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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[X] Quarterly Report Under Section 13 or 15(d) of The Securities Exchange Act
of 1934
For the quarterly period ended June 30, 1998
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from _______________ to ___________________.
Commission file number 0-21637
BRILLIANT DIGITAL ENTERTAINMENT, INC.
(Exact Name of Small Business Issuer as Specified in its Charter)
DELAWARE 95-4592204
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
6355 TOPANGA CANYON BOULEVARD, SUITE 120
Woodland Hills, California 91367
(Address of Principal Executive Offices)
(818) 615-1500
(Issuer's Telephone Number, Including Area Code)
Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 past 90 days.
Yes X No ____
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date: Common Stock, par value
$0.001, 9,403,001 shares issued and outstanding as of August 11, 1998.
Transitional Small Business Disclosure Format (check one): Yes ______ No X
Exhibit index is located on page 21.
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BRILLIANT DIGITAL ENTERTAINMENT, INC.
INDEX
PAGE NO.
PART I Financial Information 3
Item 1. Financial Statements 3
Condensed Consolidated Balance Sheet as of June 30, 1998 3
Condensed Consolidated Statements of Operations for the
three and six month periods ended June 30, 1998 and
June 30, l997 4
Condensed Consolidated Statements of Cash Flows for the
six months ended June 30, 1998 and June 30, 1997 5
Notes to Consolidated Financial Stateme 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 6
PART II Other Information 19
Item 2. Changes in Securities and Use of Proceeds 19
Item 4. Submission of Matters to a Vote of Security Holders 19
Item 6. Exhibits and Reports on Form 8-K 19
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PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
BRILLIANT DIGITAL ENTERTAINMENT, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(In thousands)
<TABLE>
JUNE 30,
1998
<S> <C>
-------------------
ASSETS (UNAUDITED)
Current assets:
Cash and cash equivalents.................................................. $ 7,419
Accounts receivable, net................................................... 1,967
Inventory.................................................................. 106
Other current assets, net.................................................. 142
--------------------
Total current assets........................................................... 9,634
Property, plant and equipment, net............................................. 928
Movie software costs........................................................... 1,496
Other assets................................................................... 369
--------------------
Total assets................................................................... $ 12,427
====================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses...................................... $ 1,651
--------------------
Total current liabilities...................................................... 1,651
--------------------
Commitments and contingencies
Stockholders' equity:
Common stock .............................................................. 9
Additional paid-in capital................................................. 21,269
Accumulated deficit........................................................ (10,311 )
Cumulative other comprehensive income (loss)............................... (191 )
--------------------
Total stockholders' equity..................................................... 10,776
-------------------
Total liabilities and stockholders' equity..................................... $ 12,427
===================
See accompanying notes.
</TABLE>
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BRILLIANT DIGITAL ENTERTAINMENT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
3 MONTHS 3 MONTHS 6 MONTHS 6 MONTHS
ENDED ENDED ENDED ENDED
6/30/98 6/30/97 6/30/98 6/30/97
-------------- -------------- -------------- --------------
(UNAUDITED) (UNAUDITED ) (UNAUDITED) (UNAUDITED)
REVENUE:
<S> <C> <C> <C> <C>
Total revenues .................. $ 1 $ 248 $ 32 $ 322
-------------- -------------- -------------- --------------
COST OF REVENUES AND EXPENSES:
Cost of revenues...................... 80 10 346 17
Sales & marketing..................... 670 142 991 205
General and administrative............ 720 459 1,228 999
Research and development.............. 1,314 572 1,651 1,060
Depreciation.......................... 112 66 132 117
-------------- -------------- -------------- --------------
Total cost of revenues and
Expenses......................... 2,896 1,249 4,348 2,398
-------------- -------------- -------------- --------------
Income (loss) from operations (2,895 ) (1,001 ) (4,316) (2,076)
OTHER INCOME (EXPENSE):
Export market development grant....... 32 154 33 155
Gain (loss) on foreign exchange....... 2 5 (6) (5)
Interest income (expense), net........ 116 78 256 169
-------------- -------------- -------------- --------------
Total other income (expense)..... 150 237 283 319
-------------- -------------- -------------- --------------
Income (loss) before
income taxes..................... (2,745 ) (764 ) (4,033) (1,757)
Provision for income taxes............ (13 ) (1 ) (16) (2)
-------------- -------------- -------------- --------------
Net income (loss)..................... $ (2,758 ) $ (765 ) $ (4,049) $ (1,759)
Foreign currency translation (58 ) (11 ) 4 8
adjustment (net of tax effects).......
-------------- -------------- -------------- --------------
Comprehensive income (loss)........... (2,816 ) (776 ) (4,045) (1,751)
============== ============== ============== ==============
Basic and diluted net income (loss)...
per share ....................... $ (0.29) (0.11) $ (0.43) $ (0.24)
============== ============== ============== ==============
Weighted average number of shares
used in computing basic and
diluted net income (loss) per
share............................. 9,403 7,200 9,403 7,200
============== ============== ============== ==============
See accompanying notes.
</TABLE>
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BRILLIANT DIGITAL ENTERTAINMENT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
-------------------------------------
1998 1997
------------------- -------------------
(UNAUDITED) (UNAUDITED)
OPERATING ACTIVITIES
<S> <C> <C>
Net income (loss)...................................................... $ (4,049) $ (1,759)
Adjustments to reconcile net income (loss)
to the net cash provided by (used in)
operating activities:
Depreciation and amortization.................................... 588 258
Changes in operating assets and liabilities:
Accounts receivable........................................... 121 --
Inventory..................................................... (32) --
Movie software costs.......................................... (821) --
Accounts payable and accruals................................. (337) (76)
Other assets.................................................. (10) (80)
Deferred revenue.............................................. -- (160)
------------------- -------------------
Net cash provided by (used in)
operating activities................................................ (4,540) (1,817)
INVESTING ACTIVITIES
Purchases of equipment................................................. (469) (331)
------------------- -------------------
Net cash used in investing activities ................................. (469) (331)
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS.................................................... (5,009) (2,148)
Translation adjustments................................................ 90 (1)
Cash and cash equivalents at beginning
of period........................................................... 12,338 7,591
------------------- -------------------
Cash and cash equivalents at end of
Period.............................................................. $ 7,419 $ 5,442
=================== ===================
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest ..................................................... $ 4 $ --
=================== ===================
Income taxes.................................................. $ 15 $ 3
================== ===================
See accompanying notes.
</TABLE>
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BRILLIANT DIGITAL ENTERTAINMENT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
for interim financial information and with the instructions to Form 10-QSB and
Item 310 of Regulation S-B. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. The accompanying unaudited condensed
consolidation financial statements reflect all adjustments that, in the opinion
of management, are considered necessary for a fair presentation of the financial
position, results of operations, and cashflows for the periods presented. The
results of operations for such periods are not necessarily indicative of the
results expected for the full fiscal year or for any future period. The
accompanying financial statements should be read in conjunction with the audited
consolidated financial statements of Brilliant Digital Entertainment, Inc. (the
"Company") included in the Company's Form 10-KSB for the fiscal year ended
December 31, 1997.
2. STOCKHOLDERS' EQUITY
On March 20, 1998, the Company granted 513,500 options to employees
pursuant to the 1996 Stock Option Plan.
In March 1998, the Company adopted a stockholder's rights plan and, in
connection therewith, distributed one preferred share purchase right for each
outstanding share of the Company's Common Stock outstanding on April 2, 1998.
Upon the occurrence of certain events, each purchase right not owned by certain
hostile acquirers will entitle its holder to purchase shares of the Company's
Series A Preferred Stock, which is convertible into Common Stock, at a value
below the then current market value of the preferred stock. The rights of the
holders of Common Stock will be subject to, and may be adversely affected by,
the rights of the holders of the share purchase rights and of any Preferred
Stock that may be issued in the future.
