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SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(a) OF THE
SECURITIES EXCHANGE ACT OF 1934
(AMENDMENT NO. )
Filed by the Registrant [X]
Filed by a Party other than the Registrant [ ]
Check the appropriate box:
[X] Preliminary Proxy Statement
[ ] Confidential, for Use of the Commission Only (as permitted by Rule
14a-6(e)(2))
[ ] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to Section 240.14a-11(c) or 240.14a-12
STAR TELECOMMUNICATIONS, INC.
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(Name of Registrant as Specified In Its Charter)
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(Name of Person(s) Filing Proxy Statement, if other than the Registrant)
Payment of Filing Fee (Check the appropriate box):
[ ] No fee required.
[ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11.
(1) Title of each class of securities to which transaction applies:
- --------------------------------------------------------------------------------
(2) Aggregate number of securities to which transaction applies:
- --------------------------------------------------------------------------------
(3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11 (Set forth the amount on which the
filing fee is calculated and state how it was determined):
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(4) Proposed maximum aggregate value of transaction:
- --------------------------------------------------------------------------------
(5) Total fee paid:
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[X] Fee paid previously with preliminary materials.
* Set forth the amount on which the filing fee is calculated and state how
it was determined.
[ ] Check box if any part of the fee is offset as provided by Exchange Act Rule
0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number,
or the Form or Schedule and the date of its filing.
(1) Amount Previously Paid:
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(2) Form, Schedule or Registration Statement No.:
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(3) Filing Party:
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(4) Date Filed:
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[STAR LOGO]
October , 1998
Dear Stockholder:
You are cordially invited to attend a Special Meeting of Stockholders (the
"Special Meeting") of STAR Telecommunications, Inc., a Delaware corporation
("STAR" or the "Company"), to be held on Tuesday, November 17, 1998 at 9:00
a.m., local time, at 801 Garden Street, Room 203, Santa Barbara, California.
On August 20, 1998, STAR entered into an Amended and Restated Agreement and
Plan of Merger with Sierra Acquisition Co., Inc., a New York corporation and
wholly-owned subsidiary of STAR ("Newco"), PT-1 Communications, Inc., a New York
corporation ("PT-1") and certain stockholders of PT-1 (the "PT-1 Stockholders")
and amended such agreement on September 1, 1998 (as amended, the "Merger
Agreement"), pursuant to which, among other things, Newco will be merged with
and into PT-1 (the "Merger"), PT-1 will survive as a wholly-owned subsidiary of
STAR and the holders of PT-1 common stock, par value $0.01 per share, ("PT-1
Common Stock"), options to acquire PT-1 Common Stock and warrants exercisable
for PT-1 Common Stock, outstanding immediately prior to the effective time of
the Merger, will be entitled to receive an aggregate of 15.05 million shares of
common stock, par value $0.001 per share, of STAR ("STAR Common Stock") and an
aggregate of $19.5 million. The Merger Agreement is attached to this Proxy
Statement as Annex A.
At the Special Meeting, stockholders will be asked to vote to approve the
Merger Agreement and the transactions contemplated thereby, including the
issuance of 15.05 million shares of STAR Common Stock (the "Share Issuance") in
exchange for all the outstanding capital stock of PT-1. As of September 1, 1998,
holders of 50.42% of the outstanding shares of STAR Common Stock have agreed to
vote in favor of the Merger Agreement and the transactions contemplated thereby,
including the Share Issuance.
THE BOARD OF DIRECTORS OF STAR (THE "BOARD") BELIEVES THAT THE MERGER AND
THE TRANSACTIONS RELATED THERETO, INCLUDING, WITHOUT LIMITATION, THE SHARE
ISSUANCE, ARE IN THE BEST INTEREST OF STAR AND ITS STOCKHOLDERS AND UNANIMOUSLY
RECOMMENDS THAT YOU VOTE FOR THE APPROVAL AND ADOPTION OF THE MERGER AGREEMENT
AND THE TRANSACTIONS CONTEMPLATED THEREBY, INCLUDING THE SHARE ISSUANCE. In
connection with the Merger, the Board has received the opinions of STAR's
financial advisors, Hambrecht & Quist LLC and Credit Suisse First Boston
Corporation, to the effect that the consideration to be paid by STAR in the
Merger was fair to the stockholders of STAR from a financial point of view.
Their opinions are attached to this Proxy Statement as Annex B and Annex C,
respectively.
Consummation of the Merger is subject to certain conditions, including the
approval of the Merger Agreement and the Share Issuance by the stockholders of
STAR and the receipt of approvals by certain regulatory authorities. The PT-1
stockholders and the Board of Directors of PT-1 have already voted to approve
the Merger Agreement.
The enclosed Proxy Statement explains in detail the Merger Agreement and
the transactions contemplated thereby. Please carefully review and consider all
of this information. It is especially important that your shares be represented
and voted at the Special Meeting. Although you may currently plan to attend the
meeting, please complete, sign, date and promptly return the enclosed proxy
card. If you attend the Special Meeting and vote in person, your vote will
supersede your proxy.
Only stockholders of record at the close of business on October 13, 1998
are entitled to notice of and to vote at the Special Meeting and any adjournment
thereof.
As always, all of us at STAR truly appreciate your continued support of the
Company.
Sincerely,
Christopher E. Edgecomb
Chairman of the Board
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STAR TELECOMMUNICATIONS, INC.
223 EAST DE LA GUERRA STREET
SANTA BARBARA, CALIFORNIA 93101
NOTICE OF SPECIAL MEETING OF STOCKHOLDERS
TO BE HELD NOVEMBER 17, 1998
TO THE STOCKHOLDERS OF STAR TELECOMMUNICATIONS, INC.:
The Special Meeting of Stockholders (the "Special Meeting") of STAR
Telecommunications, Inc. ("STAR" or the "Company") will be held at 9:00 a.m.,
local time, on Tuesday, November 17, 1998 at 801 Garden Street, Room 203, Santa
Barbara, California, for the following purposes:
1. To vote on the approval and adoption of the Amended and Restated
Agreement and Plan of Merger dated as of August 20, 1998 by and among STAR,
Sierra Acquisition Co., Inc., a New York corporation and wholly-owned
subsidiary of STAR ("Newco"), PT-1 Communications, Inc., a New York
corporation ("PT-1"), and certain stockholders of PT-1, as amended by the
First Amendment dated September 1, 1998, and the transactions contemplated
thereby, pursuant to which, among other things: (i) Newco will merge with
and into PT-1 (the "Merger") and PT-1 will survive as a wholly-owned
subsidiary of STAR and (ii) the holders of common stock, $0.01 par value
per share, of PT-1 ("PT-1 Common Stock"), options to acquire PT-1 Common
Stock and warrants exercisable for PT-1 Common Stock outstanding
immediately prior to the effective time of the Merger will be entitled to
receive an aggregate of 15.05 million shares of common stock, $0.001 par
value per share, of STAR ("STAR Common Stock") and an aggregate of $19.5
million. The Agreement and Plan of Merger is included as Annex A to the
enclosed Proxy Statement.
2. To transact such other business as may properly come before the
meeting or any adjournment or postponement thereof.
The foregoing items of business are more fully described in the Proxy
Statement accompanying this notice. Only stockholders of record of STAR Common
Stock at the close of business on October 13, 1998 will be entitled to notice of
and to vote at the Special Meeting or any adjournment or postponement thereof.
By Order of the Board of Directors
Mary A. Casey
Secretary
October , 1998
Santa Barbara, California
YOU ARE URGED TO VOTE UPON THE MATTERS PRESENTED AND TO SIGN, DATE AND
PROMPTLY RETURN THE ENCLOSED PROXY IN THE ENVELOPE PROVIDED. IT IS IMPORTANT FOR
YOU TO BE REPRESENTED AT THE MEETING. PROXIES ARE REVOCABLE AT ANY TIME PRIOR TO
THE VOTE AND THE EXECUTION OF YOUR PROXY WILL NOT AFFECT YOUR RIGHT TO VOTE IN
PERSON IF YOU ARE PRESENT AT THE MEETING.
Requests for additional copies of proxy materials should be addressed to
Mary A. Casey, Corporate Secretary, at the offices of the Company, 223 East De
La Guerra Street, Santa Barbara, California 93101.
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STAR TELECOMMUNICATIONS, INC.
223 EAST DE LA GUERRA STREET
SANTA BARBARA, CALIFORNIA 93101
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PROXY STATEMENT
SPECIAL MEETING OF STOCKHOLDERS
TO BE HELD NOVEMBER 17, 1998
GENERAL INFORMATION
This Proxy Statement is furnished in connection with the solicitation of
proxies by the Board of Directors (the "Board") of STAR Telecommunications,
Inc., a Delaware corporation ("STAR" or the "Company"), for use at the Special
Meeting of Stockholders (the "Special Meeting") to be held on Tuesday, November
17, 1998 at 9:00 a.m., local time, at 801 Garden Street, Room 203, Santa
Barbara, California, and any adjournment or postponement thereof. This Proxy
Statement and the form of proxy for the Special Meeting were first mailed or
delivered to the stockholders of the Company on or about October 16, 1998.
MATTERS TO BE CONSIDERED
The Special Meeting has been called (1) to vote on a proposal (the
"Proposal") to approve and adopt the Amended and Restated Agreement and Plan of
Merger dated as of August 20, 1998 by and among STAR, Sierra Acquisition Co.,
Inc., a New York corporation and wholly-owned subsidiary of STAR ("Newco"), PT-1
Communications, Inc., a New York corporation ("PT-1"), and certain stockholders
of PT-1 (the "PT-1 Stockholders"), as amended on September 1, 1998 (the "Merger
Agreement"), and the transactions contemplated thereby, pursuant to which, among
other things, Newco will merge with and into PT-1 (the "Merger"), PT-1 will
survive as a wholly-owned subsidiary of STAR and the holders of common stock,
$0.01 par value per share, of PT-1 (the "PT-1 Common Stock"), options to acquire
PT-1 Common Stock and warrants exercisable for PT-1 Common Stock outstanding
immediately prior to the effective time of the Merger, will be entitled to
receive an aggregate of 15.05 million shares of common stock, $0.001 par value
per share, of STAR ("STAR Common Stock") and an aggregate of $19.5 million (the
"Cash Component"); and (2) to transact such other business as may properly come
before the meeting or any adjournment or postponement thereof.
RECORD DATE AND VOTING
The Board has fixed the close of business on October 13, 1998 as the record
date (the "Record Date") for the determination of stockholders entitled to vote
at the Special Meeting and any adjournment or postponement thereof. As of the
Record Date, there were outstanding shares of STAR Common Stock.
QUORUM AND VOTING REQUIREMENTS
The holders of record of a majority of the outstanding shares of STAR
Common Stock entitled to vote at the Special Meeting, present in person or
represented by proxy, will constitute a quorum for the transaction of business
at the Special Meeting. Abstentions are counted for purposes of determining the
presence or absence of a quorum for the transaction of business, whereas broker
non-votes will not be counted for such purpose. As to all matters, each
stockholder is entitled to one vote for each share of STAR Common Stock held.
Abstentions and broker non-votes will have the same effect as a vote against the
proposals presented to stockholders. Approval of the Proposal requires the
affirmative vote of the holders of a majority of the outstanding shares of STAR
Common Stock entitled to vote thereon. As of September 1, 1998, holders of
50.42% of the outstanding shares of STAR Common Stock have agreed to vote in
favor of the Proposal.
All proxies which are properly completed, signed and returned prior to the
Special Meeting will be voted. If a stockholder specifies how the proxy is to be
voted with respect to the Proposal, the proxy will be voted in accordance with
such specifications. Any proposal with respect to which a stockholder fails to
so specify will
1
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be voted in accordance with the following recommendations of the Board: (a) FOR
the Proposal and (b) in their discretion, upon such other business as may
properly come before the meeting. Any proxy given by a stockholder may be
revoked at any time before it is exercised, by filing with the Secretary of the
Company an instrument revoking it, by delivering a duly executed proxy bearing a
later date or by the stockholder attending the Special Meeting and voting his or
her shares in person.
Proxies for the Special Meeting are being solicited by mail directly and
through brokerage and banking institutions. The Company will pay all expenses in
connection with the solicitation of proxies. In addition to the use of mails,
proxies may be solicited by directors, officers and regular employees of the
Company personally or by telephone. The Company does not expect to pay any fees
or compensation for the solicitation of proxies (other than to U.S. Stock
Transfer Corporation, the Company's transfer agent and registrar, in connection
with its services in sending proxy materials, obtaining proxies and attending
the Special Meeting), but may reimburse brokers and other persons holding shares
of STAR Common Stock in their names, or in the names of nominees, for their
expenses in sending proxy materials to the beneficial owners of such shares and
obtaining their proxies.
The STAR Common Stock is quoted on the Nasdaq National Market ("Nasdaq")
under the symbol "STRX." On August 20, 1998, the last full day of trading prior
to the announcement of the execution of the Merger Agreement, the high and low
sale prices of STAR Common Stock, as reported on Nasdaq, was $15.625 and
$14.375, respectively, per share. On , the last trading day prior
to the date of this Proxy Statement, the last reported sale price of the STAR
Common Stock on Nasdaq was $ per share.
All stockholders are urged to complete, sign and promptly return the
enclosed proxy card.
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SEE "RISK FACTORS" BEGINNING ON PAGE 23 FOR A DISCUSSION OF CERTAIN MATTERS
THAT SHOULD BE CONSIDERED BY THE STOCKHOLDERS WITH RESPECT TO THE MERGER.
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THE DATE OF THIS PROXY STATEMENT IS OCTOBER , 1998.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C>
AVAILABLE INFORMATION....................................... 4
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE............. 4
DESCRIPTION OF FORWARD-LOOKING STATEMENTS................... 5
SUMMARY..................................................... 6
The Companies............................................. 6
The Special Meeting....................................... 9
The Merger................................................ 9
The Merger Agreement...................................... 10
Selected Consolidated Financial Data of STAR.............. 14
Selected Consolidated Financial Data of PT-1.............. 16
Comparative Per Share Data................................ 18
Summary Unaudited Pro Forma Financial Data................ 20
RISK FACTORS................................................ 23
THE SPECIAL MEETING......................................... 35
THE MERGER.................................................. 37
General Description....................................... 37
Effective Time of the Merger.............................. 37
Background of the Merger.................................. 37
STAR's Reasons for the Merger............................. 39
Opinions of STAR's Financial Advisors..................... 40
PT-1's Reasons for the Merger............................. 47
The Merger Agreement...................................... 48
Related Agreements........................................ 53
Accounting Treatment of the Merger........................ 54
Federal Income Tax Consequences of the Merger............. 55
Regulatory Approvals...................................... 55
Stock Exchange Listing.................................... 55
Vote Required and Recommendation of the Board............. 55
UNAUDITED PRO FORMA FINANCIAL DATA.......................... 56
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS OF STAR......................... 70
BUSINESS OF STAR............................................ 78
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS OF PT-1......................... 92
BUSINESS OF PT-1............................................ 101
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT OF STAR COMMON STOCK........................... 110
DESCRIPTION OF STAR CAPITAL STOCK........................... 112
OTHER BUSINESS.............................................. 114
SUBMISSION OF STOCKHOLDER PROPOSALS......................... 114
EXCHANGE ACT FILINGS........................................ 114
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS.................. F-1
ANNEXES
ANNEX A: AGREEMENT AND PLAN OF MERGER....................... A-1
ANNEX B: HAMBRECHT & QUIST FAIRNESS OPINION................. B-1
ANNEX C: CREDIT SUISSE FIRST BOSTON FAIRNESS OPINION........ C-1
</TABLE>
3
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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 Securities and Exchange Commission (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 Nasdaq under the symbol "STRX."
The information contained herein with respect to STAR and its affiliates
has been provided by STAR, and the information contained herein with respect to
PT-1 and its affiliates has been provided by PT-1. Any statements contained
herein concerning the contents of any contract, agreement or other document
referred to herein and filed as an annex hereto are not necessarily complete.
With respect to each such contract, agreement or other document, reference is
made to the annex for a more complete description of the matter involved, and
each such statement is qualified in its entirety by such reference.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents, which STAR has filed with the Commission pursuant
to the Exchange Act, are incorporated herein by reference:
(i) Annual Report on Form 10-K for the year ended December 31, 1997;
(ii) Quarterly Report on Form 10-Q for the quarter ended March 31, 1998;
(iii) Quarterly Report on Form 10-Q for the quarter ended June 30, 1998;
and
(iv) Current Report on Form 8-K dated March 25, 1998.
THIS PROXY STATEMENT INCORPORATES DOCUMENTS BY REFERENCE THAT ARE NOT
PRESENTED HEREIN OR DELIVERED HEREWITH. COPIES OF ANY SUCH DOCUMENTS, OTHER THAN
EXHIBITS TO SUCH DOCUMENTS WHICH ARE NOT SPECIFICALLY INCORPORATED BY REFERENCE
THEREIN, ARE AVAILABLE WITHOUT CHARGE TO ANY PERSON TO WHOM THIS PROXY STATEMENT
IS DELIVERED, UPON WRITTEN OR ORAL REQUEST TO MARY A. CASEY, STAR
TELECOMMUNICATIONS, INC., 223 EAST DE LA GUERRA STREET, SANTA BARBARA,
CALIFORNIA 91108, (805) 899-1962. IN ORDER TO ENSURE TIMELY DELIVERY OF THE
DOCUMENTS, ANY REQUEST SHOULD BE RECEIVED BY STAR BY OCTOBER 30, 1998.
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NO PERSON IS AUTHORIZED BY STAR TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATION, OTHER THAN THOSE CONTAINED IN THIS PROXY STATEMENT, IN
CONNECTION WITH THE SOLICITATION MADE BY THIS PROXY STATEMENT AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS SHOULD NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED. THIS PROXY STATEMENT DOES NOT CONSTITUTE THE SOLICITATION OF A
PROXY IN ANY JURISDICTION IN WHICH SUCH SOLICITATION MAY NOT LAWFULLY BE MADE.
THE DELIVERY OF THIS PROXY STATEMENT SHALL NOT IMPLY THAT THERE HAS BEEN NO
CHANGE IN THE INFORMATION SET FORTH HEREIN OR IN THE AFFAIRS OF STAR OR PT-1
SINCE THE DATE HEREOF.
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4
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DESCRIPTION OF FORWARD-LOOKING STATEMENTS
THIS PROXY STATEMENT CONTAINS CERTAIN "FORWARD-LOOKING STATEMENTS" WITHIN
THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED (THE
"SECURITIES ACT"). 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 SHOULD NOT BE REGARDED AS A REPRESENTATION BY STAR, PT-1 OR ANY
OTHER PERSON THAT THE OBJECTIVES OR PLANS OF STAR OR PT-1 WILL BE ACHIEVED OR
THAT ANY OF STAR OR PT-1'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. 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. FORWARD-LOOKING STATEMENTS CONCERNING PT-1,
AND STAR AFTER CONSUMMATION OF THE MERGER, MAY BE DEEMED TO INCLUDE STATEMENTS
IN "SUMMARY," "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS OF PT-1" AND "BUSINESS OF PT-1," INCLUDING STATEMENTS
CONCERNING PT-1'S ABILITY TO INCREASE REVENUES AND GROSS MARGINS AND TO DECREASE
COST OF SERVICES AS A PERCENTAGE OF REVENUES, STATEMENTS CONCERNING FUTURE
GROWTH IN THE DEMAND FOR PREPAID CARDS, THE INTRODUCTION OF NEW PRODUCTS AND
SERVICES, THE FUTURE OF THE TELECOMMUNICATIONS INDUSTRY AND PT-1'S PLANS TO
EXPAND ITS DISTRIBUTION NETWORKS. 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, BEGINNING ON PAGE 23, OR
ELSEWHERE IN THIS PROXY STATEMENT. NEITHER STAR NOR PT-1 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 OR PT-1'S OPERATING STRATEGY.
5
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SUMMARY
This summary highlights selected information from this Proxy Statement 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. Stockholders should also carefully consider the information set forth
below in "Risk Factors."
THE COMPANIES
STAR AND NEWCO
STAR Telecommunications, Inc. ("STAR" or the "Company") 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 $58.9 million in 1995 to $404.6 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 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 and Dallas; London, England; and Dusseldorf, Frankfurt,
Hamburg and Munich, Germany. In 1998, STAR plans to put into service switches in
Atlanta, Chicago, Miami and Seattle; Paris, France; Geneva, Switzerland; and
Vienna, Austria. 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, including TPC-5, Gemini and AC-1, has recently entered into
a commitment to acquire transmission capacity on the Qwest domestic Macro
Capacity(SM) Fiber Network, which is expected to serve over 130 cities in the
U.S., and has plans to continue to acquire transmission capacity on additional
undersea fiber optic cable systems.
STAR was incorporated in Nevada in September 1993 as STAR Vending, Inc. and
was reincorporated in Delaware as STAR Telecommunications, Inc. in April 1997.
Sierra Acquisition Co., Inc. ("Newco"), which is a wholly-owned subsidiary
of STAR, was incorporated in New York on June 8, 1998 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 and Newco's executive offices are located at 223 East De La Guerra
Street, Santa Barbara, California 93101. Their telephone number at that location
is (805) 899-1962.
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PT-1
PT-1 is a leading emerging provider of international long distance services
to retail customers and telecommunications carriers. PT-1 currently provides its
retail services primarily by marketing prepaid telephone calling cards ("Prepaid
Cards"), primarily under the PT-1 brand name, through an extensive network of
distributors and believes that its Prepaid Cards are sold in more than 50,000
independent retail outlets throughout the United States. PT-1 targets retail
markets with substantial international long distance calling requirements, and
believes that its Prepaid Cards provide consumers with a convenient,
attractively priced alternative to traditional presubscribed long distance
services. During March 1998, PT-1 began to market both "dial around" and
presubscribed long distance service to retail customers in certain target
markets that also have substantial international long distance calling needs.
Over the past several months, PT-1 has also increased the amount of resources
devoted to obtaining commercial retail customers with significant international
long distance requirements. PT-1 believes that it is the ninth largest provider
of long distance services to retail customers in the United States based upon
revenues for the fiscal year ended March 31, 1998. During that period, PT-1
generated revenues and net income of $431.5 million and $11.6 million,
respectively. For the three months ended June 30, 1998 and June 30, 1997 PT-1
generated revenues of $139.7 million and $87.2 million, respectively.
PT-1 was founded in April 1995 to capitalize on the growing market for
international long distance services. PT-1 initially entered the retail
international long distance market through the distribution of Prepaid Cards
targeted at ethnic communities. After building significant international
traffic, in 1996 PT-1 began to negotiate reduced transmission rates based upon
volume with underlying carriers and began to invest in switching equipment and
lease transmission capacity to further reduce its cost of service as a
percentage of revenues. In August 1996, PT-1 began to leverage its significant
volume of international traffic by selling international long distance services
on a wholesale basis to other carriers. For the fiscal year ended March 31,
1998, revenues from retail sales and from wholesale sales were $356.3 million
and $75.2 million, respectively.
PT-1 believes its competitive strengths are its (i) established Prepaid
Card brand names, (ii) extensive distribution infrastructure, including more
than 50,000 retail outlets, (iii) substantial experience in identifying,
targeting and marketing to communities and markets with significant
international long distance usage, (iv) position as a leading provider of
telecommunications traffic to various international destinations and (v)
efficient telecommunications network. PT-1 believes that its competitive
strengths will enable it to continue to profitably increase its retail customer
base and its traffic volume and negotiate lower telecommunications costs.
PT-1's retail customers can use its Prepaid Cards at any touch tone
telephone by dialing an access number, followed by a personal identification
number (a "PIN") assigned to each Prepaid Card and the telephone number the
customer wishes to reach. PT-1's switches complete the call, and its debit card
platform ("Debit Card Platform") reduces the Prepaid Card balance during the
call. PT-1 offers Prepaid Cards that can be used to access PT-1's network by
dialing an 800 number or, in specific metropolitan markets, local area calling
cards ("LAC Cards") that only require a local call. PT-1 believes that customers
typically use its Prepaid Cards as their primary means of making long distance
calls due to (i) attractive rates, (ii) reliable service, (iii) the ease of
monitoring and budgeting their long distance spending and (iv) the appealing
variety of Prepaid Cards offered by PT-1 to different market segments.
PT-1 currently offers 25 Prepaid Cards in the U.S. and plans to introduce
up to six additional U.S. Prepaid Cards in 1998, including additional LAC Cards
and Prepaid Cards targeted at specific ethnic communities ("Country Calling
Cards"). During the three months ended June 30, 1998, PT-1's eight largest
sources of revenue (in declining order) were from traffic to Mexico, the
Dominican Republic, Colombia, Haiti, Egypt, Jamaica, India and Ecuador. In July
1995, PT-1 introduced its first Prepaid Card, The PT-1 Card, targeted initially
at ethnic communities in the New York metropolitan area. PT-1 issued its first
LAC Card, The New York Phone Card in July 1996. PT-1 currently has 11 LAC Cards
(The New Jersey Phone Card, The New York Phone Card, The Florida Card, The
Boston Card, The California Card, The Diamond Direct Card, The Payless Direct
Card, The Detroit Card, The Connecticut Card, The Chicago Card and The
D.C.-Maryland-Virginia Card), and the Alo Brasil, Hola Mexico and Hola Dominican
Republic Country
7
<PAGE> 11
Calling Cards, aimed at the Brazilian, Mexican and Dominican Republic
communities in the U.S., as well as The PT-1 Worldwide Phone Card and other
Prepaid Cards. In June 1998, PT-1 opened offices in Toronto, Canada, and Puerto
Rico and began offering additional Prepaid Cards targeted at international
calling communities in those areas.
As of June 30, 1998, PT-1's telecommunications network included (i) four
Nortel DMS250 Supernode switches, located in Edison, New Jersey (installed in
November 1996 and operated for PT-1 by a third party), Flushing, New York
(installed in August 1997), Jersey City, New Jersey (installed in November 1997)
and Miami, Florida (installed in December 1997), (ii) Debit Card Platforms
located in Edison, New Jersey (owned and operated for PT-1 by a third party),
Jersey City, New Jersey and Flushing, New York, (iii) network points-of-presence
("POPs") in approximately 100 cities in over 25 states and (iv) leased
transmission lines connecting the network POPs with PT-1's switches. PT-1
purchases transmission capacity from more than 40 local, domestic and
international long distance carriers, including STAR under various arrangements
(including leased line, fixed cost arrangements and per-minute resale
arrangements).
PT-1's strategic objective is to strengthen its position as the leading
provider in the U.S. of long distance service to end users through the sale and
distribution of Prepaid Cards and to expand further its presence in the retail
segment of the commercial long distance market. PT-1's strategy for achieving
this goal has the following key elements:
Continue to Target Consumers with Significant International Long Distance
Usage. PT-1 primarily targets consumers with significant international long
distance usage by delivering reliable international long distance services at
attractive rates. PT-1 believes that the international long distance market
provides an appealing opportunity because of its higher revenues and gross
profits per minute and its higher expected growth rate relative to the domestic
long distance market. PT-1 believes its brand awareness, its large number of
international retail customers and its international network traffic and
infrastructure will enable it to continue to successfully market international
long distance service originating in countries in North America, Latin America,
Europe and in other countries to which PT-1's domestic customers direct a
substantial volume of calls.
Increase Retail Distribution of PT-1's Products. PT-1 estimates that its
Prepaid Cards are currently sold in more than 50,000 independent retail outlets,
providing customers with convenient access to PT-1's services. PT-1 intends to
increase this retail distribution infrastructure by expanding the number of
distributors and retail outlets within existing geographic markets, entering new
geographic markets and by bringing certain of its distributors in-house. PT-1
initially concentrated its marketing and distribution efforts in the New York
metropolitan area but has expanded and is continuing to expand its market
penetration in other regions of the U.S. with significant ethnic population and,
more recently, in Canada and Puerto Rico.
Expand Offerings of Retail Products and Services. PT-1 intends to introduce
new LAC Cards in additional metropolitan areas, offer additional Country Calling
Cards and market other innovative Prepaid Cards, further segmenting the Prepaid
Card market. PT-1 also intends to grow its dial around and presubscribed long
distance services. PT-1 believes that its brand awareness, large number of
international retail customers and its ability to provide attractively priced
long distance services will enable it to successfully market convenient,
attractively priced dial around and presubscribed long distance service to new
and existing customers.
Expand PT-1's International Telecommunications Network. After consummation
of the Merger, PT-1 intends to continue to expand the international reach of its
telecommunications network through STAR's network expansion and by co-locating
with STAR's switch facilities. In particular, PT-1 intends to piggyback on
STAR's international network expansion into the U.K., Germany and additional
European cities, including Paris, Vienna and Geneva.
PT-1's principal executive offices are located at 30-50 Whitestone
Expressway, Flushing, New York 11354, and its telephone number at that location
is (718) 939-9000.
8
<PAGE> 12
THE SPECIAL MEETING
PURPOSE
At the Special Meeting, the stockholders will be asked to approve and adopt
the Merger Agreement and the transactions contemplated thereby, including the
issuance of 15.05 million shares of STAR Common Stock in exchange for all of the
outstanding capital stock of PT-1 (the "Share Issuance"), 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 801 Garden Street, Room 203, Santa
Barbara, California, on Tuesday, November 17, 1998, at 9:00 a.m. local time.
RECORD DATE; QUORUM; VOTES REQUIRED
The Board has fixed the close of business on October 13, 1998 as the Record
Date for determination of stockholders entitled to vote at the Special Meeting
and any adjournment thereof. As of the Record Date, there were outstanding
shares of STAR Common Stock. The presence, in person or by proxy,
of holders of record of a majority of the issued and outstanding shares of STAR
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, including the Share Issuance, will require the affirmative
vote of the holders of record of a majority of all outstanding shares of STAR
Common Stock. As of September 1, 1998, holders of 50.42% of the outstanding
shares of STAR Common Stock have agreed to vote in favor of the Proposal. See
"The Special Meeting."
THE MERGER
REASONS FOR THE MERGER
The Board has unanimously approved the Merger Agreement and the
transactions contemplated thereby for several reasons. Among other things, the
Board believes that the acquisition of PT-1 will (a) continue STAR's expansion
into the retail segment of the commercial long distance market, and create for
STAR an entrance into the growing Prepaid Card market, (b) create one of the
largest facilities-based long distance telecommunications companies in the U.S.,
(c) enable STAR to accelerate its development of its international
telecommunications network and (d) allow for the immediate use of the STAR
network by PT-1 customers. In reaching a decision to recommend the Merger, the
Board considered a number of factors in addition to those set forth above. See
"The Merger -- STAR's Reasons for the Merger" and "-- Vote Required and
Recommendation of the Board." No assurances can be made, however, that the
Merger will be successful for STAR or that any of the above-referenced strategic
advantages will be realized.
RECOMMENDATIONS TO STOCKHOLDERS
THE BOARD BELIEVES THAT THE MERGER IS FAIR AND IN THE BEST INTERESTS OF
STAR AND ITS STOCKHOLDERS AND UNANIMOUSLY RECOMMENDS THAT THE STOCKHOLDERS VOTE
FOR THE PROPOSAL TO APPROVE AND ADOPT THE MERGER AGREEMENT AND THE TRANSACTIONS
CONTEMPLATED THEREBY, INCLUDING THE SHARE ISSUANCE. SEE "THE MERGER -- STAR'S
REASONS FOR THE MERGER" AND "-- VOTE REQUIRED AND RECOMMENDATION OF THE BOARD."
OWNERSHIP OF STAR AFTER THE MERGER
As a result of the Merger, an aggregate of 15.05 million shares of STAR
Common Stock will be available for issuance to the stockholders of PT-1 or will
be reserved for issuance with respect to options and warrants to purchase PT-1
Common Stock outstanding at the time of the Merger (the "PT-1 Options" and "PT-1
9
<PAGE> 13
Warrants", respectively), which will be assumed by STAR. The number of shares of
STAR Common Stock issuable as a result of the Merger will constitute
approximately 26.6% (on a fully diluted basis) of the outstanding STAR Common
Stock after the Merger. See "The Merger -- The Merger Agreement."
MANAGEMENT AND OPERATIONS OF PT-1 FOLLOWING THE MERGER
It is contemplated that after the Merger, PT-1 will continue to operate as
a separate entity. The Company does not currently intend to change the domicile,
name or material operations of PT-1. The Company has advised PT-1, however, that
Christopher E. Edgecomb, Mary A. Casey, Kelly D. Enos, Samer Tawfik and Peter M.
Vita will be named as the Directors of PT-1. The Company currently intends that
substantially all of the existing officers of PT-1 will retain their offices
with PT-1 or will be appointed as officers of STAR after the Effective Time, but
may also appoint additional officers of PT-1 from time to time.
OPINIONS OF STAR'S FINANCIAL ADVISORS
In connection with the Merger, the Board has received the opinions of its
financial advisors, Hambrecht & Quist LLC ("Hambrecht & Quist") and Credit
Suisse First Boston Corporation ("CSFB"), as to the fairness of the
consideration to be paid by STAR in the Merger to the stockholders of STAR from
a financial point of view. Their opinions are attached to this Proxy Statement
as Annex B and Annex C, respectively. All stockholders are encouraged to read
these opinions in their entirety as they contain the assumptions made, the
procedures followed, the other matters considered and the limits of the review
conducted by Hambrecht & Quist and CSFB in arriving at their respective
opinions.
For purposes of delivering their opinions, Hambrecht & Quist and CSFB each
performed a variety of analyses, including comparing the financial multiples of
PT-1 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 PT-1 and
STAR based upon historical and projected future financial performance and
anticipated benefits of the Merger as provided by the management of PT-1 and
STAR. See "The Merger -- Opinions of STAR's Financial Advisors."
ACCOUNTING TREATMENT
The Merger will be accounted for by STAR under the purchase method of
accounting in accordance with Accounting Principles Board Opinion No. 16,
"Business Combinations" ("APB No. 16"). Under this method of accounting, the
purchase price will be allocated to assets acquired and liabilities assumed
based on their estimated fair values. A representative of Arthur Andersen LLP
("Arthur Andersen"), STAR's independent public accountants, will be available at
the Special Meeting to respond to appropriate questions. See "The
Merger -- Accounting Treatment of the Merger."
FEDERAL INCOME TAX CONSEQUENCES
The Merger will not have any U.S. federal, state or local income tax effect
on STAR or any stockholder of STAR. See "The Merger -- Federal Income Tax
Consequences of the Merger."
THE MERGER AGREEMENT
A copy of the Merger Agreement is attached as Annex A to this Proxy
Statement. 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 herein is qualified
in its entirety by the full text thereof.
10
<PAGE> 14
TERMS OF THE MERGER AGREEMENT
The Merger Agreement provides that, following the approval and adoption of
the Merger Agreement and the transactions contemplated thereby, including the
Share Issuance, by the stockholders of STAR and the satisfaction or waiver of
certain other conditions, Newco will be merged with and into PT-1. As a result,
PT-1 will survive as a wholly-owned subsidiary of STAR after the Merger. The
Merger will become effective (the "Effective Time") when a certificate of merger
(the "Certificate of Merger") is accepted for filing by the Department of State
of the State of New York. See "The Merger -- The Merger Agreement."
MERGER CONSIDERATION
As a result of the Merger, the holders of PT-1 Common Stock, options to
acquire PT-1 Common Stock and warrants exercisable for PT-1 Common Stock
outstanding immediately prior to the Effective Time will be entitled to receive
an aggregate of 15.05 million shares of STAR Common Stock and an aggregate of
$19.5 million. No fractional shares will be issued. Instead, PT-1 stockholders
will receive cash in lieu of any fractional shares of 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 THE STOCKHOLDERS WILL
BE DEEMED APPROVAL OF THE SHARE ISSUANCE AND THE EXCHANGE RATIO.
ASSUMPTION OF PT-1 STOCK OPTIONS AND WARRANTS
At or prior to the Effective Time, STAR and PT-1 will take all action
necessary to cause the assumption by STAR as of the Effective Time of the PT-1
Options and PT-1 Warrants. Each of the PT-1 Options and PT-1 Warrants will 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 on
substantially equivalent terms as of the Effective Time. See "The Merger -- The
Merger Agreement -- Treatment of PT-1 Stock Options and Warrants."
ISSUANCE OF STAR COMMON STOCK AND OPTIONS FOLLOWING THE MERGER
It is a condition to the obligation of PT-1 and the PT-1 Stockholders to
effect the Merger that STAR reserve (i) 250,000 shares of STAR Common Stock for
issuance to selected distributors of PT-1 in the form of restricted shares and
(ii) 100,000 shares of STAR Common Stock for issuance to selected employees of
PT-1 in the form of options.
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 approval and adoption of the Merger Agreement and the
transactions contemplated thereby by holders of record of a majority of the
issued and outstanding shares of STAR Common Stock entitled to vote thereon
at the Special Meeting;
(b) the approval for listing on Nasdaq of the STAR Common Stock
issuable to the stockholders of PT-1 pursuant to the Merger Agreement; and
(c) the approval of governmental authorities, including the Federal
Communications Commission (the "FCC"), state public utility commissions
("PUCs") and all applicable foreign telecommunications regulatory entities
(the "Foreign Agencies"), required for the transfer of ownership or control
of PT-1.
Certain conditions to the Merger may be waived by the party entitled to
assert the condition. See "The Merger -- The Merger Agreement -- Conditions."
11
<PAGE> 15
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 Foreign Agencies with
respect to the Merger. STAR and PT-1 have made the necessary filings with these
government agencies. See "The Merger -- Regulatory Approvals."
ACQUISITION PROPOSALS
Pursuant to the Merger Agreement, and subject to certain conditions and
exceptions, PT-1 and the PT-1 Stockholders have agreed that PT-1, its subsidiary
and the PT-1 Stockholders will not, 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 or access to, any corporation,
partnership, person or other entity or group (other than STAR or Newco)
concerning an offer or proposal for a merger or other business combination
involving PT-1 or any of its subsidiaries, or the acquisition of any equity
interest in, or a substantial portion of the assets of, PT-1 or any subsidiary,
other than the transactions contemplated by the Merger Agreement. See "The
Merger Agreement -- Acquisition Proposals."
TERMINATION OF THE MERGER AGREEMENT
STAR and PT-1 may agree, by mutual written consent, to terminate the Merger
Agreement without completing the Merger. Moreover, either STAR or PT-1 may
terminate the Merger Agreement if, among other things, any of the following
occurs:
(a) 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
(b) the Merger is not completed on or before March 31, 1999, or on or
before June 30, 1999, provided that all other conditions to the
consummation of the Merger have been satisfied other than the receipt of
all necessary approvals with respect to all material filings made with the
FCC, PUCs and Foreign Agencies; provided that neither party may terminate
the Merger Agreement if such failure has been caused by that party's
material breach of the Merger Agreement; provided further 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 government or 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.
PT-1 may also terminate the Merger Agreement if there occurs a material
adverse change in the financial condition, results of operations, business or
properties of STAR, except for changes caused by a general change in the economy
of the United States or in the telecommunications industry served by STAR. STAR
may terminate the Merger Agreement if there has occurred a material adverse
change in the financial condition, results of operations, business or properties
of PT-1, other than any change arising from any action authorized, directed or
otherwise approved by STAR pursuant to the Merger Agreement or from STAR's
express refusal to approve any action proposed by PT-1 and except for any change
caused by a general change in the economy of the United States or in the
telecommunications industry served by PT-1.
TERMINATION FEE
The Merger Agreement requires PT-1 to pay to STAR, in certain instances, a
termination fee of $20 million following the termination of the Merger
Agreement. See "The Merger -- The Merger Agreement -- Termination Fee."
12
<PAGE> 16
RELATED AGREEMENTS
In connection with the execution of the Merger Agreement, the parties
thereto agreed to enter into certain additional related agreements, including a
registration rights and restricted share agreement, shareholders agreement,
escrow agreement and employment and non-competition agreements. See "The
Merger -- Related Agreements."
RISK FACTORS
The information set forth under "Risk Factors" should be reviewed and
carefully considered by the stockholders in evaluating the Merger Agreement and
the Share Issuance.
OTHER BUSINESS
The stockholders may be asked to vote upon such other business as may
properly come before the Special Meeting.
13
<PAGE> 17
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. 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. The consolidated statement of operations data for the
year ended December 31, 1994 and the consolidated balance sheet data at December
31, 1994 and June 30, 1997 are unaudited and are derived from unaudited
financial statements not included in this Proxy Statement. The consolidated
balance sheet data at December 31, 1995 is derived from audited financial
statements not included in this Proxy Statement. The consolidated statements of
operations data for the six months ended June 30, 1997 and 1998 and the
consolidated balance sheet data at June 30, 1998 are unaudited and are derived
from unaudited financial statements included elsewhere in this Proxy Statement.
Although incorporated in 1993, STAR did not commence business until 1994.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------------------- -------------------
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:
Revenues.................................... $24,512 $58,937 $259,697 $404,605 $180,077 261,198
Cost of services............................ 16,042 44,270 225,957 351,821 156,612 224,470
------- ------- -------- -------- -------- --------
Gross profit.............................. 8,470 14,667 33,740 52,784 23,465 36,728
Operating expenses:
Selling, general and administrative....... 5,066 10,452 35,956 36,496 16,220 22,931
Depreciation and amortization............. 106 368 1,442 4,637 1,813 4,616
Merger expense............................ -- -- -- 286 -- 314
------- ------- -------- -------- -------- --------
Total operating expenses.................. 5,172 10,820 37,398 41,419 18,033 27,861
------- ------- -------- -------- -------- --------
Income (loss) from operations............. 3,298 3,847 (3,658) 11,365 5,432 8,867
Other income (expense):
Interest income........................... 3 22 110 492 74 1,672
Interest expense.......................... -- (64) (609) (1,738) (836) (1,340)
Legal settlements and expenses............ -- -- (100) (1,653) -- --
Other..................................... (7) (33) 39 208 (705) (258)
------- ------- -------- -------- -------- --------
Income (loss) before provision for income
taxes................................... 3,294 3,772 (4,218) 8,674 3,965 8,941
Provision for income taxes.................. 22 66 577 2,905 1,151 3,831
------- ------- -------- -------- -------- --------
Net income (loss)........................... $ 3,272 $ 3,706 $ (4,795) $ 5,769 $ 2,814 $ 5,110
======= ======= ======== ======== ======== ========
Pro forma net income (loss)
(unaudited)(1)............................ $ 1,943 $ 2,140 $ (5,738) $ 5,574 $ 2,384
======= ======= ======== ======== ========
Income per share(2)......................... $ 0.18 $ 0.19 $ (0.21) $ 0.19 $ 0.10 $ 0.14
======= ======= ======== ======== ======== ========
Diluted income per share(2)................. $ 0.18 $ 0.19 $ (0.21) $ 0.17 $ 0.10 $ 0.13
======= ======= ======== ======== ======== ========
Pro forma income (loss) per share
(unaudited)(2)............................ $ 0.11 $ 0.11 $ (0.25) $ 0.18 $ 0.09
======= ======= ======== ======== ========
Pro forma diluted income (loss) per share
(unaudited)(2)............................ $ 0.11 $ 0.11 $ (0.25) $ 0.17 $ 0.08
======= ======= ======== ======== ========
Weighted average number of common shares
outstanding(2)............................ 18,218 19,373 23,292 30,221 27,304 37,640
Weighted average number of diluted common
shares outstanding(2)..................... 18,218 19,373 23,292 32,978 28,900 39,649
OTHER CONSOLIDATED FINANCIAL AND OPERATING
DATA:
EBITDA(3)................................... $ 3,397 $ 4,182 $ (2,277) $ 14,557 $ 6,540 $ 13,225
Capital expenditures(4)..................... 515 2,716 13,646 25,422 9,799 69,944
Wholesale billed minutes of use(5).......... -- 38,106 479,681 863,295 361,178 644,169
Wholesale revenue per billed minute of
use(6).................................... $ -- $0.4102 $ 0.4288 $ 0.3997 $ 0.4208 $ 0.3500
</TABLE>
14
<PAGE> 18
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
------------------------------------------- -------------------
1994 1995 1996 1997 1997 1998
----------- ------- -------- -------- -------- --------
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Working capital (deficit)...................... $ 2,135 $ 976 $ (7,729) $ 13,760 $ 23,182 $123,952
Total assets................................... 9,081 26,582 63,054 120,316 98,865 317,927
Total long-term liabilities, net of current
portion...................................... 21 919 6,839 12,970 10,225 27,775
Retained earnings (deficit).................... 1,377 867 (7,272) (2,500) (5,053) 2,610
Stockholders' equity........................... 2,956 3,808 6,897 43,201 40,137 199,509
</TABLE>
- ---------------
(1) The pro forma net income or loss per share assumes that both STAR and L.D.
Services, Inc. ("LDS"), which was acquired by STAR on November 30, 1997, had
been C-Corporations for all periods presented.
(2) 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 income and pro forma income (loss) per share.
(3) 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.
(4) Includes assets financed with capital leases or notes. See Note 2 of Notes
to STAR Consolidated Financial Statements.
(5) Does not include wholesale billed minutes of use from T-One Corp. ("T-One")
prior to the T-One merger in March 1998.
(6) Represents wholesale gross call usage revenue per billed minute. Amounts
exclude other revenue related items such as finance charges. This data does
not include wholesale billed minutes of use from T-One prior to the T-One
merger in March 1998.
15
<PAGE> 19
SELECTED CONSOLIDATED FINANCIAL DATA OF PT-1 COMMUNICATIONS, INC.
The following selected financial data should be read in conjunction with
PT-1's Consolidated Financial Statements and Notes thereto and with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations of PT-1," each of which is included elsewhere in this Proxy
Statement. The consolidated statements of operations data for the period ended
March 31, 1996 and for the fiscal years ended March 31, 1997 and 1998, and the
balance sheet data at March 31, 1997 and 1998 have been derived from PT-1's
audited financial statements and notes thereto, which are included elsewhere in
this Proxy Statement. The consolidated statements of operations data for the
three months ended June 30, 1998 and 1997 and the consolidated balance sheet
data at June 30, 1998 and 1997 are unaudited and are derived from unaudited
financial statements included elsewhere in this Proxy Statement.
<TABLE>
<CAPTION>
PERIOD FROM FISCAL YEARS ENDED THREE MONTHS
APRIL 21, 1995 MARCH 31, ENDED JUNE 30,
(INCEPTION)(1) TO -------------------- -------------------
MARCH 31, 1996 1997 1998 1997 1998
----------------- -------- --------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AND
PER MINUTE AMOUNTS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENTS OF OPERATIONS
DATA:
Revenues(2)............................ $11,922 $169,635 $ 431,520 $ 87,235 $139,704
Cost of services....................... 13,812 166,184 395,501 80,803 131,983
------- -------- --------- -------- --------
Gross profit (loss).................. (1,890) 3,451 36,019 6,432 7,723
Operating expenses:
Selling general and administrative... 1,017 4,300 15,063 2,261 7,526
Depreciation and amortization........ 5 75 1,535 129 817
Stock based compensation(3).......... -- 7,300 2,661 1,050 272
------- -------- --------- -------- --------
Total operating expenses..... 1,022 11,675 19,259 3,440 8,615
Operating profit (loss)................ (2,912) (8,224) 16,760 2,992 (892)
Earnings (loss) before income taxes.... (2,910) (8,120) 16,730 2,972 (1,009)
Income tax provision (benefit)......... -- -- 5,150 (190) (357)
Net earnings (loss).................... $(2,910) $ (8,120) $ 11,580 $ 3,162 $ (652)
======= ======== ========= ======== ========
Net earnings (loss) per share(4)
Basic................................ $ (.05) $ (.13) $ .25 $ .07 $ (.01)
Diluted.............................. (.05) (.13) .24 .07 (.01)
Weighted average number of common
shares and common share
equivalents(4):
Basic................................ 60,900 60,681 46,922 45,419 48,406
Diluted.............................. 60,900 60,681 47,720 46,200 48,406
OTHER FINANCIAL AND OPERATING DATA:
EBITDA(5).............................. $(2,907) $ (8,149) $ 18,769 $ 3,253 $ 573
Capital expenditures................... $ 74 $ 1,489 $ 21,255 $ 1,636 $ 11,257
Number of PINs activated............... N/A 31,087 60,688 13,168 14,875
Billed minutes of use(6)............... 38,977 615,006 1,676,619 316,058 609,346
Revenues per billed minute of use(2)... .31 .28 .26 .28 .23
</TABLE>
16
<PAGE> 20
<TABLE>
<CAPTION>
AS OF MARCH 31, AS OF JUNE 30,
---------------------------------------- -------------------
1996 1997 1998 1997 1998
----------------- -------- --------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.............. 694 5,577 $ 12,390 5,391 3,334
Working capital (deficit).............. (3,064) (17,426) (21,720) (16,415) (32,348)
Property and equipment, net............ 69 1,484 22,609 3,032 33,299
Total assets........................... 2,186 18,899 87,677 31,652 93,738
Long term debt, less current portion... -- 5,000 8,254 5,000 8,254
Total shareholders' (deficiency)....... (2,907) (18,727) (1,221) (14,515) (1,668)
</TABLE>
- ---------------
(1) PT-1 was incorporated in New York on April 21, 1995 and had limited
operations until July 1995.
(2) Revenues are recorded net of distributor discounts and are not necessarily
comparable to other telecommunications carriers.
(3) Relates to (i) the grant to Joseph Pannullo, an executive officer of PT-1,
on May 9, 1997, of options to purchase 1,048,600 shares of PT-1 Common Stock
exercisable at a nominal price; (ii) the grant to certain other employees of
PT-1 of options to purchase shares of PT-1 Common Stock with a value of
$850,000, exercisable at a nominal price; (iii) the grant to Helene Kidary,
an employee, on September 30, 1997, of options to purchase 10,000 shares of
PT-1 Common Stock exercisable at a nominal price; (iv) warrants issued to
certain employees of InterExchange, Inc. ("InterExchange") to acquire shares
of PT-1 Common Stock with a fair value of $3 million at an aggregate
exercise price of $1.0 million, and (v) the issuance of shares on March 31,
1997 to two officers of PT-1 in accordance with commitments made in July
1995 and March 1996, the dates they joined PT-1. Such shares were issued in
connection with the settlement agreement dated March 27, 1997. See Notes 5
and 8 of Notes to PT-1's Consolidated Financial Statements.
(4) See Note 1 to the PT-1 Financial Statements for an explanation of the method
used to determine the number of shares used in computing net earnings (loss)
per share and weighted average number of common shares and common share
equivalents.
(5) 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, is not necessarily
comparable to EBITDA of other telecommunication companies and does not
necessarily indicate that cash flows are sufficient to fund all of PT-1'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
PT-1's liquidity determined in accordance with generally accepted accounting
principles.
(6) "Billed minutes of use" represents minutes billed by underlying carriers for
terminating PT-1's long distance traffic.
17
<PAGE> 21
COMPARATIVE PER SHARE DATA
The following table presents certain historical, pro forma and pro forma
equivalent per share financial data with respect to shares of PT-1 Common Stock
and STAR Common Stock. Also presented below is pro forma data assuming that
STAR's merger with United Digital Network, Inc. ("UDN") is completed and all
prior STAR financial data has been restated to show the effect of such
transaction on (a) STAR and UDN, separately, and (b) STAR, UDN and PT-1,
collectively. See "Risk Factors -- Risks Inherent in Acquisition Strategy." The
pro forma data does not purport to be indicative of actual results that would
have occurred had the mergers been consummated on such dates or of future
expected results. 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.
<TABLE>
<CAPTION>
PRO FORMA
PRO FORMA PRO FORMA COMBINED
COMBINED COMBINED STAR, UDN
STAR STAR AND STAR AND AND
HISTORICAL(1) UDN(2) PT-1(3) PT-1(4)
------------- --------- --------- ---------
<S> <C> <C> <C> <C>
INCOME (LOSS) PER COMMON SHARE FOR(5)(6):
Year ended December 31, 1995................ $ 0.11 $ 0.05
Year ended December 31, 1996................ $(0.25) $(0.29)
Year ended December 31, 1997................ $ 0.18 $ 0.03 $ 0.27 $ 0.16
Six months ended June 30, 1997.............. $ 0.09 $ 0.05 $(0.01) $(0.03)
Six months ended June 30, 1998.............. $ 0.14 $ 0.11 $ 0.09 $ 0.07
DILUTED INCOME (LOSS) PER COMMON SHARE
FOR(6)(7):
Year ended December 31, 1995................ $ 0.11 $ 0.05
Year ended December 31, 1996................ $(0.25) $(0.29)
Year ended December 31, 1997................ $ 0.17 $ 0.03 $ 0.25 $ 0.15
Six months ended June 30, 1997.............. $ 0.08 $ 0.05 $(0.01) $(0.03)
Six months ended June 30, 1998.............. $ 0.13 $ 0.11 $ 0.09 $ 0.07
BOOK VALUE PER COMMON SHARE AT(8):
June 30, 1998............................... $ -- $ -- $ 0.01 $ 0.01
</TABLE>
- ---------------
(1) The STAR historical per share financial data includes the effect of STAR's
acquisition of T-One, which was completed on March 10, 1998.
(2) The pro forma combined equivalent per share data for STAR and UDN assumes
that STAR's acquisition of UDN has been completed and that all prior STAR
financial data has been restated to show the effect of such transaction.
(3) The pro forma combined STAR and PT-1 per share data assumes that STAR's
acquisition of UDN has not been completed and that the PT-1 acquisition had
occurred on January 1, 1997 for the year ended December 31, 1997 and the six
months ended June 30, 1997 and 1998 and that the PT-1 acquisition had
occurred on June 30, 1998 in the case of book value data at June 30, 1998.
(4) The pro forma combined equivalent per share data for STAR, UDN and PT-1
assumes that STAR's acquisitions of both UDN and PT-1 have been completed
and that all prior financial data has been restated to show the effect of
the merger with UDN and that the PT-1 acquisition had occurred on January 1,
1997 for the year ended December 31, 1997 and the six months ended June 30,
1997 and 1998 and that the PT-1 acquisition had occurred on June 30, 1998 in
the case of book value data at June 30, 1998.
(5) The pro forma combined income (loss) per common share is based on the
applicable exchange ratio and on the combined weighted average number of
shares of STAR Common Stock or common stock, $0.01 par value per share, of
UDN (the "UDN Common Stock"), as the case may be, outstanding for each
period, plus the number of shares of STAR Common Stock issued in the PT-1
acquisition in case of the
18
<PAGE> 22
pro forma combined STAR and PT-1 and pro forma combined STAR, UDN and PT-1
financial data for the year ended December 31, 1997 and the six months ended
June 30, 1997 and 1998.
(6) Assumes that both STAR as well as LDS, which was acquired by STAR in a
pooling of interests transaction on November 30, 1997, were C-Corporations
for all periods presented.
(7) The pro forma combined diluted income (loss) per common share are based on
the applicable exchange ratio and on the combined weighted average number of
common and dilutive common equivalent shares of STAR Common Stock or UDN
Common Stock, as the case may be, outstanding for each period plus the
number of shares of STAR Common Stock issued in the PT-1 acquisition in case
of the pro forma combined STAR and PT-1 and pro forma combined STAR, UDN and
PT-1 financial data for the year ended December 31, 1997 and the six months
ended June 30, 1997 and 1998.
(8) The historical book value per common share of STAR is computed by dividing
stockholders' equity by the number of shares of STAR Common Stock
outstanding at June 30, 1998. The pro forma combined book value per common
share is computed by dividing pro forma stockholders' equity by the sum of
the number of shares of common stock of STAR, UDN outstanding at June 30,
1998 multiplied by the conversion ratio, and the number of shares of STAR
Common Stock to be issued in the Merger, as applicable.
19
<PAGE> 23
SUMMARY UNAUDITED PRO FORMA FINANCIAL DATA
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
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 and should be read in conjunction therewith and with the
related notes thereto. The unaudited pro forma financial data gives effect to
the Merger as if it had occurred on January 1, 1997 in case of the statements of
operations data and as if the Merger had occurred on June 30, 1998 in case of
the balance sheet data. None of the unaudited pro forma financial data set forth
below includes UDN. STAR reports its financial data on the basis of a December
31 fiscal year and PT-1 reports its financial data on the basis of a March 31
fiscal year.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED JUNE 30,
DECEMBER 31, ----------------------
1997 1997 1998
------------- --------- ---------
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<S> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
REVENUES................................................. $786,684 $309,162 $497,828
COST OF SERVICES......................................... 697,881 274,599 442,418
-------- -------- --------
Gross profit........................................... 88,803 34,563 55,410
-------- -------- --------
OPERATING EXPENSES:
Selling, general and administrative.................... 54,926 28,557 36,952
Depreciation and amortization.......................... 9,627 3,761 8,566
-------- -------- --------
Total operating expenses:.............................. 64,553 32,318 45,518
-------- -------- --------
Income (loss) from operations.......................... 24,250 2,245 9,892
-------- -------- --------
OTHER INCOME (EXPENSE):
Interest income........................................ -- -- 1,532
Interest expense....................................... (2,822) (1,375) (2,071)
Legal settlement and expenses.......................... (1,653) -- --
Other income (expense)................................. 682 (611) (40)
-------- -------- --------
Total other income (expense):.......................... (3,793) (1,986) (579)
-------- -------- --------
Income (loss) before provision for income taxes........ 20,457 259 9,313
PROVISION FOR INCOME TAXES (1)........................... 8,546 792 4,731
-------- -------- --------
NET INCOME (LOSS) (1).................................... $ 11,911 $ (533) $ 4,582
======== ======== ========
Earnings (loss) per common share: (1)
Basic.................................................. $ 0.27 $ (0.01) $ 0.09
Diluted................................................ $ 0.25 $ (0.01) $ 0.09
Weighted average number of common shares outstanding:
Basic.................................................. 44,016 41,099 51,435
Diluted................................................ 48,278 41,099 53,149
</TABLE>
<TABLE>
<CAPTION>
JUNE 30,
1998
-----------
(UNAUDITED)
<S> <C>
BALANCE SHEET DATA:
Working capital .......................................... $ 58,103
Total assets.............................................. 519,414
Long term obligations (including current portion)......... 48,552
Stockholders equity....................................... 302,534
</TABLE>
(1) Assumes that both STAR as well as LDS, which was acquired by STAR in a
pooling of interests transaction on November 30, 1997, were C-Corporations
for all periods presented.
20
<PAGE> 24
SUMMARY UNAUDITED PRO FORMA FINANCIAL DATA
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
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 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 acquisition of PT-1 will be accounted for as a
purchase and the UDN 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 statements 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 six months ended June 30, 1997 and
1998, the historical operating results of UDN for the twelve months ended
January 31, 1996, 1997 and 1998 and the six months ended June 30, 1997 and 1998,
respectively, and the effect of the PT-1 acquisition for the year ended December
31, 1997 and the six month periods ended June 30, 1997 and 1998. The balance
sheet data set forth below reflects the combination of the historical balance
sheet data of STAR with the historical balance sheet data of UDN plus the effect
of the PT-1 acquisition as of June 30, 1998. STAR reports its financial data on
the basis of a December 31 fiscal year, and PT-1 reports its financial data on
the basis of a March 31 fiscal year. Through April 30, 1997, UDN reported its
financial data on the basis of an April 30, fiscal year. Subsequently, UDN
changed its fiscal year end to December 31.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30
------------------------------- --------------------
1995 1996 1997 1997 1998
------- -------- -------- -------- --------
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
REVENUES....................................... $64,605 $279,123 $816,710 $323,361 $512,088
COST OF SERVICES............................... 48,569 240,749 721,361 285,370 452,699
------- -------- -------- -------- --------
Gross profit................................. 16,036 38,374 95,349 37,991 59,389
------- -------- -------- -------- --------
OPERATING EXPENSES:
Selling, general and administrative.......... 12,946 40,519 66,470 32,667 41,119
Depreciation and amortization................ 852 2,260 10,637 4,234 9,118
------- -------- -------- -------- --------
Total operating expenses:.................... 13,798 42,779 77,107 36,901 50,237
------- -------- -------- -------- --------
Income (loss) from operations................ 2,238 (4,405) 18,242 1,090 9,152
------- -------- -------- -------- --------
OTHER INCOME (EXPENSE):
Interest income.............................. 10 114 -- -- 1,369
Interest expense............................. (155) (1,057) (3,728) (1,815) (2,404)
Legal settlement and expenses................ -- (100) (1,653) -- --
Other income (expense)....................... (216) 56 276 (611) (207)
------- -------- -------- -------- --------
Total other income (expense):................ (361) (987) (5,105) (2,426) (1,242)
------- -------- -------- -------- --------
Income (loss) before provision for income
taxes...................................... 1,877 (5,392) 13,137 (1,336) 7,910
PROVISION FOR INCOME TAXES..................... 813 1,470 5,930 156 4,130
------- -------- -------- -------- --------
Pro-forma net income (loss) before
extraordinary gain......................... 1,064 (6,862) 7,207 (1,492) 3,780
Extraordinary gain on debt restructuring..... -- -- -- 52 --
------- -------- -------- -------- --------
NET INCOME (LOSS).............................. $ 1,064 $ (6,862) $ 7,207 $ (1,440) $ 3,780
======= ======== ======== ======== ========
Earnings (loss) per common share:
Basic........................................ $ 0.05 $ (0.29) $ 0.16 $ (0.03) $ 0.07
Diluted...................................... $ 0.05 $ (0.29) $ 0.15 $ (0.03) $ 0.07
Weighted average number of common shares
outstanding:
Basic........................................ 19,662 23,730 44,566 41,564 52,038
Diluted...................................... 19,662 23,730 48,828 41,564 55,552
</TABLE>
21
<PAGE> 25
<TABLE>
<CAPTION>
JUNE 30,
1998
------------
(UNAUDITED)
<S> <C>
BALANCE SHEET DATA:
Working capital........................................... $ 47,633
Total assets.............................................. 527,632
Long term obligations (including current portion)......... 50,018
Stockholders equity....................................... 299,488
</TABLE>
- ---------------
(1) Assumes that both STAR as well as LDS, which was acquired by STAR in a
pooling of interests transaction on November 30, 1997, were C-Corporations
for all periods presented.
