SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 for the fiscal year ended April 30, 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 E.I.N. 52-2027313
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
Starnet Place
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) 480-1650
Securities registered pursuant to section 12(b) of the Act:
None
Securities registered pursuant to section 12(g) of the Act:
Title of each class
Class A Voting Common Stock
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes x No
--- ---
-1-
The aggregate market value of the voting stock (which consists solely of
shares of Class A Voting Common Stock) held by non-affiliates of the
registrant as of July 24, 2000, computed by reference to the closing price
as at July 24, 2000 of $2.875 of the registrant's common stock as quoted on
the National Association of Securities Dealers' Over-the-Counter Bulletin
Board service on such date, was approximately $89,080,653.
As of July 24, 2000, there were 32,449,505 shares of the registrant's Class
A Voting Common Stock outstanding.
Documents incorporated by reference:
Definitive proxy statement to be filed pursuant to Regulation 14A by
August 28, 2000
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not 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-K or any
amendments to this Form 10-K. [ ]
Unless noted otherwise, all amounts contained in this report are in United
States dollars.
PART 1
- ------
Some of the information in this annual report contains forward-looking
statements that involve substantial risks and uncertainties. Any statement
in this annual report and in the documents incorporated by reference into
this annual report that is not a statement of an historical fact
constitutes a forward-looking statement. Further, when we use the words
"may", "expect", "anticipate", "plan", "believe", "seek", "estimate" and
similar words, we intend to identify statements and expressions that may be
forward-looking statements. We believe it is important to communicate
certain of our expectations to our investors. Forward-looking statements
are not guarantees of future performance. They involve risks,
uncertainties and assumptions that could cause Starnet's future results to
differ materially from those expressed in any forward-looking statements.
Many factors are beyond our ability to control or predict. You are
accordingly cautioned not to place undue reliance on such forward-looking
statements. We have no obligation or intent to update publicly any
forward-looking statements whether in response to new information, future
events or otherwise. Important factors that may cause our actual results
to differ from such forward-looking statements include, but are not limited
to, the risk factors discussed below under "Other Factors That May Affect
Future Results" and elsewhere in this annual report generally. You should
be aware that the occurrence of any of the events described under
"Government Licensing and Regulation" and "Other Factors That May Affect
Future Results", and elsewhere in this annual report generally, could have
a material adverse effect on our business, financial condition and results
of operation.
-2-
ITEM 1. BUSINESS
A. GENERAL DEVELOPMENT OF BUSINESS
Corporate History
- -----------------
Starnet Communications International Inc. was incorporated on June 28, 1996
in the State of Nevada as Creative Sports Marketing Inc., and subsequently
the name of the company was changed to Gelato Brats Inc. On January 27,
1997, Mitchell White, Mark Dohlen, Jason Bolduc, Christopher Zacharias and
John Carley were elected as directors, and on February 24, 1997, the name
of the company was changed to Starnet Communications International Inc.
On March 10, 1997, the company merged into a wholly-owned subsidiary,
Starnet Communications International (DE) Inc. ("Starnet Delaware"), for
the purpose of re-domiciling to that state, with the merged company
operating as Starnet Communications International Inc. ("Starnet" or the
"Company").
On March 25, 1997, the Company entered into a share purchase agreement with
Murray Partners (BVI) Inc. ("Murray Partners"), pursuant to which the
Company acquired all the outstanding shares in Starnet Communications
Canada Inc. ("Starnet Canada"), a company incorporated in British Columbia
that provided adult entertainment services via the Internet. In exchange,
Murray Partners received 10,000,000 Class A Common Voting Shares of the
Company. Shares held by Murray Partners were subsequently distributed to
its constituent members. On March 17, 2000, the Company sold all assets
related to its adult entertainment business so to focus on the Internet
gaming business.
Starnet, through its wholly-owned subsidiaries, now focuses its business
exclusively on the development, production and licensing of Internet
technologies for gaming applications. The business strategy of the Company
is to identify and commercialize leading edge technologies for the online
gaming markets.
Significant Events during the Last Fiscal Year
- ----------------------------------------------
INVESTIGATION BY CANADIAN AUTHORITIES
On August 20, 1999, the Royal Canadian Mounted Police ("RCMP") obtained a
search warrant and searched the Vancouver, British Columbia offices of
Starnet Canada. The basis for the search and continuing investigation was
the belief of the RCMP that Starnet Canada and some of its officers,
directors and employees were breaching certain gaming provisions contained
in the Criminal Code of Canada.
On August 25, 1999, the RCMP obtained an ex parte restraint order pursuant
to the provisions of the Criminal Code of Canada. This order prevents
Starnet Canada and Starnet Systems from accessing funds located in certain
Canadian bank accounts. The amount of money (including interest) in these
accounts as at April 30, 2000 is
-3-
$7,024,000. In September 1999, the Company brought an application to have
the restraint order revoked. This application was unsuccessful. On February
24, 2000, the restraint order was renewed for a further six months. The
RCMP investigation has not been completed. No charges have been brought and
the Company does not know if any will be brought.
RESTRUCTURING OF THE COMPANY'S BUSINESS
During the last fiscal year, the Company commenced a strategic
restructuring that separates Starnet's operations in accordance with its
business functions. This restructuring of the Company's business is
intended to enhance legal compliance and establish a secure platform for
rapid future growth.
One of the key components to this restructuring was the relocation, in the
Summer of 1999, of the Company's corporate headquarters from Vancouver,
British Columbia, to St. Johns, Antigua, where the Company had already had
two years of operational experience, and had been working in close
consultation and cooperation with Antiguan authorities. The relocation to
Antigua was a natural progression for the Company, as gaming had become
Starnet's primary business activity over the previous year, and Antigua is
the global Internet gaming hub, from which the majority of Internet gaming
companies operate.
While the Company's software development arm is still based in Vancouver,
where there is a large pool of talented programmers, a core group of 64
employees, including all resources that are directly or indirectly related
to the Company's licensing operations, is now located in Antigua.
RESTRUCTURING OF STARNET CANADA
In the spring of 2000, the reorganization of the operations of Starnet's
wholly-owned subsidiary, Starnet Canada, was completed. This reorganization
consisted of three principal steps: (1) the sale of its adult entertainment
assets to a third party purchaser; (2) the transfer of its licensee
marketing activities to Wiremix Media Inc. ("Wiremix"), a company owned and
controlled by former employees of Starnet Canada; and (3) the transfer of
its gaming related software development activities to Inphinity Interactive
Inc. ("Inphinity"), a newly incorporated, wholly-owned subsidiary of
Starnet. In addition, certain functions, such as investor relations,
formerly carried out by employees of Starnet Canada were assumed by the Company.
Under the terms of the transaction with Wiremix, certain assets were sold
to Wiremix and the employment obligations for certain former employees were
assumed by Wiremix. Under the terms of the arrangement, Starnet has
engaged Wiremix to provide fixed monthly marketing services to licensees of
Starnet Systems International Inc. ("Starnet Systems", formerly Softec
Systems Caribbean Inc.), Starnet's software licensing subsidiary. Services
provided by Wiremix include definition of target market, site theme
-4-
conceptualization, marketing and media planning and ongoing marketing and
advertising consulting.
SALE OF THE ADULT DIVISION
Pursuant to the terms of a letter agreement dated March 17, 2000, Starnet
completed the sale of substantially all of the assets and undertakings
comprising the adult entertainment division of Starnet Canada.
The disposition of the adult entertainment division was consummated by
management of Starnet with a view to focusing the business of the Company
on its core online gaming activities.
The purchase price for the assets was $2.3 million, of which $460,000 was
paid on March 31, 2000 into an attorney trust account, but received by the
Company after April 30, 2000, and the balance of which will be payable in
monthly installments to and including July 1, 2003. The deferred portion
of the purchase price is secured by a general security agreement in favour
of Starnet Canada, and a pledge of the shares of a subsidiary of Starnet
Canada, all interests of which were sold to the purchaser.
To the best of the Company's knowledge, the Purchaser and Kiama Ltd. are
and were at all times at arm's length to the directors and officers of
Starnet. One of the principals of the Purchaser was formerly the general
manager of the adult entertainment division and an employee of Starnet
Canada. On the closing of the sale, Starnet Canada terminated the
employment of this individual and the other employees of the adult
entertainment division.
B. FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The financial information required pursuant to this paragraph (b) complies
with generally accepted accounting principles and, accordingly, is included
in the Company's financial statements in Part II (Item 8).
-5-
C. DESCRIPTION OF BUSINESS
- -------------------------------------------------------------------------------------------------
STARNET CORPORATE ORGANIZATIONAL CHART
- -------------------------------------------------------------------------------------------------
Starnet Communications International Inc.
/
- -------------------------------------------------------------------------------------------------
/ / / / / / / / /
/ EFS USA Inc. / EFS / EFS Australia / EFS St. Kitts Inc. /
/ / International / Pty Ltd. / /
/ / Inc. / / /
/ / / / /
Starnet Starnet Inphinity World Gaming 602662 B.C. Ltd.
Systems Communications Interactive Inc. Services Inc.
International Canada Inc. and World
Inc. Broadcasts.com Inc.
- -------------------------------------------------------------------------------------------------
Starnet is a leading developer and provider of Internet gaming systems.
Starnet also operates its own Antigua-based on-line gaming system through
its subsidiary, World Gaming Services Inc. ("World Gaming"). The Company's
innovative gaming systems have been designed to: (i) offer customers a
user-friendly interface, superior interactive experience and a wide
selection of gaming options; (ii) provide licensees with financially
attractive returns, easy site maintenance and limited administration; and
(iii) protect gaming customers and licensees through its proprietary fully
integrated technology.
The Company invested the profits and technology from its earlier,
entertainment-oriented on-line interactive business to build a worldwide
Internet gaming business. By growing a gaming licensee network along with
its own site operations, Starnet plans to build rapidly market share in
this new Internet commerce industry. The Company offers fully integrated
gaming software and systems, developed by its wholly-owned Vancouver-based
software development arm, Inphinity Interactive Inc., along with fee-based
use of its Electronic Financial Services ("EFS") Internet transaction
system. Starnet's first license sale closed in March 1998, and the Company
had 45 licensees signed and operating by fiscal year ended April 30, 2000.
During the software development stage, management planned for a total
gaming experience. Along with the current suite of gaming products which
include over 20 C++ casino games, a variety of "instant play" Java Games
and a complete live sports wagering product line, the Company plans to add
a live pari-mutuel betting system, multiplayer Bingo and "instant play"
lottery games throughout the coming fiscal year.
-6-
Starnet's gaming software is owned by its wholly-owned Antigua-based
licensing subsidiary, Starnet Systems, which licenses the Company's own
gaming venue, World Gaming, and a growing list of licensees. Starnet
Systems provides a licensee with an installed turnkey gaming system.
Starnet Systems receives a monthly royalty based on the licensee's net
revenues in exchange for hosting the licensee's interative casino. In
addition, the licensee must obtain a gaming license from the Government of
Antigua and Barbuda or another jurisdiction that licenses on-line gaming
systems.
Starnet Systems develops the new licensee's interactive casino to reflect
its intended market segment. This development can reflect a particular
motif (i.e. sports theme or French Riviera theme) or ethnic market (e.g.,
Japan, Indonesia, or Latin America). Starnet's gaming systems are now
available in variety of languages, with additional variations planned for
fiscal year ending April 30, 2001.
Products and Services
- ---------------------
Through various wholly-owned subsidiaries (details of which are provided
below), the Company develops and provides its software products, EFS
transaction system and on-line gaming management services to the
independent licensees.
The Company's current software product areas include casino gaming and
sportsbook wagering, while pari-mutuel wagering, multiplayer bingo, and
"instant play" lottery games are under development. During the last fiscal
year, casino gaming contributed approximately 56% of gaming and licensee
revenue, while sportsbook wagering accounted for the remaining 44%.
CASINO GAMES
Starnet's casino games can be categorized into two types: Java games and
C++ downloadable software.
Starnet's Java games utilize the Java language to provide easily accessible
online games to the Company's licensees' websites. The cross-platform
nature of Java makes it possible to play these games on all major operating
systems, online, with virtually no downloading required. The games are
simplified to optimize loading times. Starnet currently has four casino
style Java Games (Videopoker, Blackjack, Caribbean Stud poker, and Gold
Rush slots) for players to wager on, with several additional Java games
projected to be released throughout the current fiscal year.
More than 20 different casino games are available in the C++ version of the
casino gaming product line. These games are provided for players who are
willing to take the time required to download the games. However, once
downloaded, they are easy and convenient to play and offer a more
heightened visual and audio experience. The C++ games are also offered by
most software licensees via a CD Rom which are mailed to players who
request this version.
-7-
THE SPORTSBOOK
The Sportsbook generates revenues based on booking bets that have fixed
payouts. These payouts have a commission that provides revenue for the
sportsbook. There are varying commissions that are dependent on a variety
of bet offerings. These include: pointspreads, totals, moneylines, straight
wagers, parlays, teasers, futures, propositions and others. The
Sportsbook's overall commission is usually between 3 to 5% of the total
wagering dollars.
PARTNER'S PROGRAM
Starnet's affiliate program provides a powerful marketing tool for Starnet
Systems' licensees by creating an advertising vehicle with no up-front
costs. The affiliate program effectively transforms webmasters into a sales
force for Starnet Systems' licensees, as webmasters earn a commission on
the "sales" they make. The webmasters will earn their commission based on
the players that they send through their sites. The licensee pays the
webmaster only after the casino has generated revenues from the webmaster's
players.
Additional functionality like "sliding scale" percentage payouts, detailed
banner statistics, and IP/cookie tracking, is another key component of
Starnet's affiliate program that promises to enhance the licensee's ability
to market.
Licensees
- ---------
Starnet has, historically, focused its growth strategy on licensing its
software and services in order to become a leading technology provider to
the online gaming industry. The Starnet gaming software is owned by its
Antigua-based licensing subsidiary, Starnet Systems, which licenses its
fully-integrated systems to World Gaming and a growing list of licensees.
A one-time license fee provides an installed, fully operational sytem. The
licensee's interactive casino is generally operational within 90-120 days
of signing a license agreement. Starnet Systems receives monthly fees and
a royalty based on the licensee's revenues, in exchange for continuing to
host and maintain the site. The licensee must obtain a gaming license from
the jurisdiction where the gaming servers are located, which currently is
Antigua. Starnet Systems modifies the new licensee's interactive casino to
reflect its intended market segment. This change can reflect a particular
motif or niche market (e.g., Japanese, Indonesia, or Latin America).
Starnet Systems also provides continuous support for both software and
hardware, 24 hours a day and 7 days a week. Management seeks a licensee
knowledgeable of the target market in order to maximize sales potential.