Options and warrants representing common shares of 979,000 and
1,732,000 were excluded from the average number of common and common equivalent
shares outstanding in the diluted EPS calculation for the six months ended June
30, 1997 and 1998, respectively, because they were anti-dilutive.
3. MOVIE SOFTWARE COSTS
Technological feasibility of the Company's original Digital Projector was
reached during the third quarter of 1997. Since the date of achieving
technological feasibility, the costs of developing Multipath Movies intended to
be viewed on the original projector have been capitalized. Multipath Movies
developed by the Company during the second quarter of 1998 are intended to be
viewed on the Company's new Internet Digital Projector, which the Company plans
to release in the fall of 1998. In anticipation of the release of the new
Internet Digital Projector, the Company has written off amounts incurred during
the second quarter in the production of Multipath Movies.
4. COMMITMENTS AND CONTINGENCIES
The Company has a commitment under its rental agreements for
approximately $978,000 at June 30, 1998.
5. SUBSEQUENT EVENTS
In July 1998, the Company entered into a strategic alliance with a
computer chip manufacturer. In connection with the alliance, the Company granted
warrants to purchase 300,000 shares of Common Stock of the Company to the
computer chip manufacturer.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Brilliant is a production and development studio producing a new
generation of digital entertainment that is being distributed over the Internet
and on CD-ROM. The Company, headquartered in the United States, was incorporated
in July 1996. The Company was formed through the combination of two businesses:
Brilliant Interactive Ideas, Pty. Ltd. ("BII Australia"), an entertainment
software developer and producer; and Sega Australia New Development ("SAND"), a
"skunk works" research and development operation for leading edge software
tools. BII Australia became a wholly owned subsidiary of the Company through the
exchange of all 100,000 outstanding shares of BII Australia for 1,000,000 shares
of Common Stock of the Company. In addition, the Company acquired SAND on
September 30, 1996. SAND was
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established during the second quarter of 1994 by Sega Ozisoft Pty., Limited
("Sega Ozisoft"), one of the largest publishers and distributors of
entertainment software products in Australia and New Zealand, the predecessor of
which was co-founded by Mark Dyne and Kevin Bermeister, the Chief Executive
Officer and President of the Company, respectively.
Founded in September 1993, BII Australia initially developed and sold
interactive education and entertainment CD-ROM titles primarily for children.
With the completion of the acquisition of SAND in September 1996, the nature of
the Company's business changed significantly. SAND is responsible for developing
the Multipath Movie suite of proprietary software tools, production process and
first Multipath Movie product. The Company is focusing its efforts on the
development of the Multipath Movie tools and production process, as well as the
commercialization of the Multipath Movie genre, and has completed the phase-out
of its traditional CD-ROM business. As a result of this change in the Company's
business, the following discussion may not be representative of the Company's
future operations. The Company changed its fiscal year end from June 30 to
December 31, effective December 31, 1996.
The Company intends to generate a substantial majority of its future
revenue from the development, production, distribution, licensing and on-line
exhibition of Multipath Movies and other three-dimensional digitally created
entertainment. The Company launched the first of its Multipath Movie series,
CYBERSWINE, its Multipath Movie for Kids series, POPEYE AND THE QUEST FOR THE
WOOLLY MAMMOTH, and the first two of its StoryTeller Series, NIGHT OF THE
WEREWOLF and THE HALLOWEEN PARTY, in the fourth quarter of 1997. The Company's
annual and quarterly revenue will depend upon the successful development,
distribution, timing and market acceptance of its interactive products and upon
the costs to distribute and promote these products. Specifically, the revenues
derived from the production and distribution of the Company's Multipath Movies
will depend primarily on the acceptance by the market of the Multipath Movie
concept and the underlying content of the Multipath Movie, neither of which can
be predicted nor necessarily bear a direct correlation to the production or
distribution costs incurred. See "Cautionary Statement and Risk Factors -
Acceptance of Multipath Movie Concept; Successful Development of Multipath
Movies and Appealing Creative Content" and "Cautionary Statements and Risk
Factors - Dependence on Development of Additional Multipath Movies." The
commercial success of a Multipath Movie is also expected to depend upon
promotion and marketing, production costs, impact and competition and other
factors. Accordingly, the Company's annual and quarterly revenues are and will
be extremely difficult to forecast.
The Company incurred significant marketing and operating expenses and
development costs as it continued development of its proprietary software tools
and its Multipath Movies and as it continued to expand in anticipation of
growth. As a result, the Company incurred a loss in the six months ended June
30, 1998. The Company expects that these expenses and development costs will
result in losses in the quarter ended September 30, 1998, and that the Company
could incur quarterly losses thereafter. See "Cautionary Statements and Risk
Factors - Limited Operating History; Uncertain Profitability."
RESULTS OF OPERATIONS.
REVENUES.
The Company historically has derived its revenues from software sales
and development fees. The Company licenses its traditional CD-ROM products to
publishers and distributors in exchange for non-refundable advances, and
royalties based on product sales. Royalties based on product sales are due only
to the extent revenues exceed any associated non-refundable royalty advance.
Royalties related to non-refundable advances are recognized when the CD-ROM
master is delivered to the licensees. Royalty revenues in excess of
non-refundable advances are recognized upon notification by the distributor that
a royalty has been earned by the Company. Development fees are paid by customers
in exchange for the Company's development of software packages in accordance
with customer specifications. The software development agreements generally
specify certain "milestones" which must be achieved throughout the development
process. As these milestones are achieved, the Company recognizes the portion of
the development fee allocated to each milestone. Software sales revenues are
recognized upon shipment of product. Revenues decreased from $322,000 for the
six months ended June 30, 1997 to $32,000 for the six months ended June 30,
1998. This represents a decrease of $290,000 or 90%. The decrease is mainly
attributable to the change in the Company's focus to the development of
MultipathTM Movies and the development of the associated software tools.
As a result of delays in the commencement of the U.S. shipment of
personal computers upon which the Company's products are bundled, the first U.S.
Multipath Movie bundles began shipping during July of 1998. Although this delay
is not expected to affect the number of units to be shipped pursuant to the
Company's bundling relationship with Packard Bell
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NEC, it will impact the Company's 1998 revenues and earnings since users will
not be equipped to purchase on-line episodes over the Internet as early as
expected. Further, Packard Bell NEC is attempting to achieve the volume
commitments of its agreement with the Company by bundling the Company's products
with mid- and high-end computers only. The Company is currently in discussion
with Packard Bell NEC intended to facilitate distribution of the Company's
products on a wider range of Packard Bell NEC computers, but no assurance can be
given that this will occur or that Packard Bell NEC will achieve its committed
shipment level.
COST OF REVENUES. Cost of revenues related to development fees consists
primarily of salaries, benefits and overhead associated with the development of
specific software products to customer specifications, as well as costs of
outside contractors engaged from time to time in creating aspects of software
products such as animation, voice recording and music. Cost of revenues related
to software sales consists primarily of amortized movie software costs,
royalties to third parties and the direct costs and manufacturing overhead
required to reproduce and package software products. Cost of revenues increased
from $17,000 for the six months ended June 30, 1997 to $346,000 for the six
months ended June 30, 1998. This represents an increase of $329,000. Cost of
revenues in the 1997 period included costs associated with software sales. The
increase in cost of revenues in the 1998 period is primarily a result of the
amortization ($161,000) and write down ($145,000) of capitalized movie software
costs for previously released titles.
SALES AND MARKETING. Sales and marketing expenses include primarily
costs for salaries, advertising, promotions, brochures, travel and trade shows.
Sales and marketing expenses increased from $205,000 for the six months ended
June 30, 1997 to $991,000 for the six months ended June 30, 1998. The increase
is primarily attributable to increased costs associated with the Company's
promotional efforts. Sales and marketing expenses are expected to increase in
future periods due to the continued expansion of the Company's sales and
marketing efforts.
