<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDING SEPTEMBER 30, 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: 000-13627
STARNET FINANCIAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 75-2168244
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
17000 PRESTON ROAD, SUITE 350, DALLAS, TEXAS 75248
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code: 972-239-2939
Sarkis Capital, Inc., 421 East Airport Freeway, Irving, Texas 75062
-------------------------------------------------------------------
(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 filed such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
The number of shares of Common Stock of the Registrant, par value $.01 per
share, outstanding at November 15, 1999 was 14,876,473.
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT (CHECK ONE):
X Yes No
--- ---
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STARNET FINANCIAL, INC. FORM 10-QSB
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
INDEX
<TABLE>
<S> <C>
PART I -- FINANCIAL INFORMATION
Item 1 -- Financial Statements
General Information............................................................................... 1
Risk Factors...................................................................................... 3
Consolidated Balance Sheet........................................................................ 7
Consolidated Statement of Operations.............................................................. 8
Consolidated Statement of Stockholders' Equity.................................................... 9
Consolidated Statement of Cash Flows.............................................................. 10
Notes to the Consolidated Financial Statements.................................................... 11
Item 2 -- Management's Discussion and Analysis of Financial Condition and
Plan of Operations.......................................................................... 15
PART II -- OTHER INFORMATIOn
Item 1 -- Legal Proceedings....................................................................... 17
Item 2 -- Changes in Securities and Use of Proceeds............................................... 17
Item 3 -- Defaults Upon Senior Securities......................................................... 17
Item 4 -- Submission of Matters to a Vote of Security Holders..................................... 17
Item 5 -- Other Information....................................................................... 17
Item 6 -- Exhibits and Reports on Form 8-K........................................................ 17
Signature......................................................................................... 18
</TABLE>
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STARNET FINANCIAL, INC.
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
GENERAL INFORMATION
StarNet Financial, Inc. (the "Company" or "StarNet") is engaged in the
business of originating, purchasing and selling mortgage loans secured primarily
by single-family and condominium residences through traditional distribution
channels and over the Internet. The Company:
o originates mortgage loans through the Company's "net branches"
located across the United States and through exclusive programs with
various homebuilding companies;
o conducts wholesale loan originations and processing operations using
a nationwide network of independent mortgage loan brokers;
o originates sub-prime mortgage loans; and
o conducts direct consumer mortgage loan origination over the Internet.
Investors purchase conforming loans (generally those borrowers with perfect or
good credit) and non-conforming loans (generally below average and delinquent
credit) that have been originated or purchased by StarNet. StarNet pools and
sells these loans to institutional investors. StarNet also sells individual
loans to such investors. StarNet is currently exempt from licensing or licensed
to originate, purchase closed loans, underwrite, and fund or sell residential
mortgage loans in 25 states.
U.S. Residential Mortgage Banking Industry Overview
The Mortgage Bankers Association estimates the United States mortgage
market to total over $4.3 trillion in terms of loans outstanding and projects
mortgage originations to be $1.2 trillion in 1999. The mortgage industry is
divided broadly into four major segments today:
o mortgage origination -- sourcing, verifying and documenting of
mortgage loans, typically done by mortgage brokers and single-source
lenders;
o mortgage funding -- underwriting, funding and selling closed loans to
mortgage loan purchasers;
o securitization -- aggregating loans for sale into the secondary
market; and
o servicing -- ongoing billing, collection and foreclosure/collateral
management.
Over the past two decades, the mortgage industry has evolved dramatically.
Until the late 1970's, the mortgage market was primarily a captive banking
market, where retail banks and savings and loan institutions originated loans
through their branches, underwrote and closed loans internally, funded loans
from their own customer deposits and then serviced the loans themselves. This
internal chain of production was broken by the emergence of the pure mortgage
bank that could buy mortgages from mortgage brokers and sell to
government-sponsored mortgage investors, such as Fannie Mae and Freddie Mac,
and the development of a large, liquid secondary funding and trading market for
mortgage debt. This efficient new market for mortgage funding made it viable
for the first time to uncouple from the large retail banks both the front-end
functions of mortgage origination and mortgage funding and the back-end
function of servicing mortgages.
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Now with the emergence of the Internet as a viable means of conducting
electronic commerce, the mortgage banking industry has made great efforts to
utilize this non-traditional distribution channel to increase the amount of
originated mortgages. According to Forrester Research, the market for on-line
mortgage originations is expected to grow from an estimated $18.7 billion in
1999 to over $91.2 billion in 2003, representing an increase in the percentage
of the existing mortgage market conducted over the Internet from 1.5% in 1999
to 9.6% in 2003. Mortgage origination is well-suited to an Internet-based
distribution model for a number of reasons, including:
o mortgages are information products that need no physical delivery or
warehousing;
o complex mortgage products can be made more understandable through the
use of graphical and dynamic real-time presentations, including
explanations of terminology and easy access to detailed supporting
information;
o borrower data can be efficiently captured through an Internet
website, allowing real-time automated underwriting and streamlined
overall mortgage application processing; and
o costly local offices or brokers and the expensive fee structure
associated with the traditional mortgage distribution model are no
longer required.
