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United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________ to _____________
Commission file number 000-29642
FILM ROMAN, INC.
(Exact name of registrant as specified in charter)
Delaware 95-4585357
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
12020 Chandler Boulevard, Suite 200
North Hollywood, California 91607
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (818) 761-2544
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 at least the past 90 days. YES [ X ] NO [ ].
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date:
As of November 12, 1999, 8,524,190 shares of common stock, par value $.01
per share, were issued and outstanding.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
<S> <C>
Item 1. Financial Statements.............................................................................. 3
Consolidated Balance Sheets as of December 31, 1998 and September 30, 1999
(unaudited).................................................................................. 3
Consolidated Statements of Operations for the Three and Nine Months Ended
September 30, 1998 and September 30, 1999 (unaudited)........................................ 4
Consolidated Statements of Cash Flows for the Nine Months Ended September 30,
1998
and September 30, 1999 (unaudited)........................................................... 5
Notes to Consolidated Financial Statements................................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................................................. 7
Item 3. Quantitative and Qualitative Disclosures About Market Risk........................................ 19
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K............................................................. 20
Signatures................................................................................................. 21
</TABLE>
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
FILM ROMAN, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, September 31,
1998 1999
------------ -------------
(unaudited)
<S> <C> <C>
ASSETS
Cash and cash equivalents................................................... $11,287,386 $5,566,983
Accounts receivable......................................................... 1,089,218 796,168
Film costs, net of accumulated amortization of $244,777,898 (1998)
and $274,147,382 (1999)..................................................... 20,903,771 27,529,235
Property and equipment, net of accumulated depreciation and
amortization of $1,559,112 (1998) and $1,882,376 (1999)..................... 979,090 893,840
Deposits and other assets................................................... 489,205 581,536
------------ ------------
Total Assets................................................................ $34,748,670 $35,367,762
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable............................................................ $ 628,221 $ 1,022,435
Accrued expenses............................................................ 2,350,695 2,650,984
Deferred revenue............................................................ 19,671,667 22,352,920
------------ ------------
Total liabilities........................................................... 22,650,583 26,026,339
Stockholders' equity
Preferred Stock, $0.01 par value, 5,000,000 shares authorized,
none issued.......................................................... -- --
Common stock, $0.01 par value, 20,000,000 shares authorized, 8,522,190
shares issued and outstanding (1998) and
8,524,190 shares issued and outstanding (1999)...................... 85,223 85,243
Additional paid-in capital.................................................. 36,305,684 36,308,524
Accumulated deficit......................................................... (24,292,820) (27,052,344)
------------ ------------
Total stockholders' equity ................................... 12,098,087 9,341,423
------------ ------------
Total liabilities and stockholders' equity ................... $34,748,670 $35,367,762
============ ============
</TABLE>
See accompanying notes.
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FILM ROMAN, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three Months ended Nine Months ended
September 30, September 30,
--------------------------------- ---------------------------------
1998 1999 1998 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenue................................. $ 5,273,605 $ 3,630,045 22,631,723 31,082,974
Cost of revenue......................... 6,119,261 3,970,932 22,708,367 29,369,484
Selling, general and
administrative expenses............... 1,784,148 1,692,342 4,421,840 4,759,851
----------- ----------- ------------ ------------
Operating loss.......................... (2,629,804) (2,033,229) (4,498,484) (3,046,361)
Interest income......................... 166,316 79,051 550,850 297,685
Loss before provision for income
taxes................................... (2,463,488) (1,954,178) (3,947,634) (2,748,676)
Provision for income taxes.............. 5,594 10,849
Net loss................................ $(2,463,488) $(1,959,772) $ (3,947,634) $ (2,759,525)
=========== =========== ============ ============
Net loss per share basic and
diluted................................ $ (0.29) $ (0.23) $ (0.46) $ (0.32)
=========== =========== ============ ============
Weighted average number of
shares outstanding basic and
diluted................................ 8,522,190 8,524,190 8,501,915 8,523,405
=========== =========== ============ ============
</TABLE>
See accompanying notes.
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FILM ROMAN, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Nine Months ended
September 30,
---------------------------------
1998 1999
------------ ------------
<S> <C> <C>
Operating activities:
Net loss.......................................................................... $ (3,947,634) $ (2,759,525)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization..................................................... 262,637 323,264
Amortization of film costs........................................................ 22,708,367 29,369,484
Changes in operating assets and liabilities:
Accounts receivable............................................................. 288,640 293,050
Film costs...................................................................... (27,523,674) (35,994,948)
Deposits and other assets....................................................... 54,775 (92,330)
Accounts payable................................................................ (448,799) 394,214
Accrued expenses................................................................ 493,713 300,289
Deferred revenue................................................................ 5,299,371 2,681,253
------------ ------------
Net cash used in operating activities........................................... (2,812,604) (5,485,249)
Investing activities:
Additions to property and equipment............................................... (763,664) (238,014)
------------- ------------
Net cash used in investing activities............................................. (763,664) (238,014)
Financing activities:
Options Exercised................................................................. 675 2,860
------------ ------------
Net cash provided by financing activities......................................... 675 2,860
Net decrease in cash.............................................................. (3,575,593) (5,720,403)
------------ ------------
Cash and cash equivalents at beginning of period.................................. 15,986,250 11,287,386
Cash and cash equivalents at end of period........................................ $ 12,410,657 $ 5,566,983
============ ============
Supplemental disclosure of cash flow information: Cash paid during the
period for:
Interest...................................................................... $ -- $ --
------------ ------------
Income taxes.................................................................. $ -- $ --
------------ ------------
</TABLE>
See accompanying notes.
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FILM ROMAN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) - Basis of Presentation
Film Roman, Inc., a Delaware corporation (the "Company"), currently
conducts all of its operations through its wholly owned subsidiaries, Film
Roman, Inc., a California corporation; Namor Productions, Inc., a California
corporation; Chalk Line Productions, Inc., a California corporation; Diversion
Entertainment, Inc. a Delaware corporation and Level 13 Entertainment, Inc., A
Delaware corporation. The accompanying consolidated unaudited financial
statements of the Company have been prepared in accordance with generally
accepted accounting principles for interim financial information 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 footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all adjustments consisting only of normal recurring accruals
necessary to present fairly the financial position of the Company as of
September 30, 1999 and the results of its operations for the three and nine
months ended September 30, 1998 and 1999, and the cash flows for the nine months
ended September 30, 1998 and 1999 have been included. The results of operations
for interim periods are not necessarily indicative of the results which may be
realized for the full year. For further information, refer to the financial
statements and footnotes thereto included in the Company's Annual Report on Form
10-K for the year ended December 31, 1998 (the "Form 10-K") filed with the
Securities and Exchange Commission.