22
<PAGE> 26
RISK FACTORS
The following risk factors should be considered carefully in addition to
the other information contained in this Proxy Statement in considering whether
to approve and adopt the Merger Agreement and the transactions contemplated
thereby. This Proxy Statement contains, in addition to historical information,
"forward-looking statements" within the meaning of Section 27A of the Securities
Act that involve risks and uncertainties. The Company'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. See "Description of
Forward-Looking Statements." References herein to the products, business,
results of operations, financial condition or other factors affecting the
operations of STAR or PT-1 should be considered to refer to STAR and PT-1
jointly (assuming the consummation of the Merger), unless the context otherwise
requires.
NO ASSURANCE THAT STAR WILL REALIZE ANTICIPATED BENEFITS FROM THE MERGER
STAR's acquisition of PT-1 through the Merger is the most significant
transaction in the history of STAR. The Merger involves the combination of
certain aspects of two companies that have operated independently. The process
of integrating the STAR and PT-1 businesses, operations and employees will
present a significant challenge to STAR's management and may lead to
unanticipated costs. Accordingly, there can be no assurance that PT-1 can be
successfully integrated into STAR or that STAR and its stockholders (including
persons who 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 PT-1 accounting and personnel
administrative functions involves the risk that key employees in those
operations, who can not be easily replaced, will leave even when offered
continuing employment. The integration approach adopted by STAR with respect to
PT-1 requires the devotion of a significant amount of time by senior executives,
which may detract from business operations and the development of the combined
companies.
In considering the Merger, the Board considered, among other things, the
cost savings, operating efficiencies and other synergies expected to result
following the consummation thereof. See "The Merger -- STAR's Reasons for the
Merger" and "-- Vote Required and Recommendation of the Board." There can be no
assurance that any of such cost savings, operating efficiencies or other
synergies will be accomplished as rapidly as currently expected or at all or
that such savings and synergies will not be offset by increases in other
expenses or operating losses, including losses due to problems arising from the
integration of STAR and PT-1.
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. On November 19, 1997, STAR entered into an agreement to acquire
UDN. The acquisition of UDN is subject to the approval of UDN's stockholders and
to various regulatory approvals, and the completion of this acquisition is not a
certainty. On August 20, 1998, STAR entered into the Merger Agreement to acquire
PT-1. The acquisition of PT-1 is subject to the satisfaction of certain
conditions, including the approval of STAR's stockholders and to various
regulatory approvals, any of which could prevent the consummation of the Merger.
These acquisitions, and, most particularly, the Merger, have placed, and will
continue to place, 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. Integrating
acquisitions may require integration of financial and call routing systems,
network and other physical facilities and personnel. Difficulties in integrating
these and other acquisitions can cause system degradation, added costs and loss
of personnel or customers. Additionally, STAR may incur unknown liabilities
despite management's efforts to investigate the operations of the acquired
business. The impact of the risks arising as a result of STAR's acquisition
strategy could adversely affect STAR's operating results.
23
<PAGE> 27
OPERATING RESULTS SUBJECT TO SIGNIFICANT FLUCTUATIONS; LIMITED HISTORY
STAR
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.
PT-1
PT-1 was organized in April 1995 and has only a limited operating history
upon which to evaluate its performance. PT-1's operating results may vary
significantly in the future due to numerous factors, including (i) the timing of
the introduction of new products and services, (ii) changes in U.S. and foreign
legislation and regulation which affect the competitive environment for PT-1's
products and services, (iii) market acceptance of new products and services and
(iv) other competitive conditions. Accordingly, PT-1's prospects must be
considered in light of the risks, expenses, problems and delays inherent in
establishing a new business in a rapidly changing industry, and prior results of
operations should not be relied upon as an indication of PT-1's future
performance. See "-- Ability to Continue and Manage Growth; Commercial
Market -- PT-1;" "Management's Discussion and Analysis of Financial Condition
and Results of Operations of PT-1;" "Business of PT-1 -- Telecommunications
Products and Services" and "-- Competition."
ABILITY TO CONTINUE AND MANAGE GROWTH; COMMERCIAL MARKET
STAR
STAR has increased revenues from $58.9 million in 1995 to $404.6 million in
1997, with revenues increasing in each of the last twelve 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
24
<PAGE> 28
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 acquisitions, such as the Merger. 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, as well as its systems for
ensuring regulatory compliance, all of 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, regulatory, 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" and
"Business of STAR -- Employees."
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.
PT-1
Although PT-1 has experienced substantial growth in revenues since
inception and expects to continue to grow, there can be no assurance that the
growth experienced by PT-1 will continue or that PT-1 will be able to expand its
telecommunications infrastructure, add services, expand its customer bases and
markets, install additional POPs or implement the other features of its business
strategy at the rate or to the extent presently planned. The Prepaid Card
segment of the telecommunications industry is an emerging business with an
increasing and substantial number of new market entrants. These entrants are
seeking to market, advertise and position their products and services as the
preferred method for accessing long distance telephone services. Because the
Prepaid Card segment is an emerging market, demand for and market acceptance of
newly introduced products and services is uncertain. There can be no assurance
that substantial markets will continue to develop for Prepaid Cards or that PT-1
will be able to meet its current marketing objectives, succeed in positioning
its products and services as a preferred method for accessing long distance
telephone services, increase market acceptance of its existing products and
services or achieve significant market acceptance of its new products and
services.
PT-1's recent growth has placed, and is expected to continue to place,
significant demands on all aspects of PT-1's business, including its management,
financial, technical and administrative personnel and its systems. There can be
no assurance that PT-1's systems, procedures and controls and existing office
space will be adequate to support expansion of PT-1's operations. PT-1's future
operating results will substantially depend upon the ability of its executive
officers to manage its growth and to attract and retain additional highly
qualified personnel. In addition, as PT-1 increases its service offerings and
expands its target markets, there will be additional demands on its customer
service support and sales and marketing resources. There can be no assurance
that PT-1 will successfully manage its expanding operations and continued growth
or attract additional personnel, and any failure to do so could have a material
adverse effect on PT-1's business, financial condition or results of operations.
See "Business of PT-1 -- Strategy" and "-- Employees."
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RISKS ASSOCIATED WITH GROWTH OF STAR'S 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 cables 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.
PT-1'S DEPENDENCE ON AND CONCENTRATION OF INDEPENDENT DISTRIBUTORS
PT-1 distributes substantially all of its Prepaid Cards through wholesale
distributors and does not have an internal retail sales department. Accordingly,
its success is significantly dependent upon its ability to recruit, maintain and
motivate a network of independent distributors. A significant element of PT-1's
growth strategy is to increase retail distribution of PT-1's products and
services by expanding its distribution network in existing markets and by
extending this network into new markets. There can be no assurance that PT-1
will be able to continue to effectively recruit, maintain and motivate
independent distributors or to prevent its distributors from marketing other
Prepaid Cards, and, if PT-1 is unable to do so it could have a material adverse
effect on PT-1's business, financial condition and results of operations. See
"Business of PT-1 -- Strategy."
As of March 31, 1998, PT-1's accounts receivable were concentrated among
distributors primarily in the Northeast, with one distributor representing
approximately 30% of the net accounts receivable balance at March 31, 1998.
While PT-1 believes that it could replace this distributor, a loss of this or
other distributors could have a material adverse effect on PT-1's business,
financial condition and 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. Likewise, a substantial majority of PT-1's revenues to
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date have been derived from providing international telecommunications services
to its customers. The international nature of STAR and PT-1'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 and PT-1's businesses could be adversely affected by a reversal in the
current trend toward deregulation of telecommunications carriers. STAR and PT-1
will be increasingly subject to these risks to the extent that STAR and PT-1
proceed with the planned expansion of their international operations.
Risk of Dependence on Foreign Partners. STAR and, in some cases, PT-1 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 and PT-1 may have limited
recourse if their foreign partners do not perform under their contractual
arrangements. STAR and PT-1's arrangements with foreign partners may expose STAR
or PT-1 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 PT-1 or
companies (such as national telephone companies) upon which STAR and PT-1 and
their 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 and PT-1's operations. In
highly regulated countries in which either STAR or PT-1 is not dealing directly
with the dominant local exchange carrier, the dominant carrier may have the
ability to terminate service to either company or its foreign partner and, if
this occurs, STAR or PT-1 may have limited or no recourse. In countries where
competition is not yet fully established and STAR or PT-1 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. Each of STAR and
PT-1's revenues and cost of long distance services are sensitive to foreign
currency fluctuations. STAR and PT-1 expect that an increasing portion of their
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 their
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 and PT-1 are 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 and PT-1 may be exposed to liability under
the FCPA as a result of past or future actions taken without STAR or PT-1's
knowledge by agents, strategic partners and other intermediaries. Such liability
could have a material adverse effect on STAR or PT-1's business, operating
results and financial condition.
POTENTIAL ADVERSE EFFECTS OF GOVERNMENT REGULATION
Each of STAR and PT-1's business is subject to various federal, state and
foreign laws, regulations, agency actions and court decisions. The U.S.
international telecommunications service offerings of STAR and PT-1 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. Each of STAR and PT-1 must file reports,
contracts and tariffs covering interstate service offerings with the FCC and
must pay regulatory fees, which are subject to change. STAR and, in certain
cases PT-1, are 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 or PT-1'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
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could order STAR or PT-1, as the case may be, to terminate noncompliant
arrangements, pay certain fines, or the FCC could revoke either company's
authorizations. Any of these actions could have a material adverse effect on
STAR or PT-1's respective business, operating results or 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. The FCC authority of
STAR and PT-1 currently permits the companies to provide ISR service to Canada,
the U.K., Sweden, New Zealand, Australia, the Netherlands, Germany, France,
Belgium, Denmark, Norway, Austria, Switzerland and Japan. The FCC is currently
reviewing U.S. carrier applications to provide ISR to Finland, Hong Kong and
Mexico, among other routes. Upon grant of any such ISR application to a given
country, the FCC's rules also would permit STAR and PT-1 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 Settlements
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 arrangements 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 and, in certain cases, PT-1, use
both transit and refile arrangements to terminate their 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.
FCC Policies on Use of Pay Phones. A small portion of PT-1's customers use
pay phones to access PT-1's services. The Communications Act requires long
distance carriers such as PT-1 to compensate pay phone owners when a pay phone
is used to originate a telephone call through a toll-free number. Recent
regulations adopted under the Communications Act mandate compensation in the
amount of $0.284 per call, although the basis for this compensation is currently
being reconsidered by the FCC pursuant to a court order. In February 1998, PT-1
began passing these costs on to its customers who use pay phones. However, there
can be no assurance that PT-1 will be able to successfully pass these costs on
to its customers or that these charges will not have a material adverse effect
on PT-1's business, financial condition or results of operations. See "Business
of PT-1 -- Government Regulation."
Recent and Potential FCC Actions. Regulatory action that may be taken in
the future by the FCC may intensify the competition which STAR and PT-1 face,
impose additional operating costs upon them, disrupt certain of their
transmission arrangements or otherwise require either company to modify its
operations. Future FCC action may also provide STAR and PT-1 additional
competitive flexibility by, for example, eliminating or substantially reducing
the tariff requirements applicable to each of the companies' interstate and
international telecommunications services. The FCC is encouraging new market
entrants by implement-
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ing 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 and PT-1's markets. The FCC may increase
regulatory fees charged to STAR and PT-1 and their competitors by eliminating
the exemption for carrier revenues obtained from other carriers for certain fees
or through other actions, which could raise STAR and PT-1's costs of service
without assurance that STAR and PT-1 could pass such fee increases through to
their customers. See "Business of STAR -- Government Regulation" and "Business
of PT-1 -- Government Regulation."
State. The intrastate long distance telecommunications operations of STAR
and its subsidiaries and PT-1 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
and PT-1 apply for certification to provide intrastate telecommunications
services. In most jurisdictions, STAR and PT-1 also must file and obtain prior
regulatory approval of tariffs for intrastate services. Certificates of
authority can generally be conditioned, modified or revoked by state regulatory
authorities for failure to comply with state laws and regulations. Fines and
other penalties, including revocation of a certificate of authority, may be
imposed.
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.
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."
Change of Control. The FCC and numerous state agencies also impose prior
approval requirements if control of a certificated carrier, such as STAR or
PT-1, is transferred to a third party including pro forma transfers of control
and corporate reorganizations, stock issuances and assignments of regulatory
authorizations. As a result, STAR and PT-1 have filed certain notices and
applications with respect to the Merger. While STAR and PT-1 expect to receive
all such approvals that have been requested, there can be no assurance that the
FCC or the regulatory authorities in one or more states will grant the approvals
sought; regulators may also raise material issues with regard to PT-1's
compliance with applicable regulations, including transfer, stock issuance and
similar regulations. See "Business of PT-1 -- Government Regulation."
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 Telecommunication 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. PT-1 is also
subject to regulation in the U.K. and certain other countries in connection with
certain of its business activities.
To the extent that they seek to provide telecommunications services in
other non-U.S. markets, STAR and PT-1 will be subject to the developing laws and
regulations governing the competitive provision of telecommunications services
in those markets. STAR currently plans to provide a limited range of services in
Mexico, Belgium and France, as permitted by regulatory conditions in those
markets, and to expand its
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operations as these markets implement scheduled liberalization to permit
competition in the full range of telecommunications services. The nature, extent
and timing of the opportunity for STAR to compete in these markets will be
determined, in part, by the actions taken by the governments in these countries
to implement competition and the response of incumbent carriers to these
efforts. There can be no assurance that the regulatory regime in these countries
will provide STAR or PT-1 with practical opportunities to compete in the near
future, or at all, or that STAR or PT-1 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; DEPENDENCE ON FACILITIES AND THIRD PARTIES
Any system or network failure that causes interruptions in STAR or PT-1's
operations could have a material adverse effect on their business, financial
condition or results of operations. STAR and PT-1's operations are dependent on
their ability to successfully expand their network and integrate new and
emerging technologies and equipment into their network, which are likely to
increase the risk of system failure and to cause strain upon the networks. STAR
and PT-1's operations also are dependent on each company's ability to protect
its hardware and other equipment from damage from natural disasters such as
fires, floods, hurricanes and earthquakes, other catastrophic events such as
civil unrest, terrorism and war and other sources of power loss and
telecommunications failures. Although STAR and PT-1 have taken a number of steps
to prevent their 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 and PT-1's switches and Debit Card Platforms from becoming disabled in
the event of an earthquake, power outage or otherwise. The failure of STAR or
PT-1'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 and PT-1's relationships with their customers and their business,
operating results and financial condition. See "Business of STAR -- Network" and
"Business of PT-1 -- The Telecommunications Network."
Software and Information Systems. PT-1 uses information systems and
software (including software licensed to PT-1 by GodotSoft, L.L.C.) to provide
information to management, deliver services to its customers, track inventory,
control fraud and monitor system usage. Although PT-1 engages in extensive
testing of its software prior to introduction, there can be no assurance that
errors will not be found in such information systems or software. Any such error
may result in an interruption in telecommunications services or a partial or
total failure of PT-1's network or information systems which could have a
material adverse effect on PT-1's business, financial condition and results of
operations. See "Business of PT-1 -- Information Systems; Debit Card Platforms."
DEPENDENCE ON KEY PERSONNEL
STAR and PT-1'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 and PT-1's operations, in
particular for STAR, Christopher E. Edgecomb, STAR's Chief Executive Officer and
for PT-1, Samer Tawfik, PT-1'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. PT-1 does not maintain key man life
insurance with respect to any of its executive officers. STAR and PT-1 believe
that their future success will depend in large part upon their 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 or PT-1 will be successful in attracting and retaining
such personnel. The loss of the services of one or more of STAR or PT-1's key
individuals, or the failure to attract and retain other key
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personnel, could materially adversely affect STAR or PT-1's respective business,
operating results and financial condition.
SIGNIFICANT COMPETITION
The international telecommunications industry is intensely competitive and
subject to rapid change. STAR and PT-1'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 and PT-1 are unable to predict which technological development will
challenge their competitive positions or the amount of expenditures that will be
required to respond to a rapidly changing technological environment. Further,
the number of competitors is likely to increase as a result of the competitive
opportunities created by a new Basic Telecommunications Agreement concluded by
members of the WTO in February 1997. Under the terms of 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 and PT-1 believe that competition will continue to increase,
placing downward pressure on prices. Such pressure could adversely affect STAR
and PT-1's gross margins if they are not able to reduce their costs commensurate
with such price reductions.
Competition from Domestic and International Companies. A majority of the
U.S.-based international telecommunications services revenue is currently
generated by AT&T Corp. ("AT&T"), MCI Communications Corp. ("MCI") and Sprint
Corporation ("Sprint"). STAR and PT-1 also compete 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 and PT-1. STAR and PT-1's
business would be materially adversely affected to the extent that a significant
number of such customers limit or cease doing business with either STAR or PT-1
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 and PT-1 by reducing
the number of potential customers for such companies' 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 and
in which PT-1 currently competes. 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 or that PT-1 will be able to continue to compete successfully in
the commercial market. See "Business of STAR -- Strategy -- Expand into
Commercial Market."
Competition in the Prepaid Card Market. PT-1 competes with other providers
of Prepaid Cards, including many of the largest telecommunications providers,
such as AT&T, MCI, Sprint and WorldCom. These companies are substantially larger
and have greater financial, technical, engineering, personnel and marketing
resources, longer operating histories, greater name recognition and larger
customer bases than PT-1. PT-1 also competes with smaller, emerging carriers in
both the Prepaid Card retail market and in the wholesale market, including IDT
Corporation, RSL Communications, SmarTalk Teleservices, Inc., Pacific Gateway
Exchange, Inc., FaciliCom International, Inc. and Telegroup, Inc. To the extent
PT-1 begins providing services to customers outside the U.S. market, it may
compete with the large operators such as
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British Telecommunications plc ("BT") in the U.K. PT-1 believes that additional
competitors will be attracted to the Prepaid Card market (including
Internet-based service providers and other telecommunications companies). There
can be no assurance that competition from existing or new competitors or a
decrease in the rates charged for telecommunications services by the major long
distance carriers or other competitors will not have a material adverse effect
on PT-1's business, financial condition and results of operations. See "-- Rapid
Technological Change in the Prepaid Card Market."
FTC INVESTIGATION OF PT-1
In July 1997, PT-1 was notified by the Federal Trade Commission (the "FTC")
and the New York Attorney General's Office (the "NYAG") that it was the subject
of an investigation alleging deceptive advertising practices in connection with
the sale of its Prepaid Cards. Subsequently, the FTC and NYAG indicated that
they were also reviewing whether PT-1 properly decremented minutes from its
Prepaid Cards. PT-1 understands that NYAG has ended its investigation without
taking any action. The FTC has also completed its investigation and has
determined not to take any action regarding PT-1's Prepaid Card decrementation
practices. With regard to prior advertising of Prepaid Cards by PT-1, PT-1 and
representatives of the FTC have entered into an agreement in principle, which is
subject to final approval by the FTC, pursuant to which, in complete settlement
of all allegations regarding deceptive advertising: (1) PT-1 will pay to the FTC
the sum of $300,000; (2) PT-1 does not admit any of the allegations; and (3) on
a going forward basis, PT-1 has agreed to comply with certain standards
regarding advertising (which are consistent with PT-1's current advertising
practices) and certain record keeping requirements. See "Business of PT-1 --
Legal Proceedings."
RAPID TECHNOLOGICAL CHANGE IN THE PREPAID CARD MARKET
The Prepaid Card market is characterized by rapid technological change, new
product and service introduction, new sales channels and evolving industry
standards. PT-1's success will depend, in significant part, upon its ability to
make timely and cost-effective enhancements and additions to its technology and
to introduce new products and services that meet customer demands. PT-1 expects
new products and services to be developed and introduced by other companies that
compete with its products and services. The proliferation of new
telecommunications technology, including personal and voice communication
services over the Internet, may reduce demand for long distance services,
including Prepaid Cards. There can be no assurance that PT-1 will be successful
in responding to these or other technological changes, evolving industry
standards or to new products and services offered by PT-1's current and future
competitors. The inability of PT-1 to respond to these changes could have a
material adverse effect on PT-1's business, financial condition or results of
operations. See "Business of PT-1 -- Competition" and "-- Telecommunications
Products and Services."
CUSTOMER CONCENTRATION
While the list of STAR's most significant customers varies from quarter to
quarter, STAR's five largest customers accounted for approximately 29% 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.
TAXATION OF SALE AND USE OF PREPAID CARDS
The taxation of the sale and use of Prepaid Cards is evolving and is not
specifically addressed by the laws of many of the states in which PT-1 does
business. While PT-1 believes that it has made adequate reserves to cover any
state taxes it may ultimately be required to pay, there can be no assurance that
this will be the case. In addition, certain states may enact legislation which
specifically provides for taxation of Prepaid Cards or may interpret current
laws in a manner resulting in additional tax liabilities.
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FRAUD; THEFT OF SERVICES; UNCOLLECTIBLE ACCOUNTS
From time to time, callers have obtained services without rendering payment
to PT-1 by unlawfully using PT-1's access numbers and PINs. PT-1 attempts to
manage these theft and fraud risks through its internal controls and its
monitoring and blocking systems. There can be no assurance that PT-1's risk
management practices will be sufficient to protect PT-1 in the future from
unauthorized transactions or thefts of services which could have a material
adverse effect on PT-1's business, financial condition or results of operations.
PT-1 sells Prepaid Cards to certain of its distributors on credit, sells on
a wholesale basis to carriers on 7-to-30 day terms and sells dial around and
presubscribed long distance services for which customers are billed after
services are rendered. PT-1's total accounts receivable were approximately $35.3
million at June 30, 1998. Significant accounts receivable and credit losses have
been experienced by certain participants in the telecommunications industry.
There can be no assurance that PT-1 will be able to adequately monitor and
evaluate its accounts receivable or that it will be able to collect all amounts
due for services rendered. Any material difficulty in collecting accounts
receivable could have a material adverse effect on PT-1's business, financial
condition or results of operations. See "Business of PT-1 -- Information
Systems; Debit Card Platforms" and "-- Prepaid Card Productions and Inventory
Control."
LIMITED PROTECTION OF PT-1'S PROPRIETARY RIGHTS; RISKS OF INFRINGEMENT
PT-1 believes that PT-1 and its Prepaid Card products have achieved
significant brand awareness among distributors, retail outlets and many ethnic
communities and other consumer groups. PT-1 has filed for federal trademark
protection of the PT-1 Communications and PT-1 service marks and for other names
PT-1 uses or intends to use to market its Prepaid Cards, including The PT-1 Card
and The New York Card. In addition, PT-1 recently changed its name from
Phonetime, Inc. and the name of one of its Prepaid Cards from The PTI Card to
The PT-1 Card in response to letters challenging PT-1's use of these names.
There can be no assurance that PT-1's efforts to protect its proprietary rights
will be successful or that other companies will not challenge PT-1's use of its
trademarks and service marks. PT-1 also intends to expand the marketing of
Prepaid Cards in foreign countries. This expansion may result in usage of PT-1's
Prepaid Cards in countries where intellectual property protections are more
limited than the protections available in the United States. PT-1's inability to
protect its proprietary rights or continue to use such marks in the U.S. and
abroad could result in a material adverse effect on PT-1's business, financial
condition or results of operations. See "Business of PT-1 -- Trademarks and
Service Marks."
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.
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CONTROL OF STAR BY NAMED OFFICERS AND DIRECTORS
As a result of the Merger on a fully-diluted basis, executive officers and
directors of STAR, including certain officers of PT-1, in the aggregate will
beneficially own approximately 44.5% of the outstanding shares of STAR Common
Stock and STAR's Chief Executive Officer will beneficially own approximately
22.1% 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 "Security Ownership of Certain Beneficial Owners
and Management."
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."
DILUTION OF VOTING POWER
Consummation of the Merger will result in an approximate 36.3% increase in
the number of shares of STAR Common Stock outstanding. Employees, stockholders
and distributors of PT-1 will receive approximately 26.6% of the outstanding
voting stock of STAR, on a fully-diluted basis, as a result of the Merger. Thus,
the stockholders of STAR will experience a 9.7% dilution of their relative
voting authority after the Merger.
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THE SPECIAL MEETING
Purpose; Time and Place. At the Special Meeting, holders of STAR Common
Stock on the Record Date will be asked to vote to approve and adopt the Merger
Agreement and the transactions contemplated thereby, including the Share
Issuance, and such other matters as may properly come before the Special
Meeting. The Special Meeting will be held on Tuesday, November 17, 1998 at 801
Garden Street, Room 203, Santa Barbara, California, starting at 9:00 a.m., local
time.
The Board has determined that the Merger is fair and in the best interests
of STAR and its stockholders and has unanimously approved the Merger Agreement.
THE BOARD UNANIMOUSLY RECOMMENDS THAT THE STOCKHOLDERS VOTE "FOR" THE APPROVAL
AND ADOPTION OF THE MERGER AGREEMENT AND THE TRANSACTIONS CONTEMPLATED THEREBY
AT THE SPECIAL MEETING, INCLUDING THE SHARE ISSUANCE. See "The Merger -- STAR's
Reasons for the Merger;" "-- Related Agreements" and "-- Vote Required and
Recommendation of the Board."
Voting Rights; Votes Required for Approval. The Board has fixed the close
of business on October 13, 1998 as the Record Date. Only holders of record of
shares of STAR 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 STAR 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 STAR 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 STAR 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 STAR Common
Stock outstanding on the Record Date is required to approve and adopt the
Proposal. As of September 1, 1998, holders of 50.42% of the outstanding shares
of STAR Common Stock have agreed to vote in favor of the Merger Agreement and
the transactions contemplated thereby.
Share Ownership of Management; PT-1 Approval. At the close of business on
October 13, 1998, directors and executive officers of STAR, as a group, were the
beneficial owners of an aggregate of shares (approximately
%) of the STAR Common Stock then outstanding. As of October 13, 1998,
directors and executive officers of PT-1, as a group, were beneficial owners of
an aggregate of approximately shares (approximately %) of
the PT-1 Common Stock then outstanding. The PT-1 Stockholders and the Board of
Directors of PT-1 have already approved the Merger Agreement and the
transactions contemplated thereby.
Proxies. All shares of STAR 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 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. Broker
non-votes will not be counted for the purpose of determining the presence or
absence of a quorum and will have the effect of a vote against the Proposal.
The STAR 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. STAR does not currently intend to seek an adjournment of its Special
Meeting.
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Any proxy given by a stockholder may be revoked at any time before it is
exercised by filing with Ms. Casey, the Secretary of the Company, an instrument
revoking it, by delivering a duly executed proxy bearing a later date or by the
stockholder attending the Special Meeting and voting his or her shares in
person.
It is the policy of STAR 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.
Stockholders do not need to take any action with respect to their stock
certificates, which will continue to evidence the same number of shares of STAR
Common Stock following the Merger.
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THE MERGER
GENERAL DESCRIPTION
The Merger Agreement provides for a business combination between STAR and
PT-1 in which Newco, a wholly-owned subsidiary of STAR, will be merged with and
into PT-1 and the holders of PT-1 Common Stock, options to acquire PT-1 Common
Stock and warrants exercisable for PT-1 Common Stock will be entitled to receive
shares of STAR Common Stock and cash in a transaction intended to qualify as a
tax-free reorganization for federal income tax purposes and as a purchase for
accounting purposes. As a result of the Merger, PT-1 will become a wholly-owned
subsidiary of STAR and holders of shares of PT-1 Common Stock will become
holders of shares of STAR Common Stock.
EFFECTIVE TIME OF THE MERGER
The Merger will become effective upon the filing of the Certificate of
Merger with the Department of State of the State of New York in accordance with
New York Business Corporation Law (the "Business Corporation Law"). The
Certificate of Merger will be filed as promptly as practicable after the
approval by the stockholders of STAR has been obtained and all other conditions
to the Merger have been satisfied or waived. It is currently expected that the
Merger will be consummated on or about November 17, 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 PT-1. 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 on November 30, 1997, and
T-One on March 10, 1998. In addition, on November 19, 1997, STAR entered into an
agreement to acquire UDN.
PT-1 has been evaluating a number of strategic options to provide it with
the necessary resources to fuel PT-1's continued growth and to remain
competitive in an industry undergoing rapid consolidation and change. At the
time PT-1 was approached by STAR, it was in the process of attempting to effect
an initial public offering of shares of PT-1 Common Stock. Following execution
of the Merger Agreement, PT-1 terminated the registration process with respect
to shares of PT-1 Common Stock.
On April 16, 1998, Mr. Edgecomb, Chief Executive Officer and Chairman of
the Board of STAR, and Ms. Casey, President and Secretary of STAR, had a dinner
meeting with Mr. Tawfik, Chief Executive Officer of PT-1, along with
representatives from each company's financial advisors, to discuss in very
general terms the possibility of a business combination between STAR and PT-1.
On May 7, 1998, Mr. Edgecomb and representatives of Hambrecht & Quist met
with Mr. Tawfik and other executive officers of PT-1, as well as representatives
from BT Alex. Brown Incorporated ("BT Alex. Brown"), financial advisor to PT-1,
to initiate discussions regarding a possible acquisition of PT-1 by STAR.
On May 18, 1998, the parties met again and began to discuss the material
terms and conditions of a possible business combination between STAR and PT-1.
On May 24, 1998, the parties executed a nonsolicitation agreement providing STAR
with exclusive negotiation rights to a potential merger with PT-1 through June
8, 1998.
During the week of May 25, 1998, Mr. Edgecomb and Ms. Enos, along with
other representatives from STAR, Hambrecht & Quist, CSFB and Riordan & McKinzie,
STAR's outside legal counsel, met in New York with Mr. Tawfik and John J.
Klusaritz, Executive Vice President and General Counsel of PT-1, along with
other representatives from PT-1 and BT Alex. Brown to discuss the respective
business strengths, operational strategies and financial results of each of STAR
and PT-1, and potential costs savings and
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synergies which might result from a combination of the two companies. Also at
this time, representatives from STAR and its legal and financial advisors began
to conduct a detailed review of PT-1's business, examining operational,
financial and legal information.
During the week of June 1, 1998, the representatives of STAR and PT-1
actively negotiated various terms of a merger agreement (the "Original Merger
Agreement"), including those related to an exchange ratio, a termination fee,
representations and warranties, conditions to closing, indemnification by the
PT-1 Stockholders and the operation of PT-1 during the pendency of the
transaction. The negotiations were principally conducted by Messrs. Tawfik and
Klusaritz on behalf of PT-1, and by Mr. Edgecomb and Ms. Enos, on behalf of
STAR. During this period, the management of STAR provided members of the Board
with drafts of the Original Merger Agreement and financial and other information
regarding PT-1 and informed the members of the Board of the status of the
ongoing discussions between STAR and PT-1, consulting with members of the Board
with respect to various aspects of the proposed transaction. On June 5, 1998,
the executive officers of PT-1 traveled to Santa Barbara to meet with Mr.
Edgecomb and other STAR executives and to tour STAR's executive offices. At that
time, negotiations of the Original Merger Agreement and related side agreements
continued.
On June 8, 1998, a lengthy special meeting of the Board was held. The Board
discussed with management and representatives of Hambrecht & Quist the principal
economic terms of the proposed transaction. Representatives from Hambrecht &
Quist presented to the Board a detailed report regarding the preparation of
their fairness opinion with respect to the exchange ratio, background
information regarding PT-1 and a pro forma overview of the two companies on a
combined basis. Riordan & McKinzie discussed with the Board the proposed terms
of the Original Merger Agreement and related side agreements. Mr. Edgecomb
discussed operational synergies, Ms. Enos presented to the Board the financials
of PT-1 and Mr. Edgecomb and Ms. Enos discussed anticipated operations of PT-1
following the Merger. The Board authorized the continued negotiation of the
final deal points of the Original Merger Agreement and the exchange ratio and
determined to adjourn the meeting to allow the members of the Board to continue
to analyze the transaction.
On June 9, 1998, the Board reconvened to discuss the final terms of the
Merger. Mr. Edgecomb discussed with the Board the resolution of the negotiations
between STAR and PT-1, including the exchange ratio. The Board received the
fairness opinions of Hambrecht & Quist and CSFB, which fairness opinions
concluded that the exchange ratio was fair, from a financial point of view, to
the stockholders of STAR. Based on the foregoing, the Board unanimously resolved
that the Merger and the Original Merger Agreement were fair to and in the best
interests of STAR and its stockholders, approved the Merger, the Original Merger
Agreement and the related transactions and recommended that the stockholders of
STAR approve and adopt the Original Merger Agreement and the transactions
contemplated thereby, including the Share Issuance.
On June 9, 1998, a special meeting of the Board of Directors of PT-1 (the
"PT-1 Board") was held. The PT-1 Board meeting was attended by BT Alex. Brown.
At the meeting, the management of PT-1 presented the principal economic terms of
the proposed transaction, as well as the principal reasons for pursuing the
Merger. Management indicated that the Merger would significantly accelerate
PT-1's timetable for realizing significant growth in revenue and increased
profitability. Specifically, it was management's view that the combination of
the telecommunications networks, customer bases, services offered, financial
resources and management of STAR and PT-1 would accelerate PT-1's growth,
significantly lower PT-1's cost of providing service, increase PT-1's
profitability and competitive position and thereby enhance revenue growth. Based
on the foregoing, the PT-1 Board unanimously resolved that the Original Merger
Agreement and the transactions contemplated thereby were fair to and in the best
interests of PT-1 and its stockholders, approved the Merger and the Original
Merger Agreement and recommended that its stockholders approve the transaction.
On August 12, 1998 after extensive discussions with and presentations
before the SEC, the parties determined that "pooling of interests" accounting
treatment for the Merger would not be feasible on the timetable set forth in the
Original Merger Agreement, due primarily to a PT-1 treasury stock transaction
that was completed in March 1997. Additionally, the market for emerging
telecommunications carriers became
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unstable and unpredictable. These factors led the parties to discuss the
renegotiation of several material terms of the Merger.
During the week of August 17, 1998, Mr. Edgecomb, on behalf of STAR, and
Mr. Tawfik, on behalf of PT-1, along with their representatives, negotiated the
Merger Agreement, which modified certain terms in the Original Merger Agreement,
including the number of shares of STAR Common Stock to be issued in the Merger,
the exchange ratio and other terms of the consideration to be paid to the
stockholders of PT-1.
On August 20, 1998, a special meeting of the Board was held to consider the
terms of the Merger Agreement. The Board discussed with management and
representatives of Hambrecht & Quist the revised principal economic terms of the
Merger. The Board received a new fairness opinion from Hambrecht & Quist, which
opinion concluded that the consideration to be paid to the stockholders of PT-1
was fair, from a financial point of view, to the stockholders of STAR. Riordan &
McKinzie discussed with the Board the proposed changes to the terms of the
Original Merger Agreement and related side agreements. Mr. Edgecomb discussed
his continued belief in the synergies of the Merger. Based on the foregoing, the
Board unanimously resolved that the Merger and the Merger Agreement were fair to
and in the best interests of STAR and its stockholders and approved the Merger,
the Merger Agreement and the related transactions. The Board also recommended
that the stockholders of STAR approve and adopt the Merger Agreement and the
transactions contemplated thereby, including the Share Issuance. Effective as of
September 1, 1998 the Merger Agreement was amended by the parties to modify the
consideration to be paid to the stockholders of PT-1 and to provide STAR with
managerial and operational authority over PT-1 as of that date.
STAR'S REASONS FOR THE MERGER
The Board has unanimously approved the Merger Agreement and the
transactions contemplated thereby, including the Merger. In reaching this
determination, the Board consulted with management, as well as its financial and
legal advisors, and considered a number of factors, including, without
limitation: (i) information with respect to the financial condition, business,
operations and prospects of both STAR and PT-1 on a historical and prospective
basis, including certain information reflecting the two companies on a pro forma
combined basis; (ii) the tax-free nature of the Merger; (iii) the financial
presentation and opinion of Hambrecht & Quist and (iv) the terms of the Merger
Agreement and all related agreements.
The Board also considered a number of strategic advantages that could be
created by the Merger including:
- Continuation of Commercial Market Expansion. PT-1 currently is the
leading provider in the U.S. of long distance service to end users
through the sale and distribution of Prepaid Cards. PT-1 has a
significant sales force of independent distributors with a large number
of retail customers. PT-1 also currently offers dial around and
presubscribed long distance service to residential and commercial end
users with significant international long distance calling needs.
Accordingly, the Merger would accelerate a major strategic objective of
STAR -- its expansion into the retail segment of the commercial long
distance market.
- Economies of Scale, Resources of Combined Entity. The combination of STAR
and PT-1 will create one of the largest facilities-based long distance
telecommunications companies in the U.S. and what STAR believes will be
the third largest provider of international long distance service in the
U.S. After giving effect to the Merger, for the fiscal year ended
December 31, 1997, STAR and PT-1's pro forma combined revenues and
operating income would have been approximately $786.7 million and
approximately $24.3 million, respectively. The Board believes that the
Merger will provide opportunities to achieve substantial benefits for the
respective stockholders and customers of each company through the more
efficient utilization of the combined assets, management and personnel of
STAR and PT-1. The Board further believes that the combined company,
operating in both the retail and wholesale telecommunications markets,
with the combined STAR and PT-1 assets, financials resources, management,
personnel and technical expertise will be better able to capitalize on
growth opportunities in the telecommunications industry, both
domestically and internationally, and will be
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better positioned to compete more effectively with greater negotiating
leverage, than either STAR or PT-1 on a stand-alone basis.
- Acceleration of STAR's Network Strategy. The Board believes that the
addition of PT-1's substantial retail minutes as well as the enhanced
financial strength of the combined entities will enable STAR to
accelerate its development of its international telecommunications
network by enabling STAR to deploy a domestic and international network
on a demand driven and cost efficient basis.
- Use of STAR Network by PT-1 Customers. The Board believes that the
existing telecommunications networks of STAR will serve as a cost
effective source for the transmission of long distance calls made by PT-1
customers. STAR's network will enable PT-1 to provide its retail
customers with low-cost access to additional foreign countries thereby
facilitating the development of additional retail international long
distance business and may enable both carriers to provide more
competitively priced wholesale services. PT-1's current relationships
with third party carriers do not involve significant minimum commitments
or other restrictions that would interfere with the immediate integration
of PT-1's retail traffic onto the STAR network.
The foregoing list of the information and factors considered by the Board
is not intended to be exhaustive. In view of the variety of factors considered
in connection with its evaluation of the Merger, the 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 Board may have given different weights to different
factors. The Board also consulted with its financial and legal advisors as it
deemed appropriate in the context of its review and approval of the Merger
Agreement and the Merger.
OPINIONS OF STAR'S FINANCIAL ADVISORS
Opinion of Hambrecht & Quist. STAR engaged Hambrecht & Quist to act as its
financial advisor in connection with the Merger of PT-1 and to render an opinion
as to the fairness from a financial point of view to STAR of the consideration
to be paid by the Company in the Merger. Hambrecht & Quist was selected by the
Board based on Hambrecht & Quist's qualifications, expertise and reputation, as
well as Hambrecht & Quist's historic investment banking relationship and
familiarity with STAR. Hambrecht & Quist rendered its oral opinion (subsequently
confirmed in writing) on August 20, 1998 to the Board that, as of such date, the
consideration to be paid by STAR in the Merger is fair from a financial point of
view. A COPY OF HAMBRECHT & QUIST'S OPINION DATED AUGUST 20, 1998, WHICH SETS
FORTH THE ASSUMPTIONS MADE, MATTERS CONSIDERED, THE SCOPE AND LIMITATIONS OF THE
REVIEW UNDERTAKEN AND THE PROCEDURES FOLLOWED BY HAMBRECHT & QUIST IS ATTACHED
AS ANNEX B TO THIS PROXY STATEMENT. STAR SHAREHOLDERS ARE ADVISED TO READ THE
OPINION IN ITS ENTIRETY. The assumptions made, matters considered and limits of
review contained in Hambrecht & Quist's written opinion delivered August 20,
1998 were substantially the same as those contained in the opinion attached
hereto. No limitations were placed on Hambrecht & Quist by the Board with
respect to the investigation made or the procedures followed in preparing and
rendering its opinion.
In its review of the Merger, and in arriving at its opinion, Hambrecht &
Quist, among other things: (i) reviewed the publicly available financial
statements of STAR for recent years and interim periods to date and certain
other relevant financial and operating data of STAR made available to Hambrecht
& Quist from published sources and from the internal records of STAR; (ii)
reviewed certain internal financial and operating information, including certain
projections, relating to STAR prepared by the management of STAR; (iii)
discussed the business, financial condition and prospects of STAR with certain
of its officers; (iv) reviewed the financial statements of PT-1 for recent years
and interim periods to date and certain other relevant financial and operating
data of PT-1 made available to Hambrecht & Quist from published sources and from
the internal records of PT-1; (v) reviewed certain internal financial and
operating information, including certain projections, relating to PT-1 based
upon information provided by the management of PT-1; (vi) discussed the
business, financial condition and prospects of PT-1 with certain of its
officers; (vii) reviewed the recent reported price and trading activity for the
STAR Common Stock and compared such information and certain financial
information for STAR with similar information for certain other companies
engaged in businesses Hambrecht & Quist considered comparable; (viii) reviewed
the financial terms, to the
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extent publicly available, of certain comparable merger and acquisition
transactions; (ix) reviewed the Merger Agreement and the Registration Rights and
Restricted Share Agreement; and (x) performed such other analyses and
examinations and considered such other information, financial studies, analyses
and investigations and financial, economic and market data as Hambrecht & Quist
deemed relevant.
Hambrecht & Quist did not independently verify any of the information
concerning STAR or PT-1 considered in connection with their review of the Merger
and, for purposes of its opinion, Hambrecht & Quist assumed and relied upon the
accuracy and completeness of all such information. In connection with its
opinion, Hambrecht & Quist did not prepare or obtain any independent valuation
or appraisal of any of the assets or liabilities of STAR or PT-1, nor did they
conduct a physical inspection of the properties and facilities of STAR or PT-1.
With respect to the financial forecasts and projections used in their analysis,
Hambrecht & Quist assumed that they reflected the best currently available
estimates and judgments of the expected future financial performance of PT-1 and
STAR. For the purposes of their opinion, Hambrecht & Quist also assumed that
neither STAR nor PT-1 was a party to any pending transactions, including
external financings, recapitalizations or merger discussions, other than the
Merger and those in the ordinary course of conducting their respective
businesses. For purposes of their opinion, Hambrecht & Quist assumed that the
Merger will qualify as a tax-free reorganization under the United States
Internal Revenue Code for the stockholders of PT-1 and that the Merger will be
accounted for as a purchase. Hambrecht & Quist's opinion is necessarily based
upon market, economic, financial and other conditions as they existed and can be
evaluated as of the date of the opinion and any subsequent change in such
conditions would require a reevaluation of such opinion.
The preparation of a fairness opinion is a complex process and is not
necessarily susceptible to partial analysis or summary description. The summary
of the Hambrecht & Quist analyses set forth below does not purport to be a
complete description of the presentation by Hambrecht & Quist to STAR's Board of
Directors. In arriving at its opinion, Hambrecht & Quist did not attribute any
particular weight to any analyses or factor considered by it, but rather made
qualitative judgments as to the significance and relevance of each analysis and
factor. Accordingly, Hambrecht & Quist believes that its analyses and the
summary set forth below must be considered as a whole and that selecting
portions of its analyses, without considering all analyses, or of the following
summary, without considering all factors and analyses, could create an
incomplete view of the processes underlying the analyses set forth in the
Hambrecht & Quist presentation to the STAR Board of Directors and its opinion.
In performing its analyses, Hambrecht & Quist made numerous assumptions with
respect to industry performance, general business and economic conditions and
other matters, many of which are beyond the control of STAR and PT-1. The
analyses performed by Hambrecht & Quist (and summarized below) are not
necessarily indicative of actual values or actual future results, which may be
significantly more or less favorable than suggested by such analyses.
Additionally, analyses relating to the values of businesses do not purport to be
appraisals or to reflect the prices at which businesses actually may be
acquired.
In performing its analyses, Hambrecht & Quist used stand-alone Wall Street
consensus estimates for projections of STAR's calendar year 1998 and 1999
financial performance. Hambrecht & Quist examined projections provided by PT-1's
management and derived its own financial projections based on conservative
growth assumptions for PT-1's calendar year 1998 and 1999 financial performance
(the "PT-1 Base Case"). For calendar year 1999, Hambrecht & Quist also developed
a second, more conservative case for PT-1 (the "PT-1 Conservative Case").
The following is a brief summary of certain financial analyses performed by
Hambrecht & Quist in connection with providing its written opinion to the Board
on August 20, 1998:
Contribution Analysis: Hambrecht & Quist analyzed the contribution of each
of STAR and PT-1 to certain calendar 1999 financial statement categories of the
pro forma combined company using both PT-1 Base Case and PT-1 Conservative Case
with no revenue or expense adjustments and excluding the cash component and the
resulting interest income effect. The financial statement categories included
revenue, operating income, and net income. This contribution analysis was then
compared to the pro forma ownership percentage of STAR and PT-1 stockholders in
the pro forma post-merger combined company (the "Combined Company"). Hambrecht &
Quist observed that, calculated on a fully-diluted basis, STAR stockholders are
expected to own approximately 74% of the Combined Company equity at the close of
the Merger and PT-1 stockholders are
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expected to own approximately 26% of the Combined Company equity at the close of
the Merger. Hambrecht & Quist examined the expected contributions to the
Combined Company's revenues, operating income and net income by PT-1 for
calendar year 1999 using the PT-1 Base Case. It was estimated that STAR and PT-1
would contribute approximately 54% and 46%, respectively, of the combined
revenues and approximately 53% and 47%, respectively, of the combined operating
income in calendar year 1999. It was also estimated that in calendar year 1999,
using the PT-1 Base Case, STAR would contribute 55% of net income and that PT-1
would contribute approximately 45%. Using the PT-1 Conservative Case, it was
estimated that STAR and PT-1 would contribute approximately 55% and 45%,
respectively, of the combined revenues and approximately 63% and 37%,
respectively, of the combined operating income in calendar year 1999. It was
also estimated that in calendar year 1999, using the PT-1 Conservative Case,
STAR would contribute 64% of net income and that PT-1 would contribute
approximately 36%.
Pro Forma Merger Analysis: Hambrecht & Quist analyzed the pro forma impact
of the Merger on the Combined Company's calendar 1999 earnings per share ("EPS")
using (i) stand-alone Wall Street consensus estimates of STAR's EPS in calendar
1998 and 1999 of $0.32 and $0.53, respectively, (ii) the PT-1 Base Case, and
(iii) the PT-1 Conservative Case. The analysis indicated that the EPS of the pro
forma Combined Company would be higher than for STAR as a stand-alone company
using both the PT-1 Base Case and the PT-1 Conservative Case. The actual results
and savings achieved by the Combined Company resulting from the Merger may vary
from the projected results and variations may be material.
Analysis of Publicly Traded Comparable Companies: Hambrecht & Quist
compared selected historical and projected financial information of PT-1 to
publicly traded companies Hambrecht & Quist deemed to be comparable to PT-1.
Such information included the ratio of market value to historical and projected
net income. Hambrecht & Quist also examined the ratio of the enterprise value
(market value plus debt less cash) to historical revenue, to historical earnings
before interest and taxes ("EBIT"), to historical earnings before interest,
taxes, depreciation and amortization ("EBITDA"), and to projected revenue.
Companies deemed comparable included selected telecommunication services
companies ("Comparable Public Companies") such as Excel Communications Inc.,
Frontier Corporations, SmarTalk TeleServices Inc., IDT Corporation, Pacific
Gateway Exchange Inc., PRIMUS Telecommunications Group, Inc., RSL Communications
Ltd., STAR, Telegroup Inc., Viatel Inc., and Worldcom Inc. The foregoing
multiples were applied to historical financial results of PT-1 for the
latest-twelve-month ("LTM") period ended June 30, 1998 and projected financial
results using PT-1 Base Case and PT-1 Conservative Case. Hambrecht & Quist
determined average multiples excluding the high and low values for the
Comparables Public Companies of 3.0 times LTM revenue, 23.1 times LTM EBITDA,
40.5 times LTM EBIT, 58.1 times LTM net income, 1.8 times projected calendar
year 1998 revenue, 1.2 times projected calendar 1999 revenue, 34.6 times
projected calendar 1998 net income, and 22.3 times projected calendar 1999 net
income. Based on the analysis of Comparable Public Companies, PT-1's implied
equity value applying multiples to historical results and the projections ranged
from $356 million to $1,442 million. This compared with an offer in the proposed
merger of approximately $261 million based on the closing price of STAR Common
Stock on August 18, 1998.
Analysis of Selected Merger and Acquisition Transactions: Hambrecht & Quist
compared the proposed merger with selected merger and acquisition transactions.
This analysis included 12 transactions with an aggregate consideration between
$100 million and $2 billion involving companies in the telecommunication
services industry ("Comparable M&A Transactions"). In examining these
transactions, Hambrecht & Quist analyzed certain income statement and balance
sheet parameters of the acquired company relative to the consideration offered.
The foregoing multiples were applied to historical financial results of PT-1 for
the twelve-month period ended June 30, 1998. Multiples analyzed included
consideration offered to LTM revenue, LTM EBITDA, LTM EBIT, and LTM net income.
The average multiples excluding high and low values offered in the selected
Comparable M&A Transactions was 2.0 times LTM revenues, 18.4 times LTM EBITDA,
29.2 times LTM EBIT, and 48.3 times LTM net income. Based on the analysis of
selected Comparable M&A Transactions, PT-1's implied equity value applying
multiples to historical results ranged from values between approximately $372
million and approximately $993 million. This result compared with an implied
value in the proposed merger of approximately $261 million based on the closing
price of STAR Common Stock on August 18, 1998.
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No company or transaction used in the above analyses is identical to PT-1
or the Merger. Accordingly, an analysis of the results of the foregoing is not
mathematical; rather it involves complex considerations and judgments concerning
differences in financial and operating characteristics of the companies and
other factors that could affect the public trading values of the companies or
company to which they are compared.
Discounted Cash Flow Analysis: Hambrecht & Quist performed discounted cash
flow analyses for PT-1 using projected financial performance through 2002. The
analysis aggregated (i) the present value of the projected free cash flow
(defined as EBIT), less increases in working capital, plus depreciation and
amortization, and less capital expenditures) through 2002 and (ii) the present
value of a range of terminal values for the year 2002. The terminal values for
PT-1 were determined by applying multiples ranging from 1.5 to 2.5 times PT-1's
estimated revenue for 2002. PT-1's free cash flow streams and terminal values
were discounted to present values using discount rates ranging from 18.5% to
20.5%. Such analyses indicated a range of equity values for PT-1 of between $641
million and $1,104 million. These results compared to an implied offer per share
of $261 million in the proposed merger, based on the closing price of STAR
Common Stock on August 18, 1998.
The foregoing description of Hambrecht & Quist's opinion is qualified in
its entirety by reference to the full text of such opinion which is attached as
Annex B to this Proxy Statement.
Hambrecht & Quist, as part of its investment banking services, is regularly
engaged in the valuation of businesses and their securities in connection with
mergers and acquisitions, strategic transactions, corporate restructurings,
negotiated underwriting, secondary distributions of listed and unlisted
securities, private placements and valuations for corporate and other purposes.
In the past, Hambrecht & Quist has provided investment banking and other
financial advisory services to STAR and has received fees for rendering these
services. In particular, Hambrecht & Quist acted as lead managing underwriter in
the Company's initial public offering in 1997 and as co-managing underwriter in
the Company's follow-on offering in 1998. In the ordinary course of business,
Hambrecht & Quist acts as a market maker and broker in the publicly traded
securities of STAR and receives customary compensation in connection therewith,
and also provides research coverage for STAR. In the ordinary course of
business, Hambrecht & Quist actively trades in the equity and derivative
securities of STAR for its own account and for the accounts of its customers
and, accordingly, may at any time hold a long or short position in such
securities. Hambrecht & Quist may in the future provide additional investment
banking or other financial advisory services to STAR. Hambrecht & Quist is also
familiar with PT-1, having participated in the preparation of a registration
statement on Form S-1 in connection with its potential public offering.
Pursuant to an engagement letter dated April 2, 1998, STAR has agreed to
pay Hambrecht & Quist a fee of $500,000 in connection with the delivery of a
fairness opinion rendered on June 9, 1998, and a fee of $500,000 in connection
with the delivery of the fairness opinion rendered on August 20, 1998 both of
which are credited against any further fees paid in the transaction. Upon
consummation of the Merger, STAR has agreed to pay Hambrecht & Quist a fee of
1.0% of the aggregate consideration paid in the transaction, subject to
adjustment in certain circumstances. STAR also has agreed to reimburse Hambrecht
& Quist for its reasonable out-of-pocket expenses and to indemnify Hambrecht &
Quist against certain liabilities, including liabilities under the federal
securities laws or relating to or arising out of Hambrecht & Quist's engagement
as financial advisor.
Opinion of CSFB.
STAR also engaged CSFB to act as a financial advisor in connection with the
Merger. In connection with the engagement, STAR requested that CSFB evaluate the
fairness to STAR, from a financial point of view, of the consideration to be
paid by the Company in the Merger. CSFB delivered to STAR and representatives of
the Board on September 10, 1998 its opinion to the effect that, as of such date
and based upon and subject to certain matters stated in the opinion, the
consideration to be paid by the Company in the Merger was fair to STAR from a
financial point of view.
In arriving at its opinion, CSFB reviewed certain publicly available
business and financial information relating to STAR and PT-1, as well as the
Merger Agreement. CSFB also reviewed certain other information,
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including financial forecasts provided by STAR and PT-1, and met with the
respective managements of STAR and PT-1 to discuss the business and prospects of
STAR and PT-1.
CSFB also considered certain financial and stock market data of STAR and
financial data of PT-1, and CSFB compared that data with similar data for other
publicly held companies in businesses similar to those of STAR and PT-1 and
considered, to the extent publicly available, the financial terms of certain
other business combinations and other transactions which have recently been
affected. CSFB also considered the results of certain discounted cash flow
projections and such other information, financial studies, analyses and
investigations and financial, economic and market criteria which CSFB deemed
relevant. CSFB also considered the views of the respective managements of STAR
and PT-1 concerning the business, operational and strategic benefits and
implications of the Merger, including financial forecasts provided to CSFB by
STAR and PT-1.
In connection with its review, CSFB did not assume any responsibility for
independent verification of any of the foregoing information and relied on such
information being complete and accurate in all material respects. With respect
to financial forecasts provided by STAR and PT-1, CSFB assumed that they were
reasonably prepared on bases reflecting the best currently available estimates
and judgments of the respective managements of STAR and PT-1 as to the future
financial performance of STAR and PT-1. In addition, CSFB was not requested to
make, and did not make, an independent evaluation or appraisal of the assets or
liabilities (contingent or otherwise) of STAR or PT-1. CSFB assumed, with the
consent of the Board, that the Merger would be accounted for under the
"purchase" method of accounting. CSFB's opinion is necessarily based upon
financial, economic, market and other conditions as they existed and could be
evaluated on the date of the opinion. CSFB did not express any opinion as to
what the value of the STAR Common Stock actually will be when issued to PT-1's
stockholders pursuant to the Merger or the prices at which the STAR Common Stock
will trade subsequent to the Merger. No limitations were imposed by STAR on CSFB
with respect to the investigations made or procedures followed by CSFB in
rendering its opinion.
THE FULL TEXT OF CSFB'S WRITTEN OPINION TO THE BOARD DATED SEPTEMBER 10,
1998, WHICH SETS FORTH THE ASSUMPTIONS MADE, MATTERS CONSIDERED AND LIMITATIONS
ON THE REVIEW UNDERTAKEN, IS ATTACHED AS ANNEX C TO THIS PROXY STATEMENT AND IS
INCORPORATED HEREIN BY REFERENCE. STAR'S STOCKHOLDERS ARE URGED TO READ THIS
OPINION CAREFULLY AND IN ITS ENTIRETY. CSFB'S OPINION IS DIRECTED ONLY TO THE
FAIRNESS OF THE CONSIDERATION TO BE PAID BY THE COMPANY IN THE MERGER FROM A
FINANCIAL POINT OF VIEW TO STAR, DOES NOT ADDRESS ANY OTHER ASPECT OF THE MERGER
OR ANY RELATED TRANSACTION AND DOES NOT CONSTITUTE A RECOMMENDATION TO ANY
STOCKHOLDER AS TO HOW SUCH STOCKHOLDER SHOULD VOTE AT THE SPECIAL MEETING. THE
SUMMARY OF THE OPINION OF CSFB SET FORTH IN THIS PROXY STATEMENT IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO THE FULL TEXT OF SUCH OPINION.
In preparing its opinion for the Board, CSFB performed a variety of
financial and comparative analyses, including those described below. The summary
of CSFB's analyses set forth below does not purport to be a complete description
of the analyses underlying CSFB's opinion. The preparation of a fairness opinion
is a complex analytic 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 and, therefore, such an opinion is
not readily susceptible to summary description. In arriving at its opinion, CSFB
made qualitative judgments as to the significance and relevance of each analysis
and factor considered by it. Accordingly, CSFB believes that its analyses must
be considered as a whole and that selecting portions of its analyses and
factors, without considering all analyses and factors, could create a misleading
or incomplete view of the processes underlying such analyses and its opinion. In
its analyses, CSFB made numerous assumptions with respect to STAR, PT-1,
industry performance, regulatory, general business, economic, market and
financial conditions and other matters, many of which are beyond the control of
STAR and PT-1. No company, transaction or business used in such analyses as a
comparison is identical to STAR, PT-1 or the Merger, nor is an evaluation of the
results of such analyses entirely mathematical; rather, it involves complex
considerations and judgments concerning financial and operating characteristics
and other factors that could affect the acquisition value, public trading value
or other values of the companies, their business segments or the transactions
being analyzed. The estimates contained in such analyses and the valuations
resulting from any
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particular analysis are not necessarily indicative of actual values or
predictive of future results or values, which may be significantly more or less
favorable than those suggested by such analyses. In addition, analyses relating
to the value of businesses or securities do not purport to be appraisals or to
reflect the prices at which businesses or securities actually may be sold.
Accordingly, such estimates are inherently subject to substantial uncertainty.
The following is a summary of the material financial analyses performed by
CSFB in arriving at its written opinion delivered on September 10, 1998, but
does not purport to be a complete description of the analyses performed by CSFB
for such purposes.
