<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED MARCH 31, 1999
COMMISSION FILE NUMBER 000-22581
STAR TELECOMMUNICATIONS, INC.
-----------------------------
(Exact name of registrant as specified in its charter)
Delaware 77-0362681
(State or Other Jurisdiction (IRS Employer
of Incorporation or Organization) Identification Number)
223 East De La Guerra, Santa Barbara, California, 93101
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (805) 899-1962
---------------
None
----
(Former name, former address and
former fiscal year if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
----- -----
As of May 11, 1999, the number of the registrant's Common Shares of $.001 par
value outstanding was 57,428,837.
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I - FINANCIAL INFORMATION:
Item 1: Financial Statements
Condensed Consolidated Balance Sheets As Of
December 31, 1998 And March 31, 1999 (unaudited) 3
Condensed Consolidated Statements Of Operations For The
Three Month Periods Ended March 31, 1998 And 1999 (unaudited) 4
Condensed Consolidated Statements Of Cash Flows For The
Three Month Periods Ended March 31, 1998 And 1999 (unaudited) 5
Notes To Condensed Consolidated Financial Statements 7
Item 2: Management's Discussion And Analysis Of Financial
Condition And Results Of Operations 12
Item 3: Quantitative And Qualitative Disclosures About Market Risks 17
PART II - OTHER INFORMATION 18
</TABLE>
2
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except for share data)
<TABLE>
<CAPTION>
December 31, March 31,
1998 1999
------------- --------------
(Unaudited)
<S> <C> <C>
Current Assets:
Cash and cash equivalents $ 47,297 $ 21,365
Short-term investments 835 1,117
Accounts and notes receivable, net 100,418 107,205
Receivable from related parties 765 1,410
Other current assets 43,440 46,906
------------- --------------
Total current assets 192,755 178,003
------------- --------------
Property and equipment, net 170,952 235,681
Other Assets:
Goodwill, net - 207,115
Other 10,944 17,875
------------- --------------
Total assets $ 374,651 $ 638,674
------------- --------------
------------- --------------
Current Liabilities:
Revolving lines of credit $ 19,330 $ 4,100
Current portion of long-term obligations 10,233 16,837
Accounts payable 44,128 67,427
Other accrued expenses 19,391 43,088
Related party payable - 16,963
Accrued network cost 52,920 79,734
Deferred revenue - 35,627
------------- --------------
Total current liabilities 146,002 263,776
------------- --------------
Long-Term Liabilities:
Long-term obligations, net of current portion 29,407 34,113
Other long-term liabilities 3,652 4,578
------------- --------------
Total long-term liabilities 33,059 38,691
------------- --------------
Stockholders' Equity:
Common Stock $.001 par value:
Authorized - 100,000,000 shares 43 58
Additional paid-in capital 207,464 363,985
Deferred compensation - (2,686)
Accumulated other comprehensive income (loss) 188 (1,934)
Note receivable from stockholder - (3,559)
Accumulated deficit (12,105) (19,657)
------------- --------------
Total stockholders' equity 195,590 336,207
------------- --------------
Total liabilities and stockholders' equity $ 374,651 $ 638,674
------------- --------------
------------- --------------
</TABLE>
See accompanying notes to the condensed consolidated financial statements.
3
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------------------
1998 1999
------------------------------
(Unaudited)
<S> <C> <C>
Revenue $ 136,557 $ 228,209
Operating expenses:
Cost of services 116,811 192,914
Selling, general and
administrative expenses 13,660 31,465
Depreciation and amortization 2,150 8,730
Merger expense 314 1,442
------------ ------------
132,935 234,551
------------ ------------
Income (loss) from operations 3,622 (6,342)
------------ ------------
Other income (expense):
Interest income 205 729
Interest expense (789) (1,213)
Other (160) (2,021)
------------ ------------
(744) (2,505)
------------ ------------
Income (loss) before provision (benefit)
for income taxes 2,878 (8,847)
Provision (benefit) for income taxes 1,534 (1,295)
------------ ------------
Net income (loss) $ 1,344 $ (7,552)
------------ ------------
------------ ------------
Basic income (loss) per share $ 0.04 $ (0.14)
------------ ------------
------------ ------------
Diluted income (loss) per share $ 0.03 $ (0.14)
------------ ------------
------------ ------------
</TABLE>
See accompanying notes to the condensed consolidated financial statements.
