FORM 10-QSB
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended: January 31, 2000
Or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number: 0-29290
STARNET COMMUNICATIONS INTERNATIONAL INC.
(Exact name of registrant as specified in its charter)
DELAWARE 52-2027313
(State of incorporation) (IRS Employer ID No.)
Newgate Street, P.O. Box 1589
St. John's, Antigua, West Indies
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (268) 480-1651
As of January 31, 2000, the registrant had 31,531,488 shares of Common
Stock outstanding.
Transitional Small Business Disclosure Format (check one);
Yes No X
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The registrant meets the conditions set forth in General Instruction and is
therefore filing this Form with the reduced disclosure format.
Part I - Financial Information
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Item 1 - Financial Statements:
Starnet Communications International Inc.
Consolidated Balance Sheet
As at January 31, 2000 and April 30, 1999
(in thousands of US dollars)
(Unaudited)
January 31 April 30
2000 1999
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ASSETS
CURRENT
Cash and cash equivalents 5,927 5,866
Restricted cash 6,937 0
Reserves and deposits with credit card processors 4,504 282
Accounts receivable 3,005 2,671
Prepaid expenses and deposits 616 399
Other current assets 1,638 1,507
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TOTAL CURRENT ASSETS 22,627 10,725
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Capital assets (net) 4,815 1,673
Deferred website costs (net) 129 285
Software development costs (net) 0 610
Deferred income tax asset 152 146
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27,723 13,439
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LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT
Accounts payable and accrued liabilities 4,565 1,371
Income taxes payable 238 268
Deposits from customers 3,636 1,234
Deferred revenue 160 328
Current portion of capital lease obligations 487 357
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TOTAL CURRENT LIABILITIES 9,086 3,558
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Non-current portion of capital lease
obligations 600 461
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TOTAL LIABILITIES 9,686 4,019
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SHAREHOLDERS' EQUITY
Capital stock 20,913 8,584
Retained earnings (deficit) (3,092) 884
Accumulated other comprehensive loss 216 (48)
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TOTAL SHAREHOLDERS' EQUITY 18,037 9,420
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27,723 13,439
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2
Starnet Communications International Inc.
Consolidated Statement of Operations
For the Periods Ending January 31
(in thousands of US dollars except per share information)
(Unaudited) (Unaudited)
Three Months Ended Nine Months Ended
January 31 January 31
2000 1999 2000 1999
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REVENUE
Sales
Licensing 770 250 2,958 875
Royalties and fees 3,646 1,469 9,415 2,494
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Total Sales 4,416 1,719 12,373 3,369
Cost of sales 1,751 328 3,548 762
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Gross profit 2,665 1,391 8,825 2,607
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EXPENSES
Development, selling, general and
administrative 4,227 918 9,377 2,207
Provision for bad debts 1,443 0 1,443 0
Legal 1,723 0 1,912 0
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Total expenses 7,393 918 12,732 2,207
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Income (loss) from operations (4,728) 473 (3,907) 400
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Other income (expenses) 105 0 186 19
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Net income from continuing operations
before income taxes (4,623) 473 (3,721) 419
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Income tax expense (recovery)
current 0 0 53 (74)
deferred 0 0 0
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Income taxes 0 0 53 (74)
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Income from continuing operations (4,623) 473 (3,774) 493
Income (loss) from discontinued
operations of the on-line interactive
media division (less applicable income
taxes of 1999 - $45 and 1998 - nil) (307) 416 (202) 746
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NET INCOME (LOSS) FOR THE PERIOD (4,930) 889 (3,976) 1,239
Retained earnings (deficit), beginning
of period 1,838 (808) 884 (1,158)
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RETAINED EARNINGS (DEFICIT), END
OF PERIOD (3,092) 81 (3,092) 81
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Basic earnings (loss) per share from
continuing operations $ (0.15) $ 0.02 $ (0.13) $ 0.02
Basic earnings (loss) per share $ (0.16) $ 0.04 $ (0.13) $ 0.06
Weighted average number of common
shares outstanding 30,967,287 22,523,300 29,690,911 22,474,433
Diluted earnings per share from
continuing operations n/a $ 0.02 n/a $ 0.02
Diluted earnings per share n/a $ 0.04 n/a $ 0.05
Weighted average number of common
shares outstanding for diluted
earnings per share n/a 24,379,118 n/a 23,093,039
3
Starnet Communications International Inc.