Discounted Cash Flow Analysis. CSFB performed a discounted cash flow
analysis on PT-1's projected results for fiscal years 1998 - 2002. In general,
the discounted cash flow analysis aims to analyze the sum of (i) the present
value of projected "unlevered free cash flows" (defined, for the purposes of
this analysis as the projected after-tax operating earnings plus depreciation
and amortization and other non-cash items, less projected capital expenditures
and investment in working capital, if any) for a particular company and (ii) the
present value of the "terminal value" attributable to the particular company at
the end of the projection period. In conducting the discounted cash flow
analysis of PT-1, CSFB analyzed two projections: (i) forecasts prepared by
management of PT-1 (the "CSFB PT-1 Base Case"); and (ii) forecasts prepared by
CSFB for fiscal years 1998 - 2002 assuming more modest future performance of
PT-1 resulting from lower revenue growth and lower profit margins (the "Amended
PT-1 Case"). CSFB calculated terminal values applicable to PT-1 by applying a
range of estimated EBITDA multiples of 8.0x to 9.0x to the projected EBITDA of
PT-1 in fiscal year 2002. The unlevered free cash flows and terminal values were
then discounted to the present using a range of discount rates of 11% to 12%,
representing an estimated range of the weighted average cost of capital
applicable to PT-1. Based on this analysis, the CSFB PT-1 Base Case generated an
enterprise value reference range of approximately $2.0 billion to $2.3 billion,
and the Amended PT-1 Case generated an enterprise value reference range of
approximately $345 million to $400 million. The foregoing range of enterprise
values compares to the enterprise value for PT-1 inherent in the Merger of
approximately $226 million based on the closing price of the Company's Common
Stock as of September 2, 1998.
CSFB also performed a discounted cash flow analysis for STAR based on
STAR's projection of its operating results for the fiscal years 1998 - 2002 (the
"STAR Base Case"). CSFB calculated terminal values applicable to STAR by
applying a range of estimated EBITDA multiples of 8.0x to 9.0x to the projected
EBITDA of STAR in fiscal year 2002. STAR's projected unlevered free cash flows
and terminal values were then discounted to the present using a range of
discount rates of 11% to 12%, representing an estimated range of the weighted
average cost of capital applicable to STAR. Based on this analysis, the STAR
Base Case generated an enterprise value reference range of approximately $1.1
billion to approximately $1.3 billion. The foregoing range of enterprise values
compares to STAR's enterprise value of approximately $640 million based on the
closing price of STAR Common Stock as of September 2, 1998.
Comparable Companies Analysis. To provide contextual data and comparative
market information, CSFB analyzed the operating performance of PT-1 relative to
companies which offer telecommunication services through calling cards (prepaid
or otherwise) and/or provide international long distance services to ethnic
populations and whose securities are publicly traded and that are deemed by CSFB
to be comparable to PT-1. These companies are Premiere Technologies Corp.,
SmarTalk Teleservices Inc. and Startec Global Communications Corp. (the "CSFB
PT-1 Comparable Companies"). CSFB compared, among other things, enterprise
values based on current stock prices as multiples of estimated 1998 and 1999
revenues, EBITDA and EBIT, in each case based on equity research analysts'
estimates. CSFB determined that the relevant ranges of enterprise value
multiples for the PT-1 Comparable Companies were: (i) with respect to revenues,
0.6x to 0.9x for 1998 and 0.3x to 0.6x for 1999; (ii) with respect to EBITDA
3.0x to 4.0x for 1998 and 2.0x to 3.0x for 1999; and (iii) with respect to EBIT
4.0x to 5.0x for 1998 and 2.0x to 3.0x for 1999. CSFB then calculated imputed
enterprise values of PT-1 by applying projected revenues, EBITDA and EBIT for
1998 and 1999 based on both the PT-1 Base Case and the Amended PT-1 Case to the
multiples derived from its analysis of the CSFB PT-1 Comparable Companies. This
analysis, utilizing revenue and EBITDA multiples, generated an enterprise value
reference range of (i) approximately $132 million to approximately $550 million
based on the CSFB PT-1 Base Case and (ii) approximately $65 million to
approximately $525 million based on the Amended PT-1 Case. The foregoing range
of enterprise values compares to the enterprise value for
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PT-1 inherent in the Merger of approximately $226 million based on the closing
price of STAR Common Stock as of September 2, 1998.
CSFB also analyzed the operating performance of STAR relative to certain
international and domestic long distance companies whose securities are publicly
traded and that are deemed by CSFB to be comparable to STAR. These companies are
Frontier Corp., Tel-Save Holdings Inc., RSL Communications Ltd., Pacific Gateway
Exchange Inc., Telegroup Inc. and Startec Global Communications Corp.
(collectively, the "STAR Comparable Companies"). CSFB compared, among other
things, enterprise values based on current stock prices as multiples of
estimated 1998 and 1999 revenues, EBITDA and EBIT, in each case based on equity
research analysts' estimates. CSFB determined that the relevant ranges of
enterprise value multiples for the STAR Comparable Companies were: (i) with
respect to revenues 0.6x to 1.3x for 1998 and 0.3x to 0.8x for 1999; (ii) with
respect to EBITDA 10.0x to 12.0x for 1998 and 7.0x to 9.0x for 1999; and (iii)
with respect to EBIT 19.0x to 20.0x for 1998 and 12.0 to 14.0x for 1999. CSFB
then calculated imputed enterprise values of STAR by applying projected
revenues, EBITDA and EBIT for 1998 and 1999 based on the STAR Base Case to the
multiples derived from its analysis of the STAR Comparable Companies. This
analysis, utilizing revenue and EBITDA multiples, generated an enterprise value
reference range of $400 million to $825 million. The foregoing range of
enterprise values compares to STAR's enterprise value of approximately $640
million based on the closing price of STAR Common Stock as of September 2, 1998.
Comparable Transactions Analysis. In conducting its analysis of PT-1, CSFB
analyzed, among other things, the implied transaction multiples paid in selected
merger and acquisition transactions involving companies in the business of
offering telecommunication services through calling cards, pre-paid or
otherwise. These transactions included: the acquisition of each of Smartel
Communications, Inc., GTI Telecom, Inc., Conquest Telecommunications Service
Corp. and American Express Telcom, Inc. by SmarTalk Teleservices Inc., the
acquisitions of each of Global Link Telcom Corporation, Centerpiece
Communications, Inc. and Networks Around the World, Inc. by Global
Telecommunications Solutions Inc., the acquisition of BLT Technologies, Inc. by
WorldCom and the acquisition of MSN Communications, Inc. by Telscape
International Inc. CSFB compared enterprise values inherent in these
transactions as multiples of revenues, EBITDA and EBIT of each acquired company
for the latest available twelve-month period immediately preceding the
announcement of the acquisition of such company. CSFB determined that the
relevant range of multiples for the acquired prepaid calling card companies was
2.0x -- 3.0x the revenues for the latest available twelve month period preceding
the acquisition announcement. CSFB then calculated imputed enterprise values of
PT-1 by applying actual PT-1 revenues for latest twelve months ended June 30,
1998, to the revenues multiples derived from its analyses of the acquired
companies. This analysis generated an enterprise value reference range of
approximately $1 billion to $1.5 billion. The foregoing range of enterprise
values compares to the enterprise value for PT-1 inherent in the Merger of
approximately $226 million based on the closing price of STAR Common Stock as of
September 2, 1998.
In conducting its analysis of STAR, CSFB also analyzed, among other things,
the implied enterprise value multiples paid in selected merger and acquisition
transactions involving companies in the international and domestic long distance
business. These transactions included: the acquisition of Trescom International,
Inc. by Primus Telecommunications Inc., the acquisition of IDB Communications
Group Inc. by LDDS Communications, Inc. (now WorldCom, Inc.), the acquisition of
LCI International, Inc. by Quest Communications International Inc. (now Qwest
Communications International Inc.), the acquisition of USLD Communications Corp.
by LCI International, Inc., the acquisition of Telco Communications Group Inc.
by Excel Communications Inc. (now Excelcom Inc.) and the acquisition of ALC
Communications Corporation by Frontier Corp. CSFB computed enterprise values
inherent in these transactions as multiples of revenues, EBITDA and EBIT of each
acquired company for the latest available twelve-month period immediately
preceding the announcement of the acquisition of such company. CSFB determined
that the relevant range of multiples for the acquired international and domestic
long distance companies were: (i) with respect to revenues, 2.0x to 2.5x; and
(ii) with respect to EBITDA, 16.0x to 21.0x and with respect to EBIT 18.0x to
25.0x. CSFB then calculated imputed enterprise values of STAR by applying actual
revenues, EBITDA and EBIT for the twelve months ended June 30, 1998 to the
multiples of revenues, EBITDA and EBIT, respectively, derived from its analyses
of the acquired companies. This analysis generated an enterprise value
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reference range of approximately $300 million to approximately $1.1 billion. The
foregoing range of enterprise values compares to STAR's enterprise value of
approximately $640 million based on the closing price of STAR Common Stock as of
September 2, 1998.
Pro Forma Merger Analysis. CSFB analyzed the potential pro forma effect of
the Merger on STAR's projected earnings per share for fiscal years 1998; 1999
and 2000. This analysis indicated that the Merger would be accretive to STAR's
earnings per share in 1998 and 1999, taking into account certain intermediate
and long-term cost synergies which STAR's management believes can be reliably
achieved. The actual results achieved by the combined company may vary from
projected results, and the variations may be material. The analysis also
indicated that without the successful partial achievement of such synergies the
Merger could be dilutive to STAR's earnings per share in 1998 and 1999.
Contribution Analysis. CSFB also analyzed (i) the contribution each of STAR
and PT-1 has made or is projected to make to the 1997 and 1998 combined
revenues, EBITDA and EBIT and (ii) the exchange ratio inherent in the valuation
ranges imputed from the Discounted Cash Flow Analysis, Comparable Companies
Analysis and Comparable Transactions Analysis (each of which analysis has been
discussed above). CSFB noted that STAR's stockholders, in aggregate, will have a
disproportionately favorable percentage ownership in the combined companies'
equity value (the "Company Ownership Percentage") when compared with the
percentage ownership inherent in the contribution ratios referenced in (i) above
and the imputed exchange ratios referenced in (ii) above. The Company Ownership
Percentage inherent in the Merger is approximately 75% whereas the range of
contribution percentages and exchange ratios in (i) and (ii) preceding indicate
a Company Ownership Percentage ranging from approximately 39% to approximately
65%.
CSFB has advised STAR that, in the ordinary course of business, it and its
affiliates may actively trade the securities of STAR for its and such
affiliates' own account or for the account of customers and, accordingly, may at
any time hold a long or short position in such securities. In addition, CSFB
previously rendered its opinion dated June 9, 1998 to the Board that the
consideration proposed to be paid pursuant to the terms of the Original Merger
Agreement were fair from a financial point of view to the stockholders of the
Company.
CSFB was selected by STAR as its financial advisor based on its reputation,
experience and expertise. CSFB is an internationally recognized investment
banking firm that is continually engaged in the valuation of businesses and
their securities in connection with mergers and acquisitions, negotiated
underwriting, competitive bids, secondary distributions of listed and unlisted
securities, private placements and valuations for estate, corporate and other
purposes. Neither STAR nor PT-1 has previously been a client of CSFB.
Pursuant to the terms of CSFB's engagement, STAR has agreed to pay CSFB,
upon the Closing, a transaction fee equal to 0.3% of the aggregate consideration
paid in the Merger, which fee shall in no event be less than $1.5 million nor
more than $1.8 million. STAR has also agreed to reimburse CSFB for its
reasonable out-of-pocket expenses, including the fees and expenses of legal
counsel retained by CSFB, and to indemnify CSFB and certain related persons and
entities for certain losses, claims, damages or liabilities (including actions
or proceedings in respect thereof) related to or arising out of, among other
things, its engagement as financial advisor.
PT-1'S REASONS FOR THE MERGER
The PT-1 Board of Directors has unanimously approved the Merger Agreement
and the transactions contemplated thereby, including the Merger. In reaching
this determination, the PT-1 Board consulted with the management of PT-1, as
well as its financial and legal advisors, and considered a number of factors,
including, without limitation, the following:
(i) the potential economies of scale and efficiencies expected to
result from the combination of the internal operations, systems and
departments of PT-1 and STAR;
(ii) that the combination of the networks of STAR and PT-1 could be
expected to lower the cost to countries where PT-1 currently terminates a
substantial volume of minutes as well as provide PT-1 with low-cost access
to additional foreign countries;
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(iii) the potential efficiencies and cost savings expected to result
form the combined traffic volumes of STAR and PT-1, which could result in
negotiating leverage for PT-1 and STAR;
(iv) that the Merger would permit the acceleration of development of
the combined international telecommunications network of STAR and PT-1,
including acquiring additional switches, leased lines, interests in
international cables and direct termination agreements with foreign
carriers; and
(v) that the financial resources of the combined entity would expedite
PT-1's expansion of its retail dial around and presubscribed services and
improve PT-1's ability to introduce additional retail telecommunications
products and services.
The foregoing list of the information and factors considered by the PT-1
Board is not intended to be exhaustive. In view of the variety of factors
considered in connection with its evaluation of the Merger, the PT-1 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 PT-1 Board may have given different weights
to different factors. The Board also consulted with its financial and legal
advisors as it deemed appropriate in the context of its review and approval of
the Merger.
On , 1998 the stockholders of PT-1 formally approved the Merger
Agreement and the transactions contemplated thereby, including the Merger.
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 STAR 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 PT-1 and (ii) the separate existence of Newco
will cease and PT-1 will succeed to all the rights, privileges, powers and
franchises and be subject to all the restrictions, disabilities and duties of
the Constituent Corporations. PT-1 will remain as the Surviving Corporation in
the Merger and will continue to exist as a wholly-owned subsidiary of STAR.
At the Effective Time, the holders of PT-1 Common Stock, options to acquire
PT-1 Common Stock and warrants exercisable for PT-1 Common Stock outstanding
immediately prior to the Effective Time will be entitled to receive an aggregate
of 15.05 million shares of STAR Common Stock and an aggregate of $19.5 million
(the "Merger Consideration") No fractional shares of STAR Common Stock will be
issued in the Merger. Rather, holders of PT-1 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."
Effective Time. The "Effective Time" shall mean the day on which the Merger
will become effective upon the filing, in accordance with Section 904 of the
Business Corporation Law, of the Certificate of Merger with the Department of
State of the State of New York, 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 PT-1 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. Following the Effective Time, the current
directors and officers of STAR will remain in their current positions as
directors or officers of STAR, as the case may be, and Mr. Klusaritz will serve
as General Counsel of STAR. Pursuant to the Merger Agreement, STAR has agreed
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to take all necessary steps so that Mr. Tawfik will become a member of the Board
of Directors of STAR immediately following the Effective Time.
Exchange of Certificates. 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 PT-1 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 PT-1 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 PT-1 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 PT-1 Common Stock in an amount (rounded to the
nearest whole $0.01) equal to the product of such fraction of a share multiplied
by the average closing price of STAR Common Stock on Nasdaq for the five (5)
trading days prior to the Effective Time.
Representations and Warranties. The Merger Agreement contains various
customary representations and warranties of PT-1 relating to, among other
things: (a) PT-1's and its subsidiaries' organization and similar corporate
matters; (b) PT-1'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, the 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 ("ERISA"); (i) owned and leased real
property; (j) environmental matters; (k) tax matters; (l) the accuracy of
information to be supplied in connection with the Proxy Statement and any other
documents to be filed with the SEC or any other regulatory agency; (m) financial
statements and reports; material liabilities; and projections; (n) governmental
authorizations and regulations; (o) proprietary property; (p) material
agreements; (q) insurance; (r) accounts receivable; (s) the hiring of brokers or
finders; (t) transactions with affiliated parties; (u) labor matters; (v)
continuity of interests in PT-1 by affiliates; (w) distributors; and (x)
inventory.
The Merger Agreement also contained several representations and warranties
of the PT-1 Stockholders, relating to, among other things: (a) the PT-1
Stockholders' ownership and title to PT-1 Common Stock; (b) the authorization,
execution, delivery and enforceability of the Merger Agreement and related
matters; (c) the absence of (i) violations of, conflicts with, breaches of, or
defaults under any agreement, lien, order, judgment or decree and (ii)
violations of law; (d) the PT-1 Stockholders' accredited investor status under
Rule 501 of the Securities Act; and (e) the shares of STAR Common Stock to be
issued in the Merger.
The Merger Agreement also contains various customary representations and
warranties of STAR and Newco relating to, among other things: (a) STAR and
Newco's organization; (b) STAR and Newco'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 Proxy Statement and any
other documents to be filed with the SEC or any other regulatory agency; (h) the
shares of STAR Common Stock to be issued in the Merger; (i) financial statements
and reports; (j) the hiring of brokers or finders; (k) employee benefit matters
and matters relating to ERISA; (l) environmental matters; (m) the absence of
certain material changes or events; and (n) government authorizations.
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Business of PT-1 Pending the Merger. PT-1 and the PT-1 Stockholders have
agreed that prior to the Effective Time all material managerial and operational
matters will be presented to and subject to the reasonable review and approval
of STAR. In that regard, except as otherwise consented to or approved in writing
by STAR or expressly permitted by the Merger Agreement: (a) the business of PT-1
and of its subsidiaries will be conducted in the ordinary course and consistent
with past practice; (b) neither PT-1 nor its subsidiaries will (i) amend its
Certificate of Incorporation or Bylaws; (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 of the Merger Agreement (iii)
declare, set aside or pay any dividend; (iv) make any redemption, retirement or
purchase of its capital stock; (v) split, combine or reclassify its capital
stock; (c) neither PT-1 nor its subsidiaries shall directly or indirectly (i)
issue, grant, sell or pledge or agree or propose to issue, grant, sell or pledge
any shares of its capital stock, except upon exercise of outstanding stock
options and warrants; (ii) incur any material indebtedness for borrowed money,
except material indebtedness for borrowed money incurred under existing credit
facilities; (iii) waive, release, grant or transfer any rights of material
value; or (iv) transfer, lease, license, sell, mortgage, pledge, dispose of or
encumber any material assets other than in the ordinary course of business and
consistent with past practice; (d) neither PT-1 nor its subsidiaries shall fail
to preserve intact its business organization, to use its respective best efforts
to keep available the services of its operating personnel or to use its
respective best efforts to preserve the goodwill of those having business
relationships with either PT-1 or its subsidiaries; (e) neither PT-1 nor its
subsidiaries shall directly or indirectly (i) increase the compensation payable
to any of its employees, officers or directors, except in accordance with
existing employment agreements and benefit plans; (ii) adopt any new, or make
any payment not required by any existing plan or agreements, including
provisions and actions under existing stock option plans in connection with the
Merger, in the ordinary course of business 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; (iii) grant any stock option or stock appreciation rights or issue any
warrants; (iv) enter into or amend any employment or severance agreement; or
(iv) make any loan or advance to, or enter into any written contract with any
officer, director or PT-1 Stockholder; (f) neither PT-1 nor its subsidiaries
shall directly or indirectly 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 other than in
the ordinary course of business and consistent with past practice; (g) neither
PT-1 nor its subsidiaries shall make any investment of a capital nature other
than in the ordinary course of business under certain material contracts in
place on the date of the Merger Agreement; (h) neither PT-1 nor its subsidiaries
shall enter into, modify, amend or terminate any material contract; (i) neither
PT-1 nor its subsidiaries 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 PT-1 nor its subsidiaries shall settle or compromise any
material federal, state, local or foreign income tax proceeding or audit; (k)
neither PT-1 nor its subsidiaries shall fail to advise STAR in writing of
anything that would have a material adverse effect on the financial condition,
results of operations, business or properties of PT-1 or its subsidiaries or any
breach of PT-1's representations or warranties or any known breach of any
covenant in the Merger Agreement; or (l) neither PT-1 nor its subsidiaries shall
enter into an agreement to do any of the things described above.
Acquisition Proposals. PT-1 and the PT-1 Stockholders have each agreed that
neither PT-1 nor any of its subsidiaries, nor the PT-1 Stockholders, directors,
officers, partners, employees, or other authorized persons of any of them, will,
directly or indirectly, solicit, initiate, encourage or participate in
discussions or negotiations with or the submission of any offer or proposal by
or provide any information or access 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 an offer or proposal for
a merger or other business combination involving PT-1 or any of its
subsidiaries, or the acquisition of any equity interest in, or a substantial
portion of the assets of, PT-1 or any subsidiary, other than the transactions
contemplated by the Merger Agreement (each, an "Acquisition Proposal"). PT-1
will promptly, in no event later than 24 hours after receipt of the relevant
Acquisition Proposal, notify STAR after (i) PT-1 has received any acquisition
Proposal, (ii) PT-1 has actual knowledge that any person is considering making
an Acquisition Proposal, or (iii) PT-1 has received any request for information
relating to PT-1 or any subsidiary, or for access to the
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properties, books or records of PT-1 or any subsidiary, by any person that PT-1
has actual knowledge is considering making, or has made, an Acquisition
Proposal.
Treatment of PT-1 Stock Options and Warrants. On the Effective Time, STAR
shall assume the duties and obligations of PT-1, and STAR shall be vested with
the powers, rights and privileges of PT-1, under the PT-1 Warrants and the PT-1
Options. 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.
Indemnification. The PT-1 Stockholders have agreed (a) with respect to the
representations and warranties of the PT-1 Stockholders, severally but not
jointly, and (b) with respect to the representations and warranties of PT-1,
jointly and severally, to indemnify STAR, and each of STAR's respective
officers, directors, employees, agents and representatives (collectively, the
"STAR Indemnities") against and hold such individuals harmless from any and all
claims, obligations, losses, damages, costs, expenses (including without
limitation, reasonable attorneys' fees and expenses) and other liabilities of
STAR (collectively, the "Losses") arising out of the breach of any
representation, warranty, covenant or agreement of PT-1 or the PT-1 Stockholders
in the Merger Agreement, as the case may be, whether or not such losses arise as
a result of third party claims asserted against PT-1. Notwithstanding the
foregoing, the PT-1 Stockholders shall not be liable pursuant to the
indemnification until the aggregate of all such Losses exceeds $1,000,000, in
which case, the PT-1 Stockholders will be required to indemnify the STAR
Indemnitees for the full amount of such Losses, including the $1,000,000
threshold amount, up to but not exceeding the value of the Escrow Shares (as
defined below). No claim for indemnification may be made after the Escrow
Period.
Confidentiality. Subject to applicable law and to subpoena, STAR, Newco and
PT-1, its subsidiaries and the PT-1 Stockholders 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 concerning the other party 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. Each party to the Merger Agreement shall bear his or its
own fees and expenses incurred in connection with the transactions contemplated
by the Merger Agreement, provided that, in the context of the enforcement of the
terms and conditions of the Merger Agreement, the prevailing party will be
entitled to the payment of its reasonable legal fees and expenses incurred in
connection with the enforcement of such rights. In addition, in certain
circumstances, PT-1 shall pay to Newco a termination fee. See "-- Termination
Fee."
Conditions. The respective obligations of each of STAR, Newco, PT-1 and the
PT-1 Stockholders to effect the Merger are subject to the satisfaction of the
following conditions at or prior to the Effective Time: (a) the approval and
adoption of the Merger Agreement and the transactions contemplated thereby by
the requisite vote of STAR stockholders; (b) the absence of any statute, rule,
regulation, temporary, preliminary or permanent injunction or other order by any
United States or state governmental authority, agency, commission or United
States or state court of competent jurisdiction prohibiting consummation of the
Merger or having the effect of making the Merger illegal; (c) the expiration or
termination of any waiting period applicable to the consummation of the Merger
under the HSR Act; (d) the receipt by or on behalf of STAR of all necessary
regulatory approvals from the FCC, all PUCs and Foreign Agencies required for
the transfer of ownership or control over PT-1; (e) 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 (f)
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 or
materially impair STAR's or the Surviving Corporation's ownership or operation
of all or a material portion of the
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business or assets of PT-1 and its subsidiaries, taken as a whole, or compel
STAR to dispose of all or a material portion of the business or assets or PT-1
and its subsidiaries, taken as a whole.
In addition, the obligations of PT-1 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,
taken as a whole, excluding any such change caused by a general change in the
economy or in the telecommunications industry served by STAR and its
subsidiaries; (d) PT-1 shall have received a certificate of the President or
Vice President of STAR with respect to clauses (a), (b) and (c); (e) PT-1 shall
have received an opinion of counsel in form reasonably agreed to by the parties;
(f) STAR and each PT-1 Stockholder shall have entered into a registration rights
and restricted share agreement; (g) STAR shall have taken all necessary steps
such that Mr. Tawfik will become a member of the Board immediately following the
Effective Time; and (h) PT-1 shall have received reasonably satisfactory
evidence that, following the Effective Date, (i) the shares of STAR Common Stock
issuable on exercise of the PT-1 Options and Warrants shall be subject to an
effective Registration Statement on Form S-8 filed by STAR pursuant to the
Securities Act, (ii) 250,000 shares of STAR Common Stock have been reserved for
issuance to selected distributions of PT-1 in the form of restricted shares
pursuant to restricted stock purchase agreements to be entered into between such
distributors and STAR, at no consideration per share to such distributors and
with a pro rata vesting schedule of no more than four years, such distributors
to be designated by PT-1 and reasonably acceptable to STAR and (iii) 100,000
shares of STAR Common Stock have been reserved for issuance to selected
employees in the form of stock options under STAR's presently outstanding
employee stock option plan, with such selected employees to be designated by
PT-1 and reasonably acceptable to STAR.
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 PT-1 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 PT-1 contained in the Merger Agreement which are qualified with
respect to materiality shall be true and correct and all such representations
and warranties that are not so qualified 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 PT-1 and its subsidiaries taken as a
whole, other than any change arising from any action authorized, directed or
otherwise approved by STAR pursuant to the Merger Agreement or from STAR's
express refusal to approve any action proposed by PT-1 and excluding any change
caused by a general change in the economy or in the telecommunications industry
served by PT-1 and its subsidiaries, other than any such change approved by
STAR; (d) STAR and Newco shall have received a certificate of the President or
Vice President of PT-1 with respect to clauses (a), (b) and (c); (e) Newco shall
have received letters of resignation from the members of PT-1's Board of
Directors; and (f) STAR shall have received an opinion of counsel from counsel
to PT-1 in form reasonably agreed to by the parties.
Termination. The Merger Agreement may be terminated at any time prior to
the Effective Time and before approval by the STAR stockholders in a number of
circumstances which include, among others: (a) by mutual consent of STAR and
PT-1; (b) by STAR if (i) there has occurred a material adverse change in the
financial condition, results of operations, business or properties of PT-1 and
its subsidiaries taken as a whole, other than any change arising from any action
authorized, directed or otherwise approved by STAR pursuant to the terms of the
Merger Agreement or from STAR's express refusal to approve any action proposed
by PT-1 and except for any change caused by a general change in the economy of
the United States or in the telecommunications industry served by PT-1, (ii)
there is a breach of any of the representations and warranties of PT-1 which are
qualified with respect to materiality or if STAR shall have breached in any
material respect any of such representations or warranties which are not so
qualified, or (iii) if PT-1 or any of
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the PT-1 Stockholders fails to comply in any material respect with any of its
covenants or agreements, or otherwise wilfully breaches or fails to perform
pursuant to the terms of the Merger Agreement which breaches or failures are, in
the aggregate, material in the context of the transactions contemplated by the
Merger Agreement; (c) by PT-1 (i) if there has occurred a material adverse
change in the financial condition, results of operations, business or properties
of STAR except for any change caused by a general change in the economy of the
United States or in the telecommunications industry served by PT-1, and except
as otherwise approved in writing by STAR or (ii) there is a breach of any of the
representations and warranties of STAR or Newco which are qualified with respect
to materiality or if STAR shall have breached in any material respect any of
such representations or warranties which are not so qualified, or if STAR or
Newco fails to comply in any material respect with any of its covenants or
agreements, or otherwise wilfully breaches or fails to perform pursuant to the
terms of the Merger Agreement which breaches or failures are, in the aggregate,
material in the context of the transactions contemplated by the Merger
Agreement; and (d) by either STAR or PT-1, if on or before March 31, 1999 (such
date being referred to as the "Closing Date"), or on or before June 30, 1999,
provided that if immediately prior to December 31, 1998 the approvals with
respect to all material filings with the FCC, PUCs and Foreign Agencies shall
not have been received but all other conditions to the closing of the Merger
shall have been satisfied or waived, 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.
In the event of such termination and abandonment, no party to the Merger
Agreement (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 in the Merger Agreement
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 STAR, pursuant to
clause (b)(iii) above, and, within six months following such termination, PT-1
and/or the PT-1 Stockholders enter into an agreement contemplating 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 PT-1 Common Stock or of the assets of PT-1 and its
subsidiaries and the value of the consideration to be received by the
stockholders of PT-1 with respect to such transaction equals or exceeds $500
million, then PT-1 shall, simultaneously with consummation of such transaction
or transactions, pay to STAR, by wire transfer of immediately available funds,
$20 million (the "Termination Fee").
Amendment and Waiver. Subject to applicable law, the Merger Agreement may
be amended by the parties thereto solely by action of their respective Boards of
Directors. Any such amendment must be in 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 or in any documents delivered
pursuant to the Merger Agreement, 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.
RELATED AGREEMENTS
Certain additional agreements are attached as exhibits to the Merger
Agreement, consisting of: (a) the Shareholder Agreement among PT-1 and Messrs.
Edgecomb and Crumly and Ms. Casey, which was executed simultaneously with the
Merger Agreement; (b) the Registration Rights and Restricted Share Agreement
between STAR and the PT-1 Stockholders; and (c) the Escrow Agreement among STAR
and the PT-1 Stockholders. STAR and certain executives of PT-1 also entered into
amendments (the "Amendments") to
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such officers' current employment agreements with PT-1 to provide, among other
things, for the officers' employment with PT-1 or STAR following the Merger and
certain non-competition provisions.
Shareholder Agreement. Pursuant to the Shareholder Agreement, Messrs.
Edgecomb and Crumly and Ms. Casey have agreed to vote all shares of STAR Common
Stock held, beneficially or of record, by such individuals, and to express their
consent, in favor of approval of the Merger Agreement and any actions required
in furtherance thereof and against any action or agreement that would result in
a breach in any respect of any covenant, representation or warranty or any other
obligation or agreement of STAR or Newco under the Merger Agreement. The
obligations of such individuals under the Shareholder Agreement will terminate
on the earlier of the Effective Time or termination of the Merger Agreement for
any reason. As of October 6, 1998, Mr. Edgecomb held shares, or
approximately % of the outstanding STAR Common Stock, Mr. Crumly held
shares, or approximately % of the outstanding STAR Common Stock,
and Ms. Casey held shares, or approximately % of the outstanding
STAR Common Stock.
Registration Rights and Restricted Share Agreement. The Registration Rights
and Restricted Share Agreement between STAR and the PT-1 Stockholders, which
will be executed by the parties on the Closing Date, provides for certain
transfer restrictions on the shares received by the PT-1 Stockholders in the
Merger. The Agreement prohibits the PT-1 Stockholders from transferring
1,550,000 of such shares (the "One-Year Shares"), subject to certain limited
exceptions, until the first anniversary of the Closing Date and the remaining
13.5 million of such shares until the second anniversary of the Closing Date
(the "Two-Year Shares"). The Registration Rights and Restricted Share Agreement
also provides that, with respect to the shares of STAR Common Stock received by
each PT-1 Stockholder pursuant to the Merger (the "Registrable Securities"), the
PT-1 Stockholders may, on not more than one occasion during each of the first
twelve-month periods following the second anniversary of the Closing Date,
request STAR to prepare and file with the Commission a registration statement
under the Securities Act covering the public offer and sale of the Registrable
Securities, provided that such request relates to the registration of at least
three million shares of Registrable Securities. The Agreement also provides for
customary "piggyback" registration rights commencing after the second
anniversary of the Closing Date, or, with respect to the One-Year Shares, at any
time after the first anniversary of the Closing Date, in the event STAR proposes
to register any of its stock or other securities, for its own account or for the
account of any other stockholder. The Agreement contains additional customary
terms and provisions, including reciprocal restrictions on the public sale or
distribution of shares of STAR Common Stock during certain underwritten
offerings and reciprocal indemnification and contribution provisions with
respect to information furnished or provided by STAR or the PT-1 Stockholders
for inclusion in any registration statement.
Escrow Agreement. The Escrow Agreement between STAR and the PT-1
Stockholders, which will be executed by the parties on the Closing Date,
provides that 1,505,000 of the shares of STAR Common Stock issued to the
stockholders of PT-1 in the Merger (the "Escrow Shares") will be deposited at
the Closing Date in an escrow established with Santa Barbara Bank and Trust, or
another mutually agreed upon escrow agent. The Escrow Shares will be subject to
offset pursuant to the indemnification provisions of the Merger Agreement. The
maximum liability of the PT-1 Stockholders pursuant to such indemnification is
limited to the Escrow Shares. Subject to the filing of any claims against any
portion of the Escrow Shares, the Escrow Agreement will be in place for a period
commencing at the Closing Date and ending on the first anniversary thereof,
provided that, at ninety day intervals during the escrow period, portions of the
Escrow Shares may be released to the PT-1 Stockholders.
Employment Agreements. Pursuant to the Amendments, after consummation of
the Merger, the officers of PT-1 will be Mr. Tawfik (President), Mr. Vita
(Executive Vice President), Douglas Barley (Chief Financial Officer) and Mr.
Klusaritz (General Counsel). Mr. Klusaritz will also serve as General Counsel of
STAR. Such officers also agreed to certain restrictions on competition during
their employment with PT-1 and/or STAR.
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ACCOUNTING TREATMENT OF THE MERGER
The Merger will be accounted for by STAR under the purchase method of
accounting in accordance with APB No. 16. Under this method of accounting, the
purchase price will be allocated to assets acquired and liabilities assumed
based on their estimated fair values. A representative of Arthur Andersen,
STAR's independent public accountants will be available at the Special Meeting
to respond to appropriate questions.
FEDERAL INCOME TAX CONSEQUENCES OF THE MERGER
The Merger will not have any U.S. federal, state or local income tax effect
on STAR or any stockholder of STAR.
REGULATORY APPROVALS
Under the HSR Act, and the rules promulgated thereunder by 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 PT-1 have each filed 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 on October 3,
1998, 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 PT-1 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 PT-1 or 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 PT-1 or the transfer of
control over PT-1's certificate of public convenience and necessity and daily
operations, STAR must obtain all necessary regulatory approvals required for the
transfer of ownership or control over PT-1 from the FCC, all PUCs and certain
Foreign Agencies. STAR is currently in the process of obtaining all such
necessary regulatory approvals. See "Risk Factors -- Potential Adverse Effect of
Government Regulation -- Change of Control."
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 PT-1 pursuant to the terms of the
Merger Agreement be authorized for listing on Nasdaq.
LOAN TO PT-1
In contemplation of the Merger, STAR entered into a $10.0 million loan
arrangement with STAR payable on August 17, 1999. The loan accrues interest
monthly at a rate of 6 3/4% per annum.
VOTE REQUIRED AND RECOMMENDATION OF THE BOARD
The Merger Agreement and the Share Issuance contemplated thereby requires
the affirmative vote of the holders of a majority of the outstanding shares of
STAR Common Stock entitled to vote at the Special Meeting. As of September 1,
1998, holders of 50.42% of the outstanding shares of STAR Common Stock have
agreed to vote in favor of the Proposal.
THE BOARD UNANIMOUSLY RECOMMENDS THAT THE STOCKHOLDERS VOTE "FOR" THE
APPROVAL AND ADOPTION OF THE MERGER AGREEMENT AND THE TRANSACTIONS CONTEMPLATED
THEREBY, INCLUDING THE SHARE ISSUANCE.
55
<PAGE> 59
UNAUDITED PRO FORMA FINANCIAL DATA
The following unaudited pro forma financial data is presented assuming the
Merger will be accounted for as a purchase, whereby STAR will allocate the
purchase price to assets acquired and liabilities assumed based on their fair
values. STAR also entered into an agreement to acquire UDN on November 19, 1997,
and plans to account for this transaction as a pooling of interests. The
consummation of the UDN acquisition is subject to several conditions, including
the approval of the shareholders of UDN and certain regulatory agencies. Because
of the various contingencies relating to the consummation of the UDN
transaction, the pro forma financial statements of STAR have been presented
alternatively: (1) assuming that STAR will not complete the acquisition of UDN,
and (2) assuming that STAR will complete the acquisition of UDN.
Thus the first set of unaudited pro forma condensed statement of operations
data for the twelve months ended December 31, 1997 and the six months ended June
30, 1997 and 1998 only gives effect to the acquisition of PT-1 as if it had
occurred on January 1, 1997. The unaudited pro forma condensed combined balance
sheet as of June 30, 1998 gives effect to the acquisition as if it had occurred
on June 30, 1998. The acquisition will be accounted for as a purchase
transaction. The estimated total purchase price will be allocated to the fair
value of the assets and liabilities acquired. The excess of the purchase price
plus transaction costs over the fair value of the net assets acquired will be
allocated to goodwill and as such amortized on a straight-line basis over a
40-year period. The preliminary amount allocated to goodwill is estimated to be
approximately $138 million. None of the above referenced unaudited pro forma
condensed financial statements include UDN.
The second set of unaudited pro forma condensed financial statements
assumes completion of STAR's merger with UDN in a pooling of interests
transaction. The historical condensed statement of operations data for the years
ended December 31, 1995, 1996 and 1997 and the six months ended June 30, 1997
and 1998 is combined with the historical operating results of UDN for the twelve
months ended January 31, 1996, 1997 and 1998, and the six months ended June 30,
1997 and 1998. The resulting combined unaudited pro forma statements of
operations for the twelve months ended December 31, 1997 and the six months
ended June 30, 1997 and 1998 are combined with the results of operations of PT-1
for year ended March 31, 1998 and the six months ended June 30, 1997 and 1998
assuming the acquisition of PT-1 had occurred on January 1, 1997. The historical
condensed balance sheet of STAR at June 30, 1998 is combined with the historical
condensed balance sheet of UDN assuming they had always been one entity. The
resulting pro forma balance sheet at June 30, 1998 gives effect to the
acquisition of PT-1 as if it had occurred on June 30, 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 BY STAR 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
"Description of Forward-Looking Statements." The unaudited pro forma financial
data does not reflect certain non-recurring costs expected to be incurred in
connection with the UDN 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 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 PT-1" and the consolidated financial
statements of each of STAR, UDN and PT-1 and the related notes thereto, included
elsewhere in this Proxy Statement.
56
<PAGE> 60
UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
AT JUNE 30, 1998
(IN THOUSANDS EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
STAR PT-1
JUNE 30, JUNE 30, MERGER PRO FORMA
1998 1998 ADJUSTMENTS COMBINED
-------- ----------- ----------- ---------
<S> <C> <C> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents....................... $ 9,161 $ 3,334 $ -- $ 12,495
Short-term investments.......................... 114,421 1,293 (19,500)(a) 96,214
Accounts and notes receivable................... 66,119 43,857 (10,220)(b) 99,756
Receivable from related parties................. 5,076 -- -- 5,076
Other current assets............................ 19,818 5,720 (725)(c) 24,813
-------- -------- -------- --------
Total current assets.................... 214,595 54,204 (30,445) 238,354
Property and equipment, net..................... 101,287 33,299 -- 134,586
Intangible assets, net.......................... -- 2,742 -- 2,742
Goodwill........................................ -- -- 138,194(d) 138,194
Other long-term assets.......................... 2,045 3,493 -- 5,538
-------- -------- -------- --------
Total assets............................ $317,927 $ 93,738 $107,749 $519,414
======== ======== ======== ========
CURRENT LIABILITIES:
Revolving lines of credit....................... $ -- 5,000 $ -- $ 5,000
Payable to stockholders......................... 73 -- -- 73
Current portion of long-term obligations........ 7,319 1,451 -- 8,770
Note payable.................................... -- 5,000 -- 5,000
Accounts payable and accrued expenses........... 35,309 18,034 14,000(c) 56,398
(10,220)(b)
(725)(c)
Due to carriers................................. -- 12,096 -- 12,096
Deferred revenue................................ -- 44,972 -- 44,972
Accrued network cost............................ 47,942 -- -- 47,942
-------- -------- -------- --------
Total current liabilities............... 90,643 86,553 3,055 180,251
-------- -------- -------- --------
Long-term obligations........................... 26,528 8,254 -- 34,782
Other long-term liabilities..................... 1,247 600 -- 1,847
-------- -------- -------- --------
Total long-term liabilities............. 27,775 8,854 -- 36,629
STOCKHOLDERS' EQUITY (DEFICIT)
Common stock of STAR (50,000,000 shares
authorized, 41,796,123 actual shares and
57,096,123 pro forma shares issued and
outstanding)................................. 42 -- 15(f) 57
Common stock of PT-1 (150,000,000 shares
authorized, 73,459,180 actual shares issued,
48,406,548 actual shares outstanding and no
pro forma shares issued or outstanding)...... -- 735 (735)(g) --
Paid-in capital................................. 196,857 16,056 106,368(h) 303,225
(16,056)(j)
Retained earnings (deficit)..................... 2,610 (102) 102(j) 2,610
Treasury stock.................................. -- (15,000) 15,000(k) --
Note receivable from stockholder................ -- (3,358) -- (3,358)
-------- -------- -------- --------
199,509 (1,669) 104,694 302,534
-------- -------- -------- --------
Total liabilities and stockholder's
equity................................ $317,927 $ 93,738 $107,749 $519,414
======== ======== ======== ========
</TABLE>
57
<PAGE> 61
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
FOR THE YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
STAR PT-1
YEAR ENDED YEAR ENDED
DECEMBER 31, MARCH 31, MERGER PRO FORMA
1997 1998 ADJUSTMENTS COMBINED
------------ ---------- ----------- ---------
<S> <C> <C> <C> <C>
REVENUES.................................. $404,605 $431,520 $(49,441)(l) $786,684
COST OF SERVICES.......................... 351,821 395,501 (49,441)(l) 697,881
-------- -------- -------- --------
Gross profit............................ 52,784 36,019 -- 88,803
-------- -------- -------- --------
OPERATING EXPENSES:
Selling, general and administrative
expenses............................. 36,782 17,724 420(m) 54,926
Depreciation and amortization........... 4,637 1,535 3,455(n) 9,627
-------- -------- -------- --------
41,419 19,259 3,875 64,553
-------- -------- -------- --------
Income from operations.................. 11,365 16,760 (3,875) 24,250
-------- -------- -------- --------
OTHER INCOME (EXPENSE):
Interest income......................... 492 517 (1,009)(e) --
Interest expense........................ (1,738) (1,021) (63)(e) (2,822)
Legal settlement and expenses........... (1,653) -- -- (1,653)
Other income (expense).................. 208 474 -- 682
-------- -------- -------- --------
(2,691) (30) (1,072) (3,793)
-------- -------- -------- --------
Income before provision for income
taxes................................ 8,674 16,730 (4,947) 20,457
PRO FORMA PROVISION FOR INCOME TAXES...... 3,100 5,150 296(o) 8,546
-------- -------- -------- --------
PRO FORMA NET INCOME...................... $ 5,574 $ 11,580 $ (5,243) $ 11,911
======== ======== ======== ========
Pro forma net income per common share:
Basic................................... $ 0.18 $ 0.25 $ 0.27
Diluted................................. $ 0.17 $ 0.24 $ 0.25
Weighted average number of common shares
outstanding:
Basic................................... 30,221 46,922 44,016
Diluted................................. 32,978 47,720 48,278
</TABLE>
58
<PAGE> 62
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
FOR THE SIX MONTHS ENDED JUNE 30, 1997
(IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
STAR PT-1
SIX MONTHS SIX MONTHS
ENDED ENDED MERGER PRO FORMA
JUNE 30, 1997 JUNE 30, 1997 ADJUSTMENTS COMBINED
-------------- ------------- ----------- ---------
<S> <C> <C> <C> <C>
REVENUES..................................... $180,077 $149,897 $(20,812)(l) $309,162
COST OF SERVICES............................. 156,612 138,799 (20,812)(l) 274,599
-------- -------- -------- --------
Gross profit............................... 23,465 11,098 -- 34,563
-------- -------- -------- --------
OPERATING EXPENSES:
Selling, general and administrative
expenses................................ 16,220 12,127 210(m) 28,557
Depreciation and amortization.............. 1,813 220 1,728(n) 3,761
-------- -------- -------- --------
18,033 12,347 1,938 32,318
-------- -------- -------- --------
Income from operations..................... 5,432 (1,249) (1,938) 2,245
-------- -------- -------- --------
OTHER INCOME (EXPENSE):
Interest income............................ 74 133 (207)(e) --
Interest expense........................... (836) (210) (329)(e) (1,375)
Other income (expense)..................... (705) 94 -- (611)
-------- -------- -------- --------
(1,467) 17 (536) (1,986)
-------- -------- -------- --------
Income (loss) before provision for income
taxes................................... 3,965 (1,232) (2,474) 259
PRO FORMA PROVISION INCOME TAXES
(BENEFIT)............................... 1,581 (190) (599)(o) 792
-------- -------- -------- --------
PRO FORMA NET INCOME (LOSS)................ 2,384 (1,042) (1,875) (533)
======== ======== ======== ========
Pro forma net income (loss) per common
share:
Basic................................... $ 0.09 $ (.02) $ (0.01)
Diluted................................. $ 0.08 $ (.02) $ (0.01)
Weighted average number of common shares
outstanding:
Basic................................... 27,304 52,676 41,099
Diluted................................. 28,900 52,676 41,099
</TABLE>
59
<PAGE> 63
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
FOR THE SIX MONTHS ENDED JUNE 30, 1998
(IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
STAR PT-1
SIX MONTHS SIX MONTHS
ENDED ENDED MERGER PRO FORMA
JUNE 30, 1998 JUNE 30, 1998 ADJUSTMENTS COMBINED
-------------- -------------- ----------- ---------
<S> <C> <C> <C> <C>
REVENUES.................................... $261,198 $267,384 $(30,754)(l) $497,828
COST OF SERVICES............................ 224,470 248,702 (30,754)(l) 442,418
-------- -------- -------- --------
Gross profit.............................. 36,728 18,682 -- 55,410
-------- -------- -------- --------
OPERATING EXPENSES:
Selling, general and administrative
expenses............................... 23,245 13,497 210(m) 36,952
Depreciation and amortization............. 4,616 2,222 1,728(n) 8,566
-------- -------- -------- --------
27,861 15,719 1,938 45,518
-------- -------- -------- --------
Income from operations.................... 8,867 2,963 (1,938) 9,892
-------- -------- -------- --------
OTHER INCOME (EXPENSE):
Interest Income........................... 1,672 396 (536)(e) 1,532
Interest expense.......................... (1,340) (731) -- (2,071)
Other income (expense).................... (258) 218 -- (40)
-------- -------- -------- --------
74 (117) (536) (579)
-------- -------- -------- --------
Income before provision for income
taxes.................................. 8,941 2,846 (2,474) 9,313
PROVISION FOR INCOME TAXES................ 3,831 1,203 (303)(o) 4,731
-------- -------- -------- --------
NET INCOME................................ $ 5,110 $ 1,643 $ (2,171) $ 4,582
======== ======== ======== ========
Net income per common share:
Basic.................................. $ 0.14 $ 0.03 $ 0.09
Diluted................................ $ 0.13 $ 0.03 $ 0.09
Weighted average number of common shares
outstanding:
Basic.................................. 37,640 48,404 51,435
Diluted................................ 39,649 48,587 53,149
</TABLE>
60
<PAGE> 64
UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
AT JUNE 30, 1998
(IN THOUSANDS EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
STAR UDN MERGER PRO PT-1 MERGER PRO
JUNE 30, JUNE 30, ADJUST- FORMA JUNE 30, ADJUST- FORMA
1998 1998 MENTS COMBINED 1998 MENTS COMBINED
--------- --------- ------- -------- ----------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents.............. $ 9,161 $ 658 $ -- $ 9,819 $ 3,334 $ -- $ 13,153
Short-term investments................. 114,421 -- -- 114,421 1,293 (19,500)(a) 96,214
Accounts and notes receivable.......... 66,119 6,153 (6,642)(b) 65,630 43,857 (10,220)(b) 99,267
Receivable from related parties........ 5,076 -- -- 5,076 -- -- 5,076
Other current assets................... 19,818 280 -- 20,098 5,720 (725)(c) 25,093
-------- -------- ------- -------- ------- -------- --------
Total current assets............. 214,595 7,091 (6,642) 215,044 54,204 (30,445) 238,803
Property and equipment, net............ 101,287 1,979 -- 103,266 33,299 -- 136,565
Intangible assets, net................. -- 5,653 -- 5,653 2,742 -- 8,395
Goodwill............................... -- -- -- -- -- 138,194(d) 138,194
Other long-term assets................. 2,045 137 -- 2,182 3,493 -- 5,675
-------- -------- ------- -------- ------- -------- --------
Total assets..................... $317,927 $ 14,860 $(6,642) $326,145 $93,738 $107,749 $527,632
======== ======== ======= ======== ======= ======== ========
CURRENT LIABILITIES:
Revolving lines of credit.............. $ -- $ -- $ -- $ -- 5,000 $ -- $ 5,000
Payable to stockholders................ 73 550 (550)(p) 73 -- -- 73
Current portion of long-term
obligations.......................... 7,319 1,121 -- 8,440 1,451 -- 9,891
Note payable........................... -- 4,500 (4,500)(b) -- 5,000 -- 5,000
Accounts payable and accrued
expenses............................. 35,309 10,740 (2,142)(b) 43,907 18,034 14,000(c) 64,996
(10,220)(b)
(725)(c)
Due to carriers........................ -- -- -- -- 12,096 -- 12,096
Deferred revenue....................... -- 1,200 -- 1,200 44,972 -- 46,172
Accrued network cost................... 47,942 -- -- 47,942 -- -- 47,942
-------- -------- ------- -------- ------- -------- --------
Total current liabilities........ 90,643 18,111 (7,192) 101,562 86,553 3,055 191,170
-------- -------- ------- -------- ------- -------- --------
Long-term obligations.................. 26,528 345 -- 26,873 8,254 -- 35,127
Other long-term liabilities............ 1,247 -- -- 1,247 600 -- 1,847
-------- -------- ------- -------- ------- -------- --------
Total long-term liabilities...... 27,775 345 -- 28,120 8,854 -- 36,974
STOCKHOLDER'S EQUITY (DEFICIT)
Common stock of STAR (50,000,000 shares
authorized, 41,796,123 actual shares
and 57,732,148 pro forma shares
issued and outstanding).............. 42 -- -- 42 -- 15(f) 57
Common stock of UDN (100,000,000 shares
authorized, 7,054,844 actual shares
and no pro forma shares issued and
outstanding)......................... -- 71 (71)(q) -- -- --
Common stock of PT-1 (150,000,000
shares authorized, 73,459,180 actual
shares issued, 48,406,548 actual
shares outstanding and no pro forma
shares issued or outstanding)........ -- -- -- -- 735 (735)(g) --
Paid-in capital........................ 196,857 13,007 71(q) 210,485 16,056 106,368(h) 316,853
550(p) (16,056)(i)
Retained earnings (deficit)............ 2,610 (16,674) -- (14,064) (102) 102(j) (14,064)
Treasury stock......................... -- -- -- -- (15,000) 15,000(k) --
Note receivable from stockholder....... -- -- -- -- (3,358) -- (3,358)
-------- -------- ------- -------- ------- -------- --------
199,509 (3,596) 550 196,463 (1,669) 104,694 299,488
-------- -------- ------- -------- ------- -------- --------
Total liabilities and
stockholder's equity........... $317,927 $ 14,860 $(6,642) $326,145 93,738 $107,749 $527,632
======== ======== ======= ======== ======= ======== ========
</TABLE>
61
<PAGE> 65
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
(IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
UDN
STAR TWELVE
YEAR MONTHS
ENDED ENDED MERGER PRO
DECEMBER JANUARY 31, ADJUST- FORMA
31, 1995 1996 MENTS COMBINED
-------- ------------- ------- --------
<S> <C> <C> <C> <C>
REVENUES.................................................... $58,937 $ 5,711 $ (43)(l) $64,605
COST OF SERVICES............................................ 44,270 4,342 (43)(l) 48,569
------- ------- ----- -------
Gross profit.............................................. 14,667 1,369 -- 16,036
------- ------- ----- -------
OPERATING EXPENSES:
Selling, general and administrative expenses.............. 10,452 2,494 -- 12,946
Depreciation and amortization............................. 368 484 -- 852
------- ------- ----- -------
10,820 2,978 -- 13,798
------- ------- ----- -------
Income (loss) from operations............................. 3,847 (1,609) -- 2,238
------- ------- ----- -------
OTHER INCOME (EXPENSE):
Interest income........................................... 22 (12) -- 10
Interest expense.......................................... (64) (91) -- (155)
Other income (expense).................................... (33) (183) -- (216)
------- ------- ----- -------
(75) (286) -- (361)
------- ------- ----- -------
Income (loss) before provision for income taxes........... 3,772 (1,895) -- 1,877
PRO FORMA PROVISION FOR INCOME TAXES........................ 1,632 -- (819)(o) 813
------- ------- ----- -------
PRO FORMA NET INCOME (LOSS)................................. $ 2,140 $(1,895) $ 819 $ 1,064
======= ======= ===== =======
Pro forma net income (loss) per common share:
Basic..................................................... $ 0.11 $ (0.57) $ 0.05
Diluted................................................... $ 0.11 $ (0.57) $ 0.05
Weighted average number of common shares outstanding:
Basic..................................................... 19,373 3,331 19,662
Diluted................................................... 19,373 3,331 19,662
</TABLE>
62
<PAGE> 66
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
(IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
UDN
STAR TWELVE
YEAR MONTHS
ENDED ENDED
DECEMBER 31, JANUARY 31, MERGER PRO FORMA
1996 1997 ADJUSTMENTS COMBINED
------------ ----------- ----------- ---------
<S> <C> <C> <C> <C>
REVENUES................................................ $259,697 $19,685 $(259)(l) $279,123
COST OF SERVICES........................................ 225,957 15,051 (259)(l) 240,749
-------- ------- ----- --------
Gross profit.......................................... 33,740 4,634 -- 38,374
-------- ------- ----- --------
OPERATING EXPENSES:
Selling, general and administrative expenses.......... 35,956 4,563 -- 40,519
Depreciation and amortization......................... 1,442 818 -- 2,260
-------- ------- ----- --------
37,398 5,381 -- 42,779
-------- ------- ----- --------
Income (loss) from operations......................... (3,658) (747) -- (4,405)
-------- ------- ----- --------
OTHER INCOME (EXPENSE):
Interest income....................................... 110 4 -- 114
Interest expense...................................... (609) (448) -- (1,057)
Legal settlement and expenses......................... (100) -- -- (100)
Other income.......................................... 39 17 -- 56
-------- ------- ----- --------
(560) (427) -- (987)
-------- ------- ----- --------
Income (loss) before provision for income taxes....... (4,218) (1,174) -- (5,392)
PRO FORMA PROVISION FOR INCOME TAXES (BENEFIT).......... 1,520 (50) -- 1,470
-------- ------- ----- --------
PRO FORMA NET INCOME (LOSS)............................. $ (5,738) $(1,124) $ -- $ (6,862)
======== ======= ===== ========
Pro forma net income (loss) per common share:
Basic................................................. $ (0.25) $ (0.22) $ (0.29)
Diluted............................................... $ (0.25) $ (0.22) $ (0.29)
Weighted average number of common shares outstanding:
Basic................................................. 23,292 5,048 23,730
Diluted............................................... 23,292 5,048 23,730
</TABLE>
63
<PAGE> 67
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
FOR THE YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
UDN
STAR TWELVE PT-1
YEAR MONTHS YEAR
ENDED ENDED MERGER PRO ENDED MERGER PRO
DECEMBER 31, JANUARY 31, ADJUST- FORMA MARCH 31, ADJUST- FORMA
1997 1998 MENTS COMBINED 1998 MENTS COMBINED
------------ ----------- ------- -------- --------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
REVENUES.................. $404,605 $31,179 $(1,153)(l) $434,631 $431,520 $(49,441)(l) $816,710
COST OF SERVICES.......... 351,821 24,633 (1,153)(l) 375,301 395,501 (49,441)(l) 721,361
-------- ------- ------- -------- -------- -------- --------
Gross profit............ 52,784 6,546 -- 59,330 36,019 -- 95,349
-------- ------- ------- -------- -------- -------- --------
OPERATING EXPENSES:
Selling, general and
administrative
expenses.............. 36,782 11,544 -- 48,326 17,724 420(m) 66,470
Depreciation and
amortization.......... 4,637 1,010 -- 5,647 1,535 3,455(n) 10,637
-------- ------- ------- -------- -------- -------- --------
41,419 12,554 -- 53,973 19,259 3,875 77,107
-------- ------- ------- -------- -------- -------- --------
Income (loss) from
operations.............. 11,365 (6,008) -- 5,357 16,760 (3,875) 18,242
-------- ------- ------- -------- -------- -------- --------
OTHER INCOME (EXPENSE):
Interest income......... 492 35 (28)(r) 499 517 (1,016)(e) --
Interest expense........ (1,738) (941) 28(r) (2,651) (1,021) (56)(e) (3,728)
Legal settlement and
expenses.............. (1,653) -- (1,653) -- -- (1,653)
Other income
(expense)............. 208 (406) (198) 474 -- 276
-------- ------- ------- -------- -------- -------- --------
(2,691) (1,312) -- (4,003) (30) (1,072) (5,105)
-------- ------- ------- -------- -------- -------- --------
Income (loss) before
provision for income
taxes................. 8,674 (7,320) -- 1,354 16,730 (4,947) 13,137
PRO FORMA PROVISION FOR
INCOME TAXES............ 3,100 -- (2,617)(o) 483 5,150 297(o) 5,930
-------- ------- ------- -------- -------- -------- --------
PRO FORMA NET INCOME
(LOSS).................. $ 5,574 $(7,320) $ 2,617 $ 871 $ 11,580 $ (5,244) $ 7,207
======== ======= ======= ======== ======== ======== ========
Pro forma net income
(loss) per common share:
Basic................... $ 0.18 $ (1.15) $ 0.03 $ 0.25 $ 0.16
Diluted................. $ 0.17 $ (1.15) $ 0.03 $ 0.24 $ 0.15
Weighted average number of
common shares
outstanding:
Basic................... 30,221 6,339 30,771 46,922 44,566
Diluted................. 32,978 6,339 33,528 47,720 48,828
</TABLE>
64
<PAGE> 68
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
FOR THE SIX MONTHS ENDED JUNE 30, 1997
(IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
STAR UDN PT-1
SIX SIX SIX
MONTHS MONTHS MONTHS
ENDED ENDED MERGER ENDED MERGER PRO
JUNE 30, JUNE 30, ADJUST- PRO FORMA JUNE 30, ADJUST- FORMA
1997 1997 MENTS COMBINED 1997 MENTS COMBINED
-------- -------- ------- --------- ----------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
REVENUES.......................... $180,077 $14,504 (305)(l) $194,276 $149,897 $(20,812)(l) $323,361
COST OF SERVICES.................. 156,612 11,076 (305)(l) 167,383 138,799 (20,812)(l) 285,370
-------- ------- ----- -------- -------- -------- --------
Gross profit.................... 23,465 3,428 -- 26,893 11,098 -- 37,991
-------- ------- ----- -------- -------- -------- --------
OPERATING EXPENSES:
Selling, general and
administrative expenses....... 16,220 4,110 -- 20,330 12,127 210(m) 32,667
Depreciation and amortization... 1,813 473 -- 2,286 220 1,728(n) 4,234
-------- ------- ----- -------- -------- -------- --------
18,033 4,583 -- 22,616 12,347 1,938 36,901
-------- ------- ----- -------- -------- -------- --------
Income (loss) from operations... 5,432 (1,155) -- 4,277 (1,249) (1,938) 1,090
-------- ------- ----- -------- -------- -------- --------
OTHER INCOME (EXPENSE):
Interest income................. 74 -- -- 74 133 (207)(e) --
Interest expense................ (836) (440) -- (1,276) (210) (329)(e) (1,815)
Other income (expense).......... (705) -- -- (705) 94 -- (611)
-------- ------- ----- -------- -------- -------- --------
(1,467) (440) -- (1,907) 17 (536) (2,426)
-------- ------- ----- -------- -------- -------- --------
Income (loss) before provision
for income taxes and
extraordinary gain............ 3,965 (1,595) -- 2,370 (1,232) (2,474) (1,336)
PRO FORMA PROVISION FOR INCOME
TAXES
(BENEFIT)....................... 1,581 (27) (609)(o) 945 190 (979)(o) 156
-------- ------- ----- -------- -------- -------- --------
PRO FORMA NET INCOME (LOSS) BEFORE
EXTRAORDINARY GAIN.............. 2,384 (1,568) 609 1,425 (1,422) (1,495) (1,492)
EXTRAORDINARY GAIN ON DEBT
RESTRUCTURING................... -- 52 -- 52 -- -- 52
-------- ------- ----- -------- -------- -------- --------
PRO FORMA NET INCOME (LOSS)....... $ 2,384 $(1,516) $ 609 $ 1,477 $ (1,422) $ (1,495) $ (1,440)
======== ======= ===== ======== ======== ======== ========
Pro forma net income (loss) per
common share:
Basic........................... $ 0.09 $ (0.28) $ 0.05 $ (0.03) $ (0.03)
Diluted......................... $ 0.08 $ (0.28) $ 0.05 $ (0.03) $ (0.03)
Weighted average number of common
shares outstanding:
Basic........................... 27,304 5,359 27,769 52,676 41,564
Diluted......................... 28,900 5,359 29,365 52,676 41,564
</TABLE>
65
<PAGE> 69
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
FOR THE SIX MONTHS ENDED JUNE 30, 1998
(IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
STAR UDN PT-1
SIX SIX SIX
MONTHS MONTHS MONTHS
ENDED ENDED MERGER PRO ENDED MERGER PRO
JUNE 30, JUNE 30, ADJUST- FORMA JUNE 30, ADJUST- FORMA
1998 1998 MENTS COMBINED 1998 MENTS COMBINED
---------- --------- ------- -------- ----------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
REVENUES.............. $261,198 $17,322 $(3,062)(l) $275,458 $267,384 $(30,754)(l) $512,088
COST OF SERVICES...... 224,470 13,343 (3,062)(l) 234,751 248,702 (30,754)(l) 452,699
-------- ------- ------- -------- -------- -------- --------
Gross profit........ 36,728 3,979 -- 40,707 18,682 -- 59,389
-------- ------- ------- -------- -------- -------- --------
OPERATING EXPENSES:
Selling, general and
administrative
expenses.......... 23,245 4,167 -- 27,412 13,497 210(m) 41,119
Depreciation and
amortization...... 4,616 552 -- 5,168 2,222 1,728(n) 9,118
-------- ------- ------- -------- -------- -------- --------
27,861 4,719 -- 32,580 15,719 1,938 50,237
-------- ------- ------- -------- -------- -------- --------
Income (loss) from
operations........ 8,867 (740) -- 8,127 2,963 (1,938) 9,152
-------- ------- ------- -------- -------- -------- --------
OTHER INCOME
(EXPENSE):
Interest income..... 1,672 -- (163)(r) 1,509 396 (536)(e) 1,369
Interest expense.... (1,340) (496) 163(r) (1,673) (731) -- (2,404)
Other income
(expense)......... (258) (167) -- (425) 218 -- (207)
-------- ------- ------- -------- -------- -------- --------
74 (663) -- (589) (117) (536) (1,242)
-------- ------- ------- -------- -------- -------- --------
Income (loss) before
provision for
income taxes...... 8,941 (1,403) -- 7,538 2,846 (2,474) 7,910
PROVISION FOR INCOME
TAXES............... 3,831 -- (601)(o) 3,230 1,203 (303)(o) 4,130
-------- ------- ------- -------- -------- -------- --------
NET INCOME (LOSS)..... $ 5,110 $(1,403) $ 601 $ 4,308 $ 1,643 $ (2,171) $ 3,780
======== ======= ======= ======== ======== ======== ========
Net income (loss) per
common share:
Basic............... $ 0.14 $ (0.20) $ 0.11 $ 0.03 $ 0.07
Diluted............. $ 0.13 $ (0.20) $ 0.11 $ 0.03 $ 0.07
Weighted average
number of common
shares outstanding:
Basic............... 37,640 6,956 38,243 48,404 52,038
Diluted............. 39,649 6,956 40,252 48,587 55,552
</TABLE>
66
<PAGE> 70
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL DATA
1. COMPANIES AND PERIODS COMBINED
Because of the various contingencies relating to the consummation of the
UDN transaction, the pro forma financial statements combining the operations of
STAR with PT-1 have been presented alternatively: (1) assuming that STAR will
not complete the merger with UDN, and (2) assuming that STAR will complete the
merger with UDN. Thus, the first set of pro forma statement of operations data
reflects the combination of the historical operating results of STAR for the
year ended December 31, 1997 and the six months ended June 30, 1997 and 1998
with the historical operating results of PT-1 for the year ended March 31, 1998
and the six months ended June 30, 1997 and 1998. The balance sheet data included
in the unaudited pro forma condensed financial statements reflects the
combination of the historical balance sheet data of STAR and of PT-1 as of June
30, 1998. None of the above-referenced unaudited pro forma condensed financial
statements include UDN. The second set of pro forma statement of operations
data, which assumes completion of STAR's merger with UDN, reflects the
combination of the historical operating results of STAR for the years ended
December 31, 1995, 1996 and 1997 and the six months ended June 30, 1997 and 1998
plus the historical operating results of UDN for the twelve months ended January
31, 1996, 1997 and 1998 and the six months ended June 30, 1997 and 1998,
respectively, and the historical operating results of PT-1 for the year ended
March 31, 1998 and the six months ended June 30, 1997 and 1998. The balance
sheet data included in the unaudited pro forma condensed financial statements
reflects the combination of the historical balance sheets of STAR and UDN with
the historical balance sheet of PT-1 as of June 30, 1998.
