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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, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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 7, 2000, 8,565,190 shares of common stock, par value $.01
per share, were issued and outstanding.
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TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.............................................. 3
Consolidated Balance Sheets as of December 31, 1999 and
September 30, 2000 (unaudited).................................... 3
Consolidated Statements of Operations for the Three and
Nine Months Ended September 30, 1999 and September 30, 2000
(unaudited)....................................................... 4
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 1999 and September 30, 2000 (unaudited)....... 5
Notes to Consolidated Financial Statements........................ 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................. 8
Item 3. Quantitative and Qualitative Disclosures about Market Risk........ 16
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.................................. 17
Signatures...................................................................S-1
2
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
FILM ROMAN, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, September 30,
1999 2000
------------ ------------
(unaudited)
<S> <C> <C>
ASSETS
Cash and cash equivalents................................................... $ 7,557,673 $ 5,205,513
Accounts receivable......................................................... 480,832 596,811
Film costs, net of accumulated amortization of $293,461,861 (1999) and
$318,658,737 (2000)......................................................... 18,703,495 28,120,052
Property and equipment, net of accumulated depreciation and
amortization of $2,021,674 (1999) and $2,325,021 (2000)..................... 950,651 791,158
Deposits and other assets................................................... 457,093 559,882
------------ ------------
Total Assets................................................................ $ 28,149,744 $ 35,273,416
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable............................................................ $ 1,714,705 $ 928,804
Accrued expenses............................................................ 2,496,581 1,946,142
Deferred revenue............................................................ 19,327,253 30,055,061
------------ ------------
Total liabilities........................................................... 23,538,539 32,930,007
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, 8,524,190 shares issued and outstanding at
December 31, 1999 and 8,565,190 shares issued and
outstanding at September 30, 2000 85,243 85,653
Additional paid-in capital.................................................. 36,311,837 36,370,364
Accumulated deficit......................................................... (31,785,875) (34,112,608)
------------ ------------
Total stockholders' equity......................................... 4,611,205 2,343,409
------------ ------------
Total liabilities and stockholders' equity......................... $ 28,149,744 $ 35,273,416
============ ============
</TABLE>
See accompanying notes.
3
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FILM ROMAN, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three Months ended Nine Months ended
September 30, September 30,
-------------------------------- -------------------------------
1999 2000 1999 2000
----------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
Revenue....................... $ 3,630,045 $5,039,889 $31,082,974 $25,671,673
Cost of revenue............... 3,970,932 4,651,857 29,369,484 25,196,846
Selling, general and
administrative expenses...... 1,692,342 833,876 4,759,851 3,012,806
----------- ---------- ----------- -----------
Operating loss................ (2,033,229) (445,844) (3,046,361) (2,537,979)
Interest income............... 79,051 71,353 297,685 212,834
Loss before provision for
income taxes................. (1,954,178) (374,491) (2,748,676) (2,325,145)
Provision for income taxes.... 5,594 0 10,849 1,588
Net loss...................... $(1,959,772) $ (374,491) $(2,759,525) $(2,326,733)
=========== ========== =========== ===========
Net loss per share basic and
diluted...................... $ (0.23) $ (0.04) $ (0.32) $ (0.27)
=========== ========== =========== ===========
Weighted average number of
shares outstanding basic and
diluted...................... 8,524,190 8,565,190 8,523,405 8,563,175
=========== ========== =========== ===========
</TABLE>
See accompanying notes.
4
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FILM ROMAN, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Nine Months ended
September 30,
----------------------------------
1999 2000
------------ ------------
<S> <C> <C>
Operating activities:
Net loss................................................ $ (2,759,525) $ (2,326,733)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization........................... 323,264 303,347
Amortization of film costs.............................. 29,369,484 25,196,846
Changes in operating assets and liabilities:
Accounts receivable................................... 293,050 (115,979)
Film costs............................................ (35,994,948) (34,613,403)
Deposits and other assets............................. (92,330) (102,789)
Accounts payable...................................... 394,214 (785,901)
Accrued expenses...................................... 300,289 (550,440)
Deferred revenue...................................... 2,681,253 10,727,808
------------ ------------
Net cash used in operating activities................. (5,485,249) (2,267,244)
Investing activities:
Additions to property and equipment..................... (238,014) (143,854)
------------ ------------
Net cash used in investing activities................... (238,014) (143,854)
Financing activities:
Options Exercised....................................... 2,860 58,938
------------ ------------
Net cash provided by financing activities.............. 2,860 58,938
Net decrease in cash and cash equivalents............... (5,720,403) (2,352,160)
Cash and cash equivalents at beginning of period........ 11,287,386 7,557,673
------------ ------------
Cash and cash equivalents at end of period.............. $ 5,566,983 $ 5,205,513
============ ============
</TABLE>
See accompanying notes.
