SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-K
(X) Annual Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the Fiscal Year Ended June 30, 1999 Commission File No. 0-26884
NETTER DIGITAL ENTERTAINMENT, INC.
(Exact name of Small Business Issuer in its Charter)
Delaware 95-3392054
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation)
5125 Lankershim Boulevard
North Hollywood, California 91601
(Address of principal executive office) (Zip Code)
818-753-1990
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Exchange Act:
Title of Each Class Name of Each Exchange
Which Registered
------------------- ----------------
Common Stock, $.01 Par Value NASDAQ
Common Stock Purchase Warrants NASDAQ
Securities registered pursuant to Section 12(g) of the Exchange Act:
None
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 ____
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (229.405 of this chapter) 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 amendment to this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of the
Company, based upon the closing price of the Common Stock on the NASDAQ
Automated Quotation System on September 23, 1999 was $1,590,000. Shares of
Common Stock held by each officer and director and by each person who
owns 5% or more of the outstanding Common Stock have been excluded in that
such persons may be deemed affiliates.
As of September 23, 1999, there were 3,334,405 shares of common stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Pursuant to General Instruction G(3) to this form, the information required by
Items 10, 11, 12 and 13 of Part III hereof is incorporated by reference from the
registrant's definitive Proxy Statement for its Annual Meeting of Stockholders
scheduled to be held on November 19, 1999.
PART I.
ITEM 1. BUSINESS
Introduction
Netter Digital Entertainment, Inc. (the "Company") is engaged in entertainment
production, which includes two primary business activities:
- -Production. The Company is engaged in the acquisition, development and
production of television series, made-for-television movies, documentaries,
theatrical motion pictures, and multimedia products (collectively and
individually referred to as the "Productions" or "Projects"). The Company
specializes in producing both live-action Projects ("live-action") which
incorporate traditional sets and human actors in conjunction with computer
generated images ("CGI") as well as 100% CGI animated Projects ("computer
animated"). On the live-action side, the Company has produced the award
winning series "Babylon 5," the follow-on series entitled "Crusade," and
associated television movies. As for computer animated shows, the Company has
recently completed the first season of the children's series, "Voltron: The
Third Dimension" ("Voltron"), putting it at the forefront of the fully animated
or animation intensive production market for television. The Company also
recently entered into contracts for production of two all new computer animated
television series, including a contract providing for approximately $8.0 million
in revenues to the Company in fiscal 2000 to produce 26 one-half hour episodes
of an animated television series based on one of England's most popular comic
books. The Company may undertake a Production which is sold or licensed under a
production contract with a major entertainment studio or distributor, or it may
be contracted by an outside entity to fully produce a project on the entity's
behalf. Under both scenarios, the costs of the Production are borne by the
buyer, licensor or contracting party, often severely limiting the possibility of
additional revenues above the contracted amount. The Company is now seeking to
expand on this model by undertaking projects which it can retain greater equity
ownership in, allowing it to share in all revenue streams in perpetuity. Since
its November 1995 initial public offering, the Company has increased the number
of Projects it has in development. With its unique, vertically integrated
digital production processes which closely link live-action, computer graphics
and effects, and digital post-production work, the Company is well suited to
attract state-of-the-art creative projects that can be produced efficiently
while being digitally pre-purposed for various content outlets.
- -Production Services. In support of its own Productions, for which it is
responsible for the complete production or a significant portion of a
production, as with "Babylon 5," "Crusade," and "Voltron," the Company has
developed significant expertise in computer graphics production, digital post-
production and various other digital imaging techniques. The quality and
popularity of these Productions in conjunction with the cutting edge techniques
employed in their creation has created industry-wide recognition of the
Company's creative and technical skills. To more fully exploit these skills,
the Company formed the Production Services division to support the active market
that exists for projects requiring creative, high-quality, and cost-effective
digital graphics and effects. This division provides CGI services consisting of
computer animation and visual effects to outside clients with such needs. In
the fourth quarter of fiscal 1999, this division began work under its biggest
contract to date, the creation of all of the visual effects for a major motion
picture.
1
Discontinued Operations
Effective the quarter ended December 31, 1998, the Board of Directors voted to
classify and operate the Company's Videssence subsidiary, which was acquired in
January 1997, as a discontinued operation. The Company's Board of Directors and
financial advisors determined that the Company's best strategy for growth is to
focus directly on its core entertainment business and to divest its
non-entertainment business activities. Accordingly, the Board has instructed
management to divest the Videssence subsidiary, which manufactures and
distributes media lighting products, by the end of calendar 1999. The Company
is reviewing how to best capitalize on its recent investment in Videssence and
currently is in final negotiations with a potential buyer for the Videssence
operation. Of course, there can be no assurance that the Company will
consummate a sale of the Videssence operation with this buyer or any other
buyers on terms acceptable to the Company. In the quarter ended December 31,
1998, the Company accrued a provision for an estimated anticipated loss on the
divestiture of the Videssence operation of approximately $1.9 million which
includes $750,000 for pretax operating losses during the phase-out period.
Although actual results could differ from this estimate, the Company believes
that this estimate will be adequate. The results of operations for this
business have been reclassified to discontinued operations for all periods in
the accompanying consolidated financial statements.
Background
The Company commenced operations as a television production company in 1979
doing business as Rattlesnake Productions, Inc. ("RPI"). In September 1995,
the Company was reincorporated under the laws of the State of Delaware and
changed its name to Netter Digital Entertainment, Inc. In November 1995, the
Company completed its initial public offering of securities, including common
stock and stock purchase warrants, which were and continue to be listed on the
National Association of Securities Dealers, Inc. Automated Quotation System
("NASDAQ") Small Cap Market under the symbol "NETT" and "NETTW," respectively.
The Company's first production was the network mini-series "Louis L'Amour's The
Sacketts." The Company has since produced fourteen productions, most recently,
the award winning primetime television series "Babylon 5," it's follow-on
series, "Crusade," and an all new computer animated children's series,
"Voltron."
The Company has demonstrated it can develop and deliver Projects at production
costs and quality levels consistent with market requirements. Over the last
few years, the Company has focused on developing leading edge digital production
techniques, such as three dimensional computer graphics, digitally created
virtual sets, surround stereo audio mixing, and digital editing of both picture
and sound. These integrated techniques in conjunction with our knowledge of the
production process have enabled the Company to create a unique production
methodology. This methodology is employed on hardware platforms consisting of
standard desktop computer workstations that are relatively inexpensive and
easily upgradable. Overall, this combination of process and platform creates
substantial efficiencies, allowing projects to be produced at lower costs while
maintaining high quality levels.
In January 1997, the Company branched into manufacturing with its acquisition of
Videssence, Inc. ("Videssence"), a designer, manufacturer, and distributor of
lighting products which incorporate its patented SRGB(tm) light technology for
the illumination of studios, stages and other production environments in the
television, motion picture, theater and theme park industries. Videssence's
lighting fixtures are installed in over 500 studios throughout the world,
covering forty countries, including CNN, CBS, NBC, ABC, and the BBC. In the
quarter ended December 31, 1998, the Board of Directors of the Company directed
management to divest this subsidiary, as explained above.
2
RELEASED PROJECTS
Title Principal Cast Members Programming Air Date
or Voices
- ----- ---------------------- ----------- --------
Crusade Gary Cole, Tracy Scoggins Television Series*** 1999
Voltron:The Tim Curry, Billy West Children's 1998-
Third Dimension Television Series present
Babylon 5 Bruce Boxleitner, Tracy Television Series * 1993 -
Scoggins** 1998
Hypernauts Glenn Herman, Heidi Lucas, Children's 1996
Marc Daniel Television Series
Siringo Brad Johnsen, Chad Lowe Television Movie 1995
Crystal Bernard
The Gathering Michael O'Hare, Mira Furlan TV Movie/Pilot for 1993
"Babylon 5" series
The Wild West Jack Lemmon, James Coburn, Documentary Series 1993
Helen Hunt, Bruce Boxleitner
Captain Power Tim Dunnigan, Peter MacNeill, Television Movie 1989
and The Soldiers Jessica Steen
of the Future;
The Legend Begins
Captain Power Tim Dunigan, Peter MacNeill, Children's Series 1987-1988
and the Soldiers Jessica Steen
of the Future
Five Mile Creek Louise Caire Clark, Cable 1983-1986
Rod Mullinar Television Series
Louis L'Amour's Cindy Pickett, Mary Larkin Network Pilot 1982
Cherokee Trail Timothy Scott
Wild Times Sam Elliot, Ben Johnson, Television 1980
Bruce Boxleitner Mini-Series
Roughnecks Ana Alicia, Vera Miles, Television 1980
Cathy Lee Crosby, Steve Mini-Series
Forrest, Harry Morgan
The Buffalo Stan Shaw, Richard Lawson, Network Pilot 1979
Soldiers John Beck, Hilly Hicks
Louis L'Amour's Sam Elliot, Tom Selleck Network 1979
The Sacketts Glenn Ford, Ben Johnson Mini-Series
* Five seasons of 22 one hour episodes were produced, one season per year, in
1993 through 1998. In addition, the Company produced four made for television
movies for Turner Network Television which started airing in the beginning of
1998 with the last having aired in early 1999.
** Tracy Scoggins replaced Claudia Christian in the fifth season.
*** "Crusade," the follow-on series to "Babylon 5," consists of 13 one hour
episodes.
3
Business Strategy
Historically, the Company's strategy has been to develop and produce high
quality leading edge programming which is financed 100% by the major
entertainment studios, networks, television distributors, or other production
partners with the Company avoiding the financial risk of funding its Projects.
Because the Company receives the full cost of the production, its profit
potential is usually limited to production margins, producer fees and a share of
the financing entity's net profits, if any. The Company desires to expand on
this model by producing projects for which it can retain a greater equity
position, so that it may benefit from all revenue streams in perpetuity. The
key elements of the Company's strategic growth plan are:
- -Production. The Company's increased in-house computer graphics/animation and
post-production capacity in conjunction with its production methodologies has
helped to streamline its production times and increase its ability to handle
more projects. This division's strategic plan is to achieve a capacity to
concurrently produce three major television or feature film projects in-house
and to retain greater equity participation in some or all of these productions.
As such, these could be either joint venture productions in conjunction with a
major studio or distributor, or will be the Company's own productions.
Discussions along these lines are on-going and will come to fruition if and when
projects that meet the Company's criteria for profitability and success are
successfully developed and placed. The retention of ancillary exploitation
rights such as merchandising, and the licensing of individual multimedia markets
or entertainment platforms such as the Internet, are areas of particular
interest to the Company. This could require the Company to participate in a
Project's financing risks, in exchange for an equity position, giving it the
opportunity to exploit these various distribution avenues and, with a successful
property, profit from each for as long as the projects were in the market.
- -Production Services. From experience gained in producing numerous projects in
their entirety, especially "Babylon 5," "Crusade," and "Voltron," the Company
has developed significant expertise in computer graphics, digital
post-production and various other digital imaging techniques. This has led the
Company to a growing recognition throughout the entertainment industry for
producing highly creative visual effects while maintaining tight budgetary
control. In order to more fully exploit this expertise, the Company formed the
Production Services division in the fourth quarter of fiscal 1997 to market
computer graphics/animation and digital post-production services to outside
clients. The Company has provided visual effects and post-production work in
the feature film, television production, television promotion,
industrial/corporate video and television commercial segments. The Company is
increasing its efforts in this area and will continue to bid on numerous outside
projects on a larger scale, including feature films, television mini-series and
commercials.
Production
Current Production. During fiscal 1999, the Company finished production on two
all new "Babylon 5" made for television movies and completed production on two
all new television series entitled "Crusade" and "Voltron." The movies and the
"Crusade" series were produced through the Company's 51%-owned subsidiary,
Babylonian Productions, Inc., in association with their creator, J. Michael
Straczynski for Warner Bros. and Turner Network Television ("TNT"). The movies
served as a transition from the Company's award winning television series,
"Babylon 5," to its follow-on series "Crusade," which began airing on TNT in
June 1999. In addition to airing this new series, TNT is also the home to the
re-runs of the first five seasons of "Babylon 5," consisting of 110 original
one-hour episodes, making it the exclusive "home" of the "Babylon 5" franchise
in the United States. Warner Bros. continues to directly market the series
overseas. While the Company was scheduled to produce 22 episodes of "Crusade,"
production was halted at 13 episodes, which significantly contributed to the
Company's revenue shortfall in its fiscal fourth quarter.