(2) - Net Loss per Common Share
For the three months and the nine months ended September 30, 1998 and
1999, the per share data is based on the weighted average number of common and
common equivalent shares outstanding during the period. Common equivalent
shares, consisting of outstanding stock options, are not included since they are
antidilutive.
(3) - Film Costs
The components of unamortized film costs consist of the following:
<TABLE>
<CAPTION>
December 31, 1998 September 30, 1999
----------------- (Unaudited)
-----------
<S> <C> <C>
Film productions released,
net of amortization.................. $ 4,185,682 $ 3,530,507
Film productions in process........... 16,390,064 22,795,241
Film productions in development....... 328,025 1,203,487
----------- ----------
$20,903,771 $27,529,235
=========== ==========
</TABLE>
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Form 10-Q contains certain 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. The words "expect",
"estimate", "anticipate", "predict", "believe", "plan", "should", "may" and
"projects" and similar expressions and variations thereof are intended to
identify forward-looking statements. Such forward-looking statements relate to,
among other things, trends affecting the financial condition or results of
operations of the Company, the 13 episodes of "Mission Hill" ordered by Castle
Rock Entertainment; the Company's future production and delivery
schedule (including the number of episodes of programming to be produced and
delivered during the 1999-2000 television season); plans to enter into new
business areas beyond the Company's core business of animation television
production; the Company's objectives, planned or expected activities and
anticipated financial performance and liquidity. These forward-looking
statements are based on the Company's current expectations and are subject to a
number of risks and uncertainties, including without limitation, those described
under the caption "Risk Factors" included in this report and in the Company's
Annual Report on Form 10-K for the year ended December 31, 1998. Actual results
could differ from these forward-looking statements. The Company does not make
projections of its future operating results and undertakes no obligation to
publicly update or revise any forward-looking statements, whether as a result of
new information, future events or otherwise.
General
Film Roman, Inc., a Delaware corporation (the "Company"), develops,
produces and distributes a broad range of television programming for the
television network, cable television, first-run domestic syndication and
international markets. In 1998, the Company expanded its operations to include,
on a limited basis, the development and production of feature-length theatrical
motion pictures. The Company's primary operating subsidiary, which was founded
in 1984, is one of the leading independent animation studios in North America,
having produced numerous high quality animated series including Bobby's World,
The Simpsons, King of the Hill, The Mask, BRUNO the Kid, C-Bear and Jamal, The
Twisted Tales of Felix the Cat, Mortal Kombat, Garfield & Friends, The Critic
and most recently Mission Hill.
Historically, the Company has produced most of its programming for third
parties on a "fee-for-services" basis. Fees paid to the Company for these
production services generally range from $300,000 to $600,000 per episode and
typically cover all direct production costs plus a profit margin. The Company
has begun to produce programming for which it controls some of the "proprietary
rights" associated with such programming (including, for example, international
distribution and licensing and merchandising rights). Fees paid to the Company
for these production services typically do not cover all direct production
costs. Generally, the Company seeks to cover at least 50% of its production
costs prior to production of its proprietary programs and seeks to cover the
remaining production costs through the exploitation of the proprietary rights
associated with these programs. As a result, the Company may recognize revenue
associated with its proprietary programming over a period of years.
The Company produces a limited number of animated television series in
any year and is substantially dependent on revenues from licensing these
programs to broadcasters and fees from producing programs for third parties. The
Company's future performance will be affected by issues facing all producers of
animated programming, including risks related to the limited number of time
slots allocated to children's and/or animated television programming, the
intense competition for those time slots, the limited access to distribution
channels (particularly for programs produced by independent studios), the
declining license fees paid to producers of programming by broadcasters and the
regulations implemented by the Federal Communications Commission governing
program content. While the Company seeks to limit its financial
7
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risk associated with its proprietary programming by obtaining commitments prior
to production to cover at least 50% of its direct production costs, there can be
no assurance that the Company will be able to cover the balance of its
production costs and overhead costs relating to production, licensing and
distribution through the exploitation of its proprietary rights. As a result of
the foregoing risks, there can be no assurance that the Company will be able to
generate revenues that exceed its costs.
The Company is currently seeking to enter, or has entered, into new
business areas beyond its core business of animated television production such
as live action television production, feature film production (both live action
and animation), computer generated animation, internet investments and direct-
to-video and alternative forms of distribution. The Company's future performance
will be affected by unpredictable and changing factors that influence the
success of an individual television program, feature film or direct-to-video
release such as the personal taste of the public and critics as well as public
awareness of a production and the successful distribution of a production.
Although the Company intends to attempt to limit the risks involved with
television, film and direct-to-video production, the Company will likely be
unable to limit all financial risk. Further, the level of marketing, promotional
and distribution activities and expenses necessary for such production cannot be
predicted with certainty. The Company has a very limited history of developing,
producing or distributing live action television, computer generated animation
or film productions, and there can be no assurance that the Company can compete
successfully with more established persons or entities. Live action production
involves many of the risks associated with animation production as well as
additional risks inherent to live action that are outside of the Company's
control. These risks include, but are not limited to, the risk of strike by
actors and film crew, increased union activity, delay in production due to
weather and other local conditions, inability to obtain proper permitting at a
desired site, at desired times and/or under desired terms, and accidents or
injury to actors and film crew. No assurance can be given that the Company will
produce any live action television, film or direct-to-video productions or that,
if produced, such productions will be profitable.
Board of Directors Vacancies
James McNamara resigned from the Company's Board of Directors on
September 24, 1999. Mr. McNamara was recently appointed as President of
Telemundo Network Group, LLC. On September 29, 1999 Dennis Draper also resigned
from the Board of Directors. Mr. Draper was recently appointed Vice Dean of the
University of Southern California's School of Business. Both Mr. McNamara and
Dr. Draper advised the Company that their new appointments would prevent them
from devoting sufficient time and energy to their positions as members of the
Board of Directors. The Company is currently engaged in efforts to fill these
positions.
The Company's 1999-2000 Production Schedule
Historically, the Company's primary source of revenue has been the
development and production of high quality, prime time and Saturday morning
animated series.
The market for television programming is comprised primarily of the
broadcast television networks (ABC, CBS, NBC, Fox, United Paramount Network
("UPN") and the WB network, a division of Time Warner Entertainment Company
L.P.), syndicators of first-run programming (such as Columbia, Inc., and Buena
Vista Television) which license programs on a station-by-station basis, and
basic and pay cable networks (such as the Fox Family Channel).
