<Page>
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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
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(COMMISSION FILE NUMBER)
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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STARMEDIA NETWORK, INC.
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 06-1461770
(State or Other Jurisdiction of (I.R.S. Employer Identification
Incorporation) Number)
999 BRICKELL AVE.
SUITE #808
MIAMI, FL 33131
(305)-938-3000
(Address, including zip code, and telephone number,
of registrant's principal executive offices)
-----------
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.
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<Page>
STARMEDIA NETWORK, INC. AND SUBSIDIARIES INDEX
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets at March 31, 2002
(unaudited) and December 31, 2001......................... 4
Unaudited Condensed Consolidated Statements of
Operations for the three months ended
March 31, 2002 and 2001................................... 5
Unaudited Condensed Consolidated Statements of
Cash Flows for the three months ended March 31,
2002 and 2001............................................. 6
Notes to Unaudited Condensed Consolidated
Financial Statements...................................... 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations............. 14
Item 3. Quantitative and Qualitative Disclosure About
Market Risk............................................... 19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings......................................... 19
Item 2. Changes In Securities and Use of Proceeds................. 21
Item 3. Defaults upon Senior Securities........................... 21
Item 4. Submission of Matters to a Vote of Security Holders....... 22
Item 5. Other Information......................................... 22
Item 6. Exhibits and Reports on Form 8-K.......................... 22
Item 7. Signatures................................................ 22
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PART I
FINANCIAL INFORMATION
RECENT DEVELOPMENTS
Since March 31, 2002, the Company has experienced the following
developments:
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.
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 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 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".
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."
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ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
STARMEDIA NETWORK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
MARCH 31, DECEMBER 31,
--------- ------------
2002 2001
---- ----
(UNAUDITED) (NOTE 1)
ASSETS
Current assets:
Cash and cash equivalents ............................. $ 17,405,000 $ 21,635,000
Accounts receivable, net of allowance for bad debts of
$4,095,000 (2002) and $4,453,000 (2001) ............. 2,940,000 2,963,000
Unbilled receivables .................................. 1,347,000 2,079,000
Receivable from sale of investment .................... -- 13,000,000
Other current assets .................................. 2,993,000 3,768,000
------------- -------------
Total current assets .................................... 24,685,000 43,445,000
Fixed assets, net ....................................... 21,667,000 25,184,000
Intangible assets, net of accumulated amortization of
$5,386,000 (2002) and $5,397,000 (2001) ............... 2,111,000 2,109,000
Goodwill, net of accumulated amortization of $1,111,000
(2002 and 2001) ....................................... 425,000 425,000
Other assets ............................................ 1,156,000 573,000
------------- -------------
Total assets ............................................ $ 50,044,000 $ 71,736,000
============= =============
<Caption>
LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
Current liabilities:
Accounts payable ...................................... $ 3,129,000 $ 4,419,000
Accrued expenses ...................................... 11,873,000 15,112,000
Deferred revenues ..................................... 1,668,000 2,534,000
------------- -------------
Total current liabilities ............................... 16,670,000 22,065,000
Preferred dividends payable ............................. 1,825,000 1,278,000
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 March 31, 2002 (liquidation
preference of $37,778,000 (2001) and $38,325,000
at March 31, 2002) .................................. 35,277,000 35,204,000
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 issued and outstanding at
March 31, 2002, and December 31, 2001, respectively
Common stock, $.001 par value, 200,000,000 shares
authorized, 80,320,089 shares issued
(2002 and 2001) ..................................... 80,000 80,000
Common stock issuable ................................. 1,000,000 1,000,000
Treasury stock, cost of 350,859 shares (2002), 349,912
shares (2001) ....................................... (149,000) (143,000)
Additional paid-in capital ............................ 542,115,000 542,144,000
Accumulated deficit ................................... (543,625,000) (527,116,000)
Deferred compensation ................................. (43,000) (87,000)
Accumulated comprehensive loss ........................ (3,106,000) (2,689,000)
------------- -------------
Total stockholders' (deficit) equity .................... (3,728,000) 13,189,000
------------- -------------
Total liabilities and stockholders' equity .............. $ 50,044,000 $ 71,736,000