GENERAL AND ADMINISTRATIVE. General and administrative expenses include
primarily salaries and benefits of management and administrative personnel,
rent, insurance costs and professional fees. General and administrative expenses
increased from $999,000 for the six months ended June 30, 1997 to $1,228,000 for
the six months ended June 30, 1998. The increase is most significantly
attributable to increased employment costs resulting from additional personnel.
RESEARCH AND DEVELOPMENT. Research and development expenses include
salaries and benefits of personnel conducting research and development of
software products. Research and development costs also include costs associated
with creating the Company's traditional CD-ROM software tools and the software
tools used to develop Multipath Movies. Research and development expenses
increased from $1,060,000 for the six months ended June 30, 1997 to $1,651,000
for the six months ended June 30, 1998. In accordance with Statement of
Financial Accounting Standards No. 86 ("SFAS No. 86"), the results of operations
include Multipath Movie software development costs in research and development
expenses. Technological feasibility of the Company's original Digital Projector
was reached during the third quarter of 1997. Since the date of achieving
technological feasibility, the costs of developing Multipath Movies intended to
be viewed on the original projector have been capitalized. Multipath Movies
developed by the Company during the second quarter of 1998 are intended to be
viewed on the Company's new Internet Digital Projector, which the Company plans
to release in the fall of 1998. In anticipation of the release of the new
Internet Digital Projector, the Company has written off amounts incurred during
the second quarter in the production of Multipath Movies. To the extent
capitalized Multipath Movie software costs are attributable to titles which
have begun to ship, they are subject to amortization. Amortized amounts have
been included in costs of revenues.
The Company has chosen to focus on the development of Multipath Movies
for the PC and has deferred development for other platforms, including game
consoles, until warranted by market conditions. This focus allows the Company to
devote more of its resources to development of Multipath Movie technology and
development of additional titles. The Company believes that its decision will
have no adverse impact on revenues in the near or medium term.
DEPRECIATION. Depreciation expense relates to depreciation of fixed
assets such as computer equipment and cabling, furniture and fixtures and
leasehold improvements. These fixed assets are depreciated over their estimated
useful lives (up to five years) using the straight-line method. Depreciation
expense increased from $117,000 for the six months ended June 30, 1997 to
$132,000 for the six months ended June 30, 1998. The increase is attributable to
the increase in depreciable assets.
OTHER INCOME AND EXPENSE. Other income includes amounts received under
an export market development grant, as well as interest income and expense and
gains and losses on foreign exchange transactions. Net interest income increased
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from $169,000 for the six months ended June 30, 1997 to $256,000 for the six
months ended June 30, 1998. These increases are due to the higher cash balances
as a result of the secondary offering in December 1997.
FLUCTUATING OPERATING RESULTS
Historically, the Company has experienced significant fluctuations in
its operating results from quarter to quarter and expects these fluctuations to
continue in the future. For instance the Company had anticipated completing
foreign distribution and licensing relationships in the fourth quarter of 1997,
which are now expected to be completed during 1998. These relationships were
expected to generate substantial revenues in 1997.
Also, as a result of delays in the commencement of U.S. shipments of
personal computers upon which the Company's products are bundled, the first U.S.
Multipath Movie bundles began shipping during July of 1998. Although this delay
does not affect the number of units to be shipped pursuant to the Company's
building relationship with Packard Bell NEC, it will impact the Company's 1998
revenues and earnings since users will not be equipped to purchase on-line
episodes over the Internet as early as expected.
Factors that may influence the Company's quarterly operating results
include customer demand for the Company's products, shipping schedules for PC
hardware with which Multipath Movies are bundled, introduction or enhancement of
products by the Company and its competitors, the ability of the Company to
produce and distribute retail packaged versions of Multipath Movies in advance
of peak retail selling seasons, the timing of releases of new products or
product enhancements by the Company and its competitors, introduction or
availability of new hardware, market acceptance of the Multipath Movies and
other new products, development and promotional expenses relating to the
introduction of new products or enhancements of existing products, reviews in
the industry press concerning the products of the Company or its competitors,
changes or anticipated changes in pricing by the Company or its competitors, mix
of distribution channels through which products are sold, mix of products sold,
product returns, the timing of orders from major customers, order cancellations,
delays in shipment and other developments and decisions including the timing and
extent of the development expenditures, management's evaluation and judgment
regarding a title's acceptance, other unanticipated operating expenses and
general economic conditions.
Additionally, a majority of unit sales for a product typically occurs
in the quarter in which the product is introduced. As a result, the Company's
revenues may increase significantly in a quarter in which a major product
introduction occurs and may decline in following quarters. The Company's
revenues both domestically and internationally have varied significantly between
monthly and quarterly periods. Therefore, in the future, the operating results
for any quarter should not be taken as indicative of the results for any quarter
in subsequent periods.
The Company's expense levels are, to a large extent, fixed. The Company
may be unable to adjust spending in a timely manner to compensate for any
revenue shortfall. As a result, any significant shortfall in revenue from the
Company's Multipath Movies would have an immediate material adverse effect on
the Company's business, operating results and financial condition. The Company
has increased its operating expenses to fund greater levels of Multipath Movie
production and research and development, increased marketing operations and
expanded distribution channels. As was the case during 1997 and in the first and
second quarters of 1998 and as is expected to be the case in at least the third
quarter of 1998, to the extent that such expenses precede or are not
subsequently followed by increased revenues, the Company's business, operating
results and financial condition will be materially adversely affected.
The entertainment software business is highly seasonal. Typically, net
revenues are highest during the fourth calendar quarter (which includes the
holiday buying season), decline in the first calendar quarter and are lowest in
the second and third calendar quarters. This seasonal pattern is due primarily
to the increased demand for entertainment software products during the year-end
holiday buying season. As a result, a disproportionate share of the Company's
net revenues historically have been generated in the fourth quarter of the
Company's fiscal year. The Company expects its revenues and operating results
will continue to reflect these seasonal factors.
The entertainment industry historically has been subject to substantial
cyclical variation, with consumer spending for entertainment products tending to
decline during recessionary periods. There can be no assurance that the Company
will be able to adjust its anticipated product development expenditures and
other expenses in the event of an economic downturn during such development.
Accordingly, if a recessionary period occurs, tending to result in decreased
sales of the Company's products, product development expenses likely will remain
constant and the Company's business, operating results and financial
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condition could be materially adversely affected.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 1998, the Company's principal source of liquidity was
approximately $7,419,000 in cash. In November 1996, the Company's initial public
offering (the "Initial Public Offering") of 2,000,000 shares of Common Stock at
$5 per share provided approximately $8,500,000 in cash after underwriters'
discounts and commissions and offering expenses. On December 10, 1997, the
Company closed a secondary offering (the "Secondary Offering") of 2,500,000
shares of Common Stock at $5 per share, 2,200,000 of which were sold by the
Company. The Secondary Offering resulted in gross proceeds of approximately
$9,800,000 in cash after underwriters' discounts and commissions and offering
expenses. Approximately $7,419,000 of the net proceeds of the Secondary Offering
remain available for product development and working capital and general
corporate purposes.
Net cash used in operating activities during the six months ended June
30, 1998 was primarily attributable to a net loss of $4,049,000 and an increase
in movie software costs of $821,000. Net cash used in investing activities in
the six months ended June 30, 1998 was due primarily to the acquisition of
computer equipment.
The Company has an obligation under its agreement with Morgan Creek to
fund entirely the development of two Multipath Movies, the first of which, ACE
VENTURA, is currently under development. The Company has an obligation under its
joint venture agreement with Crawfords to jointly fund two Multipath Movies. To
date no projects have been identified for development by the parties. The
Company also is required to make minimum payments of $198,000 under various
licensing agreements. At June 30, 1998, the Company had rental commitment for
its offices and production facilities of $978,000 payable over the next 5 years.