StarNet believes that in addition to traditional distribution channels
(such as regional offices and brokers), there exists a significant market
opportunity for a centralized, nationally accessible and simple-to-use on-line
service with a broad selection of products, a compelling value proposition
based upon saving borrowers money, time and effort, and an open, integrated
service that provides complete transaction fulfillment. StarNet's on-line
service will differ from those of its competitors in that it will offer a
variety of products from a number of lenders and allow the customer to complete
the mortgage application process on-line instead of merely being a referral
service where customers can only compare interest rates and costs of various
lenders or are limited to the products of a single lender.
Subsidiaries and Divisions
StarNet is comprised of three wholly owned subsidiaries and two distinct
operating divisions involved in mortgage loan origination, underwriting and/or
processing:
o StarNet Mortgage, Inc. This subsidiary originates mortgage loans
using the Company's "net branches" located across the country.
o The GM Group, Inc. (d/b/a StarNet Retail) This subsidiary markets
mortgage loan products through exclusive programs with various
homebuilding companies.
o StarNet TRAkkER, Inc. The Company intends for this subsidiary to
originate sub-prime mortgage loans.
o StarNet Funding This division conducts wholesale loan originations
and processing operations via a nationwide network of independent
mortgage loan brokers.
o StarNet Loans.com This division conducts direct consumer mortgage
loan origination via the Internet.
Background
StarNet (formerly known as Sarkis Capital, Inc.("Sarkis")) was
incorporated in March 1987, in Delaware. On May 13, 1999, Sarkis entered into
an exchange agreement with LoanNet, Inc., a
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Texas corporation ("LoanNet") and the shareholders of LoanNet, whereby Sarkis
agreed to acquire LoanNet, and its subsidiary, The GM Group, Inc., a Texas
corporation (sometimes referred to herein as "GM") from the LoanNet shareholders
in exchange for shares of Sarkis common stock (the "Exchange Agreement").
Pursuant to the Exchange Agreement, Sarkis issued 9,000,000 shares of its common
stock in exchange for all of the outstanding shares of LoanNet. The closing of
the Exchange Agreement took place on May 28, 1999. As part of the
reorganization, Sarkis changed its name to "StarNet Financial, Inc." in June
1999. The transaction was accounted for as a reverse merger.
StarNet's principal executive office is located at 17000 Preston Road,
Suite 350, Dallas, Texas 75248 and its telephone number is (972) 239-2939.
RISK FACTORS
The Company has only recently begun operations and is presently incurring
losses.
Typical of a development-stage company, the Company's ability to generate
revenue is subject to substantial uncertainty and risk. In addition, the
Company anticipates that its operating expenses will increase substantially in
the foreseeable future as it opens additional regional and net branch offices
and increases its sales and marketing activities. Accordingly, the Company
expects to incur losses at least through the first three quarters of fiscal
year 2000 and may continue to incur losses for some time thereafter. There can
be no assurance that the Company will be able to achieve or sustain operating
profitability. The success of the Company may ultimately depend on management's
ability to react expeditiously to exigencies that have not been taken into
account in the Company's business plan.
The results of the Company's operations will be affected by various factors and
subject to certain risks inherent in mortgage lending, many of which are beyond
the control of the Company, including general economic conditions and interest
rate levels.
The Company's business may be adversely affected by periods of economic
slowdown or recession which may be accompanied by decreased demand for consumer
credit and declining real estate values. Any material decline in real estate
values reduces the ability of borrowers to use home equity to support
borrowings and increases the loan-to-value ratios of loans previously made by
the Company, thereby weakening collateral coverage and increasing the
possibility of a loss in the event of default. Further, delinquencies,
foreclosures, and losses generally increase during economic slowdowns or
recessions.
Any sustained period of such increased delinquencies, foreclosures or
losses could adversely affect the pricing of the Company's loan sales. While
the Company believes the underwriting criteria and collection methods it
utilizes enable it to mitigate the higher risks, no assurance can be given that
such criteria or methods will afford adequate protection against such risk.
