UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
1-15015
-------------------------
(Commission File Number)
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
-------------------------
STARMEDIA NETWORK, INC.
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 06-1461770
(State or Other Jurisdiction of Incorporation) (I.R.S. Employer Identification Number)
999 BRICKELL AVE.
SUITE #808,
MIAMI, FL 33131
(305)-938-3000
-------------------------
Indicate by check mark whether the Registrant (1) has filed all reports required
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was required
to file such reports) and (2) has been subject to such filing requirements for
the past 90 days: Yes [X] No[ ]
As of July 1, 2002, there were 79,970,177 shares of the Registrant's Common
Stock, $0.001 par value per share, outstanding.
STARMEDIA NETWORK, INC. AND SUBSIDIARIES
INDEX
PAGE NO.
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PART I FINANCIAL INFORMATION
ITEM 1. Condensed Consolidated Financial Statements
Unaudited Condensed Consolidated Balance Sheets at September 30,
2001 and December 31, 2000 (restated)........................................................ 6
Unaudited Condensed Consolidated Statements of Operations for
the three and nine months ended September 30, 2001 and 2000 (restated)....................... 7
Unaudited Condensed Consolidated Statements of Cash Flows for the
nine months ended September 30, 2001 and 2000 (restated)..................................... 8
Notes to Unaudited Condensed Consolidated Financial Statements for the nine months
ended September 30, 2001..................................................................... 9
ITEM 2. Management's Discussion And Analysis Of Financial Condition And Results Of Operations........ 24
ITEM 3. Quantitative And Qualitative Disclosures About Market Risk................................... 35
PART II OTHER INFORMATION
ITEM 1. Legal Proceedings............................................................................ 36
ITEM 2. Changes In Securities And Use Of Proceeds.................................................... 39
ITEM 3. Defaults Upon Senior Securities.............................................................. 39
ITEM 4. Submission Of Matters To A Vote Of Security Holders.......................................... 40
ITEM 5. Other Information............................................................................ 40
ITEM 6. Exhibits And Reports On Form 8-K............................................................. 40
ITEM 7. Signatures................................................................................... 40
2
PART I
FINANCIAL INFORMATION
RECENT DEVELOPMENTS
Since September 30, 2001, the Company has experienced the following
developments:
o On November 19, 2001, the Company announced that it planned to
restate its unaudited financial statements for the quarters ended
March 31 and June 30, 2001, and its audited financial statements for
the fiscal year ended December 31, 2000 as a result of an
investigation by a Special Committee of the Company's Board of
Directors into accounting issues with respect to revenue recognition
by two of the company's Mexican subsidiaries, AdNet S.A. de C.V. and
StarMedia Mexico, S.A. de C.V. At that time, the Company had come to
a preliminary conclusion that revenues aggregating approximately $10
million were improperly recognized by those subsidiaries during the
period from October 1, 2000 through June 30, 2001, and that at that
time, the financial statements for those periods should not be
relied on. See Note 2 of Notes to Unaudited Condensed Consolidated
Financial Statements.
o Following the foregoing announcement:
-- The Nasdaq National Market suspended trading of the Company's
common stock effective as of the open of business on November
19, 2001 and delisting procedures commenced as a result of the
Company's failure to make a timely filing of its Report on
Form 10-Q for the quarter ended September 30, 2001.
Subsequently, effective as of February 1, 2002, our common stock
was delisted from and ceased to be quoted by The Nasdaq National
Market. Following delisting by The Nasdaq National Market shares
of the Company's common stock have been quoted on the Pink
Sheets LLC electronic quotation system for "over the counter"
(OTC) securities, a market which is generally not as liquid as
The Nasdaq National Market.
-- The Securities and Exchange Commission (SEC) informed the
Company that it had commenced an investigation into the
circumstances leading up to the restatements referred to above.
The investigation is on-going.
-- In late 2001 and early 2002, eleven lawsuits were filed against
the Company in the Southern District of New York in connection
with the Company's announcement relating to the Restatement
referred to in "Restatement Information" above. A lead plaintiff
for the class and lead plaintiff's counsel were subsequently
selected and a motion filed to consolidate the various claims.
The Consolidated Amended Complaint was filed on May 31, 2002 in
the Southern District of New York under the caption In re
StarMedia Network, Inc. Securities Litigation 01 Civ. 10556
(S.D.N.Y.). In June 2002, the lead plaintiffs and all defendants
executed a settlement agreement that resolves all claims in the
3
consolidated action. The settlement amount will be paid by the
Company's directors and officers liability insurance carrier.
This settlement agreement is subject to review and ratification
by the Honorable Denny Chin of the United States District Court
for the Southern District of New York. See "Legal Proceedings".
On November 19, 2001 the Company also announced as follows:
-- That Steven J. Heller had resigned as Chief Financial Officer of
StarMedia Network, effective November 15, 2001, on terms and
conditions previously agreed with StarMedia Network.
-- That the Company had terminated the employment of Justin
Macedonia as General Counsel. See "Legal Proceedings".
-- That the Company and the former stockholders of AdNet entered
into a Termination Agreement pursuant to which the Company
agreed to issue to the stockholders of AdNet 8,000,000 shares of
the Company's common stock, in full satisfaction of the
Company's obligations under earn-out and other provisions set
forth in the agreement pursuant to which the Company had
acquired AdNet.
-- That Susan Segal had been appointed to serve as acting Chairman
of the Board. She succeeded Fernando Espuelas, co-founder and
former Chief Executive Officer of the Company, who, pursuant to
his August 2001 agreement with the Company, resigned on November
15, 2001 as Chairman of the Board of Directors, and that Mr.
Espuelas continued to serve as a Director on the Company's
Board.
o In November 2001 the Company vacated its headquarters at 75 Varick
Street in New York City. Under terms negotiated with its landlord,
the Company was released from any further obligations under the
lease. The Company's headquarters are currently located in Miami,
Florida, which previously served as the headquarters of the
Company's Mobile Solutions business.
o In December 2001, the Company sold substantially all of the assets
associated with Cade?, a Brazilian online directory, to Yahoo
Brasil Ltda.
o Effective as of April 19, 2002, Enrique Narciso resigned as CEO,
President and director of the Company. As disclosed in the Report on
Form 8-K filed by the Company on April 19, 2002, in tendering his
resignation Mr. Narciso informed the Company that he needed to focus
on a personal matter that resulted in his pleading guilty to a tax
violation involving his 1998 individual federal tax return. Mr.
Narciso joined the Company in October 1999. Following Mr. Narciso's
resignation, Jose Manuel Tost was appointed President of the Company
and Jorge Rincon was appointed Chief Operating Officer of the
Company.
o Effective as of April 29, 2002, Ana Maria Lozano-Stickley was
appointed as Chief Financial Officer of the Company. Prior to that
time Ms. Lozano-Stickley had been Acting Vice President of
Accounting and Administration of the Company since January 2002.
4
o The Company has continued to undertake a realignment for the
purposes of focusing its resources on its mobile solutions business.
As part of this realignment, the Company reduced its number of
full-time employees from 520 as of close of business on December 31,
2001 to 391 as of June 21, 2002. In addition, following the
Company's change of its headquarters in late 2001 from New York to
Miami, Florida, which was previously the headquarters of the
Company's mobile solutions business, the Company has substantially
reduced its presence in New York. As of June 21, 2002, the Company
had 30 employees based in its New York City offices, as compared to
118 employees based in such office as of close of business on
December 31, 2001
o On July 1, 2002, Fernando Espuelas notified the Company that
effective as of that date he resigned as a director of the Company.
o On July 3, 2002 the Company sold most of its assets associated with
starmedia.com, its Spanish- and Portuguese-language portal, and
LatinRed, its Spanish language online community, to eresMas
Interactive S.A. ("EresMas"). Following the sale of starmedia.com
and LatinRed to EresMas, the Company is principally engaged in the
business of providing integrated Internet solutions to wireless
telephone operators targeting Spanish- and Portuguese-speaking
audiences, principally in Latin America, and the Company retains
only the following Internet media services:
o batepapo.com.br, a Brazilian chat service, which the Company is
considering either selling or closing;
o the local city guides such as nacidade.com,.br; guiasp.com.br;
guiarj.com.br; paisas.com; openchile.cl; panoramas.cl and
AdNet.com.mx, which the Company anticipates that it will
continue to operate in support of its mobile solutions business.
As part of the terms of the sale, the Company agreed to cease using
the "StarMedia" brand commercially and, subject to shareholder
approval, to amend its certificate of incorporation to change its
name. Following the sale, the Company operates commercially under
the name "CycleLogic."
5
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
STARMEDIA NETWORK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2001 DECEMBER 31, 2000
------------------ -----------------
(UNAUDITED) (RESTATED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents........................................... $ 33,705,000 $ 93,408,000
Accounts receivable, net of allowance for bad debts of $1,941,000
(2001) and $1,849,000 (2000)...................................... 6,381,000 13,524,000
Unbilled receivables................................................ 2,959,000 6,131,000
Other current assets................................................ 10,594,000 7,680,000
------------------ -----------------
TOTAL CURRENT ASSETS................................................... 53,639,000 120,743,000
Fixed assets, net................................................... 27,069,000 55,569,000
Intangible assets, net of accumulated amortization of $2,947,000
(2001) and $1,676,000 (2000)...................................... 7,589,000 5,557,000
Goodwill, net of accumulated amortization of $984,000 (2001) and
$2,435,000 (2000)................................................. 1,121,000 6,582,000
Officer loans....................................................... 350,000 4,563,000
Other assets........................................................ 2,552,000 16,091,000
------------------ -----------------
TOTAL ASSETS........................................................... $ 92,320,000 $ 209,105,000
================== =================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.................................................... $ 866,000 $ 20,737,000
Accrued expenses.................................................... 17,456,000 15,601,000
Loan payable, current portion....................................... -- 2,462,000
Deferred revenue.................................................... 2,713,000 1,128,000
------------------ -----------------
TOTAL CURRENT LIABILITIES.............................................. 21,035,000 39,928,000
Loan payable, long-term portion..................................... -- 1,902,000
Deferred rent....................................................... -- 2,199,000
Preferred dividends payable......................................... 730,000 --
SERIES A CONVERTIBLE PREFERRED STOCK
Series A Convertible Preferred Stock, $.001 par value, 1,960,784
shares authorized, 1,431,373 shares issued and outstanding at
September 30, 2001, liquidation preference of $37,230,000 at
September 30, 2001................................................ 35,166,000 --
STOCKHOLDERS' EQUITY:
Preferred Stock, authorized 10,000,000 shares: Series 1999A
junior-non-voting convertible preferred stock, $.001 par value,
2,300,000 shares authorized, 58,140 shares outstanding at
September 30, 2001 and December 31, 2000, respectively............ -- --
Common stock, $.001 par value, 200,000,000 shares authorized,
72,698,117 issued and 66,927,883 shares issued and outstanding
at September 30, 2001 and December 31, 2000, respectively......... 71,000 67,000
Treasury stock (10,417 shares of common stock $.001 par value)...... (5,000) --
Common stock issuable............................................... 8,689,000 12,260,000
Additional paid-in capital.......................................... 534,662,000 516,311,000
Accumulated deficit................................................. (505,049,000) (360,125,000)
Deferred compensation............................................... (621,000) (2,636,000)
Accumulated comprehensive loss...................................... (2,358,000) (801,000)
------------------ -----------------
Total stockholders' equity.......................................... 35,389,000 165,076,000
------------------ -----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY............................. $ 92,320,000 $ 209,105,000
================== =================
See accompanying Notes to Unaudited Condensed Financial Statements.