Licensees generally establish their marketing efforts from within their
target market and are generally expected to be capable of investing at
least $1 million to purchase the software, apply for the gaming license and
invest in marketing.
Pursuant to the terms of the license agreements, the licensee is solely
responsible for determining from which geographic locations they will
accept customers, although licensees are contractually prohibited from
accepting wagers from residents of Canada.
-8-
Should any licensee become delinquent in payment to Starnet, the Company
has full legal and technological ability to "shut down" the licensee's
interactive casino(s) remotely.
Both Global Interactive Ltd. and Internet Opportunity Antigua account for
10 percent or more, and a combined total of 37%, of the Company's
consolidated revenues, and the loss of these licensees would have a
material adverse effect on Starnet Systems and the Company as a whole. One
of these licensees has recently committed to use Starnet software on its
current sites for a period of at least three years.
It is anticipated that the majority of Starnet's future revenue and
earnings growth will come from its ongoing participation in the licensees'
revenue stream, not from initial license fees. Starnet Systems receives a
sliding scale from 25% - 10% of a licensee's net revenue (wagers less
payouts less chargebacks, house bonuses and other comps). For most
customers, it converts available credit on credit cards to Internet gaming
funds, known as V-chips, through its offshore E-commerce subsidiary, EFS.
The Company's primary cost against continuing license income is the cost of
continuing software improvements, direct site operating costs and merchant
banking fees.
Management emphasizes that the licensees are structured operationally so
that a licensee's prime responsibility, aside from the ownership of the
customer data base and the casino web pages, is to market their gaming site
to their respective market. Management notes that its monthly license
fees, which it believes are lower than many current competitors, should
make more funds available for marketing, which increases site utilization
and revenues.
Starnet Systems International Inc.
- ----------------------------------
Starnet Systems (www.starnetsystems.net), based in St. John's, Antigua, is
in the business of licensing customized, fully-integrated Internet gaming
systems (similar to the Company's World Gaming virtual gaming system) to
independent parties wanting to enter the on-line gaming industry. Starnet
Systems provides a complete range of services that the operator needs in
order to launch an on-line gaming website, including customized software,
website development and management on Starnet's network, custom database
systems to manage customer accounts, 24-hour technical support for the
licensee and its customers, and an EFS gateway to facilitate online wagers
and financial transactions. Starnet Systems provides these services in
exchange for monthly royalty fee, providing Starnet with the opportunity to
spread its gaming development and operating costs among multiple operators
and broaden its penetration of the market.
EFS Subsidiaries
- ----------------
There are four subsidiaries dedicated to electronic transferring of funds:
EFS International Inc. (based in Antigua); EFS USA Inc. (based in Nevada);
EFS Australia Pty Ltd.; and EFS St. Kitts Inc. The EFS subsidiaries are
established in these countries in order to facilitate local banking
relationships for transaction processing. On-line
-9-
revenues generated by Starnet's subsidiaries and licensees are processed
through the EFS subsidiary appropriate to the country they are domiciled
in. EFS utilizes proprietary processing technology which processes credit
card transactions via the Internet with ease and security.
This technology was the first of its kind to be certified by a Canadian
Chartered Bank for E-commerce in 1996. EFS intends to expand its services
to the constantly increasing number of independent on-line licensees and
establish subsidiaries in several other key financial centres as needed.
Inphinity Interactive Inc.
- --------------------------
Inphinity Interactive Inc. ("Inphinity") was incorporated in British
Columbia in 1999 as the software development arm of the Company.
Inphinity is an Internet software development company whose primary focus
is to design, create and develop software products for the interactive
gaming industry. Traditional gaming product categories have been adapted to
online applications for real-time wagering capabilities while new types of
gaming have been created strictly for the Internet environment. Inphinity
employs over 100 software professionals who provide a variety of products
and services to Starnet's Antigua-based licensing subsidiary, Starnet
Systems International Inc.
602662 British Columbia Ltd.
- ----------------------------
602662 British Columbia Ltd. was incorporated as a wholly-owned subsidiary
of Starnet on March 6, 2000 to provide legal services, investor relations
services and administrative support for the Company and various of its
subsidiaries.
World Gaming Services Inc.
- --------------------------
World Gaming (www.worldgaming.net and www.worldgaming.com), also based in
Antigua, is a full-service online gaming operation. Through its product
lines, World Gaming accepts, processes and manages wagers casino-style
games of chance and sporting events. World Gaming allows users resident
outside of Canada and the United States of America to wager with real
funds, which can be deposited, converted to "Virtual Chips" or withdrawn
from personal accounts with complete security. World Gaming has been
translated into five European languages and stand alone Japanese
(www.pachinkocasino.com) and Chinese (www.joyluckcasino.com) sites have
been developed to target the emerging Asian market.
WorldBroadcasts.com Inc.
- ------------------------
WorldBroadcasts.com Inc. was incorporated in September 1999 as a wholly-
owned subsidiary of the Company. WorldBroadcast.com offers live audio and
video informational channels, covering everything from live sporting
events, horseracing and
-10-
news, to handicapping related programming. In addition, the site is a test
bed for trial of new and innovative broadcasting products.
WorldBroadcasts.com entered into a strategic partnership with Activate.net
for Internet broadcasting services. Activate.net is a majority-owned
operating company of CMGI, Inc.
Starnet Communications Canada Inc.
- ----------------------------------
Since the sale of substantially all of the assets and undertakings
comprising the adult entertainment division of Starnet Canada, and the
transfer of substantially all of its other assets to Inphinity, Starnet
Canada has been inactive.
Gaming Products Under Development
- ---------------------------------
PARI-MUTUEL GAMING
While developing the proprietary, interactive pari-mutuel software,
Inphinity again employed the cross-platform nature of Java, making it
possible to play this game on all major operating systems, online, with
virtually no downloading required. This interface is simplified to
optimize loading times.
After signing a simulcast-distribution agreement with the host raceway,
this system links directly to the host track's pool, enabling instant
access to real-time betting lines and the live host pool. The live audio
and video satellite signal from the host track are up-linked via satellite
and subsequently web-cast directly to the customer's computer.
Strategic partnerships with prestigious organizations such as Amtote
International, The Daily Racing Form, Bloodstock Research Information
Systems (BRIS) and Track Data provide customers with easy access to
handicapping information and up to-date content on current Thoroughbred,
Standardbred, Quarter Horse, Greyhound and Jai-Alai events from North
America and around the world.
Starnet intends to provide 24-hour live horse coverage from racing
facilities worldwide. Pari-mutuel wagering is currently conducted in 43
states in the United States and approximately 100 other countries around
the world. Wagering systems are currently undergoing beta testing and are
expected to launch during the current fiscal year.
Pari-mutuel wagering is the lowest maintenance form of wagering a company
can offer. The bettors wager against themselves and not against the house,
therefore lowering the house exposure to zero. The house makes its profit
by taking a predetermined commission (or take-out) from the total pool,
usually between 10% and 20%. Because the players are wagering against each
other there is no need for the lines (or odds) to be monitored. The lines
are determined by the amount of money wagered on each competitor/team
involved in the wager. The more money wagered on one specific outcome the
lower the odds for that competitor will be.
-11-
LOTTERIES
A variety of interactive lottery games are under development for launch
during the current fiscal year. These entertaining games will provide
players with a chance to instantly win cash prizes. Instant games are the
fastest growing lottery segment, representing 25% of worldwide lottery
sales. A variety of "Scratch and Win" and "Pull Tab" style lottery games
will be launched during the current fiscal year.
BINGO
Two types of Bingo games are in development. "Multi-player" Bingo games
will link players from around the world and provide them with fun, fast-paced
games in a variety of themed, interactive Bingo communities. "Personal play"
Bingo games are also being developed, where players will be able to play
Instant Bingo games online that offer good odds of winning cash prizes.
Both types of Bingo products are scheduled to launch during the current
fiscal year. Annual conventional Bingo revenues are estimated to exceed $50
billion worldwide.
SPORTS BETTING
In addition to maintenance of the current turnkey Sportsbook product,
Inphinity is developing new proprietary sports betting software. This
sports betting software encapsulates Starnet Systems' current sportsbook
features, provides additional sportsbook betting options that are
geographically specific and exciting new products such as pools and pari-
mutuels. In addition, the new product will allow for a variety of
operational flexibility for licensees. The launch, which is dependent on
successful testing, is targeted for early 2001.
Starnet Systems has entered into a strategic partnership with Las Vegas
Sports Consultants, the premiere odds provider for Nevada sportsbooks, for
odds information and product consulting.
Strategic Relationships
- -----------------------
Starnet recognizes the speed at which the Internet operates, and is
committed to remaining a leader in the Internet gaming industry. As such,
Starnet has entered into several key strategic relationships, and is
pursuing additional partnerships. These partnerships are of several types:
* Alliances or partnerships with other technology companies that enable
Starnet to go to market faster with a more robust or diverse product
offering.
* Alliances or partnerships that offer new and strong distribution
channels for our products.
-12-
Starnet has also developed strategic transaction processing relationships
with numerous financial institutions and leading e-commerce providers.
Growth Strategy
- ---------------
The development of telecommunications and the emergence of new technology
have created opportunities to develop new, efficient and secure ways to
deliver information and entertainment to customers. Starnet intends to
capitalize on its technological expertise to become a world leader in
online gaming systems. Starnet's key strategic objectives are to: (i)
maintain its role as a leading provider of Internet gaming technologies and
to build on the success of its existing licensee base; (ii) lead the
consolidation of industry by pursuing strategic alliances, partnerships and
joint ventures; and (iii) develop the World Gaming Internet gaming portal
in new geographic markets.
Starnet intends to implement its business strategy by: (i) maintaining and
enhancing its technological lead; (ii) seeking key strategic alliances and;
(iii) developing a global brand name in on-line gaming. The following
summarizes Starnet's strategic focus and operating strategy:
RAPIDLY PENETRATE THE INTERNET GAMING MARKETS
Starnet intends to capitalize on its technological lead and early market
entry to capture a significant share of the Internet Gaming market. The
Company believes it is well positioned to achieve this goal since it
possesses the competitive advantage of being one of the first companies to
both operate and license proprietary turnkey gaming systems, which
incorporate the industry's largest selection of gaming products and services.
PROVIDE HIGH QUALITY, INNOVATIVE AND SUPERIOR PRODUCTS AND SERVICES
Starnet, in collaboration with its strategic partners, has focused on
designing a gaming experience using state-of-the-art technology.
Additionally, licensees may benefit from other methods of revenue
generation that conventional gaming machines cannot provide, such as the
advertising and data collection potential of the network.
MAINTAIN TECHNOLOGICAL LEAD
Starnet has achieved its technological lead through the development of its
proprietary software and networked architecture. Furthermore, Starnet has
made a strong commitment to continue research and development activities to
enhance its products and software and to develop new applications for
potential markets. Starnet will continue to use such methods to protect
its technology and mitigate competition from current and future entrants.
In addition, Starnet is committed to developing the technical capabilities
to facilitate integration between Starnet's platform and third party platforms.
-13-
Competitive Environment
- -----------------------
The Internet gaming and wagering industry is increasingly competitive.
With relatively low barriers to entry, new competitors are entering
segments such as development and licensing of casino games, sports betting
software, pari-mutuel wagering, and lottery and bingo products. In each of
these segments, there currently exist several major competitors. Because
many of these competitors focus on delivering one product, as opposed to a
full suite of products as Starnet does, the competitors may offer an
equivalent or superior product to that of Starnet. Starnet expects the
number of companies offering products and services in each market segment
to increase. Starnet expects to compete directly with these companies, as
well as other established companies that may enter the Internet gaming
industry. Many of Starnet's current and potential competitors have far
greater resources than Starnet.
Technology
- ----------
REDUNDANT HIGH-SPEED NETWORK
The Company's network is connected to the Internet via redundant high-speed
fiber, ensuring multiple backup connections to the Internet. This high
performance network infrastructure ensures reliable and responsive game
play for Starnet's licensees and the end users/players. Most of the
critical system components, such as the game servers and web servers, are
distributed across multiple machines, which protect the gaming service from
failures due to malfunctioning equipment. The highly scalable nature of
Starnet's system design makes provisioning for additional capacity
relatively easy. The network monitoring staff tracks the system at all
times to maintain constant awareness of the system's operating parameters.
New equipment is installed when necessary to compensate for increased
activity or anticipated peak demands for popular events.
The high quality Internet connection at Starnet's network facility in
Antigua is provided by an international service provider and contributes to
responsive game play. Each gaming transaction is stored on a database that
is replicated for redundancy and backed up daily to prevent data loss and
the gaming components communicate using the Secure Sockets Layer (SSL) to
encrypt and protect sensitive data from potential hackers.
In addition to Starnet's digital network serving gaming content, the
Company has developed a state of the art proprietary Electronic Funds
Transfer System ("EFS") that provides a high level of security and
integrity of funds wagered.
SECURITY MEASURES
Starnet uses advanced technologies, such as firewalls, site identification
and data encryption, and secure servers to provide users with a safe
environment to perform secure transactions, and data transmission, over the
Internet. Each transaction made with Starnet Systems' licensees online is
secure and convenient. Starnet's system is protected by the
-14-
Secure Sockets Layer ("SSL") protocol, which encrypts all information and
confirms the identity of the Company's server, before allowing a
transaction to be completed.
Firewalls are deployed, securing our system by actively monitor, log and
block unauthorized access to our network, to prevent hackers from
penetrating our gaming backend. In addition, data encryption is used to
hide sensitive information such as the customer's name, address, and credit
card number. Even if someone manages to obtain a player's personal
information from the transaction process, data encryption will not allow
that person either to read or to use it.
The Random Number Algorithm employed by Starnet is known as the "Mersenne
Twister" algorithm. This algorithm is employed to determine the random
pattern in which numbers are generated for casino games. The algorithm was
originally created at the University of Keio in Japan. Starnet retained
Dr. James Ngai (Ph.D. University of British Columbia), to conduct an
independent study of the algorithm, which resulted in his finding that at
a rate of calling 50 random numbers per second, it will take 10 to the
power of 5994.56 days before the generator will repeat itself.
The Gaming Client Application is a casino graphical interface. Gaming
calculations are performed by the game server, while the client application
displays the results and accepts input from the player for further
interaction. Communications between the client and server are encrypted
using the SSL protocol. The SSL prevents hackers from monitoring a gaming
session should they be able to intercept communications.
To tamper with the odds and payouts, a hacker would have to modify the game
server or database system. Both of these systems are protected from
external access. The game server can only be accessed using the gaming
client. Learning the client/server protocol will not aid a hacker in
gaining additional winnings from the system, since he/she would still be
limited by the game server's rules and constraints. The machines that the
game server processes run on are only accessible from Starnet's private
network. Users cannot connect to these servers using telnet, rlogin, ssh,
X windows, or any other login method. Therefore, the Company believes that
it would be almost impossible for a hacker to tamper with game server code.
