<PAGE>
FILED PURSUANT TO RULE 424((b)(4)
REGISTRATION NO. 333-48559
6,000,000 Shares
[LOGO]
STAR TELECOMMUNICATIONS, INC.
Common Stock
---------
Of the 6,000,000 shares of Common Stock offered hereby, 5,685,000 shares are
being sold by STAR Telecommunications, Inc. ("STAR" or the "Company") and
315,000 shares are being sold by a certain stockholder of the Company (the
"Selling Stockholder"). The Company will not receive any of the proceeds from
the sale of shares by the Selling Stockholder. See "Principal and Selling
Stockholders." The Company's Common Stock is quoted on the Nasdaq National
Market under the symbol "STRX." On April 28, 1998, the last reported sale price
of the Common Stock on the Nasdaq National Market was $28.9375 per share.
--------------
THE COMMON STOCK OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" BEGINNING ON PAGE 7 HEREOF.
-------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
PRICE UNDERWRITING PROCEEDS PROCEEDS
TO DISCOUNTS AND TO TO SELLING
PUBLIC COMMISSIONS(1) COMPANY(2) STOCKHOLDERS
<S> <C> <C> <C> <C>
Per Share........................ $27.00 $1.22 $25.78 $25.78
Total(3)......................... $162,000,000 $7,320,000 $146,559,300 $8,120,700
</TABLE>
(1) See "Underwriting" for indemnification arrangements with the several
Underwriters.
(2) Before deducting expenses payable by the Company estimated at $1,500,000.
(3) The Company, the Selling Stockholder and certain other stockholders of the
Company (collectively, with the Selling Stockholder, the "Selling
Stockholders") have granted the Underwriters a 30-day option to purchase up
to 900,000 additional shares of Common Stock solely to cover
over-allotments, if any. To the extent that the option is exercised, the
Underwriters will offer the additional shares at the Price to Public shown
above. If the option is exercised in full, the total Price to Public,
Underwriting Discounts and Commissions, Proceeds to Company and Proceeds to
Selling Stockholders will be $186,300,000, $8,418,000 and $150,426,300 and
$27,455,700, respectively. See "Underwriting."
----------------
The shares of Common Stock are offered by the several Underwriters, subject
to prior sale, when, as and if delivered to and accepted by them, and subject to
the right of the Underwriters to reject any order in whole or in part. It is
expected that delivery of the shares of Common Stock will be made at the offices
of BT Alex. Brown Incorporated, Baltimore, Maryland, on or about May 4, 1998.
BT ALEX. BROWN
MERRILL LYNCH & CO.
HAMBRECHT & QUIST
LEHMAN BROTHERS
FURMAN SELZ
The date of this Prospectus is April 29, 1998.
<PAGE>
DESCRIPTION OF FORWARD-LOOKING STATEMENTS
This Prospectus contains "forward-looking statements," as defined under
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 "believes," "anticipates," "intends" or
"expects." These forward-looking statements relate to plans, objectives and
expectations for future operations of STAR. In light of the risks and
uncertainties inherent in all such projected operation matters, the inclusion of
forward-looking statements in this Prospectus should not be regarded as a
representation by the Company or any other person that the objectives or plans
of the Company will be achieved or that any of the Company's operating
expectations will be realized. Revenues and results of operations are difficult
to forecast and could differ materially from those projected in the
forward-looking statements contained in this Prospectus. Forward-looking
statements may be deemed to include those set forth in "Prospectus Summary,"
regarding the Company's introduction into service of various international
gateway switches, commitments to acquire undersea cables and various aspects of
the Company's strategy. Such forward-looking statements may be deemed to include
statements in "Management's Discussion and Analysis of Financial Condition and
Results of Operations," regarding the Company'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" may be deemed to include projected growth in international
telecommunications traffic, the Company's strategy of marketing its services to
foreign-based long distance providers, expanding its U.S. and developing
European and Asian switching capabilities, expanding into commercial markets,
and pursuing acquisitions. Actual results could differ from those projected in
any forward-looking statements for the reasons detailed in the "Risk Factors"
section of the Prospectus, beginning on page 7, or elsewhere in this Prospectus.
The Company undertakes no 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 the Company's operating
strategy.
------------------------
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK OF
THE COMPANY, INCLUDING BY ENTERING STABILIZING BIDS, EFFECTING SYNDICATE
COVERING TRANSACTIONS OR IMPOSING PENALTY BIDS. FOR A DESCRIPTION OF THESE
ACTIVITIES, SEE "UNDERWRITING."
IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS AND SELLING GROUP
MEMBERS (IF ANY) OR THEIR RESPECTIVE AFFILIATES MAY ENGAGE IN PASSIVE MARKET
MAKING TRANSACTIONS IN THE COMMON STOCK ON THE NASDAQ NATIONAL MARKET IN
ACCORDANCE WITH REGULATION M. SEE "UNDERWRITING."
2
<PAGE>
SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION AND CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO APPEARING
ELSEWHERE IN THIS PROSPECTUS. SEE "AVAILABLE INFORMATION." UNLESS OTHERWISE
INDICATED, THE INFORMATION IN THIS PROSPECTUS (I) ASSUMES NO EXERCISE OF THE
UNDERWRITERS' OVER-ALLOTMENT OPTION, (II) GIVES EFFECT TO A 2.05-FOR-1 STOCK
SPLIT PAID ON MARCH 31, 1998 IN THE FORM OF A STOCK DIVIDEND TO THE HOLDERS OF
ALL SHARES OF COMMON STOCK OUTSTANDING ON FEBRUARY 20, 1998 WITH THE PAYMENT OF
1.05 SHARES FOR EACH SUCH OUTSTANDING SHARE OF COMMON STOCK (THE "STOCK SPLIT")
AND (III) ASSUMES NO EXERCISE OF OPTIONS OUTSTANDING AS OF FEBRUARY 28, 1998.
THIS PROSPECTUS CONTAINS "FORWARD-LOOKING STATEMENTS," AS DEFINED IN SECTION 27A
OF THE SECURITIES ACT. THE COMPANY'S ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY
FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT MIGHT
CAUSE SUCH A DIFFERENCE INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN
"RISK FACTORS."
THE COMPANY
STAR Telecommunications, Inc. ("STAR" or the "Company") 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 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. The Company has
grown its revenues rapidly by capitalizing on the deregulation of international
telecommunications markets, combining sophisticated information systems with
flexible routing and leveraging management's industry expertise. STAR has
increased its revenues from $46.3 million in 1995 to $376.2 million in 1997.
The Company serves the large and growing international long distance
telecommunications market. According to industry sources, worldwide gross
revenues in this market were over $60 billion in 1996 and the volume of
international traffic on the public telephone network is expected to grow at a
compound annual growth rate of approximately 13% from 1996 through the year
2000.
STAR markets its services to large global carriers seeking lower rates and
high quality overflow capacity, as well as to small and medium-sized long
distance companies that do not have the critical mass to invest in their own
international transmission facilities or to obtain volume discounts from the
larger facilities-based carriers. During the fourth quarter of 1997, the Company
provided switched international long distance services to 105 customers and
currently provides these services to nine of the top forty global carriers. The
Company 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.
The Company currently operates international gateway switching facilities in
New York, Los Angeles, Dallas and London, England. In 1998, the Company plans to
put into service switches in Atlanta, Chicago, Miami and Seattle; Dusseldorf,
Frankfurt, Hamburg and Munich, Germany; Paris, France; and Tokyo, Japan. STAR's
switching facilities are linked to a proprietary reporting system, which the
Company 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. The
Company holds ownership positions in a number of digital undersea fiber optic
cables, has recently added capacity on the TPC-5 undersea fiber optic cable
system and has entered into commitments to acquire transmission capacity on
three additional undersea fiber optic cable systems, Gemini, AC-1 and China-US.
3
<PAGE>
STRATEGY
The Company'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 the Company's strategy include
the following:
CAPITALIZE ON PROJECTED INTERNATIONAL LONG DISTANCE GROWTH. The Company
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. The
Company targets international markets with high volumes of traffic, relatively
high rates per minute and prospects for deregulation and privatization. The
Company believes that the ongoing trend toward deregulation and privatization
will create new opportunities for the Company in international markets. Although
the Company has focused to date primarily on providing services for U.S.-based
long distance providers, the Company also intends to expand the international
long distance services it offers to foreign-based long distance providers.
LEVERAGE TRAFFIC VOLUME TO REDUCE COSTS. The Company continues to focus on
building its volume of international long distance traffic. Higher traffic
volumes strengthen the Company's negotiating position with vendors, customers
and potential foreign partners, which allows the Company to lower its costs of
service. In addition, higher traffic volumes on particular routes allow the
Company 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. The Company
leverages its sophisticated information systems to analyze its routing
alternatives, and select the most cost-effective routing from among the Company
owned facilities, network of resale arrangements with other long distance
providers, operating agreements and alternative termination relationships. The
Company has invested significant resources in the development of software to
track specific usage information by customer and revenue and cost information on
specific routes on a daily basis. The Company'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. The Company 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. The Company'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. The Company 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. The Company recently acquired
L.D. Services, Inc. ("LDS") and intends to acquire United Digital Network, Inc.
("UDN"). The Company 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, the Company 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, the Company initially
intends to focus on Germany, the U.K. and selected European cities where
competition for commercial customers is less mature.
4
<PAGE>
GROWTH THROUGH ACQUISITIONS. The Company actively pursues opportunities to
enhance its business through strategic and synergistic acquisitions. These
acquisitions may focus on entering new territories, enlarging the Company'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, the Company plans to realize operating efficiencies by integrating
newly-acquired operations into the Company's billing, tracking and other
systems. On November 30, 1997, the Company acquired LDS, a long distance
provider focusing on small commercial customers throughout the United States,
for approximately 849,000 shares of Common Stock. On March 10, 1998, the Company
acquired T-One Corp. ("T-One"), an international
wholesale long distance provider, for 1,353,000 shares of Common Stock. On
November 19, 1997, the Company entered into an agreement to acquire UDN, a
commercial long distance provider. The acquisition of UDN is subject to approval
by UDN's stockholders and to various regulatory approvals. Assuming the receipt
of all necessary approvals, STAR expects to consummate the UDN acquisition in
the second quarter of 1998 for approximately 800,000 shares of Common Stock.
Each of these transactions has been, or will be, accounted for as a pooling of
interests.
STAR was incorporated in Nevada in September 1993 as STAR Vending, Inc. and
was reincorporated in Delaware as STAR Telecommunications, Inc. in April 1997.
STAR's executive offices are located at 223 East De La Guerra Street, Santa
Barbara, California 93101. Its telephone number at that location is (805)
899-1962.
5
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common Stock offered by the Company................... 5,685,000 shares
Common Stock to be outstanding after the Offering..... 39,363,519 shares(1)
Use of proceeds....................................... Capital expenditures, working capital and
general corporate purposes. See "Use of
Proceeds."
Nasdaq National Market symbol......................... STRX
</TABLE>
SUMMARY CONSOLIDATED FINANCIAL INFORMATION AND OPERATING DATA
(in thousands, except per share and per minute data)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------
1995 1996 1997
1994 --------- --------- ---------
-----------
(UNAUDITED)
<S> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA(2):
Revenues.......................................................... $ 20,915 $ 46,283 $ 237,991 $ 376,198
Gross profit...................................................... 8,140 14,386 32,406 50,961
Income (loss) from operations..................................... 3,328 4,114 (3,076) 11,049
Net income (loss)................................................. $ 3,323 $ 3,973 $ (4,220) $ 5,568
Pro forma net income (loss)(unaudited)(3)......................... $ 1,994 $ 2,407 $ (5,163) $ 5,373
Pro forma diluted income (loss) per share(unaudited)(4)........... $ 0.12 $ 0.13 $ (0.24) $ 0.17
Weighted average number of diluted common shares outstanding(4)... 16,865 18,020 21,939 31,625
OTHER CONSOLIDATED FINANCIAL AND OPERATING DATA(2):
EBITDA(5)......................................................... $ 3,351 $ 4,267 $ (1,986) $ 13,849
Capital expenditures(6)........................................... 57 2,175 13,018 24,732
Wholesale billed minutes of use................................... -- 38,106 479,681 863,295
Wholesale revenue per billed minute of use(7)..................... -- $ 0.4102 $ 0.4288 $ 0.3997
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-------------------------
ACTUAL
--------- AS ADJUSTED(8)
--------------
(UNAUDITED)
<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA(2):
Working capital...................................................................... $ 15,846 $ 160,905
Total assets......................................................................... 113,553 258,612
Long-term liabilities, net of current portion........................................ 12,271 12,271
Stockholders' equity................................................................. 44,014 189,073
</TABLE>
- ------------------------------
(1) Based on the number of shares outstanding as of December 31, 1997. Excludes
3,497,097 shares subject to outstanding options as of December 31, 1997 at a
weighted average exercise price of approximately $3.54 per share. Also
excludes 1,794,978 shares reserved for issuance under the Company's stock
plans. See "Management--1997 Omnibus Stock Incentive Plan," "--1996 Outside
Director Nonstatutory Stock Option Plan" and Note 10 of Notes to
Consolidated Financial Statements.
(2) Does not reflect the acquisition of T-One, which was consummated on March
10, 1998, or the acquisition of UDN, which remains subject to the approval
of UDN's stockholders and to various regulatory approvals. If the Company's
financial statements had been restated to include the combined operating
results of the Company and T-One at the beginning of the audited periods
presented, revenues would have been $58.9 million, $260.4 million and $406.6
million, gross profit would have been $14.7 million, $33.7 million and $52.8
million and net income (loss) would have been $2.1 million, $(5.7) million
and $5.6 million for the years ended December 31, 1995, 1996 and 1997,
respectively. See Note 14 of Notes to Consolidated Financial Statements.
(3) The pro forma net income or loss per share assumes that both STAR and LDS
had been C-Corporations for all periods presented.
(4) See Note 2 of Notes to Consolidated Financial Statements for an explanation
of the method used to determine the number of shares used in computing pro
forma net income (loss) per share.
(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 and does not
necessarily indicate that cash flows are sufficient to fund all the
Company'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 the Company's liquidity determined in accordance with generally
accepted accounting principles.
(6) Includes assets financed with capital leases or notes. See Note 2 of Notes
to Consolidated Financial Statements.
(7) Represents wholesale gross call usage revenue per billed minute. Amounts
exclude other revenue related items such as finance charges.
(8) Adjusted to reflect the sale of 5,685,000 shares of Common Stock by the
Company at the offering price of $27.00 per share and the application of the
estimated net proceeds therefrom. See "Use of Proceeds" and
"Capitalization."
6
<PAGE>
RISK FACTORS
THE FOLLOWING RISK FACTORS SHOULD BE CONSIDERED CAREFULLY IN ADDITION TO THE
OTHER INFORMATION CONTAINED IN THIS PROSPECTUS BEFORE PURCHASING THE SHARES OF
COMMON STOCK OFFERED HEREBY. THIS PROSPECTUS CONTAINS, IN ADDITION TO HISTORICAL
INFORMATION, "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF SECTION 27A OF
THE SECURITIES ACT THAT INVOLVE RISKS AND UNCERTAINTIES. 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 PROSPECTUS. SEE
"DESCRIPTION OF FORWARD-LOOKING STATEMENTS."
OPERATING RESULTS SUBJECT TO SIGNIFICANT FLUCTUATIONS
The Company'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, the Company believes that
period-to-period comparisons of its operating results are not necessarily
meaningful and should not be relied upon as indications of future performance.
FACTORS INFLUENCING OPERATING RESULTS, INCLUDING REVENUES, COSTS AND
MARGINS. The Company's revenues, costs and expenses have fluctuated
significantly in the past and are likely to continue to fluctuate significantly
in the future as a result of numerous factors. The Company'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 the Company's traffic; financial difficulties of major customers;
pricing pressure resulting from increased competition; and technical
difficulties with or failures of portions of the Company's network that impact
the Company's ability to provide service to or bill its customers. The Company'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 the
Company'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 the
Company's sales incentive plans; and costs associated with changes in staffing
levels of sales, marketing, technical support and administrative personnel. In
addition, the Company'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 the Company'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 the Company is obtained on a variable, per
minute and short term basis, subjecting the Company to the possibility of
unanticipated price increases and service cancellations. Since the Company 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, the Company's gross margins are subject to significant fluctuations over
short periods of time. The Company's gross margins also may be negatively
impacted in the longer term by competitive pricing pressures.
EXAMPLES OF FACTORS AFFECTING OPERATING RESULTS. The Company has in the
past encountered significant difficulties in the collection of accounts
receivable from certain of its customers. For example, in the fourth quarter of
1996 and the first quarter of 1997, Hi-Rim Communications, Inc. ("Hi-Rim"),
formerly one of the Company's major customers and Cherry Communications, Inc.
("CCI"), the Company's largest customer in 1996 experienced financial
difficulties and were unable to pay in full, on a timely basis, outstanding
accounts receivable. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations." In early 1997, the Company implemented
more stringent credit policies and monitoring systems. There can be no
assurance, however, that if the Company experiences similar difficulties in the
collection of future accounts receivable from its customers, the Company's
financial condition and results of operations would not be materially adversely
affected.
7
<PAGE>
ABILITY TO CONTINUE AND MANAGE GROWTH; COMMERCIAL MARKET
The Company has increased revenues from $46.3 million in 1995 to $376.2
million in 1997, with revenues increasing in each of the last ten 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 the Company's operating expenses varies with its revenues. This effect is
likely to increase as a greater percentage of the Company's cost of services are
associated with owned and leased facilities. There can be no assurance that the
Company will be able to achieve or maintain profitability on a quarterly or
annual basis in the future. It is likely that in some future quarter the
Company's operating results will be below the expectations of public market
analysts and investors. In such event, the price of the Company's Common Stock
would likely be materially adversely affected. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
As part of the Company'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 the Company's
strategy is to grow and expand through acquisition. These factors have resulted,
and will continue to result, in increased responsibilities for management
personnel and have placed, and will continue to place, increased demands upon
the Company's operating and financial systems, which may lead to unanticipated
costs and divert management's attention from day-to-day operations. The Company
may also be required to attract, train and retain additional highly qualified
management, technical, sales and marketing and customer support personnel. The
process of locating such personnel with the combination of skills and attributes
required to implement the Company's strategy is often lengthy. The inability to
attract and retain additional qualified personnel could materially and adversely
affect the Company. The Company 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. The Company's accounting systems and
policies have been developed as the Company has experienced significant growth.
There can be no assurance that the Company's personnel, systems, procedures and
controls will be adequate to support the Company's future operations. See "--
Dependence on Key Personnel," "Business--Employees" and "Management."
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. The Company 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
the Company will be able to effectively manage the costs of and risks associated
with its expansion into the commercial market.
RISKS INHERENT IN ACQUISITION STRATEGY
An important component to the Company's strategy is to grow and expand
through acquisitions. This growth strategy is dependent on the continued
availability of suitable acquisition candidates and subjects the Company to a
number of risks. The Company has recently completed two acquisitions, LDS on
November 30, 1997, and T-One on March 10, 1998. Additionally, on November 19,
1997, the Company entered into an agreement to acquire UDN. The acquisition of
UDN is subject to approval of UDN's stockholders and to various regulatory
approvals, and the Company may not complete this acquisition. These acquisitions
have placed significant demands on the Company's financial and management
resources, as the process for integrating acquired operations presents a
significant challenge to the Company's management and may lead to unanticipated
costs or a diversion of management's attention from day-to-day operations. There
can be no assurance that the Company will be able to successfully integrate
these acquisitions or any other acquisitions made by the Company in the future
into Company
8
<PAGE>
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, the
Company may incur unknown liabilities despite management's efforts to
investigate the operations of the acquired business. The impact of these risks,
and other risks arising as a result of STAR's acquisition strategy, could
adversely affect the Company's operating results.
RISKS ASSOCIATED WITH GROWTH OF TELECOMMUNICATIONS NETWORK AND CUSTOMER BASE
Historically, the Company has relied primarily on leased transmission
capacity for the delivery of its telecommunications services. The Company'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, the Company made considerable capital
expenditures in order to expand its network, and intends to continue to do so in
the future. See "Use of Proceeds" and "Business--Network." Although the
Company'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 the Company's
expectations concerning future revenue growth and market developments. As the
Company 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 the Company
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, costs
increases and a decrease in the Company's operating margins may occur. If the
Company's traffic volume were to decrease, or fail to increase to the extent
expected or necessary to make efficient use of its network, the Company's costs
as a percentage of revenues could increase significantly, which could have a
material adverse effect on the Company's business, financial condition or
results of operations.
In addition, the Company'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, the Company'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 the Company
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, the Company 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 the Company will be able to continue
to obtain sufficient transmission facilities or access to undersea fiber optic
cable on economically viable terms. The failure of the Company to obtain
telecommunications facilities that are sufficient to support its network traffic
in a manner that ensures the reliability and quality of its telecommunications
services may have a material adverse effect on its business, financial condition
or results of operations.
RISKS OF INTERNATIONAL TELECOMMUNICATIONS BUSINESS
The Company has to date generated a substantial majority of its revenues by
providing international telecommunications services to its customers on a
wholesale basis. The international nature of the Company'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, the Company's
business could be adversely affected by a reversal in the current trend toward
deregulation of telecommunications carriers. The Company will be increasingly
subject to these risks to the extent that the Company proceeds with the planned
expansion of its international operations.
9
<PAGE>
RISK OF DEPENDENCE ON FOREIGN PARTNERS. The Company 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. The Company may have limited recourse if its foreign partners do
not perform under their contractual arrangements with the Company. The Company's
arrangements with foreign partners may expose the Company 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 the Company or
companies (such as national telephone companies) upon which the Company and its
foreign partners may depend for required interconnections to local telephone
networks and other services. Accordingly, government actions in the future could
have a material adverse effect on the Company's operations. In highly regulated
countries in which the Company is not dealing directly with the dominant local
exchange carrier, the dominant carrier may have the ability to terminate service
to the Company or its foreign partner and, if this occurs, the Company may have
limited or no recourse. In countries where competition is not yet fully
established and the Company 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. The Company's revenues
and cost of long distance services are sensitive to foreign currency
fluctuations. The Company expects that an increasing portion of the Company's
net revenue and expenses will be denominated in currencies other than U.S.
dollars, and changes in exchange rates may have a significant effect on the
Company's results of operations. Although the Company utilizes hedging
instruments to reduce the risk of foreign currency fluctuations, the Company
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."
FOREIGN CORRUPT PRACTICES ACT. The Company is also subject to the Foreign
Corrupt Practices Act ("FCPA"), which generally prohibits U.S. companies and
their intermediaries from bribing foreign officials for the purpose of obtaining
or keeping business. The Company may be exposed to liability under the FCPA as a
result of past or future actions taken without the Company's knowledge by
agents, strategic partners and other intermediaries. Such liability could have a
material adverse effect on the Company's business, operating results and
financial condition.
POTENTIAL ADVERSE EFFECTS OF GOVERNMENT REGULATION
The Company's business is subject to various U.S. and foreign laws,
regulations, agency actions and court decisions. The Company's U.S.
international telecommunications service offerings are subject to regulation by
the Federal Communications Commission (the "FCC"). The FCC requires
international carriers to obtain authorizations under Section 214 of the
Communications Act of 1934, as amended, prior to acquiring international
facilities by purchase or lease, or providing international service to the
public. Prior FCC approval is also required to transfer control of a
certificated carrier. The Company must file reports and contracts with the FCC
and must pay regulatory fees, which are subject to change. The Company is also
subject to the FCC policies and rules discussed below. The FCC could determine,
by its own actions or in response to a third party's filing, that certain of the
Company's services, termination arrangements, agreements with foreign carriers,
transit or refile arrangements or reports do not or did not comply with FCC
policies and rules. If this occurred, the FCC could order the Company to
terminate noncompliant arrangements, fine the Company or revoke the Company's
authorizations. Any of these actions could have a material adverse effect on the
Company's business, operating results and financial condition.
10
<PAGE>
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 Company's FCC
authority currently permits it to provide ISR service to Canada, the U.K.,
Sweden, New Zealand, Australia and the Netherlands. The FCC is currently
reviewing U.S. carrier applications to provide ISR to Belgium, Chile, Denmark,
Finland, France, Germany, Hong Kong, Norway and Luxembourg, among other routes.
Upon grant of any such ISR application to a given country, the FCC's rules also
would permit the Company to provide ISR service to that country. Certain of the
Company's termination arrangements with foreign operators may be inconsistent
with the FCC's IPL resale policy and the Company's existing ISR authorization.
FCC INTERNATIONAL SETTLEMENTS POLICY. The FCC's International Settlement
Policy ("ISP") limits the arrangements which U.S. international carriers may
enter into with foreign carriers for exchanging public switched
telecommunications traffic, which the FCC terms International Message Telephone
Service ("IMTS"). This policy does not apply to ISR services. The ISP requires
that U.S. carriers receive an equal share of the accounting rate and receive
inbound traffic in proportion to the volume of U.S. outbound traffic which they
generate. The ISP and other FCC policies also prohibit a U.S. carrier and a
foreign carrier which possesses sufficient market power on the foreign end of
the route to affect competition adversely in the U.S. market from entering into
exclusive arrangement involving services, facilities or functions on the foreign
end of a U.S. international route which are necessary for providing basic
telecommunications and which are not offered to similarly situated U.S.
carriers. It is possible that the FCC could find that certain of the Company's
arrangements with foreign operators are inconsistent with the ISP.
