Form 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington D.C.
(X) Quarterly Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the Quarterly Period Commission File No. 0-26884
Ended March 31, 1999
NETTER DIGITAL ENTERTAINMENT, INC.
(exact name of registrant as specified in charter)
Delaware 95-3392054
(State or other (I.R.S. Employer
jurisdiction of incorporation) Identification No.)
5125 Lankershim Blvd.
North Hollywood, California 91601
(Address of principal executive office)
Registrant's telephone number, including area code: 818/753-1990
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO ___
As of May 14, 1999 the Registrant had 3,334,405 shares of its Common Stock,
$.01 par value, issued and outstanding.
NETTER DIGITAL ENTERTAINMENT, INC. AND SUBSIDIARIES
FORM 10-Q
March 31, 1999
INDEX
PART I. FINANCIAL INFORMATION
PAGE
Item 1. Financial Statements (Unaudited) NUMBER
------
Consolidated Balance Sheets as of
March 31, 1999 and June 30, 1998. 3
Consolidated Statements of Operations for
the three-month and nine-month periods ended
March 31, 1999 and March 31, 1998. 4
Consolidated Statements of Cash Flows for the
nine-month periods ended March 31, 1999
and March 31, 1998. 5
Notes to Consolidated Financial Statements 6-7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 8-12
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 13
Item 6. Exhibits and Reports on Form 8-K 14
Signatures 14
Page 2 of 14
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
NETTER DIGITAL ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
March 31, JUNE 30,
1999 1998
------------ ------------
(Unaudited)
<S> <C> <C>
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents $ 453,398 $ 1,634,809
Accounts receivable 717,447 781,374
Due from officer - 155,897
Inventory 220,345 153,529
Production costs, net 386,187 251,632
Other Current Assets 165,889 81,180
Net Current Assets, Discontinued Operations 2,963,592 3,703,998
-------------- -------------
TOTAL CURRENT ASSETS 4,906,858 6,762,419
EQUIPMENT, net 3,101,822 2,954,601
DEPOSITS AND OTHER ASSETS 243,497 209,666
-------------- -------------
$ 8,252,177 $ 9,926,686
============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and production fee advances $ 1,028,495 $ 1,434,947
Accrued expenses 72,660 138,899
Deferred revenue 366,746 1,106,957
Current portion of capital lease obligations 987,008 696,558
Provision for discontinued operations 1,298,366 -
-------------- -------------
TOTAL CURRENT LIABILITIES 3,753,275 3,377,361
CAPITAL LEASE OBLIGATIONS 1,183,739 1,337,186
NOTE PAYABLE 425,000 -
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 4,726,171 4,726,171
Retained Earnings (Deficit) (2,223,052) 147,758
-------------- -------------
TOTAL STOCKHOLDERS EQUITY 2,889,663 5,211,639
-------------- -------------
$ 8,252,177 $ 9,926,686
============== =============
<FN>
<FN1>
The accompanying notes are an integral part of the consolidated financial
statements.
</FN>
</TABLE>
Page 3 of 14
NETTER DIGITAL ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
Three Months Ended March 31, Nine Months Ended March 31,
--------------------------- --------------------------
1999 1998 1999 1998
--------------------------- ---------------------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
REVENUES: $ 6,383,205 $ 6,710,319 $ 19,884,974 $ 20,226,700
EXPENSES:
Production 5,643,781 6,035,065 17,440,134 18,089,315
General and administrative 688,134 575,091 2,016,644 1,705,010
------------ ------------ ------------ ------------
TOTAL EXPENSES 6,331,915 6,610,156 19,456,778 19,794,325
------------ ------------ ------------ ------------
OPERATING INCOME 51,290 100,163 428,196 432,375
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Interest income 2,081 3,559 8,088 18,025
Other income/(expense) - - - 9,243
Interest (expense) (48,775) (19,052) (136,371) (48,322)
------------ ------------ ------------ ------------
TOTAL OTHER (EXPENSE) (46,694) (15,493) (128,283) (21,054)
------------ ------------ ------------ ------------
INCOME FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES 4,596 84,670 299,913 411,321
PROVISION FOR INCOME TAXES - 7,500 80,000 128,000
------------ ------------ ------------ ------------
INCOME FROM CONTINUING OPERATIONS $ 4,596 $ 77,170 $ 219,913 $ 283,321
DISCONTINUED OPERATIONS
Loss from operation of Videssence, Inc.
