<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON FEBRUARY 11, 1999
REGISTRATION NO. 333-53335
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- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
POST-EFFECTIVE AMENDMENT NO. 2
TO
FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
---------------------
STAR TELECOMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C> <C>
DELAWARE 4813 77-0362681
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification No.)
</TABLE>
223 EAST DE LA GUERRA STREET
SANTA BARBARA, CALIFORNIA 93101
(805) 899-1962
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
------------------------------
KELLY D. ENOS
CHIEF FINANCIAL OFFICER
STAR TELECOMMUNICATIONS, INC.
223 EAST DE LA GUERRA STREET
SANTA BARBARA, CALIFORNIA 93101
(805) 899-1962
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
------------------------------
COPIES TO:
TIMOTHY F. SYLVESTER, ESQ. MARTIN E. WEISBERG, ESQ.
RIORDAN & MCKINZIE PARKER CHAPIN FLATTAU & KLIMPL, LLP
300 SOUTH GRAND AVENUE, 29TH FLOOR 1211 AVENUE OF THE AMERICAS
LOS ANGELES, CALIFORNIA 90071 NEW YORK, NEW YORK 10036
(213) 629-4824 (212) 704-6000
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE OF THE SECURITIES TO THE
PUBLIC:
As soon as practicable after the Registration Statement becomes effective.
If the securities being registered on this Form are being offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, check the following box. / /
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. / /
If the form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
CALCULATION OF ADDITIONAL REGISTRATION FEE
<TABLE>
<CAPTION>
PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AMOUNT TO OFFERING PRICE
SECURITIES TO BE REGISTERED BE REGISTERED(1) PER UNIT(2)
<S> <C> <C>
Common Stock, par value $0.001 per share................................ 1,113,350 shares $13.1875
<CAPTION>
TITLE OF EACH CLASS OF AMOUNT OF ADDITIONAL
SECURITIES TO BE REGISTERED REGISTRATION FEE(3)
<S> <C>
Common Stock, par value $0.001 per share................................ $0
</TABLE>
(1) The number of shares of common stock, par value $0.001 per share (the "STAR
Common Stock"), of STAR Telecommunications, Inc. ("STAR") to be registered
has been determined based on the product of (a) the sum of, as of February
10, 1999, (i) 6,867,344 outstanding shares of common stock, par value $0.01
per share (the "UDN Common Stock"), of United Digital Network, Inc. ("UDN"),
and (ii) 736,009 shares of UDN Common Stock subject to outstanding options
and warrants and (b) an exchange ratio of .146428 share of STAR Common Stock
for each share of UDN Common Stock, as provided in the Agreement and Plan of
Merger, dated as of November 19, 1997, as amended January 30, 1998, April 6,
1998 and October 13, 1998 by and among STAR, UDN and IIWII Corp. (the
"Merger Agreement").
(2) Estimated solely for purposes of calculating the registration fee pursuant
to Rule 457(f)(1) of the Securities Act of 1933, as amended (the "Securities
Act"), based on the average of the high and low sales price of a share of
STAR Common Stock reported on the Nasdaq National Market on February 10,
1999.
(3) The Registrant submitted $5,540.14 with the initial filing of this
Registration Statement on May 21, 1998 and $262.55 on May 29, 1998.
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<PAGE>
[LOGO]
February 12, 1999
Dear Stockholder:
You are cordially invited to attend a Special Meeting of Stockholders of
United Digital Network, Inc. ("UDN") at McCarthy Tetrault, Main Board Room, 13th
Floor, 777 Dunsmuir Street, Vancouver, B.C., Canada, on March 19, 1999 beginning
at 10:00 a.m. local time. The purpose of the Special Meeting is set forth below
and in the accompanying Notice of Special Meeting of Stockholders and is
described in detail in the accompanying Proxy Statement/Prospectus.
On November 19, 1997, UDN entered into an Agreement and Plan of Merger and
on January 30, 1998, April 6, 1998 and October 13, 1998, entered into amendments
thereto (as amended, the "Merger Agreement"), with STAR Telecommunications, Inc.
("STAR") and IIWII Corp., a wholly-owned subsidiary of STAR ("Newco"), pursuant
to which Newco will be merged with and into UDN (the "Merger"), with UDN
surviving as a wholly-owned subsidiary of STAR. Subject to the terms and
conditions of the Merger Agreement, each share of common stock, par value $0.01
per share, of UDN ("UDN Common Stock"), outstanding immediately prior to the
effective time of the Merger (the "Effective Time") will be converted into the
right to receive that portion of a share (the "Exchange Ratio") of common stock,
par value $0.001 per share, of STAR ("STAR Common Stock") determined by dividing
$2.05 by the average closing price of STAR Common Stock on the Nasdaq National
Market for the five (5) trading days prior to the Effective Time (the "Average
Price"), provided that if the Average Price is equal to or greater than $27.50,
or equal to or less than $14.00, the Exchange Ratio shall be determined by using
$27.50 or $14.00, as the case may be, as the Average Price, which would result
in an Exchange Ratio of 0.074545 or 0.146428, as the case may be. As of February
10, 1999, based on a closing sales price for STAR Common Stock of $13.25, the
Exchange Ratio was 0.146428 share of STAR Common Stock for each share of UDN
Common Stock. Cash will be paid in lieu of any fractional shares of STAR Common
Stock. In order to accomplish the Merger, stockholders of UDN are being asked to
approve and adopt the Merger Agreement and the transactions contemplated
thereby.
AFTER CAREFUL CONSIDERATION, THE UDN BOARD OF DIRECTORS AND A SPECIAL
COMMITTEE OF THE BOARD HAS DETERMINED THAT THE MERGER IS FAIR AND IN THE BEST
INTERESTS OF UDN AND ITS STOCKHOLDERS. ACCORDINGLY, THE BOARD AND THE SPECIAL
COMMITTEE HAVE, BY UNANIMOUS VOTE OF ALL MEMBERS PRESENT, APPROVED THE MERGER
AGREEMENT AND RELATED TRANSACTIONS AND RECOMMEND THAT YOU VOTE "FOR" THE
APPROVAL AND ADOPTION OF THE MERGER AGREEMENT AND THE TRANSACTIONS CONTEMPLATED
THEREBY.
Madison Securities, Inc. has acted as financial advisor to UDN in connection
with the Merger and delivered a written opinion (the "Madison Opinion") to the
Board of Directors and the Special Committee that, as of May 7, 1998 and subject
to the assumptions and the limitations of the opinion, the Exchange Ratio is
fair to the holders of UDN Common Stock (other than STAR and its affiliates)
from a financial point of view. A copy of the Madison Opinion is included as
ANNEX B to the Proxy Statement/Prospectus and should be read in its entirety.
Consummation of the Merger is subject to certain conditions, including the
approval and adoption of the Merger Agreement and the other transactions
contemplated thereby by UDN's stockholders and the review by, or receipt of
certain approvals from, regulatory authorities.
You are urged to read the accompanying Proxy Statement/Prospectus, which
provides you with a description of the terms of the proposed transaction. A copy
of the Merger Agreement is included as ANNEX A to the Proxy
Statement/Prospectus.
<PAGE>
IT IS IMPORTANT THAT YOUR SHARES BE REPRESENTED AT THE SPECIAL MEETING.
WHETHER OR NOT YOU PLAN TO ATTEND THE SPECIAL MEETING IN PERSON, YOU ARE URGED
TO COMPLETE, DATE AND SIGN THE ENCLOSED PROXY CARD AND RETURN IT IN THE ENCLOSED
POSTAGE PAID ENVELOPE AS PROMPTLY AS POSSIBLE.
If you have any questions prior to the UDN Special Meeting or need further
assistance, please call D.F. King & Co., Inc., our proxy solicitor, at (800)
848-2998.
Thank you for your time and attention to the accompanying Notice of Special
Meeting and Proxy Statement/Prospectus.
Very truly yours,
John R. Snedegar
President
<PAGE>
[LOGO]
NOTICE OF
SPECIAL MEETING OF STOCKHOLDERS OF
UNITED DIGITAL NETWORK, INC.
TO BE HELD MARCH 19, 1999
------------------------
NOTICE IS HEREBY GIVEN that a Special Meeting of Stockholders (the "Special
Meeting") of United Digital Network, Inc., a Delaware corporation ("UDN"), will
be held at McCarthy Tetrault, Main Board Room, 13th Floor, 777 Dunsmuir Street,
Vancouver, B.C., Canada on March 19, 1999 beginning at 10:00 a.m., local time,
for the following purposes:
1. To consider and vote upon a proposal to approve and adopt the Agreement
and Plan of Merger, dated as of November 19, 1997, as amended January 30,
1998, April 6, 1998 and October 13, 1998 (as amended, the "Merger
Agreement"), by and among UDN, STAR Telecommunications, Inc., a Delaware
corporation ("STAR"), and IIWII Corp., a Delaware corporation and a
wholly-owned subsidiary of STAR ("Newco"), and the transactions
contemplated thereby, including, among other things, the merger (the
"Merger") of Newco with and into UDN, pursuant to which each share of
common stock, par value $0.01 per share, of UDN ("UDN Common Stock")
outstanding immediately prior to the effective time of the Merger (the
"Effective Time") will be converted into the right to receive that
portion of a share (the "Exchange Ratio") of common stock, par value
$0.001 per share, of STAR ("STAR Common Stock") determined by dividing
$2.05 by the average closing price of STAR Common Stock on the Nasdaq
National Market for the five (5) trading days prior to the Effective Time
(the "Average Price"), provided that if the Average Price is equal to or
greater than $27.50, or equal to or less than $14.00, the Exchange Ratio
shall be determined by using $27.50 or $14.00, as the case may be, as the
Average Price, which would result in an Exchange Ratio of 0.074545 or
0.146428, as the case may be. Cash will be paid in lieu of any fractional
shares of STAR Common Stock. As of February 10, 1999, based on a closing
price for STAR Common Stock of $13.25, the Exchange Ratio was 0.146428
share of STAR Common Stock for each share of UDN Common Stock. As a
result of the Merger, UDN will become a wholly-owned subsidiary of STAR.
The Merger and related matters are described in greater detail in, and a
copy of the Merger Agreement is attached as ANNEX A to the accompanying
Proxy Statement/Prospectus; and
2. To transact such other business as may properly come before the Special
Meeting or any adjournments or postponements thereof.
Only stockholders of record at the close of business on February 10, 1999,
the record date for the Special Meeting, will be entitled to vote at the Special
Meeting.
Approval of the proposal described in item 1 above requires the affirmative
vote of the holders of a majority of the outstanding shares of UDN Common Stock
entitled to be voted with respect to such proposal.
IT IS IMPORTANT THAT YOUR SHARES BE REPRESENTED AT THE SPECIAL MEETING,
WHETHER OR NOT YOU PLAN TO ATTEND THE SPECIAL MEETING IN PERSON, YOU ARE URGED
TO COMPLETE, DATE AND SIGN THE ENCLOSED PROXY CARD AND RETURN IT IN THE ENCLOSED
POSTAGE-PAID ENVELOPE AS PROMPTLY AS POSSIBLE. THE ENVELOPE REQUIRES NO POSTAGE
IF MAILED IN THE UNITED STATES. Any stockholder who signs and mails a proxy may
revoke such proxy by delivering written notice of such revocation to the
Secretary of
<PAGE>
UDN prior to the time voting is declared closed or by attending the Special
Meeting and voting in person. Please see the accompanying Proxy
Statement/Prospectus for further details regarding the treatment of proxies at
the Special Meeting.
By Order of the Board of Directors
Janine Thomas
SECRETARY
Santa Ana, California
February 12, 1999
------------------------
PLEASE SIGN AND DATE THE ENCLOSED PROXY
AND RETURN IT IN THE ENCLOSED POSTAGE-PREPAID ENVELOPE
------------------------
PLEASE DO NOT MAIL ANY STOCK CERTIFICATES AT THIS TIME
<PAGE>
UNITED DIGITAL NETWORK, INC.
PROXY STATEMENT
---------------------
STAR TELECOMMUNICATIONS, INC.
PROSPECTUS
SHARES OF COMMON STOCK
---------------------
This Proxy Statement/Prospectus and the accompanying annexes (the "Proxy
Statement/Prospectus") are being furnished to the stockholders of United Digital
Network, Inc., a Delaware corporation ("UDN"), in connection with the
solicitation of proxies by the Board of Directors of UDN for use at a special
meeting of stockholders of UDN to be held on March 19, 1999, and any and all
adjournments and postponements thereof (the "Special Meeting").
At the Special Meeting, UDN's stockholders will be asked to consider a
proposal to approve and adopt the Agreement and Plan of Merger, dated as of
November 19, 1997, as amended January 30, 1998, April 6, 1998 and October 13,
1998 (as amended, the "Merger Agreement"), by and among STAR Telecommunications,
Inc., a Delaware corporation ("STAR"), IIWII Corp., a Delaware corporation and
wholly-owned subsidiary of STAR ("Newco"), and UDN and the transactions
contemplated thereby. Pursuant to the Merger Agreement, Newco will merge with
and into UDN (the "Merger"), and UDN will become a wholly-owned subsidiary of
STAR.
As a result of the Merger, each share of common stock, par value $0.01 per
share, of UDN ("UDN Common Stock") outstanding immediately prior to the
effective time (the "Effective Time") of the Merger (other than treasury shares,
which shares will be cancelled, and shares as to which dissenters' rights have
been perfected) will be converted into the right to receive that portion of a
share (the "Exchange Ratio") of common stock, par value $0.001 per share, of
STAR ("STAR Common Stock") determined by dividing $2.05 by the average closing
price of STAR Common Stock on the Nasdaq National Market for the five (5)
trading days prior to the Effective Time (the "Average Price"), provided that if
the Average Price is equal to or greater than $27.50, or equal to or less than
$14.00, the Exchange Ratio shall be determined by using $27.50 or $14.00, as the
case may be, as the Average Price, which would result in an Exchange Ratio of
0.074545 or 0.146428, as the case may be. As of February 10, 1999, based on a
closing price for STAR Common Stock of $13.25, the Exchange Ratio was 0.146428
share of STAR Common Stock for each share of UDN Common Stock. Cash will be paid
in lieu of any fractional shares of STAR Common Stock.
STAR has filed a Registration Statement on Form S-4 (the "Registration
Statement") with the Securities and Exchange Commission (the "Commission") under
the Securities Act of 1933, as amended (the "Securities Act"), with respect to
the shares of STAR Common Stock to be issued to the stockholders of UDN pursuant
to the Merger Agreement. This Proxy Statement/Prospectus constitutes the
prospectus of STAR filed as part of the Registration Statement. Completion of
the Merger is conditioned upon, among other things, the Registration Statement
being declared effective by the Commission and the shares of STAR Common Stock
to be issued in the Merger being authorized for listing on the Nasdaq National
Market.
On November 18, 1997, the last full day of trading prior to the announcement
of the execution of the Merger Agreement, the last reported sale prices of STAR
Common Stock and UDN Common Stock, as reported on the Nasdaq National Market and
Vancouver Stock Exchange, were $15.183 and $2.15, respectively. On February 10,
1999, the last trading day prior to the date of this Proxy Statement/Prospectus,
the last reported sale prices of STAR Common Stock and UDN Common Stock, as
reported on the Nasdaq National Market and Vancouver Stock Exchange, were $13.25
and $1.32 U.S., respectively.
This Proxy Statement/Prospectus and the accompanying form of proxy are first
being mailed to stockholders of UDN on or about February 12, 1999.
------------------------
THE SHARES OF STAR COMMON STOCK TO BE ISSUED IN CONNECTION WITH THE MERGER
HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE
COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROXY STATEMENT/
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
------------------------
SEE "RISK FACTORS" BEGINNING ON PAGE 25 FOR A DISCUSSION OF CERTAIN MATTERS THAT
SHOULD BE CONSIDERED BY THE STOCKHOLDERS OF UDN WITH RESPECT TO THE MERGER.
------------------------
THE DATE OF THIS PROXY STATEMENT/PROSPECTUS IS FEBRUARY 11, 1999.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
AVAILABLE INFORMATION..................................................... 4
SUMMARY................................................................... 6
The Companies........................................................... 6
The Special Meeting..................................................... 8
The Merger.............................................................. 9
The Merger Agreement.................................................... 11
Other Considerations.................................................... 14
Risk Factors............................................................ 15
Selected Consolidated Financial Data of STAR............................ 16
Selected Consolidated Financial Data of PT-1............................ 18
Selected Consolidated Financial Data of UDN............................. 20
Comparative Per Share Data.............................................. 22
Summary Unaudited Pro Forma Financial Data.............................. 24
RISK FACTORS.............................................................. 25
THE SPECIAL MEETING....................................................... 44
THE MERGER................................................................ 46
General Description..................................................... 46
Effective Time of the Merger............................................ 46
Background of the Merger................................................ 46
UDN's Reasons for the Merger; Recommendations of the UDN Board and
Special Committee..................................................... 48
Opinion of Madison Securities, Financial Advisor to UDN................. 49
STAR's Reasons for the Merger........................................... 52
The Merger Agreement.................................................... 52
Resale of Shares of STAR Common Stock Issued in the Merger;
Affiliates............................................................ 58
Accounting Treatment of the Merger...................................... 59
Interests of Certain Persons in the Merger.............................. 59
Regulatory Approvals.................................................... 59
Stock Exchange Listing.................................................. 60
Delisting and Deregistration of UDN Common Stock........................ 60
Comparative Stock Prices................................................ 60
APPRAISAL RIGHTS OF STOCKHOLDERS.......................................... 61
COMPARATIVE RIGHTS OF STOCKHOLDERS........................................ 64
UNAUDITED PRO FORMA FINANCIAL DATA........................................ 68
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL DATA............ 75
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS OF STAR...................................................... 80
BUSINESS OF STAR.......................................................... 91
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS OF PT-1...................................................... 107
BUSINESS OF PT-1.......................................................... 117
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS OF UDN....................................................... 127
BUSINESS OF UDN........................................................... 133
MANAGEMENT OF STAR AND UDN................................................ 137
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............................ 147
PRINCIPAL STOCKHOLDERS OF STAR............................................ 150
</TABLE>
2
<PAGE>
<TABLE>
<CAPTION>
PAGE
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<S> <C>
PRINCIPAL STOCKHOLDERS OF UDN............................................. 152
DESCRIPTION OF STAR CAPITAL STOCK......................................... 153
CERTAIN INCOME TAX CONSEQUENCES........................................... 155
Certain United States Federal Income Tax Consequences................... 155
Certain Canadian and Foreign Tax Consequences........................... 156
LEGAL MATTERS............................................................. 157
EXPERTS................................................................... 157
FUTURE STOCKHOLDER PROPOSALS.............................................. 157
INDEX TO FINANCIAL STATEMENTS............................................. F-1
ANNEXES
ANNEX A: AGREEMENT AND PLAN OF MERGER.................................... A-1
ANNEX B: MADISON SECURITIES OPINION...................................... B-1
ANNEX C: SECTION 262 OF THE GENERAL CORPORATION LAW OF THE STATE OF
DELAWARE........................................................ C-1
</TABLE>
3
<PAGE>
AVAILABLE INFORMATION
STAR is subject to the informational requirements of the Securities Exchange
Act of 1934, as amended (the "Exchange Act"), and, in accordance therewith,
files reports, proxy statements, registration statements and other information
with the Commission. The reports, proxy statements, registration statements and
other information filed by STAR with the Commission may be inspected and copied
at the public reference facilities maintained by the Commission at 450 Fifth
Street, N.W., Washington, D.C. 20549, and at the Commission's Regional Offices
at Seven World Trade Center, 13th Floor, New York, New York 10048 and Citicorp
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661-2511.
Copies of such material may be obtained by mail from the Public Reference
Section of the Commission at 450 West Fifth Street, N.W., Washington, D.C.
20549, at prescribed rates. The Commission also maintains a Web Site at
http://www.sec.gov which contains reports, proxy statements, registration
statements and other information regarding registrants that file electronically
with the Commission. STAR's Common Stock is listed on the Nasdaq National Market
under the symbol "STRX." UDN's Common Stock is listed on the Vancouver Stock
Exchange under the symbol "UDN.V." Reports, proxy statements and other
information filed by STAR may be inspected at the offices of the Nasdaq National
Market, Reports Section, 1735 K Street, Washington, D.C. 20006. Reports, proxy
statements and other information filed by UDN may be inspected at the offices of
the Vancouver Stock Exchange, 609 Granville Street, Vancouver, British Columbia,
Canada V7Y 1H1. After consummation of the Merger, UDN will no longer be required
to file reports, proxy statements or other information with the Vancouver Stock
Exchange.
STAR has filed with the Commission the Registration Statement with respect
to the STAR Common Stock to be issued pursuant to the Merger Agreement, of which
this Proxy Statement/Prospectus constitutes a part. The information contained
herein with respect to STAR and its affiliates has been provided by STAR, and
the information contained herein with respect to UDN and its affiliates has been
provided by UDN. This Proxy Statement/Prospectus does not contain all of the
information set forth in the Registration Statement and the exhibits thereto,
certain items of which were omitted in accordance with the rules and regulations
of the Commission. For further information, reference is hereby made to the
Registration Statement. Any statements contained herein concerning the contents
of any contract, agreement or other document referred to herein and filed as an
exhibit to the Registration Statement or otherwise filed with the Commission are
not necessarily complete. With respect to each such contract, agreement or other
document filed with the Commission as an exhibit, reference is made to the
exhibit for a more complete description of the matter involved, and each such
statement is qualified in its entirety by such reference.
NO PERSON IS AUTHORIZED BY STAR OR UDN TO GIVE ANY INFORMATION OR TO MAKE
ANY REPRESENTATION, OTHER THAN THOSE CONTAINED IN THIS PROXY
STATEMENT/PROSPECTUS, IN CONNECTION WITH THE SOLICITATION AND THE OFFERING MADE
BY THIS PROXY STATEMENT/PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR
REPRESENTATIONS SHOULD NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED. THIS PROXY
STATEMENT/PROSPECTUS DOES NOT CONSTITUTE THE SOLICITATION OF A PROXY OR AN OFFER
TO SELL, OR A SOLICITATION OF AN OFFER TO PURCHASE, ANY SECURITIES IN ANY
JURISDICTION IN WHICH SUCH SOLICITATION OR OFFERING MAY NOT LAWFULLY BE MADE.
NEITHER THE DELIVERY OF THIS PROXY STATEMENT/PROSPECTUS NOR ANY DISTRIBUTION
OF SECURITIES MADE HEREUNDER SHALL IMPLY THAT THERE HAS BEEN NO CHANGE IN THE
INFORMATION SET FORTH HEREIN OR IN THE AFFAIRS OF STAR OR UDN SINCE THE DATE
HEREOF.
------------------------
THIS PROXY STATEMENT/PROSPECTUS CONTAINS CERTAIN "FORWARD-LOOKING
STATEMENTS" WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933,
4
<PAGE>
AS AMENDED. FORWARD-LOOKING STATEMENTS ARE STATEMENTS OTHER THAN HISTORICAL
INFORMATION OR STATEMENTS OF CURRENT CONDITION. SOME FORWARD-LOOKING STATEMENTS
MAY BE IDENTIFIED BY USE OF SUCH TERMS AS "EXPECTS," "ANTICIPATES," "INTENDS,"
"ESTIMATES," "BELIEVES" AND WORDS OF SIMILAR IMPORT. THESE FORWARD-LOOKING
STATEMENTS RELATE TO PLANS, OBJECTIVES AND EXPECTATIONS FOR FUTURE OPERATIONS.
IN LIGHT OF THE RISKS AND UNCERTAINTIES INHERENT IN ALL SUCH PROJECTED OPERATION
MATTERS, THE INCLUSION OF FORWARD-LOOKING STATEMENTS IN THIS PROXY
STATEMENT/PROSPECTUS SHOULD NOT BE REGARDED AS A REPRESENTATION BY STAR OR ANY
OTHER PERSON THAT THE OBJECTIVES OR PLANS OF STAR WILL BE ACHIEVED OR THAT ANY
OF STAR'S OPERATING EXPECTATIONS WILL BE REALIZED. REVENUES AND RESULTS OF
OPERATIONS ARE DIFFICULT TO FORECAST AND COULD DIFFER MATERIALLY FROM THOSE
PROJECTED IN THE FORWARD-LOOKING STATEMENTS CONTAINED IN THIS PROXY
STATEMENT/PROSPECTUS. FORWARD-LOOKING STATEMENTS MAY BE DEEMED TO INCLUDE THOSE
SET FORTH IN "SUMMARY," REGARDING STAR'S INTRODUCTION INTO SERVICE OF VARIOUS
INTERNATIONAL GATEWAY SWITCHES, COMMITMENTS TO ACQUIRE UNDERSEA CABLES AND
VARIOUS ASPECTS OF STAR'S STRATEGY. SUCH FORWARD-LOOKING STATEMENTS MAY BE
DEEMED TO INCLUDE STATEMENTS IN "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION OF STAR," REGARDING STAR'S STRATEGY
TO LOWER ITS COST OF SERVICES AND IMPROVE ITS GROSS MARGIN AND ITS BELIEF THAT
PRICE DECLINES MAY BE OFFSET IN PART BY INCREASED CALLING VOLUMES AND DECREASED
COSTS AND ITS BELIEF IN THE SUFFICIENCY OF CAPITAL RESOURCES. FORWARD-LOOKING
STATEMENTS IN "BUSINESS OF STAR" MAY BE DEEMED TO INCLUDE PROJECTED GROWTH IN
INTERNATIONAL TELECOMMUNICATIONS TRAFFIC, STAR'S STRATEGY OF MARKETING ITS
SERVICES TO FOREIGN-BASED LONG DISTANCE PROVIDERS, EXPANDING ITS U.S. AND
DEVELOPING EUROPEAN AND ASIAN SWITCHING CAPABILITIES, EXPANDING INTO COMMERCIAL
MARKETS AND PURSUING ACQUISITIONS. ACTUAL RESULTS COULD DIFFER FROM THOSE
PROJECTED IN ANY FORWARD-LOOKING STATEMENTS FOR THE REASONS DETAILED IN THE
"RISK FACTORS" SECTION OF THIS PROXY STATEMENT/PROSPECTUS, BEGINNING ON PAGE 25,
OR ELSEWHERE IN THIS PROXY STATEMENT/PROSPECTUS. STAR DOES NOT UNDERTAKE ANY
OBLIGATION TO RELEASE PUBLICLY THE RESULTS OF ANY FUTURE REVISIONS IT MAY MAKE
TO ANY OF ITS FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES
AFTER THE DATE HEREOF, TO REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS OR TO
REFLECT ANY CHANGE IN STAR'S OPERATING STRATEGY.
5
<PAGE>
SUMMARY
THIS SUMMARY HIGHLIGHTS SELECTED INFORMATION FROM THIS PROXY
STATEMENT/PROSPECTUS AND MAY NOT CONTAIN ALL THE INFORMATION THAT IS IMPORTANT
TO YOU. TO UNDERSTAND THE MERGER FULLY AND FOR A MORE COMPLETE DESCRIPTION OF
THE LEGAL TERMS OF THE MERGER, STOCKHOLDERS SHOULD READ CAREFULLY THIS ENTIRE
DOCUMENT, INCLUDING THE ANNEXES. SEE "AVAILABLE INFORMATION." STOCKHOLDERS
SHOULD ALSO CAREFULLY CONSIDER THE INFORMATION SET FORTH BELOW IN "RISK
FACTORS." ON FEBRUARY 4, 1999, STAR TELECOMMUNICATIONS, INC. ("STAR" OR THE
"COMPANY") ACQUIRED PT-1 COMMUNICATIONS, INC. ("PT-1") VIA THE MERGER OF PT-1
WITH AND INTO A WHOLLY-OWNED SUBSIDIARY OF STAR (THE "PT-1 MERGER"). THUS THE
INFORMATION SET FORTH IN THIS PROXY STATEMENT/PROSPECTUS REFLECTS THE
CONSUMMATION OF SUCH TRANSACTIONS.
THE COMPANIES
STAR, PT-1 AND NEWCO
STAR is an emerging multinational carrier focused primarily on the
international long distance telecommunications market. STAR offers highly
reliable, low cost switched voice services on a wholesale basis, primarily to
U.S.-based long distance carriers. STAR provides international long distance
service to approximately 220 foreign countries through a flexible network
comprised of various foreign termination relationships, international gateway
switches, leased and owned transmission facilities and resale arrangements with
long distance providers. STAR has grown its revenues rapidly by capitalizing on
the deregulation of international telecommunications markets, combining
sophisticated information systems with flexible routing and leveraging
management's industry expertise. STAR has increased its revenues and net income
from $58.9 million and $3.7 million, respectively, in 1995 to $404.6 million and
$5.8 million, respectively, in 1997.
STAR markets its services to large global carriers seeking lower rates as
well as to small and medium-sized long distance companies that do not have the
critical mass to invest in their own international transmission facilities or to
obtain volume discounts from the larger facilities-based carriers. During the
fourth quarter of 1997, STAR provided switched international long distance
services to 105 customers and currently provides these services to nine of the
top forty global carriers. STAR has also recently focused on building a customer
base overseas, particularly in Europe, and has opened offices in Dusseldorf,
Frankfurt, Hamburg and Munich, Germany and London, England. In addition, STAR
has begun to market its international long distance services directly to certain
commercial customers in the U.S. and overseas.
STAR currently operates international gateway switching facilities in New
York, Los Angeles, Dallas and Miami; London, England; and Dusseldorf, Frankfurt,
Hamburg and Munich, Germany. In early 1999, STAR plans to put into service
switches in Atlanta, Chicago and Seattle; Paris, France; Geneva, Switzerland;
and Vienna, Austria. STAR's switching facilities are linked to a proprietary
reporting system, which STAR believes provides it with a competitive advantage
by permitting management on a real-time basis to determine the most
cost-effective termination alternatives, monitor customer usage and manage gross
margins by route. STAR holds ownership positions in a number of digital undersea
fiber optic cables, including TPC-5, Gemini and AC-1, has recently entered into
a commitment to acquire transmission capacity on the Qwest domestic Macro
Capacity(SM) Fiber Network, which is expected to serve over 130 cities in the
U.S., and has plans to continue to acquire transmission capacity on additional
undersea fiber optic cable systems.
STAR was incorporated in Nevada in September 1993 as STAR Vending, Inc. and
was reincorporated in Delaware as STAR Telecommunications, Inc. in April 1997.
IIWII Corp. ("Newco"), which is a wholly-owned subsidiary of STAR, was
incorporated in Delaware on July 15, 1997 for the purpose of effecting the
Merger. Newco has no material assets and has not engaged in any activities
except in connection with such proposed Merger.
STAR's and Newco's executive offices are located at 223 East De La Guerra
Street, Santa Barbara, California 93101. Its telephone number at that location
is (805) 899-1962.
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PT-1
PT-1 is a provider of international long distance services to retail
customers and telecommunications carriers. PT-1 provides retail
telecommunications services primarily by marketing prepaid telephone calling
cards ("Prepaid Cards"), principally under the PT-1 brand name, through an
extensive network of distributors who directly and indirectly sell PT-1's
Prepaid Cards to retail outlets throughout the United States. PT-1 targets
retail markets with substantial international long distance calling
requirements, and believes that its Prepaid Cards provide consumers with a
convenient, attractively priced alternative to traditional presubscribed long
distance services. PT-1 sells its Prepaid Cards exclusively to distributors, and
it does not maintain any sales or marketing relationship with the retail outlets
that carry PT-1's Prepaid Cards. During March 1998, PT-1 began to market both
"dial around" and presubscribed long distance service to retail customers in
certain target markets that also have substantial international long distance
calling needs. Over the past several months, PT-1 has also increased the amount
of resources devoted to obtaining commercial retail customers with significant
international long distance requirements. For the fiscal year ended March 31,
1998, PT-1 generated revenues and net income of $431.5 million and $11.6
million, respectively.
PT-1 was founded in April 1995 to capitalize on the growing market for
international long distance services. PT-1 initially entered the retail
international long distance market through the distribution of Prepaid Cards
targeted at ethnic communities. After building significant international
traffic, in 1996 PT-1 began to negotiate reduced transmission rates based upon
volume with underlying carriers and began to invest in switching equipment and
lease transmission capacity to further reduce its cost of service as a
percentage of revenues. In August 1996, PT-1 began to leverage its significant
volume of international traffic by selling international long distance services
on a wholesale basis to other carriers. For the fiscal year ended March 31,
1998, revenues from retail sales and from wholesale sales were $356.3 million
and $75.2 million, respectively.
PT-1 believes its competitive strengths are its (i) established Prepaid Card
brand names, (ii) extensive distribution infrastructure, (iii) substantial
experience in identifying, targeting and marketing to communities and markets
with significant international long distance usage, (iv) position as a leading
provider of telecommunications traffic to various international destinations and
(v) efficient telecommunications network. PT-1 believes that its competitive
strengths will enable it to continue to profitably increase its retail customer
base and its traffic volume and negotiate lower telecommunications costs.
PT-1's retail customers can use its Prepaid Cards at any touch tone
telephone by dialing an access number, followed by a personal identification
number (a "PIN") assigned to each Prepaid Card and the telephone number the
customer wishes to reach. PT-1's switches complete the call, and its debit card
platform ("Debit Card Platform") reduces the Prepaid Card balance during the
call. PT-1 offers Prepaid Cards that can be used to access PT-1's network by
dialing an 800 number or, in specific metropolitan markets, local area calling
cards ("LAC Cards") that only require a local call. PT-1 believes that customers
typically use its Prepaid Cards as their primary means of making long distance
calls due to, among other things, (i) attractive rates, (ii) reliable service,
(iii) the ease of monitoring and budgeting their long distance spending, (iv)
the appealing variety of Prepaid Cards offered by PT-1 to different market
segments and (v) the inability of certain PT-1 customers, many of whom are
recent immigrants to the United States, to establish credit with the major
facilities-based long distance carriers.
PT-1 was incorporated on April 21, 1995 under the name PhoneTime, Inc. In
August 1997, it changed its name to PT-1 Communications, Inc. PT-1's principal
executive offices are located at 30-50 Whitestone Expressway, Flushing, New York
11354, and its telephone number at that location is (718) 939-9000.
UDN
United Digital Network, Inc. ("UDN") is a provider of voice and data long
distance services, travelcard services, international long distance, prepaid
calling cards and various other telecommunication
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services to residential, small to medium-sized commercial customers, switchless
resellers, agents and wholesale purchasers. The principal market for its long
distance services is the central and southwest United States. UDN operates
primarily through its wholly-owned subsidiaries, Advanced Management Services,
Inc., CTN-Custom Telecommunications Network of Arizona, Inc. and United Digital
Network of Texas, Inc. UDN offers an array of services designed to afford its
customers an integrated telecommunications solution to their telecommunications
needs.
UDN was incorporated in Canada under the British Columbia Company Act on
June 2, 1980, reincorporated in 1995 as a Wyoming corporation and subsequently
merged into a wholly-owned Delaware subsidiary and accordingly now exists as a
Delaware corporation. Since its entry into the telecommunications business in
1992, UDN's long distance revenues have grown from $13,000 in 1992 to $30.6
million for the twelve month period ended December 31, 1997.
UDN's growth has resulted from a two-pronged growth strategy. First, a plan
of acquiring selected types of long distance companies has produced four major
acquisitions that have been integrated into UDN's operations. Second, a direct
sales force, complemented by a growing agent network, has produced significant
internal growth during the last two years. From fiscal year ended April 30, 1995
through September 30, 1998, UDN's customer base increased from approximately
2,000 to over 22,000 customers nationwide.
UDN has focused on retention of its customer base, exploration of
opportunities for expanding its product lines and continuing to search for
additional strategic acquisitions. UDN's executive offices are located at 4
Hutton Centre, Suite 800, Santa Ana, CA 92707. Its telephone number at that
location is (714) 445-4559.
THE SPECIAL MEETING
PURPOSE
At the Special Meeting, UDN's stockholders will be asked to approve and
adopt the Merger Agreement and the transactions contemplated thereby and to
transact any other business that properly may come before the meeting or any
adjournments or postponements thereof.
TIME, PLACE AND DATE
The Special Meeting will be held at McCarthy Tetrault, Main Board Room, 13th
Floor, 777 Dunsmuir Street, Vancouver, B.C., Canada, on March 19, 1999, at 10:00
a.m. local time.
RECORD DATE; QUORUM; VOTES REQUIRED
Holders of shares of UDN Common Stock as of the close of business on
February 10, 1999, which has been set as the "Record Date," will be entitled to
vote at the Special Meeting. As of the close of business on the Record Date,
6,867,344 shares of UDN Common Stock were outstanding and entitled to vote. The
presence, in person or by proxy, of holders of record of a majority of the
issued and outstanding shares of UDN Common Stock is necessary to constitute a
quorum for the transaction of business at the Special Meeting. Approval of the
Merger Agreement and the transactions contemplated thereby will require the
affirmative vote of the holders of record of a majority of all outstanding
shares of UDN Common Stock. See "The Special Meeting."
VOTING OF PROXIES
The Proxy accompanying this Proxy Statement/Prospectus is solicited on
behalf of UDN's Board of Directors for use at the Special Meeting. UDN's
stockholders are requested to complete, date and sign the accompanying Proxy and
promptly return it in the enclosed envelope (which requires no postage if mailed
in the United States) to UDN's transfer agent. All properly executed Proxies
received by UDN's transfer
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agent prior to the vote at the Special Meeting that are not revoked will be
voted in accordance with the instructions indicated on the Proxies or, if no
direction is indicated, to approve and adopt the Merger Agreement. A Proxy may
be revoked at any time before its exercise by filing with Janine Thomas, the
Secretary of UDN, at 4 Hutton Centre, Suite 800, Santa Ana, CA 92707, an
instrument of revocation or a duly executed proxy bearing a later date, or by
attendance at the Special Meeting and electing to vote in person. Attendance at
the Special Meeting will not in and of itself constitute revocation of a Proxy.
John Snedegar, President of UDN, has entered into a Proxy Agreement with STAR
pursuant to which Mr. Snedegar granted STAR a proxy to vote his outstanding
shares of UDN Common Stock in favor of the Merger. Mr. Snedegar beneficially
owns 11.2% of the outstanding shares of UDN Common Stock.
SOLICITATION OF PROXIES AND EXPENSES
UDN will bear the cost of the solicitation of Proxies from its stockholders.
D.F. King & Co., Inc. has been selected to act as the Proxy solicitor. In
addition to solicitation by mail, the directors, officers and employees of UDN
may solicit Proxies from UDN's stockholders by telephone, telegram, letter or in
person. UDN will request brokers, custodians, nominees and other record holders
to forward copies of this Proxy Statement/Prospectus, Proxies and other
soliciting materials to persons for whom they hold shares of UDN Common Stock
and to request authority for the exercise of Proxies. In such cases, UDN, upon
request of the record holders, will reimburse such holders for their reasonable
expenses.
THE MERGER
REASONS FOR THE MERGER
Each of the Board of Directors and the Special Committee (the "Special
Committee") of UDN and the Board of Directors of STAR have unanimously approved
the terms of the Merger for several reasons. By joining the operations of STAR
and UDN, the Merger will create for STAR a network of independent sales agents
targeted at residential and small to medium-sized commercial customers with a
demand for international calling services at competitive rates. The Merger
provides UDN with a large, well-capitalized parent with a developing,
switch-based network. No assurances can be made, however, that the Merger will
be successful for STAR or UDN.
In reaching a decision to recommend the Merger, each of the UDN and STAR
Boards of Directors and the UDN Special Committee considered a number of factors
in addition to those set forth above. See "The Merger--UDN's Reasons for the
Merger; Recommendations of the UDN Board and Special Committee" and "--STAR's
Reasons for the Merger."
RECOMMENDATIONS TO UDN STOCKHOLDERS
THE UDN BOARD OF DIRECTORS (THE "UDN BOARD") AND THE UDN SPECIAL COMMITTEE
BELIEVE THAT THE MERGER IS FAIR AND IN THE BEST INTERESTS OF UDN AND ITS
STOCKHOLDERS AND UNANIMOUSLY RECOMMEND THAT UDN STOCKHOLDERS VOTE FOR THE
PROPOSAL TO APPROVE AND ADOPT THE MERGER AGREEMENT AND THE TRANSACTIONS
CONTEMPLATED THEREBY. SEE "THE MERGER--UDN'S REASONS FOR THE MERGER;
RECOMMENDATIONS OF THE UDN BOARD AND SPECIAL COMMITTEE."
OWNERSHIP OF STAR AFTER THE MERGER
Based on an Exchange Ratio of 0.146428, STAR anticipates issuing 1,005,571
shares of STAR Common Stock to UDN stockholders in the Merger, which will
constitute approximately 1.7% (on a fully diluted basis) of the outstanding STAR
Common Stock after the Merger. The actual amounts will be based on the numbers
of outstanding shares of both companies and the Exchange Ratio at the time of
the Merger. See "The Merger--The Merger Agreement."
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MANAGEMENT AND OPERATIONS FOLLOWING THE MERGER
It is contemplated that after the Merger, UDN will continue to operate as a
separate entity. STAR does not presently intend to change the domicile, name or
material operations of UDN. STAR has advised UDN, however, that Christopher E.
Edgecomb, Mary A. Casey and Kelly D. Enos will be named as the Directors of UDN.
STAR currently intends that the existing officers of UDN will retain their
offices after the Effective Time, but may appoint additional officers of UDN
from time to time. On September 21, 1998, STAR and UDN entered into a management
agreement (the "UDN Management Agreement") pursuant to which, among other
things, STAR began to provide billing services to UDN and UDN became able to buy
switch services through STAR, thereby giving UDN greater access to more
competitive buying arrangements. See "Management of STAR and UDN--Officers and
Directors of UDN."
OTHER INTERESTS OF OFFICERS AND DIRECTORS IN THE MERGER
In considering the UDN Board's recommendation that UDN stockholders vote in
favor of the Merger Agreement and the transactions contemplated thereby, UDN
stockholders should be aware that John Snedegar, President of UDN, and Dale
Christensen, Chief Operating Officer and Chief Financial Officer of UDN, have
employment agreements that provide them with bonuses and severance benefits
which would take effect if Mr. Snedegar or Mr. Christensen exercises his right
to terminate his employment agreement upon consummation of the Merger. See
"Management of STAR and UDN--UDN Employment Agreements." In addition,
Christopher E. Edgecomb, Chief Executive Officer of STAR, owns 136,000 shares of
UDN Common Stock and David Vaun Crumly, Executive Vice President--Sales and
Marketing of STAR, owns 2,500 shares of UDN Common Stock and holds options to
purchase 18,750 shares of UDN Common Stock. Mr. Snedegar is a Director of both
STAR and UDN. See "The Merger-- Interests of Certain Persons in the Merger."
OPINIONS OF FINANCIAL ADVISOR
In deciding to approve the Merger, the UDN Board and UDN Special Committee
conditioned their approval on the receipt of the opinion of their financial
advisor, Madison Securities, Inc. ("Madison Securities"), as to the fairness of
the Exchange Ratio to the stockholders of UDN from a financial point of view.
This opinion is attached to this Proxy Statement/Prospectus as ANNEX B.
Stockholders of UDN are encouraged to read this opinion in its entirety as it
contains the assumptions made, the procedures followed, the other matters
considered and the limits of the review conducted by Madison Securities in
arriving at its opinion.
For purposes of delivering this opinion, Madison Securities performed a
variety of analyses, including comparing the historical stock prices and
financial multiples of UDN and STAR to each other and to those of other selected
public companies, comparing the financial terms of the Merger to those of other
publicly announced transactions and analyzing the relative values and
contributions of UDN and STAR based upon historical and projected future
financial performance and anticipated benefits of the Merger as provided by the
management of UDN and STAR. See "The Merger--Opinion of Madison Securities,
Financial Advisor to UDN."
CERTAIN INCOME TAX CONSEQUENCES
The Merger has been structured so that, in general, none of UDN, STAR or
their respective stockholders will recognize any gain or loss for U.S. federal
incomes tax purposes in the Merger (except for any cash received by UDN
stockholders in lieu of fractional shares and stockholders exercising
dissenters' rights); provided STAR and UDN comply with certain representations
and warranties. Stockholders of UDN and dissenting stockholders of UDN who are
residents in or citizens of Canada or another foreign jurisdiction may, as a
result of the Merger (or the exercise of appraisal rights in respect of the
Merger) realize or be required to realize a gain or loss on the exchange of
shares under the Merger (or upon the
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exercise of, or any payment being made in connection with, appraisal rights) or
experience other tax consequences. See "Certain Income Tax Consequences."
ACCOUNTING TREATMENT
Consummation of the Merger is conditioned upon receipt of a letter from
UDN's independent public accountants stating that UDN will qualify as a poolable
entity and the receipt of a letter from STAR's independent public accountants
stating that the Merger will qualify as a pooling of interests, which means that
STAR will restate its historical consolidated financial statements to include
the assets, liabilities, stockholders' equity and results of operations of UDN.
See "The Merger--Accounting Treatment of the Merger."
APPRAISAL RIGHTS OF UDN STOCKHOLDERS
Under Delaware law, holders of UDN Common Stock who have not voted in favor
of the Merger Agreement and who have fully complied with the applicable
provisions of Delaware Law have the right to require UDN to purchase for cash
their shares at the fair market value thereof (as determined by agreement with
UDN or by a court) in lieu of shares of STAR Common Stock that they would
otherwise receive in the Merger. Such stockholders exercising such rights
("Dissenting Stockholders") must (i) abstain from voting or vote such shares
against the Merger Agreement, and (ii) deliver to UDN, prior to the taking of
the vote on the Merger Agreement, written notice of such Dissenting
Stockholders' intent to demand payment for such shares. Dissenting Stockholders
must also comply with the other requirements of Section 262 of the Delaware Law,
the full text of which is attached to this Proxy Statement/ Prospectus as ANNEX
C. Any deviation from or failure to comply with all such requirements may result
in the forfeiture of the appraisal rights of Dissenting Stockholders. See
"Appraisal Rights of Stockholders."
THE MERGER AGREEMENT
A COPY OF THE MERGER AGREEMENT IS ATTACHED AS ANNEX A TO THIS PROXY
STATEMENT/PROSPECTUS. UDN'S STOCKHOLDERS ARE STRONGLY ENCOURAGED TO READ THE
MERGER AGREEMENT AS IT IS THE LEGAL DOCUMENT THAT GOVERNS THE MERGER AND THE
TRANSACTIONS CONTEMPLATED THEREBY. THE DISCUSSION OF THE MERGER AGREEMENT IS
QUALIFIED IN ITS ENTIRETY BY THE FULL TEXT THEREOF, ATTACHED HERETO AS ANNEX A.
TERMS OF THE MERGER AGREEMENT
The Merger Agreement provides that, following the approval and adoption of
the Merger Agreement and the transactions contemplated thereby by the
stockholders of UDN and the satisfaction or waiver of certain other conditions,
Newco will be merged with and into UDN. As a result, UDN will become a
wholly-owned subsidiary of STAR after the Merger. The Merger will become
effective when a certificate of merger is accepted for filing by the Secretary
of State of the State of Delaware. See "The Merger--The Merger Agreement."
MERGER CONSIDERATION
As a result of the Merger, UDN's stockholders will receive for each share of
UDN Common Stock a portion of a share (the "Exchange Ratio") of STAR Common
Stock determined by dividing $2.05 by the average closing price of STAR Common
Stock on the Nasdaq National Market for the five (5) trading days prior to the
Effective Time (the "Average Price"), provided that if the Average Price is
equal to or greater than $27.50, or equal to or less than $14.00, the Exchange
Ratio shall be determined by using $27.50 or $14.00, as the case may be, as the
Average Price, which would result in an Exchange Ratio of 0.074545 or 0.146428,
as the case may be. As of February 10, 1999, the Exchange Ratio was 0.146428
share of STAR Common Stock for each share of UDN Common Stock. No fractional
shares of STAR Common Stock will be issued. Instead, UDN stockholders will
receive cash in lieu of any fractional shares of the STAR
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Common Stock. See "The Merger--The Merger Agreement" and "--The Merger
Agreement--Fractional Shares."
A VOTE TO APPROVE AND ADOPT THE MERGER AGREEMENT BY UDN'S STOCKHOLDERS WILL
BE DEEMED APPROVAL OF THE EXCHANGE RATIO. UDN STOCKHOLDERS SHOULD NOT SEND IN
THEIR STOCK CERTIFICATES UNTIL INSTRUCTED TO DO SO AFTER THE MERGER IS FINAL.
ASSUMPTION OF UDN STOCK OPTIONS AND WARRANTS
At or prior to the Effective Time, STAR and UDN shall take all action
necessary to cause the assumption by STAR as of the Effective Time of the
options and warrants to purchase UDN Common Stock outstanding as of the
Effective Time (the "UDN Options" and "UDN Warrants," respectively). Each of the
UDN Options and UDN Warrants shall be converted without any action on the part
of the holder thereof into an option or warrant to purchase a certain number of
shares of STAR Common Stock (based on the Exchange Ratio) on substantially
equivalent terms as of the Effective Time. As of the Record Date, 433,750 shares
of UDN Common Stock were subject to outstanding UDN Options and 302,259 shares
of UDN Common Stock were subject to outstanding UDN Warrants. In addition, UDN
carries $500,000 in convertible debentures convertible into 150,000 shares of
UDN Common Stock. See "The Merger--The Merger Agreement--Treatment of UDN Stock
Options and Warrants."
CONDITIONS TO THE MERGER
Completion of the Merger depends upon the satisfaction of a number of
conditions, including, but not limited to, the following:
(a) the Registration Statement shall have been declared effective by the
Commission;
(b) the approval and adoption of the Merger Agreement and the transactions
contemplated thereby by the requisite vote of the holders of the
outstanding shares of UDN Common Stock entitled to vote thereon at the
Special Meeting;
(c) the approval for listing on the Nasdaq National Market of the STAR
Common Stock issuable to the stockholders of UDN pursuant to the Merger
Agreement;
(d) the approval of governmental authorities, including the Federal
Communications Commission (the "FCC") and state public utility
commissions ("PUCs"), required for the transfer of ownership or control
of UDN;
(e) the receipt by UDN of the opinion of Madison Securities that the
Exchange Ratio contemplated by the Merger Agreement is fair, from a
financial point of view, to the UDN stockholders;
(f) not more than 5% of the outstanding shares of UDN Common Stock
exercising appraisal rights; and
(g) the receipt by STAR of letters from Arthur Andersen LLP approving the
accounting treatment of the Merger as a "pooling of interests" and from
PricewaterhouseCoopers LLP that UDN is a poolable entity, and the SEC
shall not have objected to such accounting treatment.
Certain conditions to the Merger may be waived by the party entitled to
assert the condition. See "The Merger--The Merger Agreement--Conditions."
REGULATORY APPROVALS
The Merger is subject to the requirements of the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, as amended, and the rules and regulations promulgated
thereunder (the "HSR Act"). The HSR Act prohibits consummation of the Merger
until certain information has been furnished to the Antitrust
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Division of the Department of Justice and to the Federal Trade Commission and a
required waiting period has expired. Early termination of the waiting period
with respect to STAR and UDN's filings under the HSR Act was granted on June 16,
1998. The Department of Justice or the Federal Trade Commission may still
challenge the Merger on antitrust grounds before or after the Merger is final.
Consummation of the Merger is contingent upon the receipt of approvals from the
FCC, various PUCs and various municipalities with respect to the Merger. STAR
and UDN have received the necessary approvals from these government agencies.
See "The Merger--Regulatory Approvals."
NEGOTIATIONS
Pursuant to the Merger Agreement, and subject to certain conditions and
exceptions, UDN has agreed not to, directly and indirectly, solicit, initiate or
participate in discussions or negotiations with or the submission of any offer
or proposal by or provide any information to, any corporation, partnership,
person or other entity or group (other than STAR or Newco) concerning a proposal
to acquire (by means of a tender or exchange offer, merger, consolidation,
business combination or otherwise) all or a substantial portion of the
outstanding shares of UDN Common Stock or the assets of UDN and its
subsidiaries. UDN, however, may take certain actions with respect to the
above-described transactions where doing so is necessary for the UDN Board to
comply with its fiduciary responsibilities under applicable laws as advised by
counsel in writing. See "The Merger--Negotiations."
TERMINATION OF THE MERGER AGREEMENT
UDN and STAR may agree, by mutual written consent, to terminate the Merger
Agreement without completing the Merger. Moreover, either UDN or STAR may
terminate the Merger Agreement if, among other things, any of the following
occurs:
(a) the UDN Board of Directors fails to recommend, withdraws, modifies or
amends its approval or recommendation of the Merger and the transactions
contemplated by the Merger Agreement;
(b) the requisite approval of the UDN stockholders is not received;
(c) the other party breaches any of its representations and warranties or
fails to perform any of its covenants and agreements, which breaches and
failures are, in the aggregate, material in the context of the
transactions contemplated by the Merger Agreement; or
(d) the Merger is not completed on or before April 15, 1999; provided that
if such failure is the result of an injunction or order of a court or
governmental or regulatory body resulting from an action or proceeding
commenced by any party which is not a governmental authority, then at the
request of either party, the deadline date shall be extended for a
reasonable period of time, not in excess of 120 days, to permit the
parties to have such injunction vacated or order reversed.
TERMINATION FEES
The Merger Agreement requires UDN to pay to STAR a termination fee of $2.0
million if the Merger Agreement terminates for certain reasons. See "The
Merger--The Merger Agreement--Termination Fee."
OTHER AGREEMENTS
In connection with the execution of the Merger Agreement on November 19,
1997 and the first amendment thereto on January 30, 1998, STAR loaned $2.5
million and $2.0 million to UDN, respectively. Pursuant to separate promissory
notes executed by UDN in favor of STAR, interest on the outstanding principal
amount of the notes will be repaid in full on the Maturity Date of each
promissory note. The unpaid principal amount of each note currently bears
interest at the "Prime Rate" per annum (as reported in the WALL STREET JOURNAL)
plus 1%, which rate shall be reset quarterly. Upon execution of the Merger
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Agreement, John R. Snedegar, President of UDN, executed a Proxy Agreement
granting STAR an irrevocable proxy to vote all shares of UDN Common Stock held,
beneficially or of record, by Mr. Snedegar in favor of the Merger and in
opposition of any other proposal for any merger, reorganization,
recapitalization, sale of assets or stock of UDN or any of its subsidiaries. As
of February 1, 1999, Mr. Snedegar held 769,147 shares, or approximately 11.2%,
of the outstanding UDN Common Stock. STAR and UDN have entered into the UDN
Management Agreement, which provides, among other things, for the management by
STAR of UDN's customer billings.
OTHER CONSIDERATIONS
COMPARATIVE RIGHTS OF STOCKHOLDERS OF UDN AND STAR
The rights of UDN stockholders are currently governed by Delaware law, UDN's
Certificate of Incorporation and UDN's Bylaws. After the Merger, UDN
stockholders will become STAR stockholders and their rights will be governed by
Delaware law, STAR's Certificate of Incorporation and STAR's Bylaws. There are
various differences between the existing rights of UDN stockholders and the
rights of STAR stockholders, including, among others, certain provisions of
STAR's Certificate of Incorporation that may have the effect of deterring or
making it more difficult for a third party to acquire control of STAR. See
"Comparative Rights of Stockholders."
STOCK EXCHANGE LISTING
STAR intends to apply to have the shares of STAR Common Stock to be issued
in the Merger listed on the Nasdaq National Market. The listing on the Nasdaq
National Market of the STAR Common Stock issuable in the Merger is a condition
to UDN's obligation to consummate the Merger. See "The Merger-- Stock Exchange
Listing."
COMPARATIVE STOCK PRICES
Shares of STAR Common Stock are listed on the Nasdaq National Market and
shares of UDN Common Stock are listed on the Vancouver Stock Exchange. On
November 18, 1997, the last full trading day prior to the public announcement of
the proposed Merger, UDN Common Stock closed at $2.15 per share, and STAR Common
Stock closed at $15.183 per share. On February 10, 1999, the last full trading
day prior to the date of this Proxy Statement/Prospectus, UDN Common Stock
closed at $1.32 per share, and STAR Common Stock closed at $13.25 per share.
STAR has never paid cash dividends on the STAR Common Stock and does not intend
to pay such dividends in the foreseeable future. In addition, STAR is restricted
by its revolving credit facility from paying cash dividends without the lender's
consent. UDN has never paid dividends on the UDN Common Stock and does not
intend to pay dividends prior to consummation of the Merger. See "The
Merger--Comparative Stock Prices."
RESALE RESTRICTIONS
At or prior to the Effective Time, the STAR Common Stock issuable in
connection with the Merger shall have been registered under the Securities Act.
Accordingly, all shares of STAR Common Stock received by UDN stockholders in the
Merger will be freely transferable in the U.S., except that the stockholders
deemed "affiliates" of UDN at the time the Merger becomes final are subject to
certain regulatory restrictions and restrictions relating to the publication of
the combined operating results of STAR and UDN under the Merger Agreement
regarding the resale of their shares of STAR Common Stock. For the UDN
stockholders resident in jurisdictions other than the U.S., the free
transferability of the STAR Common Stock may vary dependent on the laws of that
jurisdiction and, accordingly, each stockholder of UDN Common Stock so affected
should consult his, her or its legal or other advisors. See "The Merger--Resale
of Shares of STAR Common Stock Issued in the Merger; Affiliates."
14
<PAGE>
RISK FACTORS
The information set forth under "Risk Factors" should be reviewed and
carefully considered by the stockholders of UDN in evaluating the Merger
Agreement.
15
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA OF
STAR TELECOMMUNICATIONS, INC.
The following selected consolidated financial data should be read in
conjunction with STAR's Consolidated Financial Statements and Notes thereto and
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations of STAR," each of which is included elsewhere in this Proxy
Statement/Prospectus. The consolidated statements of operations data for the
years ended December 31, 1995, 1996 and 1997, and the balance sheet data at
December 31, 1996 and 1997 are derived from audited financial statements
included elsewhere in this Proxy Statement/Prospectus. The consolidated
statement of operations data for the year ended December 31, 1994 and the
consolidated balance sheet data at December 31, 1994 and September 30, 1997 are
unaudited and are derived from unaudited financial statements not included in
this Proxy Statement/Prospectus. The consolidated balance sheet data at December
31, 1995 is derived from audited financial statements not included in this Proxy
Statement/ Prospectus. The consolidated statements of operations data for the
nine months ended September 30, 1997 and 1998 and the consolidated balance sheet
data at September 30, 1998 are unaudited and are derived from unaudited
financial statements included elsewhere in this Proxy Statement/Prospectus.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
---------------------------------------------- ----------------------
1994 1995 1996 1997 1997 1998
----------- --------- ---------- ---------- ---------- ----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Revenues................................... $ 24,512 $ 58,937 $ 259,697 $ 404,605 $ 283,374 $ 425,531
Operating expenses:
Cost of services......................... 16,042 44,270 225,957 351,821 246,712 363,794
Selling, general and administrative...... 5,066 10,452 35,956 36,496 25,118 38,853
Depreciation and amortization............ 106 368 1,442 4,637 3,040 8,055
Merger expense........................... -- -- -- 286 -- 314
----------- --------- ---------- ---------- ---------- ----------
Total operating expenses................. 21,214 55,090 263,355 393,240 274,870 411,016
----------- --------- ---------- ---------- ---------- ----------
Income (loss) from operations............ 3,298 3,847 (3,658) 11,365 8,504 14,515
Other income (expense):
Interest income.......................... 3 22 110 492 367 3,511
Interest expense......................... -- (64) (609) (1,738) (1,289) (2,080)
Legal settlements and expenses........... -- -- (100) (1,653) -- --
Other.................................... (7) (33) 39 208 (1,499) (171)
----------- --------- ---------- ---------- ---------- ----------
Income (loss) before provision for income
taxes.................................. 3,294 3,772 (4,218) 8,674 6,083 15,775
Provision for income taxes................. 22 66 577 2,905 2,406 6,643
----------- --------- ---------- ---------- ---------- ----------
Net income (loss).......................... $ 3,272 $ 3,706 $ (4,795) $ 5,769 $ 3,677 $ 9,132
----------- --------- ---------- ---------- ---------- ----------
----------- --------- ---------- ---------- ---------- ----------
Pro forma net income (loss)
(unaudited)(1)........................... $ 1,943 $ 2,140 $ (5,738) $ 5,574 $ 3,365
----------- --------- ---------- ---------- ----------
----------- --------- ---------- ---------- ----------
Income per share(2)........................ $ 0.18 $ 0.19 $ (0.21) $ 0.19 $ 0.13 $ 0.23
----------- --------- ---------- ---------- ---------- ----------
----------- --------- ---------- ---------- ---------- ----------
Diluted income per share(2)................ $ 0.18 $ 0.19 $ (0.21) $ 0.17 $ 0.12 $ 0.22
----------- --------- ---------- ---------- ---------- ----------
----------- --------- ---------- ---------- ---------- ----------
Pro forma income (loss) per share
(unaudited)(2)........................... $ 0.11 $ 0.11 $ (0.25) $ 0.18 $ 0.12
----------- --------- ---------- ---------- ----------
----------- --------- ---------- ---------- ----------
Pro forma diluted income (loss) per share
(unaudited)(2)........................... $ 0.11 $ 0.11 $ (0.25) $ 0.17 $ 0.11
----------- --------- ---------- ---------- ----------
----------- --------- ---------- ---------- ----------
</TABLE>
16
<PAGE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
---------------------------------------------- ----------------------
1994 1995 1996 1997 1997 1998
----------- --------- ---------- ---------- ---------- ----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
(IN THOUSANDS)
Weighted average number of common shares
outstanding(2)........................... 18,218 19,373 23,292 30,221 28,650 39,147
Weighted average number of diluted common
shares outstanding(2).................... 18,218 19,373 23,292 32,978 31,580 40,921
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF SEPTEMBER 30,
--------------------------------------------- ---------------------
1994 1995 1996 1997 1997 1998
----------- --------- --------- ---------- --------- ----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
(IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA:
Working capital (deficit).................. $ 2,135 $ 976 $ (7,729) $ 13,760 $ 20,744 $ 116,565
Total assets............................... 9,081 26,582 63,054 120,316 108,062 334,020
Total long-term liabilities, net of current
portion.................................. 21 919 6,839 12,970 12,599 32,691
Retained earnings (deficit)................ 1,377 867 (3,238) 1,534 (354) 10,666
Stockholders' equity....................... 2,956 3,808 6,897 43,201 40,822 205,065
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
----------------------------------------------- ------------------------
1994 1995 1996 1997 1997 1998
----------- ---------- ---------- ---------- ---------- ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
(IN THOUSANDS, EXCEPT PER MINUTE DATA)
OTHER CONSOLIDATED FINANCIAL AND
OPERATING DATA:
Capital expenditures(3)................. $ 515 $ 2,716 $ 13,646 $ 25,422 $ 16,879 $ 85,947
Wholesale billed minutes of use(4)...... -- 38,106 479,681 863,295 580,757 1,119,278
Wholesale revenue per billed minute of
use(5)................................ $ -- $ 0.4102 $ 0.4288 $ 0.3997 $ 0.4130 $ 0.3290
</TABLE>
- ------------------------
(1) The pro forma net income or loss per share assumes that both STAR and L.D.
Services, Inc. ("LDS"), which was acquired by STAR in a pooling of interests
transaction on November 30, 1997, were C-corporations for all periods
presented.
(2) See Note 2 of Notes to STAR Consolidated Financial Statements for an
explanation of the method used to determine the number of shares used in
computing income and pro forma income (loss) per share.
(3) Includes assets financed with capital leases or notes. See Note 2 of Notes
to STAR Consolidated Financial Statements.
(4) Does not include wholesale billed minutes of use from T-One Corp. ("T-One")
prior to the T-One merger in March 1998.
(5) Represents wholesale gross call usage revenue per billed minute. Amounts
exclude other revenue related items such as finance charges. This data does
not include wholesale billed minutes of use from T-One prior to the T-One
merger in March 1998.
17
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA OF
PT-1 COMMUNICATIONS, INC.
The following selected financial data should be read in conjunction with
PT-1's Consolidated Financial Statements and Notes thereto and with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations of PT-1," each of which is included elsewhere in this Proxy
Statement/ Prospectus. The consolidated statements of operations data for the
period ended March 31, 1996 and for the fiscal years ended March 31, 1997 and
1998, and the balance sheet data at March 31, 1997 and 1998 have been derived
from PT-1's audited financial statements and notes thereto, which are included
elsewhere in this Proxy Statement/Prospectus. The consolidated statements of
operations data for the six months ended September 30, 1998 and 1997 and the
consolidated balance sheet data at September 30, 1998 and 1997 are unaudited and
are derived from unaudited financial statements included elsewhere in this Proxy
Statement/Prospectus.
<TABLE>
<CAPTION>
PERIOD FROM
APRIL 21, 1995 FISCAL YEARS ENDED SIX MONTHS ENDED
(INCEPTION)(1) MARCH 31, SEPTEMBER 30,
TO ---------------------- -------------------------
MARCH 31, 1996 1997 1998 1997
--------------- ---------- ---------- ---------- 1998
-------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Revenues(2)................................. $ 11,922 $ 169,635 $ 431,520 $ 187,044 $ 268,919
Operating expenses:
Cost of services.......................... 13,812 166,184 395,501 170,753 248,222
Selling general and administrative........ 1,017 4,300 15,063 5,551 15,326
Depreciation and amortization............. 5 75 1,535 386 1,714
Merger costs.............................. -- -- -- -- 975
Stock based compensation(3)............... -- 7,300 2,661 1,856 382
------- ---------- ---------- ---------- -------------
Total operating expenses................ 14,834 177,859 414,760 178,546 266,619
Operating profit (loss)..................... (2,912) (8,224) 16,760 8,498 2,300
Earnings (loss) before income taxes......... (2,910) (8,120) 16,730 8,527 1,724
Income tax provision........................ -- -- 5,150 2,018 355
Net earnings (loss)......................... $ (2,910) $ (8,120) $ 11,580 $ 6,509 $ 1,369
------- ---------- ---------- ---------- -------------
------- ---------- ---------- ---------- -------------
Net earnings (loss) per share(4)
Basic..................................... $ (.05) $ (.13) $ .25 $ .14 $ .03
Diluted................................... $ (.05) $ (.13) $ .24 $ .14 $ .03
Weighted average number of common shares and
common share equivalents(4):
Basic..................................... 60,900 60,681 46,922 45,708 48,407
Diluted................................... 60,900 60,681 47,720 46,987 48,587
</TABLE>
<TABLE>
<CAPTION>
AS OF MARCH 31, AS OF SEPTEMBER 30,
------------------------------------ ------------------------
1996 1997 1998 1997 1998
--------- ---------- ------------- ---------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
(IN THOUSANDS, EXCEPT PER MINUTE DATA)
BALANCE SHEET DATA:
Cash and cash equivalents........................ $ 694 $ 5,577 $ 12,390 $ 11,546 $ 5,382
Working capital (deficit)........................ (3,064) (17,426) (21,720) (20,456) (38,484)
Property and equipment, net...................... 69 1,484 22,609 9,152 43,480
Total assets..................................... 2,186 18,899 87,677 48,678 106,952
Long term debt, less current portion............. -- 5,000 -- 5,000 --
Total shareholders' (deficiency)................. (2,907) (18,727) (1,221) (10,363) 395
</TABLE>
18
<PAGE>
<TABLE>
<CAPTION>
AS OF MARCH 31, AS OF SEPTEMBER 30,
------------------------------------ ------------------------
1996 1997 1998 1997 1998
--------- ---------- ------------- ---------- ------------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER MINUTE DATA)
<S> <C> <C> <C> <C> <C>
OTHER FINANCIAL AND OPERATING DATA:
Capital expenditures............................. $ 74 $ 1,489 $ 11,255 $ 7,949 $ 22,086
Number of PINs activated......................... N/A 31,087 60,688 28,694 30,660
Billed minutes of use(5)......................... 38,977 615,006 1,676,619 687,007 1,215,280
Revenues per billed minute of use(2)............. .31 .28 .26 .27 .22
</TABLE>
- ------------------------
(1) PT-1 was incorporated in New York on April 21, 1995 and had limited
operations until July 1995.
(2) Revenues are recorded net of distributor discounts and are not necessarily
comparable to other telecommunications carriers.
(3) Relates to (i) the grant to Joseph Pannullo, an executive officer of PT-1,
on May 9, 1997, of options to purchase 1,048,600 shares of PT-1 Common Stock
exercisable at a nominal price; (ii) the grant to certain other employees of
PT-1 of options to purchase shares of PT-1 Common Stock with a value of
$850,000, exercisable at a nominal price; (iii) the grant to Helene Kidary,
an employee, on September 30, 1997, of options to purchase 10,000 shares of
PT-1 Common Stock exercisable at a nominal price; (iv) warrants issued to
certain employees of InterExchange, Inc. ("InterExchange") to acquire shares
of PT-1 Common Stock with a fair value of $3 million at an aggregate
exercise price of $1.0 million, and (v) the issuance of shares on March 31,
1997 to two officers of PT-1 in accordance with commitments made in July
1995 and March 1996, the dates they joined PT-1. Such shares were issued in
connection with the settlement agreement dated March 27, 1997. See Notes 5
and 8 of Notes to PT-1's Consolidated Financial Statements.
(4) See Note 1 to the PT-1 Financial Statements for an explanation of the method
used to determine the number of shares used in computing net earnings (loss)
per share and weighted average number of common shares and common share
equivalents.
(5) "Billed minutes of use" represents minutes billed by underlying carriers for
terminating PT-1's long distance traffic.
19
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA OF
UNITED DIGITAL NETWORK, INC.
The following selected consolidated financial data should be read in
conjunction with UDN's Consolidated Financial Statements and Notes thereto and
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations of UDN," which are included elsewhere in this Proxy
Statement/Prospectus. The statement of income data for the years ended April 30,
1995, 1996 and 1997, and for the eight months ended December 31, 1997, and the
balance sheet data at April 30, 1996 and 1997 and December 31, 1997 are derived
from audited financial statements included elsewhere in this Proxy
Statement/Prospectus. The statement of operations data for the years ended April
30, 1993 and 1994 and the balance sheet data at April 30, 1993, 1994 and 1995
are derived from audited financial statements not included in this Proxy
Statement/Prospectus. The data presented for the nine-month periods ended
September 30, 1997 and 1998 are derived from unaudited financial statements and
include, in the opinion of UDN's management, all adjustments necessary to
present fairly the data for such periods. The results for an interim period are
not necessarily indicative of the results to be expected for a full fiscal year.
<TABLE>
<CAPTION>
EIGHT NINE MONTHS ENDED
YEAR ENDED APRIL 30, MONTHS ENDED SEPTEMBER 30,
----------------------------------------------------- DECEMBER 31, --------------------
1993 1994 1995 1996 1997 1997 1997 1998
--------- --------- --------- --------- --------- ------------- --------- ---------
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF INCOME
DATA:
Revenues........................... $ 2,495 $ 1,465 $ 2,338 $ 8,027 $ 24,012 $ 21,078 $ 22,249 $ 23,811
Operating expenses:
Cost of services................. 1,619 1,186 1,918 6,030 18,455 16,889 16,986 18,626
Selling, general and
administrative................. 962 1,278 1,941 2,675 5,155 6,162 5,415 5,681
Provision for doubtful
accounts......................... -- -- 75 229 693 3,144 904 721
Depreciation and amortization.... 498 270 273 584 901 698 720 836
--------- --------- --------- --------- --------- ------------- --------- ---------
Total operating expenses........... 3,079 2,734 4,207 9,518 25,204 26,893 24,025 25,864
--------- --------- --------- --------- --------- ------------- --------- ---------
Loss from operations............... (584) (1,269) (1,869) (1,491) (1,192) (5,815) (1,776) (2,053)
Other income (expense):
Interest income.................. 1 1 2 43 28 23 19 34
Interest expense................. (148) (110) (87) (150) (661) (641) (699) (751)
Other............................ (719) -- (119) (64) -- (6,432) -- (299)
--------- --------- --------- --------- --------- ------------- --------- ---------
Loss before income tax benefit,
extraordinary gain and
discontinued operations.......... (1,450) (1,378) (2,073) (1,662) (1,825) -- (2,456) (3,069)
Income tax benefit, net of tax..... -- -- -- -- 50 -- 27 --
Extraordinary gain on debt
restructuring.................... -- -- -- -- 97 -- 52 --
Loss from discontinued
operations....................... -- (128) -- -- -- -- -- --
Net loss........................... $ (1,450) $ (1,506) $ (2,073) $ (1,662) $ (1,678) $ (6,432) $ (2,378) $ (3,069)
--------- --------- --------- --------- --------- ------------- --------- ---------
--------- --------- --------- --------- --------- ------------- --------- ---------
Net loss per share (basic and
diluted)......................... $ (1.41) $ (.96) $ (0.92) $ (0.45) $ (0.31) $ (0.98) $ (0.39) $ (0.44)
Weighted average shares............ 1,028 1,568 2,253 3,707 5,359 6,546 6,022 6,989
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
EIGHT MONTHS
APRIL 30, ENDED SEPTEMBER 30,
------------------------------- DECEMBER 31, ----------------------
1995 1996 1997 1997 1997 1998
--------- --------- --------- ------------- --------- -----------
(IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash................................................ $ 121 $ 1,074 $ 556 $ 45 $ 74 $ 1,060
Working capital deficit............................. (1,487) (2,041) (3,184) (9,855) (5,270) (12,535)
Total assets........................................ 4,522 10,587 13,196 12,529 14,825 13,884
Total long-term liabilities, net of current
portion........................................... 653 2,061 1,995 1,044 1,128 233
Retained deficit.................................... (5,498) (7,161) (8,839) (15,271) (10,117) (18,340)
Total stockholders' equity (deficit)................ 1,116 2,806 3,089 (2,586) 1,929 (5,263)
</TABLE>
<TABLE>
<CAPTION>
EIGHT MONTHS NINE MONTHS ENDED
YEAR ENDED APRIL 30, ENDED SEPTEMBER 30,
----------------------------------------------------- DECEMBER 31, --------------------
1993 1994 1995 1996 1997 1997 1997 1998
--------- --------- --------- --------- --------- ------------- --------- ---------
(IN THOUSANDS, EXCEPT FOR PER SHARE AND PER MINUTE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
OTHER CONSOLIDATED FINANCIAL AND
OPERATING DATA:
Cash provided by (used in)
operating activities............. $ (348) $ (1,149) $ (1,819) $ (1,345) $ 238 $ (2,347) $ (651) $ (1,130)
Cash used in investing
activities....................... (1,368) (31) (239) (658) (948) (420) (516) (76)
Cash provided by (used in)
financing activities............. 1,660 (1,528) 2,063 2,956 193 2,256 632 2,221
Capital expenditures............... 408 189 194 186 674 473 223 135
</TABLE>
21
<PAGE>
COMPARATIVE PER SHARE DATA
The following table presents certain historical, pro forma and pro forma
equivalent per share financial data with respect to shares of STAR Common Stock
and UDN Common Stock. Also presented below is pro forma data assuming that
STAR's merger with PT-1 Communications, Inc. ("PT-1") is completed and all prior
STAR financial data has been restated to show the effect of such transaction on
STAR, UDN and PT-1, collectively. See "Risk Factors--Risks Inherent in
Acquisition Strategy." The pro forma data does not purport to be indicative of
the results of future operations or the results that would have occurred had the
Merger been consummated on such dates. The information presented herein should
be read in conjunction with the Unaudited Pro Forma Financial Data, including
the notes thereto, appearing elsewhere in this Proxy Statement/Prospectus. See
"Unaudited Pro Forma Financial Data".
<TABLE>
<CAPTION>
EQUIVALENT PRO FORMA
PRO FORMA UDN COMBINED
HISTORICAL ------------------------ --------------------------
---------------------- EXCLUDING INCLUDING STAR AND STAR, UDN
STAR(1) UDN PT-1(2) PT-1(3) UDN(4) AND PT-1(5)
----------- --------- ----------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
BASIC INCOME (LOSS) PER COMMON SHARE FOR(6):
Year ended December 31, 1995.................. $ 0.11 $ (0.57) $ 0.00 $ $ 0.05 $
Year ended December 31, 1996.................. (0.25) (0.22) (0.03) (0.29)
Year ended December 31, 1997.................. 0.18 (1.15) 0.00 0.00 0.03 0.03
Nine months ended September 30, 1997.......... 0.12 (0.39) 0.01 (0.01) 0.07 (0.07)
Nine months ended September 30, 1998.......... 0.23 (0.44) 0.02 0.00 0.19 0.05
DILUTED INCOME (LOSS) PER COMMON SHARE FOR(6):
Year ended December 31, 1995.................. $ 0.11 $ (0.57) $ 0.00 $ $ 0.05 $
Year ended December 31, 1996.................. (0.25) (0.22) (0.03) (0.29)
Year ended December 31, 1997.................. 0.17 (1.15) 0.00 0.00 0.03 0.03
Nine months ended September 30, 1997.......... 0.11 (0.39) 0.01 (0.01) 0.06 (0.07)
Nine months ended September 30, 1998.......... 0.22 (0.44) 0.02 0.00 0.18 0.05
BOOK VALUE PER COMMON SHARE AT:
September 30, 1998(7)......................... $ 4.86 $ (0.75) $ 0.40 $ 0.52 $ 4.63 $ 6.04
CASH DIVIDENDS DECLARED PER COMMON SHARE(8)... -- -- -- -- -- --
</TABLE>
- ------------------------
(1) The STAR historical per share financial data includes the effect of STAR's
acquisition of T-One which was completed on March 10, 1998.
(2) The equivalent pro forma UDN per share data is computed by multiplying the
corresponding pro forma combined STAR and UDN amounts by an estimated
exchange ratio of 0.086772.
(3) The equivalent pro forma UDN per share data is computed by multiplying the
corresponding pro forma combined STAR, UDN and PT-1 amounts by an estimated
exchange ratio of 0.086772.
(4) The pro forma combined STAR and UDN per share data assumes that the PT-1
Merger has not been completed and that all prior financial data has been
restated to show the effect of the Merger.
(5) The pro forma combined equivalent per share data for STAR, UDN and PT-1
reflects the pro forma combined equivalent STAR and UDN per share data and
further adjusts the data to reflect the acquisition of PT-1 as if the PT-1
Merger had occurred on January 1, 1997 for the year ended December 31, 1997
and the nine months ended September 30, 1998 and that the PT-1 Merger had
occurred on September 30, 1998 in the case of book value data at September
30, 1998. This pro forma
22
<PAGE>
data reflects an exchange ratio of 0.31607 of a share of STAR Common Stock
for each share of PT-1 Common Stock in the Merger (see Note 3 to Notes to
Unaudited Pro Forma Condensed Combined Financial Data).
(6) Assumes that both STAR and LDS, which was acquired by STAR in a pooling of
interests transaction on November 30, 1997, were C-corporations for all
periods presented.
(7) The historical book value per common share of each of STAR, UDN and PT-1 is
computed by dividing stockholders' equity by the number of shares of STAR
Common Stock, UDN or PT-1 Common Stock, as the case may be, outstanding at
September 30, 1998. The equivalent pro forma UDN book values per common
share are computed by multiplying the corresponding pro forma combined STAR
and UDN or STAR, UDN and PT-1 book values per common share by an estimated
exchange ratio of 0.086772. The pro forma combined book values per common
share are computed by dividing pro forma stockholders equity of STAR and UDN
combined or STAR, UDN and PT-1 combined, as applicable, by pro forma shares
outstanding at September 30, 1998.
(8) The amounts do not consider distributions to LDS S-Corporation shareholders
prior to LDS' merger with STAR on November 30, 1997.
23
<PAGE>
SUMMARY UNAUDITED PRO FORMA FINANCIAL DATA
The following table presents summary unaudited pro forma financial data that
was derived from the unaudited pro forma financial data included elsewhere in
this Proxy Statement/Prospectus and should be read in conjunction therewith and
with the related notes thereto. See "Unaudited Pro Forma Financial Data." The
following summary unaudited pro forma financial data is presented assuming the
Merger will be accounted for as a pooling of interests, whereby STAR will
restate its historical consolidated financial statements to include the assets,
liabilities, stockholders' equity (deficit) and results of operations of UDN.
The statement of operations data set forth below reflects the combination of the
historical operating results of STAR for the years ended December 31, 1995, 1996
and 1997 and the nine months ended September 30, 1997 and 1998, the historical
operating results of UDN for the twelve months ended January 31, 1996, 1997 and
1998 and the nine months ended September 30, 1997 and 1998, respectively, and
the effect of the PT-1 acquisition for the year ended December 31, 1997 and the
nine month periods ended September 30, 1997 and 1998. The balance sheet data set
forth below reflects the combination of the historical balance sheet data of
STAR with the historical balance sheet data of UDN plus the effect of the PT-1
acquisition as of September 30, 1998. STAR reports its financial data on the
basis of a December 31 fiscal year, and PT-1 reports its financial data on the
basis of a March 31 fiscal year. Through April 30, 1997, UDN reported its
financial data on the basis of an April 30 fiscal year. Subsequently, UDN
changed its fiscal year end to December 31.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------- --------------------
1995 1996 1997 1997 1998
--------- --------- --------- --------- ---------
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA(1):
REVENUES....................................................... $ 64,605 $ 279,123 $ 816,710 $ 520,494 $ 777,812
OPERATING EXPENSES:
Cost of services............................................. 48,569 240,749 721,361 457,612 679,233
Selling, general and administrative.......................... 12,946 40,519 66,751 48,223 69,111
Depreciation and amortization................................ 852 2,260 16,233 10,987 18,164
--------- --------- --------- --------- ---------
Total operating expenses:.................................... 62,367 283,528 804,345 516,822 766,508
--------- --------- --------- --------- ---------
Income (loss) from operations................................ 2,238 (4,405) 12,365 3,672 11,304
--------- --------- --------- --------- ---------
OTHER INCOME (EXPENSE):
Interest income.............................................. 10 114 -- -- 2,776
Interest expense............................................. (155) (1,057) (3,839) (2,667) (3,722)
Legal settlement and expenses................................ -- (100) (1,653) -- --
Other income (expense)....................................... (216) 56 276 (1,256) (274)
--------- --------- --------- --------- ---------
Total other income (expense):................................ (361) (987) (5,216) (3,923) (1,220)
--------- --------- --------- --------- ---------
Income (loss) before provision for income taxes.............. 1,877 (5,392) 7,149 (251) 10,084
PROVISION FOR INCOME TAXES..................................... 813 1,470 5,790 2,921 7,105
--------- --------- --------- --------- ---------
Net income (loss) before extraordinary gain.................. 1,064 (6,862) 1,359 (3,172) 2,979
Extraordinary gain on debt restructuring..................... -- -- -- 52 --
--------- --------- --------- --------- ---------
NET INCOME (LOSS).............................................. $ 1,064 $ (6,862) $ 1,359 $ (3,120) $ 2,979
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Earnings (loss) per common share:
Basic........................................................ $ 0.05 $ (0.29) $ 0.03 $ (0.07) $ 0.05
Diluted...................................................... $ 0.05 $ (0.29) $ 0.03 $ (0.07) $ 0.05
Weighted average number of common shares outstanding:
Basic........................................................ 19,662 23,730 46,071 44,473 55,052
Diluted...................................................... 19,662 23,730 48,828 44,473 56,826
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30,
1998
-------------
(UNAUDITED)
<S> <C>
BALANCE SHEET DATA:
Working capital.................................................................................. $ 32,793
Total assets..................................................................................... 585,461
Long term obligations (including current portion)................................................ 49,171
Stockholders equity.............................................................................. 351,259
</TABLE>
- ------------------------------
(1) Assumes that both STAR and LDS, which was acquired by STAR in a pooling of
interests transaction on November 30, 1997, were C-corporations for all
periods presented.
24
<PAGE>
RISK FACTORS
THE FOLLOWING RISK FACTORS SHOULD BE CONSIDERED CAREFULLY IN ADDITION TO THE
OTHER INFORMATION CONTAINED IN THIS PROXY STATEMENT/PROSPECTUS IN CONSIDERING
WHETHER TO APPROVE AND ADOPT THE MERGER AGREEMENT AND THE TRANSACTIONS
CONTEMPLATED THEREBY. THIS PROXY STATEMENT/PROSPECTUS CONTAINS, IN ADDITION TO
HISTORICAL INFORMATION, "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF
SECTION 27A OF THE SECURITIES ACT THAT INVOLVE RISKS AND UNCERTAINTIES. STAR'S
ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE PROJECTED IN THE FORWARD-LOOKING
STATEMENTS. FACTORS THAT MAY CAUSE SUCH A DIFFERENCE INCLUDE, BUT ARE NOT
LIMITED TO, THOSE SET FORTH BELOW AND ELSEWHERE IN THIS PROXY
STATEMENT/PROSPECTUS. SEE "DESCRIPTION OF FORWARD-LOOKING STATEMENTS."
REFERENCES HEREIN (A) TO PT-1 SHALL BE DEEMED TO BE A REFERENCE TO PT-1 AS A
WHOLLY-OWNED SUBSIDIARY OF STAR, AND (B) TO STAR OR UDN SHOULD BE CONSIDERED TO
REFER TO STAR AND UDN OPERATING AS A COMBINED ENTITY AFTER THE CONSUMMATION OF
THE MERGER.
NO ASSURANCE THAT STAR WILL REALIZE ANTICIPATED BENEFITS FROM THE PT-1 MERGER
STAR's acquisition of PT-1 is the most significant transaction in the
history of STAR. The PT-1 Merger involves the combination of certain aspects of
two companies that have operated independently. The process of integrating the
STAR and PT-1 businesses, operations and employees will present a significant
challenge to STAR's management and may lead to unanticipated costs. Accordingly,
there can be no assurance that PT-1 can be successfully integrated into STAR or
that STAR and its stockholders (including persons who became stockholders as a
result of the PT-1 Merger) will ultimately realize any of the anticipated
benefits of the PT-1 Merger.
STAR's business has historically focused on providing switched voice
services on a wholesale basis, primarily to U.S.-based long distance carriers.
Alternatively, PT-1's operations are primarily focused on the marketing of
Prepaid Cards to the retail marketplace of individual end-users. Thus, STAR and
PT-1 operate in fundamentally different business segments of the
telecommunications market. These differences create real challenges to the
ability of STAR to integrate PT-1 operations and personnel. Difficulties in the
integration process may occur due to, among other things, PT-1's emphasis on
marketing of particular Prepaid Cards to specific segments of the retail market,
its need to maintain strong ties to a network of independent distributors,
PT-1's need for the continual introduction of new products into the domestic
market to achieve desired growth and the distance between STAR's Santa Barbara
headquarters and PT-1's New York-based operations. Their can be no assurance
that STAR will be able to overcome these challenges to integration.
In addition, the integration of the STAR and PT-1 accounting and personnel
administrative functions involves the risk that key employees in those
operations, who can not be easily replaced, will leave even when offered
continuing employment. The integration approach adopted by STAR with respect to
PT-1 requires the devotion of a significant amount of time by senior executives,
which may detract from business operations and the development of the combined
companies.
In considering the PT-1 Merger, the STAR Board considered, among other
things, the cost savings, operating efficiencies and other synergies expected to
result following the consummation thereof. There can be no assurance that any of
such cost savings, operating efficiencies or other synergies will be
accomplished as rapidly as currently expected or at all or that such savings and
synergies will not be offset by increases in other expenses or operating losses,
including losses due to problems arising from the integration of STAR and PT-1.
RISKS RELATING TO THE PREPAID CARD BUSINESS
PT-1's operations and the Prepaid Card business in general have a number of
inherent risks, which can be summarized to include the following: (a) the
increased penetration into the market by competitive Prepaid Card vendors,
including those that are substantially larger than PT-1 or STAR, (b) the
relatively low barriers to entry for start-up Prepaid Card operators, (c) the
reliance on independent distributors to
25
<PAGE>
place Prepaid Cards in retail outlets, coupled with the inability to create
exclusive phone card distribution arrangements, (d) the lack of formalized
written agreements between PT-1 and its distributors and among PT-1's
distributors and any other party in the PT-1 Prepaid Card chain of supply, (e)
the price-sensitive, fickle nature of consumer demand and (f) the relative lack
of customer loyalty to any particular Prepaid Card company.
The relative lack of customer loyalty to any particular Prepaid Card company
and the increasing penetration into the Prepaid Card market by various
competitors, including those substantially larger than PT-1 or STAR, could place
downward pressure on industry wide Prepaid Card pricing. Due to PT-1's
dependence on informal relationships with independent distributors for the
marketing and sale of its products, increased competition and downward price
pressure could force PT-1 to provide Prepaid Cards that are more price
competitive in order to continue to sell Prepaid Cards to these distributors.
There can be no assurance that PT-1 will continue to provide competitively
priced Prepaid Cards to its distributors or that downward price pressure in the
Prepaid Card marketplace will not adversely affect PT-1's results of operations.
OPERATING RESULTS SUBJECT TO SIGNIFICANT FLUCTUATIONS
STAR's quarterly operating results are difficult to forecast with any degree
of accuracy because a number of factors subject these results to significant
fluctuations. As a result, STAR believes that period-to-period comparisons of
its operating results are not necessarily meaningful and should not be relied
upon as indications of future performance.
STAR's revenues, costs and expenses have fluctuated significantly in the
past and are likely to continue to fluctuate significantly in the future as a
result of numerous factors. STAR's revenues in any given period can vary due to
factors such as call volume fluctuations, particularly in regions with
relatively high per-minute rates; the addition or loss of major customers,
whether through competition, merger, consolidation or otherwise; the loss of
economically beneficial routing options for the termination of STAR's traffic;
financial difficulties of major customers; pricing pressure resulting from
increased competition; and technical difficulties with or failures of portions
of STAR's network that impact STAR's ability to provide service to or bill its
customers. STAR's cost of services and operating expenses in any given period
can vary due to factors such as fluctuations in rates charged by carriers to
terminate STAR's traffic; increases in bad debt expense and reserves; the timing
of capital expenditures, and other costs associated with acquiring or obtaining
other rights to switching and other transmission facilities; changes in STAR's
sales incentive plans; and costs associated with changes in staffing levels of
sales, marketing, technical support and administrative personnel. In addition,
STAR's operating results can vary due to factors such as changes in routing due
to variations in the quality of vendor transmission capability; loss of
favorable routing options; the amount of, and the accounting policy for, return
traffic under operating agreements; actions by domestic or foreign regulatory
entities; the level, timing and pace of STAR's expansion in international and
commercial markets; and general domestic and international economic and
political conditions. Further, a substantial portion of transmission capacity
used by STAR is obtained on a variable, per minute and short term basis,
subjecting STAR to the possibility of unanticipated price increases and service
cancellations. Since STAR does not generally have long term arrangements for the
purchase or resale of long distance services, and since rates fluctuate
significantly over short periods of time, STAR's gross margins are subject to
significant fluctuations over short periods of time. STAR's gross margins also
may be negatively impacted in the longer term by competitive pricing pressures.
PT-1 was organized in April 1995 and has only a limited operating history
upon which to evaluate its performance. PT-1's operating results may vary
significantly in the future due to numerous factors, including (i) the timing of
the introduction of new products and services, (ii) changes in U.S. and foreign
legislation and regulation which affect the competitive environment for PT-1's
products and services, (iii) market acceptance of new products and services and
(iv) other competitive conditions. Accordingly, PT-1's prospects must be
considered in light of the risks, expenses, problems and delays inherent in
26
<PAGE>
establishing a new business in a rapidly changing industry, and prior results of
operations should not be relied upon as an indication of PT-1's future
performance. See "--Ability to Continue and Manage Growth; Commercial
Market--PT-1;" "Management's Discussion and Analysis of Financial Condition and
Results of Operations of PT-1;" "Business of PT-1--Telecommunications Products
and Services" and "--Competition."
ABILITY TO CONTINUE AND MANAGE GROWTH; COMMERCIAL MARKET
STAR has increased revenues from $58.9 million in 1995 to $404.6 million in
1997, with revenues increasing in each of the last twelve quarters. Such growth
should not be considered indicative of future revenue growth or operating
results. If revenue levels fall below expectations, net income is likely to be
disproportionately adversely affected because a proportionately smaller amount
of STAR's operating expenses varies with its revenues. This effect is likely to
increase as a greater percentage of STAR's cost of services are associated with
owned and leased facilities. There can be no assurance that STAR will be able to
achieve or maintain profitability on a quarterly or annual basis in the future.
It is likely that in some future quarter STAR's operating results will be below
the expectations of public market analysts and investors. In such event, the
price of STAR Common Stock would likely be materially adversely affected. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations of STAR."
As part of STAR's significant revenue growth, it has expanded, and plans to
continue to expand, the number of its employees and the geographic scope of its
operations. Additionally, an important component of STAR's strategy is to grow
and expand through acquisition. These factors have resulted, and will continue
to result, in increased responsibilities for management personnel and have
placed, and will continue to place, increased demands upon STAR's operating and
financial systems, which may lead to unanticipated costs and divert management's
attention from day-to-day operations. STAR may also be required to attract,
train and retain additional highly qualified management, technical, sales and
marketing and customer support personnel. The process of locating such personnel
with the combination of skills and attributes required to implement STAR's
strategy is often lengthy. The inability to attract and retain additional
qualified personnel could materially and adversely affect STAR. STAR expects
that its expansion into foreign countries will lead to increased financial and
administrative demands, such as increased operational complexity associated with
expanded network facilities, administrative burdens associated with managing an
increasing number of foreign subsidiaries and relationships with foreign
partners and expanded treasury functions to manage foreign currency risks.
STAR's accounting systems and policies have been developed as STAR has
experienced significant growth. There can be no assurance that STAR's personnel,
systems, procedures and controls will be adequate to support STAR's future
operations. See "--Dependence on Key Personnel," "Business of STAR--Employees"
and "Management of STAR and UDN."
With the acquisition of LDS, STAR began providing service to the commercial
market, which is more labor intensive than the wholesale market, and as a result
has higher overhead costs. STAR also may be required to update and improve its
billing systems and procedures and/or hire new management personnel to handle
the demands of the commercial market. There can be no assurance that STAR will
be able to effectively manage the costs of and risks associated with its
expansion into the commercial market.
Although PT-1 has experienced substantial growth in revenues since inception
and expects to continue to grow, there can be no assurance that the growth
experienced by PT-1 will continue or that PT-1 will be able to expand its
telecommunications infrastructure, add services, expand its customer bases and
markets, install additional POPs or implement the other features of its business
strategy at the rate or to the extent presently planned. The Prepaid Card
segment of the telecommunications industry is an emerging business with an
increasing and substantial number of new market entrants. These entrants are
seeking to market, advertise and position their products and services as the
preferred method for accessing long distance telephone services. Because the
Prepaid Card segment is an emerging market, demand for and market acceptance of
newly introduced products and services is uncertain. There can be no assurance
that
27
<PAGE>
substantial markets will continue to develop for Prepaid Cards or that PT-1 will
be able to meet its current marketing objectives, succeed in positioning its
products and services as a preferred method for accessing long distance
telephone services, increase market acceptance of its existing products and
services or achieve significant market acceptance of its new products and
services.
PT-1's recent growth has placed, and is expected to continue to place,
significant demands on all aspects of PT-1's business, including its management,
financial, technical and administrative personnel and its systems. There can be
no assurance that PT-1's systems, procedures and controls and existing office
space will be adequate to support expansion of PT-1's operations. PT-1's future
operating results will substantially depend upon the ability of its executive
officers to manage its growth and to attract and retain additional highly
qualified personnel. In addition, as PT-1 increases its service offerings and
expands its target markets, there will be additional demands on its customer
service support and sales and marketing resources. There can be no assurance
that PT-1 will successfully manage its expanding operations and continued growth
or attract additional personnel, and any failure to do so could have a material
adverse effect on PT-1's business, financial condition or results of operations.
See "Business of PT-1--Strategy" and "--Employees."
RISKS INHERENT IN ACQUISITION STRATEGY
An important component to STAR's strategy is to grow and expand through
acquisitions. This growth strategy is dependent on the continued availability of
suitable acquisition candidates and subjects STAR to a number of risks. STAR has
recently completed three acquisitions, LDS on November 30, 1997, T-One on March
10, 1998, and PT-1 on February 4, 1999. Additionally, on November 19, 1997, STAR
entered into the Merger Agreement to acquire UDN. These acquisitions have placed
significant demands on STAR's financial and management resources, as the process
for integrating acquired operations presents a significant challenge to STAR's
management and may lead to unanticipated costs or a diversion of management's
attention from day-to-day operations. There can be no assurance that STAR will
be able to successfully integrate these acquisitions or any other acquisitions
made by STAR in the future into Company operations. Integrating acquisitions may
require integration of financial and call routing systems, network and other
physical facilities and personnel. Difficulties in integrating these and other
acquisitions can cause system degradation, added costs and loss of personnel or
customers. Additionally, STAR may incur unknown liabilities despite management's
efforts to investigate the operations of the acquired business. The impact of
these risks, and other risks arising as a result of STAR's acquisition strategy,
could adversely affect STAR's operating results.
RISKS ASSOCIATED WITH GROWTH OF TELECOMMUNICATIONS NETWORK AND CUSTOMER BASE
Historically, STAR has relied primarily on leased transmission capacity for
the delivery of its telecommunications services. STAR's telecommunications
expenses have in the past primarily been variable, based upon minutes of use,
consisting largely of payments to other long distance carriers, customer/carrier
interconnect charges, leased fiber circuit charges and switch facility costs.
During 1997 and 1998, however, STAR made considerable capital expenditures in
order to expand its network, and intends to continue to do so in the future. See
"Business of STAR--Network." Although STAR's strategy is to seek to establish
significant traffic volumes prior to investing in fixed-cost facilities, the
development of such facilities entails significant costs and prior planning,
which are based in part on STAR's expectations concerning future revenue growth
and market developments. As STAR expands its network and the volume of its
network traffic, its cost of revenues will increasingly consist of fixed costs
arising from the ownership and maintenance of its switches and undersea fiber
optic cables. While STAR believes that in the long-term these investments will
allow it to reduce its cost of service and to enhance its service offerings, in
the short-term, cost increases and a decrease in STAR's operating margins may
occur. If STAR's traffic volume were to decrease, or fail to increase to the
extent expected or necessary to make
28
<PAGE>
efficient use of its network, STAR's costs as a percentage of revenues could
increase significantly, which could have a material adverse effect on STAR's
business, financial condition or results of operations.
In addition, STAR's business depends in part on its ability to obtain
transmission facilities on a cost-effective basis. Because undersea fiber optic
cables typically take several years to plan and construct, carriers generally
make investments well in advance, based on a forecast of anticipated traffic.
Therefore, STAR's operations are subject to the risk that it will not adequately
anticipate the amount of traffic over its network, and may not procure
sufficient cable capacity or network equipment in order to ensure the cost-
effective transmission of customer traffic. Although STAR participates in the
planning of undersea fiber optic transmission facilities, it does not control
the construction of such facilities and must seek access to such facilities
through partial ownership positions. If ownership positions are not available,
STAR must seek access to such facilities through lease arrangements on
negotiated terms that may vary with industry and market conditions. There can be
no assurance that STAR will be able to continue to obtain sufficient
transmission facilities or access to undersea fiber optic cable on economically
viable terms. The failure of STAR to obtain telecommunications facilities that
are sufficient to support its network traffic in a manner that ensures the
reliability and quality of its telecommunications services may have a material
adverse effect on its business, financial condition or results of operations.
DEPENDENCE ON AND CONCENTRATION OF INDEPENDENT DISTRIBUTORS
PT-1 distributes substantially all of its Prepaid Cards through wholesale
distributors and does not have an internal retail sales department. Accordingly,
its success is significantly dependent upon its ability to recruit, maintain and
motivate a network of independent distributors. A significant element of PT-1's
growth strategy is to increase retail distribution of PT-1's products and
services by expanding its distribution network in existing markets and by
extending this network into new markets. PT-1 recruits a variety of types of
distributors, including: (a) members of targeted ethnic communities in those
metropolitan areas with high ethnic concentrations, (b) persons who are
currently distributing other types of products to retail outlets, and (c)
individuals who PT-1 believes have the requisite sales and marketing skills to
effectively promote PT-1's products. These types of distributors are typically
identified and recruited through relationships with existing distributors and
retail outlets, telemarketing and related promotional activities and direct
inquiries from potential distributors. There can be no assurance that PT-1 will
be able to continue to effectively recruit, maintain and motivate independent
distributors or to prevent its distributors from marketing other Prepaid Cards,
and, if PT-1 is unable to do so it could have a material adverse effect on
PT-1's business, financial condition and results of operations. See "Business of
PT-1--Strategy."
As of September 30, 1998, PT-1 had approximately 200 distributors purchasing
PT-1's Prepaid Cards, of which approximately 20% (or approximately 40
distributors) were individuals. PT-1 believes that most of its distributors
(both distributors that are individuals and distributors that are corporations
or other business entities) sell PT-1 Prepaid Cards to sub-distributors who, in
turn, sell the cards to retailers. To date, PT-1 has not experienced any
reliability problems with individual distributors. PT-1's accounts receivable
were concentrated among distributors primarily in the Northeast, with one
distributor, Worldwide Telecom, Inc., representing approximately 28% of the net
accounts receivable balance at September 30, 1998. While PT-1 believes that it
could replace this distributor, a loss of this or other distributors could have
a material adverse effect on PT-1's business, financial condition and results of
operations.
PT-1 believes that a majority of Prepaid Cards directly sold to its
distributors are resold to sub-distributors (sometimes called route salespeople)
who resell the cards to retail outlets. The remainder of the cards are resold by
distributors directly to retail outlets. Sub-distributors and route salespeople
typically market other products to retail outlets in addition to Prepaid Cards.
PT-1's relationship with its distributors is based upon past relationships and
buying patterns rather than formalized written agreements. Additionally, PT-1
believes that the distributor relationships between PT-1 and its distributors
and among PT-1's distributors and their sub-distributors, route salespeople and
retail outlet customers are
29
<PAGE>
based on past relationships and buying patterns and do not rely on written
contracts. Thus, as a matter of practice, formal written agreements are
virtually non-existent in the PT-1 Prepaid Card chain of supply.
Distributors located in the New York metropolitan area generally pickup
Prepaid Cards directly from PT-1's distribution sites, while PT-1 delivers
Prepaid Cards by common carrier to those distributors located outside of the New
York metropolitan area. A substantial portion of PT-1 Prepaid Card sales are to
distributors who regularly maintain one or more places of business, with
sub-distributors typically picking-up Prepaid Cards directly from the
distributors' places of business. Because PT-1's relationship with distributors
is so informal, PT-1 could lose one or more significant distributors on very
short notice. Such loss could have a material adverse effect on PT-1's results
of operations.
RISKS OF INTERNATIONAL TELECOMMUNICATIONS BUSINESS
STAR has to date generated a substantial majority of its revenues by
providing international telecommunications services to its customers on a
wholesale basis. STAR sends traffic to numerous countries throughout the world,
including India, Mexico and China. Likewise, a substantial majority of PT-1's
revenues to date have been derived from providing international
telecommunications services to its customers, with a significant amount of phone
traffic directed to Mexico, the Dominican Republic and Columbia. For the six
months ended September 30, 1998, Mexico, as a calling destination, generated
approximately 12% of PT-1's revenues. The international nature of STAR's
operations involves certain risks, such as changes in U.S. and foreign
government regulations and telecommunications standards, dependence on foreign
partners, tariffs, taxes and other trade barriers, the potential for
nationalization and economic downturns and political instability in foreign
countries. In addition, STAR's business could be adversely affected by a
reversal in the current trend toward deregulation of telecommunications
carriers. STAR will be increasingly subject to these risks to the extent that
STAR proceeds with the planned expansion of its international operations.
RISK OF DEPENDENCE ON FOREIGN PARTNERS. STAR will increasingly rely on
foreign partners to terminate its traffic in foreign countries and to assist in
installing transmission facilities and network switches, complying with local
regulations, obtaining required licenses, and assisting with customer and vendor
relationships. STAR may have limited recourse if its foreign partners do not
perform under their contractual arrangements with STAR. STAR's arrangements with
foreign partners may expose STAR to significant legal, regulatory or economic
risks.
RISKS ASSOCIATED WITH FOREIGN GOVERNMENT CONTROL AND HIGHLY REGULATED
MARKETS. Governments of many countries exercise substantial influence over
various aspects of the telecommunications market. In some cases, the government
owns or controls companies that are or may become competitors of STAR or
companies (such as national telephone companies) upon which STAR and its foreign
partners may depend for required interconnections to local telephone networks
and other services. Accordingly, government actions in the future could have a
material adverse effect on STAR's operations. In highly regulated countries in
which STAR is not dealing directly with the dominant local exchange carrier, the
dominant carrier may have the ability to terminate service to STAR or its
foreign partner and, if this occurs, STAR may have limited or no recourse. In
countries where competition is not yet fully established and STAR is dealing
with an alternative operator, foreign laws may prohibit or impede new operators
from offering services in these markets.
RISKS ASSOCIATED WITH FOREIGN CURRENCY FLUCTUATIONS. STAR's revenues and
cost of long distance services are sensitive to foreign currency fluctuations.
STAR expects that an increasing portion of STAR's net revenue and expenses will
be denominated in currencies other than U.S. dollars, and changes in exchange
rates may have a significant effect on STAR's results of operations. Although
STAR utilizes hedging instruments to reduce the risk of foreign currency
fluctuations, STAR will not be fully protected from these risks and the
instruments themselves involve a degree of risk. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations of STAR."