For the 1998-1999 broadcast season, the Company produced 24 episodes of
King of the Hill, 23 episodes of The Simpsons and 13 episodes of The Mr. Potato
Head Show for the Fox Broadcasting Company. The Company is currently scheduled
to produce the following programming for the 1999-2000 broadcast season:
The Simpsons. The Company is scheduled to produce 22 new episodes of The
Simpsons for exhibition over the Fox Broadcasting Network. Entering its
eleventh season and now the longest-running prime time animated series
in television history, The Simpsons has been honored with a Peabody
Award, 15 Emmy Awards, seven Annie Awards, three Genesis Awards, three
International Monitor Awards and three Environmental Media Awards, among
numerous other nods. The Simpsons has transformed the way the television
industry and audiences perceive animation and comedy series in general.
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King of the Hill. The Company is currently scheduled to produce 24 new
episodes of King of the Hill to be exhibited on the Fox Broadcasting
Network. King of the Hill is the hit half-hour, animated comedy, voted
the Best Television Show of 1997 by TV Guide and Entertainment Weekly,
that tells often hilarious stories about Hank Hill, his family and their
neighbors in the fictional suburb of Arlen, Texas, the heartland of
America.
Mission Hill is a new half-hour, prime time television series which
began broadcast in the fall of 1999 on the WB network. The Company is
currently scheduled to produce 13 episodes of Mission Hill. Mission Hill
is the first prime time animated comedy to focus on the lives of twenty-
somethings and teens. Mission Hill explores the world of four diverse
roommates who inhabit a downtown loft in a fictional big city.
In addition to the television series described above, the Company
delivered a movie-of-the-week, Johnny Tsunami, for the Disney Channel. On June
1, 1999, the production for Family Guy was transferred to Twentieth Century Fox.
Through June 1, 1999, the Company had completed production of one episode and
substantially completed production of 15 episodes of this series for Fox. The
Company has a slate of proprietary animated programs, including prime time,
Saturday morning, teen-oriented and feature film products, in various stages of
development.
There can be no assurance that any of these programs will be relicensed
for additional broadcast seasons through renewal of existing licenses or
issued new licenses or, if so licensed, that the terms of the license agreements
will be as favorable to the Company as those of existing licenses.
Results of Operations
Three Months Ended September 30, 1999 Compared to Three Months Ended September
30, 1998
Total revenue decreased by 32%, or $1.7 million, to $3.6 million for the
three months ended September 30, 1999, from $5.3 million for the comparable
period in the prior year. Total revenue decreased primarily because the Company
delivered fewer prime time fee-for-services episodes and fewer "proprietary"
episodes during the three months ended September 30, 1999 compared to the three
months ended September 30, 1998.
The Company delivered four "fee-for-services" episodes during the three
months ended September 30, 1999, compared to six episodes in the comparable
period in 1998. Fee-for-services revenue decreased 28%, or $1.1 million, to $2.5
million for the three months ended September 30, 1999, from $3.6 million during
the comparable period in 1998.
The Company delivered no "proprietary" episodes during the three months
ended September 30, 1999 compared to five episodes in the comparable period in
1998. "Proprietary revenue" consists of revenue derived from the U.S. license
fees paid upon the initial delivery of a new episode of proprietary programming
to a U.S. broadcaster and from the exploitation of the proprietary rights (e.g.,
merchandising, licensing and/or international distribution rights) associated
with the proprietary episodes in the Company's library that were initially
delivered in prior periods. "Proprietary" revenue decreased by 60% or $0.6
million, to $0.4 million for the three months ended September 30, 1999, from
$1.0 million in the comparable three month period in 1998.
Other revenue remained constant at $0.6 million during the three months
ended September 30, 1999, and 1998.
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Total cost of revenue decreased by 34%, or $2.1 million, to $4.0 million
for the three months ended September 30, 1999, from $6.1 million for the three
months ended September 30, 1998. Total cost of revenue, as a percentage of
sales, decreased by 4% to 111%, primarily because the costs for the three month
period ended September 30, 1998 included a larger write-down to net realizable
value as a result of changes in the Company's estimated future revenues from
certain of its episodic programming, which was partially offset by spending on
the Company's internet investment, "Level 13".
Total selling, general and administrative expenses for the three months
ended September 30, 1999 decreased by $0.1 million to $1.7 million from $1.8
million for the comparable period in 1998, due primarily to lower general and
administrative costs.
Operating loss was $2.0 million for the three months ended September 30,
1999, as compared to a loss of $2.6 million for the three months ended September
30, 1998.
Nine Months Ended September 30, 1999 Compared to Nine Months Ended September 30,
1998
Total revenue increased by 38%, or $8.5 million, to $31.1 million for
the nine months ended September 30, 1999, from $22.6 million for the comparable
period in the prior year. Total revenue increased because the Company delivered
significantly more episodes of programming in the first nine months of 1999 as
compared to the first nine months of 1998. The Company delivered a total of 49
episodes of programming for the nine months ended September 30, 1999, as
compared to 36 episodes for the nine months ended September 30, 1998.
The Company delivered 49 "fee-for-services" episodes during the nine
months ended September 30, 1999, compared to 31 episodes in the comparable
period in 1998. Fee-for-services revenue increased 55%, or $10.0 million, to
$28.2 million for the nine months ended September 30, 1999, from $18.2 million
during the comparable period in 1998.
The Company delivered no "proprietary" episodes during the nine months
ended September 30, 1999 compared to five episodes delivered during the
comparable period for 1998. "Proprietary" revenue decreased by 63% or $1.2
million, to $0.7 million for the nine months ended September 30, 1999, from $1.9
million in the comparable nine month period in 1998.
Other revenue decreased by approximately $0.3 million during the nine
months ended September 30, 1999, as compared to the same period of the prior
year, due primarily to a combined decrease of approximately $0.7 million in
revenue from the Company's participation in net profits from certain of its fee-
for-services series, and revenue from commercials and specials. This decrease
was offset by an increase in revenue of approximately $0.4 million generated by
the Company's creative services division and live action division.
Total cost of revenue increased by 30%, or $6.7 million, to $29.4
million for the nine months ended September 30, 1999, from $22.7 million for the
nine months ended September 30, 1998. Total cost of revenue, as a percentage of
sales, decreased by 5% to 95%, primarily due to higher fee-for-service margin,
and because the costs for the nine month period ended September 30, 1998,
included a larger write-down to net realizable value as a result of changes in
the Company's estimated future revenues from certain of its episodic
programming, which was partially offset by spending on the Company's internet
investment, "Level 13".