Consolidated Statement of Cash Flows
For the Periods Ending January 31
(in thousands of US dollars)
(Unaudited) (Unaudited)
Three Months Ended Nine Months Ended
January 31 January 31
2000 1999 2000 1999
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CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) (4,930) 888 (3,976) 1,238
Adjustments to reconcile net income to
net cash provided by operating
activities:
Depreciation 511 182 1,157 514
Amortization of deferred website costs 53 59 159 304
Amortization of software development
costs 473 40 611 120
Gain on disposal of fixed assets 0 (1) 0 (5)
Changes in current assets and liabilities:
Decrease (increase) in reserves and
deposits with credit card processors (3,726) (2) (4,221) (38)
Decrease (increase) in accounts
receivable 3,634 (1,083) (334) (1,552)
Decrease (increase) in prepaid expenses
and deposits 121 (26) (217) 50
Decrease (increase) in other assets 596 0 (131) 0
Increase (decrease) in accounts payable
and accrued liabilities 308 110 3,194 211
Increase (decrease) in income taxes
payable (88) 0 (30) (74)
Increase (decrease) in deposits from
customers 266 93 2,402 297
Increase (decrease) in deferred revenue (34) 22 (168) 40
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NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES (2,816) 282 (1,554) 1,105
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CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of capital assets (1,671) (142) (3,610) (319)
Transfer from (to) restricted cash (82) 500 (6,937) 500
Deferred website costs 0 (24) 0 (323)
Software development costs 0 (86) 0 (334)
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NET CASH PROVIDED BY (USED IN)
INVESTING ACTIVITIES (1,753) 248 (10,547) (476)
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CASH FLOWS FROM FINANCING ACTIVITIES
(Increase) decrease in bank indebtedness 0 (459) 0 (466)
Proceeds from loan 0 134 0 207
Proceeds from issuance of shares 302 410 12,329 410
Principal repayments under capital
lease obligations (183) (20) (372) (132)
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NET CASH PROVIDED BY FINANCING ACTIVITIES 119 65 11,957 19
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EFFECT OF EXCHANGE RATE CHANGES ON CASH 284 (8) 205 72
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NET INCREASE (DECREASE) IN CASH
DURING THE PERIOD (4,166) 587 61 720
Cash, beginning of period 10,093 273 5,866 140
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CASH, END OF PERIOD 5,927 860 5,927 860
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OTHER NON-CASH TRANSACTIONS
Leased assets acquired 340 0 622 0
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid 68 19 97 68
Income tax paid 0 0 0 0
4
Starnet Communications International Inc.
Selected Notes to the Consolidated Financial Statements
As at January 31, 2000
1. General
Restricted Cash refers to funds in the Company's bank accounts frozen
pursuant to a Restraint Order in Canada granted by the Honourable
Associate Chief Justice.
Other Current Assets consist primarily of gaming licenses from the
government of Antigua held for resale to licensees.
2. Significant Transactions
During the quarter ended January 31, 2000, the Company assessed the
collectability of its accounts receivable and recorded a provision
against certain accounts. The amount has been separately disclosed in
the Statement of Operations.
In the Statement of Operations the Company has separately disclosed legal
fees related to defending certain legal actions against the Company and
for costs to reorganize its corporate and operational structure.
Included in the total is a provision of $1.5 million to provide for costs
to defend certain of the outstanding legal issues.
Included in development, selling, general and administrative expenses is
a charge of $473 to recognize the diminished value of the deferred
software development costs due to the pending release of Starnet Systems
2000 software.
During the first quarter, the Company approved a formal plan of disposal
of the adult division. The results of operations of this division will
continue to be separately disclosed until disposal.
3. Diluted Earnings Per Share
Diluted earnings per share for the three and nine month periods ended
January 31, 2000 are not disclosed as the amounts would be anti-dilutive.
5
Item 6. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(All figures are in thousands of US dollars)
RESULTS OF OPERATIONS
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General
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The Company's Internet gaming site (www.worldgaming.net) operated by
World Gaming Services Inc. of Antigua targets only customers outside
North America subsidiary. Starnet Systems International Inc. (formerly
Softec Systems Caribbean Inc.), also of Antigua, licenses its gaming
software to third parties for a set-up fee and monthly royalties. Since
the beginning of fiscal 1999 revenues from all components of the gaming
business, including licensing, gaming site operations and financial
transaction processing, have undergone tremendous growth and represented
a majority of revenues in the last fiscal year. As revenues from
Internet gaming continued to grow, the Company decided in August 1999 to
focus on the Internet gaming business by completely divesting itself from
the adult entertainment industry, which is where the company derived most
of its revenues until the end of fiscal 1998. As a result, income from
Internet adult entertainment is classified as income from discontinued
operations and comparable figures have been adjusted accordingly. The
Company has identified potential purchasers and hopes to finalize a sale
of the division in the near future.