The Company believes that current funds and cash generated from
operations will be sufficient to meet its anticipated cash needs for working
capital and capital expenditures for at least the next year but will not be
sufficient to permit completion of the entire slate of Multipath Movie episodes
estimated to be completed in 1998. The Company intends to raise additional funds
to permit completion of all 20 titles scheduled for completion during 1998
through debt or equity financings or other means. The Company is currently
exploring alternatives to fulfill these requirements. No assurance can be given
that additional financing will be available or that, if available, it can be
obtained on terms favorable to the Company and its stockholders. If the Company
is unable to obtain additional financing sufficient to fund the completion of
all 20 titles scheduled for completion in 1998, the Company anticipates that it
may defer completion of several titles. See "Cautionary Statements and Risk
Factors - Future Capital Needs; Uncertainty of Additional Funding."
CAUTIONARY STATEMENTS AND RISK FACTORS
Several of the matters discussed in this document contain forward
looking statements that involve risks and uncertainties. Factors associated with
the forward looking statements which could cause actual results to differ
materially from those projected or forecast in the statements that appear below.
In addition to other information contained in this document, readers should
carefully consider the following cautionary statements and risks factors:
ACCEPTANCE OF MULTIPATH MOVIE CONCEPT; SUCCESSFUL DEVELOPMENT OF
MULTIPATH MOVIES WITH APPEALING CREATIVE CONTENT. The success of the Company's
Multipath Movie products will depend to a significant extent on acceptance by
the market of the Multipath Movie concept. The market for entertainment software
is emerging and is dependent upon a number of variables, including consumer
preferences, the installed base of personal computers and a sufficient number of
entertainment software titles to stimulate market development. Any competitive,
technological or other factor materially adversely affecting the introduction or
sale of personal computers or entertainment software would have a material
adverse effect on the Company. Because the market for entertainment software is
relatively small in comparison to the overall market for consumer software
products, it is impossible to predict with any degree of certainty the future
rate of growth, if any, and the size of the market for the Company's products.
Each Multipath Movie will be an individual artistic work, and its
commercial success primarily will be determined by user reaction, which is
unpredictable. The Company introduced CYBERSWINE, its first Multipath Movie, at
the end of the fourth quarter of 1997. The commercial success of the Company's
Multipath Movies will depend on its ability to predict the type of content that
will appeal to a broad audience and to develop stories and characters that
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capture the attention and imagination of the market. In addition, the success of
the Company's Multipath Movies will depend upon the Company's ability to develop
popular characters and to license recognized characters and properties from
third parties for its software titles. There can be no assurance that the
Company will be able to develop or license popular stories or characters. The
success of a Multipath Movie also depends upon the effectiveness of the
Company's marketing and successful introduction of the first Multipath Movie
through the Company's bundling relationship with Packard Bell NEC and the retail
channel, as well as the quality and acceptance of other competing programs
released into the market at or near the same time, critical reviews, the
availability of alternative forms of entertainment and leisure time activities,
general economic conditions and other tangible and intangible factors, all of
which can change and cannot be predicted with certainty. There can be no
assurance that the Company will be able to successfully introduce the Multipath
Movie through its bundling relationship with Packard Bell NEC, in the retail
channel or otherwise. Accordingly, there exists substantial risk that some or
all of the Company's Multipath Movies will not be commercially successful,
resulting in certain costs not being recouped or anticipated profits not being
realized. Further, the success of the Multipath Movie genre will substantially
depend on the market's reception of the first Multipath Movie. The failure of
the Company's initial Multipath Movie to achieve commercial success might damage
the ability of the Company to introduce additional titles. Accordingly, the
failure of any of the Company's Multipath Movies, and especially its first
Multipath Movie, to achieve commercial success, could have a material adverse
affect on the business, operating results and financial condition of the
Company.
PRODUCT DELAYS. The Company's current production schedules contemplate
that it will release a number of Multipath Movies in the fourth quarter of 1998
and 1999. As with any software product, however, until all aspects of the
development and initial distribution of a product are completed, there can be no
assurance of its release date. Release dates will vary depending on quality
assurance testing and other development factors. If the Company were unable to
commence volume shipments of a significant new product during the scheduled
quarter, its revenue and earnings would likely be materially and adversely
affected in that quarter. In the past, the Company has experienced significant
delays in the introduction of certain new products. For instance, delays in
duplication, packaging and distribution caused the Company's first Multipath
Movies, CYBERSWINE, POPEYE AND THE QUEST FOR THE WOOLLY MAMMOTH, NIGHT OF THE
WEREWOLF and THE HALLOWEEN PARTY to begin arriving at retailers at the end of
December 1997, after the holiday selling season. It is likely in the future that
such delays will continue to occur and that certain new products will not be
released in accordance with the Company's internal development schedule or the
expectations of public market analysts and investors. A significant delay in the
introduction of, or the presence of a defect in, one or more new products could
have a material adverse affect on the ultimate success of such products and on
the Company's business, operating results and financial condition, particularly
in the quarter in which such products are scheduled to be completed.
LIMITED OPERATING HISTORY; UNCERTAIN PROFITABILITY. The Company was
founded in September 1993, and shipped its initial traditional CD-ROM product in
November 1994 and substantially curtailed this aspect of its business in 1996.
The Company acquired the software tools necessary to produce Multipath Movies in
August 1996 and has only recently introduced its first Multipath Movie. The
Company has only a limited operating history upon which an evaluation of the
Company and its prospects can be based.
In the third quarter of 1997 the Company was profitable due to revenues
associated with its Packard Bell NEC bundling agreement. However, revenues in
the fourth quarter of 1997 were adversely affected by delays in duplication,
packaging and distribution which caused the Company's first Multipath Movies to
begin arriving at retailers at the end of December, after the holiday selling
season. In addition, as a result of delays in the commencement of the U.S.
shipment of personal computers upon which the Company's products are bundled,
the first U.S. Multipath Movie bundles only began shipment in July 1998.
Although this delay should not affect the number of units to be shipped pursuant
to the Company's bundling relationship with Packard Bell NEC, it will impact the
Company's 1998 revenues and earnings since users will not be equipped to
purchase on-line episodes over the Internet as early as expected. In order for
the Company to achieve sustained profitability, the Company must continue to
enter into a variety of distribution and revenue generating arrangements of this
type, as well as arrangements with Internet service providers, traditional
CD-ROM publishers and retailers. There can be no assurance that the Company will
enter into any such arrangements, or that the Company will be able to sustain
quarterly profitability.
FLUCTUATING OPERATING RESULTS. The Company intends to generate a
substantial majority of its future revenue from the development and production
of Multipath Movies and other three-dimensional digitally created entertainment.
The Company commenced the launch of the first of its Multipath Movies,
CYBERSWINE, at the end of the fourth quarter of 1997. The Company also released
the first products in the Storyteller Series and Multipath Movies for Kids
series at that
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time. The Company's annual and quarterly revenue will depend upon the successful
development, timing and market acceptance of its interactive products and upon
the costs to distribute and promote these products. Specifically, the revenues
derived from the production and distribution of the Company's Multipath Movies
will depend primarily on the acceptance by the market of the Multipath Movie
concept and the underlying content of the Multipath Movie, neither of which can
be predicted nor necessarily bear a direct correlation to the production or
distribution costs incurred. See "Acceptance of Multipath Movie Concept;
Successful Development of Multipath Movies with Appealing Creative Content," and
"- Dependence on Development of Additional Multipath Movies." The commercial
success of a film also depends upon promotion and marketing, production costs,
the impact of competition and other factors. Accordingly, the Company's annual
and quarterly revenues are and will continue to be extremely difficult to
forecast.