30
<PAGE>
FOREIGN CORRUPT PRACTICES ACT. STAR is also subject to the Foreign Corrupt
Practices Act ("FCPA"), which generally prohibits U.S. companies and their
intermediaries from bribing foreign officials for the purpose of obtaining or
keeping business. STAR may be exposed to liability under the FCPA as a result of
past or future actions taken without STAR's knowledge by agents, strategic
partners and other intermediaries. Such liability could have a material adverse
effect on STAR's business, operating results and financial condition.
POTENTIAL ADVERSE EFFECTS OF GOVERNMENT REGULATION
STAR's business is subject to various U.S. and foreign laws, regulations,
agency actions and court decisions. STAR's U.S. international telecommunications
service offerings are subject to regulation by the FCC. The FCC requires
international carriers to obtain authorizations under Section 214 of the
Communications Act of 1934, as amended, prior to acquiring international
facilities by purchase or lease, or providing international service to the
public. Prior FCC approval is also required to transfer control of a
certificated carrier. STAR must file reports and contracts with the FCC and must
pay regulatory fees, which are subject to change. STAR is also subject to the
FCC policies and rules discussed below. The FCC could determine, by its own
actions or in response to a third party's filing, that certain of STAR's
services, termination arrangements, agreements with foreign carriers, transit or
refile arrangements or reports do not or did not comply with FCC policies and
rules. If this occurred, the FCC could order STAR to terminate noncompliant
arrangements, fine STAR or revoke STAR's authorizations. Any of these actions
could have a material adverse effect on STAR's business, operating results and
financial condition.
FCC INTERNATIONAL PRIVATE LINE RESALE POLICY. The FCC's international
private line ("IPL") resale policy limits the conditions under which a carrier
may connect IPLs to the public switched telephone network ("PSTN") at one or
both ends to provide switched services, commonly known as International Simple
Resale ("ISR"). A carrier generally may only offer ISR services to a foreign
country if the FCC has found (a) the country is a member of the World Trade
Organization ("WTO") and at least 50% of the U.S. billed and settled traffic to
that country is settled at or below the FCC's benchmark settlement rate or (b)
the country is not a WTO member, but it offers U.S. carriers equivalent
opportunities to engage in ISR and at least 50% of the U.S. billed and settled
traffic is settled at or below the applicable benchmark. STAR's FCC authority
currently permits it to provide ISR service to Canada, the U.K., Sweden, New
Zealand, Australia, the Netherlands, Germany, France, Belgium, Denmark, Norway,
Austria, Switzerland, Luxembourg, Italy, Hong Kong and Japan. The FCC is
currently reviewing U.S. carrier applications to provide ISR to Finland and
Mexico, among other routes. Upon grant of any such ISR application to a given
country, the FCC's rules also would permit STAR to provide ISR service to that
country. If ISR is not permitted on a route, absent prior FCC consent, U.S.
facilities based international carriers must terminate switched telephone
traffic in accordance with the FCC's International Settlement Policy ("ISP")
which is primarily intended to deter foreign carriers with market power from
discriminating amongst competing U.S. carriers by, for example, favoring the
foreign carrier's U.S. affiliate. The ISP requires that all U.S. carriers
terminate traffic with a foreign carrier on the same terms (i.e., that
settlement rates be equivalent) and receive inbound traffic only in proportion
to the volume of U.S. outbound traffic which they generate.
On a few routes, STAR may use IPLs to terminate international switched
telephone services where ISR has not been authorized. On such routes, therefore,
STAR's termination arrangements may not be consistent with the FCC's ISP. On any
such route, however, to STAR's knowledge the foreign correspondent lacks market
power, no U.S. inbound traffic is involved, and the effective settlement rate is
lower than the prevailing rate. Thus, STAR believes its actions are not
inconsistent with the ISP's underlying purpose.
FCC INTERNATIONAL SETTLEMENTS POLICY. The ISP limits the arrangements which
U.S. international carriers may enter into with foreign carriers for exchanging
public switched telecommunications traffic, which the FCC terms International
Message Telephone Service ("IMTS"). This policy does not apply to ISR services.
The ISP requires that U.S. carriers receive an equal share of the accounting
rate and receive
31
<PAGE>
inbound traffic in proportion to the volume of U.S. outbound traffic which they
generate. The ISP and other FCC policies also prohibit a U.S. carrier and a
foreign carrier which possesses sufficient market power on the foreign end of
the route to affect competition adversely in the U.S. market from entering into
exclusive arrangement involving services, facilities or functions on the foreign
end of a U.S. international route which are necessary for providing basic
telecommunications and which are not offered to similarly situated U.S.
carriers. It is possible that the FCC could find that certain of STAR's
arrangements with foreign operators are inconsistent with the ISP.
FCC POLICIES ON TRANSIT AND REFILE. STAR and, in certain cases, PT-1, use
both transit and refile arrangements to terminate its international traffic. The
FCC routinely approves transit arrangements by U.S. international carriers. The
FCC's rules also permit carriers in many cases to use ISR facilities to route
traffic via a third country for refile through the PSTN. The extent to which
U.S. carriers may enter into refile arrangements consistent with the ISP is
currently under review by the FCC. Certain of STAR's transit or refile
arrangements may violate the ISP or other FCC policies.
FCC POLICIES ON USE OF PAY PHONES. A small portion of PT-1's customers use
pay phones to access PT-1's services. The Communications Act requires long
distance carriers such as PT-1 to compensate pay phone owners when a pay phone
is used to originate a telephone call through a toll-free number. Recent
regulations adopted under the Communications Act mandate compensation in the
amount of $0.284 per call, although the basis for this compensation is currently
being reconsidered by the FCC pursuant to a court order. In February 1998, PT-1
began passing these costs on to its customers who use pay phones. However, there
can be no assurance that PT-1 will be able to successfully pass these costs on
to its customers or that these charges will not have a material adverse effect
on PT-1's business, financial condition or results of operations. See "Business
of PT-1--Government Regulation."
RECENT AND POTENTIAL FCC ACTIONS. Regulatory action that may be taken in
the future by the FCC may intensify the competition which STAR and PT-1 face,
impose additional operating costs upon them, disrupt certain of their
transmission arrangements or otherwise require either company to modify its
operations. Future FCC action may also provide STAR and PT-1 additional
competitive flexibility by, for example, eliminating or substantially reducing
the tariff requirements applicable to each of the companies' interstate and
international telecommunications services. The FCC is encouraging new market
entrants by implementing the WTO Basic Telecommunications Agreement (the "WTO
Agreement") and through other actions. The FCC may approve pending mergers which
could produce more effective competitors in STAR and PT-1's markets. The FCC may
increase regulatory fees charged to STAR and PT-1 and their competitors by
eliminating the exemption for carrier revenues obtained from other carriers for
certain fees or through other actions, which could raise STAR and PT-1's costs
of service without assurance that STAR and PT-1 could pass such fee increases
through to their customers. See "Business of STAR--Government Regulation."
STATE. The intrastate long distance telecommunications operations of STAR
and its subsidiaries and PT-1 are subject to various state laws and regulations,
including prior certification, notification, registration and/or tariff
requirements. The vast majority of states require that STAR and its subsidiaries
and PT-1 apply for certification to provide intrastate telecommunications
services. In most jurisdictions, STAR and PT-1 also must file and obtain prior
regulatory approval of tariffs for intrastate services. Certificates of
authority can generally be conditioned, modified or revoked by state regulatory
authorities for failure to comply with state laws and regulations. Fines and
other penalties, including revocation of a certificate of authority, may be
imposed.
In 1997, prior to STAR's acquisition of LDS, LDS settled disputes with the
California Public Utilities Commission (the "California PUC") and with the
District Attorney of Monterey, California regarding LDS' alleged unauthorized
switching of long distance customers (the "Settlements"). As part of the
Settlements, LDS was subject to fines and restrictions on its business
operations in California. In addition,
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the FCC has received numerous informal complaints against LDS regarding the
alleged unauthorized switching of long distance customers, which complaints
currently remain under review.
Following STAR's acquisition of LDS and in order to comply with the
Settlements, STAR has imposed strict restrictions on certain former LDS
employees, restricting these employees with respect to California intrastate
telecommunications operations. Additionally, STAR has taken a number of steps to
reduce the risk of a repeat occurrence regarding the alleged unauthorized
switching of commercial customers in California. If STAR inadvertently fails to
comply with such guidelines or if such guidelines are determined to be
inadequate to comply with the Settlements, STAR may be subject to penalties or
revocation of its certificate of authority. See "Business of STAR--Government
Regulation--Actions Against LDS."
FOREIGN REGULATIONS. STAR is also subject to regulation in foreign
countries, such as the U.K. and Germany, in connection with certain of its
business activities. For example, STAR's use of transit, ISR or other routing
arrangements may be affected by laws or regulations in either the transited or
terminating foreign jurisdiction. Foreign countries, either independently or
jointly as members of the International Telecommunications Union ("ITU"), or
other supra-national organizations such as the European Union or the WTO, may
have adopted or may adopt laws or regulatory requirements regarding such
services for which compliance would be difficult or expensive, that could force
STAR to choose less cost-effective routing alternatives and that could adversely
affect STAR's business, operating results and financial condition. PT-1 is also
subject to regulation in the U.K. and certain other countries in connection with
certain of its business activities.
To the extent that they seek to provide telecommunications services in other
non-U.S. markets, STAR and PT-1 will be subject to the developing laws and
regulations governing the competitive provision of telecommunications services
in those markets. STAR currently plans to provide a limited range of services in
Mexico, Belgium and France, as permitted by regulatory conditions in those
markets, and to expand its operations as these markets implement scheduled
liberalization to permit competition in the full range of telecommunications
services. The nature, extent and timing of the opportunity for STAR to compete
in these markets will be determined, in part, by the actions taken by the
governments in these countries to implement competition and the response of
incumbent carriers to these efforts. There can be no assurance that the
regulatory regime in these countries will provide STAR or PT-1 with practical
opportunities to compete in the near future, or at all, or that STAR or PT-1
will be able to take advantage of any such liberalization in a timely manner.
See "Business of STAR--Government Regulation."
REGULATION OF CUSTOMERS. STAR's customers are also subject to actions taken
by domestic or foreign regulatory authorities that may affect the ability of
customers to deliver traffic to STAR. Regulatory sanctions have been imposed on
certain of STAR's customers in the past. While such sanctions have not adversely
impacted the volume of traffic received by STAR from such customers to date,
future regulatory actions could materially adversely affect the volume of
traffic received from a major customer, which could have a material adverse
effect on STAR's business, financial condition and results of operations.
RISKS OF NETWORK FAILURE; DEPENDENCE ON FACILITIES AND THIRD PARTIES
Any system or network failure that causes interruptions in STAR or PT-1's
operations could have a material adverse effect on their business, financial
condition or results of operations. STAR and PT-1's operations are dependent on
their ability to successfully expand their networks and integrate new and
emerging technologies and equipment into their network, which are likely to
increase the risk of system failure and to cause strain upon the networks. STAR
and PT-1's operations also are dependent on each company's ability to protect
its hardware and other equipment from damage from natural disasters such as
fires, floods, hurricanes and earthquakes, other catastrophic events such as
civil unrest, terrorism and war and other sources of power loss and
telecommunications failures. Although STAR and PT-1 have taken a number of steps
to prevent their network from being affected by natural disasters, fire and the
like, such as building redundant systems for power supply to the switching
equipment, there can be no assurance that
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any such systems will prevent STAR's switches and PT-1's switches and Debit Card
Platforms from becoming disabled in the event of an earthquake, power outage or
otherwise. The failure of STAR or PT-1's network, or a significant decrease in
telephone traffic resulting from effects of a natural or man-made disaster,
could have a material adverse effect on STAR and PT-1's relationships with their
customers and their business, operating results and financial condition. See
"Business of STAR--Network" and "Business of PT-1--The Telecommunications
Network."
SOFTWARE AND INFORMATION SYSTEMS. PT-1 uses information systems and
software (including software licensed to PT-1 by GodotSoft, L.L.C.) to provide
information to management, deliver services to its customers, track inventory,
control fraud and monitor system usage. Although PT-1 engages in extensive
testing of its software prior to introduction, there can be no assurance that
errors will not be found in such information systems or software. Any such error
may result in an interruption in telecommunications services or a partial or
total failure of PT-1's network or information systems which could have a
material adverse effect on PT-1's business, financial condition and results of
operations. See "Business of PT-1-- Information Systems; Debit Card Platforms."
DEPENDENCE ON KEY PERSONNEL
STAR's success depends to a significant degree upon the efforts of senior
management personnel and a group of employees with longstanding industry
relationships and technical knowledge of STAR's operations, in particular,
Christopher E. Edgecomb, STAR's Chief Executive Officer and Samer Tawfik, Chief
Executive Officer of PT-1. STAR maintains and is the beneficiary under a key
person life insurance policy in the amount of $10.0 million with respect to Mr.
Edgecomb. STAR believes that its future success will depend in large part upon
its continuing ability to attract and retain highly skilled personnel.
Competition for qualified, high-level telecommunications personnel is intense
and there can be no assurance that STAR will be successful in attracting and
retaining such personnel. The loss of the services of one or more of STAR's key
individuals, or the failure to attract and retain other key personnel, could
materially adversely affect STAR's business, operating results and financial
condition. See "Management of STAR and UDN."
SIGNIFICANT COMPETITION
The international telecommunications industry is intensely competitive and
subject to rapid change. STAR and PT-1's competitors in the international
wholesale switched long distance market include large, facilities-based
multinational corporations and smaller facilities-based providers in the U.S.
and overseas that have emerged as a result of deregulation, switch-based
resellers of international long distance services and international joint
ventures and alliances among such companies. STAR also competes abroad with a
number of dominant telecommunications operators that previously held various
monopolies established by law over the telecommunications traffic in their
countries. International wholesale switched service providers compete on the
basis of price, customer service, transmission quality, breadth of service
offerings and value-added services. Additionally, the telecommunications
industry is in a period of rapid technological evolution, marked by the
introduction of competitive product and service offerings, such as the
utilization of the Internet for international voice and data communications.
STAR and PT-1 are unable to predict which technological development will
challenge their competitive positions or the amount of expenditures that will be
required to respond to a rapidly changing technological environment. Further,
the number of competitors is likely to increase as a result of the competitive
opportunities created by a new Basic Telecommunications Agreement concluded by
members of the WTO in February 1997. Under the terms of the WTO Agreement,
starting February 5, 1998, the United States and over 65 countries have
committed to open their telecommunications markets to competition and foreign
ownership and to adopt measures to protect against anticompetitive behavior. As
a result, STAR and PT-1 believe that competition will continue to increase,
placing downward pressure on prices. Such pressure could adversely affect STAR
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and PT-1's gross margins if they are not able to reduce their costs commensurate
with such price reductions.
COMPETITION FROM DOMESTIC AND INTERNATIONAL COMPANIES. A majority of the
U.S.-based international telecommunications services revenue is currently
generated by AT&T Corp. ("AT&T"), MCI WorldCom, Inc. ("MCI WorldCom") and Sprint
Corporation ("Sprint"). STAR also competes with Pacific Gateway Exchange, Inc.,
and other U.S.-based and foreign long distance providers, including the Regional
Bell Operating Companies ("RBOCs"), which presently have FCC authority to resell
and terminate international telecommunication services. Many of these
competitors have considerably greater financial and other resources and more
extensive domestic and international communications networks than STAR or PT-1.
STAR and PT-1's business would be materially adversely affected to the extent
that a significant number of such customers limit or cease doing business with
STAR or PT-1 for competitive or other reasons. Consolidation in the
telecommunications industry could not only create even larger competitors with
greater financial and other resources, but could also adversely affect STAR and
PT-1 by reducing the number of potential customers for such companies' services.
EXPANSION INTO COMMERCIAL MARKET. With the acquisition of LDS, STAR began
providing long distance service to the commercial market, a market that is
subject to intense competition from a number of well capitalized companies. The
commercial market is also characterized by the lack of customer loyalty, with
commercial customers regularly changing service providers. There can be no
assurance that STAR will be able to compete successfully in the commercial
market. See "Business of STAR--Strategy--Expansion into Commercial Market."
COMPETITION IN THE PREPAID CARD MARKET. PT-1 competes with other providers
of Prepaid Cards, including many of the largest telecommunications providers,
such as AT&T, Sprint and MCIWorldCom. These companies are substantially larger
and have greater financial, technical, engineering, personnel and marketing
resources, longer operating histories, greater name recognition and larger
customer bases than PT-1. PT-1 also competes with smaller, emerging carriers in
both the Prepaid Card retail market and in the wholesale market, including IDT
Corporation, RSL Communications, SmarTalk Teleservices, Inc., Pacific Gateway
Exchange, Inc., FaciliCom International, Inc. and Telegroup, Inc. To the extent
PT-1 begins providing services to customers outside the U.S. market, it may
compete with the large operators such as British Telecommunications plc ("BT")
in the U.K. PT-1 believes that additional competitors will be attracted to the
Prepaid Card market (including Internet-based service providers and other
telecommunications companies). There can be no assurance that competition from
existing or new competitors or a decrease in the rates charged for
telecommunications services by the major long distance carriers or other
competitors will not have a material adverse effect on PT-1's business,
financial condition and results of operations. See "--Rapid Technological Change
in the Prepaid Card Market."
FTC INVESTIGATION OF PT-1
In July 1997, PT-1 was notified by the Federal Trade Commission (the "FTC")
and the New York Attorney General's Office (the "NYAG") that it was the subject
of an investigation alleging deceptive advertising practices in connection with
the sale of its Prepaid Cards. Primarily, the FTC alleged that PT-1's point of
sale posters for its Prepaid Cards, which did disclose the existence of
additional first minute connection charges for certain calls, did not
sufficiently disclose the specific amount of connection charges for such calls.
PT-1 modified these point of sale materials more than one year ago, and all
point of sale materials now routinely set forth the exact amount of all call
connection charges. Subsequently, the FTC and the NYAG indicated that they were
also reviewing whether PT-1 properly decremented minutes from its Prepaid Cards.
PT-1 has been informed that the NYAG has ended its investigation without taking
any action. The FTC has also completed its investigation and has determined not
to take any formal action regarding PT-1's Prepaid Card decrementation
practices. With regard to prior advertising of Prepaid Cards by PT-1, PT-1 and
representatives of the FTC have entered into an agreement in principle, which is
subject
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to final approval by the FTC, pursuant to which, in complete resolution of all
allegations regarding deceptive advertising: (1) PT-1 will pay to the FTC the
sum of $300,000; (2) PT-1 does not admit any of the allegations; and (3) on a
going forward basis, PT-1 has agreed to comply with certain standards regarding
advertising (which are consistent with PT-1's current advertising practices) and
certain record keeping requirements. The agreement with the FTC was entered into
on July 17, 1998, but remains subject to full FTC approval. PT-1 expects such
approval of the settlement agreement within the next thirty (30) days. See
"Business of PT-1--Legal Proceedings."
RAPID TECHNOLOGICAL CHANGE IN THE PREPAID CARD MARKET
The Prepaid Card market is characterized by rapid technological change, new
product and service introduction, new sales channels and evolving industry
standards. PT-1's success will depend, in significant part, upon its ability to
make timely and cost-effective enhancements and additions to its technology and
to introduce new products and services that meet customer demands. PT-1 expects
new products and services to be developed and introduced by other companies that
compete with its products and services. The proliferation of new
telecommunications technology, including personal and voice communication
services over the Internet, may reduce demand for long distance services,
including Prepaid Cards. There can be no assurance that PT-1 will be successful
in responding to these or other technological changes, evolving industry
standards or to new products and services offered by PT-1's current and future
competitors. The inability of PT-1 to respond to these changes could have a
material adverse effect on PT-1's business, financial condition or results of
operations. See "Business of PT-1--Competition" and "--Telecommunications
Products and Services."
CUSTOMER CONCENTRATION
While the list of STAR's most significant customers varies from quarter to
quarter, STAR's five largest customers accounted for approximately 29% of its
revenues in 1997, although no one customer accounted for 10% or more of revenues
in such period. STAR could lose a significant customer for many reasons,
including the entrance into the market of significant new competitors with lower
rates than STAR, downward pressure on the overall costs of transmitting
international calls, transmission quality problems, changes in U.S. or foreign
regulations or unexpected increases in STAR's cost structure as a result of
expenses related to installing a global network or otherwise.
TAXATION OF SALE AND USE OF PREPAID CARDS
Taxable income realized by PT-1 from Prepaid Card revenue is subject to
federal corporate income tax at standard rates. In addition, since November 1,
1997, PT-1 has been required to and has collected a three percent (3%) federal
excise tax on sales of Prepaid Cards to its distributors. In states that do
impose taxes on Prepaid Cards, the most common method of calculation and payment
is predicated on usage of the Prepaid Card and the revenue generated from the
underlying long distance service that is provided. Other states impose taxes on
the face value of the Prepaid Card when sold to consumers, with collection and
remittance made by the retailer at the point of sale. In the states where PT-1
does the majority of its business, and taxes on Prepaid Cards are based on their
usage, PT-1 collects and remits taxes to state authorities. PT-1 believes that
it has made adequate reserves to cover any state taxes it may ultimately be
required to pay, though there can be no assurance in that regard.
FRAUD; THEFT OF SERVICES; UNCOLLECTIBLE ACCOUNTS
From time to time, callers have obtained services without rendering payment
to PT-1 by unlawfully using PT-1's access numbers and PINs. PT-1 attempts to
manage these theft and fraud risks through its internal controls and its
monitoring and blocking systems. There can be no assurance that PT-1's risk
management practices will be sufficient to protect PT-1 in the future from
unauthorized transactions or
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thefts of services which could have a material adverse effect on PT-1's
business, financial condition or results of operations.
PT-1 sells Prepaid Cards on terms ranging from cash on delivery to net
thirty days. Prepaid Cards that are shipped via common carrier or sold over the
counter in smaller quantities are generally sold on a cash on delivery basis.
Distributors who exclusively market PT-1's Prepaid Cards and undertake market
penetration efforts in new territories on behalf of PT-1 are generally accorded
terms of net 7-to-30 days. PT-1's extension of credit to distributors is a
standard business practice with the Prepaid Card industry. PT-1 also sells its
Prepaid Cards on a wholesale basis to carriers on 7-to-30 day terms and sells
dial around and presubscribed long distance services for which customers are
billed after services are rendered.
PT-1's accounts receivable balance at September 30, 1998 was approximately
$37.4 million as compared to approximately $18.0 million at September 30, 1997,
largely as a result of increasing sales to distributors who have entered
emerging markets in geographic areas other than the eastern seaboard.
Participants in the Prepaid Card industry, other than PT-I, have experienced
significant accounts receivable and credit losses. As PT-1 expands its
commercial business following the PT-1 Merger, including its dial around and its
presubscribed long distance services, accounts receivable balances will continue
to rise materially.
While PT-1 has not experienced material difficulty in collecting its
accounts receivable through September 30, 1998, and, to date, has not suffered
material credit losses, there can be no assurance that, following the PT-1
Merger, as accounts receivable balances grow and credit is extended to new
retail customers, PT-1 will be able to adequately monitor and evaluate its
accounts receivable and its credit risks or that it will be able to collect all
amounts due for services rendered. Any material difficulty in collecting rising
accounts receivable and any material credit losses could have a material adverse
effect on PT-1's business, financial condition or results of operations. See
"Business of PT-1--Information Systems; Debit Card Platforms" and "--Prepaid
Card Productions and Inventory Control."
LIMITED PROTECTION OF PT-1'S PROPRIETARY RIGHTS; RISKS OF INFRINGEMENT
PT-1 believes that PT-1 and its Prepaid Card products have achieved
significant brand awareness among distributors, retail outlets and many ethnic
communities and other consumer groups. PT-1 has filed for federal trademark
protection of the PT-1 Communications and PT-1 service marks and for other names
PT-1 uses or intends to use to market its Prepaid Cards, including The PT-1 Card
and The New York Card. In addition, PT-1 recently changed its name from
Phonetime, Inc. and the name of one of its Prepaid Cards from The PTI Card to
The PT-1 Card in response to letters challenging PT-1's use of these names.
There can be no assurance that PT-1's efforts to protect its proprietary rights
will be successful or that other companies will not challenge PT-1's use of its
trademarks and service marks. PT-1 also intends to expand the marketing of
Prepaid Cards in foreign countries. This expansion may result in usage of PT-1's
Prepaid Cards in countries where intellectual property protections are more
limited than the protections available in the United States. PT-1's inability to
protect its proprietary rights or continue to use such marks in the U.S. and
abroad could result in a material adverse effect on PT-1's business, financial
condition or results of operations. See "Business of PT-1--Trademarks and
Service Marks."
NEED FOR ADDITIONAL CAPITAL TO FINANCE GROWTH AND CAPITAL REQUIREMENTS
STAR believes that it must continue to enhance and expand its network and
build out its telecommunications network infrastructure in order to maintain its
competitive position and continue to meet the increasing demands for service
quality, capacity and competitive pricing. STAR's ability to grow depends, in
part, on its ability to expand its operations through the ownership and leasing
of network capacity, which requires significant capital expenditures, that are
often incurred prior to STAR's receipt of the related revenue.
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STAR believes that, based upon its present business plan and its existing
cash resources, available financing and expected cash flow from operating
activities, STAR will have sufficient cash to meet its currently anticipated
working capital and capital expenditure requirements for at least twelve months.
If STAR's growth exceeds current expectations, if STAR obtains one or more
attractive opportunities to purchase the business or assets of another company,
or if STAR's cash flow from operations after the end of such period is
insufficient to meet its working capital and capital expenditure requirements,
STAR will need to raise additional capital from equity or debt sources. There
can be no assurance that STAR will be able to raise such capital on favorable
terms or at all. If STAR is unable to obtain such additional capital, STAR may
be required to reduce the scope of its anticipated expansion, which could have a
material adverse effect on STAR's business, financial condition or results of
operations.
VOLATILITY OF STOCK PRICE
The market price of the shares of STAR Common Stock has risen since STAR's
initial public offering in June 1997 and is trading at a high multiple of STAR's
earnings. The market price for such shares has been highly volatile and may be
significantly affected by factors such as actual or anticipated fluctuations in
STAR's operating results, the announcement of potential acquisitions by STAR,
changes in federal and international regulations, activities of the largest
domestic providers, industry consolidation and mergers, conditions and trends in
the international telecommunications market, adoption of new accounting
standards affecting the telecommunications industry, changes in recommendations
and estimates by securities analysts, general market conditions and other
factors. In addition, the stock market has from time to time experienced
significant price and volume fluctuations that have particularly affected the
market prices for the shares of emerging growth companies like STAR. These broad
market fluctuations may adversely affect the market price of the STAR Common
Stock.
CONTROL OF COMPANY BY NAMED OFFICERS AND DIRECTORS
Collectively, STAR's executive officers and directors and the executive
officers of PT-1 beneficially own more than 40% of the outstanding shares of
STAR Common Stock. These stockholders may be able to exercise control over all
matters requiring stockholder approval, including the election of directors and
approval of significant corporate transactions. Such concentration of ownership
may have the effect of delaying or preventing a change in control of STAR. See
"Principal Stockholders of STAR."
EFFECT OF CERTAIN CHARTER PROVISIONS; ANTI-TAKEOVER EFFECTS OF CERTIFICATE OF
INCORPORATION, BYLAWS AND DELAWARE LAW
STAR's Board of Directors has the authority to issue up to 5,000,000 shares
of Preferred Stock and to determine the price, rights, preferences, privileges
and restrictions, including voting and conversion rights of such shares, without
any further vote or action by STAR's stockholders. The rights of the holders of
STAR Common Stock will be subject to, and may be adversely affected by, the
rights of the holders of any Preferred Stock that may be issued in the future.
The issuance of Preferred Stock, while providing flexibility in connection with
possible acquisitions and other corporate purposes, could have the effect of
making it more difficult for a third party to acquire a majority of the
outstanding voting stock of STAR. STAR has no current plans to issue shares of
Preferred Stock. STAR is also subject to the anti-takeover provisions of Section
203 of the Delaware General Corporation Law, which will prohibit STAR from
engaging in a "business combination" with an "interested stockholder" for a
period of three years after the date of the transaction in which the person
became an interested stockholder, unless the business combination is approved in
a prescribed manner. The application of Section 203 could have an effect of
delaying or preventing a change in control of STAR. In addition, STAR's Amended
and Restated Certificate of Incorporation provides for a classified Board of
Directors such that approximately only one-third of the members of the Board
will be elected at each annual meeting of stockholders. Classified boards may
have the effect of delaying, deferring or discouraging changes in control of
STAR. Further,
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certain provisions of STAR's Amended and Restated Certificate of Incorporation
and Bylaws and of Delaware law could delay or make more difficult a merger,
tender offer or proxy contest involving STAR. Additionally, certain federal
regulations require prior approval of certain transfers of control of
telecommunications companies, which could also have the effect of delaying,
deferring or preventing a change in control. See "Business of STAR--Government
Regulation," "Description of STAR Capital Stock-- Preferred Stock" and
"--Anti-takeover Effects of Provisions of the Certificate of Incorporation,
Bylaws and Delaware Law."
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of the Merger, STAR will have approximately 58,356,430
shares of STAR Common Stock outstanding (assuming no exercise of any of the
options to purchase shares of STAR Common Stock outstanding and vested as of
February 9, 1999). Approximately 3,961,000 additional shares which are not
currently registered pursuant to the Securities Act will be available for
immediate unrestricted sale in the public market on the date of this Proxy
Statement/Prospectus and approximately 19,722,000 additional shares will be
available for immediate sale on the date of this Proxy Statement/Prospectus,
subject to the public information, volume limitation and notice provisions of
Rule 144 adopted under the Securities Act. Approximately 410,000 shares will be
available for sale within 45 days after the date of this Proxy
Statement/Prospectus, subject to the Rule 144 public information, volume
limitations and notice provisions. Approximately 849,000 shares issued in the
LDS acquisition will be available for sale after November 30, 1998. Pursuant to
the terms of the PT-1 Merger Agreement, approximately 1,050,000 shares of STAR
Common Stock will be available for sale in December 1999 and approximately
14,000,000 shares of STAR Common Stock will be available for sale in December
2000.
Certain stockholders holding approximately 17,252,000 shares of STAR Common
Stock (assuming consummation of the PT-1 Merger) are entitled to registration
rights with respect to their shares of STAR Common Stock. Sales of substantial
amounts of such shares in the public market, or the prospect of such sales,
could adversely affect the market price of the STAR Common Stock. Such sales
also might make it more difficult for STAR to sell equity securities or equity
related securities in the future at a time and price that STAR deems
appropriate. See "Description of STAR Capital Stock."
YEAR 2000 COMPUTER PROGRAM FAILURE
A significant percentage of the software that runs most of the computers in
the United States relies on two-digit date codes to perform computations and
decision-making functions. Commencing on January 1, 2000, these computer
programs may fail from an inability to interpret date codes properly,
misinterpreting "00" as the year 1900 rather than 2000. STAR, PT-1 and UDN have
implemented Year 2000 compliance programs to ensure that each of their software,
systems and equipment are Year 2000 compliant and to ensure that the software
and technology of their third party vendors and customers are also Year 2000
compliant. Each of STAR, PT-1 and UDN currently anticipates that its information
technology and non-information technology systems will be Year 2000 compliant
before January 1, 2000, though no assurances can be given that its compliance
testing will not detect unanticipated Year 2000 compliance problems. While STAR,
PT-1 and UDN intend to develop contingency plans to prepare for a Year 2000
failure, there can be no assurance that such contingency plans will be adequate.
If either STAR, PT-1 or UDN and/or third parties are not Year 2000 compliant as
of such date and if such contingency plans are inadequate or fail to address a
particular Year 2000 risk, such companies may be required to incur unanticipated
costs, change relationships with third parties, forego revenues or be subjected
to other material adverse effects. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations of STAR", "Management's Discussion
and Analysis of Financial Condition and Results of Operations of PT-1" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations of UDN."
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NO ASSURANCE THAT STAR WILL REALIZE ANTICIPATED BENEFITS FROM THE MERGER
The Merger involves the combination of certain aspects of two companies that
have operated independently. Accordingly, there can be no assurance that UDN can
be successfully integrated into STAR or that STAR and its stockholders
(including persons who become stockholders as a result of the Merger) will
ultimately realize any of the anticipated benefits of the Merger.
In addition, the integration of the STAR and UDN operations and accounting,
personnel administrative and legal functions involves the risk that key
employees, who can not be easily replaced, in those operations and functions
will leave even when offered continuing employment. The integration approach
adopted by STAR with respect to UDN requires the devotion of a significant
amount of time by senior executives, which may detract from business operations
and development of the combined companies.
In determining that the Merger is fair and in the best interests of its
stockholders, each of the UDN Board and the UDN Special Committee considered the
cost savings, operating efficiencies and other synergies expected to result
following the consummation thereof. See "The Merger--UDN's Reasons for the
Merger; Recommendations of the UDN Board and Special Committee" and "--STAR's
Reasons for the Merger." There can be no assurance that any of such cost
savings, operating efficiencies or other synergies will be accomplished as
rapidly as currently expected or at all or that such savings and synergies will
not be offset by increases in other expenses or operating losses, including
losses due to problems integrating the two companies.
INTERESTS OF CERTAIN PERSONS IN THE MERGER
In considering the recommendation of the Merger by the UDN Board and Special
Committee, the stockholders of UDN should be aware that John Snedegar, President
of UDN, and Dale Christensen, Chief Operating Officer and Chief Financial
Officer of UDN, have employment agreements that provide them with bonuses and
severance benefits which would take effect if Mr. Snedegar or Mr. Christensen
exercises his right to terminate his employment agreement upon consummation of
the Merger. See "Management of STAR and UDN--UDN Employment Agreements." In
addition, certain directors and officers of UDN or its subsidiaries may also be
directors and/or officers of other companies whose principal business is similar
to that of UDN. It is possible, therefore, that a conflict may arise between
their duties as directors or officers of UDN or its subsidiaries and their
duties as directors or officers of such other companies. Such interests,
together with other relevant factors, were considered by the UDN Board and
Special Committee in making their recommendation and approving the Merger
Agreement. See "The Merger--Interests of Certain Persons in the Merger."
MAINTENANCE OF UDN'S CUSTOMER BASE
Customers are not obligated to purchase any minimum usage amount from UDN
and can discontinue service, without penalty, at any time. There can be no
assurance that customers will continue to buy their long distance telephone
service through UDN. In the event that a significant portion of UDN's customers
decide to purchase long distance service directly from another long distance
service provider, there can be no assurance that UDN will be able to replace its
customer base from other sources. Loss of a significant portion of UDN's
customers would have a material adverse effect on its results of operations and
financial condition.
A high level of customer attrition is inherent in the long distance
industry, and UDN's revenues are also affected by such attrition. Attrition
results from a variety of factors including termination of customers by UDN for
non-payment and the initiatives of existing and new competitors as they engage
in, among other things, national advertising campaigns, telemarketing programs
and the issuance of cash or other forms of incentives. Although UDN is aware of
the significance of attrition on its business, telecommunications providers
generally find it difficult to measure customer attrition in a consistently
meaningful manner due to, among other factors, the wide range of revenues
attributable to individual customers, the fact that
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service to an individual customer may be provided by more than one underlying
carrier and the variety of reasons for changes in the volume of service provided
to an individual customer.
UDN'S DEPENDENCE ON THIRD PARTY TRANSMISSION FACILITIES
UDN does not own all of the transmission facilities needed to complete long
distance telephone calls. Therefore, UDN's operator services, direct dial long
distance, "800" service, wholesale long distance service and prepaid calling
cards are largely dependent upon the contractual arrangements with facilities-
based carriers for the transmission of calls on a cost-effective basis. While
UDN believes it has ample access to transmission facilities at competitive rates
and expects to continue to have such access in the foreseeable future, due to
the possibility of unforeseen changes in industry conditions, the continued
availability of transmission facilities at historical rates cannot be assured.
In addition, UDN has entered into buying arrangements with other carriers
for the provision of originating and terminating long distance services,
primarily in those areas where UDN does not have its own network facilities.
Several of these contracts have monthly minimum usage requirements for the term
of the contract and contain penalties if these minimums are not met. UDN is
currently meeting the minimum usage requirements in its contracts, however,
there is no assurance that UDN will be able to continue meeting these minimum
usage requirements. If they are not met, the resulting penalties will severely
reduce UDN's gross margin and will negatively impact UDN's results of
operations.
DILUTION OF VOTING POWER
Consummation of the Merger will result in an approximate 1.7% increase in
the number of shares of STAR Common Stock outstanding. In exchange for 100% of
the outstanding UDN Common Stock, stockholders of UDN will receive approximately
1.7% of the outstanding voting stock of STAR upon the consummation of the
Merger. Thus, the stockholders of STAR will experience a very slight dilution of
their relative voting authority after the Merger.
CERTAIN INCOME TAX CONSEQUENCES
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
The following discussion addresses certain material United States federal
income tax consequences of the Merger to stockholders of UDN Common Stock who
hold their shares as capital assets (within the meaning of Section 1221 of the
Internal Revenue Code of 1986, as amended (the "Code")). The discussion is based
on the current provisions of the Code, applicable Treasury Regulations, judicial
authority and administrative rulings and practice. It does not address all
aspects of federal income taxation that may be relevant to particular UDN
stockholders in light of their specific circumstances, or to certain types of
stockholders subject to special treatment under the federal income tax laws,
including without limitation, insurance companies, tax-exempt organizations,
foreign persons, financial institutions or broker-dealers, and stockholders who
acquired their UDN Common Stock pursuant to the exercise of employee stock
options or in other compensatory transactions. This discussion also does not
address the state, local, foreign or other federal tax consequences of the
Merger. There can be no assurance that the Internal Revenue Service will not
take a contrary view to any expressed herein. No rulings have been or will be
requested from the Internal Revenue Service with respect to the tax consequences
of the Merger. Moreover, legislative, judicial or administrative changes or
interpretations may be forthcoming that could alter or modify the statements and
conclusions set forth herein, possibly with retroactive effect.
ALL UDN STOCKHOLDERS ARE URGED TO CONSULT THEIR OWN TAX ADVISORS AS TO THE
SPECIFIC TAX CONSEQUENCES TO THEM OF THE MERGER, INCLUDING THE APPLICABILITY AND
EFFECT OF ANY FEDERAL, STATE, LOCAL AND FOREIGN TAX LAWS, AND POSSIBLE CHANGES
IN APPLICABLE TAX LAWS.
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Based on the assumptions set forth below, the Merger should qualify as a
tax-free reorganization under Section 368(a)(1) of the Code. As a result, no
gain or loss will be recognized by a stockholder whose shares of UDN Common
Stock are converted into shares of STAR Common Stock, except to the extent of
any cash received in lieu of fractional shares of STAR Common Stock. Each
stockholder receiving cash in lieu of a fractional share of STAR Common Stock
will be treated as having received such fractional share interest and as having
sold it for the cash received, recognizing gain or loss equal to the difference
between the amount of cash received and the portion of that stockholder's basis
in the shares of UDN Common Stock allocable to the fractional share interest.
Such gain or loss will generally be treated as capital gain or loss (long-term
or short-term depending on the stockholder's holding period), unless the payment
transaction is essentially equivalent to a dividend within the meaning of
Section 302 of the Code (a "Dividend Transaction"). The tax basis of the STAR
Common Stock exchanged therefor (except for the basis attributable to any
fractional share interest in STAR Common Stock), and the holding period of the
STAR Common Stock will include the holding period of the UDN Common Stock
surrendered in the Merger.
A stockholder who exercises his appraisal rights with respect to a share of
UDN Common Stock and receives payment for such stock in cash will recognize
capital gain or loss (long-term or short-term depending on the the stockholder's
holding period) measured by the difference between the amount of cash received
and the stockholder's basis in such share, provided the appraisal transaction is
not a Dividend Transaction.
A transaction is not a Dividend Transaction with respect to a UDN
stockholder if, after taking into account shares owned actually and
constructively within the meaning of Section 318 of the Code, there is a
meaningful reduction in the stockholder's proportionate interest in the
corporation. Under this rule, the Internal Revenue Service has ruled that a
redemption of a fractional share for cash in the context of a reorganization
transaction (such as the Merger) is generally not a Dividend Transaction. In
addition, the Internal Revenue Service has ruled that any reduction in the
percentage interest of a small minority shareholder in a publicly held
corporation who exercises no control over corporate affairs should constitute a
meaningful reduction.
The tax discussion set forth herein is based on the accuracy of certain
representations made by STAR and UDN, including the following: (i) the Merger
will be consummated in accordance with the Merger Agreement; (ii) following the
Merger, UDN will hold substantially all (i.e., 90% of net asset value and 70% of
gross asset value) of its own properties and substantially all of Newco's
properties, and will continue its historic business or use a significant portion
of its historic business assets in a business; (iii) UDN has not redeemed, and
persons related to UDN have not acquired (other than in exchange for STAR or UDN
stock), an amount of UDN stock, and UDN has not made any extraordinary
distributions with respect to its stock, prior to and in connection with the
Merger, that would in the aggregate, reduce the value of all outstanding UDN
stock immediately prior to the Merger (after giving effect to such redemptions,
acquisitions, and distributions) to a value of less than 50 percent of the value
of all of the outstanding stock of UDN stock immediately prior to the Merger
determined without regard to such redemptions, acquisitions and distributions;
and (iv) in connection with the Merger, neither STAR nor any person related to
STAR, will acquire any UDN Common Stock for consideration other than STAR Common
Stock (other than cash paid for fractional share and dissenters' shares) or
redeem any of the STAR Common Stock issued in the Merger.
If the Merger were not to constitute a reorganization under Section
368(a)(1) of the Code, each UDN stockholder would recognize gain or loss equal
to the difference between the fair market value of the STAR Common Stock
received and cash received in lieu of fractional share and such stockholder's
basis in the shares of UDN Common Stock exchanged therefor. Such gain or loss
would be long-term or short-term capital gain or loss, depending upon the
stockholder's holding period with respect to the UDN Stock.
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Because the former UDN stockholders will own less than 50 percent of STAR
after the Merger, the Merger will be treated as an "ownership change" with
respect to UDN for purposes of Section 382 of the Code. As a result, the ability
of STAR to use any net operating losses of UDN from periods prior to the
Effective Time will generally be limited to an annual amount equal to the total
value (determined immediately prior to the Merger) of the stock of UDN
multiplied by a long-term tax-exempt interest rate factor (as published by the
Internal Revenue Service on a monthly basis).
CERTAIN CANADIAN AND FOREIGN TAX CONSEQUENCES
Stockholders of UDN and dissenting stockholders of UDN who are residents in,
or citizens of, Canada or another foreign jurisdiction should be aware that the
Merger (or the exercise of appraisal rights in respect of the Merger) may result
in the holder realizing or being required to record a gain or loss on the
exchange of shares under the Merger (or upon the exercise of, or any payment
being made in connection with, appraisal rights) or result in other tax
consequences to such holders. Such tax consequences, if any, are not described
herein. Such stockholders are urged to consult their own Canadian or foreign
tax, legal or other financial advisors, as applicable, as to the implications of
the Merger to them under such income tax laws.
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THE SPECIAL MEETING
This Proxy Statement/Prospectus is being furnished to holders of UDN Common
Stock in connection with the solicitation of proxies by the UDN Board for use at
the Special Meeting. This Proxy Statement/ Prospectus and accompanying form of
proxy are first being mailed to the stockholders of UDN on or about February 12,
1999.
THE SPECIAL MEETING
PURPOSE; TIME AND PLACE. At the Special Meeting, holders of UDN Common
Stock will be asked to vote upon a proposal (the "Proposal") to approve and
adopt the Merger Agreement and the transactions contemplated thereby and such
other matters as may properly come before the Special Meeting. The Special
Meeting will be held at McCarthy Tetrault, Main Board Room, 13th Floor, 777
Dunsmuir Street, Vancouver, B.C., Canada, March 19, 1999, starting at 10:00
a.m., local time.
The UDN Board and the Special Committee have determined that the Merger is
fair and in the best interests of UDN and its stockholders and have unanimously
approved the Merger Agreement. THE UDN BOARD AND THE SPECIAL COMMITTEE
UNANIMOUSLY RECOMMEND THAT THE STOCKHOLDERS OF UDN VOTE "FOR" THE APPROVAL AND
ADOPTION OF THE MERGER AGREEMENT AND THE TRANSACTIONS CONTEMPLATED THEREBY AT
THE SPECIAL MEETING. See "The Merger--UDN's Reasons for the Merger;
Recommendations of the UDN Board and Special Committee."
For a discussion of (i) the interests that certain directors and executive
officers of UDN have with respect to the Merger that are different from, or in
addition to, the interests of stockholders of UDN generally and (ii) information
regarding the treatment of options and warrants to purchase UDN Common Stock and
other rights of certain directors and executive officers of UDN, see "The
Merger--Interests of Certain Persons in the Merger." Such interests, together
with other relevant factors, were considered by the UDN Board and the Special
Committee in making their recommendation and approving the Merger Agreement.
VOTING RIGHTS; VOTES REQUIRED FOR APPROVAL. The UDN Board has fixed the
close of business on February 10, 1999, as the record date for voting at the
Special Meeting (the "Record Date"). Only holders of record of shares of UDN
Common Stock on the Record Date are entitled to notice of and to vote at the
Special Meeting. On the Record Date, there were 6,867,344 shares of UDN Common
Stock outstanding and entitled to vote at the Special Meeting, held by
approximately 145 stockholders of record. Each holder of record, as of the
Record Date, of UDN Common Stock is entitled to cast one vote per share. The
presence, in person or by proxy, of the holders of a majority of the outstanding
shares of UDN Common Stock entitled to vote is necessary to constitute a quorum
at the Special Meeting. The affirmative vote, in person or by proxy, of the
holders of a majority of the shares of UDN Common Stock outstanding on the
Record Date is required to approve and adopt the Proposal.
SHARE OWNERSHIP OF MANAGEMENT. At the close of business on February 10,
1999, directors and executive officers of UDN, as a group, were the beneficial
owners of an aggregate of 1,338,464 shares (approximately 9.5%) of the UDN
Common Stock then outstanding. As of February 9, 1999, directors and executive
officers of STAR, as a group, were beneficial owners of an aggregate of
approximately 24,927,006 shares (approximately 43.5%) of the STAR Common Stock
then outstanding. The vote of the STAR stockholders is not required to approve
the Merger.
PROXIES. All shares of UDN Common Stock represented by properly executed
proxies received prior to or at the Special Meeting and not revoked will be
voted in accordance with the instructions indicated in such proxies. IF NO
INSTRUCTIONS ARE INDICATED ON A PROPERLY EXECUTED RETURNED PROXY, HOWEVER, SUCH
PROXIES WILL BE VOTED FOR THE APPROVAL OF THE PROPOSAL. A properly executed
proxy marked "ABSTAIN", although counted for purposes of determining whether
there is a quorum and for purposes of determining the
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aggregate voting power and number of shares represented and entitled to vote at
the Special Meeting, will not be voted and will have the effect of a vote
against the Proposal.
The UDN Board is not currently aware of any business to be acted upon at the
Special Meeting other than the proposed Merger. If, however, other matters are
properly brought before the Special Meeting, or any adjournments or
postponements thereof, the persons appointed as proxies will have discretion to
vote or act thereon according to their judgment. Such adjournments may be for
the purpose of soliciting additional proxies. Shares represented by proxies
voting against the approval and adoption of the Proposal will be voted against a
proposal to adjourn the Special Meeting for the purpose of soliciting additional
proxies. UDN does not currently intend to seek an adjournment of its Special
Meeting.
The persons named in the accompanying instrument of proxy are directors or
officers of UDN. A stockholder has the right to appoint a person to attend and
act for him on his behalf at the Special Meeting other than the persons named in
the enclosed instrument of proxy. To exercise this right, a stockholder shall
strike out the names of the persons named in the instrument of proxy and insert
the name of his nominee in the blank space provided, or complete another
instrument of proxy. The completed instrument of proxy should be deposited at
UDN's transfer agent at Montreal Trust Company, 4th Floor--510 Burrard Street,
Vancouver, British Columbia, V6C 3B9 prior to the time of the Special Meeting.
The instrument of proxy must be signed by the stockholder or by his attorney
in writing, or, if the stockholder is a corporation, it must either be under its
common seal or signed by a duly authorized officer.
In addition to revocation in any other manner permitted by law, a
stockholder may revoke a proxy either by (a) signing a proxy bearing a later
date and depositing it at the place and within the time aforesaid, or (b)
signing and dating a written notice of revocation (in the same manner as the
instrument of proxy is required to be executed as set out in the notes to the
instrument of proxy) and either depositing it at the place and within the time
aforesaid or with the Chairman of the Special Meeting on the day of the Special
Meeting or on the day of any adjournment thereof, or (c) registering with Janine
Thomas, the Secretary of UDN, at the Special Meeting as a stockholder present in
person, whereupon such proxy shall be deemed to be have been revoked.
It is the policy of UDN to keep confidential proxy cards, ballots and voting
tabulations that identify individual stockholders, except where disclosure is
mandated by law and in other limited circumstances.
The cost of the solicitation of proxies will be paid by UDN for UDN proxies.
In addition to solicitation by mail, arrangements will be made with brokerage
houses and other custodians, nominees and fiduciaries to send proxy materials to
beneficial owners; and UDN will, upon request, reimburse them for their
reasonable expenses. UDN has retained D.F. King & Co., Inc. to aid in the
solicitation of proxies and to verify certain records related to the
solicitation at a fee of $5,000, plus expenses. To the extent necessary in order
to ensure sufficient representation at the Special Meeting, UDN may request by
telephone or facsimile transmission the return of proxy cards. The extent to
which this will be necessary depends entirely upon how promptly proxy cards are
returned. Stockholders are urged to send in their proxies without delay. UDN
will indemnify D.F. King & Co., Inc. against certain liabilities and expenses in
connection with the proxy solicitation, including liabilities under the federal
securities laws.
STOCKHOLDERS SHOULD NOT SEND IN ANY STOCK CERTIFICATES WITH THEIR PROXY
CARDS. A TRANSMITTAL FORM WITH INSTRUCTIONS FOR THE SURRENDER OF STOCK
CERTIFICATES FOR UDN COMMON STOCK WILL BE MAILED TO FORMER UDN STOCKHOLDERS AS
SOON AS PRACTICABLE AFTER THE CONSUMMATION OF THE MERGER.
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THE MERGER
GENERAL DESCRIPTION
The Merger Agreement provides for a business combination between STAR and
UDN in which Newco, a wholly-owned subsidiary of STAR, will be merged with and
into UDN and the holders of UDN Common Stock would receive shares of STAR Common
Stock in a transaction intended to qualify as a tax-free reorganization for
United States federal income tax purposes and as a pooling of interests for
accounting purposes. As a result of the Merger, UDN would become a wholly-owned
subsidiary of STAR.
EFFECTIVE TIME OF THE MERGER
The Merger will become effective upon the filing of a Certificate of Merger
(the "Certificate of Merger") with the Secretary of State of the State of
Delaware (the "Effective Time"). The Certificate of Merger will be filed as
promptly as practicable after the approval by UDN's stockholders has been
obtained and all other conditions to the Merger have been satisfied or waived.
It is presently expected that the Merger will be consummated on or about March
19, 1999 or as soon thereafter as such conditions are satisfied.
BACKGROUND OF THE MERGER
The terms of the Merger Agreement and the related agreements are the result
of arm's-length negotiations between representatives, legal advisors and
financial advisors of STAR and UDN. The following is a brief discussion of the
background of these negotiations, which resulted in the Merger Agreement and
related transactions.
STAR actively pursues opportunities to enhance its business through
strategic and synergistic acquisitions. These acquisitions may focus on entering
new territories, enlarging STAR's presence in an existing territory, adding
capacity or expanding into new market segments, such as the commercial market.
In furtherance of this objective, STAR acquired LDS, certain non-operating
entities and majority ownership in another entity on November 30, 1997, T-One
Corp. on March 10, 1998 and PT-1 on February 4, 1999.
UDN has been evaluating a number of strategic options to provide it with the
necessary resources to fuel UDN's continued growth and to remain competitive in
an industry undergoing rapid consolidation and change. These options included
remaining independent but obtaining additional private equity to fund expansion
and further acquisitions; selling UDN to another company in the industry; or
selling an interest in UDN to a financial investor, with a plan of a subsequent
initial public offering of its shares in the United States or sale of UDN to a
strategic investor.
In July 1997, UDN engaged Madison Securities, Inc. to act as placement agent
in a private placement of equity to fund UDN's growth. Pursuant to the private
placement, UDN would have offered 30 units at a purchase price of $100,000 per
unit, with each unit consisting of 62,500 shares of UDN Common Stock and a
warrant to purchase 20,000 additional shares of UDN Common Stock. At a price of
$1.60 per share, the consummation of the private placement would have resulted
in a substantial dilutive effect on the stockholders of UDN.
On October 31, 1997, John Snedegar, the President of UDN and a member of the
Board of Directors of STAR, was attending a STAR board meeting in Santa Barbara,
California. After the board meeting, Mr. Snedegar advised Christopher Edgecomb,
Chief Executive Officer of STAR, that UDN was in the process of completing a
private placement financing, which, if completed, would be dilutive to UDN's
stockholders. Mr. Edgecomb expressed an interest, on behalf of STAR, for STAR to
acquire UDN but he added that STAR would not be interested in acquiring UDN
after the completion of the financing because an acquisition of UDN after the
financing would greatly increase the aggregate cost of UDN to STAR. Mr. Snedegar
and Mr. Edgecomb discussed a general price range of approximately $2.50 per
share. Mr. Edgecomb immediately arranged a meeting with STAR's management team
and Mr. Snedegar to
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discuss the possible merger of STAR and UDN. Mary Casey, President and Secretary
of STAR, David Vaun Crumly, Executive Vice President of STAR, and Kelly Enos,
Chief Financial Officer of STAR, together with Mr. Edgecomb, represented STAR at
the meeting. Mr. Snedegar presented UDN's business plan, which included
financial projections, at the meeting and agreed to deliver to Ms. Enos a copy
of the UDN private placement memorandum, as well as its historical financial
statements.
During the period from October 31 through November 17, 1997, the date of the
next STAR board meeting, which was held in Las Vegas, Nevada, Mr. Snedegar
delivered historical financial information to Ms. Enos, and STAR commenced its
initial due diligence investigation of UDN. In addition, during that period, Mr.
Snedegar informed the members of the UDN Board of the discussions with STAR, and
the UDN Board after analyzing the private placement and other alternatives
presently under consideration, advised Mr. Snedegar to pursue the merger
discussions with STAR. At the November 17 meeting of the STAR Board, Mr.
Edgecomb discussed the anticipated advantages of acquiring UDN. The reasons for
the Merger discussed by Mr. Edgecomb, as well as the other members of the STAR
Board, are discussed at length under the caption "STAR's Reasons for the
Merger." At the November 17 meeting, the STAR Board, with Mr. Snedegar
abstaining from voting on the proposed transaction, authorized Mr. Edgecomb to
pursue detailed discussions with UDN management to pursue a possible merger with
UDN.
On November 18, 1997, at the request of STAR a second meeting was held at
the offices of STAR in Santa Barbara, California. The meeting was attended by
Mr. Snedegar and Phil Pearce, an outside director of UDN, Dale Christensen,
Chief Operating Officer and Chief Financial Officer of UDN, on behalf of UDN,
and Mr. Edgecomb and Ms. Enos on behalf of STAR. The respective legal counsel of
STAR and UDN also attended. Periodically during the course of the meeting, Mr.
Sledge, the Chairman of the Board of UDN was added to the meeting
telephonically. At that meeting, the representatives of STAR and UDN actively
negotiated various terms of the Merger Agreement, including those related to the
exchange ratio, a loan of $2.5 million to be made by STAR to UDN before
consummation of the Merger, a break-up fee, representations and warranties,
conditions to closing, indemnification and the operation of UDN during the
pendency of the transaction. The negotiations were principally conducted by
Messrs. Sledge and Pearce on behalf of UDN, while consulting with Mr. Snedegar.
By November 18, 1997, negotiations of the principal terms of the Merger
Agreement were completed.
All of the members of the UDN Board participated in a special telephonic
meeting, held on November 18, 1997 at approximately 5:00 p.m. (California time).
Also participating in the meeting were Mr. Christensen, and Martin Eric
Weisberg, Esq., a partner of the law firm of Parker Chapin Flattau & Klimpl,
LLP, UDN's legal counsel. Mr. Snedegar reported to the Board generally about the
negotiations with STAR and the status of UDN's private placement with Madison
Securities. Prior to the meeting the members of UDN's Board had been furnished
with a term sheet which outlined the salient terms and conditions of the Merger
and the related proposed loan from STAR. Mr. Weisberg reviewed the terms set
forth on the term sheet with the Board and responded to numerous questions
regarding, among other things, the break-up fee, UDN's ability to engage in
merger discussions with other third parties, the terms for the repayment of the
loan if the Merger was not consummated, STAR's due diligence as a condition to
closing, and the requirement that UDN would have to obtain a "fairness opinion"
from an independent investment bank. Mr. Weisberg responded that UDN's
negotiating team had obtained various concessions from STAR in these and other
areas, but advised that STAR was not willing to further modify the terms. Mr.
Pearce added that, given the fact that Madison Securities had advised UDN that
it was about to commence the initial closing under the private placement, it was
imperative to decide at this meeting whether or not to proceed with the Merger.
Mr. Snedegar did not participate in the deliberations of UDN's Board. The UDN
Board, absent Mr. Snedegar, discussed the entire transaction in detail. At this
meeting, the Board debated and discussed the reasons for the Merger set forth
under the caption "UDN's Reasons for the Merger; Recommendations of the UDN
Board and Special Committee." The UDN Board also decided to retain an
independent investment bank to render an opinion as to the entire fairness of
the Merger and related loan transaction to UDN. The Board determined that
Madison Securities should be
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considered for this role since Madison Securities had done extensive due
diligence, including a valuation analysis, on UDN in connection with the private
placement. At that meeting the UDN Board unanimously approved the terms of the
proposed transaction and determined to engage Madison Securities to render the
fairness opinion. The Merger Agreement was signed on November 19, 1997.
During November and December 1997, STAR's due diligence investigation
continued and UDN finalized the schedules to the Merger Agreement. As a result
of STAR's investigation, and specifically the discovery of certain bad debt
exposure of UDN due to fraud by one of its former customers, in January 1998,
the Merger Agreement was amended to reduce the consideration to be received by
UDN stockholders and STAR agreed to loan UDN an additional $2.0 million on
substantially the same terms as the $2.5 million loaned in connection with the
execution of the Merger Agreement. At a special telephonic meeting of the UDN
Board on January 24, 1998, the UDN Board discussed and unanimously approved the
terms of a first amendment to the Merger Agreement, which was signed on January
30, 1998.
In March 1998, in light of the vast increase in the price of STAR Common
Stock, the Merger Agreement was further amended to provide for a minimum
Exchange Ratio to be received by UDN stockholders. In addition, based on the
advice of STAR regulatory counsel, the parties agreed to clarify the regulatory
approvals to be obtained prior to consummation of the Merger. The second
amendment to the Merger Agreement was signed on April 6, 1998.
In June 1998, following STAR's announcement of the PT-1 transaction, STAR
informed UDN that the information in the May 28, 1998 Proxy Statement/Prospectus
was materially incomplete and needed to include details of the PT-1 acquisition.
The parties agreed to delay the Merger and postpone the meeting of UDN
stockholders until matters relating to the PT-1 Merger and related disclosure
documents were resolved. On September 21, 1998, STAR and PT-1 entered into the
UDN Management Agreement, pursuant to which, among other things, STAR began to
provide billing services to UDN and UDN became able to buy switch services
through STAR, thereby giving UDN greater access to more competitive buying
arrangements. In October 1998, in light of the instability of the various stock
markets in the United States, the parties agreed to establish $14.00 as the base
price to be used when calculating the Exchange Ratio. The parties also extended
the termination date of the Merger Agreement to April 15, 1999.
UDN'S REASONS FOR THE MERGER; RECOMMENDATIONS OF THE UDN BOARD AND SPECIAL
COMMITTEE
The UDN Board and the Special Committee have carefully considered the terms
of the proposed Merger and believe that the Merger and the related transactions
are fair and in the best interests of UDN and its stockholders. In reaching this
determination, the UDN Board and the Special Committee consulted with their
financial and legal advisors and with senior management and considered a number
of factors, including, without limitation, the following:
(i) the consideration to be received by the UDN stockholders in the Merger
reflected an appropriate valuation of UDN;
(ii) the ability of the combined company to better compete in a rapidly
consolidating international long distance industry;
(iii) a review of the possible alternatives to a sale of UDN;
(iv) that the Merger consideration represented a premium for UDN Common
Stock on the last trading day prior to the public announcement of the
execution of the Merger Agreement;
(v) the financial presentation of UDN's financial advisor and the advisor's
opinion as of May 7, 1998 that the terms of the Merger are fair to the
stockholders of UDN from a financial point of view;
(vi) that STAR is a public company that has experienced substantial growth
in revenues and income and has a management team with a proven track
record;
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(vii) the Merger consideration represents a substantial premium over the
$1.60 per share which would have been received by UDN in the Madison
Securities private placement and such private placement would have
resulted in substantial dilution to UDN existing stockholders;
(viii) that by providing UDN with the opportunity to combine with a company
having state-of-the-art switching equipment, a history of a high level
of customer and technical support and strong financial performance, the
Merger would support a major strategic objective of UDN to provide the
resources to allow the combined entity to rapidly expand into highly
fragmented international markets;
(ix) the potential efficiencies, synergies and cost savings expected to be
realized as a result of the combination of the operations of STAR and
UDN, including the combination of billing systems and sales and
marketing service and utilization of switches and transmission
facilities;
(x) that the addition of STAR's facilities in complementary geographic
areas, as well as in new markets, would improve the combined entity's
ability to pursue its growth strategy;
(xi) information with respect to the financial condition, business,
operations and prospects of both STAR and UDN on a historical and
prospective basis, including certain information reflecting the two
companies on a pro forma combined basis, and treating the Merger as a
pooling of interests for accounting purposes;
(xii) the tax-free nature of the Merger;
(xiii) the Exchange Ratio and recent trading prices for UDN Common Stock and
STAR Common Stock; and
(xiv) the terms of the Merger Agreement.
The foregoing list of the information and factors considered by the UDN
Board is not intended to be exhaustive. In view of the variety of factors
considered in connection with its evaluation of the Merger, the UDN Board did
not find it practicable to and did not quantify or otherwise assign relative
weights to the specific factors considered in reaching its determination. In
addition, individual members of the UDN Board may have given different weights
to different factors.
THE UDN BOARD AND THE SPECIAL COMMITTEE UNANIMOUSLY RECOMMEND THAT THE
STOCKHOLDERS OF UDN VOTE "FOR" THE APPROVAL AND ADOPTION OF THE MERGER AGREEMENT
AND THE TRANSACTIONS CONTEMPLATED THEREBY.
OPINION OF MADISON SECURITIES, FINANCIAL ADVISOR TO UDN
On May 7, 1998, Madison Securities presented its fairness opinion to the UDN
Board, together with a written opinion dated May 7, 1998, that, as of such date,
the consideration to be received by UDN's stockholders pursuant to the Merger
Agreement was fair to such stockholders from a financial point of view. Madison
Securities has confirmed its written opinion as of the date of this Proxy
Statement/ Prospectus. Based on conditions then prevailing, Madison Securities
had rendered a similar opinion on April 13, 1998, as to the consideration
provided for in the Merger Agreement.
THE FULL TEXT OF THE OPINION OF MADISON SECURITIES DATED THE DATE OF THIS
PROXY STATEMENT/PROSPECTUS IS ATTACHED AS ANNEX B TO THIS PROXY
STATEMENT/PROSPECTUS. UDN'S STOCKHOLDERS ARE URGED TO READ THIS OPINION IN ITS
ENTIRETY. MADISON SECURITIES' OPINION IS DIRECTED ONLY TO THE FAIRNESS OF THE
CONSIDERATION TO BE PAID IN THE MERGER TO UDN'S STOCKHOLDERS FROM A FINANCIAL
POINT OF VIEW AND DOES NOT CONSTITUTE A RECOMMENDATION TO ANY OF UDN'S
STOCKHOLDERS AS TO HOW SUCH STOCKHOLDER SHOULD VOTE AT THE MEETING. THE SUMMARY
OF THE OPINION OF MADISON SECURITIES SET FORTH IN
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THIS PROXY STATEMENT/PROSPECTUS IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE
FULL TEXT OF SUCH OPINION.
In rendering its opinion, Madison Securities (i) reviewed the Merger
Agreement; (ii) reviewed certain publicly available financial statements and
other information of STAR and UDN, respectively; (iii) reviewed certain internal
financial statements and other financial and operating data concerning UDN and
STAR prepared by the management of UDN and STAR, respectively; (iv) discussed
the past and current operations and financial condition and the prospects of
STAR, including information relating to certain strategic, financial and
operational benefits anticipated from the Merger, with senior executives of
STAR; (v) discussed the past and current operations and financial condition and
the prospects of UDN, including information relating to certain strategic,
financial and operational benefits anticipated from the Merger, with senior
executives of UDN; (vi) reviewed the pro forma impact of the Merger on the
earnings per share and consolidated capitalization of STAR and UDN,
respectively; (vii) reviewed the reported prices and trading activity for the
STAR Common Stock; (viii) compared the financial performance of UDN and STAR and
the prices and trading activity of the UND Common Stock and the STAR Common
Stock with that of certain other publicly-traded companies and their securities;
(ix) reviewed the financial terms, to the extent publicly available, of certain
comparable acquisition transactions; (x) reviewed and discussed with the senior
managements of UDN and STAR the strategic rationale for the Merger and certain
alternatives to the Merger; (xi) reviewed the Merger Agreement and the
agreements to be entered in connection therein; and (xii) considered such other
factors as it deemed appropriate.
In connection with its view, Madison Securities did not independently verify
any of the foregoing information and relied on such information as being
complete and accurate in all material respects. With respect to the financial
forecasts, Madison Securities assumed that they had been reasonably prepared
based on reflecting the best currently available estimates and judgments of the
managements of STAR and UDN as to the future financial performance of STAR and
UDN. In addition, Madison Securities did not make an independent evaluation or
appraisal of any of the assets of STAR and UDN.
In connection with rendering its opinion, Madison Securities considered a
variety of valuation methods. The material valuation methods used are summarized
below. These analyses taken together provided the basis for Madison Securities'
opinion. For purposes of its analysis, Madison Securities assumed a price for
the UDN Common Stock of $2.05 per share:
(1) Comparable Company Analysis. Using publicly available information,
Madison Securities compared selected historical operating financial, stock
data and financial ratios for UDN and certain other companies which, in
Madison Securities' judgment, were comparable to UDN for the purpose of this
analysis. Because there was no publicly-traded company directly comparable
to UDN, the comparable company analysis was comprised of eight companies
that Madison Securities deemed most similar to UDN. These companies are CCT
Communications Corporation, DCI Telecommunications, Equalnet Holdings
Corporation, Group Long Distance, l-Link Inc., Trescom International, USTel
Inc. and Worldport Communications, Inc. (the "Selected Companies"). The
financial information analyzed included earnings per share for the latest
twelve months ("LTM"), fiscal 1997 and estimates for fiscal 1998; book value
per share; price multiples for LTM earnings per share, fiscal 1997 earnings
per share and estimated 1998 earnings per share; market capitalization;
profitability; and a multiple of firm value to revenue, earnings before
interest and taxes ("EBIT"), and earnings before interest, taxes,
depreciation and amortization ("EBITDA"). This analysis showed that the
Selected Companies operate in businesses similar to UDN's and are similar in
size to UDN. Market capitalization ranged from $9.0 million to $230.0
million. The average market capitalization was $87.5 million compared to
UDN's $16 million. The Selected Companies reported annual earnings per share
ranging from -$10.07 to $0.42. The average annual EPS were -$1.91, compared
with UDN's -$0.31. The average estimated 1998 earnings per share were
-$0.28. Share prices ranged from $1.31 to $11.31. The average price was
$6.36. The average Price/Sales ratio was 10.82, compared to UDN's 0.46. The
average operating margins were -42.92%, compared to 7.6% for UDN. To
summarize, UDN has much
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higher profitability than the average Selected Company, and at $2.05, its
Price/Sales multiple is lower than the average Selected Company.
(2) Selected Transaction Analysis. Madison Securities examined recent
IPOs of four telecommunications companies. Included in the analysis were
Global Telesystems, Nextlink Communications, Startec Global Communication
and USN Communications (The "IPO Companies"). This analysis showed that the
average offered price per share was $16.25, and the average number of shares
offered was 9.3 million. 1997 earnings of these companies ranged from
-$15.55 per share to $0.32 per share, averaging -$5.71 per share. The
average estimated 1998 earnings per share were -$3.15. Profitability
analysis showed that the average operating margin was -132.85% (range
-207.60% to 2.44%). Price/ Sales ratios ranged from 1.79 to 35.28, averaging
15.34. Offered Price/Sales ratios ranged from 0.86 to 15.22, averaging 7.81.
The analysis of recent telecommunications IPOs confirmed the findings of the
analysis in the preceeding paragraph of the Selected Companies. UDN has much
higher profitability than the average IPO Company, and at $2.05 per share,
its Price/Sales multiple is lower than the average IPO Company.
(3) Trading History of the Common Stock. Madison Securities analyzed the
price and trading volume history for the common stock of the Selected
Companies, UDN and STAR from December 16, 1997, through the date of the
fairness opinion. See "Comparative Per Share Data". The trading history of
the Selected Companies' common stock was reviewed to examine trends in the
industry and to examine industry factors affecting UDN Common Stock. The
trading history of the STAR Common Stock was examined to evaluate the market
price of the STAR Common Stock in light of historical trading levels and
volumes. It was noted that the price of the Company's Common Stock had been
trading in anticipation of the Merger and, since the announcement of the
Merger, the price of the UDN Common Stock has been tied to the price of the
STAR Common Stock.
In preparing its opinion to the UDN Board, Madison Securities performed a
variety of financial and comparative analyses, including those described above.
This summary of such analyses does not purport to be a complete description of
the analyses underlying Madison Securities' opinion. The preparation of a
fairness opinion is a complex analytical process involving various
determinations as to the most appropriate and relevant methods of financial
analyses and the application of those methods to the particular circumstances.
Therefore, such opinion is not readily susceptible to a summary description. In
arriving at its opinion Madison Securities did not attribute any particular
weight to any analysis or factor considered by it, but rather made qualitative
judgments as to the significance and relevance of each analysis and factor.
Madison Securities believes that its analyses must be considered as a whole and
that selecting portions of its analyses and other factors considered by it,
without considering all analyses and factors, could create a misleading view of
the processes underlying its opinion. Madison Securities made numerous
assumptions with respect to industry performance, general business and economic
conditions and other matters, many of which are beyond the control of the
company and Madison Securities. Any estimates contained in Madison Securities'
analyses are not necessarily indicative of actual values, which may be
significantly more or less favorable than as set forth therein. Estimates of the
financial value of companies do not purport to be appraisals or necessarily
reflect the prices at which companies actually may be sold. Because such
estimates are inherently subject to uncertainty, neither UDN, STAR, Madison
Securities nor any other person is responsible for their accuracy.
In rendering its opinion, Madison Securities expressed no view as to the
range of values at which the STAR Common Stock may trade following consummation
of the Merger, nor did Madison Securities make any recommendations to UDN's
stockholder with respect to how such holders should vote on the Merger or to the
advisability of disposing of or retaining STAR Common Stock following the
Merger.
The UDN Board selected Madison Securities as its financial advisor because
Madison Securities is a regionally recognized investment banking firm with
experience in transactions similar to the Merger. In addition, Madison
Securities has provided financial advisory and financial services for UDN and
has
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received fees for the rendering of such services. As a part of its investment
banking business Madison Securities is continually engaged in the valuation of
businesses and their securities.
Madison Securities will receive, upon completion of the Merger, total fees
of approximately $100,000 for acting as financial advisor for UDN and preparing
its fairness opinion. UDN has also agreed to reimburse Madison Securities for
its reasonable expenses, including attorney's fees, and to indemnify Madison
Securities against certain liabilities in connection with its engagement.
STAR'S REASONS FOR THE MERGER
The STAR Board has unanimously approved the Merger, with Messrs. Edgecomb
and Snedegar abstaining. In reaching this determination, the STAR Board
consulted with STAR management, as well as its financial and legal advisors, and
considered a number of factors, including, without limitation, the following:
(i) that by providing STAR with the opportunity to acquire a company having
a significant sales force of independent agents with a number of
medium-sized commercial customers with a demand for international
calling services at competitive rates, the Merger would support a major
strategic objective of STAR to continue its expansion into the
commercial market;
(ii) the potential efficiencies and cost savings expected to be realized as
a result of the combination of the operations of STAR and UDN,
including the registration by UDN and its subsidiaries under the
respective public utility and common carrier rules and regulations of
more than 30 states;
(iii) that the addition of UDN's switch in Dallas and its other facilities in
complementary geographic areas would improve the combined entity's
ability to pursue its growth strategy;
(iv) information with respect to the financial condition, business,
operations and prospects of both STAR and UDN on a historical and
prospective basis, including certain information reflecting the two
companies on a pro forma combined basis, and treating the Merger as a
pooling of interests for accounting purposes;
(v) the tax-free nature of the Merger;
(vi) the terms of the Merger Agreement; and
(vii) the opportunity to create a combined company with greater competitive
strengths and business opportunities than would be possible for STAR on
a stand-alone basis.
The foregoing list of the information and factors considered by the STAR
Board is not intended to be exhaustive. In view of the variety of factors
considered in connection with its evaluation of the Merger, the STAR Board did
not find it practicable to and did not quantify or otherwise assign relative
weights to the specific factors considered in reaching its determination. In
addition, individual members of the STAR Board may have given different weights
to different factors. The Board also consulted with its financial and legal
advisors as it deemed appropriate in the context of its review and approval of
the Merger.
THE MERGER AGREEMENT
The following is a brief description of certain terms and provisions set
forth in the Merger Agreement. This description does not purport to be complete
and is qualified in its entirety by reference to the Merger Agreement, which is
attached hereto as ANNEX A and is incorporated herein by reference. Capitalized
terms used herein without definition shall have the respective meanings ascribed
thereto in the Merger Agreement. Holders of UDN Common Stock are strongly
encouraged to read the Merger Agreement in its entirety.
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Pursuant to the terms of the Merger Agreement, at the Effective Time, (i)
Newco will be merged with and into UDN, (ii) each outstanding share of common
stock of Newco will be converted into approximately 7,564 shares of common stock
of the surviving corporation (the"Surviving Corporation"), and (iii) the
separate existence of Newco will cease and UDN will succeed to all the rights,
privileges, powers and franchises and be subject to all the restrictions,
disabilities and duties of the constituent corporations to the Merger (the
"Constituent Corporations") in accordance with the Delaware General Corporation
Law (the "DGCL"). UDN will remain as the Surviving Corporation in the Merger and
will continue to exist as a wholly-owned subsidiary of STAR.
At the Effective Time, each share of UDN Common Stock then issued and
outstanding will be converted into the right to receive consideration per share
(the "Merger Consideration") consisting of that portion of a share (the
"Exchange Ratio") of STAR Common Stock determined by dividing $2.05 by the
average closing price of STAR's Common Stock on the Nasdaq National Market for
the five (5) trading days prior to the Effective Time (the "Average Price"),
provided that if the Average Price is equal to or greater than $27.50, or equal
to or less than $14.00, the Exchange Ratio shall be determined by using $27.50
or $14.00, as the case may be, as the Average Price. The Exchange Ratio shall be
adjusted as may be necessary and appropriate to reflect any and all stock
splits, reverse stock splits, reclassifications and similar capital events that
affect STAR Common Stock. Notwithstanding the foregoing, all treasury shares
will be cancelled pursuant to the Merger Agreement. All shares of UDN Common
Stock with respect to which appraisal rights have been demanded and perfected in
accordance with Section 262(d) of the DGCL (the "Dissenting Stock") shall not be
converted into the right to receive the Merger Consideration at or after the
Effective Time, and the holder thereof shall be entitled only to such rights as
are granted by the DGCL. See "Rights of Dissenting Stockholders." No fractional
shares of STAR Common Stock will be issued in the Merger. Rather, holders of UDN
Common Stock whose shares are converted in the Merger will be entitled to a cash
payment in lieu of fractional shares, as described under "--Exchange of
Certificates" and "--Fractional Shares."
A description of certain material differences between the rights of holders
of STAR Common Stock and UDN Common Stock is set forth under "Comparative Rights
of Stockholders."
EFFECTIVE TIME. The "Effective Time" shall mean the day on which the Merger
will become effective upon the filing, in accordance with Section 251 of the
DGCL, of a duly executed certificate of merger with the Delaware Secretary of
State, which will occur upon satisfaction or waiver of all conditions set forth
in the Merger Agreement.
DIRECTORS AND OFFICERS OF THE SURVIVING CORPORATION. The Merger Agreement
provides that the directors of Newco at the Effective Time will be the initial
directors of the Surviving Corporation and the officers of UDN at the Effective
Time will be the initial officers of the Surviving Corporation. Each of these
directors will hold office from the Effective Time until his or her respective
successor has been duly elected and qualified in accordance with the Certificate
of Incorporation and Bylaws of the Surviving Corporation.
DIRECTORS AND OFFICERS OF STAR. The current directors of STAR, including
Mr. Snedegar, President and a Director of UDN, will remain as directors of STAR
following the Effective Time. The current officers of STAR will remain as
officers of STAR following the Effective Time. See "--Interests of Certain
Persons in the Merger--Directors and Officers of the Combined Company."
EXCHANGE OF CERTIFICATES. UDN STOCKHOLDERS SHOULD NOT SUBMIT THEIR STOCK
CERTIFICATES EVIDENCING SHARES OF UDN COMMON STOCK FOR EXCHANGE UNLESS AND UNTIL
THE TRANSMITTAL INSTRUCTIONS AND A FORM OF LETTER OF TRANSMITTAL ARE RECEIVED OR
OBTAINED FROM U.S. STOCK TRANSFER CORPORATION (THE "EXCHANGE AGENT").
As soon as practicable after the Effective Time, the Exchange Agent shall
send a notice and a letter of transmittal to each holder of record of UDN Common
Stock immediately prior to the Effective Time
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advising such holder of the effectiveness of the Merger and the procedure for
surrendering to the Exchange Agent the certificate or certificates to be
exchanged pursuant to the Merger. Holders of UDN Common Stock, upon surrender of
their certificates together with a duly completed letter of transmittal, will
receive the Merger Consideration without interest thereon.
FRACTIONAL SHARES. No certificates or scrip representing a fractional share
interest in STAR Common Stock will be issued. In lieu of any such fractional
share interest, each holder of UDN Common Stock who otherwise would be entitled
to receive a fractional share interest in STAR Common Stock in the Merger will
be paid cash upon surrender of UDN Common Stock in an amount (rounded to the
nearest whole US $0.01) equal to the product of such fraction multiplied by the
Average Price.
REPRESENTATIONS AND WARRANTIES. The Merger Agreement contains various
customary representations and warranties of UDN relating to, among other things:
(a) UDN's and its subsidiaries' organization and similar corporate matters; (b)
UDN's capital structure; (c) the authorization, execution, delivery and
enforceability of the Merger Agreement and related matters; (d) the absence of
(i) conflicts under charter documents or bylaws, (ii) the need (except as
specified) for governmental or other filings, permits, authorizations, consents
or approvals with respect to the Merger Agreement and the transactions
contemplated thereby, (iii) violations of, conflicts with, breaches of, or
defaults under any agreement, lien, instrument, order or decree and (iv)
violations of laws; (e) subject to certain exceptions, absence of certain
specified material changes or events; (f) litigation; (g) labor matters; (h)
employee benefit matters and matters relating to the Employee Retirement Income
Security Act of 1974, as amended; (i) owned and leased real property; (j)
environmental matters; (k) tax matters; (l) the accuracy of information to be
supplied in connection with the Registration Statement, the Proxy
Statement/Prospectus and any other documents to be filed with the SEC, the
British Columbia Securities Commission, the Vancouver Stock Exchange or any
other regulatory agency; (m) financial statements and reports; (n) material
liabilities; (o) intellectual property; (p) material agreements; (q) insurance;
(r) certain accounting matters; (s) the hiring of brokers or finders; and (t)
transactions with affiliated parties.
The Merger Agreement also contains various customary representations and
warranties of STAR relating to, among other things: (a) STAR'S organization and
similar corporate matters; (b) STAR'S capital structure; (c) authorization,
execution, delivery and enforceability of the Merger Agreement and related
matters; (d) the absence of (i) conflicts under charter documents or bylaws,
(ii) the need (except as specified) for governmental filings, permits,
authorizations, consents or approvals with respect to the Merger Agreement and
in the transactions contemplated thereby, (iii) violations of, conflicts with,
breaches of, or defaults under any agreement, lien, instrument, order or decree
and (iv) violations of laws; (e) documents filed by STAR with the SEC and the
accuracy of the information contained therein; (f) litigation; (g) the accuracy
of information to be supplied in connection with the Registration Statement, the
Joint Proxy Statement/Prospectus and any other documents to be filed with the
SEC, the British Columbia Securities Commission, the Vancouver Stock Exchange or
any other regulatory agency; (h) the shares of STAR Common Stock to be issued in
the Merger; (i) financial statements and reports; and (j) the hiring of brokers
or finders.
BUSINESS OF UDN PENDING THE MERGER. UDN has agreed that, among other
things, prior to the Effective Time, unless STAR otherwise agrees in writing or
unless otherwise expressly provided by the Merger Agreement or the Disclosure
Schedules thereto: (a) the business of UDN and of its subsidiaries will be
conducted in the ordinary course and consistent with past practice; (b) neither
UDN nor its subsidiaries will (i) amend its Certificate of Incorporation or
Bylaws; (ii) declare, set aside or pay any dividend; (iii) make any redemption,
retirement or purchase of its capital stock; (iv) split, combine or reclassify
its capital stock; (v) issue, grant, sell or pledge any shares of its capital
stock, except upon exercise of outstanding stock options and warrants; (vi)
other than any promissory notes evidencing loans from STAR to UDN, incur any
material indebtedness for borrowed money, except material indebtedness for
borrowed money incurred under existing credit facilities; (vii) waive, release,
grant or transfer any rights of
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material value; (viii) transfer, lease, license, sell, mortgage, pledge, dispose
of or encumber any material assets; (ix) fail to use their reasonable commercial
efforts to preserve intact its business organization, to keep available the
services of its operating personnel and to preserve the goodwill of those having
business relationships with UDN and its subsidiaries; (x) increase the
compensation payable to any of its officers or directors; (xi) adopt any new, or
make any payment not required by any existing, stock option, bonus,
profit-sharing, pension, retirement, deferred compensation, or other payment or
employee compensation plan; (xii) grant any stock option or stock appreciation
rights or issue any warrants; (xiii) enter into or amend any employment or
severance agreement; (xiv) make any loan or advance to, or enter into any
written contract with any officer or director; (xv) assume, guarantee, endorse
or otherwise become responsible for the obligations of any other individual,
firm or corporation or make any loans or advances to any individual, firm or
corporation; (xvi) make any investment of a capital nature other than in the
ordinary course of business; (xvii) enter into, modify, amend or terminate any
material contract; (xviii) take any action, other than reasonable and usual
actions in the ordinary course of business and consistent with past practice,
with respect to accounting policies or procedures, except for changes required
by GAAP; (xix) settle or compromise any material federal, state, local or
foreign income tax proceeding or audit; or (xx) enter into an agreement to do
any of the things described above.
ACQUISITION PROPOSALS. UDN has agreed that neither UDN nor any of its
subsidiaries, nor the directors, officers, attorneys, financial advisors, or
other authorized persons of any of them, shall, directly or indirectly, solicit,
initiate or participate in discussions or negotiations with or the submission of
any offer or proposal by or provide any information to, any corporation,
partnership, person, or other entity or group (other than Newco or STAR or any
officer or other authorized representative of Newco or STAR) concerning the
acquisition (by means of a tender or exchange offer, merger, consolidation,
business combination or otherwise) of all or a substantial portion of the
outstanding shares of UDN Common Stock or of the assets of UDN and its
subsidiaries (all such transactions being referred to herein as "Third Party
Transactions"), or, except as may be consistent with fiduciary responsibilities
under applicable law as advised in writing by outside counsel, participate in
any negotiation regarding any Third Party Transaction or otherwise cooperate in
any way with any effort or attempt by any other person to effectuate a Third
Party Transaction. However, the UDN Board may furnish such information to or
enter into discussions and/or negotiations with any corporation, partnership,
person or other entity or group that makes an unsolicited offer to engage in a
Third Party Transaction with UDN that the UDN Board in good faith determines,
with the assistance of its financial advisor, may represent a transaction more
favorable to UDN's stockholders when compared to the Merger and the Merger
Consideration if, and only to the extent that, the UDN Board determines after
consultation with outside legal counsel that the failure to take such action
would be inconsistent with the compliance by the UDN Board with its fiduciary
duties to the UDN stockholders under applicable law, provided that such party
shall enter into a confidentiality agreement on substantially the terms
contained in the Merger Agreement, UDN shall notify STAR as to the contents of
information being provided and UDN shall diligently enforce its rights under
such confidentiality agreement. UDN will promptly communicate to STAR the
identity of any potential third party purchaser making any such proposal or
contact and, prior to the execution of any agreement relating to any such Third
Party Transaction, shall also communicate the proposed terms and conditions
thereof. UDN agrees not to release any third party from, or waive any provision
of, any confidentiality or standstill agreement to which UDN is a party.
TREATMENT OF UDN STOCK OPTIONS AND WARRANTS. On the Effective Time, STAR
shall assume the duties and obligations of UDN, and STAR shall be vested with
the powers, rights and privileges of UDN, under (a) the warrants of UDN that
remain outstanding at the Effective Time and (b) the options of UDN that remain
outstanding at the Effective Time. As of the Effective Time, STAR shall have
reserved for issuance and continue to maintain sufficient shares of registered
STAR Common Stock to issue the required shares of STAR Common Stock pursuant to
the exercise of such warrants and options after the Effective Time, subject to
appropriate adjustment in the exercise price thereof, based on the Exchange
Ratio.
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INDEMNIFICATION. Under the Merger Agreement, for a period of six years from
the Effective Time, STAR has agreed to ensure and guarantee that all provisions
with respect to indemnification as set forth in UDN's certificate of
incorporation, bylaws or indemnification agreements in each case, as in effect
on the date of the Merger Agreement in favor of persons who served as directors,
officers, employees or agents of UDN and certain subsidiaries on or before the
Effective Time shall not be amended, repealed or modified.
CONFIDENTIALITY. Subject to applicable law and to subpoena, STAR, Newco and
UDN and its subsidiaries have agreed to hold, and to cause each of their
affiliates, employees, officers, directors and other representatives to hold, in
strict confidence, and to not use to the detriment of the other party, any
information or data furnished to them in connection with the transactions
contemplated by the Merger Agreement, except for information or data generally
known or available to the public. If the transactions contemplated by the Merger
Agreement are not consummated, such confidence shall be maintained and all such
information and data as requested shall be returned.
EXPENSES AND FEES. If the Merger is consummated, all reasonable fees and
expenses incurred in connection with the Merger and the transactions
contemplated thereby will be paid by the Surviving Corporation. If the Merger is
not consummated, each party shall bear its own fees and expenses. In addition,
in certain circumstances, UDN shall pay to Newco a termination fee. See
"--Termination Fee."
CONDITIONS. The respective obligations of STAR and UDN to effect the Merger
are subject to the satisfaction of the following conditions at or prior to the
Effective Time: (a) the effectiveness of the Registration Statement, of which
this Proxy Statement/Prospectus is a part, and the absence of a stop order or
proceedings seeking a stop order; (b) the approval and adoption of the Merger
Agreement and the transactions contemplated thereby by the requisite vote of UDN
stockholders; (c) the absence of any statute, rule, regulation, preliminary or
permanent injunction or other order by any United States, Canadian or state
governmental authority, agency, commission or court of competent jurisdiction
prohibiting consummation of the Merger; (d) the expiration or termination of any
waiting period applicable to the consummation of the Merger under the HSR Act;
(e) the receipt by or on behalf of STAR of all necessary regulatory approvals
from the FCC and all PUCs required for the transfer of ownership or control over
UDN (which condition may be waived by STAR); (f) the authorization for listing
of the shares of STAR Common Stock to be issued in connection with the Merger on
the Nasdaq National Market upon official notice of issuance; and (g) the absence
of any action or proceeding by or before any court or governmental authority or
other regulatory or administrative agency or commission of competent
jurisdiction which would require either party to take any action which would
result in a material adverse effect to their respective businesses.
In addition, the obligations of UDN to effect the Merger are subject to the
satisfaction at or prior to the Effective Time of the following additional
conditions: (a) each of STAR and Newco shall have performed in all material
respects its obligations under the Merger Agreement required to be performed by
it on or prior to the Effective Time; (b) the representations and warranties of
STAR and Newco contained in the Merger Agreement shall be true and correct in
all material respects as if such representations and warranties were made as of
the Effective Time, except as contemplated by the Merger Agreement; (c) there
shall not have been any material adverse change in the financial condition,
results of operations, properties or business of STAR and its subsidiaries; (d)
UDN shall have received a certificate of the President or Vice President of STAR
with respect to clauses (a), (b) and (c); (e) UDN shall have received an opinion
of counsel in form reasonably agreed to by the parties; and (f) UDN shall have
received the opinion of its financial advisors that the Merger and the other
transactions contemplated by the Merger Agreement are fair, from a financial
point of view, to the UDN stockholders.
The obligations of STAR and Newco to effect the Merger are subject to the
satisfaction at or prior to the Effective Time of the following additional
conditions: (a) Each of UDN and its subsidiaries shall have performed in all
material respects its obligations under the Merger Agreement required to be
performed by it on or prior to the Effective Time; (b) the representations and
warranties of UDN contained in the Merger Agreement shall be true and correct in
all material respects as if such representations and
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warranties were made as of the Effective Time, except as contemplated by the
Merger Agreement; (c) there shall not have been any material adverse change in
the financial condition, results of operations, properties or business of UDN;
(d) STAR and Newco shall have received a certificate of the President or Vice
President of UDN with respect to clauses (a), (b) and (c); (e) Newco shall have
received letters of resignation from the members of UDN's Board of Directors;
(f) STAR shall have received an opinion of counsel from counsel to UDN in form
reasonably agreed to by the parties; (g) holders of no more than 5% of the
outstanding shares of UDN Common Stock shall have validly exercised their
appraisal rights; (h) each affiliate of UDN shall have executed and delivered an
Affiliate Agreement; and (i) STAR shall have received letters (i) from Arthur
Andersen LLP approving the accounting treatment of the Merger as a "pooling of
interests" and (ii) from PricewaterhouseCoopers LLP that UDN has taken no action
in the past two years that would prevent the application of a "pooling of
interests" accounting treatment to the Merger, and the SEC shall not have
objected to such accounting treatment.
TERMINATION. The Merger Agreement may be terminated at any time prior to
the Effective Time and before approval by the UDN stockholders in a number of
circumstances which include, among others: (a) by mutual consent of Newco and
UDN; (b) by Newco or UDN, if (i) the Board of Directors of UDN shall have failed
to recommend, or withdrawn, modified or amended in any respect its approval or
recommendation of the Merger and of the transactions contemplated by the Merger
Agreement or the Board of Directors of UDN shall have resolved to do any of the
foregoing or (ii) the stockholders of UDN shall have failed to vote in favor of
the Merger Agreement and the Merger and, in the case of UDN seeking termination
pursuant to (b)(i) above, UDN having paid to Newco the Termination Fee, as
defined below; (c) by Newco if (i) there has occurred a material adverse change
in the financial condition, operations, or business of UDN and its subsidiaries
taken as a whole, or (ii) there is a material breach of any of the
representations and warranties of UDN, or if UDN fails to comply in any material
respect with any of its covenants or agreements, which breaches or failures are,
in the aggregate, material in the context of the transactions contemplated by
the Merger Agreement; (d) by UDN (i) if there has occurred a material adverse
change in the financial condition, operations, or business of STAR, (ii) there
is a material breach of any of the representations and warranties of STAR or
Newco, or if STAR or Newco fails to comply in any material respect with any of
its covenants or agreements, which breaches or failures are, in the aggregate,
material in the context of the transactions contemplated by the Merger Agreement
or (iii) if the average closing price per share of STAR Common Stock for five
consecutive trading days is equal to or less than $6.00; (e) by either Newco or
UDN, if on or before April 15, 1999 the Merger shall not have been consummated;
provided that such failure has not been caused by that party's material breach
of the Merger Agreement; provided further that if any condition to the Merger
Agreement shall fail to be satisfied by reason of the existence of an injunction
or order of any court or governmental or regulatory body resulting from an
action or proceeding commenced by any party which is not a government or
governmental authority, then at the request of either party the deadline date
referred to above shall be extended for a reasonable period of time, not in
excess of 120 days, to permit the parties to have such injunction vacated or
order reversed; and (f) by UDN, if it has not received the opinion of its
financial advisors that the Merger and the other transactions contemplated by
the Merger Agreement are fair, from a fiscal point of view, to the stockholders
of UDN.
In the event of such termination and abandonment, no party hereto (or any of
its directors or officers) shall have any liability or further obligation to any
other party to the Merger Agreement, except for the Termination Fee, if
required, and except that nothing herein will relieve any party from liability
for any wilful breach of the Merger Agreement prior to such termination or
abandonment.
TERMINATION FEE. If the Merger Agreement is terminated by either Newco or
UDN, pursuant to clause (b)(i) above (a) after receipt of a bona fide
Third-Party Transaction proposal or (b) prior to receipt of the fairness opinion
described in clause (f) above, then UDN shall, simultaneously with such
termination, pay to Newco by wire transfer of immediately available funds, $2.0
million (the "Termination Fee").
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AMENDMENT AND WAIVER. Subject to applicable law, the Merger Agreement may
be amended by STAR and UDN solely by action of their respective Boards of
Directors. Any such amendment must be in writing and signed by both of the
parties. At any time prior to the Effective Time, the parties may (i) extend the
time for the performance of any of the obligations or other acts of the other
parties to the Merger Agreement, (ii) waive any inaccuracies in the
representations and warranties of the other party, and (iii) waive compliance by
the other party with any of the agreements or conditions to the Merger
Agreement. Any agreement on the part of such a party to any such extension or
waiver shall be valid only if set forth in an instrument in writing signed on
behalf of such party.
PROMISSORY NOTES. Upon execution of the Merger Agreement and the first
amendment thereto and in connection with the Merger, UDN issued promissory notes
to STAR in the principal amount of $2.5 million and $2.0 million, respectively
(the "Promissory Notes"). The Promissory Notes provide for, among other things:
(a) interest equal to the "Prime Rate" (as reported in the WALL STREET JOURNAL
on the date of each Promissory Note and as reset on each Reset Date (defined as
each date that interest is payable under each Promissory Note until the
principal amount of each Promissory Note is paid in full)) per annum plus one
percent (1%); (b) interest shall be paid in full on the Maturity Date of each
promissory note; (c) the outstanding principal amount of the Promissory Note
shall become automatically due and payable in full (i) upon the closing of a
Third Party Transaction, (ii) in nine months from the issuance date of the
Promissory Note, if UDN terminates the Merger Agreement because it has not
received the opinion of its financial advisor that the Merger and the other
transactions contemplated by the Merger Agreement are fair, from a financial
point of view, to the stockholders of UDN, or the stockholders of UDN shall have
failed to vote in favor of the Merger Agreement and the Merger, or (iii) in six
months from the date of termination, if the Merger Agreement is terminated by
either STAR or UDN for any reason whatsoever pursuant to the Merger Agreement
(other than as specified in the preceding clause); and (d) the interest rate
shall be 15% commencing on the date which is six months from the date of
termination if termination is terminated by STAR pursuant to Section 8.1(b)(ii)
of the Merger Agreement.
MANAGEMENT SERVICES AGREEMENT. On September 21, 1998, STAR and UDN entered
into the UDN Management Agreement, pursuant to which, among other things, STAR
began to provide billing services to UDN and UDN became able to buy switch
services through STAR, thereby giving UDN greater access to more competitive
buying arrangements.
PROXY AGREEMENT. Upon execution of the Merger Agreement, John R. Snedegar,
President of UDN, executed a Proxy Agreement granting STAR an irrevocable proxy
to vote all shares of UDN Common Stock held, beneficially or of record, by Mr.
Snedegar, and to express consent, in favor of the Merger pursuant to the Merger
Agreement and any transaction that is reasonably necessary or appropriate to
implement the Merger and in opposition of any proposal for the amendment of
UDN's certificate of incorporation or bylaws. The obligations of Mr. Snedegar
under the Proxy Agreement shall terminate on the earlier of the Effective Time
or termination of the Merger Agreement for any reason. As of February 1, 1999,
Mr. Snedegar held 769,147 shares, or approximately 11.2%, of outstanding UDN
Common Stock.
RESALE OF SHARES OF STAR COMMON STOCK ISSUED IN THE MERGER; AFFILIATES
The shares of STAR Common Stock to be issued in the Merger will be freely
transferable in the U.S., except that shares issued to any UDN stockholder who
may be deemed to be an "affiliate" (as defined under the Securities Act, and
generally including, without limitation, directors, certain executive officers
and beneficial owners of 10% or more of a class of capital stock) of UDN for
purposes of Rule 145 under the Securities Act may be resold by them only in
transactions permitted by the resale provisions of Rule 145 or as otherwise
permitted under the Securities Act and only after publication by STAR of at
least 30 days of combined operating results of STAR and UDN. The Merger
Agreement provides that UDN shall cause such affiliate to deliver to STAR at or
prior to the Effective Time, a letter agreement from each of them to the effect
that such affiliate will not offer or sell or otherwise dispose of any shares of
STAR
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Common Stock issued to such affiliate in or pursuant to the Merger in violation
of the Securities Act or the rules and regulations promulgated thereunder. This
Proxy Statement/Prospectus does not cover resales of shares of STAR Common Stock
received by any person who may be deemed to be an affiliate of UDN. For the UDN
stockholders resident in jurisdictions other than the U.S., the free
transferability of the STAR Common Stock may vary dependent on the laws of that
jurisdiction and, accordingly, each stockholder so affected should consult his,
her or its legal or other advisors.
ACCOUNTING TREATMENT OF THE MERGER
The Merger is expected to be accounted for by the pooling of interests
method in accordance with generally accepted accounting principles, which means
that STAR will restate its historical consolidated financial statements to
include the historical assets, liabilities, stockholders' equity and results of
operations of UDN.
INTERESTS OF CERTAIN PERSONS IN THE MERGER
In reviewing the actions of the UDN Board with respect to the Merger
Agreement and the transactions contemplated thereby, UDN stockholders should be
aware that certain members of UDN's management and the UDN Board have interests
in the Merger that are in addition to the interests of UDN stockholders
generally.
DIRECTORS OF STAR. Mr. Snedegar, President and a director of UDN, also
serves as a director of STAR.
SEVERANCE PAYMENTS, NONCOMPETITION PAYMENTS AND BONUSES. Each of Messrs.
Snedegar and Christensen is a party to an employment agreement with UDN which
provides that in the event that there is a change in control of UDN, each may
elect to terminate the agreement and upon such termination, each will be
entitled to a severance payment equal to his monthly salary times the number of
months remaining in the term of the employee agreement which expires on May 31,
2000, in the case of John Snedegar, and six (6) months, in the case of Dale
Christensen. See "Certain Relationships and Related Transactions-- UDN
Employment Agreements".
STOCK OPTION PLANS. At the close of business on February 1, 1999, the
senior management of UDN held outstanding options to purchase an aggregate of
75,000 shares of UDN Common Stock, at exercise prices ranging from $1.64 to
$2.04 per share, all of which are currently vested. On the Effective Time, STAR
shall assume the duties and obligations of UDN, and STAR shall be vested with
the powers, rights and privileges of UDN under the options to purchase UDN
Common Stock outstanding at the Effective Time.
REGULATORY APPROVALS
Under the HSR Act, and the rules promulgated thereunder by the Federal Trade
Commission (the "FTC"), the Merger may not be consummated until notification and
certain information has been furnished to the FTC and the Antitrust Division of
the Department of Justice (the "Antitrust Division") and specified waiting
period requirements have been satisfied.
STAR and UDN filed notification and report forms with respect to the Merger
under the HSR Act with the FTC and the Antitrust Division, and received early
termination of the required waiting period on June 16, 1998. At any time before
or after consummation of the Merger, the Antitrust Division or the FTC could
take such action under the antitrust laws as it deems necessary or desirable in
the public interest, including seeking to enjoin the consummation of the Merger
or seeking divestiture of substantial assets of STAR or UDN or any of their
respective subsidiaries. At any time before or after the Effective Time, and
notwithstanding that the HSR Act waiting period has been terminated, any state
could take such action under its antitrust laws as it deems necessary or
desirable. Such action could include seeking to enjoin the consummation of the
Merger or seeking divestiture of substantial assets of STAR or UDN or the
Surviving
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Corporation. Private parties also may seek to take legal action under the
antitrust laws under certain circumstances.
Prior to the change in ownership or management of UDN or the transfer of
control over UDN's certificate of public convenience and necessity and daily
operations, STAR needed to obtain all necessary regulatory approvals from the
FCC and all PUCs required for the transfer of ownership or control over UDN.
STAR has obtained all such necessary regulatory approvals.
STOCK EXCHANGE LISTING
It is a condition to the consummation of the Merger that the shares of STAR
Common Stock issuable to the stockholders of UDN pursuant to the terms of the
Merger Agreement be authorized for listing on the Nasdaq National Market.
DELISTING AND DEREGISTRATION OF UDN COMMON STOCK
If the Merger is consummated, UDN Common Stock will be delisted from the
Vancouver Stock Exchange.
COMPARATIVE STOCK PRICES
STAR Common Stock has been traded on the Nasdaq National Market under the
symbol "STRX" since June 12, 1997. UDN Common Stock has been traded on the
Vancouver Stock Exchange under the symbol "UDN.V" since August 9, 1996.
The following table sets forth, for the calendar periods indicated, the high
and low trading prices per share of STAR Common Stock on the Nasdaq National
Market and the UDN Common Stock on the Vancouver Stock Exchange.
<TABLE>
<CAPTION>
STAR UDN
COMMON STOCK COMMON STOCK(1)
----------------------- -----------------------
HIGH LOW HIGH LOW
---------- --------- ---------- ---------
<S> <C> <C> <C> <C>
1996
First Quarter........................... -- -- 2 5/8 1 7/8
Second Quarter.......................... -- -- 2 1/4 1 3/8
Third Quarter........................... -- -- 2 1/8 1 3/8
Fourth Quarter.......................... -- -- 2 1 5/8
1997
First Quarter........................... -- -- 2 1 1/2
Second Quarter (from June 12, 1997 for
STAR Common Stock).................... 7 3/8 4 41/64 2 3/8 1 3/8
Third Quarter........................... 11 53/64 6 7/32 3 1 5/8
Fourth Quarter.......................... 17 11/16 9 33/64 2 1/4 1 3/4
1998
First Quarter........................... 28 3/64 14 33/64 2 1/8 1 3/8
Second Quarter.......................... 37 3/8 23 3/8 1 7/8 1 5/8
Third Quarter........................... 23 9 11/16 1 7/8 1 4/8
Fourth Quarter.......................... 18 7 1/8 1 6/8 5/8
1999
First Quarter (through February 10,
1999)................................. 16 1/2 12 1/2 1 6/8 1 4/8
</TABLE>
- ------------------------
(1) All amounts set forth in U.S. dollars, based on the exchange rate of U.S.
dollars for each Canadian dollar on the date the UDN Common Stock reached
the high and low noted above.
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STAR has never paid cash dividends on STAR Common Stock and has no intention
of paying cash dividends in the foreseeable future. STAR's existing revolving
credit facility prohibits the payment of cash dividends without the lender's
consent. UDN has never paid cash dividends on UDN Common Stock and has no
intention of paying dividends in the foreseeable future.
The reported closing sale price of STAR Common Stock on the Nasdaq National
Market on November 18, 1997, the last full day of trading for STAR Common Stock
prior to the announcement by STAR and UDN of the execution of the Merger
Agreement, was $15.183 per share (adjusted to reflect the Stock Split). The
closing sale price of UDN Common Stock on the Vancouver Stock Exchange on such
date was $2.15 per share.
On February 10, 1999, the last trading day prior to the date of this Proxy
Statement/Prospectus, the last reported sale price of STAR Common Stock on the
Nasdaq National Market was $13.25 per share, and the last reported price of UDN
Common Stock on the Vancouver Stock Exchange was $1.32 per share.
Following the Merger, STAR Common Stock will continue to be traded on the
Nasdaq National Market. At such time, UDN Common Stock will cease to be quoted
on the Vancouver Stock Exchange, and, since UDN will be a wholly-owned
subsidiary of STAR, there will be no further market for such stock. See
"--Delisting and Deregistration of UDN Common Stock."
APPRAISAL RIGHTS OF STOCKHOLDERS
GENERAL
Since UDN's state of incorporation is Delaware, dissenting stockholders who
comply with the applicable provision of the Delaware Law will be eligible for
appraisal rights in the Merger. If the Merger is consummated, any stockholder
who votes against or abstains from voting for the Merger has the right, upon
compliance with the provisions set forth in Section 262 of the Delaware Law,
more particularly described below, to have his or her shares of UDN Common Stock
appraised and to receive payment in cash for the fair value of such stock
exclusive of any element of value arising from the accomplishment or expectation
of the Merger.
