<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDING DECEMBER 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ TO________
COMMISSION FILE NUMBER: 000-13627
STARNET FINANCIAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 75-2168244
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
17000 PRESTON ROAD, SUITE 350, DALLAS, TEXAS 75248
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code: 972-239-2939
- --------------------------------------------------------------------------------
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE
LAST REPORT)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to filed such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
The number of shares of Common Stock of the Registrant, par value $.01 per
share, outstanding at December 31, 1999 was 14,901,473.
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT (CHECK ONE):
Yes X No
--- ---
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STARNET FINANCIAL, INC. FORM 10-QSB
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 1999
INDEX
<TABLE>
<S> <C>
PART I -- FINANCIAL INFORMATION
Item 1 -- Financial Statements ......................................... 1
Consolidated Balance Sheet ............................................. 2
Consolidated Statement of Operations ................................... 3
Consolidated Statement of Stockholders' Equity ......................... 4
Consolidated Statement of Cash Flows ................................... 5
Notes to the Consolidated Financial Statements ......................... 6
Item 2 -- Management's Discussion and Analysis of Financial Condition and
Plan of Operations ........................................... 16
Item 3 -- Quantitative and Qualitative Disclosures About Market Risk ... 22
PART II -- OTHER INFORMATION
Item 1 -- Legal Proceedings ............................................ 24
Item 2 -- Changes in Securities and Use of Proceeds .................... 24
Item 3 -- Defaults Upon Senior Securities .............................. 24
Item 4 -- Submission of Matters to a Vote of Security Holders .......... 24
Item 5 -- Other Information ............................................ 25
Item 6 -- Exhibits and Reports on Form 8-K ............................. 25
Signature .............................................................. 26
</TABLE>
<PAGE> 3
STARNET FINANCIAL, INC.
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
STARNET FINANCIAL, INC.
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999
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
reporting 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
three month and nine month periods ended December 31, 1999 without comparative
information from prior periods.
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STARNET FINANCIAL, INC.
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1999
(UNAUDITED)
<TABLE>
<S> <C>
ASSETS
Cash $ 951,455
Mortgage Loans Held for Sale 24,475,459
Note Receivable 472,000
Accounts Receivable 212,750
Property and Equipment, Net 672,000
Covenants not to Compete 80,417
Value of Internet Brand 47,500
Goodwill, Net 1,544,250
------------
Total Assets $ 28,455,830
============
LIABILITIES & STOCKHOLDERS' EQUITY
Liabilities
Advances under Warehouse Lines of Credit $ 24,260,650
Accounts Payable 895,989
Accrued Expenses 165,358
Funds Held on Account for Others 81,407
Notes Payable 642,034
Estimated Future Purchase Price Payable 367,695
------------
Total Liabilities $ 26,413,134
Stockholders' Equity
Preferred Stock, Authorized, 1,000,000 Shares;
Issued and Outstanding, None --
Common Stock, Authorized 20,000,000 Shares;
Issued and Outstanding, 14,901,473 Shares;
Par Value, $.01 $ 149,015
Additional Paid In Capital 4,213,850
Subscription Receivable on Common Shares (49,000)
Retained Earnings (2,271,169)
------------
Total Stockholders' Equity 2,042,697
------------
Total Liabilities & Stockholders' Equity $ 28,455,830
============
</TABLE>
See accompanying Notes to Consolidated Financial Statements
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STARNET FINANCIAL, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
DECEMBER 31, 1999
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
December 31, 1999 December 31, 1999
----------------- -----------------
<S> <C> <C>
Gross Revenue $ 2,447,106 $ 3,315,077
Expenses:
Salaries & Benefits 2,170,216 3,373,457
Travel & Entertainment 110,649 158,922
Office Occupancy Expenses 603,396 821,380
Advertising, Dues, & Business Promotion 102,612 148,019
Loan Processing Expenses 223,441 341,262
Consulting & Contract Services 242,177 362,710
Legal & Professional Services 129,225 150,056
Insurance 12,526 22,216