4
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------------------------
1998 1999
------------------------------------
(Unaudited)
<S> <C> <C>
Cash Flows From Operating Activities:
Net income (loss) $ 1,344 $ (7,552)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation and amortization 2,150 8,730
Interest on note discount 30 -
Loss on investment - 46
Gain on disposal of equipment (27) -
Compensation expense relating to stock options 20 -
Provision for doubtful accounts 1,017 2,283
Deferred income taxes (1,411) (1,315)
Deferred compensation 50 -
Change in assets and liabilities net of effects from purchase of PT-1:
Accounts and notes receivable, net (3,789) (20,448)
Receivable from related parties (303) 104
Other assets 6,361 2,853
Accounts payable 1,826 10,685
Related party payable - (1,739)
Accrued network cost (736) 16,027
Other accrued expenses (1,133) 11,407
Deferred revenue - (2,160)
Other liabilities (535) (328)
--------------- ---------------
Net cash provided by operating activities 4,864 18,593
--------------- ---------------
Cash Flows From Investing Activities:
Capital expenditures (15,712) (32,021)
Short-term investments 15,653 920
Effect of purchase of PT-1, net of cash acquired - 13,898
Payment to former shareholder of PT-1 - (2,000)
Other long term assets 18 (3,475)
--------------- ---------------
Net cash used in investing activities (41) (22,678)
--------------- ---------------
</TABLE>
See accompanying notes to the condensed consolidated financial statements.
5
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
----------------------------------
1998 1999
----------------------------------
(Unaudited)
<S> <C> <C>
Cash Flows From Financing Activities:
Repayments under lines of credit - (15,230)
Repayments under lines of credit with stockholder (56) -
Borrowings under long-term debt and capital lease obligations - 271
Payments under long-term debt and capital lease obligations (1,561) (6,264)
Issuance of common stock 274 -
Other financing activities - (45)
Stock options exercised 970 145
--------------- ---------------
Net cash used in financing activities (373) (21,123)
--------------- ---------------
Effects Of Foreign Currency Translation - (724)
Increase (decrease) in cash and cash equivalents 4,450 (25,932)
Cash and cash equivalents, beginning of period 1,948 47,297
--------------- ---------------
Cash and cash equivalents, end of period $ 6,398 $ 21,365
--------------- ---------------
--------------- ---------------
</TABLE>
See accompanying notes to the condensed consolidated financial statements.
6
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) GENERAL
The financial statements included herein are unaudited and have been prepared
in accordance with generally accepted accounting principles for interim
financial reporting and Securities Exchange Commission ("SEC") regulations.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations. In management's opinion, the financial statements reflect all
adjustments (of a normal and recurring nature) which are necessary to present
fairly the financial position, results of operations, stockholders' equity
and cash flows for the interim periods. These financial statements should be
read in conjunction with the audited financial statements for the year ended
December 31, 1998, as set forth in the STAR Telecommunications, Inc. ("STAR"
or the "Company") Annual Report on Form 10-K. The results for the three
months ended March 31, 1999, are not necessarily indicative of the results
that may be expected for the year ending December 31, 1999.
(2) BUSINESS AND PURPOSE
STAR Telecommunications, Inc., a Delaware Corporation, and Subsidiaries (the
"Company" or "STAR"), is a multinational telecommunications services company
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 services 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.
The Company operates 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 uses
these switching facilities to decrease international traffic termination
costs and to initiate outbound calls from these local markets.
The Company provides domestic commercial long distance services throughout
the United States through its subsidiaries CEO Telecommunications, Inc.
("CEO"), and CEO California, Inc. ("CEO CA"). In March 1999, the Company
expanded its commercial operations through the acquisition of United Digital
Network, Inc. and its affiliated companies ("UDN" now known as "Allstar
Telecom"). 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 condensed consolidated
financial statements presented have been restated to include the results of
operations, financial position, and cash flows of UDN.
In February 1999, the Company completed its acquisition of PT-1
Communications, Inc. ("PT-1"). PT-1 is a provider of international and
domestic long distance and local telecommunications services primarily
through the marketing of prepaid phone cards. The transaction constituted a
tax-free reorganization and has been accounted for as a purchase under
Accounting Principles Board Opinion No. 16. Accordingly, the condensed
consolidated financial statements presented include the results of
operations, financial position and cash flows of PT-1 subsequent to the date
of acquisition.
