<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
(MARK ONE)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 0-14613
------------------------
CST ENTERTAINMENT, INC.
(FORMERLY CST ENTERTAINMENT IMAGING, INC.)
(Exact name of registrant as specified in its charter)
DELAWARE 13-2614435
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
5901 GREEN VALLEY CIRCLE, SUITE 400
CULVER CITY, CALIFORNIA 90230
(Address of principal executive offices)
(Zip Code)
(310) 417-3444
(Registrant's telephone number including area code)
N/A
(Former name, former address and former fiscal year,
if changed since last report)
------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes _X_ No ____
The Registrant has 27,278,340 shares of common stock, par value $0.15 per
share, issued and outstanding as of May 6, 1996.
Total number of sequentially numbered pages in this document: 15
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<PAGE>
CST ENTERTAINMENT, INC.
FORM 10-Q FOR QUARTER ENDED
MARCH 31, 1996
INDEX
<TABLE>
<CAPTION>
PAGE NO.
-----------
<S> <C> <C>
PART I -- FINANCIAL INFORMATION
Item 1. Balance Sheets at June 30, 1995 and March 31, 1996.......................................... 4
Statements of Operations for the Quarter Ended March 31, 1995 and 1996...................... 5
Statements of Operations for the Nine Months Ended March 31, 1995 and 1996.................. 6
Statements of Cash Flows for the Nine Months Ended March 31, 1995 and 1996.................. 7-8
Notes to Financial Statements............................................................... 9-10
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....... 11-13
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings........................................................................... 14
Item 2. Changes in Securities....................................................................... 14
Item 3. Defaults upon Senior Securities............................................................. 14
Item 4. Submission of Matters to a Vote of Securities Holders....................................... 14
Item 5. Other Information........................................................................... 14
Item 6. Exhibits and Reports on Form 8-K............................................................ 14
Signature Page.............................................................................. 15
</TABLE>
<PAGE>
(This page has been left blank intentionally)
<PAGE>
ITEM 1. FINANCIAL STATEMENTS
CST ENTERTAINMENT, INC.
BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
JUNE 30, MARCH 31,
1995 1996
-------------- --------------
<S> <C> <C>
Current assets:
Cash............................................................................ $ 24,694 $ (11,837)
Accounts receivable, net........................................................ 368,868 611,922
Work-in-process................................................................. 1,161,868 809,166
Prepaid expenses................................................................ 33,384 125,025
Receivable from related parties................................................. 215,000 15,000
-------------- --------------
Total current assets.......................................................... 1,803,814 1,549,276
Property and equipment:
Color conversion equipment...................................................... 3,896,789 3,896,789
Leasehold improvements and other equipment...................................... 1,591,550 1,613,635
Capitalized software............................................................ 985,382 1,378,680
-------------- --------------
6,473,721 6,889,104
Less accumulated depreciation..................................................... 5,118,680 5,628,039
-------------- --------------
1,355,041 1,261,065
Other assets:
Patent, net of accumulated amortization of $520,633 and $553,060................ 34,211 1,784
Film library, net of accumulated amortization of $2,340,275 and $4,346,015...... 1,878,010 2,751,237
Other assets.................................................................... 16,147 18,936
Notes receivable from directors/officers........................................ 192,263 192,263
Accounts receivable -- long-term................................................ 137,559 137,559
-------------- --------------
2,258,190 3,101,779
-------------- --------------
$ 5,417,045 $ 5,912,120
-------------- --------------
-------------- --------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Line of credit.................................................................. $ -- $ 235,420
Notes payable................................................................... 492,430 736,032
Accounts payable................................................................ 333,163 562,868
Accrued expenses................................................................ 537,852 1,228,623
Deferred income................................................................. 493,087 862,883
Commitments payable............................................................. 174,258 --
Loans payable to related party.................................................. -- 50,000
-------------- --------------
Total current liabilities..................................................... 2,030,790 3,675,826
-------------- --------------
Loan payable -- non-current....................................................... -- 703,125
Stockholders' equity:
Common stock, par value $0.15 per share; authorized 40,000,000 shares; issued
26,199,624 and 27,278,340...................................................... 3,929,944 4,091,751
Additional paid-in capital...................................................... 55,667,022 56,142,741
Accumulated deficit............................................................. (56,210,711) (58,701,323)
-------------- --------------
3,386,255 1,533,169
-------------- --------------
$ 5,417,045 $ 5,912,120
-------------- --------------
-------------- --------------
</TABLE>
See accompanying notes to financial statements.
