<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 SEPTEMBER 30, 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 November 8, 1999, the number of the registrant's Common Shares of
$.001 par value outstanding was 58,616,500.
<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 September 30, 1999 (unaudited) 3
Condensed Consolidated Statements Of Operations For The
Three And Nine Month Periods Ended September 30, 1998
And 1999 (unaudited) 4
Condensed Consolidated Statements Of Cash Flows For The
Nine Month Periods Ended September 30, 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 20
PART II - OTHER INFORMATION None
</TABLE>
2
<PAGE>
ITEM 1: FINANCIAL STATEMENTS
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except for share data)
<TABLE>
<CAPTION>
December 31, September 30,
1998 1999
------------------ ------------------
(Unaudited)
<S> <C> <C>
Current Assets:
Cash and cash equivalents $ 47,297 $ 14,582
Short-term investments 835 2,426
Accounts and notes receivable, net 100,235 162,909
Receivable from related parties 762 1,920
Other current assets 43,581 45,585
------------------ ------------------
Total current assets 192,710 227,422
------------------ ------------------
Long-Term Assets:
Property and equipment, net 170,952 339,907
Goodwill, net - 203,329
Other 10,989 27,551
------------------ ------------------
Total assets $ 374,651 $ 798,209
================== ==================
Current Liabilities:
Revolving lines of credit $ 19,330 $ 42,501
Revolving line with stockholder - 2,500
Current portion of long-term obligations 10,652 15,905
Accounts payable 43,989 153,530
Taxes payable 1,640 -
Related party payable 2,267 1,253
Accrued network cost 51,262 119,366
Other accrued expenses 15,772 27,784
Deferred revenue 1,100 41,784
------------------ ------------------
Total current liabilities 146,012 404,623
------------------ ------------------
Long-Term Liabilities:
Long-term obligations, net of current portion 29,407 42,695
Other long-term liabilities 3,641 51,725
------------------ ------------------
Total long-term liabilities 33,048 94,420
------------------ ------------------
Stockholders' Equity:
Common stock $.001 par value:
Authorized - 100,000,000 shares 43 58
Additional paid-in capital 207,466 364,468
Deferred compensation - (2,335)
Accumulated other comprehensive income (loss) 188 (3,101)
Note receivable from stockholder - (3,570)
Accumulated deficit (12,106) (56,354)
------------------ ------------------
Total stockholders' equity 195,591 299,166
------------------ ------------------
Total liabilities and stockholders' equity $ 374,651 $ 798,209
================== ==================
</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 Nine Months Ended
September 30, September 30,
---------------------------------- ---------------------------------
1998 1999 1998 1999
---------------------------------- ---------------------------------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Revenue $ 169,676 $ 279,216 $ 445,134 $ 779,694
Operating expenses:
Cost of services 143,461 234,711 378,212 676,213
Selling, general and
administrative expenses 18,287 41,353 45,554 118,406
Depreciation and amortization 3,724 11,711 8,892 31,352
Merger expense - - 314 1,872
---------------- -------------- ---------------- -------------
165,472 287,775 432,972 827,843
---------------- -------------- ---------------- -------------
Income (loss) from operations 4,204 (8,559) 12,162 (48,149)
---------------- -------------- ---------------- -------------
Other income (expense):
Interest income 1,737 176 3,236 1,851
Interest expense (860) (2,462) (2,522) (5,993)
Other 87 1,271 (170) (653)
---------------- -------------- ---------------- -------------
964 (1,015) 544 (4,795)
---------------- -------------- ---------------- -------------
Income (loss) before provision (benefit)
for income taxes 5,168 (9,574) 12,706 (52,944)
Provision (benefit) for income taxes 2,812 (811) 6,642 (8,696)
---------------- -------------- ---------------- -------------
Net income (loss) $ 2,356 $ (8,763) $ 6,064 $ (44,248)
================ ============== ================ =============
Basic income (loss) per share $ 0.05 $ (0.15) $ 0.15 $ (0.78)
================ ============== ================ =============
Diluted income (loss) per share $ 0.05 $ (0.15) $ 0.14 $ (0.78)
================ ============== ================ =============
</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>
Nine Months Ended
September 30,
------------------------------------------
1998 1999
------------------------------------------
(Unaudited)
<S> <C> <C>
Cash Flows From Operating Activities:
Net income (loss) $ 6,064 $(44,248)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization 8,892 31,352
Gain on sale of investment (1,292)
Interest on note discount 55 -
Compensation expense relating to stock options 30 -
Provision for doubtful accounts 3,952 16,377
Deferred income taxes (511) 4,057
Deferred compensation 62 -
Other (5) -
Change in assets and liabilities net of effects from purchase of PT-1:
Accounts and notes receivable (37,358) (90,755)
Receivable from related parties - (465)
Other assets (10,201) (10,681)
Accounts payable 15,196 50,265
Related party payable - (2,181)
Accrued network cost 14,061 57,138
Other accrued expenses - 3,999
Deferred revenue - 2,283
Other liabilities 48 (8,714)
--------- --------
Net cash provided by operating activities 285 7,135
--------- --------
Cash Flows From Investing Activities:
Capital expenditures (57,982) (39,648)
Short-term investments (73,700) (391)
Purchase of PT-1, net of cash acquired - (4,435)
Payment to former shareholder of PT-1 - (2,000)
Proceeds from sale of investment - 1,500
Other long-term assets (5,084) (4,523)
--------- --------
Net cash used in investing activities (136,766) (49,497)
--------- --------
</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>
Nine Months Ended
September 30,
------------------------------
1998 1999
------------------------------
(Unaudited)
<S> <C> <C>
Cash Flows From Financing Activities:
Borrowings under lines of credit 1,000 280,989
Repayments under lines of credit - (262,818)
Borrowings under revolving line of credit with stockholder 2,500
Repayments under revolving line of credit with stockholder (133) -
Borrowings under long-term debt - 700
Payments under long-term debt and capital lease obligations (1,084) (11,193)
Issuance of common stock 144,711 -
Stock options exercised 2,429 630
Warrants exercised 274 -
Other financing activities (12) 6
--------- ---------
Net cash provided by financing activities 147,185 10,814
--------- ---------
Effects Of Foreign Currency Translation 216 (1,167)
Increase (decrease) in cash and cash equivalents 10,920 (32,715)
Cash and cash equivalents, beginning of period 1,948 47,297
--------- ---------
Cash and cash equivalents, end of period $ 12,868 $ 14,582
========= =========
</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 and 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. Certain prior year
balances have been reclassified to conform to the current year presentation.