The database systems are completely shut off from the Internet and can only
be accessed by a limited number of applications on a closed network, such
as the game servers and report generators.
All the information provided to the Company is kept strictly confidential,
and is used only to support the player's relationship with Starnet and the
licensee.
END-USER/PLAYER SCREENING
The Company has developed a secure network both to preserve the integrity
of the financial transactions executed over its network as well as to
screen out potential website customers who may be residents of the
jurisdictions blocked from using the systems. World Gaming is in the
process of implementing additional country and address screening. By
matching the credit card number with the customer's country, postal code,
-15-
and address, World Gaming is able to prevent most customers from those
jurisdictions blocked from using the systems. World Gaming outlines on its
web pages, and within the software itself, that it does not accept wagers
from Canadian or United States citizens. In addition, it will not pay out
winnings to any address within Canada or the United States of America.
Research and Product Development
- --------------------------------
New product development will be a primary focus of Starnet for the current
fiscal year. As the traditional casino gaming market and the interactive
online gaming market begin to converge, new games that redefine the online
gaming market will emerge. Starnet hopes to lead this convergence by
redefining the online gaming experience. The Company plans to focus on a
variety of different types, styles and themes of games, focusing on
different demographic and niche markets in order to penetrate a larger user
base. Different revenue models may also be explored, as the Company
intends to consider developing games of skill as well as the traditional
games of chance.
Research and development expenses reported for fiscal 2000 were $2.3
million, as against $620,000 for fiscal 1999 and $82,141 for fiscal 1998.
Number of Employees
- -------------------
As of July 24, 2000, the Company employed 178 persons, of which 64 were
employed in Antigua and 114 in Vancouver, British Columbia.
Government Licensing and Regulation and Related Risks
- -----------------------------------------------------
The Company's subsidiaries have various connections with the online gaming
industry. Inphinity develops interactive gaming software under contract
with Starnet Systems. Starnet Systems, in turn, licenses on-line gaming
systems to various entities (the "Licensees"), including affiliates, which
deploy such software for the purpose of conducting interactive gaming
casinos utilizing the Internet. These Licensees are licensed to operate
interactive casinos in the country where their gaming equipment is
physically located. For World Gaming, which is a subsidiary of Starnet,
this is the Country of Antigua and Barbuda. In addition, most of the
Licensees of Starnet System's software are also licensed by the Country of
Antigua and Barbuda to operate interactive casinos. In addition, some of
the Licensees of Starnet Systems' software are licensed by other countries
as well. EFS, also a subsidiary of Starnet, from its offices in Antigua
performs various services for the Licensees of Starnet Systems, including
financial transaction processing. Moreover, Starnet Systems, from its
offices in Antigua, performs various services for Licensees, including, but
not limited to, providing customer support and technical support. In
addition, Inphinity also provides support to Starnet Systems, which
benefits the Licensees of Starnet Systems, by fixing and maintaining
software systems developed by Inphinity for Starnet Systems.
-16-
The Licensees operate their interactive casinos from servers maintained by
Starnet Systems and located in Antigua. All Licensees of Starnet Systems
are, to the knowledge of Starnet, licensed by the Country of Antigua and
Barbuda and other jurisdictions where their respective operations are located.
A significant debate exists whether the laws of any country other than the
country where the computer gaming servers are physically located have
jurisdiction over the operations of the Licensees of Starnet Systems. In
addition, a significant debate exists whether the laws of any country other
than the country where the computer gaming servers are physically located
have jurisdiction over the operations of affiliates of the Company which
perform services for Licensees. Many Licensees believe that they are not
subject to the laws of any country other than the law of the country where
they are licensed. As a result, they accept customers from any country,
without regard to the laws of the country where the customer is located,
including the United States. World Gaming, a subsidiary of the Company,
however, has a policy not to accept wagers from the residents of the United
States and Canada and has implemented procedures that prevent customers
from collecting on winnings from wagers from the residents of such
countries. While such procedures, as with most precautions, may be able to
be circumvented, the Company believes that the procedures largely prevent
such wagers from occurring.
Historically, gaming activities have been subject to extensive statutory
and regulatory control by government authorities, and have been very
dependant and likely significantly affected by any changes in the political
climate and economic and regulatory policies of the countries where gaming
facilities are located. These changes may impact the operations of the
Company in a materially adverse way. Various laws and regulations could
have a direct and material effect on the business, and indirectly could
have a material effect on the public demand for software of Starnet
Systems. Most countries and jurisdictions within countries have laws or
regulations restricting gaming activities. For example, in the United
States, the Federal Interstate Wire Act contains provisions which make it
a crime for anyone in the business of gaming to use an interstate or
international wire communication line to make wagers or to transmit
information assisting in the placing of wagers, except , with respect to
transmitting information, the wagering is legal in the jurisdictions from
which and into which the transmission is made. Other United States laws
impacting gaming activities include The Interstate Horse Racing Act, the
Interstate Wagering Paraphernalia Act, the Travel Act and the Organized
Crime Control Act.
The Company believes that the activities of its subsidiaries do not violate
or are not subject to such laws and regulations. However, because there is
very little clear statutory and case law authority, this conclusion is not
free from doubt. The Company faces the risk of either civil or criminal
proceedings brought by governmental or private litigants who disagree with
the Company's interpretation of laws and regulations. Because there is
little guiding authority, there is a risk that the Company could lose such
lawsuits or actions and be subject to significant damages or civil or
criminal penalties and fines. Such proceedings could also involve
substantial litigation expense, diversion of the attention of key
executives, injunctions or other prohibitions being invoked against the
-17-
Starnet Systems' Licensees or the Company and its subsidiaries. The
uncertainty surrounding the regulation of Internet gaming could have a
material adverse effect on the Company's business, revenues, operating
results and financial condition.
Several countries, most notably law enforcement agencies in the United
States, believe that the laws of their country restrict, and in some
instances prohibit, interactive gaming operators from doing business with
residents of their countries and, in some instances, prohibit or restrict
residents of their respective countries from doing business with
interactive gaming operators located in a foreign country. The Department
of Justice of the United States of America has taken the position that the
federal criminal laws of the United States do, in fact, address interactive
gaming operators that accept wagers from residents of the United States.
They have taken this position on legislation pending in Congress, discussed
below, and have also pursued various criminal prosecutions. For example, of
several indictments issued at the request of the United States Attorney for
the Southern District of New York, the one case that went to trial involved
Jay Cohen, an owner of World Sports Exchange, a licensed gaming operator in
Antigua. On February 28, 2000 the jury in the Federal District Court case
found Jay Cohen guilty of violating United States federal law (18 U.S.C.
Section 1084), a federal statute that purports to make it illegal for a
betting or wagering business to use a wire communication facility to
transmit bets or wagers in interstate or foreign commerce. Several of the
counts for which Mr. Cohen was found guilty solely involved his Internet
operations. The decision is on appeal.
As a result of the debate on the effectiveness of laws in the United States
to address activities of interactive gaming operators, there has been an
extended effort in the United States to prohibit certain types of
interactive gaming by companies engaged in the business of gaming. After
previous similar proposals failed to pass in 1998, on March 23, 1999,
Senator Jon Kyl of the United States Senate introduced a revised proposal
intended to prohibit and criminalize Internet gambling. This Bill passed
the Senate on November 11, 1999. There can be no assurance whether any
such bill will become law. This Bill, S. 692, contains exceptions that
exempt certain types of wagering by gambling businesses. On October 21,
1999, Representative Goodlatte introduced a bill in the House of
Representatives (H.R. 3125) with similar language as the Kyl bill. H.R.
3125 was voted on by the House of Representatives on July 17, 2000 under
suspension of the rules, which limited debate and required a two-thirds
vote for passage. The vote failed to achieve the necessary two-thirds vote
required for passage. However, it was supported by over sixty percent
(60%) of those voting. Supporters of the Bill continue to try to bring the
Bill up for a vote where only a simple majority would be required. It is
impossible to predict the outcome of the legislation. If passed in its
current form, this federal legislation would prohibit wagering over the
Internet by gambling businesses, with exceptions for certain forms of gaming.
The Company believes that if such laws were found to be applicable to
activities of Licensees of Starnet Systems or to affiliates of the Company
that perform services for the Licensees, such laws would have a material
adverse effect on the Company's business, revenues, operating results and
financial condition. If it was determined that such law
-18-
was applicable to the activities of Licensees and affiliates of the
Company, the Licensees would have to change the types of wagering provided
to residents of the United States. This would impact their current
operations and there may be a delay in offering acceptable wagering
products to such customers. There would be no assurance that the wagering
products offered to such customers would be as profitable to the Licensees
or to affiliates of the Company as the wagering products currently offered
to such customers by the Licensees.
H.R. 4419, a Bill introduced in May, 2000 in the House of Representatives,
is titled the Internet Gambling Funding Prohibition Act. In the form
introduced, this Bill would prohibit any gambling business from accepting
any financial instrument (defined as any check, wire, credit card charge or
any other transaction facilitated by a financial institution) for the
purpose of Internet gaming. At a Banking Committee hearing on June 28,
2000, the Bill passed out of Committee with amendments that largely removed
the international reach of the Bill and also added exceptions to the
prohibitions for pari-mutuel and lottery. It was serially referred to the
House Judiciary Committee for consideration. In its normal course, the
Committee would consider the Bill and, if passed, it would go to the House
floor for a vote, and, if passed on the floor, it would be sent to the
Senate for consideration. If passed in its current form, the legislation
could have a material adverse effect on the Company's business, revenues,
operating results and financial condition.
Other Factors that May Affect Future Results
- --------------------------------------------
Some of the information in this annual report contains forward-looking
statements that involve substantial risks and uncertainties. Any statement
in this annual report and in the documents incorporated by reference into
this annual report that is not a statement of an historical fact
constitutes a forward-looking statement. Further, when we use the words
"may", "expect", "anticipate", "plan", "believe", "seek", "estimate" and
similar words, we intend to identify statements and expressions that may be
forward-looking statements. We believe it is important to communicate
certain of our expectations to our investors. Forward-looking statements
are not guarantees of future performance. They involve risks,
uncertainties and assumptions that could cause Starnet's future results to
differ materially from those expressed in any forward-looking statements.
Many factors are beyond our ability to control or predict. You are
accordingly cautioned not to place undue reliance on such forward-looking
statements. We have no obligation or intent to update publicly any
forward-looking statements whether in response to new information, future
events or otherwise. Important factors that may cause our actual results
to differ from such forward-looking statements include, but are not limited
to, the risk factors discussed below and elsewhere in this annual report
generally. You should be aware that the occurrence of any of the events
described in this section, under "Government Licensing and Regulation" and
elsewhere in this annual report generally, could have a material adverse
effect on our business, financial condition and results of operation.
-19-
THE COMPANY IS INVOLVED IN SIGNIFICANT LITIGATION AND THERE IS NO ASSURANCE
THAT IT WILL BE SUCCESSFUL.
Starnet is involved in a significant amount of litigation, including a
lawsuit filed by a former licensee of Starnet Systems and a class action
lawsuit that alleges that the Company knowingly made material
misrepresentations regarding the nature and inherent risks of the Company's
business in filings to the United States Securities and Exchange
Commission, press releases and other public statements. The Company is also
under investigation by the RCMP. There is a risk that the Company could
lose these lawsuits or actions and be subject to significant damages or
civil or criminal penalties and fines. Adverse judgments in any or all of
these lawsuits could materially and adversely affect the Company's
business, financial condition and results of operations.
THE COMPANY HAS A LIMITED OPERATING HISTORY, THEREFORE THERE IS A DEGREE OF
UNCERTAINTY WHETHER ITS BUSINESS PLANS WILL BE SUCCESSFUL.
Although Starnet has already generated positive cash flow and reached
profitability, it is still in the early stage of development and has only
a limited history of operations. To extent that the Company implements its
business plan, its business will be subject to all of the problems,
expenses, delays and risks inherent in a new business enterprise,
including, without limitation, limited capital, delays in program
development, possible cost overruns, uncertain market acceptance and a
limited operating history. In addition, Starnet's future success will
depend upon many factors, including those which may be beyond its control
or which cannot be predicted at this time, such as increased levels of
competition, the emergence of additional competitors, changes in economic
conditions, emergence of new technologies and changes in governmental
regulations. As a result of these and other factors, there can be no
assurance that the Company's operations will be successful.
THE COMPANY NEEDS ADDITIONAL FINANCING AND THERE IS NO ASSURANCE IT CAN BE
OBTAINED.
A substantial portion of the Company's assets will be used to fund its
expansion plans, operations and other capital needs. There can be no
assurance, however, that such assets will be sufficient for these purposes.
Current assets would not be sufficient to pursue the Company's larger
business plans, and therefore, as is true for other companies contemplating
significant growth, Starnet, in due course, is expected to require
additional financing. There can be no assurance that any such additional
financing that may be required will be available to Starnet if and when
required, or on terms acceptable to the Company, or that such additional
financing, if available, would not result in substantial dilution of the
equity interests of existing shareholders. If additional financing is not
available, the Company has and will likely continue to have sufficient cash
flow and expense flexibility to bring the Company into a positive cash flow
position. Consequently, management is confident of the Company's ability to
continue operations.
-20-
THE COMPANY DEPENDS ON KEY PERSONNEL FOR WHOM IT MAINTAINS NO KEY PERSON
LIFE INSURANCE.
The Company maintains no key person life insurance on such personnel. The
loss of key personnel could have a material adverse effect on our business,
financial condition and results of operations. In addition, the Company's
future operating results depend in part upon its ability to attract and
retain other qualified management, engineering, financial, technical,
marketing and sales and support personnel for its operations. Competition
for such personnel is intense, and there can be no assurance that the
Company will be successful in attracting or retaining such personnel. The
failure to attract or retain such persons could materially adversely affect
Starnet's business, financial condition and results of operations.
THE COMPANY FACES SIGNIFICANT COMPETITION AND THERE IS NO ASSURANCE THAT IT
WILL BE ABLE TO COMPETE.
The Internet entertainment industry involves rapid technological change and
is characterized by intense and substantial competition. Many of the
companies, both domestic and foreign, with which the Company will compete
are well established, substantially larger and have substantially greater
resources than Starnet. It is also likely that other competitors will
emerge in the future. Additionally, the Company will have to compete with
other companies that have greater market recognition, greater resources and
broader distribution capabilities than Starnet. Increased competition by
existing and future competitors could materially and adversely affect the
Company's business, financial condition and results of operations.
THE GAMING INDUSTRY IS A VOLATILE INDUSTRY.
The gaming industry is a volatile industry. The industry tends to be
sensitive to economic conditions. When economic conditions are prosperous,
gaming industry revenues increase; conversely, when economic conditions are
unfavourable, gaming industry revenues decline. Any significant decline in
general corporate conditions or the economy that affect consumer spending
could have a material adverse affect on our business, financial condition
and results of operations.
