SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended January 31, 2001 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)
The CIBC Banking Centre
Old Parham Road
P.O. Box 3265
St. John's, Antigua, West Indies
(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: (268) 480-1650
Former address, if changed since last report: n/a
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
--- ---
As of March 13, 2001, there were 32,193,181 shares of the registrant's
Class A Voting Common Stock outstanding.
Some of the information in this report contains forward-looking statements
that involve substantial risks and uncertainties. Any statement in this
report and in the documents incorporated by reference into this 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. You should be
aware that the occurrence or non-occurrence of any of the events described
in this report could have a material adverse effect on our business,
financial condition and results of operation.
PART I - FINANCIAL INFORMATION
- ------------------------------
ITEM 1. FINANCIAL STATEMENTS
Starnet Communications International Inc.
Consolidated Balance Sheets
As at January 31, 2001 and April 30, 2000
(in thousands of US dollars)
(Unaudited)
January 31 April 30
2001 2000
- ------------------------------------------------------------------------------------------
ASSETS
CURRENT
Cash and cash equivalents 2,829 5,984
Reserves and deposits with credit card processors 3,487 3,857
Accounts receivable 2,779 2,022
Prepaid expenses and deposits 732 616
Current portion of long-term receivable 37 514
Other current assets 520 1,349
- ------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 10,384 14,342
- ------------------------------------------------------------------------------------------
Restricted cash 7,666 7,234
Capital assets (net) 5,877 4,868
Long-term receivable 1,552 1,539
- ------------------------------------------------------------------------------------------
TOTAL ASSETS 25,479 27,983
- ------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued liabilities 3,267 5,223
Funds held on deposit 3,062 2,118
Deferred revenue 187 287
Current portion of capital lease obligations 708 476
- ------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 7,224 8,104
- ------------------------------------------------------------------------------------------
Non-current portion of capital lease obligations 788 503
Long-term note payable 1,500 0
- ------------------------------------------------------------------------------------------
TOTAL LIABILITIES 9,512 8,607
- ------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Capital stock 22,335 22,143
Subscription receivable (366) (381)
Accumulated deficit (5,655) (2,371)
Accumulated other comprehensive loss (347) (15)
- ------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 15,967 19,376
- ------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY 25,479 27,983
- ------------------------------------------------------------------------------------------
2
Starnet Communications International Inc.
Consolidated Statements of Operations
For the Periods Ending January 31
(in thousands of US dollars except per share information)
(Unaudited) (Unaudited)
Three Months Ended Nine Months Ended
January 31 January 31
2001 2000 2001 2000
- ----------------------------------------------------------------------------------------
REVENUE
Sales
Royalties and fees 5,891 3,646 14,245 9,415
Licensing 480 770 1,632 2,958
- ----------------------------------------------------------------------------------------
Total sales 6,371 4,416 15,877 12,373
Cost of sales 1,392 1,751 4,292 3,548
- ----------------------------------------------------------------------------------------
GROSS PROFIT 4,979 2,665 11,585 8,825
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EXPENSES
Sales 155 249 452 544
Marketing 581 520 2,079 1,373
Development 873 584 2,582 1,407
Operations 1,257 458 3,424 750
General and administrative 1,424 1,902 4,049 3,893
Provision for bad debts 140 1,443 140 1,693
Legal 130 1,723 420 1,912
Depreciation and amortization 639 514 1,954 1,160
- ----------------------------------------------------------------------------------------
TOTAL OPERATING EXPENSES 5,199 7,393 15,100 12,732
- ----------------------------------------------------------------------------------------
Loss from operations (220) (4,728) (3,515) (3,907)
- ----------------------------------------------------------------------------------------
Other income 49 105 231 186
- ----------------------------------------------------------------------------------------
LOSS FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES (171) (4,623) (3,284) (3,721)
- ----------------------------------------------------------------------------------------
Income tax expense
current 0 0 0 53
deferred 0 0 0 0
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INCOME TAXES 0 0 0 53
- ----------------------------------------------------------------------------------------
Loss from continuing operations (171) (4,623) (3,284) (3,774)
Loss from discontinued operations of
the on-line interactive media
division (less applicable
income taxes) 0 (307) 0 (202)
- ----------------------------------------------------------------------------------------
NET LOSS FOR THE PERIOD (171) (4,930) (3,284) (3,976)
Retained earnings (deficit),
beginning of period (5,484) 1,838 (2,371) 884
- ----------------------------------------------------------------------------------------
DEFICIT, END OF PERIOD (5,655) (3,092) (5,655) (3,092)
- ----------------------------------------------------------------------------------------
Basic loss per share from
continuing operations $ (0.01) $ (0.15) $ (0.10) $ (0.13)
Basic loss per share $ (0.01) $ (0.16) $ (0.10) $ (0.13)
Weighted average number of common
shares outstanding 32,201,181 30,967,287 32,161,486 29,690,911
Diluted earnings per share from
continuing operations n/a n/a n/a n/a
Diluted earnings per share n/a n/a n/a n/a
Weighted average number of common
shares outstanding for diluted
earnings per share n/a n/a n/a n/a
3
Starnet Communications International Inc.