4
<PAGE>
CST ENTERTAINMENT, INC.
STATEMENTS OF OPERATIONS
QUARTER ENDED MARCH 31, 1995 AND 1996
(UNAUDITED)
<TABLE>
<CAPTION>
1995 1996
------------- -------------
<S> <C> <C>
Revenue:
Coloring income.................................................................. $ 1,211,330 $ 312,285
Licensing/royalty income......................................................... -- 105,709
Software sales income............................................................ -- --
Other income..................................................................... 23 --
------------- -------------
1,211,353 417,994
------------- -------------
Expense:
Production....................................................................... 802,668 181,929
Cost of software sold............................................................ -- --
Research and development......................................................... 52,656 22,593
Depreciation and amortization.................................................... 233,402 150,340
Film library amortization........................................................ 2,500 147,500
Film library writedown........................................................... -- 649,740
General and administrative....................................................... 538,855 511,294
Lawsuits and litigation.......................................................... -- 737,000
Interest expense................................................................. 6,434 39,080
------------- -------------
1,636,515 2,439,476
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Loss before extraordinary item................................................... (425,162) (2,021,482)
Extraordinary item -- gain from forgiveness of debt.............................. -- --
------------- -------------
Net loss......................................................................... $ (425,162) (2,021,482)
------------- -------------
------------- -------------
Per share:
Loss before extraordinary item................................................... $ (0.02) $ (0.07)
Extraordinary item............................................................... 0.00 0.00
------------- -------------
Net loss per share............................................................... $ (0.02) $ (0.07)
------------- -------------
------------- -------------
Weighted average number of common shares outstanding............................. 25,279,624 27,225,007
------------- -------------
------------- -------------
</TABLE>
See accompanying notes to financial statements.
5
<PAGE>
CST ENTERTAINMENT, INC.
STATEMENTS OF OPERATIONS
NINE MONTHS ENDED MARCH 31, 1995 AND 1996
(UNAUDITED)
<TABLE>
<CAPTION>
1995 1996
------------- -------------
<S> <C> <C>
Revenue:
Coloring income.................................................................. $ 3,869,105 $ 1,604,385
Licensing/royalty income......................................................... 259,043 1,990,775
Software sales income............................................................ 500,000 --
Other income..................................................................... 2,663 --
------------- -------------
4,630,811 3,595,160
------------- -------------
Expense:
Production....................................................................... 2,846,604 935,585
Cost of software sold............................................................ 432,772 --
Research and development......................................................... 136,689 85,406
Depreciation and amortization.................................................... 890,738 413,093
Film library amortization........................................................ 119,629 1,356,000
Film library writedown........................................................... -- 649,740
Participation and licensing...................................................... -- 440,000
General and administrative....................................................... 1,569,527 1,381,709
Lawsuits and litigation.......................................................... -- 737,000
Interest expense................................................................. 128,386 87,239
------------- -------------
6,124,345 6,085,772
------------- -------------
Loss before extraordinary item................................................... (1,493,534) (2,490,612)
Extraordinary item -- gain from forgiveness of debt.............................. 94,390 --
------------- -------------
Net loss......................................................................... $ (1,399,144) $ (2,490,612)
------------- -------------
------------- -------------
Per share:
Loss before extraordinary item................................................... $ (0.06) $ (0.09)
Extraordinary item............................................................... 0.00 0.00
------------- -------------
Net loss per share............................................................... $ (0.06) $ (0.09)
------------- -------------
------------- -------------
Weighted average number of common shares outstanding............................. 25,108,792 26,745,723
------------- -------------
------------- -------------
</TABLE>
See accompanying notes to financial statements.