2. TRANSACTIONS
The number of shares of STAR Common Stock to be issued for all common
shares and share equivalents of PT-1 is composed as follows:
<TABLE>
<S> <C>
Common stock, options and warrants -- PT-1 shareholders..... 15,050,000
Restricted common stock -- PT-1 distributors................ 250,000
----------
Total....................................................... 15,300,000
==========
</TABLE>
The restricted shares of STAR Common Stock to be issued to PT-1
distributors will vest over four years. The options and warrants to be issued
will be in satisfaction of PT-1 Options and PT-1 Warrants. STAR will also issue
100,000 additional stock options to certain PT-1 employees under the STAR stock
option plan. To show the full dilutive effect of the transaction, 13,795,000
additional shares (15,300,000 less 1,505,000 Escrow Shares) of STAR Common Stock
were used for purposes of computing pro forma basic earnings per share. The
Escrow Shares are included in diluted earnings per share where dilutive as well
as in pro forma shares of STAR Common Stock outstanding at June 30, 1998.
The consideration for the PT-1 acquisition consists of the 15,300,000
shares of STAR Common Stock to be issued as well as a $19.5 million cash
payment. The value of the STAR Common Stock to be issued is based on the average
of the high and low market price from August 31, 1998 through September 2, 1998,
the dates surrounding the First Amendment to the Merger Agreement. This average
market price computes to $11.21 (the "Average Price"), which will be discounted
by 20% with respect to the One-Year Shares and by 40% with respect to the
Two-Year Shares. Such Average Price and the 40% discount is also attributable to
the 250,000 shares of STAR Common Stock available to distributors, which are
subject to a four year vesting schedule. The discounts to the Average Price were
calculated in connection with the restrictions on transfer attributable to the
One-Year Shares and the Two-Year Shares as determined by STAR's investment
banker. The excess of the purchase price thus computed of approximately $126
million plus estimated acquisition costs of $14 million over the net assets
acquired of $2 million represents goodwill and is amortized over a period of 40
years which represents STAR management's estimate of future benefit to the
Company.
67
<PAGE> 71
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL DATA (CONTINUED)
The ratio of STAR Common Stock to be exchanged for UDN Common Stock as
reflected in the unaudited pro forma condensed financial statements of 0.086772
is based on the closing price of STAR Common Stock of $23.625 as of May 27, 1998
as reflected in the UDN proxy statement. No share adjustment has been made for
changes in the price of STAR Common Stock since May 27, 1998 because the impact
of such change would not be material. Had the closing price of STAR Common Stock
at August 31, 1998 of $10.875 been used for purposes of the STAR/UDN exchange
ratio, an additional 745,692 shares would be reflected as outstanding in the pro
forma balance sheet as of June 30, 1998.
3. INTERCOMPANY BALANCES
At June 30, 1998, STAR had amounts due from UDN as follows (amounts in
thousands):
<TABLE>
<S> <C> <C>
Note receivable............................ $4,500
Trade receivable........................... 1,951
Interest receivable........................ 191
------
Total...................................... $6,642
======
</TABLE>
Intercompany balances between STAR and PT-1 represent trade receivables and
payables between STAR and PT-1 in the amount of $8,679,000 and $1,541,000,
respectively. There are no intercompany balances between UDN and PT-1.
4. INTERCOMPANY TRANSACTIONS
For the years ended December 31, 1995, 1996 and 1997, intercompany sales
and related cost of sales between STAR and UDN amounted to $43,000, $259,000 and
$1,153,000, respectively. Intercompany sales for the six months ended June 30,
1997 and 1998 amounted to $305,000 and $3,062,000, respectively. Intercompany
sales and cost of sales between STAR and PT-1 for the year ended December 31,
1997 amounted to $49,441,000. Sales between STAR and PT-1 for the six months
ended June 30, 1997 and 1998 amounted to $20,812,000 and $30,754,000,
respectively. There were no intercompany transactions between PT-1 and UDN for
the periods presented.
5. PRO FORMA INCOME TAXES
The pro forma provision for income taxes, pro forma net income (loss) and
pro forma net income (loss) per share of STAR Common Stock for the years ended
December 31, 1995, 1996 and 1997 as well as for the six months ended June 30,
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 interests transaction on
November 30, 1997, were C-Corporations for all periods presented (see Note 9 of
Notes to Consolidated Financial Statements of STAR).
The Merger adjustments reflect STAR's effective tax rate (as adjusted for
non-deductible goodwill amortization) in the pro forma statements of operations
for the combined entity.
6. EXCHANGE OF STOCK
The UDN adjustment reflects the elimination of UDN Common Stock less the
par value of 636,025 shares of STAR Common Stock to be issued in STAR's merger
with UDN.
7. CONVERTIBLE DEBENTURE
The UDN adjustment records the conversion of a debenture carried by UDN in
the amount of $550,000 at June 30, 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 of 0.086772.
68
<PAGE> 72
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL DATA (CONTINUED)
8. PRO FORMA EARNINGS PER SHARE
The unaudited pro forma combined earnings per share and diluted earnings
per share are based on the weighted average number of common and dilutive
equivalent shares, for each period: (1) at the exchange ratio of 0.086772 shares
of STAR Common Stock for each share of UDN Common Stock outstanding at the
effective time of STAR's acquisition of UDN and (2) 15,050,000 shares of STAR
Common Stock for all of PT-1 Common Stock, stock options and warrants
outstanding at the Effective Time plus an additional 250,000 shares of STAR
Common Stock to be issued to PT-1 distributors.
9. RESULTS OF OPERATIONS INCLUDED IN MORE THAN ONE PERIOD
The PT-1 results of operations for the six months ended June 30, 1997 and
1998 include PT-1 revenue of $62.7 million and $127.7 million and net income of
approximately $3.1 million and $2.3 million, which are also included in the
results of operations for the years ended December 31, 1997 and 1998,
respectively. The UDN results of operations for the six months ended June 30,
1997 and 1998 include UDN revenue of $2.3 million and $2.9 million, and net loss
of $99,000 and $173,000, which are also included in the results of operations
for the twelve month periods ended January 31, 1997 and 1998, respectively.
10. MERGER ADJUSTMENTS
Following is an explanation for merger adjustments reflected in the
unaudited pro forma condensed financial statements:
(a) Represents cash portion of consideration for PT-1 acquisition
(b) Represents the elimination of intercompany balances
(c) Represents accrual for merger related expenses, net of $725,000
previously incurred
(d) Represents the excess of the purchase price for PT-1 plus acquisition
related expenses over the fair value of net assets acquired
(e) Represents foregone interest income on $19,500,000 cash portion of
consideration for PT-1 acquisition
(f) Represents the par value of STAR Common Stock to be issued in the PT-1
transaction
(g) Eliminates par value of PT-1 Common Stock
(h) Represents additional paid in capital of STAR Common Stock to be issued
in the PT-1 transaction
(i) Represents elimination of paid in capital of PT-1
(j) Represents elimination of retained deficit of PT-1
(k) Represents elimination of PT-1 treasury stock which will be retired
(l) Represents elimination of intercompany revenue and related cost of
revenue
(m) Represents compensation expense relating to 250,000 restricted shares
of STAR Common Stock which will vest over four years
(n) Represents amortization of goodwill over 40 years
(o) Represents tax adjustment to reflect STAR's effective tax rate (as
adjusted for non-deductible goodwill amortization)
(p) Represents UDN convertible debt which is converted into STAR Common
Stock (see note 7)
(q) Reclassifies UDN Common Stock to additional paid in capital
(r) Represents elimination of intercompany interest on UDN note
69
<PAGE> 73
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. 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. 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 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.
70
<PAGE> 74
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.
RECENT ACQUISITIONS AND DEVELOPMENTS
STAR has recently acquired or entered into agreements to acquire the
following companies and has taken the following actions:
- United Digital Network, Inc. On November 19, 1997, STAR entered into an
agreement to acquire UDN for approximately 650,000 shares of STAR Common
Stock. The acquisition of UDN is subject
71
<PAGE> 75
to the approval of UDN's stockholders and to various regulatory
approvals, and STAR may not complete this acquisition.
- 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 STAR 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 periods presented. 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 STAR Common Stock in a transaction accounted for as a pooling of
interests. All financial data presented has been restated to include the
results of operations, financial position and cash flows of T-One.
- Stock Split. On March 31, 1998, STAR effected a 2.05-for-1 stock split
with payment to the holders of the shares of STAR Common Stock
outstanding on February 20, 1998 of a stock dividend equal to 1.05 shares
of STAR 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. On June 4, 1998, an additional 30,900 shares
of STAR Common Stock were sold by a certain stockholder of STAR to cover
an over-allotment option for the offering.
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 ENDED SIX MONTHS
DECEMBER 31, JUNE 30, ENDED JUNE 30,
--------------------- ------------- ---------------
1995 1996 1997 1997 1998 1997 1998
----- ----- ----- ----- ----- ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues...................................... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Costs of services............................. 75.1 87.0 87.0 87.0 85.6 87.0 86.0
----- ----- ----- ----- ----- ----- -----
Gross profit.................................. 24.9 13.0 13.0 13.0 14.4 13.0 14.0
Operating Expenses:
Selling, general and administrative
expenses................................. 17.8 13.8 9.1 8.9 8.6 9.0 8.9
Depreciation and amortization............... 0.6 0.6 1.1 1.0 2.1 1.0 1.8
----- ----- ----- ----- ----- ----- -----
Total operating expenses............ 18.4 14.4 10.2 9.9 10.7 10.0 10.7
Income (loss) from operations................. 6.5 (1.4) 2.8 3.0 3.7 3.0 3.3
----- ----- ----- ----- ----- ----- -----
Income (loss) before provision for income
taxes....................................... 6.4 (1.6) 2.1 1.8 4.2 2.1 3.3
Provision for income taxes.................... 0.1 0.2 0.7 0.9 1.7 0.6 1.4
----- ----- ----- ----- ----- ----- -----
Net income (loss)............................. 6.3% (1.8)% 1.4% 1.0% 2.5% 1.5% 1.9%
===== ===== ===== ===== ===== ===== =====
Pro forma net income (loss)................... 3.6% (2.2)% 1.4% 1.1% 1.3%
===== ===== ===== ===== =====
</TABLE>
THREE MONTHS ENDED JUNE 30, 1998 COMPARED TO THREE MONTHS ENDED JUNE 30,
1997.
Revenues: Revenues increased 38.5% to $131.9 million in the second quarter
of 1998 from $95.3 million in the second quarter of 1997. Wholesale revenues
increased 39.7% to $124.0 million from $88.8 million in the prior year quarter.
Wholesale minutes of use increased 67.9% to 348.5 million in the second quarter
of 1998, as
72
<PAGE> 76
compared to 207.6 million minutes of use in the comparable quarter of the year
prior. This increase reflects growth in the number of wholesale customers to 146
in the quarter ended June 30, 1998, up from 112 in the quarter ended June 30,
1997, as well as an increase in usage by existing customers. The average
wholesale rate per minute of use declined to $0.34 for the current quarter as
compared to $0.43 for the quarter ended June 30, 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 increased 22.4% to $7.9 million in the second quarter
of 1998 from $6.5 million in the second quarter of 1997 reflecting the success
of new international rate plans for targeting ethnic markets for Latin America
and the Pacific Rim. Commercial rate per minute decreased to $0.24 for the
second quarter of 1998 compared to $0.25 in the second quarter of 1997 as a
result of competitive pricing.
Gross Profit: On a consolidated basis gross profit increased 54.1% to $19.1
million in the second quarter of 1998 from $12.4 million in the second quarter
of 1997. Consolidated gross margin increased to 14.4% in the second quarter of
1998 compared to 13.0% in the same period of 1997. Wholesale gross profit
increased to $16.6 million in 1998 from $9.9 million for 1997. Wholesale gross
margin increased to 13.3% in the quarter from 11.1% in the prior year quarter.
Wholesale gross profit expanded during the second quarter of 1998 as traffic was
increasingly routed over the Company's proprietary international network. The
Company currently routes to 40 countries on its network, up from 31 countries in
the quarter ended March 31, 1998. Commercial gross profit decreased slightly to
$2.4 million in the second quarter of 1998 from $2.5 million in the second
quarter of 1997. Commercial gross margin for the second quarter of 1998
decreased to 30.4% from 38.7% in the prior year quarter as a result of increased
competition causing lower rates and one time charges related to moving LDS and
CEO customer bases onto STAR's network.
Selling, General and Administrative: For the second quarter of 1998,
selling, general and administrative expenses increased 33.8% to $11.4 million,
from $8.5 million in the second quarter of 1997. Wholesale selling, general and
administrative expensed increases to $8.7 million in the second quarter of 1998
from $6.3 million in the second quarter of 1997, and decreased slightly as a
percentage of wholesale revenues to 6.9% from 7.1% over the comparable periods.
Total expenses increased year to year in absolute dollars as STAR expanded its
proprietary international network and employee base. Commercial selling, general
and administrative expenses increased to $2.7 million in the second quarter of
1998 from $2.2 million in the second quarter of 1997. Commercial selling,
general and administrative expenses increased as a percentage of commercial
revenues to 34.4% from 33.5%, respectively, as L.D. Services increased its
telemarketing sales force to focus on new target markets. 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: Deprecation increased to $2.7 million for the second quarter
of 1998 from $993,000 for the second quarter of 1997, and increased as a
percentage of revenues to 2.1% from 1.0%. 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 continue to
increase as a percentage of revenues as the Company continues to expand its
global telecommunications network.
Other Income (Expense): The Company reported other income of $570,000 in
the second quarter of 1998 as compared to other expense of $1.1 million in the
second quarter of 1997. Interest income earned on short-term investments
increased to $1.4 million in the second quarter of 1998 from $53,000 in the
second quarter of 1997 reflecting interest earned on cash generated by the
Company's secondary equity offering in May. Interest expense increased to
$722,000 in the second quarter of 1998 from $438,000 in the second quarter of
1997 reflecting additional capital leases on new switches. Also included in
other expense in the second quarter of 1998 is $97,000 of foreign currency
losses related primarily to the balance in the inter-company account between
STAR and its foreign subsidiaries. In the second quarter of 1997 other expense
included $756,000 consisting primarily of a legal settlement at LDS.
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Provision for Income Taxes: The company's provision for income taxes
increased to $2.3 million in the second quarter of 1998 from $810,000 in the
second quarter of 1997 primarily due to the increase in profitability of the
Company.
SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO SIX MONTHS ENDED JUNE 30, 1997.
Revenues: Revenues increased to 45.0% to $261.2 million in the first half
of 1998 up from $180.1 in the first half of 1997. Minutes of use increased to
720 million in the first half of 1998 from 448 million in the first half of
1997. The increase was primarily the result of both increased sales to existing
wholesale customers and to an increase in the number of wholesale carrier
customers.
Gross Margin: Gross profit increased 56.5% to $36.7 million in the first
half of 1998 from $23.5 million in the first half of 1997. Gross margin improved
to 14.0% from 13.0%, reflecting the increasing amount of traffic terminated over
the Company's owned network.
Selling, General and Administrative: Selling, general and administrative
expenses increased 41.4% to $22.9 million during the first half of 1998 from
$16.2 million in the comparable period one year earlier, and decreased slightly
as a percentage of revenue to 8.8% from 9.0% in the prior period.
Depreciation: Depreciation increased to $4.6 million in the first half of
1998 from $1.8 million for the first half of 1997. Depreciation increased as a
result of the Company's continued expansion of its global transmission network.
Other Income (Expenses): Other income, net increased to $74,000 in the
first half of 1998 from a net expense of $1.5 million in the first half of 1997.
The swing results from interest income earned on the proceeds from the secondary
offering of $1.7 million offset by interest expense incurred on capital leases
of $1.3 million.
Provision for Income Taxes: The Company's provision for income taxes
increased to $3.8 million in the first half of 1998 from $1.2 million in the
first half of 1997. The effective tax rate increased to 42.8% in the first half
of 1998 from 29.0% in the first half of 1997 reflecting the write-off of a
customer accounts receivable in the first quarter of 1997.
YEARS ENDED DECEMBER 31, 1997 AND 1996
Revenues. Revenues increased 55.8% to $404.6 million in 1997 from $259.7
million in 1996. Wholesale revenues increased to $377.1 million from $229.8
million, with wholesale minutes of use excluding T-One 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 excluding T-One 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.
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 56.4% to $52.8 million in 1997 from
$33.7 million in 1996. Wholesale gross profit increased to $45.2 million in 1997
from $21.0 million for 1996 and wholesale gross margin increased to 12.0% from
9.1%, 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.
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Selling, General and Administrative. In 1997, selling, general and
administrative expenses (exclusive of merger related costs of $286,000)
increased 1.5% to $36.5 million, from $36.0 million in 1996. Wholesale selling,
general and administrative expenses increased to $27.1 million in 1997 from
$25.4 million in 1996, but decreased as a percentage of wholesale revenues to
7.2% from 11.1% over the comparable periods. Total expenses increased year to
year in absolute dollars as STAR expanded its proprietary international network
and employee base. Included in the 1996 selling, general and administrative
expense was $11.6 million in reserves and write-offs against deposits and
accounts receivable related to bad debts from two customers. Commercial selling,
general and administrative expenses decreased to $9.4 million in 1997 from $10.2
million in 1996 and remained flat as a percentage of commercial revenues at
approximately 34.1%. STAR expects selling, general and administrative expenses
to expand in absolute dollars and as a percentage of revenues in fiscal year
1998, as STAR expands its network and employee base and in connection with
STAR's entry into the commercial market.
Depreciation. Depreciation increased to $4.6 million for 1997 from $1.4
million for 1996, and increased as a percentage of revenues to 1.1% from 0.6% in
the prior period. Depreciation increased as a result of STAR's continuing
expansion of its proprietary international network which includes purchases of
switches, submarine cable and leasehold improvements associated with switch
sites. STAR expects depreciation expense to increase as STAR continues to expand
its global telecommunications network.
Other Income (Expense). Other expense, net, increased to $2.7 million in
1997 from $560,000 in 1996. This increase is primarily due to interest expense
of $1.7 million incurred under various capital leases and bank lines of credit
and a legal settlement and associated expenses of $1.7 million. The legal
settlement relates to the dispute settled by 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 $577,000 in 1996 primarily due to the
increase in profitability of STAR.
YEARS ENDED DECEMBER 31, 1996 AND 1995
Revenues. Revenues increased 340.6% to $259.7 million in 1996 from $58.9
million 1995. Wholesale revenues increased to $229.8 million in 1996 from $28.7
million in 1995, with minutes of use excluding T-One 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.
Gross Profit. Gross profit increased 130.0% to $33.7 million for 1996 from
$14.7 million in 1995. Wholesale gross profit increased to $21.0 million in 1996
from $2.1 million for 1995. Wholesale gross margin increased to 9.1% in 1996
from 7.3% 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.
Selling, General and Administrative. Selling, general and administrative
expenses increased 244.0% to $36.0 million in 1996 from $10.5 million in 1995.
Wholesale selling, general and administrative expenses increased to $25.8
million in 1996 from $2.5 million in 1995, and increased as a percentage of
revenues to 11.2% from 8.5% 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.
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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 $1.4 million for 1996 from $368,000
for 1995, but remained at 0.6% of revenues. Depreciation increased as a result
of STAR's purchase of switches and of the operating equipment and leasehold
improvements associated with its Los Angeles and New York switching facilities.
Depreciation expense will increase as STAR expands its ownership of switching
and transmission facilities through purchase or use of capital leases.
Other Income (Expense). Other expense, net, increased to $560,000 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 $609,000 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 $577,000 as a result of the reserve of $3.4
million of the net deferred tax asset.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 1998, STAR had cash and cash equivalents of approximately
$9.2 million, short-term investments of $114.4 million (as a result of STAR's
secondary stock offering), and a working capital surplus of $124.0 million. In
June 1997, STAR completed an initial public offering of 9.4 million shares of
STAR 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 STAR 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
STAR 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
STAR Common Stock were approximately $145.0 million.
As of June 30, 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
137.5 basis points and expires on July 1, 1999. However, the line of credit is
reduced by outstanding letters of credit in the amount of $4.2 million.
STAR generated net cash from operating activities of $11.1 million in 1997,
primarily from net income plus depreciation and amortization, while using $2.8
million in 1996. STAR's investing activities used cash of approximately $30.0
million during 1997 primarily resulting from capital expenditures and the
investment of the proceeds from the initial public offering in marketable
securities, while using $10.4 million in 1996. STAR's financing activities
provided cash of approximately $18.9 million during 1997 primarily from the sale
of STAR Common Stock and borrowings under lines of credit, offset by repayments
under various lines of credit, while providing $14.7 million in 1996.
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STAR generated net cash from operating activities of $8.7 million for the
six months ended June 30, 1998, primarily from net income plus depreciation and
amortization, as well as increases in accounts payable, accrued expenses and
accrued network costs offset by increases in accounts receivable. The Company's
investing activities used cash of $144.1 million during the six months ended
June 30, 1998, primarily from capital expenditures and the purchase of
short-term investments. The Company's financing activities generated cash of
approximately $142.7 million primarily from proceeds raised in the secondary
stock offering as well as stock options exercised, offset by payments under
capital lease obligations.
At June 30, 1998, STAR had capital lease obligations of $32.9 million, and
$0.9 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 its secondary stock 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 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 June 30, 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 $58.9
million in 1995 to $404.6 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
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
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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 carriers to terminate their traffic or use a
combination of resale agreements and owned facilities in order to terminate
their traffic as shown below:
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
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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 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.
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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 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 108 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 facilities in Dallas and Dusseldorf,
Frankfurt, Hamburg and Munich, Germany and plans to put into service in 1998
switches in Atlanta, Chicago, Miami and Seattle; Paris, France; Geneva,
Switzerland; and Vienna, Austria. STAR's international gateway switch in London,
England went into service in April 1997 and four switches in Germany became
operational in the second quarter of 1998. 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
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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.
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 STAR Common Stock. On
March 10, 1998, STAR acquired T-One, an international wholesale long distance
provider, for 1,353,000 shares of STAR 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. On August 20, 1998, STAR entered into the Merger
Agreement to acquire PT-1. Each of these transactions, except for the PT-1
acquisition, 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 60 vendors in 1997. A
substantial portion
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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 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; London, England and Dusseldorf, Frankfurt, Hamburg, and Munich,
Germany. In 1998, STAR plans to put into service international gateway switches
in Atlanta, Chicago, Miami and Seattle; Paris, France; Geneva, Switzerland and
Vienna, Austria. 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 including TPC-5, Gemini and AC-1, and has plans to acquire
transmission capacity on additional undersea fiber optic cable systems. STAR has
recently entered into a commitment to acquire transmission capacity on the Qwest
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domestic Macro Capacity(SM) Fiber Network, which is expected to serve over 130
cities in the U.S. STAR plans to increase its investment in direct and IRU
ownership of cable in situations where STAR enters into operating agreements and
in other situations in which it determines that such an investment would enhance
operating efficiency or reduce transmission costs.
Through its acquisitions of T-One and UDN, STAR has acquired, 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
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 75 direct sales and
marketing employees and over 150 telemarketing representatives as of June 30,
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;
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- vendor rates, through an audit report that allows management to determine
at a glance which vendors have the lowest rates for a particular country
in a particular time period;
- vendor usage by minute, enabling STAR to verify and audit vendor bills;
- dollarized vendor usage to calculate the monetary value of minutes passed
to STAR's vendors, which assists with calculating operating margin when
used in connection with the customer reports;
- loss reports used to rapidly highlight routing alternatives that are
operating at a loss as well as identifying routes experiencing
substantial overflow; and
- LATA (Domestic Call Area) reporting by originating and terminating LATA,
allowing for accurate Local Exchange charge audits, and protecting from
Local Exchange overcharging.
STAR has built multiple redundancies into its billing and call data
collections systems. Nine call collector computers receive call information in
real-time, immediately duplicating data, sending one copy to billing, while the
other copy is used for customer service internally and for traffic analysis.
STAR maintains two independent and redundant billing systems in order to both
verify billing internally and to ensure that bills are sent out on a timely
basis. All of the call data, and resulting billing data, are continuously backed
up on tape drives and redundant storage devices, and are regularly transported
to an off-site safe location.
COMPETITION
The international telecommunications industry is intensely competitive and
subject to rapid change. STAR's competitors in the international wholesale
switched long distance market include large, facilities-based multinational
corporations and PTTs, smaller facilities-based providers in the U.S. and
overseas that have emerged as a result of deregulation, switched-based resellers
of international long distance services and international joint ventures and
alliances among such companies. International wholesale switched long distance
providers compete on the basis of price, customer service, transmission quality,
breadth of service offerings and value-added services. STAR also competes abroad
with a number of dominant telecommunications operators that previously held
various monopolies established by law over the telecommunications traffic in
their countries. See "Risk Factors -- Significant Competition." Additionally,
the telecommunications industry is in a period of rapid technological evolution,
marked by the introduction of competitive new product and service offerings,
such as the utilization of the Internet for international voice and data
communications. STAR is unable to predict which of many possible future product
and service offerings will be important to maintain its competitive position or
what expenditures will be required to develop and provide such products and
services. STAR believes that it competes favorably on the basis of price,
transmission quality and customer service. The number of STAR's competitors is
likely to increase as a result of the new competitive opportunities created by
the WTO Agreement. Further, under the terms of the WTO Agreement, the United
States and the other 68 countries participating in the Agreement have committed
to open their telecommunications markets to competition, and foreign ownership
and adopt measures to protect against anticompetitive behavior, effective
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.
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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 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
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 which ordinarily is one-half of the
accounting rate. STAR's FCC authority currently permits it to provide ISR
service to Canada, the U.K., Sweden, New Zealand, Australia, the Netherlands,
Germany, France, Belgium, Denmark, Norway, Austria,
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Switzerland and Japan. The FCC is currently reviewing U.S. carrier applications
to provide ISR to Finland, Hong Kong and Mexico, among other routes, and upon
grant of any such ISR application to a given country, the FCC's rules also would
permit STAR to provide ISR service to that country. 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 possesses
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. The FCC recently has initiated a
rulemaking proceeding to modify the ISP by, among other things, repealing the
ISP for U.S. international carriers dealing with non-dominant carriers in
countries which are members of the World Trade Organization (WTO).
Notwithstanding these proposals and 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 therefor. 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. Pending reconsideration, the FCC has stayed a related policy
requiring U.S. international carriers to establish IMTS settlement rates at or
below the benchmark rate with any foreign affiliate beginning April 1, 1998.
STAR expects that any IMTS operating agreement which it has or may have with a
foreign affiliate will satisfy the foregoing benchmarks requirements when
applicable.
STAR currently has IMTS operating agreements with certain foreign
correspondents which provide for settlement rates above the FCC's prescribed
benchmarks. STAR will negotiate in good faith to establish IMTS settlement rates
with its foreign correspondents which satisfy the FCC's benchmarks but there can
be no assurance that such negotiations will succeed. The FCC's order adopting
the foregoing settlement benchmarks and the timetable therefor 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
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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 arrangements 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 affiliations 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 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
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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 and international revenues; the fee is
currently 0.11% of revenue. Carriers that provide domestic interstate services
to end users must pay a universal telecommunications service fee each month
based upon the total estimated demand for U.S. universal service funding. If
applicable, each carrier's share is approximately 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 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 interstate and international 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; however, approximately $150,000 in additional fees may be owed
by STAR to satisfy its TRS and annual fee obligations for 1996 and 1997 filing
years. The foregoing regulatory fees typically change annually. STAR cannot
predict the future regulatory fees for which it may be liable. Said fees could
rise significantly for STAR and amount to four percent or more of STAR's gross
international and interstate revenues if STAR is no longer exempt from paying
universal service fees because STAR provides service directly to end users, or
because amendments to the Communications Act repeal the universal service fee
exemption for revenues from connecting carriers. Because the international
telecommunication services business is highly competitive, an increase in the
regulatory fees which STAR must pay could impair its market position and have a
material adverse effect on STAR's business, operating results and financial
condition.
Recent and Potential FCC Actions. Recent FCC rulemaking orders and other
actions have lowered the entry barriers for new facilities-based and resale
international carriers by streamlining the processing of new applications and
granting non-dominant carriers greater flexibility in establishing non-standard
settlement arrangements with non-dominant foreign carriers, including the
non-dominant U.S. affiliates of such carriers. The FCC also has proposed further
to liberalize the market entry process for competing carriers by, among other
things, forbearing the current application requirement under Section 214 of the
Communications Act for carriers seeking to serve any foreign point where they do
not have an affiliate. 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 mergers of WorldCom and MCI and AT&T and Teleport Communications Group
and has recently approved 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 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
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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.
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
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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 has installed telecommunications switching facilities
in Dusseldorf, Frankfurt, Hamburg and Munich and is leasing connection
transmission facilities between these switches and additional facilities. The
network of STAR Germany will be used primarily for routing international
telecommunications traffic between the U.S., the U.K., Germany and beyond. There
can be no assurance that future changes in regulation of the services provided
by STAR Germany will not have a material adverse effect on STAR's business,
operating results and financial condition.
Other Countries. STAR plans to initiate a variety of services in certain
European countries including France and Belgium. These services will include
value-added services to closed user groups and other voice services as
regulatory liberalization in those countries permits. These and other countries
have announced plans or adopted laws to permit varying levels of competition in
the telecommunications market. Under the terms of the WTO Agreement, each of the
signatories has committed to opening its telecommunications market to
competition, foreign ownership and to adopt measures to protect against
anticompetitive behavior, effective starting on January 1, 1998. Although STAR
plans to obtain authority to provide service under current and future laws of
those countries, or, where permitted, provide service without government
authorization, there can be no assurance that foreign laws will be adopted and
implemented providing STAR with effective practical opportunities to compete in
these countries. Moreover, there can be no assurance of the nature and pace of
liberalization in any of these markets. STAR's inability to take advantage of
such liberalization could have a material adverse affect on STAR's ability to
expand its services as planned.
EMPLOYEES
As of June 30, 1998, STAR employed 560 full-time employees. STAR is not
subject to any collective bargaining agreement and it believes that its
relationships with its employees are good.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF PT-1
The following discussion of the financial condition and results of
operations of PT-1 should be read in conjunction with the financial statements,
including the notes thereto, and other detailed information regarding PT-1
included elsewhere in this Proxy Statement. This discussion contains
forward-looking statements, as defined in Section 27A of the Securities Act,
that involve risks and uncertainties. PT-1's actual results may differ
materially from those anticipated in the forward-looking statements as a result
of certain factors, including, but not limited to those discussed under "Risk
Factors" and elsewhere in this Proxy Statement. See "Description of
Forward-Looking Statements."
OVERVIEW
PT-1 is a leading emerging provider of international long distance services
to retail customers and telecommunications carriers. PT-1 currently provides its
retail services by marketing Prepaid Cards, primarily under the PT-1 brand name,
through an extensive network of distributors and believes that its Prepaid Cards
are sold in more than 50,000 independent retail outlets throughout the United
States. PT-1 targets retail markets with substantial international long distance
calling requirements, such as ethnic communities, and believes that its Prepaid
Cards provide consumers with a convenient, attractively priced alternative to
traditional presubscribed long distance services. PT-1 has used its significant
retail international traffic to negotiate international termination arrangements
with attractive rates and develop an efficient telecommunication network,
enabling PT-1 to market its services competitively on a wholesale basis to
telecommunications carriers.
Revenues. PT-1 generates revenues through the sale of Prepaid Cards to
distributors and from the provision of transmission service on a wholesale basis
to other carriers as well as retail long distance services through its recently
introduced dial-around service. PT-1 has established itself in the international
long distance market through its Prepaid Card business and is using its
international traffic volume to develop a significant wholesale and retail
customer base. Rates in the international long distance market have declined in
recent years and, as competition in this segment of the telecommunications
industry continues to intensify, PT-1 believes that this downward trend in rates
is likely to continue. While PT-1 believes that reductions in rates will be
offset in whole or in part by increased volume, efficiencies attributable to the
planned expansion of PT-1's telecommunications network as well as by lower
transmission costs per minute resulting from PT-1's increased volume of minutes,
there can be no assurance that this will be the case. See "Risk Factors--
Significant Competition."
In July 1995, PT-1 introduced its first Prepaid Card, The PT-1 Card,
initially targeted at ethnic communities with substantial international long
distance calling requirements in the New York city metropolitan area. PT-1
issued its first LAC Card, The New York Phone Card, in July 1996. PT-1 currently
has 11 LAC Cards (The New Jersey Phone Card, The New York Phone Card, The
Florida Card, The Boston Card, The California Card, The Diamond Direct Card, The
Payless Direct Card, The Detroit Card, The Connecticut Card, The Chicago Card
and The D.C.-Maryland-Virginia Card), and the Alo Brasil, Hola Mexico and Hola
Dominican Republic Country Calling Cards, targeted at the Brazilian, Mexican and
Dominican Republic communities in the U.S., as well as The PT-1 Worldwide Phone
Card and other Prepaid Cards.
PT-1 fixes its Prepaid Card rates to attract new customers and to retain
its existing customers. While PT-1's rates to specific domestic and
international destinations are often more attractive to customers than the rates
of the four primary carriers, PT-1 does not, as a policy, fix its rates at a
discount to the rates charged by the four primary carriers, or at a discount to
the rates charged by other carriers.
PT-1 sells its Prepaid Cards to distributors at a discount to their face
values of $5, $10, $20, $25, $50 and $100, and records the sale as deferred
revenue until the card user utilizes the calling time. Revenues from the
wholesale provision of international and domestic long distance services to
other carriers is also recognized at the time of customer usage. PT-1 records
revenue from the sale of dial around services and presubscribed long distance
services upon customer usage and bills its customers for these services through
billing and collection
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arrangements with LECs. PT-1's revenues are reported net of certain federal and
state excise and use taxes imposed upon Prepaid Cards.
Although PT-1's reporting currency is the U.S. dollar, PT-1 expects to
derive an increasing percentage of its revenues from international operations.
Accordingly, changes in currency exchange rates may have a significant effect on
PT-1's results of operations. PT-1 may choose to limit its exposure to foreign
currency fluctuations in the future by purchasing forward foreign exchange
contracts or engaging in other similar hedging strategies although to date it
has not done so. The failure by PT-1 to hedge its foreign currency exchange
exposure may result in foreign exchange losses to PT-1 from its non-U.S.
operations. In addition, there can be no assurance that any currency hedging
strategy that PT-1 decides to employ, if any, would be successful in avoiding
currency exchange-related losses.
Cost of Services. Cost of services primarily includes payments to other
carriers for origination, transport and termination of PT-1's international and
domestic long distance traffic. Historically, origination costs have consisted
largely of payments to other carriers, including LECs and CLECs, for local
access, and transport and termination costs have included payments to other
carriers for completing calls. Most of PT-1's transport costs are variable
payments based upon usage for domestic and international traffic, and the
remainder are fixed cost lease payments for leased lines. As a result, most of
PT-1's transmission cost is variable.
Other components of the cost of services include the cost (excluding
depreciation) of operating PT-1's switches in Jersey City, New Jersey, Flushing,
New York and Miami, Florida, and PT-1's Debit Card Platforms in Jersey City, New
Jersey and Flushing, New York, as well as payments to InterExchange for
operating the Edison Debit Card Platform and PT-1's switch in Edison, New
Jersey. Cost of services also includes the costs of producing and distributing
PT-1's Prepaid Cards and sales commissions to distributors.
Gross Margin. PT-1's gross margin has improved since inception, primarily
as a result of economies of scale associated with PT-1's increasing volume of
terminated minutes.
Selling and Marketing Expenses. Selling and marketing expenses consist
primarily of employee commissions, salaries, freight, advertising and promotion
costs and other expenses associated with the marketing and sale of Prepaid Cards
and other products and services. With the introduction of dial around and
presubscribed long distance services, PT-1 expects selling and marketing
expenses to increase as a percentage of revenues.
General and Administrative Expenses. General and administrative expenses
consist primarily of officers' salaries, professional fees, accounting and
office salaries, customer service salaries, depreciation and amortization, an
allowance for doubtful accounts and other corporate overhead costs. PT-1 expects
its expense for uncollectible accounts to increase as a percentage of revenues
as a result of (i) the introduction of dial around and presubscribed long
distance services and other services for which payment is made by its customers
after usage and (ii) PT-1's recent increase in sales of Prepaid Cards to its
distributors on credit. See "Risk Factors -- Fraud; Theft of Services;
Uncollectible Accounts."
Stock Based Compensation. PT-1 expects to continue to incur an expense for
stock based compensation related to the issuance of certain warrants to
employees of InterExchange and options granted to certain employees. See Note 5
of Notes to Consolidated Financial Statements of PT-1.
Taxes. Since November 1, 1997, PT-1 has been required to collect a three
percent (3%) federal excise tax on sales of Prepaid Cards to its distributors.
The taxation of Prepaid Cards is evolving and is not specifically addressed by
many of the states in which the Company does business. While PT-1 believes that
it has adequately provided for any such taxes it may ultimately be required to
pay, certain states may enact legislation which specifically provides for
taxation of Prepaid Cards or may interpret current laws in a manner resulting in
additional tax liabilities. See "Risk Factors -- Taxation of Sale and Use of
Prepaid Cards."
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RESULTS OF OPERATIONS
The following table sets forth certain items in PT-1's statements of
operations as a percentage of total revenues for the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
PERIOD FROM JUNE 30,
INCEPTION TO --------------
MARCH 31, 1996 1997 1998
-------------- ----- -----
<S> <C> <C> <C>
Revenues.................................................... 100.0% 100.0% 100.0%
Costs of services........................................... 115.8 92.6 94.5
----- ----- -----
Gross profit (loss)....................................... (15.8) 7.4 5.5
Operating Expenses:
Selling and marketing expenses............................ 2.7 .9 1.5
General and administrative expenses....................... 5.9 1.8 4.4
Stock based compensation.................................. -- 1.2 .2
----- ----- -----
Operating profit (loss)..................................... (24.4) 3.5 (.6)
Net earnings (loss) before income taxes..................... (24.4) 3.4 (.7)
Income tax provision........................................ -- (.2) (.3)
----- ----- -----
Net earnings (loss)......................................... (24.4)% 3.6% (.4)%
===== ===== =====
</TABLE>
THREE MONTHS ENDED JUNE 30, 1998 COMPARED TO THREE MONTHS ENDED JUNE 30. 1997
Revenues. Revenues increased 60.2% to $139.7 million in the fiscal quarter
ended June 30, 1998 from $87.2 million in the comparable quarter of 1997.
Prepaid Card revenues increased 25.2% to $94.9 million from $75.8 million in the
prior year quarter. Prepaid Card decremented minutes increased 64.8% to 507.9
million in the fiscal quarter ended June 30, 1998, compared to 308.1 million
decremented minutes in the comparable quarter of 1997. This increase in Prepaid
Card revenues was generated primarily from (i) increased market acceptance of
The PT-1 Card, (ii) the introduction of new Prepaid Country Calling Cards, and
(iii) an increase in the number of distributors. As a result of the foregoing,
the number of PINS activated increased from 13,167,701 in the June 1997 quarter
to 14,875,400 in the 1998 quarter. PT-1 did not recognize any revenue related to
the expiration of Prepaid Cards for the three months ended June 30, 1997 and
1998.
Wholesale and commercial revenues increased 275.6% in the fiscal quarter
ended June 30, 1998 to $42.7 million from $11.4 million in the comparable
quarter of 1997. Wholesale and commercial minutes of use increased 354.5% to
119.3 million in the June quarter of 1998, as compared to 26.2 million minutes
of use in the June 1997 quarter. This increase reflects growth in the number of
wholesale and commercial customers to 68 as of June 30, 1998, up from 15 as of
June 30, 1997, as well as an increase in usage by existing customers. The
average wholesale and commercial rate per minute of use declined to $0.36 for
the June 1998 quarter as compared to $0.43 for the quarter ended June 30, 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.
Revenues for the 1998 June quarter also include $2.1 million for 10-XXX or
Dial Around services, which commenced in March 1998.
Cost of Services. Cost of services increased to $132.0 million for the
fiscal quarter ended June 30, 1998 from $80.8 million for the comparable quarter
of 1997. Cost of services as a percentage of revenues increased to 94.5% for the
1998 period compared to 92.6% for the 1997 period. This increase was primarily
the result of (i) increased charges imposed by the FCC, (ii) increased sales
commissions offered to distributors, (iii) the various non-recurring costs
associated with transferring the processing of PT-1's Prepaid Card traffic from
an independent service bureau to an in-house platform, and (iv) unrecorded
expiration and service fee revenues for the June 1998 quarter. Migration of the
Prepaid Card traffic which was processed by an independent service bureau, to
in-house hardware technology and licensed software, will be completed in August
1998 and will result in a reduction of fees approximately $800,000 a month.
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Gross Profit. Gross profit increased 20.0% in the fiscal quarter ended June
30, 1998 to $7.7 million from $6.4 million in the comparable quarter of 1997.
Gross margin decreased to 5.5% in the June 1998 quarter compared to 7.4% for the
comparable 1997 quarter. Prepaid Card gross profit decreased to $4.2 million in
the June 1998 quarter from $6.0 million in 1997, and Prepaid Card gross margin
decreased to 4.4% for the quarter from 8.0% in the prior year, both as result of
the reasons discussed above. Wholesale and commercial gross profit increased to
$3.0 million in the June 1998 quarter from $0.5 million in 1997. Wholesale and
commercial gross margin increased to 7.0% for the quarter from 4.9% in the prior
year. This was primarily attributable to (i) an increased percentage of
telecommunications traffic being transported over PT-1's leased lines and a
corresponding reduction in the percentage of traffic carried and billed by other
carriers on a per minute basis, and (ii) increased efficiencies in PT-1's
telecommunications network attributable to the addition of switches and other
equipment.
Selling and Marketing Expenses. For the quarter ended June 30, 1998,
selling and marketing expenses increased 167% to $2.1 million, from $0.8 million
in the comparable quarter of 1997. Selling and marketing expenses are
principally comprised of commissions, salaries and advertising and promotion
expenses, which accounted for 84.4% of all selling and marketing expenses for
the June 1998 quarter, as compared to 76.7% for the 1997 quarter. Increases in
commissions, salaries and advertising and promotion expenses were a result of
(i) PT-1's increased sales of Prepaid Cards, (ii) the opening of additional
sales offices, both domestically and internationally, (ii) the expansion of the
wholesale and carrier sales department, (iv) advertising related to the
introduction of PT-1's dial around product, and (v) advertising campaigns in
newly entered markets.
General and Administrative Expenses. General and administrative expenses
increased to $6.2 million for the quarter ended June 30, 1998, from $1.6 million
for the comparable quarter of 1997. This increase was primarily attributable to
increases in salaries, professional fees, rent, and depreciation and
amortization expenses, which comprised 80.4% of general and administrative
expenses for the June 1998 quarter, as compared to 88.0% for the 1997 quarter.
Salaries for customer service, accounting and network operations increased due
to the additional hiring necessitated by the continued growth in traffic volume,
the expansion of PT-1's network infrastructure and capacity, and the
introduction of new products and services. Also included in network salaries for
the quarter ended June 30, 1998, are non-recurring annual bonuses of $230,000.
Rent expense increased primarily due to the opening of additional sales offices
and expansion in PT-1's primary office to accommodate the increased number of
employees. Professional fees increased to $1.9 million for the June 1998
quarter, as compared to $0.3 million for the 1997 quarter. This increase was
primarily due to non-recurring legal, accounting and other fees which were
charged to expense during the June 1998 quarter including costs related to an
initial public offering which PT-1 has decided to discontinue as a result of the
pending merger with STAR.
Stock Based Compensation. For the quarter ended June 30, 1998, stock based
compensation expense decreased to $271,868 from $1,050,000 for the comparable
quarter of 1997. This was primarily due to an option which was granted and
exercised during the 1997 quarter by Mr. Joseph Pannullo, PT-1's Chief Operating
Officer, to purchase 1,048,600 shares of PT-1 Common Stock for an aggregate
exercise price of $.0015.
Other Income(Deductions). Interest expense increased to approximately
$322,000 for the quarter ended June 30, 1998, as compared to approximately
$199,000 for the same period in 1997. This was primarily attributable to
increased bank borrowings.
Depreciation and Amortization. Depreciation and amortization expense
increased to $816,767 for the quarter ended June 30, 1998 from $129,342 for the
same period in 1997. Depreciation expense represented $476,344 for the June 1998
quarter compared to $76,961 for 1997. Depreciation expense increased primarily
as a result of PT-1's expansion of its network, which includes the purchase of
switches, telephony equipment, IRU capacity and computer equipment. Amortization
expense of $340,423 was recorded for the June 1998 quarter compared to $52,381
for the same period in 1997. This was primarily the result of (i) the issuance
of PT-1 Common Stock in November 1997, for the extension of a noncompete
agreement, (ii) additional leasehold improvements to switch sites and sales
offices, and (iii) the purchase of capitalized software. PT-1
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expects depreciation and amortization expense to increase as PT-1 continues to
expand its domestic and international network.
FISCAL YEAR ENDED MARCH 31, 1998 COMPARED TO FISCAL YEAR ENDED MARCH 31, 1997
Revenues. Revenues increased 154% to $431.5 million for the fiscal year
ended March 31, 1998 from $169.6 million for the fiscal year ended March 31,
1997. Revenues from the usage of Prepaid Cards increased to $356.3 million
during the 1998 fiscal year from $162.5 million in the prior period. This
increase in Prepaid Card revenues was generated primarily from (i) increased
market acceptance of the PT-1 Card, (ii) an increase in the number of
distributors, (iii) the introduction of new Prepaid Country Calling Cards and
(iv) higher selling prices of Prepaid Cards. Revenues from services provided to
other telecommunications providers for resale increased to $75.2 million for the
fiscal year ended March 31, 1998 from $7.1 million in the prior period. This
reflects an increase in resale customers from 9 in 1997 to 64 in 1998, primarily
due to the PT-1's ability to offer favorable rates for transmission and
termination services as a result of increased minutes purchased.
Cost of Services. Cost of services increased to $395.5 million for the
fiscal year ended March 31, 1998 from $166.2 million for the fiscal year ended
March 31, 1997. Cost of services as a percentage of revenues decreased to 91.7%
for the 1998 period compared to 98.0% for the 1997 period. This decrease was
primarily the result of (i) improvements in PT-1's ability to use
least-cost-routing to reduce its per minute transmission costs, (ii) rate per
minute decreases negotiated with underlying carriers as a result of PT-1's
substantially increased volume of traffic, (iii) an increased percentage of
telecommunications traffic being transported over PT-1's leased lines and a
corresponding reduction in the percentage of traffic carried and billed by other
carriers on a per minute basis, and (iv) increased efficiencies in PT-1's
telecommunications network attributable to the addition of switches and other
equipment. Cost of services as a percentage of revenues decreased from 1997 to
1998 despite several regulatory changes in the telecommunications industry which
increased PT-1's costs of services in 1998.
Gross Profit. Gross profit increased to $36 million for the fiscal year
ended March 31, 1998 from $3.5 million for the fiscal year ended March 31, 1997.
Gross margin improved to 8.3% during the 1998 period from 2.0% in the prior
period for the reasons discussed above.
Selling and Marketing Expenses. Selling and marketing expenses increased
154% to $4.5 million for the fiscal year ended March 31, 1998 from $1.8 million
for the fiscal year ended March 31, 1997, and as a percentage of revenue
remained a constant 1%. Selling and marketing expenses were principally
comprised of commissions, salaries, advertising and freight which accounted for
83.2% of all selling and marketing expenses for the fiscal year ended March 31,
1998, as compared to 91.6% for the 1997 period. The increases in commissions,
salaries, advertising and freight expenses were directly related to PT-1's
increased sales of Prepaid Cards.
General and Administrative Expenses. General and administrative expenses
increased to $12.1 million for the fiscal year ended March 31, 1998 from $2.6
million for the fiscal year ended March 31, 1997, and increased as a percentage
of total revenues to 2.8% from 1.5%, respectively. This increase was primarily
due to increases in salaries, professional fees, rent and depreciation and
amortization expenses, which comprised 77.7% of general and administrative
expenses for the 1998 period, as compared to 85.0% for the 1997 period. Salaries
for customer service, accounting and network administration increased due to
additional hiring made necessary by the continued increases in traffic volume
and the expansion of PT-1's telecommunications network capacity. Rent expense
increased due to the relocation of PT-1's principal executive offices in May
1997 to accommodate the increased number of employees and the opening of
additional sales offices.
Depreciation and Amortization. Depreciation and amortization expense
increased to $1,534,500 for the year ended March 31, 1998 from $75,017 for the
year ended March 31, 1997. Depreciation expense represented $908,930 for the
year ended March 31, 1998 compared to $75,017 for the year ended March 31, 1997.
Depreciation expense increased as a result of PT-1's expansion of its network
which includes the purchase of switches, telephony equipment, computer equipment
and leasehold improvements for additional switch sites. Amortization expense of
$625,570 was recorded in the fiscal year ended March 31, 1998 as a
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result of the (i) purchase of capitalized software and (ii) issuance of PT-1
Common Stock in consideration for the extension of a noncompete agreement,
respectively.
Stock Based Compensation. Stock based compensation during the year ended
March 31, 1998 decreased to $2.7 million from $7.3 million in the year ended
March 31, 1997. Stock based compensation in 1998 reflects PT-1's recording of
the expense related to (i) the issuance on May 9, 1997 to Mr. Joseph Pannullo,
PT-1's Chief Operating Officer, of an option to purchase 1,048,600 shares of
PT-1 Common Stock for an aggregate exercise price of $0.015, (ii) the issuance
on September 30, 1997 to an employee of PT-1 of options to purchase 10,000
shares of PT-1 Common Stock, exercisable at a nominal exercise price, and (iii)
shares of PT-1 Common Stock valued at $850,000 issuable to certain employees of
PT-1 pursuant to certain transactions with Mr. Pannullo. Stock based
compensation for the year ended March 31, 1997 reflects the issuance of shares
on March 27, 1997 to two officers of PT-1 in accordance with commitments made in
July 1995 and March 1996, the dates they joined PT-1. Such shares were issued in
connection with the settlement agreement dated March 27, 1997, described in note
8 to the PT-1 Consolidated Financial Statements included herein, and were valued
as of that date.
Interest Expense. Interest expense increased to $517,000 for the fiscal
year ended March 31, 1998 from $115,000 for the fiscal year ended March 31,
1997. The increase was primarily attributable to accrued interest that is
payable on a promissory note to a former officer and founder of PT-1 as part of
his redemption agreement. The balance of interest expense for the fiscal year
ended March 31, 1998 represents amounts paid under bank borrowings which
aggregated $12.76 million in principal at March 31, 1998.
Gains on Marketable Securities. During the fiscal year ended March 31,
1998, PT-1 diversified its short-term investments by purchasing various
marketable securities of public corporations. Accordingly, net realized and
unrealized gains and losses are included in the statements of operations.
Provision for Income Taxes. The provision for income taxes for the fiscal
year ended March 31, 1998 was $5.15 million. Based on a net operating loss for
the fiscal year ended March 31, 1997, there was no provision for income taxes in
1997.
FISCAL YEAR ENDED MARCH 31, 1997 COMPARED TO PERIOD FROM APRIL 21, 1995
(INCEPTION) TO MARCH 31, 1996
Revenues. Revenues increased to $169.6 million for the fiscal year ended
March 31, 1997 from $11.9 million for the period from April 21, 1995 (inception)
to March 31, 1996. Revenues from usage of Prepaid Cards increased to $162.5
million during the 1997 fiscal year from $11.9 million in the prior period. This
increase in Prepaid Card revenues was generated primarily from (i) increased
market acceptance of The PT-1 Card, (ii) an increase in the number of
distributors, (iii) the introduction of new Prepaid Country Calling Cards and
(iv) higher selling prices of Prepaid Cards. Revenues for the 1997 fiscal year
also include $7.1 million from services provided to other telecommunications
providers for resale primarily during the last quarter. PT-1 did not provide
such services during the prior period.
Cost of Services. Cost of services increased to $166.2 million for the
fiscal year ended March 31, 1997 from $13.8 million for the period from April
21, 1995 (inception) to March 31, 1996. Cost of services as a percentage of
revenues decreased to 98.0% for the 1997 fiscal year from 115.8% during the
prior period, primarily as a result of (i) increases in the rates to selected
destinations, (ii) decreases in the switching fees from InterExchange, (iii)
price decreases negotiated with vendors for the printing and packaging of PT-1's
products, (iv) rate per minute decreases negotiated with the underlying carriers
as a result of PT-1's substantially increased volume of traffic and (v) an
increasing percentage of telecommunications traffic being transported over
PT-1's leased lines and a corresponding reduction in the percentage of traffic
carried and billed by other carriers on a per minute basis.
Gross Profit (Loss). Gross profit increased to $3.5 million for the fiscal
year ended March 31, 1997 from a gross loss of $1.9 million for the period from
April 21, 1995 (inception) to March 31, 1996. Gross margin improved to 2.0%
during the 1997 fiscal year from (15.8)% in the prior period, for the reasons
discussed above, particularly the higher selling prices of Prepaid Cards.
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Selling and Marketing Expenses. Selling and marketing expenses increased to
$1.8 million for the fiscal year ended March 31, 1997 from $318,000 for the
period from April 21, 1995 (inception) to March 31, 1996. Selling and marketing
expenses were principally comprised of commissions, salaries, freight and
advertising and promotional expenses, which increased in direct relation to the
growth in revenues from 1996 to 1997.
General and Administrative Expenses. General and administrative expenses
increased to $2.6 million for the fiscal year ended March 31, 1997 from $704,000
for the period from April 21, 1995 (inception) to March 31, 1996. This increase
was primarily due to the additional salary expense that was incurred for
employees hired to accommodate PT-1's growth during the 1997 fiscal year.
Depreciation and amortization expense, which is included in general and
administrative expense, increased primarily due to the purchase and expansion of
the Edison, New Jersey switch in July 1996, as well as PT-1's increased capital
expenditures for office equipment as a result of the expansion of its employee
base.
Stock Based Compensation. Stock based compensation for the year ended March
31, 1997 was $7.3 million as compared to $0 for the period ended March 31, 1996.
Stock based compensation for the year ended March 31, 1997 reflects the issuance
of shares on March 27, 1997 to two officers of PT-1 in accordance with
commitments made in July 1995 and March 1996, the dates they joined PT-1. Such
shares were issued in connection with the settlement agreement dated March 27,
1997, described in note 8 to the financial statements, and were valued as of
that date.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, PT-1 has funded its operating and capital needs primarily
from cash generated by operations. Net cash provided by operating activities is
primarily due to the receipt of cash from distributors generally upon shipment
of PT-1's Prepaid Cards and prior to utilization of PT-1's services and
incurrence by PT-1 of related costs of services. PT-1 expects its working
capital requirements to increase as a result of its (i) introduction of dial
around and presubscribed long distance services and other services for which
payment is made by its customers after services are rendered, and (ii) the
recent increase in sales of Prepaid Cards to its distributors on credit. PT-1
has not experienced significant credit losses to date on receivables from the
sale of Prepaid Cards.
During the fiscal years ended March 31, 1998, 1997 and 1996, PT-1 generated
$25.6 million, $13.5 million and $765,000 of cash from operating activities,
respectively. During the three month period ended June 30, 1998, operating
activities used $3.6 million in cash as compared to the corresponding period in
1997 which provided $7.1 million. The decrease in cash provided by operations
was primarily the result of the net loss sustained during the period for reasons
discussed in results of operations above, an increase in accounts receivable as
a result of the sale of prepaid cards to distributors on credit terms and
slightly higher sales of Prepaid Cards resulting in increased deferred revenue
of $2 million in the 1998 period as compared to $6.2 million in the
corresponding 1997 period.