(net of income tax benefit) - 2,161 (670,806) (174,219)
Loss on the divestiture of Videssence - - (1,880,956) -
------------ ------------ ------------ ------------
NET INCOME (LOSS) $ 4,596 $ 79,331 $ (2,331,849) $ 109,102
Cumulative preferred stock dividend 12,588 10,745 38,961 31,964
------------ ------------ ------------ ------------
Net Income (Loss) to common shareholders $ (7,992) $ 68,586 $ (2,370,810) $ 77,138
============ ============ ============ ============
Basic and diluted earnings (loss) per share:
Continuing operations, including
preferred dividends (0.00) 0.02 0.05 0.07
Discontinued operations $ - $ 0.00 $ (0.76) $ (0.05)
------------ ------------ ------------ ------------
Net earnings (loss), per share $ (0.00) 0.02 (0.71) 0.02
============ ============ ============ ============
Weighted average common shares outstanding 3,334,405 3,337,110 3,334,405 3,334,601
============ ============ ============ ============
<FN>
<FN1>
The accompanying notes are an integral part of the consolidated financial
statements.
</FN>
</TABLE>
Page 4 of 14
NETTER DIGITAL ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Nine Months Ended March 31,
--------------------------------
1999 1998
--------------------------------
(Unaudited) (Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ (2,331,849) $ 109,102
-------------- --------------
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 627,650 354,382
Amortization 52,156 90,341
Provision for loss of discontinued operations 1,880,956 -
Changes in operating assets and liabilities:
Decrease/(increase) in accounts receivable 63,927 (377,530)
Decrease in due from officer 155,897 -
(Increase) in other current assets (84,709) (13,736)
(Increase) in inventory (66,816) (93,459)
(Increase)/decrease in production costs (134,555) 28,951
(Increase) in deposits and other assets (33,831) (40,733)
(Decrease) in accounts payable (406,452) (93,541)
(Decrease) in accrued expenses (66,239) (46,489)
(Decrease) in deferred revenue (740,211) (274,968)
Decrease/(increase) in net assets from
discontinued operations 215,009 (659,848)
--------------- ------------
1,462,782 (1,126,630)
--------------- ------------
NET CASH USED IN OPERATING ACTIVITIES (869,067) (1,017,528)
--------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (60,579) (299,656)
--------------- ------------
NET CASH USED IN INVESTING ACTIVITIES (60,579) (299,656)
--------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments of capital lease obligations (676,765) (217,549)
Drawdown from funding facility 425,000 -
--------------- -------------
NET CASH USED IN FINANCING ACTIVITIES (251,765) (217,549)
--------------- -------------
NET DECREASE IN CASH (1,181,411) (1,534,733)
Cash, beginning of period 1,634,809 2,533,194
--------------- -------------
Cash, end of period $ 453,398 $ 998,461
=============== =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Cash paid for interest $ 136,371 $ 137,538
Cash paid for income taxes $ 89,453 $ 10,617 9,800
Noncash activity:
Stock issued for legal fee settlement $ - $ 50,000
Stock dividend $ 38,961 $ 31,964
Purchase of equipment through leases payable $ 773,460 $ 647,807
<FN>
<FN1>
The accompanying notes are an integral part of the consolidated financial
statements.
</FN>
</TABLE>
Page 5 of 14
NETTER DIGITAL ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
BASIS OF PREPARATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial statements and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
disclosures required for annual financial statements. These financial
statements should be read in conjunction with the consolidated financial
statements and related footnotes for the year ended June 30, 1998 included in
the Form 10-KSB for the year then ended.
In the opinion of the Company's management, all adjustments (consisting of
normal recurring accruals) necessary to present fairly the Company's financial
position as of March 31, 1999 and June 30, 1998, and the results of
operations and cash flows for the three-month and nine-month periods ended
March 31, 1999 and 1998 have been included.
The results of operations for the three-month and nine-month periods ended
March 31, 1999, are not necessarily indicative of the results to be expected
for the full fiscal year. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company's
Form 10-KSB as filed with the Securities and Exchange Commission for the year
ended June 30, 1998.