6
STARMEDIA NETWORK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------- ----------------------------------
2001 2000 2001 2000
(RESTATED) (RESTATED)
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
Revenues.................................... $ 4,600,000 $ 15,929,000 $ 19,760,000 $ 37,811,000
Operating expenses:
Product and technology development ...... 11,468,000 16,654,000 40,244,000 52,012,000
Sales and marketing ..................... 8,558,000 16,971,000 38,529,000 56,748,000
General and administrative .............. 6,197,000 7,966,000 23,299,000 23,367,000
Restructuring and other charges.......... 9,251,000 3,935,000 24,602,000 3,935,000
Depreciation and amortization ........... 7,383,000 8,120,000 20,061,000 19,953,000
Stock-based compensation expense ........ 491,000 1,149,000 1,889,000 3,469,000
Impairment of fixed assets............... 2,934,000 -- 4,087,000 --
Impairment of goodwill .................. 11,405,000 -- 11,406,000 --
------------- --------------- --------------- --------------
Total operating expenses ................ 57,687,000 54,795,000 164,117,000 159,484,000
------------- --------------- --------------- --------------
Loss from operations ....................... (53,087,000) (38,866,000) (144,357,000) (121,673,000)
Other income (expense):
Interest income ......................... 582,000 2,607,000 2,877,000 9,400,000
Interest expense ........................ (230,000) (352,000) (873,000) (1,036,000)
Loss in unconsolidated subsidiary ....... -- -- (1,800,000) (2,500,000)
Other income (expenses).................. 9,000 (6,000) 64,000 (379,000)
------------- --------------- --------------- --------------
Loss before provision for income taxes ..... (52,726,000) (36,617,000) (144,089,000) (116,188,000)
Provision for income taxes ................. -- (9,000) -- (16,000)
------------- --------------- --------------- --------------
Net loss ................................... (52,726,000) (36,626,000) (144,089,000) (116,204,000)
Preferred stock dividends and accretion .... (630,000) -- (836,000) --
------------- --------------- --------------- --------------
Net loss applicable to common stockholders . $ (53,356,000) $ (36,626,000) $ (144,925,000) $ (116,204,000)
============= =============== =============== ==============
Basic and diluted net loss per common share $ (0.75) $ (0. 55) $ (2.08) $ (1.77)
============= =============== =============== ==============
Number of shares used in computing basic and
diluted net loss per share............... 71,269,145 66,384,809 69,546,285 65,631,931
============= =============== =============== ==============
See accompanying Notes to Unaudited Condensed Financial Statements.
7
STARMEDIA NETWORK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED
SEPTEMBER 30,
------------------------------------
2001 2000
(UNAUDITED)
OPERATING ACTIVITIES
Net loss.................................................................. $(144,089,000) $ (116,204,000)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization........................................... 20,061,000 19,953,000
Impairment of goodwill and fixed assets................................. 15,493,000 --
Loss on disposal of assets.............................................. 12,504,000 --
Provision for bad debts................................................. 11,101,000 1,251,000
Amortization of stock-based compensation................................ 1,889,000 3,469,000
Write-down of officer loans............................................. 11,049,000 --
Deferred rent expense................................................... (2,199,000) 5,627,000
Changes in operating assets and liabilities:
Accounts receivable..................................................... (4,238,000) (5,215,000)
Unbilled receivables.................................................... 3,172,000 --
Other current assets.................................................... 4,819,000 (15,117,000)
Accounts payable and accrued expenses................................... (10,299,000) 15,425,000
Deferred revenues....................................................... 1,726,000 (38,000)
--------------- --------------
Net cash used in operating activities..................................... (79,011,000) (90,849,000)
INVESTING ACTIVITIES
Purchase of fixed assets.................................................. (6,146,000) (38,346,000)
Intangible assets......................................................... (640,000) (2,090,000)
Other assets.............................................................. 8,242,000 (7,057,000)
Officer loans............................................................. (6,836,000) (1,365,000)
Cash paid for acquisitions................................................ (4,891,000) (10,565,000)
--------------- --------------
Net cash used in investing activities..................................... (10,271,000) (59,423,000)
FINANCING ACTIVITIES
Issuance of common stock.................................................. 254,000 4,222,000
Acquisition of treasury stock............................................. (5,000) --
Repayment of long-term debt............................................... (4,254,000) (1,133,000)
Increase in long-term debt................................................ 80,000 --
Issuance of convertible preferred stock................................... 35,060,000 --
Payments under capital leases............................................. -- (58,000)
--------------- --------------
Net cash provided by financing activities................................. 31,135,000 3,031,000
Effect of exchange rate changes on cash and cash equivalents.............. (1,556,000) 123,000
--------------- --------------
Net decrease in cash and cash equivalents................................. (59,703,000) (147,118,000)
Cash and cash equivalents, beginning of period............................ 93,408,000 274,089,000
--------------- --------------
Cash and cash equivalents, end of period.................................. $ 33,705,000 $ 126,971,000
=============== ==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid............................................................. $ 873,000 $ 1,036,000
=============== ==============
Income taxes paid......................................................... $ 392,000 $ --
=============== ==============
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Acquisition of content through common stock issued/issuable............... $ 3,000,000 $ --
=============== ==============
Shares issued/issuable for acquisitions................................... $ 5,354,000 $ --
=============== ==============
Accrued purchases of fixed assets......................................... $ 480,000 $ --
=============== ==============
See accompanying Notes to Unaudited Condensed Financial Statements.
8
STARMEDIA NETWORK, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001
1. BASIS OF PRESENTATION AND DESCRIPTION OF BUSINESS
The accompanying condensed consolidated financial statements include
the accounts of StarMedia Network, Inc. and its wholly-owned subsidiaries
(collectively, the "Company"). All intercompany account balances and
transactions have been eliminated in consolidation. StarMedia Network, Inc. was
incorporated under Delaware law in March 1996. The Company, after a significant
change in business strategy during the second half of 2001, is now principally
engaged in providing mobile Internet software and application solutions to
wireless telephone operators businesses targeting Spanish- and
Portuguese-speaking audiences worldwide, described herein as the "mobile
solutions business" or "mobile internet solutions". The Company's mobile
Internet solutions allow users to access and receive Internet content, tools and
applications through wireless devices, such as pagers, cellular phones, PCS
handsets and personal digital assistants, or PDAs. The Company was originally
established to develop Internet sites tailored specifically to the interests and
needs of Spanish and Portuguese speakers, selling advertising to advertisers
seeking to reach its user base, and historically derived a majority of its
revenues from fees paid by advertisers on its sites, described herein as the
"Internet media business" or "media solutions business". Although the Company
continues to provide Internet Media services, these services are no longer an
integral part of the Company's business.
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for the three- and nine-month
periods ended September 30, 2001 are not necessarily indicative of the results
that may be expected for the year ended December 31, 2001. The balance sheet at
December 31, 2000 (restated) has been derived from the audited financial
statements at that date but does not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company's restated
annual report on Form 10-K for the year ended December 31, 2001.
Certain amounts in the prior year's financial statements have been
reclassified to conform to the current period's presentation.
2. RESTATEMENT OF FINANCIAL STATEMENTS
The Company, in consultation with its independent accountants,
determined to restate its unaudited consolidated financial statements for the
fiscal quarters ended March 31, June 30, September 30, and December 31, 2000, as
well as quarters ended March 31 and June 30, 2001, and its audited consolidated
financial statements for the fiscal year ended December 31, 2000.
9
The Company initially announced its intention to restate these consolidated
financial statements on November 19, 2001. That announcement related to the
preliminary conclusion of a Special Committee of the Board of Directors that
approximately $10,000,0000 in revenues was improperly recognized by two of the
Company's Mexican subsidiaries during the period October 1, 2000 through June
30, 2001. Subsequent to that announcement, the Special Committee authorized the
Company's management to undertake an additional investigation in order to
confirm whether any additional accounting irregularities occurred during the
periods in question.
The Company's restated unaudited consolidated financial statements
for quarters ended March 31, June 30, September 30, and December 31, 2000, as
well as quarters ended March 31 and June 30, 2001, and for the audited fiscal
year ended December 31, 2000 contain adjustments that fall into five
categories. The first category of adjustments arises from the independent
investigation conducted by a Special Committee of the Board of Directors and
referred to in the Company's November 19, 2001 announcement. The findings of
the Special Committee's investigation indicate that the Company improperly
recognized certain revenues and pre-paid expenses. The majority of these
revenues and pre-paid expenses were recognized by its Mexican subsidiary, SMN
de Mexico (d/b/a StarMedia Mexico). The remainder was recognized by its other
Mexican subsidiary, AdNet, S.A. de C.V. ("AdNet").
The other categories of adjustments arise from management's additional
investigation to confirm the accuracy of the consolidated financial statements
to be restated based on the Special Committee's investigation. The findings of
management's investigation indicate that, in addition to the accounting
irregularities identified by the Special Committee, the Company improperly (A)
recognized certain revenues and related expenses that should have been
classified as barter transactions in accordance with US GAAP; (B) recognized
revenues from a number of sales that provided for future contingencies, were not
appropriately authorized by the customer, or for some other reason should not
have been recognized; (C) failed to write down the value of certain assets at
Mach 31, 2001 upon shutting down of a subsidiary; and (D) recognized certain
other transactions that management identified in the course of its review of the
Company's financial statements. As a result of the restatement, the consolidated
financial statements of the Company have been restated as summarized below (in
thousand except per share amounts):
For the nine months ended For the three months ended
September 30, 2000 September 30, 2000
-------------------------------------- -----------------------------------------
As As
Previously As Previously As
Reported Restated Reported Restated
--------------- --------------- ---------------- ---------------
Consolidated Statement of
Operations:
Revenues $ 40,966 $37,811 $17,146 $15,929
Sales and marketing 58,209 56,748 17,348 16,971
General and administrative 23,940 23,367 8,163 7,966
Total operating expense 161,518 159,484 55,369 54,795
Loss from operations (120,552) (121,673) (38,223) (38,866)
Net loss before provision for
income taxes (115,067) (116,188) (35,974) (36,617)
Net loss available to Common
Stockholders (115,083) (116,204) (35,983) (36,626)
Basic and diluted net loss
per common share $ (1.75) $ (1.77) $ (.54) $ (.55)
10
For additional information concerning the Company's consolidated
financial results, as restated, see the Company's selected restated consolidated
financial information data and Management's Discussion and Analysis of Financial
Condition and Results of Operations.
Management believes that it has made all the adjustments considered
necessary as a result of the special committee's investigation and management's
own investigation into prior periods financial statements. Management further
believes that the Company's consolidated financial statements for the fiscal
quarters ended March 31, June 30, September 30, and December 31, 2000; March 31
and June 30, 2001 and for the fiscal year ended December 31, 2000, as restated,
include all adjustments necessary for a fair presentation of the Company's
financial position and results of operations for such periods.
3. IMPAIRMENT OF GOODWILL
As of September 30, 2001, the Company determined that substantially
all goodwill assets were impaired. The Company recorded a goodwill impairment
charge of $11,406,000.
4. IMPAIRMENT OF FIXED ASSETS
In the first quarter of 2001, the Company decided to cease operating
the Webcast Solutions Company that had been merged in September 1999 with a
wholly owned subsidiary of the Company (the "Webcast Solutions Merger"). Webcast
Solutions was a streaming media company focused on the global delivery of audio,
video and other internet based interactive media. The reason to no longer
operate this asset mainly resulted from the significant costs that were required
to operate and maintain this investment. Furthermore, the penetration rates
previously anticipated by the Company were not achieved during the period the
asset operated and management did not expect significant short-term nor
long-term improvements. The total loss recognized as a result of this decision
totaled $1,153,000.