4
The Company completed production of 24 episodes of "Voltron" for World Events,
Inc. this year, marking the first time that an all 3-D, CGI animated television
series has been produced in the United States. With the knowledge and
experience gained from this project, the Company is now positioned to undertake
additional children's and prime-time series utilizing intensive or total
computer animation. The Company is very proud of this achievement, as one of
its major goals was to turn its ability to produce 100% CGI animated projects
into a full revenue generating operation. In the first quarter of fiscal 2000,
this achievement was again validated as the Company was contracted to begin
production on two all new, fully CGI animated television series to span the
fiscal year. One contract, valued at $8.0 million of revenue for fiscal 2000,
has the Company producing 26 one-half hour episodes of a series based on one of
England's most popular comic book characters.
Development. The development of new material or properties for television, film
and new multimedia productions is essential to the Company's future growth. It
is the Company's goal to begin to take greater equity ownership of certain
future Projects, thus creating the potential for greater ancillary rights and
profit participation. Typically, the Company either acquires an option to
purchase, or creates or co-creates its own, concept, outline, treatment, script,
or literary rights (a "Property") on which it will base a television series or
movie. When acquiring existing Properties by option, the Company will usually
pay a nominal fee for a six-month or longer option against a more substantial
price if the Company exercises the option and purchases the Property. Such
options enable the Company to develop and secure a production commitment before
actually acquiring the property. Terms of the options vary significantly and
are dependent upon the credibility of and prior success of the writer/owner of
the Property, the revenues the Company estimates can be received from
exploitation of the Property and the estimated cost of further development and
production. Certain agreements may provide for additional payments to writers
upon the sale, production, or distribution of a Project and may also provide for
participation in revenues or profits from these Projects.
On a continuing basis, the Company has numerous Projects in various stages of
development. The Company allocates a significant portion of the time and energy
of its staff to search for potentially viable material and for the development
of concepts, treatments and screenplays. As of June 30, 1999, approximately
$350,000 had been spent or committed by the Company in connection with the
development of Projects that are currently active. Although a number of
Projects which the Company develops are subsequently abandoned, the Company
believes that these expenditures are necessary if the Company is to develop
suitable Projects which have a chance of achieving commercial success. It is
not the practice of the Company, however, to expend substantial sums on a per
project basis, unless it believes that there is a strong likelihood of a
financing, production and/or distribution commitment from third parties.
Financing. Traditionally, the Company's practice has been to fund production
costs for particular Projects through production contracts with studios,
networks, distributors, or other production entities who cover 100% of the
production funding. The Company has been able to secure such production
financing to date, and intends to continue this general practice for financing
its projects in the foreseeable future. However, as discussed above, for
certain future Projects, the Company'sstrategic goal is to retain equity
participation including, for example, the retention of ancillary exploitation
rights such as merchandising. While this strategy may require additional
overhead and equity investment by the Company, as well as corresponding
additional financial risk, it is expected to provide a greater upside on
successful Projects through equity participation. These Projects will be
considered by management on a case by case basis.
Competition. The Company's entertainment production activities are subject to
intense competition. The Company's competitors include major entertainment
studios, television and cable networks and numerous independent production
companies, many of which have significantly greater experience and financial
resources than the Company. All of these studios and production companies
compete for available packaged productions, literary properties, writers and
other creative talent, production financing, and distribution. In recent years,
an increase in the international market and the number of both production
companies and television and motion picture products has intensified this
competition.
5
The entertainment business in general, and the television, multimedia and motion
picture businesses in particular, are undergoing significant changes, primarily
due to technological developments. These developments have resulted in the
availability of alternative forms of leisure time entertainment, expanded pay
television services, the Internet and more readily available multimedia home
entertainment equipment. The number of episodes of a television series and the
ability to retain ancillary rights remains a critical factor in generating
revenues in other media. Given the nature of technological development and
shifting consumer tastes, it is impossible to predict what effect technological
and other changes will have on the potential overall revenue from television and
motion pictures.
Production Services
Current Outside Client Productions. The Company, under its Production Services
division solicits work from outside clients in need of CGI effects and animation
work. As the process for orchestrating the integration of outside service work
with the Company's own current in-house productions was new when the Company
began offering such services in 1997, the Company started with a small number of
jobs in different segments of the market. Since then, the Company provided
visual effects and post-production work in the feature film, television
production, television promotion, industrial/corporate video and television
commercial segments. In fiscal 1999, the Company has performed services for
numerous clients including Warner Bros., HBO, Castlerock, Miramax, Universal,
Sony, Mattel, and Lego. In the fourth quarter of fiscal 1999, the Company
landed its largest contract to date to create all of the visual effects for a
major feature film, produced by Destination Films which will be released in
October 1999.
Growth Strategy. Through its work on "Babylon 5," "Crusade," and "Voltron," the
Company has pioneered many aspects of visual effects creation utilizing desktop
computers. The Company's strategy is to combine its technical expertise with
the cost efficiencies resulting from its production methodology and low cost
hardware platforms, to penetrate what the Company believes is an active market
for projects requiring creative, high quality digital graphics and effects
produced in a cost effective manner. Further, the Company is one of the few
companies which offers the ability to perform visual effects and post-production
work under the same roof, an important distinction which adds to the Company's
quality and efficiency.
In July 1997, the Company moved into a state-of-the-art facility in North
Hollywood, a center of the entertainment and communications media industry.
Within this facility, the Company has designed an infrastructure that allows
the animation, compositing and post-production division to be on the cutting
edge of network and rendering technology. As the entertainment industry
continues to advance through technology, the Company hopes to be at the
forefront of the service providers.
The Company now offers a multitude of services such as: 3-D CGI visual effects,
modeling and animation, compositing, matte painting, roto, online editing,
offline editing, art direction, and on-set supervision. The Company also has a
state-of-the-art motion capture facility which enables it to efficiently animate
3-D character movements. All of these services run on multiple hardware
platforms and utilize many different software programs such as: Lightwave 3D,
Alias, Discreet Logic, SoftImage, Illusion, After Effects, Electric Image, and
Matador Paint. The Company employs these programs on various hardware platforms
including Windows NT based and SGI computers. All of these different platforms
give the Company the luxury of flexibility that most other facilities do not
enjoy.
6
Competition. The Production Services business faces significant competition
from numerous independent visual effects and post-production houses. The
entertainment industry, especially in Southern California, is filled with
companies, large and small, which offer these services. With the advancements
of technology, the costs of the computer systems used to create special effects,
along with the associated software, have fallen dramatically opening up the
market to many start-up companies. As the Company expands in this market, it
will face competition from larger entities with greater experience and financial
resources such as Industrial Light and Magic, Digital Domain and Rhythm & Hues.
Employees
At June 30, 1999, the Company employed 66 persons full-time in its principal
executive offices and post-production/animation facilities. Of such persons,
four are officers. The balance are production, clerical and administrative
personnel. The Company is currently staffed to handle its current workload and
a specific amount of incoming outside production services business. The Company
anticipates increasing its technology, computer graphics animation and
post-production facilities as well as its staffing requirements in the upcoming
fiscal year as new projects are undertaken. The Company is continuing to review
its staffing requirements and additions or reductions in staff may be made if
appropriate in the opinion of management.
When the Company is in production on live action projects, a significant number
of additional employees may be engaged by the Company at its production studio
for periods of nine months or longer. The Company has granted, and will grant,
to actors, directors, screenwriters, and other important creative and financial
elements, rights to participate in the net profits or gross revenues of
particular projects. Similar participation is required pursuant to the terms of
certain collective bargaining agreements.
Some of the Company's or its subsidiary's employees have been or may be
represented by labor unions and the Company believes that it has good
relationships with its employees. The Company or certain of its subsidiaries
are signatories to various agreements with unions and guilds that operate in the
entertainment industry. Although the Company considers its employee relations
to be satisfactory at present, the renewal of these union contracts does not
depend on the Company's activities or decisions alone. If, prior to the
expiration of an existing union contract, the representatives of the employers
were unable to negotiate a new contract with the union, any resulting work
stoppage could adversely affect the Company, if the Company was in production on
a live-action project.
ITEM 2. REAL PROPERTY
The Company leases its principal executive offices and post-production and
animation facilities in a new, state-of-the-art building with 22,000 square
feet located at 5125 Lankershim Blvd., North Hollywood, California 91601. The
lease, which started in July 1997, is for seven years with annual minimum rent
of $277,000. The Company has an option to extend the lease for two additional
five year terms. During fiscal 1999, the Company also leased space for its
sound stage studios. This lease has since expired. Rent expense for the year
ended June 30, 1999 was approximately $807,000, which includes expenses from the
Company's discontinued operations, Videssence, and its sound stage facilities.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of business, the Company is from time to time party to
various actions which in the aggregate are not believed by management to be
material to its financial condition.
7
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the fourth quarter
of fiscal 1999.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock has traded in the NASDAQ Small Cap Market under the
symbol "NETT" since November 20, 1995. In addition, warrants to purchase up to
494,500 of the Company's Common Stock are listed on the NASDAQ Small Cap Market
under the symbol "NETTW." The terms of the warrants provide the holder the right
to purchase any time prior to November 21, 1999 one share of Common Stock at a
price of $6.50. The Company's Common Stock is also traded on the Pacific
Exchange.
The following table sets forth the high and low sales price per share of the
Common Stock as reported by NASDAQ for each quarter within the last two fiscal
years.
Quarter Ended High sales Low sales
--------------- ------------ -----------
September 30, 1997 $3.88 $2.13
December 31, 1997 $3.25 $1.75
March 31, 1998 $2.75 $1.50
June 30, 1998 $6.00 $1.63
September 30, 1998 $2.25 $2.00
December 31, 1998 $1.88 $1.41
March 31, 1999 $1.69 $1.50
June 30, 1999 $1.31 $1.25
On September 23, 1999, the closing prices of the Common Stock as reported by
NASDAQ were $1.13 bid and $1.25 ask. On such date there were 32 holders of
record of the Common Stock. The number of shareholders does not take into
account shareholders for whom shares are being held in the name of brokerage
firms or clearing agencies.
The Company has never paid any dividends on the Common Stock. The Company
intends to retain earnings and capital for use in its business, and no cash
dividends are expected to be paid on the Common Stock in the foreseeable future.
On March 29, 1999, the Company, obtained a $1.0 million funding facility (the
"Facility") from AIB Investments Pty Limited ("AIB"), an Australian corporation.
As of May 14, 1999, the Company had drawn down the full $1.0 million of
principal under the Facility, with each increment of principal evidenced by a
non-interest bearing Senior Subordinated Convertible Note (a "Note"), due March
29, 2002. The aggregate of $1.0 million principal of these Notes is convertible
into shares (the "Conversion Shares") of the Company's common stock at a
conversion rate of $2.00 per share, subject to anti-dilution adjustments.
Effective March 29, 1999, AIB also received five-year warrants (the "Warrants")
to purchase up to a maximum of 750,000 shares (the "Warrant Shares") of the
Company's common stock, at an exercise price of $2.50 per share, subject to
anti-dilution adjustments.
AIB has executed a standstill agreement whereby, subject to certain exceptions,
AIB and its affiliates agreed not to acquire, before March 29, 2001, additional
shares of the Company's capital stock giving them greater than 30% of the
combined voting power of the Company.
8
The above is merely a summary of the terms of the Facility and the agreements
relating thereto, and is qualified in all respects by the provisions of such
agreements, which are attached as Exhibits to the Company's Current Report on
Form 8-K dated March 29, 1999 and which are incorporated by reference into
Part IV, Item 14 hereof. The Notes, the Warrants, the Conversion Shares and the
Warrant Shares were offered and sold by the Company to AIB in reliance upon the
exemptions from registration under the Securities Act provided by Section 4(2)
of the Securities Act and Rule 506 of Regulation D promulgated thereunder.