STARNET'S SOFTWARE AND HARDWARE SYSTEMS MAY FACE PROBLEMS IF THE VOLUME OF
USAGE INCREASES.
The performance of the Company's online services is critical to its
reputation and to achieving market acceptance. Any system failure,
including network, software or hardware failure, that causes interruption
or an increase in response time of its online services could result in
decreased usage of the Company's services and, if sustained or repeated,
could reduce the attractiveness of the Company's online services to its
clients. An increase in the volume of usage of online services could
strain the capacity of the software or the hardware employed, which could
lead to slower response time or system failures, thereby adversely
affecting the Company's revenues. The process of managing
-21-
traffic within large, high traffic Internet online services such as
Starnet's is an increasingly important and complex task. The Company's
operations are dependent in part upon its ability to protect its operating
systems against physical damage from acts of God, power loss,
telecommunications failures, physical break-ins and similar events. The
occurrence of any of these events could result in interruptions, delays or
cessation in service to users of Starnet's online services, which could
have a material adverse affect on the Company's business, financial
condition and results of operations. A large portion of the Starnet's
network infrastructure is located at a single, leased facility in Antigua,
West Indies. The Company's systems and operations are vulnerable to damage
or interruption from fire, flood, power loss, telecommunications failure,
Internet breakdowns, break-ins, hurricanes and similar events. While
Starnet does not have redundant facilities at a secondary location in the
event of an emergency, it does have a variety of backup servers at its
primary site to deal with system failures. Services based on sophisticated
software and computer systems often encounter development delays and the
underlying software may contain undetected errors that could cause system
failures when introduced. Starnet is also dependent upon search engines,
web browsers, Internet service providers ("ISPs") and online service
providers ("OSPs") to provide Internet users access to its web site.
Clients may experience difficulties accessing or using the Company's web
site due to system failures or delays unrelated to the Company's systems.
Starnet does not carry sufficient business interruption insurance to
compensate it for these types of losses.
STARNET'S FUTURE GROWTH DEPENDS ON CONTINUED GROWTH IN THE USE OF THE INTERNET.
The Company's future success is substantially dependent upon continued
growth in the use of the Internet and, as it relates to the Company's
business, in the acceptance and volume of commercial transactions on the
Internet. There can be no assurance that the number of Internet users will
continue to grow or that commerce over the Internet will become more
widespread. The Internet may not prove to be a viable commercial
marketplace for a number of reasons, including lack of acceptable security
technologies, lack of access and ease of use, congestion of traffic,
inconsistent quality of service and lack of availability of cost-effective,
high-speed service, potentially inadequate development of the necessary
infrastructure, excessive governmental regulation, uncertainty regarding
intellectual property ownership or timely development and commercialization
of performance improvements, including high speed modems. Starnet's
success also depends upon, among other things, the continued development
and maintenance of a viable Internet infrastructure to support the
continued growth in the use of the Internet. The maintenance and
improvement of this infrastructure will require timely development of
products, such as high speed modems and communications equipment, to
continue to provide reliable Internet access and improved content. The
current Internet infrastructure may not be able to support an increased
number of users or the increased bandwidth requirements of users and, as
such, the performance or reliability of the Internet may be adversely
affected. Furthermore, the Internet has experienced certain outages and
delays as a result of damage to portions of its infrastructure. Similar
outages and delays in the future could adversely affect the level of
traffic on the Company's web site destination. The effectiveness of the
Internet may decline due to
-22-
delays in the development or adoption of new standards and next-generation
Internet protocols designed to support increased levels of activity. There
can be no assurance that the infrastructure or products or services
necessary to ensure the continued expansion of the Internet will be
developed, or that the Internet will become a viable commercial medium. If
the necessary infrastructure, standards, protocols, products, services or
facilities are not developed, or if the Internet does not become a viable
commercial medium, the Company's results of operations and financial
condition could be materially and adversely affected. Even if such
infrastructure, standards or protocols or complementary products, services
or facilities are developed, there can be no assurance that Starnet will
not be required to incur substantial expenditures in order to adapt its
services to changing or emerging technologies, which could have a material
adverse effect on the Company's business, results of operations and
financial condition. Moreover, it is anticipated that additional domain
levels may be created (such as ".biz"). To the extent additional domain
levels are added, their existence may greatly increase the level of
competition for the Company's site destination.
STARNET'S SYSTEM FACES ONLINE SECURITY RISKS.
Despite the implementation of security measures, Starnet's network may be
vulnerable to unauthorized access, computer viruses and other disruptive
problems. For example, given the content of the Company's web sites, there
is an incentive for "hackers" to penetrate the Company's network security.
A party that is able to circumvent security measures could misappropriate
proprietary information and, perhaps at least as critically, cause
interruptions in Starnet's operations. ISPs and OSPs have in the past
experienced, or may in the future experience, interruptions in service as
a result of the accidental or intentional actions of Internet users,
current and former employees or others. Starnet may be required to expend
significant capital or other resources to protect against the threat of
security breaches or to alleviate problems caused by such breaches. There
can be no assurance that any measures implemented will not be circumvented
in the future. Eliminating computer viruses and alleviating other security
problems may require interruptions, delays or cessation of service to
clients accessing the Company's web sites, which could have a material
adverse effect on our business, results of operations and financial condition.
THE MARKET FOR INTERNET SERVICES IS IN A STATE OF RAPID TECHNOLOGICAL
CHANGE AND THE COMPANY MAY NOT BE ABLE TO KEEP UP.
The market for Internet services is characterized by rapid technological
developments, frequent new product introductions and evolving industry
standards. The emerging character of these products and services and their
rapid evolution will require the Company to effectively use leading
technologies, continue to develop its technological expertise, enhance its
current services and continue to improve the performance, features and
reliability of its web sites. Changes in network infrastructure,
transmission and content delivery methods and underlying software platforms
and the emergence of new broadband technologies, such as DSL and cable
modems, could dramatically change the structure and competitive dynamic of
the market. In particular, technological
-23-
developments or strategic partnerships that accelerate the adoption of
broadband access technologies may require the Company to expend resources
to address these developments. There can be no assurance that Starnet will
be successful in responding quickly, cost effectively and sufficiently to
these or other such developments. In addition, the widespread adoption of
new Internet technologies or standards could require substantial
expenditures to modify or adapt the Company's web sites. A failure to
respond rapidly to technological developments could have a material adverse
effect on the Company's business, results of operations and financial condition.
STARNET MUST CONTINUE TO IMPROVE AND EXPAND ITS SKILLS AND PERSONNEL, BUT
MAY NOT BE ABLE TO DO SO.
In order to expand its business operations, the Company must continue to
improve and expand the expertise of its personnel and must attract, train
and manage qualified managers and employees to oversee and manage its
contemplated expanded operations. There can be no assurance that Starnet
will be able to manage effectively the expansion of its operations or that
its current personnel, systems, procedures and controls will be adequate to
support operations. Any failure of management to manage effectively the
Company's growth could have a material adverse effect on Starnet's
business, results of operations and financial conditions. Although
management intends to ensure that its internal controls remain adequate to
meet the demands of further growth, there can be no assurance that its
systems, controls or personnel will be sufficient to meet these demands.
Inadequacies in these areas could have a material adverse effect on the
Company's business, financial condition and results of operations.
THE COMPANY HAS LIMITED INTELLECTUAL PROPERTY PROTECTION AND THERE IS RISK
THAT STARNET'S COMPETITORS WILL BE ABLE TO APPROPRIATE ITS TECHNOLOGY.
Starnet regards its trade secrets and similar intellectual property as
critical to its success. In that context, the Company will rely on a
combination of copyright and trademark laws, trade secret protection,
confidentiality and non-disclosure agreements and contractual provisions.
There is no guarantee that these efforts will be adequate; that the Company
will be able to secure trademark registrations for all of its marks in the
United States or other countries; or that third parties will not infringe
upon or misappropriate its copyrights, trademarks, service marks and
similar proprietary rights. In addition, effective copyright and trademark
protection may be unenforceable or limited in certain countries, and the
global nature of the Internet makes it impossible to control the ultimate
destination of the Company's web sites. Since trademark and copyright
protections are not "self-enforcing", future litigation may be necessary to
enforce and protect Starnet's secrets, copyrights and other intellectual
property rights. Starnet may also be subject to litigation to defend
against claims of infringement of the rights of others or to determine the
scope and validity of the intellectual property rights of others. Such
litigation could result in substantial costs. An adverse outcome could
require the Company to cease using such intellectual property. Any
litigation regarding propriety rights could be costly and divert
management's attention, result in the loss of certain of the Company's
proprietary rights, require the Company to seek licenses from third parties
and prevent
-24-
the Company from selling its services, any one of which could have a
material adverse effect on Starnet's business, results of operations and
financial condition.
THE COMPANY MAY BE HELD LIABLE FOR THE CONTENT OF ITS WEB SITES.
As a distributor of Internet content, Starnet faces potential liability for
negligence, copyright, patent, trademark infringement, defamation,
indecency, disparagement and other claims based on the nature and content
of the materials that it transmits. Such claims have been brought, and
sometimes successfully pressed, against Internet content distributors.
Although the Company will maintain general liability insurance, its
insurance may not cover potential claims of this type or may not be
adequate to indemnify the Company for all liability that may be imposed. In
addition, although Starnet generally requires its content providers to
indemnify the Company for such liability, such indemnification may be
inadequate. Any imposition of liability that is not covered by insurance,
is in excess of insurance coverage or is not covered by an indemnification
by a content provider could have a material adverse effect on the Company's
business, results of operations and financial condition.
THE TRADING MARKET FOR STARNET'S STOCK MAY BE ILLIQUID.
The shares of Starnet's common stock are quoted on the National Association
of Securities Dealers' Over-The-Counter Bulletin Board ("OTC Bulletin
Board"). This quotation system generally supports companies that do not
meet the listing requirements of the NASDAQ SmallCap Market. As a result,
investors may find it more difficult to dispose of or to obtain accurate
quotations of the Company's common stock. In addition, quotations on the
OTC Bulletin Board depend on the willingness of broker-dealers to make a
market for the stock. There can be no assurance that Starnet's common
stock will continue to be quoted on the OTC Bulletin Board or that there
will continue to be a market for such stock.
THE COMPANY MAY BE SUBJECT TO PRODUCT LIABILITY CLAIMS, AND IT LACKS
PRODUCT LIABILITY INSURANCE.
Starnet faces an inherent risk of exposure to product liability claims in
the event that the products it develops and licenses contain errors, "bugs"
or defects. There can be no assurance that the Company will avoid
significant product liability exposure. Starnet does not currently have
product liability insurance, and there can be no assurance that insurance
coverage will be available in the future on commercially reasonable terms,
or at all. Further, there can be no assurance that such insurance, if
obtained, will be adequate to cover potential product liability claims, or
that a loss of insurance coverage or the assertion of a product liability
claim or claims would not materially adversely affect the Company's
business, financial condition and results of operations.
-25-
STARNET MAY BE SUBJECT TO REGULATION OF INTERNET GAMING.
Starnet and the Licensees are subject to applicable laws in the
jurisdictions in which they are located. As companies and consumers
involved in Internet gaming are located around the globe, including the
end-users of Starnet Systems' Licensees, there is uncertainty regarding
exactly which governments have jurisdiction or authority to regulate or
legislate with respect to various aspects of the industry. The uncertainty
surrounding the regulation of Internet gaming could have a material adverse
effect on Starnet's business, revenues, operating results and financial
condition. In addition, legislation designated to restrict or prohibit
Internet gaming may be adopted in the future in the United States or other
jurisdictions. Also, existing legislation around the world, including the
United States and individual state statutes, could be construed to prohibit
or restrict gaming through the use of the Internet and there is a risk
governmental authorities may view Starnet Systems' Licensees or the Company
as having violated such statutes. There is a risk that criminal and civil
proceedings could be initiated in such jurisdictions against Starnet
Systems' Licensees or the Company, and such proceedings could involve
substantial litigation expense, penalties, fines, diversion of the
attention of key executives, injunctions or other prohibitions being
invoked against Starnet Systems' Licensees or the Company. Such
proceedings could have a material adverse effect on the Company's business,
revenues, operating results and financial condition. In addition, as
electronic commerce develops further, it may generally be the subject of
government regulation. Also, current laws that pre-date or are incompatible
with Internet electronic commerce may be enforced in a manner that
restricts the electronic commerce market. Any such developments could have
a material adverse effect on Starnet's business, revenues, operating
results and financial condition.
ITEM 2. PROPERTIES
Starnet's Antigua-based operations occupy 3,100 square feet of commercial
space in the Cable & Wireless building on Newgate Street, St. John's. A
termination notice has been given on this space effective September 30,
2000 and the operations will move to new 6,400 square feet premises at The
CIBC Banking Centre, Old Parham Road, St. John's. The new facility will
house all of the operations of Starnet Systems, World Gaming and EFS.
The Old Parham Road lease is for a term of three years, with an option to
renew for a further three years. The annual rent is $170,000 plus utilities.
Inphinity occupies 27,000 square feet of commercial space at 1401 West 8th
Avenue, Vancouver, British Columbia, Canada. This facility houses all of
Inphinity's operations, including development and production.
The annual cost of the space at the Vancouver location is approximately
$573,000 CAD. The lease expires on May 31, 2005, although there is an
option to renew for a further five years at market rates.
-26-
ITEM 3. LEGAL PROCEEDINGS
The following are material existing and pending legal claims against the
Company:
Her Majesty the Queen in Right of Canada
- ----------------------------------------
On August 25, 1999, the RCMP obtained an ex parte restraint order from the
Honourable Associate Chief Justice of the Supreme Court of British Columbia
pursuant to the provisions of the Criminal Code of Canada. This order
prevents the Company and Starnet Systems International Inc. from accessing
funds located in their Canadian bank accounts. The amount of money in
these accounts is approximately $7,024,000. The basis for the claim is the
allegation that the funds in these bank accounts are proceeds of crime,
obtained as a result of the breach of certain gaming provisions contained
in the Criminal Code of Canada, and should therefore be forfeited to the
Crown. In September 1999, the Company brought an application to have the
restraint order revoked. This application was unsuccessful.
On February 24, 2000, the RCMP applied to the Supreme Court of British
Columbia to continue the restraint order for a further 12 months. On the
same day, the Company brought an application to have the restraint order
vacated. The application to continue the restraint order was granted but
only for a further six months. The application to vacate the restraint
order was adjourned until such time as all issues relating to privileged
documents had been dealt with.
Las Vegas Casino Inc.