Consolidated Statements of Cash Flows
For the Periods Ending January 31
(in thousands of US dollars)
(Unaudited) (Unaudited)
Three Months Ended Nine Months Ended
January 31 January 31
2001 2000 2001 2000
- ----------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss (171) (4,930) (3,284) (3,976)
Adjustments to reconcile net income to
net cash provided by operating
activities:
Depreciation 639 511 1,954 1,157
Amortization of deferred website costs 0 53 0 159
Amortization of software development
costs 0 473 0 611
Changes in current assets and liabilities:
Decrease (increase) in reserves and
deposits with credit card processors 152 (3,726) 370 (4,221)
Decrease (increase) in accounts
receivable 110 3,634 (742) (334)
Decrease (increase) in prepaid
expenses and deposits (91) 121 (116) (217)
Decrease (increase) in other assets 241 596 829 (131)
Increase (decrease) in accounts
payable and accrued liabilities (324) 308 (1,953) 3,194
Increase in income taxes payable 0 (88) 0 (30)
Increase (decrease) in funds held
on deposit (1,098) 266 944 2,402
Increase (decrease) in deferred
revenue 54 (34) (100) (168)
- ----------------------------------------------------------------------------------------
NET CASH USED IN OPERATING ACTIVITIES (488) (2,816) (2,098) (1,554)
- ----------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of capital assets (285) (1,671) (2,056) (3,610)
Transfer to restricted cash (114) (82) (435) (6,937)
- ----------------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (399) (1,753) (2,491) (10,547)
- ----------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Payments received on long-term
receivable 7 0 491 0
Proceeds from loan 0 0 1,500 0
Proceeds from issuance of shares 0 302 192 12,329
Principal repayments under capital
lease obligations (149) (183) (449) (372)
- ----------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES (142) 119 1,734 11,957
- ----------------------------------------------------------------------------------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (79) 284 (300) 205
- ----------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH DURING
THE PERIOD (1,108) (4,166) (3,155) 61
Cash, beginning of period 3,937 10,093 5,984 5,866
- ----------------------------------------------------------------------------------------
CASH, END OF PERIOD 2,829 5,927 2,829 5,927
- ----------------------------------------------------------------------------------------
OTHER NON-CASH TRANSACTIONS
Leased assets acquired 42 340 1,001 622
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid 59 68 89 97
Income tax paid 0 0 0 0
4
STARNET COMMUNICATIONS INTERNATIONAL INC.
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
AS AT JANUARY 31, 2001
(UNAUDITED)
1. Condensed Consolidated Financial Statements
The accompanying consolidated financial statements have been prepared
by the Company without audit. In the opinion of management, all
adjustments (which include only normal recurring adjustments)
necessary to present fairly the financial position at January 31, 2001,
and results of operations and cash flows for the periods ended
January 31, 2001 and 2000, have been made.
Certain information and footnote disclosures normally included in
consolidated financial statements prepared in accordance with
generally accepted accounting principles have been condensed or
omitted. It is suggested that these condensed consolidated financial
statements be read in conjunction with the financial statements and
notes thereto included in the Company's April 30, 2000 audited
consolidated financial statements. The results for operations for
periods ended January 31, 2001 and 2000 are not necessarily indicative
of the operating results for the full years.
