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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
AMENDMENT NO. 2
TO
FORM 10-SB
GENERAL FORM FOR REGISTRATION OF SECURITIES
OF SMALL BUSINESS ISSUERS UNDER SECTION 12(B)
OR 12(G) OF THE SECURITIES EXCHANGE ACT OF 1934
GENIUS PRODUCTS, INC.
A NEVADA CORPORATION
(NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)
NEVADA 88-0363979
(STATE OR OTHER JURISDICTION (IRS EMPLOYER IDENTIFICATION NO.)
OF INCORPORATION OR ORGANIZATION)
11250 EL CAMINO REAL #100
SAN DIEGO, CALIFORNIA 92130
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)(ZIP CODE)
(858) 793-8840
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES TO BE REGISTERED UNDER SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS TO NAME OF EACH EXCHANGE ON WHICH
BE SO REGISTERED: EACH CLASS IS TO BE REGISTERED:
NONE NONE
SECURITIES TO BE REGISTERED UNDER SECTION 12(G) OF THE ACT:
COMMON STOCK, PAR VALUE $0.001
(TITLE OF CLASS)
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TABLE OF CONTENTS
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PART I
DESCRIPTION OF BUSINESS
Overview.................................................. 3
Baby Genius(TM) Products.................................. 3
Pet Tunes Products........................................ 4
Product Fulfillment and Sales of CDs, Cassettes and
Videos................................................. 4
Markets..................................................... 5
Licenses and Trademarks................................... 5
Jewelry Products.......................................... 6
Other Products............................................ 6
Our Retail Strategy in the United States.................. 6
Our Retail Marketing Plan................................. 7
Our Overseas Retail Strategy.............................. 7
Our Internet Strategy..................................... 8
Our Internet Marketing Strategy........................... 8
Retail and Internet Competitors........................... 8
Risks Related to Our Business.............................10
Impact of the Year 2000...................................13
Employees.................................................14
Additional Information....................................14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.................................15
Results of Operations -- Nine Months Ended September 30,
1999 and 1998..........................................15
Results of Operations -- 1998 Compared to 1997............17
Results of Operations -- 1997 Compared to 1996............17
Liquidity and Capital Resources...........................18
DESCRIPTION OF PROPERTY.....................................19
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT................................................19
MANAGEMENT..................................................20
Directors, Executive Officers, Promoters and Control
Persons................................................20
EXECUTIVE COMPENSATION -- REMUNERATION OF DIRECTORS AND
OFFICERS..................................................21
Employment Agreements.....................................22
Director Compensation.....................................22
Non-Qualified Stock Option Plan...........................22
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..............23
LEGAL PROCEEDINGS...........................................24
PART II
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS....25
Dividend Policy...........................................26
RECENT SALES OF UNREGISTERED SECURITIES.....................27
1997: Formation, Acquisition and Initial Issuance of
Common Stock...........................................27
1998: Issuance of Common Stock............................27
1999: Issuance of Common Stock............................28
DESCRIPTION OF SECURITIES...................................28
Common Stock..............................................28
INDEMNIFICATION OF DIRECTORS AND OFFICERS...................29
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE..................................
INDEX TO FINANCIAL STATEMENTS............................... F-1
PART III
INDEX TO EXHIBITS
SIGNATURE
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PART I
DESCRIPTION OF BUSINESS
OVERVIEW
Genius Products, Inc. (the "Company") was incorporated in the State of
Nevada on January 6, 1996 under the name Salutations, Inc. ("Salutations").
In September 1997 Salutations acquired all of the outstanding shares of a
company called International Trade & Manufacturing Corporation ("ITM"), a
Nevada corporation founded in 1992 by Klaus Moeller, our current Chairman and
Chief Executive Officer, and Gerald Edick. At the time of the acquisition,
Salutations was a public company with shares quoted on the Over the Counter
("OTC") Bulletin Board. Immediately after the acquisition, Salutations
assumed all of the operations and businesses of ITM and changed its name to
International Trading & Manufacturing Corporation ("ITMC"). In October 1999
we changed the name of the Company again from International Trading &
Manufacturing Corporation to Genius Products, Inc., to reflect what has
become our core business of publishing and distributing music compact discs,
cassettes and videos under the Baby Genius(TM) and other Genius brand names.
Our shares currently trade on the OTC Bulletin Board under the symbol GNUSE.
The original business of ITM involved the design, development and
distribution of semi-precious and precious gemstone and costume jewelry. Over
the last three years, however, the jewelry business has experienced increased
competition, an erosion of profit margins and a decline in sales. As a
result, in September 1998 we shifted our focus to more profitable lines of
business involving the Genius-branded product lines discussed below.
We have significant experience in product development and marketing
through both wholesale and retail distribution channels, and through national
and regional media campaigns. We use innovative and original marketing
techniques to sell our products to targeted audiences, such as parents and
pet owners. We have strong contacts in both the music and book distribution
business and have considerable experience in the building of membership
programs.
BABY GENIUS(TM) PRODUCTS
In September 1998, we decided to launch a line of classical music
compact discs ("CDs") and cassettes for children. This was inspired by a
proclamation by the governor of Georgia, Zell Miller, who stated that all
newborn children would receive a free classical CD or cassette as a gift from
the state, to enhance the child's intellectual development and well-being. We
were also attracted by the high gross margins associated with the sale of
CDs, cassettes and videos. Accordingly, we recruited people with experience
in the production, development, distribution and marketing of CDs, cassettes,
videos and other products.
We started to develop the Baby Genius line of products and became a
music publisher in September 1998. As a result, our business has changed
significantly over the last 12 months. We now publish, distribute and license
a line of musical CDs, cassettes and videos for children under the Baby
Genius(TM) brand name.
The Baby Genius(TM) product line currently comprises 20 CDs and
cassettes and two videos. There are 11 music titles in our Classical Series:
Bedtime Beethoven, Best of . . . The IQ Builder!, Brain Power, Breakfast with
Bach, Classics for Intelligence, Classical Vitamins, It's a Boy!, It's a
Girl!, Learn with Vivaldi, Magic Mozart and one sampler title. Our
Instrumental Relaxation Series comprises five titles: Lulla-Drive for the
Car, Nature's Experience, Sweet Dreams Lullabies, Up all Night and a sampler
title. There are two titles in our Vocal Series: Children's Songs and
Favorite Nursery Rhymes, and two titles in our Christmas Series: Classical
Christmas and Christmas Sleighride. We have produced two videos: Mozart &
Friends Vol. 1 and Mozart & Friends Sleepytime Vol. 2.
We have also established a website on the Internet, located at
WWW.BABYGENIUS.COM, at which visitors can buy Baby Genius(TM) products, and
also obtain access to information and content on pregnancy, child care and
other subject matters related to child development.
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Our business plan is to develop a line of music, video and other
Genius-branded products that are stimulating, educational and beneficial to
the intellectual development and well-being of children and their families.
We have had significant success in the creation of the Baby Genius(TM)
product line. We produced and brought to market 22 titles in 10 months. Our
music and video net sales went from zero in December 1998 to almost $1.2
million by the end of November 1999. We attribute this success to the highly
marketable Baby Genius(TM) brand name, effective marketing techniques, a
national media campaign, and endorsements by our celebrity spokesperson,
Deidre Hall, and by Minnesota Public Radio. We believe that if current market
conditions continue, our retail distribution and net sales will continue to
grow, although we will need additional financing to fund the increase in
fulfillment and other costs resulting from higher sales. No assurance can be
given that current market conditions will continue, that we will obtain the
financing to implement our business plan or that even if we implement our
plan, that we will succeed in sustaining high growth rates.
Baby Genius(TM) CDs, cassettes and videos are endorsed by our celebrity
spokesperson, Deidre Hall. We entered into an agreement in February of 1999
with Panache, Inc. which provides for Ms. Hall to act as a spokesperson for
our Baby Genius(TM) products. The agreement has a one year term, and requires
us to pay Panache $100,000 and issue Panache 200,000 shares of our common
stock. Of these 200,000 shares, 80,000 shares were issued in March 1999,
60,000 shares were issued in November 1999, and 60,000 shares are to be
issued on or before March 1, 2000.
Ms. Hall has for over 20 years played the role of a pediatrician, Dr.
Marlena Evans, in the television program Days of Our Lives. Ms. Hall has
promoted our Baby Genius(TM) products through the following media: Soap Opera
Digest Magazine, CBS This Morning, The TV Channel Guide, Live with Regis and
Kathie Lee, Access Hollywood, The Rosie O'Donnell Show, E! "Out to Lunch",
Later Today and E! "News Daily". After Ms. Hall appeared on The Rosie
O'Donnell Show in September 1999 to promote one of our Baby Genius(TM) CD
special offers, we received and processed over 20,000 orders.
The Baby Genius(TM) product line is also endorsed by Minnesota Public
Radio ("MPR"), a subsidiary of Minnesota Communications Group ("MCG"). MPR
and MCG funded a portion of the Baby Genius(TM) development costs and have
been instrumental in assisting us to obtain classical music licenses. MPR and
MCG are both shareholders of the Company.
Our success has been recognized by others. In March 1999, CBS This
Morning chose the Baby Genius(TM) line of CDs as one of the "Best Products
for Mother's Day." In September 1999, the Baby Genius(TM) CD Nature
Experience received the 1999 National Association of Parenting Publications
"Gold Award."
PET TUNES PRODUCTS
In October 1999, we began developing a classical and instrumental series
of CDs and cassettes under the name Pet Tunes, comprising four titles:
Delighted Doggy, Calming Kitty, Blissful Birdy and Happy Horsy. These titles
are designed to be played to pet animals and will be marketed on the basis
that music may have beneficial effects on animals, for example, by reducing
"separation anxiety" that a pet may experience when separated from its owner.
PRODUCT FULFILLMENT AND SALES OF CDS, CASSETTES AND VIDEOS
We are the sole producers of the CDs and cassettes for our Baby
Genius(TM) Instrumental Relaxation Series and our Baby Genius(TM) Vocal
Series. We co-produce with MPR the CDs and cassettes for the Baby Genius(TM)
Classical Series. Our CDs and cassettes are manufactured by Zomax, Inc. We
are the sole producers of our two Baby Genius(TM) videos. Our videos are
manufactured by Allied Digital Technology, Inc.
Our Baby Genius(TM) product line is distributed through our own
distribution center in Iowa and also through Rounder Kids, Valley Media, The
Children's Bookstore, Newsound, Tapeworm, Advanced Marketing, Ingram, Baker &
Taylor, Dart Distributing, Inc., Movie Exchange and Ventura
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Distribution.
Baby Genius(TM) products are sold in the following outlets:
- Mass retail: Target, ShopKo, Baby's R' Us, Pamida, Musicland and
Costco. We also have commitments from the following outlets: Sears,
Best Buy, Meijers, Federated, and Robinson May.
- Toy and children's stores: Zany Brainy, Learningsmith, Noodle
Kidoodle, Imaginarium, The Learning Center and FAO Schwartz.
- Others: 1-800-Flowers, Blockbuster, Barnes & Noble, J&R Music,
Carter's Children's Wear, Transworld, Rivertown Catalog, Hastings and
SkanDisk.
- Internet websites on the World Wide Web: ibaby.com, Smarterkids.com,
Toytime.com, Americanbaby.com, Babycenter.com, Amazon.com,
Borders.com, Infantelligence.com, CDNOW.com, Reel.com,
Babyfurniture.com, Toysmart.com, TheRightStart.com, Buy.com and
eToys.com.
By November 30, 1999, Baby Genius(TM) products were available in over
2,000 outlets. Credit card transactions for sales of Baby Genius(TM) products
from our website are processed by Card Payment Systems, Inc.
MARKETS
According to the US Census Bureau, approximately 3.9 million babies were
born in the United States in each of the last five years. With respect to the
Baby Genius(TM) and related product lines, our targeted markets are the
parents, family and friends of all new born children from birth through the
age of 12 and beyond.
According to the American Veterinary Medical Association ("AVMA"), in
1996 approximately 31% of US households owned a dog, 27% owned a cat, just
under 5% owned a pet bird and just under 2% owned a horse. The AVMA also
estimates that in 1996 households collectively spent approximately $5.8
billion on their dogs, $3 billion on their cats, $50 million on their pet
birds and $339 million on their horses. We will target sales of our Pet Tunes
series at these markets.
LICENSES AND TRADEMARKS
We license our classical music from Naxos of America, Inc. Under the
terms of our non-exclusive worldwide license agreements with Naxos, we pay an
advance payment to Naxos of $6,000 for the first 150,000 copies of
manufactured CDs and cassettes which are the subject of the license and
$1,000 for each additional 50,000 copies of manufactured CDs and cassettes.
The license agreements terminate upon the expiration of the copyright of the
music which is held by Naxos or upon our discontinuation of the product line.
MCG has granted us a license to use the names Public Radio MusicSource,
PRMS, and PRMS designs. MPR has granted us a license to use the names
Minnesota Public Radio, MPR, and MPR designs. The MPR licenses are more fully
described in the "Certain Relationships and Related Transactions" section of
this registration statement.
We own all intellectual property rights relating to the Baby Genius(TM)
Instrumental Relaxation Series, the Vocal Series, and the Video series.
We own the trademark Baby Genius(TM) for music and video products,
clothing and books. We also have trademark applications pending on the
following trade names that we intend to use to develop additional product
lines: Little Genius, Kid Genius and Child Genius.
Classes of products for which trademarks under these names are pending include
music and videos, food products, books, paper goods, leather goods, furniture,
houseware, fabrics, clothing, toys and sporting goods, and cartoon character
licensing.
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JEWELRY PRODUCTS
Although jewelry sales and profit margins have declined since ITM
started the business, we continue to design, develop and distribute
semi-precious and precious gemstone and costume jewelry under ITM's original
jewelry brand name "Sanuk." Our jewelry is manufactured in Thailand and India
and marketed through the Home Shopping Network in the United States. Our
jewelry business is operated through our wholly-owned subsidiary Sanuk, Inc.,
a Nevada corporation. In order to concentrate on our core business and
implement our business plan for Genius-branded products, we plan to sell our
jewelry business in the first quarter of 2000. We are in discussions
regarding this sale with Gemstones of Montana, a company with which we have
conducted business for several years and which we believe will continue to
operate the business successfully. There can be no assurance, however, that
we will be able to sell our jewelry business to Gemstones of Montana, or any
other potential buyer, or that if such a sale were to occur, that it would be
completed in the first quarter of 2000.
OTHER PRODUCTS
A license agreement that we had entered into March 1999 with Mr. Sasha
St. Clair to market and sell a fishing device for de-boning fish, called the
"Downunder Spineless Wunder Boner" was terminated in November. Subject to
patent rights that may be issued in favor of Mr. St. Clair, we will be free
to manufacture and market the device without having to pay the royalties that
otherwise were required under the agreement. The device will be produced
either under the name "Spineless Wunder Boner", for which a trademark
application is pending under our name, or such other name as we consider
appropriate. We have entered into a license agreement with Boomerang
Marketing, Inc. to market and sell a retrievable fishing lure called the
"Boomerang Lure". The lure, which is buoyant, is designed so that if it
snags, the line will break between the lure and the hook, thereby allowing
the lure to float back to the surface. We intend to market these
products principally through the Danielson Company, which would be responsible
for all fulfillment relating to manufacturing, distribution and sales. We
also intend to market the products on TV by way of direct-response
commercials aired on national and regional cable channels. Fulfillment of
direct sales made by us would be processed through Professional Marketing
Associates, Inc. We do not anticipate revenues from sales of these products
to have a material impact on the Company's short-term financial results.
In 1998 and 1997, we considered developing two additional product lines,
The Astrology Network and The America Value Network. We decided not to pursue
these product lines after receiving unsatisfactory results from test
marketing. We created a wholly-owned subsidiary to operate The Astrology
Network business which we intend to dissolve in due course.
OUR RETAIL STRATEGY IN THE UNITED STATES
Our principal objective over the next 18 months is to continue the
growth of our core business centered on the development and marketing of
Genius-branded products, with particular emphasis on the Baby Genius(TM)
product line.
We intend to develop new products under the Baby Genius(TM) brand name,
including additional music CDs, cassettes and videos, CD-ROMS, software,
books, educational toys, baby products, clothing, and other products. We
also intend to produce animations and cartoons featuring our Baby Genius(TM)
characters. These Baby Genius(TM) products will be marketed as tools that can
help in the development and well-being of babies and children as well as
their families. We also intend to license the brand name to suitable
licensees.
We plan to aggressively build our Baby Genius(TM) brand name as well as
our retail business by increasing the number of distribution and retail
outlets in the United States and overseas through which our Baby Genius(TM)
products are sold.
We will also test and develop new product lines based on other "Genius"
brand names for which trademark registration applications are pending,
including
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Kid Genius, Little Genius and Child Genius. New products under these brand
names would be similar in application and objectives to the Baby Genius(TM)
line. The overall aim of Genius-branded product lines will be to secure the
loyalty and continuity of our targeted audience, such that these different
but related products will eventually be seen as an integrated series spanning
the development of children from birth to age 12 and beyond.