The following summary does not purport to be a complete statement of the law
in Delaware relating to dissenters' appraisal rights, and the following summary
is qualified in its entirety by the statutory provisions of the Delaware Law
which are attached to this Proxy Statement/Prospectus as ANNEX C. THE FOLLOWING
SUMMARY AND ANNEX C SHOULD BE REVIEWED CAREFULLY BY ANY STOCKHOLDER WHO WISHES
TO EXERCISE APPRAISAL RIGHTS, OR WISHES TO PRESERVE THE ABILITY TO DO SO. A
STOCKHOLDER MAY WISH TO CONSULT COUNSEL, SINCE FAILURE TO COMPLY WITH THE
PROCEDURES SET FORTH BELOW COULD RESULT IN THE LOSS OF SUCH RIGHTS.
Payments to Dissenting Stockholders, if any, made in connection with the
exercise of appraisal rights will be taxable transactions for federal income tax
purposes.
DELAWARE LAW
When the Merger is effected, stockholders of UDN who comply with the
procedures prescribed in Section 262 of the Delaware Law ("Section 262") will be
entitled to a judicial determination of the "fair value" of their shares
(exclusive of any element of value arising from the accomplishment or
expectation of the Merger) and to receive from UDN payment of such fair value in
cash. Shares of UDN Common Stock which are outstanding immediately prior to the
Effective Time and with respect to which appraisal shall have been properly
demanded in accordance with Section 262 shall not be converted into the right to
receive the Merger Consideration at or after the Effective Time unless and until
the holder of such shares withdraws his or her demand for such appraisal or
becomes ineligible for such appraisal.
The following is a brief summary of the statutory procedures to be followed
by a stockholder of UDN in order to dissent from the Merger and perfect
appraisal rights under the Delaware Law. THIS SUMMARY IS NOT INTENDED TO BE
COMPLETE AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SECTION 262, THE TEXT
OF WHICH IS
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INCLUDED AS ANNEX C OF THIS PROXY STATEMENT/PROSPECTUS. ANY STOCKHOLDER
CONSIDERING DEMANDING APPRAISAL IS ADVISED TO CONSULT LEGAL COUNSEL.
A written demand for appraisal of shares of UDN Common Stock must be
delivered to UDN by a stockholder seeking appraisal before the taking of the
vote on the Merger Agreement. This written demand must be separate from any
proxy or vote abstaining from or voting against approval of the Merger
Agreement. Voting against approval of the Merger Agreement, abstaining from
voting or failing to vote with respect to approval of the Merger Agreement will
not constitute a demand for appraisal within the meaning of Section 262.
STOCKHOLDERS ELECTING TO EXERCISE THEIR APPRAISAL RIGHTS UNDER SECTION 262
MUST NOT VOTE FOR APPROVAL OF THE MERGER AGREEMENT. A VOTE BY A STOCKHOLDER
AGAINST APPROVAL OF THE MERGER AGREEMENT IS NOT REQUIRED IN ORDER FOR THAT
STOCKHOLDER TO EXERCISE APPRAISAL RIGHTS. HOWEVER, IF A STOCKHOLDER RETURNS A
SIGNED PROXY BUT DOES NOT SPECIFY A VOTE AGAINST APPROVAL OF THE MERGER
AGREEMENT OR A DIRECTION TO ABSTAIN, THE PROXY, IF NOT REVOKED, WILL BE VOTED
FOR APPROVAL OF THE MERGER AGREEMENT, WHICH WILL HAVE THE EFFECT OF WAIVING THAT
STOCKHOLDER'S APPRAISAL RIGHTS.
A written demand for appraisal must reasonably inform UDN of the identity of
the stockholder of record and that such stockholder intends thereby to demand
appraisal. Accordingly, a demand for appraisal should be executed by or for the
stockholder of record, fully and correctly, as such stockholder's name appears
on the stock certificates. If UDN Common Stock is owned of record in a fiduciary
capacity, such as by a trustee, guardian or custodian, such demand must be
executed by the fiduciary. If, for example, a stockholder holds shares of UDN
Common Stock through a broker, who in turn holds shares through a central
securities depository nominee, such as Cede & Co., a demand for appraisal of
such shares must be made by or on behalf of such depository nominee. If UDN
Common Stock is owned of record by more than one person, as in a joint tenancy
or tenancy in common, such demand must be executed by or for all joint owners.
An authorized agent, including an agent for two or more joint owners, may
execute the demand for appraisal for a stockholder of record; however, the agent
must identify the record owner and expressly disclose the fact that, in
exercising the demand, he is acting as agent for the record owner.
A record owner, such as a broker, who holds UDN Common Stock as a nominee
for others, may exercise appraisal rights with respect to the UDN Common Stock
held for all or less than all beneficial owners of UDN Common Stock as to which
the holder is the record owner. In such case, the written demand must set forth
the number of shares of UDN Common Stock covered by such demand. Where the
number of shares of UDN Common Stock is not expressly stated, the demand will be
presumed to cover all shares of UDN Common Stock outstanding in the name of such
record owner. Beneficial owners who are not record owners and who intend to
exercise appraisal rights should instruct the record owner to comply strictly
with the statutory requirements with respect to the delivery of written demand
prior to the taking of the vote on the Merger.
A UDN stockholder who elects to exercise appraisal rights must mail or
deliver the written demands for appraisal to: Secretary, United Digital Network,
Inc., 4 Hutton Centre, Suite 800, Santa Ana, CA 92707; or should deliver such
demand to UDN in person at the Special Meeting. The written demand for appraisal
should specify the stockholder's name and mailing address and the number of
shares of UDN Common Stock covered by the demand, and should state that the
stockholder is thereby demanding appraisal in accordance with Section 262.
Within ten days after the Effective Time, UDN must provide notice as to the
date of effectiveness of the Merger to all stockholders who have duly and timely
delivered demands for appraisal and who have not voted for approval of the
Merger Agreement.
Within 120 days after the Effective Time, any Dissenting Stockholder is
entitled, upon written request, to receive from UDN a statement setting forth
the aggregate number of shares not voted in favor of approval of the Merger
Agreement and with respect to which demands for appraisal have been received by
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UDN and the number of holders of such shares. Such statement must be mailed
within 10 days after the written request therefor has been received by UDN.
Within 120 days after the Effective Time, either UDN or any Dissenting
Stockholder may file a petition in the Delaware Court of Chancery demanding a
determination of the fair value of shares of UDN Common Stock of all dissenting
stockholders. If a petition for an appraisal is timely filed, after a hearing on
such petition, the Delaware Court of Chancery will determine which of the UDN
stockholders are entitled to appraisal rights and thereafter will appraise the
shares of UDN Common Stock owned by such stockholders, determining the fair
value of such shares, exclusive of any element of value arising from the
accomplishment or expectation of the Merger, together with the fair rate of
interest to be paid, if any, upon the amount determined to be fair value. In
determining fair value, the Delaware Court of Chancery is to take into account
all relevant factors. In WEINBERGER V. UOP, INC., ET AL., the Delaware Supreme
Court discussed the factors that could be considered in determining fair value
in an appraisal proceeding, stating that "proof of value by any techniques or
methods which are generally considered acceptable in the financial community and
otherwise admissible in court" should be considered and the "[f]air price
obviously requires consideration of all relevant factors involving the value of
a company." The Delaware Supreme Court stated that in making this determination
of fair value the court and the appraiser may consider "all factors and elements
which reasonably might enter into the fixing of value," including "market value,
asset value, dividends, earnings prospects, the nature of the enterprise and any
other facts which were known or which could be ascertained as of the date of the
merger and which throw any light on future prospects of the merged corporation."
The Delaware Supreme Court has construed Section 262 to mean that "elements of
future value, including the nature of the enterprise, which are known or
susceptible of proof as of the date of the merger and not the product of
speculation, may be considered." However, such court noted that Section 262
provides that fair value is to be determined "exclusive of any element of value
arising from the accomplishment or expectation of the merger."
Upon the filing of any such petition by a dissenting stockholder, service of
a copy thereof shall be made upon STAR, which shall within 20 days of such
service file in the office of the Register in Chancery in which the petition was
filed a duly verified list containing the names and addresses of all
stockholders who have demanded payment for their shares and with whom agreements
as to the value of their shares have not been reached by STAR. If such petition
is filed by STAR, the petition shall be accompanied by such duly verified list.
Stockholders considering whether to seek appraisal should bear in mind that
the fair value of their UDN Common Stock determined under Section 262 could be
more than, the same as, or less than the value of the Merger Consideration to be
exchanged in the Merger, and that opinions of investment banking firms as to
fairness from a financial point of view are not necessarily opinions as to fair
value under Section 262. Moreover, the Surviving Corporation reserves the right
to assert in any appraisal proceeding that, for purposes thereof, the "fair
value" of the UDN Common Stock is less than the value of the Merger
Consideration.
The cost of the appraisal proceeding may be determined by the Delaware Court
of Chancery and taxed upon the parties as the court deems equitable in the
circumstances. Upon application of a dissenting stockholder, the court may order
that all or a portion of the expenses incurred by any dissenting stockholder in
connection with the appraisal proceeding, including, without limitation,
reasonable attorneys' fees, and the fees and expenses of experts, be charged pro
rata against the value of all shares entitled to appraisal. In the absence of
such a determination or assessment, each party bears its own expenses.
A dissenting stockholder who has duly demanded appraisal in compliance with
Section 262 will not, after the Effective Time, be entitled to vote for any
purpose the UDN Common Stock subject to such demand or to receive payment of
dividends or other distributions on such UDN Common Stock, except for dividends
or other distributions payable to stockholders of record at a date prior to the
Effective Time.
At any time within 60 days after the Effective Time, any dissenting
stockholder will have the right to withdraw his or her demand for appraisal and
to accept the Merger Consideration. After this period, a
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dissenting stockholder may withdraw his or her demand for appraisal only with
the consent of UDN. If no petition for appraisal is filed with the Delaware
Court of Chancery within 120 days after the Effective Time, dissenting
stockholders' rights to appraisal shall cease and they shall be entitled only to
receive the Merger Consideration. Inasmuch as UDN has no obligation to file such
a petition, any stockholder who desires such a petition to be filed is advised
to file it on a timely basis. However, no petition timely filed in the Delaware
Court of Chancery demanding appraisal shall be dismissed as to any stockholder
without the approval of the Delaware Court of Chancery, and such approval may be
conditioned upon such terms as the Delaware Court of Chancery deems just.
A vote for the Merger will constitute a waiver of appraisal rights. A
failure to vote against the Merger will not, under Delaware law, constitute a
waiver of appraisal rights. If a stockholder returns a proxy which does not
contain instructions as to how it should be voted, such proxy will be voted in
favor of the Merger and, accordingly, appraisal rights will be waived. As
described above, a vote against the Merger is not sufficient to perfect
appraisal rights. A stockholder's failure to make the written demand prior to
the Special Meeting as described above will constitute a waiver of appraisal
rights. FAILURE TO TAKE ANY REQUIRED STEP IN CONNECTION WITH THE EXERCISE OF
APPRAISAL RIGHTS MAY RESULT IN THE TERMINATION OR WAIVER OF SUCH RIGHTS.
COMPARATIVE RIGHTS OF STOCKHOLDERS
Upon consummation of the Merger, the stockholders of UDN will become
stockholders of STAR, a Delaware corporation, and their rights will be governed
by STAR's Amended and Restated Certificate of Incorporation (the "STAR Charter")
and Bylaws (the "STAR Bylaws"), which differ in certain material respects from
UDN's Restated Certificate of Incorporation (the "UDN Charter") and Amended
Bylaws (the "UDN Bylaws"). As stockholders of STAR, the rights of the former
stockholders of UDN will continue to be governed by the DGCL.
The following comparison of the STAR Charter and the STAR Bylaws, on the one
hand, and the UDN Charter and the UDN Bylaws, on the other, is not intended to
be complete and is qualified in its entirety by reference to the STAR Charter,
the STAR Bylaws, the UDN Charter and the UDN Bylaws. Copies of STAR's Charter
and the STAR Bylaws are available for inspection at the principal executive
office of STAR, and copies will be sent to the holders of UDN Common Stock upon
request. Copies of the UDN Charter and the UDN Bylaws are available for
inspection at the principal executive office of UDN, and copies will be sent to
holders of UDN Common Stock upon request.
NUMBER OF DIRECTORS
The DGCL provides that a corporation's board of directors shall consist of
at least one member and that the authorized number of directors may be fixed in
the corporation's certificate of incorporation or in the bylaws. The STAR Bylaws
provide that the authorized number of directors constituting the STAR Board
shall be established by the STAR Board pursuant to a resolution adopted by a
majority of the total number of authorized directors and is currently set at
six. The UDN Bylaws provide that the authorized number of directors constituting
the UDN Board shall be six until such Bylaws are amended by resolution duly
adopted by the UDN Board or the stockholders of UDN. The UDN Board currently
consists of five members.
CLASSIFICATION
The STAR Bylaws provide that the STAR Board will be divided into three
classes, and each class generally serves for a term of three years. The term of
only one class of directors expires annually, so it is only possible to elect
one class of the Board of Directors (or approximately one-third) in any one
year. The UDN Board is not classified.
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<PAGE>
REMOVAL OF DIRECTORS; FILLING VACANCIES ON THE BOARD OF DIRECTORS
Under the DGCL, any director or the entire board of directors generally may
be removed, with or without cause, by the holders of a majority of the shares
entitled to vote at an election of directors, provided, however, that directors
serving on a classified board may be removed only for cause unless the
corporation's charter provides otherwise. The STAR Bylaws provide that any
director may be removed only for cause by a majority of the outstanding shares
of stock entitled to vote at an election of directors. As the UDN Charter
contains no provision concerning removal of directors, under the DGCL, UDN
stockholders representing a majority of the outstanding shares of stock entitled
to vote at an election of directors may remove a UDN director only for cause.
The DGCL generally provides that all vacancies on the board of directors,
including vacancies caused by an increase in the number of authorized directors,
may be filled by a majority of the remaining directors even if they constitute
less than a quorum. Both the STAR Bylaws and the UDN Bylaws provide that
vacancies and newly created directorships resulting from an increase in the
authorized number of directors may be filled by a majority of the directors then
in office, even if less than a quorum, or by a sole remaining director.
LIMITATION ON DIRECTORS' LIABILITY
The DGCL permits a corporation to include in its certificate of
incorporation a provision limiting or eliminating the liability of its directors
to such corporation or its stockholders for monetary damages arising from a
breach of fiduciary duty, except for: (i) a breach of the duty of loyalty to the
corporation, (ii) acts or omissions not in good faith or which involve
intentional misconduct or a knowing violation of law, (iii) a declaration of a
dividend or the authorization of the repurchase or redemption of stock in
violation of the DGCL or (iv) any transaction from which the director derived an
improper personal benefit. Both the STAR Charter and the UDN Charter eliminate
director liability to the maximum extent permitted by the DGCL.
INDEMNIFICATION
The DGCL provides in general that a corporation may indemnify any person,
including its directors, officers, employees and agents, who was or is a party
or is threatened to be made a party to any threatened, pending or completed
action, suit or proceeding, whether civil, criminal, administrative or
investigative (other than actions by or in the right of the corporation) by
reason of the fact that he or she is or was a representative of or serving at
the request of the corporation, against expenses (including attorneys' fees),
judgments, fines and amounts paid in settlement actually and reasonably incurred
by him or her in connection with the action, suit or proceeding if he or she
acted in good faith and in a manner he or she reasonably believed to be in, or
not opposed to, the best interests of the corporation and, with respect to any
criminal proceeding, had no reasonable cause to believe his or her conduct was
unlawful. The DGCL permits similar indemnification in the case of actions by or
in the right of the corporation, provided that indemnification is not permitted
for (i) breach of duty of loyalty to the company, (ii) acts or omissions not in
good faith or constituting intentional misconduct or knowing violation of the
law, (iii) declaration of an improper dividend, stock purchase or redemption of
shares or (iv) any transaction from which the director derived an improper
personal benefit. In general, no indemnification for expenses in derivative
actions is permitted under the DGCL where the person has been adjudged liable to
the corporation, unless a court finds him or her entitled to such
indemnification. However, to the extent that a present or former director or
officer of a corporation has been successful on the merits or otherwise in
defense of any action, suit or proceeding, or in defense of any claim, issue or
matter, he or she shall be indemnified against expenses (including attorneys'
fees) actually and reasonably incurred by him or her in connection therewith.
The DGCL also provides that the indemnification permitted or required by the
DGCL is not exclusive of any other rights to which a person seeking
indemnification may be entitled.
65
<PAGE>
The UDN Charter provides that UDN shall indemnify any person acting as
director or officer of UDN and any person serving at the request of UDN as a
director or officer of another corporation, joint venture, partnership, trust or
other enterprise, to the fullest extent permitted by the DGCL and provides that
UDN may enter into indemnification agreements with each of its directors and
officers providing a contractual right of indemnification to the maximum extent
permitted by law. The language in the STAR Bylaws provides for indemnification
of directors to the full extent permitted by the DGCL and provides that the STAR
Board in its discretion may indemnify any person, other than a director, made a
party to any action, suit or proceeding by reason of the fact that such person,
their testator or intestate, is or was an officer or employee of the
corporation.
RESTRICTIONS ON BUSINESS COMBINATIONS/CORPORATE CONTROL
Section 203 of the DGCL applies to a broad range of business combinations
(as defined in the DGCL) between a Delaware corporation and an interested
stockholder (as defined). The DGCL definition of "business combination" includes
mergers, sales of assets, issuance of voting stock and certain other
transactions. An "interested stockholder" is defined as any person who owns,
directly or indirectly, 15.0% or more of the outstanding voting stock of a
corporation. The DGCL prohibits a corporation from engaging in a business
combination with an interested stockholder for a period of three years following
the date on which the stockholder became an interested stockholder, unless (i)
the board of directors approved the business combination before the stockholder
became an interested stockholder, or the board of directors approved the
transaction that resulted in the stockholder becoming an interested stockholder,
(ii) upon consummation of the transaction which resulted in the stockholder
becoming an interested stockholder, such stockholder owned at least 85.0% of the
voting stock outstanding when the transaction began other than shares held by
directors who are also officers and by certain employee stock plans, or (iii)
the board of directors approved the business combination after the stockholder
became an interested stockholder and the business combination was approved at a
meeting by at least two-thirds of the outstanding voting stock not owned by such
stockholder. Both STAR and UDN are subject to the provisions of Section 203 of
the DGCL.
STOCKHOLDER ACTION BY WRITTEN CONSENT; SPECIAL MEETINGS. The DGCL provides
that, unless otherwise provided in the certificate of incorporation, any action
that may be taken or is required to be taken at any annual or special meeting of
stockholders may be taken without a meeting, without prior notice and without a
vote, if a consent in writing, setting forth the action so taken, is signed by
the holders of outstanding stock having not less than the minimum number of
votes that would be necessary to authorize or take such action at a meeting at
which all shares entitled to vote thereon were present and voted. The UDN
Charter currently permits such action without a meeting. The STAR Charter
provides that any action required or permitted to be taken by the stockholders
of STAR may be taken without an annual or special meeting only by the unanimous
written consent of all stockholders entitled to vote on such action.
Under the DGCL, a special meeting of the stockholders may be called by the
board of directors or such other person as may be authorized in the certificate
of incorporation or bylaws. The STAR Bylaws provide that special meetings of
stockholders may be called by the President and shall be called by the President
or Secretary at the request in writing of a majority of the STAR Board. The UDN
Bylaws provide that special meetings of the stockholders of UDN may be called
only by the UDN Board, the Chairman of the Board or the holders of shares
entitled to cast not less than 10% of the votes at such meeting.
AMENDMENT OR REPEAL OF THE CHARTER AND BYLAWS. Under the DGCL, a
corporation may amend its certificate of incorporation, from time to time, in
any and as many respects as may be desired, so long as its certificate of
incorporation as amended would contain only such provisions as it would be
lawful and proper to insert in an original certificate of incorporation. The
DGCL also provides that a certificate of incorporation may confer on the board
of directors the power to amend the bylaws. Additionally, under the DGCL, a
corporation's bylaws may be amended by the stockholders entitled to vote, which
power may not
66
<PAGE>
be divested or limited where the board also has such power. The STAR Bylaws
provide that such Bylaws may be altered, amended or repealed or new bylaws may
be adopted by the STAR Board or by stockholders holding at least seventy-five
percent (75%) of the STAR outstanding capital stock. The UDN Bylaws provide that
such Bylaws may be amended or repealed or new bylaws may be adopted by the UDN
Board and by the affirmative vote of the holders of a majority of the
outstanding shares of stock entitled to vote generally in the election of
directors.
CUMULATIVE VOTING. Under the DGCL, cumulative voting of stock applies only
when so provided in the certificate of incorporation of a corporation. Neither
the STAR Charter nor the UDN Charter provides for cumulative voting.
STOCKHOLDER VOTE FOR MERGER. Except with respect to certain mergers between
parent and subsidiary corporations, the DGCL generally requires the affirmative
vote of a majority of the outstanding shares of the constituent corporations in
a merger; provided, that where a corporation's certificate of incorporation
provides for more or less than one vote per share on any matter, the required
vote is a majority of the combined voting power of the corporation's stock.
Under the DGCL, holders of stock which is not by its terms entitled to vote on
such a transaction are entitled to notice of the meeting at which the proposed
transaction is considered. The DGCL does not require, unless provided for in a
corporation's charter (and neither the STAR Charter nor the UDN Charter so
provides), a stockholder vote of the surviving corporation in a merger, however,
if (a) the merger agreement does not amend the existing certificate of
incorporation, (b) each outstanding or treasury share of the surviving
corporation before the merger is unchanged after the merger, (c) the number of
shares to be issued by the surviving corporation in a merger does not exceed
20.0% of the shares outstanding immediately prior to such issuance; and (d)
certain other conditions are satisfied. Neither STAR's Charter, the UDN Charter,
the STAR Bylaws nor the UDN Bylaws provide for any additional notice or voting
requirement with respect to a merger other than those required by the DGCL.
DIVIDENDS. The DGCL permits a corporation to pay dividends out of surplus
(defined as the excess, if any, of net assets over capital) or, if no surplus
exists, out of its net profits for the fiscal year in which such dividends are
declared and/or for its preceding fiscal year, provided, that dividends may not
be paid out of net profits if the capital of such corporation is less than the
aggregate amount of capital represented by the outstanding stock of all classes
having a preference upon the distribution of assets. The STAR Bylaws provide
that dividends upon the capital stock of the corporation may be declared by the
STAR Board at any regular or special meeting, pursuant to law. STAR has not
declared or paid cash dividends on the STAR Common Stock since its initial
public offering and does not intend to pay such dividends in the foreseeable
future. Additionally, STAR's existing credit facility restricts the payment of
cash dividends. According to the UDN Bylaws, subject to limitations contained in
the DGCL and the UDN Charter, holders of shares of UDN Common Stock are entitled
to receive such dividends as may be declared by the UDN Board. UDN has never
declared or paid dividends on the UDN Common Stock and does not intend to pay
dividends prior to the consummation of the Merger.
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<PAGE>
UNAUDITED PRO FORMA FINANCIAL DATA
The following unaudited pro forma financial data is presented assuming the
Merger will be accounted for as a pooling of interests, whereby STAR will
restate its historical consolidated financial statements to include the assets,
liabilities, stockholders' equity (deficit) and results of operations of UDN.
STAR acquired PT-1 on February 4, 1999, and plans to account for this
transaction as a purchase, whereby STAR will allocate the purchase price to
assets acquired and liabilities assumed based on their fair values. Thus the
unaudited pro forma financial data in this Proxy Statement/Prospectus include
the pro forma effect of the PT-1 Merger.
The historical condensed statement of operations data for the years ended
December 31, 1995, 1996 and 1997 and the nine months ended September 30, 1997
and 1998 is combined with the historical operating results of UDN for the twelve
months ended January 31, 1996, 1997 and 1998, and the nine months ended
September 30, 1997 and 1998. The resulting combined unaudited pro forma
statements of operations for the twelve months ended December 31, 1997 and the
nine months ended September 30, 1997 and 1998 are combined with the results of
operations of PT-1 for the year ended March 31, 1998 and the nine months ended
September 30, 1997 and 1998 assuming the acquisition of PT-1 had occurred on
January 1, 1997. The historical condensed balance sheet of STAR at September 30,
1998 is combined with the historical condensed balance sheets of UDN and PT-1.
The resulting pro forma balance sheet at September 30, 1998 assumes that STAR
and UDN had always been one entity and that the PT-1 acquisition occurred on
September 30, 1998.
THE UNAUDITED PRO FORMA FINANCIAL DATA DOES NOT PURPORT TO PRESENT THE
FINANCIAL POSITION OR RESULTS OF OPERATIONS OF STAR HAD THE TRANSACTIONS AND
EVENTS ASSUMED THEREIN OCCURRED ON THE DATES SPECIFIED, NOR ARE THEY NECESSARILY
INDICATIVE OF THE RESULTS OF OPERATIONS THAT MAY BE ACHIEVED BY STAR IN THE
FUTURE.
The unaudited pro forma financial data does not give effect to certain cost
savings that STAR believes may be realized as a result of the Merger. There can
be no assurances that such cost savings, if any, will be achieved. See
"Description of Forward-Looking Statements."
The unaudited pro forma financial data is based on certain assumptions and
adjustments described in the notes to the unaudited pro forma financial data
included in this Proxy Statement/Prospectus and should be read in conjunction
therewith and with "Management's Discussion and Analysis of Financial Condition
and Results of Operations of STAR," "Management's Discussion and Analysis of
Financial Condition and Results of Operations of UDN," "Management's Discussion
and Analysis of Financial Condition and Results of Operations of PT-1", and the
consolidated financial statements of each of STAR, PT-1 and UDN and the related
notes thereto, all of which have been included elsewhere in this Proxy
Statement/Prospectus.
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<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
AT SEPTEMBER 30, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
STAR UDN PT-1
SEPTEMBER SEPTEMBER MERGER PRO FORMA SEPTEMBER MERGER PRO FORMA
30, 1998 30, 1998 ADJUSTMENTS COMBINED 30, 1998 ADJUSTMENTS COMBINED
---------- ---------- -------------- ---------- ---------- -------------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents..... $ 11,808 $ 1,060 $ -- $ 12,868 $ 5,382 $ -- $ 18,250
Short-term investments........ 92,390 -- -- 92,390 2,148 (19,500)(a) 73,038
(2,000)(s)
Accounts and notes
receivable.................. 80,721 5,068 (5,977)(b) 79,812 46,940 (22,951)(b) 103,801
Receivable from related
parties..................... 330 -- -- 330 -- -- 330
Other current assets.......... 27,580 251 (671)(u) 27,160 5,390 (2,110)(c) 30,440
---------- ---------- ------- ---------- ---------- -------------- ----------
Total current assets...... 212,829 6,379 (6,648) 212,560 59,860 (46,561) 225,859
Property and equipment, net... 113,851 1,875 -- 115,726 43,480 -- 159,206
Intangible assets, net........ -- 5,558 -- 5,558 2,493 -- 8,051
Goodwill...................... -- -- -- -- -- 181,011(d) 181,011
Deferred distributor costs.... -- -- -- -- -- 2,803(t) 2,803
Other long-term assets........ 7,340 72 -- 7,412 1,119 -- 8,531
---------- ---------- ------- ---------- ---------- -------------- ----------
Total assets.............. $ 334,020 $ 13,884 $ (6,648) $ 341,256 $ 106,952 $ 137,253 $ 585,461
---------- ---------- ------- ---------- ---------- -------------- ----------
---------- ---------- ------- ---------- ---------- -------------- ----------
CURRENT LIABILITIES:
Short-term debt............... $ -- $ -- $ -- $ -- 15,000 $ (10,000)(b) $ 5,000
Payable to stockholders....... 5 1,550 -- 1,555 -- -- 1,555
Current portion of long-term
obligations................. 7,595 1,042 -- 8,637 1,736 -- 10,373
Note payable.................. -- 4,500 (4,500)(b) -- 5,000 -- 5,000
Accounts payable and accrued
expenses.................... 36,200 10,658 (1,477)(b) 46,210 21,470 14,000(c) 66,619
1,500(u) (12,951)(b)
(671)(u) (2,110)(c)
Due to carriers............... -- -- -- -- 13,113 -- 13,113
Deferred revenue.............. -- 1,163 -- 1,163 42,026 (42,026)(p) 1,163
Acquired service obligation... -- -- -- -- -- 37,779(v) 37,779
Accrued network cost.......... 52,464 -- -- 52,464 -- -- 52,464
---------- ---------- ------- ---------- ---------- -------------- ----------
Total current
liabilities............. 96,264 18,913 (5,148) 110,029 98,345 (15,308) 193,066
---------- ---------- ------- ---------- ---------- -------------- ----------
Long-term obligations......... 31,053 233 -- 31,286 7,512 -- 38,798
Other long-term liabilities... 1,638 -- -- 1,638 700 -- 2,338
---------- ---------- ------- ---------- ---------- -------------- ----------
Total long-term
liabilities............. 32,691 233 -- 32,924 8,212 -- 41,136
---------- ---------- ------- ---------- ---------- -------------- ----------
STOCKHOLDER'S EQUITY (DEFICIT)
Common stock of STAR
(100,000,000 shares
authorized, 42,205,418
actual shares and
58,117,581 pro forma
shares issued and
outstanding).............. 42 -- -- 42 -- 15(f) 57
Common stock of UDN
(100,000,000 shares
authorized, 7,054,844
actual shares and no pro
forma shares issued and
outstanding).............. -- 71 (71)(q) -- -- -- --
Common stock of PT-1
(150,000,000 shares
authorized, 73,459,180
actual shares issued,
48,406,548 actual shares
outstanding and no pro
forma shares issued or
outstanding).............. -- -- -- -- 735 (735)(g) --
Paid-in capital............. 194,138 13,007 71(q) 207,216 16,166 156,366(h) 363,582
(16,166)(i)
Accumulated other
comprehensive income...... 219 -- -- 219 -- -- 219
Retained earnings
(deficit)................. 10,666 (18,340) (1,500)(u) (9,174) 1,919 (1,919) (j) (9,174)
Treasury stock.............. -- -- -- -- (15,000) 15,000(k) --
Note receivable from
stockholder............... -- -- -- -- (3,425) -- (3,425)
---------- ---------- ------- ---------- ---------- -------------- ----------
205,065 (5,262) (1,500) 198,303 395 152,561 351,259
---------- ---------- ------- ---------- ---------- -------------- ----------
Total liabilities and
stockholder's equity.... $ 334,020 $ 13,884 $ (6,648) $ 341,256 $ 106,952 $ 137,253 $ 585,461
---------- ---------- ------- ---------- ---------- -------------- ----------
---------- ---------- ------- ---------- ---------- -------------- ----------
</TABLE>
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<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
FOR THE YEAR ENDED DECEMBER 31, 1995
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
UDN TWELVE
STAR MONTHS
YEAR ENDED ENDED PRO
DECEMBER 31, JANUARY 31, MERGER FORMA
1995 1996 ADJUSTMENTS COMBINED
------------ ----------- ------------ --------
<S> <C> <C> <C> <C>
REVENUES........................... $58,937 $ 5,711 $ (43)(l) $64,605
OPERATING EXPENSES:
Cost of services................. 44,270 4,342 (43)(l) 48,569
Selling, general and
administrative expenses........ 10,452 2,494 -- 12,946
Depreciation and amortization.... 368 484 -- 852
------------ ----------- ----- --------
55,090 7,320 (43) 62,367
------------ ----------- ----- --------
Income (loss) from operations.... 3,847 (1,609) -- 2,238
------------ ----------- ----- --------
OTHER INCOME (EXPENSE):
Interest income.................. 22 (12) -- 10
Interest expense................. (64) (91) -- (155)
Other income (expense)........... (33) (183) -- (216)
------------ ----------- ----- --------
(75) (286) -- (361)
------------ ----------- ----- --------
Income (loss) before provision
for income taxes............... 3,772 (1,895) -- 1,877
PRO FORMA PROVISION FOR INCOME
TAXES............................ 1,632 -- (819)(o) 813
------------ ----------- ----- --------
PRO FORMA NET INCOME (LOSS)........ $ 2,140 $(1,895) $ 819 $ 1,064
------------ ----------- ----- --------
------------ ----------- ----- --------
Pro forma net income (loss) per
common share:
Basic............................ $ 0.11 $ (0.57) $ 0.05
Diluted.......................... $ 0.11 $ (0.57) $ 0.05
Weighted average number of common
shares outstanding:
Basic............................ 19,373 3,331 19,662
Diluted.......................... 19,373 3,331 19,662
</TABLE>
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<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
FOR THE YEAR ENDED DECEMBER 31, 1996
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
UDN TWELVE
STAR MONTHS
YEAR ENDED ENDED
DECEMBER 31, JANUARY 31, MERGER PRO FORMA
1996 1997 ADJUSTMENTS COMBINED
------------ ----------- ------------ ---------
<S> <C> <C> <C> <C>
REVENUES........................... $259,697 $19,685 $(259)(l) $ 279,123
OPERATING EXPENSES:
Cost of services................. 225,957 15,051 (259)(l) 240,749
Selling, general and
administrative expenses........ 35,956 4,563 -- 40,519
Depreciation and amortization.... 1,442 818 -- 2,260
------------ ----------- ----- ---------
263,355 20,432 (259) 283,528
------------ ----------- ----- ---------
Income (loss) from operations.... (3,658) (747) -- (4,405)
------------ ----------- ----- ---------
OTHER INCOME (EXPENSE):
Interest income.................. 110 4 -- 114
Interest expense................. (609) (448) -- (1,057)
Legal settlement and expenses.... (100) -- -- (100)
Other income..................... 39 17 -- 56
------------ ----------- ----- ---------
(560) (427) -- (987)
------------ ----------- ----- ---------
Income (loss) before provision
for income taxes............... (4,218) (1,174) -- (5,392)
PRO FORMA PROVISION FOR INCOME
TAXES (BENEFIT).................. 1,520 (50) -- 1,470
------------ ----------- ----- ---------
PRO FORMA NET INCOME (LOSS)........ $ (5,738) $(1,124) $ -- $ (6,862)
------------ ----------- ----- ---------
------------ ----------- ----- ---------
Pro forma net income (loss) per
common share:
Basic............................ $ (0.25) $ (0.22) $ (0.29)
Diluted.......................... $ (0.25) $ (0.22) $ (0.29)
Weighted average number of common
shares outstanding:
Basic............................ 23,292 5,048 23,730
Diluted.......................... 23,292 5,048 23,730
</TABLE>
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<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
FOR THE YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
UDN
STAR TWELVE PT-1
YEAR ENDED MONTHS YEAR ENDED
DECEMBER 31, JANUARY 31, MERGER PRO FORMA MARCH 31, MERGER PRO FORMA
1997 1998 ADJUSTMENTS COMBINED 1998 ADJUSTMENTS COMBINED
------------ ----------- ------------- --------- ---------- ------------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
REVENUES...................... $404,605 $31,179 $(1,153)(l) $434,631 $431,520 $(49,441)(l) $816,710
OPERATING EXPENSES:
Cost of services............ 351,821 24,633 (1,153)(l) 375,301 395,501 (49,441)(l) 721,361
Selling, general and
administrative expenses... 36,782 11,544 -- 48,326 17,724 701(m) 66,751
Depreciation and
amortization.............. 4,637 1,010 -- 5,647 1,535 9,051(n) 16,233
------------ ----------- ------------- --------- ---------- ------------- ---------
393,240 37,187 (1,153) 429,274 414,760 (39,689) 804,345
------------ ----------- ------------- --------- ---------- ------------- ---------
Income (loss) from
operations.................. 11,365 (6,008) -- 5,357 16,760 (9,752) 12,365
------------ ----------- ------------- --------- ---------- ------------- ---------
OTHER INCOME (EXPENSE):
Interest income............. 492 35 (28)(r) 499 517 (1,016)(e) --
Interest expense............ (1,738) (941) 28(r) (2,651) (1,021) (167)(e) (3,839)
Legal settlement and
expenses.................... (1,653) -- -- (1,653) -- -- (1,653)
Other income (expense)...... 208 (406) -- (198) 474 -- 276
------------ ----------- ------------- --------- ---------- ------------- ---------
(2,691) (1,312) -- (4,003) (30) (1,183) (5,216)
------------ ----------- ------------- --------- ---------- ------------- ---------
Income (loss) before
provision for income
taxes..................... 8,674 (7,320) -- 1,354 16,730 (10,935) 7,149
PRO FORMA PROVISION FOR INCOME
TAXES....................... 3,100 -- (2,617)(o) 483 5,150 157(o) 5,790
------------ ----------- ------------- --------- ---------- ------------- ---------
PRO FORMA NET INCOME (LOSS)... $ 5,574 $(7,320) $ 2,617 $ 871 $ 11,580 $(11,092) $ 1,359
------------ ----------- ------------- --------- ---------- ------------- ---------
------------ ----------- ------------- --------- ---------- ------------- ---------
Pro forma net income (loss)
per common share:
Basic....................... $ 0.18 $ (1.15) $ 0.03 $ 0.25 $ 0.03
Diluted..................... $ 0.17 $ (1.15) $ 0.03 $ 0.24 $ 0.03
Weighted average number of
common shares outstanding:
Basic....................... 30,221 6,339 30,771 46,922 46,071
Diluted..................... 32,978 6,339 33,528 47,720 48,828
</TABLE>
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<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
STAR UDN PT-1
NINE NINE NINE
MONTHS MONTHS MONTHS
ENDED ENDED ENDED
SEPTEMBER SEPTEMBER MERGER PRO FORMA SEPTEMBER MERGER PRO FORMA
30, 1997 30, 1997 ADJUSTMENTS COMBINED 30, 1997 ADJUSTMENTS COMBINED
---------- ---------- ------------ --------- ---------- ------------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
REVENUES........................... $283,374 $22,249 $(505)(l) $305,118 $250,906 $(35,530)(l) $520,494
OPERATING EXPENSES:
Cost of services................. 246,712 16,986 (505)(l) 263,193 229,949 (35,530)(l) 457,612
Selling, general and
administrative expenses........ 25,118 6,319 -- 31,437 16,260 526(m) 48,223
Depreciation and amortization.... 3,040 720 -- 3,760 439 6,788(n) 10,987
---------- ---------- ------------ --------- ---------- ------------- ---------
274,870 24,025 (505) 298,390 246,648 (28,216) 516,822
---------- ---------- ------------ --------- ---------- ------------- ---------
Income (loss) from operations.... 8,504 (1,776) -- 6,728 4,258 (7,314) 3,672
---------- ---------- ------------ --------- ---------- ------------- ---------
OTHER INCOME (EXPENSE):
Interest income.................. 367 19 -- 386 234 (620)(e) --
Interest expense................. (1,289) (699) -- (1,988) (412) (267)(e) (2,667)
Other income (expense)........... (1,499) -- -- (1,499) 243 -- (1,256)
---------- ---------- ------------ --------- ---------- ------------- ---------
(2,421) (680) -- (3,101) 65 (887) (3,923)
Income (loss) before provision
for income taxes and
extraordinary gain............. 6,083 (2,456) -- 3,627 4,323 (8,201) (251)
PRO FORMA PROVISION FOR INCOME
TAXES (BENEFIT).................. 2,718 (27) (1,070)(o) 1,621 2,018 (718)(o) 2,921
---------- ---------- ------------ --------- ---------- ------------- ---------
PRO FORMA NET INCOME (LOSS) BEFORE
EXTRAORDINARY GAIN............... 3,365 (2,429) 1,070 2,006 2,305 (7,483) (3,172)
EXTRAORDINARY GAIN ON DEBT
RESTRUCTURING.................... -- 52 -- 52 -- -- 52
---------- ---------- ------------ --------- ---------- ------------- ---------
PRO FORMA NET INCOME (LOSS)........ $ 3,365 $(2,377) $1,070 $ 2,058 $ 2,305 $ (7,483) $ (3,120)
---------- ---------- ------------ --------- ---------- ------------- ---------
---------- ---------- ------------ --------- ---------- ------------- ---------
Pro forma net income (loss) per
common share:
Basic............................ $ 0.12 $ (0.39) $ 0.07 $ 0.05 $ (0.07)
Diluted.......................... $ 0.11 $ (0.39) $ 0.06 $ 0.04 $ (0.07)
Weighted average number of common
shares outstanding:
Basic............................ 28,650 6,022 29,173 50,480 44,473
Diluted.......................... 31,580 6,022 32,103 51,346 44,473
</TABLE>
73
<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
STAR UDN PT-1
NINE NINE NINE
MONTHS MONTHS MONTHS
ENDED ENDED ENDED
SEPTEMBER SEPTEMBER MERGER PRO FORMA SEPTEMBER MERGER PRO FORMA
30, 1998 30, 1998 ADJUSTMENTS COMBINED 30, 1998 ADJUSTMENTS COMBINED
---------- ---------- ------------- --------- ---------- ------------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
REVENUES...................... $425,531 $23,811 $(4,207)(l) $445,135 $396,599 $(63,922)(l) $777,812
OPERATING EXPENSES:
Cost of services............ 363,794 18,626 (4,207)(l) 378,213 364,942 (63,922)(l) 679,233
Selling, general and
administrative expenses... 39,167 6,402 -- 45,569 23,016 526(m) 69,111
Depreciation and
amortization.............. 8,055 836 -- 8,891 2,485 6,788(n) 18,164
---------- ---------- ------------- --------- ---------- ------------- ---------
411,016 25,864 (4,207) 432,673 390,443 (56,608) 766,508
---------- ---------- ------------- --------- ---------- ------------- ---------
Income (loss) from
operations.................. 14,515 (2,053) -- 12,462 6,156 (7,314) 11,304
OTHER INCOME (EXPENSE):
Interest income............. 3,511 34 (310)(r) 3,235 428 (887)(e) 2,776
Interest expense............ (2,080) (751) 310(r) (2,521) (1,201) -- (3,722)
Other income (expense)...... (171) (299) -- (470) 196 -- (274)
---------- ---------- ------------- --------- ---------- ------------- ---------
1,260 (1,016) -- 244 (577) (887) (1,220)
---------- ---------- ------------- --------- ---------- ------------- ---------
Income (loss) before
provision for income
taxes..................... 15,775 (3,069) -- 12,706 5,579 (8,201) 10,084
PROVISION FOR INCOME TAXES.... 6,643 -- (1,292)(o) 5,351 1,915 (161)(o) 7,105
---------- ---------- ------------- --------- ---------- ------------- ---------
NET INCOME (LOSS)............. $ 9,132 $(3,069) $ 1,292 $ 7,355 $ 3,664 $ (8,040) $ 2,979
---------- ---------- ------------- --------- ---------- ------------- ---------
---------- ---------- ------------- --------- ---------- ------------- ---------
Net income (loss) per common
share:
Basic....................... $ 0.23 $ (0.44) $ 0.19 $ 0.08 $ 0.05
Diluted..................... $ 0.22 $ (0.44) $ 0.18 $ 0.08 $ 0.05
Weighted average number of
common shares outstanding:
Basic....................... 39,147 6,989 39,752 48,405 55,052
Diluted..................... 40,921 6,989 41,526 48,587 56,826
</TABLE>
74
<PAGE>
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL DATA
1. COMPANIES AND PERIODS COMBINED
The pro forma statement of operations data, which assumes completion of the
Merger and the PT-1 Merger, reflects the combination of the historical operating
results of STAR for the years ended December 31, 1995, 1996 and 1997 and the
nine months ended September 30, 1997 and 1998 plus the historical operating
results of UDN for the twelve months ended January 31, 1996, 1997 and 1998 and
the nine months ended September 30, 1997 and 1998, respectively, and the
historical operating results of PT-1 for the year ended March 31, 1998 and the
nine months ended September 30, 1997 and 1998. The balance sheet data included
in the unaudited pro forma condensed financial statements reflects the
combination of the historical balance sheets of STAR and UDN with the historical
balance sheet of PT-1 as of September 30, 1998.
2. UDN TRANSACTION
The ratio of STAR Common Stock to be exchanged for UDN Common Stock as
reflected in the unaudited pro forma condensed financial statements of 0.086772
is based on the closing price of STAR Common Stock of $23.625 per share as of
May 27, 1998. No share adjustment has been made for changes in the price of STAR
Common Stock since May 27, 1998 because the impact of such change would not be
material. Had the closing price of STAR Common Stock at September 30, 1998 of
$12.375 per share been used for purposes of the STAR/UDN exchange ratio, an
additional 420,870 shares would be reflected as outstanding in the pro forma
balance sheet as of September 30, 1998.
STAR and UDN estimate they will incur direct transaction costs of
approximately $1.5 million associated with the Merger, consisting of fees for
investment banking, legal, accounting, financial printing and other related
charges, most of which will be charged to operations in the fiscal quarter in
which that merger is consummated. At September 30, 1998, STAR capitalized
$671,000 in UDN related Merger costs.
3. INTERCOMPANY BALANCES
At September 30, 1998, STAR had amounts due from UDN as follows (amounts in
thousands):
<TABLE>
<CAPTION>
<S> <C>
Note receivable...................................................................... $ 4,500
Trade receivable..................................................................... 1,140
Interest receivable.................................................................. 337
---------
Total................................................................................ $ 5,977
---------
---------
</TABLE>
Intercompany balances between STAR and PT-1 represent trade receivables and
payables between STAR and PT-1 in the amount of $12,908,000 and $43,000,
respectively. There are no intercompany balances between UDN and PT-1.
4. INTERCOMPANY TRANSACTIONS
For the years ended December 31, 1995, 1996 and 1997, intercompany sales and
related cost of sales between STAR and UDN amounted to $43,000, $259,000 and
$1,153,000, respectively. Intercompany sales for the nine months ended September
30, 1997 and 1998 amounted to $505,000 and $4,207,000, respectively.
Intercompany sales and cost of sales between STAR and PT-1 for the year ended
December 31, 1997 amounted to $49,441,000. Sales between STAR and PT-1 for the
nine months ended September 30, 1997 and 1998 amounted to $35,530,000 and
$63,922,000, respectively. There were no intercompany transactions between PT-1
and UDN for the periods presented.
75
<PAGE>
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL DATA (CONTINUED)
5. PRO FORMA INCOME TAXES
The pro forma provision for income taxes, pro forma net income (loss) and
pro forma net income (loss) per share of STAR Common Stock for the years ended
December 31, 1995, 1996 and 1997 as well as for the nine months ended September
30, 1997 reflect a pro forma tax adjustment, which assumes that both STAR as
well as LDS, which was acquired by STAR in a pooling of interests transaction on
November 30, 1997, were C-Corporations for all periods presented (see Note 9 of
Notes to Consolidated Financial Statements of STAR).
The Merger adjustments reflect STAR's effective tax rate (as adjusted for
non-deductible goodwill amortization) in the pro forma statements of operations
for the combined entity.
6. EXCHANGE OF STOCK
The UDN adjustment reflects the elimination of UDN Common Stock less the par
value of 612,163 shares of STAR Common Stock to be issued in STAR's merger with
UDN.
7. PRO FORMA EARNINGS PER SHARE
The unaudited pro forma combined earnings per share and diluted earnings per
share are based on the weighted average number of common and dilutive equivalent
shares, for each period: (1) at the exchange ratio of 0.086772 shares of STAR
Common Stock for each share of UDN Common Stock outstanding at the effective
time of STAR's merger with UDN and (2) 15.05 million shares of STAR Common Stock
for all of PT-1 Common Stock, stock options and warrants outstanding at the
effective time of the PT-1 Merger plus an additional 250,000 shares of STAR
Common Stock to be issued to selected PT-1 distributors.
8. GOODWILL
The number of shares of STAR Common Stock to be issued in the PT-1 Merger
for all common shares and share equivalents of PT-1 is composed as follows:
<TABLE>
<CAPTION>
<S> <C>
Common stock, options and warrants--PT-1 shareholders........................... 15,050,000
Restricted common stock--PT-1 distributors...................................... 250,000
------------
Total........................................................................... 15,300,000
------------
------------
</TABLE>
The restricted shares of STAR Common Stock to be issued to PT-1 distributors
will vest over four years. The options and warrants to be issued will be in
satisfaction of existing PT-1 options and warrants. STAR will also issue 100,000
additional stock options to certain PT-1 employees under STAR's stock option
plan. To show the full dilutive effect of the transaction, 15.3 million
additional shares of STAR Common Stock were used for purposes of computing pro
forma basic and diluted earnings per share. The 15.3 million additional shares
are also reflected in pro forma shares of STAR Common Stock outstanding at
September 30, 1998.
The consideration for the PT-1 Merger consists of 15.05 million shares of
STAR Common Stock and $19.5 million. In addition, STAR will be required to issue
250,000 restricted shares of STAR Common Stock to selected PT-1 distributors for
no consideration and to pay $2 million to a company owned by an executive of
PT-1 as a result of a change in control agreement. The value of the STAR Common
Stock to be issued is based on the average of the high and low market price from
August 31, 1998 through September 2, 1998, the dates surrounding the first
amendment to the PT-1 Merger Agreement. This
76
<PAGE>
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL DATA (CONTINUED)
8. GOODWILL (CONTINUED)
average market price computes to $11.21 per share (the "Average Price"), which
will be discounted by 10% with respect to the 13.5 million Two-Year Shares.
STAR followed the principles prescribed by APB No. 17 in identifying and
estimating the fair value of the identifiable tangible and intangible assets to
be acquired. The primary tangible assets of PT-1 consist of telecommunications
and network equipment which, for the most part, has been acquired during the
past two years. STAR believes that the carrying value of such equipment
approximates its fair value. This equipment includes the digital switches, debit
card platform, information system, and PIN database software.
The primary intangible assets to be acquired consist of PT-1's distribution
network and name. The distribution network consists of a series of wholesale
distributors who sell to sub-distributors and directly to retail outlets such as
grocery and convenience stores. These stores sell the cards to the individual
ultimate end user. While no individual distributor is considered critical to the
long term future success of PT-1, certain distributors have been identified who
are important to the near term growth objectives of PT-1. In connection with the
PT-1 Merger, STAR has agreed to issue to no more than 10 of PT-1's approximately
200 distributors for no consideration 250,000 shares of STAR Common Stock, which
are restricted and will vest over four years. STAR considers the fair value of
such shares to represent the near term value of these distributor relationships.
STAR considered other potential intangible assets for which it may be
appropriate to assign value such as franchise agreements and leases. All
contracts have been entered into during the past three years and the terms and
conditions of those contracts reflect the current economic and industry
environment.
After consideration of the above, STAR has determined that the excess of the
purchase price over the PT-1 equity represents residual goodwill in accordance
with APB No. 17.
The allocation of the purchase price is preliminary only with respect to the
assumed service obligation and certain intangible assets. STAR will have an
appraisal performed on the significant PT-1 intangible assets. Such intangible
assets include PT-1's distributor network, billing platform and software license
agreements. Such appraisal is expected to be completed within 90 days from the
date the PT-1 Merger is consummated. Based upon STAR's review, it is anticipated
that the final allocation of the purchase price will not differ materially from
STAR's preliminary allocation. Additionally, STAR does not expect a significant
amount of the purchase price to be allocated to other identified intangible
assets.
The excess of the purchase price thus computed over the net assets acquired,
as adjusted, plus estimated acquisition costs of $14 million, results in
goodwill of approximately $181 million. Goodwill is amortized over a period of
20 years, which period represents STAR's estimate of future benefit to STAR.
9. RESULTS OF OPERATIONS INCLUDED IN MORE THAN ONE PERIOD
The PT-1 results of operations for the nine months ended September 30, 1997
and 1998 include PT-1 revenue of $62.7 million and $127.7 million and net income
of approximately $3.1 million and $2.3 million, which are also included in the
results of operations for the years ended December 31, 1996 and 1997,
respectively. The UDN results of operations for the nine months ended September
30, 1997 and 1998 include UDN revenue of $2.3 million and $2.9 million, and net
loss of $99,000 and $173,000, which are also included in the results of
operations for the twelve month periods ended January 31, 1997 and 1998,
respectively.
77
<PAGE>
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL DATA (CONTINUED)
10. MERGER ADJUSTMENTS
Following is an explanation for merger adjustments reflected in the
unaudited pro forma condensed financial statements:
(a) Represents cash portion of consideration for the PT-1 Merger
(b) Represents the elimination of intercompany balances
(c) Represents accrual for PT-1 Merger related expenses, net of $2,110,000
previously incurred
(d) Represents the excess of the purchase price for PT-1 plus acquisition
related expenses over the fair value of net assets acquired
(e) Represents foregone interest income on the $19.5 million cash portion of
consideration for the PT-1 Merger, plus a $2 million payment to Godot on
consummation of the PT-1 Merger
(f) Represents the par value of STAR Common Stock to be issued in the PT-1
Merger
(g) Eliminates par value of PT-1 Common Stock
(h) Represents additional paid in capital of STAR Common Stock to be issued in
the PT-1 Merger
(i) Represents elimination of paid in capital of PT-1
(j) Represents elimination of retained deficit of PT-1
(k) Represents elimination of PT-1 treasury stock which will be retired
(l) Represents elimination of intercompany revenue and related cost of revenue
(m) Represents amortization expense relating to 250,000 restricted shares of
STAR Common Stock to be issued to certain distributors in the PT-1 Merger,
which shares will vest over four years (see note 10t)
(n) Represents amortization of goodwill from the PT-1 Merger over 20 years
(o) Represents tax adjustment to reflect STAR's effective tax rate (as adjusted
for non-deductible goodwill amortization)
(p) Represents elimination of PT-1 deferred revenue
(q) Reclassifies UDN Common Stock to additional paid in capital
(r) Represents elimination of intercompany interest on UDN notes
(s) Represents a $2 million payment to Godot due on consummation of the PT-1
Merger
(t) Represents fair market value of 250,000 shares of STAR Common Stock
issuable in the PT-1 Merger to certain PT-1 distributors. Such amount will
be amortized over the four year vesting period (see note 10m)
(u) Reflects an estimate of non-recurring expenses relating to the Merger of
which $671,000 was capitalized at September 30, 1998
(v) Represents estimated amounts to be incurred to settle the obligations
relating to the PT-1 deferred revenue. Such amount has been computed based
upon the historical deferred revenue recorded by PT-1 at September 30,
1998, which represents an assumed service obligation to STAR. The
obligation has been adjusted for the historical percentage of revenue
received by PT-1, which ultimately expires unused (2.5%). The assumed
obligation has also been reduced by PT-1's historical gross margin
78
<PAGE>
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL DATA (CONTINUED)
10. MERGER ADJUSTMENTS (CONTINUED)
percentage for the year ended March 31, 1998 as adjusted for the effect of
their revenue resulting from expired Prepaid Cards ($2,500,000), to
properly reflect STAR's assumed service obligation. STAR will recognize as
revenue an amount equal to the expense ultimately required to satisfy the
obligation. Any adjustment to the original estimate of the assumed
obligation will be recorded as an adjustment to goodwill.
79
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF STAR
THE FOLLOWING DISCUSSION OF THE FINANCIAL CONDITION AND RESULTS OF
OPERATIONS OF STAR SHOULD BE READ IN CONJUNCTION WITH "SELECTED CONSOLIDATED
FINANCIAL DATA OF STAR" AND THE STAR CONSOLIDATED FINANCIAL STATEMENTS AND THE
NOTES THERETO, EACH OF WHICH IS INCLUDED ELSEWHERE IN THIS PROXY STATEMENT. THIS
DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS, AS DEFINED IN SECTION 27A OF THE
SECURITIES ACT, THAT INVOLVE RISKS AND UNCERTAINTIES. STAR'S ACTUAL RESULTS
COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THE FORWARD-LOOKING STATEMENTS
AS A RESULT OF CERTAIN FACTORS, INCLUDING, BUT NOT LIMITED TO THOSE DISCUSSED IN
"RISK FACTORS" AND ELSEWHERE IN THIS PROXY STATEMENT. SEE "DESCRIPTION OF
FORWARD-LOOKING STATEMENTS."
OVERVIEW
STAR is an emerging multinational carrier focused primarily on the
international long distance market. STAR offers highly reliable, low-cost
switched voice services on a wholesale basis, primarily to U.S.-based long
distance carriers. STAR provides international long distance service to
approximately 220 countries through its flexible network comprised of various
foreign termination relationships, international gateway switches, leased and
owned transmission facilities and resale arrangements with other long distance
providers.
STAR installed its first international gateway switch in Los Angeles in June
1995 and initially recognized wholesale revenues in August 1995. A significant
portion of STAR's revenues in 1994 and 1995 were generated by the commercial
operations of LDS.
REVENUES. Most of STAR's revenues are generated by the sale of
international long distance services on a wholesale basis to other, primarily
domestic, long distance providers. STAR records revenues from the sale of long
distance services at the time of customer usage. STAR's agreements with its
wholesale customers are short-term in duration and the rates charged to
customers are subject to change from time to time, generally with five days
notice to the customer.
Historically, STAR has increased revenues from quarter to quarter, often
times by a significant percentage. STAR's North American wholesale minutes of
use have also greatly increased from quarter to quarter, generally by amounts
that exceed the relative increases in revenues. For example, in the nine months
ended September 30, 1998, revenues increased by 50.2% over revenues for the nine
months ended September 30, 1997. Over the same period to period comparison,
North American minutes of wholesale use increased by 73.0%. There are a variety
of reasons for the growth in STAR's call volume, including the growth of STAR's
North American customer base, which increased by 27.7% from the nine months
ended September 30, 1997 compared to the same period in 1998, an increased usage
by existing North American customers, and increased capacity over STAR's
telecommunications network, with the addition of a number of switches and growth
in available fiber optic lines.
The growth in North American wholesale minutes has been accompanied by a
corresponding decline in North American rates per minute. For example, for the
nine months ended September 30, 1998, such rates declined by 24.3% from
wholesale rates per minute in the corresponding period in 1997. The decline in
wholesale rates can be attributed to a number of factors, including a changing
country mix that includes a growing number of minutes routed by STAR to lower
rates per minute countries such as Mexico, Germany and the United Kingdom and,
as the wholesale international long distance market continues to mature and
evolve, a general downward trend in rates on competitive routes. STAR's pricing
for wholesale minutes varies materially from customer to customer and is
generally based on the time of day, the day of the week and the destination of
the call. While STAR continues to route traffic to certain destinations at
attractive rates, market conditions have forced STAR to reduce its overall
wholesale rates per minute.
Accordingly, STAR believes that the growth in its revenues has been fueled
almost entirely by STAR's ability to increase the volume of North American
wholesale minutes of use, for the reasons noted above. At the same time, the
general erosion in the rates per minute for such wholesale traffic has partially
offset the contribution to the increase of revenues made by such increased
volume of minutes.
80
<PAGE>
STAR completed its acquisition of T-One in March 1998. Revenues from T-One's
operations for the periods set forth below were not material to the overall
result of operations of STAR during such periods.
COSTS OF SERVICES (EXCLUSIVE OF DEPRECIATION AND AMORTIZATION). STAR has
pursued a strategy of attracting customers and building calling volume and
revenue by offering favorable rates compared to other long distance providers.
STAR continues to lower its cost of services (exclusive of depreciation and
amortization) by (i) expanding STAR's owned network facilities, (ii) continuing
to utilize STAR's sophisticated information systems to route calls over the most
cost-effective routes and (iii) leveraging STAR's traffic volumes and
information systems to negotiate lower variable usage-based costs with domestic
and foreign providers of transmission capacity.
Costs of services (exclusive of depreciation and amortization) include those
costs associated with the transmission and termination of international long
distance services and does not include depreciation or amortization expense.
Currently, a majority of transmission capacity used by STAR is obtained on a
variable, per minute basis. As a result, some of STAR's current costs of
services (exclusive of depreciation and amortization) is variable. STAR's
contracts with its vendors provide that rates may fluctuate, with rate change
notice periods varying from five days to one year, with certain of STAR's longer
term arrangements requiring STAR to meet minimum usage commitments in order to
avoid penalties. Such variability and the short-term nature of many of the
contracts subject STAR to the possibility of unanticipated cost increases and
the loss of cost-effective routing alternatives. Each quarter management reviews
the cost of services (exclusive of depreciation and amortization) accrual and
adjusts the balance for resolved items. Cost of services (exclusive of
depreciation and amortization) also include fixed costs associated with the
leasing of network facilities.
STAR recently began to provide international long distance services to
commercial customers in certain European countries, including Germany. STAR
began providing long distance service to commercial markets in the U.S. with its
acquisition of LDS in November 1997. STAR believes that traffic from commercial
customers will be more profitable than wholesale traffic. STAR also expects,
however, that an expansion into this market will also increase the risk of bad
debt exposure and lead to higher overhead costs. Information related to
wholesale and commercial revenues and operations will be reported in future
Exchange Act filings made by STAR in accordance with Financial Accounting
Standards Board Statement No. 131.
Prices in the international long distance market have declined in recent
years and, as competition continues to increase, STAR believes that prices are
likely to continue to decline. Additionally, STAR believes that the increasing
trend of deregulation of international long distance telecommunications will
result in greater competition, which could adversely affect STAR's revenue per
minute. STAR believes, however, that the effect of such decreases in prices will
be offset by increased calling volumes and decreased costs.
OPERATING EXPENSES. Selling, general and administrative expenses consist
primarily of personnel costs, depreciation and amortization, tradeshow and
travel expenses and commissions and consulting fees, as well as an accrual for
bad debt expense. These expenses have been increasing over the past year, which
is consistent with STAR's recent growth, accelerated expansion into Europe, and
investment in systems and facilities. STAR expects this trend to continue, and
to include, among other things, a significant increase in depreciation and
amortization. Management believes that additional selling, general and
administrative expenses will be necessary to support the expansion of STAR's
network facilities, its sales and marketing efforts and STAR's expansion into
commercial markets.
FOREIGN EXCHANGE. STAR's revenues and cost of long distance services are
sensitive to foreign currency fluctuations. STAR expects that an increasing
portion of STAR's revenues and expenses will be denominated in currencies other
than U.S. dollars, and changes in exchange rates may have a significant effect
on STAR's results of operations.
81
<PAGE>
FACTORS AFFECTING FUTURE OPERATING RESULTS. STAR's quarterly operating
results are difficult to forecast with any degree of accuracy because a number
of factors subject these results to significant fluctuations. As a result, STAR
believes that period-to-period comparisons of its operating results are not
necessarily meaningful and should not be relied upon as indications of future
performance.
STAR's revenues, costs and expenses have fluctuated significantly in the
past and are likely to continue to fluctuate significantly in the future as a
result of numerous factors. STAR's revenues in any given period can vary due to
factors such as call volume fluctuations, particularly in regions with
relatively high per-minute rates; the addition or loss of major customers,
whether through competition, merger, consolidation or otherwise; the loss of
economically beneficial routing options for the termination of STAR's traffic;
financial difficulties of major customers; pricing pressure resulting from
increased competition; and technical difficulties with or failures of portions
of STAR's network that impact STAR's ability to provide service to or bill its
customers. STAR's cost of services (exclusive of depreciation and amortization)
and operating expenses in any given period can vary due to factors such as
fluctuations in rates charged by carriers to terminate STAR's traffic; increases
in bad debt expense and reserves; the timing of capital expenditures, and other
costs associated with acquiring or obtaining other rights to switching and other
transmission facilities; changes in STAR's sales incentive plans; and costs
associated with changes in staffing levels of sales, marketing, technical
support and administrative personnel. In addition, STAR's operating results can
vary due to factors such as changes in routing due to variations in the quality
of vendor transmission capability; loss of favorable routing options; the amount
of, and the accounting policy for, return traffic under operating agreements;
actions by domestic or foreign regulatory entities; the level, timing and pace
of STAR's expansion in international and commercial markets; and general
domestic and international economic and political conditions. Further, a
substantial portion of transmission capacity used by STAR is obtained on a
variable, per minute and short-term basis, subjecting STAR to the possibility of
unanticipated price increases and service cancellations. Since STAR does not
generally have long term arrangements for the purchase or resale of long
distance services, and since rates fluctuate significantly over short periods of
time, STAR's operating results are subject to significant fluctuations over
short periods of time. STAR's operating results also may be negatively impacted
in the longer term by competitive pricing pressures.
RECENT ACQUISITIONS AND DEVELOPMENTS
STAR has recently acquired or entered into agreements to acquire the
following companies and has taken the following actions:
- L.D. SERVICES, INC. On November 30, 1997, STAR acquired LDS, certain
non-operating entities and majority ownership in another entity for
approximately 849,000 shares of STAR Common Stock in a transaction
accounted for as a pooling of interests. STAR's audited financial
statements have been restated to include LDS' historical performance for
all periods presented. The commercial business of LDS has historically had
higher revenue per minute and higher selling, general and administrative
expenses and operating costs than STAR's wholesale operations. As STAR
integrates and expands the commercial accounts of LDS, such increase in
operations may affect STAR's future operating margins. In 1997, LDS
settled disputes with the California PUC and with the District Attorney of
Monterey, California. The resulting payments and restrictions on LDS'
activities adversely affected its 1997 operating results. See "Business of
STAR--Government Regulation-- Actions Against LDS."
- T-ONE CORP. On March 10, 1998, STAR acquired T-One for 1,353,000 shares of
STAR Common Stock in a transaction accounted for as a pooling of
interests. All financial data presented has been restated to include the
results of operations, financial position and cash flows of T-One.
- STOCK SPLIT. On March 31, 1998, STAR effected a 2.05-for-1 stock split
with payment to the holders of the shares of STAR Common Stock outstanding
on February 20, 1998 of a stock dividend equal to 1.05 shares of STAR
Common Stock for each such outstanding share.
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- PUBLIC OFFERING. On May 4, 1998, STAR consummated a firmly underwritten
public offering of 6,000,000 shares of STAR Common Stock, of which
5,685,000 shares were sold by STAR and 315,000 shares were sold by a
certain stockholder of STAR. On June 4, 1998, an additional 30,900 shares
of STAR Common Stock were sold by a certain stockholder of STAR to cover
an over-allotment option for the offering.
- PT-1 COMMUNICATIONS, INC. On August 20, 1998, the Company entered into an
Amended and Restated Agreement and Plan of Merger with PT-1. Per the
agreement, as amended on September 1, 1998 and December 29, 1998, the
Company issued 15,050,000 shares of common stock and $19,500,000 cash or
short term promissory notes for all outstanding shares, options and
warrants of PT-1 plus an additional 250,000 shares to certain PT-1
distributors. The PT-1 Merger was consummated on February 4, 1999.
RESULTS OF OPERATIONS
The following table sets forth certain selected items in STAR's statements
of operations as a percentage of total revenues for the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED SEPTEMBER
YEARS ENDED DECEMBER 31, SEPTEMBER 30, 30,
----------------------------- ----------------- ---------------
1995 1996 1997 1997 1998 1997 1998
------ ------- ------ ------ ------ ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues................................ 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Operating Expenses:
Cost of services...................... 75.1 87.0 87.0 87.2 84.8 87.1 85.5
Selling, general and administrative
expenses............................ 17.8 13.8 9.1 8.6 9.7 8.9 9.2
Depreciation and amortization......... 0.6 0.6 1.1 1.2 2.1 1.1 1.9
------ ------- ------ ------ ------ ------ ------
Total operating expenses.......... 93.5 101.4 97.2 97.0 96.6 97.0 96.6
Income (loss) from operations........... 6.5 (1.4) 2.8 3.0 3.4 3.0 3.4
------ ------- ------ ------ ------ ------ ------
Income (loss) before provision for
income taxes.......................... 6.4 (1.6) 2.1 2.1 4.2 2.1 3.7
Provision for income taxes.............. 0.1 0.2 0.7 1.2 1.7 0.8 1.6
------ ------- ------ ------ ------ ------ ------
Net income (loss)....................... 6.3% (1.8)% 1.4% 0.8% 2.4% 1.3% 2.1%
------ ------- ------ ------ ------ ------ ------
------ ------- ------ ------ ------ ------ ------
Pro forma net income (loss)............. 3.6% (2.2)% 1.4% 0.9% 1.2%
------ ------- ------ ------ ------
------ ------- ------ ------ ------
</TABLE>
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 1997
REVENUES: Total revenues increased 59.1% to $164.3 million in the third
quarter of 1998 from $103.3 million in the third quarter of 1997. Total revenues
for the third quarter of 1998 increased 24.6% from $131.9 million in the second
quarter ended June 30, 1998.
Revenues from North American wholesale customers increased 54.2% to $149.4
million from $96.9 million in the prior year quarter. Minutes of use generated
by North American wholesale customers increased 97.2% to 475.1 million minutes
of use in the third quarter of 1998, as compared to 240.9 million minutes of use
in the comparable quarter of the year prior. This increase in revenues and
minutes reflects growth in the number of North American wholesale customers to
175 at September 30, 1998, up from 137 customers at September 30, 1997, as well
as an increase in usage by existing customers, primarily resulting from STAR's
expanding transmission capacity. The increase in revenues was partially offset
by a decline in rates per minute, as the average North American wholesale rate
per minute of use declined to $0.30 for the current quarter as compared to $0.40
for the quarter ended September 30, 1997, as well as the quarter ended June 30,
1998 of $0.34, reflecting continued lower prices on competitive routes. The
decline in rates
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per minute is also attributable to the change in country mix to include a larger
proportion of lower rate per minute countries such as Mexico, Germany and the
United Kingdom. The period to period decline in rates per minute was not a
significant factor in the relative increase in minutes of use.
North American commercial revenues increased 28.1% to $8.2 million in the
third quarter of 1998 from $6.4 million in the third quarter of 1997 reflecting
the continued success of new international rate plans that target ethnic markets
for Latin America and the Pacific Rim. Traditionally, the telemarketing
operation experiences declining minutes of use during the third quarter summer
months due to the usage trends of its international users. On a quarter to
quarter basis, the growth in North American commercial minutes and the average
North American commercial rate per minute at $0.24 remained flat due to these
trends.
The third quarter also includes revenues of $6.7 million generated from
STAR's European operations, representing the initial realization of benefits
from STAR's investment in the German telecommunication marketplace. Management
believes that the prospects for growth in Germany remain strong as Star
Telecommunications Deutscheland, GmbH is fully utilizing its interconnect with
Deutsche Telekom, AG to lower STAR's cost of services and to grow its European
commercial customer base.
COST OF SERVICES (EXCLUSIVE OF DEPRECIATION AND AMORTIZATION): Cost of
services (exclusive of depreciation and amortization) increased 54.6% to $139.3
million in the third quarter of 1998 from $90.1 million in the third quarter of
1997 and decreased as a percentage of revenues for the same periods to 84.8%
from 87.2%. The growth in cost of services (exclusive of depreciation and
amortization) reflects the increase in minutes of use offset by an overall
declining average cost per minute as well as an increase in leased private line
cost. The average cost per minute declined as a result of changes in country mix
to include a larger proportion of lower cost per minute countries, competitive
pricing pressures as well as an increasing proportion on traffic routed over the
STAR's proprietary network. STAR currently routes to 43 countries on its global
network, up from 40 countries in the quarter ended June 30, 1998. Management
believes that countries will continue to be added to STAR's global network,
thereby contributing to an overall decline in cost per minute.
SELLING, GENERAL AND ADMINISTRATIVE: For the third quarter of 1998,
selling, general and administrative expenses increased 78.9% to $15.9 million
from $8.9 million in the third quarter of 1997 and increased as a percentage of
revenues to 9.7% from 8.6% over the comparable periods. North American wholesale
selling, general and administrative expenses increased to $10.1 million in the
third quarter of 1998 from $6.4 million in the comparable period of 1997 and
increased as a percentage of North American wholesale revenue from 6.6% to 6.8%.
North American commercial selling, general and administrative expenses
increased to $3.0 million during the period from $2.2 million in the third
quarter of 1997. North American commercial selling, general and administrative
expenses increased as a percentage of North American commercial revenues to
36.6% during the period from 34.4% in the third quarter of 1997, reflecting the
expansion of the telemarketing sales force to focus on new ethnic markets.
Selling, general and administrative expenses related to the European
operations amounted to $2.8 million in the third quarter of 1998, an increase
from $348,000 in the third quarter of 1997 reflecting the start up of new
business efforts in Europe. STAR expects overall selling, general and
administrative expenses to continue to grow as a percentage of revenues as STAR
adds personnel to become a carrier in additional European countries and
continues to hire a sales force to expand its North American commercial customer
base.
DEPRECIATION AND AMORTIZATION: Depreciation expense increased to $3.4
million for the third quarter of 1998 from $1.2 million for the third quarter of
1997, and increased as a percentage of revenues to 2.1% from 1.2% over the
comparable period in the prior year. Depreciation expense increased with the
operation of new switch sites, the purchase of additional fiber capacity to
connect STAR's expanding network and leasehold improvements. Depreciation
attributable to North American assets amounted to
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$2.4 million. European operations realized total depreciation of $1.1 million.
STAR expects depreciation expense to continue to increase as a percentage of
revenues as it continues to expand its global telecommunications network. As of
July 1, 1998, STAR revised the remaining lives of certain operating equipment
from five to ten years. This change increased income before income taxes by
approximately $1.0 million.
INCOME FROM OPERATIONS: Income from operations increased to $5.6 million
during the third quarter of 1998 from $3.1 million in the third quarter of 1997
and operating margin increased to 3.4% from 3.0%, respectively. Operating margin
is expanding overall as STAR continues to increasingly route traffic over its
proprietary network. Offsetting the declining cost of services on a per minute
basis were the startup costs of launching operations in new European countries
and the expansion of the North American based commercial operations.
OTHER INCOME (EXPENSE): STAR reported other income of $1.2 million in the
third quarter of 1998 as compared to other expense of approximately $1.0 million
for the third quarter of 1997. Interest income earned on short-term investments
increased to $1.8 million in the third quarter of 1998 from $293,000 in the
third quarter of 1997 as a result of interest earned on investing the proceeds
from STAR's secondary equity offering in May 1998. Interest expense increased to
$740,000 during the quarter from $453,000 in the third quarter of 1997 in
response to the additional capital leases for the financing of new switches.
Included in other expense for the third quarter ended September 30, 1997 is
approximately $700,000 for a legal settlement which relates to the dispute
settled by LDS with the District Attorney of Monterey County.
PROVISION FOR INCOME TAXES: STAR's provision for income taxes increased to
$2.8 million in the third quarter of 1998 from $1.3 million in the third quarter
of 1997. The effective tax rate decreased to 41.1% in the third quarter of 1998
from 59.3% in the third quarter of 1997. The effective tax rate in the third
quarter of 1997 includes the impact of the valuation reserve on the deferred tax
asset created by foreign operating losses and other book/tax timing differences.
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED SEPTEMBER
30, 1997
REVENUES: Total revenues increased 50.2% to $425.5 million in the nine
months ended September 30, 1998 up from $283.4 million in the nine months ended
September 30, 1997. The increase in total revenues can be attributed to the
growth of the North American wholesale operations.
North American wholesale minutes of use increased to 1.1 billion with an
average rate per minute of $0.33 for the period ended September 30, 1998 as
compared to minutes of use of 635.9 million at an average rate per minute of
$0.41 in the comparable period of 1997. The volume growth was driven by an
increase in sales to existing North American wholesale customers taking
advantage of STAR's expanding transmission capacity and an increase in the
number of North American wholesale carrier customers, which growth was partially
offset by a decline in rates per minute from period to period. The relative
decline in rates per minute was not a significant factor in the period to period
increase in minutes of use.
COST OF SERVICES (EXCLUSIVE OF DEPRECIATION AND AMORTIZATION): Cost of
services (exclusive of depreciation and amortization) increased 47.5% to $363.8
million during the nine months ended September 30, 1998, up from $246.7 million
for the comparable period of 1997, but decreased as a percentage of revenues to
85.5% from 87.1%, respectively. The decrease in cost of services (exclusive of
depreciation and amortization) relative to revenues reflects the increasing
amount of traffic terminated over STAR's owned 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.
SELLING, GENERAL AND ADMINISTRATIVE: Selling, general and administrative
expenses increased 54.7% to $38.9 million during the first nine months of 1998
from $25.1 million in the comparable period of 1997 and increased as a
percentage of revenues to 9.1% from 8.9%, respectively. The increase in these
expenses
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both in absolute terms and as a percentage of revenues reflects the continued
expansion of the STAR network in its North American and European operations.
DEPRECIATION AND AMORTIZATION: Depreciation expense increased to $8.1
million for the nine months ended September 30, 1998 from $3.0 million for the
comparable period of 1997. Depreciation expense increased as a result of STAR's
continued expansion of its global transmission network which involved the
expansion and start-up of new switch sites, the purchase of fiber capacity and
the build out of direct termination arrangements around the world. As of July 1,
1998, STAR revised the remaining lives of certain operating equipment from five
to ten years. This change increased income before income taxes by approximately
$1.0 million.
INCOME FROM OPERATIONS: Income from operations increased 70.7% to $14.5
million during the nine months ended September 30, 1998 from $8.5 million during
the same period of 1997. Operating margin increased to 3.4% from 3.0%,
respectively. Operating margin will continue to expand as STAR continues to
diversify its revenue base and as traffic is migrated from leased facilities
onto STAR's owned network.
OTHER INCOME (EXPENSE): Other income, net increased to $1.3 million in the
nine months ended September 30, 1998 from a net expense of $2.4 million in the
comparable period of 1997. This increase can be attributed to interest income of
$3.5 million earned on the proceeds from the secondary offering offset by
interest expense of $2.1 million incurred on capital leases for the nine months
ended September 30, 1998. Other expense for the nine months ended September 30,
1997 included $1.6 million in legal settlements which relate to the disputes
settled by LDS with the California PUC and the District Attorney of Monterey
County.
PROVISION FOR INCOME TAXES: STAR's provision for income taxes increased to
$6.6 million for the nine months ended September 30, 1998 from $2.4 million for
the comparable period in 1997. The effective tax rate increased to 42.1% during
the nine months ended September 30, 1998 from 39.6% during the comparable period
in 1997. The lower effective tax rate for the period ended September 30, 1997
includes the write-off of a customer accounts receivable in the first quarter of
1997.
YEARS ENDED DECEMBER 31, 1997 AND 1996.
REVENUES: Revenues increased 55.8% to $404.6 million in 1997 from $259.7
million in 1996. Wholesale revenues increased to $377.1 million from $229.8
million, with wholesale minutes of use increasing to 863.3 million minutes in
1997, as compared to 479.7 million minutes of use in the prior year. This
increase reflects an increase in the number of wholesale customers from 84 in
1996 to 105 at the end of 1997, as well as an increase in usage by existing
customers, primarily resulting from STAR's expanding transmission capacity and
improving transmission quality. The average rate per minute of usage for
wholesale customers declined from $0.43 cents per minute in 1996 to $0.40 cents
per minute in 1997, reflecting the change in country mix to include a larger
proportion of lower rate per minute countries as well as lower prices on
competitive routes. The decline in rates per wholesale minute partially offset
the increase in wholesale minutes of use. The period to period decline in rates
per minute was not a significant factor in the relative increase in minute of
use. Wholesale minutes or average rate per minute computations do not include
the revenue or minutes of T-One.
Commercial revenues decreased to $27.5 million in 1997 from $29.9 million in
1996 reflecting the termination of the LDS customer base in California due to
the 1997 settlement entered into by LDS with each of the California PUC and the
District Attorney of Monterey, California. In 1997, commercial revenues
generated in the State of California was $10.4 million, as compared to
California-generated commercial revenues of $14.5 million in 1996. See "Business
of STAR--Governmental Regulation-- Actions Against LDS."
COST OF SERVICES (EXCLUSIVE OF DEPRECIATION AND AMORTIZATION): Cost of
services (exclusive of depreciation and amortization) increased 55.7% to $351.8
million in 1997 from $226.0 million in 1996. Wholesale cost of services
(exclusive of depreciation and amortization) increased to $335.5 million in 1997
from
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$208.8 million for 1996 and as a percentage of wholesale revenues decreased to
88.0% from 90.9%, respectively. Wholesale cost of services (exclusive of
depreciation and amortization) declined during 1997 as traffic was increasingly
routed over STAR's proprietary international network. Commercial cost of
services (exclusive of depreciation and amortization) decreased 5.2% to $16.3
million in 1997 from $17.2 million in 1996 and as a percentage of commercial
revenue increased to 59.3% from 57.4% over such periods, reflecting declining
prices in the competitive long distance market. As STAR migrates the LDS
commercial customer base onto STAR's network, LDS's cost of commercial long
distance services (exclusive of depreciation and amortization) is expected to
decline.
SELLING, GENERAL AND ADMINISTRATIVE: In 1997, selling, general and
administrative expenses (exclusive of merger related costs of $286,000)
increased 1.5% to $36.5 million, from $36.0 million in 1996. Wholesale selling,
general and administrative expenses increased to $27.1 million in 1997 from
$25.4 million in 1996, but decreased as a percentage of wholesale revenues to
7.2% from 11.1% over the comparable periods. Total expenses increased year to
year in absolute dollars as STAR expanded its proprietary international network
and employee base. Included in the 1996 selling, general and administrative
expense was $11.6 million in reserves and write-offs against deposits and
accounts receivable related to bad debts from two customers. Commercial selling,
general and administrative expenses decreased to $9.4 million in 1997 from $10.2
million in 1996 and remained flat as a percentage of commercial revenues at
approximately 34.1%. STAR expects selling, general and administrative expenses
to expand in absolute dollars and as a percentage of revenues in fiscal year
1998, as STAR expands its network and employee base and in connection with
STAR's entry into the commercial market.
DEPRECIATION AND AMORTIZATION: Depreciation increased to $4.6 million for
1997 from $1.4 million for 1996, and increased as a percentage of revenues to
1.1% from 0.6% in the prior period. Depreciation increased as a result of STAR's
continuing expansion of its proprietary international network which includes
purchases of switches, submarine cable and leasehold improvements associated
with switch sites. STAR expects depreciation expense to increase as STAR
continues to expand its global telecommunications network.
OTHER INCOME (EXPENSE): Other expense, net, increased to $2.7 million in
1997 from $560,000 in 1996. This increase is primarily due to interest expense
of $1.7 million incurred under various capital leases and bank lines of credit
and a legal settlement and associated expenses of $1.7 million. The legal
settlement relates to the dispute settled by LDS with the California PUC and the
District Attorney of Monterey County. See "Business of STAR--Governmental
Regulation--Actions Against LDS." Interest income earned on short-term
investments increased to $492,000 in 1997 from $110,000 in 1996 due to interest
earned on the proceeds of STAR's June 1997 initial public offering.
PROVISION FOR INCOME TAXES: The historical provision for income taxes
increased to $2.9 million in 1997 from $577,000 in 1996 primarily due to the
increase in profitability of STAR.
YEARS ENDED DECEMBER 31, 1996 AND 1995.
REVENUES: Revenues increased 340.6% to $259.7 million in 1996 from $58.9
million 1995. Wholesale revenues increased to $229.8 million in 1996 from $28.7
million in 1995, with minutes of use increasing to 479.7 million in 1996, as
compared to 38.1 million minutes of use in the prior year. These wholesale
minutes do not include any minutes from T-One. The increase in wholesale revenue
resulted from STAR's commencement of operations as an international long
distance carrier, an increase in the number of customers as compared to the
prior year and an increase in minutes of wholesale traffic from new and existing
customers. The increase in traffic is also attributable to an increase in the
number of routes with favorable rates that STAR was able to offer to customers.
Commercial revenues decreased to $29.9 million in 1996 from $30.2 million in
1995 due to a decrease in the rate per minute charged, which was partially
offset by an increase in the number of minutes sold. In 1996, commercial revenue
generated in the State of California was $14.5 million, as compared to
California-generated commercial revenues of $15.4 million in 1995.
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COST OF SERVICES (EXCLUSIVE OF DEPRECIATION AND AMORTIZATION): Cost of
services (exclusive of depreciation and amortization) increased 410.4% to $226.0
million for 1996 from $44.3 million in 1995. Wholesale cost of services
(exclusive of depreciation and amortization) increased to $208.8 million in 1996
from $26.6 million for 1995. Wholesale cost of services (exclusive of
depreciation and amortization) as a percentage of wholesale revenues decreased
to 90.9% in 1996 from 92.7% in 1995, reflecting the change from STAR's prior
consulting business to operating as an international long distance carrier. Cost
of services (exclusive of depreciation and amortization) was positively impacted
during 1996 by the negotiation of lower rates on routes with significant
traffic, and negatively impacted by increases in traffic on routes with lower
margins. Commercial cost of services (exclusive of depreciation and
amortization) decreased to $17.2 million in 1996 from $17.6 million in 1995
representing 57.4% and 58.2% of commercial revenues, respectively. Cost of
services (exclusive of depreciation and amortization) from commercial services
declined as costs associated with the local exchange carriers declined.
SELLING, GENERAL AND ADMINISTRATIVE: Selling, general and administrative
expenses increased 244.0% to $36.0 million in 1996 from $10.5 million in 1995.
Wholesale selling, general and administrative expenses increased to $25.8
million in 1996 from $2.5 million in 1995, and increased as a percentage of
revenues to 11.2% from 8.5% in the prior period. Selling, general and
administrative expenses increased between periods as STAR increased its employee
base and incurred payroll, employee benefits, commission and related expenses.
STAR also established a reserve for doubtful accounts to reflect its
significantly higher revenue levels and invested in sales and marketing
activities, including tradeshows and travel. Hi-Rim and CCI, two of STAR's major
customers in 1996, informed STAR that they were experiencing financial
difficulties and would be unable to pay in full outstanding accounts receivable.
As a result, the full amount of the approximately $10.8 million owed to STAR by
Hi-Rim and CCI as of December 31, 1996 which was not subsequently collected or
for which no offsetting value was received, was written off or reserved in 1996.
In addition, STAR wrote-off $820,000 of intangible assets relating to CCI.
Commercial selling, general and administrative expenses increased to $10.2
million in 1996 from $8.0 million in 1995 reflecting higher operating costs.
DEPRECIATION: Depreciation increased to $1.4 million for 1996 from $368,000
for 1995, but remained at 0.6% of revenues. Depreciation increased as a result
of STAR's purchase of switches and of the operating equipment and leasehold
improvements associated with its Los Angeles and New York switching facilities.
Depreciation expense will increase as STAR expands its ownership of switching
and transmission facilities through purchase or use of capital leases.
OTHER INCOME (EXPENSE): Other expense, net, increased to $560,000 in 1996
from $75,000 in 1995. This increase is primarily due to a $100,000 legal
settlement in the second quarter of 1996 as well as $609,000 in interest expense
incurred under various bank and stockholder lines of credit. This increase was
offset by $110,000 in interest income on short-term investments and cash
equivalents primarily from funds raised in private placements of equity
securities during the first three quarters of 1996.
PROVISION FOR INCOME TAXES: Through December 31, 1995 STAR had elected to
be taxed as an S-Corporation for both federal and state income tax purposes and
thus was only subject to 1.5% tax on taxable income for state purposes. LDS was
an S-Corporation through the date of the merger on November 30, 1997. The pro
forma provision for income taxes, assumes that both STAR and LDS were
C-Corporations for all periods presented. During 1996, the historical provision
for income taxes increased to $577,000 as a result of the reserve of $3.4
million of the net deferred tax asset.
LIQUIDITY AND CAPITAL RESOURCES.
As of September 30, 1998, STAR had cash and cash equivalents of
approximately $11.8 million, short-term investments of $92.4 million (as a
result of STAR's secondary stock offering), and a working capital surplus of
$116.6 million. In June 1997, STAR completed an initial public offering of 9.4
million shares of
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STAR Common Stock of which approximately 8.1 million shares were sold by STAR
and approximately 1.3 million shares were sold by certain selling stockholders.
The net proceeds to STAR (after deducting underwriting, discounts and offering
expenses) from the sale of such shares of STAR Common Stock were approximately
$30.9 million. As of December 31, 1997, STAR had used the proceeds from the
offering to repay indebtedness of $14.2 million, to purchase switching and
transmission related equipment and to finance STAR's operations in the U.K.
On May 4, 1998, STAR completed a secondary offering of 6,000,000 shares of
STAR Common Stock of which 5,685,000 shares were sold by STAR and 315,000 shares
were sold by a selling stockholder. The net proceeds to STAR (after deducting
underwriting discounts and offering expenses) from the sale of such shares of
STAR Common Stock were approximately $145.0 million.
As of September 30, 1998, STAR had no funds outstanding on its $25 million
revolving line of credit, which bears interest at the bank's cost of funds plus
137.5 basis points and expires on July 1, 1999. However, available borrowing
under the line of credit is reduced by outstanding letters of credit in the
amount of $4.9 million.
STAR generated net cash from operating activities of $11.1 million in 1997,
primarily from net income plus depreciation and amortization, while using $2.8
million in 1996. STAR's investing activities used cash of approximately $30.0
million during 1997 primarily resulting from capital expenditures and the
investment of the proceeds from the initial public offering in marketable
securities, while using $10.4 million in 1996. STAR's financing activities
provided cash of approximately $18.9 million during 1997 primarily from the sale
of STAR Common Stock and borrowings under lines of credit, offset by repayments
under various lines of credit, while providing $14.7 million in 1996.
STAR generated net cash from operating activities of $4.3 million for the
nine months ended September 30, 1998, primarily from net income plus
depreciation and amortization, as well as increases in accounts payable and
accrued expenses offset by increases in accounts and notes receivable. The
increase in accounts and notes receivable was due to general increases in volume
and extended payment terms for certain customers. The Company's investing
activities used cash of $136.7 million during the nine months ended September
30, 1998, primarily from capital expenditures and the purchase of short-term
investments. The Company's financing activities generated cash of approximately
$142.0 million primarily from $144.7 million net proceeds raised in the
secondary stock offering as well as stock options exercised, offset by payments
under capital lease obligations.
At September 30, 1998, STAR had capital lease obligations of $37.7 million,
and $0.9 million in term loans, relating to its switching facilities and
operating equipment. STAR believes that the proceeds from its secondary stock
offering and cash generated from operations, as well as funding under its bank
line of credit, will satisfy STAR's current liquidity needs. Nevertheless, as
STAR continues to expand its network facilities and pursues its strategy of
growth through acquisition, STAR's liquidity needs may increase, perhaps
significantly, which could require STAR to seek such additional financing or the
expansion of its borrowing capacity under current or new lines of credit.
The Company also entered into a 20 year commitment to purchase IRUs from IXC
Communications, Inc. for approximately $31 million and a 20 year, $70 million
agreement to purchase capacity on the Qwest nationwide Macro Capacity (SM) Fiber
network.
As appropriate, STAR will use capital lease financing or raise additional
debt or equity capital to finance new projects or acquisitions. STAR had foreign
currency contracts outstanding at December 31, 1997 in the notional amount of
$6.3 million. STAR had no foreign currency contracts outstanding at September
30, 1998.
While the termination of the LDS customer base in California will result in
a loss of commercial revenues from that state during 1998, management does not
believe that the loss of such revenues will have a material impact on STAR's
liquidity in the future.
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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 January 1, 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 February 28, 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 January 1999.
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.
Historically, STAR has not incurred any costs to date to reprogram, replace
and test its information and non-information technology systems for Year 2000
compliance. The costs associated with STAR's Year 2000 compliance efforts will
be incurred during the remainder of 1998 and 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
in connection with STAR's Year 2000 compliance efforts will be expensed as
incurred.
STAR currently anticipates that its information technology and
non-information technology systems will be Year 2000 compliant before January 1,
2000, though no assurances can be given that STAR's compliance testing will not
detect unanticipated Year 2000 compliance problems. Furthermore, STAR does not
yet know the Year 2000 compliance status of integral third parties and is
therefore currently unable to assess the likelihood or the risk to STAR of third
party system failures. However, a system failure by any of STAR's significant
customers or vendors could have a material adverse effect on STAR's operations.
The Company believes that the most reasonably likely worst case scenario
resulting from the century change will be its inability to route telephone
traffic at current rates to desired locations for an indeterminable period of
time. Such worst case scenario could have a material adverse affect on STAR's
results of operations and liquidity.
STAR intends to develop contingency plans to handle a Year 2000 system
failure experienced by its information and non-information technology systems
and to handle any necessary interactions with the computers and technology of
any integral non-complying third party.
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CAPITALIZE ON PROJECTED INTERNATIONAL LONG DISTANCE GROWTH. STAR believes
that the international long distance market provides attractive opportunities
due to its higher revenue and profit per minute, and greater projected growth
rate as compared to the domestic long distance market. STAR targets
international markets with high volumes of traffic, relatively high rates per
minute and prospects for deregulation and privatization. STAR believes that the
ongoing trend toward deregulation and privatization will create new
opportunities for STAR in international markets. Although STAR has focused to
date primarily on providing services for U.S.-based long distance providers,
STAR also intends to expand the international long distance services it offers
to foreign-based long distance providers.
LEVERAGE TRAFFIC VOLUME TO REDUCE COSTS. STAR continues to focus on building
its volume of international long distance traffic. Higher traffic volumes
strengthen STAR's negotiating position with vendors, customers and potential
foreign partners, which allows STAR to lower its costs of service. In addition,
higher traffic volumes on particular routes allow STAR to lower its cost of
services on these routes by transitioning from acquiring capacity on a variable
cost per minute basis to fixed cost arrangements such as longer-term capacity
agreements with major carriers, long-term leases and ownership of facilities.
LEVERAGE INFORMATION SYSTEMS AND SWITCHING CAPABILITIES. STAR leverages its
sophisticated information systems to analyze its routing alternatives, and
select the most cost-effective routing from among STAR owned facilities, network
of resale arrangements with other long distance providers, operating agreements
and alternative termination relationships. STAR has invested significant
resources in the development of software to track specific usage information by
customer and revenue and cost information on specific routes on a daily basis.
STAR's information systems are critical components in managing its customer and
vendor relationships, routing traffic to the most cost-effective alternative,
and targeting its marketing efforts.
MAINTAIN HIGH QUALITY. STAR believes that reliability, call completion
rates, voice quality, rapid set up time and a high level of customer and
technical support are key factors evaluated by U.S. and foreign-based
telecommunications companies and large corporate customers in selecting a
carrier for their international traffic. STAR's state-of-the-art switching
equipment is fully compliant with international C-7 and domestic SS-7 signaling
standards. STAR strives to provide a consistently high level of customer and
technical support and has technical support personnel at its switching
facilities 24 hours per day, seven days per week to assist its customers and to
continually monitor network operations.
EXPAND INTO COMMERCIAL MARKET. STAR plans to expand into niche commercial
markets in the U.S. and in other deregulating countries where it believes it can
leverage its international network and where the customer base has a significant
international calling pattern. As an example of this strategy, STAR is using the
LDS telemarketing sales force to target small commercial customers in ethnic
markets to increase traffic to Mexico and Latin America. Additionally, STAR
intends to use UDN's network of independent sales agents to target medium-sized
commercial customers with a demand for international calling services at
competitive rates. Finally, STAR plans to use its direct sales forces to target
larger commercial customers, concentrating at first on potential customers in
Los Angeles and New York. With respect to the offering of commercial services
abroad, STAR initially intends to focus on Germany, the U.K. and selected
European cities where competition for commercial customers is less mature.
GROWTH THROUGH ACQUISITIONS. STAR actively pursues opportunities to enhance
its business through strategic and synergistic acquisitions. These acquisitions
may focus on entering new territories, enlarging STAR's presence in an existing
territory, adding capacity or expanding into new market segments, such as the
commercial market. In addition to expanding its revenue base, STAR plans to
realize operating efficiencies by integrating newly-acquired operations into
STAR's billing, tracking and other systems. On November 30, 1997, STAR acquired
LDS, a long-distance provider focusing on small commercial customers throughout
the United States, for approximately 849,000 shares of Common Stock. On March
10, 1998, STAR acquired T-One, an international wholesale long distance
provider, for 1,353,000 shares of Common
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Stock. Each of these transactions has been accounted for as a pooling of
interests. On August 20, 1998, STAR entered into the PT-1 Merger Agreement, and
should consummate the PT-1 Merger and related transactions on or about February
3, 1999.
NETWORK
STAR provides international long distance services to approximately 220
foreign countries through a flexible, switched-based network consisting of
resale arrangements with other long distance providers, various foreign
termination relationships, international gateway switches and leased and owned
transmission facilities. STAR's network employs state-of-the-art digital
switching and transmission technologies and is supported by comprehensive
monitoring and technical support personnel. STAR's switching facilities are
staffed 24 hours per day, seven days per week.
TERMINATION ARRANGEMENTS
STAR seeks to retain flexibility and maximize its termination opportunities
by utilizing a continuously changing mix of routing alternatives, including
resale arrangements, operating agreements and other advantageous termination
arrangements. This diversified approach is intended to enable STAR to take
advantage of the rapidly evolving international telecommunications market in
order to provide low-cost international long distance service to its customers.
STAR utilizes resale arrangements to provide it with multiple options for
routing traffic through its switches to each destination country. Traffic under
resale arrangements typically terminates pursuant to a third party's
correspondent relationships. STAR purchased capacity from 57 vendors in 1997. A
substantial portion of this capacity is obtained on a variable, per minute and
short-term basis, subjecting STAR to the possibility of unanticipated price
increases and service cancellations. STAR's contracts with its vendors provide
that rates may fluctuate, with rate change notice periods varying from five days
to one year, with certain of STAR's longer term arrangements requiring STAR to
make minimum usage commitments in order to achieve additional volume discounts.
As a result of deregulation and competition in the international
telecommunications market, the pricing of termination services varies by carrier
depending on such factors as call traffic and time of day. Since STAR does not
typically enter into long-term contracts with these providers, pricing can
change significantly over short periods of time. STAR's proprietary information
systems enable STAR to track the pricing variations in the international
telecommunications market on a daily basis, allowing STAR's management to locate
and reroute traffic to the most cost-effective alternatives. See "Risk
Factors--Operating Results Subject to Significant Fluctuations."
STAR currently has operating agreements with carriers in a number of
countries and is in the process of negotiating additional operating agreements
for other countries. STAR has been and will continue to be selective in entering
into operating agreements. STAR also has agreements with international providers
of long distance services for termination of traffic that STAR routes over a its
network to such countries. STAR currently has such termination arrangements with
several carriers in a number of countries, and STAR is in the process of
expanding its coverage of such countries and entering into similar arrangements
in additional countries. The FCC or foreign regulatory agencies may take the
view that certain of STAR's termination arrangements do not comply with current
rules and policies applicable to international settlements, such as current ISR
rules. To the extent that the revenue generated under such arrangements becomes
a significant portion of overall revenue, the loss of such arrangements, whether
as a result of regulatory actions or otherwise, could have a material adverse
effect on STAR's business, operating results and financial condition. In
addition, the FCC could impose sanctions on STAR, including forfeitures, if
certain of STAR's arrangements are found to be inconsistent with FCC rules. See
"--Government Regulation," "Risk Factors--Risks of International
Telecommunications Business," and "--Potential Adverse Effects of Government
Regulation."
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SWITCHES AND TRANSMISSION FACILITIES
International long distance traffic to and from the U.S. is generally
transmitted through an international gateway switching facility across undersea
digital fiber optic cable or via satellite to a termination point. International
gateway switches are digital computerized routing facilities that receive calls,
route calls through transmission lines to their destination and record
information about the source, destination and duration of calls. STAR's global
network facilities include both international gateway switches and undersea
digital fiber optic cable.
STAR currently operates international gateway switches in New York, Los
Angeles, Dallas and Miami; London, England; and Dusseldorf, Frankfurt, Hamburg,
and Munich, Germany. In early 1999, STAR plans to put into service international
gateway switches in Atlanta, Chicago, Seattle; Paris, France; and Tokyo, Japan.
STAR considers any of its switches to be international gateway switches if STAR
can route international calls across such switch.
STAR's switching facilities are linked to a proprietary reporting system,
which STAR believes provides it with a competitive advantage by permitting
management on a real-time basis to determine the most cost-effective termination
alternatives, monitor customer usage and manage gross margins by route. STAR has
installed multiple redundancies into its switching facilities to decrease the
risk of a network failure. For example, STAR employs both battery and generator
power back-up and has installed hardware that automatically shifts the system to
auxiliary power during a power outage, rather than relying on manual override.
STAR is in the process of adding a network control center in its Los Angeles
facility, which is expected to be completed in 1999.
STAR currently holds ownership positions in a number of digital undersea
fiber optic cables, including TPC-5, Gemini and AC-1 and has plans to acquire
transmission capacity on additional undersea fiber optic cable systems. STAR has
recently entered into a commitment to acquire transmission capacity on the Qwest
domestic Macro Capacity (SM) Fiber Network, which is expected to serve over 130
cities in the U.S. STAR plans to increase its investment in direct and IRU
ownership of cable in situations where STAR enters into operating agreements and
in other situations in which it determines that such an investment would enhance
operating efficiency or reduce transmission costs.
Through its acquisitions of T-One and UDN, STAR has acquired, or will
acquire, additional switching and transmission facilities. By acquiring T-One,
STAR has added a switch located in the same building as STAR's New York
international gateway switch and has added a number of operating agreements to
countries in Africa and the Middle East, among other locations. In addition,
T-One owns capacity on certain cable and satellite systems. Upon consummation of
the acquisition of UDN, STAR will acquire a switch located in the same building
as STAR's Dallas switch. STAR plans to integrate these facilities into its
existing network.
SALES AND MARKETING
STAR markets its services on a wholesale basis to other telecommunications
companies through its experienced direct sales force and marketing/account
management team who leverage the long-term industry relationships of STAR's
senior management. STAR reaches its customers primarily through domestic and
international trade shows and through relationships gained from years of
experience in the telecommunications industry. STAR had 103 direct sales and
marketing employees and over 140 telemarketing representatives as of September
30, 1998.
In the wholesale market, STAR's sales and marketing employees utilize the
extensive, customer specific usage reports and network utilization data
generated by STAR's sophisticated information systems to effectively negotiate
agreements with customers and prospective customers and to rapidly respond to
changing market conditions. STAR believes that it has been able to compete more
effectively as a result of the personalized service and ongoing senior
management-level attention that is given to each customer.
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In connection with STAR's expansion into the commercial market, STAR expects
to target small commercial customers through LDS' existing telemarketing
operation, deliver services to medium-sized commercial customers through UDN's
network of independent sales agents and utilize a direct sales force to approach
larger commercial accounts. Establishment of a sales force capable of
effectively expanding STAR's services into the commercial market can be expected
to require substantial efforts and management and financial resources and may
increase STAR's operating costs. See "Risk Factors--Risks Associated with Growth
of Telecommunications Network and Customer Base."
INFORMATION AND BILLING SYSTEMS
STAR's operations use advanced information systems including call data
collection and call data storage linked to a proprietary reporting system. STAR
also maintains redundant billing systems for rapid and accurate customer
billing. STAR's switching facilities are linked to a proprietary reporting
system, which STAR believes provides it with a competitive advantage by
permitting management on a real-time basis to determine the most cost-effective
termination alternatives, monitor customer usage and manage gross margins by
route. STAR's systems also enable it to ensure accurate and timely billing and
to reduce routing errors. As STAR's systems were designed for the wholesale
marketplace, STAR is currently in the process of modifying its systems in
anticipation of its entrance into the commercial marketplace.
STAR's proprietary reporting software compiles call, price and cost data
into a variety of reports which STAR can use to re-program its routes on a
real-time basis. STAR's reporting software can generate the following reports as
needed:
- customer usage, detailing usage by country and by time period within
country, in order to track sales and rapidly respond to any loss of
traffic from a particular customer;
- country usage, subtotaled by vendor or customer, which assists STAR with
route and network planning;
- vendor rates, through an audit report that allows management to determine
at a glance which vendors have the lowest rates for a particular country
in a particular time period;
- vendor usage by minute, enabling STAR to verify and audit vendor bills;
- dollarized vendor usage to calculate the monetary value of minutes passed
to STAR's vendors, which assists with calculating operating margin when
used in connection with the customer reports;
- loss reports used to rapidly highlight routing alternatives that are
operating at a loss as well as identifying routes experiencing substantial
overflow; and
- LATA (Domestic Call Area) reporting by originating and terminating LATA,
allowing for accurate Local Exchange charge audits, and protecting from
Local Exchange overcharging.
STAR has built multiple redundancies into its billing and call data
collections systems. Nine call collector computers receive call information in
real-time, immediately duplicating data, sending one copy to billing, while the
other copy is used for customer service internally and for traffic analysis.
STAR maintains two independent and redundant billing systems in order to both
verify billing internally and to ensure that bills are sent out on a timely
basis. All of the call data, and resulting billing data, are continuously backed
up on tape drives and redundant storage devices, and are regularly transported
to an off-site safe location.
COMPETITION
The international telecommunications industry is intensely competitive and
subject to rapid change. STAR's competitors in the international wholesale
switched long distance market include large, facilities-based multinational
corporations and PTTs, smaller facilities-based providers in the U.S. and
overseas that
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have emerged as a result of deregulation, switched-based resellers of
international long distance services and international joint ventures and
alliances among such companies. International wholesale switched long distance
providers compete on the basis of price, customer service, transmission quality,
breadth of service offerings and value-added services. STAR also competes abroad
with a number of dominant telecommunications operators that previously held
various monopolies established by law over the telecommunications traffic in
their countries. See "Risk Factors--Significant Competition." Additionally, the
telecommunications industry is in a period of rapid technological evolution,
marked by the introduction of competitive new product and service offerings,
such as the utilization of the Internet for international voice and data
communications. STAR is unable to predict which of many possible future product
and service offerings will be important to maintain its competitive position or
what expenditures will be required to develop and provide such products and
services. STAR believes that it competes favorably on the basis of price,
transmission quality and customer service. The number of STAR's competitors is
likely to increase as a result of the new competitive opportunities created by
the WTO Agreement. Further, under the terms of the WTO Agreement, the United
States and the other 68 countries participating in the Agreement have committed
to open their telecommunications markets to competition, and foreign ownership
and adopt measures to protect against anticompetitive behavior, effective
starting on February 5, 1998. As a result, STAR believes that competition will
continue to increase, placing downward pressure on prices. Such pressure could
adversely affect STAR's gross margins if STAR is not able to reduce its costs
commensurate with such price reductions.