Investment Property Expenses 839 (454)
Interest -- --
Depreciation & Amortization 57,459 110,131
Other Expense 29,230 53,296
---------------- ----------------
Total Expenses 3,681,770 5,540,994
Net Income From Operations (1,234,664) (2,225,917)
Provision for Income Taxes -- --
---------------- ----------------
Net Income $ (1,234,664) $ (2,225,917)
Net Income Per Share
Basic and Diluted $ (0.08) $ (0.20)
Weighted Average Common Shares Outstanding
Basic 14,881,756 11,302,908
Diluted 16,275,886 11,769,308
</TABLE>
See accompanying Notes to Consolidated Financial Statements
3
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STARNET FINANCIAL, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
DECEMBER 31, 1999
(UNAUDITED)
<TABLE>
<CAPTION>
Additional Retained Subscription
Common Stock Paid In Capital Earnings Receivable Total
------------ --------------- ------------- ------------- ------------
<S> <C> <C> <C> <C> <C>
Balance at March 31, 1999 $ 1,238 $ 219,762 $ (45,252) $ 175,748
Shares Issued in Connection
with Section 506 Registration 1,858 328,142 330,000
Shares of Sarkis Capital, Inc. issued
prior to merger 3,000 51,000 54,000
Effect of Acquisition/Reverse Merger
with Sarkis Capital, Inc. 101,904 (101,831) 73
Shares Issued in Connection with
Private Placement Memorandum 36,265 3,590,208 $ (49,000) 3,577,473
Warrants Exercised 2,000 34,000 36,000
Costs Related to Issuance of Stock (179,681) (179,681)
Stock Issued for Services Rendered 250 24,750 25,000
Shares Issued in Connection with
Acquisition of Residential Lenders 2,500 247,500 250,000
Net Income (2,225,917) (2,225,917)
Balance at December 31, 1999 $ 149,015 $ 4,213,850 $ (2,271,169) $ (49,000) $ 2,042,697
</TABLE>
See accompanying Notes to Consolidated Financial Statements
4
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STARNET FINANCIAL, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
DECEMBER 31, 1999
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months
Ended
December 31, 1999
-----------------
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $ (2,225,917)
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and Amortization 489,999
Mortgage Loans Issued (114,362,528)
Proceeds from Mortgage Loans Sold 112,444,330
Decrease in Accts Receivable & Similar Operating Assets 117,968
Increase in Accts Payable & Similar Operating Liabilities 702,050
Net Cash from Operating Activities (2,834,097)
CASH FLOWS FROM INVESTING ACTIVITIES
Decrease (Increase) in Property & Equipment (349,254)
Acquisitions and Dispositions of Businesses, Net of Cash Acquired (2,106,973)
Net Cash from Investing Activities (2,456,227)
CASH FLOWS FROM FINANCING ACTIVITIES
Advances under Warehouse Lines of Credit 114,857,563
Repayment of Warehouse Lines of Credit (113,306,806)
Note Receivable for Disposition of Business (472,000)
Notes Payable for Acquisitions 555,490
Deferred Purchase Price for Acquisition 367,695
Costs Related to Issuance of Stock (179,681)
Proceeds of Stock Issuance 4,272,546
Net Cash from Financing Activities 6,094,809
Net Change in Cash 804,485
Cash Beginning of Period 146,970
Cash End of Period $ 951,455
</TABLE>
See accompanying Notes to Consolidated Financial Statements
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The financial statements included herein have been prepared without audit by the
management of StarNet Financial, Inc. (the "Company"), pursuant to the rules and
regulations of the Securities and Exchange Commission (the "SEC"). These interim
financial statements have been prepared on the same basis as the annual
financial statements. Certain information and disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been omitted pursuant to such SEC rules and regulations. In the
opinion of the Company's management, the financial statements include all
adjustments necessary to present fairly the financial position of the Company as
of December 31, 1999, its results of operations for the three month and nine
month periods ended December 31, 1999, and its cash flows for the nine month
period ended December 31, 1999.
2. Organization
The accompanying financial statements present the financial position of the
Company, including 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 GM's operations,
personnel and relationships were retained. The Company incorporated StarNet
Mortgage, Inc. in June 1999 and StarNet TRAkkER, Inc. in October 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.
3. Summary of Significant Accounting Policies
Principles of Consolidation - The consolidated financial statements include the
accounts of StarNet Financial, Inc. and its wholly owned subsidiaries. All
intercompany accounts and transactions have been eliminated.