The following tables set forth selected information from the statements
of operations for the three months ended January 31, 2000 and 1999 and
the balance sheets as at January 31, 2000 and April 30, 1999.
Selected Statement of Operations Information
- --------------------------------------------
For three months ended
January 31, 2000 January 31, 1999
---------------- ----------------
Net Sales 4,416 1,719
Gross Profit 2,665 1,391
Operating Expenses 7,393 918
Income (loss) from continuing operations (4,623) 473
Income (loss) from discontinued
operations (307) 416
Net Income (loss) (4,930) 889
Selected Balance Sheet Information
- ----------------------------------
At January 31, 2000 At April 31, 1999
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Cash and Cash Equivalents 5,927 5,866
Restricted Cash 6,937 0
Working Capital 13,541 7,167
Total Assets 27,723 13,439
Long Term Debt 600 461
Retained Earnings (Deficit) (3,092) 884
Total Shareholders' Equity 18,037 9,420
6
OPERATIONAL RESTRUCTURING PROVISIONS AND ADJUSTMENTS
Management has continued to fully cooperate with Canadian authorities as
they complete their investigation (the "Investigation") into the business
operations of the Company. As a result, the Company has been successful
in completing the first phase in the reorganization of the Company's
various operating entities. The Company has also succeeded in developing
a detailed plan for resolving other related legal actions and has begun a
comprehensive process of reviewing and restructuring licensee operations
to ensure the continued success of the underlying business. This process
has resulted in the identification of several adjustments and provisions
that impact the Company's financial results for the quarter and the nine
months ended January 31, 2000. They are as follows:
1. A reduction of $806 to royalty revenues due to an overestimate of
royalty revenues from a major licensee and an increase of $160 to
operating expenses due to an understatement of fees payable to the
same licensee for periods prior to November 1, 1999.
2. A bad debt provision of $1,443 consisting of $1,064 from 14
licensees that were indirectly affected by the investigation and
legal actions described above. The company recognized this revenue
when it entered into contracts with the licensees, customized their
web sites, and delivered the software. However, several licensees
failed to generate sufficient web site revenues to pay Starnet the
royalty and license fees required by their contracts. A further
$379 relates to unpaid financial service fees and minimum royalties
for the affected licensees. Combined, these licensees contributed
less than 5% of Starnet revenues.
3. Legal expenses of $412 for the nine months to January 31, 2000
relating to the initial phase of the corporate restructuring and
litigation costs.
4. A provision of $1,500 to cover the anticipated legal costs to:
a. Defend the Company against the following actions:
i. The investigation $ 690
ii. Various shareholder class action suits 630
iii. The Las Vegas Casino Gaming site lawsuit 75
b. Complete the corporate restructuring. 105
This provision is management's estimate of the legal expenses to
defend the above actions. The outcome of these cases is not
determinable and management has not made any provision for any
losses associated with a negative result. Therefore, the final
total costs may vary from the amounts provided.
5. Amortization of the remaining $473 in deferred software development
costs to recognize the diminished value of this asset due to the
planned release of Starnet Systems 2000 in the 4th quarter.
7
REVENUE
Before taking into account the revenue adjustment as described above, the
Company recorded sales of $5,222 for the three months ended January 31,
2000, a 204% increase over the net sales recorded for the three months
ended January 31, 1999. Royalties and fees accounting for $4,452 of the
total with year on year growth of 203% and software ($265) and gaming
($505) licenses totaled $770, up considerably from the $250 of the same
quarter last year. After the adjustment, the net sales reported for the
quarter were $4,416, a 157% increase over the same period last year. For
the nine months ended January 31, 2000, net sales were $12,373, up 267%
from the 3,369 recorded during the same period last year.
At January 31, 2000, the Company had 41 active licensees, up from 36 at
October 31, 1999 and from 9 at January 31, 1999. However, a number of
these licensees are below the revenue levels considered necessary for
financial viability and a provision has been made against amounts owed to
Starnet. If these amounts remain unpaid and the licensees are unable to
increase site revenues, the Company will attempt, in return for a waiver
of the outstanding debts, to reclaim the player databases and the related
gaming site sites. Going forward, Starnet has revised the qualifications
necessary to obtain Starnet software and now requires demonstrated
Internet marketing experience as well as sufficient funds to spend on
acquiring and retaining customers.
Along with the growth in sales, gross profit increased to $2,665 for the
quarter ended January 31, 2000 from $1,391 for the comparable quarter.
