FORM 10-QSB
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended: October 31, 1999
Or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number: 0-29290
STARNET COMMUNICATIONS INTERNATIONAL INC.
(Exact name of registrant as specified in its charter)
DELAWARE 52-2027313
(State of incorporation) (IRS Employer ID No.)
Newgate Street
PO Box 3265
St. John's, Antigua
West Indies
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (268) 480-1651
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
----- -----
As of October 31, 1999, the registrant had 31,226,507 shares of Common
Stock outstanding.
Transitional Small Business Disclosure Format (check one);
Yes No X
----- -----
The registrant meets the conditions set forth in General Instruction and is
therefore filing this Form with the reduced disclosure format.
<PAGE>
Part I - Financial Information
------------------------------
Item 1 - Financial Statements:
STARNET COMMUNICATIONS INTERNATIONAL INC.
CONSOLIDATED BALANCE SHEET
AS AT OCTOBER 31, 1999 AND APRIL 30, 1999
(in thousands of US dollars)
(UNAUDITED)
OCTOBER 31, OCTOBER 31,
1999 1998
- --------------------------------------------------------------------------
ASSETS
CURRENT
Cash and cash equivalents 8,162 5,000
Restricted cash 6,855 0
Accounts receivable 6,638 2,671
Prepaid expenses 621 149
Deposits 2,825 1,398
Other current assets 2,234 1,507
- --------------------------------------------------------------------------
TOTAL CURRENT ASSETS 27,335 10,725
- --------------------------------------------------------------------------
Capital assets (net) 3,258 1,673
Deferred website costs (net) 180 285
Software development costs (net) 473 610
Deferred income tax asset 150 146
- --------------------------------------------------------------------------
31,396 13,439
- --------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS'
EQUITY
CURRENT
Accounts payable and accrued liabilities 4,256 1,371
Income taxes payable 326 268
Deposits from customers 3,371 1,234
Deferred revenue 194 328
Current portion of capital lease
obligations 340 357
- --------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 8,487 3,558
- --------------------------------------------------------------------------
Non-current portion of capital lease
obligations 576 461
- --------------------------------------------------------------------------
TOTAL LIABILITIES 9,063 4,019
- --------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Capital stock 20,610 8,584
Retained earnings 1,838 884
Accumulated other comprehensive loss (115) (48)
- --------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 22,333 9,420
- --------------------------------------------------------------------------
31,396 13,439
- --------------------------------------------------------------------------
2
<PAGE>
STARNET COMMUNICATIONS INTERNATIONAL INC.
CONSOLIDATED STATEMENT OF INCOME
FOR THE PERIODS ENDING OCTOBER 31
(in thousands of US dollars except per share information)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------
(UNAUDITED) (UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
OCTOBER 31 OCTOBER 31
1999 1998 1999 1998
- -----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
REVENUE
Sales
Licensing 938 625 2,188 625
Royalties and fees 3,404 366 5,769 1,025
- -----------------------------------------------------------------------------
Total Sales 4,342 991 7,957 1,650
Cost of sales 931 218 1,797 434
- -----------------------------------------------------------------------------
GROSS MARGIN 3,411 773 6,160 1,216
- -----------------------------------------------------------------------------
EXPENSES
Development, selling, general and 3,003 763 5,339 1,289
administrative
- -----------------------------------------------------------------------------
Income (loss) from operations 408 10 821 (73)
- -----------------------------------------------------------------------------
Other income (expenses) 52 39 81 19
- -----------------------------------------------------------------------------
Net income from continuing operations 460 49 902 (54)
before income taxes
- -----------------------------------------------------------------------------
Income tax expense (recovery)
Current 53 (74) 53 (74)
Deferred 0 0 0
- -----------------------------------------------------------------------------
Income taxes 53 (74) 53 (74)