In February 2000, the Company entered into a software license agreement
with Software.com, Inc to purchase for $9,000,000 a non-exclusive and
non-transferable license to use Software.com's Intermail Mx electronic messaging
software during a period of 3 years. As part of the change in business strategy
and focus and to reduce operating costs, the Company decided in September 2001
to terminate the usage of the software and return the license to Software.com,
Inc. The Company reached an agreement with Software.com, Inc. on March 31, 2002.
The terms of the settlement require the Company to return all copies of the
software in July 2002. A settlement payment of $1,250,000 was made on March 2002
to finalize the
11
agreement. In September 2001, an impairment loss of $2,934,000 was recognized to
write-off the carrying value of the software.
5. BARTER TRANSACTIONS
A portion of the Company's revenues is derived from barter transactions
(agreements whereby the Company trades advertising on its network or services in
exchange for advertising or services from unrelated parties). Barter advertising
revenues and expenses are recognized in accordance with Emerging Issues Task
Force Issue No. 99-17, "Accounting for Barter Advertising". Barter service
revenues and expenses are recognized in accordance with Accounting Principles
Board Opinion No. 29, "Accounting for Nonmonetary Transactions". Revenues from
barter transactions are recognized during the period in which the advertisements
are displayed on the Company's network or the services are rendered. Barter
expense is recognized when the Company's advertisements are run or services are
rendered by the unrelated party. For the three months ended September 30, 2001
and 2000, revenues derived from barter transactions were approximately $955,000
and $1,900,000, respectively. For the nine months ended September 30, 2001 and
2000, revenues derived from barter transactions were approximately $5,800,000
and $5,400,000, respectively.
6. ACQUISITIONS
In April 2001, the Company acquired certain assets of Obsidiana,
Inc. ("Obsidiana"), a premier online destination for Latin American women, in
exchange for 1,125,000 shares of the Company's common stock, valued at
approximately $2,600,000. The stockholders of Obsidiana included entities
managed by J.P. Morgan Partners and Flatiron Partners. The entire value of
the purchase price was attributed to goodwill at the time of purchase. The
Company accounted for the Obsidiana acquisition under the purchase method of
accounting and the results of operations have been included in the Company's
financial statements from the date of acquisition. Pro-forma consolidated
results of operations are not included, as the effects of the Obsidiana
acquisition were not material to the Company. In September 2001, the Company
as part of the restructuring and change in business strategy, wrote-off the
remaining goodwill totaling $2,258,000.
7. FOREIGN CURRENCY AND INTERNATIONAL OPERATIONS
The functional currency of the Company's active subsidiaries in
Argentina, Brazil, Chile, Mexico, Spain and Colombia is the local currency. The
financial statements of these subsidiaries are translated to U.S. dollars using
period-end exchange rates for assets and liabilities, and average rates for the
period for revenues and expenses. Translation gains and losses are deferred and
accumulated as a component of stockholders' equity. The functional currency of
the Company's active subsidiary in Venezuela, which is a highly inflationary
economy, is the U.S. dollar. Accordingly, monetary assets and liabilities are
translated using the current exchange rate in effect at the period-end date,
while nonmonetary assets and liabilities are translated at historical rates.
Operations are generally translated at the weighted average exchange rate in
effect during the period. The resulting foreign exchange gains and losses are
recorded in the consolidated statements of operations.
12
8. STOCKHOLDERS' EQUITY
In February 2001, the Company issued 1,058,476 of shares of its common
stock in connection with its settlement of a guarantee related to the Gratis1
transaction described in Note 13 below, valued at approximately $4,500,000. An
additional 1,148,435 shares of the Company's common stock were issued during
September 2001 in connection with the final settlement of this obligation,
valued at approximately $3,400,000.
In March 2001, the Company issued 8,035 shares of its common stock in
connection with its November 1999 acquisition of Paisas.com, valued at
approximately $139,000.
In April 2001, in connection with its February 2000 acquisition of Ola
Turista Ltda., the owner of Guia and Guia RJ, and its September 1999 acquisition
of PageCell International Holdings, Inc., the Company issued an additional
592,128 shares and 528,787 shares, valued at approximately $2,000,000 and
$1,380,000, respectively.
In April 2001, the Company issued 1,125,000 shares of its common stock
in connection with its acquisition of Obsidiana, valued at approximately
$2,621,000.
In July 2001, the Company issued 784,314 shares of its common stock to
Primedia, Inc. valued at $2,000,000 in connection with the execution of a
content license agreement with Primedia, Inc., Primedia Magazines Inc., and
About.com, Inc.
In connection with its April 2000 acquisition of AdNet S.A. de C.V.
("AdNet"), the Company was obligated under its agreements with respect to such
acquisition to pay additional consideration in the form of the Company's common
stock over a five-year period from the acquisition date, subject to AdNet
meeting certain specified performance targets. In November 2001, the Company,
AdNet and the former stockholders of AdNet entered into a Termination Agreement
pursuant to which the Company agreed to issue to the former stockholders of
AdNet 8,000,000 shares of the Company's common stock, in full satisfaction of
the Company's obligations under the stock purchase agreement and certain other
related agreements between the Company and the former stockholders of AdNet. The
result of such Termination Agreement has been reflected in the accompanying
financial statements as of September 30, 2001 as common stock issuable in the
amount of $7,689,000. The Company has not issued the remaining 400,000 shares
pending resolution of outstanding claims that the Company has against the former
stockholders.
During the nine months ended September 30, 2001, the Company issued
204,627 shares of its common stock for approximately $106,000 in connection
with the exercise of stock options. Additionally, the Company sold 66,135
shares of common stock for approximately $147,000 in connection with its
Employee Stock Purchase Plan.
In May 2001, the Company issued 1,431,373 shares of its Series A
Convertible Preferred Stock at a price per share of $25.50 to BellSouth
Enterprises, Inc. ("BellSouth"), About.com, Inc. ("About.com"), and certain
other investors resulting in total proceeds of approximately $35,100,000 to the
Company, net of issuance costs of approximately $1,400,000 (the "BellSouth
Investment"). These shares are convertible into 14,313,730 shares of the
Company's common stock at any time at the option of the holder. After 60 months
from the date of issuance, the Company shall redeem the Series A Preferred Stock
for cash or shares of the Company's
13
common stock, in an amount equal to $36,500,000, plus accrued dividends thereon.
The carrying value of the Series A Convertible Preferred Stock is being accreted
up to its redemption value over 60 months using the effective interest method.
Such accretion was $106,000 during the nine months ended September 30, 2001.
Dividends accrue at 6% per annum and totaled approximately $730,000 during the
nine months ended September 30, 2001.
In addition, in connection with the BellSouth Strategic Agreement (see
Note 12), the Company agreed to issue warrants to BellSouth to purchase up to
4,500,000 shares of the Company's common stock, with exercise prices ranging
from $4.55 to $8.55 per share that vest in May 2002 and expire during the period
from May 2005 through May 2007. These warrants were valued, by an independent
appraiser, at approximately $2,200,000 and are being amortized over 60 months.
During August 2001, the Company issued 251,172 shares of the Company's
common stock valued at $500,000 to JP Morgan Ventures Corporation as partial
consideration for services rendered by JP Morgan Securities in connection with
the sale of Series A Convertible Preferred Stock. Under the terms of the
agreement with JP Morgan Securities, if the Company does not have in place an
effective registration statement covering these shares by November 30, 2001,
JP Morgan Ventures Corporation will have the right to cause the Company to
repurchase such shares for $500,000. The value of these shares has not been
included in stockholders' equity due to the fact that the Company has not yet
filed such registration statement, and accordingly, the $500,000 is included
in accrued expenses in the accompanying balance sheet.
9. STOCK OPTIONS
In connection with the granting of stock options in 1998 and the
exchange of non-qualified options to incentive stock options, the Company
recorded deferred compensation of approximately $19,500,000. In connection with
the granting of stock options in 1999, the Company recorded additional deferred
compensation of approximately $6,400,000. Deferred compensation is adjusted
quarterly for exercises, cancellations and terminations and is being amortized
for financial reporting purposes over the vesting period of the options. The
amounts recognized as expense during the nine-month period ended September 30,
2001 and September 30, 2000 were approximately $1,900,000 and $3,500,000,
respectively.
Diluted net loss per share does not include the effect of options
and warrants to purchase 24,265,853 and 15,433,932 shares of common stock at
September 30, 2001 and 2000, respectively. Diluted net loss per share at
September 30, 2001 also does not include the effect of 14,313,730 shares of
common stock issuable upon the conversion of preferred stock on a "as if
converted" basis, respectively, as the effect of their inclusion is
antidilutive.
10. DUE FROM OFFICERS
During the year ended December 31, 2000, the Company provided lines of
credit to certain officers totaling $6,400,000, under which $4,600,000 was
advanced to such officers. Such lines are non-recourse and bear interest at
rates ranging from 6.75% to 10.0% per annum. In January 2001, the lines of
credit available to the Company's officers were increased to $12,400,000. As of
September 30, 2001, the Company had made loans to officers under such
14
lines of credit totaling approximately $11,000,000. These loans are secured
by shares of the Company's common stock held by its officers to the extent
permitted by Regulation U under the Securities Exchange Act of 1934, as
amended. In addition, during the year ended December 31, 2000, the Company
made an unsecured, recourse loan totaling $500,000 to its then Chief
Operating Officer. As a result of the termination of certain officers'
employment and management's determination that the remaining loans were
unrealizable due to a reduction in value of the supporting collateral, the
Company provided a full reserve and/or fully wrote-off the $11,500,000 plus
the $600,000 of interest outstanding as of June 30, 2001 (see Note 11 below).
In connection with the termination of employment of the Company's former
Chief Financial Officer, Chief Operating Officer and Senior Vice President of
Global Sales, the Company terminated the lines of credit provided to them and
completely discharged all amounts owed there under. For the termination of
the former Chief Financial Officer's line of credit, 326,000 shares of the
Company's common stock were returned to the Company. Such shares were
recorded as treasury stock with a value of $114,000, the value of such shares
on the day they were returned to the company. Loans to other officers
continue to be outstanding.
11. RESTRUCTURING AND OTHER CHARGES
In May 2001, the Company announced a restructuring, the purpose of
which was to realign the Company's business operations and reduce its
operational overhead. In connection with such restructuring and the lease
termination noted below, the Company recorded during the period ended September
30, 2001 aggregate charges of approximately $24,600,000. The total charge
includes approximately $11,000,000 of loans and related interest to officers
(see Note 10 above), approximately $2,600,000 of severance payments to employees
and certain officers of the Company and approximately $2,200,000 of other costs
related to the restructuring. Additionally, in September 2001, the Company
negotiated a settlement to terminate the lease of the Company's former offices
at 75 Varick Street in New York City. The Company agreed to leave a substantial
portion of its fixed assets and leasehold improvements at the location to the
new tenant resulting in a loss on disposal of assets of $8,500,000. The
settlement required the Company to vacate the premises by November 9, 2001 in
exchange for its release from any further obligations under the lease.
Additionally, a $5,000,000 letter of credit in favor of the landlord at the
vacated premises was released in November 2001. As such, $5,000,000 of
restricted cash became unrestricted at the time the settlement was executed. As
of September 30, 2001, the Company had paid approximately $22,800,000 of
restructuring and other expenses.