2. Unaudited Financial Statements
The accompanying unaudited financial statements include all of the
adjustments which, in the opinion of management, are necessary for a
fair presentation. Such adjustments are of a normal recurring nature.
3. General
Restricted Cash refers to funds in the Company's bank accounts frozen
pursuant to a Restraint Order in Canada, and collateral for leases and
letters of credit.
Other Current Assets consist primarily of gaming licenses from the
government of Antigua held for resale to licensees.
4. Loan Payable
The Company's subsidiary, Starnet Systems International, Inc., entered
into an agreement to borrow up to $1.5 million from Simpson Bay Limited
(the "Lender"), all of which it had received at January 31, 2001.
Interest is payable monthly at a rate of 8% per annum. Under the
agreement, Starnet Systems was required to use commercially reasonable
efforts to provide to Lender the opportunity for Lender, in its sole
discretion, to have the Loan satisfied by the issuance of common stock
in the Company.
5
As at January 31, 2001, since Starnet Systems had not made available to
the Lender an opportunity to convert the loan to common stock in the
Company, the Lender currently has the right to demand payment on the
loan, which if demanded would be immediately due and payable by Starnet
Systems. The Company anticipates that completion of the Plan of
Reorganization (note 7) will require the Company, in accordance with the
loan agreement with the Lender, to offer stock in the Company in
satisfaction of the loan. The Company is working on making such an offer
available to the Lender in connection with the reorganization and the
Company has been advised by the Lender that, while non-binding, it is the
intention of the Lender to elect to convert the loan to common stock in
response to such offer. Therefore the Company has continued to classify
the loan as long term.
5. Discontinued Operations
Income (loss) from discontinued operations refers to the on-line
interactive media division that was disposed of in April 2000. The
receivable related to the proceeds of sale is included in long-term
receivable.
6. Contingencies and Commitments
In connection with the continuing investigation of the Company by the
Royal Canadian Mounted Police ("RCMP") in Vancouver, Canada, an
application with respect to the continued detention of the items
previously seized pursuant to the search warrants and the extension of
the restraint orders against the funds being held, resulted in an Order
issued by the Supreme Court of British Columbia on February 15, 2001
extending all such orders that, among other things, prevents the
Company and Starnet Systems International, Inc. from accessing
approximately $7.3 million. The Order extended the detention and
restraint until June 17, 2001. Prior to the Order being issued, the
Company was advised that the police overseeing the investigation had
delivered to the Crown their report with the results of their
investigation, which the Company understands recommended that charges be
laid against the Company. The Crown had indicated that they were
considering the laying of various charges but, with the understanding that
the Company would not object, agreed to seek the extension described
above. The Company expects this additional time will allow the Crown
to complete its review of the RCMP report concerning allegations that the
Company and some of its officers, directors and employees were breaching
certain provisions of the Criminal Code of Canada.
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. On March 7, 2000, the United States
District Court for the District of Delaware ordered that these ten
actions be consolidated in a single proceeding. An amended
Consolidated Class Action Complaint was filed on June 7, 2000. The
6
Plaintiff class alleges generally that material misrepresentations
regarding the nature and inherent risks of the Company's business were
knowingly made to its investors (including the Plaintiff class). The
relief sought includes damages and costs for the Plaintiff class. The
amount of the damages claimed is unspecified. 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. The Company filed a motion to dismiss on September 14,
2000, which as of the date of this report has not been responded to by
the Plaintiff nor ruled upon by the District Court. Settlement
discussions are continuing with counsel to the Plantiffs, although, at
this time, management is unable to determine the likely outcome of such
discussions.
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 the Company's subsidiary, 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, the
Supreme Court of British Columbia granted a stay of the lawsuit as
against Starnet Systems only. Should LVC wish to proceed with its
claim against Starnet Systems, it must do so through the arbitration
process provided for in the software license agreement. LVC has not
yet taken any steps to do so. The Company filed a motion with the
Supreme Court of British Columbia to require LVC to post security for
costs as a condition for prosecuting its claim against the Company.
The court denied the Company's motion on February 22, 2001, while
allowing the Company to reapply as it may wish. The Company intends to
submit a futher application and is in the process of doing so. 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.
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.