- ---------------------
Plaintiff: Las Vegas Casino Inc. ("LVC")
Defendants: The Company, a number of its subsidiaries and various employees
Court: Supreme Court of British Columbia, Action No. C994793,
Vancouver Registry
Date Filed: September 16, 1999
The plaintiff alleges that the Company, a number of its subsidiaries,
including Starnet Systems (formerly Softec Systems Caribbean Inc.), and
various employees of the Company and its subsidiaries, caused a $1 billion
loss arising by reason of alleged misappropriation of funds and breach and
wrongful termination of its software license agreement with Starnet
Systems. The relief sought includes general and exemplary damages,
declarative relief, an accounting, interest and costs.
On July 12, 2000, Starnet Systems was granted a stay of the lawsuit as
against it only, with the result that, pursuant to the terms of the
software license agreement, the plaintiff's claim and Starnet Systems'
claim for unpaid fees will proceed to arbitration.
-27-
The Company believes that LVC's allegations are without merit and intends
to defend LVC's lawsuit and to contest arbitration proceedings vigorously.
As this matter is at a preliminary stage, its financial impact, if any,
cannot be determined at this time, although management is of the opinion
that it will not result in any significant losses to the Company.
U.S. Class Action Claims
- ------------------------
A. Plaintiff: Alan Fenster, P.C.
Defendants: The Company, John Carley ("Carley"), Mark Dohlen
("Dohlen"), Christopher H. Zacharias ("Zacharias")
Court: United States District Court, District of Delaware,
C.A. No. 99-681
Date Filed: October 15, 1999
B. Plaintiff: Manuel Jankovits
Defendants: The Company, Carley, Dohlen, Zacharias
Court: United States District Court, District of Delaware,
C.A. No. 99-702
Date Filed: October 21, 1999
C. Plaintiff: Philip J. Pendery
Defendants: The Company, Carley, Dohlen, Zacharias, Jason King
("King")
Court: United States District Court, District of Delaware,
C.A. No. 99-716
Date Filed: October 26, 1999
D. Plaintiff: Vinh Nguyen
Defendants: The Company, Carley, Dohlen, Zacharias, King
Court: United States District Court, District of Delaware,
C.A. No. 99-750
Date Filed: November 5, 1999
E. Plaintiff: On-Site Trading, Inc.
Defendants: The Company, Carley, Dohlen, Zacharias
Court: United States District Court, District of Delaware,
C.A. No. 99-758
Date Filed: November 5, 1999
F. Plaintiff: Jim Moore
Defendants: The Company, Carley, Dohlen, Zacharias
Court: United States District Court, District of Delaware,
C.A. No. 99-794
Date Filed: November 16, 1999
G. Plaintiff: Paul Martinez
Defendants: The Company, Carley, Dohlen, Zacharias, King
Court: United States District Court, District of Delaware,
C.A. No. 99-806
Date Filed: November 23, 1999
-28-
H. Plaintiff: Joseph Guisinger
Defendants: The Company, Carley, Dohlen, Zacharias
Court: United States District Court, District of Delaware,
C.A. No. 99-817
Date Filed: November 29, 1999
I. Plaintiff: Robert Reynolds
Defendants: The Company, Carley, Dohlen, Zacharias
Court: United States District Court, District of Delaware,
C.A. No. 99-845
Date Filed: December 8, 1999
J. Plaintiff: Terry A. Perrine
Defendants: The Company, Carley, Dohlen, Zacharias
Court: United States District Court, District of Delaware,
C.A. No. 99-852
Date Filed: December 9, 1999
The class alleged in the class action claims consists of all persons who
purchased the Company's common stock from March 11, 1999 to August 20, 1999
inclusive, excluding the defendants and persons connected with the Company.
The basis for all of the U.S. class action claims is similar. The
plaintiffs generally allege that the Company:
1. Failed to properly advise its investors of the risks associated with
the Company's business;
2. Misled its investors as to the risks associated with the Company's
business;
3. Misled its investors by stating that the Company did not accept wagers
from persons resident in Canada or the United States, when it, in
fact, did do so; and
4. Misled its investors by stating that their business was legal within
Canada and the United States when it was not.
The relief sought includes declaration of a class, and damages and costs
for the class. The amount of the damages claimed is unspecified.
On March 7, 2000, the United States District Court for the District of
Delaware ordered that these ten actions be consolidated under the heading
IN RE STARNET COMMUNICATIONS INTERNATIONAL INC. SECURITIES LITIGATION, C.A.
No. 99-681 (SLR).
As this issue is at a preliminary stage, its financial impact, if any,
cannot be determined at this time. It is the Company's intention to defend
this lawsuit vigorously.
-29-
Home Gambling Network, Inc.
- ---------------------------
Plaintiff: Home Gambling Network, Inc.
Defendant: The Company
Court: United States District Court for the District of Nevada,
Action No. CV S-99-00339-JBR (LRL)
Date Filed: March 22, 1999
The plaintiff filed a lawsuit against the Company, alleging infringement of
its patent entitled "Method of Participating in a Live Casino Game from a
Remote Location". The plaintiff's patent contemplates the use of a live
video feed to play real-time footage of a person facilitating the play on
a casino game. The player watches the game being dealt and winnings and
losses are directly debited or credited from the payer's bank account. The
amount of the damages claimed was unspecified.
Pursuant to a settlement reached by the parties, this action was dismissed
without prejudice on December 29, 1999, with each party bearing its own
costs and legal fees.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) An annual meeting of security holders of Starnet was held at the Royal
Antiguan Resort, Deep Bay, St. John's, Antigua on April 19, 2000.
(c) The following matters were submitted to a vote of security holders
through the solicitation of proxies or otherwise:
Election of Directors
---------------------
The following persons received the votes cast for and withheld with
respect to the election of directors:
FOR WITHHELD
Meldon Ellis 19,612,708 48,401
Wolf Bergelt 19,497,176 163,933
Clare Roberts 19,614,979 46,130
Nicholas Jackson 19,611,194 49,915
Jason Bolduc 19,195,776 465,313
Dean Grimm 19,014,252 646,857
Fred Hazell 19,620,579 40,530
Brownell Combs II 19,620,579 40,530
Matthew Stasior 19,620,479 40,630
-30-
Ratification of Independent Public Accounts
-------------------------------------------
In other business, the security holders ratified the appointment of
Jones, Jensen & Co. (now HJ & Associates, L.L.C.) as Starnet's
independent public accountants. The votes cast for and against, and
those abstaining from voting, were as follows:
FOR AGAINST ABSTAIN
19,634,827 5,654 20,628
PART II
ITEM 5. MARKET FOR STARNET'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information
- ------------------
The Company's common stock is traded on OTC Bulletin Board under the symbol
"SNMM" and on the Berlin Exchange's Over-The-Counter market under the
symbol "SNM".
The following table sets out the range of high and low bid information for
the Company's common stock for each full quarterly period within the two
most recent fiscal years as quoted on the OTC Bulletin Board. Bid
quotations reflect inter-dealer prices, without retail markup, mark-down or
commission and may not necessarily represent actual transactions.
QUARTER ENDED HIGH ($) LOW ($)
July 30, 1998 0.75 1.50
October 31, 1998 7/8 0.45
January 31, 1999 6 1/32 3/8
April 30, 1999 17.01 3 11/16
July 30, 1999 29.00 8.56
October 31, 1999 15.94 3.00
January 31, 2000 4.56 1.75
April 30, 2000 10.00 2.81
Security Holders
- ----------------
As of July 24, 2000, there were 160 registered holders of shares of the
outstanding Class A Voting Common Stock of the Company.
-31-
Dividends
- ---------
No dividends have been declared or paid on the Company's common stock.
Recent Sales of Unregistered Securities
- ---------------------------------------
No equity securities of Starnet were sold by the Company during the period
covered by this Report that were not registered under the Securities Act,
other than unregistered sales made in reliance on Regulation S.
ITEM 6. SELECTED FINANCIAL DATA
Selected income statement data for the years ended April 30 (in thousands
of US dollars, except per share figures):
2000 1999 1998 1997 1996
---------------------------------------------------
Net sales 17,881 6,255 257 -- --
Income (loss) from continuing
operations (4,462) 1,031 (818) -- --
Income (loss) from continuing
operations per common share $(0.16) $0.04 $(0.04) -- --
Cash dividends declared per
common share -- -- -- -- --
Prior to 1998, the Company's activities were limited to activities that
have since been classified as discontinued operations.
Selected balance sheet data as at April 30 (in thousands of US dollars):
2000 1999 1998 1997 1996
---------------------------------------------------
Total assets 27,983 13,439 3,275 1,197 N/A
Long-term obligations 979 818 419 312 N/A
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
Some of the information in this annual report contains forward-looking
statements that involve substantial risks and uncertainties. Any statement
in this annual report and in the documents incorporated by reference into
this annual report that is not a statement of an historical fact
constitutes a forward-looking statement. Further, when we use the words
"may", "expect", "anticipate", "plan", "believe", "seek", "estimate" and
similar words, we intend to identify statements and expressions that may be
forward-looking statements.
-32-
We believe it is important to communicate certain of our expectations to
our investors. Forward-looking statements are not guarantees of future
performance. They involve risks, uncertainties and assumptions that could
cause Starnet's future results to differ materially from those expressed in
any forward-looking statements. Many factors are beyond our ability to
control or predict. You are accordingly cautioned not to place undue
reliance on such forward-looking statements. We have no obligation or
intent to update publicly any forward-looking statements whether in
response to new information, future events or otherwise. Important factors
that may cause our actual results to differ from such forward-looking
statements include, but are not limited to, the risk factors discussed
below and elsewhere in this annual report generally. You should be aware
that the occurrence of any of the events described in this section, under
"Government Licensing and Regulation", "Other Factors That May Affect
Future Results" and elsewhere in this annual report generally, could have
a material adverse effect on our business, financial condition and results
of operation.
Results Of Operations
- ---------------------
(Financial figures are in thousands)
The Company's Internet casino, which targets only customers outside North
America, is operated by its subsidiary, World Gaming Services Inc. of
Antigua. Starnet Systems, also of Antigua, licenses its gaming software to
third parties for a set up fee and monthly royalty. Inphinity Interactive
Inc. was incorporated in 1999 to develop gaming software and web pages. In
April 2000, the Company sold the assets of its adult entertainment business
to a third party to focus entirely on the Internet gaming industry. The
adult business has been classified separately as discontinued operations.
Revenues from all components of the gaming business, which include
licensing, casino operations and financial transaction processing, have
undergone tremendous growth and generated revenues of $17,800, representing
an increase of 186% over the gaming revenues of $6,300 for the year ended
April 30, 1999.
The following tables set out selected information from the statements of
operations for the year ended April 30, 2000 and 1999 and the balance
sheets as at April 30, 2000 and 1999:
SELECTED STATEMENT OF OPERATIONS INFORMATION
For the year ended
April 30, 2000 April 30, 1999
-------------- --------------
Net Sales 17,881 6,255
Gross Margin 12,738 5,380
Operating Expenses 17,624 4,376
Income (Loss) From Continuing Operations (4,462) 998
Net Income (Loss) (3,255) 2,042
-33-
SELECTED BALANCE SHEET INFORMATION
At April 30, 2000 At April 30, 1999
----------------- -----------------
Working Capital 6,238 7,106
Total Assets 27,983 13,439
Long Term Debt 503 461
Retained Earnings (Deficit) (2,371) 884
Total Shareholders' Equity 19,376 9,420
The revenue growth is primarily due to a 198% increase in royalties and
fees generated from gaming operations, financial transaction processing
and web site production for licensees, from $4,645 in 1999 to $13,853 in
2000. Revenue from software licensing, including Antigua gaming
licenses, also increased a healthy 150%, from $1,610 to $4,028, which
represented 23% of total revenue compared to 26% in 1999.
During the year, the Company completed software for 33 new licensees but
lost 5 for a net increase of 28 and a total of 45 active licensees as at
April 30, 2000. Together, the licensees generated $56,000 in system wide
revenues in the Company's fiscal year 2000, up 273% from $15,000 in 1999.
However, there are some licensees experiencing relatively low revenue
levels and the Company believes they will likely close over the upcoming
year or merge with one of the more successful licensees. Royalty revenue
from one of the operating licensees represented approximately 23% of the
total sales for the Company in fiscal 2000 compared to 19% in fiscal 1999.
Along with the growth in sales, gross profit increased to $12,738 for the
year ended April 30, 2000 from $5,380 for the prior year. The gross
margin decreased from 86.0% for the year ended April 30, 1999 to 71.2%
for the year ended April 30, 2000 due to the relatively lower gross
margin from reselling the Antigua gaming licenses.
In order to support the rapid growth in the underlying business, the
Company invested heavily in software development, selling, network
operations and general and administration to ensure the Company's place
as one of the leaders in the industry. Consequently these expenses
increased by 304% to $11,704 for the year ended April 30, 2000 from
$2,891 for the prior year.
As mentioned earlier in this Report, the Company's business operations
have been under investigation by the Canadian authorities (the
"Investigation") and management has been cooperating fully with the RCMP.
As a result, the Company has successfully refocused its efforts on the
on-line gaming industry. The Company has also succeeded in developing a
detailed plan for resolving other related legal actions and has begun a
comprehensive process of reviewing the licensee operations to ensure the
continued success of the underlying business. This process has resulted
in the identification of
-34-
several adjustments and provisions that impact the Company's financial
results for the year ended April 30, 2000. They are as follows:
1. A bad debt provision of $1,734 consisting of $1,064 from 14
licensees that were negatively 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. Another $291 was provided for in the
fourth quarter to cover other miscellaneous receivables. Combined,
the affected licensees contributed less than 5% to Starnet revenues.
2. Legal expenses of $2,082 for the twelve months to April 30, 2000
Included in this amount is a provision made during the year for
$1,500 to cover the anticipated legal costs to:
a. Defend the Company against the following actions:
i. The Investigation
ii. Various Shareholder Class Action suits
iii. The Las Vegas Casino law suit
b. Complete Phase 2 of the corporate re-structuring
Of this amount, $1,282 remains as an accrual at year-end to cover the
anticipated legal costs to bring these matters to a conclusion.
Depreciation and amortization increased from $997 in 1999 to $2,011 in
2000 as new computer equipment was purchased to handle the increase in
network traffic. The Company also expanded its facilities in Antigua.
Also a write-down of the remaining Deferred Software Development costs
was made to recognize the diminished value of this asset due to the
planned release of Starnet Systems 2000 in the first quarter of fiscal
year 2001.
The loss from continuing operations for the year ended April 30, 2000 was
$4,462 compared to an operating income of $1,031 for the prior year. The
loss was mainly the result of a substantial investment in software
development that was expensed during the year. The investment will lead
to a completely new software platform that will be launched in the first
half of fiscal year 2001.