PT-1's accounts receivable from Prepaid Card sales have increased from
approximately $7.5 million at March 31, 1997 to approximately $29.8 million at
March 31, 1998 and to approximately $35.3 million at June 30, 1998. This
increase in accounts receivable results primarily from an increase in Prepaid
Card sales and a change in PT-1's sales terms to certain of its distributors
from payment on delivery of Prepaid Cards to credit terms.
PT-1's accounts receivable from other carriers increased from approximately
$300,000 at March 31, 1997 to approximately $7.5 million at March 31, 1998 and
to approximately $8.6 million at June 30, 1998. This increase was attributable
to the growth in PT-1's wholesale business where revenues are billed subsequent
to their recognition in the financial statements.
PT-1's working capital deficiency at June 30, 1998 and March 31, 1998 and
1997 amounted to $32.3 million, $21.7 million and $17.4 million, respectively.
In each of these periods, working capital deficiency generally resulted from
PT-1's deferral of revenue from card sales prior to use of calling time by the
ultimate card user. Such deferred revenue is recognized as calling time and is
used in accordance with the terms of its Prepaid Cards. PT-1 expects deferred
revenue will continue to increase, particularly if card sales
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continue to increase and that the working capital deficit will ultimately
decrease over time although there can be no assurances that this will be the
case.
PT-1 used $11.3 million, $21.3 million and $1.5 million for capital
expenditures during the three months ended June 30, 1998 and the fiscal years
ended March 31, 1998 and 1997, respectively. PT-1 also issued a $650,000
non-interest bearing promissory note, due in ten equal monthly installments, as
a portion of the consideration for certain software licensing rights.
Additionally, PT-1 used excess cash to purchase short-term investments of $10.8
million and $2.1 million during the fiscal years ended March 31, 1998 and 1997,
respectively. Sale of a portion of these investments resulted in cash provided
of $6.8 million during fiscal year 1998 and $3.5 million during the three months
ended June 30, 1998.
On March 26, 1997, PT-1 redeemed shares of PT-1 Common Stock from Thomas
Hickey, a former executive officer and director of PT-1, for payment of $5.0
million and the issuance of a promissory note in the principal amount of $10.0
million. The note bears interest at a rate of 8.0% per annum, compounded semi-
annually, and is secured by certain of the repurchased shares. PT-1 repaid $5.0
million of the principal of the note on March 25, 1998, and must repay the
outstanding principal of $5.0 million and all accrued and unpaid interest on or
prior to March 25, 1999.
On October 8, 1997, PT-1 entered into a $5.0 million revolving credit
facility and a $5.0 million letter of credit facility with Chase Manhattan Bank,
N.A. As of March 31, 1998, $2.76 million was outstanding under the credit
facility, which bears interest at a rate equal to either the London Interbank
Offered Rate plus 2.25%, the prime rate, or a fixed rate to be determined
pursuant to the credit facility. Borrowings under the credit facility are
secured by PT-1's equipment and accounts receivable. PT-1 may borrow up to 75%
of the value of eligible equipment and accounts receivable. The credit facility
expires September 30, 1998, at which time PT-1 will seek to extend the term
through 1999. PT-1 expects to continue to meet its current and long-term
obligations through the continued provision of cash from operating activities.
In March 1998, PT-1 entered into a sale and leaseback transaction for
certain of its telecommunications equipment for $10.0 million. Payments,
including interest at 8.76%, are due in monthly installments of $206,420 through
April 2003. The debt is secured by the underlying equipment and accounts
receivable.
On August 17, 1998, PT-1 entered into a $10.0 million loan arrangement with
STAR payable on August 17, 1999. This loan accrues interest monthly at a rate of
6 3/4%.
CERTAIN CAPITAL TRANSACTIONS
On February 25, 1997, litigation related to disputed ownership interests
and control of PT-1 was commenced against PT-1, Thomas Hickey, a former director
and executive officer of PT-1, and Mr. Tawfik. On March 20, 1997, a second
action was commenced asserting similar claims against the same defendants. Such
litigation involved disputed equity issuance commitments in connection with the
initial capitalization of PT-1 and the employment of certain key executives. On
March 27, 1997, a settlement agreement among the parties was reached which
included the dismissal of litigation, execution of equity issuance commitments,
release of claims, the resignation of Mr. Hickey as an executive officer and
employee of PT-1 and the redemption of 25,052,632 shares of PT-1 Common Stock
for $15 million which was satisfied by a cash payment of $5 million and the
issuance of a note in the principal amount of $10 million (the "Note").
On November 7, 1997, in connection with PT-1's then pending initial public
offering, PT-1, Mr. Hickey and certain executive officers of PT-1 entered into
additional agreements pursuant to which Mr. Hickey affirmed the validity of
agreements entered into on March 27, 1997, and agreed to an extended
noncompetition agreement for consideration of 483,980 shares of PT-1 Common
Stock. Additional releases were obtained for claims relating to Mr. Hickey's
interest in PT-1 and the pending initial public offering.
The Note accrued interest at a rate of 8% per annum. PT-1 paid $5 million
of the Note on March 25, 1998 in accordance with its terms and must repay the
remaining outstanding principal and all accrued interest on or prior to March
25, 1999. PT-1 pledged two-thirds of the shares of PT-1 Common Stock it redeemed
from Mr. Hickey as collateral for the Note.
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EFFECTS OF NEWLY-ISSUED ACCOUNTING STANDARDS
In June 1997, the FASB issued SFAS 130 "Reporting Comprehensive Income."
This statement is effective for financial statements issued for periods
beginning after December 15, 1997. Management has not yet evaluated the effect
of its financial reporting from the adoption of this statement but does not
expect the adoption of SFAS 130 to have a material effect on PT-1's financial
position or results of operations.
In June 1997, the FASB issued SFAS 131 "Disclosure about Segments of an
Enterprise and Related Information." SFAS 131 requires the reporting of profit
and loss, specific revenue and expense items and assets for reportable segments.
It also requires the reconciliation of total segment revenues, total segment
profit or loss, total segment assets, and other amounts disclosed for segments,
to the corresponding amounts in the general purpose financial statements. SFAS
131 is in effect for fiscal years beginning after December 15, 1997. PT-1 has
not yet determined what additional disclosures may be required, if any, in
connection with the adoption of SFAS 131.
On June 1998, the FASB issued SFAS 133 "Accounting for Derivative
Instruments and Hedging Activities." SFAS 133 requires companies to recognize
all derivatives as either assets or liabilities in the statement of financial
position and measure these instruments at fair value. SFAS 133 is in effect for
all fiscal quarters of fiscal years beginning after June 15, 1999. PT-1 has not
yet determined what additional disclosures may be required, if any, in
connection with the adoption of SFAS 133.
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BUSINESS OF PT-1
OVERVIEW
PT-1 is a leading emerging provider of international long distance services
to retail customers and telecommunications carriers. PT-1 currently provides its
retail services primarily by marketing Prepaid Cards, primarily under the PT-1
brand name, through an extensive network of distributors and believes that its
Prepaid Cards are sold in more than 50,000 independent retail outlets throughout
the U.S. PT-1 targets retail markets with substantial international long
distance calling requirements, such as ethnic communities, and believes that its
Prepaid Cards provide consumers with a convenient, attractively priced
alternative to traditional presubscribed long distance services. During March
1998, PT-1 began to market both "dial around" and presubscribed long distance
services to retail customers in certain target markets that also have
substantial international long distance calling needs. Over the past several
months, PT-1 has also increased the amount of resources devoted to obtaining
commercial retail customers with significant international long distance
requirements. PT-1 has used its significant retail international traffic to
negotiate international termination arrangements with attractive rates, enabling
PT-1 to market its services competitively on a wholesale basis to
telecommunications carriers and develop an efficient telecommunications network.
PT-1 believes that it is the ninth largest provider of retail international long
distance services in the United States based upon revenues for the fiscal year
ended March 31, 1998. During that period, PT-1 generated revenues and net income
of $431.5 million and $11.6 million, respectively.
INDUSTRY
The telecommunications market is typically segmented into the local
exchange market, the domestic long distance market and the international long
distance market. PT-1 operates in the latter two markets in the U.S., targeting
retail and wholesale customers with significant volumes of international long
distance usage. For an overview of the international long distance market, see
"Business of STAR -- Industry Background."
PT-1 APPROACH
PT-1 was founded in April 1995 to capitalize on the growing market for
international long distance services. PT-1 initially entered the retail
international long distance market through the distribution of Prepaid Cards
targeted at ethnic communities. After building significant international
traffic, in 1996 PT-1 began to negotiate reduced transmission rates based upon
volume with underlying carriers and began to invest in switching equipment and
lease transmission capacity to further reduce its cost of service as a
percentage of revenues. In August 1996, PT-1 began to leverage its significant
volume of international traffic by selling international long distance services
on a wholesale basis to other carriers. For the fiscal year ended March 31,
1998, revenues from retail sales and from wholesale sales were $356.3 million
and $75.2 million, respectively. During the three months ended June 30, 1998,
PT-1's eight largest sources of revenue (in declining order) were from traffic
to Mexico, the Dominican Republic, Colombia, Haiti, Egypt, Jamaica, India and
Ecuador.
PT-1 believes its competitive strengths are its (i) established Prepaid
Card brand names, (ii) extensive distribution infrastructure, including more
than 50,000 retail outlets, (iii) substantial experience in identifying,
targeting and marketing to communities and markets with significant
international long distance usage, (iv) position as a leading provider of
telecommunications traffic to various international destinations and (v)
efficient telecommunications network. PT-1 believes that its competitive
strengths will enable it to profitably continue to increase its retail customer
bases and its traffic volume and leverage these increases to negotiate lower
telecommunications costs.
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STRATEGY
PT-1's strategic objective is to strengthen its position as the leading
provider in the U.S. of long distance service to end users through the sale and
distribution of Prepaid Cards and to expand further its presence in the retail
segment of the commercial long distance market. PT-1's strategy for achieving
this goal has the following key elements:
Continue to Target Consumers with Significant International Long Distance
Usage. PT-1 primarily targets consumers with significant international long
distance usage by delivering reliable international long distance services at
attractive rates. PT-1 believes that the international long distance market
provides an appealing opportunity because of its higher revenues and gross
profits per minute and its higher expected growth rate relative to the domestic
long distance market. PT-1 believes its brand awareness, large number of
international retail customers and its international network traffic and
infrastructure will enable it to continue to successfully market international
long distance service originating in countries in North America, Latin America,
Europe and in other countries to which PT-1's domestic customers direct a
substantial volume of calls.
Increase Retail Distribution of PT-1's Products. PT-1 estimates that its
Prepaid Cards are currently sold in more than 50,000 independent retail outlets,
providing customers with convenient access to PT-1's services. PT-1 intends to
increase this retail distribution infrastructure by expanding the number of
distributors and retail outlets within existing geographic markets, entering new
geographic markets and by bringing certain of its distributors in-house. PT-1
initially concentrated its marketing and distribution efforts in the New York
metropolitan area, but has expanded and is continuing to expand its market
penetration in other regions of the U.S., Canada and Puerto Rico with
significant ethnic populations.
Expand Offerings of Retail Products and Services. PT-1 intends to introduce
new LAC Cards in additional metropolitan areas, offer additional Country Calling
Cards and market other innovative Prepaid Cards, further segmenting the Prepaid
Card market. PT-1 also intends to grow its "dial around" and pre-subscribed long
distance services. PT-1 believes that its brand awareness, large number of
international retail customers and its ability to provide attractively priced
long distance services will enable it to successfully market convenient,
attractively priced dial around and presubscribed long distance service to new
and existing customers.
Expand PT-1's International Telecommunications Network. After consummation
of the Merger, PT-1 intends to continue to expand the international reach of its
telecommunications network through STAR's network expansion and by co-locating
with STAR's switch facilities. In particular, PT-1 intends to piggyback on
STAR's international network expansion into the U.K., Germany and additional
European cities, including Paris, Vienna and Geneva.
TELECOMMUNICATIONS PRODUCTS AND SERVICES
PT-1 offers high quality retail and wholesale telecommunications services
over its own network and by interconnecting its network with the network of
other carriers.
Prepaid Cards. PT-1 primarily offers retail services through a variety of
Prepaid Cards that provide access to more than 230 countries and territories at
rates that are between 10% and 50% less than rates for comparable calls charged
by the major facilities-based carriers. PT-1's Prepaid Cards can be used at any
touch tone telephone simply by dialing an access number, followed by a PIN
assigned to the card, and the telephone number the customer wishes to reach.
Prior to the connection, the caller is informed of the remaining dollar balance
and number of minutes available. PT-1's Prepaid Cards are designed to appeal to
a variety of market segments in the U.S. that generate high levels of
international and domestic traffic. In March 1998, PT-1 began offering dial
around long distance services targeting its current customer base which has
significant international long distance calling requirements. This method of
long distance calling is referred to as "dial around" because customers are not
required to change their presubscribed long distance carrier to use the service.
Rather the customer must enter a seven digit carrier identification code ("CIC
Code") prior to dialing the long distance number in order to access PT-1's
network. PT-1's CIC Code is 1016868.
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PT-1 has billing and collection arrangements with local exchange carriers
under which PT-1's dial around customers are billed for PT-1's services as part
of their monthly phone bills. In March 1998, PT-1 also introduced presubscribed
long distance services targeted to ethnic communities, other consumers and
commercial accounts. With this service, a customer's telephone is automatically
connected to PT-1's network, and all of the customer's long distance calls are
made over PT-1's network.
PT-1'S PREPAID CARDS INCLUDE THE FOLLOWING:
The PT-1 Card (introduced in July 1995) was PT-1's first Prepaid Card and
offers competitively priced domestic and international long distance calling.
Customers using the PT-1 Card access PT-1's network by dialing a toll-free
number.
Local Area Calling Cards ("LAC Cards") are targeted at customers in
specific regions and enable them to access PT-1's network by dialing either a
local number or a toll-free number depending upon the region. PT-1 currently
markets The New York Phone Card (introduced in July 1996), The New Jersey Card
(introduced in February 1997), The Detroit Card (introduced in July 1997), The
Connecticut Card (introduced in September 1997), The Boston Card, The Chicago
Card, The D.C.-Maryland-Virginia Card and The Florida Card (all introduced in
November 1997) and The California Card (introduced in May 1998) and The Diamond
Direct Card and The Payless Direct Card (both introduced in June 1998). PT-1
expects to offer additional LAC Cards in other target metropolitan markets where
PT-1 believes that there is sufficient demand during 1998.
Country Calling Cards are designed for specific ethnic communities and
offer attractive rates to the countries to which they generate high levels of
international traffic. PT-1 currently markets the Alo Brasil, Hola Mexico and
Hola Dominican Republic cards that offer competitive rates to Brazil, Mexico and
the Dominican Republic, and are targeted to Mexican, Brazilian and Dominican
Republic calling communities in the U.S. and intends to introduce additional
Country Calling Cards that will appeal to other market segments.
Co-Branded Cards are used by major corporations for national marketing
programs and promotional gifts. Co-Branded Cards are designed and packaged using
logos, trademarks and other design elements linking the benefits of the cards to
the corporation's product and services. PT-1 currently offers an Amoco Prepaid
Card pursuant to an agreement with Amoco Oil Company and expects to offer
additional cards.
The World Card (introduced in September 1996), which offers both a
different commission structure to PT-1's distributors and different rates, is
designed to appeal to a variety of market segments.
International Origination. PT-1 intends to capitalize on its brand
awareness in certain ethnic communities in the United States by offering
international long distance services, through the sale of Prepaid Cards, to
consumers located in the U.K., Canada and other countries to which PT-1's U.S.
customers direct a substantial number of calls.
In addition, PT-1 intends to offer additional retail services in 1998 to
increase customer retention and loyalty, broaden distribution channels, appeal
to new customer groups and increase usage of PT-1's services by its existing
customers.
There can be no assurance that PT-1 will be able to introduce such services
or that, if introduced, such services will be successful.
THE TELECOMMUNICATIONS NETWORK
Overview
PT-1 currently manages its own telecommunications network and also utilizes
the transmission capacity of more than 40 different local and long distance
carriers.
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Network and Operations
Switching Facilities. PT-1 manages a state-of-the-art digital switch based
network consisting of more than 130,000 switch ports, approximately 50,000
Prepaid Card processing ports, and a central switching center located at PT-1's
headquarters in Flushing, New York. PT-1 has selected Northern Telecom
("Nortel") as its primary switch vendor and has entered into a support agreement
with Nortel to provide 24 hours per day, 365 days per year support services to
PT-1, including technical assistance, trouble resolution and network
maintenance. PT-1 currently has Nortel DMS250 Supernode switches installed at
its Edison, New Jersey switch site (operated for PT-1 by InterExchange), at its
corporate headquarters in Flushing, New York, in Jersey City, New Jersey and in
Miami, Florida.
Points of Presence. As of June 30, 1998 PT-1 had network POPs in
approximately 100 cities in more than 25 states. In areas where PT-1 has network
POPs, calls are transported to PT-1's network POPs by local exchange carriers or
CLECs and then transported from the network POPs to PT-1's switches over leased
transmission lines. PT-1 intends to double the number of network POPs by the end
of 1998.
Telecommunications Network Management and Information Systems. PT-1's
network management and information systems enable it to (i) economically and
efficiently route traffic over PT-1's network and the networks of other
carriers, (ii) offer reliable services with high call completion rates and voice
quality and (iii) focus its marketing efforts. PT-1 believes that these systems,
particularly their ability to provide high quality service to international
destinations, provide it with a competitive advantage relative to many other
providers of telecommunication services. PT-1 monitors its network and initiates
changes to its overall switch network and traffic routing where appropriate to
optimize routing and minimize costs. Because a substantial portion of the
traffic carried by PT-1 terminates overseas and call completions vary by
carrier, PT-1 closely monitors the call completion efficiencies of its
suppliers. PT-1 tracks call completions to all destinations for all carriers on
an hourly basis and re-routes its traffic accordingly. PT-1 intends to configure
large portions of its network with Common Channel Signaling System 7 (SS7). This
network protocol reduces call setup and connect time delays and provides
additional technical capabilities and efficiencies for call routing and network
engineering. With the installation of the switch in Jersey City, New Jersey,
PT-1 has duplicated the functional network management capabilities in this
alternate site in accordance with its ongoing review of site diversity and
disaster recovery procedures. See "-- Information Systems; Debit Card
Platforms."
INFORMATION SYSTEMS; DEBIT CARD PLATFORMS
PT-1 markets a wide variety of Prepaid Cards, each with a specific rate
table (updated periodically). In addition, each Prepaid Card distributed by PT-1
is assigned a unique PIN and a face value ranging from $5 to $100. The Prepaid
Card's dollar balance is reduced by the cost of each call, which is based upon a
number of factors, including the type of Prepaid Card, destination and special
promotions then in effect. The cost of each call is decremented by one of PT-1's
Debit Card Platforms at the time of the call.
The ability to maintain accurate Prepaid Card dollar balances and to
decrement these balances at the proper rates is essential to PT-1's continued
success. Accordingly, PT-1 has invested significant resources in the
acquisition, development and maintenance of its Debit Card Platforms and
information systems and software. PT-1's information systems enable it to track
real-time customer usage and to quickly generate cost and profit reports (by
route). The information systems also produce more than 100 daily reports
concerning network routing, call completion rates and usage for the preceding
day, as well as a variety of weekly and monthly reports. PT-1's Prepaid Card
systems are supported by redundant systems and databases. Critical Prepaid Card
information is backed up, depending on the sensitivity of the information, on a
daily, weekly or monthly basis.
PT-1 owns and operates Debit Platforms in Jersey City, New Jersey and
Flushing, New York. In addition, pursuant to an agreement between PT-1 and
InterExchange, Inc. ("InterExchange"), a portion of PT-1's traffic is outsourced
to a debt platform located in Edison, New Jersey owned and operated by
InterExchange in exchange for a fee paid by PT-1 to InterExchange. The
InterExchange Agreement expires in January 2000 (unless terminated earlier in
accordance with its terms) and may be renewed thereafter for four consecutive
six month periods.
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PT-1 believes that its internal systems have been equipped to appropriately
handle any information management issues which may arise in connection with
transactions occurring on or after January 1, 2000. PT-1 has also contacted its
significant vendors to determine whether their systems are being evaluated, and
modified if necessary, to ensure year 2000 compliance and PT-1 has been advised
by InterExchange that the Edison Debit Card Platform is year 2000 compliant.
PT-1 expects to continue to monitor year 2000 compliance issues with its
significant vendors.
MARKETING AND DISTRIBUTION
Since inception, PT-1 has focused on building a substantial network of
wholesale distributors which, in turn, sell to sub-distributors and directly to
retail outlets including convenience stores, grocery stores, gas stations,
supermarkets and news stands. The sub-distributors generally sell only to retail
outlets. As of June 30, 1998, approximately 912 distributors purchased Prepaid
Cards directly from PT-1, reaching over 50,000 independent retail outlets.
PT-1 has targeted heavily populated metropolitan areas, with an emphasis on
areas with substantial ethnic community populations which generate significant
international calling volume, in the development and expansion of its
distribution network. Many of PT-1's distributors are members of such ethnic
communities or otherwise have personal or business relationships in such
communities. In developing relationships with distributors, PT-1 also focuses on
expansion into new geographic and metropolitan areas, again with an emphasis on
those areas with substantial ethnic community populations. PT-1 believes that
the success of its Prepaid Cards has created significant brand loyalty and
encourages distributors and retail outlets to actively market PT-1's products.
PT-1 regularly provides distributors and retail outlets with point-of-purchase
advertising and explanatory materials including posters of various sizes
presenting certain of PT-1's current rates, and detailed rate sheets. PT-1
frequently adds new Prepaid Card products to its service offerings, and adjusts
its pricing for particular traffic segments in order to target certain customer
groups, respond to competitive pressures and otherwise increase market share.
PT-1 has recently expanded its internal sales department to focus on larger
retail chains and department stores, the tourist industry, airport and hotel
gift shops, gas stations and other retail outlets owned or franchised by larger
companies.
CUSTOMER SERVICE
PT-1 believes that effective and convenient multilingual customer service
is essential to attracting and retaining customers. Because a substantial
portion of PT-1's existing and future customers are foreign-born, PT-1 believes
that it is critical to provide customer service on a multilingual basis. PT-1's
customer service center handles an average of 6,000 to 7,000 customer inquiries
per day, including inquiries relating to Prepaid Card balances, Prepaid Card
availability, rates, international calling service, billing and becoming a
distributor. PT-1 currently employs 50 full-time customer service
representatives ("CSRs"), eight senior CSRs, a manager and a director of
customer service. All CSRs are fluent in both English and Spanish, and some are
fluent in Portuguese. PT-1's customer service center is operational ten hours
per day, six days per week. PT-1 intends to expand the customer service center
and its hours of operation during the next twelve months. Calls coming into
PT-1's customer service center are categorized by Prepaid Card product. PT-1's
internal software system provides real-time access to on-screen call records,
complete with historical detail, to track, resolve, protect and support the
individual needs of PT-1's entire customer base.
PREPAID CARD PRODUCTION AND INVENTORY CONTROL
PT-1 controls its Prepaid Card inventory by PIN and by physical count.
Generally, Prepaid Cards are received by, stored at and shipped from the
warehouse facility located at PT-1's headquarters. Physical inventory is counted
on a daily basis and reconciled against all incoming card deliveries and
outgoing shipments to distributors. PT-1 utilizes multiple print vendors for
card production and packaging.
All PINs are inactive when the Prepaid Cards arrive at PT-1's storage
facilities. Calls cannot be completed until PINs are activated by PT-1 or by
InterExchange (at PT-1's direction). PINs are activated
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only shortly before the cards are shipped from PT-1's warehouses to
distributors, in order to minimize the number of cards with activated PINs in
its warehouse.
PINs are created electronically with unique inventory and batch codes. PT-1
has developed PIN generation and database management software enabling the Debit
Card Platforms to quickly locate Prepaid Card information while limiting fraud
and other forms of unauthorized access. In addition, if security or financial
controls have been compromised, PT-1 also maintains the ability to deactivate
specified PINs and block calls from specified telephone numbers.
COMPETITION
The telecommunications services industry is intensely competitive. PT-1
competes with other providers of Prepaid Cards and with providers of
telecommunications services in general. Many of the largest telecommunications
providers currently offer Prepaid Cards, in addition to the other
telecommunications services PT-1 intends to provide in the future. As a service
provider in the long distance telecommunications industry, PT-1 competes with
four dominant providers, AT&T, MCI, Sprint and WorldCom, all of which are
substantially larger and have greater financial, technical, engineering,
personnel and marketing resources, longer operating histories, greater name
recognition and larger customer bases than PT-1. PT-1 also competes with
smaller, emerging carriers in both the Prepaid Card retail market and in the
wholesale market, including IDT Corporation, RSL Communications, SmarTalk
Teleservices, Inc., Pacific Gateway Exchange, Inc., FaciliCom International,
Inc. and Telegroup, Inc. To the extent PT-1 begins providing services to
customers outside the U.S. market, it may compete with the large operators such
as BT in the U.K. PT-1 believes that its success will attract additional
competitors to the Prepaid Card market. However, PT-1 believes it has certain
advantages that may discourage potential competitors from entering the Prepaid
Card market, including brand loyalty, its established distribution network, its
ability to offer competitive rates and its Debit Card Platforms and associated
hardware and software. See "Risk Factors -- Significant Competition."
The telecommunications industry is rapidly evolving and subject to constant
technological change. PT-1 believes that existing competitors are likely to
continue to expand their service offerings and to develop new sales channels.
The ability of PT-1 to compete effectively in the telecommunications services
industry will depend in part upon PT-1's continued ability to develop additional
products appealing to increasingly specialized segments of the market for
telecommunications service.
Recent changes in the regulation of the telecommunications industry may
affect PT-1's competitive position. The Communications Act is expected to open
the long distance market to competition from the RBOCs. The entry of these
well-capitalized and well-known entities into the long distance market likely
will increase competition for long distance customers, including customers who
use Prepaid Cards to make long distance calls. The Communications Act also
grants the FCC the authority to deregulate other aspects of the
telecommunications industry, which in the future may, if authorized by the FCC,
facilitate the offering of telecommunications services by regulated entities,
including the RBOCs, in competition with PT-1. See "Risk Factors--Potential
Adverse Effects of Government Regulation" and "--Government Regulation."
GOVERNMENT REGULATION
PT-1's business operations are subject to extensive U.S. federal and state
regulation. The Communications Act and FCC regulations apply to interstate
telecommunications and international telecommunications that originate or
terminate in the United States. State regulatory authorities have jurisdiction
over telecommunications that originate and terminate within the state. In its
provision of services in the U.K., PT-1 is subject to the regulations of Oftel,
the telecommunications regulator in the U.K. See "Risk Factors--Potential
Adverse Effects of Government Regulation."
FEDERAL
The Communications Act bars the 50 states from restricting competition for
local exchange services, and establishes a framework for additional competition
in the long distance market by the Regional Bell Operating Companies ("RBOCs").
The Communications Act also grants the FCC the authority to deregulate other
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<PAGE> 110
aspects of the telecommunications industry and to implement certain policy
objectives, including access charge reform and establishment of the Universal
Service Fund. Pursuant to an FCC order (the "Universal Service Order") Universal
Service Fund contributions are generally equal to approximately four percent of
a carrier's interstate and international and approximately one percent of its
intra-state "end user" gross revenues, effective January 1, 1998. However, the
FCC will adjust the amount of these contributions each calendar quarter, and
they may increase significantly in future periods.
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. PT-1 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 interstate and 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.
PT-1 holds both facilities-based and resale international authorizations,
including a "global" authorization that provides broad authority to offer
switched and private line international services. PT-1 has filed tariffs for its
interstate and international services with the FCC.
Interstate carriers are also subject to a variety of miscellaneous
regulations that, for instance, govern the documentation and verifications
necessary to change a consumer's long distance carriers, and limit the use of
toll-free numbers for pay-per-call services.
STATE
PT-1's intrastate services are subject to various state laws and
regulations, including prior certification, notification and registration
requirements. In certain states, prior regulatory approval may be required for
changes in control of telecommunications operations. Most states require PT-1 to
apply for certification to provide telecommunications services, or at least to
register, before commencing intrastate service. In most of the states where
certification or registration is required, PT-1 must file and maintain detailed
tariffs listing rates for intrastate service. Many states also impose various
reporting requirements and/or require prior approval for transfers of control of
certified carriers and assignments of carrier assets, including customer bases,
carrier stock offerings and incurrence by carriers of significant debt
obligations. Certificates of authority can generally be conditioned, modified,
canceled, terminated or revoked by state regulatory authorities for failure to
comply with state law and/or the rules, regulations and policies of the state
regulatory authorities. Fines and other penalties, including revocation, may be
imposed for such violations. In addition, states may establish their own
intrastate universal service funding programs, to which PT-1 may in some cases
be required to contribute.
PT-1 has made and is continuing to make the filings and taken the actions
it believes are necessary to become certified or tariffed to provide intrastate
telecommunications services. PT-1 is certified to do business as a domestic or
foreign corporation in all 50 states and in Puerto Rico and provides intrastate
telecommunications services in 25 states. PT-1 expects to obtain intrastate
telecommunications authority as necessary in the remaining states in which it
intends to sell its Prepaid Cards to its distributors. See "Risk
Factors--Potential Adverse Effects of Government Regulation."
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UNITED KINGDOM
In the U.K., telecommunications services offered by PT-1 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. PT-1 currently has an ISVR
license and an IFL license, which permits PT-1 to directly own interests in
undersea cables landing in the U.K. as well as other telecommunication
facilities and to originate end-user long distance traffic in the U.K.
The loss of PT-1's U.K. licenses, or the placement of significant
restrictions thereon, could have a material adverse effect on the business,
financial condition or results of operations of PT-1. See "Risk
Factors--Potential Adverse Effects of Government Regulation."
CANADA
In Canada, PT-1 is registered with the Canadian Radio-television and
Telecommunications Commission ("CRTC") as a reseller. Under this registration,
PT-1 may resell switched services or private lines to provide Canada-Canada,
Canada-U.S., or Canada-overseas telecommunications services. In its provision of
services in Canada, PT-1 is subject to the Canadian Telecommunications Act of
1991 (the "Canadian Act") and, to a limited degree, to the rules and policies of
the CRTC. CRTC policy currently prohibits PT-1 from routing Canada-Canada,
Canada-overseas, or overseas-Canada traffic through the United States, although
said policy is expected to be repealed by the end of 1998. In addition, although
the Canadian Act currently prohibits the CRTC from imposing licensing
requirements or imposing other significant regulations on resellers such as
PT-1, legislation pending in the Canadian Parliament, if enacted, would allow
the CRTC to require resellers such as PT-1 to obtain a license and to abide by
certain requirements.
TRADEMARKS AND SERVICE MARKS
PT-1 uses the names "PT-1 Communications" and "PT-1" as its primary
business names and has filed for federal trademark protection of these service
marks. In addition, filings have been made at the U.S. Patent and Trademark
Office to register the distinctive PT-1 logo, as well as over 30 names which
PT-1 uses or intends to use to identify its Prepaid Cards. These filings are all
pending and PT-1 has no assurance that they will be granted. PT-1 regards its
trademarks, service marks and trade names as valuable assets and believes they
have value in the marketing of its products and services. See "Risk
Factors--Limited Protection of PT-1's Proprietary Rights; Risks of
Infringement."
EMPLOYEES
As of June 30, 1998, PT-1 had 260 full-time employees. None of PT-1's
employees are members of a labor union or are covered by a collective bargaining
agreement. Management believes that PT-1's relationship with its employees is
good.
PROPERTIES
PT-1 leases certain office space under operating leases and subleases,
including PT-1's principal headquarters in Flushing, New York. The principal
offices, warehouses, sales offices and switch sites currently leased or
subleased by PT-1 are as follows:
<TABLE>
<CAPTION>
LOCATION SQUARE FOOTAGE LEASE EXPIRATION
- ------------------------------------------------------- -------------- ----------------
<S> <C> <C>
Flushing, New York (headquarters and warehouse)........ 34,800 March 2002
Miami, Florida......................................... 10,400 March 2008
Jersey City, New Jersey................................ 5,600 January 2008
Houston, Texas......................................... 4,000 August 2000
Staten Island, New York................................ 2,700 October 2001
Cleveland, Ohio........................................ 1,500 June 2000
Jersey City, New Jersey................................ 300 September 1999
</TABLE>
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LEGAL PROCEEDINGS
In July 1997, PT-1 was notified by the FTC and the NYAG that it was the
subject of an investigation alleging deceptive advertising practices in
connection with the sale of its Prepaid Cards. Subsequently, the FTC and NYAG
indicated that they were also reviewing whether PT-1 properly decremented
minutes from its Prepaid Cards. PT-1 understands that NYAG has ended its
investigation without taking any action. The FTC has also completed its
investigation and has determined not to take any action regarding PT-1's Prepaid
Card decrementation practices. With regard to prior advertising of Prepaid Cards
by PT-1, PT-1 and representatives of the FTC have entered into an agreement in
principle, which is subject to final approval by the FTC, pursuant to which, in
complete settlement of all allegations regarding allegedly deceptive
advertising; (1) PT-1 will pay to the FTC the sum of $300,000; (2) PT-1 does not
admit any of the allegations; and (3) on a going forward basis, PT-1 has agreed
to comply with certain standards regarding advertising (which are consistent
with PT-1's current advertising practices) and certain record keeping
requirements.
PT-1 is not aware of any pending legal proceedings against PT-1 which,
individually or in the aggregate, PT-1 would expect to have a material adverse
effect on its business, financial condition or operating results. PT-1 is, from
time to time, involved in various regulatory proceedings before various public
utilities commissions, as well as before the FCC. See "Risk Factors--Potential
Adverse Effects of Government Regulation."
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<PAGE> 113
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
OF STAR COMMON STOCK
The following table sets forth certain information known to the Company
regarding beneficial ownership of STAR's Common Stock as of October 13, 1998 by
(i) each person who is known by the Company to own beneficially more than five
percent of the Company's Common Stock, (ii) each director, (iii) each of the
executive officers of STAR, and (iv) all current officers and directors as a
group.
<TABLE>
<CAPTION>
AMOUNT OF SHARES PERCENTAGE OF SHARES
BENEFICIALLY BENEFICIALLY
NAME AND ADDRESS OF BENEFICIAL OWNER(1) OWNED OWNED(2)
--------------------------------------- ---------------- --------------------
<S> <C> <C>
Entities affiliated with the Hunt Family Trusts(3)
3900 Thanksgiving Tower
Dallas, Texas 75201.................................. 2,099,183 5.0%
Gordon Hutchins, Jr.(4).............................. 178,350 *
John R. Snedegar(5).................................. 30,750 *
Mark Gershien........................................ -- *
Arunas A. Chesonis................................... -- *
Christopher E. Edgecomb.............................. 12,702,807 30.1%
Mary A. Casey........................................ 1,596,613 3.8%
David Vaun Crumly(6)................................. 881,166 2.1%
James E. Kolsrud(7).................................. 172,997 *
Kelly D. Enos(8)..................................... 174,875 *
All directors and executive officers as a group
(9 persons)(9)..................................... 15,737,558 37.3%
</TABLE>
- ---------------
* Represents beneficial ownership of less than 1% of the outstanding shares of
STAR 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 shares of STAR
Common Stock outstanding as of October 13, 1998. The number of shares of
STAR Common Stock beneficially owned includes the shares issuable pursuant
to stock options that are exercisable within sixty days of October 13, 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 of STAR Common Stock issuable upon the exercise
of stock options exercisable within sixty days of October 13, 1998.
(5) Consists of 20,500 shares of STAR Common Stock, and 10,250 shares of STAR
Common Stock issuable upon the exercise of stock options exercisable within
sixty days of October 13, 1998.
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<PAGE> 114
(6) Consists of 737,666 shares of STAR Common Stock, and 143,500 shares of STAR
Common Stock issuable upon the exercise of stock options exercisable within
sixty days of October 13, 1998.
(7) Consists of 101,250 shares of STAR Common Stock, 20,497 shares of STAR
Common Stock held in joint tenancy and 51,250 shares of STAR Common Stock
issuable upon the exercise of stock options exercisable within sixty days of
October 13, 1998.
(8) Consists of 96,720 shares of STAR Common Stock and 78,155 shares of STAR
Common Stock issuable upon the exercise of stock options exercisable within
sixty days of October 13, 1998.
(9) Includes 461,505 shares of STAR Common Stock issuable upon the exercise of
stock options exercisable within sixty days of October 13, 1998.
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<PAGE> 115
DESCRIPTION OF STAR CAPITAL STOCK
The authorized capital stock of STAR consists of 100,000,000 shares of
Common Stock, $0.001 par value, and 5,000,000 shares of Preferred Stock, $0.001
par value.
COMMON STOCK
As of October 13, 1998, there were approximately shares of STAR
Common Stock outstanding that were held of record by approximately
stockholders. There will be approximately shares of STAR Common
Stock outstanding (assuming no exercise after October 13, 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 the Board 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 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 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, as the classification of the Board
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 and
in the policies formulated by the Board and to discourage certain types of
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
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<PAGE> 116
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
currently 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.
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.
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<PAGE> 117
OTHER BUSINESS
The Company is not aware of any other business to be presented at the
Special Meeting. All shares represented by Company proxies will be voted in
favor of the Proposal described herein unless otherwise indicated on the form of
the proxy. If any other matters properly come before the meeting, Company proxy
holders will vote thereon according to their best judgment.
SUBMISSION OF STOCKHOLDER PROPOSALS
Any stockholder who wishes to present a proposal for action at the annual
meeting of stockholders to be held in 1999 and who wishes to have it set forth
in the corresponding proxy statement and identified in the corresponding form of
proxy prepared by management must notify the Company no later than January 31,
1999 in such form as required under the rules and regulations promulgated by the
Commission.
If a stockholder proposal is introduced at the 1999 Annual Meeting without
any discussion of the proposal in the proxy statement, and if the proponent does
not notify the Company on or before March 1, 1999, as required by Rule
14a-4(c)(1) under the Securities Exchange Act of 1934, as amended, of the intent
to raise such proposal at the 1999 Annual Meeting, the proxies received by the
Company for the 1999 Annual Meeting will be voted by the persons named as
proxies in their discretion in regard to such proposal. Notice is to be given to
the Company in writing at its principal office, 223 East De La Guerra Street,
Santa Barbara, California 93101, directed to the attention of the Secretary.
EXCHANGE ACT FILINGS
All documents filed by STAR pursuant to Section 13(a), 13(c), 14 or 15(d)
of the Exchange Act subsequent to the date of this Proxy Statement and prior to
the date of the Special Meeting shall be deemed to be incorporated by reference
herein and to be a part hereof from the date of filing of such documents. Any
statement contained in a document incorporated or deemed to be incorporated by
reference herein shall be deemed to be modified or superseded for purposes of
this Proxy Statement to the extent that a statement contained herein or in any
other subsequently filed document that also is or is deemed to be incorporated
by reference herein modifies or supersedes such statement. Any such statement so
modified or superseded shall not be deemed, except as so modified or superseded,
to constitute a part of this Proxy Statement.
By Order of the Board of Directors
Mary A. Casey
Secretary
Santa Barbara, California
October , 1998
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STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
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-7
</TABLE>
F-1
<PAGE> 119
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 T-One acquisition
as described in
Note 1 and to the
stock split discussed
in Note 14 as to which the
date is March 31, 1998)
F-2
<PAGE> 120
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1996 1997
----------- ------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents................................. $ 1,845,000 $ 1,903,000
Short-term investments.................................... 1,656,000 18,631,000
Accounts receivable, net of allowance of $6,262,000 and
$7,955,000 at December 31, 1996 and 1997,
respectively............................................ 35,178,000 46,675,000
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...................................... 874,000 87,000
----------- ------------
Total current assets............................... 41,589,000 77,905,000
----------- ------------
PROPERTY AND EQUIPMENT:
Operating equipment....................................... 10,245,000 31,340,000
Leasehold improvements.................................... 4,362,000 6,477,000
Furniture, fixtures and equipment......................... 2,555,000 4,711,000
----------- ------------
17,162,000 42,528,000
Less -- Accumulated depreciation and amortization......... (1,964,000) (6,569,000)
----------- ------------
15,198,000 35,959,000
----------- ------------
OTHER ASSETS:
Investments............................................... 153,000 27,000
Deposits.................................................. 5,630,000 6,055,000
Other..................................................... 484,000 370,000
----------- ------------
6,267,000 6,452,000
----------- ------------
Total assets....................................... $63,054,000 $120,316,000
=========== ============
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......................... 498,000 480,000
Current portion of note payable........................... -- 284,000
Current portion of obligations under capital leases....... 872,000 2,495,000
Accounts payable.......................................... 17,930,000 14,009,000
Taxes payable............................................. -- 2,156,000
Related party payable..................................... 269,000 --
Accrued line costs........................................ 19,494,000 38,403,000
Accrued expenses.......................................... 2,415,000 5,609,000
Other current liabilities................................... -- 571,000
----------- ------------
Total current liabilities.......................... 49,318,000 64,145,000
----------- ------------
LONG-TERM LIABILITIES:
Long-term debt, net of current portion.................... 1,435,000 968,000
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............................... 352,000 642,000
----------- ------------
Total long-term liabilities........................ 6,839,000 12,970,000
----------- ------------
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 -- 24,576,810 and
35,031,519 at December 31, 1996 and 1997,
respectively............................................ 25,000 35,000
Additional paid-in capital................................ 14,259,000 45,696,000
Deferred compensation..................................... (118,000) (30,000)
Retained deficit.......................................... (7,272,000) (2,500,000)
----------- ------------
Stockholders' equity.................................... 6,897,000 43,201,000
----------- ------------
Total liabilities and stockholders' equity......... $63,054,000 $120,316,000
=========== ============
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
F-3
<PAGE> 121
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------
1995 1996 1997
----------- ------------ ------------
<S> <C> <C> <C>
REVENUES.......................................... $58,937,000 $259,697,000 $404,605,000
COSTS OF SERVICES................................. 44,270,000 225,957,000 351,821,000
----------- ------------ ------------
Gross Profit.................................... 14,667,000 33,740,000 52,784,000
----------- ------------ ------------
OPERATING EXPENSES:
Selling, general and administrative expenses.... 10,452,000 35,956,000 36,496,000
Depreciation and amortization................... 368,000 1,442,000 4,637,000
Merger expense.................................. -- -- 286,000
----------- ------------ ------------
10,820,000 37,398,000 41,419,000
----------- ------------ ------------
Income (loss) from operations........... 3,847,000 (3,658,000) 11,365,000
----------- ------------ ------------
OTHER INCOME (EXPENSES):
Interest income................................. 22,000 110,000 492,000
Interest expense................................ (64,000) (609,000) (1,738,000)
Legal settlement and expenses................... -- (100,000) (1,653,000)
Other income (expense).......................... (33,000) 39,000 208,000
----------- ------------ ------------
(75,000) (560,000) (2,691,000)
----------- ------------ ------------
Income (loss) before provision for
income taxes.......................... 3,772,000 (4,218,000) 8,674,000
PROVISION FOR INCOME TAXES........................ 66,000 577,000 2,905,00
----------- ------------ ------------
NET INCOME (LOSS)................................. $ 3,706,000 $ (4,795,000) $ 5,769,000
=========== ============ ============
Income (loss) before provision for
income taxes.......................... 3,772,000 (4,218,000) 8,674,000
PRO FORMA INCOME TAXES (UNAUDITED)................ 1,632,000 1,520,000 3,100,000
----------- ------------ ------------
PRO FORMA NET INCOME (LOSS) (UNAUDITED)........... $ 2,140,000 $ (5,738,000) $ 5,574,000
=========== ============ ============
Income (loss) per common share.................... $ 0.19 $ (0.21) $ 0.19
=========== ============ ============
Diluted income (loss) per common share............ $ 0.19 $ (0.21) $ 0.17
=========== ============ ============
Pro forma basic income (loss) per common share
(unaudited)..................................... $ 0.11 $ (0.25) $ 0.18
=========== ============ ============
Pro forma diluted income (loss) per common share
(unaudited)..................................... $ 0.11 $ (0.25) $ 0.17
=========== ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-4
<PAGE> 122
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 RETAINED
-------------------- -------------------- PAID-IN DEFERRED EARNINGS
SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION (DEFICIT) TOTAL
---------- ------- ---------- ------- ----------- ------------ ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31,
1994..................... -- $ -- 18,808,959 $19,000 $ 1,560,000 $ -- $ 1,377,000 $ 2,956,000
Issuance of common stock... -- -- 1,843,339 2,000 101,000 -- -- 103,000
Conversion of debt to
equity................... -- -- -- -- 990,000 -- -- 990,000
Stockholder
contributions............ -- -- -- -- 269,000 -- -- 269,000
Net income................. -- -- -- -- -- -- 3,706,000 3,706,000
Cash distributions to
stockholders............. -- -- -- -- -- -- (4,216,000) (4,216,000)
---------- ------- ---------- ------- ----------- --------- ----------- -----------
Balance, December 31,
1995..................... -- -- 20,652,298 21,000 2,920,000 -- 867,000 3,808,000
Effect of terminating the
S-corporation election... -- -- -- -- (690,000) -- 690,000 --
Conversion of capital to
debt..................... -- -- -- -- (1,200,000) -- -- (1,200,000)
Compensation expense
relating to stock
options.................. -- -- -- -- 168,000 (118,000) -- 50,000
Issuance of common stock... -- -- 3,924,512 4,000 5,564,000 -- -- 5,568,000
Issuance of preferred
stock.................... 2,802,446 3,000 -- -- 7,497,000 -- -- 7,500,000
Net loss................... -- -- -- -- -- -- (4,795,000) (4,795,000)
Cash distributions to
stockholders............. -- -- -- -- -- -- (4,034,000) (4,034,000)
---------- ------- ---------- ------- ----------- --------- ----------- -----------
Balance, December 31,
1996..................... 2,802,446 3,000 24,576,810 25,000 14,259,000 (118,000) (7,272,000) 6,897,000
Effect of L.D
Services terminating the
S-corporation election... -- -- -- -- (61,000) -- 61,000 --
Conversion of redeemable
preferred stock to common
stock.................... (2,802,446) (3,000) 1,868,284 2,000 1,000 -- -- --
Initial public offering of
common stock............. -- -- 8,097,500 8,000 30,936,000 -- -- 30,944,000
Exercise of stock
options.................. -- -- 488,925 -- 447,000 -- -- 447,000
Compensation expense
relating to stock
options.................. -- -- -- -- -- 88,000 -- 88,000
Tax benefit from
non-qualified stock
options.................. -- -- -- -- 114,000 -- -- 114,000
Cash distributions to
stockholders............. -- -- -- -- -- -- (1,058,000) (1,058,000)
Net income................. -- -- -- -- -- -- 5,769,000 5,769,000
---------- ------- ---------- ------- ----------- --------- ----------- -----------
Balance, December 31,
1997..................... -- $ -- 35,031,519 $35,000 $45,696,000 $ (30,000) $(2,500,000) $43,201,000
========== ======= ========== ======= =========== ========= =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-5
<PAGE> 123
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)........................................ $ 3,706,000 $ (4,795,000) $ 5,769,000
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization............................ 368,000 1,442,000 4,637,000
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 16,284,000 7,791,000
Deferred income taxes.................................... (6,000) (15,000) (3,699,000)
Deferred compensation.................................... -- 116,000 (59,000)
Decrease (increase) in assets:
Accounts receivable...................................... (14,305,000) (29,491,000) (19,288,000)
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..................................... (11,000) (859,000) 804,000
Increase (decrease) in liabilities:
Accounts payable......................................... 12,329,000 109,000 (3,921,000)
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 3,194,000
Deposits................................................. -- -- 164,000
------------ ------------ ------------
Net cash provided by (used in) operating activities.... 2,485,000 (2,847,000) 11,133,000
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures..................................... (1,664,000) (8,480,000) (13,760,000)
Investments.............................................. -- (153,000) 126,000
Short-term investments................................... (1,000) (1,631,000) (16,975,000)
Other.................................................... -- (139,000) 639,000
------------ ------------ ------------
Net cash used in investing activities.................. (1,665,000) (10,403,000) (29,970,000)
------------ ------------ ------------
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) (3,073,000) (471,000)
Borrowings under long-term debt.......................... -- 2,000,000 193,000
Payments under long-term debt............................ -- (67,000) (1,983,000)
Payments under capital lease obligations................. (52,000) (358,000) (1,946,000)
Issuance of common stock................................. -- 5,568,000 30,944,000
Capital contribution..................................... 269,000 -- --
Stock options exercised.................................. -- -- 447,000
Issuance of preferred stock.............................. -- 7,500,000 --
------------ ------------ ------------
Net cash (used in) provided by financing activities.... (570,000) 14,721,000 18,895,000
------------ ------------ ------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........... 250,000 1,471,000 58,000
CASH AND CASH EQUIVALENTS, beginning of year............... 124,000 374,000 1,845,000
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, end of year..................... $ 374,000 $ 1,845,000 $ 1,903,000
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-6
<PAGE> 124
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.
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 a
pooling of interests under Accounting Principles Board Opinion No. 16.
Accordingly, all consolidated financial statements presented have been restated
to include the results of operations, financial position, and cash flows of
T-One (see Note 8).
On March 31, 1998, the Company effected a 2.05 for 1 stock split in the
nature of a stock dividend. The stock split has been retroactively reflected in
the condensed consolidated financial statements 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.
F-7
<PAGE> 125
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
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.
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 equalled $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. 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-8
<PAGE> 126
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
The following table summarizes outstanding commitments to purchase foreign
currency at December 31, 1997:
<TABLE>
<CAPTION>
MATURITY NOTIONAL FAIR
DATE AMOUNT 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 $2,669,000 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 primarily 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-9
<PAGE> 127
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
CONSOLIDATED STATEMENTS OF CASH FLOWS
During the years ended December 31, 1995, 1996 and 1997 cash paid for
interest was $45,000, $541,000 and $1,462,000, 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............... -- -- 1,890,000
Debt converted to equity....................... 1,093,000 -- --
Operating agreement acquired through issuance
of note...................................... -- -- 350,000
Equity converted to debt....................... -- 1,200,000 --
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)................. $ 2,140,000 $(5,738,000) $ 5,574,000
=========== =========== ===========
Weighted average number of common shares
used to compute basic earnings (loss) per
share..................................... 19,373,000 23,292,000 30,221,000
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..................................... 19,373,000 23,292,000 32,978,000
=========== =========== ===========
Basic pro forma net income (loss) per common
share (unaudited)......................... $ 0.11 $ (0.25) $ 0.18
Diluted pro forma net income (loss) per
common share (unaudited).................. $ 0.11 $ (0.25) $ 0.17
</TABLE>
CONCENTRATIONS OF RISK
The Company's two largest customers account for approximately 21 percent
and 6 percent of gross accounts receivable at December 31, 1996 and 1997,
respectively. The Company's largest customer and second largest customer in 1997
represent 2 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, Inc. had a
receivable balance exceeding 10 percent of gross accounts receivable at December
31, 1996 and no individual customer has an account receivable balance greater
than 10 percent of gross accounts receivable at December 31, 1997.
The two largest customers represent approximately 14 percent, 26 percent
and 16 percent of revenues during the years ended December 31, 1995, 1996 and
1997, respectively. During 1995 and 1996, only sales to
F-10
<PAGE> 128
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
Cherry Communications, Inc. exceeded 10 percent of total sales. For the year
ended December 31, 1997, no customer exceeded 10 percent of revenues.
The Company performs ongoing credit evaluations of its customers. The
Company analyzes daily traffic patterns and concludes whether or not the
customer's credit status justifies the traffic volume. If the customer is deemed
to carry too large a volume in relation to its credit history, the traffic
received by the Company's switch is reduced to prevent further build up of the
receivable from this customer. The Company's allowance for doubtful accounts is
based on current market conditions.
Purchases from the four largest vendors for the years ended December 31,
1995 and 1996 amounted to 53 percent and 44 percent of total purchases,
respectively. Purchases from the four largest vendors for the year ended
December 31, 1997 amounted to 34 percent of total purchases.
Included in the Company's balance sheets at December 31, 1996 and 1997 are
approximately $840,000 and $7,028,000 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.
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.
F-11
<PAGE> 129
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
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............................... 669,000 384,000
Sales and other taxes............................... 10,000 295,000
Line and billing cost............................... 324,000 2,592,000
Legal settlement.................................... 300,000 --
Other............................................... 304,000 1,243,000
---------- ----------
$2,415,000 $5,609,000
========== ==========
</TABLE>
4. LINES OF CREDIT
BANK LINE OF CREDIT
Effective September 30, 1997, the Company executed an agreement with Sanwa
Bank, California for a $25 million line of credit, which expires on July 1,
1999. The facility has certain financial and non-financial covenants that
include, among other restrictions, the maintenance of minimum levels of tangible
net worth. 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 totalled $1,448,000. The
debt matures on March 30, 1998 with interest payable at maturity at a rate of 9
percent. There was $1,422,000 and $1,310,000 available to be borrowed against
these lines of credit at December 31, 1996 and 1997, respectively. The Company
recognized interest expense related to this debt of $11,000, $34,000 and $9,000
for the years ended December 31, 1995, 1996 and 1997, respectively.
F-12
<PAGE> 130
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
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 $ --
Bank promissory note, payable in $30,000 monthly
installments including interest at prime plus 1.25
percent, (9.75 percent at December 31, 1997) through
December 31, 1999........................................ 1,200,000 904,000
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
---------- -----------
$7,741,000 $15,366,000
========== ===========
</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-13
<PAGE> 131
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................................... $ 3,561,000 $4,969,000 $ 8,530,000
1999................................... 3,506,000 1,906,000 5,412,000
2000................................... 3,471,000 372,000 3,843,000
2001................................... 3,134,000 -- 3,134,000
2002................................... 2,843,000 -- 2,843,000
Thereafter............................. 8,484,000 -- 8,484,000
----------- ---------- -----------
$24,999,000 $7,247,000 $32,246,000
=========== ========== ===========
</TABLE>
Facility and equipment rent expense for the years ended December 31, 1995,
1996 and 1997 was approximately $255,000, $1,137,000 and $3,333,000,
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-14
<PAGE> 132
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
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, most of which are secured by the bank line of credit, total
approximately $5 million.
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.
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.
F-15
<PAGE> 133
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
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. On March 10, 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 the T-One shareholder in exchange for all outstanding T-One
shares. The accompanying consolidated financial statements have been restated to
include the financial position and results of operations of LDS and T-One for
all periods presented.
Revenues 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>
Revenues:
STAR.................................... $16,125,000 $208,086,000 $348,738,000
LDS..................................... 30,158,000 29,905,000 27,460,000
T-ONE................................... 12,654,000 22,432,000 30,438,000
Eliminations............................ -- (726,000) (2,031,000)
----------- ------------ ------------
Total........................... $58,937,000 $259,697,000 $404,605,000
=========== ============ ============
Net income (loss):
STAR.................................... $ (568,000) $ (6,644,000) $ 5,605,000
LDS..................................... 4,541,000 2,424,000 (37,000)
T-ONE................................... (267,000) (575,000) 201,000
----------- ------------ ------------
$ 3,706,000 $ (4,795,000) $ 5,769,000
=========== ============ ============
</TABLE>
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
F-16
<PAGE> 134
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
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................ $ 3,129,000 $ 4,215,000
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........................................ -- 276,000
Legal settlement........................................ 123,000 --
Net operating losses.................................... 228,000 684,000
State income taxes...................................... 48,000 392,000
Change in tax method.................................... 120,000 60,000
----------- -----------
3,945,000 6,601,000
Deferred tax liability:
Depreciation............................................ (561,000) (786,000)
----------- -----------
Subtotal.................................................. 3,384,000 5,815,000
Valuation reserve......................................... (3,384,000) (2,116,000)
----------- -----------
Net deferred tax asset.................................... $ -- $ 3,699,000
=========== ===========
</TABLE>
In prior years, T-One generated net operating losses ("NOL") for financial
statement and income tax purposes which are available for carryforwards against
future income. As of December 31, 1997, T-One has NOL deductions available for
carryforward in the amount of approximately $500,000. These NOL will expire
through 2010. The Company also has foreign NOL of approximately $600,000.
F-17
<PAGE> 135
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
The provision for income taxes for the years ended December 31, 1995, 1996
and 1997 are as follows:
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
-------------------------------- -------------------------------------
1995 1996 1997 1995 1996 1997
------- -------- ----------- ---------- ---------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Current
Federal taxes............. $ 4,000 $280,000 $ 4,900,000 $1,369,000 $1,118,000 $ 5,282,000
State taxes............... 68,000 164,000 1,147,000 418,000 359,000 1,270,000
------- -------- ----------- ---------- ---------- -----------
72,000 444,000 6,047,000 1,787,000 1,477,000 6,552,000
------- -------- ----------- ---------- ---------- -----------
Deferred
Federal taxes............. (6,000) 133,000 (2,273,000) (127,000) 63,000 (2,512,000)
State taxes............... -- -- (869,000) (28,000) (20,000) (940,000)
------- -------- ----------- ---------- ---------- -----------
(6,000) 133,000 (3,142,000) (155,000) 43,000 (3,452,000)
------- -------- ----------- ---------- ---------- -----------
Provision for income
taxes..................... $66,000 $577,000 $ 2,905,000 $1,632,000 $1,520,000 $ 3,100,000
======= ======== =========== ========== ========== ===========
</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>
HISTORICAL PRO FORMA
--------------------------------------- --------------------------------------
1995 1996 1997 1995 1996 1997
----------- ----------- ----------- ---------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Income taxes at the statutory
federal rate................. $ 1,282,000 $(1,434,000) $ 3,036,000 $1,282,000 $(1,434,000) $ 3,036,000
State income taxes, net of
federal income tax effect.... 230,000 (257,000) 498,000 230,000 (257,000) 498,000
Foreign taxes at rates
different than U.S. taxes.... -- -- 187,000 -- -- 187,000
Change in valuation reserve.... 112,000 3,124,000 (1,268,000) 112,000 3,124,000 (1,268,000)
Permanent differences.......... -- 104,000 35,000 13,000 108,000 309,000
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.......................... 27,000 (2,000) 265,000 (5,000) (21,000) 338,000
----------- ----------- ----------- ---------- ----------- -----------
$ 66,000 $ 577,000 $ 2,905,000 $1,632,000 $ 1,520,000 $ 3,100,000
=========== =========== =========== ========== =========== ===========
</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 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
F-18
<PAGE> 136
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
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 of 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
Stock Option Plan upon the effective date of the initial public offering. The
plan provides for awards to employees, outside directors and consultants in the
form of restricted shares, stock units, stock options and stock appreciation
rights and terminates on January 22, 2007. The maximum number of shares
available for issuance under this plan may not exceed 1,025,000 shares plus the
number of shares still unissued under the Supplemental Stock 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-19
<PAGE> 137
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
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- NUMBER WEIGHTED-
NUMBER REMAINING AVERAGE EXERCISABLE AVERAGE
OUTSTANDING AT CONTRACTED EXERCISE AT EXERCISE
RANGE OF EXERCISE PRICES 12/31/97 LIFE PRICE 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:
<TABLE>
<CAPTION>
1996 1997
----------- ----------
<S> <C> <C>
Pro forma Net Income (Loss) Per Share
Pro forma Net Income (Loss).............................. $(6,111,000) $4,957,000
Pro forma Basic Net Income (Loss) per share.............. $ (0.26) $ 0.16
Pro forma Diluted Net Income (Loss) per share............ $ (0.26) $ 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
F-20
<PAGE> 138
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
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.
Since inception of T-One through December 31, 1994, the sole shareholder of
T-One contributed $1,221,000 in the form of cash and equipment to T-One. During
1995, he contributed an additional $269,000 and in 1996, exercised an available
election to convert $1,200,000 of the contributed capital into a note payable.
Concurrent with the conversion of capital to debt, T-One entered into a note
agreement with a bank for the same amount. Proceeds of the bank borrowings were
used to repay the amounts due to the shareholder (see Note 5).
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.
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.
