statement).
2.3** Stock Purchase Agreement dated as of January 26, 1998 by and among the Registrant, T-One Corp. and
Taha Mikati, as amended.
3.1** Amended and Restated Certificate of Incorporation of the Registrant.
3.2** Bylaws of the Registrant.
4.1+++ Specimen Common Stock certificate.
4.2+ Registration Rights Agreement, dated September 24, 1996, between the Registrant and the investors
named therein.
4.3+ Registration Rights Agreement, dated July 12, 1996, between the Registrant and the investor named
therein.
4.4+ Investor Rights Agreement dated July 25, 1996, between the Registrant and the investors named
therein.
</TABLE>
II-1
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
4.5* Registration Rights Agreement dated as of November 30, 1997 by and among the Company and the
shareholders listed on the signature page thereto.
4.6** Registration Rights Agreement dated as of March 10, 1998 between the Registrant and Taha Mikati.
5.1- Opinion of Riordan & McKinzie, a Professional Law Corporation.
10.1+ Form of Indemnification Agreement.
10.2+ 1996 Amended and Restated Stock Incentive Plan.
10.3+ 1996 Outside Director Nonstatutory Stock Option Plan.
10.4++ 1997 Omnibus Stock Incentive Plan.
10.5+ Employment Agreement between the Registrant and Mary Casey dated July 14, 1995, as amended.
10.6+ Employment Agreement between the Registrant and Kelly Enos dated December 2, 1996.
10.7+ Employment Agreement between the Registrant and David Vaun Crumly dated January 1, 1996.
10.8+ Employment Agreement between the Registrant and James Kolsrud dated December 18, 1996.
10.9+ Consulting Agreement between the Registrant and Gordon Hutchins, Jr. dated May 1, 1996.
10.10+ Nonstatutory Stock Option Agreement between the Registrant and Gordon Hutchins, Jr. dated May 15,
1996.
10.11+ Free Standing Commercial Building Lease between the Registrant and Thomas M. Spear, as receiver for
De La Guerra Court Investments, dated for reference purposes as of March 1, 1996.
10.12+ Standard Office Lease--Gross between the Registrant and De La Guerra Partners, L.P. dated for
reference purposes as of July 9, 1996.
10.13+ Office Lease between the Registrant and WHUB Real Estate Limited Partnership dated June 28, 1996, as
amended.
10.14+ Standard Form of Office Lease between the Registrant and Hudson Telegraph Associates dated February
28, 1996.
10.15+ Agreement for Lease between the Registrant and Telehouse International Corporation of Europe Limited
dated July 16, 1996.
10.16+ Sublease between the Registrant and Borton, Petrini & Conron dated March 20, 1994, as amended.
10.17+ Office Lease between the Registrant and One Wilshire Arcade Imperial, Ltd. dated June 28, 1996.
10.18+ Lease Agreement between the Registrant and Telecommunications Finance Group dated April 6, 1995.
10.19+ Lease Agreement between the Registrant and Telecommunications Finance Group dated January 3, 1996, as
amended.
10.20++ Master Lease Agreement between the Registrant and NTFC Capital Corporation dated December 20, 1996.
10.21+ Variable Rate Installment Note between the Registrant and Metrobank dated October 4, 1996.
10.22+ Assignment of Purchase Order and Security Interest between the Registrant and DSC Finance Corporation
dated January 1, 1996.
10.23++ Line of Credit Promissory Note between the Registrant and Christopher E. Edgecomb dated November 7,
1996, as amended.
10.24++ Office Lease Agreement between the Registrant and Beverly Hills Center LLC effective as of April 1,
1997.
</TABLE>
II-2
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
10.25** Credit Agreement dated as of September 30, 1997 among the Registrant, the financial institutions
party thereto and Sanwa Bank California, as amended.
10.26** Office Lease between the Registrant, Hudson Telegraph Associates and American Communications Corp.,
as amended.
10.27** Amendment Number Three to Employment Agreement between the Registrant and Mary A. Casey dated as of
July 1, 1997.