Revenue Recognition - 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").
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
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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 twenty-year period using the straight-line method. The
values of certain assets acquired as a result of the stock acquisition of
Residential Lenders, Inc. and the asset acquisition of Occidental Mortgage
Corporation have been estimated in the accompanying financial statements but are
subject to revision as the results of appraisals and similar valuation
techniques are obtained. The Company will periodically evaluate whether changes
have occurred that could require revision of the estimated useful life of the
goodwill or impair the recoverability of its carrying value. If such
circumstances arise, the Company will record an impairment loss.
Income Taxes - The Company accounts for income taxes in accordance with SFAS No.
109, "Accounting for Income Taxes," which requires the use of the "liability
method." As the Company has not yet earned profits, a valuation allowance has
been established in the amount of any net deferred tax assets.
Advances Under Warehouse Lines of Credit - The Company finances its "Mortgage
Loans Held for Sale" through warehouse loan advances in accordance with
agreements with various commercial banks and institutional investors (see Note
5). These advances are repaid upon receipt of loan sale proceeds from permanent
investors.
Net Income (Loss) Per Share - The Company computes net loss per share in
accordance with SFAS No. 128, "Earnings per Share." Under the provisions of SFAS
No. 128 basic net loss per share is computed by dividing the net loss available
to common stockholders for the period by the weighted average number of common
shares outstanding during the period. Diluted net loss per share is computed by
dividing the net loss available to common stockholders for the period by the
weighted average number of common and common equivalent shares outstanding
during the period, to the extent such common equivalent shares are dilutive.
Common equivalent shares are composed of incremental common shares issuable upon
the exercise of outstanding stock options and warrants.
4. Restricted Cash
At December 31, 1999, cash in the amount of $140,812 was pledged as security for
certain loans which were financed by advances from IMPAC Warehouse Lending Group
as discussed more fully in Note 6 below.
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5. Leases
The Company leases six office spaces and certain equipment. Future payments due
under noncancelable leases are as follows:
<TABLE>
<S> <C>
2000 $ 754,525
2001 $ 353,321
2002 $ 155,393
2003 & After $ 126,624
</TABLE>
6. 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 December 31, 1999,
the Company had drawn $1,968,735 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 December 31, 1999,
the Company had drawn $22,291,915 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.
7. 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. GM was a party to two separate joint
venture arrangements with homebuilders in Dallas. One of these arrangements has
been retained by StarNet Mortgage, Inc. Results of operations of GM are included
in the accompanying financial statements from April 1 through December 31, 1999.
In September 1999, the Company acquired certain assets of a wholesale branch
loan origination office in Houston, Texas. The effects of this acquisition prior
to the current quarter were immaterial.
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
December 31, 1999. The purchase price paid and assets acquired were as follows:
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<TABLE>
<S> <C>
Purchase Price:
Note Payable $ 365,000
Estimated Contingent Purchase Price 1,200,000
------------
1,565,000
Historical Book Value of Net Assets Acquired 105,854
Purchase Price in Excess of Net Assets Acquired $ 1,459,146
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 1,069,146
------------
$ 1,459,146
</TABLE>
A portion of the purchase price for the OMC assets was based upon the volume of
loans that were funded by OMC in the four months subsequent to the acquisition.
The amount of this contingent consideration has been estimated in the financial
statements.
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 the OMC transaction, the Company issued to OMC a
warrant to purchase 300,000 shares of common stock of the Company. The exercise
price of the warrant 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.
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 December 31,
1999. The purchase price paid and assets acquired were as follows:
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<TABLE>
<S> <C>
Purchase Price:
Cash $ 175,700
Note Payable 200,000
Common Stock, 250,000 shares 250,000
----------
625,700
Historical Book Value of Net Assets Acquired 7,028
Purchase Price in Excess of Net Assets Acquired $ 618,672
Preliminary Allocation of Purchase
Price in Excess of Net Assets Acquired:
Adjustment to Estimated Fair Value of:
Property & Equipment $ 12,020
Purchase Value of Loans in Process 12,000
Covenants Not to Compete 50,000
Value of Internet Brand, etc 50,000
Goodwill 494,652
----------
$ 618,672
</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.