The results for the three and nine months ended September 30, 1999 are not
necessarily indicative of the results that may be expected for the year
ending December 31, 1999.
(2) BUSINESS AND PURPOSE
STAR is a multinational telecommunications services company focused on the
wholesale and commercial international and domestic long distance markets.
The Company offers highly reliable low-cost switched voice and data 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 Holding, GmbH and affiliates ("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 Telecommunications, 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 consolidated financial
statements 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 and dial around service. 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 and nine month
periods ended September 30, 1998 and 1999. No common share equivalents were
considered in the computation of diluted earnings per share for 1999 as the
effect would be anti-dilutive (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- -------------------
1998 1999 1998 1999
------ ------ ------ ------
<S> <C> <C> <C> <C>
Weighted number of common shares used to
compute basic income (loss) per share 43,093 58,476 40,143 56,528
Weighted average common share equivalents 1,267 - 1,816 -
------ ------ ------ ------
Weighted average number of common shares and
share equivalents used to compute diluted
income (loss) per share 44,360 58,476 41,959 56,528
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
For the three and nine month periods ending September 30, 1998, options to
purchase 73,000 shares of common stock were outstanding, but were not included
in the computation of diluted earnings per share, as the exercise prices of
these options were greater than the average market price of the Company's common
stock. For the three and nine month periods ended September 30, 1999, stock
options for 3,497,000 shares 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 (loss) 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 and nine month periods ended September 30, 1998,
comprehensive income equaled net income. During the three and nine month
periods ended September 30, 1999, comprehensive income (loss) consisting of
foreign currency translation adjustments of $1,084,000 and ($3,289,000),
respectively, resulted in total comprehensive loss of $7,679,000 and
$47,537,000, respectively.
(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 is recognizing
the related compensation expense of approximately $2.8 million over the four
year vesting period.
8
<PAGE>
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.
Pro forma revenue, net loss and loss per common share of the combining companies
for the nine month period ended September 30, 1998 and 1999, assuming the
acquisition occurred at the beginning of each period presented, are as follows
(in thousands):
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30,
---------------------------
1998 1999
--------- ---------
<S> <C> <C>
Revenue: $ 775,237 $ 800,543
--------- ---------
--------- ---------
Net loss: $ (6,553) $ (52,103)
--------- ---------
--------- ---------
Loss per share:
Basic $ (0.16) $ (0.92)
--------- ---------
--------- ---------
Diluted $ (0.16) $ (0.92)
--------- ---------
--------- ---------
</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 36,142 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.
On June 9, 1999, the Company entered into a two-year credit facility
agreement with Foothill Capital Corporation ("Foothill"). The Company failed
to meet the EBITDA and tangible net worth covenants in accordance with the
agreement for the period ended June 30, 1999. On October 15th, the Company
received an amendment from the lender group which included resetting the
financial covenants in accordance with the Company's updated financial
forecast. In exchange for the amendment, the Company agreed to pay to
Foothill a supplemental agency fee of $500,000, and a term loan supplemental
fee of $2,000,000 due January 31, 2000. If the term loan is retired on or
before November 30, 1999, the term loan supplemental fee is reduced to
$600,000; if the term loan is retired before December 31, 1999, the term loan
supplemental fee is reduced to $1,000,000. Additionally, the prepayment
premium for early retirement of the facility was reduced to $1,000,000.
Interest rates were adjusted to 2.75 percent over the prime rate of interest
for the revolving line of credit and 8.0 percent over the prime rate for the
term note. The interest rate on the term note increases 1.0 percent per month
for the remainder of the term. The Company also agreed to the reduction of
eligible borrowings on the revolving portion of the line of credit to $30
million from $75 million. The expiration date of the $25 million term loan
was also modified to January 31, 2000
9
<PAGE>
from June 9, 2000. As of September 30, 1999, the Company had $17.5 million
outstanding on its revolving line of credit, and $25.0 million outstanding on
the term portion of the facility.
Effective April 1, 1999, management recharacterized the balance of the
intercompany loan from STAR to GmbH from a note payable to equity. As a
result, the translation effect on the note balance after April 1, 1999 is
reflected as other comprehensive loss in the accompanying financial
statements.