Historically, the Company has experienced significant fluctuations in
its operating results from quarter to quarter and it expects these fluctuations
to continue in the future. Factors that may influence the Company's quarterly
operating results include customer demand for the Company's products, shipping
schedules for PC hardware with which Multipath Movies are bundled, introduction
or enhancement of products by the Company and its competitors, the ability of
the Company to produce and distribute retail packaged versions of Multipath
Movies in advance of peak retail selling seasons, the timing of releases of new
products or product enhancements by the Company and its competitors,
introduction or availability of new hardware, market acceptance of the Multipath
Movies and other new products, development and promotional expenses relating to
the introduction of new products or enhancements of existing products, reviews
in the industry press concerning the products of the Company or its competitors,
changes or anticipated changes in pricing by the Company or its competitors, mix
of distribution channels through which products are sold and the timing of
negotiation and completion of distribution arrangements, mix of products sold,
product returns, the timing of orders from major customers, order cancellations,
delays in shipment and other developments and decisions including the timing and
extent of development expenditures, management's evaluation and judgment
regarding a title's acceptance, other unanticipated operating expenses and
general economic conditions. Additionally, a majority of the unit sales for a
product typically occurs in the quarter in which the product is introduced. As a
result, the Company's revenues may increase significantly in a quarter in which
a major product introduction occurs and may decline in following quarters. The
Company's revenues both domestically and internationally have varied
significantly between monthly and quarterly periods. Therefore, in the future,
the operating results for any quarter should not be taken as indicative of the
results for any quarter in subsequent periods.
The Company's expense levels are, to a large extent, fixed. The Company
may be unable to adjust spending in a timely manner to compensate for any
revenue shortfall. As a result, any significant shortfall in revenue from the
Company's Multipath Movies would have an immediate material adverse effect on
the Company's business, operating results and financial condition. The Company
plans to increase its operating expenses to fund greater levels of Multipath
Movie production and research and development, increased marketing operations
and expanded distribution channels. To the extent that such expenses precede or
are not subsequently followed by increased revenues, the Company's business,
operating results and financial condition will be materially adversely affected.
The entertainment software business is highly seasonal. Typically, net
revenues are highest during the fourth calendar quarter (which includes the
holiday buying season), decline in the first calendar quarter and are lowest in
the second and third calendar quarters. This seasonal pattern is due primarily
to the increased demand for entertainment software products during the year-end
holiday buying season. As a result, a disproportionate share of the Company's
net revenues historically have been generated in the fourth quarter of the
Company's fiscal year. The Company expects its revenues and operating results
will continue to reflect these seasonal factors.
The entertainment industry historically has been subject to
substantial cyclical variation, with consumer spending for entertainment
products tending to decline during recessionary periods. There can be no
assurance that the Company will be able to adjust its anticipated product
development expenditures and other expenses in the event of an economic downturn
during such development. Accordingly, if a recessionary period occurs, tending
to result in decreased sales of the Company's products, product development
expenses likely will remain constant and the Company's business, operating
results and financial condition could be materially adversely affected. See "--
Rapid Technological Change; Changing Product Platforms and Formats."
Due to all of the foregoing factors, it is also likely that in some
future periods the Company's operating results will be below the expectations of
public market analysts and investors. In such event, the price of the Company's
Common Stock would likely be materially adversely affected.
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FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING. The Company's
future capital requirements will depend on many factors, including but not
limited to, the number of Multipath Movies developed, the cost of content
development, marketing and distribution, the size and timing of future
acquisitions, if any, and the availability of additional financing. The Company
anticipates that its existing funds will not be sufficient to fund completion of
the entire slate of 20 Multipath Movie episodes estimated to be completed in
1998, and intends to attempt to raise additional funds to permit completion of
all titles through debt or equity financing. No assurance can be given that such
additional financing will be available or that, if available, it can be obtained
on terms favorable to the Company and its stockholders. If the Company is unable
to obtain additional financing sufficient to fund the completion of all titles
scheduled for completion in 1998, the Company anticipates that it may defer
completion of several titles. In addition, any equity financing could result in
dilution to the Company's stockholders. The Company's inability to obtain
adequate funds would adversely affect the Company's operations and ability to
implement its strategy.
SUBSTANTIAL DEPENDENCE UPON THIRD PARTIES. The Company depends
substantially upon third parties for several critical elements of its business
including the development and licensing of content and the distribution of its
products.
DEPENDENCE UPON STRATEGIC RELATIONSHIPS. The Company has entered into
strategic relationships with Packard Bell NEC, Morgan Creek and CompuServe, as
well as licensing arrangements with numerous additional companies that own the
stories underlying and/or characters in many of the Company's current and
planned products. The Company's business strategy is based largely on its
strategic and licensing relationships with these and other companies and its
ability to continue to enter into similar strategic and licensing relationships
in the future. In these relationships, mutual agreement of the parties is
generally required for significant matters, or approval of the strategic partner
or both parties is required to release products or to commence distribution of
products. For example, the Company will be dependent on Packard Bell NEC and
other OEMs to bundle Multipath Movies with their hardware products as a
significant element of the Company's launch of the Multipath Movie genre.
Packard Bell NEC's obligation to distribute such Multipath Movies will depend
upon Packard Bell NEC's acceptance of master CD-ROMs complying with the
Company's specifications. Consequently, Packard Bell NEC may, in the exercise of
its approval rights, delay the introduction of certain of the Company's
Multipath Movie titles. The Company is also unable to control, manage or
accurately predict the shipping schedules of Packard Bell NEC and other OEM
distributors. Delays in such shipping schedules or other distribution problems
affecting OEM distributors may materially adversely affect the Company's ability
to release its products. For instance, the Company expected Packard Bell NEC to
commence U.S. shipment of personal computers bundled with CYBERSWINE in January
1998. As a result of delays in Packard Bell NEC's shipping schedules, Packard
Bell NEC began U.S. shipment of the Company's first Multipath Movie bundles in
mid-1998. Further, Packard Bell NEC is attempting to achieve the volume
commitments of its agreement with the Company by bundling the Company's products
with mid- and high-end computers only. The Company is currently in discussion
with Packard Bell NEC intended to facilitate distribution of the Company's
products on a wider range of Packard Bell NEC computers, but no assurance can be
given that this will occur or that Packard Bell NEC will achieve its committed
shipment level. Also, Morgan Creek and many other content licensers have various
creative controls and approval rights pursuant to their joint venture agreements
with the Company. These creative controls and approval rights allow Morgan Creek
as well as content licensers to arbitrarily reject or delay the Multipath Movie
productions of the respective joint ventures. There can be no assurance that the
Company will not be subject to delays resulting from disagreements with or an
inability to obtain approvals from its strategic partners or that the Company
will achieve its objectives in respect of any or all of its strategic
relationships or continue to maintain and develop these or other strategic
relationships, or that licenses between the Company and any such third party
will be renewed or extended at their expiration dates. Many content licensers
are also reluctant to grant broad licenses covering multiple formats (e.g., a
license covering both Internet and television distribution rights) to companies
without proven track records in the television production business, and, where
rights are available, there is often significant competition for licenses. As a
result of such competition, and the reluctance by owners of content to grant
broad licenses, there can be no assurance that licensed content will be
available to the Company at prices, or upon terms or conditions acceptable to
the Company or which permit the Company to implement its strategy of producing
Multipath Movies for multiple formats. Delays resulting from disagreements with
licensers or joint venture partners or the Company's failure to renew or extend
a key license, maintain any of its strategic relationships or enter into new
licenses and strategic relationships on sound financial terms could materially
adversely affect the Company's business, operating results and financial
condition.
USE OF INDEPENDENT SOFTWARE DEVELOPERS AND CONTENT PROVIDERS. In
addition to internally developing software
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and creating content, the Company uses entertainment software created by
independent software developers as well as content developed by third parties.
The Company has less control over the scheduling and the quality of the software
generated by independent contractors than over that developed by its own
employees. Additionally, the Company may not be able to secure the services of
talented content developers. The Company's business and future operating results
will depend in part on the Company's continued ability to maintain relationships
with skilled independent software developers and content providers, and to enter
into and renew product development agreements with such developers. There can be
no assurance that the Company will be able to maintain such relationships or
enter into and renew such agreements.