10.28** Amendment Number One to Employment Agreement between the Registrant and Kelly D. Enos dated as of
November 12, 1997.
10.29** Amendment Number One to First Restatement of Employment Agreement between the Registrant and James
Kolsrud dated as of June 16, 1997.
10.30** Amendment Number One to Employment Agreement between the Registrant and David Vaun Crumly dated as of
November 11, 1997.
10.31** First Amendment to Amended and Restated 1996 Stock Incentive Plan.
10.32*** Agreement dated as of December 1, 1997 between the Registrant and Nortel Dasa Network Systems GmbH &
Co. KG.
10.33** Leasing Agreement between the Registrant and Nortel Dasa Network Systems GmbH & Co. KG.
10.34** Guarantee Agreement between the Registrant and Nortel Dasa Network Systems GmbH & Co. KG.
10.35** Note and Security Agreement dated as of December 18, 1997 between the Registrant and NationsBanc
Leasing Corporation.
10.36** Amendment of Lease dated as of September 30, 1997 between the Registrant and Hudson Telegraph
(reference is hereby made to Exhibit 10.14).
10.37 Intentionally omitted.
10.38** Lease Agreement dated July 29, 1996 between the Registrant and Telecommunications Finance Group.
10.39** Promissory Note issued by Christopher E. Edgecomb in favor of the Registrant dated November 26, 1997.
10.40** Stock Pledge Agreement dated November 26, 1997 between the Registrant and Christopher E. Edgecomb.
10.41** Commercial Lease dated October 31, 1997 between the Registrant and Prinzenpark GbR.
10.42** Commercial Lease dated October 9, 1997 between the Registrant and WSL Weststadt Liegenschafts GmbH.
10.43** Office Lease between the Registrant and Airport-Center KGHP Gewerbeban GmbH & Cie.
10.44** Lease dated November 19, 1997 between the Registrant and DIFA Deutsche Immobilien Fonds
Aktiengesellschaft.
21.1*** Subsidiaries of the Registrant.
23.1 Consent of Arthur Andersen LLP, Independent Public Accountants.
23.2- Consent of Riordan & McKinzie (contained in Exhibit 5.1).
23.3 Consent of Madison Securities, Inc.
23.4 Consent of Price Waterhouse LLP, Independent Public Accountants.
23.5 Consent of Weaver and Tidwell, Independent Public Accountants.
</TABLE>
II-3
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
24.1** Power of Attorney.
27.1** Financial Data Schedule.
99.1 Form of UDN Proxy.
99.2 Opinion of Madison Securities, Inc. (incorporated by reference from ANNEX B to the Proxy
Statement/Prospectus constituting Part I of this Registration Statement).
</TABLE>
- ------------------------
+ Filed as an exhibit to the Company's Registration Statement on Form S-1
(Registration No. 333-21325) on February 7, 1997 and incorporated by
reference herein.
++ Filed as an exhibit to Amendment No. 1 to the Company's Registration
Statement on Form S-1 (Registration No. 333-21325) on May 16, 1997 and
incorporated by reference herein.
+++ Filed as an exhibit to Amendment No. 2 to the Company's Registration
Statement on Form S-1 (Registration No. 333-21325) on May 29, 1997 and
incorporated by reference herein.
* Filed on December 15, 1997 as an exhibit to the Company's Current Report on
Form 8-K (File No. 000-22581) and incorporated by reference herein.
** Filed as an exhibit to the Company's Registration Statement on Form S-1
(Registration No. 333-48559) on March 24, 1998 and incorporated by reference
herein.
***Filed as an exhibit to the Company's Annual Report on Form 10-K (File No.
000-22581) on March 31, 1998 and incorporated by reference herein.
- To be filed by amendment.
(B) FINANCIAL STATEMENT SCHEDULES
Not Applicable
ITEM 22. UNDERTAKINGS
The undersigned registrant hereby undertakes:
(1) That prior to any public reoffering of the securities registered
hereunder through use of a prospectus which is a part of this registration
statement, by any person or party who is deemed to be an underwriter within
the meaning of Rule 145(c), the issuer undertakes that such reoffering
prospectus will contain the information called for by the applicable
registration form with respect to reofferings by persons who may be deemed
underwriters, in addition to the information called for by the other Items
of the applicable form.
