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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-KSB
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED MARCH 31, 2000
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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Commission File Number 33-13627
STARNET FINANCIAL, INC.
(herein referred to as "Registrant", "Company", or "StarNet")
(Name of small business issuer in its charter)
DELAWARE 75-2168244
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
17311 NORTH DALLAS PARKWAY, SUITE 350, DALLAS, TEXAS 75248
(Address of principal executive offices)
972-818-1212
(Issuer's telephone number)
Securities registered pursuant to section 12(b) of the Act: NONE
Securities registered pursuant to section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.01
Check whether the Issuer (1) filed all reports required to be filed by section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such report(s), and (2) has been
subject to such filing requirements for the past 90 days. (1) Yes [x] No [ ] (2)
Yes [x] No [ ]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [ ]
State issuer's revenues for its most recent fiscal year: $4,929,177
State the aggregate market value of the voting and non-voting common equity held
by non-affiliates computed by reference to the price at which the common equity
was sold, or the average bid and asked prices of such common equity, as of a
specified date within the past 60 days:
The Company does not have an active trading market. Therefore, it is
difficult to determine the true market value of the common equity held
by non-affiliates. Based on the closing price for the Company's Common
Stock at June 30, 2000 of $1.6870 per share, the market value of shares
held by non-affiliates would be approximately $21,545,166.
As of July 14, 2000 the Registrant had 19,199,578 shares of common stock issued
and outstanding.
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
THE COMPANY
StarNet Financial, Inc. ("StarNet" or the "Company") 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 our "net branches" located across
the United States;
o conducts wholesale loan originations and processing operations using
a nationwide network of independent mortgage loan brokers; and
o conducts direct consumer mortgage loan origination over the Internet.
Our loan origination activities include (i) offering a variety of
residential mortgage loans, (ii) attracting suitable loan applicants, (iii)
reviewing borrower credit and mortgaged property title, appraised value and
insurance ("underwriting"), (iv) issuing conditional loan commitments, and (v)
funding qualified loans at closing. Upon origination, we pool and sell both our
conforming loans (generally loans to borrowers with perfect or good credit) and
our non-conforming loans (generally loans to borrowers with below average or
delinquent credit) to institutional investors. We also sell individual loans to
such investors.
We are licensed, or are exempt from licensing requirements, to
originate, purchase closed loans, underwrite, and fund or sell residential
mortgage loans in 33 states in the United States. We sell loans primarily to DLJ
Mortgage Capital, Impac Mortgage Holdings, Homeside Lending, Cendant Mortgage,
Chase Manhattan Mortgage, IndyMac, Interfirst Mortgage, Household Finance, Ohio
Savings Bank and numerous other mortgage companies and investors. In addition,
we participate in the following Texas bond programs: Denton County Finance
Corporation Single Family Mortgage Revenue Bonds, Garland Housing Finance
Corporation Single Family Mortgage Revenue Bonds, Collin County Housing Finance
Corporation Single Family Mortgage Revenue Bonds, Grand Prairie Housing Finance
Corporation Single Family Mortgage Revenue Bonds, and Tarrant County Housing
Finance Corporation Single Family Mortgage Revenue Refunding Bonds.
As a mortgage lender, we generate revenues by originating and
subsequently selling loans. These revenues consist of loan processing fees, net
gain on sale, and net interest income. Loan processing fees include application,
documentation, commitment, and processing fees paid by borrowers. Net gain on
sale consists of the difference in price paid by the borrower and the price paid
by the purchaser (or permanent investor), which includes the value of the rights
to service loans. Net interest income consists of the difference between
interest received by us for the time we hold a loan and interest paid by us
under our credit facilities. Our profit on sales of loans depends on the price
we are able to sell our loans into the secondary market. Currently, when we
receive a rate lock on a loan, we sell that loan immediately under a best
efforts contract and then deliver it into a bulk or flow contract. We receive
additional fees when we close a loan. These fees range from a processing fee to
a warehousing fee and can equal up to one-half of one percent of the loan
amount. In addition, when we sell loans into the secondary market, we are able
to make additional marketing gains because of interest rate movements in the
market from the time we lock the rate with our investors under a best efforts
contract.
Our expenses largely consist of:
o salaries, commissions and benefits paid to employees;
o occupancy and equipment costs;
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o Internet and other technology-related expenses, including
licensing and participation fees and advertising costs; and
o data processing and communication costs.
Many of these expenses are variable rather than fixed. Commissions paid to loan
originators vary depending on their originations, and other salaries and
benefits fluctuate from quarter to quarter based on our assessment of the
appropriate level of personnel (other than loan originators), which generally
correlates to current and anticipated loan origination volume.
OUR STRATEGY
Growth Strategy
The total value of our mortgage loan originations for fiscal year 2000
was $216,572,896. Our goal is to continue to expand our wholesale and retail
mortgage banking business primarily through our traditional originating channels
and through our Internet-based origination channel. To achieve this goal, we are
concentrating on the following growth strategies:
o Expand our traditional business into new regions. We intend to
extend our business model and expand our traditional lending
activities into new geographic regions. During the past fiscal
year, we opened new regional loan offices in Houston and
Denver. We intend to open three additional offices over the
next 12 months in the eastern and central United States and
possibly other areas. In connection with our geographic
expansion, we plan to advertise in related local and regional
print media to create name recognition and create awareness of
our products and services.
o Hire additional sales-oriented loan originators. We intend to
hire additional loan originators and production personnel in
our existing markets. In the future, the majority of our
business will be generated through these personnel. We also
intend to expand into geographic areas with experienced loan
originators and production personnel who have already
established a client base.
o Expand through selective strategic acquisitions. At various
times, we expect to consider acquiring mortgage lenders that
share our business philosophy regarding progressive marketing,
innovative use of technology and sound underwriting. In order
to increase core sales, we may also consider acquiring other
mortgage banking-related companies to enhance our product and
service offerings. In evaluating acquisition candidates, we
will consider factors such as the impact of the acquisition on
our earnings, our ability to support and retain production
personnel and our ability to enhance and expand the acquired
business. We believe our broad and competitive product line
and the technical and other back-up support we offer make us
an attractive partner for potential acquisition candidates.
o Enhance and expand our Internet business. We believe the
Internet will be an increasingly important medium to provide
mortgage products and services. We intend to increase our
Internet mortgage origination volume by opening additional
Internet call centers, by expanding our business into the
remaining states in which we are not yet licensed or otherwise
qualified and by establishing relationships with additional
websites so as to increase the number of sources that refer
customers to us. We also intend to develop further
enhancements to our website to allow prospective borrowers to
apply for a mortgage loan, lock in an interest rate and
receive a commitment in one online session. Further, we
anticipate that our customers will be able to log onto our
secure website at any time, and through the use of a unique,
personal password, monitor the progress of
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their loan application. We intend to start an intensive
marketing campaign in selected markets to promote our own
StarNetMortgage.com website and create name recognition. We
also intend to enter into contracts to provide private label
Internet origination services to thrifts and smaller banks.
o Form joint ventures with homebuilders and realtors. We
currently market mortgage loans through joint ventures with
realtors and corporate affinity lending. We intend to also
market loans through joint ventures with homebuilders, which
we believe, in turn, will enhance the Company's revenues.
o Enter the correspondent mortgage banking business. We intend
to enter into the correspondent mortgage banking business,
where we will buy loans from well-managed mortgage bankers who
have sufficient capital resources and then pool and sell these
loans into the secondary market. By becoming a conduit for
mortgage bankers to sell their loans, we anticipate that we
will strengthen our relationships with these brokers and
expand our other business.
o Total mortgage lending solution. We intend to offer title
insurance, abstract services, home equity lines of credit and
credit-life insurance products to our mortgage customers. We
believe we can enhance the revenues we earn through the
cross-selling of these and other products and services and
leverage our origination network without significant
additional capital investments.
Operating Strategy
We believe that, by taking advantage of the following competitive
advantages in both our traditional and Internet-based origination channels, we
will be able to continue to expand our mortgage banking business:
o Lending to home buyers. We concentrate on making loans to home
buyers rather than to home owners who are refinancing their
mortgages. We believe this makes our business less susceptible
to interest rate increases, because in a rising interest rate
environment home purchase mortgage volume tends to be more
stable than mortgage refinancing volume, which tends to
decrease significantly.
o Range of products available. We believe we have one of the
broadest and best-priced product offerings in the industry.
Offering a variety of well-priced loan products enables us to
best serve the largest number of mortgage customers, each of
whom may find different loan characteristics desirable. Our
products are listed in the "Services and Products" section.
o Use of advanced technology. In a continuous effort to increase
efficiency, we have dedicated ourselves to maintaining
state-of-the-art information systems. We are in the process of
installing an "enterprise" computer system. This system
controls most aspects of our operations, from the processing
of a loan application through the closing of the loan and our
sale of the loan to institutional investors. The system also
performs checks and balances on many aspects of our
operations, and it supports our marketing efforts. We believe
this integrated approach reduces our marginal origination cost
per loan. We intend to continually look for new ways to
improve efficiencies through automation.
o Use of comprehensive and user-friendly website. In September
1999, we introduced a new, technologically advanced version of
our StarNetMortgage.com website that was designed to provide
customers with 24-hour access to our interest rates and
product terms and the ability to lock in an interest rate, to
file a pre-approval request or application, to check the
status of their pending application and to obtain their credit
report. Our website also provides mortgage customers with an
array of "tools" that assist them in determining
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how much financing they can afford, what kind of mortgage best
suits their needs and otherwise provides answers to frequently
asked questions. We intend to introduce a number of
enhancements to our website that will enable our customers, in
one continuous online session, to apply for a loan, receive a
loan commitment, if approved, and lock in an interest rate.
o Loan products specifically underwritten for sale to investors.
Our underwriting process is designed to ensure that each loan
we originate can be sold to a third-party investor by
conforming the loan to the underwriting and credit standards
of that investor. Whenever possible, we use "artificial
intelligence" underwriting systems, including Fannie Mae's
Desktop Underwriter(R), to ensure consistency with our
investors' predetermined standards. These systems interface
with our "enterprise" computer system. In addition, we have a
series of internal and external quality control procedures in
place to ensure compliance with our underwriting standards.
o Involved sales strategy. Our loan originators are primarily
compensated through sales commissions, which encourages them
to be responsive to our customers. In addition, we foster a
consultative sales strategy that emphasizes pro-active and
frequent customer assistance. Our loan originators actively
guide customers through the loan application process, not
merely providing information requested by the customer, but
keeping customers informed about rate changes and market
conditions.
OUR HISTORY
In March 1987, we were incorporated in Delaware under the name of
"Sarkis Capital, Inc." On May 13, 1999, we entered into an exchange agreement
with LoanNet, Inc., a Texas corporation ("LoanNet"), and the shareholders of
LoanNet, whereby we agreed to acquire LoanNet and its subsidiary, The GM Group,
Inc., a Texas corporation (d/b/a StarNet Retail, sometimes referred to herein as
"GM"), from the LoanNet shareholders in exchange for shares of our Common Stock
(the "Exchange Agreement"). Pursuant to the Exchange Agreement, we issued
9,000,000 shares of our 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, we changed our name to "StarNet Financial,
Inc." in June 1999. The transaction was accounted for as a recapitalization.
Effective as of October 1, 1999, we purchased substantially all of the
assets of Occidental Mortgage Company, which was engaged in the business of
originating mortgage loans. In connection with the asset purchase, we delivered
to Occidental (i) a five-year promissory note in the original principal amount
of $365,000 and (ii) a five-year warrant to purchase up to 300,000 shares of
Common Stock with an exercise price of $1.00 per share. Additionally, for a
period of four months beginning October 15, 1999, we agreed to pay Occidental an
amount equal to one percent (1%) of the aggregate mortgage loans closed by us
which are attributable to mortgage loans that Occidental had in process
immediately prior to closing.
Also effective as of October 1, 1999, we acquired all of the
outstanding capital stock of Residential Lenders, Inc., which is engaged in the
business of originating mortgage loans. In connection with the acquisition, we
issued 250,000 shares of Common Stock; made an initial cash payment of $175,000,
less certain disbursements; and paid an additional $200,000 to the shareholders
of RLI.
Effective as of December 31, 1999, we sold all of the capital stock of
GM. We did, however, retain certain operations, personnel and relationships of
GM.
On April 28, 2000, we purchased substantially all of the assets of Wall
Street Mortgage of Dallas, Inc., which is engaged in the business of residential
mortgage brokering. In connection with the acquisition, we issued 57,557 shares
of Common Stock and a warrant to purchase up to 12,500 shares of Common Stock
with an exercise price of $4.625 per share. As part of this acquisition, we have
acquired several exclusive advertising agreements with cyberXpo.com, Inc., a
Dallas, Texas-based company, that operates various mobile Internet access
venues, or
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"cyberCenters," in seven states. Such advertising agreements provide us with the
exclusive right to display mortgage lending and real estate advertising at any
cyberCenter that is operating in a mall, airport or in a previously agreed upon
retail location.
We conduct our business through two wholly owned subsidiaries and two
distinct operating divisions. StarNet Mortgage, Inc. and Residential Lenders,
Inc. are our wholly owned subsidiaries. Occidental Mortgage Company and StarNet
Retail are operated as divisions.
For the purposes of the "Business" section, references to "StarNet",
the "Company", "we", "our" and "us" include StarNet Mortgage, StarNet Retail,
RLI and Occidental, unless otherwise indicated. Our principal executive office
is located at 17311 North Dallas Parkway, Suite 350, Dallas, Texas 75248, and
our telephone number is (972) 818-1212.
OUR OPERATING STRUCTURE
A description of our four business units follows:
StarNet Mortgage, Inc. ("StarNet Mortgage")
StarNet Mortgage is our residential loan origination subsidiary
comprised of "net branch" offices presently being established across the United
States. The net branch concept has been described by industry analysts as one of
the most mutually-attractive relationships between a mortgage banking company
and its originators in the marketplace today. Unlike traditional retail office
operations where expansion into a new market by the mortgage company requires
finding, leasing and furnishing an office, recruiting and hiring originators and
support personnel, and implementing start-up marketing programs, the net branch
approach places the burden of overhead on the branch rather than the company.
This enables a mortgage company to grow at an accelerated rate without a
proportionate increase in its operating expenses.
Our net branch program offers one of the most comprehensive packages of
benefits, products, and services to experienced mortgage professionals in the
marketplace, including affiliation with a national corporate identity, full
lender status as a mortgage banker, exemption from certain regulatory licensing,
fee disclosure and net worth requirements, access to a comprehensive and
competitive product line, FHA and VA direct endorsement underwriting, sub-prime
underwriting, improved processing efficiency through Internet-based automation
systems, established investor relationships, marketing programs, staff training,
production and recruitment incentives, accounting, bookkeeping and payroll
services, and group benefits like health insurance.
Our net branches cover their own overhead expenses, maintain their own
profit-and-loss statements, and retain branch profits after expenses. StarNet
Mortgage receives certain processing and document preparation fees on a "per
loan" basis from the branch to cover its own net branch servicing expenses,
while branch loan origination contributes to our production volume growth and
profitability.