COMPETITION FROM DOMESTIC AND INTERNATIONAL COMPANIES AND ALLIANCES. A
majority of the U.S.-based international telecommunications services revenue is
currently generated by AT&T, MCI WorldCom. STAR also competes with Pacific
Gateway Exchange, Inc. and other U.S.-based and foreign long distance providers,
including the RBOCs, which presently have FCC authority to resell and terminate
international telecommunication services. Many of these companies have
considerably greater financial and other resources and more extensive domestic
and international communications networks than STAR. STAR's business would be
materially adversely affected to the extent that a significant number of such
customers limit or cease doing business with STAR for competitive or other
reasons. Consolidation in the telecommunications industry could not only create
even larger competitors with greater financial and other resources, but could
also adversely affect STAR by reducing the number of potential customers for
STAR's services.
EXPANSION INTO COMMERCIAL MARKET. With the acquisition of LDS, STAR began
providing long distance service to the commercial market, a market that is
subject to intense competition from a number of well capitalized companies. The
commercial market is also characterized by the lack of customer loyalty, with
commercial customers regularly changing service providers. There can be no
assurance that STAR will be able to compete successfully in the commercial
market.
GOVERNMENT REGULATION
STAR's U.S. interstate and international telecommunications service
offerings generally are subject to the regulatory jurisdiction of the FCC.
Certain telecommunication services offered by STAR in the U.S. may also be
subject to the jurisdiction of state regulatory authorities, commonly known as
public utility commissions ("PUCs"). STAR's telecommunications service offerings
outside the U.S. are also generally subject to regulation by national regulatory
authorities. In addition, U.S. and foreign regulatory authorities may affect
STAR's international service offerings as a result of the termination or transit
arrangements associated therewith. U.S. or foreign regulatory authorities may
take actions or adopt regulatory requirements which could adversely affect STAR.
See "Risk Factors--Potential Adverse Effect of Government Regulation."
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U.S. REGULATION
STAR's business is subject to various U.S. and foreign laws, regulations,
agency actions and court decisions. STAR's U.S. international telecommunications
service offerings are subject to regulation by the FCC. The FCC requires
international carriers to obtain authorization under Section 214 of the
Communications Act prior to acquiring international facilities by purchase or
lease, or providing international service to the public. Prior FCC approval is
also required to transfer control of a certificated carrier. STAR is also
subject to FCC policies and rules that regulate the manner in which
international telecommunication services may be provided, including, for
instance, the circumstances under which a carrier may provide international
switched services using IPL facilities and under which it may route traffic
through third countries to or from its final destination.
The Communications Act and the FCC's rules and policies also impose certain
other obligations on carriers providing international telecommunication
services. These include the obligation to file at the FCC and to maintain
tariffs containing the rates, terms, and conditions applicable to their
services; to file certain reports regarding international traffic and
facilities; to file certain contracts with correspondent carriers; to disclose
affiliations with foreign carriers and significant foreign ownership interests;
to pay certain regulatory fees based, among other things, upon the carrier's
revenues and ownership of international transmission capacity.
INTERNATIONAL SERVICES. FCC rules require STAR to obtain prior FCC
authorization to acquire and operate international communication circuits in
satellites and undersea fiber optic cables; similar FCC authority is required
for STAR to resell such capacity. STAR holds both facilities-based and resale
international authorizations, including a "global" authorization that provides
broad authority to offer switched and private line international services. STAR
has filed tariffs for international services with the FCC.
FCC INTERNATIONAL PRIVATE LINE RESALE POLICY. The FCC's IPL resale policy
limits the conditions under which a carrier may connect IPLs to the PSTN at one
or both ends to provide switched services, commonly known as ISR. A carrier
generally may only offer ISR services to a foreign country if the FCC has found
(a) the country is a member of the WTO and at least 50% of the U.S. billed and
settled traffic to that country is settled at or below the benchmark settlement
rate adopted by the FCC in IB Docket No. 96-261; or (b) the country is not a WTO
member, but it offers U.S. carriers equivalent opportunities to engage in ISR
and at least 50% of the U.S. billed and settled traffic is settled at or below
the applicable benchmark. Settled traffic refers to traffic subject to an
accounting rate agreement between U.S. and foreign carriers. An accounting rate
is a per minute wholesale charge negotiated by international carriers for
terminating traffic in either direction. Each carrier is paid a settlement rate
for terminating traffic on its own network which ordinarily is one-half of the
accounting rate. STAR's FCC authority currently permit it to provide ISR service
to Canada, the U.K., Sweden, New Zealand, Australia, the Netherlands, Germany,
France, Belgium, Denmark, Norway, Austria, Switzerland, Luxembourg, Italy,
Ireland, Hong Kong and Japan. The FCC is currently reviewing U.S. carrier
applications to provide ISR to Finland and Mexico among other routes, and upon
grant of any such ISR application to a given country, the FCC's rules also would
permit STAR to provide ISR service to that country. If ISR is not permitted on a
route, absent prior FCC consent, U.S. facilities based international carriers
must terminate switched telephone traffic in accordance with the ISP which is
primarily intended to deter foreign carriers with market power from
discriminating amongst competing U.S. carriers by, for example, favoring the
foreign carrier's U.S. affiliate. The ISP requires that all U.S. carriers
terminate traffic with a foreign carrier on the same terms (i.e., that
settlement rates be equivalent) and receive inbound traffic only in proportion
to the volume of U.S. outbound traffic which they generate.
On a few routes, STAR may use IPLs to terminate international switched
telephone services where ISR has not been authorized. On such routes, therefore,
STAR's termination arrangements may not be
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consistent with the FCC's ISP. On any such route, however, to STAR's knowledge
the foreign correspondent lacks market power, no U.S. inbound traffic is
involved, and the effective settlement rate is lower than the prevailing rate.
Thus STAR believes its actions are not inconsistent with the ISP's underlying
purpose. If the FCC were to determine, by its own actions or in response to the
filing of a third party that any of STAR's IPL arrangements violate its ISR
policy or STAR's ISR authorization, the FCC could order STAR to terminate any
non-conforming arrangements. In addition, STAR could be subject to a monetary
forfeiture and to other penalties, including the revocation of STAR's FCC
authorizations to operate as an international carrier. Any such FCC action could
have a material adverse effect upon STAR's business, operating results and
financial condition.
FCC INTERNATIONAL SETTLEMENTS POLICY. The FCC's ISP places limits on the
arrangements which U.S. international carriers may enter into with foreign
carriers for exchanging public switched telecommunications traffic, which the
FCC terms International Message Telephone Service. The policy does not apply to
ISR services. The ISP is primarily intended to deter dominant foreign carriers
from discriminating amongst competing U.S. carriers by, for example, favoring
the foreign carrier's U.S. affiliate. Absent FCC consent, the ISP requires that
U.S. carriers receive an equal share of the accounting rate (i.e., that
settlement rates be equivalent) and receive inbound traffic in proportion to the
volume of U.S. outbound traffic which they generate. The ISP and other FCC
policies also prohibit a U.S. carrier from offering or accepting a "special
concession" from a foreign carrier where the foreign carrier possess sufficient
market power on the foreign end of the route to affect competition adversely in
the U.S. market." A "special concession" is defined by the FCC as an exclusive
arrangement involving services, facilities or functions on the foreign end of a
U.S. international route which are necessary for providing basic
telecommunications, and which are not offered to similarly situated U.S.
carriers authorized to serve that route. U.S. international carriers wishing to
establish settlement arrangements for IMTS which do not comply with the ISP must
obtain a waiver of the FCC's rules or a declaratory ruling from the FCC under
the FCC's "flexibility" policy that the non-standard arrangement is in the
public interest. FCC policy provides that a request by a U.S. international
carrier to establish a non-standard settlement arrangement with a foreign
carrier in a WTO member country is presumptively in the public interest, and
that said presumption generally may be overcome only by a demonstration that the
foreign carrier is not subject to competition in its home market from more than
one facilities-based international carrier. Notwithstanding the FCC's ISP waiver
and flexibility policies, it is possible that the FCC could find that certain of
STAR's arrangements with foreign operators were or are inconsistent with the ISP
and that STAR has not requested prior FCC authority therefore. If the FCC were
to determine by its own actions or in response to the filing of a third party
that STAR has violated the ISP, the FCC could order STAR to terminate any
non-conforming arrangement. In addition, STAR could be subject to a monetary
forfeiture and to other penalties, including revocation of STAR's FCC
authorizations to operate as an international carrier. Any such FCC action could
have a material adverse effect upon STAR's business, operating results and
financial condition.
The FCC's policies also require U.S. international carriers providing IMTS
to negotiate and adopt settlement rates with foreign correspondents for IMTS
which are at or below certain benchmark rates beginning January 1, 1999 for high
income countries. Pending reconsideration, the FCC has stayed a related policy
requiring U.S. international carriers to establish IMTS settlement rates at or
below the benchmark rate with any foreign affiliate beginning April 1, 1998.
STAR expects that any IMTS operating agreement which it has or may have with a
foreign affiliate will satisfy the foregoing benchmarks requirement when
applicable.
STAR currently has IMTS operating agreements with certain foreign
correspondents which provide for settlement rates above the FCC's prescribed
benchmarks. STAR will negotiate in good faith to establish IMTS settlement rates
with its foreign correspondents which satisfy the FCC's benchmarks but there can
be no assurance that such negotiations will succeed. The FCC's order adopting
the foregoing settlement benchmarks and the timetable therefor was upheld by the
U.S. Court of Appeals, but is currently being reconsidered by the FCC. Subject
to FCC reconsideration, if STAR is unable to negotiate
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benchmark settlement rates with certain foreign correspondents, the FCC may
intervene on its own action or in response to a filing by a third party. STAR is
unable to predict the form which such intervention may take but it could disrupt
STAR's arrangement for transmitting traffic to certain countries require STAR to
suspend direct service to certain countries or require STAR to make alternative
termination arrangements with certain countries all of which could have a
material adverse effect on STAR's business, operating results and financial
condition.
FCC POLICIES ON TRANSIT AND REFILE. International switched
telecommunication traffic is frequently routed indirectly via one or more third
countries to its final destination. When such arrangements are mutually agreed,
they are commonly based on a transit agreement under which settlement payments
are made to all parties. In other cases, traffic may be sent to a third country
and then forwarded or refiled for delivery to its final destination without the
knowledge or consent of the destination carrier. STAR uses both transit and
refile arrangements to terminate its international traffic. The FCC routinely
approves transit arrangements by U.S. international carriers. The FCC's rules
also permit carriers to use ISR facilities in many cases to route traffic via a
third country for refile through the public switched network. However, the
extent to which U.S. carriers may enter into refile arrangements consistent with
the ISP is currently under review by the FCC. In 1997, the FCC stated that
above-cost accounting rates had led an increasing amount of international
traffic to migrate to least cost routes through the use of practices such as
hubbing, refile and reorigination. The FCC stated that such practices are an
economically rational response to inflated settlement rates. Notwithstanding the
FCC's past rules, policies and statements regarding the scope of permissible
transit and refile arrangements, the FCC could find by its own actions or in
response to the filing of a third party, that certain of STAR's transit or
refile arrangements violate the ISP or other FCC policies. In that event, the
FCC could order STAR to terminate any non-conforming transit or refile
arrangements. In addition, STAR could be subject to a monetary forfeiture and to
other penalties, including revocation of STAR's FCC authorizations to operate as
an international carrier. Any such FCC action could have a material adverse
effect on STAR's business, operating results and financial condition.
REPORTING REQUIREMENTS. International telecommunication carriers also are
required by the FCC's rules timely to file certain reports regarding
international traffic and revenues, the ownership and use of international
facilities; and their affiliates with foreign carriers. The FCC considers a U.S.
carrier to be affiliated with a foreign carrier if it has a 25% interest in the
capital stock of the carrier or it controls the foreign carrier or is under
common ownership or control. The FCC requires these reports so that, among other
things, it may monitor the development of industry competition and the potential
for a dominant foreign carrier to discriminate amongst U.S. carriers. STAR
generally has filed said traffic, facilities and foreign affiliation reports.
The FCC's rules require international telecommunication carriers to file at the
FCC copies of their contracts with other carriers, including operating
agreements, within 30 days of execution. STAR has filed copies of its operating
agreements with the FCC. Competitive U.S. international carriers do not
routinely file other carrier-to-carrier contracts with the FCC and, consistent
with industry practice, STAR has not filed certain other carrier contracts.
Notwithstanding the foregoing FCC filings by STAR, the FCC by its own action or
in response to the filing of a third party could determine that STAR has failed
to meet certain of the foregoing filing and reporting requirements or that
certain Company filings are deficient. In that event, STAR could be directed to
remedy any asserted non-compliance; STAR could also be subject to a monetary
forfeiture and to other penalties, and, although STAR believes that it would be
largely unprecedented in such circumstances, and hence unlikely, the FCC could
revoke STAR's authorizations to operate as an international carrier. Any such
FCC action could have a material adverse effect on STAR's business, results and
financial condition.
REGULATORY FEES. The Communications Act, and FCC rules and policies, impose
certain fees upon carriers providing interstate and international
telecommunication services. These fees are levied, among other things, to defray
the FCC's operating expenses, to underwrite universal telecommunication service
(e.g., by subsidizing certain services used by schools and libraries), such as
Internet access, and by other
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telecommunications users in areas of the U.S. where service costs are
significantly above average), to fund the Telecommunications Relay Service
("TRS"), which provides special options for hearing-impaired users, and to
support the administration of telephone numbering plans.
Carriers that provide domestic interstate services must pay an annual
regulatory fee based on their interstate revenues; the fee is currently 0.11% of
net revenue. Carriers that provide domestic interstate services to end users
must pay a universal telecommunications service fee each month based upon the
total estimated demand for U.S. universal service funding. If applicable, each
carrier's share is approximately 4% of the carrier's annual end user revenues.
STAR generally offers its services only to other carriers which in turn provide
services to end-users. Such carrier-to-carrier revenues are not subject to
universal service fees, and thus STAR generally is not liable to pay universal
service fees. Carriers that only offer international service (i.e., service
between the United States and a foreign country or service between two foreign
carriers) also are not subject to the universal service fee. However, if an
international carrier has an affiliate that provides domestic interstate
services, then the carrier's international revenues are subject to said fee.
Until its acquisition of LDS, STAR did not offer domestic interstate services.
As a result of the operations of LDS, any revenue STAR receives from end users
for international services may be subject to universal service fees. U.S.
interstate and international carriers must pay a percentage of their total
revenue each year to support the North American Numbering Plan Administrator.
For the 1998 filing year, the contribution rate is less than .003% of net
telecommunications revenue. U.S. carriers must pay a certain percentage of their
domestic interstate revenues to support the TRS Fund. For the 1998 filing year,
the contribution rate was less than .04% of gross domestic interstate revenue.
STAR has routinely paid the foregoing regulatory fees; however, approximately
$150,000 in additional fees may be owed by STAR to satisfy its TRS and annual
fee obligations for the 1996 and 1997 filing years. The foregoing regulatory
fees typically change annually. STAR cannot predict the future regulatory fees
for which it may be liable. Said fees could rise significantly for STAR and
amount to four percent or more of STAR's gross international and interstate
revenues if STAR is no longer exempt from paying universal service fees as a
result of an affiliate's provision of domestic interstate services, or because
STAR provides service directly to end users, or because amendments to the
Communications Act repeal the universal service fee exemption for revenues from
connecting carriers. Because the international telecommunication services
business is highly competitive, an increase in the regulatory fees which STAR
must pay could impair its market position and have a material adverse effect on
STAR's business, operating results and financial condition.
RECENT AND POTENTIAL FCC ACTIONS. Recent FCC rulemaking orders and other
actions have lowered the entry barriers for new facilities-based and resale
international carriers by streamlining the processing of new applications and
granting non-dominant carriers greater flexibility in establishing non-standard
settlement arrangements with non-dominant foreign carriers, including the
non-dominant U.S. affiliates of such carriers. In addition, the FCC's rules
implementing the WTO Agreement presume that competition will be advanced by the
U.S. entry of facilities-based and resale carriers from WTO member countries,
thus further increasing the number of potential competitors in the U.S. market
and the number of carriers which may also offer end-to-end services. The FCC has
recently approved the mergers of AT&T and Teleport Communications Group and LCI
International, Inc. and Qwest Communications International Inc. FCC approval and
consummation of these mergers increases concentration in the international
telecommunications service industry and the potential market power of STAR's
competitors. The FCC also recently has sought to reduce the foreign termination
costs of U.S. international carriers by prescribing maximum or benchmark
settlement rates which foreign carriers may charge U.S. carriers for terminating
switched telecommunications traffic. This FCC action may reduce STAR's
settlement costs, although the costs of other U.S. international carriers also
may be reduced in a similar fashion. The FCC has not stated how it will enforce
the new settlement benchmarks if U.S. carriers are unsuccessful in negotiating
settlement rates at or below the prescribed benchmarks, but any future FCC
intervention could disrupt STAR's transmission arrangements to certain countries
or require STAR to modify its existing arrangements; other U.S. international
carriers might be similarly affected. The 1996 amendment to the Communications
Act permits the FCC to forbear enforcement of the tariff provisions in the Act,
which apply to all
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interstate and international carriers, and the U.S. Court of Appeals is
currently reviewing an FCC order directing all domestic interstate carriers to
detariff their offerings. Subject to the Court's decision, the FCC may forbear
its current tariff rules for U.S. international carriers, such as STAR, or order
such carriers to detariff their services. In that event, STAR would have greater
flexibility in pricing its service offerings and to compete, although any such
FCC action likely would grant other non-dominant international carriers
equivalent freedom. The FCC routinely reviews the contribution rate for various
levels of regulatory fees, including the rate for fees levied to support
universal service, which fees may be increased in the future for various
reasons, including the need to support the universal service programs mandated
by the Communications Act, the total costs for which are still under review by
the FCC. The FCC also is reviewing the extent to which international carriers
may refile traffic using international private line facilities or otherwise.
Future FCC actions regarding refile could affect STAR by, for example, requiring
it to discontinue certain termination arrangements which it now has or to
implement alternative routing arrangements for certain countries; on the other
hand, the FCC may further liberalize its existing rules and policies regarding
refile in which case STAR is likely to be well positioned to expand certain
refile operations even though new opportunities may become available to its
competitors. STAR can not predict the net effect of these or other possible
future FCC actions on its business, operating results and financial condition,
although the net effect could be material.
STATE REGULATION
STATE. The intrastate long distance telecommunications operations of STAR
and its subsidiaries are subject to various state laws and regulations,
including prior certification, notification, registration and/or tariff
requirements. In certain states, prior regulatory approval is required for
changes in control of telecommunications services. The vast majority of states
require STAR and its subsidiaries to apply for certification to provide
intrastate telecommunications services, or at a minimum to register or to be
found to be exempt from regulation, prior to commencing sale of intrastate
services. Additionally, the vast majority of states require STAR or its
subsidiaries to file and maintain detailed tariffs setting forth rates charged
by STAR to its end-users for intrastate services. Many states also impose
various reporting requirements and/or require prior approval for transfers of
control of certificated carriers and assignments of carrier assets, including
customer bases, carrier stock offerings, and incurrence by carriers of
significant debt. Certificates of authority can generally be conditioned,
modified, canceled, terminated or revoked by state regulatory authorities for
failure to comply with state laws and/or rules, regulations and policies of the
state regulatory authorities. Fines and other penalties, including, for example,
the return of all monies received for intrastate traffic from residents of a
state in which a violation has occurred may be imposed.
STAR, along with its regulated subsidiaries, believes it has made the
filings and taken the actions it believes are necessary to provide the
intrastate services it currently provides to end users throughout the U.S. STAR
and/or its subsidiaries are qualified to do business as foreign corporations,
and have received certification to provide intrastate telecommunications
services in all states where certification is required, and have received
approval for changes of control where such approvals are necessary. STAR and its
subsidiaries are required to make periodic filings in order to maintain
certificated status and remain qualified as foreign corporations.
In early 1997, the FCC instituted significant changes to the current
incumbent local exchange carrier access charge structure. These changes were
meant, in part, to bring access charges closer to their actual costs. While
there has been a general trend towards access charge reductions, new primary
interexchange carrier charges (PICCs) were authorized by the FCC to be imposed
on interexchange carriers serving presubscribed access charges closer to their
actual costs. PICCs are a flat-rated, per presubscribed line, per month access
charge imposed upon all facilities-based carriers (although they may be passed
through to resellers). Facilities-based carriers were assessed interstate PICCs
effective January 1, 1998. Intrastate PICCs have also been adopted in the five
state Ameritech region (Michigan, Wisconsin, Illinois, Indiana, and Ohio), and
may be adopted elsewhere. At the same time, STAR may pursue underlying carriers
for pass throughs of any access charge reductions they may realize from
incumbent local exchange carriers.
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ACTIONS AGAINST LDS. In 1997, prior to STAR's acquisition of LDS, LDS
settled disputes with the California PUC and with the District Attorney of
Monterey, California regarding LDS' alleged unauthorized switching of long
distance customers. As part of the Settlements, LDS was subject to fines and
restrictions on its business operations in California. In addition, the FCC has
received numerous informal complaints against LDS regarding the alleged
unauthorized switching of long distance customers, which complaints currently
remain under review.
Following STAR's acquisition of LDS and in order to comply with the
Settlements, STAR has imposed strict restrictions on certain former LDS
employees, restricting these employees with respect to California intrastate
telecommunications operations. Additionally, STAR has taken a number of steps to
reduce the risk of a repeat occurrence regarding the alleged unauthorized
switching of commercial customers in California. There can, however, be no
assurance that LDS or STAR will not be subject to further regulatory review by
the California PUC or the FCC.
FOREIGN REGULATION
UNITED KINGDOM. In the U.K., telecommunications services offered by STAR
and through its affiliate, STAR Europe Ltd. ("STAR Europe"), are subject to
regulation by various U.K. regulatory agencies. The U.K. generally permits
competition in all sectors of the telecommunications market, subject to
licensing requirements and license conditions. STAR has been granted a license
to provide international services on a resale basis and STAR Europe has been
granted a license to provide international services over its own facilities,
which licenses are subject to a number of restrictions. Implementation of these
licenses have permitted STAR to engage in cost-effective routing of traffic
between the U.S. and the U.K. and beyond.
GERMANY. In Germany, telecommunications services offered by STAR through
its affiliate, STAR Telecommunications Deutschland GmbH ("STAR Germany"), are
subject to regulation by the Regulierungsbehorde fur Telekommunikation und Post
(which is under the jurisdiction of the Ministry of Economy). Germany permits
the competitive provision of international facilities-based and resale services.
STAR Germany was granted a license for the provision of voice telephony on the
basis of self-operated telecommunications networks on December 4, 1997. Under
this license, STAR Germany has installed telecommunications switching facilities
in Dusseldorf, Frankfurt, Hamburg and Munich and is leasing connection
transmission facilities between these switches and additional facilities. The
network of STAR Germany will be used primarily for routing international
telecommunications traffic between the U.S., the U.K., Germany and beyond. There
can be no assurance that future changes in regulation of the services provided
by STAR Germany will not have a material adverse effect on STAR's business,
operating results and financial condition.
OTHER COUNTRIES. STAR plans to initiate a variety of services in certain
European countries including France and Belgium. These services will include
value-added services to closed user groups and other voice services as
regulatory liberalization in those countries permits. These and other countries
have announced plans or adopted laws to permit varying levels of competition in
the telecommunications market. Under the terms of the WTO Agreement, each of the
signatories has committed to opening its telecommunications market to
competition, foreign ownership and to adopt measures to protect against
anticompetitive behavior, effective starting on January 1, 1998. Although STAR
plans to obtain authority to provide service under current and future laws of
those countries, or, where permitted, provide service without government
authorization, there can be no assurance that foreign laws will be adopted and
implemented providing STAR with effective practical opportunities to compete in
these countries. Moreover, there can be no assurance of the nature and pace of
liberalization in any of these markets. STAR's inability to take advantage of
such liberalization could have a material adverse affect on STAR's ability to
expand its services as planned.
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EMPLOYEES
As of September 30, 1998, STAR employed 675 full-time employees. STAR is not
subject to any collective bargaining agreement and it believes that its
relationships with its employees are good.
PROPERTIES
STAR's principal offices are located in Santa Barbara, California in four
facilities providing an aggregate of approximately 24,972 square feet of office
space. Approximately 5,332 square feet of this office space is leased pursuant
to two leases that both expire in July 1999. The remaining approximately 12,327
square feet of office space is located in two buildings and is rented by STAR
pursuant to a lease that expires in June 2003. STAR also leases approximately
16,595 square feet of space for its switching facility in Los Angeles,
California under a sublease and a lease expiring in April 2006, an aggregate of
approximately 33,445 square feet of space for its switching facilities in New
York, New York under three leases which expire in December 31, 2001, July 31,
2003 and April 2008, respectively, approximately 6,167 square feet of space for
its switching facility in Dallas, Texas under a lease expiring in April 2007,
and approximately 8,000 square feet of space for its switching facility in
London, England under a lease expiring in July 2006. STAR leases approximately
14,628 square feet in Dusseldorf, approximately 27,835 square feet in Frankfurt,
approximately 12,002 square feet in Hamburg and approximately 12,408 square feet
in Munich, Germany under four leases expiring on or about January 1, 2008. The
aggregate facility lease payments made by STAR in 1997 were approximately $2.2
million. STAR believes that all other material terms of its leases are
commercially reasonable terms that are typically found in commercial leases in
each of the respective areas in which STAR leases space. STAR believes that its
facilities are adequate to support its current needs and that additional
facilities will be available at competitive rates as needed.
LITIGATION
STAR is not presently a party to any material pending litigation. From time
to time, however, STAR is party to various legal proceedings, including billing
disputes and collection matters, that arise in the ordinary course of business.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF PT-1
THE FOLLOWING DISCUSSION OF THE FINANCIAL CONDITION AND RESULTS OF
OPERATIONS OF PT-1 SHOULD BE READ IN CONJUNCTION WITH THE FINANCIAL STATEMENTS,
INCLUDING THE NOTES THERETO, AND OTHER DETAILED INFORMATION REGARDING PT-1
INCLUDED ELSEWHERE IN THIS PROXY STATEMENT. THIS DISCUSSION CONTAINS
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. PT-1'S ACTUAL
RESULTS MAY DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THE FORWARD-LOOKING
STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING, BUT NOT LIMITED TO THOSE
DISCUSSED UNDER "RISK FACTORS" AND ELSEWHERE IN THIS PROXY STATEMENT.
OVERVIEW
PT-1 is a provider of international long distance services to retail
customers and telecommunications carriers. PT-1 currently provides its retail
services by marketing Prepaid Cards, primarily under the PT-1 brand name,
through an extensive network of distributors and independent retail outlets
throughout the United States. PT-1 targets retail markets with substantial
international long distance calling requirements, such as ethnic communities,
and believes that its Prepaid Cards provide consumers with a convenient,
attractively priced alternative to traditional presubscribed long distance
services. PT-1 has used its significant retail international traffic to
negotiate international termination arrangements with attractive rates and
develop an efficient telecommunication network, enabling PT-1 to market its
services competitively on a wholesale basis to telecommunications carriers.
REVENUES. PT-1 generates revenues through the sale of Prepaid Cards to
distributors and from the provision of transmission service on a wholesale basis
to other carriers as well as retail long distance services through its recently
introduced dial-around service. PT-1 has established itself in the international
long distance market through its Prepaid Card business and is using its
international traffic volume to develop a significant wholesale and retail
customer base. Rates in the international long distance market have declined in
recent years and, as competition in this segment of the telecommunications
industry continues to intensify, PT-1 believes that this downward trend in rates
is likely to continue. In its current fiscal year, PT-1 has experienced slight,
immaterial increases in average rates per minute. PT-1 believes that such
increases will cease and that PT-1 will be subject to the general erosion of
rates experienced by the other international telecommunication providers. PT-1
believes that such reductions in rates over time will be offset in part by
increased volume, efficiencies attributable to the planned expansion of PT-1's
telecommunications network as well as by lower transmission costs per minute
resulting from PT-1's increased volume of minutes.
In July 1995, PT-1 introduced its first Prepaid Card, The PT-1 Card,
initially targeted at ethnic communities with substantial international long
distance calling requirements in the New York City metropolitan area. PT-1
issued its first LAC Card, The New York Phone Card, in July 1996. PT-1 currently
has 14 LAC Cards (The New Jersey Phone Card, The New York Phone Card, The
Florida Card, The Boston Card, The California Card, The Diamond Direct Card, The
Payless Direct Card, The Detroit Card, The Connecticut Card, The Chicago Card,
The D.C.-Maryland-Virginia Card, The Georgia Card, The Texas Card and The
Pennsylvania Card), and the Alo Brasil, Hola Mexico, Hola Dominican Republic and
Hola Columbia Country Calling Cards, targeted to the Brazilian, Mexican,
Dominican Republic and Columbian communities in the U.S., as well as The PT-1
Worldwide Phone Card and other Prepaid Cards.
PT-1 fixes its Prepaid Card rates to attract new customers and to retain its
existing customers. While PT-1's rates to specific domestic and international
destinations are often more attractive to customers than the rates of the four
primary carriers, PT-1 does not, as a policy, fix its rates at a discount to the
rates charged by the four primary carriers, or at a discount to the rates
charged by other carriers.
PT-1 sells its Prepaid Cards to distributors at a discount to their face
values of $5, $10, $20, $25, $50 and $100, and records the sale as deferred
revenue until the card user utilizes the calling time. Revenues from the
wholesale provision of international and domestic long distance services to
other carriers is also
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recognized at the time of customer usage. PT-1 records revenue from the sale of
dial around services and presubscribed long distance services upon customer
usage and bills its customers for these services through billing and collection
arrangements with LECs. PT-1's revenues are reported net of certain federal and
state excise and use taxes imposed upon Prepaid Cards.
Although PT-1's reporting currency is the U.S. dollar, PT-1 expects to
derive an increasing percentage of its revenues from international operations.
Accordingly, changes in currency exchange rates may have a significant effect on
PT-1's results of operations. PT-1 may choose to limit its exposure to foreign
currency fluctuations in the future by purchasing forward foreign exchange
contracts or engaging in other similar hedging strategies although to date it
has not done so. The failure by PT-1 to hedge its foreign currency exchange
exposure may result in foreign exchange losses to PT-1 from its non-U.S.
operations. In addition, there can be no assurance that any currency hedging
strategy that PT-1 decides to employ, if any, would be successful in avoiding
currency exchange-related losses.
COST OF SERVICES (EXCLUSIVE OF DEPRECIATION AND AMORTIZATION). Cost of
services (exclusive of depreciation and amortization) primarily includes
payments to other carriers for origination, transport and termination of PT-1's
international and domestic long distance traffic. Historically, origination
costs have consisted largely of payments to other carriers, including LECs and
CLECs, for local access, and transport and termination costs have included
payments to other carriers for completing calls. Most of PT-1's transport costs
are variable payments based upon usage for domestic and international traffic,
and the remainder are fixed cost lease payments for leased lines. As a result,
most of PT-1's transmission cost is variable.
Other components of the cost of services (exclusive of depreciation and
amortization) include the cost of operating PT-1's switches in Jersey City, New
Jersey, Flushing, New York and Miami, Florida, and PT-1's Debit Card Platforms
in Jersey City, New Jersey and Flushing, New York, as well as payments to
InterExchange for operating the Edison Debit Card Platform and PT-1's switch in
Edison, New Jersey. Cost of services (exclusive of depreciation and
amortization) also includes the costs of producing and distributing PT-1's
Prepaid Cards.
SELLING AND MARKETING EXPENSES. Selling and marketing expenses consist
primarily of employee commissions, salaries, freight, advertising and promotion
costs and other expenses associated with the marketing and sale of Prepaid Cards
and other products and services. With the introduction of dial around and
presubscribed long distance services, PT-1 expects selling and marketing
expenses to increase as a percentage of revenues.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
consist primarily of officers' salaries, professional fees, accounting and
office salaries, customer service salaries, depreciation and amortization, an
allowance for doubtful accounts and other corporate overhead costs. PT-1 expects
its expense for uncollectible accounts to increase as a percentage of revenues
as a result of (i) the introduction of dial around and presubscribed long
distance services and other services for which payment is made by its customers
after usage and (ii) PT-1's recent increase in sales of Prepaid Cards to its
distributors on credit. See "Risk Factors--Fraud; Theft of Services;
Uncollectible Accounts."
STOCK BASED COMPENSATION. PT-1 expects to continue to incur an expense for
stock based compensation related to the issuance of certain warrants to
employees of InterExchange and options granted to certain employees. See Note 5
of Notes to Consolidated Financial Statements of PT-1.
TAXES. Since November 1, 1997, PT-1 has been required to collect a three
percent (3%) federal excise tax on sales of Prepaid Cards to its distributors.
The taxation of Prepaid Cards is evolving and is not specifically addressed by
many of the states in which the Company does business. While PT-1 believes that
it has adequately provided for any such taxes it may ultimately be required to
pay, certain states may enact legislation which specifically provides for
taxation of Prepaid Cards or may interpret current laws in a
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manner resulting in additional tax liabilities. See "Risk Factors--Taxation of
Sale and Use of Prepaid Cards."
RESULTS OF OPERATIONS
The following table sets forth certain items in PT-1's statements of
operations as a percentage of total revenues for the periods indicated:
<TABLE>
<CAPTION>
PERIOD FROM SIX MONTHS ENDED
INCEPTION TO YEARS ENDED MARCH
MARCH 31, 31, SEPTEMBER 30,
------------- -------------------- --------------------
1996 1997 1998 1997 1998
------------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Revenues......................................................... 100.0% 100.0% 100.0% 100.0% 100.0%
Operating Expenses:
Cost of services (exclusive of depreciation and
amortization)................................................ 115.8 98.0 91.7 91.3 92.3
Selling and marketing.......................................... 2.7 1.0 1.0 1.0 1.6
General and administrative..................................... 5.9 1.5 2.8 2.2 4.8
Merger costs................................................... -- -- -- -- 0.4
Stock based compensation....................................... -- 4.3 .6 1.0 .1
----- --------- --------- --------- ---------
Total operating expenses..................................... 124.4 104.8 96.1 95.5 99.2
----- --------- --------- --------- ---------
Income(loss) from operations (24.4) (4.8) 3.9 4.5 0.8
Income(loss) before provision
for income taxes............................................... (24.4) (4.8) 3.9 4.6 0.6
Provision for income taxes....................................... -- -- (1.2) (1.1) (0.1)
----- --------- --------- --------- ---------
Net income(loss)................................................. (24.4) (4.8) 2.7 3.5 .5
----- --------- --------- --------- ---------
----- --------- --------- --------- ---------
</TABLE>
SIX MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO SIX MONTHS ENDED SEPTEMBER 30,
1997
REVENUES. Revenues increased 43.7% to $268.9 million in the six months
ended September 30, 1998 from $187.0 million in the comparable period of 1997.
Prepaid Card revenues increased 15.8% to $189.4 million in the 1998 period from
$163.5 million in the prior year period. Prepaid Card terminated minutes
increased 49.4% to 1.03 billion in the six months ended September 30, 1998,
compared to 687 million terminated minutes for the comparable period in 1997.
The increase in Prepaid Card revenues and calling volumes were generated
primarily from (i) increased market acceptance of the PT-1 Prepaid Card, (ii)
the introduction of new Prepaid Cards, (iii) an increase in the number of
distributors, and (iv) recognition of revenues related to the expiration of
Prepaid Cards. Prepaid Card terminated minutes increased at a faster pace than
associated Prepaid Card revenues due to decreases in the rates per minute
charged to consumers for domestic and international long distance calls. As a
result of the foregoing, the PINs activated increased from 28.7 million in the
six months ended September 30, 1997 to 30.7 million in the corresponding period
in 1998.
Wholesale and commercial revenues increased 213.6% for the six months ended
September 30, 1998 to $74 million from $23.6 million in the comparable period of
1997. Wholesale and commercial minutes of use increased 198.0% to 220.0 million
in the six months ended September 30, 1998 as compared to 73.7 million minutes
of use in the comparable period of 1997. This increase reflects growth in the
number of wholesale and commercial customers to 82 as of September 30, 1998, up
from 33 as of September 30, 1997, as well as an increase in usage by existing
customers. The average wholesale and commercial rate per minute increased to
approximately $0.34 for the 1998 six-month period as compared to $0.32 for the
comparable 1997 period, reflecting a larger proportion of traffic being carried
to higher rate per minute routes. PT-1 does not believe that this immaterial
increase in rates period to period is sustainable and
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believes that the growth in wholesale and commercial revenues will be primarily
premised on increased call volume.
Revenues for the six months ended September 30, 1998 also include $5.3
million for dial around services, which commenced in March 1998.
COST OF SERVICES (EXCLUSIVE OF DEPRECIATION AND AMORTIZATION). Cost of
services (exclusive of depreciation and amortization) increased to $248.2
million for the six months ended September 30, 1998 from $170.8 million for the
comparable period of 1997. Cost of services (exclusive of depreciation and
amortization) as a percentage of revenues increased to 92.3% for the 1998 period
compared to 91.3% for the 1997 period, primarily due to the imposition of FCC
charges in 1998 that aggregated $5.85 million for the six months ended September
30, 1998. Decreases in carrier charges for access and termination services
during the six months ended September 30, 1998 helped to mitigate the increase
in cost of services from the prior year period.
SELLING AND MARKETING EXPENSES. Selling and marketing expenses increased
133% to $4.3 million for the six months ended September 30, 1998, from $1.8
million for the comparable period in 1997. Selling and marketing expenses are
principally comprised of commissions, salaries, and advertising and promotion
expenses which accounted for 79.8% of all selling and marketing expenses for the
six months ended September 30, 1998, as compared to 70.9% for the comparable
period of 1997. Increases in commissions, salaries and advertising and promotion
expenses were a result of (i) PT-1's increased sales of Prepaid Cards, (ii) the
opening of additional sales offices, both domestically and internationally,
(iii) the expansion of the wholesale and carrier sales department, (iv)
advertising related to the introduction of PT-1's dial around product, and (v)
advertising campaigns in newly entered markets.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased to $12.8 million for the six months ended September 30, 1998, from
$4.1 million for the comparable period in 1997. General and administrative
expenses as a percentage of revenues increased to 4.8% for the six months ended
September 30, 1998 as compared to 2.2% for the 1997 period, primarily due to
salaries relating to recently hired technology and sales personnel, the
concentration of carrier resale and the expansion of PT-1's network. This
increase was primarily attributable to increases in salaries, bad debts,
professional fees, rent and depreciation and amortization expenses, which
comprised 78.3% of general and administrative expenses for the six month period
in 1998, as compared to 86.4% for the comparable period in 1997. Salaries for
customer service, accounting and network operations increased due to (i) the
additional hiring necessitated by the continued growth in traffic volume, (ii)
the expansion of PT-1's network infrastructure and capacity, (iii) the
introduction of new products and services and (iv) the transfer of all
processing for PT-1's Card traffic from an independent service bureau to an
in-house platform. Rent expense increased principally due to the opening of
additional sales and switch POPs. Professional fees increased to $2.2 million
for the six months ended September 30, 1998, as compared to $.7 million for the
comparable 1997 period. This was primarily due to non-recurring costs associated
with PT-1's initial public offering and the pending Merger, and the retention of
consulting professionals for various projects.
STOCK BASED COMPENSATION. For the six months ended September 30, 1998,
stock based compensation expense decreased to $381,664 from $1,855,525 in the
comparable 1997 period. This was primarily due to an option which was granted
and exercised during the six months ended September 30, 1997, by Mr. Pannullo to
purchase 1,048,600 shares of PT-1 Common Stock for an aggregate exercise price
of $0.015. Additionally, certain on-vesting stock based awards granted to PT-1's
former service bureau, which were recorded in the six months ended September 30,
1997, were cancelled in the 1998 period.
OTHER INCOME (DEDUCTIONS). Interest expense increased to approximately
$794,000 for the six months ended September 30, 1998, as compared to
approximately $402,000 for the same period in 1997. This was attributable to
increased bank borrowings and the receipt of $10 million in borrowings from STAR
under an interest bearing one year promissory note payable.
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DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
increased to $1.7 million for the six months ended September 30, 1998, from
$385,791 for the same period in 1997. Depreciation expense represented $1.03
million for the six months ended September 30, 1998 compared to $312,576 for
1997. Depreciation expense increased primarily as a result of PT-1's expansion
of its network, which includes the purchase of switches, telephony equipment,
IRU capacity and computer equipment. Amortization expense of $679,831 was
recorded for the six months ended September 30, 1998, compared to $73,214 for
the same period in 1997. This was primarily the result of (i) the issuance of
PT-1 Common Stock in November 1997, for the extension of a noncompete agreement,
(ii) additional leasehold improvements to switch sites and sales offices, and
(iii) the purchase of IRU capacity.
FISCAL YEAR ENDED MARCH 31, 1998 COMPARED TO FISCAL YEAR ENDED MARCH 31, 1997
REVENUES. Revenues increased 154% to $431.5 million for the fiscal year
ended March 31, 1998 from $169.6 million for the fiscal year ended March 31,
1997. Revenues from the usage of Prepaid Cards increased to $356.3 million
during the 1998 fiscal year from $162.5 million in the prior period. This
increase in Prepaid Card revenues was generated primarily from (i) increased
market acceptance of the PT-1 Card, (ii) an increase in the number of
distributors, (iii) the introduction of new Prepaid Country Calling Cards and
(iv) higher selling prices of Prepaid Cards. Revenues from services provided to
other telecommunications providers for resale increased to $75.2 million for the
fiscal year ended March 31, 1998 from $7.1 million in the prior period. This
reflects an increase in resale customers from 9 in 1997 to 64 in 1998, primarily
due to the PT-1's ability to offer favorable rates for transmission and
termination services as a result of increased minutes purchased.
COST OF SERVICES (EXCLUSIVE OF DEPRECIATION AND AMORTIZATION). Cost of
services (exclusive of depreciation and amortization) increased to $395.5
million for the fiscal year ended March 31, 1998 from $166.2 million for the
fiscal year ended March 31, 1997. Cost of services (exclusive of depreciation
and amortization) as a percentage of revenues decreased to 91.7% for the 1998
period compared to 98.0% for the 1997 period. This decrease was primarily the
result of (i) improvements in PT-1's ability to use least-cost-routing to reduce
its per minute transmission costs, (ii) rate per minute decreases negotiated
with underlying carriers as a result of PT-1's substantially increased volume of
traffic, (iii) an increased percentage of telecommunications traffic being
transported over PT-1's leased lines and a corresponding reduction in the
percentage of traffic carried and billed by other carriers on a per minute
basis, and (iv) increased efficiencies in PT-1's telecommunications network
attributable to the addition of switches and other equipment. Cost of services
(exclusive of depreciation and amortization) as a percentage of revenues
decreased from 1997 to 1998 despite several regulatory changes in the
telecommunications industry which increased PT-1's costs of services in 1998.
SELLING AND MARKETING EXPENSES. Selling and marketing expenses increased
154% to $4.5 million for the fiscal year ended March 31, 1998 from $1.8 million
for the fiscal year ended March 31, 1997, and as a percentage of revenue
remained a constant 1%. Selling and marketing expenses were principally
comprised of commissions, salaries, advertising and freight which accounted for
83.2% of all selling and marketing expenses for the fiscal year ended March 31,
1998, as compared to 91.6% for the 1997 period. The increases in commissions,
salaries, advertising and freight expenses were directly related to PT-1's
increased sales of Prepaid Cards.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased to $12.1 million for the fiscal year ended March 31, 1998 from $2.6
million for the fiscal year ended March 31, 1997, and increased as a percentage
of total revenues to 2.8% from 1.5%, respectively. This increase was primarily
due to increases in salaries, professional fees, rent and depreciation and
amortization expenses, which comprised 77.7% of general and administrative
expenses for the 1998 period, as compared to 85.0% for the 1997 period. Salaries
for customer service, accounting and network administration increased due to
additional hiring made necessary by the continued increases in traffic volume
and the expansion of PT-1's
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telecommunications network capacity. Rent expense increased due to the
relocation of PT-1's principal executive offices in May 1997 to accommodate the
increased number of employees and the opening of additional sales offices.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
increased to $1,534,500 for the year ended March 31, 1998 from $75,017 for the
year ended March 31, 1997. Depreciation expense represented $908,930 for the
year ended March 31, 1998 compared to $75,017 for the year ended March 31, 1997.
Depreciation expense increased as a result of PT-1's expansion of its network
which includes the purchase of switches, telephony equipment, computer equipment
and leasehold improvements for additional switch sites. Amortization expense of
$625,570 was recorded in the fiscal year ended March 31, 1998 as a result of the
(i) purchase of capitalized software and (ii) issuance of PT-1 Common Stock in
consideration for the extension of a noncompete agreement, respectively.
STOCK BASED COMPENSATION. Stock based compensation during the year ended
March 31, 1998 decreased to $2.7 million from $7.3 million in the year ended
March 31, 1997. Stock based compensation in 1998 reflects PT-1's recording of
the expense related to (i) the issuance on May 9, 1997 to Mr. Joseph Pannullo,
PT-1's Chief Operating Officer, of an option to purchase 1,048,600 shares of
PT-1 Common Stock for an aggregate exercise price of $0.015, (ii) the issuance
on September 30, 1997 to an employee of PT-1 of options to purchase 10,000
shares of PT-1 Common Stock, exercisable at a nominal exercise price, and (iii)
shares of PT-1 Common Stock valued at $850,000 issuable to certain employees of
PT-1 pursuant to certain transactions with Mr. Pannullo. Stock based
compensation for the year ended March 31, 1997 reflects the issuance of shares
on March 27, 1997 to two officers of PT-1 in accordance with commitments made in
July 1995 and March 1996, the dates they joined PT-1. Such shares were issued in
connection with the settlement agreement dated March 27, 1997, described in note
8 to the PT-1 Consolidated Financial Statements included herein, and were valued
as of that date.
INTEREST EXPENSE. Interest expense increased to $1,021,452 for the fiscal
year ended March 31, 1998 from $10,959 for the fiscal year ended March 31, 1997.
The increase was primarily attributable to accrued interest that is payable on a
promissory note to a former officer and founder of PT-1 as part of his
redemption agreement. The balance of interest expense for the fiscal year ended
March 31, 1998 represents amounts paid under bank borrowings which aggregated
$12.76 million in principal at March 31, 1998.
GAINS ON MARKETABLE SECURITIES. During the fiscal year ended March 31,
1998, PT-1 diversified its short-term investments by purchasing various
marketable securities of public corporations. Accordingly, net realized and
unrealized gains and losses are included in the statements of operations.
PROVISION FOR INCOME TAXES. The provision for income taxes for the fiscal
year ended March 31, 1998 was $5.15 million. Based on a net operating loss for
the fiscal year ended March 31, 1997, there was no provision for income taxes in
1997.
FISCAL YEAR ENDED MARCH 31, 1997 COMPARED TO PERIOD FROM APRIL 21, 1995
(INCEPTION) TO MARCH 31, 1996
REVENUES. Revenues increased to $169.6 million for the fiscal year ended
March 31, 1997 from $11.9 million for the period from April 21, 1995 (inception)
to March 31, 1996. Revenues from usage of Prepaid Cards increased to $162.5
million during the 1997 fiscal year from $11.9 million in the prior period. This
increase in Prepaid Card revenues was generated primarily from (i) increased
market acceptance of The PT-1 Card, (ii) an increase in the number of
distributors, (iii) the introduction of new Prepaid Country Calling Cards and
(iv) higher selling prices of Prepaid Cards. Revenues for the 1997 fiscal year
also include $7.1 million from services provided to other telecommunications
providers for resale primarily during the last quarter. PT-1 did not provide
such services during the prior period.
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COST OF SERVICES (EXCLUSIVE OF DEPRECIATION AND AMORTIZATION). Cost of
services (exclusive of depreciation and amortization) increased to $166.2
million for the fiscal year ended March 31, 1997 from $13.8 million for the
period from April 21, 1995 (inception) to March 31, 1996. Cost of services
(exclusive of depreciation and amortization) as a percentage of revenues
decreased to 98.0% for the 1997 fiscal year from 115.8% during the prior period,
primarily as a result of (i) increases in the rates to selected destinations,
(ii) decreases in the switching fees from InterExchange, (iii) price decreases
negotiated with vendors for the printing and packaging of PT-1's products, (iv)
rate per minute decreases negotiated with the underlying carriers as a result of
PT-1's substantially increased volume of traffic and (v) an increasing
percentage of telecommunications traffic being transported over PT-1's leased
lines and a corresponding reduction in the percentage of traffic carried and
billed by other carriers on a per minute basis.
SELLING AND MARKETING EXPENSES. Selling and marketing expenses increased to
$1.8 million for the fiscal year ended March 31, 1997 from $318,000 for the
period from April 21, 1995 (inception) to March 31, 1996. Selling and marketing
expenses were principally comprised of commissions, salaries, freight and
advertising and promotional expenses, which increased in direct relation to the
growth in revenues from 1996 to 1997.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased to $2.6 million for the fiscal year ended March 31, 1997 from $704,000
for the period from April 21, 1995 (inception) to March 31, 1996. This increase
was primarily due to the additional salary expense that was incurred for
employees hired to accommodate PT-1's growth during the 1997 fiscal year.
Depreciation and amortization expense, which is included in general and
administrative expense, increased primarily due to the purchase and expansion of
the Edison, New Jersey switch in July 1996, as well as PT-1's increased capital
expenditures for office equipment as a result of the expansion of its employee
base.
STOCK BASED COMPENSATION. Stock based compensation for the year ended March
31, 1997 was $7.3 million as compared to $0 for the period ended March 31, 1996.
Stock based compensation for the year ended March 31, 1997 reflects the issuance
of shares on March 27, 1997 to two officers of PT-1 in accordance with
commitments made in July 1995 and March 1996, the dates they joined PT-1. Such
shares were issued in connection with the settlement agreement dated March 27,
1997, described in note 8 to the financial statements, and were valued as of
that date.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, PT-1 has funded its operating and capital needs primarily
from cash generated by operations. Net cash provided by operating activities is
primarily due to the receipt of cash from distributors generally upon shipment
of PT-1's Prepaid Cards and prior to utilization of PT-1's services and
incurrence by PT-1 of related costs of services. PT-1 expects its working
capital requirements to increase as a result of its (i) introduction of dial
around and presubscribed long distance services and other services for which
payment is made by its customers after services are rendered, and (ii) the
recent increase in sales of Prepaid Cards to its distributors on credit. PT-1
has not experienced significant credit losses to date on receivables from the
sale of Prepaid Cards.
During the fiscal years ended March 31, 1998, 1997 and 1996, PT-1 generated
$25.7 million, $13.5 million and $765,000 of cash from operating activities,
respectively. During the six month period ended September 30, 1998, operating
activities used $1.7 million in cash as compared to the corresponding period in
1997 which provided $19.3 million. The decrease in cash provided by operations
was primarily the result of the recognition of revenue related to the expiration
of Prepaid Cards resulting in a decrease of deferred revenue of $900,000 in 1998
as compared to an increase of $15 million in the corresponding 1997 period.
PT-1's accounts receivable from Prepaid Card sales have increased from
approximately $7.5 million at March 31, 1997 to approximately $29.8 million at
March 31, 1998 and to approximately $37.4 million at
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September 30, 1998. This increase in accounts receivable results primarily from
an increase in Prepaid Card sales and a change in PT-1's sales terms to certain
of its distributors from payment on delivery of Prepaid Cards to credit terms.
PT-1's accounts receivable from other carriers increased from approximately
$300,000 at March 31, 1997 to approximately $7.5 million at March 31, 1998 and
to approximately $9.5 million at September 30, 1998. This increase was
attributable to the growth in PT-1's wholesale business where revenues are
billed subsequent to their recognition in the financial statements.
PT-1's working capital deficiency at September 30, 1998 and March 31, 1998
and 1997 amounted to $38.5 million, $21.7 million and $17.4 million,
respectively. In each of these periods, working capital deficiency generally
resulted from PT-1's deferral of revenue from card sales prior to use of calling
time by the ultimate card user. Such deferred revenue is recognized as calling
time and is used in accordance with the terms of its Prepaid Cards. PT-1 expects
deferred revenue will continue to increase, particularly if card sales continue
to increase and that the working capital deficit will ultimately decrease over
time although there can be no assurances that this will be the case.
PT-1 used $22.1 million, $11.3 million and $1.5 million for capital
expenditures during the six months ended September 30, 1998 and the fiscal years
ended March 31, 1998 and 1997, respectively. PT-1 also issued a $650,000
non-interest bearing promissory note, due in ten equal monthly installments, as
a portion of the consideration for certain software licensing rights.
Additionally, PT-1 used excess cash to purchase investments in certificates of
deposit of $10.8 million and $2.1 million during the fiscal years ended March
31, 1998 and 1997, respectively. Sale of a portion of these investments resulted
in cash provided of $6.8 million during fiscal year 1998 and $4.9 million during
the six months ended September 30, 1998.
On March 26, 1997, PT-1 redeemed shares of PT-1 Common Stock from Thomas
Hickey, a former executive officer and director of PT-1, for payment of $5.0
million and the issuance of a promissory note in the principal amount of $10.0
million. The note bears interest at a rate of 8.0% per annum, compounded
semi-annually, and is secured by certain of the repurchased shares. PT-1 repaid
$5.0 million of the principal of the note on March 25, 1998, and must repay the
outstanding principal of $5.0 million and all accrued and unpaid interest on or
prior to March 25, 1999.
On October 8, 1997, PT-1 entered into a $5.0 million revolving credit
facility and a $5.0 million letter of credit facility with Chase Manhattan Bank,
N.A. ("Chase"). As of March 31, 1998, $2.76 million was outstanding under the
credit facility, which bears interest at a rate equal to either the London
Interbank Offered Rate plus 2.25%, the prime rate, or a fixed rate to be
determined pursuant to the credit facility. Borrowings under the credit facility
are secured by PT-1's equipment and accounts receivable. PT-1 may borrow up to
75% of the value of eligible equipment and accounts receivable. PT-1 is
currently negotiating with Chase to extend the term of such credit facility
through 1999. PT-1 expects to continue to meet its current and long-term
obligations through the continued provision of cash from operating activities.
In March 1998, PT-1 entered into a capital lease for $10 million of its
telecommunications equipment. Payments, including interest at 8.76%, are due in
monthly installments of $206,420 through April 2003.
On August 17, 1998, PT-1 entered into a $10.0 million loan arrangement with
STAR payable on August 17, 1999. This loan accrues interest monthly at a rate of
6.75%.
CERTAIN CAPITAL TRANSACTIONS
On February 25, 1997, litigation related to disputed ownership interests and
control of PT-1 was commenced by Peter Vita against PT-1, Thomas Hickey, a
former director and executive officer of PT-1, and Mr. Tawfik. On March 20,
1997, a second action was commenced by Douglas Barley asserting similar claims
against the same defendants. Such litigation involved disputed equity issuance
commitments in connection with the initial capitalization of PT-1 and the
employment of certain key executives. On March 27, 1997, a settlement agreement
among the parties was reached which included the dismissal of
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litigation, execution of equity issuance commitments, release of claims, the
resignation of Mr. Hickey as an executive officer and employee of PT-1 and the
redemption of 25,052,632 shares of PT-1 Common Stock for $15 million which was
satisfied by a cash payment of $5 million and the issuance of a note in the
principal amount of $10 million (the "Note"). In connection with the March 27,
1997 settlement agreement, Peter Vita obtained an aggregate of 8.75 million
shares of PT-1 Common Stock (6.5 million shares from PT-1 and 2.25 million
shares from Mr. Hickey), and Mr. Barley obtained an aggregate of 3.5 million
shares of PT-1 Common Stock (2.6 million shares from PT-1 and 900,000 shares
from Mr. Hickey) in return for agreeing to dismiss the litigation and release
the defendants from the claims made. The shares transferred were valued at an
aggregate of $7.3 million, based upon the value of the shares redeemed by PT-1
from Mr. Hickey on such date.
Following PT-1's preparation of a draft registration statement on Form S-1
in connection with an initial public offering of shares of PT-1 Common Stock,
which set forth detailed financial and other information regarding PT-1 since
its inception, Mr. Hickey claimed that he was provided inadequate information in
connection with his entering into the March 27, 1997 agreement. On November 7,
1997, Mr. Hickey entered into additional agreements with PT-1 and certain
executive officers of PT-1 which reaffirmed that the March 27, 1997 settlement
agreement remained in full force and effect, contained a broad release by Mr.
Hickey of any and all potential claims against PT-1 or any stockholders of PT-1,
and contained an express covenant not to bring any further claims regarding such
matters. Mr. Hickey also agreed to an extended noncompetition agreement for
consideration of 483,980 shares of PT-1 Common Stock valued at approximately
$3.4 million.
The Note accrued interest at a rate of 8% per annum. PT-1 paid $5 million of
the Note on March 25, 1998 in accordance with its terms and must repay the
remaining outstanding principal and all accrued interest on or prior to March
25, 1999. PT-1 pledged two-thirds of the shares of PT-1 Common Stock it redeemed
from Mr. Hickey as collateral for the Note.
EFFECTS OF NEWLY-ISSUED ACCOUNTING STANDARDS
In June 1997, the FASB issued SFAS 130 "Reporting Comprehensive Income."
This statement is effective for financial statements issued for periods
beginning after December 15, 1997. Management has not yet evaluated the effect
of its financial reporting from the adoption of this statement but does not
expect the adoption of SFAS 130 to have a material effect on PT-1's financial
position or results of operations.
In June 1997, the FASB issued SFAS 131 "Disclosure about Segments of an
Enterprise and Related Information." SFAS 131 requires the reporting of profit
and loss, specific revenue and expense items and assets for reportable segments.
It also requires the reconciliation of total segment revenues, total segment
profit or loss, total segment assets, and other amounts disclosed for segments,
to the corresponding amounts in the general purpose financial statements. SFAS
131 is in effect for fiscal years beginning after December 15, 1997. PT-1 has
not yet determined what additional disclosures may be required, if any, in
connection with the adoption of SFAS 131.
In June 1998, the FASB issued SFAS 133 "Accounting for Derivative
Instruments and Hedging Activities." SFAS 133 requires companies to recognize
all derivatives as either assets or liabilities in the statement of financial
position and measure these instruments at fair value. SFAS 133 is in effect for
all fiscal quarters of fiscal years beginning after June 15, 1999. PT-1 has not
yet determined what additional disclosures may be required, if any, in
connection with the adoption of SFAS 133.
YEAR 2000 COMPLIANCE
Certain information technology equipment and software employs two-digit date
codes to perform computational and decision making functions. On January 1, 2000
and thereafter, such equipment and
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software may misinterpret "00" as the year 1900 instead of the year 2000, and,
as a result, systems, equipment and software may operate improperly or fail.
PT-1 believes its proprietary internal software is Year 2000 compliant, and
PT-1 believes, based upon representations of manufacturers, that its purchased
information technology ("IT") and non-IT systems are fully Year 2000 compliant.
PT-1 has been advised by the manufacturer of its telecommunications switches
that such switches and embedded software are Year 2000 compliant. PT-1 has begun
a Year 2000 compliance program which is designed to identify, evaluate and
address potential Year 2000 compliance issues with its systems, equipment and
software. The objective of the Year 2000 compliance program is to avoid
interruptions in PT-1's systems and any material adverse effect upon PT-1 which
might result from the foregoing. PT-1 plans to (a) conduct comprehensive tests
of all of its IT and non-IT systems, equipment and software to determine its
Year 2000 compliance status and (b) obtain certification from its systems,
equipment and software vendors as to their Year 2000 compliance by the end of
the first quarter of 1999. Although PT-1 will not be able to determine the total
cost of its Year 2000 compliance program prior to the end of the first quarter
of 1999, PT-1 does not currently expect to incur significant costs in connection
with its Year 2000 compliance program. Any costs incurred in connection with
such program will be expensed as incurred.
After the closing of the Merger, PT-1's Year 2000 compliance program will be
incorporated into the Year 2000 compliance program currently being implemented
by STAR. The joint Year 2000 compliance program is expected to include
contingency plans to handle (a) Year 2000 failures of STAR and PT-1's internal
systems, equipment and software and (b) any necessary interactions with the
computers and technology of any non-complying third party after STAR and PT-1
have adequately evaluated the Year 2000 compliance of these parties.
PT-1 believes that the most reasonably likely worst case scenario resulting
from the century change would be the material disruption of PT-1's operations,
impacting the provision of telecommunications services to customers. While
PT-1's management believes that its efforts to address and connect possible Year
2000 failures will be successful, there can be no assurance in that regard.
While PT-1 has not identified any specific material risks associated with
its Year 2000 compliance status, PT-1's Year 2000 compliance program is not yet
completed. PT-1 may be required to incur unanticipated costs in connection with
its Year 2000 compliance or experience lower than expected revenues or incur
higher than expected costs as a result of third parties' failure to be Year 2000
compliant. Such costs could have a material adverse effect on PT-1's financial
condition and results of operations.
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BUSINESS OF PT-1
OVERVIEW
PT-1 is a provider of international long distance services to retail
customers and telecommunications carriers. PT-1 provides retail
telecommunications services primarily by marketing Prepaid Cards, principally
under the PT-1 brand name, through an extensive network of distributors, who
directly and indirectly sell PT-1's Prepaid Cards to retail outlets throughout
the United States. PT-1 targets retail markets with substantial international
long distance calling requirements, such as ethnic communities, and believes
that its Prepaid Cards provide consumers with a convenient, attractively priced
alternative to traditional presubscribed long distance services. PT-1 sells its
Prepaid Cards exclusively to distributors and it does not maintain any sales or
marketing relationship with the retail outlets that carry PT-1's Prepaid Cards.
During the six months ended September 30, 1998, PT-1's eight largest sources of
revenues were derived from traffic routed to Mexico (12%), the Dominican
Republic (5%), Colombia, Haiti, Jamaica and India (3%), and Nigeria and Yemen,
which individually represented less than 3% of revenues. For the fiscal year
ended March 31, 1998, traffic to Mexico and the Dominican Republic were the
largest sources of revenues, at 14% and 7% of total revenues, respectively.
During March 1998, PT-1 began to market both dial around and presubscribed long
distance services to retail customers in certain target markets that also have
substantial international long distance calling needs. Over the past several
months, PT-1 has also increased the amount of resources devoted to obtaining
commercial retail customers with significant international long distance
requirements. PT-1 has used its significant retail international traffic to
negotiate international termination arrangements with attractive rates, enabling
PT-1 to market its services competitively on a wholesale basis to
telecommunications carriers and develop an efficient telecommunications network.
For the fiscal year ended March 31, 1998, PT-1 generated revenues and net income
of $431.5 million and $11.6 million, respectively.
INDUSTRY
The telecommunications market is typically segmented into the local exchange
market, the domestic long distance market and the international long distance
market. PT-1 operates in the latter two markets in the United States, targeting
retail and wholesale customers with significant volumes of international long
distance usage. For an overview of the international long distance market, see
"Business of STAR-- Industry Background."
PT-1 APPROACH
PT-1 was founded in April 1995 to capitalize on the growing market for
international long distance services. PT-1 initially entered the retail
international long distance market through the distribution of Prepaid Cards
targeted at ethnic communities. After building significant international
traffic, in 1996 PT-1 began to negotiate reduced transmission rates based upon
volume with underlying carriers and began to invest in switching equipment and
lease transmission capacity to further reduce its cost of service as a
percentage of revenues. In August 1996, PT-1 began to leverage its significant
volume of international traffic by selling international long distance services
on a wholesale basis to other carriers. For the fiscal year ended March 31,
1998, revenues from retail sales and from wholesale sales were $356.3 million
and $75.2 million, respectively.
PT-1 believes its competitive strengths are its (i) established Prepaid Card
brand names, (ii) extensive distribution infrastructure, (iii) substantial
experience in identifying, targeting and marketing to communities and markets
with significant international long distance usage and, (iv) efficient
telecommunications network. PT-1 believes that its competitive strengths will
enable it to profitably continue to increase its retail customer bases and its
traffic volume and leverage these increases to negotiate lower
telecommunications costs.
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STRATEGY
PT-1's strategic objective is to expand further its presence in the retail
segment of the commercial long distance market. PT-1's strategy for achieving
this goal has the following key elements:
CONTINUE TO TARGET CONSUMERS WITH SIGNIFICANT INTERNATIONAL LONG DISTANCE
USAGE. PT-1 primarily targets consumers with significant international long
distance usage by delivering reliable international long distance services at
attractive rates. PT-1 believes that the international long distance market
provides an appealing opportunity because of its higher revenues and gross
profits per minute and its higher expected growth rate relative to the domestic
long distance market. PT-1 believes its brand awareness, large number of
international retail customers and its international network traffic and
infrastructure will enable it to continue to successfully market international
long distance service originating in countries in North America, Latin America,
Europe and in other countries to which PT-1's domestic customers direct a
substantial volume of calls.
INCREASE DISTRIBUTION OF PT-1'S PRODUCTS. PT-1 intends to increase its
distribution infrastructure by expanding the number of distributors within
existing geographic markets, entering new geographic markets and by bringing
certain of its distributors in-house. PT-1 initially concentrated its marketing
and distribution efforts in the New York metropolitan area and the northeastern
United States, but has expanded and is continuing to expand its market
penetration in other regions of the United States, Canada and Puerto Rico with
significant ethnic populations.
EXPAND OFFERINGS OF RETAIL PRODUCTS AND SERVICES. PT-1 intends to introduce
new LAC Cards in additional metropolitan areas, offer additional Country Calling
Cards and market other innovative Prepaid Cards, further segmenting the Prepaid
Card market. PT-1 also intends to grow its dial around and pre-subscribed long
distance services. PT-1 believes that its brand awareness, large number of
international retail customers and its ability to provide attractively priced
long distance services will enable it to successfully market convenient,
attractively priced dial around and presubscribed long distance service to new
and existing customers.
EXPAND PT-1'S INTERNATIONAL TELECOMMUNICATIONS NETWORK. After consummation
of the Merger, PT-1 intends to continue to expand the international reach of its
telecommunications network through STAR's network expansion and by co-locating
with STAR's switch facilities. In particular, PT-1 intends to piggyback on
STAR's international network expansion into the U.K., Germany and additional
European cities, including Paris, Vienna and Geneva.
TELECOMMUNICATIONS PRODUCTS AND SERVICES
PT-1 offers high quality retail and wholesale telecommunications services
over its own network and by interconnecting its network with the network of
other carriers.
PREPAID CARDS. PT-1's Prepaid Cards can be used at any touch tone telephone
simply by dialing an access number, followed by a PIN assigned to the card, and
the telephone number the customer wishes to reach. Prior to the connection, the
caller is informed of the remaining dollar balance and number of minutes
available. PT-1's Prepaid Cards are designed to appeal to a variety of market
segments in the U.S. that generate high levels of international and domestic
traffic. In March 1998, PT-1 began offering dial around long distance services
targeting its current customer base which has significant international long
distance calling requirements. This method of long distance calling is referred
to as "dial around" because customers are not required to change their
presubscribed long distance carrier to use the service. Rather the customer must
enter a seven digit carrier identification code ("CIC Code") prior to dialing
the long distance number in order to access PT-1's network. PT-1's CIC Code is
1016868.
PT-1 has billing and collection arrangements with local exchange carriers
under which PT-1's dial around customers are billed for PT-1's services as part
of their monthly phone bills. In March 1998, PT-1 also introduced presubscribed
long distance services targeted to ethnic communities, other consumers and
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commercial accounts. With this service, a customer's telephone is automatically
connected to PT-1's network, and all of the customer's long distance calls are
made over PT-1's network.
PT-1'S PREPAID CARDS INCLUDE THE FOLLOWING:
The PT-1 Card (introduced in July 1995) was PT-1's first Prepaid Card and
offers competitively priced domestic and international long distance calling.
Customers using the PT-1 Card access PT-1's network by dialing a toll-free
number.
Local Area Calling Cards ("LAC Cards") are targeted at customers in specific
regions and enable them to access PT-1's network by dialing either a local
number or a toll-free number depending upon the region. PT-1 currently markets
The New York Phone Card (introduced in July 1996), The New Jersey Card
(introduced in February 1997), The Detroit Card (introduced in July 1997), The
Connecticut Card (introduced in September 1997), The Boston Card, The Chicago
Card, The D.C.-Maryland-Virginia Card and The Florida Card (all introduced in
November 1997), The California Card (introduced in May 1998), The Diamond Direct
Card and The Payless Direct Card (both introduced in June 1998), The Georgia
Card and The Texas Card (introduced in August 1998) and The Pennsylvania Card
(introduced in September 1998). PT-1 expects to offer additional LAC Cards in
other target metropolitan markets where PT-1 believes that there is sufficient
demand during 1998.
Country Calling Cards are designed for specific ethnic communities and offer
attractive rates to the countries to which they generate high levels of
international traffic. PT-1 currently markets the Alo Brasil, Hola Mexico, Hola
Dominican Republic and Hola Colombia cards that offer competitive rates to
Brazil, Mexico, the Dominican Republic and Colombia, and are targeted to
Mexican, Brazilian, Dominican Republic and Colombian calling communities in the
U.S. and intends to introduce additional Country Calling Cards that will appeal
to other market segments.
Co-Branded Cards are used by major corporations for national marketing
programs and promotional gifts. Co-Branded Cards are designed and packaged using
logos, trademarks and other design elements linking the benefits of the cards to
the corporation's product and services. PT-1 currently offers an Amoco Prepaid
Card pursuant to an agreement with Amoco Oil Company, a Ramada Express Hotel and
Casino Prepaid Card and a Playboy Prepaid Card and expects to offer additional
cards.
The World Card (introduced in September 1996), which offers both a different
commission structure to PT-1's distributors and different rates, is designed to
appeal to a variety of market segments.
INTERNATIONAL ORIGINATION. PT-1 intends to capitalize on its brand
awareness in certain ethnic communities in the United States by offering
international long distance services, through the sale of Prepaid Cards, to
consumers located in the U.K., Canada and other countries to which PT-1's U.S.
customers direct a substantial number of calls.
In addition, PT-1 intends to offer additional retail services in 1998 to
increase customer retention and loyalty, broaden distribution channels, appeal
to new customer groups and increase usage of PT-1's services by its existing
customers.
There can be no assurance that PT-1 will be able to introduce such services
or that, if introduced, such services will be successful.
THE TELECOMMUNICATIONS NETWORK
OVERVIEW
PT-1 currently manages its own telecommunications network and also utilizes
the transmission capacity of more than 40 different local and long distance
carriers.
NETWORK AND OPERATIONS
SWITCHING FACILITIES. PT-1 manages a state-of-the-art digital switch based
network consisting of more than 130,000 switch ports, approximately 50,000
Prepaid Card processing ports, and a central switching
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center located at PT-1's headquarters in Flushing, New York. PT-1 has selected
Northern Telecom ("Nortel") as its primary switch vendor and has entered into a
support agreement with Nortel to provide 24 hours per day, 365 days per year
support services to PT-1, including technical assistance, trouble resolution and
network maintenance. PT-1 currently has Nortel DMS250 Supernode switches
installed at its corporate headquarters in Flushing, New York, in Jersey City,
New Jersey and in Miami, Florida.
POINTS OF PRESENCE. As of June 30, 1998 PT-1 had network POPs in
approximately 100 cities in more than 25 states. In areas where PT-1 has network
POPs, calls are transported to PT-1's network POPs by local exchange carriers or
CLECs and then transported from the network POPs to PT-1's switches over leased
transmission lines. PT-1 intends to double the number of network POPs by the end
of 1998.
TELECOMMUNICATIONS NETWORK MANAGEMENT AND INFORMATION SYSTEMS. PT-1's
network management and information systems enable it to (i) economically and
efficiently route traffic over PT-1's network and the networks of other
carriers, (ii) offer reliable services with high call completion rates and voice
quality and (iii) focus its marketing efforts. PT-1 believes that these systems,
particularly their ability to provide high quality service to international
destinations, provide it with a competitive advantage relative to many other
providers of telecommunication services. PT-1 monitors its network and initiates
changes to its overall switch network and traffic routing where appropriate to
optimize routing and minimize costs. Because a substantial portion of the
traffic carried by PT-1 terminates overseas and call completions vary by
carrier, PT-1 closely monitors the call completion efficiencies of its
suppliers. PT-1 tracks call completions to all destinations for all carriers on
an hourly basis and re-routes its traffic accordingly. PT-1 intends to configure
large portions of its network with Common Channel Signaling System 7 (SS7). This
network protocol reduces call setup and connect time delays and provides
additional technical capabilities and efficiencies for call routing and network
engineering. With the installation of the switch in Jersey City, New Jersey,
PT-1 has duplicated the functional network management capabilities in this
alternate site in accordance with its ongoing review of site diversity and
disaster recovery procedures. See "--Information Systems; Debit Card Platforms."
INFORMATION SYSTEMS; DEBIT CARD PLATFORMS
PT-1 markets a wide variety of Prepaid Cards, each with a specific rate
table (updated periodically). In addition, each Prepaid Card distributed by PT-1
is assigned a unique PIN and a face value ranging from $5 to $100. The Prepaid
Card's dollar balance is reduced by the cost of each call, which is based upon a
number of factors, including the type of Prepaid Card, destination and special
promotions then in effect. The cost of each call is decremented by one of PT-1's
Debit Card Platforms at the time of the call.
The ability to maintain accurate Prepaid Card dollar balances and to
decrement these balances at the proper rates is essential to PT-1's continued
success. Accordingly, PT-1 has invested significant resources in the
acquisition, development and maintenance of its Debit Card Platforms and
information systems and software. PT-1's information systems enable it to track
real-time customer usage and to quickly generate cost and profit reports (by
route). The information systems also produce more than 100 daily reports
concerning network routing, call completion rates and usage for the preceding
day, as well as a variety of weekly and monthly reports. PT-1's Prepaid Card
systems are supported by redundant systems and databases. Critical Prepaid Card
information is backed up, depending on the sensitivity of the information, on a
daily, weekly or monthly basis.
MARKETING AND DISTRIBUTION
Since inception, PT-1 has focused on building a substantial network of
wholesale distributors located primarily in the Northeast. These distributors
then sell PT-1's Prepaid Cards to sub-distributors and directly to retail
outlets including convenience stores, grocery stores, gas stations, supermarkets
and news stands. Approximately 25% of PT-1's distributors are located in the
State of New York and the remainder are located in 35 other states. The
sub-distributors generally sell only to retail outlets. For the year ended March
31, 1998, sales of Prepaid Card to two distributors, Worldwide Telecom, Inc. and
Diamond Phone
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Card, represented approximately 18% and 16% of net Prepaid Card sales,
respectively. At September 30, 1998, Worldwide Telecom, Inc. represented
approximately 28% of the net accounts receivable balance. See "Risk
Factors--Fraud; Theft of Services; Uncollectible Accounts."
PT-1 believes that a majority of Prepaid Cards directly sold to its
distributors are resold to sub-distributors (sometimes called route salespeople)
who resell the cards to retail outlets. The remainder of the cards are resold by
distributors directly to retail outlets. PT-1 has approximately 200
distributors, of which approximately 20% are individuals. The majority of PT-1's
distributors are corporations or other business entities. A majority of
distributors sell only PT-1 Prepaid Cards, though many others carry Prepaid
Cards offered by competitive telecommunications carriers. Most distributors work
from an office. PT-1 believes that while certain distributors have formal
arrangements for the supply of Prepaid Cards to retail outlets, the majority of
distribution arrangements are unwritten, informal agreements based upon
historical relationships.
PT-1's relationships with its distributors are also based upon past
relationships and buying patterns rather than formalized written agreements.
Additionally, PT-1 believes that the distributor relationships between PT-1 and
its distributors and among PT-1's distributors and their subdistributors, route
salespeople and retail outlet customers are based on past relationships and
buying patterns and do not rely on written contracts. Thus, as a matter of
practice, formal written agreements are virtually non-existent in the PT-1
Prepaid Card chain of supply. PT-1 typically sells the Prepaid Cards to its
distributors at a prearranged discount of the card's face value. PT-1 believes
that distributors then resell the cards at a discount that is less than the
discount applied to their purchase of the cards from PT-1, thereby generating a
profit. In certain cases, to incentivize distributors, PT-1 will provide
additional discounts and/or rebates to distributors purchasing a set dollar
amount of cards.
Distributors are typically identified and recruited through relationships
with existing distributors and retail outlets, telemarketing and related
promotional activities and direct inquiries from potential distributors. PT-1
competes with other Prepaid Card providers for sales to Prepaid Card
distributors. PT-1 believes that its ability to maintain and grow its
relationships with distributors depends primarily upon continuing to offer
Prepaid Cards that are attractive to end users.
PT-1 has targeted heavily populated metropolitan areas, with an emphasis on
areas with substantial ethnic community populations which generate significant
international calling volume, in the development and expansion of its
distribution network. Many of PT-1's distributors are members of such ethnic
communities or otherwise have personal or business relationships in such
communities. In developing relationships with distributors, PT-1 also focuses on
expansion into new geographic and metropolitan areas, again with an emphasis on
those areas with substantial ethnic community populations. PT-1 believes that
the success of its Prepaid Cards has created significant brand loyalty and
encourages distributors and retail outlets to actively market PT-1's products.
PT-1 regularly provides distributors and retail outlets with point-of-purchase
advertising and explanatory materials including posters of various sizes
presenting certain of PT-1's current rates, and detailed rate sheets. PT-1
frequently adds new Prepaid Card products to its service offerings, and adjusts
its pricing for particular traffic segments in order to target certain customer
groups, respond to competitive pressures and otherwise increase market share.
PT-1 has two unrelated exclusive sales distribution centers, which are
distribution sites owned and operated by independent distributors that sell only
PT-1 Prepaid Cards. In return for selling PT-1 Prepaid Cards exclusively, these
distributors are given certain rights to use the PT-1 name for promotional
purposes. In general, other distributors may advertise that they are independent
distributors of PT-1 products but otherwise may not use the PT-1 name.
Approximately 10.1% of PT-1's sales of Prepaid Cards for the quarter ended
September 30, 1998 were made to these unrelated exclusive sales distribution
centers. Because of the exclusivity of these arrangements, PT-1 typically is
more willing to extend credit terms to the distributors operating such sales
distribution centers than to other distributors. PT-1's arrangement with each of
these two unrelated distribution centers is based upon past relationships rather
than formalized written agreements. As such, PT-1 has no written agreements with
either party.
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PT-1 has recently expanded its internal sales department to focus on larger
retail chains and department stores, the tourist industry, airport and hotel
gift shops, gas stations and other retail outlets owned or franchised by larger
companies.
CUSTOMER SERVICE
PT-1 believes that effective and convenient multilingual customer service is
essential to attracting and retaining customers. Because a substantial portion
of PT-1's existing and future customers are foreign-born, PT-1 believes that it
is critical to provide customer service on a multilingual basis. PT-1's customer
service center handles an average of 6,000 to 7,000 customer inquiries per day,
including inquiries relating to Prepaid Card balances, Prepaid Card
availability, rates, international calling service, billing and becoming a
distributor. PT-1 currently employs 50 full-time customer service
representatives ("CSRs"), eight senior CSRs, a manager and a director of
customer service. All CSRs are fluent in both English and Spanish, and some are
fluent in Portuguese. PT-1's customer service center is operational ten hours
per day, six days per week. PT-1 intends to expand the customer service center
and its hours of operation during the next twelve months. Calls coming into
PT-1's customer service center are categorized by Prepaid Card product. PT-1's
internal software system provides real-time access to on-screen call records,
complete with historical detail, to track, resolve, protect and support the
individual needs of PT-1's entire customer base.
PREPAID CARD PRODUCTION AND INVENTORY CONTROL
PT-1 controls its Prepaid Card inventory by PIN and by physical count.
Generally, Prepaid Cards are received by, stored at and shipped from the
warehouse facility located at PT-1's headquarters. Physical inventory is counted
on a daily basis and reconciled against all incoming card deliveries and
outgoing shipments to distributors. PT-1 utilizes multiple print vendors for
card production and packaging.
All PINs are inactive when the Prepaid Cards arrive at PT-1's storage
facilities. Calls cannot be completed until PINs are activated by PT-1. PINs are
activated only shortly before the cards are shipped from PT-1's warehouses to
distributors, in order to minimize the number of cards with activated PINs in
its warehouse.
PINs are created electronically with unique inventory and batch codes. PT-1
has developed PIN generation and database management software enabling the Debit
Card Platforms to quickly locate Prepaid Card information while limiting fraud
and other forms of unauthorized access. In addition, if security or financial
controls have been compromised, PT-1 also maintains the ability to deactivate
specified PINs and block calls from specified telephone numbers.
COMPETITION
The telecommunications services industry is intensely competitive. PT-1
competes with other providers of Prepaid Cards and with providers of
telecommunications services in general. Many of the largest telecommunications
providers currently offer Prepaid Cards, in addition to the other
telecommunications services PT-1 intends to provide in the future. As a service
provider in the long distance telecommunications industry, PT-1 competes with
three dominant providers, AT&T, MCI WorldCom and Sprint, all of which are
substantially larger and have greater financial, technical, engineering,
personnel and marketing resources, longer operating histories, greater name
recognition and larger customer bases than PT-1. PT-1 also competes with
smaller, emerging carriers in both the Prepaid Card retail market and in the
wholesale market, including IDT Corporation, RSL Communications, SmarTalk
Teleservices, Inc., Pacific Gateway Exchange, Inc., FaciliCom International,
Inc. and Telegroup, Inc. To the extent PT-1 begins providing services to
customers outside the U.S. market, it may compete with the large operators such
as BT in the U.K. PT-1 believes that its success will attract additional
competitors to the Prepaid Card market. However, PT-1 believes it has certain
advantages that may discourage potential competitors from entering the Prepaid
Card market, including brand loyalty, its established distribution network, its
ability to offer
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competitive rates and its Debit Card Platforms and associated hardware and
software. See "Risk Factors-- Significant Competition."
The telecommunications industry is rapidly evolving and subject to constant
technological change. PT-1 believes that existing competitors are likely to
continue to expand their service offerings and to develop new sales channels.
The ability of PT-1 to compete effectively in the telecommunications services
industry will depend in part upon PT-1's continued ability to develop additional
products appealing to increasingly specialized segments of the market for
telecommunications service.
Recent changes in the regulation of the telecommunications industry may
affect PT-1's competitive position. The Communications Act is expected to open
the long distance market to competition from the RBOCs. The entry of these
well-capitalized and well-known entities into the long distance market likely
will increase competition for long distance customers, including customers who
use Prepaid Cards to make long distance calls. The Communications Act also
grants the FCC the authority to deregulate other aspects of the
telecommunications industry, which in the future may, if authorized by the FCC,
facilitate the offering of telecommunications services by regulated entities,
including the RBOCs, in competition with PT-1. See "Risk Factors--Potential
Adverse Effects of Government Regulation" and "--Government Regulation."
GOVERNMENT REGULATION
PT-1's business operations are subject to extensive U.S. federal and state
regulation. The Communications Act and FCC regulations apply to interstate
telecommunications and international telecommunications that originate or
terminate in the United States. State regulatory authorities have jurisdiction
over telecommunications that originate and terminate within the state. In its
provision of services in the U.K., PT-1 is subject to the regulations of Oftel,
the telecommunications regulator in the U.K. See "Risk Factors--Potential
Adverse Effects of Government Regulation."
FEDERAL
The Communications Act bars the 50 states from restricting competition for
local exchange services, and establishes a framework for additional competition
in the long distance market by the RBOCs. The Communications Act also grants the
FCC the authority to deregulate other aspects of the telecommunications industry
and to implement certain policy objectives, including access charge reform and
establishment of the Universal Service Fund. Pursuant to an FCC order, the
Universal Service Order, Universal Service Fund contributions are generally
equal to approximately 4% of a carrier's interstate and international and
approximately 1% of its intra-state "end user" gross revenues, effective January
1, 1998. However, the FCC will adjust the amount of these contributions each
calendar quarter, and they may increase significantly in future periods.
The FCC requires international carriers to obtain authorization under
Section 214 of the Communications Act prior to acquiring international
facilities by purchase or lease, or providing international service to the
public. Prior FCC approval is also required to transfer control of a
certificated carrier. PT-1 is also subject to FCC policies and rules that
regulate the manner in which international telecommunication services may be
provided, including, for instance, the circumstances under which a carrier may
provide international switched services using IPL facilities and under which it
may route traffic through third countries to or from its final destination.
The Communications Act and the FCC's rules and policies also impose certain
other obligations on carriers providing interstate and international
telecommunication services. These include the obligation to file at the FCC and
to maintain tariffs containing the rates, terms, and conditions applicable to
their services; to file certain reports regarding international traffic and
facilities; to file certain contracts with correspondent carriers; to disclose
affiliations with foreign carriers and significant foreign ownership interests;
to pay certain regulatory fees based, among other things, upon the carrier's
revenues.
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PT-1 holds both facilities-based and resale international authorizations,
including a perpetual "global" authorization that provides broad authority to
offer switched and private line international services. PT-1 has filed tariffs
for its interstate and international services with the FCC.
Interstate carriers are also subject to a variety of miscellaneous
regulations that, for instance, govern the documentation and verifications
necessary to change a consumer's long distance carriers, and limit the use of
toll-free numbers for pay-per-call services.
STATE
PT-1's intrastate services are subject to various state laws and
regulations, including prior certification, notification and registration
requirements. In certain states, prior regulatory approval may be required for
changes in control of telecommunications operations. Most states require PT-1 to
apply for certification to provide telecommunications services, or at least to
register, before commencing intrastate service. In most of the states where
certification or registration is required, PT-1 must file and maintain detailed
tariffs listing rates for intrastate service. Many states also impose various
reporting requirements and/or require prior approval for transfers of control of
certified carriers and assignments of carrier assets, including customer bases,
carrier stock offerings and incurrence by carriers of significant debt
obligations. Certificates of authority can generally be conditioned, modified,
canceled, terminated or revoked by state regulatory authorities for failure to
comply with state law and/or the rules, regulations and policies of the state
regulatory authorities. Fines and other penalties, including revocation, may be
imposed for such violations. In addition, states may establish their own
intrastate universal service funding programs, to which PT-1 may in some cases
be required to contribute.
PT-1 has made and is continuing to make the filings and taken the actions it
believes are necessary to become certified or tariffed to provide intrastate
telecommunications services. PT-1 is certified to do business as a domestic or
foreign corporation in all 50 states and in Puerto Rico and provides intrastate
telecommunications services in 25 states. PT-1 expects to obtain intrastate
telecommunications authority as necessary in the remaining states in which it
intends to sell its Prepaid Cards to its distributors. See "Risk
Factors--Potential Adverse Effects of Government Regulation."
UNITED KINGDOM
In the U.K., telecommunications services offered by PT-1 are subject to
regulation by various U.K. regulatory agencies. The U.K. generally permits
competition in all sectors of the telecommunications market, subject to
licensing requirements and license conditions. PT-1 currently has an ISVR
license (which is valid through December 2002) and an IFL license (which is
perpetual), which permits PT-1 to directly own interests in undersea cables
landing in the U.K. as well as other telecommunication facilities and to
originate end-user long distance traffic in the U.K.
The loss of PT-1's U.K. licenses, or the placement of significant
restrictions thereon, could have a material adverse effect on the business,
financial condition or results of operations of PT-1. See "Risk
Factors--Potential Adverse Effects of Government Regulation."
CANADA
In Canada, PT-1 is registered with the Canadian Radio-television and
Telecommunications Commission ("CRTC") as a reseller. Under this registration,
PT-1 may resell switched services or private lines to provide Canada-Canada,
Canada-U.S., or Canada-overseas telecommunications services. In its provision of
services in Canada, PT-1 is subject to the Canadian Telecommunications Act of
1991 (the "Canadian Act") and, to a limited degree, to the rules and policies of
the CRTC. CRTC policy currently prohibits PT-1 from routing Canada-Canada,
Canada-overseas, or overseas-Canada traffic through the United States, although
said policy is expected to be repealed by the end of 1998. In addition, although
the Canadian Act currently prohibits the CRTC from imposing licensing
requirements or imposing other significant regulations on resellers such as
PT-1, legislation pending in the Canadian Parliament, if enacted, would allow
the CRTC to require resellers such as PT-1 to obtain a license and to abide by
certain requirements.
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TRADEMARKS AND SERVICE MARKS
PT-1 uses the names "PT-1 Communications" and "PT-1" as its primary business
names and has filed for federal trademark protection of these service marks. In
addition, filings have been made at the U.S. Patent and Trademark Office to
register the distinctive PT-1 logo, as well as over 30 names which PT-1 uses or
intends to use to identify its Prepaid Cards. These filings are all pending and
PT-1 has no assurance that they will be granted. PT-1 regards its trademarks,
service marks and trade names as valuable assets and believes they have value in
the marketing of its products and services. See "Risk Factors--Limited
Protection of PT-1's Proprietary Rights; Risks of Infringement."
EMPLOYEES
As of September 30, 1998, PT-1 had 279 full-time employees. None of PT-1's
employees are members of a labor union or are covered by a collective bargaining
agreement. Management believes that PT-1's relationship with its employees is
good.
PROPERTIES
PT-1 leases certain office space under operating leases and subleases,
including PT-1's principal headquarters in Flushing, New York. The principal
offices, warehouses, sales offices and switch sites currently leased or
subleased by PT-1 are as follows:
<TABLE>
<CAPTION>
SQUARE
LOCATION FOOTAGE LEASE EXPIRATION
- ---------------------------------------------------------------- --------- ------------------
<S> <C> <C>
Flushing, New York (headquarters and warehouse)................. 34,800 March 2002
Miami, Florida.................................................. 10,400 March 2008
Jersey City, New Jersey......................................... 5,600 January 2008
Houston, Texas.................................................. 4,000 August 2000
Seattle, Washington............................................. 3,148 November 2000
Toronto, Canada................................................. 2,750 March 2000
Staten Island, New York......................................... 2,700 October 2001
New York, New York.............................................. 2,627 June 1999
West New York, New Jersey....................................... 2,000 June 2003
Cleveland, Ohio................................................. 1,500 June 2000
Columbus, Ohio.................................................. 1,200 June 2000
Rio Pedras, Puerto Rico......................................... 1,200 June 2000
</TABLE>
LEGAL PROCEEDINGS
In July 1997, PT-1 was notified by the FTC and the NYAG that it was the
subject of an investigation alleging deceptive advertising practices in
connection with the sale of its Prepaid Cards. The FTC alleged that PT-1's point
of sale posters for its Prepaid Cards, which did disclose the existence of
additional first minute connection charges for certain calls, did not
sufficiently disclose the specific amount of connection charges for such calls.
PT-1 modified these point of sale materials more than one year ago, and all
point of sale materials now routinely set forth the exact amount of all call
connection charges. Subsequently, the FTC and the NYAG indicated that they were
also reviewing whether PT-1 properly decremented minutes from its Prepaid Cards.
PT-1 has been informed that the NYAG has ended its investigation without taking
any action. The FTC has also completed its investigation and has determined not
to take any formal action regarding PT-1's Prepaid Card decrementation
practices. With regard to prior advertising of Prepaid Cards by PT-1, PT-1 and
representatives of the FTC have entered into an agreement in principle, which is
subject to final approval by the FTC, pursuant to which, in complete resolution
of all allegations regarding allegedly deceptive advertising; (1) PT-1 will pay
to the FTC the sum of $300,000; (2) PT-1 does not admit any of the allegations;
and (3) on a going forward basis, PT-1 has agreed to comply with certain
standards regarding advertising (which are consistent with PT-1's current
advertising practices) and certain record keeping requirements. The agreement
with the FTC was entered into on July 17, 1998 but remains subject
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to full FTC approval. PT-1 expects such approval of the settlement agreement
within the next thirty (30) days.
PT-1 is not aware of any pending legal proceedings against PT-1 which,
individually or in the aggregate, PT-1 would expect to have a material adverse
effect on its business, financial condition or operating results. PT-1 is, from
time to time, involved in various regulatory proceedings before various public
utilities commissions, as well as before the FCC. See "Risk Factors--Potential
Adverse Effects of Government Regulation."
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF UDN
RESULTS OF OPERATIONS
The following table sets forth certain selected items in UDN's statements of
operations as a percentage of total revenues for the periods indicated:
<TABLE>
<CAPTION>
NINE MONTHS
EIGHT MONTHS EIGHT MONTHS ENDED
ENDED ENDED SEPTEMBER
YEARS ENDED APRIL 30, APRIL 30, DECEMBER 31, 30,
--------------------------- ------------- ------------- ------------
1995 1996 1997 1997 1997 1997 1998
------- ------- ------- ------------- ------------- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues................................ 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Operating expenses:
Costs of services..................... 82.0 75.1 76.9 76.0 80.1 76.3 78.2
Selling, general and administrative
expenses............................ 83.0 33.3 21.5 23.4 29.3 24.3 23.9
Provision for doubtful accounts....... 3.2 2.9 2.8 3.6 14.9 4.1 3.0
Depreciation and amortization
expense............................. 11.7 7.3 3.8 3.7 3.3 3.3 3.5
------- ------- ------- ----- ----- ----- -----
Total operating expenses.............. 179.9 118.6 105.0 106.7 127.6 108.0 108.6
------- ------- ------- ----- ----- ----- -----
Loss from operations before other
expenses.............................. (79.9) (18.6) (5.0) (6.7) (27.6) (8.0) (8.6)
Other income (expense):
Other gains and losses................ (5.1) (0.8) -- -- -- 0.3 (1.3)
Interest expense, net................. (3.6) (1.3) (2.6) (2.7) (2.9) (3.0) (3.0)
------- ------- ------- ----- ----- ----- -----
Total other income (expense).......... (8.7) (2.1) (2.6) (2.7) (2.9) (3.0) (4.3)
------- ------- ------- ----- ----- ----- -----
Loss before income tax benefit and
extraordinary gain.................... (88.6) (20.7) (7.6) (9.4) (30.5) (11.0) (12.9)
Income tax benefit...................... -- -- 0.2 0.2 -- 0.1 --
------- ------- ------- ----- ----- ----- -----
Loss before extraordinary gain.......... (88.6) (20.7) (7.4) (9.2) (30.5) (10.9) (12.9)
Extraordinary gain on debt
restructuring......................... -- -- 0.4 0.6 -- 0.2 --
------- ------- ------- ----- ----- ----- -----
Net loss................................ (88.6)% (20.7)% (7.0)% (8.6)% (30.5)% (10.7)% (12.9)%
------- ------- ------- ----- ----- ----- -----
------- ------- ------- ----- ----- ----- -----
</TABLE>
NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
REVENUES. In the nine months ended September 30, 1998, revenues increased
7% to $23.8 million as compared to $22.2 million in the nine months ended
September 30, 1997. A new international calling program that began in October
1997 produced $3.8 million of new revenue and growth in agent/affinity revenue
produced $3.0 million in new revenue. Offsetting that growth was a decline in
UDN's switchless resale base of $4.2 million caused primarily by the loss of
several major customers and a higher than normal attrition rate, and a decline
of $0.6 million in prepaid calling card revenue caused by less traffic received
from a large multilevel marketing customer. Since the Merger Agreement was
signed in November 1997, UDN has not entered into any new buying arrangements.
Particularly in the switchless resale market, UDN has struggled to provide
competitive, profitable rates, has lost several major customers and has
experienced a higher rate of attrition due to UDN's continuing to operate under
old buying arrangements. On September 21, 1998, UDN entered into a Management
Agreement with STAR, which, among other things, gives UDN access to STAR's more
competitive buying arrangements. Following completion of the Merger, UDN
believes that it will be able to halt the attrition in the switchless resale
base and be able to once again start growing that portion of UDN's revenue base,
though there can be no assurance in that regard.
COSTS OF SERVICES (EXCLUSIVE OF DEPRECIATION AND AMORTIZATION). UDN has
historically reported losses and losses of $3.1 million and $2.4 million were
realized for the respective nine-month periods ended September 30, 1998 and
1997. As detailed below, increases in general and administrative expenses,
interest expenses and other expenses contributed to this loss. In addition, an
increase in costs of services (exclusive
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of depreciation and amortization) as a percentage of revenue also contributed to
the losses. In the nine months ended September 30, 1998 and September 30, 1997,
respectively, costs of services (exclusive of depreciation and amortization) and
as a percentage of revenue were $18.6 million (78.2%) and $17.0 million (76.3%).
The increase in costs of services (exclusive of depreciation and amortization)
in the nine months ended September 30, 1998 was caused by two main factors.
First, international calling revenue has higher costs than UDN's other revenue
sources and international revenues have increased as a percentage of UDN's total
revenues. Second, as mentioned above, UDN has been operating since November 1997
with old buying arrangements. As UDN continues to meet the competitive pricing
in the marketplace where required, existing customers' rates are lowered and the
rates at which new customers are being sold continue to decrease. With no
corresponding significant decrease in cost during the nine months ended
September 30, 1998, costs of services (exclusive of depreciation and
amortization) continued to increase. The signing of the Management Agreement
with STAR in September 1998 should begin to favorably impact the costs of
services (exclusive of depreciation and amortization) in the fourth quarter of
1998.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses ("SG&A expenses") were $5.7 million or 23.9% of revenue
for the nine months ended September 30, 1998, as compared to $5.4 million or
24.3% of revenue for the nine months ended September 30, 1997. The increase in
total SG&A expenses during the most recent nine-month period was caused by
several factors. UDN is incurring costs related to transitioning to new billing
and order-entry systems. UDN outgrew its existing systems, and temporarily added
significant new staff to manually process the order-entry flow. Also, resources
are being expended in order to consolidate the separate billing processes.
Furthermore, significant growth in UDN's agent/affinity revenue has caused a
corresponding increase in monthly commission expenses. Finally, UDN is incurring
certain expenses related to maintaining personnel through both the completion of
the Merger and through the billing and order entry systems conversion. As a part
of the Merger Agreement, UDN is in the process of converting to STAR's billing
and order-entry systems. Billing on the new system began in October 1998 and
should result in a further reduction in billing and order-entry expenses.
INTEREST. Net interest expense grew from $680,000 in the nine months ended
September 30, 1997 to $718,000 in the nine months ended September 30, 1998. The
primary factor contributing to this increase is interest on the $2.5 million
owed to STAR under a promissory note dated November 19, 1997, and interest on
the $2.0 million promissory note dated February 2, 1998, also to STAR. UDN
accrued $281,000 in interest payable to STAR in the nine months ended September
30, 1998. Positively impacting interest expense was a decrease in notes payable
and other interest bearing long-term obligations which came due during the last
twelve months and were paid in part with funds received from the STAR loans.
DEPRECIATION. Depreciation and amortization expenses for the nine months
ended September 30, 1998 and 1997 were $836,000 and $720,000, respectively. This
increase was caused by the additional depreciation of approximately $600,000 in
new property, equipment and other items that were added during 1997 and in the
first nine months of 1998.
OTHER INCOME (EXPENSE). Other expenses of $299,000 were incurred in the
nine months ended September 30, 1998. These expenses result from legal and audit
requirements related to the Merger Agreement.
EIGHT MONTHS ENDED DECEMBER 31, 1997 AND EIGHT MONTHS ENDED APRIL 30, 1997
REVENUES. UDN's revenues increased 23.4% to $21.1 million for the eight
months ended December 31, 1997 as compared to $17.1 million for the eight months
ended April 30, 1997. The acquisition of CTN on January 1, 1997 constituted $1.7
million of this increase as CTN revenues were present only in the last four
months of the eight month period ended April 30, 1997 and were present for all
of the eight month period ended December 31, 1997. Growth in agent/affinity
revenues accounted for an additional
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$1.1 million of new revenues, while a new international calling program that
began in October 1997 produced $0.4 million in increased revenues.
COSTS OF SERVICES (EXCLUSIVE OF DEPRECIATION AND AMORTIZATION). In the
eight month periods ended December 31, 1997 and April 30, 1997, cost of services
(exclusive of depreciation and amortization) were $16.9 million (80.1% of
revenues) and $13.0 million (76% of revenues), respectively. The increase of
costs of services (exclusive of depreciation and amortization) as a percentage
of revenues in the eight months ended December 31, 1997 was caused by a number
of factors. The start-up of UDN's California network and switching operations
resulted in significant network underutilization and unbillable call records.
UDN's Arizona switch also experienced operating problems that caused increased
costs in certain types of calls. UDN believes that these were one-time factors
that have been rectified, although network inefficiencies may continue to impact
gross profits as UDN's California network continues to grow at a rapid pace.
Another factor affecting costs of services (exclusive of depreciation and
amortization) is the increase during the eight months ended December 31, 1997 in
international and wholesale revenues as a percentage of UDN's total revenue.
International and wholesale services have lower gross margins than UDN's other
services.
SELLING, GENERAL AND ADMINISTRATIVE. For the eight months ended December
31, 1997 and April 30, 1997, UDN's SG&A were $6.2 million (29.3% of revenues)
and $4.0 million (23.4% of revenues), respectively. The most recent eight month
period was negatively impacted by several factors. First, UDN is incurring costs
related to transitioning to new billing and order-entry systems. UDN has
outgrown its existing systems, has temporarily added significant new staff in
order to manually process the order entry flow, and is expending resources in
order to consolidate the separate billing processes. Additionally, UDN expanded
its sales and marketing efforts through increases in personnel and through agent
commission and incentive plans. Significant growth in UDN's agent/affinity
revenue has caused a corresponding increase in monthly commission expenses. The
combination of the above factors has caused the most recent eight month SG&A to
increase substantially as a percentage of revenues. As a part of the Merger
Agreement, UDN is in the process of converting to STAR's billing and order-entry
systems. The completion of the conversion by fourth quarter 1998 should cause a
major reduction in billing and order-entry expenses. This will, in the view of
UDN management, cause SG&A to decrease and to compare more favorably as a
percentage of revenue.
PROVISION FOR DOUBTFUL ACCOUNTS. UDN's provision for doubtful accounts
increased from $622,000 (3.6% of revenue) in the eight months ended April 30,
1997 to $3.1 million (14.9% of revenue) in the eight months ended December 31,
1997. The most recent eight month period was negatively impacted by the
bankruptcies of two major wholesale customers and an approximate $1.3 million
write-off due to a fraud situation that arose in December 1997.
DEPRECIATION. UDN's depreciation and amortization expenses for the eight
months ended December 31, 1997 increased to $0.7 million from $0.6 million in
the eight months ended April 30, 1997. The increase in the most recent eight
month period results from amortization of the goodwill and customer base costs
associated with the January 1997 CTN acquisition.
INTEREST EXPENSE. UDN's interest expense in the eight month period ended
December 31, 1997 increased to $0.6 million from $0.5 million in the eight month
period ended April 30, 1997. Three factors contributed to this increase. First,
UDN has accrued interest of $28,000 on the $2.5 million promissory note dated
November 19, 1997 with STAR. Second, $1.1 million of the purchase price related
to the January 1, 1997 CTN acquisition was financed through the issuance of
notes payable to the sellers. UDN had interest expense from the CTN notes of
$43,000 in the eight month period ended December 31, 1997 and only $21,000 in
the comparable eight month period ended April 30, 1997. Third, borrowings under
UDN's accounts receivable financing arrangement began for DNI in July 1996 and
in September 1996 for AMS. As revenues have grown, financing under the accounts
receivable financing arrangement has grown.
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The remaining increase in interest expense from the eight months ended April 30,
1997 to the eight months ended December 31, 1997 results from UDN's increase in
financing of accounts receivable.
OTHER INCOME (EXPENSE). In the eight months ended April 30, 1997, an
extraordinary gain of $97,000, net of a tax benefit of $50,000, was recognized
on the settlement of amounts owed under a switching equipment lease.
YEARS ENDED APRIL 30, 1997, 1996 AND 1995
REVENUES. UDN's revenues increased 199% to $24.0 million in the year ended
April 30, 1997 from $8.0 million in the 1996 period, and 1996 revenues were up
243% from $2.3 million in the 1995 period. This increase resulted from a growth
strategy combining significant internal growth with three acquisitions. On April
27, 1995, UDN acquired DNI. On March 26, 1996, UDN acquired AMS. On January 1,
1997, UDN acquired CTN. Internal growth in the period ended April 30, 1997 was
primarily through UDN's agent/affinity programs and through a recently initiated
international calling program, while the 1996 comparable period revenue growth
was through agent/affinity programs and prepaid calling card programs. The 1995
revenues were derived through direct sales efforts primarily in the Dallas/Ft.
Worth metropolitan area.
COSTS OF SERVICES (EXCLUSIVE OF DEPRECIATION AND AMORTIZATION). In the year
ended April 30, 1997, UDN's costs of services (exclusive of depreciation and
amortization) was $18.5 million (76.9% of revenues). This compares to costs of
services (exclusive of depreciation and amortization) of $6.0 million (75.1% of
revenues) in the year ended April 30, 1996 and to $1.9 million (82.0% of
revenues) in the year ended April 30, 1995. 1995 costs of services (exclusive of
depreciation and amortization) was larger as a percentage of revenues than in
1996 and 1997 due to initial over-capacity in UDN's newly expanded network. The
acquisition of DNI in April 1995 caused a significant improvement which resulted
from the consolidation of UDN's network into the DNI network, the consolidation
of switching platforms and the more efficient usage of the network as a result
of the significant increase in revenues. The increase in costs of services
(exclusive of depreciation and amortization) as a percentage of revenues in the
year ended April 30, 1997 (76.9%) as compared to the year ended April 30, 1996
(75.1%) resulted from the acquisition of AMS in March 1996. AMS is a switchless
reseller with significantly higher costs of services (exclusive of depreciation
and amortization) as a percentage of revenues than is found in UDN's switched
customer base. The costs of services (exclusive of depreciation and
amortization) as a percentage of revenues in UDN's switched customer base
actually decreased in 1997 to 68.7%, as compared to 75.1% in 1996, but UDN's
total costs of services increase by the addition of the AMS switchless base,
which had a costs of services as a percentage of revenues of 85.9% in 1997.