FCC POLICIES ON TRANSIT AND REFILE. The Company uses both transit and
refile arrangements to terminate its international traffic. The FCC routinely
approves transit arrangements by U.S. international carriers. The FCC's rules
also permit carriers in many cases to use ISR facilities to route traffic via a
third country for refile through the PSTN. The extent to which U.S. carriers may
enter into refile arrangements consistent with the ISP is currently under review
by the FCC. Certain of the Company's transit or refile arrangements may violate
the ISP or other FCC policies.
RECENT AND POTENTIAL FCC ACTIONS. Regulatory action that may be taken in
the future by the FCC may intensify the competition which the Company faces,
impose additional operating costs upon the Company, disrupt certain of the
Company's transmission arrangements or otherwise require the Company to modify
its operations. Future FCC action may also provide the Company additional
competitive flexibility by, for example, eliminating or substantially reducing
the tariff requirements applicable to the Company's interstate and international
telecommunications services. The FCC is encouraging new market entrants by
implementing the WTO Basic Telecommunications Agreement (the "WTO Agreement")
and through other actions. The FCC may approve pending mergers which could
produce more effective competitors in the Company's markets. The FCC may
increase regulatory fees charged to the Company and its competitors by
eliminating the exemption for carriers which provide only international services
or through other actions, which could raise the Company's costs of service
without assurance that the Company and its competitors could pass fee increases
through to their customers. See "Business--Government Regulation."
STATE. The intrastate long distance telecommunications operations of STAR
and its subsidiaries are subject to various state laws and regulations,
including prior certification, notification, registration and/or
11
<PAGE>
tariff requirements. The vast majority of states require that STAR and its
subsidiaries apply for certification to provide intrastate telecommunications
services. Certificates of authority can generally be conditioned, modified or
revoked by state regulatory authorities for failure to comply with state laws
and regulations. Fines and other penalties, including revocation of a
certificate of authority, may be imposed.
In 1997, prior to the Company'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 the Company'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, the Company 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 the Company
inadvertently fails to comply with such guidelines or if such guidelines are
determined to be inadequate to comply with the Settlements, the Company may be
subject to penalties or revocation of its certificate of authority. See
"Business--Government Regulation--Actions Against LDS."
FOREIGN REGULATIONS. The Company 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, the Company's use of transit, ISR or other
routing arrangements may be affected by laws or regulations in either the
transited or terminating foreign jurisdiction. Foreign countries, either
independently or jointly as members of the International Telecommunications
Union ("ITU"), or other supra-national organizations such as the European Union
or the WTO, may have adopted or may adopt laws or regulatory requirements
regarding such services for which compliance would be difficult or expensive,
that could force the Company to choose less cost-effective routing alternatives
and that could adversely affect the Company's business, operating results and
financial condition.
To the extent that it seeks to provide telecommunications services in other
non-U.S. markets, the Company is subject to the developing laws and regulations
governing the competitive provision of telecommunications services in those
markets. The Company currently plans to provide a limited range of services in
Mexico, Belgium and France, as permitted by regulatory conditions in those
markets, and to expand its operations as these markets implement scheduled
liberalization to permit competition in the full range of telecommunications
services in the next several years. The nature, extent and timing of the
opportunity for the Company 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 the
Company with practical opportunities to compete in the near future, or at all,
or that the Company will be able to take advantage of any such liberalization in
a timely manner. See "Business--Government Regulation."
REGULATION OF CUSTOMERS. The Company'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 the Company. Regulatory sanctions
have been imposed on certain of the Company's customers in the past. While such
sanctions have not adversely impacted the volume of traffic received by the
Company 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 the Company's business, financial
condition and results of operations.
12
<PAGE>
RISKS OF NETWORK FAILURE
Any system or network failure that causes interruptions in the Company's
operations could have a material adverse effect on its business, financial
condition or results of operations. The Company's operations are dependent on
its ability to successfully expand its network and integrate new and emerging
technologies and equipment into its network, which are likely to increase the
risk of system failure and to cause strain upon the network. The Company's
operations also are dependent on the Company's protection of its hardware and
other equipment from damage from natural disasters such as fires, floods,
hurricanes and earthquakes, other catastrophic events such as civil unrest,
terrorism and war and other sources of power loss and telecommunications
failures. Although the Company has taken a number of steps to prevent its
network from being affected by natural disasters, fire and the like, such as
building redundant systems for power supply to the switching equipment, there
can be no assurance that any such systems will prevent the Company's switches
from becoming disabled in the event of an earthquake, power outage or otherwise.
The failure of the Company'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 the Company's relationship with its customers and the
Company's business, operating results and financial condition. See
"Business--Network."
DEPENDENCE ON KEY PERSONNEL
The Company'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 the Company's operations, in
particular, Christopher E. Edgecomb, the Company's Chief Executive Officer. The
Company maintains and is the beneficiary under a key person life insurance
policy in the amount of $10.0 million with respect to Mr. Edgecomb. The Company
believes that its future success will depend in large part upon its continuing
ability to attract and retain highly skilled personnel. Competition for
qualified, high-level telecommunications personnel is intense and there can be
no assurance that the Company will be successful in attracting and retaining
such personnel. The loss of the services of one or more of the Company's key
individuals, or the failure to attract and retain other key personnel, could
materially adversely affect the Company's business, operating results and
financial condition. See "Management."
SIGNIFICANT COMPETITION
The international telecommunications industry is intensely competitive and
subject to rapid change. The Company'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. The Company 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. The
Company is unable to predict which technological development will challenge its
competitive position or the amount of expenditures that will be required to
respond to a rapidly changing technological environment. Further, the number of
the Company's competitors is likely to increase as a result of the competitive
opportunities created by a new Basic Telecommunications Agreement concluded by
members of the WTO in April 1997. Under the terms of the WTO Agreement, starting
February 5, 1998, the United States and over 65 countries have committed to open
their telecommunications markets to competition, foreign ownership and adopt
measures to protect against anticompetitive behavior. As a result, the Company
believes that competition will continue to increase, placing downward pressure
on prices. Such pressure could adversely
13
<PAGE>
affect the Company's gross margins if the Company is not able to reduce its
costs commensurate with such price reductions.
COMPETITION FROM DOMESTIC AND INTERNATIONAL COMPANIES. A majority of the
U.S.-based international telecommunications services revenue is currently
generated by AT&T Corp. ("AT&T"), MCI Communications Corp. ("MCI") and Sprint
Corporation ("Sprint"). The Company also competes with WorldCom, Inc.
("WorldCom"), Pacific Gateway Exchange, Inc. and other U.S.-based and foreign
long distance providers, including the Regional Bell Operating Companies
("RBOCs"), which presently have FCC authority to resell and terminate
international telecommunication services. Many of these competitors have
considerably greater financial and other resources and more extensive domestic
and international communications networks than the Company. The Company's
business would be materially adversely affected to the extent that a significant
number of such customers limit or cease doing business with the Company 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 the Company by reducing the number of
potential customers for the Company's services.
EXPANSION INTO COMMERCIAL MARKET. With the acquisition of LDS, STAR began
providing long distance service to the commercial market, a market that is
subject to intense competition from a number of well capitalized companies. The
commercial market is also characterized by the lack of customer loyalty, with
commercial customers regularly changing service providers. There can be no
assurance that STAR will be able to compete successfully in the commercial
market. See "Business--Strategy--Expansion into Commercial Market."
CUSTOMER CONCENTRATION
While the list of the Company's most significant customers varies from
quarter to quarter, the Company's five largest customers accounted for
approximately 30% of its revenues in 1997. The Company could lose a significant
customer for many reasons, including the entrance into the market of significant
new competitors with lower rates than the Company, downward pressure on the
overall costs of transmitting international calls, transmission quality
problems, changes in U.S. or foreign regulations or unexpected increases in the
Company's cost structure as a result of expenses related to installing a global
network or otherwise.
NEED FOR ADDITIONAL CAPITAL TO FINANCE GROWTH AND CAPITAL REQUIREMENTS
The Company 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. The Company'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 the Company's receipt of the
related revenue.
The Company believes that, based upon its present business plan, the
proceeds from the Offering, together with the Company's existing cash resources
and expected cash flow from operating activities, will be sufficient to meet its
currently anticipated working capital and capital expenditure requirements for
at least twelve months. If the Company's growth exceeds current expectations, if
the Company obtains one or more attractive opportunities to purchase the
business or assets of another company, or if the Company's cash flow from
operations after the end of such period is insufficient to meet its working
capital and capital expenditure requirements, the Company will need to raise
additional capital from equity or debt sources. There can be no assurance that
the Company will be able to raise such capital on favorable terms or at all. If
the Company is unable to obtain such additional capital, the Company may be
required to reduce the scope of its anticipated expansion, which could have a
material adverse effect on the Company's business, financial condition or
results of operations.
14
<PAGE>
VOLATILITY OF STOCK PRICE
The market price of the shares of Common Stock has risen since the Company's
initial public offering in June 1997 and is trading at a high multiple of the
Company's earnings. The market price for such shares has been highly volatile
and may be significantly affected by factors such as actual or anticipated
fluctuations in the Company's operating results, the announcement of potential
acquisitions by the Company, changes in federal and international regulations,
activities of the largest domestic providers, industry consolidation and
mergers, conditions and trends in the international telecommunications market,
adoption of new accounting standards affecting the telecommunications industry,
changes in recommendations and estimates by securities analysts, general market
conditions and other factors. In addition, the stock market has from time to
time experienced significant price and volume fluctuations that have
particularly affected the market prices for the shares of emerging growth
companies like the Company. These broad market fluctuations may adversely affect
the market price of the Company's Common Stock.
CONTROL OF COMPANY BY NAMED OFFICERS AND DIRECTORS
Upon the consummation of this offering, the Company's Named Officers (as
defined below) and directors in the aggregate will beneficially own
approximately 38.0% of the outstanding shares of Common Stock and the Company's
Chief Executive Officer will beneficially own approximately 32.2% of the
outstanding shares. These stockholders will 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 the
Company. See "Principal and Selling Stockholders."
EFFECT OF CERTAIN CHARTER PROVISIONS; ANTI-TAKEOVER EFFECTS OF CERTIFICATE OF
INCORPORATION, BYLAWS AND
DELAWARE LAW
The Company's Board of Directors has the authority to issue up to 5,000,000
shares of Preferred Stock and to determine the price, rights, preferences,
privileges and restrictions, including voting and conversion rights of such
shares, without any further vote or action by the Company's stockholders. The
rights of the holders of Common Stock will be subject to, and may be adversely
affected by, the rights of the holders of any Preferred Stock that may be issued
in the future. The issuance of Preferred Stock, while providing flexibility in
connection with possible acquisitions and other corporate purposes, could have
the effect of making it more difficult for a third party to acquire a majority
of the outstanding voting stock of the Company. The Company has no current plans
to issue shares of Preferred Stock. The Company is also subject to the
anti-takeover provisions of Section 203 of the Delaware General Corporation Law,
which will prohibit the Company from engaging in a "business combination" with
an "interested stockholder" for a period of three years after the date of the
transaction in which the person became an interested stockholder, unless the
business combination is approved in a prescribed manner. The application of
Section 203 could have an effect of delaying or preventing a change in control
of the Company. In addition, the Company's Amended and Restated Certificate of
Incorporation provides for a classified Board of Directors such that
approximately only one-third of the members of the Board will be elected at each
annual meeting of stockholders. Classified boards may have the effect of
delaying, deferring or discouraging changes in control of the Company. Further,
certain provisions of the Company's Amended and Restated Certificate of
Incorporation and Bylaws and of Delaware law could delay or make more difficult
a merger, tender offer or proxy contest involving the Company. Additionally,
certain federal regulations require prior approval of certain transfers of
control of telecommunications companies, which could also have the effect of
delaying, deferring or preventing a change in control. See "Business--Government
Regulation," "Description of Capital Stock--Preferred Stock" and
"--Anti-takeover Effects of Provisions of the Certificate of Incorporation,
Bylaws and Delaware Law."
15
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, the Company will have approximately
41,489,000 shares of Common Stock outstanding (assuming no exercise of the
Underwriters' over-allotment option and no exercise of outstanding and vested
options to purchase approximately 1,367,000 shares of Common Stock outstanding
and vested as of February 28, 1998) of which 9,430,000 have been previously
registered pursuant to the Securities Act. Of the approximately 41,489,000
shares of Common Stock outstanding, the 6,000,000 shares offered hereby will be
freely transferable without restriction or further registration under the
Securities Act. Approximately 558,000 additional shares which are not currently
registered will be available for immediate unrestricted sale in the public
market on the date of this Prospectus and approximately 1,601,000 additional
shares will be available for immediate sale on the date of this Prospectus,
subject to the public information, volume limitation and notice provisions of
Rule 144 adopted under the Securities Act. Approximately 410,000 shares will be
available for sale within 45 days after the date of this prospectus, subject to
the Rule 144 public information, volume limitations and notice provisions.
Approximately 1,875,000 shares will be available for sale in the public market
45 days after the date of this Prospectus upon the expiration of certain lock-up
agreements, subject to the Rule 144 public information, volume limitation and
notice provisions described below. Upon the expiration of certain additional
lock-up agreements 90 days after the date of this Prospectus, (i) approximately
16,246,000 shares will be available for sale in the public market, subject to
the Rule 144 public information, volume limitation and notice provisions and
(ii) approximately 2,050,000 shares will be available for unrestricted sale in
the public market. Approximately 1,353,000 shares issued in the T-One
acquisition shall be available for sale on the date of the publication by the
Company of at least 30 days of combined operating results of STAR and T-One.
Approximately 849,000 shares issued in the LDS acquisition will be available for
sale after November 30, 1998.
Certain stockholders holding approximately 7,153,000 shares of Common Stock
are entitled to registration rights with respect to their shares of Common
Stock. Sales of substantial amounts of such shares in the public market after
this offering, or the prospect of such sales, could adversely affect the market
price of the Common Stock. Such sales also might make it more difficult for the
Company to sell equity securities or equity related securities in the future at
a time and price that the Company deems appropriate. See "Description of Capital
Stock," "Shares Eligible for Future Sale" and "Underwriting."
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. The Company believes
that the Company'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 the Company's customers and vendors that
interface with the Company's systems may run on programs that have Year 2000
problems and may disrupt the Company's billing, credit and tracking systems.
Failure of any of the computer programs integral to the Company's key customers
and vendors could adversely affect the Company's business, operating results and
financial condition. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
16
<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from the sale of the shares of Common Stock
to be sold by the Company in this offering (at the public offering price of
$27.00) are estimated to be $145,059,000 ($148,926,000 if the Underwriters'
over-allotment option is exercised in full), after deducting underwriting
discounts and commissions and estimated offering expenses payable by the
Company. The Company will not receive any of the proceeds from the sale of
shares of Common Stock by the Selling Stockholder or from the sale of shares of
Common Stock, if any, by the Selling Stockholder and certain stockholders of the
Company (collectively, with the Selling Stockholder, the "Selling Stockholders")
pursuant to the Underwriters' over-allotment option.
The Company intends to use approximately $80 million of the proceeds of the
offering to expand the Company's network, including the purchase of fiber optic
cable capacity, the purchase of switches and the buildout of leasehold
improvements for these facilities. The remainder of the proceeds are expected to
be used for working capital, expansion of the Company's marketing and sales
organization and general corporate purposes. Although the Company may use a
portion of the net proceeds for possible acquisitions of businesses that are
complementary to those of the Company, there are no current plans in this
regard. Pending such uses, the Company plans to invest the net proceeds in
short-term, interest-bearing, investment grade securities. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Business--Strategy."
PRICE RANGE OF COMMON STOCK
The Company's Common Stock has been traded on the Nasdaq National Market
since June 12, 1997. The following table sets forth, for the fiscal periods
indicated, the quarterly high and low sales prices for the Common Stock, as
reported by Nasdaq and as adjusted to reflect the Stock Split that occurred on
March 31, 1998.
<TABLE>
<CAPTION>
HIGH LOW
--------- ---------
<S> <C> <C>
FISCAL YEAR ENDED DECEMBER 31, 1997
- -----------------------------------------------------------------------------------------------
Second Quarter (from June 12, 1997)............................................................ 7 3/8 4 41/64
Third Quarter.................................................................................. 11 53/64 6 7/32
Fourth Quarter................................................................................. 17 11/16 9 33/64
FISCAL YEAR ENDING DECEMBER 31, 1998
- -----------------------------------------------------------------------------------------------
First Quarter.................................................................................. 28 3/64 14 33/64
Second Quarter (through April 28, 1998)........................................................ 37 3/8 27 3/8
</TABLE>
The last reported sale price of the Common Stock on the Nasdaq National
Market on April 28, 1998 was $28.9375 per share. As of March 16, 1998, there
were 155 holders of record of the Company's Common Stock.
DIVIDEND POLICY
The Company has never paid cash dividends on its Common Stock and has no
intention of paying cash dividends in the foreseeable future. The Company
anticipates that all future earnings, if any, generated from operations will be
retained by the Company to develop and expand its business. Any future
determination with respect to the payment of dividends will be at the discretion
of the Board of Directors and will depend upon, among other things, the
Company's operating results, financial condition and capital requirements, the
terms of then-existing indebtedness, general business conditions and such other
factors as the Board of Directors deems relevant. In addition, the Company's
existing revolving credit facility prohibits the payment of cash dividends
without the lender's consent.
17
<PAGE>
CAPITALIZATION
The following table sets forth (i) the actual capitalization of the Company
as of December 31, 1997 and (ii) the capitalization of the Company as adjusted
to reflect the sale of 5,685,000 shares of Common Stock offered hereby by the
Company (at the public offering price of $27.00) and the application of the
estimated net proceeds therefrom. See "Use of Proceeds."
<TABLE>
<CAPTION>
DECEMBER 31, 1997
----------------------
ACTUAL AS ADJUSTED
--------- -----------
(IN THOUSANDS)
<S> <C> <C>
Long-term liabilities, less current portion............................................... $ 12,271 $ 12,271
--------- -----------
Stockholders' equity:
Preferred stock: $0.001 par value, 5,000,000 shares authorized, no shares issued and
outstanding on an actual basis and as adjusted........................................ -- --
Common stock: $0.001 par value, 50,000,000 shares authorized, 33,678,519 shares issued
and outstanding on an actual basis; 50,000,000 shares authorized, 39,363,519 shares
outstanding as adjusted(1)............................................................ 34 39
Additional paid-in capital.............................................................. 45,407 190,461
Deferred compensation................................................................... (30) (30)
Retained earnings (deficit)............................................................. (1,397) (1,397)
--------- -----------
Stockholders' equity.................................................................. 44,014 189,073
--------- -----------
Total capitalization.................................................................. $ 56,285 $ 201,344
--------- -----------
--------- -----------
</TABLE>
- ------------------------
(1) Excludes 3,497,097 shares subject to outstanding options as of December 31,
1997 at a weighted average exercise price of approximately $3.54 per share.
Also excludes 1,794,978 shares reserved for issuance under the Company's
stock plans. See "Management--1997 Omnibus Stock Incentive Plan," "--1996
Outside Director Nonstatutory Stock Option Plan" and Note 10 of Notes to
Consolidated Financial Statements.
18
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with the Company's Consolidated Financial Statements and Notes
thereto and with "Management's Discussion and Analysis of Financial Condition
and Results of Operations," each of which is included elsewhere in this
Prospectus. The consolidated statements of operations data for the years ended
December 31, 1995, 1996 and 1997, and the balance sheet data at December 31,
1996 and 1997 are derived from audited financial statements included elsewhere
in this Prospectus. The consolidated statement of operations data for the year
ended December 31, 1994 and the consolidated balance sheet data at December 31,
1994 are unaudited and are derived from unaudited financial statements not
included in this Prospectus. The consolidated balance sheet data at December 31,
1995 is derived from audited financial statements not included in this
Prospectus. Although incorporated in 1993, the Company did not commence business
until 1994.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
1994 1995 1996 1997
----------- --------- --------- ---------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AND PER
MINUTE DATA)
<S> <C> <C> <C> <C>
CONSOLIDATED STATEMENTS OF OPERATIONS
DATA(1):
Revenues.................................. $ 20,915 $ 46,283 $ 237,991 $ 376,198
Cost of services.......................... 12,775 31,897 205,585 325,237
----------- --------- --------- ---------
Gross profit............................ 8,140 14,386 32,406 50,961
Operating expenses:
Selling, general and administrative..... 4,782 10,086 34,331 35,381
Depreciation and amortization........... 30 186 1,151 4,245
Merger expense.......................... -- -- -- 286
----------- --------- --------- ---------
Total operating expenses................ 4,812 10,272 35,482 39,912
----------- --------- --------- ---------
Income (loss) from operations........... 3,328 4,114 (3,076) 11,049
----------- --------- --------- ---------
Other income (expenses):
Interest income......................... 3 22 110 492
Interest expense........................ -- (64) (601) (1,633)
Legal settlements and expenses.......... -- -- (100) (1,653)
Other................................... (7) (33) 39 208
----------- --------- --------- ---------
Income (loss) before provision for
income taxes.......................... 3,324 4,039 (3,628) 8,463
Provision for income taxes................ 1 66 592 2,895
----------- --------- --------- ---------
Net income (loss)......................... $ 3,323 $ 3,973 $ (4,220) $ 5,568
----------- --------- --------- ---------
----------- --------- --------- ---------
Pro forma net income (loss)
(unaudited)(2)........................... $ 1,994 $ 2,407 $ (5,163) $ 5,373
----------- --------- --------- ---------
----------- --------- --------- ---------
Pro forma diluted income (loss) per share
(unaudited)(3)........................... $ 0.12 $ 0.13 $ (0.24) $ 0.17
----------- --------- --------- ---------
----------- --------- --------- ---------
Weighted average number of diluted common
shares outstanding(3).................... 16,865 18,020 21,939 31,625
OTHER CONSOLIDATED FINANCIAL AND OPERATING
DATA(1):
EBITDA(4)................................. $ 3,351 $ 4,267 $ (1,986) $ 13,849
Capital expenditures(5)................... 57 2,175 13,018 24,732
Wholesale billed minutes of use........... -- 38,106 479,681 863,295
Wholesale revenue per billed minute of
use(6)................................... $ -- $ 0.4102 $ 0.4288 $ 0.3997
</TABLE>
19
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------------
1994 1995 1996 1997
----------- --------- --------- ---------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA(1):
Working capital (deficit)................. $ 2,007 $ 1,222 $ (6,342) $ 15,846
Total assets.............................. 5,105 18,316 54,000 113,553
Total long-term liabilities, net of
current portion.......................... -- 904 5,870 12,271
Retained earnings (deficit)............... 1,839 1,596 (5,968) (1,397)
Stockholders' equity...................... 2,197 3,047 7,911 44,014
</TABLE>
- ------------------------
(1) Does not reflect the acquisition of T-One, which was consummated on March
10, 1998, or the acquisition of UDN, which remains subject to the approval
of UDN's stockholders and to various regulatory approvals. If the Company's
financial statements had been restated to include the combined operating
results of the Company and T-One at the beginning of the audited periods
presented, revenues would have been $58.9 million, $260.4 million and
$406.6 million, gross profit would have been $14.7 million, $33.7 million
and $52.8 million and net income (loss) would have been $2.1 million,
$(5.7) million and $5.6 million for the years ended December 31, 1995, 1996
and 1997, respectively. See Note 14 of Notes to Consolidated Financial
Statements.
(2) The pro forma net income or loss per share assumes that both STAR and LDS
had been
C-Corporations for all periods presented.
(3) See Note 2 of Notes to Consolidated Financial Statements for an explanation
of the method used to determine the number of shares used in computing pro
forma net income (loss) per share.
(4) EBITDA represents earnings before interest income and expense, income
taxes, depreciation and amortization expense. EBITDA does not represent
cash flows as defined by generally accepted accounting principles and does
not necessarily indicate that cash flows are sufficient to fund all of the
Company'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 the Company's liquidity determined in accordance with generally
accepted accounting principles.
(5) Includes assets financed with capital leases or notes. See Note 2 of Notes
to Consolidated Financial Statements.
(6) Represents wholesale gross call usage revenue per billed minute. Amounts
exclude other revenue related items such as finance charges.
20
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION OF THE FINANCIAL CONDITION AND RESULTS OF
OPERATIONS OF THE COMPANY SHOULD BE READ IN CONJUNCTION WITH "SELECTED
CONSOLIDATED FINANCIAL DATA" AND THE CONSOLIDATED FINANCIAL STATEMENTS AND THE
NOTES THERETO, EACH OF WHICH IS INCLUDED ELSEWHERE IN THIS PROSPECTUS. THIS
DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS, AS DEFINED IN SECTION 27A OF THE
SECURITIES ACT, THAT INVOLVE RISKS AND UNCERTAINTIES. STAR'S ACTUAL RESULTS
COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THE FORWARD-LOOKING STATEMENTS
AS A RESULT OF CERTAIN FACTORS, INCLUDING, BUT NOT LIMITED TO THOSE DISCUSSED IN
"RISK FACTORS" AND ELSEWHERE IN THIS PROSPECTUS. SEE "DESCRIPTION OF
FORWARD-LOOKING STATEMENTS."
OVERVIEW
The Company 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 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.
The Company installed its first international gateway switch in Los Angeles
in June 1995 and initially recognized wholesale revenues in August 1995. A
significant portion of the Company's revenues in 1994 and 1995 were generated by
the commercial operations of LDS.