F-21
<PAGE> 139
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
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............ $ 28,779,000 $30,158,000 $ -- $ 58,937,000
Interest income............................. -- 22,000 -- 22,000
Interest expense............................ 64,000 -- -- 64,000
Depreciation and amortization............... 310,000 58,000 368,000
Segment net income (loss)................... (835,000) 4,541,000 -- 3,706,000
Other significant non-cash items:
Capital lease additions................... 888,000 164,000 -- 1,052,000
Debt converted to equity.................. 1,093,000 -- -- 1,093,000
Segment assets.............................. 20,143,000 5,447,000 -- 25,590,000
Expenditures for segment assets............. 1,603,000 61,000 -- 1,664,000
1996
Revenues from external customers............ $229,792,000 $29,905,000 $ -- $259,697,000
Interest income............................. 83,000 27,000 -- 110,000
Interest expense............................ 597,000 12,000 -- 609,000
Depreciation and amortization............... 1,364,000 78,000 -- 1,442,000
Segment net income (loss)................... (7,219,000) 2,424,000 -- (4,795,000)
Other significant non-cash items:
Capital lease additions................... 5,097,000 69,000 -- 5,166,000
Equity converted to debt.................. 1,200,000 -- -- 1,200,000
Segment assets.............................. 57,728,000 5,326,000 -- 63,054,000
Expenditures for segment assets............. 8,466,000 14,000 -- 8,480,000
1997
Revenues from external customers............ $377,145,000 $27,460,000 $ -- $404,605,000
Interest income............................. 519,000 -- (27,000) 492,000
Interest expense............................ 1,738,000 27,000 (27,000) 1,738,000
Depreciation and amortization............... 4,581,000 56,000 -- 4,637,000
Segment net income (loss)................... 5,806,000 (37,000) -- 5,769,000
Other significant non-cash items:
Capital lease additions................... 9,772,000 -- -- 9,772,000
Property additions financed by notes
payable................................ 1,890,000 -- -- 1,890,000
Operating agreement acquired through
issuance of note....................... 350,000 -- -- 350,000
Segment assets.............................. 113,472,000 6,844,000 -- 120,316,000
Expenditures for segment assets............. 13,743,000 17,000 -- 13,760,000
</TABLE>
The Company had no customers, collectively, representing more than 10
percent of consolidated revenue in any foreign country.
F-22
<PAGE> 140
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
13. QUARTERLY CONSOLIDATED INFORMATION (UNAUDITED)
The following table presents unaudited quarterly operating results,
including the results of LDS and T-One, 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............................................ $48,353 $55,491 $ 73,860 $ 81,993
Gross profit......................................... 7,023 7,540 8,048 11,129
Operating income (loss).............................. 1,955 1,816 1,074 (8,503)
Pro forma net income (loss).......................... 1,098 915 491 (8,242)
1997
Net sales............................................ $84,827 $95,250 $103,535 $120,993
Gross profit......................................... 11,101 12,364 13,199 16,120
Operating income..................................... 2,561 2,871 2,977 2,956
Pro forma net income................................. 1,347 1,037 984 2,206
</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.
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.
15. EVENTS SUBSEQUENT TO THE DATE OF AUDITORS REPORT (UNAUDITED)
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 percent of aggregate eligible
accounts receivable, revising certain covenants and releasing all pledged
collateral.
PUBLIC OFFERING
On May 4, 1998, the Company completed a public offering of 6,000,000 shares
of common stock of which 5,685,000 were sold by the Company and 315,000 shares
were sold by a selling stockholder. 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.
COMMITMENT
On June 25, 1998, the Company announced a 20-year, $70 million agreement to
purchase capacity on the Qwest nationwide Macro Capacity (SM) Fiber Network.
AUTHORIZED CAPITAL
On July 1, 1998, the Company's stockholders voted to amend and restate the
certificate of incorporation to increase the number of shares of the Company's
authorized common stock from 50 million shares to 100 million shares.
F-23
<PAGE> 141
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
PT-1 ACQUISITION
On August 20, 1998, the Company entered into an Amended and Restated
Agreement and Plan of Merger with PT-1 Communications, Inc. (PT-1). Per the
agreement, as amended on September 1, 1998, the Company will issue 15,050,000
shares of common stock and $19,500,000 cash for all outstanding shares, options
and warrants of PT-1 plus an additional 250,000 shares to certain PT-1
distributors. On August 17, 1998, the Company provided a $10 million loan to
PT-1 at 6.75 percent interest and due on August 17, 1999.
F-24
<PAGE> 142
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
INDEX TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
Condensed Consolidated Balance Sheets As Of December 31,
1997 and June 30, 1998...................................... F-25
Condensed Consolidated Statements Of Income For The Three
and Six Month Periods Ended June 30, 1997 and 1998.......... F-26
Condensed Consolidated Statements Of Cash Flows For The Six
Month Periods Ended June 30, 1997 and 1998.................. F-27
Notes To Condensed Consolidated Financial Statements........ F-28
</TABLE>
F-24
<PAGE> 143
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1997 1998
------------ -----------
(UNAUDITED)
<S> <C> <C>
Current Assets:
Cash and cash equivalents................................. $ 1,903 $ 9,161
Short-term investments.................................... 18,631 114,421
Accounts receivable, net.................................. 46,675 66,119
Receivable from related parties........................... -- 5,076
Other current assets...................................... 10,696 19,818
-------- --------
Total current assets.............................. 77,905 214,595
-------- --------
Property and equipment, net................................. 35,959 101,287
Other assets................................................ 6,452 2,045
-------- --------
Total assets...................................... $120,316 $317,927
======== ========
Current Liabilities:
Revolving lines of credit with stockholder................ $ 138 $ 73
Current portion of long-term obligations.................. 3,259 7,319
Accounts payable and other accrued expenses............... 22,345 35,309
Accrued network cost...................................... 38,403 47,942
-------- --------
Total current liabilities......................... 64,145 90,643
-------- --------
Long-Term Liabilities:
Long-term obligations, net of current portion............. 12,107 26,528
Other long-term liabilities............................... 863 1,247
-------- --------
Total long-term liabilities....................... 12,970 27,775
-------- --------
Stockholders' Equity:
Common Stock $.001 par value:
Authorized -- 50,000,000 shares........................ 35 42
Additional paid-in capital................................ 45,696 196,857
Deferred compensation..................................... (30) --
Retained earnings (deficit)............................... (2,500) 2,610
-------- --------
Total stockholders' equity........................ 43,201 199,509
-------- --------
Total liabilities and stockholders' equity........ $120,316 $317,927
======== ========
</TABLE>
See accompanying notes to the condensed consolidated financial statements.
F-25
<PAGE> 144
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ -------------------
1997 1998 1997 1998
------- -------- -------- --------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Revenue.............................................. $95,250 $131,929 $180,077 $261,198
Cost of services..................................... 82,886 112,877 156,612 224,470
------- -------- -------- --------
Gross profit............................... 12,364 19,052 23,465 36,728
Operating expenses
Selling, general and administrative expenses....... 8,500 11,371 16,220 22,931
Depreciation and amortization...................... 993 2,737 1,813 4,616
Merger expense..................................... -- -- -- 314
------- -------- -------- --------
9,493 14,108 18,033 27,861
------- -------- -------- --------
Income from operations..................... 2,871 4,944 5,432 8,867
------- -------- -------- --------
Other income (expense):
Interest income.................................... 53 1,389 74 1,672
Interest expense................................... (438) (722) (836) (1,340)
Other.............................................. (756) (97) (705) (258)
------- -------- -------- --------
(1,141) 570 (1,467) 74
------- -------- -------- --------
Income before provision for income taxes... 1,730 5,514 3,965 8,941
Provision for income taxes........................... 810 2,296 1,151 3,831
------- -------- -------- --------
Net income........................................... $ 920 $ 3,218 $ 2,814 $ 5,110
======= ======== ======== ========
Income before provision for income taxes... 1,730 3,965
Pro forma income taxes............................... 693 1,581
------- --------
Pro forma net income................................. $ 1,037 $ 2,384
======= ========
Basic income per share............................... $ 0.03 $ 0.08 $ 0.10 $ 0.14
======= ======== ======== ========
Diluted income per share............................. $ 0.03 $ 0.08 $ 0.10 $ 0.13
======= ======== ======== ========
Pro forma basic income per share..................... $ 0.04 $ 0.09
======= ========
Pro forma diluted income per share................... $ 0.03 $ 0.08
======= ========
</TABLE>
See accompanying notes to the condensed consolidated financial statements.
F-26
<PAGE> 145
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
---------------------
1997 1998
-------- ---------
(UNAUDITED)
<S> <C> <C>
Cash Flows From Operating Activities:
Net income................................................ $ 2,814 $ 5,110
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.......................... 1,813 4,616
Loss on disposal of equipment.......................... 42 --
Compensation expense relating to stock options......... 40 30
Provision for doubtful accounts........................ 2,737 1,067
Deferred income taxes.................................. -- (2,234)
Deferred compensation.................................. (73) 52
Decrease (increase) in assets:
Accounts receivable.................................. (9,560) (20,511)
Receivable from related parties...................... 100 (5,076)
Other assets......................................... (3,090) 2,485
Increase (decrease) in liabilities:
Accounts payable and other accrued expenses.......... (3,020) 12,964
Accrued network cost................................. 9,272 9,539
Other liabilities.................................... 65 682
-------- ---------
Net cash provided by operating activities......... 1,140 8,724
-------- ---------
Cash Flows From Investing Activities:
Capital expenditures...................................... (3,746) (48,340)
Short-term investments, net............................... (15,314) (95,790)
Proceeds from the sale of assets.......................... 18 --
-------- ---------
Net cash used in by investing activities.......... (19,042) (144,130)
-------- ---------
Cash Flows From Financing Activities:
Repayments under lines of credit.......................... (7,814) --
Repayments under lines of credit with stockholder......... 77 (65)
Payments under long-term debt and capital lease
obligations............................................ (1,987) (3,473)
Stockholder distributions for LDS......................... (595) --
Issuance of common stock.................................. 30,981 144,743
Other financing activities................................ 426 (11)
Stock options exercised................................... -- 1,470
-------- ---------
Net cash used in financing activities............. 21,088 142,664
-------- ---------
Increase (decrease) in cash and cash equivalents............ 3,186 7,258
Cash and cash equivalents, beginning of period.............. 1,845 1,903
-------- ---------
Cash and cash equivalents, end of period.................... $ 5,031 $ 9,161
======== =========
</TABLE>
See accompanying notes to the condensed consolidated financial statements.
F-27
<PAGE> 146
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 STAR Telecommunications, Inc. ("STAR" or the "Company") Annual
Report on Form 10-K. The results for the three and six month periods ended June
30, 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 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 T-One.
(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 subsidiaries, LD Services, Inc. ("LDS") and Arvilla
Telecommunications, Inc. ("CEO").
(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.
The following schedule summarizes the information used to compute net
income per common share for the three and six months ended June 30, 1997 and
1998 (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
---------------- ----------------
1997 1998 1997 1998
------ ------ ------ ------
<S> <C> <C> <C> <C>
Weighted number of common shares used to compute
basic earnings per share...................... 28,153 39,627 27,304 37,640
Weighted average common share equivalents....... 1,625 1,994 1,596 2,009
------ ------ ------ ------
Weighted average number of common share and
share equivalents used to compute diluted
earnings per share............................ 29,778 41,621 28,900 39,649
====== ====== ====== ======
</TABLE>
F-28
<PAGE> 147
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(4) PRO FORMA INCOME TAXES
The results of operations and provision for income taxes for the three and
six months ended June 30, 1997 reflect 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
equity 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 three and six month periods ended
June 30, 1997 and 1998, comprehensive income equaled net income.
(6) SIGNIFICANT EVENTS
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. In June 1998, the Company signed a definitive agreement to
acquire PT-1 Communications, Inc. ("PT-1").
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.
In June 1998, the Company signed a 20 year, $70 million dollar agreement
with Qwest Communications International Inc. ("Qwest") to purchase the long-term
rights to use capacity over Qwest's domestic network.
(7) STATEMENTS OF CASH FLOWS
During the six month periods ended June 30, 1997 and 1998, cash paid for
interest was $876,000 and $1,253,000 respectively. For the same periods, cash
paid for income taxes amounted to $1,752,000 and $1,576,000 respectively.
Non-cash investing and financing activities are as follows (in thousands):
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
-----------------
1997 1998
------ -------
<S> <C> <C>
Equipment purchased through notes and capital leases...... $6,053 $21,604
Tax benefits related to stock options..................... -- 4,966
------ -------
$6,053 $26,570
====== =======
</TABLE>
(8) SEGMENT INFORMATION
At June 30, 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-29
<PAGE> 148
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Both segments are accounted for in accordance with Generally Accepted
Accounting Principles or "GAAP". Reportable segment information for the three
months and six months ended June 30, 1997 and 1998 are as follows (in
thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED, JUNE 30, 1997 WHOLESALE COMMERCIAL TOTAL
--------------------------------- --------- ---------- --------
<S> <C> <C> <C>
Revenue from external customers............... $ 88,790 $ 6,460 $ 95,250
Interest income............................... 53 0 53
Interest expense.............................. 437 1 438
Depreciation and amortization................. 989 4 993
Segment profit (loss)......................... 1,341 (421) 920
Segment assets................................ 93,834 5,032 98,866
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED, JUNE 30, 1998 WHOLESALE COMMERCIAL TOTAL
--------------------------------- --------- ---------- --------
<S> <C> <C> <C>
Revenue from external customers............... $124,022 $ 7,907 $131,929
Interest income............................... 1,382 7 1,389
Interest expense.............................. 721 1 722
Depreciation and amortization................. 2,714 23 2,737
Segment profit (loss)......................... 3,505 (287) 3,218
Segment assets................................ 309,061 8,866 317,927
</TABLE>
<TABLE>
<CAPTION>
SIX MONTHS ENDED, JUNE 30, 1997 WHOLESALE COMMERCIAL TOTAL
------------------------------- --------- ---------- --------
<S> <C> <C> <C>
Revenue from external customers............... $165,244 $14,833 $180,077
Interest income............................... 74 0 74
Interest expense.............................. 834 2 836
Depreciation and amortization................. 1,803 10 1,813
Segment profit................................ 2,760 54 2,814
Segment assets................................ 93,834 5,032 98,866
</TABLE>
<TABLE>
<CAPTION>
SIX MONTHS ENDED, JUNE 30, 1998 WHOLESALE COMMERCIAL TOTAL
------------------------------- --------- ---------- --------
<S> <C> <C> <C>
Revenue from external customers............... $255,215 $ 5,983 $261,198
Interest income............................... 1,663 9 1,672
Interest expense.............................. 1,339 1 1,340
Depreciation and amortization................. 4,590 26 4,616
Segment profit (loss)......................... 5,482 (372) 5,110
Segment assets................................ 309,061 8,866 317,927
</TABLE>
(9) NEW PRONOUNCEMENTS
In June 1998, the AICPA issued statement of Financial Accounting Standards
No. 133 "Accounting For Derivative Instruments and Hedging Activities." The
Company has not yet analyzed the impact of this new standard. The Company will
adopt the standard in January of 2000.
(10) SUBSEQUENT EVENTS
On July 1, 1998, the Company's stockholders voted to amend and restate the
certificate of incorporation to increase the number of shares of the Company's
authorized common stock from 50 million shares to 100 million shares.
F-30
<PAGE> 149
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report................................ F-32
Consolidated Balance Sheets as of March 31, 1997 and 1998
and June 30, 1998 (unaudited)............................. F-33
Consolidated Statements of Operations for the period from
April 21, 1995 (inception) to March 31, 1996, for the
years ended March 31, 1997 and 1998 and for the three
months ended June 30, 1998 and 1997 (unaudited)........... F-34
Consolidated Statements of Cash Flows for the period from
April 21, 1995 (inception) to March 31, 1996, for the
years ended March 31, 1997 and 1998 and for the three
months ended June 30, 1998 and 1997 (unaudited)........... F-35
Consolidated Statements of Stockholders' Deficiency for the
period from April 21, 1995 (inception) to March 31, 1996,
for the years ended March 31, 1997 and 1998 and for the
three months ended June 30, 1998 (unaudited).............. F-36
Notes to Consolidated Financial Statements.................. F-37
</TABLE>
F-31
<PAGE> 150
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
PT-1 Communications, Inc.:
We have audited the accompanying consolidated balance sheets of PT-1
Communications, Inc. and subsidiary as of March 31, 1997 and 1998 and the
related consolidated statements of operations, stockholders' deficiency and cash
flows for the period from April 21, 1995 (inception) to March 31, 1996 and for
the years ended March 31, 1997 and 1998. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with generally accepting 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 consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
PT-1 Communications, Inc. and subsidiary as of March 31, 1997 and 1998, and the
results of their operations and their cash flows for the period from April 21,
1995 (inception) to March 31, 1996 and for the years ended March 31, 1997 and
1998 in conformity with generally accepted accounting principles.
New York, New York
June 22, 1998, except for
the third paragraph of
Note 8, for which the
date is September 1, 1998.
F-32
<PAGE> 151
PT-1 COMMUNICATIONS, INC.
AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
MARCH 31,
--------------------------- JUNE 30,
1997 1998 1998
------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 5,577,238 $ 12,389,554 $ 3,333,669
Short-term investments (notes 1 and 3).................... 668,994 4,757,264 1,292,636
Accounts receivable, less allowance for doubtful accounts
of $391,000, $478,000 and $466,000, respectively (notes
4 and 6)................................................ 7,540,474 29,771,970 35,283,766
Due from carriers......................................... 269,153 7,516,370 8,573,110
Inventory................................................. 317,390 842,793 1,282,904
Prepaid expenses.......................................... 827,755 690,939 1,238,399
Deferred tax asset........................................ -- 2,505,217 3,200,000
------------ ------------ ------------
Total current assets............................... 15,201,004 58,474,107 54,204,484
Investments (notes 1 and 3)................................. 1,472,000 2,406,440 2,406,440
Property and equipment, net (notes 1, 2 and 5).............. 1,483,823 22,609,454 33,298,530
Deposits.................................................... 403,729 507,333 513,592
Officer loans receivable (note 6)........................... 338,528 202,820 572,773
Intangible assets........................................... -- 2,991,457 2,742,166
Deferred offering costs (note 11)........................... -- 485,790 --
------------ ------------ ------------
Total assets....................................... $ 18,899,084 $ 87,677,401 $ 93,737,985
============ ============ ============
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Accounts payable and accrued expenses..................... 1,902,210 7,940,817 9,523,955
Accrued taxes payable..................................... 4,374,679 10,599,910 8,509,523
Due to carriers........................................... 870,259 9,086,026 12,096,219
Notes payable (notes 5 and 8)............................. 5,000,000 5,130,000 5,000,000
Short-term debt (note 10)................................. -- 4,506,001 6,451,027
Deferred revenue.......................................... 20,479,361 42,931,616 44,971,632
------------ ------------ ------------
Total current liabilities.......................... 32,626,509 80,194,370 86,552,356
------------ ------------ ------------
Long-term debt (note 10).................................... -- 8,253,999 8,253,999
Note payable (note 8)....................................... 5,000,000 -- --
Deferred tax liability...................................... -- 450,000 600,000
------------ ------------ ------------
Total liabilities.................................. 37,626,509 88,898,369 95,406,355
------------ ------------ ------------
Stockholders' deficiency:
Preferred stock, no par value. Authorized 15,000,000
shares; no shares issued and outstanding................ -- -- --
Common stock, par value $.01 per share. Authorized
150,000,000 shares; 70,000,000 shares issued and
44,947,368 outstanding in 1997 and 73,459,180 shares
issued and 48,406,548 outstanding in 1998............... 700,000 734,592 734,592
Additional paid-in capital................................ 6,602,613 15,784,614 16,056,482
Retained earnings (accumulated deficit)................... (11,030,038) 550,357 (101,842)
Treasury stock, at cost 25,052,632 shares in 1997 and 1998
(note 8)................................................ (15,000,000) (15,000,000) (15,000,000)
Less: Note receivable from stockholder (note 8) $3,570,000
face amount, noninterest bearing until April 15, 1999
(less unamortized discount of $279,469, based on imputed
interest of 8%)......................................... -- (3,290,531) (3,357,602)
------------ ------------ ------------
Total stockholders' deficiency..................... (18,727,425) (1,220,968) (1,668,370)
------------ ------------ ------------
Total liabilities and stockholders' deficiency..... $ 18,899,084 $ 87,677,401 $ 93,737,985
============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-33
<PAGE> 152
PT-1 COMMUNICATIONS, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
PERIOD FROM
APRIL 21, 1995 YEARS ENDED MARCH 31, THREE MONTHS ENDED JUNE 30,
(INCEPTION) --------------------------- ----------------------------
TO MARCH 31, 1996 1997 1998 1997 1998
----------------- ------------ ------------ ------------ -------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenue........................ $11,922,606 $169,635,313 $431,519,685 $87,235,050 $139,704,173
Cost of services............... 13,812,202 166,184,501 395,500,937 80,802,562 131,982,568
----------- ------------ ------------ ----------- ------------
Gross profit
(loss)............. (1,889,596) 3,450,812 36,018,748 6,432,488 7,721,605
----------- ------------ ------------ ----------- ------------
Operating expenses:
Selling and marketing
expenses.................. 318,070 1,761,650 4,485,214 798,152 2,137,299
General and administrative
expenses.................. 704,429 2,612,894 12,112,035 1,592,211 6,205,899
Stock based compensation..... -- 7,300,000 2,661,166 1,050,000 271,868
----------- ------------ ------------ ----------- ------------
Total operating
expenses................ 1,022,499 11,674,544 19,258,415 3,440,363 8,615,066
----------- ------------ ------------ ----------- ------------
Operating (loss) income... (2,912,095) (8,223,732) 16,760,333 2,992,125 (893,461)
Interest income................ 2,115 114,633 517,304 84,933 236,293
Interest expense............... -- (10,959) (1,021,452) (199,452) (323,304)
Net gains on marketable
securities................... -- -- 507,170 94,599 (28,510)
Loss on disposition of fixed
assets....................... -- -- (32,960) -- --
----------- ------------ ------------ ----------- ------------
(Loss) income before
income taxes....... (2,909,980) (8,120,058) 16,730,395 2,972,205 (1,008,982)
Income tax expense............. -- -- 5,150,000 (190,000) (356,783)
----------- ------------ ------------ ----------- ------------
Net (loss) income.... $(2,909,980) $ (8,120,058) $ 11,580,395 $ 3,162,205 (652,199)
=========== ============ ============ =========== ============
Net earnings (loss) per common
share:
Basic........................ $(.05) $(.13) $0.25 $0.07 ($0.01)
Diluted...................... $(.05) $(.13) $0.24 $0.07 ($0.01)
Weighted average number of
common shares outstanding
Basic........................ 60,900,000 60,681,000 46,922,000 45,419,000 48,406,000
Diluted...................... 60,900,000 60,681,000 47,720,000 46,200,000 48,406,000
</TABLE>
F-34
<PAGE> 153
PT-1 COMMUNICATIONS, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
PERIOD FROM
APRIL 21, 1995 YEARS ENDED MARCH 31, THREE MONTHS THREE MONTHS
(INCEPTION) TO -------------------------- ENDED JUNE 30, ENDED JUNE 30,
MARCH 31, 1996 1997 1998 1997 1998
-------------- ----------- ------------ -------------- --------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash provided by operating activities:
Net (loss) income.......................... $(2,909,980) $(8,120,058) $ 11,580,395 3,162,205 (652,199)
Adjustments to reconcile net (loss) income
to net cash provided by operating
activities:
Depreciation and amortization............ 4,943 75,017 1,534,500 129,342 816,767
Noncash compensation..................... -- 7,300,000 2,661,166 1,050,000 271,868
Loss on sale of marketable securities.... -- -- (1,082,072) -- (28,510)
Amortization of discount on stock
subscription receivable................ -- -- (122,964) -- (67,071)
Loss on disposal of property, plant and
equipment.............................. -- -- 32,960 -- --
Increase in accounts receivable, net..... (962,305) (6,578,169) (22,231,496) (3,452,584) (5,511,796)
Decrease (increase) in due from
carriers............................... (331,347) 62,194 (7,247,217) (1,233,598) (1,056,740)
(Increase) decrease in officer loans
receivable............................. -- (338,528) 135,708 (22,803) (369,953)
Increase in inventory.................... (36,200) (281,190) (525,403) (148,568) (440,111)
(Increase) decrease in prepaid
expenses............................... (5,804) (821,951) 136,816 229,001 (547,460)
Increase in deposits..................... (87,155) (316,574) (103,604) (152,473) (6,259)
Increase in deferred income taxes........ -- -- (2,055,217) (300,000) (544,783)
Increase in accounts payable and accrued
expenses............................... 390,761 1,511,449 6,038,607 (376,776) 1,583,138
Increase (decrease) in accrued taxes
payable................................ 605,000 3,769,679 6,225,231 (3,029,935) (2,090,387)
(Decrease) increase in due to carriers... 2,251,398 (1,381,139) 8,215,767 5,054,647 3,010,193
Increase in deferred revenue............. 1,846,023 18,633,338 22,452,255 6,182,367 2,040,016
----------- ----------- ------------ ---------- -----------
Net cash provided by (used in)
operating activities............... 765,334 13,514,068 25,645,432 7,090,825 (3,593,287)
----------- ----------- ------------ ---------- -----------
Cash flows from investing activities:
Purchases of investments................... -- (2,140,994) (10,783,000) (5,291,748) --
Sale of investments........................ -- -- 6,842,362 -- 3,435,689
Capital expenditures....................... (74,319) (1,489,464) (21,254,715) (1,635,514) (11,179,103)
Purchase of capitalized software........... -- -- (391,973) (350,000) --
----------- ----------- ------------ ---------- -----------
Net cash used in investing
activities......................... (74,319) (3,630,458) (25,587,326) (7,277,262) (7,763,414)
----------- ----------- ------------ ---------- -----------
Cash flows from financing activities:
Proceeds from issuance of common stock..... 2,600 13 -- -- --
Proceeds from bank loan.................... -- -- 12,760,000 -- 1,945,026
Payment for treasury stock................. -- (5,000,000) -- -- --
Payment on notes payable................... -- -- (5,520,000) -- (130,000)
Offering costs............................. -- -- (485,790) -- 485,790
----------- ----------- ------------ ---------- -----------
Net cash (used in) provided by
financing
activities......................... 2,600 (4,999,987) 6,754,210 -- 2,300,816
----------- ----------- ------------ ---------- -----------
Net increase (decrease) in cash and
cash equivalents................... 693,615 4,883,623 6,812,316 (186,437) (9,055,885)
Cash and cash equivalents at beginning of
year....................................... -- 693,615 5,577,238 5,577,238 12,389,554
----------- ----------- ------------ ---------- -----------
Cash and cash equivalents at end of year..... $ 693,615 $ 5,577,238 $ 12,389,554 5,390,801 3,333,669
=========== =========== ============ ========== ===========
Supplemental information:
Cash paid for interest..................... $ -- $ -- $ 211,923 0 $ 206,051
=========== =========== ============ ========== ===========
Cash paid for income taxes................. $ -- $ -- $ 5,250,000 100,000 $ 3,725,000
=========== =========== ============ ========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-35
<PAGE> 154
PT-1 COMMUNICATIONS, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIENCY
PERIOD FROM APRIL 21, 1995 (INCEPTION) TO MARCH 31, 1996,
THE YEARS ENDED MARCH 31, 1997 AND 1998,
AND THE THREE MONTHS ENDED JUNE 30, 1998 (UNAUDITED)
<TABLE>
<CAPTION>
RETAINED NOTE
ADDITIONAL EARNINGS TREASURY STOCK RECEIVABLE
PAID-IN (ACCUMULATED ------------------------- FROM
SHARES AMOUNT CAPITAL DEFICIT) SHARES AMOUNT STOCKHOLDER
---------- -------- ----------- ------------ ---------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at April 21, 1995
(inception).................... -- $ -- $ -- $ -- -- $ -- $ --
Issuance of common stock......... 60,900,000 609,000 (606,400) -- -- -- --
Net loss......................... -- -- -- (2,909,980) -- -- --
---------- -------- ----------- ----------- ---------- ------------ -----------
Balance at March 31, 1996........ 60,900,000 609,000 (606,400) (2,909,980) -- -- --
Issuance of common stock (note
8)............................. 9,100,000 91,000 7,209,013 -- -- -- --
Purchase of treasury stock....... -- -- -- -- 25,052,632 (15,000,000) --
Net loss......................... -- -- -- (8,120,058) -- -- --
---------- -------- ----------- ----------- ---------- ------------ -----------
Balance at March 31, 1997........ 70,000,000 700,000 6,602,613 (11,030,038) 25,052,632 (15,000,000) --
Compensation expense related to
stock options.................. -- -- 1,661,166 -- -- -- --
Issuance of common stock (note
8)............................. 483,980 4,840 3,383,020 -- -- -- --
Exercise of stock options (notes
5 and 8)....................... 2,975,200 29,752 4,137,815 -- -- -- (3,290,531)
Net income....................... -- -- -- 11,580,395 -- -- --
---------- -------- ----------- ----------- ---------- ------------ -----------
Balance at March 31, 1998........ 73,459,180 $734,592 $15,784,614 $ 550,357 25,052,632 $(15,000,000) $(3,290,531)
Compensation expense related to
stock options.................. 271,868
Imputed interest................. (67,071)
Net loss (unaudited)............. (652,199)
---------- -------- ----------- ----------- ---------- ------------ -----------
Balance at June (unaudited) 30,
1998........................... 73,459,180 $734,592 $16,056,482 (101,842) 25,052,632 $(15,000,000) $(3,357,602)
========== ======== =========== =========== ========== ============ ===========
<CAPTION>
TOTAL
STOCKHOLDERS'
DEFICIENCY
-------------
<S> <C>
Balance at April 21, 1995
(inception).................... $ --
Issuance of common stock......... 2,600
Net loss......................... (2,909,980)
------------
Balance at March 31, 1996........ (2,907,380)
Issuance of common stock (note
8)............................. 7,300,013
Purchase of treasury stock....... (15,000,000)
Net loss......................... (8,120,058)
------------
Balance at March 31, 1997........ (18,727,425)
Compensation expense related to
stock options.................. 1,661,166
Issuance of common stock (note
8)............................. 3,387,860
Exercise of stock options (notes
5 and 8)....................... 877,036
Net income....................... 11,580,395
------------
Balance at March 31, 1998........ $ (1,220,968)
Compensation expense related to
stock options.................. 271,868
Imputed interest................. (67,071)
Net loss (unaudited)............. (652,199)
------------
Balance at June (unaudited) 30,
1998........................... $ (1,668,370)
============
</TABLE>
See accompanying notes to consolidated financial statements.
F-36
<PAGE> 155
PT-1 COMMUNICATIONS, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE PERIOD FROM APRIL 21, 1995 (INCEPTION) TO MARCH 31, 1996
AND FOR THE YEARS ENDED MARCH 31, 1997 AND 1998
(INFORMATION AS OF JUNE 30, 1998 AND FOR THE THREE MONTHS ENDED
JUNE 30, 1998 AND 1997 IS UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) DESCRIPTION OF BUSINESS
The consolidated financial statements include the accounts of PT-1
Communications, Inc. and PT-1 Technologies, Inc., a wholly owned subsidiary.
PT-1 Communications, Inc., formerly PhoneTime, Inc., was incorporated on April
21, 1995. All intercompany balances and transactions have been eliminated in
consolidation. PT-1 Communications, Inc. and Subsidiary ("PT-1" or the
"Company") are engaged in the sale of international and domestic long-distance
and local telecommunications services primarily through the marketing of prepaid
phone cards, which it manufactures and distributes on a wholesale basis. PT-1
provides card users access to long-distance and international service through
contractual arrangements with carriers, which comprise the Company's least-cost
routing network. In addition, PT-1 provides international and domestic
long-distance services to other telecommunications carriers on a wholesale
basis.
(B) REVENUE RECOGNITION AND DEFERRED REVENUE
Revenue from telecommunications services is recognized when the services
are provided. Sales of prepaid phone cards are initially recorded as deferred
revenue upon shipment and are recognized as revenue in accordance with the terms
of the card as the ultimate card users utilize calling time and service fees are
assessed. Effective April 1, 1996, the Company began to assess a $.25 monthly
service fee per card, commencing 30 days after the first use of a card. All
prepaid phone cards sold by the Company since October 1, 1996 expire upon the
earlier to occur of (i) an expiration date printed on the prepaid phone card or
(ii) six months after the prepaid phone card is first used. The Company did not
recognize any revenue related to the expiration of the cards for the period from
April 21, 1995 (inception) through March 31, 1996 and for the year ended March
31, 1997. The Company recognized approximately $2.5 million of revenue related
to the expiration of cards for the year ended March 31, 1998. The Company did
not recognize any revenue related to the expiration of cards for the three
months ended June 30, 1997 and 1998. The primary card costs associated with the
provision of telecommunications services are carrier costs for transport of
traffic and switch administration fees.
For the period from April 21, 1995 (inception) through March 31, 1996 and
for the years ended March 31, 1997 and 1998, approximately $-0-, $7,084,000 and
$75,188,000, respectively, of wholesale revenue was included in revenues. For
the three months ended June 30, 1997 and 1998, 11,399,000 and 42,611,000
respectively of wholesale revenues was included in telecommunications services
revenues.
(C) CASH EQUIVALENTS
For purposes of the consolidated statements of cash flows, the Company
considers all highly liquid investments with original maturities of three months
or less to be cash equivalents.
(D) INVESTMENTS
Management determines the appropriate classification of its investments at
the time of purchase and classifies them as trading, held to maturity or
available for sale, in accordance with the provisions of Statement of Financial
Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt
and Equity Securities."
F-37
<PAGE> 156
PT-1 COMMUNICATIONS, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(E) PROPERTY AND EQUIPMENT AND SOFTWARE
Property and equipment consist principally of telecommunications equipment,
office equipment, packaging machinery and equipment, furniture and fixtures and
leasehold improvements. Property and equipment are stated at cost with
depreciation provided using the straight-line method over the estimated useful
lives of the related assets. Leasehold improvements are amortized over the life
of the lease or the useful life of the improvement, whichever is shorter. The
estimated useful lives are as follows:
<TABLE>
<S> <C>
Telecommunications equipment and network.................... 7-20 years
Office equipment............................................ 5 years
Machinery and equipment..................................... 15 years
Furniture and fixtures...................................... 10 years
Leasehold improvements...................................... 5 years
Computer software........................................... 3-4 years
</TABLE>
The Company's telecommunications equipment is subject to technological risks and
rapid market changes due to new products and services and changing customer
demand. These changes may result in future adjustments to the estimated useful
lives of these assets.
(F) INVENTORY
Inventory consists of costs of production and packaging of unsold phone
cards and is valued using the average-cost method.
(G) CAPITALIZED SOFTWARE
The Company capitalizes certain computer software license acquisition costs
which are amortized utilizing the straight-line method over three years, the
period for which the Company maintains exclusive rights to such license.
In March 1998, the Company adopted the provisions of Statement of Position
(SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained
for Internal Use." The SOP requires that certain costs related to the
development or purchase of internal-use software be capitalized and amortized
over the estimated useful life of the software. The SOP also requires that costs
related to the preliminary project stage and the post-implementation/operations
stage of an internal-use computer software development project be expensed as
incurred.
(H) INCOME TAXES
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be realized or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amounts expected to be realized.
(I) FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires the determination of fair value for certain of the Company's assets and
liabilities. The Company estimates that the carrying value of its financial
instruments approximates fair value.
F-38
<PAGE> 157
PT-1 COMMUNICATIONS, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(J) IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF
In accordance with SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," the Company
reviews for the impairment of long-lived assets and certain identifiable
intangibles to be held and used by the Company whenever events and changes in
circumstances indicate that the carrying value of an asset may not be
recoverable.
The Company assesses the recoverability of an asset by determining whether
the amortization of the asset balance over its remaining life can be recovered
through projections of undiscounted future cash flows of the related asset. The
amount of asset impairment, if any, is measured based on projected discounted
future cash flows using a discount rate reflecting the Company's average cost of
funds.
(K) RISKS AND UNCERTAINTIES
The preparation of 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 financial
statements and the reported amounts of revenue and expense during the reporting
period. Estimates are used in determining the allowance for doubtful accounts,
depreciation and amortization, carrier cost liabilities and the realization of
deferred tax assets. The accompanying consolidated balance sheets include
liabilities with respect to carrier line costs and related disputes which are
determined based upon various assumptions. It is reasonably possible that the
final resolution of some of these disputes may require expenditure by the
Company in excess of estimates and in a range of amounts that cannot be
reasonably estimated. Actual results could differ from those estimates.
The taxation of prepaid phone cards is evolving and is not specifically
addressed by many of the states in which the Company does business. While the
Company believes it has adequately provided for any such taxes it may ultimately
be required to pay, certain states may enact legislation which specifically
provides for taxation of such cards or may interpret current laws in a manner
resulting in additional tax liabilities.
(L) STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation in accordance with SFAS
No. 123, "Accounting for Stock-Based Compensation," which permits entities to
recognize as expense over the vesting period the fair value of all stock-based
awards on the date of grant. Alternatively, SFAS No. 123 also allows entities to
continue to apply the provisions of the Accounting Principles Board (APB)
Opinion No. 25 and provide pro forma net income and pro forma earnings per share
disclosures for employee stock option grants as if the fair value-based method,
as defined in SFAS No. 123, had been applied. The Company has elected to
continue to apply the provisions of APB Opinion No. 25 and provide the pro forma
disclosure required by SFAS No. 123. As such, compensation expense is generally
recorded on the date of grant only if the current market price of the underlying
stock exceeded the exercise price.
(M) ADVERTISING COSTS
Advertising costs are expensed as incurred. Advertising costs period from
April 21, 1995 (inception) through March 31, 1996 and for the years ended March
31, 1997 and 1998 amounted to approximately $108,000, $202,000 and $760,000,
respectively. Advertising costs amounted to approximately $90,000 and $647,000
for the three months ended June 30, 1997 and 1998, respectively.
(N) INTANGIBLE ASSETS
Intangible assets consist of a noncompetition agreement which is being
amortized by use of the straight-line method over the estimated life of the
agreement (see note 8).
F-39
<PAGE> 158
PT-1 COMMUNICATIONS, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(o) NET EARNINGS (LOSS) PER SHARE
The Company adopted the provisions of SFAS 128, "Earnings Per Share" for
the year ended March 31, 1998. SFAS 128, which supercedes APB Opinion No. 15,
"Earnings Per Share" was issued in February 1997. SFAS 128 requires dual
presentation of basic and diluted earnings per share ("EPS") for complex capital
structures on the face of the statement of operations. Basic EPS is computed by
dividing net income or loss by the weighted average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution from the
exercise or conversion of securities into common stock. Net earnings (loss) and
weighted average shares outstanding used for computing diluted loss per common
share were the same as that used for computing net earnings (loss) per common
share for all periods presented.
Potentially dilutive instruments totalling 9,000,000 for the year ended
March 31, 1997 and 447,091 for the three months ended June 30, 1998 have not
been included in the computation of diluted net income (loss) per common share
because they were antidilutive for those periods.
(2) PROPERTY AND EQUIPMENT
Property and equipment consist of the following as of March 31, 1997 and
1998 and June 30, 1998:
<TABLE>
<CAPTION>
MARCH 31 JUNE 30
------------------------ ----------
1997 1998 1998
---------- ---------- ----------
UNAUDITED
<S> <C> <C> <C>
Telecommunications equipment and networks...... $1,174,032 19,885,282 29,722,657
Office equipment............................... 141,920 931,374 1,328,203
Packaging machinery and equipment.............. 120,396 412,638 412,638
Furniture and fixtures......................... 96,793 273,055 319,840
Leasehold improvements......................... 30,642 1,222,099 2,180,395
Software....................................... -- 1,142,876 1,160,144
---------- ---------- ----------
1,563,783 23,867,324 35,123,877
Less accumulated depreciation.................. 79,960 1,257,870 1,825,347
---------- ---------- ----------
$1,483,823 22,609,454 33,298,530
========== ========== ==========
</TABLE>
(3) INVESTMENTS
Short-term investments include certificates of deposit and marketable
securities. Marketable securities are composed of common stock investments in
public corporations and are classified as trading securities, which are carried
at their fair value based upon the quoted market prices of those investments.
Accordingly, net realized and unrealized gains and losses on trading securities
are included in the consolidated statements of operations. Net realized gains
and losses are determined on the first-in first-out basis.
The composition of investments at March 31, 1997 and 1998 and June 30, 1998
is as follows:
<TABLE>
<CAPTION>
MARCH 31 JUNE 30
----------------------- ---------
1997 1998 1998
---------- --------- ---------
UNAUDITED
<S> <C> <C> <C>
Certificates of deposit.......... $2,140,994 6,081,632 2,645,943
Marketable securities............ -- 1,082,072 1,053,133
---------- --------- ---------
$2,140,994 7,163,704 3,699,076
========== ========= =========
</TABLE>
Net gains on trading securities of $507,170 for the year ended March 31,
1998 is composed of a net realized gain of $302,825 and unrealized holding gains
of $204,345. Net losses on trading securities of ($29,000) for the months ended
June 30, 1998 is composed of a net unrealized holding loss of ($29,000).
F-40
<PAGE> 159
PT-1 COMMUNICATIONS, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Certificates of deposit at March 31, 1998 mature at varying dates through
January 1999 and bear interest at rates which range from 4.1% to 5.3% at March
31, 1997 and 1998 and June 30, 1998. At March 31, 1997 and 1998 and June 30,
1998, certificates of deposit with a carrying value of $1,472,000, $2,406,000
and $2,406,000, respectively, collateralize standby letters of credit to certain
of the Company's service providers. These letters of credit expire at various
dates through March 20, 1999, have been issued as security against services
provided to the Company and are expected to be renewed.
(4) BUSINESS CONCENTRATIONS
SALES
For the year ended March 31, 1997, prepaid phone card sales to three
distributors represented approximately 10%, 11% and 13% of net prepaid phone
card sales. For the year ended March 31, 1998, prepaid phone card sales to two
distributors represented approximately 18% and 16% of net prepaid phone card
sales.
ACCOUNTS RECEIVABLE
The Company's accounts receivable are primarily due from distributors. Two
distributors individually represented approximately 35% and 15% of the net
accounts receivable balance at March 31, 1997 and one distributor represents
approximately 30% of the net accounts receivable balance at March 31, 1998.
At March 31, 1997, accounts receivable of approximately $585,000 relate to
PT-1 California, an unrelated exclusive sales distribution center. At March 31,
1998, accounts receivable of approximately $2,953,000 and $71,000, respectively,
relate to PT-1 California and PT-1 Ohio, an unrelated exclusive sales
distribution center.
COST OF SERVICES
For the year ended March 31, 1998, one telecommunications service provider
represented approximately 35% of cost of services.
(5) ASSET PURCHASE AND SOFTWARE-LICENSING AGREEMENT
On May 9, 1997, PT-1 entered into an asset purchase agreement with
Interactive Telephone Company ("Interactive") and Joseph Pannullo ("Pannullo"),
the sole director and stockholder of Interactive, for $600,000 for computer
hardware and other assets. Interactive is in the business of providing
long-distance telecommunications services to issuers of prepaid debit phone
cards.
On May 9, 1997, PT-1 entered into a three-year employment agreement with
Pannullo. In connection with this agreement, the Company granted Pannullo an
option to purchase 1,048,600 shares of stock at an aggregate option price of
$0.01. Pannullo exercised his option on May 20, 1997 and the Company has
reflected compensation expense of $1,000,000, the fair market value of the
option for the year ended March 31, 1998. Pursuant to the agreement, in the
event that Mr. Pannullo's employment is terminated for cause or as a result of a
voluntary termination (each as defined), in either case within one year of May
9, 1997, the Company has the right to repurchase the shares for their fair
market value.
On May 9, 1997, PT-1 entered into a software license agreement with Godot
Soft, LLC ("Godot"), which is owned by Pannullo, and Pannullo for a license fee
of $1,000,000. The license fee was paid with $350,000 in cash and the delivery
of a $650,000 noninterest-bearing promissory note payable in ten equal monthly
installments commencing 90 days following the effective date. In addition, the
software license agreement provides that if (i) the Company engages in a
specified transfer of control transaction and (ii) Sam Tawfik ("Tawfik"), the
Company's Chief Executive Officer, and his affiliates and family members receive
at least $100 million in cash or publicly held securities as a result of such
transaction, the Company must pay a fee of $2.0 million to Godot. Such amount
would become payable if the merger transaction described in note 12 closes.
F-41
<PAGE> 160
PT-1 COMMUNICATIONS, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(6) RELATED PARTY TRANSACTIONS
During the year ended March 31, 1997, the Company made loans to two of its
officers and a former employee aggregating $591,542, of which $202,820 remains
outstanding at March 31, 1998. These loans bear interest at rates which range
from 8% to 8.5% and have no specified repayment terms. During the three months
ended June 30, 1998. PT-1 made an additional $350,000 loan to an officer. The
note is secured by 70,000 shares of PT-1 common stock.
Through March 31, 1996, PT-1 sold phone cards to a corporation controlled
by the Company's then President and a director on terms identical to those
extended to the company's customers. For the period from April 21, 1995
(inception) to March 31, 1996, these purchases aggregated approximately
$1,050,000.
(7) TAXES
The components of income tax expense (benefit) for the year ended March 31,
1998 are presented in the following table:
<TABLE>
<S> <C>
Current:
Federal............................................... $ 6,283,840
State................................................. 921,939
-----------
Total current................................. 7,205,779
Deferred:
Federal............................................... (1,787,050)
State................................................. (268,729)
-----------
Total deferred................................ (2,055,779)
-----------
Total......................................... $ 5,150,000
===========
</TABLE>
The statutory Federal income tax rate for the period ended March 31, 1996
and years ended March 31, 1997 and 1998 was 35% and the effective income tax
rate was 0%, 0% and 30.78%, respectively.
The following table shows the principal reasons for the difference between
the effective tax rate and the statutory federal income tax rate for the year
ended March 31,:
<TABLE>
<CAPTION>
1996 1997 1998
-------------------- -------------------- -------------------
AMOUNT % AMOUNT % AMOUNT %
----------- ------ ----------- ------ ----------- -----
<S> <C> <C> <C> <C> <C> <C>
Expected federal income (benefit)
tax at statutory rate........... $(1,018,493) 35.00% $(2,842,020) 35.00% $ 5,855,838 35.00%
State income taxes, net of federal
benefit......................... -- -- -- -- 424,587 2.54%
Change in valuation allowance..... 1,011,500 (34.76%) 278,500 (3.43%) (1,290,000) (7.71%)
Stock based compensation not
deductible for tax purposes..... -- -- 2,555,000 (31.47%) -- --
Other............................. 6,993 (0.24%) 8,520 (0.10%) 159,575 0.95%
----------- ------ ----------- ------ ----------- -----
$ 0 0.00% $ 0 0.00% $ 5,150,000 30.78%
=========== ====== =========== ====== =========== =====
</TABLE>
F-42
<PAGE> 161
PT-1 COMMUNICATIONS, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets at March 31, 1997 and 1998 are described
below:
<TABLE>
<CAPTION>
1997 1998
------------------------- -----------------------
CURRENT NONCURRENT CURRENT NONCURRENT
----------- ---------- --------- ----------
<S> <C> <C> <C> <C>
Net operating loss carryforwards.... $ 1,032,000 -- -- --
Stock-based compensation expense.... -- -- 605,739 --
Accounts receivable primarily due to
allowance for doubtful accounts... 136,000 -- 182,744 --
Accrued expenses.................... 183,000 -- 1,794,896 --
Net unrealized gain on marketable
securities........................ -- -- (78,162) --
Depreciation........................ -- (61,000) -- (450,000)
----------- ------- --------- --------
Total deferred tax asset
(liability)............. 1,351,000 (61,000) 2,505,217 (450,000)
Less valuation allowance............ (1,290,000) -- -- --
----------- ------- --------- --------
Net deferred tax assets
(liabilities)........... $ 61,000 (61,000) 2,505,217 (450,000)
=========== ======= ========= ========
</TABLE>
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Management considers
projected future taxable income and tax planning in making these assessments.
During the years ended March 31, 1997 and 1998, the valuation allowance
increased by $278,500 and decreased by $1,290,000, respectively.
The Company currently believes that the realization of its deferred tax
assets is more likely than not based on the generation of net income during the
period and the Company's projection of future taxable income. For the year ended
March 31, 1998, the Company utilized the prior period net operating loss
carryforwards of $2,950,000, providing a tax benefit of $1.1 million to the
Company's consolidated statements of operations.
(8) CAPITAL TRANSACTIONS
The Company was initially capitalized with the issuance of 20 shares of
common stock for a capital contribution of $2,600. As of April 6, 1996 and
December 30, 1997, PT-1's Board of Directors declared stock splits of
4.35-for-one and 700,000-for-one, respectively (collectively, the "Stock
Split"). Retroactive treatment has been made in the consolidated financial
statements to reflect the stock split.
TRANSACTION WITH THOMAS HICKEY
On February 25, 1997, litigation related to disputed ownership interests
and control of the Company was commenced against the Company, Thomas Hickey
(Hickey), a former director and executive officer of the Company, and Sam Tawfik
(Tawfik), the Company's Chief Executive Officer. On March 20, 1997, a second
action was commenced asserting similar claims against the same defendants. Such
litigation involved disputed equity issuance commitments in connection with the
establishment of the Company and employment of key executives. On March 26,
1997, a settlement agreement among the parties was reached which included the
dismissal of litigation, execution of equity issuance commitments (as described
below), release of claims, the resignation of Hickey as an executive officer and
employee of the Company and the redemption of 25,052,632 shares of common stock
of the Company for $15 million which was satisfied by a cash payment of $5
million and the issuance of a note in the principal amount of $10 million (the
Note).
F-43
<PAGE> 162
PT-1 COMMUNICATIONS, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In connection with the March 27, 1997 settlement agreement described above,
two officers received shares of the Company for nominal consideration in
accordance with commitments made in July 1995 and March 1996, the dates they
joined the Company. Certain of the shares were newly issued shares and certain
shares were transferred from Hickey to the two officers. In accordance with the
provisions of APB Opinion No. 25, the Company has recognized non-cash
compensation expense for the year ended March 31, 1997, of approximately $7.3
million related to all of the shares provided to the two officers. Such value
was determined based upon the value ascribed to the shares redeemed from Hickey
on March 27, 1997.
On November 7, 1997, in connection with the Company's then pending initial
public offering, the Company, Hickey and certain executive officers of the
Company entered into additional agreements pursuant to which Hickey affirmed the
validity of agreements entered into on March 26, 1997, and agreed to an extended
noncompetition agreement for consideration of 483,980 shares of common stock.
Additional releases were obtained for claims relating to Hickey's interest in
the Company and the pending initial public offering. The fair value of the
common stock issued in consideration for the extended noncompetition agreement
was recorded as an intangible asset and is being amortized by use of the
straight-line method over the life of the agreement. Amortization expense of
approximately $396,000 was recorded in connection with this agreement.
The Note accrued interest at a rate of 8% per annum. The Company paid $5
million of the Note on March 25, 1998 in accordance with its terms and must
repay the remaining outstanding principal and all accrued interest on or prior
to March 25, 1999. The Company pledged two-thirds of the shares of common stock
if redeemed from Hickey as collateral for the Note.
STOCK OPTIONS AND WARRANTS
On May 12, 1997 and during June 1997, the Company granted incentive
stock/stock options compensation awards in connection with three employment
agreements. The incentive awards, which vest at specified future dates ranging
from 18 to 36 months from the effective dates of the agreements, are not
dependent upon performance targets and provide for a maximum value of $850,000
in the aggregate payable in stock or stock options of equivalent value. The
Company has recorded compensation expense of $384,269 for the year ended March
31, 1998 in connection with such incentive awards.
On May 26, 1997, the Company granted an option to purchase 1,916,600 shares
of common stock in connection with an employment agreement. The option is
exercisable for $3.57 million, the fair market value at the date of grant. On
October 15, 1997, the optionee exercised the option and obtained a loan for the
exercise price from the Company. The loan is with recourse to the optionee,
noninterest bearing for a period of up to 18 months, bears interest at a market
rate thereafter and matures on the earlier of (i) two years from the date of the
loan, (ii) one year after the closing of the Offering or (iii) upon a sale of
control of the Company.
On June 29, 1997, the Company entered into a service agreement with
Interexchange, Inc. (Interexchange), a debit card service provider. In
connection with the execution of the Interexchange Agreement, the Company
granted warrants from the purchase of shares of Common Stock to certain
principals of Interexchange (collectively, the "Interexchange Warrants"). The
Interexchange Warrants are exercisable for shares of Common Stock with an
aggregate fair market value equal to (i) $1,000,000, at a total exercise price
of $.15 and (ii) $2.0 million, at an aggregate exercise price equal to
$1,000,000 (collectively, the "Warrant Shares"). Interexchange Warrants with
respect to one-third of the Warrant Shares vest and become exercisable upon each
of: (i) the earlier to occur of the closing of the Offering or March 31, 1998,
(ii) January 1, 1999 and (iii) December 1, 1999, in each case if and only if the
Interexchange Agreement has not been terminated on or before such date (other
than as a result of a breach by the Company). The Interexchange Warrants expire
upon the fifth anniversary of their respective vesting dates. In the event of a
change of control, any unvested Interexchange Warrants at such time shall
immediately vest and become exercisable and the fair market value shall be fixed
as of the date of such change of control. In connection with the warrants, the
Company will record compensation expense of approximately $2.0 million, the
difference
F-44
<PAGE> 163
PT-1 COMMUNICATIONS, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
between the exercise price and market value, over the vesting period applicable
to each portion of the grant. The Company has recorded compensation expense of
approximately $1,200,000 for the year ended March 31, 1998, in connection with
the warrants.
On September 30, 1997, the Board of Directors adopted, and the shareholders
of the Company approved, the 1997 Stock Incentive Plan (the "Stock Incentive
Plan"), which provides for the grant to officers, key employees and directors of
the Company and its subsidiaries of both "incentive stock options" within the
meaning of the Internal Revenue Code, and stock options that are nonqualified
for federal income tax purposes. The total number of shares for which options
may be granted pursuant to the Stock Incentive Plan and the maximum number of
shares for which options may be granted pursuant to the Stock Incentive Plan and
the maximum number of shares for which options may be granted to any person is
3,500,000 shares, subject to certain adjustments to reflect changes in the
Company's capitalization.
As of March 31, 1998, options to purchase an aggregate 628,000 shares of
Common Stock were granted under the Stock Incentive Plan and a total of
2,872,000 shares of Common Stock remained available for future grants. The
outstanding options were held by 30 individuals. The Company has recorded
compensation expense of $70,000 for the year ended March 31, 1998 in connection
with such options. Shares subject to options granted under the plan that have
lapsed or terminated may again be subject to options granted under the plan.
The following table summarizes the transactions of the Company's Stock
Incentive Plan for the year ended March 31, 1998:
<TABLE>
<CAPTION>
WEIGHTED
SHARES AVERAGE
SUBJECT TO OPTION PRICE
OPTION PER SHARE
---------- ------------
<S> <C> <C>
Balance at April 1, 1997.................................... -- $ --
Options granted........................................... 3,720,700 3.14
Options exercised......................................... (2,975,200) 1.20
Options canceled.......................................... (117,500) 10.53
---------- ------
Balance at March 31, 1998................................... 628,000 $10.97
========== ======
Options granted........................................... -- --
Options exercised......................................... -- --
Options canceled.......................................... (55,000) 10.73
---------- ------
Balance at June 30, 1998 (unaudited)........................ 573,000 $10.97
========== ======
</TABLE>
The Company did not grant any stock options for the year ended March 31,
1997.
The following table summarizes information about shares subject to options
under the Company's Stock Incentive Plan at June 30, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- -------------------------------------------------------------- ----------------------------
WEIGHTED
WEIGHTED AVERAGE WEIGHTED
NUMBER RANGE OF AVERAGE REMAINING NUMBER AVERAGE
OUTSTANDING EXERCISE PRICE EXERCISE PRICE LIFE IN YEARS EXERCISABLE EXERCISE PRICE
- ----------- --------------- -------------- ------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
553,000 $10.00 - $11.00 $10.86 0.63 207,657 $10.87
20,000 $13.20 - $15.40 $14.30 1.00 -- $ --
------- -------
573,000 $10.00 - $15.40 $10.97 0.64 207,657 $10.87
======= =======
</TABLE>
F-45
<PAGE> 164
PT-1 COMMUNICATIONS, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(9) COMMITMENTS AND CONTINGENCIES
(A) LEASE
At March 31, 1998, the Company was committed under a noncancelable
operating lease for the rental of office space for which it is also obligated to
pay a pro rata portion of increases in real property taxes as additional rent.
The Company's future minimum operating lease payments are as follows:
<TABLE>
<CAPTION>
YEAR ENDING MARCH 31, AMOUNT
--------------------- ----------
<S> <C>
1999.............................................. $1,331,000
2000.............................................. 1,275,000
2001.............................................. 1,260,000
2002.............................................. 1,214,000
2003.............................................. 376,000
Thereafter........................................ 2,050,000
----------
$7,506,000
==========
</TABLE>
Total rent expense for the years ended March 31, 1997 and 1998 was
approximately $76,000 and $788,000, respectively.
(B) TELECOMMUNICATIONS SERVICE AGREEMENTS
The Company has an agreement with a telecommunications company with an
annual usage commitment of $1,500,000. The Company has exceeded the annual usage
commitment since the inception of this agreement.
The Company has minimum volume commitments of approximately 940,000 minutes
per month with eight of its service providers which, if not met, may require the
Company to make payments to these providers. As of March 31, 1998, the Company
anticipates that it will fulfill these commitments.
The Company is committed to paying a minimum monthly service charge of
$500,000 through January 1, 2001 for use of a debit platform switching network.
The Company has disputed carrier cost charges of approximately $3.2 million
with one of its telecommunication providers. The Company believes it will settle
this dispute favorably and at March 31, 1998 has accrued $1.6 million relating
to this dispute.
(C) EMPLOYMENT CONTRACTS
The Company has employment agreements with certain executive officers and
key management personnel, the terms of which expire at various times through
June 2000. Such agreements provide for minimum salary levels, as well as for
incentive bonuses that are payable if specified management goals are attained.
The aggregate commitment for future salaries at March 31, 1998, excluding
bonuses, was approximately $3,047,000. All agreements contain covenants not to
compete.
(D) LETTERS OF CREDIT
At March 31, 1997 and 1998 and June 30, 1998, certificates of deposit with
carrying values of $1,472,000 and $2,406,000 and $2,406,000, respectively,
collateralize standby letters of credit to the Company's major service provider.
These letters of credit have been issued as security against services advanced.
(E) REGULATORY
The Company is subject to regulation by various government agencies and
jurisdictions and believes it is in compliance with all applicable laws and
regulations. However, implementation and interpretation of the
F-46
<PAGE> 165
PT-1 COMMUNICATIONS, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Telecom Act of 1996 (the Act) is ongoing and subject to litigation by various
Federal and state agencies and courts. As a result, the impact of the Act on the
Company is not yet completely determinable and future interpretations and
rulings may impact the financial position and results of operations of the
Company.
The Telecommunications Act (Section 276) mandated that the FCC promulgate
rules to establish a per call compensation plan to ensure that all payphone
providers are fairly compensated for each completed intrastate and interstate
payphone initialed call, including calls on which payphone providers had not
heretofore received compensation. Such calls included those placed to toll free
numbers (800/888) such as operator assisted and prepaid calling card calls, and
calls placed through network access codes. In September 1996, the FCC
promulgated rules to implement Section 276 of the Telecommunications Act which
established a three-phase compensation plan for payphone providers. On July 1,
1997, the D.C. Circuit Court of Appeals vacated significant portions of the
FCC's rules including the per call rate which was found to be arbitrary and
capricious, and remanded the matter to the FCC for reconsideration. On remand,
the FCC in September 1997, established a two-year "default" compensation rate of
$0.284 per payphone-originated toll free or access code call. At the end of the
two year interim period, the per call payphone compensation rate will be the
deregulated market-based local coin rate less $0.066. This amount is payable by
all "switched-based" interexchange carriers (but again may be passed through to
non-facilities-based resellers). The revised FCC's rules became effective on
October 7, 1997, but continue to be subject to regulatory and legal challenges.
In 1998, the Company began incurring certain universal service support
obligation costs resulting from the Federal Communications Commission Universal
Service Order. The Universal Service Order created new universal service support
obligations for telecommunications services for schools and libraries and rural
health care facilities. The Universal Service Order is currently being
challenged.
PT-1 believes that these regulations or other potential changes in the
regulatory environment will not have a material effect on the Company.