Since the completion of the StarNet Mortgage program for its net branch
operations, we have successfully recruited 26 new originators in seven states.
We project that number to grow to 100 by May 2001. Geographical market coverage
by our net branch offices is expected to coincide with our defined expansion and
state licensing timetable. Qualification criteria and hiring standards for
prospective net branch representatives have been established by us, and
adherence is closely monitored by an executive oversight committee.
While StarNet Mortgage recognizes its ultimate market to be mortgage
consumers across the country, it also realizes that its primary avenue to these
consumers is through its net branch originators. Accordingly, its initial
marketing efforts are targeted at prospective originators already established
and successful in their respective markets. Individuals or groups fitting this
prospect profile include experienced mortgage bankers and loan officers or
originators with other mortgage companies or financial institutions.
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As of May 1, 2000, we have entered into a management agreement with
StarBranch Mortgage, Inc. to manage and operate all of our net branch
operations. This management agreement gives StarBranch the responsibility and
authority as net branch operations manager to (1) contract with branch offices
in any state in which we are licensed, (2) to monitor, supervise and oversee the
operations, processes and origination of loans by the net branch offices, (3) to
hire necessary staff to properly conduct the net branch operations, (4) fix
compensation and benefits for such employees, and (5) to generally administer
and manage the net branch operations. However, the net branch operations will
continue to be subject to the authority of the Board of Directors of our
subsidiary, StarNet Mortgage.
StarNet Mortgage also has a working relationship with a network of over
2,400 mortgage brokers in 33 states. Over 1,900 of these brokers presently
operate within the states constituting our initial geographic marketplace. Those
brokers are in the following states:
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Arizona 56
Connecticut 1
Hawaii 7
Kansas 4
Maryland 1
Missouri 6
New Jersey 1
North Carolina 13
Oregon 37
Texas 586
Wisconsin 1
California 1377
Florida 23
Idaho 10
Kentucky 2
Michigan 1
Montana 3
New Mexico 16
Ohio 2
South Carolina 2
Utah 20
Wyoming 1
Colorado 116
Georgia 5
Indiana 4
Louisiana 1
Minnesota 3
Nevada 26
New York 1
Oklahoma 1
Tennessee 1
Washington 72
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We anticipate wholesale production during the fiscal year 2001 to
exceed $650 million in loans and to continue to grow at an accelerated rate as
we commence activity in other states.
StarNet Retail
StarNet Retail is our residential loan origination division under which
the retail operations and homebuilder group programs are conducted or will be
conducted. StarNet Retail is a fully-approved FHA loan underwriter offering a
comprehensive menu of conventional as well as government-insured mortgage
products to its clients.
StarNet Retail is developing an active retail division that will
generate monthly production from residential real estate agencies and
homebuilders. Due to the nature of the business conducted by StarNet Retail, the
period of time between loan approval or commitment and closing is extended by
the time required for home construction. This creates a significant pipeline of
business at any given point in time for us.
StarNet Retail also intends to develop joint venture agreements with
homebuilders. It is intended that the majority of the loans that will result
from these joint ventures will be FHA government-insured which then will be sold
to investors immediately following closing. StarNet Retail's management
anticipates pursuing such homebuilder programs in those markets that coincide
with our corporate geographical expansion.
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Residential Lenders, Inc. ("RLI")
RLI is our retail originator in our Eastern Region and our Internet
originating division. RLI receives approximately 1,500 hits per week on their
website. From these hits, RLI will contact the customer and turn that lead into
a new loan. RLI also advertises extensively on the Internet. RLI has recently
entered into the wholesale arena. This wholly owned subsidiary has hired staff
to originate mortgage loans throughout the Eastern region of the United States.
The Internet has become a substantial medium for both communication and
electronic commerce. International Data Corporation ("IDC") estimates the number
of Internet users worldwide will increase from 115 million in 1998 to
approximately 400 million in 2002. In addition, IDC expects that the number of
U.S. households using the Internet for online banking will grow from less than
6.6 million in 1998 to more than 32 million in 2003, showing the growth in
reliance on the Internet for financial services. Consumers have become
proficient in using the Internet for finding, evaluating and purchasing a wide
variety of products and services.
Because of its flexibility, the Internet provides companies with
additional ways to reach consumers with the most current information about their
products and services. This information can be updated instantaneously to
provide new features and presentations, or to adjust prices and terms according
to market changes. In addition, the Internet provides a cost-efficient means of
conducting a document-intensive business such as mortgage banking. Consumers can
apply online, have access to their file, update information instantly, and check
the status of their loans 24 hours a day, seven days a week.
To market and sell loans on the Internet, we intend to work with many
of the leading websites in our industry, including Microsoft HomeAdvisor,
E-Loan, GetSmart, LendingTree and Consumer Financial Network. We believe a large
number of Internet mortgage shoppers will be introduced to lenders on these and
other future websites. We believe our inclusion in these websites gives us a
strategic advantage because they are developing their business processes and
software in conjunction with their existing participating lenders and, in some
cases, limiting access by additional lenders.
Occidental Mortgage Company
Occidental is our division which originates mortgage loans from 33
states and through three areas of origination: wholesale, retail and Internet
originations.
Prior to our acquisition of the assets of Occidental, Occidental had
been in existence for 32 years, originating primarily FHA loans from its retail
loan representatives. This division originates the majority of its loans from
the wholesale arena, focusing on non-conforming loans. Occidental has been the
largest seller of loans to Impac Mortgage Holdings, a real estate investment
trust, for the past four years.
Occidental operates two offices in Irvine, California, and Denver,
Colorado, serving 33 states. It has centralized underwriting and funding out of
the Irvine location, thus making the Denver location a production office only.
In addition, all of our secondary marketing is handled out of the Irvine
location.
General Overview
Each of our subsidiaries and our Occidental division also offers
integrated, interactive, easy-to-use websites providing complete mortgage
transaction fulfillment. Currently, most mortgage lending websites act primarily
as referral sites to prospective borrowers. These types of sites do not offer
transaction fulfillment for the consumer and therefore do not control the entire
mortgage process.
Utilizing our StarNetMortgage.com website, borrowers can choose the
subsidiary or division in their geographic area and will be able to efficiently
search, analyze and compare various mortgage products from a number of lenders
and apply for, qualify for, and obtain the loan most compatible with their
individual financial characteristics and borrowing requirements. They will also
be able to track online the status of their mortgage
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applications from submission through closing and to monitor their loans on an
ongoing basis after closing, enabling them to optimize any potential refinance
decisions in the future.
We intend to continue to streamline and refine our online origination
and processing procedures, enabling borrowers to directly benefit from the cost,
speed, and convenience efficiencies made possible by improved techniques and
technologies.
Our management recognizes that successful online origination requires a
comprehensive web marketing plan designed to attract attention, generate traffic
and ultimately reach prospective borrowers. As part of that plan, we are
negotiating a strategic alliance with a major Internet service provider in order
to enhance our visibility and exposure.
U.S. RESIDENTIAL MORTGAGE INDUSTRY OVERVIEW
Traditional United States Mortgage Market
The Mortgage Bankers Association estimates that the United States'
mortgage market totaled over $4.3 trillion of loans outstanding and that
mortgage originations were $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. 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.
This transformation has created both a large, concentrated and
efficient secondary mortgage market and a large, fragmented and inefficient
mortgage origination and banking market. There are over 20,000 mortgage
brokerage operations in the United States, according to the National Association
of Mortgage Brokers. However, there is no multi- lender originator that operates
nationally and enjoys a widely recognized consumer brand. In 1999, no mortgage
originator had over 10% market share in terms of the total number of originated
mortgages in the United States. While increased competition at all levels of the
industry has resulted in tremendous innovation in the mortgage choices available
to consumers, the level of complexity associated with these loans has also
increased. In addition, the underwriting and lending processes remain paper and
time intensive with little visibility into the process for consumers. As a
result of the cumbersome underwriting and lending process, we believe that the
traditional mortgage lending process causes many consumers to feel:
o uncertain that their single-source lenders and brokers are
providing unbiased advice and recommending the most suitable
mortgage products;
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o skeptical that interest rates and closing costs initially
quoted will ultimately be available;
o intimidated by the number and variety of mortgage products
available;
o pressured to commit to a particular product before they have
researched and compared products to their satisfaction;
o frustrated with the amount and types of fees that they are
required to pay in connection with the obtainment of a
mortgage; and
o overwhelmed by the substantial time and effort that it takes
to get a mortgage loan.
Furthermore, many borrowers receive little ongoing assistance in
managing their debt after the loan is closed. Many direct lenders who also
engage in mortgage servicing are not committed to proactive monitoring of their
customers' loans because they risk losing servicing fees if customers refinance
with other lenders. Multi-lender brokers have the incentive to pursue
refinancing opportunities but typically lack the technological capability to
proactively monitor the market changes of thousands of loan products on a
continuous basis.
Market Opportunity for Online Mortgage Origination
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. 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.
Many companies have attempted to capitalize on this large market
opportunity. Existing mortgage banks have created Internet websites to sell
their loans directly online as an alternative method to the traditional mortgage
origination process. These existing mortgage banks, however, do not offer the
consumer a multi-lender selection or comparisons of mortgage products and may
also be reluctant to reduce their fees for Internet customers due to their fear
of merely diverting customers from their traditional distribution channels.
A number of Internet websites currently exist that serve as
multi-lender distribution channels for mortgage banks. These Internet websites
act as referral sites and offer links to various mortgage banks. While many of
these referral websites offer a variety of mortgage lenders, they do not offer
complete transaction fulfillment for the consumer and therefore do not control
the entire mortgage process. Furthermore, because these referral sites do not
eliminate the necessity for the services of commissioned loan agents, they do
not provide substantial cost savings to the consumer.
We believe 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 online 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. Our online service differs from those
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of our competitors in that we offer a variety of products and allow the customer
to complete the mortgage application process online 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.
SERVICES AND PRODUCTS
We provide a broad range of mortgage lending services, which include
conventional, governmental, jumbo (large loan amounts) and non-conforming home
mortgage loans. The majority of our loans are made to owners of single-family
and condominium residences who use the loan proceeds to purchase new homes or
(to a lesser extent) refinance existing home mortgages. We provide funds and
close loans to approved mortgage brokers and correspondent lenders who originate
the mortgage for the consumer. We solicit these brokers for business, competing
with other lenders.
We provide a variety of products to our approved mortgage broker
customers related to home loans. In general, we offer mortgage brokers products
for their clients who have credit from "A" (perfect and good credit) to "D"
(below average and delinquent) and who desire conventional loans, government
loans, conforming loans, and non- conforming loans. All mortgage products are
secured by the real property used as collateral for the mortgage.
Mortgage brokers submit loan packages to our representatives for review
and approval. After the mortgage loan is closed, we package the loans into
groups and sell the loans to mortgage lending conduits. We determine to whom we
will sell the loans based on the conduits' price and service at the time the
interest rate is locked and a commitment is delivered to the customer. We do not
retain the rights to service either the mortgage loans we close or the loans we
purchase from approved correspondent lenders. We anticipate that we will enter
into a sub-servicing agreement with a FNMA-approved servicer at the time we
obtain FNMA approval. We do not anticipate permanently servicing our loan
originations during fiscal year 2001.
SALES AND MARKETING
Pricing and Yield Management. We use the latest technology included in
the "Telerate Plus" financial markets package produced by Bridge Information
Systems, Inc. Telerate Plus uses Bridge's market service to provide real-time
mortgage prices and yields, as well as instrumentalized data for analysis and
charting. It also provides us with up-to-the- minute news and economic
statistics regarding the mortgage markets. Athena (part of the Telerate Plus
software package) provides charting capabilities, enabling us to have
flexibility in trading our mortgage loans. Athena assists in mapping out the
strategy in the fixed-income and derivative markets. With the flexibility and
customization power of Athena, our risk manager can chart the
open-high-low-close data from any source, with up-to-the-minute data updates.
Mortgage providers hedge their risk by selling loans. In accordance
with this practice, we cover our interest rate risk initially by selling the
mortgages into the immediate cash market. When a loan is quoted firm to the
customer, the loan will be sold "optional" delivery, which gives us the
opportunity to search the market for a buyer willing to pay a better price for
the loan before it is sold. When the loan is closed, the interest rate risk will
be covered in either the cash- forward markets or with derivatives on the
futures market. If a loan is not delivered, a non-delivery pair-off fee is
assessed. However, when selling to FNMA, delivery is mandatory once the sale of
a loan is approved; our opportunity to shop for a better price is not available.
Distribution. We currently originate approximately 90% of our mortgage
loans through traditional distribution channels such as independent mortgage
brokers. We believe that such percentage is comparable to major mortgage banking
firms' percentage of originations through traditional distribution channels.
Independent mortgage brokers generally receive commissions based on originating
fee and premium price.
We have established relationships with a network of over 2,400 mortgage
brokers across the country and intend to maintain strong working relationships
with them and anticipate we will also pay competitive commissions. We also plan
to offer these mortgage brokers significant opportunities to participate in the
development of specific corporate strategies and procedures through their
attendance at meetings with our senior executives.
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<PAGE> 12
The remaining 10% of our mortgage loans are currently originated
through the Internet. On April 15, 2000 we acquired several exclusive
advertising agreements with cyberXpo.com, Inc., a Dallas, Texas-based company
that operates various mobile Internet access venues, or "cyberCenters," in seven
states. Such advertising agreements provide us with the exclusive right to
display mortgage lending and real estate advertising at any cyberCenter that is
operating in a mall, airport or in a previously agreed upon retail location.
Since we began cyberCenter advertising on April 28, 2000, we have already
noticed an increase in our Internet mortgage loan origination rate and we
anticipate that this rate will continue to increase in the future. Additionally,
we anticipate that by continuing to utilize the Internet to originate mortgages
we will, in time, be able to decrease the amount of commissions paid to
independent mortgage brokers.
We also anticipate that our future Internet originations will be
facilitated through Internet call centers. We currently have one Internet call
center in Orlando, Florida and anticipate opening more call centers in the next
12 months. When a customer is introduced to us over the Internet, we will
communicate with that customer online or through our Internet call center. Our
call center employs representatives who are trained to work with customers in a
consultative manner. Our consultative sales approach stresses proactive and
frequent contact with customers. For example, our representatives provide
customers with written analysis, comparing the costs of different loan products,
showing closing costs and amortization schedules. The representatives are
trained to call customers frequently, to provide them with updated information
about interest rates and to answer frequently-asked questions. The objective of
our call center representatives is to build a relationship with potential
customers and gain the confidence and business of those customers.
Homebuilder Relationships and Net Branches. We anticipate expanding
mortgage loan originations by developing relationships with homebuilders and
using our net branches across the country. We intend to have sales agents visit
homebuilders on a regular basis to develop business, to solicit their input and
to answer their questions. We expect that the sales managers will be supported
by a help desk, staffed full time by employees trained to meet homebuilders' and
their customers' needs. Our senior executives plan to call upon these customers
to ensure that we understand and respond to their mortgage loan requirements.