6
<PAGE>
CST ENTERTAINMENT, INC.
STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED MARCH 31, 1995 AND 1996
(UNAUDITED)
INCREASE (DECREASE) IN CASH
<TABLE>
<CAPTION>
1995 1996
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net loss.......................................................................... $ (1,399,144) $ (2,490,612)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization................................................... 1,010,366 1,769,093
Non-cash payment of expenses.................................................... -- 183,006
Non-cash revenue from commitments payable....................................... (666,000) (174,258)
Gain from forgiveness of debt................................................... (94,390) --
Film library writedown.......................................................... -- 649,740
(Increase) decrease in operating assets:
Accounts receivable............................................................... (139,731) (243,054)
Work in process................................................................... (303,214) 486,520
Prepaid expenses.................................................................. 14,843 (46,766)
Receivable from related parties................................................... -- 200,000
Other assets...................................................................... -- (2,789)
Increase (decrease) in liabilities:
Accounts payable.................................................................. 22,674 260,931
Accrued expenses.................................................................. 77,459 690,771
Deferred income................................................................... 460,465 369,796
Loans payable to related party.................................................... -- 50,000
Commitments payable............................................................... -- --
------------- -------------
Total adjustments................................................................... 382,472 4,192,990
------------- -------------
Net cash used in operating activities........................................... (1,016,672) 1,702,378
------------- -------------
Cash flows from investing activities:
Additions to property and equipment............................................... (210,300) (22,085)
Additions to capitalized software................................................. (360,168) (243,298)
Sales of capitalized software..................................................... 432,772 --
Additions to film library......................................................... (64,368) (2,878,967)
Additions to note receivables from officers....................................... -- --
------------- -------------
Net cash used in investing activities........................................... (202,064) (3,144,350)
------------- -------------
Cash flows from financing activities:
Payments of notes payable......................................................... (9,253) (6,398)
Payments on term loan............................................................. -- (46,875)
Additions to notes and loans payable.............................................. -- 1,250,000
Additions to line of credit....................................................... -- 204,914
Proceeds from sale of restricted stock............................................ 860,971 --
Proceeds from exercise of stock options........................................... 20,494 3,800
------------- -------------
Net cash provided by financing activities....................................... 872,212 1,405,441
------------- -------------
Net increase (decrease) in cash..................................................... (346,524) (36,531)
Cash at beginning of period......................................................... 601,602 24,694
------------- -------------
Cash at end of period............................................................... $ 255,078 $ (11,837)
------------- -------------
------------- -------------
</TABLE>
(Continued)
7
<PAGE>
CST ENTERTAINMENT, INC.
STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED MARCH 31, 1995 AND 1996
(UNAUDITED)
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
<TABLE>
<CAPTION>
1995 1996
---------- ---------
<S> <C> <C>
Cash paid during the nine months for interest............................................... $ 135,886 $ 8,269
---------- ---------
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</TABLE>
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING & FINANCING ACTIVITIES
NINE MONTHS ENDED MARCH 31, 1995
The Company liquidated $94,390 of accounts payable through the forgiveness
of debt.
NINE MONTHS ENDED MARCH 31, 1996
The Company capitalized $30,476 and $133,798 of depreciation expense under
its work-in-process for the quarter and nine months ended March 31, 1996,
respectively.
The Company repaid $250,000 of notes payable by converting it to 500,000
shares of the Company's common stock.
The Company liquidated $7,226 of accounts payable by issuing 14,450 shares
of the Company's common stock.
The Company paid $37,500 of outside consulting expense and prepaid $50,000
of outside consulting expense by issuing 100,000 shares of the Company's
common stock.
The Company paid $150,000 by issuing 300,000 shares of common stock for the
repurchase of certain rights to the animation software previously sold to
Toreal Holdings Limited.
The Company liquidated $24,000 of accounts payable by issuing 57,600
warrants to purchase the Company's common stock.
The Company paid $70,000 of outside legal expense by issuing 160,000 shares
of the Company's common stock.