7
<PAGE>
(3) NEW ACCOUNTING POLICIES
With the acquisition of PT-1, the Company entered the prepaid phone card
business. Sales of prepaid phone cards are initially recorded as deferred
revenue upon shipment. Revenue is recognized with the terms of the card as
the ultimate card users utilize calling time and service fees are assessed.
(4) NET INCOME (LOSS) PER COMMON SHARE
The following schedule summarizes the information used to compute basic and
diluted net income or loss per common share for the three month periods ended
March 31, 1998 and 1999. No common share equivalents will be considered in
the computation of diluted earnings per share for 1999 as the effect would be
anti-dilutive (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
MARCH 31,
----------------------
1998 1999
--------- ---------
<S> <C> <C>
Weighted number of common shares used to
compute basic income (loss) per share 36,633 52,628
Weighted average common share equivalents 2,192 -
--------- ---------
Weighted average number of common shares and
share equivalents used to compute diluted
income (loss) per share 38,825 52,628
--------- ---------
--------- ---------
</TABLE>
For the three month periods ended March 31, 1998 and 1999, stock options to
purchase 5,000 and 3,683,000 shares, respectively, were excluded from the
computation of diluted earnings per share as such options were anti-dilutive.
(5) COMPREHENSIVE INCOME (LOSS)
On January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income". For year end financial statements, SFAS 130 requires
that comprehensive income, which is the total of net income and all other
non-owner changes in equity, be displayed in a financial statement, with the
same prominence as other consolidated financial statements. For the year end
financial statements, the Company displays the components of other
comprehensive income (loss) in the consolidated statements of stockholders'
equity. During the three month period ended March 31, 1998, comprehensive
income equaled net income and during the three month period ended March 31,
1999, comprehensive loss consisting of foreign currency translation
adjustments equaled $2,122,000, resulting in total comprehensive loss of
$9,674,000.
(6) SIGNIFICANT EVENTS
On February 4, 1999, the Company acquired PT-1, a New York based provider of
international and domestic long distance and local prepaid phone cards. The
Company issued 15,050,000 shares of its common stock and $19.5 million in
short-term promissory notes for all outstanding shares, options, and warrants
of PT-1. The Company also will issue, for no consideration, an additional
250,000 shares of common stock to certain PT-1 distributors. The Company will
recognize the related compensation expense of approximately $2.8 million over
the four year vesting period.
The acquisition has been accounted for by the purchase method and,
accordingly, the results of operations of PT-1 have been included with those
of the Company since the date of acquisition. The purchase price has been
allocated to assets and liabilities based on preliminary estimates of fair
value as of the date of acquisition. The final allocation of the purchase
price will be determined when appraisals and other studies are completed.
Based on the preliminary allocation of the purchase price over the net assets
acquired, goodwill of approximately $209 million was recorded. Such goodwill
is being amortized on a straight-line basis over 20 years.
8
<PAGE>
Pro forma revenue, net income (loss) and income (loss) per share of the
combining companies for the three month periods ended March 31, 1998 and
1999, assuming the acquisition occurred at the beginning of each period
presented, are as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
MARCH 31,
-----------------------------
1998 1999
------------ -------------
<S> <C> <C>
Revenue $ 254,434 $ 249,058
Net income (loss) $ 163 $ (11,205)
Income (loss) per share:
Basic $ - $ (0.19)
Diluted $ - $ (0.19)
</TABLE>
The historical pro forma financial results of STAR for 1998 and 1999 have
been adjusted primarily for the historical results of PT-1, an increase in
interest expense due to the short-term debt incurred to purchase PT-1,
forgone interest on a $2 million payment made in connection with the
acquisition, amortization of shares to be issued to distributors and
amortization of goodwill. The pro forma information presented above does not
purport to be indicative of the results that actually would have been
obtained if the combined operations had been conducted during the periods
presented or of future operations of the combined companies.
In March 1999, the Company acquired UDN, a telephone service provider focused
on switched and dedicated local and long distance, toll free and calling
cards services to multinational corporations, in a transaction that was
accounted for as a pooling of interests. The Company issued approximately
1,005,000 shares of common stock in exchange for all outstanding shares of
UDN, plus 63,512 stock options in exchange for UDN options based on the
exchange ratio of 1 to 0.1464. The accompanying condensed consolidated
financials statements are restated to include the financial position and
results of operations of UDN for all periods presented.