REVENUES. Most of the Company's revenues are generated by the sale of
international long distance services on a wholesale basis to other, primarily
domestic, long distance providers. The Company records revenues from the sale of
long distance services at the time of customer usage. The Company'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. The Company has pursued a strategy of attracting
customers and building calling volume and revenue by offering favorable rates
compared to other long distance providers. The Company continues to lower its
costs of services by (i) expanding the Company's owned network facilities, (ii)
continuing to utilize the Company's sophisticated information systems to route
calls over the most cost-effective routes and (iii) leveraging the Company'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 the Company is obtained on a variable, per minute
basis. As a result, some of the Company's current costs of services is variable.
The Company'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
the Company's longer term arrangements requiring the Company to meet minimum
usage commitments in order to avoid penalties. Such variability and the short-
term nature of many of the contracts subject the Company to the possibility of
unanticipated cost increases and the loss of cost-effective routing
alternatives. Included in the Company's costs of services are accruals for rate
and minute disputes and unreconciled billing differences between the Company and
its vendors. Each quarter management reviews the costs of services accrual and
adjusts the balance for resolved items. Costs of services also include fixed
costs associated with the leasing of network facilities.
The Company 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
21
<PAGE>
exposure and lead to higher overhead costs. Information related to wholesale and
commercial revenues and operations will be reported in future Exchange Act
filings made by STAR in accordance with Financial Accounting Standards Board
Statement No. 131.
Prices in the international long distance market have declined in recent
years and, as competition continues to increase, STAR believes that prices are
likely to continue to decline. Additionally, STAR believes that the increasing
trend of deregulation of international long distance telecommunications will
result in greater competition, which could adversely affect STAR's revenue per
minute and gross margin. STAR believes, however, that the effect of such
decreases in prices will be offset by increased calling volumes and decreased
costs.
OPERATING EXPENSES. Selling, general and administrative expenses consist
primarily of personnel costs, depreciation and amortization, tradeshow and
travel expenses and commissions and consulting fees, as well as an accrual for
bad debt expense. These expenses have been increasing over the past year, which
is consistent with STAR's recent growth, accelerated expansion into Europe, and
investment in systems and facilities. The Company 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 the Company's network facilities, its sales and marketing efforts and STAR's
expansion into commercial markets.
FOREIGN EXCHANGE. The Company's revenues and cost of long distance services
are sensitive to foreign currency fluctuations. The Company expects that an
increasing portion of the Company'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 the Company's results of operations.
FACTORS AFFECTING FUTURE OPERATING RESULTS. The Company's quarterly
operating results are difficult to forecast with any degree of accuracy because
a number of factors subject these results to significant fluctuations. As a
result, STAR believes that period-to-period comparisons of its operating results
are not necessarily meaningful and should not be relied upon as indications of
future performance.
The Company's revenues, costs and expenses have fluctuated significantly in
the past and are likely to continue to fluctuate significantly in the future as
a result of numerous factors. The Company'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 the Company is obtained on a variable, per minute and short term basis,
subjecting the Company 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
22
<PAGE>
of time. The Company's gross margins also may be negatively impacted in the
longer term by competitive pricing pressures.
RECENT ACQUISITIONS AND DEVELOPMENTS
The Company has recently acquired or entered into agreements to acquire the
following companies and has taken the following actions:
- L.D. SERVICES, INC. On November 30, 1997, the Company acquired LDS,
certain non-operating entities and majority ownership in another entity
for approximately 849,000 shares of Common Stock in a transaction
accounted for as a pooling of interests. The Company's audited financial
statements have been restated to include LDS' historical performance for
all relevant periods. The commercial business of LDS has historically had
higher gross margins and higher selling, general and administrative
expenses and operating costs than the Company's wholesale operations. As
the Company integrates and expands the commercial accounts of LDS, such
increase in operations may affect the Company'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--Government Regulation--Actions Against LDS."
- T-ONE CORP. On March 10, 1998, the Company acquired T-One for 1,353,000
shares of Common Stock in a transaction accounted for as a pooling of
interests. Consistent with applicable accounting standards, as of the date
of this Prospectus, the Company's audited financial statements have not
been restated to include T-One's historical performance. For the fiscal
year ended December 31, 1997, T-One had revenues of $30.4 million, gross
profit of $1.8 million, selling, general and administrative expenses of
$1.5 million and net income of $0.2 million. See Note 14 of Notes to
Consolidated Financial Statements.
- UNITED DIGITAL NETWORK, INC. On November 19, 1997, the Company entered
into an agreement to acquire UDN in a transaction to be accounted for as a
pooling of interests. The acquisition of UDN is subject to approval by
UDN's stockholders and to various regulatory approvals. Assuming the
receipt of all necessary approvals, management expects to consummate the
UDN acquisition in the second quarter of 1998 for approximately 800,000
shares of Common Stock. In connection with the UDN acquisition, STAR has
loaned an aggregate of $4.5 million to UDN. The Company's financial
statements have not been restated to reflect the acquisition of UDN. Based
solely on information provided by UDN to STAR, which has not been
independently verified by STAR, for the nine month period ended January
31, 1998, UDN had revenues of $23.9 million and a net loss of $6.5
million. STAR believes that, because UDN operates in the commercial
market, its higher gross margins and operating costs will have an impact
on the Company's margins upon consummation of the merger and on a
going-forward basis once STAR's operating results are restated to include
UDN's historical performance. UDN's Common Stock trades on the Vancouver
Stock Exchange under the symbol UDN.
- STOCK SPLIT. On March 31, 1998, the Company effected the Stock Split with
payment to the holders of the shares of Common Stock outstanding on
February 20, 1998 of a stock dividend equal to 1.05 shares of Common Stock
for each such outstanding share.
23
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth certain selected items in the Company's
statements of operations as a percentage of total revenues for the periods
indicated:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1995 1996 1997
--------- --------- ---------
<S> <C> <C> <C>
Revenues.......................................................................... 100.0% 100.0% 100.0%
Costs of services................................................................. 68.9 86.4 86.5
--------- --------- ---------
Gross profit...................................................................... 31.1 13.6 13.5
Operating expenses:
Selling, general and administrative expenses.................................... 21.8 14.4 9.4
Depreciation and amortization................................................... 0.4 0.5 1.1
--------- --------- ---------
Total operating expenses........................................................ 22.2 14.9 10.6
Income (loss) from operations..................................................... 8.9 (1.3) 2.9
--------- --------- ---------
Income (loss) before provision for income taxes................................... 8.7 (1.5) 2.3
Provision for income taxes........................................................ 0.1 0.3 0.8
--------- --------- ---------
Net income (loss)................................................................. 8.6% (1.8)% 1.5%
--------- --------- ---------
--------- --------- ---------
</TABLE>
YEARS ENDED DECEMBER 31, 1997 AND 1996
REVENUES. Revenues increased 58.1% to $376.2 million in 1997 from $238.0
million in 1996. Wholesale revenues increased to $348.7 million from $208.1
million, with minutes of use increasing to 863.3 million minutes in 1997, as
compared to 479.7 million minutes of use in the prior year. This increase
reflects an increase in the number of wholesale customers from 84 in 1996 to 105
at the end of 1997, as well as an increase in usage by existing customers. The
average rate per minute of usage for wholesale customers declined from $0.43
cents per minute in 1996 to $0.40 cents per minute in 1997, reflecting the
change in country mix to include a larger proportion of lower rate per minute
countries as well as lower prices on competitive routes. Taking into account the
acquisition of T-One, on a pro forma basis, revenues in 1997 would have been
$406.6 million, an increase of 56.1% from $260.4 million in 1996.
Commercial revenues decreased to $27.5 million in 1997 from $29.9 million in
1996 reflecting the termination of the LDS customer base in California due to
the 1997 settlement entered into by LDS with each of the California PUC and the
District Attorney of Monterey, California. See "Business--Governmental
Regulation--Actions Against LDS."
GROSS PROFIT. Gross profit increased 57.3% to $51.0 million in 1997 from
$32.4 million in 1996. Wholesale gross profit increased to $39.8 million in 1997
from $19.7 million for 1996 and wholesale gross margin increased to 11.4% from
9.4%, respectively. Wholesale gross profit expanded during 1997 as traffic was
increasingly routed over the Company'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 the Company's
network, LDS' cost of commercial long distance services is expected to decline.
Taking into account the acquisition of T-One, on a pro forma basis, gross profit
in 1997 would have been $52.8 million, an increase of 56.4% over gross profit of
$33.7 million in 1996.
SELLING, GENERAL AND ADMINISTRATIVE. In 1997, selling, general and
administrative expenses increased 3.1% to $35.4 million, from $34.3 million in
1996. Wholesale selling, general and administrative expenses increased to $26.0
million in 1997 from $24.1 million in 1996, but decreased as a percentage of
wholesale revenues to 7.5% from 11.6% over the comparable periods. Total
expenses increased year to year in
24
<PAGE>
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%. The Company expects selling, general and administrative
expenses to expand in absolute dollars and as a percentage of revenues in fiscal
year 1998, as the Company expands its network and employee base and in
connection with the Company's entry into the commercial market.
DEPRECIATION. Depreciation increased to $4.2 million for 1997 from $1.2
million for 1996, and increased as a percentage of revenues to 1.1% from 0.5% in
the prior period. Depreciation increased as a result of STAR's continuing
expansion of its proprietary international network which includes purchases of
switches, submarine cable and leasehold improvements associated with switch
sites. STAR expects depreciation expense to increase as the Company continues to
expand its global telecommunications network.
OTHER INCOME (EXPENSE). Other expense, net, increased to $2.6 million in
1997 from $552,000 in 1996. This increase is primarily due to interest expense
of $1.6 million incurred under various capital leases and bank lines of credit
and a legal settlement and associated expenses of $1.7 million. The legal
settlement relates to the dispute settled by LDS with the California PUC and the
District Attorney of Monterey County. See "Business--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 the Company's June 1997 initial public offering.
PROVISION FOR INCOME TAXES. The provision for income taxes increased to
$2.9 million in 1997 from $592,000 in 1996, primarily due to the increase in
profitability of the Company.
YEARS ENDED DECEMBER 31, 1996 AND 1995
REVENUES. Revenues increased 414.2% to $238.0 million in 1996 from $46.3
million 1995. Wholesale revenues increased to $208.1 million in 1996 from $16.1
million in 1995, with minutes of use increasing to 479.7 million in 1996, as
compared to 38.1 million minutes of use in the prior year. The increase in
wholesale revenue resulted from STAR's commencement of operations as an
international long distance carrier, an increase in the number of customers as
compared to the prior year and an increase in minutes of wholesale traffic from
new and existing customers. The increase in traffic is also attributable to an
increase in the number of routes with favorable rates that STAR was able to
offer to customers. Commercial revenues decreased to $29.9 million in 1996 from
$30.2 million in 1995 due to a decrease in the rate per minute charged, which
was partially offset by an increase in the number of minutes sold. Taking into
account the acquisition of T-One, on a pro forma basis revenues would have been
$260.4 million in 1996, an increase of 341.9% from $58.9 million in 1995.
GROSS PROFIT. Gross profit increased 125.3% to $32.4 million for 1996 from
$14.4 million in 1995. Wholesale gross profit increased to $19.7 million in 1996
from $1.8 million for 1995. Wholesale gross margin decreased to 9.4% in 1996
from 11.0% in 1995, reflecting the change from STAR's prior consulting business
to operating as an international long distance carrier. Gross profit was
positively impacted during 1996 by the negotiation of lower rates on routes with
significant traffic, and negatively impacted by increases in traffic on routes
with lower margins. Commercial gross profit increased to $12.7 million in 1996
from $12.6 million in 1995 with gross margin increasing to 42.6% from 41.8%,
respectively. The gross profit from commercial services expanded as costs
associated with the local exchange carriers declined. Taking into account the
acquisition of T-One, on a pro forma basis, gross profit in 1996 would have been
$33.7 million, an increase of 130.0% from $14.7 million in 1995.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses increased 240.4% to $34.3 million in 1996 from $10.1 million in 1995.
Wholesale selling, general and administrative expenses
25
<PAGE>
increased to $24.1 million in 1996 from $2.1 million in 1995, and decreased as a
percentage of revenues to 11.6% from 12.8% in the prior period. Selling, general
and administrative expenses increased between periods as STAR increased its
employee base and incurred payroll, employee benefits, commission and related
expenses. STAR also established a reserve for doubtful accounts to reflect its
significantly higher revenue levels and invested in sales and marketing
activities, including tradeshows and travel. Hi-Rim and CCI, two of STAR's major
customers in 1996, informed STAR that they were experiencing financial
difficulties and would be unable to pay in full outstanding accounts receivable.
As a result, the full amount of the approximately $10.8 million owed to STAR by
Hi-Rim and CCI as of December 31, 1996 which was not subsequently collected or
for which no offsetting value was received, was written off or reserved in 1996.
In addition, STAR wrote-off $820,000 of intangible assets relating to CCI.
Commercial selling, general and administrative expenses increased to $10.2
million in 1996 from $8.0 million in 1995 reflecting higher operating costs.
DEPRECIATION. Depreciation increased to $1.2 million for 1996 from $186,000
for 1995, an increase as a percentage of revenues to 0.5% from 0.4% in the prior
period. Depreciation increased as a result of STAR's purchase of switches and of
the operating equipment and leasehold improvements associated with its Los
Angeles and New York switching facilities. Depreciation expense will increase as
STAR expands its ownership of switching and transmission facilities through
purchase or use of capital leases.
OTHER INCOME (EXPENSE). Other expense, net, increased to $552,000 in 1996
from $75,000 in 1995. This increase is primarily due to a $100,000 legal
settlement in the second quarter of 1996 as well as $601,000 in interest expense
incurred under various bank and stockholder lines of credit. This increase was
offset by $110,000 in interest income on short-term investments and cash
equivalents primarily from funds raised in private placements of equity
securities during the first three quarters of 1996.
PROVISION FOR INCOME TAXES. Through December 31, 1995, STAR had elected to
be taxed as an S-Corporation for both federal and state income tax purposes and
thus was only subject to 1.5% tax on taxable income for state purposes. LDS was
an S-Corporation through the date of the merger on November 30, 1997. The pro
forma provision for income taxes, assumes that both STAR and LDS were
C-Corporations for all periods presented. During 1996, the historical provision
for income taxes increased to $592,000 as a result of the reserve of $2.9
million of the net deferred tax asset.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1997, STAR had cash and cash equivalents of approximately
$1.5 million, short-term investments of $18.6 million and a working capital
surplus of $15.8 million. In June 1997, the Company completed an initial public
offering of 9.4 million shares of Common Stock of which approximately 8.1
million shares were sold by the Company and approximately 1.3 million shares
were sold by certain selling stockholders. The net proceeds to the Company
(after deducting underwriting discounts and offering expenses) from the sale of
such shares of Common Stock were approximately $30.9 million. As of December 31,
1997, the Company had used the proceeds from the offering to repay indebtedness
of $14.2 million, to purchase switching and transmission related equipment and
to finance the Company's operations in the U.K.
As of December 31, 1997, STAR had no funds outstanding on its $25 million
revolving line of credit, which bears interest at a rate of the bank's cost of
funds plus 175 basis points and expires on July 1, 1999. However, the line of
credit is reduced by outstanding letters of credit in the amount of $4.9
million.
STAR generated net cash from operating activities of $10.1 million in 1997,
primarily from net income plus depreciation and amortization, while using $3.4
million in 1996. The Company's investing activities used cash of approximately
$29.6 million during 1997 primarily resulting from capital expenditures and the
investment of the proceeds from the initial public offering in marketable
securities, while using $9.8 million in 1996. The Company's financing activities
provided cash of approximately $19.3 million during 1997
26
<PAGE>
primarily from the sale of Common Stock and borrowings under lines of credit,
offset by repayments under various lines of credit, while providing $14.7
million in 1996.
STAR had capital lease obligations of $13.6 million, and $0.8 million in
term loans, relating to its switching facilities and operating equipment. STAR
anticipates making capital expenditures of approximately $80.0 million over the
next 12 months to expand its global network. STAR believes that the proceeds
from this 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 the Company continues to expand its network facilities and
pursues its strategy of growth through acquisition, the Company's liquidity
needs may increase, perhaps significantly, which could require the Company 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. The Company had foreign currency contracts outstanding at December
31, 1997 in the notional amount of $6.3 million. See Note 2 of Notes to
Consolidated Financial Statements.
YEAR 2000 COMPLIANCE. The Company has made a concerted effort to insure
that the software components of its information and billing systems are Year
2000 compliant. As such, management believes that, after January 1, 2000, the
Company 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 the Company's customers
and vendors rely on software that is not Year 2000 compliant.
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BUSINESS
OVERVIEW
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 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. The Company has grown its revenues rapidly by capitalizing
on the deregulation of international telecommunications markets, combining
sophisticated information systems with flexible routing and leveraging
management's industry expertise. STAR has increased its revenues from $46.3
million in 1995 to $376.2 million in 1997.
INDUSTRY BACKGROUND
The international long distance telecommunications services industry
consists of all transmissions of voice and data that originate in one country
and terminate in another. This industry is undergoing a period of fundamental
change which has resulted in substantial growth in international
telecommunications traffic. According to industry sources, worldwide gross
revenues for providers of international telephone service were over $60 billion
in 1996 and the volume of international traffic on the public telephone network
is expected to grow at a compound annual growth rate of approximately 13% from
1996 through the year 2000.
From the standpoint of U.S.-based long distance providers, the industry can
be divided into two major segments: the U.S. international market, consisting of
all international calls billed in the U.S., and the overseas market, consisting
of all international calls billed in countries other than the U.S. The U.S.
international market has experienced substantial growth in recent years, with
gross revenues from international long distance services rising from
approximately $8.5 billion in 1990 to approximately $14.9 billion in 1996,
according to FCC data.
The Company believes that a number of trends in the international
telecommunications market will continue to drive growth in international
traffic, including:
- continuing deregulation and privatization of telecommunications markets;
- pressure to reduce international outbound long distance rates paid by end
users driven by increased competition in newly deregulated global markets;
- the dramatic increase in the availability of telephones and the number of
access lines in service around the world;
- the increasing globalization of commerce, trade and travel;
- the proliferation of communications devices such as faxes, cellular
telephones, pagers and data communications devices;
- increasing demand for data transmission services, including the Internet;
and
- the increased utilization of high quality digital undersea cable and
resulting expansion of bandwidth availability.
THE DEVELOPMENT OF THE U.S. AND OVERSEAS MARKETS
The 1984 deregulation of the U.S. telecommunications industry enabled the
emergence of a number of new long distance companies in the U.S. Today, there
are over 500 U.S. long distance companies, most of which are small or
medium-sized companies. In order to be successful, these small and medium-sized
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companies need to offer their customers a full range of services, including
international long distance. However, most of these carriers do not have the
critical mass to receive volume discounts on international traffic from the
larger facilities-based carriers such as AT&T, MCI and Sprint. In addition,
these small and medium-sized companies generally have only limited capital
resources to invest in international facilities. New international carriers such
as STAR emerged to take advantage of this demand for less expensive
international bandwidth. These emerging multinational carriers acted as
aggregators of international traffic for smaller carriers, taking advantage of
larger volumes to obtain volume discounts on international routes (resale
traffic), or investing in facilities when volume on particular routes justify
such investments. Over time, as these emerging international carriers became
established and created high quality networks, they began to carry overflow
traffic from the larger long distance providers seeking lower rates on certain
routes.
Deregulation and privatization have also allowed new long distance providers
to emerge in foreign markets. By eroding the traditional monopolies held by
single national providers, many of which are wholly or partially government
owned, such as Post Telegraph & Telephone operators ("PTTs"), deregulation is
providing U.S.-based providers the opportunity to negotiate more favorable
agreements with PTTs and emerging foreign providers. In addition, deregulation
in certain foreign countries is enabling U.S.-based providers to establish local
switching and transmission facilities in order to terminate their own traffic
and begin to carry international long distance traffic originated in that
country. STAR believes that growth of traffic originated in markets outside of
the U.S. will be higher than the growth in traffic originated within the U.S.
due to recent deregulation in many foreign markets, relative economic growth
rates and increasing access to telecommunications facilities in emerging
markets.
INTERNATIONAL SWITCHED LONG DISTANCE SERVICES
International switched long distance services are provided through switching
and transmission facilities that automatically route calls to circuits based
upon a predetermined set of routing criteria. The call typically originates on a
local exchange carrier's network and is transported to the caller's domestic
long distance carrier. The domestic long distance provider then carries the call
to an international gateway switch. An international long distance provider
picks up the call at its gateway and sends it directly or through one or more
other long distance providers to a corresponding gateway switch operated in the
country of destination. Once the traffic reaches the country of destination, it
is then routed to the party being called though that country's domestic
telephone network.
International long distance providers can generally be categorized by their
ownership and use of switches and transmission facilities. The largest U.S.
carriers, such as AT&T, MCI and Sprint, primarily utilize owned transmission
facilities and generally use other long distance providers to carry their
overflow traffic. Since only very large carriers have transmission facilities
that cover the over 200 countries to which major long distance providers
generally offer service, a significantly larger group of long distance providers
own and operate their own switches but either rely solely on resale agreements
with other long distance
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carriers to terminate their traffic or use a combination of resale agreements
and owned facilities in order to terminate their traffic as shown below:
[LOGO]
OPERATING AGREEMENTS. Under traditional operating agreements, international
long distance traffic is exchanged under bilateral agreements between
international long distance providers in two countries. Operating agreements
provide for the termination of traffic in, and return traffic to, the
international long distance providers' respective countries at a standard
"accounting rate" with that international provider. Under a traditional
operating agreement, the international long distance provider that originates
more traffic compensates the long distance provider in the other country by
paying a net amount based on the difference between minutes sent and minutes
received and the settlement rate, which is generally one-half of the accounting
rate.
Under a typical operating agreement both carriers jointly own the
transmission facilities between two countries. A carrier gains ownership rights
in a digital fiber optic cable by purchasing direct ownership in a particular
cable prior to the time the cable is placed in service, acquiring an
"Indefeasible Right of Use" ("IRU") in a previously installed cable, or by
leasing or obtaining capacity from another long distance provider that either
has direct ownership or IRUs in the cable. In situations where a long distance
provider has sufficiently high traffic volume, routing calls across directly
owned or IRU cable is generally more cost-effective on a per call basis than the
use of short-term variable capacity arrangements with other long distance
providers or leased cable. However, direct ownership and acquisition of IRUs
require a company to make an initial investment of its capital based on
anticipated usage.
TRANSIT ARRANGEMENTS. In addition to utilizing an operating agreement to
terminate traffic delivered from one country directly to another, an
international long distance provider may enter into transit arrangements
pursuant to which a long distance provider in an intermediate country carries
the traffic to a country of destination. Such transit arrangements involve
agreement among the providers in all the countries involved and are generally
used for overflow traffic or where a direct circuit is unavailable or not volume
justified.
RESALE ARRANGEMENTS. Resale arrangements typically involve the wholesale
purchase and sale of transmission and termination services between two long
distance providers on a variable, per minute basis. The resale of capacity,
which was first permitted in the U.S. market in the 1980s enabled the emergence
of new international long distance providers that rely at least in part on
capacity acquired on a wholesale basis from other long distance providers.
International long distance calls may be routed through a facilities-based
carrier with excess capacity, or through multiple long distance resellers
between the originating long
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distance provider and the facilities-based carrier that ultimately terminates
the traffic. Resale arrangements set per minute prices for different routes,
which may be guaranteed for a set time period or subject to fluctuation
following notice. The resale market for international capacity is constantly
changing, as new long distance resellers emerge and existing providers respond
to fluctuating costs and competitive pressures. In order to be able to
effectively manage costs when utilizing resale arrangements, long distance
providers need timely access to changing market data and must quickly react to
changes in costs through pricing adjustments or routing decisions.
ALTERNATIVE TERMINATION ARRANGEMENTS. As the international
telecommunications market has become deregulated, service providers have
developed alternative arrangements to reduce their termination costs by, for
example, routing traffic via third countries to obtain lower settlement rates or
using international private line facilities to bypass the settlement rates
applicable to traffic routed over the PSTN. These arrangements include ISR,
traffic refiling and the acquisition of transmission and switching facilities in
foreign countries so as to self-correspond. Refiling of traffic takes advantage
of disparities in settlement rates between different countries. An originating
operator typically refiles traffic by sending it first to a third country that
enjoys lower settlement rates with the destination country where upon it is
forwarded or refiled to the destination country thereby resulting in a lower
overall termination cost. The difference between transit and refiling is that,
with respect to transit, the operator in the destination country typically has a
direct relationship with the originating operator and is aware of the
arrangement, while with refiling, the operator in the destination country
typically is not aware that it is terminating refiled traffic originated in
another country. While the United States has taken no position with respect to
whether refile comports with international regulation, refile is illegal in many
countries. With ISR, a long distance provider completely bypasses the settlement
system by connecting an IPL to the PSTN on one or both ends. While ISR currently
is only sanctioned by U.S. and other regulatory authorities on some routes, ISR
services are increasing and are expected to expand significantly as deregulation
of the international telecommunications market continues. In addition, new
market access agreements, such as the WTO Agreement, have made it possible for
many international service providers to establish their own transmission and
switching facilities in certain foreign countries, enabling them to
self-correspond and directly terminate traffic. See "--Government Regulation."
The highly competitive and rapidly changing international telecommunications
market has created a significant opportunity for carriers that can offer high
quality, low cost international long distance service. Deregulation,
privatization, the expansion of the resale market and other trends influencing
the international telecommunications market are driving decreased termination
costs, a proliferation of routing options, and increased competition. Successful
companies among both the emerging and established international long distance
companies will need to aggregate enough traffic to lower costs of both
facilities-based or resale opportunities, maintain systems which enable analysis
of multiple routing options, invest in facilities and switches and remain
flexible enough to locate and route traffic through the most advantageous
routes.