(F) LEGAL
On July 31, 1997, the Company was notified by the Federal Trade Commission
(FTC) and the New York Attorney General Office (NYAG) that it was the subject of
an investigation alleging deceptive advertising practices in connection with the
sale of its prepaid telephone cards. The Company has recently been informed that
the NYAG office is no longer pursuing this matter. The Company does not believe
its advertising practices are deceptive and it is currently in discussions with
the FTC offices regarding resolution. Management does not believe that the
outcome, if unfavorable, will have a material adverse effect on the Company's
business, financial condition or results of operations. The Company estimates
that the range it would be obligated to pay is approximately $250,000 to
$300,000. The Company has accrued $250,000 at March 31, 1998 relating to this
claim.
(10) DEBT
SHORT-TERM DEBT
The following table displays the details of debt maturing within one year:
<TABLE>
<CAPTION>
MARCH 31, JUNE 30,
------------------------ -----------
1997 1998 1998
---------- ---------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Borrowings under credit facility....... $ -- $2,760,000 $5,000,000
Current portion of long-term debt...... -- 1,746,001 1,451,027
---------- ---------- ----------
$ -- $4,506,001 $6,451,027
========== ========== ==========
</TABLE>
F-47
<PAGE> 166
PT-1 COMMUNICATIONS, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
On October 8, 1997, the Company entered into a $5.0 million revolving
credit facility and a $5.0 million letter of credit facility with Chase
Manhattan Bank, N.A. (the "Credit Facility"). Borrowings under the Credit
Facility bear interest at a rate equal to either the adjusted London Interbank
Offer Rate plus 2.25%, the prime rate or a fixed rate to be determined pursuant
to the Credit Facility. Borrowings under the Credit Facility are secured by the
Company's equipment and accounts receivable. The Company may borrow up to 75% of
eligible equipment and accounts receivable. The Credit Agreement expires on
September 30, 1998. The amount borrowed on the line of credit was $2,760,000 at
March 31, 1998 and $5,000,000 at June 30, 1998.
LONG-TERM DEBT
In March 1998, the Company entered into a sales and leaseback transaction
for certain of its telecommunications equipment for $10,000,000. No gain or loss
was recognized on this transaction. For accounting purposes, the Company has
treated this transaction as a financing arrangement. Payments including interest
at 8.76%, are due in monthly installments of $206,420, through April 2003.
Depreciation on the telecommunications equipment has been reflected in
accordance with the Company's normal accounting policies. The debt is secured by
the Company's equipment and accounts receivable. The Company is in compliance
with debt covenants as of March 31, 1998.
Maturities of long-term debt outstanding at March 31, 1998 are as follows:
<TABLE>
<CAPTION>
YEAR ENDING MARCH 31, AMOUNT
--------------------- -----------
<S> <C>
1999........................................... $ 1,746,001
2000........................................... 1,826,163
2001........................................... 1,992,717
2002........................................... 2,174,461
2003........................................... 2,260,658
-----------
10,000,000
Less current portion of long-term debt...... 1,746,001
-----------
$ 8,253,999
===========
</TABLE>
(11) DEFERRED OFFERING COSTS
The Company has deferred offering costs of $485,790 relating to its
proposed initial public offering. In connection with the merger transaction
described in note 12 the Company is not pursuing the initial public offering and
such costs will be expensed in the first quarter of fiscal 1999.
(12) TRANSACTIONS WITH STAR TELECOMMUNICATIONS, INC.
In June 1998, PT-1 entered into a Capacity Purchase and Assignment
Agreement with STAR Telecommunications, Inc. (STAR) for $4.5 million. Pursuant
to this agreement PT-1 acquired an indefeasible right of use (IRU) from STAR
under the Capacity Purchase Agreement dated May 12, 1998. Such IRU is included
in property equipment.
On August 17, 1998 PT-1 obtained a loan from STAR for $10 million with a
maturity date of August 17, 1999. The loan accrues interest monthly at 6 3/4%
and PT-1 may defer payment of all interest until the maturity date.
On August 20, 1998, PT-1 entered into an amended and restated agreement and
plan of merger with STAR. The acquisition will be completed through the issuance
of 15 million shares of STAR common stock and the payment of $19.5 million to
PT-1 stockholders. Effective as of September 1, 1998, the merger agreement was
amended by the parties to modify the consideration to be paid to the
stockholders of PT-1 and to provide Star with managerial and operational
authority over PT-1 as of that date.
F-48
<PAGE> 167
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 and for the eight months ended December
31, 1997.................................................. F-51
Report of Independent Accountants for the year ended April
30, 1995.................................................. F-52
Consolidated Financial Statements:
Consolidated Balance Sheets as of April 30, 1996 and 1997
and as of December 31, 1997............................ F-53
Consolidated Statements of Operations for the years ended
April 30, 1995, 1996 and 1997 and for the eight months
ended December 31, 1997................................ F-54
Consolidated Statements of Shareholders' Equity (Deficit)
for the years ended April 30, 1995, 1996 and 1997 and
for the eight months ended December 31, 1997........... F-55
Consolidated Statements of Cash Flows for the years ended
April 30, 1995, 1996 and 1997 and for the eight months
ended December 31, 1997................................ F-56
Notes to Consolidated Financial Statements.................. F-57
</TABLE>
F-49
<PAGE> 168
REPORT OF INDEPENDENT ACCOUNTANTS
May 31, 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 (deficit)
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 at December 31, 1997, and
the results of their operations and their cash flows for the years ended April
30, 1996 and 1997 and for the eight months ended December 31, 1997, 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/ PRICEWATERHOUSECOOPERS LLP
Dallas, Texas
F-50
<PAGE> 169
INDEPENDENT AUDITOR'S REPORT
To the Shareholders
UNIDEX COMMUNICATIONS CORP.
We have audited the consolidated balance sheet of Unidex Communications
Corp. and Subsidiaries as of April 30, 1995, and the consolidated statements of
operations, shareholders' equity and cash flows for the year then ended. 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
financial position of Unidex Communications Corp. and Subsidiaries as of April
30, 1995, and the results of operation and cash flows for the year then ended in
conformity with generally accepted accounting principles, except for the
omission of the disclosure of proforma results of operations relating to a
business acquisition on April 27, 1996. The Company has included the omitted
proforma information in Note 6. 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 financial position of the Unidex
Communications Corp. and Subsidiaries as of April 30, 1995 and the results of
its operations and its cash flows for the year then ended in accordance with
generally accepted accounting principles.
/s/ 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-51
<PAGE> 170
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
AS OF
AS OF APRIL 30, DECEMBER 31,
-------------------------- ------------
1996 1997 1997
----------- ----------- ------------
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents........................ $ 1,073,649 $ 556,366 $ 45,317
Accounts and notes receivable, net (Note 5)...... 2,452,336 3,918,905 3,787,173
Receivable from employee......................... 12,010 -- --
Prepaid expenses and other....................... 140,991 453,247 383,369
----------- ----------- ------------
Total current assets..................... 3,678,986 4,928,518 4,215,859
Property and equipment, net (Note 6)............... 1,369,576 1,947,234 2,038,308
Intangible assets, net (Note 7).................... 5,367,809 6,158,354 6,012,110
Other assets....................................... 170,791 162,067 262,376
----------- ----------- ------------
Total assets............................. $10,587,162 $13,196,173 $ 12,528,653
=========== =========== ============
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Trade accounts payable........................... $ 3,407,351 $ 5,628,664 $ 8,121,197
Other accrued liabilities........................ 220,834 330,640 374,178
Notes and accounts payable to related parties,
net (Note 12)................................. 1,143,650 896,470 3,634,333
Current maturities of long-term obligations (Note
8)............................................ 559,596 689,712 1,306,825
Accrued taxes, other than income taxes........... 388,881 567,352 634,242
----------- ----------- ------------
Total current liabilities................ 5,720,312 8,112,838 14,070,775
----------- ----------- ------------
Long-term obligations (Note 8)..................... 436,700 1,309,792 1,043,803
Long-term obligations to related parties, net (Note
12).............................................. 1,624,586 684,990 --
Commitments and contingencies (Note 13)
Shareholders' equity (deficit):
Common stock, $.01 par value, 100,000,000 shares
authorized; 5,250,340, 6,378,442, and
6,808,594 issued at April 30, 1996 and 1997,
and December 31, 1997, respectively (Notes 2
and 9)........................................ 52,503 63,784 68,086
Additional paid-in capital....................... 9,913,694 11,863,723 12,617,072
Retained deficit................................. (7,160,633) (8,838,954) (15,271,083)
----------- ----------- ------------
Total shareholders' equity (deficit)..... 2,805,564 3,088,553 (2,585,925)
----------- ----------- ------------
Total liabilities and shareholders'
equity (deficit)....................... $10,587,162 $13,196,173 $ 12,528,653
=========== =========== ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-52
<PAGE> 171
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE EIGHT
MONTHS
ENDED
FOR THE YEARS ENDED APRIL 30, DECEMBER 31,
--------------------------------------- -----------------
1995 1996 1997 1997
----------- ----------- ----------- -----------------
<S> <C> <C> <C> <C>
Telecommunications revenues............. $ 2,338,467 $ 8,026,587 $24,012,368 $21,078,166
Cost of revenues........................ 1,917,734 6,029,796 18,455,095 16,888,577
----------- ----------- ----------- -----------
Gross profit....................... 420,733 1,996,791 5,557,273 4,189,589
----------- ----------- ----------- -----------
Operating expenses:
Selling, general and administrative... 1,941,624 2,675,265 5,154,901 6,161,937
Provision for doubtful accounts....... 74,662 228,827 693,164 3,144,128
Depreciation and amortization......... 273,053 583,530 900,545 698,106
----------- ----------- ----------- -----------
Total operating expenses........... 2,289,339 3,487,622 6,748,610 10,004,171
----------- ----------- ----------- -----------
Loss from operations before other
expenses.............................. (1,868,606) (1,490,831) (1,191,337) (5,814,582)
Other expenses:
Interest expense, net................. (85,431) (107,474) (634,103) (617,547)
Loss on sale of assets................ (118,680) -- -- --
Loss on impairment of assets.......... -- (63,997) -- --
----------- ----------- ----------- -----------
Total other expenses............... (204,111) (171,471) (634,103) (617,547)
----------- ----------- ----------- -----------
Loss before income tax benefit and
extraordinary gain.................... (2,072,717) (1,662,302) (1,825,440) (6,432,129)
----------- ----------- ----------- -----------
Income tax benefit (Note 10)............ -- -- 50,000 --
----------- ----------- ----------- -----------
Loss before extraordinary gain.......... (2,072,717) (1,662,302) (1,775,440) (6,432,129)
----------- ----------- ----------- -----------
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) (6,432,129)
=========== =========== =========== ===========
Loss per weighted average common shares
outstanding (basic and diluted):
Loss before extraordinary gain on debt
restructuring...................... $ (0.92) $ (0.45) $ (0.33) $ (0.98)
Extraordinary gain.................... -- -- 0.02 --
----------- ----------- ----------- -----------
Net loss per share.................... $ (0.92) $ (0.45) $ (0.31) $ (0.98)
=========== =========== =========== ===========
Weighted average number of common
shares outstanding (basic and
diluted)........................... 2,252,953 3,706,993 5,359,156 6,546,499
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-53
<PAGE> 172
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED APRIL 30, 1995, 1996 AND 1997
AND FOR THE EIGHT MONTHS ENDED DECEMBER 31, 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
--------- ------- ----------- ------------ -----------
Net loss............................ -- -- -- (6,432,129) (6,432,129)
Issuance of common stock for:
Private placements................ 337,152 3,372 586,644 -- 590,016
Exercise of warrants.............. 68,000 680 117,955 -- 118,635
Exercise of stock options......... 25,000 250 48,750 -- 49,000
--------- ------- ----------- ------------ -----------
Balance at December 31, 1997........ 6,808,594 $68,086 $12,617,072 $(15,271,083) $(2,585,925)
========= ======= =========== ============ ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-54
<PAGE> 173
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE EIGHT
MONTHS
FOR THE YEARS ENDED APRIL 30, ENDED
--------------------------------------- DECEMBER 31,
1995 1996 1997 1997
----------- ----------- ----------- -------------
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss.................................. $(2,072,717) $(1,662,302) $(1,678,321) $(6,432,129)
Adjustments to reconcile net loss to net
cash used by operating activities:
Depreciation and amortization.......... 276,026 583,530 900,545 698,106
Gain on debt restructuring............. -- -- (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............................. -- -- 263,307 137,468
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) 76,112
Prepaid expenses and other assets.... 47,751 152,385 (631,734) 27,529
Increase (decrease), net of effect of
acquisition:
Accounts and notes payable and
accrued expenses.................. 29,143 (705,416) 1,666,637 3,146,311
----------- ----------- ----------- -----------
Net cash used in operating
activities...................... (1,819,338) (1,345,284) (3,324,473) (2,346,603)
----------- ----------- ----------- -----------
Cash flows from investing activities:
Additions to property and equipment....... (193,745) (186,439) (673,714) (472,802)
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 52,717
----------- ----------- ----------- -----------
Net cash used in investing
activities...................... (238,617) (658,044) (947,962) (420,085)
----------- ----------- ----------- -----------
Cash flows from financing activities:
Proceeds from issuance of common stock.... 2,132,920 3,236,725 1,350,309 757,652
Proceeds from factoring of trade
receivables, net....................... -- -- 3,562,230 --
Proceeds from short-term loan............. -- -- -- 2,500,000
Principal payments on obligations......... (303,080) (280,825) (1,157,387) (1,002,013)
Advances from shareholders................ 233,329 -- -- --
----------- ----------- ----------- -----------
Net cash provided by financing
activities...................... 2,063,169 2,955,900 3,755,152 2,255,639
----------- ----------- ----------- -----------
Increase (decrease) in cash and cash
equivalents............................... 5,214 952,572 (517,283) (511,049)
Cash and cash equivalents at beginning of
period.................................... 115,863 121,077 1,073,649 556,366
----------- ----------- ----------- -----------
Cash and cash equivalents at end of
period.................................... $ 121,077 $ 1,073,649 $ 556,366 $ 45,317
=========== =========== =========== ===========
Supplemental disclosure of cash flow
information:
Interest paid............................. $ 93,105 $ 113,815 $ 719,758 $ 581,252
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-55
<PAGE> 174
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 Columbia. 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, United Digital Network of Texas, Inc. (UDN),
Advanced Management Services, Inc. (AMS) and CTN-Custom Telecommunications
Network of Arizona, Inc. (CTN). In September 1997, the Company formed UDN with
the merger of Answer-Net, Inc. (ANI) and Digital Network, Inc. (DNI).
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
Fiscal Year
Effective January 1, 1998, the Company changed its fiscal year ended April
30 to a fiscal year ended December 31.
Basis of Presentation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries UDN, 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.
Cash and Cash Equivalents
Cash and cash equivalents represent cash and short-term, highly liquid
investments with original maturities three months or less.
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.
F-56
<PAGE> 175
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Revenue Recognition
The Company recognizes revenue from its direct dial, prepaid calling card,
and travel card long distance services as such services are performed.
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-57
<PAGE> 176
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (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 and for the eight months ended December 31,
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.
Income Taxes
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.
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.
Effective January 1, 1998, Company adopted SFAS 128 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.
In June 1997, the FASB issued Financial Statement of Accounting Standards
No. 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.
F-58
<PAGE> 177
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
On June 15, 1998, FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
133"). SFAS 133 is effective for all fiscal quarters of all fiscal years
beginning after June 15, 1999. SFAS 133 requires that all derivative instruments
be recorded on the balance sheet at their fair value. Changes in the fair value
of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as part of
a hedge transaction and, if it is, the type of hedge transaction. Management of
the Company anticipates that, due to its limited use of derivative instruments,
the adoption of SFAS 133 will not have a significant effect on the Company's
results of operations or its 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 assets acquired......................................... 148,424
Goodwill.................................................... 679,241
-----------
Purchase price.............................................. $ 827,665
===========
</TABLE>
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.
F-59
<PAGE> 178
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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.
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
$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.
F-60
<PAGE> 179
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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,
---------------------------------------
1995 1996 1997
----------- ----------- -----------
<S> <C> <C> <C>
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>
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,
$489,802, and $225,108 during the years ended April 30, 1995, 1996 and 1997, and
the eight months ended December 31, 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-61
<PAGE> 180
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 EIGHT
MONTHS
ENDED
FOR THE YEARS ENDED APRIL 30, DECEMBER 31,
----------------------------- -------------
1996 1997 1997
------------ ------------- -------------
<S> <C> <C> <C>
Trade receivables:
Billed....................................... $1,262,617 $ 3,420,941 $ 6,018,752
Unbilled..................................... 1,337,640 3,213,712 1,613,583
Receivable from Freshstart Communications...... -- 614,858 430,608
Credit reserve due from factor................. -- 330,695 293,297
Other.......................................... 74,790 332,468 117,448
---------- ----------- -----------
Total notes and unfactored accounts
receivable................................... 2,675,047 7,912,674 8,473,688
Total receivables assigned to factor........... -- (3,562,230) (2,079,193)
---------- ----------- -----------
Total notes and accounts receivables........... 2,675,047 4,350,444 6,394,495
Allowance for doubtful accounts................ (222,711) (431,539) (2,607,322)
---------- ----------- -----------
Total accounts and notes receivable, net....... $2,452,336 $ 3,918,905 3,787,173
========== =========== ===========
</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, 1996, 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 the eight month period ended December 31, 1997, the Company received
$16,058,301 in proceeds from the factoring of trade receivables.
During the eight months ended December 31, 1997, bad debt expense of $3.0
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 customers'
bankruptcies, and the write-off of a $1.3 million receivable resulting from
customer fraud.
F-62
<PAGE> 181
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, DECEMBER 31,
------------------------- ------------
1996 1997 1997 LIFE
----------- ----------- ------------ ----
<S> <C> <C> <C> <C>
Communications equipment............... $ 3,281,643 $ 4,153,300 $ 4,353,018 2-8 years
Office equipment....................... 321,250 569,705 790,897 5 years
Leasehold improvements................. 20,053 43,894 56,988 5 years
----------- ----------- -----------
3,622,946 4,766,899 5,200,903
Accumulated depreciation............... (2,253,370) (2,819,665) (3,162,595)
----------- ----------- -----------
Total property and equipment, net...... $ 1,369,576 $ 1,947,234 $ 2,038,308
=========== =========== ===========
</TABLE>
Total depreciation expense, including amortization of equipment under
capital leases, charged to operations for the years ended April 30, 1995, 1996
and 1997 and for the eight months ended December 31, 1997, was $245,768,
$436,688, $498,701, and $401,750 respectively.
7. INTANGIBLE ASSETS
Intangible assets consist of:
<TABLE>
<CAPTION>
APRIL 30, DECEMBER 31,
----------------------- ------------
1996 1997 1997 LIFE
---------- ---------- ------------ ----
<S> <C> <C> <C> <C>
Goodwill.................................. $4,193,143 $5,094,387 $5,244,497 25 years
Customer lists............................ 1,316,832 1,606,832 1,579,307 7 years
---------- ---------- ----------
5,509,975 6,701,219 6,823,804
Accumulated amortization.................. (142,166) (542,865) (811,694)
---------- ---------- ----------
Total intangible assets, net.............. $5,367,809 $6,158,354 $6,012,110
========== ========== ==========
</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).
F-63
<PAGE> 182
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. LONG-TERM OBLIGATIONS
Long-term obligations consist of:
<TABLE>
<CAPTION>
APRIL 30, DECEMBER 31,
--------------------- ------------
1996 1997 1997
-------- ---------- ------------
<S> <C> <C> <C>
Convertible debenture with interest of 7% per annum
due January 1999. Amounts contingent on certain
factors discussed in Note 3....................... $ -- $ 500,000 $ 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........................................... -- 463,581 307,553
Repayable in monthly installments of $7,395
including interest at 16.9% per annum. Final
payment due November 1998...................... -- 116,828 68,520
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 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 -- --
Repayable monthly in amounts of $72,728 plus
interest at 9.5% per annum. Final payment due
July 1998...................................... -- -- 543,351
Capital lease obligations......................... 804,538 877,997 890,106
-------- ---------- ----------
Total long-term obligations......................... 996,296 1,999,504 2,350,628
Less current maturities:
Debt.............................................. 191,758 387,322 935,911
Capital lease obligations......................... 367,838 302,390 370,914
-------- ---------- ----------
Long-term portion................................... $436,700 $1,309,792 $1,043,803
======== ========== ==========
</TABLE>
Principal repayments of long-term obligations are due approximately as
follows:
<TABLE>
<CAPTION>
YEARS ENDING
DECEMBER 31,
------------
<S> <C>
1998.................................................... $1,306,825
1999.................................................... 903,251
2000.................................................... 92,585
2001.................................................... 46,104
2002.................................................... 1,863
----------
Total long-term obligations............................. $2,350,628
==========
</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-64
<PAGE> 183
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. Accordingly, the Company does not recognize compensation cost for
options issued except for option grants with exercise prices below the fair
value of the stock on the date of grant. Had compensation cost for the Company's
stock option issuances 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
and for the eight months ended December 31, 1997.
<TABLE>
<CAPTION>
EIGHT
MONTHS
ENDED
YEARS ENDED APRIL 30, DECEMBER 31,
--------------------------------------- ------------
1995 1996 1997 1997
----------- ----------- ----------- ------------
<S> <C> <C> <C> <C>
Net loss per share (basic and diluted)
As reported............................... $(2,072,717) $(1,662,302) $(1,678,321) $(6,432,129)
Pro forma................................. $(2,113,190) $(2,150,441) $(1,983,310) $(6,520,477)
Net loss per share (basic and diluted)
As reported............................... $ (.92) $ (.45) $ (.31) $ (.98)
Pro forma................................. $ (.94) $ (.58) $ (.37) $ (1.00)
</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
and for the eight months ended December 31, 1997.
<TABLE>
<CAPTION>
EIGHT
MONTHS
ENDED
YEARS ENDED APRIL 30, DECEMBER 31,
--------------------------------- ------------
1995 1996 1997 1997
--------- --------- --------- ------------
<S> <C> <C> <C> <C>
Dividend yield...................................... -- -- -- --
Expected volatility................................. 55.00% 53.54% 48.45% 50.00%
Risk free rate of return............................ 7.60% 5.91% 6.22% 6.23%
Expected life....................................... 2.5 years 3.5 years 3.5 years 3.5 years
</TABLE>
The Company has periodically granted nonqualified stock options to
officers, directors and key employees during the years ended April 30, 1995,
1996, and 1997 and for the eight months ended December 31, 1997. These options
are subject to varying vesting terms, the maximum of which is two years and
expire after various periods after the date of grant, the maximum of which is
five years.
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. Vesting of these options is subject to the achievement of certain
performance targets. Outstanding stock options to officers, directors, key
employees, and others entitle the holders to purchase 403,000, 386,875, 438,125,
and 560,517 common shares at April 30, 1995, 1996, and 1997 and
F-65
<PAGE> 184
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31, 1997, respectively. The weighted average exercise prices of these
options are $1.02, $2.79, $2.65, and $2.61 (Canadian), respectively.
Additional information regarding options granted and outstanding is
summarized below:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE WEIGHTED AVERAGE
OPTION PRICE FAIR VALUE
SHARES (CANADIAN) (CANADIAN)
-------- ---------------- ----------------
<S> <C> <C> <C>
Outstanding at April 30, 1994................ 153,250 $4.49
Granted.................................... 61,250 $2.73 $0.81
Canceled/Expired........................... (71,250) $3.68
--------
Outstanding at April 30, 1995................ 143,250 $4.14
Granted.................................... 386,250 $2.74 $1.26
Canceled/Expired........................... (118,250) $4.34
--------
Outstanding at April 30, 1996................ 411,250 $2.77
Granted.................................... 296,250 $2.49 $1.03
Canceled/Expired........................... (101,875) $2.75
--------
Outstanding at April 30, 1997................ 605,625 $2.64
Granted.................................... 76,250 $2.50 $1.16
Canceled/Expired........................... (25,000) $2.28
Exercised.................................. (25,000) $2.80
--------
Outstanding at December 31, 1997............. 631,875 $2.59
</TABLE>
The following table summarizes information about the fixed-price stock
options outstanding at December 31, 1997.
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------------- ------------------------------
RANGE OF WEIGHTED-AVERAGE WEIGHTED-AVERAGE SHARES WEIGHTED-AVERAGE
EXERCISE SHARES REMAINING EXERCISE EXERCISABLE EXERCISE
PRICES OUTSTANDING CONTRACTUAL PRICE AT PRICE
(CANADIAN) AT 12/31/97 LIFE (CANADIAN) 12/31/97 (CANADIAN)
---------- ----------- ------------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
$2.22-$2.92 631,875 3.08 years $2.59 560,517 $2.61
</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, 361,125 and
112,394 common shares during the years ended April 30, 1995, 1996 and 1997 and
at December 31, 1997, respectively. Total outstanding warrants entitle the
holders to purchase up to 1,475,792, 1,551,949, 1,757,222 and 1,767,941 shares
as of April 30, 1995, 1996 and 1997 and as of December 31, 1997, respectively,
at prices ranging from $2.00 to $6.00, $2.00 to $4.40, $2.22 to $4.00 and $2.22
to $4.00 (Canadian) per share are exercisable at any time, and expire on various
dates through October 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
expired in March 1998.
F-66
<PAGE> 185
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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
December 31, 1997. In December 1998, any shares not released from escrow will be
canceled.
10. INCOME TAXES
The components of the deferred taxes were as follows:
<TABLE>
<CAPTION>
APRIL 30, DECEMBER 31,
-------------------------- ------------
1996 1997 1997
----------- ----------- ------------
<S> <C> <C> <C>
Deferred tax assets:
Allowance for doubtful accounts... $ 76,000 $ 158,057 $ 886,489
Depreciation...................... 23,000 92,943 63,338
Net operating loss
carryforwards.................. 1,669,000 1,933,553 3,318,301
----------- ----------- -----------
Gross deferred tax asset.......... 1,768,000 2,184,553 4,268,128
Deferred tax liability:
Basis difference arising from
purchase accounting............ 279,000 416,433 368,833
----------- ----------- -----------
Gross deferred tax liability...... 279,000 416,433 368,833
----------- ----------- -----------
Valuation allowance................. (1,489,000) (1,768,120) (3,899,295)
----------- ----------- -----------
Net deferred tax asset.............. $ -- $ -- $ --
=========== =========== ===========
</TABLE>
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 EIGHT
MONTHS ENDED
FOR THE YEARS ENDED APRIL 30, DECEMBER 31,
--------------------------------- -------------
1995 1996 1997 1997
--------- --------- --------- -------------
<S> <C> <C> <C> <C>
Income tax benefit at federal statutory
rate.................................. $(705,000) $(565,000) $(570,629) $(2,186,958)
Operating losses not benefited.......... 750,000 407,000 264,319 1,321,373
Nondeductible amortization arising from
purchase accounting................... -- 57,000 70,693 55,784
Change in valuation reserve and other... (45,000) 101,000 235,617 809,801
--------- --------- --------- -----------
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 and at December 31, 1997, the
Company had net operating loss carryforwards of approximately $4,909,511,
$5,686,922 and $9,759,709, 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.
F-67
<PAGE> 186
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. LEASES
The Company leases certain office facilities and equipment under capital
leases and noncancellable operating leases expiring through January 2002. 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 DECEMBER 31, LEASES LEASES
------------------------- ---------- ---------
<S> <C> <C>
1998........................................................ $ 445,225 $268,954
1999........................................................ 426,498 199,449
2000........................................................ 107,132 131,307
2001........................................................ 49,302 --
2002........................................................ 1,956 --
---------- --------
Total minimum lease payments................................ 1,030,113 $599,710
========
Amounts representing interest............................... (140,007) --
----------
Present value of net minimum lease payments................. 890,106
Current portion............................................. (370,914)
----------
Long-term capitalized lease obligations..................... $ 519,192
==========
</TABLE>
Assets recorded under capital leases are included in property and equipment
as follows:
<TABLE>
<CAPTION>
APRIL 30, DECEMBER 31,
------------------------ ------------
1996 1997 1997
---------- ---------- ------------
<S> <C> <C> <C>
Communications equipment....................... $ 948,733 $1,322,695 $1,382,314
Office equipment............................... 64,106 53,432 218,920
---------- ---------- ----------
1,012,839 1,376,127 1,601,234
Accumulated amortization....................... (202,852) (497,816) (616,497)
---------- ---------- ----------
$ 809,987 $ 878,311 $ 984,737
========== ========== ==========
</TABLE>
The total rent expense incurred during the years ended April 30, 1995, 1996
and 1997 and for the eight months ended December 31, 1997 was $126,660,
$186,470, $300,662, and $212,206, 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 the eight months
ended December 31, 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.
F-68
<PAGE> 187
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. RELATED PARTY TRANSACTIONS
The Company has the following obligations to related parties:
<TABLE>
<CAPTION>
APRIL 30, DECEMBER 31,
------------------------ ------------
1996 1997 1997
---------- ---------- ------------
<S> <C> <C> <C>
Obligations to shareholders:
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................................ 750,000 750,000 750,000
Notes payable
Repayable in four installments of $250,000
from June 1997 to June 1998, with interest
imputed at 11% (Amount contingent on
certain factors discussed in Note 3)...... 1,000,000 725,341 439,667
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 1,189,667
Obligation to STAR Telecommunications, Inc.:
Includes interest at Prime Rate plus 1%, paid
quarterly beginning February 1998, on
outstanding principal. Principal repayment
terms contingent upon approval of Merger
(Note 14)................................. -- -- 2,500,000
---------- ---------- ----------
-- -- 2,500,000
Less: Discount on convertible debentures and
note payable imputed at 11%.................. (456,109) (192,801) (55,334)
---------- ---------- ----------
Total notes payable to related parties......... 2,768,236 1,581,460 3,634,333
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 3,634,333
---------- ---------- ----------
$1,624,586 $ 684,990 --
========== ========== ==========
</TABLE>
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
F-69
<PAGE> 188
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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.
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,
$8,801,941 and $7,555,214 for the years ended April 30, 1996 and 1997 and the
eight months ended December 31, 1997. The aggregate amount of minimum purchases
of network usage under these various agreements are $7,700,000 and $3,000,000
for the years ended December 31, 1998 and 1999, 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.
14. FINANCING OF OPERATIONS
At December 31, 1997, the Company's current liabilities exceeded its
current assets by $9,854,916 and the Company was experiencing losses and cash
flow deficits from operations. The financial stability of the Company depends on
its ability to raise additional capital until operations reach a profitable
level.
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. In November 1997, in connection with the changes, STAR and the
Company executed a promissory note in the amount of $2.5 million to fund the
Company's working capital needs.
15. SUBSEQUENT EVENTS
In January 1998, STAR and the Company amended the Merger and executed an
additional promissory note in the amount of $2.0 million to fund the Company's
working capital needs.
In January 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-70
<PAGE> 189
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Consolidated Financial Statements (Unaudited):
Consolidated Balance Sheet as of June 30, 1998............ F-73
Consolidated Statements of Operations for the six months
ended June 30, 1997 and
June 30, 1998.......................................... F-74
Consolidated Statement of Shareholders' Deficit as of June
30, 1998............................................... F-75
Consolidated Statements of Cash Flows for the six months
ended June 30, 1997 and
June 30, 1998.......................................... F-76
Notes to Unaudited Consolidated Financial Statements........ F-77
</TABLE>
F-71
<PAGE> 190
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
JUNE 30,
1998
------------
(UNAUDITED)
<S> <C>
Current assets:
Cash and cash equivalents................................. $ 658,276
Accounts and notes receivable, net of allowance of
$473,847............................................... 6,152,560
Prepaid expenses and other................................ 279,731
------------
Total current assets.............................. 7,090,567
------------
Property and equipment, net of accumulated depreciation of
$3,492,639................................................ 1,978,992
Intangible assets, net of accumulated amortization of
$1,033,200................................................ 5,653,037
Other assets................................................ 137,193
------------
Total assets...................................... $ 14,859,789
============
Current liabilities:
Trade accounts payable.................................... $ 9,434,113
Other accrued liabilities................................. 526,538
Advance payment from customer............................. 1,200,000
Notes and accounts payable to related parties, net........ 550,000
Note payable to STAR Telecommunications, Inc.............. 4,500,000
Current maturities of long-term obligations............... 1,121,410
Accrued taxes, other than income taxes.................... 779,871
------------
Total current liabilities......................... 18,111,932
------------
Long-term obligations....................................... 344,730
Shareholders' equity (deficit):
Common stock, $.01 par value, 100,000,000 shares
authorized; 7,054,844 issued at June 30, 1998.......... 70,548
Additional paid-in capital................................ 13,006,564
Retained deficit.......................................... (16,673,985)
------------
Total shareholders' deficit....................... (3,596,873)
------------
Total liabilities and shareholders' deficit....... $ 14,859,789
============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-72
<PAGE> 191
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED
JUNE 30,
--------------------------
1997 1998
----------- -----------
(UNAUDITED)
<S> <C> <C>
Telecommunications revenues................................. $14,504,007 $17,321,913
Cost of revenues............................................ 11,076,384 13,342,815
----------- -----------
Gross profit.............................................. 3,427,623 3,979,098
----------- -----------
Operating expenses:
Selling, general and administrative....................... 3,416,688 3,927,382
Provision for doubtful accounts........................... 693,303 239,853
Depreciation and amortization............................. 472,829 551,547
----------- -----------
Total operating expenses............................... 4,582,820 4,718,782
----------- -----------
Loss from operations before other expenses.................. (1,155,197) (739,684)
Other expenses:
Interest expense, net..................................... (439,870) (495,526)
Other..................................................... -- (167,692)
----------- -----------
Total other expenses................................... (439,870) (663,218)
----------- -----------
Loss before income tax benefit and extraordinary gain....... (1,595,067) (1,402,902)
Income tax benefit.......................................... 26,812 --
----------- -----------
Loss before extraordinary gain............................ (1,568,255) (1,402,902)
----------- -----------
Extraordinary gain on debt restructuring (net of income
taxes of $26,812)......................................... 52,049 --
----------- -----------
Net loss.................................................... $(1,516,206) $(1,402,902)
=========== ===========
Loss per weighted average common shares outstanding (basic
and diluted):
Loss before extraordinary gain on debt restructuring...... $ (.29) $ (.20)
Extraordinary gain........................................ .01 --
----------- -----------
Net loss per share........................................ $ (.28) $ (.20)
=========== ===========
Weighted average number of common shares outstanding
(basic and diluted).................................... 5,359,156 6,955,507
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-73
<PAGE> 192
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
CONSOLIDATED STATEMENT OF SHAREHOLDERS' DEFICIT
<TABLE>
<CAPTION>
ADDITIONAL
PAID-IN RETAINED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
--------- ------- ----------- ------------ -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Balance at December 31,
1997......................... 6,808,594 $68,086 $12,617,072 $(15,271,083) $(2,585,925)
Net loss....................... -- -- -- (1,402,902) (1,402,902)
Issuance of common stock for:
Exercise of options.......... 75,000 750 117,203 -- 117,953
Exercise of warrants......... 171,250 1,712 272,289 -- 274,001
--------- ------- ----------- ------------ -----------
Balance at June 30, 1998....... 7,054,844 $70,548 $13,006,564 $(16,673,985) $(3,596,873)
========= ======= =========== ============ ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-74
<PAGE> 193
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
ENDED JUNE 30,
--------------------------
1997 1998
----------- -----------
(UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $(1,516,206) $(1,402,902)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization.......................... 472,829 551,547
Extraordinary gain on debt restructuring............... (78,861) --
Interest amortization of note discounts................ 121,262 55,334
Other, net............................................. 14,749 6,838
(Increase) decrease, net of effects of acquisitions:
Accounts and notes receivable.......................... (1,116,716) (2,323,424)
Prepaid expenses and other assets...................... (21,628) 148,681
Increase, net of effects of acquisitions:
Accounts and notes payable and accrued expenses........ 1,903,199 2,267,555
----------- -----------
Net cash used in operating activities............. (221,372) (696,371)
----------- -----------
Cash flows from investing activities:
Additions to property and equipment....................... (74,920) (139,995)
Purchase of CTN........................................... (350,000) --
Proceeds from notes....................................... 36,681 38,178
----------- -----------
Net cash used in investing activities............. (388,239) (101,817)
Cash flows from financing activities:
Proceeds from issuance of common stock.................... 1,350,310 391,953
Proceeds from issuance of short-term debt................. -- 2,000,000
Principal payments on obligations......................... (1,005,119) (980,805)
----------- -----------
Net cash provided by financing activities......... 345,191 1,411,148
----------- -----------
(Decrease) increase in cash................................. (264,420) 612,960
Cash at beginning of period................................. 608,141 45,316
----------- -----------
Cash at end of period....................................... $ 343,721 $ 658,276
=========== ===========
Supplemental disclosure of cash flow information:
Interest paid............................................. $ 456,289 $ 323,632
=========== ===========
</TABLE>
The accompanying notes are integral part of these consolidated financial
statements.
F-75
<PAGE> 194
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO UNAUDITED 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).
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 June 30,
1998, the Company's current liabilities exceeded its current assets by
$11,021,665. 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.
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 June 30, 1997 and 1998 and for
the six 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 eight months ended December
31, 1997.
Cash and cash equivalents
Cash and cash equivalents represent cash and short-term, highly liquid
investments with original maturities three months or less.
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 six month periods ended June 30, 1997 and 1998.
New Accounting Standards
On June 15, 1998, the FASB issued Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" (SFAS 133). SFAS 133 is effective for all fiscal quarters of all
fiscal years beginning after June 15, 1999. SFAS 133 requires that all
derivative instruments be recorded on the balance sheet at their fair value.
Changes in the fair value of derivatives are recorded each period in current
earnings or other comprehensive income, depending on whether a derivative is
designated as part of a hedge transaction and, if it is the type of hedge
transaction. Management of the Company anticipates that, due
F-76
<PAGE> 195
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
to its limited use of derivative instruments, the adoption of SFAS 133 will not
have a significant effect on the Company's results of operations or its
financial position.
4. ADVANCE PAYMENT FROM CUSTOMER
In March 1998, the Company received an advance payment from one customer
for future long distance telephone services through pre-paid calling cards. This
payment will be recognized as revenue when the related services are provided.
F-77
<PAGE> 196
ANNEX A
AMENDED AND RESTATED
AGREEMENT AND PLAN OF MERGER
BY AND AMONG
STAR TELECOMMUNICATIONS, INC.
SIERRA ACQUISITION CO., INC.
PT-1 COMMUNICATIONS, INC.
AND
SAMER TAWFIK
PETER M. VITA
DOUGLAS BARLEY
JOSEPH A. PANNULLO
JOHN J. KLUSARITZ
Dated as of August 20, 1998
A-1
<PAGE> 197
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<C> <S> <C>
ARTICLE I THE MERGER.................................................. A-5
1.1 The Merger.................................................. A-5
1.2 Filing...................................................... A-5
1.3 Effective Time of the Merger................................ A-6
1.4 Certificate of Incorporation and Bylaws..................... A-6
1.5 Directors and Officers...................................... A-6
1.6 Warrants and Options........................................ A-6
ARTICLE II CONVERSION OF AND SURRENDER AND PAYMENT FOR COMMON STOCK.... A-6
2.1 Conversion.................................................. A-6
2.2 Escrow of Shares............................................
ARTICLE III CLOSING; CERTAIN EFFECTS OF MERGER.......................... A-7
3.1 Closing Date................................................ A-7
3.2 Deliveries of the Company's Stockholders.................... A-7
3.3 Deliveries of Acquiror...................................... A-7
3.4 Effect of Merger............................................ A-7
3.5 Further Assurances.......................................... A-8
ARTICLE IV REPRESENTATIONS AND WARRANTIES OF THE ACQUIROR AND NEWCO.... A-8
4.1 Organization................................................ A-8
4.2 Capital Stock............................................... A-8
4.3 Authority Relative to Agreement............................. A-8
4.4 Acquiror Shares............................................. A-9
4.5 No Violations or Consents................................... A-9
4.6 Litigation.................................................. A-9
4.7 Financial Statements and Reports............................ A-9
4.8 Proxy Statement; Other Information.......................... A-10
4.9 Brokers..................................................... A-10
4.10 Benefit Plans............................................... A-10
4.11 ERISA....................................................... A-10
4.12 Environmental Matters....................................... A-10
4.13 Absence of Certain Changes.................................. A-11
4.14 Government Authorizations................................... A-11
ARTICLE V REPRESENTATIONS AND WARRANTIES OF THE STOCKHOLDERS.......... A-11
5.1 Ownership and Title to the Shares........................... A-11
5.2 Authority Relative to Agreement............................. A-11
5.3 No Violations or Consents................................... A-12
5.4 Rule 501.................................................... A-12
5.5 Restricted Securities....................................... A-12
ARTICLE VI REPRESENTATIONS AND WARRANTIES OF THE COMPANY AND THE
STOCKHOLDERS................................................ A-12
6.1 Corporate Organization; Subsidiaries........................ A-12
6.2 Capital Stock............................................... A-13
6.3 Options, Warrants or Other Rights........................... A-13
</TABLE>
A-2
<PAGE> 198
<TABLE>
<CAPTION>
PAGE
----
<C> <S> <C>
6.4 Authority Relative to Agreement............................. A-13
6.5 No Violations or Consents................................... A-13
6.6 Governmental Authorizations and Regulations................. A-14
6.7 Litigation.................................................. A-14
6.8 Financial Statements and Reports; Material Liabilities;
Projections................................................. A-14
6.9 Absence of Certain Changes.................................. A-15
6.10 Benefit Plans............................................... A-16
6.11 ERISA....................................................... A-16
6.12 Environmental Matters....................................... A-17
6.13 Real Estate Leases.......................................... A-18
6.14 Title to Properties; Absence of Liens and Encumbrances...... A-18
6.15 Tax Matters................................................. A-18
6.16 Proprietary Property........................................ A-19
6.17 Labor Matters............................................... A-19
6.18 Insurance................................................... A-19
6.19 Material Contracts.......................................... A-19
6.20 Proxy Statement; Other Information.......................... A-20
6.21 Brokers..................................................... A-20
6.22 Transactions with Affiliated Parties........................ A-20
6.23 Distributors................................................ A-21
6.24 Accounts Receivable......................................... A-21
6.25 Inventory................................................... A-21
ARTICLE VII COVENANTS AND AGREEMENTS.................................... A-21
7.1 Proxy Statement; Special Meeting............................ A-21
7.2 Conduct of the Business of the Company Prior to the
Effective Time.............................................. A-21
7.3 Access to Properties and Record............................. A-23
7.4 Acquisition Proposals....................................... A-23
7.5 Indemnification by the Stockholders......................... A-23
7.6 Confidentiality............................................. A-24
7.7 Reasonable Best Efforts..................................... A-25
7.8 Withdrawal of Company S-1................................... A-25
7.9 Proxy of Principal Stockholders............................. A-25
7.10 Certain Events.............................................. A-25
7.11 Financial Statements........................................ A-25
7.12 Conduct of the Business of Acquiror Prior to the Effective
Time........................................................ A-25
ARTICLE VIII CONDITIONS PRECEDENT........................................ A-26
8.1 Conditions to Each Party's Obligation to Effect the
Merger...................................................... A-26
8.2 Conditions to the Obligation of the Company and the
Stockholders to Effect the Merger........................... A-26
8.3 Conditions to Obligations of the Acquiror and Newco to
Effect the Merger........................................... A-27
ARTICLE IX TERMINATION, AMENDMENT AND WAIVER........................... A-28
9.1 Termination................................................. A-28
9.2 Termination Fee............................................. A-28
9.3 Amendment................................................... A-28
9.4 Waiver...................................................... A-28
</TABLE>
A-3
<PAGE> 199
<TABLE>
<CAPTION>
PAGE
----
<C> <S> <C>
ARTICLE X MISCELLANEOUS............................................... A-29
10.1 Survival.................................................... A-29
10.2 Expenses and Fees........................................... A-29
10.3 Notices..................................................... A-29
10.4 Headings.................................................... A-30
10.5 Publicity................................................... A-30
10.6 Entire Agreement; Knowledge................................. A-30
10.7 Assignment.................................................. A-30
10.8 Counterparts................................................ A-30
10.9 Invalidity, Etc. ........................................... A-30
10.10 Specific Performance........................................ A-30
10.11 Governing Law............................................... A-31
10.12 Termination of Original Agreement........................... A-31
10.13 No Solicitation............................................. A-31
</TABLE>
EXHIBITS
<TABLE>
<S> <C>
Exhibit A Certificate of Merger
Exhibit B Escrow Agreement
Exhibit C Form of Registration Rights and Share Restriction Agreement
Exhibit D Form of Proxy
</TABLE>
A-4
<PAGE> 200
AMENDED AND RESTATED
AGREEMENT AND PLAN OF MERGER
AMENDED AND RESTATED AGREEMENT AND PLAN OF MERGER dated as of August 20,
1998 (this "Agreement"), by and among STAR Telecommunications, Inc., a Delaware
corporation (the "Acquiror"), Sierra Acquisition Co., Inc., a New York
corporation and wholly-owned subsidiary of the Acquiror ("Newco"), PT-1
Communications, Inc., a New York corporation (the "Company"), and Samer Tawfik,
Peter M. Vita, Douglas Barley, Joseph A. Pannullo and John J. Klusaritz
(collectively, the "Stockholders").
RECITALS:
A. Acquiror, Newco, the Company and the Stockholders previously entered
into an Agreement and Plan of Merger dated June 9, 1998 (the "Original
Agreement").
B. After subsequent review and contemplation, 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 New York Business Corporation Law (the "Business 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");
C. The Stockholders beneficially own an aggregate of 92.8% of the issued
and outstanding shares (the "Shares") of the Company's Common Stock, $.01 par
value per share (the "Common Stock"), determined on a fully diluted basis,
taking into account all outstanding warrants, options and other rights or
interests to subscribe for shares of Common Stock; and
D. The Boards of Directors of the Acquiror and Newco wish to amend and
restate the Original Agreement and, in that regard, have each approved the
transactions contemplated by this Agreement, including without limitation, the
Merger, upon the terms and subject to the conditions set forth herein, including
without limitation, the approval of the stockholders of the Acquiror. The Board
of Directors of the Company also wishes to amend and restate the Original
Agreement and, in that regard, have each approved the transactions contemplated
by this Agreement, including without limitation, the Merger, upon the terms and
subject to the conditions set forth herein. Such approvals comply in all
respects with the requirements of Sections 912(b) and 913(c)(2)(A) of the
Business Corporation Law.
AGREEMENT
NOW, THEREFORE, in consideration of the mutual representations, warranties,
covenants, agreements and conditions contained herein, the sufficiency of which
is hereby acknowledged by the parties, 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 Business 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 Business
Corporation Law.
1.2 Filing. Upon the satisfaction or waiver of the conditions set forth in
Section 8 hereof (other than the condition set forth in Section 8.1(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
A-5
<PAGE> 201
be executed and filed with the Department of State of the State of New York in
accordance with the terms of Section 904 of the Business Corporation Law.
1.3 Effective Time of the Merger. The Merger shall become effective
immediately upon the filing of the Certificate of Merger with the Department of
State of the State of New York in accordance with Section 904. The date and time
of such filing is herein sometimes referred to as the "Effective Time."
1.4 Certificate of Incorporation and Bylaws. Upon the effectiveness of the
Merger, the Certificate of Incorporation of Newco (as in effect on the date of
the Agreement) 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 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 6.3. 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
with respect to the number of shares of Acquiror Common Stock to be acquired
thereunder and the exercise price thereof, based on the Exchange Ratio, as
defined below. Schedule 1.6 sets forth the number of shares of Acquiror Common
Stock that will be subject to each of the Warrants and Options.
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 Common Stock shall be
automatically converted into the right to receive consideration per share equal
to (i) 0.303715621 of a share (the "Exchange Ratio") of the Acquiror's common
stock, $0.001 per share ("Acquiror Common Stock") and (ii) $0.41316724 (the
"Cash Component"). The Exchange Ratio shall be adjusted as may be necessary and
appropriate to reflect any and all stock splits, reverse stock splits,
reclassifications, recapitalizations, dividends payable in shares of Acquiror
Common Stock or in any other securities convertible into or exchangeable for
shares of Acquiror Common Stock and similar capital events that affect Acquiror
Common Stock. Additionally, the Exchange Ratio may be reduced in connection with
the issuance by the Company prior to the Closing Date of additional options to
purchase shares of Common Stock. At the Effective Time, the Cash Component
shall, in no circumstances, exceed $20 million. The aggregate number of shares
of Acquiror Common Stock to be issued in the Merger at the Effective Time shall
be referred to herein as the "Acquiror Shares."
(b) 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.
(c) 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 will be
entitled to receive from the Acquiror an amount of cash (rounded to the nearest
whole $0.01) equal to the product of (i) such fraction of a share multiplied by
(ii) the average closing price of
A-6
<PAGE> 202
Acquiror Common Stock on The Nasdaq National Market for the five (5) trading
days prior to the Effective Time (the "Average Price").
2.2 Escrow of Shares. A total of ten percent (10%) of the Acquiror Shares
(the "Escrow Shares") shall be deposited at the Closing Date in an escrow
established with Santa Barbara Bank and Trust, a California bank, or such other
Person mutually agreeable to Acquiror and the Stockholders (the "Escrow Agent"),
such escrow to be pursuant to the terms of that certain escrow agreement to be
entered into by and among Acquiror, the Stockholders and the Escrow Agent, such
agreement in substantially the form attached hereto as Exhibit B (the "Escrow
Agreement"). As further set forth in the Escrow Agreement, the Escrow Shares
shall be held in escrow for a period (the "Escrow Period") commencing at the
Closing Date, as defined below, and ending on the first anniversary thereof. The
Escrow Shares shall be subject to offset pursuant to the terms of Section 7.5,
as further set forth in the Escrow Agreement. Any such offset against the Escrow
Shares shall be calculated as set forth in the Escrow Agreement.
ARTICLE III
CLOSING; CERTAIN EFFECTS OF MERGER
3.1 Closing Date. Subject to the fulfillment of the conditions specified
in Article VIII (any or all of which may be waived in writing by the respective
parties whose performance is conditioned upon satisfaction of such conditions,
except that the condition set forth in Section 8.1(b) may not be waived), the
purchase and sale of the shares of Common Stock shall be consummated at a
closing (the "Closing") to be held at the offices of Acquiror, at 223 East de la
Guerra Street, Santa Barbara, CA 93101 at 11:00 a.m. or at such time as
Acquiror, the Company and the Stockholders shall mutually agree but not later
than March 31, 1999 (such date and time being herein referred to as the "Closing
Date"), providing that if, immediately prior to such date, the conditions set
forth in 8.1(d) have not been satisfied but all other conditions in Article VIII
have been satisfied or waived by the appropriate party thereto, then the Closing
Date may be extended to no later than June 30, 1999.
3.2 Deliveries of the Company's Stockholders. At the Closing, the
stockholders of the Company shall deliver to Acquiror (a) stock certificates
representing all of the outstanding shares of Common Stock, each of which has
been duly endorsed for transfer and with appropriate stock powers, and (b) all
of the agreements, documents and instruments required to be delivered by the
Company and the Stockholders under Section 8.3.
3.3 Deliveries of Acquiror. At the Closing, Acquiror shall deliver to the
stockholders of the Company (a) certificates representing the Acquiror Shares,
(b) his or her pro rata portion of the Cash Component, (c) any cash that may be
due to any of the stockholders of the Company in payment for any fractional
shares, as calculated pursuant to Section 2.1(c), and (d) all of the agreements,
documents and instruments required to be delivered by the Acquiror under
Sections 8.2. Simultaneously therewith, the Stockholders shall deposit with the
Escrow Agent certificates representing the Escrow Shares pursuant to the terms
of the Escrow Agreement.
3.4 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
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the Surviving Corporation to the same extent as if said debts, liabilities and
duties had been incurred or contracted by it.
3.5 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
jurisdiction of its incorporation, 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. Acquiror 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, results of operations,
business or properties of Acquiror (an "Acquiror Material Adverse Effect"). True
and correct copies of the Certificate of Incorporation Bylaws of Acquiror and
Newco have been delivered or made available to the Company.
4.2 Capital Stock. The authorized capital stock of the Acquiror consists
in its entirety of (a) 50,000,000 shares of Acquiror Common Stock, $0.001 par
value, of which, as of May 15, 1998, 41,755,594 were issued and outstanding and
(b) 5,000,000 shares of Preferred Stock, $0.001 par value per share, none of
which is issued and outstanding. All outstanding shares of Acquiror Common Stock
have been duly authorized and validly issued, are fully paid and non-assessable,
are free of preemptive rights and were issued in compliance with all applicable
securities laws and regulations. To the knowledge of Acquiror and except as
otherwise contemplated by this Agreement, there are no voting trusts or other
agreements, arrangements or understandings with respect to the voting of
Acquiror Common Stock. 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. Except with respect to the approval of the stockholders of Acquiror,
which shall be subject to the Special Meeting, as defined below, 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, including without limitation the affirmative vote of the Board of
Directors as contemplated by Section 203(a)(1) of the Delaware General
Corporation Law (the "DGCL"). 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. Each other agreement to be
executed in connection with this Agreement by the Acquiror and Newco on or prior
to the Closing Date will be duly executed and delivered by each of Acquiror and
Newco, as the case may be, and will
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constitute a legal, valid and binding obligation of each of Acquiror and Newco,
enforceable against each of Acquiror and Newco in accordance with its respective
terms, subject to applicable bankruptcy, insolvency, moratorium, reorganization
or other laws affecting the enforcement of creditors' rights generally or by
general equitable principles.
4.4 Acquiror Shares. The Acquiror Shares 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 bylaws 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 Act") and the rules
and regulations arising thereunder, the rules and regulations of The Nasdaq
Stock Market, the Business Corporation Law or the "takeover", "blue sky" or
"public utilities" 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.
4.6 Litigation. Except as may be disclosed in the Acquiror SEC Filings, as
defined below, there are no actions, proceedings, claims, complaints, grievances
or unfair labor practice complaints 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
of the assets or properties of it before any court or governmental or regulatory
authority or body or arbitrator which, if adversely determined against Acquiror,
would have, individually or in the aggregate, an Acquiror Material Adverse
Effect. There are no such proceedings pending or, to the best knowledge of
Acquiror, threatened against Acquiror or Newco challenging the validity or
propriety of the transactions contemplated by this Agreement.
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 April 29, 1998, Registration No. 333-48559, (b) its
Registration Statement on Form S-4 dated May 29, 1998, Registration No.
333-53335, (c) its Annual Report on Form 10-K for the fiscal year ended December
31, 1997 and (d) its Quarterly Reports on Form 10-Q for the quarter ended March
31, 1998 and June 30, 1998 (collectively,"Acquiror SEC Filings"). The Acquiror
SEC Filings made in compliance with the Exchange Act were filed in a timely
manner pursuant to the rules and regulations thereof. 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 consolidated
financial statements of the Acquiror included in the Acquiror SEC Filings were
prepared in accordance with generally accepted
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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 Proxy Statement; Other Information. The Proxy Statement, as defined
below, and any other documents to be filed with the Securities and Exchange
Commission (the "SEC") or any regulatory agency in connection with the
transactions contemplated hereby, will not be, at the respective times such
documents are filed with the SEC and, with respect to the Proxy Statement, when
first published, sent or given to the stockholders of Acquiror, false or
misleading with respect to any material fact, or omit to state any material fact
necessary in order to make the statements therein, in light of the circumstances
under which there are made, not misleading. All documents which the Acquiror or
Newco files or is responsible for filing with the SEC and any 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 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 Proxy 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 Hambrecht & Quist and Credit Suisse First Boston as its financial
advisors in connection with the transactions contemplated by this Agreement.
4.10 Benefit Plans. Except as described in Acquiror's SEC Filings,
Acquiror does not have outstanding any employment agreement with any officer or
employee of Acquiror, 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 Acquiror Benefit
Plans, as defined in Section 4.11 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.
4.11 ERISA. All of Acquiror's 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 are sponsored, or being maintained or contributed to, by Acquiror
that provide for payment of more than $25,000 in annual benefits (the "Acquiror
Benefit Plans") are described in Acquiror's SEC Filings. None of the Company
Employee Benefit Plans are "multiemployer plans" as defined in Section 3(37) of
ERISA. No "prohibited transactions" (as such term is defined in Section 4975 of
the Internal Revenue Code (the "IRC"), or in Part 4 of Subtitle B of Title I of
ERISA) have occurred with respect to any Acquiror Benefit Plan that could result
in the imposition of taxes or penalties that, in the aggregate, could have an
Acquiror Material Adverse Effect. Each Acquiror 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 an Acquiror
Material Adverse Effect. With respect to each Acquiror Benefit Plan, Acquiror
has not incurred liabilities which, in the aggregate, could have an Acquiror
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. There is no pending or, to the best
knowledge of Acquiror, threatened legal action, proceeding or investigation
against or involving any Acquiror Benefit Plan which could result in reduced
liabilities.
4.12 Environmental Matters. "Acquiror Real Properties" shall mean all real
property now or previously owned, operated or leased by Acquiror and located in
the United States. Except as set forth in Acquiror's SEC Filings: (i) Acquiror
and, to the best of Acquiror's knowledge, each of the Acquiror Real Properties
is in compliance with, and has no liability under any or all applicable
Environmental Laws,
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(ii) neither Acquiror nor any of the Acquiror 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 and (iii) there are no facts or circumstances
which could reasonably form the basis for the assertion of any claims against
Acquiror relating to environmental matters, except, in any such case, where the
failure to comply or such liability could not be reasonably expected to have an
Acquiror 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.
4.13 Absence of Certain Changes. Since June 30, 1998, except as
contemplated by this Agreement, the Acquiror has conducted its business in the
ordinary course, consistent with past practices, and there has not been any (a)
material adverse change in the financial condition, results of operations,
business or properties of Acquiror, (b) sale, assignment or transfer of a
material portion of the Company's assets, other than in the ordinary course of
business, consistent with past practices, (c) changes in accounting methods,
principles or practices by Acquiror materially affecting Acquiror's assets,
liabilities or results of operations, except as otherwise required by GAAP, (d)
declaration, setting aside or payment of any dividend or other distribution or
payment (whether in cash, stock or property) with respect to any shares of
Acquiror Common Stock or (e) any other event or condition of any character that
in any one case or in the aggregate has had an Acquiror Material Adverse Effect.
4.14 Government Authorizations. Acquiror has all federal and state
governmental licenses, permits and other authorizations, including without
limitation all licenses and authorizations required by the United States Federal
Communications Commission (the "FCC") and by state public utilities commissions
("Acquiror Permits"), necessary to conduct Acquiror's business as presently
conducted, except where the failure to hold any such licenses, permits and other
authorizations would not result in an Acquiror Material Adverse Effect. Such
Acquiror Permits are valid and in full force and effect and Acquiror is not
aware of any threatened suspension, cancellation or invalidation of any such
Acquiror Permit. Except as set forth in Acquiror's SEC Filings, the Acquiror has
not received notice from either the FCC or any state public utilities
commissions of any complaint filed therewith concerning Acquiror, its operations
or services.
ARTICLE V
REPRESENTATIONS AND WARRANTIES
OF THE STOCKHOLDERS
Except as set forth in the disclosure schedules attached hereto (the
"Disclosure Schedules"), the Stockholders, severally but not jointly, represent
and warrant to Acquiror as follows:
5.1 Ownership and Title to the Shares. As set forth on Schedule 5.1, such
Stockholder is the record and beneficial owner of that number of shares of
Common Stock and of the Options and Warrants, if any, set forth opposite his
name on such schedule and has good and valid title in and to such securities.
Except as set forth on Schedule 5.1, such shares are, and on the Closing Date
will be, free and clear of any and all liens, security interests, mortgages,
deeds of trust, pledges, claims, rights of first refusal, options, encumbrances,
restrictions, preemptive or subscriptive rights or other rights of third parties
("Encumbrances").