- -----------------------------------------------------------------------------
Income from continuing operations 407 123 849 20
Income (loss) from discontinued operations
of the on-line Interactive media
division (less applicable income taxes
of 1999 - $45 and 1998 - nil) (66) 124 105 330
- -----------------------------------------------------------------------------
NET INCOME FOR THE PERIOD 341 247 954 350
Retained earnings (deficit), beginning
of period 1,497 (1,055) 884 (1,158)
- -----------------------------------------------------------------------------
RETAINED EARNINGS (DEFICIT),
END OF PERIOD 1,838 (808) 1,838 (808)
- -----------------------------------------------------------------------------
Basic earnings per share from continuing
operations $ 0.01 $ 0.01 $ 0.03 $ -
Basic earnings per share $ 0.01 $ 0.01 $ 0.03 $ 0.02
Weighted average number of common
shares Outstanding 30,483,604 22,450,000 29,054,349 22,450,000
Diluted earnings per share from
continuing operations $ 0.01 $ 0.01 $ 0.03 $ -
Diluted earnings per share $ 0.01 $ 0.01 $ 0.03 $ 0.01
Weighted average number of common
shares outstanding for diluted
earnings per share 33,259,232 22,450,000 33,174,185 22,450,000
</TABLE>
3
<PAGE>
STARNET COMMUNICATIONS INTERNATIONAL INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE PERIODS ENDING OCTOBER 31
(in thousands of US dollars)
<TABLE>
<CAPTION>
(UNAUDITED) (UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
OCTOBER 31 OCTOBER 31
1999 1998 1999 1998
- -----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income 341 247 954 350
Adjustments to reconcile net income to
net cash provided by operating
activities:
Depreciation 384 165 646 332
Amortization of deferred website costs 70 113 106 245
Amortization of software development
costs 69 40 138 80
Gain on disposal of fixed assets 0 (4) 0 (4)
Changes in current assets and liabilities:
Decrease (increase) in accounts
receivable (1,862) (272) (3,968) (469)
Decrease (increase) in prepaid
expenses (229) 77 (472) 76
Decrease (increase) in other assets 8 0 (727) 0
Increase (decrease) in accounts
payable and accrued liabilities 2,266 11 2,886 101
Increase (decrease) in income taxes
payable 14 (74) 58 (74)
Increase (decrease) in deposits
from customers 1,700 (105) 2,136 204
Increase (decrease) in deferred
revenue (128) 32 (134) 18
- -----------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) 2,633 230 1,623 859
OPERATING ACTIVITIES
- -----------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of capital assets (1,411) (78) (1,939) (177)
Deferred website costs 0 (130) 0 (299)
Software development costs 0 (166) 0 (248)
Deposits (1,297) 2 (1,426) (36)
- -----------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) (2,708) (372) (3,365) (760)
INVESTING ACTIVITIES
- -----------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Increase) decrease in bank indebtedness 0 5 0 (7)
Proceeds from loan 0 73 0 73
Proceeds from issuance of shares 3,134 0 12,027 0
Principal repayments under capital (38) (54) (189) (112)
lease obligations
- -----------------------------------------------------------------------------
NET CASH PROVIDED BY FINANCING 3,096 24 11,838 (46)
ACTIVITIES
- -----------------------------------------------------------------------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (142) 17 (79) 80
- -----------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH 2,879 (101) 10,017 133
DURING THE PERIOD
Cash, beginning of period 12,138 374 5,000 140
- -----------------------------------------------------------------------------
CASH, END OF PERIOD 15,017 273 15,017 273
- -----------------------------------------------------------------------------
OTHER NON-CASH TRANSACTIONS
Leased assets acquired 0 0 282 0
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid 19 24 29 49
Income tax paid 0 0 0 0
</TABLE>
4
<PAGE>
Item 2. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(All figures are in thousands of US dollars)
RESULTS OF OPERATIONS
- ---------------------
General
- -------
Until the end of fiscal 1998, the Company derived its revenues principally
from its Internet web sites, namely Sizzle, Chisel and Redlight. Through
substantial research in the past two years, the Company identified the
opportunity of offering gaming services over the Internet and successfully
launched its gaming products in March 1998.