During the second quarter of 1999, GmbH recorded a cost of services accrual
of approximately $6.7 million for a retroactive rate increase imposed by a
European telecom carrier that is currently being disputed. The outcome of
this dispute is not determinable as of September 30, 1999.
On September 29, 1999 Star Telecommunications Deutschland GmbH entered into
an agreement with Deutsche Leasing AG to finance new and pre-existing
equipment through a capital lease-financing arrangement. Under the terms of
the agreement the Company has the option to finance equipment up to 80DM
million or roughly $45 million. The contract includes provisions to increase
that amount as STAR Telecom Deutschland's equipment needs expand. The
financing terms of the agreement are a minimum lease commitment of four years
with an interest rate of approximately 6%. Cash generated from these
arrangements will be used to help fund the growth and operations of the
German business.
(7) STATEMENTS OF CASH FLOWS
During the nine month periods ended September 30, 1998 and 1999, cash paid
for interest was approximately $2,766,000 and $5,043,000, respectively. For
the same periods, cash paid for income taxes amounted to approximately
$2,545,000 and $1,802,000, respectively.
Non-cash investing and financing activities, which are excluded from the
consolidated statements of cash flows, are as follows (in thousands):
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30,
---------------------------
1998 1999
--------- ---------
<S> <C> <C>
Equipment purchased through capital leases $ 28,100 $ 3,957
Assets acquired through vendor financing - 52,990
Assets acquired through other non-cash
transactions 44,322
Other non-cash transactions 4,905 9,220
Tax benefits related to stock options 5,474 -
Detail of acquisition:
Fair value of assets acquired - 303,743
Liabilities assumed - (144,563)
Common stock issued - (153,578)
Notes payable issued - (1,167)
-------- ---------
$ 38,479 $ 114,924
-------- ---------
-------- ---------
</TABLE>
(8) SEGMENT INFORMATION
At September 30, 1999, STAR has two separately managed business segments, North
American and European long distance telecommunications. During the first quarter
of 1999, the Company began operating in the Pacific Rim through two joint
ventures. Earnings from operations in the Pacific Rim are included with the
North American segment. Total earnings and assets from the Pacific Rim represent
less than five percent of the total for the North American segment.
10
<PAGE>
<TABLE>
<CAPTION>
NORTH
THREE MONTHS ENDED, SEPTEMBER 30, 1998 (in thousands) AMERICAN EUROPEAN TOTAL
<S> <C> <C> <C>
Revenue from external customers $ 162,927 $ 6,749 $169,676
Revenue from other segments 8,129 14,774 22,903
Interest income 1,713 24 1,737
Interest expense 476 384 860
Depreciation and amortization 2,669 1,055 3,724
Segment net income before provision for income taxes 4,234 934 5,168
Segment assets 293,287 48,639 341,926
<CAPTION>
NORTH
THREE MONTHS ENDED, SEPTEMBER 30, 1999 (in thousands) AMERICAN EUROPEAN TOTAL
<S> <C> <C> <C>
Revenue from external customers $ 248,637 $ 30,579 $279,216
Revenue from other segments 9,076 5,397 14,473
Interest income 60 116 176
Interest expense 2,536 (74) 2,462
Depreciation and amortization 8,657 3,054 11,711
Segment net loss before benefit for income taxes (4,096) (5,478) (9,574)
Segment assets 633,904 164,305 798,209
<CAPTION>
NORTH
NINE MONTHS ENDED, SEPTEMBER 30, 1998 (in thousands) AMERICAN EUROPEAN TOTAL
<S> <C> <C> <C>
Revenue from external customers $ 438,191 $ 6,943 $445,134
Revenue from other segments 8,129 16,742 24,871
Interest income 3,211 25 3,236
Interest expense 1,559 963 2,522
Depreciation and amortization 6,870 2,022 8,892
Segment net income (loss) before provision for income taxes 14,906 (2,200) 12,706
Segment assets 293,287 48,639 341,926
<CAPTION>
NORTH
NINE MONTHS ENDED, SEPTEMBER 30, 1999 (in thousands) AMERICAN EUROPEAN TOTAL
<S> <C> <C> <C>
Revenue from external customers $ 697,170 $ 82,524 $779,694
Revenue from other segments 24,871 24,831 49,702
Interest income 1,706 145 1,851
Interest expense 3,943 2,050 5,993
Depreciation and amortization 23,696 7,656 31,352
Segment net loss before benefit for income taxes (32,544) (20,400) (52,944)
Segment assets 633,904 164,305 798,209
</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) SUBSEQUENT EVENTS
In October 1999, the Company sold 1,750,000 shares of its investment in Paetec
for approximately $8.5 million.
In October 1999, the Company began initiating traffic over its recently
completed switch in Geneva, Switzerland. The switch site is expected to
decrease international termination costs and initiate outbound calls from the
local market.