12. RELATED PARTY TRANSACTIONS
GRATIS1
During 2000, the Company acquired a non-controlling 50% interest in
Gratis1 ("G1"), which was subsequently reduced to approximately 48%. G1 was
formed to provide free unlimited Internet access to users in Latin America. The
owners of G1 also included Chase Equity Associates, The Flatiron Fund 2000 LLC,
the Flatiron Associates II LLC, and CMGI, among others. The Company accounted
for its investment in G1 under the equity method of accounting and during the
second quarter of 2000, the Company's share of equity losses in G1 exceeded its
investment basis of $2,500,000 and the investment was written-off.
15
J.P. Morgan Partners (SBIC) LLC (formerly Chase Equity Associates), The
Flatiron Fund 2000 LLC and the Flatiron Associates II LLC (the "Lenders")
purchased debt securities from G1 in an aggregate amount of $17,300,000.
Approximately $10,300,000 of such securities were backed by a limited guaranty
by the Company, payable in its common stock. In January 2001, G1 ceased
operations and in February 2001, the Company issued to the Lenders 1,058,476
shares of its common stock with a market value of approximately $4,500,000
pursuant to the guaranty of approximately $7,000,000 of such securities. In
connection with the remaining $3,300,000 guaranty, the Company issued an
additional 1,148,435 shares of its common stock during September 2001, valued at
approximately $3,400,000, representing the final settlement of this obligation
plus accrued interest.
With respect to the $7,000,000 of such debt securities which were not
subject to such limited guaranty, in the event of a change of control of the
Company, the Lenders would have the right to put (and the Company would have a
corresponding right to call) such securities to the Company for shares of its
common stock or merger consideration, as the case may be, at their fair market
value for the face amount of such debt securities plus a 25% annualized return.
During the quarter ended September 30, 2000, an agreement between the
Company and AT&T Global Network Services ("AT&T") to provide Internet access
services in Argentina, Brazil, Chile, Colombia and Mexico was assigned to G1.
AT&T was entitled to draw upon a $2,800,000 letter of credit, guaranteed by the
Company, in the event G1 failed to perform under this agreement. Following
payment by G1 of a $1,000,000 to AT&T in December 2000, the amount drawable
under the letter of credit was reduced to $1,800,000. As of September 30, 2001,
AT&T had fully drawn down on the letter of credit. Accordingly, during nine
months ended September 30, 2001, the Company recognized an expense of $1,800,000
related to the guaranty.
BELLSOUTH
In May 2001, the Company entered into an agreement with BellSouth to
create multi-access portals in Latin America (the "BellSouth Strategic
Agreement"). Under the terms of the five-year agreement, the Company will design
and service the multi-access portals and mobile applications and provide
content, software application integration and support to BellSouth's operating
companies in Latin America. BellSouth will supply wireless communications,
marketing of services and billing capabilities. The two companies will share
revenues generated by the new multi-access portals. All revenues associated with
design and maintenance activities and the technology licenses are being
recognized ratably over the life of the agreement, while the user fees and
transaction revenues are being recognized when the services are rendered
In addition, in connection with the BellSouth Strategic Agreement (see
Note 8), the Company agreed to issue warrants to BellSouth to purchase up to
4,500,000 shares of the Company's common stock, with exercise prices ranging
from $4.55 to $8.55 per share that vest in May 2002 and expire during the period
from May 2005 through May 2007. These warrants were valued by an independently
appraiser, at approximately $2.2 million and are being amortized over 60 months.
16
For the three months ended September 30, 2001, the Company recognized
$200,000 in revenue, net of amortization for warrants, in connection with the
BellSouth Strategic Agreement.
ABOUT.COM, INC.
During the quarter ended June 30, 2001, the Company entered into a
five-year agreement with About.com to create a jointly operated co-branded
website, within the About.com website. About.com granted the Company certain
worldwide license rights to use its content and proprietary technology in
exchange for $2,000,000 in cash and $3,000,000 in shares of the Company's common
stock. At September 30, 2001, $2,000,000 of such shares (784,314 shares) have
been issued and $1,000,000 remains in common stock issuable. The aggregate
purchase price of $5,000,000 has been allocated to intangible assets
($3,500,000), prepaid maintenance ($700,000) and advertising prepaid expenses
($800,000).
TERMINATION AGREEMENTS
In August 2001, the Company entered into separation and release
agreements with Messrs. Jack C. Chen, the Company's former President and Vice
Chairman of the Company's Board of Directors, and Fernando J. Espuelas, the
Company's former Chief Executive Officer, under which each will cease his
employment with the Company. Each of these separation and release agreements
supercedes each executive's respective employment agreement with the Company.
Under the agreements, (i) each executive is entitled to a one time payment of
$650,000, which was paid to the executives in August 2001, and to payment of
medical and dental premiums through February 2003, (ii) the Line of Credit
provided to each executive under certain agreements dated December 28, 2000 (as
amended on January 31, 2001) will remain in full force and effect in accordance
with its terms, and (iii) in the case of Mr. Chen, he received limited
administrative support through December 31, 2001. Even though each executive's
Line of Credit remains intact under the agreement, each executive agreed not to
draw down any additional amounts thereunder. Mr. Espuelas agreed to remain the
Chairman of the Company's Board of Directors until November 15, 2001, at which
time he resigned from such position, remaining thereafter as a director of the
Company, until July 1, 2002 at which time he resigned.
In October 2001, the Company entered into a separation and release
agreement with Mr. Steven J. Heller, the Company's Chief Financial Officer,
under which Mr. Heller ceased his employment with the Company on November 15,
2001. Under the agreement, the executive's employment agreement expires and is
null and void. Under the agreement, the Company agreed to terminate the Line of
Credit provided to the executive under a letter agreement dated December 28,
2000, and completely discharge all amounts owed thereunder, and in consideration
for such termination of the Line of Credit, the executive agreed to deliver to
the Company 326,000 shares of the Company's common stock. In addition, the
executive is entitled to a one-time payment of $350,000, which was paid to him
in November 2001.
On April 19, 2002 the Company and Enrique Narciso entered into an
agreement (the "Narciso Separation Agreement") setting out the terms on
conditions of Mr. Narciso's resignation as CEO, President and director of the
Company. Under the Narciso Separation Agreement, the Company paid Mr. Narciso
$75,000 and agreed to provide continued health insurance coverage for one year
in consideration for Mr. Narciso's cooperation in transitioning to
17
a new management team and contacting existing customers and vendors of the
Company in order to facilitate the transition.
TRANSACTIONS WITH FORMER SHAREHOLDERS OF ADNET
In connection with the Company's purchase of AdNet from Grupo MVS S.A.
de C.V. ("Grupo MVS") and Harry Moller Publicidad S.A. de C.V. ("HMP") in April
2000 Grupo MVS and HMP were paid in part with shares of the Company's common
stock, and thereby became shareholders of the Company. In addition, under the
AdNet purchase agreement, each of Grupo MVS and HMP entered into long-term
services agreements with AdNet pursuant to which each of them would provide to
AdNet certain advertising and promotional services in consideration for fees to
be mutually agreed, subject to agreed parameters. It was further contemplated
under the AdNet purchase agreement that Grupo MVS and HMP would act as agents of
AdNet in selling advertising. The revenues and expenses of the Company from this
arrangement were restated and, as restated, are not material (See note 2).
In addition, in December 2000 SMN de Mexico, S.A. de C.V. entered into
arrangements with Grupo MVS and HMP that were similar to those already in place
with AdNet. The revenues and expenses of the Company associated with these
arrangements were restated in their entirety, and the Company's restated
financial statements reflect no such revenues or expenses (See note 2).
13. COMPREHENSIVE LOSS
Total comprehensive loss was approximately $54,000,000 and $145,600,000
for the three and nine month periods ended September 30, 2001, respectively and
approximately $36,600,000 and $116,500,000 for the three and nine month periods
ended September 30, 2000, respectively.
14. NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued
Statements of Financial Accounting Standards (SFAS) No. 141, Business
Combinations, and No. 142, Goodwill and Other Intangible Assets. SFAS No. 141
requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001. SFAS No. 141 also includes guidance
on the initial recognition and measurement of goodwill and other intangible
assets arising from business combinations completed after June 30, 2001. SFAS
No. 142 prohibits the amortization of goodwill and intangible assets with
indefinite useful lives. SFAS No. 142 requires that these assets be reviewed for
impairment at least annually. Intangible assets with finite lives will continue
to be amortized over their estimated useful lives. Additionally, SFAS No. 142
requires that goodwill included in the carrying value of equity method
investments no longer be amortized. The Company does not expect the adoption of
this statement to have a material effect on its financial position and results
of operations.
In August 2001, the FASB issued Statement of Financial Accounting
Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets which addresses financial accounting and reporting for the impairment or
disposal of long-lived assets and supersedes SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and Long-Lived Assets
18
to be Disposed of, and the accounting and reporting provisions of APB Opinion
No. 30, Reporting the Results of Operations for a Disposal of a Segment of a
Business. The adoption of this statement is not expected to have a material
effect on the Company's financial position and results of operations.
15. LEGAL PROCEEDINGS
In August 2001, the Company, three of its executive officers and each
of the underwriters who participated in the Company's May 25, 1999 initial
public offering were named as defendants in three class action complaints filed
in the United States District Court for the Southern District of New York: Earl
Arneson v. StarMedia Network, Inc, et al; John R. Longman v. StarMedia Network,
Inc., et al; and BH Holdings LLC v. StarMedia Network, Inc., et al. The
complaints, which are substantially identical, each seek unspecified damages for
alleged violations of Sections 11, 12 and 15 of the Securities Act of 1933,
Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5
promulgated thereunder in connection with the Company's initial public offering.
The complaints allege that the underwriters charged the Company excessive
commissions and inflated transaction fees not disclosed in the registration
statement and allocated shares of the Company's initial public offering to
favored customers in exchange for purported promises by such customers to
purchase additional shares in the aftermarket, thereby allegedly inflating the
market price for the Company's common stock. These actions have been
consolidated with hundreds of other securities class actions commenced against
more than 300 companies and approximately 40 investment banks in which
plaintiffs make substantially similar allegations as those made against the
Company with respect to the initial public offerings at issue in those cases.
All of these actions have been consolidated under the caption In re: Initial
Public Offering Securities Litigation, 21 MC 92 (SAS). The judge in the
consolidated action has adjourned without date the time for all defendants to
respond to the complaints.
On November 19, 2001, the Company announced to the public that it had
commenced an investigation into the facts and circumstances related to certain
accounting irregularities related to Mexican subsidiaries and that a restatement
(the "Restatement") of its audited financial statements for the year ended
December 31, 2000 and its unaudited financial statements for the quarters ended
March 31, 2001 and June 30, 2001 would likely be necessary. The Company informed
the SEC of this matter concurrently with its public announcement. Subsequently,
the SEC has informed the Company that it has opened an investigation into this
matter. The SEC investigation is on-going.
In late 2001 and early 2002, eleven lawsuits were filed against the
Company in the Southern District of New York in connection with the Company's
announcement relating to the restatement referred to above. A lead plaintiff
for the class and lead plaintiff's counsel were subsequently selected and a
motion filed to consolidate the various claims. The Consolidated Amended
Complaint was filed on May 31, 2002 in the Southern District of New York
under the caption In re StarMedia Network, Inc. Securities Litigation 01 Civ.