SELLING, GENERAL AND ADMINISTRATIVE. UDN's SG&A were $5.2 million in the
year ended April 30, 1997, a 93% increase over SG&A of $2.7 million in the year
ended April 30, 1996, which in turn was up 42% over SG&A of $1.9 million in the
year ended April 30, 1995. SG&A as a percentage of revenue declined
significantly as UDN grew during the last three years. SG&A were 21.5% of
revenue in the year ended April 30, 1997, while they were 33.3% in 1996 and
83.0% in 1995. This improvement was the result of the economies realized as the
operations of the DNI, AMS and CTN acquisitions were consolidated and as revenue
growth in the year ended April 30, 1997 increased rapidly.
PROVISION FOR DOUBTFUL ACCOUNTS. In the year ended April 30, 1995, UDN's
provision for doubtful accounts was $75,000 (3.2% of revenue), while in the year
ended April 30, 1996 the provision for doubtful accounts was $229,000 (2.9% of
revenue) and in the year ended April 30, 1997 was $693,000 (2.8% of revenue).
While the total provision for doubtful accounts has increased each year, its
percentage as compared to total revenue has declined in each of the last two
years, indicating an improvement in the quality of the Company's customer base
and in its management of the accounts receivable.
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DEPRECIATION. UDN's depreciation and amortization expense grew to $0.9
million in the year ended April 30, 1997 from $0.6 million in the year ended
April 30, 1996, which was an increase from $0.3 million in the year ended April
30, 1995. Amortization of the customer base and goodwill associated with the
acquisition of DNI comprise the majority of the increase for the year ended
April 30, 1996. Amortization of the AMS and CTN acquisitions caused the increase
in the year ended April 30, 1997.
INTEREST EXPENSE. UDN's interest expense in the year ended April 30, 1995
was $85,000 which was primarily related to the financing of switching, computer
and other equipment. In the year ended April 30, 1996, interest expense
increased to $0.1 million due to interest on the notes issued as part of the DNI
acquisition price and also to interest expense on the acquired DNI switch. In
the year ended April 30, 1997, interest expense increased to $0.6 million as a
result of the notes and convertible debentures issued as part of the AMS and CTN
acquisitions. In addition, in July 1996, UDN began incurring interest expense
under an accounts receivable financing arrangement on the DNI receivables, which
was expanded in September 1996 to include financing on the AMS receivables.
Interest expense of $200,000 was realized from the financing of receivables
during the year ended April 30, 1997.
OTHER INCOME (EXPENSE). In the year ended April 30, 1997, UDN realized an
extraordinary gain of $97,000, net of income taxes, which was related to the
settlement of amounts owed under a switching equipment lease. In the year ended
April 30, 1996, a loss on impairment of assets was recorded to reflect the write
down of certain excess switching equipment to reflect fair market value. In the
year ended April 30, 1995, UDN recorded a $0.1 million loss on the sale of
assets, which resulted from the March 1995 sale of UDN's answering service
business.
LIQUIDITY, CAPITAL RESOURCES AND OTHER
At September 30, 1998, UDN has $1.1 million cash on hand and a working
capital deficit of $12.5 million, which compares to $45,000 cash on hand and a
working capital deficit of $9.9 million at December 31, 1997. This working
capital deficit further compares to working capital deficits $3.2 million at
April 30, 1997 and $2.0 million at April 30, 1996. The continuing decrease in
working capital during each successive period relates primarily to UDN's ongoing
net losses.
UDN has historically operated with small cash balances and negative working
capital. Funds have been raised, as needed, generally through private placements
of shares of UDN Common Stock. In their audit report on the April 30, 1997
financial statements, UDN's independent accountants raise substantial doubt
about UDN's ability to continue as a going concern due to UDN's significant
working capital deficiency and current cash flows that are not sufficient to
repay debts on the scheduled due dates. At the time that the Merger Agreement
was executed in November 1997, UDN was in the process of raising $3.0 million in
a private placement through Madison Securities, Inc.
In the eight months ended December 31, 1997, $0.8 million had been raised
through the issuance of shares of UDN Common Stock. In the previous fiscal year
ended April 30, 1997, $1.4 million was raised through the issuance of shares of
UDN Common Stock. As a part of the Merger Agreement, UDN terminated the $3.0
million Madison private placement and received from STAR a loan in the amount of
$2.5 million. In December 1997, UDN discovered the extent of a fraud situation
and certain other uncollectible amounts out of its Phoenix location. On January
30, 1998, the original Merger Agreement was amended and on February 2, 1998 UDN
received a second loan in the amount of $2.0 million. On July 21, 1998, UDN
received a loan of $1.0 million from an officer of UDN. The proceeds of the loan
were used to pay certain trade payables which had come due. UDN believes it has
sufficient funds on hand to be able to meet its obligations as they become due
through the closing date of the Merger.
In September 1997, UDN began expending funds to expand its operations by
installing a California statewide network utilizing a new switch lease
agreement. Also, in the latter months of 1997, UDN began expending significant
funds on the development of a new billing system. This effort was terminated
upon the signing of the Merger Agreement and UDN is now proceeding with
integrating its three different
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billing systems into the STAR billing platform. These efforts combined with the
unexpected losses realized in the fraud situation, the other bad debt
write-offs, debt repayments, the cost of manually processing high numbers of new
orders and the cost of the sales and marketing and incentive plans have caused
UDN to experience a severe lack of liquidity. The STAR loans have temporarily
cured that situation. However, should the Merger terminate without completion,
UDN will be in the position of finding another billing alternative and of
raising sufficient capital to repay the STAR loans and to meet its other
obligations. There can be no assurance that UDN would be successful in raising
such funds in that eventuality or that UDN will have sufficient liquidity to
continue operations as a going concern.
YEAR 2000 COMPLIANCE
Certain information technology equipment and software employs two-digit date
codes to perform computational and decision making functions. On January 1, 2000
and thereafter, such equipment and software may misinterpret "00" as the year
1900 instead of the year 2000, and, as a result, systems, equipment and software
may operate improperly or fail.
UDN is reviewing its computer programs and systems to ensure that the
programs and systems will function properly and be Year 2000 compliant. In this
process, UDN expects to replace some existing systems and upgrade others. UDN
presently believes that, with modifications to existing software and conversions
to new software, the year 2000 problem will not pose significant operational
problems for UDN's computer systems.
UDN's Year 2000 compliance program is designed to identify, evaluate and
address potential Year 2000 compliance issues with its systems, equipment and
software in order to avoid interruptions in UDN's systems and any material
adverse effect upon UDN's operations. UDN plans to (a) conduct comprehensive
tests of all of its information technology and non-information technology
systems, equipment and software to determine its Year 2000 compliance status and
(b) obtain certification from its systems, equipment and software vendors as to
their Year 2000 compliance by the end of the first quarter of 1999. Although UDN
will not be able to determine the total cost of its Year 2000 compliance program
prior to the end of the first quarter of 1999, UDN does not currently expect to
incur significant costs in connection with its Year 2000 compliance program. Any
costs incurred in connection with such program will be expensed as incurred.
After the Closing of the Merger, UDN's Year 2000 compliance program will be
incorporated into the Year 2000 compliance program currently being implemented
by STAR. The joint Year 2000 compliance program is expected to include
contingency plans to handle (a) Year 2000 failures of STAR and UDN's internal
systems, equipment and software and (b) any necessary interactions with the
computers and technology of any non-complying third party after STAR and UDN
have adequately evaluated the Year 2000 compliance of these parties.
While UDN has not identified any specific material risks associated with its
Year 2000 compliance status, UDN's Year 2000 compliance program is not yet
completed. UDN may be required to incur unanticipated costs in connection with
its Year 2000 compliance or experience lower than expected revenues or incur
higher than expected costs as a result of third parties' failure to be Year 2000
compliant. Such costs could have a material adverse effect on UDN's financial
condition and results of operations.
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BUSINESS OF UDN
UDN is a provider of voice and data long distance services, travelcard
services, international long distance, prepaid calling cards and various other
telecommunication services to residential, small to medium-sized commercial
customers, switchless resellers, agents and wholesale purchasers. The principal
market for its long distance services is the central and southwest United
States. UDN has customers in over 40 states. UDN operates primarily through its
wholly-owned subsidiaries, Advanced Management Services, Inc. ("AMS"),
CTN-Custom Telecommunications Network of Arizona, Inc. ("CTN") and United
Digital Network of Texas, Inc. ("DNI"). UDN offers an array of services designed
to afford its customers an integrated telecommunications solution to their
telecommunication needs.
UDN was incorporated in Canada under the British Columbia Company Act on
June 2, 1980 under the name Stag Explorations Ltd. and, on November 30, 1990,
UDN changed its name to Stag Holdings Ltd. and, on February 8, 1993, UDN changed
its name to Unidex Communications Corp. On April 25, 1995, UDN reincorporated in
the United States by filing Articles of Continuance with the Secretary of State
of Wyoming, which allowed UDN to continue its existence as a Wyoming
corporation. Subsequently, UDN merged into its wholly-owned subsidiary, a
Delaware corporation, and continued its existence as Unidex Communications Corp,
a Delaware corporation.
Effective August 9, 1996, UDN changed its name from Unidex Communications
Corp. to United Digital Network, Inc., consolidated its share capital on the
basis of four old shares for one new share, and increased its authorized capital
to 100 million shares of common stock, par value, $0.01 per share.
UDN's growth has resulted from a two-pronged growth strategy. First, a plan
of acquiring selected types of long distance companies has produced four major
acquisitions that have been successfully integrated into UDN's operations.
Second, a direct sales force, complemented by a small but rapidly growing agent
network, has produced significant internal growth during the last two years.
ACQUISITIONS
In March 1993, for a purchase price of $747,000, UDN acquired ANI, a Texas
based company. ANI was a small start-up long distance company in Texas that also
provided various "live-operator" functions such as answering services and third
party customer service to business customers.
In April 1995, for a purchase price of $828,000, UDN acquired DNI, a Dallas,
Texas based company which provides telecommunications services to small and
medium sized commercial customers in Texas and Oklahoma. DNI's operations were
integrated into UDN's existing Dallas base of business. This acquisition brought
to UDN a more sophisticated switching platform, a more efficient and flexible
customer-billing system and its own leased network facilities in the south
central United States.
In March 1996, for a purchase price of $5.0 million UDN, subject to
adjustment based on various revenue performance criteria, acquired AMS, a
Phoenix, Arizona based long distance switchless reseller which has in the past
specialized in marketing long distance services to the motor freight industry.
The $5.0 million purchase price consisted of $1.0 million in cash and $4.0
million in convertible debentures and promissory notes; as a result of discounts
applied to the convertible debentures and promissory notes under generally
accepted accounting principles, the purchase price has been recorded by UDN at
$3.5 million for financial reporting purposes. The acquisition of AMS gave UDN
an expanded agent program, a nationwide retail customer base and a long distance
provider in the trucking industry market. AMS provides services to customers in
Arizona and over 40 other states. Prior to the AMS acquisition, most of UDN's
revenue came from Texas and Oklahoma.
In January 1997, UDN entered into a capital lease agreement with RealSource,
Inc. to lease, with the option to purchase for a nominal amount, the WorldDial
Prepaid Calling Platform, the WorldDial Point-
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of-Sale Activation Platform and all equipment necessary for the operation
thereof ("WorldDial Platforms"). UDN has commenced providing services to certain
prepaid card marketers and anticipates that this activity will provide
increasing revenues during the next 12 months.
In January 1997, for a purchase price of $1.4 million, UDN acquired CTN, a
switch-based reseller located in Phoenix, Arizona. CTN has a commercial customer
base and a complete originating and terminating network in Arizona and New
Mexico. With the acquisition of CTN, UDN's network extends through Arizona,
California, New Mexico, Oklahoma and Texas.
INTERNAL GROWTH
From fiscal year ending April 30, 1995 through June 30, 1998, UDN's customer
base increased from approximately 2,000 customers to over 22,000 customers
nationwide. As a part of UDN's two-pronged growth strategy, besides
acquisitions, UDN's internal growth contributed significantly to this increase
in customers and total revenue. During the fiscal year ended April 30, 1997,
internal growth contributed nearly $750,000 in new monthly revenues.
Approximately one-fourth of this growth came from UDN's pre-paid calling card
product line, with the remainder coming from revenue increases in agent,
affinity group and direct sales customers.
PRODUCT OFFERINGS
UDN provides long-distance voice and data services primarily in the
south-central and southwestern United States. UDN offers a broad array of
services designed to afford small and medium-sized commercial clients, and on a
limited basis residential customers, integrated telecommunications solutions to
their telecommunication needs. UDN operates in Texas, Oklahoma and California
under the name DNI in Arizona and in over 40 other states under the name AMS,
and also in Arizona and New Mexico under the name CTN. UDN's direct sales force
targets businesses with monthly telecommunication expenses within a range of
$250 to $10,000. UDN provides these clients with basic inbound and outbound long
distance service as well as travelcard, prepaid calling cards and international
long distance services. To complement these offerings and to be viewed by its
clients as a provider of "bundled" products, UDN also provides on a limited
basis the following services: Conference Calling, Fax Mail-Box, FAX Broadcast,
FAX-on-Demand, voice mail and Dedicated and Switched Data Services.
UDN's strategy is to provide a broad product line so that its clients will
view UDN as a one-stop provider of telecommunication services. UDN believes that
the more services a client obtains from UDN, the less susceptible a client will
be to switch to one of UDN's competitors. One of UDN's strengths is its ability
to customize products to fit a customer's needs.
Like many other resellers, UDN buys bulk long distance services from various
wholesale carriers. Unlike many resellers, however, UDN also originates and
terminates a majority of its traffic on its own network throughout Texas,
Oklahoma, Arizona and New Mexico. With significant volumes, this constitutes a
lower cost method of routing long distance traffic. With the CTN acquisition,
UDN obtained an Arizona and New Mexico network and a switch-sharing lease
arrangement on a switch located in Phoenix, Arizona. UDN's network is built
around its DEX-400 switch located in Dallas. During 1997, UDN entered into a
switch-sharing arrangement with STAR for the use of a switch in southern
California. A statewide California network is being implemented.
UDN's business plan contemplates continuing growth by marketing its services
through four separate channels:
1. DIRECT SALES. UDN currently employs direct-sales representatives in
both the Dallas and Phoenix offices. These representatives each carry a
monthly quota for generating new business, and focus on selling to small and
medium-sized commercial accounts.
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2. AGENT SALES. UDN uses a nationwide force of over 75 independent
agents to sell UDN's services to both residential and commercial accounts.
The independent agents are paid on the basis of a percentage of revenue that
is billed by the clients that they have brought to UDN. In addition to the
existing agent development group, a director of third party marketing was
hired in May 1996 who is focusing on developing agents primarily through
affinity marketing.
3. WHOLESALE SERVICES--SWITCHLESS RESELLERS AND CARRIER SALES. A
switchless reseller is a non-facilities based long distance company for whom
UDN acts as a wholesale provider of long distance services. The switchless
reseller's clients are connected directly to UDN's network. Call detail
records are sent to the reseller at the end of each month, which allows the
reseller to utilize his own billing system in order to bill his clients.
Alternatively, UDN may provide billing services to the switchless reseller
and, for a fee, will bill the switchless reseller's customers for him.
"Carrier sales" are those minutes other long distance carriers send to UDN
to be terminated by UDN on its own network which presently covers Texas,
Oklahoma, Arizona, New Mexico and portions of southern California. Although
carrier sales constitute lower margin revenue, UDN's strategy is to have a
base of wholesale clients for expanding its network geographically, which in
turn should provide additional markets for higher margin direct sales and
may ultimately increase margins in the agent base.
4. PREPAID CALLING CARDS. The agreement with RealSource, Inc. with
respect to the WorldDial Platforms has made prepaid calling cards a recent
addition to UDN's product line. Prepaid calling cards constitute a rapidly
growing market.
In addition to continuing to expand the above channels to market, UDN
intends to focus on several other key areas to ensure the future growth of UDN.
First, UDN must retain its customer base. The replacement of lost clients is a
major expense to UDN and results in lost revenues.
Second, UDN will continue to explore opportunities for expanding its product
line. Just as the acquisition of the WorldDial Platforms has expanded UDN's
product lines, UDN intends to continue to acquire, develop and market products
and services that meet the expanding needs of its clients. These products may
include, among others, local service, cellular service, paging and personal
communications services.
UDN currently serves over 22,000 customers nationwide, primarily located in
Texas, Oklahoma, Arizona and California. Long distance revenues have grown as
follows from UDN's entrance into the market in 1992:
<TABLE>
<CAPTION>
LONG DISTANCE
REVENUES
-------------
<S> <C>
Fiscal year ended April 30, 1993............................................... $ 13,000
Fiscal year ended April 30, 1994............................................... $ 152,000
Fiscal year ended April 30, 1995............................................... $ 1,378,000
Fiscal year ended April 30, 1996............................................... $ 8,027,000
Fiscal year ended April 30, 1997............................................... $24,012,000
Eight months ended December 31, 1997........................................... $21,078,000
Nine months ended September 30, 1998........................................... $23,811,000
</TABLE>
EMPLOYEES
As of December 31, 1998, UDN had 46 employees, of which 6 are full-time
direct-sales representatives.
DESCRIPTION OF PROPERTY
UDN and its subsidiaries lease each of their principal executive offices.
UDN does not own all of the transmission facilities needed to complete long
distance telephone calls. Other than the switching facility in
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Dallas, UDN leases ports on switching facilities in Los Angeles and Phoenix.
Therefore, UDN's operator services, direct dial long distance, "800" service,
wholesale long distance service and international business are largely dependent
upon the contractual arrangement with facilities-based carriers for the
transmission of calls on a cost-effective basis. UDN has contractual
arrangements with a carrier for the use of its switch and transmission
facilities in Los Angeles and Phoenix. These contracts are on a month-to-month
basis.
LEGAL PROCEEDINGS
Except as set forth below, UDN is not engaged in any material litigation,
and the officers and directors presently know of no threatened or pending
material litigation in which it is contemplated that UDN will be made a party.
In January 1998, AMS filed an action in Maricopa County Court of the State
of Arizona against The Software Group, LLC, d/b/a Global Software Group, LLC
("Global") and three individuals seeking $1.3 million in damages for an alleged
breach of service contracts with AMS. AMS claims that Global and the three
individuals failed to pay amounts due to AMS for services provided to Global
under the service contracts. One of the individuals has filed a counterclaim
against UDN and Messrs. Snedegar and Christensen. AMS intends to vigorously
pursue its claim against Global. There can be no assurance, however, that AMS
will prevail in its collection of damages. In addition, whether or not AMS is
ever able to collect its damages, such collection process could be time
consuming and costly.
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<PAGE>
MANAGEMENT OF STAR AND UDN
OFFICERS AND DIRECTORS OF STAR
The officers and directors of STAR and their ages as of February 9, 1999,
are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---------------------------------------- --- ------------------------------------------------------------------
<S> <C> <C>
Christopher E. Edgecomb(1).............. 39 Chief Executive Officer, Chairman of the Board and Director
Mary A. Casey(1)(2)..................... 36 President, Secretary and Director
David Vaun Crumly....................... 35 Executive Vice President--Sales and Marketing
James E. Kolsrud........................ 54 Executive Vice President--Operations and Engineering
Kelly D. Enos........................... 40 Chief Financial Officer, Treasurer and Assistant Secretary
Mark Gershien........................... 46 Director
Gordon Hutchins, Jr.(3)................. 49 Director
John R. Snedegar(2)(3).................. 49 Director
Arunas A. Chesonis...................... 36 Director
Samer Tawfik............................ 33 Director
</TABLE>
- ------------------------
(1) Member of Non-Executive Stock Option Committee
(2) Member of Audit Committee
(3) Member of Compensation Committee
CHRISTOPHER E. EDGECOMB co-founded STAR in September 1993, served as
President of STAR until January 1996 and has served as STAR's Chief Executive
Officer and Chairman of the Board since January 1996. Mr. Edgecomb has been a
Director of STAR since its inception. Prior to that time, Mr. Edgecomb was a
founder and the Executive Vice President of West Coast Telecommunications
("WCT"), a nation-wide long distance carrier, from August 1989 to December 1994.
Prior to founding WCT, Mr. Edgecomb was President of Telco Planning, a
telecommunications consulting firm, from January 1986 to July 1989. Prior to
that time, Mr. Edgecomb held senior level sales and marketing positions with TMC
Communications, American Network and Bay Area Teleport.
MARY A. CASEY has been a Director and Secretary of STAR since co-founding
STAR in September 1993, and has served as STAR's President since January 1996.
Prior to that time, Ms. Casey was Director of Customer Service at WCT from
December 1991 to June 1993, and served as Director of Operator Services at Call
America, a long distance telecommunications company, from May 1988 to December
1991.
DAVID VAUN CRUMLY has served as STAR's Executive Vice President--Sales and
Marketing since January 1996. Prior to that time, Mr. Crumly served as a
consultant to the Company from November 1995 to January 1996, was Vice President
of Carrier Sales of Digital Network, Inc. from June 1995 to November 1995 and
was Director of Carrier Sales of WCT from June 1992 to June 1995. Prior to
joining WCT, Mr. Crumly served in various sales and marketing capacities with
Metromedia, a long-distance company, from September 1990 to June 1992 and with
Claydesta, a long-distance company, from May 1987 to September 1989.
JAMES E. KOLSRUD has served as STAR's Executive Vice President--Operations
and Engineering since September 1996. Prior to joining STAR, Mr. Kolsrud was an
international telecommunications consultant from March 1995 to September 1996.
Prior to that time, he was a Vice President, Corporate Engineering and
Administration of IDB Communications Group, Inc. ("IDB"), an international
communications
137
<PAGE>
company, from October 1989 to March 1995, and prior to that time, he was
President of the International Division of IDB.
KELLY D. ENOS has served as STAR's Chief Financial Officer since December
1996 and as Treasurer and Assistant Secretary since April 1997. Prior to that
time, Ms. Enos was an independent consultant in the merchant banking field from
February 1996 to November 1996 and a Vice President of Fortune Financial, a
merchant banking firm, from April 1995 to January 1996. Ms. Enos served as a
Vice President of Oppenheimer & Co., Inc., an investment bank, from July 1994 to
March 1995 and a Vice President of Sutro & Co., an investment bank, from January
1991 to June 1994.
MARK GERSHIEN has served as a Director of STAR since March 1998. Mr.
Gershien has been the Senior Vice President of Sales and Marketing for Level 3
Communications, a telecommunications and information services company, since
January 1998. Prior to that time, Mr. Gershien was the Senior Vice President of
National Accounts for WorldCom, Inc., an international telecommunications
company, and President and Chief Executive Officer of MFS Telecom, a division of
MFS Communications, Inc. prior to its merger with WorldCom, Inc.
GORDON HUTCHINS, JR. has served as a Director of STAR since January 1996.
Mr. Hutchins has been President of GH Associates, a telecommunications
consulting firm, since July 1989. Prior to founding GH Associates, Mr. Hutchins
served as President and Chief Executive Officer of ICC Telecommunications, a
competitive access provider, and held senior management positions with several
other companies in the telecommunications industry.
JOHN R. SNEDEGAR has served as a Director of STAR since January 1996. Mr.
Snedegar has been the President of UDN since June 1990. See "--Officers and
Directors of UDN."
ARUNAS A. CHESONIS has served as a Director of STAR since May 1998. From May
1987 to April 1998, Mr. Chesonis served in various executive positions with ACC
Corp. and its subsidiaries, including most recently President of ACC Corp. and
President and Chief Operating Officer of ACC Global Corp.
SAMER TAWFIK has served as a Director of STAR since February 1999. Mr.
Tawfik founded PT-1 in April 1995 and has served as Chief Executive Officer of
PT-1 since that time. From 1984 to 1994, Mr. Tawfik was principal owner and
manager of three amusement companies.
STAR BOARD COMPOSITION
In accordance with the terms of STAR's Certificate of Incorporation, the
terms of office of the Board of Directors are divided into three classes: Class
I, whose term will expire at the annual meeting of stockholders to be held in
2001; Class II, whose term will expire at the annual meeting of stockholders to
be held in 1999; and Class III, whose term will expire at the annual meeting of
stockholders to be held in 2000. The Class I directors are Gordon Hutchins, Jr.
and John R. Snedegar, the Class II directors are Mark Gershien, Mary A. Casey
and Samer Tawfik, and the Class III directors are Christopher E. Edgecomb and
Arunas A. Chesonis. At each annual meeting of stockholders after the initial
classification, the successors to directors whose term will then expire will be
elected to serve from the time of election and qualification until the third
annual meeting following election. This classification of the Board of Directors
may have the effect of delaying or preventing changes in control or changes in
management of STAR. See "Risk Factors--Anti-takeover Effects of Certificate of
Incorporation, Bylaws and Delaware Law" and "Description of STAR Capital
Stock--Anti-takeover Effects of Provisions of the Certificate of Incorporation,
Bylaws and Delaware Law."
Each officer is elected by and serves at the discretion of the STAR Board.
Each of STAR's officers and directors, other than nonemployee directors, devotes
substantially full time to the affairs of STAR. STAR's nonemployee directors
devote such time to the affairs of STAR as is necessary to discharge their
duties. There are no family relationships among any of the directors, officers
or key employees of STAR.
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<PAGE>
STAR DIRECTOR COMPENSATION
STAR's non-employee directors receive $2,000 for each Board meeting attended
and $1,000 for each telephonic Board meeting. In addition, each non-employee
director is reimbursed for out-of-pocket expenses incurred in connection with
attendance at meetings of the Board of Directors and its committees. In 1996,
Messrs. Hutchins and Snedegar were each granted stock options to purchase 20,500
shares of STAR's Common Stock. In 1997, Messrs. Hutchins and Snedegar and Roland
Van der Meer, a former director, were each granted stock options to purchase
10,250 shares of STAR's Common Stock. In 1998, Messrs. Hutchins, Snedegar and
Gershien were each granted stock options to purchase 20,250 shares of STAR
Common Stock, and Mr. Chesonis was granted stock options to purchase 20,000
shares of STAR Common Stock. See "Certain Transactions--Transactions with STAR
Outside Directors."
STAR EXECUTIVE COMPENSATION
The following Summary Compensation Table sets forth the compensation earned
by STAR's Chief Executive Officer and four other executive officers who earned
(or would have earned) salary and bonus in excess of $100,000 for services
rendered in all capacities to STAR and its subsidiaries (the "STAR Named
Officers") for each of the fiscal years in the two year period ended December
31, 1997.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
-------------
SECURITIES
UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION FISCAL YEAR SALARY ($) BONUS ($) OPTIONS (#) COMPENSATION ($)
- ------------------------------------------------- ----------- ----------- ----------- ------------- -----------------
<S> <C> <C> <C> <C> <C>
Christopher E. Edgecomb ......................... 1997 360,000 -- -- 3,202(1)
Chief Executive Officer and Chairman of the 1996 360,000 -- -- 9,223(1)
Board
Mary A. Casey ................................... 1997 217,500 -- -- 13,615(2)
President and Secretary 1996 156,042 -- -- 15,028(2)
David Vaun Crumly ............................... 1997 380,779 1,014 -- 6,202(2)
Executive Vice President--Sales and Marketing 1996 298,002 -- 410,000 3,202(2)
James E. Kolsrud ................................ 1997 177,083 1,014 -- 5,528(3)
Executive Vice President--Operations and 1996 25,000 -- 205,000 --
Engineering
Kelly D. Enos(4) ................................ 1997 150,000 1,014 20,500 25,924(5)
Chief Financial Officer and Treasurer 1996 12,500 -- 153,750 --
</TABLE>
- ------------------------
(1) Consists of life and health insurance premiums paid by STAR.
(2) Consists of life and health insurance premiums and a car allowance paid by
STAR.
(3) Consists of health insurance premiums paid by STAR.
(4) Ms. Enos joined STAR in December 1996.
(5) Consists of a moving allowance of $22,721 and life and health insurance
premiums paid by STAR.
139
<PAGE>
The following table contains information concerning the stock option grants
made to each of the STAR Named Officers named below for the year ended December
31, 1997.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE OF ASSUMED
NUMBER OF ANNUAL RATES OF STOCK
SECURITIES PERCENT OF TOTAL PRICE APPRECIATION
UNDERLYING OPTIONS GRANTED EXERCISE FOR OPTION TERM(1)
OPTIONS TO EMPLOYEES IN PRICE PER EXPIRATION ---------------------
NAME GRANTED (#) FISCAL YEAR SHARE ($/SH) DATE 5% ($) 10% ($)
- ------------------------------------ ----------- ----------------- ------------- ----------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Kelly D. Enos....................... 20,500(2) 2.3% $ 6.83 06/27/07 $ 88,045 $ 223,124
</TABLE>
- ------------------------
(1) The 5% and 10% assumed annual rates of compounded stock price appreciation
are mandated by rules of the Securities and Exchange Commission. There can
be no assurance provided to any executive officer or any other holder of
STAR's securities that the actual stock price appreciation over the 10-year
option term will be at the assumed 5% and 10% levels or at any other defined
level. Unless the market price of the STAR Common Stock appreciates over the
option term, no value will be realized from the option grants made to the
executive officer.
(2) The option becomes exercisable in four equal annual installments on June 26,
1998, 1999, 2000 and 2001, respectively.
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
No options were exercised by the STAR Named Officers for the fiscal year
ended December 31, 1997. No stock appreciation rights were exercised during such
year or were outstanding at the end of that year.
STAR COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee of STAR's Board (the "Compensation Committee")
was formed in May 1996, and, in 1997, the members of the Compensation Committee
were Gordon Hutchins, Jr., John R. Snedegar and Roland A. Van der Meer. None of
these individuals was at any time during the year ended December 31, 1997, or at
any other time, an officer or employee of STAR. Mr. Van der Meer resigned from
the Board and the Compensation Committee, effective as of February 1, 1998. The
Non-Executive Compensation Committee of STAR's Board (the "Non-Executive
Compensation Committee") was formed in 1997, and the members are Christopher E.
Edgecomb and Mary A. Casey. No member of the Compensation Committee or the
Non-Executive Compensation Committee served at any time during the year ended
December 31, 1997 as a member of the board of directors or compensation
committee of any entity that has one or more executive officers serving as a
member of STAR's Board, Compensation Committee or Non-Executive Compensation
Committee, except that Mr. Hutchins was a director of UDN for a portion of 1997.
The Compensation Committee and the Non-Executive Compensation Committee shall
collectively be referred to hereafter as the "Compensation Committees."
STAR 1997 OMNIBUS STOCK INCENTIVE PLAN
STAR's 1997 Omnibus Stock Incentive Plan (as amended, the "Omnibus Plan")
was adopted by the Board of Directors on January 30, 1997 as the successor to
STAR's 1996 Supplemental Option Plan (the "Supplemental Plan"). STAR has
reserved 4,075,000 shares for issuance under the Omnibus Plan. This share
reserve is comprised of (i) the 2,050,000 shares that were available for
issuance under the Supplemental Plan, plus (ii) an increase of 2,025,000 shares.
As of September 30, 1998, 215,866 shares had been issued under the Supplemental
and Omnibus Plans, options for approximately 1,986,461 shares were outstanding
(699,067 of which were granted under the Supplemental Plan) and approximately
1,256,314 shares remained available for future grant. Shares of STAR Common
Stock subject to outstanding options,
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<PAGE>
including options granted under the Supplemental Plan, which expire or terminate
prior to exercise, will be available for future issuance under the Omnibus Plan.
In addition, if stock appreciation rights ("SARs") and stock units are settled
under the Omnibus Plan, then only the number of shares actually issued in
settlement will reduce the number of shares available for future issuance under
this plan.
Under the Omnibus Plan, employees, outside directors and consultants may be
awarded options to purchase shares of STAR Common Stock, SARs, restricted shares
and stock units. Options may be incentive stock options designed to satisfy
Section 422 of the Internal Revenue Code or nonstatutory stock options not
designed to meet such requirements. SARs may be awarded in combination with
options, restricted shares or stock units, and such an award may provide that
the SARs will not be exercisable unless the related options, restricted shares
or stock units are forfeited.
The Omnibus Plan is administered by the Board or the Compensation Committees
(the "Administrator"). The Administrator has the complete discretion to
determine which eligible individuals are to receive awards; determine the award
type, number of shares subject to an award, vesting requirements and other
features and conditions of such awards; interpret the Omnibus Plan; and make all
other decisions relating to the operation of the Omnibus Plan.
The exercise price for options granted under the Omnibus Plan may be paid in
cash or in outstanding shares of STAR Common Stock. Options may also be
exercised on a cashless basis, by a pledge of shares to a broker or by
promissory note. The payment for the award of newly issued restricted shares
will be made in cash. If an award of SARs, stock units or restricted shares from
STAR's treasury is granted, no cash consideration is required.
The Administrator has the authority to modify, extend or assume outstanding
options and SARs or may accept the cancellation of outstanding options and SARs
in return for the grant of new options or SARs for the same or a different
number of shares and at the same or a different exercise price.
The Board may determine that an outside director may elect to receive his or
her annual retainer payments and meeting fees from STAR in the form of cash,
options, restricted shares, stock units or a combination thereof. The Board will
decide how to determine the number and terms of the options, restricted shares
or stock units to be granted to outside directors in lieu of annual retainers
and meeting fees.
Upon a change in control, the Administrator may determine that an option or
SAR will become fully exercisable as to all shares subject to such option or
SAR. A change in control includes a merger or consolidation of STAR, certain
changes in the composition of the Board and acquisition of 50% or more of the
combined voting power of STAR's outstanding stock. In the event of a merger or
other reorganization, outstanding options, SARs, restricted shares and stock
units will be subject to the agreement of merger or reorganization, which may
provide for the assumption of outstanding awards by the surviving corporation or
its parent, their continuation by STAR (if STAR is the surviving corporation),
accelerated vesting and accelerated expiration, or settlement in cash.
The Board may amend or terminate the Omnibus Plan at any time. Amendments
may be subject to stockholder approval to the extent required by applicable
laws. In any event, the Omnibus Plan will terminate on January 22, 2007, unless
sooner terminated by the Board.
STAR 1996 OUTSIDE DIRECTOR NONSTATUTORY STOCK OPTION PLAN
STAR's 1996 Outside Director Nonstatutory Stock Option Plan (the "Director
Plan") was ratified and approved by the Board of Directors as of May 14, 1996.
STAR has reserved 410,000 shares of STAR Common Stock for issuance under the
Director Plan. As of September 30, 1998, 82,000 shares had been issued under the
Director Plan, options for 71,500 shares were outstanding and 256,500 shares
remained available for future grant. If an outstanding option expires or
terminates unexercised, then the shares subject to such option will again be
available for issuance under the Director Plan.
141
<PAGE>
Under the Director Plan, outside directors of STAR may receive nonstatutory
options to purchase shares of STAR Common Stock. The Director Plan is
administered by the Board or the Compensation Committee (the "Administrator").
The Administrator has the discretion to determine which eligible individuals
will receive options, the number of shares subject to each option, vesting
requirements and any other terms and conditions of such options.
The exercise price for options granted under the Director Plan will be at
least 85% of the fair market value of the STAR Common Stock on the option grant
date, shall be 110% of the fair market value of the STAR Common Stock on the
option grant date if the option is granted to a holder of more than 10% of the
STAR Common Stock outstanding and may be paid in cash, check or shares of STAR
Common Stock. The exercise price may also be paid by cashless exercise or pledge
of shares to a broker.
The Administrator may modify, extend or renew outstanding options or accept
the surrender of such options in exchange for the grant of new options, subject
to the consent of the affected optionee.
Upon a change in control, the Board may accelerate the exercisability of
outstanding options and provide an exercise period during which such accelerated
options may be exercised. The Board also has the discretion to terminate any
outstanding options that had been accelerated and had not been exercised during
such exercise period. In the event of a merger of STAR into another corporation
in which holders of STAR Common Stock receive cash for their shares, the Board
may settle the option with a cash payment equal to the difference between the
exercise price and the amount paid to holders of STAR Common Stock pursuant to
the merger.
The Board may amend or terminate the Director Plan at any time. In any
event, the Director Plan will terminate on May 14, 2006, unless sooner
terminated by the Board.
STAR EMPLOYMENT AGREEMENTS AND CHANGE OF CONTROL ARRANGEMENTS
STAR has an employment agreement with Mary A. Casey, pursuant to which Ms.
Casey holds the position of President of STAR, is paid an annual salary of
$20,000 per month, subject to adjustment to reflect increases in the Consumer
Price Index, was entitled to purchase 1,677,273 shares of STAR Common Stock, and
is eligible to receive a bonus, as determined by the Chief Executive Officer and
Board of Directors. The agreement also provides that Ms. Casey will receive a
severance payment equal to $7,000 per month for the first six months after
termination of employment, and an additional payment of $7,000 per month for the
next six months, minus any amounts earned by her from other employment during
such period. In addition, the agreement provides that if Ms. Casey's employment
is terminated (other than for cause) within four months after a Sale Transaction
(as defined below), she will continue to receive the compensation provided in
the agreement until the expiration of the agreement on December 31, 2000,
instead of the severance payments described above. A Sale Transaction is an
acquisition of more than 75% of the voting securities of STAR, pursuant to a
tender offer or exchange offer approved in advance by the Board of Directors.
In January 1996, STAR entered into an employment agreement with David Vaun
Crumly pursuant to which Mr. Crumly became Executive Vice President of STAR. The
agreement provides for an annual salary of $10,000 per month with an annual
increase, plus incentive bonuses tied to gross revenues of STAR. The agreement
also provides for a commission on certain accounts of STAR and an option to
purchase 369,000 shares of STAR Common Stock at an exercise price of $0.73 per
share. In addition, in the event of a Sale Transaction, Mr. Crumly will receive
a bonus payment equal to the lesser of $1,500,000 or a percentage of the monthly
gross sales of accounts relating to customers introduced to STAR by Mr. Crumly.
If his employment is terminated in certain circumstances, without cause, within
four months after a Sale Transaction, Mr. Crumly is entitled to receive the
compensation provided in this agreement, minus any compensation earned by other
employment, until the expiration of the agreement on December 31, 2000.
142
<PAGE>
In December 1996, STAR entered into an employment agreement with Kelly D.
Enos, pursuant to which Ms. Enos became Chief Financial Officer of STAR. The
agreement provides for an annual salary of $150,000 (which has been increased to
$160,000) and an option to purchase 153,750 shares of STAR Common Stock at an
exercise price of $4.00 per share. The agreement also provides that Ms. Enos
will receive a severance payment equal to the compensation which she would have
received under the remaining term of the agreement if she terminates the
agreement as a result of STAR's default of its material obligations and duties
under the agreement or if she is terminated by STAR without cause within four
months after a Sale Transaction.
In September 1996, STAR entered into an employment agreement with James E.
Kolsrud, pursuant to which Mr. Kolsrud became Executive Vice
President--Operations and Engineering of STAR. The agreement provides for a
monthly salary of $16,667, an option to purchase 205,000 shares of STAR Common
Stock pursuant to STAR's 1996 Supplemental Stock Option Plan at a price of $4.00
per share, reimbursement of reasonable out-of-pocket expenses incurred in
connection with Company business, and fringe benefits accorded to executives of
STAR as determined by the Board of Directors. In the event of termination
pursuant to the agreement, Mr. Kolsrud shall be entitled to receive compensation
accrued and payable to him as of the date of his termination or death, and all
other amounts payable to him under the agreement shall thereupon cease. If his
employment is terminated in certain circumstances within four months after a
Sale Transaction, then Mr. Kolsrud shall continue to receive the compensation
provided in the agreement until the expiration of the agreement on December 31,
2000.
OFFICERS AND DIRECTORS OF UDN
After the Merger, the officers and directors of UDN are expected to be and
their ages as of February 9, 1999 are, as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ----------------------------------- --- -----------------------------------------------------------------------
<S> <C> <C>
John R. Snedegar .................. 49 President
Laguna Hills, CA 92653
Dale W. Christensen ............... 46 Chief Operating Officer and Chief Financial Officer
Carrollton, TX 75007
Christopher E. Edgecomb ........... 39 Director
Santa Barbara, CA 93101
Mary A. Casey ..................... 36 Director
Santa Barbara, CA 93101
Kelly D. Enos ..................... 40 Director
Santa Barbara, CA 93101
</TABLE>
JOHN R. SNEDEGAR has been the President and a Director of UDN since June
1990. From June 1980 to February 1992, Mr. Snedegar was the President and CEO of
AmeriTel Management, Inc., a provider of long distance telecommunications and
management services. Mr. Snedegar is also a director for StarBase Corporation, a
software development company, Micro General Corporation, a full service
communications service provider, TeleHub Communications Corporation, a
long-distance technology company and Techwave Inc., an electronic commerce
software company, and of STAR. Mr. Snedegar also serves as President of Kendall
Venture Funding, Ltd., a reporting company in Alberta, Canada.
DALE W. CHRISTENSEN co-founded ANI Communications in February 1992, and
joined UDN as Chief Operating Officer and Chief Financial Officer upon UDN's
acquisition of ANI later that same year. From 1989 to 1992, Mr. Christensen was
the Controller of International Telecharge, Inc. ("ITI"), a telecommunications
company that provided alternative operator services primarily to the pay phone
and hospitality markets.
For biographies of Mr. Edgecomb, Ms. Casey and Ms. Enos, see "--Officers and
Directors of STAR."
All directors hold office until the next annual meeting of stockholders or
until their successors have been duly elected or qualified or until his earlier
death, resignation or removal. Executive officers of UDN are appointed by and
serve at the discretion of the UDN Board.
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<PAGE>
UDN DIRECTOR COMPENSATION
The members of the UDN Board of Directors are not compensated in such
capacity. However, the UDN Board of Directors may, by resolution, reimburse
directors for out-of-pocket expenses incurred in their capacity as directors of
UDN.
UDN EXECUTIVE COMPENSATION
The following Summary Compensation Table sets forth the compensation earned
by UDN's President and one other executive officer who earned (or would have
earned) salary and bonus in excess of $100,000 for services rendered in all
capacities to UDN and its subsidiaries (the "UDN Named Officers") for each of
the fiscal years in the three year period ended April 30, 1998.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
------------
SECURITIES
FISCAL UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY ($) BONUS OPTIONS (#) COMPENSATION
- ----------------------------------- ------ -------------- -------- ------------ ------------
<S> <C> <C> <C> <C> <C>
John R. Snedegar, ................. 1998 $ 125,587 $ 50,000 -- $7,200
President/Chief Executive Officer 1997 118,019 25,000 -- 6,000
1996 -- -- -- --
Dale W. Christensen, .............. 1998 $ 101,443 $ 23,750 37,500 $2,400
Chief Operating Officer and Vice 1997 104,877 20,000 -- --
President Finance 1996 90,930 6,500 37,500 --
</TABLE>
The following table contains information concerning the stock option grants
made to each of the UDN Named Officers named below for the year ended April 30,
1998.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
MARKET VALUE OF
NUMBER OF PERCENT OF SECURITIES
SECURITIES TOTAL OPTIONS EXERCISE UNDERLYING
UNDERLYING GRANTED TO PRICE PER OPTIONS ON THE
OPTIONS GRANTED EMPLOYEES IN SHARE DATE OF GRANT EXPIRATION
NAME (#)(1) FISCAL YEAR (CDN $/SH) (CDN $/SECURITY) DATE
- ---------------------------------------- --------------- --------------- ------------- ----------------- -----------
<S> <C> <C> <C> <C> <C>
Dale W. Christensen..................... 37,500 49.0% $ 2.28 $ 2.28 6/11/02
</TABLE>
- ------------------------
(1) These options are fully vested.
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
No options were exercised by the UDN Named Officers for the fiscal year
ended April 30, 1998. No stock appreciation rights were exercised during such
year or were outstanding at the end of that year.
<TABLE>
<CAPTION>
UNEXERCISED OPTIONS @ APRIL VALUE OF UNEXERCISED
30, IN-THE-MONEY
1998 OPTIONS AT APRIL 30, 1998
NAME EXERCISABLE/UNEXERCISABLE (#) EXERCISABLE/UNEXERCISABLE ($$)
- ------------------------------------------------- ------------------------------ -------------------------------
<S> <C> <C>
Dale W. Christensen.............................. 75,000/0 nil
</TABLE>
144
<PAGE>
OUTSTANDING STOCK OPTIONS
<TABLE>
<CAPTION>
NUMBER OF UDN EXERCISE PRICE EXPIRY DATE OF
CLASS OF OPTIONEE SHARES UNDER OPTION PER SHARE OPTION
- ------------------------------------------------ ------------------- -------------------- --------------------
<S> <C> <C> <C>
Executive Officers, as a group (1 person)....... 37,500 US$ 1.64/CD$2.80 May 2, 2000
37,500 US$ 2.04/CD$2.28 June 11, 2002
Directors who are not executive officers, as a 25,000 US$ 2.16/CD$2.92 May 11, 2000
group (3 persons)............................. 75,000 US$ 2.14/CD$2.92 January 15, 2001
50,000 US$ 1.97/CD$2.68 March 26, 2001
Other employees of UDN, or its subsidiaries, as 15,000 US$ 1.64/CD$2.80 May 2, 2000
a group (21 persons).......................... 37,500 US$ 1.77/CD$2.40 August 21, 2000
81,250 US$ 2.02/CD$2.76 June 6, 2001
25,000 US$ 1.84/CD$2.50 October 4, 2001
36,250 US$ 1.59/CD$2.22 April 4, 2002
13,750 US$ 2.04/CD$2.28 June 11, 2002
</TABLE>
UDN EMPLOYMENT AGREEMENTS
EMPLOYMENT CONTRACT WITH MR. SNEDEGAR. UDN entered into an Employment
Agreement, dated June 1, 1996, with its President, John R. Snedegar, pursuant to
which Mr. Snedegar is employed for a four-year term from June 1, 1996, at a base
salary of $125,000 per annum. The agreement also provides for typical
perquisites such as reimbursement of expenses, paid vacation, automobile
allowance and medical, disability and life insurance. Mr. Snedegar can earn a
bonus of up to $50,000 per fiscal year at the discretion of the Board of
Directors or based on revenue and profitability targets to be established by the
Board (the "Bonus").
Mr. Snedegar may terminate the agreement for any reason upon ninety days'
prior written notice. In the event that Mr. Snedegar's employment is terminated
without cause, Mr. Snedegar will be entitled to a severance payment equal to his
monthly base salary times the number of months remaining in the term of the
agreement up to a maximum of 24 months, in addition to two times the amount of
the Bonus earned during the fiscal year prior to termination.
In the event that there is a change in control of UDN, Mr. Snedegar may
elect to terminate the agreement. In that event, Mr. Snedegar will be entitled
to a severance payment equal to his monthly base salary times the number of
months remaining in the term of the contract, up to a maximum of 24 months, in
addition to two times the amount of the Bonus earned during the fiscal year
prior to termination and will continue to receive life insurance, health
insurance and disability insurance benefits for a period of two years from the
date of termination.
In the event that the agreement is otherwise terminated, Mr. Snedegar will
be entitled to receive an amount equivalent to the Bonus for the fiscal year in
which termination occurs multiplied by a fraction, the numerator of which is the
number of days in that year prior to termination and the denominator is 365.
EMPLOYMENT CONTRACT WITH MR. CHRISTENSEN. UDN entered into an Employment
Agreement dated May 1, 1997, with its Chief Financial Officer and Chief
Operating Officer, Dale W. Christensen, pursuant to which Mr. Christensen is
employed for a two-year term from May 1, 1997, which has been extended through
October 31, 1999, at a base salary of $100,000 per annum. The agreement also
provides for typical perquisites such as reimbursement of expenses, paid
vacation, automobile allowance and medical and disability insurance. Mr.
Christensen can earn a bonus of up to $25,000 per fiscal year based on revenue
and profitability targets to be agreed upon between UDN's President and Mr.
Christensen (the "Bonus").
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Mr. Christensen may terminate the agreement for any reason upon thirty days'
prior written notice. In the event that Mr. Christensen's employment is
terminated by UDN without cause, Mr. Christensen will be entitled to a severance
payment equal to his monthly base salary times the number of months remaining in
the term of the agreement up to a maximum of six months, in addition to the
amount of the Bonus which would have been earned in the fiscal year of
termination, multiplied by a fraction of which the numerator is the number of
days in that year prior to termination and the denominator is 365.
In the event that there is a change in control of UDN, Mr. Christensen may
elect to terminate the agreement. In that event, Mr. Christensen will be
entitled to a severance payment equal to his monthly base salary times the
number of months remaining in the term of the contract, up to a maximum of six
months and will continue to receive medical and disability insurance benefits
for a period of six (6) months from the date of termination.
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CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
TRANSACTIONS WITH STAR OUTSIDE DIRECTORS
STAR provides services to Digital Network, Inc. ("DNI"), a wholly owned
subsidiary of UDN. John R. Snedegar, a Director of STAR, is President of UDN.
For the year ended December 31, 1997 and the nine months ended September 30,
1998, DNI made payments to STAR in the amount of approximately $1,141,000 and
$4,207,450, respectively for such services.
On November 19, 1997, STAR entered into the Merger Agreement. Messrs.
Snedegar and Edgecomb beneficially own 11.2% and 2%, respectively, of the
outstanding common stock of UDN. In connection with the Merger, STAR has loaned
$4.5 million to UDN at market rates of interest. See "The Merger-- The Merger
Agreement--Promissory Notes."
GH Associates, an affiliate of Gordon Hutchins, Jr., a Director of STAR,
provides consulting services to STAR. For the years ended December 31, 1995,
1996 and 1997 and for the nine months ended September 30, 1998, STAR made
payments of approximately $60,000, $154,000, $72,000 and $56,000, respectively,
to GH Associates for general business consulting services relating to the
telecommunications industry and for the performance of other tasks requested by
STAR's Chief Executive Officer, President and Board of Directors. In addition,
in connection with these services, STAR granted to Mr. Hutchins a nonstatutory
option to purchase 205,000 shares of STAR Common Stock at an exercise price of
$1.46 per share.
STAR's Outside Directors have been granted nonstatutory stock options under
the Director Plan. See "Management of STAR and UDN--STAR Director Compensation."
TRANSACTIONS WITH STAR EXECUTIVE OFFICERS
Each of Kelly D. Enos, David Vaun Crumly and James E. Kolsrud received
incentive stock options to purchase 4,100 shares of STAR Common Stock at an
exercise price of $16.31 in January 1998, and incentive stock options to
purchase 100 shares of STAR Common Stock at an exercise price of $27.00 in May
1998.
On October 4, 1996, STAR entered into a $12.0 million line of credit with
Comerica Bank. This line of credit was guaranteed by Christopher E. Edgecomb,
STAR's Chief Executive Officer. STAR has entered into a new revolving credit
facility since that time and Mr. Edgecomb's guarantee of the Comerica Bank line
has been terminated. Mr. Edgecomb did not receive any additional compensation in
connection with such guarantee. STAR has entered into lines of credit with Mr.
Edgecomb in the aggregate amount of $1,448,000. Borrowings under the lines of
credit bear interest at a rate of 9.0% and there was $82,000 outstanding under
these lines of credit as of March 31, 1998. In addition, on November 27, 1997
STAR provided a short-term loan to Mr. Edgecomb for $8.0 million. The loan
carried interest of 7% per annum and was repaid in seven days.
Mr. Edgecomb owns Star Aero Services, Inc. ("Star Aero"), which has
ownership interests in five airplanes that STAR utilizes for business travel
from time to time. For the years ended December 31, 1995, 1996 and 1997, STAR
paid $144,000, $68,000 and $171,000, respectively, in costs related to the use
of Star Aero services.
Mr. Crumly had controlling ownership of three companies that resold
transmission capacity to STAR during 1996 for a total of approximately $240,000.
No fees were paid to Mr. Crumly during 1997 with respect to such transmission
capacity. In addition, STAR reimbursed approximately $131,000 in legal fees
incurred by such companies in connection with a dispute with the provider of the
capacity that was resold to STAR.
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Mr. Kolsrud has a 12.5% interest in Interpacket Group, Inc. ("Interpacket")
which has direct termination arrangements with STAR for certain countries in
Central and South America. For the years ended December 31, 1996 and 1997, STAR
paid $37,000 and $256,000, respectively, for services rendered by Interpacket.
In addition, STAR purchased satellite transmission equipment and services from
Interpacket during 1997 and the nine months ended September 30, 1998 for
$1,114,000 and $6.3 million, respectively.
INDEMNIFICATION OF STAR DIRECTORS AND OFFICERS
STAR's Amended and Restated Certificate of Incorporation limits the
liability of its directors for monetary damages arising from a breach of their
fiduciary duty as directors, except to the extent otherwise required by the
Delaware General Corporation Law. Such limitation of liability does not affect
the availability of equitable remedies such as injunctive relief or rescission.
STAR's Bylaws provide that STAR shall indemnify its directors and officers
to the fullest extent permitted by Delaware law, including in circumstances in
which indemnification is otherwise discretionary under Delaware law. STAR's has
also entered into or will enter into indemnification agreements with its
officers and directors containing provisions that may require STAR, among other
things, to indemnify such officers and directors against certain liabilities
that may arise by reason of their status or service as directors or officers
(other than liabilities arising from willful misconduct of a culpable nature),
to advance their expenses incurred as a result of any proceeding against them as
to which they could be indemnified, and to obtain directors' and officers'
insurance if available on reasonable terms.
STAR believes that all of the transactions set forth above were made on
terms no less favorable to STAR than could have been obtained from unaffiliated
third parties. All future transactions, including loans between STAR and its
officers, directors, principal stockholders and their affiliates will be
approved by a majority of the Board of Directors, including a majority of the
independent and disinterested outside directors on the Board of Directors, and
will continue to be on terms no less favorable to STAR than could be obtained
from unaffiliated third parties.
TRANSACTIONS WITH UDN DIRECTORS AND OFFICERS
Donald Sledge is covered by UDN's health and dental insurance plan, and UDN
reimburses the annual costs of his life insurance policy.
In March 1996, UDN acquired all of the outstanding common stock of AMS for
consideration totaling $5.0 million, consisting of $1.0 million in cash, $3.0
million in convertible debentures and $1.0 million in notes payable.
Ninety-three percent of the outstanding shares of AMS were owned by Ennis
Rushton and Cindy Rushton, his wife. Immediately following this transaction, Mr.
Rushton became a director of UDN.
Under the AMS acquisition agreement, UDN was entitled to reduce the
outstanding amount of the convertible debentures and notes payable issued in the
transaction by the amounts by which (a) the net worth of AMS at closing was less
than an agreed upon amount and (b) revenue in several specified post-closing
periods was less than an agreed upon amount. Pursuant to these provisions, UDN
reduced the outstanding debentures by approximately $1.1 million as a result of
the closing-date equity level of AMS, and by approximately $368,000 as a result
of the post-closing revenue of AMS. Ennis and Cindy Rushton disputed the amount
of the reduction relating to post-closing revenue. In addition, subsequent to
the AMS acquisition, $500,000 of the convertible debentures were converted by
the holders into 250,000 shares of UDN Common Stock. In March 1998, UDN settled
the dispute with Ennis and Cindy Rushton by a reduction of $200,000 in the
amount outstanding under the Convertible Debenture. All amounts due under the
notes payable to the AMS sellers have been paid and the net amount outstanding
under the Convertible Debenture is $550,000. On July 30, 1998, UDN signed an
extension agreement with the holder of the debenture under which the right to
convert the debenture into shares of UDN Common Stock expired and a $33,000
extension fee was paid by UDN to the debenture holder.
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In each of fiscal 1998 and fiscal 1996, Dale Christensen was granted options
to acquire 37,500 shares of UDN Common Stock.
On July 21, 1998, UDN issued a promissory note in the principal amount of
$1.0 million payable to the order of Mr. Snedegar. The outstanding principal
balance of the note accrues interest at 10% and matures on the earlier of thirty
days after the occurrence of a Change of Control (as defined in the promissory
note) and July 21, 1999.
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PRINCIPAL STOCKHOLDERS OF STAR
The following table sets forth certain information known to STAR regarding
beneficial ownership of STAR Common Stock as of February 9, 1999, as adjusted to
reflect the issuance of shares in the Merger by (i) each person who is known by
STAR to own beneficially more than five percent of STAR's Common Stock, (ii)
each of STAR's directors, (iii) each of the Named Officers, and (iv) all current
officers and directors as a group.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED SHARES BENEFICIALLY OWNED
BEFORE THE MERGER(1) AFTER THE MERGER(1)
--------------------------- ---------------------------
NAME AND ADDRESS OF BENEFICIAL OWNER NUMBER PERCENT(2) NUMBER PERCENT(2)
- ------------------------------------------------------------ ------------ ------------- ------------ -------------
<S> <C> <C> <C> <C>
Gordon Hutchins, Jr.(3) .................................... 188,600 * 188,600 *
John R. Snedegar(4) ........................................ 10,250 * 122,874 *
Mark Gershien(5) ........................................... 10,250 * 10,250 *
Arunas A. Chesonis ......................................... -- -- -- --
Christopher E. Edgecomb(6) ................................. 12,676,907 22.1% 12,696,821 21.8%
Mary A. Casey .............................................. 1,596,613 2.8% 1,596,613 2.7%
David Vaun Crumly(7) ....................................... 891,416 1.5% 894,527 1.5%
James E. Kolsrud(8) ........................................ 174,022 * 174,022 *
Kelly D. Enos(9) ........................................... 214,337 * 214,337 *
Samer Tawfik ............................................... 9,138,711 15.9% 9,138,711 15.7%
All directors and executive officers as a group (9
persons)(10) ............................................. 24,901,106 43.4% 25,036,755 42.9%
</TABLE>
- ------------------------
* Represents beneficial ownership of less than 1% of the outstanding shares of
Common Stock.
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and includes voting or investment power
with respect to securities. The address for each listed director and officer
is c/o STAR Telecommunications, Inc., 223 East De La Guerra Street, Santa
Barbara, California 93101. To STAR's knowledge, except as indicated in the
footnotes to this table and pursuant to applicable community property laws,
the persons named in the table have sole voting and investment power with
respect to all shares of STAR Common Stock.
(2) Percentage of beneficial ownership is based on 57,350,859 shares of STAR
Common Stock outstanding as of January 27, 1999 and 58,356,430 shares of
STAR Common Stock after the completion of the Merger. The number of shares
of STAR Common Stock beneficially owned includes the shares issuable
pursuant to stock options and warrants that are exercisable within sixty
days of February 9, 1999.
(3) Consists of 188,600 shares issuable upon the exercise of stock options
exercisable within sixty days of February 9, 1999.
(4) Prior to the Merger, consists of 10,250 shares of STAR Common Stock issuable
upon the exercise of stock options exercisable within sixty days of February
9, 1999. After completion of the Merger, consists of 5,308 shares of STAR
Common Stock owned by a trust for the benefit of Mr. Snedegar's children,
under which Mr. Snedegar is a potential beneficiary and the sole trustee. In
addition, Mr. Snedegar is a potential beneficiary and the sole trustee under
the Snedegar Revocable Living Trust ("SRLT"). SRLT, in turn, owns 100% of
the issued shares of Norexco Petroleum Company ("Norexco"), which in turn
owns 100% of the issued shares of Avalon Management Corp. ("Avalon"). Avalon
is the general partner of and owns 25% of a limited partnership, Access
Financial, L.P. ("Access"), which owns 40,802 shares of STAR Common Stock.
The post-merger number also includes 4,347 shares of STAR Common Stock
subject to share purchase warrants owned by Access and exercisable within
sixty days of February 9, 1999 and 10,250 shares of STAR Common Stock
issuable upon the exercise of stock options exercisable within sixty days of
February 9, 1999.
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(5) Consists of 10,250 shares of STAR Common Stock issuable upon the exercise of
stock options exercisable within sixty days of February 9, 1999.
(6) Mr. Edgecomb disclaims beneficial ownership with respect to 4,100 shares of
STAR Common Stock.
(7) Prior to the Merger, consists of 737,666 shares of STAR Common Stock, and
153,750 shares of STAR Common Stock issuable upon the exercise of stock
options exercisable within sixty days of February 9, 1999, and after the
completion of the Merger, consists of 738,032 shares of STAR Common Stock
and 156,495 shares of STAR Common Stock issuable upon the exercise of stock
options exercisable within sixty days of February 9, 1999.
(8) Consists of 101,250 shares of STAR Common Stock, 20,497 shares of STAR
Common Stock held in joint tenancy and 52,275 shares of STAR Common Stock
issuable upon the exercise of stock options exercisable within sixty days of
February 9, 1999.
(9) Consists of 96,720 shares of STAR Common Stock and 117,617 shares of STAR
Common Stock issuable upon the exercise of stock options exercisable within
sixty days of February 9, 1999.
(10) Prior to the Merger, consists of 532,742 shares of STAR Common Stock
issuable upon the exercise of stock options exercisable within sixty days of
February 9, 1999, and after completion of the Merger, includes 535,487
shares of STAR Common Stock issuable upon the exercise of stock options and
warrants exercisable within sixty days of February 9, 1999.
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PRINCIPAL STOCKHOLDERS OF UDN
The following table sets forth the number of and percentage of outstanding
shares of UDN Common Stock owned by UDN Named Officers and the UDN directors and
principal stockholders as of February 9, 1999.
<TABLE>
<CAPTION>
SHARES OF COMMON STOCK
BENEFICIALLY OWNED(1)
-------------------------
NAMES AND ADDRESS OF BENEFICIAL OWNER NUMBER PERCENT(2)
- ---------------------------------------- ------------- ------
<S> <C> <C>
John R. Snedegar ....................... 769,147(3) 11.2%
18872 MacArthur Boulevard, Suite 300
Irvine, California 92612
Dale W. Christensen .................... 199,317(4) 2.9%
1431 Greenway Drive, Suite 640
Irving, Texas 75038
Ennis Rushton .......................... 232,500 3.4%
660 Bird Lane
Litchfield, Arizona
Donald Sledge .......................... 112,500(5) 1.6%
27 Cherry Hill Court
Alamo, California 94507
Janine Thomas .......................... 25,000(6) 0.4%
109 Stevens Drive
W. Vancouver, BC V751C2
All Directors and Executive Officers as
a Group (5 persons) .................. 1,338,464 19.5%
</TABLE>
- ------------------------
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and includes voting or investment power
with respect to securities. To UDN's knowledge, except as indicated in the
footnotes to this table and pursuant to applicable community property laws,
the persons named in the table have sole voting and investment power with
respect to all shares of UDN Common Stock.
(2) Percentage of beneficial ownership is based on 6,867,344 shares of UDN
Common Stock outstanding as of February 9, 1999.
(3) Includes 36,250 shares of UDN Common Stock owned by a trust for the benefit
of Mr. Snedegar's children, under which Mr. Snedegar is a potential
beneficiary and the sole trustee. In addition, Mr. Snedegar is a potential
beneficiary and the sole trustee under SRLT. SRLT, in turn, owns 100% of the
issued shares of Norexco which in turn owns 100% of the issued shares of
Avalon. Avalon is the general partner of and owns 25% of Access which owns
278,650 shares of UDN. Includes share purchase warrants to purchase 29,688
shares of UDN Common Stock owned by Access, which warrants are currently
exercisable and expire on February 10, 1999.
(4) Includes 7,500 shares of UDN Common Stock issuable upon exercise of share
purchase warrants, which warrants are currently exercisable and expire of
February 10, 1999. Also includes 75,000 shares of UDN Common Stock issuable
upon exercise of stock options exercisable within sixty days of February 9,
1999.
(5) Includes 75,000 shares of UDN Common Stock issuable upon the exercise of
stock options exercisable within sixty days of February 9, 1999.
(6) Includes 25,000 shares of UDN Common Stock issuable upon the exercise of
stock options exercisable within sixty days of February 9, 1999.
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DESCRIPTION OF STAR CAPITAL STOCK
The authorized capital stock of STAR consists of 100,000,000 shares of
Common Stock, $0.001 par value, and 5,000,000 shares of Preferred Stock, $0.001
par value.
COMMON STOCK
As of February 9, 1999, there were approximately 57,350,859 shares of STAR
Common Stock outstanding that were held of record by approximately 158
stockholders. There will be approximately 58,356,430 shares of Common Stock
outstanding (assuming no exercise after February 9, 1999 of outstanding options)
after giving effect to the issuance of shares of STAR Common Stock in the
Merger.
The holders of STAR Common Stock are entitled to one vote per share on all
matters to be voted upon by the stockholders. Subject to preferences that may be
applicable to any outstanding Preferred Stock, the holders of STAR Common Stock
are entitled to receive ratably such dividends, if any, as may be declared from
time to time by STAR's Board of Directors out of funds legally available
therefor. In the event of the liquidation, dissolution, or winding up of STAR,
the holders of STAR Common Stock are entitled to share ratably in all assets
remaining after payment of liabilities, subject to prior distribution rights of
Preferred Stock, if any, then outstanding. The STAR Common Stock has no
preemptive or conversion rights or other subscription rights. There are no
redemption or sinking fund provisions applicable to the STAR Common Stock. All
outstanding shares of STAR Common Stock are fully paid and nonassessable, and
the shares of STAR Common Stock to be issued upon completion of this offering
will be fully paid and nonassessable.
PREFERRED STOCK
Pursuant to STAR's Amended and Restated Certificate of Incorporation, the
Board of Directors has the authority to issue up to 5,000,000 shares of
Preferred Stock in one or more series and to fix the rights, preferences,
privileges and restrictions thereof, including dividend rights, dividend rates,
conversion rights, voting rights, terms of redemption, redemption prices,
liquidation preferences and the number of shares constituting any series or the
designation of such series, without further vote or action by the stockholders.
The issuance of Preferred Stock may have the effect of delaying, deferring or
preventing a change in control of STAR without further action by the
stockholders and may adversely affect the voting and other rights of the holders
of STAR Common Stock. The issuance of Preferred Stock with voting and conversion
rights may adversely affect the voting power of the holders of STAR Common
Stock, including the loss of voting control to others. At present, STAR has no
plans to issue any of the Preferred Stock.
ANTI-TAKEOVER EFFECTS OF PROVISIONS OF THE CERTIFICATE OF INCORPORATION, BYLAWS
AND DELAWARE LAW
CERTIFICATE OF INCORPORATION AND BYLAWS. STAR's Amended and Restated
Certificate of Incorporation provides that the Board of Directors be divided
into three classes of directors, with each class serving a staggered three-year
term. The classification system of electing directors may tend to discourage a
third party from making a tender offer or otherwise attempting to obtain control
of STAR and may maintain the incumbency of the Board of Directors, as the
classification of the Board of Directors generally increases the difficulty of
replacing a majority of the directors. The Amended and Restated Certificate of
Incorporation also provides that all stockholder actions must be effected at a
duly called meeting and not by a consent in writing. Further, provisions of the
Bylaws and the Amended and Restated Certificate of Incorporation provide that
the stockholders may amend the Bylaws or certain provisions of the Amended and
Restated Certificate of Incorporation only with the affirmative vote of 75% of
STAR's capital stock. These provisions of the Amended and Restated Certificate
of Incorporation and Bylaws could discourage potential acquisition proposals and
could delay or prevent a change in control of STAR. These provisions are
intended to enhance the likelihood of continuity and stability in the
composition of the Board of Directors and in the policies formulated by the
Board of Directors and to discourage certain types of
153
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transactions that may involve an actual or threatened change of control of STAR.
These provisions are designed to reduce the vulnerability of STAR to an
unsolicited acquisition proposal. The provisions also are intended to discourage
certain tactics that may be used in proxy fights. However, such provisions could
have the effect of discouraging others from making tender offers for STAR's
shares and, as a consequence, they also may inhibit fluctuations in the market
price of STAR's shares that could result from actual or rumored takeover
attempts. Such provisions also may have the effect of preventing changes in the
management of STAR. See "Risk Factors--Effect of Certain Charter Provisions;
Anti-takeover Effects of Certificate of Incorporation, Bylaws and Delaware Law."
DELAWARE TAKEOVER STATUTE. STAR is subject to Section 203 of the Delaware
General Corporation Law ("Section 203"), which, subject to certain exceptions,
prohibits a Delaware corporation from engaging in any business combination with
any interested stockholder for a period of three years following the date that
such stockholder became an interested stockholder, unless: (i) prior to such
date, the board of directors of the corporation approved either the business
combination or the transaction that resulted in the stockholder becoming an
interested stockholder; (ii) upon consummation of the transaction that resulted
in the stockholder becoming an interested stockholder, the interested
stockholder owned at least 85% of the voting stock of the corporation
outstanding at the time the transaction commenced, excluding for purposes of
determining the number of shares outstanding those shares owned (x) by persons
who are directors and also officers and (y) by employee stock plans in which
employee participants do not have the right to determine confidentially whether
shares held subject to the plan will be tendered in a tender or exchange offer;
or (iii) on or subsequent to such date, the business combination is approved by
the board of directors and authorized at an annual or special meeting of
stockholders, and not by written consent, by the affirmative vote of at least
66 2/3% of the outstanding voting stock that is not owned by the interested
stockholder.
Section 203 defines business combination to include: (i) any merger or
consolidation involving the corporation and the interested stockholder; (ii) any
sale, transfer, pledge or other disposition of 10% or more of the assets of the
corporation involving the interested stockholder; (iii) subject to certain
exceptions, any transaction that results in the issuance or transfer by the
corporation of any stock of the corporation to the interested stockholder; (iv)
any transaction involving the corporation that has the effect of increasing the
proportionate share of the stock of any class or series of the corporation
beneficially owned by the interested stockholder; or (v) the receipt by the
interested stockholder of the benefit of any loans, advances, guarantees,
pledges or other financial benefits provided by or through the corporation. In
general, Section 203 defines an interested stockholder as any entity or person
beneficially owning 15% or more of the outstanding voting stock of the
corporation and any entity or person affiliated with or controlling or
controlled by such entity or person.
REGISTRATION RIGHTS
Holders of approximately 17,252,000 shares of STAR Common Stock are entitled
to certain rights with respect to the registration of such shares under the
Securities Act. Under the terms of the agreement between STAR and the holders of
such registrable securities, if STAR proposes to register any of its securities
under the Securities Act, either for its own account or for the account of other
security holders exercising registration rights, such holders are entitled to
notice of such registration and are entitled to include shares of such Common
Stock therein. Additionally, certain holders are also entitled to demand
registration rights pursuant to which they may require STAR to file a
registration statement under the Securities Act at its expense with respect to
their shares of Common Stock, and STAR is required to use its best efforts to
effect such registration. All of these registration rights are subject to
certain conditions and limitations, among them the right of the underwriters of
an offering to limit the number of shares included in such registration and the
right of STAR not to effect a requested registration within six months following
an offering of STAR's securities pursuant to which the holder exercising demand
rights was given the right to participate in without any allocation limits.
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TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the STAR Common Stock is U.S. Stock
Transfer Corporation, 1745 Gardena Avenue, Glendale, California 91204, and its
telephone number is (818) 502-1404.
CERTAIN INCOME TAX CONSEQUENCES
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
The following discussion addresses certain material federal income tax
consequences of the Merger to stockholders of UDN Common Stock who hold their
shares as capital assets (within the meaning of Section 1221 of the Internal
Revenue Code of 1986, as amended (the "Code")). The discussion is based on the
current provisions of the Code, applicable Treasury Regulations, judicial
authority and administrative rulings and practice. It does not address all
aspects of federal income taxation that may be relevant to particular UDN
stockholders in light of their specific circumstances, or to certain types of
stockholders subject to special treatment under the federal income tax laws,
including without limitation, insurance companies, tax-exempt organizations,
foreign persons, financial institutions or broker-dealers, and stockholders who
acquired their UDN Common Stock pursuant to the exercise of employee stock
options or in other compensatory transactions. This discussion also does not
address the state, local, foreign or other federal tax consequences of the
Merger. There can be no assurance that the Internal Revenue Service will not
take a contrary view to any expressed herein. No rulings have been or will be
requested from the Internal Revenue Service with respect to the tax consequences
of the Merger. Moreover, legislative, judicial or administrative changes or
interpretations may be forthcoming that could alter or modify the statements and
conclusions set forth herein, possibly with retroactive effect.
ALL UDN STOCKHOLDERS ARE URGED TO CONSULT THEIR OWN TAX ADVISORS AS TO THE
SPECIFIC TAX CONSEQUENCES TO THEM OR THE MERGER, INCLUDING THE APPLICABILITY AND
EFFECT OF ANY FEDERAL, STATE, LOCAL AND FOREIGN TAX LAWS, AND POSSIBLE CHANGES
IN APPLICABLE TAX LAWS.
Based on the assumptions set forth below, the Merger should qualify as a
tax-free reorganization under Section 368(a)(1) of the Code. As a result, no
gain or loss will be recognized by a stockholder whose shares of UDN Common
Stock are converted into shares of STAR Common Stock, except to the extent of
any cash received in lieu of fractional shares of STAR Common Stock. Each
stockholder receiving cash in lieu of a fractional share of STAR Common Stock
will be treated as having received such fractional share interest and as having
sold it for the cash received, recognizing gain or loss equal to the difference
between the amount of cash received and the portion of that stockholder's basis
in the shares of UDN Common Stock allocable to the fractional share interest.
Such gain or loss will generally be treated as capital gain or loss (long-term
or short-term depending on the stockholder's holding period), unless the payment
transaction is essentially equivalent to a dividend within the meaning of
Section 302 of the Code (a "Dividend Transaction"). The tax basis of the STAR
Common Stock exchanged therefor (except for the basis attributable to any
fractional share interest in STAR Common Stock), and the holding period of the
STAR Common Stock will include the holding period of the UDN Common Stock
surrendered in the Merger.
A stockholder who exercises his appraisal rights with respect to a share of
UDN Common Stock and receives payment for such stock in cash will recognize
capital gain or loss (long-term or short-term depending on the the stockholder's
holding period) measured by the difference between the amount of cash received
and the stockholder's basis in such share, provided the appraisal transaction is
not a Dividend Transaction.
A transaction is not a Dividend Transaction with respect to a UDN
stockholder if, after taking into account shares owned actually and
constructively within the meaning of Section 318 of the Code, there is a
meaningful reduction in the stockholder's proportionate interest in the
corporation. Under this rule, the
155
<PAGE>
Internal Revenue Service has ruled that a redemption of a fractional share for
cash in the context of a reorganization transaction (such as the Merger) is
generally not a Dividend Transaction. In addition, the Internal Revenue Service
has ruled that any reduction in the percentage interest of a small minority
shareholder in a publicly held corporation who exercises no control over
corporate affairs should constitute a meaningful reduction.
The tax discussion set forth herein is based on the accuracy of certain
representations made by STAR and UDN, including the following: (i) the Merger
will be consummated in accordance with the Merger Agreement; (ii) following the
Merger, UDN will hold substantially all (i.e., 90% of net asset value and 70% of
gross asset value) of its own properties and substantially all of Newco's
properties, and will continue its historic business or use a significant portion
of its historic business assets in a business; (iii) UDN has not redeemed, and
persons related to UDN have not acquired (other than in exchange for STAR or UDN
stock), an amount of UDN stock, and UDN has not made any extraordinary
distributions with respect to its stock, prior to and connection with the
Merger, that would in the aggregate, reduce the value of all outstanding UDN
stock immediately prior to the Merger (after giving effect to such redemptions,
acquisitions, and distributions) to a value of less than 50 percent of the value
of all of the outstanding stock of UDN stock immediately prior to the Merger
determined without regard to such redemptions, acquisitions and distributions;
and (iv) in connection with the Merger, neither STAR nor any person related to
STAR, will acquire any UDN Common Stock for consideration other than STAR Common
Stock (other cash paid for fractional share and dissenters' shares) or redeem
any of the STAR Common Stock issued in the Merger.
If the Merger were not to constitute a reorganization under Section
368(a)(1) of the Code, each UDN stockholder would recognize gain or loss equal
to the difference between the fair market value of the STAR Common Stock
received and cash received in lieu of fractional share and such stockholder's
basis in the shares of UDN Common Stock exchanged therefor. Such gain or loss
would be long-term or short-term capital gain or loss, depending upon the
stockholder's holding period with respect to the UDN Stock.
Because the former UDN stockholders will own less than 50 percent of STAR
after the Merger, the Merger will be treated as an "ownership change" with
respect to UDN for purposes of Section 382 of the Code. As a result, the ability
of STAR to use any net operating losses of UDN from periods prior to the
Effective Time will generally be limited to an annual amount equal to the total
value (determined immediately prior to the Merger) of the stock of UDN
multiplied by a long-term tax-exempt interest rate factor (as published by the
Internal Revenue Service on a monthly basis).
CERTAIN CANADIAN AND FOREIGN TAX CONSEQUENCES
Stockholders of UDN and dissenting stockholders of UDN who are residents in,
or citizens of, Canada or another foreign jurisdiction should be aware that the
Merger (or the exercise of appraisal rights in respect of the Merger) may result
in the holder realizing or being required to record a gain or loss on the
exchange of shares under the Merger (or upon the exercise of, or any payment
being made in connection with, appraisal rights) or result in other tax
consequences to such holders. Such tax consequences, if any, are not described
herein. Such stockholders are urged to consult their own Canadian or foreign
tax, legal or other financial advisors, as applicable, as to the implications of
the Merger to them under such income tax laws.
156
<PAGE>
LEGAL MATTERS
The validity of the STAR Common Stock offered hereby will be passed upon for
STAR by Riordan & McKinzie, a Professional Corporation, Los Angeles, California.
Certain legal matters will be passed on for UDN by Parker Chapin Flattau &
Klimpl, LLP, New York, New York.
EXPERTS
The Consolidated Financial Statements of STAR Telecommunications, Inc. as of
December 31, 1996 and 1997 and for each of the years in the three year period
ended December 31, 1997, included in this Proxy Statement/Prospectus and
elsewhere in this Registration Statement have been audited by Arthur Andersen
LLP, independent public accountants, as set forth in their reports with respect
thereto, and are included herein in reliance upon the authority of said firm as
experts in accounting and auditing in giving said reports.
The Consolidated Financial Statements of PT-1 Communications, Inc. and
subsidiary as of March 31, 1997 and 1998 and for the period from April 21, 1995
(inception) to March 31, 1996 and for each of the years in the two-year period
ended March 31, 1998, included in this Proxy Statement/Prospectus and elsewhere
in this Registration Statement have been audited by KPMG LLP, independent public
accountants, as set forth in their reports with respect thereto, and are
included herein in reliance upon the authority of said firm as experts in
accounting and auditing in giving said reports.
The Consolidated Financial Statements of United Digital Network, Inc. as of
April 30, 1996 and 1997 and as of December 31, 1997, and for each of the years
in the two year period ended April 30, 1997, and the eight month period ended
December 31, 1997, included in this Proxy Statement/Prospectus and elsewhere in
this Registration Statement have been audited by PricewaterhouseCoopers LLP,
independent accountants, as set forth in their reports with respect thereto, and
are included herein in reliance upon the authority of said firm as experts in
accounting and auditing in giving said reports.
The Consolidated Financial Statements of United Digital Network, Inc. as of
April 30, 1995 and for the one-year period ended April 30, 1995, included in
this Proxy Statement/Prospectus and elsewhere in this Registration Statement
have been audited by Weaver & Tidwell, L.L.P., independent accountants, as set
forth in their report with respect thereto, and are included herein in reliance
upon the authority of said firm as experts in accounting and auditing in giving
said reports.
FUTURE STOCKHOLDER PROPOSALS
UDN expects to hold an annual meeting of stockholders in 1998 unless the
Merger is completed prior thereto. Any UDN stockholder who intends to submit a
proposal for inclusion in the proxy materials for the 1998 annual meeting of UDN
must submit such proposal to the Secretary of UDN by March 1, 1999.
157
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Report of Independent Public Accountants................................................................... F-2
Consolidated Balance Sheets as of December 31, 1996 and 1997............................................... F-3
Consolidated Statements of Operations for the years ended December 31, 1995, 1996 and 1997................. F-4
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1996 and 1997....... F-5
Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1996 and 1997................. F-6
Notes to Consolidated Financial Statements................................................................. F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders
of STAR Telecommunications, Inc. and Subsidiaries:
We have audited the accompanying consolidated balance sheets of STAR
TELECOMMUNICATIONS, INC. (a Delaware corporation) AND SUBSIDIARIES, as of
December 31, 1996 and 1997, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of STAR Telecommunications,
Inc. and Subsidiaries as of December 31, 1996 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997 in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Los Angeles, California
February 12, 1998
(except with respect
to the T-One acquisition as
described in Note 1 and to
the stock split discussed in
Note 14 as to which the
date is March 31, 1998)
F-2
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
1996 1997
------------- -------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents............. $ 1,845,000 $ 1,903,000
Short-term investments................ 1,656,000 18,631,000
Accounts receivable, net of allowance
of $6,262,000 and $7,955,000
at December 31, 1996 and 1997,
respectively........................ 35,178,000 46,675,000
Receivable from related parties....... 115,000 --
Other receivables..................... 284,000 2,198,000
Prepaid expenses...................... 960,000 4,712,000
Prepaid taxes......................... 677,000 --
Deferred income taxes................. -- 3,699,000
Other current assets.................. 874,000 87,000
------------- -------------
Total current assets................ 41,589,000 77,905,000
------------- -------------
PROPERTY AND EQUIPMENT:
Operating equipment................... 10,245,000 31,340,000
Leasehold improvements................ 4,362,000 6,477,000
Furniture, fixtures and equipment..... 2,555,000 4,711,000
------------- -------------
17,162,000 42,528,000
Less--Accumulated depreciation and
amortization........................ (1,964,000) (6,569,000)
------------- -------------
15,198,000 35,959,000
------------- -------------
OTHER ASSETS:
Investments........................... 153,000 27,000
Deposits.............................. 5,630,000 6,055,000
Other................................. 484,000 370,000
------------- -------------
6,267,000 6,452,000
------------- -------------
Total assets........................ $ 63,054,000 $ 120,316,000
------------- -------------
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Revolving lines of credit............. $ 7,814,000 $ --
Revolving lines of credit with
stockholder......................... 26,000 138,000
Current portion of long-term debt..... 498,000 480,000
Current portion of note payable....... -- 284,000
Current portion of obligations under
capital leases...................... 872,000 2,495,000
Accounts payable...................... 17,930,000 14,009,000
Taxes payable......................... -- 2,156,000
Related party payable................. 269,000 --
Accrued line costs.................... 19,494,000 38,403,000
Accrued expenses...................... 2,415,000 5,609,000
Other current liabilities............... -- 571,000
------------- -------------
Total current liabilities........... 49,318,000 64,145,000
------------- -------------
LONG-TERM LIABILITIES:
Long-term debt, net of current
portion............................. 1,435,000 968,000
Capital lease obligations, net of
current portion..................... 4,936,000 11,139,000
Deferred compensation................. 116,000 57,000
Deposits.............................. -- 164,000
Other long-term liabilities........... 352,000 642,000
------------- -------------
Total long-term liabilities......... 6,839,000 12,970,000
------------- -------------
STOCKHOLDERS' EQUITY:
Series A Preferred Stock, $.001 par
value, authorized--5,000,000 shares;
issued and outstanding--2,802,446 at
December 31, 1996 and none at
December 31, 1997................... 3,000 --
Common Stock, $.001 par value,
authorized--50,000,000 shares issued
and outstanding-- 24,576,810 and
35,031,519 at December 31, 1996 and
1997, respectively.................. 25,000 35,000
Additional paid-in capital............ 10,225,000 41,662,000
Deferred compensation................. (118,000) (30,000)
Retained earnings (deficit)........... (3,238,000) 1,534,000
------------- -------------
Stockholders' equity................ 6,897,000 43,201,000
------------- -------------
Total liabilities and
stockholders' equity............. $ 63,054,000 $ 120,316,000
------------- -------------
------------- -------------
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
F-3
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------
1995 1996 1997
------------- -------------- --------------
<S> <C> <C> <C>
REVENUES......................................................... $ 58,937,000 $ 259,697,000 $ 404,605,000
OPERATING EXPENSES:
Cost of services............................................... 44,270,000 225,957,000 351,821,000
Selling, general and administrative expenses................... 10,452,000 35,956,000 36,496,000
Depreciation and amortization.................................. 368,000 1,442,000 4,637,000
Merger expense................................................. -- -- 286,000
------------- -------------- --------------
55,090,000 263,355,000 393,240,000
------------- -------------- --------------
Income (loss) from operations................................ 3,847,000 (3,658,000) 11,365,000
OTHER INCOME (EXPENSES):
Interest income................................................ 22,000 110,000 492,000
Interest expense............................................... (64,000) (609,000) (1,738,000)
Legal settlement and expenses.................................. -- (100,000) (1,653,000)
Other income (expense)......................................... (33,000) 39,000 208,000
------------- -------------- --------------
(75,000) (560,000) (2,691,000)
------------- -------------- --------------
Income (loss) before provision for income taxes.............. 3,772,000 (4,218,000) 8,674,000
PROVISION FOR INCOME TAXES....................................... 66,000 577,000 2,905,00
------------- -------------- --------------
NET INCOME (LOSS)................................................ $ 3,706,000 $ (4,795,000) $ 5,769,000
------------- -------------- --------------
------------- -------------- --------------
Income (loss) before provision for income taxes.............. 3,772,000 (4,218,000) 8,674,000
PRO FORMA INCOME TAXES (UNAUDITED)............................... 1,632,000 1,520,000 3,100,000
------------- -------------- --------------
PRO FORMA NET INCOME (LOSS) (UNAUDITED).......................... $ 2,140,000 $ (5,738,000) $ 5,574,000
------------- -------------- --------------
------------- -------------- --------------
Income (loss) per common share................................... $ 0.19 $ (0.21) $ 0.19
------------- -------------- --------------
------------- -------------- --------------
Diluted income (loss) per common share........................... $ 0.19 $ (0.21) $ 0.17
------------- -------------- --------------
------------- -------------- --------------
Pro forma basic income (loss) per common share (unaudited)....... $ 0.11 $ (0.25) $ 0.18
------------- -------------- --------------
------------- -------------- --------------
Pro forma diluted income (loss) per common share (unaudited)..... $ 0.11 $ (0.25) $ 0.17
------------- -------------- --------------
------------- -------------- --------------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-4
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK ADDITIONAL RETAINED
-------------------- ------------------- PAID-IN DEFERRED EARNINGS
SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION (DEFICIT) TOTAL
---------- -------- ---------- ------- ----------- ------------ ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1994.... -- $ 18,808,959 $19,000 $ 1,560,000 $ -- $ 1,377,000 $ 2,956,000
Issuance of common stock...... -- 1,843,339 2,000 101,000 -- 103,000
Conversion of debt to
equity...................... -- -- -- 990,000 -- 990,000
Stockholder contributions..... -- -- -- 269,000 -- 269,000
Net income.................... -- -- -- -- 3,706,000 3,706,000
Cash distributions to
stockholders................ -- -- -- -- (4,216,000) (4,216,000)
---------- -------- ---------- ------- ----------- ------------ ----------- -----------
Balance, December 31, 1995.... -- -- 20,652,298 21,000 2,920,000 -- 867,000 3,808,000
Effect of terminating the
S-corporation election...... -- -- -- (690,000) -- 690,000 --
Conversion of capital to
debt........................ -- -- -- (1,200,000) -- (1,200,000)
Compensation expense relating
to stock options............ -- -- -- 168,000 (118,000) -- 50,000
Issuance of common stock...... -- -- 3,924,512 4,000 5,564,000 -- -- 5,568,000
Issuance of preferred stock... 2,802,446 3,000 -- -- 7,497,000 -- 7,500,000
Net loss...................... -- -- -- -- -- -- (4,795,000) (4,795,000)
Cash distributions to
stockholders................ -- -- -- (4,034,000) -- -- (4,034,000)
---------- -------- ---------- ------- ----------- ------------ ----------- -----------
Balance, December 31, 1996.... 2,802,446 3,000 24,576,810 25,000 10,225,000 (118,000) (3,238,000) 6,897,000
Effect of L.D Services
terminating the
S-corporation election...... -- -- -- (61,000) -- 61,000 --
Conversion of redeemable
preferred stock to common
stock....................... (2,802,446) (3,000) 1,868,284 2,000 1,000 -- -- --
Initial public offering of
common stock................ -- -- 8,097,500 8,000 30,936,000 -- -- 30,944,000
Exercise of stock options..... -- -- 488,925 447,000 -- -- 447,000
Compensation expense relating
to stock options............ -- -- -- -- 88,000 -- 88,000
Tax benefit from non-qualified
stock options............... -- -- -- 114,000 -- -- 114,000
Cash distributions to
stockholders................ -- -- -- -- -- (1,058,000) (1,058,000)
Net income.................... -- -- -- -- -- 5,769,000 5,769,000
---------- -------- ---------- ------- ----------- ------------ ----------- -----------
Balance, December 31, 1997.... $ 35,031,519 $35,000 $41,662,000 $(30,000) $ 1,534,000 $43,201,000
---------- -------- ---------- ------- ----------- ------------ ----------- -----------
---------- -------- ---------- ------- ----------- ------------ ----------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-5
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------------
1995 1996 1997
-------------- -------------- --------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).............................................. $ 3,706,000 $ (4,795,000) $ 5,769,000
Adjustments to reconcile net income (loss) to net cash provided
by (used in) operating activities:
Depreciation and amortization................................ 368,000 1,442,000 4,637,000
Loss on investment........................................... 80,000 --
Loss on disposal of equipment................................ -- -- 42,000
Compensation expense relating to stock options............... -- 50,000 88,000
Provision for doubtful accounts.............................. 217,000 16,284,000 7,791,000
Deferred income taxes........................................ (6,000) (15,000) (3,699,000)
Deferred compensation........................................ -- 116,000 (59,000)
Decrease (increase) in assets:
Accounts receivable............................................ (14,305,000) (29,491,000) (19,288,000)
Receivable from related parties................................ 129,000 (65,000) 115,000
Other receivables.............................................. (268,000) -- (1,914,000)
Prepaid expenses............................................... (114,000) (830,000) (3,752,000)
Deposits....................................................... (630,000) (4,948,000) (425,000)
Prepaid taxes.................................................. -- (677,000) 677,000
Other current assets........................................... (11,000) (859,000) 804,000
Increase (decrease) in liabilities:
Accounts payable............................................... 12,329,000 109,000 (3,921,000)
Taxes payable.................................................. -- -- 2,270,000
Related party payables......................................... 320,000 (51,000) (269,000)
Accrued line costs............................................. 476,000 19,018,000 18,909,000
Accrued expenses............................................... 194,000 1,865,000 3,194,000
Deposits....................................................... -- -- 164,000
-------------- -------------- --------------
Net cash provided by (used in) operating activities........ 2,485,000 (2,847,000) 11,133,000
-------------- -------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures........................................... (1,664,000) (8,480,000) (13,760,000)
Investments.................................................... -- (153,000) 126,000
Short-term investments......................................... (1,000) (1,631,000) (16,975,000)
Other.......................................................... -- (139,000) 639,000
-------------- -------------- --------------
Net cash used in investing activities...................... (1,665,000) (10,403,000) (29,970,000)
-------------- -------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Stockholders' distributions.................................... (4,216,000) (4,034,000) (1,058,000)
Borrowings under lines of credit............................... 1,460,000 14,746,000 34,211,000
Repayments under lines of credit............................... (130,000) (8,262,000) (42,025,000)
Borrowings under lines of credit with stockholder.............. 3,418,000 701,000 583,000
Repayments under lines of credit with stockholder.............. (1,319,000) (3,073,000) (471,000)
Borrowings under long-term debt................................ -- 2,000,000 193,000
Payments under long-term debt.................................. -- (67,000) (1,983,000)
Payments under capital lease obligations....................... (52,000) (358,000) (1,946,000)
Issuance of common stock....................................... -- 5,568,000 30,944,000
Capital contribution........................................... 269,000 --
Stock options exercised........................................ -- 447,000
Issuance of preferred stock.................................... -- 7,500,000 --
-------------- -------------- --------------
Net cash (used in) provided by financing activities........ (570,000) 14,721,000 18,895,000
-------------- -------------- --------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS................. 250,000 1,471,000 58,000
CASH AND CASH EQUIVALENTS, beginning of year..................... 124,000 374,000 1,845,000
-------------- -------------- --------------
CASH AND CASH EQUIVALENTS, end of year........................... $ 374,000 $ 1,845,000 $ 1,903,000
-------------- -------------- --------------
-------------- -------------- --------------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-6
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
(1) NATURE OF BUSINESS
STAR Telecommunications, Inc., a Delaware corporation, and Subsidiaries (the
"Company" or "STAR"), is an emerging multinational carrier focused primarily on
the international long distance market. The Company offers highly reliable,
low-cost switched voice services on a wholesale basis primarily to U.S.-based
long distance carriers. STAR provides international long distance service
through a flexible network comprised of foreign termination relationships,
international gateway switches, leased and owned transmission facilities and
resale arrangements with other long distance providers. While the Company was
incorporated in 1993, it did not commence its current business as a provider of
long distance services until the second half of 1995. During the six months
ended June 1995, the Company primarily acted as an agent for, and provided
various consulting services to, companies in the telecommunications industry.
During 1996 and 1997, the Company established several wholly-owned foreign
subsidiaries to further expand its international network. The Company made
substantial investments to install switch facilities in two of these
subsidiaries, Star Europe Limited (SEL) which is located in London, England, and
Star Telecommunications Deutschland (GmbH) which is located in Frankfurt,
Germany. The Company plans to use these switch facilities to decrease
international traffic termination costs and to initiate outbound calls from
these local markets.
In December 1997, the Company entered into the domestic commercial
long-distance market through the acquisition of L.D. Services, Inc., also known
as LCCR Inc. ("LDS"). LDS is a retail long-distance service provider throughout
the United States. The merger constituted a tax-free reorganization and has been
accounted for as a pooling of interests under Accounting Principles Board
Opinion No. 16. Accordingly, all prior period consolidated financial statements
presented have been restated to include the results of operations, financial
position and cash flows of LDS as though it had always been a part of STAR (see
Note 8). The pro forma results of operations and pro forma income or loss per
common share for 1995, 1996 and 1997 assumes that both STAR and LDS had been
C-Corporations for all periods presented.
In March 1998, the Company consummated a merger with T-One Corp. ("T-One").
The merger constituted a tax-free reorganization and has been accounted for as a
pooling of interests under Accounting Principles Board Opinion No. 16.
Accordingly, all consolidated financial statements presented have been restated
to include the results of operations, financial position, and cash flows of
T-One (see Note 8).
On March 31, 1998, the Company effected a 2.05 for 1 stock split in the
nature of a stock dividend. The stock split has been retroactively reflected in
the condensed consolidated financial statements for all periods presented.
The Company is subject to various risks in connection with the operation of
its business. These risks include, but are not limited to, regulations (both
domestic and foreign), dependence on transmission facilities-based carriers and
suppliers, price competition and competition from larger industry participants.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
STAR Telecommunications, Inc. and its wholly-owned subsidiaries. All significant
intercompany balances and transactions have been eliminated.
F-7
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION
The Company records revenues for telecommunications sales at the time of
customer usage. Finance charges for customer late payments are included in
revenues and amount to $32,000, $1,467,000 and $2,747,000 for the years ended
December 31, 1995, 1996 and 1997, respectively.
COST OF SERVICES
Cost of services for wholesale long distance services represents direct
charges from vendors that the Company incurs to deliver service to its
customers. These include leasing costs for the dedicated phone lines, which form
the Company's network, and rate-per-minute charges from other carriers that
terminate traffic on behalf of the Company. In addition, retail long distance
service cost includes billing and collection service fees from local exchange
carriers and call rating services.
ACCOUNTING FOR INTERNATIONAL LONG DISTANCE TRAFFIC
The Company has carrier service agreements with telecommunication carriers
in foreign countries under which international long distance traffic is both
originated and terminated on the Company's network. The Company records revenues
and related costs as the traffic is recorded in the switch. Revenue from foreign
customers equalled $178,000 and $6,577,000 for the years ended December 31, 1996
and 1997, respectively. The Company recognized settlement costs relating to
foreign carrier agreements of $152,000 in 1996 and $12,314,000 in 1997, which
are included in cost of services in the consolidated statements of operations.
The Company had no revenues or costs relating to foreign customers during 1995.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of demand deposits and money market funds,
which are highly liquid short-term instruments with original maturities of three
months or less. Cash and cash equivalents are stated at cost, which approximates
market.
FINANCIAL INSTRUMENTS
The carrying amounts of notes payable and capital lease obligations
approximate their fair value because interest rates approximate market rates for
similar instruments.
Off balance sheet derivative financial instruments at December 31, 1997
consist of foreign currency exchange agreements.
The Company enters into foreign currency exchange contracts to manage
foreign currency exposures. The principle objective of such contracts is to
minimize the risks and/or costs associated with financial and global operating
activities. The Company does not utilize financial instruments for trading or
other speculative purposes. The counterparty to these contractual arrangements
is a multinational financial institution with which the Company also has other
financial relationships.
The Company enters into forward currency exchange contracts in the normal
course of business to manage its exposure against foreign currency fluctuations
on payable positions resulting from fixed asset
F-8
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
purchases and other contractual expenditures denominated in foreign currencies.
At December 31, 1997, gains and losses on foreign exchange contracts are not
material to the consolidated financial statements.
The fair values of foreign currency contracts are estimated by obtaining
quotes from brokers. At December 31, 1997, the Company has foreign currency
contracts outstanding with the notional value of $6,305,000 which had an
estimated fair value to receive $6,218,000 worth of German marks and British
pounds, the difference of which has been recognized in operations.
The following table summarizes outstanding commitments to purchase foreign
currency at December 31, 1997:
<TABLE>
<CAPTION>
NOTIONAL
MATURITY DATE AMOUNT FAIR VALUE DIFFERENCE
-------------------------- ------------ ------------ ----------
<S> <C> <C> <C> <C>
British Pounds........... 1/29/98 through 3/27/98 $ 364,000 $ 373,000 $ 9,000
Deutsche Mark............ 1/05/98 through 1/26/98 5,941,000 5,845,000 (96,000)
------------ ------------ ----------
$ 6,305,000 $ 6,218,000 $ (87,000)
------------ ------------ ----------
------------ ------------ ----------
</TABLE>
MARKETABLE SECURITIES
Marketable securities consists of interest bearing securities with original
maturities in excess of three months. At December 31, 1997, the fair market
value of temporary investments, classified as "available for sale securities",
approximated cost, thus no unrealized holding gains or losses were reported in
the accompanying balance sheets. During fiscal year 1997, the Company realized
gains from the sale of securities of approximately $48,000.
PROPERTY AND EQUIPMENT
Property and equipment are carried at cost. Depreciation and amortization of
property and equipment are computed using the straight-line method over the
following estimated useful lives:
<TABLE>
<S> <C>
Operating equipment............................... 5-25 years
Leasehold improvements............................ Life of lease
Computer equipment................................ 3-7 years
Furniture and fixtures............................ 5-7 years
</TABLE>
Operating equipment includes assets financed under capital lease obligations
of $6,218,000 and $15,921,000 at December 31, 1996 and 1997, respectively.
Accumulated amortization related to assets financed under capital leases was
$391,000 and $2,123,000 at December 31, 1996 and 1997, respectively.
In addition, operating equipment includes seven Indefeasible Rights of Use
(IRU) in cable systems amounting to $110,000 and $2,669,000 and four ownership
interests in an international cable amounting to $148,000 and $1,534,000 at
December 31, 1996 and 1997, respectively. These assets are amortized over the
life of the agreements of 14 to 25 years (see Note 5).
F-9
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Replacements and betterments, renewals and extraordinary repairs that extend
the life of the asset are capitalized; other repairs and maintenance are
expensed. The cost and accumulated depreciation applicable to assets sold or
retired are removed from the accounts and the gain or loss on disposition is
recognized in other income or expense.
DEPOSITS AND OTHER ASSETS
Deposits represent payments made to long distance providers to secure lower
rates. These deposits are refunded or applied against future services. Other
assets at December 31, 1996 primarily represent initial public offering
expenses, which were subsequently charged to additional paid in capital during
1997 at the time of the initial public offering.
ACCRUED LINE COSTS
Accrued line costs represent accruals for services to transmit and terminate
long distance telephone traffic, which has been provided to the Company but not
yet billed. It also includes differences between billings received by the
Company and the liability computed by the Company's own systems which are being
resolved by the Company and its vendors. Such disputed amounts have not been
material to the results of operations for each statement of operations period
presented.
CONSOLIDATED STATEMENTS OF CASH FLOWS
During the years ended December 31, 1995, 1996 and 1997 cash paid for
interest was $45,000, $541,000 and $1,462,000, respectively. For the same
periods, cash paid for income taxes amounted to $51,000, $1,262,000 and
$3,761,000, respectively.
Non-cash investing and financing activities are as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------
1995 1996 1997
------------ ------------ ------------
<S> <C> <C> <C>
Equipment purchased through capital leases.............................. $ 1,052,000 $ 5,166,000 $ 9,772,000
Notes issued for asset purchases........................................ -- -- 1,890,000
Debt converted to equity................................................ 1,093,000 -- --
Operating agreement acquired through issuance of note................... -- -- 350,000
Equity converted to debt................................................ -- 1,200,000 --
Tax benefits related to stock options................................... -- -- 114,000
</TABLE>
These non-cash transactions are excluded from the consolidated statements of
cash flows.
F-10
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NET INCOME (LOSS) PER COMMON SHARE
The following schedule summarizes the information used to compute pro forma
net income or loss per common share for the years ended December 31, 1995, 1996
and 1997:
<TABLE>
<CAPTION>
1995 1996 1997
------------- ------------- -------------
<S> <C> <C> <C>
Pro forma net income (loss)......................................... $ 2,140,000 $ (5,738,000) $ 5,574,000
------------- ------------- -------------
------------- ------------- -------------
Weighted average number of common shares used to compute basic
earnings (loss) per share......................................... 19,373,000 23,292,000 30,221,000
Weighted average common share equivalents........................... -- -- 2,757,000
------------- ------------- -------------
Weighted average number of common shares and common share
equivalents used to compute diluted net income (loss) per common
share............................................................. 19,373,000 23,292,000 32,978,000
------------- ------------- -------------
------------- ------------- -------------
Basic pro forma net income (loss) per common share (unaudited)...... $ 0.11 $ (0.25) $ 0.18
Diluted pro forma net income (loss) per common share (unaudited).... $ 0.11 $ (0.25) $ 0.17
</TABLE>
CONCENTRATIONS OF RISK
The Company's two largest customers account for approximately 21 percent and
6 percent of gross accounts receivable at December 31, 1996 and 1997,
respectively. The Company's largest customer and second largest customer in 1997
represent 2 percent and 4 percent of accounts receivable as of December 31,
1997, respectively. The Company's largest customer in 1996 was Cherry
Communications, Inc. The second largest customer in 1996 was Hi-Rim
Communications, Inc. Only one customer, Cherry Communications, Inc. had a
receivable balance exceeding 10 percent of gross accounts receivable at December
31, 1996 and no individual customer has an account receivable balance greater
than 10 percent of gross accounts receivable at December 31, 1997.
The two largest customers represent approximately 14 percent, 26 percent and
16 percent of revenues during the years ended December 31, 1995, 1996 and 1997,
respectively. During 1995 and 1996, only sales to Cherry Communications, Inc.
exceeded 10 percent of total sales. For the year ended December 31, 1997, no
customer exceeded 10 percent of revenues.
The Company performs ongoing credit evaluations of its customers. The
Company analyzes daily traffic patterns and concludes whether or not the
customer's credit status justifies the traffic volume. If the customer is deemed
to carry too large a volume in relation to its credit history, the traffic
received by the Company's switch is reduced to prevent further build up of the
receivable from this customer. The Company's allowance for doubtful accounts is
based on current market conditions.
Purchases from the four largest vendors for the years ended December 31,
1995 and 1996 amounted to 53 percent and 44 percent of total purchases,
respectively. Purchases from the four largest vendors for the year ended
December 31, 1997 amounted to 34 percent of total purchases.
F-11
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Included in the Company's balance sheets at December 31, 1996 and 1997 are
approximately $840,000 and $7,028,000 of equipment which is located in foreign
countries.
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
RECENTLY ISSUED ACCOUNTING STANDARDS
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share". The statement replaces primary EPS with basic EPS, which is computed by
dividing reported earnings available to common stockholders by weighted average
shares outstanding. The provision requires the calculation of diluted EPS. The
Company adopted this statement in 1997 and all prior year earnings per share
amounts have been recalculated based on the provisions of SFAS No. 128.
TRANSLATION OF FOREIGN CURRENCY
Management determined that the functional currency of its foreign
subsidiaries is still the U.S. dollar. Thus all foreign translation gains or
losses are reflected in the results of operations in other income (expense).
The foreign subsidiary balance sheets are translated into U.S. dollars using
the year-end exchange rates except for prepayments, property, other long-term
assets, and stockholders' equity accounts, which are translated at rates in
effect when these balances were originally recorded. Revenues and expenses are
translated at average rates during the year except for depreciation and
amortization, which are translated at historical rates.