11
<PAGE>
1) 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; (xi) concentration of credit
risk; and (xii) availability of long term financing. 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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------- ------------------------
1998 1999 1998 1999
----------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Revenues 100.0% 100.0% 100.0% 100.0%
Operating expenses:
Cost of services 84.5 84.1 85.0 86.7
Selling, general and administrative 10.8 14.8 10.2 15.2
Depreciation and amortization 2.2 4.2 2.0 4.0
Merger expense - - 0.1 0.2
----------- --------- ---------- ---------
97.5 103.1 97.3 106.2
----------- --------- ---------- ---------
Income (loss) from operations 2.5 (3.1) 2.7 (6.2)
----------- --------- ---------- ---------
Other income (expense):
Interest income 1.0 0.1 0.7 0.2
Interest expense (0.5) (0.9) (0.6) (0.8)
Other 0.1 0.5 - (0.1)
----------- --------- ---------- ---------
0.6 (0.4) 0.1 (0.6)
----------- --------- ---------- ---------
Income (loss) before provision for income
taxes 3.0 (3.4) 2.9 (6.8)
----------- --------- ---------- ---------
Provision (benefit) for income taxes 1.7 (0.3) 1.5 (1.1)
----------- --------- ---------- ---------
Net income (loss) 1.4% (3.1)% 1.4% (5.7)%
=========== ========= ========== =========
</TABLE>
12
<PAGE>
THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 1998
Revenues: Total revenues increased 64.6% to $279.2 million in the third
quarter of 1999 from $169.7 million in the third quarter of 1998. The
increase is primarily a result of the continued growth in the North American
commercial operations, which contributed revenues from prepaid phone-card and
dial around programs, and the European operations.
Revenues from North American wholesale customers decreased 18.9% to $120.2
million in the current quarter from $148.2 million in the prior year's third
quarter. North American wholesale revenues for the three months ended
September 30, 1999, include broadband sales activity. Minutes of use generated
by North American wholesale customers increased 19.6% to 568.1 million
minutes of use in the third quarter of 1999, as compared to 475.1 million
minutes of use in the comparable quarter of the prior year. The increase in
minutes of use reflects the continued growth in the number of North American
wholesale customers to 225 at September 30, 1999, up from 175 customers at
September 30, 1998, as well as an increase in usage by existing customers.
The decrease in revenues for the third quarter of 1999 resulted from a
significant decline in rates per minute, as the average North American
wholesale rate per minute of use declined to $0.18 for the current quarter as
compared to $0.30 for the quarter ended September 30, 1998, reflecting
continued lower prices on competitive routes. This decline is also
attributable to a change in country mix that included a larger proportion of
lower rate per minute countries such as Mexico, Germany, the United Kingdom,
Canada and Japan. 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 revenues increased over 750.0% to $128.4 million in
the third quarter of 1999 from $14.7 million in the third quarter of 1998.
The increase is due primarily to the consummation of the PT-1 acquisition in
the first quarter of 1999 which diversified the Company's revenue base with
both prepaid phone-card and dial around programs. Minutes of use generated by
North American commercial customers increased over 950% to 831.8 million
minutes in the third quarter of 1999, as compared to 78.0 million minutes of
use in the comparable quarter of the prior year. The average North American
commercial rate per minute increased to $0.15 per minute in the third quarter
of 1999 from $0.14 per minute in the third quarter of 1998 primarily due to
the increase in commercial usage from the prepaid phone-card and dial around
programs.
The third quarter of 1999 also includes revenues from the European operations
which increased over 350% to $30.6 million, as compared to approximately $6.7
million in the third quarter of 1998. The increase is attributable to
increased usage over ten switches in the third quarter of 1999 as compared to
four switches in the third quarter of 1998 in both the German operations and
the operations in the United Kingdom. Management believes that the prospects
for growth in Europe remain strong as STAR Telecommunications Deutschland
GmbH is fully utilizing its interconnect with Deutsche Telekom AG, as well as
with other European PTTs. In addition, management expects continued growth in
European revenues as the Company expands into Austria and Switzerland. The
Company completed the build out of its Austrian and Swiss switch sites in the
third quarter of 1999.
Cost of Services (Exclusive of Depreciation and Amortization): Total cost of
services (exclusive of depreciation and amortization) increased 63.6% to
$234.7 million in the third quarter of 1999 from $143.5 million in the third
quarter of 1998 and decreased as a percentage of revenues for the same
periods to 84.1% from 84.6%.
Cost of services (exclusive of depreciation and amortization) from North
American vendors increased 54.8% to $209.4 million in the third quarter of
1999 from $135.3 million in the third quarter of 1998 and increased as a
percentage of North American revenues to 84.2% from 83.1%, respectively. Cost
of services includes costs relating to broadband sales during the three
months ended September 30, 1999. The growth in cost of services reflects the
increase in minutes of use from the commercial usage generated from prepaid
phone-card and dial around programs offset by an overall declining average
cost per minute. The average cost per minute declined as a result of
competitive pricing pressures, a larger proportion of lower cost per minute
countries, as well as an increasing proportion of traffic routed over the
Company's proprietary network. Management believes that the average cost per
minute will continue to decline as STAR further
13
<PAGE>
expands its domestic and international network. Cost of services (exclusive
of depreciation and amortization) for the quarter ended September 30, 1999,
were negatively impacted as a result of delays in delivery for domestic
network capacity which resulted in redundant leased line costs. Management
anticipates reduced line costs in the fourth quarter 1999 as the capacity is
delivered and the redundant costs are eliminated, although there can be no
assurances in that regard.
The third quarter of 1999 also includes cost of services from the European
operations (exclusive of depreciation and amortization) which increased over
200% to $25.3 million, compared to $8.2 million in the third quarter of 1998.