Marketing. We currently market our services through trade shows,
advertising and promotions in newspapers, magazines, billboards, radio,
television and the Internet and through direct contact with mortgage brokers. We
also plan to market our services through direct contact with homebuilders, as
well as to maintain a nationwide toll-free telephone number for loan
applications and to assign sales representatives to each city where we operate.
THE COMPETITIVE LANDSCAPE
We compete against savings and loan associations, thrifts, commercial
banks, consumer finance companies and other mortgage bankers in the origination
of single-family and condominium residential mortgage loans. Many of our
competitors are large and operate on a national basis. We compete on the basis
of quality of services along with the use of technology and the relationships
established by our sales and operations staff.
PRINCIPAL SUPPLIERS
The Company purchases its loan products for resale and its service
products from a select group of suppliers. While we rely on relatively few
suppliers, the products are available from numerous sources throughout the
country.
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<PAGE> 13
GOVERNMENT REGULATIONS
Our 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 our operations. We are subject to the rules and
regulations of, and examinations by, 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 us,
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.
Further, federal and state regulations continue to affect the mortgage
loan industry relative to fee disclosure obligations, broker licensure
requirements and approval/renewal criteria for government-insured loan
underwriting.
Mortgage broker fee disclosure requirements, originally mandated under
the Real Estate Settlement Procedures Act and expanded under the Housing
Community Development Act of 1992, were clarified in HUD Statements of Policy in
1996. As a result of these clarifications, mortgage loan brokers are obligated
to disclose virtually all income received in mortgage transactions from any
sources whatsoever, direct or indirect, to prospective borrowers. Originators or
mortgage bankers funding their own loans are not subject to this same degree of
disclosure.
Legislation requiring the licensure of mortgage loan brokers has been
adopted in 45 states in the United States, with the remainder of the states
expected to follow suit in the near future. In addition to requiring background
investigations and continuing educational requirements, many states have
established specific criteria designed to demonstrate financial soundness on the
part of the individual mortgage loan broker.
Mortgage loan companies seeking approval and/or renewal of the ability
to underwrite readily-marketable FHA/VA government insured loans continue to
face expanded and stricter requirements by HUD relative to minimum net worth
standards and prior mortgage loan origination volume. We plan on maintaining
excess capital to the minimum net worth required by HUD at all times.
We believe that we are in compliance in all material respects with
applicable federal, state and local laws and regulations.
EMPLOYEES
At June 30, 2000, we had 91 full-time employees in the following
departments:
<TABLE>
<S> <C>
Sales 36
Administration 16
Operations 34
Secondary Marketing 5
</TABLE>
Consultants. We have used, and intend to continue using, outside
consulting firms to assist us in planning our operations and implementing our
business plan. Among the consultants we have engaged are Crossroad
Communications and John Duff & Associates.
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<PAGE> 14
Labor Relations. None of our employees are represented by a labor
union. We believe we have and will continue to have a good relationship with our
employees. Management meets with employees on a routine basis to discuss our
objectives, as well as more specific labor issues such as scheduling,
compensation and work rules.
ITEM 2. DESCRIPTION OF PROPERTY
Our current headquarters in Dallas, Texas consists of approximately
7,899 square feet of leased office space, with the lease expiring on January 31,
2001. The monthly rental amount for the Dallas facility is $10,268. The Company
also maintains the following facilities:
<TABLE>
<CAPTION>
SQUARE LEASE EXPIRATION MONTHLY RENTAL
LOCATION FOOTAGE AMOUNTS
<S> <C> <C> <C>
Irvine, CA 9,448 square feet 4/30/01 $ 17,478.80
Orlando, FL 2,400 square feet 01/15/04 $ 4,031.49
Houston, TX 2,749 square feet 8/14/01 $ 2,978.25
Denver, CO 1400 square feet 8/31/01 $ 1543.75
Springfield, MO 3,309 square feet 12/01/04 $ 2,757.50
</TABLE>
We believe that these facilities will be adequate for our current and
proposed operations. In the opinion of our management, the Company's properties
are adequately covered by insurance.
ITEM 3. LEGAL PROCEEDINGS
On January 3, 2000, an action was brought against us for breach of
contract and fraud by Joni Baquerizo, James Cunningham, Sam W. Pitts, Jr., and
Jay Robinson, each of whom is a former employee (the "Plaintiffs"). The
Plaintiffs allege that we owe them unpaid wages, unpaid bonuses and stock
options. We believe that the Plaintiffs' claims are without merit and intend to
vigorously defend ourselves in this litigation.
From time to time, we are a defendant, or are threatened to be made a
defendant, in lawsuits encountered in the ordinary course of our business, the
resolution of which should not have a material adverse effect on our financial
position. Except as disclosed above, we are not currently aware of any
litigation currently pending or threatened to which we are subject to or to
which we may be a party.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders of the Company
during the quarter ended March 31, 2000.
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<PAGE> 15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
GENERAL
On October 19, 1999, our Common Stock commenced trading on the NASD
Over-the-Counter Bulletin Board (the "Bulletin Board") under the symbol "SNFN."
There was no material market for our Common Stock prior to October 19, 1999. The
table below sets forth the high and low bid prices of our Common Stock for the
periods indicated, as reported by the Bulletin Board.
These quotations reflect inter-dealer prices without retail mark-up,
mark-down or commission and may not necessarily represent actual transactions.
<TABLE>
<CAPTION>
Price Range of
Common Stock
------------
High Low
--------- --------
FISCAL YEAR ENDING MARCH 31, 2000:
<S> <C> <C>
Third Quarter ......................... $ 10.25 $ 2.50
Fourth Quarter ........................ 6.50 2.00
</TABLE>
On March 31, 2000, the closing bid price for a share of our Common
Stock, as reported on the Bulletin Board, was $2.75. As of March 31, 2000, there
were approximately 500 stockholders of record of our Common Stock.
MARKET PRICE
When the trading price of our Common Stock is below $5.00 per share,
our Common Stock is considered to be a "penny stock" which is subject to rules
promulgated by the SEC (Rules 15g-1 through 15g-9) under the Securities Exchange
Act of 1934 (the "Exchange Act"). These rules impose significant requirements on
brokers under these circumstances, including: (a) delivering to customers the
SEC's standardized risk disclosure document; (b) providing to customers current
bids and offers; (c) disclosing to customers the broker-dealers and sales
representative compensation; and (d) providing to customers monthly account
statements.
Shown below is certain information concerning all sales of securities
by us that were not registered under the Securities Act of 1933, as amended (the
"Securities Act") and that have not been previously reported in our Quarterly
Reports on Form 10-QSB.
We conducted a private placement of up to 7,500,000 shares of our
Common Stock from January 21, 2000 until June 30, 2000 at an offering price of
$1 per share. As part of this private placement, we issued 1,486,105 shares of
Common Stock. Exemption from registration was claimed under Section 4(2) of the
Securities Act regarding transactions by an issuer not involving a public
offering.
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on its Common
Stock, and the Company currently intends to retain any future earnings to fund
the development of its business and therefore does not anticipate paying any
cash dividends on its Common Stock in the foreseeable future. Future declaration
and payment of dividends on its Common Stock, if any, will be determined in
light of the then-current conditions, including the Company's
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<PAGE> 16
earnings, operations, capital requirements, financial conditions, restrictions
in financing agreements, and other factors deemed relevant by the Board of
Directors.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This report contains forward-looking statements that involve risks and
uncertainties. Our actual results may be very different from the results
discussed in the forward-looking statements. Some of the factors that could
cause differences are discussed below.
OVERVIEW
We are 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. It is the intent of our
management to create a mortgage lending operation which is highly diversified in
the following ways:
o Product lines. We offer or intend to offer conforming conventional,
Federal Housing Administration ("FHA") and Veterans Administration
("VA") mortgages, "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).
o Geography. We have employees in California, Florida, Texas, Colorado,
Nevada and Missouri. We are presently qualified to do business in 33
states. We expect to be qualified and licensed as required in the
remainder of the United States within the next three to six months. We
also expect to open three new regional offices by the end of fiscal
year 2001.
o Channels of distribution. We are originating and/or purchasing mortgage
loans by traditional retail loan officers, broker-correspondents, "net
branch" employees, and the Internet.
Our history 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.
Effective as of October 1, 1999, we acquired Residential Lenders, Inc.,
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
us to continue our diversification both as to geography and distribution
channel.
Effective as of October 1, 1999, we also acquired the assets and
operations of Occidental Mortgage Company, 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 customer
payments, hold tax and insurance escrows and pay the same when due). Management
believes that this acquisition serves geographic and product line
diversification.
In September 1999, we established a wholesale loan office in Houston,
Texas, staffed with personnel knowledgeable and experienced in sub-prime and
non-conforming loans as well as conforming conventional, FHA and VA loans.
In December 1999, we established a wholesale loan office in Denver,
Colorado, staffed with personnel knowledgeable and experienced in non-conforming
loans. We believe that we will be able to service the Rocky Mountain area with
centralized underwriting and closing from our Western Regional office in Irvine,
California.
Effective as of December 31, 1999, we sold all of the capital stock of
GM. We did, however, retain certain operations, personnel and relationships of
GM.
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<PAGE> 17
On April 28, 2000, we purchased substantially all of the assets of Wall
Street Mortgage of Dallas, Inc., a Dallas-based company which is engaged in the
business of residential mortgage brokering. As part of this acquisition, we have
acquired several exclusive advertising agreements with cyberXpo.com, Inc., a
Dallas, Texas-based company, that operates various mobile Internet access
venues, or "cyberCenters," in seven states. Such advertising agreements provide
us with the exclusive right to display mortgage lending and real estate
advertising at any cyberCenter that is operating in a mall, airport or in a
previously agreed upon retail location.
We continually evaluate prospective acquisitions. However, having
experienced rapid growth, we intend 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 our operations and
optimize their effectiveness in fulfilling our strategic objectives.
PRODUCTION
<TABLE>
<CAPTION>
STARNET MORTGAGE
FISCAL YEAR ENDED 3/31/00 - NEW APPLICATIONS
FISCAL YEAR ENDED 3/31/00
<S> <C>
StarNet - Dallas $ 98,657,785
StarNet - Houston 37,519,026
RLI - Eastern Region 36,124,454
OMC - Western Region 532,688,233
------------
TOTAL: $ 704,989,498
</TABLE>
<TABLE>
<CAPTION>
STARNET MORTGAGE
FISCAL YEAR ENDED 3/31/00 - CLOSINGS
FISCAL YEAR ENDED 3/31/00
<S> <C>
StarNet - Dallas $ 43,783,191
StarNet - Houston 19,348,729
RLI - Eastern Region 16,315,070
OMC - Western Region 137,125,906
-------------
TOTAL: $ 216,572,896
</TABLE>
We anticipate receiving and processing $1,800,000,000 of mortgage loan
applications during fiscal year 2001, and we anticipate that we will close up
to $650,000,000 of those loans during fiscal year 2001. We anticipate wholesale
loan production to grow at an accelerated rate as we commence activity in other
states. However, these expectations are subject to interest rate fluctuations
and other market conditions, which we have no control over.
PIPELINE
The loan pipeline (the "Pipeline") is the volume of loans in our
combined system that have met all of our preliminary criteria subject to
completion of underwriting documentation. As of March 31, 2000, the Pipeline had
a total of $157,644,146 in mortgage loans available. The Pipeline consists of
approximately $100,000,000 of non- conforming loans ("A"), $25,000,000 in
sub-prime loans ("B/C") and the balance is in government-insured loans and
various conforming product. As of March 31, 2000, the total approximate Pipeline
by region was as follows:
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<PAGE> 18
<TABLE>
<CAPTION>
<S> <C>
Western Region $ 85,967,076
Central Region (Dallas and Houston) $ 47,297,070
Eastern Region $ 24,380,000
================
$ 157,644,146
</TABLE>
The loans generated by us can be sold on an individual basis ("flow")
or sold in package form ("bulk"). We can form one package or several packages
during a month, depending on the best execution (i.e., highest price). Loans
sold on a flow can be sold rapidly. Loans sold in bulk generally require more
time to assemble, often 15 to 30 days from the date of our funding.
As of March 31, 2000, we had a cash position of $294,172. Throughout
the 2000 fiscal year, we have experienced negative cash flows from operations
amounting to $5,250,005. Rising interest rates leading to a decline in loan
production place additional pressures on liquidity.
During the fourth quarter of fiscal year 2000 and the first quarter of
fiscal year 2001, we conducted a private placement of our common stock. As part
of this private placement, we issued 1,486,702 shares of Common Stock, and we
raised approximately $1.4 million in cash. Additional capital will need to be
raised for us to continue our business as contemplated in our business plan
beyond the next 12-month period.
RESULTS OF OPERATIONS
As a mortgage lender, we generate revenues through the origination and
subsequent sale of funded loans. These revenues are made up of loan processing
fees, net gain on sale, and net interest income. Loan processing fees include
application, documentation, commitment, and processing fees paid by borrowers.
New gain on sale consists of the difference in price paid by the borrower and
the price paid by the permanent investor, which includes the value of the rights
to service loans. Net interest income consists of the difference between
interest received by us for the time we hold a loan and interest paid by us
under our credit facilities.
Our expenses largely consist of:
o salaries and benefits paid to employees;
o occupancy and equipment costs;
o Internet and other technology-related expenses, including licensing
and participation fees and advertising costs; and
o data processing and communication costs.
A substantial portion of these expenses are variable in nature. Commissions paid
to loan originators are 100% variable, while other salaries and benefits
fluctuate from quarter to quarter based on our assessment of the appropriate
levels of non-loan originator staffing, which correlates to the current level of
loan origination volume and our estimates of future loan origination volume.
Seasonality affects the mortgage industry as loan originators are
typically at their lowest levels during the first and fourth quarters of the
calendar year due to a reduced level of home buying activity during the winter
months. Loan originations generally increase during the warmer months beginning
in March and continuing through October. As a result, we expect higher earnings
in our first and second quarters and lower earnings in the third and fourth
quarters of our fiscal year.
Interest rate and economic cycles also affect the mortgage industry, as
loan originations typically fall in rising interest rate environments. During
these periods, refinancing originations decrease, as higher interest rates
provide reduced economic incentives for borrowers to refinance their existing
mortgages. Due to stable and
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<PAGE> 19
decreasing interest rate environments over recent years, our current performance
may not be indicative of results in rising interest rate environments.
Prior to May 1999, we were known as Sarkis Capital, Inc. ("Sarkis"), an
inactive publicly held corporation pursuing a business combination with a
privately held company believed to have growth and profit potential,
irrespective of the industry in which the privately held company was operating.
With the acquisition of LoanNet, Occidental, RLI and Wall Street, we have
embarked on a plan to become a significant competitor in the mortgage banking
industry. Subsequent to the acquisitions, we raised approximately $3.6 million
in capital through a private placement of our Common Stock which closed on
September 30, 1999 and approximately $1.4 million through a private placement of
our Common Stock which closed on June 30, 2000. As such, our prior results are
not indicative of our future prospects.