============= =============
</Table>
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
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STARMEDIA NETWORK, INC., AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
<Table>
<Caption>
THREE MONTHS ENDED
MARCH 31,
2002 2001
---- ----
(UNAUDITED)
Revenues .................................................... $ 2,451,000 $ 8,871,000
Operating expenses:
Product and technology development ........................ 7,546,000 14,542,000
Sales and marketing ....................................... 2,150,000 17,472,000
General and administrative ................................ 4,216,000 9,158,000
Restructuring and other charges ........................... 347,000 --
Depreciation and amortization ............................. 3,867,000 5,739,000
Stock-based compensation expense .......................... 14,000 715,000
Impairment of fixed assets ................................ -- 1,153,000
Loss on sale of fixed assets .............................. 104,000 --
------------ ------------
Total operating expenses .................................... 18,244,000 48,779,000
------------ ------------
Loss from operations ........................................ (15,793,000) (39,908,000)
Other income (expense):
Interest income ........................................... 123,000 1,375,000
Interest expense .......................................... -- (75,000)
Other expenses ............................................ (219,000) (35,000)
------------ ------------
Loss before provision for income taxes ...................... (15,889,000) (38,643,000)
Provision for income taxes .................................. -- --
------------ ------------
Net loss .................................................... $(15,889,000) $(38,643,000)
Preferred stock dividends and accretion ..................... (620,000) --
------------ ------------
Net loss applicable to common stockholders .................. $(16,509,000) $(38,643,000)
============ ============
Basic and diluted net loss per common share ................. $ (0.21) $ (0.57)
============ ============
Number of shares used in computing basic and diluted net loss
per share ................................................. 79,969,851 67,467,437
============ ============
</Table>
See accompanying See accompanying Notes to Unaudited Condensed Consolidated
Financial Statements..
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<Page>
STARMEDIA NETWORK, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
FOR THE THREE MONTHS ENDED
--------------------------
MARCH 31,
---------
2002 2001
---- ----
(UNAUDITED)
OPERATING ACTIVITIES
Net loss ...................................................... $(15,889,000) $(38,643,000)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization ............................... 3,867,000 5,739,000
Provision for bad debts ..................................... (7,000) 6,120,000
Loss on asset impairment .................................... -- 1,153,000
Loss on sale of fixed assets ................................ 104,000 --
Amortization of stock-based compensation .................... 14,000 715,000
Deferred rent expense ....................................... -- 335,000
Changes in operating assets and liabilities:
Accounts receivable ...................................... (46,000) (11,000)
Unbilled receivables ..................................... 732,000 143,000
Other assets ............................................. 387,000 421,000
Accounts payable and accrued expenses .................... (4,213,000) (195,000)
Deferred revenues ........................................ (862,000) 297,000
------------ ------------
Net cash used in operating activities ......................... (15,913,000) (23,926,000)
INVESTING ACTIVITIES
Purchase of fixed assets ...................................... (308,000) (7,186,000)
Intangible assets ............................................. -- (104,000)
Other assets .................................................. (587,000) 1,918,000
Officer loans ................................................. -- (2,478,000)
------------ ------------
Net cash used in investing activities ......................... (895,000) (7,850,000)
FINANCING ACTIVITIES
Issuance of common stock ...................................... -- 22,000
Purchase of treasury stock .................................... (6,000) --
Proceeds from the sale of investment .......................... 13,000,000 --
Repayment of long-term debt ................................... -- (731,000)
------------ ------------
Net cash used in financing activities ......................... 12,994,000 (709,000)
Effect of exchange rate changes on cash and cash equivalents .. (416,000) 457,000
------------ ------------
Net decrease in cash and cash equivalents ..................... (4,230,000) (32,028,000)
Cash and cash equivalents, beginning of period ................ 21,635,000 93,408,000
------------ ------------
Cash and cash equivalents, end of period ...................... $ 17,405,000 $ 61,380,000
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid ................................................. -- $ 184,000
Income taxes paid ............................................. -- $ 392,000
SUPPLEMENTAL DISCLOSURE OF NON CASH INVESTING AND FINANCING
ACTIVITIES
Accrued costs for acquisitions ................................ -- $ 5,576,000
Shares issued for acquisitions ................................ -- $ 4,639,000
</Table>
See accompanying Notes to Unaudited Condensed Consolidated Financial
Statements.