5.2 Authority Relative to Agreement. Such Stockholder has the full power
and authority to execute this Agreement and the other transactions contemplated
on his part hereby. Such Stockholder has taken all steps that may be necessary
to duly authorize the execution and delivery by the Company and by such
Stockholder of this Agreement and the consummation of the transactions
contemplated on his or its part hereby, in accordance with the provisions of
Section 913(c)(2)(A) of the Business Corporation Law, and no other actions on
the part of such Stockholder is necessary to authorize the execution and
delivery of this Agreement by such Stockholder or the consummation of the
transactions contemplated on his or its part hereby. This Agreement has been
duly executed and delivered by such Stockholder, and constitutes a legal, valid
and binding obligation of such Stockholder, enforceable against such Stockholder
in accordance with its terms, except to the extent that its enforceability may
be limited by applicable bankruptcy, insolvency,
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reorganization or other laws affecting the enforcement of creditors' rights
generally or by general equitable principles. Each other agreement to be
executed in connection with this Agreement by such Stockholder on or prior to
the Closing Date will be duly executed and delivered by the Stockholder and will
constitute a legal, valid and binding obligation of each such Stockholder,
enforceable against such Stockholder in accordance with its respective terms,
subject to applicable bankruptcy, insolvency, moratorium, reorganization or
other laws affecting the enforcement of creditors' rights generally or by
general equitable principles.
5.3 No Violations or Consents. The execution, delivery and performance of
this Agreement by such Stockholder and the consummation of the transactions
contemplated hereby will not (i) 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 such Stockholder pursuant to any provision of any contract
to which such Stockholder is bound, lien, order, judgment or decree to which
such party is subject or by which such Stockholder or any of his property or
assets is bound, or (ii) violate or conflict with any law, rule, regulation,
permit, ordinance or regulation applicable to such Stockholder or by which any
property or asset of such Stockholder is bound or affected.
5.4 Rule 501. Such Stockholder is an "accredited investor" within the
meaning of Rule 501 of the Securities Act. In connection with the Merger, each
such Stockholder is acquiring shares of Acquiror Common Stock for investment for
his own account, not as a nominee or agent and not with a view towards the
resale or other distribution of any part thereof, and such Stockholder has no
present intention of selling, granting any participation in, or otherwise
distributing such shares of Acquiror Common Stock.
5.5 Restricted Securities. Such Stockholder understands that the shares of
Acquiror Common Stock he will receive in the Merger will be characterized as
"restricted securities" under the federal securities laws inasmuch as they are
being acquired from Acquiror in a transaction not involving a public offering
and that under such laws and applicable regulations such securities may be
resold without registration under the Securities Act, only in certain limited
circumstances. In this connection, such Stockholder represents that he is
familiar with Rule 145 of the Securities Act, as presently in effect, and
understands the holding period and resale limitations imposed thereby and by the
Securities Act.
ARTICLE VI
REPRESENTATIONS AND WARRANTIES
OF THE COMPANY AND THE STOCKHOLDERS
Except as set forth in the Disclosure Schedules, the Company and the
Stockholders jointly and severally represent and warrant to Acquiror as follows:
6.1 Corporate Organization; Subsidiaries.
(a) Organization. The Company is a corporation duly organized, validly
existing and in good standing under the laws of the State of New York 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, results of operations,
business or properties of the Company and its Subsidiaries (as defined below),
taken as a whole (a "Company Material Adverse Effect"). True and correct copies
of the Certificate of Incorporation and the Bylaws of the Company have been
delivered or made available to Acquiror.
(b) Subsidiaries. Schedule 6.1(b) contains a true and complete list of
all direct and indirect domestic and foreign subsidiaries of the Company
(individually, a "Subsidiary" and collectively, the "Subsidiaries"), listing the
name and jurisdiction of incorporation or organization of each such Subsidiary.
Each Subsidiary is a corporation duly organized and validly existing and in good
standing under the laws of its respective jurisdiction of incorporation, has the
corporate power and authority to own, operate or lease the
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properties and assets now owned, operated or leased by such Subsidiary and to
carry on its business as now being conducted by such Subsidiary, is duly
qualified as a foreign corporation to do business, and is in good standing, in
each jurisdiction set forth on Schedule 6.1(b), which are all of the
jurisdictions in which the failure so to qualify would have a Company Material
Adverse Effect. All of the issued and outstanding capital stock of each
Subsidiary is owned by the Company or one of the Subsidiaries, as the case may
be, free and clear of any and all Encumbrances (as defined below). There are no
outstanding rights to purchase or otherwise receive from any Subsidiary any
shares of capital stock or any other security of such Subsidiary and there are
no outstanding securities of any kind convertible into or exchangeable for such
capital stock. The Company does not own, directly or indirectly, any stock,
partnership interest, joint venture interest or other security, investment or
interest in any other corporation, organization or entity, other than the
Subsidiaries.
6.2 Capital Stock. As of the date hereof, the authorized capital stock of
the Company consists in its entirety of (a) One Hundred Fifty Million
(150,000,000) shares of Common Stock, of which Forty-eight Million Four Hundred
Six Thousand Five Hundred Forty-eight (48,406,548) are issued and outstanding
and (b) Fifteen Million (15,000,000) shares of preferred stock, $.01 par value
per share, none of which are issued and outstanding. All outstanding shares of
Common Stock have been duly authorized and validly issued, are fully paid and
non-assessable, are free of preemptive rights and were issued in compliance with
all applicable securities laws and regulations. Except as otherwise contemplated
by this Agreement, there are no voting trusts or other agreements, arrangements
or understandings with respect to the voting of the Shares to which the Company,
the Stockholders or any other person is a party. Except as set forth on Schedule
6.3 or as otherwise contemplated by this Agreement, there are no preemptive
rights, registration rights, subscriptions, options, warrants, rights,
convertible securities or other agreements or commitments of any character
relating to issued or unissued shares of Common Stock or other securities of the
Company and there are no outstanding contractual obligations of the Company to
repurchase, redeem or otherwise acquire or sell, issue or otherwise transfer any
outstanding securities thereof.
6.3 Options, Warrants or Other Rights. Except as set forth on Schedule 6.3
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.
6.4 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 of Directors and its stockholders, such authorization being in compliance
with the provisions of Sections 912(b) and 913(c)(2)(A) of the Business
Corporation Law, and no other corporate proceedings on the part of the Company
or the 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. 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. Each other
agreement to be executed in connection with this Agreement by the Company on or
prior to the Closing Date will be duly executed and delivered by the Company,
and will constitute a legal, valid and binding obligation of the Company,
enforceable against each of the Company in accordance with its respective terms,
subject to applicable bankruptcy, insolvency, moratorium, reorganization or
other laws affecting the enforcement of creditors' rights generally or by
general equitable principles.
6.5 No Violations or Consents. Except as set forth on Schedule 6.5, the
execution, delivery and performance of this Agreement by the Company and the
consummation of the transactions contemplated hereby will not (i) violate or
conflict with any provision of any charter or bylaws of the Company or any
Subsidiary, (ii) require the consent, waiver, approval, license or authorization
of or any filing by the Company
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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 Communications Act or the "blue sky" or "public utility" 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 Company or any Subsidiary pursuant to any provision of any Material
Contract (as defined below), lien, order, judgment or decree to which any such
party 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 or regulation applicable to the Company or any
Subsidiary or by which any property or asset of the Company or any Subsidiary 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.
6.6 Governmental Authorizations and Regulations. Schedule 6.6 is a true
and complete list of all material governmental licenses, franchises, permits and
other authorizations, including without limitation any and all licenses issued
to the Company or any Subsidiary by the FCC, by state public utilities
commissions and by all applicable foreign telecommunications regulatory entities
(the "Foreign Agencies") ("Company Permits") held by the Company and the
Subsidiaries. Such Company Permits are all governmental licenses, franchises,
permits and other authorizations necessary to the conduct of the business of the
Company and the Subsidiaries. Such Company Permits are valid and in full force
and effect and the Company knows of no threatened suspension, cancellation or
invalidation of any such Company Permit. Except as set forth on Schedule 6.6,
the Company has not received notice from any of the FCC, any state public
utilities commissions or any Foreign Agencies of any complaint filed therewith
concerning the Company, its operations or services and, to the best knowledge of
the Company and the Stockholders, there is not reasonable basis for the filing
of any such complaint. Neither the Company nor any Subsidiary is in conflict
with, or is in default or violation of, any law, rule, regulation, order,
judgment, Company 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.
6.7 Litigation. Except as set forth on Schedule 6.7 hereto, there are no
actions, proceedings, claims, complaints, grievances or unfair labor practice
complaints (collectively, "Actions") pending or, to the best knowledge of the
Company and the Stockholders, threatened, or, to the best knowledge of the
Company and the Stockholders, investigations pending or threatened against the
Company or any of the assets or properties of the Company before any court or
governmental or regulatory authority or body or arbitrator, which, if such
Action were determined adversely to the Company, would have, individually or in
the aggregate, a Company Material Adverse Effect. There are no Actions pending
or, to the best knowledge of the Company and the Stockholders, threatened
against the Company challenging the validity or propriety of the transactions
contemplated by this Agreement. None of the assets, property or other rights of
the Company or any Subsidiaries thereof is subject to any order, judgment,
injunction, writ or decree, which would have, individually or in the aggregate,
a Company Material Adverse Effect.
6.8 Financial Statements and Reports; Material Liabilities; Projections
(a) Financial Statements and Reports. The Company's audited balance
sheets and its audited statements of operations, stockholder's equity and cash
flows as of and for the fiscal years ended March 31, 1995, 1996, 1997 and 1998
(the "Audited Financials"), as well as the Company's unaudited balance sheet and
unaudited statements of operations (the "June Statement of Operations"),
stockholders' equity and cash flows as of and for the quarter ended June 30,
1998 (collectively with the Audited Financials, the "Company Financial
Statements") were prepared from and are in accordance with the books and records
of the Company and were prepared in accordance with GAAP applied on a consistent
basis and (except as may be indicated
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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.
(b) Material Liabilities. Except as set forth on Schedule 6.8(b), the
Company has 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 Financial Statements, 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, individually and in the aggregate, are not material.
(c) Projections. The projections dated May 1, 1998 delivered by the
Company to the Acquiror were prepared in good faith in a manner that was
reasonable in the context of the financial information and data set forth
therein, provided that Acquiror and Newco acknowledge that such projections are
forward-looking statements, are subject to the uncertainties inherent thereto
and that the Company's actual results may differ, perhaps materially, from such
projections.
6.9 Absence of Certain Changes. Except as set forth on Schedule 6.9, since
April 1, 1998, the Company has conducted its business in the ordinary course and
there has not been any:
(a) material adverse change in the financial condition, assets,
liabilities, business or results of operations of the Company or any Subsidiary,
provided that the financial information set forth in the June Statement of
Operations previously provided to the Company shall not be deemed a material
adverse change for purposes of this Agreement;
(b) addition to or modification of employee benefits plans, arrangements
or practices, other than in the ordinary course of business;
(c) sale, assignment or transfer of any of the material assets of the
Company or any Subsidiary, other than in the ordinary course of business,
consistent with past practice;
(d) cancellation of any indebtedness owed to the Company in an aggregate
amount greater than Seventy-five Thousand Dollars ($75,000), or waiver of any
rights of similar value to the Company relating to any of its business
activities or properties, other than in the ordinary course of business;
(e) amendment, cancellation or termination of any Material Contract,
other than in the ordinary course of business, consistent with past practice;
(f) any breach of, or default under, any Material Contract by the
Company or any Subsidiary;
(g) change in accounting methods, principles or practices by the Company
materially affecting its assets, liabilities or results of operations;
(h) material revaluation by the Company or any Subsidiary of its assets,
including without limitation, any material write-offs, material increases in any
reserves or any material write-up of the value of inventory, property, equipment
or any other asset;
(i) material damage, destruction or loss (if not covered by insurance)
affecting any office or other facility maintained by the Company or any other
material asset of the Company and resulting in a loss in an aggregate amount in
excess of One Hundred Thousand Dollars ($100,000);
(j) Encumbrance with respect to any assets of the Company or any
Subsidiary, except Encumbrances arising in the ordinary course of business;
(k) declaration, setting aside or payment of any dividend or other
distribution or payment (whether in cash, stock or property) with respect to any
shares of Common Stock, or any redemption, purchase or other acquisition of any
of such shares, or any other payment to the stockholders of the Company with
respect to the shares of Common Stock held thereby;
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(l) issuance by the Company of, or commitment by it to issue, any shares
of Common Stock or other equity securities or any securities convertible into or
exchangeable or exercisable for shares of the Common Stock or other equity
securities;
(m) indebtedness for borrowed money incurred by the Company or any
Subsidiary or any commitment to incur indebtedness for borrowed money entered
into by the Company or any Subsidiary, or any loans made or agreed to be made by
the Company, including without limitation, any loans made to any of the
Company's executive officers;
(n) incurrence of other liabilities by the Company or any Subsidiary
involving an aggregate amount in excess of One Hundred Fifty Thousand Dollars
($150,000) or more, except in the ordinary course of business, or any material
increase or change in any assumptions underlying, or methods of calculating, any
bad debt, contingency or other reserves;
(o) payment, discharge or satisfaction of any liabilities other than the
payment, discharge or satisfaction in the ordinary course of business,
consistent with past practice, of liabilities reserved against in the Financial
Statements or of liabilities incurred in the ordinary course of business,
consistent with past practice, since such date or of other liabilities involving
Fifty Thousand Dollars ($50,000) or less individually and One Hundred Fifty
Thousand Dollars ($150,000) or less in the aggregate;
(p) increase in the compensation of officers or employees (including any
such increase pursuant to any bonus, pension, profit sharing or other plan or
commitment) or any increase in the compensation payable or to become payable to
any officer or employee or any severance or termination pay, except for
increases in the ordinary course of business, consistent with past practice or
as required by law or any existing agreement;
(q) granting of any bonus, incentive compensation, service, award or
other like benefit to any officer or employee except in accordance with plans or
arrangements disclosed on Schedule 6.11; or
(r) other event or condition of any character which in any one case or
in the aggregate could be reasonably expected to have a Company Material Adverse
Effect.
6.10 Benefit Plans. Except as disclosed on Schedule 6.10, the Company does
not have outstanding any employment agreement with any officer or employee of
the Company or any Subsidiary 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 6.11 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 the transactions
contemplated by this Agreement which would be treated as an "excess parachute
payment" as defined in Section 280G of 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.
6.11 ERISA. Set forth on Schedule 6.11 are all of the employee benefit
plans, as defined in Section 3(3) of 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 (a) 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
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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 6.10, 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 3(2) of ERISA or Section 412 of the IRC. 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. 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. 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 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. Except as disclosed on Schedule 6.10,
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 6.11 are
likewise true with respect to each Subsidiary.
6.12 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 6.12:
(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, (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 and (iii) 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, except, in any
such case, where the failure to comply or such liability could not be reasonably
expected to have a Company Material
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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.
6.13 Real Estate Leases. Schedule 6.13 sets forth a complete and accurate
list, copies of which have 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 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, except, in either such instance, for defaults or events that could not
be reasonably expected to 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.
6.14 Title to Properties; Absence of Liens and Encumbrances. The Company
does not own any real property. 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 balance sheet of the Company as of March 31, 1998 (the "Company
Balance Sheet") (other than assets disposed of in the ordinary course of
business since March 31, 1998), free and clear of all Encumbrances, except liens
for taxes not yet due and payable and such liens or other imperfections of
title, 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
6.14.
6.15 Tax Matters. Except as set forth on Schedule 6.15, the Company has
paid, or the Company Balance Sheet contains adequate provision for, all federal,
state, local, foreign or other governmental income, excise, 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. Company Taxes paid and/or incurred from the date of the Company Balance
Sheet until the Effective Time will 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 6.15, 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 as set forth on Schedule 6.15, (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, (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 as
set forth on Schedule 6.15, 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
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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.
6.16 Proprietary Property. Schedule 6.16 contains a complete and accurate
list of all material trade names, trademarks, service marks, copyrights, trade
names, brand names, software and proprietary and other technical information
(collectively "Proprietary Property"), including all contracts, agreements and
licenses relating thereto, owned by the Company or the Subsidiaries or in which
any of them has any rights to any such Proprietary Property. To the Company's
knowledge, none of the Company or the Subsidiaries has infringed or is now
infringing on any Proprietary Property belonging to any other person, firm or
corporation. The Company and the Subsidiaries own or hold adequate licenses or
other rights to use all Proprietary Property necessary for them to conduct their
respective businesses as they are being conducted, including without limitation,
all such rights relating to all software and related Proprietary Property used
in and necessary for the operation of the Company's debit card platform and the
Company's billing system relating to its 10XXX program, except where the failure
to hold such rights could not be reasonably expected to result in a Company
Material Adverse Effect. Except as disclosed on Schedule 6.16, none of the
Company or the Subsidiaries has granted any licenses with respect to any of
their respective Proprietary Property. None of the Company or the Subsidiaries
has received any notice of, nor does the Company have any knowledge with respect
to, any claim of infringement or other conflict or claimed conflict with respect
to the rights of others to the use of the corporate name of the Company or any
Subsidiary or any of their Proprietary Property, except such conflicts or
claimed conflicts which, in the aggregate, would not result in a Company
Material Adverse Effect. No Proprietary Property is subject to any outstanding
order, judgment, decree, stipulation or agreement restricting the use thereof by
the Company or any Subsidiary or restricting the licensing thereof by the
Company or any Subsidiary to any Person. Except as set forth on Schedule 6.16,
neither the Company nor any Subsidiary has entered into any agreement to
indemnity any other party against any charge of infringement of any patent,
trademark, service mark or copyright.
6.17 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 6.17, 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 material 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.
6.18 Insurance. Schedule 6.18 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.
6.19 Material Contracts. Schedule 6.19 lists, as of the date of this
Agreement, the following contracts or agreements to which the Company or a
Subsidiary is a party or is bound (collectively, the "Material Contracts"), (i)
all contracts or other agreements, whether or not made in the ordinary course of
business, which are material to the business of the Company and the Subsidiaries
taken as a whole; (ii) all contracts in the nature of mortgages, indentures,
promissory notes, loan or credit agreements or similar instruments under which
the Company and the Subsidiaries have borrowed or may borrow at least
$1,000,000; (iii) any personal property lease providing for annual rentals of
$500,000 or more; (iv) any agreement with a term of at least one year for the
purchase of materials, supplies, goods, services, equipment or other assets
providing for either
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annual payments by the Company and the Subsidiaries of $500,000 or more or
aggregate payments by the Company and the Subsidiaries of $1,000,000 or more;
(v) any sales, distribution or other similar agreement with a term of at least
six months, providing for the sale by the Company or any Subsidiary of
materials, supplies, goods, services, equipment or other assets that provides
for (A) annual payments to the Company and the Subsidiaries of $200,000 or more
and (B) does not by its terms permit the Company or any Subsidiary to pass any
increase in the costs of such materials, supplies, goods, services, equipment or
other assets on to the counterpart thereto; (vi) any material partnership, joint
venture or other similar agreement or arrangement; (vii) any material agreement
relating to the acquisition or disposition of any business (whether by merger,
sale of stock, sale of assets or otherwise) entered into since April 1, 1997;
(viii) any and all carrier services agreements, operating agreements and
agreements with vendors; (ix) any material option, license, franchise or similar
agreement; (x) any material agency, dealer, sales representative, marketing or
other similar agreement; (xi) any agreement that limits the freedom of the
Company or any Subsidiary to compete in any line of business or with any Person
or in any area or which would so limit the freedom of the Company or any
Subsidiary after the Effective Date; (xii) all agreements with qualified
independent distributors; (xiii) any agreement with any person directly or
indirectly owning, controlling or holding with power to vote, 5% or more of the
outstanding voting securities of the Company. Except as set forth on Schedule
6.19, each of the Material Contracts is valid and binding and in full force and
effect, enforceable by the Company in accordance with its terms, except to the
extent that such enforceability may be subject to applicable bankruptcy,
insolvency, moratorium, reorganization or other laws affecting the enforcement
of creditors' rights generally or by general equitable principles. None of the
Company or the Subsidiaries or, to the knowledge of the Company, any other party
thereto, is in default in any respect, and no event has occurred which (whether
with or without notice, lapse of time or the happening or occurrence of any
other event) would constitute a default of the Company or any Subsidiary or, to
the knowledge of the Company, any third party, under any of the Material
Contracts, except such defaults which, in the aggregate, would not result in a
Company Material Adverse Effect. True and complete copies of each of the
Material Contracts have been delivered or made available to the Acquiror.
6.20 Proxy Statement; Other Information. The information supplied or to be
supplied in writing by the Company specifically for inclusion in the Proxy
Statement and any other documents to be filed with the SEC 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 Acquiror, not 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, 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 a supplement to the Proxy Statement, the Company
will promptly inform the Acquiror.
6.21 Brokers. Except as set forth in Schedule 6.21, 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. The Company has delivered to the Acquiror copies of all current
engagement letters that the Company has entered with BT Alex. Brown
Incorporated.
6.22 Transactions with Affiliated Parties. Schedule 6.22 sets forth a true
and complete list and description of all transactions engaged in since April 1,
1996 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 6.22.
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6.23 Distributors. Schedule 6.23 hereto sets forth the Company's five (5)
largest distributors for the fiscal year ended March 31, 1998 and for the fiscal
quarter ended June 30, 1998 (the "Large Distributors").
6.24 Accounts Receivable. The accounts receivable of the Company set forth
on the Company Balance Sheet or which have arisen since April 1, 1998 have
arisen only from bona fide transactions in the ordinary course of business. The
services sold and delivered that gave rise to such accounts were sold and
delivered in conformity in all material respects with applicable Material
Contracts and, except as set forth on Schedule 6.24, as of March 31, 1998 there
were no refunds, rebates, discounts or other adjustments payable with respect to
any such accounts receivable.
6.25 Inventory. As of the date of the Company Balance Sheet, inventories
set forth on the Company Balance Sheet consisted in all material respects of
items of a quantity and quality saleable in the ordinary course of business net
of applicable reserves. All such inventories are valued on the Company Balance
Sheet in accordance with GAAP applied on a basis consistent with past practices.
ARTICLE VII
COVENANTS AND AGREEMENTS
7.1 Proxy Statement; Special Meeting. As promptly as practicable following
the execution of this Agreement, Acquiror agrees that this Agreement shall be
submitted at a special meeting of its stockholders duly called and held pursuant
to Section 251(c) of the DGCL (the "Special Meeting") to consider and vote upon
the approval of the Merger. In connection with the Original Agreement, on July
14, 1998 the Acquiror filed the Proxy Statement in its preliminary form with the
SEC. In connection with the execution of this Agreement, the Acquiror shall, as
expeditiously as possible, prepare and file with the SEC an amendment to the
preliminary Proxy Statement and all other filings relating to the Special
Meeting as required by the Exchange Act and the rules and regulations of the SEC
promulgated thereunder and, in that regard, the Company will provide all
necessary assistance as may be requested by the Acquiror with respect to such
filing. Acquiror shall use all commercially reasonable efforts to solicit from
its stockholders proxies to be voted at the Special Meeting in favor of this
Agreement and the transactions contemplated hereby, including without
limitation, the Merger, which solicitation shall include the recommendations of
the Company's Board of Directors in favor of this Agreement, the Merger and such
other transactions. Acquiror will provide the Company and its advisors drafts of
the revised preliminary Proxy 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 and of any request by the SEC or its staff for amendments
or supplements to the Proxy Statement 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
or its staff, on the other hand, with respect to the Proxy Statement. The term
"Proxy Statement" shall mean such proxy statement at the time it initially is
mailed to the stockholders of Acquiror and all duly filed amendments or
revisions made thereto, if any, similarly mailed.
7.2 Conduct of the Business of the Company Prior to the Effective
Time. The Company and the Stockholders agree that prior to the Effective Time,
except as set forth on Schedule 7.2, 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 Bylaws, (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 or (v) split, combine or reclassify its outstanding shares of
capital stock;
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(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) 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 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 preserve intact the business
organization of the Company and the Subsidiaries, use their respective best
efforts to keep available the services of its operating personnel and use their
respective best efforts to preserve the goodwill of those having business
relationships with each of them, including, without limitation, the Large
Distributors;
(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 6.10, (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 or any Stockholder;
(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 any other
assets or otherwise by the purchase of any property or assets of any other
individual, firm or corporation, except with respect to capital expenditures
incurred in the ordinary course of business under Material Contracts in place on
the date of this Agreement;
(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 settle or compromise
any material federal, state, local or foreign income or excise tax proceeding or
audit;
(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 any
agreement, commitment or arrangement to do any of the things described in
clauses (a) through (k).
From time to time, at the request of Acquiror, representatives of the Company
shall be available to meet with the chief executive officer or chief financial
officer of the Acquiror to discuss the Company and all ongoing operational
issues and matters and to provide such periodic financial information and data
as may be requested
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by the Acquiror. Following the execution of this Agreement, the Company and
Acquiror shall commence negotiations with respect to the terms and conditions of
a route management agreement to be entered into between such parties prior to
the Closing Date.
7.3 Access to Properties and Record. Each party to this Agreement shall
afford to the other parties hereto and their respective accountants, financial
advisors, 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 without
limitation, all regulatory filings with the FCC, state public utilities
commissions and Foreign Agencies from the last four years and all 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 7.3 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.
7.4 Acquisition Proposals. Following the execution of this Agreement, none
of the Company, any Subsidiary, the Stockholders nor any of the Company's or any
Subsidiary's directors, partners, officers, employees or other representatives
or agents shall, directly or indirectly, communicate, solicit, initiate,
encourage or participate in discussions or negotiations with or the submission
of any offer or proposal by or provide any information or access to, any
corporation, partnership, person, or other entity or group (other than Newco or
Acquiror or an officer or other authorized representative of Newco or Acquiror)
concerning any Acquisition Proposal. The Company will promptly, and in no event
later than 24 hours after receipt of the relevant Acquisition Proposal, notify
(which notice shall be provided orally and in writing) the Acquiror after (i)
the Company has received any Acquisition Proposal, (ii) the Company has actual
knowledge that any person is considering making an Acquisition Proposal, or
(iii) the Company has received any request for information relating to the
Company or any Subsidiary, or for access to the properties, books or records of
the Company or any Subsidiary, by any person that the Company has actual
knowledge is considering making, or has made, an Acquisition Proposal. Such
notice shall contain, among other things, the identity of the person making or
considering an Acquisition Proposal and the terms and conditions of such
Acquisition Proposal, including without limitation the consideration offered or
to be offered in connection therewith. The Company will keep the Acquiror fully
informed of the status and details of any such Acquisition Proposal or request.
The Company and the Stockholders shall, and shall cause the Company's and each
Subsidiary's directors, officers, employees, financial advisors and other agents
or representatives to, cease immediately and cause to be terminated all
activities, discussions or negotiations, if any, with any persons heretofore
conducted with respect to any Acquisition Proposal. For purposes of this
Agreement, "Acquisition Proposal" means any offer or proposal for a merger or
other business combination involving the Company or any Subsidiary or the
acquisition of any equity interest in, or a substantial portion of the assets
of, the Company or any Subsidiary, other than the transactions contemplated by
this Agreement.
7.5 Indemnification by the Stockholders.
(a) Following the Effective Time, the Stockholders agree, (i) with
respect to the representations and warranties set forth in Article V, severally
but not jointly, and (ii) with respect to the representations and warranties set
forth in Article VI, jointly and severally, to indemnify Acquiror, and each of
Acquiror's respective officers, directors, employees, agents and representatives
(collectively, the "Acquiror Indemnitees"), against, and hold such Acquiror
Indemnitees harmless from any and all claims, obligations, losses, damages,
costs, expenses (including without limitation, reasonable attorneys' fees and
expenses) and other liabilities of Acquiror (collectively, the "Losses") arising
out of the breach of any representation, warranty, covenant or agreement of the
Company or the Stockholders herein, whether or not such Losses arise as a result
of third party claims asserted against the Company. Notwithstanding the
foregoing, the Stockholders shall not be liable to the Acquiror Indemnitees
under this Section 7.5(a) until the aggregate of all such Losses exceeds One
Million Dollars ($1,000,000) (the "Stockholders's Threshold Amount"), in which
case the Stockholders shall be required to indemnify the Acquiror Indemnitees
for the full amount of such Losses, including the Stockholders's Threshold
Amount. Notwithstanding the foregoing, no claim for indemnification under this
Section 7.5(a) may be made after the Escrow Period.
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(b) Each of the Acquiror Indemnitees agrees to give the Stockholders
prompt written notice of any claim, assertion, event or proceeding by or in
respect of a third party of which it has knowledge concerning any Loss as to
which it may request indemnification hereunder with respect to any such third
party claim. The Stockholders shall have the right to direct, through counsel of
their own choosing, the defense or settlement of any such third party claim or
proceeding (provided that the Stockholders shall have first acknowledged its
indemnification obligations hereunder specifically in respect of such claim or
proceeding) at its own expense, which counsel shall be reasonably satisfactory
to the Acquiror Indemnitees. If the Stockholders elect to assume the defense of
any such claim or proceeding, the Acquiror Indemnitees may participate in such
defense, but in such case the expenses of the Acquiror Indemnitees incurred in
connection with such participation shall be paid by the Acquiror Indemnitees.
The Acquiror Indemnitees shall reasonably cooperate with the Stockholders in the
defense or settlement of any such claim, assertion, event or proceeding. If the
Stockholders elect to direct the defense of any such claim or proceeding, the
Acquiror Indemnitees shall not pay, or permit to be paid, any part of any claim
or demand arising from such asserted Loss, unless the Stockholders consent in
writing to such payment or unless the Stockholders withdraws from the defense of
such asserted Loss, or unless a final judgment from which no appeal may be taken
by or on behalf of the Stockholders is entered against any Acquiror Indemnitee
for such Loss. The Stockholders will not settle or compromise any claim subject
to this Section 7.5(b) without the prior consent of the affected Acquiror
Indemnitees, such consent not to be unreasonably withheld, provided that such
consent shall not be necessary if such settlement or compromise includes (i) the
payment of monetary damages by the Stockholders on behalf of such Acquiror
Indemnitees and (ii) the full release of such Persons. If the Stockholders shall
fail to defend, or if, after commencing or undertaking any such defense, the
Stockholders fail to prosecute or withdraws from such defense, the Acquiror
Indemnitees shall have the right to undertake the defense or settlement thereof
at the Stockholders's expense.
(c) Any Loss subject to indemnification pursuant to this Section 7.5
shall be offset against any appropriate number of Escrow Shares pursuant to the
terms and conditions of the Escrow Agreement.
(d) Notwithstanding any other provision herein to the contrary, (i)
following the Effective Time, the indemnification of Acquiror by the
Stockholders in this Section 7.5 shall be the exclusive remedy for any breach of
any representation, warranty, covenant or agreement of the Company or the
Stockholders in this Agreement or the Escrow Agreement, (ii) recourse for any
Loss shall be limited exclusively to the right to receive Escrow Shares in
accordance with the terms of this Agreement and the Escrow Agreement and (iii)
in determining the number of Escrow Shares required to satisfy any Loss, the
Escrow Shares shall be valued at the average closing price of Acquiror Common
Stock on The Nasdaq Stock Market for the five (5) trading days prior to the date
on which such Escrow Shares are delivered in satisfaction of a claim in respect
of such Loss.
7.6 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, its
Subsidiaries and the Stockholders 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
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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.
7.7 Reasonable Best Efforts. Subject to the terms and conditions hereof,
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 have removed
or rescinded any temporary, preliminary or permanent injunction, including the
injunctions or other orders described in Section 8.1(b). 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 (a) 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 and (b) the FCC and applicable state regulatory agencies and public
utilities commissions in connection with the transfer of any licenses required
hereunder, including without limitation, any license held by the Company under
Section 214 of the Communications 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.
7.8 Withdrawal of Company S-1. Prior to the Closing Date, the Company
shall file all necessary documents with the SEC and take all other necessary
steps to terminate the registration process with respect to the registration of
the shares of the Company's Common Stock under the Securities Act.
7.9 Proxy of Principal Stockholders. On or prior to its execution of this
Agreement, Acquiror shall receive from Chris Edgecomb, Mary Casey and David Vaun
Crumly proxies, substantially in the form of Exhibit C hereto (the "Proxies"),
which Proxies shall include, among other things, the agreement of such parties
to vote in favor of this Agreement and the transactions contemplated hereby,
including without limitation, the Merger.
7.10 Certain Events. Acquiror will promptly advise the Company and the
Stockholders in writing of any event or condition that would have a material
adverse effect on the ability of Acquiror to consummate the transactions
contemplated hereby, including without limitation, the Merger, or of any
material breach of Acquiror's representations or warranties or any material
breach of a covenant contained herein of which Acquiror has knowledge.
7.11 Financial Statements. As promptly as practical but no later than
forty five days following the end of each of the Company's fiscal quarters, the
Company shall deliver to Acquiror the Company's balance sheet and its statements
of operations, stockholders' equity and cash flows for such fiscal quarter,
which financial statements shall be accompanied by the certification of the
Company's chief financial officer that such financial statements have been
prepared in accordance with GAAP, consistently applied, subject only to normal
year-end adjustments.
7.12 Conduct of the Business of Acquiror Prior to the Effective Time.
Acquiror agrees that prior to the Effective Time, except as expressly permitted
by this Agreement or as otherwise consented to by the Company, which consent
shall not apply to Section 7.12(e), Acquiror:
(a) shall preserve intact its business organization and shall use all
reasonable efforts to keep available the services of its key operating personnel
and to preserve the goodwill of those parties having a material business
relationship with Acquiror;
(b) shall not change in any material respect Acquiror's accounting
methods, principles or practices, except for actions taken in the ordinary
course of business and actions consistent with or required by GAAP;
(c) shall not enter into a plan of dissolution or liquidation or
otherwise commence the winding down of Acquiror's operations;
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(d) shall not, except with respect to options granted and/or exercised
in the ordinary course of business, issue a material number of shares of
Acquiror Common Stock at a price that is more than 10% below the last closing
sales price of Acquiror Common Stock, as quoted on The Nasdaq Stock Market on
the trading day immediately prior to the date of issuance; and
(e) shall not enter into any transaction or series of relating
transactions with an aggregate purchase price of more than $100 million without
notifying the Company prior thereto.
ARTICLE VIII
CONDITIONS PRECEDENT
8.1 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) 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 Acquiror Common Stock entitled to vote thereon at the Special Meeting.
(b) No United States or state governmental authority or other agency or
commission or United States 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.
(c) Any waiting period applicable to the Merger under the HSR Act shall
have expired or been terminated.
(d) All material filings with the FCC required under the Communications
Act, with state agencies under state public utility statutes and with Foreign
Agencies under applicable foreign statutes shall have been made, and all
approvals with respect to such material filings shall have been received.
(e) 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.
(f) 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 dispose of all or a material portion of the business or
assets of Acquiror and the Subsidiaries, taken as a whole.
8.2 Conditions to the Obligation of the Company and the Stockholders 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
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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) Acquiror and each Stockholder shall have entered into a registration
rights and share restriction agreement in the form of Exhibit D hereto.
(f) The Company shall have received from Riordan & McKinzie, counsel to
the Acquiror and Newco, an opinion dated the Effective Time and covering such
matters as may be reasonably requested by the Company and the Stockholders.
(g) The Acquiror shall have taken all necessary steps such that ST will
become a member of the Board of Directors of the Acquiror immediately following
the Effective Time.
(h) The Company shall have received reasonably satisfactory evidence
that, following the Effective Date, (i) the shares of Acquiror Common Stock
issuable on exercise of the Options and Warrants will be subject to an effective
Registration Statement on Form S-8 filed by Acquiror pursuant to the Securities
Act, (ii) 250,000 shares of Acquiror Common Stock have been reserved for
issuance to selected distributors of the Company in the form of restricted
shares pursuant to restricted stock purchase agreements to be entered into
between such distributors and the Acquiror, at no consideration per share to
such distributors and with a pro rata vesting schedule of no more than four
years, such distributors to be designated by the Company and reasonably
acceptable to the Acquiror and (iii) 100,000 shares of Acquiror Common Stock
have been reserved for issuance to selected employees in the form of stock
options under the Acquiror's presently outstanding employee stock option plan,
with such selected employees to be designated by the Company and reasonably
acceptable to the Acquiror.
8.3 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 8.3.
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(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 8.3(e), which resignations shall be effective as of the Effective Time.
(f) The Acquiror shall have received from Swidler & Berlin, Chartered,
and Rakisons, domestic and foreign counsel to the Company, respectively,
opinions dated the Effective Time and covering such matters as may be reasonably
requested by Acquiror, such matters to include, among other things, opinions
relating to all federal, state and foreign regulatory approvals.
ARTICLE IX
TERMINATION, AMENDMENT AND WAIVER
9.1 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 Acquiror:
(a) by the mutual consent of Acquiror and the Company, acting through
their respective Boards of Directors;
(b) by Acquiror if (i) there has occurred a material adverse change in
the financial condition, results of operations, business or properties of the
Company and its Subsidiaries, taken as a whole, except for any change caused by
a general change in the economy of the United States or in the
telecommunications industry served by the Company, and except as otherwise
approved in writing by Acquiror, (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 (iii) the Company or the Stockholders fail to comply in
any material respect with any of the covenants or agreements contained herein
applicable thereto or otherwise wilfully breach or fail to perform pursuant to
the terms hereof, which breaches or failures, as the case may be, are, in the
aggregate, material in the context of the transactions contemplated by this
Agreement;
(c) by the Company (i) if there has occurred a material adverse change
in the financial condition, results of operations, business or properties of the
Acquiror, except for any change caused by a general change in the economy of the
United States or in the telecommunications industry served by Acquiror, and
except as otherwise approved in writing by the Company, (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 (iii) the Acquiror
or Newco fails to comply in any material respect with any of its covenants or
agreements contained herein or otherwise wilfully breaches or fails to perform
pursuant to the terms hereof, 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
(d) by either Newco or the Company, if on or before March 31, 1999 the
Merger shall not have been consummated, except as otherwise set forth in that
last clause of Section 3.1 and provided that neither party may terminate under
this Section 9.1(d) 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.
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 9.2, and
except that nothing herein will relieve any party from liability for any
willful breach of this Agreement prior to such termination or
abandonment.
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9.2 Termination Fee. If (a) this Agreement is terminated by Acquiror
pursuant to Section 9.1(b)(iii), (b) within six (6) months following such
termination, the Company and/or the Stockholders enter into an agreement or
series of related agreements contemplating the acquisition, 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 and (c) the value of the
consideration to be received by the stockholders of the Company with respect to
such transaction or transactions equals or exceeds $500 million (determined on
the execution of the agreement or agreements relating to such transaction or
transactions), then the Company shall, simultaneously with consummation of such
transaction or transactions, pay to Acquiror $20 million by wire transfer in
immediately available funds.
9.3 Amendment. Subject to the applicable provisions of the Business
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.
9.4 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.
ARTICLE X
MISCELLANEOUS
10.1 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 end of the Escrow Period.
10.2 Expenses and Fees. Each party to this Agreement shall bear his or its
own fees and expenses incurred in the connection with the transactions
contemplated hereby, provided that, in the context of the enforcement of the
terms and conditions of this Agreement, the prevailing party shall be entitled
to the payment of its reasonable legal fees and expenses incurred in connection
with the enforcement of such rights.
10.3 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.
233 East De La Guerra Street
Santa Barbara, California 93101
Attention: Chief Financial Officer
Fax: (805) 966-7593
with copies to:
Riordan & McKinzie
300 South Grand Avenue, 29th Floor
Los Angeles, California 90071
Attention: Timothy F. Sylvester, Esq.
Fax: (213) 229-8550
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<PAGE> 225
(b) if to the Company or the Stockholders, to:
PT-1 Communications, Inc.
30-50 Whitestone Expressway
Flushing, NY 11354
Attention: General Counsel
Fax: (718) 939-4976
with copies to:
Swidler & Berlin, Chartered
3000 K Street, N.W., Suite 300
Washington, D.C. 20007-5116
Attention: Morris DeFeo, Esq.
Fax: (202) 424-7643
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.
10.4 Headings. The headings contained in this Agreement are inserted for
convenience only and do not constitute a part of this Agreement.
10.5 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 delivering a
draft of any such press release to such parties.
10.6 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 actual knowledge of such party or, in
the case of Acquiror or the Company, the actual knowledge of the executive
officers thereof.
10.7 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. This Agreement is not
intended to confer upon any other person any rights or remedies hereunder.
10.8 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.
10.9 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.
10.10 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.
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<PAGE> 226
10.11 Governing Law. The validity and interpretation of this Agreement
shall be governed by and construed in accordance with the laws of the State of
New York, without reference to the conflict of laws principles thereof.
10.12 Termination of Original Agreement. On the execution and delivery of
this Agreement, the Original Agreement shall terminate and shall have no further
force or effect.
10.13 No Solicitation. Following the termination of this Agreement
pursuant to Section 9.1., for a period of one (1) year thereafter, the Aquiror
will not, directly or indirectly, initiate contact with any officer, director or
employee of the Company regarding the business, operations, prospects or
finances of the Company, or directly or indirectly solicit, for the purpose of
hiring, any such person.
[The remainder of this page is left blank intentionally]
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<PAGE> 227
IN WITNESS WHEREOF, Acquiror, Newco, the Company and the Stockholders have
caused this Agreement to be signed by their respective officers thereunto duly
authorized, all as of the date first written above.
ACQUIROR: STAR Telecommunications, Inc.
By:
------------------------------------
Christopher E. Edgecomb
NEWCO: Sierra Acquisition Co., Inc.
By:
------------------------------------
Christopher E. Edgecomb
COMPANY: PT-1 Communications, Inc.
By:
------------------------------------
Samer Tawfik
THE STOCKHOLDERS:
--------------------------------------
Samer Tawfik
--------------------------------------
Peter M. Vita
--------------------------------------
Douglas Barley
--------------------------------------
Joseph A. Pannullo
--------------------------------------
John J. Klusaritz
A-32
<PAGE> 228
FIRST AMENDMENT
TO
AMENDED AND RESTATED
AGREEMENT AND PLAN OF MERGER
FIRST AMENDMENT TO AMENDED AND RESTATED AGREEMENT AND PLAN OF MERGER dated
as of September 1, 1998 (the "First Amendment"), by and among STAR
Telecommunications, Inc., a Delaware corporation (the "Acquiror"), Sierra
Acquisition Co., Inc., a New York corporation and wholly-owned subsidiary of the
Acquiror ("Newco"), PT-1 Communications, Inc., a New York corporation (the
"Company"), and Samer Tawfik, Peter M. Vita, Douglas Barley, Joseph A. Pannullo
and John J. Klusaritz (collectively, the "Stockholders").
RECITALS:
A. Acquiror, Newco, the Company and the Stockholders previously entered
into an Amended and Restated Agreement and Plan of Merger dated August 20, 1998
(the "Amended Merger Agreement").
B. The parties to the Amended Merger Agreement wish to enter into this
First Amendment to modify the terms of the Amended Merger Agreement, to the
extent set forth below.
C. Capitalized terms not otherwise defined herein shall have the meanings
therefor as set forth in the Amended Merger Agreement.
AGREEMENT
NOW, THEREFORE, in consideration of the mutual representations, warranties,
covenants, agreements and conditions contained herein, the sufficiency of which
is hereby acknowledged by the parties, the parties hereby agree as follows:
1. Share Issuance; Cash Component. Section 2.1(a) of the Amended Merger
Agreement shall be deleted in its entirety and shall be replaced with the
following:
"(a) The issued and outstanding shares of the capital stock of the
Company outstanding at the Effective Time shall be automatically converted
into the right to receive an aggregate of (i) 15,050,000 shares (the "Share
Issuance") of the Acquiror's common stock, $0.001 par value per share
("Acquiror Common Stock"), based on an exchange ratio determined by the
Company and the Stockholders immediately prior to the Effective Time,
taking into account all Warrants and Options then outstanding, and (ii)
$19,500,000 (the "Cash Component"), which shall be allocated in a manner
determined by the Company and the Stockholders immediately prior to the
Effective Time. The number of shares of Acquiror Common Stock subject to
the Share Issuance shall be adjusted as may be necessary and appropriate to
reflect any and all stock splits, reverse stock splits, reclassifications,
recapitalizations, dividends payable in shares of Acquiror Common Stock or
in any other securities convertible into or exchangeable for shares of
Acquiror Common Stock and similar capital events that affect Acquiror
Common Stock. Notwithstanding anything contained in this Agreement to the
contrary, under no circumstance shall the number of shares of Acquiror
Common Stock subject to the Share Issuance or the Cash Component exceed the
amounts set forth in the first sentence of this Section 2.1(a)."
2. Escrow. The first clause of Section 2.2 of the Amended Merger Agreement
shall be deleted in its entirety and replaced with the following clause, "A
total of One Million Five Hundred and Five Thousand (1,505,000) shares of
Acquiror Common Stock (the "Escrow Shares") . . . . " The third sentence of
Section 2.2 of the Amended Merger Agreement shall be modified by adding the
following proviso at the end thereof, "provided that a portion of the Escrow
Shares may be released to the Stockholders on a quarterly basis during the
Escrow Period, as further set forth in the Escrow Agreement."
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<PAGE> 229
3. Conduct of Business. The first clause of Section 7.2 of the Amended
Merger Agreement shall be deleted in its entirety and replaced with the
following:
"The Company and the Stockholders agree that, prior to the Effective
Time, all material managerial and operational matters shall be presented to
and subject to the reasonable review and approval of the Acquiror. In that
regard, except as otherwise consented to or approved in writing by the
Acquiror or expressly permitted by this Agreement:"
4. Management Meetings. The penultimate sentence of Section 7.2 of the
Amended Merger Agreement shall be deleted in its entirety and replaced with the
following sentence:
"On a weekly basis, representatives of the Company shall meet with the
chief executive officer or chief financial officer of the Acquiror to
discuss the Company and all ongoing operational issues and matters and
shall provide such periodic financial information and data as may be
requested by the Acquiror. Each such meeting shall be scheduled at a time
that is mutually convenient to the respective representatives of each of
the Company and the Acquiror. Any such meeting may, at the election of the
parties, be held via telephonic conference call."
5. Material Adverse Change. Section 8.3(c) of the Amended Merger Agreement
shall be deleted in its entirety and replaced with the following:
"(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, other than any change arising from any action authorized, directed
or otherwise approved by the Acquiror pursuant to Section 7.2 or from the
Acquiror's express refusal to approve any action proposed by the Company
under Section 7.2 and excluding any such change caused by a general change
in the economy or in the telecommunications industry served by the Company
and its Subsidiaries."
6. Termination. Section 9.1(b)(i) of the Amended Merger Agreement shall be
deleted in its entirety and replaced with the following:
"(i) there has occurred a material adverse change in the financial
condition, results of operations, business or properties of the Company and
its Subsidiaries, taken as a whole, other than any change arising from any
action authorized, directed or otherwise approved by the Acquiror pursuant
to Section 7.2 or from the Acquiror's express refusal to approve any action
proposed by the Company under Section 7.2 and except for any change caused
by a general change in the economy of the United States or in the
telecommunications industry served by the Company,"
7. Exchange Ratio Information. A new Section 8.3(g) should be added to the
Amended Merger Agreement and should read as follows:
"(g) The Acquiror shall have received from the Company and the
Stockholders the allocation of shares of Acquiror Common Stock subject to
the Share Issuance and the allocation of the Cash Component."
8. Hickey Shares. A new Section 9.5 shall be added to the Amended Merger
Agreement to read as follows:
"9.5 Hickey Shares. Notwithstanding anything contained in this
Agreement to the contrary, if any shares of Common Stock held by Thomas
Hickey, any trust affiliated therewith and/or any successors and assigns
thereof do not vote in favor of the Merger, such failure to vote in favor
of the Merger (a) shall not be deemed a breach of this Agreement by the
Company or by the Stockholders, (b) shall not be deemed a failure of a
condition precedent to the Acquiror's obligation to otherwise consummate
the Merger pursuant to the terms hereof, (c) shall not be a basis for
termination of this Agreement by the Acquiror and (d) shall not alter the
consideration to be received in the Merger by any other stockholder of the
Company."
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<PAGE> 230
9. No Further Amendment. Except as otherwise modified above, the Amended
Merger Agreement shall remain in full force and effect without further
amendment, modification or alteration thereof.
[The remainder of this page intentionally left blank]
A-35
<PAGE> 231
IN WITNESS WHEREOF, Acquiror, Newco, the Company and the Stockholders have
caused this First Amendment to be signed by their respective officers thereunto
duly authorized, all as of the date first written above.
ACQUIROR: STAR Telecommunications, Inc.
By:
--------------------------------------
Kelly Enos
Chief Financial Officer
NEWCO: Sierra Acquisition Co., Inc.
By:
--------------------------------------
Kelly Enos
Chief Financial Officer
COMPANY: PT-1 Communications, Inc.
By:
--------------------------------------
Samer Tawfik
Chief Executive Officer
THE STOCKHOLDERS: --------------------------------------
Samer Tawfik
--------------------------------------
Peter M. Vita
--------------------------------------
Douglas Barley
--------------------------------------
Joseph A. Pannullo
--------------------------------------
John J. Klusaritz
A-36
<PAGE> 232
ANNEX B
August 20, 1998
Confidential
The Board of Directors
STAR Telecommunications, Inc.
223 East De La Guerra Street
Santa Barbara, California 93101
Ladies and Gentlemen:
You have requested our opinion as to the fairness from a financial point of
view to STAR Telecommunications, Inc. ("STAR" or the "Company") of the
consideration to be paid by the Company in connection with the proposed
acquisition by STAR of the common stock of PT-1 Communications, Inc ("PT-1")
(the "Proposed Transaction") under the terms of the Amended and Restated
Agreement and Plan of Merger, dated as of August 20, 1998, among STAR, Sierra
Acquisition Co., Inc., PT-1, and certain shareholders of PT-1 and the related
Exhibits and Schedules thereto (the "Agreement"). The Agreement provides, among
other things, that STAR will, upon consummation of the Proposed Transaction,
issue 15,000,000 shares of STAR common stock (the "Shares") and pay $20,000,000
in cash in exchange for all of the outstanding common stock of PT-1. In
addition, STAR and certain shareholders of PT-1 have entered into a Registration
Rights and Restricted Share Agreement dated as of August 20, 1998 (the "Lock-up
Agreement") pursuant to which the Shares will be subject to certain resale
restrictions for a period of up to two years, as more fully described in the
Lock-up Agreement. For purposes of this opinion, we have assumed that the
Proposed Transaction will qualify as a tax-free reorganization under the United
States Internal Revenue Code and that the Proposed Transaction will be accounted
for as a purchase.
Hambrecht & Quist LLC ("Hambrecht & Quist"), as part of its investment
banking services, is regularly engaged in the valuation of businesses and their
securities in connection with mergers and acquisitions, strategic transactions,
corporate restructurings, negotiated underwritings, secondary distributions of
listed and unlisted securities, private placements and valuations for corporate
and other purposes. We have acted as a financial advisor to the Board of
Directors of STAR in connection with the Proposed Transaction, and we will
receive a fee for our services, which include the rendering of this opinion.
In the past, we have provided investment banking and other financial
advisory services to STAR and have received fees for rendering these services.
In particular, Hambrecht & Quist acted as lead managing underwriter in the
Company's initial public offering in 1997 and as co-managing underwriter in the
Company's follow-on offering in 1998. In the ordinary course of business,
Hambrecht & Quist acts as a market maker and broker in the publicly traded
securities of STAR and receives customary compensation in connection therewith,
and also provides research coverage for STAR. In the ordinary course of
business, Hambrecht & Quist actively trades in the equity and derivative
securities of STAR for its own account and for the accounts of its customers
and, accordingly, may at any time hold a long or short position in such
securities. Hambrecht & Quist may in the future provide additional investment
banking or other financial advisory services to STAR. Hambrecht & Quist is also
familiar with PT-1, having participated in the preparation of a registration
statement on Form S-1 in connection with its potential initial public offering.
In connection with our review of the Proposed Transaction, and in arriving
at our opinion, we have, among other things:
(i) reviewed the publicly available financial statements of STAR for
recent years and interim periods to date and certain other relevant
financial and operating data of STAR made available to us from
published sources and from the internal records of STAR;
(ii) reviewed certain internal financial and operating information,
including certain projections, relating to STAR prepared by the
management of STAR;
B-1
<PAGE> 233
(iii) discussed the business, financial condition and prospects of STAR
with certain of its officers;
(iv) reviewed the financial statements of PT-1 for recent years and
interim periods to date and certain other relevant financial and
operating data of PT-1 made available to us from published sources
and from the internal records of PT-1;
(v) reviewed certain internal financial and operating information,
including certain projections, relating to PT-1 prepared by the
management of PT-1;
(vi) discussed the business, financial condition and prospects of the PT-1
with certain of its officers;
(vii) reviewed the recent reported prices and trading activity for the
common stock of STAR and compared such information and certain
financial information for STAR with similar information for certain
other companies engaged in businesses we consider comparable;
(viii) reviewed the financial terms, to the extent publicly available, of
certain comparable merger and acquisition transactions;
(ix) reviewed the Agreement and the Lock-up Agreement; and
(x) performed such other analyses and examinations and considered such
other information, financial studies, analyses and investigations and
financial, economic and market data as we deemed relevant.
In rendering our opinion, we have assumed and relied upon the accuracy and
completeness of all of the information concerning STAR or PT-1 considered in
connection with our review of the Proposed Transaction, and we have not assumed
any responsibility for independent verification of such information. We have not
undertaken any independent valuation or appraisal of any of the assets or
liabilities of STAR or PT-1; nor have we conducted a physical inspection of the
properties and facilities of either company. With respect to the financial
forecasts and projections made available to us and used in our analysis, we have
assumed that they reflect the best currently available estimates and judgments
of the expected future financial performance of STAR and PT-1. For purposes of
this opinion, we have assumed that neither STAR nor PT-1 is a party to any
pending transactions, including external financings, recapitalizations or
material merger discussions, other than the Proposed Transaction and those
activities undertaken in the ordinary course of conducting their respective
businesses. Our opinion is necessarily based upon market, economic, financial
and other conditions as they exist and can be evaluated as of the date of this
letter and any change in such conditions would require a reevaluation of this
opinion.
It is understood that this letter is for the information of the Board of
Directors in connection with its evaluation of the Proposed Transaction and may
not be used for any other purpose without our prior written consent; provided,
however, that this letter may be reproduced in full in the Proxy Statement
relating to the Proposed Transaction. This letter does not constitute a
recommendation to any stockholder as to how such stockholder should vote on the
Proposed Transaction.
Based upon and subject to the foregoing and after considering such other
matters as we deem relevant, we are of the opinion that as of the date hereof
the consideration to be paid by STAR in the Proposed Transaction is fair to the
Company from a financial point of view.
Very truly yours,
HAMBRECHT & QUIST LLC
By: /s/ DAVID G. GOLDEN
----------------------------------
David G. Golden
Managing Director
B-2
<PAGE> 234
ANNEX C
September 10, 1998
Board of Directors
STAR Telecommunications, Inc.
223 East De La Guerra Street
Santa Barbara, California 93101
Dear Sirs and Madam:
You have asked us to advise you with respect to the fairness to STAR
Telecommunications, Inc. (the "Acquiror") from a financial point of view of the
consideration to be paid by the Acquiror pursuant to the terms of the Amended
and Restated Agreement and Plan of Merger, dated as of August 20, 1998, (the
"Merger Agreement"), among PT-1 Communications, Inc. (the "Company"), the
Acquiror, Sierra Acquisition Co., Inc. (the "Sub") and certain stockholders of
the Company named therein. The Merger Agreement provides for the merger (the
"Merger") of the Sub with and into the Company pursuant to which the Company
will be the surviving entity and will become a wholly owned subsidiary of the
Acquiror. The Merger Agreement also provides that STAR will issue 15 million
shares of its common stock and pay $20 million (the Acquiror common stock and
the cash, collectively the "Merger Consideration") in exchange for all of the
outstanding common stock of the Company.
In arriving at our opinion, we have reviewed certain publicly available
business and financial information relating to the Company and the Acquiror, as
well as the Merger Agreement. We have also reviewed certain other information,
including financial forecasts, provided to us by the Company and the Acquiror,
and have met with the Company's and the Acquiror's managements to discuss the
business and prospects of the Company and the Acquiror.
We have also considered certain financial and stock market data, as
applicable, of the Company and the Acquiror, and we have compared those data
with similar data for other publicly held companies in businesses similar to the
Company and the Acquiror and we have considered the financial terms of certain
other business combinations and other transactions which have recently been
effected. We also considered such other information, financial studies, analyses
and investigations and financial, economic and market criteria which we deemed
relevant.
In connection with our review, we have not assumed any responsibility for
independent verification of any of the foregoing information and have relied on
its being complete and accurate in all material respects. With respect to the
financial forecasts, we have assumed that they have been reasonably prepared on
bases reflecting the best currently available estimates and judgments of the
Company's management and the Acquiror's management as to the future financial
performance of the Company and the Acquiror, respectively. In addition, we have
not been requested to make, and have not made, an independent evaluation or
appraisal of the assets or liabilities (contingent or otherwise) of the Company
or the Acquiror, nor have we been furnished with any such evaluations or
appraisals. Our opinion is necessarily based upon financial, economic, market
and other conditions as they exist and can be evaluated on the date hereof. We
are not expressing any opinion as to the actual value of the Acquiror's common
stock when issued to the Company's stockholders pursuant to the Merger or the
prices at which such common stock will trade subsequent to the Merger.
We have acted as financial advisor to the Acquiror in connection with the
Merger and will receive a fee for our services, which fee is contingent upon the
consummation of the Merger.
In the ordinary course of our business, we and our affiliates may actively
trade the debt and equity securities of both the Company and the Acquiror for
our and such affiliates' own accounts and for the accounts of 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 the Acquiror in connection with its consideration of the Merger and
is not to be quoted or referred to, in whole or in part, in any registration
statement, prospectus or proxy statement, or in any other document used in
connection with
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<PAGE> 235
the offering or sale of securities, nor shall this letter be used for any other
purposes, without our prior written consent.
Based upon and subject to the foregoing, it is our opinion that, as of the
date hereof, the Merger Consideration to be paid by the Acquiror in the Merger
is fair to the Acquiror from a financial point of view.
Very truly yours,
CREDIT SUISSE FIRST BOSTON
CORPORATION
C-2
<PAGE> 236
STAR TELECOMMUNICATIONS, INC.
SPECIAL MEETING OF STOCKHOLDERS NOVEMBER 17, 1998
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
The undersigned stockholder of STAR Telecommunications, Inc., a Delaware
corporation (the "Company") hereby acknowledges receipt of the Notice of Special
Meeting of Stockholders and Proxy Statement, each dated October , 1998, and
hereby appoints Christopher E. Edgecomb, Mary A. Casey and Kelly D. Enos, and
each of them, the true and lawful attorneys and proxies of the undersigned, with
full power of substitution, to vote all shares of the Common Stock, $.001 par
value ("Common Stock"), of the Company which the undersigned is entitled to
vote, at the Special Meeting of the Stockholders of the Company to be held at
801 Garden Street, Room 203, Santa Barbara, California on Tuesday, November 17,
1998 at 9:00 a.m., Pacific Time, and at any and all adjournments thereof, on the
proposals set forth below:
THIS PROXY WILL BE VOTED AS DIRECTED AND AS SAID PROXIES DEEM ADVISABLE ON
SUCH OTHER MATTERS AS MAY PROPERLY COME BEFORE THE MEETING OR ANY POSTPONEMENTS
OR ADJOURNMENTS THEREOF. ANY PROPOSAL WITH RESPECT TO WHICH A STOCKHOLDER FAILS
TO SO SPECIFY WILL BE VOTED IN ACCORDANCE WITH THE RECOMMENDATION OF THE BOARD.
(See reverse side)
<PAGE> 237
(Continued on reverse side)
THE DIRECTORS UNANIMOUSLY RECOMMEND A VOTE FOR THE APPROVAL OF PROPOSAL 1.
1. Proposal to approve and adopt an Amended and Restated Agreement and Plan of
Merger (the "Merger Agreement") by and among the Company, Sierra Acquisition
Co., Inc., a New York corporation and wholly-owned subsidiary of the Company
("Newco"), PT-1 Communications, Inc., a New York corporation ("PT-1") and
certain stockholders of PT-1, as amended, and the transactions contemplated
thereby, including the merger of Newco with and into PT-1, after which PT-1
will survive as a wholly-owned subsidiary of the Company, and the issuance of
15.05 million shares of Common Stock.
[ ] FOR [ ] AGAINST [ ] ABSTAIN
2. Such other matters as may properly come before the Meeting.
Dated:............., 1998
-------------------------
(Signature)
-------------------------
(Signature)
Please sign exactly as
your name appears hereon.
When shares are held by
joint tenants, both
should sign. When signing
as attorney, as executor,
administrator, trustee or
guardian, please give
full title as such. If a
corporation, please sign
in full corporate name by
President or other
authorized officer. If a
partnership, please sign
in partnership name by
authorized person.