7. Plan of Reorganization
On January 19, 2001, pursuant to an Agreement and Plan of
Reorganization dated November 8, 2000, shareholders approved a
reorganization in which the Company will become an indirect wholly
owned subsidiary of World Gaming Plc, a new holding company
incorporated in England and Wales. The Company will not complete the
reorganization until the ordinary shares of World Gaming Plc are
admitted or authorized to trade on a stock exchange or trading
facility. Under the reorganization, common shares of the Company will
be exchanged for shares in World Gaming Plc at the time of completion
of the reorganization. The Company expects that the reorganization
will be completed on or before April 15, 2001.
8. Diluted Earnings Per Share
Diluted earnings per share for the nine and three month periods ended
January 31, 2001 are not disclosed as the amounts would be anti-dilutive.
7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION (All figures in thousands of US dollars)
Results Of Operations
- ---------------------
Starnet Systems International Inc., a subsidiary of the Company incorporated
and operating out of Antigua, licenses its gaming software to third parties
for a set up fee and monthly royalties. Inphinity Interactive Inc., a
wholly owned subsidiary was incorporated in 1999 to develop gaming software
and web pages. The Company's Internet casino, which targets only customers
outside North America, is operated by its subsidiary, World Gaming Services,
Inc., also incorporated and operating out of Antigua. 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. For the three months ended
January 31, 2001, revenues from all components of the gaming business,
which include licensing, casino operations and financial transaction
processing generated revenues of $6,371, up 44% from the gaming revenues of
$4,416 for the quarter ended January 31, 2000 and up 16% from Q2. Revenue
for the nine months ended January 31, 2001 increased 28% to $15,877. The
underlying business also showed healthy growth as system wide deposits and
revenues were up 41% and 60%, respectively. Third quarter gross profit
increased 87% to $4,979 compared to the same period last year.
Total operating costs dropped to $5,199 in Q3 compared to $5,259 in Q2, and
included severance costs of $260 relating to the January staff reduction in
the Company's Inphinity Interactive subsidiary and a $140 bad debt
provision against additional licensee fee receivables related to the prior
year. The loss from continuing operations was $171 compared to a loss of
$4,623 for the same period last year and a loss of $1,291 in Q2. Excluding
severance, bad debts and the UK reorganization costs, the core business
generated a profit of $359 for the quarter as follows:
Reported loss -171
Severance costs +260
Bad debts +140
UK reorganization costs +130
----
Income from regular operations +359
====
The following tables set out selected information from the statements of
operations for the quarters ended January 31, 2001 and 2000 and the balance
sheets as at January 31, 2001 and April 30, 2000:
SELECTED STATEMENT OF OPERATIONS INFORMATION (IN THOUSANDS OF US DOLLARS)
FOR THE THREE MONTHS ENDED
January 31, 2001 January 31, 2000
---------------- ----------------
Net Sales 6,371 4,416
Gross Profit 4,979 2,665
Operating Expenses 5,199 7,393
Net Loss (171) (4,930)
8
SELECTED BALANCE SHEET INFORMATION (IN THOUSANDS OF US DOLLARS)
At January 31, 2001 At April 30, 2000
------------------- -----------------
Working Capital 3,160 6,238
Total Assets 25,479 27,983
Long Term Debt 2,288 503
Accumulated Deficit (5,655) (2,371)
Total Shareholders' Equity 15,967 19,376
The revenue of $6,371 for the quarter reached a new record for the Company
and represents a 16% increase on the Q2 revenues and a 44% increase from
the reported revenues for the same quarter last year. The reported revenues
for Q3 of last year were net of a one-time downward adjustment of $806 to
the royalty revenues due to an overestimate of royalty revenue from a major
licensee. Prior to the adjustment, the Q3 revenues last year were $5,222
which means the real year on year revenue increase for the quarter was 22%.
This rate of growth corresponds to the year to date growth rate that led to
a revenue increase of 28% to $15,877 which includes a 51% increase in
royalty and fee revenues. As described in previous quarters, licensing
revenues dropped 45% as the Company increased its qualification
requirements for new licensees.