OUR RETAIL MARKETING PLAN
We believe our retail success is due to excellent contacts in the music
distribution business, and with wholesale and retail outlets. We have also
succeeded in creating high product visibility. We have produced 18 retail
titles resulting in 36 retail shelf spaces for CDs and cassettes, an amount
of space which we believe is significantly large for this product line
category. This retail presence is enhanced by our participation in programs
to secure prime shelf space and fixtures, including listening stations and
"end-caps". We also actively market Baby Genius(TM) counter and floor
displays, blister packs, and interactive kiosks where customers can listen to
our music. In addition, we participate in co-op advertising campaigns with
Zany Brainy, Target and Rounderkids in which Baby Genius(TM) products are
featured items. We intend to continue these retail strategies.
We also will seek to continue with endorsements of the Baby Genius(TM)
line of products by MPR and MCG, as well as by Deidre Hall or other
celebrities who are willing to participate in national media campaigns. These
campaigns promote both our retail products and our Baby Genius(TM) website.
We have exhibited the Baby Genius(TM) product line at national shows and
exhibitions including the East Coast Video Show in Atlantic City, Investment
Expo, Inc. in New York City, and the Juvenile Products Manufacturers
Association in Dallas. We intend to continue exhibiting the Baby Genius(TM)
product line and are scheduled to exhibit at Toy Fair 2000 in New York City
in February 2000. We will also continue to pursue non-traditional marketing
strategies by selling products through outlets such as 1-800-Flowers and
Carter's Children Wear.
OUR OVERSEAS RETAIL STRATEGY
The Baby Genius(TM) brand name has universal appeal and we believe the
name and product line can be repackaged and marketed for distribution and
sales in many countries.
In August 1999 we produced a Spanish version of the Baby Genius(TM)
Mozart and Friends videos for distribution in Mexico, and in October 1999 we
received a commitment for trial sales from Calimex, a chain of supermarkets
in Tijuana and surrounding areas.
In November we entered into a Sales, Marketing and Distribution
Agreement with Storemount Enterprises, Ltd. which grants exclusive rights to
Storemount to distribute Genius products in the United Kingdom and
non-exclusive rights to distribute products in all other areas other than
North and South America. We have the right to terminate the exclusive UK
distribution arrangement on 60 days notice in our sole discretion, and the
non-exclusive arrangement without prior notice.
We have also been approached by a number of distributors' wishing to
distribute Baby Genius(TM) products in overseas markets including Canada,
Europe and South East Asia. While we hope to enter into relationships with
international distributors, there can be no assurance that any such
relationships will be entered into or, if we enter into any such
relationships, that it will result in profitable international sales.
OUR INTERNET STRATEGY
We believe that an Internet presence will complement our retail business
by providing additional exposure for the Baby Genius(TM) brand name to our
target audience. With continued growth in electronic commerce over the
Internet ("e-commerce"), we anticipate a strong Internet presence will be
necessary to maintain brand name recognition, maximize sales, and keep up
with our competitors who sell their products over the Internet. We also
believe that a
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strong brand name that is recognized in the retail sector will provide a base
for a complementary e-commerce business. In addition, we believe that
customer satisfaction obtained by providing content, information, products,
services and features through our website will increase brand recognition and
customer goodwill and will lead to higher retail sales.
In the short term we intend to focus on the retail business, enter
into strategic partnerships and maintain our website to sell Baby Genius(TM)
products, provide content that we consider useful for expectant mothers and
parents, and build a database of members to whom we can provide goods,
services and related promotions. In December 1999 we entered into a Services
Agreement with UNICARE, a member of the WellPoint Health Networks, Inc.
group. WellPoint Health Networks serves 7 million medical and 30 million
specialty members nationally through Blue Cross of California in California
and UNICARE throughout other parts of the country. Under the Agreement,
UNICARE will provide Baby Genius members access to a 24-hour medical help
line, known as MedCall, via a unique 800 number, and to an on-line medical
and health information service known as the Healthwise Knowledgebase via a
hotlink on the www.babygenius.com site. The services are scheduled to start
on January 1, 2000.
In the medium term we will evaluate the commercial feasibility of
developing our website internally and through strategic partnerships with
other established websites, to provide a full range of content, information,
products, services and features.
We believe a fully-developed website could generate multi-source
e-commerce revenues from the sale of Genius-branded products and services,
membership fees, commissions on sales of third party products, and targeted
advertising.
We have engaged American Digital Networks Corporation (ADN)to prepare a
proposal to develop, host, operate and maintain our web site. ADN has
experience in creating and hosting heavily trafficked storefronts and is the
developer of e-StoreManager(TM) which provides comprehensive e-commerce
capabilities.
OUR INTERNET MARKETING STRATEGY
Our short term objective is to increase at the lowest possible cost our
membership base of persons who visit our website. We define a "member" as any
visitor to our website who provides us with their credit card number and
e-mail address. To minimize the cost of signing-up members, we will evaluate
the feasibility of entering into strategic relationships with companies that
already have an existing customer base. We will also look at participating in
membership programs operated by third parties.
One proven method whereby we obtained very high traffic over a
limited time is the airing of Baby Genius(TM) product promotions on national
TV. In September 1999, in connection with Deidre Hall's appearance on the
Rosie O'Donnell Show promoting the Baby Genius(TM) product line, we offered
two Baby Genius(TM) classical music CDs/cassettes for a nominal charge of
$4.95 shipping and handling. As a result of this promotion, in the 48-hour
period immediately following the broadcast we received and processed over
20,000 orders for this special offer.
This type of exposure benefits both retail sales as well as our Internet
presence.
We will continue with national media campaigns that promote both our
website and the Baby Genius(TM) product line.
RETAIL AND INTERNET COMPETITORS
The retail and Internet markets for baby development, educational and
entertainment products, including CDs, cassettes and videos, is highly
competitive. We face significant competition with respect to the number of
products currently available, as well as in securing distribution and retail
outlets. The costs of entry into the retail and Internet markets for products
competitive to our Baby Genius(TM) products are low, and there are no
significant barriers to entry. There are many companies who could introduce
directly competitive products in the short term that have established brand
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names, are better funded, have established distribution channels, and have
greater resources than the Company. These established companies include
Disney, Fox, Paramount, Sony and Time-Warner.
Within the category of classical music CDs and cassettes for children,
established competitors include:
- Bach & Baby: Playtime by Bach & Baby
- Baby Bach by Baby Einstein
- Baby Tunes series by Baby Tunes
- Classical Kids by The Children's Group
- Mozart for Mothers-to-Be by Mozart
- Smart Music: Classical Music series
- The Classical Child series by Metromusic, Inc.
- The Mozart Effect Vols. 1-3 by Classical Productions for Children
Ltd./The Children's Group Inc., and BMG
- The Kids Collection of Greatest Classics by The Kids Collection
Baby Genius(TM) classical music CDs and cassettes also compete with other
non-classical titles for children such as:
- Baby, It's You: Giggles & Gurgles by Sony
- Baby Sounds by various artists
- Baby Tunes series
- Teletubbies series
- KidRhino series
- Music for Little People series
Within the category of classical music videos for children, established
competitors include:
- The Baby Einstein series by Baby Einstein
Baby Genius(TM) classical music videos also compete with other
non-classical titles for children such as:
- Barney series by Lyrick Studios
- Dr. Seuss series by Fox Home Entertainment
- Little Bear series by Paramount Home Video
- Madeleine, The Jungle Book, The Little Mermaid, Winnie-the-Pooh by
Disney Home Video
- Paddington Bear series by Time-Life
- Sesame Street series by Sony Wonder
- Teletubbies series by PBS HomeVideo/Warner
With respect to Internet websites, there are numerous websites that are
devoted exclusively to the delivery of content, products, services and
features within the baby sector, including Babycenter.com, iBaby.com
(iVillage), BabyData.com, BabyServ.com, Babystyle.com and Parenthoodweb.com.
These websites have a competitive advantage over our website as they are now
established as the leading websites with the highest traffic in the
baby/parent Internet sector. In addition, the companies operating these
websites have greater financial resources which can be used exclusively for
the development of their e-commerce
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business.
RISKS RELATED TO OUR BUSINESS
Forward-Looking Statements. Some of the information in this registration
statement contains forward-looking statements that involve substantial risks
and uncertainties. You can identify these statements by forward-looking words
such as "may," "will," "expect," "anticipate," "believe," "estimate," and
"continue" or similar words. You should read statements that contain these
words carefully because they:
- discuss our future expectations;
- contain projections of our future results of operations or of our
financial condition; and
- state other "forward-looking" information.
We believe it is important to communicate our expectations. There may be
events in the future, however, that we are not able to accurately predict or
over which we have no control. The risk factors listed in this section, as
well as any cautionary language in this registration statement, provide
examples of risks, uncertainties and events that may cause our actual results
to differ materially from the expectations we describe in our forward-looking
statements. You should be aware that the occurrence of the events described
in these risk factors and elsewhere in this registration statement could have
an adverse effect on our business, results of operations and financial
condition.
Dependence on Short-Term Financing. We are dependent on obtaining
short-term financing to sustain operations. We are currently operating at a
loss and have negative cash flow. The credit terms we extend to our customers
are more favorable than those we have with our vendors and service providers,
and we have insufficient cash balances to sustain losses. Accordingly, we
have to finance our working capital requirements either by selling shares of
the Company's common stock or by obtaining funds from other sources such as
factoring our invoices (selling our accounts receivable). Our ability to
factor invoices depends on a number of criteria including the credit rating
of our customers, the amount owed by any one customer as a percentage of the
total amount of receivables outstanding, and the ageing of receivables owed
by a customer. In addition, certain customers have held and continue to hold
in reserve amounts otherwise due under our invoices as security for product
returns. This is standard practice in the music and entertainment industry
where reserves average around 10% of sales. We also have the right to receive
up to $400,000 of funding under an Investment Agreement with Minnesota
Communications Group (MCG) which is conditional on satisfying certain
contractual requirements. If MCG take the position that such conditions have
not been satisfied, they may refuse to fund us. We cannot guarantee that we
will be able to factor a sufficient amount of invoices to cover our financing
requirements, and a failure to obtain financing would have a material adverse
effect on our business, operations and financial condition.
Dependence on Long Term Financing. Our ability to implement our business
plan and grow the Company is dependent on raising a significant amount of
capital. We are actively seeking to raise an amount of not less than $5
million but no assurance can be made that we will succeed in raising any
funds. If we are unable to raise capital our ability to implement our
business plan and the growth of the Company would be adversely affected.
Inability to Utilize Net Operating Loss. In 1997 and 1998 the Company
incurred losses resulting in a net operating loss carryforward as of December
31, 1998, of $2,036,134 and $1,018,961 for federal and state income tax
purposes respectively. The federal and state net operating losses begin to
expire in 2018 and 2003, respectively. Because the Company anticipates
significant expenditures with respect to implementing its business plan,
including its Internet, e-commerce business, there is a risk that the Company
will be unable to make enough profits, if any, during the net operating loss
carry forward period to realize the deferred income tax asset.
Dependence on Key Personnel. We are dependent on our executive officers,
the loss of any one of whom would have an adverse effect on the Company.
While we have employment agreements with our executive officers, unforeseen
circumstances could cause these persons to no longer be able to render their
services to us.
Dependence on New Products. Our future growth will be dependent on our
ability to identify and develop Genius-branded products which can be sold at
acceptable margins through wholesale and retail outlets as well as on the
Internet, and on our ability to acquire the necessary rights to market and
distribute such products, and to enter into arrangements with third-party
manufacturers and distributors to produce and distribute such products. There
can be no assurance that we will be successful in identifying and developing
quality products that may be successfully marketed through these channels or
in
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entering into relationships with third-party manufacturers and distributors. A
failure to identify and develop new products would have a detrimental impact on
our future performance.
Exposure of Significant Spokesperson. Deidre Hall currently serves as
the celebrity spokesperson for our products. Our continued success is
dependent on our ability to retain Ms. Hall or attract other celebrity
spokespersons. There can be no assurance that we will be able to recruit and
retain such celebrity spokespersons.
Industry Trends. Our recent growth in sales has been based in part on both
the evolution of consumer tastes and preferences towards educational products
for babies and children. We believe it is also based on recent publicity on the
effect of classical music on child development. There are differences of
opinion, however, in the scientific community regarding the efficacy of
classical music on child development. A change in consumer tastes and
preferences regarding our products may have an adverse effect on our results of
operations. There can be no assurance that consumer tastes and preferences will
continue to favor our products and marketing segments.
Need For Strong Brand Identity. We believe that our growth in sales and the
recognition of the Baby Genius(TM) brand name have been largely attributable to
Deidre Hall participating in a successful national media campaign and the
endorsement of the Baby Genius(TM) music titles by Ms. Hall, Minnesota Public
Radio and Public Radio MusicSource. We have benefited from frequent and visible
national and local media exposure from Ms. Hall in particular. The frequency or
quality of this media exposure and these endorsements may not continue. We
believe that continuing to strengthen the Baby Genius(TM) brand name will be
critical to achieve widespread acceptance of our products. Favorable public
perception of our Genius-branded products will depend largely on our ability to
continue providing users with high quality products and the success of our
marketing efforts. We plan to increase our marketing expenditures to create and
maintain brand recognition. However, brand promotion activities may not yield
increased revenues and, even if they do, any increased revenues may not offset
the expenses we incur in building our brand.
Trademark Infringement Claims. We may be held liable for copyright or
trademark infringement if the content or packaging of our CDs, cassettes, videos
or other products infringes upon the copyrights or trademarks of others. Such
claims of infringement, if brought, could materially adversely affect our
business or financial condition.
Acceptance and Effectiveness of Internet Electronic Commerce. Our success
in establishing an e-commerce business through our Baby Genius(TM) web site will
be dependent on an increase in the use of the Internet for e-commerce. If the
markets for e-commerce do not develop or develop more slowly than we expect, our
e-commerce business may be harmed. If Internet usage does not grow, we may not
be able to increase revenues from Internet advertising and sponsorships which
also may harm both our retail and e-commerce business. Internet use by consumers
is in an early stage of development, and market acceptance of the Internet as a
medium for content, advertising and e-commerce is highly uncertain. A number of
factors may inhibit the growth of Internet usage, including inadequate network
infrastructure, security concerns, inconsistent quality of service, and limited
availability of cost-effective, high-speed access. If these or any other factors
cause use of the Internet to slow or decline, our results of operations could be
adversely affected.
Competition In Internet Commerce. Increased competition from e-commerce
could result in reduced margins or loss of market share, any of which could harm
both our retail and e-commerce businesses. Competition is likely to increase
significantly as new companies enter the market and current competitors expand
their services. Many of our present and potential competitors are likely to
enjoy substantial competitive advantages, including larger numbers of users,
more fully-developed e-commerce opportunities, larger technical, production and
editorial staffs, and substantially greater financial, marketing, technical and
other resources. If we do not compete effectively or if we experience any
pricing pressures, reduced margins or loss of market share resulting from
increased competition, our business could be adversely affected.
Unreliability of Internet Infrastructure. The Internet has experienced, and
is expected to continue to experience, significant growth in number of users and
amount of traffic. If the Internet continues to experience increased numbers
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of users, frequency of use or increased bandwidth requirements, the Internet
infrastructure may not be able to support these increased demands or perform
reliably. The Internet has experienced a variety of outages and other delays
as a result of damage to portions of its infrastructure, and could face
additional outages and delays in the future. These outages and delays could
reduce the level of Internet usage and traffic on our website. In addition,
the Internet could lose its viability due to delays in the development or
adoption of new standards and protocols to handle increased levels of
activity. If the Internet infrastructure is not adequately developed or
maintained, use of our website may be reduced. Even if the Internet
infrastructure is adequately developed, and maintained, we may incur
substantial expenditures in order to adapt our services and products to
changing Internet technologies. Such additional expenses could severely harm
our financial results.
Transactional Security Concerns. A significant barrier to Internet
e-commerce is the secure transmission of confidential information over public
networks. Any breach in our security could cause interruptions in the operation
of our website and have an adverse effect on our business.
Governmental Regulation of the Internet. There are currently few laws that
specifically regulate communications or commerce on the Internet. Laws and
regulations may be adopted in the future, however, that address issues including
user privacy, pricing, taxation and the characteristics and quality of products
and services sold over the Internet. An increase in regulation or the
application of existing laws to the Internet could significantly increase our
costs of operations and harm our business.
Technological Change. The market for CDs, cassettes and video technology is
subject to change. There can be no assurance that over time these technologies
will not be affected by competition from another form of information storage and
retrieval technology, such as on-line information services. A further strong
advance in the technology surrounding cable and satellite that would give
consumers access to information and entertainment may limit the expansion of the
market for applications based on CDs, cassettes and video. In addition, existing
CD technology may also be replaced by new CD technologies such as digital video
disc technology. The replacement of CD technology by another information storage
and retrieval technology, or the replacement of existing CD technology by a new
technology at a pace too rapid for production adjustments, may also have a
material adverse effect on our business, financial condition and results of
operations.
Change of Control Payments. We have entered into Change of Control
Executive Employment Agreements with six of our executive officers and key
employees. These Agreements provide that if any executive officer or key
employee is terminated after a change of control of the Company occurring on
or before December 31, 2001, the terminated officer or employee may receive,
among other things, a lump sum payment equal to ten times the highest annual
compensation paid by the Company to that officer or employee in the preceding
three years. If a change of control of the Company occurs on or before
December 31, 2001, and any executive officer or key employee is terminated,
we may incur substantial expenditures to satisfy the payments due under the
Change of Control Executive Employment Agreements. These expenditures could
adversely affect our financial results and potentially discourage any hostile
buyer from making an unsolicited offer to purchase the Company.