THE STAR APPROACH
STAR is an emerging multinational carrier focused primarily on the
international long distance market. 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 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. The Company has grown its revenues rapidly by capitalizing
on the deregulation of international telecommunications markets, combining
sophisticated information systems with flexible routing and leveraging
management's industry expertise.
STAR markets its services to large global carriers seeking lower rates and
high quality overflow capacity, as well as to small and medium-sized long
distance companies that do not have the critical mass
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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, the Company provided switched international long distance services to
105 customers and currently provides these services to nine of the top forty
global carriers. The Company 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
The Company'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 the Company's strategy include
the following:
EXPAND SWITCHING AND TRANSMISSION FACILITIES. The Company 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. The Company has expanded its international gateway
switching facilities through the addition of a facility in Dallas and plans to
put into service in 1998 switches in Atlanta, Chicago, Miami and Seattle;
Dusseldorf, Frankfurt, Hamburg and Munich, Germany; Paris, France; and Tokyo,
Japan. The Company's international gateway switch in London, England went into
service in April 1997 and four switches in Germany are expected to be
operational in the second quarter of 1998. In addition, the Company is planning
to install a network of switches in selected other European and Asian cities.
CAPITALIZE ON PROJECTED INTERNATIONAL LONG DISTANCE GROWTH. The Company
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. The
Company targets international markets with high volumes of traffic, relatively
high rates per minute and prospects for deregulation and privatization. The
Company believes that the ongoing trend toward deregulation and privatization
will create new opportunities for the Company in international markets. Although
the Company has focused to date primarily on providing services for U.S.-based
long distance providers, the Company also intends to expand the international
long distance services it offers to foreign-based long distance providers.
LEVERAGE TRAFFIC VOLUME TO REDUCE COSTS. The Company continues to focus on
building its volume of international long distance traffic. Higher traffic
volumes strengthen the Company's negotiating position with vendors, customers
and potential foreign partners, which allows the Company to lower its costs of
service. In addition, higher traffic volumes on particular routes allow the
Company 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. The Company
leverages its sophisticated information systems to analyze its routing
alternatives, and select the most cost-effective routing from among the Company
owned facilities, network of resale arrangements with other long distance
providers, operating agreements and alternative termination relationships. The
Company has invested significant resources in the development of software to
track specific usage information by customer and revenue and cost information on
specific routes on a daily basis. The Company'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.
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MAINTAIN HIGH QUALITY. The Company 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. The Company'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. The Company 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,
the Company 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, the Company 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, the Company initially
intends to focus on Germany, the U.K. and selected European cities where
competition for commercial customers is less mature.
GROWTH THROUGH ACQUISITIONS. The Company actively pursues opportunities to
enhance its business through strategic and synergistic acquisitions. These
acquisitions may focus on entering new territories, enlarging the Company'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, the Company plans to realize operating efficiencies by integrating
newly-acquired operations into the Company's billing, tracking and other
systems. On November 30, 1997, the Company acquired LDS, a long distance
provider focusing on small commercial customers throughout the United States,
for approximately 849,000 shares of Common Stock. On March 10, 1998, the Company
acquired T-One, an international wholesale long distance provider, for 1,353,000
shares of Common Stock. On November 19, 1997, the Company entered into an
agreement to acquire UDN, a commercial long distance provider. The acquisition
of UDN is subject to approval by UDN's stockholders and to various regulatory
approvals. Assuming the receipt of all necessary approvals, STAR expects to
consummate the UDN acquisition in the second quarter of 1998 for approximately
800,000 shares of Common Stock. Each of these transactions has been, or will be,
accounted for as a pooling of interests.
NETWORK
The Company 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. The Company's network employs state-of-the-art digital
switching and transmission technologies and is supported by comprehensive
monitoring and technical support personnel. The Company's switching facilities
are staffed 24 hours per day, seven days per week.
TERMINATION ARRANGEMENTS
The Company 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 the
Company to take advantage of the rapidly evolving international
telecommunications market in order to provide low-cost international long
distance service to its customers.
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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. The Company purchased capacity from 57 vendors in
1997. A substantial portion of this capacity is obtained on a variable, per
minute and short-term basis, subjecting the Company to the possibility of
unanticipated price increases and service cancellations. The Company'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 the Company'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 the Company does not typically enter into long-term contracts with
these providers, pricing can change significantly over short periods of time.
The Company's proprietary information systems enable the Company to track the
pricing variations in the international telecommunications market on a daily
basis, allowing the Company's management to locate and reroute traffic to the
most cost-effective alternatives. See "Risk Factors--Operating Results Subject
to Significant Fluctuations."
The Company currently has operating agreements with carriers in a number of
countries and is in the process of negotiating additional operating agreements
for other countries. The Company has been and will continue to be selective in
entering into operating agreements. The Company also has agreements with
international providers of long distance services for termination of traffic
that the Company routes over its network to such countries. The Company
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 the
Company'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 the
Company's business, operating results and financial condition. In addition, the
FCC could impose sanctions on the Company, including forfeitures, if certain of
the Company'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.
The Company currently operates international gateway switches in New York,
Los Angeles, Dallas and London, England. In 1998, the Company plans to put into
service international gateway switches in Atlanta, Chicago, Miami and Seattle;
Dusseldorf, Frankfurt, Hamburg and Munich, Germany; Paris, France; and Tokyo,
Japan. The Company considers any of its switches to be international gateway
switches if the Company can route international calls across such switch.
STAR's switching facilities are linked to a proprietary reporting system,
which the Company 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. The Company has installed multiple redundancies into its switching
facilities to decrease the risk of a network failure. For example, the Company
employs both battery and generator power back-up and has
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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.
The Company currently holds ownership positions in a number of digital
undersea fiber optic cables, and has recently added capacity on the TPC-5
undersea fiber optic cable system and has entered into commitments to acquire
transmission capacity on three additional undersea fiber optic cable systems,
Gemini, AC-1 and China-US. The Company plans to increase its investment in
direct and IRU ownership of cable in situations where the Company 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,
the Company has added a switch located in the same building as the Company'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, the Company will acquire a switch located in the same
building as the Company's Dallas switch. The Company plans to integrate these
facilities into its existing network.
SALES AND MARKETING
The Company 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 the Company's senior management. The Company reaches its
customers primarily through domestic and international trade shows and through
relationships gained from years of experience in the telecommunications
industry. The Company had 20 direct sales and marketing employees and over 145
telemarketing representatives as of March 1, 1998.
In the wholesale market, the Company's sales and marketing employees utilize
the extensive, customer specific usage reports and network utilization data
generated by the Company's sophisticated information systems to effectively
negotiate agreements with customers and prospective customers and to rapidly
respond to changing market conditions. The Company 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 the Company's expansion into the commercial market, the
Company 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 the Company's services into the commercial
market can be expected to require substantial efforts and management and
financial resources and may increase the Company's operating costs. See "Risk
Factors--Risks Associated with Growth of Telecommunications Network and Customer
Base."
INFORMATION AND BILLING SYSTEMS
The Company's operations use advanced information systems including call
data collection and call data storage linked to a proprietary reporting system.
The Company also maintains redundant billing systems for rapid and accurate
customer billing. STAR's switching facilities are linked to a proprietary
reporting system, which the Company 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. The Company's systems also enable it to ensure accurate and
timely billing and to reduce routing errors. As the Company's systems were
designed for the wholesale marketplace, the Company is currently in the process
of modifying its systems in anticipation of its entrance into the commercial
marketplace.
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The Company's proprietary reporting software compiles call, price and cost
data into a variety of reports which the Company can use to re-program its
routes on a real-time basis. The Company'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 the Company
with route and network planning;
- vendor rates, through an audit report that allows management to determine
at a glance which vendors have the lowest rates for a particular country
in a particular time period;
- vendor usage by minute, enabling the Company to verify and audit vendor
bills;
- dollarized vendor usage to calculate the monetary value of minutes passed
to the Company'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. The Company'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. The
Company 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. The Company 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. The Company believes that it
competes favorably on the basis of price, transmission quality and customer
service. The number of the Company'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, the Company believes that competition will
continue to
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increase, placing downward pressure on prices. Such pressure could adversely
affect the Company's gross margins if the Company 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. The Company 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 the Company.
The Company's business would be materially adversely affected to the extent that
a significant number of such customers limit or cease doing business with the
Company 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 the
Company by reducing the number of potential customers for the Company's
services.
EXPANSION INTO COMMERCIAL MARKET. With the acquisition of LDS, STAR began
providing long distance service to the commercial market, a market that is
subject to intense competition from a number of well capitalized companies. The
commercial market is also characterized by the lack of customer loyalty, with
commercial customers regularly changing service providers. There can be no
assurance that STAR will be able to compete successfully in the commercial
market.
GOVERNMENT REGULATION
The Company's U.S. interstate and international telecommunications service
offerings generally are subject to the regulatory jurisdiction of the FCC.
Certain telecommunication services offered by the Company in the U.S. may also
be subject to the jurisdiction of state regulatory authorities, commonly known
as public utility commissions ("PUCs"). The Company'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 the Company'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 the Company. See "Risk Factors--Potential Adverse Effect
of Government Regulation."
U.S. REGULATION
The Company's business is subject to various U.S. and foreign laws,
regulations, agency actions and court decisions. The Company'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. The Company 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.
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INTERNATIONAL SERVICES. FCC rules require the Company 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 the Company to resell such capacity. The Company holds both facilities-based
and resale international authorizations, including a "global" authorization that
provides broad authority to offer switched and private line international
services. The Company 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. The Company's FCC authority currently permit it to provide ISR
service to Canada, the U.K., Sweden, New Zealand, Australia and the Netherlands.
The FCC is currently reviewing U.S. carrier applications to provide ISR to
Belgium, Chile, Denmark, Finland, France, Germany, Hong Kong, Norway and
Luxembourg, among other routes, and upon grant of any such ISR application to a
given country, the FCC's rules also would permit the Company to provide ISR
service to that country. Certain of the Company's termination arrangements with
foreign operators involve IPL arrangements which may be inconsistent with the
foregoing FCC IPL resale policy and the Company'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 the Company's IPL arrangements violate its ISR policy or
the Company's ISR authorization, the FCC could order the Company to terminate
any non-conforming arrangements. In addition, the Company could be subject to a
monetary forfeiture and to other penalties, including the revocation of the
Company's FCC authorizations to operate as an international carrier. Any such
FCC action could have a material adverse effect upon the Company's business,
operating results and financial condition.
FCC INTERNATIONAL SETTLEMENTS POLICY. The FCC's ISP places limits on the
arrangements which U.S. international carriers may enter into with foreign
carriers for exchanging public switched telecommunications traffic, which the
FCC terms International Message Telephone Service. The policy does not apply to
ISR services. The ISP is primarily intended to deter dominant foreign carriers
from discriminating amongst competing U.S. carriers by, for example, favoring
the foreign carrier's U.S. affiliate. Absent FCC consent, the ISP requires that
U.S. carriers receive an equal share of the accounting rate (i.e., that
settlement rates be equivalent) and receive inbound traffic in proportion to the
volume of U.S. outbound traffic which they generate. The ISP and other FCC
policies also prohibit a U.S. carrier from offering or accepting a "special
concession" from a foreign carrier where the foreign carrier possess sufficient
market power on the foreign end of the route to affect competition adversely in
the U.S. market. A "special concession" is defined by the FCC as an exclusive
arrangement involving services, facilities or functions on the foreign end of a
U.S. international route which are necessary for providing basic
telecommunications, and which are not offered to similarly situated U.S.
carriers authorized to serve that route. U.S. international carriers wishing to
establish settlement arrangements for IMTS which do not comply with the ISP must
obtain a waiver of the FCC's rules or a declaratory ruling from the FCC under
the FCC's "flexibility" policy that the non-standard arrangement is in the
public interest. FCC policy provides that a request by a U.S. international
carrier to establish a non-standard settlement arrangement with a foreign
carrier in a WTO member country is presumptively in the public interest, and
that said presumption generally may be overcome only by a demonstration that the
foreign carrier is not subject to competition in its home market from more than
one facilities-based international carrier. Notwithstanding the FCC's ISP waiver
and flexibility
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policies, it is possible that the FCC could find that certain of the Company's
arrangements with foreign operators were or are inconsistent with the ISP and
that the Company has not requested prior FCC authority therefore. If the FCC
were to determine by its own actions or in response to the filing of a third
party that the Company has violated the ISP, the FCC could order the Company to
terminate any non-conforming arrangement. In addition, the Company could be
subject to a monetary forfeiture and to other penalties, including revocation of
the Company's FCC authorizations to operate as an international carrier. Any
such FCC action could have a material adverse effect upon the Company'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. The Company expects that any IMTS operating agreement which it
has or may have with a foreign affiliate will satisfy the foregoing benchmarks
requirement.
The Company currently has IMTS operating agreements with certain foreign
correspondents which provide for settlement rates above the FCC's prescribed
benchmarks. The Company 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 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 the Company 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. The Company is
unable to predict the form which such intervention may take but it could disrupt
the Company's arrangement for transmitting traffic to certain countries require
the Company to suspend direct service to certain countries or require the
Company to make alternative termination arrangements with certain countries, all
of which could have a material adverse effect on the Company'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. The Company 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 the
Company's transit or refile arrangements violate the ISP or other FCC policies.
In that event, the FCC could order the Company to terminate any non-conforming
transit or refile arrangements. In addition, the Company could be subject to a
monetary forfeiture and to other penalties, including revocation of the
Company's FCC authorizations to operate as an international carrier. Any such
FCC action could have a material adverse effect on the Company's business,
operating results and financial condition.
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REPORTING REQUIREMENTS. International telecommunication carriers also are
required by the FCC's rules timely to file certain reports regarding
international traffic and revenues, the ownership and use of international
facilities and their affiliates with foreign carriers. The FCC considers a U.S.
carrier to be affiliated with a foreign carrier if it has a 25% interest in the
capital stock of the carrier or it controls the foreign carrier or is under
common ownership or control. The FCC requires these reports so that, among other
things, it may monitor the development of industry competition and the potential
for a dominant foreign carrier to discriminate amongst U.S. carriers. The
Company 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. The Company 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, the Company has not filed certain other
carrier contracts. Notwithstanding the foregoing FCC filings by the Company, the
FCC by its own action or in response to the filing of a third party could
determine that the Company has failed to meet certain of the foregoing filing
and reporting requirements or that certain Company filings are deficient. In
that event, the Company could be directed to remedy any asserted non-compliance;
the Company could also be subject to a monetary forfeiture and to other
penalties, and, although the Company believes that it would be largely
unprecedented in such circumstances, and hence unlikely, the FCC could revoke
the Company's authorizations to operate as an international carrier. Any such
FCC action could have a material adverse affect on the Company's business,
results and financial condition.
REGULATORY FEES. The Communications Act and FCC rules and policies impose
certain fees upon carriers providing interstate and international
telecommunication services. These fees are levied, among other things, to defray
the FCC's operating expenses, to underwrite universal telecommunication service
(e.g., by subsidizing certain services used by schools and libraries, such as
Internet access, and by other telecommunications users in areas of the U.S.
where service costs are significantly above average), to fund the
Telecommunications Relay Service ("TRS"), which provides special options for
hearing-impaired users, and to support the administration of telephone numbering
plans.
Carriers that provide domestic interstate services must pay an annual
regulatory fee based on their interstate revenues; the fee is currently 0.12% of
revenue. The bulk of the Company's revenue, which is derived from international
services, is not subject to this fee. Carriers that provide domestic interstate
services to end users must pay a universal telecommunications service fee each
month based upon the total estimated demand for U.S. universal service funding.
If applicable, each carrier's share is approximately four percent of the
carrier's annual end user revenues. The Company 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
the Company 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, the Company did
not offer domestic interstate services. As a result of the operations of LDS,
any revenue the Company receives from end users for international services may
be subject to universal service fees. U.S. interstate and international carriers
must pay a percentage of their total revenue each year to support the North
American Numbering Plan Administrator. For the 1998 filing year, the
contribution rate is less than .003 percent of net telecommunications revenue.
U.S. carriers must pay a certain percentage of their interstate revenues to
support the TRS Fund. For the 1998 filing year, the contribution rate is less
than .04 percent of gross domestic interstate revenue. The Company has generally
paid the foregoing regulatory fees and, with regard to the annual regulatory
fees owed by interstate carriers, the Company is currently owed approximately
$20,000 by the FCC due to the inadvertent overpayment of said fee for a prior
year. The foregoing regulatory fees typically change annually. The Company
cannot predict the future regulatory fees for which it may be liable. Said fees
could
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rise significantly for the Company and amount to four percent or more of the
Company's gross international and interstate revenues if the Company is no
longer exempt from paying universal service fees as a result of an affiliate's
provision of domestic interstate services, or because the Company provides
service directly to end users, or because amendments to the Communications Act
repeal the universal service fee exemption for carriers which only offer
international service or services provided to connecting carriers. Because the
international telecommunication services business is highly competitive, an
increase in the regulatory fees which the Company must pay could impair its
market position and have a material adverse effect on the Company's business,
operating results and financial condition.
RECENT AND POTENTIAL FCC ACTIONS. Recent FCC rulemaking orders and other
actions have lowered the entry barriers for new facilities-based and resale
international carriers by streamlining the processing of new applications and
granting non-dominant carriers greater flexibility in establishing non-standard
settlement arrangements with non-dominant foreign carriers, including the
non-dominant U.S. affiliates of such carriers. In addition, the FCC's rules
implementing the WTO Agreement presume that competition will be advanced by the
U.S. entry of facilities-based and resale carriers from WTO member countries,
thus further increasing the number of potential competitors in the U.S. market
and the number of carriers which may also offer end-to-end services. The FCC is
reviewing the proposed merger of WorldCom and MCI, and is expected soon to
review the proposed merger of LCI International, Inc. and Qwest Communications
International Inc. FCC approval and consummation of these mergers would increase
concentration in the international telecommunications service industry and the
potential market power of the Company'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
the Company'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 the Company's transmission arrangements to
certain countries or require the Company to modify its existing arrangements;
other U.S. international carriers might be similarly affected. The 1996
amendment to the Communications Act permits the FCC to forbear enforcement of
the tariff provisions in the Act, which apply to all interstate and
international carriers, and the U.S. Court of Appeals is currently reviewing an
FCC order directing all domestic interstate carriers to detariff their
offerings. Subject to the Court's decision, the FCC may forbear its current
tariff rules for U.S. international carriers, such as the Company, or order such
carriers to detariff their services. In that event, the Company 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 the Company 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 the Company is likely to be well positioned to
expand certain refile operations even though new opportunities may become
available to its competitors. The Company 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
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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. The Company
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, the Company 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 the Company's acquisition of LDS,
LDS settled disputes with the California PUC and with the District Attorney of
Monterey, California regarding LDS' alleged unauthorized switching of long
distance customers. As part of the Settlements, LDS was subject to fines and
restrictions on its business operations in California. In addition, the FCC has
received numerous informal complaints against LDS regarding the alleged
unauthorized switching of long distance customers, which complaints currently
remain under review.
Following the Company'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, the Company 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 the
Company 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. The Company has been granted a
license to provide international services on a resale basis and STAR Europe has
been granted a license to provide
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international services over its own facilities, which licenses are subject to a
number of restrictions. Implementation of these licenses have permitted the
Company 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 the Company
through its affiliate, STAR Telecommunications Deutschland GmbH ("STAR
Germany"), are subject to regulation by the Regulierungsbehorde fur
Telekommunikation und Post (which is under the jurisdiction of the Ministry of
Economy). Germany permits the competitive provision of international
facilities-based and resale services. STAR Germany was granted a license for the
provision of voice telephony on the basis of self-operated telecommunications
networks on December 4, 1997. Under this license, STAR Germany is presently
installing telecommunications switching facilities in Dusseldorf, Frankfurt,
Hamburg and Munich and is leasing connection transmission facilities between
these switches and additional facilities. The network of STAR Germany will be
used primarily for routing international telecommunications traffic between the
U.S., the U.K., Germany and beyond. There can be no assurance that future
changes in regulation of the services provided by STAR Germany will not have a
material adverse effect on the Company's business, operating results and
financial condition.
OTHER COUNTRIES. The Company 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 the
Company 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 the Company 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. The Company's inability to
take advantage of such liberalization could have a material adverse affect on
the Company's ability to expand its services as planned.
EMPLOYEES
As of March 1, 1998, the Company employed 454 full-time employees. The
Company is not subject to any collective bargaining agreement and it believes
that its relationships with its employees are good.
PROPERTIES
The Company's principal offices are located in Santa Barbara, California in
four facilities providing an aggregate of approximately 24,972 square feet of
office space. Approximately 5,332 square feet of this office space is leased
pursuant to two leases that both expire in July 1999. The remaining
approximately 12,327 square feet of office space is located in two buildings and
is rented by the Company pursuant to a lease that expires in June 2003. The
Company also leases approximately 16,595 square feet of space for its switching
facility in Los Angeles, California under a sublease and a lease expiring in
April 2006, an aggregate of approximately 33,445 square feet of space for its
switching facilities in New York, New York under three leases which expire in
December 31, 2001, July 31, 2003 and April 2008, respectively, approximately
6,167 square feet of space for its switching facility in Dallas, Texas under a
lease expiring in April 2007, and approximately 8,000 square feet of space for
its switching facility in London, England under a lease expiring in July 2006.
The Company leases approximately 14,628 square feet in Dusseldorf, approximately
27,835 square feet in Frankfurt, approximately 12,002 square feet in Hamburg and
approximately 12,408 square feet in Munich, Germany under four leases expiring
on or about January 1, 2008. The aggregate facility lease payments made by the
Company in 1997 were approximately $2.2 million. The Company believes that all
other material terms of its leases are commercially reasonable terms that are
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typically found in commercial leases in each of the respective areas in which
the Company leases space. The Company believes that its facilities are adequate
to support its current needs and that additional facilities will be available at
competitive rates as needed.
LITIGATION
The Company is not presently a party to any material pending litigation.
From time to time, however, the Company is party to various legal proceedings,
including billing disputes and collection matters, that arise in the ordinary
course of business.
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MANAGEMENT
OFFICERS AND DIRECTORS
The officers and directors of the Company, and their ages as of March 16,
1998, are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------ --- -----------------------------------------------------------------
<S> <C> <C>
Christopher E. Edgecomb(1).... 39 Chief Executive Officer, Chairman of the Board and Director
Mary A. Casey(1)(2)........... 35 President, Secretary and Director
David Vaun Crumly............. 34 Executive Vice President--Sales and Marketing
James E. Kolsrud.............. 53 Executive Vice President--Operations and Engineering
Kelly D. Enos................. 39 Chief Financial Officer and Treasurer
Mark Gershien................. 46 Director
Gordon Hutchins, Jr.(3)....... 48 Director
John R. Snedegar(2)(3)........ 48 Director
</TABLE>
- ------------------------
(1) Member of Non-Executive Stock Option Committee
(2) Member of Audit Committee
(3) Member of Compensation Committee
CHRISTOPHER E. EDGECOMB co-founded the Company in September 1993, served as
President of the Company until January 1996 and has served as the Company's
Chief Executive Officer and Chairman of the Board since January 1996. Mr.
Edgecomb has been a Director of the Company since its inception. Prior to that
time, Mr. Edgecomb was a founder and the Executive Vice President of West Coast
Telecommunications ("WCT"), a nation-wide long distance carrier, from August
1989 to December 1994. Prior to founding WCT, Mr. Edgecomb was President of
Telco Planning, a telecommunications consulting firm, from January 1986 to July
1989. Prior to that time, Mr. Edgecomb held senior level sales and marketing
positions with TMC Communications, American Network and Bay Area Teleport.
MARY A. CASEY has been a Director and Secretary of the Company since
co-founding the Company in September 1993, and has served as the Company's
President since January 1996. Prior to that time, Ms. Casey was Director of
Customer Service at WCT from December 1991 to June 1993, and served as Director
of Operator Services at Call America, a long distance telecommunications
company, from May 1988 to December 1991.
DAVID VAUN CRUMLY has served as the Company's Executive Vice
President--Sales and Marketing since January 1996. Prior to that time, Mr.
Crumly served as a consultant to the Company from November 1995 to January 1996,
was Vice President of Carrier Sales of Digital Network, Inc. from June 1995 to
November 1995 and was Director of Carrier Sales of WCT from June 1992 to June
1995. Prior to joining WCT, Mr. Crumly served in various sales and marketing
capacities with Metromedia, a long-distance company, from September 1990 to June
1992 and with Claydesta, a long-distance company, from May 1987 to September
1989.
JAMES E. KOLSRUD has served as the Company's Executive Vice
President--Operations and Engineering since September 1996. Prior to joining the
Company, Mr. Kolsrud was an international telecommunications consultant from
March 1995 to September 1996. Prior to that time, he was a Vice President,
Corporate Engineering and Administration of IDB Communications Group, Inc.
("IDB"), an international communications company, from October 1989 to March
1995, and prior to that time, he was President of the International Division of
IDB.
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KELLY D. ENOS has served as the Company's Chief Financial Officer since
December 1996 and as Treasurer since April 1997. Prior to that time, Ms. Enos
was an independent consultant in the merchant banking field from February 1996
to November 1996 and a Vice President of Fortune Financial, a merchant banking
firm, from April 1995 to January 1996. Ms. Enos served as a Vice President of
Oppenheimer & Co., Inc., an investment bank, from July 1994 to March 1995 and a
Vice President of Sutro & Co., an investment bank, from January 1991 to June
1994.