The Company's Internet casino, which targets only customers outside North
America, is operated by its subsidiary, World Gaming Services Inc. of
Antigua. Starnet Systems International Inc. (formerly Softec Systems
Caribbean Inc.), also of Antigua, licenses its gaming software to third
parties for a set up fee and monthly royalty. Since the beginning of fiscal
1999, revenues from all components of the gaming business, which include
licensing, casino operations and financial transaction processing, have
undergone tremendous growth and represented a majority of revenues in the
last fiscal year. As revenues from Internet gaming continue to grow, the
Company decided in August 1999 to focus on the Internet gaming business by
divesting itself from the adult entertainment industry completely. As a
result, income from Internet adult entertainment is classified as income
from discontinued operations and comparable figures have been adjusted
accordingly. The Company has identified potential purchasers and hopes to
finalize a sale of the division in the near future.
The following tables set forth selected information from the statements of
operations for the three months ended October 31, 1999 and 1998 and the
balance sheets as at October 31, 1999 and April 30, 1999.
Selected Statement of Operations Information
- --------------------------------------------
For three months ended
October 31, 1999 October 31, 1998
---------------- ----------------
Net Sales 4,342 991
Gross Margin 3,411 773
Operating Expenses 3,003 763
Income from continuing operations 407 123
Income (loss) from discontinued
operations (66) 124
Net Income 341 247
5
<PAGE>
Selected Balance Sheet Information
- ----------------------------------
At October 31, 1999 At April 30, 1999
------------------- -----------------
Cash and Cash Equivalents 8,162 5,000
Restricted Cash 6,855 0
Working Capital 18,848 7,167
Total Assets 31,396 13,439
Long Term Debt 576 461
Retained Earnings 1,838 884
Total Shareholders' Equity 22,333 9,420
The Company's revenues increased 338% to $4,342 for the three months ended
October 31, 1999 compared to $991 for the three months ended October 31,
1998. The revenue for the quarter increased 20% from the first quarter
ended July 31, 1999 revenue of $3,615. The growth is primarily due to the
increase in the number of licensees and licensees' revenues. Licensing fees
fell slightly in the quarter to $938 from $1,250 in the first quarter of
the current fiscal year. However, royalties and fees rose 44% from $2,365
in the first quarter to $3,404 in the current quarter. The Company expects
revenues to continue to grow in the next quarter.
At October 31, 1999, the Company had completed the software for 43
licensees, but some of these licensees were not in operation pending
confirmation of their gaming licenses. In June 1999, the Company terminated
the licensing agreement with one of its largest licensees due to non-payment
of the on-going royalty. At October 31, 1999, the receivable from
this terminated licensee amounted to approximately $250 for which an
allowance has been made. Legal action has already been taken in an attempt
to collect the outstanding balance from this licensee. The Company does not
expect the loss in revenues from this licensee to be significant as more
licensees commence operations and revenues of their casino operations increase.
Along with the growth in sales, gross margin increased to $3,411 for the
quarter ended October 31, 1999 from $773 for the comparable quarter. Gross
margin is steady at 78% for the quarters ended October 31, 1999 and 1998.
Operating expenses increased by 294% to $3,003 for the quarter ended
October 31, 1999 from $763 for the prior year quarter. However, as a
percentage of sales, operating expenses decreased from 77% to 69% as a
result of substantial revenue growth and efficiencies gained as the Company
handled a greater level of activity.
Included in these operating expenses are costs related to development of an
improved version of the Company's gaming software. Under generally
accepted accounting principles, these
6
<PAGE>
costs cannot be capitalized, but are estimated to be $500 for the six
months ended October 31, 1999.
Part of the increase in operating costs for the current quarter is due to
legal costs incurred by the Company to defend a lawsuit from a former
licensee and an investigation by the Canadian authorities into its business
activities. In the current quarter, the company has incurred approximately
$200 in legal fees for these matters. The Company expects both of these
matters to not have a long-term detrimental effect on the operations of the
Company.
The Company also experienced a disruption in the processing of credit cards
for payments related to its adult division. This caused a decrease in
revenue in September and October and resulted in a loss from discontinued
operations for the quarter. The problems have been resolved and the
Company is continuing efforts to recover at least a portion of lost revenues.
The tax provision recorded in the quarter relates to the operations of the
Company in Canada. The majority of its operations occur in jurisdictions
where there is no income tax. A portion of the tax relates to income
generated from the adult entertainment business and an income tax expense
of $45 was recorded in the income from discontinued operations for the
first quarter of 1999.