Inability to Qualify for or Maintain a Listing on The Nasdaq Market. Our
shares of common stock are currently traded on the OTC Bulletin Board We intend
to apply for the listing of our shares of common stock on the Nasdaq SmallCap
Market ("Nasdaq") at such time, if ever, as we qualify for such listing. We
believe a listing on Nasdaq will improve the market liquidity of our shares
of common stock by eliminating the delay of buy/sell transactions which are
commonly experienced on the OTC Bulletin Board and creating greater coverage
of our company by the news media and security analysts. There can be no
assurance that we will be able to achieve the minimum financial requirements
and other criteria to be listed on Nasdaq. If we become listed on Nasdaq, we
will have to maintain the financial requirements and other criteria required
for continued listing on Nasdaq. Our failure to maintain these requirements
would result in our shares being delisted from Nasdaq. If we are delisted
from Nasdaq, our shares will once again trade on the OTC Bulletin Board or in
the so called "pink sheets" over-the-counter market.
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Risk of Low-Price Stocks. Our common stock is subject to Rule 15g-1
through 15g-9 under the Securities Exchange Act of 1934, as amended, which
imposes certain sales practice requirements on broker-dealers which sell our
common stock to persons other than established customers and "accredited
investors" (generally, individuals with net worths in excess of $1,000,000 or
annual incomes exceeding $200,000 (or $300,000 together with their spouses)).
For transactions covered by this rule, a broker-dealer must make a special
suitability determination for the purchaser and have received the purchaser's
written consent to the transaction prior to the sale. This rule adversely
affects the ability of broker-dealers to sell our common stock and purchasers
of our common stock to sell their shares of such common stock. Additionally,
our common stock is subject to the Securities and Exchange Commission
regulations for "penny stock". Penny stock includes any non-Nasdaq equity
security that has a market price of less than $5.00 per share, subject to
certain exceptions. The regulations require that prior to any non-exempt
buy/sell transaction in a penny stock, a disclosure schedule prepared by the
Securities and Exchange Commission relating to the penny stock market must be
delivered to the purchaser o such penny stock. This disclosure must include
the amount of commissions payable to both the broker-dealer and the
registered representative and current price quotations for the common stock.
The regulations also require that monthly statements be sent to holders of
penny stock which disclose recent price information for the penny stock and
information of the limited market for penny stocks. These requirements
adversely affect the market liquidity of our common stock.
Costs of Repurchasing Certain Shares. During the period 1997 through 1999, we
issued shares in Arizona, Pennsylvania and Washington, for which no share
registration filings were made under the securities laws of those states and
for which exemptions from registration appear to be unavailable. In order to
comply with the laws of those states, we will offer to repurchase all such
shares from investors who originally acquired them from the company, who were
resident in those states at the time of purchase, and who continue to hold
such shares at the time the offer is made. We will pay to each shareholder
who accepts the offer, the price per share they originally paid, plus
interest, where applicable, accrued from the date of initial purchase to the
date of repurchase.
The total number of shares subject to repurchase is 307,550 and the potential
cost to the Company would be $420,323, plus accrued interest of approximately
$34,522 if we repurchased all shares on March 31, 2000. The costs of
repurchasing shares subject to the offer would be paid out of company funds
but we do not have sufficient cash to repurchase all such shares, and even a
low number of repurchases would have a material adverse impact on the
Company's operations and financial condition if the Company was unable to
raise funds to pay for such costs. If we were unable to repurchase shares for
lack of funds, the selling shareholders might seek to exercise certain rights
as creditors or seek to enforce claims for breach of contract. In addition,
interest would continue to accrue on the outstanding amounts owed to
shareholders in Pennsylvania and Washington at annual rates of 6% and 8%
respectively.
If, at the time a repurchase offer is made, the market price of the company's
shares is higher than the repurchase price, we do not believe that all
affected shareholders would accept the repurchase offer. No assurance can be
made, however, that shareholders will decline any repurchase offer, and the
Company may be obligated to repurchase all shares subject to the offers.
Repurchase offers in Pennsylvania and Washington have to be approved by the
regulatory authorities of those states, and the authorities in Washington
will not approve our repurchase offers until certain proceedings between the
Company and the state's Department of Financial Institutions, Securities
Division, have been concluded. Those proceedings are described in the section
on "Legal Proceedings" below. Delays in obtaining regulatory approval would
also cause increases in the amount of interest payable pursuant to repurchase
offers.
IMPACT OF THE YEAR 2000
The Year 2000 issue relates to the way computer systems and programs
interpret calendar date entries in two-digit code fields. Computer systems
may fail or make miscalculations if they are unable to distinguish the year
2000 from 1900. In addition, some computer systems not normally characterized
as information technology systems may contain embedded hardware or software
that may be susceptible to this problem. As a result, many companies will
need to upgrade or replace computer systems in order to ensure uninterrupted,
Year 2000 error-free computer operations.
We outsource and rely on other companies for the manufacture of CDs,
cassettes and video tapes, for the fulfillment of our wholesale and on-line
customers' orders, for the processing of our on-line customers' payments by
credit card and checks, and for the distribution of our products. We have
requested our principal vendors and service providers to represent their Year
2000 readiness. No binding assurance has been given to us by any of these
companies that their computer systems are compliant in managing the Year 2000
date change, and, if their computer systems are not Year 2000 compliant, they
may suffer system failures that may have a material impact on the manufacture
and distribution of our products, and the fulfillment and processing of our
orders. Such failures may have a material adverse effect on the Company's
business, results of operations and final condition.
Similarly, while we have also requested our principal customers to
represent their Year 2000 readiness, we have received no binding assurances
from any of them that their computer systems are Year 2000 compliant, and if
their systems are not compliant they may suffer system failures affecting the
processing of purchase orders, the computations in accounts payable and the
payment of invoices. Such failures may lead to delays in our receiving
purchase orders, payments of our invoices or mistakes in calculating the
amount that our customers owe us. Such failures may also have a material
adverse effect on the Company's business, results of operations and financial
condition.
If, as a result of Year 2000 computer system failures on the part of our
suppliers and service providers, we fail to process orders in a timely or
accurate manner, or at all, our wholesale and on-line customers may take
action resulting from such failures, including, on the part of our wholesale
customers, canceling future purchase orders or ceasing to do business with
us, and, with respect to our on-line customers, demands for the return of
checks or moneys paid, or for credit charge-backs to their credit card
accounts. We may experience in such circumstances a decline in sales from our
wholesale and on-line customers, and would have to repay cash received in
respect of unfulfilled sales. All of these events may also have a material
adverse effect on the Company's business, results of operations and financial
condition. If, as a result of computer failures on the part of third parties,
we are unable to fulfill our customers' orders, there is no assurance that we
would be able to assert successful claims against our third party service
providers for such failures.
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We intend to have our web site hosted, maintained and operated by
American Digital Networks Corporation of San Diego who have given us oral
assurances that their Internet hosting operations and computer systems are
Year 2000 compliant.
Our use of computers is limited to personal computers manufactured by
Dell and Gateway that we bought in 1999 and 1998. We use basic operating and
applications software, including Microsoft Windows 98, Microsoft Office 2000,
and Sage MAS90 accounting systems, all of which were factory-installed or
purchased in the last 18 months from retail vendors. We believe that our
internal computers are Year 2000 compliant but we have not determined and we
do not have the resources to determine whether our systems are compliant. No
assurance can be made that our systems are compliant.
EMPLOYEES
We currently have 10 full-time employees and one part-time employee. Our
employees are non-union and none are represented by an organized labor union.
We believe our relationship with our employees is very good and we have never
experienced an employee-related work stoppage. We will need to hire and
retain highly-qualified management personnel in order to execute our business
plan. No assurance can be given that we will be able to locate and hire such
personnel, or that, if hired, we will continue to be able to pay the higher
salaries necessary to retain such skilled employees.
ADDITIONAL INFORMATION
We intend to provide an annual report to our security holders, and to
make quarterly reports available for inspection by our security holders. The
annual report will include audited financial statements.
This registration statement became effective on January 2, 2000, as a
result of which we are now subject to the informational requirements of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), which
requires us to file reports, proxy statements and other information with the
Securities and Exchange Commission (the "SEC"). Such reports, proxy
statements and other information may be inspected at public reference
facilities of the Commission at Judiciary Plaza, 450 Fifth Street N.W.,
Washington D.C. 20549; Northwest Atrium Center, 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661; 7 World Trade Center, New York, New
York, 10048; and 5670 Wilshire Boulevard, Los Angeles, California 90036.
Copies of such material can be obtained from the Public Reference Section of
the Commission at Judiciary Plaza, 450 Fifth Street N.W., Washington, D.C.
20549 at prescribed rates. The SEC maintains an Internet website that
contains reports, proxy and information statements, and other information
regarding issuers that file electronically with the SEC. The address of that
website is www.sec.gov.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and
results of operations should be read in conjunction with the Financial
Statements and the related notes. This discussion contains forward-looking
statements based upon current expectations that involve risks and uncertainties,
such as our plans, objectives, expectations and intentions. Our actual results
and the timing of certain events could differ materially from those anticipated
in these forward-looking statements as a result of certain factors, including
those set forth under "Risk Factors," "Business" and elsewhere in this
prospectus. See "Forward-Looking Statements."
In 1999 we changed our core business to the Baby Genius(TM) product line
and started generating music sales immediately. The growth in revenues from
sales of Baby Genius(TM) products has been high, we went from zero in net
sales in December 1998 to just under $1.2 million by the end of November
1999. Correspondingly, our expenses also rose in connection with the
fulfillment of such sales and the costs associated with the development of
the Baby Genius(TM) product line. In 1998 we experienced a significant drop
in sales in our jewelry business, mainly as result of increased competition
and higher product returns. While our revenues for the 9-month periods ending
September 1999 and September 1998 can be compared on an aggregate basis, the
results of operations for these two periods reflect fundamentally different
businesses, with different margins and cost structures. Our change in
business focus and introduction of the Baby Genius(TM) line of products is
more fully described in the "Business" section of this registration statement.
RESULTS OF OPERATIONS -- NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
The interim year-to-date financial statements for the nine months ending
September 30, 1999 and September 30, 1998 have been prepared by management.
References in this section to 1999 or 1998 results means the 9-month periods
ending on September 30 of each of those years, and not our full fiscal
(calendar) year.
Net sales for the 9-month periods decreased by 28.5% ($634,099) to
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$1,590,787 in 1999 from $2,224,886 in 1998. Sales in 1999 consist of $897,727
in Baby Genius(TM)product sales and $693,060 in jewelry and other sales.
There were no Baby Genius(TM) sales in 1998, and the $1,531,826 (69%)
decrease in jewelry sales to $693,060 in 1999 from $2,224,886 in 1998 was due
to market conditions and the fact that our management has devoted a
substantial amount of its efforts and resources to developing the Baby
Genius(TM) product line.
Accounts receivable at September 30, 1999 represent 41% of total assets at
that date and 42% of revenue for the nine months then ended. This increase is
the result of sales of Baby Genius(TM) products which commenced in the second
quarter of 1999. At September 30, 1999, accounts receivable of about $110,000
(16%) were 60 days or more past due. Of this amount, about $60,000 represent
holdbacks for possible returns and is from one customer, which is the Company's
largest distributor. No material amount of Baby Genius(TM) product has been
returned and the Company expects the hold back to be paid by the customer.
The Company's customers are large retail and distribution companies. The
Company has not had any uncollectible accounts and, due to the nature of the
Company's customers, does not expect any from its current customers.
Cost of sales for the 9-month periods were $822,223 (52% of sales) in 1999
and $2,127,645 (96% of sales) in 1998. It should be noted, however, that the
cost of Baby Genius(TM) product sales in 1999 was $190,093 (12%) of sales. The
cost of jewelry and other sales was $632,129 in 1999 and $2,127,645 in 1998,
representing 91% of sales in both years.
Personnel costs increased by 15% ($80,250) to $614,837 in 1999 from
$534,587 in 1998. Most of this increase was for additional employees in
connection with the development of the Baby Genius(TM) product line. In 1999 we
entered into six new employment agreements with our employees. Five of these
agreements are with existing employees and formalize certain terms and
conditions under which those employees were already employed. These employment
agreements will not cause an increase in the Company's current payroll expenses.
In addition, on August 23, 1999 the Company entered into a three-year
employment agreement with our new President which provides for an annual salary
of $150,000, and other benefits, including car, health, housing and severance
benefits. The salary and benefits payable under this agreement has resulted in
an increase in the Company's payroll and overhead of approximately $16,000 per
month.
Advertising and sales costs increased by 331% ($465,306) to $605,835 in
1999 from $140,529 in 1998. Again, most of these increased costs were related
to launching the Baby Genius(TM) product line, including costs of a national
spokesperson, an Internet media and publicity tour, advertising and Internet
expenses. Of this amount, $116,667 was the value of shares issued or issuable
to the national spokesperson.
General and administrative costs increased by 5% ($18,088) to $357,490 in
1999 from $339,402 in 1998, resulting primarily from relocation to new offices
and a corresponding increase in rental expenses.
Legal, professional and consulting fees increased 672% ($347,128) to
$398,779 in 1999 from $51,651 in 1998. Of this increase, 13% is attributable to
legal fees, 20% is attributable to professional fees (principally accounting
fees) and 67% is attributable to consulting fees. The increase results from the
following: trademarks for and licensing of new Baby Genius(TM) products, costs
associated with music production licenses, the MCG Investment Agreement, the
national spokesperson arrangements entered into in 1999, and consultants hired
for sales and marketing. In addition, we are incurring, and will continue to
incur, higher professional fees expected to be $150,000 annually because of our
obligation to become a reporting company under the Securities Exchange Act of
1934.
Interest expenses were $11,247 in 1999 as opposed to interest income of
$1,005 for the same period in 1998. The increase in interest expense related to
an accounts receivable line of credit and the amortization of the deferred costs
incurred in connection with the issuance of debentures.
Net losses, however, increased 13% ($121,333) to $1,090,056 in 1999 from
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$970,323, because of an extraordinary gain on the settlement of debt. In late
1998, the Home Shopping Network (HSN) returned a large order of product which
was defective. In 1999 the Company returned the product to the manufacturer and
received credit which was greater than the original cost of the product. This
excess has been recorded as an extraordinary item and was used to offset other
purchases from the same supplier. The Company continues to maintain good
relations with the supplier.
Development of the Baby Genius(TM) brand name and products has resulted in
high costs typically associated with a start-up business. We are currently
operating at a loss and we expect to continue do so over the short to medium
term.
RESULTS OF OPERATIONS -- 1998 COMPARED TO 1997
References in this section to results in 1998 and 1997 refer to our full
fiscal (calendar) year, and not to 9-month periods ending on September 30.
Net sales decreased 31% ($1,128,000) to $2,511,136 in 1998 from $3,639,468
in 1997. This sales decline was due principally to the decision by HSN to reduce
the volume of gemstone jewelry offered for sale, and the return of a large order
of defective product in late 1998.
Cost of sales was $2,479,032 (99% of sales) in 1998 and $3,343,693 (92%) of
sales in 1997. This increase in cost of sales as a percent of sales resulted
principally from the design costs of new jewelry products in 1998, and lower
gross profit margins on jade jewelry introduced in 1998.
Personnel costs increased 235% ($502,215) to $716,100 in 1998 from $213,885
in 1997. We hired additional personnel to develop and launch new product lines,
including Astrology Network products although we eventually abandoned The
Astrology Network business.
Advertising and sales costs increased 472% ($603,249) to $730,859 in 1998
from $127,610 in 1997. Most of this increase related to the cost of producing
and airing an Astrology Network infomercial.
General and administrative expenses increased 37% ($107,129) to $397,096 in
1998 from $289,967 in 1997, principally as a result of increased overhead and
costs associated with development of The Astrology Network.
Legal and professional fees increased 204% ($58,795) to $87,615 in 1998
from $28,820 in 1997, which was primarily for legal costs associated with
contracts and copyright activities of new product lines.
Interest expense increased 122% ($131,906) to $240,233 in 1998 from
$108,327 in 1997, which consisted of $200,000 arising from the beneficial
conversion feature relating to convertible debentures issued during the year and
a $68,000 increase in factoring costs.
Our net loss increased $1,666,965 to $2,140,599 in 1998 from $473,634 in
1997. The 1998 loss includes the value of options issued at below market
value to employees and non-employees of $51,500 and $258,000, respectively,
the $200,000 beneficial conversion feature described above and $105,000 of
stock sold to employees at less than fair value.
As a result of this loss and the losses incurred in 1997, the Company
accrued a net operating loss carryforward as of December 31, 1998, of
$2,141,134 and $1,071,461 for federal and state income tax purposes
respectively. The federal and state net operating losses begin to expire in
2018 and 2003, respectively. Because the Company anticipates significant
expenditures with respect to implementing its business plan, including its
Internet e-commerce business, it is uncertain that the Company will be
sufficiently profitable, if at all, during the net operating loss carry
forward period to realize the deferred income tax asset.