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 have
determined that at this time 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 1999. The Company is reviewing how to best capitalize
on its recent investment in Videssence and is currently in negotiations with
potential buyers for the Videssence operation. Of course, there can be no
assurance that the Company will consummate a sale of the Videssence operation
with one of these buyers or any other buyers on terms acceptable to the
Company. In the quarter ended December 31, 1998, the Company accrued a
provision for the estimated anticipated loss on divestiture of the Videssence
operation of approximately $1.9 million which includes $750,000 for pretax
operating losses during the phase-out period. 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
unaudited consolidated financial statements.
Page 6 of 14
The assets of the discontinued operation are as follows:
March 31, June 30,
1999 1998
---- ----
Accounts Receivable, net $ 654,727 $ 1,503,637
Inventory 1,540,783 1,477,496
Other Current Assets 66,882 53,357
------------ ------------
Total Current Assets 2,262,392 3,034,490
Property, Plant and Equipment,
net of accumulated depreciation 153,735 202,793
Other Assets 119,830 124,094
Intangibles 1,860,202 1,938,434
------------ ------------
Total Assets $ 4,396,159 $ 5,299,811
Total Liabilities 1,432,567 1,595,813
------------ ------------
Total Net Assets $ 2,963,592 $ 3,703,998
============ ============
Summarized results of the discontinued operation are as follows:
Three Months Ended Nine Months Ended
March 31, March 31,
1999* 1998 1999* 1998
---- ---- ---- ----
Net Sales $- $1,180,921 $ 1,400,018 $ 3,073,760
Cost and expenses - 1,178,760 2,127,824 3,337,979
---------- ---------- ----------- -----------
(Loss) before inc. taxes $- $2,161 ($727,806) ($264,219)
Income tax (benefit) - - (57,000) (90,000)
---------- ---------- ----------- -----------
(Loss) from discontinued
operations $- $2,161 ($670,806) ($174,219)
========== =========== =========== ===========
* Includes results of operations through the measurement date of December 31,
1998.
DUE FROM OFFICER/RECEIVABLE FROM RELATED PARTY
On March 29, 1999, Netter Digital Entertainment, Inc., a Delaware corporation
(the "Company"), obtained a $1.0 million funding facility (the "Facility") from
AIB Investments Pty Limited ("AIB"), an Austrailian corporation. As of March
31, 1999, the Company has drawn down $425,000 of principal under this Facility
evidenced by a non-interest bearing Senior Subordinated Convertible Note (a
"Note), due March 29, 2002. Subsequent to March 31, 1999, the Company drew down
the remaining available principal balance of $575,000, which is also 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 recieved 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.
Page 7 of 14
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
General
The Company is engaged in two primary business activities:
= Entertainment 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 combining live action film production with computer
graphics and other digital imaging in the creation of dramatic series,
documentaries, and children's programming utilizing state-of-the-art
entertainment production technology. The Company has produced the award
winning series "Babylon 5" and the follow-on series entitled "Crusade."
With its recent work on the children's series, "Voltron: The Third Dimension"
("Voltron"), the Company is at the forefront of the fully animated or
animation intensive production market for television. The Company's general
practice has been to sell or license its Productions under a production
contract with a major entertainment studio or distributor who is responsible
for the production costs of the Production. The Company has also established
an objective to retain greater equity participation in the projects it
produces by increasing its overhead and equity commitments for future
projects (see "Liquidity and Capital Resources" below).
= Computer Animation and Visual Effects Production Services. As an outgrowth
of its traditional core business of developing and producing media Productions,
the Company has entered the business of providing digital media production
services to outside clients. In support of its own Productions, especially
"Babylon 5" and "Crusade," the Company has developed significant expertise in
computer graphics production, digital post-production and various other
digital imaging techniques. The quality and popularity of the Company's
productions has created industry-wide recognition of its creative and
technical skills in these areas. The Company believes that an active market
exists for projects requiring creative, high quality, cost effective digital
graphics and effects. In order to more fully exploit its strengths in these
areas, the Company formed the Netter Digital Technologies Division (or
"production services") to market computer graphics and digital post-production
services to outside clients. 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.