5
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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, Level 13 Entertainment, Inc., a
Delaware corporation, and Special Project Films, 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, 2000 and the results of its
operations for the three and nine months ended September 30, 1999 and 2000, and
the cash flows for the nine months ended September 30, 1999 and 2000 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, 1999
(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, 1999 and 2000,
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, 1999 September 30, 2000
------------------ (unaudited)
-----------
<S> <C> <C>
Film productions released, net of amortization...... $ 1,029,946 $ 652,198
Film productions in process......................... 17,174,838 26,421,290
Film productions in development..................... 498,711 1,046,564
----------- -----------
$18,703,495 $28,120,052
=========== ===========
</TABLE>
6
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(4) - Foreign Distribution Agreement
In April of this year the Company entered into a foreign distribution
agreement with the Harvey Entertainment Company. Under the terms of this
agreement, Harvey will distribute for a period of two years, outside of the US
and Canada, all television rights which the Company designates. The Company has
heretofore designated its current library for distribution under the terms of
this agreement. This arrangement enables the Company to reduce its overhead
attributable to the international division. Given the size of the Company's
library, management believes that this arrangement is more cost effective than
distributing its own product, while at the same time enabling the Company to
continue to seek co-production and other international arrangements. Moreover,
the term is sufficiently short so as to enable management to reevaluate its
international distribution strategy as the market changes.
(5) - Recent Accounting Pronouncements
In June 2000, the American Institute of Certified Public Accountants issued
SOP 00-2, "Accounting by Producers or Distributors of Films". SOP 00-2
establishes new accounting standards for producers and distributors of films,
including changes in revenue recognition and accounting for advertising,
development and overhead costs. Development costs for abandoned projects and
certain indirect overhead costs are to be charged directly to expense instead of
those costs being capitalized to film costs, which is what current guidance
prescribes. The Company is in the process of evaluating the overall impact of
SOP 00-2, which is effective for fiscal years beginning after December 15, 2000,
on its consolidated financial statements. The Company does not anticipate such
adoption will have a material impact on future earnings or its financial
position.
7
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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 "The Oblongs" currently expected
to debut on the WB network ("The WB") in January 2001 and the 13 episodes of
"Doomsday" intended to be broadcast starting in the fall of 2001 on UPN; the
Company's future production and delivery schedule (including the number of
episodes of programming to be produced and delivered during the 2000-2001
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 Related to the
Business Risk Factors" included in the Company's Form 10-K for the year ended
December 31, 1999. 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 update or revise publicly any forward-
looking statements, whether as a result of new information, future events or
otherwise.
General
Film Roman, Inc. ("Film Roman" or the "Company") develops, produces and
distributes a broad range of television programming for the television
networks, 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 was founded in 1984 and has grown into one of the
leading independent animation studios in the world. Film Roman has produced or
is producing some of the world's best known animated series, including The
Simpsons, King of the Hill, The Mask, Bobby's World, The Twisted Tales of Felix
the Cat and Garfield & Friends. Over the years, the Company has primarily
produced animation for television, on a fee-for-service and a proprietary basis.
Production work on a fee-for-service basis has historically accounted for
the largest and most reliable portion of the Company's revenues. Fees paid to
the Company for these production services generally range from $300,000 to
$800,000 per episode and typically cover all direct production costs plus a
profit margin. The Company also produces 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 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 revenue that
exceed its costs.
8
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The Company is also continuing expansion of its production capabilities
into live action and expansion of its intended markets beyond television,
including motion pictures, cable, direct-to-video, commercials and the Internet.
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 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, and the level of marketing, promotional and
distribution activities and expenses necessary for such productions cannot be
predicted with certainty. The Company has a very limited history of developing,
producing or distributing live action television, computer generated animation
and theatrical 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,
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.