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<Page>
STARMEDIA NETWORK, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR
MARCH 31, 2002
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 months ended
March 31, 2002 are not necessarily indicative of the results that may be
expected for the year ended December 31, 2002. The balance sheet at December 31,
2001 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 annual report on Form 10-K for the year ended
December 31, 2001.
The Company has incurred recurring operating losses and may have
insufficient capital to fund all of its obligations. These conditions raise
substantial doubt about the Company's ability to continue as a going concern.
The financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or the amounts
and classification of liabilities that may result from the outcome of this
uncertainty.
While management believes that additional financing or proceeds from the
sale of the Company's Internet media services business will be available, there
can be no assurance that the Company will obtain such additional capital or that
such additional financing will be sufficient for the Company's continued
existence. Furthermore, there can be no assurances that the Company will be able
to generate sufficient revenues from the operation of the mobile solutions
business to meet the Company's obligations.
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. 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.
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<Page>
The Company's unaudited restated 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):
<Table>
<Caption>
For the period ended
March 31, 2001
--------------------
As previously
Reported As restated
-------- -----------
Consolidated Statement
of Operations:
Revenues $ 16,039 $ 8,871
Sales and marketing 19,664 17,472
General and administrative 7,674 9,158
Loss from impairment of fixed assets -- 1,153
Total operating expenses 48,334 48,779
Loss from operations (32,295) (39,908)
Interest expense (184) (75)
Loss before provision for
income taxes (31,139) (38,643)
Provision for income taxes (87) --
Net Loss (31,226) (38,643)
Basic and diluted net loss
per Common Share $ (0.46) $ (0.57)
</Table>
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.
-8-
<Page>
3. BARTER TRANSACTIONS
A portion of the Company's revenues are derived from barter transactions
(agreements whereby the Company trades advertising on its Network or services in
exchange for advertising 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 Principals Board Opinion
No. 29, "Accounting for Non-monetary 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 by the unrelated party,
which is typically the same period when the barter revenues are recognized. For
the three months ended March 31, 2002 and 2001, revenue derived from advertising
barter transactions were approximately $319,000 and $3.1 million, respectively.
4. 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' (deficit) equity. The functional currency of the
Company's Venezuelan subsidiary which in a highly inflationary is the U.S.
dollar. Accordingly, the U.S. dollar is the functional currency, and 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 statement of operations.
5. STOCKHOLDERS' (DEFICIT) EQUITY
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 Bell South
Enterprises, Inc. ("BellSouth") and certain other investors resulting in total
proceeds of approximately $35.1 million 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
common stock, in an amount equal to $36.5 million, 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 $73,000 during the quarter ended March 31, 2002.
Dividends accrue at 6% per annum and totaled approximately $547,000 during the
quarter ended March 31, 2002.
During the quarter ended March 31, 2002, the Company repurchased 947
shares of its common stock in connection with the termination agreement of a
certain employee.
6. 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 three-month period ended March 31, 2002
and March 31, 2001 were approximately $14,000 and $715,000, respectively.
Diluted net loss per share does not include the effect of options and
warrants to 15,822,528 and 23,399,256 shares of common stock at March 31, 2002
and 2001, respectively. Diluted net loss per share for the three-months ended
March 31, 2002 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.
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<Page>
7. 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, the Company recorded during the
three months ended March 31, 2002 aggregate charges of approximately $347,000,
which includes severance payments to employees of the Company. Substantially all
restructuring and other charges previously accrued were paid during the quarter
ended March 31, 2002.
8. RELATED PARTY TRANSACTIONS
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 5), 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 $2.2 million 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 its placement agent "JP Morgan Ventures Corporation"
in connection with the aforementioned financing. Under the terms of the
agreement with "JP Morgan Ventures Corporation," 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' deficit due to the fact that the Company has not yet
filed such registration statement.