Fluctuations in interest rates and increases and decreases of the prime
rate may directly impact the mortgage market and the ability of the Company to
attract "A" or "B/C" or other classes of mortgage loans. If interest rates
should rise, the number of applications for new mortgages may decrease. The "A"
mortgage market is primarily composed of borrowers who are interest-rate-driven
or for purchasing homes; that is, "A" mortgage borrowers refinance current
mortgages for ones with lower interest rates and otherwise more favorable
terms. As interest rates increase, such refinancing and purchase activities
diminish and the number of loan applications in the "A" market decrease. The
"B/C" market is primarily comprised of borrowers who are payment-driven with a
use of the mortgage loan as a source of equity. Often a goal of the "B/C"
borrower is to leverage available equity for immediate use, and despite
increases in interest rates, the "B/C" borrower focuses primarily on the amount
of the monthly payment. Thus, the decrease in loan applications in the
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"B/C" market which may occur when interest rates increase, is typically not as
significant as in the "A" mortgage market. However, since the Company intends to
originate in the "A" mortgage market, there can be no assurance that in the
event that interest rates rise, that such a rise will not have a negative impact
on the Company's financial position by causing fewer "A" mortgages to be
processed by the Company.
Mortgage lending is a highly competitive business, and the Company's results
will be dependent upon the success of its marketing efforts and its ability to
attract and retain key personnel.
As a marketer of mortgage loans, the Company faces intense competition,
primarily from mortgage banking companies, commercial banks, credit unions,
thrift institutions, and finance companies. Many of these competitors are
substantially larger and have more capital and other resources than the
Company. Competition can take many forms, including convenience in obtaining a
loan, customer service, marketing and distribution channels, and interest
rates. Furthermore, the Company depends largely on real estate brokers,
homebuilders, visitors to its Internet website, independent mortgage brokers,
financial institutions and other mortgage bankers for its originations and
purchases of new loans. The Company's competitors also use the Internet to
obtain originations and purchases of new loans and also seek to establish
relationships with the Company's independent mortgage brokers, financial
institutions, and other mortgage bankers, none of whom is obligated by contract
or otherwise to continue to do business with the Company. Competition may be
affected by fluctuations in interest rates and general economic conditions.
During periods of rising interest rates, competitors which have "locked-in" low
borrowing costs may have a competitive advantage. During periods of declining
interest rates, competitors may solicit the Company's customers to refinance
their loans. During economic slowdowns or recessions, the Company's borrowers
may have new financial difficulties and may be receptive to offers by the
Company's competitors.
The Company's success also depends in large part on the efforts and
abilities of its senior management, including Daniel L. Jackson, Chief
Executive Officer, Kenneth F. Urbanus, Chief Operating Officer and President,
Michael J. Gulinson, Chief Financial Officer, Edward P. Dayton, Executive Vice
President, Tom Deutsch, Executive Vice President, and Jennifer Salsbury,
Executive Vice President. The loss of one or more of these individuals could
adversely affect the Company's business.
The Company also believes that its future success depends in part on its
ability to continue to attract and retain highly skilled employees. The Company
may be unable to continue to employ our key personnel or to attract and retain
qualified personnel in the future. The Company's future success depends on its
continuing ability to identify, hire, train and retain highly qualified
technical, sales, marketing and customer service personnel.
The substantial growth projected by the Company, if achieved, must be
efficiently and effectively managed.
The Company's growth has placed, and will likely continue to place, a
significant strain on its managerial, operational and financial resources. The
Company needs to:
o Improve its financial and management controls, reporting systems and
procedures
o Expand, train and manage its work force for marketing, sales and
support and website development and design
o Manage multiple relationships with various customers and other third
parties
The loss of key purchasers of the Company's loans or a reduction in prices paid
could adversely affect its financial condition.
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The Company sells substantially all of the mortgages it originates to
institutional buyers. Generally, the Company sells the servicing rights to its
loans at the time it sell those loans. In the first six months of 1999, 100% of
the loans the Company sold were sold to three financial institutions, all of
which compete with the Company directly for retail originations. If these
financial institutions or any other significant purchaser of the Company's
loans cease to buy its loans or servicing rights and equivalent purchasers
cannot be found on a timely basis, then the Company's business and results of
operations could be materially adversely affected. The Company's results of
operations could also be affected if these financial institutions or other
purchasers lower the price they pay to the Company or adversely change the
material terms of their loan purchases from the Company.
The prices at which the Company sells its loans vary over time. A number
of factors determines the price the Company receives for its loans. These
factors include:
o the number of institutions that are willing to buy the Company's
loans;
o the amount of comparable loans available for sale;
o the levels of prepayments of, or defaults on, loans;
o the types and volume of loans the Company sells;
o the level and volatility of interest rates; and
o the quality of the Company's loans.
The prices at which the Company can sell its mortgage servicing rights vary
over time and may be materially adversely affected by a number of factors,
including the general supply of and demand for mortgage servicing rights and
changes in interest rates. Servicing rights for a particular loan category that
was originated at higher interest rates tend to have a lower value than those
originated with comparatively lower interest rates due to the greater
likelihood that loans with higher interest rates will be prepaid more quickly.
Because the Company's ability to fund mortgage loans depends on the
availability of financing sources, its revenues and business would be
negatively affected if its current financing sources were canceled or not
renewed.