Given the present convertibility of the Notes into 500,000 Conversion Shares
and the present exercisability of the Warrants into up to 750,000 Warrant
Shares, AIB and certain of its affiliates are the beneficial owners of
approximately 27.3% of the Company's outstanding Common Stock, based on the
3,334,405 shares outstanding as of September 23, 1999.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated historical financial data presented below for the five
years ended June 30, 1999, are derived from the audited consolidated financial
statements of the Company and have been restated to reflect certain results of
operations which have been reclassified as discontinued operations. The
following data should be read in conjunction with the Consolidated Financial
Statements of the Company and the Notes thereto included elsewhere herein and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
<TABLE>
<CAPTION>
Fiscal Year 1999 1998 1997 1996 1995
---------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net revenues 23,280,450 28,396,765 23,300,891 23,655,054 18,878,661
Operating income (loss) from
continuing operations (626,899) 775,748 48,036 (359,418) 144,622
Income (loss) from continuing
operations (709,145) 512,328 145,115 (256,844) 97,395
Basic and diluted earnings
(loss) per share from
continuing operations (0.23) 0.14 0.04 (0.11) 0.05
Total assets 6,858,857 9,926,686 8,783,241 3,705,439 1,087,962
Capital leases 1,997,379 2,033,744 228,302 - -
Long-term debt (net of
discount of $220,000) 780,000 - - - -
</TABLE>
9
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED HEREIN, THE MATTERS
ADDRESSED IN THIS ITEM 7 CONSTITUTE "FORWARD LOOKING STATEMENTS"
WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS
AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED. SUCH FORWARD LOOKING STATEMENTS ARE SUBJECT TO A VARIETY OF
RISKS AND UNCERTAINTIES, INCLUDING DEPENDENCE ON REVENUES FROM
LIMITED SOURCES AND DEPENDENCE ON NEW PRODUCTION CONTRACTS THAT
COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE
ANTICIPATED BY THE COMPANY'S MANAGEMENT. FOR FURTHER DISCUSSION ON
ASSOCIATED RISK FACTORS SEE THE HEADING "RISK FACTORS" IN THE COMPANY'S
REGISTRATION STATEMENT ON FORM S-3 (Registration No.333-56963) FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION ON JUNE 16, 1998, AND THE DISCUSSION
UNDER THE HEADING "YEAR 2000" BELOW IN THIS ITEM 7.
General
Historically, the Company's primary operations have been to develop and produce
media entertainment Projects under agreements with studios, networks, and
distributors or other production entities who fund 100% of production costs of
the Project. Employing this strategy, the Company avoids the financial risk of
funding such production costs, but limits its ongoing revenue participation
since the financing entity retains a significant portion of the rights to the
main and ancillary markets for the Projects. Under these arrangements,
revenues are recognized when earned (typically upon receipt) and associated
costs are recognized when incurred.
These revenues are primarily dependent on the number of Projects being produced
by the Company and the agreement relating to such Projects. Accordingly, year
to year comparisons of production revenues from these sources are not
necessarily indicative of future revenues. During fiscal 1999 and fiscal 1998,
the Company derived approximately 75% and 93%, respectively, of its
entertainment production revenues from Warner Bros. for the
"Babylon 5"/"Crusade" television franchise. As discussed above in "PART I.
ITEM 1. BUSINESS," the Company's business strategy is to expand its
entertainment production business as well as through the Company's marketing of
its computer animation and visual effects production services to outside
clients. Of course, there can be no assurance that this strategy will be
successful and, if either of the two new productions which began in the first
quarter of fiscal 2000 (see "Production - Current Production") are not
renewed after their first seasons or replaced by series generating comparable
revenues, the Company's financial condition and operations could be materially
adversely affected.
Results of Operations
Fiscal 1999 compared to fiscal 1998
Net Revenues. Net revenues decreased to approximately $23.3 million for the
fiscal year ended June 30, 1999, a decrease of 18.0%, as compared to
approximately $28.4 million for the fiscal year ended June 30, 1998. This
decrease resulted primarily from an $8.9 million shortfall in revenues, mostly
attributable to the fourth quarter, from the "Babylon 5"/"Crusade" franchise as
the production of "Crusade," the follow-on series to "Babylon 5," was halted at
13 episodes compared to 22 episodes of "Babylon 5" in fiscal 1998. This revenue
shortfall was partially offset by a $2.7 million increase from the Company's
work on "Voltron," and a $1.0 million increase in its Production Services
division. The "Babylon 5" Fan Club, with its expanding merchandise sales and
fan base, also contributed an additional $100,000 of revenues, as compared to
the prior year.
10
Gross Margin. The Company's gross profit for fiscal 1999 was approximately
$1.9 million, or 8.2% of revenues, as compared to approximately $3.1 million,
or 11.0% of revenues, for fiscal 1998. The gross margin for fiscal 1999 was
severely impacted by the revenue shortfall described above. For the nine month
period ended March 31, 1999, gross margin was 12.3% as compared to 10.6% for the
same prior year period, illustrating the improvements that the Company continues
to make in its operating methodologies and the benefits from a greater portion
of revenues being derived from higher margin Projects such as "Voltron" and
other Production Services related product. However, with the decrease in fourth
quarter revenues, the Company was unable to sustain the favorable gross margins
it had realized over the first three quarters.
General and Administrative Expenses. General and administrative expenses
increased to approximately $2.5 million, or approximately 10.9% of the Company's
net revenues in fiscal 1999, as compared to approximately $2.3 million, or
approximately 8.2% of revenues, in fiscal 1998. The increase was primarily
attributable to increases in overhead at the Company's Fan Club division and due
to a decline in revenues and, to a lesser extent, the additional workload in the
Production Services division and the Company's intensified efforts in market
penetration and expansion.
Other Income and Expenses. Interest income decreased to approximately $8,000
for fiscal 1999, as compared to approximately $22,000 for fiscal 1998, as
withdrawals from short-term investments were used for expansion of in-house
post-production and graphics/animation facilities and working capital. Interest
expense increased to approximately $204,000 in fiscal 1999, from approximately
$71,000 in fiscal 1998, due to the continuing use of lease lines to finance
capital expansion in its graphics/animation facilities.
Fiscal 1998 compared to fiscal 1997
Net revenues. Net revenues increased to approximately $28.4 million for the
fiscal year ended June 30, 1998, an increase of 21.9%, as compared to
approximately $23.3 million for the fiscal year ended June 30, 1997. This
increase resulted from several factors. Revenues from the Company's "Babylon 5"
franchise increased $3.2 million as the production on two new television movies
provided $4.5 million of additional revenues to offset a $1.3 million decrease
in Season 5 revenue compared to Season 4. The latter difference stemmed from
production timing. Also, the first full year of the Production Services
division, the Company's start-up on "Voltron," and the expanding revenue base of
the "Babylon 5" fan club contributed an additional $1.9 million of revenues.
Gross Margin. The Company's gross margin for fiscal 1998 was approximately $3.1
million, or 11.0% of revenues, as compared to approximately $2.0 million, or
8.8% of revenues, for fiscal 1997. This increase resulted from the Company's
continual improvement in its operating methodologies and the increase in
business generated from the Production Services division which generates higher
margins than the traditional core entertainment production business relating to
the production of the "Babylon 5" franchise.
General and Administrative Expenses. General and administrative expenses
increased to approximately $2.3 million, or approximately 8.2% of the Company's
net revenues in fiscal 1998, as compared to approximately $2.0 million, or
approximately 8.6% of revenues, in fiscal 1997. The dollar increase stemmed
from additional rent and other facility expenses as the Company moved to its
new, larger building. Also, travel and consulting costs increased as
management worked to restructure Videssence and increase communication with the
investment community.
11
Other Income and Expenses. Interest income decreased to approximately 22,000
for fiscal 1998, as compared to approximately $83,000 for fiscal 1997, as
proceeds from the Company's November 1995 initial public offering were fully
drawn from short-term investments and used for expansion of its in-house
post-production and graphics/animation facilities and working capital for
Videssence. Interest expense increased to approximately $71,000 in fiscal 1998,
from $0 in fiscal 1997, due to the start of lease lines utilization to finance
capital expansion in its graphics/animation facilities.
Discontinued Operations
Effective the quarter ended December 31,1998, the Board of Directors voted to
classify and operate the Company's Videssence subsidiary as a discontinued
operation. The Company's Board of Directors and financial advisors determined
that the Company's best strategy for growth is to focus directly on its core
entertainment business and to divest its non-entertainment business activities.
Accordingly, the Board instructed management to divest the Videssence
subsidiary, which manufactures and distributes media lighting products, by the
end of the 1999 calendar year. The Company is reviewing how to best capitalize
on its recent investment in Videssence and currently is in negotiations with a
potential buyer for the Videssence operation. Of course, there can be no
assurance that the Company will consummate a sale of the Videssence operation
with this buyer or any other buyer on terms acceptable to the Company. In the
quarter ended December 31, 1998, the Company accrued a provision for an
estimated anticipated loss on the divestiture of the Videssence operation of
approximately $1.9 million which includes $750,000 for pretax operating losses
during the phase-out period beginning January 1, 1999. Actual results could
differ from this estimate. The results of operations for this business have been
reclassified to discontinued operations for all periods in the accompanying
consolidated financial statements.
Pretax loss at the Videssence operation for the year ended June 30, 1999 was
$1,396,277, as compared to a pretax loss of $533,330 for the same respective
period of the prior year. The primary factors leading to this increased loss
were a write-down of inventory, a sales shortfall due to lower than anticipated
demand for new products, and higher than anticipated sales returns. For the
year ended June 30, 1997, Videssence realized pretax income of approximately
$45,000. The primary factor for the decrease from fiscal 1997 to fiscal 1998
was lower than expected sales, especially from the international markets during
the fourth quarter of fiscal 1998. For a further discussion of the assets,
liabilities and operating results of Videssence, see the section entitled
"Discontinued Operations" in the "Notes to Consolidated Financial Statements."
Liquidity and Capital Resources
The Company has funded its operations to date primarily through cash flows from
operations, the initial public offering of Common Stock and warrants completed
in November 1995, which generated net proceeds of approximately $3.2 million,
and a February 1997 preferred stock placement which raised $424,000 in gross
proceeds and the Facility from AIB Investments Pty Limited ("AIB") in March
1999. The entire $1.0 million in principal has been drawn down on the Facility
and is evidenced by non-interest bearing Senior Subordinated Convertible Notes,
due March 29, 2002 (for further information, see "Item 5 - Market for Common
Equity and Related Stockholder Matters" above). On June 10, 1999, the Company
entered into a short-term note with AIB for $450,000 with interest bearing 10%
annually. This note is due on demand anytime after June 30, 1999. As of
September 23, 1999, demand has not been made on this note and all interest
through August 31, 1999 has been paid.
With respect to production costs for particular entertainment Projects,
historically, the Company has entered into production contracts with studios,
networks and distributors which have covered 100% of the production funding.
More recently, the Company is contracted by another production entity to produce
a project, as with "Voltron," with this other entity funding 100% of the costs.
In both instances, the production funds are received by the Company during the
production stage of a Project. To date, the Company has been able to secure
production financing from a major studio, network or distributor for its
Projects or has been able to secure production contracts with others. While the
Company believes that similar financing arrangements can be made for future
productions, there can be no assurance that the Company will be successful in
obtaining such production financing or contracts. In that event, the Company
would have to secure alternative sources for financing Projects. Moreover, as
the Company continues to develop new forms of high technology production
activities and projects for new entertainment ancillary markets, it may elect to
make additional overhead and equity commitments for these new projects. These
potential, new financial commitments, if pursued, could create additional risk
for the Company as to whether it will recover the costs of its investment
and generate a profit.
12
During fiscal 1999 and fiscal 1998, the Company derived approximately 75% and
93%, respectively, of its entertainment production revenues from its agreements
with Warner Bros. relating to the production of the "Babylon 5" and "Crusade"
series and the associated made-for-television movies. As discussed above, under
"Results of Operations," the cessation of production on "Crusade" caused a
shortfall of revenues in the fourth quarter of fiscal 1999. In the first
quarter of fiscal 2000, the Company was contracted to begin production on two
all new, 100% CGI animated television series to run throughout fiscal 2000. On
one of these series, part of the contractual payments are deffered until the
latter part of the third and fourth quarters of fiscal 2000, which could cause a
cash flow shortfall in the second and third quarters. The Company is actively
engaged in discussions on several potential new Projects and is actively
pursuing a potential source of additional financing. Although there can be no
assurance that the Company will be sucessful in these efforts, managemnet
believes that the Company will avoid a cash flow shortfall through one or more
of these alternatives. Further, as one of these productions only runs through
February 2000, the Company is actively seeking an additional series to be a
replacement for the remaining months of the fiscal year. If the Company is
unable to contract for this replacement series or if either of these series are
not renewed through an additional agreement extension after the first season and
the Company is unable to replace the series with ones generating comparable
revenues, the Company's financial condition and operations could be materially
adversely affected.
Cash used in operating activities was approximately $2.1 million for the fiscal
year ended June 30, 1999. The biggest uses of cash were operating losses as
well as a decrease in deferred revenues as prepaid production costs were used to
complete various projects.
Cash provided by financing activities was approximately $800,000 for the fiscal
year ended June 30, 1999. The biggest providers of cash were drawdowns from the
Facility and short-term notes payable of $1.45 million which in conjunction with
a decrease in notes receivable of $156,000 more than offset principal payments
on capital leases of approximately $800,000.
Cash used for capital equipment investment was approximately $255,000 for fiscal
1999. The use of cash was primarily for additions of computer and
post-production equipment to expand its post-production and graphics/animation
facilities.
Year 2000
The Year 2000 issue results from the development of computer programs and
computer chips using two digits rather than four digits to define the
applicable year. Computer programs and/or equipment with time-sensitive
software or computer chips may recognize the date using "00" as the year 1900
rather than the year 2000. This could result in system failure or
miscalculations and cause disruptions to business operations.