The increase in cost of services (exclusive of depreciation and amortization)
from the European operations was attributable to increased usage.
Selling, General and Administrative Expenses: For the third quarter of 1999,
total selling, general and administrative expenses increased over 125% to
$41.4 million from $18.3 million in the third quarter of 1998 and increased
as a percentage of revenues to 14.8% from 10.8% over the comparable 1998
period. The increase is primarily a result of continued growth in the
Company's North American commercial and European operations.
North American selling, general and administrative expenses increased over
100% to $33.0 million in the third quarter of 1999 from $15.5 million in the
third quarter of 1998. For the third quarter of 1999, North American selling,
general and administrative expenses increased as a percentage of North
American revenues to 13.3% from 9.5% in the third quarter of 1998. The
increase is primarily a result of the inclusion of PT-1 operating expenses
subsequent to the acquisition, which includes payroll, advertising, bad debt,
and other related expenses in connection with the expansion of the prepaid
phone-card and the dial around programs. The increase is also attributable to
increased payroll and commission expense due to the sales force expansion and
additional back office support personnel for Allstar in the first and second
quarters of 1999. During the third quarter of 1999, the Company began to
realize the effects of staff reductions made to eliminate redundant positions
after the PT-1 and UDN mergers and to eliminate back office support for the
telemarketing operations. Due to severance and other related costs incurred
in the third quarter of 1999 in connection with the staff reductions,
management anticipates that payroll expense will decrease as a percentage of
revenues in the fourth quarter of 1999. Additionally, professional fees
increased in the third quarter of 1999 compared to the third quarter of 1998,
as a result of tax planning efforts for the domestic and international
subsidiaries and as a result of professional services rendered in connection
with exploring various financing alternatives.
Selling, general and administrative expenses related to the European
operations increased 200% to $8.4 million in the third quarter of 1999, from
approximately $2.8 million in the third quarter of 1998. This increase
reflects the Company's commitment to continue expansion efforts in Europe by
adding personnel, facilities, and other expenses to become a carrier in
additional European countries and to expand the Company's commercial sales
force and back office support in Germany.
Depreciation and Amortization: Depreciation and amortization expense
increased over 200% to $11.7 million for the third quarter of 1999 from $3.7
million for the third quarter of 1998, and increased as a percentage of
revenues to 4.2% from 2.2% over the comparable period in the prior year. The
increase is primarily due to approximately 2.6 million of goodwill
amortization expense resulting from the PT-1 acquisition. In addition,
depreciation expense increased due to significant asset additions in Europe
and the inclusion of depreciation expense for the PT-1 assets. Depreciation
expense also increased as a result of the Company's additional domestic
broadband capacity during 1999. Depreciation and amortization attributable to
North American assets amounted to $8.7 million. European operations realized
total depreciation and amortization of $3.1 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 third quarter of 1999, loss from
operations was $8.6 million as compared to income from operations of $4.2
million in the third quarter of 1998. Operating margin in the third quarter
of 1999 was a negative 3.1% as compared to a positive 2.5% in the third
quarter of 1998. Operating margin decreased in the third quarter of 1999
primarily due to rate compression in the wholesale market, goodwill
14
<PAGE>
amortization, as well as increased payroll, commission and operating expenses
attributable to the expansion of the Company's commercial programs. The
decrease in operating margin in the third quarter of 1999 was partially
offset by profit realization of $5.9 million from a broadband sale. The
operating margin for the three month period ended September 30, 1999
increased from a negative 12.2% in the second quarter of 1999. The increase
is primarily due to the stabilization of rates in the wholesale market, an
increase in the profitability of European operations, and the staff
reductions due to the Company's realization of synergies from its
acquisitions and the reduction of back office support for the telemarketing
operations, as well as the profit from the broadband sale.
Other Income (Expense): The Company reported other expense, net, of
approximately $1.0 million in the third quarter of 1999 as compared to other
income, net, of approximately $964,000 for the third quarter of 1998. This
decrease is primarily due to interest expense of $2.5 million in the current
quarter as opposed to approximately $860,000 in the third quarter of 1998.
The increase resulted from interest expense incurred on borrowings on STAR's
line of credit and interest payments for capital lease obligations for the
quarter ending September 30, 1999. In the third quarter of 1998, the Company
earned a substantial amount of interest on the proceeds from its May 1998,
secondary equity offering. Therefore, interest income decreased from $1.7
million in the third quarter 1998 to $176,000 in the third quarter 1999. In
addition, other income reflects a $1.3 million gain from the sale of an
investment during the third quarter 1999.
Provision (Benefit) for Income Taxes: The Company recorded a tax benefit of
approximately $811,000 in the third quarter of 1999 due to operating losses.
The provision for income taxes for the third quarter of 1998 was $2.8 million.
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED SEPTEMBER
30, 1998
Revenues: Total revenues increased 75.2% to $779.7 million in the nine months
ended September 30, 1999 from $445.1 million in the nine months ended
September 30, 1998. The increase is primarily a result of the continued
growth in the North American commercial operations, which contributed
revenues from prepaid phone-card and dial around programs, and the European
operations.