The Company paid $30,506 of interest expense on its line of credit and term
loan by adding such amounts to its available line of credit balance.
See accompanying notes to financial statements.
8
<PAGE>
CST ENTERTAINMENT, INC.
NOTES TO UNAUDITED FINANCIAL STATEMENTS
MARCH 31, 1996
NOTE 1 -- COMMENTS
In the opinion of the Company's management, the accompanying unaudited
financial statements contain all adjustments, consisting of only normal
recurring accruals, necessary to present fairly the Company's financial position
at March 31, 1996, the results of operations for the quarter and nine months
ended March 31, 1996 and 1995 and the cash flows for the nine months ended March
31, 1996 and 1995. Although management of the Company believes that the
disclosures in the financial statements are adequate to make the information
presented not misleading, certain information and footnote disclosures normally
included in financial statements that have been prepared in accordance with
generally accepted accounting principles have been condensed or omitted pursuant
to the rules and regulations of the Securities and Exchange Commission. For
further information, refer to the financial statements and footnotes thereto
included in the Company's Annual Report on Form 10-K for the year ended June 30,
1995.
The results of operations for the quarter and nine months ended March 31,
1996 are not necessarily indicative of the results of operations to be expected
for the full year ending June 30, 1996.
Certain prior period amounts have been reclassified to conform to current
period's presentation.
NOTE 2 -- LICENSE AGREEMENT
In August 1995, the Company entered into a $800,000 licensing agreement
whereby the Company will produce and deliver eight colorized one-half hour
episodes. In exchange, the Company will receive foreign licensing fees which
will be recognized as revenue upon delivery to the customer. As such, the
Company will maintain certain domestic distribution rights and is currently
pursuing licensing those rights. In October, 1995, the Company amended the
agreement to produce an additional 18 (eighteen) one-half hour episodes under
similar terms and conditions. The Company delivered one episode in the quarter
ended March 31, 1996, and twenty-one episodes in the nine months ended March 31,
1996. The Company anticipates delivering the remaining five episodes by fiscal
year end June 30, 1996.
NOTE 3 -- NOTES PAYABLE
In July 1995, the Company obtained short-term financing by entering into a
$500,000 note payable. The note bears interest at 12.50% and the principal and
accrued interest are due November 1, 1995. The note is convertible at the option
of the creditor into shares of the Company's common stock. The Company also
issued 750,000 warrants to the creditor. The warrants are exercisable at $0.65
per share. The exercise price will be reduced to $0.50 per share if the note
payable is not repaid in full by November 1, 1995. The note is secured by
certain fixed assets of the Company. In November, 1995, $250,000 of the note was
converted into 500,000 shares of the Company's common stock. The maturity date
of the remaining $250,000 of the note and applicable accrued interest was
extended to February 1, 1996. As of May 6, 1996, the Companies were negotiating
payment terms for the remaining $250,000 note and applicable accrued interest.
NOTE 4 -- LOANS PAYABLE TO RELATED PARTY
In July 1995, Mr. Jonathan D. (Jody) Shapiro issued a short-term loan to the
Company for $100,000 at an interest rate of 10.25%. Principal and interest was
due on demand subject to certain terms and conditions. The loan was secured by
certain fixed assets of the Company. In November 1995, the Company repaid the
principal and accrued interest due to Mr. Shapiro. In December 1995, Mr. Shapiro
again loaned the Company $50,000 under similar terms and conditions of the first
loan. As of May 6, 1996, the loan and applicable accrued interest were still
outstanding.
NOTE 5 -- LINE OF CREDIT/TERM LOAN
In November 1995, the Company obtained a line of credit and term loan with
Coast Business Credit. The line of credit is for $750,000 and is based on valid
trade receivables. The term loan portion is also for $750,000, and is due three
years from loan inception. The interest rate on the line of credit and term loan
is prime +3% and 3.5%, respectively, and minimum monthly principal loan
repayments of $15,625 are due regardless of the outstanding balance.
Additionally, minimum monthly interest payments of $3,000 are due
9
<PAGE>
CST ENTERTAINMENT, INC.