Net sales and historical net income (loss) of the combining companies for the
three month periods ended March 31, 1998 and 1999, are as follows (in
thousands):
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
MARCH 31,
------------------------------
1998 1999
------------ -------------
<S> <C> <C>
Revenue:
STAR $ 129,269 $ 223,274
UDN 8,673 7,478
Elimination (1,385) (2,543)
------------ -------------
Total $ 136,557 $ 228,209
------------ -------------
------------ -------------
Net income (loss):
STAR $ 1,893 $ (4,086)
UDN (549) (3,466)
------------ -------------
Total $ 1,344 $ (7,552)
------------ -------------
------------ -------------
</TABLE>
9
<PAGE>
(7) STATEMENTS OF CASH FLOWS
During the three month periods ended March 31, 1998 and 1999, cash paid for
interest was approximately $762,000 and $1,381,000, respectively. For the
same periods, cash paid for income taxes amounted to approximately $1,575,000
and $1,684,000, respectively.
Non-cash investing and financing activities, which are excluded from the
consolidated statements of cash flows, are as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
MARCH 31,
--------------------------------
1998 1999
-------------- ----------------
<S> <C> <C>
Equipment purchased through capital leases $ 18,098 $ -
Tax benefits related to stock options 4,643 -
Detail of acquisition:
Fair value of assets acquired - 303,743
Liabilities assumed - (144,563)
Common stock issued - (153,578)
Notes payable issued - (19,500)
-------------- ----------------
$ 22,741 $ (13,898)
-------------- ----------------
-------------- ----------------
</TABLE>
(8) SEGMENT INFORMATION
At March 31, 1999, STAR has two separately managed business segments, North
American and European long distance telecommunications.
<TABLE>
<CAPTION>
NORTH
THREE MONTHS ENDED, MARCH 31, 1998 (in thousands) AMERICAN EUROPEAN TOTAL
<S> <C> <C> <C>
Revenues from external customers $ 136,557 $ - $136,557
Interest income 205 - 205
Interest expense 525 264 789
Depreciation and amortization 1,851 299 2,150
Segment net income (loss) before provision (benefit)
for income taxes 3,793 (915) 2,878
Segment assets 117,453 35,537 152,990
<CAPTION>
NORTH
THREE MONTHS ENDED, MARCH 31, 1999 (in thousands) AMERICAN EUROPEAN TOTAL
<S> <C> <C> <C>
Revenues from external customers $ 202,718 $ 25,491 $228,209
Interest income 718 11 729
Interest expense 897 316 1,213
Depreciation and amortization 6,598 2,132 8,730
Segment net loss before provision (benefit) for income taxes (5,762) (3,085) (8,847)
Segment assets 513,645 125,029 638,674
</TABLE>
(9) NEW PRONOUNCEMENTS
In June 1998, the AICPA issued SFAS No. 133 "Accounting for Derivative
Instruments and Hedging Activities." The Company has not yet analyzed the
impact of this new standard. The Company will adopt the standard in January
of 2000.
10
<PAGE>
(10) SUBSEQUENT EVENTS
In April 1999, the Company signed a commitment letter with Foothill Capital
Corporation ("Foothill") for a fully underwritten commitment for a revolving
line of credit with up to $100 million in potential borrowings, based on
eligibility. Borrowings on the facility are limited to 85 percent of eligible
accounts receivable and are secured by substantially all of the assets of the
Company. The credit facility provides for the borrowings at an interest rate
of libor plus 300 basis points. The Company intends to use the credit
facility to supplement working capital and to pay down the Company's existing
line of credit with Sanwa Bank, California ("Sanwa") and PT-1's existing line
of credit with Chase Manhattan Bank Corporation ("Chase"). The completion of
the Foothill financing is subject to the execution of definitive loan
documents and customary conditions for financing of this type.
On May 14, 1999, the Company received a waiver from Sanwa for failing to meet
a financial covenant that requires the Company to maintain profitability
every quarter. Additionally, on May 14, 1999 the Company received a waiver
from Chase for PT-1's failure to repay the Chase line of credit following the
Company's acquisition of PT-1. The Company intends to replace the $25 million
Sanwa facility with the Foothill facility in May of 1999.