10556 (S.D.N.Y.). In June 2002 the lead plaintiffs and all defendants have
executed a settlement agreement that resolves all claims in the consolidated
action. The settlement amount will be paid by the Company's directors and
officers' liability insurance carrier. This settlement agreement is subject
to review and
19
ratification by the Honorable Denny Chin of the United States District Court for
the Southern District of New York. A list of the eleven lawsuits before
consolidation follows:
---------------------------------------------------------------------------------------------
CASE NAME DATE FILED
---------------------------------------------------------------------------------------------
Kramon v. StarMedia Network, et al. November 20, 2001
---------------------------------------------------------------------------------------------
Stourbridge Ltd., et al. v. StarMedia Network, et al. November 20, 2001
---------------------------------------------------------------------------------------------
Rennel Trading Corp. v. StarMedia Network, et al. November 21, 2001
---------------------------------------------------------------------------------------------
Ehrenreich v. StarMedia Network, et al. November 27, 2001
---------------------------------------------------------------------------------------------
Howe v. StarMedia Network, et al. November 27, 2001
---------------------------------------------------------------------------------------------
Mayper v. StarMedia Network, et al. November 28, 2001
---------------------------------------------------------------------------------------------
Dorn v. StarMedia Network, et al. December 3, 2001
---------------------------------------------------------------------------------------------
Hindo v. StarMedia Network, et al. December 12, 2001
---------------------------------------------------------------------------------------------
Mather v. StarMedia Network, et al. December 19, 2001
---------------------------------------------------------------------------------------------
Nulf v. StarMedia Network, et al. December 19, 2001
---------------------------------------------------------------------------------------------
Vasko v. StarMedia Network, at al. January 7, 2002
---------------------------------------------------------------------------------------------
In April 2002, AT&T Corp. filed a claim in the United States District
Court for the Southern District of New York seeking payment from the Company for
telecommunications services rendered to the Company in the amount of
approximately $337,000, and in June 2002 AT&T amended that complaint to increase
the amounts claimed to approximately $1,400,000. In addition, for over a year
the Company has engaged in periodic discussions with AT&T regarding the
Company's alleged commitments to purchase a variety of services from AT&T, and
in April 2002 had received correspondence from AT&T alleging that approximately
a total of $1,100,000 was payable by the Company. The Company denies that it
owes most of the amounts alleged to be payable by AT&T. The parties have
commenced settlement discussions.
In October 2001, Fausto Zapata, formerly President of SMN de Mexico, S
de RL, filed a notice in the applicable Labor Courts in Mexico City alleging
that the Company failed to make payments due to him under an employment
agreement following his termination by the Company. The amounts claimed by Mr.
Zapata exceed 8.5 million Pesos, or approximately $900,000. The Company
maintains that it owes Mr. Zapata solely the minimum amounts required to be paid
following termination of his at-will employment, which the Company calculates to
be approximately 600,000 Mexico Pesos, or approximately $65,000.
In January 2002 Mr. Carlos Ponce filed a claim in the U.S. District
Court in the Southern District Court of Florida in connection with allegations
by Mr. Ponce that the Company exceeded the scope of a license to use his image
in connection with an advertising campaign. Mr. Ponce claims violations of
common law and statutory rights of publicity under Florida law, unfair business
practices, misappropriation, and also asserts claims under the Lanham Act. Mr.
Ponce seeks damages allegedly in excess of $1,000,000, treble damages, punitive
damages, and injunctive and other equitable relief. The Company filed an answer
to the complaint in February 2002. In June 2002 the judge in this case issued an
order to show cause directing the plaintiff to show cause why the case should
not be dismissed. Mr. Ponce has responded and delivered to the Company a request
to produce documents. The Company denies Mr. Ponce's claims and
20
believes that even if such claims were proven, the damages sought are grossly
overstated, and that the Lanham Act claim may be legally deficient.
In May 2002 the Company was notified that Digital Impact has presented
a demand for arbitration seeking payment of approximately $594,000 allegedly
owed to Digital Impact by the Company in connection with the Company's
termination of an agreement between Digital Impact and the Company.
In June 2001, the Company commenced an action entitled StarMedia
Network, Inc. v. Patagon.com International, Inc. in the Commercial Division of
the Supreme Court of the State of New York, New York County against Patagon.com
International, Inc. ("Patagon"). The complaint seeks to recover compensatory and
consequential damages in an amount not less than $4,250,000 for Patagon's breach
of a Web Content Agreement pursuant to which the Company and Patagon hosted a
co-branded website linked to the Company's internet property StarMedia.com
through its "Money Channel." The complaint alleges that Patagon breached the Web
Content Agreement by wrongfully and prematurely terminating the agreement. In
August 2001, Patagon filed an Answer and Counterclaim (the "Counterclaim") to
the complaint in which Patagon seeks to recover unspecified damages on claims
for breach of contract and breach of the duty of good faith and fair dealing
premised upon the Company's alleged breach of the Web Content Agreement. Also in
August 2001, the Company served its Answer and Affirmative Defenses to the
Counterclaim in which it denied all of the material allegations of the
Counterclaim and asserted affirmative defenses to the claims asserted therein.
Discovery is pending in this case.
In September 2001, Justin K. Macedonia, the then General Counsel of the
Company, filed a notice of intention to arbitrate against the Company, asserting
that the Company was obligated to make tax indemnity payments to him in the
amount of $1,700,000. The Company denied any obligation to make such payment and
asserted counterclaims against Mr. Macedonia. Mr. Macedonia's employment with
the Company terminated in November 2001. The arbitration hearing was concluded
in March 2002. In May 2002 the arbitrator issued a final judgment denying Mr.
Macedonia's claims, as well as the Company's counterclaims.
In December 2000, a consulting company filed suit against the Company
in the New York Supreme Court claiming unpaid fees of approximately $2,300,000.
In October 2001, pursuant to a Settlement Agreement, the Company and the
consulting company agreed to settle the lawsuit. The Company agreed to pay the
consulting company an amount within the range that the Company had previously
reserved for such lawsuit in its financial statements. The suit was settled for
an amount not material to the Company. The Company has paid such amount and such
lawsuit has been dismissed with prejudice.
The Company intends to vigorously defend the aforementioned claims
that are threatened or pending against it but believes that an adverse
outcome with respect to one or more of these matters could have a material
adverse effect on the financial condition of the Company.
The Company is subject to legal proceedings and claims in the ordinary
course of business from time to time, including claims of alleged infringement
of trademarks, copyrights and other intellectual property rights, and a variety
of claims arising in connection with our e-mail, message boards and other
communications and community features, such as claims alleging defamation and
invasion of privacy.
21
The Company intends to vigorously defend the aforementioned allegations
and believes that the outcome of these matters will not have a material adverse
effect on the financial condition of the Company.
16. SUBSEQUENT EVENT
On July 3, 2002 the Company sold substantially all of the assets
associated with starmedia.com, the Company's Spanish- and Portuguese-language
portal, and LatinRed, the Company's Spanish language online community, to
eresMas Interactive S.A. ("EresMas") for $8,000,000 in cash. In addition,
in order to facilitate the transfer of these assets, the Company agreed to
provide transitional services to EresMas under a Transition Licensing
Agreement. The Company will record a loss of approximately $500,000 from the
aforementioned sale. The assets sold comprised substantially of fixed assets
and intangible assets. As part of the terms of the sale to Eresmas, the Company
has agreed to cease using the "StarMedia" brand commercially and, subject to
shareholder approval, to amend its certificate of incorporation to change its
name. Following the sale, the Company operates commercially under the name
"CycleLogic."
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR
FINANCIAL STATEMENTS AND THE NOTES TO THOSE STATEMENTS AND OTHER FINANCIAL
INFORMATION APPEARING ELSEWHERE IN THIS REPORT.
THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS RELATING TO FUTURE
EVENTS AND FUTURE PERFORMANCE OF THE COMPANY WITHIN THE MEANING OF SECTION 27A
OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF
1934, INCLUDING, WITHOUT LIMITATION, STATEMENTS REGARDING THE COMPANY'S
EXPECTATIONS, BELIEFS, INTENTIONS OR FUTURE STRATEGIES THAT ARE SIGNIFIED BY THE
WORDS "EXPECTS," "ANTICIPATES," "INTENDS," "BELIEVES" OR SIMILAR LANGUAGE.
ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN SUCH
FORWARD-LOOKING STATEMENTS. ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS
DOCUMENT ARE BASED ON INFORMATION AVAILABLE TO THE COMPANY ON THE DATE HEREOF,
AND THE COMPANY ASSUMES NO OBLIGATION TO UPDATE ANY FORWARD LOOKING STATEMENTS.
THE COMPANY CAUTIONS INVESTORS THAT ITS BUSINESS AND FINANCIAL PERFORMANCE ARE
SUBJECT TO SUBSTANTIAL RISKS AND UNCERTAINTIES. IN EVALUATING THE COMPANY'S
BUSINESS, PROSPECTIVE INVESTORS SHOULD CAREFULLY CONSIDER THE INFORMATION SET
FORTH IN OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2000
UNDER THE CAPTION "RISK FACTORS" IN ADDITION TO THE OTHER INFORMATION SET FORTH
HEREIN.
22
RESTATEMENT
The Company, in consultation with its independent accountants,
determined to restate its unaudited consolidated financial statements for the
fiscal quarters ended March 31, June 30, September 30, and December 31, 2000, as
well as quarters ended March 31 and June 30, 2001, and its audited consolidated
financial statements for the fiscal year ended December 31, 2000. The Company
initially announced its intention to restate these consolidated financial
statements on November 19, 2001. That announcement related to the preliminary
conclusion of a Special Committee of the Board of Directors that approximately
$10,000,000 in revenues was improperly recognized by two of the Company's
Mexican subsidiaries during the period October 1, 2000 through June 30, 2001.
Subsequent to that announcement, the Special Committee authorized the Company's
management to undertake an additional investigation in order to confirm whether
any additional accounting irregularities occurred during the periods in
question.
Additional information related to the restatements and adjustments made
to the Company's financial statements for the periods mentioned above are set
forth in Note 2 of Notes to Consolidated Financial Statements.
OVERVIEW
StarMedia Network, Inc. (d/b/a CycleLogic) was incorporated in Delaware
in March 1996. We commenced operations in September 1996 and launched the
StarMedia network of websites targeted at Spanish and Portuguese-speaking
Internet users in December 1996. In May 1999, we completed the initial public
offering of our common stock and in October 1999 we completed a follow-on public
offering of our common stock. Our principal executive offices are located at 999
Brickell Ave. Suite 808, Miami, Florida, 33131 and our telephone number is (305)
938-3000. Previously, our principal offices were located at 75 Varick Street,
New York, New York, 10013.
The Company was established as an Internet media company. The Company
was among the first companies to develop Internet sites tailored specifically to
the interests and needs of Spanish and Portuguese speakers. In so doing, we were
also among the first to attract a broad user base among Spanish- and
Portuguese-speaking Internet users. Much like operators of traditional media
companies (print, television, radio, etc.), the Company sold advertising to
advertisers seeking to reach its user base, and historically derived a majority
of its revenues from fees paid to us by advertisers on our sites.
The Company subsequently acquired Internet properties and businesses
that were deemed to be complementary to this business. One such acquisition was
the September 1999 purchase of PageCell International Holdings (PageCell), which
formed the basis of our mobile Internet solutions business. These solutions
consist of a unique mix of technology and content that allows operators and
their end users to take full advantage of the Internet across multiple
platforms.