The Company's ability to make mortgage loans depends largely on its
ability to secure financing on acceptable terms. Currently, the Company funds
substantially all of its loans through its warehouse facility and under loan
purchase and sale agreements with three commercial banks. Each of these
financing arrangements provides for termination upon 30 day notice. The
Company's financing facilities require it to observe financial and other
covenants. If the Company is not able to renew any of these financing
arrangements or arrange for new financing on terms acceptable to it, or if it
defaults on its covenants and is unable to access funds under any of these
arrangements, then it will have to reduce its mortgage originations, which
would reduce its revenues.
Mortgage lending is a regulated industry at the federal level and in many
states. The Company must become compliant and maintain our compliance with
federal and state laws and regulations.
The United States Congress and other governmental officials have
occasionally suggested the elimination of the home mortgage interest deduction
for federal income tax purposes, either in part or entirely, based on borrower
income levels, type of loan or principal amount of loan. The competitive
advantages of tax-deductible interest, when compared with other sources of
financing,
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could be eliminated or seriously impaired by such government action.
The Company's business is subject to extensive regulation, supervision and
licensing by federal, state and local governmental authorities and is subject
to various laws and judicial and administrative decisions imposing requirements
and restrictions on part or all of its operations. The Company is subject to
the rules and regulations of, and examinations by, the United States Department
of Housing and Urban Development ("HUD") and state regulatory authorities with
respect to originating, processing, underwriting and selling loans. These rules
and regulations, among other things, impose licensing obligations on the
Company, establish eligibility criteria for mortgage loans, prohibit
discrimination, provide for inspections and appraisals of properties, require
credit reports on loan applications, regulate assessment, collection,
foreclosure and claims handling, investment and interest payments on escrow
balances and payment features, mandate certain disclosures and notices to
borrowers and, in some cases, fix maximum interest rates, fees and mortgage
loan amounts. Failure to comply with these requirements can lead to demands for
indemnifications or mortgage loan repurchases, certain rights of rescission for
mortgage loans, class action lawsuits and administrative enforcement actions.
Although the Company believes that it has the necessary systems and
procedures to facilitate compliance with these requirements and believes that
it is in compliance in all material respects with applicable local, state and
federal laws, rules and regulations, there can be no assurance that more
restrictive laws, rules and regulations will not be adopted in the future that
could make compliance more difficult or expensive.
The Company also intends to provide residential mortgage lending services
to customers located throughout the United States through its website. As a
result, it may be required to qualify to do business or be subject to tax or
other laws and regulations in these jurisdictions even if it does not have a
physical presence or employees or property in these jurisdictions. The
application of these multiple sets of laws and regulations is uncertain, and
the Company could find that it is subject to regulation, taxation, enforcement
or other liability in unexpected ways, which could materially adversely affect
its business, financial condition and results of operations.
The Company must remain current with rapidly changing technologies.
The Company will need to continually expand and upgrade its infrastructure
and systems in order to ensure high levels of service and reliability. Its
current and planned personnel, financial and operating procedures and controls
may not be adequate to support its future operations.
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STARNET FINANCIAL, INC.
CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 1999
(UNAUDITED)
<TABLE>
<S> <C>
ASSETS
Cash 1,686,247
Mortgage Loans Held for Sale 5,679,149
Accounts Receivable 1,345,670
Property, plant and equipment, Net 161,340
Investment property 300,000
Goodwill, Net 535,106
Organization Costs, Net 196,555
Total Assets 9,914,067
=========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Advances under Warehouse Lines of Credit 5,679,149
Accounts payable 669,538
Accrued Expenses 416,513
Funds Held on Account for Others 103,825
Total Liabilities 6,869,025
---------
Stockholders' Equity:
Preferred stock, Authorized 1,000,000 Shares;
Issued and Outstanding, None --
Common stock, Authorized 20,000,000 Shares;
Issued and Outstanding 14,626,473 Shares;
par value, $0.01 146,265
Additional paid-in capital 4,121,281
Subscription Receivable on Common Shares (186,000)
Retained earnings (1,036,505)
Total Stockholders' Equity 3,045,042
---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY 9,914,067
=========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
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STARNET FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, 1999 September 30, 1999
------------------ ------------------
<S> <C> <C>
Gross Revenue 397,254 958,305
Expenses:
Salaries and Benefits 404,955 1,193,220
Travel & Entertainment 23,312 56,349
Office Occupancy Expenses 59,197 208,895
Advertising, Dues & Business
Promotion 29,057 45,386
Loan Processing Expenses 32,284 117,796
Consulting & Contract Services 27,144 120,533
Legal & Professional Services 18,749 20,831
Insurance 17,346 19,710
Investment Property Expenses 3,249 4,558
Interest 37,340 57,960
Depreciation & Amortization 5,282 52,672
Other Expenses 11,027 51,647
Total expenses 668,942 1,949,557
Net Income from operations (271,688) (991,252)
Provision for Income Taxes 2,259 --
Net Income (273,947) (991,252)
Net Income Per Share
Basic (0.04) (0.10)
Diluted (0.04) (0.10)
Weighted Average Common Shares
Outstanding
Basic 7,397,802 9,503,980
Diluted 7,397,802 9,503,980
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
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STARNET FINANCIAL, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
SEPTEMBER 30, 1999
(UNAUDITED)
<TABLE>
<CAPTION>
Additional Retained Subscription
Common Stock Paid In Capital Earnings Receivable (1) Total
<S> <C> <C> <C> <C> <C>
Balance at March 31, 1999 1,238 219,762 (45,252) 175,748
Shares Issued in Connection
with Section 506 Registration 1,858 328,142 330,000
Shares of Sarkis Capital, Inc. issued
prior to merger 3,000 51,000 54,000
Effect of Acquisition/Reverse Merger
with Sarkis Capital, Inc. 101,904 (101,831) 73
Net Income (273,947) (273,947)
Balance at June 30, 1999 108,000 497,073 (319,199) -- 285,874
Shares Issued in Connection with
Private Placement Memorandum 36,265 3,590,208 (186,000) 3,440,473
Warrants Exercised 2,000 34,000 36,000
Net Income (717,306) (717,306)
Balance at September 30, 1999 146,265 4,121,281 (1,036,505) (186,000) 3,045,042
</TABLE>
(1) Balance of Subscription not received as of November 10, 1999. A receivable
of $1,206,818 has been recorded on balances received between October 1 and
November 10
See accompanying Notes to Consolidated Financial Statements.
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STARNET FINANCIAL, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
SEPTEMBER 30, 1999
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Six Months
Ended Ended
June 30, 1999 September 30, 1999
------------- ------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income (273,947) (991,252)
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and Amortization 5,282 52,672
Mortgage Loans Issued (8,305,918) (12,132,684)
Proceeds from Mortgage Loans Sold 3,377,967 11,409,780
Decrease (Increase) is Accounts Receivable & Similar
Operating Assets (40,084) 265,196
Increase (Decrease) in Accounts Payable & Similar Operating
Liabilities 84,213 286,596
Net Cash from Operating Activities (5,152,487) (1,109,693)
CASH FLOWS FROM INVESTING ACTIVITIES
Decrease (Increase) in Property & Equipment (57,191) (76,186)
Acquisition of Businesses, Net of Cash Acquired (216,154) (444,199)
Net Cash from Investing Activities (273,345) (520,385)
CASH FLOWS FROM FINANCING ACTIVITIES
Advances under Warehouse Lines of Credit 8,305,918 12,132,684
Repayment of Warehouse Lines of Credit (3,363,820) (11,395,633)
Decrease (Increase) in Organizational Costs 3,000 (211,424)
Proceeds of Stock Issuance 384,073 2,653,728
Net Cash from Financing Activities 5,329,171 3,179,355
Net Change in Cash (96,661) 1,549,277
Cash Beginning of Period 146,970 146,970
Cash End of Period 50,309 1,696,247
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
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STARNET FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The financial statements included herein have been prepared by StarNet
Financial, Inc. (the "Company") without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission (the "SEC"). These
interim financial statements have been prepared on the same basis as the annual
financial statements. Certain information and disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been omitted pursuant to such SEC rules and regulations.
Certain amounts in the June 30, 1999 financial statements have been
reclassified to conform to the September 30, 1999 presentation. In the opinion
of management of the Company, the financial statements include all adjustments
necessary to present fairly the financial position of the Company as of
September 30, 1999, and its results of operations and its cash flows for the
three months and six months ended September 30, 1999. As neither Sarkis nor
LoanNet had operations of any significance prior to April 1, 1999, the
financial statements presented are those of StarNet Financial, Inc. for the
three months and six months ended September 30, 1999 without comparative
information from prior periods.
2. Organization
The accompanying financial statements present the financial position,
results of operations and cash flows for StarNet Financial, Inc. and its wholly
owned subsidiaries, The GM Group, Inc. ("GM") and StarNet Mortgage, Inc.
("StarNet Mortgage"). GM was acquired in April 1999 from the previous owners
for cash and a note payable in a transaction accounted for as a purchase.
StarNet Mortgage was incorporated by the Company in June 1999.
3. Summary of Significant Accounting Policies
Principles of Consolidation - The consolidated financial statements
include the accounts of StarNet Financial, Inc. and its wholly owned
subsidiaries. All intercompany accounts and transactions have been eliminated.
Revenue Recognition - Revenues are recognized when services are
performed and are recorded at amounts disclosed to customers per all related
FNMA, HUD/FHA and RESPA rules and regulations.