11
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This Quarterly Report on Form 10-Q contains certain "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933,
as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended. Forward-looking statements are statements other than historical
information or statements of current condition. Some forward looking
statements may be identified by use of such terms as "believes",
"anticipates", "intends", or "expects". These forward-looking statements
relate to the plans, objectives and expectations of the Company for future
operations. In light of the risks and uncertainties inherent in all such
projected operation matters, the inclusion of forward-looking statements in
this report 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. The
Company's revenues and results of operations are difficult to forecast and
could differ materially from those projected in the forward-looking
statements contained in this report as a result of numerous factors including
among others, the following: (i) changes in customer rates per minute; (ii)
foreign currency fluctuations; (iii) termination of certain service
agreements or inability to enter into additional service agreements; (iv)
inaccuracies in the Company's forecast of traffic growth; (v) changes in or
developments under domestic or foreign laws, regulations, licensing
requirements or telecommunications standards; (vi) foreign political or
economic instability; (vii) changes in the availability of transmission
facilities; (viii) loss of the services of key officers; (ix) loss of a
customer which provides significant revenues to the Company; (x) highly
competitive market conditions in the industry; and (xi) concentration of
credit risk. The foregoing review of the important factors should not be
considered as exhaustive; the Company undertakes no obligation to release
publicly the results of any future revisions it may make to forward-looking
statements to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events.
The following table sets forth income statement data as a percentage of
revenues for the periods indicated.
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31,
-----------------------------
1998 1999
------------- ------------
<S> <C> <C>
Revenues 100% 100%
Operating expenses:
Cost of services 85.5 84.5
Selling, general and administrative 10.0 13.8
Depreciation and amortization 1.6 3.8
Merger expense 0.2 0.6
------------- ------------
97.3 102.8
------------- ------------
Income (loss) from operations 2.7 (2.8)
------------- ------------
Other income (expense):
Interest income 0.2 0.3
Interest expense (0.6) (0.5)
Other (0.1) (0.9)
------------- ------------
(0.5) (1.1)
Income before provision for income taxes 2.1 (3.9)
------------- ------------
Provision (benefit) for income taxes 1.1 (0.6)
------------- ------------
Net income (loss) 1.0% (3.3)%
------------- ------------
------------- ------------
</TABLE>
12
<PAGE>
THREE MONTHS ENDED MARCH 31, 1998 COMPARED TO THREE MONTHS ENDED MARCH, 31,
1999
Revenue: Total revenue increased 67.1% to $228.2 million in the first
quarter of 1999 from $136.6 million in the first quarter of 1998. The
increase is primarily a result of the continued growth in the European
operations and the acquisition of PT-1 which was consummated on February 4,
1999 and was accounted for as a purchase. Had the merger with PT-1 not
occurred during the first quarter of 1999, the Company's total revenues would
have increased 33.8% to $182.8 million in the first quarter of 1999 from the
first quarter of 1998.
Revenue from North American wholesale customers increased 6.6% to $127.7
million in the current quarter from $119.8 million in the prior year's first
quarter. Minutes of use generated by North American wholesale customers
increased 59.5% to 517.3 million minutes of use (including 45.1 million
minutes of use from PT-1) in the first quarter of 1999, as compared to 324.4
million minutes of use in the comparable quarter of the year prior. This
increase in revenue and minutes reflects the continued growth in the number
of North American wholesale customers to 179 at March 31, 1999, up from 131
customers at March 31, 1998, as well as an increase in usage by existing
customers. The increase in revenue for the first quarter of 1999 was
substantially offset by a decline in rates per minute, as the average North
American wholesale rate per minute of use declined to $0.25 for the current
quarter as compared to $0.37 for the quarter ended March 31, 1998, reflecting
continued lower prices on competitive routes. This decline is also
attributable to a change in country mix that includes a larger proportion of
lower rate per minute countries such as Mexico, Germany and the United
Kingdom. The period to period decline in rate per minute was not a
significant factor in the relative increase in minutes of use.
North American commercial revenue increased 346.4% to $75.0 million
(including $61.0 million of revenue from PT-1 and $7.5 million of revenue
from UDN) in the first quarter of 1999 from $16.8 million (including $8.7
million of revenue from UDN) in the first quarter of 1998. The increase is
due primarily to the consummation of the PT-1 acquisition in the first
quarter of 1999 which diversifies the Company's revenue base with the
addition of prepaid phone-cards and dial around programs. Minutes of use
generated by North American commercial customers increased 343.8% to 425.2
million minutes (including 354.7 million minutes of use from PT-1) in the
first quarter of 1999, as compared to 95.8 million minutes of use in the
comparable quarter of the prior year. The average North American commercial
rate per minute increased to $0.18 cents per minute in 1999 from $0.16 cents
per minute in 1998 primarily due to higher rates per minute of use realized
from the PT-1 commercial programs.