The Company's Production and Production Services operations rely heavily on
computers in the development and production of projects and in the provision of
digital media production services, but do not rely heavily on computers for
operating activities such as the processing of payroll. The Company also makes
use of computers for efficient communications with employees and customers,
including extensive use of e-mail systems and the Internet. Finally, embedded
technology such as microcontrollers are commonly found in computers used
throughout the Company's operations. The complete failure of these systems
could have a material negative impact on the operations of the Company. In
addition, most of the Company's major suppliers and customers rely heavily on
computer systems and failures in such systems could disrupt their operations.
13
The Company has completed the process of identifying and addressing potential
Year 2000 difficulties in its technological operations, including information
technology ("IT") applications, IT technology and support, desktop hardware and
software, non-IT systems and important third party operations. Based on its
assessment of these efforts, the Company believes that Year 2000 issues will
not have a material adverse effect on the Company's business, operations or
financial condition. Further, management expects that costs which have been or
will be incurred to assure Year 2000 capability will not have a material adverse
effect on the Company's financial position or results of operations. The
Company has undertaken continuing efforts to update, modify or replace, and
test systems in the ordinary course of business. Based on such efforts, the
Company does not believe that it will be required to otherwise modify or
replace significant portions of its software so that its computer systems will
function properly with respect to dates in the year 2000 and thereafter.
The Company estimates its cost to assess and achieve Year 2000 compliance will
be less than $10,000, of which less than $5,000 has been incurred through June
30, 1999. These amounts do not include costs incurred in the Company's
replacement or upgrading of existing computer systems in the ordinary course of
business. No system replacements were made or accelerated to comply with Year
2000 issues. These estimates are subject to revisions based on future
assessments and responses from vendors and customers. The Company expects to
continue to fund its Year 2000 costs through its cash flows from operations and
to expense modification costs as incurred.
Management believes the primary Year 2000 risks to the Company's business are
external to the Company and relate to the Year 2000 readiness of the Company's
third party suppliers and customers. Consequently, the Company's Year 2000
effort also includes communication with significant third party suppliers and
customers to determine the extent to which the Company's systems are vulnerable
to those parties' failures to reach Year 2000 compliance. The Company is
currently contacting significant suppliers of products and services to
determine that the suppliers' operations and the products and services they
provide are Year 2000 capable. Based on responses it has received to date, the
Company does not believe that the impact of Year 2000 issues on such suppliers
will be material to the Company's business, operations or financial condition.
However, there can be no assurance that another company's failure to ensure
Year 2000 capability will not have an adverse effect on the Company.
Overall, the Company believes that it will complete its Year 2000 effort and
that there will not be a significant disruption to its business caused by the
failure of its own computer systems. In addition, the Company believes that,
to the extent that its production and Production Services operations rely on
suppliers for specialty services, there are a variety of alternative suppliers
available in the event the Company's existing suppliers face Year 2000 problems.
The Company's Videssence subsidiary relies heavily on suppliers of parts for its
lighting products. Although there are alternative sources for these items, the
Videssence subsidiary may experience a disruption in its receipt of these parts
if it is forced to replace existing suppliers who experience Year 2000 problems.
Consequently, the Company's Videssence subsidiary could experience disruptions
in its operations as a result of failures in the computer systems of its major
vendors. Accordingly, the Company is developing contingency plans such as
backup vendors to help mitigate the effects of such failures, if any.
14
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to certain market risks that are inherent in the
Company's financial instruments arising from transactions that are entered
into in the normal course of business. The Company is subject to interest rate
risk on its $450,000 short term note payable, obtained in June 1999, which has
a fixed interest rate of 10%. Similarly, when the Company enters into capital
leases, these leases have fixed interest rates based on the prevailing rates at
the date of contract. The Company runs the risk that market rates will decline
and the required payments will exceed those base on current market rates. There
is no interest rate risk with the Company's $1.0 million long-term notes
payables as these notes are interest free. Under its current policies, the
Company does not use interest rate derivative instruments to manage its exposure
to interest rate changes. The Company generally does not transact business in
foreign currencies and is therfore generally not exposed to financial market
risk resulting from foreign currency exchange rates.
15
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NETTER DIGITAL ENTERTAINMENT, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
______
INDEPENDENT AUDITORS' REPORT F-2
CONSOLIDATED BALANCE SHEETS - June 30, 1999 and 1998 F-3
CONSOLIDATED STATEMENTS OF OPERATIONS -
for the years ended June 30, 1999, 1998 and 1997 F-4
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY -
for years ended June 30, 1999, 1998 and 1997 F-5
CONSOLIDATED STATEMENTS OF CASH FLOWS -
for years ended June 30, 1999, 1998 and 1997 F-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-7 to F-17
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
Netter Digital Entertainment, Inc.
and Subsidiaries
We have audited the accompanying consolidated balance sheets of Netter
Digital Entertainment, Inc. and Subsidiaries as of June 30, 1999 and 1998, and
the related consolidated statements of operations, stockholders' equity and cash
flows for the years ended June 30, 1999, 1998 and 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform our audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatements. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Netter Digital
Entertainment, Inc. and Subsidiaries as of June 30, 1999 and 1998 and the
results of its operations and its cash flows for the years ended June 30, 1999,
1998 and 1997 in conformity with generally accepted accounting principles.
/s/ Feldman Sherb Horowitz & Co., P.C.
--------------------------------------
Feldman Sherb Horowitz & Co., P.C.
Certified Public Accountants
New York, New York
August 13, 1999
F-2
NETTER DIGITAL ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30,
---------------------------------
1999 1998
---------------------------------
ASSETS
------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 63,086 $ 1,634,809
Accounts receivable, net 781,835 781,374
Inventories 220,930 153,529
Due from officer - 155,897
Production costs,net 350,881 251,632
Other 63,961 81,180
Deferred tax asset 150,000 -
Net assets, discontinued operations 1,782,605 3,703,998
-------------- ---------------
TOTAL CURRENT ASSETS 3,413,298 6,762,419
EQUIPMENT, net 3,108,890 2,954,601
DEPOSITS AND OTHER ASSETS 336,669 209,666
-------------- ---------------
$ 6,858,857 $ 9,926,686
============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and production fee advances $ 1,244,051 $ 1,434,947
Accrued expenses 95,979 138,899
Deferred revenue 160,228 1,106,957
Current portion of capital lease obligations 997,040 696,558
Notes payable 450,000 -
-------------- ---------------
TOTAL CURRENT LIABILITIES 2,947,298 3,377,361
CAPITAL LEASE OBLIGATIONS 1,000,339 1,337,186
NOTE PAYABLE (net discount of $220,000) 780,000 -
MINORITY INTEREST 500 500
STOCKHOLDERS' EQUITY :
Preferred stock, $.001 par value, 2,000,000 shares
authorized; 57,286 shares issued and outstanding 353,200 304,366
Common stock, $.01 par value, 20,000,000 shares
authorized; 3,334,405 shares issued and outstanding 33,344 33,344
Additional paid-in capital 4,966,171 4,726,171
Retained (deficit) Earnings (3,221,995) 147,758
-------------- ---------------
TOTAL STOCKHOLDERS EQUITY 2,130,720 5,211,639
-------------- ---------------
$ 6,858,857 $ 9,926,686
============== ===============
<FN>
<FN1>
See notes to consolidated financial statements.
</FN>
</TABLE>
F-3
NETTER DIGITAL ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended June 30,
------------------------------------------
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
REVENUES:
Production $ 23,280,450 $ 28,396,765 $ 23,300,891
------------ ------------ ------------
EXPENSES:
Production 21,382,644 25,288,142 21,258,498
General and administrative 2,524,705 2,332,875 1,994,357
------------ ------------ ------------
TOTAL EXPENSES 23,907,349 27,621,017 23,252,855
------------ ------------ ------------
OPERATING INCOME (LOSS) (626,899) 775,748 48,036
------------ ------------ ------------
OTHER INCOME (EXPENSE):
Interest income 8,095 21,761 83,389
Interest (expense) (204,369) (71,424) -
Other income 1,554 9,243 28,690
------------ ------------ ------------
TOTAL OTHER INCOME (EXPENSE) (194,720) (40,420) 112,079
------------ ------------ ------------
INCOME (LOSS) FROM CONTINUING
OPERATION BEFORE INCOME TAXES (821,619) 735,328 160,115
(BENEFIT) PROVISION FOR INCOME TAXES (112,474) 223,000 15,000
------------ ------------ ------------
NET INCOME (LOSS) FROM
CONTINUING OPERATIONS $ (709,145) $ 512,328 $ 145,115
DISCONTINUED OPERATIONS:
Income (Loss) from operation of
Videssence, Inc., (net of
tax/(benefit)) (727,806) (351,330) 45,261
Provision for loss on divestiture
of Videssence, Inc. (1,880,956) - -
------------ ------------ ------------
INCOME (LOSS) FROM DISCONIUED OPERATIONS (2,608,762) (351,330) 45,261
------------ ------------ ------------
NET INCOME (LOSS) (3,317,907) 160,998 190,376
Cumulative preferred stock dividend 51,846 42,530 14,354
------------ ------------ ------------
Net Income (Loss) to common shareholders $ (3,369,753) $ 118,468 $ 176,022
============ ============ ============
BASIC AND DILUTED EARNINGS (LOSS)
PER SHARE:
Continuing operations $ (0.23) $ 0.14 $ 0.04
Discontinued operations (0.78) (0.10) 0.02
------------ ------------ ------------
Net earnings (loss) per common share $ (1.01) $ 0.04 $ 0.06
============ ============ ============
Weighted average number of common shares 3,334,405 3,334,552 3,056,944
============ ============ ============
<FN>
<FN1>
See notes to consolidated financial statements.
</FN>
</TABLE>
F-4
NETTER DIGITAL ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Retained
Preferred Stock Common Stock Additional Earnings Total
Number of Number of Paid in (Accumulated Stockholders'
Shares Amount Shares Amount Capital Deficit) Equity
--------- -------- --------- -------- --------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, June 30, 1996 - $ - 2,795,000 $ 27,950 $ 3,533,331 $ (146,732) $ 3,414,549
Stock issued in connection
with acquisition - - 522,221 5,222 1,107,109 - 1,112,331
Stock issued in connection
with settlement - - 10,000 100 35,803 - 35,903
Sale of preferred stock 47,145 261,939 - - - - 261,939
Stock dividend 1,595 14,354 - - - (14,354) -
Net income - - - - - 190,376 190,376
--------- -------- ---------- --------- -------- ----------- ------------
Balance, June 30, 1997 48,740 $ 276,293 3,327,221 $ 33,272 $4,676,243 $ 29,290 $ 5,015,098
Stock issued in connection
with settlement - - 11,729 117 49,883 - 50,000
Retirement of common stock - - (4,545) (45) 45 - -
Stock dividend 3,119 28,073 - - - (28,073) -
Accrual of stock dividend
payable - - - - - (14,457) (14,457)
Net income - - - - - 160,998 160,998
--------- --------- ---------- --------- --------- ----------- -----------
Balance, June 30, 1998 51,859 $ 304,366 3,334,405 $ 33,344 $4,726,171 $ 147,758 5,211,639
Stock dividend 5,427 48,834 - - - (34,377) 14,457
Accrual of stock dividend - - - - - (17,469) (17,469)
Issuance of warrants - - - - 240,000 - 240,000
Net loss - - - - - (3,317,907) (3,317,907)
--------- ---------- ----------- ------- ---------- ------------ -----------
Balance, June 30, 1999 57,286 $ 353,200 3,334,405 $ 33,344 $4,966,171 $(3,221,995) $ 2,130,720
========= ========== =========== ======= ========== ============ ===========
<FN>
<FN1>
See notes to consolidated financial statements
</FN>
</TABLE>
F-5
NETTER DIGITAL ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended June 30,
-------------------------------------------------
1999 1998 1997
------------- ------------- -------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (3,317,907) $ 160,998 $ 190,376
------------- ------------- -------------
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation 819,214 520,307 238,087
Amortization 124,311 104,311 43,463
Provision for discontinued operations 1,212,482 - -
Changes in operating assets and liabilities,
net of effects of acquisitions:
Increase in accounts receivable (461) (487,928) (351,971)
Increase in inventories (67,401) (123,614) (29,915)
(Increase) decrease in production costs (99,249) 43,087 (229,510)
Decrease (increase) in other current assets 17,219 (8,793) (17,980)
Increase in deferred tax asset (150,000) - -
Increase in deposits and other assets (127,003) (48,572) (77,576)
(Decrease) increase in accounts payable (190,896) (261,831) 1,487,163
(Decrease) increase in accrued expenses (42,920) (42,132) 100,256
(Decrease) increase in deferred revenues (946,729) 576,755 530,202
Decrease (increase) in net assets from
discontinued operations 652,992 (938,916) (549,671)
--------------- --------------- ---------------
(954,448) (1,291,944) 860,998
--------------- --------------- ---------------
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (2,116,348) (506,328) 1,332,924
--------------- --------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (254,996) (138,770) (647,120)
Proceeds from sale of equipment - 22,866 -
Advances to subsidiary prior to acquisition - - (275,000)
--------------- --------------- ---------------
NET CASH (USED IN) INVESTING ACTIVITIES (254,996) (115,904) (922,120)
--------------- --------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Acquistion costs net of cash required - - (342,989)
Issuance of preferred stock - - 261,939
Decrease in due from officer 155,897 - 38,979
Proceeds from issuance of notes payable 1,450,000 - -
Principal payments of capital lease obligations (806,276) (276,153) (16,762)
--------------- --------------- ---------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 799,621 (276,153) (58,833)
--------------- --------------- ---------------
NET (DECREASE) IN CASH (1,571,723) (898,385) 351,971
Cash, beginning of year 1,634,809 2,533,194 2,181,223
--------------- --------------- --------------
Cash, end of year $ 63,086 $ 1,634,809 $ 2,533,194
=============== =============== ==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest $ 184,369 $ 60,121 $ -
=============== =============== ==============
Income taxes $ 37,526 $ 53,000 $ -
=============== =============== ==============
Noncash activity:
Stock issued for legal fee settlement $ - $ 50,000 $ 35,903
=============== =============== ==============
Stock dividend $ 51,846 $ 42,530 $ 14,354
=============== =============== ==============
Purchase of equipment through leases payable $ 769,911 $ 2,119,407 $ 171,124
=============== =============== ==============
Issuance of Common Stock in connection
with acquisition of Videssence $ - $ - $ 1,112,330
=============== =============== ==============
<FN>
<FN1>
See notes to consolidated financial statements.