The business of our licensees, which affects our results of operations,
also showed mixed signs of strong growth. Revenues of our licensees (or
system-wide revenues) for the three months ended January 31, 2001 increased
92% to $31,124 compared to the same period last year and jumped 60% from
Q2. Deposits made to our licensees by their customers (or system-wide
deposits) increased to $57,610 for Q3, up 41% from $40,753 for the same
period last year. However the quarter on quarter growth was only 3%
compared to a 51% increase from Q2 to Q3 last year. The decrease in the
growth rate is attributable to the much higher base this year compared to
last year but also some US banks began declining I-gaming credit card
deposits during the quarter. To minimize the impact of these credit card
limitations, the Company expanded the number of processors used and added
additional payment methods. The quarter on quarter growth for system wide
revenue was higher than the growth in deposits, due to strong sports
betting profits during the quarter compared to last quarter and Q3 of last year.
Gross profit increased 87% to $4,979 for the quarter ended January 31, 2001
from $2,665 for the prior year. The gross margin increased as expected to
78% for the quarter compared to 71% in Q2 and 60% for the same period last
year. The higher margins were due to a greater portion of the revenue
coming from high margin royalties and fees.
9
Sales, marketing, development and operations costs for Q3 were level with
Q2 despite a 16% rise in revenue over the same period as follows:
Q3 Q2 Variance
Sales 155 177 -12%
Marketing 581 743 -22%
Development 873 863 1%
Operations 1,257 1,087 16%
--------------------------
Total 2,866 2,870 0%
==========================
An increase in the operations expenses is partially attributable to the 25%
increase in royalty and fee revenues. This increase was offset by decreases
in sales and marketing as the Company has continued to trim expenses. In
total these expenses were relatively flat for the third quarter in a row
and in line with expectations. However the General and Administration and
non-operating Legal costs continued to be impacted by one-time adjustments.
The General and Administration for Q3 of $1,424 includes $260 in severance
pay relating to the staff reduction in the Company's Inphinity Interactive
subsidiary. The reduction is expected to lead to annualized cost savings of
over $1 million. The legal costs of $130 in Q3 was attributable to the
costs associated with the Company's efforts to reorganize into a new
holding company incorporated in England and Wales. The reorganization
plans were approved by the shareholders in January 2001 and the total
expense to date is $347. Prior year legal costs included a $1,500 charge
against costs associated with several issues including the RCMP
investigation and the class action suits. Of this amount, $710 was incurred
to January 31, 2001 leaving $790 in the Accounts payable and accruals.
Provision for bad debts for the quarter was $140 compared to $1,443 for the
same quarter last year. The current year Q3 provision relates to certain
software licenses booked after Q3 last year but before the new
qualification criteria was implemented. The total operating expenses were
$5,199, down 30% from $7,393 in the same period last year and down slightly
from Q2. For the nine months ended January 31, 2001, operating expenses
were $15,100, up 19% from $12,732 in the same period last year.
The loss from continuing operations of $171 was down considerably from the
same quarter last year and Q2. After backing out the reorganization legal
costs of $130, the bad debt provision of $140 and the severance charge of
$260, the income from regular operations was $359. EBITDA of $419 was also
positive for the first time since the quarter ended October 31, 1999.
Despite these positive indications, the Q4 results could be negatively
affected by settlements in the class action and/or RCMP issues. Such
settlements, however, would greatly help the Company by reducing the
current level of uncertainty that concerns all shareholders. The year to
date loss from continuing operations was $3,284 compared to loss of $3,721
for the prior year.
On April 1, 2000, the Company sold the business and all of the assets of
its interactive media division therefore there was no income from this
discontinued division during the quarter compared to a loss of $307 for the
same period last year. This interactive media division had incurred a loss
of $202 for the nine months ended January 31, 2000.
10
There is no tax provision for the quarter or the year to date as the
majority of the Company's income is generated from Starnet Systems in
Antigua, which is not subject to income tax.
Liquidity and Capital Resources
- -------------------------------
At January 31, 2001, the Company had $2,829 in cash and cash equivalents
down from $5,984 at April 30, 2000 and down from $3,937 at October 31,
2000. The decrease in the quarter was caused by $488 used in operations,
as a decrease of $1,098 in the funds held on deposit more than offset the
EBITDA for the quarter. A substantial portion of the reduction in funds
held on deposit was due to a licensee obtaining its own merchant account.