RESULTS OF OPERATIONS -- 1997 COMPARED TO 1996
Net sales increased 16% ($512,576) to $3,639,468 in 1997 from $3,126,892 in
1996, which was due to expanded product lines in the jewelry business. Sales to
HSN were approximately 95% of total sales in both 1997 and 1996. Jewelry sales
amounted to 99% of total sales in each year. We did not increase prices in 1997,
and, therefore, the entire sales increase was due to an increase in the volume
of products sold.
Cost of sales were $3,343,693 (92% of sales) in 1997 and $2,716,692 (87% of
sales) in 1996, reflecting a $627,001 (23%) increase. This change occurred
because of the increase in sales and reduction of the gross profit margin to 8%
in 1997 from 13% in 1996. Increased cost of sales reflected increased costs in
the jewelry market in which we operate, in a period when wholesale and retail
prices were stagnant due to increased competition.
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Operating expenses increased 102% ($322,771) to $660,282 in 1997 from
$327,511 in 1996. Costs incurred in 1997 included $97,000 related to the
production costs of the infomercial for The Astrology Network and an outbound
telemarketing campaign for the American Value Network. There were no similar
costs in 1996.
Interest expenses increased 203% ($72,598) to $108,327 in 1997 from $35,729
in 1996. Higher interest expenses were incurred during 1997 because of
management's decision to factor (borrow against) the Company's accounts
receivable. Long term debt and interest payable totaling $418,813 was settled in
full through the issuance of common stock at the end of 1997.
LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of liquidity are sales of shares of the Company's
common stock, the factoring of our accounts receivable and our conditional
funding rights under our Investment Agreement with Minnesota Communications
Group (MCG). We hold no significant cash balances. In addition, we issue
shares in private placements at a discount to the then-current market price
as resales of privately placed shares are restricted under Rule 144 of the
Securities Exchange Act of 1934, as amended, which reduces their liquidity
and accordingly their value as compared to freely trading shares on the open
market. At September 30, 1999, $420,323 of proceeds from sales of securities
is subject to repayment. Under the Investment Agreement, subject to
satisfying all conditions to funding, we have the right to request a further
$400,000 from MCG. We project that operations will break even sometime in the
second quarter of 2000, although no assurance can be made that we will break
even at that time or at all. Such projections do not, however, take into
account the possible repayment of the $420,323 in proceeds relating to
certain shares that we may be obligated to repurchase, plus accrued interest
of $34,522 that we may be obligated to pay in connection with such
repurchases, as described above in the section under "Risk Factors" headed
"Costs of Repurchasing Certain Shares". We estimate that if our sources of
liquidity continue to be available, if we can raise funds to pay for any
necessary share repurchases, and assuming we continue to maintain our current
sales, we will be able to fund operations until we break even. If our sales
decline or we are unable to sell shares to fund operations and obligatory
share repurchases, or factor our invoices or if we are not funded by MCG for
whatever reason, we would reduce our overhead expenses until we obtained
alternative financing.
In the nine-month period ending September 30, 1999, net cash used in
operations was $1,790,057.
In addition to the net loss incurred during this period of $1,090,056,
other principle uses of cash included an increase in accounts receivable of
$343,864, an increase in deferred costs of $156,517, and a decrease in
accounts payables of $365,341. The increase in accounts receivable in 1999
reflects the high growth of the music business and the receivables that
accrued as a result of such growth. Deferred costs in 1999 consists of costs
associated with the Company's Baby Genius(TM) spokesperson and production
costs of the Company's music videos exclusive of the value of common stock
issued and to be issued to the spokesperson. Accounts payable decreased in
1999 reflecting payments of outstanding accounts in the jewelry business and
payments of new music accounts as the Company sought to establish good
relationships with its new suppliers and services providers for the music
business.
Net cash used in investing activities in the 1999 nine-month period was
$133,380, relating to the purchase of property and plant of $111,380 and license
agreements of $22,000 exclusive of common stock issued.
Net cash provided by financing activities in the 1999 nine-month period
totaled $1,911,367 from proceeds raised by the issuance of common stock.
For the fiscal year ending December 31, 1998, net cash used in operations
was $1,232,384. In addition to the net loss incurred during this period of
$473,634, principle uses of cash included an increase in accounts receivable of
$470,380, an increase in deposits of $36,138, and an increase in prepaid
memberships costs of $33,739. Accounts receivable increased as a result of sales
made late in 1998 collected in 1999. Deposits were made in connection with the
lease of the Company's new offices occupied in early 1999.
Net cash used in investing activities in 1998 was $30,359, relating to the
purchase of property and equipment.
Net cash provided by financing activities in 1998 was $1,175,685,
comprising $200,000 raised by the issuance of two convertible debentures and
$975,685 raised by the issuance of common stock, of which $121,500 is subject
to redemption by investors.
For the fiscal year ending December 31, 1997, net cash used in operations
was $386,255. In addition to the net loss incurred during this period, the
principal use of cash included an increase in inventories of $336,318,
reflecting the cost of products acquired in late 1997 and shipped in early 1998.
18
<PAGE>
No cash was used in investing activities in the 1997. Net cash
provided by financing activities in 1997 was $402,090 raised by the issuance
of common stock, of which $37,500 is subject to redemption by investors.
We need a significant capital investment to provide the funds needed for
us to grow. We are searching for financial and/or strategic business partners
willing to invest at least $5 million in the Company. The use of funds of any
such investment would be applied, among things, to recruit highly qualified
senior management, increase the number of retail outlets in which Baby
Genius(TM) and other products are sold, build up the Baby Genius(TM) brand
name, develop new products, launch a national and regional marketing,
advertising and public relations campaign, organize our back-office
operations, refine and develop our website, pay professional fees associated
with being a reporting company under the Securities Exchange Act of 1934, to
repurchase any shares subject to redemption which may be tendered to the
Company, and cover such other expenditures that the Board of Directors may
deem to be in the best interests of the Company.
There can be no assurance, however, that we will be able to secure
short-term financing or a capital investment, and that even if we do, there is
no assurance that our business plan can be implemented, or if implemented, that
it will be successful. The continued growth of the Company is conditional on
obtaining financing on a timely basis.
DESCRIPTION OF PROPERTY
In September 1998, we entered into a sublease agreement for a 3,928 square
foot facility located in San Diego, California, which we use as our principal
executive offices. The sublease has a five year term which commenced in December
1998. Our monthly rent for this space is as follows:
<TABLE>
<CAPTION>
MONTH OF TERM AMOUNT
- ------------- ---------
<S> <C>
1-12............................................ $9,034.40
13-24........................................... $9,230.80
25-36........................................... $9,427.20
37-48........................................... $9,623.60
49-60........................................... $9,820.00
</TABLE>
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of January 12, 2000, certain
information with respect to our equity securities owned of record or
beneficially by (i) our sole directors, (ii) each person who owns
beneficially more than 5% of our common stock; and (iii) all of our executive
officers and sole director as a group.
<TABLE>
<CAPTION>
NAME AND ADDRESS AMOUNT AND NATURE PERCENT OF
OF BENEFICIAL OWNER OF BENEFICIAL OWNER COMMON STOCK(1)
- ------------------- ------------------- ---------------
<S> <C> <C>
Gerald R. Edick.................................... 2,351,104 21.26%(2)(7)
1888 Viking Way
La Jolla, CA 92037
Klaus Moeller...................................... 1,590,000 14.38%(3)(4)(5)(7)
1014 Doheny
</TABLE>
19
<PAGE>
<TABLE>
<S> <C> <C>
Los Angeles, CA 90069
Michael Meader..................................... 1,100,000 9.95%(6)(7)
14955 Rancho Santa Fe Farms Road
Rancho Santa Fe, CA 92067-6341
All officers and sole director as a group (3
persons)......................................... 2,845,700 24.74%(8)
Isabel Moeller..................................... 1,151,021 11.17%
P.O. Box 1289
P. 8400 Praia do Carvoiero
Algarve, Portugal
Minnesota Communications Group..................... 1,239,626 11.37%(9)(10)
45 East Seventh Street
Saint Paul, Minnesota 55101
</TABLE>
- ---------------
(1) Percentages are based on a total of 10,306,628 shares outstanding as of
December 9, 1999 plus the number of shares that the beneficial owner or
group may acquire by exercising options or rights that are currenlty
exercisable or exercisable within the next 60 days.
(2) Includes 761,104 shares held by Gulfstream Capital Holding, Ltd., which are
owned beneficially by Mr. Edick.
(3) Includes 360,000 shares held by Shelly Moeller (as her sole property), who
is the wife of Klaus Moeller. Mr. Moeller disclaims all beneficial
ownership of such shares, including all voting, transfer and investment
powers relating thereto.
(4) Includes 150,000 shares held by Dorian Lowell as custodian for Tia Moeller,
who is the daughter of Klaus Moeller. Mr. Moeller disclaims all beneficial
ownership of such shares, including all voting, transfer and investment
powers relating thereto.
(5) Includes 150,000 shares held by Dorian Lowell as custodian for Hayden
Moeller, who is the son of Klaus Moeller. Mr. Moeller disclaims all
beneficial ownership of such shares, including all voting, transfer and
investment powers relating thereto.
(6) Includes 100,000 shares held by Suzanne Meader, who is the wife of Michael
Meader.
(7) Includes options to purchase 750,000 common shares as they are currently
exercisable or are exercisable within 60 days.
(8) Includes options that are currently exercisable or exercisable within
the next 60 days by Messrs. Moeller, Meader and Lowell to acquire
750,000, 750,000 and 300,000 shares, respectively.
(9) Includes 32,126 shares held by MCG's subsidiary MPR, which are owned
beneficially by MCG.
(10) Includes 600,000 shares which may be purchased by MCG within the next 60
days pursuant to our Investment Agreement with MCG.
MANAGEMENT
DIRECTOR, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
The following table sets forth the names and ages of our current sole
director, Klaus Moeller, and executive officers, the position held by
each person and the date such person became a director or executive
officer. The executive officers are selected annually by the Board of
Directors. Under our Bylaws, directors serve one year terms until their
successors are elected. There is currently a vacancy on the Board of
Directors, following the resignation of Gerald Edick. The executive
officers serve until death, resignation or removal by the Board of
Directors. There are no family relationships between our sole director
and executive officers. The shareholders agreement between Mr. Edick,
Mr. Meader, Mr. Moeller and Minnesota Communications Group ("MCG")
provides that MCG has the right to designate one
20
<PAGE>
person which Mr. Edick, Mr. Meader and Mr. Moeller will nominate and vote to
become a member of our Board of Directors. MCG has not exercised this right.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Klaus Moeller........................ 39 Chairman of the Board and Chief
Executive Officer
Dorian Lowell........................ 40 President
Michael Meader....................... 34 Executive Vice President
</TABLE>
Klaus Moeller has served as our Chief Executive Officer and as a
director of the Company since we acquired ITM in October 1997. Prior to the
acquisition, Mr. Moeller had been the Chairman and Chief Executive Officer of
ITM since its inception in 1992. Mr. Moeller has a background in marketing,
advertising, real estate and auditing.
Dorian Lowell was appointed President in October 1999. He previously had
served as our Chief Operating Officer since August 1999. Mr. Lowell is a
corporate attorney specializing in corporate finance, mergers and
acquisitions, bankruptcy law and project finance. Before joining the Company,
he served as a consultant to various businesses. From 1997 to 1999, he was
General Counsel for Caithness Corporation, a private investment firm located
in New York City. Before joining Caithness Corporation, Mr. Lowell practiced
law in New York City for seven years with the international Wall Street law
firm Cleary, Gottlieb, Steen & Hamilton. Mr. Lowell is a member of the New
York Bar, and holds law degrees from Oxford University and Harvard Law School.
Michael Meader was appointed our Executive Vice President in April of
1998. Mr. Meader worked as an outside consultant to the Company for a number
of years prior to him joining the Company. He has played, and will continue
to play, an essential role in the development of the Company's Music
Division. His expertise encompasses distribution, category management and
service for programs designed for mass-market retailers. From 1994 to 1998,
Mr. Meader served as Vice President of Specialty Products at ARAMARK
Corporation. While at ARAMARK, he controlled all corporate operations related
to ARAMARK's Music Division.
EXECUTIVE COMPENSATION -- REMUNERATION OF DIRECTORS AND OFFICERS
The following table sets forth compensation information for services
rendered to the Company by certain executive officers in all capacities
during each of the prior three fiscal years. Other than as set forth below,
no executive officer's salary and bonus exceeded $100,000 in any of the
applicable years. The following information includes the dollar value of base
salaries, bonus awards, the number of stock options granted and certain other
compensation, if any, whether paid or deferred.
<TABLE>
<CAPTION>
OTHER ANNUAL STOCK LTIP ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION AWARDS OPTIONS PAYOUTS COMPENSATION
- --------------------------- ---- ------- ----- ------------ ------ ------- ------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Gerald Edick............. 1998 102,000 0 0 0 0 0 0
1997 66,000 0 0 0 750,000(1) 0 0
1996 30,000 0 0 0 0 0 0
Klaus Moeller............ 1998 102,000 0 0 0 0 0 0
1997 66,000 0 0 0 750,000(1) 0 0
1996 30,000 0 0 0 0 0 0
Michael Meader........... 1998 102,000 0 0 0 0 0 0
1997 0 0 0 0 750,000(1) 0 0
</TABLE>
- ---------------
21
<PAGE>
(1) Represents options to purchase shares of our common stock at an exercise
price of $1.25 per share which vested on January 1, 1999.
EMPLOYMENT AGREEMENTS
We have entered into the following employment agreements:
Klaus Moeller. We entered into a three year employment agreement with
Mr. Moeller dated June 1, 1999 to serve as our Chief Executive Officer. The
employment agreement provides for annual base compensation in the amount of
$150,000 and a car allowance, as well as customary health insurance benefits.
Dorian Lowell. We entered into a three year employment agreement with
Mr. Lowell dated August 23, 1999 to serve as our President. The employment
agreement provides for annual base compensation in the amount of $150,000 and
a housing and car allowance, as well as customary health insurance benefits.
Michael Meader. We entered into a three year employment agreement with
Mr. Meader dated June 1, 1999 to serve as our Executive Vice President. The
employment agreement provides for annual base compensation in the amount of
$150,000 and a car allowance, as well as customary health insurance benefits.
Larry Balaban. We entered into a three year employment agreement with
Mr. Balaban dated January 1, 1999 to serve as one of our Senior Vice
Presidents. The employment agreement provides for annual base compensation in
the amount of $110,000, as well as customary health insurance benefits.
Howard Balaban. We entered into a three year employment agreement with
Mr. Balaban dated January 1, 1999 to serve as one of our Senior Vice
Presidents. The employment agreement provides for annual base compensation in
the amount of $110,000 plus certain commissions for sale of our products, as
well as customary health insurance benefits.
Vinko Kovac. We entered into a three year employment agreement with Mr.
Kovac dated January 1, 1999 to serve as one of our Vice Presidents. The
employment agreement provides for annual base compensation in the amount of
$45,000, as well as customary health insurance benefits.
Each of the six individuals listed above have also entered into a Change
of Control Executive Employment Agreement. Each Change of Control Executive
Employment Agreement provides that in the event such individual is terminated
after a change in control of the Company which occurs on or before December
31, 2001, and such termination was other than because of his death or
disability or cause, or such individual terminates his employment for good
reasons, such individual will receive his full salary through the date of his
termination, along with a lump sum payment equal to ten times the highest
annual compensation (including base salary, incentive compensation and all
monetary bonuses or similar awards) paid or payable by us to him for any of
the three fiscal years preceding his termination. In addition, the Change of
Control Executive Employment Agreement provides that upon termination, any
unvested or partially vested options held by such individual will fully vest.
DIRECTOR COMPENSATION
Our sole director does not receive compensation for his services as
director.
NON-QUALIFIED STOCK OPTION PLAN
Our Board of Directors adopted a Non-Qualified Stock Option Plan (the
"Stock Option Plan") on December 9, 1997. The Stock Option Plan authorizes us
to grant non-qualified stock options to purchase shares of our common stock
to any person who performs services of special importance to the Company. As
of September 30, 1999, 5,000,000 shares of common stock were reserved for
issuance under the Stock Option Plan, of which 4,370,000 shares were subject
to outstanding options and 630,000 shares remained available for future
grants. A committee of two members (the "Committee") appointed by our Board
of Directors administers the Stock Option Plan. The Committee or the Board of
Directors may select the recipients to whom options are granted and
determines the number of shares to be awarded. Options granted under the
Stock Option Plan are
22
<PAGE>
exercisable at a price determined by the Committee, but in no event will the
option price be lower than the fair market value for our common stock on the
date of the grant. Options become exercisable at such times and in such
installments as the Committee provides in the terms of each individual option
agreement. In general, the Committee is given broad discretion to issue
options.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In January 1999, we entered into a ten year License Agreement with
Minnesota Communications Group ("MCG"), the beneficial owner of approximately
8.82% of our common stock. The License Agreement allows us to use certain
trademarks owned by MCG in connection with our promotion, marketing, sale and
distribution of CDs and cassettes. We paid MCG 7,500 shares of our common
stock for the first 500,000 CDs and cassettes we sold under the License
Agreement, and we pay MCG a royalty of $0.024 per each additional CD and
cassette sold.