</FN>
</TABLE>
F-6
NETTER DIGITAL ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 1999, 1998 AND 1997
1. ORGANIZATION:
Netter Digital Entertainment, Inc. was incorporated in September 1995 under the
laws of the State of Delaware. Babylonian Productions, Inc., a majority owned
subsidiary (51%), was incorporated in June 1993 under the laws of the State of
California. Netter Digital Entertainment, Inc. and Babylonian Productions, Inc.
are collectively referred to as "NDEI". NDEI is engaged in the development,
acquisition and production of television series, made for television movies,
documentaries, theatrical motion pictures and multimedia products.
On January 10, 1997, NDEI purchased all the outstanding shares of Videssence,
Inc. ("Videssence") in exchange for 522,221 shares of NDEI's Common Stock.
This transaction was completed pursuant to an Agreement and Plan of Merger
(the "Plan") dated April 26, 1996 between Videssence and NDEI. Under the Plan
the Videssence shareholders can earn up to an additional maximum of 788,000
shares of NDEI's common stock upon Videssence achieving certain performance
based criteria over the next five years. Acquisition costs amounted to
$495,998. This merger was accounted for as a purchase. Videssence designs,
manufactures and distributes media lighting products which incorporate the
patented SRGB(tm) light technology for the illumination of studios, stages and
other production environments in the sound stage, media picture, theater and
other theme park industries. Hereafter, NDEI and Videssence are collectively
referred to as (the "Company").
Effective December 31, 1998, the Company elected to operate the Company's
Videssence subsidiary as a discontinued operation. The results of operations
for Videssence have been reclassified to discontinued operations for all periods
presented.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
A. Principles of consolidation - The consolidated financial statements include
the accounts of the Company and its subsidiaries. All material intercompany
transactions have been eliminated.
B. Estimates - The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reporting amounts of revenues and
expenses during the reported period. Actual results could differ from those
estimates.
C. Cash and cash equivalents - The Company considers all highly liquid temporary
cash investments with an original maturity of three months or less when
purchased, to be cash equivalents.
F-7
D. Revenue recognition - Production revenues - The Company derives revenues
primarily from providing contract production services to distributors and
other production entities including producers-profit participation. Revenues
are recognized as earned. Amounts advanced under production contracts are
deferred and not recognized as revenues until obligations under such
contracts are performed. Conversely, amounts expended under production
contracts not yet reimbursed are recorded as a receivable. To date, the
Company has not recognized any material revenues from producers-profit
participation.
E. Inventories - Inventories consist of finished retail products that are
marketed through the "Babylon 5" Fan Club. Inventories are recorded at the
lower of cost or market. Cost is determined using the average cost method.
F. Equipment - Equipment is recorded at cost. Depreciation is calculated using
the straight line method based on the estimated useful lives of the related
assets, which range from three to seven years.
G. Product warranty - The Company accrues for an estimate of expenses relating
to the one-year warranty covering all parts and labor relating to the sale of
its products.
H. Net income (loss) per common share - Basic earnings per share has been
calculated based upon the weighted average number of common shares
outstanding. Stock options and convertible preferred stock have been
excluded as common stock equivalents in the diluted earnings per share
because they are either antidilutive, or their effect is not material.
I. Income taxes - The Company recognizes deferred tax assets and liabilities
based on the difference between the financial statements' carrying amount
and the tax basis of assets and liabilities, using the effective tax rates
in the years in which the differences are expected to reverse. A valuation
allowance related to deferred tax assets is also recorded when it is probable
that some or all of the deferred tax asset will not be realized.
J. Concentration of credit risk - Financial instruments that potentially subject
the Company to significant concentrations of credit risk consisting of cash
and trade receivables. At times the cash in any one bank may exceed the FDIC
$100,000 limit. The Company places its cash with high credit quality
financial institutions. In regards to trade receivables, management believes
the risk is relatively limited due to the credit assessment of its customers.
K. Minority interest - Minority interest represents the minority shareholders'
proportionate share of the equity of the Company's subsidiary, Babylonian
Productions, Inc. which was 49% at June 30, 1999, 1998 and 1997. The minority
interest is adjusted for the minority's share of the earnings or loss of
Babylonian Productions, Inc.
L. Stock based compensation - The Company accounts for stock transactions in
accordance with APB Opinion No.25, "Accounting for Stock Issued to
Employees." In accordance with Statement of Financial Accounting Standards
No.123, "Accounting for Stock based Compensation," and has adopted the pro
forma disclosure requirements of Statement No.123.
F-8
M. Fair value of financial instruments - The carrying amounts reported in the
balance sheet for cash, receivables, accounts payable, and accrued expenses
approximate fair value based on the short-term maturity of these instruments.
N. Impairment of long - lived assets - The Company reviews long-lived assets for
impairment whenever circumstances and situations change such that there is an
indication that the carrying amounts may not be recovered. At June 30, 1999,
the Company believes that there has been no impairment of its long-lived
assets.
O. Comprehensive Income - The Company has adopted Statement of Financial
Accounting Standards No. 130 ("SFAS 130) "Reporting Comprehensive Income".
Comprehensive income is comprised of net loss and all changes to the
statements of stockholders' equity, except those due to investments by
stockholders, changes in paid-in capital and distribution to stockholders.
For the years ended December 31, 1999, 1998 and 1997 the Company had deemed
comprehensive income to be negligible.
3. DISCONTINUED OPERATIONS:
In December 1998, the Company's Board of Directors adopted a plan to discontinue
the operations of Videssence and has instructed management to divest the
subsidiary by the end of calendar year 1999. Management is negotiating with a
potential buyer for the sale of Videssence. Accordingly, Videssence is reported
as a discontinued operation for the years ended June 30, 1999, 1998 and 1997.
Net assets of the discontinued operation at June 30, 1999 are $1,782,605 which
consist primarily of inventory, accounts receivable and intangibles.
The Company accrued a provision for an estimated loss on the divestiture of
Videssence operation of approximately $1,900,000 which includes $750,000 for
pretax operating losses during the phase-out period, which began January 1,
1999.
Summarized results of the discontinued operation are as follows:
For the year ended June 30,
--------------------------------------------
1999 1998 1997
------------ ------------ ------------
Net Sales $ 3,097,775 $ 3,915,786 $ 2,410,987
============ ============ ============
Income (loss) from operations
(net of income tax benefit) $ (727,806) $ (351,330) $ 45,261
Loss on disposal (1,880,956) - -
-------------- ------------- -------------
Total income (loss) on
discontinued operations $ (2,608,762) $ (351,330) $ 45,261
============== ============= =============
F-9
4. RELATED PARTY TRANSACTION:
During the years ended June 30, 1999, 1998 and 1997, the Company rented
trailers, in connection with two of its productions, for approximately $113,000,
$119,000 and $119,000 per annum, respectively, from a company which is 50%
owned by an officer of the Company and his spouse.
During fiscal year ended June 30, 1997, the Company leased some of its recording
equipment for approximately $55,000. The supplier is a company owned by an
officer of the Company's son and administered by the officer's wife.
In March 1996, the Company entered into a consulting agreement which expired in
February 1997, with an individual who through March 1997 was also a member of
the Company's Board of Directors. In March 1997, the Company entered into a
new six month consulting agreement with the same individual for monthly fee of
$3,000.
In March 1998, the Company entered into a one year consulting agreement, with a
former member of the Company's Board of Directors. The agreement had a minimum
annual guarantee of $50,000 and incentives based on additional projects
initiated by the consultant.
5. PRODUCTION COSTS:
Production costs consist of the following:
June 30,
-------------------------
1999 1998
Story rights and scenarios $ 350,881 $ 251,632
Production costs are deferred and will be amortized under the Individual Film
Forecast Method. Production costs will be amortized in relation to the revenue
recognized from each production, and amortization will be calculated based on
management's latest estimate of the production's gross profit margin over its
remaining life, which requires the Company to use estimates of the future
revenue generating potential of each production. Such estimates are subject to
a variety of cost factors. These estimates will be re-evaluated periodically
and, when necessary, production costs will be written down to net realizable
value.
F-10
6. EQUIPMENT:
Equipment consists of the following:
June 30,
---------------------------
1999 1998
------------ ------------
Leasehold improvement $ 112,614 $ 108,918
Furniture and office equipment 234,373 217,488
Computer equipment 285,239 263,245
Post-production, animation and
compositing equipment 3,959,538 3,032,180
------------ ------------
4,591,764 3,621,831
Less: accumulated depreciation 1,482,874 667,230
------------ ------------
$ 3,108,890 $ 2,954,601
============ ============
The Company has equipment under capital leases as follows:
June 30,
--------------------------
1999 1998
------------ ------------
Furniture and office equipment $ 225,124 $ 212,830
Computer equipment 62,609 62,609
Post-production, animation and
compositing equipment 2,772,709 2,015,092
------------ ------------
$ 3,060,442 $ 2,290,531
7. DEBT:
Debt consists of the following:
Note payable, net of discount of $240,000, non-
interest bearing due March 29, 2002 convertible
into 500,000 shares of the Company's common
stock. $ 760,000
Notes payable on demand, bearing interest at
10% per annum. 450,000
-----------
$1,210,000
The estimated fair value of the Company's debt approximates its carrying amount.
F-11
8. CAPITAL LEASE OBLIGATIONS:
Current Long-term Total
portion
------------- ------------- ------------
Total minimum lease payments $ 1,134,819 $ 1,056,890 $ 2,191,709
Less: amounts representing
interest 137,779 56,551 194,330
------------- ------------- -------------
Amounts representing principal $ 997,040 $ 1,000,339 $ 1,997,379
============= ============= =============
Future minimum payments are due as follows:
Year ended June 30,
2000 $ 997,041
2001 $ 856,622
2002 $ 143,716
------------
Total $ 1,997,379
============
9. COMMITMENT AND CONTINGENCIES:
In July 1997, the Company entered into a new seven year lease agreement for its
principal executive offices expiring in June 2004 at an annual rental of
$277,000 with the option to extended the lease for two additional five years
terms. The Company also leases space for its manufacturing facilities under
a noncancellable three year operating lease requiring annual rent of $77,000
expiring November 2000. Rent expense under all operating leases for the years
ended June 30, 1999, 1998 and 1997 including its discontinued manufacturing
facilities and its sound stage facilities were approximately $807,000, $785,000
and $509,000, respectively.
The future minimum rental payments including the Company's discontinued
manufacturing facility as of June 30, 1999 are as follows:
Year ended June 30,
2000 $ 393,000
2001 $ 333,000
2002 $ 290,000
2003 $ 290,000
2004 $ 145,000
F-12
10. STOCKHOLDERS' EQUITY:
In September 1995, the Company issued an aggregate of 125,000 three year
warrants in connection with a bridge financing. Each warrant is exercisable
for one share of common stock at a price of $4.00 per share; 75,000 of these
warrants were exercised for proceeds of $300,000.