The first quarter of 1999 also includes revenue of $25.5 million dollars
generated from the European operations. Management believes that the
prospects for growth in Germany remain strong as STAR Telecommunications
Deutschland GmbH is fully utilizing its interconnect with Deutsche Telekom,
AG as well as other European PTTs.
Cost of Services (Exclusive of Depreciation and Amortization): Total cost of
services (exclusive of depreciation and amortization) increased 65.2% to
$192.9 million in the first quarter of 1999 from $116.8 million in the first
quarter of 1998 and decreased as a percentage of revenue for the same
periods to 84.5% from 85.5%. Had the merger with PT-1 not occurred, the
Company's total cost of services (exclusive of depreciation and amortization)
would have increased 29.4% to $151.1 million in the first quarter of 1999,
and would have decreased as a percentage of revenue to 82.7%.
Cost of services (exclusive of depreciation and amortization) from North
American vendors increased 49.5% to $174.6 million in 1999 from $116.8
million in 1998 and increased as a percentage of North American revenue to
86.1% from 85.5%, respectively. The first quarter 1999 also includes cost of
services (exclusive of depreciation and amortization) of $18.3 million
generated from the European operations. The growth in cost of services
reflects the increase in minutes of use from the wholesale sector, as well as
commercial usage generated from the PT-1 customer base offset by an overall
declining average cost per minute. The average cost per minute declined as a
result of changes in country mix that include a larger proportion of lower
cost per minute countries, competitive pricing pressures as well as an
increasing proportion of traffic routed over the Company's proprietary
network. The Company currently routes to over 55 countries on its global
network. Management believes that countries will continue to be added to
STAR's global network thereby contributing to an overall decline in cost per
minute.
13
<PAGE>
Selling, General and Administrative: For the first quarter of 1999, total
selling, general and administrative expenses, exclusive of merger expenses,
increased 130.3% to $31.5 million from $13.7 million in the first quarter of
1998 and increased as a percentage of revenues to 13.8% from 10.0% over the
comparable 1998 period. The increase is primarily a result of continued
growth in the Company's North American commercial and European operations, as
well as the inclusion of selling, general, and administrative costs of PT-1.
Excluding PT-1 operations, the Company's total selling, general, and
administrative expenses increased 69.3% to $23.2 million in the first quarter
of 1999 and as a percentage of revenues would have been 12.7%.
North American selling, general and administrative expenses increased 100.8%
to $25.5 million in the first quarter of 1999 from $12.7 million in the
comparable period of 1998. North American selling, general and administrative
expenses increased as a percentage of North American revenue to 12.6% from
9.3%, respectively, primarily as a result of the development of new
commercial programs. During the quarter, the Company established ten new
sales offices to support a commercial sales force for Allstar Telecom and
added 105 new sales representatives. In addition, the Company incurred
substantial advertising, promotional, and other related expenses as it
launched new phone-card and dial around programs.
Selling, general and administrative expenses related to the European
operations amounted to $6.0 million in the first quarter of 1999, an increase
from approximately $986,000 in the first quarter of 1998 reflecting continued
expansion efforts in Europe. The Company expects overall selling, general and
administrative expenses to continue to grow as a percentage of revenues as
the Company adds personnel to become a carrier in additional European
countries and continues to hire a sales force to expand its commercial
customer base.
Depreciation and Amortization: Depreciation and amortization expense
increased to $8.7 million for the first quarter of 1999 from $2.2 million for
the first quarter of 1998, and increased as a percentage of revenues to 3.8%
from 1.6% over the comparable period in the prior year. The increase is due
in part to $1.7 million of goodwill amortization expense resulting from the
acquisition of PT-1. In addition, depreciation expense increased with the
operation of new switch sites, the purchase of additional fiber capacity to
connect the Company's expanding network and leasehold improvements.
Depreciation and amortization attributable to North American assets amounted
to $6.6 million. European operations realized total depreciation and
amortization of $2.1 million. STAR expects depreciation and amortization
expense to continue to increase as a percentage of revenues as the Company
continues to expand its global telecommunications network.
Income (Loss) from Operations: In the first quarter of 1999, loss from
operations was $6.3 million compared to income from operations of $3.6
million in the first quarter of 1998. Operating margin in the first quarter
1999 was (2.8)% as compared to 2.7% in 1998. Operating margin decreased in
the first quarter 1999 due to the losses following the Company's completion
of two significant acquisitions and $1.4 million in merger expense. In
addition, operating margin decreased due to the expansion of the North
American commercial sales programs.