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
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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 year ended March 31, 1999 and
for the nine month period ended December 31, 1999. For the fiscal year,
information presented is for Sarkis Capital, Inc., predecessor to StarNet
Financial, Inc. The separate results of operation 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 three month period ended December 31, 1999 are included for all
business units. Actual results for GM for the period of 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.
A preliminary allocation of the purchase prices has been made to major
categories of assets and liabilities in the pro forma financial information
based on available information. The actual allocation of purchase price and the
resulting effect on income from operations may differ significantly from the pro
forma amounts included herein. These pro forma adjustments represent the
Company's preliminary determination of purchase accounting adjustments and are
based upon available information and certain assumptions that the Company
believes to be reasonable. Consequently, the amounts reflected in the pro forma
information are subject to change, and the final amounts may differ
substantially.
<TABLE>
<CAPTION>
Pro Forma Information
---------------------
Year Ended Nine Months Ended
March 31, 1999 December 31, 1999
<S> <C> <C>
Revenue $ 7,859,497 $ 5,644,412
Expenses 7,837,011 8,405,286
Net Income (15,590) (2,760,874)
Earnings Per Share
Basic & Diluted $ (.01) $ (.24)
Pro Forma Weighted Average
Common Shares Outstanding
Basic 1,750,000 11,469,018
Diluted 2,050,000 12,135,418
</TABLE>
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8. Capital Stock Transactions
In April 1999, the Company issued 330,000 shares in connection with a private
placement of its common stock 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 of common stock and a warrant to purchase 200,000 shares of common stock
were also issued. The warrant was exercised during the period reported.
Commencing in June 1999 and ending in September 1999, the Company issued
3,626,473 shares of common stock in a private placement under Rule 506 of
Regulation D of the Securities Act. The Company also issued 250,000 shares of
common stock to the shareholders of RLI in connection with the acquisition of
RLI and 25,000 shares of common stock as compensation for financial advisory
services rendered.
Additionally, the Board of Directors approved the 1999 Stock Option plan (the
"Plan"), which 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.
9. Earnings Per Share
The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share computations:
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<TABLE>
<CAPTION>
Three Months Ended
December 31, 1999
Income Shares Per Share
<S> <C> <C> <C>
Net Income $ (1,199,664)
Net Income Available to $ (1,234,664) 14,881,756 $ (.08)
Common Stockholders
Effect of Dilutive -- --
Securities
Net Income Available to $ (1,234,664) 14,881,756 $ (.08)
Common Stockholders plus
Assumed Conversions
</TABLE>
As of December 31, 1999, warrants to purchase 750,000 shares of common stock had
been issued and were outstanding. As of December 31, 1999, options to purchase
780,000 shares of common stock had been granted in connection with the Plan.
Such warrants and options were not included in the computation of diluted
earnings per share because the warrants and options had an anti-dilutive effect
on earnings per share.
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<TABLE>
<CAPTION>
Nine Months Ended
Dec 31, 1999
Income Shares Per Share
<S> <C> <C> <C>
Net Income $ (2,225,917)
Net Income Available to $ (2,225,917) 11,302,908 $ (.20)
Common Stockholders
Effect of Dilutive -- --
Securities
Net Income Available to $ (2,225,917) 11,302,908 $ (.20)
Common Stockholders plus
Assumed Conversions
</TABLE>
As previously discussed in Note 8, a warrant to purchase 200,000 shares of
common stock, which was issued May 14, 1999, was exercised on September 30,
1999. The warrant was not included in the computation of diluted earnings per
share because the warrant had an anti-dilutive effect on earnings per share.
Warrants and options discussed previously for the three month period ended
December 31, 1999 were also not included in the computation of diluted earnings
per share because they had an anti-dilutive effect on earnings per share.
10. 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.
11. Contingencies
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
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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 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. Except
as disclosed above, the Company is not currently aware of any litigation
currently pending or threatened to which it is subject or to which it may be a
party.
12. Related Party Transactions
Daniel L. Jackson, the Chairman of the Board of Directors and the Chief
Executive Officer of the Company, is the sole director and President of a firm
that provides consulting services to the Company. This consulting firm advises
the Company's management concerning strategic planning, acquisitions, and
raising of capital pursuant to a contract effective May 1, 1999. The contract is
for one year but may be terminated by either party or extended and renewed for
subsequent one year periods by mutual consent. It provides for monthly payments
of $14,000.