Cash was also used to purchase new capital expenditures of $285 and repay
capital leases of $149. Due to the Investigation by Canadian authorities
of the business operations of the Company prior to August 1999, the freeze
on two of the Company's bank accounts with a Canadian bank was extended
another four months to June 2001. The amount affected totaled approximately
$7,400 including interest. The Company also has reserves and deposits held
by credit card processors totaling $3,487 which includes $330 relating to
a discontinued business. A majority of the funds are held as a rolling
reserve, which is released to the Company after six months.
Working capital at January 31, 2001 decreased to $3,160 from $6,238 at
April 30, 2000 and from $3,331 at October 31, 2000. Accounts receivable
increased from $2,022 at April 30, 2000 to $2,779 at January 31, 2001. 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. Other current assets at
January 31, 2001 dropped to $520 from $1,349 at April 30, 2000. 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 period. The casino licenses are held for sale
to prospective licensees.
Net cash used by operations for the quarter ended January 31, 2001 of $488
was down from $2,816 for the same period last year. For the quarter the
positive EBITDA was offset by a decrease in the funds held on deposit as
described above. For the year to date, cash used from operations was
$2,098, up from $1,554 for the same period last year.
Net cash used for investing activities for the quarter ended January 31,
2001 was $399 compared to $1,753 for the same period last year. For the
year to date, the amount was $2,491 compared to $10,547 for the same period
last year. Last year's figure included $6,937 of restricted cash as
explained above.
Net cash used for financing activities for the three months ended January 31,
2001 was $142 compared to $119 cash provided in Q3 last year. Cash
provided year to date was $1,734, down considerably from the same period
last year as the lower stock price reduced the number of options and
warrants exercised.
11
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
PART II - OTHER INFORMATION
- ---------------------------
ITEM 1. LEGAL PROCEEDINGS
The following are material existing and pending legal claims against the
Company:
Her Majesty the Queen in Right of Canada (the "Crown")
- ------------------------------------------------------
On August 25, 1999, the Royal Canadian Mounted Police ("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
$7,188,000. 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 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.
An application filed by the RCMP on August 14, 2000 resulted in the Supreme
Court of British Columbia extending an ex parte restraint order that
prevents the Company and Starnet Systems International Inc. from accessing
approximately $7.3 million for an additional six months. The Company has
appealed the restraining order extension to the British Columbia Court of
Appeal.
A further application with respect to the continued detention of the items
previously seized pursuant to the search warrants and the extension of the
restraint orders against the funds being held resulted in an Order issued by
the Supreme Court of British Columbia on February 15, 2001 extending all such
orders that, among other things, prevents the Company and Starnet Systems
International Inc. from accessing approximately $7.3 million. The Order
extended the detention and restraint until June 17, 2001. Prior to the
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Order being issued, the Company was advised that the police overseeing the
investigation had delivered to the Crown their report with the results of
their investigation, which the Company understands recommended that charges be
laid against the Company. The Crown had indicated that they were considering
the laying of various charges but, with the understanding that the Company
would not object, agreed to seek the extension described above. The
Company expects this additional time will allow the Crown to complete its
review of the RCMP report concerning allegations that the Company and some of
its officers, directors and employees were breaching certain provisions of
the Criminal Code of Canada.
U.S. Class Action Claims
- ------------------------
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. 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).
An amended Consolidated Class Action Complaint was filed in the United
States District Court for the District of Delaware on June 7, 2000. The
Plaintiff class consists potentially of all persons who purchased the
Company's Class A Voting Common Stock from March 11, 1999 to August 20,
1999 inclusive, excluding the Defendants. The Plaintiffs allege generally
as follows:
(a) The Company became involved in internet gaming;
(b) The Company represented to its investors (including the
Plaintiff class) that the legality of internet gaming was
uncertain;
(c) The Company represented to its investors (including the
Plaintiff class) that it had taken steps to minimize the
risk of exposure to a criminal or quasi criminal prosecution
for being involved in internet gaming;
(d) The representations made by the Company were false or incomplete;
(e) The false or misleading representations of the Company
caused its share price to rise;
(f) The members of the Plaintiff class purchased the Company's
shares;
(g) In August of 1999, the RCMP searched the Company's
Vancouver, British Columbia offices;
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(h) The share price of the Company dropped dramatically;
(i) The members of the Plaintiff class lost money as a result of
the drop in the share price;
(j) Certain former officers of the Company (John Carley, Chris
Zacharias and Mark Dohlen - the "Individual Defendants")
were involved in or aware of the false or misleading
representations; and
(k) The Individual Defendants were involved with the preparation
of or approved of the false or misleading representations of
the Company for the purpose of inflating the price of the
Company's stock, thereby allowing the Individual Defendants
to reap millions of dollars in profits from the sale of the
Company's shares at inflated prices.