Also in January 1999, we entered into a ten year License Agreement with
Minnesota Public Radio ("MPR"), a subsidiary of MCG. The License Agreement
allows us to use certain trademarks owned by MPR in connection with our
promotion, marketing, sale and distribution of CDs. We paid MPR 17,500 shares
of our common stock for the first 500,000 CDs and cassettes we sold under the
License Agreement, and we pay MPR a royalty of $0.056 per each additional CD
and cassette sold.
In March 1999, we entered into an Investment Agreement with MCG which
grants MCG the right to purchase up to 1,500,000 shares of our common stock
at a purchase price of $1.00 per share. This agreement is effective until
March 31, 2001. Pursuant to this agreement, MCG purchased 200,000 shares in
March 1999 and 400,000 shares in April 1999.
In March 1999, MCG entered into a Shareholders Agreement with Gerald
Edick, Michael Meader and Klaus Moeller . The Shareholders Agreement provides
that Messrs. Edick, Meader and Moeller will take such actions as reasonably
requested by MCG to ensure the presence on our Board of Directors of one
person designated by MCG. In addition, except in certain circumstances, Mr.
Edick, Mr. Meader and Mr. Moeller may not transfer their shares of our common
stock without MCG's consent, nor may they sell their shares without extending
MCG the right to participate proportionately in the sale.
In September 1999, Gerald Edick, a co-founder of ITM, left the Company and
resigned as President and as a member of the Company's Board of Directors. In
consideration of his services we entered into a letter agreement with Mr. Edick
under which we will pay him a severance of $200,000 in equal installments over
one year, and continue his medical benefits until September 30, 2000, unless he
independently secures medical benefits before that date. Mr. Edick also retains
all of his options to purchase 750,000 shares of our common stock which were
granted to him on December 7, 1997 and which fully vested on January 1, 1999.
In November 1999 we entered into a Sales, Marketing and Distribution
Agreement with Storemount Enterprises, Ltd. which grants exclusive rights to
Storemount to distribute Genius products in the United Kingdom and non-exclusive
rights to distribute products in all other areas other than North and South
America. Under the Agreement, we are will reimburse Storemount for initial
start-up costs not to exceed a fixed amount. We have the right to terminate the
exclusive UK distribution arrangement on 60 days notice in our sole discretion,
and the non-exclusive arrangement without prior notice.
In December 1999 we entered into a Services Agreement with Cost Care,
Inc., doing business as UNICARE Managed Care Services, which is a member of
the WellPoint Health Networks, Inc. group. Under the Agreement, UNICARE will
provide Baby Genius(TM)
23
<PAGE>
members access to a 24-hour medical help line, known as MedCall, and to an
on-line medical and health information service known as the Healthwise
Knowledgebase. The services are scheduled to start on January 1, 2000. The
Company pays for the MedCall services on a fee per member per month basis
that increases as the volume of calls increase. The MedCall fees are limited
for the first year of the Agreement. The Healthwise Knowledgebase services
are provided for a fixed fee per member per month. The Agreement can be
terminated by either party on 30-days prior written notice.
In December 1999 we entered into a Financial Public Relations Letter of
Agreement with Porter, LeVay & Rose, an investor/public relations firm based
in New York City. Under the Agreement, the Company will pay Porter, LeVay &
Rose on a monthly basis for 12 months, plus out-of-pocket expenses. The
monthly rates start at $5,500 for December and January 2000, $6,500 for
February and March, $9,000 for April and May and $7,000 from June through
November. While the Agreement is intended to continue for 12 months and be
renewed for a further 12 months, it can be terminated by either party upon 30
days written notice.
In December 1999 we entered into a License Agreement with Boomerang
Marketing, Inc. (BMI), to market and sell a retrievable fishing lure. Under
the Agreement BMI has licensed us the patent and trade mark rights to the
product for ten years in consideration of royalties fixed in dollars based on
the number of units are sold. Sales of units in Australia and Japan earn
double the royalty rate. We are obligated to pay non-refundable minimum
monthly and annual royalties payments. We have to pay a BMI a $40,000 advance
royalty before March 1, 2000. The minimum royalty is credited against normal
royalties and the advance royalty is credited against the minimum and normal
royalties. It is intended that we utilize the services of the inventor of the
product, and pay him an hourly rate plus health benefits. We have the right
to terminate the Agreement on 30 days prior written notice or immediately if
we determine in our sole discretion that a TV infomercial test is
unsuccessful.
LEGAL PROCEEDINGS
On September 23, 1999, the Securities Administrator of the State of
Washington filed a Summary Order to Cease and Desist with the State of
Washington Department of Financial Institutions Securities Division against
the Company, the Martin Consulting Group, Martin H. Engelman, their employees
and agents. The relief sought is that the respondents cease and desist from
violations of RCW 21.20.140, 21.20.040, and 21.20.010 of the Securities Act
of Washington. The Summary Order alleges, among other things, that Engelman
and the Company offered to sell shares of the Company that were not
registered in the state or otherwise qualified for an exemption from
registration. Engelman was hired by us to represent the Company at the Third
Annual Seattle Money Show and provide information to interested parties about
the Company and its products. We are in discussions with the Securities
Administrator regarding entering into an administrative order and although no
terms of an order have yet been proposed by the Securities Administrator, the
purpose of entering an order would be to resolve all claims based on the
allegations set forth in the Summary Order to Cease and Desist. Until we
receive a draft order from the Securities Administrator, we are unable to
determine the effects or consequences of such an order. If we and our counsel
determine that the terms of a proposed order are not acceptable, we would
likely contest the Summary Order at a hearing. The costs of a hearing and the
uncertainty of the outcome leads us to believe, however, that entering into
an administrative order on acceptable terms is in the best interests of the
Company. We do not believe that entering into an administrative order will
affect the Company's business or its ability to raise capital except possibly
in the State of Washington and those states where having an outstanding
administrative order may result in the loss of certain available exemptions
from registration of securities.
All sales of the Company's shares in the State of Washington were made
pursuant to Section 4(2) of the Securities Act of 1933, as amended.
We are not a party to any other legal or administrative proceedings.
24
<PAGE>
PART II
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
After our acquisition of International Trade & Manufacturing Corporation,
25
<PAGE>
our common stock traded on the OTC Bulletin Board under the trading symbol ITMH.
On November 9, 1999, following our name change to Genius Products, Inc., our
stock symbol changed to GNUS. The market represented by the OTC Bulletin Board
is extremely limited and the price for our common stock quoted on the OTC
Bulletin Board is not necessarily a reliable indication of the value of our
common stock. The following table sets forth the high and low bid prices for
shares of our common stock for the periods noted, as reported on the OTC
Bulletin Board. Quotations reflect inter-dealer prices, without retail mark-up,
mark-down or commission and may not represent actual transactions.
<TABLE>
<CAPTION>
YEAR PERIOD HIGH LOW
- ---- --------------- ----- -----
<S> <C> <C> <C>
Fiscal Year 1997........................... Fourth Quarter 4.000 2.000
Fiscal Year 1998........................... First Quarter 5.500 2.000
Second Quarter 5.125 1.812
Third Quarter 5.375 2.562
Fourth Quarter 3.375 1.312
Fiscal Year 1999........................... First Quarter 4.500 1.500
Second Quarter 4.375 2.000
Third Quarter 6.250 1.750
</TABLE>
Our common stock is subject to Rule 15g-1 through 15g-9 under the
Securities Exchange Act of 1934, as amended, which imposes certain sales
practice requirements on broker-dealers which sell our common stock to
persons other than established customers and "accredited investors"
(generally, individuals with net worths in excess of $1,000,000 or annual
incomes exceeding $200,000 (or $300,000 together with their spouses)). For
transactions covered by this rule, a broker-dealer must make a special
suitability determination for the purchaser and have received the purchaser's
written consent to the transaction prior to the sale.
As of December 9, 1999, we had approximately 10,306,628 shares of common
stock issued and outstanding which were held by 880 shareholders of record
including the holders that have their shares held in a depository trust in
"street" name. The transfer agent for our common stock is Interwest Transfer
Company, 1981 East 4800 South, Salt Lake City, Utah 84117.
DIVIDEND POLICY
We have never declared or paid cash dividends on our common stock. We
currently anticipate that we will retain all future earnings for use in the
operation and expansion of our business, and we do not anticipate paying any
26
<PAGE>
cash dividends in the foreseeable future.
RECENT SALES OF UNREGISTERED SECURITIES
1997: FORMATION, ACQUISITION AND INITIAL ISSUANCE OF COMMON STOCK
In the third quarter of 1997, prior to our acquisition of International
Trade & Manufacturing Corporation ("ITM"), ITM sold 423,000 shares of its
common stock in a private placement pursuant to Rule 504 of Regulation D
("Rule 504") under the Securities Act of 1933 (the "Act") at a price of $1.00
per share. ITM received net proceeds of $ 409,845 from this transaction.
In September 1997, we acquired ITM. At that time, we had 516,250 shares
issued and outstanding and we acquired 100% of ITM's issued and outstanding
shares of common stock, consisting of 4,700,000 shares originally issued and
outstanding, plus the 423,000 shares issued by ITM in the third quarter of
1997, for a total of 5,123,000 shares. In October we issued 600,000 shares of
our common stock, valued at $1.00 per share, to WMA & Associates ("WMA"),
pursuant to Section 4(2) of the Act, for services related to the ITM private
placement and our acquisition of ITM.
In the fourth quarter of 1997, pursuant to Section 4(2) of the Act, we
issued 468,813 shares of our common stock, at a price of $1.00 per share, in
satisfaction of an obligation owed by us by a financing company in the amount
of $468,813, including accrued interest.
1998: ISSUANCE OF COMMON STOCK
During the first quarter of 1998, we sold 955,000 shares of our common
Stock, at a price of $1.05 per share, in a private placement pursuant to
Section 3(b) of the Act and Rule 504. After payment of $96,957 to WMA for
services related to this private placement, we received net proceeds of
$902,928.
Also in 1998, we sold shares of our common stock pursuant to Sections
4(2) and 4(6) of the Act at the following times and in the following amounts:
- In the second quarter of 1998, we issued 75,000 shares of our common
stock, and granted options to purchase 150,000 shares of our common
stock at an exercise price of $3.40 per share, to two accredited
investors, pursuant to an International Marketing and Distribution
Agreement between the Company and HSN Direct International Limited.
- In the fourth quarter of 1998, we sold 96,000 shares of our common
stock at a price of $1.50 per share in a private placement to
fourteen accredited investors. After payment of $21,600 and $10,000
to G. Barton and G. Logan, respectively, for services related to
this private placement, and other offering expenses of $29,643, we
received net proceeds of approximately $107,000.
- In the fourth quarter of 1998, we sold convertible debentures to two
accredited investors. The debentures are convertible into 400,000
shares of our common stock at a price of $0.50 per share. We received
net proceeds of $180,000 from this transaction.
27
<PAGE>
- In December 1998, we sold 475,000 shares of our common stock to
three individuals at a price of $0.40 per share. We received net
proceeds of $190,000 from this transaction.
1999: ISSUANCE OF COMMON STOCK
Between January and June 1999, we sold 453,150 shares of our common
stock at a price of $1.25 per share for gross proceeds of $566,437.50, less
offering costs of $90,647.50, for net proceeds of $475,790, pursuant to
Section 4(2) of the Act.
In March 1999, pursuant to Section 4(2) of the Act, we issued 17,500
shares of our common stock to Minnesota Public Radio ("MPR") and 7,500 shares
to Minnesota Communications Group ("MCG"), pursuant to two trademark
licensing agreements between the Company and each of MPR and MCG. The shares
were valued at $1.00 per share.
In February 1999, pursuant to Section 4(2) of the Act, we issued 80,000
shares of our common stock to Deidre Hall, our national spokesperson for Baby
Genius(TM) pursuant to an agreement between Ms. Hall and the Company at a
value of $1.00 per share.
In March and April 1999, pursuant to Section 4(2) of the Act, we sold
200,000 and 400,000 shares, respectively, of our common stock to MCG pursuant
to an investment agreement between MCG and the Company at a price of $1.00
per share. We received net proceeds of $600,000 from these sales.
In June 1999, pursuant to Section 4(2) of the Act we:
- Sold 40,000 shares of our common stock at a price of $1.00 per share
for net proceeds of $40,000 to three consultants to the Company;
- Issued 19,250 shares of our common stock at a price of $1.00 per share
to consultants to the Company for professional services rendered; and
- Issued 16,250 shares of our common stock at a price of $1.00 per share
to two employees as partial compensation for services rendered.
In July and August, 1999 we sold 478,780 shares to shares of common stock
to accredited investors at a price of $1.45 per share, for gross proceeds of
$694,231, less offering costs of $121,977, for net proceeds of $572,254,
pursuant to Section 4(2) of the Act.
During the same period, pursuant to Section 4(2) of the Act we:
- Sold 90,000 shares of our common stock at a price of $1.00 per share
for net proceeds of $90,000 to two accredited investors;
- Issued 22,000 shares of our common stock at a price of $1.00 per
share to consultants to the Company for professional services
rendered; and
- Issued 14,626 shares of our common stock to MPR in satisfaction of
a royalty due under the MPR Agreement at a price of $1.16 per share.
The value of the royalty was $16,966.
DESCRIPTION OF SECURITIES
COMMON STOCK
Our authorized capital stock consists of 25,000,000 shares of $0.001 par
28
<PAGE>
value common stock, of which 10,306,628 shares were issued and outstanding as
of December 9, 1999, The Company has reserved 5,000,000 shares of common
stock for issuance pursuant to outstanding options, warrants, rights and
convertible debentures, out of which 4,870,000 are subject to outstanding
options, warrants, rights, and convertible debentures. Each issued and
outstanding share is fully paid and non-assessable. No pre-emptive rights
exist with respect to any of our common stock. Holders of shares of our
common stock are entitled to one vote for each share on all matters to be
voted on by the stockholders. Holders of shares of our common stock have no
cumulative voting rights. Holders of shares of our common stock are entitled
to share ratably in dividends, if any, as may be declared, from time to time
by our Board of Directors in its discretion, from funds legally available
therefor. In the event of a liquidation, dissolution or winding up of the
Company, the holders of shares of our common stock are entitled to their pro
rata share of all assets remaining after payment in full of all liabilities.
INDEMNIFICATION OF DIRECTORS AND OFFICERS
The Corporation Law of the State of Nevada and our Bylaws provide for
indemnification of our directors for liabilities and expenses that they may
incur in such capacities. In general, our directors and officers are
indemnified with respect to actions taken in good faith and in a manner such
person believed to be in our best interests, and with respect to any criminal
action or proceedings, actions that such person has no reasonable cause to
believe were unlawful. Furthermore, the personal liability of our directors
is limited as provided in our Articles of Incorporation.
We maintain directors and officers liability insurance with an aggregate
coverage limit of $3,000,000.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933, as amended, may be permitted to directors, officers or persons
controlling the Company pursuant to the foregoing provisions, we have been
informed that in the opinion of the Securities and Exchange Commission, such
indemnification is against public policy as expressed in the Act and is
therefore unenforceable.
29
<PAGE>
GENIUS PRODUCTS, INC.
(FORMERLY INTERNATIONAL TRADING & MANUFACTURING CORPORATION)
INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS
AS OF SEPTEMBER 30, 1999 AND 1998 AND
FOR THE TWO NINE-MONTH PERIODS ENDED SEPTEMBER 30, 1999 AND 1998
(UNAUDITED)
Consolidated Financial Statements of Genius Products, Inc.
(formerly International Trading & Manufacturing
Corporation):
Consolidated Balance Sheet, September 30, 1999
(Unaudited)............................................ F-3
Consolidated Statements of Operations for the Two
Nine-Month Periods and Two Three-Month Periods Ended
September 30, 1999 and 1998 (Unaudited)................ F-4
Consolidated Statements of Shareholders' Equity for the
Period Ended September 30, 1999 (Unaudited)............ F-5
Consolidated Statements of Cash Flows for the Two
Nine-Month Periods Ended September 30, 1999 and 1998
(Unaudited)............................................ F-6
Notes to Consolidated Financial Statements.................. F-7
AS OF DECEMBER 31, 1998 AND 1997 AND
FOR EACH OF THE TWO YEARS IN THE PERIOD THEN ENDED
F-1
<PAGE>
<TABLE>
<S> <C>
Report of Independent Auditors.............................. F-10
Consolidated Financial Statements of Genius Products, Inc.
(formerly International Trading & Manufacturing Corporation):
Consolidated Balance Sheets, December 31, 1998 and 1997... F-11
Consolidated Statements of Operations for the Years Ended
December 31, 1998 and 1997............................. F-12
Consolidated Statements of Shareholders' Equity for the
Years Ended December 31, 1998 and 1997................. F-13
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1998 and 1997............................. F-14
Notes to Consolidated Financial Statements.................. F-15
</TABLE>
F-2
<PAGE>
GENIUS PRODUCTS, INC.