Due to the evolution of our business strategy, we believe that our
historical results of operations for the periods presented may not be directly
comparable. Further, we believe the historical results of operations do not
fully reflect the operating efficiencies and improvements that are expected to
be achieved by the continued integration of our acquired businesses.
The following discussion should be read in conjunction with the
consolidated financial statements and the related notes thereto and other
detailed information appearing elsewhere herein.
FISCAL YEAR ENDED MARCH 31, 2000 COMPARED WITH FISCAL YEAR ENDED MARCH
31, 1999
No comparison to the fiscal year ended March 31, 1999 is relevant since
we did not begin mortgage loan operations until the fiscal year ended March 31,
2000.
REVENUES
During fiscal year 2000, we had gross revenues of $4,929,177.
LOAN PROCESSING EXPENSES
Loan processing expenses amounted to 464,027 in fiscal year 2000.
MARKETING AND SALES EXPENSE
Marketing and sales expense consists primarily of advertising and
promotional expenditures. Marketing and sales expense amounted to $368,500 in
fiscal year 2000.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expenses for fiscal year 2000 consisted of
$5,396,410 in compensation and benefits, $565,822 in travel and entertainment,
$1,216,159 in office occupancy expenses, $593,459 in consulting and contract
services, $216,901 in legal and professional services, $39,656 in insurance and
$329,003 in depreciation and amortization.
INTEREST EXPENSE
Interest expense is comprised of interest on indebtedness. Interest
expense amounted to $36,696 in fiscal year 2000.
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<PAGE> 20
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2000, we had a cash position of $294,172. Throughout
fiscal year 2000, we have experienced negative cash flows from operations
amounting to $5,250,005. Rising interest rates leading to a decline in loan
production place additional pressures on liquidity.
During the fourth quarter of fiscal year 2000 and the first quarter of
fiscal year 2001, we conducted a private placement of our common stock. As part
of this private placement, we issued 1,486,702 shares of Common Stock, and we
raised approximately $1.4 million. Additional capital will need to be raised for
us to continue our business as contemplated in our business plan beyond the next
12-month period.
The discussion above addresses working capital requirements. In
addition to working capital, we fund our "Mortgage Loans Held for Sale" through
advances under warehouse lines of credit. Our subsidiary, StarNet Mortgage,
currently uses three lines of credit (implemented by means of "loan purchase
agreements") with an aggregate limit of $11,000,000 provided by First State Bank
of Moulton and Lott State Bank. Additionally, StarNet Mortgage maintains two
warehouse lines of credit with DLJ Mortgage Capital, Inc., a New York
corporation, and IMPAC Warehouse Lending Group, a California corporation.
We have a critical need for additional working capital to execute our
business strategy. We anticipate using the net proceeds of the private placement
discussed above to open additional regional offices, hire additional personnel
and maintain net worth requirements for federal agency approvals and credit
facilitation. In the event that we are unable to obtain additional capital, we
will forego further expansion of our net branch and regional office network,
reduce the number of employees and overhead expenses, curtail our loan
production activities and/or sell loans earlier than is optimal and concentrate
our efforts on our existing operations.
We believe that the lines of credit, funds generated from operations
and the net proceeds of the private placement will be sufficient to finance our
current and anticipated operations for at least the next 12 months. Our long-
term capital requirements beyond this 12-month period will depend on numerous
factors, including the following:
o the rate of market acceptance of our products and services;
o the ability to expand our customer base; and
o the level of expenditures for sales and marketing and other
factors.
To the extent that the lines of credit, the net proceeds of the private
placement and our revenues are insufficient to fund the activities in the short
or long term, we would need to raise additional funds by incurring debt or
through public or private offerings of our stock. We are, however, actively
negotiating with other providers of mortgage warehouse lending facilities for
increased limits and more favorable terms.
INFLATION
Fluctuations in interest rates and increases and decreases of the prime
rate may directly impact the mortgage market and our ability 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 diminishes purchase activities 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 "B/C" market which may
occur when interest rates increase, is typically not as significant as in the
"A" mortgage market. However, since we intend to continue to concentrate our
loan origination
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<PAGE> 21
efforts 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
our financial position by causing fewer "A" mortgages to be processed.
However, management does not believe that inflation will have a
material impact on the Company's pricing of goods or services since the Company,
generally, has the ability to adjust prices for its technical services to meet
the current market conditions.
RISK FACTORS
We have only recently begun operations and are presently incurring
losses.
Although, a number of our subsidiaries and divisions have been in
operation for a number of years, we have only operated as a consolidated group
for a short period of time. Consequently, our business profile is that of a
development-stage company. Typical of a development-stage company, our ability
to generate revenue is subject to substantial uncertainty and risk. In addition,
we anticipate that our operating expenses will increase substantially in the
foreseeable future as we open additional regional and net branch offices and
increase our sales and marketing activities. Accordingly, we expect to incur
losses at least through the second quarter of fiscal year 2001 and may continue
to incur losses for some time thereafter. There can be no assurance that we will
begin expanded operations successfully or on a timely basis or that we will be
successful in obtaining market acceptance. There can be no assurance that we
will be able to achieve or sustain operating profitability. Our success may
ultimately depend on management's ability to react expeditiously to exigencies
that have not been taken into account in our business plan.
We have a need for additional financing.
We require substantial capital to pursue our operating strategy. We
fund, and expect to continue to fund, mortgage loans not only with our own cash,
but also primarily with cash obtained through borrowings from nonaffiliated
lenders. Our subsidiary, StarNet Mortgage, currently uses three warehouse lines
of credit with an aggregate borrowing limit of $11,000,000 provided by First
State Bank of Moulton and Lott State Bank.(1)
Additionally, StarNet Mortgage maintains two true warehouse lines of
credit with DLJ Mortgage Capital, Inc., a New York corporation, and IMPAC
Warehouse Lending Group, a California corporation, with borrowing limits of
$30,000,000 and $25,000,000, respectively. Through the practice of managing the
flow of loans through shipping and investor purchase, the credit facilities can
be turned up to two times their size. We fund substantially all of the loans
which we originate and purchase through borrowings under our warehouse lines of
credit. These borrowings are in turn repaid with the proceeds received by
selling such loans either through whole loan sales or bulk sales.
We conducted a private placement of our Common Stock during the last
quarter of fiscal year 2000 and the first quarter of fiscal year 2001. We
anticipate that the net proceeds of this private offering will permit us not
only to maintain, but to increase the line-of-credit facilities available for
funding mortgage loans. To the extent that we are unable to obtain additional
line-of-credit financing, or even to maintain or replace (at comparable levels)
our existing warehouse lines of credit, we would have to curtail our loan
production activities or sell loans earlier than is optimal, thereby having a
material adverse effect on our results of operations and financial conditions.
Further, we may need additional capital to satisfy future capital requirements.
----------
(1) Rather than true "warehouse" lines of credit, StarNet Mortgage has
agreements known as "loan purchase agreements" with all of the aforementioned
banks. These agreements require that StarNet Mortgage provide a firm commitment
showing the loan rate locked, price to be purchased at, and the expiration date
of the lock for each loan before funds are released. These commitments assure
that each loan will be purchased out of the line at a guaranteed price within a
given time frame.
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We cannot assure you that we will be able to raise needed capital from
other sources on terms favorable to us, if at all. If we are unable to obtain
sufficient capital in the future, our ability to pursue our business strategy
and results of operations for future periods may be impaired.
Our additional financing requirements could result in dilution to
existing stockholders.
If additional financing is required, it could be obtained through one
or more transactions which effectively dilute the ownership interests of holders
of our Common Stock. Further, there can be no assurance that we will be able to
secure such additional financing. We have the authority to issue additional
shares of Common Stock, as well as additional classes or series of ownership
interests or debt obligations of the Company which may be convertible into any
class or series of ownership interests in the Company. We are authorized to
issue 60,000,000 shares of Common Stock and 3,000,000 shares of preferred stock.
Such securities may be issued without the approval or other consent of the
holders of our Common Stock.
We have substantial indebtedness.
We rely on lines-of-credit to fund our operations. From time-to-time,
the amount of indebtedness under these lines-of-credit is substantial. Our
substantial indebtedness could increase our vulnerability to general economic
and industry conditions, limit our ability to fund future working capital,
capital expenditures and other general corporate requirements, and require us to
dedicate a substantial portion of our cash flow from operations to payments on
our indebtedness, thereby reducing the availability of our cash flow to fund
working capital, capital expenditures and other general corporate purposes. Our
profit margins may also decrease if interest rates on our lines-of-credit
increase.
We have a limited number of offices.
Currently, we have six regional offices established. We intend to
establish three additional regional offices during fiscal year 2001. Because of
our small number of traditional offices, we may be at a competitive disadvantage
compared to other mortgage banking firms that can spread their operating costs
across more offices and originate more loan production and revenue within their
much more extensive branch office networks.
Our future success will be dependent on our ability to attract and
retain key personnel.
Our success depends in large part on the efforts and abilities of our
senior management, including Daniel L. Jackson, our Chief Executive Officer,
Kenneth F. Urbanus, our Chief Operating Officer and President, Edward P. Dayton,
our Executive Vice President-Operations and Secretary, Thomas Deutsch, our
Executive Vice President-National Production, and Ms. Jennifer Salsbury, our
Executive Vice President-Risk Management/Secondary Marketing. The loss of one or
more of these individuals could adversely affect our business. We currently have
employment agreements with Ms. Salsbury and Messrs. Urbanus, Dayton and Deutsch.
We do not carry key-man insurance on any of our executive officers.
We further believe that our future success also depends significantly
upon our ability to attract, train, retain and motivate highly skilled mortgage
bankers, as well as technical, sales and management employees and consultants.
We cannot assure you that we will be able to retain our current key personnel or
attract and retain qualified personnel, which would materially and adversely
affect our business and operating results.
The substantial growth projected by us, if achieved, must be
efficiently and effectively managed.
Our growth has placed, and will likely continue to place, a significant
strain on our managerial, operational and financial resources. We need to:
o improve our financial and management controls, reporting
systems and procedures;
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o expand, train and manage our work force for marketing, sales
and support and website development and design; and
o manage multiple relationships with various customers and other
third parties.
We face risks in connection with any potential acquisition that could
have a material adverse impact on our growth or our operations.
From time to time, we may consider selective strategic acquisitions of
mortgage lenders and other mortgage banking-related companies. There is
substantial competition for acquisition opportunities in the mortgage industry.
This competition could result in an increase in the price of, and a decrease in
the number of, attractive acquisition candidates. As a result, we may not be
able to successfully acquire attractive candidates on terms we deem acceptable.
In addition, we cannot assure you that we will be able to obtain the requisite
financing on terms we deem acceptable. Pursuing acquisitions also involves a
number of special risks, including adverse short-term effects on our results of
operations, dilution resulting from issuances of our Common Stock, diversion of
management's time, strain on our financial and administrative infrastructure,
difficulties in integrating acquired businesses and personnel, loss of personnel
and unanticipated legal liabilities. We cannot guarantee you that we will be
able to overcome these acquisition risks or that they will not adversely affect
our growth and results of operations.
The loss of key purchasers of our loans or a reduction in prices paid
could adversely affect our financial condition.
We sell substantially all of the mortgages that we originate to
institutional buyers. Generally, we sell the servicing rights to our loans at
the time we sell those loans. During fiscal year 2000, we sold our loans to
twenty different investors, some of which compete with us directly for retail
originations. If these financial institutions or other significant purchasers of
our loans cease to buy our loans or servicing rights and equivalent purchasers
cannot be found on a timely basis, then our business and results of operations
could be materially adversely affected. Our results of operations could also be
affected if these financial institutions or other purchasers lower the price
they pay to us or adversely change the material terms of their loan purchases
from us.
The prices at which we sell our loans vary over time. A number of
factors determines the price we receive for our loans. These factors include:
o the number of institutions that are willing to buy our 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 we sell;
o the level and volatility of interest rates; and
o the quality of our loans.
The prices at which we can sell our 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.
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Our hedging strategy may not protect us from interest rate risk and may
lead to losses.
Although we generally sell our loans within 30 days after funding,
there may be unexpected delays that could increase our interest rate exposure.
While we use hedging and other strategies to minimize our exposure to interest
rate risks, no hedging or other strategy can completely protect us. In addition,
the nature and timing of hedging transactions may influence the effectiveness of
these strategies. Poorly designed strategies or improperly executed transactions
could actually increase our risk and losses. In addition, hedging strategies
involve transaction and other costs. We cannot assure you that our hedging
strategy and the hedges that we make will adequately offset the risks of
interest rate volatility or that our hedges will not result in losses.
We rely on others for consulting services.
We may enter into agreements with contractors, which may include firms
providing website design, software design, information systems and marketing
services. We have verbally entered into certain of these agreements, but only
one of the agreements was committed to writing. The verbal agreements are
terminable at will, and the written agreement terminated on April 30, 2000. When
and if terminated, there is no assurance that the verbal agreements could be
replaced on the same or similar financial terms.
To expand our Internet business, we intend to expend significant funds
currently without assurance of increased future earnings or
profitability.
We anticipate expending significant funds to implement our growth
strategy. There may be a significant delay between the timing of these
expenditures and any increase in earnings, which may depress our earnings. Our
future plans are subject to both known and unknown risks and uncertainties that
may cause our actual results in future periods to be materially adversely
different than our prior performance. As a result, we cannot guarantee that our
future revenues will increase or that we will continue to be profitable.
Our Internet success will depend, in part, on the development and
maintenance of the Internet's infrastructure and consumer acceptance of the
Internet as a distribution channel for mortgages. Internet-based mortgage
lending is relatively new, and we cannot assure you that consumers will increase
their use of the Internet for obtaining mortgage loans. In order to increase our
loan volume on the Internet, we depend on building and maintaining relationships
with operators of Internet mortgage websites, attracting consumers with our loan
terms and service, and controlling our costs. However, our ability to
significantly increase the number of loans we originate over the Internet and to
continue to originate loans profitably over the Internet remains uncertain.
To expand our Internet business, we must safeguard our customers'
financial data and our computer systems against Internet intruders and
hackers.
Our online loan origination and processing activities will be adversely
affected if we are unable to satisfactorily safeguard the security and privacy
of our customers' financial data. A significant barrier to the future growth of
e-commerce and online communication is the concern over the security of
confidential information transmitted over the Internet. We use Netscape
Communicator v. 4.5 rather than earlier Netscape versions or other browsers to
avoid certain security problems, such as root certification authority
recognition. We believe that we have taken adequate measures to ensure the
privacy and confidentiality of our customers' financial information.
Nevertheless, continuing consumer confidence in and usage of the Internet for
mortgage loan origination and processing could be adversely affected by evidence
of the inability of a mortgage loan originator to assure the privacy and
confidentiality of customers' financial information.
Our computer systems may be subject to break-in by hackers accessing
our computer systems through the our Internet website. We currently use the
Intruder Alert software package for Internet website security. Internet Alert
will notify us of any attempted break-in to our computer network, stop the
intruder, and then build a visual map showing the intruder's Internet Service
Provider thus allowing us to locate and report the intruder to the authorities.