Net income from continuing operations for the quarter ended October 31,
1999 was $407, compared to $123 for the prior year quarter. This is down
slightly from the first quarter ended July 31 of $442. Net income for the
quarter ended October 31, 1999 was $341 , compared to $247 for the prior
year quarter.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
At October 31, 1999, the Company had $15,017 in cash and cash equivalents
compared to $5,000 at April 30, 1998. The increase in cash balance is
mainly a result of the exercise of stock options and warrants in the six
months ended October 31, 1999. Due to the investigation by Canadian
authority of the business operations of the Company, two of the Company's
bank accounts with a Canadian bank were frozen on August 25, 1999 pursuant
to an interim Restraint Order granted by the Honourable Associate Chief
Justice. The amount affected totaled approximately $6.9 million. Despite
the fact that the interim restraint order is slowing down the Company's
expansion plan, it does not prevent the Company from continuing its
operations. The Company is appealing the decision of the Court to refuse to
revoke the interim Restraint Order.
Working capital at October 31, 1999 increased significantly to $18,848 from
$7,167 at April 30, 1999. Accounts receivable increased from $2,671 at
April 30, 1999 to $6,638 at October 31, 1999. The majority of the
receivables are from new licensees that were offered an installment payment
plan on the initial licensing fees and from operating licensees that have
their own merchant accounts. Other current assets at October 31, 1999
amounted to $2,234 compared to $1,507 at April 30, 1999. The increase is
mainly due to prepayments made to the Antiguan government for the purchase
of additional casino licenses. The casino licenses are held for sale to
prospective licensees.
7
<PAGE>
Net cash generated from operations for the three months ended October 31,
1999 was $1,109 compared to $230 for the three months ended October 31,
1998. In the current year, the increase in accounts receivable was more
than offset by increases in deposits from customers and increases in
payables to licensees from the increased activity of the gaming operations.
Net cash used for investing activities for the quarter ended October 31,
1999 was $1,182 compared to $372 for the prior year quarter. The increase
in cash used is mainly due to purchases of capital assets to cope with
increased volume.
Net cash provided by financing activities for the three months ended
October 31, 1999 was $3,096 compared to $24 for the three months ended
October 31, 1998. The increase was from the proceeds of the exercise of
stock options and warrants.
Impact of Inflation
- -------------------
The Company believes that inflation has not had a material effect on its
past business.
Part II - Other Information
---------------------------
Item 1 - Legal Proceedings
The following are existing legal claims against the Company:
Her Majesty the Queen in Right of Canada
A claim has been made by Her Majesty against The Company for the sum
of approximately $7 million (U.S.). The basis for the claim is that these
funds are proceeds of crime and accordingly should be forfeited to the
Crown.
Las Vegas Casino Inc.
Claimant: Las Vegas Casino Inc.
Defendant: The Company and other defendants
Court: Supreme Court of British Columbia Action number C994793 Vancouver
Registry
Claim: Damages, Exemplary Damages, Declaration, Accounting, Interest and
Costs.
The plaintiff alleges that:
1. A subsidiary of the Company, Softec Systems Caribbean Inc. wrongfully
terminated its license agreement and that it has suffered a loss thereby;
8
<PAGE>
2. The Company or its subsidiaries wrongfully failed to pay to it monies
that its gambling web sites generated; and
3. The software provided by the Company or its subsidiaries was defective
and it lost business as a result of the problems associated with it.
U. S. class action claims
A: Action Number: 99-702 United States District Court
District of Delaware
Plaintiff: Manuel Jankovits
Defendants The Company
John Carley
Mark Dohlen
Christopher H. Zacharias
B: Action number: 99-716 United States District Court
District of Delaware
Plaintiff: Philip J. Pendery
Defendants The Company
Same as above plus Jason King
C: Action Number: 99-750 United States District Court
District of Delaware
Plaintiff: Vinh Nguyen
Defendants: The Company
Same as above plus Jason King
D: Action Number: 99-758 United District Court
District of Delaware
Plaintiff: On-Site Trading Inc.