Total selling, general and administrative expenses for the nine months
ended September 30, 1999 increased by $0.4 million to $4.8 million from $4.4
million for the comparable period in 1998, due primarily to increased
development costs resulting from the development of live action programming,
feature film
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programming and new animation programming partially offset by lower
costs in licensing and merchandising and international distribution.
Operating loss was $3.0 million for the nine months ended September 30,
1999, as compared to a loss of $4.5 million for the nine months ended September
30, 1998.
Subsequent Events
On October 4, 1999, the Company announced that it had determined not to
continue the employment relationship of David Pritchard, its chief executive
officer and president. Accordingly, Mr. Pritchard has left the Company to pursue
other interests. The board of directors does not contemplate a change in any
other top executive officer positions and is currently taking steps to find a
successor for Mr. Pritchard.
Production has begun on a new fee-for-service series entitled, The
Oblongs, to be distributed by Warner Brothers Television. The Company is in
production on 13 episodes which are scheduled to air on the WB network in the
2000-2001 broadcast season.
The Company has reached agreement with UPN and Artists Television Group
on the principal terms for a new proprietary series, Doomsday, which the Company
will co-produce with Howard Stern Productions and Artists Television Group. The
Company is currently negotiating a definitive agreement with respect to that
series, and has commenced production on 13 episodes, which are to air on UPN.
Liquidity and Capital Resources
At September 30, 1999, the Company had cash and short-term investments
of approximately $5.6 million compared to $11.3 million at December 31, 1998.
The Company's cash and short-term investment balances have continued to decline
since December 31, 1998. Management believes that its existing cash balances and
short-term investments, combined with anticipated cash flow from operations,
will nevertheless be sufficient to meet its cash requirements through the next
12 months. However, if the Company is successful in the execution of its more
aggressive and broad production strategies, it will be required to make
additions to personnel and augment its development and production capabilities
in the areas of animated programming, computer generated animated programming,
live action television series, feature films and internet investments. In such a
case, the Company may need to secure additional equity or debt financing during
fiscal 2000 in order to fulfill its growth strategies. Recent operating losses,
the Company's declining cash balances, trends in the entertainment industry
adversely affecting independent production companies similar to the Company, and
the Company's historical stock performance may make it difficult for the Company
to attract equity investments on terms that are deemed to be favorable to the
Company. In addition, the Company's losses may make it more difficult for the
Company to attract significant debt financing. As a consequence, there can be no
assurance that the Company will be successful in arranging for additional equity
or debt financing at levels sufficient to meet its planned needs. The failure to
obtain such financing would have an adverse effect on the implementation of the
Company's growth strategies.
For the nine months ended September 30, 1999, net cash used in operating
activities was approximately $5.5 million due to cash used in connection with
film production activities offset by an increase in accounts payable, deferred
revenue and in accrued expenses. Cash used in investing activities for the nine
months ended September 30, 1999 was $238,014. Cash provided by financing
activities for the nine months ended September 30, 1999 was $2,860.
The Company recognizes revenues in accordance with the provisions of
Financial Accounting Standards Board Statement No. 53 ("FAS 53"). Cash collected
in advance of revenue recognition is recorded as deferred revenue. As of
September 30, 1999, the Company had a balance in its deferred revenue account of
$22.4 million. There will be no net cost to the Company (future receipts less
future expenditures) to finish the programs for which cash has been collected in
advance and included in deferred revenue.
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Impact of Year 2000
General Overview:
The Company's Year 2000 Project is currently proceeding on schedule. The
Company began its assessment in the Spring of 1998 in response to a need to
address the issue of older computer programs and embedded computer chips'
inability to distinguish between the year 1900 and the year 2000. Critical
programs with the Company were written to use two digits rather than four digits
to define the applicable year. As a result, those programs have time-sensitive
software that recognizes a date using 00 as the year 1900 rather than the year
2000. This programming method could cause a system failure or miscalculation
which could cause the disruption of operations, including, among other things, a
temporary inability to process transactions, send invoices or engage in similar
normal business activities.
The assessment project schedule to be Year 2000 compliant by mid-1999 in
all areas within the Company has been met. All internal areas deemed critical
with potential to affect the Company's ability to do business (i.e. Computer
Server Room, Finance, Human Resources, Legal) are Year 2000 compliant at this
time. The Company is currently in the process of determining the Year 2000
compliance level of any and all external partners with the potential to affect
the Company's ability to do business as of January 1, 2000. Thus far, critical
partners (as well as local utilities providers) have responded with assurances
of their Y2K viability, nevertheless, correspondence has gone out to potential
backup partners (where applicable) in the event of any unforeseeable Y2K
mishaps.
Project:
The Company's Year 2000 Project is divided into three sections -
Applications software, Communications systems (telephones, voicemail, etc.) and
Infrastructure.
The methodology used to assess these three primary sections includes: a)
prioritizing by critical area; b) inventorying for potential Year 2000 problems
(i.e. computer workstations, servers, software); c) repairing/recoding program
code (where applicable) and/or replacing hardware/software as necessary; d)
testing material items; and e) designing and implementing contingency and
business continuation plans for the Company.
As of October 1, 1999, the priority assessment has been completed as it
relates to the Company's computer systems. Year 2000 issues as they relate to
the physical premises (building power, incoming phone service, etc.) are outside
the Company's control and correspondence inquiring as to Year 2000 compliance
has been delivered to the principals of the building's property management,
phone system suppliers, alarm system suppliers and communications service
providers (i.e. MCI, Pacific Bell). The Company has received assurances
indicating that the Company's internal alarm systems and communications systems
are Year 2000 compliant. The concern now is whether or not incoming services are
Year 2000 compliant. Because it is not possible to gauge the readiness of third-
party vendors, the Company is in the process of drafting a contingency plan in
the event that the Company's third-party vendors do not complete their Year 2000
implementations in time. This contingency plan will continue to be monitored and
updated into the Year 2000.
Inventorying of potential Year 2000 systems is 100% completed.
As of October 1, 1999, the main accounting system in use by the Company,
Show Auditor, has been recoded to comply with Year 2000 issues and has been
tested as compliant. Software changes have also been implemented within the
Company's network servers, Human Resources division, International Division and
Legal divisions to meet Year 2000 compliance. Compliance is 100% completed at
the desktop application level (word processing, spreadsheets and operating
systems) at each of the Company's computer workstations. This has been
accomplished by either installing the latest software patches, upgrading
software or replacing software as necessary. The Company's Communications
systems are Year 2000 compliant as mentioned above; therefore, recoding or
replacing is not necessary at this time. The Company has instituted a policy of
buying only Year 2000 compliant computer systems and applications to assure that
all new machines are Year 2000 compliant. Further, the Company acquired hardware
technology from
12
<PAGE>
Micro2000, Inc. to insert into older computer systems to make them Year 2000
compliant at the hardware level. As of October 1, 1999, the Centurion Y2K
hardware card has been tested and implemented. All Infrastructure activities are
completed as of October 1, 1999.