The Company's 2000-2001 Production Schedule
The Company has historically been a major producer of animated prime time,
first run syndicated and Saturday morning programming. The market for these
programs is composed of television networks (ABC, CBS, NBC, FOX, UPN and Warner
Brothers); syndicators of first run programming that license programming on
local stations nationwide (Columbia-Tristar, Universal, Paramount, King, Fox,
MGM and Viacom); and cable networks and services (USA, Disney Channel, Fox
Family, HBO, Showtime and TNT).
The Company is currently scheduled to produce the following programming for
the 2000-2001 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 twelfth season and now the longest-running prime time animated series
in television history, The Simpsons has been honored with a Peabody Award,
Emmy Awards, Annie Awards, Genesis Awards, International Monitor Awards and
three Environmental Media Awards, among numerous other honors. The Simpsons
has transformed the way the television industry and audiences perceive
animation and comedy series in general.
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.
The Oblongs. The Company is currently scheduled to produce 13
episodes of The Oblongs which is currently expected to be broadcast in
January 2001 on the WB Network. The Oblongs is a new half-hour, prime time
animated television series.
Doomsday. The Company is currently scheduled to produce 13 episodes
of Doomsday, which is intended to be broadcast starting in the fall of
2001 on UPN. Doomsday is a new half-hour, prime time television series, in
which the Company has a proprietary interest.
X-Men. The Company is currently scheduled to produce 13 episodes of
X-Men, which airs Saturday mornings on the WB Network. X-Men is a new
half-hour, animated television series.
9
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My First Mister. The Company completed in the first quarter of 2000
principal photography for My First Mister, a live-action feature film
financed by a third party which stars Albert Brooks and Leelee Sobiesky and
is directed by Christine Lahti.
Twelfth Lap. The Company is currently producing one movie-of-the-
week, Twelfth Lap, for the Disney Channel, which is scheduled to be
broadcast during the 2001 broadcast season.
Results of Operations
Three Months Ended September 30, 2000 Compared to Three Months Ended September
30, 1999
Total revenue increased by 39%, or $1.4 million, to $5.0 million for the
three months ended September 30, 2000, from $3.6 million for the comparable
period in the prior year. Total revenue increased primarily because the Company
delivered more prime time fee-for-services episodes during the three months
ended September 30, 2000 compared to the three months ended September 30, 1999.
The Company delivered six fee-for-services episodes during the three
months ended September 30, 2000, compared to four episodes in the comparable
period in 1999. Fee-for-services revenue increased 92%, or $2.3 million, to
$4.8 million for the three months ended September 30, 2000, from $2.5 million
during the comparable period in 1999.
The Company delivered no proprietary episodes during the three months
ended September 30, 2000 or 1999. 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 almost 100% or $0.4 million, to almost zero
for the three months ended September 30, 2000, from $0.4 million in the
comparable three month period in 1999.
Other revenue decreased by approximately $0.5 million during the three
months ended September 30, 2000, as compared to the same period of the prior
year. The decrease is due to a decrease in revenue from commercials and
specials, from the Company's creative services division and the Company's live
action unit.
Total cost of revenue increased by 18%, or $0.7 million, to $4.7 million
for the three months ended September 30, 2000, from $4.0 million for the three
months ended September 30, 1999. Total cost of revenue, as a percentage of
sales, decreased by 17% to 94%, primarily due to higher fee-for-service margins
offset by lower commercial and special margins.
Total selling, general and administrative expenses for the three months
ended September 30, 2000 decreased by $0.9 million to $0.8 million from $1.7
million for the comparable period in 1999, due primarily to decreased
development expenses, lower general and administrative costs and lower costs in
the international division.
Operating loss was $0.4 million for the three months ended September 30,
2000, as compared to a loss of $2.0 million for the three months ended September
30, 1999.
Nine Months Ended September 30, 2000 Compared to Nine Months Ended September 30,
1999
Total revenue decreased by 17%, or $5.4 million, to $25.7 million for the
nine months ended September 30, 2000, from $31.1 million for the comparable
period in the prior year. Total revenue decreased because the Company delivered
significantly fewer episodes of programming in the first nine months of 2000 as
compared to the first nine months of 1999. The Company delivered a total of 35
episodes of programming for the nine months ended September 30, 2000, as
compared to 49 episodes for the nine months ended September 30, 1999. This
decrease in the number of episodes delivered results from the Company's ceasing
production of Family Guy.