NOTES TO UNAUDITED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1996
NOTE 5 -- LINE OF CREDIT/TERM LOAN (CONTINUED)
on the line of credit regardless of the outstanding balance. The line of credit
and term loan are secured by the majority of the assets of the Company. In April
1996, the line of credit and term loan were restructured whereby the term loan
portion was increased to $1,000,000. Accordingly, the line of credit portion was
reduced to $500,000. All other terms and conditions of the debt agreements
remained essentially unchanged.
NOTE 6 -- GERMAN LICENSING AGREEMENT
In November, 1995, the Company entered into a long-term licensing agreement
with Munich based BMG Ariola Muenchen GmbH ("BMG") and Bavaria Kopierwerk GmbH
("Bavaria") to represent CST's technology to a nine-country network in Europe.
As part of the agreement, BMG installed CST's patented software at its studio
facility in Munich which is linked to CST's facility via phone lines. In
conjunction with the licensing agreement, the Company received a $200,000
advance, and in turn recognized an expense for $160,000 based on the terms of
the agreement. Services became on-line in February 1996, and the Company is
currently working on its first Color FX project for BMG.
NOTE 7 -- PATENT INFRINGEMENT LAWSUIT
On January 25, 1996, the Company announced that it has filed a lawsuit
against Silicon Graphics, Inc., Eastman Kodak Co and LucasFilm Ltd. that alleges
infringement of CST's patented technology entitled Priority Masking Techniques
For Video Special Effects. The patent was issued to CST by the U.S. Patent &
Trademark Office as U.S. Patent No. 4,642,676 on February 10, 1987.
The lawsuit, filed in the U.S. District Court for the Northern District of
California, alleges that each of the defendants has been making, using and/or
selling devices that embody CST's proprietary technology and otherwise inducing
others to infringe its technology. CST is seeking an injunction to halt further
infringement, an accounting of damages and the payment of attorney fees.
NOTE 8 -- REPURCHASE OF ANIMATION SOFTWARE RIGHTS
During the quarter ended December 31, 1995, the Company repurchased certain
rights to the animation software previously sold to Toreal Holdings Limited, in
consideration for which the Company issued 300,000 shares of common stock.
NOTE 9 -- BANK OF AMERICA LAWSUIT
On April 18, 1996, in Case No. SC 031 643 entitled BANK OF AMERICA NATIONAL
TRUST ETC. V. CST ENTERTAINMENT IMAGING, INC., ETC., ET AL., the Superior Court
of California, County of Los Angeles, entered a judgment in favor of Bank of
America National Trust and Savings Association ("Bank of America") and against
CST Entertainment, Inc. (the "Company") in the principal sum of $437,421.50,
plus interest at the rate of 7% per annum on $404,610.54 of such principal sum
from December 12, 1994 to March 8, 1996, plus additional interest, at the rate
of $77.60 per day, from March 9, 1996 to April 18, 1996. The foregoing judgment
was based upon Bank of America's allegations that the Company had in its
possession and control property belonging to Gerald Shefsky, the Company's
Chairman of the Board and former Chief Executive Officer, which property is
subject to execution in satisfaction of a prior judgment obtained by Bank of
America against Mr. Shefsky in the amount of $486,528.20. The Company intends to
appeal the decision and defend its position vigorously. The Company has accrued
amounts for the judgment, including the principal, interest and applicable legal
expenses related to this lawsuit during the quarter ended March 31, 1996.
NOTE 10 -- FILM LIBRARY WRITEDOWN
The Company's film library is carried at the lower of cost or estimated net
realizable value. The film library costs primarily include the rights to acquire
the film and internally generated costs of production and colorization. The film
library is evaluated periodically, and when management determines costs are not
recoverable, the library is written down to net realizable value. The film
library was written down by $649,740 to $2,751,237 during the quarter ended
March 31, 1996.