Defendants: The Company
Same as above
9
<PAGE>
E. Action Number: 99-7994 United States District Court
District of Delaware
Plaintiff: Jeff Moore
Defendants: The Company
Same as above
F. Action Number: 99-806 United States District Court
District of Delaware
Plaintiff: Paul Matinez
Defendants: The Company
Same as above plus Jason King
G. Action Number: 99-817 United States District Court
District of Delaware
Plaintiff: Joseph Guisinger
Defendants: The Company
Same as above
H. Action Number: 99-852 United States District Court
District of Delaware
Plaintiff: Terry Perrine
Defendants: The Company
Same as above
I. Action Number: 99/845 United States District Court
District of Delaware
Plaintiff: Robert Reynolds
Defendants: The Company
Same as above
J. Action number 99-681 United States District
Plaintiff Alan Fenster
Defendants The Company
John Carley
Mark Dohlen
Christopher Zacharias
10
<PAGE>
The basis for all of the U.S. claims is similar in that the plaintiffs
generally allege that the Company:
1. Failed to properly advise its investors of the risks associated with its
business;
2. Misled its investors as to the risks associated with its business;
3. Mislead its investors by telling them that it was not allowing gambling
within Canada and the United States when it in fact was; and
4. Mislead its investors by telling them that their business was legal
within Canada and the United States when it was not.
In each of the above U.S. class action claims the plaintiffs are
requesting the following relief:
1. Declaration of a class;
2. Damages for the class; and
3. Costs for the class.
Item 5 - Other Information
Kyl Bill
- --------
The Internet Gambling Prohibition Act of 1999 (Kyl Bill) passed by the U.S.
Senate on November 22, 1999 (and its counterpart in the House, the
Goodlatte Bill) could have a negative affect on certain Internet companies
involved in the online gaming business if passed into law. A previous
version of the Kyl Bill passed the U.S. Senate last year but did not become
law.
There are many objections to the Kyl Bill, including the impracticality of
enforcement, the infringement on constitutional protections of freedom of
expression and the potential threat it poses to the overall development of
e-commerce and the Internet.
The Kyl Bill contains several exemptions that provide special protections
to horse racing, dog racing, state lotteries, Indian tribes, hotel-casinos
and fantasy leagues. These exemptions may lay the groundwork for special
protections for other companies on the Internet.
Starnet is developing products (such as Internet Horse Racing) which will
allow its licensees to generate revenues from Internet-based gaming
activities that will fit within the exemptions of the Kyl Bill.
11
<PAGE>
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibit No. Description
----------- -----------
27 Financial Data Schedule
(b) The Company filed reports on Form 8-K on August 27, 1999 and
November 2, 1999 and on Form 8-KA on September 9, 1999.
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.
STARNET COMMUNICATIONS INTERNATIONAL INC.
(Registrant)
Date: December 15, 1999 /s/ MELDON ELLIS
-----------------------------------
Meldon Ellis
President and Secretary/Treasurer
Date: December 15, 1999 /s/ JOHN CARLEY
-----------------------------------
John Carley
Chief Financial Officer
12
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> APR-30-2000
<PERIOD-START> MAY-01-1999
<PERIOD-END> OCT-31-1999
<CASH> 15,017,000
<SECURITIES> 0
<RECEIVABLES> 6,888,000
<ALLOWANCES> 250,000
<INVENTORY> 0
<CURRENT-ASSETS> 27,335,000
<PP&E> 5,352,000
<DEPRECIATION> 2,094,000
<TOTAL-ASSETS> 31,396,000
<CURRENT-LIABILITIES> 8,487,000
<BONDS> 0
0
0
<COMMON> 20,610,000
<OTHER-SE> 1,723,000
<TOTAL-LIABILITY-AND-EQUITY> 31,396,000
<SALES> 7,957,000
<TOTAL-REVENUES> 7,957,000
<CGS> 0
<TOTAL-COSTS> 7,136,000
<OTHER-EXPENSES> (81,000)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 29,000
<INCOME-PRETAX> 902,000
<INCOME-TAX> 0
<INCOME-CONTINUING> 849,000
<DISCONTINUED> 105,000
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 954,000
<EPS-BASIC> 0.032
<EPS-DILUTED> 0.029
</TABLE>