The Company filed a Motion to Dismiss on September 14, 2000, which as of
the date of this report has not yet been responded to by the Plaintiff nor
ruled upon by the District Court.
The relief sought includes damages and costs for the Plaintiff class. The
amount of the damages claimed is unspecified. 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.
Settlement discussions are continuing with counsel for the Plaintiffs,
although, at this time, management is unable to determine the likely outcome
of such discusssions.
Las Vegas Casino Inc.
- ---------------------
Las Vegas Casino Inc. ("LVC") alleges in a suit filed on September 16, 1999
in the Supreme Court of British Columbia, Action No. C994793, Vancouver
Registry, 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, the Supreme Court of British Columbia granted a stay of
the lawsuit as against Starnet Systems only. Should LVC wish to proceed
with its claim against Starnet Systems, it must do so through the
arbitration process provided for in the software license agreement. LVC
has not yet taken any steps to do so.
The Company filed a motion with the Supreme Court of British Columbia to
require LVC to post security for costs as a condition for prosecuting its
claim against the Company. The court denied the Company's motion on
February 22, 2001, while allowing
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the Company the opportunity to reapply as it may wish. The Company does
intend to submit a further application and is in the process of doing so.
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.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On January 19, 2001, at a Special Meeting of Shareholders, a majority of
the Company's shareholders voted in favor of the Company's plan to
reorganize into a new holding company incorporated in England and Wales.
Of the 17,129,518 shares voting on the plan of reorganization, the
reorganization proposal received 16,651,734 votes in favor, 448,678 votes
against, and 29,106 abstaining.
ITEM 5. OTHER INFORMATION
Managing Director of Licensee Services
- --------------------------------------
The Company has hired Liam Gillen as its Managing Director of Licensee
Services, pursuant to a two-year executive employment agreement dated
November 27, 2000. Mr. Gillen is responsible for relations with all current
and prospective licensees of the Company who utilize all of the services
offered by the Company to its customers. In addition, he oversees various
operations in Antigua, including Customer Service and Licensee Relations.
Under the executive employment agreement, Mr. Gillen will be paid a monthly
salary of $8,000 and will receive options to purchase shares of the Company's
common stock pursuant to the terms and conditions thereunder. The agreement
also contains provisions relating to non-solicitation, non-competition,
confidentiality and assignment of intellectual property. Mr. Gillen's
executive employment agreement is attached hereto as Exhibit 10.14.
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Chief Executive Officer
- -----------------------
As previously announced in a press release dated March 2, 2001, the Company
executed an agreement with an individual for the position of President and
Chief Executive Officer. The Agreement was subject to various conditions and
required further negotiations. The Company has since concluded not to
further pursue negotiations with such individual. The agreement has been
terminated by the Company in accordance with its terms, and the Company
believes it has no liability under the agreement.
The Company is continuing its search for a President and Chief Executive
Officer and expects to name a successor in the near future.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits required by Item 601 of Regulation S-K:
------------------------------------------------
Exhibit 10.14 Executive Employment Agreement, dated November 27,
2000, between the Company and Liam Gillen
(b) Reports on Form 8-K:
--------------------
The Company filed a Form 8-K dated January 5, 2001 to report a
workforce reduction at one of its subsidiaries under Item 5. The text
of a press release relating to the workforce reduction was filed under
Item 7.
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SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
STARNET COMMUNICATIONS INTERNATIONAL INC.
Date: March 19, 2001 By: /s/ Fred Hazell
----------------------------
Fred Hazell
Chairman, President and Chief Executive Officer
Date: March 19, 2001 By: /s/ Chris Thompson
----------------------------
Chris Thompson
Vice-President, Finance
17