Mortgage Loans held for Sale - In general, when the Company accepts an
application for a loan from a customer, or provides a rate lock commitment to a
mortgage correspondent or broker, it simultaneously obtains a commitment to
purchase the loan from a third party (permanent) investor on a "best-efforts"
basis (in some cases subject to certain mandatory minimum delivery amounts).
Funded loans in the process of being delivered to subsequent investors are
carried at the lower of cost or market value.
Property and Equipment - Property and equipment are stated at cost and
are depreciated using the straight line method over the estimated useful lives
of the related assets, ranging from three to ten years. Leasehold improvements
are amortized over the term of the lease.
Goodwill - The net excess of aggregate purchase price paid over the
fair value of net assets acquired is included in the accompanying balance sheet
as goodwill, and is amortized over a twenty year period using the straight-line
method. The values of certain assets acquired in connection with the
acquisition of GM have been estimated in the accompanying financial statements,
but are subject to revision as the results of appraisals and similar valuation
techniques are obtained. The Company will periodically evaluate whether changes
have occurred that could require revision of the estimated
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useful life of the goodwill or impair the recoverability of its carrying value.
If such circumstances arise, the Company will record an impairment loss.
Income Taxes - The Company accounts for income taxes in accordance
with SFAS No. 109, "Accounting for Income Taxes," which requires the use of the
"liability method." As the Company has not yet earned profits, a valuation
allowance has been established in the amount of any net deferred tax assets.
Advances under Warehouse Lines of Credit - The Company finances its
Mortgage Loans Held for Sale through warehouse loan advances in accordance with
agreements with various commercial banks. (See Note 5.) These advances are
repaid upon receipt of loan sale proceeds from permanent investors.
Net Income (Loss) per Share - The Company computes net loss per share
in accordance with SFAS No. 128, "Earnings per Share." Under the provisions of
SFAS No. 128, basic net loss per share is computed by dividing the net loss
available to common stockholders for the period by the weighted average number
of common shares outstanding during the period. Diluted net loss per share is
computed by dividing the net loss available to common stockholders for the
period by the weighted average number of common and common equivalent shares
outstanding during the period, to the extent such common equivalent shares are
dilutive. Common equivalent shares are composed of incremental common shares
issuable upon the exercise of stock options and warrants.
4. Leases
The Company leases three office spaces and certain equipment. Future
payments due under noncancelable leases are as follows:
1999 $ 60,723
2000 $ 191,617
2001 $ 67,982
2002 & After $ 16,795
5. Warehouse Lines of Credit
The Company has lines of credit available to fund its Mortgage Loans
Held for Sale from three commercial banks totaling $11,000,000. At September
30, 1999, the Company had drawn $5,679,149 against these lines of credit. The
interest rate charged is prime plus 2. The agreements governing these lines of
credit provide for termination upon thirty days notice.
6. Acquisitions
As discussed in Note 2 and Note 3 (Goodwill) above, the Company
acquired GM in April 1999. GM is an FHA-approved mortgagee and produces loans
through retail loan officers in the Dallas/Fort Worth metropolitan area. In
addition, GM is party to two separate joint venture arrangements with
homebuilders in Dallas.
In September, 1999, the Company acquired certain assets of a wholesale
branch loan origination office in Houston, Texas. The effects of this
acquisition in the September 1999 financial statements are immaterial.
7. Capital Stock Transactions
In April, 1999, the Company issued 330,000 shares in connection with a
private placement under Regulation D of the SEC rules and regulations.
12
<PAGE> 15
As more fully described in the introductory material, LoanNet, Inc.
("LoanNet"), the predecessor to the Company, entered into a reverse acquisition
in which LoanNet shares were exchanged for shares of Sarkis Capital, Inc. The
name of the resulting entity was changed to StarNet Financial, Inc. In
connection with this transaction, warrants for a total of 200,000 shares were
also issued. The warrants were exchanged for shares during the period reported.
Commencing in June 1999 and ending in September 1999, the Company
issued 3,626,473 shares in a private placement under Regulation D of the SEC
rules and regulations.
8. Earnings Per Share
The following is a reconciliation of the numerators and denominators
of the basic and diluted earnings per share computations:
<TABLE>
<CAPTION>
Three Months Ended
June 30, 1999
Income Shares Per Share
<S> <C> <C> <C>
Net Income (273,947)
Net Income
Available to
Common
Stockholders (273,947) 7,397,802 (.04)
Effect of Dilutive
Securities -- --
Net Income
Available to
Common
Stockholders plus
Assumed
Conversions (273,947) 7,397,802 (.04)
</TABLE>
As of June 30, 1999, warrants to purchase 200,000 shares of common
stock had been issued and were outstanding. Such warrants were not included in
the computation of diluted earnings per share because the warrants had an
anti-dilutive effect on earnings per share.