(FORMERLY INTERNATIONAL TRADING & MANUFACTURING CORPORATION)
CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 1999
(UNAUDITED)
ASSETS
<TABLE>
<S> <C>
Current assets:
Cash and equivalents........................................ $ 104,087
Restricted cash........................................... --
Trade accounts receivable, net............................ 671,819
Due from officers......................................... 8,000
Inventory................................................. 138,400
Prepaid expenses.......................................... 10,741
Other assets.............................................. 6,357
----------
Total current assets.............................. 939,404
Property and equipment, net................................. 129,579
Deferred costs.............................................. 150,107
Deposits.................................................... 36,138
Intangible asset............................................ 37,000
Other asset................................................. 10,165
----------
TOTAL ASSETS................................................ $1,302,393
==========
</TABLE>
LIABILITIES AND SHAREHOLDERS' EQUITY
F-3
<PAGE>
<TABLE>
<S> <C>
Current liabilities:
Accounts payable.......................................... $ 144,842
Accrued expenses.......................................... 47,425
Debentures payable........................................ 200,000
Accrued stock............................................. 36,667
----------
TOTAL LIABILITIES........................................... 428,934
----------
Redeemable Common Stock..................................... 420,323
Commitments and contingencies
Shareholders' equity:
Common stock; $0.001 par value; 25,000,000 shares
authorized, 10,148,199 shares issued and outstanding at
September 30, 1999..................................... 10,148
Additional paid-in capital................................ 4,393,757
Accumulated deficit....................................... (3,950,769)
----------
TOTAL SHAREHOLDERS' EQUITY.................................. 453,136
==========
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.................. $1,302,393
==========
</TABLE>
The accompanying notes are an integral part of the financial statements.
GENIUS PRODUCTS, INC.
(FORMERLY INTERNATIONAL TRADING & MANUFACTURING CORPORATION)
CONSOLIDATED STATEMENTS OF OPERATIONS
AS OF SEPTEMBER 30, 1999 AND
FOR THE TWO NINE-MONTH AND TWO THREE-MONTH PERIODS
ENDED SEPTEMBER 30, 1999 AND 1998
(UNAUDITED)
<TABLE>
<CAPTION>
THREE THREE
NINE MONTHS NINE MONTHS MONTHS MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net sales.................................... $1,590,787 $2,224,886 $ 747,462 $ 634,291
Cost of sales................................ 822,223 2,127,645 262,494 595,230
----------- ---------- --------- ---------
Gross profit............................... 768,564 97,241 484,968 39,061
----------- ---------- --------- ---------
Personnel costs.............................. 614,837 534,587 97,878 252,294
General and administrative costs............. 357,490 339,402 47,146 132,918
Advertising expense.......................... 605,835 140,529 396,642 93,891
Legal and professional fees.................. 398,779 51,651 342,084 34,684
----------- ---------- --------- ---------
1,976,941 1,066,169 883,750 513,787
----------- ---------- --------- ---------
Income (loss) from operations.............. (1,208,377) (968,928) (398,782) (474,726)
Interest income (expense).................... (11,247) 1,005 (2,625) 580
----------- ---------- --------- ---------
Loss before provision for income taxes and
extraordinary item......................... (1,219,624) (967,923) (401,407) (474,146)
Provision for income taxes................... (340) (800) (340) --
Extraordinary gain on settlement of debt..... 129,908 -- -- --
----------- ---------- --------- ---------
NET LOSS..................................... $(1,090,056) $ (968,723) $(401,747) $(474,146)
</TABLE>
F-4
<PAGE>
<TABLE>
<S> <C> <C> <C> <C>
========== ========== ========= =========
NET LOSS PER SHARE, BASIC AND DILUTED........ $ (0.12) $ (0.13) $ (0.04) $ (0.06)
========== ========== ========= =========
</TABLE>
The accompanying notes are an integral part of the financial statements.
GENIUS PRODUCTS, INC.
(FORMERLY INTERNATIONAL TRADING & MANUFACTURING CORPORATION)
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
AS OF SEPTEMBER 30, 1999 AND 1998 AND
FOR THE TWO NINE-MONTH PERIODS
ENDED SEPTEMBER 30, 1999 AND 1998
(UNAUDITED)
<TABLE>
<CAPTION>
(FORMERLY INTERNATIONAL TRADING &
MANUFACTURING CORPORATION
[FORMERLY SALUTATIONS, INC.])
---------------------------------------------------------------
COMMON COMMON PAID-IN ACCUMULATED SHAREHOLDERS'
SHARES STOCK CAPITAL DEFICIT EQUITY
---------- ------- ---------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1998............ 8,309,063 $ 8,309 $2,699,409 $(2,860,713) $ (152,915)
Shares issued pursuant to investment
agreement............................. 600,000 600 599,400 -- 600,000
Shares issued in private placements,
net of offering costs............ 1,061,930 1,062 1,176,982 -- 1,178,044
Less proceeds from sale of
shares subject to redemption..... (261,323) (261,323)
Shares issued for services.......... 152,126 152 154,314 -- 154,466
Shares issued for licensing
agreements....................... 25,000 25 24,975 -- 25,000
Net loss............................ -- -- -- (1,090,056) (1,090,056)
---------- ------- ---------- ----------- ----------
Balance, September 30, 1999........... 10,148,119 $10,148 $4,393,757 $(3,950,769) $ 453,136
========== ======= ========== =========== ==========
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-5
<PAGE>
GENIUS PRODUCTS, INC.
(FORMERLY INTERNATIONAL TRADING & MANUFACTURING CORPORATION)
CONSOLIDATED STATEMENTS OF CASH FLOWS
AS OF SEPTEMBER 30, 1999 AND 1998 AND
FOR THE TWO NINE-MONTH PERIODS
ENDED SEPTEMBER 30, 1999 AND 1998
(UNAUDITED)
<TABLE>
<CAPTION>
NINE-MONTHS NINE-MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net loss.................................................... $(1,090,056) $(968,723)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation.............................................. 10,829 6,241
Value of stock and options granted for services........... 102,876 --
Decrease (increase) in assets:
Accounts receivable....................................... (343,864) --
Inventories............................................... (1,504) 303,307
Prepaid expenses.......................................... 22,998 (31,414)
Other current assets...................................... 17,667 (21,307)
Due from officers......................................... -- (17,446)
Deferred costs............................................ (156,517) --
Deposits.................................................. -- --
Other assets.............................................. -- (10,000)
Increase (decrease) in liabilities:
</TABLE>
F-6
<PAGE>
<TABLE>
<S> <C> <C>
Accounts payable.......................................... (365,341) (112,328)
Accrued expenses.......................................... 14,511 71,546
----------- ---------
NET CASH USED IN OPERATING ACTIVITIES....................... 1,671,734 (780,124)
----------- ---------
Cash flows used in investing activities:
Purchases of property and equipment....................... (111,380) (13,681)
Purchase of intangible assets............................. (22,000) --
----------- ---------
NET CASH USED IN INVESTING ACTIVITIES....................... $ (133,380) (13,681)
----------- ---------
Cash flows provided by financing activities:
Proceeds from sale of common stock and redeemable
common stock.............................................. $ 1,778,044 $ 902,978
----------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES................... 1,778,044 902,978
----------- ---------
NET INCREASE IN CASH........................................ (27,070) 109,173
CASH AND EQUIVALENTS AT BEGINNING OF YEAR................... 131,157 8,348
----------- ---------
CASH AND EQUIVALENTS AT END OF YEAR......................... $ 104,087 $ 117,521
=========== =========
</TABLE>
Supplemental Disclosures of Cash Flow Information
<TABLE>
<CAPTION>
1999 1998
------- ----
<S> <C> <C>
Interest paid............................................... $39,398 --
Income taxes paid........................................... -- --
</TABLE>
The accompanying notes are an integral part of the financial statements.
GENIUS PRODUCTS, INC.
(FORMERLY INTERNATIONAL TRADING & MANUFACTURING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF SEPTEMBER 30, 1999 AND 1998 AND
FOR THE TWO NINE-MONTH PERIODS
ENDED SEPTEMBER 30, 1999 AND 1998
(UNAUDITED)
1. BASIS OF PRESENTATION
The consolidated financial statements have been prepared by the Company
without audit, pursuant to the rules and regulations of the Securities and
Exchange Commission. Certain information and footnote disclosure normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. The Company believes that the disclosures are adequate to make the
information presented not misleading when read in conjunction with the Company's
consolidated financial statements for the year ended December 31, 1998. The
financial information presented reflects all adjustments, which are, in the
opinion of management, necessary for a fair statement of the results for the
interim periods presented.
In the opinion of the Company, the accompanying unaudited financial
statements contain all adjustments, consisting of only normal recurring
adjustments, except as noted elsewhere in the notes to the financial statements,
necessary to present fairly its financial position as of September 30, 1999 and
F-7
<PAGE>
the results of its operations and cash flows for the nine-month periods in the
period ended September 30, 1999 and 1998.
2. NAME CHANGE
During 1999, International Trading & Manufacturing Corporation changed its
name to Genius Products, Inc. This change is a result of the Company's
introduction in 1999 of its Baby Genius line of music and video products. The
Company believes these products will represent the majority of its activities.
3. COMMITMENTS
During the nine months ended September 30, 1999, the Company entered into
employment agreements with six individuals (five of whom are officers) providing
for a combined annual base compensation aggregating $715,000. In addition, each
of these six individuals has entered into an employment agreement with the
Company which provides that in the event of a change in ownership control of the
Company on or before December 31, 2001, each individual will receive his full
salary through the date of his termination, along with a lump sum payment
equaling ten times the highest annual compensation paid for any of the three
fiscal years preceding his termination. In addition, any unvested or partially
vested options held by such individual will fully vest.
4. EXTRAORDINARY ITEM
In the first quarter of 1999, the Company settled amounts due to jewelry
suppliers for less than the amount due. These amounts related to sales made by
the Company in 1998 that were returned by the purchaser in 1998. The gain
realized by the Company upon satisfaction of this debt has been recorded as an
extraordinary item.
5. LOSS PER COMMON SHARE
The Company adopted Statements on Financial Accounting Standards No. 128,
Earnings Per Share. Loss per common share has been calculated in accordance with
this statement.
GENIUS PRODUCTS, INC.
(FORMERLY INTERNATIONAL TRADING & MANUFACTURING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
AS OF SEPTEMBER 30, 1999 AND 1998 AND
FOR THE TWO NINE-MONTH PERIODS
ENDED SEPTEMBER 30, 1999 AND 1998
(UNAUDITED)
The computations of basic and diluted loss per common share for the two
nine-month periods and the two three-month periods ended September 30, 1999 and
1998 are as follows:
<TABLE>
<CAPTION>
NINE-MONTH PERIODS
ENDED SEPTEMBER 30,
-------------------------
1999 1998
----------- ----------
<S> <C> <C>
Amounts available to common shareholders:
Loss before extraordinary item............................. $(1,044,964) $ (968,723)
Extraordinary item....................................... 129,908 --
----------- ----------
Net loss................................................. $ (915,056) $ (968,723)
=========== ==========
Weighted-average shares, basic and diluted................. 9,227,394 7,508,563
----------- ----------
Amounts per common share, basic and diluted:
</TABLE>
F-8
<PAGE>
<TABLE>
<S> <C> <C>
Loss before extraordinary item........................... $ (0.11) $ (0.13)
Extraordinary item....................................... 0.01 --
----------- ----------
Net loss................................................. $ (0.10) $ (0.13)
=========== ==========
</TABLE>
<TABLE>
<CAPTION>
THREE-MONTH PERIODS
ENDED SEPTEMBER 30,
------------------------
1999 1998
---------- ----------
<S> <C> <C>
Amounts available to common shareholders:
Net loss.................................................... $ (326,747) $ (474,146)
========== ==========
Weighted-average shares, basic and diluted.................. 9,969,750 7,414,396
---------- ----------
Loss per common share, basic and diluted.................... $ (0.03) $ (0.06)
========== ==========
</TABLE>
6. INVESTMENT AGREEMENT
In March 1999, the Company entered into an investment agreement with
Minnesota Communications Group ("MCG"), an affiliate of Minnesota Public Radio.
The investment agreement provides MCG the right to purchase up to 1.5 million
shares of the Company's common stock at a purchase price of $1.00 per share.
This agreement is effective until March 31, 2000. Pursuant to this agreement,
MCG purchased 600,000 shares of the Company's common stock in March and April
1999.
7. COMMON STOCK
During the period January 1, 1999 through August 31, 1999, the Company
sold, including the 600,000 shares of common stock sold to MCG described above,
1,661,930 shares of its common stock. The Company realized $1,778,044 from the
sale of these shares.
In addition, during this same period the Company issued 179,466 shares of
common stock for consulting and legal services and trademark license agreements.
8. DEFERRED CHARGES
Deferred charges at September 30, 1999 consist of the cost of an agreement
with the spokesperson for the Company's Baby Genius(TM) products, and the cost
of artwork and production costs of the Company's video products. Payments to the
spokesperson are amortized over the one year life of the agreement, and the
video production costs are amortized over their estimated useful life of three
years.
9. ACCRUED STOCK LIABILITY
The Company entered into an agreement with the spokesperson for the
Company's Baby Genius(TM) products. The agreement provides for the Company to
issue 200,000 shared of its common stock. Of these shares, 80,000 shares were
issued in March 1999, 60,000 shares were issued in November 1999 and a further
60,000 are to be issued in February 2000. As of September 30, 1999 the fair
market value of the shares to be issued is recorded as an accrued stock
liability.
10. SIGNIFICANT CUSTOMERS
Sales to significant customers during the nine-month periods ended
September 30, 1999 and 1998 follow.
<TABLE>
<CAPTION>
1999 1998
Customer Sales % Sales %
<S> <C> <C> <C> <C>
Home Shopping Network $ 732,787 46 $2,224,886 100
Rounder Kids 313,746 20
</TABLE>
11. REDEEMABLE COMMON STOCK
During 1997, 1998 and through September 30, 1999, the company sold
certain shares in private placement transactions which may be subject to
redemption. The total number of shares subject to redemption at September
30, 1999, was 307,550 and the consideration due if redemption is elected for
all such shares is $420,323 as of September 30, 1999.
F-9
<PAGE>
<TABLE>
<S> <C> <C> <C> <C>
Target 268,836 17
</TABLE>
No other customer accounted for ten percent or more of net sales.
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors
Genius Products, Inc. (formerly International Trading & Manufacturing)
We have audited the accompanying consolidated balance sheets of Genius
Products, Inc. (formerly International Trading & Manufacturing Corporation)
and its subsidiaries as of December 31, 1998 and 1997 (as restated-see Note
13), and the related consolidated statements of operations, shareholders'
equity (deficit) and cash flows for each of the two years in the period ended
December 31, 1998. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Genius Products, Inc. (formerly International Trading & Manufacturing
Corporation) as of December 31, 1998 and 1997 (as restated-see Note 13), and
the consolidated results of its operations and its cash flows for each of the
two years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles.
/s/ KELLY & COMPANY
Kelly & Company
Newport Beach, California
September 16, 1999, (except as to Note 13 "Restatement" to which the date is
January 14, 2000)
F-10
<PAGE>
GENIUS PRODUCTS, INC.
(FORMERLY INTERNATIONAL TRADING & MANUFACTURING CORPORATION)
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
(RESTATED)
ASSETS
<TABLE>
<CAPTION>
1998 1997
----------- ---------
<S> <C> <C>
Current assets:
Cash and equivalents........................................ $ 131,157 $ 18,395
Restricted cash........................................... -- 14,195
Trade accounts receivable, net............................ 327,955 1,500
Due from officers......................................... 8,000 --
Inventory................................................. 136,896 454,318
Prepaid membership fees................................... 33,739 --
Other..................................................... 24,024 4,075
----------- ---------
Total current assets.............................. 661,771 492,483
Property and equipment, net................................. 29,028 5,735
Deposits.................................................... 36,138 --
Intangible asset............................................ 12,000 --
Other asset................................................. 10,165 --
----------- ---------
TOTAL ASSETS................................................ $ 749,102 $ 498,218
=========== =========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable............................................ $ 510,183 $ 338,674
Convertible debentures payable............................ 200,000 --
Other..................................................... 32,914 --
----------- ---------
Total current liabilities......................... 743,097 338,674
----------- ---------
TOTAL LIABILITIES........................................... 743,097 338,674
----------- ---------
Redeemable common stock..................................... 159,000 37,500
Commitments and contingencies
Shareholders' equity:
Common stock; $0.001 par value; 25,000,000 shares authorized; 8,309,063 and
6,708,063 shares issued and outstanding at December 31, 1998 and 1997,
respectively .......................................... 8,309 6,708
Additional paid-in capital................................ 2,699,409 835,450
Accumulated deficit....................................... (2,860,713) (720,114)
----------- ---------
TOTAL SHAREHOLDERS' EQUITY.................................. (152,995) 122,044
----------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.................. $ 749,102 $ 498,218
=========== =========
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-11
<PAGE>
GENIUS PRODUCTS, INC.