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<PAGE> 25
The results of our operations will be affected by various factors and
will be subject to certain risks inherent in the mortgage lending
industry, many of which are beyond our control, including general
economic conditions and interest rate levels.
Our 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 us, 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 our loan sales. While we believe
the underwriting criteria and collection methods we utilize enable us to
mitigate the higher risks, we cannot assure you 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 our ability 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 diminishes purchase activities 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 "B/C" market which may
occur when interest rates increase, is typically not as significant as in the
"A" mortgage market. However, since we intend to continue to concentrate our
loan origination efforts 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 our financial position by causing fewer "A" mortgages to be
processed.
We retain some risk on loans that we sell.
Although we sell substantially all loans which we originate and
purchase on a nonrecourse basis, we retain some risk on substantially all loans
sold. During the period of time that loans are held pending sale, we are subject
to the various business risks associated with the lending business, including
the risk of borrower default, the risk of foreclosure and the risk that a rapid
increase in interest rates would result in a decline in the value of loans to
potential purchasers.
In the ordinary course of our business, we may be subject to claims
made against us by borrowers and private investors arising from, among other
things, losses that are claimed to have been incurred as a result of alleged
breaches of fiduciary obligations, misrepresentations, errors and omissions of
our employees, officers and agents (including our appraisers), incomplete
documentation and failures to comply with various laws and regulations
applicable to our business. We believe that there are no such claims currently
asserted. However, any such claims asserted in the future may result in legal
expenses or liabilities which could have a material adverse effect on our
results of operations and financial condition.
We are at any one time potentially subject to past portfolio
liabilities, particularly from our conforming loan business. We may receive
demands for repurchase from various investors. Though we will attempt to have
such individual requests rescinded or cured, there can be no assurance that
individual defects will be cured. Regardless, we do not believe that this risk
would seriously impair our ability to operate successfully.
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We face intense and increasing competition in the mortgage lending
industry that could adversely impact our market share and our revenues.
As a marketer of mortgage loans, we face intense competition, primarily
from traditional mortgage lenders, such as commercial banks, savings and loan
associations, credit unions, thrift institutions, and finance companies, as well
as from Internet-based lending companies and other lenders on the Internet.
Furthermore, entry barriers in the mortgage industry are relatively low and
increased competition is likely. As we seek to expand our business, we will face
a greater number of competitors, many of whom will be well-established in the
markets we seek to penetrate.
Competition can take many forms, including convenience in obtaining a
loan, customer service, marketing and distribution channels, and interest rates.
Furthermore, we depend largely on real estate brokers, visitors to our Internet
website, independent mortgage brokers, financial institutions and other mortgage
bankers for our originations and purchases of new loans. Many of our competitors
are substantially larger, have better name recognition and have more capital and
other resources than us. Our competitors also use the Internet to obtain
originations and purchases of new loans and also seek to establish relationships
with our independent mortgage brokers, financial institutions, and other
mortgage bankers, none of whom is obligated by contract or otherwise to continue
to do business with us.
Competition may also 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
our customers to refinance their loans. During economic slowdowns or recessions,
our borrowers may have new financial difficulties and may be receptive to offers
by our competitors.
Competition may also lower the rates we are able to charge borrowers,
thereby potentially lowering the amount of premium income on future loan sales
and sales of servicing rights. Increased competition also may reduce the volume
of our loan originations and loan sales. We cannot assure you that we will be
able to compete successfully in this evolving market.
Mortgage banking is a highly regulated industry at both the federal and
state levels of government. We must become compliant and maintain our
compliance with a myriad of federal and state laws and regulations.
Our 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 our operations. We are 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 us, 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.
Our operations on the Internet are not currently subject to direct
regulation by any government agency in the United States beyond mortgage-related
regulations and regulations applicable to businesses generally. A number of
legislative and regulatory proposals currently under consideration by federal,
state and local governmental organizations may lead to laws or regulations
concerning various aspects of business on the Internet, including:
o user privacy;
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o taxation;
o content;
o access charges;
o liability for third-party activities; and
o jurisdiction.
The adoption of new laws or the application of existing laws may decrease the
use of the Internet, increase our costs or otherwise adversely affect our
business.
The United States Congress and other governmental officials have also
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, could be eliminated or seriously impaired by such government action.
Regulatory and legal requirements are subject to change. If such
requirements change and become more restrictive, it would be more difficult and
expensive for us to comply and could affect the way we conduct our business,
which could adversely impact our results of operations. Although we believe we
are currently in material compliance with the laws, rules and regulations to
which we are subject, we cannot assure you that we are, or will be, in full
compliance with applicable laws, rules and regulations. If we cannot comply with
those laws or regulations, or if new laws limit or eliminate some of the
benefits of purchasing a mortgage, our business and results of operations may be
materially adversely affected.
Item 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information called for by this Item is included beginning on Page
F-1 of this Annual Report on Form 10-KSB.
Item 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
There have been no changes in or disagreements with accountants on
accounting principles or practices, financial statement disclosure, or auditing
scope or procedures during the year ended March 31, 2000. However, as of June 1,
1999, Jackson & Rhodes, P.C. was dismissed as the Company's certifying
accountants. The Board of Directors approved the engagement of Farmer, Fuqua,
Hunt & Munselle, P.C. as the Company's new principal certifying accountants as
of June 1, 1999. As of May 31, 2000, Farmer, Fuqua, Hunt & Munselle, P.C.
resigned as the Company's certifying accountants. During its tenure, Farmer,
Fuqua, Hunt & Munselle, P.C. had not audited the Company or any of its
subsidiaries. The Board of Directors approved the engagement of Simonton, Kutac
& Barnidge, LLP, as the Company's new principal certifying accountants as of
June 1, 2000.
During each of its tenure as certifying accountant for the Company,
Jackson & Rhodes, P.C. and Farmer, Fuqua, Hunt & Munselle, P.C.'s reports on the
financial statements of the Company did not contain an adverse opinion or
disclaimer of opinion or were qualified or modified as to uncertainty, audit
scope or accounting principles. The dismissal and resignation of Jackson &
Rhodes and Farmer, Fuqua, Hunt & Munselle, respectively, were not the result of
any disagreements on any matter involving accounting principles or practices,
financial statement disclosure or auditing scope or procedure.
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PART III
ITEM 9. EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of the Company and their ages as
of June 30, 2000 are as follows:
<TABLE>
<CAPTION>
Name Age Position with Company
<S> <C> <C>
Daniel L. Jackson (1) 50 Chairman of the Board and Chief Executive
Officer
Kenneth F. Urbanus (2) 47 President, Chief Operating Officer and
Director
Edward P. Dayton 57 Executive Vice President-Operations and
Secretary
Thomas Deutsch 50 Executive Vice President-National Production
Jennifer Salsbury 49 Executive Vice President-Risk
Management/Secondary Marketing
Bradley M. Pence (1)(2) 33 Director
Edward P. Rea (1)(2) 59 Director
</TABLE>
---------------------
(1) Audit committee member.
(2) Compensation committee member.
BIOGRAPHICAL INFORMATION
Mr. Daniel L. Jackson has been a director and Chief Executive Officer
of the Company since May 1999. Mr. Jackson has 25 years experience providing
accounting, taxation, and advisory services to various industries and
government. Since 1987, he has been engaged as a Certified Public Accountant,
Certified Management Consultant and Certified Fraud Examiner with Jackson &
Rhodes P.C.
Mr. Kenneth F. Urbanus has been President, Chief Operating Officer and
a director of the Company since October 1999. From 1996 until assuming his
duties with the Company, he was President, Chief Executive Officer and Senior
Vice President-Production of Occidental Mortgage Company in Irvine, California.
From 1992 to 1994, he was a vice president of CenFed Bank, FSB, where he managed
the government lending department as well as the retail and wholesale lending
activities in Orange and San Diego Counties, California.
Mr. Edward Dayton has been Executive Vice President-Operations of the
Company since August 1999. From 1990 until assuming his duties with the Company,
he was Regional Division Manager-Wholesale Lending of Stratford Mortgage in
Dallas, Texas.
Mr. Thomas Deutsch has been Executive Vice President-National
Production of the Company since October 1999. From 1996 until assuming his
duties with the Company, he was Senior Vice President and Director of Wholesale
Lending of Occidental Mortgage Company. From 1987 to 1996, he was Senior Vice
President of Imperial Credit Industries, where he managed the wholesale
division.
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Ms. Jennifer Salsbury has been Executive Vice President-Risk
Management/Secondary Marketing of the Company since October 1999. From 1996
until assuming her duties with the Company, she was Senior Vice President of
Occidental Mortgage Company, where she handled risk management. From 1991 to
1996, she was Senior Vice President-Secondary Marketing of Rancho Mortgage
Corporation, where she was responsible for risk management, quality control, and
corporate training.
Mr. Bradley M. Pence has been a director of the Company since May 1999.
Mr. Pence is not employed by the Company. Since 1995, he has been with Churchill
Capital Company, L.L.C. of Dallas, Texas, where he is an expert in originating,
underwriting and placing large commercial property transactions.
Mr. Edward P. Rea has been a director of the Company since May 1999.
Mr. Rea is not employed by the Company. Since 1998, he has been an independent
business consultant. From 1994 until 1998, he was President and co-founder of
The Crafters' Marketplace, Ltd. in Ontario, Canada, where he created and
directed a retail chain of 26 craft outlet stores throughout Canada with annual
sales in excess of $35,000,000.
The Company has no knowledge of any arrangement or understanding in
existence between any executive officer named above and any other person
pursuant to which any such executive officer was or is to be elected to such
office or offices. All officers of the Company serve at the pleasure of the
Board of Directors. All Officers of the Company will hold office until the next
annual meeting of the shareholders of the Company.
RECENT CHANGES
As of June 7, 2000, Michael J. Gulinson, the former Executive Vice
President - Finance and Chief Financial Officer of the Company, resigned to
pursue other interests.
BOARD COMMITTEES
We maintain a Compensation Committee, consisting of three board
members, and an Audit Committee consisting of three board members. The
Compensation Committee is responsible for review and making recommendations to
our board of directors on all matters relating to compensation and benefits
provided to executive management. The members of the Compensation Committee are
Messrs. Pence, Rea and Urbanus. The Compensation Committee has the exclusive
authority to administer our 1999 Stock Option Plan. The Audit Committee assists
our board of directors in exercising its fiduciary responsibilities for
oversight of audit and related matters, including corporate accounting,
reporting and control practices. It is responsible for recommending to our board
of directors the independent auditors for the following fiscal year. The Audit
Committee meets periodically with our management, financial personnel and the
independent auditors to review internal accounting controls and auditing and
financial reporting matters. The members of the Audit Committee are Messrs.
Jackson, Pence and Rea.
COMPENSATION OF DIRECTORS
We do not currently pay any remuneration to our non-employee directors.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Other than Mr. Urbanus, none of the members of the compensation committee
is currently or has been, at any time since our incorporation, an officer or
employee of ours. No member of the compensation committee serves as a member of
the board of directors or compensation committee of any entity that has one or
more executive officers serving as a member of our board of directors or
compensation committee.
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INDEMNIFICATION OF OFFICERS AND DIRECTORS
Mandatory Indemnification of Directors and Officers
Our Restated Certificate of Incorporation provides that to the fullest
extent permitted by Delaware statutory or decisional law, a director of the
Company shall not be liable to us or our stockholders for any act or omission in
such director's capacity as a director. Any repeal or amendment of the
Certificate of Incorporation, or adoption of any other provision of the
Certificate of Incorporation inconsistent with such exculpatory provisions, by
our stockholders shall be prospective only and shall not adversely affect any
limitation on the liability to the Company or our stockholders of a director of
the Company existing at the time of such repeal, amendment or adoption of an
inconsistent provision.
Additionally, the By-laws provide that, we shall indemnify any person who
was or is a party or is threatened to be made a party to any threatened,
pending, or completed action, suit, or proceeding, whether civil, criminal,
administrative, or investigative (other than an action, suit, or proceeding by
or in the right of the Company) (collectively referred to as an "Action"), by
reason of the fact that he is or was a director or officer of the Company,
against expenses (including, without limitation, attorneys' fees), judgments,
fines, and amounts paid in settlement (collectively, "Expenses") actually and
reasonably incurred by him in connection with such Action, if he acted in good
faith and in a manner he reasonably believed to be in or not opposed to the best
interests of the Company and, with respect to any criminal Action, had no
reasonable cause to believe his conduct was unlawful.
We shall also indemnify any person who was or is a party or is threatened
to be made a party to any threatened, pending, or completed action, suit, or
proceeding by or in the right of the Company to procure a judgment in its favor
by reason of the fact that he is or was a director or officer of the Company
against Expenses actually and reasonably incurred by him in connection with the
defense or settlement of such action, suit, or proceeding if he acted in good
faith and in a manner he reasonably believed to be in or not opposed to the best
interests of the Company.
Discretionary Indemnification of Directors and Officers
In addition to the above mandatory indemnification, our By-laws provide
that we may indemnify any person who was or is a party or is threatened to be
made a party to any Action by reason of the fact that he is or was an employee
or agent of the Company, or is or was serving at the request of the Company as a
director, officer, employee, or agent of another corporation, partnership, joint
venture, trust, or other enterprise (each such person being hereinafter referred
to as a "Corporate Functionary"), against Expenses actually and reasonably
incurred by him in connection with such Action, if he acted in good faith and in
a manner he reasonably believed to be in or not opposed to the best interests of
the Company and, with respect to any criminal Action, had no reasonable cause to
believe his conduct was unlawful. The termination of any Action by judgment,
order, settlement, or conviction, or upon a plea of nolo contendere or its
equivalent, shall not, of itself, create a presumption that the person did not
act in good faith and in a manner which he reasonably believed to be in or not
opposed to the best interests of the Company or, with respect to any criminal
Action, that he had reasonable cause to believe that his conduct was unlawful.
An "other enterprise" includes, without limitation, an employee benefit plan,
and a "fine" includes, without limitation, any excise tax imposed with respect
to an employee benefit plan.
We may also indemnify any person who was or is a party or is threatened to
be made a party to any threatened, pending, or completed action, suit, or
proceeding by or in the right of the Company to procure a judgment in its favor
by reason of the fact that he is or was a Corporate Functionary against Expenses
actually and reasonably incurred by him in connection with the defense or
settlement of such action, suit, or proceeding, if he acted in good faith and in
a manner he reasonably believed to be in or not opposed to the best interests of
the Company.
Notwithstanding the foregoing, no indemnification shall be made in respect
of any claim, issue, or matter as to which a Corporate Functionary shall have
been adjudged to be liable to the Company, unless and only to the extent that
the Court of Chancery or the court in which such action, suit, or proceeding was
brought shall determine upon application that, despite the adjudication of
liability but in view of all the circumstances of the case, such Corporate
30
<PAGE> 31
Functionary is fairly and reasonably entitled to indemnity for such expenses
which the Court of Chancery or such other court shall deem proper.