Since the acquisition of PageCell the Company has, in addition to its
media business, engaged in the business of providing Internet solutions to
wireless telephone operators in Latin America. In May 2001, the Company signed a
strategic agreement with BellSouth International under which the Company would
design and implement "multi-access portals" for BellSouth's subsidiaries in
Latin America. At the same time, BellSouth and several other investors invested
23
$35.1 million in the Company. Since the summer of 2001, the Company has
undertaken a realignment for the general purpose of reducing the costs of
operating our Internet media services business and focusing our resources on
the development of our mobile solutions business. Management believes this
realignment was necessary in order to preserve the Company's prospects of
becoming profitable. The rationale for this realignment was that since the
StarMedia network was established, the Company's media business has continued
to incur significant operating losses as the costs of providing content,
tools and applications necessary to attract and maintain a broad user base
continued to significantly exceed the revenues derived from basic
advertisers' fees. Also underlying this realignment was the expectation of
management and the board of directors that the deterioration of the Internet
advertising market in Latin America and the U.S. during 2001 would continue
and was unlikely to increase to levels that would support the established
levels of operating costs of the Company's media business.
In early 2002, the Company's management and board of directors
determined that, notwithstanding the realignment undertaken as of that time,
the continued operation of the Company's media assets would undermine the
Company's prospects for profitability. Accordingly, the Company undertook
efforts to sell its remaining media assets, including the starmedia.com
portal and its LatinRed community products. On July 3, 2002, the Company sold
most of the intellectual property, hardware and other assets associated with
the operation of starmedia.com and LatinRed to EresMas, and agreed that it
would cease to conduct business under the StarMedia name. Effective as of
July 3, 2002, the Company operates commercially under the name "CycleLogic."
This change of name has been approved by management and the board of
directors, who expect to propose at the next meeting of the Company's
shareholders that the Company amend its certificate of incorporation to
formally change its name to "CycleLogic, Inc." Any such amendment is subject
to the approval by the Company's shareholders.
The Company is now principally engaged in providing integrated
Internet solutions to wireless telephone operators in Latin America targeting
Spanish-and Portuguese-speaking end-users. In addition, we continue to
operate several Spanish- and Portuguese-language websites and to design and
operate portals for third parties. Substantially all of our revenues are
currently being generated from our mobile solutions business. Our customers
are in Latin America and most of our revenues come from Venezuela, Brazil,
Colombia, Argentina, and Chile.
MOBILE INTERNET SOLUTIONS. We are one of the leading providers of
mobile Internet software and application solutions to wireless telephone
operators in Spanish- and Portuguese-speaking markets. We offer comprehensive
end-to-end solutions that are comprised of an integrated and customized suite of
technology platforms, content and applications. Our mobile Internet solutions
enable wireless carriers and enterprises to provide end-users with access to
personalized Internet content, email, messaging, secure mobile banking and other
mCommerce opportunities through a variety of technologies, including SMS (Short
Message Services), WAP (Wireless Application Protocol) and voice telephony.
Through our solutions, end users can access this content through a variety of
devices, including personal computers, cellular phones, pagers, PDAs and PCs and
GSM handsets. By providing their end-users the services enabled by our mobile
Internet solutions, wireless operators hope to increase user airtime and
subscription
24
fees (thereby increasing their average revenue per user or "ARPU") and reduce
their customer turnover rates (referred to in the industry as "churn rates").
Our scalable, proprietary technology is comprised of our Wireless
Internet Server (WIS) and "Gen3" wireless portal technology.
o WIS TECHNOLOGY. The WIS software is a carrier-class technology that
permits mobile operators to deliver short-message services (SMS) and
other content from the Internet to their customers in a manner that
is fully integrated with the wireless operator's provisioning
systems (the systems that determine which customers have elected to
receive specific services), billing systems, gateway infrastructure
systems, and other back-end systems. Two components of our WIS
technology are:
-- TRANSACTIONAL-BILLING. This feature of the WIS technology allows
wireless operators to apply different business rules to permit
flexible billing (for post-paid and pre-paid) based on the type
of mobile Internet service accessed by an end-user, the
end-user's subscription plan and other variables identified by
the operator.
-- WIRELESS MARKETPLACE. This feature of the WIS technology allows
wireless operators to efficiently and cost-effectively
distribute third parties' content and applications (in addition
to the Company's own) through the WIS and to integrate such
services within their overall mobile Internet service offerings.
The WIS software is designed to operate on dedicated servers
placed in the wireless operators' premises.
o GEN3 WIRELESS PORTAL TECHNOLOGY. Our Gen3 wireless portal
technology allows wireless operators to provide to their customers
personalized Internet websites that can be viewed through different
browser types and devices, including their personal computers and
wireless devices (such as WAP-enabled phones and PDAs). Using this
technology, the content and services offered on end-users' portals,
as well as the branding of the portal, vary based on the user's
profile and subscription of services.
Although our competitors have been able to develop technologies that
are similar to our WIS technology and Gen3 wireless portal technology, the
Company believes that its proprietary technologies' ability to interface with
wireless operators' back end systems via our Transactional Billing system and
Wireless Marketplace gives it a competitive advantage over other solutions
providers. This technology allows our customers to better target their end-users
by being able to track and identify the services or plans being accessed through
the different platforms (personal computer, mobile telephones and PDAs) used by
the end-user.
We use third party content and technology to further enhance the
services and tools that wireless operators can deliver through our WIS and Gen3
wireless portal technology. In addition, we have integrated third-party voice
recognition, text-to-speech and telephony technologies (also known as voice
portal technologies), along with our proprietary technologies, to create an
integrated access platform, allowing end-users to have seamless interactive
access via voice, web, WAP and SMS to a variety of
25
content and applications. This integrated access platform is the basis of the
Multiple Access Portal (MAP) services we provide to subsidiaries of BellSouth
International in Latin America.
The Company derives revenues from its mobile Internet solutions through
set up and installation fees, technology licenses fees and usage-based fees. We
currently have agreements for the use of our WIS technology with more than 20
wireless operators throughout the region, including subsidiaries of BellSouth
International, Verizon, Telefonica and Americas Telecom.
INTERNET MEDIA SERVICES. Historically, the Company has also provided
extensive services to consumers, including community features such as
o free email, promotional email newsletters, user surveys, chats,
instant messaging, and home pages;
o tools and applications, such as games, multimedia players,
comprehensive city guide content, and sophisticated search
capabilities;
o local and global editorial content; and
o online shopping in Spanish and Portuguese.
The Company has derived revenues from its Internet media services
principally through sales of advertising and promotions on these services,
including banners, buttons and sponsorships. For the nine months ended
September 30, 2001, two advertisers, individually, accounted for more than
10% of our total revenues and our top five advertisers accounted for 41% of
our total revenues. In addition, the Company has used the information derived
about users of its services, particularly from user surveys and email usage
patterns, to sell targeted direct marketing emails to advertisers seeking to
target specific user profiles. As explained above, these revenues are no
longer an integral part of the Company's business model.
Currently, the Company continues to operate the following media
services:
o batepapo.com.br, a Brazilian chat services, which the Company may
either sell or shut down in the near future; and
o local Internet city guides such as nacidade.com.br; guiasp.com.br;
guiarj.com.br; paisas.com; yoinvito.com; panoramas.cl and
openchile.cl, which the Company expects to continue to operate in
connection with its mobile solutions business.
PORTAL SOLUTIONS. The Company provides portal development services to
enable companies to leverage the power of the Internet to reach their business
objectives. We use our content, technology and know-how to create branded,
content-rich websites (commonly referred to as "portals") for consumer-oriented
businesses that desire to attract and serve customers through the Internet.
Through the Company's portal development services enterprises can establish a
powerful presence on the World Wide Web, which enables them to improve customer
26
service, conduct further transactions, and increase their service/product
offerings, ultimately resulting in increased revenues.
In the past we were able to draw on the existing content, tools and
applications from our Internet media services and include them as part of our
portal solutions. Following the sale or liquidation of our Internet media
services business, the Company will continue to develop and access third party
content, tools and applications in order to continue to provide portal solutions
to businesses, although we do not expect this to be our principal business and
we may not generate significant revenues from this business
The Company derives revenues from its portal solutions principally
through development fees and maintenance fees it charges its portal solutions
customers. Historically, it has also generated revenues from on-line promotions
and advertising it undertakes with respect to the portals it develops. The
Company does not anticipate that this will be a significant source of revenues
for its portal solutions business in the future.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001 AND
SEPTEMBER 30, 2000.
REVENUES
Total revenues decreased to $4.6 million for the three months ended
September 30, 2001 from $15.9 million for the three months ended September 30,
2000. This decrease in revenues was primarily due to a decrease in the volume of
revenue-producing advertising impressions and sponsorships. Barter revenues for
the three months ended September 30, 2001 and 2000 were 21% and 12%,
respectively, of total revenues for such periods.
For the three months ended September 30, 2001 and September 30, 2000,
one advertiser accounted for more than 10% of our total revenues. For the three
months ended September 30, 2001, our top five advertisers accounted for 42% of
our total revenues. For the three months ended September 30, 2000, our top five
advertisers accounted for 34% of our total revenues.
OPERATING EXPENSES
PRODUCT AND TECHNOLOGY
Product and technology development expenses decreased to $11.5 million,
or 249% of total revenues, for the three months ended September 30, 2001, from
$16.7 million, or 105% of total revenues, for the three months ended September
30, 2000. This decline was primarily due to decreases of approximately $2.8
million in expenses related to content acquisition and $2.6 million in salaries
and hosting costs, partially offset by an increase in consultant fees of
$600,000.
SALES AND MARKETING
Sales and marketing expenses decreased to $8.6 million, or 186% of
total revenues for the three months ended September 30, 2001 from $17.0 million,
or 107% of total revenues, for
27
the three months ended September 30, 2000. This decrease was primarily due to
decreases in advertising, trade show events, salaries and commissions,
consulting and travel, and bad debt expense totaling $8.0 million. We believe
the Company has adequate coverage for bad debt and will continue to review the
collectibility of our receivables.
GENERAL AND ADMINISTRATIVE
General and administrative expenses decreased to $6.2 million, or 135%
of total revenues, for the three months ended September 30, 2001, from $8.0
million, or 50% of total revenues, for the three months ended September 30,
2000. This decrease is primarily the result of a decrease of approximately
$600,000 in office rent expense due to the decreased utilization of space at
our offices as a result of our restructuring, and a decrease of approximately
$1.1 million in salary and travel expenses, partially offset by increases
in utilities, legal, tax, and audit fees.
RESTRUCTURING AND OTHER CHARGES
For the three months ended September 30, 2001, we recorded
restructuring and other charges totaling approximately $9.3 million, which was
part of the company-wide realignment of its business operations and an effort to
reduce its operational overhead that was initiated during the quarter ended June
30, 2001. This included charges of $8.2 million resulting from the Company
vacating the premises of its New York headquarters and the related settlement
pursuant to which the Company left a substantial portion of its fixed assets,
furniture and fixtures and leasehold improvements to the new tenant at the
vacated premises. During the same quarter in 2000, we recorded restructuring
charges totaling approximately $3.9 million related to the integration of
acquisitions and subsequent company-wide realignment of business operations.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expenses decreased to $7.4 million, or
161% of total revenues, for the three months ended September 30, 2001, from $8.1
million, or 51% of total revenues, for the three months ended September 30,
2000. This decrease is due to the net effect of an increase in depreciation
expense due to additional capital purchases offset by a decrease of goodwill
amortization due to a write-down of goodwill in December 2000.
STOCK-BASED COMPENSATION EXPENSE
Of the cumulative deferred compensation amount, $491,000 was recorded
as an expense for the three months ended September 30, 2001 compared with $1.1
million recorded as an expense for the three months ended September 30, 2000.
The decrease relates to the reduction in employees. The unamortized balance is
being amortized over the vesting period for the individual options, which is
generally three years for options issued prior to February 1999 and four years
for options issued thereafter.
28
IMPAIRMENT OF GOODWILL
The Company determined that all goodwill was impaired. As a result, for
the three months ended September 30, 2001, the Company recorded a goodwill
impairment charge of $11.4 million related to these assets.