DEPENDENCE ON DEVELOPMENT OF ADDITIONAL MULTIPATH MOVIES. The Company's
success will depend largely upon its ability in the future to continuously
develop new, commercially-successful Multipath Movie titles and to replace
revenues from Multipath Movie titles in the later stages of their life cycles.
If revenues from new products or other activities fail to replace declining
revenues from existing products, the Company's business, operations and
financial condition could be materially adversely affected. In addition, the
Company's success will depend upon its ability to develop popular characters and
to license recognized characters and properties from third parties for its
digital entertainment products. If the Company is unable to develop popular
characters or if the cost of licensing characters and properties from third
parties becomes prohibitive, the Company's business, operating results and
financial condition could be adversely affected. Also, the Company may from time
to time, enter into agreements with licensers of intellectual property that
involve advance payments of royalties and guaranteed minimum royalty payments.
If the sales volumes of products subject to such arrangements are not sufficient
to recover such advances and guarantees, the Company will be required to write
off unrecovered portions of such payments. If the Company is required to write
off a material portion of any advances, or ultimately accrue for the guarantees,
its business, operating results and financial condition could be materially
adversely affected.
RISKS ASSOCIATED WITH INTERNET DELIVERY. The Company also intends to
distribute certain of its Multipath Movies through its Internet site and through
a site on the CompuServe on-line service. Accordingly, any system failure that
causes interruption or an increase in response time on the Company's Internet
site or the CompuServe site, could result in less traffic to and distribution of
Multipath Movies via the Internet and, if sustained or repeated, could reduce
the attractiveness of the Company's products. The Company is also dependent upon
Web browsers and Internet and on-line service providers to ensure user access to
its products. User acceptance with respect to payment methods over the Internet
may also create barriers to distribution of the Company's products through the
Internet. Any disruption in the Internet access provided to the Company's
Internet site or any failure by the Company's Internet site to handle higher
volumes of transactions could have a material adverse effect on the Company's
business, operating results and financial condition.
The seamless appearance of Multipath Movies delivered over the Internet
requires that while a scene is being viewed, succeeding scenes must be
downloaded. This requires the use of 28.8 kilobits per second or faster modems,
computers equipped with high-speed Pentium (or equivalent) microprocessors, 24
megabytes of random access memory and appropriately configured operating
systems. These requirements generally are not satisfied by the majority of the
base of currently installed PCs. There can be no assurance that adequately
equipped and configured computers will become widespread. Users of computers
with less sophisticated PCs may experience noticeable latencies or "lag times"
between scene changes. Additionally, the performance characteristics of
Multipath Movies delivered via the Internet may not equal those of Multipath
Movies delivered solely on CD-ROMs, particularly with respect to perceived
seamlessness and sound quality. Moreover, communications between the user and an
Internet site delivering Multipath Movies may require routing of Multipath Movie
instructions through several servers and may result in brief but noticeable lag
times. Noticeable lag times or negative comparisons to Multipath Movies
distributed on CD-ROM may reduce the attractiveness of on-line versions of the
Multipath Movies.
The Company presently serves its Multipath Movies delivered over the
Internet through a single vendor. Any significant interruption in service
provided by this vendor could interrupt sales and delivery of Multipath Movies
and materially adversely affect the Company's ability to conduct its business
and maintain customer satisfaction, and thereby materially adversely affect the
Company's business, operating results and financial condition.
RISKS ASSOCIATED WITH RETAIL DISTRIBUTION. The Company anticipates that
a significant proportion of sales of Multipath Movies will be made through
distributors and to retailers. The Company is currently expending significant
resources developing a retail sales channel. The expenditures associated with
this development are likely to precede
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the realization of significant sales through this channel. Moreover, the Company
has no prior experience in the development or management of the retail channel
or sales through such channel. The competition for shelf space in retail stores
is intense. To the extent that the number of consumer software products and
computer platforms increases, this competition for shelf space may further
intensify. The Company's products are expected to constitute a small percentage
of a retailer's sales volume, and there can be no assurance that retailers will
provide the Company's products with adequate levels of shelf space and
promotional support. Due to the increased competition for limited retail shelf
space and promotional resources, retailers and distributors are increasingly in
a better position to negotiate favorable terms of sale, including price
discounts and product return policies, as well as cooperative market development
funds. Increased competition could result in loss of shelf space for, and
reduction in sell-through of, the Company's products at retail stores, as well
as significant price competition, any of which could adversely affect the
Company's business, operating results and financial condition.
Retailers often require software publishers to pay fees in exchange for
preferred shelf space. The amounts paid to retailers by software publishers and
distributors for preferred shelf space are generally determined on a case by
case basis and there is, as of yet, no industry standard for determining such
fees, although larger publishers and distributors will likely have a competitive
advantage in this regard to the extent they have greater financial resources and
negotiating leverage.
At the time of retail product shipment, the Company will establish
reserves, including reserves which estimate the potential for future returns
based on seasonal terms of sale and distributor and retailer inventories of the
Company's products, as well as other factors. The Company intends to recognize
revenue from the sale of its products upon shipment except for sales made to
certain distributors where the right of ownership does not pass at delivery.
Product returns or price protection concessions that exceed the Company's
reserves could materially adversely affect the Company's business, operating
results and financial condition and could increase the magnitude of quarterly
fluctuations in the Company's operating and financial results. Furthermore, if
the Company's assessment of the creditworthiness of its customers receiving
product on credit proves incorrect, the Company could be required to
significantly increase the reserves previously established. There can be no
assurance that such future write-offs will not occur or that amounts written off
will not have a material adverse effect on the Company's business, results of
operations and financial condition.
MANUFACTURING RISKS. The production of the Company's Multipath Movies
for the retail distribution channel consists of pressing CD-ROM disks,
assembling purchased product components, printing product packaging and user
manuals and packaging finished products, all of which will be performed for the
Company by third party vendors in accordance with the Company's specifications
and forecasts. Currently, the Company will use primarily one vendor for these
services. While these services are available from multiple vendors and at
multiple sites, there can be no assurance that an interruption in the
manufacture of the Company's products could be remedied without undue delay and
without materially adversely affecting the Company's results of operations. The
Company does not have contractual agreements with any of its third party
vendors, which may result in an inability to secure adequate services in a
timely manner. Demand for the services of these vendors is also seasonal, with
peak demand, and service and production backlogs and delays occurring in
September, October and November of each year. The Company's retail Multipath
Movies must be manufactured, assembled, printed, packaged and shipped in this
environment of strained capacity and must compete for capacity and priority with
the CD-ROM products of many substantially larger competitors of the Company
which are able to wield substantially greater influence with the Company's
vendors than can currently be exerted by the Company. If the Company is unable
to secure adequate services to timely produce and deliver its products for
fourth quarter sales, the Company's business, operating results and financial
condition would be materially adversely effected.
SOFTWARE TOOLS AND PRODUCT DEVELOPMENT. The suite of software tools
that will enable the Company to create its Multipath Movie has been developed
over the past three years, and additional refinement of these tools may be
necessary in order to continue to enhance the Multipath Movie format. The
Company believes that its future success depends in large part upon the
continuous enhancement of the software tools used to create the Multipath Movie.
If problems in the development of the Company's software tools arise, no
assurance can be given that the Company will be able to successfully remedy
these problems. Also, entertainment products as complex as those offered by the
Company may contain undetected errors or defects when first introduced or as new
versions are released. The Company has in the past discovered software errors in
certain of its new products and enhancements after their introduction. Although
the Company has not experienced material adverse effects resulting from any such
errors to date, there can be no assurance that errors or defects will not be
found in new products or releases after commencement of commercial shipments,
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resulting in adverse product reviews and a loss of or delay in market
acceptance, which would have a material adverse effect upon the Company's
business, operating results and financial condition.