(2) That every prospectus (i) that is filed pursuant to paragraph (2)
immediately preceding, or (ii) that purports to meet the requirements of
section 10(a)(3) of the Securities Act and is used in connection with an
offering of securities subject to Rule 415, will be filed as a part of an
amendment to the registration statement and will not be used until such
amendment is effective, and that, for purposes of determining any liability
under the Securities Act, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to
be the initial bona fide offering thereof.
(3) To respond to requests for information that is incorporated by
reference into the prospectus pursuant to Items 4, 10(b), 11, or 13 of this
Form, within one business day of receipt of such request, and to send the
incorporated documents by first class mail or other equally prompt means.
This includes information contained in documents filed subsequent to the
effective date of the registration statement through the date of responding
to the request.
II-4
<PAGE>
(4) To supply by means of post-effective amendment all information
concerning a transaction, and the company being acquired involved therein,
that was not the subject of and included in the registration statement when
it became effective.
(5) Insofar as indemnification for liabilities arising under the
Securities Act may be permitted to directors, officers and controlling
persons of the registrant pursuant to the foregoing provisions, or
otherwise, the registrant has been advised that in the opinion of the
Commission such indemnification is against public policy as expressed in the
Securities Act and is, therefore, unenforceable. In the event that a claim
for indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or
controlling person of the registrant in the successful defense of any
action, suit or proceeding) is asserted by such director, officer or
controlling person in connection with the securities being registered, the
registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against
public policy as expressed in the Securities Act and will be governed by the
final adjudication of such issue.
(6) To file, during any period in which offers or sales are being made,
a post-effective amendment to this registration statement:
(i) To include any prospectus required by section 10(a)(3) of the
Securities Act.
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth in
the registration statement. Notwithstanding the foregoing, any increase
or decrease in volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered) and any
deviation from the low or high end of the estimated maximum offering
range may be reflected in the form of prospectus filed with the
Commission pursuant to Rule 424(b) if, in the aggregate, the changes in
volume and price represent no more than a 20% change in the maximum
aggregate offering price set forth in the "Calculation of Registration
Fee" table in the effective registration statement.
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or
any material change to such information in the registration statement.
(7) That, for the purpose of determining any liability under the
Securities Act, each such post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
(8) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
II-5
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
registrant has duly caused this Registration Statement on Form S-4 to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Santa Barbara, State of California, on this 20th day of May, 1998.
<TABLE>
<S> <C> <C>
STAR TELECOMMUNICATIONS, INC.
By: /s/ KELLY D. ENOS
-----------------------------------------
Kelly D. Enos
Chief Financial Officer
</TABLE>
KNOW MEN BY ALL THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Christopher E. Edgecomb, Mary A. Casey and Kelly
D. Enos, and each of them, his true and lawful attorneys-in-fact and agents,
each with full power of substitution and resubstitution, for him and in his
name, place and stead, in any and all capacities, to sign any and all
amendments, including post-effective amendments, to this Registration Statement,
and any registration statement relating to the offering covered by this
Registration Statement and filed pursuant to Rule 462(b) under the Securities
Act of 1933, and to file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
said attorneys-in-fact and agents, and each of them, full power and authority to
do and perform each and every act and thing requisite and necessary to be done,
as fully to all intents and purposes as he might or could do in person, hereby
ratifying and confirming all that each of said attorneys-in-fact and agents or
their substitute or substitutes may lawfully do or cause to be done by virtue
hereof.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following persons in the
capacities and on the dates indicated.
/s/ CHRISTOPHER E. EDGECOMB Chief Executive Officer
- ------------------------------ and Director (Principal May 20, 1998
Christopher E. Edgecomb Executive Officer)
/s/ MARY A. CASEY
- ------------------------------ President and Director May 20, 1998
Mary A. Casey
/s/ KELLY D. ENOS Chief Financial Officer
- ------------------------------ (Principal Financial and May 20 1998
Kelly D. Enos Accounting Officer)
/s/ GORDON HUTCHINS, JR.