(3) ACCRUED EXPENSES
Accrued expenses at December 31, 1996 and 1997 consist of the following:
<TABLE>
<CAPTION>
1996 1997
------------ ------------
<S> <C> <C>
Payroll and related............................................... $ 783,000 $ 943,000
Management bonuses................................................ 25,000 152,000
Professional services............................................. 669,000 384,000
Sales and other taxes............................................. 10,000 295,000
Line and billing cost............................................. 324,000 2,592,000
Legal settlement.................................................. 300,000 --
Other............................................................. 304,000 1,243,000
------------ ------------
$ 2,415,000 $ 5,609,000
------------ ------------
------------ ------------
</TABLE>
F-12
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(4) LINES OF CREDIT
BANK LINE OF CREDIT
Effective September 30, 1997, the Company executed an agreement with Sanwa
Bank, California for a $25 million line of credit, which expires on July 1,
1999. The facility has certain financial and non-financial covenants that
include, among other restrictions, the maintenance of minimum levels of tangible
net worth. Borrowings on the facility are limited to 75 percent of eligible
accounts receivable and are secured by substantially all of the assets of the
Company. The credit facility provides for borrowings at an interest rate based
upon the bank's cost of funds plus 1.75 percent (7.47 percent at December 31,
1997). The Company plans to use the credit facility to support letters of credit
and for working capital or other general corporate purposes. At December 31,
1997, no amounts were outstanding, however the Company's availability under this
credit facility was reduced to $20.1 million due to $4.9 million in letters of
credit which were outstanding at December 31, 1997.
The weighted average interest rate on short term debt during the years ended
December 31, 1995, 1996 and 1997 was 10.21 percent, 9.68 percent and 9.12
percent, respectively.
LINES OF CREDIT WITH STOCKHOLDER
At December 31, 1996 and 1997, the Company's revolving lines of credit with
the founder and chief executive officer of the Company totalled $1,448,000. The
debt matures on March 30, 1998 with interest payable at maturity at a rate of 9
percent. There was $1,422,000 and $1,310,000 available to be borrowed against
these lines of credit at December 31, 1996 and 1997, respectively. The Company
recognized interest expense related to this debt of $11,000, $34,000 and $9,000
for the years ended December 31, 1995, 1996 and 1997, respectively.
(5) LONG-TERM DEBT
The Company finances some of its telecommunication equipment under capital
lease arrangements or through notes payable as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1996 1997
------------ -------------
<S> <C> <C>
Bank debt at prime plus 1.5 percent........................................ $ 733,000 $ --
Bank promissory note, payable in $30,000 monthly installments including
interest at prime plus 1.25 percent, (9.75 percent at December 31, 1997)
through December 31, 1999................................................ 1,200,000 904,000
Notes payable for Indefeasible Rights of Use on submarine cable, payable in
quarterly installments of principal plus interest at LIBOR plus 6 percent
(11.72 percent at December 31, 1997) through September 1999.............. -- 762,000
Note payable for Indefeasible Right of Use, payable in quarterly
installments of $9,000 plus interest at LIBOR plus 6 percent through
September 1999........................................................... -- 66,000
Obligations under capital leases........................................... 5,808,000 13,634,000
------------ -------------
$ 7,741,000 $ 15,366,000
------------ -------------
------------ -------------
</TABLE>
F-13
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(5) LONG-TERM DEBT (CONTINUED)
Minimum future lease payments under capital leases at December 31, 1997 are
as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
- -----------------------------------------------------------------------------------------
<S> <C>
1998..................................................................................... $ 3,944,000
1999..................................................................................... 3,943,000
2000..................................................................................... 3,614,000
2001..................................................................................... 2,927,000
2002..................................................................................... 2,505,000
Thereafter............................................................................... 814,000
-------------
17,747,000
Less: Amount representing interest....................................................... (4,113,000)
-------------
13,634,000
Less: Current portion.................................................................... (2,495,000)
-------------
$ 11,139,000
-------------
-------------
</TABLE>
(6) COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
The Company leases office space, dedicated private telephone lines,
equipment and other items under various agreements expiring through 2006. At
December 31, 1997, the minimum aggregate payments under non-cancelable operating
leases are summarized as follows:
<TABLE>
<CAPTION>
DEDICATED
FACILITIES PRIVATE
YEAR ENDING DECEMBER 31, AND EQUIPMENT LINES TOTAL
- ----------------------------------------------------------- ------------- ------------ -------------
<S> <C> <C> <C>
1998....................................................... $ 3,561,000 $4,969,000 $ 8,530,000
1999....................................................... 3,506,000 1,906,000 5,412,000
2000....................................................... 3,471,000 372,000 3,843,000
2001....................................................... 3,134,000 -- 3,134,000
2002....................................................... 2,843,000 -- 2,843,000
Thereafter................................................. 8,484,000 -- 8,484,000
------------- ------------ -------------
$ 24,999,000 $7,247,000 $ 32,246,000
------------- ------------ -------------
------------- ------------ -------------
</TABLE>
Facility and equipment rent expense for the years ended December 31, 1995,
1996 and 1997 was approximately $255,000, $1,137,000 and $3,333,000,
respectively. Dedicated private line expense was approximately $604,000,
$7,045,000 and $9,414,000, for those same periods and is included in cost of
services in the accompanying consolidated statements of operations.
EMPLOYMENT AGREEMENTS
The Company has employment agreements through December 31, 2000 with several
employees and executives. Some of these agreements provide for a continuation of
salaries in the event of a termination,
F-14
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(6) COMMITMENTS AND CONTINGENCIES (CONTINUED)
with or without cause, following a change in control of the Company. One
agreement provides for a payment of at least $1,500,000 in the event of a change
in control of the Company.
The Company expensed $116,000 and $64,000 of deferred compensation relating
to these agreements for the years ended December 31, 1996 and 1997,
respectively.
PURCHASE COMMITMENTS
The Company is obligated under various service agreements with long distance
carriers to pay minimum usage charges. The Company anticipates exceeding the
minimum usage volume with these vendors. Minimum future usage charges at
December 31, 1997 are as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
- -------------------------------------------------------------------------------
<S> <C>
1998........................................................................... $ 44,053,000
1999........................................................................... 8,356,000
2000........................................................................... 2,949,000
2001........................................................................... 65,000
2002........................................................................... 65,000
Thereafter..................................................................... 774,000
-------------
$ 56,262,000
-------------
-------------
</TABLE>
The Company has entered into six fixed asset purchase agreements. These
commitments are to purchase IRU's, switches, and leasehold improvements for
switch sites. The total commitment approximates $63 million. The Company plans
to finance the majority of these costs through capital lease arrangements.
LEGAL MATTERS
The Company is subject to litigation from time to time in the normal course
of business. Although it is not possible to predict the outcome of such
litigation, based on the facts known to the Company and after consultation with
counsel, management believes that such litigation will not have a material
adverse effect on its financial position or results of operations.
On September 4, 1997, prior to the merger between LDS and the Company, LDS
entered into a settlement agreement with the Consumer Services Division of the
California Public Utilities Commission (PUC). The agreement settles the alleged
unauthorized switching of long-distance customers to LDS between the years 1995
and 1996. It includes a payment of $760,000 to the PUC for restitution to
affected customers as defined in the agreement. Additionally, LDS agreed to a
voluntary revocation of its operating authority in the State of California.
Under the agreement, service to all California customers has to be terminated
within 120 days after approval of the agreement by the PUC. On November 19,
1997, the PUC approved the agreement along with a transfer of control to STAR.
On November 15, 1997, LDS settled a civil suit with the District Attorney of
Monterey, California for a monetary payment of $700,000 and various non-monetary
concessions as defined in the agreement. This
F-15
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(6) COMMITMENTS AND CONTINGENCIES (CONTINUED)
suit was of the same nature as the above action of the PUC and covers complaints
from the years 1994 through 1997.
LETTERS OF CREDIT
At December 31, 1997, the Company has nine standby letters of credit
outstanding, which expire between January 20, 1998 and December 19, 1998. These
letters of credit, most of which are secured by the bank line of credit, total
approximately $5 million.
(7) RELATED PARTY TRANSACTIONS
The founder and chief executive officer of the Company owns Star Aero
Services, Inc. (Star Aero). Star Aero's principal assets represent airplanes
which it provides to the Company for business travel on an as needed basis. In
return, the Company pays for costs related to the airplanes. Star Aero
reimburses the Company for certain costs relating to the maintenance of the
planes. For the years ended December 31, 1995, 1996 and 1997, the Company paid
$144,000, $68,000 and $171,000, respectively, in costs related to the use of
Star Aero services. As of December 31, 1995 and 1996, the Company had
receivables from Star Aero of $50,000 and $115,000, respectively. The Company
had no receivables from Star Aero at December 31, 1997.
During 1997, the Company provided a short-term loan to the chief executive
officer for $8,000,000. The loan carried interest of 7 percent per annum, was
secured by $30,000,000 of the stockholder's stock in the Company, and was repaid
in seven days.
During 1995, the Company invested $128,000 in a company related to an
employee of STAR. During 1996 and 1997, the Company provided services to this
company in the amounts of $167,000 and $926,000. As of December 31, 1996 and
1997, accounts receivable from this related party amounted to $57,000 and
$41,000, respectively.
During 1995, 1996 and 1997, the Company purchased consulting services from a
company owned by a board member in the amount of $60,000, $154,000 and $72,000,
respectively.
During 1996 and 1997, the Company purchased consulting services from a
company owned in part by an employee and a significant stockholder for $37,000
and $256,000, respectively. In addition, the Company purchased equipment and
services from this company in the amount of $1,114,000 in 1997. This significant
stockholder is also a 30 percent investor in a company, whose subsidiary
provided consulting services to the Company in the amount of $12,000 in 1996 and
$213,000 in 1997. In addition, the Company purchased telecommunication services
from three related companies for $240,000 during 1996 and paid legal fees on
behalf of these companies in the amount of $131,000.
During the years ended December 31, 1995, 1996 and 1997, the Company also
provided long distance telephone service to a company controlled by another
board member in the amount of $43,000, $250,000 and $1,141,000, respectively.
Accounts receivable for these services total $721,000 as of December 31, 1997.
In addition, the Company loaned $2,500,000 to this related party. The Company
has announced its intention to merge the two companies (see Note 14).
F-16
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(8) BUSINESS COMBINATIONS
In November 1997, the Company acquired LDS, a domestic commercial long
distance telecommunications provider, in a transaction that was accounted for as
a pooling of interests. The Company issued 849,298 shares of its common stock to
LDS' shareholders in exchange for all outstanding LDS shares plus shares of
certain non-operating entities owned by LDS' shareholders and majority ownership
in an affiliated telephone retailer controlled by LDS. On March 10, 1998, the
Company acquired T-One, an international wholesale long distance
telecommunications provider based in New York, in a transaction that was
accounted for as a pooling of interests. The Company issued 1,353,000 shares of
its common stock to the T-One shareholder in exchange for all outstanding T-One
shares. The accompanying consolidated financial statements have been restated to
include the financial position and results of operations of LDS and T-One for
all periods presented.
Revenues and historical net income (loss) of the combining companies for the
last three years are as follows:
<TABLE>
<CAPTION>
1995 1996 1997
------------- -------------- --------------
<S> <C> <C> <C>
Revenues:
STAR....................................... $ 16,125,000 $ 208,086,000 $ 348,738,000
LDS........................................ 30,158,000 29,905,000 27,460,000
T-ONE...................................... 12,654,000 22,432,000 30,438,000
Eliminations............................... -- (726,000) (2,031,000)
------------- -------------- --------------
Total.................................... $ 58,937,000 $ 259,697,000 $ 404,605,000
------------- -------------- --------------
------------- -------------- --------------
Net income (loss):
STAR....................................... $ (568,000) $ (6,644,000) $ 5,605,000
LDS........................................ 4,541,000 2,424,000 (37,000)
T-ONE...................................... (267,000) (575,000) 201,000
------------- -------------- --------------
$ 3,706,000 $ (4,795,000) $ 5,769,000
------------- -------------- --------------
------------- -------------- --------------
</TABLE>
(9) INCOME TAXES
Through December 31, 1995, the Company had elected to be taxed as an
S-Corporation for both federal and state income tax purposes. While the election
was in effect, all taxable income, deductions, losses and credits of the Company
were included in the tax returns of the shareholders. Accordingly, for federal
income tax purposes, no tax benefit, liability or provision has been reflected
in the accompanying historical consolidated financial statements for the year
ended December 31, 1995. For state tax purposes, an S-Corporation is subject to
a 1.5 percent tax on taxable income, with a minimum tax of approximately $1,000
annually. Effective January 1, 1996, the Company terminated its S-Corporation
election and is now taxable as a C-Corporation.
In addition, the results of operations and provision for income taxes for
LDS through November 30, 1997 reflects LDS' status as an S-Corporation. The
unaudited pro forma income taxes, pro forma net income (loss), and pro forma
earnings per share information reflected in the consolidated statements of
operations assumes that both STAR and LDS were taxed as C-Corporations for all
periods presented.
F-17
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(9) INCOME TAXES (CONTINUED)
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes," under which deferred assets and liabilities are
provided on differences between financial reporting and taxable income using
enacted tax rates. Deferred income tax expenses or credits are based on the
changes in deferred income tax assets or liabilities from period to period.
Under SFAS No. 109, deferred tax assets may be recognized for temporary
differences that will result in deductible amounts in future periods. A
valuation allowance is recognized if, on the weight of available evidence, it is
more likely than not that some portion or all of the deferred tax asset will not
be realized.
The Company has recorded a net deferred tax asset of $3,699,000 at December
31, 1997. Realization is dependent on generating sufficient taxable income in
the future. Although realization is not assured, management believes it is more
likely than not that the net deferred tax asset recorded will be realized.
The components of the net deferred tax assets at December 31, 1996 and 1997
are as follows:
<TABLE>
<CAPTION>
1996 1997
------------- -------------
<S> <C> <C>
Deferred tax asset:
Reserve for accounts and note receivable...................... $ 3,129,000 $ 4,215,000
Accrued line cost............................................. 201,000 798,000
Vacation accrual.............................................. 24,000 138,000
Deferred compensation......................................... 47,000 38,000
Accrued bonuses............................................... 25,000 --
Accrued services.............................................. -- 276,000
Legal settlement.............................................. 123,000 --
Net operating losses.......................................... 228,000 684,000
State income taxes............................................ 48,000 392,000
Change in tax method.......................................... 120,000 60,000
------------- -------------
3,945,000 6,601,000
Deferred tax liability:
Depreciation.................................................. (561,000) (786,000)
------------- -------------
Subtotal........................................................ 3,384,000 5,815,000
Valuation reserve............................................... (3,384,000) (2,116,000)
------------- -------------
Net deferred tax asset.......................................... $ -- $ 3,699,000
------------- -------------
------------- -------------
</TABLE>
In prior years, T-One generated net operating losses ("NOL") for financial
statement and income tax purposes which are available for carryforwards against
future income. As of December 31, 1997, T-One has NOL deductions available for
carryforward in the amount of approximately $500,000. These NOL will expire
through 2010. The Company also has foreign NOL of approximately $600,000.
F-18
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(9) INCOME TAXES (CONTINUED)
The provision for income taxes for the years ended December 31, 1995, 1996
and 1997 are as follows:
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
------------------------------------ -----------------------------------------
1995 1996 1997 1995 1996 1997
--------- ---------- ------------- ------------ ------------ -------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Current
Federal taxes................. $ 4,000 $ 280,000 $ 4,900,000 $ 1,369,000 $ 1,118,000 $ 5,282,000
State taxes................... 68,000 164,000 1,147,000 418,000 359,000 1,270,000
--------- ---------- ------------- ------------ ------------ -------------
72,000 444,000 6,047,000 1,787,000 1,477,000 6,552,000
--------- ---------- ------------- ------------ ------------ -------------
Deferred
Federal taxes................. (6,000) 133,000 (2,273,000) (127,000) 63,000 (2,512,000)
State taxes................... -- -- (869,000) (28,000) (20,000) (940,000)
--------- ---------- ------------- ------------ ------------ -------------
(6,000) 133,000 (3,142,000) (155,000) 43,000 (3,452,000)
--------- ---------- ------------- ------------ ------------ -------------
Provision for income taxes...... $ 66,000 $ 577,000 $ 2,905,000 $ 1,632,000 $ 1,520,000 $ 3,100,000
--------- ---------- ------------- ------------ ------------ -------------
--------- ---------- ------------- ------------ ------------ -------------
</TABLE>
Differences between the provision for income taxes and income taxes at the
statutory federal income tax rate for the years ended December 31, 1995, 1996
and 1997 are as follows:
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
------------------------------------------- ------------------------------------------
1995 1996 1997 1995 1996 1997
------------- ------------- ------------- ------------ ------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Income taxes at the statutory
federal rate................ $ 1,282,000 $ (1,434,000) $ 3,036,000 $ 1,282,000 $ (1,434,000) $ 3,036,000
State income taxes, net of
federal income tax effect... 230,000 (257,000) 498,000 230,000 (257,000) 498,000
Foreign taxes at rates
different than U.S. taxes... -- -- 187,000 -- -- 187,000
Change in valuation reserve... 112,000 3,124,000 (1,268,000) 112,000 3,124,000 (1,268,000)
Permanent differences......... 104,000 35,000 13,000 108,000 309,000
Effect of STAR S-Corp status
until December 31, 1995..... 223,000 -- -- -- -- --
Effects of LDS S-Corp status
until November 30, 1997..... (1,808,000) (958,000) 152,000 -- -- --
Other......................... 27,000 (2,000) 265,000 (5,000) (21,000) 338,000
------------- ------------- ------------- ------------ ------------- -------------
$ 66,000 $ 577,000 $ 2,905,000 $ 1,632,000 $ 1,520,000 $ 3,100,000
------------- ------------- ------------- ------------ ------------- -------------
------------- ------------- ------------- ------------ ------------- -------------
</TABLE>
F-19
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(10) STOCK OPTIONS
On January 22, 1996, the Company adopted the 1996 Stock Incentive Plan (the
"Plan"). The Plan, which was amended on March 31, 1996, provides for the
granting of stock options to purchase up to 1,476,000 shares of common stock and
terminates January 22, 2006. Options granted become exercisable at a rate of not
less than 20 percent per year for five years.
During 1996, the Company entered into three separate stock option agreements
outside the Plan. The first agreement, dated March 1, 1996, provided for 410,000
non-incentive stock options exercisable immediately. The options were
exercisable at fair market value at the date of issuance, which was $0.98 per
share, to expire in 10 years. The second stock option agreement was entered into
on May 1, 1996 for an additional 410,000 shares to also be issued at $0.98 per
share. Of these options half vested on March 1, 1997 and half expired. On May
15, 1996, the Company granted 205,000 options, valued at $1.46 per share at the
date of issuance to a director. Of these options 34 percent were exercisable
immediately. The remaining options are exercisable equally on May 15, 1997 and
1998.
At December 31, 1996 and 1997, 1,025,000 and 820,000 options, respectively,
issued outside of a plan were outstanding.
On September 23, 1996, the Company adopted the 1996 Supplemental Stock
Option Plan. This plan, which expires on August 31, 2006, replaces the Plan and
has essentially the same features. The Company can issue options or other rights
to purchase up to 2,050,000 shares of stock which expire up to 10 years after
the date of grant, except for incentive options issued to a holder of more than
10 percent of the common stock outstanding, which expire five years after the
date of grant.
In December 1996, the Company issued 174,000 options at $4.00 per share. The
Board of Directors determined the market value of the December options to be
$4.68 per share. The Company is recognizing the difference between the market
value at the date of grant and the exercise price as compensation expense over
the vesting period.
At December 31, 1996 and 1997, 2,358,000 and 1,873,000 options,
respectively, were outstanding under the aggregate of the 1996 Stock Incentive
Plan and the Supplemental Stock Option Plan.
On May 14, 1996, the Company adopted the 1996 Outside Director Nonstatutory
Stock Option Plan (the "Director Plan"). The number of shares which may be
issued under this plan upon exercise of options may not exceed 410,000 shares.
The exercise price of an option is determined by the Board of Directors and may
not be less than 85 percent of the fair market value of the common stock at the
time of grant and has to be 110 percent of the fair market value of the common
stock at the time of grant if the option is granted to a holder of more than 10
percent of the common stock outstanding. At the discretion of the administrator,
the options vest at a rate of not less than 20 percent per year, which may
accelerate upon a change in control, as defined. The plan expires on May 14,
2006. At December 31, 1996 and 1997, 82,000 and 41,000 options, respectively,
were outstanding under the Director Plan.
On January 30, 1997, the Board of Directors approved the 1997 Omnibus Stock
Incentive Plan (the "Omnibus Plan") to replace the existing 1996 Supplemental
Stock Option Plan upon the effective date of the initial public offering. The
plan provides for awards to employees, outside directors and consultants in the
form of restricted shares, stock units, stock options and stock appreciation
rights and terminates on January 22, 2007. The maximum number of shares
available for issuance under this plan may not exceed 1,025,000 shares plus the
number of shares still unissued under the Supplemental Stock Option Plan.
F-20
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(10) STOCK OPTIONS (CONTINUED)
Options granted to any one optionee may not exceed more than 1,025,000 common
shares per year subject to certain adjustments. Incentive stock options may not
have a term of more than 10 years from the date of grant. At December 31, 1997,
763,000 options were outstanding under the Omnibus Plan.
Information regarding the Company's stock option plans and nonqualified
stock options as of December 31, 1995, 1996 and 1997, and changes during the
years ended on those dates is summarized as follows:
<TABLE>
<CAPTION>
WEIGHTED-AVERAGE
SHARES EXERCISE PRICE
---------- -----------------
<S> <C> <C>
December 31, 1995.............................................. -- $ --
Granted...................................................... 3,491,355 1.89
Exercised.................................................... --
Forfeited.................................................... (26,855) 1.95
---------- -----
December 31, 1996.............................................. 3,464,500 1.89
---------- -----
Granted...................................................... 914,296 7.91
Exercised.................................................... (488,925) 0.89
Forfeited.................................................... (392,774) 2.40
---------- -----
December 31, 1997.............................................. 3,497,097 $ 3.54
---------- -----
---------- -----
</TABLE>
At December 31, 1996, 912,425 options were exercisable at a weighted average
exercise price of $1.10 per share. At December 31, 1997, 1,275,645 options were
exercisable at a weighted average exercise price of $1.51 per share. The options
outstanding at December 31, 1997 expire in various years through 2007.
Information about stock options outstanding at December 31, 1997 is
summarized as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
---------------------------------------------------
WEIGHTED
AVERAGE WEIGHTED- NUMBER WEIGHTED-
NUMBER REMAINING AVERAGE EXERCISABLE AVERAGE
OUTSTANDING AT CONTRACTED EXERCISE AT EXERCISE
RANGE OF EXERCISE PRICES 12/31/97 LIFE PRICE 12/31/97 PRICE
- ------------------------------------------------- -------------- ------------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C>
$0.73 to $1.46................................... 1,807,126 8.28 $ 1.17 1,113,695 $ 1.14
$4.00 to $6.83................................... 1,146,721 8.96 $ 4.68 161,950 $ 4.07
$8.11 to $11.10.................................. 543,250 9.66 $ 9.06 -- $ --
-------------- --- ----- ---------- -----
3,497,097 8.72 $ 3.54 1,275,645 $ 1.51
-------------- --- ----- ---------- -----
-------------- --- ----- ---------- -----
</TABLE>
The Company has elected to adopt FASB No. 123 for disclosure purposes only
and applies Accounting Principle Board (APB) Opinion No. 25 and related
interpretations in accounting for its employee stock options. Approximately
$50,000 and $88,000 in compensation cost was recognized relating to consultant
options for the years ended December 31, 1996 and 1997, respectively. Had
compensation cost for stock options awarded under these plans been determined
based on the fair value at the dates of grant consistent with the methodology of
FASB No. 123, the Company's net income or loss and basic and diluted income or
F-21
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(10) STOCK OPTIONS (CONTINUED)
loss per share for the years ended December 31, 1996 and 1997 would have
reflected the following pro forma amounts:
<TABLE>
<CAPTION>
1996 1997
------------- ------------
<S> <C> <C>
Pro forma Net Income (Loss) Per Share
Pro forma Net Income (Loss).................................... $ (6,111,000) $ 4,957,000
Pro forma Basic Net Income (Loss) per share.................... $ (0.26) $ 0.16
Pro forma Diluted Net Income (Loss) per share.................. $ (0.26) $ 0.15
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the minimum value method of option pricing with the following assumptions used
for the grants; weighted average risk-free interest rate of 6.4 and 6.2 percent
and an expected life of ten years and six years for the years ended December 31,
1996 and 1997, respectively. Expected volatility for 1997 was 31.05 percent and
it is assumed that no dividends would be issued during the option term. Because
the Company did not have a stock option program prior to 1996, the resulting pro
forma compensation cost may not be representative of that to be expected in
future years.
(11) CAPITAL STOCK
During 1994, the Company issued 16,606,661 shares of stock to the Company's
founder for $10,000. During 1995, this stockholder converted $990,000 of debt
into capital for no additional shares. During 1995, the Company also issued
1,843,339 shares to another executive of the Company on conversion of a loan.
On February 23, 1996, the Company sold 2,049,980 shares of common stock to
various investors for $1,500,000. On July 12, 1996, the Company sold 1,874,532
shares of common stock to an investor for $4,068,000.
On July 25, 1996, the Company sold 2,802,446 shares of Series A preferred
stock to a group of investors for $7,500,000. In connection with this
transaction, the Company and buyers of the preferred shares entered into an
investor's rights agreement which obligated the Company to file up to two
registration statements to register such shares. These preferred shares
converted to common stock at a ratio of 3-for-2 as a result of the public
offering in accordance with the investors rights agreement.
In June 1997, the Company completed its Initial Public Offering ("IPO") of
9,430,000 shares of common stock of which 8,097,500 shares were sold by the
Company and 1,332,500 shares were sold by certain selling shareholders. The net
proceeds to the Company (after deducting underwriting discounts and offering
expenses of approximately $4.6 million) from the sale of shares was
approximately $30.9 million.
On November 30, 1997, the Company completed the acquisition of LDS pursuant
to the terms of the agreement and 849,298 shares were issued for all of the
outstanding shares to LDS.
Since inception of T-One through December 31, 1994, the sole shareholder of
T-One contributed $1,221,000 in the form of cash and equipment to T-One. During
1995, he contributed an additional $269,000 and in 1996, exercised an available
election to convert $1,200,000 of the contributed capital into a note payable.
Concurrent with the conversion of capital to debt, T-One entered into a note
agreement with
F-22
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(11) CAPITAL STOCK (CONTINUED)
a bank for the same amount. Proceeds of the bank borrowings were used to repay
the amounts due to the shareholder (see Note 5).
(12) BUSINESS SEGMENTS
At December 31, 1997, Star has two business segments, wholesale long
distance and commercial long distance telecommunications. The wholesale segment
provides long distance services to U.S. and foreign based telecommunications
companies and the commercial segment, obtained by acquisition of LDS, provides
commercial long distance services to small retailers throughout the United
States.
The accounting policies of the segments are the same as those described in
the significant accounting policies, however, the Company evaluates performance
based on profit or loss from operations before income taxes and non-recurring
gains or losses. There are no intercompany sales among the wholesale and
commercial segments and both segments are managed separately.
Reportable segment information for the years ended December 31, 1995, 1996
and 1997 are as follows:
<TABLE>
<CAPTION>
WHOLESALE COMMERCIAL ALL OTHER TOTAL
-------------- ------------- ---------- --------------
<S> <C> <C> <C> <C>
1995
Revenues from external customers................... $ 28,779,000 $ 30,158,000 $ -- $ 58,937,000
Interest income.................................... -- 22,000 -- 22,000
Interest expense................................... 64,000 -- -- 64,000
Depreciation and amortization...................... 310,000 58,000 368,000
Segment net income (loss).......................... (835,000) 4,541,000 -- 3,706,000
Other significant non-cash items:
Capital lease additions.......................... 888,000 164,000 -- 1,052,000
Debt converted to equity......................... 1,093,000 -- -- 1,093,000
Segment assets..................................... 20,143,000 5,447,000 -- 25,590,000
Expenditures for segment assets.................... 1,603,000 61,000 -- 1,664,000
1996
Revenues from external customers................... $ 229,792,000 $ 29,905,000 $ -- $ 259,697,000
Interest income.................................... 83,000 27,000 -- 110,000
Interest expense................................... 597,000 12,000 -- 609,000
Depreciation and amortization...................... 1,364,000 78,000 -- 1,442,000
Segment net income (loss).......................... (7,219,000) 2,424,000 -- (4,795,000)
Other significant non-cash items:
Capital lease additions.......................... 5,097,000 69,000 -- 5,166,000
Equity converted to debt......................... 1,200,000 -- -- 1,200,000
Segment assets..................................... 57,728,000 5,326,000 -- 63,054,000
Expenditures for segment assets.................... 8,466,000 14,000 -- 8,480,000
</TABLE>
F-23
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(12) BUSINESS SEGMENTS (CONTINUED)
<TABLE>
<CAPTION>
WHOLESALE COMMERCIAL ALL OTHER TOTAL
-------------- ------------- ---------- --------------
<S> <C> <C> <C> <C>
1997
Revenues from external customers................... $ 377,145,000 $ 27,460,000 $ -- $ 404,605,000
Interest income.................................... 519,000 -- (27,000) 492,000
Interest expense................................... 1,738,000 27,000 (27,000) 1,738,000
Depreciation and amortization...................... 4,581,000 56,000 -- 4,637,000
Segment net income (loss).......................... 5,806,000 (37,000) -- 5,769,000
Other significant non-cash items:
Capital lease additions.......................... 9,772,000 -- -- 9,772,000
Property additions financed by notes payable..... 1,890,000 -- -- 1,890,000
Operating agreement acquired through issuance of
note........................................... 350,000 -- -- 350,000
Segment assets..................................... 113,472,000 6,844,000 -- 120,316,000
Expenditures for segment assets.................... 13,743,000 17,000 -- 13,760,000
</TABLE>
The Company had no customers, collectively, representing more than 10
percent of consolidated revenue in any foreign country.
(13) QUARTERLY CONSOLIDATED INFORMATION (UNAUDITED)
The following table presents unaudited quarterly operating results,
including the results of LDS and T-One, for each of the Company's eight quarters
in the two-year period ended December 31, 1997 (amounts in thousands):
<TABLE>
<CAPTION>
QUARTER ENDED
----------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31,
----------- --------- ---------- ----------
<S> <C> <C> <C> <C>
1996
Net sales........................................................ $ 48,353 $ 55,491 $ 73,860 $ 81,993
Operating income (loss).......................................... 1,955 1,816 1,074 (8,503)
Pro forma net income (loss)...................................... 1,098 915 491 (8,242)
1997
Net sales........................................................ $ 84,827 $ 95,250 $ 103,297 $ 121,231
Operating income................................................. 2,561 2,871 3,072 2,861
Pro forma net income............................................. 1,347 1,037 981 2,209
</TABLE>
(14) SUBSEQUENT EVENTS
ACQUISITIONS
In November 1997, the Company signed a merger agreement with United Digital
Network, Inc. ("UDN"). The Company intends to account for the transaction as a
pooling of interests. At December 31, 1997, the Company has accounts receivable
from UDN in the amount of $721,000 and a note receivable of $2.5 million plus
accrued interest of $28,000. Both the accounts receivable and the note have been
fully
F-24
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
(14) SUBSEQUENT EVENTS (CONTINUED)
reserved at December 31, 1997. Subsequent to year end, the Company loaned an
additional $2 million to UDN which has also been fully reserved since the time
of issuance.
EQUITY TRANSACTIONS
On February 3, 1998 the Company announced a 2.05 for 1 stock split in the
nature of a stock dividend. The stock split is effective March 31, 1998 and has
been retroactively reflected in the accompanying consolidated financial
statements for all periods presented.
(15) EVENTS SUBSEQUENT TO THE DATE OF AUDITORS REPORT (UNAUDITED)
LINE OF CREDIT
On March 18, 1998, the Company amended the line of credit agreement with
Sanwa Bank by adjusting the borrowing base to 55 percent of aggregate eligible
accounts receivable, revising certain covenants and releasing all pledged
collateral.
PUBLIC OFFERING
On May 4, 1998, the Company completed a public offering of 6,000,000 shares
of common stock of which 5,685,000 were sold by the Company and 315,000 shares
were sold by a selling stockholder. The net proceeds to the Company (after
deducting underwriting discounts and offering expenses) from the sale of such
shares of common stock were approximately $145 million.
COMMITMENT
On June 25, 1998, the Company announced a 20-year, $70 million agreement to
purchase capacity on the Qwest nationwide Macro Capacity (SM) Fiber Network.
AUTHORIZED CAPITAL
On July 1, 1998, the Company's stockholders voted to amend and restate the
certificate of incorporation to increase the number of shares of the Company's
authorized common stock from 50 million shares to 100 million shares.
PT-1 ACQUISITION
On August 20, 1998, the Company entered into an Amended and Restated
Agreement and Plan of Merger with PT-1 Communications, Inc. (PT-1). Per the
agreement, as amended on September 1, 1998 and December 29, 1998, the Company
will issue 15,050,000 shares of common stock and $19,500,000 cash or short term
promissory notes for all outstanding shares, options and warrants of PT-1 plus
an additional 250,000 shares to certain PT-1 distributors. On August 17, 1998,
the Company provided a $10 million loan to PT-1 at 6.75 percent interest and due
on August 17, 1999. The acquisition of PT-1 was completed on February 4, 1999.
F-25
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
INDEX TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Condensed Consolidated Balance Sheets As Of December 31, 1997 and September 30, 1998....................... F-27
Condensed Consolidated Statements Of Income For The Three and Nine Month Periods Ended September 30, 1997
and 1998................................................................................................. F-28
Condensed Consolidated Statements Of Cash Flows For The Nine Month Periods Ended
September 30, 1997 and 1998.............................................................................. F-29
Notes To Condensed Consolidated Financial Statements....................................................... F-30
</TABLE>
F-26
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
(UNAUDITED)
<S> <C> <C>
Current Assets:
Cash and cash equivalents......................................................... $ 1,903 $ 11,808
Short-term investments............................................................ 18,631 92,390
Accounts and notes receivable, net................................................ 46,675 80,721
Receivable from related parties................................................... -- 330
Other current assets.............................................................. 10,696 27,580
------------ -------------
Total current assets.......................................................... 77,905 212,829
------------ -------------
Property and equipment, net......................................................... 35,959 113,851
Other assets........................................................................ 6,452 7,340
------------ -------------
Total assets.................................................................. $ 120,316 $ 334,020
------------ -------------
------------ -------------
Current Liabilities:
Revolving lines of credit with stockholder........................................ $ 138 $ 5
Current portion of long-term obligations.......................................... 3,259 7,595
Accounts payable and other accrued expenses....................................... 22,345 36,200
Accrued network cost.............................................................. 38,403 52,464
------------ -------------
Total current liabilities..................................................... 64,145 96,264
------------ -------------
Long-Term Liabilities:
Long-term obligations, net of current portion..................................... 12,107 31,053
Other long-term liabilities....................................................... 863 1,638
------------ -------------
Total long-term liabilities................................................... 12,970 32,691
------------ -------------
Stockholders' Equity:
Common Stock $.001 par value:
Authorized--100,000,000 shares.................................................. 35 42
Additional paid-in capital........................................................ 41,662 194,138
Deferred compensation............................................................. (30) --
Accumulated other comprehensive income............................................ -- 219
Retained earnings (deficit)....................................................... 1,534 10,666
------------ -------------
Total stockholders' equity.................................................... 43,201 205,065
------------ -------------
Total liabilities and stockholders' equity.................................... $ 120,316 $ 334,020
------------ -------------
------------ -------------
</TABLE>
See accompanying notes to the condensed consolidated financial statements.
F-27
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- ---------------------
1997 1998 1997 1998
-------- --------- --------- ---------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Revenue........................................... $103,297 $ 164,333 $ 283,374 $ 425,531
Operating expenses:
Cost of services................................ 90,100 139,324 246,712 363,794
Selling, general and administrative expenses.... 8,898 15,922 25,118 38,853
Depreciation and amortization................... 1,227 3,439 3,040 8,055
Merger expense.................................. -- -- -- 314
-------- --------- --------- ---------
100,225 158,685 274,870 411,016
-------- --------- --------- ---------
Income from operations...................... 3,072 5,648 8,504 14,515
-------- --------- --------- ---------
Other income (expense):
Interest income................................. 293 1,839 367 3,511
Interest expense................................ (453) (740) (1,289) (2,080)
Other........................................... (794) 87 (1,499) (171)
-------- --------- --------- ---------
(954) 1,186 (2,421) 1,260
-------- --------- --------- ---------
Income before provision for income taxes.... 2,118 6,834 6,083 15,775
Provision for income taxes........................ 1,255 2,812 2,406 6,643
-------- --------- --------- ---------
Net income........................................ $ 863 $ 4,022 $ 3,677 $ 9,132
-------- --------- --------- ---------
-------- --------- --------- ---------
Income before provision for income taxes.... 2,118 6,083
Pro forma income taxes............................ 1,137 2,718
-------- ---------
Pro forma net income.............................. $ 981 $ 3,365
-------- ---------
-------- ---------
Basic income per share............................ $ 0.02 $ 0.10 $ 0.13 $ 0.23
-------- --------- --------- ---------
-------- --------- --------- ---------
Diluted income per share.......................... $ 0.02 $ 0.09 $ 0.12 $ 0.22
-------- --------- --------- ---------
-------- --------- --------- ---------
Pro forma basic income per share.................. $ 0.03 $ 0.12
-------- ---------
-------- ---------
Pro forma diluted income per share................ $ 0.03 $ 0.11
-------- ---------
-------- ---------
</TABLE>
See accompanying notes to the condensed consolidated financial statements.
F-28
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------
1997 1998
--------- ----------
(UNAUDITED)
<S> <C> <C>
Cash Flows From Operating Activities:
Net income............................................................................. $ 3,677 $ 9,132
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization........................................................ 3,040 8,055
Loss on disposal of equipment........................................................ 42 --
Compensation expense relating to stock options....................................... 60 30
Provision for doubtful accounts...................................................... 4,068 3,952
Deferred income taxes................................................................ -- (511)
Deferred compensation................................................................ (66) 62
Increase in assets:
Accounts and notes receivable...................................................... (8,214) (37,998)
Receivable from related parties.................................................... (174) (330)
Other assets....................................................................... (1,495) (6,038)
Increase (decrease) in liabilities:
Accounts payable and other accrued expenses........................................ (1,470) 13,855
Accrued network cost............................................................... 13,042 14,061
Other liabilities.................................................................. 63 48
--------- ----------
Net cash provided by operating activities........................................ 12,573 4,318
--------- ----------
Cash Flows From Investing Activities:
Capital expenditures................................................................... (6,649) (57,847)
Short-term investments................................................................. (19,206) (73,759)
Other long-term assets................................................................. 385 (5,084)
--------- ----------
Net cash used in investing activities............................................ (25,470) (136,690)
--------- ----------
Cash Flows From Financing Activities:
Borrowing under lines of credit........................................................ 34,211 --
Repayments under lines of credit....................................................... (42,025) --
Borrowing under lines of credit with stockholders...................................... 583 --
Repayments under lines of credit with stockholder...................................... (423) (133)
Payments under long-term debt and capital lease obligations............................ (3,061) (4,818)
Stockholder distributions for LDS...................................................... (794) --
Issuance of common stock............................................................... 30,914 144,711
Other financing activities............................................................. -- (12)
Stock options exercised................................................................ 67 2,310
--------- ----------
Net cash provided by financing activities........................................ 19,472 142,058
--------- ----------
Effects of Foreign Currency Translation.................................................. -- 219
Increase in cash and cash equivalents.................................................... 6,575 9,905
Cash and cash equivalents, beginning of period........................................... 1,845 1,903
--------- ----------
Cash and cash equivalents, end of period................................................. $ 8,420 $ 11,808
--------- ----------
--------- ----------
</TABLE>
See accompanying notes to the condensed consolidated financial statements.
F-29
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) GENERAL
The financial statements included herein are unaudited and have been
prepared in accordance with generally accepted accounting principles for interim
financial reporting and Securities Exchange Commission ("SEC") regulations.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to such rules and regulations. In
management's opinion, the financial statements reflect all adjustments (of a
normal and recurring nature) which are necessary to present fairly the financial
position, results of operations, stockholders' equity and cash flows for the
interim periods. These financial statements should be read in conjunction with
the audited financial statements for the year ended December 31, 1997 of STAR
Telecommunications, Inc. ("STAR" or the "Company") as set forth in this Proxy
Statement/Prospectus. The results for the three and nine month periods ended
September 30, 1998, are not necessarily indicative of the results that may be
expected for the year ending December 31, 1998.
In March 1998, the Company consummated a merger with T-One Corp. ("T-One").
The merger constituted a tax-free reorganization and has been accounted for as a
pooling of interests under Accounting Principles Board Opinion No. 16.
Accordingly, all prior period consolidated financial statements presented have
been restated to include the results of operations, financial position, and cash
flows of T-One.
(2) BUSINESS AND PURPOSE
STAR is an emerging multinational carrier focused primarily on the
international long-distance market. The Company offers highly reliable, low-cost
switched voice 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.
During 1996 and 1997, the Company established several wholly-owned foreign
subsidiaries to further expand its international network. The company made
substantial investments to install switch facilities in two of these
subsidiaries, Star Europe Limited (SEL) which is located in London, England, and
Star Telecommunications Deutschland (GmbH) which is located in Frankfurt,
Germany. The Company plans to use these switch facilities to decrease
international traffic termination cost and to initial outbound calls from these
local markets.
In December 1997, the Company entered into the domestic long-distance market
through the acquisition of L.D. Services, Inc. ("LDS"). In addition, the Company
established a domestic long-distance provider Arvilla Telecommunication, Inc.
("Arvilla"). Effective September 25, 1998, LDS and Arvilla were merged into a
wholly-owned subsidiary, CEO Telecommunications, Inc. ("CEO").
(3) NET INCOME PER COMMON SHARE
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share". The statement replaces primary EPS with basic EPS, which is computed by
dividing reported earnings available to common stockholders by weighted average
shares outstanding. The provision requires the calculation of diluted EPS. The
Company adopted this statement in 1997 and prior year earnings per share
information has been restated to be consistent with SFAS No. 128.
F-30
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(3) NET INCOME PER COMMON SHARE (CONTINUED)
The following schedule summarizes the information used to compute net income
per common share for the three and nine months ended September 30, 1997 and 1998
(in thousands):
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
1997 1998 1997 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Weighted number of common shares used to compute basic
earnings per share................................... 34,589 42,087 28,650 39,147
Weighted average common share equivalents.............. 2,114 1,245 2,930 1,774
--------- --------- --------- ---------
Weighted average number of common share and share
equivalents used to compute diluted earnings per
share................................................ 36,703 43,332 31,580 40,921
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
(4) PRO FORMA INCOME TAXES
The results of operations and provision for income taxes for the three and
nine months ended September 30, 1997 reflect LDS' status as an S-Corporation
prior to the merger with STAR. The pro-forma income taxes, pro-forma net income,
and pro-forma earnings per share information reflected in the condensed
consolidated statements of income assumes that both STAR and LDS were taxed as
C-Corporations for all periods presented.
(5) COMPREHENSIVE INCOME
On January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income". For year end financial statements, SFAS 130 requires that
comprehensive income, which is the total of net income and all other non-owner
changes in equity, be displayed in a financial statement with the same
prominence as other consolidated financial statements. Under SFAS No. 130, the
Company's foreign currency translation adjustments are considered to be
components of other comprehensive income. During the three and nine month
periods ended September 30, 1997, comprehensive income equaled net income.
During the three and nine month periods ended September 30, 1998, comprehensive
income equaled approximately $4,241,000 and $9,351,000, respectively.
(6) CHANGE IN ACCOUNTING ESTIMATE
As of July 1, 1998, the Company prospectively revised the remaining lives of
certain operating equipment from five to ten years. The increase in the
estimated life of these assets was based on the knowledge gained by the Company
in making the transition from a reseller of telephone services to a facility
based provider, as well as to the fact that the Company is purchasing more
sophisticated telephone switches and has transitioned from a Stromberg platform
to a Nortel based telecommunications platform. All such assets will be amortized
over their respective useful lives. This change increased income before
provision for income taxes for the three and nine-month periods ended September
30, 1998 by approximately one million dollars. The difference between
depreciating all switch equipment over a 5 year life versus a 10 year life since
acquisition would represent approximately $945,000 for the 3 month period and
F-31
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(6) CHANGE IN ACCOUNTING ESTIMATE (CONTINUED)
$1,770,000 for the 9 month period, or 1 cent or 3 cent per diluted share for the
3 and 9 month periods, respectively.
(7) SIGNIFICANT EVENTS
In November 1997, the Company signed a merger agreement with United Digital
Network, Inc. ("UDN"). The Company intends to account for the transaction as a
pooling of interests. In August 1998, the Company signed an amended and restated
agreement to acquire PT-1 Communications, Inc. ("PT-1") which will be accounted
for as a purchase. The Company anticipates closing these transactions in the
first quarter of 1999.
According to SFAS 52, "Foreign Currency Translation," the functional
currency of a foreign subsidiary of a U.S. company ordinarily will be the
currency of the country in which the entity is located or the U.S. dollar. The
determination of the functional currency is basically a matter of fact. On July
1, 1998, due to changes in facts and circumstances, the Company changed the
functional currency of its German subsidiary from the U.S. dollar to the German
mark.
(8) STATEMENTS OF CASH FLOWS
During the nine month periods ended September 30, 1997 and 1998, cash paid
for interest was approximately $1,175,000 and $2,342,000 respectively. For the
same periods, cash paid for income taxes amounted to approximately $2,693,000
and $2,545,000 respectively.
Non-cash investing and financing activities are as follows (in thousands):
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------
1997 1998
--------- ---------
<S> <C> <C>
Equipment purchased through notes and capital leases.................... $ 10,230 $ 28,100
Tax benefits related to stock options................................... -- 5,474
--------- ---------
$ 10,230 $ 33,574
--------- ---------
--------- ---------
</TABLE>
F-32
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(9) SEGMENT INFORMATION
At September 30, 1998, STAR has two business segments, North American and
European long distance telecommunications.
<TABLE>
<CAPTION>
NORTH
THREE MONTHS ENDED, SEPTEMBER 30, 1997 AMERICA EUROPE TOTAL
- ----------------------------------------------------------- ---------- --------- ----------
<S> <C> <C> <C>
Revenue.................................................... $ 103,297 $ -- $ 103,297
Interest income............................................ 293 -- 293
Interest expense........................................... 356 97 453
Depreciation and amortization.............................. 1,084 143 1,227
Segment profit (loss)...................................... 1,451 (588) 863
Segment assets............................................. $ 102,097 $ 5,965 $ 108,062
</TABLE>
<TABLE>
<CAPTION>
NORTH
THREE MONTHS ENDED, SEPTEMBER 30, 1998 AMERICA EUROPE TOTAL
- ----------------------------------------------------------- ---------- --------- ----------
<S> <C> <C> <C>
Revenue.................................................... $ 157,584 $ 6,749 $ 164,333
Interest income............................................ 1,814 25 1,839
Interest expense........................................... 356 384 740
Depreciation and amortization.............................. 2,384 1,055 3,439
Segment profit (loss)...................................... 9,733 (5,711) 4,022
Segment assets............................................. $ 285,381 $ 48,639 $ 334,020
</TABLE>
<TABLE>
<CAPTION>
NORTH
NINE MONTHS ENDED, SEPTEMBER 30, 1997 AMERICA EUROPE TOTAL
- ----------------------------------------------------------- ---------- --------- ----------
<S> <C> <C> <C>
Revenue.................................................... $ 283,374 $ -- $ 283,374
Interest income............................................ 367 -- 367
Interest expense........................................... 1,153 136 1,289
Depreciation and amortization.............................. 2,824 216 3,040
Segment profit............................................. 4,895 (1,218) 3,677
Segment assets............................................. $ 102,097 $ 5,965 $ 108,062
</TABLE>
<TABLE>
<CAPTION>
NORTH
NINE MONTHS ENDED, SEPTEMBER 30, 1998 AMERICA EUROPE TOTAL
- ---------------------------------------------------------- ---------- ---------- ----------
<S> <C> <C> <C>
Revenue................................................... $ 418,588 $ 6,943 $ 425,531
Interest income........................................... 3,486 25 3,511
Interest expense.......................................... 1,116 964 2,080
Depreciation and amortization............................. 6,033 2,022 8,055
Segment profit (loss)..................................... 19,944 (10,812) 9,132
Segment assets............................................ $ 285,381 $ 48,639 $ 334,020
</TABLE>
The Company provides wholesale and commercial long distance telephone
service. The commercial segment represents less than 10% of revenue, net income
or assets of the Company for the periods presented.
F-33
<PAGE>
STAR TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(10) NEW PRONOUNCEMENTS
In June 1998, the AICPA issued statement of Financial Accounting Standards
No. 133 "Accounting For Derivative Instruments and Hedging Activities." The
Company has not yet analyzed the impact of this new standard. The Company will
adopt the standard in January of 2000.
(11) SUBSEQUENT EVENTS
In November 1998, the Company signed a twenty year, $31 million dollar
indefeasible right of use (IRU) agreement with IXC Communication, Inc. ("IXC")
to purchase capacity on IXC's U.S. based digital fiber network.
F-34
<PAGE>
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Independent Auditors' Report............................................................................... F-36
Consolidated Balance Sheets as of March 31, 1997 and 1998 and September 30, 1998 (unaudited)............... F-37
Consolidated Statements of Operations for the period from April 21, 1995 (inception) to March 31, 1996, for
the years ended March 31, 1997 and 1998 and for the six months ended September 30, 1998 and 1997
(unaudited).............................................................................................. F-38
Consolidated Statements of Cash Flows for the period from April 21, 1995 (inception) to March 31, 1996, for
the years ended March 31, 1997 and 1998 and for the six months ended September 30, 1998 and 1997
(unaudited).............................................................................................. F-39
Consolidated Statements of Stockholders' Deficiency for the period from April 21, 1995 (inception) to March
31, 1996, for the years ended March 31, 1997 and 1998 and for the six months ended September 30, 1998
(unaudited).............................................................................................. F-40
Notes to Consolidated Financial Statements................................................................. F-41
</TABLE>
F-35
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
PT-1 Communications, Inc.:
We have audited the accompanying consolidated balance sheets of PT-1
Communications, Inc. and subsidiary as of March 31, 1997 and 1998 and the
related consolidated statements of operations, stockholders' deficiency and cash
flows for the period from April 21, 1995 (inception) to March 31, 1996 and for
the years ended March 31, 1997 and 1998. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with generally accepting auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
PT-1 Communications, Inc. and subsidiary as of March 31, 1997 and 1998, and the
results of their operations and their cash flows for the period from April 21,
1995 (inception) to March 31, 1996 and for the years ended March 31, 1997 and
1998 in conformity with generally accepted accounting principles.
KPMG LLP
New York, New York
June 22, 1998,
except for the third paragraph
of Note 8, for which the date
is September 1, 1998.
F-36
<PAGE>
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
MARCH 31,
----------------------------
1997 1998 SEPTEMBER 30, 1998
------------- ------------- ------------------
(UNAUDITED)
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents........................................ $ 5,577,238 $ 12,389,554 $ 5,381,815
Marketable securities............................................ -- 1,082,872 1,036,483
Short-term investments (notes 1 and 3)........................... 668,994 3,674,392 1,111,744
Accounts receivable, less allowance for doubtful accounts of
$391,000, $478,000 and $1,137,000, respectively (notes 4 and
6)............................................................. 7,540,474 29,771,970 37,433,981
Due from carriers................................................ 269,153 7,516,370 9,506,461
Inventory........................................................ 317,390 842,793 975,697
Prepaid expenses................................................. 827,755 690,939 814,241
Deferred tax asset............................................... -- 2,505,217 3,600,000
------------- ------------- ------------------
Total current assets........................................... 15,201,004 58,474,107 59,860,422
Long-term investments (notes 1 and 3).............................. 1,472,000 2,406,440 5,305
Property and equipment, net (notes 1, 2 and 5)..................... 1,483,823 22,609,454 43,480,486
Deposits........................................................... 403,729 507,333 524,517
Officer loans receivable (note 6).................................. 338,528 202,820 588,401
Intangible assets.................................................. -- 2,991,457 2,492,876
Deferred offering costs (note 11).................................. -- 485,790 --
------------- ------------- ------------------
Total assets................................................... $ 18,899,084 $ 87,677,401 $ 106,952,007
------------- ------------- ------------------
------------- ------------- ------------------
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Accounts payable and accrued expenses............................ $ 1,902,210 $ 7,940,817 $ 12,275,147
Accrued taxes payable............................................ 4,374,679 10,599,910 9,195,103
Due to carriers.................................................. 870,259 9,086,026 13,112,500
Notes payable (notes 5 and 8).................................... 5,000,000 5,130,000 5,000,000
Short-term debt (note 10)........................................ -- 2,760,000 15,000,000
Current portion of capital lease obligation...................... -- 1,746,001 1,735,513
Deferred revenue................................................. 20,479,361 42,931,616 42,025,892
------------- ------------- ------------------
Total current liabilities...................................... 32,626,509 80,194,370 98,344,155
------------- ------------- ------------------
Capital lease obligation (note 9).................................. -- 8,253,999 7,512,418
Note payable (note 8).............................................. 5,000,000 -- --
Deferred tax liability............................................. -- 450,000 700,000
------------- ------------- ------------------
Total liabilities.............................................. 37,626,509 88,898,369 106,556,573
------------- ------------- ------------------
Stockholders' equity deficiency:
Preferred stock, no par value. Authorized 15,000,000 shares; no
shares issued and outstanding.................................. -- -- --
Common stock, par value $.01 per share. Authorized 150,000,000
shares; 70,000,000 shares issued and 44,947,368 outstanding in
1997 and 73,459,180 shares issued and 48,406,548 outstanding in
1998........................................................... 700,000 734,592 734,592
Additional paid-in capital....................................... 6,602,613 15,784,614 16,166,278
Retained earnings (accumulated deficit).......................... (11,030,038) 550,357 1,919,237
Treasury stock, at cost 25,052,632 shares in 1997 and 1998 (note
8)............................................................. (15,000,000) (15,000,000) (15,000,000)
Less: Note receivable from stockholder (note 8) $3,570,000 face
amount, noninterest bearing until April 15, 1999 (less
unamortized discount of $279,469, based on imputed interest of
8%)............................................................ -- (3,290,531) (3,424,673)
------------- ------------- ------------------
Total stockholders' equity (deficiency)........................ (18,727,425) (1,220,968) 395,434
------------- ------------- ------------------
Total liabilities and stockholders' equity (deficiency)........ $ 18,899,084 $ 87,677,401 $ 106,952,007
------------- ------------- ------------------
------------- ------------- ------------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-37
<PAGE>
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
PERIOD FROM APRIL SIX MONTHS ENDED SEPTEMBER 30,
21, 1995 YEARS ENDED MARCH 31,
(INCEPTION) TO ------------------------------ ------------------------------
MARCH 31, 1996 1997 1998 1997 1998
----------------- -------------- -------------- -------------- --------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenue.......................... $ 11,922,606 $ 169,635,313 $ 431,519,685 $ 187,043,760 $ 268,919,366
Operating expenses:
Cost of services............... 13,812,202 166,184,501 395,500,937 170,752,512 248,222,120
Selling and marketing
expenses..................... 318,070 1,761,650 4,485,214 1,828,395 4,274,320
Merger costs................... -- -- -- -- 975,439
General and administrative
expenses..................... 704,429 2,612,894 12,112,035 4,108,778 12,766,070
Stock based compensation....... -- 7,300,000 2,661,166 1,855,525 381,664
----------------- -------------- -------------- -------------- --------------
Total operating expenses..... 14,834,701 177,859,045 414,759,352 178,545,210 266,619,613
----------------- -------------- -------------- -------------- --------------
Operating (loss) income...... (2,912,095) (8,223,732) 16,760,333 8,498,550 2,299,753
Interest income.................. 2,115 114,633 517,304 186,459 268,630
Interest expense................. -- (10,959) (1,021,452) (401,535) (793,534)
Net gains on marketable
securities..................... -- -- 507,170 243,785 (50,542)
Loss on disposition of fixed
assets......................... -- -- (32,960) -- --
----------------- -------------- -------------- -------------- --------------
(Loss) income before income
taxes...................... (2,909,980) (8,120,058) 16,730,395 8,527,259 1,724,307
Income tax expense............... -- -- 5,150,000 2,018,000 355,427
----------------- -------------- -------------- -------------- --------------
Net (loss) income............ $ (2,909,980) $ (8,120,058) $ 11,580,395 $ 6,509,259 $ 1,368,880
----------------- -------------- -------------- -------------- --------------
----------------- -------------- -------------- -------------- --------------
Net earnings (loss) per common
share:
Basic.......................... $ (.05) $ (.13) $ 0.25 $ 0.14 $ 0.03
Diluted........................ $ (.05) $ (.13) $ 0.24 $ 0.14 $ 0.03
Weighted average number of common
shares outstanding
Basic.......................... 60,900,000 60,681,000 46,922,000 45,708,000 48,407,000
Diluted........................ 60,900,000 60,681,000 47,720,000 46,987,000 48,587,000
</TABLE>
F-38
<PAGE>
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
PERIOD FROM APRIL SIX MONTHS ENDED
21, 1995 YEARS ENDED MARCH 31, SEPTEMBER 30,
(INCEPTION) TO ------------------------- ------------------------
MARCH 31, 1996 1997 1998 1997 1998
----------------- ----------- ------------ ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash provided by operating activities:
Net (loss) income........................ $(2,909,980) $(8,120,058) $ 11,580,395 $ 6,509,259 $ 1,368,880
Adjustments to reconcile net (loss)
income to net cash provided by
operating activities:
Depreciation and amortization.......... 4,943 75,017 1,534,500 385,791 1,713,754
Noncash compensation................... -- 7,300,000 2,661,166 1,855,525 381,664
Sales of marketable securities......... -- -- 3,156,836 1,608,019 532,003
Purchases of marketable securities..... -- -- (4,034,562) (1,509,159) (518,822)
Unrealized (gain) loss on marketable
securities........................... -- -- (204,346) (98,960) 61,750
Amortization of discount on stock
subscription receivable.............. -- -- (122,964) -- (134,142)
Loss on disposal of property, plant and
equipment............................ -- -- 32,960 -- --
Provision for doubtful accounts........ 80,000 311,194 86,569 43,730 659,613
(Increase) in accounts receivable...... (1,042,305) (6,889,363) (22,318,065) (10,469,986) (8,321,624)
Decrease (increase) in due from
carriers............................. (331,347) 62,194 (7,247,217) 182,117 (1,990,091)
(Increase) decrease in officer loans
receivable........................... -- (338,528) 135,708 (30,984) (385,581)
Increase in inventory.................. (36,200) (281,190) (525,403) (70,203) (132,904)
(Increase) decrease in prepaid
expenses............................. (5,804) (821,951) 136,816 618,993 (123,307)
Increase in deposits................... (87,155) (316,574) (103,604) (181,268) (17,184)
Increase in deferred income taxes...... -- -- (2,055,217) (272,000) (844,783)
Increase in accounts payable and
accrued expenses..................... 390,761 1,511,449 6,038,607 1,894,916 4,334,330
Increase (decrease) in accrued taxes
payable.............................. 605,000 3,769,679 6,225,231 427,276 (1,404,807)
Increase (decrease) in due to
carriers............................. 2,251,398 (1,381,139) 8,215,767 3,493,483 4,026,474
Increase (decrease) in deferred
revenue.............................. 1,846,023 18,633,338 22,452,255 14,929,538 (905,724)
----------------- ----------- ------------ ----------- -----------
Net cash provided by (used in)
operating activities............... 765,334 13,514,068 25,645,432 19,316,087 (1,700,501)
----------------- ----------- ------------ ----------- -----------
Cash flows from investing activities:
Purchases of investments in certificates
of deposit............................. -- (2,140,994) (10,783,000) (9,629,887) --
Proceeds from maturities of investments
in certificates of deposit............. -- -- 6,842,362 5,047,371 4,935,246
Capital expenditures..................... (74,319) (1,489,464) (11,254,715) (7,949,355) (22,086,205)
Purchase of capitalized software......... -- -- (391,973) (350,000) --
----------------- ----------- ------------ ----------- -----------
Net cash used in investing
activities......................... (74,319) (3,630,458) (15,587,326) (12,881,871) (17,150,959)
----------------- ----------- ------------ ----------- -----------
Cash flows from financing activities:
Proceeds from issuance of common stock... 2,600 13 -- -- --
Proceeds from loans...................... -- -- 2,760,000 -- 12,240,000
Payment for treasury stock............... -- (5,000,000) -- -- --
Payment on notes payable................. -- -- (5,520,000) (130,000) (130,000)
Payments of capital lease obligation..... -- -- -- -- (752,069)
Offering costs........................... -- -- (485,790) (335,950) 485,790
----------------- ----------- ------------ ----------- -----------
Net cash (used in) provided by
financing activities............... 2,600 (4,999,987) (3,245,790) (465,950) 11,843,721
----------------- ----------- ------------ ----------- -----------
Net increase (decrease) in cash and
cash equivalents................... 693,615 4,883,623 6,812,316 5,968,266 (7,007,739)
Cash and cash equivalents at beginning of
year..................................... -- 693,615 5,577,238 5,577,238 12,389,554
----------------- ----------- ------------ ----------- -----------
Cash and cash equivalents at end of year... $ 693,615 $ 5,577,238 $ 12,389,554 $11,545,504 $ 5,381,815
----------------- ----------- ------------ ----------- -----------
----------------- ----------- ------------ ----------- -----------
Supplemental information:
Cash paid for interest................... $ -- $ -- $ 211,923 $ -- $ 517,572
----------------- ----------- ------------ ----------- -----------
----------------- ----------- ------------ ----------- -----------
Cash paid for income taxes............... $ -- $ -- $ 5,250,000 $ 100,000 $ 2,183,475
----------------- ----------- ------------ ----------- -----------
----------------- ----------- ------------ ----------- -----------
</TABLE>
See accompanying notes to consolidated financial statements.
F-39
<PAGE>
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY)
PERIOD FROM APRIL 21, 1995 (INCEPTION) TO MARCH 31, 1996,
THE YEARS ENDED MARCH 31, 1997 AND 1998,
AND THE SIX MONTHS ENDED SEPTEMBER 30, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
RETAINED NOTE TOTAL
ADDITIONAL EARNINGS TREASURY STOCK RECEIVABLE STOCKHOLDERS'
PAID-IN (ACCUMULATION ------------------------ FROM EQUITY
SHARES AMOUNT CAPITAL DEFICIT) SHARES AMOUNT STOCKHOLDER (DEFICIENCY)
---------- -------- ----------- -------------- ---------- ------------ ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at April 21,
1995
(inception)....... -- $ -- $ -- $ -- -- $ -- $ -- $ --
Issuance of common
stock............. 60,900,000 609,000 (606,400) -- -- -- -- 2,600
Net loss............ -- -- -- (2,909,980) -- -- -- (2,909,980)
---------- -------- ----------- -------------- ---------- ------------ ----------- -------------
Balance at March 31,
1996.............. 60,900,000 609,000 (606,400) (2,909,980) -- -- -- (2,907,380)
Issuance of common
stock (note 8).... 9,100,000 91,000 7,209,013 -- -- -- -- 7,300,013
Purchase of treasury
stock............. -- -- -- -- 25,052,632 (15,000,000) -- (15,000,000)
Net loss............ -- -- -- (8,120,058) -- -- -- (8,120,058)
---------- -------- ----------- -------------- ---------- ------------ ----------- -------------
Balance at March 31,
1997.............. 70,000,000 700,000 6,602,613 (11,030,038) 25,052,632 (15,000,000) -- (18,727,425)
Compensation expense
related to stock
options........... -- -- 1,661,166 -- -- -- -- 1,661,166
Issuance of common
stock (note 8).... 483,980 4,840 3,383,020 -- -- -- -- 3,387,860
Exercise of stock
options (notes 5
and 8)............ 2,975,200 29,752 4,137,815 -- -- -- (3,290,531) 877,036
Net income.......... -- -- -- 11,580,395 -- -- -- 11,580,395
---------- -------- ----------- -------------- ---------- ------------ ----------- -------------
Balance at March 31,
1998.............. 73,459,180 734,592 15,784,614 550,357 25,052,632 (15,000,000) (3,290,531) (1,220,968)
Compensation expense
related to stock
options........... 381,664 381,664
Imputed interest.... (134,142) (134,142)
Net income
(unaudited)....... 1,368,880 1,368,880
---------- -------- ----------- -------------- ---------- ------------ ----------- -------------
Balance at September
30, 1998
(unaudited)....... 73,459,180 $734,592 $16,166,278 $ 1,919,237 25,052,632 $(15,000,000) $(3,424,673) $ 395,434
---------- -------- ----------- -------------- ---------- ------------ ----------- -------------
---------- -------- ----------- -------------- ---------- ------------ ----------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-40
<PAGE>
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE PERIOD FROM APRIL 21, 1995 (INCEPTION) TO MARCH 31, 1996
AND FOR THE YEARS ENDED MARCH 31, 1997 AND 1998
(INFORMATION AS OF SEPTEMBER 30, 1998 AND FOR THE SIX MONTHS ENDED
SEPTEMBER 30, 1998 AND 1997 IS UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) DESCRIPTION OF BUSINESS
The consolidated financial statements include the accounts of PT-1
Communications, Inc. and PT-1 Technologies, Inc., a wholly owned subsidiary.
PT-1 Communications, Inc., formerly PhoneTime, Inc., was incorporated on April
21, 1995. All intercompany balances and transactions have been eliminated in
consolidation. PT-1 Communications, Inc. and Subsidiary ("PT-1" or the
"Company") are engaged in the sale of international and domestic long-distance
and local telecommunications services primarily through the marketing of prepaid
phone cards, which it manufactures and distributes on a wholesale basis. PT-1
provides card users access to long-distance and international service through
contractual arrangements with carriers, which comprise the Company's least-cost
routing network. In addition, PT-1 provides international and domestic
long-distance services to other telecommunications carriers on a wholesale
basis.
(B) REVENUE RECOGNITION AND DEFERRED REVENUE
Revenue from telecommunications services is recognized when the services are
provided.
Sales of prepaid phone cards are made to distributors with no contractual
right of return. At the time of sale, the Company becomes legally obligated to
provide such service. Such sales are initially recorded as deferred revenue upon
shipment and revenue is recognized in accordance with the terms of the card as
the ultimate card users utilize calling time and service fees for all prepaid
cards. The terms of the card refer to the rates, fees and expiration dates of
the card as well as any other provisions which govern their use. Effective April
1, 1996, the Company began to assess a monthly service fee per card, commencing
30 days after the date a prepaid phone card is first used to make a telephone
call by reducing the unused card balance available for calls. All prepaid phone
cards sold by the Company since October 1, 1996 expire upon the earlier to occur
of (i) an expiration date printed on the prepaid phone card or (ii) six months
after the prepaid phone card is first used. Upon expiration and cancellation of
the prepaid phone card, the Company recognizes the related deferred revenue as
revenue. Prepaid phone cards sold prior to October 1, 1996 did not carry an
expiration date. The Company did not recognize any revenue related to the
expiration of the cards for the period from April 21, 1995 (inception) through
March 31, 1996 and for the year ended March 31, 1997. For the year ended March
31, 1998 the Company recognized approximately $2.5 million of revenue related to
the expiration of cards which were sold since October 1, 1996. The Company
recognized $0 and $6.7 million of revenue related to the expiration of cards for
the six months ended September 30, 1997 and 1998, respectively. The primary card
costs associated with the provision of telecommunications services are carrier
costs for transport of traffic and switch administration fees.
For the period from April 21, 1995 (inception) through March 31, 1996 and
for the years ended March 31, 1997 and 1998, approximately $-0-, $7,084,000 and
$75,188,000, respectively, of wholesale revenue was included in revenues. For
the six months ended September 30, 1997 and 1998, $23,557,000 and $73,630,000
respectively of wholesale revenues was included in telecommunications services
revenues.
F-41
<PAGE>
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM APRIL 21, 1995 (INCEPTION) TO MARCH 31, 1996
AND FOR THE YEARS ENDED MARCH 31, 1997 AND 1998
(INFORMATION AS OF SEPTEMBER 30, 1998 AND FOR THE SIX MONTHS ENDED
SEPTEMBER 30, 1998 AND 1997 IS UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(C) CASH EQUIVALENTS
For purposes of the consolidated statements of cash flows, the Company
considers all highly liquid investments with original maturities of three months
or less to be cash equivalents.
(D) MARKETABLE SECURITIES
Management determines the appropriate classification of its marketable
securities at the time of purchase and classifies them as trading, held to
maturity or available for sale, in accordance with the provisions of Statement
of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain
Investments in Debt and Equity Securities."
(E) PROPERTY AND EQUIPMENT AND SOFTWARE
Property and equipment consist principally of telecommunications equipment,
telecommunication networks, office equipment, packaging machinery and equipment,
furniture and fixtures and leasehold improvements. Property and equipment are
stated at cost with depreciation provided using the straight-line method over
the estimated useful lives of the related assets. Leasehold improvements are
amortized over the life of the lease or the useful life of the improvement,
whichever is shorter. The estimated useful lives are as follows:
<TABLE>
<S> <C>
7-10
Telecommunications equipment..................................... years
Telecommunication networks....................................... 20 years
Office equipment................................................. 5 years
Machinery and equipment.......................................... 15 years
Furniture and fixtures........................................... 10 years
Leasehold improvements........................................... 5 years
Computer software................................................ 3-4 years
</TABLE>
Telecommunications equipment is comprised of telephone switches and
communications equipment utilized to route and connect calls. Telecommunication
networks includes two Indefeasible Rights of Use (IRU) in fiber optic telephone
cable systems which have been accounted for as capital leases. These assets are
amortized over the life of the agreements not to exceed 20 years (see Notes 2
and 12).
The Company's telecommunications equipment is subject to technological risks
and rapid market changes due to new products and services and changing customer
demand. These changes may result in future adjustments to the estimated useful
lives of these assets.
(F) INVENTORY
Inventory consists of costs of production and packaging of unsold phone
cards, is valued using the average-cost method and is charged to cost of
services when the cards are sold.
F-42
<PAGE>
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM APRIL 21, 1995 (INCEPTION) TO MARCH 31, 1996
AND FOR THE YEARS ENDED MARCH 31, 1997 AND 1998
(INFORMATION AS OF SEPTEMBER 30, 1998 AND FOR THE SIX MONTHS ENDED
SEPTEMBER 30, 1998 AND 1997 IS UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(G) CAPITALIZED SOFTWARE
The Company capitalizes certain computer software license acquisition costs
which are amortized utilizing the straight-line method over three years, the
period for which the Company maintains exclusive rights to such license.
On April 1, 1997, the Company adopted the provisions of Statement of
Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use." The SOP requires that certain costs related to the
development or purchase of internal-use software be capitalized and amortized
over the estimated useful life of the software. The SOP also requires that costs
related to the preliminary project stage and the post-implementation/operations
stage of an internal-use computer software development project be expensed as
incurred. There was no cumulative effect of adopting this SOP and subsequent to
its adoption there were no material amounts capitalized under its provisions.
(H) INCOME TAXES
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be realized or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amounts expected to be realized.
(I) FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires the determination of fair value for certain of the Company's assets and
liabilities. The Company estimates that the carrying value of its financial
instruments approximates fair value.
(J) IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF
In accordance with SFAS No. 121, "Accounting for the Impairment of Long-
Lived Assets and for Long-Lived Assets to Be Disposed Of," the Company reviews
for the impairment of long-lived assets and certain identifiable intangibles to
be held and used by the Company whenever events and changes in circumstances
indicate that the carrying value of an asset may not be recoverable.
The Company assesses the recoverability of an asset by determining whether
the amortization of the asset balance over its remaining life can be recovered
through projections of undiscounted future cash flows of the related asset. The
amount of asset impairment, if any, is measured based on projected discounted
future cash flows using a discount rate reflecting the Company's average cost of
funds.
F-43
<PAGE>
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM APRIL 21, 1995 (INCEPTION) TO MARCH 31, 1996
AND FOR THE YEARS ENDED MARCH 31, 1997 AND 1998
(INFORMATION AS OF SEPTEMBER 30, 1998 AND FOR THE SIX MONTHS ENDED
SEPTEMBER 30, 1998 AND 1997 IS UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(K) RISKS AND UNCERTAINTIES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expense during the reporting
period. Estimates are used in determining the allowance for doubtful accounts,
depreciation and amortization, carrier cost liabilities and the realization of
deferred tax assets. The accompanying consolidated balance sheets include
liabilities with respect to carrier line costs and related disputes which are
determined based upon various assumptions (see Note 9(b)). It is reasonably
possible that the final resolution of some of these disputes may require
expenditure by the Company in excess of estimates and in a range of amounts that
cannot be reasonably estimated. Actual results could differ from those
estimates.
The taxation of prepaid phone cards is evolving and is not specifically
addressed by many of the states in which the Company does business. While the
Company believes it has adequately provided for any such taxes it may ultimately
be required to pay, certain states may enact legislation which specifically
provides for taxation of such cards or may interpret current laws in a manner
resulting in additional tax liabilities.
(L) STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation in accordance with SFAS
No. 123, "Accounting for Stock-Based Compensation," which permits entities to
recognize as expense over the vesting period the fair value of all stock-based
awards on the date of grant. Alternatively, SFAS No. 123 also allows entities to
continue to apply the provisions of the Accounting Principles Board (APB)
Opinion No. 25 and provide pro forma net income and pro forma earnings per share
disclosures for employee stock option grants as if the fair value-based method,
as defined in SFAS No. 123, had been applied. The Company has elected to
continue to apply the provisions of APB Opinion No. 25 and provide the pro forma
disclosure required by SFAS No. 123. As such, compensation expense is generally
recorded on the date of grant only if the current market price of the underlying
stock exceeded the exercise price.
(M) ADVERTISING COSTS
Advertising costs are expensed as incurred. Advertising costs period from
April 21, 1995 (inception) through March 31, 1996 and for the years ended March
31, 1997 and 1998 amounted to approximately $108,000, $202,000 and $760,000,
respectively. Advertising costs amounted to approximately $207,000 and
$1,178,000 for the six months ended September 30, 1997 and 1998, respectively.
(N) INTANGIBLE ASSETS
Intangible assets consist of a noncompetition agreement which is being
amortized by use of the straight-line method over the estimated life of the
agreement (see note 8).
F-44
<PAGE>
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM APRIL 21, 1995 (INCEPTION) TO MARCH 31, 1996
AND FOR THE YEARS ENDED MARCH 31, 1997 AND 1998
(INFORMATION AS OF SEPTEMBER 30, 1998 AND FOR THE SIX MONTHS ENDED
SEPTEMBER 30, 1998 AND 1997 IS UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(O) NET EARNINGS (LOSS) PER SHARE
The Company adopted the provisions of SFAS 128, "Earnings Per Share" for the
year ended March 31, 1998. SFAS 128, which supercedes APB Opinion No. 15,
"Earnings Per Share" was issued in February 1997. SFAS 128 requires dual
presentation of basic and diluted earnings per share ("EPS") for complex capital
structures on the face of the statement of operations. Basic EPS is computed by
dividing net income or loss by the weighted average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution from the
exercise or conversion of securities into common stock. Net earnings (loss) and
weighted average shares outstanding used for computing diluted loss per common
share were the same as that used for computing net earnings (loss) per common
share for all periods presented.
Potentially dilutive instruments totalling 9,000,000 for the year ended
March 31, 1997 and 447,091 for the three months ended June 30, 1998 have not
been included in the computation of diluted net income (loss) per common share
because they were antidilutive for those periods.
(P) TAXES ON PREPAID CARDS
Various jurisdictions levy taxes on telecommunications services whether
provided through prepaid cards or some other means utilizing different methods
and rates. The Company accrues for excise, sales and other usage based taxes on
telecommunication services based on the enacted method and rate for each
jurisdiction in the period usage occurs and revenue is recognized.
(2) PROPERTY AND EQUIPMENT
Property and equipment consist of the following as of March 31, 1997 and
1998 and September 30, 1998:
<TABLE>
<CAPTION>
MARCH 31,
-------------------------- SEPTEMBER
1997 1998 30, 1998
------------ ------------ ------------
UNAUDITED
<S> <C> <C> <C>
Telecommunications equipment....................... $ 1,174,032 19,885,282 30,639,820
Telecommunication networks......................... -- -- 8,600,000
Office equipment................................... 141,920 931,374 1,896,582
Packaging machinery and equipment.................. 120,396 412,638 412,638
Furniture and fixtures............................. 96,793 273,055 368,273
Leasehold improvements............................. 30,642 1,222,099 2,704,803
Software........................................... -- 1,142,876 1,331,412
------------ ------------ ------------
1,563,783 23,867,324 45,953,528
Less accumulated depreciation...................... 79,960 1,257,870 2,473,042
------------ ------------ ------------
$ 1,483,823 22,609,454 43,480,486
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
F-45
<PAGE>
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM APRIL 21, 1995 (INCEPTION) TO MARCH 31, 1996
AND FOR THE YEARS ENDED MARCH 31, 1997 AND 1998
(INFORMATION AS OF SEPTEMBER 30, 1998 AND FOR THE SIX MONTHS ENDED
SEPTEMBER 30, 1998 AND 1997 IS UNAUDITED)
(2) PROPERTY AND EQUIPMENT (CONTINUED)
In March 1998, the Company acquired telecommunications equipment for $10
million under a lease with a financing company. The Company has accounted for
the lease as a capital lease and included the $10 million of equipment in
telecommunications equipment. The lease requires monthly payments of $206,420,
including interest at 8.76%, until April 2003 and is secured by the Company's
equipment and accounts receivable. At March 31, 1998, the Company was in
compliance with the covenants contained in the lease.
(3) MARKETABLE SECURITIES AND INVESTMENTS
Marketable securities are composed of common stock investments in public
corporations and are classified as trading securities, which are carried at
their fair value based upon the quoted market prices of those investments.
Accordingly, net realized and unrealized gains and losses on trading securities
are included in the consolidated statements of operations. Net realized gains
and losses are determined on the first-in first-out basis.
Net gains on trading securities of $507,170 for the year ended March 31,
1998 is composed of a net realized gain of $302,825 and unrealized holding gains
of $204,345. Net losses on trading securities of ($50,542) for the six months
ended September 30, 1998 is composed of a net unrealized holding gain of $11,208
and a net unrealized holding loss of ($61,750).
Investments in the accompanying balance sheet represent certificates of
deposit which mature at varying dates through January 1999 and bear interest at
rates which range from 4.1% to 5.3%. These investments are stated at cost plus
accrued interest which approximates fair value. At March 31, 1997 and 1998 and
September 30, 1998, certificates of deposit with a carrying value of $1,472,000,
$2,406,000, and $0, respectively, collateralize standby letters of credit to
certain of the Company's service providers and are classified as long-term
investments. These letters of credit expire at various dates through March 20,
1999, have been issued as security against services provided to the Company and
are expected to be renewed.
(4) BUSINESS CONCENTRATIONS
SALES
For the period from April 21, 1995 (inception) through March 31, 1996 no one
distributor represented 10% or more of prepaid phone card revenue. For the years
ended March 31, 1997 and 1998 and the six month periods ended September 30, 1997
and 1998, prepaid phone card sales to five individual distributors represented
approximately 5%, 13%, 6%, 11% and 10%, 18%, 17%, 12%, 4% and 5%, 15%, 17%, 9%,
7% and 8%, and 21%, 16%, 11%, 0% and 0%, of prepaid phone card revenue for each
respective period.
ACCOUNTS RECEIVABLE
The Company's accounts receivable are primarily due from distributors. Two
distributors individually represented approximately 35% and 15% of the net
accounts receivable balance at March 31, 1997 and one distributor represents
approximately 30% of the net accounts receivable balance at March 31, 1998.
F-46
<PAGE>
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM APRIL 21, 1995 (INCEPTION) TO MARCH 31, 1996
AND FOR THE YEARS ENDED MARCH 31, 1997 AND 1998
(INFORMATION AS OF SEPTEMBER 30, 1998 AND FOR THE SIX MONTHS ENDED
SEPTEMBER 30, 1998 AND 1997 IS UNAUDITED)
(4) BUSINESS CONCENTRATIONS (CONTINUED)
At March 31, 1997, accounts receivable of approximately $585,000 relate to
PT-1 California, an unrelated exclusive sales distribution center. At March 31,
1998, accounts receivable of approximately $2,953,000 and $71,000, respectively,
relate to PT-1 California and PT-1 Ohio, unrelated exclusive sales distribution
centers. These exclusive sales distribution centers are sites where PT-1's
prepaid cards are exclusively distributed by those PT-1 distributors who are
authorized to use the PT-1 name for promotional purposes.
COST OF SERVICES
For the year ended March 31, 1998, one telecommunications service provider
represented approximately 35% of cost of services.
(5) ASSET PURCHASE AND SOFTWARE-LICENSING AGREEMENT
On May 9, 1997, PT-1 entered into an asset purchase agreement with
Interactive Telephone Company ("Interactive") and Joseph Pannullo ("Pannullo"),
the sole director and stockholder of Interactive, for $600,000 for computer
hardware and other assets. Interactive is in the business of providing long-
distance telecommunications services to issuers of prepaid debit phone cards.
On May 9, 1997, PT-1 entered into a three-year employment agreement with
Panullo. In connection with this agreement, the Company granted Panullo an
option to purchase 1,048,600 shares of stock at an aggregate option price of
$0.01. The Company has recorded compensation expense of $1 million, the
intrinsic value of the option representing the difference between the fair value
of the stock and the exercise price, on the grant date in accordance with APB
25. The entire $1 million was recognized as compensation expense on May 9, 1997,
since the option immediately vested. Because the option was exercisable for a
nominal amount, the fair value of the option approximated the amount recognized
as compensation. The fair value of the stock was determined by the Company's
board of directors utilizing a recent arms length transaction adjusted for other
considerations including growth of the business. The fair value was supported by
an independent valuation report.
On May 9, 1997, PT-1 entered into a software license agreement with Godot
Soft, LLC ("Godot"), which is owned by Pannullo, and Pannullo for a license fee
of $1,000,000. The license fee was paid with $350,000 in cash and the delivery
of a $650,000 noninterest-bearing promissory note payable in ten equal monthly
installments commencing 90 days following the effective date. The license fee
has been capitalized as software and is being amortized over a period of 4
years, the term of PT-1s' exclusivity. In addition, the software license
agreement provides that if (i) the Company engages in a specified transfer of
control transaction and (ii) Sam Tawfik ("Tawfik"), the Company's Chief
Executive Officer, and his affiliates and family members receive at least $100
million in cash or publicly held securities as a result of such transaction, the
Company must pay a fee of $2.0 million to Godot. Such amount would become
payable if the merger transaction described in note 12 closes.
F-47
<PAGE>
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM APRIL 21, 1995 (INCEPTION) TO MARCH 31, 1996
AND FOR THE YEARS ENDED MARCH 31, 1997 AND 1998
(INFORMATION AS OF SEPTEMBER 30, 1998 AND FOR THE SIX MONTHS ENDED
SEPTEMBER 30, 1998 AND 1997 IS UNAUDITED)
(6) RELATED PARTY TRANSACTIONS
During the year ended March 31, 1997, the Company made loans to two of its
officers and a former employee aggregating $591,542, of which $202,820 remains
outstanding at March 31, 1998. These loans bear interest at rates which range
from 8% to 8.5% and have no specified repayment terms. During the six months
ended September 30, 1998. PT-1 made an additional $350,000 loan to an officer.
The note is secured by 70,000 shares of PT-1 common stock.
Through March 31, 1996, PT-1 sold phone cards to Tempus International, a
corporation controlled by the Company's then President and a director, on terms
identical to those extended to the company's customers. For the period from
April 21, 1995 (inception) to March 31, 1996, these purchases aggregated
approximately $1,050,000.
(7) TAXES
The components of income tax expense (benefit) for the year ended March 31,
1998 are presented in the following table:
<TABLE>
<S> <C>
Current:
Federal............................... $ 6,283,840
State................................. 921,939
-------------
Total current....................... 7,205,779
Deferred:
Federal............................... (1,787,050)
State................................. (268,729)
-------------
Total deferred...................... (2,055,779)
-------------
Total............................... $ 5,150,000
-------------
-------------
</TABLE>
The statutory Federal income tax rate for the period ended March 31, 1996
and years ended March 31, 1997 and 1998 was 35% and the effective income tax
rate was 0%, 0% and 30.78%, respectively.
F-48
<PAGE>
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM APRIL 21, 1995 (INCEPTION) TO MARCH 31, 1996
AND FOR THE YEARS ENDED MARCH 31, 1997 AND 1998
(INFORMATION AS OF SEPTEMBER 30, 1998 AND FOR THE SIX MONTHS ENDED
SEPTEMBER 30, 1998 AND 1997 IS UNAUDITED)
(7) TAXES (CONTINUED)
The following table shows the principal reasons for the difference between
the effective tax rate and the statutory federal income tax rate for the year
ended March 31,:
<TABLE>
<CAPTION>
1996 1997 1998
--------------------- --------------------- ---------------------
AMOUNT % AMOUNT % AMOUNT %
----------- -------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C>
Expected federal income (benefit) tax at
statutory rate........................ $(1,018,493) 35.00% $(2,842,020) 35.00% $ 5,855,838 35.00%
State income taxes, net of federal
benefit............................... -- -- -- -- 424,587 2.54%
Change in valuation allowance........... 1,011,500 (34.76%) 278,500 (3.43%) (1,290,000) (7.71%)
Stock based compensation not deductible
for tax purposes...................... -- -- 2,555,000 (31.47%) -- --
Other................................... 6,993 (0.24%) 8,520 (0.10%) 159,575 0.95%
----------- -------- ----------- -------- ----------- --------
$ 0 0.00% $ 0 0.00% $ 5,150,000 30.78%
----------- -------- ----------- -------- ----------- --------
----------- -------- ----------- -------- ----------- --------
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets at March 31, 1997 and 1998 are described
below:
<TABLE>
<CAPTION>
1997 1998
-------------------------- -----------------------
CURRENT NONCURRENT CURRENT NONCURRENT
------------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
Net operating loss carryforwards............................ $ 1,032,000 -- -- --
Stock-based compensation expense............................ -- -- 605,739 --
Accounts receivable primarily due to allowance for doubtful
accounts.................................................. 136,000 -- 182,744 --
Accrued expenses............................................ 183,000 -- 1,794,896 --
Net unrealized gain on marketable securities................ -- -- (78,162) --
Depreciation................................................ -- (61,000) -- (450,000)
------------- ----------- ---------- -----------
Total deferred tax asset (liability)...................... 1,351,000 (61,000) 2,505,217 (450,000)
Less valuation allowance.................................... (1,290,000) -- -- --
------------- ----------- ---------- -----------
Net deferred tax assets (liabilities)..................... $ 61,000 (61,000) 2,505,217 (450,000)
------------- ----------- ---------- -----------
------------- ----------- ---------- -----------
</TABLE>
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Management considers
projected future taxable income and tax planning in making these assessments.
During the years ended March 31, 1997 and 1998, the valuation allowance
increased by $278,500 and decreased by $1,290,000, respectively.
F-49
<PAGE>
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM APRIL 21, 1995 (INCEPTION) TO MARCH 31, 1996
AND FOR THE YEARS ENDED MARCH 31, 1997 AND 1998
(INFORMATION AS OF SEPTEMBER 30, 1998 AND FOR THE SIX MONTHS ENDED
SEPTEMBER 30, 1998 AND 1997 IS UNAUDITED)
(7) TAXES (CONTINUED)
The Company currently believes that the realization of its deferred tax
assets is more likely than not based on the generation of net income during the
period and the Company's projection of future taxable income. For the year ended
March 31, 1998, the Company utilized the prior period net operating loss
carryforwards of $2,950,000, providing a tax benefit of $1.1 million to the
Company's consolidated statements of operations.
(8) CAPITAL TRANSACTIONS
The Company was initially capitalized with the issuance of 20 shares of
common stock for a capital contribution of $2,600. As of April 6, 1996 and
December 30, 1997, PT-1's Board of Directors declared stock splits of 4.35-for-
one and 700,000-for-one, respectively (collectively, the "Stock Split").
Retroactive treatment has been made in the consolidated financial statements to
reflect the stock split.
TRANSACTION WITH THOMAS HICKEY
On February 25, 1997, litigation related to disputed ownership interests and
control of the Company was commenced against the Company, Thomas Hickey
(Hickey), a former director and executive officer of the Company, and Sam Tawfik
(Tawfik), the Company's Chief Executive Officer. On March 20, 1997, a second
action was commenced asserting similar claims against the same defendants. Such
litigation involved disputed equity issuance commitments in connection with the
establishment of the Company and employment of key executives. On March 26,
1997, a settlement agreement among the parties was reached which included the
dismissal of litigation, execution of equity issuance commitments (as described
below), release of claims, the resignation of Hickey as a director, executive
officer and employee of the Company and the redemption of 25,052,632 shares of
common stock of the Company for $15 million which was satisfied by a cash
payment of $5 million and the issuance of a note in the principal amount of $10
million (the Note).
In connection with the March 27, 1997 settlement agreement described above,
two officers received 12.25 million shares of the Company for nominal
consideration in accordance with commitments made in July 1995 and March 1996,
the dates they joined the Company. Certain of the shares were newly issued
shares and certain shares were transferred from Hickey to the two officers. In
accordance with the provisions of APB Opinion No. 25, the Company has recognized
non-cash compensation expense for the year ended March 31, 1997, of
approximately $7.3 million related to all of the shares provided to the two
officers. Such value was determined based upon the value ascribed to the shares
redeemed from Hickey on March 27, 1997.
On November 7, 1997, in connection with the Company's then pending initial
public offering, the Company, Hickey and certain executive officers of the
Company entered into additional agreements pursuant to which Hickey affirmed the
validity of agreements entered into on March 26, 1997, and agreed to an extended
noncompetition agreement for consideration of 483,980 shares of common stock
valued at approximately $3.4 million. The Company determined the fair market
value of the common stock as of November 7, 1997 based upon consultation with
its investment advisors in connection with its then
F-50
<PAGE>
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM APRIL 21, 1995 (INCEPTION) TO MARCH 31, 1996
AND FOR THE YEARS ENDED MARCH 31, 1997 AND 1998
(INFORMATION AS OF SEPTEMBER 30, 1998 AND FOR THE SIX MONTHS ENDED
SEPTEMBER 30, 1998 AND 1997 IS UNAUDITED)
(8) CAPITAL TRANSACTIONS (CONTINUED)
proposed intial public offering and as a result of arms length negotiations with
Mr. Hickey. Additional releases were obtained for claims relating to Hickey's
interest in the Company and the pending initial public offering. The fair value
of the common stock issued in consideration for the extended noncompetition
agreement was recorded as an intangible asset and is being amortized by use of
the straight-line method over the 41 month life of the agreement. Amortization
expense of approximately $396,000 was recorded in connection with this
agreement.
The Note accrued interest at a rate of 8% per annum. The Company paid $5
million of the Note on March 25, 1998 in accordance with its terms and must
repay the remaining outstanding principal and all accrued interest on or prior
to March 25, 1999. The Company pledged two-thirds of the shares of common stock
if redeemed from Hickey as collateral for the Note.
STOCK OPTIONS AND WARRANTS
On May 12, 1997 and during June 1997, the Company granted incentive
stock/stock options compensation awards in connection with three employment
agreements. The incentive awards, which vest at specified future dates ranging
from 18 to 36 months from the effective dates of the agreements, are not
dependent upon performance targets and provide for a maximum value of $850,000
in the aggregate payable in stock or stock options of equivalent value. The
Company has recorded compensation expense of $384,269 for the year ended March
31, 1998 in connection with such incentive awards.
On May 26, 1997, the Company granted an option to purchase 1,916,600 shares
of common stock in connection with an employment agreement. The option is
exercisable for $3.57 million, the fair market value at the date of grant. On
October 15, 1997, the optionee exercised the option and obtained a loan for the
exercise price from the Company. The loan is with recourse to the optionee,
noninterest bearing for a period of up to 18 months, bears interest at a market
rate thereafter and matures on the earlier of (i) two years from the date of the
loan, (ii) one year after the closing of the Offering or (iii) upon a sale of
control of the Company. The acceleration provision due to a change in control
has been waived by STAR in connection with the proposed merger.
On June 29, 1997, the Company entered into a service agreement with
Interexchange, Inc. (Interexchange), a debit card service provider. In
connection with the execution of the Interexchange Agreement, the Company
granted warrants from the purchase of shares of Common Stock to certain
principals of Interexchange (collectively, the "Interexchange Warrants"). The
Interexchange Warrants are exercisable for shares of Common Stock with an
aggregate fair market value equal to (i) $1,000,000, at a total exercise price
of $.15 and (ii) $2.0 million, at an aggregate exercise price equal to
$1,000,000 (collectively, the "Warrant Shares"). Interexchange Warrants with
respect to one-third of the Warrant Shares vest and become exercisable upon each
of: (i) the earlier to occur of the closing of the Offering or March 31, 1998,
(ii) January 1, 1999 and (iii) December 1, 1999, in each case if and only if the
Interexchange Agreement has not been terminated on or before such date (other
than as a result of a breach by the Company). The Interexchange Warrants expire
upon the fifth anniversary of their respective vesting dates. In the event of a
change of control, any unvested Interexchange Warrants at such time shall
immediately vest and become
F-51
<PAGE>
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM APRIL 21, 1995 (INCEPTION) TO MARCH 31, 1996
AND FOR THE YEARS ENDED MARCH 31, 1997 AND 1998
(INFORMATION AS OF SEPTEMBER 30, 1998 AND FOR THE SIX MONTHS ENDED
SEPTEMBER 30, 1998 AND 1997 IS UNAUDITED)
(8) CAPITAL TRANSACTIONS (CONTINUED)
exercisable and the fair market value shall be fixed as of the date of such
change of control. In connection with the warrants, the Company will record
compensation expense of approximately $2,000,000, the difference between the
exercise price and market value, over the vesting period applicable to each
portion of the grant. The Company has recorded compensation expense of
approximately $1,200,000 for the year ended March 31, 1998, in connection with
the warrants.
On September 30, 1997, the Board of Directors adopted, and the shareholders
of the Company approved, the 1997 Stock Incentive Plan (the "Stock Incentive
Plan"), which provides for the grant to officers, key employees and directors of
the Company and its subsidiaries of both "incentive stock options" within the
meaning of the Internal Revenue Code, and stock options that are nonqualified
for federal income tax purposes. The total number of shares for which options
may be granted pursuant to the Stock Incentive Plan and the maximum number of
shares for which options may be granted pursuant to the Stock Incentive Plan and
the maximum number of shares for which options may be granted to any person is
3,500,000 shares, subject to certain adjustments to reflect changes in the
Company's capitalization.
As of March 31, 1998, options to purchase an aggregate 628,000 shares of
Common Stock were granted under the Stock Incentive Plan and a total of
2,872,000 shares of Common Stock remained available for future grants. The
outstanding options were held by 30 individuals. The Company has recorded
compensation expense of $70,000 for the year ended March 31, 1998 in connection
with such options. Shares subject to options granted under the plan that have
lapsed or terminated may again be subject to options granted under the plan.
The following table summarizes the transactions of the Company's Stock
Incentive Plan for the year ended March 31, 1998:
<TABLE>
<CAPTION>
WEIGHTED
SHARES AVERAGE
SUBJECT TO OPTION PRICE
OPTION PER SHARE
----------- -------------
<S> <C> <C>
Balance at April 1, 1997.......................................... -- $ --
Options granted................................................. 3,720,700 3.14
Options exercised............................................... (2,975,200) 1.20
Options canceled................................................ (117,500) 10.53
----------- ------
Balance at March 31, 1998......................................... 628,000 $ 10.97
----------- ------
Options granted................................................. -- --
Options exercised............................................... -- --
Options canceled................................................ (61,000) 10.75
----------- ------
Balance at September 30, 1998 (unaudited)......................... 567,000 $ 10.98
----------- ------
----------- ------
</TABLE>
The Company did not grant any stock options for the year ended March 31,
1997.
F-52
<PAGE>
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM APRIL 21, 1995 (INCEPTION) TO MARCH 31, 1996
AND FOR THE YEARS ENDED MARCH 31, 1997 AND 1998
(INFORMATION AS OF SEPTEMBER 30, 1998 AND FOR THE SIX MONTHS ENDED
SEPTEMBER 30, 1998 AND 1997 IS UNAUDITED)
(8) CAPITAL TRANSACTIONS (CONTINUED)
The following table summarizes information about shares subject to options
under the Company's Stock Incentive Plan at September 30, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- -------------------------------------------------------------- --------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER RANGE OF EXERCISE EXERCISE REMAINING LIFE NUMBER EXERCISE
OUTSTANDING PRICE PRICE IN YEARS EXERCISABLE PRICE
- ----------- ----------------- ------------- --------------- ----------- -------------
<S> <C> <C> <C> <C> <C>
547,000 $ 10.00 - $11.00 $ 10.86 0.31 399,659 $ 10.87
20,000 $ 13.20 - $15.40 $ 14.30 0.50 10,000 $ 13.20
- ----------- -----------
567,000 $ 10.00 - $15.40 $ 10.98 0.32 409,659 $ 10.87
- ----------- -----------
- ----------- -----------
</TABLE>
(9) COMMITMENTS AND CONTINGENCIES
(A) LEASE
At March 31, 1998, the Company was committed under a noncancelable operating
lease for the rental of office space for which it is also obligated to pay a pro
rata portion of increases in real property taxes as additional rent.
The Company's future lease payments are as follows:
<TABLE>
<CAPTION>
OPERATING CAPITAL
YEAR ENDING MARCH 31, LEASES LEASES
- ---------------------------------------------------------------- ------------ --------------
<S> <C> <C>
1999............................................................ $ 1,331,000 $ 2,270,620
2000............................................................ 1,275,000 2,477,040
2001............................................................ 1,260,000 2,477,040
2002............................................................ 1,214,000 2,477,040
2003............................................................ 376,000 2,477,040
Remainder....................................................... 2,050,000 206,420
------------ --------------
$ 7,506,000 12,385,200
------------
------------
Less Amount Representing Interest............................... (2,385,200)
Capital Lease Obligation........................................ 10,000,000
--------------
--------------
</TABLE>
Total rent expense for the years ended March 31, 1997 and 1998 was
approximately $76,000 and $788,000, respectively.
(B) TELECOMMUNICATIONS SERVICE AGREEMENTS
The Company has an agreement with a telecommunications company with an
annual usage commitment of $1,500,000. The Company has exceeded the annual usage
commitment since the inception of this agreement.
F-53
<PAGE>
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM APRIL 21, 1995 (INCEPTION) TO MARCH 31, 1996
AND FOR THE YEARS ENDED MARCH 31, 1997 AND 1998
(INFORMATION AS OF SEPTEMBER 30, 1998 AND FOR THE SIX MONTHS ENDED
SEPTEMBER 30, 1998 AND 1997 IS UNAUDITED)
(9) COMMITMENTS AND CONTINGENCIES (CONTINUED)
The Company has minimum volume commitments of approximately 940,000 minutes
per month with eight of its service providers which, if not met, may require the
Company to make payments to these providers. As of March 31, 1998, the Company
anticipates that it will fulfill these commitments.
The Company is committed to paying a minimum monthly service charge of
$500,000 through January 1, 2001 for use of a debit platform switching network.
The Company has disputed carrier cost charges of approximately $3.2 million
with one of its telecommunication providers since the Company believes it has
been improperly charged fees for uncompleted calls. The Company believes it will
settle this dispute favorably and at March 31, 1998 has accrued $1.6 million
relating to this dispute.
(C) EMPLOYMENT CONTRACTS
The Company has employment agreements with certain executive officers and
key management personnel, the terms of which expire at various times through
June 2000. Such agreements provide for minimum salary levels, as well as for
incentive bonuses that are payable if specified management goals are attained.
The aggregate commitment for future salaries at March 31, 1998, excluding
bonuses, was approximately $3,047,000. All agreements contain covenants not to
compete.
(D) LETTERS OF CREDIT
At March 31, 1997 and 1998 and September 30, 1998, certificates of deposit
with carrying values of $1,472,000 and $2,406,000 and $0, respectively,
collateralize standby letters of credit to the Company's major service provider.
These letters of credit have been issued as security against services advanced.
(E) REGULATORY
The Company is subject to regulation by various government agencies and
jurisdictions and believes it is in compliance with all applicable laws and
regulations. However, implementation and interpretation of the Telecom Act of
1996 (the Act) is ongoing and subject to litigation by various Federal and state
agencies and courts. As a result, the impact of the Act on the Company is not
yet completely determinable and future interpretations and rulings may impact
the financial position and results of operations of the Company.
The Telecommunications Act (Section 276) mandated that the FCC promulgate
rules to establish a per call compensation plan to ensure that all payphone
providers are fairly compensated for each completed intrastate and interstate
payphone initialed call, including calls on which payphone providers had not
heretofore received compensation. Such calls included those placed to toll free
numbers (800/888) such as operator assisted and prepaid calling card calls, and
calls placed through network access codes. In September 1996, the FCC
promulgated rules to implement Section 276 of the Telecommunications Act which
established a three-phase compensation plan for payphone providers. On July 1,
1997, the D.C. Circuit Court of Appeals vacated significant portions of the
FCC's rules including the per call rate which was found to be arbitrary and
capricious, and remanded the matter to the FCC for reconsideration. On remand,
the FCC in September 1997, established a two-year "default" compensation rate of
$0.284 per
F-54
<PAGE>
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM APRIL 21, 1995 (INCEPTION) TO MARCH 31, 1996
AND FOR THE YEARS ENDED MARCH 31, 1997 AND 1998
(INFORMATION AS OF SEPTEMBER 30, 1998 AND FOR THE SIX MONTHS ENDED
SEPTEMBER 30, 1998 AND 1997 IS UNAUDITED)
(9) COMMITMENTS AND CONTINGENCIES (CONTINUED)
payphone-originated toll free or access code call. At the end of the two year
interim period, the per call payphone compensation rate will be the deregulated
market-based local coin rate less $0.066. This amount is payable by all
"switched-based" interexchange carriers (but again may be passed through to non-
facilities-based resellers). The revised FCC's rules became effective on October
7, 1997, but continue to be subject to regulatory and legal challenges. The
Company accrues $0.284 for each terminated toll free call which originates from
a payphone, in the period the call is made, in accordance with the FCC's rules.
In 1998, the Company began incurring certain universal service support
obligation costs resulting from the Federal Communications Commission Universal
Service Order. The Universal Service Order created new universal service support
obligations for telecommunications services for schools and libraries and rural
health care facilities. The Universal Service Order is currently being
challenged.
PT-1 believes that these regulations or other potential changes in the
regulatory environment will not have a material effect on the Company.
(F) LEGAL
On July 31, 1997, the Company was notified by the Federal Trade Commission
(FTC) and the New York Attorney General Office (NYAG) that it was the subject of
an investigation alleging deceptive advertising practices in connection with the
sale of its prepaid telephone cards. The Company has recently been informed that
the NYAG office is no longer pursuing this matter. The Company does not believe
its advertising practices are deceptive and it is currently in discussions with
the FTC offices regarding resolution. Management does not believe that the
outcome, if unfavorable, will have a material adverse effect on the Company's
business, financial condition or results of operations. The Company estimates
that the range it would be obligated to pay is approximately $250,000 to
$300,000. The Company has accrued $250,000 at March 31, 1998 relating to this
claim.
(10) SHORT-TERM DEBT
On October 8, 1997, the Company entered into a $5.0 million revolving credit
facility and a $5.0 million letter of credit facility with Chase Manhattan Bank,
N.A. (the "Credit Facility"). Borrowings under the Credit Facility bear interest
at a rate equal to either the adjusted London Interbank Offer Rate plus 2.25%,
the prime rate or a fixed rate to be determined pursuant to the Credit Facility.
Borrowings under the Credit Facility are secured by the Company's equipment and
accounts receivable. The Company may borrow up to 75% of eligible equipment and
accounts receivable. The Credit Agreement expires on September 30, 1998. The
amount borrowed on the line of credit was $2,760,000 at March 31, 1998 and
$5,000,000 at September 30, 1998.
(11) DEFERRED OFFERING COSTS
The Company has deferred offering costs of $485,790 relating to its proposed
initial public offering. In connection with the merger transaction described in
note 12 the Company is not pursuing the initial public offering and such costs
will be expensed in the first quarter of fiscal 1999.
F-55
<PAGE>
PT-1 COMMUNICATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM APRIL 21, 1995 (INCEPTION) TO MARCH 31, 1996
AND FOR THE YEARS ENDED MARCH 31, 1997 AND 1998
(INFORMATION AS OF SEPTEMBER 30, 1998 AND FOR THE SIX MONTHS ENDED
SEPTEMBER 30, 1998 AND 1997 IS UNAUDITED)
(12) TRANSACTIONS WITH STAR TELECOMMUNICATIONS, INC.
In June and September 1998, PT-1 entered into two Capacity Purchase and
Assignment Agreements with STAR Telecommunications, Inc. (STAR) for $4.5 million
and $4.1 million, respectively. Pursuant to these agreements, PT-1 acquired two
indefeasible rights of use (IRU) from STAR which have been accounted for as
capital leases and are included in telecommunications network.