Other Income (Expense): The Company reported other expense, net, of $2.5
million in the first quarter of 1999 as compared to other expense, net, of
approximately $744,000 for the first quarter of 1998. This increase is
primarily due to the recognition of $3.2 million foreign currency translation
loss related to the intercompany note between STAR and its German
subsidiaries. Interest income earned on short-term investments increased to
approximately $729,000 in the first quarter of 1999 from $205,000 in the
first quarter of 1998. Interest expense increased to $1.2 million during the
quarter 1999 from $789,000 in the first quarter of 1998 due to additional
capital lease obligations for switches and interest incurred on borrowings
from STAR's lines of credit.
Provision (benefit) for Income Taxes: The Company recorded a tax benefit of
$1.3 million in the first quarter of 1999 due to operating losses. The
provision for income taxes for the first quarter of 1998 was $1.5 million.
LIQUIDITY AND CAPITAL RESOURCES.
As of March 31, 1999, STAR had cash and cash equivalents of approximately
$21.4 million, short-term investments of $1.1 million, and a working capital
deficit of $85.8 million.
14
<PAGE>
As of March 31, 1999, STAR had $4.1 million outstanding on its $25 million
revolving line of credit, which bears interest at the bank's cost of funds
plus 175.0 basis points and expires on July 1, 1999. Available borrowing
under the line of credit is further reduced by outstanding letters of credit
in the amount of $6.5 million.
At March 31, 1999, STAR had capital lease obligations of $37.2 million and
$13.8 million in term loans, relating to its switching facilities and
operating equipment.
STAR provided net cash from operating activities of $18.6 million for the
three months ended March 31, 1999, primarily from increases in accounts
payable, accrued expenses and accrued network costs offset by increases in
accounts and notes receivables. The increase in accounts and notes
receivables were due to general increases in volume and an increase in
European days sales outstanding. The Company's investing activities used cash
of $22.7 million during the three months ended March 31, 1999, primarily for
capital expenditures, offset by the effect of the PT-1 acquisition. The
Company's financing activities used cash of approximately $21.1 million.
In April 1999, the Company signed a commitment letter with Foothill Capital
Corporation ("Foothill") for a fully underwritten commitment for a revolving
line of credit with up to $100 million in potential borrowings, based on
eligibility. Borrowings on the facility are limited to 85 percent of eligible
accounts receivable and are secured by substantially all of the assets of the
Company. The credit facility provides for the borrowings at an interest rate
of libor plus 300 basis points. The Company intends to use the credit
facility to supplement working capital and to pay down the Company's existing
line of credit with Sanwa Bank, California and PT-1's existing line of credit
with Chase Manhattan Bank Corporation. The completion of the Foothill
financing is subject to the execution of definitive loan documents and
customary conditions for financing of this type.
STAR believes that the cash generated from operations, as well as funding
under the Foothill revolving line of credit and available debt in the private
or public market, will satisfy STAR's current liquidity needs. Nevertheless,
as STAR continues to expand its network facilities, STAR's liquidity needs
may increase, perhaps significantly, which could require STAR to seek such
additional financing or the expansion of its borrowing capacity under current
or new lines of credit.
YEAR 2000 COMPLIANCE.
A significant percentage of the software that runs most of the computers in
the United States relies on two-digit date codes to perform a number of
computation and decision making functions. Commencing on January 1, 2000,
these computer programs may fail from an inability to interpret date codes
properly, misreading "00" for the year 1900 instead of the year 2000.
STAR has initiated a comprehensive program to identify, evaluate and address
issues associated with the ability of its information technology and
non-information technology systems to properly recognize the Year 2000 in
order to avoid interruption of the operation of these systems and a material
adverse effect on STAR's operations as a result of the century change. Each
of the information technology software programs that STAR currently uses has
either been certified by its respective vendor as Year 2000 compliant or will
be replaced with software that is so certified prior to July 1999.
STAR intends to conduct comprehensive tests of all of its software programs
for Year 2000 compliance as part of its Year 2000 readiness program. An
integral part of STAR's non-information technology systems, its
telecommunications switches, is not currently Year 2000 compliant. The
respective vendors of STAR's twelve switches are in the process of upgrading
the switches and have informed STAR that the switches will be compliant on or
before July 1999. STAR does not believe that its other non-information
technology systems will be affected by the Year 2000, but will not know
definitively until STAR tests and evaluates such equipment during 1999. With
respect to operations at PT-1, STAR is in the process of reviewing PT-1's
Year 2000 critical matters to assess compliance issues. At this time, STAR
has not completed its assessment of the nature of PT-1's Year 2000 compliance
issues or the cost of redemption, if any.