10
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The Company delivered 35 fee-for-services episodes during the nine months
ended September 30, 2000, compared to 49 episodes in the comparable period in
1999. Fee-for-services revenue decreased 15%, or $4.2 million, to $24.0 million
for the nine months ended September 30, 2000, from $28.2 million during the
comparable period in 1999.
The Company delivered no proprietary episodes during the nine months
ended September 30, 2000 and 1999. Proprietary revenue decreased by 43% or
$0.3 million, to $0.4 million for the nine months ended September 30, 2000, from
$0.7 million in the comparable nine month period in 1999.
Other revenue decreased by approximately $0.9 million during the nine
months ended September 30, 2000, as compared to the same period of the prior
year, due primarily to a combined decrease of approximately $1.1 million in
revenue from commercials and specials from the Company's creative services
division and the Company's live action unit. The decrease was offset by an
increase of $0.2 million in revenue from the Company's participation in net
profits from certain of its fee-for-service series and the Company's feature
unit.
Total cost of revenue decreased by 14%, or $4.2 million, to $25.2 million
for the nine months ended September 30, 2000 from $29.4 million for the nine
months ended September 30, 1999. Total cost of revenue, as a percentage of
sales, increased by 3% to 98%, primarily due to lower fee-for-services,
commercial and special margins.
Total selling, general and administrative expenses for the nine months
ended September 30, 2000 decreased by $1.8 million to $3.0 million from $4.8
million for the comparable period in 1999, due primarily to decreased costs in
the development department, lower executive costs and a decrease in
international costs.
Operating loss was $2.5 million for the nine months ended September 30,
2000, as compared to a loss of $3.0 million for the nine months ended September
30, 1999.
Certain Events
Investment by PentaMedia
On October 23, 2000 the Company announced that its Board of Directors had
agreed to a letter of intent pursuant to which PentaMedia Graphics, Ltd.
("PentaMedia"), India's largest multimedia production company, will purchase a
51% stake in Film Roman at closing by means of new common stock issued by the
Company. The transaction, which calls for a $15,000,000 investment in the
Company by PentaMedia, is targeted to close in January 2001. The Company is
negotiating a definitive purchase agreement with PentaMedia which will govern
the terms of the stock purchase by PentaMedia. Consummation of the transactions
contemplated by the purchase agreement requires approval by regulatory bodies in
both the United States and India and approval by Film Roman stockholders. No
assurance can be given that regulatory bodies in both countries will approve the
purchase or that stockholders of the Company will approve the transaction.
Nasdaq SmallCap Market
Trading of the Company's common stock was transferred from the Nasdaq
National Market to the Nasdaq Small Cap Market on June 27, 2000. This transfer
was made pursuant to an application that the Company filed with NASDAQ. The
Company applied for this transfer because the Company was no longer in
compliance with the listing requirements of the Nasdaq National Market. By
letter dated August 29, 2000 (the "Letter"), NASDAQ notified the Company that
its common stock has not maintained a minimum bid price of $1.00 over the thirty
days prior to the date of the Letter. If the Company has not regained
compliance with Marketplace Rule 4310(c)(4) within 90 days of the Letter, the
Company's common stock will be delisted. The Company intends to appeal the
NASDAQ staff's determination by requesting a hearing before the NASDAQ Listing
Qualifications Panel. A hearing request will stay the delisting of the
Company's securities pending a decision by the NASDAQ Listing Qualifications
Panel.
11
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Foreign Distribution Agreement
In April of this year the Company entered into a foreign distribution
agreement with the Harvey Entertainment Company. Under the terms of this
agreement, Harvey will distribute for a period of two years, outside of the US
and Canada, all television rights which the Company designates. The Company has
heretofore designated its current library for distribution under this agreement.
This arrangement enables the Company to reduce its overhead attributable to the
international division. Given the size of the Company's library, management
believes that this arrangement is more cost effective than distributing its own
product, while at the same time enabling the Company to continue to seek co-
production and other international arrangements. Moreover, the term is
sufficiently short so as to enable management to reevaluate its international
distribution strategy as the market changes.
Liquidity and Capital Resources
At September 30, 2000, the Company had cash and short-term investments of
approximately $5.2 million compared to $7.6 million at December 31, 1999. The
Company's cash and short-term investment balances have continued to decline
since December 31, 1999, and the Company expects cash to decline further during
fiscal 2000. 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 may 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. To enable the
Company to pursue such strategies, the Company entered into the letter of
intent with PentaMedia discussed previously (See Investment by PentaMedia).