In November 1995, the Company completed a public offering of its securities,
selling 860,000 shares of common stock and 430,000 warrants for net proceeds of
approximately $3,200,000. The warrants are exercisable to purchase one share of
common stock at a price of $6.50 per share. The warrants are exercisable at any
time after issuance and expire in November 1999. The underwriters of the public
offering received a warrant to purchase up to 129,000 shares or warrants, or any
combination thereof. The warrant is exercisable for a period of four years
commencing November 20, 1996 at an exercise price of $6.00 per share and $.012
per warrant.
Preferred Stock
The Company is authorized to issue 2,000,000 shares of preferred stock, $.001
par value, the terms of which (including, without limitation, dividend rate,
conversion rates, voting rights, terms of redemption and liquidation
preferences) may be fixed by the Board of Directors at their sole discretion.
During the year ended June 30, 1997 the Company sold 47,145 shares of Series A
Cumulative, Convertible Preferred Stock ("Series A Preferred Stock") at a price
of $9.00 per share. Dividends will be paid in nonassessable shares of Series A
Preferred Stock in an amount per share equal to 10% per annum. Each share of
Series A Preferred Stock is convertible at any time at the option of the holder
into three shares of common stock. The Series A Preferred Stock is redeemable,
in whole or in part, at the option of the Company, for cash at a redemption
price of $9.00 per share.
Stock Options and Warrants
The Company adopted a Stock Option Plan ("Plan") in September 1995. The Plan is
administered by a committee of two ("Committee") appointed by the Board of
Directors and provides that the Committee has sole discretion to select options
and to establish terms and conditions of each option, subject to provisions of
the Plan. If options granted are "incentive stock options", the exercise price
of the options may not be less than 100% of the fair market value of the
Company's common stock on the date of grant (110% of the fair market value if
the grant is to an employee who owns more than 10% of the outstanding common
stock). Nonstatutory options may be granted under the Plan at an exercise price
of not less than 85% of fair market value of the common stock at the date of
grant. The maximum grant term is 10 years. The Plan is designed for officers,
directors, and other key employees and is authorized to grant up to 500,000
options. As of June 30, 1999, 481,400 options have been granted at price
ranging from $1.31 to $10.25 per share and no options have been exercised.
In November 1997 the Company adopted the 1997 Incentive Stock Option Plan ("1997
Plan"). The 1997 Plan is administered by the Board of Directors (the "Board")
and provides that the Board has sole discretion to grant options and to
establish terms and conditions of each option, subject to provisions of the
Plan. If options granted are "incentive stock options", the exercise price of
the options may not be less than 100% of the fair market value of the Company's
common stock on the date of grant (110% of the fair market value if the grant is
to an employee who owns more than 10% of the outstanding common stock). The
maximum grant term is 10 years. The Plan is designed for officers, employee
directors, and other key employees and is authorized to grant up to 600,000
options. As of June 30, 1999, 449,700 options have been granted at prices of
$1.25 - $2.48 per share and no options have been exercised.
F-13
In November 1997, the Company adopted the 1997 Directors' Stock Option Plan
("1997 Directors' Plan"). The 1997 Directors' Plan is administered by a
committee of the Board of Directors and provides that the committee shall adopt
all rules and regulations and make other determinations that are desirable for
the administration of the 1997 Directors' Plan. Each Non-Employee Director
shall be automatically be granted 30,000 options to purchase shares of common
stock upon initial election to the Board and will be granted 10,000 additional
options upon each subsequent reelection to the Board. The purchase price of
these options shall be the fair market value on the date of the grant. The 1997
Directors' Plan is designed for Non-Employee Directors and is authorized to
grant up to 350,000 options. As of June 30, 1999, 80,000 options have been
granted at a prices of $2.25 - $2.88 per share and no options have been
exercised.
During the year ended June 30, 1999, the Company borrowed an aggregate of
$1,000,000 through the issuance of non-interest bearing senior subordinated
notes maturing on March 29, 2002. In connection with the issuance of the notes,
the borrower also received 750,000 warrants expiring March 29, 2004 for the
purchase of the Company's Stock at an exercise price of $2.50 per share. Such
warrants have been valued at $240,000. The notes are convertible into shares of
the Company's common stock at a conversion rate of $2.00 per share.
For disclosure purposes the fair value of each stock option grant is estimated
on the date of grant using the Black-Scholes option-pricing model with the
following weighted-average assumptions used for stock options granted during
the years ended June 30, 1999, 1998 and 1997, respectively: annual dividends of
$0.00 for both years, expected volatility of 50%, risk-free interest rate of
6.0% and expected life from two to five years for all grants. The
weighted- average fair values of the stock options granted during the years
ended June 30, 1999, 1998 and 1997 were $1.27, $1.95 and $1.71, respectively.
If the Company recognized compensation cost for the employee stock option plan
in accordance with SFAS No. 123, the Company's pro forma net income (loss) and
income (loss) per share would have been $(3,875,399) and $(1.16) in 1999,
$(182,8200) and $(0.05) in 1998 and $35,339 and $0.01 in 1997.
F-14
The following table summarizes the changes in options and warrants outstanding
and the related price ranges for shares of the Company's common stock:
<TABLE>
<CAPTION>
Options Warrants
------------------------------------- -------------------------------------
Number Price Number of Number Price Number of
of Shares Per Share Shares of Shares Per Share Shares
Range Exercisable Range Exercisable
---------- ------------ ----------- ---------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at
July 1, 1996 402,000 $5.00-$10.25 120,400 683,500 $4.00-$6.50 50,000
=========== ===========
Granted 220,000 $3.00-$4.38 - - -
Exercised - - - (10,000) -
Canceled (100,000) - - - -
----------- -----------
Outstanding at
June 30, 1997 522,000 $3.00-$10.25 206,800 673,500 $4.00-$6.50 673,500
=========== ===========
Granted 589,500 $1.81-$7.50 - 64,145 $3.50-$7.50
Exercised - - - - -
Canceled (139,300) - - - -
----------- -----------
Outstanding at
June 30, 1998 972,200 $1.81-$10.25 556,750 737,645 $3.50-$7.50 737,645
Granted 482,200 $1.25-$7.50 750,000 $2.50
Exercised - - - - -
Canceled (28,300) (50,000)
----------- ------------
Outstanding at
June 30, 1999 1,426,100 $1.25-$10.25 868,750 1,437,645 $2.50-$7.50 1,437,645
=========== =========== =========== ===========
</TABLE>
11. EMPLOYMENT AGREEMENTS:
The Company has agreements for the services of certain of its officers. Such
agreements expire in September 2000 and provide for a base compensation of
approximately $700,000. These agreements also provide for additional
compensation based on certain revenue or other operating results and for
payments by the Company in the event of death, disability, or termination. The
aggregate amounts paid pursuant to such agreements was $693,000, $709,000 and
$673,000 for the years ended June 30, 1999, 1998 and June 30, 1997,
respectively.
Subsequent to June 30, 1999, the Company entered into a two year employment
agreement with its new senior vice-president at an annual compensation of
$200,000.
F-15
12. INCOME TAXES:
The provision (benefit) for income taxes consists of the following:
June 30,
----------------------------------------
1999 1998 1997
------------ ------------ ------------
Current federal and state
income taxes $ 37,526 $ 223,000 $ 15,000
Deferred federal and state
income tax benefit (150,000) - -
------------ ------------ ------------
$ (112,474) $ 223,000 $ 15,000
The provision for income taxes differs from the amount computed by applying the
statutory federal income tax rate to income before provision for income taxes is
as follows:
June 30,
----------------------------------------
1999 1998 1997
----------- ----------- -----------
Income (benefit) tax provision
computed at the statutory rate $(1,128,000) $ 250,000 $ 54,000
Income tax benefit recognized - (70,000) (30,000)
Deductions for which no benefit
recognized 978,000 - -
Tax rate differences - - (14,000)
Provision for state income taxes 37,526 43,000 5,000
------------ ------------ ------------
Income tax (benefit) provision $ (112,474) $ 223,000 $ 15,000
============ ============ ============
The Company has a net operating loss carryforward for tax purposes totaling
approximately $2,700,000 at June 30, 1999 expiring in the years 2011 to 2017.
F-16
Listed below are the tax effects of the items related to the net Company's tax
asset:
Tax benefit of net operating loss carryforward $ 783,000
Depreciation 95,000
------------
Total 878,000
Expenses not currently deductible (38,000)
Valuation allowance (690,000)
------------
Net deferred tax asset recorded $ 150,000
============
13. SIGNIFICANT CONCENTRATIONS:
During the years ended June 30, 1999, 1998 and 1997, the Company derived
approximately 75%, 93% and 99%, respectively, of its entertainment revenue
from one distributor.
F-17
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The information required by this item is incorporated by reference from the
Company's definitive proxy statement for its Annual Meeting of Stockholders
scheduled to be held on November 19, 1999.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from the
Company's definitive proxy statement for its Annual Meeting of Stockholders
scheduled to be held on November 19, 1999.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT
The information required by this item is incorporated by reference from the
Company's definitive proxy statement for its Annual Meeting of Stockholders
scheduled to be held on November 19, 1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference from the
Company's definitive proxy statement for its Annual Meeting of Stockholders
scheduled to be held on November 19, 1999.
16
PART IV
ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K
(a) 1. FINANCIAL STATEMENTS
Reports of Independent Auditors.
Consolidated Balance Sheets as of June 30, 1999 and 1998.
Consolidated Statements of Income for the years ended June 30, 1999, 1998,
and 1997.
Consolidated Statements of Stockholders' Equity for the years ended June
30, 1999, 1998, and 1997.
Consolidated Statements of Cash Flows for the years ended June 30, 1999,
1998, and 1997.
Notes to Consolidated Financial Statements.
2. FINANCIAL STATEMENT SCHEDULES
All schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required
under the related instructions or are inapplicable, and therefore have
been omitted.
3. Exhibits (numbered in accordance with Item 601 of regulation S-K).
Exhibit Description
Number
- ------- -----------
2.1 Agreement and Plan of Merger and Reorganization, as amended. (5)
2.2 Amendment No. 2 to the Agreement of Merger and Reorganization. (6)
2.3 Amendment No. 3 to the Agreement of Merger and Reorganization. (7)
2.4 Amendment No. 4 to the Agreement of Merger and Reorganization. (7)
2.5 Amendment No. 5 to the Agreement of Merger and Reorganization. (7)
3.1 Certificate of Incorporation. (1)
3.2 Bylaws. (1)
4.1 Certificate of Designation. (8)
4.2 Purchase Agreement dated March 29,1999 between the Company and AIB.
(14)
4.3 Warrant dated March 29, 1999. (14)
4.4 Standstill Agreement dated March 29, 1999. (14)
4.5 Note Payable between the Company and Allco Financial Group Limited
dated June 10, 1999. (15)
10.1 Mr. Netter's Employment Agreement. (1)
10.2 Mr. Copeland's Employment Agreement. (1)
10.3 "Babylon 5" Production Agreement. (1)
10.4 1995 Stock Option Plan. (1)
10.5 Talbot Consulting/Completion Fee Agreement. (6)
10.6 Warrant, dated September 4, 1997, issued to W.J. Gallagher &
Company. (9)
10.7 Letter Agreement, dated September 1, 1997, between the Company and
H.D. Brous & Co., Inc. (9)
10.8 Stock Option Agreement, dated September 1, 1997, between the
Company and H.D. Brous & Co., Inc. (9)
10.9 Lease for premises at 5125 Lankershim Blvd., North Hollywood, CA.
(9)
17
10.10 Equipment and furniture lease with Lyon Credit Corporation. (9)
10.11 Equipment lease with Terminal Marketing Company. (9)
10.12 Installment note and Loan and Security Agreement with Comerica
Bank. (9)
10.13 Mr. Costa's Employment Agreement. (9)
10.14 Mr. Francis's Employment Agreement. (9)
10.15 Mr. Cercone's Employment Agreement. (9)
10.16 Letter agreement, dated October 20, 1997, between the Company and
Martin E. Janis & Company, Inc. (10)
10.17 Consulting Agreement, dated October 1, 1997, by and between Netter
Digital Entertainment, Inc. and Geoffrey Talbot. (11)
10.18 Stock Option Agreement, dated October 1, 1997, by and between
Netter Digital Entertainment, Inc. and Geoffrey Talbot. (11)
10.19 Equipment lease with Comerica Leasing Corporation. (12)
10.20 Equipment lease with Digital Financial Services. (12)
10.21 Amendment to Employment Agreement, Douglas Netter. (13)
10.22 Amendment to Employment Agreement, John Copeland. (13)
10.23 Employment Agreement, Jay Fukuto. (15)
20 Press release, dated March 31, 1999. (14)
21 List of Subsidiaries. (9)
27 Financial Data Schedule. (13)
---------------------------
(1) Incorporated by reference to the Company's Registration Statement on Form
SB-2 (Registration Number is 33-97402-LA) declared effective November 20, 1995.