RAPID EXPANSION AND MANAGEMENT OF GROWTH. Implementation of the
Company's business plan, including introduction and marketing of the Company's
Multipath Movies, management of the Company's joint venture with Morgan Creek,
management of the Company's strategic relationship with Packard Bell NEC,
negotiation of additional content licensing and distribution agreements,
management of Internet service providers, the expansion of the Company's studio
in Australia, and the general strains of the Company's role as a public company
have resulted in a significant expansion of the Company and will require that
the Company continue to significantly expand its operations in all areas. This
growth in the Company's operations and activities has placed and will continue
to place a significant strain on the Company's management, operational,
financial and accounting resources. Successful management of the Company's
operations will require the Company to continue to implement and improve its
financial and management information systems. In addition, the restructuring of
the Company and resulting management and reporting of Australian operations and
financial results from the United States have placed and will continue to place
an additional strain on the Company's accounting and information systems
resources. The Company's ability to manage its future growth, if any, and to
increase production levels and commence marketing and distribution of its
products will also require it to hire and train new employees, including
management and technical personnel, and motivate and manage its new employees
and integrate them into its overall operations and culture. The Company recently
has made additions to its management team and is in the process of expanding its
marketing and production staff, a process that is expected to continue. The
Company's failure to manage implementation of its business plan would have a
material adverse effect on the Company's business, operating results and
financial condition.
RISKS ASSOCIATED WITH ACQUISITIONS. In the future, the Company may
acquire complementary companies, products or technologies, and from time to time
engages in discussions relating to possible acquisitions. Acquisitions involve
numerous risks, including adverse short-term effects on the combined business'
reported operating results, impairments of goodwill and other intangible assets,
the diversion of management's attention, the dependence on retention, hiring and
training of key personnel, the amortization of intangible assets and risks
associated with unanticipated problems or legal liabilities.
RAPID TECHNOLOGICAL CHANGE; CHANGING PRODUCT PLATFORMS AND FORMATS. The
entertainment software market and the PC industry in general are characterized
by rapid and significant technological developments and frequent changes in
computer operating environments. To compete successfully in these markets, the
Company must continually improve and enhance its existing products and
technologies and develop new products and technologies that incorporate
technological advances while remaining competitive in terms of performance and
price. The Company's success also will depend substantially upon its ability to
anticipate the emergence of, and to adapt its products to, popular platforms for
consumer software.
The Company has designed its Multipath Movies for use with the
IBM-compatible PC. The Company intends to design future products for use with
new platforms that will require substantial investments in research and
development. Generally, such research and development efforts must occur one to
two years in advance of the widespread release or use of the platforms in order
to introduce products on a timely basis following the release of such platforms.
The research and development efforts in connection with games for certain
advanced and emerging platforms may require greater financial and technical
resources than currently possessed by the Company. In addition, there can be no
assurance that the new platforms for which the Company develops products will
achieve market acceptance and, as a result, there can be no assurance that the
Company's development efforts with respect to such new platforms will lead to
marketable products or products that generate sufficient revenues to offset the
research and development costs incurred in connection with their development.
Failure to develop products for new platforms that achieve significant market
acceptance would have a material adverse effect on the Company's business,
operating results and financial condition. There can be no assurance that
technological developments will not render certain of the Company's existing
products obsolete, that the Company will be able to adapt its products or
technologies to emerging hardware platforms, that the Company has chosen to
support platforms that ultimately will be successful or that the Company will be
able successfully to create software titles for such platforms in a timely
manner, or at all. See "-Software Tools and Product Development."
DEPENDENCE ON KEY PERSONNEL. The Company's success has and will
continue to depend to a significant extent upon certain key management, product
development and technical personnel, many of whom would be difficult to
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replace, particularly Mark Dyne, its Chairman and Chief Executive Officer, and
Kevin Bermeister, its President. Although the Company has entered into
employment agreements with certain officers, such agreements are terminable upon
30 days notice by either party. Accordingly, there can be no assurance that such
employees will continue to be available to the Company. The loss of the services
of one or more of these key employees could have a material adverse effect on
the Company and the Company's future success will depend in large part upon its
ability to attract, retain and motivate personnel with a variety of technical
and managerial skills, including software development and programming expertise.
Significant competition exists for such personnel and the companies with which
the Company competes are often larger and more established than the Company.
Additionally, there is currently an industry-wide shortage of technical
personnel which makes it more difficult to attract and retain such personnel.
There can be no assurance that the Company will be able to retain and motivate
its managerial and technical personnel or attract additional qualified members
to management or technical staff. The inability to attract and retain necessary
technical and managerial personnel could have a material and adverse effect upon
the Company's business, operating results and financial condition.
SHARED RESPONSIBILITIES AND OTHER EMPLOYMENT COMMITMENTS OF CHIEF
EXECUTIVE OFFICER AND PRESIDENT. The Company's Chief Executive Officer and
Chairman, Mark Dyne, and its President, Kevin Bermeister, also serve as joint
managing directors of Sega Ozisoft Pty., Limited ("Sega Ozisoft") and other
businesses. Mark Dyne also serves as Chairman of the Board of Tag-It Pacific,
Inc. Kevin Bermeister also serves as managing director of Sega Enterprises
(Australia) Pty., Ltd. Although Messrs. Dyne and Bermeister are active in the
management of the Company, they are not required to spend a specified amount of
time at the Company nor are they able to devote their full time and resources to
the Company. Further, the Company does not have employment agreements with
either of Messrs. Dyne or Bermeister. There can be no assurance that the
inability of Messrs. Dyne and Bermeister to devote their full time and resources
to the Company will not adversely affect the Company's business, operating
results or financial condition.
CONFLICTS OF INTEREST. Certain of the Company's directors and officers
are directors or officers of potential competitors and/or strategic partners of
the Company. These relationships may give rise to conflicts of interest between
the Company, on the one hand, and one or more of the directors, or officers
and/or their affiliates, on the other hand. The Company's Certificate of
Incorporation provides that Mark Dyne and Kevin Bermeister are required to
present to the Company any corporate opportunities for the development of any
type of digital entertainment with the exception of opportunities for (i)
minority participation in the development of digital entertainment and (ii)
participation in the development by others of digital entertainment where
publishing and distribution rights for the product to be developed are offered
to Messrs. Dyne and/or Bermeister solely for Australia, New Zealand and/or
Southern Africa. The Company's Certificate of Incorporation provides that
Messrs. Dyne and Bermeister are not required to present to the Company any other
opportunities that potentially may be of benefit to the Company.
LIMITED PROPRIETARY PROTECTION. The Company's success and ability to
compete is dependent in part upon its proprietary technology. The Company also
relies on trademark, trade secret and copyright laws to protect its technology,
with the source code for the Company's proprietary software being protected both
as a trade secret and as a copyrighted work. Also, it is the Company's policy
that all employees and third-party developers sign nondisclosure agreements.
However, there can be no assurance that such precautions will provide meaningful
protection from competition or that competitors will not be able to develop
similar or superior technology independently. Also, the Company has no license
agreements with the end users of its products and does not copy-protect its
software, so it may be possible for unauthorized third parties to copy the
Company's products or to reverse engineer or otherwise obtain and use
information that the Company regards as proprietary. Although the Company is not
aware of unauthorized copying of its products, if a significant amount of
unauthorized copying of the Company's products were to occur, the Company's
business, operating results and financial condition could be adversely affected.
Furthermore, policing unauthorized use of the Company's products is difficult
and costly, and software piracy can be expected to be a persistent problem. If
litigation is necessary in the future to enforce the Company's intellectual
property rights, to protect the Company's trade secrets or to determine the
validity and scope of the proprietary rights of others, such litigation could
result in substantial costs and diversion of resources and could have a material
adverse effect on the Company's business, operating results and financial
condition. Ultimately, the Company may be unable, for financial or other
reasons, to enforce its rights under intellectual property laws and the laws of
certain countries in which the Company's products are or may be distributed may
not protect the Company's products and intellectual rights to the same extent as
the laws of the United States.