- ------------------------------ Director May 20, 1998
Gordon Hutchins, Jr.
/s/ JOHN R. SNEDEGAR
- ------------------------------ Director May 20, 1998
John R. Snedegar
/s/ MARK GERSHIEN
- ------------------------------ Director May 20, 1998
Mark Gershien
/s/ ARUNAS CHESONIS
- ------------------------------ Director May 20, 1998
Arunas Chesonis
II-6
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT SEQUENTIALLY
NUMBER DESCRIPTION OF DOCUMENT NUMBERED PAGE
- ----------- ---------------------------------------------------------------------------------------- -----------------
<C> <S> <C>
2.1* Amended and Restated Stock Acquisition Agreement and Plan of Merger dated as of November
30, 1997 by and among the Registrant, Big Dave's Acquisition Corp., LCCR, Inc., and the
shareholders listed on the signature page thereto.
2.2 Agreement and Plan of Merger dated as of November 19, 1997 by and among the Registrant,
IIWII Corp. and United Digital Network, Inc. (the "UDN Merger Agreement"), as amended
(incorporated by reference from ANNEX A to the Proxy Statement/Prospectus constituting
Part I of this Registration Statement).
2.3** Stock Purchase Agreement dated as of January 26, 1998 by and among the Registrant, T-One
Corp. and Taha Mikati, as amended.
3.1** Amended and Restated Certificate of Incorporation of the Registrant.
3.2** Bylaws of the Registrant.
4.1+++ Specimen Common Stock certificate.
4.2+ Registration Rights Agreement, dated September 24, 1996, between the Registrant and the
investors named therein.
4.3+ Registration Rights Agreement, dated July 12, 1996, between the Registrant and the
investor named therein.
4.4+ Investor Rights Agreement dated July 25, 1996, between the Registrant and the investors
named therein.
4.5* Registration Rights Agreement dated as of November 30, 1997 by and among the Company and
the shareholders listed on the signature page thereto.
4.6** Registration Rights Agreement dated as of March 10, 1998 between the Registrant and Taha
Mikati.
5.1- Opinion of Riordan & McKinzie, a Professional Law Corporation.
10.l+ Form of Indemnification Agreement.
10.2+ 1996 Amended and Restated Stock Incentive Plan.
10.3+ 1996 Outside Director Nonstatutory Stock Option Plan.
10.4++ 1997 Omnibus Stock Incentive Plan.
10.5+ Employment Agreement between the Registrant and Mary Casey dated July 14, 1995, as
amended.
10.6+ Employment Agreement between the Registrant and Kelly Enos dated December 2, 1996.
10.7+ Employment Agreement between the Registrant and David Vaun Crumly dated January 1, 1996.
10.8+ Employment Agreement between the Registrant and James Kolsrud dated December 18, 1996.
10.9+ Consulting Agreement between the Registrant and Gordon Hutchins, Jr. dated May 1, 1996.
10.10+ Nonstatutory Stock Option Agreement between the Registrant and Gordon Hutchins, Jr.
dated May 15, 1996.
10.11+ Free Standing Commercial Building Lease between the Registrant and Thomas M. Spear, as
receiver for De La Guerra Court Investments, dated for reference purposes as of March 1,
1996.
10.12+ Standard Office Lease--Gross between the Registrant and De La Guerra Partners, L.P.
dated for reference purposes as of July 9, 1996.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT SEQUENTIALLY
NUMBER DESCRIPTION OF DOCUMENT NUMBERED PAGE
- ----------- ---------------------------------------------------------------------------------------- -----------------
<C> <S> <C>
10.13+ Office Lease between the Registrant and WHUB Real Estate Limited Partnership dated June
28, 1996, as amended.
10.14+ Standard Form of Office Lease between the Registrant and Hudson Telegraph Associates
dated February 28, 1996.