13. 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.
14. Recent Developments
In January 2000, the Company issued a private placement memorandum by which it
seeks to privately place a minimum of 500,000 shares and a maximum of 2,500,000
shares with accredited investors at a price of $3 per share, thereby raising up
to $7,500,000 in additional capital.
In January 2000, the Company forwarded an information statement pursuant to
Regulation 14C to its stockholders notifying them that a majority of the
stockholders, as of December 30, 1999, had approved (i) amendments to the
Company's Certificate of Incorporation to increase the authorized number of
shares of preferred stock from 1,000,000 to 3,000,000 shares, to increase the
authorized number of shares of common stock from 20,000,000 to 60,000,000
shares, to allow the Board of Directors to repeal, alter or amend the Company's
By-laws, to provide for the indemnification of officers and directors of the
Company, and to prevent the invalidation of interested party transactions with
the Company and (ii) the 1999 Stock Option Plan. The Amended and Restated
Certificate of Incorporation was filed with the Delaware Secretary of State on
January 12, 2000, with an effective date of February 11, 2000.
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At its January 2000 meeting, the Audit Committee of the Board of Directors
approved an action to engage Ernst & Young as independent auditors and is
presently negotiating the terms of that engagement. This action was not as a
result of any disagreements with the predecessor auditors.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This document contains forward-looking statements within the meaning of Section
27A of the Securities Act and Section 21E of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), which can be identified by the use of
words such as "intend," "anticipate," "believe," "estimate," "project," or
"expect" or other similar statements. These statements discuss future
expectations, contain projections of results of operations or of financial
condition or state other "forward-looking" information. We do not undertake to
update publicly any forward-looking statements for any reason, even if new
information becomes available or other events occur in the future. We believe
that our forward-looking statements are within the safe harbor provided by the
Exchange Act.
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our financial statements, the
notes to our financial statements and the other financial information contained
elsewhere in this document. In addition to the historical information, this
Management's Discussion and Analysis of Financial Condition and Results of
Operations and other parts of this document contain forward-looking information
as described above that involve risks and uncertainties. Our actual results
could differ materially from those anticipated by the forward-looking
information as a result of certain factors.
GENERAL
We are engaged in the business of originating, purchasing and selling mortgage
loans secured by single-family and condominium residences through traditional
distribution channels and over the Internet. We:
- originate wholesale loans using a nationwide network of independent
mortgage loan brokers;
- originate retail loans with consumers directly over the Internet; and
- originate retail loans through our "net branches" located across the
United States and through exclusive programs with various homebuilding
companies.
We pool and sell both conforming loans (generally loans to borrowers with
perfect or good credit) and 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 to originate,
underwrite, fund, purchase funded loans or sell loans, or are exempt from
licensing requirements, in twenty-five states.
16
<PAGE> 19
BACKGROUND
In March 1987, we were incorporated in Delaware under our former name of "Sarkis
Capital, Inc." Effective May 1999, we exchanged 9,000,000 shares of our common
stock, $.01 par value (the "Common Stock") for all of the outstanding common
stock of LoanNet, Inc., a Texas corporation ("LoanNet"). In connection with the
share exchange, we also acquired LoanNet's subsidiary, The GM Group, Inc., a
Texas corporation ("GM"). In June 1999, we changed our name to StarNet
Financial, Inc.
Effective October 1, 1999, we purchased substantially all of the assets of
Occidental Mortgage Corporation, a California corporation ("Occidental"), which
was engaged in the business of originating mortgage loans. We now operate
Occidental as a division.
Also effective October 1, 1999, we acquired all of the outstanding capital stock
of Residential Lenders, Inc., a Florida corporation ("RLI"), which is engaged in
the business of originating mortgage loans. RLI is now our wholly owned
subsidiary.
Effective as of December 31, 1999, we sold the stock of GM, although we retained
certain operations, personnel and relationships.
Our principal executive office is located at 17000 Preston Road, Suite 350,
Dallas, Texas 75248, and our telephone number is (972) 665-0009. We are located
on the World Wide Web at http://www.starnetfinancial.com, where general
information is available about us.