(FORMERLY INTERNATIONAL TRADING & MANUFACTURING CORPORATION)
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(RESTATED)
<TABLE>
<CAPTION>
1998 1997
----------- ----------
<S> <C> <C>
Net sales................................................... $ 2,511,136 $3,639,468
Cost of sales............................................... 2,479,032 3,343,693
----------- ----------
Gross profit.............................................. 32,104 295,775
----------- ----------
Personnel costs............................................. 716,100 213,885
Infomercial expense......................................... 556,125 95,058
General and administrative costs............................ 397,096 289,967
Advertising expense......................................... 174,734 32,552
Legal and professional fees................................. 87,615 28,820
----------- ----------
1,931,670 660,282
Loss from operations...................................... (1,899,566) (364,507)
Interest expense............................................ (240,233) (108,327)
Loss before provision for income taxes...................... (2,139,799) (472,834)
Provision for income taxes.................................. (800) (800)
----------- ----------
NET LOSS.................................................... $(2,140,599) $ (473,634)
=========== ==========
NET LOSS PER SHARE, BASIC AND DILUTED....................... $ (0.29) $ (0.09)
=========== ==========
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-12
<PAGE>
GENIUS PRODUCTS, INC.
(FORMERLY INTERNATIONAL TRADING & MANUFACTURING CORPORATION)
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(RESTATED)
<TABLE>
<CAPTION>
Total
Common Common Paid-In Accumulated Shareholders'
Shares Stock Capital Deficit Equity
---------- ------- ------------ ----------- --------------
<S> <C> <C> <C> <C> <C>
Balance, December 31,
1996........................ 1,000 $1 $999 $(246,480) $(245,480)
Stock Split prior to
reorganization.......... 4,699,000 4,699 (4,699) -- --
Shares issued in private
placement offering, net
of offering costs....... 423,000 423 409,422 -- 409,845
Less proceeds from sale of
shares subject to
redemption.............. (37,500) (37,500)
Shares issued for services
in connection with the
business combination.... 600,000 600 (600) -- --
Shares issued in reverse
merger transaction...... 516,250 516 (516) -- --
Shares issued in payment
of debt and related
accrued interest........ 468,813 469 468,344 -- 468,813
</TABLE>
F-13
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
Net loss................ -- -- -- (473,634) (473,634)
---------- ------- ------------ ----------- --------------
Balance, December 31, 1997.. 6,708,063 $6,708 $835,450 $(720,114) $122,044
========== ======= ============ =========== ==============
Shares issued in private
placement, net of
offering costs.......... 955,000 955 901,973 -- 902,928
Shares issued in private
placement, net of
offering costs.......... 96,000 96 82,661 -- 82,757
Less proceeds from sale of
shares subject to
redemption.............. -- -- (121,500) -- (121,500)
Shares issued for
services................ 75,000 75 196,800 -- 196,875
Options to purchase common
stock granted to
employees as
incentives.............. -- -- 51,500 -- 51,500
Value of options to purchase
common stock granted to
non-employees for
services................ -- -- 258,000 -- 258,000
Value of beneficial
conversion feature of
convertible debt........ -- -- 200,000 -- 200,000
Shares issued in private
placement, net of
offering costs.......... 475,000 475 189,525 -- 190,000
Value of common stock sold
to employees at a
discount............... -- -- 105,000 -- 105,000
Net loss.................. -- -- -- (2,140,599) (2,035,599)
---------- ------- ------------ ----------- --------------
Balance, December 31, 1998.. 8,309,063 $8,309 $2,699,409 $(2,860,713) $(152,995)
========== ======= ============ =========== ==============
</TABLE>
The accompanying notes are an integral part of the financial statements.
GENIUS PRODUCTS, INC.
(FORMERLY INTERNATIONAL TRADING & MANUFACTURING CORPORATION)
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(RESTATED)
<TABLE>
<CAPTION>
1998 1997
----------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net loss.................................................... $(2,140,599) $(473,634)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation.............................................. 7,246 2,873
Sales returns............................................. 143,925 --
Accrued interest satisfied by the issuance of stock....... -- 43,559
Common stock issued for services.......................... 196,875 --
Stock options granted to employees........................ 51,500 --
Value of stock options granted to a non-employee for
services............................................... 258,000 --
Interest expense arising from beneficial conversion
feature on convertible notes payable................... 200,000 --
Value of common stock sold to employees at a discount..... 105,000 --
Decrease (increase) in assets:
Restricted cash........................................... 14,195 29,847
Accounts receivable....................................... (470,380) 64,785
Due from officers......................................... (8,000) --
Inventories............................................... 317,422 (336,318)
Prepaid membership costs.................................. (33,739) --
Other current assets...................................... (19,949) (3,250)
Deposits.................................................. (36,138) --
Intangible assets......................................... (12,000) --
Other assets.............................................. (10,165) 17,431
Increase in liabilities:
Accounts payable.......................................... 171,509 268,452
Other current liabilities................................. 32,914 --
----------- ---------
</TABLE>
F-14
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
NET CASH USED IN OPERATING ACTIVITIES....................... (1,232,384) (386,255)
----------- ---------
Cash flows used in investing activities:
Purchases of property and equipment....................... (30,539) --
----------- ---------
NET CASH USED IN INVESTING ACTIVITIES....................... (30,539) --
----------- ---------
Cash flows provided by financing activities:
Proceeds from issuance of convertible debentures payable
to others.............................................. 200,000 --
Proceeds from sale of common stock and redeemable
common stock........................................... 1,175,685 402,090
----------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES................... 1,375,685 402,090
----------- ---------
NET INCREASE IN CASH........................................ 112,762 15,835
CASH AND EQUIVALENTS IN BEGINNING OF YEAR................... 18,395 2,560
----------- ---------
CASH AND EQUIVALENTS AT END OF YEAR......................... $ 131,157 $ 18,395
=========== =========
Supplemental Disclosures of Cash Flow Information
Interest paid............................................... $ 39,398 $ 66,126
Income taxes paid........................................... -- $ 1,600
Supplemental Schedule of Non-Cash Investing and Financing
Activities
Satisfaction of debt through issuance of stock:
Liabilities satisfied..................................... -- $(468,813)
Shares issued............................................. -- $ 468,813
Issuance of stock pursuant to reorganization:
Reduction in paid-in capital.............................. -- $ (1,116)
Common stock issued....................................... -- $ 1,116
</TABLE>
The accompanying notes are an integral part of the financial statements.
GENIUS PRODUCTS, INC.
(FORMERLY INTERNATIONAL TRADING & MANUFACTURING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
1. NATURE OF OPERATIONS
The historical major line of business of Genius Products, Inc. (formerly
International Trading & Manufacturing Corporation) and its subsidiaries (the
"Company") has been the development and sale on a wholesale basis of fine and
costume jewelry. The Company's major customer is a television shopping
network that broadcasts in the United States. The Company designs its
products and uses independent foreign manufacturing facilities to produce
them to the Company's specifications.
During the year ended December 31, 1998, the Company developed and
trademarked the brand, Baby Genius(TM). The first products using this name
are a collection of music products produced by the Company under the name of
Baby Genius(TM) Classical Series featuring an assortment of classical,
instrumental, and relaxation music designed for expectant mothers, infants
and children. Sales of these products commenced in the first calendar quarter
of 1999.
The Company is currently developing its website to serve as an
e-commerce retail and information site with an intended focus on parents,
parents-to-be and children. The website is anticipated to be fully
operational in the first calendar quarter of 2000.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements of the Company include the
accounts of Genius Products, Inc. (formerly International Trading &
Manufacturing Corporation) (a Nevada corporation), and its subsidiaries
International Trade & Manufacturing Corporation (a Nevada corporation doing
business in California) Sanuk Jewelry Corporation, (a Nevada corporation),
and The Astrology Network
F-15
<PAGE>
Corporation (a Nevada corporation). All significant intercompany transactions
have been eliminated.
Revenue Recognition
Revenues, the related cost of sales, and an allowance for returned goods
are recorded upon the shipment of goods.
The Company maintains a policy that allows for the return of
defective or damaged goods or for goods that do not meet the Company's
customers' specifications. Damaged or defective goods are returned by the
Company to the vendor for a full refund and are recorded as a reduction of
cost of sales. The returned goods inventory is reduced to net realizable
value and resold. Sales of returned goods are reported as revenue when they
are shipped.
Business Combinations
The Company (formerly Salutations, Inc.) acquired all of the issued and
outstanding shares of International Trade & Manufacturing Corporation (a Nevada
corporation)(Trade). Trade has been deemed to be the acquiror for accounting
purposes and the historical financial statements, prior to the acquisition, are
those of Trade. Immediately after the acquisition Salutations, Inc. changed its
name to International Trading & Manufacturing Corporation, and then to Genius
Products, Inc. The transaction has been recorded as a capital transaction.
Salutations, Inc. had no operations, assets or liabilities at the acquisition
date. No goodwill was recorded as a result of this transaction.
Cash and Equivalents
The Company maintains cash accounts in a bank depository insured by the
Federal Deposit Insurance Corporation. The Company maintains cash balances in
accounts which exceeded the federally insured limits by $30,665 at December 31,
1998; however, the Company has not experienced any losses in such accounts. The
Company has no requirements for compensating balances.
F-16
<PAGE>
GENIUS PRODUCTS, INC.
(FORMERLY INTERNATIONAL TRADING & MANUFACTURING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
Inventory
Inventory consists of finished goods and is valued at the lower of cost
or market. Cost is determined on a first in first out ("FIFO") method of
valuation. The Company regularly monitors inventory for excess or obsolete
items and makes any valuation corrections when such adjustments are needed.
Property and Equipment
Property and equipment are recorded at cost and are depreciated using
the straight line method over the expected useful lives noted below. The cost
and related accumulated depreciation of assets are removed from the accounts
upon retirement or other disposition, and the resulting profit or loss is
reflected in the statement of operations. Renewals and betterments that
materially extend the life of the assets are capitalized.
ESTIMATED
USEFUL LIFE
-----------
Computer equipment................................ 5 years
Furniture and fixtures............................ 5-7 years
Intangible Asset
The intangible asset is a license to use certain classical compositions
in the production of the Company's line of music products that became
available for sale after the year ended December 31, 1998. The license will
be amortized on a straight line basis over a three year period (the estimated
life of the music products sale promotion).
Impairment of Long-Lived Assets
The Company annually evaluates its long-lived assets, including its one
identifiable intangible asset, for potential impairment. When circumstances
indicate that the carrying amount of an asset is not recoverable, as
demonstrated by the projected undiscounted cash flows, an impairment loss is
recognized. The Company's management has determined that there was no such
impairment present at December 31, 1998 and 1997.
Income Taxes
The Company accounts for deferred income taxes using the liability
method. Deferred income taxes are computed based on the tax liability or
benefit in future years of the reversal of temporary differences in the
recognition of income or deduction of expenses between financial and tax
reporting. Deferred tax assets and/or liabilities are classified as current
and noncurrent based on the classification of the related asset or liability
for financial reporting purposes, or based on the expected reversal date for
deferred taxes that are not related to an asset or liability.
Stock Based Compensation
Statement of Financial Accounting Standards ("SFAS") No. 123,
"Accounting for Stock-Based Compensation," established accounting and
disclosure requirements using a fair-value-based method of accounting for
stock-based employee and nonemployee compensation plans.
The Company accounts for stock-based employee compensation using the
intrinsic value method prescribed in Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" as permitted by SFAS No. 123.
Compensation cost for stock options granted to employees, if any, is measured
as the excess of the market price of the Company's stock at the date of grant
over the amount an employee must
F-17
<PAGE>
GENIUS PRODUCTS, INC.
(FORMERLY INTERNATIONAL TRADING & MANUFACTURING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
pay to acquire the stock. Compensation cost for stock options granted to
nonemployees is determined using a fair value method at the date of grant.
Compensation cost is recorded over the requisite vesting period.
Common Shares and Per Share Amounts
All common shares and per share amounts have been adjusted to give
retroactive effect, where applicable, for stock splits.
Earnings per Common Share
In 1997 the Financial Accounting Standards Board issued SFAS No. 128,
"Earnings Per Share". This pronouncement replaced the previously reported
primary and fully diluted earnings per share with basic and diluted earnings
per share, respectively. Loss per common share has been calculated in
accordance with the requirements of this statement for the years ended
December 31, 1998 and 1997.
Basic earnings per share ("EPS") is computed by dividing income or loss
available to common shareholders by the weighted average number of common
shares outstanding for the year. Diluted EPS is similar to basic EPS except
that the weighted average of common shares outstanding is increased to
include the number of additional common shares that would have been
outstanding if potentially dilutive common shares had been issued.
Advertising and Infomercial Costs
Advertising costs including infomercial production costs are expensed
when they are incurred. Infomercial production costs in 1998 include the
value of 75,000 common shares issued ($196,800) and options on 150,000 common
shares granted ($258,000) in connection with the production of infomercials.
Vulnerability Due to Certain Concentrations
Financial instruments which potentially subject the Company to
concentrations of credit risk consist primarily of trade accounts receivable.
The Company's jewelry sales are exclusively to one customer that is a
television shopping network that broadcasts in the United States and returned
products are sold to a wholesaler. Its Baby Genius(TM) products are sold
through traditional retail markets and will also be sold through its website,
once developed. Exposure to losses on accounts receivable is principally
dependent on the individual customer's financial condition, as credit sales
are not collateralized. The Company monitors its exposure to credit losses
and writes off those accounts receivable that it deems to be not collectable.
The Company is dependent on a limited number of vendors from Pacific Rim
countries for its products. Although alternate sources of supply do exist for
its products, loss of certain suppliers could disrupt ongoing operations. All
transactions with foreign vendors were in United States currency.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect amounts reported in the financial statements. Changes
in these estimates and assumptions are considered reasonably possible and may
have a material impact on the financial statements.
F-18
<PAGE>
GENIUS PRODUCTS, INC.
(FORMERLY INTERNATIONAL TRADING & MANUFACTURING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
Reclassifications
Certain reclassifications have been made to prior years financial
statements to conform with the 1998 presentation.
3. TRADE ACCOUNTS RECEIVABLE
Pursuant to a factoring agreement entered into in 1996, the Company's
principal bank has served as its factor. The bank purchased with recourse, as
the owner, the Company's interest in the individual accounts receivable. As a
reserve against future claims, the bank required twenty percent of the
invoice face amount of the active account receivable involved in its
factoring program to be held in a restricted interest bearing account. In
addition to the factoring recourse reserve, the monies advanced under the
agreement were also secured by inventories, those accounts receivable not
already factored, equipment of the Company, and the personal guarantees of
two of its officers who are also major shareholders.
This factoring agreement expired October 9, 1998 and was not renewed. At
December 31, 1998, the Company had no contingent liabilities resulting from
the bank's purchases of accounts receivable as all factoring program amounts
were collected prior to the expiration of the agreement.
The bank charged a fee equal to 2.38% of the face value of the factored
accounts receivable. For the years ended December 31, 1998 and 1997, the
bank's fees amounted to $39,398 and $66,126, respectively.
4. DUE FROM OFFICERS
Due from officers consists of advances made to two vice-presidents of
the Company related to moving expenses at their hire date.
5. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
DECEMBER 31,
-------------------
1998 1997
-------- -------
Computer and equipment.................................. $ 27,844 --
Furniture and fixtures.................................. 13,872 $11,177
-------- -------
41,716 11,177
Less: accumulated depreciation........................ (12,688) (5,442)
-------- -------
TOTAL PROPERTY AND EQUIPMENT............................ $ 29,028 $ 5,735
======== =======
Depreciation expense for the years ended December 31, 1998 and 1997 was
$7,246 and $2,873, respectively.
6. LETTER OF CREDIT
In September 1998, the Company entered into a letter of credit agreement
with its bank. The letter of credit is for $10,000 and is used to satisfy the
reserve requirement of the Company's merchant account for processing credit
card purchases of the Company's products. The letter of credit is
collateralized by a $10,000 certificate of deposit and expires August 21,
2000.
F-19
<PAGE>
GENIUS PRODUCTS, INC.
(FORMERLY INTERNATIONAL TRADING & MANUFACTURING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
7. CONVERTIBLE DEBENTURES PAYABLE
During 1998, the Company issued two convertible debentures to individual
investors totaling $200,000. The debentures are without interest or
collateral and are due December 31, 1999. The debenture may be converted in
whole or in part into shares of the Company's common stock at any time until
December 31, 1999, at a conversion price of $.50 per share. The value of the
beneficial conversion feature was estimated to be $200,000, and additional
paid in capital and interest expense of $200,000 was recognized. In
connection with the issuance of these debentures, the Company paid a fee of
$20,000 to an individual as a commission. The prepaid loan fee is being
amortized to interest expense using the effective interest method over the
life of the debentures.
8. DEFERRED INCOME TAXES
The components of the provision for income taxes are as follows:
1998 1997
---- ----
Federal..................................................... -- --
State..................................................... $800 $800
---- ----
800 800
---- ----
Deferred tax expense (benefit):
Federal................................................... -- --
State..................................................... -- --
---- ----
TOTAL PROVISION............................................. $800 $800
==== ====
Significant components of the Company's deferred income tax assets and
liabilities at December 31, 1998 and 1997 are as follows:
1998 1997
--------- ---------
Deferred income tax assets:
Net operating loss carryforward...................... $ 827,632 $ 203,672
Other................................................ 2,004 1,477
--------- ---------
Total deferred income tax asset................. 829,636 205,149
Valuation allowance.................................. (829,636) (205,149)
--------- ---------
NET DEFERRED INCOME TAX ASSET........................ -- --
========= =========
F-20
<PAGE>
GENIUS PRODUCTS, INC.