10.15+ Agreement for Lease between the Registrant and Telehouse International Corporation of
Europe Limited dated July 16, 1996.
10.16+ Sublease between the Registrant and Borton, Petrini & Conron dated March 20, 1994, as
amended.
10.17+ Office Lease between the Registrant and One Wilshire Arcade Imperial, Ltd. dated June
28, 1996.
10.18+ Lease Agreement between the Registrant and Telecommunications Finance Group dated April
6, 1995.
10.19+ Lease Agreement between the Registrant and Telecommunications Finance Group dated
January 3, 1996, as amended.
10.20++ Master Lease Agreement between the Registrant and NTFC Capital Corporation dated
December 20, 1996.
10.21+ Variable Rate Installment Note between the Registrant and Metrobank dated October 4,
1996.
10.22+ Assignment of Purchase Order and Security Interest between the Registrant and DSC
Finance Corporation dated January 1, 1996.
10.23++ Line of Credit Promissory Note between the Registrant and Christopher E. Edgecomb dated
November 7, 1996, as amended.
10.24++ Office Lease Agreement between the Registrant and Beverly Hills Center LLC effective as
of April 1, 1997.
10.25** Credit Agreement dated as of September 30, 1997 among the Registrant, the financial
institutions party thereto and Sanwa Bank California, as amended.
10.26** Office Lease between the Registrant, Hudson Telegraph Associates and American
Communications Corp., as amended.
10.27** Amendment Number Three to Employment Agreement between the Registrant and Mary A. Casey
dated as of July 1, 1997.
10.28** Amendment Number One to Employment Agreement between the Registrant and Kelly D. Enos
dated as of November 12, 1997.
10.29** Amendment Number One to First Restatement of Employment Agreement between the Registrant
and James Kolsrud dated as of June 16, 1997.
10.30** Amendment Number One to Employment Agreement between the Registrant and David Vaun
Crumly dated as of November 11, 1997.
10.31** First Amendment to Amended and Restated 1996 Stock Incentive Plan.
10.32*** Agreement dated as of December 1, 1997 between the Registrant and Nortel Dasa Network
Systems GmbH & Co. KG.
10.33** Leasing Agreement between the Registrant and Nortel Dasa Network Systems GmbH & Co. KG.
10.34** Guarantee Agreement between the Registrant and Nortel Dasa Network Systems GmbH & Co.
KG.
10.35** Note and Security Agreement dated as of December 18, 1997 between the Registrant and
NationsBanc Leasing Corporation.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT SEQUENTIALLY
NUMBER DESCRIPTION OF DOCUMENT NUMBERED PAGE
- ----------- ---------------------------------------------------------------------------------------- -----------------
<C> <S> <C>
10.36** Amendment of Lease dated as of September 30, 1997 between the Registrant and Hudson
Telegraph (reference is hereby made to Exhibit 10.14).
10.37 Intentionally omitted.
10.38** Lease Agreement dated July 29, 1996 between the Registrant and Telecommunications
Finance Group.
10.39** Promissory Note issued by Christopher E. Edgecomb in favor of the Registrant dated
November 26, 1997.
10.40** Stock Pledge Agreement dated November 26, 1997 between the Registrant and Christopher E.
Edgecomb.
10.41** Commercial Lease dated October 31, 1997 between the Registrant and Prinzenpark GbR.
10.42** Commercial Lease dated October 9, 1997 between the Registrant and WSL Weststadt
Liegenschafts GmbH.
10.43** Office Lease between the Registrant and Airport-Center KGHP Gewerbeban GmbH & Cie.
10.44** Lease dated November 19, 1997 between the Registrant and DIFA Deutsche Immobilien Fonds
Aktiengesellschaft.
21.1*** Subsidiaries of the Registrant.
23.1 Consent of Arthur Andersen LLP, Independent Public Accountants.
23.2- Consent of Riordan & McKinzie (contained in Exhibit 5.1).