MARK GERSHIEN has served as a Director of the Company since March 1998. Mr.
Gershien has been the Senior Vice President of Sales and Marketing for Level 3
Communications, a telecommunications and information services company, since
January 1998. Prior to that time, Mr. Gershien was the Senior Vice President of
National Accounts for WorldCom, Inc., an international telecommunications
company, and President and Chief Executive Officer of MFS Telecom, a division of
MFS Communications, Inc. prior to its merger with WorldCom, Inc.
GORDON HUTCHINS, JR. has served as a Director of the Company since January
1996. Mr. Hutchins has been President of GH Associates, a telecommunications
consulting firm, since July 1989. Prior to founding GH Associates, Mr. Hutchins
served as President and Chief Executive Officer of ICC Telecommunications, a
competitive access provider, and held senior management positions with several
other companies in the telecommunications industry.
JOHN R. SNEDEGAR has served as a Director of the Company since January 1996.
Mr. Snedegar has been the President and a Director of UDN since June 1990. From
June 1980 to February 1992, Mr. Snedegar was the President and CEO of AmeriTel
Management, Inc., a provider of long distance telecommunications and management
services. Mr. Snedegar is also a director for StarBase Corporation, a software
development company. Mr. Snedegar also serves as President of Kendall Venture
Funding, Ltd., a reporting company in Alberta, Canada.
BOARD COMPOSITION
In accordance with the terms of the Company's Amended and Restated
Certificate of Incorporation, the terms of office of the Board of Directors are
divided into three classes: Class I, whose term will expire at the annual
meeting of stockholders to be held in 1998; Class II, whose term will expire at
the annual meeting of stockholders to be held in 1999; and Class III, whose term
will expire at the annual meeting of stockholders to be held in 2000. The Class
I directors are Gordon Hutchins, Jr. and John R. Snedegar, the Class II
directors are Mark Gershien and Mary A. Casey, and the Class III director is
Christopher E. Edgecomb. At each annual meeting of stockholders after the
initial classification, the successors to directors whose term will then expire
will be elected to serve from the time of election and qualification until the
third annual meeting following election. This classification of the Board of
Directors may have the effect of delaying or preventing changes in control or
changes in management of the Company. See "Risk Factors--Anti-takeover Effects
of Certificate of Incorporation, Bylaws and Delaware Law" and "Description of
Capital Stock--Anti-takeover Effects of Provisions of the Certificate of
Incorporation, Bylaws and Delaware Law."
Each officer is elected by and serves at the discretion of the Board of
Directors. Each of the Company's officers and directors, other than nonemployee
directors, devotes substantially full time to the affairs of the Company. The
Company's nonemployee directors devote such time to the affairs of the Company
as is necessary to discharge their duties. There are no family relationships
among any of the directors, officers or key employees of the Company.
DIRECTOR COMPENSATION
The Company's non-employee directors receive $2,000 for each Board meeting
attended and $1,000 for each telephonic Board meeting. In addition, each
non-employee director is reimbursed for out-of-pocket expenses incurred in
connection with attendance at meetings of the Board of Directors and its
46
<PAGE>
committees. In 1996, Messrs. Hutchins and Snedegar were each granted stock
options to purchase 20,500 shares of Common Stock. In 1997, Messrs. Hutchins,
Snedegar and Roland Van der Meer, a former director, were each granted stock
options to purchase 10,250 shares of Common Stock. In 1998, Messrs. Hutchins,
Snedegar and Gershien were each granted stock options to purchase 10,250 shares
of Common Stock. See "Certain Transactions--Transactions with Outside
Directors."
EXECUTIVE COMPENSATION
The following Summary Compensation Table sets forth the compensation earned
by the Company's Chief Executive Officer and four other executive officers who
earned (or would have earned) salary and bonus in excess of $100,000 for
services rendered in all capacities to the Company and its subsidiaries (the
"Named Officers") for each of the fiscal years in the two year period ended
December 31, 1997.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
-------------
SECURITIES
FISCAL UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) OPTIONS (#) COMPENSATION($)
- --------------------------------------------------- ----------- --------- ----------- ------------- -----------------
<S> <C> <C> <C> <C> <C>
Christopher E. Edgecomb............................ 1997 360,000 -- -- 3,202(1)
Chief Executive Officer 1996 360,000 -- -- 9,223(1)
and Chairman of the Board
Mary A. Casey...................................... 1997 217,500 -- -- 13,615(2)
President and Secretary 1996 156,042 -- -- 15,028(2)
David Vaun Crumly.................................. 1997 380,779 1,014 -- 6,202(2)
Executive Vice President--Sales 1996 298,002 -- 410,000 3,202(2)
and Marketing
James E. Kolsrud................................... 1997 177,083 1,014 -- 5,528(3)
Executive Vice President--Operations 1996 25,000 -- 205,000 --
and Engineering
Kelly D. Enos(4)................................... 1997 150,000 1,014 20,500 25,924(5)
Chief Financial Officer and Treasurer 1996 12,500 -- 153,750 --
</TABLE>
- ------------------------
(1) Consists of life and health insurance premiums paid by the Company.
(2) Consists of life and health insurance premiums and a car allowance paid by
the Company.
(3) Consists of health insurance premiums paid by the Company.
(4) Ms. Enos joined the Company in December 1996.
(5) Consists of a moving allowance of $22,721 and life and health insurance
premiums paid by the Company.
47
<PAGE>
The following table contains information concerning the stock option grants
made to each of the Named Officers named below for the year ended December 31,
1997.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE OF ASSUMED
ANNUAL RATES OF
NUMBER OF PERCENT OF STOCK PRICE
SECURITIES TOTAL OPTIONS APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OPTION TERM(1)
OPTIONS EMPLOYEES IN PRICE PER EXPIRATION --------------------
NAME GRANTED(#) FISCAL YEAR SHARE($/SH) DATE 5%($) 10%($)
- --------------------------------------- ----------- --------------- ----------- ----------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Kelly D. Enos.......................... 20,500(2) 2.3% $ 6.83 06/27/07 $ 88,045 $ 223,124
</TABLE>
- --------------------------
(1) The 5% and 10% assumed annual rates of compounded stock price appreciation
are mandated by rules of the Securities and Exchange Commission. There can
be no assurance provided to any executive officer or any other holder of the
Company's securities that the actual stock price appreciation over the
10-year option term will be at the assumed 5% and 10% levels or at any other
defined level. Unless the market price of the Common Stock appreciates over
the option term, no value will be realized from the option grants made to
the executive officer.
(2) The option becomes exercisable in four equal annual installments on June 26,
1998, 1999, 2000 and 2001, respectively.
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
No options were exercised by the Named Officers for the fiscal year ended
December 31, 1997. No stock appreciation rights were exercised during such year
or were outstanding at the end of that year.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee of the Company's Board (the "Compensation
Committee") was formed in May 1996, and, in 1997, the members of the
Compensation Committee were Gordon Hutchins, Jr., John R. Snedegar and Roland A.
Van der Meer. None of these individuals was at any time during the year ended
December 31, 1997, or at any other time, an officer or employee of the Company.
Mr. Van der Meer resigned from the Board and the Compensation Committee,
effective as of February 1, 1998. The Non-Executive Compensation Committee of
the Company's Board (the "Non-Executive Compensation Committee") was formed in
1997, and the members are Christopher E. Edgecomb and Mary A. Casey. No member
of the Compensation Committee or the Non-Executive Compensation Committee served
at any time during the year ended December 31, 1997 as a member of the board of
directors or compensation committee of any entity that has one or more executive
officers serving as a member of the Company's Board, Compensation Committee or
Non-Executive Compensation Committee, except that Mr. Hutchins was a director of
UDN for a portion of 1997. The Compensation Committee and the Non-Executive
Compensation Committee shall collectively be referred to hereafter as the
"Compensation Committees."
1997 OMNIBUS STOCK INCENTIVE PLAN
The Company's 1997 Omnibus Stock Incentive Plan (the "Omnibus Plan") was
adopted by the Board of Directors on January 30, 1997 as the successor to the
Company's 1996 Supplemental Option Plan (the "Supplemental Plan"). The Company
has reserved 3,075,000 shares for issuance under the Omnibus Plan. This share
reserve is comprised of (i) the 2,050,000 shares that were available for
issuance under the Supplemental Plan, plus (ii) an increase of 1,025,000 shares.
As of February 28, 1998, 16,621 shares had been issued under the Supplemental
and Omnibus Plans, options for 2,143,045 shares were outstanding (889,413 of
which were granted under the Supplemental Plan) and approximately 915,330 shares
remained available for future grant. Shares of Common Stock subject to
outstanding options, including options
48
<PAGE>
granted under the Supplemental Plan, which expire or terminate prior to
exercise, will be available for future issuance under the Omnibus Plan. In
addition, if stock appreciation rights ("SARs") and stock units are settled
under the Omnibus Plan, then only the number of shares actually issued in
settlement will reduce the number of shares available for future issuance under
this plan.
Under the Omnibus Plan, employees, outside directors and consultants may be
awarded options to purchase shares of Common Stock, SARs, restricted shares and
stock units. Options may be incentive stock options designed to satisfy Section
422 of the Internal Revenue Code or nonstatutory stock options not designed to
meet such requirements. SARs may be awarded in combination with options,
restricted shares or stock units, and such an award may provide that the SARs
will not be exercisable unless the related options, restricted shares or stock
units are forfeited.
The Omnibus Plan is administered by the Board or the Compensation Committees
(the "Administrator"). The Administrator has the complete discretion to
determine which eligible individuals are to receive awards; determine the award
type, number of shares subject to an award, vesting requirements and other
features and conditions of such awards; interpret the Omnibus Plan; and make all
other decisions relating to the operation of the Omnibus Plan.
The exercise price for options granted under the Omnibus Plan may be paid in
cash or in outstanding shares of Common Stock. Options may also be exercised on
a cashless basis, by a pledge of shares to a broker or by promissory note. The
payment for the award of newly issued restricted shares will be made in cash. If
an award of SARs, stock units or restricted shares from the Company's treasury
is granted, no cash consideration is required.
The Administrator has the authority to modify, extend or assume outstanding
options and SARs or may accept the cancellation of outstanding options and SARs
in return for the grant of new options or SARs for the same or a different
number of shares and at the same or a different exercise price.
The Board may determine that an outside director may elect to receive his or
her annual retainer payments and meeting fees from the Company in the form of
cash, options, restricted shares, stock units or a combination thereof. The
Board will decide how to determine the number and terms of the options,
restricted shares or stock units to be granted to outside directors in lieu of
annual retainers and meeting fees.
Upon a change in control, the Administrator may determine that an option or
SAR will become fully exercisable as to all shares subject to such option or
SAR. A change in control includes a merger or consolidation of the Company,
certain changes in the composition of the Board and acquisition of 50% or more
of the combined voting power of the Company's outstanding stock. In the event of
a merger or other reorganization, outstanding options, SARs, restricted shares
and stock units will be subject to the agreement of merger or reorganization,
which may provide for the assumption of outstanding awards by the surviving
corporation or its parent, their continuation by the Company (if the Company is
the surviving corporation), accelerated vesting and accelerated expiration, or
settlement in cash.
The Board may amend or terminate the Omnibus Plan at any time. Amendments
may be subject to stockholder approval to the extent required by applicable
laws. In any event, the Omnibus Plan will terminate on January 22, 2007, unless
sooner terminated by the Board.
1996 OUTSIDE DIRECTOR NONSTATUTORY STOCK OPTION PLAN
The Company's 1996 Outside Director Nonstatutory Stock Option Plan (the
"Director Plan") was ratified and approved by the Board of Directors as of May
14, 1996. The Company has reserved 410,000 shares of Common Stock for issuance
under the Director Plan. As of February 28, 1998, 61,500 shares had been issued
under the Director Plan, options for 82,000 shares were outstanding and 266,500
shares remained available for future grant. If an outstanding option expires or
terminates unexercised, then the shares subject to such option will again be
available for issuance under the Director Plan.
49
<PAGE>
Under the Director Plan, outside directors of the Company may receive
nonstatutory options to purchase shares of Common Stock. The Director Plan is
administered by the Board or the Compensation Committee (the "Administrator").
The Administrator has the discretion to determine which eligible individuals
will receive options, the number of shares subject to each option, vesting
requirements and any other terms and conditions of such options.
The exercise price for options granted under the Director Plan will be at
least 85% of the fair market value of the Common Stock on the option grant date,
shall be 110% of the fair market value of the Common Stock on the option grant
date if the option is granted to a holder of more than 10% of the Common Stock
outstanding and may be paid in cash, check or shares of Common Stock. The
exercise price may also be paid by cashless exercise or pledge of shares to a
broker.
The Administrator may modify, extend or renew outstanding options or accept
the surrender of such options in exchange for the grant of new options, subject
to the consent of the affected optionee.
Upon a change in control, the Board may accelerate the exercisability of
outstanding options and provide an exercise period during which such accelerated
options may be exercised. The Board also has the discretion to terminate any
outstanding options that had been accelerated and had not been exercised during
such exercise period. In the event of a merger of the Company into another
corporation in which holders of Common Stock receive cash for their shares, the
Board may settle the option with a cash payment equal to the difference between
the exercise price and the amount paid to holders of Common Stock pursuant to
the merger.
The Board may amend or terminate the Director Plan at any time. In any
event, the Director Plan will terminate on May 14, 2006, unless sooner
terminated by the Board.
EMPLOYMENT AGREEMENTS AND CHANGE OF CONTROL ARRANGEMENTS
The Company has an employment agreement with Mary A. Casey, pursuant to
which Ms. Casey holds the position of President of the Company, is paid an
annual salary of $20,000 per month, subject to adjustment to reflect increases
in the Consumer Price Index, was entitled to purchase 1,677,273 shares of Common
Stock, and is eligible to receive a bonus, as determined by the Chief Executive
Officer and Board of Directors. The agreement also provides that Ms. Casey will
receive a severance payment equal to $7,000 per month for the first six months
after termination of employment, and an additional payment of $7,000 per month
for the next six months, minus any amounts earned by her from other employment
during such period. In addition, the agreement provides that if Ms. Casey's
employment is terminated (other than for cause) within four months after a Sale
Transaction (as defined below), she will continue to receive the compensation
provided in the agreement until the expiration of the agreement on December 31,
2000, instead of the severance payments described above. A Sale Transaction is
an acquisition of more than 75% of the voting securities of STAR, pursuant to a
tender offer or exchange offer approved in advance by the Board of Directors.
In January 1996, the Company entered into an employment agreement with David
Vaun Crumly pursuant to which Mr. Crumly became Executive Vice President of the
Company. The agreement provides for an annual salary of $10,000 per month with
an annual increase, plus incentive bonuses tied to gross revenues of the
Company. The agreement also provides for a commission on certain accounts of the
Company and an option to purchase 369,000 shares of Common Stock at an exercise
price of $0.73 per share. In addition, in the event of a Sale Transaction, Mr.
Crumly will receive a bonus payment equal to the lesser of $1,500,000 or a
percentage of the monthly gross sales of accounts relating to customers
introduced to the Company by Mr. Crumly. If his employment is terminated in
certain circumstances, without cause, within four months after a Sale
Transaction, Mr. Crumly is entitled to receive the compensation provided in this
agreement, minus any compensation earned by other employment, until the
expiration of the agreement on December 31, 2000.
50
<PAGE>
In December 1996, the Company entered into an employment agreement with
Kelly D. Enos, pursuant to which Ms. Enos became Chief Financial Officer of the
Company. The agreement provides for an annual salary of $150,000 (which has been
increased to $160,000) and an option to purchase 153,750 shares of Common Stock
at an exercise price of $4.00 per share. The agreement also provides that Ms.
Enos will receive a severance payment equal to the compensation which she would
have received under the remaining term of the agreement if she terminates the
agreement as a result of STAR's default of its material obligations and duties
under the agreement or if she is terminated by the Company without cause within
four months after a Sale Transaction.
In September 1996, STAR entered into an employment agreement with James E.
Kolsrud, pursuant to which Mr. Kolsrud became Executive Vice
President--Operations and Engineering of STAR. The agreement provides for a
monthly salary of $16,667, an option to purchase 205,000 shares of Common Stock
pursuant to the Company's 1996 Supplemental Stock Option Plan at a price of
$4.00 per share, reimbursement of reasonable out-of-pocket expenses incurred in
connection with Company business, and fringe benefits accorded to executives of
the Company as determined by the Board of Directors. In the event of termination
pursuant to the agreement, Mr. Kolsrud shall be entitled to receive compensation
accrued and payable to him as of the date of his termination or death, and all
other amounts payable to him under the agreement shall thereupon cease. If his
employment is terminated in certain circumstances within four months after a
Sale Transaction, then Mr. Kolsrud shall continue to receive the compensation
provided in the agreement until the expiration of the agreement on December 31,
2000.
51
<PAGE>
CERTAIN TRANSACTIONS
TRANSACTIONS WITH OUTSIDE DIRECTORS
The Company provided services to Digital Network, Inc. ("DNI") in the amount
of approximately $1,141,000 in 1997. DNI is a wholly owned subsidiary of UDN,
and John R. Snedegar, a Director of the Company, is President of UDN. On
November 19, 1997, the Company entered into an agreement to acquire UDN. Messrs.
Snedegar and Edgecomb beneficially own 11% and 2%, respectively, of the
outstanding common stock of UDN. In the context of the potential acquisition of
UDN, the Company has loaned $4.5 million to UDN at market rates of interest.
Assumming the receipt of all necessary stockholder and regulatory approvals,
management expects to consummate the UDN acquisition in the second quarter of
1998 for approximately 800,000 shares of Common Stock. Prior to consummation of
the acquisition of UDN, the Company will receive a fairness opinion from an
investment banking firm that the consideration paid was fair, from a financial
point of view, to the stockholders of the Company. UDN's Common Stock is traded
on the Vancouver Stock Exchange under the symbol UDN.
GH Associates, an affiliate of Gordon Hutchins, Jr., a Director of the
Company, provides consulting services to the Company. In 1995, 1996 and 1997,
the Company made payments of approximately $60,000, $154,000 and $72,000,
respectively, to GH Associates for general business consulting services relating
to the telecommunications industry and for the performance of other tasks
requested by the Company's Chief Executive Officer, President and Board of
Directors. In addition, in connection with these services, the Company granted
to Mr. Hutchins a nonstatutory option to purchase 205,000 shares of Common Stock
at an exercise price of $1.46 per share.
The Company's Outside Directors have been granted nonstatutory stock options
under the Director Plan. See "Management--Director Compensation."
TRANSACTIONS WITH EXECUTIVE OFFICERS AND PRINCIPAL STOCKHOLDERS
In January 1998, the Company granted to each of Kelly D. Enos, David Vaun
Crumly and James E. Kolsrud incentive stock options to purchase 4,100 shares of
Common Stock at an exercise price of $16.31.
On October 4, 1996, the Company entered into a $12.0 million line of credit
with Comerica Bank. This line of credit was guaranteed by Christopher E.
Edgecomb, the Company's Chief Executive Officer. The Company has entered into a
new revolving credit facility since that time and Mr. Edgecomb's guarantee of
the Comerica Bank line has been terminated. Mr. Edgecomb did not receive any
additional compensation in connection with such guarantee. STAR has entered into
lines of credit with Mr. Edgecomb in the aggregate amount of $1,448,000 that
expire on March 30, 1998. Borrowings under the lines of credit bear interest at
a rate of 9.0% and there was $138,000 outstanding under these lines of credit as
of December 31, 1997. In addition, on November 27, 1997 the Company provided a
short-term loan to Mr. Edgecomb for $8.0 million. The loan carried interest of
7% per annum and was repaid in seven days.
Mr. Edgecomb owns Star Aero Services, Inc. ("Star Aero"), which has
ownership interests in five airplanes that the Company utilizes for business
travel from time to time. 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.
Mr. Crumly had controlling ownership of three companies that resold
transmission capacity to the Company during 1996 for a total of approximately
$240,000. No fees were paid to Mr. Crumly during 1997 with respect to such
transmission capacity. In addition, the Company has agreed to reimburse legal
fees incurred by such companies in connection with a dispute with the provider
of the capacity that was resold to the Company. To date, the fees paid or
incurred total approximately $131,000.
Mr. Kolsrud has a 25% interest and Gotel Investments, Ltd. ("Gotel"),
currently a holder of more than 5% of the outstanding Common Stock of the
Company, has a 12.5% interest in Interpacket Group,
52
<PAGE>
Inc. ("Interpacket") which has direct termination arrangements with the Company
for certain countries in Central and South America. For the years ended December
31, 1996 and 1997, the Company paid $37,000 and $256,000, respectively, for
services rendered by Interpacket. In addition, the Company purchased satellite
transmission equipment and services from Interpacket during 1997 in the amount
of $1,114,000.
Gotel has a 30% interest in Virtual Technology Holdings, Inc., which
provides consulting services to STAR through its wholly-owned subsidiary Virtual
Technology, Inc., in connection with the Company's London switch. For the years
ended December 31, 1996 and 1997, STAR paid $12,000 and $213,000, respectively,
for such services.
INDEMNIFICATION
The Company's Amended and Restated Certificate of Incorporation limits the
liability of its directors for monetary damages arising from a breach of their
fiduciary duty as directors, except to the extent otherwise required by the
Delaware General Corporation Law. Such limitation of liability does not affect
the availability of equitable remedies such as injunctive relief or rescission.
The Company's Bylaws provide that the Company shall indemnify its directors
and officers to the fullest extent permitted by Delaware law, including in
circumstances in which indemnification is otherwise discretionary under Delaware
law. The Company's has also entered into or will enter into indemnification
agreements with its officers and directors containing provisions that may
require the Company, among other things, to indemnify such officers and
directors against certain liabilities that may arise by reason of their status
or service as directors or officers (other than liabilities arising from willful
misconduct of a culpable nature), to advance their expenses incurred as a result
of any proceeding against them as to which they could be indemnified, and to
obtain directors' and officers' insurance if available on reasonable terms.
The Company believes that all of the transactions set forth above were made
on terms no less favorable to the Company than could have been obtained from
unaffiliated third parties. All future transactions, including loans between the
Company and its officers, directors, principal stockholders and their affiliates
will be approved by a majority of the Board of Directors, including a majority
of the independent and disinterested outside directors on the Board of
Directors, and will continue to be on terms no less favorable to the Company
than could be obtained from unaffiliated third parties.
53
<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information known to the Company
regarding beneficial ownership of Common Stock as of March 16, 1998, by (i) each
person who is known by STAR to own beneficially more than five percent of the
Company's Common Stock, (ii) each of the Company's directors, (iii) each of the
Named Officers and (iv) all current officers and directors as a group.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED SHARES BENEFICIALLY OWNED
SHARES TO
BEFORE THE OFFERING(2) BE SOLD IN AFTER THE OFFERING(2)
------------------------- THE -------------------------
NAME AND ADDRESS OF BENEFICIAL OWNER(1) NUMBER PERCENT OFFERING NUMBER PERCENT
- ----------------------------------------------------- ------------ ----------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Entities affiliated with the Hunt Family Trusts(3)... 2,099,182 5.9% -- 2,099,182 5.1%
3900 Thanksgiving Tower
Dallas, Texas 75201
Gotel Investments, Ltd.(4)........................... 1,874,532 5.2 -- 1,874,532 4.5
16, Rue de la Pelissiere
1204, Geneva
Switzerland
Gordon Hutchins, Jr.(5).............................. 178,350 * -- 178,350 *
John R. Snedegar(6).................................. 30,750 * -- 30,750 *
Mark Gershien........................................ -- * -- -- *
Christopher E. Edgecomb(7)........................... 13,668,707 38.2 315,000 13,353,707 32.2
Mary A. Casey(8)..................................... 1,646,613 4.6 -- 1,646,613 4.0
David Vaun Crumly(9)................................. 594,500 1.7 -- 594,500 1.4
James E. Kolsrud(10)................................. 71,747 * -- 71,747 *
Kelly D. Enos(11).................................... 54,837 * -- 54,837 *
All directors and executive officers as a group
(8 persons)(12).................................... 16,245,504 44.8 315,000 15,930,504 38.0
</TABLE>
- ------------------------
* Represents beneficial ownership of less than 1% of the outstanding shares of
Common Stock.
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and includes voting or investment power
with respect to securities. The address for each listed director and
officer is c/o STAR Telecommunications, Inc., 223 East De La Guerra Street,
Santa Barbara, California 93101. To the Company's knowledge, except as
indicated in the footnotes to this table and pursuant to applicable
community property laws, the persons named in the table have sole voting
and investment power with respect to all shares of Common Stock.
(2) Percentage of beneficial ownership is based on approximately 35,804,000
shares of Common Stock outstanding as of March 16, 1998 and 41,489,000
shares of Common Stock after the completion of this offering. The number of
shares of Common Stock beneficially owned includes the shares issuable
pursuant to stock options that are exercisable within sixty days of March
31, 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
54
<PAGE>
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) The board of directors of Gotel holds voting and investment power for all
shares of Common Stock held by Gotel. Gotel's board of directors is
comprised of Walter Stresemann and Gregory Elias.
(5) Consists of 178,350 shares issuable upon the exercise of stock options
exercisable within sixty days of March 31, 1998.
(6) Consists of 20,500 shares of Common Stock and 10,250 shares issuable upon
the exercise of stock options exercisable within sixty days of March 31,
1998.