Revenues from North American wholesale customers decreased 5.5 % to $368.9
million in the nine months ended September 30, 1999 from $390.2 million in
the nine months ended September 30, 1998. North American wholesale revenues
for the nine months ended September 30, 1999 include broadband sales
activity. Minutes of use generated by North American wholesale customers
increased 54.5% to 1.7 billion minutes of use in the nine months ended
September 30, 1999, as compared to 1.1 billion minutes of use in the
comparable period of the year prior. The increase in minutes of use reflects
the continued growth in the number of North American wholesale customers to
225 at September 30, 1999, up from 175 customers at September 30, 1998, as
well as an increase in usage by existing customers. The decrease in revenue
for the nine months ended September 30, 1999 resulted from a significant
decline in rates per minute, as the average North American wholesale rate
per minute of use declined to $0.21 for the current nine month period as
compared to $0.33 for the nine month period ended September 30, 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, the United Kingdom,
Canada and Japan. 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 revenues increased to $328.3 million in the nine
months ended September 30, 1999 from $48.0 million in the comparable 1998
period. The growth is due primarily to the consummation of the PT-1
acquisition in the first quarter of 1999 which diversified the Company's
revenue base with both prepaid phone-card and dial around programs. Minutes
of use generated by North American commercial customers increased over 600%
to 2.0 billion minutes in the nine months ended September 30, 1999, as
compared to 269.3 million minutes of use in the comparable nine month period
of the prior year. The average North American commercial rate per minute
increased to $0.16 per minute in the nine months ended September 30, 1999
from $0.15 per minute in the nine months ended September 30, 1998, primarily
due to the increase in commercial usage from the prepaid phone-card and dial
around programs.
15
<PAGE>
The nine months ended September 30, 1999 also includes revenues from the
European operations which increased to $82.5 million, as compared to $6.9
million in the comparable nine month period of 1998. Management believes that
the prospects for growth in Europe remain strong as STAR Telecommunications
Deutschland GmbH is fully utilizing its interconnect with Deutsche Telekom
AG, as well as with other European PTTs. In addition, management expects
continued growth in European revenues as the Company expands into Austria and
Switzerland. The Company completed the build out of its Austrian and Swiss
switch sites in the third quarter of 1999.
Cost of Services (Exclusive of Depreciation and Amortization): Total cost of
services (exclusive of depreciation and amortization) increased 78.8% to
$676.2 million in the nine months ended September 30, 1999 from $378.2
million in the nine months ended September 30, 1998 and increased as a
percentage of revenues for the same periods to 86.7% from 85.0%.
Cost of services (exclusive of depreciation and amortization) from North
American vendors increased 64.5% to $607.5 million in the nine months ended
September 30, 1999 from $369.2 million in the comparable 1998 period and
increased as a percentage of North American revenues to 87.1% from 84.3%,
respectively. Cost of services includes costs relating to broadband sales
during the nine months ended September 30, 1999. The growth in cost of
services reflects the increase in minutes of use from the commercial usage
generated from prepaid phone-card and dial around programs offset by an
overall declining average cost per minute. The average cost per minute
declined as a result of competitive pricing pressures, a larger proportion of
lower cost per minute countries, as well as an increasing proportion of
traffic routed over the Company's proprietary network. Management believes
that the average cost per minute will continue to decline as STAR expands its
domestic and international network. Cost of services (exclusive of
depreciation and amortization) for the nine months ended September 30, 1999,
were negatively impacted as a result of delays in delivery for domestic
network capacity which resulted in redundant leased line costs. Management
anticipates delivery and acceptance of this capacity in the fourth quarter of
1999, although there can be no assurances in that regard.
The nine months ended September 30, 1999 also includes cost of services
(exclusive of depreciation and amortization) of $68.7 million generated from
the European operations, as compared to $9.0 million in the comparable nine
months ended September 30, 1998. The increase in cost of services (exclusive
of depreciation and amortization) from the European operations was
attributable to increased usage, increased private line costs, and a reserve
of approximately $6.7 million for a retroactive rate increase imposed by a
European telecom carrier in the second quarter of 1999.
Selling, General and Administrative Expenses: For the nine months ended
September 30, 1999, total selling, general and administrative expenses,
exclusive of merger expenses, increased over 150% to $118.4 million from
$45.6 million in the nine months ended September 30, 1998 and increased as a
percentage of revenues to 15.2% from 10.2% over the comparable 1998 period.
The increase is primarily a result of continued growth in the Company's North
American commercial and European operations.
North American selling, general and administrative expenses increased over
100% to $97.1 million in the nine months ended September 30, 1999 from $40.1
million in the comparable 1998 period. North American selling, general and
administrative expenses increased as a percentage of North American revenues
to 13.9% from 9.2%, respectively. The increase is primarily a result of the
inclusion of PT-1 operating expenses subsequent to the acquisition, which
includes payroll, advertising, bad debt and other related expenses in
connection with the expansion of the prepaid phone-card and dial around
programs. In addition, the increase is attributable to the sales force
expansion and additional back office support personnel for Allstar in the
first and second quarters of 1999. The provision for bad debt expense
increased for the nine month period ending September 30, 1999 as compared to
the nine month period ending September 30, 1998 due, in part, to a reserve
for a commercial customer of UDN in the second quarter of 1999 as well as
increased bad debt reserves related to the North American wholesale and
commercial segments.