SUBSIDIARIES AND DIVISIONS
We are comprised of five business units involved in mortgage loan origination,
underwriting and/or processing:
- StarNet Mortgage, Inc. originates mortgage loans using our "net
branches" located across the country.
- StarNet Retail markets mortgage loan products through our own loan
officers.
- StarNet Trakker, Inc. originates sub-prime mortgage loans.
- Residential Lenders, Inc. originates mortgage loans using the Internet
from its Orlando, Florida headquarters.
- Occidental Mortgage originates mortgage loans in through mortgage
brokers and correspondent lenders.
17
<PAGE> 20
LIQUIDITY AND CAPITAL RESOURCES
Since our inception, we have financed loan fundings primarily through advances
under warehouse lines of credit and other working capital requirements primarily
through a private placement of our common stock of $3.6 million, which closed in
September 1999. Acquisitions have been financed by a combination of stock
issuances, working capital obtained by the private placement, and deferred
payment arrangements, some of which have been evidenced by notes payable. We
acquired a note receivable in connection with the disposition of GM.
We believe our existing warehouse lines of credit are adequate for our loan
funding needs and could remain in place. However, we expect to evaluate the
advisability of consolidating the sources of our lines and to determine if more
cost effective options are available.
We are currently incurring losses from operations. The negative cash flow from
operating activities (excluding loan fundings and sales) totaled $1.7 million
for the nine month period ended December 31, 1999. We expect to continue to
experience negative cash flows from operating activities at least through the
remainder of our fiscal year. Based on financial projections and business plans
prepared by management, we believe that we will become profitable during our
next fiscal year. In the interim, as more fully described in the "Plan of
Operation" below, we will be incurring additional costs of $25,000 to $50,000
per month to improve our management controls, systems, and equipment.
During the current fiscal year, we have invested approximately $350,000 in
long-lived assets. These assets are primarily computer hardware and software and
amounts paid to third party contractors for Internet web site development and
office interconnectivity.
Approximately $2.5 million was expended during the current fiscal year in
connection with acquisitions. Approximately $800,000 of this amount remains
financed as of December 31, 1999 through notes payable and deferred payment
arrangements. Approximately $500,000 of these deferred payments will be made
during the next quarter.
Beginning in January 2000, we began conducting a private placement of our common
stock to accredited investors of up to 2,500,000 shares of common stock at a
price of $3 per share. In the event that the Maximum Offering is subscribed for,
anticipated use of the proceeds is as follows:
18
<PAGE> 21
<TABLE>
<S> <C>
Expansion efforts $ 1,500,000
Information technology 1,000,000
Working Capital 1,825,000
Net Worth Requirements 3,000,000
Offering Expenses 175,000
------------
$ 7,500,000
</TABLE>
REVENUES AND EXPENSES
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.
Net 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:
- salaries and benefits paid to employees;
- occupancy and equipment costs;
- loan processing expenses such as appraisals and credit reports;
- Internet and other technology-related expenses, including licensing
and participation fees and advertising costs; and
- data processing and communication costs.
A substantial portion of these expenses is 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 originations 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.
19
<PAGE> 22
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 decreasing interest rate environments over recent years, our
current performance may not be indicative of results in rising interest rate
environments.
During the current quarter, we accepted applications for new loans as follows:
<TABLE>
<S> <C>
StarNet - Dallas $ 25,309,575
StarNet - Houston 14,255,322
RLI 10,209,367
Occidental 285,119,018
-------------
$ 334,893,282
</TABLE>
Only a percentage of loan applications will ultimately close. A higher
percentage of conforming loan applications, such as those originated by StarNet
- - Dallas and RLI, will close compared to the non-conforming loans originated by
StarNet - Houston and Occidental. On the other hand, non-conforming loan volume
is less susceptible to the seasonal and interest rate cycles described above.