(7) Includes 650,000 shares of Common Stock held by Mr. Edgecomb that may be
sold to the Underwriters in connection with the exercise of the
over-allotment option. Following the full exercise of such option, after
the offering, the number of shares of Common Stock beneficially owned by
Mr. Edgecomb would be 12,703,707 or 30.5% of the shares outstanding, and
the number of shares of Common Stock beneficially owned by all executive
officers and directors as a group would be 15,180,504 or 36.1% of the
shares outstanding. See "Underwriting" for a description of the
Underwriters' over-allotment option.
(8) Includes 75,000 shares of Common Stock held by Ms. Casey that may be sold
to the Underwriters in connection with the exercise of the overallotment
option. Following the full exercise of such option, after the offering, the
number of shares of Common Stock beneficially owned by Ms. Casey would be
1,571,613 or 3.8% of the shares outstanding, and the number of shares of
Common Stock beneficially owned by all executive officers and directors as
a group would be 15,180,504 or 36.1% of the shares outstanding. See
"Underwriting" for a description of the Underwriters' over-allotment
option.
(9) Consists of 451,000 shares of Common Stock, and 143,500 shares of Common
Stock issuable upon the exercise of stock options exercisable within sixty
days of March 31, 1998. Includes 25,000 shares of Common Stock held by Mr.
Crumly that may be sold to the Underwriters in connection with the exercise
of the over-allotment option. Following the full exercise of such option,
after the offering, the number of shares of Common Stock beneficially owned
by Mr. Crumly would be 569,500 or 1.4% of the shares outstanding, and the
number of shares of Common Stock beneficially owned by all executive
officers and directors as a group would be 15,180,504 or 36.1% of the
shares outstanding. See "Underwriting" for a description of the
Underwriters' over-allotment option.
(10) Consists of 20,497 shares of Common Stock held in joint tenancy and 51,250
shares of Common Stock issuable upon the exercise of stock options
exercisable within sixty days of March 31, 1998.
(11) Consists of 16,400 shares of Common Stock and 38,437 shares of Common Stock
issuable upon the exercise of stock options exercisable within sixty days
of March 31, 1998.
(12) Includes 421,787 shares of issuable upon the exercise of stock options
exercisable within sixty days of March 31, 1998.
55
<PAGE>
DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company consists of 50,000,000 shares of
Common Stock, $0.001 par value, and 5,000,000 shares of Preferred Stock, $0.001
par value.
COMMON STOCK
As of March 16, 1998, there were approximately 35,804,000 shares of Common
Stock outstanding that were held of record by approximately 155 stockholders.
There will be approximately 41,489,000 shares of Common Stock outstanding
(assuming no exercise of the Underwriters' over-allotment option and assuming no
exercise after February 28, 1998, of outstanding options) after giving effect to
the sale of shares of Common Stock to the public offered hereby.
The holders of 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 Common Stock are
entitled to receive ratably such dividends, if any, as may be declared from time
to time by the Company's Board of Directors out of funds legally available
therefor. See "Dividend Policy." In the event of the liquidation, dissolution,
or winding up of the Company, the holders of 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 Common
Stock has no preemptive or conversion rights or other subscription rights. There
are no redemption or sinking fund provisions applicable to the Common Stock. All
outstanding shares of Common Stock are fully paid and nonassessable, and the
shares of Common Stock to be issued upon completion of this offering will be
fully paid and nonassessable.
PREFERRED STOCK
Pursuant to the Company's Amended and Restated Certificate of Incorporation,
the Board of Directors has the authority to issue up to 5,000,000 shares of
Preferred Stock in one or more series and to fix the rights, preferences,
privileges and restrictions thereof, including dividend rights, dividend rates,
conversion rights, voting rights, terms of redemption, redemption prices,
liquidation preferences and the number of shares constituting any series or the
designation of such series, without further vote or action by the stockholders.
The issuance of Preferred Stock may have the effect of delaying, deferring or
preventing a change in control of the Company without further action by the
stockholders and may adversely affect the voting and other rights of the holders
of Common Stock. The issuance of Preferred Stock with voting and conversion
rights may adversely affect the voting power of the holders of Common Stock,
including the loss of voting control to others. At present, the Company 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. The Company's Amended and Restated
Certificate of Incorporation provides that the Board of Directors be divided
into three classes of directors, with each class serving a staggered three-year
term. The classification system of electing directors may tend to discourage a
third party from making a tender offer or otherwise attempting to obtain control
of the Company and may maintain the incumbency of the Board of Directors, as the
classification of the Board of Directors generally increases the difficulty of
replacing a majority of the directors. The Amended and Restated Certificate of
Incorporation also provides that all stockholder actions must be effected at a
duly called meeting and not by a consent in writing. Further, provisions of the
Bylaws and the Amended and Restated Certificate of Incorporation provide that
the stockholders may amend the Bylaws or certain provisions of the Amended and
Restated Certificate of Incorporation only with the affirmative vote of 75% of
the Company'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 the Company. These
provisions are intended to enhance the likelihood of continuity and
56
<PAGE>
stability in the composition of the Board of Directors and in the policies
formulated by the Board of Directors and to discourage certain types of
transactions that may involve an actual or threatened change of control of the
Company. These provisions are designed to reduce the vulnerability of the
Company 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 the Company's shares and, as a consequence, they also may inhibit
fluctuations in the market price of the Company'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 the Company. See "Risk Factors--Effect
of Certain Charter Provisions; Anti-takeover Effects of Certificate of
Incorporation, Bylaws and Delaware Law."
DELAWARE TAKEOVER STATUTE. The Company 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 Common Stock are entitled to
certain rights with respect to the registration of such shares under the
Securities Act. Under the terms of the agreements between the Company and the
holders of such registrable securities, if the Company 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 the
Company to file a registration statement under the Securities Act at its expense
with respect to their shares of Common Stock, and the Company is required to use
its best efforts to effect such registration. Further, holders may require the
Company to file additional registration statements on Form S-3 at the Company'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
57
<PAGE>
limit the number of shares included in such registration and the right of the
Company not to effect a requested registration within six months following an
offering of the Company's securities, including the offering made hereby.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the Common Stock is U.S. Stock Transfer
Corp., 1745 Gardena Avenue, Glendale, California 91204, and its telephone number
is (818) 502-1404.
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this Offering, the Company will have approximately
41,489,000 shares of Common Stock outstanding (assuming no exercise of the
Underwriters' over-allotment option and no exercise of outstanding and vested
options to purchase approximately 1,367,000 shares of Common Stock outstanding
and vested as of February 28, 1998) of which 9,430,000 have been previously
registered pursuant to the Securities Act. Of the approximately 41,489,000
shares of Common Stock outstanding, the 6,000,000 shares offered hereby will be
freely transferable without restriction or further registration under the
Securities Act. Approximately 558,000 additional shares which are not currently
registered will be available for immediate unrestricted sale in the public
market on the date of this Prospectus and approximately 1,601,000 additional
shares will be available for immediate sale on the date of this Prospectus,
subject to the public information, volume limitation and notice provisions of
Rule 144 adopted under the Securities Act.
Approximately 410,000 shares will be available for sale within 45 days after
the date of this Prospectus, subject to the Rule 144 public information, volume
limitations and notice provisions. Approximately 1,875,000 shares will be
available for sale in the public market 45 days after the date of this
Prospectus upon the expiration of certain lock-up agreements (described below),
subject to the Rule 144 public information, volume limitation and notice
provisions described below. Upon the expiration of certain additional lock-up
agreements (described below) 90 days after the date of this Prospectus, (i)
approximately 16,246,000 shares will be available for sale in the public market,
subject to the Rule 144 public information, volume limitation and notice
provisions and (ii) approximately 2,050,000 shares will be available for
unrestricted sale in the public market.
Approximately 1,353,000 shares issued in the T-One acquisition shall be
available for sale on the date of the publication by the Company of at least 30
days of combined operating results of STAR and T-One.
Approximately 849,000 shares issued in the LDS acquisition will be available
for sale after November 30, 1998.
In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated) who has beneficially owned shares for at least one
year is entitled to sell within any three-month period a number of such shares
that does not exceed the greater of (i) 1% of the then outstanding shares of
Common Stock (approximately 415,000 shares immediately after the offering) or
(ii) the average weekly trading volume during the four calendar weeks preceding
such sale, subject to the filing of a Form 144 with respect to such sale. A
person (or persons whose shares are aggregated) who is not deemed to have been
an affiliate of the Company at any time during the 90 days immediately preceding
the sale who has beneficially owned his or her shares for at least two years is
entitled to sell such shares pursuant to Rule 144(k) without regard to the
limitations described above. Persons deemed to be affiliates must always sell
pursuant to Rule 144, even after the applicable holding periods have been
satisfied.
The Company, its directors, executive officers and certain other
stockholders have agreed pursuant to the Underwriting Agreement and other
agreements that they will not sell any Common Stock without the prior consent of
BT Alex. Brown Incorporated for a period of in some cases 45 days and in other
cases
58
<PAGE>
90 days from the date of this Prospectus (the "90-day Lockup Period"), except
that the Company may, without such consent, grant options and sell shares
pursuant to the Company's stock option plans.
The Company has filed a registration statement under the Securities Act to
register all of the shares of Common Stock reserved for issuance upon exercise
of options granted under the Company's Supplemental Plan, Omnibus Plan and
Director Plan. Therefore, shares issued from time to time upon exercise of
vested options under any of such Plans may be sold in the public market,
subject, in the case of directors, officers and other affiliates, to the volume
and other limitations of Rule 144 applicable to affiliates. Based on options
outstanding as of February 28, 1998, holders of vested options exercisable for
approximately 1,367,000 shares of Common Stock will be eligible to sell their
shares without restriction immediately upon exercise on the date of this
Prospectus, and holders of options exercisable for approximately 1,543,000
shares of Common Stock will be eligible to sell their shares after the
expiration of the 90-day Lock-Up Period, subject, in the case of affiliates, to
the Rule 144 volume and other limitations.
In addition, after this offering, the holders of approximately 7,153,000
shares of Common Stock will be entitled to certain rights with respect to
registration of such shares under the Securities Act. Registration of such
shares under the Securities Act would result in such shares becoming freely
tradeable without restriction under the Securities Act (except for shares
purchased by affiliates of the Company) immediately upon the effectiveness of
such registration. See "Description of Capital Stock--Registration Rights."
59
<PAGE>
UNDERWRITING
Subject to the terms and conditions of an Underwriting Agreement, the
underwriters named below (the "Underwriters"), through their representatives, BT
Alex. Brown Incorporated, Merrill Lynch, Pierce, Fenner & Smith Incorporated,
Hambrecht & Quist LLC, Lehman Brothers Inc. and Furman Selz LLC (the
"Representatives") have severally agreed to purchase from the Company and the
Selling Stockholder the following respective number of shares of Common Stock at
the public offering price less the underwriting discounts and commissions set
forth on the cover page of this Prospectus:
<TABLE>
<CAPTION>
UNDERWRITER NUMBER OF SHARES
- --------------------------------------------------------------------------- -----------------
<S> <C>
BT Alex. Brown Incorporated................................................ 1,803,000
Merrill Lynch, Pierce, Fenner & Smith Incorporated......................... 1,803,000
Hambrecht & Quist LLC...................................................... 798,000
Lehman Brothers Inc........................................................ 798,000
Furman Selz LLC............................................................ 798,000
-----------------
Total.............................................................. 6,000,000
-----------------
-----------------
</TABLE>
The Underwriting Agreement provides that the obligations of the Underwriters
are subject to certain conditions precedent and that the Underwriters will
purchase all shares of the Common Stock offered hereby if any of such shares are
purchased.
The Company and the Selling Stockholder have been advised by the
Representatives that the Underwriters propose to offer the shares of Common
Stock directly to the public at the public offering price set forth on the cover
page of this Prospectus and to certain dealers at such price less a concession
not in excess of $0.70 per share. The Underwriters may allow and such dealers
may reallow, a concession not in excess of $0.10 per share to certain other
dealers. After the offering, the public offering price and other selling terms
may be changed by the Representatives.
The Company and the Selling Stockholders have granted to the Underwriters an
option, exercisable no later than 30 days after the date of this Prospectus, to
purchase up to an aggregate of 900,000 additional shares of Common Stock at the
public offering price, less the underwriting discounts and commissions, set
forth on the cover page of this Prospectus. To the extent that the Underwriters
exercise such option, each of the Underwriters will have a firm commitment to
purchase approximately the same percentage of such additional shares as the
number of shares of Common Stock to be purchased by it shown in the above table
bears to the total number of shares of Common Stock offered hereby, and the
Company and the Selling Stockholders will be obligated, pursuant to the option,
to sell shares to the Underwriters if any. The Underwriters may exercise such
option only to cover over-allotments, if any, made in connection with the sale
of shares of Common Stock offered hereby. If purchased, the Underwriters will
offer such additional shares on the same terms as those on which the 6,000,000
shares are being offered.
In connection with this offering, certain Underwriters may engage in passive
market making transactions in the Common Stock on the Nasdaq National Market
immediately prior to the commencement of sales in this offering in accordance
with Rule 103 of Regulation M. Passive market making consists of displaying bids
on the Nasdaq National Market limited by the bid prices of independent market
makers and making purchases limited by such prices and effected in response to
order flow. Net purchases by a passive market maker on each day are limited to a
specified percentage of the passive market maker's average daily trading volume
in the Common Stock during a specified period and must be discontinued when such
limit is reached. Passive market making may stabilize the market price of the
Common Stock at a level above that which might otherwise prevail and, if
commenced, may be discontinued at any time.
Subject to applicable limitations, the Underwriters, in connection with this
offering, may place bids for or make purchases of the Common Stock in the open
market or otherwise, for long or short account or
60
<PAGE>
cover short positions incurred, to stabilize, maintain or otherwise affect the
price of the Common Stock, which may be higher than the price that might
otherwise prevail in the open market. There can be no assurance that the price
of the Common Stock will be stabilized, or that stabilizing, if commenced, will
not be discontinued at any time. Subject to applicable limitations, the
Underwriters may also place bids or make purchases on behalf of the underwriting
syndicate to reduce a short position created in connection with this Offering.
The Underwriters are not required to engage in these activities and may end
these activities at any time.
The Underwriting Agreement contains certain covenants of indemnity among the
Underwriters, the Company and the Selling Stockholders against certain civil,
liabilities, including liabilities under the Securities Act of 1933, as amended.
The Company, each of its directors and executive officers and certain
stockholders, who in the aggregate will beneficially own, following this
offering, approximately 20,273,000 shares of Common Stock (including options to
purchase shares of Common Stock that are currently exercisable or exercisable
within 60 days of March 31, 1998), have agreed that they will not, directly or
indirectly, without the prior written consent of BT Alex. Brown Incorporated,
offer, sell, offer to sell, contract to sell or otherwise dispose of any shares
of Common Stock for a period of in some cases 45 days and in other cases 90 days
after the date of this Prospectus, except that the Company (i) may issue shares
of Common Stock upon the exercise or conversion of other currently outstanding
options; (ii) may issue options to purchase shares of Common Stock to its
directors, officers and employees in connection with its existing stock option
plans; and (iii) may issue shares of Common Stock or securities convertible
into, or exercisable for, shares of Common Stock pursuant to an acquisition
transaction. Additionally, certain shares of the Selling Stockholders held by
brokers as security for margin loans may be sold by such brokers in the event of
a margin call on such shares.
The Company may, from time to time, engage the services of one or more of
the Underwriters to provide investment banking, merger and acquisition and
related services.
LEGAL MATTERS
The validity of the Common Stock offered hereby will be passed upon for the
Company by Riordan & McKinzie, a Professional Corporation, Los Angeles,
California. Certain legal matters in connection with the offering will be passed
upon for the Underwriters by Wilson Sonsini Goodrich & Rosati, Professional
Corporation, Palo Alto, California.
EXPERTS
The Consolidated Financial Statements of STAR Telecommunications, Inc. as of
December 31, 1996 and 1997 and for each of the years in the three year period
ended December 31, 1997, included in this Prospectus and elsewhere in this
Registration Statement have been audited by Arthur Andersen LLP, independent
public accountants, as set forth in their reports with respect thereto, and are
included herein in reliance upon the authority of said firm as experts in
accounting and auditing in giving said reports.
AVAILABLE INFORMATION
STAR has filed with the Commission the Registration Statement with respect
to the Common Stock to be issued hereby, of which this Prospectus constitutes a
part. This Prospectus does not contain all of the information set forth in the
Registration Statement and the exhibits and schedules thereto. For further
information, reference is hereby made to the Registration Statement and the
exhibits and schedules thereto. Any statements contained herein concerning the
contents of any contract, agreement or other document referred to herein and
filed as an exhibit to the Registration Statement or otherwise filed with the
Commission are not necessarily complete. With respect to each such contract,
agreement or other
61
<PAGE>
document filed with the Commission as an exhibit, reference is made to the
exhibit for a more complete description of the matter involved, and each such
statement is qualified in its entirety by such reference.
STAR is subject to the informational requirements of the Securities Exchange
Act of 1934, as amended, and, in accordance therewith, files reports, proxy
statements, registration statements and other information with the Commission.
The reports, proxy statements, registration statements and other information
filed by STAR with the Commission may be inspected and copied at the public
reference facilities maintained by the Commission at Room 1024, Judiciary Plaza,
450 Fifth Street, N.W., Washington, D.C. 20549, and at the Commission's Regional
Offices at Seven World Trade Center, 13th Floor, New York, New York 10048 and
Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois
60661-2511. Copies of such material may be obtained by mail from the Public
Reference Section of the Commission at 450 West Fifth Street, N.W., Washington,
D.C. 20549, at prescribed rates. The Commission also maintains a Web Site at
http://www.sec.gov which contains reports, proxy statements, registration
statements and other information regarding registrants that file electronically
with the Commission. STAR's Common Stock is listed on the Nasdaq National Market
under the symbol "STRX." Reports, proxy statements and other information filed
by STAR may be inspected at the offices of the Nasdaq National Market, Reports
Section, 1735 K Street, Washington, D.C. 20006.
62
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Report of Independent Public Accountants................................................................... F-2
Consolidated Balance Sheets as of December 31, 1996 and 1997............................................... F-3
Consolidated Statements of Operations for the years ended December 31, 1995, 1996 and 1997................. F-4
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1996 and 1997....... F-5
Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1996 and 1997................. F-6
Notes to Consolidated Financial Statements................................................................. F-8
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders
of STAR Telecommunications, Inc. and Subsidiaries:
We have audited the accompanying consolidated balance sheets of STAR
TELECOMMUNICATIONS, INC. (a Delaware corporation) AND SUBSIDIARIES, as of
December 31, 1996 and 1997, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of STAR Telecommunications,
Inc. and Subsidiaries as of December 31, 1996 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997 in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Los Angeles, California
February 12, 1998
(except with respect
to the stock split discussed
in Note 14 as to which the
date is March 31, 1998)
F-2
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1996 1997
---------- -----------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents............................................................ $1,726,000 $ 1,458,000
Short-term investments............................................................... 1,630,000 18,579,000
Accounts receivable, net of allowance of $6,202,000 and $7,745,000 at December 31,
1996 and 1997, respectively........................................................ 27,660,000 42,407,000
Receivable from related parties...................................................... 115,000 --
Other receivables.................................................................... 284,000 2,198,000
Prepaid expenses..................................................................... 960,000 4,712,000
Prepaid taxes........................................................................ 677,000 --
Deferred income taxes................................................................ -- 3,699,000
Other current assets................................................................. 825,000 61,000
---------- -----------
Total current assets............................................................... 33,877,000 73,114,000
---------- -----------
PROPERTY AND EQUIPMENT:
Operating equipment.................................................................. 8,653,000 29,142,000
Leasehold improvements............................................................... 4,248,000 6,289,000
Furniture, fixtures and equipment.................................................... 2,418,000 4,564,000
---------- -----------
15,319,000 39,995,000
Less-Accumulated depreciation and amortization....................................... (1,407,000) (5,638,000)
---------- -----------
13,912,000 34,357,000
---------- -----------
OTHER ASSETS:
Investments.......................................................................... 153,000 27,000
Deposits............................................................................. 5,630,000 6,055,000
Other................................................................................ 428,000 --
---------- -----------
6,211,000 6,082,000
---------- -----------
Total assets....................................................................... $54,000,000 $113,553,000
---------- -----------
---------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Revolving lines of credit............................................................ $7,814,000 $ --
Revolving lines of credit with stockholder........................................... 26,000 138,000
Current portion of long-term debt.................................................... 267,000 480,000
Current portion of obligations under capital leases.................................. 872,000 2,495,000
Accounts payable..................................................................... 9,391,000 7,987,000
Taxes payable........................................................................ -- 2,156,000
Related party payable................................................................ 269,000 --
Accrued line costs................................................................... 19,494,000 38,403,000
Accrued expenses..................................................................... 2,086,000 5,609,000
---------- -----------
Total current liabilities.......................................................... 40,219,000 57,268,000
---------- -----------
LONG-TERM LIABILITIES:
Long-term debt, net of current portion............................................... 466,000 348,000
Capital lease obligations, net of current portion.................................... 4,936,000 11,139,000
Deferred compensation................................................................ 116,000 57,000
Deposits............................................................................. -- 164,000
Other long-term liabilities.......................................................... 352,000 563,000
---------- -----------
Total long-term liabilities........................................................ 5,870,000 12,271,000
---------- -----------
STOCKHOLDERS' EQUITY:
Series A Preferred Stock, $.001 par value, authorized-- 5,000,000 shares
Issued and outstanding-- 2,802,446 at December 31, 1996 and none at December 31,
1997............................................................................... 3,000 --
Common Stock, $.001 par value, authorized - 50,000,000 shares
Issued and outstanding-- 23,223,810 and 33,678,519 at December 31, 1996 and 1997,
respectively....................................................................... 23,000 34,000
Additional paid-in capital........................................................... 13,971,000 45,407,000
Deferred compensation................................................................ (118,000) (30,000)
Retained earnings (deficit).......................................................... (5,968,000) (1,397,000)
---------- -----------
Stockholders' equity............................................................... 7,911,000 44,014,000
---------- -----------
Total liabilities and stockholders' equity....................................... $54,000,000 $113,553,000
---------- -----------
---------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
F-3
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------
1995 1996 1997
------------- -------------- --------------
<S> <C> <C> <C>
REVENUES......................................................... $ 46,283,000 $ 237,991,000 $ 376,198,000
COSTS OF SERVICES................................................ 31,897,000 205,585,000 325,237,000
------------- -------------- --------------
Gross Profit................................................... 14,386,000 32,406,000 50,961,000
------------- -------------- --------------
OPERATING EXPENSES:
Selling, general and administrative expenses................... 10,086,000 34,331,000 35,381,000
Depreciation and amortization.................................. 186,000 1,151,000 4,245,000
Merger expense................................................. -- -- 286,000
------------- -------------- --------------
10,272,000 35,482,000 39,912,000
------------- -------------- --------------
Income (loss) from operations................................ 4,114,000 (3,076,000) 11,049,000
------------- -------------- --------------
OTHER INCOME (EXPENSES):
Interest income................................................ 22,000 110,000 492,000
Interest expense............................................... (64,000) (601,000) (1,633,000)
Legal settlement and expenses.................................. -- (100,000) (1,653,000)
Other income (expense)......................................... (33,000) 39,000 208,000
------------- -------------- --------------
(75,000) (552,000) (2,586,000)
------------- -------------- --------------
Income (loss) before provision for income taxes.............. 4,039,000 (3,628,000) 8,463,000
PROVISION FOR INCOME TAXES....................................... 66,000 592,000 2,895,000
------------- -------------- --------------
NET INCOME (LOSS)................................................ $ 3,973,000 $ (4,220,000) $ 5,568,000
------------- -------------- --------------
------------- -------------- --------------
Income (loss) before provision for income taxes.............. 4,039,000 (3,628,000) 8,463,000
PRO FORMA INCOME TAXES (UNAUDITED)............................... 1,632,000 1,535,000 3,090,000
------------- -------------- --------------
PRO FORMA NET INCOME (LOSS) (UNAUDITED).......................... $ 2,407,000 $ (5,163,000) $ 5,373,000
------------- -------------- --------------
------------- -------------- --------------
Pro forma basic income (loss) per common share (unaudited)....... $ 0.13 $ (0.24) $ 0.19
------------- -------------- --------------
------------- -------------- --------------
Pro forma diluted income (loss) per common share (unaudited)..... $ 0.13 $ (0.24) $ 0.17
------------- -------------- --------------
------------- -------------- --------------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-4
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK ADDITIONAL
---------------------- ---------------------- PAID-IN DEFERRED
SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION
--------- ----------- --------- ----------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1994.............................. -- $ -- 17,455,959 $ 17,000 $ 341,000 $ --
Issuance of common stock................................ -- -- 1,843,339 2,000 101,000 --
Conversion of debt to equity............................ -- -- -- -- 990,000 --
Net income.............................................. -- -- -- -- -- --
Cash distributions to stockholders...................... -- -- -- -- -- --
--------- ----------- --------- ----------- ---------- -------------
Balance, December 31, 1995.............................. -- -- 19,299,298 19,000 1,432,000 --
Effect of terminating the S-corporation election........ -- -- -- -- (690,000) --
Compensation expense relating to stock options.......... -- -- -- -- 168,000 (118,000)
Issuance of common stock................................ -- -- 3,924,512 4,000 5,564,000 --
Issuance of preferred stock............................. 2,802,446 3,000 -- -- 7,497,000 --
Net loss................................................ -- -- -- -- -- --
Cash distributions to stockholders...................... -- -- -- -- -- --
--------- ----------- --------- ----------- ---------- -------------
Balance, December 31, 1996.............................. 2,802,446 3,000 23,223,810 23,000 13,971,000 (118,000)
Effect of L.D. Services terminating the S-corporation
election.............................................. -- -- -- -- (61,000) --
Conversion of redeemable preferred stock to common
stock................................................. (2,802,446) (3,000) 1,868,284 3,000 -- --
Initial public offering of common stock................. -- -- 8,097,500 8,000 30,936,000 --
Exercise of stock options............................... -- -- 488,925 -- 447,000 --
Compensation expense relating to stock options.......... -- -- -- -- -- 88,000
Tax benefit from non-qualified stock options............ -- -- -- -- 114,000 --
Cash distributions to stockholders...................... -- -- -- -- -- --
Net income.............................................. -- -- -- -- -- --
--------- ----------- --------- ----------- ---------- -------------
Balance, December 31, 1997.............................. -- $ -- 33,678,519 $ 34,000 $45,407,000 $ (30,000)
--------- ----------- --------- ----------- ---------- -------------
--------- ----------- --------- ----------- ---------- -------------
<CAPTION>
RETAINED
EARNINGS
(DEFICIT) TOTAL
---------- ----------
<S> <C> <C>
Balance, December 31, 1994.............................. $1,839,000 $2,197,000
Issuance of common stock................................ -- 103,000
Conversion of debt to equity............................ -- 990,000
Net income.............................................. 3,973,000 3,973,000
Cash distributions to stockholders...................... (4,216,000) (4,216,000)
---------- ----------
Balance, December 31, 1995.............................. 1,596,000 3,047,000
Effect of terminating the S-corporation election........ 690,000 --
Compensation expense relating to stock options.......... -- 50,000
Issuance of common stock................................ -- 5,568,000
Issuance of preferred stock............................. -- 7,500,000
Net loss................................................ (4,220,000) (4,220,000)
Cash distributions to stockholders...................... (4,034,000) (4,034,000)
---------- ----------
Balance, December 31, 1996.............................. (5,968,000) 7,911,000
Effect of L.D. Services terminating the S-corporation
election.............................................. 61,000 --
Conversion of redeemable preferred stock to common
stock................................................. -- --
Initial public offering of common stock................. -- 30,944,000
Exercise of stock options............................... -- 447,000
Compensation expense relating to stock options.......... -- 88,000
Tax benefit from non-qualified stock options............ -- 114,000
Cash distributions to stockholders...................... (1,058,000) (1,058,000)
Net income.............................................. 5,568,000 5,568,000
---------- ----------
Balance, December 31, 1997.............................. $(1,397,000) $44,014,000
---------- ----------
---------- ----------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-5
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------
1995 1996 1997
-------------- ------------- -------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)................................................ $ 3,973,000 $ (4,220,000) $ 5,568,000
Adjustments to reconcile net income (loss) to net cash provided
by (used in) operating activities:
Depreciation and amortization.................................. 186,000 1,151,000 4,245,000
Loss on investment............................................. 80,000 -- --
Loss on disposal of equipment.................................. -- -- 42,000
Compensation expense relating to stock options................. -- 50,000 88,000
Provision for doubtful accounts................................ 217,000 15,753,000 7,695,000
Deferred income taxes.......................................... -- -- (3,699,000)
Deferred compensation.......................................... -- 116,000 (59,000)
Decrease (increase) in assets:
Accounts receivable.............................................. (10,522,000) (28,476,000) (22,442,000)
Receivable from related parties.................................. 129,000 (65,000) 115,000
Other receivables................................................ (268,000) -- (1,914,000)
Prepaid expenses................................................. (114,000) (830,000) (3,752,000)
Deposits......................................................... (630,000) (4,948,000) (425,000)
Prepaid taxes.................................................... -- (677,000) 677,000
Other current assets............................................. -- (825,000) 764,000
Increase (decrease) in liabilities:
Accounts payable................................................. 8,035,000 (1,269,000) (1,404,000)
Taxes payable.................................................... -- -- 2,270,000
Related party payables........................................... 320,000 (51,000) (269,000)
Accrued line costs............................................... 476,000 19,018,000 18,909,000
Accrued expenses................................................. 194,000 1,865,000 3,523,000
Deposits......................................................... -- -- 164,000
-------------- ------------- -------------
Net cash provided by (used in) operating activities........ 2,076,000 (3,408,000) 10,096,000
-------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures............................................. (1,123,000) (7,852,000) (13,436,000)
Investments...................................................... -- (153,000) 126,000
Short-term investments........................................... -- (1,630,000) (16,949,000)
Other............................................................ -- (139,000) 639,000
-------------- ------------- -------------
Net cash used in investing activities...................... (1,123,000) (9,774,000) (29,620,000)
-------------- ------------- -------------
</TABLE>
F-6
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------
1995 1996 1997
------------- ------------- --------------
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Stockholders' distributions...................................... $ (4,216,000) $ (4,034,000) $ (1,058,000)
Borrowings under lines of credit................................. 1,460,000 14,746,000 34,211,000
Repayments under lines of credit................................. (130,000) (8,262,000) (42,025,000)
Borrowings under lines of credit with stockholder................ 3,418,000 701,000 583,000
Repayments under lines of credit with stockholder................ (1,319,000) (1,873,000) (471,000)
Borrowings under long-term debt.................................. -- 800,000 193,000
Payments under long-term debt.................................... -- (67,000) (1,622,000)
Payments under capital lease obligations......................... (52,000) (358,000) (1,946,000)
Issuance of common stock......................................... -- 5,568,000 30,944,000
Stock options exercised.......................................... -- -- 447,000
Issuance of preferred stock...................................... -- 7,500,000 --
------------- ------------- --------------
Net cash (used in) provided by financing activities.......... (839,000) 14,721,000 19,256,000
------------- ------------- --------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS................... 114,000 1,539,000 (268,000)
CASH AND CASH EQUIVALENTS, beginning of year....................... 73,000 187,000 1,726,000
------------- ------------- --------------
CASH AND CASH EQUIVALENTS, end of year............................. $ 187,000 $ 1,726,000 $ 1,458,000
------------- ------------- --------------
------------- ------------- --------------
</TABLE>
The accompanying notes are an integral part of these consolidated statements
F-7
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
1. NATURE OF BUSINESS
STAR Telecommunications, Inc., a Delaware corporation, and Subsidiaries (the
"Company" or "STAR"), is an emerging multinational carrier focused primarily on
the international long distance market. The Company offers highly reliable,
low-cost switched voice services on a wholesale basis primarily to U.S.-based
long distance carriers. STAR provides international long distance service
through a flexible network comprised of foreign termination relationships,
international gateway switches, leased and owned transmission facilities and
resale arrangements with other long distance providers. While the Company was
incorporated in 1993, it did not commence its current business as a provider of
long distance services until the second half of 1995. During the six months
ended June 1995, the Company primarily acted as an agent for, and provided
various consulting services to, companies in the telecommunications industry.