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
RESULTS OF OPERATIONS
Coloring revenue for the quarter and nine months ended March 31, 1996
decreased approximately 74% and 59%, respectively, as compared to 1995. In the
nine months ended March 31, 1995, the Company delivered over $1,800,000
(approximately 964 minutes) of "The Little Rascals" colorized product. There
were no such significant coloring contracts for the first nine months of fiscal
1996, consistent with the Company's diversification of its sales. The Company is
currently in production on three significant coloring contracts (approximately
300 minutes) and anticipates completion and delivery by fiscal year end June 30,
1996.
The increase in Licensing/royalty income in 1996 is due primarily to the
results of the Featurizations division. The Company completed and delivered one
project for its Featurizations division during the quarter ended March 31, 1996
and seventeen episodes of programming during the nine months ended March 31,
1996 (See Note 2 of Notes to Unaudited Financial Statements). In addition, the
Company also recognized $200,000 in licensing revenue related to the BMG/Bavaria
agreement (See Note 6 of Notes to Unaudited Financial Statements).
The decrease in software sales income for the quarter and nine months ended
March 31, 1996 is due to the sale of the Company's animation software in
December, 1994. The Company had no such sale in the quarter or nine months ended
March 31, 1996.
The average price per minute delivered increased 74% and 25% in the quarter
and nine months ended March 31, 1996 as compared to 1995. The increase is due
primarily to the majority of the March 31, 1996 quarter end revenues being Color
FX projects which generate a higher price per minute. Additionally, the
difference is the result of the Company steadily increasing its rates charged
for services.
Delivered minutes decreased 82% and 51% in the quarter and nine months ended
March 31, 1996 as compared to 1995. Minutes produced decreased 42% and 24% in
the quarter and nine months ended March 31, 1996 as compared to 1995. The
decreases in 1996 are attributable to the differences in the Company's
operations in 1996 as compared to 1995 as described above. Also, in November
1995, the Company reduced its labor force by changing from three eight-hour
shifts to two eight-hour shifts. In addition, the Company reduced its labor
force again in January 1996 by changing from two eight-hour shifts to two
four-hour shifts for a significant portion of its production labor force. In
April 1996, the Company increased its production labor force back to two
eight-hour shifts.
The ratio of cost of production to color conversion revenue increased 130%
and increased 81% in the quarter and nine months ended March 31, 1996 as
compared to 1995 and is partly attributable to the differences in the Company's
operations in 1996 as compared to 1995 as described above. This increase is also
due primarily to costs incurred in the completion of the licensing projects in
the nine months ended March 31, 1996.
The average cost of minute produced increased 21% and 45% in the quarter and
nine months ended March 31, 1996 as compared to 1995 and is attributable to the
differences in the Company's operations in 1996 as compared to 1995 as described
above.
Production expense decreased significantly in the quarter and nine months
ended March 31, 1996 due to the change in the Company's revenue base. In the
quarter and nine months ended March 31, 1996, a significant portion of the
revenue was licensing and royalty income. As such, capitalizable costs
associated with these projects are being amortized in accordance with Statement
of Financial Standards ("SFAS") No. 53. The decrease is also due to the
reduction in the production labor force as described above.
Research and development costs decreased 57% and 38% in the quarter and nine
months ended March 31, 1996 as compared to 1995. The decreases are the result of
more of the Company's research and development personnel in 1995 being deployed
to provide alternative adaptions and enhancements of animation and coloring
software.
11
<PAGE>
General and administrative expenses decreased 5% and 12% in the quarter and
nine months ended March 31, 1996, as compared to 1995. The decreases were due to
more projects in production resulting in more overhead being capitalized to the
Company's film library and work-in-process than in the same periods for 1995.
The decreases also resulted from the employment of fewer corporate personnel in
the Company.
Lawsuits and litigation expense increased for the quarter and nine months
ended March 31, 1996 due mainly to the significant legal costs associated with
the Patent Infringement and Bank of America lawsuits (See Notes 7 and 9 of Notes
to Unaudited Financial Statements).
Participation and licensing expense increased for the nine months ended
March 31, 1996 due to new licensing agreements entered into in August and
November, 1995 (see Notes 2 and 6 of Notes to Unaudited Financial Statements).