For the period ended March 31, 2002, the Company recognized $200,000 in
revenue, net of amortization for the warrants, in connection with the BellSouth
Strategic Agreement.
9. COMPREHENSIVE LOSS
Total comprehensive loss was approximately $16.3 million and $38.8 million
for the three months ended March 31, 2002, and three months ended March 31,
2001, respectively.
10. 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. 41 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. The
impact of adopting Statement 142 was to decrease the net loss and net loss per
share by $291,000 and $.004, respectively, for the three months ended March 31,
2002. 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 adoption of this statement had no material effect on
the Company's financial position and results of operations.
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<Page>
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 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 had no material effect on the Company's financial position and results
of operations.
11. 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.). 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:
<Table>
<Caption>
-----------------------------------------------------------------------------
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, et al. January 7, 2002
</Table>
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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 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
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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 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.
12. 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.
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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 recognize 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. Henceforth, the Company will operate 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, 2001 UNDER THE
CAPTION "RISK FACTORS" IN ADDITION TO THE OTHER INFORMATION SET FORTH HEREIN.
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 Bell South International under which the Company would
design and implement "multi-access portals" for Bell South's subsidiaries in
Latin America. At the same time, Bell South and several other investors invested
$35.1 million in the Company.
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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 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 formally change its
name to "CycleLogic, Inc." Any such change of name 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 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.
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-- 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 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 three months ended March
31, 2002, one advertiser accounted for more than 10% of total revenues and our
top five customers accounted for 45% 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.
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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
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 MARCH 31, 2002 AND MARCH 31,
2001
REVENUES
Total revenues decreased to $2.5 million for the three months ended March
31, 2002 from $8.9 million, for the three months ended March 31, 2001. This
decrease is mainly attributed to a decline in the volume of revenue-producing
advertising impressions and sponsorships. Barter revenue for the three months
ended March 31, 2002 and 2001 were 13% and 35%, respectively.
For the three months ended March 31, 2002, one advertiser accounted for
more than 10% of total revenues. For the three months ended March 31, 2001, two
advertisers, individually, accounted for more than 10% of our total revenues.
For the three months ended March 31, 2002, our top five customers
accounted for 45% of our total revenues. For the three months ended March 31,
2001, our top five customers accounted for 49% of our total revenues.
OPERATING EXPENSES
PRODUCT AND TECHNOLOGY
Product and technology expenses decreased to $7.5 million, or 308% of
total revenues, for the three months ended March 31, 2002, from $14.5 million,
or 164% of total revenues, for the three months ended March 31, 2001. This
decrease was primarily due to a decrease of approximately $3.7 million for
compensation-related expense, $1.4 million for consulting and contract fees,
and $1.2 million in hosting and content acquisition related expense.
SALES AND MARKETING
Sales and marketing expenses decreased to $2.2 million, or 88% of total
revenues for the three months ended March 31, 2002 from $17.5 million, or 197%
of total revenues for the three months ended March 31, 2001. This decrease was
primarily due to decreases of approximately $2.8 million in compensation-related
expense, $5.1 million in advertising expense, and $6.1 million for bad debt
reserve. We believe the Company has ample coverage for bad debt and will
continue to review the collectibility of our receivables.
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GENERAL AND ADMINISTRATIVE
General and administrative expenses decreased to $4.2 million, or 172% of
total revenues, for the three months ended March 31, 2002, from $9.2 million, or
103% of total revenues, for the three months ended March 31, 2001. The decrease
in general and administrative expenses was primarily attributed to decreases in
approximately $2.0 million in compensation-related expenses, approximately
$1.5 million in office rent and utilities due to a significant reduction in our
operating lease arrangements for the quarter ended March 31, 2001, and
approximately $1.0 million in miscellaneous expenses recorded for the quarter
ended March 31, 2001 in connection with the restatement.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expenses decreased to $3.9 million, or 158%
of total revenues, for the three months ended March 31, 2002, from $5.7 million
or 65% of total revenues, for the three months ended March 31, 2001. This
decrease is attributed to decreases in depreciation expense due to a reduction
in capital purchases, fixed asset impairment in year 2001, and the adoption of
FASB Statement 142, which states that goodwill and indefinite lived intangible
assets are no longer amortized but are reviewed annually, or more frequently if
impairment indicators arise, for impairment. Goodwill and intangibles were
impaired in 2001. For the period ended March 31, 2002, the Company reviewed and
assessed that there were no impairment for goodwill and intangibles.