(2) Incorporated by reference to the Company's Registration Statement on Form
8-A dated November 20, 1995.
(3) Incorporated by reference to the Company's Form 10-QSB for the quarter ended
December 31, 1995.
(4) Incorporated by reference to the Company's Form 10-QSB for the quarter ended
March 31, 1996.
(5) Incorporated by reference to the Company's Proxy Statement , dated June 26,
1996 for the approval/disapproval of the proposed merger between the Company and
Videssence, Inc.
(6) Incorporated by reference to the Company's Form 10-KSB for the year ended
June 30, 1996.
(7) Incorporated by reference to the Company's Form 8-K dated January 10, 1997.
(8) Incorporated by reference to the Company's Form 10-QSB for the quarter ended
September 30, 1996.
(9) Incorporated by reference to the Company's Form 10-KSB for the year ended
June 30, 1997.
(10) Incorporated by reference to the Company's Form 10-QSB for the quarter
ended September 30, 1997.
(11) Incorporated by reference to the Company's Form 10-QSB for the quarter
ended December 31, 1997.
(12) Incorporated by reference to the Company's Form 10-QSB for the quarter
ended March 31, 1998.
18
(13) Incorporated by reference to the Company's Form 10-KSB for the year ended
June 30, 1998.
(14) Incorporated by reference to the Company's Form 10-Q for the quarter ended
March 31, 1999.
(15) Filed herewith.
(b) REPORTS ON FORM 8-K
During the last quarter of the period covered by this report, the Company filed
one report on Form 8-K. In that report, filed on April 8, 1999, the Company
reported, that on March 29, 2000, (i) it obtained the $1.0 million Facility
from AIB, with each increment of principal drawn on the funding facility being
evidenced by a non-interest bearing Senior Subordinated Convertible Note,
due March 29, 2002, convertible into shares of the Company's common stock at a
conversion rate of $2.00 per share, subject to anti-dilution adjustments, and
(ii) the Company issued AIB five-year warrants to purchase up to 750,000 shares
of the Company's common stock, at an exercise price of $2.50 per share, subject
to anti-dilution adjustments. For further discussion of the Facility, see
"Liquidity and Capital Resources."
19
SIGNATURE
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
NETTER DIGITAL ENTERTAINMENT, INC.
Dated: September 24, 1999 By: /s/Chad Kalebic
Chad Kalebic, Chief Financial Officer
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the Registrant and in the capacities and on the
dates indicated.
SIGNATURE TITLE DATE
- --------- ----- ----
/s/Douglas Netter Chairman of the Board of September 24, 1999
Douglas Netter Directors, Chief Executive
Officer, and President
(Principal Executive Officer)
/s/John Copeland Executive Vice President and Septmeber 24, 1999
John Copeland Secretary/Director
/s/Chad Kalebic Chief Financial Officer September 24, 1999
Chad Kalebic (Principal Financial and
Accounting Officer)
/s/Paul Costa Director September 24, 1999
Paul Costa
/s/Dr. Leonard Silverman Director September 24, 1999
Dr. Leonard Silverman
/s/Kate Netter Forte Director September 24, 1999
Kate Netter Forte
/s/Lennart Ringquist Director September 24, 1999
Lennart Ringquist
20
NETTER DIGITAL ENTERTAINMENT, INC.
Senior Subordinated Note
Note Due On Demand
Subsequent to June 30, 1999
No. BN-1 June 10, 1999
NETTER DIGITAL ENTERTAINMENT, INC., a Delaware corporation (the "Company"), for
value received, hereby, promises to pay to Allco Finance Group Limited ("AFGL")
or registered assigns on demand made on anytime after June 30, 1999 (the "Demand
Date") the principal amount of FOUR HUNDRED FIFTY THOUSAND DOLLARS ($450,000.00)
with an interest rate of 10% per annum, calculated on a daily basis. Such
amount shall be due and payable within seven (7) business days from the date
demand is made on the Company. The Company agres to pay interest on overdue
principal, if any, at the rate of the lesser of (a) the maximum interest rate
permitted by law and (b) 15% (the "Overdue Rate") per annum from the date such
payment is due until paid.
Both the principal hereof and interest hereon are payable as directed by AFGL
in coin or currency of the United States of America which at the time of payment
shall be legal tender for the payment of public and private debts. If any
amount of principal or interest, if any, on or in respect of this Note becomes
due and payable on any date which is not a Business Day, such amount shall be
payable on the next preceeding Business Day.
This Note is registered on the books of the Company and is transferable only by
surrender thereof at the principal office of the Company duly endorsed or
accompanied by a writted instrument or transfer duly executed by the registered
holder of this Note or its attorney duly authorized in writing. Payment of or
on account of principal and interest, if any, on this Note shall be made only to
or upon the order in writing of the registered holder.
This note is govered by and construed in accordance with the internal laws of
California.
NETTER DIGITAL ENTERTAINMENT, INC.,
a Delaware corporation
/s/Douglas Netter
- -----------------
Douglas Netter
Title: Chief Executive Officer
/s/Chad Kalebic
- ---------------
Chad Kalebic
Title: Chief Financial Officer
EMPLOYMENT AGREEMENT
This Employment Agreement (this "Agreement") is entered into as of the 7th
day of September, 1999 by and between NETTER DIGITAL ENTERTAINMENT, INC., a
Delaware Corporation ("Company"), and Jay Fukuto ("Employee"):
1. ENGAGEMENT.
(a) Engagement; Title: Company hereby engages Employee, to render services as
a Senior Vice President in charge of Animation of Company and Employee hereby
accepts such engagement.
(b) Reporting. Employee shall report and be subject to the overall direction
and supervision of Douglas Netter, President and John Copeland, Executive Vice
President.
2. NATURE AND PLACE OF SERVICES:
(a) Employee shall be primarily responsible for development and production of
animated productions and will render all services usually and customarily
rendered by and required of executives similarly employed in the entertainment
industry, as well as such other services as may be reasonably required by
Company.
(b) Employee shall render his services for the Company in Los Angeles County,
California.
(c) Employee shall be accorded credit on screen on a case by case basis
pursuant to the Company's practices.
3. EXCLUSIVITY: Employee shall work full-time for Company and its affiliates
during the Term hereof. Without limiting the foregoing, Employee's services
shall be rendered exclusively to Company and its affiliates hereunder during the
Term (as defined below) of this Agreement, and Employee shall not render
services of any nature to or for any other person, firm or corporation during
the Term of this Agreement without the prior written consent of Company. For so
long as Employee is employed pursuant to the terms hereof. Notwithstanding,
Company acknowledges that Employee is currently working on a project based on
"Viet Nam Veterans." (the "Project"). Employee shall endeavor to attach Company
to produce the Project. However, should Company not be attached, Employee may
pursue the production of the Project elsewhere, so long as Employee's services
on the Project do not materially interfere with Employee's obligations to
Company pursuant to the terms and conditions of this Agreement.
4. TERM: The term of this Agreement ("Term") shall commence on September 7,
1999 and, subject to termination as hereinafter provided, expire with the close
of business on September 6, 2001.
5. COMPENSATION:
(a) Fixed Salary. As consideration for the services to be rendered by
Employee pursuant hereto, and upon condition that Employee is substantially
performing all of the services required hereunder, that Employee is not in
material default, and that grounds do not then exist under this Agreement for
the termination of Employee hereunder, Company will pay or will cause to be paid
to Employee, subject to all applicable laws and requirements respecting
withholding of federal, state, and/or local taxes, a fixed annual salary,
payable in equal installments, no less frequently than semi-monthly, in the
amount of Two Hundred Thousand Dollars ($200,000)
(b) Stock Options: Company shall, effective upon the next Board of
Director's meeting ("Strike Date"), but no later than October 8, 1999, grant to
Employee an option to purchase Fifty Thousand (50,000) shares ("Option Shares")
of Company's Common Stock at a purchase price as set by the Board of Directors
on the Strike Date, subject to the terms and conditions of that certain Employee
Stock Option Plan dated as of August 29, 1997 (the "Stock Option Plan").
(c) Employee Benefits:
(i) Reimbursements: Company shall reimburse Employee for all ordinary
and necessary business, entertainment, travel and other expenses reasonably
incurred by Employee in the performance of Employee's duties and obligations
under this Agreement. Company agrees to repay or reimburse Employee for such
business expenses upon the presentation of itemized statements of such business
expenses in accordance with Company's policy.
(ii) Annual Vacations: Employee shall be entitled to take two (2) weeks
annual vacation for each Term Year.
(iii) Employee Benefits: Company shall provide Employee with health
insurance no less favorable in benefits than any other employee of Company. To
the extent that Company establishes any other employee benefit plan which
provides benefits to executives of Company generally, Employee shall be entitled
to participate in such plan pursuant to the terms thereof, except that Company
may exclude, except to the extent provided in paragraph 5(b) above, Employee's
participation in any plan which is a stock option plan or plan similar to a
stock option plan.
6. REPRESENTATIONS AND WARRANTIES:
(a) Representations of Employee. Employee represents and warrants that
Employee has all right, power, authority and capacity, and is free to enter into
this Agreement; that by doing so, Employee will not violate or interfere with
the rights of any other person or entity; and that Employee is not subject to
any contract, understanding or obligation which will or might prevent, interfere
with or impair the performance of this Agreement by Employee. Employee will
indemnify and hold Company harmless with respect to any losses, liabilities,
demands, claims, fees, expenses, damages and costs (including attorneys fees and
court costs) resulting from or arising out of any claim or action based upon
Employee's entering into this Agreement.
(b) Representations of Company. Company represents and warrants that Company
has all right, power and authority, without the consent of any other person, to
execute and deliver, and perform its obligations under, this Agreement. All
corporate and other actions required to be taken by Company to authorize the
execution, delivery and performance of this Agreement and the consummation of
all transactions contemplated hereby have been duly and properly taken. This
Agreement is the lawful, valid and legally binding obligation of Company,
enforceable in accordance with its terms.
7. RELATIONSHIP AND COVENANTS OF EMPLOYEE:
(a) Covenant Not To Disclose: Employee shall not at any time during or
after the termination of the Term, knowingly reveal, divulge or make known to
any person (other than Company or its affiliates) or use for Employee's own
account any confidential information concerning or used by Company of which
Employee was apprised or otherwise had become aware during the term of
Employee's employment by Company (excluding any such information which becomes
public for reasons other than Employee's breach of this Agreement or which
Employee is required to disclose by law).
(b) Covenant to Deliver Records: All memoranda, notes, records and other
documents made or compiled by Employee, or made available to Employee during the
term of this Agreement concerning the business of Company shall be Company's
property and shall be delivered to Company on the termination of this Agreement
or at any other time on request. Employee shall keep in confidence and shall not
use for Employee or others, or divulge to others, any secret or confidential
information, knowledge or data of Company obtained by Employee as a result of
Company's employment, unless authorized by Company or required by law. Employee
shall be entitled to retain for his own records only copies of any and all
memoranda, notes, records and other documents made or compiled by Employee
during the Term of this Agreement.
(c) Covenant Not To Divert: Employee shall not so long as Employee is
employed hereunder, or if such employment shall terminate during or at the
expiration of the Term, for a period of one year following such termination,
directly or indirectly, either on Employee's own behalf, or as a member of a
partnership, joint venture or corporation, or as an employee or agent on behalf
of any person, firm, partnership, joint venture or corporation, either
(i) solicit, induce (or attempt to induce), or endeavor to entice away any
clients of Company (unless Company consents in writing), (ii) solicit, divert,
or seek to develop or exploit any existing entertainment projects on which
Company is working at the time of termination (unless Company thereafter advises
Employee in writing that it has abandoned such project) , or (iii) solicit,
interfere with, induce (or attempt to induce) or endeavor to entice away any
employee associated with Company to become affiliated with him or any other
person, firm, partnership, joint venture, corporation or business organization.
Notwithstanding the foregoing, Employee will not induce a breach or interfere
with Company's contractual rights with any third parties. Employee may
undertake business with clients, talent and/or others where such business does
not violate the preceding sentence.