IMPAIRMENT OF FIXED ASSETS
In February 2000, the Company entered into a software license
agreement with Software.com, Inc to purchase for $9,000,000 a non-exclusive and
non-transferable license to use Software.com's Intermail Mx electronic messaging
software during a period of 3 years. As part of the change in business strategy
and focus and to reduce operating costs, the Company decided in September 2001
to terminate the usage of the software and return the license to Software.com,
Inc. The Company reached an agreement with Software.com, Inc. on March 31, 2002.
The terms of the settlement require the Company to return all copies of the
software in July 2002. A settlement payment of $1,300,000 was made on March 2002
to finalize the agreement. As a result, for the three months ended September 30,
2001, an impairment loss of $2,934,000 was recognized to write-off the carrying
value of the software purchased from Software.com.
INTEREST
Interest income includes income from our cash and investments. Interest
income decreased to $582,000 for the three months ended September 30, 2001 from
$2.6 million for the three months ended September 30, 2000. Interest income
decreased as a result of a decrease in the average invested cash balance for the
above periods coupled with lower average interest rates.
Interest expense decreased to $230,000 for the three months ended
September 30, 2001 from $352,000 for the three months ended September 30, 2000.
This decrease is due to the net effect of the decrease in interest related to an
equipment lease line that was paid in full during the quarter ended June 30,
2001 and the interest expense resulting from the issuance of the Company's
common stock in connection with the G1 transaction described in Note 9 to the
unaudited condensed consolidated financial statement.
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001 AND SEPTEMBER
30, 2000
REVENUES
Total revenues decreased to $19.8 million for the nine months ended
September 30, 2001 from $37.8 million, for the nine months ended September 30,
2000. This decrease in revenues was primarily due to a decrease in the volume of
revenue-producing advertising impressions and sponsorships. Barter revenues for
the nine months ended September 30, 2001 and 2000 were 29% and 14%,
respectively, of total revenues for such periods.
29
For the nine months ended September 30, 2001, two advertisers,
individually, accounted for more than 10% of our total revenues. For the nine
months ended September 30, 2000, no single advertiser accounted for more than
10% of our total revenues. For the nine months ended September 30, 2001, our top
five advertisers accounted for 41% of our total revenues. For the nine months
ended September 30, 2000, our top five advertisers accounted for 28% of our
total revenues.
OPERATING EXPENSES
PRODUCT AND TECHNOLOGY
Product and technology development expenses decreased to $40.2 million,
or 204% of total revenues, for the nine months ended September 30, 2001, from
$52.0 million, or 138% of total revenues, for the nine months ended September
30, 2000. This decrease was primarily due to decreases of approximately $4.3
million in expenses related to content acquisition, $4.2 million in hosting
related expenses, $2.9 million in salaries, offset by $2.3 million increased in
consulting expense.
SALES AND MARKETING
Sales and marketing expenses decreased to $38.5 million, or 195% of
total revenues, for the nine months ended September 30, 2001 from $56.7 million,
or 150% of total revenues, for the nine months ended September 30, 2000. This
decrease was primarily due to the net effect of decreases in advertising,
salaries, trade show events, consulting and travel, totaling approximately $26.5
million, partially offset by an increase in bad debt expense of $9.9 million. We
believe the Company has adequate coverage for bad debt and will continue to
review the collectibility of our receivables.
GENERAL AND ADMINISTRATIVE
General and administrative expenses decreased to $23.3 million, or
118% of total revenues, for the nine months ended September 30, 2001, from
$23.4 million, or 62% of total revenues, for the nine months ended September
30, 2000. This decrease was primarily attributed to a decrease of approximately
$800,000 in office rent due to the decreased utilization of space at our
offices as a result of our restructuring, a decrease of approximately $600,000
in recruiting expense, partially offset by increases in utilities, legal, tax
and audit fees.
RESTRUCTURING AND OTHER CHARGES
For the nine months ended September 30, 2001, we recorded restructuring
charges totaling approximately $24.6 million, which was the result of a
company-wide realignment of its business operations and an effort to reduce its
operational overhead and included provision for approximately $11.0 million of
loans and related interest made to certain officers of the Company, determined
by management to be unrealizable due to the impairment in collateral value.
Additionally, as a result of the Company vacating the premises of its New York
headquarters and the related settlement pursuant to which the Company left its
fixed assets, furniture and fixtures and leasehold improvements to the new
tenant at the vacated premises, the
30
Company incurred a loss of $8.5 million. During the same period in 2000, we
recorded restructuring charges totaling approximately $3.9 million related to
the integration of acquisitions and subsequent company-wide realignment of
business operations.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expenses increased to $20.1 million, or
102% of total revenues, for the nine months ended September 30, 2001, from $20.0
million, or 53% of total revenues, for the nine months ended September 30, 2000.
This increase is due to the net effect of an increase in depreciation expense
due to additional capital purchases offset by a decrease of goodwill
amortization due to a write-down of goodwill in December 2000.
STOCK-BASED COMPENSATION EXPENSE
Of the cumulative deferred compensation amount, $1.9 million was
recorded as an expense for the nine months ended September 30, 2001 compared
with $3.5 million recorded as an expense for the nine months ended September 30,
2000. The decrease relates to the reduction in employees. The unamortized
balance is being amortized over the vesting period for the individual options,
which is typically three years for options issued prior to February 1999 and
four years for options issued thereafter.
IMPAIRMENT OF FIXED ASSETS
In February 2000, the Company entered into a software license agreement
with Software.com, Inc to purchase for $9,000,000 a non-exclusive and
non-transferable license to use Software.com's Intermail Mx electronic messaging
software during a period of 3 years. As part of the change in business strategy
and focus and to reduce operating costs, the Company decided in September 2001
to terminate the usage of the software and return the license to Software.com,
Inc. The Company reached an agreement with Software.com, Inc. on March 31, 2002.
The terms of the settlement require the Company to return all copies of the
software in July 2002. A settlement payment of $1,300,000 was made on March 2002
to finalize the agreement. As a result, for the nine months ended September 30,
2001, an impairment loss of $2,934,000 was recognized to write-off the carrying
value of the software purchased from Software.com.
In the first quarter of 2001, the Company decided to cease operating
the Webcast Solutions Company that had been merged in September 1999 with a
wholly owned subsidiary of the Company (the "Webcast Solutions Merger"). Webcast
Solutions was a streaming media company focused on the global delivery of audio,
video and other internet based interactive media. The decision to cease
operation of this asset mainly resulted from the significant costs that were
required to operate and maintain this investment. Furthermore, the penetration
rates previously anticipated by the Company were not achieved during the period
the asset operated and management did not expect significant short-term nor
long-term improvements. The total loss recognized as a result of this decision
totaled $1,153,000 for the nine months ended September 30, 2001.
31
LOSS IN UNCONSOLIDATED SUBSIDIARY
During 2000 the Company acquired a non-controlling 50% interest in
Gratis1 ("G1"), which was subsequently reduced to approximately 48%. G1 was
formed to provide free unlimited Internet access to users in Latin America.
In September 2000, an agreement between the Company and AT&T Global
Network Services ("AT&T") to provide Internet access services in Argentina,
Brazil, Chile, Colombia and Mexico was assigned to G1. AT&T was entitled to draw
upon a $2,800,000 letter of credit, guaranteed by the Company, in the event G1
failed to perform under this agreement. Following payment by G1 of a $1,000,000
debt to AT&T in December 2000, the amount drawable under letter of credit was
reduced to $1,800,000. As of September 30, 2001, AT&T had fully drawn down on
the letter of credit. Accordingly, during the period ended September 30, 2001,
the Company recognized an expense of $1,800,000 related to the guaranty.
INTEREST
Interest income includes income from our cash and investments. Interest
income decreased to $2.9 million for the nine months ended September 30, 2001
from $9.4 million for the nine months ended September 30, 2000. Interest income
decreased as a result of a decrease in the average invested cash balance for the
above periods coupled with lower average interest rates.
Interest expense is comprised primarily of interest related to an
equipment lease line which was paid in full during the quarter ended June 30,
2001. Interest expense decreased slightly to $873,000 for the nine months ended
September 30, 2001 from $1.0 million for the nine months ended September 30,
2000.
LIQUIDITY AND CAPITAL RESOURCES
To date, we have financed our operations primarily through the sale of
our equity securities. At September 30, 2001, we had $33.7 million in cash and
cash equivalents, a decrease of $59.7 million from December 31, 2000.
For the nine months ended September 30, 2001, we used $79.0 million in
operating activities, substantially related to our $144.1 million loss during
the period, which included non-cash activities such as $20.1 million for
depreciation and amortization, $15.5 million in impairment of goodwill and fixed
assets, $12.5 million in loss on disposition of assets, $11.1 million in
provision for bad debts, $1.9 million for amortization of stock-based
compensation, and $11.0 million relating to write-down of officer loans.
For the nine months ended September 30, 2001, we used $10.3 million in
investing activities, including $6.1 million for the purchase of fixed assets,
$6.8 million for advances to officers, $4.9 million for acquisitions, offset by
$8.2 million provided by release of letters of credit which consisted of $5.0
million released as a result of vacating the premise on 75 Varick street and
$1.8 million released, as AT&T had fully drawn down on the letter of credit.
Net cash provided by financing activities were $31.1 million for the
nine months ended
32
September 30, 2001. Net cash provided by financing activities during the nine
months ended September 30, 2001 consisted primarily of net proceeds of $35.1
million resulting from the issuance of the Company's Series A Convertible
Preferred Stock, partially offset by $4.3 million used for the repayment of
long-term debt.
During the quarter ended June 30, 2001, the Company issued 1,431,373
shares of its Series A Convertible Preferred Stock at a price per share of
$25.50 to BellSouth and certain other investors resulting in total proceeds of
$35.1 million to the Company, net of issuance costs of approximately $1.4
million. The shares are convertible into 14,313,730 shares of the Company's
common stock at any time at the option of the holder. After 60 months from the
date of issuance, the Company shall redeem the Series A Convertible Preferred
Stock for cash or shares of the Company's common stock, in an amount equal to
$36.5 million, plus accrued dividends thereon. Dividends accrued at 6% per annum
and totaled $548,000 during the quarter ended September 30, 2001. In addition,
in connection with the BellSouth Strategic Agreement, the Company agreed to
issue warrants to BellSouth to purchase up to 4,500,000 shares of the Company's
common stock, with exercise prices ranging from $4.55 to $8.55 per share that
vest in May 2002 and expire during the period from May 2005 through May 2007.
Our principal commitments consist of obligations outstanding under
operating leases.
We have experienced a substantial decrease in our capital expenditures
and operating lease arrangements during the year consistent with the
restructuring and realignment of our operations.
Despite the proceeds from the financing transaction described above and
our steps to reduce operating expenses significantly through a reduction of our
work force and other operating costs, our current cash and cash equivalents may
not be sufficient to meet our anticipated cash needs for working capital and
capital expenditures for the next 12 months. If working capital is insufficient
to satisfy our liquidity requirements, we may seek to sell additional equity or
debt securities or establish a credit facility. The sale of additional equity or
convertible debt securities would result in additional dilution to our
stockholders. The incurrence of additional indebtedness would result in
increased fixed obligations and could result in operating covenants that would
restrict our operations. We cannot assure you that financing will be available
in amounts or on terms acceptable to us, if at all.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
COLLECTION RISK
Our accounts receivable are subject, in the normal course of business,
to collection risks. We regularly assess these risks and have established
policies and business practices to protect against the adverse effects of
collection risks.