The Company implemented a policy of periodic checking/testing of all
internal applications software and hardware systems until the Year 2000. The
purpose of this phase is to assure that all Year 2000 compliance changes
continue working as expected. This phase will also involve the installation of
any last minute software patches as provided by software developers/
manufacturers. Further the Company purchased and installed Novell Zenworks
2.0 and Novell Check 2000 v.3.11 for Zenworks. These packages, in tandem,
manage the Company's PC-based computers and maintain status checks on the Y2K
status of software packages loaded onto the desktops. Further, Zenworks also
allows the Information Technologies division to disable the capacity of users
to load any software packages onto their desktops thus ensuring that only
approved Y2K compliant packages reside on Company computers.
The Company is involved in prioritizing non-computer-related systems to
assess their potential impact on the Company's operations. These systems would
include operations such as delivery services, materials suppliers, etc.
Contingency plans to address any of these systems which prove to be critical to
the Company's operations will continue to be monitored and adjusted into the
Year 2000.
Costs:
The total cost of the required modifications necessary to become Year
2000 compliant is not expected to be material to the Company's financial
position and is estimated at approximately $100,000. This does not include the
Company's potential share of Year 2000 costs that may be incurred by the Company
by way of partnerships and joint ventures in which the Company participates but
is not the controlling entity. Accordingly, the foreseeable costs arising from
such third-party relationships cannot be determined at this time. The total
amount expended on the Year 2000 Project through October 1, 1999 was $40,000,
which was related to the cost to repair or replace software and related hardware
problems.
Risks:
The failure to correct material Year 2000 problems could result in an
interruption in, or a failure of, certain normal business operations. These
failures could potentially materially affect the Company's results of operations
and financial condition; however, due to the general uncertainty which is
inherent in potential Year 2000 problems, resulting in part from the uncertainty
of the Year 2000 readiness of third-party suppliers, customers or partners, the
Company is unable to determine, at this time, whether the consequences of Year
2000 failures will have a material impact on the Company's results of operations
or financial condition.
The Year 2000 assessment project is the Company's response to this
potential problem and is expected to significantly reduce the Company's level of
uncertainty about the Year 2000 problem and the compliance and readiness of its
material third-party vendors. The Company believes that with the implementation
of new systems and completion of the Year 2000 project as scheduled, the
possibility of significant interruptions affecting the Company's operations
should be reduced.
Readers are cautioned that forward-looking statements contained in this
Year 2000 disclosure should be read in conjunction with the Company's
disclosures under the heading, "Risk Factors" in the Company's Annual Report on
Form 10-K for the year ended December 31, 1998 and in this Report. Readers
should understand that the dates on which the Company believes the Year 2000
project will be completed are based upon Management's best estimates, which were
derived utilizing numerous assumptions of future events, including the
availability of certain resources, third-party modification plans and other
factors. However, there can be no guarantee that these estimates will be
achieved, or that there will not be a delay in, or increased costs associated
with, the implementation of the Company's Year 2000 compliance project. A delay
in specific factors that might cause differences between the estimates and
actual results include, but are not limited to, the availability and cost of
personnel trained in these areas, the ability to correct all relevant computer
code, timely responses to and corrections by third-parties and suppliers, the
ability to implement interfaces between the new systems and the systems not
being replaced,
13
<PAGE>
and similar uncertainties. Due to the general uncertainty inherent in the Year
2000 problem, resulting in part from the uncertainty of Year 2000 readiness of
third-parties and the inter-connection of national and international businesses,
the Company cannot ensure that its ability to timely and cost effectively
resolve problems associated with the Year 2000 issue may not affect its
operations and business, or expose it to third-party liability.
Risk Factors
Dependence on a Limited Number of Television Programs
Our revenue has historically come from the production of a relatively small
number of animated television programs. For example, the Simpsons, King of the
Hill, and The Mr. Potato Head Show accounted for approximately 40%, 41% and 6%,
respectively, of our total revenue for the year ended December 31, 1998. As
audiences' tastes change frequently, we cannot assure you that broadcasters will
continue to broadcast our "proprietary" or "fee-for-services" programs or that
we will continue to be engaged to produce such programs. We currently enjoy
limited profit participation and/or limited licensing and merchandising
participation in King of the Hill and Mission Hill. However, we cannot assure
you that:
. those shows will remain on the air,
. we will continue to produce them, or
. they will be sufficiently successful to generate participation to us
While we continually endeavor to develop new programming, there can be no
assurance that revenue from existing or future programming will replace a
possible loss of revenue associated with the cancellation of any particular
program.
Impact of FCC Regulations Requiring Educational Content Programming
Certain FCC rules may adversely affect the number of time slots available for
our productions. These regulations strongly encourage broadcasters (through
license renewal procedures) to (1) offer at least three hours per week of
programming specifically designed to serve the educational and information needs
of children ages 16 and under, (2) identify each program as educational, (3)
schedule this programming weekly, and (4) offer this programming in 30-minute
formats. It is possible that programming qualifying for the new FCC
requirements will have a competitive advantage over non-qualifying programs.
This could further diminish the number of time slots available for our existing
programs, thus intensifying the strong competition for the remaining time slots.
While the full impact of the regulations on demand for children's programming
remains uncertain, we have experienced some significant impact. For example,
CBS, one of our primary customers over the years, elected to change its
programming slate to conform to the FCC regulations. In its first year
implementing this strategy, CBS did not order any new animated programming from
us. In its second year of implementation, CBS reduced its license fees.
Risks of Vertical Integration
Over the last decade, broadcasters, distributors and producers of televison
and motion picture programming have become increasingly integrated vertically
through mergers, acquisitions, partnerships, joint ventures or other
affiliations. We have not entered into any of these relationships. These
relationships, coupled with the recent repeal of certain regulations of the FCC
which had limited the ability of network broadcasters to control certain rights
in television programming, have resulted in broadcasters working more with their
affiliated producers of animated programming, limiting the number of time slots
available for other producers. We cannot assure you that the number of time
slots currently available for children's and/or animated programming and,
specifically, for animated programming supplied by independent animation
studios, will not decrease, or that we will compete successfully for available
time slots.