During the current quarter, we closed and funded loans as follows:
<TABLE>
<S> <C>
StarNet - Dallas $ 17,130,610
StarNet - Houston 7,725,369
RLI 8,578,571
Occidental 83,587,192
-------------
$ 116,721,742
</TABLE>
Our loan "pipeline," which is the volume of loans applications accepted and in
the process of completing underwriting documentation and/or awaiting closing,
was approximately $189,115,000 at December 31, 1999. The pipeline consists of
approximately $100,000,000 of non-conforming "A" quality loans, $25,000,000 in
subprime "B/C" quality loans, $30,000,000 in government-insured loans, and the
balance in various conforming products. The source of the pipeline is broken
down as follows:
20
<PAGE> 23
<TABLE>
<S> <C>
StarNet - Dallas $ 43,513,384
StarNet - Houston 5,859,900
RLI 9,480,000
Occidental 130,261,916
--------------
$ 189,115,200
</TABLE>
PLAN OF OPERATION
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 that 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, North Carolina,
Colorado and Nevada. We are presently qualified to do business in 25 states
and are licensed to conduct mortgage banking operations in seven of those
states as required. We expect to be qualified and licensed as required in
the remainder of the United States within the next 12 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.
In connection with our acquisition of LoanNet, we acquired LoanNet's subsidiary
GM. The GM operation provided retail loan origination capability. GM also had
established relationships with large-scale homebuilders in the Dallas, Texas
area. Although we disposed of the common stock of GM, effective as of December
31, 1999, we retained certain retail loan origination capabilities and
homebuilder relationships of GM.
Effective as of October 1, 1999, we acquired RLI, a Florida-based retail loan
operation specializing in conforming lending. RLI has operated an Internet web
site for approximately three years from which it currently derives approximately
three fourths of the volume of its business. This acquisition, therefore, helps
us to continue our diversification both as to geography and distribution
channel.
21
<PAGE> 24
Effective as of October 1, 1999, we also acquired the assets and operations of
OMC, a California-based retail and wholesale loan operation specializing in
sub-prime and non-conforming lending. OMC 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 also 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 also 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 office in Irvine, California.
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest rate movements significantly affect our volume of closed loans and
represent the primary component of market risk to us. In a higher interest rate
environment, consumer demand for mortgage loans, particularly refinancing of
existing mortgages, declines. As previously discussed, non-conforming and
sub-prime loans are less affected by rising interest rates than conforming and
government insured loans. Additionally, we have concentrated primarily on
origination of loans for home purchase as opposed to refinancing to mitigate our
vulnerability to a rising interest rate environment.
Interest rate movements affect the interest income earned on loans held for
sale, interest expense on advances on our warehouse lines of credit, the value
of loans held for sale, and ultimately the gain on sale of loans.
We manage the market risk on loans we originate by selling the loans on a best
efforts basis to the anticipated permanent investor at the same time that we
lock in an interest rate with a borrower. If we process a loan and deliver it to
the permanent investor within the investor's commitment period, we have no
interest rate exposure on the loan. If we cannot timely process and deliver the
loan, depending upon the nature of the delay, we may experience a reduced gain
or loss on the sale of the loan. With the exception of pre-selling loans
(individually or in pools), we do not presently engage in other hedging
activities.
We do not maintain a trading portfolio. All closed mortgage loans are held for
sale, which requires us to perform market valuations of our pipeline, closed
loan inventory,
22
<PAGE> 25
and forward sale commitments in order to insure that our loans are carried at
the lower of cost or market and that any losses in our pipeline would be
properly accrued.
Because we pre-sell our mortgage loan commitments, we do not believe that a 100
basis point increase or decrease in interest rates would have a material adverse
effect on our earnings. As the period of time that we own a loan and upon which
we have received advances under our warehouse lines is typically less than
thirty days, we would not expect to incur material losses from changes in the
differences in interest rates on the loans and on the advances.
In the future, if we do not pre-sell the loan commitments, our market risk could
change substantially.
23
<PAGE> 26
PART II --OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On January 3, 2000, an action was brought against the Company in County Court of
Law No. 3 in Dallas County, Texas, 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 the Company
owes them unpaid wages, unpaid bonuses and stock options. The Company believes
that the Plaintiffs' claims are without merit and intend to vigorously defend
itself in this litigation.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
As of September 30, 1999, the Company concluded a private placement offering
under Rule 506 of Regulation D in September 1999. In conjunction with that
offering, the Company issued 3,626,473 shares of its common stock, $0.01 par
value (the "Common Stock"), to accredited and non-accredited investors. The
offering price of the Common Stock in the private placement was $1.00 per share.