Results of Operations
Revenues. The Company's revenues for the third quarter and nine-month periods
ended March 31, 1999 were approximately $6.4 million and $19.9 million,
respectively, for a decrease of 1.7% and 4.9% as compared to the respective
prior year periods. The decrease in the third quarter resulted primarily
from a shortfall of approximately $1.5 million in revenues generated from the
"Babylon5"/"Crusade" productions this year as compared to last year. This
difference resulted from the fact that the production of "Crusade" has been
limited to 13 episodes (with no additional episodes ordered at this time), as
compared to 22 episodes of "Babylon 5" in the prior year. This decrease was
largely offset by a $1.2 million increase in revenues from the Company's
Netter Digital Technologies Division as compared to the same period of the
prior year resulting primarily from the Company's work on "Voltron" and
other contracts as part of the Division's growth over the last year. The
decrease in the nine-month period also reflects a decrease in revenues from
the "Babylon 5"/"Crusade" productions and an increase in revenues from the
Company's Netter Digital Technologies Division.
Page 8 of 14
The Company expects that revenue for the fourth fiscal quarter will be
materially adversely affected by the end of the "Crusade" production at 13
episodes for this season which begins airing in June 1999. At this time, the
Company has not received a reorder for "Voltron" which completes production
of its first season during the fourth fiscal quarter. Two new productions
are scheduled to begin during the fourth fiscal quarter, both of which are 3D
CGI animated children's shows. Final production contracts have not yet been
completed on either of these new productions. Of course, there can be no
assurance that the "Crusade" production will be extended beyond 13 episodes,
that "Voltron" will be renewed or that the contracts will be finalized on the
two new productions.
Gross Margin. The Company's gross margin for the quarter ended March 31, 1999
increased from 10.1% of net revenues in the prior year to 11.6% of net
revenues. For the nine-month period ended March 31, 1999, gross margin
increased from 10.6% to 12.3% of revenues, as compared to the prior year.
These increases in gross margin resulted primarily from the larger
percentage of total revenue coming from the Company's Netter Digital
Technologies Division which realizes higher gross margins than the
entertainment production business.
General and Administrative Expenses. General and administrative expenses were
approximately 10.8% and 10.1% as a percentage of net revenues for the three-
month and nine-month periods ended March 31, 1999, respectively, as compared to
8.6% and 8.4% for the same prior year periods. This increase resulted
primarily from the increase in overhead to accommodate the additional work
from its Netter Digital Technologies Division and an increase in overhead
at the Company's Fan Club operation. Furthermore, the increase in the
percentage was affected by a decrease in revenues for the third quarter ended
March 31, 1999 as compared to the comparable prior period.
Other Income and Expenses. Interest income decreased to $2,081 and $8,088 for
the quarter and nine-month period ended March 31, 1999, respectively, compared
to $3,559 and $18,025 for the same prior year periods, as proceeds from the
Company's November 1995 initial public offering were fully drawn from short
term investments and used for working capital for Videssence by the end of
the Company's fiscal year ended June 30, 1998. Interest expense increased to
$48,775 and $136,371 for the quarter and nine-month period ended March 31,
1999, respectively, from $19,052 and $48,322 in the same period of the
previous year due to the Company's further utilization of capital lease lines
for continued expansion of its computer animation and visual effects 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 has instructed
management to divest the Videssence subsidiary, which manufactures and
distributes media lighting products, by the end of 1999. The Company is
reviewing how to best capitalize on its recent investment in Videssence and
currently is in negotiations with potential buyers for the Videssence
operation. Of course, there can be no assurance that the Company will
consummate a sale of the Videssence operation with one of these buyers 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. 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 unaudited
consolidated financial statements.
Page 9 of 14
Pretax losses at the Videssence operation for the quarter and nine-month
periods ended March 31, 1999 were $582,590 and $1,310,396, respectively,
as compared to a pretax profit of $2,161 and a pretax loss of $264,219 for the
same respective periods of the prior year. The primary factors leading to
this decrease compared to last year were a write-down of inventory, a sales
shortfall comprised of lower than anticipated demand for new products, higher
than anticipated sales returns, and delays in production which led to a larger
backlog than usual at March 31, 1999. For a further summary 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, its 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. On March 29, 1999, the Company obtained a $1.0 million funding
facility (the "Facility") from AIB Investments Pty Limited. As described
in Part II, Item 2 hereof, as of May 14, 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.