14
<PAGE>
Declining Value of License Fee Agreements and Increasing Control of
Proprietary Rights by Broadcasters
Competition created by the emergence of new broadcasters (such as UPN, WB,
Nickelodeon and the USA Network) has provided television audiences with more
choices, thereby generally reducing the number of viewers watching any one
program. As a result, the market share of, and license fees paid by, FOX, CBS
and ABC have decreased. There continues to be intense competition for the time
slots offered by the networks, especially FOX, CBS and ABC. This trend
continues to depress license fees to a level that may make it difficult for us
to finance certain proprietary programs. Moreover, broadcasters are demanding a
greater percentage of the revenue generated from the exploitation of proprietary
rights associated with the programs which they license. Broadcasters may also
seek control of and exploit all of the proprietary rights associated with the
programs which they license. We believe that these industry-wide trends may
have a significant adverse impact on our business, results of operations and
financial condition.
It is Possible That Our Current Programs May Not Sustain Their Popularity and
Our New Programs May Not Become Popular
We derive substantially all of our revenue from the production and
distribution of animated television programs. Each production is an individual
artistic work, and consumer reaction will determine its commercial success. We
cannot assure you that we will be able to continue to create entertaining
episodes for our existing programs or that we will be able to create new
programs that are appealing to broadcasters. When advertisers decide whether to
pay for advertising during a program's broadcast, they look closely at Nielsen
ratings. Broadcasters also consider Nielsen ratings when deciding whether to
renew a series or license a new series. Producers of syndicated programming,
like us, often receive payments from syndicators based on a share of the revenue
received from advertisers who advertise during a specific program. We try to
develop and produce programming that will perform well in the Nielsen ratings
system. Nielsen ratings for our programming depend on many factors beyond our
control, including:
. audience reaction
. competing programming
. availability of alternative forms of entertainment
. time slots when aired
. critical reviews
We cannot assure you that our programs will obtain favorable Nielsen ratings
or that broadcasters will license the rights to broadcast any of our programs in
development or will renew licenses to broadcast programs which we currently
produce. Even if a broadcaster renews the license to broadcast our programming,
we cannot guarantee that our program will remain popular. If our programming
becomes less popular, we will most likely derive less revenue which could impact
our financial condition.
Our Revenues Result from Sales to a Limited Number of Major Customers.
During the year ended December 31, 1998, we derived approximately 80% and 5%,
respectively, of our net sales from our top two customers, Twentieth Century Fox
Television (a Division of Twentieth Century Fox) and Fox Kids Network. Neither
of these customers is contractually obligated to continue to do business with
us. On May 13, 1999, Twentieth Century Fox Television and we jointly announced
that, due to production differences, we mutually agreed that Fox should assume
responsibility for the production of Family Guy. The transfer was effective June
1, 1999. In order to be successful, we must continue our relationships with our
customers; we must continue to develop relationships with new customers; and our
existing programs must continue to be broadcast. In the event our relationship
with either of our top customers terminates, we could experience an adverse
impact on our business.
Risks Related to Expansion of Production of Proprietary Programming
We produce substantially all of our programming on a "fee-for-services" basis.
As a result, we do not typically own or control licensing or distribution
rights, but may have profit participation rights based on a percentage of
adjusted gross profits or net profits earned by the owners of these distribution
rights. The
15
<PAGE>
fees we receive for these production services typically cover all direct
production costs plus a margin. We intend to expand our production of
programming for which we own or control licensing and/or distribution rights
("proprietary programming"). Proprietary rights associated with such programming
may include domestic and international broadcast distribution, home video
distribution, licensing and merchandising, feature film and interactive/game
development. While we seek to limit the financial risk associated with our
proprietary programming by obtaining commitments prior to production to cover at
least 50% of our direct production costs, we cannot be sure that we will be able
to recover the balance of our production and overhead costs through the
exploitation of our remaining rights. We derived $4.9 million, and $3.3 million,
in revenues from proprietary programming for the years ended December 31, 1997
and 1998, respectively. Since we only recently have begun to retain the
proprietary rights associated with our animated programs, we have a limited
history of operations and experience related to the exploitation of these
rights.
Risk of Budget and Cost Overruns
We review cost reports and update our cost projections regularly. Although we
have generally completed each of our productions within its budget, we cannot
assure you that the actual production costs for our programming will remain
within budget. Risks such as production delays, higher talent costs, increased
subcontractor costs, political instability overseas, and other unanticipated
events may substantially increase production costs and delay completion of the
production of any one or more of our programs.
Risks Related to Overestimation of Revenue or Underestimation of Costs
We follow Financial Accounting Standards Board Statement No. 53, "Individual
Film Forecast" ("FASB 53"), regarding revenue recognition and amortization of
production costs. All costs incurred in connection with an individual program or
film, including acquisition, development, production and allocable production
overhead costs and interest, are capitalized as television and film costs. These
costs are stated at the lower of unamortized cost or estimated net realizable
value. We amortize our estimated total production costs for an individual
program or film in the proportion that revenue realized relates to management's
estimate of the total revenue expected to be received from such program or film.
As a result, if revenue or cost estimates change with respect to a program or
film, we may be required to write-down all or a portion of our unamortized costs
for the program or film. We cannot assure you that these write-downs will not
have a significant impact on our results of operations and financial condition.
Seasonality
Our results of operations depend on our production and delivery schedule of
television programs. Broadcasters typically make most of their annual
programming commitments in the first and second quarters of any calendar year so
that new programs will be ready for delivery in the third quarter and, to a
greater extent, the fourth quarter of that year. Producers typically recognize
revenues from license and production agreements when the producer delivers the
finished product to the customer and the customer accepts it. As a result of the
production cycle, we do not recognize revenue evenly throughout the year. We
typically recognize a significant portion of our revenue in the fourth quarter.
Our results of operations fluctuate materially from quarter to quarter and year
to year. The results of any one period do not necessarily indicate results for
future periods. Cash flows also fluctuate and do not necessarily correlate with
revenue recognition
Competition
Programming. The creation, development, production and distribution of
television programming, together with the exploitation of the proprietary rights
related to such programming, is a highly competitive business. We compete with
producers, distributors, licensors and merchandisers, many of whom are larger
and have greater financial resources than we do. Although the number of outlets
available to producers of animated programming has increased with the emergence
of new broadcasters, the number of time slots available to independent producers
of children's and animated programming remains limited. Moreover, because
license fees in the United States have dropped substantially recently, companies
that do not rely on U.S. broadcast license fees to finance the production of
animation programming, particularly international animation companies which
receive governmental subsidies, have
16
<PAGE>
achieved a competitive advantage. These companies now serve as an additional
source of competition for the limited slots available to independent animation
companies. We also believe that we face competition from a variety of companies
in three principal areas: (1) for the time slots for animated programming
offered by broadcasters, (2) for the acquisition of characters, story lines,
plots and ideas and (3) for the right to license and distribute our products
throughout the United States and internationally.