In the quarter ended September 30, 1995, the Company recorded a $280,000 license
fee expense in conjunction with the delivery of the four 30-minute science
fiction anthology segments described above. In the quarter ended December 31,
1995, the Company recorded a $160,000 licensing expense in conjunction with the
foreign license agreement entered into with BMG/Bavaria.
Interest expense increased 507% and decreased 32% in the quarter and nine
months ended March 31, 1996 as compared to 1995. The increase was due to the
increase in interest incurred on the notes payable, loans payable and line of
credit. The decrease is primarily the result of interest costs incurred in
financing arrangements entered into in the nine months ended March 31, 1995
whereby Company receivables were sold at discounted values.
Depreciation and amortization expense decreased 36% and 54% for the quarter
and nine months ended March 31, 1996. The decrease is attributed to the
allocation of depreciation and amortization expense to production products and
many of the assets becoming fully depreciated during the current and previous
quarter. Depreciation and amortization expense before capitalization to
production products was $180,816 and $546,891 for the quarter and nine months
ended March 31, 1996.
The increase in film amortization expense in the quarter and nine months
ended March 31, 1996 is a direct result of amortization costs associated with
licensing revenues.
LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital position as of March 31, 1996 was a negative
$2,126,550 as compared to a negative $326,734 as of March 31, 1995. The Company
has experienced significant negative cash flows from operations and the
Company's independent certified public accountants included an explanatory
paragraph in their last fiscal year-end report with respect to the Company's
ability to continue as a going concern.
The following are the Company's plans for improving operations: securement
of production work; securement of working capital; production capacity
flexibility; development of Featurization products and other products for its
own library; expansion of the Company's Color FX division; animation "inking and
painting" production; and animation software licensing.
The Company has secured some contracts for color conversion work. The
Company continues to negotiate for contracts on substantial amounts of color
conversion work. Future color conversion revenues and profits are dependent upon
the successful attainment of these contracts, neither of which can be assumed.
During the quarter ended September 30, 1995, the Company completed the color
conversion of the final picture for credit under its commitment obligation and
recognized revenue of $273,258.
During the nine months ended March 31, 1996, the Company expended $22,085 on
property and equipment for leasehold improvements and other equipment. The
Company anticipates it will have capital expenditures over the next twelve
months of between $100,000 and $300,000 for additional work-stations and/or
upgrade of current work-stations.
12
<PAGE>
The Company expended $115,892 on the adaption of animation software for
alternative uses and $127,406 on the enhancement of coloring software in the
nine months ended March 31, 1996. The Company expects to devote additional
resources in the current fiscal year for the production and enhancements of its
proprietary software.
During the nine months ended March 31, 1996, the Company produced and
completed 20 productions for its film library, including three films under its
MGM/UA agreement, at a cost of approximately $2.9 million. Furthermore, the
Company delivered the Science Fiction Anthology "Attack of the Killer "B"
Movies" to a foreign distributor. The Company anticipates future expenditures of
$3 to $4 million over the next twelve months for future library products.
Should the Company be successful in obtaining the contracts currently under
negotiation, the Company anticipates cash flows from operations to be positive
over the next twelve months. The Company believes it will cover any needed cash
requirements, including capital ependitures, over the next twelve months through
operating cash flow, pre-sales of its library products, sales of software
products, placements of the Company's equity securities or other financing
arrangements which the Company is currently pursuing (See Note 5 of Notes to
Unaudited Financial Statements).
The Company received proceeds of $3,800 from the exercise of stock options.
The Company does not anticipate significant amounts of warrants or employee
stock options will be exercised in 1996 as the majority of the Company's
outstanding warrants and options are at an exercise price greater than the
current market price of the Company's common stock.
Future color conversion revenues and profits are dependent upon the
successful attainment of contracts currently in negotiations. The Company has
not yet attained annualized operating profitability. There can be no assurance
that the Company's efforts will be sufficiently successful to ensure the
ultimate viability of the Company.
13
<PAGE>
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings.