Selling, general and administrative expenses related to the European
operations increased over 250% to $21.3 million in the nine months ended
September 30, 1999, from approximately $5.5 million in the
16
<PAGE>
comparable 1998 period. The increase reflects the Company's commitment to
continue expansion efforts in Europe by adding personnel to become a carrier
in additional European countries and to expand the Company's commercial sales
force and back office support personnel in Germany.
Depreciation and Amortization: Depreciation and amortization expense
increased over 250% to $31.4 million for the nine months ended September 30,
1999 from $8.9 million for the comparable 1998 period, and increased as a
percentage of revenues to 4.0% from 2.0% over the comparable period in the
prior year. The increase is primarily due to approximately $7 million of
goodwill amortization expense resulting from the PT-1 acquisition. In
addition, depreciation expense increased due to significant asset additions
in Europe and the inclusion of the depreciation expense for PT-1 assets.
Depreciation expense also increased as a result of the Company's additional
domestic broadband capacity during 1999. Depreciation and amortization
attributable to North American assets amounted to $23.7 million. European
operations realized total depreciation and amortization of $7.7 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 nine months ended September 30, 1999,
loss from operations was $48.1 million as compared to income from operations
of $12.2 million in the comparable 1998 period. Operating margin in the nine
months ended September 30, 1999 was a negative 6.2% as compared to a positive
2.7% in 1998. Operating margin decreased in the nine months ended September
30, 1999 due primarily to rate compression in the wholesale market, goodwill
amortization, an accrued rate dispute related to European operations in the
second quarter of 1999, and additional bad debt reserves in the second
quarter of 1999, as well as increased payroll, commission, and operating
expenses attributable to the Company's expansion of its commercial programs.
The decrease in operation margin was partially offset by profit realization
of $5.9 million from a broadband sale in the third quarter of 1999. In
addition, the Company's completion of two significant acquisitions in 1999
and approximately $1.9 million in merger expense contributed to the decline
in operating margin in the nine months ended September 30, 1999.
Other Income (Expense): The Company reported other expense, net, of $4.8
million the nine months ended September 30, 1999 as compared to other income,
net, of approximately $544,000 for the comparable 1998 period. This increase
is primarily due to an increase in interest expense to $6.0 million during
the first nine months of 1999 from $2.5 million in the comparable period in
1998 due to interest incurred on borrowings from STAR's line of credit and
additional capital lease obligations for switches. During the nine months
ended September 30,1998, the Company earned a substantial amount of interest
on the proceeds from its May 1998 secondary equity offering. Therefore,
interest income decreased to $1.9 million from $3.2 million for the periods
ended September 30, 1999 and 1998, respectively. In addition, other expense
increased due to the recognition of a $1.8 million foreign currency
translation loss related to the intercompany note between STAR and its German
subsidiaries in the first quarter of 1999. In addition, other income reflects
a $1.3 million gain from the sale of an investment in the third quarter of
1999.
Provision (Benefit) for Income Taxes: The Company recorded a tax benefit of
$8.7 million in the nine months ended September 30, 1999 due to operating
losses. The provision for income taxes for the nine months ended September
30, 1998 was $6.6 million.
LIQUIDITY AND CAPITAL RESOURCES
The Company has incurred significant operating and net losses over the past
nine months. Several factors contributed to this situation. The Company
experienced significant pricing pressures in the wholesale market, with
deteriorating wholesale gross margins during the last nine months. The
Company continues to deploy new international direct circuits in an effort to
increase the number of on-net countries which historically have provided
higher wholesale margins. Wholesale gross margins were further affected by
delayed delivery of North American fiber routes by one of the Company's major
vendors which significantly increased the cost of the Company's leased lines.
Completion of the Company's domestic broadband network is expected to provide
margin improvement by the end of 1999, though there can be no assurances in
that regard. The Company continues to operate Allstar Telecom, which
currently operates at
17
<PAGE>
a loss. During the third quarter of 1999 the company reduced the number of
sales representatives and sales offices in an attempt to reduce the extent of
these losses. Although losses are expected to continue at Allstar, the level
of negative cash flow forecasted though the end of 1999 is expected to
decrease. In addition, the Company took steps to control costs by
discontinuing the telemarketing efforts of CEO Telecommunications. However,
due to related severance and shut down costs, the results of these changes
are not expected to impact the Company's financial results until the fourth
quarter of 1999.
Cash provided by operating activities for the nine months ended September 30,
1999 totaled $ 7.1 million as compared with cash provided by operating
activities of $0.3 million for the same period in 1998 reflecting increases
in accounts payable and accrued network cost offset by the use of cash to
fund operating losses and increases in accounts receivable.
Cash used in investing activities for the nine months ended September 30,
1999, totaled $49.5 million primarily as a result of capital expenditures.
Capital expenditures for the nine months ended September 30, 1999 were $39.6
million as compared to $58.0 million for the same period last year. These
capital expenditures related primarily to the continued development of the
Star network which included switch expansion, and the replacement of leased
line facilities with IRU's and ownership interests on both domestic and
international cable systems. Cash expended for other long-term assets was
$4.5 million during the nine months ended September 30, 1999, primarily
reflecting increased investments in the Pacific Rim joint ventures. Cash
expended for acquisitions net of cash acquired was $4.4 million during the
nine months ended September 30, 1999, as a result of the PT-1 purchase.