(FORMERLY INTERNATIONAL TRADING & MANUFACTURING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
Reconciliation of the effective tax rate to the U.S. statutory rate is as
follows:
FOR THE YEARS
ENDED
DECEMBER 31,
--------------
1998 1997
----- -----
Tax expense at U.S. statutory rate.......................... (34.0)% (34.0)%
State tax provision......................................... -- --
Other....................................................... 7.5 1.3
Change in valuation allowance............................... 26.5 32.9
----- -----
EFFECTIVE INCOME TAX RATE................................... --% 0.2%
===== =====
The Company has incurred a loss in each of its two most recent years. In
addition, the Company's business plan anticipates significant expenditures in
the future developing its e-commerce business segment. It is uncertain
whether the Company will achieve sufficient profitable operations during the
net operating loss carry forward period to realize the deferred income tax
asset. Therefore a valuation allowance equal to the asset has been recorded.
The Company has a net operating loss carryforward as of December 31,
1998 of $2,141,134 and $1,071,461 respectively, for federal and state income
tax purposes. The federal and state net operating losses begin to expire in
2018 and 2003, respectively.
9. COMMITMENTS AND CONTINGENCIES
The Company has operating leases for its corporate office and certain
vehicles. Two of such vehicle leases were entered into for the personal
benefit of two officers of the Company, and the minimum lease payments are to
be reimbursed to the Company. Future minimum lease payments at December 31,
1998, are as follows:
TOTAL
--------
1999.............................................. $146,559
2000.............................................. 131,357
2001.............................................. 116,905
2002.............................................. 115,680
2003.............................................. 108,020
--------
TOTAL FUTURE MINIMUM LEASE PAYMENTS..... $618,521
========
Rental expense, resulting from the operating lease agreements, was
$68,761 and $65,297 during the years ended December 31, 1998 and 1997,
respectively.
The Company's corporate facility lease expired in June 1998, and
thereafter it continued its occupancy on a month to month basis. The Company
entered into a sublease agreement commencing December 1, 1998 for its
corporate office facilities and, subsequent to year end, moved their
corporate headquarters to a new location in San Diego, California. The term
of the sublease is five years. Monthly lease payments are $9,034 during the
first year and increase each year thereafter by approximately $196 per month.
10. STOCK BASED COMPENSATION
The Company currently has a formal stock option plan that provides for
the granting of options to employees and consultants.
Employees
During the year ended December 31, 1997, the Company granted options to
four of its officers to purchase a total of 2,275,000 shares of its common
stock at an exercise price of $1.25 per share. The exercise
GENIUS PRODUCTS, INC.
(FORMERLY INTERNATIONAL TRADING & MANUFACTURING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
F-21
<PAGE>
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
price is equal to the estimated fair market value of the stock at the date of
grant. These options vest over three years and expire ten years after the date
of grant.
During the year ended December 31, 1998, the Company granted options to
three of its employees to purchase a total of 110,000 shares of its common stock
at an exercise price of $1.25. These options were granted at a price below fair
market value, which resulted in the recognition of an additional $51,500 of
compensation expense.
The weighted average fair value of the stock options granted during the
years ended December 31, 1998 and 1997 was $2.16 and $.94, respectively. The
following summarizes information about stock options granted and outstanding at
December 31, 1998 and 1997, and changes during the years then ended:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER OF EXERCISED
OPTIONS PRICE
--------- ---------
<S> <C> <C>
OUTSTANDING AT DECEMBER 31, 1996....................... -- --
Granted................................................ 2,275,000 $1.25
Exercised............................................ -- --
Cancelled............................................ -- --
Expired.............................................. -- --
--------- -----
OUTSTANDING AT DECEMBER 31, 1997....................... 2,275,000 1.25
Granted.............................................. 110,000 1.25
Exercised............................................ -- --
Cancelled............................................ -- --
Expired.............................................. -- --
--------- -----
OUTSTANDING AT DECEMBER 31, 1998....................... 2,385,000 $1.25
========= =====
</TABLE>
No options were exercisable at December 31, 1998 or 1997.
SFAS No. 123, "Accounting for Stock-Based Compensation", requires the use
of option valuation models to provide supplemental information regarding options
granted after 1994. Pro forma information regarding net loss and loss per share
shown below was determined as if the Company had accounted for its employee
stock options under the fair value method of that statement.
The fair value of each option granted was estimated at the date of grant
using the Black-Scholes Option Pricing Model (the "BSOPM"). The BSOPM was
developed for use in estimating the fair value of traded options. The Company's
employee stock options have characteristics significantly different from those
of traded options, such as vesting restriction and extremely limited
transferability. In addition, the assumptions used in option valuation models
are highly subjective, particularly the expected stock price volatility of the
underlying stock. Because changes in these subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the existing
models do not provide a reliable single measure of the fair value of its
employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized over the options' vesting periods. The pro forma effect on
net loss for 1998 and 1997 may not be representative of the actual results had
the Company accounted for the stock options using the fair value method.
F-22
<PAGE>
GENIUS PRODUCTS, INC.
(FORMERLY INTERNATIONAL TRADING & MANUFACTURING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Net loss, as reported............................. $(2,035,599) $ (473,634)
Pro forma net loss................................ $(2,827,767) $(1,186,467)
BASIC LOSS PER SHARE, AS REPORTED................. $ (0.28) $ (0.09)
PRO FORMA BASIC LOSS PER SHARE.................... $ (0.34) $ (0.23)
</TABLE>
For purposes of the above pro forma calculation, the fair value of options
granted by the Company in fiscal years 1998 and 1997, is estimated using the
BSOPM with the weighted average assumptions listed below.
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
--------------
1998 1997
----- -----
<S> <C> <C>
Risk-free interest rate..................................... 4.91% 5.86%
Expected dividend yield..................................... -- --
Expected stock price volatility............................. 1.46 1.46
Expected life in years...................................... 10.00 10.00
</TABLE>
Nonemployees
On October 20, 1998, the Company granted options to two individuals, for
services rendered, to purchase a total of 150,000 shares of its common stock at
an exercise price of $3.40 per share.
The Company accounts for stock-based compensation awards to nonemployees
based upon fair values at the grant dates in accordance with SFAS No. 123,
"Accounting for Stock-Based Compensation". The consideration received for the
granting of stock options is based on the fair value of the goods or services
received or the options issued, whichever is more reliably measurable. The BSOPM
is used to determine the fair value of the options when the value of the
services is based on the value of the options issued. The fair value of the
options is amortized over the period the Company received the goods or services.
The weighted average fair value of the options granted during the year
ended December 31, 1998 was $1.72. The following summarizes information about
options granted to nonemployees and outstanding at December 31, 1998 and 1997,
and changes during the years then ended:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
OPTIONS EXERCISE
OUTSTANDING PRICE
----------- --------
<S> <C> <C>
BALANCE AT DECEMBER 31, 1997........................... -- --
Granted................................................ 150,000 $3.40
Exercised............................................ -- --
Cancelled............................................ -- --
------- -----
BALANCE AT DECEMBER 31, 1998........................... 150,000 $3.40
======= =====
</TABLE>
F-23
<PAGE>
GENIUS PRODUCTS, INC.
(FORMERLY INTERNATIONAL TRADING & MANUFACTURING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
The fair value of the options granted was estimated using the Black-Scholes
Option Pricing Model with the weighted-average assumptions below:
<TABLE>
<S> <C>
Risk free interest rate............................... 3.98%
Expected dividend yield............................... --
Expected stock price volatility....................... 1.46
Expected life in years................................ 3.00
</TABLE>
11. DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS
The estimated fair value amounts of all financial instruments, on the
Company's December 31, 1998 and 1997 balance sheets, have been determined by
using available market information and appropriate valuation methodologies. Fair
value is described as the amount at which the instrument could be exchanged in a
current transaction between informed willing parties, other than in a forced
liquidation. However, considerable judgment is necessarily required in
interpreting market data to develop the estimates of fair value. Accordingly,
the estimates presented herein are not necessarily indicative of the amounts
that the Company could realize in a current market exchange. The use of
different market assumptions and/or estimation methodologies may have a material
effect on the estimated fair value amounts. The Company does not have any off
balance sheet financial instruments.
The following methods and assumptions were used by the Company in
estimating fair value disclosures for the financial statements:
Cash and equivalents, accounts receivable, inventory, accounts payable, and
certain other current liability amounts approximate fair value due to the short
term maturities of these instruments.
12. EARNINGS PER SHARE
In the year ended December 31, 1997, the Company has adopted SFAS No. 128,
"Earnings Per Share". Loss per common share has been calculated in accordance
with the requirements of this statement.
The computations of net loss per common share for the years ended December
31, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
1998 1997
----------- ----------
<S> <C> <C>
Net loss available to common shareholders
(numerator)...................................... $(2,035,599) $ (473,634)
Weighted-average shares outstanding basic an
diluted (denominator).............................. 7,299,730 5,106,321
----------- ----------
Basic and diluted loss per common share............ $ (0.28) $ (0.09)
=========== ==========
</TABLE>
The effect of the potentially dilutive securities listed below were not
included in the computation of diluted loss per share, because to do so would
have been anti dilutive for the periods presented.
<TABLE>
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
Shares of common stock issuable under:
Employee stock options................................ 2,385,000 2,275,000
Convertible debentures payable...................... 400,000 --
Non-employee stock options.......................... 150,000 --
</TABLE>
F-24
<PAGE>
GENIUS PRODUCTS, INC.
(FORMERLY INTERNATIONAL TRADING & MANUFACTURING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
13. COMMON STOCK
Pre-acquisition of International Trade & Manufacturing Corporation
Stock Split
In July 1997, prior to the acquisition, the Company's shareholders approved
a four thousand seven hundred to one forward stock split. Accordingly, $4,699
was transferred from common stock to additional paid-in capital representing the
par value of the shares issued in the stock split.
Private Placement Offering
In the year ended December 31 1997, the Company completed a private
placement offering of 423,000 shares of common shares at a price of $1.00 per
share. Total net proceeds of the offering was $402,090 which was used for
general corporation purposes.
Cancellation of Outstanding Shares
In July 1997, an officer and shareholder of Salutations, Inc. turned in
200,000 shares of common stock that were subsequently canceled.
Stock Split
In September 1997, concurrent to the acquisition described below,
Salutations, Inc.'s shareholders approved a two and one half for one forward
stock split. Accordingly, $516 was transferred from common stock to additional
paid-in capital representing the par value of the shares issued in the stock
split.
Shares Issued in Connection with the Acquisition of International Trade &
Manufacturing Corporation
Concurrent with the acquisition by Salutations, Inc., the Company issued
600,000 shares of common stock to an outside party for assistance in the
corporate reorganization and agreed to pay consulting fees of $5,000 per month.
Acquisition of International Trade & Manufacturing Corporation
On September 30, 1997, the Company (formerly Salutations, Inc.) acquired
all of the issued and outstanding shares of International Trade & Manufacturing
Corporation in exchange for 5,123,000 shares of the Company's common stock.
After the transaction, the former shareholders of International Trade &
Manufacturing, Inc. held 80.8 percent of the outstanding common stock of the
Company.
As part of the acquisition, Salutations, Inc. changed its name to
International Trading & Manufacturing Corporation. The board of directors of
International Trading & Manufacturing Corporation (formerly Salutations, Inc.)
was replaced by the corporate officers and board of directors of International
Trade & Manufacturing Corporation.
Post-acquisition of International Trade & Manufacturing Corporation
Common Shares Issued in Exchange for Debt
In the year ended December 31, 1997, the Company issued 486,813 shares of
common stock at market value of $468,813 in payment for $353,989 of notes
payable and $114,824 of accrued interest to note holders at December 31, 1997.
F-25
<PAGE>
GENIUS PRODUCTS, INC.
(FORMERLY INTERNATIONAL TRADING & MANUFACTURING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
Private Placement Offering
In the year ended December 31, 1998, the Company completed a second private
placement offering of 955,000 shares of common stock at a price of $1.25 per
share. Total net proceeds of the offering was $902,928 which was used for
general corporation business.
Issuance of Common Stock to Private Investors
During the year ended December 31, 1998, the Company sold 96,000 shares of
common stock pursuant to a private placement, less commissions paid and other
financing costs, for net proceeds of $82,757.
Issuance of Common Stock for Advertising Services
In October 1998, the Company issued 75,000 shares of common stock valued at
$196,875 to non-employees for services rendered in connection with the creation
of an infomercial.
Issuance of Common Stock to Officers and Employees
In December 1998, the Company sold 475,000 shares of its common stock at
$.40 per share. These shares were purchased by (i) an associate of a holder of
more than 10% of the outstanding shares of the Company's common stock; (ii) an
officer of the Company; and (iii) an employee of the corporation. The net
proceeds of these sales totaled $190,000.
14. IMPACT OF THE YEAR 2000, (UNAUDITED)
The Company anticipates that the Year 2000 could impact the business of the
Company. Many business software applications use only the last two digits to
indicate the applicable year. Unless these programs are modified, computers
running time-sensitive software may be unable to distinguish between the year
1900 and the year 2000, which would result in system failures, miscalculations,
and general disruption of operations, including, among other things, a temporary
inability to process transactions or to engage in other normal business
activities. Many Year 2000 problems might not be readily apparent when they
first occur, but instead could imperceptibly degrade technology systems and
corrupt information stored in computerized databases, in some cases before
January 1, 2000.
The Company anticipates the completion of a preliminary assessment of each
of its operations and the Year 2000 readiness and feels that the appropriate
actions will be taken. The Company does not believe the Year 2000 issue will
pose significant problems for the Company's computer systems. The Company
recognizes, however, that the Year 2000 issue could have a material impact on
the operations of the Company. There is no guarantee that the systems of other
companies on which the Company's systems rely will be timely readied for the
Year 2000. Moreover, there can be no guarantee that the Company's suppliers,
customers, or other parties with whom the Company does business will not
experience significant Year 2000 problems, which might result in an adverse
effect on the Company's operations. The Company's computer system currently runs
several programs which may be affected by Year 2000. The Company anticipates
taking the necessary steps to determine whether the programs are Year 2000
compliant and, if not, what steps need to be taken to reduce the effect of Year
2000.
F-26
<PAGE>
GENIUS PRODUCTS, INC.
(FORMERLY INTERNATIONAL TRADING & MANUFACTURING CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
15. SUBSEQUENT EVENTS
Investment Agreement
In March 1999, the Company entered into an investment agreement with
Minnesota Communications Group ("MCG"), an affiliate of Minnesota Public Radio.
The investment agreement provides MCG the right to purchase up to 1.5 million
shares of the Company's common stock at a purchase price of $1.00 per share.
This agreement is effective until March 31, 2000. Pursuant to this agreement,
MCG purchased 600,000 shares of the Company's common stock in March and April
1999.
Sales of Common Stock
During the period January 1, 1999 through August 31, 1999, the Company
sold, including the 600,000 shares of common stock sold to MCG described above,
1,661,930 shares of its common stock. The Company realized $1,738,044 from the
sale of these shares.
In addition, during this same period the Company issued 227,126 shares of
common stock for consulting and legal services and trademark license agreements.
Redeemable Common Stock
Subsequent to the issuance of its December 31, 1998 financial
statements, the Company reviewed certain aspects of all previous issuances of
its common stock. In this connection, the Company determined that during
1997, 1998 and through September 30, 1999, the company sold certain shares in
private placement transactions which may be subject to redemption. The total
number of shares subject to redemption at December 31, 1998 and 1997 was
118,500 and 37,500 respectively. The consideration due if redemption is
elected for all such shares is $159,000 and $37,500 as of December 31, 1998
and 1997 respectively. Accordingly, the balance of paid-in capital as of
December 31, 1998 and 1997 have been reduced by $159,000 and $37,500
respectively from amounts previously reported to retroactively reflect the
amounts subject to redemption as redeemable common stock.
Recognition of Compensation Expense
In December 1998, the Company sold 475,000 shares of its common stock to
several individuals at a net price per share of $.40 each. The sales of these
shares included 175,000 shares sold to two employees. Subsequent to the
issuance of its December 31, 1998 financial statements, the Company
determined that with respect to the shares sold to these employees,
compensation of $.60 per share totaling $105,000 should also have been
recognized at the date of sale. As a result, paid in capital, personal costs
and correspondingly, net loss as of and for the year ended December 31, 1998
have been increased by $105,000 respectively from the amount previously
reported to reflect the additional compensation deemed to have been received
by these individuals. There is no income tax effect on this restatement by
these individuals and diluted loss per share has been increased by $(0.014)
to $(0.294).
F-27
<PAGE>
PART III
INDEX TO EXHIBITS
<TABLE>
<S> <C>
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* Previously filed
</TABLE>
SIGNATURE
In accordance with the provisions of Section 12 of the Securities Exchange
Act of 1934, Genius Products, Inc. has duly caused this Amendment No. 2 to Form
10-SB to be signed on its behalf by the undersigned, thereunto duly authorized.
GENIUS PRODUCTS, INC., a Nevada
corporation
January 14, 2000 By: /s/ KLAUS MOELLER
------------------------------------
Name: Klaus Moeller,
Title: Chief Executive Officer and
Sole Director
II-1