The recipients of the above described securities represented their intention to
acquire the securities for investment only and not with a view to distribution
thereof. Appropriate legends were affixed to the stock certificates issued in
such transactions. All recipients had adequate access to information about the
Registrant through a private placement memorandum.
As of October 1, 1999, the Company issued 250,000 shares of Common Stock to the
shareholders of Residential Lenders, Inc. ("RLI") in connection with the
acquisition of all of the outstanding capital stock of RLI. Exemption from
registration was claimed under Section 4(2) of the Securities Act regarding
transactions by an issuer not involving a public offering.
As of October 15, 1999, the Compensation Committee of the Board of Directors
granted options to purchase 730,000 shares of Common Stock to ten employees of
the Company. The exercise prices for these options range from $0.01 to $1.00,
and the vesting schedules of these options range from immediately to five years.
Exemption from registration was claimed under Section 4(2) of the Securities Act
regarding transactions by an issuer not involving a public offering.
As of November 1, 1999, the Compensation Committee of the Board of Directors
granted an option to purchase 50,000 shares of Common Stock to one employee of
the Company. The exercise price for this option is $3.375, and the vesting
schedule for this option is one year. Exemption from registration was claimed
under Section 4(2) of the Securities Act regarding transactions by an issuer not
involving a public offering.
As of December 22, 1999, the Company issued 25,000 shares of Common Stock to
Western Capital Bankers as compensation for financial advisory services
rendered. Exemption from registration was claimed under Section 4(2) of the
Securities Act regarding transactions by an issuer not involving a public
offering.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The information required by this item regarding matters submitted to a vote of
security holders is incorporated by reference to the definitive Information
Statement filed pursuant to Regulation 14C with the Commission on January 24,
2000.
24
<PAGE> 27
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
EXHIBIT NO.
- -----------
27.1 Financial Data Schedule (Filed herewith.)
(b) Reports on Form 8-K
The Company filed an amended Current Report on Form 8-K (a "Current Report") on
October 28, 1999 in order to clarify Item 4 of the Current Report filed on June
8, 1999 relating to the change in the Company's certifying accountants.
The Company filed a Current Report on November 17, 1999 to report under Item 2
the acquisition of all of the outstanding capital stock of Residential Lenders,
Inc. ("RLI") and the acquisition of the assets of Occidental Mortgage
Corporation. The appropriate pro forma financial statements for the acquisitions
were filed in an amended Current Report on December 10, 1999. The Company filed
an amended Current Report on January 4, 2000 in order to clarify the
consideration given to RLI reported under Item 2 of the Current Report filed on
November 11, 1999.
The Company filed an amended Current Report on February 1, 2000 in order to file
as an exhibit the letter from Jackson & Rhodes, PC confirming their agreement
with statements made in the amended Current Report filed on October 28, 1999.
25
<PAGE> 28
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
STARNET FINANCIAL, INC.
Date: February 14, 2000
By: /s/ KENNETH F. URBANUS
--------------------------------------------
Kenneth F. Urbanus
(Principal Executive Officer)
By: /s/ MICHAEL J. GULINSON
--------------------------------------------
Michael J. Gulinson, Chief Financial Officer
(Principal Financial and Accounting Officer)
26
<PAGE> 29
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAR-31-1999
<PERIOD-END> DEC-31-1999
<CASH> 951,455
<SECURITIES> 0
<RECEIVABLES> 684,750
<ALLOWANCES> 0
<INVENTORY> 24,475,459
<CURRENT-ASSETS> 26,111,664
<PP&E> 672,000
<DEPRECIATION> 57,459
<TOTAL-ASSETS> 28,455,830
<CURRENT-LIABILITIES> 26,413,134
<BONDS> 0
0
0
<COMMON> 149,015
<OTHER-SE> 1,893,681
<TOTAL-LIABILITY-AND-EQUITY> 28,455,830
<SALES> 0
<TOTAL-REVENUES> 2,447,106
<CGS> 0
<TOTAL-COSTS> 3,595,081
<OTHER-EXPENSES> 29,230
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (1,234,664)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,234,664)
<EPS-BASIC> (.08)
<EPS-DILUTED> 0
</TABLE>