ITEM 10. EXECUTIVE COMPENSATION
EXECUTIVE COMPENSATION
The following table contains information concerning the annual
compensation and long-term compensation payable to named executive officers
during the period for the fiscal year ended March 31, 2000.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
-------------------------------------------------------- -------------
FISCAL OTHER
YEAR ANNUAL SECURITIES ALL OTHER
NAME AND PRINCIPAL ENDED COMPENSA- UNDERLYING COMPEN-
POSITION MARCH 31, SALARY ($) BONUS ($) TION ($) OPTIONS (#) SATION ($)
----------------------- --------- ---------- --------- --------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Daniel L. Jackson
Chief Executive Officer 2000 -- -- -- 200,000 --
Kenneth F. Urbanus
President and Chief
Operating Officer 2000 240,000 -- -- 200,000 --
Michael J. Gulinson (1)
Executive Vice President
and Chief Financial Officer 2000 130,000 -- -- 50,000 --
Edward P. Dayton
Executive Vice President-
Operations 2000 75,000 (2) -- 50,000 --
Thomas Deutsch
Executive Vice President-
National Production 2000 108,000 (3) -- 50,000 --
Jennifer Salsbury
Executive Vice President-
Risk Management /
Secondary Marketing 2000 144,000 (4) -- 50,000 --
</TABLE>
----------
(1) Mr. Gulinson resigned as of June 7, 2000.
(2) Mr. Dayton's bonus consists of two basis points on all closed loans.
(3) Mr. Deutsch's incentive bonus consists of two basis points of funded loans
for the first $10,000,000 during a month and four basis points of funded
loans over $10,000,000 during a month.
(4) Ms. Salsbury's monthly incentive bonus consists of one and a half basis
points on the net gain on loans that are sold each month.
31
<PAGE> 32
The following table provides information with respect to the executive
officers included in the Summary Compensation Table who received option grants
during the period for the fiscal year ended March 31, 2000.
INCENTIVE STOCK OPTIONS
<TABLE>
<CAPTION>
OPTION GRANTS IN LAST FISCAL YEAR
[INDIVIDUAL GRANTS]
-----------------------------------------------------------------------------
NUMBER OF % OF TOTAL
SECURITIES OPTIONS
UNDERLYING GRANTED TO EXERCISE OR
OPTIONS EMPLOYEES IN BASE PRICE EXPIRATION
NAME GRANTED (#) FISCAL YEAR ($/SHARE) DATE
---- ----------- ------------ ----------- ----------
<S> <C> <C> <C> <C>
Daniel L. Jackson(1) 200,000 25.6% $ 1.00 10/14/2009
Kenneth F. Urbanus(2) 200,000 25.6% $ 1.00 10/14/2009
Michael J. Gulinson(3) 50,000 6.4% $ 3.375 10/31/2009
Edward P. Dayton(4) 50,000 6.4% $ 1.00 10/14/2009
Thomas Deutsch(5) 50,000 6.4% $ 1.00 10/14/2009
Jennifer Salsbury(5) 50,000 6.4% $ 1.00 10/14/2009
</TABLE>
----------
(1) Mr. Jackson's options are incentive options, were granted on October 15,
1999, and vest in 50% increments over two years.
(2) Mr. Urbanus's options are incentive options, were granted on October 15,
1999, and vest in 20% increments over five years.
(3) Mr. Gulinson's options expired on June 7, 2000, the date of his
resignation, because none were exercisable on that date.
(4) Mr. Dayton's options are incentive options, were granted on October 15,
1999, and become completely vested as of October 31, 2000.
(5) Mr. Deutsch and Ms. Salisbury's options are incentive options, were granted
on October 15, 1999, and vest in 20% increments over five years.
32
<PAGE> 33
The following table provides information on the stock options that the
executive officers included in the Summary Compensation Table held at March 31,
2000:
<TABLE>
<CAPTION>
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FY-END OPTION VALUES
----------------------------------------------------------
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING IN-THE-MONEY
UNEXERCISED OPTIONS OPTIONS AT
AT FISCAL YEAR-END FISCAL YEAR-END
(#) ($)*
EXERCISABLE/ EXERCISABLE/
NAME UNEXERCISABLE UNEXERCISABLE
---- ------------------------------- --------------------
<S> <C> <C>
Daniel L. Jackson 200,000 $ 400,000
Kenneth F. Urbanus 200,000 $ 400,000
Michael J. Gulinson 50,000 --
Edward P. Dayton 50,000 $ 100,000
Thomas Deutsch 50,000 $ 100,000
Jennifer Salsbury 50,000 $ 100,000
</TABLE>
----------
* Based on the closing price of the Common Stock on the Bulletin Board
on March 31, 2000 of $3.00 per share.
Employment Contracts
As of October 15, 1999, we entered into an employment agreement with
Kenneth F. Urbanus, our President and Chief Operating Officer (the "Urbanus
Agreement"). The Urbanus Agreement provides for an annual base salary of
$240,000, a transportation allowance of $1,000 per month, participation in any
savings and retirement plan and welfare benefit plans adopted by the Company,
and other standard provisions.
As of November 1, 1999, we entered into an employment agreement with
Michael J. Gulinson, our Executive Vice President-Finance and Chief Financial
Officer (the "Gulinson Agreement"). The Gulinson Agreement provides for an
annual base salary of $130,000, a transportation allowance of $500 per month,
participation in any savings and retirement plan and welfare benefit plans
adopted by the Company, and other standard provisions. Mr. Gulinson resigned as
of June 7, 2000.
As of October 1, 1999, we entered into an employment agreement with
Edward P. Dayton, our Executive Vice President-Operations (the "Dayton
Agreement"). The Dayton Agreement provides for an annual base salary of $75,000,
an incentive bonus equal to two basis points on all funded loans, a
transportation allowance of $500 per month, participation in any savings and
retirement plan and welfare benefit plans adopted by the Company, and other
standard provisions.
As of October 1, 1999, we entered into an employment agreement with
Thomas Deutsch, our Executive Vice President-National Production (the "Deutsch
Agreement"). The Deutsch Agreement provides for an annual base salary of
$108,000, an incentive bonus equal to two basis points of funded loans for the
first $10,000,000 during a month and four basis points of funded loans over
$10,000,000 during a month, a transportation allowance of $750 per month,
participation in any savings and retirement plan and welfare benefit plans
adopted by the Company, and other standard provisions.
As of October 1, 1999, we entered into an employment agreement with
Jennifer Salsbury, our Executive Vice President-Risk Management/Secondary
Marketing (the "Salsbury Agreement"). The Salsbury Agreement provides for
33
<PAGE> 34
an annual base salary of $144,000, an monthly incentive bonus equal to one and a
half basis points on the net gain on loans that are sold each month, a
transportation allowance of $500 per month, participation in any savings and
retirement plan and welfare benefit plans adopted by the Company, and other
standard provisions.
1999 STOCK OPTION PLAN
In October 1999, our board of directors adopted, and in December 1999
our shareholders approved, our 1999 Stock Option Plan (the "Option Plan"), under
which both incentive stock options and nonqualified stock options may be granted
to our key employees, non-employee directors, and independent contractors and
consultants. The Option Plan will terminate on October 3, 2009, and no options
may be granted under the Option Plan thereafter. The term of an option granted
under the Option Plan may not exceed ten years from the date of grant of that
option. The options granted under the Option Plan are generally for the maximum
ten-year period. Approximately 150 of our employees may participate in the
Option Plan; though options have been granted to only 11 key employees to date.
The compensation committee administers and interprets the Option Plan.
In that capacity, the compensation committee has complete discretion, within the
limits set forth in the Option Plan, to determine the terms of the options
granted, including the term of, the number of shares subject to, the exercise
price of, and the form of consideration payable upon exercise of each such
option. However, the Option Plan requires the exercise price of each incentive
stock option be at least the fair market value of our Common Stock at the time
of the option grant. Additionally, no incentive stock option may be granted
under the Option Plan to anyone who owns more than 10% of our outstanding Common
Stock unless the exercise price is at least 110% of the fair market value of our
Common Stock at the date of grant and the option is not exercisable for more
than five years after it is granted. The board of directors or the compensation
committee may amend, alter or discontinue the Option Plan without the
stockholders' approval, except that the board of directors or the compensation
committee do not have the power or authority to materially increase the number
of securities that may be issued under the Option Plan or to materially modify
the requirements of eligibility for participation in the Option Plan.
As of March 31, 2000, options to purchase 780,000 shares of Common
Stock had been granted. Of that number, options to purchase 50,000 shares of
Common Stock had been exercised pursuant to the Option Plan. The market value as
of March 31, 2000 of all shares of Common Stock subject to outstanding options
was $2,190,000 (based upon the closing bid price of the Common Stock of $3.00 as
reported on the Bulletin Board on such date).
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
PRINCIPAL SHAREHOLDERS
The following table sets forth as of July 14, 2000 the number and
percentage of outstanding shares of Common Stock beneficially owned by each
person who beneficially owns:
o More than 5% of the outstanding shares of our Common Stock;
o Each of our executive officers;
o Each of our directors; and
o All of our officers and directors as a group.
Except as otherwise noted, the persons named in this table, based upon
information provided by these persons, have sole voting and investment power
with respect to all shares of Common Stock owned by them.
34
<PAGE> 35
<TABLE>
<CAPTION>
Number of
Shares
Beneficially % Beneficially
Name of Beneficial Owner Owned(1)(2) Owned
------------------------------------------------- ---------------- -------------------
<S> <C> <C>
Daniel L. Jackson (3)
17000 Preston Road, Suite 250
Dallas, Texas 75248 2,998,975 15.5%
Oslin Nation Trust (4)
8150 North Central Highway, Suite 1700
Dallas, Texas 75206 2,948,975 15.2%
Rea Capital Corporation (5)
4751 West Park Boulevard, Suite 106-422
Plano, Texas 75903 2,359,800 12.2%
Sarkis J. Kechejian (6)
421 East Airport Freeway
Irving, Texas 75062 1,685,146 8.7%
Bradley M. Pence 100,110 *
Edward P. Rea (7) -- --
Kenneth F. Urbanus (8) 956,903 4.9%
Edward P. Dayton 12,500 *
Tom Deutsch -- --
Jennifer Salsbury -- --
All directors and executive officers as a group
(7 persons) (9) 4,068,488 20.7%
</TABLE>
----------
* Less than 1%.
(1) The rules of the SEC provide that, for the purposes hereof, a person is
considered the "beneficial owner" of shares with respect to which the
person, directly or indirectly, has or shares the voting or investment
power, irrespective of his economic interest in the shares. Unless
otherwise noted, each person identified possesses sole voting and
investment power over the shares listed, subject to community property
laws.
(2) Based on 19,199,578 shares outstanding on July 14, 2000. Shares of Common
Stock subject to warrants that are exercisable within 60 days of July 14,
2000, are deemed beneficially owned by the person holding such warrant for
the purposes of calculating the percentage of ownership of such person but
are not treated as outstanding for the purpose of computing the percentage
of any other person. All common shares held by the officers and directors
listed above are "restricted securities" and as such are subject to
limitations on resale. The shares held by the officers and directors may be
sold pursuant to Rule 144 under certain circumstances, subject to certain
lock-up agreements.
(3) Includes 2,948,975 shares of Common Stock (which includes 150,000 shares of
Common Stock issuable upon the exercise of a warrant) owned by the Oslin
Nation Trust, for which Mr. Jackson serves as trustee.
(4) Includes 150,000 shares of Common Stock issuable upon the exercise of a
warrant.
(5) Includes 150,000 shares of Common Stock issuable upon the exercise of a
warrant.
(6) Includes 160,000 shares of Common Stock held by the Kechejian Foundation,
which Mr. Kechejian controls. Includes 150,000 shares of Common Stock
issuable upon the exercise of a warrant. Includes the cancellation of
125,000 shares of Common Stock, which will be canceled under an agreement
with the Oslin Nation Trust and Rea Capital
35
<PAGE> 36
Corporation. Includes 87,000 shares of Common Stock held by the Sarkis J.
Kechejian Trust, for which Mr. Kechejian serves as trustee. Does not
include 250,000 shares of Common Stock held by Mr. Kechejian's wife.
(7) Does not include 2,359,800 shares of Common Stock (which includes 150,000
shares of Common Stock issuable upon the exercise of a warrant) owned by
Rea Capital Corporation. Mr. Edward P. Rea's wife owns all of the issued
and outstanding shares of capital stock of Rea Brothers, Ltd. which owns
all of the issued and outstanding shares of capital stock of Rea Capital
Corporation. Mr. Rea disclaims beneficial ownership of the shares owned by
his wife, Rea Brothers, Ltd. and Rea Capital Corporation.
(8) Includes 611,903 shares of Common Stock and a warrant to purchase 300,000
shares of Common Stock held by Occidental Mortgage Corporation, which Mr.
Urbanus controls.
(9) Includes 150,000 shares of Common Stock issuable upon the exercise of a
warrant held by Oslin Nation Trust, for which Mr. Jackson serves as
trustee. Also includes 300,000 shares of Common Stock issuable upon the
exercise of a warrant held by Occidental Mortgage Corporation, which Mr.
Urbanus controls.
Rule 13d-3 under the Securities Exchange Act of 1934, involving the
determination of beneficial owners of securities, includes as beneficial owners
of securities, among others, any person who directly or indirectly, through any
contract, arrangement, understanding, relationship or otherwise has, or shares,
voting power and/or investment power with respect to such securities; and, any
person who has the right to acquire beneficial ownership of such security within
sixty days through means, including, by notice of any option, warrant or
conversion of a security. Any securities not outstanding which are subject to
such options, warrants or conversion privileges shall be deemed to be
outstanding securities of the class owned by such person, but shall not be
deemed to be outstanding for the purpose of computing the percentage of the
class by any other person.
There are no contractual arrangements or pledges of the Company's
securities, known to the Company, which may at a subsequent date result in a
change of control of the Company.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On May 1, 1999, we entered into a consulting agreement with LoanNet
Consulting, which expired on April 30, 2000. Daniel L. Jackson is the sole
director and President of LoanNet Consulting and the Chairman of the Board of
Directors, Chief Executive Officer and a stockholder of the Company. The
consulting agreement was for one year and was not renewed upon completion of its
term. The agreement provided for a monthly payment of $14,000. LoanNet
Consulting advised our management on issues concerning strategic planning,
acquisitions, and raising of capital.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit Number
--------------
3.1 Articles of Incorporation of Registrant incorporated herein by
reference from Registrant's Registration Statement on Form
S-1, File No. 33-13627, filed with the Securities and Exchange
Commission on April 28, 1987
3.2 Amended and Restated Certificate of Incorporation of
Registrant under Section 245 of the Delaware General
Corporation Law*
3.3 By-laws of Registrant incorporated herein by reference from
Registrant's Registration Statement on Form S-1, File No.