13
<PAGE> 16
<TABLE>
<CAPTION>
Six Months Ended
Sep 30, 1999
Income Shares Per Share
<S> <C> <C> <C>
Net Income (991,252)
Net Income
Available to
Common
Stockholders (991,252) 9,503,980 (.10)
Effect of Dilutive
Securities -- --
Net Income
Available to
Common
Stockholders plus
Assumed
Conversions (991,252) 9,503,980 (.10)
</TABLE>
Warrants issued May 14 were exercised on September 30. The warrants
were not included in the computation of diluted earnings per share because the
warrants had an anti-dilutive effect on earnings per share. As of September 30,
no dilutive securities were outstanding.
9. Related Party Transactions
A stockholder of the Company wholly owns a firm which provides
consulting services to the Company. The firm advises management concerning
strategic planning, acquisitions, and raising of capital pursuant to a contract
effective May 1, 1999. The contract is for one year but may be terminated by
either party or extended and renewed for subsequent one year periods by mutual
consent. It provides for monthly payments of $14,000.
10. Use of Estimates and Assumptions
Management uses estimates and assumptions in preparing its financial
statements. Those estimates and assumptions affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities,
and the reported amounts of revenues and expenses. Actual results may vary from
the estimates that were used.
11. Recent Developments
In October 1999, the Company acquired all of the outstanding shares of
Residential Lenders, Inc., a retail loan origination operation located in
Orlando, Florida, for cash, shares of the Company, and a promissory note.
14
<PAGE> 17
Also in October 1999, the Company acquired substantially all of the
assets and operations of Occidental Mortgage Corporation, a retail and
wholesale loan origination operation located in Irvine, California, for a
promissory note, options to purchase Company stock at substantially the same
terms as the recently concluded private placement, and consideration contingent
upon the volume of loans funded from October 1999 through January 2000.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Certain matters discussed in the Plan of Operation are
"forward-looking statements." These forward-looking statements can generally be
identified as such because the context of the statement will include such words
as the Company "believes," "anticipates," "expects," or words of similar
import. Similarly, statements that describe the Company's future operating
performance, financial plans, objectives or goals are also forward-looking
statements. Such forward-looking statements are subject to certain factors,
risks and uncertainties which could cause actual results to differ materially
from those currently anticipated. Stockholders, potential investors and other
readers are urged to consider the risk factors enumerated above and are
cautioned not to place undo reliance on any such forward-looking statements
contained herein.
PLAN OF OPERATION
StarNet Financial, Inc. (the "Company") is engaged in the business of
originating, purchasing and selling mortgage loans secured primarily by
single-family residences through traditional channels of distribution and over
the Internet.
LoanNet, Inc., the predecessor to the Company, was incorporated in
February 1999. In May 1999, it became a public company through a merger with
Sarkis Capital, Inc. Subsequent to that merger, approximately $3.6 million in
capital was raised through a private placement offering.
It is the intent of the management of the Company to create a mortgage
lending operation which is highly diversified in the following ways:
A. Product lines. The Company offers or intends to offer conforming
conventional, FHA and VA mortgages, and also "sub-prime" mortgages (generally
loans to borrowers with below average or delinquent credit) and
"non-conforming" mortgages (which allow for more limited documentation of
borrowers' credit.)
B. Geography. The Company has employees in California, Florida, and
Texas. It presently is qualified to do business in 24 states and is licensed in
seven of those states as required. The Company expects to be qualified and
licensed as required in the remainder of the United States within the next 12
months.
C. Channels of distribution. The Company is originating and/or
purchasing mortgage loans by traditional retail loan officers, through
broker-correspondents, through "net-branch" employees, and via the Internet.
The history of the Company to date reflects the implementation of this
strategy. The initial operations consisted of the establishment of a lending
office in Dallas, Texas, which included "wholesale" and "net-branch"
capability. Such operations have the ability to operate nationwide.
The Company next acquired The GM Group, Inc. ("GM"). This operation
provided retail loan origination capability, including approval as a FHA
mortgagee. GM also has established
15
<PAGE> 18
relationships with large-scale homebuilders in the Dallas area.
Within the period reflected in the accompanying financial statements,
the Company has also established a wholesale loan office in Houston, Texas,
staffed with personnel knowledgeable and experienced in sub-prime and
nonconforming loans as well as conforming conventional, FHA and VA loans.
Finally, the Company has been and continues to invest in the
development and implementation of an Internet website to facilitate loan
production and expansion of its wholesale and net-branch operations.
Subsequent to September 30, 1999, the Company acquired Residential
Lenders, Inc. ("RLI"), a Florida-based retail loan operation specializing in
conforming lending. RLI has operated an Internet website for approximately
three years from which it derives a substantial volume of its business. This
acquisition, therefore helps the Company continue its diversification both as
to geography and distribution channel.