Pursuant to the terms of a letter agreement dated March 17, 2000, the
Company sold the business and all of the assets of its adult
entertainment division. Prior to the sale, the discontinued division
suffered a loss of $355 compared to a profit of $1,011 in the prior year
as management focused its efforts on other areas. The proceeds from the
sale were $1,944 (net of a $356 discount) resulting in a gain of $1,562
before income taxes.
-35-
Tax recovery for the year ended April 30, 2000 was $116. The majority of
the Company's income is generated from Starnet Systems in Antigua, which
is not subject to income tax. However, although the Company's Canadian
subsidiaries are subject to tax, the high development costs during the
year more than offset the taxable capital gain from the sale of the
discontinued operations, and allowed for a recovery of taxes paid in the
prior year.
Liquidity and Capital Resources
- -------------------------------
(Financial figures are in thousands)
At April 30, 2000, the Company had $5,984 in cash and cash equivalents
compared to $5,000 at April 30, 1999. Due to the Investigation by
Canadian authorities of the business operations of the Company, two of
the Company's bank accounts with a Canadian bank were frozen on August
25, 1999 pursuant to a restraint order granted by the Supreme Court of
British Columbia. The amount affected totaled approximately $7,024. An
additional $516 represents interest and amounts held as collateral.
Despite the fact that the restraint order is slowing down the Company's
expansion plan, it does not prevent the Company from continuing its
operations. 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 $3,857 on hand, a significant portion is held as a
rolling reserve, which is released to the company after six months.
Working capital at April 30, 2000 decreased to $6,238 from $7,106 at
April 30, 1999. Accounts receivable decreased from $2,671 at April 30,
1999 to $2,022 at April 30, 2000. The majority of the receivables are
from new licensees that were offered an installment payment plan on the
initial licensing fees and from operating licensees that have their own
merchant accounts. Prepaid expenses and deposits increased by $384 to
$616 at April 30, 2000 due to increased security deposits required for
the expanded operations. Other current assets at April 30, 2000 dropped
to $1,349 from $1,424 at April 30, 1999. The decrease is the net effect
of prepayments made to the Antiguan Government for the purchase of
additional casino licenses less the portion allocated to costs of sales
during the year. The casino licenses are held for sale to prospective
licensees. Of the original cost of $2,250, $901 has been expensed for
the year against gaming license revenue of $1,273. The remaining balance
will be expensed as revenue is generated but the expense will not be less
than $281 in any quarter.
Net cash used by operations for the year ended April 30, 2000 was $557
compared to cash generated of $291 for the year ended April 30, 1999.
The decrease in cash from operations was mainly due to the investment in
development expenses that were expensed during the year.
Net cash used for investing activities for the year ended April 30, 2000
was $9,548 compared to $827 for the year ended April 30, 1999. The
majority of the difference is due to the significant increase to
restricted cash of $7,173, most of which is due to the
-36-
Investigation. Also, significant purchases of capital assets were
required to meet the growing processing requirements.
Net cash provided by financing activities for the year ended April 30,
2000 was $11,035 compared to $5,416 for the year ended April 30, 1999. The
increase was from the proceeds of the exercise of stock options and warrants.
Contingencies and Commitments
- -----------------------------
On September 16, 1999, Las Vegas Casino Inc. ("LVC") commenced an action
against the Company, a number of its subsidiaries and various employees
of the Company and its subsidiaries. LVC, a former software licensee of
Starnet Systems, alleges a $1 billion loss arising from alleged
misappropriation of funds, and breach and wrongful termination of its
software license agreement. Starnet Systems terminated the software
license agreement with LVC on July 22, 1999 as a result of LVC's failure
to pay over $200,000 in fees owed to Starnet Systems. On July 12, 2000,
Starnet Systems was granted a stay of the lawsuit as against it only,
with the result that LVC's claim and Starnet Systems' claim for unpaid
fees will proceed to arbitration. The Company believes that LVC's
allegations are without merit and intends to defend LVC's lawsuit and to
contest arbitration proceedings vigorously. As this matter is at a
preliminary stage, its financial impact, if any, cannot be determined at
this time, although management is of the opinion that it will not result
in any significant losses to the Company.
On August 20, 1999, the Royal Canadian Mounted Police ("RCMP") obtained a
search warrant and searched the Vancouver, British Columbia offices of
Starnet Communications Canada Inc. The basis for the search was the
allegation of the RCMP that the Company and some of its officers,
directors and employees were breaching certain gaming provisions
contained in the Criminal Code of Canada.
On August 25, 1999, the RCMP obtained an ex parte restraint order
pursuant to the provisions of the Criminal Code of Canada. This order
prevents the Company and Starnet Systems International Inc. from
accessing funds located in their Canadian bank accounts. The amount of
money in these accounts is approximately $7,024,000. In September 1999,
the Company brought an application to have the restraint order revoked.
This application was unsuccessful.
On February 24, 2000, the RCMP applied to the Supreme Court of British
Columbia to continue the restraint order for a further 12 months. On the
same day, the Company brought an application to have the restraint order
vacated. The application to continue the restraint order was granted but
only for a further six months. The application to vacate the restraint
order was adjourned until such time as all issues relating to privileged
documents had been dealt with.
Despite the fact that the restraint order is slowing down the Company's
expansion plan, it does not prevent the Company from continuing its
operations or expansion plan. The RCMP investigation has not been
completed and no charges have been laid.
-37-
Between October 15, 1999 and December 9, 1999, ten class action claims
were commenced in the United States against the Company and some of its
directors and officers. The class action lawsuits allege that material
misrepresentations regarding the nature and inherent risks of the
Company's business were knowingly made in filings to the United States
Securities and Exchange Commission, press releases and other public
statements. The amount of the damages claimed is unspecified. These
actions have now been consolidated in a single proceeding. As this issue
is at a preliminary stage, its financial impact, if any, cannot be
determined at this time. It is the Company's intention to defend these
lawsuits vigorously.
In all of the above-noted matters, management has been unable to
determine the likely outcomes. Consequently, no provision for loss has
been made in these financial statements in respect of these matters.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information with respect to this item is contained in the financial
statements listed in Item 14 of this Report. Such information is
incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Ernst & Young L.L.P. ("Ernst & Young") declined to stand for re-election
as independent auditors as of August 24, 1999. Neither of Ernst &
Young's reports on the financial statements for the 1998 and 1999 fiscal
years has contained adverse opinions or disclaimers of opinion, or were
modified as to uncertainty, audit scope or accounting principles. There
were no disagreements with Ernst & Young on any matter of accounting
principles or practices, financial statement disclosure, or auditing
scope or procedure.
HJ & Associates, L.L.C. (formerly Jones, Jensen & Co.) were appointed as
of October 25, 1999 as independent auditors for the purpose of auditing
the Company's financial statements.
PART III
- --------
The information required by Part III (Items 10, 11, 12 and 13), which
relates to directors and executive officers of the Company, executive
compensation, security ownership of certain beneficial owners and
management, and certain relationships and related transactions, is
incorporated herein from the Company's definitive proxy statement to be
filed pursuant to Regulation 14A by August 28, 2000.
-38-
PART IV
- -------
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements (included in Part II of this Report):
----------------------------------------------------------
Independent Auditors' Report
Report of Independent Auditors - incorporated by reference from
Item 7 of Form 10-KSB/A dated August 12, 1999.
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Stockholders' Equity
Consolidated Statements of Cash Flows
Notes to the Consolidated Financial Statements
Exhibits required by Item 601 of Regulation S-K:
------------------------------------------------
3.1 Articles of Incorporation(1)
3.2 Bylaws(1)
3.3 Certificate of Incorporation(2)
3.4 By-laws(4)
10.1 Bank of Montreal(1)
10.2 Pacific Rim Investments Inc.(1)
10.3 Simulcast Agreement(1)
10.4 CompuServe Agreement(1)
10.5 Starnet Communications International Inc. 1997 Stock Option Plan(2)
10.7 Starnet Communications International Inc. 1999 Stock Option Plan(3)
10.8 Software License Agreement between Starnet Systems
International Inc. and Global Interactive Ltd. dated
February 19, 2000(4)
-39-
10.9 Commitment Letter between Starnet Systems International Inc.
and Simpson Bay, Ltd. dated June 23, 2000(4)
10.10 Employment Agreement between Starnet Communications
International Inc. and Meldon Ellis dated October 1, 1999(4)
10.11 Consulting Services Agreement between Starnet Communications
International Inc. and Wolf Bergelt dated April 1, 1999(4)
16.1 Letter from Ernst & Young L.L.P. dated September 9, 1999
regarding change in certifying accountant - incorporated by
reference from Exhibit 24.1 of Form 8-K/A dated September
10, 1999
21.1 Subsidiaries of the Registrant(4)
23.1 Consent of Independent Auditors dated July 28, 2000(4)
27.1 Financial Data Schedule(4)
- ----------------------------
(1) Incorporated by reference from Form 10-SB dated June 18, 1997.
(2) Incorporated by reference from Form S-8 dated March 12, 1998.
(3) Incorporated by reference from Form S-8 dated March 10, 1999.
(4) Filed herewith.
(b) Reports on Form 8-K:
--------------------
The following report on Form 8-K was filed during or subsequent to
the last quarter of the period covered by this Report:
June 14, 2000 - sale of the assets and undertakings comprising the
adult entertainment division of Starnet Communications Canada Inc.
to 596773 B.C. Ltd.
-40-
STARNET COMMUNICATIONS INTERNATIONAL INC.
CONSOLIDATED FINANCIAL STATEMENTS
APRIL 30, 2000
C O N T E N T S
Independent Auditors' Report . . . . . . . . . . . . . . . . . . . . F-3
Consolidated Balance Sheets. . . . . . . . . . . . . . . . . . . . . F-4
Consolidated Statements of Operations. . . . . . . . . . . . . . . . F-5
Consolidated Statements of Stockholders' Equity. . . . . . . . . . . F-7
Consolidated Statements of Cash Flows. . . . . . . . . . . . . . . . F-8
Notes to the Consolidated Financial Statements . . . . . . . . . . . F-10
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
Starnet Communications International Inc.
We have audited the accompanying consolidated balance sheet of Starnet
Communications International Inc. as of April 30, 2000 and the related
consolidated statements of operations, shareholders' equity and cash flows
for the year ended April 30, 2000. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is
to express an opinion on these consolidated financial statements based on
our audit. The consolidated financial statements for the years ended April
30, 1999 and 1998 were audited by other auditors, whose report dated June
30, 1999, expressed an unqualified opinion.
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 consolidated financial
statements are free of material misstatement. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall consolidated financial statement
presentation. We believe that our audit provides a reasonable basis for
our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial
position of Starnet Communications International Inc. at April 30, 2000,
and the consolidated results of their operations and their cash flows for
the year ended April 30, 2000 in conformity with generally accepted
accounting principles.
HJ & Associates, LLC
Salt Lake City, Utah
July 22, 2000
F-3
STARNET COMMUNICATIONS INTERNATIONAL INC.
Consolidated Balance Sheets
(In Thousands of US $)
ASSETS
------
April 30,
-----------------------------
2000 1999
----------- -----------
CURRENT ASSETS
Cash and cash equivalents $ 5,984 $ 5,000
Reserves and deposits with credit card processors (Note 3) 3,857 1,337
Accounts receivable (Note 4) 2,022 2,671
Prepaid expenses and deposits 616 232
Other current assets (Note 5) 1,349 1,424
Current portion of long-term receivable (Note 16) 514 -
----------- -----------
Total Current Assets 14,342 10,664
----------- -----------
OTHER ASSETS
Restricted cash (Note 6) 7,234 61
Capital assets (net) (Note 7) 4,868 1,673
Deferred website costs (Note 8) - 285
Software development costs (net) (Note 9) - 610
Deferred income tax asset (Note 10) - 146
Long-term receivable (Note 16) 1,539 -
----------- -----------
Total Other Assets 13,641 2,775
----------- -----------
TOTAL ASSETS $ 27,983 $ 13,439
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES
Accounts payable and accrued liabilities $ 5,223 $ 1,371
Income taxes payable (Note 10) - 268
Funds held on deposit (Note 11) 2,118 989
Deferred revenue 287 573
Current portion of capital lease obligations (Note 12) 476 357
----------- -----------
Total Current Liabilities 8,104 3,558
----------- -----------
LONG-TERM LIABILITIES
Non-current portion of capital lease obligations (Note 12) 503 461
----------- -----------
Total Long-Term Liabilities 503 461
----------- -----------
Total Liabilities 8,607 4,019
----------- -----------
COMMITMENTS AND CONTINGENCIES (Note 14)
STOCKHOLDERS' EQUITY
Capital stock (Note 13) 22,143 8,584
Subscription receivable (381) -
Retained earnings (deficit) (2,371) 884
Accumulated other comprehensive loss (15) (48)
----------- -----------
Total Stockholders' Equity 19,376 9,420
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 27,983 $ 13,439
=========== ===========
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
STARNET COMMUNICATIONS INTERNATIONAL INC.
Consolidated Statements of Operations
(In Thousands of US $)
For the Years Ended
April 30,
-----------------------------------------
2000 1999 1998
----------- ----------- -----------
REVENUE
Sales
Licensing $ 4,028 $ 1,610 $ 150
Royalties and fees 13,853 4,645 107
----------- ----------- -----------
Total Sales 17,881 6,255 257
----------- ----------- -----------
Cost of sales 5,143 875 56
----------- ----------- -----------
Gross Profit 12,738 5,380 201
----------- ----------- -----------
OPERATING EXPENSES
Development, selling, general
and administrative 11,704 2,891 461
Provision for bad debts 1,734 250 -
Legal 2,082 198 35
Depreciation 2,011 997 401
Interest and bank charges 93 40 50
----------- ----------- -----------
Total Operating Expenses 17,624 4,376 947
----------- ----------- -----------
INCOME (LOSS) FROM OPERATIONS (4,886) 1,004 (746)
OTHER INCOME (EXPENSES) 308 27 (23)
----------- ----------- -----------
INCOME (LOSS) FROM CONTINUING
OPERATIONS BEFORE INCOME TAXES (4,578) 1,031 (769)
----------- ----------- -----------
INCOME TAX EXPENSE (RECOVERY)
Current (266) - 74
Deferred 150 - (25)
----------- ----------- -----------
Total Income Taxes (116) - 49
----------- ----------- -----------
INCOME (LOSS) FROM CONTINUING
OPERATIONS $ (4,462) $ 1,031 $ (818)
----------- ----------- -----------
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
STARNET COMMUNICATIONS INTERNATIONAL INC.