33-13627, filed with the Securities and Exchange Commission on
April 28, 1987
36
<PAGE> 37
3.4 Amended and Restated By-laws of Registrant*
10.1 Employment Agreement by and between Registrant and Kenneth F.
Urbanus, dated October 15, 1999*
10.2 Employment Agreement by and between Registrant and Edward P.
Dayton, dated October 1, 1999*
10.3 Employment Agreement by and between Registrant and Thomas
Deutsch, dated October 1, 1999*
10.4 Employment Agreement by and between Registrant and Jennifer
Salsbury, dated October 1, 1999*
10.5 1999 Stock Option Plan*
10.6 Master Repurchase Agreement between StarNet Mortgage, Inc. and
DLJ Mortgage Capital, Inc., dated May 31, 2000*
10.7 Master Repurchase Agreement between Impac Warehouse Lending
Group and StarNet Financial, Inc. and StarNet Mortgage, Inc.,
dated as of November 5, 1999*
10.8 Mortgage Purchase Agreement by and between First State Bank
Moulton, Texas and StarNet Mortgage, Inc., dated December 23,
1999*
10.9 Mortgage Purchase Agreement by and between Lott State
Bank-Marlin Branch and The GM Group, Inc., dated May 22, 1997*
16.1 Letter on change in certifying accountant incorporated herein
by reference from Registrant's Current Report on Form 8-K,
File No. 33-13627, filed with the Securities and Exchange
Commission on June 8, 1999, and as amended in the Registrant's
Current Report on Form 8-K/A, File No. 33-13627, filed with
the Securities and Exchange Commission on February 1, 2000
16.2 Letter on change in certifying accountant incorporated herein
by reference from Registrant's Current Report on Form 8-K,
File No. 000-30693, filed with the Securities and Exchange
Commission on June 16, 1999
21.1 Subsidiaries of the Registrant*
27.1 Financial Data Schedule*
* Filed herewith
(b) Reports on Form 8-K:
On January 4, 2000, the Company filed a Form 8-K/A to clarify the
purchase price paid for Residential Lenders, Inc. On February 1, 2000, the
Company filed a Form 8-K/A in order to file the letter from Jackson & Rhodes
P.C., dated as of February 1, 2000, concerning its resignation as the
registrant's certifying accountant, as Exhibit 16.1.
37
<PAGE> 38
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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: July 14, 2000 By: /s/ Kenneth F. Urbanus
---------------------------------
Kenneth F. Urbanus, President and
Chief Operating Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of this
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
Chairman of the Board July 14, 2000
-------------------------------- and Chief Executive Officer
Daniel A. Jackson
/s/ Kenneth F. Urbanus Director, President, July 14, 2000
------------------------------- Chief Operating Officer
Kenneth F. Urbanus (Principal Executive Officer)
(Principal Financial Officer)
(Principal Accounting Officer)
/s/ Bradley M. Pence Director July 14, 2000
----------------------------------
Bradley M. Pence
/s/ Edward P. Rea Director July 14, 2000
------------------------------------
Edward P. Rea
</TABLE>
38
<PAGE> 39
STARNET FINANCIAL, INC.
AUDITED FINANCIAL INFORMATION
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report.................................................F-2
Consolidated Balance Sheet at March 31, 2000.................................F-3
Consolidated Statement of Operations
for the Year Ended March 31, 2000...................................F-4
Consolidated Statement of Changes in Stockholders' Equity
for the Year Ended March 31, 2000...................................F-5
Consolidated Statement of Cash Flows
for the Year Ended March 31, 2000...................................F-6
Notes to Consolidated Financial Statements..............................F7- F-19
</TABLE>
<PAGE> 40
INDEPENDENT AUDITORS' REPORT
Board of Directors
StarNet Financial, Inc.
We have audited the accompanying balance sheet of StarNet Financial, Inc. as of
March 31, 2000 and the related statements of operations, changes in
stockholders' equity, and cash flows for the year then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of StarNet Financial, Inc. as of
March 31, 2000 and the results of its operations and its cash flows for the year
then ended in conformity with generally accepted accounting principles.
SIMONTON, KUTAC & BARNIDGE L.L.P.
Houston, Texas
June 26, 2000
<PAGE> 41
STARNET FINANCIAL, INC.
CONSOLIDATED BALANCE SKEET
MARCH 31, 2000
<TABLE>
<S> <C>
ASSETS
Current assets:
Cash $ 294,172
Mortgage loans held for sale 25,009,987
Real estate owned 91,000
Notes receivable 236,000
Accounts receivable 115,813
Prepaid expenses 123,893
------------
Total current assets 25,870,865
------------
Property and equipment, net 746,559
------------
Other assets:
Goodwill, net 1,278,149
Other intangibles, net 115,834
Other assets 40,852
------------
Total assets $ 28,052,259
============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Advances under warehouse lines-of-credit $ 24,821,434
Accounts payable 897,339
Accrued expenses 97,938
Funds held on account for others 107,799
Notes payable 36,019
------------
Total current liabilities 25,960,529
------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, authorized, 1,000,000 shares;
issued and outstanding, none --
Common stock, authorized 60,000,000 shares;
issued and outstanding, 19,199,578 shares; par value, $.01 191,996
Additional paid-in-capital 8,396,822
Stock subscriptions receivable (2,100,000)
Accumulated deficit (4,397,088)
------------
Total stockholders' equity 2,091,730
------------
Total liabilities and stockholders' equity $ 28,052,259
============
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE> 42
STARNET FINANCIAL, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED MARCH 31,2000
<TABLE>
<S> <C>
Gross revenue $ 4,929,177
Expenses:
Salaries and benefits 5,396,410
Travel and entertainment 565,822
Office occupancy expenses 1,216,159
Advertising, dues, and business promotion 368,500
Loan processing expenses 464,027
Consulting and contract services 593,459
Legal and professional services 216,901
Insurance 39,656
Interest 36,696
Depreciation and amortization 329,003
Other expense 54,380
------------
9,281,013
------------
Net loss $ (4,351,836)
============
Net loss per share, basic and diluted $ (0.35)
============
Weighted average common shares outstanding 12,389,293
============
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 43
STARNET FINANCIAL, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
YEAR ENDED MARCH 31,2000
<TABLE>
<CAPTION>
Common Stock Stock
-------------------------- Additional Subscriptions Accumulated
Shares Amount Paid In Capital Receivable Deficit Total
----------- ----------- --------------- ------------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance at March 31, 1999 1,500,000 $ 15,000 $ 206,000 $ -- $ (45,252) $ 175,748
Shares issued with 506 registration -- -- 330,000 -- -- 330,000
before merger
Shares of Sarkis Capital, Inc. issued
prior to merger 300,000 3,000 51,000 -- -- 54,000
Effect of acquisition/reverse merger
with Sarkis Capital, Inc. 9,000,000 90,000 (89,927) -- -- 73
Shares issued in connection with
private placements 7,263,175 72,632 7,190,541 (2,100,000) -- 5,163,173
Warrants and options exercised 250,000 2,500 34,000 -- -- 36,500
Costs related to issuance of stock -- -- (252,331) -- -- (252,331)
Stock options issued as compensation -- -- 50,000 -- -- 50,000
Stock issued for services rendered 25,000 250 24,750 -- -- 25,000
Shares issued in connection with
acquisition of Residential Lenders 250,000 2,500 247,500 -- -- 250,000
Shares Issued to convert debt 611,403 6,114 605,289 -- -- 611,403
Net loss -- -- -- -- (4,351,836) (4,351,836)
----------- ----------- ----------- ----------- ----------- -----------
Balance at March 31, 2000 19,199,578 $ 191,996 $ 8,396,822 $(2,100,000) $(4,397,088) $ 2,091,730
=========== =========== =========== =========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 44
STARNET FINANCIAL, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
YEAR ENDED MARCH 31, 2000
<TABLE>
<S> <C>
Net loss $ (4,351,836)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 329,003
Mortgage loans issued (190,729,206)
Proceeds from mortgage loans sold 188,899,199
Stock and options issued as compensation 75,000
Accounts receivable and other operating assets (618,874)
Accounts payable and other operating liabilities 1,146,709
-------------
Net cash used in operating activities (5,250,005)
-------------
Cash flows from investing activities:
Property and equipment (555,238)
Acquisitions and dispositions of businesses, net of cash acquired (1,160,219)
-------------
Net cash used in investing activities (1,715,457)
-------------
Cash flows from financing activities:
Advances under warehouse lines-of-credit 191,967,425
Repayment of warehouse lines-of-credit (190,186,176)
Net proceeds of stock issuance 5,331,415
-------------
Net cash provided by financing activities 7,112,664
-------------
Net increase in cash and cash equivalents 147,202
Cash, beginning of year 146,970
-------------
Cash, end of year $ 294,172
=============
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE> 45
STARNET FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2000
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
The predecessor company to StarNet Financial, Inc. was incorporated in
February 1999 as LoanNet, Inc. ("LoanNet") to engage in mortgage lending
activities. In May 1999, LoanNet was acquired by Sarkis Capital, Inc.
("Sarkis"), a public shell company. This transaction has been accounted for
as a reverse acquisition for which LoanNet was the acquirer for accounting
purposes. The name of the resulting entity was changed to StarNet
Financial, Inc. 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 year ended March 31, 2000 without
comparative information from prior periods.
The accompanying financial statements present the financial position of
StarNet Financial, Inc. ("the Company"), its divisions (StarNet Retail, and
Occidental) and its wholly owned subsidiaries (StarNet Mortgage, Inc.,
StarNet Trakker, Inc., and Residential Lenders, Inc.). The results of
operations and cash flows include The GM Group, Inc. ("GM"). GM was
acquired in April 1999 for cash and a note payable in a transaction
accounted for as a purchase. GM's stock was sold as of December 31, 1999 in
exchange for a note receivable; however certain of its operations,
personnel and relationships were retained. The Company incorporated StarNet
Mortgage, Inc. in June 1999. Residential Lenders, Inc. was acquired in
October 1999 for cash, a note payable, and common stock of the Company in a
transaction accounted for as a purchase.
The Company operates as a wholesale and retail mortgage banking
organization primarily through traditional origination channels and through
Internet-based channels. The Company is licensed to originate, underwrite,
fund, purchase closed loans or sell loans or is exempt from licensing
requirements in 25 states. The Company sells its loans primarily to
numerous investors.
Going Concern
The Company's financial statements have been presented on the basis that it
is a going concern, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. The financial
statements do not include any adjustments that might result from the
outcome of this uncertainty. The Company is reporting cumulative net losses
since inception of $4,397,088 as of March 31, 2000. The following is a
summary of management's plan to raise capital and generate additional
operating funds.
F-7
<PAGE> 46
STARNET FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Going Concern (Continued)
The Company at March 31, 2000 held three loans with a principal balance
totaling $424,000. These loans were held with company funds. As of June 28,
2000 the company had reached an agreement to sell these loans. The proceeds
will total approximately $375,000 cash. In addition, the company has
approximately $116,000 in a pledge account pertaining to $4,000,000 of
loans being purchased the first week of July 2000. These loans also carry a
2% cash gain which is approximately $80,000. Included in that group of
loans are three loans where the company has paid down the principal by
$96,000. When these loans are purchased, approximately $300,000 of cash
will be released. In total, these two transactions will generate $750,000
of working capital.
Additionally, during the first three months of the current fiscal year, the
Company has reduced overhead significantly. The company has subleased three
locations and closed one. The closing of the San Ramon office in the
western region will save approximately $40,000 per month in overhead. The
subleasing of two office suites in Dallas will save $7,000 per month and
the subleasing of an office suite in Irvine, California will save $9,000
per month. Along with the subleasing of office space, the company has
centralized many of its operations and eliminated duplication of overhead,
saving the company an additional $100,000 per month.
The company has also arranged a new warehouse facility at a rate
significantly less than the current borrowing rate. If the company has a
monthly outstanding borrowing that is equal to the average of the last
twelve months the company will save approximately $600,000 in interest
expense annually.
By making these various changes stated above, the Company has reduced its
operational break-even point dramatically. It is anticipated that the
Company will generate a cash profit in July 2000.
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.
Cash and Cash Equivalents
The Company considers all liquid investments, with an original maturity of
three months or less when purchased, to be cash equivalents.
F-8
<PAGE> 47
STARNET FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Revenue Recognition
Fee income for services rendered to customers, including appraisals, credit
reports, flood certifications, tax services and similar items are
recognized as collected, typically when loans are closed and funded. All
other loan revenue, including loan premium or discount (whether from the
customer or investor), service release fees and net interest, is recognized
when loans are sold to a third party (a "permanent investor").
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.
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
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 permanent 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 five-year period using the straight-line method.
The values of certain assets acquired as a result of the acquisitions of
the stock of Residential Lenders, Inc., and the assets and operations of
Occidental Mortgage Corporation have been estimated in the accompanying
financial statements but are subject to revision as the results of
appraisals and similar
F-9
<PAGE> 48
STARNET FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Goodwill (Continued)
valuation techniques are obtained. The Company will periodically evaluate
whether changes have occurred that could require revision of the estimated
useful life of the goodwill or impair the recoverability of its carrying
value. If such circumstances arise, the Company will record an impairment
loss. Amortization of intangibles amounted to $177,692 for the year ended
March 31, 2000.
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. The
Company has approximately $4,000,000 of net operating loss carryforwards
available for tax purposes.
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
and institutional investors (see Note 4). 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 outstanding stock options and
warrants. Because the options and warrants are antidilutive, basic and
dilutive net loss per share are identical.
2. RESTRICTED CASH
At March 31, 2000 cash in the amount of $217,705 was pledged as security
for certain loans which were financed by advances from IMPAC Warehouse
Lending Group as discussed more fully in Note 5 below.
F-10
<PAGE> 49
STARNET FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. LEASES
The Company leases six office spaces and certain equipment. Future payments
due under noncancelable leases are as follows:
<TABLE>
<S> <C>
2000 $541,533
2001 300,375
2002 134,087
2003 86,616
Thereafter 13,846
</TABLE>
4. 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 March 31,
2000 the Company had drawn $1,861,515 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 by either
party. Additionally, the Company has a line of credit with IMPAC Warehouse
Lending Group of Newport Beach, California with a borrowing limit of
$25,000,000. At March 31, 2000 the Company had drawn $22,959,919 against
this line-of-credit. The interest rate charged is prime plus 1.25%. The
agreement regarding this line-of-credit provides for termination upon
written notice by either party.
5. ACQUISITIONS AND DISPOSITIONS
The Company acquired GM in April 1999, and disposed of GM's common stock
effective as of December 31, 1999, although it retained certain of GM's
operations, personnel and relationships. Prior to the disposition, GM
operated as StarNet Retail and produced loans through retail loan officers
in the Dallas/Fort Worth, Texas metropolitan area. Results of operations of
The GM Group are included in the accompanying financial statements from
April 1 through December 31, 1999.
In September 1999, the Company acquired certain assets and operations of a
wholesale branch loan origination office in Houston, Texas. The effects of
this acquisition prior to the current quarter were immaterial.