With respect to production costs for particular entertainment Projects, the
Company has customarily entered into production contracts with studios,
networks and distributors who cover 100% of the production funding. Such
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 all of its Projects.
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. 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.
During the quarter and nine-month period ended March 31, 1999, the Company
derived approximately 77% of revenues from its agreements with Warner Bros.
relating to the production of the "Babylon 5" series, the follow-on "Crusade"
series, and the associated made for television movies. The Company is
finishing production on 13 episodes of the "Crusade" series. Additional
episodes have not been ordered as of the date of this report. If the
Company is unable to obtain an extension or renewal of this series or
replace the series with one generating comparable revenues, the Company's
financial condition and operations could be materially adversely affected.
Page 10 of 14
Cash used in operating activities was approximately $869,000 for the nine-
months ended March 31, 1999. The biggest contributors to this usage was the
loss at the Company's Videssence subsidiary as sales were lower than expected.
Accounts payable decreased as production on "Crusade" slowed down and deferred
revenue decreased as prepaid production costs were used for the production
services business.
Cash used in financing activities was approximately $252,000 for the nine-
months ended March 31, 1999 as money used for principal payments on capital
leases more than offset a drawdown of $425,000 from the Facility.
The operating needs at the Company's Videssence subsidiary have required more
of the Company's cash flow over the last 12 months than originally
anticipated. As of March 31, 1999, the Company's sources of liquidity included
cash and cash equivalents totaling approximately $450,000.
The Company has approximately $2.2 million of outstanding capital leases as of
March 31, 1999. The Company uses capital leases primarily for equipment
additions to its in-house 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 entertainment production and computer animation and visual
effects production 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. In contrast, the Company's Videssence subsidiary
relies heavily on computers for the processing of payroll, accounts receivable
and accounts payable, but does not rely heavily on computers in manufacturing
and distributing its products. 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.
The Company has substantially 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.
Page 11 of 14
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 March 31, 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
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 entertainment production and computer animation and
visual effects production 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.
Forward-Looking Statements
The foregoing discussion contains "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Act of 1934, as amended. There are risks and
uncertainties that could cause future events and results to differ materially
from those anticipated by management in the forward-looking statements
included in this report. Among these risks and uncertainties are the effect of
the Year 2000 computer problem on the Company's internal systems and the effect
on the Company's business of any failures in the computer systems of the
Company's major vendors or customers.
Page 12 of 14
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
On March 29, 1999, Netter Digital Entertainment, Inc., a Delaware corporation
(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 has drawn down the full $1.0 million of principal under this
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.
Under the terms of the Facility, the Company has agreed to file a Registration
Statement under the Securities Act of 1933, as amended (the "Securities Act"),
as expeditiously as possible and, in any event, by June 28, 1999, covering the
resale of the Conversion Shares and the Warrant Shares. Also in connection
with this transaction, the Company has appointed Nicholas Bain as AIB's
representative on the Company's Board of Directors. AIB will become entitled to
to a second representative on the Board of Directors if it exercises
Warrants with an aggregate exercise price of $1,036,836. AIB has executed a
standstill agreement whereby, subject to certain exceptions, AIB and its
affiliates shall not 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.
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 II, Item 6 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 up to 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 May 14, 1999.
Page 13 of 14
Item 6. Exhibits and Reports on Form 8-K
(a.) Exhibits
Exhibit Description
4.1 Purchase Agreement dated March 29, 1999 between the
Company and AIB. (1)
4.2 Warrant dated March 29, 1999. (1)
4.3 Standstill Agreement dated March 29, 1999. (1)
20 Press Release, dated March 31, 1999. (1)
27 Financial Data Schedule. (2)
- ----------------------
(1) Incorporated by reference from Item 7 of the Company's Current
Report on Form 8-K dated March 29, 1999.
(2) Filed herewith.
(b.) Reports on Form 8-K
The Company has filed a Current Report on Form 8-K dated March 29,
1999 which reported the Company's obtaining the $1.0 million facility.
SIGNATURE
Pursuant to the requirements of the Securities Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
NETTER DIGITAL ENTERTAINMENT, INC.
Registrant
Dated: May 14, 1999 By: /s/Chad Kalebic
Chad Kalebic
Chief Financial Officer
Page 14 of 14
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