Creative Properties and Creative Personnel. We compete with other animation
companies for characters, storylines, plots and ideas created by third parties.
Third parties select us based on their perception of whether we are best able to
create and develop a successful program from the initial idea or character. We
also compete with other animation companies (including the film and television
animation operations of major studios) for the animators, writers, producers and
other creative personnel needed to successfully develop and produce animated
programming. We believe that we compete for creative properties and creative
personnel with a variety of companies including The Walt Disney Company, Warner
Bros., Hanna-Barbera, DIC, Klasky-Csupo, Marvel Entertainment, Saban
Entertainment, Cinar Films, DreamWorks SKG, Nelvana, Universal Cartoon Studios,
Sony Cartoon Studios and Hyperion Productions, many of which have greater
financial resources to obtain creative properties and creative personnel.
Licensing and Merchandising. In the first quarter of 1998, we decided to
reduce our fixed overhead by outsourcing our licensing and merchandising
activities. However, we expect that the exploitation of our licensing and
merchandising rights will remain an important part of our strategy. We compete
with other owners of creative content who seek to license their characters and
properties to a limited number of distributors. In connection with our recent
initiatives to exploit the proprietary rights associated with our programming,
we have entered into several licensing and merchandising agreements. However,
for the year ended December 31, 1998, we derived no significant revenue from our
licensing and merchandising activities and we cannot assure you that we will
derive significant revenue in the future.
Risks Related to International Operations
Risks of International Business Generally. Part of our strategy involves
our current and planned activities in a number of developing nations. There are
many risks inherent in our international business activities. Our projects
could be adversely affected by:
. reversals or delays in the opening of foreign markets to new competitors;
. unexpected changes in regulatory requirements;
. export controls, tariffs and other barriers;
. currency fluctuations;
. investment policies;
. nationalization, expropriation and limitations on repatriation of cash,and
. social and political risks.
Overseas Subcontractors. Like other producers of animated programming, we
subcontract some of the less creative and more labor-intensive components of our
production process to animation studios located in low-cost labor countries,
primarily in the Far East. As the number of animated feature films and animated
television programs increases, the demand for the services of overseas studios
has increased substantially. This increased demand may lead overseas studios to
raise their fees which may result in increased animated programming production
costs or our inability to contract with our preferred overseas studios.
Many of the subcontractors we use are located in South Korea and, to a lesser
extent, Taiwan, the Philippines and China. Each of these areas has recently
experienced significant political and/or economic turmoil, such as, but not
limited to, devaluation of the won and other Asian currencies. The Asian
markets may continue to deteriorate, which could have a substantial impact on
our ability to contract favorably with studios in Asia. These conditions could
cause significant disruptions in the delivery of animation products to us. In
that event, we may be required to retain new subcontractors. We cannot assure
you that different subcontracting arrangements will be as favorable to us as our
current arrangements.
17
<PAGE>
International Sales-Market Fractionalization. We derived approximately
8% and 4% of our revenue for the years ended December 31, 1997 and 1998,
respectively, from licensing international distribution rights to our
proprietary programming. We anticipate that revenue from these activities will
not grow substantially until we produce additional proprietary programming for
which we own and control international distribution rights. Just as in the US,
there are an increasing number of broadcast outlets for animation in most major
international territories. While this has created more opportunities to sell
product, on the one hand, the total advertising dollars available is now being
spread amongst this larger number of outlets, so the revenues each broadcaster
receives and, consequently, the amount of the license fees they can pay, has
begun to diminish substantially. Our ability to continue to expand our
international business (as well as our ability to contract upon favorable terms
with overseas studios) depends, in part, on the local economic conditions,
currency fluctuations, local changes in regulatory requirements, compliance with
a variety of foreign laws and regulations, and cultural barriers. In addition,
political instability in a foreign nation may adversely affect our ability to
distribute our product in that country. As a result, we cannot assure you that
our international operations will be profitable.
Risks Associated with Possible New Businesses
Due in part to the recent changes in the television industry described in this
Report, we have made, and intend to continue to make a substantial commitment to
new business areas beyond our core business of animation television production.
We have begun live action television production, feature film development with
the expectation of production (both live action and animation), internet
investments and direct-to-video production (both live action and animation).
Some of this production may be on a "fee-for-services" or a "proprietary" basis.
The television, feature film and direct-to-video industries are highly
speculative and involve a substantial degree of risk. The success of an
individual television program, feature film or direct-to-video release depends
upon unpredictable and changing factors, such as personal tastes of the public
and critics. In addition, we are evaluating entering the Internet distribution
market through the Level 13 branded animation destination. This is a new
business for us that may require that we use significant resources in an effort
that may not be successful. Therefore, there is a substantial risk that our
projects will not be successful, resulting in costs not being recouped and
anticipated profits not being realized. Although we intend to limit the risks of
production through co-production, pre-sale financing and/or distribution
arrangements, we will likely be unable to limit all of the financial risk of a
television production, feature film or direct-to-video release. In addition,
because the success of a television production, feature film or direct-to-video
release, and Internet distribution depends upon consumer taste and critical
response, as well as public awareness and the successful distribution of a
production, we cannot predict the level of marketing, promotional and
distribution activities and expenses necessary in any particular instance.
Moreover, we have no history of developing, producing, or distributing live
action television or film productions, or with distribution over the Internet
and we cannot assure you that we can compete successfully with more established
persons or entities. Live action production involves many of the risks
associated with animation production that are described in this Report, as well
as additional risks inherent to live action that are outside of our control,
including the risk of work stoppage or strike, increased union activity, delay
in production due to weather and other local conditions, inability to obtain
proper permitting to film at a desired site, at desired times and/or under
desired terms, and accidents or injury to actors and film crew. We cannot be
sure that we will produce any live action television or film projects or that,
if produced, that such projects will be profitable. The World Wide Web is an
evolving marketplace, and we cannot predict consumer taste or the advances in
underlying technology. Likewise, we cannot assure you that we will be successful
should we decide to promote Level 13 as an independent animation
destination/network.
Technological Changes; Possible Changes in Production of Our Products
The proliferation of new production technologies may change the manner in
which we create and distribute programming. Recently, certain animators have
begun to use computer-generated animation, including three-dimensional digital
animation, instead of two-dimensional cel animation, to create their animated
programming. We cannot be sure that the introduction and proliferation of three-
dimensional digital animation or other technological changes will not cause our
historical methods of producing animation to become less cost competitive or
less appealing to our audiences. In addition, we cannot be sure that we will be
able to adapt to such changes in a cost-effective manner.