On August 17, 1998 PT-1 obtained a loan from STAR for $10 million with a
maturity date of August 17, 1999. The loan accrues interest monthly at 6 3/4%
and PT-1 may defer payment of all interest until the maturity date.
On August 20, 1998, PT-1 entered into an amended and restated agreement and
plan of merger with STAR. Effective as of September 1, 1998 and December 29,
1998 the merger agreement was amended by the parties to modify the consideration
to be paid to the stockholders of PT-1 and to provide Star with managerial and
operational authority over PT-1 as of September 1, 1998. The acquisition was
completed through the issuance of 15,050,000 shares of STAR common stock and
$19.5 million or short term promissory notes for all outstanding shares, options
and warrants of PT-1 plus an additional 250,000 to certain PT-1 distributors.
F-56
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Report of Independent Accountants for the years ended April 30, 1996 and 1997 and for the eight months
ended December 31, 1997.................................................................................. F-58
Report of Independent Accountants for the year ended April 30, 1995........................................ F-59
Consolidated Financial Statements:
Consolidated Balance Sheets as of April 30, 1996 and 1997 and as of December 31, 1997...................... F-60
Consolidated Statements of Operations for the years ended April 30, 1995, 1996 and 1997 and for the eight
months ended December 31, 1997........................................................................... F-61
Consolidated Statements of Shareholders' Equity (Deficit) for the years ended April 30, 1995, 1996 and 1997
and for the eight months ended December 31, 1997......................................................... F-62
Consolidated Statements of Cash Flows for the years ended April 30, 1995, 1996 and 1997 and for the eight
months ended December 31, 1997........................................................................... F-63
Notes to Consolidated Financial Statements................................................................. F-64
</TABLE>
F-57
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
United Digital Network, Inc. and Subsidiaries
(formerly Unidex Communications Corp.)
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, shareholders' equity (deficit) and of
cash flows present fairly, in all material respects, the financial position of
United Digital Network, Inc. and its Subsidiaries (formerly Unidex
Communications Corp.) at April 30, 1996 and 1997 and at December 31, 1997, and
the results of their operations and their cash flows for the years ended April
30, 1996 and 1997 and for the eight months ended December 31, 1997, in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these financial statements in accordance
with generally accepted auditing standards which require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As described in Note
14 to the consolidated financial statements, the Company has a significant
working capital deficiency and its current cash flow from operations is not
sufficient to permit the Company to repay debts on the scheduled due dates.
These conditions raise substantial doubt about the Company's ability to continue
as a going concern. Management's plans in regard to this matter are also
described in Note 14. The financial statements do not include any adjustment
that might result from the outcome of this uncertainty.
/s/ PRICEWATERHOUSECOOPERS LLP
Dallas, Texas
May 31, 1998
F-58
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Shareholders
UNIDEX COMMUNICATIONS CORP.
We have audited the consolidated statements of operations, shareholders'
equity and cash flows of Unidex Communications Corp. and Subsidiaries as of
April 30, 1995, and the consolidated statements of operations, shareholders'
equity and cash flows for the year then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our previously issued report dated July 21, 1995, we expressed an opinion
that the 1995 consolidated financial statements presented fairly the results of
operation, changes in shareholders' equity and cash flows of Unidex
Communications Corp. and Subsidiaries for the year ended April 30, 1995 in
conformity with generally accepted accounting principles, except for the
omission of the disclosure of proforma results of operations relating to a
business acquisition. The Company has included the omitted proforma information
in Note 3. Accordingly, our present opinion on the 1995 financial statements is
different from that presented in our previous report.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the results of operation, changes in
shareholders' equity and cash flows of the Unidex Communications Corp. and
Subsidiaries for the year ended April 30, 1995 in accordance with generally
accepted accounting principles.
/s/ WEAVER AND TIDWELL, L.L.P.
Dallas, Texas
July 21, 1995, except for the
proforma information relating to
the business acquisition, as to which
the date is May 20, 1997.
F-59
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
AS OF APRIL 30, AS OF
---------------------------- DECEMBER 31,
1996 1997 1997
------------- ------------- -------------
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents......................................... $ 1,073,649 $ 556,366 $ 45,317
Accounts and notes receivable, net (Note 5)....................... 2,452,336 3,918,905 3,787,173
Receivable from employee.......................................... 12,010 -- --
Prepaid expenses and other........................................ 140,991 453,247 383,369
------------- ------------- -------------
Total current assets............................................ 3,678,986 4,928,518 4,215,859
Property and equipment, net (Note 6)................................ 1,369,576 1,947,234 2,038,308
Intangible assets, net (Note 7)..................................... 5,367,809 6,158,354 6,012,110
Other assets........................................................ 170,791 162,067 262,376
------------- ------------- -------------
Total assets.................................................... $ 10,587,162 $ 13,196,173 $ 12,528,653
------------- ------------- -------------
------------- ------------- -------------
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Trade accounts payable............................................ $ 3,407,351 $ 5,628,664 $ 8,121,197
Other accrued liabilities......................................... 220,834 330,640 374,178
Notes and accounts payable to related parties, net (Note 12)...... 1,143,650 896,470 3,634,333
Current maturities of long-term obligations (Note 8).............. 559,596 689,712 1,306,825
Accrued taxes, other than income taxes............................ 388,881 567,352 634,242
------------- ------------- -------------
Total current liabilities....................................... 5,720,312 8,112,838 14,070,775
------------- ------------- -------------
Long-term obligations (Note 8)...................................... 436,700 1,309,792 1,043,803
Long-term obligations to related parties, net (Note 12)............. 1,624,586 684,990 --
Commitments and contingencies (Note 13)
Shareholders' equity (deficit):
Common stock, $.01 par value, 100,000,000 shares authorized;
5,250,340, 6,378,442, and 6,808,594 issued at April 30, 1996 and
1997, and December 31, 1997, respectively (Notes 2 and 9)....... 52,503 63,784 68,086
Additional paid-in capital........................................ 9,913,694 11,863,723 12,617,072
Retained deficit.................................................. (7,160,633) (8,838,954) (15,271,083)
------------- ------------- -------------
Total shareholders' equity (deficit)............................ 2,805,564 3,088,553 (2,585,925)
------------- ------------- -------------
Total liabilities and shareholders' equity (deficit)............ $ 10,587,162 $ 13,196,173 $ 12,528,653
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-60
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE
EIGHT MONTHS
FOR THE YEARS ENDED APRIL 30, ENDED
------------------------------------------- DECEMBER 31,
1995 1996 1997 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Telecommunications revenues.......................... $ 2,338,467 $ 8,026,587 $ 24,012,368 $ 21,078,166
Operating expenses:
Costs of services.................................. 1,917,734 6,029,796 18,455,095 16,888,577
Selling, general and administrative................ 1,941,624 2,675,265 5,154,901 6,161,937
Provision for doubtful accounts.................... 74,662 228,827 693,164 3,144,128
Depreciation and amortization...................... 273,053 583,530 900,545 698,106
------------- ------------- ------------- -------------
Total operating expenses......................... 4,207,073 9,517,418 25,203,705 26,892,748
------------- ------------- ------------- -------------
Loss from operations before other expenses........... (1,868,606) (1,490,831) (1,191,337) (5,814,582)
Other expenses:
Interest expense, net.............................. (85,431) (107,474) (634,103) (617,547)
Loss on sale of assets............................. (118,680) -- -- --
Loss on impairment of assets....................... -- (63,997) -- --
------------- ------------- ------------- -------------
Total other expenses............................. (204,111) (171,471) (634,103) (617,547)
------------- ------------- ------------- -------------
Loss before income tax benefit and extraordinary
gain............................................... (2,072,717) (1,662,302) (1,825,440) (6,432,129)
------------- ------------- ------------- -------------
Income tax benefit (Note 10)......................... -- -- 50,000 --
------------- ------------- ------------- -------------
Loss before extraordinary gain....................... (2,072,717) (1,662,302) (1,775,440) (6,432,129)
------------- ------------- ------------- -------------
Extraordinary gain on debt restructuring (net of
income taxes of $50,000)........................... -- -- 97,119 --
------------- ------------- ------------- -------------
Net loss............................................. $ (2,072,717) $ (1,662,302) $ (1,678,321) $ (6,432,129)
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Loss per weighted average common shares outstanding
(basic and diluted):
Loss before extraordinary gain on debt
restructuring.................................... $ (0.92) $ (0.45) $ (0.33) $ (0.98)
Extraordinary gain................................. -- -- 0.02 --
------------- ------------- ------------- -------------
Net loss per share................................. $ (0.92) $ (0.45) $ (0.31) $ (0.98)
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Weighted average number of common shares
outstanding (basic and diluted).................. 2,252,953 3,706,993 5,359,156 6,546,499
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-61
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED APRIL 30, 1995, 1996 AND 1997
AND FOR THE EIGHT MONTHS ENDED DECEMBER 31, 1997
----------------------------------------------------------
COMMON STOCK ADDITIONAL
------------------ PAID-IN RETAINED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
--------- ------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Balance at April 30, 1994............... 1,854,002 $ -- $ 4,074,620 $ (3,425,614) $ 649,006
Net loss................................ -- -- -- (2,072,717) (2,072,717)
Issuance of common stock for:
Private placements.................... 1,205,625 -- 2,015,722 -- 2,015,722
Exercise of warrants.................. 43,405 -- 167,113 -- 167,113
Acquisition of DNI.................... 250,000 -- 407,006 -- 407,006
Consideration for finder's fees....... 1,984 -- -- -- --
Issuance costs.......................... -- -- (49,915) -- (49,915)
--------- ------- ----------- ------------ -----------
Balance at April 30, 1995............... 3,355,016 -- 6,614,546 (5,498,331) 1,116,215
--------- ------- ----------- ------------ -----------
Net loss................................ -- -- -- (1,662,302) (1,662,302)
Increase in par value to $.01/share..... -- 33,550 (33,550) -- --
Issuance of common stock for:
Private placements.................... 1,444,432 14,444 2,674,593 -- 2,689,037
Exercise of warrants.................. 450,892 4,509 714,644 -- 719,153
Compensation expense.................... -- -- 47,000 -- 47,000
Issuance costs.......................... -- -- (103,539) -- (103,539)
--------- ------- ----------- ------------ -----------
Balance at April 30, 1996............... 5,250,340 52,503 9,913,694 (7,160,633) 2,805,564
--------- ------- ----------- ------------ -----------
Net loss................................ -- -- -- (1,678,321) (1,678,321)
Issuance of common stock for:
Private placements.................... 722,250 7,222 1,143,272 -- 1,150,494
Exercise of warrants.................. 155,852 1,559 264,259 -- 265,818
Conversion of 11% debentures.......... 250,000 2,500 497,498 -- 499,998
Compensation expense.................... -- -- 45,000 -- 45,000
--------- ------- ----------- ------------ -----------
Balance at April 30, 1997............... 6,378,442 63,784 11,863,723 (8,838,954) $ 3,088,553
--------- ------- ----------- ------------ -----------
Net loss................................ -- -- -- (6,432,129) (6,432,129)
Issuance of common stock for:
Private placements.................... 337,152 3,372 586,644 -- 590,016
Exercise of warrants.................. 68,000 680 117,955 -- 118,635
Exercise of stock options............. 25,000 250 48,750 -- 49,000
--------- ------- ----------- ------------ -----------
Balance at December 31, 1997............ 6,808,594 $68,086 $12,617,072 $(15,271,083) $(2,585,925)
--------- ------- ----------- ------------ -----------
--------- ------- ----------- ------------ -----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-62
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE EIGHT
MONTHS
FOR THE YEARS ENDED APRIL 30, ENDED
------------------------------------------- DECEMBER 31,
1995 1996 1997 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss............................................ $ (2,072,717) $ (1,662,302) $ (1,678,321) $ (6,432,129)
Adjustments to reconcile net loss to net cash used
by operating activities:
Depreciation and amortization..................... 276,026 583,530 900,545 698,106
Gain on debt restructuring........................ -- -- (147,119) --
Loss on disposal of assets........................ 118,680 -- -- --
Loss on impairment................................ -- 63,997 -- --
Compensation recognized for stock options......... -- 47,000 45,000 --
Interest amortization of notes discount........... -- -- 263,307 137,468
Proceeds from factoring of trade receivables,
net............................................. -- -- 3,562,230 2,091,772
Other............................................. (14,914) (3,494) 7,990 --
(Increase) decrease, net of effect of acquisition:
Unfactored accounts and notes receivable........ (203,307) 179,016 (3,750,778) (2,015,660)
Prepaid expenses and other assets............... 47,751 152,385 (631,734) 27,529
Increase (decrease), net of effect of acquisition:
Accounts and notes payable and accrued
expenses...................................... 29,143 (705,416) 1,666,637 3,146,311
------------- ------------- ------------- -------------
Net cash used in operating activities......... (1,819,338) (1,345,284) 237,757 (2,346,603)
------------- ------------- ------------- -------------
Cash flows from investing activities:
Additions to property and equipment................. (193,745) (186,439) (673,714) (472,802)
Purchase of CTN, net of cash acquired............... -- -- (350,000) --
Purchase of AMS, net of cash acquired............... -- (542,980) -- --
Purchase of DNI, net of cash acquired............... (200,000) -- -- --
Sale of assets...................................... 150,000 -- -- --
Receipts on notes................................... 5,128 71,375 75,752 52,717
------------- ------------- ------------- -------------
Net cash used in investing activities......... (238,617) (658,044) (947,962) (420,085)
------------- ------------- ------------- -------------
Cash flows from financing activities:
Proceeds from issuance of common stock.............. 2,132,920 3,236,725 1,350,309 757,652
Proceeds from short-term loan....................... -- -- -- 2,500,000
Principal payments on obligations................... (303,080) (280,825) (1,157,387) (1,002,013)
Advances from shareholders.......................... 233,329 -- -- --
------------- ------------- ------------- -------------
Net cash provided by financing activities..... 2,063,169 2,955,900 192,922 2,255,639
------------- ------------- ------------- -------------
Increase (decrease) in cash and cash equivalents...... 5,214 952,572 (517,283) (511,049)
Cash and cash equivalents at beginning of period...... 115,863 121,077 1,073,649 556,366
------------- ------------- ------------- -------------
Cash and cash equivalents at end of period............ $ 121,077 $ 1,073,649 $ 556,366 $ 45,317
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Supplemental disclosure of cash flow information:
Interest paid....................................... $ 93,105 $ 113,815 $ 719,758 $ 581,252
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-63
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) DESCRIPTION OF BUSINESS
United Digital Network, Inc. (the "Company"), formerly Unidex Communications
Corp., was incorporated in 1980 under the British Columbia Company Act in
British Columbia, Canada, and its shares are publicly traded on the Vancouver
Stock Exchange. In April 1995, the Company's continuance was authorized to the
jurisdiction of Wyoming under the Wyoming Business Corporation Act from the
Registrar of Companies for the Province of British Columbia. The Company then
merged with a wholly-owned subsidiary domiciled in the state of Delaware,
thereafter becoming a Delaware Corporation. The Company operates through its
principal subsidiaries, United Digital Network of Texas, Inc. (UDN), Advanced
Management Services, Inc. (AMS) and CTN-Custom Telecommunications Network of
Arizona, Inc. (CTN). In September 1997, the Company formed UDN with the merger
of Answer-Net, Inc. (ANI) and Digital Network, Inc. (DNI).
The Company's principal business activity is providing basic long distance
services, travelcard services, prepaid calling card services, and various other
telecommunication services to residential and small to medium sized commercial
customers. The majority of the Company's customers are located in the states of
Texas, Oklahoma, Arizona, New Mexico and California, as well as customers
located nationwide in the motor freight industry.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
FISCAL YEAR
Effective January 1, 1998, the Company changed its fiscal year ended April
30 to a fiscal year ended December 31.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries UDN, AMS and CTN. The financial statements and
related footnotes are presented in U.S. dollars, unless otherwise indicated, and
all significant intercompany accounts and transactions are eliminated in
consolidation. Certain previously reported amounts have been reclassified to
conform to the current year presentation.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents represent cash and short-term, highly liquid
investments with original maturities three months or less.
FINANCIAL INSTRUMENTS
The fair market value of financial instruments is determined by reference to
various market data and other valuation techniques as appropriate. The Company
believes that the fair values of financial instruments approximate their
recorded values.
F-64
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
BUSINESS AND CREDIT CONCENTRATIONS
In the normal course of business, the Company extends unsecured credit to
its customers. Management has provided an allowance for doubtful accounts to
provide for amounts which may eventually become uncollectible and to provide for
any disputed charges.
REVENUE RECOGNITION
The Company recognizes revenue from its direct dial, prepaid calling card,
and travel card long distance services as such services are performed.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation for financial
statement purposes, which includes amortization of assets under capital leases,
is provided utilizing the straight-line method over the estimated useful lives
of the depreciable assets or the lease terms.
Expenditures for major renewals and betterments, which significantly extend
the useful lives of existing property and equipment, are capitalized and
depreciated. Upon retirement or disposition of property and equipment, the cost
and related accumulated depreciation are removed from the accounts and any
resulting gain or loss is recognized in income. Expenditures for repair and
maintenance are charged to expense as incurred.
In March 1995, the FASB issued Statement of Financial Accounting Standards
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of" ("SFAS 121"), which requires that an entity review
long-lived assets for impairment, and any impairment loss for assets to be held
and used shall be reported as a component of income from continuing operations
before income taxes. The impairment loss recognized shall be measured as the
amount by which the carrying amount of the asset exceeds the fair value of the
asset.
In November 1995, the Company adopted SFAS 121. The application of SFAS 121
resulted in a charge to income for the 1996 fiscal year and a decrease in the
value of two long-lived assets.
FOREIGN CURRENCY TRANSACTIONS
Foreign currency transaction gains and losses are included in determining
net income and are not significant.
INTANGIBLE ASSETS
Intangible assets consist of the acquired cost of goodwill and customer
lists. These intangibles are amortized utilizing the straight-line method over
their estimated useful lives. The realizability of goodwill and customer lists
is evaluated periodically as events or circumstances indicate a possible
inability to recover their carrying amount. Such evaluation is based on various
analyses, including cash flow and profitability projections that incorporate, as
applicable, the impact on existing company businesses. The analyses necessarily
involve significant management judgment to evaluate the capacity of an acquired
business to perform within projections. Historically, the Company has generated
sufficient returns from acquired businesses to recover the cost of their
intangible assets.
F-65
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires the Company to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent liabilities at the date of the financial statements and
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
SHAREHOLDERS' EQUITY (DEFICIT)
Loss per share is computed by dividing the net loss by the weighted average
number of shares of common stock outstanding during the periods. The effect of
outstanding options and warrants on the computation of net loss per share is
antidilutive and, therefore, is not included in the computation for the years
ended April 30, 1995, 1996 and 1997 and for the eight months ended December 31,
1997.
On June 5, 1996, the Company's board of directors declared a four-for-one
reverse common stock split. As a result, effective August 9, 1996, all of the
Company's 50,000,000 shares of common stock, both issued and unissued, were
consolidated into 12,500,000 shares. The Company's par value of $.01 per share
remained unchanged. All share and per share amounts appearing in the
consolidated financial statements and notes thereto have been retroactively
adjusted for the stock split.
On June 5, 1996, the Company's board of directors also approved an increase
in the authorized shares of the Company from 12,500,000 to 100,000,000 shares
effective August 9, 1996. Concurrent with this change, the Company's name was
changed to United Digital Network, Inc.
INCOME TAXES
Deferred income taxes are calculated utilizing an asset and liability
approach, whereby deferred taxes are provided for tax effects of basis
differences for assets and liabilities arising from differing treatments for
financial and income tax reporting purposes. Valuation allowances against
deferred tax assets are provided where appropriate.
NEW ACCOUNTING STANDARDS
In February 1997, the FASB issued Financial Statement of Accounting
Standards No. 128, "Earnings per Share" ("SFAS 128"). SFAS 128 specifies the
computation, presentation and disclosure requirements for earnings per share
("EPS") for entities with publicly held common stock or potential common stock.
Effective January 1, 1998, Company adopted SFAS 128 and has restated all prior
period EPS amounts pursuant to SFAS 128. SFAS 128 simplifies the standards for
computing EPS previously found in Accounting Principles Board Opinion No. 15,
"Earnings per Share" and makes them comparable to international EPS standards.
It replaces the presentation of primary EPS with a presentation of basic EPS. It
also requires dual presentation of basic and diluted EPS on the face of the
statement of operations for all entities with complex capital structures and
requires a reconciliation of the numerator and denominator of the basic EPS
computation to the numerator and denominator of the diluted EPS computation.
Basic EPS excludes the effect of potentially dilutive securities while
diluted EPS reflects the potential dilution that would occur if securities or
other contracts to issue common stock were exercised, converted
F-66
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
into or resulted in the issuance of common stock. Common stock equivalents
consist of common stock issuable under the assumed exercise of stock options and
warrants, computed based on the treasury stock method and the assumed conversion
of the Company's issued and outstanding preferred stock. Common stock
equivalents are not included in diluted EPS calculations to the extent their
inclusion would have an anti-dilutive effect.
In June 1997, the FASB issued Financial Statement of Accounting Standards
No. 130, "Reporting Comprehensive Income." This statement establishes standards
for reporting and display of comprehensive income and its components (revenues,
expenses, gains and losses) in a full set of general-purpose financial
statements.
This statement is effective for fiscal years beginning after December 15,
1997. The Company believes that the adoption of this standard will not have a
material effect on the Company's consolidated results of operations or financial
position.
On June 15, 1998, FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
133"). SFAS 133 is effective for all fiscal quarters of all fiscal years
beginning after June 15, 1999. SFAS 133 requires that all derivative instruments
be recorded on the balance sheet at their fair value. Changes in the fair value
of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as part of
a hedge transaction and, if it is, the type of hedge transaction. Management of
the Company anticipates that, due to its limited use of derivative instruments,
the adoption of SFAS 133 will not have a significant effect on the Company's
results of operations or its financial position.
(3) ACQUISITIONS
DIGITAL NETWORK, INC.
Effective April 27, 1995, the Company acquired all of the outstanding shares
of Digital Network, Inc. (DNI). DNI provides telecommunication services to
customers in Texas and southern Oklahoma.
The acquisition was accounted for using the purchase method of accounting,
and accordingly, the purchase price was allocated to the assets purchased and
the liabilities assumed based upon fair values at the date of acquisition. The
excess of the purchase price over the fair values of the net assets acquired was
$679,241, and was reflected as goodwill.
A summary of the DNI excess of cost over the net assets acquired is as
follows:
<TABLE>
<S> <C>
Assets, including identified intangible
assets of $360,000.................... $ 1,331,363
Property and equipment.................. 1,261,674
Current liabilities..................... (1,906,894)
Long-term debt, net..................... (537,719)
--------------
Net assets acquired..................... 148,424
Goodwill................................ 679,241
--------------
Purchase price.......................... $ 827,665
--------------
--------------
</TABLE>
F-67
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) ACQUISITIONS (CONTINUED)
ADVANCED MANAGEMENT SERVICES, INC.
Effective March 26, 1996, the Company acquired all of the outstanding common
stock of AMS, a long distance carrier based in Phoenix, Arizona. The acquisition
was accomplished through the payment of $1,100,000 in cash and the issuance of a
series of convertible debentures and a note payable totaling $2,381,947, net of
discount. The Company has recorded adjustments to the purchase price and
reductions to the notes and debentures payable to the sellers based on
management's best estimate of allowable adjustments defined in the stock
purchase agreement.
The present value of the notes and debentures was imputed using an interest
rate of 11%. Future payments are contingent upon, and may be reduced, if various
revenue and equity targets through March 1998 as outlined in the purchase
agreement are not met.
The acquisition was accounted for using the purchase method of accounting,
and accordingly, the purchase price was allocated to the assets purchased and
the liabilities assumed based upon fair values at the date of acquisition. The
excess of the purchase price over the fair values of the net liabilities
acquired was $3,541,050 and was reflected as goodwill.
A summary of the AMS excess of cost over net liabilities acquired is as
follows:
<TABLE>
<S> <C>
Assets, including identified intangible
assets of $820,000.................... $ 2,994,730
Property and equipment.................. 24,295
Liabilities............................. (3,078,128)
--------------
Net liabilities acquired................ (59,103)
Goodwill................................ 3,541,050
--------------
Purchase price.......................... $ 3,481,947
--------------
--------------
</TABLE>
The Company's consolidated statement of operations includes the results of
operations of AMS since March 26, 1996.
CTN-CUSTOM TELECOMMUNICATIONS NETWORK OF ARIZONA, INC.
Effective January 1, 1997, the Company acquired all of the outstanding
common stock of CTN, a long distance carrier based in Phoenix, Arizona. The
acquisition was accomplished through the payment of $350,000 in cash and the
issuance of a convertible debenture and a note payable totaling $1,050,000,
accumulating interest at 7% per annum.
Future payments are contingent upon, and may be reduced, if various revenue
targets through November 1997, as outlined in the purchase agreement, are not
met.
The acquisition was accounted for using the purchase method of accounting,
and accordingly, the purchase price was allocated to the assets purchased and
the liabilities assumed based upon fair values at the date of acquisition. The
excess of the purchase price over the fair values of the net assets acquired was
F-68
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) ACQUISITIONS (CONTINUED)
$975,956 and was reflected as goodwill. A summary of the CTN excess of cost over
net assets acquired is as follows:
<TABLE>
<S> <C>
Assets, including identified intangible
assets of $290,000.................... $ 1,298,495
Property and equipment.................. 18,369
Liabilities............................. (842,950)
--------------
Net assets acquired..................... 473,914
Goodwill................................ 975,956
--------------
Purchase price.......................... $ 1,449,870
--------------
--------------
</TABLE>
The Company's consolidated statement of operations includes the results of
operations of CTN since January 1, 1997.
The following unaudited pro forma combined results of operations for the
Company assume that the acquisition of CTN was completed at May 1, 1995, the
acquisition of AMS was completed at May 1, 1994 and the acquisition of DNI was
completed at May 1, 1993. These pro forma amounts represent the historical
operating results of DNI combined with those of the Company with appropriate
adjustments which give effect to interest expense and amortization. These pro
forma amounts are not necessarily indicative of consolidated operating results
which would have occurred had AMS and DNI been included in the operations of the
Company during the periods presented, or which may result in the future, because
these amounts do not reflect full transmission and switched service cost
optimization, and the synergistic effect on operating, selling, and general and
administrative expenses.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED APRIL 30,
-------------------------------------------
<S> <C> <C> <C>
1995 1996 1997
------------- ------------- -------------
Revenues.................................................. $ 17,429,712 $ 21,647,023 $ 26,966,853
Net loss.................................................. (3,190,433) (2,722,749) (2,104,696)
Net loss per share outstanding (basic and diluted)........ (1.42) (.73) (.39)
</TABLE>
(4) NONCASH INVESTING AND FINANCING ACTIVITIES
During the year ended April 30, 1996, the Company purchased all of the
capital stock of AMS for $1,100,000 in cash and the issuance of a series of
convertible debentures and a note payable totaling $2,381,947. During the year
ended April 30, 1995, the Company purchased all of the capital stock of DNI for
$200,000 in cash and the issuance of a $200,000 note payable and the issuance of
250,000 shares of common stock at $1.628 a share. Additionally, during fiscal
1995, the Company sold net assets with a carrying value of $578,876 in exchange
for $150,000 cash and a $295,000 note receivable.
The Company recorded capital lease obligations of $87,465, $19,949,
$489,802, and $225,108 during the years ended April 30, 1995, 1996 and 1997, and
the eight months ended December 31, 1997, respectively.
During the year ended April 30, 1996, accounts payable to shareholders of
$17,926 and notes payable of $50,000 were relieved through the exercise of
warrants.
F-69
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(4) NONCASH INVESTING AND FINANCING ACTIVITIES (CONTINUED)
During the year ended April 30, 1997, an accrued liability of $66,000 was
relieved through the issuance of common stock.
During the year ended April 30, 1997 the Company purchased all of the
capital stock of CTN for $350,000 in cash and the issuance of a convertible
debenture and a note payable totaling $1,050,000.
(5) ACCOUNTS AND NOTES RECEIVABLE
Accounts and notes receivable consist of the following:
<TABLE>
<CAPTION>
FOR THE EIGHT
FOR THE YEARS ENDED APRIL MONTHS
30, ENDED
--------------------------- DECEMBER 31,
1996 1997 1997
------------ ------------- -------------
<S> <C> <C> <C>
Trade receivables:
Billed.................................................... $ 1,262,617 $ 3,420,941 $ 6,018,752
Unbilled.................................................. 1,337,640 3,213,712 1,613,583
Receivable from Freshstart Communications................... -- 614,858 430,608
Credit reserve due from factor.............................. -- 330,695 293,297
Other....................................................... 74,790 332,468 117,448
------------ ------------- -------------
Total notes and unfactored accounts receivable.............. 2,675,047 7,912,674 8,473,688
Total receivables assigned to factor........................ -- (3,562,230) (2,079,193)
------------ ------------- -------------
Total notes and accounts receivables........................ 2,675,047 4,350,444 6,394,495
Allowance for doubtful accounts............................. (222,711) (431,539) (2,607,322)
------------ ------------- -------------
Total accounts and notes receivable, net.................... $ 2,452,336 $ 3,918,905 $ 3,787,173
------------ ------------- -------------
------------ ------------- -------------
</TABLE>
The Company's monthly billing cycle is such that certain services performed
in the last month of one fiscal year will not be billed until the first month of
the subsequent fiscal year. These services are recognized as revenue and
recorded as unbilled receivables when earned.
In May 1996, the Company entered into a receivables purchase facility with
Receivables Funding Corporation (RFC). Under this facility, the Company
transfers receivables with recourse to RFC subject to the conditions of the
facility. The transfers are recorded in the period in which they occur. DNI and
AMS began transferring approximately 90% of eligible receivables to RFC
beginning in July and September, 1996, respectively.
In June 1996, the FASB issued Statement of Financial Accounting Standards
No. 125, "Accounting for Transfer and Servicing of Financial Assets and
Extinguishment of Liabilities" ("SFAS 125"). SFAS 125 requires that a transfer
of financial assets be accounted for as either a sale of these assets or as a
secured borrowing with a pledge of collateral. There are certain criteria which
must be met to classify the transfer as a sale. The Company adopted SFAS 125 for
the 1997 fiscal year. Under the provisions of SFAS 125, the Company's transfers
of receivables to RFC meet the criteria for classification as sales.
In the eight month period ended December 31, 1997, the Company received
$16,058,301 in proceeds from the factoring of trade receivables.
F-70
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(5) ACCOUNTS AND NOTES RECEIVABLE (CONTINUED)
During the eight months ended December 31, 1997, bad debt expense of $3.0
million was recorded by the Company. Included in this amount was the write-off
of receivables from two major wholesale customers as a result of the customers'
bankruptcies and the write-off of a $1.3 million receivable resulting from
customer fraud.
(6) PROPERTY AND EQUIPMENT
Property and equipment consist of:
<TABLE>
<CAPTION>
APRIL 30,
---------------------------- DECEMBER 31,
1996 1997 1997 LIFE
------------- ------------- ------------- ----------
<S> <C> <C> <C> <C>
Communications equipment...................... $ 3,281,643 $ 4,153,300 $ 4,353,018 2-8 years
Office equipment.............................. 321,250 569,705 790,897 5 years
Leasehold improvements........................ 20,053 43,894 56,988 5 years
------------- ------------- -------------
3,622,946 4,766,899 5,200,903
Accumulated depreciation...................... (2,253,370) (2,819,665) (3,162,595)
------------- ------------- -------------
Total property and equipment, net............. $ 1,369,576 $ 1,947,234 $ 2,038,308
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
Total depreciation expense, including amortization of equipment under
capital leases, charged to operations for the years ended April 30, 1995, 1996
and 1997 and for the eight months ended December 31, 1997, was $245,768,
$436,688, $498,701, and $401,750 respectively.
(7) INTANGIBLE ASSETS
Intangible assets consist of:
<TABLE>
<CAPTION>
APRIL 30,
-------------------------- DECEMBER 31,
1996 1997 1997 LIFE
------------ ------------ ------------ ---------
<S> <C> <C> <C> <C>
Goodwill......................................... $ 4,193,143 $ 5,094,387 $5,244,497 25 years
Customer lists................................... 1,316,832 1,606,832 1,579,307 7 years
------------ ------------ ------------
5,509,975 6,701,219 6,823,804
Accumulated amortization......................... (142,166) (542,865) (811,694)
------------ ------------ ------------
Total intangible assets, net..................... $ 5,367,809 $ 6,158,354 $6,012,110
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
Additions to goodwill and customer lists were recorded during fiscal years
1995, 1996 and 1997 as a result of the Company's acquisitions (Note 3).
F-71
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) LONG-TERM OBLIGATIONS
Long-term obligations consist of:
<TABLE>
<CAPTION>
APRIL 30,
----------------------- DECEMBER 31,
1996 1997 1997
---------- ----------- ------------
<S> <C> <C> <C>
Convertible debenture with interest of 7% per annum due January
1999. Amounts contingent on certain factors discussed in Note
3............................................................. $ -- $ 500,000 $ 500,000
Notes payable
Repayable in monthly installment amounts of $24,625 including
interest at 7% per annum, commencing in February 1997, due
January 1999................................................ -- 463,581 307,553
Repayable in monthly installments of $7,395 including interest
at 16.9% per annum. Final payment due November 1998......... -- 116,828 68,520
Repayable to a bank in monthly installments of $2,042
including interest at the Prime Rate plus 2% per annum,
fully retired............................................... 50,117 -- --
Repayable in monthly installment amounts of $3,678 plus
interest at 8%, final payment due June 1995. This note is
currently in default........................................ 41,098 41,098 41,098
Repayable to a bank in monthly installments of $1,825
including interest at the Prime Rate plus 2% per annum,
fully retired............................................... 63,743 -- --
Repayable in monthly installments of $4,894 including interest
at 8%, fully retired........................................ 36,800 -- --
Repayable monthly in amounts of $72,728 plus interest at 9.5%
per annum. Final payment due July 1998...................... -- -- 543,351
Capital lease obligations..................................... 804,538 877,997 890,106
---------- ----------- ------------
Total long-term obligations..................................... 996,296 1,999,504 2,350,628
Less current maturities:
Debt.......................................................... 191,758 387,322 935,911
Capital lease obligations..................................... 367,838 302,390 370,914
---------- ----------- ------------
Long-term portion............................................... $ 436,700 $ 1,309,792 $1,043,803
---------- ----------- ------------
---------- ----------- ------------
</TABLE>
Principal repayments of long-term obligations are due approximately as
follows:
<TABLE>
<CAPTION>
YEARS ENDING
DECEMBER 31,
------------
<S> <C>
1998............................................................................ $1,306,825
1999............................................................................ 903,251
2000............................................................................ 92,585
2001............................................................................ 46,104
2002............................................................................ 1,863
------------
Total long-term obligations..................................................... $2,350,628
------------
------------
</TABLE>
F-72
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) LONG-TERM OBLIGATIONS (CONTINUED)
In September 1996, the Company recorded an extraordinary gain of $68,258
from the restructuring of a capital lease to a note payable.
In February 1997, the Company recorded an extraordinary gain of $78,861 from
the full settlement of two notes payable.
(9) STOCK OPTIONS, WARRANTS, AND OTHER ACCOUNTING FOR STOCK-BASED COMPENSATION
In October 1995, Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-based Compensation" ("SFAS 123"), was issued by the
Financial Accounting Standards Board. The statement requires the fair value of
stock options and other stock-based compensation issued to employees to either
be included as compensation expense in the income statements of companies or the
pro forma effect on net income and earnings per share of such compensation
expense to be disclosed in the footnotes to the Company's financial statements
beginning in 1996. The Company has elected to adopt SFAS 123 on a disclosure
basis only. Accordingly, the Company does not recognize compensation cost for
options issued except for option grants with exercise prices below the fair
value of the stock on the date of grant. Had compensation cost for the Company's
stock option issuances been determined based on the fair market value at the
grant dates for awards consistent with the method provided by SFAS 123, the
Company's net loss and net loss per share would have been reflected by the
following pro forma amounts for the years ended April 30, 1995, 1996, and 1997
and for the eight months ended December 31, 1997.
<TABLE>
<CAPTION>
EIGHT
MONTHS
YEARS ENDED APRIL 30, ENDED
------------------------------------------- DECEMBER 31,
1995 1996 1997 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net loss:
As reported............................... $ (2,072,717) $ (1,662,302) $ (1,678,321) $ (6,432,129)
Pro forma................................. $ (2,113,190) $ (2,150,441) $ (1,983,310) $ (6,520,477)
Net loss per share (basic and diluted):
As reported............................... $ (.92) $ (.45) $ (.31) $ (.98)
Pro forma................................. $ (.94) $ (.58) $ (.37) $ (1.00)
</TABLE>
The fair value of each grant is estimated on the date of grant using the
Black-Scholes Option Pricing Model with the following weighted-average
assumptions used for grants during the years ended April 30, 1995, 1996 and 1997
and for the eight months ended December 31, 1997.
<TABLE>
<CAPTION>
EIGHT
MONTHS
YEARS ENDED APRIL 30, ENDED
---------------------------------- DECEMBER 31,
1995 1996 1997 1997
---------- ---------- ---------- ------------
<S> <C> <C> <C> <C>
Dividend yield...................................... -- -- -- --
Expected volatility................................. 55.00% 53.54% 48.45% 50.00%
Risk free rate of return............................ 7.60% 5.91% 6.22% 6.23%
Expected life....................................... 2.5 years 3.5 years 3.5 years 3.5 years
</TABLE>
F-73
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(9) STOCK OPTIONS, WARRANTS, AND OTHER ACCOUNTING FOR STOCK-BASED COMPENSATION
(CONTINUED)
The Company has periodically granted nonqualified stock options to officers,
directors and key employees during the years ended April 30, 1995, 1996, and
1997 and for the eight months ended December 31, 1997. These options are subject
to varying vesting terms, the maximum of which is two years and expire after
various periods after the date of grant, the maximum of which is five years.
During the years ended April 30, 1996 and 1997, respectively, the Company
recorded compensation expense and an increase in additional paid-in-capital in
the amount of $47,000 and $45,000, respectively, for options granted to
outsiders. Vesting of these options is subject to the achievement of certain
performance targets. Outstanding stock options to officers, directors, key
employees, and others entitle the holders to purchase 403,000, 386,875, 438,125,
and 560,517 common shares at April 30, 1995, 1996, and 1997 and December 31,
1997, respectively. The weighted average exercise prices of these options are
$1.02, $2.79, $2.65, and $2.61 (Canadian), respectively.
Additional information regarding options granted and outstanding is
summarized below:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE WEIGHTED AVERAGE
OPTION PRICE FAIR VALUE
SHARES (CANADIAN) (CANADIAN)
---------- ----------------- -----------------
<S> <C> <C> <C>
Outstanding at April 30, 1994........................... 153,250 $ 4.49
Granted............................................... 61,250 $ 2.73 $ 0.81
Canceled/Expired...................................... (71,250) $ 3.68
----------
Outstanding at April 30, 1995........................... 143,250 $ 4.14
Granted............................................... 386,250 $ 2.74 $ 1.26
Canceled/Expired...................................... (118,250) $ 4.34
----------
Outstanding at April 30, 1996........................... 411,250 $ 2.77
Granted............................................... 296,250 $ 2.49 $ 1.03
Canceled/Expired...................................... (101,875) $ 2.75
----------
Outstanding at April 30, 1997........................... 605,625 $ 2.64
Granted............................................... 76,250 $ 2.50 $ 1.16
Canceled/Expired...................................... (25,000) $ 2.28
Exercised............................................. (25,000) $ 2.80
----------
Outstanding at December 31, 1997........................ 631,875 $ 2.59
</TABLE>
The following table summarizes information about the fixed-price stock
options outstanding at December 31, 1997.
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------ ------------------------------
<C> <C> <S> <C> <C> <C>
RANGE OF WEIGHTED-AVERAGE WEIGHTED-AVERAGE SHARES WEIGHTED-AVERAGE
EXERCISE SHARES REMAINING EXERCISE EXERCISABLE EXERCISE
PRICES OUTSTANDING CONTRACTUAL PRICE AT PRICE
(CANADIAN) AT 12/31/97 LIFE (CANADIAN) 12/31/97 (CANADIAN)
- ------------- ----------- ---------------- ----------------- ----------- -----------------
$ 2.22-$2.92 631,875 3.08 years $ 2.59 560,517 $ 2.61
</TABLE>
F-74
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(9) STOCK OPTIONS, WARRANTS, AND OTHER ACCOUNTING FOR STOCK-BASED COMPENSATION
(CONTINUED)
WARRANTS
The Company issued warrants attached to certain shares issued for cash
entitling the holders to purchase an additional 1,205,625, 797,216, 361,125 and
112,394 common shares during the years ended April 30, 1995, 1996 and 1997 and
at December 31, 1997, respectively. Total outstanding warrants entitle the
holders to purchase up to 1,475,792, 1,551,949, 1,757,222 and 1,767,941 shares
as of April 30, 1995, 1996 and 1997 and as of December 31, 1997, respectively,
at prices ranging from $2.00 to $6.00, $2.00 to $4.40, $2.22 to $4.00 and $2.22
to $4.00 (Canadian) per share are exercisable at any time, and expire on various
dates through October 1999.
Pursuant to an agreement, the Company issued additional warrants to certain
warrant holders entitling them to purchase an additional 647,216 common shares
as the Company did not file with various securities regulatory authorities as
defined in the agreement by December 22, 1996. The additional warrants issued
expired in March 1998.
ESCROW SHARES
The Company issued 187,500 common shares to certain shareholders subject to
an escrow agreement dated May 19, 1988 and amended October 21, 1993, concurrent
with its initial public offering on the Vancouver Stock Exchange.
Under the terms of the escrow agreement, shares are to be released from
escrow on the basis of one share for each $1.52 (Canadian) of cumulative cash
flow, as defined by the agreement. Any shares released from escrow and issued to
employees will be treated as compensation. No shares had been released as of
December 31, 1997. In December 1998, any shares not released from escrow will be
canceled.
(10) INCOME TAXES
The components of the deferred taxes were as follows:
<TABLE>
<CAPTION>
APRIL 30,
---------------------------- DECEMBER 31,
1996 1997 1997
------------- ------------- -------------
<S> <C> <C> <C>
Deferred tax assets:
Allowance for doubtful accounts.......................... $ 76,000 $ 158,057 $ 886,489
Depreciation............................................. 23,000 92,943 63,338
Net operating loss carryforwards......................... 1,669,000 1,933,553 3,318,301
------------- ------------- -------------
Gross deferred tax asset................................. 1,768,000 2,184,553 4,268,128
Deferred tax liability:
Basis difference arising from purchase accounting........ 279,000 416,433 368,833
------------- ------------- -------------
Gross deferred tax liability............................. 279,000 416,433 368,833
------------- ------------- -------------
Valuation allowance........................................ (1,489,000) (1,768,120) (3,899,295)
------------- ------------- -------------
Net deferred tax asset..................................... $ -- $ -- $ --
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
F-75
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(10) INCOME TAXES (CONTINUED)
The following is a reconciliation of the provision for income taxes at the
U.S. federal income tax rate to the income taxes reflected in the consolidated
statements of operations:
<TABLE>
<CAPTION>
FOR THE EIGHT
FOR THE YEARS ENDED APRIL 30, MONTHS ENDED
------------------------------------- DECEMBER 31,
1995 1996 1997 1997
----------- ----------- ----------- -------------
<S> <C> <C> <C> <C>
Income tax benefit at federal statutory rate..... $ (705,000) $ (565,000) $ (570,629) $ (2,186,958)
Operating losses not benefited................... 750,000 407,000 264,319 1,321,373
Nondeductible amortization arising from purchase
accounting..................................... -- 57,000 70,693 55,784
Change in valuation reserve and other............ (45,000) 101,000 235,617 809,801
----------- ----------- ----------- -------------
Income tax benefit provided...................... $ -- $ -- $ -- $ --
----------- ----------- ----------- -------------
----------- ----------- ----------- -------------
</TABLE>
The net deferred tax asset is fully reserved because of management's
uncertainty regarding the Company's ability to recognize the benefit of the
asset in future years. A portion of the deferred tax asset at April 30, 1997,
has been recognized as a tax benefit, the result of an extraordinary gain from
debt restructuring. At April 30, 1996 and 1997 and at December 31, 1997, the
Company had net operating loss carryforwards of approximately $4,909,511,
$5,686,922 and $9,759,709, respectively. Utilization of the net operating loss
carryforwards may be limited by the separate return loss year rules and by
ownership changes which have occurred or could occur in the future.
(11) LEASES
The Company leases certain office facilities and equipment under capital
leases and noncancellable operating leases expiring through January 2002. At the
end of the capital lease terms, the Company has the option to purchase the
leased equipment. Minimum annual rentals under these leases are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
YEARS ENDING DECEMBER 31, LEASES LEASES
- ------------------------------------------------------------------------------ ------------ ----------
<S> <C> <C>
1998.......................................................................... $ 445,225 $ 268,954
1999.......................................................................... 426,498 199,449
2000.......................................................................... 107,132 131,307
2001.......................................................................... 49,302 --
2002.......................................................................... 1,956 --
------------ ----------
Total minimum lease payments.................................................. 1,030,113 $ 599,710
----------
----------
Amounts representing interest................................................. (140,007) --
------------
Present value of net minimum lease payments................................... 890,106
Current portion............................................................... (370,914)
------------
Long-term capitalized lease obligations....................................... $ 519,192
------------
------------
</TABLE>
F-76
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(11) LEASES (CONTINUED)
Assets recorded under capital leases are included in property and equipment
as follows:
<TABLE>
<CAPTION>
APRIL 30,
-------------------------- DECEMBER 31,
1996 1997 1997
------------ ------------ ------------
<S> <C> <C> <C>
Communications equipment..................................... $ 948,733 $ 1,322,695 $1,382,314
Office equipment............................................. 64,106 53,432 218,920
------------ ------------ ------------
1,012,839 1,376,127 1,601,234
Accumulated amortization..................................... (202,852) (497,816) (616,497)
------------ ------------ ------------
$ 809,987 $ 878,311 $ 984,737
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
The total rent expense incurred during the years ended April 30, 1995, 1996
and 1997 and for the eight months ended December 31, 1997 was $126,660,
$186,470, $300,662, and $212,206, respectively. In addition to minimum rentals,
one lease provides for the Company to pay contingent rentals based on usage.
Contingent rentals under this lease were not significant in the eight months
ended December 31, 1997.
The Company was in default on certain lease obligations totaling $211,110 at
April 30, 1996 due to nonpayment. The Company successfully restructured the
lease agreement and recorded an extraordinary gain during fiscal 1997.
F-77
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(12) RELATED PARTY TRANSACTIONS
The Company has the following obligations to related parties:
<TABLE>
<CAPTION>
APRIL 30,
------------------------ DECEMBER 31,
1996 1997 1997
----------- ----------- ------------
<S> <C> <C> <C>
Obligations to shareholders:
Convertible debenture with interest imputed at 11% per annum (Amounts
contingent on certain factors discussed in Note 3)
Due February 1997..................................................... $ 838,056 $ -- --
Due December 1997..................................................... 250,000 250,000 --
Due July 1998......................................................... 750,000 750,000 750,000
Notes payable
Repayable in four installments of $250,000 from June 1997 to June
1998, with interest imputed at 11% (Amount contingent on certain
factors discussed in Note 3)........................................ 1,000,000 725,341 439,667
Notes repayable in monthly installment amounts of $9,202 each
including interest at 6% per annum, refinanced in July 1996, due
June 1997........................................................... 200,000 36,532 --
Notes repayable in monthly installment amounts of $3,144 each
including interest at 12% per annum, refinanced in July 1996, due
June 1997........................................................... 150,000 12,388 --
Other................................................................. 36,289 -- --
----------- ----------- ------------
3,224,345 1,774,261 1,189,667
Obligation to STAR Telecommunications, Inc.:
Includes interest at Prime Rate plus 1%, paid quarterly beginning
February 1998, on outstanding principal. Principal repayment terms
contingent upon approval of Merger (Note 14)........................ -- -- 2,500,000
----------- ----------- ------------
-- -- 2,500,000
Less: Discount on convertible debentures and note payable imputed at
11%................................................................... (456,109) (192,801) (55,334)
----------- ----------- ------------
Total notes payable to related parties.................................. 2,768,236 1,581,460 3,634,333
Less current maturities:
Long-term debt, net of discount on convertible debenture imputed at
11% of $80,695, $51,144 and $55,334 respectively.................... 1,143,650 896,470 3,634,333
----------- ----------- ------------
$ 1,624,586 $ 684,990 --
----------- ----------- ------------
----------- ----------- ------------
</TABLE>
In March 1996, in order to finance the acquisition of AMS, the Company
issued a series of convertible debentures with scheduled maturities through July
1998. The debentures are convertible at the option of the holder into a maximum
of 875,000 shares of the Company's common stock at a conversion rate of .5
shares for each $1 of outstanding debentures.
In February 1997, the holder of the convertible debentures converted
$500,000 of the outstanding debentures into 250,000 shares of the Company's
common stock.
F-78
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(12) RELATED PARTY TRANSACTIONS (CONTINUED)
In January 1997, as part of the financing of the acquisition of CTN, the
Company issued a convertible debenture with scheduled maturity in January 1999.
This debenture is convertible at the option of the holder into a maximum of
150,000 shares of the Company's common stock at a conversion rate of 3 shares
for each $10 of the outstanding debenture.
The Company is provided executive office space by another company of which a
Company executive is a director.
Interest of $1,587 and $12,706 was paid to directors of the Company for the
years ended April 30, 1996 and 1997, respectively.
(13) COMMITMENTS AND CONTINGENCIES
The Company has entered into various long-term commitments for the purchase
of network usage. Total payments under these agreements were $1,613,863,
$8,801,941 and $7,555,214 for the years ended April 30, 1996 and 1997 and the
eight months ended December 31, 1997. The aggregate amount of minimum purchases
of network usage under these various agreements are $7,700,000 and $3,000,000
for the years ended December 31, 1998 and 1999, respectively.
The Company is involved in various claims and legal actions arising in the
ordinary course of business. Management believes it is unlikely that the final
outcome of any of the claims or proceedings to which the Company is a party
would have a materially adverse effect on the Company's financial position or
results of operations.
(14) FINANCING OF OPERATIONS
At December 31, 1997, the Company's current liabilities exceeded its current
assets by $9,854,916 and the Company was experiencing losses and cash flow
deficits from operations. The financial stability of the Company depends on its
ability to raise additional capital until operations reach a profitable level.
On November 19, 1997, the Company entered into an Agreement and Plan of
Merger (the "Merger") whereby IIWII Corp., a wholly-owned subsidiary of STAR
Telecommunications, Inc. ("STAR"), will be merged with and into the Company.
Under the terms of amendments to the Merger dated January 30, 1998, April 6,
1998, October 13, 1998 and January , 1999 (the "Amendments"), UDN's
stockholders will receive for each share of UDN Common Stock a portion of a
share (the "Exchange Ratio") of STAR Common Stock determined by dividing $2.05
by the average closing price of STAR Common Stock on the Nasdaq National Market
for the five trading days prior to the Effective Time (the "Average Price"),
provided that if the Average Price is equal to or greater than $27.50, the
Exchange Ratio shall be determined by using $27.50 as the Average Price. STAR
will also assume all outstanding options, warrants, and other rights to acquire
the Company's stock. The Merger is subject to approval by the stockholders of
both companies and certain other conditions, including the receipt of an opinion
that the Merger may be accounted for as a pooling of interests. In November
1997, in connection with the changes, STAR and the Company executed a promissory
note in the amount of $2.5 million to fund the Company's working capital needs.
F-79
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(15) SUBSEQUENT EVENTS
In January 1998, STAR and the Company amended the Merger and executed an
additional promissory note in the amount of $2.0 million to fund the Company's
working capital needs.
In January 1998, the Company entered into an Agreement of Compromise,
Settlement and Release (the "Agreement") related to disputes arising under the
AMS stock purchase agreement dated March 5, 1996. Under the Agreement, the
convertible debenture in the amount of $750,000 due in July 1998 was reduced to
$550,000 as a result of allowable adjustments defined in the stock purchase
agreement.
F-80
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Consolidated Financial Statements (Unaudited):
Consolidated Balance Sheet as of September 30, 1998...................................................... F-82
Consolidated Statements of Operations for the nine months ended September 30, 1997 and September 30,
1998................................................................................................... F-83
Consolidated Statement of Shareholders' Deficit as of September 30, 1998................................. F-84
Consolidated Statements of Cash Flows for the nine months ended September 30, 1997 and September 30,
1998................................................................................................... F-85
Notes to Unaudited Consolidated Financial Statements....................................................... F-86
</TABLE>
F-81
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30,
1998
--------------
(UNAUDITED)
<S> <C>
ASSETS
Current assets:
Cash and cash equivalents....................................................................... $ 1,060,014
Accounts and notes receivable, net of allowance of $477,960..................................... 5,067,599
Prepaid expenses and other...................................................................... 250,902
--------------
Total current assets.......................................................................... 6,378,515
--------------
Property and equipment, net of accumulated depreciation of $3,682,404............................. 1,875,054
Intangible assets, net of accumulated amortization of $1,128,388.................................. 5,557,849
Other assets...................................................................................... 72,963
--------------
Total assets.................................................................................. $ 13,884,381
--------------
--------------
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Trade accounts payable.......................................................................... $ 9,285,690
Other accrued liabilities....................................................................... 798,389
Advance payment from customer................................................................... 1,162,539
Notes and accounts payable to related parties, net.............................................. 1,550,000
Notes payable to STAR Telecommunications, Inc................................................... 4,500,000
Current maturities of long-term obligations..................................................... 1,042,089
Accrued taxes, other than income taxes.......................................................... 575,188
--------------
Total current liabilities..................................................................... 18,913,895
--------------
Long-term obligations............................................................................. 233,463
Shareholders' equity (deficit):
Common stock, $.01 par value, 100,000,000 shares authorized; 7,054,844 issued at September 30,
1998.......................................................................................... 70,548
Additional paid-in capital...................................................................... 13,006,564
Retained deficit................................................................................ (18,340,089)
--------------
Total shareholders' deficit................................................................... (5,262,977)
--------------
Total liabilities and shareholders' deficit................................................... $ 13,884,381
--------------
--------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-82
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE NINE MONTHS
ENDED
SEPTEMBER 30,
----------------------------
1997 1998
------------- -------------
(UNAUDITED)
<S> <C> <C>
Telecommunications revenues........................................................ $ 22,249,272 $ 23,811,208
Operating expenses:
Costs of services................................................................ 16,985,736 18,625,545
Selling, general and administrative.............................................. 5,415,004 5,681,084
Provision for doubtful accounts.................................................. 904,318 720,853
Depreciation and amortization.................................................... 720,363 836,497
------------- -------------
Total operating expenses....................................................... 24,025,421 25,863,979
------------- -------------
Loss from operations before other expenses......................................... (1,776,149) (2,052,771)
Other expenses:
Interest expense, net............................................................ (680,308) (717,531)
Other............................................................................ -- (298,704)
------------- -------------
Total other expenses........................................................... (680,308) (1,016,235)
------------- -------------
Loss before income tax benefit and extraordinary gain.............................. (2,456,457) (3,069,006)
Income tax benefit................................................................. 26,812 --
------------- -------------
Loss before extraordinary gain................................................... (2,429,645) (3,069,006)
------------- -------------
Extraordinary gain on debt restructuring (net of income taxes of $26,812).......... 52,049 --
------------- -------------
Net loss......................................................................... $ (2,377,596) $ (3,069,006)
------------- -------------
------------- -------------
Loss per weighted average common shares outstanding (basic and diluted):
Loss before extraordinary gain on debt restructuring............................. $ (.40) $ (.44)
Extraordinary gain............................................................... .01 --
------------- -------------
Net loss per share............................................................... $ (.39) $ (.44)
------------- -------------
------------- -------------
Weighted average number of common shares outstanding (basic and diluted)......... 6,021,870 6,988,983
------------- -------------
------------- -------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-83
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
CONSOLIDATED STATEMENT OF SHAREHOLDERS' DEFICIT
<TABLE>
<CAPTION>
ADDITIONAL
PAID-IN RETAINED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
---------- --------- ------------- -------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1997............... 6,808,594 $ 68,086 $ 12,617,072 $ (15,271,083) $ (2,585,925)
Net loss................................... -- -- -- (3,069,006) (3,069,006)
Issuance of common stock for:
Exercise of options...................... 75,000 750 117,203 -- 117,953
Exercise of warrants..................... 171,250 1,712 272,289 -- 274,001
---------- --------- ------------- -------------- -------------
Balance at September 30, 1998.............. 7,054,844 $ 70,548 $ 13,006,564 $ (18,340,089) $ (5,262,977)
---------- --------- ------------- -------------- -------------
---------- --------- ------------- -------------- -------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-84
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE NINE MONTHS
ENDED
SEPTEMBER 30,
----------------------------
1997 1998
------------- -------------
(UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net loss.......................................................................... $ (2,377,596) $ (3,069,006)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization................................................... 720,363 836,497
Extraordinary gain on debt restructuring........................................ (78,861) --
Interest amortization of note discounts......................................... 174,892 55,334
Proceeds from factoring of trade receivables, net............................... 2,189,740 567,688
Other, net...................................................................... 8,138 (5,426)
(Increase) decrease, net of effects of acquisitions:
Unfactored accounts and notes receivable........................................ (4,593,638) (1,826,895)
Prepaid expenses and other assets............................................... (103,959) 241,737
Increase, net of effects of acquisitions:
Accounts and notes payable and accrued expenses................................. 3,410,348 2,070,279
------------- -------------
Net cash used in operating activities....................................... (650,573) (1,129,792)
------------- -------------
Cash flows from investing activities:
Additions to property and equipment............................................... (223,420) (134,995)
Purchase of CTN................................................................... (350,000) --
Proceeds from notes............................................................... 57,592 58,924
------------- -------------
Net cash used in investing activities....................................... (515,828) (76,071)
Cash flows from financing activities:
Proceeds from issuance of common stock............................................ 1,468,946 391,954
Proceeds from issuance of short-term debt......................................... -- 3,000,000
Principal payments on obligations................................................. (1,427,189) (1,171,393)
Private placement advances........................................................ 590,016
------------- -------------
Net cash provided by financing activities................................... 631,773 2,220,561
------------- -------------
(Decrease) increase in cash......................................................... (534,628) 1,014,698
Cash at beginning of period......................................................... 608,141 45,316
------------- -------------
Cash at end of period............................................................... $ 73,513 $ 1,060,014
------------- -------------
------------- -------------
Supplemental disclosure of cash flow information:
Interest paid..................................................................... $ 692,053 $ 424,240
------------- -------------
------------- -------------
</TABLE>
The accompanying notes are integral part of these consolidated financial
statements.
F-85
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) DESCRIPTION OF BUSINESS
United Digital Network (the "Company"), formerly Unidex Communications
Corp., operates through its principal subsidiaries, United Digital Network of
Texas, Inc. ("DNI"), Advanced Management Services, Inc. ("AMS") and Custom
Telecom Network ("CTN").
The Company's principal business activity is providing basic long distance
services, travelcard service, international long-distance, and various other
telecommunication services to residential and small to medium sized commercial
customers. The principal markets for its long distance services are the central
and southwest United States as well as customers located nationwide in the motor
freight industry.
The Company has suffered recurring losses from operations that raise
substantial doubt about its ability to continue as a going concern. At September
30, 1998, the Company's current liabilities exceeded its current assets by $12.5
million. The Company is actively pursuing opportunities for a business
combination in order to achieve financial stability. On November 19, 1997, the
Company entered into a merger agreement with STAR Telecommunications, Inc.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries DNI, AMS and CTN. The financial statements and
related footnotes are presented in U.S. dollars, unless otherwise indicated, and
all significant intercompany accounts and transactions are eliminated in
consolidation. The interim financial data as of September 30, 1997 and 1998 and
for the nine month periods then ended is unaudited; however, in the opinion of
the Company, the interim data includes all adjustments, consisting only of
normal recurring adjustments, necessary to present fairly the financial
position, results of operations and cash flows for the interim periods. The
interim consolidated financial statements and the notes thereto should be read
in conjunction with the consolidated financial statements and notes included in
the Company's consolidated financial statements for the eight months ended
December 31, 1997.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents represent cash and short-term, highly liquid
investments with original maturities three months or less.
LOSS PER SHARE
Loss per share is computed by dividing the net loss by the weighted average
number of shares of common stock outstanding during the periods. The effect of
outstanding options and warrants on the computation of net loss per share is
antidilutive and, therefore, is not included in the computation of loss per
share amounts for the nine month periods ended September 30, 1997 and 1998.
NEW ACCOUNTING STANDARDS
On June 15, 1998, the FASB issued Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" (SFAS 133). SFAS 133 is effective for all fiscal quarters of all
fiscal years beginning after June 15, 1999. SFAS 133 requires that all
derivative instruments
F-86
<PAGE>
UNITED DIGITAL NETWORK, INC. AND SUBSIDIARIES
(FORMERLY UNIDEX COMMUNICATIONS CORP.)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
be recorded on the balance sheet at their fair value. Changes in the fair value
of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as part of
a hedge transaction and, if it is the type of hedge transaction. Management of
the Company anticipates that, due to its limited use of derivative instruments,
the adoption of SFAS 133 will not have a significant effect on the Company's
results of operations or its financial position.
(3) ADVANCE PAYMENT FROM CUSTOMER
In March 1998, the Company received an advance payment from one customer for
future long distance telephone services through pre-paid calling cards. This
payment will be recognized as revenue when the related services are provided.
(4) SUBSEQUENT EVENTS
In January 1998, the Company entered into an agreement of Compromise,
Settlement and Release (the "Agreement") related to disputes arising under the
AMS stock purchase agreement dated March 5, 1996. Under the Agreement, the
convertible debenture in the amount of $750,000 due in July 1998 was reduced to
$550,000 as a result of allowable adjustments defined in the stock purchase
agreement. On July 30, 1998, the Company signed an extension agreement with the
holder of the debenture under which the right to convert the debenture into
shares of the Company's common stock expired and a $33,000 extension fee was
paid by the Company to the debenture holder.
On July 21, 1998, the Company issued a promissory note in the principal
amount of $1,000,000 payable to the order of John R. Snedegar, the President of
the Company. The promissory note provides for interest of ten percent and
matures on the earlier of thirty days after the occurrence of a Change of
Control (as defined in the promissory note) and July 21, 1999. Through September
30, 1998, the Company had accrued $16,000 in interest payable under this note.
On September 21, 1998, STAR and the Company entered into a Management
Agreement pursuant to which, among other things, STAR provides billing services
for the Company and the Company is able to buy switch services through STAR and
which provides the Company greater access to more competitive buying
arrangements.
F-87
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
ANNEX A
AGREEMENT AND PLAN OF MERGER
BY AND AMONG
STAR TELECOMMUNICATIONS, INC.,
IIWII CORP.
AND
UNITED DIGITAL NETWORK, INC.
Dated as of November 19, 1997
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C> <C>
ARTICLE I THE MERGER....................................................................................... A-1
1.1 The Merger...................................................................................... A-1
1.2 Filing.......................................................................................... A-1
1.3 Effective Time of the Merger.................................................................... A-1
1.4 Certificate of Incorporation and By-Laws........................................................ A-1
1.5 Directors and Officers.......................................................................... A-1
1.6 Warrants and Options............................................................................ A-2
ARTICLE II CONVERSION OF AND SURRENDER AND
PAYMENT FOR COMMON STOCK....................................................................... A-2
2.1 Conversion...................................................................................... A-2
2.2 Closing of Transfer Books....................................................................... A-3
2.3 Surrender of Certificates....................................................................... A-3
ARTICLE III CERTAIN EFFECTS OF MERGER...................................................................... A-3
3.1 Effect of Merger................................................................................ A-3
3.2 Further Assurances.............................................................................. A-4
ARTICLE IV REPRESENTATIONS AND WARRANTIES OF THE
ACQUIROR AND NEWCO............................................................................ A-4
4.1 Organization.................................................................................... A-4
4.2 Capital Stock................................................................................... A-4
4.3 Authority Relative to Agreement................................................................. A-4
4.4 Acquiror Common Stock........................................................................... A-4
4.5 No Violations or Consents....................................................................... A-4
4.6 Litigation...................................................................................... A-5
4.7 Financial Statements and Reports................................................................ A-5
4.8 Registration Statement; Blue Sky Filings; Proxy Statement; Other Information.................... A-5
4.9 Brokers......................................................................................... A-6
ARTICLE V REPRESENTATIONS AND WARRANTIES OF THE COMPANY.................................................... A-6
5.1 Corporate Organization.......................................................................... A-6
5.2 Capital Stock................................................................................... A-6
5.3 Options, Warrants or Other Rights............................................................... A-6
5.4 Authority Relative to Agreement................................................................. A-6
5.5 No Violations or Consents....................................................................... A-7
5.6 Governmental Authorizations and Regulations..................................................... A-7
5.7 Litigation...................................................................................... A-8
5.8 Financial Statements and Reports; Material Liabilities.......................................... A-8
5.9 Absence of Certain Changes or Events............................................................ A-8
5.10 Benefit Plans................................................................................... A-8
5.11 ERISA........................................................................................... A-9
5.12 Environmental Matters........................................................................... A-10
5.13 Real Estate Leases.............................................................................. A-10
5.14 Title to Properties; Absence of Liens and Encumbrances.......................................... A-10
5.15 Tax Matters..................................................................................... A-11
5.16 Intellectual Property........................................................................... A-12
5.17 Labor Matters................................................................................... A-12
5.18 Insurance....................................................................................... A-12
</TABLE>
i
<PAGE>
<TABLE>
<CAPTION>
PAGE
---------
<S> <C> <C>
5.19 Contracts....................................................................................... A-12
5.20 Registration Statement; Blue Sky Filings; Proxy Statement; Other Information.................... A-13
5.21 Brokers......................................................................................... A-13
5.22 Continuity of Interest.......................................................................... A-13
5.23 Transactions with Affiliated Parties............................................................ A-13
ARTICLE VI COVENANTS AND AGREEMENTS........................................................................ A-13
6.1 Registration Statement; Proxy Statement; Stockholder Meeting; Vancouver Exchange................ A-13
6.2 Conduct of the Business of the Company Prior to the Effective Time.............................. A-14
6.3 Access to Properties and Record; Acquiror Notice................................................ A-16
6.4 Negotiations.................................................................................... A-16
6.5 Indemnification................................................................................. A-16
6.6 Confidentiality................................................................................. A-17
6.7 Reasonable Best Efforts......................................................................... A-17
6.8 Certification of Stockholder Vote............................................................... A-17
6.9 Loan to Company................................................................................. A-17
6.10 Outsourcing Agreement........................................................................... A-18
6.11 Affiliate Agreements............................................................................ A-18
6.12 Proxy Agreement................................................................................. A-18
6.13 Disclosure Schedules............................................................................ A-18
ARTICLE VII CONDITIONS PRECEDENT........................................................................... A-18
7.1 Conditions to Each Party's Obligation to Effect the Merger...................................... A-18
7.2 Conditions to the Obligation of the Company to Effect the Merger................................ A-19
7.3 Conditions to Obligations of the Acquiror and Newco to Effect the Merger........................ A-19
7.4 Closing Conditions Deemed Satisfied............................................................. A-20
ARTICLE VIII TERMINATION, AMENDMENT AND WAIVER............................................................. A-20
8.1 Termination..................................................................................... A-20
8.2 Fees and Expenses............................................................................... A-21
8.3 Amendment....................................................................................... A-21
8.4 Waiver.......................................................................................... A-21
ARTICLE IX MISCELLANEOUS................................................................................... A-22
9.1 Survival........................................................................................ A-22
9.2 Expenses and Fees............................................................................... A-22
9.3 Notices......................................................................................... A-22
9.4 Headings........................................................................................ A-23
9.5 Publicity....................................................................................... A-23
9.6 Entire Agreement; Knowledge..................................................................... A-23
9.7 Assignment...................................................................................... A-23
9.8 Counterparts.................................................................................... A-23
9.9 Invalidity, Etc................................................................................. A-23
9.10 Specific Performance............................................................................ A-23
9.11 Governing Law................................................................................... A-23
</TABLE>
ii
<PAGE>
EXHIBITS
<TABLE>
<CAPTION>
<S> <C>
Exhibit A Certificate of Merger
Exhibit B Promissory Note
Exhibit C Affiliate Agreements
Exhibit D Proxy Agreement
</TABLE>
iii
<PAGE>
ANNEX A
AGREEMENT AND PLAN OF MERGER
AGREEMENT AND PLAN OF MERGER dated as of November 19, 1997 (this
"Agreement"), by and among STAR Telecommunications, Inc., a Delaware corporation
(the "Acquiror"), IIWII Corp., a Delaware corporation and wholly-owned
subsidiary of the Acquiror ("Newco"), and United Digital Network, Inc., a
Delaware corporation (the "Company").
R E C I T A L S:
A. The Boards of Directors of Newco, the Acquiror and the Company deem it
advisable and in the best interests of their respective stockholders to merge
Newco with and into the Company (the "Merger") upon the terms and conditions set
forth herein and in accordance with the General Corporation Law of the State of
Delaware (the "General Corporation Law") (the Company and Newco being
hereinafter sometimes referred to as the "Constituent Corporations" and the
Company, following the effectiveness of the Merger, being hereinafter sometimes
referred to as the "Surviving Corporation"); and
B. The Boards of Directors of the Acquiror, Newco and the Company have
approved the Merger upon the terms and subject to the conditions set forth
herein and, in the case of the Company, on the receipt of a "fairness opinion"
from its financial advisor in form, substance, and scope that is satisfactory to
the Board of Directors of the Company.
A G R E E M E N T
NOW, THEREFORE, in consideration of the mutual representations, warranties,
covenants, agreements and conditions contained herein, and in order to set forth
the terms and conditions of the Merger and the mode of carrying the same into
effect, the parties hereby agree as follows:
ARTICLE I
THE MERGER
1.1 THE MERGER. Upon the terms and conditions hereinafter set forth and in
accordance with the General Corporation Law, at the Effective Time, as defined
below, Newco shall be merged with and into the Company and thereupon the
separate existence of Newco shall cease, and the Company, as the Surviving
Corporation, shall continue to exist under and be governed by the General
Corporation Law.
1.2 FILING. Upon the satisfaction or waiver of the conditions set forth in
Section 7 hereof (other than the condition set forth in Section 7.1(b) which may
not be waived), Newco and the Company will cause a Certificate of Merger, in
substantially the form of EXHIBIT A attached hereto (the "Certificate of
Merger"), to be executed and filed with the Secretary of State of the State of
Delaware as provided in Section 251 of the General Corporation Law.
1.3 EFFECTIVE TIME OF THE MERGER. The Merger shall become effective
immediately upon the filing, in accordance with Section 251 of the General
Corporation Law, of the Certificate of Merger with the Secretary of State of the
State of Delaware in accordance with Section 251. The date and time of such
filing is herein sometimes referred to as the "Effective Time."
1.4 CERTIFICATE OF INCORPORATION AND BY-LAWS. Upon the effectiveness of
the Merger, the Certificate of Incorporation of Newco shall be the certificate
of incorporation of the Surviving Corporation and the By-Laws of Newco as in
effect on the date hereof shall be the By-Laws of the Surviving Corporation.
1.5 DIRECTORS AND OFFICERS. The persons who are directors of Newco
immediately prior to the Effective Time and the officers of the Company shall,
after the Effective Time and in accordance with the
A-1
<PAGE>
Certificate of Merger, serve as the directors and officers, respectively, of the
Surviving Corporation, in each case such directors and officers to serve until
their successors have been duly elected and qualified in accordance with the
Certificate of Incorporation and By-Laws of the Surviving Corporation.
1.6 WARRANTS AND OPTIONS. On the Effective Time, the Acquiror shall assume
the duties and obligations of the Company, and the Acquiror shall be vested with
the powers, rights and privileges of the Company, under (a) the warrants of the
Company that remain outstanding at the Effective Time (the "Warrants") and (b)
the options of the Company that remain outstanding at the Effective Time (the
"Options"), as such warrants and options are listed on Schedule 5.3. As of the
Effective Time, the Acquiror shall have reserved for issuance and continue to
maintain sufficient shares of Acquiror Common Stock, as defined below, to issue
the required shares of Acquiror Common Stock pursuant to the exercise of
Warrants and Options after the Effective Time, subject to appropriate adjustment
in the exercise price thereof, based on the Exchange Ratio, as defined below.
ARTICLE II
CONVERSION OF AND SURRENDER AND PAYMENT FOR COMMON STOCK
2.1 CONVERSION. At the Effective Time, by virtue of the Merger and without
any action on the part of the holders thereof:
(a) Each of the issued and outstanding shares of the Common Stock, $.01
par value, of the Company ("Common Stock"), other than (i) Dissenting Stock,
as defined below, or (ii) shares of Common Stock held in the treasury of the
Company, shall be automatically converted into the right to receive
consideration per share (the "Merger Consideration") consisting of that
portion of a share (the "Exchange Ratio") of the Acquiror's common stock,
$0.001 per share ("Acquiror Common Stock"), determined by dividing $2.75 by
the average closing price of Acquiror's Common Stock on the Nasdaq National
Market for the five (5) trading days prior to the Effective Time (the
"Average Price"), provided that, if the Average Price is equal to or greater
than $32.73, then the Exchange Ratio shall be determined by dividing $3.00
by the Average Price, provided, further, that, if the Average Price is less
than or equal to $26.78, then the Exchange Ratio shall be determined by
dividing $2.50 by the Average Price. The Exchange Ratio shall be adjusted as
may be necessary and appropriate to reflect any and all stock splits,
reverse stock splits, reclassifications and similar capital events that
affect Acquiror Common Stock.
(b) Each issued and outstanding share of the Common Stock of Newco shall
be converted into approximately Seven Thousand Five Hundred Sixty-Four
(7,564) validly issued, fully paid and non-assessable shares of common
stock, $.01 par value (the "New Common Stock"), of the Surviving
Corporation.
(c) All shares of Common Stock which are held by the Company as treasury
shares shall be canceled and retired and cease to exist, without any
conversion thereof or payment with respect thereto.
(d) No fraction of a share of Acquiror Common Stock will be issued in
the Merger, but, in lieu thereof, each holder of Common Stock who would
otherwise be entitled to a fraction of a share of Acquiror Common Stock
(after aggregating all fractional shares of Acquiror Common Stock to be
received by such holder) will be entitled to receive from the Acquiror an
amount of cash (rounded to the nearest whole US $0.01) equal to the product
of (i) such fraction of a share multiplied by (ii) the Average Price.
Notwithstanding any provision of this Agreement to the contrary, shares of
the Common Stock with respect to which appraisal rights have been demanded and
perfected in accordance with Section 262(d) of the General Corporation Law (the
"Dissenting Stock") shall not be converted into the right to receive the Merger
Consideration at or after the Effective Time, and the holder thereof shall be
entitled only to such
A-2
<PAGE>
rights as are granted by the General Corporation Law. Notwithstanding the
preceding sentence, if any holder of shares of Common Stock who demands
appraisal of such shares under the General Corporation Law shall effectively
withdraw his demand for such appraisal (in accordance with Section 262(k) of the
General Corporation Law) or becomes ineligible for such appraisal (through
failure to perfect or otherwise) then, as of the Effective Time or the
occurrence of such event, whichever is the last to occur, such holder's
Dissenting Stock shall cease to be Dissenting Stock and shall be converted into
and represent the right to receive the Merger Consideration, without interest
thereon, as provided in this Section 2.1. The Company shall give Acquiror (i)
prompt notice of any written demands for appraisal, withdrawals of demands for
appraisal and any other instrument served pursuant to Section 262 of the General
Corporation Law received by the Company and (ii) the opportunity to participate
in all negotiations and proceedings with respect to demands for appraisal under
such Section.
2.2 CLOSING OF TRANSFER BOOKS. At the Effective Time, the stock transfer
books of the Company shall be closed, and no transfer of shares of Common Stock
of the Company shall thereafter be made. If, after the Effective Time,
certificates previously representing shares of Common Stock are presented to the
Surviving Corporation or the Exchange Agent, as defined below, such certificates
shall be canceled and exchanged for the Merger Consideration as provided in
Section 2.1, subject to applicable law in the case of Dissenting Stock.
2.3 SURRENDER OF CERTIFICATES. At least five days prior to the mailing of
the Proxy Statement, as defined below, Newco shall, subject to the reasonable
approval of the Company, designate an exchange agent (the "Exchange Agent") to
effect the exchange for Acquiror Common Stock of certificates that, prior to the
Effective Time, represented shares of Common Stock entitled to the Merger
Consideration. As soon as practicable after the Effective Time, the Exchange
Agent shall send a notice and transmittal form to each holder of record of
Common Stock immediately prior to the Effective Time advising such holder of the
effectiveness of the Merger and the procedure for surrendering to the Exchange
Agent (who may appoint forwarding agents with the approval of Newco) the
certificate or certificates to be exchanged pursuant to the Merger. Upon the
surrender for exchange of such a certificate, together with such letter of
transmittal duly completed and properly executed in accordance with instructions
thereto and such other documents as may be required pursuant to such
instructions, the holder shall receive the Merger Consideration. After the
Effective Time, until so surrendered and exchanged, each certificate which
immediately prior to the Effective Time represented outstanding shares of the
Common Stock (other than Dissenting Stock) shall represent solely the right to
receive the Merger Consideration.
ARTICLE III
CERTAIN EFFECTS OF MERGER
3.1 EFFECT OF MERGER. On and after the Effective Time, the Surviving
Corporation shall possess all the rights, privileges, powers and franchises, and
be subject to all the restrictions, disabilities and duties of each of the
Constituent Corporations; and all and singular rights, privileges, powers and
franchises of each of the Constituent Corporations, and all property, real,
personal and mixed, and all debts due to either of the Constituent Corporations
on whatever account, as well for stock subscriptions as all other things in
action or belonging to each of the Constituent Corporations, shall be vested in
the Surviving Corporation; and all property, rights, privileges, powers and
franchises, and all and every other interest shall be thereafter the property of
the Surviving Corporation as they were of the Constituent Corporations, and the
title to any real estate vested by deed or otherwise, in either of the
Constituent Corporations shall not revert or be in any way impaired; but all
rights of creditors and all liens upon any property of either of the Constituent
Corporations shall be preserved unimpaired, and all debts, liabilities and
duties of the Constituent Corporations shall thenceforth attach to and be the
sole responsibility of the Surviving Corporation and may be enforced against the
Surviving Corporation to the same extent as if said debts, liabilities and
duties had been incurred or contracted by it.
A-3
<PAGE>
3.2 FURTHER ASSURANCES. If at any time after the Effective Time the
Surviving Corporation shall consider or be advised that any further deeds,
assignments or assurances in law or any other acts are necessary, desirable or
proper to vest, perfect or confirm, of record or otherwise, in the Surviving
Corporation, the title to any property or right of the Constituent Corporations
acquired or to be acquired by reason of, or as a result of, the Merger, the
Constituent Corporations agree that the Surviving Corporation and its proper
officers and directors shall and will execute and deliver all such deeds,
assignments and assurances in law and do all acts necessary, desirable or proper
to vest, perfect or confirm title to such property or right in the Surviving
Corporation and otherwise to carry out the purposes of this Agreement, and that
the proper officers and directors of the Constituent Corporations and the proper
officers and directors of the Surviving Corporation are fully authorized in the
name of the Constituent Corporations or otherwise to take any and all such
action.
ARTICLE IV
REPRESENTATIONS AND WARRANTIES OF THE ACQUIROR AND NEWCO
The Acquiror and Newco jointly and severally represent and warrant to the
Company as follows:
4.1 ORGANIZATION. Each of Acquiror and Newco is a corporation duly
organized, validly existing and in good standing under the laws of the State of
Delaware, and each has the requisite corporate power and authority to own, lease
and operate its assets and to conduct its business in the manner in which it is
presently conducted.
4.2 CAPITAL STOCK. The authorized capital stock of the Acquiror consists
in its entirety of 50,000,000 shares of Common Stock, $0.001 par value, of
which, as of September 30, 1997, 15,798,254 are issued and outstanding, and
5,000,000 shares of Preferred Stock, $0.001 par value per share, none of which
is issued and outstanding. The authorized capital stock of Newco consists in its
entirety of 1,000 shares of common stock, $.01 par value, all of which are
issued and outstanding. All of the outstanding shares of Newco common stock are
owned beneficially and of record by the Acquiror.
4.3 AUTHORITY RELATIVE TO AGREEMENT. Each of the Acquiror and Newco has
full corporate power and authority to execute and deliver this Agreement and to
consummate the Merger and the other transactions contemplated on its part
hereby. The execution, delivery and performance by each of the Acquiror and
Newco of this Agreement and the consummation of the transactions contemplated
hereby have been duly authorized by all necessary corporate action on the part
of the Acquiror and Newco. This Agreement has been duly executed and delivered
by each of the Acquiror and Newco, and is a legal, valid and binding obligation
of each of the Acquiror and Newco, enforceable against each of the Acquiror and
Newco in accordance with its terms, except to the extent that its enforceability
may be limited by applicable bankruptcy, insolvency, reorganization or other
laws affecting the enforcement of creditors' rights generally or by general
equitable principles.
4.4 ACQUIROR COMMON STOCK. The shares of Acquiror Common Stock to be
issued in connection with the Merger have been duly authorized and, when issued
as contemplated hereby at the Effective Time, will be validly issued, fully paid
and non-assessable, and not subject to any preemptive rights or other rights or
interests of third parties.
4.5 NO VIOLATIONS OR CONSENTS. The execution, delivery and performance of
this Agreement by each of the Acquiror and Newco and the consummation by each of
them of the transactions contemplated hereby, will not (i) violate or conflict
with any provision of any charter or by-laws of the Acquiror or Newco, (ii)
require the consent, waiver, approval, license or authorization of or any filing
by the Acquiror or Newco with any public authority, other than (a) the filing of
a pre-merger notification report under The Hart-Scott-Rodino Antitrust
Improvements Act of 1976, as amended, and the rules and regulations promulgated
thereunder (the "HSR Act"), (b) in connection with or in compliance with the
provisions of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), the Securities Act of 1933, as amended (the "Securities Act"), the
Communications Act of 1934, as amended (the "Communications
A-4
<PAGE>
Act"), the General Corporation Law or the "takeover" or "blue sky" laws of
various states and (c) any other filings and approvals expressly contemplated by
this Agreement, (iii) violate, conflict with or result in a breach of or the
acceleration of any obligation under, or constitute a default (or an event which
with notice or the lapse of time or both would become a default) under, or give
to others any right of termination, amendment, acceleration or cancellation of,
or result in the creation of a lien or other encumbrance on any property or
asset of the Acquiror or Newco pursuant to any provision of any indenture,
mortgage, lien, lease, agreement, instrument, order, judgment or decree to which
the Acquiror or Newco is subject or by which the Acquiror or Newco or any of
their property or assets is bound, or (iv) violate or conflict with any law,
rule, regulation, permit, ordinance or decree applicable to the Acquiror or
Newco or by which any property or asset of either of them is bound or affected
except, in each of the instances set forth in items (i) through (iv) above,
where failure to give such notice, make such filings, or obtain such
authorizations, consents or approvals, or where such violations, conflicts,
breaches or defaults, in the aggregate, would not have an Acquiror Material
Adverse Effect, as defined below.
4.6 LITIGATION. Except as may be disclosed in the Acquiror SEC Filings, as
defined below, there are no suits, arbitrations, actions or proceedings pending
or, to the best of the Acquiror's knowledge, threatened or, to the best of the
Acquiror's knowledge, investigations pending or threatened against the Acquiror
or with respect to any property or asset of it before any court, arbitrator,
administrator or governmental or regulatory authority or body which, in the
aggregate, are likely to have a material adverse effect on the business,
operations or financial condition of the Acquiror (an "Acquiror Material Adverse
Effect").
4.7 FINANCIAL STATEMENTS AND REPORTS. The Acquiror heretofore has
delivered to the Company true and complete copies of (a) its Registration
Statement on Form S-1 dated June 12, 1997, Registration No. 333-21325, and (b)
its Quarterly Reports on Form 10-Q for the quarters ended June 30, 1997 and
September 30, 1997 (collectively,"Acquiror SEC Filings"). As of the respective
times such documents were filed or, as applicable, became effective, the
Acquiror SEC Filings complied as to form and content, in all material respects,
with the requirements of the Securities Act and the Exchange Act, as the case
may be, and the rules and regulations promulgated thereunder, and did not
contain any untrue statement of a material fact or omit to state any material
fact required to be stated therein or necessary to make the statements therein,
in light of the circumstances under which they were made, not misleading. The
financial statements of the Acquiror included in the Acquiror SEC Filings were
prepared in accordance with generally accepted accounting principles ("GAAP")
applied on a consistent basis and (except as may be indicated therein or in the
notes thereto) present fairly the consolidated financial position, results of
operations and cash flows of the Acquiror and its consolidated subsidiaries as
of the dates and for the periods indicated subject, in the case of unaudited
interim consolidated financial statements, to normal recurring year-end
adjustments.
4.8 REGISTRATION STATEMENT; BLUE SKY FILINGS; PROXY STATEMENT; OTHER
INFORMATION. The Registration Statement, as defined below, and the information
supplied or to be supplied in writing by either the Acquiror or Newco for
inclusion in the Proxy Statement, as defined below, and any other documents to
be filed with the Securities and Exchange Commission (the "SEC"), including,
without limitation, the British Columbia Securities Commission ("BCSC"), the
Vancouver Stock Exchange (the "VSE") or any regulatory agency in connection with
the transactions contemplated hereby, will not be, at the respective times such
documents are filed or declared effective by the SEC and on the Effective Time,
and, with respect to the Proxy Statement, when first published, sent or given to
stockholders of the Company, false or misleading with respect to any material
fact, or omit to state any material fact necessary in order to make the
statements therein not misleading or, in the case of the Proxy Statement or any
amendment thereof or supplement thereto, at the time of the special meeting of
the Company's stockholders provided for in Section 6.1, be false or misleading
with respect to any material fact, or omit to state any material fact necessary
to correct any statement in any earlier communication with respect to the
solicitation of any proxy for such meeting. All documents which the Acquiror or
Newco files or is responsible for filing with
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the SEC and any regulatory agency in connection with the Merger (including,
without limitation, the Registration Statement) will comply as to form and
content in all material respects with the provisions of applicable law and
regulations. Notwithstanding the foregoing, the Acquiror and Newco make no
representations or warranties with respect to any information that has been
supplied in writing by the Company or its auditors, attorneys or financial
advisors specifically for use in the Registration Statement or in any other
documents to be filed by the Acquiror with the SEC or any other regulatory
agency in connection with the transactions contemplated hereby.
4.9 BROKERS. Neither the Acquiror nor Newco has paid or become obligated
to pay any fee or commission to any broker, finder, investment banker or other
intermediary in connection with this Agreement, except that the Acquiror has
retained Lehman Brothers as its financial advisor in connection with the
transactions contemplated by this Agreement.
ARTICLE V
REPRESENTATIONS AND WARRANTIES OF THE COMPANY
Except as set forth in the disclosure schedules to be delivered to the
Acquiror by the Company (the "Disclosure Schedules") pursuant to Section 6.13,
the Company represents and warrants to the Acquiror and Newco as follows:
5.1 CORPORATE ORGANIZATION. Each of the Company and each of its
subsidiaries Advanced Management Services, Inc. CTN-- Custom Telecommunications
Network of Arizona, Inc. and United Digital Network of Texas, Inc. (formerly
known as AnswerNet, Inc., which includes, pursuant to a merger, Digital Network,
Inc.) (each a "Subsidiary" and collectively, the "Subsidiaries"), is a
corporation duly organized, validly existing and in good standing under the laws
of its state of incorporation with all requisite corporate power and authority
to own, operate and lease its properties and to carry on its business as it is
now being conducted, and is qualified or licensed to do business and is in good
standing in each jurisdiction in which the failure to be so qualified or
licensed, in the aggregate, would have a material adverse effect on the
financial condition, operations or business of the Company and the Subsidiaries
taken as a whole (a "Company Material Adverse Effect"). The Certificates of
Incorporation and By-Laws of the Company and the Subsidiaries are in full force
and effect. The Company is not in violation of or in default under any provision
of its Certificate of Incorporation or By-Laws. The Subsidiaries are the only
subsidiaries, direct or indirect, of the Company.
5.2 CAPITAL STOCK. The authorized capital stock of the Company consists in
its entirety of 100,000,000 shares of Common Stock, $.01 par value, of which, as
of the date hereof, 7,564,103 are issued and outstanding and none are held in
the Company's treasury. Except as set forth on SCHEDULE 5.2, all of the
outstanding shares of capital stock of each of the Subsidiaries are owned
beneficially and of record by the Company free and clear of all liens, charges,
encumbrances, options, rights of first refusal or limitations or agreements
regarding voting rights of any nature, other than the Proxy Agreement, as
defined below. All of the outstanding shares of capital stock of the Company and
the Subsidiaries have been duly authorized, validly issued and are fully paid
and nonassessable.
5.3 OPTIONS, WARRANTS OR OTHER RIGHTS. Except as set forth on SCHEDULE 5.3
or as contemplated by this Agreement, there is no outstanding right,
subscription, warrant, call, unsatisfied preemptive right, option or other
agreement or arrangement of any kind to purchase or otherwise to receive from
the Company or any Subsidiary any of the outstanding, authorized but unissued,
unauthorized or treasury shares of the capital stock or any other equity
security of the Company or any Subsidiary and there is no outstanding security
of any kind convertible into or exchangeable for such capital stock.
5.4 AUTHORITY RELATIVE TO AGREEMENT. The Company has full corporate power
and authority to execute and deliver this Agreement and to consummate the Merger
and the other transactions contemplated on its part hereby. The execution and
delivery by the Company of this Agreement and the consummation of the
transactions contemplated on its part hereby have been duly authorized by its
Board
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of Directors, and (other than the approval and adoption of this Agreement by the
holders of a majority of the then outstanding shares of Common Stock, as
provided in Section 6.1 hereof, the filing and recordation of appropriate merger
documents as required by the General Corporation Law and the receipt of a
satisfactory fairness opinion from its financial advisor) no other corporate
proceedings on the part of the Company or its stockholders are necessary to
authorize the execution and delivery of this Agreement by the Company or the
consummation of the transactions contemplated on its part hereby. In that
regard, the Company hereby represents that its Board of Directors has (i)
determined that the Merger is fair to and in the best interests of the Company's
stockholders, (ii) approved the Merger and (iii) resolved to recommend in the
Proxy Statement adoption of this Agreement and authorization of the Merger by
the stockholders of the Company, such matters to be subject to the fiduciary
duties of such directors and to the receipt of a satisfactory fairness opinion
from its financial advisor. This Agreement has been duly executed and delivered
by the Company, and constitutes a legal, valid and binding obligation of the
Company, enforceable against the Company in accordance with its terms, except to
the extent that its enforceability may be limited by applicable bankruptcy,
insolvency, reorganization or other laws affecting the enforcement of creditors'
rights generally or by general equitable principles.
5.5 NO VIOLATIONS OR CONSENTS. Except as set forth on SCHEDULE 5.5, the
execution, delivery and performance of this Agreement by the Company and the
consummation by it of the transactions contemplated hereby will not (i) violate
or conflict with any provision of any charter or by-laws of the Company or any
Subsidiary, (ii) require the consent, waiver, approval, license or authorization
of or any filing by the Company or any Subsidiary with any third party or public
authority (other than (a) the filing of a premerger notification report under
the HSR Act, (b) in connection with or in compliance with the provisions of the
Exchange Act, the Securities Act, the General Corporation Law, the
Communications Act or the "takeover" or "blue sky" or "public utility" laws of
various states, and (c) and any other filings and approvals expressly
contemplated by this Agreement, including, without limitation, those with the
BCSC and the VSE), (iii) violate, conflict with or result in a breach of or the
acceleration of any obligation under, or constitute a default (or an event which
with notice or the lapse of time or both would become a default) under, or give
to others any right of termination, amendment, acceleration or cancellation of,
or result in the creation of a lien or other encumbrance on any property or
asset of the Company or any Subsidiary pursuant to any provision of any
indenture, mortgage, lien, lease, agreement, instrument, order, judgment or
decree to which the Company or any Subsidiary is subject or by which the Company
or any Subsidiary or any of their property or assets is bound, or (iv) violate
or conflict with any law, rule, regulation, permit, ordinance, regulation or
decree applicable to the Company or any Subsidiary or by which any property or
asset of either of them is bound or affected except, in each of the instances
set forth in items (i) through (iv) above, where failure to give such notice,
make such filings, or obtain such authorizations, consents or approvals, or
where such violations, conflicts, breaches or defaults, in the aggregate, would
not have a Company Material Adverse Effect.
5.6 GOVERNMENTAL AUTHORIZATIONS AND REGULATIONS. SCHEDULE 5.6 is a true
and complete list of all material governmental licenses, franchises, permits and
other authorizations ("Permits") held by the Company and/or the Subsidiaries.
Such Permits are all governmental licenses, franchises, permits and other
authorizations necessary to the conduct of the business of the Company and the
Subsidiaries, except where the failure to hold such Permits, in the aggregate,
would not have a Company Material Adverse Effect. Such Permits are valid and in
full force and effect and the Company knows of no threatened suspension,
cancellation or invalidation of any such Permit except where any such action
would not result in a Company Material Adverse Effect. Neither the Company nor
any Subsidiary is in conflict with, or is in default or violation of, any law,
rule, regulation, order, judgment, Permit, ordinance, regulation or decree
applicable to the Company or any Subsidiary or by which any property or asset of
either of them is bound or affected, except where such conflicts, defaults or
violations, in the aggregate, would not have a Company Material Adverse Effect.
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5.7 LITIGATION. Except as may be disclosed in the PPM, as defined below,
or on SCHEDULE 5.7, there are no suits, arbitrations, actions or proceedings,
pending or, to the best of the Company's or any Subsidiary's knowledge,
threatened or, to the best of the Company's or any Subsidiary's knowledge,
investigations pending or threatened against the Company or any Subsidiary or
with respect to any property or asset of any of them before any court,
arbitrator, administrator or governmental or regulatory authority or body which,
in the aggregate, are likely to have a Company Material Adverse Effect.
5.8 FINANCIAL STATEMENTS AND REPORTS; MATERIAL LIABILITIES.
(a) The Company has delivered to the Acquiror true and complete copies
of its Confidential Private Placement Memorandum dated October 28, 1997 (the
"PPM") As of the date thereof, the PPM did not contain any untrue statement
of a material fact or omit to state any material fact required to be stated
therein or necessary to make the statements therein, in light of the
circumstances under which they were made, not misleading. The financial
statements in the PPM were prepared in accordance with GAAP applied on a
consistent basis and (except as may be indicated therein or in the notes
thereto) present fairly the consolidated financial position, results of
operations and cash flows of the Company and its consolidated subsidiaries
as of the dates and for the periods indicated subject, in the case of
un-audited interim consolidated financial statements, to normal recurring
year-end adjustments and subject to the "going concern" opinion of the
Company's independent accountants. (The audited consolidated balance sheet
of the Company and the Subsidiaries as of April 30, 1997 included in the PPM
is hereinafter called the "Company Balance Sheet," and April 30, 1997 is
hereinafter called the "Company Balance Sheet Date," and the Company's
balance sheet for the three month period ended July 31, 1997 included in the
PPM is hereafter called the "Interim Balance Sheet").
(b) Except as set forth on SCHEDULE 5.8(b), the Company and its
Subsidiaries, considered as a whole, have no material liabilities or
obligations (whether fixed, accrued, contingent or otherwise) that are not
fully reflected or provided for on, or disclosed in the notes to, the
Company Balance Sheet or the Company Interim Balance Sheet, except for (i)
liabilities in the ordinary course of business that could not be reasonably
expected to have a Company Material Adverse Effect or (ii) liabilities
incurred in the ordinary course of business that are not required by GAAP to
be reflected thereon and which are not material.
5.9 ABSENCE OF CERTAIN CHANGES OR EVENTS. Since the Company Balance Sheet
Date and except as disclosed on SCHEDULE 5.9, the business of the Company and
the Subsidiaries have been conducted in the ordinary course consistent with past
practice, and (i) there has not been any material adverse change in the
financial condition, results of operations, properties, or business of the
Company or any Subsidiary, nor, to the Company's knowledge, has there occurred
any event or development that could be reasonably foreseen to result in a
Company Material Adverse Effect.
5.10 BENEFIT PLANS. Except as disclosed on SCHEDULE 5.10, neither the
Company nor any Subsidiary has outstanding any employment agreement with any
officer or employee of the Company or any Subsidiary or any bonus, incentive
compensation, deferred compensation, profit sharing, stock option, stock bonus,
stock purchase, savings, severance, salary continuation, consulting, retirement
(including health and life insurance benefits provided after retirement) or
pension plan (including Company Employee Benefit Plans as defined in Section
5.11 hereof) or arrangement with or for the benefit of any officer, employee or
other person, or for the benefit of any group of officers, employees or other
persons that provides for payment of more than $100,000 in annual benefits.
Neither the Company nor any Subsidiary has made, or entered into any agreement
to make, any payment that becomes payable as a result of the consummation of
this transaction which would be treated as an "excess parachute payment" as
defined in Section 280G of the Internal Revenue Code of 1986, as amended (the
"IRC"). There are no such agreements, plans or other arrangements entered into
with or provided for any independent contractors with whom the Company or any
Subsidiary has a business relationship.
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5.11 ERISA. Set forth on SCHEDULE 5.10 are all of the employee benefit
plans, as defined in Section 3(3) of the Employee Retirement Income Security Act
of 1974, as amended ("ERISA"), but without regard to whether any such plan is in
fact subject to ERISA, that is sponsored, or is being maintained or contributed
to, by the Company or any Subsidiary that provides for payment of more than
$25,000 in annual benefits (the "Company Employee Benefit Plans"). None of the
Company Employee Benefit Plans are "multiemployer plans" as defined in Section
3(37) of ERISA. The Company has furnished or made available or will promptly
after the date hereof make available to Newco and the Acquiror (a) a true and
complete copy of the plan document and summary plan description for each Company
Employee Benefit Plan, (b) a true and complete copy of the most recently filed
Form 5500 (including the related schedules) with respect to each Company
Employee Benefit Plan for which such form is required to be filed, (c) a true
and complete copy of any trust agreement, insurance contract or other agreement
or arrangement serving as source of funding any benefits payable under any
Company Employee Benefit Plan, and (d) the most recently issued financial
statement and actuarial report, if any, for each Company Employee Benefit Plan.
No "prohibited transactions" (as such term is defined in Section 4975 of the
IRC, or in Part 4 of Subtitle B of Title I of ERISA) have occurred with respect
to any Company Employee Benefit Plan that could result in the imposition of
taxes or penalties that, in the aggregate, could have a Company Material Adverse
Effect. With respect to each of the Company Employee Benefit Plans that is
intended to qualify for favorable income tax treatment under Section 401(a) of
the IRC, (i) the Internal Revenue Service ("IRS") has issued a favorable
determination letter with respect to such plan; (ii) except as set forth on
SCHEDULE 5.10, the Company has furnished Newco and Acquiror with a copy of the
determination letter most recently issued by the IRS with respect to such plan
and the application filed with the IRS for such determination letter; and (iii)
to the best knowledge of the Company, no event has occurred from the date of
each such favorable determination letter that would adversely affect the
tax-qualified status of the plan in question. Each Company Employee Benefit Plan
has been administered in compliance with the applicable requirements of ERISA
and the IRC, and in compliance with all other applicable provisions of law,
except for such noncompliance, if any, that, in the aggregate, would not have a
Company Material Adverse Effect. With respect to each Company Employee Benefit
Plan, neither the Company nor any Subsidiary has incurred liabilities which, in
the aggregate, could have a Company Material Adverse Effect as a result of the
violation of or the failure to comply with any applicable provision of ERISA,
the IRC, any other applicable provision of law, or any provision of such plan.
None of the Company Employee Benefit Plans which is an "employee pension benefit
plan", as that term is defined in Section 3(2) of ERISA (a "Company Employee
Pension Benefit Plan"), has incurred an "accumulated funding deficiency," within
the meaning of Section 302 of ERISA or Section 412 of the IRC which, in the
aggregate, could have a Company Material Adverse Effect. Neither the Company nor
any Subsidiary has failed to make any contribution to, or to make any payment
under, any Company Employee Benefit Plan that it was required to make pursuant
to the terms of the plan or pursuant to applicable law in any amount which, in
the aggregate, could have a Company Material Adverse Effect. To the best
knowledge of the Company, no "reportable events," with respect to which a notice
must be filed with the Pension Benefit Guaranty Corporation ("PBGC"), has
occurred with respect to any Company Employee Pension Benefit Plan subject to
Title IV of the ERISA which events, in the aggregate, could have a Company
Material Adverse Effect. No proceedings by the PBGC to terminate any Company
Employee Pension Benefit Plan pursuant to Subtitle C of Title IV of ERISA have
to the best of the Company's knowledge, been instituted or threatened which, in
the aggregate, could have a Company Material Adverse Effect. Except for any
liabilities in an amount which, in the aggregate, would not have a Company
Material Adverse Effect, neither the Company nor any Subsidiary (1) has incurred
any liability to the PBGC in connection with any Company Employee Pension
Benefit Plan, including any liability under Section 4069 of ERISA and any
penalty imposed under Section 4071 of ERISA, (2) has terminated any Company
Employee Pension Benefit Plan, or ceased operations at any facility or withdrawn
from any Company Employee Pension Benefit Plan, in a manner that could subject
it to liability or any liens under Section 4062, 4063, 4064 or 4068 of ERISA or
(3) has any knowledge as to the existence of any state of facts, or as to the
occurrence of any transactions, that might reasonably be anticipated to result
in any
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liability of the Company or any Subsidiary to the PBGC under any other provision
of Title IV of ERISA. There is no pending or, to the best knowledge of the
Company, threatened legal action, proceeding or investigation against or
involving any Company Employee Benefit Plan which could result in liabilities to
the Plan, the Company or any Subsidiary that, in the aggregate, could have a
Company Material Adverse Effect. Except as disclosed on SCHEDULE 5.10, the
present value of accrued benefits of each Company Employee Benefit Plan that is
a defined benefit plan as defined in Section 3(35) of ERISA does not exceed the
value of the assets of such plan available to pay such benefits by an amount
that, in the aggregate for all such plans, could have a Company Material Adverse
Effect. All representations made by the Company in this Section 5.11 are
likewise true with respect to each Subsidiary.
5.12 ENVIRONMENTAL MATTERS. "Company Real Properties" shall mean all real
property now or previously owned, operated or leased by the Company, any
Subsidiary or any predecessor-in-interest. Except as set forth on SCHEDULE 5.12:
(i) the Company, each of the Subsidiaries, and to the best of the Company's
knowledge, each of the Company Real Properties is in compliance with, and has no
liability under any or all applicable Environmental Laws, except where the
failure to comply or such liability would not have a Company Material Adverse
Effect; (ii) none of the Company, any Subsidiary or any of the Company Real
Properties has been alleged in writing by any governmental agency or third party
to be in violation of, to be liable under, or to be subject to any
administrative or judicial proceeding pursuant to, any Environmental Law, the
violation of which would have a Company Material Adverse Effect; and (iii) to
the best knowledge of the Company and each Subsidiary, there are no facts or
circumstances which could reasonably form the basis for the assertion of any
claims against the Company or any Subsidiary relating to environmental matters
which, in the aggregate, would have a Company Material Adverse Effect. As used
herein, Environmental Law means any federal, state, or local law, statute, rule
or regulation, or the common law governing or relating to the environment or to
occupational health and safety.
5.13 REAL ESTATE LEASES. SCHEDULE 5.13 sets forth a complete and accurate
list, a copy of which has been delivered to the Acquiror of (i) all leases and
subleases under which the Company or any Subsidiary is lessor or lessee of any
real property, together with all amendments, supplements, nondisturbance
agreements and other agreements pertaining thereto; (ii) all material options
held by the Company or any Subsidiary or contractual obligations on the part of
the Company or any Subsidiary to purchase or acquire any interest in real
property; and (iii) all options granted by the Company or any Subsidiary or
contractual obligations on the part of the Company or any Subsidiary to sell or
dispose of any material interest in real property (except for sale-leaseback
transactions) in each such instance in items (i) through (iii) above, which
provides for a payment of more than $25,000. Such leases, subleases and other
agreements are in full force and constitute binding obligations of the Company
and, to the best of its knowledge, the other parties thereto, and (i) there are
no defaults thereunder by the Company or any Subsidiary or, to the best of
Company's knowledge, by any other party thereto; and (ii) no event has occurred
which (with notice, lapse of time or both or occurrence of any other event)
would constitute a default by the Company or any Subsidiary or, to the best of
the Company's knowledge, by any other party thereto, other than defaults or
events which, in the aggregate, would not have a Company Material Adverse
Effect. The Company or a Subsidiary has good, valid and insurable leasehold
title to all such leased property, free and clear of all encumbrances, liens,
charges or other restrictions of any kind or character, except for Permitted
Liens, as defined below.