The gross margin fell to 60% from 81% for the quarters ended January 31,
2000 and 1999 as a greater portion of the revenue coming from lower-margin
gaming licenses, and the effect of the adjustment for the royalty
over estimate. The year-to-date gross margin was still a healthy 71%.
EXPENSES
Development, selling, general and administration expenses increased 360%
and 325% to $4,227 for the quarter ended January 31, 2000 and $9,377 for the
year to date, respectively. However, the year on year increase for the
quarter was only 296% after excluding the one time write-down of the
deferred software development cost and the fee adjustments described
above. The expenditure growth rate still exceeds the underlying sales
growth due to the resources needed to complete Starnet Systems 2000 and
develop products for casino, sports betting, horse racing, lotteries and
bingo. Although the expenditures are not being capitalized, the resulting
new products are expected to help the Company increase market share as
the Internet gaming industry continues to expand.
Total operating expenses are significantly higher than the previous
quarter and the same quarter last year due to the adjustments and
provisions described above. The combined effect is a net loss from
continuing operations for the quarter and the nine months ending January
31, 2000 of $4,623 and $3,774, respectively, compared to positive net
incomes last year.
The Company also suffered a loss of $307 for the quarter and $202 for the
year to date from discontinued operations for the quarter as management
has focused its efforts on other areas. A new purchaser has signed a
letter of intent and is expected to complete its due diligence and
complete the sale before the end of the current fiscal year.
8
LIQUIDITY AND CAPITAL RESOURCES
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After reclassifying cash that is being processed by various merchant
banks as cash rather than deposits, the Company had $5,927 in cash and
cash equivalents at January 31, 2000 compared to $5,866 at April 30,
1999. Due to the investigation by Canadian authorities of the business
operations of the Company, two of the Company's accounts with a Canadian
bank were frozen on August 25, 1999 pursuant to a interim restraint order
granted by the Honourable Associate Chief Justice. The amount affected
totals approximately $6.9 million. The Company is filing an application
to revoke or vary the interim restraint order. Due to the significant
increase in the volume and amount of credit card cash transactions, the
Company has reclassified reserves held by the merchant banks as reserves
and deposits with credit card processors. Of the $4,504 on hand, a
significant portion is held as a rolling reserve which is released to the
company after six months.
Working capital at January 31, 2000 increased to $13,541 from $7,167 at
April 30, 1999 but decreased from $18,848 as at October 31, 1999 as
accounts receivable dropped from $6,638 at October 31, 1999 to $3,005 at
the end of January due to the bad debt provision described above and the
partial settlement with a major licensee. Of the remaining receivables,
only $342 is attributable to new licensees that were offered an
installment payment plan on the initial licensing fees. Other current
assets at January 31, 2000 amounted to $1,638 compared to $1,507 at April
30, 1999. The increase is mainly due to prepayments made to the Antiguan
government for the purchase of additional gaming site licenses. The
gaming site licenses are held for sale to prospective licensees. Of the
original cost of $2,250, $612 has been expensed for the year to date
against gaming license revenue of $750. The remaining balance will be
expensed as revenue is generated but the expense will not be less than
$281 in any quarter.
Despite the deficit of $3,092 resulting from the one-time adjustments and
provisions as described above, the shareholders' equity remains a very
healthy $18,037 as at January 31, 2000 up from $9,420 at April 30, 1999.
Net cash used for investing activities for the quarter ended January 31,
2000 was $1,753 compared to $282 for the prior year quarter. The increase
in cash used is mainly due to purchases of capital assets and increases
in funds held by credit card processors to handle increased volume.
Net cash provided by financing activities for the three months ended
January 31, 2000 was $119 and is comparable to the $65 for the three
months ended January 31, 1999.
Impact of Inflation
- -------------------
The Company believes that inflation has not had a material effect on its
past business.
9
Part II - Other Information
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Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibit No. Description
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27 Financial Data Schedule
(b) Reports on Form 8-K
A Form 8-K dated October 25, 1999, was filed on November 2,
1999 showing a change in Certifying Accountant. Jones, Jensen
and Company, LLC were appointed as independent auditors for the
purpose of auditing the Company's financial statements as of
October 25, 1999.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
STARNET COMMUNICATIONS INTERNATIONAL INC.
(Registrant)
Date: March 13, 2000 /s/ MELDON ELLIS
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Meldon Ellis
President and CEO
Date: March 13, 2000 /s/ MELDON ELLIS
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Meldon Ellis
Acting Chief Financial Officer