F-11
<PAGE> 50
STARNET FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. ACQUISITIONS AND DISPOSITIONS (CONTINUED)
In October 1999, the Company acquired substantially all of the assets and
operations of Occidental Mortgage Corporation ("OMC"). Results of
operations of OMC are included in the accompanying financial statements
from October 1 through March 31, 2000. The purchase price paid and assets
acquired were as follows:
<TABLE>
<S> <C>
Purchase price:
Note payable $ 365,000
Adjusted contingent purchase price 1,019,060
Costs associated with acquisition 26,104
----------
1,410,164
----------
Historical book value of net assets acquired 105,854
----------
Purchase price in excess of net assets acquired $1,304,310
==========
Preliminary allocation of purchase price in
excess of net assets acquired:
Purchase value of loans in process $ 350,000
Covenant not to compete 40,000
Goodwill 914,310
----------
$1,304,310
==========
</TABLE>
A portion of the purchase price for the OMC assets was based upon the
volume of loans that were to be funded by OMC in the four months subsequent
to the acquisition. The amount of this adjusted contingent consideration is
shown above.
The purchase value of loans in process is the estimated gain after expenses
related to loan applications received prior to the transaction but
estimated to close subsequent to it. As part of the transaction, a
principal associated with OMC executed an employment agreement containing
covenants not to compete with the Company in the event of termination of
his employment.
Also, in connection with this transaction, the Company issued to OMC a
warrant to purchase 300,000 shares of common stock of the Company. The
exercise price of the options is consistent with the price obtained in a
private placement of the common stock of the Company, which concluded in
September 1999. Therefore, the Company does not deem the issuance of the
warrant as additional purchase price paid for the assets of OMC.
F-12
<PAGE> 51
STARNET FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. ACQUISITIONS AND DISPOSITIONS (CONTINUED)
In October 1999, the Company also acquired all of the outstanding capital
stock of Residential Lenders, Inc ("RLI"). Results of operations of RLI are
included in the accompanying financial statements from October 1 through
March 31, 2000. The purchase price paid and assets acquired were as
follows:
<TABLE>
<S> <C>
Purchase price:
Cash $175,700
Note payable 200,000
Common stock, 250,000 shares 250,000
Costs associated with acquisition 22,713
--------
648,413
Historical book value of net assets acquired 7,028
--------
Purchase price in excess of net assets acquired $641,385
========
Preliminary allocation of purchase price in
excess of net assets acquired:
Property and equipment $ 12,020
Purchase value of loans in process 12,000
Covenant not to compete 50,000
Value of internet brand 50,000
Goodwill 517,365
--------
$641,385
========
</TABLE>
The purchase value of loans in process is the estimated gain after expenses
related to loan applications received prior to the transaction but
estimated to close subsequent to it. As part of the RLI acquisition,
certain principals associated with RLI executed employment agreements
containing covenants not to compete with the Company in the event of
termination of their employment. RLI has and will continue to operate an
Internet web site from which it derives approximately 75% of the volume of
its business. It has agreements in place with Internet content providers
for banner displays and links to the RLI web site. As a result, it has
established a "brand awareness" with potential customers.
Certain assets and liabilities of RLI were excluded from the transaction,
including cash, a receivable from a related party and certain liabilities
incurred prior to the effective date of the transaction.
F-13
<PAGE> 52
STARNET FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. ACQUISITIONS AND DISPOSITIONS (CONTINUED)
Common Stock of the Company issued in connection with the RLI transaction
was valued at $1.00 per share, consistent with the price obtained in a
private placement of the Company's Common Stock, which concluded in
September 1999.
The unaudited pro forma condensed combined financial information set forth
below has been prepared to illustrate the effect of the transactions on the
results of operations of the combined companies had the OMC and RLI
transactions been consummated as of April 1, 1998. The pro forma
adjustments do not anticipate any synergies that are expected to result
from the transactions.
Pro forma information is presented for the fiscal years ended March 31,
2000 and 1999. For the fiscal year ended March 31, 1999, information
presented is for Sarkis Capital, Inc., predecessor to StarNet Financial,
Inc. The separate results of operations utilized in the pro forma
information for RLI and OMC are for their fiscal years ended December 31,
1998, and for the six month period from January 1 through June 30, 1999.
Actual results for the six months ended March 31, 2000 are included for all
business units. Actual results for GM for the period May 1 through December
31, 1999 have been removed from the pro forma results.
The pro forma financial information does not purport to be indicative of
the results of operations or financial position of the Company which would
have actually been obtained had the transactions been completed as of the
assumed dates and for the periods presented or which may be obtained in the
future.
Pro Forma Financial Information (Unaudited):
<TABLE>
<CAPTION>
Year Ended
March 31, 2000 March 31, 1999
-------------- --------------
<S> <C> <C>
Revenue $ 7,258,512 $ 7,859,497
Expenses $ 12,142,002 7,830,403
------------ ------------
Net income (loss) $ (4,883,490) $ 29,094
============ ============
Earnings (loss) per share, basic and diluted $ (0.39) $ 0.02
============ ============
Proforma weighted average common shares outstanding 12,399,088 1,750,000
</TABLE>
F-14
<PAGE> 53
STARNET FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. PROPERTY AND EQUIPMENT
Property and equipment at March 31, 2000 is summarized below:
<TABLE>
<S> <C>
Furniture and fixtures $ 512,953
Computer equipment and software 301,458
Leasehold improvements 37,766
---------
852,177
Less accumulated depreciation and amortization (105,618)
---------
$ 746,559
=========
</TABLE>
Depreciation expense amounted to $151,311 for the year ended March 31,
2000.
7. INCOME TAXES
There were no significant temporary differences between the Company's tax
and financial bases, except for the Company's net operating loss
carryforwards amounting to approximately $4,000,000 at March 31, 2000.
These carryforwards will expire, if not utilized, in 2015. The Company has
deferred tax assets amounting to approximately $1,360,000 at March 31, 2000
related to the net operating loss carryovers. The realization of the
benefits from these deferred tax assets appears uncertain due to net
losses. Accordingly, a valuation allowance has been recorded which offsets
the deferred tax assets.
8. CAPITAL STOCK TRANSACTIONS
In April 1999, the Company issued 330,000 shares in connection with a
private placement under Rule 506 of Regulation D of the Securities Act of
1933, as amended (the "Securities Act").
As more fully described in the introductory material, LoanNet, the
predecessor to the Company, entered into a reverse acquisition in which
LoanNet shares were exchanged with the shares of Sarkis. The name of the
resulting entity was changed to StarNet Financial, Inc. In connection with
this transaction, 300,000 shares and warrants to purchase an additional
200,000 shares were also issued. The warrants were exchanged for shares
during the third quarter.
Commencing in June 1999 and ending in September 1999, the Company issued
3,626,473 shares in a private placement under Rule 506 of Regulation D of
the Securities Act. The Company also issued 250,000 shares to RLI
shareholders in connection with the acquisition of RLI, and in December
1999, the Company issued 25,000 shares of its common stock as compensation
for financial advisory services rendered.
F-15
<PAGE> 54
STARNET FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. CAPITAL STOCK TRANSACTIONS (CONTINUED)
Additionally, the Board of Directors approved the 1999 Stock Option plan
(the "Plan") that allows the Compensation Committee of the Board to grant
up to 5,000,000 shares to key employees, directors, and independent
contractors and consultants. A majority of the stockholders approved the
Plan in December 1999. The Compensation Committee has currently granted
780,000 options under the Plan with exercise prices ranging from $.01 to
$3.375 per share, which vest over periods ranging from immediately to five
years. Options to purchase 50,000 shares at $.01 were exercised in January
2000.
Commencing in January, 2000, the Company started an additional private
placement of its shares (at $1.00 per share) under Rule 506 of Regulation D
of the Securities Act. The private placement remains open. As of March 31,
2000, the Company had sold 3,636,702 shares, of which $2,100,000 had not
been collected and is deducted from shareholders' equity at that date. A
total of 611,403 shares were also exchanged in settlement of the balance of
the Note Payable ($290,000) and Contingent Purchase Price ($321,403)
recorded in connection with the acquisition of OMC.
The Company has issued compensatory stock options to employees and
directors. A summary of the status of stock options is set forth below:
<TABLE>
<CAPTION>
Weighted
Average
Warrants and Exercise
Options Price
------------ ----------
<S> <C> <C>
Outstanding at beginning of year -- $ --
Granted 1,530,000 $ 0.97
Expired --
Exercised (50,000) $ 0.01
----------
Outstanding at end of year 1,480,000 $ 1.08
----------
Exercisable at end of year 956,000 $ 1.02
----------
</TABLE>
Fair value for the stock underlying stock options was determined using
information available from other stock sale transactions at or near the
grant date. In management's opinion, these transactions between willing
parties included the best information available at the time of grant to
estimate the market value of the common stock of the Company. These fair
values were used to determine the compensatory components of the stock
options granted during the year ended March 31, 2000.
F-16
<PAGE> 55
STARNET FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. CAPITAL STOCK TRANSACTIONS (CONTINUED)
Compensation costs for employee options are recognized as an expense in an
amount equal to the excess of the fair market value of the stock at the
date of measurement over the amount the employee must pay. The measurement
date is generally the grant date. Under this method, compensation expense
amounted to $50,000 for the year ended March 31, 2000. There is no future
compensation expense to be recorded in subsequent periods. Using the fair
value method, the fair value of each option grant is estimated on the date
of grant using the Black-Scholes option pricing model with the following
weighted-average assumptions used for grants in the year ended March 31,
2000: dividend yield of 0.0 percent; expected volatility of 0 percent; risk
free interest rates of 4.5 percent; expected lives of one year. Using the
fair value method of FASB Statement 123 would have had no effect on the
Company's net loss for the year ended March 31, 2000, as the fair value of
the options issued approximated the $50,000 cost recorded.
9. YEAR 2000 ISSUE
The Year 2000 issue is the result of computer programs being written using
two digits rather than four digits to define a specific year. Absent
corrective actions, a computer program that has date-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000.
This could result in system failures or miscalculations causing disruptions
to various activities and operations. To date, the Company has experienced
no material problems with regard to this issue and does not anticipate
future problems.
10. CONTINGENCIES
Litigation
On January 3, 2000, an action was brought against the Company for breach of
contract and fraud by Joni Baquerizo, James Cunningham, Sam W. Pitts, Jr.,
and Jay Robinson, each of whom is a former employee (the "Plaintiffs"). The
Plaintiffs allege that they are owed unpaid wages, unpaid bonuses and stock
options. Management believes that the Plaintiffs' claims are without merit
and intends to vigorously defend itself in this litigation.
From time to time, the Company is a defendant (actual or threatened) in
other lawsuits encountered in the ordinary course of business, the
resolution of which should not have a material adverse effect on the
Company's financial position.
F-17
<PAGE> 56
STARNET FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. CONTINGENCIES (CONTINUED)
Concentration of Credit Risk
The Company invests its cash and certificates of deposit primarily in
deposits with major banks. Certain deposits, at times, are in excess of
federally insured limits. The Company has not incurred losses related to
its cash.
Geographic Concentration
The Company originates loans in approximately 30 states; however, a large
percentage of the number of loans originated have been in the following
states: California 60%, Texas 20% and Colorado and Florida, combined 13%.
Fair Value of Financial Instruments
The following disclosure of the estimated fair value of financial
instruments is made in accordance with the requirements of SFAS No. 107,
Disclosures about Fair Value of Financial Instruments. The estimated fair
value amounts have been determined by the Company, using available market
information and appropriate valuation methodologies. The fair value of
financial instruments classified as current assets or liabilities including
cash and cash equivalents and notes and accounts payable approximate
carrying value due to the short-term maturity of the instruments.
11. RELATED PARTY TRANSACTIONS
Daniel L. Jackson, the Chairman of the Board of Directors of the Company,
is the sole director and President of a firm that 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 and was terminated on
April 30, 2000. It provides for monthly payments of $14,000. Mr. Jackson is
also President of an accounting firm which has provided tax and consulting
services to the Company aggregating $21,326 during the year ended March 31,
2000.
12. SUBSEQUENT EVENTS
Effective April 28, 2000 the Company acquired certain assets, liabilities
and operations of Wall Street Mortgage Corporation of Dallas, Texas in
exchange for 57,557 shares of its common stock and a warrant to purchase
12,500 shares at a price of $4.625.
F-18
<PAGE> 57
STARNET FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. SUBSEQUENT EVENTS (CONTINUED)
In June 2000, the Company and DLJ Mortgage Capital, Inc. ("DLJ") entered
into a $30 million warehouse lending facility. The warehouse lending
facility will be used to finance the origination and sale of residential
mortgage loans by the Company's subsidiary, StarNet Mortgage, Inc.
("Mortgage"). The Company and DLJ have also entered into a $100 million
loan purchase commitment in which DLJ has agreed to purchase up to $100
million of certain fixed rate mortgage loans from Mortgage.
F-19
<PAGE> 58
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<S> <C>
3.1 Articles of Incorporation of Registrant incorporated herein by
reference from Registrant's Registration Statement on Form S-1, File
No. 33-13627, filed with the Securities and Exchange Commission on
April 28, 1987
3.2 Amended and Restated Certificate of Incorporation of Registrant
under Section 245 of the Delaware General Corporation Law*
3.3 By-laws of Registrant incorporated herein by reference from
Registrant's Registration Statement on Form S-1, File No. 33-13627,
filed with the Securities and Exchange Commission on April 28, 1987
3.4 Amended and Restated By-laws of Registrant*
10.1 Employment Agreement by and between Registrant and Kenneth F.
Urbanus, dated October 15, 1999*
10.2 Employment Agreement by and between Registrant and Edward P. Dayton,
dated October 1, 1999*
10.3 Employment Agreement by and between Registrant and Thomas Deutsch,
dated October 1, 1999*
10.4 Employment Agreement by and between Registrant and Jennifer
Salsbury, dated October 1, 1999*
10.5 1999 Stock Option Plan*
10.6 Master Repurchase Agreement between StarNet Mortgage, Inc. and DLJ
Mortgage Capital, Inc., dated May 31, 2000*
10.7 Master Repurchase Agreement between Impac Warehouse Lending Group
and StarNet Financial, Inc. and StarNet Mortgage, Inc., dated as of
November 5, 1999*
10.8 Mortgage Purchase Agreement by and between First State Bank Moulton,
Texas and StarNet Mortgage, Inc., dated December 23, 1999*
10.9 Mortgage Purchase Agreement by and between Lott State Bank-Marlin
Branch and The GM Group, Inc., dated May 22, 1997*
16.1 Letter on change in certifying accountant incorporated herein by
reference from Registrant's Current Report on Form 8-K, File No.
33-13627, filed with the Securities and Exchange Commission on June
8, 1999, and as amended in the Registrant's Current Report on Form
8-K/A, File No. 33-13627, filed with the Securities and Exchange
Commission on February 1, 2000
16.2 Letter on change in certifying accountant incorporated herein by
reference from Registrant's Current Report on Form 8-K, File No.
000-30693, filed with the Securities and Exchange Commission on June
16, 1999
21.1 Subsidiaries of the Registrant*
27.1 Financial Data Schedule*
</TABLE>
* Filed herewith