5.14 TITLE TO PROPERTIES; ABSENCE OF LIENS AND ENCUMBRANCES. SCHEDULE 5.14
lists all real property owned by the Company or any Subsidiary as of the date of
this Agreement. The Company and/or a Subsidiary has good, valid and insurable
title in fee simple to all of the real property listed on SCHEDULE 5.14, free
and clear of all encumbrances, liens, charges or other restrictions of any
character whatsoever, except for (i) statutory liens for current taxes or
assessments not due or delinquent or the validity of which is being contested in
good faith, (ii) mechanics, workers, repairmen's and other similar liens arising
or incurred in the ordinary course of business, (iii) such other liens,
imperfections in title,
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charges, easements, restrictions and other encumbrances, if any, which in the
aggregate do not have a Company Material Adverse Effect, and (iv) except as set
forth on SCHEDULE 5.14 (collectively "Permitted Liens"). Except for leased
assets, the Company and the Subsidiaries have good and insurable title to all of
their material tangible personal property used in their businesses, including,
without limitation, those reflected in the Company Balance Sheet (other than
assets disposed of in the ordinary course of business since the Company Balance
Sheet Date), free and clear of all liens, charges, pledges, security interests
or other encumbrances, except liens for taxes not yet due and payable and such
liens or other imperfections of title of the type and nature described as
"Permitted Liens" above to the extent applicable, if any, as would not, in the
aggregate, have a Company Material Adverse Effect on the operation of the
business of the Company or any Subsidiary, and except as reflected or disclosed
in the Company Balance Sheet, or on SCHEDULE 5.14.
5.15 TAX MATTERS. Except as set forth on SCHEDULE 5.15, the Company has
paid, or the Company Balance Sheet contains adequate provision for, all federal,
state, local, foreign or other governmental income, franchise, payroll,
F.I.C.A., unemployment, withholding, real property, personal property, sales,
payroll, disability and all other taxes imposed on the Company or any Subsidiary
or with respect to any of their respective properties, or otherwise payable by
them, including interest and penalties, if any, in respect thereof
(collectively, "Company Taxes"), for the Company taxable period ended on the
date of the Company Balance Sheet and all fiscal periods of the Company prior
thereto, except such nonpayment, or failure to make adequate provision, which,
in the aggregate, would not have a Company Material Adverse Effect. Company
Taxes paid and/or incurred from the date of the Company Balance Sheet until the
Effective Time include only Company Taxes incurred in the ordinary course of
business determined in the same manner as in the taxable period ending on the
date of the Company Balance Sheet. Except as disclosed on SCHEDULE 5.15, the
Company and its Subsidiary have timely filed all income tax, excise tax, sales
tax, use tax, gross receipts tax, franchise tax, employment and payroll related
tax, property tax, and all other tax returns which the Company and/or each
Subsidiary (as the case may be) are required to file ("Tax Returns"), and have
paid or provided for all the amounts shown to be due thereon, except where such
failure to make such timely filings, in the aggregate, would not have a Company
Material Adverse Effect, and except for the nonpayment of such amounts which, in
the aggregate, would not have a Company Material Adverse Effect. Except as set
forth on SCHEDULE 5.15, (i) neither the Company nor any Subsidiary has filed or
entered into, or is otherwise bound by, any election, consent or extension
agreement that extends any applicable statute of limitations with respect to
taxable periods of the Company, (ii) the Company is not a party to any
contractual obligation requiring the indemnification or reimbursement of any
person with respect to the payment of any Tax, (iii) no claim has ever been made
or threatened by an authority in a jurisdiction where the Company or any
Subsidiary do not file Tax Returns that they are or may be subject to Taxes by
that jurisdiction, except for any such claims as, in the aggregate, would not
have a Company Material Adverse Effect, (iv) no issues have been raised by the
relevant taxing authorities on audit that are of a recurring nature and that
would have an effect upon the Taxes of the Company or any Subsidiary, except for
any issue which, in the aggregate, would not have a Company Material Adverse
Effect. Except as set forth on SCHEDULE 5.15, to the best of the Company's and
each Subsidiary's knowledge, no action or proceeding is pending or threatened by
any governmental authority for any audit, examination, deficiency, assessment or
collection from the Company or any Subsidiary of any Company Taxes, no
unresolved claim for any deficiency, assessment or collection of any Company
Taxes has been asserted against the Company or any Subsidiary, and all resolved
assessments of Company Taxes have been paid or are reflected in the Company
Balance Sheet, except for any of the foregoing which, in the aggregate, would
not have a Company Material Adverse Effect.
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5.16 INTELLECTUAL PROPERTY. SCHEDULE 5.16 lists all the registered
patents, trademarks, service marks, copyrights, trade names and applications for
any of the foregoing owned by the Company or any Subsidiary as of the date of
this Agreement (the "Registered Intellectual Property"). The Company and/or the
Subsidiaries have good title to the Registered Intellectual Property and have
good title to, or valid licenses or rights to use, all patents, copyrights,
trademarks, trade names, brand names, proprietary and other technical
information, technology and software (collectively "Intellectual Property")
which are used in the operation of their businesses as presently conducted,
except for such title, license or use imperfections as, in the aggregate, would
not have a Company Material Adverse Effect. There are no claims or proceedings
pending or, to the Company's and each Subsidiary's knowledge, threatened against
the Company or any Subsidiary asserting that the Company or any Subsidiary is
infringing or engaging in the unauthorized use of any Intellectual Property of
any other person or entity, except such claims or proceedings which, in the
aggregate, would not have a Company Material Adverse Effect.
5.17 LABOR MATTERS. Neither the Company nor any Subsidiary is a party to
any collective bargaining agreement with respect to any of their employees. None
of the employees of the Company or any Subsidiary are represented by any labor
union and, as of the date hereof, neither the Company nor any Subsidiary has any
knowledge of any union organizational efforts involving the Company's employees
during the past five years. Except as set forth on SCHEDULE 5.17, neither the
Company nor any Subsidiary has received written notice of any claim, or has
knowledge of any facts which are likely to give rise to any claim, that they
have not complied in any respect with any laws relating to the employment of
labor, including, without limitation, any provisions thereof relating to wages,
hours, collective bargaining, the payment of social security and similar taxes,
equal employment opportunity, employment discrimination or employment safety,
except such claims which, in the aggregate, would not have a Company Material
Adverse Effect.
5.18 INSURANCE. SCHEDULE 5.18 lists, as of the date of this Agreement, all
material policies of fire, products liability, general liability, vehicle,
worker's compensation, directors' and officers' liability, title and other
insurance owned or held by or covering the Company or any Subsidiary or any of
their property or assets which are material to the business of the Company and
any Subsidiary, taken as a whole. As of the date hereof, all of such policies
are in full force and effect, except as to matters or defaults which, in the
aggregate, would not have a Company Material Adverse Effect, and no written
notice of cancellation or termination has been received with respect to any such
policy which has not been replaced or cannot be replaced on substantially
similar terms prior to the date of such cancellation or termination.
5.19 CONTRACTS. SCHEDULE 5.19 contains a complete and correct list of all
material agreements, contracts and commitments (collectively, the "Contracts"),
(a) to which the Company is a party or by which it is bound, or (b) by which any
of the assets, properties or the business is bound, and in either case, which
constitute (i) mortgages, indentures, security agreements, and other agreements
and instruments relating to the borrowing of money by or from, or any extension
or credit to or from, the Company; (ii) sales agency or marketing agreements;
(iii) agreements or commitments for capital expenditures; (iv) brokerage or
finder's agreements; (v) partnership, joint venture or other arrangements or
agreements involving a sharing of profits or expenses; (vi) contracts or
commitments to sell, lease or otherwise dispose of any assets, properties or
business other than in the ordinary course of business; (vii) contracts or
commitments limiting the freedom of the Company to compete in any line of
business or in any geographic area or with any person, and any nondisclosure or
nonsolicitation agreements which limit the Company; (viii) any other agreements,
contracts and commitments material to the business, operations or financial
condition of the Company in each instance under items (i) through (viii) above
which Contract relates to an aggregate amount of more than $75,000. All of the
Contracts are valid and in full force and effect and the Company has performed
all of its obligations under each Contract and no default, violation or breach
by the Company or, to the Company's knowledge, any other party, under any
Contract has occurred which affects the enforceability of such Contract or any
party's rights thereunder, except for such defaults, violations and breaches
which would not, in the aggregate, have a Company Material Adverse Effect.
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5.20 REGISTRATION STATEMENT; BLUE SKY FILINGS; PROXY STATEMENT; OTHER
INFORMATION. The Proxy Statement and the information supplied or to be supplied
in writing by the Company for inclusion in the Registration Statement and any
other documents to be filed with the SEC, the BCSC, the VSE or any other
regulatory agency in connection with the transactions contemplated hereby will,
at the respective times such documents are filed, or, as applicable, declared
effective, and on the Effective Time, and, with respect to the Proxy Statement,
when first published, sent or given to stockholders of the Company, be false or
misleading with respect to any material fact, or omit to state any material fact
necessary in order to make the statements therein not misleading or, in the case
of the Proxy Statement or any amendment thereof or supplement thereto, at the
time of the special meeting of the Company's stockholders provided for in
Section 6.1, be false or misleading with respect to any material fact, or omit
to state any material fact necessary to correct any statement in any earlier
communication with respect to the solicitation of any proxy for such meeting.
If, at any time prior to the Effective Time, any event relating to the Company
or any of its affiliates, officers or directors is discovered by the Company
that should be set forth in an amendment to the Registration Statement or a
supplement to the Proxy Statement, the Company will promptly inform the
Acquiror, and such amendment or supplement will be promptly filed with the VSE
and disseminated to the stockholders of the Company, to the extent required by
applicable securities laws. All documents which the Company files or is
responsible for filing with the VSE and any other regulatory agency in
connection with the Merger (including, without limitation, the Proxy Statement)
will comply as to form and content in all material respects with the provisions
of applicable law. Notwithstanding the foregoing, neither the Company nor the
Subsidiary make any representations or warranties with respect to any
information that has been supplied in writing by the Acquiror or Newco, or their
auditors, attorneys, financial advisors, specifically for use in the Proxy
Statement, or in any other documents to be filed with the VSE or any other
regulatory agency in connection with the transactions contemplated hereby.
5.21 BROKERS. Except as set forth in Schedule 5.21, neither the Company
nor any Subsidiary has paid or become obligated to pay any fee or commission to
any broker, finder, investment banker or other intermediary in connection with
this Agreement.
5.22 CONTINUITY OF INTEREST. The Company has caused each person who is an
affiliate, as defined in Rule 12b-2 under the Exchange Act (an "Affiliate"), to
deliver to the Acquiror and each Affiliate has, concurrently with the signing of
this Agreement, signed an affiliate agreement in the form attached hereto as
EXHIBIT C (an "Affiliate Agreement") providing, among other things, that such
person has no plan or intention and will not sell, pledge, transfer or otherwise
dispose of shares of Acquiror Common Stock or in any way reduce their risk
relative to any such shares, until such time as financial results covering at
least 30 days of combined operations of the Acquiror and the Company have been
published within the meaning of Section 201.01 of the Codification of Financial
Reporting Policies of the SEC and except in compliance with the applicable
provisions of the Securities Act, and the rules and regulations thereunder.
5.23 TRANSACTIONS WITH AFFILIATED PARTIES. SCHEDULE 5.23 sets forth a true
and complete list and description of all transactions engaged in between the
Company and any director, officer, employee, stockholder, partner or agent of
the Company, or any of their respective spouses or children, any trust of which
any such person is the grantor, trustee or beneficiary, any corporation of which
any such person or party is a stockholder, employee, officer or director, or any
partnership or other person in which any such person or party owns an interest
(all such persons, trusts, corporations and partnerships being herein referred
to collectively as "Affiliated Parties" and individually as an "Affiliated
Party"). No Affiliated Party is a party to any agreement, contract or commitment
with the Company except as set forth in SCHEDULE 5.24.
ARTICLE VI
COVENANTS AND AGREEMENTS
6.1 REGISTRATION STATEMENT; PROXY STATEMENT; STOCKHOLDER MEETING; VANCOUVER
EXCHANGE.
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(a) As promptly as practicable after the execution of this Agreement,
the Acquiror and Newco will file with the SEC a registration statement on
Form S-4 (as amended or supplemented, the "Registration Statement") relating
to the registration under the Securities Act of the Acquiror Common Stock to
be received in the Merger, and file with state securities administrators
such registration statements or other documents as may be required under
applicable blue sky laws to qualify or register such Acquiror Common Stock
in such states as are designated by the Company (the "Blue Sky Filings").
The Acquiror and Newco will use their reasonable best efforts to cause the
Registration Statement to become effective as soon as practicable. In the
process of its preparation of the Registration Statement, the Acquiror will
provide the Company and its advisors drafts of the Registration Statement
and will provide the Company and its advisors a reasonable opportunity to
participate in such drafting process. The Acquiror will notify the Company
promptly of the receipt of any comments from the SEC or its staff or from
any state securities administrators and of any request by the SEC or its
staff or by any state securities administrators for amendments or
supplements to the Registration Statement or any Blue Sky Filings or for
additional information, and will supply the Company and its legal counsel
with copies of all correspondence between the Acquiror or any of its
representatives, on the one hand, and the SEC, its staff or any state
securities administrators, on the other hand, with respect to the
Registration Statement.
(b) As promptly as practicable following the execution of this
Agreement, and after receipt by the Company of a fairness opinion from its
financial advisor, the Company agrees that this Agreement shall be submitted
at a meeting (the "Meeting") of its stockholders duly called and held
pursuant to Section 251(c) of the General Corporation Law. As soon as
practicable after the date of this Agreement, the Company shall take all
action, to the extent necessary in accordance with applicable law, its
Certificate of Incorporation and By-Laws, to convene a meeting of its
stockholders promptly to consider and vote upon the approval of the Merger,
and the Company shall prepare and file with the VSE, subject to the prior
approval of the Acquiror, which approval the Acquiror shall not unreasonably
withhold, such information as may be necessary to allow the VSE to approve
the merger (the "VSE Approval"), preliminary and final versions of a proxy
statement and proxy and other filings relating to the Meeting as required by
the VSE and the applicable regulations thereof. The term "Proxy Statement"
shall mean such proxy statement at the time it initially is mailed to
stockholders and all duly filed amendments or revisions made thereto, if
any, similarly mailed. Notice of the Meeting shall be mailed to the
Company's stockholders of the Company along with the Proxy Statement. The
Company will notify the Acquiror promptly of the receipt of any comments
from the VSE with respect to the Proxy Statement and will supply the
Acquiror and its legal counsel with copies of all correspondence from or to
the VSE and any other applicable regulatory authority. The Company, after
consultation with the Acquiror and its legal counsel, shall respond promptly
to any comments made by the VSE with respect to the VSE Approval and the
Proxy Statement and cause the Proxy Statement and proxy to be mailed to its
stockholders at the earliest practicable time following the execution
hereof.
6.2 CONDUCT OF THE BUSINESS OF THE COMPANY PRIOR TO THE EFFECTIVE
TIME. Except as set forth on SCHEDULE 6.2, the Company agrees that prior to the
Effective Time, except as otherwise consented to or approved in writing by the
Acquiror or expressly permitted by this Agreement:
(a) the business of the Company and the Subsidiaries shall be conducted
only in the ordinary course and consistent with past practice;
(b) each of the Company and each Subsidiary shall not (i) amend its
Certificate of Incorporation or By-Laws, (ii) change the number of
authorized, issued or outstanding shares of its capital stock, except upon
the exercise of stock options or warrants outstanding on the date hereof,
(iii) declare, set aside or pay any dividend or other distribution or
payment in cash, stock or property in respect of shares of its capital
stock, (iv) make any direct or indirect redemption, retirement, purchase or
other acquisition of any of its capital stock (except for repurchases of
Common Stock from employees
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pursuant to existing stock subscription agreements between the Company and
certain of its employees) or (v) split, combine or reclassify its
outstanding shares of capital stock;
(c) neither the Company nor any Subsidiary shall, directly or
indirectly, (i) issue, grant, sell or pledge or agree or propose to issue,
grant, sell or pledge any shares of, or rights of any kind to acquire any
shares of the capital stock of the Company or any Subsidiary, except that
the Company may issue shares of Common Stock upon the exercise of stock
options or warrants outstanding on the date hereof, (ii) other than in the
ordinary course of business and consistent with past practice and other than
with respect to the Promissory Note, incur any material indebtedness for
borrowed money, except material indebtedness for borrowed money incurred
under credit facilities existing as of the date hereof, (iii) waive,
release, grant or transfer any rights of material value, except in the
ordinary course of business consistent with past practices or (iv) transfer,
lease, license, sell, mortgage, pledge, dispose of or encumber any material
assets of the Company or any Subsidiary other than in the ordinary course of
business and consistent with past practice;
(d) the Company and the Subsidiaries shall use their reasonable
commercial efforts to preserve intact the business organization of the
Company and the Subsidiaries, to keep available the services of its
operating personnel and to preserve the goodwill of those having business
relationships with each of them, including, without limitation, suppliers
and customers;
(e) neither the Company nor any Subsidiary will, directly or indirectly,
(i) increase the compensation payable or to become payable by it to any of
its employees, officers or directors, except in accordance with employment
agreements, welfare and benefit plans set forth on SCHEDULE 5.10, and
except, with respect to employees who are not directors or officers, for
increases in the ordinary course of business, consistent with past practice,
(ii) adopt additional, or make any payment or provision, other than as
required by existing plans or agreements, including provisions and actions
under existing stock option plans in connection with the Merger, in the
ordinary course of business and consistent with prior practice, with respect
to any stock option, bonus, profit sharing, pension, retirement, deferred
compensation, employment or other payment or employee compensation plan,
agreement or arrangement for the benefit of employees of the Company or any
Subsidiary, (iii) grant any stock options or stock appreciation rights or
issue any warrants, (iv) enter into or amend any employment or severance
agreement or arrangement or (v) make any loan or advance to, or enter into
any written contract, lease or commitment with, any officer or director of
the Company or its Subsidiary;
(f) neither the Company nor any Subsidiary shall, directly or
indirectly, assume, guarantee, endorse or otherwise become responsible for
the obligations of any other individual, firm or corporation other than a
Subsidiary or make any loans or advances to any individual, firm or
corporation except in the ordinary course of its business and consistent
with past practices;
(g) neither the Company nor any Subsidiary shall make any investment of
a capital nature either by purchase of stock or securities, contributions to
capital, property transfers, acquisition or financing of equipment or
otherwise, or other than in the ordinary course of business, by the purchase
of any property or assets of any other individual, firm or corporation;
(h) neither the Company nor any Subsidiary shall enter into modify or
amend in any material respect or take any action to terminate their
respective material contracts, except in the ordinary course of business;
(i) neither the Company nor any Subsidiary shall take any action, other
than reasonable and usual actions in the ordinary course of business and
consistent with past practice, with respect to accounting policies or
procedures, except for changes required by GAAP;
(j) neither the Company nor any Subsidiary shall, without the consent of
the Acquiror, settle or compromise any material federal, state, local or
foreign income tax proceeding or audit;
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(k) the Company and the Subsidiaries will promptly advise the Acquiror
in writing of any Company Material Adverse Effect or any breach of the
Company's representations or warranties, or any material breach of a
covenant contained herein of which the Company or any Subsidiary has
knowledge; and
(l) neither the Company nor any Subsidiary shall enter into an agreement
to do any of the things described in clauses (a) through (k).
6.3 ACCESS TO PROPERTIES AND RECORD; ACQUIROR NOTICE. The Company and the
Subsidiaries shall afford to the Acquiror and Newco and their respective
accountants, counsel and representatives, reasonable access during normal
business hours throughout the period prior to the Effective Time to all of their
properties, books, contracts, commitments and written records (including, but
not limited to, tax returns for the preceding six years), and shall make
reasonably available their officers and employees to answer fully and promptly
questions put to them thereby; provided that no investigation pursuant to this
Section 6.3 shall alter any representation or warranties of any party hereto or
conditions to the obligation of the parties hereto; provided, further, that such
access shall not unreasonably interfere with the normal business operations of
any of the parties hereto. In connection with the preparation of its fairness
opinion, the Company's financial advisor shall be provided with the reasonable
level of access to the Acquiror and its books and records that may be necessary
with respect thereto. The Acquiror will provide the Company written notice of
any Acquiror Material Adverse Effect.
6.4 NEGOTIATIONS. Following the execution of this Agreement by the
Company, neither the Company nor any Subsidiary, nor the directors, officers,
attorneys, financial advisors, or other authorized persons of any of them,
shall, directly or indirectly, solicit, initiate or participate in discussions
or negotiations with or the submission of any offer or proposal by or provide
any information to, any corporation, partnership, person, or other entity or
group (other than Newco or the Acquiror or any officer or other authorized
representative of Newco or the Acquiror) concerning any Third Party Transaction,
as defined below, or, except as provided in Section 8.1(b) or as may be
consistent with fiduciary responsibilities under applicable law as advised in
writing by outside counsel, participate in any negotiation regarding any Third
Party Transaction or otherwise cooperate in any way with any effort or attempt
by any other person to effectuate a Third Party Transaction. Notwithstanding the
foregoing, the Board of Directors of the Company may furnish such information to
or enter into discussions and/or negotiations with any corporation, partnership,
person or other entity or group that makes an unsolicited offer to engage in a
Third Party Transaction with the Company that the Board of Directors of the
Company in good faith determines, with the assistance of its financial advisor,
may represent a transaction more favorable to the Company's stockholders when
compared to the Merger and the Merger Consideration if, and only to the extent
that, the Board determines after consultation with outside legal counsel that
the failure to take such action would be inconsistent with the compliance by the
Board of Directors with its fiduciary duties to the stockholders of the Company
under applicable law, provided that such party shall enter into a
confidentiality agreement on substantially the terms contained in Section 6.6 of
this Agreement, the Company shall notify the Acquiror as to the contents of
information being provided and the Company shall diligently enforce its rights
under such confidentiality agreement. The Company represents and warrants that
the Company is not currently involved in discussions or negotiations with any
third party with respect to a Third Party Transaction. The Company will promptly
communicate to the Acquiror the identity of any potential third party purchaser
making any such proposal or contact and, prior to the execution of any agreement
relating to any such Third Party Transaction, shall also communicate the
proposed terms and conditions thereof. The Company agrees not to release any
third party from, or waive any provision of, any confidentiality or standstill
agreement to which the Company is a party.
6.5 INDEMNIFICATION. The Acquiror agrees that all provisions with respect
to indemnification by the Company and the Subsidiaries or with respect to
liability to the Company or any Subsidiary now existing in favor of any present
or former director, officer, employee or agent (and their respective heirs and
assigns) of the Company or any Subsidiary, respectively (the "Indemnified
Parties"), as set forth in their respective
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Certificates of Incorporation, as amended, or By-Laws or pursuant to other
agreements in effect on the date hereof, shall survive the Merger, shall not be
amended, repealed or modified and shall continue in full force and effect for a
period of at least six years from the Effective Time.
6.6 CONFIDENTIALITY.
(a) Subject to applicable law and to subpoena, the Acquiror and Newco
will hold, and will cause each of their affiliates, employees, officers,
directors and other representatives to hold, in strict confidence, and to
not use to the detriment of the Company or the Subsidiaries, any information
or data concerning the Company or the Subsidiaries furnished to them in
connection with the transactions contemplated by this Agreement, except for
information or data generally known or available to the public; and if the
transactions contemplated by this Agreement are not consummated, such
confidence shall be maintained and the Acquiror and Newco will return to the
Company or the Subsidiaries all such information and data as the Company or
the Subsidiaries may request.
(b) Subject to applicable law and to subpoena, each of the Company and
the Subsidiaries will hold, and will cause each of the Company's and each
Subsidiary's employees, officers, directors and other representatives to
hold, in strict confidence, and to not use to the detriment of the Acquiror
or Newco, any information or data concerning the Acquiror or Newco furnished
to them in connection with the transactions contemplated by this Agreement,
except for information or data generally known or available to the public;
and if the transactions contemplated by this Agreement are not consummated,
such confidence shall be maintained and the Company and the Subsidiaries
will return to the Acquiror or Newco all such information and data as the
Acquiror or Newco may request.
6.7 REASONABLE BEST EFFORTS. Subject to the terms and conditions hereof
and the fiduciary obligations of the directors of the Company, each of the
parties hereto agrees to use their reasonable best efforts to take, or cause to
be taken, all action and to do, or cause to be done, all things necessary to
satisfy the conditions set forth herein as soon as practicable, including,
without limitation, reasonable best efforts necessary to list on the Nasdaq
National Market the shares of the Acquiror Common Stock issuable pursuant to the
Merger or thereafter, reasonable best efforts necessary to have removed or
rescinded any temporary, preliminary or permanent injunction, including the
injunctions or other orders described in Section 7.1(c), and reasonable best
efforts necessary to defend against any and all litigation, including the
proceedings described in Section 7.1(f) brought against either of the parties
hereto. The Acquiror and the Company each agree to take, or cause to be taken,
all action, and to do, or cause to be done, all things necessary or required by
the United States Federal Trade Commission or the United States Department of
Justice in connection with the expiration or termination of the waiting period
under the HSR Act; provided that neither party will be required to take any
action or to do anything in connection with the foregoing which would materially
impair the Acquiror's or the Surviving Corporation's ownership or operation of
all or a material portion of the business and assets of the Company and its
Subsidiary taken as a whole, or compel the Acquiror to dispose of all or a
material portion of the business or assets of the Acquiror and its subsidiaries,
taken as a whole. No party hereto will take any action for the purpose of
delaying, impairing or impeding the receipt of any required consent,
authorization, order or approval or the making of any required filing or
registration.
6.8 CERTIFICATION OF STOCKHOLDER VOTE. At or prior to the closing of the
transactions contemplated by this Agreement, the Company shall deliver to
Acquiror a certificate of the Company's Secretary setting forth (i) the number
of shares of Common Stock voted in favor of adoption of this Agreement and
consummation of the Merger and the number of shares of Common Stock voted
against adoption of this Agreement and consummation of the Merger; and (ii) the
number of shares of Dissenting Stock.
6.9 LOAN TO COMPANY. On the execution of this Agreement, the Acquiror
shall loan to the Company $2.5 million pursuant to the terms and conditions set
forth in that certain promissory note attached hereto as Exhibit B (the
"Promissory Note").
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6.10 OUTSOURCING AGREEMENT. The Company and the Acquiror shall use
reasonable efforts to negotiate the terms and conditions of and enter into a
billing outsourcing agreement, which shall provide, among other things, for the
management by Acquiror of the Company's customer billings and which shall be on
terms at least as favorable as the terms of the Company's present outsourcing
agreement.
6.11 AFFILIATE AGREEMENTS. To ensure that the Merger is accounted for as a
"pooling of interests," the Company will deliver to Newco from such affiliates
of the Company as deemed necessary by the Acquiror's independent auditors a
written agreement in the form attached hereto as Exhibit C (the "Affiliate
Agreements") relating to the disposition of the shares of the Acquiror's Common
Stock received thereby in the Merger.
6.12 PROXY AGREEMENT. On the execution of this Agreement, John R. Snedegar
shall deliver to the Acquiror a proxy agreement substantially in the form
attached hereto as Exhibit D (the "Proxy Agreement").
6.13 DISCLOSURE SCHEDULES. The Company shall use its reasonable best
efforts to deliver the Disclosure Schedules to the Acquiror promptly following
the execution of this Agreement.
ARTICLE VII
CONDITIONS PRECEDENT
7.1 CONDITIONS TO EACH PARTY'S OBLIGATION TO EFFECT THE MERGER. The
respective obligations of each party to effect the Merger shall be subject to
the fulfillment at or prior to the Effective Time of the following conditions:
(a) The Registration Statement shall have been declared effective, and
no stop order suspending the effectiveness of the Registration Statement
shall have been issued by the SEC or shall be continuing to be in effect,
and no proceedings for that purpose shall have been initiated or threatened
by the SEC.
(b) This Agreement and the Merger contemplated hereby shall have been
approved and adopted by the requisite vote of the holders of the outstanding
shares of Common Stock of the Company entitled to vote thereon at the
Meeting.
(c) No United States, Canadian or state governmental authority or other
agency or commission or United States, Canadian or state court of competent
jurisdiction shall have enacted, issued, promulgated, enforced or entered
any statute, rule, regulation, injunction or other order (whether temporary,
preliminary or permanent) which is in effect and has the effect of making
the acquisition of Common Stock by Newco illegal or otherwise prohibiting
consummation of the transactions contemplated by this Agreement.
(d) Any waiting period applicable to the Merger under the HSR Act shall
have expired or been terminated.
(e) All filings with the FCC required under the Communications Act and
with state agencies under state public utility statutes, if necessary, shall
have been made.
(f) The shares of Acquiror Common Stock issuable in the Merger or
thereafter shall have been authorized for listing on the Nasdaq National
Market, upon official notice of issuance.
(g) There shall not have been instituted or pending any action or
proceeding by or before any court or governmental authority or other
regulatory or administrative agency or commission, domestic or foreign, by
any government or governmental authority, nor shall there be any
determination by any government, governmental authority, regulatory or
administrative agency or commission which, in either case, would require
either party to take any action or do anything in connection with the
foregoing which would result in a material adverse effect to their
respective businesses or materially impair Acquiror's or the Surviving
Corporation's ownership or operation of all or a material portion of the
business or assets of the Company and the Subsidiary, taken as a whole, or
compel Acquiror to
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dispose of all or a material portion of the business or assets of Acquiror
and the Subsidiaries, taken as a whole.
7.2 CONDITIONS TO THE OBLIGATION OF THE COMPANY TO EFFECT THE MERGER. The
obligation of the Company to effect the Merger shall be subject to the
fulfillment at or prior to the Effective Time of the following additional
conditions:
(a) Each of the Acquiror and Newco shall have performed in all material
respects its obligations under this Agreement required to be performed by it
on or prior to the Effective Time pursuant to the terms hereof.
(b) All representations or warranties of the Acquiror and Newco in this
Agreement which are qualified with respect to an Acquiror Material Adverse
Effect or materiality shall be true and correct, and all such
representations or warranties that are not so qualified shall be true and
correct in all material respects, in each case as if such representation or
warranty was made as of the Effective Time, except to the extent that any
such representation or warranty is made as of a specified date, in which
case such representation or warranty shall have been true and correct as of
such specified date.
(c) Since the date of this Agreement, there shall not have been any
material adverse change in the financial condition, results of operations,
properties or business of the Acquiror and its Subsidiaries, taken as a
whole, excluding any such change caused by a general change in the economy
or in the telecommunications industry served by the Acquiror and its
Subsidiaries.
(d) Each of the Acquiror and Newco shall have delivered a certificate of
its President or Vice President to the effect set forth in paragraphs (a),
(b) and (c) of this Section 7.2.
(e) The Company shall have received from Riordan & McKinzie, counsel to
the Acquiror and Newco, an opinion dated the Effective Time in the form
reasonably agreed to by the parties hereto.
(f) The Company shall have received the opinion of its financial
advisors that the Merger and other transactions contemplated by this
Agreement are fair, from a financial point of view, to the stockholders of
the Company.
7.3 CONDITIONS TO OBLIGATIONS OF THE ACQUIROR AND NEWCO TO EFFECT THE
MERGER. The obligations of Acquiror and Newco to effect the Merger shall be
subject to the fulfillment at or prior to the Effective Time of the following
additional conditions:
(a) Each of the Company and its Subsidiaries shall have performed in all
material respects each of its obligations under this Agreement required to
be performed by it on or prior to the Effective Time pursuant to the terms
hereof.
(b) All representations or warranties of the Company in this Agreement
which are qualified with respect to a Company Material Adverse Effect or
materiality shall be true and correct, and all such representations or
warranties that are not so qualified shall be true and correct in all
material respects, in each case as if such representation or warranty were
made as of the Effective Time except to the extent that any such
representation or warranty is made as of a specified date, in which case
such representation or warranty shall have been true and correct as of such
specified date.
(c) Since the date of this Agreement, there shall not have been any
material adverse change in the financial condition, results of operations,
properties or business of the Company and its Subsidiaries, taken as a
whole, excluding any such change caused by a general change in the economy
or in the telecommunications industry served by the Company and its
Subsidiaries and other than any such change approved by the Acquiror.
(d) The Company shall have delivered a certificate of its President or
Vice President to the effect set forth in paragraphs (a), (b) and (c) to
this Section 7.3.
(e) Newco shall have received letters of resignation addressed to the
Company from those members of the Company's board of directors as listed on
SCHEDULE 7.3(e), which resignations shall be effective as of the Effective
Time.
A-19
<PAGE>
(f) The Acquiror shall have received from Parker Chapin Flattau &
Klimpl, LLP, counsel to the Company, an opinion dated the Effective Time in
the form reasonably agreed to by the parties hereto.
(g) Holders of no more than 5% of the outstanding shares of Common Stock
shall not have caused such shares to become Dissenting Stock.
(h) Newco shall have received executed Affiliate Agreements from
designated Company affiliates.
(i) The Acquiror shall have received letters (i) from Arthur Andersen
LLP approving the accounting treatment of the Merger as a "pooling of
interests" and (ii) from Price Waterhouse LLP that the Company has taken no
action in the past two years that would prevent the application of a
"pooling of interests" accounting treatment to the Merger, and the SEC shall
not have objected to such accounting treatment.
7.4 CLOSING CONDITIONS DEEMED SATISFIED. If the Meeting has been completed
and has resulted in a vote sufficient to approve the Merger in accordance with
applicable law, and if all other conditions precedent to the consummation of the
Merger contained in this Article VII (other than the conditions set forth in
Sections 7.1(c) and (d)) have been satisfied or have otherwise been waived as of
the date of such Meeting, such conditions precedent to the consummation of the
Merger (except as provided in the next succeeding sentence) shall terminate, and
the parties to this Agreement agree to consummate the Merger as soon as
practicable thereafter; provided, however, that in no event shall any party be
required to consummate the Merger or any other transactions contemplated by this
Agreement to the extent that such consummation would violate any applicable laws
or regulations. In such event, the Acquiror, on the one hand, and the Company,
on the other hand, shall cooperate to deliver, as soon as practicable after the
satisfaction or waiver of such conditions precedent, the officer's certificates
and opinions required of the Acquiror by Section 7.2(d) and 7.2(f), and required
of the Company by Section 7.3(d) and 7.3(f), respectively, and, upon the
Effective Time, the Acquiror shall deliver the certificate required of the
Exchange Agent by Section 7.2(e) and the Company will deliver to Newco the
letters of resignation required by Section 7.3(e).
ARTICLE VIII
TERMINATION, AMENDMENT AND WAIVER
8.1 TERMINATION. This Agreement may be terminated and the Merger
contemplated herein may be abandoned at any time prior to the Effective Time and
before approval by the stockholders of the Company:
(a) by the mutual consent of Newco and the Company;
(b) by Newco or the Company, if (i) the Board of Directors of the
Company shall have failed to recommend, or withdrawn, modified or amended in
any respect its approval or recommendation of the Merger and of the
transactions contemplated hereby or the Board of Directors of the Company
shall have resolved to do any of the foregoing or (ii) the stockholders
shall have failed to vote in favor of this Agreement and the Merger and, in
the case of the Company seeking termination pursuant to Section 8.1(b)(i),
the Company having paid to Newco the Termination Fee, as defined below, in
accordance with the terms of Section 8.2.
(c) by Newco if (i) there has occurred a material adverse change in the
financial condition, operations, or business of the Company and its
Subsidiaries taken as a whole, or (ii) there is a breach of any of the
representations and warranties of the Company which are qualified with
respect to a Company Material Adverse Effect or materiality or if the
Company shall have breached in any material respect any of such
representations or warranties which are not so qualified, or if the Company
fails to comply in any material respect with any of its covenants or
agreements contained herein, which breaches or failures, as the case may be,
are, in the aggregate, material in the context of the transactions
contemplated by this Agreement;
A-20
<PAGE>
(d) by the Company (i) if there has occurred a material adverse change
in the financial condition, operations, or business of the Acquiror or (ii)
there is a breach of any of the representations and warranties of the
Acquiror or Newco which are qualified with respect to an Acquiror Material
Adverse Effect or materiality or if the Acquiror or Newco shall have
breached in any material respect any of such representations or warranties
which are not so qualified, or if the Acquiror or Newco fails to comply in
any material respect with any of its covenants or agreements contained
herein, which breaches or failures, as the case may be, are, in the
aggregate, material in the context of the transactions contemplated by this
Agreement; and
(e) by either Newco or the Company, if on or before May 1, 1998 the
Merger shall not have been consummated; provided that neither party may
terminate under this Section 8.1(e) if such failure has been caused by that
party's material breach of this Agreement; provided further that if any
condition to this Agreement shall fail to be satisfied by reason of the
existence of an injunction or order of any court or governmental or
regulatory body resulting from an action or proceeding commenced by any
party which is not a government or governmental authority, then at the
request of either party the deadline date referred to above shall be
extended for a reasonable period of time, not in excess of 120 days, to
permit the parties to have such injunction vacated or order reversed.
(f) by the Acquiror by the later to occur of December 3, 1997, or the
date that is three business days after delivery by the Company of the final
version of the Disclosure Schedules.
(g) by the Company if it has not satisfied the condition set forth in
Section 7.2 (f).
In the event of such termination and abandonment, no party hereto (or any of
its directors or officers) shall have any liability or further obligation to any
other party to this Agreement except as provided in Section 8.2, and except that
nothing herein will relieve any party from liability for any wilful breach of
this Agreement prior to such termination or abandonment.
8.2 FEES AND EXPENSES. If this Agreement is terminated by Newco or the
Company pursuant to Section 8.1(b)(i), (a) after receipt of a bona fide proposal
to acquire (by means of a tender or exchange offer, merger, consolidation,
business combination or otherwise) all or a substantial portion of the
outstanding shares of Common Stock or of the assets of the Company and the
Subsidiaries (all such transactions being referred to herein as "Third Party
Transactions"), or (b) prior to the satisfaction of the condition set forth in
Section 7.2(f), then the Company shall, simultaneously with such termination,
pay to Newco by wire transfer of immediately available funds, $2,000,000.00 (the
"Termination Fee").
8.3 AMENDMENT. Subject to the applicable provisions of the General
Corporation Law, this Agreement may be amended by the parties hereto solely by
action taken by their respective Boards of Directors. This Agreement may not be
amended except by an instrument in writing signed on behalf of each of the
parties hereto.
8.4 WAIVER. At any time prior to the Effective Time, the parties hereto,
by action taken by their respective Boards of Directors, may (i) extend the time
for the performance of any of the obligations or other acts of the other parties
hereto, (ii) waive any inaccuracies in the representations and warranties of the
other party contained herein or in any documents delivered pursuant hereto, and
(iii) waive compliance by the other party with any of the agreements or
conditions herein. Any agreement on the part of a party hereto to any such
extension or waiver shall be valid only if set forth in an instrument in writing
signed on behalf of such party.
A-21
<PAGE>
ARTICLE IX
MISCELLANEOUS
9.1 SURVIVAL. All representations, warranties and agreements contained in
this Agreement or in any instrument delivered pursuant to this Agreement shall
terminate and be extinguished at the Effective Time or the earlier date of
termination of this Agreement pursuant to Section 8.1, as the case may be,
except that the agreements set forth in Article I and in Sections 6.5, 6.6, 6.7,
6.9, 6.10 and 9.5 will survive the Effective Time indefinitely and those set
forth in Sections 8.2 and 9.5 will survive the termination of this Agreement
indefinitely, and other than any covenant the breach of which has resulted in
the termination of this Agreement.
9.2 EXPENSES AND FEES. If the Merger is consummated, all reasonable fees
and expenses incurred in connection with the Merger and the transactions
contemplated thereby will be paid by the Surviving Corporation. If the Merger is
not consummated, each party hereto shall, subject to the provision of Section
8.2 above, bear their respective fees and expenses.
9.3 NOTICES. All notices and other communications given or made pursuant
hereto shall be in writing and shall be deemed to have been given or made if in
writing and delivered personally or sent by registered or certified mail
(postage prepaid, return receipt requested) or by telecopier to the parties at
the following addresses and facsimile numbers:
(a) if to Newco or the Acquiror to:
STAR Telecommunications, Inc.
223 E. De La Guerra St.
Santa Barbara, CA 93101
Attention: Chris Edgecomb
Fax: (805) 884-1137
with copies to:
Riordan & McKinzie
300 South Grand Avenue, Ste. 2900
Los Angeles, CA 90071
Attention: Timothy F. Sylvester, Esq.
Fax: (213) 229-8550
(b) if to the Company, to:
United Digital Network, Inc.
18872 MacArthur Blvd., Suite 300
Irvine, CA 92612
Attention: John R. Snedegar
Fax: (714) 833-8679
with copies to:
Parker Chapin Flattau & Klimpl, LLP
1211 Avenue of the Americas
New York, NY 10036
Attention: Martin E. Weisberg, Esq.
Fax: (212) 704-6288
or at such other addresses as shall be furnished by the parties by like notice,
and such notice or communication shall be deemed to have been given or made as
of the date so delivered or mailed or confirmation of transmission.
A-22
<PAGE>
9.4 HEADINGS. The headings contained in this Agreement are inserted for
convenience only and do not constitute a part of this Agreement.
9.5 PUBLICITY. The parties hereto shall not, and shall cause their
affiliates not to, issue or cause the publication of any press release or other
announcement with respect to the Merger or this Agreement without consulting
with all other parties and their respective counsel and without delivering a
draft of any such press release to such parties.
9.6 ENTIRE AGREEMENT; KNOWLEDGE. This Agreement constitutes the entire
agreement among the parties and supersedes all other prior agreements and
understandings, both written and oral, among the parties, or any of them, with
respect to the subject matter hereof. For purposes of this Agreement,
"knowledge" of any party shall mean the knowledge of the executive officers of
that party after such officers shall have made all reasonable inquiries.
9.7 ASSIGNMENT. This Agreement and all of the provisions hereof shall be
binding upon and inure to the benefits of the parties hereto and their
respective successors and permitted assigns. Neither this Agreement nor any of
the rights, interests or obligations shall be assigned by any of the parties
hereto without the prior written consent of the other parties, provided that
Newco's rights and duties hereunder may be assigned to a wholly owned subsidiary
of the Acquiror, which assumes all of Newco's duties and obligations. This
Agreement is not intended to confer upon any other person any rights or remedies
hereunder.
9.8 COUNTERPARTS. This Agreement may be executed in one or more
counterparts, all of which shall be considered one and the same agreement and
each of which shall be deemed an original.
9.9 INVALIDITY, ETC. In the event that any provision of this Agreement
shall be deemed contrary to law or invalid or unenforceable in any respect by a
court of competent jurisdiction, the remaining provisions shall remain in full
force and effect to the extent that such provisions can still reasonably be
given effect in accordance with the intentions of the parties, and the invalid
and unenforceable provisions shall be deemed, without further action on the part
of the parties, modified, amended and limited solely to the extent necessary to
render the same valid and enforceable.
9.10 SPECIFIC PERFORMANCE. Each of the parties hereto acknowledges and
agrees that the other parties hereto would be irreparably damaged in the event
any of the provisions of this Agreement were not performed in accordance with
their specific terms or were otherwise breached. Accordingly, each of the
parties hereto agrees that they each shall be entitled to an injunction or
injunctions to prevent breaches of the provisions of this Agreement and to
enforce specifically this Agreement and the terms and conditions hereof in any
action instituted in any court of the United States or any state having
competent jurisdiction, in addition to any other remedy to which such party may
be entitled, at law or in equity.
9.11 GOVERNING LAW. The validity and interpretation of this Agreement
shall be governed by the laws of the State of Delaware, without reference to the
conflict of laws principles thereof.
[THE REMAINDER OF THIS PAGE IS INTENTIONALLY LEFT BLANK]
A-23
<PAGE>
IN WITNESS WHEREOF, the Acquiror, Newco and the Company have caused this
Agreement to be signed by their respective officers thereunto duly authorized,
all as of the date first written above.
<TABLE>
<S> <C> <C>
ACQUIROR: STAR TELECOMMUNICATIONS, INC.
By: /s/ CHRIS EDGECOMB
-----------------------------------------
Chris Edgecomb
CHIEF EXECUTIVE OFFICER
</TABLE>
<TABLE>
<S> <C> <C>
NEWCO: IIWII CORP.
By: /s/ KELLY ENOS
-----------------------------------------
Kelly Enos
CHIEF FINANCIAL OFFICER
</TABLE>
<TABLE>
<S> <C> <C>
COMPANY: UNITED DIGITAL NETWORK, INC.
By: /s/ JOHN R. SNEDEGAR
-----------------------------------------
John R. Snedegar
CHIEF EXECUTIVE OFFICER
</TABLE>
A-24
<PAGE>
FIRST AMENDMENT TO AGREEMENT AND PLAN OF MERGER
FIRST AMENDMENT TO AGREEMENT AND PLAN OF MERGER dated as of January 30, 1998
(this "Amendment"), by and among STAR Telecommunications, Inc., a Delaware
corporation (the "Acquiror"), IIWII Corp., a Delaware corporation and
wholly-owned subsidiary of the Acquiror ("Newco"), and United Digital Network,
Inc., a Delaware corporation (the "Company").
R E C I T A L S:
A. The parties to this Amendment entered into that certain Agreement and
Plan of Merger dated as of November 19, 1997 (the "Merger Agreement"), which set
forth the terms and conditions pursuant to which the Merger would be
consummated.
B. The parties to this Amendment hereby wish to amend the Merger Agreement
on the terms set forth below.
C. Capitalized terms not otherwise defined herein shall have the meanings
therefor in the Merger Agreement.
A G R E E M E N T
NOW, THEREFORE, in consideration of the mutual representations, warranties,
covenants, agreements and conditions contained herein, and in order to set forth
the terms and conditions of the Merger and the mode of carrying the same into
effect, the parties hereby agree as follows:
ARTICLE I
THE MERGER
1. CONVERSION. Section 2.1(a) of the Agreement shall be deleted in its
entirety and replaced with the following:
(a) Each of the issued and outstanding shares of the Common Stock, $.01
par value, of the Company ("Common Stock"), other than (i) Dissenting Stock,
as defined below, or (ii) shares of Common Stock held in the treasury of the
Company, shall be automatically converted into the right to receive
consideration per share (the "Merger Consideration") consisting of that
portion of a share (the "Exchange Ratio") of the Acquiror's common stock,
$0.001 per share ("Acquiror Common Stock"), determined by dividing US$2.05
by the average closing price of Acquiror's Common Stock on the Nasdaq
National Market for the five (5) trading days prior to the Effective Time
(the "Average Price").
2. SECOND LOAN TO COMPANY. Promptly following the execution of this
Amendment, the Acquiror shall loan to the Company $2 million pursuant to the
terms and conditions set forth in that certain promissory note attached hereto
as Exhibit B-1. Following the receipt of such funds, the Company shall
immediately apply at least $700,000 to balances due by the Company to the
Acquiror.
3. WAIVER OF SECTION 8.1(F). STAR hereby waives Section 8.1(f) of the
Merger Agreement. In that regard, the Acquiror acknowledges that, subject to
Sections 6.2(k) and 7.3(b) of the Merger Agreement, it has completed its due
diligence investigation of the Company.
4. NO FURTHER AMENDMENT. Except as otherwise set forth in this Amendment,
the Merger Agreement shall remain in full force and effect without further
amendment, modification or alteration.
A-25
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be
signed by their respective officers thereunto duly authorized, all as of the
date first written above.
<TABLE>
<S> <C> <C>
ACQUIROR: STAR TELECOMMUNICATIONS, INC.
By: /s/ KELLY ENOS
-----------------------------------------
Kelly Enos
CHIEF EXECUTIVE OFFICER
</TABLE>
<TABLE>
<S> <C> <C>
NEWCO: IIWII CORP.
By: /s/ KELLY ENOS
-----------------------------------------
Kelly Enos
CHIEF FINANCIAL OFFICER
</TABLE>
<TABLE>
<S> <C> <C>
COMPANY: UNITED DIGITAL NETWORK, INC.
By: /s/ JOHN R. SNEDEGAR
-----------------------------------------
John R. Snedegar
CHIEF EXECUTIVE OFFICER
</TABLE>
A-26
<PAGE>
SECOND AMENDMENT TO AGREEMENT AND PLAN OF MERGER
SECOND AMENDMENT TO AGREEMENT AND PLAN OF MERGER dated as of April 6, 1998
(this "Second Amendment"), by and among STAR Telecommunications, Inc., a
Delaware corporation (the "Acquiror"), IIWII Corp., a Delaware corporation and
wholly-owned subsidiary of the Acquiror ("Newco"), and United Digital Network,
Inc., a Delaware corporation (the "Company").
R E C I T A L S:
A. The parties to this Second Amendment entered into that certain Agreement
and Plan of Merger dated as of November 19, 1997, as amended to date (the
"Merger Agreement"), which set forth the terms and conditions pursuant to which
the Merger would be consummated.
B. The parties to this Second Amendment hereby wish to amend the Merger
Agreement on the terms set forth below.
C. Capitalized terms not otherwise defined herein shall have the meanings
therefor in the Merger Agreement.
A G R E E M E N T
NOW, THEREFORE, in consideration of the mutual representations, warranties,
covenants, agreements and conditions contained herein, and in order to set forth
the terms and conditions of the Merger and the mode of carrying the same into
effect, the parties hereby agree as follows:
1. CONVERSION. Section 2.1(a) of the Agreement shall be deleted in its
entirety and replaced with the following:
"(a) Each of the issued and outstanding shares of the Common Stock,
$.01 par value, of the Company ("Common Stock"), other than (i) Dissenting
Stock, as defined below, or (ii) shares of Common Stock held in the treasury
of the Company, shall be automatically converted into the right to receive
consideration per share (the "Merger Consideration") consisting of that
portion of a share (the "Exchange Ratio") of the Acquiror's Common Stock,
$0.001 par value per share ("Acquiror Common Stock"), determined by dividing
US$2.05 by the average closing price of Acquiror's Common Stock on the
Nasdaq National Market for the five (5) trading days prior to the Effective
Time (the "Average Price"), provided that, if the Average Price is equal to
or greater than $27.50, the Exchange Ratio shall be determined by using
$27.50 as the Average Price."
2. COVENANTS AND AGREEMENTS. The following Section should be added to
"Article VI Covenants and Agreements," as follows:
"6.14 REGULATORY APPROVALS.
(a) The Company agrees to utilize all reasonable efforts and to
cooperate with Acquiror in every way as may be necessary, reasonable or
advisable to consummate and make effective the transactions contemplated by
this Agreement and will use all reasonable efforts to assist Acquiror in
obtaining all Regulatory Approvals, waivers, permits, consents, other
approvals, authorizations and clearances and to effect all registrations,
filings and notices with or to third parties or governmental, regulatory or
public bodies or authorities which are, in the reasonable opinion of
Acquiror, necessary or desirable in connection with the transactions
contemplated by this Agreement. Until such time as the Regulatory Approvals
have been obtained, there shall be no change in the ownership or management
of the Company and no transfer of control whatsoever over the Company's
certificates of public convenience and necessity and daily operations.
Pending receipt of the Regulatory Approvals, the Company, its current
shareholders, officers, directors and employees shall remain directly and
solely responsible for the operation of the Company's telecommunications
services and for compliance with all applicable provisions of federal
telecommunications law, state public service commission laws and all
applicable
A-27
<PAGE>
regulations and policies thereunder. Further, pending receipt of the
Regulatory Approvals, the Company, its current shareholders, officers,
directors and employees shall manage and operate the Company's
telecommunications services in a manner that is fully consistent with the
terms and conditions of the Company's certificates of public convenience and
necessity, the public interest and the best interest of the Company's
shareholders. As used herein, "Regulatory Approvals" shall mean all
necessary regulatory approvals from the FCC and from any and all state
public service commissions required for the transfer of ownership or control
over the Company.
(b) Acquiror agrees to use its reasonable efforts to take, as promptly
as possible, or cause to be taken, all action and do, or cause to be done,
all things necessary, proper or advisable to consummate and make effective
the transactions contemplated by this Agreement, and Acquiror specifically
agrees to use all reasonable efforts to obtain all Regulatory Approvals,
waivers, permits, consents, other approvals, authorizations and clearances
and to effect all registrations, filings and notices with or to third
parties or governmental, regulatory or public bodies or authorities which
are, in the reasonable opinion of Acquiror, necessary or desirable in
connection with the transactions contemplated by this Agreement. Until such
time as the Regulatory Approvals have been obtained, there shall be no
change in the ownership or management of the Company and no transfer of
control whatsoever over the Company's certificates of public convenience and
necessity and daily operations. Pending receipt of the Regulatory Approvals,
the Company, its current shareholders, officers, directors and employees
shall remain directly and solely responsible for the operation of the
Company's telecommunications services and for compliance with all applicable
provisions of federal telecommunications law, state public service
commission laws and all applicable regulations and policies thereunder.
Further, pending receipt of the Regulatory Approvals, the Company, its
current shareholders, officers, directors and employees shall manage and
operate the Company's telecommunications services in a manner that is fully
consistent with the terms and conditions of the Company's certificates of
public convenience and necessity, the public interest and the best interest
of the Company's shareholders."
3. CONDITIONS PRECEDENT.
(a) Section 7.1(e) of the Agreement is hereby amended by adding the
following sentence:
"The Regulatory Approvals, all licenses, permits, authorizations, consents
and other approvals of and filing with any governmental or regulatory agency
required to be obtained or made in connection with the consummation of the
transactions contemplated by this Agreement shall have been duly obtained or
made by or on behalf of Acquiror."
(b) The introductory language of Section 7.2 shall be modified by adding
the following clause after the word "conditions":
"each of which may be waived by the Company, in its sole discretion:"
(c) The introductory language of Section 7.3 shall be modified by adding
the following clause after the word "conditions":
"each of which may be waived by the Acquiror and Newco, in their sole
discretion:"
4. TERMINATION, AMENDMENT AND WAIVER. Section 8.1(e) of the Agreement is
hereby amended by deleting the date "May 1, 1998" in the first line and
replacing such date with "July 15, 1998".
5. NO FURTHER AMENDMENT. Except as otherwise set forth in this Amendment,
the Merger Agreement shall remain in full force and effect without further
amendment, modification or alteration.
A-28
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Second Amendment to
be signed by their respective officers thereunto duly authorized, all as of the
date first written above.
<TABLE>
<S> <C> <C>
ACQUIROR: STAR TELECOMMUNICATIONS, INC.
By: /s/ KELLY ENOS
-----------------------------------------
Kelly Enos
CHIEF EXECUTIVE OFFICER
</TABLE>
<TABLE>
<S> <C> <C>
NEWCO: IIWII CORP.
By: /s/ KELLY ENOS
-----------------------------------------
Kelly Enos
CHIEF FINANCIAL OFFICER
</TABLE>
<TABLE>
<S> <C> <C>
COMPANY: UNITED DIGITAL NETWORK, INC.
By: /s/ JOHN R. SNEDEGAR
-----------------------------------------
John R. Snedegar
CHIEF EXECUTIVE OFFICER
</TABLE>
A-29
<PAGE>
AMENDED AND RESTATED THIRD AMENDMENT TO AGREEMENT AND PLAN OF MERGER
AMENDED AND RESTATED THIRD AMENDMENT TO AGREEMENT AND PLAN OF MERGER dated
as of October 13, 1998 (this "Third Amendment"), by and among STAR
Telecommunications, Inc., a Delaware corporation (the "Acquiror"), IIWII Corp.,
a Delaware corporation and wholly-owned subsidiary of the Acquiror ("Newco"),
and United Digital Network, Inc., a Delaware corporation (the "Company").
R E C I T A L S:
A. The parties to this Third Amendment entered into that certain Agreement
and Plan of Merger dated as of November 19, 1997, as amended to date (the
"Merger Agreement"), which sets forth the terms and conditions pursuant to which
the Merger would be consummated.
B. The parties to this Third Amendment hereby wish to amend the Merger
Agreement on the terms set forth below.
C. Capitalized terms not otherwise defined herein shall have the meanings
therefor in the Merger Agreement.
A G R E E M E N T
NOW, THEREFORE, in consideration of the mutual representations, warranties,
covenants, agreements and conditions contained herein, and in order to set forth
the terms and conditions of the Merger and the mode of carrying the same into
effect, the parties hereby agree as follows:
1. CONVERSION. Section 2.1(a) of the Merger Agreement shall be deleted in
its entirety and replaced with the following:
"(a) Each of the issued and outstanding shares of the Common Stock,
$.01 par value, of the Company ("Common Stock"), other than (i) Dissenting
Stock, as defined below, or (ii) shares of Common Stock held in the treasury
of the Company, shall be automatically converted into the right to receive
consideration per share (the "Merger Consideration") consisting of that
portion of a share (the "Exchange Ratio") of the Acquiror's Common Stock,
$0.001 par value per share ("Acquiror Common Stock"), determined by dividing
US$2.05 by the average closing price of Acquiror's Common Stock on the
Nasdaq National Market for the five (5) trading days prior to the Effective
Time (the "Average Price"), provided that, if the Average Price is equal to
or greater than $27.50, the Exchange Ratio shall be determined by using
$27.50 as the Average Price, and provided further that, if the Average Price
is equal to or less than $14.00, the Exchange Ratio shall be determined by
using $14.00 as the Average Price."
2. TERMINATION, AMENDMENT AND WAIVER.
(a) Section 8.1(e) of the Merger Agreement is hereby amended by deleting
the date "July 15, 1998" in the first line and replacing such date with
"April 15, 1999".
(b) To add a new Section 8.1(h) of the Merger Agreement to read in its
entirety as follows:
"(h) by the Company if the average closing price per share of
Acquiror's Common Stock on the Nasdaq National Market for five (5)
consecutive trading days is equal to or less than $6.00."
3. NO FURTHER AMENDMENT. Except as otherwise set forth in this Amendment,
the Merger Agreement shall remain in full force and effect without further
amendment, modification or alteration.
A-30
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Third Amendment to
be signed by their respective officers thereunto duly authorized, all as of the
date first written above.
<TABLE>
<S> <C> <C>
ACQUIROR: STAR TELECOMMUNICATIONS, INC.
By: /s/ KELLY D. ENOS
-----------------------------------------
Kelly D. Enos
CHIEF FINANCIAL OFFICER
</TABLE>
<TABLE>
<S> <C> <C>
NEWCO: IIWII CORP.
By: /s/ KELLY D. ENOS
-----------------------------------------
Kelly D. Enos
CHIEF FINANCIAL OFFICER
</TABLE>
<TABLE>
<S> <C> <C>
COMPANY: UNITED DIGITAL NETWORK, INC.
By: /s/ JOHN R. SNEDEGAR
-----------------------------------------
John R. Snedegar
CHIEF EXECUTIVE OFFICER
</TABLE>
A-31
<PAGE>
ANNEX B
May 7, 1998
Board of Directors
United Digital
18872 Macarthur Blvd.
Suite 300
Irvine, CA 92612
Members of the Board:
We understand that Star Telecommunications, Inc. ("Star"), United Digital
Network, Inc. ("United Digital") and IIWII Corp. ("Merger Sub"), a wholly-owned
subsidiary of Star, have entered into an Agreement and Plan of Merger, dated as
of November 19, 1997 (the "Merger Agreement"), which provides, among other
things, for the merger (the "Merger") of Merger Sub with and into United
Digital. Pursuant to the Merger, United Digital will become a wholly-owned
subsidiary of Star and each issued and outstanding share of common stock, par
value $0.01 per share, of United Digital (the "United Digital Common Stock"),
other than shares held in treasury or held by United Digital or any subsidiary
of United Digital, shall be converted into the right to receive a fraction of a
share of common stock, par value $0.001 per share, of Star (the "Star Common
Stock"). This conversion is subject to terms and conditions which are more fully
set forth in the Merger Agreement. Capitalized terms used herein without
definition shall have the same meanings herein as are ascribed to those terms in
the Merger Agreement.
You have asked for our opinion as to whether the Exchange Ratio pursuant to
the Merger Agreement is fair from a financial point of view to the holders of
shares of United Digital Common Stock.
For purposes of the opinion set forth herein, we have:
(i) reviewed certain publicly available financial statements and other
information of Star and United Digital, respectively;
(ii) reviewed certain internal financial statements and other financial and
operating data concerning United Digital and Star prepared by the
management of United Digital and Star, respectively;
(iii) discussed the past and current operations and financial condition and
the prospects of Star, including information relating to certain
strategic, financial and operational benefits anticipated from the
Merger, with senior executives of Star;
(iv) discussed the past and current operations and financial condition and
the prospects of United Digital, including information relating to
certain strategic, financial and operational benefits anticipated from
the Merger, with senior executives of United Digital;
(v) reviewed the pro forma impact of the Merger on the earnings per share
and consolidated capitalization of Star and United Digital,
respectively;
(vi) reviewed the reported prices and trading activity for the Star Common
Stock;
(vii) compared the financial performance of United Digital and Star and the
prices and trading activity of the United Digital Common Stock and the
Star Common Stock with that of certain other publicly-traded companies
and their securities;
(viii) reviewed the financial terms, to the extent publicly available, of
certain comparable acquisition transactions;
(ix) reviewed and discussed with the senior managements of United Digital
and Star the strategic rationale for the Merger and certain
alternatives to the Merger;
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(x) reviewed the Merger Agreement and the agreements to be entered in
connection therein; and
(xi) considered such other factors as we have deemed appropriate.
We have assumed and relied upon, without independent verification, the
accuracy and completeness of the information furnished to us by United Digital,
Star and other publicly available sources and reviewed by us for the purposes of
this opinion. With respect to the internal financial statements and other
financial and operating data including estimates of the strategic, financial and
operational benefits anticipated from the Merger provided by United Digital and
Star, we have assumed that they have been reasonably prepared on a basis
reflecting the best currently available estimates and judgments of the prospects
of Star and United Digital, respectively. We have relied upon the assessment by
the managements of Star and United Digital of their ability to retain key
employees of both Star and United Digital. We have also relied upon, without
independent verification, the assessment by managements of United Digital and
Star of the strategic and other benefits expected to result from the Merger. We
have also relied upon, without independent verification, the assessment by
mangements of United Digital and Star of the timing and risks associated with
the integration of United Digital with Star. We have not made any independent
valuation or appraisal of the assets, liabilities or technology of Star or
United Digital, respectively, nor have we been furnished with any such
appraisals. We have assumed that the Merger will be accounted for as a
"pooling-of-interests" business combination in accordance with U.S. Generally
Accepted Accounting Principles and the Merger will be treated as a tax-free
reorganization and/or exchange pursuant to the Internal Revenue Code of 1986 and
will be consummated in accordance with the terms set forth in the Merger
Agreement. Our opinion is necessarily based on economic, market and other
conditions as in effect on, and the information made available to us as of, the
date hereof. In arriving at our opinion, we were not authorized to solicit, and
did not solicit, interest from any third party with respect to an acquisition,
business combination or other extraordinary transaction involving United
Digital, nor did we discuss the acquisition with any parties other than Star.
We have acted as financial advisor to the Board of Directors of United
Digital in connection with this transaction and will receive a fee for our
services. In the past, Madison Securities, Inc. has provided financial advisory
and financing services for United Digital and have received fees for the
rendering of these services. In addition, in the ordinary course of our business
we may actively trade the securities of Star for our own account and for the
accounts of our customers and, accordingly, may at any time hold a long or short
position in such securities.
It is understood that this letter is for the information of the Board of
Directors of United Digital and may not be used for any other purpose without
our prior written consent, except that this opinion may be included in its
entirety in any filing made by Star and/or United Digital with the Securities
and Exchange Commission with respect to the transactions contemplated by the
Merger Agreement. In addition, this opinion does not in any manner address the
prices at which the Star Common Stock will actually trade at any time and we
express no recommendation or opinion as to how the holders of United Digital
Common Stock should vote at the shareholders' meeting held in connection with
the Merger.
Based upon and subject to the foregoing, we are of the opinion on the date
hereof that the Exchange Ratio pursuant to the Merger Agreement is fair from a
financial point of view to the holders of shares of United Digital Common Stock.
Very truly yours,
/s/Madison Securities, Inc.
----------------------------------------------------------------------
MADISON SECURITIES, INC.
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ANNEX C
SECTION 262 OF THE GENERAL
CORPORATION LAW OF THE STATE OF DELAWARE
Section 262 APPRAISAL RIGHTS. (a) Any stockholder of a corporation of this
State who holds shares of stock on the date of the making of a demand pursuant
to subsection (d) of this section with respect to such shares, who continuously
holds such shares through the effective date of the merger or consolidation, who
has otherwise complied with subsection (d) of this section and who has neither
voted in favor of the merger or consolidation nor consented thereto in writing
pursuant to Section 228 of this title shall be entitled to an appraisal by the
Court of Chancery of the fair value of his shares of stock under the
circumstances described in subsections (b) and (c) of this section. As used in
this section, the word "stockholder" means a holder of record of stock in a
stock corporation and also a member of record of a nonstock corporation; the
words "stock" and "share" mean and include what is ordinarily meant by those
words and also membership or membership interest of a member of a nonstock
corporation; and the words "depository receipt" mean a receipt or other
instrument issued by a depository representing an interest in one or more
shares, or fractions thereof, solely of stock of a corporation, which stock is
deposited with the depository.
(b) Appraisal rights shall be available for the shares of any class or
series of stock of a constituent corporation in a merger or consolidation to be
effected pursuant to Section Section 251, 252, 254, 257, 258, 263 or 264 of this
title:
(1) Provided, however, that no appraisal rights under this section shall
be available for the shares of any class or series of stock, which stock, or
depository receipts in respect thereof at the record date fixed to determine
the stockholders entitled to receive notice of and to vote at the meeting of
stockholders to act upon the agreement of merger or consolidation, were
either (i) listed on a national securities exchange or designated as a
national market system security on an interdealer quotation system by the
National Association of Securities Dealers, Inc. or (ii) held of record by
more than 2,000 holders; and further provided that no appraisal rights shall
be available for any shares of stock of the constituent corporation
surviving a merger if the merger did not require for its approval the vote
of the stockholders of the surviving corporation as provided in subsection
(f) of Section 251 of this title.
(2) Notwithstanding paragraph (1) of this subsection, appraisal rights
under this section shall be available for the shares of any class or series
of stock of a constituent corporation if the holders thereof are required by
the terms of an agreement of merger or consolidation pursuant to Section
Section 251, 252, 254, 257, 258, 263 and 264 of this title to accept for
such stock anything except:
a. Shares of stock of the corporation surviving or resulting from
such merger or consolidation, or depository receipts in respect thereof;
b. Shares of stock of any other corporation, or depository receipts
in respect thereof, which shares of stock or depository receipts at the
effective date of the merger or consolidation will be either listed on a
national securities exchange or designated as a national market system
security on an interdealer quotation system by the National Association
of Securities Dealers, Inc. or held of record by more than 2,000 holders;
c. Cash in lieu of fractional shares or fractional depository
receipts described in the foregoing subparagraphs a. and b. of this
paragraph; or
d. Any combination of the shares of stock and cash in lieu of
fractional shares or fractional depository receipts described in the
foregoing subparagraphs a., b. and c. of this paragraph.
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(3) In the event all of the stock of a subsidiary Delaware corporation
party to a merger effected under Section 253 of this title is not owned by
the parent corporation immediately prior to the merger, appraisal rights
shall be available for the shares of the subsidiary Delaware corporation.
(c) Any corporation may provide in its certificate of incorporation that
appraisal rights under this section shall be available for the shares of any
class or series of its stock as a result of an amendment to its certificate of
incorporation, any merger or consolidation in which the corporation is a
constituent corporation or the sale of all or substantially all of the assets of
the corporation. If the certificate of incorporation contains such a provision,
the procedures of this section, including those set forth in subsections (d) and
(e) of this section, shall apply as nearly as is practicable.
(d) Appraisal rights shall be perfected as follows:
(1) If a proposed merger or consolidation for which appraisal rights are
provided under this section is to be submitted for approval at a meeting of
stockholders, the corporation, not less than 20 days prior to the meeting,
shall notify each of its stockholders who was such on the record date for
such meeting with respect to shares for which appraisal rights are available
pursuant to subsections (b) or (c) hereof that appraisal rights are
available for any or all of the shares of the constituent corporations, and
shall include in such notice a copy of this section. Each stockholder
electing to demand the appraisal of his shares shall deliver to the
corporation, before the taking of the vote on the merger or consolidation, a
written demand for appraisal of his shares. Such demand will be sufficient
if it reasonably informs the corporation of the identity of the stockholder
and that the stockholder intends thereby to demand the appraisal of his
shares. A proxy or vote against the merger or consolidation shall not
constitute such a demand. A stockholder electing to take such action must do
so by a separate written demand as herein provided. Within 10 days after the
effective date of such merger or consolidation, the surviving or resulting
corporation shall notify each stockholder of each constituent corporation
who has complied with this subsection and has not voted in favor of or
consented to the merger or consolidation of the date that the merger or
consolidation has become effective; or
(2) If the merger or consolidation was approved pursuant to Section
Section 228 or 253 of this title, the surviving or resulting corporation,
either before the effective date of the merger or consolidation or within 10
days thereafter, shall notify each of the stockholders entitled to appraisal
rights of the effective date of the merger or consolidation and that
appraisal rights are available for any or all of the shares of the
constituent corporation, and shall include in such notice a copy of this
section. The notice shall be sent by certified or registered mail, return
receipt requested, addressed to the stockholder at his address as it appears
on the records of the corporation. Any stockholder entitled to appraisal
rights may, within 20 days after the date of mailing of the notice, demand
in writing from the surviving or resulting corporation the appraisal of his
shares. Such demand will be sufficient if it reasonably informs the
corporation of the identity of the stockholder and that the stockholder
intends thereby to demand the appraisal of his shares.
(e) Within 120 days after the effective date of the merger or consolidation,
the surviving or resulting corporation or any stockholder who has complied with
subsections (a) and (d) hereof and who is otherwise entitled to appraisal
rights, may file a petition in the Court of Chancery demanding a determination
of the value of the stock of all such stockholders. Notwithstanding the
foregoing, at any time within 60 days after the effective date of the merger or
consolidation, any stockholder shall have the right to withdraw his demand for
appraisal and to accept the terms offered upon the merger or consolidation.
Within 120 days after the effective date of the merger or consolidation, any
stockholder who has complied with the requirements of subsections (a) and (d)
hereof, upon written request, shall be entitled to receive from the corporation
surviving the merger or resulting from the consolidation a statement setting
forth the aggregate number of shares not voted in favor of the merger or
consolidation and with respect to which demands for appraisal have been received
and the aggregate number of holders of such shares. Such
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written statement shall be mailed to the stockholder within 10 days after his
written request for such a statement is received by the surviving or resulting
corporation or within 10 days after expiration of the period for delivery of
demands for appraisal under subsection (d) hereof, whichever is later.
(f) Upon the filing of any such petition by a stockholder, service of a copy
thereof shall be made upon the surviving or resulting corporation, which shall
within 20 days after such service file in the office of the Register in Chancery
in which the petition was filed a duly verified list containing the names and
addresses of all stockholders who have demanded payment for their shares and
with whom agreements as to the value of their shares have not been reached by
the surviving or resulting corporation. If the petition shall be filed by the
surviving or resulting corporation, the petition shall be accompanied by such a
duly verified list. The Register in Chancery, if so ordered by the Court, shall
give notice of the time and place fixed for the hearing of such petition by
registered or certified mail to the surviving or resulting corporation and to
the stockholders shown on the list at the addresses therein stated. Such notice
shall also be given by one or more publications at least one week before the day
of the hearing, in a newspaper of general circulation published in the City of
Wilmington, Delaware or such publication as the Court deems advisable. The forms
of the notices by mail and by publication shall be approved by the Court, and
the costs thereof shall be borne by the surviving or resulting corporation.
(g) At the hearing on such petition, the Court shall determine the
stockholders who have complied with this section and who have become entitled to
appraisal rights. The Court may require the stockholders who have demanded an
appraisal for their shares and who hold stock represented by certificates to
submit their certificates of stock to the Register in Chancery for notation
thereon of the pendency of the appraisal proceedings; and if any stockholder
fails to comply with such direction, the Court may dismiss the proceedings as to
such stockholder.
(h) After determining the stockholders entitled to an appraisal, the Court
shall appraise the shares, determining their fair value exclusive of any element
of value arising from the accomplishment or expectation of the merger or
consolidation, together with a fair rate of interest, if any, to be paid upon
the amount determined to be the fair value. In determining such fair value, the
Court shall take into account all relevant factors. In determining the fair rate
of interest, the Court may consider all relevant factors, including the rate of
interest which the surviving or resulting corporation would have had to pay to
borrow money during the pendency of the proceeding. Upon application by the
surviving or resulting corporation or by any stockholder entitled to participate
in the appraisal proceeding, the Court may, in its discretion, permit discovery
or other pretrial proceedings and may proceed to trial upon the appraisal prior
to the final determination of the stockholder entitled to an appraisal. Any
stockholder whose name appears on the list filed by the surviving or resulting
corporation pursuant to subsection (f) of this section and who has submitted his
certificates of stock to the Register in Chancery, if such is required, may
participate fully in all proceedings until it is finally determined that he is
not entitled to appraisal rights under this section.
(i) The Court shall direct the payment of the fair value of the shares,
together with interest, if any, by the surviving or resulting corporation to the
stockholders entitled thereto. Interest may be simple or compound, as the Court
may direct. Payment shall be so made to each such stockholder, in the case of
holders of uncertificated stock forthwith, and the case of holders of shares
represented by certificates upon the surrender to the corporation of the
certificates representing such stock. The Court's decree may be enforced as
other decrees in the Court of Chancery may be enforced, whether such surviving
or resulting corporation be a corporation of this State or of any state.
(j) The costs of the proceeding may be determined by the Court and taxed
upon the parties as the Court deems equitable in the circumstances. Upon
application of a stockholder, the Court may order all or a portion of the
expenses incurred by any stockholder in connection with the appraisal
proceeding, including, without limitation, reasonable attorney's fees and the
fees and expenses of experts, to be charged pro rata against the value of all
the shares entitled to an appraisal.
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<PAGE>
(k) From and after the effective date of the merger or consolidation, no
stockholder who has demanded his appraisal rights as provided in subsection (d)
of this section shall be entitled to vote such stock for any purpose or to
receive payment of dividends or other distributions on the stock (except
dividends or other distributions payable to stockholders of record at a date
which is prior to the effective date of the merger or consolidation); provided,
however, that if no petition for an appraisal shall be filed within the time
provided in subsection (e) of this section, or if such stockholder shall deliver
to the surviving or resulting corporation a written withdrawal of his demand for
an appraisal and an acceptance of the merger or consolidation, either within 60
days after the effective date of the merger or consolidation as provided in
subsection (e) of this section or thereafter with the written approval of the
corporation, then the right of such stockholder to an appraisal shall cease.
Notwithstanding the foregoing, no appraisal proceeding in the Court of Chancery
shall be dismissed as to any stockholder without the approval of the Court, and
such approval may be conditioned upon such terms as the Court deems just.
(l) The shares of the surviving or resulting corporation to which the shares
of such objecting stockholders would have been converted had they assented to
the merger or consolidation shall have the status of authorized and unissued
shares of the surviving or resulting corporation.
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<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporation Law authorizes a court to
award or a corporation's Board of Directors to grant indemnification to
directors and officers in terms sufficiently broad to permit such
indemnification under certain circumstances for liabilities (including
reimbursement for expenses incurred) arising under the Securities Act of 1933,
as amended (the "Securities Act"). Article VII, Section 6, of the Registrant's
Bylaws provides for mandatory indemnification of its directors and officers and
permissible indemnification of employees and other agents to the maximum extent
permitted by the Delaware General Corporation Law. The Registrant's Amended and
Restated Certificate of Incorporation provides that, pursuant to Delaware law,
its directors shall not be liable for monetary damages for breach of the
directors' fiduciary duty as directors to the Company and its stockholders. This
provision in the Amended and Restated Certificate of Incorporation does not
eliminate the directors' fiduciary duty, and in appropriate circumstances
equitable remedies such as injunctive or other forms of non-monetary relief will
remain available under Delaware law. In addition, each director will continue to
be subject to liability for breach of the director's duty of loyalty to the
Company for acts or omissions not in good faith or involving intentional
misconduct, for knowing violations of law, for actions leading to improper
personal benefit to the director, and for payment of dividends or approval of
stock repurchases or redemptions that are unlawful under Delaware law. The
provision also does not affect a director's responsibilities under any other
law, such as the federal securities laws or state or federal environmental laws.
The Registrant has entered or will enter into Indemnification Agreements with
its officers and directors that provide the Registrant's officers and directors
with further indemnification to the maximum extent permitted by the Delaware
General Corporation Law.
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(A) EXHIBITS.
The following Exhibits are attached hereto and incorporated herein by
reference.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
2.1* Amended and Restated Stock Acquisition Agreement and Plan of Merger dated as of November 30, 1997 by
and among the Registrant, Big Dave's Acquisition Corp., LCCR, Inc., and the shareholders listed on
the signature page thereto.
2.2 Agreement and Plan of Merger dated as of November 19, 1997 by and among the Registrant, IIWII Corp.
and United Digital Network, Inc. (the "UDN Merger Agreement"), as amended (incorporated by reference
from ANNEX A to the Proxy Statement/Prospectus constituting Part I of this Registration Statement).
2.3** Stock Purchase Agreement dated as of January 26, 1998 by and among the Registrant, T-One Corp. and
Taha Mikati, as amended.
2.4- Amended and Restated Agreement and Plan of Merger dated as of August 20, 1998 by and among the
Registrant, Sierra Acquisition Co., Inc., PT-1 Communications, Inc. and the Stockholders listed on
the signature page thereto, (the "PT-1 Merger Agreement").
2.5-- First Amendment to the PT-1 Merger Agreement dated September 1, 1998.
2.6-- Second Amendment to the PT-1 Merger Agreement dated December 29, 1998.
3.1** Amended and Restated Certificate of Incorporation of the Registrant.
3.2** Bylaws of the Registrant.
4.1+++ Specimen Common Stock certificate.
4.2+ Registration Rights Agreement, dated September 24, 1996, between the Registrant and the investors
named therein.
</TABLE>
II-1
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
4.3+ Registration Rights Agreement, dated July 12, 1996, between the Registrant and the investor named
therein.
4.4+ Investor Rights Agreement dated July 25, 1996, between the Registrant and the investors named
therein.
4.5* Registration Rights Agreement dated as of November 30, 1997 by and among the Company and the
shareholders listed on the signature page thereto.
4.6** Registration Rights Agreement dated as of March 10, 1998 between the Registrant and Taha Mikati.
5.1-- Opinion of Riordan & McKinzie, a Professional Law Corporation.
10.1+ Form of Indemnification Agreement.
10.2+ 1996 Amended and Restated Stock Incentive Plan.
10.3+ 1996 Outside Director Nonstatutory Stock Option Plan.
10.4++ 1997 Omnibus Stock Incentive Plan.
10.5+ Employment Agreement between the Registrant and Mary Casey dated July 14, 1995, as amended.
10.6+ Employment Agreement between the Registrant and Kelly Enos dated December 2, 1996.
10.7+ Employment Agreement between the Registrant and David Vaun Crumly dated January 1, 1996.
10.8+ Intentionally omitted.
10.9+ Consulting Agreement between the Registrant and Gordon Hutchins, Jr. dated May 1, 1996.
10.10+ Nonstatutory Stock Option Agreement between the Registrant and Gordon Hutchins, Jr. dated May 15,
1996.
10.11+ Free Standing Commercial Building Lease between the Registrant and Thomas M. Spear, as receiver for
De La Guerra Court Investments, dated for reference purposes as of March 1, 1996.
10.12+ Standard Office Lease--Gross between the Registrant and De La Guerra Partners, L.P. dated for
reference purposes as of July 9, 1996.
10.13+ Office Lease between the Registrant and WHUB Real Estate Limited Partnership dated June 28, 1996, as
amended.
10.14+ Standard Form of Office Lease between the Registrant and Hudson Telegraph Associates dated February
28, 1996.
10.15+ Agreement for Lease between the Registrant and Telehouse International Corporation of Europe Limited
dated July 16, 1996.
10.16+ Sublease between the Registrant and Borton, Petrini & Conron dated March 20, 1994, as amended.
10.17+ Office Lease between the Registrant and One Wilshire Arcade Imperial, Ltd. dated June 28, 1996.
10.18+ Lease Agreement between the Registrant and Telecommunications Finance Group dated April 6, 1995.
10.19+ Lease Agreement between the Registrant and Telecommunications Finance Group dated January 3, 1996, as
amended.
10.20++ Master Lease Agreement between the Registrant and NTFC Capital Corporation dated December 20, 1996.
10.21+ Variable Rate Installment Note between the Registrant and Metrobank dated October 4, 1996.
10.22+ Assignment of Purchase Order and Security Interest between the Registrant and DSC Finance Corporation
dated January 1, 1996.
</TABLE>
II-2
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
10.23++ Line of Credit Promissory Note between the Registrant and Christopher E. Edgecomb dated November 7,
1996, as amended.
10.24++ Office Lease Agreement between the Registrant and Beverly Hills Center LLC effective as of April 1,
1997.
10.25** Credit Agreement dated as of September 30, 1997 among the Registrant, the financial institutions
party thereto and Sanwa Bank California, as amended.
10.26** Office Lease between the Registrant, Hudson Telegraph Associates and American Communications Corp.,
as amended.
10.27** Amendment Number Three to Employment Agreement between the Registrant and Mary A. Casey dated as of
July 1, 1997.
10.28** Amendment Number One to Employment Agreement between the Registrant and Kelly D. Enos dated as of
November 12, 1997.
10.29** Amendment Number One to First Restatement of Employment Agreement between the Registrant and James
Kolsrud dated as of June 16, 1997.
10.30** Amendment Number One to Employment Agreement between the Registrant and David Vaun Crumly dated as of
November 11, 1997.
10.31** First Amendment to Amended and Restated 1996 Stock Incentive Plan.
10.32*** Agreement dated as of December 1, 1997 between the Registrant and Nortel Dasa Network Systems GmbH &
Co. KG.
10.33** Leasing Agreement between the Registrant and Nortel Dasa Network Systems GmbH & Co. KG.
10.34** Guarantee Agreement between the Registrant and Nortel Dasa Network Systems GmbH & Co. KG.
10.35** Note and Security Agreement dated as of December 18, 1997 between the Registrant and NationsBanc
Leasing Corporation.
10.36** Amendment of Lease dated as of September 30, 1997 between the Registrant and Hudson Telegraph
(reference is hereby made to Exhibit 10.14).
10.37 Intentionally omitted.
10.38** Lease Agreement dated July 29, 1996 between the Registrant and Telecommunications Finance Group.
10.39** Promissory Note issued by Christopher E. Edgecomb in favor of the Registrant dated November 26, 1997.
10.40** Stock Pledge Agreement dated November 26, 1997 between the Registrant and Christopher E. Edgecomb.
10.41** Commercial Lease dated October 31, 1997 between the Registrant and Prinzenpark GbR.
10.42** Commercial Lease dated October 9, 1997 between the Registrant and WSL Weststadt Liegenschafts GmbH.
10.43** Office Lease between the Registrant and Airport-Center KGHP Gewerbeban GmbH & Cie.
10.44** Lease dated November 19, 1997 between the Registrant and DIFA Deutsche Immobilien Fonds
Aktiengesellschaft.
10.45- Second Restatement of Employment Agreement between the Company and James Kolsrud dated as of July 9,
1998.
10.46- First Amendment to 1997 Omnibus Stock Incentive Plan.
21.1*** Subsidiaries of the Registrant.
23.1 Consent of Arthur Andersen LLP, Independent Public Accountants.
23.2 Consent of Riordan & McKinzie (contained in Exhibit 5.1).
23.3 Consent of Madison Securities, Inc.
</TABLE>
II-3
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
23.4 Consent of PricewaterhouseCoopers LLP, Independent Public Accountants.
23.5 Consent of Weaver and Tidwell, Independent Public Accountants.
23.6 Consent of KPMG LLP, Independent Public Accountants.
24.1 Power of Attorney (included on page II-6 of this Registration Statement, as originally filed).
27.1-- Financial Data Schedule.
99.1 Form of UDN Proxy.
99.2 Opinion of Madison Securities, Inc. (incorporated by reference from ANNEX B to the Proxy
Statement/Prospectus constituting Part I of this Registration Statement).
</TABLE>
- ------------------------
+ Filed as an exhibit to the Company's Registration Statement on Form S-1
(Registration No. 333-21325) on February 7, 1997 and incorporated by
reference herein.
++ Filed as an exhibit to Amendment No. 1 to the Company's Registration
Statement on Form S-1 (Registration No. 333-21325) on May 16, 1997 and
incorporated by reference herein.
+++ Filed as an exhibit to Amendment No. 2 to the Company's Registration
Statement on Form S-1 (Registration No. 333-21325) on May 29, 1997 and
incorporated by reference herein.
* Filed on December 15, 1997 as an exhibit to the Company's Current Report on
Form 8-K (File No. 000-22581) and incorporated by reference herein.
** Filed as an exhibit to the Company's Registration Statement on Form S-1
(Registration No. 333-48559) on March 24, 1998 and incorporated by reference
herein.
***Filed as an exhibit to the Company's Annual Report on Form 10-K (File No.
000-22581) on March 31, 1998 and incorporated by reference herein.
- Filed as an exhibit to the Company's Quarterly Report on Form 10-Q (File No.
000-22581) on November 11, 1998 and incorporated by reference herein.
-- Previously filed as an exhibit to this Registration Statement.
(B) FINANCIAL STATEMENT SCHEDULES
Not Applicable
ITEM 22. UNDERTAKINGS
The undersigned registrant hereby undertakes:
(1) That prior to any public reoffering of the securities registered
hereunder through use of a prospectus which is a part of this registration
statement, by any person or party who is deemed to be an underwriter within
the meaning of Rule 145(c), the issuer undertakes that such reoffering
prospectus will contain the information called for by the applicable
registration form with respect to reofferings by persons who may be deemed
underwriters, in addition to the information called for by the other Items
of the applicable form.
(2) That every prospectus (i) that is filed pursuant to paragraph (2)
immediately preceding, or (ii) that purports to meet the requirements of
section 10(a)(3) of the Securities Act and is used in connection with an
offering of securities subject to Rule 415, will be filed as a part of an
amendment to the registration statement and will not be used until such
amendment is effective, and that, for purposes of determining any liability
under the Securities Act, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to
be the initial bona fide offering thereof.
(3) To respond to requests for information that is incorporated by
reference into the prospectus pursuant to Items 4, 10(b), 11, or 13 of this
Form, within one business day of receipt of such request,
II-4
<PAGE>
and to send the incorporated documents by first class mail or other equally
prompt means. This includes information contained in documents filed
subsequent to the effective date of the registration statement through the
date of responding to the request.
(4) To supply by means of post-effective amendment all information
concerning a transaction, and the company being acquired involved therein,
that was not the subject of and included in the registration statement when
it became effective.
(5) Insofar as indemnification for liabilities arising under the
Securities Act may be permitted to directors, officers and controlling
persons of the registrant pursuant to the foregoing provisions, or
otherwise, the registrant has been advised that in the opinion of the
Commission such indemnification is against public policy as expressed in the
Securities Act and is, therefore, unenforceable. In the event that a claim
for indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or
controlling person of the registrant in the successful defense of any
action, suit or proceeding) is asserted by such director, officer or
controlling person in connection with the securities being registered, the
registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against
public policy as expressed in the Securities Act and will be governed by the
final adjudication of such issue.
(6) To file, during any period in which offers or sales are being made,
a post-effective amendment to this registration statement:
(i) To include any prospectus required by section 10(a)(3) of the
Securities Act.
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth in
the registration statement. Notwithstanding the foregoing, any increase
or decrease in volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered) and any
deviation from the low or high end of the estimated maximum offering
range may be reflected in the form of prospectus filed with the
Commission pursuant to Rule 424(b) if, in the aggregate, the changes in
volume and price represent no more than a 20% change in the maximum
aggregate offering price set forth in the "Calculation of Registration
Fee" table in the effective registration statement.
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or
any material change to such information in the registration statement.
(7) That, for the purpose of determining any liability under the
Securities Act, each such post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
(8) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
II-5
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
registrant has duly caused this Post-Effective Amendment No. 2 to the
Registration Statement on Form S-4 to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Santa Barbara, State of
California, on this 11th day of February, 1999.
<TABLE>
<S> <C> <C>
STAR TELECOMMUNICATIONS, INC.
By: /s/ KELLY D. ENOS
-----------------------------------------
Kelly D. Enos
Chief Financial Officer
</TABLE>
Pursuant to the requirements of the Securities Act of 1933, this
Post-Effective Amendment No. 2 to the Registration Statement has been signed
below by the following persons in the capacities and on the dates indicated.
* Chief Executive Officer
- ------------------------------ and Director (Principal February 11, 1999
Christopher E. Edgecomb Executive Officer)
*
- ------------------------------ President and Director February 11, 1999
Mary A. Casey
/s/ KELLY D. ENOS Chief Financial Officer
- ------------------------------ (Principal Financial and February 11, 1999
Kelly D. Enos Accounting Officer)
*
- ------------------------------ Director February 11, 1999
Gordon Hutchins, Jr.
*
- ------------------------------ Director February 11, 1999
John R. Snedegar
*
- ------------------------------ Director February 11, 1999
Mark Gershien
*
- ------------------------------ Director February 11, 1999
Arunas Chesonis
- ------------------------------ Director February , 1999
Samer Tawfik
*By: /s/ KELLY D. ENOS
-------------------------
Kelly D. Enos
ATTORNEY-IN-FACT
II-6
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT SEQUENTIALLY
NUMBER DESCRIPTION OF DOCUMENT NUMBERED PAGE
- ----------- ---------------------------------------------------------------------------------------- -----------------
<C> <S> <C>
2.1* Amended and Restated Stock Acquisition Agreement and Plan of Merger dated as of November
30, 1997 by and among the Registrant, Big Dave's Acquisition Corp., LCCR, Inc., and the
shareholders listed on the signature page thereto.
2.2 Agreement and Plan of Merger dated as of November 19, 1997 by and among the Registrant,
IIWII Corp. and United Digital Network, Inc. (the "UDN Merger Agreement"), as amended
(incorporated by reference from ANNEX A to the Proxy Statement/Prospectus constituting
Part I of this Registration Statement).
2.3** Stock Purchase Agreement dated as of January 26, 1998 by and among the Registrant, T-One
Corp. and Taha Mikati, as amended.
2.4- Amended and Restated Agreement and Plan of Merger dated as of August 20, 1998 by and
among the Registrant, Sierra Acquisition Co., Inc., PT-1 Communications, Inc. and the
Stockholders listed on the signature page thereto, (the "PT-1 Merger Agreement").
2.5-- First Amendment to the PT-1 Merger Agreement dated September 1, 1998.
2.6-- Second Amendment to the PT-1 Merger Agreement dated December 29, 1998.
3.1** Amended and Restated Certificate of Incorporation of the Registrant.
3.2** Bylaws of the Registrant.
4.1+++ Specimen Common Stock certificate.
4.2+ Registration Rights Agreement, dated September 24, 1996, between the Registrant and the
investors named therein.
4.3+ Registration Rights Agreement, dated July 12, 1996, between the Registrant and the
investor named therein.
4.4+ Investor Rights Agreement dated July 25, 1996, between the Registrant and the investors
named therein.
4.5* Registration Rights Agreement dated as of November 30, 1997 by and among the Company and
the shareholders listed on the signature page thereto.
4.6** Registration Rights Agreement dated as of March 10, 1998 between the Registrant and Taha
Mikati.
5.1-- Opinion of Riordan & McKinzie, a Professional Law Corporation.
10.l+ Form of Indemnification Agreement.
10.2+ 1996 Amended and Restated Stock Incentive Plan.
10.3+ 1996 Outside Director Nonstatutory Stock Option Plan.
10.4++ 1997 Omnibus Stock Incentive Plan.
10.5+ Employment Agreement between the Registrant and Mary Casey dated July 14, 1995, as
amended.
10.6+ Employment Agreement between the Registrant and Kelly Enos dated December 2, 1996.
10.7+ Employment Agreement between the Registrant and David Vaun Crumly dated January 1, 1996.
10.8+ Intentionally omitted.
10.9+ Consulting Agreement between the Registrant and Gordon Hutchins, Jr. dated May 1, 1996.
10.10+ Nonstatutory Stock Option Agreement between the Registrant and Gordon Hutchins, Jr.
dated May 15, 1996.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT SEQUENTIALLY
NUMBER DESCRIPTION OF DOCUMENT NUMBERED PAGE
- ----------- ---------------------------------------------------------------------------------------- -----------------
<C> <S> <C>
10.11+ Free Standing Commercial Building Lease between the Registrant and Thomas M. Spear, as
receiver for De La Guerra Court Investments, dated for reference purposes as of March 1,
1996.
10.12+ Standard Office Lease--Gross between the Registrant and De La Guerra Partners, L.P.
dated for reference purposes as of July 9, 1996.
10.13+ Office Lease between the Registrant and WHUB Real Estate Limited Partnership dated June
28, 1996, as amended.
10.14+ Standard Form of Office Lease between the Registrant and Hudson Telegraph Associates
dated February 28, 1996.
10.15+ Agreement for Lease between the Registrant and Telehouse International Corporation of
Europe Limited dated July 16, 1996.
10.16+ Sublease between the Registrant and Borton, Petrini & Conron dated March 20, 1994, as
amended.
10.17+ Office Lease between the Registrant and One Wilshire Arcade Imperial, Ltd. dated June
28, 1996.
10.18+ Lease Agreement between the Registrant and Telecommunications Finance Group dated April
6, 1995.
10.19+ Lease Agreement between the Registrant and Telecommunications Finance Group dated
January 3, 1996, as amended.
10.20++ Master Lease Agreement between the Registrant and NTFC Capital Corporation dated
December 20, 1996.
10.21+ Variable Rate Installment Note between the Registrant and Metrobank dated October 4,
1996.
10.22+ Assignment of Purchase Order and Security Interest between the Registrant and DSC
Finance Corporation dated January 1, 1996.
10.23++ Line of Credit Promissory Note between the Registrant and Christopher E. Edgecomb dated
November 7, 1996, as amended.
10.24++ Office Lease Agreement between the Registrant and Beverly Hills Center LLC effective as
of April 1, 1997.
10.25** Credit Agreement dated as of September 30, 1997 among the Registrant, the financial
institutions party thereto and Sanwa Bank California, as amended.
10.26** Office Lease between the Registrant, Hudson Telegraph Associates and American
Communications Corp., as amended.
10.27** Amendment Number Three to Employment Agreement between the Registrant and Mary A. Casey
dated as of July 1, 1997.
10.28** Amendment Number One to Employment Agreement between the Registrant and Kelly D. Enos
dated as of November 12, 1997.
10.29** Amendment Number One to First Restatement of Employment Agreement between the Registrant
and James Kolsrud dated as of June 16, 1997.
10.30** Amendment Number One to Employment Agreement between the Registrant and David Vaun
Crumly dated as of November 11, 1997.
10.31** First Amendment to Amended and Restated 1996 Stock Incentive Plan.
10.32*** Agreement dated as of December 1, 1997 between the Registrant and Nortel Dasa Network
Systems GmbH & Co. KG.
10.33** Leasing Agreement between the Registrant and Nortel Dasa Network Systems GmbH & Co. KG.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT SEQUENTIALLY
NUMBER DESCRIPTION OF DOCUMENT NUMBERED PAGE
- ----------- ---------------------------------------------------------------------------------------- -----------------
<C> <S> <C>
10.34** Guarantee Agreement between the Registrant and Nortel Dasa Network Systems GmbH & Co.
KG.
10.35** Note and Security Agreement dated as of December 18, 1997 between the Registrant and
NationsBanc Leasing Corporation.
10.36** Amendment of Lease dated as of September 30, 1997 between the Registrant and Hudson
Telegraph (reference is hereby made to Exhibit 10.14).
10.37 Intentionally omitted.
10.38** Lease Agreement dated July 29, 1996 between the Registrant and Telecommunications
Finance Group.
10.39** Promissory Note issued by Christopher E. Edgecomb in favor of the Registrant dated
November 26, 1997.
10.40** Stock Pledge Agreement dated November 26, 1997 between the Registrant and Christopher E.
Edgecomb.
10.41** Commercial Lease dated October 31, 1997 between the Registrant and Prinzenpark GbR.
10.42** Commercial Lease dated October 9, 1997 between the Registrant and WSL Weststadt
Liegenschafts GmbH.
10.43** Office Lease between the Registrant and Airport-Center KGHP Gewerbeban GmbH & Cie.
10.44** Lease dated November 19, 1997 between the Registrant and DIFA Deutsche Immobilien Fonds
Aktiengesellschaft.
10.45- Second Restatement of Employment Agreement between the Company and James Kolsrud dated
as of July 9, 1998.
10.46- First Amendment to 1997 Omnibus Stock Incentive Plan.
21.1*** Subsidiaries of the Registrant.
23.1 Consent of Arthur Andersen LLP, Independent Public Accountants.
23.2 Consent of Riordan & McKinzie (contained in Exhibit 5.1).
23.3 Consent of Madison Securities, Inc.
23.4 Consent of PricewaterhouseCoopers LLP, Independent Public Accountants.
23.5 Consent of Weaver and Tidwell, Independent Public Accountants.
23.6 Consent of KPMG LLP, Independent Public Accountants.
24.1 Power of Attorney (included on page II-6 of this Registration Statement, as originally
filed).
27.1-- Financial Data Schedule.
99.1 Form of UDN Proxy.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT SEQUENTIALLY
NUMBER DESCRIPTION OF DOCUMENT NUMBERED PAGE
- ----------- ---------------------------------------------------------------------------------------- -----------------
<C> <S> <C>
99.2 Opinion of Madison Securities, Inc. (incorporated by reference from ANNEX B to the Proxy
Statement/Prospectus constituting Part I of this Registration Statement).
</TABLE>
- ------------------------
+ Filed as an exhibit to the Company's Registration Statement on Form S-1
(Registration No. 333-21325) on February 7, 1997 and incorporated by
reference herein.
++ Filed as an exhibit to Amendment No. 1 to the Company's Registration
Statement on Form S-1 (Registration No. 333-21325) on May 16, 1997 and
incorporated by reference herein.
+++ Filed as an exhibit to Amendment No. 2 to the Company's Registration
Statement on Form S-1 (Registration No. 333-21325) on May 29, 1997 and
incorporated by reference herein.
* Filed on December 15, 1997 as an exhibit to the Company's Current Report on
Form 8-K (File No. 000-22581) and incorporated by reference herein.
** Filed as an exhibit to the Company's Registration Statement on Form S-1
(Registration No. 333-48559) on March 24, 1998 and incoroporated by
reference herein.
***Filed as an exhibit to the Company's Annual Report on Form 10-K (File No.
000-22581) on March 31, 1998 and incorporated by reference herein.
- Filed as an exhibit to the Company's Quarterly Report on Form 10-Q (File No.
000-22581) on November 11, 1998 and incorporated by reference herein.
--Previously filed as an exhibit to this Registration Statement.
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our
reports dated February 12, 1998 (except with respect to the T-One acquisition as
described in Note 1 and to the stock split discussed in Note 14 of the Notes to
Consolidated Financial Statements as to which the date is March 31, 1998) and to
all references to our firm included in or made a part of this registration
statement (No. 333-53335) on Form S-4.
/s/ ARTHUR ANDERSEN
ARTHUR ANDERSEN LLP
Los Angeles, California
February 11, 1999
<PAGE>
EXHIBIT 23.3
CONSENT OF MADISON SECURITIES, INC.
We hereby consent to the use of our opinion letter dated May 7, 1998 to the
Board of Directors of United Digital Network, Inc. (the "Company") attached as
Annex B to the Company's Proxy Statement/ Prospectus on Form S-4 (the
"Prospectus") and to the references to our firm in the Prospectus under the
headings of "Summary" and "The Merger." In giving such consent, we do not admit
that we come within the category of persons whose consent is required under
Section 7 of the Securities Act of 1933, as amended, or the rules and
regulations of the Securities and Exchange Commission thereunder and we do not
thereby admit that we are experts with respect to any part of the Regulations
Statement under the meaning of the term "expert" as used in the Securities Act.
/s/ Madison Securities, Inc.
Chicago, Illinois
February 10, 1999
<PAGE>
EXHIBIT 23.4
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the use in the Prospectus constituting part of this
Registration Statement on Form S-4 of STAR Telecommunications, Inc. of our
report dated May 31, 1998, relating to the financial statements of United
Digital Network, Inc., which appears in such Prospectus. We also consent to the
reference to us under the heading "Experts" in such Prospectus.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Dallas, Texas
February 10, 1999
<PAGE>
EXHIBIT 23.5
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the use in this registration statement of STAR
Telecommunications, Inc. on Form S-4 of our report on Unidex Communication Corp.
dated July 21, 1995, except for the proforma information relating to the
business acquisition, as to which the date is May 20, 1997, appearing in the
Prospectus, which is part of this registration statement.
/s/ WEAVER AND TIDWELL, L.L.P.
Weaver and Tidwell, L.L.P.
Dallas, Texas
February 10, 1999
<PAGE>
EXHIBIT 23.6
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
We consent to the inclusion of our report dated June 22, 1998, except for
the third paragraph of Note 8 for which the date is September 1, 1998, with
respect to the consolidated balance sheets of PT-1 Communications, Inc. and
subsidiary as of March 31, 1997 and 1998, and the related consolidated
statements of operations, stockholders' deficiency, and cash flows for the
period from April 21, 1995 (inception) to March 31, 1996 and for each of the
years in the two year period ended March 31, 1998, and to the reference to our
firm under the heading "Experts" in the Star Telecommunications, Inc. Prospectus
and Registration Statement on Form S-4 dated January , 1999.
/s/ KPMG LLP
KPMG LLP
New York, New York
February 11, 1999
<PAGE>
UNITED DIGITAL NETWORK, INC.
INSTRUMENT OF PROXY
THIS INSTRUMENT OF PROXY IS SOLICITED BY THE BOARD OF DIRECTORS OF THE COMPANY
The undersigned, being a stockholder of UNITED DIGITAL NETWORK, INC. (the
'Company'), hereby appoints JOHN SNEDEGAR, or failing him, JANINE THOMAS, with
full power of substitution of each of them, both directors of the Company, or
____________ , as proxyholder for the undersigned, to vote for the undersigned
at the Special Meeting of the Company, to be held at McCarthy Tetrault, Main
Board Room, 13th Floor, 777 Dunsmuir Street, Vancouver, British Columbia Canada
on Friday, the 19th day of March, 1999, at 10:00 a.m., local time, and at any
adjournment thereof and to vote the shares in the capital stock of the Company
registered in the name of the undersigned.
The undersigned hereby acknowledges receipt of the Notice of Special Meeting
and the Proxy Statement relating to the Special Meeting and hereby revokes any
proxy or proxies heretofore given.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THE AGREEMENT AND THE PLAN OF
MERGER.
1. To approve and adopt the Agreement and Plan of Merger, dated as of
November 19, 1997, as amended January 30, 1998, April 6, 1998 and October 13,
1998, by and among the Company, STAR Telecommunications, Inc., a Delaware
corporation ('STAR'), and IIWII Corp., a Delaware corporation and a wholly-owned
subsidiary of STAR ('Newco'), and the transactions contemplated thereby,
including, among other things, the merger of Newco with and into the Company.
/ / FOR / / AGAINST / / ABSTAIN
2. Upon such other matters as may properly come before the Special Meeting
and any adjournments or postponements thereof. In their discretion, the
proxyholders are authorized to vote upon such other business as may properly
come before the Special Meeting and any adjournments or postponements thereof.
<PAGE>
THE SHARES REPRESENTED BY THIS INSTRUMENT OF PROXY WILL BE VOTED OR WITHHELD
FROM VOTING IN ACCORDANCE WITH THE INSTRUCTIONS GIVEN AND, IF A CHOICE IS
SPECIFIED WITH RESPECT TO ANY MATTER TO BE ACTED UPON, THE SHARES WILL BE VOTED
ACCORDINGLY. IF NO CHOICE IS SPECIFIED IN THIS INSTRUMENT OF PROXY AND ONE OF
THE PERSONS NAMED IN THIS INSTRUMENT OF PROXY IS APPOINTED AS PROXYHOLDER, THE
SHARES REPRESENTED BY THIS INSTRUMENT OF PROXY WILL BE VOTED IN FAVOR OF SUCH
MATTERS. THIS INSTRUMENT OF PROXY CONFERS UPON THE PERSON NAMED HEREIN AS
PROXYHOLDER DISCRETIONARY AUTHORITY WITH RESPECT TO AMENDMENTS OR VARIATIONS TO
MATTERS IDENTIFIED IN THE NOTICE OF SPECIAL MEETING AND OTHER MATTERS WHICH MAY
PROPERLY COME BEFORE THE MEETING.
NOTES TO INSTRUMENT OF PROXY
1. If the stockholder does not want to appoint any of the persons named in
the instrument of proxy, he should strike out their names and insert, in the
blank space provided, the name of the person he wishes to act as his
proxyholder. Such other person need not be a stockholder of the Company.
2. The instrument of proxy will not be valid unless it is dated and signed
by stockholder or by his attorney duly authorized by him in writing, or, in the
case of a corporation, is executed under its corporate seal or by an officer or
officers or attorney for the Company duly authorized.
3. The instrument of proxy to be effective must be deposited at the
Company's transfer agent, Montreal Trust Company, 4th Floor, 510 Burrard Street,
Vancouver, B.C., V6C 3B9, prior to the time of the Meeting or any adjournment
thereof.
4. Please sign exactly as your name appears on your account. If the shares
are registered in the names of two or more persons, each should sign. If acting
as attorney, executor, trustee or in another representative capacity, sign name
and title.
WITNESS my hand this _____ day of
_____, 1999.
___________________________________
Name (Please Print)
___________________________________
(Signature of Stockholder)
Address: __________________________