In the event the investment by PentaMedia is not approved or closed, the
Company may need to secure additional equity or debt financing during fiscal
2000/2001 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 and listing performance may make it difficult for
the Company to attract equity investments on terms that are 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 could have an adverse effect on the implementation of the
Company's growth strategies and its ability to successfully run its operation.
For the nine months ended September 30, 2000, net cash used in operating
activities was $2,267,244 due to cash used in connection with film production
activities offset by an increase in deferred revenue. Cash used in investing
activities for the nine months ended September 30, 2000 was $143,854 due to
additions to property and equipment. Cash provided by financing activities for
the nine months ended September 30, 2000 was $58,938 related to the exercise of
the Company's stock options.
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, 2000, the Company had a balance in its deferred revenue account
of $30.1 million. There will be an appropriate net cost to the Company (future
receipts less future expenditures) of $1.3 million to finish the programs for
which cash has been collected in advance and included in deferred revenue.
12
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Recent Accounting Pronouncements
In June 2000, the American Institute of Certified Public Accountants issued
SOP 00-2, "Accounting by Producers or Distributors of Films." SOP 00-2
establishes new accounting standards for producers and distributors of films,
including changes in revenue recognition and accounting for advertising,
development and overhead costs. Development costs for abandoned projects and
certain indirect overhead costs are to be charged directly to expense instead of
those costs being capitalized to film costs, which is what current guidance
prescribes. The Company is in the process of evaluating the overall impact of
SOP 00-2, which is effective for fiscal years beginning after December 15, 2000,
on its consolidated financial statements. The Company does not anticipate such
adoption will have a material impact on future earnings or its financial
position.
Risk Factors
The Company's business is subject to numerous risk factors, not all of which
can be known or anticipated and any one of which could adversely impact the
Company or its financial condition. Some of those risk factors are as follows:
Failure to Renew Licenses or Production Agreements. There can be no assurance
that any of the programs being produced by the Company will be relicensed for
additional broadcast seasons or renewed for production or, if so relicensed or
renewed, that the terms of the license agreements or production agreements will
be as favorable to the Company as those of existing licenses or production
agreements.
Dependence on a Limited Number of Television Programs. Company revenue has
historically come from the production of a relatively small number of animated
television programs. For example, King of the Hill, The Simpsons, Family Guy
and Mission Hill accounted for approximately 33%, 30%, 14% and 12%,
respectively, of the Company's total revenue for the year ended December 31,
1999. No assurance can be given that broadcasters will continue to broadcast
Film Roman proprietary or fee-for-services programs or that Film Roman will
continue to be engaged to produce programming.
Impact of FCC Regulations. Certain FCC rules may adversely affect the number
of time slots available for Film Roman productions.
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. Film Roman has not entered
into any of these relationships. As a result, the number of time slots available
for children's and/or animated programming and, specifically, for animated
programming supplied by independent animation studios, may decrease, making it
more difficult to compete successfully for available time slots.
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 may continue to decrease and make it difficult for
the Company to finance certain proprietary programs.
Current Programs May Not Sustain Their Popularity and New Programs May Not
Become Popular. The Company derives substantially all of its 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. No assurance can be made that the Company will be able to continue to
create entertaining episodes for its existing programs or that the Company will
be able to create new programs that are appealing to broadcasters.
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Risks Related to Expansion of Production of Proprietary Programming. The
Company intends to expand its production of programming for which it owns or
controls certain licensing and/or distribution rights ("proprietary
programming"). These rights may include domestic and international broadcast
distribution, home video distribution, licensing and merchandising, feature film
and interactive/game development ("proprietary rights"). While the Company
seeks to limit the financial risk associated with the development of its
proprietary programming by obtaining commitments prior to production to cover at
least 50% of its direct production costs, the Company cannot be sure that it
will be able to recover the balance of its production and overhead costs through
the exploitation of its remaining rights.
Risk of Budget and Cost Overruns. Although the Company reviews cost reports
and updates its cost projections regularly and has generally completed each
production within its budget, no assurance can be made that the actual
production costs for programming will remain within budget.
Risks Related to Overestimation of Revenue or Underestimation of Costs. The
Company follows 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. The Company amortizes its 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, the Company may be required
to write-down all or a portion of its unamortized costs for the program or film.