Consolidated Statements of Operations (Continued)
(In Thousands of US $)
For the Years Ended
April 30,
-----------------------------------------
2000 1999 1998
----------- ----------- -----------
INCOME (LOSS) FROM DISCONTINUED
OPERATIONS OF THE ON-LINE INTER-
ACTIVE MEDIA DIVISION (LESS
APPLICABLE INCOME TAXES) (Note 15) $ (355) $ 1,011 $ (220)
GAIN ON SALE OF THE ON-LINE
INTERACTIVE MEDIA DIVISION
(INCLUDING APPLICABLE INCOME
TAXES OF $-0- (Note 15) 1,562 - -
----------- ----------- -----------
NET INCOME (LOSS) FOR THE YEAR (3,255) 2,042 (1,038)
RETAINED EARNINGS (DEFICIT),
BEGINNING OF YEAR 884 (1,158) (120)
----------- ----------- -----------
RETAINED EARNINGS (DEFICIT),
END OF YEAR $ (2,371) $ 884 $ (1,158)
=========== =========== ===========
BASIC EARNINGS (LOSS) PER SHARE
FROM CONTINUING OPERATIONS $ (0.16) $ 0.04 $ (0.04)
=========== =========== ===========
BASIC EARNINGS (LOSS) PER SHARE $ (0.12) $ 0.09 $ (0.05)
=========== =========== ===========
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING 29,625,460 22,951,546 21,002,885
=========== =========== ===========
DILUTED EARNINGS PER SHARE FROM
CONTINUING OPERATIONS $ - $ 0.04 $ -
=========== =========== ===========
DILUTED EARNINGS PER SHARE $ - $ 0.08 $ -
=========== =========== ===========
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING FOR
DILUTED EARNINGS PER SHARE - 25,960,005 -
=========== =========== ===========
The accompanying notes are an integral part of these
consolidated financial statements.
F-6
STARNET COMMUNICATIONS INTERNATIONAL INC.
Consolidated Statements of Stockholders' Equity
For the Years Ended April 30, 1998, 1999 and 2000
(In Thousands of US $)
Accumulated
Common Stock Retained Other
----------------------- Subscription Earnings Comprehensive
Shares Amount Receivable (Deficit) Income
---------- ---------- ---------- ---------- ----------
Balance, April 30, 1997 20,000,000 $ 20 $ - $ (120) $ 29
Common shares issued for cash 2,450,000 2,450 - - -
Movement in other comprehensive
income (loss) - foreign currency
translation adjustments - - - - 6
Net loss for the year ended
April 30, 1998 - - - (1,038) -
Less: share issue costs - (49) - - -
---------- ---------- ---------- ---------- ----------
Balance, April 30, 1998 22,450,000 2,421 - (1,158) 35
Shares issued for cash
pursuant to exercise of
options 1,602,434 1,263 - - -
Shares issued for cash
pursuant to exercise of
warrants 2,450,000 4,900 - - -
Movement in other comprehensive
income (loss) - foreign currency
translation adjustments - - - - (83)
Net income for the year ended
April 30, 1999 - - - 2,042 -
---------- ---------- ---------- ---------- ----------
Balance, April 30, 1999 26,502,434 8,584 - 884 (48)
Shares issued for cash pursuant
to exercise of options 3,109,692 3,759 (381) - -
Shares issued for cash pursuant
to exercise of warrants 2,450,000 9,800 - - -
Movement in other comprehensive
income (loss) - foreign currency
translation adjustments - - - - 33
Net loss for the year
ended April 30, 2000 - - - (3,255) -
---------- ---------- ---------- ---------- ----------
Balance, April 30, 2000 32,062,126 $ 22,143 $ (381) $ (2,371) $ (15)
========== ========== ========== ========== ==========
The accompanying notes are an integral part of these
consolidated financial statements.
F-7
STARNET COMMUNICATIONS INTERNATIONAL INC.
Consolidated Statements of Cash Flows
(In Thousands of US $)
For the Years Ended
April 30,
-----------------------------------------
2000 1999 1998
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (3,255) $ 2,042 $ (1,038)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation 1,665 706 378
Amortization of deferred website costs 159 394 327
Amortization of software development costs 611 189 27
Deferred income tax 150 - (26)
Gain on disposal of fixed assets (1,562) - (1)
Changes in current assets and liabilities:
Decrease (increase) in reserves and deposits
with credit card processors (2,520) (1,141) (229)
Decrease (increase) in accounts receivable 242 (2,537) (78)
Decrease (increase) in prepaid expenses and deposits (384) (87) (33)
Decrease (increase) in other assets 75 (1,410) (194)
Increase (decrease) in accounts payable and accrued
liabilities 3,687 85 173
Increase (decrease) in income taxes payable (268) 193 74
Increase (decrease) in funds held on deposit 1,129 1,043 191
Increase (decrease) in deferred revenue (286) 48 57
----------- ----------- -----------
Net Cash Provided by (Used In) Operating
Activities (557) 291 (372)
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of capital assets (4,428) (570) (527)
Transfer from (to) restricted cash (7,173) 500 (500)
Proceeds from sale of on-line entertainment assets 1,944 - -
Proceeds from sale of marketing assets 109 - -
Deferred website costs - (423) (394)
Software development costs - (334) (492)
----------- ----------- -----------
Net Cash Used in Investing Activities $ (9,548) $ (827) $ (1,913)
----------- ----------- -----------
The accompanying notes are an integral part of these
consolidated financial statements.
F-8
STARNET COMMUNICATIONS INTERNATIONAL INC.
Consolidated Statements of Cash Flows (Continued)
(In Thousands of US $)
For the Years Ended
April 30,
-----------------------------------------
2000 1999 1998
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
(Increase) decrease in bank indebtedness $ - $ (466) $ 466
Increase in long-term receivable (2,053) - -
Proceeds from issuance of shares 13,559 6,163 2,401
Payments to related parties - - (133)
Repayment of loan - - (200)
Principal repayments under capital lease obligations (471) (281) (142)
----------- ----------- -----------
Net Cash Provided by Financing Activities 11,035 5,416 2,392
----------- ----------- -----------
EFFECT OF EXCHANGE RATES ON CASH 54 (21) 6
----------- ----------- -----------
NET INCREASE IN CASH AND CASH EQUIVALENTS
DURING THE YEAR 984 4,859 113
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 5,000 141 28
----------- ----------- -----------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 5,984 $ 5,000 $ 141
=========== =========== ===========
Other non-cash transactions:
Leased assets acquired $ 732 $ 685 $ 276
Supplemental cash flow information:
Interest paid $ 84 $ 93 $ 72
Income tax paid $ 128 $ - $ -
The accompanying notes are an integral part of these
consolidated financial statements.
F-9
STARNET COMMUNICATIONS INTERNATIONAL INC.
Notes to Consolidated Financial Statements
April 30, 2000
NOTE 1 - NATURE OF BUSINESS AND BASIS OF PRESENTATION
Starnet Communications International Inc. (the "Company")
develops, operates and markets proprietary software that is
currently being used for on-line gaming. The Company's revenues
are earned from licensing fees, service fees and royalties from
licensees located outside North America.
The Company also provided software for interactive media but the
division was sold during the year enabling the Company to focus
on on-line gaming. The results from the interactive media
division are classified as discontinued operations (Note 15).
NOTE 2 - ACCOUNTING POLICIES
The consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the
United States of America. A summary of significant accounting
policies is set out below:
a. Basis of Presentation
The consolidated financial statements include the accounts of the
Company and all its wholly-owned subsidiaries. All significant
intercompany balances and transactions have been eliminated.
Unless otherwise stated, all amounts are in thousands of US Dollars.
b. Revenue Recognition
Initial license fees of gaming software are recognized as revenue
upon the completion of the license sale transactions. Before the
revenues are recognized, deposits from licensees are recorded as
deferred revenue.
Gaming and monthly licensing royalty revenues and other fees are
recognized over the period services are provided.
Revenues from the resale of Antigua government issued gaming
licenses are recognized when collection is assured.
Gaming revenues are presented net of customer winnings.
c. Capital Assets
Property and equipment are recorded at cost and are depreciated
or amortized using the straight-line method over the estimated
useful life of the assets at the following rates:
Furniture and fixtures 3 years
Computer hardware and equipment 3 years
Computer software 3 years
Automobiles 4 years
F-10
STARNET COMMUNICATIONS INTERNATIONAL INC.
Notes to Consolidated Financial Statements
April 30, 2000
NOTE 2 - ACCOUNTING POLICIES (Continued)
c. Capital Assets (Continued)
Leasehold improvements are amortized over the term of the related
lease using the straight-line method.
One-half of the normal depreciation rate is applied in the year
of acquisition or capitalization of the capital assets.
d. Deferred Website Costs
Costs which relate to the development of the Company's on-line
interactive sites are capitalized. Deferred website costs are
amortized one half in the year incurred, one third in the
following year, and one sixth in the second following year. The
website costs balance shown in the balance sheet is presented net
of accumulated amortization.
e. Software Development Costs
Software development costs incurred subsequent to establishing
technological feasibility are capitalized. Capitalized costs are
amortized using the straight-line method over three years.
Capitalization ceases and amortization commences on the date that
the software is available for general release. The software
development costs in the balance sheet are reported at the lower
of unamortized cost or net realizable value.
f. Cash and Cash Equivalents
For the purposes of the statement of cash flows, cash and cash
equivalents consist of cash on hand, balances with banks,
available balances with credit card processors and investments in
money market instruments.
g. Foreign Currency Translation
All transactions in currencies other than the United States
dollar during the year are translated at the exchange rates on
the transaction dates. Monetary assets and liabilities
denominated in a foreign currency are translated at the
prevailing year-end rates of exchange. Exchange gains or losses
are included in the consolidated statements of income (loss) and
retained earnings (deficit).
The financial statements of all subsidiaries expressed in
currencies other than the United States dollar are translated.
All assets and liabilities are translated at the exchange rate on
the balance sheet date and all revenues and expenditures are
translated at the average rate for the year. Translation
adjustments are reflected as a separate component of
shareholders' equity.
F-11
STARNET COMMUNICATIONS INTERNATIONAL INC.
Notes to Consolidated Financial Statements
April 30, 2000
NOTE 2 - ACCOUNTING POLICIES (Continued)
h. Leases
Leases which transfer substantially all of the benefits and risks
of ownership are recorded as the acquisition of assets and
incurrence of obligations. Under this method of accounting, both
assets and obligations, including interest thereon, are amortized
over the life of the lease.
i. Advertising
The Company expenses the costs of advertising as incurred.
j. Net Earnings Per Common Share
The Company has adopted Statement of Financial Accounting
Standards No. 128 ("FAS 128") regarding the determination and
disclosure of earnings per share for the purpose of preparing its
financial statements. The calculations of net earnings per
common share are based upon the weighted average number of common
shares of the Company outstanding during each year.
The adoption of FAS 128 has no impact on previously reported
information.
k. Stock Options
The Company has elected to follow Accounting Principles Board
Opinion No. 25 in accounting for stock based awards and
consequently has not recognized compensation expense for these
awards made during the year.
l. Use of Estimates
The preparation of financial statements in conformity with
generally accepted accounting principles requires the Company's
management to make estimates and assumptions that affect the
amounts reported in the consolidated financial statements and
related notes to the consolidated financial statements. Actual
results may differ from those estimates.
NOTE 3 - RESERVES AND DEPOSITS WITH CREDIT CARD PROCESSORS
Reserves and deposits consist of the following:
April 30,
-----------------------------
2000 1999
----------- -----------
Rolling reserve $ 2,909 282
Deposits held by merchant banks 948 1,055
----------- -----------
$ 3,857 $ 1,337
=========== ===========
F-12
STARNET COMMUNICATIONS INTERNATIONAL, INC.
Notes to Consolidated financial Statements
April 30, 2000
NOTE 3 - RESERVES AND DEPOSITS WITH CREDIT CARD PROCESSORS (Continued)
The Company has obtained merchant accounts with several
international banks for credit card processing. Under the
conditions of the merchant agreement, the Company is required to
provide the banks with security deposits. The deposits will be
held until the merchant accounts are canceled and they are non-
interest bearing.
NOTE 4 - ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
April 30,
-----------------------------
2000 1999
----------- -----------
Amounts due from licensees $ 3,174 $ 2,571
Income tax receivable 128 -
Other 427 127
Less: allowance for bad debts (1,707) (27)
----------- -----------
$ 2,022 $ 2,671
=========== ===========
The Company incurred significant credit losses during the year as
a result of the ongoing investigation into the business
operations of the Company by the Canadian authorities. These
amounts have been fully reserved for.
NOTE 5 - OTHER CURRENT ASSETS
Other current assets consist of the following:
April 30,
-----------------------------
2000 1999
----------- -----------
Deferred gaming license costs $ 1,349 $ 1,250
Deferred software customization costs - 174
----------- -----------
$ 1,349 $ 1,424
=========== ===========
Deferred gaming license costs relate to amounts paid to the
Antiguan government for the purchase of casino licenses. These
licenses are held for sale to prospective licensees.
F-13
STARNET COMMUNICATIONS INTERNATIONAL INC.
Notes to Consolidated Financial Statements
April 30, 2000
NOTE 6 - RESTRICTED CASH
April 30,
-----------------------------
2000 1999
----------- -----------
Equipment lease and payroll processing
deposits (Note 12) $ 210 $ 61
Funds restricted by Canadian Authorities (Note 14) 7,024 -
----------- -----------
$ 7,234 $ 61
=========== ===========
NOTE 7 - CAPITAL ASSETS
Capital assets are recorded at cost less accumulated depreciation
and consist of the following:
Accumulated Net Book
Cost Depreciation Value
---------- ------------- ----------
April 30, 2000
--------------
Computer hardware and equipment $ 3,298 $ 1,140 $ 2,158
Computer hardware under capital
leases 1,174 734 440
Automobiles 202 44 158
Leasehold improvements 509 220 289
Furniture and fixtures 203 97 106
Computer software 2,074 393 1,681
Domain name 45 9 36
---------- ---------- ----------
$ 7,505 $ 2,637 $ 4,868
========== ========== ==========
April 30, 1999
--------------
Computer hardware and equipment $ 1,773 $ 799 $ 974
Computer hardware under capital
leases 764 383 381
Automobiles under capital leases 38 14 24
Leasehold improvements 262 142 120
Furniture and fixtures 127 65 62
Computer software 104 37 67
Domain name 45 - 45
---------- ---------- ----------
$ 3,113 $ 1,440 $ 1,673
========== ========== ==========
NOTE 8 - DEFERRED WEBSITE COSTS
Website costs are recorded at cost less accumulated amortization
and consist of the following:
April 30,
-----------------------------
2000 1999
----------- -----------
Net balance, beginning of year $ 285 $ 256
Costs capitalized during the year - 423
Current year amortization (285) (394)
----------- -----------
Net balance, end of year $ - $ 285
=========== ===========
F-14
STARNET COMMUNICATIONS INTERNATIONAL INC.