PATENT INFRINGEMENT LAWSUIT
On January 25, 1996, the Company announced that it has filed a lawsuit
against Silicon Graphics, Inc., Eastman Kodak Co and LucasFilm Ltd.
that alleges infringement of CST's patented technology entitled
Priority Masking Techniques For Video Special Effects. The patent was
issued to CST by the U.S. Patent & Trademark Office as U.S. Patent No.
4,642,676 on February 10, 1987.
The lawsuit, filed in the U.S. District Court for the Northern District
of California, alleges that each of the defendants has been making,
using and/or selling devices that embody CST's proprietary technology
and otherwise inducing others to infringe its technology. CST is
seeking an injunction to halt further infringement, an accounting of
damages and the payment of attorney fees.
BANK OF AMERICA LAWSUIT
On April 18, 1996, in Case No. SC 031 643 entitled BANK OF AMERICA
NATIONAL TRUST ETC. V. CST ENTERTAINMENT IMAGING, INC., ETC., ET AL.,
the Superior Court of California, County of Los Angeles, entered a
judgment in favor of Bank of America National Trust and Savings
Association ("Bank of America") and against CST Entertainment, Inc.
(the "Company") in the principal sum of $437,421.50, plus interest at
the rate of 7% per annum on $404,610.54 of such principal sum from
December 12, 1994 to March 8, 1996, plus additional interest, at the
rate of $77.60 per day, from March 9, 1996 to April 18, 1996. The
foregoing judgment was based upon Bank of America's allegations that
the Company had in its possession and control property belonging to
Gerald Shefsky, the Company's Chairman of the Board and former Chief
Executive Officer, which property is subject to execution in
satisfaction of a prior judgment obtained by Bank of America against
Mr. Shefsky in the amount of $486,528.20.
Item 2. Changes in Securities. None.
Item 3. Defaults upon Senior Securities. None.
Item 4. Submissions of Matters to a Vote of Security Holders.
On January 29, 1996, the Company held its Annual Meeting of
Shareholders for the fiscal year ended June 30, 1995. At the meeting,
the three items voted upon in the proxy solicitation were approved.
These items included re-election of the five incumbent Board members,
re-appointment of the independent accountants, and the proposal to
increase the aggregate number of shares of Common Stock under the
Company's 1990 Stock Option Plan from 2,400,000 to 4,400,000.
Item 5. Other Information. None.
Item 6. Exhibits and Reports on Form 8-K. (Form 8-K filed previously with the
Commission on May 8, 1996 via EDGAR).
14
<PAGE>
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CST ENTERTAINMENT, INC.
/s/ JONATHAN D. SHAPIRO
--------------------------------------
JONATHAN D. SHAPIRO
PRESIDENT AND CHIEF EXECUTIVE OFFICER
/s/ JEFFREY M. JACOBS
--------------------------------------
JEFFREY M. JACOBS
CONTROLLER
May 6, 1996
15
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM UNAUDITED
FINANCIAL STATEMENTS - QUARTER AND NINE MONTHS ENDED, MARCH 31, 1996 (FORM 10Q)
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JUN-30-1995
<PERIOD-START> JUL-01-1995
<PERIOD-END> MAR-31-1996
<CASH> (11,837)
<SECURITIES> 0
<RECEIVABLES> 681,022
<ALLOWANCES> 19,100
<INVENTORY> 809,166
<CURRENT-ASSETS> 1,549,276
<PP&E> 6,889,104
<DEPRECIATION> 5,628,039
<TOTAL-ASSETS> 5,912,120
<CURRENT-LIABILITIES> 3,675,826
<BONDS> 0
0
0
<COMMON> 4,091,751
<OTHER-SE> (2,558,582)
<TOTAL-LIABILITY-AND-EQUITY> 5,912,120
<SALES> 1,604,385
<TOTAL-REVENUES> 3,595,160
<CGS> 935,585
<TOTAL-COSTS> 5,998,533
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 87,239
<INCOME-PRETAX> (2,490,612)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,490,612)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
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<NET-INCOME> (2,490,612)
<EPS-PRIMARY> (0.09)
<EPS-DILUTED> (0.09)
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