Cash provided by financing activities for the nine months ended September 30,
1999, totaled $10.8 million primarily reflecting additional borrowings under
the Company's line of credit offset by repayments of the line of credit,
long-term debt and capital lease obligations. The Company's indebtedness at
September 30, 1999 was approximately $103.6 million, of which $42.7 million
represented long-term debt and $60.9 million represented short-term debt. The
Company's debt is currently a combination of capital lease obligations for
operating equipment and amounts due under the Company's existing credit
facility.
On June 9, 1999, the Company entered into a two-year credit facility
agreement with Foothill Capital Corporation ("Foothill"). The Company failed
to meet the EBITDA and tangible net worth covenants in accordance with the
agreement for the period ended June 30, 1999. On October 15th, the Company
received an amendment from the lender group which included resetting the
financial covenants in accordance with the Company's updated financial
forecast. In exchange for the amendment, the Company agreed to pay to
Foothill a supplemental agency fee of $500,000, and a term loan supplemental
fee of $2,000,000 due January 31, 2000. If the term loan is retired on or
before November 30, 1999, the term loan supplemental fee is reduced to
$600,000; if the term loan is retired before December 31, 1999, the term loan
supplemental fee is reduced to $1,000,000. Additionally, the prepayment
premium for early retirement of the facility was reduced to $1,000,000.
Interest rates were adjusted to 2.75 percent over the prime rate of interest
for the revolving line of credit and 8.0 percent over the prime rate for the
term note. The interest on the term note increases 1 percent per month for
the remainder of the term. The Company also agreed to the reduction of
eligible borrowings on the revolving portion of the line of credit to $30
million from $75 million. The expiration date of the $25 million term loan
was modified to January 31, 2000 from June 9, 2000. As of September 30, 1999,
the Company had $17.5 million outstanding on its revolving line of credit,
and $25.0 million outstanding on the term portion of the facility. The
Company is in full compliance of all debt covenants as of September 30, 1999.
On September 29, 1999 Star Telecommunications Deutschland GmbH entered into
an agreement with Deutsche Leasing AG to finance new and pre-existing
equipment through a capital lease-financing arrangement. Under the terms of
the agreement the Company has the option to finance equipment up to 80DM
million or roughly $45 million. The contract includes provisions to increase
that amount as STAR Telecom Deutschland's equipment needs expand. The
financing terms of the agreement are a minimum lease commitment of four years
with an interest rate of approximately 6%. Cash generated from these
arrangements will be used to help fund the growth and operations of the
German business.
The Company believes that the current credit facility will provide adequate
funding for the Company's ongoing operations through the end of 1999, but
will not be sufficient to fund the Company's continuing network buildout nor
to fund operations in 2000. As a result, the Company intends to raise
additional capital in 1999 to fund operations and capital expenditures
through the year 2000. The company has retained Deutsche Bank Alex. Brown to
represent the Company in its efforts to raise private equity and/or high
yield debt. Although this effort is well under way, the Company can give no
assurances that any funding will be completed.
18
<PAGE>
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 instituted 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
determined to be Year 2000 compliant through internal resources.
STAR completed 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 are its telecommunications
switches. All of STAR's switches are now Year 2000 compliant. STAR evaluated
its other non-information technology systems and believes that they will not
be affected by the Year 2000. With respect to operations at PT-1, STAR has
determined that all major systems critical to operations are Year 2000
compliant.
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 has contacted its significant vendors and customers to
ascertain whether the systems used by such third parties are Year 2000
compliant. All significant customers and vendors have confirmed that they are
Year 2000 compliant. No customers or vendors have indicated that they will
not be Year 2000 compliant.
The costs associated with STAR's Year 2000 compliance efforts will be
incurred throughout 1999. STAR estimates that any remaining costs of
ongoing efforts will be nominal, as testing is virtually complete. Costs
incurred to date in connection with STAR's Year 2000 compliance efforts have
been immaterial and expensed as incurred.
19
<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 position and results of operations. No material changes have
occurred in the past nine months that would impact the Company's exposure to
foreign currency risk.
INTEREST RATE RISK. The Company has borrowings under a line of credit
agreement and various 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. The Company replaced its Sanwa line
of credit with the revolving credit facility with Foothill in June 1999.
The following table presents the hypothetical impact on the Company's
financial results for changes in interest rates for the Foothill obligation
at September 30, 1999. The modeling technique used measures the change in the
Company's results arising from selected potential changes in interest rates.
Market rate changes reflect immediate hypothetical parallel shifts in the
yield curve of plus or minus 50 basis points ("BPS"), 100 BPS, and 150 BPS
over a twelve month time horizon.
INTEREST RATE EXPOSURE ANALYSIS
INCREASE OR (DECREASE) IN ANNUAL INTEREST EXPENSE
DUE TO CHANGES IN INTEREST RATES
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
DESCRIPTION 50 BPS 100BPS 150BPS (50)BPS (100)BPS (150)BPS
- ----------- ------ ------ ------ ------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Line of Credit $ 213 $ 425 $ 638 $ (213) $ (425) $ (638)
</TABLE>
20
<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: November 12, 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)
21
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S CONSOLIDATED BALANCE SHEETS, CONSOLIDATED STATEMENTS OF OPERATIONS,
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY, AND CONSOLIDATED STATEMENTS OF
CASH FLOWS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH SCHEDULES
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
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0
0
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</TABLE>