Notes to Consolidated Financial Statements
April 30, 2000
NOTE 9 - SOFTWARE DEVELOPMENT COSTS
Software development costs are recorded at cost less accumulated
amortization and consist of the following:
April 30,
-----------------------------
2000 1999
----------- -----------
Net balance, beginning of year $ 610 $ 466
Costs capitalized during the year - 333
Current year amortization (610) (189)
----------- -----------
Net balance, end of year $ - $ 610
=========== ===========
NOTE 10 - INCOME TAXES
The Company's operations located in Canada are subject to tax to
the extent that income is generated in the country. In 1999, due
to the profitability of its discontinued operations, the Company
paid Canadian tax. In 2000, the loss related to development
activities allows a recovery of tax previously paid:
For the Years Ended
April 30,
-----------------------------
2000 1999
----------- -----------
TAX PAYABLE - beginning of year $ 268 $ 74
Provision for (recovery of) current income tax (266) 205
Payments of tax (128) -
Difference due to exchange rate (2) (11)
----------- -----------
Tax payable (receivable) - end of year (Note 4) $ (128) $ 268
=========== ===========
DEFERRED TAX (ASSET) - beginning of year $ (146) $ 27
Deferred income tax expense (recovery) 150 (172)
Difference due to exchange rate (4) (1)
----------- -----------
Deferred income tax asset, end of year $ - $ (146)
=========== ===========
F-15
STARNET COMMUNICATIONS INTERNATIONAL INC.
Notes to Consolidated Financial Statements
April 30, 2000
NOTE 11 - FUNDS HELD ON DEPOSITS
As of April 30, 2000, the Company held $2,118 (1999 - $989) in
cash representing funds held on deposit in the form of e-cash
balances. These deposits are non-interest bearing and repayable
on demand.
NOTE 12 - CAPITAL LEASE OBLIGATIONS
At April 30, 2000, the Company had entered into capital leases
for equipment and automobiles. The future payments for the 12
months ended April 30 are:
2001 $ 557
2002 394
2003 105
2004 2
2005 -
----------
Total minimum lease payments 1,058
Less amounts representing interest at
rates varying from 6% to 11% (79)
----------
Present value of minimum lease payments 979
Current portion of capital lease
obligations (476)
----------
$ 503
==========
Three of the equipment leases require the company to pledge term
deposits for $210 (1999 - $61). The term deposits will be
returned upon the expiry of the lease and are non-interest bearing.
NOTE 13 - CAPITAL STOCK
Authorized
----------
100,000,000 Class A voting common shares, par value $0.001
50,000,000 Class B nonvoting common shares, par value $0.001
50,000,000 preferred shares, par value $0.001
F-16
STARNET COMMUNICATIONS INTERNATIONAL INC.
Notes to Consolidated Financial Statements
April 30, 2000
NOTE 13 - CAPITAL STOCK (Continued)
(a) The Company had the following shares and warrants issued and
outstanding:
2000 1999
---------------------- ----------------------
Shares Amount Shares Amount
---------- ---------- ---------- ----------
Outstanding Class A
shares, beginning of
year 26,502,434 $ 8,584 22,450,000 $ 2,421
Shares issued for cash
pursuant to exercise of
options 3,109,692 3,759 1,602,434 1,263
Shares issued for cash
pursuant to exercise of
warrants 2,450,000 9,800 2,450,000 4,900
---------- ---------- ---------- ----------
Outstanding Class A
shares, end of year 32,062,126 $ 22,143 26,502,434 $ 8,584
========== ========== ========== ==========
On December 2, 1997, the Company completed an offering of
2,450,000 units at $1.00 per unit. Each unit consisted of one
Class A voting common share and a single warrant exercisable at
$2.00. Each warrant exercised at $2.00 entitled the purchaser to
one Class A voting common share and a second warrant (the
"Piggyback Warrant"). Each Piggyback Warrant was exercisable,
within one year of the Piggyback Warrant being issued, at $4.00.
The exercising of the Piggyback Warrant entitled the purchaser to
one share of common stock.
During the year ended April 30, 1999, all 2.45 million warrants
at $2.00 had been exercised. During the year ended April 30,
2000, all of the 2.45 million Piggyback Warrants were exercised
at $4.00 for total proceeds of $9.8 million.
(b) Stock Options
On March 12, 1998, the Board of Directors approved a stock option
plan, which authorized the issuance of 3,000,000 options to
employees of the Company and its subsidiaries at an exercise
price of $0.74. The options expire on January 1, 2008. On
December 31, 1998, the Board of Directors authorized the issuance
of up to 4,000,000 additional options at an exercise price to be
determined based on the trading price of the Company's shares on
the grant date. On December 23, 1999, the Board of Directors
authorized the issuance of up to 5,000,000 additional options at
an exercise price to be determined based on the trading price of
the Company's shares on the grant date.
Options issued to employees generally vest straight-line on a
monthly basis over two years while options issued to directors
vest one-half immediately and one-half after one year. Options
expire ten years after the date granted. As at April 30, 2000,
7,287,874 shares were reserved for issuance pursuant to the
exercise of options.
F-17
STARNET COMMUNICATIONS INTERNATIONAL INC.
Notes to Consolidated Financial Statements
April 30, 2000
NOTE 13 - CAPITAL STOCK (Continued)
A summary of the Company's stock option activity and related
information follows:
2000 1999
---------------------- ----------------------
Weighted Weighted
Average Average
Number of Exercise Number of Exercise
Options Price Options Price
---------- ---------- ---------- ----------
Outstanding at May 1 5,136,795 $ 1.45 2,750,834 $ 0.74
Granted 3,719,900 3.67 4,611,750 1.57
Exercised (3,109,692) 1.21 (1,602,706) 0.83
Forfeited (502,279) 3.04 (623,083) 0.84
---------- ---------- ---------- ----------
Outstanding at April 30, 5,244,724 $ 2.99 5,136,795 $ 1.45
========== ========== ========== ==========
At April 30, 2000, options outstanding were as follows:
Options Outstanding Options Exercisable
-------------------------------------- ---------------------------------------
Weighted
Average Weighted Weighted
Range of Number Remaining Average Number Average
Exercise of Contractual Exercise of Exercise
Prices Options Life (Years) Price Options Price
-------------- --------- ------------ ---------- --------- ----------
$0.74 - $1.43 238,050 7.7 $ 0.74 1,693,058 $ 0.77
$1.44 - $2.50 1,313,801 8.7 1.60 913,372 1.60
$2.51 - $5.99 3,473,862 9.6 3.16 935,820 3.36
$6.00 - $11.00 131,143 9.1 8.18 68,929 8.22
$11.01 - $23.06 87,868 9.2 15.50 51,806 15.56
-------------- --------- ------------ ---------- --------- ----------
$0.74 - $23.06 5,244,724 9.2 $ 2.99 3,662,985 $ 1.98
============== ========= ============ ========== ========= ==========
c. Accounting for Stock Based Compensation
The Company has adopted the disclosure-only provisions of FAS
123, Accounting for "Stock-Based Compensation". Accordingly, no
compensation cost has been recognized for the stock option plan.
Had compensation cost for the Company's stock option plan been
determined based on the fair value at the grant date for awards
in 2000 and 1999 consistent with the provisions of SFAS No. 123,
the Company's loss and loss per share would have been increased
to the pro forma amounts indicated below:
F-18
STARNET COMMUNICATIONS INTERNATIONAL INC.
Notes to Consolidated Financial Statements
April 30, 2000
NOTE 13 - CAPITAL STOCK (Continued)
April 30,
-----------------------------
2000 1999
----------- -----------
Net income (loss) as reported $ (3,255) $ 2,042
Pro forma net income (loss) under FAS 123 (3,255) 747
Net income (loss) per share - basic, as reported (0.16) 0.09
Pro forma net income (loss) per share - basic,
under FAS 123 (0.16) 0.03
Net income (loss) per share - diluted, as reported - 0.08
Pro forma net income (loss) per share - diluted,
under FAS 123 - 0.03
For purposes of pro forma disclosures, the estimated fair value
of options granted is amortized to expense over a 2 year period.
The fair value of option grants is estimated on the date of grant
using the Black-Scholes option-pricing model discounted for lack
of liquidity with the following weighted-average assumptions.
April 30,
-----------------------------
2000 1999
----------- -----------
Dividend yield 0% 0%
Expected volatility 219% 125%
Risk-free interest rate 5.08% 4.6%
Expected lives 2 years 2 years
NOTE 14 - COMMITMENTS AND CONTINGENCIES
At April 30, 2000, the Company has entered into commitments for
leases for premises and equipment. The future payments for the
12 months ended April 30 are:
2001 $ 36
2002 384
2003 396
2004 393
2005 389
----------
$ 1,598
==========
F-19
STARNET COMMUNICATIONS INTERNATIONAL INC.
Notes to Consolidated Financial Statements
April 30, 2000
NOTE 14 - COMMITMENTS AND CONTINGENCIES (Continued)
On August 20, 1999, the Royal Canadian Mounted Police (RCMP)
obtained a search warrant and searched the Vancouver, Canada
offices of Starnet Communications Canada, Inc., a subsidiary of
the company. The basis for the search and continuing
investigation ("the Investigation") was the allegation of the
RCMP that the Company and some of its officers, directors and
employees were breaching certain gaming provisions contained in
the Criminal Code of Canada.
On August 25, 1999, the RCMP obtained an ex parte restraint order
pursuant to the provisions of the Criminal Code of Canada. This
order prevents the Company and Starnet Systems International Inc.
from accessing funds located in their Canadian bank accounts.
The amount of money (including interest) in these accounts as at
April 30, 2000 is $7,024. In September 1999, the Company brought
an application to have the restraint order revoked. This
application was unsuccessful. On February 24, 2000, the
restraint order was renewed for a further six months. The RCMP
investigation has not been completed. No charges have been laid.
Between October 15, 1999 and December 9, 1999, ten class action
claims were commenced in the United States against the Company
and some of its directors and officers. These class action
lawsuits allege that material misrepresentations regarding the
nature and inherent risks of the company's business were
knowingly made in filings to the United States Securities and
Exchange Commission, press releases and other public statements.
The amount of the damages claimed is unspecified. These actions
have now been consolidated in a single proceeding.
On September 16, 1999, Las Vegas Casino Inc. ("LVC") commenced an
action against the Company, a number of its subsidiaries and
various employees of the Company and its subsidiaries. LVC
alleges that the Company breached and wrongfully terminated its
license agreement and misappropriated $15 million from LVC, and
that LVC lost gambling revenues in the amount of $1 billion as a
result of the breach and wrongful termination. LVC had
previously entered into a license agreement with Starnet Systems
International Inc. ("Starnet Systems"). Starnet Systems
terminated the license agreement because of LVC's non-payment of
its royalty fees. The company believes that these allegations
are without merit.
In all the above-noted matters, management has been unable to
determine the likely outcomes. Consequently, no provision for
loss has been made in these financial statements in respect to
these matters except for an accrual to cover the estimated legal
costs to defend these lawsuits vigorously:
F-20
STARNET COMMUNICATIONS INTERNATIONAL INC.
Notes to Consolidated Financial Statements
April 30, 2000
NOTE 14 - COMMITMENTS AND CONTINGENCIES (Continued)
The Investigation $ 551
Class Actions 651
Other 80
----------
Total $ 1,282
==========
As these matters are at preliminary stages, any additional
financial impact, if any, cannot be determined at this time.
NOTE 15 - SALE OF BUSINESS SEGMENTS
a. Marketing Department
On February 18, 2000, the Company sold certain assets to a group
of former employees who were previously employed in the marketing
department. The Company also entered into an agreement whereby
the new company would employ a number of employees comprising the
marketing department of the Company and provide marketing
services to the Company for a period of three years.
The assets with a net book value of $109 were sold for total
consideration of $109 consisting of a promissory note. The
amount is subject to interest at a rate of 5% per annum and is
repayable in 36 installments of $3 per month, ending February
2003. there was no gain or loss recorded on the transaction.
Total consideration $ 109
Net book value of assets sold $ 109
Net gain or loss $ -
b. On-line Entertainment Division
On March 31, 2000, the Company sold certain assets, consisting
primarily of computer equipment, furniture, and website URL
domain names, for total consideration of $2,300. The amount is
payable over a three year period, including a down payment upon
closing of $460, and is non-interest bearing. The Company has
recorded an 8% discount on the total amount receivable amounting
to $356. The minimum monthly payment is $10 but at such time
that the cumulative net profit of the business, before tax,
amounts to $460, the remaining amount, less a $700 final payment
due on July 1, 2003, will be paid in equal monthly installments
from that date until July 1, 2003 at which time any remaining
amount will be due. The parties have also entered into an escrow
agreement whereby the URL domains will be used as security until
the purchase price is paid in full.
F-21
STARNET COMMUNICATIONS INTERNATIONAL INC.
Notes to Consolidated Financial Statements
April 30, 2000
NOTE 15 - SALE OF BUSINESS SEGMENTS (Continued)
The gain of $1,562 recorded is calculated as follows:
Total sale price $ 2,300
Discount at 8% (356)
----------
1,944
Exchange rate difference 16
Net book value of assets sold (398)
----------
Net gain on sale $ 1,562
==========
The following is a summary of the discontinued operations for the
years ended April 30.
2000 1999 1998
---------- ---------- ----------
Sales $ 2,705 $ 3,518 $ 3,113
Cost of sales 1,586 1,321 928
General and administrative 1,175 860 2,093
Depreciation and amortization 299 224 238
Interest and bank charges - 69 74
Income tax - 33 -
---------- ---------- ----------
Income (loss) from discontinued
operations $ (355) $ 1,011 $ (220)
========== ========== =========
No income tax expense or benefit has been attributed to the
discontinued operations.
NOTE 16 - LONG-TERM RECEIVABLES
Payments due to the Company under the long-term receivables for
the twelve months ended April 30 are:
2000
----------
2001 $ 601
2002 162
2003 162
2004 1,500
----------
Total minimum payments 2,425
Less: interest portion (372)
----------
Present value of minimum payments 2,053
Current portion of long-term
receivable 514
----------
Total $ 1,539
==========
The long-term receivables related to the sale of business
segments (Note 15).
F-22
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 Communications International Inc.
(Registrant)
Date: July 28, 2000 By: /s/ Meldon Ellis
-----------------------------------
President, Chief Executive Officer and
Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Date: July 28, 2000 By: /s/ Meldon Ellis
---------------------------------
President, Chief Executive Officer
and Director
Date: July 28, 2000 By: /s/ Chris Thompson
---------------------------------
Vice-President, Finance
Date: July 28, 2000 By: /s/ Fred Hazell
---------------------------------
Chair of the Board
Date: July 28, 2000 By: /s/ Wolf Bergelt
---------------------------------
Director
Date: July 28, 2000 By: /s/ Brownell Combs II
---------------------------------
Director
Date: July 28, 2000 By: /s/ Nicholas Jackson
---------------------------------
Director