No assurances can be made that these write-downs will not have a significant
impact on results of operations and financial condition.
Competition. 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. The Company
competes with producers, distributors, licensors and merchandisers, many of whom
are larger and have greater financial resources than the Company does. 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
achieved a competitive advantage. These companies now serve as an additional
source of competition for the limited slots available to independent animation
companies. As a result of these factors, the Company cannot make assurances that
it will be able to remain competitive.
Risks Related to International Operations. There are many risks inherent in
the Company's international business activities. 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, the
Company subcontracts 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 production
costs or the Company's inability to contract with its preferred overseas
studios.
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Risks Associated with Possible New Businesses. The Company has begun live
action television production, feature film development and production (both live
action and animation) and direct-to-video production (both live action and
animation). 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. Therefore, there is a substantial risk that Film Roman's projects
will not be successful, resulting in costs not being recouped and anticipated
profits not being realized.
Technological Changes; Possible Changes in Production of Our Products. The
proliferation of new production technologies may change the manner in which the
animation industry creates and distributes 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. The Company cannot be sure that the
introduction and proliferation of three-dimensional digital animation or other
technological changes will not cause its historical methods of producing
animation to become less cost competitive or less appealing to our audiences. In
addition, the Company cannot be sure that it will be able to adapt to such
changes in a cost-effective manner.
Dependence upon Key Personnel. The Company's success depends to a
significant extent upon the expertise and services of John Hyde, its President
and Chief Executive Officer. Although the Company has employment agreements
with Mr. Hyde and certain other key management personnel, the loss of services
of Mr. Hyde and/or other key management personnel could have an adverse effect
on the Company's business, results of operations and financial condition. The
Company does not currently carry "key man" life insurance policies on any of its
executives.
Casualty Risks. Substantially all of the Company's operations and personnel
are located in its 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, the
Company's disaster recovery plans may not be adequate to protect the Company and
its business interruption insurance may not fully compensate the Company for
losses.
Possible Adverse Effect of Anti-takeover Provisions. Certain provisions of
the Company's certificate of incorporation, by-laws and Delaware law (including
a stockholders rights plan (sometimes referred to as a "poison pill") which was
adopted in 1998) could be used by the 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 the Company's common stock.
In addition, the Company's 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
the Company, even if a change in control were in its best interests.
Nasdaq SmallCap Market. Trading of the Company's common stock was
transferred from the Nasdaq National Market to the Nasdaq SmallCap Market on
June 27, 2000. If the Company does not continue to meet the listing criteria
for the Nasdaq SmallCap Market, it could materially adversely affect the
Company's stock price.
Volatility of Stock Price. The market price of the Company's common stock
could fluctuate significantly in response to the Company's operating results and
other factors.
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Impending Labor Strikes. The existing collective bargaining agreement
governing contracts and agreements with members of the Writers' Guild is due to
expire on April 30, 2001. Additionally, the existing collective bargaining
agreement governing contracts and agreements with members of the Screen Actors'
Guild is set to expire on June 30, 2001. In the event that either or both of
these collective bargaining agreements is allowed to expire and a strike or
strikes occur, the Company's ability to deliver programming will be materially
affected as the vast majority of its current programming is subject to both
collective bargaining agreements.
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 nine months ended September 30, 2000, the Company
earned interest income of $212,834.
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.
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PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27. Financial Data Schedule
(b) Reports on Form 8-K
(1) On October 23, 2000, the Company filed a Form 8-K reporting that the
Company entered into a Letter of Intent with Pentamedia Graphics, Ltd.
regarding the purchase of common stock from the Company by PentaMedia
Graphics, Ltd. which would give PentaMedia Graphics, Ltd. ownership of
51% of the Company's common stock.
(2) On October 13, 2000, the Company filed a Form 8-K reporting that John
Vein, Chief Operating Officer of Film Roman, Inc., announced his
resignation from the Company.
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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 13, 2000
FILM ROMAN, INC.
By: /s/ Dixon Q. Dern
-----------------------------------------------------
Dixon Q. Dern
Secretary
By: /s/ Michael B. Winchester
-----------------------------------------------------
Michael B. Winchester
Executive Vice President and Chief Financial
Officer
<PAGE>
INDEX TO EXHIBITS
Exhibit
Number Description
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27 Financial Data Schedule