23.3 Consent of Madison Securities, Inc.
23.4 Consent of Price Waterhouse LLP, Independent Public Accountants.
23.5 Consent of Weaver and Tidwell, Independent Public Accountants.
24.1** Power of Attorney.
27.1** Financial Data Schedule.
99.1 Form of UDN Proxy.
99.2 Opinion of Madison Securities, Inc. (incorporated by reference from ANNEX B to the Proxy
Statement/Prospectus constituting Part I of this Registration Statement).
</TABLE>
- ------------------------
+ Filed as an exhibit to the Company's Registration Statement on Form S-1
(Registration No. 333-21325) on February 7, 1997 and incorporated by
reference herein.
++ Filed as an exhibit to Amendment No. 1 to the Company's Registration
Statement on Form S-1 (Registration No. 333-21325) on May 16, 1997 and
incorporated by reference herein.
+++ Filed as an exhibit to Amendment No. 2 to the Company's Registration
Statement on Form S-1 (Registration No. 333-21325) on May 29, 1997 and
incorporated by reference herein.
* Filed on December 15, 1997 as an exhibit to the Company's Current Report on
Form 8-K (File No. 000-22581) and incorporated by reference herein.
** Filed as an exhibit to the Company's Registration Statement on Form S-1
(Registration No. 333-48559) on March 24, 1998 and incoroporated by
reference herein.
***Filed as an exhibit to the Company's Annual Report on Form 10-K (File No.
000-22581) on March 31, 1998 and incorporated by reference herein.
- To be filed by amendment.
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our
reports dated February 12, 1998 (except with respect to the stock split
discussed in Note 14 of the Notes to Consolidated Financial Statements as to
which the date is March 31, 1998) and to all references to our firm included in
or made a part of this registration statement on Form S-4.
ARTHUR ANDERSEN LLP
Los Angeles, California
May 19, 1998
<PAGE>
EXHIBIT 23.3
CONSENT OF MADISON SECURITIES, INC.
We hereby consent to the use of our opinion letter dated May 7, 1998 to the
Board of Directors of United Digital Network, Inc. (the "Company") attached as
Annex B to the Company's Proxy Statement/ Prospectus on Form S-4 (the
"Prospectus") and to the references to our firm in the Prospectus under the
headings of "Summary" and "The Merger." In giving such consent, we do not admit
that we come within the category of persons whose consent is required under
Section 7 of the Securities Act of 1933, as amended, or the rules and
regulations of the Securities and Exchange Commission thereunder and we do not
thereby admit that we are experts with respect to any part of the Regulations
Statement under the meaning of the term "expert" as used in the Securities Act.
Madison Securities, Inc.
Chicago, Illinois
May 20, 1998
<PAGE>
EXHIBIT 23.4
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the use in the Prospectus constituting part of this
Registration Statement on Form S-4 of STAR Telecommunications, Inc. of our
report dated September 5, 1997, except as to Notes 2, 9 and 15, which are as of
May 18, 1998, relating to the financial statements of United Digital Network,
Inc., which appears in such Prospectus. We also consent to the reference to us
under the heading "Experts" in such Prospectus.
PRICE WATERHOUSE LLP
Dallas, Texas
May 20, 1998
<PAGE>
EXHIBIT 23.5
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the use in this registration statement of Star
Telecommunications, Inc. on Form S-4 of our report on Unidex Communication Corp.
dated July 21, 1995, except for the proforma information relating to the
business acquisition, as to which the date is May 20, 1997, appearing in the
Prospectus, which is part of this registration statement.
/s/ WEAVER AND TIDWELL, L.L.P.
Weaver and Tidwell, L.L.P.
Dallas, Texas
May 20, 1998
<PAGE>
UNITED DIGITAL NETWORK, INC.