The Company believes that its products, including its suite of software
tools, do not infringe any valid existing
Page 17
<PAGE>
proprietary rights of third parties. Since the software tools used to create the
Multipath Movies were developed by SAND, a division of Sega Ozisoft, the Company
relies entirely on the representations of Sega Ozisoft contained in the SAND
Acquisition Agreement between BII Australia and Sega Ozisoft that, to Sega
Ozisoft's best knowledge, the SAND technology and software acquired by the
Company does not infringe the proprietary rights of others. Additionally,
although the Company has received no communication from third parties alleging
the infringement of proprietary rights of such parties, there can be no
assurance that third parties will not assert infringement claims in the future.
Any such third party claims, whether or not meritorious, could result in costly
litigation or require the Company to enter into royalty or licensing agreements.
There can be no assurance that the Company would prevail in any such litigation
or that any such licenses would be available on acceptable terms, if at all. If
the Company were found to have infringed upon the proprietary rights of third
parties, it could be required to pay damages, cease sales of the infringing
products and redesign or discontinue such products, any of which alternatives,
individually or collectively, could have a material adverse effect on the
Company's business, operating results and financial condition.
VOLATILITY OF STOCK PRICE. The Company's Common Stock is traded on the
American Stock Exchange, and there has been substantial volatility in the market
price of the Common Stock. The trading price of the Common Stock has been and is
likely to continue to be subject to significant fluctuations in response to
variations in quarterly operating results, the gain or loss of significant
contracts, changes in management, announcements of technological innovations or
new products by the Company or its competitors, legislative or regulatory
changes, general trends in the industry, recommendations by securities industry
analysts and other events or factors. In addition, the stock market has
experienced extreme price and trading volume fluctuations which have affected
the market price of the common stock of many technology companies in particular
and which have at times been unrelated to operating performance of the specific
companies whose stock is affected. In addition, in the past the Company has not
experienced significant trading volume in its Common Stock, has not been
actively followed by stock market analysts and has had limited market-making
support from broker-dealers. If market-making support does not continue at
present or greater levels, and/or the Company does not continue to receive
analyst coverage, the average trading volume in the Common Stock may not
increase or even sustain its current levels, in which case, there can be no
assurance that an adequate trading market will exist to sell large positions in
the Common Stock.
INFLUENCE BY MANAGEMENT. As of June 30, 1998, the Company's officers
and directors owned, in the aggregate, approximately 22.3% of the Company's
outstanding shares of Common Stock. As a result, these stockholders are able to
exert influence over the outcome of all matters submitted to a vote of the
holders of the Company's Common Stock, including the election of the Company's
Board of Directors and thus, the policies of the Company. The voting power of
these stockholders could also discourage potential acquirers from seeking to
acquire control of the Company through the purchase of the Common Stock, which
might have a depressive effect on the price of the Common Stock.
EFFECT OF CERTAIN CHARTER PROVISIONS; STOCKHOLDER'S RIGHTS PLAN;
ANTI-TAKEOVER EFFECTS OF CERTIFICATE OF INCORPORATION, BYLAWS AND DELAWARE LAW.
The Company's Board of Directors has the authority to issue up to 1,000,000
shares of Preferred Stock and to determine the price, rights, preferences,
privileges and restrictions, including voting rights, of those shares without
any further vote or action by the stockholders. The Preferred Stock could be
issued with voting, liquidation, dividend and other rights superior to those of
the Common Stock. In March 1998, the Company adopted a stockholder's rights plan
(the "Rights Agreement") and, in connection therewith, distributed one preferred
share purchase right for each outstanding share of the Company's Common Stock
outstanding on April 2, 1998. Pursuant to the Rights Agreement, upon the
occurrence of certain triggering events related to an unsolicited takeover
attempt of the Company, each purchase right not owned by certain hostile
acquirers will entitle its holder to purchase shares of the Company's Series A
Preferred Stock, which is convertible into Common Stock, at a value below the
then current market value of the preferred stock. The rights of the holders of
Common Stock will be subject to, and may be adversely affected by, the rights of
the holders of the share purchase rights and of any Preferred Stock that may be
issued in the future. The issuance of Preferred Stock, while providing desirable
flexibility in connection with possible acquisitions and other corporate
purposes, could have the effect of making it more difficult for a third party to
acquire a majority of the outstanding voting stock of the Company. Further,
certain provisions of the Company's Certificate of Incorporation and Bylaws and
of Delaware law could delay or make more difficult a merger, tender offer or
proxy contest involving the Company.
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<PAGE>
PART II
OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The Company's Registration Statement on Form SB-2 (File No. 333-12163)
relating to the public offering (the "Offering") of an aggregate of 2,000,000
shares (the "Shares") of Common Stock, par value $0.001 per share (the "Common
Stock"), was declared effective by the Securities and Exchange Commission on
November 22, 1996. Credit Suisse First Boston and Cruttendon Roth Incorporated
acted as co-managing underwriters for the Offering.
All of the Shares were offered and sold by the Company for $5.00 per
share, for an aggregate offering price of $10,000,000. The Company's expenses in
connection with the Offering included underwriting discounts and commissions of
$875,000, and other expenses of approximately $625,000, for total expenses of
approximately $1,500,000, resulting in net proceeds ("Net Proceeds") to the
Company of approximately $8,500,000.
As of June 30, 1998, the Company had exhausted these proceeds and had
applied them as follows: (i) $1,600,000 to establish a production studio in New
South Wales, Australia, (ii) $954,000 for software tool development, (iii)
$275,000 to acquire content licenses, (iv) $1,225,000 to repay certain
indebtedness (of which approximately $1,145,000 was paid to stockholders and
other affiliates of the Company), and (v) $4,446,000 for working capital.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
At the Company's 1998 Annual Meeting of Stockholders held on May 22,
1998 (the "Annual Meeting"), the Company's stockholders elected Ray Musci, Jeff
Scheinrock and Mark Miller to serve a Class II Directors of the Company. At the
Annual Meeting, 8,808,185 shares were voted in favor of, and no shares were
voted against, the election of each of Messrs. Musci, Scheinrock and Miller, and
36,859 shares were withheld from voting. There were no broker non-votes at the
Annual Meeting.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
27.1 Financial Data Schedule
(b) Reports on Form 8-K.
Current Report on Form 8-K filed on April 6, 1998
reporting under Item 5 the adoption by the Company
of its Stockholders' Rights Plan.
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<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
BRILLIANT DIGITAL ENTERTAINMENT, INC.
Date: August 12, 1998 /s/ Michael Ozen
------------------------------------------------------
By: Michael Ozen
Its: Chief Financial Officer (Principal Financial
and Accounting Officer) and Secretary
Page 20
<PAGE>
EXHIBIT INDEX
EXHIBIT NUMBER EXHIBIT DESCRIPTION
27.1 Financial Data Schedule.
Page 21
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
UNAUDITED FINANCIAL STATEMENTS INCLUDED IN THE FORM 10-QSB OF BRILLIANT DIGITAL
ENTERTAINMENT, INC. TO WHICH THIS EXHIBIT IS A PART AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER
SHARE DATA).
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 7,419
<SECURITIES> 0
<RECEIVABLES> 1,967
<ALLOWANCES> 0
<INVENTORY> 106
<CURRENT-ASSETS> 9,634
<PP&E> 928
<DEPRECIATION> 0
<TOTAL-ASSETS> 12,427
<CURRENT-LIABILITIES> 1,651
<BONDS> 0
0
0
<COMMON> 9
<OTHER-SE> 10,767
<TOTAL-LIABILITY-AND-EQUITY> 12,427
<SALES> 32
<TOTAL-REVENUES> 32
<CGS> 346
<TOTAL-COSTS> 4,348
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (4,033)
<INCOME-TAX> (16)
<INCOME-CONTINUING> (4,049)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,049)
<EPS-PRIMARY> (.43)
<EPS-DILUTED> (.43)
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