During 1996 and 1997, the Company established several wholly-owned foreign
subsidiaries to further expand its international network. The Company made
substantial investments to install switch facilities in two of these
subsidiaries, Star Europe Limited (SEL) which is located in London, England, and
Star Telecommunications Deutschland (GmbH) which is located in Frankfurt,
Germany. The Company plans to use these switch facilities to decrease
international traffic termination costs and to initiate outbound calls from
these local markets.
In December 1997, the Company entered into the domestic commercial
long-distance market through the acquisition of L.D. Services, Inc., also known
as LCCR Inc. ("LDS"). LDS is a retail long-distance service provider throughout
the United States. The merger constituted a tax-free reorganization and has been
accounted for as a pooling of interests under Accounting Principles Board
Opinion No. 16. Accordingly, all prior period consolidated financial statements
presented have been restated to include the results of operations, financial
position and cash flows of LDS as though it had always been a part of STAR (see
Note 8). The pro forma results of operations and pro forma income or loss per
common share for 1995, 1996 and 1997 assumes that both STAR and LDS had been
C-Corporations for all periods presented.
The Company is subject to various risks in connection with the operation of
its business. These risks include, but are not limited to, regulations (both
domestic and foreign), dependence on transmission facilities-based carriers and
suppliers, price competition and competition from larger industry participants.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
STAR Telecommunications, Inc. and its wholly-owned subsidiaries. All significant
intercompany balances and transactions have been eliminated.
REVENUE RECOGNITION
The Company records revenues for telecommunications sales at the time of
customer usage. Finance charges for customer late payments are included in
revenues and amount to $32,000, $1,467,000 and $2,747,000 for the years ended
December 31, 1995, 1996 and 1997, respectively.
F-8
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
COST OF SERVICES
Cost of services for wholesale long distance services represents direct
charges from vendors that the Company incurs to deliver service to its
customers. These include leasing costs for the dedicated phone lines, which form
the Company's network, and rate-per-minute charges from other carriers that
terminate traffic on behalf of the Company. In addition, retail long distance
service cost includes billing and collection service fees from local exchange
carriers and call rating services.
ACCOUNTING FOR INTERNATIONAL LONG DISTANCE TRAFFIC
The Company has carrier service agreements with telecommunication carriers
in foreign countries under which international long distance traffic is both
originated and terminated on the Company's network. The Company records revenues
and related costs as the traffic is recorded in the switch. Revenue from foreign
customers equaled $178,000 and $6,577,000 for the years ended December 31, 1996
and 1997, respectively. The Company had no revenues from foreign customers
during 1995.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of demand deposits and money market funds,
which are highly liquid short-term instruments with original maturities of three
months or less from the date of purchase. Cash and cash equivalents are stated
at cost, which approximates market.
FINANCIAL INSTRUMENTS
The carrying amounts of notes payable and capital lease obligations
approximate their fair value because interest rates approximate market rates for
similar instruments.
Off balance sheet derivative financial instruments at December 31, 1997
consist of foreign currency exchange agreements.
The Company enters into foreign currency exchange contracts to manage
foreign currency exposures. The principle objective of such contracts is to
minimize the risks and/or costs associated with financial and global operating
activities. The Company does not utilize financial instruments for trading or
other speculative purposes. The counterparty to these contractual arrangements
is a multi-national financial institution with which the Company also has other
financial relationships.
The Company enters into forward currency exchange contracts in the normal
course of business to manage its exposure against foreign currency fluctuations
on payable positions resulting from fixed asset purchases and other contractual
expenditures denominated in foreign currencies. At December 31, 1997, gains and
losses on foreign exchange contracts are not material to the consolidated
financial statements.
The fair values of foreign currency contracts are estimated by obtaining
quotes from brokers. At December 31, 1997, the Company has foreign currency
contracts outstanding with the notional value of $6,305,000 which had an
estimated fair value to receive $6,218,000 worth of German marks and British
pounds, the difference of which has been recognized in operations.
F-9
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following table summarizes outstanding commitments to purchase foreign
currency at December 31, 1997:
<TABLE>
<CAPTION>
MATURITY NOTIONAL
DATE AMOUNT FAIR VALUE DIFFERENCE
-------------------------- ------------ ------------ ----------
<S> <C> <C> <C> <C>
British Pounds..................... 1/29/98 through 3/27/98 $ 364,000 $ 373,000 $ 9,000
Deutsche Mark...................... 1/05/98 through 1/26/98 5,941,000 5,845,000 (96,000)
------------ ------------ ----------
$ 6,305,000 $ 6,218,000 $ (87,000)
------------ ------------ ----------
------------ ------------ ----------
</TABLE>
MARKETABLE SECURITIES
Marketable securities consists of interest bearing securities with original
maturities in excess of three months. At December 31, 1997, the fair market
value of temporary investments, classified as "available for sale securities",
approximated cost, thus no unrealized holding gains or losses were reported in
the accompanying balance sheets. During fiscal year 1997, the Company realized
gains from the sale of securities of approximately $48,000.
PROPERTY AND EQUIPMENT
Property and equipment are carried at cost. Depreciation and amortization of
property and equipment are computed using the straight-line method over the
following estimated useful lives:
<TABLE>
<S> <C>
Operating equipment....................................... 5-25 years
Leasehold improvements.................................... Life of lease
Computer equipment........................................ 3-7 years
Furniture and fixtures.................................... 5-7 years
</TABLE>
Operating equipment includes assets financed under capital lease obligations
of $6,218,000 and $15,921,000 at December 31, 1996 and 1997, respectively.
Accumulated amortization related to assets financed under capital leases was
$391,000 and $2,123,000 at December 31, 1996 and 1997, respectively.
In addition, operating equipment includes seven Indefeasible Rights of Use
(IRU) in cable systems amounting to $110,000 and $2,303,000 and four ownership
interests in an international cable amounting to $148,000 and $1,534,000 at
December 31, 1996 and 1997, respectively. These assets are amortized over the
life of the agreements of 14 to 25 years (see Note 5).
Replacements and betterments, renewals and extraordinary repairs that extend
the life of the asset are capitalized; other repairs and maintenance are
expensed. The cost and accumulated depreciation applicable to assets sold or
retired are removed from the accounts and the gain or loss on disposition is
recognized in other income or expense.
DEPOSITS AND OTHER ASSETS
Deposits represent payments made to long distance providers to secure lower
rates. These deposits are refunded or applied against future services. Other
assets at December 31, 1996 represent initial public offering expenses, which
were subsequently charged to additional paid in capital during 1997 at the time
of the initial public offering.
F-10
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CONSOLIDATED STATEMENTS OF CASH FLOWS
During the years ended December 31, 1995, 1996 and 1997 cash paid for
interest was $45,000, $534,000 and $1,359,000, respectively. For the same
periods, cash paid for income taxes amounted to $51,000, $1,262,000 and
$3,761,000, respectively.
Non-cash investing and financing activities are as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------
1995 1996 1997
------------- ------------- -------------
<S> <C> <C> <C>
Equipment purchased through capital leases.......................... $ 1,052,000 $ 5,166,000 $ 9,772,000
Notes issued for asset purchases.................................... -- -- 1,524,000
Debt converted to equity............................................ 1,093,000 -- --
Tax benefits related to stock options............................... -- -- 114,000
</TABLE>
These non-cash transactions are excluded from the consolidated statements of
cash flows.
NET INCOME (LOSS) PER COMMON SHARE
The following schedule summarizes the information used to compute pro forma
net income or loss per common share for the years ended December 31, 1995, 1996
and 1997:
<TABLE>
<CAPTION>
1995 1996 1997
------------- ------------- -------------
<S> <C> <C> <C>
Pro forma net income (loss)......................................... $ 2,407,000 $ (5,163,000) $ 5,373,000
------------- ------------- -------------
------------- ------------- -------------
Weighted average number of common shares used to compute basic
earnings (loss) per share.......................................... 18,020,000 21,939,000 28,868,000
Weighted average common share equivalents........................... -- -- 2,757,000
------------- ------------- -------------
Weighted average number of common shares and common share
equivalents used to compute diluted net income (loss) per common
share.............................................................. 18,020,000 21,939,000 31,625,000
------------- ------------- -------------
------------- ------------- -------------
Basic pro forma net income (loss) per common share (unaudited)...... $ 0.13 $ (0.24) $ 0.19
Diluted pro forma net income (loss) per common share (unaudited).... $ 0.13 $ (0.24) $ 0.17
</TABLE>
CONCENTRATIONS OF RISK
The Company's two largest customers account for approximately 25 percent and
7 percent of gross accounts receivable at December 31, 1996 and 1997,
respectively. The Company's largest customer and second largest customer in 1997
represent 3 percent and 4 percent of accounts receivable as of December 31,
1997, respectively. The Company's largest customer in 1996 was Cherry
Communications, Inc. The second largest customer in 1996 was Hi-Rim
Communications, Inc. Only one customer, Cherry Communications had a receivable
balance exceeding 10 percent of gross accounts receivable at December 31, 1996
and no individual customer has an account receivable balance greater than 10
percent of gross accounts receivable at December 31, 1997.
F-11
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The two largest customers represent approximately 16 percent, 26 percent and
17 percent of revenues during the years ended December 31, 1995, 1996 and 1997,
respectively. During 1995 and 1996, only sales to Cherry Communications exceeded
10 percent of total sales. For the year ended December 31, 1997, only one
customer equaled 10 percent of consolidated sales.
The Company performs ongoing credit evaluations of its customers. The
Company analyzes daily traffic patterns and concludes whether or not the
customer's credit status justifies the traffic volume. If the customer is deemed
to carry too large a volume in relation to its credit history, the traffic
received by the Company's switch is reduced to prevent further build up of the
receivable from this customer. The Company's allowance for doubtful accounts is
based on current market conditions.
Purchases from the four largest vendors for the years ended December 31,
1995 and 1996 amounted to 57 percent and 45 percent of total purchases,
respectively. Purchases from the four largest vendors for the year ended
December 31, 1997 amounted to 36 percent of total purchases.
Included in the Company's balance sheets at December 31, 1996 and 1997 are
approximately $179,000 and $6,367,000 of equipment which is located in foreign
countries.
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
RECENTLY ISSUED ACCOUNTING STANDARDS
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share". The statement replaces primary EPS with basic EPS, which is computed by
dividing reported earnings available to common stockholders by weighted average
shares outstanding. The provision requires the calculation of diluted EPS. The
Company adopted this statement in 1997 and all prior year earnings per share
amounts have been recalculated based on the provisions of SFAS No. 128.
F-12
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
TRANSLATION OF FOREIGN CURRENCY
Management determined that the functional currency of its foreign
subsidiaries is still the U.S. dollar. Thus all foreign translation gains or
losses are reflected in the results of operations in other income (expense).
The foreign subsidiary balance sheets are translated into U.S. dollars using
the year-end exchange rates except for prepayments, property, other long-term
assets, and stockholders' equity accounts, which are translated at rates in
effect when these balances were originally recorded. Revenues and expenses are
translated at average rates during the year except for depreciation and
amortization, which are translated at historical rates.
3. ACCRUED EXPENSES
Accrued expenses at December 31, 1996 and 1997 consist of the following:
<TABLE>
<CAPTION>
1996 1997
------------ ------------
<S> <C> <C>
Payroll and related......................................................... $ 783,000 $ 943,000
Management bonuses.......................................................... 25,000 152,000
Professional services....................................................... 640,000 384,000
Sales and other taxes....................................................... 10,000 295,000
Line and billing cost....................................................... 324,000 2,592,000
Other....................................................................... 304,000 1,243,000
------------ ------------
$ 2,086,000 $ 5,609,000
------------ ------------
------------ ------------
</TABLE>
4. LINES OF CREDIT
BANK LINE OF CREDIT
Effective as of September 30, 1997, the Company executed an agreement with
Sanwa Bank, California for a $25 million line of credit, which expires on July
1, 1999. The facility has certain financial and non-financial covenants that
include, among other restrictions, the maintenance of minimum levels of tangible
net worth. Borrowings on the facility are limited to 75 percent of eligible
accounts receivable and are secured by substantially all of the assets of the
Company. The credit facility provides for borrowings at an interest rate based
upon the bank's cost of funds plus 1.75 percent (7.47 percent at December 31,
1997). The Company plans to use the credit facility to support letters of credit
and for working capital or other general corporate purposes. At December 31,
1997, no amounts were outstanding, however the Company's availability under this
credit facility was reduced to $20.1 million due to $4.9 million in letters of
credit which were outstanding at December 31, 1997.
The weighted average interest rate on short term debt during the years ended
December 31, 1995, 1996 and 1997 was 10.21 percent, 9.68 percent and 9.12
percent, respectively.
LINES OF CREDIT WITH STOCKHOLDER
At December 31, 1996 and 1997, the Company's revolving lines of credit with
the founder and chief executive officer of the Company totaled $1,448,000. The
debt matures on March 30, 1998 with interest
F-13
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
4. LINES OF CREDIT (CONTINUED)
payable at maturity at a rate of 9 percent. There was $1,422,000 and $1,310,000
available to be borrowed against these lines of credit at December 31, 1996 and
1997, respectively. The Company recognized interest expense related to this debt
of $11,000, $34,000 and $9,000 for the years ended December 31, 1995, 1996 and
1997, respectively.
5. LONG-TERM DEBT
The Company finances some of its telecommunication equipment under capital
lease arrangements or through notes payable as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1996 1997
------------ -------------
<S> <C> <C>
Bank debt at prime plus 1.5 percent........................................ $ 733,000 $ --
Notes payable for Indefeasible Rights of Use on submarine cable, payable in
quarterly installments of principal plus interest at LIBOR plus 6 percent
(11.72 percent at December 31, 1997) through September 1999............... -- 762,000
Note payable for Indefeasible Right of Use, payable in quarterly
installments of $9,000 plus interest at LIBOR plus 6 percent through
September 1999............................................................ -- 66,000
Obligations under capital leases........................................... 5,808,000 13,634,000
------------ -------------
$ 6,541,000 $ 14,462,000
------------ -------------
------------ -------------
</TABLE>
Minimum future lease payments under capital leases at December 31, 1997 are
as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
- -----------------------------------------------------------------------------------------
<S> <C>
1998................................................................................. $ 3,944,000
1999................................................................................. 3,943,000
2000................................................................................. 3,614,000
2001................................................................................. 2,927,000
2002................................................................................. 2,505,000
Thereafter........................................................................... 814,000
-------------
17,747,000
Less: Amount representing interest....................................................... (4,113,000)
-------------
13,634,000
Less: Current portion.................................................................... (2,495,000)
-------------
$ 11,139,000
-------------
-------------
</TABLE>
F-14
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
6. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
The Company leases office space, dedicated private telephone lines,
equipment and other items under various agreements expiring through 2006. At
December 31, 1997, the minimum aggregate payments under non-cancelable operating
leases are summarized as follows:
<TABLE>
<CAPTION>
FACILITIES AND DEDICATED
YEAR ENDING DECEMBER 31, EQUIPMENT PRIVATE LINES TOTAL
- --------------------------------------------------------- -------------- ------------- -------------
<S> <C> <C> <C>
1998................................................. $ 3,375,000 $ 4,969,000 $ 8,344,000
1999................................................. 3,318,000 1,906,000 5,224,000
2000................................................. 3,283,000 372,000 3,655,000
2001................................................. 2,946,000 -- 2,946,000
2002................................................. 2,739,000 -- 2,739,000
Thereafter........................................... 8,423,000 -- 8,423,000
-------------- ------------- -------------
$ 24,084,000 $ 7,247,000 $ 31,331,000
-------------- ------------- -------------
-------------- ------------- -------------
</TABLE>
Facility and equipment rent expense for the years ended December 31, 1995,
1996 and 1997 was approximately $195,000, $1,076,000 and $3,199,000,
respectively. Dedicated private line expense was approximately $604,000,
$7,045,000 and $9,414,000, for those same periods and is included in cost of
services in the accompanying consolidated statements of operations.
EMPLOYMENT AGREEMENTS
The Company has employment agreements through December 31, 2000 with several
employees and executives. Some of these agreements provide for a continuation of
salaries in the event of a termination, with or without cause, following a
change in control of the Company. One agreement provides for a payment of at
least $1,500,000 in the event of a change in control of the Company.
The Company expensed $116,000 and $64,000 of deferred compensation relating
to these agreements for the years ended December 31, 1996 and 1997,
respectively.
PURCHASE COMMITMENTS
The Company is obligated under various service agreements with long distance
carriers to pay minimum usage charges. The Company anticipates exceeding the
minimum usage volume with these vendors. Minimum future usage charges at
December 31, 1997 are as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
- -----------------------------------------------------------------------------------------
<S> <C>
1998..................................................................................... $ 44,053,000
1999..................................................................................... 8,356,000
2000..................................................................................... 2,949,000
2001..................................................................................... 65,000
2002..................................................................................... 65,000
Thereafter............................................................................... 774,000
-------------
$ 56,262,000
-------------
-------------
</TABLE>
F-15
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
6. COMMITMENTS AND CONTINGENCIES (CONTINUED)
The Company has entered into six fixed asset purchase agreements. These
commitments are to purchase IRU's, switches, and leasehold improvements for
switch sites. The total commitment approximates $63 million. The Company plans
to finance the majority of these costs through capital lease arrangements.
LEGAL MATTERS
The Company is subject to litigation from time to time in the normal course
of business. Although it is not possible to predict the outcome of such
litigation, based on the facts known to the Company and after consultation with
counsel, management believes that such litigation will not have a material
adverse effect on its financial position or results of operations.
On September 4, 1997, prior to the merger between LDS and the Company, LDS
entered into a settlement agreement with the Consumer Services Division of the
California Public Utilities Commission (PUC). The agreement settles the alleged
unauthorized switching of long-distance customers to LDS between the years 1995
and 1996. It includes a payment of $760,000 to the PUC for restitution to
affected customers as defined in the agreement. Additionally, LDS agreed to a
voluntary revocation of its operating authority in the State of California.
Under the agreement, service to all California customers has to be terminated
within 120 days after approval of the agreement by the PUC. On November 19,
1997, the PUC approved the agreement along with a transfer of control to STAR.
On November 15, 1997, LDS settled a civil suit with the District Attorney of
Monterey, California for a monetary payment of $700,000 and various non-monetary
concessions as defined in the agreement. This suit was of the same nature as the
above action of the PUC and covers complaints from the years 1994 through 1997.
LETTERS OF CREDIT
At December 31, 1997, the Company has nine standby letters of credit
outstanding, which expire between January 20, 1998 and December 19, 1998. These
letters of credit, all of which are secured by the bank line of credit, total
$4,900,000.