18
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Officer Vacancy; Dependence upon Key Personnel
As described in "Subsequent Events" above, David Pritchard's employment as
President and Chief Executive Officer of the Company was not continued by the
Company and we have not retained a successor for those positions. While the
Board of Directors is seeking a successor to fill those positions, there can be
no assurance that it will find a suitable person or be able to negotiate
successfully to retain any acceptable candidate. Failure to locate a suitable
successor to Mr. Pritchard in a timely fashion could have an adverse effect on
the our financial position and future production prospects.
We believe that our future success will depend, in part, on our continuing
ability to attract, retain and motivate qualified personnel in both our existing
and new businesses.
Our success continues to depend to a significant extent on the services of key
management personnel. We cannot be sure that we will be able to retain our
existing management personnel. We do not currently carry "key man" life
insurance policies on any of our executives. In addition, our continued success
is highly dependent on the artistic and production capabilities of our creative
staff. We are a signatory to the Screen Actors Guild collective bargaining
agreement and certain of our voice-over actors are Screen Actors Guild members.
We also have a wholly owned subsidiary, Namor Productions Inc., which is a
signatory to the Writer's Guild of America collective bargaining agreement.
Casualty Risks
Substantially all of our operations and personnel are located in our North
Hollywood headquarters, resulting in vulnerability to fire, flood, power loss,
telecommunications failure or other local conditions, including the risk of
seismic activity. If a disaster were to occur, our disaster recovery plans may
not be adequate to protect the Company and our business interruption insurance
may not fully compensate us for our losses.
Possible Adverse Effect of Anti-takeover Provisions
Certain provisions of our certificate of incorporation, by-laws and
Delaware law (including a stockholders rights plan (sometimes referred to as a
"poison pill") which we adopted in 1998) could be used by our incumbent
management to make it substantially more difficult for a third party to acquire
control of the Company. These provisions could discourage potential takeover
attempts and could adversely affect the market price of our common stock.
In addition, our corporate documents authorize the Board of Directors to issue
shares of preferred stock and to establish the rights of that preferred stock
without stockholder approval. If the Board issues preferred stock, it could
have the effect of delaying or preventing a change in control of our company,
even if a change in control were in our best interests.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company does not utilize market risk sensitive instruments (such as
derivative financial instruments) for trading or other purposes.
The Company has low exposure to interest rate risk. The Company currently does
not have any debt (fixed or floating rate) other than trade liabilities and
invests its cash assets in debt instruments with maturities of less than 90
days. Thus, a decrease (or increase) in future interest rates will directly and
proportionately decrease (or increase, respectively) the Company's future
interest income. For the three months ended September 30, 1999, the Company
earned interest income of $79,051.
The Company is not exposed to significant foreign exchange rate risk.
All of the Company's contracts with foreign subcontractors are dollar-
denominated. The Company makes limited international sales in foreign
currencies, the aggregate of which the Company estimates to be less than one
percent of the Company's yearly revenue.
19
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
In March 1998, Mike Waeghe filed a Petition for Arbitration against the
Company for breach of contract and breach of the covenant of good faith and fair
dealing, based on his writer/producer agreement ("Agreement") relating to the
Blues Brothers: The Animated Series (the "Series"). The Company developed and
was in production on a 13 episode order from UPN. Due to creative differences,
the Series was put on hiatus. Within weeks of the decision to resume production,
UPN cancelled the Series and reached a settlement with the Company. No episodes
were completed, and none aired. Waeghe alleges that there were two separate
Series orders, and that, therefore, the Company owes him a second set of fixed
compensation payments totaling approximately $250,000. Waeghe also alleges that
the Company did not use its best efforts to produce and sell the Series, such
that he should receive contingent compensation of more than $1.0 million in the
form of net profits, broadcast royalties and the like. Waeghe assigned his
claims to his loan-out corporation Mad Cow Productions. The Company filed a
Cross-Complaint against Waeghe for the overpayment of his fixed compensation in
part based on its advance of fixed compensation payments to Waeghe that he never
earned under the Agreement because no episodes were completed. Each side
requested attorney fees under the Agreement.
A binding arbitration was conducted before the Honorable Elwood Lui,
Retired Court of Appeal Justice, in October 1999. The Company has not yet
received a decision on this matter, and cannot predict the outcome of the case.
If the arbitrator rules in favor of Waeghe on his fixed compensation claim, the
outcome is unlikely to have material effect on the Company's finances. If the
arbitrator rules in favor of Waeghe on his contingent compensation claim, the
outcome is likely to have a material effect on the Company's finances.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
INDEX TO EXHIBITS
Exhibit
Number Description
- ------- -----------
27 Financial Data Schedule
(b) Reports on Form 8-K.
No reports on Form 8-K were filed by the Company during the quarter
ended September 30, 1999.
20
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Dated: November 15, 1999
FILM ROMAN, INC.
By: /s/ Greg Arsenault
-----------------------------------------------------
Greg Arsenault
Senior Vice President - Finance and Administration
(Duly authorized officer and chief accounting
officer)
21
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
UNAUDITED FINANCIAL STATEMENTS OF FILM ROMAN, INC., AS OF AND FOR THE THREE
MONTH AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 1999, AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1999
<PERIOD-START> JUL-01-1999 JAN-01-1999
<PERIOD-END> SEP-30-1999 SEP-30-1999
<CASH> 5,566,983 5,566,983
<SECURITIES> 0 0
<RECEIVABLES> 796,168 796,168
<ALLOWANCES> 0 0
<INVENTORY> 27,529,235 27,529,235
<CURRENT-ASSETS> 0 0
<PP&E> 2,776,216 2,776,216
<DEPRECIATION> 1,882,376 1,882,376
<TOTAL-ASSETS> 35,367,762 35,367,762
<CURRENT-LIABILITIES> 0 0
<BONDS> 0 0
0 0
0 0
<COMMON> 85,243 85,243
<OTHER-SE> 36,308,524 36,308,524
<TOTAL-LIABILITY-AND-EQUITY> 35,367,762 35,367,762
<SALES> 3,630,045 31,082,974
<TOTAL-REVENUES> 3,630,045 31,082,974
<CGS> 3,970,932 29,369,484
<TOTAL-COSTS> 3,970,932 29,369,484
<OTHER-EXPENSES> 1,692,342 4,759,851
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 79,051 297,685
<INCOME-PRETAX> (1,954,178) (2,748,676)
<INCOME-TAX> 5,594 10,849
<INCOME-CONTINUING> (1,959,772) (2,759,525)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (1,959,772) (2,759,525)
<EPS-BASIC> (0.23) (0.32)
<EPS-DILUTED> 0 0
</TABLE>