(d) Limitations on Covenants: The provisions under this Paragraph 7 shall
survive the termination of this Agreement. The parties hereto agree that in the
event any of the provisions set forth in this Paragraph 7 are held by any court
or other duly constituted legal authority to be effective in any particular area
or jurisdiction only if modified to limit their duration or scope or to be void
or otherwise unenforceable in any particular area or jurisdiction, then such
provisions shall be deemed amended and modified with respect to that particular
area or jurisdiction so as to comply with the order of any such court or other
duly constituted legal authority and, as to all other areas and jurisdictions,
and as to all other provisions of this Paragraph 7, such provisions shall remain
in full force and effect as set forth in this Agreement.
(e) Remedies: Employee acknowledges that Company will have no adequate
remedy at law if Employee violates the terms of the provisions of this Paragraph
7 or any other provisions of this Agreement (including, without limitation, the
exclusivity provisions of Paragraph 3, above). In such event, Company shall have
the right, in addition to any other rights it may have, to obtain in any court
of competent jurisdiction injunctive relief to restrain any breach or threatened
breach or specific performance of this Agreement.
8. CERTAIN RIGHTS OF COMPANY: Company shall have the right (but not the
obligation) to use, publish and broadcast, and to authorize others to do so, the
name, approved likeness and approved biographical material of Employee to
advertise, publicize and promote the business of Company and of affiliates,
but not for the purposes of direct endorsement without Employee's consent. An
"approved likeness" and "approved biographical material" shall be, respectively,
any photograph or other depiction of Employee, or any biographical information
or life story concerning the professional career of Employee, which has been
submitted to and approved by Employee prior to its first use, publication or
broadcast, such approval not to be unreasonably withheld.
9. TERMINATION:
(a) Disability: If Employee shall be rendered incapable by illness (physical
or mental disability) of substantially complying with the material terms,
provisions and conditions hereof on his part to be performed for a period in
excess of 45 consecutive days or 90 days in the aggregate during the Term, then
Company may, at its option, prior to the date Employee resumes the rendering of
services, terminate this Agreement by written notice to that effect sent by
registered or certified mail. Such termination shall terminate any and all
obligations to Employee under this Agreement effective as of the date of such
written notice except (i) Employee's right to receive the Fixed Salary in
Paragraph 5(a) for the Term Year in which the date of such written notice falls,
pro-rated to the date of such written notice, and (ii) Employee's vested rights
with respect to the option set forth in the Employee Stock Option Plan.
(b) Death: If Employee dies during the Term of this Agreement, such death
shall terminate any and all obligations to Employee under this Agreement
effective as of the date of death except (i) Employee's right to receive the
Fixed Salary in Paragraph 5(a) for the Term Year in which the date of death
falls, pro-rated to the date of death, and (ii) Employee's vested rights with
respect to the option set forth in the Employee Stock Option Plan.
(c) Cause Company may terminate Employee's employment hereunder for cause,
which shall mean (i) indictment of Employee for a felony or a crime involving a
high degree of moral turpitude, (ii) the commission by Employee of an act or
acts of dishonesty constituting a crime, which act or acts are intended to
result directly or indirectly, in gain or personal enrichment at the expense of
Company or any of its subsidiaries or affiliates by Employee, (iii)
certification by a medical doctor that Employee is a habitual alcoholic or is a
narcotic addict, (iv) Employee's material breach of this Agreement. To the
extent that a breach pursuant to subparagraph (iv) is curable by Employee
without harm to Company or its reputation, then Company shall, instead of
immediately terminating Employee pursuant to this Paragraph, provide Employee
with notice of such breach and, specifying the actions required to cure such
breach. Employee shall have ten days to cure such breach by performing the
actions so specified. If Employee fails to cure such breach within the ten day
period, Company may terminate Employee. Any termination pursuant to this
Paragraph shall terminate any and all obligations to Employee under this
Agreement and the Stock Option Agreement effective as of the date of such
written notice except Employee's right to receive the Fixed Salary in Paragraph
5(a) for the Term Year in which the date of such written notice falls, pro-rated
to the date of such written notice.
(d) At Convenience of Company: Company shall have the absolute and
unconditional right to terminate Employee's employment hereunder at any time,
other than pursuant to Paragraphs 9(a), 9(b) or 9(c), by a ninety day (90)
written notice to that effect delivered in person or sent by registered or
certified mail. Such termination shall terminate any and all obligations to
Employee under this Agreement, subject to Company's obligation to pay Employee
the remaining Compensation due and owing to Employee, on Company's regular
payroll periods for the balance of the Term and Employee's vested rights, if
any, with respect to the grant of options set forth in paragraph 5(b), above.
Notwithstanding the foregoing, any compensation due and owing to Employee
hereunder shall be subject to offset based on any money paid or payable to
Employee for services rendered to third parties, during the balance of the
Term.
10. ARBITRATION:
(a) The terms of this Paragraph 10.contain the sole and exclusive method,
means and procedure to resolve any and all claims, disputes or disagreements
arising under this Agreement, except those arising under the provisions of
Paragraph 8, above. The parties irrevocably waive any and all rights to the
contrary and shall at all times conduct themselves in accordance with the terms
of this Paragraph 10; any attempt to circumvent the terms of this Paragraph 10
shall be null and void and of no force or effect.
(b) Within ten (10) days after delivery of written notice (the "Notice of
Dispute") of the existence and nature of any dispute given by any party to the
other party, and unless otherwise provided herein in any specific instance, the
parties shall each (i) appoint one (1) lawyer or retired judge licensed to
practice law in the County of Los Angeles for a continuous period immediately
preceding the date of delivery (the "Dispute Date") of the Notice of Dispute
of not less than ten (10) years, but who has at no time ever represented or
acted on behalf of any of the parties, and (ii) deliver written notice of the
identity of such lawyer and a copy of his or her written acceptance of such
appointment and acknowledgment of and agreement to be bound by the time
constraints and other terms of this Paragraph 10 (the "Acceptance") to the other
party hereto. In the event that any party fails to so act, that party's
arbitrator shall be appointed pursuant to the same procedure that is followed
when agreement cannot be reached as to the third arbitrator. Within ten (10)
days after such appointment and notice, such lawyers shall appoint a third
lawyer (who, together with the first two (2) lawyers, shall hereinafter be
referred to collectively as the "Arbitration Panel") of the same qualification
and background as the first two (2) lawyers (including the qualification that he
or she has at no timeever represented or acted on behalf of any of the parties)
and shall deliver written notice of the identity of such lawyers and a copy of
his or her written Acceptance of such appointment to each of the parties. If
agreement cannot be reached on the appointment of a third lawyer within such
period, such appointment and notification shall be made as rapidly as possible
by any court of competent jurisdiction, by any licensing authority, agency or
organization having jurisdiction over such lawyers, by any professional
association of lawyers in existence for not less than ten (10) years at the time
of such dispute or disagreement and the geographical membership boundaries of
which extend to the County of Los Angeles, or by any arbitration association or
organization in existence for not less than ten (10) years at the time of such
dispute or disagreement and the geographic boundaries of which extend to the
County of Los Angeles, as determined by the party giving such Notice of Dispute
and simultaneously confirmed in writing delivered by such party to the other
party. Any such court, authority, agency, association or organization shall be
entitled either to directly select such third lawyer or to designate in writing
delivered to each of the parties an individual who shall do so. In the event of
any subsequent vacancies or inabilities to perform among the Arbitration Panel,
the lawyer or lawyers involved shall be replaced in accordance with the terms of
this Paragraph 10 as if such replacement was an initial appointment to be made
under this Paragraph 10 within the time constraints set forth in this Paragraph
10, measured from the date of notice of such vacancy or inability to the person
or persons required to make such appointment, with all attendant consequences of
failure to act timely if such appointment is not so made. Unless the parties
shall otherwise agree, all arbitration proceedings shall be conducted at such
location within Los Angeles County as the members of the Arbitration Panel shall
by majority vote from time to time designate.
(c) The Arbitration Panel shall (i) enforce and interpret the rights and
obligations set forth in this Agreement to the extent not prohibited by law,
(ii) fix and establish any and all rules as it shall consider appropriate in its
sole and absolute discretion to govern the proceedings before it, including any
and all rules of discovery, procedure and/or evidence, provided however, that
such rules shall be consistent with such rules established by the American
Arbitration Association and (iii) make and issue any and all orders, final or
otherwise, and any all awards, as a court of competent jurisdiction sitting at
law or in equity could make and issue and as it shall consider appropriate in
its sole and absolute discretion, including the awarding of monetary damages
(but specifically excluding the awarding of consequential, punitive or exemplary
damages or the awarding of attorneys' fees and costs to either party) to the
prevailing party as determined by the Arbitration Panel in its sole and absolute
discretion, and the issuance of injunctive relief.
(d) The decision of the Arbitration Panel shall be final and binding, and may
be confirmed and entered by any court of competent jurisdiction at the request
of any party and may not be appealed to any court of competent jurisdiction or
otherwise, except upon a claim of fraud on the part of any member of the
Arbitration Panel (except as to the arbitrator chosen by the party claiming the
fraud), or on the basis of a manifest error as to the applicable law. The
Arbitration Panel shall retain jurisdiction over any dispute until its award has
been implemented, and judgment on any such award may be entered in any court
having appropriate jurisdiction and may be enforced against either party and its
assets pursuant to applicable laws and procedures.
(e) The compensation and expenses of the Arbitrators shall be borne by the
non-prevailing party as determined by the Arbitration Panel in its sole and
absolute discretion, unless the Arbitration Panel does not make a determination
that one of the parties is the prevailing party, in which case the parties shall
bear the cost as fixed by the Arbitration Panel.
11. GENERAL:
(a) Assignment; Successors; Affiliates. Company may assign this Agreement (or
the interest of Company therein) to any affiliate of Company or to any entity
which is a party to a merger, reorganization, or consolidation with Company or
to a subsidiary of Company or to an entity or entities acquiring substantially
all of the assets of Company or of any division with respect to which Employee
is providing services (providing any such assignee assumes Company's obligations
under this Agreement). Employee shall, if requested by Company, perform
Employee's services and duties, as specified in this Agreement, to or for the
benefit of any subsidiary or other affiliate of Company. Upon such assignment,
acquisition, merger, consolidation, or reorganization, the term "Company" as
used herein shall be deemed to refer to such assignee or such successor entity.
Notwithstanding anything herein to the contrary, no assignment by Company may
change the reporting provision of paragraph 1(b), above. Should both Douglas
Netter and John Copeland cease working full time for the Company, Employee may
terminate this Agreement, subject to thirty (30) days prior written notice.
Should Employee elect such termination, Employee's stock options ganted pursuant
to paragraph 5(b) above, shall vest, if at all, pursuant to terms and conditions
of the Stock Option Plan. Employee shall not have the right to assign
Employee's interest in this Agreement, any rights under this Agreement or any
duties imposed under this Agreement nor shall Employee (or Employee's spouse,
heirs, beneficiaries, administrator's or executors) have the right to pledge,
hypothecate or otherwise encumber Employee's right to receive compensation
hereunder without the consent of Company.
(b) Headings: The subject headings of the paragraphs and subparagraphs of
this Agreement are included for purposes of convenience only, and shall not
affect the construction or interpretation of any of its provisions.
(c) Severability: It is agreed that if any term, covenant, provision,
paragraph or condition of this Agreement shall be illegal, such illegality shall
not invalidate the whole Agreement but it shall be construed as if not
containing the illegal part, and the rights and obligations of the parties shall
be construed and enforced accordingly.
(d) Entire Agreement: The parties hereto agree that this Agreement
supersedes all existing agreements between Company and Employee, whether oral,
written, expressed or implied, and contains the entire understanding and
agreement between the parties. This Agreement shall not be amended, modified
or supplemented in any respect except by a subsequent written agreement entered
into by both parties hereto.
(e) Choice of Law: This Agreement and the performance hereunder shall be
construed in accordance with and under and pursuant to the internal substantive
laws of the State of California applicable to agreements fully executed and to
be performed entirely in such state.
(f) Notices: All communications and notices hereunder shall be in writing and
shall be deemed to have been duly given and delivered personally if sent by
United States registered or certified mail, postage prepaid:
If to Company: Netter Digital Entertainment, Inc..
5125 Lankershim Blvd.
North Hollywood, California 91601
If to Employee: Jay Fukuto
5210 Tampa Avenue
Tarzana, California 91356
With a copy to: Catalyst Literary and Talent Agency
31756 West Oak Ranch Court
Westlake Village, California 91361
Attention: Harvey Harrison
or to such other addresses as may be designated in writing by either of the
parties.
IN WITNESS WHEREOF, Company and Employee have executed this Agreement as of
the 7th of September, 1999.
NETTER DIGITAL ENTERTAINMENT, INC.
/s/Douglas Netter
- -----------------
Douglas Netter
Its: President
Agreed and Accepted:
/s/Jay Fukuto
- -------------
Jay Fukuto
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