The Company has also acquired the assets and operations of Occidental
Mortgage Corporation ("Occidental"), a California-based retail and wholesale
loan operation specializing in sub-prime and non-conforming lending. Occidental
also has limited capability to service loans (i.e. collect of customer
payments, hold tax and insurance escrows, pay the same when due, etc.).
Management believes that this acquisition serves geographic and product line
diversification.
The Company continually evaluates prospective acquisitions; however,
having experienced rapid growth, it intends to focus during the near term on
the further development of the infrastructure (in terms of management, systems,
equipment, policies and procedures) necessary to cohesively integrate its
operations and optimize their effectiveness in fulfilling the Company's
strategic objectives.
At September 30, the Company had a cash position of $1.7 million.
Subsequent to the balance sheet date, the Company has collected or expects to
collect an additional $1.4 million in connection with its private placement
offering which concluded in September. Cash resources for subsequent operations
therefore total approximately $3.1 million.
Based on historical data, the Company has experienced average monthly
negative cash flows from operational-related activities (net income adjusted
for depreciation and amortization) of approximately $156,000. Accordingly,
based upon historical data, the Company has sufficient cash resources for the
next twelve months.
Several factors, however, will differentiate its ongoing operations
from historical results. First, historical results include higher than normal
expenses associated with the recently concluded private placement, including
consulting fees, advertising, business promotion, travel and entertainment.
However, the infrastructure development referred to previously is expected to
increase cash requirements by $25,000 to $50,000 per month and therefore will
more than offset the reduction in the private placement expenses.
Significantly, though, the Company believes that, after four to six months of
neutral effect on its cash flow, the RLI and Occidental acquisitions will
provide from $100,000 to $200,000 positive monthly cash flows.
The Company is preliminarily planning an additional offering of common
stock during the next twelve months. Additionally, the Company believes that, if
required, it can obtain short-term borrowings for liquidity and working capital
purposes.
The discussion above addresses working capital requirements. In
addition to working capital, the Company funds it Mortgage Loans Held for Sale
through advances under warehouse lines of
16
<PAGE> 19
credit. Management believes that existing lines of credit are adequate for its
funding needs and could remain in place. However, the Company expects to
evaluate the advisability of consolidating the sources of its lines and to
determine if more cost effective options are available.
PART II --OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The Company concluded a private placement offering under Rule 506 of
Regulation D in September 1999. In conjunction with that offering, the Company
issued 3,626,473 shares of its common stock, $0.01 par value (the "Common
Stock"), to accredited and non-accredited investors. The offering price of the
Common Stock in the private placement was $1.00 per share.
The recipients of the above described securities represented their
intention to acquire the securities for investment only and not with a view to
distribution thereof. Appropriate legends were affixed to the stock
certificates issued in such transactions. All recipients had adequate access to
information about the Registrant through a private placement memorandum.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
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) Exhibits
EXHIBIT NO
27.1 Financial Data Schedule (Filed herewith.)
(b) Reports on Form 8-K
On August 13 , 1999, the Company filed a Current Report on Form 8-K to
report the change of the Company's name from Sarkis Capital, Inc. to StarNet
Financial, Inc.
On August 23, 1999, the Company filed an amendment to the Current Report
on Form 8-K, which was filed on June 8, 1999, to report the pro forma financial
information related to the share exchange agreement with LoanNet, Inc., a Texas
corporation.
17
<PAGE> 20
SIGNATURE
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 FINANCIAL, INC.
Date: November 19, 1999 By: /s/ Daniel L. Jackson
--------------------------------------------
Daniel L. Jackson, Chief Executive Officer
(Principal Executive Officer)
By: /s/ Michael J. Gulinson
--------------------------------------------
Michael J. Gulinson, Chief Financial Officer
(Principal Accounting Officer)
18
<PAGE> 21
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> MAR-31-1999
<PERIOD-END> SEP-30-1999
<CASH> 1,686,247
<SECURITIES> 0
<RECEIVABLES> 1,345,670
<ALLOWANCES> 0
<INVENTORY> 5,679,149
<CURRENT-ASSETS> 8,711,066
<PP&E> 161,340
<DEPRECIATION> 52,672
<TOTAL-ASSETS> 9,914,067
<CURRENT-LIABILITIES> 6,869,025
<BONDS> 0
0
0
<COMMON> 146,265
<OTHER-SE> 2,898,776
<TOTAL-LIABILITY-AND-EQUITY> 9,914,067
<SALES> 0
<TOTAL-REVENUES> 958,305
<CGS> 0
<TOTAL-COSTS> 1,897,910
<OTHER-EXPENSES> 51,647
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 57,960
<INCOME-PRETAX> (991,252)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (991,252)
<EPS-BASIC> (.10)
<EPS-DILUTED> 0
</TABLE>