INSTRUMENT OF PROXY
THIS INSTRUMENT OF PROXY IS SOLICITED BY THE BOARD OF DIRECTORS OF THE COMPANY
The undersigned, being a stockholder of UNITED DIGITAL NETWORK, INC. (the
"Company"), hereby appoints JOHN SNEDEGAR, or failing him, JANINE THOMAS,
both directors of the Company, or ______________, as proxyholder for the
undersigned, to vote for the undersigned at the Special Meeting of the
Company, to be held at McCarthy Tetrault, Main Board Room, 13th Floor, 777
Dunsmuir Street, Vancouver, British Columbia Canada on Tuesday, the 30th
day of June, 1998, at 10:00 a.m., local time, and at any adjournment
thereof and to vote the shares in the capital stock of the Company
registered in the name of the undersigned.
The undersigned hereby acknowledges receipt of the Notice of Special
Meeting and the Proxy Statement relating to the Special Meeting and hereby
revokes any proxy or proxies heretofore given.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THE AGREEMENT AND THE PLAN OF
MERGER.
1. To approve and adopt the Agreement and Plan of Merger, dated as of
November 19, 1997, as amended January 30, 1998 and April 6, 1998, by
and among the Company, STAR Telecommunications, Inc., a Delaware
corporation ("STAR"), and IIWII Corp., a Delaware corporation and a
wholly-owned subsidiary of STAR ("Newco"), and the transactions
contemplated thereby, including, among other things, the merger
of Newco with and into the Company.
/ / FOR / / AGAINST / / ABSTAIN
2. Upon such other matters as may properly come before the Special
Meeting and any adjournments or postponements thereof. In their
discretion, the proxyholders are authorized to vote upon such other
business as may properly come before the Special Meeting and any
adjournments or postponements thereof. This proxy does not convey
discretionary authority to adjourn or postpone the meeting for the
purpose of soliciting additional votes.
<PAGE>
THE SHARES REPRESENTED BY THIS INSTRUMENT OF PROXY WILL BE VOTED OR
WITHHELD FROM VOTING IN ACCORDANCE WITH THE INSTRUCTIONS GIVEN AND, IF A
CHOICE IS SPECIFIED WITH RESPECT TO ANY MATTER TO BE ACTED UPON, THE SHARES
WILL BE VOTED ACCORDINGLY. IF NO CHOICE IS SPECIFIED IN THIS INSTRUMENT OF
PROXY AND ONE OF THE PERSONS NAMED IN THIS INSTRUMENT OF PROXY IS
APPOINTED AS PROXYHOLDER, THE SHARES REPRESENTED BY THIS INSTRUMENT OF
PROXY WILL BE VOTED IN FAVOR OF SUCH MATTERS. THIS INSTRUMENT OF PROXY
CONFERS UPON THE PERSON NAMED HEREIN AS PROXYHOLDER DISCRETIONARY AUTHORITY
WITH RESPECT TO AMENDMENTS OR VARIATIONS TO MATTERS IDENTIFIED IN THE
NOTICE OF SPECIAL MEETING AND OTHER MATTERS WHICH MAY PROPERLY COME BEFORE
THE MEETING.
WITNESS my hand this ______ day of _______________, 1998.
_______________________________ _______________________________
NAME (PLEASE PRINT) (SIGNATURE OF STOCKHOLDER)
Address: ____________________________________
NOTES TO INSTRUMENT OF PROXY
1. IF THE STOCKHOLDER DOES NOT WANT TO APPOINT ANY OF THE PERSONS NAMED
IN THE INSTRUMENT OF PROXY, HE SHOULD STRIKE OUT THEIR NAMES AND
INSERT, IN THE BLANK SPACE PROVIDED, THE NAME OF THE PERSON HE WISHES
TO ACT AS HIS PROXYHOLDER. SUCH OTHER PERSON NEED NOT BE A
STOCKHOLDER OF THE COMPANY.
2. The instrument of proxy will not be valid unless it is dated and
signed by stockholder or by his attorney duly authorized by him in
writing, or, in the case of a corporation, is executed under its
corporate seal or by an officer or officers or attorney for the
Company duly authorized.
3. The instrument of proxy to be effective must be deposited at the
Company's transfer agent, Montreal Trust Company, 4th Floor, 510
Burrard Street, Vancouver, B.C., V6C 3B9, prior to the time of the
Meeting.