33
INTEREST RATE RISK
Our investments are classified as cash and cash equivalents with
original maturities of three months or less. Therefore, changes in the market's
interest rates do not affect the value of the investments as recorded by us.
FOREIGN CURRENCY EXCHANGE RISK
We do not hedge our exposure to foreign currency exchange risk. We are
subject to exchange rate fluctuations, which may be a significant risk, because
of our operations in Latin America.
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In August 2001, the Company, three of its executive officers and each
of the underwriters who participated in the Company's May 25, 1999 initial
public offering were named as defendants in three class action complaints filed
in the United States District Court for the Southern District of New York: Earl
Arneson v. StarMedia Network, Inc, et al; John R. Longman v. StarMedia Network,
Inc., et al; and BH Holdings LLC v. StarMedia Network, Inc., et al. The
complaints, which are substantially identical, each seek unspecified damages for
alleged violations of Sections 11, 12 and 15 of the Securities Act of 1933,
Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5
promulgated thereunder in connection with the Company's initial public offering.
The complaints allege that the underwriters charged the Company excessive
commissions and inflated transaction fees not disclosed in the registration
statement and allocated shares of the Company's initial public offering to
favored customers in exchange for purported promises by such customers to
purchase additional shares in the aftermarket, thereby allegedly inflating the
market price for the Company's common stock. These actions have been
consolidated with hundreds of other securities class actions commenced against
more than 300 companies and approximately 40 investment banks in which
plaintiffs make substantially similar allegations as those made against the
Company with respect to the initial public offerings at issue in those cases.
All of these actions have been consolidated under the caption In re: Initial
Public Offering Securities Litigation, 21 MC 92 (SAS). The judge in the
consolidated action has adjourned without date the time for all defendants to
respond to the complaints.
On November 19, 2001, the Company announced to the public that it
had commenced an investigation into the facts and circumstances related to
certain accounting irregularities related to Mexican subsidiaries and that a
restatement of its audited financial statements for the year ended December
31, 2000 and its unaudited financial statements for the quarters ended March
31, 2001 and June 30, 2001 would likely be necessary. The Company informed
the SEC of this matter concurrently with its public announcement.
Subsequently, the SEC has informed the Company that it has opened an
investigation into this matter. The SEC investigation is on-going.
34
In late 2001 and early 2002, eleven lawsuits were filed against the
Company in the Southern District of New York in connection with the Company's
announcement relating to the restatement referred to above. A lead plaintiff for
the class and lead plaintiff's counsel were subsequently selected and a motion
filed to consolidate the various claims. The Consolidated Amended Complaint was
filed on May 31, 2002 in the Southern District of New York under the caption In
re StarMedia Network, Inc. Securities Litigation 01 Civ. 10556 (S.D.N.Y.). The
lead plaintiffs and all defendants have executed a settlement agreement that
resolves all claims in the consolidated action. The settlement amount will be
paid by the Company's directors and officers' liability insurance carrier. This
settlement agreement is subject to review and ratification by the Honorable
Denny Chin of the United States District Court for the Southern District of New
York. A list of the eleven lawsuits before consolidation follows:
---------------------------------------------------------------------------------------------
CASE NAME DATE FILED
---------------------------------------------------------------------------------------------
Kramon v. StarMedia Network, et al. November 20, 2001
---------------------------------------------------------------------------------------------
Stourbridge Ltd., et al. v. StarMedia Network, et al. November 20, 2001
---------------------------------------------------------------------------------------------
Rennel Trading Corp. v. StarMedia Network, et al. November 21, 2001
---------------------------------------------------------------------------------------------
Ehrenreich v. StarMedia Network, et al. November 27, 2001
---------------------------------------------------------------------------------------------
Howe v. StarMedia Network, et al. November 27, 2001
---------------------------------------------------------------------------------------------
Mayper v. StarMedia Network, et al. November 28, 2001
---------------------------------------------------------------------------------------------
Dorn v. StarMedia Network, et al. December 3, 2001
---------------------------------------------------------------------------------------------
Hindo v. StarMedia Network, et al. December 12, 2001
---------------------------------------------------------------------------------------------
Mather v. StarMedia Network, et al. December 19, 2001
---------------------------------------------------------------------------------------------
Nulf v. StarMedia Network, et al. December 19, 2001
---------------------------------------------------------------------------------------------
Vasko v. StarMedia Network, at al. January 7, 2002
---------------------------------------------------------------------------------------------
In April 2002, AT&T Corp filed a claim in the United States District
Court for the Southern District of New York seeking payment from the Company for
telecommunications services rendered to The Company in the amount of
approximately $337,000, and in June 2002 AT&T amended that complaint to increase
the amounts claimed to approximately $1,400,000. In addition, for over a year
the Company has engaged in periodic discussions with AT&T regarding the
Company's alleged commitments to purchase a variety of services from AT&T, and
in April 2002 had received correspondence from AT&T alleging that approximately
a total of $1,100,000 was payable by the Company. The Company denies that it
owes most of the amounts alleged to be payable by AT&T. The parties have
commenced settlement discussions.
In October 2001, Fausto Zapata, formerly President of SMN de Mexico, S
de RL, filed a notice in the applicable Labor Courts in Mexico City alleging
that the Company failed to make payments due to him under an employment
agreement following his termination by the Company. The amounts claimed by Mr.
Zapata exceed 8.5 million Pesos, or approximately $900,000. The Company
maintains that it owes Mr. Zapata solely the minimum amounts required to be paid
following termination of his at-will employment, which the Company calculates to
be approximately 600,000 Mexico Pesos, or approximately $65,000.
35
In January 2002 Mr. Carlos Ponce filed a claim in the U.S. District
Court in the Southern District Court of Florida in connection with allegations
by Mr. Ponce that the Company exceeded the scope of a license to use his image
in connection with an advertising campaign. Mr. Ponce claims violations of
common law and statutory rights of publicity under Florida law, unfair business
practices, misappropriation, and also asserts claims under the Lanham Act. Mr.
Ponce seeks damages allegedly in excess of $1,000,000, treble damages, punitive
damages, and injunctive and other equitable relief. The Company filed an answer
to the complaint in February 2002. In June 2002 the judge in this case issued an
order to show cause directing the plaintiff to show cause why the case should
not be dismissed. Mr. Ponce has responded and delivered to the Company a request
to produce documents. The Company denies Mr. Ponce's claims and believes that
even if such claims were proven, the damages sought are grossly overstated, and
that the Lanham Act claim may be legally deficient.
In May 2002 the Company was notified that Digital Impact has presented
a demand for arbitration seeking payment of approximately $594,000 allegedly
owed to Digital Impact by the Company in connection with the Company's
termination of an agreement with Digital Impact and the Company.
In June 2001, the Company commenced an action entitled StarMedia
Network, Inc. v. Patagon.com International, Inc. in the Commercial Division of
the Supreme Court of the State of New York, New York County against Patagon.com
International, Inc. ("Patagon"). The complaint seeks to recover compensatory and
consequential damages in an amount not less than $4,250,000 for Patagon's breach
of a Web Content Agreement pursuant to which the Company and Patagon hosted a
co-branded website linked to the Company's internet property StarMedia.com
through its "Money Channel." The complaint alleges that Patagon breached the Web
Content Agreement by wrongfully and prematurely terminating the agreement. In
August 2001, Patagon filed an Answer and Counterclaim (the "Counterclaim") to
the complaint in which Patagon seeks to recover unspecified damages on claims
for breach of contract and breach of the duty of good faith and fair dealing
premised upon the Company's alleged breach of the Web Content Agreement. Also in
August 2001, the Company served its Answer and Affirmative Defenses to the
Counterclaim in which it denied all of the material allegations of the
Counterclaim and asserted affirmative defenses to the claims asserted therein.
Discovery is pending in this case.
In September 2001, Justin K. Macedonia, the then General Counsel of the
Company, filed a notice of intention to arbitrate against the Company, asserting
that the Company was obligated to make tax indemnity payments to him in the
amount of $1,700,000. The Company denied any obligation to make such payment and
asserted counterclaims against Mr. Macedonia. Mr. Macedonia's employment with
the Company terminated in November 2001. The arbitration hearing was concluded
in March 2002. In May 2002 the arbitrator issued a final judgment denying Mr.
Macedonia's claims, as well as the Company's counterclaims.
In December 2000, a consulting company filed suit against the Company
in the New York Supreme Court claiming unpaid fees of approximately $2,300,000.
In October 2001, pursuant to a Settlement Agreement, the Company and the
consulting company agreed to settle
36
the lawsuit. The Company agreed to pay the consulting company an amount within
the range that the Company had previously reserved for such lawsuit in its
financial statements. The suit was settled for an amount not material to the
Company. The Company has paid such amount and such lawsuit has been dismissed
with prejudice.
The Company is subject to legal proceedings and claims in the ordinary
course of business from time to time, including claims of alleged infringement
of trademarks, copyrights and other intellectual property rights, and a variety
of claims arising in connection with our e-mail, message boards and other
communications and community features, such as claims alleging defamation and
invasion of privacy.
The Company intends to vigorously defend the aforementioned claims
that are threatened or pending against it but believes that an adverse
outcome with respect to one or more of these matters could have a material
adverse effect on the financial condition of the Company.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
PREFERRED STOCK
None.
COMMON STOCK
In September 2001, the Company issued 1,148,435 shares of its common
stock in connection with the final settlement of its obligation related to the
Gratis1 transaction described in Note 8 above, valued at approximately $3.4
million.
In August 2001, the Company issued 251,172 shares of its common stock
to its placement agent, JP Morgan Ventures Corporation, in connection with the
BellSouth Investment, valued at approximately $500,000. Under the terms of the
agreement pursuant to which these shares were issued, if the Company does not
have in place an effective registration statement covering such shares within 6
months from the date JP Morgan became entitled to receive its fee from the
Company, JP Morgan will have the right to cause the Company to repurchase such
shares for a purchase price of $500,000.
In July 2001, the Company issued 784,314 shares of its common stock in
connection with the execution of a content license agreement with Primedia,
Inc., Primedia Magazines, Inc. and About.com, Inc., valued at approximately $2.0
million.
We believe that the issuances of the Company's common stock described above are
exempt from the registration requirements of the Securities Act pursuant to
Section 4(2) thereof or Regulation D promulgated thereunder
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
NONE.
37
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
On August 7, 2001, Mr. Jack Chen resigned from the Company's Board of
Directors. On August 7, 2001, Mr. Fernando J. Espuelas stepped down as Chief
Executive Officer of the Company. Mr. Enrique Narciso was appointed to the
positions of President and Director and then Chief Executive Officer of the
Company, on June 1, 2001 and August 7, 2001, respectively. Mr. Espuelas
remained as Chairman of the Company's Board of Directors following his
resignation as CEO. During the quarter ended September 30, 2001, Gerardo
Rosencrantz and Marie-Josee Kravis also resigned from the Company's Board
of Directors. As of September 30, 2001, the Company's Board of Directors
consisted of:
Mr. Fernando J. Espuelas
Mr. Douglas M. Karp
Mr. Enrique Narciso
Ms. Susan L. Segal
Mr. Frederick R. Wilson
See Recent Developments for changes in Board of Directors after September 30,
2001.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) None.
(b) Reports on Form 8-K:
None.
ITEM 7. SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. Date: July 10, 2002.
STARMEDIA NETWORK, INC.
/s/ Ana M. Lozano-Stickley
--------------------------------------------------------------
By: Ana M. Lozano-Stickley
CHIEF FINANCIAL OFFICER (DULY AUTHORIZED OFFICER AND PRINCIPAL
FINANCIAL OFFICER)
38