STOCK-BASED COMPENSATION EXPENSE
Of the cumulative deferred compensation amount, $14,000 was recorded as an
expense for the three months ended March 31, 2002 compared with $715,000
recorded as expense for the three months ended March 31, 2001. 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.
INTEREST
Interest income includes income from our cash and investments. Interest
income decreased to $123,000 for the three months ended March 31, 2002 from $1.4
million for the three months ended March 31, 2001. Interest income decreased as
a result of a decrease in the average invested cash balance for the above
periods.
For the quarter ended March 31, 2002, the Company had no debts
outstanding, therefore, there was no interest expense recorded. For the quarter
ended March 31, 2001, $75,000 in interest expense was recorded.
LIQUIDITY AND CAPITAL RESOURCES
To date, we have financed our operations primarily through the sale of our
equity securities. At March 31, 2002, we had $17.4 million in cash and cash
equivalents, a decrease of $4.2 million from December 31, 2001.
We used $15.9 million in operating activities for the three months ended
March 31, 2002, a decrease from $23.9 million for the three months ended March
31, 2001 due to our efforts to reduce cost. Cash used in operating activities
substantially related to our loss of $15.9 million and $38.6 million during the
periods ended March 31, 2002 and March 31, 2001, respectively. For the three
months ended March 31, 2002, non-cash activities included $3.9 million in
depreciation and amortization. For the three months ended March 31, 2001,
non-cash activities were $5.7 million for depreciation and amortization, $6.1
million in loss on asset impairment, and $1.2 million in loss on sale of fixed
assets.
For the three months ended March 31, 2002, we used $895,000 in investing
activities, including $308,000 for purchase of fixed assets and $587,000 in
purchase of other assets. For the three months ended March 31, 2001, we used
$7.9 million in investing activities, including $7.2 million in purchase of
fixed assets, $2.5 million in advances to officers, offset by $1.9 million in
cash provided by release of letters of credit.
Net cash provided by (used in) financing activities was $13.0 million and
($709,000) for the three months ended March 31, 2002 and 2001, respectively. Net
cash provided by financing activities during the three months ended March 31,
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2002 consisted of cash from sale of investment in KD Sistemas. Net cash used by
financing activities during the three months ended March 31, 2001 consisted
primarily of repayment of long-term debt.
Our principal commitments consist of obligations outstanding under
operating leases.
We have experienced a substantial decrease in our capital expenditures
this past year and operating lease arrangements have been reduced significantly.
While we have reduced 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 an additional credit facility.
The sale of additional equity or convertible debt securities could 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. While management believes that additional financing or proceeds from the
sale of the Company's Internet media services business will be available, there
can be no assurance that the Company will obtain such additional capital or that
such additional financing will be sufficient for the Company's continued
existence. Furthermore, there can be no assurances that the Company will be able
to generate sufficient revenues from the operation of the mobile solutions
business to meet the Company's obligations. These conditions raise substantial
doubt about the Company's ability to continue as a going concern.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE 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.
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
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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.
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:
<Table>
<Caption>
-----------------------------------------------------------------------------
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, et al. January 7, 2002
</Table>
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
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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 owned
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 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.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) None.
(b) Reports on Form 8-K:
A Form 8-K was filed on January 8, 2002, reporting sale Cade?, a
popular Brazilian search engine and web directory acquired in 1999, to Yahoo!
Brasil, a property of Yahoo! Inc. (Nasdaq:YHOO), a global Internet
communications, commerce and media company. The financial terms of the
transaction were not disclosed.
A Form 8-K was filed on January 25, 2002, reporting the status of the
investigation by the Company's Special Committee and delisting by The Nasdaq
National Market. No financial statements were filed with this Current Report.
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)
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