7. RELATED PARTY TRANSACTIONS
The founder and chief executive officer of the Company owns Star Aero
Services, Inc. (Star Aero). Star Aero's principal assets represent airplanes
which it provides to the Company for business travel on an as needed basis. In
return, the Company pays for costs related to the airplanes. Star Aero
reimburses the Company for certain costs relating to the maintenance of the
planes. For the years ended December 31, 1995, 1996 and 1997, the Company paid
$144,000, $68,000 and $171,000, respectively, in costs related to the use of
Star Aero services. As of December 31, 1995 and 1996, the Company had
receivables from Star Aero of $50,000 and $115,000, respectively. The Company
had no receivables from Star Aero at December 31, 1997.
During 1997, the Company provided a short-term loan to the chief executive
officer for $8,000,000. The loan carried interest of 7 percent per annum, was
secured by $30,000,000 of the stockholder's stock in the Company, and was repaid
in seven days.
F-16
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
7. RELATED PARTY TRANSACTIONS (CONTINUED)
During 1995, the Company invested $128,000 in a company related to an
employee of STAR. During 1996 and 1997, the Company provided services to this
company in the amounts of $167,000 and $926,000. As of December 31, 1996 and
1997, accounts receivable from this related party amounted to $57,000 and
$41,000, respectively.
During 1995, 1996 and 1997, the Company purchased consulting services from a
company owned by a board member in the amount of $60,000, $154,000 and $72,000,
respectively.
During 1996 and 1997, the Company purchased consulting services from a
company owned in part by an employee and a significant stockholder for $37,000
and $256,000, respectively. In addition, the Company purchased equipment and
services from this company in the amount of $1,114,000 in 1997. This significant
stockholder is also a 30 percent investor in a company, whose subsidiary
provided consulting services to the Company in the amount of $12,000 in 1996 and
$213,000 in 1997. In addition, the Company purchased telecommunication services
from three related companies for $240,000 during 1996 and paid legal fees on
behalf of these companies in the amount of $131,000.
During the years ended December 31, 1995, 1996 and 1997, the Company also
provided long distance telephone service to a company controlled by another
board member in the amount of $43,000, $250,000 and $1,141,000, respectively.
Accounts receivable for these services total $721,000 as of December 31, 1997.
In addition, the Company loaned $2,500,000 to this related party. The Company
has announced its intention to merge the two companies (see Note 14).
8. BUSINESS COMBINATIONS
In November 1997, the Company acquired LDS, a domestic commercial long
distance telecommunications provider, in a transaction that was accounted for as
a pooling of interests. The Company issued 849,298 shares of its common stock to
LDS' shareholders in exchange for all outstanding LDS shares plus shares of
certain non-operating entities owned by LDS' shareholders and majority ownership
in an affiliated telephone retailer controlled by LDS. The accompanying
consolidated financial statements have been restated to include the financial
position and results of operations of LDS for all periods presented.
Net sales and historical net income (loss) of the combining companies for
the last three years are as follows:
<TABLE>
<CAPTION>
1995 1996 1997
------------- -------------- --------------
<S> <C> <C> <C>
Net Sales:
STAR................................................. $ 16,125,000 $ 208,086,000 $ 348,738,000
LDS.................................................. 30,158,000 29,905,000 27,460,000
------------- -------------- --------------
Total................................................ $ 46,283,000 $ 237,991,000 $ 376,198,000
------------- -------------- --------------
------------- -------------- --------------
Net Income (Loss):
STAR................................................. $ (568,000) $ (6,644,000) $ 5,605,000
LDS.................................................. 4,541,000 2,424,000 (37,000)
------------- -------------- --------------
Total................................................ $ 3,973,000 $ (4,220,000) $ 5,568,000
------------- -------------- --------------
------------- -------------- --------------
</TABLE>
F-17
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
9. INCOME TAXES
Through December 31, 1995, the Company had elected to be taxed as an
S-Corporation for both federal and state income tax purposes. While the election
was in effect, all taxable income, deductions, losses and credits of the Company
were included in the tax returns of the shareholders. Accordingly, for federal
income tax purposes, no tax benefit, liability or provision has been reflected
in the accompanying historical consolidated financial statements for the year
ended December 31, 1995. For state tax purposes, an S-Corporation is subject to
a 1.5 percent tax on taxable income, with a minimum tax of approximately $1,000
annually. Effective January 1, 1996, the Company terminated its S-Corporation
election and is now taxable as a C-Corporation.
In addition, the results of operations and provision for income taxes for
LDS through November 30, 1997 reflects LDS' status as an S-Corporation. The
unaudited pro-forma income taxes, pro-forma net income (loss), and pro-forma
earnings per share information reflected in the consolidated statements of
operations assumes that both STAR and LDS were taxed as C-Corporations for all
periods presented.
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes," under which deferred assets and liabilities are
provided on differences between financial reporting and taxable income using
enacted tax rates. Deferred income tax expenses or credits are based on the
changes in deferred income tax assets or liabilities from period to period.
Under SFAS No. 109, deferred tax assets may be recognized for temporary
differences that will result in deductible amounts in future periods. A
valuation allowance is recognized if, on the weight of available evidence, it is
more likely than not that some portion or all of the deferred tax asset will not
be realized.
The Company has recorded a net deferred tax asset of $3,699,000 at December
31, 1997. Realization is dependent on generating sufficient taxable income in
the future. Although realization is not assured, management believes it is more
likely than not that the net deferred tax asset recorded will be realized.
The components of the net deferred tax assets at December 31, 1996 and 1997
are as follows:
<TABLE>
<CAPTION>
1996 1997
------------- -------------
<S> <C> <C>
Deferred tax asset:
Reserve for accounts and note receivable................................ $ 3,104,000 $ 4,169,000
Accrued line cost....................................................... 201,000 798,000
Vacation accrual........................................................ 24,000 138,000
Deferred compensation................................................... 47,000 38,000
Accrued bonuses......................................................... 25,000 --
Accrued services........................................................ -- 183,000
Foreign net operating losses............................................ -- 468,000
State income taxes...................................................... 48,000 392,000
------------- -------------
3,449,000 6,186,000
Deferred tax liability:
Depreciation............................................................ (565,000) (804,000)
------------- -------------
Subtotal.................................................................. 2,884,000 5,382,000
Valuation reserve......................................................... (2,884,000) (1,683,000)
------------- -------------
Net deferred tax asset.................................................... $ -- $ 3,699,000
------------- -------------
------------- -------------
</TABLE>
F-18
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
9. INCOME TAXES (CONTINUED)
The provision for income taxes for the years ended December 31, 1995, 1996
and 1997 are as follows:
<TABLE>
<CAPTION>
PRO FORMA
HISTORICAL (UNAUDITED)
-------------------------------- ----------------------------------
1995 1996 1997 1995 1996 1997
--------- --------- ---------- --------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Current
Federal taxes............................. $ -- $ 393,000 $4,899,000 $1,365,000 $1,231,000 $5,281,000
State taxes............................... 66,000 199,000 1,138,000 416,000 394,000 1,261,000
--------- --------- ---------- --------- ----------- ----------
66,000 592,000 6,037,000 1,781,000 1,625,000 6,542,000
--------- --------- ---------- --------- ----------- ----------
Deferred
Federal taxes............................. -- -- (2,273,000) (121,000) (70,000) (2,512,000)
State taxes............................... -- -- (869,000) (28,000) (20,000) (940,000)
--------- --------- ---------- --------- ----------- ----------
-- -- (3,142,000) (149,000) (90,000) (3,452,000)
--------- --------- ---------- --------- ----------- ----------
Provision for income taxes.................. $ 66,000 $ 592,000 $2,895,000 $1,632,000 $1,535,000 $3,090,000
--------- --------- ---------- --------- ----------- ----------
--------- --------- ---------- --------- ----------- ----------
</TABLE>
Differences between the provision for income taxes and income taxes at the
statutory federal income tax rate for the years ended December 31, 1995, 1996
and 1997 are as follows:
<TABLE>
<CAPTION>
PRO FORMA
HISTORICAL (UNAUDITED)
---------------------------------- ----------------------------------
1995 1996 1997 1995 1996 1997
---------- ---------- ---------- --------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Income taxes at the statutory federal
rate................................ $1,373,000 $(1,234,000) $2,962,000 $1,373,000 ($1,234,000) $2,962,000
State income taxes, net of federal
income tax effect................... 246,000 (221,000) 486,000 246,000 (221,000) 486,000
Foreign taxes at rates different than
U.S. taxes.......................... -- -- 187,000 -- -- 187,000
Change in valuation reserve........... -- 2,884,000 (1,201,000) -- 2,884,000 (1,201,000)
Permanent differences................. -- 104,000 33,000 13,000 108,000 307,000
Effect of STAR S-Corp status until
December 31, 1995................... 223,000 -- -- -- -- --
Effects of LDS S-Corp status until
November 30, 1997................... (1,808,000) (958,000) 152,000 -- -- --
Other................................. 32,000 17,000 276,000 -- (2,000) 349,000
---------- ---------- ---------- --------- ----------- ----------
$ 66,000 $ 592,000 $2,895,000 $1,632,000 $1,535,000 $3,090,000
---------- ---------- ---------- --------- ----------- ----------
---------- ---------- ---------- --------- ----------- ----------
</TABLE>
10. STOCK OPTIONS
On January 22, 1996, the Company adopted the 1996 Stock Incentive Plan (the
"Plan"). The Plan, which was amended on March 31, 1996, provides for the
granting of stock options to purchase up to 1,476,000 shares of common stock and
terminates January 22, 2006. Options granted become exercisable at a rate of not
less than 20 percent per year for five years.
During 1996, the Company entered into three separate stock option agreements
outside the Plan. The first agreement, dated March 1, 1996, provided for 410,000
non-incentive stock options exercisable immediately. The options were
exercisable at fair market value at the date of issuance, which was $0.98 per
share, to expire in 10 years. The second stock option agreement was entered into
on May 1, 1996 for an
F-19
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
10. STOCK OPTIONS (CONTINUED)
additional 410,000 shares to also be issued at $0.98 per share. Of these options
half vested on March 1, 1997 and half expired. On May 15, 1996, the Company
granted 205,000 options, valued at $1.46 per share at the date of issuance to a
director. Of these options 34 percent were exercisable immediately. The
remaining options are exercisable equally on May 15, 1997 and 1998.
At December 31, 1996 and 1997, 1,025,000 and 820,000 options, respectively,
issued outside a plan were outstanding.
On September 23, 1996, the Company adopted the 1996 Supplemental Stock
Option Plan. This plan which expires on August 31, 2006, replaces the Plan and
has essentially the same features. The Company can issue options or other rights
to purchase up to 2,050,000 shares of stock which expire up to 10 years after
the date of grant, except for incentive options issued to a holder of more than
10 percent of the common stock outstanding, which expire five years after the
date of grant.
In December 1996, the Company issued 174,000 options at $4.00 per share. The
Board of Directors determined the market value of the December options to be
$4.68 per share. The Company is recognizing the difference between the market
value at the date of grant and the exercise price as compensation expense over
the vesting period.
At December 31, 1996 and 1997, 2,358,000 and 1,873,000 options,
respectively, were outstanding under the aggregate of the 1996 Stock Incentive
Plan and the Supplemental Stock Option Plan.
On May 14, 1996, the Company adopted the 1996 Outside Director Nonstatutory
Stock Option Plan (the "Director Plan"). The number of shares which may be
issued under this plan upon exercise of options may not exceed 410,000 shares.
The exercise price of an option is determined by the Board of Directors and may
not be less than 85 percent of the fair market value of the common stock at the
time of grant and has to be 110 percent of the fair market value of the common
stock at the time of grant if the option is granted to a holder of more than 10
percent of the common stock outstanding. At the discretion of the administrator,
the options vest at a rate of not less than 20 percent per year, which may
accelerate upon a change in control, as defined. The plan expires on May 14,
2006. At December 31, 1996 and 1997, 82,000 and 41,000 options, respectively,
were outstanding under the Director Plan.
On January 30, 1997, the Board of Directors approved the 1997 Omnibus Stock
Incentive Plan (the "Omnibus Plan") to replace the existing 1996 supplemental
plan upon the effective date of the initial public offering. The plan provides
for awards to employees, outside directors and consultants in the form of
restricted shares, stock units, stock options and stock appreciation rights and
terminates on January 22, 2007. The maximum number of shares available for
issuance under this plan may not exceed 1,025,000 shares plus the number of
shares still unissued under the supplemental option plan. Options granted to any
one optionee may not exceed more than 1,025,000 common shares per year subject
to certain adjustments. Incentive stock options may not have a term of more than
10 years from the date of grant. At December 31, 1997, 763,000 options, were
outstanding under the Omnibus Plan.
F-20
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
10. STOCK OPTIONS (CONTINUED)
Information regarding the Company's stock option plans and nonqualified
stock options as of December 31, 1995, 1996 and 1997, and changes during the
years ended on those dates is summarized as follows:
<TABLE>
<CAPTION>
WEIGHTED-AVERAGE
SHARES EXERCISE PRICE
--------------- -----------------
<S> <C> <C>
December 31, 1995.......................................... -- $ --
Granted.................................................... 3,491,355 1.89
Exercised.................................................. -- --
Forfeited.................................................. (26,855) 1.95
--------------- ------
December 31, 1996.......................................... 3,464,500 1.89
--------------- ------
Granted.................................................... 914,296 7.91
Exercised.................................................. (488,925) 0.89
Forfeited.................................................. (392,774) 2.40
--------------- ------
December 31, 1997.......................................... 3,497,097 $ 3.54
--------------- ------
--------------- ------
</TABLE>
At December 31, 1996, 912,425 options were exercisable at a weighted average
exercise price of $1.10 per share. At December 31, 1997, 1,275,645 options were
exercisable at a weighted average exercise price of $1.51 per share. The options
outstanding at December 31, 1997 expire in various years through 2007.
Information about stock options outstanding at December 31, 1997 is
summarized as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
-------------------------------------------------------------------
WEIGHTED-
AVERAGE WEIGHTED- WEIGHTED-
NUMBER REMAINING AVERAGE NUMBER AVERAGE
OUTSTANDING CONTRACTED EXERCISE EXERCISABLE EXERCISE
RANGE OF EXERCISE PRICES AT 12/31/97 LIFE PRICE AT 12/31/97 PRICE
- ---------------------------------------------------- ----------- ------------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C>
$0.73 to $1.46...................................... 1,807,126 8.28 $ 1.17 1,113,695 $ 1.14
$4.00 to $6.83...................................... 1,146,721 8.96 $ 4.68 161,950 $ 4.07
$8.11 to $11.10..................................... 543,250 9.66 $ 9.06 -- $ --
----------- ----- ----------- ----------- -----
3,497,097 8.72 $ 3.54 1,275,645 $ 1.51
----------- ----- ----------- ----------- -----
----------- ----- ----------- ----------- -----
</TABLE>
The Company has elected to adopt FASB No. 123 for disclosure purposes only
and applies Accounting Principle Board (APB) Opinion No. 25 and related
interpretations in accounting for its employee stock options. Approximately
$50,000 and $88,000 in compensation cost was recognized relating to consultant
options for the years ended December 31, 1996 and 1997, respectively. Had
compensation cost for stock options awarded under these plans been determined
based on the fair value at the dates of grant consistent with the methodology of
FASB No. 123, the Company's net income or loss and basic and diluted income or
loss per share for the years ended December 31, 1996 and 1997 would have
reflected the following pro-forma amounts:
F-21
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
10. STOCK OPTIONS (CONTINUED)
Pro-forma Net Income (Loss) Per Share
<TABLE>
<CAPTION>
1996 1997
------------- ------------
<S> <C> <C>
Pro-Forma Net Income (Loss)...................................... $ (5,536,000) $ 4,756,000
Pro-Forma Basic Net Income (Loss) per share...................... $ (0.25) $ 0.16
Pro Forma Diluted Net Income (Loss) per share.................... $ (0.25) $ 0.15
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the minimum value method of option pricing with the following assumptions used
for the grants; weighted average risk-free interest rate of 6.4 and 6.2 percent
and an expected life of ten years and six years for the years ended December 31,
1996 and 1997, respectively. Expected volatility for 1997 was 31.05 percent and
it is assumed that no dividends would be issued during the option term. Because
the Company did not have a stock option program prior to 1996, the resulting
pro-forma compensation cost may not be representative of that to be expected in
future years.
11. CAPITAL STOCK
During 1994, the Company issued 16,606,661 shares of stock to the Company's
founder for $10,000. During 1995, this stockholder converted $990,000 of debt
into capital for no additional shares. During 1995, the Company also issued
1,843,339 shares to another executive of the Company on conversion of a loan.
On February 23, 1996, the Company sold 2,049,980 shares of common stock to
various investors for $1,500,000. On July 12, 1996, the Company sold 1,874,532
shares of common stock to an investor for $4,068,000.
On July 25, 1996, the Company sold 2,802,446 shares of Series A preferred
stock to a group of investors for $7,500,000. In connection with this
transaction, the Company and buyers of the preferred shares entered into an
investor's rights agreement which obligated the Company to file up to two
registration statements to register such shares. These preferred shares
converted to common stock at a ratio of 3-for-2 as a result of the public
offering in accordance with the investors rights agreement.
In June 1997, the Company completed its Initial Public Offering ("IPO") of
9,430,000 shares of common stock of which 8,097,500 shares were sold by the
Company and 1,332,500 shares were sold by certain selling shareholders. The net
proceeds to the Company (after deducting underwriting discounts and offering
expenses of approximately $4.6 million) from the sale of shares was
approximately $30.9 million.
On November 30, 1997, the Company completed the acquisition of LDS pursuant
to the terms of the agreement and 849,298 shares were issued for all of the
outstanding shares to LDS.
12. BUSINESS SEGMENTS
At December 31, 1997, Star has two business segments, wholesale long
distance and commercial long distance telecommunications. The wholesale segment
provides long distance services to U.S. and foreign based telecommunications
companies and the commercial segment, obtained by acquisition of LDS, provides
commercial long distance services to small retailers throughout the United
States.
F-22
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
12. BUSINESS SEGMENTS (CONTINUED)
The accounting policies of the segments are the same as those described in
the significant accounting policies, however, the Company evaluates performance
based on profit or loss from operations before income taxes and non-recurring
gains or losses. There are no intercompany sales among the wholesale and
commercial segments and both segments are managed separately.
Reportable segment information for the years ended December 31, 1995, 1996
and 1997 are as follows:
<TABLE>
<CAPTION>
WHOLESALE COMMERCIAL ALL OTHER TOTAL
-------------- ------------- ---------- --------------
<S> <C> <C> <C> <C>
1995
Revenues from external customers..................... $ 16,125,000 $ 30,158,000 $ -- $ 46,283,000
Interest income...................................... -- 22,000 -- 22,000
Interest expense..................................... (64,000) -- -- (64,000)
Depreciation and amortization........................ (128,000) (58,000) -- (186,000)
Segment profit (loss)................................ (568,000) 4,541,000 -- 3,973,000
Other significant non-cash items:
Capital lease additions............................ 888,000 164,000 -- 1,052,000
Property additions financed by notes payable....... -- -- -- --
Debt converted to equity........................... 1,093,000 -- -- 1,093,000
Segment assets....................................... 12,869,000 5,447,000 -- 18,316,000
Expenditures for segment assets...................... 1,062,000 61,000 -- 1,123,000
1996
Revenues from external customers..................... $ 208,086,000 $ 29,905,000 $ -- $ 237,991,000
Interest income...................................... 83,000 27,000 -- 110,000
Interest expense..................................... (589,000) (12,000) -- (601,000)
Depreciation and amortization........................ (1,073,000) (78,000) -- (1,151,000)
Segment profit (loss)................................ (6,644,000) 2,424,000 -- (4,220,000)
Other significant non-cash items:
Capital lease additions............................ 5,097,000 69,000 -- 5,166,000
Property additions financed by notes payable....... -- -- -- --
Segment assets....................................... 48,674,000 5,326,000 -- 54,000,000
Expenditures for segment assets...................... 7,838,000 14,000 -- 7,852,000
1997
Revenues from external customers..................... $ 348,738,000 $ 27,460,000 $ -- $ 376,198,000
Interest income...................................... 519,000 -- (27,000) 492,000
Interest expense..................................... (1,633,000) (27,000) 27,000 (1,633,000)
Depreciation and amortization........................ (4,189,000) (56,000) -- (4,245,000)
Segment profit (loss)................................ 5,605,000 (37,000) -- 5,568,000
Other significant non-cash items:
Capital lease additions............................ 9,772,000 -- -- 9,772,000
Property additions financed by notes payable....... 1,524,000 -- -- 1,524,000
Segment assets....................................... 106,709,000 6,844,000 -- 113,553,000
Expenditures for segment assets...................... 13,419,000 17,000 -- 13,436,000
</TABLE>
F-23
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
12. BUSINESS SEGMENTS (CONTINUED)
The Company had no customers, collectively, representing more than 10
percent of consolidated revenue in any foreign country.
13. QUARTERLY CONSOLIDATED INFORMATION (UNAUDITED)
The following table presents unaudited quarterly operating results,
including the results of LDS, for each of the Company's eight quarters in the
two-year period ended December 31, 1997 (amounts in thousands):
<TABLE>
<CAPTION>
QUARTER ENDED
---------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31,
----------- --------- --------- ----------
<S> <C> <C> <C> <C>
1996
Net sales............................................... $ 42,926 $ 50,064 $ 68,433 $ 76,568
Gross profit............................................ 6,689 7,206 7,714 10,797
Operating income (loss)................................. 2,100 1,961 1,219 (8,356)
Net income (loss)....................................... 1,477 1,294 870 (7,861)
1997
Net sales............................................... $ 79,382 $ 89,167 $ 94,867 $ 112,782
Gross profit............................................ 10,789 11,730 12,913 15,529
Operating income........................................ 2,495 2,633 3,100 2,821
Net income.............................................. 1,907 656 1,014 1,991
</TABLE>
14. SUBSEQUENT EVENTS
ACQUISITIONS
In November 1997, the Company signed a merger agreement with United Digital
Network, Inc. ("UDN"). Under the terms of the agreement, as amended, UDN
stockholders will receive approximately 800,000 shares of STAR common stock. The
Company intends to account for the transaction as a pooling of interests. At
December 31, 1997, the Company has accounts receivable from UDN in the amount of
$721,000 and a note receivable of $2.5 million plus accrued interest of $28,000.
Both the accounts receivable and the note have been fully reserved at December
31, 1997. Subsequent to year end, the Company loaned an additional $2 million to
UDN.
On March 10, 1998, the Company consummated a merger with T-One Corp.
("T-One") to be accounted for as a pooling of interests. In connection with this
merger, the Company issued 1,353,000 shares of its common stock for all
outstanding shares of T-One. The following unaudited pro forma data
F-24
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
14. SUBSEQUENT EVENTS (CONTINUED)
summarizes the combined operating results of the Company and T-One as if the
merger had occurred at the beginning of the periods presented.
<TABLE>
<CAPTION>
1995 1996 1997
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<S> <C> <C> <C>
Revenue.......................................................... $ 58,937,000 $ 260,423,000 $ 406,636,000
Gross profit..................................................... 14,667,000 33,739,000 52,784,000
Income (loss) from operations.................................... 3,847,000 (3,658,000) 11,365,000
Net income (loss) (1)............................................ 2,140,000 (5,738,000) 5,574,000
Diluted income (loss) per common share (2)....................... $ 0.11 $ (0.25) $ 0.17
</TABLE>
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(1) Includes pro forma income (loss) of STAR plus net income (loss) of T-One
assuming STAR and LDS C-Corporation status.
(2) The diluted pro forma income (loss) per common share is based on the sum of
the historical average common shares outstanding, as reported by STAR, and
the historical average common shares outstanding for T-One (adjusted to
reflect non-dilutive common stock equivalents) converted to STAR shares at
the exchange ratio of 13,530 STAR shares per T-One share.
EQUITY TRANSACTIONS
On February 3, 1998 the Company announced a 2.05 for 1 stock split in the
nature of a stock dividend. The stock split is effective March 31, 1998 and has
been retroactively reflected in the accompanying consolidated financial
statements for all periods presented.
Subsequent to year end, the Company granted 219,350 additional stock options
to employees and directors.
LINE OF CREDIT
On March 18, 1998, the Company amended the line of credit agreement with
Sanwa Bank by adjusting the borrowing base to 55% of aggregate eligible accounts
receivable, revising certain covenants and releasing all pledged collateral.
F-25
<PAGE>
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NO PERSON HAS BEEN AUTHORIZED IN CONNECTION WITH THE OFFERING MADE HEREBY TO
GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS
PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE
RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY UNDERWRITER. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO
BUY ANY OF THE SECURITIES OFFERED HEREBY TO ANY PERSON OR BY ANYONE IN ANY
JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER
THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY
CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS
CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF.
----------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Prospectus Summary............................. 3
Risk Factors................................... 7
Use of Proceeds................................ 17
Price Range of Common Stock.................... 17
Dividend Policy................................ 17
Capitalization................................. 18
Selected Consolidated Financial Data........... 19
Management's Discussion and Analysis of
Financial Condition and Results of
Operations................................... 21
Business....................................... 28
Management..................................... 45
Certain Transactions........................... 52
Principal and Selling Stockholders............. 54
Description of Capital Stock................... 56
Shares Eligible for Future Sale................ 58
Underwriting................................... 60
Legal Matters.................................. 61
Experts........................................ 61
Available Information.......................... 61
Index to Consolidated Financial
Statement.................................... F-1
</TABLE>
6,000,000 Shares
[LOGO]
STAR TELECOMMUNICATIONS, INC.
Common Stock
------------
PROSPECTUS
------------
BT ALEX. BROWN
MERRILL LYNCH & CO.
HAMBRECHT & QUIST
LEHMAN BROTHERS
FURMAN SELZ
April 29, 1998
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