15
<PAGE>
STAR's computer systems interface with the computers and technology of many
different telecommunications companies, including those of foreign companies,
on a daily basis. STAR considers the Year 2000 readiness of its foreign
customers and vendors of particular importance given the general concern that
the computer systems abroad may not be as prepared as those in domestic
operations to handle the century change. As part of its Year 2000 compliance
program, STAR intends to contact its significant vendors and customers to
ascertain whether the systems used by such third parties are Year 2000
compliant. STAR plans to have all Year 2000 compliance initial testing and
any necessary conversions completed by July 1999.
The costs associated with STAR's Year 2000 compliance efforts will be
incurred throughout 1999. STAR estimates the costs of such efforts will be
between $70,000 and $150,000 over the life of the project; though such
expenditures may increase materially following testing of non-information
technology systems and the evaluation of the Year 2000 compliance status of
integral third party vendors and customers. Costs incurred to date in
connection with STAR's Year 2000 compliance efforts have been immaterial and
will be expensed as incurred.
16
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
FOREIGN CURRENCY RISK. As a global enterprise, the Company faces exposure to
adverse movements in foreign currency exchange rates. The Company's foreign
currency exposures may change over time as the level of activity in foreign
markets grows and could have a material adverse impact upon the Company's
financial results. No material changes have occurred in the quarter that
would impact the Company's exposure to foreign currency risk.
INTEREST RATE RISK. The Company has borrowings under various line of credit
agreements and long-term debt for capital equipment. Some of these agreements
are based on variable interest rates. At any time, a sharp rise in interest
rates could have a material adverse impact upon the Company's cost of working
capital and interest expense. No material changes have occurred in the
quarter that would impact the Company's exposure to interest rate risk.
17
<PAGE>
PART II. OTHER INFORMATION
ITEM 2. CHANGE IN SECURITIES.
On February 4, 1999, the Company issued approximately 15.05 million shares of
common stock, $0.001 par value per share, of the Company ("STAR Common
Stock") to the stockholders of PT-1 Communications, Inc. ("PT-1") as partial
consideration for all of the outstanding capital stock of PT-1. In connection
with the acquisition of PT-1, the Company will issue for no consideration
250,000 shares of STAR Common Stock to selected independent distributors of
PT-1. The issuance of the 15.3 million shares of STAR Common Stock was exempt
from registration under the Securities Act of 1933 (the "Act") pursuant to
Section 4(2) of the Act.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Pursuant to the terms of the Company's revolving line of credit with Sanwa
Bank, California ("Sanwa") the Company was required, among other things, to
maintain profitability on a quarterly basis. The Company's net loss for the
quarter ended March 31, 1999 resulted in a breach of such convenant. On May
14, 1999 the Company received a written waiver of such breach from Sanwa.
Pursuant to the terms of PT-1's revolving line of credit with Chase Manhattan
Bank Corporation ("Chase"), PT-1 was to repay the balance due thereunder on a
change of control. To date, the Chase line of credit has not been repaid. On
May 14, 1999 the Company received a waiver from Chase of this breach.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(b) The Company filed a Current Report on Form 8-K on April 6, 1999
pursuant to Item 2 "Acquisition or Disposition of Assets", disclosing
the Company's acquisition of all of the outstanding capital stock of
United Digital Network, Inc.
The Company filed a Current Report on Form 8-K on February 19, 1999
pursuant to Item 2 "Acquisition or Disposition of Assets", disclosing
the Company's acquisition of all of the outstanding capital stock of
PT-1.
18
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
STAR TELECOMMUNICATIONS, INC.
Dated: May 14, 1999 By: /s/ Christopher E. Edgecomb
-------------------------------------
Christopher E. Edgecomb
Chief Executive Officer and Director
(Principal Executive Officer)
By: /s/ John J. Pasini
-------------------------------------
John J. Pasini
Vice President of Finance
(Principal Accounting Officer)
19
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THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S CONDENSED CONSOLIDATED BALANCE SHEETS, CONDENSED CONSOLIDATED
STATEMENTS OF OPERATIONS AND CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH SCHEDULES.
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